The opinion of the court was delivered by: LASKER
This is an action by four subordinated lenders (the lenders) of Pickard & Company, Inc. (Pickard), a defunct brokerage firm, against the New York Stock Exchange (the Exchange), of which Pickard was a member, and Aubrey B. Lank, Receiver of Pickard. The complaint alleges that Pickard was guilty of securities law and common law fraud in the solicitation and renewal of the subordinated loan agreements. The Exchange is charged in three counts with securities fraud,
aiding and abetting Pickard's fraud and breaching its contract with the Securities Exchange Commission entered into pursuant to § 6(a)(1) of the Securities Exchange Act of 1934, 15 U.S.C. § 78(f)(a)(1) (1971), by which the Exchange undertook to comply with the securities laws and to enforce compliance by its members. Jurisdiction is predicated on § 27 of the Securities Exchange Act of 1934, 15 U.S.C. § 78aa (1971), § 22 of the Securities Act of 1933, 15 U.S.C. § 77v (1971), and on diversity of citizenship.
Two motions are now before the court. The lenders seek to stay an arbitration proceeding in which they and Lank are currently engaged to resolve a dispute over entitlement to the subordinated accounts. The Exchange, asserting a variety of infirmities in the lenders' allegations against it, moves to dismiss the complaint or for summary judgment and, alternatively, to strike certain portions of the complaint.
At various times in 1966, each of the four plaintiffs deposited assets in customer accounts at Pickard and entered written agreements which subordinated their rights to the assets to those of other creditors of Pickard. In connection with these transactions each plaintiff also acquired non-voting stock of Pickard. Throughout the period from 1966 to early 1968, the plaintiffs agreed to extend the subordination agreements each time they became due to expire. The last extension was agreed to in January, 1968, when the agreements were about to expire on February 1. The affairs of Pickard were then in serious disarray, and its solvency was in question. Independent accountants had attempted unsuccessfully to complete an audit of Pickard's books since the fall of 1967. The lenders were told of this situation and were also told that without their accounts, Pickard would be forced to go out of business. They consented to extend the agreements to March, 1968.
The continued use of the lenders' accounts, however, failed to prevent disaster, and in February the decision to liquidate Pickard was made. The subordination agreements provided that in the event of liquidation the lenders would not be entitled to share in the distribution of Pickard's assets until the claims of all general creditors were satisfied. Since the ability of Pickard to pay its debts was still uncertain and the answer hinged on the outcome of further auditing procedures, the lenders executed further agreements under which their assets were delivered to a custodian to be held until the question of entitlement could be resolved. The custodian agreements provided that in the event Pickard and the lenders could not agree which of them was entitled to the assets, the dispute would be resolved by arbitration.
Pickard served a demand for arbitration on February 18, 1969. The first hearing, however, was not held until April 25, 1974. Since that time there have been two further hearings, the latest on March 25, 1975. At that hearing, and in the course of preparation for it, the lenders for the first time came into possession of the information which provides the basis for their allegations of wrongdoing against both defendants. Pursuant to a subpoena they obtained a memorandum to the Exchange's Board of Governors dated July 25, 1968 which contains a summary of charges brought against various officers of Pickard in the wake of its final collapse. This document establishes that Pickard had a history of noncompliance with SEC and Exchange rules extending as far back as July, 1965. The Exchange was well aware of Pickard's problems. No less than four disciplinary actions were taken, three by the Exchange and one by NASD from January, 1966 to March 1967, and a variety of trading restrictions and sanctions were imposed on Pickard as a result. (Burns Affidavit, September 16, 1975; Exhibit A; (Exchange Memo) at 4-7)
Lloyd W. McChesney, the former Chief Examiner of the Exchange and the man who served as Liquidator of Pickard, was called to testify at the March 25th arbitration hearing and the lenders questioned him on the contents of the newly discovered memorandum. The following exchanges occurred:
"Q. Do you know whether there has been any disclosure to the public that Pickard & Company had been censured and warned?
A. I think it was rare at that time that any kind of activity was published.
Q. Was it just kept in the house with the Board of Governors?
A. It would have been. The Board of Governors, the Exchange staff, who were interested interested (sic) in that particular area and the firm itself, of course.
Q If you were an accountant advising an investor, would you consider this restriction in how to advise the investor?
Q. It would make a difference whether you would recommend an investment, couldn't it? Certainly would influence a decision and would be a negative influence, would it not?
(Burns Affidavit, September 16, 1975; Ex. B. (Arbitration Transcript) at 229, 248). The lenders interpret the thrust of McChesney's testimony to be that it was the policy of the Exchange not to disclose information about disciplinary action and restrictions against members to the investing public and that such information, in the case of Pickard, would have had a materially adverse impact on an investor's decision to become a subordinated lender in the firm.
The complaint in this action was filed on April 8, 1975, two weeks after McChesney testified. Pickard is charged with securities law and common law fraud for inducing the lenders to execute the subordination agreements and the extension agreements without disclosing its violations of SEC and Exchange rules and the sanctions and restrictions under which it operated. The Exchange is charged with complicity in Pickard's fraud, based primarily on its knowledge and approval of the lenders' applications to enter the subordination agreements and its alleged policy of nondisclosure. The lenders also claim that the Exchange directly participated in the fraudulent omission in the January, 1968 transaction in which the lenders agreed to a final extension of their loan agreements, because it was a Vice President of the Exchange who personally prevailed upon them to extend. In a separate count the Exchange is charged, on the basis of the same allegations, with aiding and abetting Pickard's fraud. Finally, the lenders assert that the Exchange breached its contract with the SEC in which it ...