The opinion of the court was delivered by: WERKER
The original complaint in this case was filed by Thomas J. Byrnes and Francis R. Santangelo ("Byrnes") against Faulkner, Dawkins & Sullivan ("Faulkner") and Singer & Mackey, Inc. ("Singer") in Supreme Court, New York County alleging breach of contract. The complaint alleged that on June 7, 1971, Byrnes made a contract to sell, pursuant to a registration statement, 44,000 shares of the common stock of White Shield Corporation ("White Shield") to Faulkner and Singer but that Faulkner and Singer repudiated the contract without just cause. A more complete statement of the underlying facts and the prior history of the case are contained in an earlier opinion written by the Honorable Judge Murray Gurfein, now Circuit Court Judge, reported at 362 F. Supp. 864 (S.D.N.Y. 1973).
In that opinion, Judge Gurfein dismissed for lack of subject matter jurisdiction an action brought by Byrnes for a judgment declaring that the affirmative defenses asserted by Faulkner in the state court action were insufficient as a matter of law. However, Judge Gurfein did find that federal jurisdiction existed over the counterclaims which Faulkner asserted in its answer to Byrnes' action under § 17 of the Securities Act of 1933 ("1933 Act") and § 10 of the Securities Exchange Act of 1934 ("1934 Act").
Judge Gurfein granted Byrnes leave to answer the counterclaim of Faulkner and to assert his own counterclaim, suggesting that the breach of contract claims which formed the basis of the original suit would be cognizable in federal court as compulsory counterclaims under the Federal Rules of Civil Procedure, Rule 13(a).
Following this decision Faulkner did not submit additional papers but relied on its original answer as filed. Byrnes answered Faulkner's counterclaims and filed its own counterclaims. Faulkner's original answer had also stated two counterclaims against Tobey & Kirk, Byrnes' broker, which Tobey & Kirk answered without asserting any counterclaims. Although technically the designation of the parties as plaintiff and defendant should be changed to indicate their current posture, each of the parties has continued to use the original designation. To avoid confusion, the court has also adopted this nomenclature. Thus, Byrnes and Santangelo are hereinafter referred to as plaintiffs and counterclaim-defendants; Faulkner is the defendant and counterclaim-plaintiff; Tobey & Kirk is also a counterclaim-defendant.
The parties have made cross motions. Byrnes moved to dismiss all of Faulkner's affirmative defenses and counterclaims and for summary judgment on Byrnes' prayer for a declaratory judgment. Faulkner moved for summary judgment on all of its affirmative defenses except the first and sixth, on its first counterclaim, and on Byrnes' counterclaim. Tobey & Kirk moved for summary judgment dismissing Faulkner's counterclaims against it. Since Tobey & Kirk's motion incorporated by reference the memorandum submitted by the plaintiffs in support of their motion and provided no additional independent authority each of the motions with respect to dismissal of Faulkner's Second and Third Counterclaims will be treated as one motion made by all counterclaim-defendants.
Faulkner's First Affirmative Defense and Third Counterclaim
Faulkner's First Affirmative Defense and Third Counterclaim assert that Tobey & Kirk represented to it that the shares of White Shield which Faulkner agreed to buy were not part of a registered distribution. Faulkner asserts further that in agreeing to buy the shares, it relied on that representation which was false and fraudulent when made and in violation of § 17 of the 1933 Act
and § 10(b) of the 1934 Act.
Faulkner raises this as a defense to plaintiffs' claim and also seeks to recover damages for the expenses incurred and profit lost on the cancelled resale to Singer & Mackey.
The plaintiffs seek summary judgment on this defense and counterclaim on the ground that there are no material issues of fact to be tried. They assert that the testimony of all of the parties to this transaction negates any thought that fraudulent representations were made as to the status of the stock offered to Faulkner. Faulkner, on the other hand, contends that there were fraudulent and material misrepresentations made, that the facts are in sharp dispute, and that summary judgment with respect to this defense is inappropriate.
