Filed: January 13, 1998

UNITED STATES COURT OF APPEALS

FOR THE FOURTH CIRCUIT

No. 97-1315

(CA-95-1091-K)

Banca Cremi, S.A., etc., et al,

Plaintiffs - Appellants,

versus

Alex. Brown & Sons, etc., et al,

Defendants - Appellees.

ORDER

The Court amends its opinion filed December 30, 1997, as

follows:

On page 2, section 1, line 17 -- Amicus' name in the counsel

listing is corrected to read "PSA THE BOND MARKET . . . ."

For the Court - By Direction

/s/ Patricia S. Connor

Clerk
PUBLISHED

UNITED STATES COURT OF APPEALS

FOR THE FOURTH CIRCUIT

BANCA CREMI, S.A., Institucion de

Banca Multiple, Grupo Financiero

Cremi; BANCA CREMI GRAND

CAYMAN,

Plaintiffs-Appellants,

v.

No. 97-1315

ALEX. BROWN & SONS,

INCORPORATED; JOHN ISAAC EPLEY,

Defendants-Appellees.

SECURITIES & EXCHANGE COMMISSION;

PSA THE BOND MARKET TRADE

ASSOCIATION,

Amici Curiae.

Appeal from the United States District Court

for the District of Maryland, at Greenbelt.

Frank A. Kaufman, Senior District Judge.

(CA-95-1091-K)

Argued: September 29, 1997

Decided: December 30, 1997

Before LUTTIG and WILLIAMS, Circuit Judges, and MAGILL,

Senior Circuit Judge of the United States Court of Appeals for the

Eighth Circuit, sitting by designation.

_________________________________________________________________

Affirmed by published opinion. Senior Judge Magill wrote the opinion, in which Judge Luttig and Judge Williams joined.

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COUNSEL

ARGUED: Howard N. Feldman, DICKSTEIN, SHAPIRO, MORIN

& OSHINSKY, L.L.P., Washington, D.C., for Appellants. Susan Sholar McDonald, Senior Litigation Counsel, SECURITIES AND

EXCHANGE COMMISSION, Washington, D.C., for Amicus Curiae

SEC. Michael Roger Klein, WILMER, CUTLER & PICKERING,

Washington, D.C., for Appellees. ON BRIEF: Howard Schiffman,

Woody N. Peterson, Jennifer Tara Holubar, DICKSTEIN, SHAPIRO,

MORIN & OSHINSKY, L.L.P., Washington, D.C., for Appellants.

Richard H. Walker, General Counsel, Jacob H. Stillman, Associate

General Counsel, Susan K. Straus, SECURITIES AND EXCHANGE

COMMISSION, Washington, D.C., for Amicus Curiae SEC. Robert

F. Hoyt, Adam R. Waldman, WILMER, CUTLER & PICKERING,

Washington, D.C., for Appellees. Peter Buscemi, Lloyd H. Feller,

MORGAN, LEWIS & BOCKIUS, L.L.P., Washington, D.C.; Robert

C. Mendelson, Katherine M. Polk, MORGAN, LEWIS & BOCKIUS,

L.L.P., New York, New York; Paul Saltzman, Senior Vice President

and General Counsel, PSA THE BOND MARKET TRADE ASSOCIATION, New York, New York, for Amicus Curiae Association.

_________________________________________________________________

OPINION

MAGILL, Senior Circuit Judge:

Banca Cremi, S.A., Institucion de Banca Multiple, Grupo Financiero Cremi and Banca Cremi Grand Cayman (together, the Bank)

purchased a number of collateralized mortgage obligations (CMOs)

through John Isaac Epley, a broker with the brokerage firm of Alex.

Brown & Sons, Incorporated (Alex. Brown). Although most of its

CMO purchases were profitable, the Bank lost money on six CMO

purchases after the market in CMOs collapsed in 1994. The Bank

brought suit in the district court against Epley and Alex. Brown,

alleging that Epley and Alex. Brown had committed securities fraud

in violation of § 10(b) of the Securities and Exchange Act of 1934,

15 U.S.C. § 78j(b), and Rule 10b-5, 17 C.F.R. § 240.10b-5, by making material misrepresentations and omissions regarding the CMOs,

by selling securities that were unsuitable, and by charging excessive

 2
markups. The Bank also alleged Texas state common-law tort claims

for fraud, negligence, negligent misrepresentation, and breach of fiduciary duty, and a claim based on the Maryland Securities Act. The

district court granted Epley and Alex. Brown's motion for summary

judgment on all of the Bank's claims,1 and the Bank now appeals. We

affirm.

I.

A.

CMOs, first introduced in 1983, are securities derived from pools

of private home mortgages backed by U.S. government-sponsored

enterprises.2 From 1987 to 1993, U.S. government-sponsored CMO

issuances grew dramatically, from $900 million to $311 billion per

year. The market in CMOs largely collapsed in 1994, and in 1995

new issuances fell to $25.4 billion.

Historically, investments in fixed-rate home mortgages have not

been attractive to institutional investors. Investors in most fixed-rate

securities benefit when interest rates fall. The fixed-rate security then

earns interest at a rate higher than decreased prevailing rates. However, unlike other fixed-rate investments such as U.S. treasuries,

fixed-rate home mortgages do not benefit from declines in interest

rates. Because home mortgages may be freely prepaid, home owners

frequently refinance their homes to take advantage of a drop in interest rates. When the mortgage is prepaid, the investor's funds are

returned. If the investor seeks to reinvest those funds, as would be the

case with most institutional investors, they must be reinvested at the

low prevailing rate, rather than earning interest at the higher rate of

the original mortgage. This is called the "prepayment risk." If interest

rates rise, home mortgages are generally not refinanced, and they lose

value just like any other fixed-rate security. Thus, investments in

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1 The district court's opinion is recorded at Banca Cremi v. Alex.

Brown, 955 F. Supp. 499 (D. Md. 1997).

2 These entities include the Federal National Mortgage Association, the

Federal Home Loan Mortgage Corporation, and the Government

National Mortgage Association.

 3
home mortgages perform poorly both when interest rates rise and

when they fall.

CMOs concentrate the prepayment risk in some securities in order

to reduce that risk in other securities. In so doing, CMOs were

designed to make home mortgage investments more attractive to institutional investors, increase the liquidity in the secondary home mortgage market, and reduce the interest costs to consumers buying

homes.

A CMO issuer begins with a large pool of home mortgages, often

worth billions of dollars. Each pool of home mortgages generates two

streams of income. The first income stream is the aggregate of all

interest payments made on the underlying mortgages. The second

income stream is the aggregate of all principal payments made on the

underlying mortgages. These income streams are divided into numerous CMO "tranches," which are the securities sold to investors. To

determine what portion of the two income streams are received by an

investor in a CMO tranche, each tranche has two unique formulae:

one that determines the tranche's interest rate, and the other that

determines the tranche's principal repayment priority.

The interest rate on a CMO tranche can be a fixed rate, a floating

rate, or a rate that floats inversely to an index rate. Floating interest

rates can also be leveraged, meaning that the interest rate shifts more

dramatically than the index rate. For example, where a floating rate

CMO is leveraged by a multiplier of two, the CMO's interest rate will

increase by two percent when the index rate increases by one percent.

The tranche's principal repayment priority determines when the

tranche will receive principal payments made on the underlying mortgages. Each principal payment is divided among all of the tranches

in a CMO issuance. High priority tranches receive principal payments

first. Support tranches receive principal payments last. Because of

this, support tranches are the most sensitive to "extension risk."

Extension risk is the opposite of prepayment risk: when interest rates

rise, the expected maturity of the support tranche CMO increases,

often dramatically.

CMO tranches are categorized into classes which have similar

properties and risks. The least risky is the planned amortization class

 4
(PAC). PACs have little prepayment risk, and appeal to institutional

investors for this reason. Two of the riskiest classes of CMOs, inverse

floaters and inverse interest-only strips, are at issue in this litigation.

Inverse floaters have a set principal amount and earn interest at a

rate that moves inversely to a specified floating index rate. Inverse

floaters will often be leveraged, so a small increase in interest rates

causes a dramatic decrease in the inverse floating rate. Usually,

inverse floaters are also support tranches, so an increase in interest

rates causes their maturity date to extend. Inverse floaters earn high

returns if interest rates decline or remain constant, but lose substantial

value if interest rates increase.

Inverse interest-only strips (inverse IOs) do not receive principal

payments. The interest rate for an inverse IO floats inversely to a

specified index rate, like an inverse floater. Interest is calculated by

reference to the outstanding principal amount of another reference

tranche. As the reference tranche is paid off, the principal on which

the inverse IO earns interest decreases accordingly. Like an inverse

floater, a rate increase reduces the inverse IO's floating rate. According to some investors, a rate increase also reduces prepayment of the

reference tranche, extending the maturity of the inverse IO and, ultimately, increasing the total interest payments made on the inverse IO.

