Landry v. Hemphill, Noyes & Co.

Decision Date07 February 1973
Docket NumberNo. 71-1178,71-1179.,71-1178
Citation473 F.2d 365
PartiesNorman A. LANDRY, Plaintiff, Appellant, v. HEMPHILL, NOYES & CO., et al., Defendants, Appellees. Norman A. LANDRY, Plaintiff, Appellee, v. HEMPHILL, NOYES & CO., Defendant, Appellant.
CourtU.S. Court of Appeals — First Circuit

COPYRIGHT MATERIAL OMITTED

Norman A. Landry, pro se.

James C. Heigham, Boston, Mass., with whom Jeffrey L. Heidt, and Choate, Hall & Stewart, Boston, Mass., were on brief, for Hemphill, Noyes & Co. et al.

Before COFFIN, Chief Judge, McENTEE and CAMPBELL, Circuit Judges.

McENTEE, Circuit Judge.

Among a plethora of other issues, this appeal presents us with a novel question concerning the limitations to be placed upon an implied private action for the violation of Regulation T of the Federal Reserve Board, promulgated pursuant to § 7 of the Securities Exchange Act, 15 U.S.C. § 78g. That question is: May a customer recover from a broker-dealer his entire market loss on a transaction which has been partially financed on credit extended by the broker-dealer in excess of the limits permitted by the regulation? After briefly summarizing the facts necessary to an understanding of the case, we shall consider that issue, and then turn to the other points which have been raised by the parties on appeal.

I The Facts

The case arises from the efforts of plaintiff, Norman A. Landry, a former customer of the brokerage house of Hemphill, Noyes & Co., to recover trading and other losses sustained in his securities account with that firm between the years of 1962 and 1964. In addition to the partnership, plaintiff named as defendants Walter Winchester, the manager of the Worcester office of Hemphill, Noyes, and Phillip J. Murphy, a former salesman with that firm. The complaint upon which the action was tried set forth essentially two causes of action. First, the plaintiff alleged that a number of his losing transactions had been made on credit extended by Hemphill, Noyes in excess of the limits permitted by Regulation T. Secondly, plaintiff sought to recover commissions paid to the defendants as a result of the alleged "churning" of his account.1 The complaint also enumerated various fraudulent practices allegedly committed by the defendants in violation of § 10(b) of the Securities Exchange Act, 15 U.S.C. § 78j, and Rule 10b-5 promulgated thereunder. The district court in effect directed a verdict for the individual defendants on the Regulation T claim, and additionally ruled that Hemphill, Noyes was entitled to recover a $9,989 debit balance existing in plaintiff's account after its liquidation in June 1964. The jury returned a verdict in excess of $50,000 against Hemphill, Noyes for its violations of Regulation T, and also found that the plaintiff was entitled to recover varying amounts from all three defendants on the churning claim. The churning verdicts were, however, set aside by the district court on defendants' motion for judgment n. o. v. Alleging numerous errors in the proceedings below, plaintiff appealed, and defendant Hemphill, Noyes countered with a cross appeal.

The evidence at trial revealed that plaintiff is a high school graduate and that he has been engaged in the insulating, painting and carpentry contracting business with his father and brother-in-law since 1946. In the early 1960's he was the president of the corporation and in that capacity earned a salary of $15,000-$25,000 a year. During the same period he derived additional income from his ownership of certain rental real estate.

Landry's first stock market transaction was executed in 1953 through a neighbor, Bernard Bagdis, and he began to do business with Hemphill, Noyes when Bagdis became associated with the firm about two years later. From the time of his initial entry into the market up until 1957 there were fifty or sixty transactions executed in Landry's account. Among these were several transactions on margin, including one short sale on which the plaintiff realized a small profit. In 1957 Landry executed a margin agreement with Hemphill, Noyes which in part provided that the firm might liquidate his account at its discretion and collect from him any remaining debit balance.

From 1957 until January 1962 plaintiff executed his orders through defendant Walter Winchester. A total of five or six transactions were effected in Landry's account during this period. In January 1962 the account was transferred to William Mitchell, another salesman with the Worcester Hemphill, Noyes office. In the same month Landry wrote a letter to the Research Department of Hemphill, Noyes in which he set forth his current stock holdings in detail and solicited advice as to further investments. In this letter, he described himself as being an "investing stockholder." Landry executed a total of seven transactions through Mitchell in the months during which the latter handled his account.

