UNITED STATES DISTRICT COURT SOUTHERN DISTRICT OF NEW YORK
October 28, 1980
BRUAN, GORDON, & CO., Plaintiff, against KYE HELLMERS, 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
[EDITOR'S NOTE: The page numbers of this document may appear to be out of sequence; however, this pagination accurately reflects the pagination of the original published document.]
CONSTANCE BAKER MOTLEY, U.S.D.J.
On August 27, 1980, this court filed a memorandum opinion disposing of various pending motions in this case. Defendants have moved for reconsideration of the portion of the opinion denying defendants' motion to dismiss the complaint pursuant to Fed. R. Civ. P. 12(b) for plaintiff's failure to exhaust administrative remedies. In the alternative, defendants request that this issue be certified for interlocutory appeal pursuant to 28 U.S.C. § 1292(b). These motions were heard on September 26, 1980. At that hearing the Securities and Exchange Commission (SEC) requested leave to appear amicus curiae in support of defendants' motion. Leave was granted, whereupon the SEC addressed the merits and subsequently filed papers. Plaintiff was given leave to file a reply and did so. On reconsideration and for the reasons stated below, defendants' motion is granted, and the complaint is dismissed. Although the pertinent facts were stated previously in this court's decision of August 27, 1980, a brief description of the parties and plaintiff's complaint follows to aid in understanding the court's disposition of the instant motion.
Plaintiff, Bruan Gordon & Co. (Bruan), is a registered broker-dealer. Prior to the acts complained of, plaintiff was a member in good standing of defendant, the National Association of Securities Dealers, Inc. (NASD).defendant is a self-regulatory organization (SRO) registered with the SEC as a national securities association pursuant to Section 19 of the Securities Exchange Act of 1934, 15 U.S.C. §§ 78a et. seq. (Exchange Act). NASD serves as the SRO for the over-the-counter securities market. The individual defendants, Kye Hellmers, Raymond J. Arden, and Peter Bulger (the individual defendants) are officers of the NASD.
Plaintiff's complaint contains three causes of action. The first alleges a conspiracy by the individual defendants to "expand the jurisdiction of defendant NASD and District No. 12 over its member constituents beyond that authorized by law" in order to "elevate themselves in esteem and position within the ranks of the NASD and District No. 12." Complaint, P9. Three overt acts are alleged to have taken place in furtherance of this conspiracy. First, it is alleged that plaintiff was "ordered" by letter dated June 28, 1979, and signed by defendant Hellmers, to suspend all of its options business, both over-the-counter and on the American Stock Exchange (AMEX), pending the qualification of a new registered options principal (ROP) pursuant to Article I, Section 2(d), Schedule C of the NASD's rules. Complaint, P10(a). This action allegedly exceeds the NASD's jurisdiction since the NASD's authority is allegedly limited to regulating the over-the-counter market. Second, the complaint alleges that the NASD carried out a "dragnet" audit of plaintiff's books and records in July, 1979, in an effort to interfere with plaintiff's business and to "concoct any possible violation of rules by Bruan." Complaint, P10(b). Finally, NASD's institution of formal disciplinary proceedings against plaintiff for alleged violation of NASD's "free riding" rules is alleged to be improperly selective prosecution resulting from a desire to injure Bruan. Complaint, P10(c). All three overt acts were allegedly conduced "wrongfully, wilfully, intentionally and maliciously."
Plaintiff's second cause of action constitutes an allegation of tortious interference with business relationships arising out of the same overt acts previously described. The third cause of action alleges fraud in connection with the letter to plaintiff of June 28, 1979, stating that plaintiff was prohibited from conducting all new options trading pending qualification of a new ROP.
Determination of the instant motion to dismiss must begin by examining the relationship between the exhaustion doctrine and the NASD. The Exhaustion doctrine is a "long settled rule of judicial administration that no one is entitled to judicial relief for a supposed or threatened injury until the prescribed administrative remedy has been exhausted." Myers v. Bethlehem Shipbuilding Corp., 303 U.S. 41, 50-51 (1938). Requiring litigants to exhaust their administrative remedies avoids "premature interruption of the administrative process" and insures that the administrative agency involved has an opportunity to apply its expertise and correct its own errors. McKart v. United States, 395 U.S. 185, 193 (1969); Parisi v. Davidson, 405 U.S. 34, 37 (1972).
