BANKERS TRUST CO. v. MALLIS
Legal provision: Federal Rules of Civil Procedure, including Appellate Procedure (or relevant rules of a circuit court)
Argument of Jack H. Weiner
Chief Justice Warren E. Burger: We will hear arguments next in 1359, Bankers Trust against Mallis and Kupferman.
Mr. Weiner, you may proceed whenever you are ready.
Mr. Jack H. Weiner: Mr. Chief Justice and may it please the court.
Section 10b and Rule 10b5 under the Securities and Exchange Act of 1934 does not prescribe all fraudulent schemes that have anything to do with securities.
It only prescribes and renders unlawful, those fraudulent schemes that are “in connection with the purchase or sale of any securities.”
This case presents two questions.
One, whether a pledge of securities as collateral or commercial loan was a purchase or sale herein within the meaning of the 1934 Act which defines purchase “to include any contract to buy, purchase, or otherwise acquire” to permit a pledgee to bring in action under Section 10b and Rule 10b5.
The second question is whether the “in connection with” requirements of the Act is satisfied when a bank which releases collectible to its debtor upon the repayment of the indebtedness as it was required to do under law and the alleged sale is the pledge of securities to a plaintiff who is totally unknown to the bank.
The facts in this case are fairly simple.
Justice Potter Stewart: Do you say they are simple?
Mr. Jack H. Weiner: Yes, your honor, they are fairly simple.
Justice Potter Stewart: I read the briefs in this case a week ago on an airplane and I thought I was going crazy.
Mr. Jack H. Weiner: Well, Maybe I could help clarify them for you, Justice Stewart.
Justice Potter Stewart: I thought the altitude was getting to me.
Mr. Jack H. Weiner: Maybe I can help clarify and feel free to interrupt and ask any questions, Justice Stewart.[Laughter]
Chief Justice Warren E. Burger: We will not hesitate counsel.
Mr. Jack H. Weiner: Thank you, sir.
Bankers Trust is a bank.
It received approximately 40,000 shares of equity national stock as collateral for a loan in August of 1970.
At that time, the lending officers received an opinion letter of counsel that the stock would be negotiable within six months.
When a bank receives a pledge of stock, it does not look to the collateral for repayment.
It primarily asks how the indebtedness is going to be repaid and looks at the credit worthiness of the borrower plus other elements relating to repayment.
A banker does not make a loan with the expectation that he is going to be required to foreclose on collateral to collect its indebtedness regardless of whether the collateral has stock, real estate, cattle, or accounts receivable financing.
A banker does not want to be involved in an expensive foreclosure proceeding.
He does not want to have to use lawyers.
He merely wants a return of the moneys he loaned.
The bank, in this case, played no role whatsoever in arranging with Mallis and Kupferman , the respondents herein, to borrow money from Franklin National Bank which they then loaned to Arnold and Fowlers and received their pledge back up collateral from Arnold and Fowlers.
Justice William H. Rehnquist: Let me just isolate, if I may, the very first part of the transaction which you described where the Bankers Trust received the pledge from the Georgia Bank.
Mr. Jack H. Weiner: It did not.
It received it from Mr. Kates.
Justice William H. Rehnquist: Okay, from Mr. Kates.
Would you do so far as to say that if Mr. Kates had made a fraudulent representation with respect to the value of the securities that he was pledging to Bankers Trust and Bankers Trust alleged that it relied on that representation that Bankers Trust would not have a 10b5 action against Kates?
Mr. Jack H. Weiner: Our position is that Bankers Trust Co. does not need to proceed against him in 10b5 at the time he pledged the collateral.
Justice William H. Rehnquist: Could it?
Mr. Jack H. Weiner: No, our position, your honor, is that it does not need that.
He would have executed a note at that time as well as the pledge of collateral and we could proceed against him on the note.
Justice William H. Rehnquist: Could you proceed against him?
You certainly could not proceed against him on the note under 10b5.
Mr. Jack H. Weiner: No, we would not need that.
We would proceed against him in State Court.
Justice William H. Rehnquist: Could you proceed against him by virtue of the fraudulent representation in connection with the pledge by virtue of 10b5?
Mr. Jack H. Weiner: Our position is we do not need that as a remedy.
Justice William H. Rehnquist: I was not asking if you need it.
I was asking whether it would be available if your management changed and the new management thought you did need it.
Justice Lewis F. Powell: Is your position not simply that there would be no sale under this action?
Mr. Jack H. Weiner: That is correct.
There is no sale when you are on the pledge.
Justice William H. Rehnquist: That was what I was trying to find out.
Mr. Jack H. Weiner: Do you have any other questions, Justice Rehnquist?
Justice William H. Rehnquist: Not right now.
Mr. Jack H. Weiner: Okay.
The loan was in the process of being repaid.
In 1971, a dispute arose between Kates, the pledger, and Equity National, the issuer of the stock.
Bankers was informed to the dispute by Equity National who asked that the stock be returned to them.
They then contacted Kates and Kates’ attorneys advised Bankers not to return the collateral but he was entitled to return of the collateral upon repayment of the indebtedness.
Bankers then informed Equity National that it was obligated to return the collateral to its borrower, Kates, upon repayment of the indebtedness.
It might consider it talking to Equity National if it were indemnified.
Equity National did nothing.
A year later, negotiations began between Kates, Arnold, and Fowler with respect to the Equity National stock as well as a block of odd 100,000 shares of Merck stock.
At that time, Kates wanted to have these transactions handled together.
Bankers did not introduce Kates to Arnold and Fowler.
It had not relationship there.
On February 24, 1972, a contract of sale was entered into between Kates, Arnold, and Fowler with respect to the Equity National stock and with respect to the Merck stock.
Justice Potter Stewart: There was Mr. Kupferman somewhere in here too.
Mr. Jack H. Weiner: No, he comes in later in the picture.
He is much later in the picture, your honor.
Justice John Paul Stevens: Mr. Weiner, that particular sale you would concede as a sale within the meaning of the statute, the sale between Kates to Arnold and Fowler.
Mr. Jack H. Weiner: The sale between Kates to Arnold and Fowler is a sale.
Justice John Paul Stevens: Your position is the pledges were not in connection with that sale or the release of the pledge.
Mr. Jack H. Weiner: That is correct, sir.
In that contract, the closing was scheduled for February 29.
On February 29th , apparently, Arnold and Fowler did not have the $156,000 but Fowler gave Kates an additional $10,000 to get an extension of time.
He received a four or five day extension of time for this thing.
Again, this was unknown to Bankers.
Unknown to Bankers, Mallis had some dealings with Mr. Arnold on or about March 1.
Arnold told Mallis of the deal and he said, someone could make some money if they would loan him the funds for which he would be able to consummate the transaction which he was going to make $400,000 out of for 180,000.
Arnold suggested that he participate.
In his affidavits, Mr. Mallis states the suggestion was also by Mr. Murfet of Franklin National Bank.
Mr. Murfet of Franklin National Bank told Mallis that Kates enjoyed a good reputation in the business world and that the securities appeared worthwhile and free of any restrictions.
