The opinion of the court was delivered by: PIERCE
PIERCE, District Judge: This securities action brought by plaintiff David E. Rolf presents important questions concerning the duties and responsibilities of a broker dealer and its registered representative under circumstances in which their customer is being defrauded by his investment adviser. Unlike the usual case brought under the federal securities laws, here it is clear that fraud and breach of fiduciary duty are present. The key questions in this case are whether the broker aided or participated in the fraud, and whether the broker and his employer took adequate steps to protect their customer against the investment advisor who traded plaintiff's account pursuant to a power of attorney.
The matter was tried before the Court without a jury for nine days in June and July 1976. The allegations of the complaint are as follows.
Plaintiff David Rolf's complaint seeks to hold defendants liable in damages for alleged violations of Section 10(b) of the Securities Exchange Act of 1934, and Rule 10b-5 promulgated thereunder, which prohibits securities fraud by any person through the instrumentalities of interstate commerce or of any facility of any national securities exchange. Also claimed are violations of Section 15(c)(1) of the Exchange Act, and Rule 15c1-2, which similarly prohibits securities fraud by broker dealers in the over-the-counter markets. Plaintiff also alleges violations of Section 15A of the Exchange Act, dealing with registration and regulation of broker dealer associations, and of Article III, Section 2 of the Rules of Fair Practice adopted by the National Association of Securities Dealers, Inc. ("NASD") promulgated thereunder, the latter requiring suitability of securities recommended by brokers for investors. Finally, plaintiff asserts violations of Rule 405(1) and (2) of the New York Stock Exchange ("NYSE"), which require due diligence and diligent supervision in the management of securities accounts handled by registered representatives.
This Court has jurisdiction over this action brought to enforce liabilities and duties created under the Exchange Act and by the rules and regulations promulgated thereunder pursuant to 15 U.S.C. § 78aa.
In brief, plaintiff claims that the defendants churned his account, that they severely altered the nature of his securities portfolio by placing unsuitable securities therein, that they failed to properly supervise his account, and that they aided and abetted each other in these alleged violations. In sum, plaintiff claims that the defendants took an account worth $1,423,000 in May of 1969 and returned to him in January of 1971 an account worth only $225,000 as a result of their fraud. For damages, plaintiff seeks, inter alia, a return of commissions and interest; an award equal to the net trading losses claimed; and, although the complaint states no cause of action under state law, punitive damages of one million dollars.
At the trial of this action, plaintiff abandoned all claims made against his investment adviser, defendant Akiyoshi Yamada, in exchange for Yamada's testimony against the remaining defendants (see PX-19). Defendants Blyth Eastman Dillon & Co. ("BEDCO") and its registered representative Michael Stott assert that they are not liable because plaintiff has not proved his claims, because Yamada and not the other defendants controlled plaintiff's account, and because they breached no duty owed to the plaintiff. In their answer defendants BEDCO and Stott assert cross-claims against Yamada for indemnity.
Having heard all the evidence and having considered the matter, the Court dismisses plaintiff's churning claim, but finds defendants BEDCO and Stott liable for violations of the NYSE and NASD rules, which violations involved breach of defendants' fiduciary duties tantamount to fraud. The Court also finds defendant Stott liable for aiding and abetting Yamada in the fraud which the investment adviser perpetrated upon plaintiff in violation of Rule 10b-5 and through breach of his own fiduciary duties. The following shall constitute the Court's findings of fact and conclusions of law pursuant to Rule 52(a) Fed. R. Civ. P.
Plaintiff David E. Rolf is a physician, surgeon and ophthalmologist residing in Shaker Heights, Ohio. Dr. Rolf has practiced medicine since 1936, and at the time of trial he was sixty-eight years old. Rolf began investing his earnings in the stock market in 1950, and by 1962 his portfolio was worth approximately $400,000. Plaintiff testified that he works long hours at the hospital, and that he is on twenty-four hour call. During the period 1950 through 1962, plaintiff retained several different Cleveland brokers, switching firms often because he felt that the brokers were not sufficiently knowledgeable and that they did not have his interests at heart. During this period plaintiff maintained non-discretionary accounts, making his own decisions with respect to transactions in securities. Rolf was an active follower of the stock market, primarily through the Wall Street Journal. Prior to his first contact with BEDCO in 1963, plaintiff had maintained accounts at Merrill Lynch, Pierce, Fenner & Smith, Inc., Paine Webber & Co., Hartzmark & Co., Prescott & Co., Bache & Co., and finally, at Walston & Co. where Rolf first engaged an investment adviser with discretionary authority over his securities. Rolf stated that during this period his investment objective was capital growth first and security second. Plaintiff testified that he switched to discretionary accounts in 1962 because he was too busy with medicine to be in constant consultation with brokers, and because he felt his portfolio was too large for him to handle.
