Newcome v. Esrey

• Citation: 862 F.2d 1099
• Decision Date: 16 December 1988
• Docket Number: No. 87-1603,87-1603
• Parties: , Fed. Sec. L. Rep. P 94,106 Vaughan S. NEWCOME, Plaintiff-Appellant, v. A. Jack ESREY; Shearson Lehman Brothers, Inc., Defendants-Appellees.
• Court: U.S. Court of Appeals — Fourth Circuit

Page 1099

862 F.2d 1099

57 USLW 2387, Fed. Sec. L. Rep. P 94,106

Vaughan S. NEWCOME, Plaintiff-Appellant, v. A. Jack ESREY; Shearson Lehman Brothers, Inc., Defendants-Appellees.

No. 87-1603.

United States Court of Appeals, Fourth Circuit.

Argued Nov. 5, 1987.

Decided Dec. 16, 1988.

Thomas Bullene Throckmorton (George W.R. Glass; Scully, Throckmorton & Glass, on brief) for plaintiff-appellant.

Arthur L. Smith (Peper, Martin, Jensen, Maichel and Hetlage, on brief) for defendants-appellees.

Before WINTER, Chief Judge, and RUSSELL, WIDENER, HALL, PHILLIPS, MURNAGHAN, SPROUSE, ERVIN, CHAPMAN, WILKINSON and WILKINS, Circuit Judges.

SPROUSE, Circuit Judge:

Vaughan S. Newcome appeals the district court's dismissal of her securities fraud action against A. Jack Esrey and Shearson Lehman Brothers, Inc. (the brokers). Newcome based her federal claims on section 17(a) of the Securities Act of 1933, 15 U.S.C. Sec. 77q(a), as well as section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. Sec. 78j(b), and the corresponding Securities Exchange Commission regulation, rule 10b-5, 17 C.F.R. Sec. 240.10b-5. She also included pendent Virginia state-law claims. The district court first found that section 17(a) provides by implication the basis for a private right of action. It then held, however, that the arbitration clause in the brokerage agreement Newcome had signed was enforceable against claims brought under section 17(a) and dismissed her claim under that section. The district court also dismissed Newcome's section 10(b) claim, holding that it too was barred by the arbitration clause in the brokerage contract, 659 F.Supp. 100. On appeal briefs and oral argument were initially considered by a panel consisting of Judge Sprouse, Judge Chapman, and Judge Boyle. ¹ The court thereafter sua sponte ordered rehearing en banc without further oral argument. The en banc court now affirms the district court's holding that the arbitration clause is enforceable to prevent litigation of the section 10(b) claim. We also affirm the dismissal of the section 17(a) claim, but on different grounds than those expressed by the district court; we hold that no private right of action is available under section 17(a). ²

I

Newcome, a widowed housewife with no business or financial expertise, had wanted to invest the inheritance and life insurance proceeds she had received after her husband's death. Esrey was a stockbroker and financial consultant employed by Shearson Lehman Brothers, Inc. Newcome engaged Esrey to be her investment advisor and to invest her stock portfolio at his discretion in shares of common stock. Upon employing Esrey, Newcome signed a Customer's Agreement. The Customer's Agreement contained a provision requiring arbitration of "any controversy arising out of or relating to [the account], to transactions with [both parties] or to this agreement or the breach thereof...."

Newcome failed to profit as expected from the stock transactions. She brought this action alleging that Esrey engaged in a continuous course of overtrading ("churning") her securities in a manner calculated only to generate excessive commissions. She claimed that Shearson approved and profited from these transactions and that neither defendant informed her of the investments consequences to the account. Newcome also alleged that the overtrading resulted in tax liabilities out of proportion to the profits earned. She claimed that the brokers defrauded her and breached their fiduciary duty to her by failing to manage her account in a prudent manner.

The brokers moved to dismiss Newcome's action on alternative grounds. They contended the section 17(a) claim should be dismissed because that section creates no private cause of action. They further contended that, even if a private cause of action is available under section 17(a), the entire action should be dismissed because the Federal Arbitration Act, 9 U.S.C. Secs. 1-14, required both the section 10(b) and the section 17(a) claims to be arbitrated pursuant to the terms of the contract rather than litigated in a judicial forum. The district court, relying on this circuit's decision in Newman v. Prior, 518 F.2d 97 (4th Cir.1975), ruled that section 17(a) impliedly creates a private cause of action. It dismissed the entire action, however, ruling that both the section 17(a) and section 10(b) claims were subject to arbitration under the Federal Arbitration Act. In reaching that conclusion, the court found that the holding of Wilko v. Swan, 346 U.S. 427, 74 S.Ct. 182, 98 L.Ed. 168 (1953), does not apply to claims under either section 10(b) or section 17(a). ³ The court held that the right to pursue court actions grounded on these provisions could be waived by an arbitration agreement, that Newcome had agreed to arbitrate her claims, and, therefore, that her claims were subject to compulsory arbitration under the Federal Arbitration Act.