Then, there was an agreement by Mallis and Kupferman to borrow moneys from Franklin and loan the money to Arnold and Fowler.
Bankers, again, was totally unaware of this.
Bankers was not privy to any of these transactions with Mallis and Kupferman.
On the morning of March 3, Mallis and Kupferman went into the offices of Franklin National Bank in the suburbs.
They signed the necessary documents.
Then, Mallis was told by Murfet “no need to be present.”
He expected the transaction to be paid by a sale of 100,000 shares of Merck and Co. stock.
The pledged transaction was a usurious contract because Dr. Mallis, at the time he loaned these gentlemen $156,000, was going to make “a profit of of $50,000 within 30 days.”
Arithmetically computed that comes to 383%.
This was raised by Mr. Fowler in the State Court action.
The critical fact here is that no one alleges that Bankers Trust nor any of its representatives including its attorneys did anything either by action or non-action until the closing on the afternoon of March 3.
Bankers did not introduce Kates to Arnold and Fowler.
Bankers did not even know the existence of Mallis and Kupferman until after the closing and the beginning of these lawsuits.
Justice John Paul Stevens: Mr. Weiner, would it make any difference if the bank had introduced the parties or known all these details?
Would that have any relevance to the legal issue?
Mr. Jack H. Weiner: It does not have any real relevance to the issue.
Justice John Paul Stevens: Then why do we dwell on those facts?
Mr. Jack H. Weiner: But they go to the “in connection with.”
Justice John Paul Stevens: They go to whether or not “in connection with” the fraud, is that not it?
Mr. Jack H. Weiner: Yes, in connection with arguments.
Justice John Paul Stevens: Do we not, for purposes of our decision, have to assume that Bankers Life committed some kind of a fraud but it is not in connection with the sale of this here?
Mr. Jack H. Weiner: That is correct, sir.
Bankers’ only function at the collateral was to return collateral to its debtor, Kates, upon repayment of the indebtedness as it was required to do under the New York Uniform Commercial Code.
At the closing, Arnold asked Kates for an affidavit on behalf of the respondents, Mallis and Kupferman.
On the basis of information furnished by Fowler, he knew that there was a problem between Equity National, Kates, and Arnold.
Fowler had contacted the President of Equity National and he told Arnold of this.
That is in the deposition in the State Court which we just obtained.
Arnold accepted an affidavit from Kates saying that there were no restrictions.
At that time, Bankers had not knowledge with respect to these transactions.
The stock was redeemed by Mr. Kates and it was returned to the Kates’.
Indeed, at the closing, a check was offered to Bankers Trust Co. made payable to Bankers Trust Co. and Kates.
Bankers Trust Co. refused to touch that check because Bankers Trust said “I am not privy to any of these transactions.”
Eventually, a State Court of action was instituted against Bankers.
That action was dismissed.
The court there said that how could Bankers be liable when they did not know these people and had nothing these people.
At the same time that action was dismissed, a suit against Fowler and Arnold who were still part of that action alleging a breach of contract as well as fraud.
Fowler and Arnold instituted third party actions on the breach of contracts against Bankers.
These actions are still pending in the State Court.
Indeed, the deposition of Mallis by Bankers is now scheduled for February 1, 1978.
This is clearly an analogous situation to the Blue Chip case and Bourbon whereby there is a remedy in State Court, the cases are still pending in the State Court, and there is no need for 10b or 10b5 in this situation.
It is our position that a pledge of stock is not a sale within the meaning of the Act.
The plain language of the Act in Blue Chip Stamps and Hawk Felder, as pointed out by this court there, stated that since we are dealing with a judicially created right the court must construe the statute narrowly.
The statute requires that there would be a purchase or sale.
A pledger of stock is not a seller of stock.
All right, title, and interest remain in the pledger.
The pledger has the right to the dividends.
He has all voting rights.
Any increase in value of the stock remains in the pledger.
He has the right to dispose off the securities when and to whomever he wishes.
A pledge is merely a security interest.
The Pledgee, as his bankers, must act in accordance with the law.
The Uniform Commercial Code very carefully defines the duties and obligations of a pledgee in that situation.
Justice Potter Stewart: Mr. Weiner, when you talk about the Act I take it you are talking about the Securities Exchange Act of 1944.
Mr. Jack H. Weiner: That is correct, sir.
Justice Potter Stewart: I looked at the complaint and the action seems to have been brought out of the Securities Act of 1933.
Mr. Jack H. Weiner: The action was originally instituted under the Securities Act of 1933.
In fact, they even assert in that that the only obligation of Bankers was to return the collateral to Mr. Kates.
Subsequent thereto, there were various attempts to amend the complaint and they attempted to amend the complaint by making numerous affidavits to Judge Pollack.
Judge Pollack treated these affidavits as if they were a part of an amended complaint and treated this as if it were an action under the 1934 Act and Rule 10b5.
That is how it proceeded from Judge Pollack to the Court of Appeals.
Justice Potter Stewart: It is clear now all around that this is a complaint under the 1934 Act.
Mr. Jack H. Weiner: That is correct.
We are litigating it as --
Justice Potter Stewart: And Rule 10b5.
Mr. Jack H. Weiner: And Rule 10b5.
Justice Potter Stewart: Promulgated under that statute.
Mr. Jack H. Weiner: Yes.
Justice Potter Stewart: The complaint does not indicate that.
Mr. Jack H. Weiner: I know it does not.
Justice Potter Stewart: Mr. Weiner, do you contend there is a difference in the meaning of the word “sale” between the ’33 Act and the ’34 Act?
Mr. Jack H. Weiner: Yes, there is.
There is a very plain difference, sir.
The sale in the ’33 Act is much broader than it is in the ’34 Act.
Justice John Paul Stevens: They use the word “pledge,” does it not?
Mr. Jack H. Weiner: No, it does not.
They say “otherwise disposed of an interest for value.”
We would prefer that that Act also be construed as not including a pledge.
Justice John Paul Stevens: It is pretty hard to do so, would it not be?
Mr. Jack H. Weiner: Pardon?
Justice John Paul Stevens: It is pretty hard not to say a pledge is a disposition of an interest in the securities.
Mr. Jack H. Weiner: The SEC, Allan Troop, the general counsels, and it was cited in our brief, refer to that definition, and they indicate that a pledge was not a sale for purposes of the 1933 Act.
Justice Potter Stewart: In any event, we are dealing here with a ’34.
Mr. Jack H. Weiner: We are dealing with the ’34 Act, sir.
Justice Potter Stewart: And Rule 10b5 promulgated there under.
Justice John Paul Stevens: There is no statutory definition of sale, is that right?
Mr. Jack H. Weiner: There is none in the Act, sir.
It is just sale and purchase.
I am saving time for clearinghouse.
As this court has stated in its recent decisions in Santa Fe, Piper, Blue Chip Stamps, Congress in enacting the 1934 Securities Act did not intend to create a federal commercial law.
Congress merely intended to regulate the sale and purchase of securities as an investment.
Congress did not intend to get involved with lending the commercial paper situation in this area.
Indeed, if we would broadly construe purchase for 10b5 purposes, as sought by the SEC and as found by the Second Circuit, would render an unmanageable flood of litigation.