It is not immediately obvious that the exhaustion doctrine applies to NASD, a private corporation. However, at least two Circuits have directly confronted this question and applied the exhaustion doctrine to NASD. See First Jersey Securities, Inc. v. Bergen, 605 F.2d 690, 695 (3d. Cir. 1979) (First Jersey Securities); Merrill Lynch, Pierce, Fenner & Smith, Inc. v. National Association of Securities Dealers, Inc., 616 F.2d 1363, 1369 (5th Cir. 1980) (Merrill Lynch). Each case utilizes a similar analysis in deciding to require exhaustion of administrative remedies in NASD proceedings. Essentially, both courts conclude that NASD's status as a registered national securities association pursuant to specific statutory authorization requires NASD to perform many of the same functions as a public administrative agency. See 15 U.S.C. § 78o-3; First Jersey Securities, Inc. v. Bergen, 605 F.2d at 696; Merrill Lynch, Pierce, Fenner & Smith, Inc. v. National Association of Securities Dealers, Inc., 616 F.2d at 1367. In fact, "[as] a registered securities association, it has been 'delegated governmental power in order to enforce... compliance by members of the industry with both the legal requirements laid down in the Exchange Act and ethical Standards going beyond those requirements.'" Merrill Lynch, Pierce, Fenner & Smith v. National Association of Securities Dealers, 616 F.2d at 1367 (Quoting, S. Rep. No. 94-75, 94th Cong., 1st Sess. 23 (1975), U.S. Code Cong. & Admin. News. 1975, pp. 179, 201). This supervisory responsibility is exercised subject to "a comprehensive review procedure" which provide for appeal of NASD's determinations to the SEC and ultimately to a United States Court of Appeals. First Jersey Securities, Inc. v. Bergen, 605 F.2d at 696. The quasi-official status of NASD therefore fully activates the policies underlying the exhaustion doctrine and requires the doctrine's application to NASD.
Since exhaustion of administrative remedies does apply in the instant case, this court must determine the formulation of the doctrine accepted in this Circuit. That formulation may be found in a recent decision affirming this Court's dismissal of a complaint against the SEC for failure to exhaust administrative remedies. Touche Ross & Co. v. Securities and Exchange Commission, 609 F.2d 570 (2d Cir. 1979) (Touche Ross). Touche Ross involved an action for declaratory and injunctive relief to stop an ongoing administrative proceeding which had been instituted against Touche Ross & Company by the SEC. Touche Ross contended that the SEC Rule 2(e) which Touche Ross & Company was accused of violating had been promulgated without statutory authority and thus the SEC was acting without jurisdiction. It also was argued that the proceedings before the SEC were "biased" and were not in accordance with due process.609 F.2d at 575.
In affirming this court's dismissal of the action for failure to exhaust administrative remedies, however, the Second Circuit went further and decided the question whether the SEC had exceeded its authority in enacting Rule 2(e). In so doing, the Second Circuit served notice "that normally we will not tolerate the interruption of the administrative process to hear piecemeal appeals of a litigant's claims on the merits." 609 F.2d at 574. Touche Ross & Company's claim that the SEC proceedings in question were biased was first disposed of in a manner highly relevant to the instant motion. The Court stated:
If the claim of bias were the only basis for appellants' demand for injunctive relief, it would be unnecessary for us to go further than to hold, with respect to that claim, that exhaustion of administrative remedies is required. As the Court of Appeals for the District of Columbia Circuit has held, allegations of agency bias or prejudgment based on ex parte communications are insufficient for injunctive relief and cannot be reviewed until the agency has made an adverse determination and an appeal has been taken raising these claims on the record as a whole.... We agree. Until the Commission has acted and actual bias has been demonstrated, the orderly administrative procedures of the agency should not be interrupted by judicial intervention. 609 F.2d at 575. (Citations omitted.)
