21 N.Y.2d 219 (1967)

A stockbroker who sells stolen stock certificates for a new customer without conducting adequate due diligence to verify the customer’s identity is liable for conversion to the true owner of the stock, even if the owner’s negligence contributed to the theft.

Summary

Hartford Accident & Indemnity Co., as assignee of Bache & Co., sued Walston & Co. for conversion after Walston sold stolen stock certificates and remitted the proceeds to the thief. A Bache employee stole stock certificates and had them reissued in a fictitious name (“Jack Arbetell”). An individual impersonating Arbetell opened an account at Walston, deposited the certificates, and received the proceeds from their sale. The New York Court of Appeals held that Walston was liable for conversion because it failed to exercise due diligence to verify the identity of its customer, as required by New York Stock Exchange rules, and could not claim bona fide purchaser status.

Facts

1. Bache & Co. possessed stock certificates endorsed in blank.
2. A Bache employee, Norman Mais, stole the certificates and arranged for their reissuance in the name of “Jack Arbetell.”
3. Mais then delivered the reissued certificates to an accomplice, Yudelowitz.
4. An individual claiming to be Jack Arbetell opened an account at Walston & Co., presenting the certificates for sale.
5. Walston employees witnessed the Arbetell impersonator’s signature based on minimal identification (business cards).
6. Walston sold the stock certificates and paid the proceeds to the Arbetell impersonator.
7. Bache & Co. discovered the theft and was forced to replace the stolen shares at a higher price.
8. Hartford, as Bache’s insurer and assignee, sued Walston for conversion.

Procedural History

The trial court dismissed Hartford’s complaint. The Appellate Division unanimously affirmed. The New York Court of Appeals reversed and ordered a new trial, finding that material issues of fact remained regarding Walston’s due diligence and good faith.

Issue(s)

1. Whether a selling broker, Walston, is protected from liability for conversion under the Stock Transfer Act when it sells stolen stock certificates and pays the proceeds to an imposter.
2. Whether Walston acted in good faith as a purchaser for value, considering its minimal efforts to verify the identity of its customer and the requirements of New York Stock Exchange Rule 405.

Holding

1. No, because the certificates were not properly endorsed, and Walston failed to observe reasonable commercial standards by not adequately verifying the customer’s identity.
2. No, because Walston did not exercise due diligence to learn the essential facts about its customer, as required by New York Stock Exchange rules, and therefore cannot claim bona fide purchaser status.

Court’s Reasoning

The Court reasoned that Walston, as a selling broker, had a duty to exercise due diligence to “know its customer,” as mandated by New York Stock Exchange Rule 405. The court emphasized that the minimal identification obtained by Walston (business cards) was insufficient to meet this standard. The court stated that the requirements of “good faith” and that a certificate be endorsed “by the person appearing by the certificate to be the owner of the shares represented thereby” impose greater duties upon the selling broker than merely seeing that the certificate has been signed by someone in the name of the registered owner without making a serious effort to ascertain with whom the broker is dealing.

The court rejected Walston’s argument that the certificates should be treated as if they were endorsed in blank, stating that this would nullify the protection afforded to stock owners by requiring selling brokers to exercise due diligence. The court distinguished cases involving negotiable instruments, noting that stock transfers require a greater duty of inquiry. The court cited Fidelity & Deposit Co. v. Queens County Trust Co., stating that brokers cannot shirk their duties and claim to have acted in good faith without being charged with knowledge of facts that compliance with reasonable commercial standards would have disclosed.

The dissenting opinion argued that the misappropriation occurred when the old certificates, endorsed in blank, were diverted, making the new certificates bearer instruments. The dissent reasoned that Mais, the faithless employee, had the authority to direct the transfer agents, and the fictitious payee doctrine should apply, treating the certificates as payable to bearer. The dissent emphasized the policy of furthering negotiability and argued that the loss should fall on Bache, which was in a better position to prevent the fraud.