In re Kardos

• Citation: 27 F.2d 690
• Decision Date: 09 July 1928
• Docket Number: No. 356.,356.
• Parties: In re KARDOS et al.
• Court: United States Courts of Appeals. United States Court of Appeals (2nd Circuit)

27 F.2d 690 (1928)

In re KARDOS et al.

No. 356.

Circuit Court of Appeals, Second Circuit.

July 9, 1928.

David W. Kahn, of New York City, for appellant Case.

McKerchner & Link, of New York City (Herman M. Pogul, of New York City, of counsel), for appellant and appellee Wilson.

Saul S. Myers, of New York City (Earl B. Barnes, of New York City, of counsel), for appellant Ablett.

Francis R. Holmes, of New York City, for Crusey.

Before MANTON, L. HAND, and AUGUSTUS N. HAND, Circuit Judges.

AUGUSTUS N. HAND, Circuit Judge.

The bankrupts were stockbrokers doing business in New York. They did not trade directly on the New York Stock Exchange, but transacted their Stock Exchange business through certain Stock Exchange houses, among them Marks & Graham. They took orders from their customers to buy or sell securities listed on the New York Stock Exchange, and transmitted the orders to Marks & Graham (or other Stock Exchange firms), without the knowledge of the customer, and without disclosing the customer's identity to Marks & Graham. So far as the books of Marks & Graham showed, the bankrupts were marginal customers of that firm. When the failure of the bankrupts occurred, Marks & Graham were both short and long of a large volume of securities in the bankrupts' account, and thereafter proceeded to liquidate the account and turn over to the estate the surplus cash and securities remaining after the payment of the indebtedness owing to them.

Claim of Katherine Wilson.

This claimant delivered to the bankrupts on January 30, 1922, two bonds of the Tacajo Sugar Company, having a par value of $2,000. The bonds were deposited as margin for a trading account, which Miss Wilson proposed to open with Kardos & Burke. They at the same time gave to her a receipt, in the form commonly given to their margin customers, whereby they were authorized to repledge all securities held for the account of their customer for sums due thereon, or for any greater sums. On February 1st the bankrupts delivered these bonds to their brokers, Marks & Graham, by whom they were credited to the account of the bankrupts, which was a brokerage account for the buying and selling of securities.

On February 2, Miss Wilson began to buy and sell securities through the bankrupts, continuing these operations until February 23, when the bankruptcy occurred. Thereafter Marks & Graham liquidated their account with Kardos & Burke, and there remained over a surplus of cash and securities, which were surrendered to the receiver. In such surplus securities were contained the two Tacajo Sugar bonds, which had not been sold, because they had not a sufficient market.

The claimant filed a petition in the omnibus proceeding to recover her two bonds. The trustee in bankruptcy contended that they were subject to the burden of the loan of Marks & Graham to Kardos & Burke, on the ground that the claimant was in the same position as their other margin customers, and should, therefore, share in the proceeds of the loan with them; and the master so held. The District Court, however, reversed the master in respect to this claim, and found:

(a) That the bonds were converted by the bankrupts on February 1, 1922, when they put them up as additional collateral with Marks & Graham, because at that time the claimant had not begun to trade with Kardos & Burke, and the latter had no right to use her bonds as collateral prior thereto;

(b) That, in view of this conversion, the rights of Miss Wilson to the excess collateral turned back to the trustee in bankruptcy must be "determined from the standpoint of a wrongful and illegal use by the bankrupt of her property, as against an authorized use of the property of the other claimants";

(c) That in these circumstances she had a preferential claim to the redelivery of her bonds.

The District Judge added:

"The fact that the claimant herein actually traded with the bankrupts after the conversion, and at the time of the bankruptcy was indebted to them, does not change her status as a preferred claimant."

There can be no reasonable doubt that, when Kardos & Burke delivered the bonds to Marks & Graham, with whom they had a trading account, they did this to furnish additional collateral against which they might have a credit, and that such an act was an exercise of dominion over the bonds which brought about a conversion. It by no means follows, however, that the conversion in all respects changed the relationship between the bankrupts and the claimant in respect to the bonds.