Whenever a loan goes into default, the debtor pledgee frequently would utilize any source to avoid and delay repayment of an obligation because, as this court is aware, the federal laws are very extensive with respect to discovery, and summary judgment is more difficult to get in the Federal Courts than it is in the State Court action.
Federal Courts have a sufficient burden to handle litigation which is properly before it.
They should not be and do not need to be involved in extensive litigation which is properly the subject of State Court action.
As the SEC and Mallis assert, anytime a transaction touches securities the transactions will be subject to the Federal Courts and the scope of 10b and 10b5 will be extended far beyond what Congress intended.
Congress plainly did not intend to include as part of the securities laws the release of collateral from a pledge.
Although, as Justice Stevens asked, we do not believe that there was any misrepresentation and there was no purchase.
Nonetheless, before an action can be instituted the plaintiff must satisfy the statutory requirement in connection between the alleged misrepresentation and the purchase or sale.
There must be a nexus or causation between the defendants and the plaintiff.
In this case, there was no such nexus.
Bankers did not know of their existence.
Bankers accepted the pledge of collateral on August 1970.
Its customer redeemed the collateral on March 3, 1972.
The contract had been entered into to purchase the collateral on February 26 and everything had been locked in long before there was any participation of Bankers at the closing.
There is no possible way of imposing upon Bankers a duty to make any disclosure when it did not even know these people’s existence.
Bankers was only a passive participant in a transaction organized by Arnold and Mallis.
The Court of Appeals sought to place a connecting link by finding that Bankers was a seller by the release of the collateral and Mallis and Kupferman purchasers by virtue of the acceptance of the pledge.
But, this finding skips two intervening transactions.
Bankers release the collateral to Kates.
Kates had sold the stock to Arnold and Fowler.
Arnold and Fowler may have pledged the stock to Mallis and Kupferman.
There was no real connection in this situation.
A bank’s release of a collateral to its debtor is plainly no representation of the value of the collateral to any third party nor of its bona fides to any unknown third party.
As Judge Cardosa stated in Moris and recognized by this court in Blue Chip Stamps and Hawk Felder, to hold Bankers Trust liable in this case would be to extend liability in an indeterminate amount for an indeterminate time to an indeterminate class.
Congress did not so intend to expand the securities laws.
Chief Justice Warren E. Burger: Do I correctly read the Second Circuit opinion as relying on cases that arose chiefly under the ’33 Act rather than the ’34 Act?
Mr. Jack H. Weiner: That is correct, sir.
Chief Justice Warren E. Burger: Where there is a much broader definition of sale.
Mr. Jack H. Weiner: That is correct, sir, but the gentile and guilt going for both ’33 Act cases.
They were both enforcement actions.
In fact, this court in National Securities stated that there is a distinction between a 10b5 action and enforcement action.
That is what the Second Circuit did.
Chief Justice Warren E. Burger: Mr. Warden?
Argument of John L. Warden
Mr. John L. Warden: Mr. Chief Justice and may it please the court.
The principle proposition that is decisive of this case is the fact that the words “purchase” and “sale” used in the 1934 Act are ordinary words and, under the teachings of this court, must therefore be accorded their commonly accepted meanings.
Those commonly accepted meanings do not include pledge transaction.
That is, the pledging of securities or other property or the release of a pledge.
Purchase and sale involve the transfer of ownership for consideration.
A pledge does not transfer ownership or a general property interest in the pledged property.
I might say, at this point in response to Mr. Justice Stewart’s question earlier about statutory definition that does include pledge that is in the Public Utility Holding Company Act of 1935.
It's inclusion there, we submit, shows that when Congress wants to impose upon a common word such as purchase or sale, an artificial or special meaning to avoid repetition lengthy number of terms and in order to achieve the purposes of a statute, it knows perfectly well how to do so.
There is no indication in the legislative history or otherwise that either the 1933 Act or the 1934 Act was intended to regulate credit transactions in the ordinary course of business on a face-to-face basis.
As Professor Loss has pointed out in criticizing even the Gil Films decision, under the ’33 Act, federal law was not required to deal with the individual loan transactions.
What Congress was concerned about was the regulation of primary and secondary public securities markets of this country.
The statutes as drafted, of course, cover personally negotiated purchases and sales, a point made by the SEC in its brief.
That is quite true.
The statute as drafted both of them do cover that.
That indicates that Congress did no attempt to draw the line between public trading insecurities and private purchases and sales of securities.
But, it did deal with purchases and sales, not with regulation of credit transactions.
The Court of Appeals and the SEC, in its brief, have suggested that the ordinary meaning of purchase and sale should be disregarded because of the statutory definition which says sale includes a contract to sell or otherwise dispose off.
There is nothing in the legislative history that indicates that the addition of the words “or otherwise dispose off” was intended to take away the very core of the meaning of the word “sale.”
In fact, as we pointed out in our brief, a strict definition of the word “sale” as obtained at that time involved the transfer of ownership for a price paid in money.
The words” and otherwise dispose off” extend the definition of the word “sale” to an exchange or barter transaction or, as this case held in SEC against National Securities, a statutory merger where there is, in fact, an exchange of ownership but not for consideration in money.
To attempt to read anything more into those words, without any warrant in the legislative history is to engage in construction by speculation.
Justice Potter Stewart: Do you think there has to be a transfer of title, so to speak, or transfer of ownership?
Mr. John L. Warden: Mr. Justice Stewart, I think that it would probably be sufficient if there were a purchase and sale in the ordinary informal sense.
That is, if I said to someone “I will sell you a part interest in the 100 shares of General Motors that I own” and he said “fine, I will pay $1,000 for that,” and I took it.
I think that would be a purchase or sale within the meaning of the statute.
I do not think that transfer on the books of the transfer agent or turning the shares and to get 250 share certificates would be required.
Justice Lewis F. Powell: Mr. Warden, what about the phrase “in connection with”?
Mr. John L. Warden: Well, Your honor, I do not think that anything that was done or alleged to have been done by Bankers Trust in this case is in connection with the transaction of which the plaintiffs complain.
That transaction, as Mr. Weiner pointed out, was entirely arranged before this closing occurred in the offices of Bankers Trust.
I might point out that that as one of the aspects of the case it is a very serious concern in the banking community, because it is quite a common thing for banks which, after all, maintain conference rooms for the purposes of closings to afford the use of those rooms to their customers for the conduct of transactions.
If that brings one’s activities into disputes that otherwise do not involve the bank, what you have is an inhibition on a bank’s banking facilities available to people which does not include the public interest in any way.
Justice John Paul Stevens: Mr. Warden, is that quite correct?
I understood Mr. Weiner to agree that we must assume that the bank is charged with a fraud here and we have to accept that for the case.
That is something more than making a conference room available, is it not?
Mr. John L. Warden: It is not quite clear from reading this record.
I happen to agree with Justice Stewart that the facts of this case are rather hard to understand.
Justice John Paul Stevens: If there is no fraud we do not have objectify it.
Mr. John L. Warden: It is not quite clear.
