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 In fact, defendants could have withdrawn the Securities from the brokerage account at any time, even though they were subject to short sales against the box, so long as defendants deposited, at or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.
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 prevent redelivery upon the pledgor's performance is conversion") (emphasis added). As these cases are concerned primarily with whether the pledgee can return the collateral upon repayment of the pledgor's obligation, they support the practical definition of "encumbrance" proposed by the defendants and adopted by the Court.
Similarly, section 9-207(2)(e) of the Uniform Commercial Code, which was intended to codify the preexisting case law, see id. ; official comment to Section 9-207, provides that, unless otherwise agreed, a secured party may repledge collateral in its possession "upon terms which do not impair the debtor's right to redeem it."
Therefore, under the U.C.C., unless the parties agree otherwise, a secured party is free to repledge collateral so long as it can be returned to the pledgor upon satisfaction of the underlying debt.
Because Section 9-207(2) applies only in the absence of contrary agreement, the contractual prohibition on "encumbrance" of the Securities takes the parties out of the scope of this provision. To the extent Section 9-207(2)(e) does apply, however, the short sales would have been permissible even if they encumbered the shares, so long as defendants could have returned the Securities upon repayment of the loan.
Plaintiff cites no authority which directly supports the contention that the short sales violated the contractual prohibition on "encumbrance" of the Securities. In this regard, the pivotal distinction from the rehypothecation cases plaintiff cites is that defendants did nothing to grant or otherwise create a security interest in the Securities themselves. While the Securities were, in a sense, by virtue of being the equity in the brokerage account at the time, collateral for the short sale orders, they were not the required collateral for such orders; any equivalent security or sufficiently valuable equity would have sufficed. Thus, the only way Schreiber could prevail on this motion would be to demonstrate that, had the loan been repaid in full, defendants could not, under any circumstances, have garnered sufficient assets, from within the account or otherwise, to satisfy the Regulation T requirements and return the Securities to Schreiber. See FED R. CIV. P. 56(c) (summary judgment warranted where there is "no genuine issue as to any material fact"). Since Schreiber has failed to produce such evidence, its motion for partial summary judgment must be denied.
Dated: Brooklyn, New York
June 17, 1997
RAYMOND J. DEARIE
United States District Judge