Source: https://law.justia.com/cases/federal/appellate-courts/F2/637/318/348678/
Timestamp: 2020-02-20 19:08:31
Document Index: 473205726

Matched Legal Cases: ['art, 570', '§ 78', '§ 97', '§ 17', '§ 77', '§ 10', '§ 78']

Fed. Sec. L. Rep. P 97,872lila A. Miley, Plaintiff-appellee, v. Oppenheimer & Company, Inc., Anthony L. Geller and John W.hamilton, Defendants-appellants, 637 F.2d 318 (5th Cir. 1981) :: Justia
Justia › US Law › Case Law › Federal Courts › Courts of Appeals › Fifth Circuit › 1981 › Fed. Sec. L. Rep. P 97,872lila A. Miley, Plaintiff-appellee, v. Oppenheimer & Company, Inc., Anthony...
Fed. Sec. L. Rep. P 97,872lila A. Miley, Plaintiff-appellee, v. Oppenheimer & Company, Inc., Anthony L. Geller and John W.hamilton, Defendants-appellants, 637 F.2d 318 (5th Cir. 1981)
U.S. Court of Appeals for the Fifth Circuit - 637 F.2d 318 (5th Cir. 1981)
Churning occurs when a securities broker enters into transactions and manages a client's account for the purpose of generating commissions and in disregard of his client's interests. McNeal v. Paine, Webber, Jackson & Curtis, Inc., supra, 598 F.2d at 890 n.1 (5th Cir. 1979); Mihara v. Dean Witter & Co., Inc., 619 F.2d 814, 820 (9th Cir. 1980). Once an investor proves that: (1) the trading in his account was excessive in light of his investment objectives; (2) the broker in question exercised control over the trading in the account; and (3) the broker acted with the intent to defraud or with willful and reckless disregard for the investor's interests, Mihara v. Dean Witter & Co., Inc., supra, 619 F.2d at 821; Rolf v. Blyth, Eastman, Dillon & Company, Inc., 424 F. Supp. 1021, 1039-1040 (S.D.N.Y.,1977) aff'd in part and rev'd in part, 570 F.2d 38 (2nd Cir.), cert. denied, 439 U.S. 1039, 99 S. Ct. 642, 58 L. Ed. 2d 698 (1978), the broker may be held liable for a violation of the federal securities laws under section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b) and S.E.C. Rule 10b-5.4 McNeal v. Paine, Webber, Jackson & Curtis, Inc., supra, 598 F.2d at 890 n.1. See Mihara v. Dean Witter & Co., Inc., supra, 619 F.2d at 820; Hecht v. Harris, Upham & Co., 430 F.2d 1202, 1206-07 (9th Cir. 1970); Newburger, Loeb & Co. v. Gross, 563 F.2d 1057, 1069 (2nd Cir. 1977), cert. denied, 434 U.S. 1035, 98 S. Ct. 769, 54 L. Ed. 2d 782 (1978); Carras v. Burns, 516 F.2d 251, 288 (4th Cir. 1975); Landry v. Hemphill, Noyes & Co., 473 F.2d 365, 368 n.1 (1st Cir.), cert. denied, 414 U.S. 1002, 94 S. Ct. 356, 38 L. Ed. 2d 237 (1973). Additionally, upon proving the three requisite elements of a federal securities law churning violation, the investor will, in most or perhaps all cases, be entitled to hold the broker liable under a pendent state claim for breach of fiduciary duty.