Section 17 of the 1933 Act makes it unlawful for any person selling securities to engage in any practice which operates as a fraud upon the purchaser. Section 10(b) of the 1934 Act makes the use of a deceptive device in connection with the purchase or sale of securities unlawful. These sections cover transactions in the over-the-counter market. American Bank & Trust Co. v. Barad Shaff Securities Corp., 335 F. Supp. 1276 (S.D.N.Y. 1972).
The parties seem to agree, as does the court, that failure to disclose the fact that the stock being sold was, in fact, registered stock would be a material and fraudulent omission in violation of Section 17 of the 1933 Act and Section 10(b) of the 1934 Act. Cf. Vohs v. Dickson, 495 F.2d 607 (5th Cir. 1974). This is particularly true in light of In the Matters of Jaffee & Co. CCH FED. SEC. L. REP. P 77,805 (1970), discussed later in this opinion, in which the SEC required a market maker to cease all open-market purchases of a security if it purchased any shares which were being sold as part of a distribution. The issue is whether in fact there was such an omission.
The parties have each cited several sections of the testimony taken at depositions and assert that such testimony confirms or refutes the allegations on disclosure. The evidence before the court clearly is inconclusive. The issue is largely a question of credibility, a matter which cannot be determined on the pleadings in a motion for summary judgment. Cross v. United States, 336 F.2d 431 (2d Cir. 1964); Hirsch v. Archer-Daniels-Midland Co., 258 F.2d 44 (2d Cir. 1958).
In addition, the plaintiffs argue that Faulkner, which believed it would be dangerous for a market maker to buy stock which was being sold as part of a distribution, was under an obligation to inquire as to the status of the stock being sold. The plaintiffs cite In the Matters of Jaffee & Co., supra, in support of their position. In that case, where the trader employed by a market maker had received a copy of a prospectus of the stock being sold, the SEC held that the market maker "should have inquired into the status of the offering." Id. at 83,858. That case is not dispositive of this one, however, since there is direct evidence that Faulkner did not receive a copy of the White Shield prospectus prior to the sale.
Because the facts are in sharp dispute as to both the fact of omission and extent of Faulkner's inquiry as to the status of the stock, plaintiffs' motion for summary judgment on Faulkner's First Affirmative Defense and Third Counterclaim is denied.
SECOND AFFIRMATIVE DEFENSE
All parties have sought summary judgment with respect to Faulkner's Second Affirmative Defense. That defense asserts that the sale of White Shield stock was illegal because the written comparison
sent to Faulkner by Tobey & Kirk constituted a prospectus as defined in § 2(10) of the 1933 Act which did not conform to the requirements of § 10 of that Act and because that comparison was not accompanied or preceded by a statutory prospectus as required in § 5(b) of that Act. The plaintiffs acknowledge that no prospectus was sent to the defendant but assert that the requirements of Section 5(b) do not apply to transactions between broker dealers and that in any event, the comparison Tobey & Kirk sent does not constitute a prospectus for the purposes of the 1933 Act.
Section 5(b)(1) of the 1933 Act
makes it unlawful for any person, directly or indirectly -- (1) to make use of any means . . . of . . . communication in interstate commerce . . . to carry or transmit any prospectus relating to any security with respect to which a registration statement has been filed . .. unless such prospectus meets the requirements of section 77j of this title.
There is no question that the comparison sent by Tobey & Kirk does not meet the requirements of section 77j
which requires a prospectus to contain the information contained in the registration statement.
The real issue is whether the comparison is a prospectus at all such that the requirement in section 5(b) is even applicable. Section 77b(10) of 15 U.S.C.
defines the term prospectus as "any . . . communication, written . . . which . . . confirms the sale of any security." Taken literally, the statute which is broad and inclusive, would seem to include a comparison sent by one broker to another, confirming the sale of a security.
The plaintiffs, however, have raised several objections to this reading. First, they argue that the 1933 Act in which the above-quoted language is contained was intended to regulate transactions between broker dealers and their customers, i.e., the public, not the activities among broker dealers themselves. That relationship, the argument goes, is fully regulated by the 1934 Act. With that assertion, this court cannot completely agree.
