APPEAL FROM THE UNITED STATES DISTRICT COURT FOR THE DISTRICT OF NEW JERSEY D.C. No. B-73-1010 In Bankruptcy
Before Rosenn, Van Dusen, and Garth, Circuit Judges.
This appeal concerns the recurring and difficult question of ownership of negotiable securities found in the control of a stockbroker upon his insolvency. The problem arises out of the practice of brokerage houses engaged in securities trading and underwriting to carry on their extensive business activities not only with their own funds but also with borrowed money collateralized by securities purchased for, and fully paid by, their customers. Paragon Securities Company ("Paragon"), a New Jersey corporation, had been engaged in the business of buying and selling securities, primarily municipal bonds. Its sudden demise in August 1973 left a flurry of distraught customers' claims to securities under Paragon's control at the time it so ignominiously expired. See, e.g., In the Matter of Paragon Securities Co., 589 F.2d 1240 (3d Cir. 1978). Among the claims is one of Pearl Levine, a disenchanted customer of Paragon, who filed a reclamation proceeding against the trustee in bankruptcy for certain bearer bonds. The bankruptcy judge applied section 60e of the Bankruptcy Act, 11 U.S.C. § 96(e) (1976), and denied her claim. On appeal, the United States District Court for the District of New Jersey affirmed.
Levine appealed from the judgment of the district court to this court claiming that state law, not the Bankruptcy Act, should govern her claim and that under either state or federal law she is entitled to reclamation. We are constrained to disagree and we affirm the judgment of the district court.
In its trading of bonds and securities, Paragon engaged Securities Processing Services ("SPS"), a New York corporation which functioned as a private clearing facility for municipal bond dealers. SPS received all of the bonds purchased by Paragon, and upon specific instructions from Paragon would either deliver the bonds to Paragon's customers or retain them in SPS vaults in one of three accounts it maintained for Paragon.
The first account ("98" account) contained all of the major new issues which Paragon had purchased or underwritten. The "46" account was also a general inventory account, but included secondary or old market issues. The third ("124" account) was for customer safekeeping. The bonds in this account, unlike the other bonds, were tagged and identified as belonging to the specific Paragon customer who had purchased them.
In addition to serving as a private clearing house, SPS often advanced money to Paragon for purchases of bonds. As collateral for these loans, SPS held a lien interest in the securities comprising the "98" and "46" accounts. It does not appear that Paragon's customers whose bonds were held in the general inventory accounts were aware that their bonds were being used in this manner.
Levine maintained a trading account with Paragon and traded bonds with some frequency. On February 21, 1973, she purchased $30,000 of Marion County bonds bearing an interest rate of 8 1/4 percent and due March 1, 1990, for a total price of $32,412.30. The purchase order provided that the bonds were to be held by Paragon. The bonds were delivered to SPS on June 6, 1973, and were placed in the general inventory account. In letters dated June 1 and July 2, Levine requested that Paragon deliver the bonds to her. Unhappily for Levine, Paragon's failure to respond promptly to these requests led to her subsequent undoing and this litigation.
On August 1, 1973, Paragon filed a petition for voluntary dissolution in the New Jersey state court and obtained the appointment of a receiver. The following day SPS received instructions from Paragon to ship the Marion County bonds to Levine. Before the preparations for delivery could be completed, however, the receiver cancelled the instruction. On August 6, 1973, an involuntary petition in bankruptcy was filed in the United States District Court for the District of New Jersey, and on August 28 Paragon was adjudicated a bankrupt.
Upon learning of Paragon's precarious financial position, SPS promptly moved to protect its position and sold a major portion of the bonds in the general inventory account to satisfy Paragon's debt to SPS. Unfortunately, the bonds sold included many which had been fully paid for by Paragon's customers but had not been delivered or transferred to the customers' safekeeping account. SPS sold bonds having an approximate face value of $1,600,000 and only turned over to the bankruptcy trustee $670,000 worth of bonds, including $30,000 of Marion County bonds. However, customer claims against the trustee to be satisfied by these bonds aggregated $1,800,000. Levine filed a complaint in bankruptcy court seeking reclamation of the Marion County bonds.
We must first determine whether section 60e of the Bankruptcy Act, 11 U.S.C. § 96(e) (1976),*fn1 is applicable. Section 60e governs the liquidation of bankrupt stockbrokers. It divides customer claimants into three classes:
(1) Cash customers who are able to specifically identify their securities in accordance with the provisions of section 60e(4). These customers are ...