For affirmance as modified -- Chief Justice Hughes, Justices Mountain, Sullivan, Pashman, Clifford and Schreiber and Judge Conford. For reversal -- None. The opinion of the court was delivered by Schreiber, J.
Is an owner of stock, which had been transmitted to a bank as collateral security for a loan to a third person, entitled to the return of the stock because in making the loan the bank violated the federal margin requirements of Regulation U, 12 C.F.R. § 221.1 et seq. (1976), and the usury laws of New Jersey, N.J.S.A. 31:1-1 et seq. ? This issue arose in the context of an action by the Peoples National Bank of New Jersey (PNB) against John B. Fowler, Jr. on a note in the face amount of $350,000, secured by 24,013 shares of common stock of the Jeannette Glass Company (Glass Company) owned by Maurice Stonehill. PNB joined Stonehill as a party defendant to compel him to remove a stop-transfer order placed against the stock with the Glass Company. The defendant Stonehill counterclaimed seeking delivery of the stock certificates of 24,013 shares and crossclaimed against Fowler for any losses to which Stonehill might be subjected in the main suit.
At the conclusion of the trial, the trial court entered a judgment of $218,313 in favor of PNB against Fowler, ordered Stonehill to remove all restrictions prohibiting the transfer of the 24,013 shares of Jeannette Glass Company common stock, authorized PNB to sell the stock and apply
the proceeds to the indebtedness, dismissed Stonehill's counterclaim against PNB, and entered a judgment of $218,313 in favor of Stonehill against Fowler, less the market value of any shares which were not needed to satisfy the principal indebtedness and which PNB was to return to Stonehill.
The Appellate Division affirmed the judgments essentially for the reasons stated by the trial court in its written opinion. We granted Stonehill's petition for certification limited to consideration of whether Maurice L. Stonehill is entitled to recover his stock.*fn1
Fowler was the Chief Executive Officer and principal stockholder of a stock brokerage firm, J.S. Love and Co., Inc. (Love). Love, as a member of the New York Stock Exchange, had to maintain certain asset-to-liability ratios in accordance with the Exchange's regulations. When Love's ratios fell below those minima, Fowler borrowed funds, which he in turn advanced to Love, so that Love's qualifications as a member of the Exchange remained unimpaired.
Fowler borrowed $250,000 from Chemical Bank New York Trust Company (Chemical) on May 6, 1970 for a six-month period and deposited 24,013 shares of Jeannette Glass Company common stock with Chemical as collateral for the indebtedness. The stock was owned by Maurice Stonehill, who was the Chairman of the Board of Directors of the Glass Company and owned more than 10% of its issued and outstanding common stock. Stonehill had been a long-time friend of Fowler and as a favor to him (he received no compensation) had forwarded the stock certificates endorsed in blank with appropriate powers of attorney to be used as security in connection with the Chemical loan. The funds from the Chemical advance became part of the working
capital of Love and were used in its stock brokerage business for carrying customers' margin accounts and for buying and selling securities.
Fowler was unable to make payment on the due date, November 6, 1970, and when Chemical indicated it desired repayment, Fowler searched for other banking sources, principally in New York City, to refinance the unpaid balance of the Chemical indebtedness and to obtain additional funds for Love, which was again in need of an infusion of capital. These efforts proved fruitless. By February 1, 1971, Chemical was demanding payment of the unpaid principal sum of $196,350 plus $12,246 interest and threatening to sell the pledged stock.
Around February 24, 1971, William G. Rohrer, President of PNB, indicated an interest in refinancing the Chemical loan and Fowler met with Rohrer and Francis Mason, a Vice-President, at PNB's office in Laurel Springs, New Jersey, on March 1, 1971. Fowler advised the bank of the Chemical loan, of Stonehill's pledged stock, and of Stonehill's control relationship with Jeannette Glass Company. An agreement was reached under the terms of which Fowler would execute a note in the face amount of $350,000, bearing interest at the rate of 8% per annum, repayable in 11 equal monthly installments of $10,000 commencing April 15, 1971, with the balance due on the twelfth month. The note was to be secured by 24,013 shares of Jeannette Glass Company common stock owned by Stonehill and a $50,000 non-interest bearing certificate of deposit. Fowler also agreed to open a checking account where he would keep a compensating balance of $5,000. The note was prepared and signed at that time.
On March 2, 1971, Fowler closed the loan at PNB. Francis Mason represented PNB. At the closing Mason prepared Federal Reserve Form U-1, which was entitled a "Statement of Purpose of a Stock-Secured Extension of Credit by a Bank" and is commonly known as a Regulation U purpose statement. It was signed by Fowler and Mason. The statement reflected the fact that the collateral for the loan was
24,013 shares of Jeannette Glass Company stock having a market price of $24 per share. The printed form stated that the undersigned (Mason) as a duly authorized officer of the bank was aware that the stock-secured credit may be subject to Regulation U, a regulation which under certain circumstances limited the amount of money which could be borrowed where stock was pledged as collateral for a bank loan. The form further stated that the bank officer must act in good faith, which requires that such officer (1) must be alert to the circumstances surrounding the credit, and (2) has made a reasonable investigation if he has any information which would cause a prudent man not to accept the statement without inquiry. No inquiry had in fact been made by PNB directed to Stonehill, the Chemical Bank, or even to Fowler to determine whether the proposed loan would violate Regulation U.
Fowler also delivered at the closing a letter from Stonehill addressed to PNB, dated February 26, 1971, in which he authorized Fowler to use 48,017 shares of Jeannette Glass Company common stock registered in his name as collateral for a loan which PNB was making to Fowler. This letter had previously been executed by Stonehill, undated and with no addressee, and given to Fowler. Stonehill had known that Fowler was attempting to renegotiate the Chemical loan, but he was not aware of any of the details of the PNB transaction. He did not know his stock had been pledged with PNB until sometime after the transaction had been concluded. For his part, Fowler admitted that he was familiar with the details of Regulation U and that he was aware at the time the loan transaction with PNB was completed that Regulation U had been violated.
The proceeds from the PNB loan were used as follows:
(a) $210,000 was sent to Chemical to satisfy the balance due on its loan. Chemical in turn transmitted to PNB certificates for 24,013 shares of Jeannette Glass Company common stock registered in Stonehill's name ...