Rich v. New York Stock Exchange

• Citation: 379 F. Supp. 1122
• Decision Date: 22 July 1974
• Docket Number: No. 73 Civ. 4642.,73 Civ. 4642.
• Parties: Norman RICH et al., Plaintiffs, v. NEW YORK STOCK EXCHANGE et al., Defendants.
• Court: U.S. District Court — Southern District of New York

379 F. Supp. 1122

Norman RICH et al., Plaintiffs, v. NEW YORK STOCK EXCHANGE et al., Defendants.

No. 73 Civ. 4642.

United States District Court, S. D. New York.

July 22, 1974.

Julien & Schlesinger, P. C. by Alfred S. Julien, Stuart A. Schlesinger and David Jaroslawicz, New York City, for plaintiffs.

Milbank, Tweed, Hadley & McCloy, by Russell E. Brooks, New York City, for New York Stock Exchange.

Rosenman Colin Kaye Petschek Freund & Emil, by Marvin G. Pickholz, New York City, for Ladenburg, Thalmann & Co.

MEMORANDUM

BRIEANT, District Judge.

Early in the year 1973, Weis Securities, Inc. (hereinafter "Weis"), a member firm of the New York Stock Exchange, (hereinafter the "Exchange" or "NYSE") was engulfed by financial difficulties. On May 24, 1973, when its condition appeared to be beyond salvation, the Securities Investors Protection Corporation ("SIPC") petitioned this Court, pursuant to the provisions of the Securities Investor Protection Act of 1970 for liquidation of Weis, and the appointment of a SIPC trustee. 15 U.S.C. § 78aaa et seq. The trustee was appointed on May 30, 1973 and proceeded immediately thereafter to resolve customer claims.

Plaintiffs were among 35,000 customers of Weis who, until May 24, 1973, were unaware and uninformed of Weis' impending demise. Institution of SIPC proceedings then deprived plaintiffs of access to or physical possession of their securities in Weis' possession, and the use of the capital these securities represented. This deprivation continued in most cases for at least several weeks, while the SIPC trustee performed his duties. Some customers, as is usual in such matters, never received all their securities in kind, although paid in cash to the limits of the protection provided under the SIPC provisions.

By this purported class action pursuant to Rule 23, F.R.Civ.P., plaintiffs seek damages for themselves and those similarly situated, from the Exchange, former officers and directors of Weis, and Ladenburg, Thalmann & Co. (hereinafter "Ladenburg"), a member NYSE firm.

Plaintiffs' second amended complaint alleges five causes of action, but upon analysis and consideration of the affidavits and memoranda submitted in their behalf, it appears that plaintiffs' claims are based on two theories only.

First, plaintiffs assert that the Exchange failed to discharge its duty imposed by section 6(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78f, to supervise and discipline Weis. This failure allegedly was the proximate cause of the SIPC liquidation, as a result of which they were damaged.¹ Second, plaintiffs assert that just prior to the liquidation, Weis, with the aid and acquiescence of the other defendants, transferred certain of its large and "privileged" margin accounts ("tippees") to other members of the Exchange, including defendant Ladenburg.

This action allegedly was also in violation of section 6(b) and section 10 of the Securities Exchange Act of 1934, 15 U.S.C. §§ 78f, 78j and Rule 10b-5 promulgated by the Securities and Exchange Commission (hereinafter "SEC").

In April 1973 several principals of Weis informed the Exchange that, for an unspecified period, the firm "may have" been "understating its profit and loss report to the Exchange by several million dollars." (Bishop deposition, p. 25). Defendants disclaim any prior actual knowledge by the Exchange that Weis faced financial difficulties. Plaintiffs come forward with no evidence to the contrary.

The Exchange immediately launched an intensive effort to study Weis' problems, and aid in improving its capital position, so that the firm would survive and customer safety would be assured. As a result of those efforts, a merger of Weis with Ladenburg was suggested. Weis accepted this suggestion and, in turn, proposed to the Exchange that, pending negotiations and consummation of the merger, it transfer some of its larger margin accounts to Ladenburg in order to effect an automatic and immediate improvement of its debt-capital ratio. This suggestion was approved by the Exchange, as a time tested technique of "restoring stability to financially troubled firms." (Defendants' brief, p. 9). According to the Exchange, Weis then unilaterally selected and transferred to Ladenburg those accounts with the largest debit balances.