In 1963, plaintiff took his securities to Eastman Dillon Union Securities & Co., and entrusted their management to S. Logan Stirling, a partner and a prominent investment adviser associated with that firm and with defendant BEDCO, the successor corporation to Eastman Dillon Union Securities & Co. BEDCO was at all relevant times a registered broker dealer and a member of the New York Stock Exchange and the National Association of Securities Dealers. During the relevant period, BEDCO engaged in corporate and municipal underwritings, maintained a large research department, and employed a substantial retail sales force. BEDCO dealt in listed and over-the-counter securities for individual clients and as a market-maker (Tr. 1005).
While Dr. Rolf did not come into contact with BEDCO's Michael Stott until 1969, Stott had been a registered representative with that firm since 1958, and in 1963 Stott was branch manager of BEDCO's Paterson, New Jersey, office. Later Stott became branch manager of BEDCO's Newark office; at each branch office one of his primary responsibilities was supervision of the registered representatives (Tr. 757). In the fall of 1967 Stott returned to BEDCO's New York office as a registered representative. By 1969, Stott was handling approximately 150 individual and institutional accounts at BEDCO, earning one-third of all commissions on the securities he traded (Tr. 914-15). That year Stott first met a young and ambitious investment adviser, Akiyoshi Yamada.
Yamada, the son of a wealthy Japanese industrialist, had attended Harvard Business School for one year prior to 1965 when he joined the investment banking firm of Kuhn Loeb & Co. (Tr. 557). Yamada described Kuhn Loeb as a conservative and prestigious firm which generally handled "triple-A" clients. (Tr. 509). At Kuhn Loeb, Yamada eventually became an officer of the firm purportedly with expertise in research and "special situations". In 1969, at the age of 26, Yamada left Kuhn Loeb to form an investment partnership; during the period of the complaint he was not associated with any research firm or brokerage house (Tr. 558).
Yamada was described at trial by John P. Cione, BEDCO's chief compliance officer, as one of a "new breed" of young money managers who emerged as highly successful in the stock market during 1969 and 1970. Yamada was committed to "special situations" and was one of a number of young advisers who were making mutual funds, hedge funds, and assorted speculative ventures very profitable (Tr. 1111). During the period of the complaint Yamada was handling six sizeable portfolios, three institutional and three individual, of which Dr. Rolf's was the largest individual account. Yamada traded plaintiff's stocks on a discretionary basis from April 1969 through January 1971 (Tr. 1041-42).
In 1972, defendant Yamada was enjoined by the Securities and Exchange Commission from engaging in fraudulent and manipulative practices in connection with the purchase and sale of securities. On December 21, 1972, at the age of thirty, Yamada pleaded guilty before Judge Irving Ben Cooper of this Court to a criminal conspiracy to violate the federal securities laws as set forth in Count One of Indictment 72 Cr. 363, in connection with the sale of Lady Goldie Bracelet Co. securities. On May 18, 1973, Yamada pleaded guilty to two further violations of 18 U.S.C. § 371 set forth in criminal informations 73 Cr. 426 and 73 Cr. 427, in connection with a securities fraud involving Microthermal Applications, Inc., and a manipulation of Health Evaluation Systems, Inc., the stock of the latter being one involved in this action. On June 26, 1973, Judge Cooper sentenced Yamada to two years in prison, five years on probation, and fined him $30,000. Thereafter, on April 15, 1974, Yamada pleaded guilty to submitting false statements to Judge Cooper in support of a motion to reduce or suspend his sentence, in violation of 18 U.S.C. § 1001. For this crime, Judge Morris Lasker of this Court sentenced Yamada to one year, later reduced to six months, consecutive to the previously imposed period of imprisonment. (See DX-VV). Yamada admitted each of these convictions at trial, and further admitted that he had perjured himself before the Securities and Exchange Commission (Tr. 695).
The foregoing discussion raises questions regarding Yamada's credibility as a witness in this action. However, the Court finds that on many points Yamada's testimony is supported by that of Rolf or by documentary evidence. Further, the Court finds that it cannot credit the whole of the testimony of either of the other two principal witnesses, Dr. Rolf and Michael Stott.
