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May 8, 1985

COMARK and MARINE MIDLAND BANK, N.A., Defendants MARINE MIDLAND BANK, N.A., Third-Party Plaintiff, vs. E. KEITH OWENS and ROBERT W. BELL, Third-Party Defendants

The opinion of the court was delivered by: LASKER


Since the time when the decision denying defendant Marine Midland's motion for partial summary judgment was handed down, Wichita v. Comark, No. 82 Civ. 4703(MEL), slip op (S.D.N.Y. Feb. 25, 1985), the plaintiffs and Marine settled the claims between them. *fn1" However, before this occurred Marine moved, inter alia, under Civil Rule 3(j) of the United States District Court for the Southern and Eastern Districts of New York to reargue its motion and we granted leave to the United States Department of the Treasury and the Federal Reserve Bank of New York ("New York Fed") to serve and file a memorandum of law relating to the earlier decision as amici curiae. See Wichita v. Comark, No. 82 Civ. 4703(MEL) (S.D.N.Y. Mar. 13, 1985). In light of the significant points raised by Marine and the government's representatives, we take this opportunity to present their more salient arguments and to comment briefly upon the impact of those arguments on the earlier decision.

The opinion of February 25, 1985 construed 31 C.F.R. §§ 306.118(a) & (b) (1984), and concluded that subsection (b) (and hence "applicable" state law) governed in the instance at hand because the securities which were the subject of the dispute between plaintiffs and Marine were book entry securities held by a Federal Reserve member bank (Marine) for the account of its customer (Comark). See Wichita v. Comark, supra, slip op. at 4-10. The Treasury Department does not dispute that subsection (b) applies to this case, although it contends that a different analysis, not previously presented or found in our search of the relevant literature, supports this conclusion.


It is the intent of Treasury that, with respect to the rights and liabilities of the Federal Reserve Bank making payment as fiscal agent for the Treasury Department, subpart (a) of Section 306.118 of the Book-Entry Regulations is applicable to all transfers and pledges of Treasury securities on the book-entry system, whether the securities represent an investment on behalf of a customer. Thus, federal law would preempt state law and the book-entry would be dispositive for purposes of determining to whom the Federal Reserve bank is legally required to make payment. Subpart (b) of Section 306.118 of the Book-Entry Regulations applies with respect to the rights and liabilities of parties whose interests are recorded on the books of member banks with Federal Reserve book-entry accounts.

 Declaration of Paul Allan Schott, Assistant General Counsel for Banking and Finance, United States Department of the Treasury, P6, attached to Notice of Motion, filed Mar. 12, 1985. The government has further explained how subsections (a) and (b) interact with each other in a letter which we reprint in full in the appendix to this opinion.

 The earlier decision also found that a question of fact existed as to whether the disputed securities were "delivered" to the plaintiffs under Section 8-313(1)(c) of the pre-amended New York version of the Uniform Commercial Code in effect between March of 1981 and June of 1982, the period in which the transactions in question took place. We concluded that although Marine did not actually identify the securities in question as belonging to the plaintiffs, in light of the allegations made by the plaintiffs in their opposing papers Marine might have been under an obligation to make such an identification. See Wichita v. Comark, supra, slip op. at 13, 21-26.

 Marine now renews an argument found in its earlier Reply Memorandum in support of its original motion for summary judgment: that no authority exists to support the proposition that a secured lender can be divested from its perfected security interest through the unilateral acts of a borrower. The Treasury Department and the New York Fed also argue that for policy reasons the unilateral acts of government securities dealers should not be permitted to bind clearing banks under UCC § 8-313(1)(c) and deprive banks of secured creditor status. The government contends that imposing upon clearing banks a duty, under certain circumstances, to identify securities in their possession as belonging to the customers of government securities dealers would compel the banks to regard as unsecured "clearance loans" extended to securities dealers.

 The arguments made by Marine, the Department of the Treasury and the New York Fed regarding the proper interpretation of the federal Book Entry Regulations and Article 8 of the Uniform Commercial Code raise significant issues which are worthy of further consideration. Given the settlement of that portion of the case relating to these questions, however, the issues raised are now moot and it would be inappropriate further to consider them. Nontheless [sic], we recognize the importance of the points made by Marine and the government. Accordingly, in order to mitigate any possible harm to the government securities market caused by the earlier decision, we conclude that the earlier opinion should not be treated as an authoritative interpretation of the federal and state law provisions there construed.

 It is so ordered.