First, and perhaps foremost, the investor is harmed by having had to pay the excessive commissions to the broker the "skimmed milk" of the churning violation. The broker's wrongful collection of commissions generated by the intentional, excessive trading of the account constitutes a compensable violation of both the federal securities laws and the broker's common law fiduciary duty, regardless of whether the investor's portfolio increased or decreased in value as a result of such trading. Second, the investor is harmed by the decline in the value of his portfolio the "spilt milk" of the churning violation as a result of the broker's having intentionally and deceptively concluded transactions, aimed at generating fees, which were unsuitable for the investor. The intentional and deceptive mismanagement of a client's account, resulting in a decline in the value of that portfolio, constitutes a compensable violation of both the federal securities laws and the broker's common law fiduciary duty, regardless of the amount of the commissions paid to the broker. In sum, once a jury finds that the broker has churned an investor's account, it may also find that the investor would have paid less commissions and that his portfolio would have had a greater value had the broker not committed the churning violation.7 See Nichols, The Broker's Duty to His Customer Under Federal Fiduciary and Suitability Standards, 26 Buff. L. Rev. 435, 445 (1977) ("Where there is excessive trading in an account ("churning"), the customer can be damaged in many ways. He must pay the brokerage commissions on both purchases and sales, he may miss dividends, incur unnecessary capital gain or ordinary income taxes depending on the holding period, and, most difficult to measure, he may lose the benefits that a well-managed portfolio in long-term holdings might have brought him."); Brodsky, Measuring Damages in Churning and Suitability Cases, 6 Sec.Reg. Law J. 157, 159-160 (1978) ("Most often, the customer complains that the broker churned unsuitable securities. Then, both causes of action are appropriate and both damage theories (excess commissions and excess decline in portfolio value) should be considered.")
Defendant Oppenheimer fails to cite a single case in which a court refused to award both excess commissions and excess decline in portfolio value on the ground that such recovery would constitute double compensation. In fact, those courts and authorities which have considered the issue have concluded that, in an attempt to excessively trade an account so as to generate commissions, a broker may enter into unsuitable transactions, thereby simultaneously damaging the value of the portfolio. E. g., Mihara v. Dean Witter & Co., supra, 619 F.2d at 826 (affirming a damage award as properly compensating for both commissions earned through the excessive trading and trading losses resulting from the unsuitable transactions entered into as the result of such trading); Hecht v. Harris, Upham & Co., supra, 430 F.2d at 1211 (finding actual damages from churning to be both excess commissions and trading losses, but refusing to grant recovery for trading losses due to waiver and estoppel); Carras v. Burns, supra, 516 F.2d at 259; Note, Churning By Securities Dealers, 80 Harv. L. Rev. 869, 883-87 (1967); Nichols, supra at 445; Brodsky, supra at 159-160.
However, neither the difficulty of the task nor the guarantee of imprecision in results can be a basis for judicial abdication from the responsibility to set fair and reasonable damages in a case. It is clear that awarding full "out of pocket" recovery i. e. the difference between the original and final values of Miley's portfolio would be to assume, in effect, that none of Oppenheimer's transactions were legitimate, and to disregard the ordinary hazards of the stock market. See Note, Churning By Securities Dealers, 80 Harv. L. Rev. 869, 884 (1969). Such compensation would clearly constitute a windfall for the plaintiff. However, a refusal to grant any compensation for the decline in portfolio value would be to assume, in effect, that all of Oppenheimer's transactions were legitimate and to disregard the jury's finding that the broker wrongly concluded unsuitable transactions to the detriment of the investor. See id. at 883-84. Such a refusal to grant any compensation for trading losses would clearly constitute a windfall for the defendant.
In order to approximate the trading losses caused by the broker's misconduct, it is necessary to estimate how the investor's portfolio would have fared in the absence of the such misconduct. The trial judge must be afforded significant discretion to choose the indicia by which such estimation is to be made, based primarily on the types of securities comprising the portfolio.10 However, in the absence of either a specialized portfolio or a showing by either party that a different method is more accurate, it seems that the technique discussed by Judge Oakes in Rolf v. Blyth, Eastman, Dillon & Co., Inc., 570 F.2d 38, 49 (2nd Cir.), cert. denied, 439 U.S. 1039, 99 S. Ct. 642, 58 L. Ed. 2d 698 (1978) and employed by Judge Mahon in this case is preferable. See Brodsky, supra at 157. ("Given the recognized difficulty in computing damages in these cases, that (the Rolf) formula is a logical approach toward compensating a customer for loss.") This mode of estimation utilizes the average percentage performance in the value of the Dow Jones Industrials or the Standard and Poor's Index during the relevant period as the indicia of how a given portfolio would have performed in the absence of the broker's misconduct.
