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SCHENCK v. BEAR

November 13, 1979

ROBERT SCHENCK, Plaintiff,
v.
BEAR, STEARNS & CO., MERKIN & CO, INC., et al., Defendants



The opinion of the court was delivered by: MOTLEY

FINDINGS OF FACT AND CONCLUSIONS OF LAW

FINDINGS OF FACT

 From mid-1972 until the present time, plaintiff Robert Schenck was a citizen of the United States and a resident of Paris, France. Defendant Bear, Stearns & Co. ("Bear, Stearns") is a stock brokerage firm, with its principal place of business in New York, and is a member of the New York Stock Exchange. Defendant Merkin & Co., Inc. ("Merkin") is a stock brokerage firm with its principal place of business in New York.

 Plaintiff Schenck is a relatively sophisticated securities investor who from 1967 through 1972 was associated with four stock brokerage firms as a registered representative and/or registered principal. The sequence of events leading to plaintiff's claims began in April, 1972, when plaintiff opened a margin securities account through TPO Inc., a New York brokerage house which ceased operations in 1973 and whose accounts were subsequently carried through defendant Merkin.

 In a margin account, the customer borrows money from his broker in order to purchase securities. The customer advances only a portion of the purchase price and pays interest on the amount borrowed to finance the securities purchased. The broker retains possession of the securities purchased as collateral. By trading on margin, a customer is able to purchase a greater number of securities with a given amount of capital than he could purchase with that same amount of capital in a cash account.

 Plaintiff moved to Paris shortly after opening his account. He did, however, return to New York several times each year, spending much of his time in New York at the offices of Merkin, following his investments. At Merkin, the registered representative for plaintiff's account was Alvin Corwin. Corwin is presently a vice president and director of the retail bond division of the brokerage firm of A.G. Becker & Co.

 Virtually all of plaintiff's transactions at TPO and Merkin were in speculative debentures. Plaintiff's account was nondiscretionary, and no purchases were made without his prior approval or consent.

 Commencing in 1972 and until March, 1975, plaintiff purchased debentures issued by GAC Properties Credit, Inc. ("GAC debentures") which bore interest at rates of eleven percent and twelve percent per annum. The interest which plaintiff earned on the debentures was greater than the interest he paid on the margin account loans. The GAC debentures purchased by plaintiff were in denominations of $ 1,000 each and traded at a percentage of their face value. For example, if the debentures were trading at 76 they would be trading at a price of seventy-six percent of face value or $ 760 per debenture. The GAC debentures traded at a discount from face value in part because they were considered speculative or risky investments.

 Plaintiff was aware of the speculative nature and risk of GAC debentures and was so informed by Corwin. Plaintiff was also aware and was advised by Corwin that because of the speculative nature of these debentures, plaintiff had to follow their progress and market activity very closely.

 On or about June 9, 1975, defendant Merkin, which had been clearing its transactions through other brokerage houses, entered into a clearing agreement with defendant Bear, Stearns. A clearing broker, such as Bear, Stearns, maintains all pertinent books and records relating to customers' accounts introduced to it by the introducing broker, such as Merkin. The clearing broker makes loans on the margin accounts to such customers, and is responsible for computing the margin requirements for such margin accounts and for issuing calls to the customers for additional margin.

 Margin accounts, such as plaintiff's, are subject to two types of margin requirements. Pursuant to Regulation "T" promulgated by the Board of Governors of the Federal Reserve Board, when a customer initially purchases a security, he is obligated to have a specific amount of equity in his account; this is an "initial margin" requirement. The second type of margin requirement is a "maintenance margin" requirement, regulating the amount of equity a customer must maintain in his account after he has complied with Regulation "T". Rule 431 of the New York Stock Exchange effectively limits loans to seventy-five percent of the market value of the securities in a margin account. In addition, brokers generally impose margin requirements stricter than those provided in Rule 431.

 The clearance agreement between Merkin and Bear, Stearns provides in part as follows:

 
In connection with the carrying of customers' accounts of Merkin it is agreed that Merkin will accept the responsibility for the initial deposit of margin whenever an account is opened or reopened or whenever a payment is required by Regulation "T" as amended, promulgated by the Board of Governors of the Federal Reserve Board and the responsibility for payment in full of the case of all cash transactions for individual accounts. After the initial payment as required by Regulation "T" in a margin account further responsibility for maintaining proper margin in the account is solely that of Bear, Stearns. Bear, Stearns may in its sole discretion execute a buy-in or sell-out in a cash or margin account carried for Merkin whenever it deems such action appropriate and regardless of whether the account is then in compliance with the margin maintenance requirements of the New York Stock Exchange, Inc. or has requested an extension of time in which to make payment. Bear, Stearns reserves the right in its sole discretion to decline to make application to the New York Stock Exchange, Inc. for an extension of time for any account of Merkin to make any payment required by Regulation "T".

