Landy v. Federal Deposit Insurance Corporation, 72-1202 to 72-1204.

• Court: United States Courts of Appeals. United States Court of Appeals (3rd Circuit)
• Citation: 486 F.2d 139
• Docket Number: No. 72-1202 to 72-1204.,72-1202 to 72-1204.
• Parties: Eugene W. LANDY, Appellant in 72-1202, et al., v. FEDERAL DEPOSIT INSURANCE CORPORATION, Appellant in 72-1203, Receiver for the Eatontown National Bank, et al. Appeal of Gloria LANDY et al., Appellants in No. 72-1204.
• Decision Date: 30 July 1973

486 F.2d 139 (1973)

Eugene W. LANDY, Appellant in 72-1202, et al., v. FEDERAL DEPOSIT INSURANCE CORPORATION, Appellant in 72-1203, Receiver for the Eatontown National Bank, et al.

Appeal of Gloria LANDY et al., Appellants in No. 72-1204.

Nos. 72-1202 to 72-1204.

United States Court of Appeals, Third Circuit.

Argued January 16, 1973.

Decided July 30, 1973.

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Eugene W. Landy, pro se, Richard M. Phillips, Alan J. Berkeley, Cherif Sedky, Hill, Christopher & Phillips, Washington, D. C., Daniel O'Hern, Abramoff, Apy & O'Hern, Red Bank, N. J., of counsel, for appellants in 72-1202 and 72-1204 and as cross-appellees in 72-1203.

John Warren, Jr., Parsons, Canzona, Blair & Warren, Red Bank, N. J., for F. D. I. C. as appellee in Nos. 72-1202 and 72-1204 and cross-appellant in 72-1203.

George J. Koelzer, Lum, Biunno & Tompkins, Newark, N. J., for Merrill, Lynch, Pierce, Fenner & Smith, Inc.

Peter N. Perretti, Jr., Riker, Danzig, Scherer & Brown, Newark, N. J., for Bache & Co., Inc.

Walter F. Waldau, Stryker, Tams & Dill, Newark, N. J., for New York Stock Exchange.

Mark F. Hughes, Jr., Kraft & Hughes, Newark, N. J., for Cowen & Co.

Ronald M. Sturtz, Hannoch, Weisman, Stern & Besser, Newark, N. J., for Edward

R. Burt & Co., Halle & Stieglitz, and Stern, Lauer & Co.

Allan H. Klinger, Calissi, Klinger, Cuccio & Baldino, Hackensack, N. J., Lewis A. Kaplan, Paul, Weiss, Rifkind, Wharton & Garrison, New York City, for Filor, Bullard & Smyth, a partnership.

William D. Hardin, Pitney, Hardin & Kipp, Newark, N. J., for National State Bank of Elizabeth.

Samuel Kaufman, Kaufman, Kaufman & Kaufman, Newark, N. J., Stephen R. Steinberg, Reavis & McGrath, New York City, for TPO Inc.

Irving J. Rosenberg, Newark, N. J., for Thomson & McKinnon Auchincloss, Inc.

Gary L. Falkin, Perth Amboy, N. J., Beckerman, Franzblau & Cohen, Newark, N. J., for James Perry.

Bernard A. Schwarz, Union City, N. J., for Spingarn, Heine & Co. and Max Heine.

James A. Hession, Schumann, Hession, Kennelly & Dorment, Jersey City, N. J., Denis McInerney, Cahill, Gordon, Sonnett, Reindel & Ohl, New York City, for Federal Reserve Bank of New York.

Before KALODNER, ADAMS, and ROSENN, Circuit Judges.

OPINION OF THE COURT

ROSENN, Circuit Judge.

An incredible misuse of funds in stock market speculation¹ by Douglas Schotte, president of the Eatontown National Bank (ENB), rapidly culminated in its financial collapse. This appeal involves a series of complex issues spawned by that catastrophe. The appellants, four named plaintiffs in the district court, brought suit in the District of New Jersey under the federal securities laws on behalf of themselves as purchasers of ENB's shares between January 1, 1967, and August 8, 1970, on behalf of the class of all other shareholders of the bank who purchased stock during that period, and derivatively on behalf of the now defunct bank.² The appellants are Eugene Landy, a bank director, Gloria Landy, his wife, Harry Gross, his wife's uncle, and Freehold Glass Co., Inc., Gross's corporation.

The United States Comptroller of the Currency closed ENB on August 8, 1970, after the discovery of the vast misappropriations of funds. According to appellants' complaint, Schotte devised a simplistic scheme of speculation in the securities market, hoping euphorically that the stocks purchased would rise in value prior to the time for payment. Without any authorization, he traded in the name of the bank and covered his losses with cashier's checks issued without consideration to the bank. Apparently, Schotte delayed payment for the purchased securities until the brokers pressed him, a delay often considerable because of a mixture of broker backroom office problems and their desire to retain Schotte's burgeoning business. When pressed for payment, Schotte either sold the stock if it had appreciated or issued a cashier's check signed by him as president of ENB. He allegedly concealed the scheme by making false statements to the shareholders and causing ENB to issue false financial statements. The scheme failed, leaving ENB with a devastating loss estimated at four million dollars.

