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Securities and Exchange Commission v. F. O. Baroff Co.

decided: May 29, 1974.


Appeal from an order of the United States District Court for the Southern District of New York, Lawrence W. Pierce, Judge, affirming an order of the Bankruptcy Judge denying the claim of Samuel Lubin under the Securities Investor Protection Act as a "customer" of F. O. Baroff Company, Inc. Order affirmed.

Mansfield and Timbers, Circuit Judges, and Davis, Judge.*fn*

Author: Davis

DAVIS, Judge:

We are called upon to decide a relatively narrow point, but one of some significance, under the Securities Investor Protection Act of 1970, 15 U.S.C. § 78aaa et seq. The object of that statute, and the function of the Securities Investor Protection Corporation (SIPC) it created, is to protect the public customers of securities dealers from suffering the consequences of financial instability in the brokerage industry. Securities and Exchange Commission v. Alan F. Hughes, Inc., 461 F.2d 974, 977 (2d Cir. 1972); Securities Investor Protection Corporation v. Charisma Sec's Corp., 352 F. Supp. 302, 306 (SDNY 1972). Once a broker or dealer is found to be on the brink of collapse or in danger of failing to meet its obligations to its customers, a trustee is appointed for liquidation of the business. The firm's clients are cushioned (within limits) from personal loss through a special fund collected by SIPC from all securities dealers registered under the 1934 Securities Exchange Act (much in the way that the Federal Deposit Insurance Corporation protects the depositors of banks). But the Securities Investor Protection Act allows only those who meet its definition of a "customer" to share in this assurance. The question posed in this case is whether a voluntary lender of securities to a failing brokerage house, who made his loan to help out the company and not for a purpose related to securities trading or investments, qualifies under the Act's scheme.

The case comes before us on facts assumed to be true by the parties, the Bankruptcy Judge, and the District Court.*fn1 On November 30, 1971, appellant Lubin delivered 7,000 shares of the common stock of Electronic Transistor Corp. to F. O. Baroff Co., Inc., a broker-dealer. Baroff opened an account in Lubin's name and issued him a stock record receipt memorializing the delivery. Lubin also gave the broker a hypothecation letter, saying:

This is your authority to use the 6,000 [sic] shs. of Electronic Transistors Corp. in my account as collateral for F. O. Baroff Company, Inc. loans.

You understand that I may revoke this authority at any time and you will agree to deliver such securities to me, free of all loans and encumbrances, except monies which may be due to F. O. Baroff Company, Inc. upon such notice.

The record is barren of positive proof as to Lubin's motive, but in a subsequent letter to the trustee of Baroff from Lubin's attorneys, this explanation is made: "Mr. Lubin had theretofore done a considerable amount of business with the F. O. Baroff Co., Inc. firm. He was aware that Baroff was in a cash bind and that this loan of securities was intended to help Baroff alleviate that condition. It was understood that the securities would be returned in a short period of time as soon as Baroff as [sic] able to straighten out its situation." It is not contended that this loan of securities was made in connection with any existing or anticipated securities transactions undertaken by Lubin or on his behalf. Nor is there any suggestion of a benefit or consideration passing to him from the company. Apparently he did not have a live account with the firm at the time he made the loan.

About five weeks after this transaction, Baroff consented to an adjudication that its customers were in need of the protection of the Securities Investor Protection Act, and its liquidation commenced under a trustee's supervision.

Lubin made claim under the Act with respect to the 7,000 loaned shares, but the trustee resisted on the ground that as to those securities Lubin was not a "customer" entitled to protection.*fn2 The Bankruptcy Judge agreed with the trustee's conclusion, both initially and on rehearing. Lubin sought review by the District Court but lost there as well.*fn3

Appellant's contention is simply that he falls within the literal definition of a "customer" in the 1970 statute, and is therefore entitled to its protections. The term "customer" is spelled out at section 6(c) (2) (A) (ii) of the Act, 15 U.S.C. § 78fff(c) (2) (A) (ii):

(ii) "customers" of a debtor means persons (including persons with whom the debtor deals as principal or agent) who have claims on account of securities received, acquired, or held by the debtor from or for the account of such persons (I) for safekeeping, or (II) with a view to sale, or (III) to cover consummated sales, or (IV) pursuant to purchases, or (V) as collateral security, or (VI) by way of loans of securities by such persons to the debtor, and shall include persons who have claims against the debtor arising out of sales or conversions of such securities, and shall include any person who has deposited cash with the debtor for the purpose of purchasing securities, but shall not include any person to the extent that such person has a claim for property which by contract, agreement, or understanding, or by operation of law, is part of the capital of the debtor or is subordinated to the claims of creditors of the debtor.

Lubin relies on subpart VI of this definition, "by way of loans of securities * * * to the debtor." In the literal sense, that is what happened here; Lubin made a loan to Baroff of his Electronic Transistor stock. The problem is whether that fact is sufficient and dispositive.

Judge Learned Hand has vividly admonished us not to be caught in the trap of language which seems, literally, too broad or too narrow to accommodate the patent legislative purposes. Guiseppi v. Walling, 144 F.2d 608, 624 (2d Cir. 1944) (concurring opinion), aff'd sub nom Gemsco, Inc. v. Walling, 324 U.S. 244, 89 L. Ed. 921, 65 S. Ct. 605 (1945); Cabell v. Markham, 148 F.2d 737, 739-40 (2d Cir. 1945), aff'd, 326 U.S. 404, 90 L. Ed. 165, 66 S. Ct. 193 (1945). Securities legislation is no exception. See, e.g. Diskin v. Lomasney & Co., 452 F.2d 871, 874 (2d Cir. 1971). This court has already heeded the caution in reading another ...

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