 The Honorable Morris E. Lasker

 United States District Judge

 Room 1903

 United States Courthouse

 Foley Square

 New York, New York 10007

 Re: Witicha [sic] Federal Savings & Loan Association, et al. v. Comark, et. al 82 CIV 4703 (MEL)

 Dear Judge Lasker:

 As discussed in Chambers on March 12, 1985, this letter is intended to supplement the interpretation of 31 C.F.R. § 306.118 set out at pages 4-8 of our joint Treasury-Federal Reserve memorandum of law.

 Subsection (a) of 31 C.F.R. § 306.118 contemplates two types of entries on the books of a Reserve Bank -- an entry of transfer and an entry of a pledge. This distinction represents a conscious attempt by Treasury to fit book-entry securities into the existing body of law that controls the transfer and pledge of Treasury securities in physical form, i.e., the Uniform Commercial Code.1a

 Thus, a subsection (a) transfer of book-entry securities, like a transfer of physical Treasury securities in bearer form, is not determinitive of beneficial ownership. With respect to each type of security, the transferee acquires possession, the right to receive principal and interest, and the ability to transfer those same rights in the security to others. However, those powers do not make the transferee the beneficial owner of the security.

 Rather, they permit the issuer, custodians, brokers and other parties who do not assert rights in the security, to rely on the transferee's control of the security in discharging their respective obligations to make payment, safekeep, receive and redeliver that security.

 In these respects, a subsection (a) transfer does have "priority over any transfer . . . theretofore or thereafter effected . . . under [subsection] (b) . . . ." The transferee's power to retransfer the security over Fedwire cannot be abridged by the customer who asserts an interest "theretofore" effected or perfected under subsection (b), nor can the Treasury be required to make payments to a customer who claims that following the transferee's acquisition of the security his interest was "thereafter" effected or perfected. Possession and control of the security on the books of the Federal Reserve Bank always remains in the subsection (a) transferee.

 Absent an entry of pledge under subsection (a), the beneficial interests of the subsection (a) transferee are subject to subsection (b and applicable law. For example, a bank that acts as a trustee may acquire book-entry securities for its trust customers. As a subsection (a) transferee, that trustee bank's rights and authority on the Federal Reserve book-entry system are identical in both the trust securities and securities it owns outright. However, the trustee bank has a state law fiduciary obligation to the trust customer to account for principal and interest and properly maintain the securities. The trustee bank will be liable for unauthorized transfers and, unless the subsequent transferee is a bona fide purchaser, the transferee will be liable in conversion. Thus, the practical effect of the priority accorded a subsection (a) transfer is extremely limited. The Treasury and Federal Reserve Banks are responsible only to the Fedwire transferee; *fn2" middlemen can rely on a Fedwire delivery without inquiry into the specific rights of the transferor in the securities transferred. *fn3" However, any party asserting beneficial rights in these securities, including a subsection (a) transferee, remains subject to claims arising under state law that he acquired his rights in a wrongful transaction.

 In contrast, a pledge under subsection (a), i.e., one that is directly recorded as a pledge on the books of a Reserve Bank, *fn4" will confer beneficial rights in the pledged securities, *fn5" and the pledgee's security interest will defeat conflicting interests of parties under subsection (b). *fn6" As we understand the facts of this case, no entry of pledge is alleged to have been made on the books of a Reserve Bank.

 We hope that this letter helps clarify the interpretation of 31 C.F.R. § 306.118 contained in our memorandum of law. We will gladly supply additional materials at your Honor's request. Respectfully, Rudolph W. Giuliani James H. Oltman United States Attorney for Attorney for Federal Reserve Bank the Southern District of New York of New York, Board of Governors Attorney for United States of the Federal Reserve System, Department of the Treasury and Federal Open Market Committee United States Courthouse Annex Federal Reserve Bank of New York One St. Andrew Plaza 33 Liberty Street New York, New York 10007 New York, New York 10045 (212) 791-0055 (212) 791-5025 By:/s/ By:/s/ PAUL K. MILMED MARYSUE SULLIVAN Assistant United States Assistant Counsel Attorney



140 Broadway


New York, New York 10005


Attorneys for Plaintiffs




125 Broad Street


New York, New York 10004


Attorneys for Defendant Marine Midland Bank, N.A.




3699 Wilshire Boulevard -- 9th Floor


Los Angeles, California 90010


Attorneys for Defendant Comark Government Securities, Inc.




30 Broad Street


New York, New York 10004


Attorneys for Third-Party Defendant E. Keith Owens




441 O'Campo Drive


Pacific Palisades, California 40272

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