Source: https://law.justia.com/cases/federal/appellate-courts/F2/430/1202/463099/
Timestamp: 2020-07-12 14:18:21
Document Index: 563292038

Matched Legal Cases: ['§ 77', '§ 78', '§ 1', '§ 78', '§ 78', '§ 338', '§ 78', '§ 78']

Bertha Hecht, Plaintiff, Appellee and Appellant, v. Harris, Upham & Co., a Partnership, Harris, Upham & Co., Inc., a Corporation, Defendants, Appellants and Appellees, 430 F.2d 1202 (9th Cir. 1970) :: Justia
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Bertha Hecht, Plaintiff, Appellee and Appellant, v. Harris, Upham & Co., a Partnership, Harris, Upham & Co., Inc., a Corporation, Defendants, Appellants and Appellees, 430 F.2d 1202 (9th Cir. 1970)
U.S. Court of Appeals for the Ninth Circuit - 430 F.2d 1202 (9th Cir. 1970) June 8, 1970
As Modified on Denial of Rehearing September 4, 1970
COPYRIGHT MATERIAL OMITTED COPYRIGHT MATERIAL OMITTED Emanuel Becker (argued), New York City, Thomas A. H. Hartwell, of Cooley, Crowley, Gaither, Godward, Castro & Huddleson, San Francisco, Cal., E. C. Mahoney, Burlingame, Cal., for appellant.
The cross appeals by Harris, Upham & Co., Harris, Upham & Co. Inc. (appellants), and Mrs. Bertha Hecht (appellee) are from a judgment of the District Court awarding appellee $504,391.02. The opinion of the District Court is reported at 283 F. Supp. 417 (1968). The basic facts of the case are set forth there.
The account remained with Harris, Upham & Co. until March 1964 when Mrs. Hecht's tax consultants advised her that the account was substantially depleted. At that time the account had a net value of about $251,308.00. Suit was later commenced in District Court against Wilder and Harris, Upham & Co. and others for alleged violations of Section 17(a) of the Securities Act of 1933 (15 U.S.C. § 77q(a); Section 10(b) of the Securities Exchange Act of 1934 (15 U.S.C. § 78j(b); Rule 10b-5 promulgated by the Commissions; (17 C.F.R. 240.10b-5); and the Commodity Exchange Act of 1936 (7 U.S.C. § 1 et seq.). Appellee also alleged violations of the Rules of the National Association of Securities Dealers and the common law of the State of California. Liability of Harris, Upham & Co. was alleged under Section 20(a) of the Securities Exchange Act (15 U.S.C. § 78t(a)).
The District Court ruled that Mrs. Hecht was guilty of laches, had waived certain of her rights and was estopped from asserting the wrongful conversion of her account. On the issue of excessive trading, referred to as account churning, the District Court held appellee was entitled to recover all commissions deducted from her account during the period it was with Harris, Upham & Co. and all interest charged to her. Appellee was also awarded damages for the alleged fraud in the Colonial and Itek transactions. A summary of damages awarded is set forth in the District Court's opinion, 283 F. Supp. at p. 444.
The District Court held that churning1 was a violation of Section 10(b) and Rule 10b-5. One of the principal Congressional purposes of the Securities Exchange Act is to protect the investor in a highly sophisticated field. With knowledge of this objective "* * it is the duty of the courts to be alert to provide such remedies as are necessary to make effective the congressional purpose." J. I. Case Co. v. Borak, 377 U.S. 426, 433 and 435, 84 S. Ct. 1555, 1560, 12 L. Ed. 2d 423 (1964); Deckert v. Independence Shares Corporation, 311 U.S. 282, 288, 61 S. Ct. 229, 85 L. Ed. 189 (1940).
