Cross-appeals from a judgment of the United States District Court for the Southern District of New York, Lawrence W. Pierce, Judge, finding aiding and abetting liability of a registered representative and his broker employer under § 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder, but limiting damages to commissions paid and interest thereon.
Smith, Mansfield and Oakes, Circuit Judges. Mansfield, Circuit Judge, dissenting.
On cross appeals from a judgment of the United States District Court for the Southern District of New York, Lawrence W. Pierce, Judge,*fn1 plaintiff David E. Rolf (Rolf) endorses the district court's holding on questions of liability, but challenges the district court's measure of damages. Defendants in turn attack the district court's theories of liability. In the court below, Judge Pierce imposed aiding and abetting liability on defendant Michael Stott (Stott) and derivative liability on his employer, Blyth, Eastman Dillon & Co., Inc. (BEDCO), for Stott's substantial assistance to and participation in a web of securities fraud perpetrated by defendant Akiyoshi Yamada (Yamada),*fn2 contrary to § 10(b) of the Securities Exchange Act of 1934 (SEA), 15 U.S.C. § 78j(b) and Rule 10b-5 thereunder, 17 C.F.R. § 240.10(b)-5. Judge Pierce also implied a private cause of action under New York Stock Exchange (NYSE) Rule 405 and under Article III, Section 2 of the constitution of the National Association of Securities Dealers (NASD). The Judge then awarded damages and interest totaling $55,790. We agree with Judge Pierce on the aiding and abetting liability of Stott. We therefore affirm as to him and in view of BEDCO's acknowledgment for purposes of this appeal that it is vicariously liable by reason of Section 20 of the 1934 Act, 15 U.S.C. § 78t(a), affirm also as to it. Brief for Defendants-Appellees-Cross-Appellants at 28n.*. Accordingly, we do not reach the question whether there is an implied cause of action under the NYSE rule or the NASD constitution. We disagree with Judge Pierce on the measure of damages, however, and accordingly remand for reconsideration thereof.
Rolf is an ophthalmologist from Shaker Heights, Ohio. Long an investor and an aggressive trader in the stock market, he began his association with Eastman Dillon Union Securities & Co., BEDCO's predecessor firm, in 1963 when he entrusted a discretionary account to S. Logan Stirling, a partner of the firm. The value of Rolf's portfolio at that time was approximately $400,000. In March of 1969 Stirling was forced to retire owing to ill health. At the end of April, a BEDCO partner assigned the Rolf account to Stott, a registered representative with the firm for 11 years during 4 of which he was a manager of BEDCO branch offices. Stott then telephoned Rolf and offered his services. Rolf, however, wanted an investment advisor to manage his account, not simply a broker. Stott, therefore, at Rolf's request, supplied the names of two investment advisors. Rolf ultimately interviewed and selected Yamada, one of the "new breed" of young money-managers with supposed expertise in research and "special situations."
The district court found that Rolf's investment intent was to combine Yamada's and Stott's strengths into a "Stirling-type" operation, 424 F. Supp. 1021, 1028 (1977). By combining Yamada's youth and zeal with Stott's reliability and supervision, Rolf hoped to realize, as he had with Stirling's advice, substantial capital gain in an investment program emphasizing preservation and augmentation of capital. In furtherance of these investment objectives, Rolf executed a broad authorization giving his investment advisor, Yamada, full trading discretion. Rolf left the account and its accompanying trading commissions with Stott and BEDCO in return for Stott's supervision of Yamada.
