The notice standards embodied in 1977 Article 8 have not led to
significant confusion in their application. Commentators have been
able to formulate clear guidelines to regulate the behavior of partici-
pants in American securities markets.
205Parallel guidelines exist for
good faith behavior.
206In addition, the weakening of notice standards
combined with the dropping of the good faith requirement raises the
issue of what restraints there would be on market participants. Un-
der 1977 Article 8, a transferee must be concerned about constructive
notice of adverse claims or about suspicious circumstances, which
should make a transferee attentive to the business practices of the
transferor. This attentiveness is necessary to provide a shield from
202. See, e.g., Otten v. Marasco, 353 F.2d 563, 565 (2d Cir. 1965) (“[I]t is clear that failure to inquire may under certain circumstances constitute bad faith under New York law.”); Garner v. First Nat’l City Bank, 465 F. Supp. 372, 383 n.15 (S.D.N.Y. 1979) (stating that it is not necessary to hold that a defendant had knowledge of adverse claim to deny bona fide purchaser status; it is enough if “suspicious circumstances” existed).
203. See, e.g., Gutekunst v. Continental Ins. Co., 486 F.2d. 194, 196 (2d Cir. 1973) (stating “the clear rule set forth in New York decisions” and section 8-304(3) of 1962 New York Article 8 is that “it is not ignorance, but guilty knowledge or conduct that can be equated with guilty knowledge, that can rise to bad faith”); Chemical Bank v. Haskell, 411 N.E.2d 1339, 1342 (N.Y. 1980) (stating that in a case under Article 3, “suspicious circum- stances which might well have induced a prudent banker to investigate more thoroughly” are not enough to jeopardize bona fide purchaser status); Hall v. Bank of Blasdell, 118 N.E.2d 464, 467 (N.Y. 1954) (stating that in a case under Negotiable Instruments Law, the “existence of merely suspicious circumstances does not, without more, amount to notice of an infirmity or defect”). The Article 8 Bar Report cites Benjamin Ctr. v. Hampton Affiliates, Inc., 482 N.Y.S.2d 514, 515 (App. Div. 1984), aff’d and modified on other grounds, 488 N.E.2d 828 (N.Y. 1985), which does not discuss the issue of suspicious circumstances and, therefore, does not supply much support for the Article 8 Bar Report’s position.
204. See Rogers, supra note 7, at 1471. 205. See, e.g., Yadley & Ilkson, supra note 200. 206. See id.
liability under either section 8-302 (bona fide purchaser) or 8-318 (no
conversion for good faith conduct by agent or bailee).
Weakening the incentive to transferee attentiveness puts in-
creased weight on federal regulation of broker-dealers as the primary
means of disciplining bad actor transferees who are negligently or in-
tentionally jeopardizing the property rights of beneficial owners of
securities.
207This policy choice to favor federal regulation is criticized
in Part VIII of this Article. The immediate transferee in the indirect
holding system is usually either a financial institution itself or a fi-
nancial institution acting as an agent, in either case possessing ex-
tensive knowledge of the relevant market practices and partici-
pants.
208Who better to police transferors?
209207. See infra Part IV for further discussion.
208. Ironically, exactly this principle was proposed by the SEC and the SROs in con- nection with clearing brokers acting on behalf of introducing brokers. See Michael Sico- nolfi, Heat Rises on Wall Street ‘Clearing’ Operations, WALL ST. J., June 17, 1997, at C1.
The collapse of A.R. Baron & Co., a small brokerage, in July 1996 was the catalyst for ex- amining the duties of clearing brokers. See Diana B. Henriques & Peter Truell, Should a Clearing-House Be Its Broker’s Keeper? Queries For Bear Stearns After a Firm Fails, N.Y. TIMES, Apr. 23, 1997, at D1. A number of legal actions were commenced against Bear Stearns Companies, which had cleared trades for over 3,000 accounts for A.R. Baron, alleg- ing that Bear Stearns knew about unauthorized trades and sales misrepresentations in- volving these accounts but continued to do a clearing business with A.R. Baron. See id. In turn, the SEC and the Manhattan District Attorney’s office commenced investigations of Bear Stearns’ role. See Patrick McGeehan & Michael Siconolfi, New Rules Expected on Clearing: More Responsibility Seen for Big Firms, WALL ST. J., June 4, 1997, at C1. Ultimately, the SROs decided to propose imposing reporting requirements on clearing brokers without requiring “an affirmative duty for clearing firms to report to regulators suspicious activity at their introducing brokers.” Betty Santangelo & Marc E. Elovitz, Pro- posed Rules Regarding the Responsibilities of Securities Clearing Firms for Their Introduc- ing Brokers, SCHULTE ROTH & ZABEL LLP SECURITIES LAW DEVELOPMENTS, Fall 1997, at 1, 2. The NYSE has proposed an amendment to its Rule 382 to make clearing brokers re- sponsible for forwarding complaints of an introducing broker’s customers to the appropri- ate regulator; creating mechanisms for introducing firms to request certain reports “to as- sist the introducer in supervising and monitoring customer accounts”; requiring the clear- ing broker to maintain these reports; and requiring the introducing broker to “represent to the carrying organization that it has supervisory procedures in place, which it enforces and which are satisfactory to the carrying organization, with respect to the issuance of [nego- tiable] instruments” by introducing brokers to their customers. Self-Regulatory Organiza- tions; Notice of Filing of Proposed Rule Change by the New York Stock Exchange, Inc., to Amend its Rule 382 Relating to Carrying Agreements, Exchange Act Release No. 34-39200 (Oct. 10, 1997), 62 Fed. Reg. 53,369, 53,370 (1997) (emphasis added). NASD is considering a similar rule. See Self-Regulatory Organization; Notice of Filing of Proposed Rule Change and Amendment No. 1 by the National Association of Securities Dealers, Inc. to Amend its Rule 3230 Relating to Clearing Agreements, Exchange Act Release No. 34-39349 (Nov. 28, 1997), 62 Fed. Reg. 63,589 (1997).
It is of course possible that these reporting and record keeping obligations will be liber- ally interpreted to require reporting by clearing brokers of suspicious activity. See Santan- gelo & Elovitz, supra, at 2; see also Confirmation of Transaction Under Unfixed Commis- sions, Exchange Act Release No. 34-11629 (Sept. 3, 1975), 7 SEC Docket 782 (in situations involving potential violations by an institution of its fiduciary duty to its customers, noting that a broker acting on behalf of such institution “would have a duty of inquiry with re- spect to his participation in a cause of conduct which, to a reasonable person, would raise a question of fraudulent or deceptive acts or practices”). The Financial Crimes Enforcement