Section 10(b) of the Securities Exchange Act of 1934 and Commission Rule 10b-5 make unlawful the use of any manipulative or deceptive device or contrivance by any person in connection with the sale and purchase of any security upon a national securities exchange or otherwise. Specifically, Rule 10b-5 promulgated by the Commission in 1942 provides in pertinent part that " [i]t shall be unlawful for any person, directly or indirectly, * * * (a) to employ any device, scheme, or artifice to defraud, * * * or (c) to engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person * *." 17 C.F.R. Sec. 240.10b-5. Abuse of the confidence of the customer for personal gain by a broker by frequent and numerous transactions disproportionate to the size and nature of the account, has been held a violation of Rule 10b-5. Lorenz v. Watson, 258 F. Supp. 724 (E.D. Pa. 1966) extensive trading and churning of a discretionary investment account disproportionate to its size and character; Newkirk v. Hayden, Stone & Co., CCH Fed.Sec.L.Rep. para. 91,621 (S.D. Cal. 1965) (churning of a discretionary trading account with an equity of $8,439.65 by a broker who earned $2,722.55 in commissions during a three month period). cf. Carr v. Warner, 137 F. Supp. 611 (D. Mass. 1955) and its companion case Nash v. J. Arthur Warner & Co., 137 F. Supp. 615 (D. Mass. 1955) (purchase and sale of securities excessive in size and frequency in view of the financial resources and character of the investors' accounts). On occasion this court has sustained the Commission's finding of churning. Irish v. SEC, 367 F.2d 637 (9th Cir. 1966) (broker advancing his own interests to the detriment of his customers by making excessive trades in their accounts). See also, Stevens v. Abbott, Proctor & Paine, 288 F. Supp. 836 (E.D.Virginia 1968) (excessive trading of an account by a broker to derive profits for himself without regard for the interests of his customer); Moscarelli v. Stamm, 288 F. Supp. 453, 457-458 (E.D.N.Y. 1968) (alleged unauthorized excessive trading of securities account through broker misrepresentation).
This Court held in Royal Air Properties, Inc. v. Smith, 312 F.2d 210 (9th Cir. 1962) that since civil liability was judicially implied from violations of Section 10(b), estoppel, waiver and laches should be applicable. It was there stated that " [t]he purpose of the Securities Exchange Act is to protect the innocent investor, not one who loses his innocence and then waits to see how his investment turns out before he decides to invoke the provisions of the Act." 312 F.2d 213-214.
"All during the course of the account, plaintiff regularly received from Harris, Upham the customary confirmation slips showing each security or commodity transaction as made and requesting immediate notice of any error. She also received from Harris, Upham the customary monthly statements of her account.
It was the practice of Wilder to be in contact with plaintiff by telephone concerning her account almost every morning of the business week, and also to visit her at her home at least weekly and sometimes several times a week. Also, plaintiff would often telephone Wilder at his office during the day.
It was the practice of plaintiff to put her confirmation slips on a table in her home, `separating the buys from the sells', in order to discuss them with Wilder. After the discussions Wilder would gather up the confirmation slips and statements and take them to his home — although he had duplicates for his own use at the office.
During the period of the account plaintiff had her own income tax accountants with whom she consulted concerning her personal tax deductions. Wilder supplied schedules to these income tax accountants, which indicated plaintiff's capital gains and losses arising out of her securities transactions. Plaintiff was also represented on occasion by attorneys — including representation by able and reputable counsel, recommended by Wilder in connection with the distribution of her husband's estate." 283 F. Supp. at p. 426.
With these facts in mind the court later concluded:
"Having, with this knowledge and understanding, permitted Wilder and his firm to continue handling the account on this basis in reliance upon her apparent acquiescence for nearly seven years, the Court finds that plaintiff's conduct is such that she is barred by estoppel, laches and waiver (within the meaning of the second appeal in Royal Air Properties, Inc. v. Smith, 9 Cir., 333 F.2d 568 (1964)) from suddenly taking the position that such trading of the account in securities and commodities was unsuitable for her needs and objectives, contrary to her instructions and should never have occurred." 283 F. Supp. at pp. 429-430.
"Four elements must be present to establish the defense of estoppel: (1) The party to be estopped must know the facts; (2) he must intend that his conduct shall be acted on or must so act that the party asserting the estoppel has a right to believe it is so intended; (3) the latter must be ignorant of the true facts; and (4) he must rely on the former's conduct to his injury." (citations omitted.)