Inverse floaters were first introduced in 1986. Inverse IOs were

introduced in 1987. Markets for both of these securities remained

strong in the environment of decreasing or stable interest rates that

predominated between 1986 and the beginning of 1994. On February

4, 1994, the Federal Reserve Board increased short-term interest rates

for the first time in five years. Over the next nine months, short-term

rates increased by a total of 2.5 percent, from 3 percent to 5.5 percent.

In response to the rate increases, a wave of selling hit bond markets

and investors in all types of bonds suffered significant losses.3

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3 Most fixed-rate investments dropped significantly in value. Five-year

bonds had their worst year since 1926. The price on zero-coupon treasuries dropped 18.7 percent, while long-term treasury bonds lost 7.5 percent in value.

 5
CMOs were particularly hard hit, for a variety of reasons. The

jump in rates halted mortgage prepayments. This in turn extended the

average maturity of all CMOs, including, most dramatically, support

tranche CMOs such as inverse floaters. Because of their degree of

leverage, certain CMOs were extremely sensitive to the interest rate

jumps, and their holders flooded the market after the first interest rate

increase. CMO liquidity, which had never been a problem in the stable or declining interest rate environment that had existed since their

introduction, dried up as all CMO holders tried to sell. The fear of

liquidity problems built on itself, reducing the number of willing purchasers during the critical period after the Federal Reserve Board

increased interest rates. In April 1994 an investment fund which primarily invested in CMOs filed for bankruptcy, reporting near total

losses of its $600 million CMO investment. As a result of these incidents, the market in CMOs virtually collapsed in 1994.

B.

Alex. Brown is a securities brokerage firm, incorporated under the

laws of Maryland, with its principal place of business in Baltimore,

Maryland. Alex. Brown is registered as a broker-dealer under § 15 of

the Securities and Exchange Act of 1934, 15 U.S.C. § 78o. Beginning

in April 1993, John Isaac Epley was employed by Alex. Brown in its

Houston, Texas office as a vice president. Prior to his employment by

Alex. Brown, Epley had worked in Houston as a securities broker for

MMAR Group.

Banca Cremi, S.A., is a credit institution incorporated under the

laws of Mexico. Banca Cremi Grand Cayman is its wholly owned

subsidiary, incorporated under the laws of the Cayman Islands. Both

institutions have their principal place of business in Mexico City,

Mexico. On June 30, 1993, the Bank had assets of nearly $5 billion

and an annual operating income in excess of $36 million.

The Bank's Nuevos Negocios Internacionales (NNI) unit specialized in international investment transactions. The unit engaged in

Eurobond issuances, interest rate swaps, investments in Brady Bonds,

and various other esoteric investments. According to the NNI monthly

reports, the NNI unit held investments with a face value of up to $115

 6
million during 1993 and accumulated income of over $6 million that

year. J.A. at 482.

Three individuals had primary oversight responsibilities for the

NNI unit's operations and investments. The NNI unit director, Jose

Luis Mendez, held a degree in economics, and primarily advised the

Bank on U.S. dollar-denominated investments. The NNI unit subdirector, Armando Aguirre, also held a degree in economics. Prior to

joining the Bank in 1981, Aguirre served as an economics teacher, a

currency investment adviser, and a developer of accounting systems.

Aguirre approved all of the NNI unit's CMO trades. The NNI unit

assistant director, Monica Buentello, held a degree in international

relations, had completed postgraduate course work in international

commerce and analysis, and had participated in seminars on derivatives and CMOs while working at the Bank.

C.

The relationship between Epley and the Bank began in June 1992

when Epley, then an MMAR Group employee, made an unsolicited

phone call to sell CMOs to the Bank. Over the next few months,

Epley discussed CMOs with Buentello and others in the NNI unit.

The Bank allegedly told Epley that it wished to "invest in securities

that: [(1)] had low risk to capital; [(2)] were highly liquid; [(3)] would

be held for short periods (generally 90-180 days); and [(4)] could reasonably be expected to provide a good yield." J.A. at 1537 (Buentello

Aff.). The Bank also allegedly told Epley that it would be "beneficial

if" the investments met the liquidity coefficient requirement of a

Mexican banking regulation, Circular 292.4 Id. at 1538.

Epley provided the Bank with general background materials

describing the functioning and risks of CMOs. First, Epley provided

the Bank with the MMAR Group Guide to CMO Structures (Group

Guide). The Group Guide dedicated two pages to a description of

inverse floaters and inverse IOs, calling them each volatile. Second,

Epley provided the Bank with the MMAR Group Guide to Inverse

_________________________________________________________________

4 Circular 292 requires that fifteen percent of a Mexican bank's U.S.

dollar-denominated investments be in short-term, highly liquid securities.

 7
IOs, which described the risks and benefits of inverse IOs.5 Third,

Epley wrote a letter to Buentello dated July 22, 1992 (risk letter), outlining four types of risks of inverse floaters: credit risk, coupon risk,

price volatility, and liquidity risk. Describing the coupon risk, the risk

letter stated that in "most cases" the index would need to increase by

six percent before the yield of the inverse floater became zero. See

J.A. at 1437. As for price volatility, the risk letter stated that the price

had an inverse relationship to interest rates, "as with all fixed income

securities." Id. As for liquidity risk, the letter claimed that many firms

would bid on inverse floaters and that demand "currently" far

exceeded supply. Id. at 1438.

During the summer of 1992, the Bank's NNI unit independently

investigated the benefits and risks of CMOs. The Bank discussed the

potential investment in CMOs with its counsel and established a

fourteen-step review procedure to be followed prior to each CMO

purchase. The review procedure was later formalized into a written

manual. See J.A. at 1254-79. Buentello, with assistance from Epley,

authored a lengthy analysis entitled "Banca Cremi Investment System

in Inverse Floater." See id. at 643-71. The analysis concluded that

inverse floaters are leveraged "to obtain extraordinary returns" of

around twenty percent. Id. at 645-46.

The Bank's analysis explained that since the market for inverse

floaters began, high returns and decreasing interest rates had given

rise to "a more and more liquid market." J.A. at 657-58. The analysis

described the interest rate structure of inverse floaters in detail, using

charts and graphs to illustrate the sensitivity of inverse floaters to

shifts in the index rate. Similar to Epley's risk letter, the Bank's analysis recognized that if the index rate increased by six percent, the

yield of an inverse floater CMO would dwindle to nothing. The analysis noted that, "[l]ike all fixed rate securities, there is an inverse relationship between interest rates and bond price," and that interest rates

ultimately "influenc[e] returns on the bonds." Id. at 649. Finally,

while the analysis indicated that investments in CMOs complied with

Circular 292, the Bank also reasoned that if these investments did not

_________________________________________________________________

5 It is not clear exactly when these brochures were provided to the

Bank, but it is undisputed that both were provided prior to the purchase

of the CMOs that are the subject of this suit.

 8
comply with Circular 292, they would be like any other international

investment. Id. at 645, 659.

Between August 1992 and August 1993, the Bank made additional

efforts to refine its knowledge of CMO investing. In October 1992

NNI unit director Mendez purchased several lengthy treatises that

described mortgage investments and CMOs in extensive detail. These

books were made available to the NNI unit staff. In May 1993 Buentello attended a seminar on derivatives investing. Buentello also

attended a seminar at which CMO investing and pricing methods

were discussed.

Throughout this period, the Bank was courted by other brokerage

houses who sought to obtain the Bank's CMO business, and the Bank

authorized the NNI unit to engage in CMO transactions with these

brokerage houses. Each brokerage house provided the Bank with their

own internal documents describing the benefits and risks of CMO

investing. In January 1993 one of these brokerage houses forwarded

to the Bank an article warning of what could occur to CMO investments if interest rates were to rise: "[i]f interest rates rise . . . what

investors thought was a safe, secure medium-term maturity can suddenly be transformed into a highly risky long-term security." Randall

W. Forsyth, The Pinocchio Security: Here's the Awful Truth About

CMOs, Barron's, Jan. 18, 1993, at 15. The article suggested that, in

these circumstances, a CMO's price would drop ten to twenty percent

"if you can get a bid for it at all." Id. Epley indicated to the Bank that

he disagreed with the Barron's article, and wrote in a letter that the

risks of a CMO were "less of a concern" for an institutional investor.

J.A. at 1441. Epley included a different Barron's article by Andrew

Bary, who "specialize[d] in covering the institutional investor's capital markets." J.A. at 1442.6

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6 The parties have not included this article in the record, which is

referred to in Epley's letter as having been published "one month prior"

to The Pinocchio Security. During that period, Bary authored only two

articles on CMO investing for Barron's, and both were critical of CMOs.

The first article reasoned that "[i]nstitutional demand" had helped the

CMO market grow, despite the fact that "liquidity remains notoriously

poor," even for large institutional investors. Andrew Bary, Capital Markets: Trading Points, Barron's, Nov. 23, 1992, at 48. In the other, Bary

 9
The Bank purchased its first CMO in August 1992. For the next

year and a half, the Bank purchased a total of twenty-nine CMOs.

