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Newburger, Loeb & Co. v. Gross

decided.: August 24, 1977.


Cross appeals from a judgment of the Southern District, Owen, Judge, which dismissed plaintiff's churning claim under section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), awarded judgment on certain of defendants' counterclaims for civil conspiracy, violation of state partnership law, breach of fiduciary obligation, and conversion, and which dismissed the remaining state and federal counterclaims of the plaintiff, defendants, and additional defendants on the counterclaims. Affirmed in part; reversed and remanded in part.

Lumbard and Meskill, Circuit Judges, and Jameson, District Judge.*fn*

Author: Lumbard

LUMBARD, Circuit Judge:

These appeals and cross appeals from a judgment of the Southern District, Owen, Judge, are the latest chapter in the financial misfortunes of New York brokerage firm of Newburger, Loeb & Co. (hereinafter the "Partnership") and its successor, Newburger, Loeb & Co., Inc. (hereinafter the "Corporation") during the years 1969-71, which resulted in the departure of the managing partner, Charles Gross, and the arrangements made by the survivors and others to reorganize and rescue the business.

We affirm so much of the judgment of the district court which:

(1) Dismissed, as lacking in merit, the Corporation's churning claim, under section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), against defendants Charles Gross, Mabel Bleich, Jeanne Donoghue, and Gross & Co.

(2) Awarded judgment to the defendants on their first, second and fourth counterclaims against the Corporation, and against the Partnership, individual members of the Partnership,*fn1 the promoters of the Corporation,*fn2 and Robert S. Persky and his law firm, Finley, Kumble, Underberg, Persky & Roth (which at the time of judgment was known as Finley, Kumble, Wagner, Heine, Underberg & Grutman), who were brought in as additional defendants on the counterclaims, for conspiracy to injure the defendants with respect to their interests in the Partnership.

We hold that the district court properly exercised its ancillary jurisdiction over these counterclaims.

(3) Dismissed, as lacking in merit, defendants' ninth counterclaim under the federal antitrust laws for destruction of Gross' employment opportunity with Rafkind & Co., a New York brokerage firm.

(4) Dismissed defendants' fifth, sixth, seventh and eighth counterclaims for lack of subject matter jurisdiction.

(5) Dismissed the six counterclaims of the Corporation and the additional defendants against Gross.

We reverse those parts of the judgment which:

(1) Awarded judgment to Gross on defendants' third counterclaim for conversion of Gross' interest in warrants to buy stock of Geon Industries, Inc., and Computer Softwear Systems, Inc.

We hold that Judge Owen erroneously exercised jurisdiction over this claim after Judge Ward correctly held that it was not within the ancillary jurisdiction of the court.

(2) Awarded $50,000 punitive damages to Gross.

Finally, although we affirm the finding of liability on defendants' first, second and fourth counterclaims, we remand these counterclaims for recomputation of damages in light of our reversal of defendants' third counterclaim and certain difficulties with the court's computation of damages.

To further discussion of the issues, we summarize the underlying facts. The partnership was an established Wall Street brokerage firm. From about May 1959 through December 31, 1968 it acted as a clearing house for the partnership of Gross & Co., which consisted in part of Charles Gross, his sister, Jeanne Donoghue, his secretary, Mabel Bleich, and Charles Jordon; thus, the Partnership executed orders for Gross & Co. and sent confirmations and statements to its customers. Among these customers were David and Mary Buckley, who had an active account with Gross & Co. in 1962-66.

In 1969 Gross & Co. liquidated and on January 1, 1969, Gross became a general partner in the Partnership with an initial investment of about $400,000. Bleich and Donoghue became limited partners, investing about $75,000 each. Gross soon thereafter became managing partner of the Partnership and invested another $400,000 in the firm. The Partnership began to experience the record-keeping problems common on Wall Street in late 1969 and early 1970 caused by the greatly increased volume of transactions in the 1960's, which have come to be known as the "back office crunch," see, e.g., Hirsch v. du Pont, 553 F.2d 750, slip op. 2747 (2d Cir. 1977). By the summer of 1970 the firm was experiencing serious capital problems. A number of the partners expressed dissatisfaction with Gross' management, and he stepped down as managing partner. As he was not satisfied with the proposed new management, Gross gave notice of his withdrawal from the firm on August 31, 1970, which under the terms of the partnership agreement became effective as of September 30, 1970. Gross also demanded the return of his "additional capital" (claimed to be $400,000) and fifteen per cent of his "committed capital," pursuant to the partnership agreement. The agreement provided that at least eighty-five per cent of the "partnership interest" of a withdrawn general partner remained in the firm, at the risk of the business, for twelve months from the effective date of withdrawal. On December 31, 1970, Bleich and Donoghue submitted notices of withdrawal from the firm.

