Shearson Lehman Bros., Inc. v. M & L Investments

• Decision Date: 17 November 1993
• Docket Number: Nos. 91-4206,91-4217,s. 91-4206
• Citation: 10 F.3d 1510
• Parties: Fed. Sec. L. Rep. P 98,050 SHEARSON LEHMAN BROTHERS, INC., Plaintiff-Counter-Defendant--Appellee-Cross-Appellant, v. M & L INVESTMENTS, a Utah General Partnership; Mike Strand; Lois Strand, Defendants-Counter-Claimants--Appellants- Cross-Appellees.
• Court: U.S. Court of Appeals — Tenth Circuit

Page 1510

10 F.3d 1510

Fed. Sec. L. Rep. P 98,050

SHEARSON LEHMAN BROTHERS, INC. Plaintiff-Counter-Defendant--Appellee-Cross-Appellant, v. M & L INVESTMENTS, a Utah General Partnership; Mike Strand Lois Strand Defendants-Counter-Claimants--Appellants- Cross-Appellees.

Nos. 91-4206, 91-4217.

United States Court of Appeals Tenth Circuit.

Nov. 17, 1993.

John T. Caine of Richards, Caine & Allen, Ogden, UT, for defendants-counter-claimants--appellants-cross-appellees.

Terry Ross of Keesal, Young & Logan, P.C., Long Beach, CA (Robert D. Feighner and Shannon L. McDougald of Keesal, Young & Logan, P.C., Long Beach, CA, Reid Lewis of Moyle & Draper, P.C., Salt Lake City, UT, with him on the brief), for plaintiff-counter-defendant--appellee-cross-appellant.

Before BALDOCK, HOLLOWAY and KELLY, Circuit Judges.

BALDOCK, Circuit Judge.

Defendants M & L Investments ("M & L"), Mike Strand ("Strand") and Lois Strand appeal the district court's restitution award of 40,000 shares of stock, 776 F.Supp. 1489 (D.Utah 1991). Plaintiff Shearson Lehman Brothers, Inc. ("Shearson") cross-appeals the district court's determination that Shearson's Regulation T violation, 12 C.F.R. Sec. 220.8, served as an affirmative defense against Shearson's breach of contract action for stock nonpayment. We have jurisdiction over the appeal and cross-appeal ¹ under 28 U.S.C. Sec. 1291.

M & L is a general partnership consisting of two partners, Strand and his wife, Lois. The Strands are Utah residents, and Mike Strand controlled all of the partnership's activities. He is a sophisticated stock market participant with substantial experience in securities trading who sometimes serves as a stock promotor. Shearson is a Delaware corporation with its principle place of business in New York.

In March 1986, Strand was approached by two individuals seeking to hire Strand to promote the stock issued by Atlantic Mining Corporation ("Atlantic Mining"). At that time, the stock was trading for substantially less than one dollar per share. Strand agreed to promote the stock, initially agreeing to raise its value to one dollar per share. Sometime in April 1986, Strand began buying and selling Atlantic Mining shares in an account held in M & L's name at Shearson. He successfully raised the value of the stock to one dollar per share within a few days by contacting acquaintances who were active in the stock market and touting the qualities of the stock.

Strand then agreed to raise the price to three dollars per share and later, to nine dollars per share. After the stock reached nine dollars per share, he continued promoting the stock but with no specific target price. By July 1986, the price of Atlantic Mining stock was at twelve dollars per share.

During the time Strand was promoting the stock, he purchased and sold the stock through the M & L account at Shearson. The M & L account was a "cash account," meaning that the customer must pay for any purchases made in the account at his direction within seven days. See 12 C.F.R. Sec. 220.8(b)(1)(i) (1991). The date on which payment is due is called the "settlement date."

Between April 21 and May 27, 1986, Strand purchased 72,000 shares of Atlantic Mining through his account at Shearson, of which he sold 2,800, giving him a net total of 69,200 shares. Though some of his payments were late, he had fully paid for the 69,200 shares by May 29, 1986.

Beginning in mid-May, Strand made frequent requests that Shearson deliver to him physical possession of the stock certificates representing the stock he had purchased. From what we can glean from the record, it appears that the transfer of physical possession takes some time to complete, usually between four and six weeks. Shearson placed Strand's request for the certificates, and on approximately June 22, 1986, Strand received two stock certificates which together represented 40,000 shares of Atlantic Mining stock. Although Strand continued to request physical possession of the certificates for the remaining 29,200 shares he had purchased through Shearson, Shearson never delivered these certificates.

From June 24 to 27, 1986, Strand placed an order or orders to buy 34,500 additional shares of Atlantic Mining stock through his Shearson account. Shearson purchased the shares for between eight and ten dollars per share, creating a debt of $318,886.41, which Strand failed to pay by the settlement date.