Epley was in continual contact with the Bank during its period of

CMO trading. Epley sent numerous faxes and letters to the Bank

encouraging the Bank to make additional CMO purchases. Most of

these suggested purchases were not pursued by the Bank. Epley introduced the NNI unit to a leading CMO expert and finance professor,

Frank J. Fabozzi. Fabozzi was made available to the Bank for technical consultation and sent the Bank textbooks he had written which

described CMOs and other financial instruments. Additionally, on

request, Alex. Brown would perform a "portfolio analysis" of the

Bank's holdings.7 Prior to each CMO purchase, Epley provided the

Bank with the yield matrix for that CMO. The yield matrix set forth

the formula of the CMO's floating interest rate. It also provided a

table that indicated how the CMO's yield and average maturity

changed when interest rate and prepayment conditions changed.

Although the yield matrix indicated the average maturity of the CMO,

it did not specify the formula that was used to calculate the precise

maturity of the CMO.

_________________________________________________________________

explained that "[w]hen rates fall, the yield on the inverse floater jumps,

and when rates rise, the yield on the inverse floater plunges . . . resulting

in a sharp drop in the security's price." Andrew Bary, Capital Markets:

Trading Points, Barron's, Dec. 14, 1992, at 54. Bary asked:

How did an opportunity exist to buy federal-agency mortgage

securities yielding 20%? Because most portfolio managers . . .

were afraid of the price volatility of inverse floaters.

Id. Bary concluded that "[i]f a broker offers one, it pays, of course, to be

very careful," in part, because "[e]ven mortgage experts have a hard time

valuing them." Id.

7 The Bank only requested one such analysis, which was performed by

Alex. Brown in July 1993. Alex. Brown's analysis provided a table that

showed the sensitivity of the price of each CMO the Bank owned to

interest rate changes. The July 1993 analysis indicated that, of the three

types of CMOs the Bank held at that time, the prices of both its inverse

floaters and its inverse IOs were more sensitive to interest rate changes

than its PACs.

 10
The CMOs initially earned interest at rates as high as twenty-four

percent. The Bank played the CMO market aggressively, trading

CMOs frequently to take advantage of short-term market swings. The

Bank sold eight CMOs within three weeks of purchasing them,

including one trade made within twenty-four hours of the Bank's purchase. The Bank sold a total of twenty-three CMOs, each at a profit,

prior to the CMO market downturn in March 1994. The aggregate

price of these twenty-three CMOs exceeded $96 million. The Bank's

profits exceeded $2 million.

Alex. Brown never charged the Bank a commission for the Bank's

CMO purchases. Rather, Alex. Brown purchased the securities and

then sold them to the Bank with a markup. The Bank never asked

Epley or Alex. Brown what markup it placed on the CMOs, and Alex.

Brown never disclosed the amount of markup. Although Alex. Brown

found purchasers for each of the twenty-three CMOs sold by the

Bank, Alex. Brown never charged the Bank a markdown on the sales.

The Bank held six CMOs at the time of the market downturn in

March 1994.8 These six CMOs are the subject of the instant suit.

After the market downturn in February 1994, the price of the six

CMOs dropped precipitously. The Bank claims losses on the six

CMOs of around $21 million of the original purchase price of around

$40 million.9

The Bank filed a complaint for securities fraud against Epley and

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8 These include: (1) FN 93-169 SC, an inverse floater purchased on

August 31, 1993, for approximately $8 million; (2) FN 93-203 SA, an

inverse floater purchased on September 23 and 28, 1993, for approximately $10.1 million; (3) FN 93-210 SD, an inverse floater purchased on

December 6, 1993, for approximately $9.1 million; (4) FHLMC 1676 S,

an inverse floater purchased on January 24, 1994, for approximately $4.6

million; (5) FNR 94-29 SD, an inverse floater purchased on February 2,

1994, for approximately $4.9 million; and (6) FHR 1711 S, an inverse

IO purchased on March 4, 1994, for approximately $6.1 million.

9 The Bank's CMO losses were only the beginning of its troubles. Later

in 1994, the Bank's chairman disappeared with $700 million of the

Bank's assets, leading the Bank to be put into receivership by Mexican

banking authorities.

 11
Alex. Brown in the United States District Court for the District of

Maryland. The Bank claimed that Epley and Alex. Brown violated

§ 10(b) and Rule 10b-5 by: (1) making material misstatements and

omissions regarding the CMOs sold to the Bank; (2) selling the Bank

the CMOs which it knew to be unsuitable investments for the Bank;

and (3) failing to disclose fraudulently excessive markups totaling $2

million on the CMO sales. The Bank also claimed violations of the

Maryland Securities Act, common law breach of fiduciary duty, negligence, negligent misrepresentation, and fraud.

In support of their claim that Epley and Alex. Brown made numerous material omissions and misstatements, the Bank alleged that

Epley and Alex. Brown failed to provide the Bank with material

information about the functioning of each of the CMOs, including: (1)

the impact of interest rates on CMO price; (2) the precise principal

repayment priority; and (3) the impact of interest rates on CMO

liquidity. The Bank also alleged that the defendants failed in their

duty to provide: (1) information normally included in a CMO

prospectus10; (2) sophisticated computer software to reverse engineer

new issue CMOs to reveal their performance in various market conditions; (3) information regarding the CMOs' qualification under Mexico's Circular 292; and (4) information regarding the CMOs'

qualification under U.S. banking regulations. The Bank also alleged

that Epley and Alex. Brown made material misstatements when they:

(1) downplayed the impact of a change in interest rates on CMO

prices by comparing it to that of other fixed income securities; (2)

stated that demand for CMOs currently far exceeds supply; (3)

claimed that CMOs had relatively low risk levels; (4) claimed that the

inverse IOs sold to the Bank had a self-hedging feature; and (5) told

the Bank that the criticisms in the Barron's Pinocchio Security article

should be less of a concern for institutional investors than for individual investors.

After discovery, the district court granted summary judgment to

Epley and Alex. Brown on all claims. The district court concluded

that the Bank had failed to raise a genuine issue of material fact as

_________________________________________________________________

10 The Bank does not claim that a prospectus, itself, should have been

provided. In fact, it is unclear whether prospectuses for the CMO tranches existed at the time of their purchase.

 12
to three of the four elements that must be proved to establish a violation of § 10(b). First, the district court reasoned that Epley and Alex.

Brown had made no material omissions or misstatements regarding

the risks of the CMOs because they made general disclosures of yield,

price, and liquidity risks. Further, the district court found that the

Bank's allegation that scienter existed because Epley and Alex.

Brown encouraged purchases in order to earn excessive markups to

be based only on speculation. Finally, the district court concluded that

several factors, including the Bank's size and its sophistication and

the expertise of the NNI unit employees, did not allow the Bank to

justifiably rely on any misstatements that Epley and Alex. Brown

might have made.11

The district court rejected the Bank's suitability claim as a subset

of the rejected § 10(b) claim. The district court also rejected the

Bank's claim that the markups were excessive, concluding that most

of the markups were within standards provided by the National Association of Securities Dealers (NASD), and that no evidence had been

submitted to establish that the higher markups were not justified by

special circumstances.

The district court also rejected the Bank's state law claims, holding

that the Maryland Securities Act did not apply to Alex. Brown

because it was a broker-dealer, and that, based on either Texas or

Maryland state law, the Bank's tort claims failed as a matter of law.

The Bank appeals the district court's grant of summary judgment.

II.

We review the district court's grant of summary judgment de novo.

See Myers v. Finkle, 950 F.2d 165, 167 (4th Cir. 1991). To defeat the

motion for summary judgment, the Bank must raise a genuine issue

of material fact as to each element essential to its case. See Celotex

Corp. v. Catrett, 477 U.S. 317, 322 (1986). A factual issue raised by

the Bank is only genuine if a reasonable jury could return a verdict

for the Bank on each element necessary to its case. See Anderson v.

Liberty Lobby, Inc., 477 U.S. 242, 248 (1986).

_________________________________________________________________

11 The district court did not address proximate causation, the final element of a § 10(b) claim.

 13
To establish liability under § 10(b), the Bank must prove that "(1)

the defendant[s] made a false statement or omission of material fact

(2) with scienter (3) upon which the plaintiff justifiably relied (4) that

proximately caused the plaintiff's damages." Cooke v. Manufactured

Homes, Inc., 998 F.2d 1256, 1260-61 (4th Cir. 1993) (quotations and

citation omitted). In this case, the Bank has failed to present evidence

that would permit a reasonable jury to find that the Bank justifiably

relied on any omissions or misstatements made by Epley and Alex.

Brown.12

A.

A dissatisfied investor cannot recover for a poor investment on the

basis of a broker's alleged omission or misstatement where, "through

minimal diligence, the investor should have discovered the truth."

Brown v. E.F. Hutton Group, Inc., 991 F.2d 1020, 1032 (2d Cir.

1993). Because the justifiable reliance requirement "requir[es] plaintiffs to invest carefully," it "promotes the anti-fraud policies" of the

securities acts by making fraud more readily discoverable. Dupuy v.