The court recognizes that the primary purpose of the Act is to protect the investing public. Wilko v. Swan, 346 U.S. 427, 98 L. Ed. 168, 74 S. Ct. 182 (1953); Securities and Exchange Commission v. Ralston Purina Co., 346 U.S. 119, 97 L. Ed. 1494, 73 S. Ct. 981 (1953); Berko v. Securities and Exchange Commission, 316 F.2d 137 (2d Cir. 1963). However, the statute itself seems to negate the plaintiff's argument by its own language.
Section 5 of the 1933 Act
which is the heart of the statute makes it unlawful for any person to do any of the acts therein prohibited. Section 2(2) of the Act
defines "person" to mean "an individual, a corporation, a partnership, an association, etc." The plaintiffs admit that neither they nor Tobey & Kirk is excluded from the reach of that definition. Thus they concede that it would have been unlawful to deliver the shares of White Shield stock unaccompanied by an official prospectus. Section 5 of the Act admittedly covers transactions between brokers.
Further evidence that the 1933 Act did not intend to cover only the relationship between brokers and the public can be found in Section 4.
Section 4 provides that certain transactions shall be exempted from the application of Section 5. There is no such exemption per se for transactions between two broker-dealers. Surely if the Congress intended to relieve these parties of responsibility under the 1933 Act, it would have done so in this section. The court therefore concludes that the plaintiffs cannot avoid the requirements of Section 5(b) on the ground that Tobey & Kirk and Faulkner are both broker dealers.
Second, the plaintiffs argue that an examination of the legislative history of Section 2(10)
supports its contention that the term prospectus was not intended to include a comparison sent from one broker dealer to another. The original act defined a prospectus as a "communication . . . which offers any security for sale." In 1954, the statute was amended to include within the term prospectus, any communication which "confirms the sale of any security." Both the Senate and the House reports explain that the addition of these words was "to avoid any implication of departure from settled interpretations that confirmations are 'prospectuses'." S. Rep. No. 1036, 83d Cong., 2d Sess. 12 (1954); H.R. Rep. No. 1542, 83d Cong., 2d Sess. 21 (1954). Both reports contain citations to SEC Securities Act Release No. 2623 (July 25, 1941).
The release, an opinion by the General Counsel, explains what he considers to be the scope of the term prospectus:
"Under the Act a 'prospectus' includes every kind of written communication which attempts or offers to dispose of, or solicits an offer to buy, a security for value, or which constitutes a contract of sale or disposition of a security for value. If the term 'prospectus' is construed in accordance with its language and spirit, it must in my opinion be read to cover any document which is designed to procure orders for a security, or to effectuate the disposition of a security, whether or not the document purports on its face to offer the security for sale, or otherwise to dispose of it for value." Id. at 3129.
The release continues by giving concrete examples of situations which might arise and by explaining what the prospectus delivery requirements are in each case. The plaintiffs place heavy reliance on examples 7 through 10 which purport to relieve a broker of the requirements of delivering a prospectus in circumstances analogous to those of the case at bar.
Those questions and answers do not provide the plaintiffs with the authority they seek for two reasons. They deal on their face with brokers' transactions as exempted from compliance with section 5 by the terms of section 4. The trade in question is not such a transaction. Second, the questions and answers relied upon have in part been superseded. CCH FED. SEC. L. REP. P 3195 at 3131 n.2.
The plaintiffs seek support from this series of questions to illustrate the unsolicited nature of the transaction in an attempt to avoid the application of the definition of the term "prospectus" to the comparison sent by Tobey & Kirk. The theory propounded is that in adding the words "or confirms the sale of any security" the Congress intended to encompass only those situations where some act by the seller could be considered a solicitation to buy the stock.
There is some support for this view had this transaction been conducted as a result of a customer's solicitation. Questions 7 through 10 indicate that where a broker sells securities to another broker at the request of the selling broker's customer, the transaction is unsolicited and therefore exempt from section 5.
