The opinion of the court was delivered by: GURFEIN
In his original complaint of October 9, 1969, the plaintiff, a former limited partner of Ira Haupt & Co. (hereinafter Haupt), now bankrupt, stated two claims for relief against the New York Stock Exchange (hereinafter Exchange). The first count charged a violation of Section 6 of the Securities Exchange Act of 1934 (15 U.S.C. § 78f) in that the Exchange failed adequately to supervise Haupt as a member firm of the Exchange to the damage of the plaintiff. He denominated the count as one "to enforce a liability or duty created by said Act." The second count charged the Exchange with a violation of Section 10(b) of the 1934 Act (15 U.S.C. § 78j(b)) and Rule 10b-5 in that the Exchange wilfully omitted to state material facts and stated untrue material facts in connection with the sale to plaintiff of a limited partnership -- allegedly a "security" as defined in the Act. Diversity of citizenship was not alleged. Jurisdiction was asserted under Sections 6 and 27 (15 U.S.C. § 78aa) as well as Section 10(b) of the 1934 Act.
The defendant, on December 8, 1969, moved to dismiss the first count on the ground that it was barred by the three-year statute of limitations applicable to actions "to recover upon a liability, penalty or forfeiture created or imposed by statute" (N.Y.C.P.L.R. § 214(2) (McKinney 1963)). That motion was apparently withdrawn upon advice by the plaintiff's attorneys that an amended complaint would be served. This amended complaint was served in January of 1970.
The amended complaint repeats the second count (the 10b-5 count), but the first count is different. Instead of charging a violation of the 1934 Act -- a liability created by statute -- the plaintiff alleges a contract between the Exchange and the Securities and Exchange Commission (hereinafter SEC) of which the plaintiff as an "investor" is a third party beneficiary. In New York "an action upon a contractual obligation or liability" is subject to a six-year statute (N.Y.C.P.L.R. § 213(2) (McKinney 1963)). The avowed purpose of the plaintiff is to found the action on a theory which will not be time-barred under the three-year limitation imposed by the above-quoted Section 214(2).
The defendant Exchange now moves to dismiss the new first count solely on the grounds that it is time-barred under the three-year statute.
It may be noted that the New York statute on "a liability created by statute" was, in 1934, when Congress enacted the Securities Exchange Act, a six year statute (C.P.A. § 48(2)). Both parties assume that, since there is no applicable federal statute, the appropriate statute of limitations of the forum state will apply (Cope v. Anderson, 331 U.S. 461, 463, 67 S. Ct. 1340, 91 L. Ed. 1602 (1947)).
To understand the respective contentions it is necessary to mention some antecedent events briefly. Haupt, a limited partnership, was a brokerage house which extended large credit to a concern named Allied Crude Vegetable Oil Refining Co. which, it turned out, had supplied fake warehouse receipts as collateral for vegetable oil. Haupt had given credits of from 2.5 million dollars to 13 million dollars, and had carried on margin for Allied a long position in cottonseed oil futures. In November 1963, when Allied failed to meet margin calls against the long position, Haupt became liable for 18 million dollars in margin. On November 19, 1963 the general partners of Haupt notified the Exchange that Haupt's aggregate indebtedness exceeded its net capital by more than 2,000 per cent. Subsequently Haupt was suspended by the Exchange and it was discovered that the warehouse receipts were worthless. Thereafter Haupt was adjudicated a bankrupt.