Dupuy, 551 F.2d 1005, 1014 (5th Cir. 1977). A plaintiff's failure to

prove that it justifiably relied on a broker's alleged omission or misstatement is necessarily fatal to a securities fraud claim. See Myers,

950 F.2d at 167.13

An investor's reliance on a broker's omission or misstatement is

never justified when the "investor's conduct rises to the level of recklessness." Brown, 991 F.2d at 1032.14 A plaintiff is reckless if he "in-

_________________________________________________________________

12 Because the Bank cannot show justifiable reliance, its § 10(b) action

fails as a matter of law and we need not address the district court's other

grounds for granting summary judgment against the plaintiff on this

claim.

13 Courts often infer reliance when a plaintiff alleges that the defendant

made a material omission, see Carras v. Burns, 516 F.2d 251, 257 (4th

Cir. 1975), requiring the defendant to rebut the inference by proving the

lack of reliance. See id. No presumption of reliance exists, however,

"when the plaintiff alleges both nondisclosure and positive misrepresentation instead of only nondisclosure." Cox v. Collins, 7 F.3d 394, 395-96

(4th Cir. 1993).

14 Indeed, courts traditionally have held that reliance is not justified

when the investor was merely negligent. See Royal Am. Managers, Inc.

 14
tentionally refuse[s] to investigate in disregard of a risk known to him

or so obvious that he must be taken to have been aware of it, and so

great as to make it highly probable that harm would follow." Dupuy,

551 F.2d at 1020 (quotations and citation omitted). Stated differently,

a plaintiff is reckless if he "possesses information sufficient to call [a

mis-] representation into question," but nevertheless "close[s] his eyes

to a known risk." Teamsters Local 282 Pension Trust Fund v.

Angelos, 762 F.2d 522, 530 (7th Cir. 1985) (citation omitted). Thus,

"[i]f the investor knows enough so that the lie or omission still leaves

him cognizant of the risk, then there is no liability." Id.

This Court weighs eight factors to determine whether an investor

is justified in relying on a material omission or misstatement:

(1) the sophistication and expertise of the plaintiff in

financial and securities matters;

(2) the existence of long standing business or personal

relationships;

(3) access to relevant information;

(4) the existence of a fiduciary relationship;

(5) concealment of the fraud;

(6) the opportunity to detect the fraud;

(7) whether the plaintiff initiated the stock transaction or

sought to expedite the transaction; and

_________________________________________________________________

v. IRC Holding Corp., 885 F.2d 1011, 1015 (2d Cir. 1989). Many federal

courts reconsidered the negligence standard after the Supreme Court, in

Ernst & Ernst v. Hochfelder, 425 U.S. 185, 193 (1976), held that a person could only be liable under § 10(b) for intentional conduct. See Dupuy

v. Dupuy, 551 F.2d 1005, 1017-20 (5th Cir. 1977). At least one court has

apparently retained the negligence standard. See Straub v. Vaisman &

Co., 540 F.2d 591, 598 (3d Cir. 1976) ("The obligation of due care must

be a flexible one, dependent upon the circumstances of each case. We

require only that the plaintiff act reasonably.").

 15
(8) the generality or specificity of the misrepresentations.

Myers, 950 F.2d at 167 (quotations and alteration omitted). No single

factor is dispositive of whether reliance is justified. Id. The first

Myers factor, the sophistication of the investor, has long been a critical element in determining whether an investor was entitled to § 10(b)

relief. See Kohler v. Kohler Co., 319 F.2d 634, 642 (7th Cir. 1963)

(considering an investor's "business acumen" and access to "extrinsic

sources of sound business advice" to conclude there was no reliance,

although the transaction might not have been fair if the investor "had

been a novice"); List v. Fashion Park, Inc., 340 F.2d 457, 463-64 (2d

Cir. 1965) (no reliance where investor was "an experienced and successful investor in securities" who did not ask his broker for information regarding the claimed omission). A sophisticated investor

requires less information to call a "[mis-]representation into question"

than would an unsophisticated investor. Angelos, 762 F.2d at 530.

Likewise, when material information is omitted, a sophisticated investor is more likely to "know[ ] enough so that the . . . omission still

leaves him cognizant of the risk." Id.

When an investor is an individual, this Court looks to several factors to determine if the investor is sophisticated, including "wealth[,]

. . . age, education, professional status, investment experience, and

business background." Myers, 950 F.2d at 168. Some of these factors

may not be perfectly suited for application to an institutional investor.

Cf. C. Edward Fletcher, Sophisticated Investors Under the Federal

Securities Laws, 1988 Duke L.J. 1081, 1149-53 (reviewing factors

gauging sophistication of individual investors, and concluding that

there should be a "conclusive presumption" that all institutional investors are sophisticated). However, the factors which are relevant to an

institution strongly support the sophistication of the Bank. The Bank,

with assets of $5 billion, is unquestionably wealthy. In addition, while

the Bank's investment choices may have been unwise, its investment

experience is extraordinary, and far surpasses most sophisticated individual investors. As a business entity, the Bank obviously has a business background, and its employees--hired for their business

expertise--had extensive education and experience in economics and

finance.15

_________________________________________________________________

15 The NASD has also promulgated factors specifically designed to

measure the sophistication of institutional investors. Order Approving

 16
Despite its extensive investment experience and extraordinary

resources, the Bank nevertheless contends that, while it may be

sophisticated in certain types of investments, it was not sophisticated

in CMO investments. See, e.g., McAnally v. Gildersleeve, 16 F.3d

1493, 1500 (8th Cir. 1994) (recognizing that an individual's sophistication in "stocks and bonds" did not necessarily suggest sophistication in commodities futures options); Order Approving NASD

Suitability Interpretation, 61 Fed. Reg. 44,100, 44,112 (1996) (NASD

Fair Practice Rules) (in approving NASD fair practice rules, SEC recognized that even a sophisticated institutional investor may not be

capable of understanding a "particular investment risk"). The Bank

argues that deposition testimony of its employees and an expert witness that the Bank was unsophisticated in CMO investments created

a genuine issue of fact.

We reject this argument. The Bank's NNI unit, whose function was

to invest Bank funds in dollar-denominated investments, employed

three well-educated investment professionals to select a sound, but

profitable, investment strategy. Mendez, Aguirre, and Buentello conducted a thorough, independent investigation of the benefits and risks

of CMO investments by attending seminars, purchasing treatises on

the subject, and developing a multi-step review process for each

CMO investment. Rather than blindly relying on Epley and Alex.

Brown, the record shows that the Bank rejected Epley's suggested

investments far more often than it accepted them. Indeed, the Bank

consulted with five other brokerage houses regarding CMO investments, and each of these brokerage houses gave the Bank detailed

information describing the benefits and the risks of CMO investments. After a year of trading in CMOs, the Bank displayed a knowledge and an aggressiveness that belie its current claim that it did not

understand CMO investments. See J.A. at 447-48 (indicating dramatic

price changes over short time periods for many of the Bank's profit-

_________________________________________________________________

NASD Suitability Interpretation, 61 Fed. Reg. 44,100, 44,112 (1996).

The two most important factors are an institutional investor's "capability

to evaluate investment risk independently, and the extent to which the

[investor] is exercising independent judgment." Id. at 44,105. In light of

the undisputed record, it is clear that the Bank would also qualify as a

highly sophisticated institutional investor under the NASD standards.

 17
able CMO trades: FNMA 92 112 SC was sold after one day at a profit

reflecting an annual increase of over 350%; FN 93-115 SB was sold

after two weeks at a profit reflecting an annual increase of around

58%; FNMA 1992 162 SB was sold after two weeks at a profit

reflecting an annual increase of around 38%); NASD Fair Practice

Rules, 61 Fed. Reg. at 44,105 n.20 ("[An institution] who initially

needed help understanding a potential investment may ultimately

develop an understanding and make an independent investment decision."). Accordingly, we agree with the district court that the Bank

was a "sophisticated investor" for the purposes of this case. See Banca

Cremi v. Alex. Brown, 955 F. Supp. 499, 515 (D. Md. 1997).

The second Myers factor also lends no support to the Bank's claim

of justifiable reliance. There is no evidence in the record that the

Bank enjoyed a long-standing business or personal relationship with

Epley or Alex. Brown, and the undisputed evidence strongly supports

the lack of any such relationship. The Bank began purchasing CMOs

a mere two months after first being "cold called" by Epley, and the

conduct of the Bank--consulting with competing brokerage houses

and rejecting most of Epley's recommendations--suggests that the

Bank dealt with Epley and Alex. Brown at arm's length. Accordingly,

this is not a situation where the defendants could have "exploited the

business relationship [with the plaintiff] knowing that [the plaintiff]

was not likely to investigate the merits of [the defendants'] recommendation." Straub v. Vaisman & Co., 540 F.2d 591, 598 (3d Cir.

