Utah State University of Agriculture and Applied Science v. Bear Stearns & Co.

• Decision Date: 24 January 1977
• Docket Number: Nos. 75-1854,s. 75-1854
• Parties: Fed. Sec. L. Rep. P 95,847 UTAH STATE UNIVERSITY OF AGRICULTURE AND APPLIED SCIENCE, Plaintiff-Appellant, v. BEAR, STEARNS & CO., et al., Defendants-Appellees. to 75-1856, 75-1858, 75-1860 to 75-1862 and 76-1330.
• Court: U.S. Court of Appeals — Tenth Circuit

Page 164

549 F.2d 164

Fed. Sec. L. Rep. P 95,847

UTAH STATE UNIVERSITY OF AGRICULTURE AND APPLIED SCIENCE, Plaintiff-Appellant, v. BEAR, STEARNS & CO., et al., Defendants-Appellees.

Nos. 75-1854 to 75-1856, 75-1858, 75-1860 to 75-1862 and 76-1330.

United States Court of Appeals, Tenth Circuit.

Argued and Submitted Sept. 23, 1976.

Decided Jan. 24, 1977.

David L. Wilkinson, Special Asst. Atty. Gen., Salt Lake City, Utah (Vernon B. Romney, Atty. Gen., Salt Lake City, Utah, was with him on the brief), for plaintiff-appellant.

Harold G. Christensen, Parker M. Neilson and Keith E. Taylor, Salt Lake City, Utah (Daniel M. Allred, Krege B. Christensen, Parsons, Behle & Latimer, Salt Lake City, Utah, Dawson, Nagel, Sherman & Howard, Denver, Colo., Worsley, Snow & Christensen, R. Brent Stephens, Craig S. Cook and Alan E. Walcher, Salt Lake City, Utah, were with them on the briefs), for defendants-appellees.

Before McWILLIAMS, BREITENSTEIN and BARRETT, Circuit Judges.

BREITENSTEIN, Circuit Judge.

These eight companioned appeals are from judgments dismissing actions brought by plaintiff-appellant, Utah State University, against various brokers to recover losses sustained in securities transactions. The claims are based on alleged violations of certain statutes, administrative regulations, and rules of private organizations of securities dealers. We affirm.

Utah State University of Agriculture and Applied Science, USU, is a corporation existing under the constitution of the State of Utah and operates at Logan, Utah, as a land grant university. Defendants are all brokerage firms organized under the laws of various states other than Utah. Each defendant is a member of the New York Stock Exchange, NYSE, the American Stock Exchange, AMEX, and the National Association of Security Dealers, NASD. Jurisdiction is based on § 27 of the Securities Exchange Act of 1934, 15 U.S.C. § 78aa.

In furtherance of its securities investment program, the governing body of USU on January 20, 1972, adopted a resolution which said:

(1) USU "is authorized and empowered to open and maintain an account with any broker" who is a member of a major security exchange or of NASD.

(2) The authorization covers "the purchase, trade and sale, long or short, (of) * * * stocks, bonds and securities of every nature on margin or otherwise * * *."

(3) Two named officers, Broadbent and Catron, have power to act under the resolution for USU.

(4) "(T)his resolution shall be and remain in full force and effect until written notice of the revocation hereof shall be delivered to the brokers."

Between February, 1972, and March, 1973, Catron opened accounts with numerous brokerage firms and purchased millions of dollars worth of securities. Catron, a well-educated man with business and accounting experience, had been a licensed securities salesman. He became the Controller of USU in July, 1970.

In the Spring of 1972, the Utah State Auditor's Office notified Catron that later in the year an audit would be made of the USU investment program. To improve the program's cash flow picture, Catron engaged in a series of transactions in which he sold stock through one broker and immediately repurchased the same stock utilizing another broker. By this operation he received immediate payment for the stock sold and did not have to pay for the stock bought until its delivery.

In December, 1972, an independent auditing firm employed by USU questioned the legality of the USU stock purchase program. In the same month local newspapers reported the belief of an assistant attorney general of Utah that the USU stock purchases were illegal. On December 4, 1972, USU instructed Catron to stop purchasing securities on its behalf. Catron did not stop the USU security transactions until March, 1973, when USU sent to each brokerage firm a written revocation of Catron's authority. On December 23, 1975, the Supreme Court of Utah held that USU did not have the power to purchase common stock with its public funds. See First Equity Corporation of Florida v. Utah State University, Utah, 544 P.2d 887.

In each of the eight appeals before us, USU is the plaintiff-appellant. The following list shows the defendant-appellee in each case:

No. 75-1854 - Bear, Stearns & Co.

No. 75-1855 - Blyth Eastman Dillon & Co.

No. 75-1856 - Bosworth, Sullivan & Company

No. 75-1858 - Hornblower & Weeks - Hemphill

Noyes, Inc.

No. 75-1860 - Shearson, Hammil & Co.

No. 75-1861 - Sutro & Co.

