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SERZYSKO v. CHASE MANHATTAN BANK

September 19, 1968

Edward Serzysko, Plaintiff-Appellant,
v.
The Chase Manhattan Bank, Defendant-Appellee


Graven, Senior District Judge (by assignment).


The opinion of the court was delivered by: GRAVEN

GRAVEN, Senior District Judge (by assignment):

1. The plaintiff is a citizen and resident of the State of New York. The defendant is a corporation engaged in the banking business in the City of New York, New York. The plaintiff seeks to recover damages allegedly caused to him by reason of loans made to him by the defendant, which loans he alleges were made in violation of Regulation U (12 C.F.R. 221) promulgated by the Board of Governors of the Federal Reserve System pursuant to Section 7(a) of the Securities Exchange Act of 1934, 15 U.S.C.A. Sec. 78(g). That Regulation relates to the margin requirements for loans made for the purpose of the purchasing or carrying of registered securities. Jurisdiction is based upon the Securities Exchange Act of 1934, 15 U.S.C.A. Sec. 78aa. The trial was to the Court.

 Under the provisions of the Securities Exchange Act of 1934 and the regulations promulgated thereunder, issues of stock which are registered on a national securities exchange constitute registered securities. The New York Stock Exchange is a national securities exchange.

 2. Commencing in September, 1958, the defendant made the plaintiff a number of loans. The loans were secured by collateral. The collateral in the main consisted of registered securities. In 1962, following a decline in the market value of the collateral, the defendant sold the collateral then remaining and applied the proceeds thereof on the then existing loan of the plaintiff. After applying the proceeds there was an unpaid balance on the loan of approximately $14,000.00. In this action the plaintiff seeks to recover the damages allegedly sustained by him by reason of the loans and such sale. The defendant by a counterclaim seeks to recover from the plaintiff the present unpaid balance of the loan.

 3. Section 78g, Title 15 U.S.C.A., provides, in part, as follows:

 
"(a) For the purpose of preventing the excessive use of credit for the purchase or carrying of securities, the Board of Governors of the Federal Reserve System shall, prior to October 1, 1934, and from time to time thereafter, prescribe rules and regulations with respect to the amount of credit that may be initially extended and subsequently maintained on any security * * * registered on a national securities exchange. * * *
 
"* * *
 
"(c) It shall be unlawful for any member of a national securities exchange or any broker or dealer who transacts a business in securities through the medium of any such member, directly or indirectly to extend or maintain credit or arrange for the extension or maintenance of credit to or for any customer -
 
"(1) On any security * * * registered on a national securities exchange, in contravention of the rules and regulations which the Board of Governors of the Federal Reserve System shall prescribe under subsections (a) and (b) of this section.
 
"* * *
 
"(d) It shall be unlawful for any person not subject to subsection (c) of this section to extend or maintain credit or to arrange for the extension or maintenance of credit for the purpose of purchasing or carrying any security registered on a national securities exchange, in contravention of such rules and regulations as the Board of Governors of the Federal Reserve System shall prescribe to prevent the excessive use of credit for the purchasing or carrying of or trading in securities in circumvention of the other provisions of this section. * * *."

 Paragraph (c) above set forth relates to brokers and dealers. Paragraph (d) above set forth relates to banker lenders.

 Pursuant to the authority granted to the Board of Governors of the Federal Reserve System by the Securities Exchange Act of 1934, that Board promulgated Regulations T and U. Regulation T governs the extension of credit to a customer by any member of a national exchange or any broker or dealer transacting business with a member. Regulation U covers loans by banks for the purpose of purchasing or carrying registered securities. Both prescribe minimum margin requirements referred to as maximum loan values which have been varied from time to time. It appears that the regulation places the entire burden of observing the margin requirements on the lender.

 The Board of Governors of the Federal Reserve System is charged with the responsibility of promulgating regulations relating to margin requirements and the administration of them. The enforcement of the regulations of that Board has been assigned to the Securities and Exchange Commission. The Securities and Exchange Commission may bring an action to enjoin violators of the Act or to transmit evidence of violations to the Attorney General for the institution of criminal proceedings. Section 78u, Title 15 U.S.C.A.

