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June 17, 1997


The opinion of the court was delivered by: DEARIE

 DEARIE, District Judge.

 Plaintiff Schreiber Family Charitable Foundation ("Schreiber") has sued for breach of an agreement (the "Agreement") to pledge stock as collateral for a loan, and now moves for partial summary judgment. On December 23, 1994, Schreiber entered into the Agreement with defendant First Financial Acceptance Co., Inc. ("First Financial"), pledging 300,000 American Depository Receipts ("ADR's") of Great Central Mines, Ltd. (the "Securities"), an Australian gold mining company, as security for a $ 1.275 million loan to be made to Schreiber. ADR's are certificates, tradable in the United States, which represent shares of foreign stock. The Agreement prohibits First Financial from "encumbering" the Securities except in accordance with its terms. On the same date, Schreiber executed a $ 1.275 million promissory note in favor of First Financial. The ADR's were actually delivered to First Financial on or about January 4, 1995, and $ 1.25 million in loan proceeds were disbursed to Schreiber during January and February. First Financial assigned the loan to defendant Keystone Financial, Inc., an affiliated entity. *fn1"

 Defendants executed short sales of Great Central Mines ADR's against the box, and used the proceeds to fund the loan. Briefly, a short sale occurs when a non-owner of a security enters an order to sell that security with the intention of later purchasing the security at a lower price (or otherwise acquiring the security) to cover the sale order. In a short sale against the box, the seller actually possesses the security which is the subject of the sale order, but may not deliver it to fulfill that order. Instead, the seller may later borrow or purchase identical securities to fulfill the sale order. See Bissell v. Merrill Lynch & Co., Inc., 937 F. Supp. 237, 240 (S.D.N.Y. 1996) (Schwartz, J.); J. WILLIAM HICKS, EXEMPTED TRANSACTIONS UNDER THE SECURITIES ACT OF 1933 § 10.04[3][d][i] (1992). The securities held by the seller are referred to as "in the box."

 In an ordinary short sale, Federal Reserve Board Regulation T requires the seller to maintain an equity margin of at least 150% of the value of the short position (i.e., to hold, in a margin account, pending the required delivery, cash or securities worth at least 150% of the value of the securities to be delivered). See 12 C.F.R. § 220.18(c). *fn2" In a short sale against the box, the seller need not do this, as he already holds securities identical to those which must be delivered. See 12 C.F.R. § 220.4(b)(2) ("A short sale 'against the box' shall be treated as a long sale for the purpose of computing the equity and the required margin."). *fn3" The seller must maintain the securities in the box pending the required delivery or face the 150% margin requirement. In a sense, a short sale is a sale on credit, and the maintenance of the securities in the box, or the 150% margin requirement, serves as the security for the "loan" of the sale price from the buyer. See Bissell, 937 F. Supp. at 240.

 Schreiber alleges that these short sales against the box "encumbered" the pledged Securities in violation of the Agreement. When, in January 1995, defendants allegedly failed to document the whereabouts of the Securities to Schreiber's satisfaction, Schreiber withheld all loan payments. Defendants retained the Securities, and began delivering them to cover the short sales on or about March 30, 1995 (at least two months after Schreiber's alleged default). Schreiber claims that the Securities were worth approximately $ 1.9 million at the time they were pledged, *fn4" and now claims it is entitled to at least $ 650,000, the difference between this alleged value and the amount of loan proceeds it received. Schreiber's theory appears to be that when defendants breached the Agreement, Schreiber became entitled to return of the Securities or their market value. Since Schreiber retained the $ 1.25 million loan proceeds, it now seeks what it claims to be the remaining value of the Securities, measured as of the time they were pledged.

 According to Schreiber, defendants delivered 252,000 of the 300,000 ADR's to cover the short sales (which netted $ 1,527,624, see Schreiber's Local Rule 3(g) Statement, at Exh. F, p.13) on or about March 30, 1995, id. At Exh. H, p.2, and sold the remaining 48,000 ADR's at approximately the same time. *fn5" Schreiber estimates the actual proceeds of the sales at $ 1.725 million, less than the $ 1.9 million at which it estimates the Securities' value when they were pledged. In fact, the value of the Securities decreased rather steadily from January through March of 1995, reaching their lowest closing price for the first half of that year on March 29, at $ 4.25 per share, or $ 1,275,000.