Seven years ago, this court noted that "it is well established that exemplary damages may be awarded if allowable under state law when a state law violation is joined with a 10b-5 complaint." Coffee v. Permian Corp., 474 F.2d 1040, 1044 (5th Cir.), cert. denied, 412 U.S. 920, 93 S. Ct. 2736, 37 L. Ed. 2d 146 (1973) (citing Young v. Taylor, 466 F.2d 1329 (10th Cir. 1972) and Herpich v. Wallace, 430 F.2d 792 (5th Cir. 1970)); see Stowell v. Ted S. Finkle Investment Services, Inc., 489 F. Supp. 1209, 1215 (S.D. Fla. 1980). Oppenheimer acknowledges the holding of Coffee and readily admits that an award of punitive damages is allowable under Texas law under certain circumstances.
However, Oppenheimer argues that we must now reassess and reverse the COFFEE DECISION IN LIGHT OF THE INTERVENINg supreme court opinion in ernst & Ernst v. Hochfelder, 425 U.S. 185, 96 S. Ct. 1375, 47 L. Ed. 2d 668 (1976). Admitting that by its terms the Hochfelder opinion is totally unrelated to the issue of punitive damages, Oppenheimer correctly points out that under Hochfelder, mere negligence is insufficient to ground recovery under Rule 10b-5. Since intentional, reckless and willful misconduct will support an award of punitive damages under Texas law, see, e. g., Ware v. Paxton, 359 S.W.2d 897, 899 (Tex.1962); Courtesy Pontiac, Inc. v. Ragsdale, 532 S.W.2d 118, 121 (Tex.Civ.App. Tyler 1975, writ ref'd n.r.e.), Oppenheimer correctly concludes in its brief that the same conduct which is required by Hochfelder before an award of compensatory damages can be made under federal statutory securities law will support an award for punitive damages under state law.
Despite the lack of guidance provided by the cited Texas caselaw, we are by no means forced to apply the four-part Texas test for assessing the fairness of punitive damage awards to churning cases in a vacuum. Although we do not decide what amount of punitive damages, if any, should be awarded in every intentional, business tort case, we feel that a formula of punitive damages equal to three times compensatory damages is a fairly good standard against which to assess whether a jury abused its discretion. While there is nothing magical about the three-times-compensatory-damages formula, many courts which have weighed the kind of factors which comprise the Texas four-part test in awarding punitive damages for intentional, big business torts have selected that figure. See, e. g., Palmer Coal & Rock Co. v. Gulf Oil Co., 524 F.2d 884, 887 (10th Cir. 1975), cert. denied, 424 U.S. 969, 96 S. Ct. 1466, 47 L. Ed. 2d 736 (1976) (affirming award of $1,500,000 punitive damages in fraud case with $500,000 compensatory damages); Northern v. McGraw-Edison Co., 542 F.2d 1336 (9th Cir. 1976), cert. denied, 429 U.S. 1097, 97 S. Ct. 1115, 51 L. Ed. 2d 544 (1977) (lowering punitive damages in business fraud case to $35,000 where average compensatory damage was $12,000); Malandris v. Merrill, Lynch, Pierce, Fenner & Smith, 447 F. Supp. 543 (D.Co.1977) (awarding $3,000,000 punitive damages in investor fraud case where compensatory damages $1,030,000). Moreover, we are greatly impressed by one commentator's insightful analysis on this issue:
The federal circuit courts are divided on the very complex question as to whether a private cause of action can be maintained under the Know Your Customer Rule of the NYSE, Rule 405,11 and under the Suitability Rule of the NASD, Section 2 of Article III.12 Compare Colonial Realty Corp. v. Bache & Co., 358 F.2d 178, 182 (2nd Cir.), cert. denied, 385 U.S. 817, 87 S. Ct. 40, 17 L. Ed. 2d 56 (1966) (no cause of action exists) with Buttrey v. Merrill, Lynch, Pierce, Fenner & Smith, Inc., 410 F.2d 135, 142 (7th Cir.), cert. denied, 396 U.S. 838, 90 S. Ct. 98, 24 L. Ed. 2d 88 (1969) (cause of action exists). Oppenheimer attempts to project this court into the fray a rather precarious position, and one in which we currently neither desire nor deserve to be by arguing that Judge Mahon's instructions in effect created a private cause of action under these rules. We feel that Oppenheimer mischaracterizes Judge Mahon's reference to those rules, and resist its treacherous offer to rule on the existence of such implied causes of action under these two rules.
