Lange v. H. Hentz & Co.

• Decision Date: 09 September 1976
• Docket Number: Civ. A. No. 3-74-139-F.
• Citation: 418 F. Supp. 1376
• Parties: Larry LANGE et al. v. H. HENTZ & COMPANY et al.
• Court: U.S. District Court — Northern District of Texas

418 F. Supp. 1376

Larry LANGE et al. v. H. HENTZ & COMPANY et al.

Civ. A. No. 3-74-139-F.

United States District Court, N. D. Texas, Dallas Division.

September 9, 1976.

George H. Kolb, Dallas, Tex., for plaintiffs.

Robert S. Travis, Denis L. Toothe, Fort Worth, Tex., E. Russell Nunnally, Dallas, Tex., for defendants.

MEMORANDUM ORDER

ROBERT W. PORTER, District Judge.

I. NATURE OF THE CONTROVERSY

Plaintiffs posit, among other theories of recovery,¹ that Defendant-broker-dealers have breached certain duties owed to them as prescribed by Article III, Sections 2, 13 and 18² of the National Association of Security Dealers' NASD Rules of Fair Trade. Defendants have moved to dismiss all claims asserted against them which are bottomed upon a breach of those Rules. That motion is based upon an asserted absence of subject matter jurisdiction and a failure on the part of Plaintiffs to state a claim upon which relief can be granted. After reviewing the factual basis upon which this case rests, and after analyzing the scope and structure of the NASD Rules, I decide both that this Court is without jurisdiction to consider violations of NASD rules under § 27 of the Securities and Exchange Act³ and Title 28 U.S.C. § 1331, and that in any case no civil liability should be implied from the NASD Rules in question in this case.

As a factual predicate for their claims, Plaintiffs assert that Defendant Hall, a securities dealer and an employee of Defendant Hentz Co.⁴ became involved in midwifing Semiconductor Substrates Corporation (SCS) which Hall purportedly represented to have a vast and unfulfilled potential. Ostensibly Hall was so enthusiastic over the future of SCS that he purchased a large block of cheap stock for himself. It is asserted, however, that Hall recognized, at least as early as 1972, that SCS would require a large infusion of capital to remain healthy. Together with a group of investors, but still unbeknownst to Hentz Company, which is alleged to have been blissfully though negligently unaware of the imminent SCS failure, Hall began to rig a market in SCS stock between the fall of 1972 and the spring of 1973 with the intent of driving the SCS stock price above the price of some 400,000 outstanding SCS warrants which were to expire in August of 1973. As that expiration date approached, Hall allegedly became frantic and induced Plaintiffs to purchase, or at least not to sell, SCS stock so as to protect his own substantial investment. The warrant price, however, was never reached and SCS, deprived of approximately $3,000,000.00 in unconverted warrants, was driven into ruin. This suit resulted as Plaintiffs are attempting to recover the monetary losses suffered as a result of the collapse of SCS.

II. HISTORY, STRUCTURE AND SCOPE OF THE NASD RULES

From the concept of cooperative (industry-government) regulation developed in the National Recovery Administration was born the organization of the National Association of Security Dealers which, it was hoped, would provide an effective administrative starting point for the development and enforcement of high professional standards within the ranks of brokers and dealers in the securities industry. See S.Rep. No.1455, 75th Cong., 3d Sess. 3-5 (1938); H.R.Rep.No.2307, 75th Cong., 3d Sess. 4-5 (1938); S.Rep.No.379, 88th Cong., 1st Sess. 14-15 (1963). Then Chairman of the SEC, William O. Douglas, outlined the twin objectives of NASD in an address in early 1938, when he stated that NASD would bring about voluntary self-discipline in conformity to the law and would also encourage obedience to ethical standards beyond those which any law could establish. Address by SEC Chairman William O. Douglas, Bond Club of Hartford, Connecticut, Jan. 7, 1938, quoted in Report of the Special Study of Securities Markets of the Securities and Exchange Commission, H.R.Doc. No. 93, 88th Cong., 1st Sess., pt. 4, at 606 (1964). Senator Maloney, the author of the original NASD scheme, described the allocation of responsibility between NASD and the Commission as one in which:

Congress has undertaken to provide a mechanism whereby the securities business of the country may deal with all problems of technical regulation, leaving to the Securities and Exchange Commission what it is hoped will be the residual position of policing the submarginal fringe which recognizes no sanctions save those of the criminal law and of dealing with those problems of regulation with which the industry, as organized under the act, finds itself unsuited or unable to deal. Id.