What it is that supposedly constituted that misrepresentation or how it was in connection with the transaction of which these plaintiffs complain, Mr. Justice Stevens, and that it is clear from the facts, and there are more facts here than there are in most motion to dismiss situations and there are a lot of affidavits, and there was a State Court record that the transaction was entirely arranged by the Kates’ with Fowler and Arnold.
Fowler and Arnold found these plaintiffs and the Bankers Trust Co. had never heard of.
Then, the closing occurs and it is alleged that some unknown misrepresentation was made at that closing.
But, the closing was a ministerial proceeding.
Justice John Paul Stevens: Is it not alleged and do we not have to assume it for the purpose of the decision it may not be proved ultimately that, at the closing, Bankers Trust made a fraudulent misrepresentation?
We have to assume that for purposes of decision.
Mr. John L. Warden: That is what the Court of Appeals decision says.
Justice John Paul Stevens: That is different than just making a conference room available.
Mr. John L. Warden: That is what the court ruled, no but I think that does indicate Your Honor, you are quite right.
That is what the Court of Appeals decision says and this court must assume it.
But, I do not think that is entirely different than the point I was making because talk of that kind is pretty cheap and once they are in the conference room and these transactions occur and instruments are passed across the title, it is very easy for someone to allege, in this allegation by the way, three years after the State Court complaint was dismissed, the allegation of misrepresentation made in this case is made on information.
Three years after their case have been thrown out of the State Court.
Justice John Paul Stevens: Mr. Warden, it may be a very weak case but it has nothing to do with the legal question we are supposed to decide.
Mr. John L. Warden: Proceeding from there, we do have to decide whether the misrepresentation was in any way “in connection with.”
What is that misrepresentation and how could it be “in connection with?”
Either Bankers Trust would have to be considered a seller, and the Court of Appeals handled that problem by saying that the release of the pledge is a sale and with no further explication at all and all the release of the pledge is a performance of a duty imposed on the bank by law on the payment of the loan, or somehow there would have to be a finding that Bankers Trust was an aider and abettor in this court as expressly reserved in Blue Chip Stamps the question of whether there is any civil liability for aiding and abetting under 10b5.
One of the other of those bridges would have to be crossed in order to make this misrepresentation that this court must assume existed, and I quite agree.
Chief Justice Warren E. Burger: But are all those matters that were to be resolved in a later stage in the proceeding as Justice Stevens suggested?
Mr. John L. Warden: Your honor, I think that they are both questions of law.
Whether a release of a pledge is a sale under 10b is a question of law.
I submit the answer to that is no, it is not.
Whether there is civil liability for aiding and abetting under 10b5 is a question of law.
Then, if that question is answered in the affirmative, the plaintiff would be free to attempt to prove the aiding and abetting.
Chief Justice Warren E. Burger: In other words, what you are saying, I take it, is that if the Court of Appeals had read the 1934 Act definitions they would have arrived at these results as a matter of law.
Mr. John L. Warden: That is correct, your honor.
Chief Justice Warren E. Burger: And they would not have to dealt into the facts.
Mr. John L. Warden: That is correct, Mr. Chief Justice.
It is our position that these statutes on their face and in the history were not passed to regulate credit transactions and that a loan, whether or not secured by stock or other property, remains a loan and is not, as the SEC contends, an investment in securities.
Chief Justice Warren E. Burger: Mr. Hauser?
Argument of Noel W. Hauser
Mr. Noel W. Hauser: Mr. Chief Justice and may it please the court.
As counsel to the respondents, I have agreed to share my argument time with the General Counsel to the SEC and he will generally argue that a pledge of stock is the equivalent of a sale for the purposes of the Securities and Exchange Act of 1934 and that, therefore, the respondents have standing as pledgees to sue.
The appellants, it seems to me, have spent most of their argument time in arguing against the position taken by the SEC in their brief amicus curiae to this court.
I, on the other hand, represent some people who are out $156,000 as a result of what I consider to be egregious fraud.
In view of the fact that some of the members of the court apparently have had some problem in obtaining the facts from this record which comes about because Judge Pollack dismissed the complaint before any discovery and even in advance of a motion to dismiss.
Justice William H. Rehnquist: He denied lease to amend, did he not?
Mr. Noel W. Hauser: He denied lease to amend.
He refused no opportunity to discover any facts which would allow the opportunity to discover the jurisdictional basis.
Justice William H. Rehnquist: You cannot file a motion for discovery until you have received permission to file your amended complaint.
Mr. Noel W. Hauser: That is correct.
Justice William H. Rehnquist: And he denied lease to amend.
Mr. Noel W. Hauser: He denied that lease.
Justice William H. Rehnquist: So you cannot complain about the lack of discovery.
Mr. Noel W. Hauser: Well, I can complain about it in this respect.
In Woodward against the Bank of Dallas, which is cited by the briefs by the parties to this court, the District Court in a similar pledge situation held and held twice before the trial that dismissal in a pledge situation of a 10b5 case would be premature because the plaintiff might be able to prove enough facts to spell out the requisite standing to sue as required by Rule 10b5.
Eventually, when the case did reach the Fifth Circuit, I think it was, the court dismissed the complaint but not on the basis that there was not any jurisdiction.
They expressly found there was jurisdiction where stock had been pledged to a bank, dismissed it on the ground that the bank’s knowledge of what had occurred with respect to a fraud was insufficient to impose liability upon them.
We would deny that opportunity.
Justice Thurgood Marshall: Coming back to this gigantic fraud and all you are talking about, how much of that is involved in the litigation now pending in the New York State torts?
Mr. Noel W. Hauser: The amount that the plaintiffs are out at this time is $156,000 plus five years interest.
As regards to their action in the State Court, it has been dismissed against Bankers Trust Co.
They have no claim against Bankers Trust Co. now.
The only thing they have is a claim against the so-called buyers of record are Arnold and Fowler for deceit, breach of contract, malpractice, whatever else they could think of.
Those parties in their turn have asserted a third party claim against Bankers Trust Co.
But, the plaintiffs do not have Bankers Trust Co. as a direct defendant of that action.
There were restrictions on the transferability of the stocks in question and they were spelled out on the certificates themselves.
They are made a part of the record of pages 34 and 38.
Bankers was advised by hand-delivered letter from the issue of the Securities Equity National Industries in March of 1971 that these stocks were worthless.
At that time, they held the stock as collateral having received it from Jerome Kates.
They received a second letter from the issuer in April of 1971.
They knew they were in trouble with this stock in Kates because they went so far as to reduce their claim to judgment on July 20, 1971.
Justice William H. Rehnquist: When you said they knew they were in trouble, do you mean they knew the pledge they had taken as security was very likely worthless.
Mr. Noel W. Hauser: Absolutely.
I do not think it is a common experience on the part of banks which have made loans to reduce their claims to judgment where they hold collateral.
But, in this case, they did so.
On July 20, 1971, judgment was entered in favor of Bankers and against Jerome Kates and Judith Kates who had pledged the stock to the bank.
In February of 1972, the issue commenced an action in the District Court.
On March 3, 1972, a closing took place.
Bankers says, and there is no support for it in the record, that they were served with a summons and complaint in the action which had been filed a month before in the District Court on March 10th 1973 one week to the day after the closing.
