The opinion of the court was delivered by: BARTELS
This is an action by the plaintiffs individually and on behalf of others who purchased securities during 1965 and 1966 through the brokerage firm of A.L. Stamm & Co., to recover damages for losses resulting from numerous trades on a national securities exchange. Jurisdiction is predicated upon 15 U.S.C.A. §§ 77v and 78aa.
Defendants (partners of A. L. Stamm) move to dismiss the action as a class action pursuant to Rule 23 of the Federal Rules of Civil Procedure, 28 U.S.C.A., and the plaintiffs cross-move for partial summary judgment pursuant to Rule 56 of the Federal Rules of Civil Procedure, 28 U.S.C.A.
Plaintiffs charge that Stamm through its employee Adolph Bennett and other employees induced the plaintiffs to make purchases and sales of securities in the maximum amount on a national securities exchange for the benefit of Stamm by means of fraudulent representations and agreements whereby Stamm agreed that payment for the securities could be made by the plaintiffs "as each might from time to time determine himself able to do" without complying with the applicable margin requirements of the Securities Exchange Act of 1934 (Act) and, further, that Stamm would provide the necessary credit and would not sell the securities so purchased for non-payment or failure to provide collateral; that in breach of these fraudulent statements and these agreements Stamm, after permitting the purchase and sale of securities in violation of the prescribed margin requirements, subsequently demanded additional collateral and sold plaintiffs' securities for their failure to comply, causing them substantial losses. They allege that defendants' acts violate 15 U.S.C.A. §§ 77 l, 77q, 78g, 78j(b), 78 o,1 78bb and 78cc and the rules and regulations thereunto appertaining.
Defendants, in their answer and affidavits, deny knowledge of the charges except they admit the number of purchases and sales made and in turn counterclaim against the plaintiffs for unpaid balances in plaintiffs' accounts, accusing them of employing deceptive and manipulative devices in violation of Section 10(b) of the Act, 15 U.S.C.A. § 78j(b), and Rule 10b-5, 17 C.F.R. § 240.10b-5, by entering into a fraudulent conspiracy with one or more of Stamm's employees to place orders for the purchase and sale of securities, knowing that plaintiffs could not pay for the same but representing that they were ready, able and willing to do so; that upon discovery of the fraudulent conspiracy the defendants sold the securities in plaintiffs' accounts for failure to make payment therefor, and that by reason of said conspiracy the defendants sustained monetary losses, for which they seek recovery. Defendants contend that plaintiffs' active participation and conspiracy with Stamm's employees bars them from recovery and that their claims do not satisfy the requirements of Rule 23 for a class action.
Plaintiffs' right of action is based upon four theories of recovery, (1) churning of plaintiffs' accounts in violation of Section 10(b) and Rule 10b-5 promulgated thereunder;
(2) liability resulting from Stamm's violation of the margin requirements prescribed by Section 7(a) and (c) of the Act (15 U.S.C.A. § 78g(a) and (c)) and Regulation "T" issued by the Board of Governors of the Federal Reserve System thereunder, 12 C.F.R. §§ 220.1 et seq. ; (3) breach of agreement not to sell plaintiffs' securities for failure to provide collateral, and (4) fraudulent representations by Stamm not to sell plaintiffs' securities for such failure. They claim there is no factual issue involved upon the first two theories and that they are therefore entitled to a partial summary judgment as to liability.
The right to a summary judgment, partial or otherwise, depends not only upon the existence of a genuine issue of material fact but also upon whether the admitted facts establish a legal cause of action. Rule 56(c), Fed. Rules Civ. Proc., 28 U.S.C.A.; Krieger v. Ownership Corporation, 270 F.2d 265 (3 Cir. 1959). Stamm admits that plaintiffs purchased a large number of securities through its agency within a short time without adequate security through the dishonest acts of its employees Adolph Bennett and Kevin Mullen "with the fraudulent result that Stamm's funds were utilized to pay for the securities so purchased ". Plaintiffs assume that defendants are bound by the conduct of their employees in spite of the charge made by the defendants concerning the conspiracy between the employees and the plaintiffs, and that the admissions of the defendants with respect to multiple transactions and violation of the margin requirements automatically entitle the plaintiffs to a partial summary judgment upon the issue of liability. As a matter of law, this conclusion does not follow and summary judgment must be denied for the reasons hereafter discussed.
This claim for relief is founded upon Section 10(b) of the Act and Rule 10b-5 issued thereunder, which, in substance, makes unlawful the employment of any manipulative or deceptive device or contrivance by any person in connection with the purchase and sale of any security upon a national securities exchange or otherwise. Rule 10b-5 makes it unlawful for any person so engaged "(a) To employ any device, scheme, or artifice to defraud," and "(c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person." In defining these terms with respect to Section 15(c) of the Act (15 U.S.C.A. § 78 o (c)) pertaining to broker-dealer transactions on Over-the-Counter markets, the Commission's rule states that such devices include "any act of any broker or dealer designed to effect with or for any customer's account in respect to which such broker or dealer or his agent or employee is vested with any discretionary power any transactions of purchase or sale which are excessive in size or frequency in view of the financial resources and character of such account." 17 C.F.R. § 240.15c1-7(a).
