Quincy Co-Op. Bank v. AG Edwards & Sons, Inc.

• Decision Date: 27 August 1986
• Docket Number: Civ. A. 85-2913-MA.
• Citation: 655 F. Supp. 78
• Court: U.S. District Court — District of Massachusetts
• Parties: QUINCY CO-OPERATIVE BANK, Plaintiff, v. A.G. EDWARDS & SONS, INC. and Jack Concannon, Defendants.

655 F. Supp. 78

QUINCY CO-OPERATIVE BANK, Plaintiff, v. A.G. EDWARDS & SONS, INC. and Jack Concannon, Defendants.

Civ. A. 85-2913-MA.

United States District Court, D. Massachusetts.

August 27, 1986.

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Ronald R. Cloutier, Martin J. Hernon, Warner & Stackpole, Boston, Mass., for plaintiff.

Glass & Brand, Robert Glass, Boston, Mass., for defendant A.G. Edwards & Sons, Inc.

MEMORANDUM AND ORDER

MAZZONE, District Judge.

This securities fraud action arises out of the sale of bonds that were called sooner, and at a lower price, than the buyer, relying on its broker's assurances, expected. Plaintiff is Quincy Co-Operative Bank (the Bank). Defendants are A.G. Edwards & Sons, Inc. (Edwards), a registered broker-dealer, and Jack Concannon, a broker who worked at Edwards' Worcester office.

Claiming that it was misled about when the bonds could be called, the Bank alleges that defendants violated section 12(2) of the Securities Act of 1933, 15 U.S.C. § 77l (2), and the Massachusetts blue sky law, Mass. Gen.Laws Ann. ch. 110A, § 410. The Bank also alleges several state common-law claims for misrepresentation, negligence and breach of contract. This matter is before the Court on the Bank's motion for summary judgment on all six counts of its complaint. For reasons explained below, this motion is denied.

I.

In October, 1983, Concannon proposed a bond purchase to Leo Sheehan who, as the Bank's Vice President and Comptroller, handled the Bank's securities portfolio. Concannon suggested the Bank buy first mortgage bonds issued by the Arizona Public Service Co. which paid sixteen percent interest and were due in April, 1987. The bonds were then selling on the secondary bond market at a premium over face value.

Sheehan says that Concannon several times assured him that the bonds could not be called any earlier than April, 1987, and then only at a 105.91 percent of face value. Neither the Bank nor Edwards has been able to locate Concannon, but Edwards says its brokers follow the secondary bond market industry-wide practice of relying on published reference services for information on bonds. Both reference services, Moody's and Standard & Poor's, described the Arizona Public Service Co. bonds as due in 1992, but callable in April, 1987 at 105.91 percent of face value.

In late October, 1983, the Bank bought Arizona Public Service Co. bonds with a face value of $500,000, paying a $66,250 premium. Edwards placed the order on October 21. Following industry practice, the bonds were delivered and paid for five business days later. On October 28 Edwards received, by computer entry, $500,000 worth of bonds from a broker working for the seller. Immediately, a second computer entry transferred the bonds to Edwards' account with a clearing agent, the Depository Trust Corp.; Edwards already owned $22,000 worth of Arizona Public Service Co. bonds and the new ones were added to its inventory. Edwards then transferred the bonds in its own records to the Bank's account with Edwards. On the Bank's instructions, Depository Trust Corp. transferred the bonds the next business day, October 31, to the account of First National Bank, the Bank's custodian. All these transactions were accomplished by computer entry. Neither the Bank nor its custodian ever physically received the bonds.

The Bank paid Edwards a slightly higher price for the bonds than Edwards itself paid, the $1250 difference representing Edwards' commission for handling the transaction.

A year later, in November, 1984, the bonds were called at face value. An indenture provision allowed Arizona Public Service Co. to call the bonds if real estate it owned was sold under certain conditions. There is no dispute that the bonds were properly called pursuant to this provision. Although the Bank was paid the $500,000 face value of the bonds, and had received $80,000 in interest during the year it held the bonds, it claims that it was misled about when the bonds could be called and could have earned more money in a different investment. The Bank seeks damages of $58,000.

II.

Section 12(2) creates a right of action for a purchaser who claims the security he or she bought was offered or sold by means of a prospectus or oral communication which includes an untrue statement of a material fact or omits to state a material fact. 15 U.S.C. § 77l(2). Section 12(2) also provides that a defendant who can show that he or she "in the exercise of reasonable care could not have known" of the claimed untruth or omission is not liable. Id.