In a State Court action, they thereafter made the representation to the court that they believed on the closing that the stock was valuable.
They certainly made that same representation in the closing room when my clients through a representative of the Franklin National Bank expended the sum of $156,000.
Justice John Paul Stevens: Is that in the record?
Mr. Noel W. Hauser: Yes.
Justice John Paul Stevens: The fact that they made a representation or is it just alleged?
Mr. Noel W. Hauser: The plaintiffs have an affidavit as part of the record.
It appears as part of the record that an affirmative representation was made by a representative of the Bankers Trust Co.
I understand that this court is not bound by facts which are not on the record.
But, for whatever it is worth, I can make the affirmative representation that I have an affidavit of my own file to that effect.
Justice John Paul Stevens: Is there affidavit in the record?
Mr. Noel W. Hauser: The affidavit was not obtained until after the record was filed in this court.
Justice William H. Rehnquist: You mean their affidavit was not before Judge Pollack?
Mr. Noel W. Hauser: The plaintiffs’ affidavit was before Judge Pollack.
Justice William H. Rehnquist: The plaintiffs’ affidavit was before Judge Pollack.
Mr. Noel W. Hauser: Yes, it was.
Justice Lewis F. Powell: Is it now included?
Mr. Noel W. Hauser: It is included in the record to this court.
Justice John Paul Stevens: Does that include a representation about the Bankers Trust representation?
Mr. Noel W. Hauser: Do you mean, in the complaint which we were not allowed to amend?
The answer is no.
Justice John Paul Stevens: No, but the affidavit, that was before Judge Pollack?
Mr. Noel W. Hauser: Yes, the affidavit alleges that affirmative representation.
Justice William H. Rehnquist: Where is that?
Mr. Noel W. Hauser: Page 110.
Justice John Paul Stevens: This was before Judge Pollack?
Mr. Noel W. Hauser: Yes, sir.
Yes, page 110.
Justice John Paul Stevens: What does it say?
What are you referring to?
Mr. Noel W. Hauser: I will quote the language exactly.
“We are informed by our attorneys and believe that we have a good meritorious cause of action against the defendants, Federal Deposit Insurance Corporation, European-American Bank, as well as Franklin National Bank.”
I will skip down to b: “against Bankers Trust Co. which withheld vitally material information from us and our representatives and, as we are informed, actually misrepresented that the securities in question were genuine when, in fact, they were not.”
Justice Thurgood Marshall: Told by whom?
Mr. Noel W. Hauser: By the representative.
Justice Thurgood Marshall: It would not help me at all because I do not know a thing from here.
We started off with “we are informed” and we ended up with “we are informed.”
Mr. Noel W. Hauser: “Bankers Trust Co. withheld vitally material information from us and our representatives.”
Justice Thurgood Marshall: I understood you to say that there was an affidavit which said positively that Bankers Trust said that this was good.
Mr. Noel W. Hauser: Yes, sir.
Justice Thurgood Marshall: Where is that here?
Mr. Noel W. Hauser: Right here.
Justice William H. Rehnquist: That is an information.
Mr. Noel W. Hauser: Yes, it is.
Justice William H. Rehnquist: That is no good.
Mr. Noel W. Hauser: We were denied the opportunity, as I mentioned before, to amend our complaint so as to affirmatively allege it.
We have not had that opportunity.
There are three reasons why this court should affirm the Second Circuit’s decision.
In the first place, it is not at all clear whatever the plaintiffs may have understood this transaction to have meant to them.
They say that they were lenders.
They understood that they were lenders.
But, the only document in the record which indicates what their relationship with was with Arnold and Fowler appears at page 49 of the record.
I would call Your Honor’s attention to the language of the letter.
“Your participation in the purchase,” says Mr. Arnold to Mr. Mallis, “your advance of 156,000 toward the purchase price,” “your participation in the trade,” “your investment,” and finally, “you will be reimbursed.”
A loan presupposes that it will be repaid.
But, nowhere in that letter does it say by whom.
I do not think that any member of this court would grant summary judgment against Arnold or Fowler on the theory that he received a loan from Mallis or Kates.
It seems to me that if they did not borrow the money that neither Mallis nor Kates was a lender, and I think it is too early to conclude what their position was, certainly it can conclusively assume that they were lenders rather than participants in the trade.
Let us assume for a moment that they were lenders.
If, as this court has said, the starting point for the determination of standing to sue under the Rule 10b5 is the statute and the statute says that a fraud made “in connection with” a sale is the trigger for a 10b5 liability.
Of course, there was a sale here.
The reason that the case is perhaps a little confusing is because it is sandwiched in between the release of one pledge and the creation of another pledge.
But, the pledge to Mallis and Kupferman was simultaneous with the purchase by Arnold and Fowler if, indeed, they were the purchasers.
I draw your attention to the fact that Arnold, when he signed the purchase agreement, signed it as attorney.
That is in a representative capacity.
Now, there could have been no sale except for the fact that Mallis and Kupferman came with the money through their representative, of course, to a closing.
At the closing, their money was expended and the sale took place.
Justice Lewis F. Powell: Mr. Hauser, this sale you are describing now is a sale from Kates.
Mr. Noel W. Hauser: Yes, exactly right.
Justice Lewis F. Powell: Not from Bankers Trust?
Mr. Noel W. Hauser: No.
Justice Lewis F. Powell: That is right.
Mr. Noel W. Hauser: Not from Bankers Trust.
I do not claim that Bankers Trust was a seller.
Justice John Paul Stevens: You do not claim that the release of the pledge was a sale then?
Mr. Noel W. Hauser: I do not believe that the mere release of a pledge is a sale, no.
Justice John Paul Stevens: So you do not say Bankers Trust was a seller.
Mr. Noel W. Hauser: I do not believe that Bankers Trust was a seller.
I do not believe that.
Within the meaning of the Act, I do not believe that they were the seller.
The next question is were the plaintiffs connected.
They advanced at the closing 86% of the purchase price of this stock and they received at the closing all of the things sold.
They were more connected than Arnold was because Arnold put up less than 24% of the purchase price.
There could have been no sale without the use of their funds at the closing.
They were directly and intimately connected with the sale.
To say that they were not imposed upon “in connection with,” in the words of the statute, a sale is to make a mockery of what the statute calls for.
Chief Justice Warren E. Burger: Does the Second Circuit opinion seem to be in some disagreement with you on whether the release of the pledge is a sale or with Bankers Trust?
Mr. Noel W. Hauser: Yes, I do not think that to the extent that the Second Circuit said that the release by Bankers of the pledge was a sale of stock, I do not think that it was necessary to their decision. I think that all of that was required.
Justice John Paul Stevens: Do you think they thought it was?
Mr. Noel W. Hauser: Do I think they thought it was a sale?
Justice John Paul Stevens: I know but do you think they thought that holding was essential to their decision?
Mr. Noel W. Hauser: I do not think so.
I think that the decision would have been the same way strictly on the basis of a finding that the plaintiffs were buyers within the meaning of the statute.
Justice John Paul Stevens: This release was in connection with the sale?