 In connection with plaintiff's account at Merkin, which was cleared through Bear, Stearns, plaintiff executed a Customer's Agreement with Bear, Stearns which provides:

 
2. Any and all property belonging to me or in which I may have an interest held by you or carried in any of my accounts (either individually or jointly with others) shall be subject to a general lien for the discharge of my obligations to you, wherever or however arising and without regard to whether or not you have made advances with respect to such property, and you are hereby authorized to sell and/or purchase any and all property in any of my accounts without notice to satisfy such general lien.
 
3(a). Without notice to me, any and all property, in my margin accounts may be carried in your general loans, and may be pledged, repledged, hypothecated or rehypothecated, separately or in common with other property, for the sum due to you thereon or for a greater sum and without retaining in you possession and control for delivery or a like amount of similar property. I will maintain such margins in my margin accounts as you may in your discretion require from time to time and will pay on demand any debit balance owing with respect to any of my margin accounts, and if not paid, you without notice to me may liquidate part of or all of my holdings with you to satisfy said debit balance.
 
3(b). You may, in the event of my death or whenever in your discretion you consider it necessary for your protection, sell any or all property held in any of my accounts, cancel any open orders for the purchase or sale of any property with or without notice to me, and you may borrow or buy in any property required to make delivery against any sale, including a short sale, effected for me. Such sale or purchase may be public or private and may be made without advertising or notice to me and in such manner as you may in your discretion determine, and no demands, calls, tenders or notices which you may make or give in any one or more instances shall invalidate the aforesaid waiver on my part. At any such sale you may purchase the property free of any right of redemption and I shall be liable for any deficiency in my accounts.
 
12. This agreement constitutes our complete agreement and is not subject to oral modification and shall be governed by the laws of the State of New York.

 On this Customer's Agreement plaintiff listed an address in Paris, France as his mailing address. Plaintiff never advised Bear, Stearns in writing that he was in New York or that mail should be directed to him in New York.

 Testimony in this case indicated that according to the practice and custom in the securities industry, a clearing firm may, as a courtesy, notify an introducing firm of the issuance of a margin call to one of its customers. The responsibility to notify the customer, if any, however, rests exclusively with the clearing firm. Testimony also suggests that plaintiff was aware of the fact that his margin account was with Bear, Stearns, which would notify him of the issuance of any margin call.

 Plaintiff arrived in New York during the first week of July, 1975, and remained until his departure to Paris on August 14, 1975. During this period plaintiff spent much of his time at Merkin's offices following his investments, including GAC debentures.

 Beginning the week of August 4, 1975, the GAC debentures experienced a substantial and sudden decline in market value. By Friday, August 8, 1975, the quoted bid price had dropped from 72, the price on August 1, to 59. Plaintiff was aware of these developments.

 On August 8, 1975, the New York Stock Exchange suspended trading in the debentures due to substantial losses sustained by GAC. Trading of the debentures continued thereafter in the over-the-counter market. Plaintiff was aware of these developments.

 On August 8, 1975, Corwin, at plaintiff's request, sold 100 of plaintiff's GAC debentures at a price of $ 590 each plus accrued interest. Plaintiff wanted to sell more of the debentures but was unable to do so because no buyers could be found.

 Plaintiff was present at Merkin's offices almost continuously during business hours from Monday, August 11 through Wednesday, August 13, 1975. During this period, both plaintiff and Corwin attempted to obtain information from GAC regarding the cause of the developments as to the GAC debentures, but they were unable to do so. By Monday, August 11, 1975, plaintiff was aware of the probability of a margin call on his account and was so informed by Corwin. Plaintiff was aware that during the week beginning August 11, 1975, the bid price for the debentures had dropped as low as 42, representing a drop of 30 points in less than a one-week period.

 During the week of August 11, 1975, plaintiff knew that the debit balance in his account with Bear, Stearns was approximately $ 160,000. Plaintiff testified that if the GAC debentures were selling at 42, or $ 420 each, the value of his 350 GAC debentures, inclusive of accrued interest thereon, was only slightly greater than the $ 160,000 he owed Bear, Stearns. Exclusive of accrued interest, the value of the securities in plaintiff's account was $ 13,000 less than the amount he owed Bear, Stearns. Even if interest were included, plaintiff's equity in his account was less than the 25% minimum limitation prescribed by Rule 431 of the New York Stock Exchange.

 As early as August 11, 1975, plaintiff was aware that his account was undermargined. Not only had he been advised by Corwin that there was a good probability he would receive a margin call, but on each day during the period August 11 through August 13, 1975, he asked Corwin if a margin call had been issued. During this period, plaintiff was specifically told by Corwin that he was a "likely candidate for a margin call."

 During the period from August 11 to August 13, 1975, plaintiff told Corwin that if a call were to be issued after his departure from New York, Corwin should advise plaintiff's father, Sidney Schenck, of the call and that the father, after contacting plaintiff and receiving instructions from him, would then guarantee plaintiff's account and deliver certain bonds owned by the father as additional collateral. The father would not deliver any bonds or meet the call absent specific instructions from plaintiff.

 Although plaintiff and Corwin knew that a margin call was imminent, they did not know the precise amount of the additional margin that Bear, Stearns would require. Corwin did not know the value of the bonds owned by plaintiff's father, nor if the ...


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