Oppenheimer's last argument asserts that Judge Mahon erred in refusing to order arbitration of Miley's pendent state law claims. While admitting that Miley's federal securities law claim was not subject to arbitration, Wilko v. Swan, 346 U.S. 427, 74 S. Ct. 182, 98 L. Ed. 168 (1953), Oppenheimer contends that Judge Mahon should have severed the federal claims from the two pendent state claims and: (1) stayed the trial of the federal claim pending the conclusion of the arbitration of the state claims; or (2) allowed both the trial of the federal claim and the arbitration of the state claims to run their natural courses, without entering any stays; or (3) stayed the arbitration of the state claims pending the completion of the trial on the federal claim. We have carefully considered this difficult issue of federal procedure, focusing primarily upon the relationship between the federal and state claims. Although Oppenheimer's argument merits a full analysis of the arbitration issue, we conclude that it does not provide grounds for concluding that the breach of fiduciary duty claims on which judgment was entered in this case should have been submitted to arbitration.14 We therefore find that the failure to submit this case to arbitration does not require reversal of the judgment.
An important judicially-created exception known as "the doctrine of intertwining" has been carved out of this statutory pro-arbitration scheme. The leading case in this circuit developing this exception to the mandate that federal courts should enforce arbitration agreements is Sibley v. Tandy, 543 F.2d 540 (5th Cir. 1976) rehearing denied, 547 F.2d 286, cert. denied, 434 U.S. 824, 98 S. Ct. 71, 54 L. Ed. 2d 82 (1977). In Sibley, Judge Godbold noted that "when it is impractical if not impossible to separate out non-arbitrable from arbitrable contract claims, a court should deny arbitration in order to preserve its exclusive jurisdiction over federal securities act claims." Id. at 543. Additionally, the court in Sibley noted that arbitration should not be ordered where "(a)n arbitrator making a decision on the common law claims would (be) impelled to review the same facts needed to establish the plaintiff's securities law claim." Id.
Despite Judge Godbold's reference to the effect that whether two claims are intertwined depends on whether the same facts underlie each claim, Oppenheimer argues that the "doctrine of intertwining" requires a refusal to order arbitration only when the legal issues are inseparable. See, e. g., Lee v. Ply Gem Industries, Inc., 593 F.2d 1266, 1274-75 (D.C. Cir.), cert. denied, 441 U.S. 967, 99 S. Ct. 2417, 60 L. Ed. 2d 1073 (1979); Greater Continental Corp. v. Schechter, 422 F.2d 1100, 1103 (2nd Cir. 1970); Dehart v. Moore, 424 F. Supp. 55, 57 (S.D. Fla. 1976). Oppenheimer's argument continues by noting that since Miley's case was presented and instituted on "three separate and distinct causes of action" her claims are not "legally intertwined." Although Oppenheimer is correct to the extent that it contends that the mere identity of the evidentiary facts underlying the federal and pendent state claims in a case is not proper grounds for refusing to submit the state claims to arbitration, we feel that Oppenheimer's narrow conception of "legal intertwining" misconstrues both the meaning and purpose of the intertwining doctrine, and the basic import of Sibley.
