Union Bank of Switzerland v. HS EQUITIES

• Decision Date: 13 June 1978
• Docket Number: No. 76 Civil 4378.,76 Civil 4378.
• Citation: 457 F. Supp. 515
• Parties: UNION BANK OF SWITZERLAND, Plaintiff, v. HS EQUITIES, INC., Defendant.
• Court: U.S. District Court — Southern District of New York

457 F. Supp. 515

UNION BANK OF SWITZERLAND, Plaintiff, v. HS EQUITIES, INC., Defendant.

No. 76 Civil 4378.

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

June 13, 1978.

Sullivan & Cromwell, New York City, for plaintiff; Francis Carling, New York City, of counsel.

Robert J. Poulson, Jr., New York City, for defendant.

OPINION, FINDINGS OF FACT AND CONCLUSIONS OF LAW

EDWARD WEINFELD, District Judge.

This action is brought by Union Bank of Switzerland ("UBS" or "Bank"), a Swiss bank, to recover from the defendant, HS Equities, Inc., successor to Hayden, Stone Incorporated ("Hayden Stone" or "defendant"),¹ who acted as a broker for UBS in the sale and purchase of securities in this country, the sum of $104,435.99 which defendant paid to the Internal Revenue Service ("IRS") as interest equalization tax ("IET").² The tax liability arose as a result of transactions executed for UBS upon its order, which in fact were for the account of one of its customers, Gerald Martin Zelmanowitz—an American citizen who engaged in foreign securities transactions through UBS.

The basic facts are not in dispute. Plaintiff maintained an "omnibus" brokerage account identified as AM 0086 with Hayden Stone; that is, UBS executed purchase and sale transactions through Hayden Stone for various of its customers through that single account. Hayden Stone was not advised as to the identity of UBS's customers. Hayden Stone received its instructions with respect to each transaction directly from the Bank, executed the transaction in the Bank's name, and either credited (in the case of a sale) or debited (in the case of a purchase) the omnibus account.

When Hayden Stone executed a transaction at the direction of UBS, it sent a confirmation notice to UBS at or about the time of the occurrence. The notice contained the name of the security, the number of shares purchased or sold, the date of the transaction, the purchase or sale price, and the amount of any broker's commission to be added to the purchase price or deducted from the sale proceeds. Upon receipt of the confirmation notice, UBS would debit or credit, whichever was appropriate, its customer's account. The basis of the Bank's accounting for its customers was Hayden Stone's confirmation notice or confirmation by wire. After transmitting the confirmation notice to the plaintiff, Hayden Stone forwarded any proceeds due to plaintiff to the Chase Manhattan Bank, which acted as UBS's agent in New York.

Monthly statements were sent by Hayden Stone to plaintiff which showed the date, the name of the security, the number of shares, and the price for all purchases and sales in the account for the month. These statements also included the amounts and reasons for all cash charges or deductions in the account for that month. The November 1967 monthly statement sent by Hayden Stone to plaintiff contained cumulative deductions of approximately $104,000 for the IET on various transactions executed upon plaintiff's instructions which pertained to its customer Zelmanowitz. In addition to the foregoing, the parties have stipulated that the monthly statements of account sent by Hayden Stone to UBS with respect to account AM 0086 were not reviewed by the Bank upon receipt. Against that background, we consider the facts upon which plaintiff's claim is grounded.

On October 24, 1967, Gerald Martin Zelmanowitz opened an account with the Geneva branch of UBS. Zelmanowitz deposited at least $100,000 in cash in the account on that date and indicated that he was interested in buying stocks in Europe and Canada and selling them in New York. Jacques Martin, the bank official dealing with Zelmanowitz, initially told the new depositor that the Bank could not undertake such transactions because they would be subject to the IET. However, upon Zelmanowitz's assurance to Martin that he had Internal Revenue Service certificates indicating prior American ownership of securities which entitled him to exemption from the IET,³ UBS accepted the account and upon Zelmanowitz's instructions purchased stocks in foreign markets and sold them in New York through its omnibus account with Hayden Stone.

At some point, the IRS began to investigate transactions in various stocks being traded through the omnibus account. In November 1967 an IRS agent visited Robert Kleinberg, then regional counsel in Hayden Stone's legal department. The agent suggested that Hayden Stone look into whether it should be withholding the IET for transactions in five stocks sold through account AM 0086 on behalf of Zelmanowitz. Apparently up to that time, Hayden Stone had not been withholding any amounts from the omnibus account for IET purposes.