Plaintiff's Investment Intent
Dr. Rolf's claim that he was an unsophisticated investor is undercut both by the events leading up to and those during the period of the complaint. First, as noted, plaintiff in earlier years had engaged a series of brokerage firms on a non-discretionary basis. Further, plaintiff makes no complaint concerning the securities bought for his account by S. Logan Stirling of BEDCO from 1963 through March 1969, and there is substantial evidence that certain of those stocks were aggressive investments.
The best evidence of Rolf's investment intent during the Stirling period is contained in a letter from the plaintiff to Stirling dated June 14, 1967:
"My objective is to double my equity. It would be interesting to see how long it takes." (DX-C)
Plaintiff testified that during the Stirling period, he would have been happy with an annual growth rate of ten percent, but that he would have been dissatisfied with anything less (Tr. 315).
There is substantial evidence that Dr. Rolf kept careful watch over his securities. During the period of the complaint, plaintiff checked the published prices of his securities three or four times per week (DX-III). He also employed a bookkeeper to keep track of his holdings and their value, both during the Stirling period and during the period of the complaint (Tr. 307; PX-24).
Further, although Rolf gave Stirling complete discretionary authority over his account (DX-P), the doctor telephoned Stirling's office as many as six times per week (Tr. 741). Rolf testified that he was fully satisfied with Stirling's handling of his BEDCO account, and pleased by the fact that the size of the portfolio more than doubled in the six years between 1963 and 1969.
In mid-March 1969, S. Logan Stirling took ill and left BEDCO, having suffered a brain tumor which proved fatal. Plaintiff claims, but the evidence does not support the conclusion, that Stirling was incapacitated as early as late 1968. However, the Court does conclude that from March through early May 1969, Rolf's million-dollar account went unattended by anyone at BEDCO. BEDCO's compliance officer admitted not only that the account was "dormant" during the period between Stirling's illness and Rolf's selection of Yamada, but further that during April 1969 some unidentified person at BEDCO sold one thousand shares of Talcott National Corp., purchased one thousand shares of Asamera Oil Corp., and sold one thousand shares of Occidental Petroleum Corp. (Tr. 1069-71; see DX-UU). This apparent indifference to plaintiff's investment needs at BEDCO is further illustrated by the manner in which Akiyoshi Yamada came to be selected as Rolf's investment adviser.
Michael Stott testified that following Stirling's departure from BEDCO, Mr. Schlesinger, a BEDCO partner, assigned the Rolf account to him. In late April 1969, Stott telephoned Rolf and offered to handle his account. Rolf stated that he wanted an investment adviser, and that Scott, while a capable and experienced broker, was just not an analyst with sufficient expertise to direct his investments. However, Rolf was willing to keep the account at BEDCO, and he asked Stott to recommend an investment adviser.
Stott testified flatly that he never knew what Rolf's investment objectives were (Tr. 881-82), and further, that he did not even look at the stocks in plaintiff's portfolio prior to their first contact (Tr. 941-48). Accordingly, the Court concludes that Stott recommended two advisers, Akiyoshi Yamada and Donald Geddes, knowing nothing about the plaintiff beyond the fact that Rolf's account had been handled by Mr. Stirling.
While Stott's trial testimony on the point is somewhat inconsistent with his deposition (see Tr. 888-89), it appears that Stott did little more than give plaintiff two names and two telephone numbers.
Dr. Rolf testified that Stott told him Geddes had experience with large accounts; however, according to the plaintiff, Yamada was more fully described. Stott told Rolf that Yamada had a Harvard Business School background, that he was from an illustrious and wealthy Japanese family, and that he was a brilliant analyst. Rolf travelled to New York shortly thereafter to interview the two.
Rolf and Yamanda met in a New York restaurant to discuss plaintiff's investments. Rolf thought Yamada both brilliant and capable, but was somewhat wary of Yamada's youth (Tr. 31). When Rolf spoke of an interest in preserving his equity, Yamada assured him that none of his clients had ever lost a penny (Tr. 30).
Yamada's testimony concerning Rolf's objectives is consistent with the rest of the evidence in the case. While Yamada stated that Rolf was unsophisticated and "groping" for guidance, it was clear to Yamada that Rolf wanted a very aggressive investment program, and that he was willing to engage in extensive trading in order to "double his equity" (Tr. 511, 514; PX-3).