Thus self-regulation was to encompass more than simple illegality. Guiding the brokerdealer to do that which is right and fair was to be as much a goal of cooperative self

                    § 6(b)(SEA) . . . .  15 U.S.C. § 78f
                    § 15(SEA) . . . .              § 78o
                    § 27(SEA) . . . .              § 78aa
                    § 32(SEA) . . . .              § 78ff
                

regulation as was condemning that which is wrong and unfair. Rules, example, and professional banishment were to be used to attain the former, while the jailhouse was to be used to stamp out the latter.

The structure of the NASD-SEC relationship is contained in a few important sections of the SEA. Section 15A provides:

Any association of brokers or dealers may be registered with the Commission as a national securities association . . ..

as long as sanctions are imposed for:

conduct . . . inconsistent with just and equitable principles of trade. SEA 6(b)

A dealer's registration may be suspended or revoked for the violation of Section 15A. All disciplinary actions by NASD against members or associates of such members are subject to Commission review on the SEC's own motion or by motion of the parties SEA § 15A(g) with the standard required for reversal being that the penalty imposed by NASD is "excessive or oppressive, having due regard to the public interest". SEA § 15A(h). For violations of its rules NASD may: (1) censure a member broker-dealer or one associated therewith, and/or (2) fine the member or associate up to $5,000, and/or (3) suspend a member or associate, and/or (4) expel a member or revoke an associate's registration, and/or (5) suspend or bar a member or associate from association with all members, and/or (6) impose any other appropriate and fitting penalty which is just. CCH NASD Manual Art. III, § 1, ¶ 2301, at 2114 (1970). Restitution is not available in a NASD proceeding, although costs may be imposed. CCH NASD Manual Art. III, § 1, ¶ 2302, at 2116 (1969). Yet despite owing its existence and in large measure its power and prestige to the SEC, NASD is still a private association governed by its own rules as developed and applied by its own members.

III. JURISDICTION

Title 15 U.S.C. § 27. The question in the first instance of whether this Court has jurisdiction to hear this case must depend upon the language of the statutory jurisdictional grants and that language in turn must be interpreted with an understanding of NASD's unique historical and functional setting as an entity separate and apart from the SEC. Sections 27 and 32 provide respectively that:

The district courts of the United States . . . shall have exclusive jurisdiction of violations . . . thereunder, and of all suits in equity and actions at law brought to enforce any liability or duty created by this title or the rules and regulations thereunder. (emphasis supplied)

And any person who willfully violates any provision of this title, or any rule or regulation thereunder the violation of which is made unlawful . . . shall upon conviction be fined not more than $10,000 or imprisoned not more than two years . . . (emphasis supplied)

While in contrast Section 29(a), provides:

Any condition, stipulation, or provision binding any person to waive compliance with any provision . . . thereunder, or of any rule of an exchange required thereby shall be void. (emphasis supplied)

Clearly the issue presented by the above language is whether Congress intended to extend exclusive federal jurisdiction to any "duty" created under the SEA even if that duty were created by a private association's rules or whether it was meant that only those rules and regulations promulgated directly under the guidance of the SEC are to give rise to federal jurisdiction. Commentators have divided on the subject. Compare. Rediker, Civil Liability of Broker-Dealers Under SEC and NASD Suitability Rules, 1970 Sec.L.Rev. 279, with Lowenfels, Implied Liability Based Upon Stock Exchange Rules, 66 Col.L.Rev. 12, 22; Implied Securities Liabilities, 51 Cornell L.Rev. 633, 647 (1966). In Colonial Realty Corp. v. Bache, 358 F.2d 178 (2nd Cir.) cert. denied 385 U.S. 817, 87 S.Ct. 40, 17 L.Ed.2d 56 (1966) Judge Friendly advanced the argument that the omission of the phrase "rules of an exchange" from Sections 27 and 32 and the careful placement of that language in Section 29(a) meant that Congress intended that there be conferred on the federal courts exclusive jurisdiction only for violations of rules developed under SEC authority.⁵ See also, 6 L. Loss, Securities Regulation, 3866 (Supp.1969). I agree, recognition of the distinction between the phrases "rules of the exchange" and "rules and regulations under the SEA" is a wise one. By the language contained in Section 32, which is all but identical to the language contained in Section 27, Congress could not have meant that NASD should be given the authority to define new crimes. That task lies with Congress or perhaps, in narrowly defined circumstances, with the SEC. Yet to interpret the words "the rules and regulations" under the SEA in Section 27 to include the words "rules of the exchange" when they nowhere appear in the text of Section 27 would be tantamount to recognizing such broad authority. And such authority, in addition to being rife with the constitutional problems of delegation and vagueness, would inevitably flood the judicial system with what Judge Friendly in Colonial has correctly termed the "garden...