 Defendants claim that the short sales did not encumber the Securities, and that Schreiber breached the parties' agreement by failing to repay the loan. Defendants cite the Agreement, which explicitly authorizes them to sell the Securities if Schreiber defaults, on notice to Schreiber and "without liability for any diminution in price which may have occurred," and to retain the amount of any outstanding loan principal, interest and related expenses and fees.

 Defendants claim they should be entitled to retain the full amounts realized on the sales, even though these amounts exceed the value of the loan. Defendants argue that if they had executed straight sales of the Securities in late March, 1995 (the time they delivered many of the Securities to satisfy the earlier short sales), the return would have been less than the amount they were entitled to under the Agreement. *fn6" Only because they had previously sold Great Central Mines ADR's short against the box, thereby successfully hedging against a declining market, defendants argue, did they realize more on the ultimate sales than they would otherwise have been entitled to under the Agreement. In other words, they claim they should not have to disgorge their profits from the short sales because, had they disposed of the Securities through straight sales in March, they would have lost money. To do otherwise, they claim, would be to penalize them for making what amounts to a propitious business decision. In fact, certain of the defendants have counterclaimed for an unspecified deficiency amount.


 The pivotal question for this case, or at least this motion, is whether a short sale against the box "encumbers" the securities in the box. While the Court has not located or been directed by the parties to any relevant judicial authority on this question, the Court concludes that such a sale does not create an encumbrance. While Regulation T requires specified amounts of equity to be held in a margin account pending the required delivery of securities sold short, it does not require that specific securities be held. So long as defendants' account contained sufficient equity to satisfy the Regulation T margin requirements, there was no requirement that the pledged Securities remain in the account.

 As a practical matter (and as defendants have proposed to the Court), the question of encumbrance amounts to whether defendants could have returned the Securities to Schreiber, at any given time, had Schreiber repaid the loan in full. That is, if Schreiber had repaid the loan in full at any time, and if defendants could have returned the Securities free and clear at that time, then the Securities, for practical purposes, were not encumbered. In fact, defendants could have withdrawn the Securities from the brokerage account at any time, even though they were subject to short sales against the box, so long as defendants deposited, at or before the time of the withdrawal, sufficient equity in the account to satisfy the Regulation T requirements. *fn7"

 Defendants could have satisfied the margin requirements either by depositing assets worth at least 150% of the value of the Securities sold short, or by purchasing identical securities and depositing them to the account. The loan repayment of $ 1.25 million plus interest might have been used to make such a deposit or purchase. Furthermore, in addition to the Securities, defendants held United States Treasury bonds valued at $ 403,376 in the brokerage account as of January 27, 1995. Because the Securities' value was declining through the first quarter of 1995, there were times at which the combined value of a full loan repayment and these Treasury bonds would have been adequate to purchase replacement securities sufficient to satisfy the Regulation T requirements. In any event, there appears to be no reason defendants could not have deposited assets from other sources into the account to satisfy the margin requirements. Defendants assert that to find a security encumbered merely because it is held in a brokerage account subject to a margin requirement would transform accepted practices and the nature of innumerable financial transactions, and make compliance with agreements such as this dependent on the hourly vicissitudes of a dynamic market.

 Schreiber points to certain older cases holding that a broker may not rehypothecate pledged securities in excess of the client's debt to the broker. See, e.g., In re Salmon Weed & Co., Inc., 53 F.2d 335 (2d Cir. 1931); Vance Lumber Co. v. Fraser, Goodwin & Colver, 162 Wash. 347, 298 P. 438, 440-41 (Wash. 1931). That is, if a client pledges securities to her broker to secure a debt (as when the broker has extended credit to purchase other securities on the client's behalf), the broker may repledge the client's securities to secure the broker's indebtedness to a third party, so long as the broker's indebtedness to the third party does not exceed the client's indebtedness to the broker. The rationale for this rule was that, should the client repay her debt to the broker in full, the broker must be able to return the securities which were pledged as collateral. See Vance Lumber, 298 P. at 440-41. Thus, if the broker's indebtedness may be satisfied by the funds of the client's repayment, the client's repayment should make the client's securities immediately available to the broker for return to the client, and there is no conversion. See Borden v. District of Columbia, 417 A.2d 402, 404 n.6 (D.C. 1980) ("wrongful or unauthorized disposition of collateral by the pledgee so as to ...

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