Yamada's testimony to the effect that Rolf was interested in special situations, new issues, and aggressive trading is confirmed by a letter written by Rolf to Yamada much later. In that letter dated September 2, 1970, Rolf referred to his original investment intent as follows:
"As you recall, we started out with roughly $2,000,000 of Securities which could be used for trading.... It was my impression that we would wind up with 3.5 to 5 million in a years time." (PX-3)
In brief, Dr. Rolf decided that Yamada would be an appropriate investment adviser, and although he also interviewed Geddes, plaintiff settled on Yamada.
Rolf and Yamada agreed that Yamada would receive compensation equal to ten percent of plaintiff's capital gains. Rolf requested that trading be done through BEDCO and Stott, if at all possible. Rolf testified repeatedly, and the Court credits the statements, that Rolf sought to balance Yamada's youth and zeal with BEDCO and Stott's reliability and supervision. Indeed, in the plaintiff's mind, by the combination of Stott and Yamada, he was obtaining a "Stirling-type" operation (Tr. 35). Rolf told Stott that he expected BEDCO to look after his account, and that he didn't intend to keep his commission business at BEDCO without receiving something in return (Tr. 34). On May 9, 1969, Rolf executed a trading authorization granting to Yamada full discretionary authority over his BEDCO account:
"Messrs. Eastman Dillon, Union Securities & Co.
"I hereby authorize AKI YAMADA to buy, sell, including short sales, and trade in, for my account and risk and in my name, stocks, bonds and any other securities.... You will kindly follow his instructions in every respect concerning my account with you... as he may order and direct. In all matters and in all things aforementioned he is authorized to act for me and in my behalf in the same manner and with the same force and effect as I might or could do...." (DX-B)
It is clear from the evidence that in May 1969, Rolf expected Yamada to take substantial risks for capital gains, but at the same time to preserve the million dollar portfolio which Rolf had built up over the years through his own earnings and efforts and through the efforts of prior brokers. Indeed, since Rolf had no pension or retirement plan, his stocks represented his main security for his later years (Tr. 19).
It is also clear that Rolf expected BEDCO to supervise his account and Rolf understood that Stott was to look after his interests. As Rolf testified, he made this clear to Stott at the outset:
"I said, 'Mike, I can take this account any place. I am going to leave this account here,' but I said, 'Look, I want you to watch this. After all, you are going to be compensated for this, you are going to get all the commission business, and when I am back in Cleveland and busy, you keep your eye on things.'" (Tr. 34)
Contrary to his expectations, Rolf received from Yamada only the substantial risks and he received no supervision by BEDCO. The explanation lies in how Stott and Yamada saw their respective roles and in the very effective methods they used to shuffle Rolf between the two of them.
On May 9, 1969, the date when Rolf gave Yamada the trading authorization, Rolf's margin account contained twenty-three issues, all but one of which had been purchased by Stirling:
Loew's Theatres Wts., Leasco Data Processing Wts., Anaconda Co., Asamera Oil Corp., Avent Inc., Buttes Gas & Oil Co., CNA Financial Corp., Cities Service Co., Ebasco Industries Inc., Glen Alden Corp., INA Corp., International Industries Inc., General Electric Co., Leesona Corp., Levin Townsend Computer Corp., Loew's Theatres Inc., National General Corp., Occidental Petroleum Corp., Penn Central Co., Pittson Co., Raytheon Corp., Scientific Resources Corp., Teledyne Inc. (DX-UU at 2)
With the exception of the two warrants, each of the above securities were listed on the American or the New York Stock Exchange. Eighteen were issued by companies that had enjoyed continuous profits for five years or longer. Sixteen paid cash dividends. Yamada characterized six of the issues as "blue chip" and plaintiff's expert witness made similar observations. Yamada described the warrants as "aggressive" investments and two of the stocks as "racy". As of May 9, 1969, after reducing the value of the portfolio by the debit balance, plaintiff's margin account was worth $1,423,000 net.
Both Yamada and Rolf testified that they agreed in April 1969 to make certain changes in the account. Yamada was of the opinion that many of the stocks involved had seen their day, and that it was time to move on to newer and more profitable investments. However, Yamada stated that Rolf did not agree to liquidate the account; that decision was made by the adviser alone. Between May 1969 and January 1970, Yamada sold all 23 issues, 14 at a loss. Plaintiff made no complaint.
The evidence in this case most fraught with hazards concerning credibility is the testimony of Stott and Yamada regarding their relations with each other. However, it is clear that the two were in contact by telephone several times daily.
Further, Stott continually conveyed to Yamada the recommendations of BEDCO's research department with respect to certain issues, and many of those stocks were subsequently purchased for Rolf's account.
