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SECURITIES & EXCH. COM'N v. FIRST SECURITIES CO.

September 5, 1973

SECURITIES AND EXCHANGE COMMISSION, PLAINTIFF,
v.
FIRST SECURITIES COMPANY OF CHICAGO, DEFENDANT.



The opinion of the court was delivered by: Julius J. Hoffman, Senior District Judge.

MEMORANDUM OF DECISION AND ORDER

Exceptions have been taken to the Special Master's Report of April 5, and Supplemental Report of May 30, 1973. The exceptions raise issues concerning the following matters:

I. Means of Classification

Transcending all matters is selection of a means for classifying the assets of and claims against First Securities Company of Chicago, the estate in receivership. The issue posed is whether Section 60(e) of the Bankruptcy Act [11 U.S.C. § 96(e)] would serve as an equitable means for such classification. With the exception of the Escrow Claimants, all parties who have addressed the issue agree that Section 60(e) should be applied, by analogy, to this proceeding. The Special Master has likewise urged the Court to utilize this section as a vehicle for classification.

Although the proponents of the application of Section 60(e) acknowledge that this is a case of first impression, they seek to bolster their proposal by suggesting that the case of In re Rosenbaum Grain Corporation, 112 F.2d 315 (7th Cir. 1940), serves as authority for such an application. They assert that this case established the broad principle that Section 60(e) may be applied, by analogy, to situations in which this section is not, per se, applicable.

In the Rosenbaum case, the debtor, a commodity futures broker, filed a voluntary petition for corporate reorganization under Section 77B of the Bankruptcy Act, 11 U.S.C. § 207. The claimants, marginal grain customers of the broker, filed priority claims against the estate. The District Court denied priority to the claimants for the reason that they had not sufficiently complied with the requirement of tracing their property into the hands of the trustee in bankruptcy. The 7th Circuit Court of Appeals reversed and remanded, concluding that since the relationship of a commodity futures broker and his customer was analogous to that of a stockbroker and his customer, the claimants, in fact, had successfully traced their property to the assets in bankruptcy.

In asserting that the Rosenbaum case established this broad principle, the Securities and Exchange Commission and the Receiver rely upon obiter dictum contained in footnote 6 of the opinion (112 F.2d at 319), which reads as follows:

  We have stated in the opinion that the same law
  applying to stock broker [sic] bankruptcies
  should apply to grain broker bankruptcies. The
  instant case arose prior to the Chandler Act, 11
  U.S.C.A. § 96, sub. e (Supp. 1938), so we must keep
  in mind that the analogous law applicable here is
  the law pertaining to stock broker bankruptcies
  prior to the Chandler Act. . . .

However, prior to the Chandler Act, courts differed as to the applicable law. Some applied the "Massachusetts rule," which premised recovery upon the debtor-creditor relationship. Others applied the "New York rule," which was grounded on the pledgor-pledgee relationship and required tracing.*fn1 Therefore, prior to the Chandler Act, the rights of customers of insolvent stockbrokers in receivership were determined by these common law rules. This District, that is to say, the U.S. District Court for the Northern District of Illinois, has followed the New York rule.

  The Escrow Claimants have taken exception to the Special
Master's recommendation that Section 60(e) of the Bankruptcy
Act be applied, by analogy, to classify the assets and claims
in this receivership. They argue that receivership proceedings
are controlled by principles of equity; equity requires
equality; Section 60(e) establishes priorities; therefore, the
application of Section 60(e) would create inequality. The
Escrow Claimants rely on the Report of Special Study of
Securities Markets of the Securities and Exchange Commission
[H.R.Doc.No.95, 88th Cong., 1st Sess. (1963)], which declares,
"Section 60(e) does not apply to receiverships." However, the
study goes on to say that:

   . . [w]hen liquidation is accomplished in this
  manner [i. e. through receivership proceedings]
  it appears that the old Massachusetts and New
  York doctrines may still have vitality and the
  capriciousness of result which Section 60(e) was
  designed to eliminate may prevail. Part 1, Ch.
  III, at 413.

The Report then recommended that Section 60(e) be amended to empower the Commission to petition to have an insolvent broker-dealer adjudicated a bankrupt. Thereafter, Congress enacted the "Securities Investor Protection Act of 1970" (15 U.S.C. § 78aaa et seq.), which creates a comprehensive plan for the protection of investors whose broker-dealers are in financial trouble. The liquidation proceeding in this plan is patterned after Section 60(e) of the Bankruptcy Act, but the shortcomings of Section 60(e) have been eliminated. See Report of Special Study of Securities Markets of the Securities and Exchange Commission, supra, pp. 410 et seq.; also, 3 U.S. Code Congressional and Administrative News, p. 5274, 91st Cong., 2nd Sess. (1970).

This is a receivership. proceeding. It is conducted under the equity jurisdiction of the District Court. In certain circumstances, "equity follows the law."

  In a broad sense, [this] maxim means that equity
  follows the law to the extent of obeying it and
  conforming to its general rules and
  policies . . . where no countervailing equity
  requires different treatment. . . . The maxim is
  strictly applicable whenever the rights of the
  parties are clearly defined and established by
  law, especially . . . by statutory provisions. 30
  C.J.S. Equity § 103, at 1066-1068.

In selecting a means of classification, this Court must choose between an extensively-criticized common law rule [see, e. g., 3 Colliers ΒΆ 60.71, at 1158, n. 3 (14th ed. 1964)], and a statutory provision designed to eliminate ...


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