The argument that agency bias should serve as one of the exceptions to the exhaustion requirement was thus clearly presented to the Second Circuit in Thouche Ross. The passage just quoted must therefore be read as a portion of the holding in that case and is, accordingly, binding on this court. As a result, paragraph 10(c) of plaintiff's complaint alleging agency bias must be dismissed. Paragraph 10(c), as previously mentioned, alleges that a disciplinary proceeding begun against plaintiff by defendants was improperly motivated and constituted an overt act in furtherance of the conspiracy alleged in the complaint. The above quoted passage makes clear that a federal district court in the Circuit may not assert its jurisdiction to try such an allegation. The agency involved must be allowed to speak in the first instance.
The Touche Ross decision then considered what circumstances might create an exception to the exhaustion doctrine. Close reading of the decision indicates that the Second Circuit recognizes only a single narrow exception to the exhaustion requirement in the event the agency action complained of "is plainly beyond [the agency's] jurisdiction as a matter of law or is being conducted in a manner that cannot result in a valid order." 609 F.2d at 576 (Quoting, Sterling Drug, Inc. v. Weinberger, 509 F.2d 1236, 1239 (2d Cir. 1975) (Friendly, J.)). Applying this formulation of the exhaustion doctrine to the instant case requires that paragraph 10(b) of plaintiff's complaint must also be dismissed.
Paragraph 10(b) of the complaint characterizes an audit of plaintiff conducted by NASD in July, 1979, as a "dragnet" operation allegedly motivated by a desire to "gain revenge" against plaintiff. At no point does plaintiff contend that the NASD lacks authority to conduct such an audit. In fact, plaintiff does not deny defendants' assertion that all of the NASD's members are subject to similar audits in the normal course of the NASD's self-regulatory efforts. Plaintiff's only complains of the manner in which the audit was conducted. Plaintiff does not allege that the audit exceeds NASD's jurisdiction. It appears on the fact of the complaint that the audit complained of resulted in the disciplinary proceeding just mentioned. The disciplinary proceeding provides an obvious administrative forum for plaintiff to press its contention that the audit was improperly conducted. If the audit was conducted in a biased fashion, then plaintiff must demonstrate that bias by initially pressing its complaint before the NASD. See, First Jersey Securities v. Bergen, 605 F.2d 690 (3d Cir. 1979); Merrill Lynch, Pierce, Fenner & Smith, Inc. v. National Association of Securities Dealers, Inc., 616 F.2d 1363 (5th Cir. 1980).
The remaining portions of the complaint ultimately depend upon an allegation that the NASD and certain of its named officers willfully engaged in an ultra vires act by ordering plaintiff to refrain from accepting any new security options customers, pending qualification of a new ROP. Plaintiff contends that this "order" was intended to prevent all further options trading, whether it was over-the-counter or on the American Stock Exchange (AMEX). Plaintiff alleges that such action was beyond NASD's jurisdiction in so far as it purported to restrict plaintiff's dealings on AMEX. Defendants sharply disagree with plaintiff's version of their actions. According to defendants, the June 28, 1979, letter in question cannot be read as "ordering" plaintiff to do anything. In addition, defendants contend that even if the letter can be treated as an "order" it does not, by its own terms, apply to plaintiff's AMEX trading. In this connection it must be noted that plaintiff's own general counsel filed an affidavit in opposition to defendants' original motions for dismissal and/or summary judgment, now under reconsideration in part, in which he says the following:
In any event, it was not until early June 1980 that plaintiff confirmed, what we had originally believed and strenuously argued, that defendant Hellmers' position that the subject NASD By-Laws prohibited an NASD member from effecting all options transactions, including transactions in AMEX listed options, without an ROP was, in fact, squarely against the NASD's own internal and published interpretation, with which defendant Hellmers must have been familiar as the self-described NASD options "Specialist." At that time plaintiff received NASD Notice to Members 80-22, dated June 4, 1980, a copy of which is annexed hereto as Exhibit "E", announcing the Commission's approval of numerous option rule changes submitted by the NASD in response to recommendations of the Commission Special Study of the Options Market. As will be clear to the Court, this release confirms what we always believed and what we have told Mr. Hellmers, that the NASD option rules only apply to options business effected on an "access" basis. As it turns out, the June 4, 1980 NASD release only repeats the November 15, 1978 NASD release notifying the public of the Commission's approval of the initial NASD "access" rules which defendants now have the hardihood to produce was an exhibit to the moving affidavit of John E. Pinto, Jr., Vice President in Charge of the NASD's Surveillance Department, in support of their hindsight claim that the Hellmers directive only "intended" to apply to "access" transactions.