Mr. Noel W. Hauser: Yes.
Justice William H. Rehnquist: Your position then is that a fraudulent representation by someone who himself is not a seller is actionable under 10b5?
Mr. Noel W. Hauser: Absolutely.
Justice John Paul Stevens: But it is necessary that for you to claim, and for us to agree with you, that a pledge is a sale.
Mr. Noel W. Hauser: No, I do not think so.
Justice John Paul Stevens: Because you say there was a sale that took place here and then this release was in connection with the sale.
Mr. Noel W. Hauser: Right, I say that if the sale occurs at the identical time as does the pledge, the pledge is in connection with the sale.
You cannot have a sale without a pledge.
Justice John Paul Stevens: How do you view the question whether a pledge is a sale?
Mr. Noel W. Hauser: How do I view whether a pledge is a sale?
Justice John Paul Stevens: Is a pledge a sale or not?
Mr. Noel W. Hauser: I do not think that it is necessary.
Justice John Paul Stevens: You disagree with the Court of Appeals again.
Mr. Noel W. Hauser: I do not disagree with the Court of Appeals on that.
I do not think that it is necessary to reach that conclusion as to whether every pledge ipso facto constitutes a sale within the meaning of the Securities and Exchange Act.
Justice William H. Rehnquist: You would not suggest the Court of Appeals did not think it was necessary for its decision to hold that a pledge was a sale?
Mr. Noel W. Hauser: I do think that the Court of Appeals so thought.
Justice John Paul Stevens: But you do not necessarily defend that conclusion?
Mr. Noel W. Hauser: I do not necessarily defend that conclusion.
I do know that somehow somewhere, I do not know exactly when, where fraudulent securities are pledged to a pledgee, I know that somewhere there comes a time that the pledgee has standing to sue for a violation of Rule 10b5.
Mr. Justice Rehnquist asked a question during the course of Mr. Weiner’s argument, what would happen if a note was given and stock given back in exchange.
My time is up.
Justice William H. Rehnquist: I would be interested to hear what you would say.
Mr. Noel W. Hauser: And Mr. Weiner responded that there would not be any answer, that there would be no occasion to go to 10b5 remedy.
But suppose, for example, that the note itself was a forgery and the fellow had sent along his collateral and now denied liability although conceding that he had signed the stock for whatever purpose.
The bank would be foreclosed from suing on the debt, but they would not be foreclosed from suing under 10b5 and it is not a farfetched possibility.
Justice William H. Rehnquist: Your position, I take it, is that you can rely on the sale from Arnold to Mallis and the misrepresentation made by Bankers Trust was in connection with the sale.
Mr. Noel W. Hauser: Positively.
Justice John Paul Stevens: That would protect the new pledgee or not?
Could the new pledgee recover too?
Mr. Noel W. Hauser: Yes.
The plaintiffs are the new pledgee.
Justice John Paul Stevens: Yes, I know.
But they are not the buyers.
You said that you do not need to hold that they are buyers at all.
Let us assume that they are not buyers, that a pledge is not a sale or a purchase.
The new pledgee is not a buyer and he did not get the stock from a seller.
Bankers is not a seller either, but it makes a misrepresentation connection with a sale.
The new pledgee can recover?
Mr. Noel W. Hauser: Yes, I say that the sale as to which the pledgee generates with the use of his funds is sufficient to supply the statutory requirement of “in connection with” a sale.
Justice John Paul Stevens: That certainly is not the theory of the Court of Appeals, is it?
Mr. Noel W. Hauser: No, I do not think it is.
Chief Justice Warren E. Burger: Mr. Pitt?
Argument of Harvey L. Pitt
Mr. Harvey L. Pitt: Mr. Chief Justice and may it please the court.
Chief Justice Warren E. Burger: Do you think, Mr. Pitt, the Court of Appeals opinion stands independent of the analysis we have just been discussing?
Mr. Harvey L. Pitt: I think that the analysis of the Court of Appeals with respect to a pledge being a sale is correct.
We take no position on whether the release of the stock with respect to a natural fulfillment of the pledge agreement is a sale for purposes of the Act and, as the petitioners themselves argue, that was irrelevant.
Justice John Paul Stevens: You think the Court of Appeals did not need to say that?
Mr. Harvey L. Pitt: I think that the opinion stands analytically without that holding.
It may well be that some of the judges on the Second Circuit were concerned about finding a completed transaction, a sale and a purchase, but I think, as our brief attempts to demonstrate, analytically there was a sale with respect to the pledge transaction.
Justice John Paul Stevens: Do you think then there is very little chance that if we were to disagree with the Court of Appeals on whether a release is a sale, there is very little chance that if we remanded it to them they would come out any other way than they did?
Mr. Harvey L. Pitt: I would agree with that.
I would also say, at this juncture, that our concern is not with the release of the securities after a pledge transaction although there is a conceivable possibility that in some circumstances fraud may be induced in the holder of the collateral and that might be actionable.
Justice John Paul Stevens: In your view, Bankers liability rest on finding if they made a misrepresentation it was in connection with the sale, not that they were a seller.
Mr. Harvey L. Pitt: That is correct.
I think that we have gotten away from privity and Mr. Rehnquist’s decision in Blue Chip Stamps case this court specifically referred to the fact that 10b5 has gone light years away.
Justice John Paul Stevens: What sale do you say their release was in connection with, the new pledge?
Mr. Harvey L. Pitt: If I may, your honor, not the release, the sale occurred when Arnold and Fowler pledged their stock to Mallis and Kupferman and Bankers Trust affirmatively made a misrepresentation to these plaintiffs.
Justice John Paul Stevens: So it is in connection with the new pledge that you say they made a misrepresentation.
Mr. Harvey L. Pitt: That is correct and that is all this court need to focus on, except in so far as it may be concerned about the motivation of Bankers Trust as is alleged in the pleadings in the courts below.
Justice Potter Stewart: So we are not talking here at all about the pledge by Kates to Bankers Trust nor the release by Bankers Trust of the collateral.
Mr. Harvey L. Pitt: Definitely not.
We are talking solely about the pledge from Arnold and Fowler to Mallis that was induced by Bankers Trust’s affirmative misrepresentation as alleged in the papers in this court proceeding.
Justice Potter Stewart: Again, that is quite a deviation from the Second Circuit’s reasoning, is it not?
Mr. Harvey L. Pitt: Pardon?
Justice Potter Stewart: Is this not quite a deviation from the reasoning of the Second Circuit?
Mr. Harvey L. Pitt: Your honor, that is precisely what the Second Circuit was holding with respect to that side of the transaction.
Justice Potter Stewart: That is the pledge.
Mr. Harvey L. Pitt: That is the pledge.
The Second Circuit also felt it appropriate.
Justice Potter Stewart: That the release to Kates by Bankers Trust of the collateral was a sale, it said that.
Mr. Harvey L. Pitt: But, analytically, once Bankers Trust was satisfied as to the legal terms of its contract with Kates.
It is arguable that that release should not be deemed a sale.
That is not of concern in this case and that is not an issue we think that is before this court.
