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NEW YORK STOCK EXCH., INC. v. SLOAN

May 2, 1975

New York Stock Exchange, Inc., et al.
v.
Sloan, et al.


Lasker, District Judge.


The opinion of the court was delivered by: LASKER

LASKER, District Judge:

This suit raises novel questions as to the scope of liability of the New York Stock Exchange ("Exchange") under § 6 of the Securities Exchange Act of 1934, 15 U.S.C. § 78f. In June 1970, Orvis Brothers & Co., a member firm of the Exchange, commenced liquidation after a period of financial deterioration. The Exchange brings this action to recover some $5,000,000. expended from its Special Trust Fund to compensate public customers of Orvis for the losses which resulted. Defendants are a varied group including the general and limited partners of Orvis, certain of its subordinated lenders and its accountants.

 The amended complaint charges that Orvis failed to keep accurate books and records and concealed the precarious financial condition of the firm until May, 1970, in violation of the rules and regulations of the Exchange and the Securities Exchange Act of 1934. It further claims that the general and limited partners and subordinated lenders of Orvis conspired to enable the firm to continue in business, despite its failure to meet Exchange net capital requirements, by improperly overstating Orvis' net capital position at the time of an audit of the firm. Finally, the complaint alleges that two subordinated lenders received a preferential transfer of securities at a time when the firm was insolvent.

 All but one of the defendants have answered the amended complaint. Sixteen of the defendants counterclaim against the Exchange for loss of their investments in the firm, charging that the Exchange failed to perform its statutory duty under § 6 to make and enforce Exchange rules, particularly Rule 325, the net capital rule. They claim that the Exchange knew or should have known of Orvis' financial difficulties and alleged violations of Exchange rules as early as 1968, but that it adopted a policy of not enforcing or selectively enforcing its rules with regard to Orvis. They further allege that the Exchange permitted Orvis to continue in business despite its poor financial condition without disclosing to defendants (most of whom claim they were merely "passive" investors not involved in the management of the firm) its knowledge of that condition.

 The Exchange moves for partial summary judgment dismissing the counterclaims described, contending the partners, limited partners and subordinated lenders of a member firm do not have standing to assert a violation of § 6. The Exchange has submitted no factual material in support of the motion other than the two page affidavit of its counsel and the four page affidavit of an official of the Exchange. *fn1" These explain the thrust of the present motion, but do not state facts relating to the events leading up to Orvis' liquidation. Some of the counterclaimants have filed affidavits which raise genuine issues of fact as to whether they were partners or lenders to Orvis at the relevant time. Because these affidavits would in any event require denial of the motion for summary judgment as to the counterclaimants submitting them, and the Exchange's reply papers make clear that its attack is directed at the pleadings, we treat the present motion as arising under Rule 12(c). Such a course is proper for the additional reason that summary judgment should be used sparingly in complex lawsuits which, like the present one, raise novel questions of law. Poller v. Columbia Broadcasting System, 368 U.S. 464, 473, 82 S. Ct. 486, 7 L. Ed. 2d 458 (1962); Kennedy v. Silas Mason Co., 334 U.S. 249, 256-257, 92 L. Ed. 1347, 68 S. Ct. 1031 (1948); Eccles v. Peoples Bank of Lakewood Village, 333 U.S. 426, 434, 92 L. Ed. 784, 68 S. Ct. 641 (1948).

 I.

 Analysis of the question of standing to sue under § 6 *fn2" begins with Baird v. Franklin, 141 F.2d 238 (2d Cir.) cert. denied, 323 U.S. 737, 89 L. Ed. 591, 65 S. Ct. 38 (1944), in which the existence of a private right of action under that section was first recognized. In Baird, a member of the Exchange converted the securities of one of its public customers. The Exchange had notice of the conversion, but took no disciplinary action against the member. Although the panel spoke with one voice in holding that the customer had a right of action against the Exchange for dereliction of its § 6 duties, the majority held that she had failed to prove that the Exchange's conduct caused her loss. The opinion of Judge Clark, who dissented from the result, presents the court's view as to the implication of a private action under § 6:

 
"There can be no doubt that § 6(b) places a duty upon the Stock Exchange to enforce the rules and regulations prescribed by that section. Any other construction would render the provision meaningless . . . Sections 6(b) and (d) were surely intended to be read together, and the latter makes it clear that the purpose of the requirements of the former is 'to insure fair dealing and to protect investors.' This can be realized only if § 6(b) is construed as imposing the two-fold duty upon an exchange of enacting certain rules and regulations and of seeing that they are enforced." 141 F.2d at 244.