Nos. 75-1862- Merrill Lynch, Pierce, Fenner

76-1330 Smith, Inc.

USU sued the brokers to recover its losses on stocks purchased and sold and to recover the commissions paid to brokers on all stock transactions regardless of whether USU received a loss or gain. The complaint asserts federal law claims which may be grouped in three categories:

1 Violations of fair practice and suitability rules of NYSE, AMEX, and NASD.

2 Violations of § 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), and of Rule 10b-5, 17 C.F.R. § 240.10b-5, promulgated thereunder.

3 Violations of Federal Reserve System Regulation T, 12 C.F.R. Part 220, promulgated pursuant to 15 U.S.C. § 78g(a).

The complaints also allege various pendent claims under state laws.

In the Sutro case no Regulation T claim is presented. The two appeals relating to Merrill Lynch will be discussed separately. All defendants except Merrill Lynch filed motions to dismiss the pertinent complaint.

By order, the court allowed the parties "to file affidavits and other supporting material" so that the motions to dismiss could be considered as motions for summary judgment under Rule 12(b), F.R.Civ.P. Many affidavits were filed on each side. The deposition of Catron was presented. The court dismissed the counts based on the NASD, NYSE, and AMEX rules for failure to state a claim in that violations of exchange and association rules do not give rise to a private cause of action. With regard to the Rule 10b-5 claims the court held that violations of the NYSE, AMEX, and NASD suitability rules did not give rise to a Rule 10b-5 claim and hence, the complaint did not state a cause of action under Rule 10b-5.

As to the claims based on Regulation T, the court held that the regulation did not give rise to a private cause of action and hence failed to state a claim. The court also held that summary judgment was proper on the Regulation T claims because USU was in pari delicto. On the pendent claims, the court, in dismissing, noted the pendency of state court actions involving those claims. No questions are raised on these appeals regarding the dismissals of the pendent claims.

The NASD, NYSE, and AMEX Rules.

Article III, § 1, of the NASD Rules of Fair Practice requires a member to "observe high standards of commercial honor and just and equitable principles of trade." Section 2 of the same Article requires a member in recommending the purchase of a security to a customer to have reasonable grounds for believing that the security is suitable for the particular customer. This proscription is often called the "Suitability Rule."

NYSE Rule 405, called the Know-Your-Customer Rule, and the similar AMEX Rule 411 require that a member use "due diligence to learn the essential facts relative to every customer, order" or account.

The Securities Exchange Act of 1934 requires the registration of national securities associations and exchanges. The rules of these self-regulatory bodies must be approved by the Securities and Exchange Commission, SEC. See 15 U.S.C. § 78o -3(b) and § 78f(b). The areas and concerns which the rules must cover are statutorily imposed. Ibid. SEC must approve any changes in the rules. 15 U.S.C. § 78s(b). SEC can "abrogate, add to and delete from" any of the self-regulatory rules in order to further the purposes of the Act. 15 U.S.C. § 78s(c). Brokers who are not members of NASD have similar rules imposed on them by SEC regulation. For example, forms of NASD's Rules of Fair Practice, Art. III, §§ 1 and 2 which are involved in these appeals, are imposed on non-members by 17 C.F.R. §§ 240.15b10-2 and 240.15b10-3.

Colonial Realty Corporation v. Bache & Co., 2 Cir., 358 F.2d 178, cert. denied 385 U.S. 817, 87 S.Ct. 40, 17 L.Ed.2d 56, rejected an implied cause of private action for violation of Art. III, § 1, of the NASD rules. The court recognized that the Securities Exchange Act of 1934 did not specifically authorize actions for violation of private association rules. The court said that an implied cause of action could be established by the courts to effectuate the congressional purpose and federal policy behind the 1934 Act. In so holding, the court relied on J. I. Case v. Borak, 377 U.S. 426, 84 S.Ct. 1555, 12 L.Ed.2d 423. The court in Colonial Realty said that it would recognize an implied cause of action where the rule violated; (1) amounted to a substitute for an SEC regulation, and (2) established an explicit duty unknown to the common law. 358 F.2d at 182.

Buttrey v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 7 Cir., 410 F.2d 135, cert. denied 396 U.S. 838, 90 S.Ct. 98, 24 L.Ed.2d 88, recognized an implied cause of action under NYSE Rule 405. The court said that determination of whether violation of a rule is actionable depends on whether its design is "for the direct protection of investors" and said one of the functions of Rule 405 was the protection of the public. Ibid. at 142. Critics of the Buttrey decision have pointed out that Rule 405 was not promulgated to protect customers from shady brokers but rather to protect brokers from unscrupulous customers. This criticism has its basis in SEC, Report of Special Study of Securities Markets of the Securities and Exchange Commission, H.R.Doc.No.95, 88th Cong. 1st Sess., pt. 1, at 316.

In Buttrey the court did not say that an alleged violation of Rule 405 was per se actionable. 410 F.2d at 142. The complaint there under consideration alleged fraudulent conversion of securities. The court said, Ibid. at...