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SEC v. KENNETH BOVE & CO.

July 10, 1974

Securities And Exchange Commission, et al., Plaintiffs
v.
Kenneth Bove & Co., Inc., Defendant


Pollack, District Judge.


The opinion of the court was delivered by: POLLACK

POLLACK, District Judge.

The Trustee in this SIPC ("Securities Investor Protection Corporation") liquidation being conducted pursuant to the Securities Investor Protection Act of 1970 (the "Act"), 15 U.S.C. §§ 78aaa et seq., has moved for an order determining that the claim filed herein by Joseph and Irma Steinberg (the "claimants") is not that of a "customer" entitled to protection under the Act nor is it an "open contractual commitment" with the Debtor entitled to completion by the Trustee under the Act. The Debtor, Kenneth Bove & Co., Inc., was placed in liquidation under the Act on May 25, 1972.

 The claimants were parties to a single transaction with the Debtor; viz., an agreement made on May 4, 1972 to sell to the Debtor 7,800 shares of Princeton Associates for Human Resources ("PAHR") common stock for $23,302.50 net. Delivery and settlement were to be made on May 11, 1972. However, the shares were not delivered to or actually "received in" by the Debtor even by May 25, the date on which the Debtor was taken over for liquidation under the Act.

 The claimants allege that it was initially arranged that they would "personally deliver" the shares to the Debtor, but that they were later instructed (allegedly) by the Debtor to deliver the shares to Merrill Lynch, Pierce, Fenner & Smith, another brokerage house. SIPC and its Trustee have no knowledge of any such instructions or to their object and there is no recorded information in the Debtor's records to substantiate the claimants' assertion.

 It is undisputed that the claimants were not customers of the Debtor prior to the instant transaction and that the 7,800 shares of PAHR were not delivered to the Debtor at any time.

 The claimants contend (upon their version of the facts) that they are "customers" within the meaning of the Act entitled to a protected "net equity" claim, or, alternatively, that they had an "open contractual commitment" that should now be completed by the Trustee under the mandate of Section 6(d) of the Act.

 Since the Court finds that the claimants did not entrust their stock to the Debtor and thus did not become "customers" as defined in the Act nor do they possess an "open contractual commitment" contemplated by the Act, which a trustee is obligated to complete, the motion of the Trustee to exclude their claim from the protection afforded by the Act to "customers", must be granted.

 Section 6(c) (2) (A) (ii) of the Act defines the term "customers" as follows:

 
" [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; . . ."

 To have a protected "net equity" claim under the Act as a "customer", the claimant must have entrusted his securities to the debtor in liquidation. Claimants' shares were never actually received by the debtor; the Debtor never came into their possession or control so as to become accountable under the Act to the claimants therefor. In order for claimants to fall within the class of "customers" of a Debtor entitled to benefits under the Act, it is necessary that the claim be "on account of securities received, acquired, or held by the debtor."

 The circumscribed class of customers protected under the Act, those persons who have "entrusted" property to the Debtor, was intentionally chosen by Congress to afford relief akin to the preference given to a reclamation claim which was well understood in bankruptcy proceedings. This type of claim was grounded on possession of identifiable securities by the broker.

 In 1938 there was added to the Bankruptcy Act a new subsection (e) to § 60, 11 U.S.C. § 96(e) (1), dealing with stockbroker bankruptcies. This was supposed to clarify and codify the law as theretofore administered although it actually considerably changed it. 5A Remington on Bankruptcy § 2514 (Fifth Edition). The general effect of reclamation rights in such bankruptcies was to permit customers to trace and reclaim identifiable property and funds in the stockbroker's possession.

 The 1938 amendment of the Bankruptcy Act set forth definitions of reclaimable "property"; this included cash and securities and also a definition of the "customers" entitled to seek reclamation of property. The defined customers are "persons who have claims on account of securities received, acquired, or held by the stockbroker." Sec. 60(e) (1), 11 U.S.C. 96(e) (1). Undoubtedly, in framing the SIPA, Congress had in mind a similar concept of a protected customer, i.e., one who had entrusted his securities to the debtor and who was claiming against the debtor "on account of securities received, acquired, or held by the debtor ". The definition in the Bankruptcy Act and SIPA sections is in identical language. Under each law, the preferential protection is accorded to a person who can trace and identify the trust property or funds in the hands of the stockbroker; other claimants must look to the general assets of the stockbroker for satisfaction.

 The statements of Homer H. Budge, a former chairman of the Securities and Exchange Commission, during the legislative hearings preceding the enactment of the Act evidence this intent. See Hearings on Federal Broker-Dealer Insurance before the Subcommittee on Securities, Committee on Banking and Currency, U.S. Senate, 91st Cong. 2d Sess. at 8 (1970). Accordingly, the absence of actual receipt, acquisition or possession of the property of a claimant by the brokerage firm under liquidation has been held to be dispositive against a claim to participation in the coverage under the Act extended by SIPC. See SEC v. S.J. Salmon & Co., Inc., Civil No. 72-560 (S.D.N.Y. June 13, 1973) (claim of Galaxy Fund, Inc.); SEC v. Horizon Securities, Inc., Civil No. 72-5112 (S.D.N.Y. May 31, 1974) (claim of Charon Styx Associates). The Court of Appeals in SEC v. F.O. Baroff Co., Inc., 497 F.2d 280 (2d Cir. 1974) has ...


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