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CUMIS INS. SOCY. v. E. F. HUTTON & CO.

October 16, 1978

CUMIS INSURANCE SOCIETY, INC., Plaintiff,
v.
E. F. HUTTON & COMPANY, INC., George D. Oppenheimer & Co., Inc., George D. Oppenheimer, Generex Corporation, Joseph Saleh and Jacob Jaeger, Defendants. E. F. HUTTON & COMPANY, INC., Third-Party Plaintiff, v. The CHESTNUT RUN FEDERAL CREDIT UNION, Third-Party Defendant and Fourth-Party Plaintiff, v. EMPLOYERS MUTUAL LIABILITY INSURANCE COMPANY OF WISCONSIN, a corporation of the State of Wisconsin and the Aetna Casualty and Surety Company, a corporation of the State of Connecticut, Fourth-Party Defendants



The opinion of the court was delivered by: GOETTEL

This securities action presents a good example of a plaintiff's deep-pocket theory that attempts to stretch the securities laws beyond recognition. The Court finds them not sufficiently elastic to reach this particular pocket.

The plaintiff, Cumis Insurance Society ("Cumis"), is the assignee of two credit unions, Wepco and Amcello, who were the victims of a fraud perpetrated by an investment advisor named George Oppenheimer. The complaint names E. F. Hutton & Co. ("Hutton"), a broker with which Oppenheimer did business, and several other parties as defendants. Three other defendants, Generex Corp., Joseph Saleh and Jacob Jaeger, have filed cross-claims against Hutton for indemnity or contribution. *fn1"

Over one and a half years ago, Hutton moved for summary judgment, under Fed.R.Civ.P. 56, on all claims against it. The plaintiff, agreeing that no material facts were in dispute, cross-moved for summary judgment on its claims against Hutton. The initial papers raised phantom issues of fact sufficient under this Circuit's stringent requirements to require denial of the motions. The Court offered to hold an evidentiary hearing to resolve the apparent conflicts. The parties, however, represented to the Court that the facts were sufficiently clear that the case could be submitted on a stipulation of facts. After months of negotiation between counsel for Cumis and Hutton, that stipulation is now before the Court, and it establishes the following facts.

 I

 From 1969 to March, 1973, George Oppenheimer worked as a registered representative for Merrill Lynch, Pierce, Fenner & Smith, Inc. ("Merrill Lynch"). Oppenheimer became something of an expert in the accounts of credit unions, including the accounts of plaintiff's assignors, Wepco and Amcelle. This type of brokerage work was a fairly specific expertise, since the permissible investments of credit unions established under the Federal Credit Union Act, 12 U.S.C. §§ 1751-75, are restricted to obligations guaranteed by the United States, i. e., government securities. See id. § 1757(7). In March of 1973, Oppenheimer decided to leave Merrill Lynch and strike out on his own as a small investment advisor. He left Merrill Lynch with a good record, and he took with him some of his previous clients, including Wepco and Amcelle.

 On March 19, 1973, Oppenheimer opened a margin account with Hutton in the name of George D. Oppenheimer & Co. One of the reasons that led him to Hutton was a social friendship with Darryl Vignon, a Hutton account executive. When he opened the account, Oppenheimer told Vignon and the Hutton branch manager, Jerome Lichtstein, that he would be investing for himself and others, but the "others" were not identified. Vignon and Lichtstein did not inquire as to Oppenheimer's clients, except to verify that he would not have more customers than the statutory limit above which he would have had to register as an advisor under the Investment Advisors Act, 15 U.S.C. §§ 80b-1 to 80b-21. See id. § 80b-3(b)(3).

 At the time Oppenheimer opened the account, Hutton requested and received all the information necessary to fill out its standard forms for new margin accounts, including a copy of the certificate of incorporation of George D. Oppenheimer & Co., and corporate resolutions authorizing the opening of the account. Telephone inquiries by Hutton to Merrill Lynch confirmed that Oppenheimer had left Merrill Lynch in good standing and facilitated the transfer of his accounts at Merrill Lynch to the Hutton branch. Aside from these routine procedures, Hutton undertook no further investigation of Oppenheimer at that time.

 The account became the largest and most productive one that Vignon had as an account executive. Oppenheimer made many purchases and sales of stocks through the account, and many large checks, including some drawn on Oppenheimer's personal bank account, were deposited. Frequent withdrawals of cash were also made by Oppenheimer. Through March and April, the only aberration of any sort in the account was the deposit of a $ 112,000 check, drawn on Oppenheimer's corporate bank account, which was later dishonored.

 On May 2, 1973, Oppenheimer delivered to Hutton two Government National Mortgage Association certificates ("GNMAs") *fn2" issued in the name of Wepco, in the amounts of $ 200,000 and $ 300,000. The two GNMAs had been duly indorsed in blank by Wepco's manager, and Oppenheimer pledged them as collateral for loans extended by Hutton in the margin account. Oppenheimer had obtained the GNMAs after orally promising Wepco to use the proceeds generated by the pledges to invest on behalf of Wepco in government securities. *fn3" Since the GNMAs were effectively "bearer" instruments, Vignon and Lichtstein made no inquiry into how Oppenheimer had obtained possession of them, whether he planned to invest the proceeds on behalf of Wepco, or what authority he had in investing the proceeds. Vignon either was told or assumed that the proceeds of the loan would be invested on behalf of Wepco, but he did not inquire as to the nature of the investments Oppenheimer planned to make, nor was the topic of federal credit unions and their permissible investments discussed. *fn4" There is no evidence that Vignon or the branch manager, Lichtstein, were aware of the investment limitations on federal credit unions. Further, nothing on the certificates themselves indicated any limitation on Oppenheimer's authority with respect to them.