 Section 78ff, Title 15 U.S.C.A., provides, in part, as follows:

 
"(a) Any person who willfully violates any provision of this chapter, or any rule or regulation thereunder the violation of which is made unlawful or the observance of which is required under the terms of this chapter * * * shall upon conviction be fined not more than $10,000, or imprisoned not more than two years, or both * * *; but no person shall be subject to imprisonment under this section for the violation of any rule or regulation if he proves that he had no knowledge of such rule or regulation. * * *"

 Section 78cc, Title 15 U.S.C.A., provides, in part, as follows:

 
"* * *
 
"(b) Every contract made in violation of any provision of this chapter or of any rule or regulation thereunder, and every contract * * * heretofore or hereafter made, the performance of which involves the violation of, or the continuance of any relationship or practice in violation of, any provision of this chapter or any rule or regulation thereunder, shall be void (1) as regards the rights of any person who, in violation of any such provision, rule, or regulation, shall have made or engaged in the performance of any such contract, and (2) as regards the rights of any person who, not being a party to such contract, shall have acquired any right thereunder with actual knowledge of the facts by reason of which the making or performance of such contract was in violation of any such provision, rule, or regulation * * *."

 Section 221.1(a) of Regulation U provides, in part:

 
"No bank shall make any loan secured directly or indirectly by any stock for the purpose of purchasing or carrying any stock registered on a national securities exchange * * * in an amount exceeding the maximum loan value of the collateral, as prescribed from time to time for stocks in Section 221.4 * * *."

 In Section 221.3(b) of the Regulation "carrying" is defined as encompassing a loan made "for the purpose of reducing or retiring indebtedness incurred to purchase that stock."

 Section 221.3(a) of Regulation U provides:

 
"(a) In determining whether or not a loan is for the purpose specified * * * a bank may rely upon a statement with respect thereto only if such statement (1) is signed by the borrower; (2) is accepted in good faith and signed by an officer of the bank as having been so accepted; and (3) if it merely states what is not the purpose of the loan, is supported by a memorandum or notation of the lending officer describing the purpose of the loan. To accept the statement in good faith, the officer must be alert to the circumstances surrounding the loan and the borrower and must have no information which would put a prudent man upon inquiry and if investigated with reasonable diligence would lead to the discovery of the falsity of the statement."

 Section 78aa, Title 15 U.S.C.A., provides, in part, as follows:

 
"The district courts of the United States * * * shall have exclusive jurisdiction of violations of this chapter or the rules and regulations thereunder, and of all suits in equity and actions at law brought to enforce any liability or duty created by this chapter or the rules and regulations thereunder. * * *"

 4. The Securities Exchange Act contains no provision providing for a private cause of action for violation of the regulations promulgated by the Board of Governors of the Federal Reserve System relating to margin requirements. Private remedies are expressly provided in connection with violations of certain other sections of the Act. Sections 78i(e), 78p(e), 78r(a), Title 15 U.S.C.A. There are a number of other sections as to which the Act has not provided any private remedies but as to which a private cause of action has been implied. J.I. Case Co. v. Borak (1964), 377 U.S. 426, 84 S. Ct. 1555, 12 L. Ed. 2d 423 - (implied as to Section 14(a) of the Act Section 78n(a), Title 15 U.S.C.A.). See Notes, 77 Harvard L. Review 285 (1963-1964), 66 Columbia L. Review 1462 (1966). See, also, 61 Michigan L. Review 947 (1962-1963). The weight of authority is to the effect that a private cause of action is to be implied in the case of a violation of the margin regulations promulgated under the provisions of the Act. Smith v. Bear (2d Cir. 1956), 237 F.2d 79, 87-88, 60 A.L.R.2d 1119; Remar v. Clayton Securities Corporation (D.C. Mass. 1949), 81 F. Supp. 1014; Appel v. Levine (S.D.N.Y. 1948), 85 F. Supp. 240; Warshow v. H. Hentz & Co. (S.D.N.Y. 1961), 199 F. Supp. 581; Glickman v. Schweickart & Co. (S.D.N.Y. 1965), 242 F. Supp. 670; Moscarelli v. Stamm (E.D.N.Y. July 12, 1968), 288 F. Supp. 453.

 This Court holds that a private cause of action for violation of the margin requirements of the Act is to be implied. The troublesome and difficult questions involved in the present case and in certain other cases is as to the nature and character of the implied private cause of action. In all of the District Court cases above cited, the question as to the implied cause of action arose in connection either with motions to dismiss or for summary judgment and there was no evidentiary hearing on the merits. In the present case there was a complete and lengthy evidentiary hearing at which all of the facts relating to the transactions involved were fully developed.