1976) (quotations omitted).16

The third, fifth, and sixth Myers factors look to whether the Bank

_________________________________________________________________

16 Relying on innuendo and veiled suggestions, the Bank apparently

contends that Buentello and Epley had a sexual relationship, and that

Epley and Alex. Brown exploited that relationship. We first note that an

appellate brief is not a paperback romance novel, where tawdry goingson can be hinted at with a smirk and a wink; if the Bank had a point to

make with its innuendo, we would have preferred that it were clear about

it. As there is not a shred of evidence in the record to support the Bank's

salacious suggestions, and even less evidence to suggest that this hintedat relationship had any effect on Buentello's business decisions, we find

it unfortunate that the Bank found it necessary to tarnish the reputations

of the opposing party and its own employee.

 18
had access to the relevant information on CMOs, whether Epley and

Alex. Brown concealed the alleged fraud, and whether the Bank had

an opportunity to detect the fraud. In this case, there is no allegation

that Epley or Alex. Brown concealed specific risks of individual

investments, but rather that they misrepresented the risks associated

with an entire field of investment. Clearly, the Bank--through its

independent research, contacts with other brokerage houses, and discussions with Epley and Alex. Brown--not only had access to, but

actually possessed more than sufficient information to make it aware

of the substantial risks of investing in CMOs. The Bank knew that,

although it could enjoy substantial earnings from CMO investments

if interest rates decreased or remained the same, any increase in interest rates could wreak havoc on its CMO investment strategy. The

Bank also knew that more sophisticated analyses of its CMO portfolio

was available, such as the price analysis performed by Alex. Brown

on the Bank's portfolio in July 1993. The July 1993 price analysis

indicated that both inverse floaters and inverse IOs were more sensitive to interest rate increases than other types of CMOs, not to mention other more conservative fixed-rate investments such as U.S.

Treasury Bonds. Despite possessing this information, the Bank purchased the six CMOs and never requested any analysis either before

or after purchase.

The fourth Myers factor, whether the defendants owed a fiduciary

duty to the plaintiff, is also not implicated in this case. As will be discussed below, see infra, § V, Epley and Alex. Brown were not the

agents of the Bank, but rather interacted with the Bank at arm's length

in principal-to-principal dealings, and no common law fiduciary duty

was ever created.

The seventh Myers factor looks to whether the Bank initiated or

sought to expedite the transaction. While the Bank had sufficient time

to review each of its CMO purchases, and evidenced independent

decision-making by rejecting numerous suggested purchases by Epley

and employing elaborate procedures to review each suggested purchase, it was Epley who initially suggested these investments to the

Bank. Accordingly, we agree with the Bank that this factor lends

some support to its argument for justifiable reliance. But see Chance

v. F.N. Wolf & Co., No. 93-2390, 1994 WL 529901, at *6 (4th Cir.

Sept. 30, 1994) (unpublished, table decision reported at 36 F.3d 1091)

 19
(defendant entitled to judgment as a matter of law on justifiable reliance despite fact that defendant "initiated all of the stock transactions").

The final Myers factor looks to whether the misrepresentations

were general or specific. The Bank argues, and we agree, that the

defendants' alleged misstatements were general. Contrary to the

Bank, however, we conclude that a general statement creates less justifiable reliance than would a specific statement. See Hillson Partners

Ltd. Partnership v. Adage Corp., 42 F.3d 204, 215 (4th Cir. 1994)

(explaining that investor is more justified in relying on specific predictions); Zobrist v. Coal-X, Inc., 708 F.2d 1511, 1518 (10th Cir.

1983) (noting that there is no "valid reason" to rely on general misrepresentations as to risk when more specific warnings have been provided); Hughes v. Dempsey-Tegeler & Co., 534 F.2d 156, 177 (9th

Cir. 1976) (sophisticated investor was not justified in relying on general positive comments regarding investment risks). Epley's general

positive statements concerning CMOs did not justify reliance when

the Bank possessed a variety of resources, including investmentspecific yield and average life tables, scholarly works, and an article

published in a popular business journal explaining in great detail the

workings and risks of CMOs.

In sum, in this case the Bank had access to an extraordinary wealth

of information regarding CMOs. With few exceptions, the depth and

breadth of this information illustrated one overriding point: investments in CMOs, while potentially very profitable, were undoubtedly

highly risky. As a sophisticated business entity handling five billion

dollars of other people's money, the Bank had the advice of its own

employees and a horde of the defendants' competitors. Nevertheless,

the Bank invested in CMOs through arm's length dealings with the

defendants. While the vast majority of these investments were profitable for the Bank, a half-dozen proved disastrously timed,17 and the

_________________________________________________________________

17 The Bank has never alleged that the defendants had any reason to

believe that the CMO market would collapse when it did. Indeed, in a

meeting at which Buentello discussed its CMO losses, the Bank concluded that the CMO price drop was caused by the "totally unpredictable

situation [of an increased estimate of U.S. GNP] and the unprecedented

 20
Bank now alleges that its misfortune resulted from its justifiable

naivete in listening to the defendants' purported lies.

As in any "action[ ] for fraud, reliance on false statements must be

accompanied by a right to rely." Foremost Guar. Corp. v. Meritor

Sav. Bank, 910 F.2d 118, 125 (4th Cir. 1990). Here, the Bank lost its

right to rely by its own recklessness. The Bank continued to purchase

CMOs after it had sufficient information, given its sophistication, to

be well apprised of the risks it would face were interest rates to rise.

Given that the Bank was aware of the risks involved in investing in

CMOs, the Bank was not justified in relying on Epley and Alex.

Brown's alleged omissions and misstatements. Accordingly, we

affirm the district court's grant of summary judgment against the

Bank on this claim.

B.

The Bank next contends that Epley and Alex. Brown learned that

CMO investments did not comply with the requirements of Mexican

Circular 292 and U.S. banking regulations, but failed to inform the

Bank of this. Because the defendants allegedly had a duty to the Bank

to inform them of this understanding of Mexican and United States

law, the Bank contends that the Bank justifiably relied on this omission. Because the Bank contends that it would not have invested in

the CMOs had it possessed this information, the Bank contends that

the omission was material and caused its investment losses.

While the plaintiff has presented a very creative claim, it is not a

meritorious one. Any non-reckless Mexican bank attempting to interpret Mexican banking regulations would turn to Mexican lawyers or

_________________________________________________________________

move by the Fed to increase short-term rates in a preventative fashion."

J.A. at 458. In light of this recognition by the plaintiffs that their losses

were caused by general market forces rather than the defendants' alleged

misdeeds, it is puzzling at best on what basis the plaintiffs hoped to

prove liability under § 10(b). Cf. Bastian v. Petran Resources Corp., 892

F.2d 680, 685 (7th Cir. 1990) (noting that "[d]efrauders are a bad lot and

should be punished, but Rule 10b-5 does not make them insurers against

national economic calamities").

 21
Mexican government officials for assistance, rather than relying on an

American salesman's opinion. Furthermore, while the requirements of

Circular 292 are not discussed in detail by the parties, it appears

undisputed that to comply, a security must have a stated maturity of

less than one year. As many home mortgages have maturities of several decades, we believe that only a reckless investor would fail to

recognize that investments in CMOs might not comply with Mexican

law. Accordingly, even if the Bank had some legitimate, or even

coherent, reason for eschewing appropriate legal assistance in interpreting Circular 292, any reliance on the defendants' silence was not

justifiable. See Dupuy, 551 F.2d at 1020 (no justifiable reliance where

a plaintiff "intentionally refuse[s] to investigate in disregard of a risk

known to him or so obvious that he must be taken to have been aware

of it, and so great as to make it highly probable that harm would follow" (quotations and citation omitted)).

III.

The Bank next claims that Epley and Alex. Brown committed

§ 10(b) fraud by selling securities to the Bank that the defendants

knew were not suited for the Bank's investment goals. We disagree.

While this Court has never considered an unsuitability claim under

§ 10(b), several courts have recognized an unsuitability claim in certain circumstances. See, e.g., O'Connor v. R.F. Lafferty & Co., 965

F.2d 893, 898 (10th Cir. 1992) (recognizing two types of unsuitability

claims, one based on § 10(b) fraud and one similar to churning

claim); Craighead v. E.F. Hutton & Co., 899 F.2d 485, 493 (6th Cir.

1990) (recognizing unsuitability claim as a type of fraud claim);

Lefkowitz v. Smith Barney, Harris Upham & Co., 804 F.2d 154, 155

(1st Cir. 1986) (per curiam) (same); Clark v. John Lamula Investors,

Inc., 583 F.2d 594, 600-01 (2d Cir. 1978) (recognizing unsuitability

claim).

A § 10(b) unsuitability claim has five elements:

(1) that the securities purchased were unsuited to the

buyer's needs;

 22
(2) that the defendant knew or reasonably believed the

securities were unsuited to the buyer's needs;

(3) that the defendant recommended or purchased the

unsuitable securities for the buyer anyway;

(4) that, with scienter, the defendant made material misrepresentations (or, owing a duty to the buyer, failed to disclose material information) relating to the suitability of the

securities; and

(5) that the buyer justifiably relied to its detriment on the

defendant's fraudulent conduct.

