Source: https://supreme.justia.com/cases/federal/us/209/365/
Timestamp: 2019-04-21 10:48:49+00:00

Document:
While a broker who carries stocks for a customer on margin may not be strictly a pledgee at common law, he is essentially a pledgee and not the owner of the stock. Markham v. Jaudon, 41 N.Y. 235, approved. Neither the right of the broker to repledge stock carried on margin for a customer nor his right to sell such stock for his protection when the margin is exhausted alters the relation of the parties, is inconsistent with the customer's ownership, or converts the broker into the owner of the stock.
A certificate of stock is not the property itself, but the evidence of the property in the shares, and, as one share of stock is not different in kind or quality from every other share of the same issue and company, the return of a different certificate, or the right to substitute one certificate for another of the same number of shares, is not a material change in the property right held by the broker for his customer.
A broker who turns over to a customer, upon demand and payment of advances, stock which he is carrying on margin for that customer, or certificates for an equal number of shares, does not make the customer a preferred creditor within the meaning of § 60a of the Bankrupt Law; in the absence of fraud or preferential transfer the broker has the right to continue to use his estate for the redemption of pledged stocks in order to comply with the valid demand of a customer for stocks carried for him on margin.
A payment by the broker to a customer on account of excess margins to which the customer is entitled and which is taken into consideration when the account is finally closed held, under the circumstances of this case, not to be a preferential payment within the meaning of 60a of the Bankrupt Law.
This case comes here upon a writ of certiorari to the United States Circuit Court of Appeals for the Second Circuit. The petitioner, Richardson, brought suit in the District Court of the United States for the Southern District of New York as trustee in bankruptcy of J. Francis Brown, against John M. Shaw and Alexander Davidson, respondents, to recover certain alleged preferences.
Brown, the bankrupt, was a stockbroker transacting business in Boston. The respondents, John M. Shaw and Alexander Davidson, were partners and stockbrokers, transacting business in New York as John M. Shaw & Company, and, as customers of Brown, they transacted business with him on speculative account for the purchase and sale of stocks on margin. The account was carried on in Brown's books in the name of "Royal B. Young, Attorney," as agent of Shaw & Company.
The transactions between Brown and Shaw & Company were carried on for several months, from February to June, 1903. A debit and credit account was opened February 10, when Shaw & Company deposited with Brown $500 as margin, which was credited to them on the account, and Brown purchased for them certain securities at a cost of $3,987.50, which was charged to them on the account.
"It is understood and agreed that all securities carried in this account or deposited to secure the same may be carried in our general loans and may be sold or bought at public or private sale, without notice, when such sale or purchase is deemed necessary by us for our protection. "
According to the agreement, the securities carried in this account or deposited to secure the same might be carried in Brown's general loans, and such securities were so pledged by him, and Young, as agent of Shaw & Company, was informed of the fact. The stocks were figured at the market price every day and statements rendered to Young.
The bankrupt, Brown, transacted much of his general business with Brown, Riley & Company, of Boston. He pledged his general securities with that company.
On June 24, 1903, Young, the agent of Shaw & Company, as above stated, learned of Brown's precarious financial condition, and demanded payment of $5,000 cash from Brown's agent, Fletcher. At that time the margins already paid by Shaw & Company exceeded the agreed ten percent, and Fletcher returned to them $5,000 of such margin.
to Shaw & Company, and a check was given by them, through the Beacon Trust Company, to the order of Brown, Riley & Company, for $34,919.62, and the securities to the value of $45,583.75 were turned over to them. None of the certificates of stock which Brown delivered to Shaw & Company were the identical certificates which they had delivered to Brown as margin. Two certain bonds, known as the "Shannon bonds," had been deposited with Brown.
Among the creditors (customers) of Brown on the final day of settlement there were a number of general customers upon transactions in purchase and sale of stocks by Brown as broker, similar to the transactions in the purchase and sale of stocks by Brown as broker for Shaw & Company.
On July 27, 1903, Brown made an assignment, and was adjudicated a bankrupt within four months, and petitioner in this case, Henry Arnold Richardson, was elected trustee.
It was conceded by plaintiff's counsel that it was the custom of the market to deliver shares from broker to customer of the same amount without regard to whether they were the identical shares received.
This suit was brought to recover the $5,000 paid to Shaw & Company June 24, 1903, which sum, it is alleged, was paid to them as excessive margins, and, it is alleged, enabled them to obtain a preference as one of the creditors of Brown. The second cause of action in the suit states that Shaw & Company are indebted to Brown's estate in the sum of $10,664.13, being the amount he transferred for their benefit, as above set forth.