Defendants oppose plaintiffs' motion for class action determination, and have moved for summary judgment pursuant to Rule 56, F.R.Civ.P. Defendants' summary judgment motion is based on the contention that plaintiffs have no provable damages. We need not reach this point. Obviously speculative, remote or conjectural damages cannot be recovered in an action under the securities laws. However, arguably, on the facts of this case, plaintiffs' right to immediate possession of certificates for their shares of stock, and their right to draw out their cash on demand were impaired by the unavoidable delay consequent on the activities of SIPC. If defendants by their tortious conduct produced this result, and if the damage was foreseeable, as it would be, it would seem plaintiffs could recover the traditional measure of damages for the wrongful distraint of a chattel, Chattanooga Discount Corp. v. West, 219 F. Supp. 140 (D.C.Ala.1963), or the wrongful failure to pay money when due.² But we need not reach this issue because, upon uncontested facts and evidence presented in the affidavits on this motion and the depositions, no cause of action exists in plaintiffs' favor.

Plaintiffs' first theory is based on defendant NYSE's alleged violations of section 6(b) of the Securities Exchange Act of 1934. Section 6(b), which provides for the registration of National Securities Exchanges with the SEC:

"No registration shall be granted or remain in force unless the rules of the exchange include provision for the expulsion, suspension, or disciplining of a member for conduct or proceeding inconsistent with just and equitable principles of trade, and declare that the willful violation of any provisions of this title or any rule or regulation thereunder shall be considered conduct or proceeding inconsistent with just and equitable principles of trade."

Section 6(b) further provides that one purpose of the rules and regulations enacted by the Exchanges is "to insure fair dealing and to protect investors." In addition, section 15A(b)(8) of the 1934 Act, 15 U.S.C. § 78o-3(b)(8) specifies that a national securities association may not register under the 1934 Act unless:

". . . the rules of the association are designed to prevent fraudulent and manipulative acts and practices, to promote just and equitable principles of trade . . . and, in general, to protect investors and the public interest . . . ."

Specifically, plaintiffs have argued that the Exchange failed to enforce Rule 325, its net capital rule, adopted in compliance with the aforementioned statutes. This Rule provides that the ratio of a member firm's aggregate indebtedness to its net capital may be no lower than 15 to 1. CCH, NYSE Guide, Vol. II, Rule 325.

A private right of action against the Exchange for failure to fulfill its statutory obligations may be founded on section 6(b). Baird v. Franklin, 141 F. 2d 238 (2d Cir.), cert. denied, 323 U.S. 737, 65 S.Ct. 38, 89 L.Ed. 591 (1944).

In Baird, plaintiff alleged that the defendant New York Stock Exchange firm converted its securities and that it suffered damages as a result of the Exchange's failure to take disciplinary action against the member firm. Holding that there is "no substantial resemblance between the duties of bailees or other fiduciaries and those of the Stock Exchange," the Second Circuit concluded that the Exchange was under a statutory duty, giving rise to a private claim for damages arising from its breach, "to investigate the dealings and the financial conditions of the members and to suspend or expel members who it had reason to believe had been guilty of conduct inconsistent with just and equitable principles of trade." 141 F.2d at p. 239.

The duty of the Exchange under section 6 to enforce compliance with its rules "so far as within its powers" must be evaluated reasonably. The Exchange has 579 member organizations, which employ approximately 56,000 registered representatives. Marbury Management, Inc. v. Kohn, 373 F.Supp. 140 (S.D.N.Y. 1974); Butterman v. Walston & Co., 387 F.2d 822 (7th Cir. 1967), cert. denied 391 U.S. 913, 88 S.Ct. 1806, 20 L.Ed.2d 652 (1968). The Exchange's supervision need not be "fluoroscopic," and liability should not be imposed on the Exchange merely because a violation of its rules escaped its detection. Hochfelder v. Midwest Stock Exchange, 350 F.Supp. 1122, 1125 (S.D.Ill.1972). Liability should attach only if plaintiff demonstrates that the Exchange had reason to believe or suspect that a member firm was in violation of the rules, and then failed or refused to take remedial action, which failure to act resulted in an injury to the plaintiff. Steinberg v. Merrill Lynch, Pierce, Fenner & Smith, Inc., CCH Fed.Sec.L.Rep. ¶ 94,599 (S.D.N.Y. June 14, 1974); Marbury Management, Inc. v. Kohn, supra; Baird v. Franklin, supra. No sheriff can prevent all felonies in his bailiwick, and the law does not so require.

It was held in Colonial Realty Corp. v. Bache & Co., 358 F.2d 178, 182 (2d Cir.), cert. denied 385 U.S. 817, 87 S.Ct. 40, 17 L.Ed.2d 56 (1966), that the question of

"whether the courts are to imply federal civil liability for violation of exchange or dealer association rules by a member cannot be determined on an all-or-nothing basis . . . rather, the court must look to the nature of the particular rule and its place in the regulatory scheme, with the party urging the implication of a federal liability carrying a considerably heavier burden of persuasion than when the violation is of the statute or an SEC regulation."

Since the Court in Colonial declined to adopt a per se rule with regard to the violation of Exchange rules, our research has...