Prudential-Bache Securities, Inc. v. Stricklin, PRUDENTIAL-BACHE

CourtUnited States Courts of Appeals. United States Court of Appeals (4th Circuit)
Writing for the CourtBefore POWELL; POWELL
Citation890 F.2d 704
PartiesSECURITIES, INC., Plaintiff-Appellee, v. James M. STRICKLIN, Defendant-Appellant.
Decision Date06 December 1989
Docket NumberNo. 89-2042,PRUDENTIAL-BACHE

Page 704

890 F.2d 704
PRUDENTIAL-BACHE SECURITIES, INC., Plaintiff-Appellee,
v.
James M. STRICKLIN, Defendant-Appellant.
No. 89-2042.
United States Court of Appeals,
Fourth Circuit.
Argued Oct. 3, 1989.
Decided Dec. 6, 1989.

Page 705

L. Holmes Eleazer, Jr. (Fenton T. Erwin, Jr., Weinstein & Sturges, P.A., Charlotte, N.C., on brief), for defendant-appellant.

Richard Byron Whisnant (John R. Wester, Robinson, Bradshaw & Hinson, P.A., Charlotte, N.C., on brief) for plaintiff-appellee.

Before POWELL, Associate Justice (Retired), United States Supreme Court, sitting by designation, and ERVIN, Chief Circuit Judge, and HILTON, United States District Judge, sitting by designation.

POWELL, Associate Justice:

The question presented is whether appellee wrongfully liquidated appellant's trading positions in "naked put options" on October 16, 1987. We find that appellee's action was authorized by contract and does not provide a legal defense to a valid debt owed by appellant to appellee. Accordingly, we affirm the district court's grant of appellee's motion for summary judgment.

I.

Appellant James M. Stricklin was a broker in the Charlotte office of the brokerage firm J.C. Bradford & Company. On March 5, 1987, he signed an agreement with appellee Prudential-Bache Securities, Inc. opening a personal trading account. Appellant used his Prudential-Bache account to sell (or "write") put option contracts based on the Standard & Poors Index. For a fixed premium, one of appellant's customers could purchase the option to sell to appellant, within some period of time, a certain number of "shares" in the Standard & Poors Index for a fixed price. If the index rose above the fixed price during the period of the option, the customer would not exercise the option since he could sell the shares for a higher price on the open market. The option would then expire, and appellant would keep the premium. If the index declined below the fixed price, the customer would exercise the option, and appellant would have to buy the shares at a price higher than the price for which he could then sell those shares on the open market. The greater the decline in the index, the greater appellant's losses.

If appellant also owned put option contracts, or maintained a short position, on the Standard & Poors Index, his positions would be "covered." If a customer exercised an option, appellant could purchase the customer's shares and then immediately sell those shares at a fixed price to a third party. Appellant did not hold such positions. The put option contracts he sold were "naked" (or "uncovered"). As such, he needed either to deposit in his Prudential-Bache account an amount equal to the aggregate exercise prices of all of the put option contracts he wrote or to maintain his account "on margin." Appellant chose the latter. In essence, he deposited with appellee a portion of the money needed to cover all of the options he sold and borrowed the rest from appellee.

Once this relationship is established, the holder of the option will look to the brokerage house, not to the broker operating the account on margin, for performance in the event of exercise. See G. Munn, Encyclopedia of Banking and Finance 738 (8th ed. 1983). If appellant's customers exercise their options, appellee will purchase the shares for the price stated in the put option and then post a loss to appellant's account. The amount of the loss is the difference between the amount paid for the shares and the value of those shares on the open market. If the losses exceed the original deposit, appellee can recover this amount from appellant.

As the Standard & Poors Index drops, the put writer's losses increase, thus increasing his liability to appellee. Since the

Page 706

index can drop hypothetically all the way to zero, this liability can increase almost infinitely. 1 Since brokers often cannot pay back such enormous losses, securities firms try to limit their exposure by using two methods. First, the firm can issue a margin call. This means that the put writer must deposit more of his own funds into the account to continue activity. Second, the firm can liquidate the put writer's position by buying back all of the put...