 5. The plaintiff was born in Poland in 1906. He served in the Polish Merchant Marine until 1943. From 1943 up to September, 1952, he served in the United States Merchant Marine. From September, 1952, up until June, 1953, he attended the New York Finance Institute of the New York Stock Exchange. His courses in that Institute included courses on stock exchange transactions. From July, 1953, until October, 1953, he was a trainee with the stockbroker firm of Cosgrove, Miller & Whitehead. From October, 1953, until March 24, 1956, he was a registered representative of that firm and its successor. From March 23, 1960, until May 24, 1962, he was a registered representative of the stockbroker firm of Hill, Darlington & Company and its successor. From May 25, 1962 on, he was a registered representative of the stockbroker firm of Burnham & Company. All of the firms referred to were members of the New York Stock Exchange. As a registered representative of the broker firms referred to, the plaintiff handled the accounts of customers of the firms, including margin accounts.

 During the periods of time here involved Harold Hardiman was the executive officer in charge of a branch of the defendant referred to as the Broadway Branch. George Hughes was also an officer of the same branch. During the forenoon of September 8, 1958, Thomas W. Hill, a member of the firm of Hill, Darlington & Company, talked with Mr. Hardiman. Mr. Hardiman had been acquainted with Mr. Hill for some time and regarded him as being highly reputable. Mr. Hill stated to Mr. Hardiman that Edward Serzysko, one of their registered representatives, was desirous of securing a loan from the Chase Manhattan Bank for the purpose of opening up a checking account. Mr. Hill further stated that he had a very high regard for Mr. Serzysko. Mr. Hardiman then brought up the matter of Regulation U. He informed Mr. Hill that the Bank would not consider making a loan for use in purchasing or carrying registered securities within the scope of Regulation U. Loans not within the scope of Regulation U are referred to as nonpurpose loans. Mr. Hardiman, Mr. Hill and the plaintiff met for lunch on September 8, 1958, at which time the matter of the loan was discussed. The discussion covered the matter of Regulation U. All of them were familiar with that Regulation. Mr. Hardiman told the plaintiff and Mr. Hill that the Bank would only make a nonpurpose loan. The plaintiff represented to Mr. Hardiman that he desired the loan for the purpose of purchasing convertible bonds and other bonds. The purchase of bonds was not within the scope of Regulation U and a loan for such purpose would be a nonpurpose loan.

 Pursuant to the discussion Hardiman prepared the papers for the proposed loan, which papers were dated September 12, 1958. On that date the plaintiff was the owner of registered securities having a market value of $203,704.00. They were pledged with a loan from the plaintiff from Hill, Darlington & Company in the approximate amount of $100,000.00. During the discussion on September 8, 1958, the matter of that loan was not referred to. On September 12, 1958, the Bank made the plaintiff a loan in the sum of $150,000.00 evidenced by a demand note. As security for the payment of the note the plaintiff pledged the shares of stock owned by him which, as heretofore noted, had a market value of around $200,000.00. On September 9, 1958, prior to the closing of the loan, the plaintiff in writing directed the Bank to pay Hill, Darlington & Company approximately $100,500.00 for debit to his account. Upon the delivery of the shares of stock the Bank paid Hill, Darlington & Company the sum of $100,623.03. At the time of the making of the loan the plaintiff was orally informed by Mr. Hardiman that he would be expected to maintain a checking account equal to 10 percent of the loan.

 6. In connection with the securing of the loan of September 12, 1958, the plaintiff executed a purpose statement. That statement was, in part, as follows:

 "STATEMENT WITH RESPECT TO PURPOSE OF LOAN

 Date SEP 12 1958

 To THE CHASE MANHATTAN BANK,

 189 Broadway Branch

 (Head Office or Branch)

 Pursuant to Regulation U promulgated by the Board of Governors of the Federal Reserve System, the following statement refers to a loan in the amount of $150,000.00, dated SEP 12 1958 due on demand, made by said bank to the undersigned.

 A. The above described loan is not (is or is not) for the purpose of purchasing or carrying* stock registered on a national securities exchange.

 /s/ Edward Serzysko

 (Signature of Borrower or Bank ...


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