At the close of the plaintiff's case, he requested to go to the jury upon the issue of defendants' knowledge of Brown's insolvency. The court held that no preference was shown, and directed a verdict for defendants. The judgment was affirmed. 147 F. 659, 665.
with Shaw & Company, being insolvent and dealing with several customers, as to each of whom he had pledged the stocks carried for them, and, under the understanding of the parties, being under obligation to each of them to redeem the stocks from the loan for which they were pledged, this obligation created a right of demanding the pledged stocks and securities on the part of each of the customers, which put the broker in the debtor class and the customers into the creditor class, so that, if the broker used his assets to carry out such obligation to a particular customer, whereby the latter was able to redeem his stock from such pledge upon payment only of the amount of his indebtedness to the broker, with the result that the broker could not carry out similar obligations to other customers in like situation, a preference is created under § 60 of the Bankrupt Act, and this, says the learned counsel in his brief, under any theory concerning the relation of broker and customer, is "the main proposition upon which we hang our appeal."
"The broker undertakes and agrees:"
"1. At once to buy for the customer the stocks indicated."
"2. To advance all the money required for the purchase beyond the ten percent furnished by the customer."
until notice is given by either party that the transaction must be closed. An appreciation in the value of the stocks is the gain of the customer, and not of the broker."
"4. At all times to have, in his name and under his control, ready for delivery, the shares purchased, or an equal amount of other shares of the same stock."
"5. To deliver such shares to the customer when required by him, upon the receipt of the advances and commissions accruing to the broker; or,"
"6. To sell such shares, upon the order of the customer, upon payment of the like sums to him, and account to the customer for the proceeds of such sale."
"Under this contract the customer undertakes--"
"1. To pay a margin of ten percent on the current market value of the shares."
"2. To keep good such margin according to the fluctuations of the market."
"3. To take the shares so purchased on his order whenever required by the broker, and to pay the difference between the percentage advanced by him and the amount paid therefor by the broker."
was, in spirit and in effect, if not technically and in form, a contract of pledge."
The case had been approved in other cases in New York, some of which are: Stewart v. Drake, 16 N.Y. 449; Stenton v. Jerome, 54 N.Y. 480; Baker v. Drake, 66 N.Y. 518; Gruman v. Smith, 81 N.Y. 25; Gillett v. Whiting, 120 N.Y. 402; Content v. Banner, 184 N.Y. 121; Douglas v. Carpenter, 17 App.Div. 329. And approved in other states: Cashman v. Root, 89 Cal. 373; Brewster v. Van Liew, 119 Ill. 554; Gilpin v. Howell, 5 Pa. 41; Wynkoop v. Seal, 64 Pa. 361; Esser v. Linderman, 71 Pa. 76.
The subject was fully considered in a case which leaves nothing to be added to the discussion, Skiff v. Stoddard, 63 Conn.198, in which the conclusions in Markham v. Jaudon were adopted and approved. These views have been very generally accepted as settled law by the text writers on the subject. 1 Dos Passos on Stockbrokers (2d ed.) 179-200; Jones, Pledges, § 496; Mechem, Agency, § 936.
"The broker acts in a threefold relation: first, in purchasing the stock, he is an agent; then, in advancing money for the purchase, he becomes a creditor, and finally, in holding the stock to secure the advances made, he becomes a pledgee of it. It does not matter that the actual possession of the stock was never in the customer. The form of a delivery of the stock to the customer, and a redelivery by him to the broker, would have constituted a strict, formal pledge. But this delivery and redelivery would leave the parties in precisely the same situation they are in when, waiving this formality, the broker retains the certificates as security for the advances."
money embraced in the speculation, if he acts honestly, faithfully, and prudently, the entire risk is upon the client. . . . To introduce a different rule would give opportunities for sharp practices and frauds, which the law should not invite."
The rule thus established by the courts of the state where such transactions are the most numerous, and which has long been adopted and generally followed as a settled rule of law, should not be lightly disturbed, and an examination of the cases and the principles upon which they rest leads us to the conclusion that in no just sense can the broker be held to be the owner of the shares of stock which he purchases and carries for his customer. While we recognize that the courts of Massachusetts have reached a different conclusion, and hold that the broker is the owner, carrying the shares upon a conditional contract of sale, and, while entertaining the greatest respect for the Supreme Judicial Court of that state, we cannot accept its conclusion as to the relation of broker and customer under the circumstances developed in this case. We say this, recognizing the difficulties which can be pointed out in the application of either rule.
At the inception of the contract, it is the customer who wishes to purchase stocks, and he procures the broker to buy on his account. As was said by Mr. Justice Bradley, speaking for the Court in Galigher v. Jones, 129 U. S. 193, 129 U. S. 198, a broker is but an agent and is bound to follow the directions of his principal, or give notice that he declines the agency.
manner he secured the privilege of selling when necessary for his protection.
