UNITED STATES DISTRICT COURT, SOUTHERN DISTRICT OF NEW YORK
August 27, 1980
BRUAN, GORDON & CO., Plaintiff,
Kye bHELLMERS, Raymond J. Arden, Peter Bulger, National Association of Securities Dealers, Inc. and District No. 12 of the National Association of Securities Dealers, Inc., Defendants
The opinion of the court was delivered by: MOTLEY
Three motions are presently before the court: 1) Plaintiff Bruan, Gordon & Co. ("Bruan, Gordon") has moved to remand this action to the Supreme Court of the State of New York, on the ground that the court lacks subject matter jurisdiction. 2) Defendants have moved for an order dismissing the complaint and/or granting summary judgment, on the grounds that plaintiff has failed to exhaust its administrative remedies and that defendants have immunity from liability. 3) Defendants have also moved for an order staying discovery until such time as the court rules on defendants' motion for summary judgment and/or dismissal.
Plaintiff's complaint in this action alleges the following facts and claims:
Plaintiff is a registered broker-dealer engaged in the securities brokerage business. Prior to the acts complained of, plaintiff was a member in good standing of defendant National Association of Securities Dealers, Inc. ("NASD"). NASD is a national securities association registered with the Securities Exchange Commission ("SEC") pursuant to Section 19 of the Securities Exchange Act of 1934 ("Exchange Act"). NASD is a self-regulatory organization comprised of securities broker-dealers registered under the Exchange Act for the purpose of regulating the conduct of broker-dealers in the over-the-counter market.
In its first cause of action, plaintiff alleges that defendants Kye Hellmers, Raymond J. Arden, and Peter Bulger (the "individual defendants"), officers of NASD, have engaged in a combination and conspiracy directed at plaintiff by wrongfully, intentionally, and maliciously interfering with plaintiff's business for their own personal benefit and gain. The alleged purpose of this agreement is to attempt to expand the jurisdiction of NASD beyond that authorized by law. In particular, plaintiff alleges that the individual defendants combined and conspired to do, among other things, the following acts in furtherance of their conspiracy: 1) By letter dated June 28, 1979, the individual defendants wrongfully ordered plaintiff to refrain from accepting any new security options customers, knowing that such a prohibition was not within the jurisdiction of NASD. 2) In July, 1979, the individual defendants wrongfully conducted a dragnet audit examination of plaintiff, in an attempt to gain revenge for plaintiff's pointing out that the prohibition of options trading was clearly beyond NASD's jurisdictional authority. 3) In February, 1980, the individual defendants wrongfully caused NASD to selectively and invidiously institute formal disciplinary proceedings against plaintiff.
In its second cause of action, plaintiff alleges that the individual defendants knew that NASD did not have jurisdiction to prohibit plaintiff from conducting options business, and that the individual defendants wrongfully, wilfully, intentionally, and maliciously interfered with plaintiff's business and customer relations.
In its third cause of action, plaintiff alleges that defendants wrongfully, wilfully, intentionally, and maliciously represented to plaintiff in writing that plaintiff was prohibited from conducting any transactions in options, and that defendants knew that this directive was false, misleading, and beyond defendants' legal jurisdiction.
Plaintiff seeks $ 250,000 in compensatory damages and $ 750,000 in punitive damages on each cause of action.
Motion to Remand
To warrant removal of an action from a state to a federal court on the ground that there exists a federal question, a controversy with respect to a federal question must be essential to plaintiff's cause of action and must be disclosed upon the face of the complaint. Gully v. First National Bank, 299 U.S. 109, 112, 112-13, 57 S. Ct. 96, 97, 97-98, 81 L. Ed. 70 (1936). It is not enough that a defense founded upon federal law is, or will be asserted. Louisville & N.R. Co. v. Mottley, 219 U.S. 467, 31 S. Ct. 265, 55 L. Ed. 297 (1911). In the case at hand, plaintiff argues that its three causes of action-conspiracy, interference with business, and fraud-are common law causes of action which involve a directive by NASD outside the jurisdiction of NASD's own by-laws. Plaintiff argues that, accordingly, its complaint does not allege a violation of the Exchange Act, or even the NASD rules, and that removal was thus improper.