 Unfortunately for Wepco, of course, Oppenheimer never intended to invest its money in government securities. Ultimately, he sought out some apparently speculative, high risk common stocks in an attempt to make larger profits. To aid his scheme, he sent fraudulent purchase and sales confirmations for government securities to Wepco to substantiate his claims that he was investing only proper government obligations.

 There is no evidence that anyone at Hutton was directly involved in Oppenheimer's scheme. Indeed, the speculative stocks that he bought with Wepco's funds were purchased through brokers other than Hutton with the funds taken from the margin account. *fn5" So far as the parties were able to determine, it appears that Oppenheimer never bought anything for Wepco or Amcelle through Hutton.

 During May, the Oppenheimer account at Hutton continued to be very active. On May 23rd, Oppenheimer opened a second margin account, this one in the name of Hudson Valley Securities Corp. ("Hudson Valley"). As he had before, Vignon secured all the necessary information to complete the Hutton forms, including a certificate of incorporation for Hudson Valley and corporate resolutions authorizing the opening of the account. Also, as before, the only apparent aberration in the account in the weeks immediately thereafter was one check, in the amount of $ 380,000, which was deposited by Oppenheimer and later dishonored on June 13, 1973. Oppenheimer, however, managed to cover the check on that same day. *fn6"

 On or around June 11th, Oppenheimer presented Hutton with another GNMA, this one issued in the name of Amcelle in the amount of $ 500,000. The certificate had been duly indorsed by Paul Herring, Amcelle's manager, to George D. Oppenheimer & Co. This GNMA had been obtained by Oppenheimer under an oral agreement with Amcelle identical in all material respects to the one he had made earlier with Wepco. See Note 3 Supra. Oppenheimer pledged the Amcelle GNMA as collateral in his Oppenheimer & Co. account, but there were two technical deficiencies in the transfer. Herring's signature on his indorsement had not been properly guaranteed, and the transfer indorsement to Hutton was made incorrectly on a bond transfer form rather than a government securities assignment form.

 Apparently because of the large amount of the certificate, and because it was specially indorsed to Oppenheimer & Co., Lichtstein, the Hutton branch manager, requested that Oppenheimer document his right to possession of it. Oppenheimer produced a letter from Herring to him, stating in part that the indorsement had been "executed for your use in purchasing securities for the Amcelle Employees' Federal Credit Union." Lichtstein was evidently satisfied with this documentation and, again, there was no discussion of credit unions or the statutory restrictions on their investments. Instead, according to Oppenheimer's subsequent testimony, Oppenheimer represented to either Lichtstein or Vignon that he had complete authority to trade in securities of any type on behalf of Wepco and Amcelle. Oppenheimer also testified later that Hutton had no knowledge of his illegal scheme. In addition, the parties have stipulated that Hutton had no knowledge of Oppenheimer's oral agreements with the credit unions.

 Throughout July, Oppenheimer continued to use the proceeds of the loans to invest in non-government securities, without the knowledge of Wepco or Amcelle. The activity in the Oppenheimer accounts was very heavy, and apparently because of the size and activity of the accounts, Lichtstein conferred with in-house counsel for Hutton on July 5th, to discuss the accounts and the GNMAs that were being used as collateral. At that time, Hutton's counsel advised only that Oppenheimer should not be permitted to draw checks on the accounts to himself individually, which previously had occurred once.

 Hutton's counsel followed up his conference with Lichtstein by requesting a private investigation of Oppenheimer and his companies. In its report dated July 12th, Intelligence Services, Inc. stated that its expedited investigation had revealed nothing perjorative about Oppenheimer. Rather, it found that Oppenheimer's finances were in apparent order, and that he had maintained an "excellent reputation in the vicinity of his residence and business address." Hutton's in-house counsel also verified from official sources that Oppenheimer's corporate records revealed no irregularities. No investigation was made concerning Oppenheimer's clients and their investments.

 Through July, activity in the Oppenheimer account remained heavy. In August, however, the proverbial house of cards began to collapse. Because the three GNMAs were "self-liquidating" securities, *fn7" their value as collateral in the margin account was steadily decreasing. As a result, the credit Hutton had extended to Oppenheimer was becoming insufficiently collateralized, creating a margin call in the account.

 Oppenheimer panicked. He disclosed his fraudulent scheme to Herring, the Amcelle manager, and offered to pay Herring a weekly bribe for his cooperation in further subsidizing Oppenheimer while Oppenheimer attempted to extricate himself from his financial morass. Herring refused, notified Amcelle's attorneys, who in turn notified the authorities, and Oppenheimer eventually pleaded guilty to a state criminal fraud charge and was sentenced to prison.

 In the aftermath of the disclosures, the Wepco GNMAs were apparently reregistered by Hutton in its name and sold to cover the margin call in the Oppenheimer account. Amcelle, however, notified its transfer agent not to permit transfer of its GNMA. After some negotiation between Amcelle and Hutton, Amcelle's board of directors, on August 9, 1973, authorized transfer of the GNMA to ...


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