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PINNACLE SEC. INV. ASSOCS., L.P. v. AMEX

November 26, 1996

PINNACLE SECURITY INVESTMENT ASSOCIATES, L.P., Plaintiff, against AMERICAN STOCK EXCHANGE, INC., Defendant.


The opinion of the court was delivered by: CEDARBAUM

 CEDARBAUM, J.

 In this action, Pinnacle Security Investment Associates ("Pinnacle"), a limited partnership, sues the American Stock Exchange, Inc. (the "Exchange") for damages from an alleged violation of § 6(c)(1) of the Securities Exchange Act of 1934 (the "Exchange Act"), 15 U.S.C. § 78f(c)(1). Section 6(c)(1) provides that "[a] national securities exchange shall deny membership to . . . any person . . . which is not a registered broker or dealer." The Exchange has moved to dismiss the complaint pursuant to Fed. R. Civ. P. 12(b)(6) on the grounds that: (1) § 6(c)(1) does not apply to the discipline of an existing member but rather to the denial of a membership application; and (2) there is no private right of action under § 6(c)(1). This motion presents issues of first impression. For the reasons that follow, the motion to dismiss is granted.

 Allegations of the Complaint

 In August 1994, Pinnacle entered into an agreement with U.S. Equity Management Corporation ("USEMCO"), a registered broker-dealer and a member of the New York Stock Exchange, pursuant to which USEMCO would invest Pinnacle's funds. (Am. Compl. PP 6-7, 9.) On November 9, 1994, the Securities and Exchange Commission entered an order canceling the registration of USEMCO as a broker-dealer. (Id. P 10.) The Exchange should have known of that order on or about the same date. (Id. P 15.) According to the complaint, the Exchange negligently failed to suspend USEMCO's membership until April 1995. (Id. PP 16-17.) Between November 9, 1994, and March 29, 1995, Pinnacle invested $ 1,234,000 with USEMCO. (Id. P 13.) Pinnacle would not have invested those funds if USEMCO were not a member of the Exchange. (Id. P 14.) Upon USEMCO's suspension, it ceased operating and did not return any of Pinnacle's funds. (Id. P 17.)

 Discussion

 On a motion to dismiss the complaint, the factual allegations of the complaint are accepted as true, Leatherman v. Tarrant County Narcotics Intelligence & Coordination Unit, 507 U.S. 163, 164, 122 L. Ed. 2d 517, 113 S. Ct. 1160 (1993), and all reasonable inferences are drawn in favor of the plaintiffs, Bolt Electric, Inc. v. City of New York, 53 F.3d 465, 469 (2d Cir. 1995). A motion to dismiss should be granted only if it appears beyond doubt that the plaintiffs can prove no set of facts that would entitle them to relief. Id.

 Pinnacle's Claim Under Section 6(c)(1)

 Section 6(c)(1) of the Exchange Act provides: "A national securities exchange shall deny membership to (A) any person, other than a natural person, which is not a registered broker or dealer or (B) any natural person who is not, or is not associated with, a registered broker or dealer." 15 U.S.C. § 78f(c)(1). The Exchange argues that § 6(c)(1) does not apply to the facts of this case, for reasons discussed below, and that therefore the complaint should be construed as arising under § 6(b). The Second Circuit held in Baird v. Franklin, 141 F.2d 238, 244 (2d Cir. 1944), cert. denied, 323 U.S. 737, 89 L. Ed. 591, 65 S. Ct. 38 (1944), that § 6(b) as it existed prior to 1975 imposed a duty on exchanges to enforce their own rules. That duty was made explicit by the 1975 amendments to the Exchange Act. Securities Acts Amendments of 1975, Pub. L. No. 94-29, 89 Stat. 97 (1975) (the "1975 Amendments"); § 19(g), 15 U.S.C. § 78s(g). The Exchange contends that the gravamen of Pinnacle's complaint is that the Exchange failed to enforce its rule providing that "an organization shall cease to be a member organization and shall dispose of its membership if it becomes subject to any 'statutory disqualification' as defined in Section 3(a)(39) of the Securities Exchange Act of 1934." Am. Stock Ex. Guide (CCH) P 9179 at 2319. Since USEMCO became subject to a statutory disqualification upon the loss of its registration, 15 U.S.C. § 78(c)(39)(B)(i)(I), the Exchange argues that Pinnacle's complaint is really based on the Exchange's failure to enforce its rules as required by § 6(b). Pinnacle, however, expressly disclaims reliance on § 6(b). (Mem. of Pl. in Opp'n to Def.'s Mot. to Dismiss the Compl., at 2 n.1.) Thus, I will not read the complaint as arising under § 6(b) but will address the alleged violation of § 6(c)(1).