Edwards contends that the Bank is not entitled to summary judgment on its section 12(2) claim because there are unresolved disputes over key facts. These include: what Concannon told the Bank and whether it was material; whether Edwards is liable for Concannon's representations; whether the Bank's action is time-barred because the Bank was not duly diligent in discovering the omitted fact; and whether Edwards was careless in recommending the bonds. Edwards also contends that it is not liable because it acted in the transaction merely as a broker on the Bank's behalf and did not sell the bonds to the Bank. Having carefully read the pleadings, affidavits and depositions submitted on this motion, I must conclude that Edwards sold the bonds to the Bank and did so by oral communications which omitted a material fact about the bonds. However, I must also conclude that whether Edwards acted reasonably in relying on unverified information published by investment reference services is a genuine issue of material fact which cannot be decided by summary judgment.

A.

Edwards sold the bonds to the Bank and is a "seller" for purposes of section 12(2), despite Edwards' contention that it acted merely as the Bank's broker.¹ A split exists among the circuits on whether a section 12(2) plaintiff must establish privity between himself and the defendant. The Third, Seventh and, arguably, the Ninth Circuits have held that section 12(2) requires privity between the plaintiff-purchaser and defendant-seller. Collins v. Signetics Corp., 605 F.2d 110 (3d Cir.1979); Sanders v. John Nuveen & Co., 619 F.2d 1222 (7th Cir.1980); cert. denied, 450 U.S. 1005, 101 S.Ct. 1719, 68 L.Ed.2d 210 (1981); Feldman v. Simkins Industries, 679 F.2d 1299, 1305 (9th Cir.1982). Other circuits have read the term "seller" to include those whose participation in the sale was a "substantial factor in causing the transaction to take place." Stokes v. Lokken, 644 F.2d 779, 785 (8th Cir.1981); Lawler v. Gilliam, 569 F.2d 1283, 1287 (4th Cir.1978), or those whose actions in connection with the sale proximately caused the injury to the plaintiff. David v. Avco Financial Services, 739 F.2d 1057, 1063-68 (6th Cir. 1984); Pharo v. Smith, 621 F.2d 656, 664-68 (5th Cir.1980).

The First Circuit has not had recent occasion to rule on this question, but in Cady v. Murphy, 113 F.2d 988 (1st Cir.), cert. denied, 311 U.S. 705, 61 S.Ct. 175, 85 L.Ed. 458 (1940), the court held that a broker who acted as an agent for the seller, or as an agent for both buyer and seller, could be liable as a seller under section 12(2).

Edwards asserts that it acted merely as the Bank's broker arranging the transaction at the Bank's request. Thus, Edwards argues that it was not a seller in either sense: it was not in privity with the Bank, nor was it a substantial factor in bringing about the Bank's purchase. I am not persuaded.

Edwards did, in fact, pass title to the bonds to the Bank, and so was literally its immediate seller. The records of the transaction show that Edwards bought the bonds from a broker acting for the seller, added them to its account at the clearing agent, then sold them to the Bank at a marked-up price. Edwards' confirmation slip, which it sent to the Bank, indicates that Edwards acted as the principal in the transaction not as the Bank's agent.

Relying on Canizaro v. Kohlmeyer & Co., 370 F.Supp. 282 (E.D.La.1974), Edwards argues that it possessed the bonds only in a "narrow, technical sense," because the entire transaction—from seller's agent to Edwards to the Bank—took place by computerized book entry on a single day; Edwards says this is the only way brokers operating in the secondary bond market can handle transactions and earn their commission.

Canizaro, however, differs from the case before the Court in several important respects. There, the plaintiff-purchaser approached the defendant-broker and asked it briefly to investigate a stock and to handle plaintiff's purchase. The broker did not buy the stock for its own account nor sold the stock out of its own inventory. Id. at 287. The broker did not own any other shares of the stock on its own account and had never before dealt in the stock. Id. Although the confirmation slip indicated the broker had acted as a principal in the transaction, the Canizaro court concluded that a "broker who does no more than act solely as the buyer's agent in executing a purchase order and who has neither solicited the order nor recommended the stock, cannot be deemed to be an offeror or seller." Id.

Here, of course, Edwards, acting through Concannon, approached the Bank, recommended the bonds, and supplied all of the information about the bonds on which the Bank relied in making its decision. Edwards was already dealing in the Arizona Public Service Co. bonds as a broker-dealer. I am convinced that brokers and others who have a substantial role in a securities sale can be considered "sellers" for purposes of section 12(2) liability. Whether Edwards' role as a broker alone would be sufficient to make Edwards a section 12(2) seller without the additional fact that Edwards purchased the bonds and re-sold them to the Bank is something that I need not decide today.

Section 12(2) is a regulatory statute whose purpose is to ensure that potential purchasers are given correct, material information before purchasing securities. Croy v....