Justice Potter Stewart: Then we have now a third theory to support 10b5 liability, i.e. that Bankers Trust’s made a misrepresentation in connection with a sale from 'a' to 'b', Bankers Trust being x'.
That is the theory that was just passed by your brother, as I understood.
Mr. Harvey L. Pitt: If I have given the impression that there is yet a third theory then I must apologize.
Justice Potter Stewart: It is not you.
It is your brothers, I say.
Mr. Harvey L. Pitt: I believe that the theory that we have espoused is wholly consistent with the Second Circuit’s decision.
Justice John Paul Stevens: I do not say that we do not have before us the question of whether a release of a pledge is a sale.
The Second Circuit said it was and, if that were sustainable, you might get one result in this case and if it was not, you might get another.
Mr. Harvey L. Pitt: Analytically, I would submit that that is irrelevant to the decision and I would like to explain why.
Justice John Paul Stevens: I know you already submitted it.
Mr. Harvey L. Pitt: I would like to explain why if I may.
The fraud occurred in connection with a misrepresentation made to Mallis to pay over funds sufficient to accomplish the purchase and upon which he was induced to rely on the investment value of the securities that served as collateral for the loan transaction.
If there was fraud, as this court must assume based on the procedural posture of this case, then Mallis and Kupferman in taking the stock were defrauded based on the investment value of that stock.
It matters not that prior to that transaction, Bankers Trust released the stock to Kates so that Kates could give it to Arnold and Fowler.
That is really irrelevant to the fraud in this case.
Justice Thurgood Marshall: Mr. Pitt, Bankers Trust on the paragraph on page 110, do you have anything more than that to show its implication or are you also relying on this one paragraph about the informants?
Mr. Harvey L. Pitt: We are relying on 110 as I understand it.
Justice Thurgood Marshall: And what else?
Mr. Harvey L. Pitt: No, on 110 as to the affirmative misrepresentations, yes.
Justice Thurgood Marshall: And what else?
Mr. Harvey L. Pitt: What else?
We are relying solely on the fact that, as a motion to dismiss, this could be pleaded on information and belief.
Justice Thurgood Marshall: All I am trying to get is that this is all you have.
Mr. Harvey L. Pitt: This is all, your honor.
Justice William H. Rehnquist: That is a denial of a motion to amend not a motion to dismiss, is it not?
Mr. Harvey L. Pitt: Your Honor, as I understand the procedures, what occurred here was that Judge Pollack instituted a motion to dismiss on his own suggestion and, in connection with that, refused to allow an amendment of the complaint.
However, in his decision dismissing the complaint, which is what he did, he indicated that he would deem the complaint most favorably alleged under Section 10b and Rule 10b5.
He effectively extrapolated all of the materials that are before this court and deemed it to be an amendment and still dismissed it.
But, he denied formal leave to amend the complaint.
Justice Potter Stewart: According to the Court of Appeals there was no judgment in the District Court.
Mr. Harvey L. Pitt: Except the motion to dismiss.
Justice Potter Stewart: A motion is not a judgment.
Mr. Harvey L. Pitt: I am sorry.
Except the dismissal of the action.
Justice Potter Stewart: They say every good case requires a mystery document.
In this case, the missing document is the judgment.
Mr. Harvey L. Pitt: That may be, Your Honor.
Justice Lewis F. Powell: Mr. Pitt, I take it from what you said that it would not have made any difference to your position whether there ever had been a pledge to Bankers on a release by Bankers.
Is that correct?
Mr. Harvey L. Pitt: No, although I think when this case was tried one of the allegations that the plaintiffs appeared to be making is that Bankers realizing it had a defective set of securities as collateral was anxious and deliberately misrepresented the value of that stock so that it could get out of its bad transaction.
In that sense, I think it might be relevant.
But of course that is speculation at this juncture.
Justice Potter Stewart: That goes to the merits of the case.
Mr. Harvey L. Pitt: That is precisely what we have been hearing to some extent, I must say, respectfully from my brothers.
Justice Potter Stewart: The question here is whether or not there was a purchase or a sale as within the meaning of the ’34 Act and 10b5.
As my brother Powell suggested, that question is wholly interdependent on whether there had ever been a pledge by a case to Bankers Trust.
Mr. Harvey L. Pitt: That is precisely our position.
Justice Lewis F. Powell: Bankers Trust could have held the securities in safekeeping, not having ever received them under a pledge.
Mr. Harvey L. Pitt: Analytically, that would not affect the allegation of fraud in this case.
I quite agree.
Indeed if I may assert what we think the issue is, we would assert that when a person is deceived into parting with money in exchange for an interest in securities, that is precisely the type of situation to which the federal securities laws anti-fraud protection were intended to apply.
Justice Lewis F. Powell: But there has to be a sale.
Mr. Harvey L. Pitt: There must be a disposition of an interest which is a sale.
That is correct.
Justice Lewis F. Powell: And the pledge by Arnold to Mallis and Kupferman was a sale under your theory.
Mr. Harvey L. Pitt: Yes, it was.
Justice Lewis F. Powell: May I ask this entirely?
I have interrupted you.
How long has the SEC taken the position you take here today that a pledge is a sale?
Mr. Harvey L. Pitt: We have taken that position since the late 1950s.
Justice Lewis F. Powell: Have you issued any release as to that effect?
Mr. Harvey L. Pitt: We have filed a number of lawsuits.
We have a number of cases which are set forth in our amicus brief before this court.
We have articulated that in certain cases.
We have exempted pledge transactions where they would otherwise be included within the definition of a sale.
Indeed, the petitioners take comfort surprisingly to us from our Rule 16a6 in which we specifically felt the need to exempt a pledge from the operative term “sale” for the purposes of that rule so as not to encompass those pledges in that special limited circumstance.
But, otherwise, we have taken this position consistently since the 1950s.
Justice Lewis F. Powell: Is there anything in the legislative history of either the Act of ’33 or ’34 that supports your position that a pledge is a sale?
Mr. Harvey L. Pitt: If there is something specific on pledges, I must confess, I am unaware of that.
Justice Lewis F. Powell: The hearings that led up to those Acts were very extensive and they dealt with all sorts of problems relating to securities.
I would be curious, I would have thought, not to have gotten into the business of lending money and putting up a collateral if congress had intended to deal with it.
Mr. Harvey L. Pitt: Your honor, I had occasion before coming here today to review our amicus brief and the Superintendent of insurance case where this court expressly held that not only shareholders but creditors were specifically within the intendment of the Securities Exchange Act protections for Anti-fraud.
In our brief, we did cite legislative history which was rather defused.
I cannot tell you that there were expressed references to pledged transactions.
But, it talked about the value of the securities held by banks, the value of securities held by insurance companies, the massive loans that were utilized.
I would point out to the court that Section 2 of the Securities Exchange Act talks about making and preserving the investment decision of investors reasonably complete and effective from anti-fraud provisions.
I do not think there is any question that the Securities Exchange Act covers any situation in which there is an investment tent and an investment interest.
I think it would be anomalous to suggest that when someone puts up $156,000 largely in reliance on the underlying value of securities and then takes the possession of those securities that that does not constitute an investment decision that this court, in National Securities, talked about in terms of the definition of sale and, in Blue Chip, talked about in terms of the limited coverage of some of the exemptions this court has applied more recently.
