Opinion ID: 320641
Heading Depth: 1
Heading Rank: 2

Heading: regulation t and the s.m.a. defense

Text: 4 McCormick brought his Regulation T action under section 27 of the Securities Exchange Act of 1934, 15 U.S.C. 78aa, which vests exclusive jurisdiction of violations of the Act and 'rules and regulations thereunder' in the federal courts. The district court apparently assumed that Goodbody was subject to civil liability to its customer for violation of initial margin requirements, and Goodbody does not question that assumption. In Pearlstein v. Scudder & German, 2 Cir. 1970, 429 F.2d 1136, cert. denied, 1971, 401 U.S. 1013, 91 S.Ct. 1250, 28 L.Ed.2d 550, the Second Circuit held that the customer had a right of action against the brokerage house under section 27 for its violation of section 7 margin reguirements, 15 U.S.C. & 78g. 5 The Court reasoned that, 5 although the congressional committee report which recommended the enactment of Section 7 indicates that the protection of individual investors was a purpose only incidental to the protection of the overall economy from excessive speculation, it has been recognized in numerous cases since that time that private actions by market investors are a highly effective means of protecting the economy as a whole from margin violations by brokers and dealers. 6 429 F.2d at 1140. We agree with the Second Circuit's analysis as it relates to regulations promulgated under section 7, 6 and conclude that the court below correctly decided to determine the claim on its merits. 7 The parties brought the Regulation T issue into sharp focus before the district court. In paragraph 9(f) of their Pretrial Stipulation the parties provided that the court must determine 'whether excessive credit was extended to Plaintiffs by GOODBODY & CO., a limited partnership, in violation of Regulation T.' They then gave the following explanation: 8 The parties agree that in order to resolve this issue of law, the Court must necessarily determine the legality of the account maintained by (Goodbody), which was labeled by (Goodbody) as a Special Miscellaneous Account. Specifically, the Court must determine whether said Special Miscellaneous Account was authorized by Regulation T and whether it was maintained by (Goodbody) pursuant to Regulation T. If the Court should determine that (Goodbody) was permitted by Regulation T to maintain a Special Miscellaneous Account, that the account labeled by (Goodbody) as a Special Miscellaneous Account was the type of account authorized by Regulation T, Section 4(f)(6), that the entries which were made in the S.M.A. ledgers which (Goodbody) maintained were made in a manner authorized by Regulation T, and that the effect of the accounting procedures so employed was to eliminate what would otherwise be an excessive extension of credit, then the Defendants did not violate Regulation T. However, if the Court should find that Regulation T, Section 4(f)(6) does not authorize the maintenance of a Special Miscellaneous Account which (Goodbody) maintained or that said Special Miscellaneous Account was not maintained for Plaintiffs by (Goodbody) in a manner consistent with Regulation T, then there would have been excessive extensions of credit. (Pretrial Stipulation P9(f), Vol. IV, pp. 1504-05). 9 The 'Special Miscellaneous Account' (S.M.A.) is an accounting procedure first adopted by members of the New York Stock Exchange in 1942. Prior to the advent of the S.M.A. the practice among brokerage firms was to permit the customer to deposit the proceeds of a sale in a cash account; the customer could then use the cash to purchase additional securities in his margin account, or he could withdraw the cash at any time. The S.M.A. procedure consists of bookkeeping notations which enable a customer to preserve his right to use the proceeds of a sale without necessitating the opening or maintaining of a separate cash account. This type of account is maintained for the customer in conjunction with his general margin account, 7 and the customer-- including McCormick in the present case-- is so notified on each monthly statement sent to him by the broker. 8 The available credit balance in the S.M.A. in a 'restricted' margin account 9 (such as McCormick's) consists of: (1) that part of the difference between the sale price and the 70% 'retention requirement' that the customer has not withdrawn in cash; (2) any cash deposited by the customer; (3) dividends on securities held by the broker for the customer's account; and (4) certain appreciations in market value of the securities held in the account. In other words, the S.M.A. reflects those sums which the customer could have withdrawn following transactions and changes in his general margin account, but did not. 10 10 The substance of plaintiff's F.M.A. complaint is that credit in an S.M.A. cannot properly be employed as 'buying power' to legitimize extensions of credit that would otherwise be in violation of Regulation T. Plaintiff also contends that even if use of an S.M.A. may sometimes be valid, Goodbody has failed to establish the authenticity of its records of McCormick's account. 11 We find no merit in McCormick's secondary contention. The district court found that the recitation of the nine disputed transactions in the Pretrial Stipulation and in the Summary of Plaintiff's Account attached to the Pretrial Stipulation-- both of which incorporated Goodbody's S.M.A. notations--'accurately set forth the nine transactions in question.' (Findings of Fact P 9, Record, Vol. VI, pp. 2093-94). Goodbody kept its S.M.A. records in the regular course of business; the evidence indicates that the records of McCormick's account were maintained in the usual manner; all computations appear to be mathematically sound. McCormick stresses that Goodbody has the burden of proving the authenticity of its S.M.A. notations. In the complete absence of any indication to the contrary, we are satisfied that Goodbody met that burden. The district court's finding is not clearly erroneous. 12 McCormick's primary argument, that an S.M.A. cannot be used as purchasing power to meet Regulation T initial margin requirements, has been addressed in some depth by Judge Pollack for the United States District Court for the Southern District of New York. Manevich v. duPont, S.D.N.Y., 338 F.Supp. 1124, aff'd mem., 2 Cir. 1972, 465 F.2d 1398. We agree with Judge Pollack that the use of S.M.A. notations to meet initial margin requirements is consistent with Regulation T. Section 4(f)(6) of Regulation T, 12 C.F.R. 220.4(f)(6), provides: 13 220.4 Special accounts. 14 . . . .al 15 (f) Special miscellaneous account. In a special miscellaneous account, a creditor may: 16 (6) Effect for any customer the collection or exchange (other than by sale or purchase) of securities deposited by the customer specifically for such purposes, and (subject to any other applicable provisions of law) received from or for any customer, and pay out or deliver to or for any customer, any money or securities. 17