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June 6, 1977

Drasner et al.
Thomson McKinnon Securities, Inc.

The opinion of the court was delivered by: POLLACK

POLLACK, District Judge: This case is before the Court after a trial before a jury which rendered a verdict for plaintiffs. The defendant presented motions herein during trial and again after verdict to dismiss the complaint, to set aside the verdict which the jury returned responding to special questions put to it, for a directed verdict in defendant's favor on the complaint and on defendant's counter-claim or in the alternative for a new trial. The defendant is entitled to relief to the extent hereafter indicated.

Plaintiffs, husband and wife (Drasners), were experienced traders in the stock and commodity markets having had a number of accounts with brokers over a period of 20 years. They became margin account customers of defendant (Thomson) in 1973 opening an account in each of their names and in joint name. Before transacting business through Thomson, the Drasners had engaged in writing options through Put and Call brokers in the Over-The-Counter market. With the advent in 1973 of the Chicago Board of Options Exchange (CBOE), a national exchange, the Drasners started to sell options listed on the CBOE on orders placed with brokerage houses. These apparently were options sold on stock which the Drasners owned at the time, known as covered options.

In about February 1974 the Drasners decided to engage in the sale of naked options (on stock which they did not own at the time) apparently with the realization that they could cover the calls sold by them by purchases of equivalent options on the CBOE before maturity of the calls they had sold and thus limit any impending losses on the calls they had written.

 Their sales of naked calls proved profitable in 1974. They wrote about 50 calls per month receiving the premiums payable to them therefor and realized about $65,000 in profits that year. The course of prices of stocks on which they sold calls was downward during 1974 resulting in minimal or no exercise of the calls by the purchasers.

 In 1975 the Drasners were not so fortunate. They continued selling naked calls on highly volatile listed stocks traded on the New York Stock Exchange but market prices spiked sharply upward making the calls written by the Drasners attractive to the purchasers. The exercise thereof would require delivery by the Drasners of stock at the call prices and below the market prices. A substantial loss on the options written by the Drasners kept building up between January and May 1975.

 Thomson closed out the Drasner accounts on May 9, 1975 with the result that after the collateral posted in the accounts was liquidated and the outstanding calls were bought in there was a total deficit in the three accounts of $79,578.47.

 This action was thereafter brought by the Drasners against Thomson seeking to disavow all of the calls that the Drasners had written between January and May 1975 on the ground that in violation of Regulation T issued by the Federal Reserve Board the defendant had failed to require the Drasners to deposit initial margin in their accounts allegedly obligatory under Regulation T, 12 C.F.R. § 220.1 et seq.

 A jury has awarded the plaintiffs a damage verdict representing the market value of plaintiffs' collateral in their accounts in 1975 as well as the highest value the securities attained within 30 days after their accounts were closed out on the theory that such collateral was converted by defendant by the close-out and has denied the defendant a recovery of the deficit in the accounts following the close-out thereof.

 The plaintiffs cast their claims in a number of different Counts. All Counts other than those to be specifically mentioned hereafter were dismissed either on consent or by the Court's action. The remaining Counts seek damages for violation of Regulation T (Count One), rescission of the option transactions for violation of Regulation T (Count Three), damages for violation of section 10b of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), and Rule 10b-5 17 C.F.R. § 240.10b5, promulgated thereunder (Count Nine), damages for violation of New York General Business Law § 352C (Count Ten), damages for common law fraud (Count Eleven), and damages for conversion of collateral on hand on May 9, and May 12, 1975 (Count Seventeen).

 The defendant's motions essentially assert that the Court lacks jurisdiction of the plaintiffs' claim under Regulation T inasmuch as Regulation T did not govern the writing of naked options prior to January 1, 1977; that there is no private right of action for a violation of Regulation T; that Regulation X, 12 C.F.R. § 224, bars any recovery under Regulation T by these plaintiffs; that plaintiffs have failed to establish a claim under the Securities Exchange Act of 1934 having failed to prove fraud as required under § 10b, 15 U.S.C. § 78j(b), and that the Court lacks jurisdiction of the pendent common law claims.

 Alternatively, the defendant seeks a new trial on the grounds that the verdict is against the weight of the evidence, is not in accordance with the law; and includes profits on transactions which have been disclaimed by the plaintiffs. Furthermore, allegedly as a matter of law, the defendant asserts that the jury erred in denying the defendants' counterclaims.


 Fair Trial

 The defendant complains, properly, that the trial was prejudicially marred by unwarranted inflammatory conduct on the part and on behalf of the plaintiffs which was persistent throughout and was calculated to and did divert the minds of the jury from the issues in the claims on trial, and thereby resulted in a trial of a party to the litigation, rather than a trial of the claims in suit.

