Opinion ID: 2307607
Heading Depth: 1
Heading Rank: 7

Heading: The Customer Agreement as a Misrepresentation

Text: RCM Customers claim that they were deceived into believing that their securities and other assets would be safeguarded, and, in particular, that RCM would not rehypothecate excess margin or fully-paid securities. They allege that, in fact, RCM routinely rehypothecated all of its customers' securities, regardless of the customers' outstanding margin debt, and did so from the start of each customer's account. The allegations as to RCM's conduct are sufficient to satisfy the element of intent at the time of contract formation. The crux of the issue, therefore, is whether RCM's rehypothecation of securities even when they were not deemed collateral was so inconsistent with the provisions of the Customer Agreement that the Agreement was itself a deception. [15] Section B [16] of the Customer Agreement establishes the terms by which RCM would extend margin financing to RCM Customers, and provides in relevant part: B. MARGIN This Margin section applies in the event [RCM] finances any of your Transactions from time-to-time in Financial Instruments. 1. Security Interest. [RCM] reserves the right to require the deposit or maintenance of collateral (consisting of cash, United States government obligations or such other marketable securities or other property which may be acceptable to [RCM]) to secure performance of your obligations to [RCM]. ... To secure your obligations under Transactions entered into pursuant to this Agreement, you hereby grant to [RCM] and its affiliates (collectively, Refco Entities) a first priority, perfected security interest in all of your cash, securities and other property (whether held individually or jointly with others) and the proceeds thereof from time-to-time in the possession or under the control of such Refco Entities, whether or not such cash, securities and other property were deposited with such Refco Entities. 2. Rights and Use of Margin. [RCM] shall have the right to loan, pledge, hypothecate or otherwise use or dispose of such cash, securities and other property free from any claim or right, until settlement in full of all Transactions entered into pursuant to this Agreement. [RCM's] sole obligation shall be to return to you such cash, like amounts of similar cash, securities and other property (or the cash value thereof in the event of any liquidation of collateral) to the extent they are not deemed to be collateral to secure Transactions entered into pursuant to this Agreement with any Refco Entities or have not been applied against obligations owing by you to Refco Entities, whether as a result of the liquidation of positions and any Transactions entered into pursuant to this Agreement or otherwise. App. 154. Section B.1 states that upon RCM's extension of margin financing to a customereven a dimeRCM would obtain a first priority, perfected security interest in all of [RCM Customers'] cash, securities and other property (whether held individually or jointly with others) and the proceeds thereof. App. 154. Section B.1 also gave RCM the right to demand additional collateral in the event that a customer's collateral became insufficient to secure the customer's outstanding margin debt if, for example, the value of the customer's securities collateral decreased in value such that RCM's margin loan was under-secured. In addition, Section B.2 states that, if a customer's securities are no longer deemed collateral to secure the customer's outstanding margin debt, RCM was obligated to return such securities to the customer. It is evident that the promised return did not contemplate either securities or their value being returned to the actual possession of the RCM Customers. Margin accounts move up or down with both the buying or selling by the customer and the price movements of the collateral. The constant transfer of collateral back and forth between accounts in RCM's name or a customer's name would have imposed administrative costs on all parties, and no one argues that such constant transfers were required by the Customer Agreement. Moreover, all of the RCM Customers had to have been aware that, if RCM was not asking for more collateral, some of their securities were probably excess collateral. However, there is no allegation or indication that any RCM Customer ever noticed or complained about the lack of back-and-forth transfers. In context, therefore, return must mean that, with respect to securities not deemed to be collateral, the customer could demand their return from the fungible pool. Moreover, in the case of a requested return, RCM had the option of transferring physical securities or the cash value thereof in the event of any liquidation of collateral. Thus, RCM, after rehypothecating all its customers' securities, could have satisfied a demand for return of excess securities by paying their cash value in lieu of the actual securities. On review of the Customer Agreement, we conclude that it unambiguously warned the RCM Customers that RCM intended to exercise full rehypothecation rights as to the Customers' excess margin securities. Stripped of verbiage not pertinent to this dispute and substituting a crude and colloquial description for the specified collateral, Sections B.1 and 2 read: B. Margin This Margin section applies in the event [RCM] finances any of your Transactions ... in [your account]. 1. Security Interest. [RCM] reserves the right to require ... [appropriate stuff as] collateral... [T]o secure performance of your obligations to [RCM] ... you hereby grant to [RCM] ... a first priority, perfected security interest in all your [stuff] in the possession of ... [Refco Entities].... 2. Rights and Use of Margin. [RCM] shall have the right to ... use or dispose of such [stuff] free from any claim or right, until settlement in full of all Transactions.... [RCM's] sole obligation shall be to return to you such [stuff] ... to the extent [it is] not deemed to be collateral to secure Transactions.... App. 154. Appellants' argument that the first use of such [stuff] in B.2 refers only to stuff deemed to be collateral is not consistent with the language of the agreement. The only referent for the first such [stuff] is all your [stuff] in B.1. Moreover, the second use of such [stuff] in B.2 is modified by to the extent [it is] not deemed to be collateral, a most peculiar modifier if such [stuff] means only stuff deemed to be collateral. RCM Customers also allege that RCM rehypothecated Customer assets at times that RCM Customers had no outstanding margin debt in breach of the Customer Agreement. However, the Customer Agreement provides only that the cash value of securities not deemed collateral shall be return[ed] to the customers, i.e., recorded on RCM's books as money payable on demand to the particular customer. A perfectly plausible reading of the Agreement is that, on the occasions that some customers had no outstanding margin transactions, they had only a right to demand payment of the value of 100 percent of the securities that had been given to RCM. There is, therefore, no disparity between the provisions of the Customer Agreement and RCM's conduct remotely supportive of a claim that the Agreement was a misrepresentation actionable under Section 10(b). The Trade Confirmation also supports this conclusion. Section D.2 of the Customer Agreement incorporates the terms of the Trade Confirmation, which include, among other things, a reiteration of RCM's rights to sell, pledge, hypothecate, assign, invest or use, such collateral or property deposited with it. App. 712.