Over-trading, per se, in an account whose transactions are initiated by a customer does not constitute churning in the absence of any fiduciary relationship. See, Thomson & McKinnon, 35 SEC 451, 454 (1953). But over-trading will constitute churning whenever a broker or dealer, who is in a position to determine the volume and frequency of transactions by reason of the confidence imposed in him, abuses the confidence of the customer for personal gain by frequent and numerous transactions disproportionate to the investment in the account. Looper & Co., 38 SEC 294, 296 (1958); 3 Loss, Securities Regulation, 1479-80 (2nd Ed. 1961); Note, Churning by Securities Dealers, 80 Harv. L. Rev. 869 (1967). Such conduct on the part of the broker provides an action for breach of trust under common law principles. But breach of trust would not be sufficient to confer jurisdiction upon this Court in the absence of diversity.
The Act does not expressly provide for civil liability for violation of Section 10(b). Nevertheless, in order to make effective the objectives of the Act, "it is the duty of the courts to be alert to provide such remedies as are necessary to make effective the congressional purpose". J.I. Case Company v. Borak, 377 U.S. 426, 433, 12 L. Ed. 2d 423, 84 S. Ct. 1555 (1964); Deckert v. Independence Shares Corporation, 311 U.S. 282, 288, 85 L. Ed. 189, 61 S. Ct. 229 (1940). Since one of the purposes of the Act is the protection of the individual investor as well as the public at large, a civil tort has been implied from a violation of the standard of conduct set forth in the Act upon the principles enunciated in Restatement (Second), Torts, § 286 (1965). J.I. Case Company v. Borak, supra; Remar v. Clayton Securities Corporation, 81 F. Supp. 1014 (D. Mass. 1949); Reader v. Hirsch & Co., 197 F. Supp. 111 (S.D.N.Y. 1961); Lorenz v. Watson, 258 F. Supp. 724 (E.D. Pa. 1966).
It is quite clear in this Circuit that a tort will be implied from a Section 10(b) violation. Vine v. Beneficial Finance Company, 374 F.2d 627 (2nd Cir. 1967); Fischman v. Raytheon Mfg. Co., 188 F.2d 783 (2 Cir. 1951).
The question is whether churning comes within the definition of such a tort, an issue not expressly determined in this Circuit. In the absence of deception, a mere breach of a fiduciary duty may not set forth a Section 10(b) violation. O'Neill v. Maytag, 339 F.2d 764 (2 Cir. 1964). But churning as a stock manipulation, involving a breach of the customer's confidence, constitutes a deception arising theoretically from a broker's violation of his promise and representation to fairly deal with the customer implied from the customer-broker relationship. See, Charles Hughes & Co., Inc. v. SEC, 139 F.2d 434, 435-36 (2 Cir. 1943), cert. denied, 321 U.S. 786, 88 L. Ed. 1077, 64 S. Ct. 781; 3 Loss, Securities Regulation, supra, at 1482-93; Churning by Securities Dealers, supra, at 870. Every fraudulent and deceptive device in connection with the purchase and sale of securities is prohibited by Section 10(b) and Rule 10b-5. A.T. Brod & Co. v. Perlow, 375 F.2d 393, 397 (2 Cir. 1967). District courts in other jurisdictions have held that churning as a deceptive device was included in the Section 10(b) proscription (Lorenz v. Watson, supra; Hecht v. Harris, Upham & Co., 283 F. Supp. 417 (N.D. Cal. 1968); Nash v. J. Arthur Warner & Co., 137 F. Supp. 615 (D. Mass. 1955)), a conclusion which is consistent with the expanding definition of fraud under the federal securities laws and adopted by this Court. See also, R.H. Johnson & Co. v. SEC, 97 U.S. App. D.C. 364, 231 F.2d 523 (D.C. Cir. 1956), cert. denied, 352 U.S. 844, 77 S. Ct. 48, 1 L. Ed. 2d 60; Norris & Hirshberg, Inc. v. SEC, 85 U.S. App. D.C. 268, 177 F.2d 228 (D.C. Cir. 1949). Federal jurisdiction being present under the Act, plaintiffs may assert their claim of common law breach of trust. United Mine Workers of America v. Gibbs, 383 U.S. 715, 724-727, 16 L. Ed. 2d 218, 86 S. Ct. 1130 (1966); Hurn v. Oursler, 289 U.S. 238, 77 L. Ed. 1148, 53 S. Ct. 586 (1933).
Plaintiff Moscarelli claims his account was turned over approximately twelve (12) times each month for a period of four months, and that a chart of the purchases and sales of National Video Corporation stock in his account reveals fifteen (15) purchases and twelve (12) sales in less than four months. According to the complaint, similar excessive turnover rates exist in the accounts of the other plaintiffs. There is little doubt that such purchases and sales took place. Defendants deny not the number of transactions, but that the transactions were unauthorized by plaintiffs or that there was any misrepresentation to the plaintiffs. To establish churning, it is not sufficient to prove merely an abnormal number of purchases and sales within a short period. Aside from the issue of Stamm's liability for its agents' conduct which is hereafter considered, there are other issues of fact which remain open, such as (1) the nature of plaintiffs' accounts; (2) the existence of any misrepresentations or agreements on the part of Stamm with respect ...