Fred Kayne became managing partner after Gross stepped down. Before joining the Partnership Kayne and Charles Sloane had been employed as registered representatives of the firm at its California office. According to Kayne and Sloane, they were induced by Gross to join the firm and became general partners in late February, 1970, each investing $50,000. In the summer of 1970, after becoming managing partner, Kayne brought in Robert Muh and Paul Risher as consultants. At about this time, the law firm of Finley, Kumble, Underberg, Persky & Roth began to handle legal matters for the Partnership, with Robert S. Persky as the partner in charge.

Defendants allege that shortly after Kayne became managing partner he began to plot with Muh, Risher, Sloane, Lawrence J. Berkowitz (house counsel to the Partnership), and Persky to transform the Partnership into a corporation and to gain control of its assets for a small investment. According to the testimony of Gross, early in September, 1970, he met with Persky and Kayne who attempted to persuade him not to withdraw from the Partnership and who told him that he would "be sorry" if he did not cooperate.

The fortunes of the Partnership continued to dwindle, however, and in November, 1970, both Kayne and Sloane withdrew. On November 17, 1970, the New York Stock Exchange notified the firm that if it was not in compliance with the "required excess capital" provision of the Exchange constitution by November 20, steps would be taken to suspend the firm. The Partnership was also directed to prepare for possible liquidation.

Under continuing pressure from the Exchange, a reorganization was proposed by Risher and Muh as an alternative to the Partnership's liquidation. The assets of the Partnership were to be transferred to a corporation; in return, the general and limited partners and the subordinated lenders were to receive a variety of securities in accordance with their capital positions. The corporation's promoters were Berkowitz, Kayne, Muh, Risher and Sloane. See note 2, supra. In return for investments of $10,000 each, Kayne, Risher, and Muh would each receive sixteen per cent of the common stock. Kayne and Sloane were to participate in management along with Risher and Muh. An infusion of fresh capital was to come from Alex Aixala (in the form of $1,000,000 worth of Bacardi stock), an investor brought in by Persky.

After numerous negotiations, Gross, Bleich and Donoghue refused to consent to the proposed transfer of assets; apparently, Gross felt the proposed transfer was a plot by the promoters to gain control of the Partnership assets for a small investment. The Corporation and the additional defendants contend, on the other hand, that Gross had no legal right to object to the reorganization and was merely attempting to gain a special benefit for himself by demanding a cash return of part of his investment. Although it appears that the promoters did not believe that Gross' consent (as a withdrawn general partner) was necessary to the reorganization, Gross contends they wished to dissuade him from withdrawing his capital. In any event, Bleich and Donoghue would not consent to the transfer without Gross' approval, and the promoters believed that the transfer could not be legally completed under New York law without the consent of Bleich and Donoghue (who were withdrawn limited partners).

According to the defendants, numerous attempts were made to "persuade" the defendants (particularly Gross) to consent to the transfer. The principal coercive tactic was the threat to tie up the defendants in lengthy litigation, including (1) the threat to bring suit on a claim of churning the account of David and Mary Buckley, and (2) the threat to sue Gross for fraudulently inducing Kayne and Sloane to join the Partnership and for mismanaging the Partnership's assets.

David and Mary Buckley maintained an account with Gross & Co. from April, 1962, through August, 1966, which was handled by Charles Jordon. Although the account was extremely active, by August, 1966, it showed a deficit of $332,000, which was owed to the Partnership as the clearing house. Between 1966 and 1970 unsuccessful efforts were made to collect the amounts owing. The Buckleys threatened bankruptcy if the collection efforts were pressed. In 1970 the Partnership commenced an arbitration proceeding under the rules of the Exchange. The Buckleys asserted one set-off and two counterclaims against the Partnership. The first counterclaim alleged that their account had been churned by Gross & Co. during the years 1962-66, for which the Buckleys claimed $75,000 in damages. Richard Miles, director of compliance for the Partnership in 1969-70, testified that the Buckley account was referred to him in 1970 by Leo Stern, a general partner. Miles concluded that the churning claim was without merit and was asserted as a bargaining tool. Miles testified that he communicated this evaluation to Robert Stern, the general partner to whom Miles reported, who agreed with this evaluation. According to Persky's testimony, the collection file was turned over to him in November or December of 1970. On December 30, 1970, the Partnership's $332,000 claim against the Buckleys was settled; the Buckleys agreed to pay the Partnership $50,000 and assign to it the churning claim against Gross & Co. in exchange for a release.

Risher testified that after the settlement Persky called him and stated that he thought it was a "good idea" to get the assignment of the churning claim. Persky stated in his deposition that the idea of obtaining the Buckley claim originated with him, that before and after the settlement there were discussions as to how the claim might be used in negotiations with Gross, and that he believed the churning claim might bring home to Gross "the reality of the situation." Despite the fact that there is no evidence that the Buckleys ever dealt with Charles Gross personally, the complaint in this case, which was prepared by Persky, alleged that Gross was the customer's man with whom the Buckleys dealt;*fn3 further, as the district court found, when this error was pointed out to Finley, Kumble, no attempt was made to correct it or to add Charles Jordon as a party. The amount of damages claimed by the Corporation was $250,000 - more than three times the amount claimed by the Buckleys.

