Mercury Investment Co. v. AG Edwards & Sons

• Decision Date: 27 January 1969
• Docket Number: Civ. A. No. 67-H-853.
• Citation: 295 F. Supp. 1160
• Parties: MERCURY INVESTMENT CO. v. A. G. EDWARDS & SONS and A. B. Alkek, Jr.
• Court: U.S. District Court — Southern District of Texas

295 F. Supp. 1160

MERCURY INVESTMENT CO. v. A. G. EDWARDS & SONS and A. B. Alkek, Jr.

Civ. A. No. 67-H-853.

United States District Court S. D. Texas, Houston Division.

January 27, 1969.

Frank Pinedo, Houston, Tex., for plaintiff.

Ben G. Sewell, Houston, Tex., for defendant A. G. Edwards & Sons.

R. F. Wheless, Jr., Barrow, Bland & Rehmet, Houston, Tex., for defendant A. B. Alkek, Jr.

Memorandum and Order

SINGLETON, District Judge.

Plaintiff, a customer of A. G. Edwards & Sons (hereinafter referred to as "Edwards"), a brokerage firm dealing in securities, has brought this action against that firm and A. B. Alkek, Jr., its employee, to recover damages for alleged violations of Section 10(b) of the Securities Exchange Act of 1934 (15 U. S.C. § 78j(b)); Securities Exchange Commission Rule 10b-5 (17 C.F.R. 240.10b-5); Art. III, sec. 2 of the Rules of the National Association of Securities Dealers (N.A.S.D.); Section 33 of the Texas Securities Act; Art. 4004 Texas Revised Civil Statutes and the common law of the State of Texas.

The case is now before the Court on defendant Edwards' motion to dismiss certain portions of plaintiff's complaint for failure to state a claim upon which relief can be granted. Defendant seeks the dismissal of that part of plaintiff's complaint which is predicated on a violation of Section 2, Article III, of the Rules of Fair Practice of N.A.S.D. Defendant contends that the allegation of a violation of an N.A.S.D. rule by an N. A.S.D. member does not state a federal claim upon which relief can be granted. The N.A.S.D. is a private securities dealers association which enforces rules which it promulgates through disciplinary proceedings. Thus, contends defendant, citing Colonial Realty Corp. v. Bache & Co., 358 F.2d 178 (2d Cir. 1966), a violation of such a dealer association rule by a member does not give rise to an implied federal civil liability.

If the problem confronting the Court were as simple as defendant contends, there would be little need for this opinion. A reference to the Colonial case would be sufficient. However, Colonial (the only case cited to the Court by either party) does not lend weight to the simplistic approach urged by defendant. Colonial dealt with one particular rule of the dealer's association and held that it did not give rise to federal civil liability. A different rule is involved in this case.

Colonial did not issue a blanket holding that such dealer rules could never give rise to federal civil liability. It did attempt to establish certain criteria for determining whether a particular rule gives rise to such liability.

The Court in Colonial said:

"We start from the proposition that the judicial recognition and enforcement of a private remedy not expressly afforded by the Securities Exchange Act is predicated on the duty of the courts `to make effective the congressional purpose' represented in `the statute and the federal policy which it has adopted.' * * * Implication of a private right of action may be suggested by explicit statutory condemnation of certain conduct and a general grant of jurisdiction to enforce liabilities created by the statute, * * * or from such considerations as the protection intended by the legislature and the ineffectiveness of existing remedies, administrative and judicial, fully to achieve that end. * * * Whether such a claim can be maintained for violation of stock exchange rules is a thorny problem because the effect and significance of particular rules may vary with the manner of their adoption and their relationship to provisions and purposes of the statute and SEC regulations thereunder * * *.

* * * * * *

"Whether the courts are to imply federal civil liability for violation of exchange or dealer association rules by a member cannot be determined on the simplistic all-or-nothing basis urged by the two parties; rather, the court must look to the nature of the particular rule and its place in the regulatory scheme, with the party urging the implication of a federal liability carrying a considerably heavier burden of persuasion than when the violation is of the statute or an SEC regulation. The case for implication would be strongest when the rule imposes an explicit duty unknown to the common law." Colonial Realty Corp. v. Bache & Co., supra, at 181-182. (Emphasis added.)

The N.A.S.D. rule in question in the present case is the so-called "suitability" rule. (Art. III, Sec. 2). It provides as follows:

"In recommending to a customer the purchase, sale or exchange of any security, a member shall have reasonable ground for believing that the recommendation is suitable for such customer upon the basis of the facts, if any, disclosed by such customer as to his other security holdings and as to his financial situation and needs."

Plaintiff contends that since this rule "imposes an explicit duty unknown to the common law" it meets the Colonial criteria. Plaintiff fails to recognize that initially Colonial requires the Court to determine if the N.A.S.D. rule is consistent with the federal regulatory scheme. See Hecht v. Harris, Upham & Co., 283 F.Supp. 417, 430 (N.D.Cal. 1968).

"On this point we merely note that the Security Acts * * * are essentially directed at fraud — not against mere negligence or errors of judgment on the part of the broker. Although an agent must exercise the degree of care or skill impliedly represented by the terms of his undertaking, even a fiduciary does not guarantee the principal against incidental

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