 The plaintiffs were the main witnesses on their own behalf. Their schooled histrionics, affected ignorance of matters on which they possessed virtually expert knowledge, their dramatizations and theatrical displays on the witness stand went beyond mere matter bearing on credibility. These were skillfully culminated in a highly inflammatory summation to the jury that defendant was in effect conducting a bucket shop where the customers had no chance, that the option transactions were "fixed gambling" and the customers were bound to lose their money. Counsel portrayed the incidents pertaining to alleged undelivered margin calls and the broker promise to give time and indulgence for deposit of the needed margin in May 1975 as conduct in line with stock option trading encouraged by defendant that was "fixed," analogous to "a fixed football pool" and a "fixed race track" resulting in "losses because the gambling was fixed."

 The issues in this case were thus improperly expanded by plaintiffs to include matters which were not properly before the jury and which seriously prejudiced the defendant's right to a fair trial. The counsel's summation clearly sought to arouse undue passion and prejudice and exceeded the bounds of propriety to a degree to which objection would have been futile and exception unavailing and thus unnecessary.

 The jury was helpless against the battering assault to perpetuate in their minds a notion that the complexity of the formula for computing margin requirements and the definitions posed by the plaintiffs somehow provided an excuse to plaintiffs from the results of the unprofitable calls on volatile stocks which they sold in 1975 in a market of rising stock prices.

 Trial conduct similar in purpose and effect has been held grounds for ordering a new trial. Koufakis v. Carvel, 425 F.2d 892, 904 (2d Cir. 1970). See also, N.Y. Central R.R. Co. v. Johnson, 279 U.S. 310, 49 S. Ct. 300, 73 L. Ed. 706 (1929); 78 A.L.R. 1458, 1474, 1478.

 Thus, in Secor v. Heyman, 123 Misc. 168, 205 N.Y.S. 348 (1st Dep't 1924), where a stock brokerage firm sued its customer to recover the price of stock purchased on his behalf, the Court ordered a new trial because the defendant's counsel in summation stated:

 "There is many a man sitting on the benches in the park because he lost his money down on Wall Street."

 Similarly, in Coleman v. Miller, 19 S.W. 2d 829 (Ct. of Civil Appeals of Texas, 1929), a new trial was granted, in part because counsel made the following argument:

 "The plaintiff... has been referred to as a stock salesman.... [He] did not sell any stock but sat in a swivel chair while other men sold the stock.... He is not a stock salesman but is a kid-glove, patent leather, spat-wearing parasite." Id. at 839.

 In Koufakis, supra, an action by a dealer against the franchisor for breach of the franchise agreement, a new trial was ordered where the dealer's counsel alluded to the Mafia in characterizing the head of the franchise organization.

 In Laughing v. Utica Steam Engine and Boiler Works, 16 A.D.2d 294, 228 N.Y.S. 2d 44 (4th Dep't 1962), a personal injury action, a new trial was ordered, in part because counsel characterized the opposing party as follows:

 "the best I can say of their clients is that they are not entitled to be represented by such fine, upstanding men."

 In Colorado Canal Co. v. Sims, 82 S.W. 531 (Tex. Civ. App. 1904), plaintiff's counsel's statement, in his closing argument, that he did not ask the jury to bring in a verdict against the defendant because it was an irrigation corporation, although such corporations had swindled everyone who did business with them, was held grounds for reversal.

 The verdict in this case borders on a travesty on justice, reaches a seriously erroneous result on a variety of bases, was unfairly influenced by misconduct attributable to the plaintiffs and at all events is against the weight of credible evidence. The myriad details illustrating the foregoing need not be chronicled because a new trial is unnecessary as a matter of law on the issues relating to federal margin requirements. There is, in the Court's opinion a fundamental flaw in plaintiffs' Regulation T oriented claims herein* which makes it unnecessary to order a new trial as to such claims for a miscarriage of justice - a new trial which defendant would otherwise receive but for the insufficiency of law of the claims invoking Regulation T obligations or representations.


 The security involved herein

 To properly understand the argot in the industry it will be useful to cover some relevant definitions of terms and background information on matters encountered in this case.

 The "writer" of an option is a person who, through his broker has sold an option on the Exchange and has thereby undertaken with the Clearing Corporation to deliver the underlying stock upon the timely assignment of an exercise notice to him against payment of the specified exercise price.

 The buyer of the option pays and the writer receives an amount known as the "premium".

 "Margin" is the amount which a customer pays when he uses a broker's credit to purchase a security. Margin is referred to in two separate categories. It may refer to an "initial" margin requirement at the time of purchase or short sale; or it may refer to a minimum requirement of margin to be maintained in the account, i.e., "maintenance margin." Regulation T of the Federal Reserve Board governs the amount of credit (if any) which may be initially extended by a broker at the time a customer enters into any securities transaction. Apart from Regulation T, the New York Stock Exchange sets minimum initial and maintenance margin requirements. Additionally, some brokerage firms require higher maintenance requirements than fixed by the Exchange.

 A "debit balance" in an account represents money which the broker has loaned to the customer. In purchasing securities on margin, the customer must pay the amount of money, if any, required by Regulation T and the balance of the purchase price, if any, is loaned to the customer. In the case of an option, no loan is needed by or made to the writer-customer by his broker. The cost to the purchaser of an option (the premium) must be paid up in full by him at the time of the commitment; the purchase may not be margined. The option writer requires no financing from the broker when he sells the option; the premium paid by the purchaser for the option is credited to the account of the writer when collected through his broker.

