Neill v. David A. Noyes & Co.

• Decision Date: 21 July 1976
• Docket Number: No. 76 C 48.,76 C 48.
• Citation: 416 F. Supp. 78
• Court: U.S. District Court — Northern District of Illinois
• Parties: Thomas B. NEILL and Kaye L. Neill, Plaintiffs, v. DAVID A. NOYES & COMPANY, a partnership, and Allen M. Grigg, Defendants.

416 F. Supp. 78

Thomas B. NEILL and Kaye L. Neill, Plaintiffs, v. DAVID A. NOYES & COMPANY, a partnership, and Allen M. Grigg, Defendants.

No. 76 C 48.

United States District Court, N. D. Illinois, E. D.

July 21, 1976.

Dan Brusslan of Fischel, Kahn, Weinberg & Brusslan, Chicago, Ill., for plaintiffs.

Samuel S. Berger and Warren Krinsky, Chicago, Ill., for defendants.

MEMORANDUM OPINION

AUSTIN, District Judge.

This litigation involves alleged violations of certain margin requirements by the Defendants in the sale of securities owned by the Plaintiffs. The Defendants have moved to dismiss the lawsuit on the basis that the claims presented by the Plaintiffs are not valid. For the following reasons, that motion must be denied.

For a number of years prior to the instigation of this lawsuit, the Plaintiffs maintained a margin account with the Defendant Noyes & Company. A margin account, of course, requires that its owner keep a certain amount of equity in that account at all times. In the spring of 1975, Defendant Grigg gave advice to the Plaintiffs which allegedly resulted in the sale of shares of the National Semiconductor Corporation (NSM). The complaint claims that these sales then resulted in the account of the Plaintiffs becoming undermargined, with a resultant loss falling upon the Plaintiffs. The complaint further alleges that the Defendant Grigg told the Neills that it would not be necessary for them to deposit additional margin in order to carry out these transactions. The Plaintiffs claim that specific instructions were given to Mr. Grigg to check with the Margin Clerk at Noyes & Company before the consummation of any transaction, to be sure that no additional money or securities would have to be deposited in the account to meet the margin requirements. Despite these precautions, the Plaintiffs charge that their account did become undermargined, and furthermore, the Defendants failed to liquidate the account within the time-limits prescribed. Consequently, the Plaintiffs claim that they suffered a monetary loss.

DISCUSSION

Section 7 of the Securities and Exchange Act of 1934 (15 U.S.C. § 78g) authorizes the Board of Governors of the Federal Reserve System to promulgate regulations governing margin requirements. This authorization resulted in Regulation T, which the Defendants in this action allegedly violated. Regulation T is violated when there is insufficient excess credit in an account to properly margin a particular transaction, and the broker-dealer fails to either receive an additional cash deposit or to liquidate a sufficient number of securities to bring the margin up to the required level within a specified number of days following the transaction. See 12 C.F.R. 220.3(b), (e).

The imposition of civil liability for violations of regulations such as Regulation T has been accepted by a number of the nation's courts. As one court stated: "The recent cases have been uniform in recognizing civil liability for violation of the margin requirements of Regulation T." Avery v. Merrill Lynch, Pierce, Fenner & Smith, 328 F.Supp. 677 (D.C.D.C.1971). See also, Note, Federal Margin Requirements as a Basis for Civil Liability, 66 Colum.L.Rev. 1462 (1966). When the Congress enacted the Securities and Exchange Act of 1934, it is clear that it intended to accomplish several objectives, including the protection of the small investor from the dangers of excessive trading on credit. See, e. g., Landry v. Hemphill, Noyes & Company, 473 F.2d 365, 370 (1st Cir. 1973). It is my opinion that this purpose of the Congress is best served by allowing a private cause of action in situations like that alleged by the Plaintiffs here.

In coming to this conclusion, I am accepting the so-called "Pearlstein Doctrine" as put forth by the Second Circuit in Pearlstein v. Scudder & German, 429 F.2d 1136 (2d Cir. 1970), cert. denied, 401 U.S. 1013, 91 S.Ct. 1250, 28 L.Ed.2d 550 (1971). In that decision, the Second Circuit determined that it was desirable to allow private suits for violations of federal margin regulations because such lawsuits served to protect the small investor. Judge Waterman, writing for the majority, felt that the threat of this type of lawsuit would motivate brokers to observe margin requirements more closely. The desirability of such a goal was clearly indicated by that court:

In our view, the danger of permitting a windfall to an unscrupulous investor is outweighed by the salutary policing effect which the threat of private suits for compensatory damages can have upon brokers and dealers above and beyond the threats of governmental action . .. (Supra at 1141).