It is well-established that violation of NASD rules does not provide an independent basis of liability, at least where suits by customers are involved. Architectural League of New York v. Bartos, 404 F. Supp. 304, 314 (S.D.N.Y.1975). A breach of NASD rules alone is simply a breach of a private association's rules and does not present a question which arises under the laws of the United States. Lange v. H. Hentz Co., 418 F. Supp. 1376, 1380-81 (N.D.Tex.1976). While the Second Circuit has not addressed this jurisdictional issue, the Second Circuit has stated that a determination of whether a private right of action exists for violation of dealer association rules depends upon the nature of the particular rule and its place in the regulatory scheme. Colonial Realty Corp. v. Bache & Co., 358 F.2d 178, 182 (2d Cir. 1966), cert. denied, 385 U.S. 817, 87 S. Ct. 40, 17 L. Ed. 2d 56 (1966).
The critical issue in considering plaintiff's motion to remand, then, is whether a controversy with respect to the Exchange Act, as opposed to the NASD rules or by-laws, is essential to plaintiff's causes of action and are disclosed upon the face of the complaint. While the court must ascertain from the complaint whether federal law is a pivotal issue in the case, the lack of any reference to federal law in the complaint is not controlling. North American Phillips Corp. v. Emery Air Freight Corp., 579 F.2d 229, 233 (2d Cir.1978). Thus, further inquiry must be made as to whether, regardless of artful pleading, in fact the action is one governed by federal law. State of New York v. Local 144, 410 F. Supp. 225, 226 (S.D.N.Y.1976); see Coditron Corp. v. AFA Protective Systems, Inc., 392 F. Supp. 158, 160 (S.D.N.Y.1975); Hearst Corp. v. Shopping Center Network, 307 F. Supp. 551, 556 (S.D.N.Y.1969). Moreover, the nature of plaintiff's claim must be evaluated on the basis of the record as it stands at the time the petition for removal is filed. Westmoreland Hospital Ass'n v. Blue Cross of Western Pennsylvania, 605 F.2d 119, 123 (3d Cir.), cert. denied, 444 U.S. 1077, 100 S. Ct. 1025, 62 L. Ed. 2d 759 (1980). Although certain allegations may be unnecessary for the ultimate disposition of the case, surplusage of federal claims is not the test. Id. Accordingly, federal jurisdiction is proper where a complaint is based in part on federal statutes or federal legal principles. Id. at 124. In the case at hand, plaintiff's complaint discloses a federal question involving the federal statutory authority of NASD. The complaint alleges that defendants attempted to expand the jurisdiction of NASD "beyond that authorized by law," that defendants' action was "clearly beyond the NASD's jurisdictional authority," and that NASD's directive was "beyond defendants' legal jurisdiction." While the complaint lacks specific references to NASD's jurisdictional authority under federal securities law, it is clear that the complaint's references to NASD's legal jurisdiction and jurisdiction "authorized by law" are inartful attempts to disguise reliance upon federal securities law. Obviously, any determination by a court as to whether NASD exceeded its legal jurisdiction necessarily involves a federal question controversy with respect to NASD's proper jurisdiction under federal securities law. Thus, at least upon the face of the complaint, federal law is a pivotal issue in the case. Plaintiff's argument that the complaint was intended to allege only a violation of NASD's by-laws is without merit. Having alleged in its complaint that defendants exceeded NASD's legal jurisdiction, plaintiff cannot avoid removal by belatedly arguing that it intended to refer to jurisdiction under NASD's by-laws rather than jurisdiction under federal securities law. While plaintiff's future litigation strategy may not involve disposition of issues involving federal securities law, plaintiff's complaint is based in part on federal securities law, in at best a thinly veiled disguise.
