Levitin v. PaineWebber, Inc.

United States Court of Appeals for the Second Circuit · 1998 · Corporations

159 F.3d 698 (2d Cir. 1998)

Updated August 22, 2026

CorporationsSecurities regulationBroker-dealer margin accountsShort salesFederal preemptionSection 10(b)Rule 10b-5material omission

Facts

Levitin opened a margin account with PaineWebber and engaged in short sales, which required collateral under federal margin rules. She alleged that PaineWebber used collateral securing those short sales as part of its general cash reserves, earned profits from that use, usually did not disclose those profits, and did not remit them to ordinary customers. She also alleged that PaineWebber sometimes negotiated partial remittances of such earnings with large favored customers without disclosing that possibility to others. Her contract with PaineWebber permitted commingling and hypothecation and did not promise her profits from posted collateral beyond gains from a decline in the shorted stock's price.

Issue

Did PaineWebber's failure to disclose that it could profit from short-sale collateral, its retention of those profits, or its failure to disclose that some large customers could negotiate partial remittance of such profits state a federal securities fraud claim under Section 10(b)? Also, could Levitin rely on an alleged New York property right in the collateral or its earnings to support a federal deception theory?

Rule

A Section 10(b) omission claim fails where the omitted fact is one a reasonable investor is presumed to know because it is basic to investing, including that money has a time value and that a broker may earn returns on customer funds posted as short-sale collateral. A federal deception theory based on nondisclosure of a supposed state-law property right also fails where the asserted state rule is preempted by the pervasive federal scheme governing margin and short sales or where state law does not support the claimed fiduciary relationship. A plaintiff also must allege personal injury from the nondisclosure; absent allegations that she could have negotiated a remittance, nondisclosure that some large customers could do so is not actionable.

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In Chicago, Elena Morris opened a standard nondiscretionary margin account with North Harbor Brokerage LLC and used it for several short sales. She later sued, alleging the firm never told her it could earn returns by using cash and securities held as collateral for her open short positions, and her account agreement did not promise that she would receive those returns.

Does Elena state the strongest Section 10(b) omission claim?

Explanation. The majority held that no actionable deception exists where the omitted fact is so basic that any reasonable investor would be expected to know it. In this setting, that includes knowing that funds posted as collateral can generate income for the broker. The omission therefore does not significantly alter the total mix of information for the reasonable investor, especially where the agreement did not promise the customer those earnings. (Derived from Levitin v. PaineWebber, Inc. (1998).)