Despite some recent changes in § 7, it is my opinion that the Pearlstein doctrine remains viable. In fact, the Second Circuit has not invalidated it, although that court had the opportunity to do so only last year. Pearlstein v. Scudder & German, 527 F.2d 1141, 1145 n. 3 (2d Cir. 1975). See also, Comment, Civil Liability for Margin Violations — The Effect of Section 7(f) and Regulation X, 43 Fordham L.Rev. 93 (1974). Innocent investors, or those alleged to have been defrauded by their brokers, continue to possess a valid cause of action for violation of margin requirements. The overall purposes of the Securities and Exchange Act of 1934 are best met by allowing this type of cause of action to continue. See Spoon v. Walston & Company, Inc., 478 F.2d 246 (6th Cir. 1973); Jennings v. Boenning & Company, 388 F.Supp. 1294 (E.D.Pa.1975).

The Defendants point to several cases which rejected the Pearlstein doctrine as being unsound. I have chosen not to follow those decisions because they are distinguishable from the case presently at bar. The Plaintiffs in this case allege fraud on the part of the broker and there is no indication from the record before me that the Plaintiffs were anything other than innocent customers of the broker-defendant. Cases such as Goldman v. Bank of Commonwealth, 467 F.2d 439 (6th Cir. 1972), cited by the Defendants as flatly rejecting Pearlstein, cannot be read in such an absolute light. The factual pattern in Goldman, and other cases like it, usually involved a plaintiff who was anything but innocent, whereas the Plaintiffs here have not yet been shown to be unscrupulous investors taking advantage of a slight clerical error on the part of the broker. For these reasons, the case presently at bar is distinguishable from most of those cases which do not fully accept the Pearlstein rationale.

The Plaintiffs further claim that alleged violations of the rules of the New York Stock Exchange, the American Stock Exchange, and the National Association of Securities Dealers result in the creation of a private right of action. All of these rules were promulgated pursuant to authority granted to either the stock exchanges or the dealers' association by the various sections of the Securities and Exchange Act of 1934.

In determining whether or not an implied federal civil liability exists for violations of these rules, it is best to apply a case-by-case approach, examining all relevant factors to decide if the Congress intended the courts to imply this right under these circumstances. Colonial Realty Corp. v. Bache & Company, 358 F.2d 178 (2d Cir. 1966). Having conducted the appropriate analysis, I conclude that the Plaintiffs possess a potential cause of action based upon both the exchanges' rules and those established by the dealers' association. The rules of the New York Stock Exchange, and those of the nation's other stock exchanges as well, are integral parts of the regulation of the securities industry; Rule 402, allegedly violated by the Defendants here, was designed to protect the investing public and, therefore, a private cause of action is consistent with this purpose. Buttrey v. Merrill Lynch, Pierce, Fenner & Smith, 410 F.2d 135 (7th Cir. 1969), cert. denied, 396 U.S. 838, 90 S.Ct. 98, 24 L.Ed.2d 88 (1969). See also, Note, Private Actions as a Remedy for Violations of Security Exchange Rules, 83 Harv.L.Rev. 825 (1970).

The margin requirements of Rule 431 are likewise actionable, especially in situations where the alleged rule violation is accompanied by allegations of fraud perpetrated upon the investor by the broker. Evans v. Kerbs & Company, 411 F.Supp. 616 (S.D.N. Y.1976). An analysis of Rule 431, and its counterpart from the American Stock Exchange, reveals that protection of the broker is not the sole purpose for their existence. But rather, protection of the investor is also a factor to be considered. Cf. Daley v. Capitol Bank & Trust Company, 506 F.2d 1375 (1st Cir. 1974). In appropriate circumstances, where the broker's customer has not allowed trading to continue in an account known to be undermargined, I believe a private cause of action should be available for violations of Rule 431. It is true that some courts have determined that no privately enforceable claim is available for violation of exchange margin rules. However, most of those cases, such as McCormick v. Esposito, 500 F.2d 620 (5th Cir. 1974), cert. denied, 420 U.S. 912, 95 S.Ct. 834, 42 L.Ed.2d 842 (1975), and Gordon v. duPont Glore Forgan, Inc., 487 F.2d 1260 (5th Cir. 1973), cert. denied, 417...