In addition to federal question jurisdiction pursuant to 28 U.S.C. § 1331, the court also has subject matter jurisdiction over this action pursuant to 28 U.S.C. § 1442(a)(1). Section 1442(a)(1) provides that an action may be removed to federal court if it is an action against "[any] officer of the United States or any agency thereof or person acting under him, for any act under color of law." With respect to disciplinary proceedings, NASD should be considered as a "person" acting under the SEC. In an analogous situation, this court has held that the New York Stock Exchange may be considered an agent or arm of the SEC with respect to the discipline of persons. Trama v. New York Stock Exchange, (1979 Transfer Binder) Fed.Sec.L.Rep. (CCH) P 96,748, at 94,919 (S.D.N.Y.1978). While NASD is not a federal officer or agency for other purposes, such as triggering the privilege against self-incrimination, NASD is a "person" acting under the SEC in connection with disciplinary proceeding, for purposes of determining jurisdiction under Section 1442(a)(1). Accordingly, the court has subject matter jurisdiction in the present action, as plaintiff's complaint alleges that the individual defendants wrongfully, wilfully, intentionally and maliciously caused NASD to institute formal disciplinary proceedings against plaintiff as part of a conspiracy by the individual defendants. Thus, insofar as plaintiff's complaint alleges that the individual defendants improperly caused NASD to institute disciplinary proceedings, plaintiff's complaint involves an action against a person acting under the SEC for acts "under the color of law." While plaintiff now argues that the gravamen of its complaint is the June 28, 1979, letter, the fact remains that the NASD disciplinary proceeding is an integral part of plaintiff's complaint, thus affording subject matter jurisdiction over this action.
In summary, plaintiff's motion to remand this action to state court must be denied on the ground that the court has subject matter jurisdiction pursuant to both 28 U.S.C. § 1331 and 28 U.S.C. § 1442(a)(1).
Motion for Dismissal and/or Summary Judgment
Defendants have moved for dismissal and/or summary judgment on the grounds that plaintiff has failed to exhaust its administrative remedies and that defendants have immunity from liability. For the reasons set forth below, defendants' motion must be denied on the ground that there are genuine issues as to material facts.
With respect to plaintiff's alleged failure to exhaust its administrative remedies, it is well-established that the doctrine of exhaustion of administrative remedies applies with equal force to the disciplinary proceedings of NASD. First Jersey Securities, Inc. v. Bergen, 605 F.2d 690, 696 (3d Cir. 1979), cert. denied, 444 U.S. 1074, 100 S. Ct. 1020, 62 L. Ed. 2d 756 (1980); accord, Merrill Lynch, Pierce, Fenner & Smith, Inc. v. National Association of Securities Dealers, Inc., 616 F.2d 1363, 1370 (5th Cir. 1980). However, while the exhaustion doctrine would normally apply to NASD disciplinary proceedings, extraordinary circumstances may compel a court to hear a case. First Jersey Securities, Inc. v. Bergen, supra, 605 F.2d at 696. For example, a narrow exception to the exhaustion doctrine exists in situations where plaintiffs allege that an agency is acting "plainly beyond its jurisdiction." Touche Ross & Co. v. SEC, 609 F.2d 570, 574-76 (2d Cir. 1979).
Applying these principles to the case at hand, it is readily apparent that there are genuine issues as to material facts. First, there is a genuine issue as to whether there exist administrative remedies within NASD or the SEC whereby plaintiff could obtain any redress for the alleged order in the June 28, 1979, letter and the subsequent audit examination. Second, there is a genuine issue as to whether NASD was acting "plainly beyond its jurisdiction," as alleged by plaintiff. Defendants vigorously dispute plaintiff's version of the facts-a version which would appear to show that NASD was acting "plainly beyond its jurisdiction" and which would appear to bring this case within the narrow exception to the exhaustion doctrine. Given these genuine issues as to material facts, it cannot be said that defendants are entitled to judgment as a matter of law on the ground that plaintiff has failed to exhaust its administrative remedies.