At the beginning of July, 1986, Shearson's Salt Lake office manager began discussing the M & L unpaid balance with Strand for the additional 34,500 shares. Strand represented to Shearson that he would soon pay his account balance, but payment was not received. The stock reached its peak value of nearly thirteen dollars per share at this time--i.e., near the beginning of July.

On approximately July 11, 1986, Shearson began liquidating the M & L account. This was approximately seven days after the settlement date--i.e., the date payment was due--for the ordered 34,500 shares. When Strand learned of the liquidation, he immediately ordered Shearson to stop and represented that he was arranging a loan to pay the outstanding balance. Based on Strand's representations, Shearson suspended the liquidation in mid-July, after it had been liquidating the account for approximately three business days and after only 4,500 shares had been sold.

At some point between mid-June and the end of July, Strand returned to Shearson the certificates he had previously received for the 40,000 shares of Atlantic Mining stock. Shearson contended at trial that Strand returned the certificates as a show of good faith on his overdue account. Strand asserts he returned the certificates for safe-keeping to await the arrival of the remaining certificates. When Strand returned the certificates, their market value was approximately $400,000.

Shearson continued to demand payment through the end of July but did not resume liquidation sales until negotiations with Strand for payment effectively stopped. On August 7, 1986, Shearson filed this breach of contract suit, and on September 19, 1986, Shearson liquidated all the remaining shares of Atlantic Mining in the M & L account at the market price of approximately fifty cents a share. After the liquidation, a debit balance of approximately $268,529.10 remained. In the district court, Strand filed a counter-claim for restitution of the 40,000 shares returned to Shearson in June or July and claimed as an affirmative defense to Shearson's breach of contract action that Shearson's recovery was barred because Shearson had violated applicable federal regulations--i.e., Regulation T, 12 C.F.R. Sec. 220.8--governing liquidation of cash accounts. ²

Exercising diversity jurisdiction, the district court found that Shearson violated Regulation T by failing to promptly liquidate the M & L account after the seven-day settlement period had elapsed. Then, applying New York law, which was the parties' choice of law in their contract, the court held that Shearson's violation of Regulation T was an affirmative defense to Strand's breach. Thus, the court held that Strand did not have to pay the outstanding balance of $268,529.10. On Strand's claim for restitution of the stock certificates, representing the 40,000 shares for which he had already paid, the court ordered Shearson to return the certificates to Strand.

I.

On appeal, Shearson asserts: (1) it did not violate Regulation T; (2) the parties waived reliance on New York law by relying exclusively on Utah and Tenth Circuit law in their representations to the district court; and (3) even if New York law applies, there is no affirmative defense for Regulation T violations under New York law. Therefore, Shearson argues, it is entitled to its damages for Strand's breach of contract. We address each argument in turn.

We first address Shearson's assertion that it did not violate Regulation T. With regard to cash accounts, Regulation T requires purchasers of stock to pay for the stock ordered within seven days of the day they placed the order for the stock. 12 C.F.R. Sec. 220.8. If the purchaser fails to make timely payment, Regulation T requires the holder of the account, in this case Shearson, to "promptly liquidate" the account. Id. ³ Thus, the determination of whether Shearson violated Regulation T depends upon whether Shearson promptly liquidated Strand's account. We review de novo the legal interpretation of terms in a federal regulation. Brabson v. Metropolitan Life Ins. Co., 795 F.2d 897, 899 (10th Cir.1986).

We agree with the district court's determination that Shearson failed to promptly liquidate the account. While there might be some situations in which it would be a close question as to whether a liquidation was prompt, Shearson's liquidation of M & L's account is not one of them. Shearson did not attempt to sell the shares until one week after payment was due under Regulation T--i.e., seven days after the seven-day settlement period had elapsed--and then left the shares on the market for only three days after selling only 4,500 shares. Furthermore, Shearson did not attempt to liquidate the balance of the M & L account again for two more months, at which time Shearson was able to liquidate the account, albeit for a much lower price than it had paid for the stocks. ⁴ Therefore, we hold that Shearson did not "promptly liquidate," thus violating Regulation T. ⁵ See Pearlstein v. Scudder & German, 429 F.2d 1136, 1139-40 (2d Cir.1970) ("it seems reasonably clear that defendant violated [Regulation T] when it failed in each instance to sell the bonds after seven business days had expired without payment"), cert. denied, 401 U.S. 1013, 91 S.Ct. 1250, 28 L.Ed.2d 550 (1971).

To address Shearson's second argument--i.e., that the parties waived reliance on New York law by relying exclusively on Utah and Tenth Circuit law in their representations to the district court--we must first determine which law to apply to...