The risk of the venture is entirely upon the customer. He profits if it succeeds; he loses if it fails. The broker gets out of the transaction, when closed in accordance with the understanding of the parties, his commission and interest upon the advances, and nothing else. That such was the arrangement between the parties is shown in the testimony of the broker's agent, who testified: "If these stocks carried for J.M. Shaw & Company made a profit, that profit belongs to Shaw & Company over and above what he owed us."
When Young, the agent of Shaw & Company, demanded the stocks, their right of ownership in them was recognized, and, while pledged, they were under the control of the broker, were promptly redeemed, and turned over to the customer. Consistently with the terms of the contract, as understood by both parties, the broker could not have declined to thus redeem and turn over the stock, and, when adjudicated a bankrupt, his trustee had no better rights, in the absence of fraud or preferential transfer, than the bankrupt himself. Security Warehousing Co. v. Hand, 206 U. S. 415, 206 U. S. 423; Thompson v. Fairbanks, 196 U. S. 516, 196 U. S. 526; Humphrey v. Tatman, 198 U. S. 91; York Mfg. Co. v. Cassell, 201 U. S. 344, 201 U. S. 352.
It is objected to this view of the relation of customer and broker that the broker was not obliged to return the very stocks pledged, but might substitute other certificates for those received by him, and that this is inconsistent with ownership on the part of the customer, and shows a proprietary interest of the broker in the shares; but this contention loses sight of the fact that the certificate of shares of stock is not the property itself, it is but the evidence of property in the shares. The certificate, as the term implies, but certifies the ownership of the property and rights in the corporation represented by the number of shares named.
"one share of stock is not different in kind or value from every other share of the same issue and company. They are unlike distinct articles of personal property which differ in kind and value, such as a horse, wagon, or harness. The stock has no earmark which distinguishes one share from another, so as to give it any additional value or importance; like grain of a uniform quality, one bushel is of the same kind and value as another."
Nor is the right to repledge inconsistent with ownership of the stock in the customer. Skiff v. Stoddard, 63 Conn. 216, 219; Ogden v. Lathrop, 65 N.Y. 158. It was obtained in the present case by a contract specifically made, and did not affect the right of the customer, upon settlement of the accounts, to require of the broker the redemption of the shares and their return in kind.
It is true that the right to sell for the broker's protection, which was not exercised in this case, presents more difficulty, and is one of the incongruities in the recognition of ownership in the customer; nevertheless it does not change the essential relations of the parties, and certainly does not convert the broker into what he never intended to be and for which he assumes no risk, and takes no responsibility in the purchase and carrying of shares of stock.
interpretation of the contract preserves as its distinctive feature the principal proposition that the customer purchases merely the right to have delivery to him in the future at his option, of stocks or securities at the price of the day of the agreement, and its corollary that the customer derives no right, title, or interest in the stocks or securities until final performance, the difficulties in the way of harmonizing the situation are bound to exist. The fundamental difficulty grows out of the necessary attempt in some way to transform the customer, who enjoys all the incidents and assumes all the risks of ownership, into a person who in fact has no right, title, or interest, and to create out of the broker, who enjoys none of the incidents of ownership, and assumes not a particle of its responsibility, a person clothed with a full title and an absolute ownership."
We reach the conclusion, therefore, that, although the broker may not be strictly a pledgee, as understood at common law, he is essentially a pledgee, and not the owner, of the stock, and turning it over upon demand to the customer does not create the relation of a preferred creditor within the meaning of the Bankrupt Law.
We cannot consent to the contention of the learned counsel for the petitioner that the insolvency of the broker at once converts every customer having the right to demand pledged stocks into a creditor who becomes a preferred creditor when the contract with him is kept and the stocks are redeemed and turned over to him.
to defraud or delay his creditors or give preference to anyone, and does not impair the value of his estate. An insolvent is not bound, in the misfortune of his insolvency, to abandon all dealing with his property; his creditors can only complain if he waste his estate or give preference in its disposition to one over another. His dealing will stand if it leave his estate in as good plight and condition as previously."
"A person shall be deemed to have given a preference if, being insolvent, he has, within four months before the filing of the petition, or after the filing of the petition and before the adjudication, procured or suffered a judgment to be entered against himself in favor of any person, or made a transfer of any of his property, and the effect of the enforcement of such judgment or transfer will be to enable any one of his creditors to obtain a greater percentage of his debt than any other of such creditors of the same class."