The prospect that it might be liable for large sums under the IET caused Hayden Stone to take "unusual" and "drastic" action. In November, Hayden Stone "froze" or stopped all trading in account AM 0086 and also segregated or "blocked" 18¾% of UBS's account to cover taxes which might be due on transactions already completed. Hayden Stone's November 1967 monthly statement to UBS indicated a series of debits for the IET which had been withheld upon previously completed transactions in the AM 0086 account.

UBS informed Zelmanowitz of the blocking of the proceeds in his account during a telephone call by Zelmanowitz from New York to the Bank. Thereafter Zelmanowitz, although he was not Hayden Stone's customer, called upon Kleinberg demanding an explanation for the blockage in the transfer of proceeds from the stock sales. Kleinberg took the position that Hayden Stone had no account in Zelmanowitz's name and that it could only take instructions from UBS concerning the account. Apparently, Zelmanowitz convinced Kleinberg that he was the beneficial owner of the stocks in question and had direct knowledge of the transactions, whereupon Kleinberg informed Zelmanowitz he would have to submit further documentation to avoid future tax withholding from the proceeds of stock sales. When thereafter Zelmanowitz furnished Hayden Stone the appropriate IRS "validation certificates," Hayden Stone unblocked the account.

The now calm waters again grew turbulent at the instance of the IRS. Sometime in late November or early December 1967, an IRS agent notified Kleinberg that the validation certificates submitted by Zelmanowitz might have been improperly issued and thus if Hayden Stone chose not to withhold the tax it did so at its peril.

On December 1, 1967, the Hayden Stone office in Zurich sent UBS a letter confirming a telephone call of that day which stated:

Dear Mr. Martin,

I informed you today on the telephone that a new investigation through the Internal Revenue Service concerning your trades in various European and Canadian Securities is pending.

I recommended you to bloc an amount equal to the interest equalisation tax in your client's account until further notice. We will not fail to submit to you all details concerning this problem upon receipt of the file from our head office in New York.

Please be assured of our full cooperation with your esteemed firm in order to settle these transactions.

We remain,

Yours faithfully Hayden, Stone AG s/R. Stierli Manager

At this point, Hayden Stone was in somewhat of a quandary. It sought to maintain its working relationship with UBS but viewed the government's "suggestion" of potential liability as a sword of Damocles. After consultation with outside counsel, Hayden Stone decided to rescind the freeze on UBS's account. Kleinberg testified that Hayden Stone "came to the conclusion . . that the regulations, or the Interest Equalization Tax law itself, permitted us to rely on the documents, the validation certificate presented by Zelmanowitz, and that the fact that the government was suggesting that we rely on them at our peril was not sufficient for us to not accept them at face value."⁴

Zelmanowitz, who incidentally was not called by either party as a witness at the trial, nor was his testimony offered by way of deposition, evidently had gained the confidence of Kleinberg — at least to a sufficient degree so that Kleinberg freely discussed with him transactions in UBS's omnibus account and entrusted Zelmanowitz to make personal delivery of letters from Hayden Stone to the Bank relative to such transactions.

On December 5, 1967, Kleinberg wrote the following letter to UBS, which was hand delivered in Switzerland by Zelmanowitz explaining the recent events and Hayden Stone's conclusions:

Union Bank of Switzerland Geneva, Switzerland Re: Account No. AM-0086

Gentlemen:

During the past week Hayden, Stone Incorporated issued instructions to our Zurich branch office to temporarily block your account and to withhold all funds until further notice. These instructions have now been rescinded and I wish to emphasize that the issuance of these instructions was not meant to reflect upon the integrity of the Union Bank of Switzerland. A full explanation of the events leading up to this unusual action is beyond the scope and intention of this letter.

Without fully setting forth all of the details leading up to our action, suffice it to say that we were motivated by a simple misunderstanding. Our federal tax authorities led us to believe that there was some mistake in the issuance of certain documents to Mr. Gerald Zelmanowitz. When this information was communicated to us we reacted by freezing your account until such time as the facts could be ascertained.

We now know that the tax officials were in error and acted in such a way that we had no choice but to issue instructions which have no doubt caused inconvenience both to you and to Mr. Zelmanowitz.

We wish to apologize for the inconvenience which resulted from this misunderstanding. Furthermore, we wish to emphasize that none of the events which transpired during this past week should reflect adversely upon the reputation of Mr. Zelmanowitz. Our drastic action with respect to your account was based solely upon a misunderstanding and

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