II

Newcome challenges the district court's holding that her section 10(b) claim is subject to the arbitration provision in the Customer's Agreement. Two months after the district court dismissed Newcome's claims, however, the United States Supreme Court decided Shearson/American Express, Inc. v. McMahon, 482 U.S. 220, 107 S.Ct. 2332, 96 L.Ed.2d 185 (1987). In McMahon the Court held that agreements subjecting section 10(b) claims to binding arbitration are valid under the securities laws and enforceable under the Federal Arbitration Act. Id. 107 S.Ct. at 2343. After McMahon it is difficult to ascertain the basis on which Newcome would have us rule that arbitration provisions related to actions under section 10(b) are unenforceable. Suffice it to say that McMahon requires our affirmance of the district court's action dismissing the section 10(b) claim.

III

The district court's holding that a right to a court action under section 17(a) could be waived by an arbitration agreement necessarily was preceded by its holding that section 17(a) gives rise to a private civil cause of action. Newcome challenges the district court's holding that her section 17(a) claim was subject to the arbitration clause in the Customer's Agreement. The brokers contest the district court's initial determination that Newman required it to hold that section 17(a) authorizes a private cause of action.

District courts in this circuit generally have interpreted Newman as requiring them to hold that section 17(a) provides a private cause of action. See, e.g., Shotto v. Laub, 632 F.Supp. 516 (D.Md.1986); Nunes v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 609 F.Supp. 1055 (D.Md.1985); Reid v. Madison, 438 F.Supp. 332 (E.D.Va.1977). One of our district courts, however, confronted by recent Supreme Court doctrine concerning implication of rights of action and other developments in securities law, differed on the question whether Newman mandated that it recognize a private right of action under section 17(a). Allegheny & Western Energy Corp. v. Columbia Gas System, Inc., Fed.Sec.L.Rep. (CCH) p 92,921 (S.D.W.Va.1986) [available on WESTLAW, 1986 WL 13360]. This circuit itself has cast doubt on the continuing validity of Newman. S.E.C. v. American Realty Trust, 586 F.2d 1001, 1006-07 (4th Cir.1978) (noting in dicta that implication of a private right of action under section 17(a)(2) "would probably require some substantial disregard of the whole legislative scheme"). Because the resolution of this question logically precedes the resolution of the question of arbitrability and because it appears to be a source of some confusion within this circuit, we now reconsider the "private cause of action" issue ⁴ and overrule Newman, holding that section 17(a) implies no private cause of action.

IV

A

In Newman we considered a section 17(a) action against Prior, a seller of oil and gas production interests. Among Prior's arguments on appeal, he contended that section 17(a) created no private cause of action. We stated without amplification, "[a]lthough there is authority to the contrary, this circuit is committed to the rule that Sec. 17(a) supports a private damage claim for the fraudulent sale of a security." 518 F.2d at 99. When we decided Newman in 1975, the state of the law on the issue was uncertain. ⁵ Those early decisions finding that Congress intended to imply a private cause of action when it enacted section 17(a), including our decision in Newman, were reached without benefit of the Supreme Court's seminal decision in Cort v. Ash, 422 U.S. 66, 95 S.Ct. 2080, 45 L.Ed.2d 26 (1975), and its progeny, which have developed the analysis for determining whether a federal statute impliedly creates a private cause of action. ⁶ In the light of those cases and other developments in the securities laws, the decisions implying a private right of action have come under increasing criticism. ⁷

In Cort the Supreme Court instructed that in determining whether private causes of action are to be implied from federal statutes which generally proscribe various types of conduct, four factors should be considered:

First, is the plaintiff "one of the class for whose especial benefit the statute was enacted,"--that is, does the statute create a federal right in favor of the plaintiff? Second, is there any indication of legislative intent, explicit or implicit, either to create such a remedy or to deny one? Third, is it consistent with the underlying purposes of the legislative scheme to imply such a remedy for the plaintiff? And finally, is the cause of action one traditionally relegated to state law, in an area basically the concern of the States, so that it would be inappropriate to infer a cause of action based solely on federal law?

422 U.S. at 78, 95 S.Ct. at 2088 (citations omitted).

The parameters of the Cort analysis have been drawn more tightly in the cases that have followed. In Touche Ross & Co. v. Redington, 442 U.S. 560, 575-76, 99 S.Ct. 2479, 2488-89, 61 L.Ed.2d 82 (1979), the Court emphasized that the first...