In pari delicto defense in securities transactions

Under the in pari delicto principle, public policy dictates that parties who both transgress the law should not be permitted to profit from their wrongdoing. Pursuant to this doctrine, the courts leave the erring parties where they are and do not allow them to recover damages from each other, in order to render the statute effective and to accomplish its objectives.

The question is whether this rule is applicable with equal force to stock market transactions that involve violations of the Securities Regulation Code (SRC).

The Supreme Court appears to have answered this question in the 2006 case of Abacus vs Ampil (483 SCRA 315, 27 February 2006). In this case, a customer (Ampil) of a broker-dealer, Abacus Securities, opened a cash/regular account with the latter so it could trade stocks listed on the Philippine Stock Exchange.

Abacus bought stocks for Ampil on April 10 and 11, 1997. Ampil failed to fully pay for the stock purchases. Abacus continued to purchase stocks for Ampil’s account on April 25 and 29, 1997 without liquidating the April 10 and 11 purchases by selling the unpaid stocks within the mandatory closeout period (not later than 10 days from the date of the purchase) prescribed by the Revised Securities Act (RSA).

Abacus eventually sued Ampil to collect P3.4 million representing the unpaid purchase price for all the stock purchases it made on Ampil’s behalf. Ampil invoked the in pari delicto defense and filed a counterclaim for damages, contending that Abacus violated the mandatory closeout rule under the RSA. Ampil claimed that, had Abacus complied with the rule, he would not have accumulated the unpaid obligations that Abacus was suing him for.

The Supreme Court held that Abacus could recover the purchase price for the April 10 and 11 transactions, but not for the April 25 and 29 transactions. It likewise dismissed Ampil’s counterclaim for damages.

The high court ruled that the in pari delicto defense did not apply to the April 10 and 11, 1997 transactions because, at that time, there was no violation of the RSA by Abacus. Abacus’ violation occurred when it continued to make purchases for Ampil on April 25 and 29, 1997 despite the latter’s failure to fully pay for the April 10 and 11 purchases, and the failure of Abacus to sell the securities within the mandatory closeout period provided for by the law.

The Court then held that “the in pari delicto rule applies only to transactions entered into after the initial trades made on April 10 and 11, 1997.”

According to the high court, “[w]hen [Abacus] tolerated the subsequent purchases of [Ampil] without performing its obligation to liquidate the first failed transaction, and without requiring [Ampil] to deposit cash before embarking on trading stocks any further, [Abacus], as the broker, violated the law at its own peril. Hence, it cannot now complain for failing to obtain the full amount of its claim for these latter transactions.”

It appears, therefore, that the in pari delicto doctrine is applicable to stock market transactions.

This, however, is a simplistic and superficial way of reading the Abacus case. Note that the court stated that there are “peculiar facts of the present case [that] bar the application of the in pari delicto rule … to all the transactions entered into by the parties.”

The court found that the mandatory closeout rule is not really intended to protect investors, but to prevent undue speculation in the stock market.

The court also found that the client (Ampil) was “not an unsophisticated, small investor merely prodded by [Abacus] to speculate on the market with the possibility of large profits with low—or no—capital outlay, as he pictures himself to be. Rather, he is an experienced and knowledgeable trader who is well versed in the securities market and who made his own investment decisions.”

He “knowingly speculated on the market by taking advantage of the ‘no-cashout’ arrangement extended to him by [Abacus].”

But there are intriguing questions relating to the Abacus decision. What if Ampil was not a sophisticated client? Would that mean that Abacus could recover the purchase price for the April 25 and 29 transactions from him? If so, would it not be unfair to allow recovery for Abacus considering that the counterparty (Ampil) was the weaker party? In short, was the characterization of Ampil as a sophisticated investor relevant only for the purpose of determining whether he could recover on his counterclaim for damages against Abacus?

More importantly, does the Abacus case apply to other stock market-related violations like nondisclosure of material information, insider trading and manipulation? What about Article 1416 of our Civil Code which expressly provides that when “the prohibition by the law is designed for the protection of the plaintiff, he may, if public policy is thereby enhanced, recover what he has paid or delivered?”

The point is that the Abacus case should not be taken hook, line and sinker. More care should be taken before applying the case to stock market transactions that involve violations of the Securities Regulation Code.

(The author is co-managing partner and head of the Corporate and Special Projects department of the Angara Abello Concepcion & Regala Law Offices (Accralaw).  The views in this column are solely the author’s and should not in any way be attributed to Accralaw. The author may be contacted through francis.ed.lim@gmail. com)