To invoke laches as a defense there must be (1) a lack of diligence by the party against whom the defense is asserted, and (2) prejudice to the party asserting the defense. Costello v. United States, 365 U.S. 265, 282, 81 S. Ct. 534, 5 L. Ed. 2d 551 (1961). Where these elements are present, the damage to the party asserting the defense is caused by his detrimental reliance on his adversary's conduct. Royal Air Properties, Inc. v. Smith, 333 F.2d 568, 570 (9th Cir. 1964).
The waiver of a legal right is "the voluntary or intentional relinquishment of a known right. It emphasizes the mental attitude of the actor." Matsuo Yoshida v. Liberty Mut. Ins. Co., 240 F.2d 824, 829 (9th Cir. 1957).
To have these findings upset on appeal it must be shown that they are "clearly erroneous" within the meaning of Rule 52(a), Fed. R. Civ. P. In Clostermann v. Gates Rubber Company, 394 F.2d 794, 796 (9th Cir. 1968), it is stated:
"A finding is `clearly erroneous' when although there is evidence to support it, the reviewing court, on the entire evidence, is left with the definite and firm conviction that a mistake has been committed." (citations omitted)
A review of the record does not disclose that the findings are "clearly erroneous". They will not be disturbed on this appeal.
Appellee claims the District Court erred in not holding that the National Association of Securities Dealers (N.A. S.D.), "suitability" rule (Art. III, Sec. 2,) gives rise to civil liability. Unlike the fraud requirement of the Securities Exchange Act, the N.A.S.D. "suitability" rule would, if applicable, allow recovery against a member who did not have "reasonable grounds" to believe his investment recommendation was suitable for the customer. This rule has received varied consideration from the courts. Compare Colonial Realty Corp. v. Bache & Co., 358 F.2d 178 (2nd Cir. 1966), with Avern Trust v. Clarke, 415 F.2d 1238, 1242 (7th Cir. 1969). The District Court might have entertained pendent jurisdiction over the common-law claims in which violations of Art. III, Sec. 2, might have been admissible, Mercury Investment Co. v. A. G. Edwards & Sons, 295 F. Supp. 1160 (S.D.Texas 1969), however it did not reach that question.
"In any event, we have found on the evidence in this case that plaintiff is barred by estoppel and waiver from proceeding merely upon the theory that her account, as handled by defendants was `unsuitable' to her needs and objectives." 293 F. Supp. at p. 431.
"Although plaintiff had enough experience to tell from the confirmation slips and monthly statements that she was paying commissions and interest on transactions in her account [of which she had knowledge], she just did not have the sufficient competence to understand whether the frequency and volume of the transactions might be `excessive.'" 283 F. Supp. at p. 434.
Nor does the fact the account was a trading account mean it could not be excessively traded. Newkirk v. Hayden, Stone & Co., CCH Fed.Sec.L.Rep. para. 91,621 (S.D. Cal. 1965); See, Stevens v. Abbott, Proctor & Paine, 288 F. Supp. 836 (E.D.Virginia 1968).
The gist of an allegation of churning is fraud in law and differs from common law fraud. Proof of a specific intent to defraud is unnecessary. Securities & Exchange Commission v. Texas Gulf Sulphur Co., 401 F.2d 833, 854-855 (2nd Cir. 1968); R. H. Johnson & Co. v. S.E.C., 97 U.S.App. D.C. 364, 231 F.2d 523 (1956), cert. denied, 352 U.S. 844, 77 S. Ct. 48, 1 L. Ed. 2d 60; Norris & Hirshberg, Inc. v. S.E.C., 85 U.S.App.D.C. 268, 177 F.2d 228 (1949). Appellee had the burden of establishing churning by a "preponderance of the evidence".
When, as in this case, a single fraudulent scheme involves both securities and commodities a District Court is entitled to award damages for the entire loss. Errion v. Connell, 236 F.2d 447, 454 (9th Cir. 1956); Goodman v. H. Hentz & Co., 265 F. Supp. 440, 445 (N.D. Ill. 1967); Sinva, Inc. v. Merrill, Lynch, Pierce, Fenner & Smith, Inc., 253 F. Supp. 359 (S.D.N.Y. 1966).
