Prudential Securities Inc. v. E-Net, Inc.

• Decision Date: 05 September 2001
• Docket Number: No. 1312,1312
• Citation: 780 A.2d 359,140 Md. App. 194
• Parties: PRUDENTIAL SECURITIES INC. v. E-NET, INC., et al.
• Court: Court of Special Appeals of Maryland

780 A.2d 359

140 Md. App. 194

PRUDENTIAL SECURITIES INC. v. E-NET, INC., et al.

No. 1312, Sept. Term, 2000.

Court of Special Appeals of Maryland.

September 5, 2001.

Gilbert W. Boyce (Joseph A. Ingrisano and Kutak Rock, LLP on the brief), Washington, DC, for appellant.

Professor James Steven Rogers, Newton, MA, as amicus curiae.

Beth A. Levene (Bruce R. Genderson, George A. Borden, Lisa M. Duggan and Williams & Connolly LLP, on the brief), Washington, DC, for appellee, E-Net, Inc.

Ralph Drury Martin (Richard S. Kraut, Michael J. Dixon and Dilworth Paxson PLLC on the brief), Washington, DC, for appellee, American Stock Transfer & Trust Co.

Argued before HOLLANDER, KENNEY and ROBERT L. KARWACKI (Ret'd, specially assigned), JJ. KENNEY, Judge.

Appellant, Prudential Securities, Inc. ("Prudential"), appeals the entry of judgment by the Circuit Court for Montgomery County granting motions to strike the Amended Complaint and motions for summary judgment filed by appellees, e-Net, Inc. ("e-Net") and American Stock Transfer and Trust Co ("AST"). It presents six issues on appeal, which we have rephrased and reordered as follows:

I. Did the trial court err when it granted summary judgment in favor of appellees on Count I of the Complaint because both § 8-204 of the Uniform Commercial Code and Maryland common law recognize a cause of action for appellees' negligence?

II. Did the trial court err when it found there were no genuine issues of material fact as to whether appellees' failure to enforce the lockup was the proximate cause of appellant's loss?

III. Did the trial court err in granting summary judgment on the grounds of assumption of the risk because there were issues of material fact as to whether appellant assumed or appreciated the risk that the collateral shares would not bear their required restrictive legends, or would not be subject to a stop transfer order?

IV. Did the trial court err because there were genuine issues of material fact as to whether PSI was contributorily negligent?

V. Did the trial court err in dismissing PSI's claim for negligent misrepresentation because PSI proved all the essential elements of such a cause of action, including misrepresentation by e-Net and AST?

VI. Did the trial court abuse its discretion in granting appellees' motion to strike the Amended Complaint where there was no pending trial date, where appellant diligently amended the Complaint to conform to the facts of the case, and where appellees suffered no prejudice from the amendment? For the reasons set forth below, we reverse the trial court's ruling striking the amended complaint but affirm its decision granting summary judgment.

FACTUAL AND PROCEDURAL BACKGROUND

Appellee e-Net, Inc. is a Delaware corporation with its principal place of business in Germantown, Maryland. It provides a service whereby customers can make telephone calls over the internet. Thomas Prousalis, Jr. acquired 450,000 shares of e-Net stock in January 1995, apparently in exchange for acting as counsel to e-Net in connection with its formation and initial capitalization. In 1997, e-Net sought to initiate an Initial Public Offering ("IPO") and again enlisted Prousalis's legal services. In connection with the IPO, Prousalis agreed not to sell, transfer, or otherwise dispose of his shares for two years after e-Net's IPO, which was scheduled for April 1997 (the "lockup agreement"). e-Net also engaged AST as its transfer agent to implement any applicable restrictions and to maintain stop transfer orders on restricted e-Net shares.

From April 1997 to March 1998, Prousalis's shares were evidenced by a single certificate on which AST had affixed two restrictive legends. The first legend reflected a restriction imposed by securities law ("1993 Securities Act" restriction), while the second restriction reflected Prousalis's lockup agreement.¹ This certificate was held in account with Dean Witter Reynolds, Inc. ("Dean Witter"). Prousalis's broker was Mark A. Rodgers, and the account was maintained in Clearwater, Florida.

In March 1998, e-Net authorized AST to remove the 1933 Securities Act restriction from Prousalis's certificate. e-Net also instructed AST to maintain stop transfer orders on all restricted shares, including those of Prousalis. AST thereafter reissued Prousalis's certificates in new denominations, giving him four stock certificates representing 100,000 shares each and one certificate representing 50,000 shares. Rather than excluding only the 1993 Securities Act restriction from the face of the certificate, it excluded the lockup restrictions on the shares as well. In addition, AST failed to indicate within its system that the shares were still subject to the lockup agreement. Prousalis deposited four reissued, unlegended e-Net certificates into his brokerage account with Dean Witter. These certificates represented 400,000 of Prousalis's 450,000 shares in e-Net.