Justice Lewis F. Powell: Mr. Pitt, in that connection, this transaction is quite extraordinary.
It is very rare that private individuals lend this sort of money.
The Securities Acts were concerned primarily, I had thought, were protecting unsophisticated investors.
Here, we are dealing primarily with banks and lending institutions by definition, sophisticated investors.
The Acts certainly were not designed primarily to protect them.
I suppose you would agree with that.
Mr. Harvey L. Pitt: If I may, I have two responses to that.
First, of course, I guess this case is ample evidence of the fact that not only sophisticated investors find themselves in this position.
But, more importantly, I think this question and your prior question focus on what the legitimate concern of the Securities and Exchange Commission is.
That concern deals with the fact that when securities are pledged, the next step is that those pledged securities can be foreclosed upon.
They become distributed in the marketplace.
The enforcement actions we referred to have shown that organized crime and many individuals are using pledge transactions as a means to circumvent our rules.
Justice Lewis F. Powell: If foreclosed and if the securities have not been registered, they are subject to the provisions of the Act of ’33.
Mr. Harvey L. Pitt: Some of the cases we have had have had knowing schemes in that direction.
Banks may be participants and not just victims.
In addition, I think it fair to point out that although the banks this court has been faced with today assert that they would not like the protections of this Act, there are many cases in which banks themselves have sought the protections of Section 10b and Rule 10b5 in these kinds of situations.
There are smaller banks and there are larger banks but many of them, including the Exchange National Bank in a billion-dollar transaction in an opinion written by Judge Friendly recently, where the protections of Section 10b and Rule 10b5 were eagerly sought out by banking institutions.
Justice Potter Stewart: This bank is not planning about the protections of the Act.
The banks in this situation are going to be defendants, not plaintiffs.
Mr. Harvey L. Pitt: In this particular situation, I agree with Justice Powell that this is a very unusual situation where the bank is alleged to have made an affirmative misrepresentation.
I grant you the record is weak, and I grant you the fact that on trial, this case may not prove out at all.
That is not our concern at this juncture.
Justice Thurgood Marshall: I was told in pleading, when you plead something like fraud you would be as specific as you can.
Mr. Harvey L. Pitt: I was taught the same thing, your honor, and I wish this complaint had been more specific but I would hope.
Justice Thurgood Marshall: The difference is I stick to my teaching and you have left yours.
Mr. Harvey L. Pitt: I hope not, your honor.
I would suggest that if we are to make a statutory determination that can have far-reaching ramifications, not only for private litigants but for the government, the Commission in civil enforcement actions and the Justice Department in criminal actions that, hopefully, some poor pleading, if that in fact is the case here, will not upset an important statutory protection that we think needs -- .
Justice John Paul Stevens: Mr. Pitt, did I understand you to say to Justice Powell that there was not any case authority for you position?
Mr. Harvey L. Pitt: No.
If I said that, I apologize.
I thought I was asked whether there were specific references as to pledge transactions in the legislative history.
As to a specific reference to pledge transactions, I am not aware of any.
As to loan and credit agreements and the importance of providing the protections of the securities laws in this context, I think there is ample legislative history.
Some of it is cited in our superintendent of insurance amicus brief before this court.
I think this court’s decision in superintendent of insurance amply supports that conclusion, particularly footnote 8 on page 12 of the reported decision.
Justice John Paul Stevens: How long has the courts held that a pledge is a sale?
Mr. Harvey L. Pitt: Consistently with one minor exception since we commenced raising this issue which was started in late 1950s.
In the late 1950s, the Second, Fifth, Seventh, and Tenth Circuits have all acknowledged that pledges are sales.
Justice John Paul Stevens: Under the ’33 and ’34 Act?
Mr. Harvey L. Pitt: Under the both Acts.
In one case, I believe, the Fifth Circuit had an erroneous interpretation of a limitation as to when a pledge could be a sale.
But, it is my understanding that these circuits have held that, at least as to the ’33 Act, and I am not a sure but I think in one case as to the ’34 Act the Downum case that we cite in which we alleged the 10b5 violation that under the ’34 Act as well.
If I may, in that respect, this court has said in Mr. Justice Marshall’s opinion in National Securities as well as in the Hawk Felder decision that the interpretation of the ’33 and ’34 Act should be construed in para materia because they were both complimenting ends toward a comprehensive scheme of regulation of the nation’s securities trading activities.
Chief Justice Warren E. Burger: Thank you.
Rebuttal of Jack H. Weiner
Mr. Jack H. Weiner: I thought I had a few minutes left.
Chief Justice Warren E. Burger: Yes, you have about four minutes left.
Mr. Jack H. Weiner: Yes.
Your honor, Mr. Pitt referred to the phrase “interest” in definition of sale.
That is not in the 1934 Act.
That is in the 1933 Act.
The 1934 Act very clearly speaks about sale or other disposition thereof.
That is one point.
The second point that is important is that there is a substantial difference between buying stock to make a collateralized loan and making a collateralized loan.
The lending factor which we sought to stress earlier is based on the general credit of the individual.
They are not looking at the value of collateral.
The Gil Films case, which is the first time that the SEC really pushed the question as to whether or not a pledge was a sale, was in 1960.
Professor Loss refers to that case.
In that case, there was a sham transaction and it was not a pure bona fide pledge and they expanded the question therein.
Now, one of the factors that is really very, very important here is that a lot has been stated about what is beyond the record.
Subsequent, and I would like to clarify some facts which have just come to our attention as a result of the State Court action.
We have just completed the deposition of Mr. Fowler.
In this examination, Mr. Fowler makes it clear.
Number one, he was aware of the conflict and he and Arnold were fully aware of the conflict between Equity National Industries and the Kates’.
Justice Potter Stewart: That goes to the merits of this controversy.
Mr. Jack H. Weiner: Yes.
Justice Potter Stewart: That is no part of what is before us now, is it?
Mr. Jack H. Weiner: I recognize that, sir.
But, there have been numerous allegations totally without merit.
I would like this court to remember that.
Justice Potter Stewart: All we have is the pleadings.
Mr. Jack H. Weiner: That is correct.
Justice Potter Stewart: And all we have here is a fairly precise issue as to whether or not a pledge is a sale within the meaning of the ’34 Act.
Mr. Jack H. Weiner: And whether or not it was “in connection with.”
Justice Potter Stewart: What confused me was that you and your brief were talking about the pledge by Kates to Bankers Trust and the release of the pledge and the SEC is talking about quite a different pledge.
They are talking about the one that Arnold and Fowler had made to Mallis and Kupferman of the Equity National stock.
Mr. Jack H. Weiner: Because the Court of Appeals speaks about it.
Justice Potter Stewart: I know it does and that is what makes this case actually confusing.
But, the single issue is a rather precise one and has nothing to do with the merits.
Mr. Jack H. Weiner: And whether or not it was “in connection with” also.
That is a subsidiary question, also, your honor.
Chief Justice Warren E. Burger: Thank you, Gentlemen.
The case is submitted.