Brown v. E.F. Hutton Group, Inc., 991 F.2d 1020, 1031 (2d Cir.

1993) (emphasis added). A claim for § 10(b) suitability fraud "is a

subset of the ordinary § 10(b) fraud claim." Id.; see also O'Connor,

965 F.2d at 897 (Court recognizing that this type of suitability claim

could be analyzed "simply as a misrepresentation or failure to disclose a material fact. In such a case, the broker has omitted telling the

investor the recommendation is unstable for the investor's interests.

The court may then use traditional laws concerning omission to examine the claim." (citation omitted)).

Because the Bank's suitability claim is a "subset" of the Bank's

§ 10(b) claim, we conclude that it must fail for the same reason: lack

of justifiable reliance. The Bank had sufficient information concerning the risks of CMOs to render unjustified any reliance on a recommendation that the securities were suitable investments. Yield tables

apprised the Bank that inverse floaters' yield decreased and average

maturity increased dramatically if interest rates increased. In light of

its sophistication, the Bank must be presumed to have been aware

that, were interest rates to increase, there would be substantial "risk

to capital," contrary to one of its stated goals. 18

_________________________________________________________________

18 For example, the yield table for one of the six CMOs, FN 93-210 SD,

indicates that a one point increase in interest (accompanied, as the table

suggests, by a reduction in prepayments) would convert a security maturing in 3.8 years and yielding 14.8 percent interest into a security maturing in 16.11 years and yielding only 7.42 percent interest. Naturally, an

investor as sophisticated as the Bank would understand that the result of

this change would be a dramatic fluctuation in the market price of the

security.

 23
Similarly, the Bank knew that CMOs were a new product whose

demand had grown because the market remained strong, and knew

that a Barron's article had warned that an interest rate increase might

lead to liquidity problems. Thus, given the Bank's sophistication, it

must have been aware that if interest rates increased, its CMOs might

not remain "highly liquid," contrary to another of the Bank's stated

goals.

Finally, the Bank was apprised in the yield tables that the average

maturity for each of the CMOs was well in excess of the "90-180

days" it claims as its investment goal. Given the Bank's sophistication, it must have understood that it might have to hold the security

for over 180 days if it did not want to accept the going market price

for the CMO. See J.A. at 447-48 (Bank earned a substantial profit in

selling three CMOs after holding them for over 180 days). In sum, the

Bank appeared to have been most interested in its final stated goal:

"good yield." The only reasonable conclusion is that the Bank itself

chose its CMO investment strategy by balancing CMO risks and benefits against its four competing goals.19 The Bank cannot now claim

that its investment strategy was the result of it justifiably relying on

the recommendations of Epley and Alex. Brown.

IV.

Next, the Bank contends that Epley and Alex. Brown fraudulently

charged excessive markups for the CMOs purchased by the Bank, and

that the district court erred in granting summary judgment on this

claim. We disagree.

"A securities broker's mark-up equals the price charged to the customer minus the prevailing market price." Bank of Lexington & Trust

Co. v. Vining-Sparks Sec., Inc., 959 F.2d 606, 613 (6th Cir. 1992). For

_________________________________________________________________

19 The Tenth Circuit also recognized a distinct type of suitability claim

which arises when a broker's act of purchasing a stock is fraudulent.

O'Connor v. R.F. Lafferty & Co., 965 F.2d 893, 898 (10th Cir. 1992).

One element of this claim is that "the broker exercised control over the

investor's account." Id. Because the Bank does not claim that Alex.

Brown controlled the Bank's CMO account, this type of suitability claim

is unavailable to the Bank.

 24
example, where the securities purchased have a market value of

$100,000 and the broker charges its customers $105,000, the markup

is $5000, or five percent. Where, as in the instant case, the broker

charges no commission, the markup represents the sole compensation

received by the broker for the transaction.

"A mark-up is excessive when it bears no reasonable relation to the

prevailing market price." Id. Factors relevant in determining reasonableness include:

(1) the type of security involved; (2) the availability of the

security in the market; (3) the price of the security; (4) the

amount of money involved in a transaction; (5) disclosure;

(6) the pattern of markups or markdowns; and (7) the nature

of the member's business.

3C Harold S. Bloomenthal, Securities and Federal Corporate Law,

App. 12.13 (Apr. 1, 1992). Although each case requires an independent analysis for determining whether a given markup is reasonable,

the Board of Governors of the NASD has determined that, as a general guideline, a five percent markup is reasonable. See id.20

Although securities brokers are required to disclose markups in

equity securities, see 17 C.F.R. § 240.10b-10(a)(2)(ii)(A) & (B), there

is no requirement for a broker to disclose the amount of markup

charged for a debt security in a riskless transaction. See id. The SEC

once considered promulgating regulations requiring such a disclosure.

See Release No. 34-15220, 15 S.E.C. Docket 1260, 1978 WL 19902

(S.E.C.) (Oct. 6, 1978), at *1. However, the SEC withdrew its proposed regulations "because [the SEC] has concluded that [the regulations] would not achieve the purposes of the proposal at an acceptable

cost and that there are alternative ways of achieving the same goal

with fewer adverse side effects." Release No. 34-18987, 25 S.E.C.

Docket 1223, 1982 WL 35762 (S.E.C.) (Aug. 20, 1982), at *2.

_________________________________________________________________

20 Because the reasonableness of markups is situation-specific, the

NASD guideline recognizes that markups of under five percent may be

excessive. See 3C Harold S. Bloomenthal, Securities and Federal Corporate Law, App. 12.13 (Apr. 1, 1992).

 25
The SEC has brought administrative actions for fraud under 17

C.F.R. § 240.10b-5 against securities brokers who have allegedly

charged excessive markups to their debt securities customers without

disclosing the markups. See, e.g., Ettinger v. Merrill Lynch, Pierce,

Fenner & Smith, Inc., 835 F.2d 1031, 1033 (3d Cir. 1987) (citing

cases). The SEC has explained that

[i]nherent in the relationship between a dealer and his customer is the vital representation that the customer will be

dealt with fairly, and in accordance with the standards of the

profession. It is neither fair dealing nor in accordance with

such standards to exploit trust and ignorance for profits far

higher than might be realized from an informed customer.

It is fraud to exact such profits through the purchase or sale

of securities while the representation on which the relationship is based is knowingly false. This fraud is avoided only

by charging a price which bears a reasonable relation to the

prevailing price or disclosing such information as will permit the customer to make an informed judgment upon

whether or not he will complete the transaction.

Trost & Co., 12 S.E.C. 531, 535 (1942). Because the securities dealer

creates this implied duty to disclose excessive markups by "hang[ing]

out its professional shingle," this theory of liability is referred to as

the "shingle theory" by the SEC. See Reply Br. of the Amicus Curiae

SEC at 2.

In Ettinger, the Third Circuit recognized a private cause of action

for a violation of this implied duty to disclose certain markups. See

835 F.2d at 1033, 1036 (failure to disclose excessive markup actionable under Rule 10b-5 despite dealer's compliance with Rule 10b-10).

To date, it appears that only the Sixth Circuit has also recognized

such a private cause of action. See Bank of Lexington, 959 F.2d at 614

(affirming denial of liability for alleged fraud, and concluding that

"[a]lthough an undisclosed mark-up of 5 percent on municipal bonds

might sometimes violate Rule 10b-5, the Bank fails to convince us

that the district court clearly erred when it found that a 5 percent

mark-up on the bonds sold to the Bank, without more, was not so

excessive as to require disclosure"). As with all allegations of fraud

under § 10(b), a plaintiff alleging a "shingle theory" failure to disclose

 26
an excessive markup must present evidence to satisfy four elements:

(1) a misrepresentation or omission of a material fact; (2) made with

scienter; (3) upon which the plaintiff justifiably relied; and (4) which

proximately caused the plaintiff's damages. See Cooke, 998 F.2d at

1260-61 (describing elements of fraud).

In the instant case, the Bank alleged that Epley and Alex. Brown

charged undisclosed and excessive markups on nineteen CMO

transactions.21 These included two markups of 5.25 percent, one

markup of 4.99 percent, seven markups of between 3.1 percent and

3.77 percent, seven markups of between 2.4 percent and 2.84 percent,

and two markups of 2.06 percent and 1.78 percent, respectively. In

brokering over $100,000,000 in CMOs to the Bank, Epley and Alex.

Brown received some $2,000,000 in markups.

