The Supreme Court agreed yesterday to decide whether a federal securities law prohibits fraudulent practices that victimize brokers who serve as intermediaries but who aren't investors.

The court acted in a case involving a $1 million "short selling" scheme devised by Neil T. Naftalin of Minneapolis, owner of a registered broker-dealer firm and a sophisticated professional investor.

During a five-week period in 1969, he placed orders with five brokerage firms to sell certain stocks that he believed had peaked in price and were about to start to decline in value.

The firms wouldn't have executed his order if the had known what he knew: he didn't own the shares he asked them to sell.

Naftalin gambled that the firms would never discover his non-ownership, because he had expected the scenario to play out this way:

Between the dates of his sell orders and the dates when he'd have to produce proof of ownership, the prices of the stocks would fall sharply.

Going to entirely different brokers after placing the sell orders, he would make offsetting purchases of the same numbers of shares in the same companies in which he had "invested" orginally.

He would pay much less for the second buy of stocks than for the first.

He would take as profit the difference between the price at which he sold and the price at which he "covered," i.e., the sum paid in the second stock buy.

A hitch developed: Instead of falling, prices of the "sold" securities rose sharply before the time when Naftalin had to prove his "ownership."

As a result, he couldn't make the covering purchases, and the firms that couldn't deliver the shares they hadn't received to the investors who'd bought them. So the firms were forced to buy substitute shares on the open market -- at an aggregate loss exceeding $1 million.

A federal court convicted Naftalin on eight counts of scheming to defraud in violation of the Securities Act of 1933.

The 8th U.S. Circuit Court of Appeals thought the evidence sufficient to establish fraud. Last June, however, the court reversed on the ground that the purpose of the section of the law relied upon by the prosecution -- 17 (a) (1) -- was to protect not injured brokers, but investors.

One of the indictment counts involved fraud on a broker who had traded -- as an investor -- for his own account. But the conviction on this count was reversed along with the others, because "the indictment did not allege that (he) was a purchaser," and Naftalin "could not be tried on charges that were not made."

In a successful petition for Supreme Court review, Solicitor General Wade H. McCree Jr. wrote that the 8th Circuit ruling "effectively removes federal criminal prohibitions against fraudulent securities schemes in which the fraudulent statements are made to financial institutions serving as intermediaries..."

Contrary to the ruling, McCree argued, the law "applies on its face to all fraudulent practices in 'the offer o sale of any securities.'"

If the ruling is upheld, McCree said, the Securities and Exchange Commission will lose its "power to protect the principal participants in the nation's securities markets" under the section of the law at issue and Weaken "the integrity of the securities marketplace."

Public Utilities

Acting in a hotly disputed California public utilities case, the court declined petitions by the state's two largest phone companies for review of a decision that they say exposed them to liability for back federal income taxes of at least $1 billion currently and at least $2 billion ultimately.

The decision, made by the state's highest tribunal, upheld a California Public Utilities Commission order specifying the accounting methods to be used by Pacific Telephone and Telegraph Co. and General Telephone Co. in connection with Internal Revenue Code provisions concerning accelerated depreciation and investment tax credit.

Without comment, the court declined a plea by Solicitor General Wade H. McCree to resolve "a fundamental issue potentially affecting the tax liabilities of all public utilities."