The District Court held Harris, Upham & Co. liable for the churning of Mrs. Hecht's account on the grounds that it did not maintain an adequate system of internal control and that in failing to be diligent, even with the system then in force, it did not act in good faith. Liability was imposed under Section 20(a) of the Act (15 U.S.C. § 78t (a)).2
In Kamen v. Paul H. Aschkar & Company, 382 F.2d 689, 697 (9th Cir. 1967) this Court said the test of liability under Section 20(a) is that the controlling person "* * * must have acted in bad faith and directly or indirectly induced the conduct constituting a violation or cause of action." In that case the manner of supervision of the activities of the employees was held sufficient to establish liability.
There is substantial authority imposing Section 20(a) liability under circumstances similar to those which were before the trial court in this case. Lorenz v. Watson, 258 F. Supp. 724 (E.D. Pa. 1966); Goodman v. H. Hentz & Co., 265 F. Supp. 440 (N.D. Ill. 1967); See also, Moscarelli v. Stamm, 288 F. Supp. 453, 460 (E.D.N.Y. 1968); Anderson v. Francis I. duPont & Co., 291 F. Supp. 705, 710 (D. Minn. 1968); Myzel v. Fields, 386 F.2d 718, 738 (8th Cir. 1967), cert. denied, 390 U.S. 951, 88 S. Ct. 1043, 19 L. Ed. 2d 1143 (1968). We affirm the court's finding of liability for churning under Section 20(a).
Both parties agree and the trial court properly held that the California statute of limitations for fraud (3 years as provided in Cal.C.C.P. § 338(4)) applies to plaintiff's cause of action. Fratt v. Robinson, 203 F.2d 627, 634-635 (9th Cir. 1953); Royal Air Properties, Inc. v. Smith, 312 F.2d 210, 214 (9th Cir. 1962).
Defendant argues however that there was no withholding of information and that the plaintiff had facts within her knowledge which constituted notice sufficient to bar her suit entirely. The District Court held to the contrary and found that Wilder did not "frankly and fairly" explain "basic considerations" which would have indicated the amount of trading actually going on in the account. 283 F. Supp. at p. 434. It was concluded that:
"* * * the information on hand to plaintiff at any one time, considered in the light of the limitations upon her competence and circumstances already reviewed, was not sufficient to put her on notice that the trading of her account was excessive — until she was so advised by her income tax accountants in March, 1964 — the date we find to be the date of discovery so far as `excessive' trading is concerned." supra at p. 441.
Appellants first argue that no recovery should have been granted since the transactions were first set out in pleadings submitted more than three months after the Statute of Limitations had expired. Conceding that this might be true, at the close of the trial motions were made by both parties under Rule 15(c) of the Fed. R. Civ. P. to conform the pleadings to the proof at trial. The motions were granted. The effect of this order was to relate the Itek and Colonial transactions back to the time of filing the complaint for the purposes of tolling the statute. There was sufficient identity between these transactions and the conduct alleged in the complaint to satisfy the rule. We do not find appellants were thereby prejudiced within the meaning of Rural Fire Protection Co. v. Hepp, 366 F.2d 355, 362 (9th Cir. 1966). Accordingly the Statute of Limitations did not bar Mrs. Hecht's recovery.
The District Court, 283 F. Supp. at 444, by schedule specified damages awarded in the sum of $439,520. This included the sum of $64,250 covering the Itek and Colonial transactions. The balance was broken down as follows:
Actual damages due to churning: Commissions and interest paid by plaintiff $232,000 Other damages due to churning 143,000 -------- $375,000 ========
We have trouble with the $143,000 item of "other damages due to churning".
The court's reasoning in allowing these items of damage, notwithstanding its ruling on waiver and estoppel, was that Wilder's purpose in guiding Mrs. Hecht into the commodities market was solely to provide an additional opportunity to generate commissions and that "the commodity account may be regarded as a mere device for churning the securities account * * *." 283 F. Supp. at 437. Therefore, "Since the commodity account was `a mere device for churning the securities account', the commodity losses of plaintiff, although not recoverable by plaintiff as such, are nevertheless, recoverable insofar as they proximately resulted from this means of churning the securities account." 283 F. Supp. at 440.