 The writer of an option binds himself contractually to the Clearing Corporation to deliver the underlying stock. The Clearing Corporation is the issuer of and obligor on every CBOE option and its aggregate obligations to holders of options are backed up by the aggregate contractual obligations which writers owe to the Clearing Corporation.

 An option which is not hedged by a position in the underlying security (an uncovered option) exposes both the customer writing the option and the brokerage firm carrying the account to potential loss in the event the market price of the underlying security moves in an unfavorable direction. In the case of a call, the writer customer agrees to sell a security at a specified price (exercise price). The call is likely to be exercised if the market value of the underlying security rises above the specified price. In such case, the holder of the call will purchase the stock at the specified price. If the call is not hedged with an offsetting "long" position in the underlying security, the writer customer and the brokerage firm carrying the account are exposed to the extent of the difference between the two prices.

 Because of this potential exposure, New York Stock Exchange Rule 431(d)(2) requires that unhedged call options must be margined in the writer's account as if they had been exercised. A call written for a customer's account represents a potential "short" position and requires the same maintenance margin as a "short" position in a security - generally, 30 percent of the market value of the underlying security.

 Margin requirements under the rules of the CBOE are different; they are based upon the market price of the options rather than on the price of the underlying stock. The CBOE margin rules give members the alternative of margining customer accounts either under the CBOE's rules or the manner established under the rules of the New York Stock Exchange.

 CBOE options have a market price of their own, namely, the premium payable therefor, and that moves up or down on the CBOE in conjunction with price movements in the underlying stock. The margin required by the CBOE is 100% of the market value of the option or $250 per trading unit, whichever is greater. In addition, the option must be marked to the CBOE market on a daily basis.

 Prior to the establishment of the CBOE, the writer of an option and the brokerage firm carrying the "short" option position were at the complete risk of the market during the life of the option. Before CBOE there was no way in which the liability could be removed from the writer unless the brokerage firm carrying his account was fortunate enough to find the current holder of the option and repurchase it. The writer, in most cases, simply waited for the call to expire or until it was exercised against him, at which time he assumed his loss. The only ways to limit the loss were to purchase an equivalent call option or assume a position in the security under option offsetting the "short" position that would result if and when the call was exercised.

 The CBOE maintains a secondary market in listed call options. In the event the writer of a CBOE call wishes to remove his liability under the terms of the option, or in the event the writer customer fails to meet a margin call and the brokerage firm wishes to liquidate his position in the option, this can be accomplished by buying-in an identical option in the secondary market and so closing the "short" option position. In other words, the same procedure is followed as in closing out a "short" position in the stock.

 It is the CBOE Clearing Corp. to which an option holder looks for fulfillment of his option contract upon exercise. The Clearing Corp. looks, in turn, to the clearing members carrying short positions in the particular class of option exercised. If an exercise notice has been assigned to a broker he in turn assigns it to a customer's account by allocation on a "first in, first out" basis on the basis of random selection or by any other method that the CBOE has approved as being fair and equitable. Upon allocation of an Exercise Assignment Notice to a customer, the underlying stock must be immediately sold and delivered by the writer of the option for the exercise value of the option contract. This sale is recorded in the general (margin) account of the customer and is subject to the same margin procedures prescribed for any sale of stock in any of the accounts of the customer.


 Federal margin requirement on uncovered options

 As already indicated, this suit was brought on the claim of a federal private right of action arising from alleged violation of federal margin requirements for option writing during 1974 and 1975. However, effective January 1, 1977, the Governors of the Federal Reserve Board instituted, for the first time, a margin requirement on uncovered option writing, by amendment to Regulation T. Since none of the transactions in this case took place thereafter and all of the uncovered options sold by the plaintiffs were sold in 1974-75, there was no violation of Regulation T by the plaintiffs or defendant based on failure to comply with a federal margin rule.

 The Federal Reserve Board on September 27, 1976, instituted the margin requirement by an addition to Regulation T and made it effective January 1, 1977, following notice of proposed rule-making published three years earlier on May 23, 1973 at 38 Federal Register 13571. The notice invited comment on a proposal to require a uniform deposit of margin by a broker's customer, in connection with the issuance, endorsement and guarantee of any put, call or combination thereof. As initially proposed the rule would have required a margin deposit on option transactions based upon the current minimum requirement of the major stock exchanges.

 On August 20, 1975, a revision of the 1973 proposal was published by the Federal Reserve Board at 40 Federal Register 36,390 and further comments were invited. The revised proposal of August 1975, called for an initial margin requirement of 30 percent of the current market price of the underlying security for uncovered options; that, in fact, was the current minimum requirement of the major stock exchanges.

 After reviewing the comments received and the evolving conditions in the options market, the Board determined on September 27, 1976 that it is in the public interest to adopt an amendment "instituting" a uniform ...

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