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Securities Investor Protection Corp. v. Morgan

decided: January 23, 1976.

SECURITIES INVESTOR PROTECTION CORPORATION, APPLICANT-APPELLANT, SECURITIES AND EXCHANGE COMMISSION, PLAINTIFF,
v.
MORGAN, KENNEDY & CO., INC.; IRWIN RUDNET AND GERALD RUDNET, DEFENDANT-APPELLEES. CLAIM OF READING BODY WORKS, INC., PROFIT SHARING PLAN TRUST, CLAIMANT-APPELLEE



Appeal from a decision of the United States District Court for the Southern District of New York, Marvin E. Frankel, Judge, affirming an order of Bankruptcy Judge Roy Babitt, which adjudged the one hundred and eight employee-beneficiaries of a trust created under a profit-sharing plan to be "customers" of a bankrupt stock brokerage house within the meaning of the Securities Investor Protection Act. Reversed and remanded.

Moore and Timbers, Circuit Judges, and Albert W. Coffrin,*fn* District Judge.

Author: Moore

MOORE, Circuit Judge:

In this appeal we are asked to determine whether the one hundred and eight employee-beneficiaries of a trust created under a profit-sharing plan qualify as "customers" of a bankrupt broker-dealer for the purpose of receiving compensation for losses available to such customers under the Securities Investor Protection Act of 1970 (SIPA), 15 USC § 78aaa et seq.*fn1 The question was resolved in the beneficiaries' favor below. For the reasons which follow, we reverse and remand to the Bankruptcy Court.

I. FACTUAL BACKGROUND

In 1957 Reading Body Works, Inc. (Reading) established a profit-sharing plan (the Plan), pursuant to which a trust fund was created and maintained through yearly employer contributions based upon Reading's net earnings. The Plan provided that employees would earn "credits" or a percentage interest in the fund according to annual compensation level and consecutive years of service. The employees' individual credit units were in proportion to the units of all employees, and were based upon the current value of the assets in the trust. Separate accounts for each employee were maintained in the records of the trust to reflect the individual employee's accumulated credits and the current value of each employee's account. Each employee's interest in the trust was vested and non-forfeitable, but payable only upon the employee's termination of employment with Reading.

Title to the trust assets was held by three trustees (the Trustees) who were responsible for the management of the trust and the investment of its assets. In 1972, an account was established with Morgan-Kennedy & Co. (the debtor). The account was held in the Trustees' names; the names of the various employee-beneficiaries did not appear on the debtor's books or records. Control over investment decisions was exercised solely by the Trustees, who communicated regularly with the debtor with respect to all transactions.

Liquidation proceedings against the debtor were commenced under SIPA in 1973, and a trustee (Bondy) was appointed. The Plan's Trustees subsequently submitted a claim for $133,501.15, the amount owed by the debtor to the trust on the filing date of the liquidation proceedings. Bondy thereafter informed the Securities Investor Protection Corporation (SIPC), the corporation created under SIPA that advances funds to liquidating trustees in order to compensate for customer losses, that he intended to treat the one hundred and eight trust beneficiaries as separate customers of the debtor; this would entitle each of the one hundred and eight to SIPA's maximum insurance coverage per customer of $50,000 for securities and $20,000 for cash held by the debtor as of the date of commencement of liquidation proceedings.

Bondy's interpretation of the term "customer" was disputed by SIPC. SIPC claimed that the trust, and not each of its beneficiaries, was the debtor's customer under SIPA; accordingly, SIPC recognized only one valid insurance claim. The Trustees supported Bondy's position; they also argued alternatively that, if SIPC's position respecting the definition of customer was correct, then the three Trustees should be treated as separate customers, and the claims accorded the $50,000 maximum award for securities held by the debtor.

Both the Bankruptcy Court and the District Court ruled in favor of Bondy and the Trustees on the definitional issue and did not reach the alternative arguments raised by the Trustees.

II. THE STATUTORY SETTING

SIPA was enacted by Congress in 1970 to afford protection to public customers in the event broker-dealers with whom they transact business encounter financial difficulties and are unable to satisfy their obligations to their public customers. S.E.C. v. Alan F. Hughes, Inc., 461 F.2d 974, 977 (2d Cir. 1972).

To this end SIPA establishes a Securities Investor Protection Corporation, commonly known by the acronym "SIPC". SIPC is a non-profit membership organization, whose members include all brokers or dealers who are members of a national securities exchange or are otherwise registered as brokers or dealers under 15 USC § 780(b). Unless a broker or dealer falls within one of the exceptions (not relevant here) contained in § 78 ccc(a)(2)(b), membership in SIPC is mandated. The role of SIPC has been aptly described by one commentator:

SIPC's main function is to step in to liquidate a broker or dealer when customers' assets are in danger, and to protect a customer up to a total amount of $50,000 represented by proven claims to cash and securities expected to be in the hands of the broker or dealer. But no more than $20,000 represented by claims to cash can be recovered ...


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