 It is doubtful that the Exchange's failure to suspend or otherwise discipline USEMCO constitutes a violation of § 6(c)(1). The statute speaks of "denying" membership. It is undisputed that when USEMCO was admitted as a member of the Exchange, it was a registered broker-dealer. Pinnacle contends that once USEMCO lost its registration, the Exchange should have "denied" it membership. Pinnacle's position might be better described as a claim that the Exchange did not promptly discipline an existing member. But the plain language of the statute appears to refer to denial of a membership application rather than to discipline of a member.

 Moreover, the legislative history of the 1975 Amendments, which first enacted § 6(c)(1), supports reading § 6(c)(1) to apply to denials of membership to applicants and not to discipline of existing members. The Senate Report notes: "The self-regulatory organizations exercise government power, and they do so in basically three ways . . . : (1) by imposing a disciplinary sanction, broadly defined, on a member . . ., (2) by denying membership to an applicant, and (3) by requiring members to cease doing business . . . with a particular non-member or with respect to a particular security." Senate Committee on Banking, Housing and Urban Affairs, S. Rep. No. 75, 94th Cong., 1st Sess. 23 (1975) ("Senate Report"), reprinted in 1975 U.S.C.C.A.N. 179, 202-03. The Senate Report goes on to explain that "when a member violates the Act or a self-regulatory organization's rules, the organization must be in a position to impose appropriate penalties [which, under § 6(b)(6), include expulsion and suspension] . . . . Similarly, a self-regulatory organization must be able to prevent an unqualified person from obtaining access to facilities and business opportunities by denying membership." Id. at 203. These statements support an interpretation that Congress viewed denial of membership and discipline as two separate functions to be performed by exchanges.

 The structure of the statute as a whole also suggests that denial of membership is something separate and independent of discipline of existing members, and that Congress intended § 6(c)(1) to apply only to the former. Section 6(b)(2) ensures that, subject to § 6(c), "any registered broker or dealer . . . may become a member" of the Exchange. 15 U.S.C. § 78f(b)(2). Section 6(c), entitled in part "denial of membership in national exchanges," provides that an exchange "shall deny membership to . . . any person . . . which is not a registered broker or dealer" and "may . . . deny membership to any registered broker or dealer . . . who is subject to a statutory disqualification." 15 U.S.C. § 78f(c)(1)-(2). These provisions were enacted to help clarify regulatory responsibilities by ensuring that an exchange's "undertaking to regulate a broker or dealer would not be discretionary with respect to persons qualified for membership. In other words, if a person meets the requirements for membership he must be admitted." Senate Report at 202. Once a person is admitted as a member, the Exchange has a responsibility to discipline that member. "With respect to a person admitted, i.e., a member, an exchange or association must enforce compliance with its rules, the Exchange Act, and the rules and regulations thereunder." Id. Section 6(b)(6) requires that "the rules of the exchange provide that . . . its members . . . shall be appropriately disciplined for violation of the provisions of [the Exchange Act], the rules or regulations thereunder, or the rules of the exchange, by expulsion, suspension, . . . or any other fitting sanction." 15 U.S.C. § 78f(b)(6). Thus, the statute itself has separate provisions dealing with an exchange's responsibility and power to deny membership to an applicant and an exchange's independent power to discipline an existing member.

 The plain language of the statute, the legislative history and the overall statutory structure all point to the conclusion that § 6(c)(1) does not apply to the facts of this case. But even if § 6(c)(1) were held to apply, ...


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