The above description of the controversy surrounding the NASD's alleged proscription of plaintiff's AMEX options trading is in itself eloquent testimony in favor of the exhaustion requirement. If plaintiff had utilized the administrative mechanisms open to it in June, 1979, this court would not now be confronted with the task of trying to determine on these motions what, if any, action was taken by NASD and the individual defendants in June, 1979 and the meaning or parameters of such action. It appears from the affidavit of plaintiff's general counsel, Mark B. Borteck, that plaintiff waited until June, 1980, to "confirm" that the alleged "order" to cease options trading was, in fact, not authorized by NASD's own interpretation of its rules. Borteck Affidavit at P22. This confirmation allegedly resulted from receipt by plaintiff of a NASD Notice to Members relating to options trading. Id. Read another way, this affidavit means that plaintiff did absolutely nothing about the alleged options "order" for almost a year. If this court were to try this case on these facts, it would encourage exactly the sort of premature review of administrative agency action which the exhaustion doctrine is designed to prevent. See McKart v. United States, 395 U.S. 185, 193 (1969).
This court's present decision with respect to the June 28, 1979, letter results, in part, from its conclusion that administrative remedies did in fact exist when the letter was received. The SEC's memorandum, submitted amicus curiae, points out that "[the] self-regulatory organizations excercise authority subject to SEC oversight and have no authority to regulate independent of the SEC's control." Report of the Sen. Comm. on Banking, Housing and Urban Affairs to Accompany S.249, S. Rep. No. 94-75, 94th Cong., 1st Sess. 23 (1975). Plaintiff could have complained directly to the SEC about the letter of June 27, 1980. The SEC has statutory authority to bring an injunctive action in federal district court against any SRO. See Section 21(d) of the Securities Exchange Act of 1934 (Exchange Act), 15 U.S.C. 78s(h). The SEC may also commence its own administrative proceedings against an SRO "to censure or impose limitations upon the activities, functions and operations of self-regulatory organizations." Section 19(h) of the Exchange Act, 15 U.S.C. 78s(h).
Plaintiff argues that these sections of the Exchange Act are discretionary with the SEC and, therefore, do not provide an adequate administrative remedy to activate the exhaustion requirement. Plaintiff's argument turns the exhaustion requirement on its head. The way to demonstrate that a remedy is inadequate is to exhaust it or point to prior demonstrated inadequacies. Plaintiff's resort to the SEC would have demonstrated either that no remedy existed or it would have enabled the SEC to investigate what the June 28, 1979, etter actually meant. That determination would either have solved the problem, or at least avoided the necessity of asking a federal court to make determinations better made by the experienced administrative agency in the field.
Plaintiff may not avail itself of the narrow exception to the exhaustion requirement ennunciated in Touche Ross. The Second Circuit's standard, set forth above, requires that the agency action complained of must be "plainly beyond its jurisdiction as a matter of law." 609 F.2d at 576. Such a conclusion is not possible on the record before this court. It is unclear whether the June 28, 1979, letter, in fact, constituted agency action, if it did, it is unclear what actin was taken. Simply alleging action beyond jurisdictional limits is insufficient. See First Jersey, supra, 605 F.2d at 697; Merrill Lynch, supra, 616 F.2d at 1371. Plaintiff does not deny that defendants possessed the authority to prohibit over-the-counter options trading if the NASD's by-laws were violated. That may have been all the June 28, 1979, letter was intended to do. We cannot be sure, however, because plaintiff made no attempt to settle the matter administratively.
One final point must be made. This court adheres to the portion of its August 27, 1980, opinion denying defendant's motion for summary judgment on the grounds of absolute sovereign immunity. Therefore, this dismissal is without prejudice in so far as the complaint alleged actionable conduct on the part of the individual defendants in connection with the alleged prohibition of options trading. This dismissal is not intended to bar a subsequent suit for damages if, after administrative proceedings to determine the facts surrounding the June 28, 1979, letter, plaintiff still feels that individuals abused their official position in a tortious fashion.
For the reasons expressed above, the complaint is dismissed in its entirety.