While Yamada and Stott met socially only on occasion, it is clear that their business interests were intertwined. Yamada stated that he relied upon Stott for recommendations with respect to oil and gas stocks; Stott's testimony on this point is equivocal.
There is no dispute that Stott had family connections with the management of two oil companies whose issues were purchased for Rolf, Standard Oil of New Jersey and West Coast Production.
Stott testified that he handled a total of six accounts referred to him by Yamada, but he stated that these accounts produced only a small proportion of his commission income (Tr. 794-95). Of the forty-one issues purchased for Rolf by Yamada and Stott during the complaint period, thirty-five were at some point traded through BEDCO (PX-24). Yamada testified that Stott recommended a total of twelve of the issues involved (Tr. 518-530); Stott admitted to recommending six of these.
With respect to the stocks which he did admit he recommended to Yamada, Stott testified that he did not specifically recommend the stocks for Rolf. Rather, Stott maintained that he simply gave Yamada the results of BEDCO's research, and that the recommendations were in actuality for Yamada's more speculative ventures, such as Takara Partners and the hedge funds (Tr. 780-81). The Court does not find this attempted distinction credible, particularly in light of the fact that Stott himself continually executed purchases and sales in these very stocks for Rolf's account; in these circumstances, there can be little doubt that Stott realized that Yamada was, at least in part, relying on the recommendations made by Stott and by BEDCO research in determining what to buy for the plaintiff; indeed, Stott admitted as much (Tr. 965).
Moreover, BEDCO's cross-index of all securities traded by Stott reveals that as to seven, not six, of the issues, Stott was at the time in question recommending and buying the stocks for his non- discretionary accounts of other customers (see PX-25). With regard to three more of the stocks listed by Yamada, the cross-index shows that Stott bought the issues for other investment advisers as well as for Yamada. Finally, as to one issue which Yamada claimed Stott was recommending, defendants report that there is no record in the cross-index as to whether or not Stott bought this issue for others (see PX-25). While PX-25, standing alone, does not establish that Stott recommended each of the twelve issues for Rolf, the document does serve to credit the testimony of Yamada to the effect that Stott was involved with the decision to purchase the issues.
Accordingly, in light of all of the findings hereinabove, and weighing all the evidence on the question, including the Court's observation of the demeanor of the witnesses, the Court concludes that Stott either recommended or was somehow involved with the decision to purchase the following twelve securities for plaintiff:
Simplex Wire & Cable Co., Teradyne, Inc., Standard Oil, N.J., Reading & Bates Offshore, Intertherm, Inc., Food Fair Properties, International Funeral, Natomas Corp., Asamera Oil Corp., Carter Wallace, Inc., West Coast Production, Equity Funding Corp. (PX-25; Tr. 518-530)
Accordingly, contrary to his testimony at trial, the Court finds that Stott was indeed involved with the management of the Rolf account, particularly during the first eight months of the complaint period.
One internal regulation at BEDCO prevented the trading of certain stocks through the firm. According to BEDCO's compliance officer, BEDCO would not solicit stocks which were selling at less than $5.00 per share (Tr. 978-79). For this reason, as well as for reasons of his own, between May 1969 and March 1971, Yamada opened no less than eight other accounts in plaintiff's name at eight different brokerage firms. Plaintiff stated that he was almost completely ignorant as to why all these other accounts were being opened. Upon inquiry, he learned that in some cases, Yamada had opened the accounts to give other broker associates some business; in other cases, Yamada opened the accounts to buy stocks from the firms that were engaged in underwriting new issues which BEDCO would not handle.
Despite these new accounts and the purchase and sale of stocks through those houses, Dr. Rolf was under the impression that BEDCO was looking after his portfolio as a whole. Indeed, the BEDCO account was a custody account, and in the great majority of cases where stocks were bought elsewhere by Yamada, Stott nevertheless received confirmation slips and the securities were delivered into BEDCO. Even though BEDCO received no commissions on these outside purchases, in a few cases the stocks were subsequently sold through BEDCO, producing commissions for Stott and his employer. According to Dr. Rolf, Stott assured him that BEDCO could still oversee the account since the stocks were often delivered in, and since confirmation slips were sent to Stott.
As Yamada's liquidation program quickly resulted in a wealth of new issues, many of which were over-the-counter stocks, Dr. Rolf was apparently both excited by the challenge of speculation and concerned over the strange names of the new issues. Beginning in July 1969, Rolf began calling Stott for assurance and for information about the new stocks. Stott testified that Rolf called him six or seven times per month from July 1969 through May 1970. Thereafter, Stott or his secretary called Rolf every day ...