The "doctrine of intertwining" was formulated as an exception to the requirement that arbitrable claims be referred to arbitration in order to preserve the exclusive jurisdiction of the federal courts in areas where such exclusivity exists. See, Sibley v. Tandy, supra, 543 F.2d at 542-43; Shapiro v. Jaslow, 320 F. Supp. 598, 600 (S.D.N.Y. 1970). The Wilko doctrine, for example, requiring that federal securities claims must be adjudicated in federal court could be rendered totally meaningless if an arbitrator could, in effect, resolve the merits of a federal securities claim during the course of arbitrating pendent state claims.
However, when the same factual (and legal) conclusions must be drawn from the common evidentiary facts in order to resolve the federal and pendent state claims when the same "ultimate facts" underlie each claim a threat is posed to the exclusive federal jurisdiction. A federal forum is charged with the sole responsibility and is correlatively granted the sole right to decide the ultimate issues essential to a federal securities claim, based on its own appraisal of the evidence. Allowing an arbitrator to make the primary appraisal of the evidence and to reach the primary conclusions on the issues central to the resolution of the case presents a threat of binding the federal forum through collateral estoppel, Sennett v. Oppenheimer & Co., 502 F. Supp. 939, 1979-1980 CCH Fed.Sec.L.Rep. § 97,378 (N.D. Ill. 1980); Greater Continental Corp. v. Schechter, supra, 422 F.2d at 1130, and, at the very least, forces the federal court to reach its findings in the light of prior conclusions by the arbitrators on the very same issues.
However, in cases like the present one in which the jury does find a violation of the federal securities laws, we do not think it proper to submit the pendent claims to arbitration. The plaintiff has suffered a single legal wrong, for which there are several alternative routes of recovery. A judgment can be entered only upon one of the alternative grounds.16 Siedman v. Merrill, Lynch, Pierce, Fenner & Smith, Inc., 465 F. Supp. 1233, 1239 (S.D.N.Y. 1979). Although a jury would have already concluded that the broker violated federal law to the detriment of the investor, the investor could be forced to endure a long and protracted arbitration procedure before his judgment could be entered and collected. In all likelihood, the plaintiff would choose not to pursue his state claims and to collect his judgment upon conclusion of his federal trial, thereby effectively undercutting the very purpose of pendent jurisdiction. Moreover, in the case where a federal court has already found a willful and reckless mismanagement of the client's account for the broker's personal gain and in disregard of the investor's objectives, it makes no sense to submit the case to a new forum to resolve the breach of fiduciary duty issue. The misconduct which is a prerequisite of a federal securities law violation will, in almost all cases (and certainly under Texas law), satisfy the standard for finding a breach of fiduciary duty. Therefore, in the present case, once the jury had concluded that Oppenheimer had violated the federal securities laws by its handling of Miley's account, there was no error in allowing the jury to pass on the pendent breach of fiduciary duty claim.17
The problem of excessive trading by investment brokers seeking to generate high commissions was first dealt with almost exclusively by the Securities and Exchange Commission. The Commission relied on the general broker-dealer antifraud provisions of the federal securities acts, e.g., Securities Act of 1933, § 17(a), 15 U.S.C. § 77q(a) (1964); Securities Exchange Act of 1934, §§ 10(b) and 15(c), 15 U.S.C. §§ 78j(b), 78o (c) (1964), to control such misconduct by brokers. Note, Churning By Securities Dealers, 80 Harv. L. Rev. 869 (1969)
"Every member organization is required through a general partner, a principal executive officer or a person or persons designated under the provisions of Rule 342(b) (1) to (1) Use due diligence to learn the essential facts relative to every customer, every order, every cash or margin account accepted or carried by such organization and every person holding power of attorney over any account accepted or carried by such organization. (2) Supervise diligently all accounts handled by registered representatives of the organization...."