 For purposes of the present motion, Baird is as important for what it did not decide as for what it did. There can be no doubt after Baird that public customers of a member firm are entitled to sue the Exchange for violation of § 6. *fn3" However, few courts have been faced with the question, left open in that case, whether those in the position of the present counterclaimants have a similar right, and none has definitively determined it.

 In Pettit v. American Stock Exchange, 217 F. Supp. 21 (S.D.N.Y. 1963), corporate reorganization trustees sued the Exchange, among others, alleging a conspiracy to defraud a corporation of 587,000 shares of unregistered stock by distributing it through the facilities of the Exchange in a rigged market. In addition to their § 10(b) claims plaintiffs alleged that the scheme could not have been accomplished if the Exchange had properly carried out its § 6 duties. In moving to dismiss the § 6 claim, the Exchange argued that the statute is designed solely to protect public customers. The court rejected that contention, observing without further discussion that ". . . the statutory scheme should not be so restricted where, as here, the loss to the corporation arises from a fraudulent transaction in its securities which is successfully perpetrated through the conduct of the Exchange." 217 F. Supp. at 29.

 In holding that those standing in the shoes of public investors, such as corporate reorganization trustees, are entitled to sue under § 6, Pettit broadened the Baird rule somewhat. However, the trustees in Pettit were not members of the Exchange "community," as are the partners or subordinated lenders of a member firm. The Exchange argues on the present motion that, for purposes of § 6, such "insiders" of the Exchange community are a different species than public customers or their representatives; it claims that § 6 was intended to protect only the latter.

 The few cases which have dealt with the issue cast some doubt on this contention. In Weinberger v. New York Stock Exchange, 335 F. Supp. 139 (S.D.N.Y. 1971), a former limited partner of Ira Haupt & Co. sued the Exchange for the loss of his investment in the firm. He claimed, among other things, that it had failed adequately to supervise Haupt with regard to the latter's extension of credit to a vegetable oil refining company. As Haupt discovered too late, the company had supplied fake warehouse receipts as collateral and Haupt was soon afterward adjudicated a bankrupt.

 The three-year limitations period applicable to actions for breach of a duty created by statute would have barred a claim based directly on § 6. Accordingly, plaintiff, as an alleged "investor" in Haupt, sought recovery as a third-party beneficiary of the "contract" between the SEC and the Exchange, by which the latter agreed to make and enforce rules "appropriate for the protection of investors." *fn4" Relying on Baird v. Franklin, the court observed that "the policy of federal law . . . makes an investor more than an incidental beneficiary of the contract mandated by [§ 6]" and held that plaintiff was entitled to sue for its breach. 335 F. Supp. at 144.

 However, in so holding, the court decided only that the intended beneficiaries of the agreement between the Exchange and the SEC have a right of action based upon it. cf. Baird v. Franklin, 141 F.2d at 244. It did not decide whether plaintiff, who as noted above was a limited partner, was in fact within the benefited class -- an inquiry as crucial to a determination of standing in an action based on contract as one based on a statute. See Restatement of Contracts § 145 (1932), Fata v. S. A. Healy Co., 289 N.Y. 401, 46 N.E.2d 339 (1943); United States ex rel. Johnson v. Morley Const. Co., 98 F.2d 781, 788-789 (2nd Cir.); Lemon v. Bossier Parish School Board, 240 F. Supp. 709, 713 (W.D. La. 1965), aff'd, 370 F.2d 847 (5th Cir. 1967). Indeed, the Exchange appears to have made only the general argument that no action based on contract existed; it ...


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