Although all but two of the markups in the instant case were below

the NASD's five percent guideline, the SEC contends that "there is

no safe harbor of five percent for markups on any securities," Reply

Br. of Amicus Curiae SEC at 11, and the Bank alleges that all nineteen of the markups were excessive. To support its allegation of

excess, the Bank proffered a well-compensated expert witness who

testified that any markup of more than one percent was excessive. See

J.A. at 1758 (James I. Midanek Dep. (Sept. 12, 1996) at 205).22

By presenting expert testimony that Epley and Alex. Brown's

markups between 1.77 percent and 5.25 percent were excessive, the

Bank contends that it has met its burden of resisting a summary judgment motion. Because the Bank has presented a "prima facie" case of

excessive markups, the Bank asserts that "the burden of proof shifts

_________________________________________________________________

21 It appears that some of these transactions may have taken place while

Epley was with his previous employer, MMAR Group. Because we conclude that no fraudulent markups have been proven by the Bank, we need

not distinguish between those transactions involving both defendants and

those transactions involving only Epley.

22 Mr. Midanek, who holds a bachelor's degree in accounting, acknowledged that he received $450 per hour for his testimony on behalf of the

Bank. See J.A. at 1593 (James I. Midanek Report at 4).

 27
to the broker to show that the markups were reasonable." Appellants'

Br. at 45.23

Because the markups in the instant case were undisclosed and

allegedly excessive, the SEC, as amicus, contends that these omissions were necessarily material. See Br. of Amicus Curiae SEC at 17

("Because a reasonable investor in making his investment decision

would consider it important that he was being charged an excessive

markup, the Commission has long held that such a markup is material

as a matter of law."). Further, because this case involves an omission

rather than a misstatement, the Bank contends that reliance can be

presumed. See Appellants' Reply Br. at 21; see also Edens v. Goodyear Tire & Rubber Co., 858 F.2d 198, 207 (4th Cir. 1988) ("where

fraudulent conduct involves primarily a failure to disclose, positive

proof of reliance is not a prerequisite to recovery" (quotations and

citation omitted)). Finally, the Bank contends that the scienter

requirement is satisfied "[w]hen a dealer knows the prevailing market

price and the price it is charging the customer and knows or recklessly

disregards the fact that this markup is excessive." Appellants' Reply

Br. at 21 n.33 (quoting Meyer Blinder, 50 S.E.C. 1215, 1230 (1992)).24

In summary, the Bank argues that securities dealers have an

inferred duty to disclose certain markups, despite the SEC's specific

decision not to require such disclosures through regulations. Dissatis-

_________________________________________________________________

23 The Bank cites First Honolulu Sec., Inc., 51 S.E.C. 695 (1993), in

which the SEC declared:

The NASD, as proponent of the issue, had the burden of introducing prima facie evidence of the excessiveness of the markups.

The NASD met this burden by presenting evidence that the

transactions at issue existed, the size of the transactions, the

nature of the securities, the prices paid by Applicants contemporaneously, and the prices charged to the customers. Once the

NASD presented evidence of the markups, the burden shifted to

Applicants to refute this evidence.

Id. at 701 n.23.

24 The element of proximate cause and damages is also automatically

satisfied in a "shingles theory" claim because the funds that went to the

dealer for the allegedly excessive markup would have been retained by

the customer had the customer known that the markup was excessive.

 28
fied customers who feel that an undisclosed markup is excessive,

including a markup of well under the NASD five percent guideline,

may bring a private cause of action for fraud based on a dealer's failure to meet this inferred duty to disclose. Once a plaintiff presents an

expert witness's testimony that the markup charged is excessive, the

burden shifts to the defendant to prove that he did not commit fraud.

To the extent of defeating a summary judgment motion, every element of fraud--materiality, reliance, scienter, and proximate cause of

damages--is inferred or can be presumed. In other words, once a

markup exceeds the amount that a paid expert witness, after the fact,

declares excessive, a defendant must proceed to trial to prove that he

did not commit fraud.

We are acutely uncomfortable with this scheme. If the state of the

law were actually as the Bank and the SEC contend, it is unthinkable

that any dealer would ever fail to disclose any markup, no matter how

minimal, and thereby risk a lawsuit that would inevitably lead to the

expense and notoriety of a jury trial. Indeed, the SEC acknowledges

that this is the only practical alternative that dealers would have. See

Reply Br. of Amicus Curiae SEC at 11 ("a broker-dealer in doubt

over whether a markup is proper may protect itself by making such

a disclosure"). It is puzzling why, if Rule 10b-5 always imposed this

requirement to disclose on dealers, the SEC considered amending

Rule 10b-10 to impose a preexisting requirement. See Release No. 34-

15220, 15 S.E.C. Docket 1260, 1978 WL 19902 (S.E.C.), at *1. It is

even more puzzling why the SEC, having once abandoned an effort

to administratively require such disclosures, should now seek to judicially impose the identical requirements on dealers. See Release No.

34-18987, 25 S.E.C. Docket 1223, 1982 WL 35762 (S.E.C.), at *2.

Assuming that a private cause of action is available to the Bank,

we must reject the Bank's suggestion that the burden of proof in this

case should shift to the defendant. As the facts of the instant case

demonstrate, it is very easy to accuse someone of fraud, and it is clear

that the mere accusation of fraud can be damaging to a defendant's

reputation. A plaintiff alleging fraud has both a heavy burden of

pleading fraud with particularity, see Fed. R. Civ. P. 9(b),25 and in

_________________________________________________________________

25 As was explained by our sister circuit in Parnes v. Gateway 2000,

Inc., there are three reasons for Federal Rule of Civil Procedure 9(b)'s

heightened burden of pleading in fraud cases:

 29
proving each element of the cause of action. See, e.g., White v.

National Steel Corp., 938 F.2d 474, 490 (4th Cir. 1991) (In case of

fraud, "plaintiffs carry an unquestionably heavy burden of proof. The

existence of actual fraud is not deducible from facts and circumstances which would be equally consistent with honest intentions. In

sum, a presumption always exists in favor of innocence and honesty

in a given transaction and the burden is upon one who alleges fraud

to prove it by clear and distinct evidence." (quotations, citations, and

alteration omitted) (applying West Virginia law)). In the instant case,

the plaintiff has failed to meet this burden.

While reliance can often be inferred in a failure-to-disclose case,

see Edens, 858 F.2d at 207, that inference has been rebutted in the

instant case. See Carras v. Burns, 516 F.2d 251, 257 (4th Cir. 1975)

(inference of reliance is rebuttable). An economist for the Bank, NNI

unit director Mendez, explained why the defendants' markup was

unimportant to the Bank:

Q[uestion by counsel]: Was Alex Brown the counter party

in these transactions?

A[nswer by Mendez]: Yes, of course.

Q. Did you know what the difference was between their

purchase price and their sales price?

A. No.

_________________________________________________________________

First, it deters the use of complaints as a pretext for fishing expeditions of unknown wrongs designed to compel in terrorem settlements. Second, it protects against damage to professional

reputations resulting from allegations of moral turpitude. Third,

it ensures that a defendant is given sufficient notice of the allegations against him to permit the preparation of an effective

defense.

122 F.3d 539, 549 (8th Cir. 1997) (quotations and citations omitted).

These same principles support our decision that a plaintiff alleging fraud

should retain the burden of proof.

 30
Q. And you never asked?

A. No.

Q. Because as is true of all these other investments made

during this period of time, that's not consistent with business practice?

A. That's correct.

Q. Because you satisfy yourself with respect to the cost to

you?

A. To the price that we were buying it for from Alex

Brown.

J.A. at 272-73 (Mendez Dep. (Feb. 29, 1996) at 56-57 (emphasis

added)). NNI unit subdirector Aguirre, also an economist, agreed with

director Mendez's appraisal:

Q[uestion by counsel]: [J]ust to be clear, Banca Cremi was

accustomed to dealing with some transactions in which the

intermediary made a profit on the purchase and sale instead

of charging a commission?

A[nswer by Aguirre]: I believe that this is something that

would not be valid for only an institution like Cremi, but for

any type of institution.

Q. That in some markets people act as principals for profits, rather than agents for commissions?

A. You see it daily. That's a daily activity in any exchange

market.

Q. In that circumstance, is Banca Cremi's interest in seeing that the price it pays, if it's buying, or the price it sells

for, if it's selling, is a price it believes is reasonable?

 31
A. Well, I find that to be actually a very complex question.

You rest, and you have to take into consideration the expertise within each area and each field where your operators are

operating. I couldn't ask whether the price is good, whether

it was bad, and I couldn't do any exchange operation. There

are hundreds of them that are transacted daily.

Q. And the experience and expertise of the person you're

dealing with is also germane to what they charge. Correct?

A. Again, let me tell you: This is something--it's a daily

activity in the markets, whether the profit was large or

whether it was small.

J.A. at 241-42 (Aguirre Dep. (Feb. 28, 1996) at 85-86). The district

court accurately summarized this testimony in noting that

as a matter of general policy, the Bank did not inquire about,

or express any concern about the amount of any markups.

According to the deposition testimony of Aguirre and

Mendez, so long as the Bank believed the total price of an

investment transaction was acceptable, the amount of the

broker's markup was not a consideration in its decision to

invest.

Banca Cremi, 955 F. Supp. at 518 (citing Aguirre Dep. at 84-86;

Mendez Dep. at 56-57).