The defendants in this suit are:

(1) Twelve brokerage firms that opened accounts and executed transactions with Schotte, and sixteen individuals associated with these brokerage firms;

(2) The New York Stock Exchange (NYSE);

(3) The National State Bank of Elizabeth, New Jersey (the Elizabeth Bank);

(4) The Federal Reserve Bank of New York (the Reserve Bank);

(5) Edward R. Burt & Co. (Burt), a firm of certified public accountants;

(6) The Federal Deposit Insurance Corp. (FDIC) in its capacity as receiver for the Eatontown Bank; and

(7) Douglas Schotte.

Schotte and the FDIC, as receiver (standing in for the defunct bank), are allegedly liable under section 10 of the Securities Exchange Act of 1934, 15 U.S.C. § 78j, and rule 10b-5 promulgated thereunder, 17 C.F.R. § 240.10b-5, as a result of the scheme and false representations.

As to the brokers and firms, the complaint avers: they are liable under rule 10b-5, and, independently liable, for violation of the New York Stock Exchange "know your customer" rule and regulations of the Board of Governors of the Federal Reserve System; they allowed Schotte to open accounts in violation of the National Banking Act; they knew that the accounts were a part of a scheme to defraud the shareholders; they knew Schotte was not acting in a fiduciary capacity as he purported; they allowed the fraud to continue in order to garner the commissions generated, ultimately aggregating three million dollars; and four individual brokers made misleading statements to the appellants.

The complaint alleges that the Elizabeth Bank was the correspondent bank for ENB and provided its computer services. When Schotte would issue the cashier's checks without depositing the necessary funds, the payee would deposit the checks in its bank and they would be cleared through the Reserve Bank. Although ENB did not have the requisite funds to cover the checks and pay the Reserve Bank, Schotte induced the Elizabeth Bank to somehow credit an ENB account with the funds necessary to pay the Reserve Bank. The complaint also alleges that: Schotte was in some manner able to return the same check as many as four or five times and have funds credited at the Elizabeth Bank; the Elizabeth Bank was negligent in handling the ENB account; the funds created by the Elizabeth Bank did not appear on the ENB books, thus allowing Schotte to misappropriate approximately four million dollars; and the returned cashier's checks were manually processed, and the daily statements of account of ENB revealed to the Elizabeth Bank the misuse of the account.

The complaint also alleges that the Reserve Bank was liable because it continued to process and reprocess the same cashier's checks, thus allowing payment for checks with the same or similar checks. The actions were allegedly negligent, violated contractual agreements with ENB, and violated the Reserve Bank's own rules and regulations.

The firm of Edward R. Burt & Co. prepared certified financials for ENB in the years 1967, 1968, 1969, and 1970. In addition, they were retained to conduct four partial examinations of ENB on a surprise basis each year. They allegedly issued an erroneous certification of the condition of the bank, which constituted a misstatement in violation of rule 10b-5, negligence under the New Jersey common law, and a breach of duty of care owed the shareholders. The certified financial statements, in reliance on which plaintiffs claimed to have purchased their shares, were also alleged to be false and misleading because they failed to state important facts.

The New York Stock Exchange is allegedly liable for willfully failing to enforce its rules pertaining to members. It allegedly allowed member firms to operate with incomplete records and lost securities. Plaintiffs say the records are in such disorder that it is impossible to trace the approximately two hundred million dollars in securities traded by Schotte or to determine whether the securities held by the brokers are actually assets of ENB. Moreover, according to the complaint, it would have been impossible for Schotte to perpetrate the fraud if the Exchange enforced its rules 410, 415-21, and 425 on proper record-keeping, and had it enforced rule 325 requiring the brokerage firms to maintain an adequate capital base.

Appellants sued the various defendants in a number of capacities. All defendants except the Elizabeth Bank, the Reserve Bank, and the NYSE were sued by the plaintiffs on behalf of themselves, derivatively on behalf of the bank, and on behalf of the class of all stockholders who purchased during the relevant period. The three designated defendants were sued only derivatively. In addition, the brokers' liability for violations of Federal Reserve Board regulations was asserted only derivatively.

In an opinion and order dated September 9, 1971, the district court denied the motions of the FDIC and Burt (except insofar as suit was brought against them derivatively) to dismiss the complaint, but granted similar motions by the brokers, the Elizabeth Bank, the Reserve Bank, and the NYSE. Schotte made no motion. In an opinion and order dated December 9, 1971, the district court granted Burt's motion to dismiss the class action against it, granted its motion for summary judgment against Gloria Landy, Gross, and Freehold Glass, and denied summary judgment against Eugene Landy. Plaintiffs have appealed from the aforesaid orders and judgments, except from the dismissal of the class action.³

These decisions left standing only the claim of Eugene Landy against defendant Burt and the claims of the named plaintiffs as individuals and on behalf of the class against the FDIC as receiver and against Schotte. Subsequent to the district court decisions in this case, the FDIC, as receiver,...