Questions 8 and 10 were superseded by 17 C.F.R. § 230.154. Under that regulation, a broker was deemed not to solicit an order when, in response to a quotation submitted by a dealer in the "sheets," he inquired of that dealer as to his interest in purchasing. Such a solicitation within 60 days of the insertion of a bid in the sheets was deemed not to disqualify an otherwise exempt broker's transaction under section 4. SEC Securities Act Release No. 131 (March 13, 1934).
Rule 154 was subsequently rescinded when Rule 144 was adopted.
Although the Rule is directly concerned with the public resale of restricted securities without registration, the new rule retained a similar provision regarding the availability of a broker's exemption to a broker who offers to sell restricted securities to a broker or dealer who had indicated an interest in that security during the preceding 60 days. SEC Securities Act Release No. 5223 (January 11, 1972). Presumably, such an indication of interest would include the insertion of a bid in the sheets. Rule 144 deems such a transaction as unsolicited.
There is a basic problem with this analysis, as applied to the instant case. Each of the releases which dealt with the concept of unsolicited orders did so in the context of a broker's exemption from section 5, not in consideration of whether a particular communication constituted a prospectus. Presumably, the sending of a document that clearly was a prospectus would not alter the determination as to whether or not a particular transaction was exempt. The point of these releases is that offering to sell a security to a broker who has inserted quotations in the sheets does not constitute a solicitation, regardless of the form in which that offer is made. That still does not contradict the language in section 2(10) that defines a prospectus as any written communication which confirms the sale of a security irrespective of the status of the transaction in which it is used. The Court therefore rejects the argument, based on questions 7 through 10 of the General Counsel's opinion that a comparison does not constitute a prospectus for the purposes of Section 2(10).
There is one statement, however, in the Senate Reports cited above that lends stronger support to the position taken by the plaintiffs that the comparison sent by Tobey & Kirk to Faulkner is not to be deemed a prospectus for purposes of the 1933 Act. The report discusses certain amendments to the 1933 Act made in 1954 and in the context of explaining an amendment which shortened the period during which transactions, by dealers not participating in the distribution, were not exempt from the provisions of section 5 of the Act, the report included this statement: "Section 5(b) of the Securities Act requires that all persons, unless exempt, use prospectuses in connection with the sale to the public of a registered security." S. Rep. No. 1036, 83d Cong., 2d Sess. 6 (1954) (emphasis added). It can certainly be argued that that is a recognition, at least by the Committee on Banking and Commerce, as constituted on February 25, 1954, that the prospectus delivery requirement in section 5(b)(1) was not intended to include comparisons exchanged by brokers. Nonetheless, this is insufficient authority to counteract what is otherwise clear statutory language. And it is a well-known maxim that the party who seeks to contradict the clear and unambiguous language of a statute must bear the burden of convincing the court that the interpretation he proposes is the correct one.
A third basis upon which the plaintiffs argue that the comparison sent by Tobey & Kirk does not constitute a prospectus is the inconsistency between the regulations regarding the contents of comparisons as prescribed at 17 C.F.R. § 240.15(c)1-4 (1975) and the rule covering broker confirmations promulgated by the National Association of Securities Dealers (NASD) in sections 9 through 11 of the Uniform Practice Code. That is an argument which in this court's opinion, is devoid of merit.
First, it would seem to be stating the obvious to point out that the documents which meet the definition of prospectus in section 2(10) of the Act will be of infinite variety. It can hardly be argued that a certain document is not a prospectus merely because it is different from a second document which clearly is a prospectus. Thus, merely because a broker's comparison is not the same as a confirmation to a customer which all of the parties admit is a prospectus within the meaning of the Act is not to say that it therefore cannot be a prospectus.
Furthermore, the regulations cited by the plaintiffs to describe the contents of a confirmation are not at all relevant to the definition of prospectus. Section 15(c)(1) of the 1934 Act
directed the Commission to enact "rules and regulations (to) define such devices or contrivances as are manipulative, deceptive, or otherwise fraudulent" for the purposes of that Act. It was pursuant to this authorization that the ...