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United States Fidelity & Guaranty Co. v. Royal National Bank of New York and Merrill Lynch

decided: December 14, 1976.

UNITED STATES FIDELITY & GUARANTY COMPANY, PLAINTIFF-APPELLANT,
v.
ROYAL NATIONAL BANK OF NEW YORK AND MERRILL LYNCH, PIERCE, FENNER & SMITH, INC., DEFENDANTS-APPELLEES



Appeal from an order and judgment of the United States District Court for the Southern District of New York, Henry F. Werker, Judge, dismissing the complaint in an action for conversion and entering judgment for defendants. Opinion below reported at 413 F. Supp. 43.

Friendly, Hays and Mulligan, Circuit Judges.

Author: Mulligan

MULLIGAN, Circuit Judge:

The plaintiff, United States Fidelity and Guaranty Company (USF&G) appeals from an order and judgment of Hon. Henry F. Werker, United States District Court for the Southern District of New York, entered on January 15, 1976 dismissing its complaint and awarding judgment to the defendants. USF&G had brought an action for conversion against the defendants Royal National Bank of New York (Royal) and Merrill Lynch, Pierce, Fenner & Smith, Inc. (Merrill Lynch) for cashing United States Treasury Notes having a face value of $212,000. The notes were alleged to have been stolen from W. E. Hutton & Company (Hutton), insured against the loss by USF&G which, upon payment of the claim, became subrogated to and was assigned the cause of action against the defendants. After a four-day bench trial in August, 1975, Judge Werker filed an opinion on January 12, 1976, reported at 413 F. Supp. 43, finding that Royal had been authorized to sell the notes by its customer Frank Mazzochi, Jr., had acted in good faith observing reasonable commercial standards as his agent and thus was shielded from liability by N.Y. U.C.C. § 8-318. He further found that Merrill Lynch was a bona fide purchaser of the bills, that it had the right to rely on its customer Royal and consequently that there was no violation of Rule 405 of the New York Stock Exchange. We affirm.

I

Sometime between May and August 1966, United States Treasury Notes disappeared from the vault of the Bankers Trust Co. where they had been deposited by Hutton for safekeeping. On August 4, 1966 Mazzochi appeared at Royal's branch bank at 149th Street in the Bronx and presented a $10,000 United States Treasury Note which he stated he wished to cash. This note and those subsequently presented by Mazzochi were among those missing from the Bankers Trust vault. The notes were in bearer form, were due November 15, 1970 and all bore a 5% interest rate. (Mazzochi was later convicted in a state court of criminally concealing and withholding stolen property.)

Mazzochi was no stranger to the bank. He was introduced to Royal in 1965 by local businessmen as the new president of the Mutual Credit Union (Mutual) which had an account at Royal since 1951. The clerical details of the August 4 transaction as well as those subsequent were handled by Rudolph Santoro who was acting head of the loan department of the Royal branch. Mazzochi was referred by Santoro to Robert Kayner, a credit officer of the bank. Kayner had known Mazzochi for six months to a year, as a bank customer with several business accounts. He further knew that he was the president of Mutual which was an account well known to Royal. Mazzochi told Kayner that he was selling the note which belonged to his family. Although he wished a bank check in payment, he was persuaded to open a personal checking account in which the proceeds from the sale of the note would be deposited. Kayner approved the sale and on August 5 the notes were sold by Royal to Merrill Lynch "for the account of Frank Mazzochi, Jr." On August 5 and on August 9 Mazzochi made his second and third visits to the bank with Treasury Notes totalling $130,000. In both cases Santoro handled the clerical details, Kayner approved the transactions and the order for the sale was placed with Merrill Lynch. As the result of these three transactions Royal had credited to Mazzochi's personal checking account the sum of $140,192.12.

Mazzochi commenced his cash withdrawals on August 9 when he took out $35,000; on August 10 he withdrew $13,000 and thereafter he withdrew $10,000 on nine separate occasions between August 12 and August 29, 1966. On September 2, he withdrew $500 reducing the balance in his checking account to approximately $1700.

On September 12, 1966 Mazzochi once more appeared at Royal with twelve Treasury Notes totaling in face value $72,000. Since Kayner had been transferred, Santoro brought the transaction to the attention of another officer of Royal, Edward I. McGraw. Santoro advised McGraw of the prior sales. The record is not clear as to whether McGraw knew at that time that Mazzochi had made the earlier substantial cash withdrawals. Because McGraw died prior to the trial, his deposition was admitted as testimony at trial. As an officer of Mutual which had maintained a moderate four-figure account at Royal, Mazzochi was known by McGraw on a first name basis for two years. Mazzochi informed McGraw that the notes were his. Although McGraw advised Mazzochi that a transaction of this size was unusual, he gave his approval and the notes were forwarded to Merrill Lynch for sale as in the previous cases. When the proceeds of this sale were received from Merrill Lynch, McGraw had been made aware of Mazzochi's previous withdrawals. His concern was that the substantial sums withdrawn might constitute a violation of Federal Reserve regulations. He ordered the proceeds of the sale to be held in a suspense account rather than in Mazzochi's personal account until further inquiry could be made. McGraw contacted Royal's General Counsel who advised him to obtain an affidavit from Mazzochi certifying that he was the owner of the notes. McGraw also discussed the matter with the Cashier of Royal's main office, Peter Walter, who called both the FBI and the Secret Service. Royal's counsel also called counsel to the Deputy Comptroller of the Currency. No information was received from any agency contacted that these Treasury Notes had been reported stolen or missing. In fact, no such information could have been given since Hutton made no report until November 2, 1966 when, at the urging of the USF&G, it advised the FBI and the police that the notes were missing. The court below found that this nondisclosure was deliberate on the part of Hutton in order to avoid the adverse publicity which might have resulted if a report were made.

On September 20 Mazzochi executed an affidavit in McGraw's presence swearing that he was the rightful owner of each of the notes which had been sold. Mazzochi, unable to obtain the funds, retained counsel in an effort to persuade the bank to release them. On September 29, 1966 the proceeds of the sale were credited to his personal account. The energetic Mazzochi promptly withdrew $10,000 in cash on September 30 and $61,000 on October 3, 1966.

II

On appeal the parties agree that Royal's liability is to be determined by New York law which here is codified in the Uniform Commercial Code § 8-318 which provides:

An agent or bailee who in good faith (including observance of reasonable commercial standards if he is in the business of buying, selling or otherwise dealing with securities) has received securities and sold, pledged or delivered them according to the instructions of his principal is not liable for conversion or for participation in breach of fiduciary duty although the principal had no right to dispose of them.

The issue as to Royal's liability therefore turns on whether it acted in good faith, taking into account the observance of reasonable commercial standards in its dealings with Mazzochi. Royal on this appeal argues that since it was not "in the business of buying, selling or otherwise dealing with securities" but merely did this as an accommodation for its customer for which it received no fee, the commercial standards test should not be applied but only a more lenient test of good faith simpliciter. The trial court assumed that the bank had to observe reasonable commercial standards and found that it had. We see no merit to the argument Royal now urges. Appellee cites no authority for its position, Royal was commercially sophisticated and while it was not in the business of buying and selling securities, it was "otherwise dealing with securities." Even absent the statute, in ...


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