With respect to defendants' alleged immunity from liability, defendants enjoy a qualified immunity in connection with their conduct of disciplinary proceedings against plaintiff. See Trama v. New York Stock Exchange, supra, (1979 Transfer Binder) Fed.Sec.L.Rep. (CCH) at 94,919. Under this qualified immunity, a defendant would be liable for damages only if "he knew or reasonably should have known that the action he took within his sphere of official responsibility would violate the constitutional rights of the (plaintiff), or if he took the action with the malicious intention to cause a deprivation of constitutional rights or other injury to the (plaintiff)." Id. at 94,919-20 (quoting Wood v. Strickland, 420 U.S. 308, 322, 95 S. Ct. 992, 1000, 43 L. Ed. 2d 214 (1975)). The court has also suggested in dictum that under certain circumstances an absolute immunity might be granted to those officials involved in the adjudicatory process of an agency or stock exchange. Id. at 94,920.
Applying these principles to the case at hand, it is readily apparent that there are genuine issues as to material facts and that defendants are not entitled to judgment as a matter of law. The qualified privilege established in Trama applies only to the conduct of disciplinary proceeding by NASD or similarly situated associations and stock exchanges; the court has never suggested that NASD would enjoy a qualified privilege with respect to all of its activities. Even assuming arguendo that NASD enjoys a qualified privilege which is not restricted to disciplinary proceedings, there is a genuine issue of material fact as to whether defendants acted with malicious intent in the case at hand. The court need not decide today whether NASD officials performing adjudicative functions enjoy an absolute immunity. Plaintiff's complaint alleges that defendants engaged in several actions in furtherance of their alleged conspiracy-only one of the these actions directly involved the performance of adjudicatory functions by defendants. The other two alleged actions, the alleged order contained in the June 28, 1979, letter and the subsequent audit examination, cannot be considered as adjudicatory actions by NASD. Accordingly, even assuming arguendo that the absolute immunity enjoyed by federal executive officials involved in adjudication applied to NASD officials, that absolute immunity would not provide defendants from liability for the non-adjudicatory actions in the case at hand.
Finally, defendants argue that they are immune from liability under the doctrine of Barr v. Matteo, 360 U.S. 564, 79 S. Ct. 1335, 3 L. Ed. 2d 1434 (1959), which clothes the official acts of an executive officer with immunity from civil defamation suits. While the court is willing to characterize NASD as an agent or arm of the SEC with respect to the conduct of disciplinary proceedings, the court is unwilling to afford Barr v. Matteo the expansive reading suggested by defendants. The court does not view Barr v. Matteo as allowing NASD absolute immunity for all its actions-such a sweeping holding would be unprecedented. The fact that NASD may be considered an arm or agent of the SEC with respect to disciplinary proceedings certainly does not transform officials of NASD into federal executive officers. Moreover, in the case at hand defendants appear to have waived any immunity they might enjoy for intentional torts. Article I, Section 4(a)(3) of the NASD by-laws provides that NASD shall not be liable except for wilful malfeasance by an officer while acting within the scope of his employment. While defendants disavow any construction of this provision as a waiver of immunity, at best there remains a genuine issue of material fact as to the proper application of this provision and whether NASD has agreed that it and its officers may be held civilly liable for intentional torts.
In summary, defendants' motion for dismissal and/or summary judgment must be denied on the ground that there are genuine issues of material fact and that defendants are not entitled to judgment as a matter of law. The court has discussed several, but not necessarily all, of the disputed issues of fact above.
For the reasons stated above, both plaintiff's motion to remand and defendants' motion for dismissal and/or summary judgment are denied. As there has been no discovery in this action pending the court's disposition of these motions, defendants' motion for a stay of discovery is now moot.
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