The first count substantially alleges these described events and also alleges that the Exchange in 1934 had applied to the SEC to be registered as a national securities exchange. Pursuant to Section 6(a)(1) of the 1934 Act it filed an agreement by which it undertook to comply and to enforce, so far as was within its powers, compliance by its members with the provisions of the Act and its rules. This agreement, it is alleged, was for the purpose of insuring fair dealing in securities and protecting investors, and was executed as a condition to and in consideration of becoming registered as a national exchange. The SEC is alleged to have accepted this agreement in 1934. On July 1, 1963, the Exchange filed an annual amendment to its application for registration and filed therewith a renewed agreement. This allegedly reaffirmed the agreement of compliance and enforcement previously mentioned (Amended Compl. Paras. 3-5). Implementing the agreement, Article III of the Exchange's Constitution as of May 31, 1963 provided that the Board of Governors was vested with all powers necessary, inter alia, for the government of the Exchange and the regulation of the business conduct of its members; the Constitution also gave the Board the power to make rules and to provide penalties for their violation (Art. III § 1; Amended Compl. Para. 6). Further provisions establish the rule-making power of the Board with respect to the formation of member firms and the business conduct of members (Art. III § 5). It is also provided in Article III § 6:
"The Board of Governors shall have general supervision over members, allied members, member firms and member corporations. It may examine into the business conduct and financial conditions of members, allied members, member firms and member corporations. It shall have supervision over partnership and corporate arrangements and over all offices of such members, firms and corporations, whether foreign or domestic, and over all persons employed by such members, firms and corporations, and may adopt such rules with respect to the employment, compensation and duties of such employees as it may deem appropriate . . ."
The complaint goes on to allege that, notwithstanding its contractual obligation to comply and enforce compliance of its members with the 1934 Act and rules thereunder, the Exchange, in contravention of Section 6 of the Act, failed to promulgate or enforce rules requiring that general partners of member firms (1) delegate only to qualified principals or employees authority for supervision and control, and provide for appropriate procedures of supervision and control; (2) establish a system of follow-up and review; and (3) "require that the amounts and types of credit extended by a member organization shall be supervised by a general partner qualified by experience for such control in the types of business in which the member organization extends credit" (Amended Compl. Para. 7). It is then alleged that, as a result of the Exchange's failure to promulgate and enforce such rules, the general partners of Haupt failed to delegate authority to qualified people or to supervise them appropriately or to supervise the amounts and types of credit extended by Haupt to customers (Amended Compl. Para. 8). The "salad oil" debacle is attributed to the foregoing lack of supervision of Haupt by the Exchange (Amended Compl. Para. 9).
It is further alleged that, under Rule 419 of the Rules of the Exchange, members are required to make available to customers on request a statement of financial condition prepared in conformity with generally accepted accounting principles (Amended Compl. Para. 10). The Exchange allegedly received from Haupt, on August 12, 1963, a financial statement dated May 29, 1963 which overstated by more than $400,000, or almost 5% of net worth, the amount of capital contributed by limited partners and subject to the claims of creditors. The Exchange had received previously from Haupt an answer to the Exchange's financial questionnaire which allegedly revealed this falsity. The Exchange knew or should have known that Haupt was distributing the false statement "to customers and prospective purchasers of partnership interests in Haupt, such as plaintiff" (Amended Compl. Para. 11). Yet, it is alleged, the Exchange knowingly failed to exercise its remedial and disciplinary powers in the face of this action, notwithstanding its contractual obligation to comply and to enforce compliance with the 1934 Act and its rules (Amended Compl. Para. 12).
On or about October 10, 1963 Haupt allegedly sold a limited partnership to the plaintiff for $250,000. The agreement with the SEC by the Exchange "was made for the benefit and protection of investors, of which plaintiff is one" (Amended Compl. Para. 14). Damages for breach of that agreement is alleged in the sum of $250,000.
The jurisdiction for the amended complaint is alleged to rest upon a federal question and an amount in controversy in excess of $10,000 pursuant to 28 U.S.C. § 1331(a). Again, diversity of citizenship is not alleged, nor is there an allegation that there is pendent jurisdiction for the first count because of the second count.
Section 6 of the Securities Exchange Act of 1934 reads as follows:
"(a) Any exchange may be registered with the Commission as a national securities exchange under the terms and conditions hereinafter provided in this section, by filing a registration statement in such form as the Commission may prescribe, containing the agreements, setting ...