A creditor is defined to include anyone who owns a demand or claim provable in bankruptcy. Sec. 1, sub. 9, Bankruptcy Act 1898, 3 U.S.Comp.St. 3419. It is essential, therefore, in order to set aside the alleged preference, that Shaw & Company, at the time of the transfer, should have stood in the relation of creditor to the bankrupt. Of course, if the New York rule based upon Markham v. Jaudon is correct, and the broker was the pledgee of the customer's stock, there can be no question that, in redeeming these stocks for the purpose of satisfying the pledge, no preferential transfer under the Bankruptcy Act resulted.
In our view, we think no different result is reached, so far as a preference in bankruptcy is concerned, if the Massachusetts cases could be taken to lay down the correct rule of the relations between broker and customer.
to deliver them to the customer upon the payment of so much money, and, until the money was paid, the right to have performance did not accrue.
In Covell v. Lound, 135 Mass. 41, the right of the broker was considered after the customer had refused to pay the necessary margin, and after the customer had requested the broker to do the best he could for him and to sell the stock at the broker's board without notice, and it was held that, under such circumstances the broker was not liable for conversion.
In Weston v. Jordan, 168 Mass. 401, the question was as to the relation between customer and broker after the broker had parted with the shares after repeated demands by the customer and refusal by the broker to deliver the shares, and it was held that a valid cause of action arose in favor of the customer, whether for breach of contract or for conversion it matters not.
"No doubt, whichever view be taken, there will be anomalies, and no doubt it is possible to read into either a sufficient number of implied understandings to make it consistent with itself. Purchases on margin certainly retain some of the characteristics of ordinary single purchases by an gent, out of which they grew. The broker buys and is expected to buy stock from third persons to the amount of the order. Rothschild v. Brookman, 5 Bligh (N.R.) 165; Taussig v. Hart, 58 N.Y. 425. He charges his customer a commission. He credits him with dividends and charges him with assessments on stock. However the transaction is closed, the profit or loss is the customer's. But none of these features is decisive."
there is nothing in the case decisive of the question now before us.
"The defendant seeks to have these decisions reconsidered; but the facts of the present case do not call for such reconsideration of the general doctrine. Even if, at the outset, Jordan were to be deemed a pledgor and Wheatland a pledgee of the shares, that relation was changed by what happened afterwards. . . . After Wheatland had parted with the control of the shares, and after repeated demands for them by Jordan and refusals by Wheatland to deliver them, Jordan had a valid ground of action against Wheatland, either for breach of contract or for a conversion, it matters not which."
The facts in the present case are entirely different from those disclosed in the case just cited. In the present case, there was no demand for the return of the stocks which was refused by the broker; but, recognizing the obligation of the contract, when the stocks were demanded the broker proceeded to redeem them from the pledge which he had made of them under the right given by the contract between the parties, and turned them over to the customer. In such case, the relation of debtor and creditor did not arise as it might upon the refusal, as in Weston v. Jordan, to turn over the stocks upon demand.
After an examination of the Massachusetts cases, Judge Lowell held in In re Swift, 105 F. 493, while following the Massachusetts rule as between broker and customer, that no cause of action arose until after demand by the customer. And the same view was taken in the same case upon review in the Court of Appeals for the First Circuit in an opinion by Judge Putnam, 112 F. 315. While both courts held that, under the law as defined in the Massachusetts cases, bankruptcy excused demand, they held that the customer did not become a creditor upon insolvency, but only after demand and refusal or its equivalent.
How then stood the parties at the time of the demand for the return of these shares of stock? They were held upon a contract which required the broker, upon demand, to turn over the shares purchased, or similar shares, to the customer upon payment of advancements, interest, and commissions. These stocks were redeemed and turned over to him; as a consequence, the relation of debtor and creditor as between the broker and customer did not arise.
Upon the principles heretofore discussed, we think the payment of the $5,000 on June 24 was not a preferential payment to a creditor. The customer had demanded settlement, the broker had paid the $5,000, and on the following day this sum was taken into account in settling the account before turning over to the customer the stock belonging to him, according to the understanding of the parties.
I am wrong. I suppose that it is possible to say that, after a purchase of stock is announced to a customer, he becomes an equitable tenant in common of all the stock of that kind in the broker's hands; that the broker's powers of disposition, extensive as they are, are subject to the duty to keep stock enough on hand to satisfy his customers' claims, and that the nature of the stock identifies the fund as fully as a grain elevator identifies the grain for which receipts are out. It would seem to follow that the customer would have a right to demand his stock of the trustee himself, as well as to receive it from the bankrupt, on paying whatever remained to be paid. A just deference to the views of my brethren prevents my dissenting from the conclusion reached, although I cannot but feel a lingering doubt.

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