It has been held that, if a pledgee converts his pledge, he may still set off the pledgor's debt against the recovery. Gruman v. Smith, 81 N. Y. 25; Stearns v. Marsh, 4 Denio (N. Y.) 227, 47 Am. Dec. 248; Farrar v. Paine, 173 Mass. 58, 53 N. E. 146. And, in accordance with the same general reasoning, it was held in Donald v. Suckling, 1 Q. B. 585, and Halliday v. Holgate, 3 Ex. 299, that the conversion of a pledge by a pledgee would not enable the pledgor to maintain trover or detinue without tender of the amount of his debt. These decisions show that the lien was preserved in spite of the conversion, for, if it had not been, there could have been no set-off, as the debts were not mutual. We think it can make no difference whether a conversion occurs before a customer begins to trade or afterwards. If the pledge survives in the first case we can see no reason why the lien should not be attributed to whatever the res may be in the second case. The violation of the pledgee's duty is the same in either event, and ought to be attended by similar consequences.

The order of the District Court, in so far as it relates to these bonds, should therefore be reversed, and the report of the master confirmed.

Claim of Howard O. Crusey.

This claimant is seeking to recover $1,845.33, which Kardos & Burke had on deposit in the Equitable Trust Company of New York at the time of their bankruptcy, and is basing his claim upon evidence that he has traced the proceeds of sale of his securities into that bank account. The District Court allowed the claim, and the trustee in bankruptcy appealed.

Crusey gave orders to the bankrupts to sell 10 shares of Tennessee Coal & Iron and 15 shares of Pullman Company stock, and to purchase 15 shares of the stock of the American Telephone & Telegraph Company. The first selling order, given on February 3, 1922, was for 10 shares of Pullman, and the second, given on February 5, was for 5 shares of Pullman and 10 shares of Tennessee Coal & Iron. Crusey apparently did not deliver the certificates for these stocks to Kardos & Burke until February 8, for that is the date of the receipt (page 71).

The 15 shares of Pullman Company stock were sold on the Consolidated Exchange, the first 10 on February 4, and the remaining 5 on February 6, to a broker named McHie, and the 10 shares of Tennessee Copper were sold on February 6 to a Consolidated Exchange firm named Eichle. The accountant, Bernard Reis, testified that there was no delivery against these sales according to the books of the bankrupts (folio 128). He also testified that their books contained "so-called personal trading accounts," and that "stock was purchased and sold in the trading accounts for the purpose of reducing the number of shares Kardos & Burke had to carry for their customers."

The proof indicates that these sales, for which statements were rendered to Crusey, were either matched against purchases for a "house account," or offset against some other purchaser that day. The former transaction would be a nullity (In re Wettengel C. C. A. 238 F. 798), and the latter should have been followed by a credit of the proceeds of the sale to the account of Crusey with the bankrupts. No one has shown that Crusey got anything out of these mythical sales, except a confirmation slip. The inference that no real sales were made to McHie and Eichle is fortified by the fact that Crusey's certificates for Pullman and Tennessee Copper were in the possession of the bankrupts from February 8 until they sold them for their own account on February 9, although they had made no delivery to McHie or Eichle. The District Court held that enough was shown to establish that the sales were nullities, and we are of the same opinion.

The certificates of stock which Crusey delivered for sale were turned over by Kardos & Burke to Marks & Graham about February 9, and sold for account of the former on that date. Marks & Graham thereupon transmitted their check for $8,283.18, which represented the difference between the purchases and sales on that day for account of Kardos & Burke, and included the proceeds of the sales of the Pullman and Tennessee Copper stocks, amounting to $1,845.33. The check was deposited in the account of Kardos & Burke with the Equitable Trust Company and the balances in that account between the date of the deposit and the date of bankruptcy were never less than the amount of Crusey's claim. This sum of $1,845.33 was credited by the bankrupts to account No. 700, which was one of their trading or so-called "house accounts." It was this sum which the claimant Crusey sought to reclaim in the omnibus proceeding.

It is contended on behalf of the bankrupt estate that, even if the sales to McHie and Eichle were nullities, and those through Marks & Graham were therefore for account of Crusey, yet this reclamation must fail, because Kardos & Burke were directed to sell the stocks in order to procure funds with which to purchase 15 shares of American Telephone & Telegraph stock, and they purchased such stock from a broker named Bellan.

But the American Telephone & Telegraph stock purporting to have been purchased on the Consolidated Exchange from Bellan was never received by Kardos & Burke. Reis, the accountant, testified that they did not receive stock to complete this purchase from "any broker or outsider"; that they had a number of trading accounts on their books, generally known as "numbered...