In this case, it is clear that the Bank did not rely on any shinglecreated presumption that the defendants were charging an undefined

"fair" rate of markup. Rather, the Bank was uninterested in the defendants' income, and instead based its trading decisions solely on the

purchase prices of the CMOs. Given the state of the record and the

utter lack of proof that a disclosed markup would have mattered, we

conclude that the Bank's excessive markup claim must fail.26

_________________________________________________________________

26 We also note that the alleged presumption of scienter in the instant

case is rather difficult to square with the uncontested fact that Epley and

Alex. Brown stayed within the NASD five percent guideline on all of the

 32
V.

Finally, the Bank argues that the Bank's state law statutory and tort

claims for breach of fiduciary duty, fraud, negligence, and negligent

misrepresentation necessarily raise factual questions for a jury to

decide, and that the district court erred in granting summary judgment. We conclude that the Bank's state law claims fail as a matter

of law, and accordingly affirm the district court's grant of summary

judgment.

We review the district court's interpretation of state law de novo.

See Salve Regina College v. Russell, 499 U.S. 225, 231 (1991). This

Court must follow the forum state's choice of law rules to determine

which state's substantive law to apply. See Klaxon Co. v. Stentor

Elec. Mfg. Co., 313 U.S. 487, 496 (1941). In this case, Maryland, the

forum state, adheres to the lex loci delictus rule--the place of the

wrong--for determining which state's tort law should be applied. See

Chambco v. Urban Masonry Corp., 659 A.2d 297, 299 (M.D. App.

1995). Because the alleged wrongdoing of the defendants occurred in

Houston, Texas, we conclude that a Maryland court would apply the

law of Texas to the Bank's tort claims. See Farwell v. Un, 902 F.2d

_________________________________________________________________

markups with only two exceptions, and in each of these charged only .25

percent above the guideline range. Scienter exists "if the defendant knew

the statement was misleading or knew of the existence of facts which, if

disclosed, would have shown it to be misleading." Carras v. Burns, 516

F.2d 251, 256 (4th Cir. 1975) (quotations and citations omitted). In light

of the defendants' adherence to an industry-wide guideline, the plaintiff

has rather a heavy burden to persuade that the defendants nevertheless

knew that their markups were fraudulently excessive. Cf. Decision by

National Business Conduct Committee of NASD, District Bus. Conduct

Comm. v. MMAR Group, Inc., (Oct. 22, 1996) at 14, reprinted in Appellees' Add. at 33 ("Generally, in litigated cases, the [SEC] has not found

mark-ups or mark-downs of less than 4% to be excessive, and has not

found mark-ups or mark-downs of less than 7% to be fraudulent, regardless of the size of the transaction. . . . We do not suggest that we therefore may never find mark-ups below 4% to be excessive or mark-ups

below 7% to be fraudulent. Rather, we believe that these factors should

be considered in light of respondents' arguments regarding lack of notice

in the particular circumstances of this case.").

 33
282, 286-87 (4th Cir. 1990) (applying Maryland choice of law, and

concluding that Delaware substantive law applied where allegedly

negligent psychiatric care occurred in Delaware and suicide allegedly

caused by negligent care occurred in Pennsylvania); Sacra v. Sacra,

426 A.2d 7, 9 (M.D. App. 1981) (applying substantive law of Delaware in wrongful death case where automobile collision in Delaware

propelled vehicle over state-line into Maryland where impact with

utility pole caused death).

Under Texas law, for Epley and Alex. Brown to be liable in tort

for a breach of fiduciary duty, they must first have owed a fiduciary

duty to the Bank. See Duncan v. Lichtenberger, 671 S.W.2d 948, 953

(Tex. App. 1984). "Fiduciary relationships arise when a party occupies a position of confidence toward another." Miller-Rogaska, Inc.

v. Bank One, 931 S.W.2d 655, 663 (Tex. App. 1996). "A fiduciary

duty is an extraordinary one and will not lightly be created. . . .

Although a fiduciary duty may be imposed on relations outside the

traditional ones, the exact same requirements necessary to establish a

traditional fiduciary relation must be met to establish an informal

fiduciary relation." Gillum v. Republic Health Corp., 778 S.W.2d 558,

567 (Tex. App. 1989). Because "the relationship between agent and

principal is a fiduciary relationship," Magnum Corp. v. Lehman Bros.

Kuhn Loeb, Inc., 794 F.2d 198, 200 (5th Cir. 1986) (quotations, citation, and alteration omitted), a securities broker can be a fiduciary to

a customer where "[t]he relationship between a securities broker and

its customer is that of principal and agent." Id. (applying Texas law).

In the instant case, the Bank's employees have made it abundantly

clear that the defendants did not act as agents for the Bank, but rather

conducted their business at arm's length in a principal-to-principal

relationship. See J.A. at 272-73 (Mendez Dep. at 56-57); id. at 241-42

(Aguirre Dep. at 85-86). There was accordingly no formal relationship giving rise to a fiduciary duty, and the record reveals no informal

relationship which could allow the imposition of such a duty. See,

e.g., Farah v. Mafrige & Kormanik, P.C., 927 S.W.2d 663, 675 (Tex.

App. 1996) ("[T]he fact a business relationship has been cordial and

of long duration is not by itself evidence of a confidential relationship. The fact one businessman trusts another and relies upon another

to perform a contract does not rise to a confidential relationship. Subjective trust is not enough to transform arms-length dealing into a

 34
fiduciary relationship." (citations omitted)). Because Epley and Alex.

Brown were not fiduciaries, they cannot be liable for the alleged

breach of a fiduciary duty.

Nor has the Bank presented sufficient evidence to allow its allegation of negligence to go to the jury. The essential elements of the tort

of negligence include the existence of a duty owed by the defendant

to the plaintiff, a breach of that duty, and damages to the plaintiff that

are proximately caused by the breach. See Greater Houston Transp.

Co. v. Phillips, 801 S.W.2d 523, 525 (Tex. 1990). In this case, the

Bank alleges that the defendants "owed a duty to use reasonable care

in selling securities to Plaintiffs and in advising Plaintiffs to purchase

securities[,]" Compl. (Apr. 11, 1995) at 24,¶ 87, reprinted in J.A. at

34, and breached that duty "[b]y recommending and selling to Plaintiffs securities which they knew or should have known were highly

speculative and risky, and were unsuitable investments for Plaintiffs

in light of their financial condition, risk profile and investment objectives." Id. at ¶ 88.

While a securities broker acting as an agent has a "duty to disclose

to the customer information that is material and relevant to the

order[,]" Magnum Corp., 794 F.2d at 200, Epley and Alex. Brown

were not, as we have discussed above, acting as the Bank's agents.

The Bank has directed us to no authority that would support a broad

general duty of a principal selling a security to warn another principal

that an investment may be imprudent or may not meet all of a buyer's

investment goals, and we rather doubt that Texas would impose such

a duty. In any event, it is apparent that, in light of the undisputed facts

of this case, Epley and Alex. Brown met any duty they may have had

by adequately informing the Bank of the risks and advantages of

CMO investment.

Similar to the federal action for fraud under § 10(b), the Texas

common law tort actions of fraud and negligent misrepresentation

contain the element of reliance. See Trenholm v. Ratcliff, 646 S.W.2d

927, 930 (Tex. 1983) (elements of fraud); Federal Land Bank Ass'n

v. Sloane, 825 S.W.2d 439, 442 (Tex. 1992) (elements of negligent

misrepresentation). As we have explained in part II.A. of this opinion,

the Bank cannot show justifiable reliance in light of the undisputed

 35
facts of this case. Accordingly, the district court correctly granted

summary judgment against the Bank on these claims.

Finally, the Bank contends that Alex. Brown, which was incorporated under the laws of Maryland, should be liable for a violation of

the Maryland Securities Act, Md. Code Ann., Corps. & Ass'ns §§ 11-

101 to 908. Specifically, the Bank alleges that the defendants violated

§ 11-302(c) of the Act by failing to advise the Bank of the risks

involved with investing in CMOs.

Section 11-302(c) provides:

(c) Misrepresentations.--In the solicitation of or in dealings

with advisory clients, it is unlawful for any person knowingly to make any untrue statement of a material fact, or

omit to state a material fact necessary in order to make the

statements made, in light of the circumstances under which

they are made, not misleading.

Md. Code Ann., Corps. & Ass'ns § 11-302(c) (emphasis added). The

Act specifies that an "`[i]nvestment adviser' does not include . . . [a]

broker-dealer or its agent whose performance of[investment advisory

services] is solely incidental to the conduct of business as a brokerdealer and who receives no special compensation for them." Md.

Code Ann., Corps. & Ass'ns § 11-101(h)(2)(iv). In this case, it is

clear that, to the extent that Epley and Alex. Brown provided "investment advisory services," such services were "solely incidental to the

conduct of business as a broker-dealer." Id. Because the Bank was not

an "advisory client" of the defendants, § 11-302(2)(c) does not apply,

and the Bank cannot pursue an action under this statute.

For the foregoing reasons, the district court's grant of summary

judgment is affirmed.

AFFIRMED

 36