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8 practice notes
  • Pompano-Windy City Partners v. Bear Stearns & Co., No. 87 Civ. 7560 (PKL)
    • United States
    • United States District Courts. 2nd Circuit. United States District Courts. 2nd Circuit. Southern District of New York
    • June 4, 1992
    ...experienced investor and a broker"). Before proceeding, the Court turns to discuss Prudential-Bache Securities, Inc. v. Stricklin, 890 F.2d 704, 707 (4th Cir. 1989), which involved a similar situation to the case at bar. As a result of the October 1987 market crash, Stricklin's account at P......
  • Morgan Stanley & Co. v. Peak Ridge Master SPC Ltd., No. 10 Civ. 8405(ALC).
    • United States
    • United States District Courts. 2nd Circuit. United States District Courts. 2nd Circuit. Southern District of New York
    • March 15, 2013
    ...a contract specifically provides for margin calls on options at any time and without notice.”); Prudential–Bache Sec., Inc. v. Stricklin, 890 F.2d 704, 706–07 (4th Cir.1989) (rejecting a claim that 24–hour notice, which the broker normally gave to customers, was necessary before broker coul......
  • First Union Discount Brokerage Services, Inc. v. Milos, No. 91-5818
    • United States
    • United States Courts of Appeals. United States Court of Appeals (11th Circuit)
    • August 9, 1993
    ...and to its other customers--to issue and enforce the margin call. This we refuse to do. In Prudential-Bache Securities, Inc. v. Stricklin, 890 F.2d 704 (4th Cir.1989), the Fourth Circuit contemplated another put option investor's efforts to resist paying the brokerage house that loaned him ......
  • Moss v. J.C. Bradford and Co., No. 332PA93
    • United States
    • North Carolina United States State Supreme Court of North Carolina
    • July 29, 1994
    ...186 (7th Cir.1992); Modern Settings, Inc. v. Prudential-Bache, 936 F.2d 640 (2d Cir.1991); Prudential-Bache Securities, Inc. v. Stricklin, 890 F.2d 704 (4th Cir.1989); Misabec Mercantile, Inc. v. Donaldson, 853 F.2d 834 (11th Cir.1988). Bradford also would have us decide in its favor based ......
  • Request a trial to view additional results
8 cases
  • Pompano-Windy City Partners v. Bear Stearns & Co., No. 87 Civ. 7560 (PKL)
    • United States
    • United States District Courts. 2nd Circuit. United States District Courts. 2nd Circuit. Southern District of New York
    • June 4, 1992
    ...experienced investor and a broker"). Before proceeding, the Court turns to discuss Prudential-Bache Securities, Inc. v. Stricklin, 890 F.2d 704, 707 (4th Cir. 1989), which involved a similar situation to the case at bar. As a result of the October 1987 market crash, Stricklin's account at P......
  • Morgan Stanley & Co. v. Peak Ridge Master SPC Ltd., No. 10 Civ. 8405(ALC).
    • United States
    • United States District Courts. 2nd Circuit. United States District Courts. 2nd Circuit. Southern District of New York
    • March 15, 2013
    ...a contract specifically provides for margin calls on options at any time and without notice.”); Prudential–Bache Sec., Inc. v. Stricklin, 890 F.2d 704, 706–07 (4th Cir.1989) (rejecting a claim that 24–hour notice, which the broker normally gave to customers, was necessary before broker coul......
  • First Union Discount Brokerage Services, Inc. v. Milos, No. 91-5818
    • United States
    • United States Courts of Appeals. United States Court of Appeals (11th Circuit)
    • August 9, 1993
    ...and to its other customers--to issue and enforce the margin call. This we refuse to do. In Prudential-Bache Securities, Inc. v. Stricklin, 890 F.2d 704 (4th Cir.1989), the Fourth Circuit contemplated another put option investor's efforts to resist paying the brokerage house that loaned him ......
  • Moss v. J.C. Bradford and Co., No. 332PA93
    • United States
    • North Carolina United States State Supreme Court of North Carolina
    • July 29, 1994
    ...186 (7th Cir.1992); Modern Settings, Inc. v. Prudential-Bache, 936 F.2d 640 (2d Cir.1991); Prudential-Bache Securities, Inc. v. Stricklin, 890 F.2d 704 (4th Cir.1989); Misabec Mercantile, Inc. v. Donaldson, 853 F.2d 834 (11th Cir.1988). Bradford also would have us decide in its favor based ......
  • Request a trial to view additional results

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