Gross testified that at a meeting on January 15, 1971, attended by Risher, Muh, and Persky, he was told by Persky that he should go along with the proposed transfer and convince Bleich and Donoghue to consent. Persky told Gross that there were many claims that could be used against him if they "stood in the way of the deal," including the Buckley claim and allegations of malfeasance and it was in Gross' interest "not to be tied up in litigation for a long, long time, and to be free to work in the street." Persky told Gross to take the Buckley claim "very, very seriously." Gross refused to bend. He told Persky, Risher and Muh that they could keep their claims and that he thought the fairest solution was for the Partnership to liquidate. Shortly after this meeting concluded, Gross received a call from Kayne and Sloane in California. Sloane was extremely angry and told Gross that they had heard what had happened at the meeting and that, "If you kill this deal, we are going to sue you. You will be sued for a long time. You may never get out of the courts."

Similarly, on January 23, 1971, Kayne called Gross and arranged to meet him for lunch. Gross testified that at this meeting Kayne threatened him with litigation in California if he did not consent to the transfer. The district court credited Gross' version of these meetings. In addition to finding that various threats had been made against Gross, the court found, based on the testimony of Bleich, that Risher threatened Bleich with the Buckley claim to a point that made her cry.

On February 3, 1971, eight days prior to the date set for the proposed transfer of assets, Kayne and Sloane sued Gross in the District Court for the Central District of California, charging that Gross had fraudulently induced them to join the Partnership and had mismanaged its assets. Eventually, this suit was dismissed after a NYSE arbitration, which found in favor of Gross. The present suit was commenced by the Corporation on February 17, 1971.

Gross also claimed that an additional tactic used to coerce his consent was the destruction of a job opportunity. The Partnership articles, which were effective for a period of two years, provided that any general partner who voluntarily withdrew from the Partnership (as did Gross) could not "engage in the business of broker or dealer in securities and commodities whether for his own account or for others" until the expiration of the partnership agreement on December 31, 1971. After Gross left the Partnership, he was offered a job opportunity as a trader by Rafkind & Co. On January 19, 1971, Rafkind wrote the Partnership requesting clearance to employ Gross. Gross alleges that Berkowitz threatened Rafkind with suit, and in any case, Berkowitz sent a letter to Rafkind informing it of the Partnership covenant not to compete; the letter also indicated that the Exchange had been notified that Gross was subject to the restrictive covenant. Rafkind then dropped the job offer and so informed the Partnership. Gross claims that at a meeting on February 5, 1971, he was told by Risher that if an "accommodation" could be reached, he could have his job with Rafkind. However, despite these and other coercive tactics alleged by the defendants, Gross, Bleich and Donoghue refused to consent to the transfer.

The closing date for the transfer of assets from the Partnership to the Corporation had been set for February 11, 1971. The Exchange had advised the Partnership that if the required improvements in its capital position were not made, the Partnership would be suspended on February 12, 1971. The record indicates that at the January 15, 1971, meeting, attended by Persky, Risher and Muh, counsel for the defendants Philip Mandel, stated that the transfer could not legally take place without the consent of Gross, Bleich and Donoghue.

A condition precedent to the Corporation's obligation to execute the transfer agreement was the issuance of a letter of opinion from counsel to the Partnership, stating that the Partnership had the authority to make the transfer. Paul Burak, whose firm, Rosenman, Colin, Kaye, Petschek, Freund & Emil, had been retained to represent the Partnership, testified that a member of his firm researched the issue and concluded in a memorandum dated January 25, 1971, that under New York Partnership Law § 98, the transfer could not take place without the consent of all of the limited partners. Section 98(1)(b) provides, inter alia, that without the consent of all limited partners, a general partner or all of the general partners have no authority to "do any act which would make it impossible to carry on the ordinary business of the partnership." Burak conveyed his firm's position, that the transfer could not be conducted without the consent of all of the limited partners, to the Partnership; specifically, he testified that he discussed the matter with Andrew Newburger. Burak also conferred with Persky, who unsuccessfully attempted to persuade Rosenman, Colin to give a favorable opinion.

On the day of the closing, Rosenman, Colin refused to issue the letter of opinion. However, Persky, whose firm now represented the Corporation, stated that his firm had done some research in the area and it was agreed that Persky would issue the opinion letter as special counsel to the Partnership. The letter was issued, examined by counsel for the parties, and the deal was closed.

Under the transfer agreement the Corporation agreed to assume all liability for the claims of Gross, Bleich and Donoghue arising out of the transfer. The Corporation set up a reserve fund of $300,000 for this purpose.*fn4 However, no ...

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