The opinion of the court was delivered by: GORBEY
Defendants have moved, pursuant to Federal Rule of Civil Procedure 12(b)(6), to dismiss the complaint on the ground that plaintiff, Trustee of the Estate of the debtor, lacks standing to bring this action.
This case is a civil action brought under § 6 of the Securities and Exchange Act of 1934, 15 U.S.C. § 78f and § 9(c) of the Securities Investor Protection Act of 1970, 15 U.S.C. § 78iii(c), the rules and regulations of the Securities and Exchange Commission, and common law principles.
The complaint alleges that the defendant PBW Stock Exchange, Inc. (hereinafter referred to as "Exchange") is a National Securities Exchange registered with the Securities and Exchange Commission, and it has filed with the Commission its rules and exchange practices which are required to be adequate to protect investors. The debtor was a member of the Exchange during the time relevant to the complaint, and in accordance with § 9(c) of the Securities Investor Protection Act, defendant Exchange had the responsibility for the examination of the compliance by the debtor with applicable financial responsibility rules.
The other defendants are members of the Business Conduct Committee of the defendant Exchange and are, therefore, charged with the duty of enforcing the Exchange rules concerning financial responsibility and § 9(c) of the Securities Investor Protection Act.
The first cause of action rests upon the allegation that, at the time the defendants became aware that the liability limit on the debtor's fidelity bond was $100,000 below the amount required by the rules of the Exchange, the defendants had known for a long period of the managerial and financial difficulties of the debtor and of the incompetence and inexperience of its employees, but nevertheless negligently failed to require compliance.
The second cause of action rests upon the allegation that when defendants concluded that the management of the debtor was inadequate to administer the existing affairs of the debtor, they forbade the opening of any new branch offices. Nevertheless, defendants did nothing to prevent the opening of debtor's New York branch, which because of faulty control, defalcations in excess of $600,000 occurred within the short space of two months and which were the immediate cause of the debtor's insolvency. Such loss is alleged to be the result of defendants' negligence. Defendants assert, however, that the losses suffered were the result of the negligence of the officers of the bankrupt debtor, that any cause of action was owned by the debtor prior to the Trustee's appointment, therefore the doctrine of estoppel is applicable.
In the memorandum in support of defendants' motion to dismiss, defendant points out at page 2, footnote 1:
"We know of no case based on the failure of an exchange to enforce its discretionary order such as the one alleged in the complaint relating to branch offices, or any case against individual members of an exchange for failure of the exchange to enforce rules."
Research for the solution of the issue raised in this case must, of course, begin with the landmark case of BAIRD v. FRANKLIN, 141 F.2d 238 (2d Cir. 1944) in which it was held that § 6 of the Exchange Act may be the basis for a suit against an exchange by members of the investing public. Subsequently it was held in PETTIT v. AMERICAN STOCK EXCHANGE, 217 F. Supp. 21 (S.D. N.Y. 1963) that a bankruptcy trustee of a corporation whose shares were sold on the American Stock Exchange could maintain an action against the Exchange. In SILVER v. NEW YORK STOCK EXCHANGE, 373 U.S. 341, 83 S. Ct. 1246, 10 L. Ed. 2d 389 (1963), it was determined that a non-member of a stock exchange, in an antitrust case, had standing to complain of the manner in which the Exchange rules applied to them.
In J.I. CASE CO. v. BORAK, 377 U.S. 426, 84 S. Ct. 1555, 12 L. Ed. 2d 423 (1964), a private suit for damages for a violation of the Federal Securities Acts and Regulations thereunder was allowed. Thereafter, in 1966, Judge Friedly's dictum in COLONIAL REALTY CORPORATION v. BACHE & CO., 358 F.2d 178 (2d Cir. 1966), laid the foundation for subsequent decisions that private liability for a violation of some exchange rules may be implied. AVERN TRUST v. CLARKE, 415 F.2d 1238 (7th Cir. 1969).
In BUTTREY v. MERILL LYNCH, PIERCE, FENNER & SMITH, INC., 410 F.2d 135 (1969), the Seventh Circuit upheld the right of a Trustee in bankruptcy of a securities dealer to bring a § 6 action based upon a violation of the "know your customer" rule. In so doing, the court explicitly rejected the contention that the Trustee was barred from recovering by the responsibility of the bankrupt principal for the illegal transaction.
The question was raised, but not decided by the Third Circuit in 1973, in LANDY v. FEDERAL DEPOSIT INSURANCE CORP., 486 F.2d 139.
In NEW YORK STOCK EXCHANGE, INC. v. SLOAN, 394 F. Supp. 1303, 1309, footnote 6 (S.D. N.Y. 1975), it was said of the SILVER case, supra :
"Although the case is analytically distinguishable from one arising under the Exchange Act, there can be no question after Silver, if there was prior to it, that those in the position of petitioners there can sue under § 6 itself for violation of the statutory command that Exchange rules 'insure fair dealing'."
In the SLOAN case the court stated at page 1313:
"The absence of interested private parties may in some cases have the effect of insulating the Exchange from the consequences of its own negligence. In such circumstances, recognition of a private action by limited partners and subordinate lenders not only provides a remedy for investors with a large ...