Prousalis then pledged his e-Net shares to Dean Witter in order to open a margin credit account. This pledge required that formal ownership of the shares be transferred from his name to the name of a stock clearinghouse called Depository Trust Company ("DTC").² DTC operated a national depository, which allowed stocks, once entered into their system, to be transferred by book entry within their system. In other words, in the event of a transfer, certificates are not exchanged and no formal transfer of ownership was recorded by e-Net or AST. At oral argument, Prudential's attorney explained that shares that come through DST are, by definition, unrestricted. Once Prousalis opened the margin account with Dean Witter, he was able to buy additional shares of unrestricted e-Net stock, giving him a total of 693,200 shares.

In early August 1998, Rodgers left Dean Witter and began working for Prudential. On August 7, 1998, Prousalis opened a margin account with Prudential at its Clearwater branch and instructed Dean Witter to transfer all of his e-Net shares to that account.³ Dean Witter complied with this request, and the transfer was completed through the DTC system. At the same time, Prousalis sought a loan from Prudential for $5,892,200, which represented 50% of the value of the e-Net shares transferred. The loan would be secured by the e-Net shares owned by Prousalis.

Joseph Luino, Prudential's Senior Vice President of Credit Control Administration, was vested with the authority to decide whether the loan should be made. Concerned that there may be some restriction on the saleability of the pledged e-Net shares, Luino contacted Valerie Kerr of Prudential's Executive Services and Strategies ("ESS") department for guidance on the saleability of the stock offered as collateral.

Kerr requested that Prudential's Clearwater branch complete a standard "margin checklist" document in accordance with Prudential's internal operation procedures. The margin checklist requests information about the customer and the shares being offered as collateral and is designed to elicit whether there are any restrictions on the transferability of the shares. It specifically asked whether the shares were subject to any lockup agreement, and if so, when the lockup agreement expired.⁴ The Clearwater branch failed to complete the checklist.

Although the margin checklist was never completed and Kerr did not render an opinion on the saleability of the shares, Luino, who stated in a deposition that Kerr advised him the shares were not restricted, extended Prousalis the margin loan on the day it was requested, August 7, 1998. The actual transfer of e-Net shares from Dean Witter to appellant occurred the following Monday, August 10, 1998, through the DTC system. Neither AST nor e-Net was made aware of the transfer. The loan amount was 50% of the market value of Prousalis's e-Net shares, which at the time, were trading at $17 per share. The e-Net shares thereafter increased in market value, reaching a high of $20 per share on August 18, 1998. This high, however, was short-lived and, on September 3, 1998, e-Net's stock closed at $7¾ per share. At this point, Prudential exercised its right to a "margin call" and demanded that Prousalis deposit approximately $3.5 million in additional cash or securities into his margin account pursuant to his margin loan agreement. The margin account agreement required Prousalis to "maintain such margins as [Prudential] may in [its] discretion require from time to time and [to] pay on demand any debit balance."

Prousalis failed to deposit the requested amount into his account, and, on September 4, 1998, Prudential began selling Prousalis's e-Net shares to satisfy the debt. Between September 4, 1998, and September 16, 1998, Prudential sold 243,200 shares of e-Net stock at approximately $4.03 per share. The debt was still not satisfied, and, by April 7, 1999, Prudential sold an additional 235,883 of Prousalis's e-Net shares. By June 24, 1999, Prudential had completed the sale of all of Prousalis's e-Net shares. Prudential claims to have lost approximately $3,500,825.12 on the loan.

On October 5, 1998, Prudential filed suit, asserting:

Count I U.C.C. § 8-204⁵ and negligence, against both e-Net and AST

Count II negligent misrepresentation based on the erroneous removal of the lockup legend on Prousalis's e-Net shares, against e-Net and AST

Count III breach of warranty based on U.C.C. § 8-208, against AST only.

Count III was dismissed on February 12, 1999, pursuant to a motion to dismiss filed by AST.⁶ e-Net and AST filed cross-claims against each other, and AST brought third party complaints against Dean Witter, Rodgers, Prousalis, and Prousalis's wife, Gayle. A scheduling order was entered in the case establishing July 19, 1999, as the discovery deadline. The discovery deadline was extended several times, ultimately to April 14, 2000.

The numerous postponements of the discovery deadline were mostly due to difficulties in scheduling the depositions of Rodgers and...