By taking $143,000 of the judgment away from the plaintiff the Court is adopting the formula for measure of recovery set forth in Newkirk v. Hayden, Stone & Co. CCH Fed.Sec.L.Rep. para. 91,621 (S.D.Calif.1965). There are court said: "Damages should be limited to the amount of the commissions because this is the only element of damage which was proximately caused by defendants." In narrowing recovery for churning solely to commissions earned (plus interest on the margin account) the Majority overlooks the fact that the dealer in his zeal to earn commissions may have caused damage unrelated in amount to what he earned in commissions.1
The trial court concluded from the facts of this case that "* * * the excessive trading of plaintiff's account by Wilder in both securities and commodities did constitute a single scheme. Although only $7,500 was originally deposited in plaintiff's commodity account, Wilder was able to effect an enormous amount of commodity trading by transferring a total of $245,360 from her security account to the commodities account. Thus, the security and commodity transactions were inextricably co-mingled." (Emphasis added). 283 F. Supp. at 437.
Although Mrs. Hecht was held to be estopped to deny knowledge that securities were being sold to enable Wilder to purchase commodities, the trial court also found "* * * she just did not have the sufficient competence to understand whether the frequency and volume of the transactions might be `excessive'." 283 F. Supp. at 434.
The Majority would further disallow damages of $78,000 awarded for net commodity losses. The Majority has concluded that " [i]f loss of value in the account occurred (beyond the cost of commissions), it would seem to be due not to the number of transactions engaged in but to the unfortunate choice of risk those transactions entailed." Maj. Damage Opin. at p. 1212.
The record in this case might support that conclusion had the trial judge made it. The fact is he did not. He found that there was an excessive transferring of money from the securities account into the commodities account, and that the action was pursuant to Wilder's fraudulent scheme to generate commissions. Mrs. Hecht was therefore more deeply involved in commodity trading than she knew. As a consequence her losses were just that much greater. For that she was entitled to redress. The trial court awarded her $78,000 — the net commodity losses.
The loss of $78,000 could very well have been a substantial profit considering the size of the account and assuming it was properly traded. The evidence in this case discloses churning of a grand magnitude. In the eight years the commodity account was with Harris, Upham & Co., total sales and purchases exceeded $89,000,000; commissions charged to Mrs. Hecht were $98,338; and the account profited in only two of the eight years. The years of most significant transferring from the securities account to the commodities account were also the years in which the commodities account sustained its greatest losses, e. g., in 1963 there were eleven transfers from the securities account to the commodities account in the amount of $104,000. In that year the commodity account sustained losses in excess of $116,000.
In my judgment the award of $78,000 for commodity account losses is sustained by the evidence. While the damages may have been difficult to compute "* * * the risk of the uncertainty should be thrown upon the wrongdoer instead of upon the injured party." Story Parchment Co. v. Paterson Parchment Paper Co., 282 U.S. 555, 563, 51 S. Ct. 248, 250, 75 L. Ed. 544 (1931).
The SEC has provided a definition of churning in the regulation under 15 U. S.C. § 78 o(c) (1). See 17 C.F.R. 240.15c 1-7(a). The definition reads:
"The term `manipulative, deceptive, or other fraudulent device or contrivance', as used in section 15(c) of the act, is hereby defined to include any act of any broker or dealer designed to effect with or for any customer's account in respect to which such broker or dealer or his agent or employee is vested with any discretionary power any transactions of purchase or sale which are excessive in size or frequency in view of the financial resources and character of such account."
This was relied upon in Lorenz v. Watson, 258 F. Supp. 724, 730 (E.D. Pa. 1966). See Churning by Securities Dealers, 80 Harv. L. Rev. 869 (1967).
§ 78t
Churning by Securities Dealers, 80 Harv. L. Rev. 869, 883 (1967). See e. g. Stevens v. Abbott, Proctor & Paine, 288 F. Supp. 836, 851 (E.D. Va. 1968) where the court in addition to awarding commissions charged in the amount of $59,689.99, also awarded $35,831.78 for capital gains taxes incurred