In July 1962, at the suggestion of Winchester, Landry was introduced to defendant Phillip J. Murphy. At that time Murphy was not a registered representative under the Rules of the New York Stock Exchange, and did not become fully registered until November of that year. Shortly after their initial meeting, Landry transferred his account to Murphy. Plaintiff testified that he had given Murphy discretionary powers over the account and that the latter had guaranteed him a ten percent return on his investment. Murphy denied receiving discretionary powers or making any such promise.

Activity in plaintiff's account started to increase after he began doing business with Murphy. Beginning in March 1963 his transactions started to include a sizeable number of short sales. At about the same time, however, the stock market began to rise to the detriment of those holding short positions. There was conflicting testimony as to whether Murphy advised plaintiff to cover his short sales and thus limit his losses during August 1963.

At some point during January 1964 the defendants became aware that plaintiff's account was undermargined. On May 21, Hemphill, Noyes sent Landry a telegram advising him that an additional deposit of $37,000 was required, and that his account would be liquidated by selling long positions and covering shorts if payment were not made by May 25. Landry did not comply with this request for additional margin and his account was accordingly liquidated, leaving a debit balance of $9,989.58. Eliminating the sales and cover purchases made in the course of this liquidation, there had been approximately 120 transactions effected in Landry's account between July 1962 and June 1, 1964.

It was undisputed that throughout the relevant period there were serious bookkeeping errors in plaintiff's margin account as maintained by Hemphill, Noyes. The evidence revealed that on fourteen occasions transactions were executed on margin insufficient to meet the requirements of Regulation T.2 Twelve of these transactions resulted in a loss to the plaintiff. The undermargining of plaintiff's account was apparently due in large part to the failure of Hemphill, Noyes to "net-out," or pair-off, short sales with subsequent long purchases of the same security as required by the regulation.3 This resulted in a situation where the defendants would pair-off a further sale of the same security with the prior purchase, thus treating it as a long transaction not requiring margin, whereas in reality the plaintiff had no existing position in the security and was therefore actually selling short. At least partially as a result of such errors, the defendant continually failed to demand the necessary cash deposits on transactions which were, for Regulation T purposes, short sales requiring margin.

While most of the transactions which violated the margin requirements were made on totally overextended credit, several involved only partial overextensions. The most important of these was a short sale of 100 shares of Xerox on June 13, 1963. On that date there was sufficient excess credit in Landry's account to properly margin a transaction involving 80 shares of that security. Nevertheless, plaintiff's expert witness included the entire transactional loss of $14,000 in his calculation of plaintiff's damages. Defendants requested the court to instruct the jury that, as a matter of law, plaintiff could only recover his loss on that part of a transaction which could not have been made without an illegal extension of credit. Had the court given such an instruction, plaintiff would have been limited to a twenty percent recovery on the Xerox transaction. The instruction was denied, however, and the jury's answer to Special Interrogatory No. 2 indicated that it had assessed the entire loss against Hemphill, Noyes. Defendant's subsequent motion to amend and alter judgment on these grounds was similarly denied.

II Regulation T
A. Partial Overextensions of Credit

Arguing that no evidence was presented at trial from which the jury could reasonably conclude that defendant's partial overextension of credit was causally related to plaintiff's entire loss on the Xerox transaction, Hemphill, Noyes contends that the district court's failure to give its requested instruction was reversible error. While we are in agreement that proof of proximate cause was an indispensable part of plaintiff's burden in this case, see, e. g., Junger v. Hertz, Neumark & Warner, 426 F.2d 805 (2d Cir.), cert. denied, 400 U.S. 880, 91 S.Ct. 125, 27 L.Ed.2d 118 (1970); Aubin v. H. Hentz & Co., 303 F.Supp. 1119 (S.D.Fla.1969); Moscarelli v. Stamm, 288 F.Supp. 453 (E.D.N.Y.1968), we nevertheless conclude that the measure of recovery applied by the jury was proper.

It is well established that a subsidiary purpose of § 7(c) of the Securities Exchange Act is to protect the small investor from the dangers of excessive trading on credit. See, e. g., Remar v. Clayton Securities Corp., 81 F. Supp. 1014 (D.Mass.1949). To the...

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