On May 9, 1969, the date of the trading authorization, Rolf's equity in his portfolio stood at $1,423,000. The portfolio consisted of 21 good quality, listed securities and the warrants of two companies.*fn3 By January of 1970 Yamada had liquidated the entire portfolio, selling 14 issues at a loss. The net value of Rolf's portfolio had declined to approximately $712,000 of which $338,000 was invested in the restricted stock of Delanair, Inc.*fn4 During this period of portfolio liquidation Yamada and Stott were in daily contact. The district court found that out of 41 issues purchased for Rolf in the complaint period Stott "either recommended or was somehow involved with the decision to purchase" 12 securities, some of which were highly speculative. Id. at 1030.*fn5
With the rash of new, unfamiliar securities which found their way into Rolf's portfolio, Rolf became concerned and sought assurances from Stott as early as July, 1969. Specifically Rolf wished to ascertain that Yamada's purchases were consistent with the former's investment goals and strategy. To assuage Rolf's fears, the district court found, Stott undertook a hand-holding operation whereby Stott would reassure Rolf of Yamada's competence whenever Rolf questioned it. Id. at 1031. For example, when in August, 1969, Yamada decided to purchase nearly $400,000 in Delanair stock, Rolf checked with Stott who assured the doctor that if Yamada recommended the stock, then it was safe to proceed.
By March 29, 1970, the value of Rolf's portfolio had dropped to $446,000 of which nearly one-half was tied up in Delanair. In early April, Rolf complained to Stott who began to assume the posture that he was a mere "order taker." Rolf disagreed with this self-description, asking Stott to "work closely with Aki," and reminded Stott that Stott was his "man in N.Y." Id. at 1032-33. Later, on December 14, 1970, Rolf again asked Stott to "keep [his] pulse on the situation."
The district court discredited Stott's testimony that he was not involved in the management of Rolf's portfolio specifically finding that Stott was in fact so enmeshed. Id. at 1028, 1030, 1031. Stott and Yamada were in daily contact. Stott made numerous recommendations to Yamada for Rolf accounts using BEDCO research analysis, id. at 1030, but never counseled against a Yamada purchase. Id. at 1033. And most of the trades were executed through Stott at BEDCO. For those stocks purchased through other brokerage houses, because of BEDCO internal rules, Stott received confirmation slips. Additionally, such securities were delivered to and held by BEDCO.
The district court's finding on the question of Stott's attitude toward the quality of the purchases is not altogether clear. The lower court states on the one hand that it gives " some weight to Yamada's statement that Stott referred to the stocks in the Rolf account as 'junk,'" i.e., of very low quality. Id. at 1033 (emphasis added). But the Judge goes on to conclude "that Stott did indeed consider many of the securities to be 'junk' and that he told this to Yamada." Id.
The district court unequivocally found, however, that Yamada was engaged in fraudulent stock manipulations, of which Stott was ignorant. The district court also concluded unambiguously that Yamada's overall management of the account was fraudulent in nature, over and above the specific manipulations of which Stott was unaware. Id. at 1043. Stott was of course knowledgeable that many of the securities purchased for Rolf were highly speculative, "high-fliers." Id. at 1035. Nevertheless, neither Stott nor BEDCO ever identified any security as unsuitable for Rolf. Id. at 1036. Stott's services to Rolf consisted solely of certain "buy" recommendations, executing transactions and performing the accompanying paperwork. The court concluded that
Stott's practice of continually voicing his confidence in Yamada and in Yamada's investment decisions constituted a fraud upon Dr. Rolf, who sincerely believed that Stott had some basis for his statements. The statements of support and the assurances which were repeatedly made were made with willful and reckless disregard for whether they were true or false.
The district court based liability on alternative legal theories. The first was that Stott owed a fiduciary duty to Rolf which he breached; that by virtue of that breach Stott aided and abetted Yamada's fraud and was therefore liable under § 10(b) of the SEA, 15 U.S.C. § 78j(b), and Rule 10b-5 thereunder, 17 C.F.R. § 240.10(b)-5; and that BEDCO's liability for Stott's participation in Yamada's fraud derives alternatively from the common law doctrine of respondeat superior or the securities law doctrine of controlling persons liability, § 20(a), SEA, 15 U.S.C. § 78t(a). The district court also rested liability on an implied private cause of action from violations of NYSE Rule 405 and the NASD constitution, Article III, Section 2.*fn6 The Judge then awarded damages of $55,790, on a "churning" theory, even though he dismissed plaintiff's churning claim, on the ground that any other measure of damages would be "speculative." 424 F. Supp. at 1045.