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E. F. HUTTON & CO. v. PENHAM

September 24, 1982

E. F. HUTTON & COMPANY, INC., Plaintiff,
v.
JULIAN E. PENHAM, Defendant



The opinion of the court was delivered by: DUFFY

OPINION & ORDER

 KEVIN THOMAS DUFFY, D.J.:

 This decision is in great part dependent on the failure of the parties to sustain their requisite burden of proof by credible evidence. That failure requires the dismissal of the plaintiff's claims and the defendant's counterclaims. The result may not satisfy either party but I am convinced that justice will be accomplished thereby and hopefully that the appallingly vicious vendetta waged by each will be finally put to rest. Cf. Parklane Hosiery Co., Inc. v. Shore, 439 U.S. 322, 58 L. Ed. 2d 552, 99 S. Ct. 645 (1979) for a discussion of res judicata and collateral estoppel.

 The plaintiff E.F. Hutton & Company, Inc. ("Hutton") is a large brokerage dealer with membership on all of the major exchanges and a wide-spread system of branch offices. Julian Penham, the defendant, is a former Hutton "registered representative" or "account executive." Hutton brought this action alleging violations of Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b) (1976), Rule 10b-5, 17 C.F.R. § 240.10b-5 (1981), Section 17(a) of the Securities Act of 1933, 15 U.S.C.§ 77q(a) (1976), Section 352-c of the New York General Business Law, and common law fraud supposedly arising out of Penham's handling of certain customer option trading accounts and his own Hutton options account. In essence, Hutton alleges that Penham executed unauthorized trades on his customers' behalf and at the same time executed option trades in his own account that he was unable to cover. Penham, appearing pro se, denied the allegations.

 A non-jury trial was held before me on June 14, 15, 16, 17, 18, and 23, 1982 to resolve Hutton's allegations and Penham's counterclaims. *fn1" The following shall constitute my findings of fact and conclusions of law.

 I.

 The tale which was unraveled at trial has as its central characters Julian Penham and Irwin Dublirer, the former Hutton manager of the A-19 Branch Office where Penham worked during his tenure at Hutton. Mr. Dublirer, Penham's direct superior, was responsible for Mr. Penham's activities at Hutton and was eventually responsible for the defendant being fired.

 Penham's previous employment in the securities industry included Shields, Modell, Roland, Inc., Herzfeld and Stern and Oppenheimer & Co. before he was hired by Hutton in July, 1980. Trial Transcript at 406. Penham opened option trading accounts for himself (Defendant's Exhibit 2), and his customers soon after his arrival at Hutton. Hutton's procedure required that all option investors, including its own account executives, sign an option agreement form. If the form is not signed within fifteen days of receipt or mailing, Hutton's internal regulations required that all transactions in that account are to be blocked. Trial Transcript at 74, 559; June 23, 1982 Stipulation at 4 P 13, at 9 P 6. Obviously this requirement is in recognition of the extreme volatility of the options market.

 Mr. Penham amassed an impressive record at Hutton; as of September 30, 1980, Penham led all account executives at his branch in revenue production. Defendant's Exhibit 8. Penham's glory days at Hutton, however, were not long lived. On December 1st and 3rd, 1980, Penham ordered the purchase of a total of 550 Kerr-McGee Corporation options: 210 January 90 Calls *fn2" at market prices of 10 at 7-1/8, 100 at 5-3/8, 57 at 5-1/4 and 43 at 5-1/8; 340 January 100 Calls at market prices of 140 at 3-3/4, 150 at 3-5/8 and 50 at 3-1/4. Plaintiff's Exhibits 1, 2 and 3. These orders were placed in Penham's own trading account and he was subsequently sent written confirmations of these transactions. Plaintiff's Exhibits 1, 2, and 3. These trades were effected despite the fact that Penham never signed the option agreement form as required by Hutton. Defendant's Exhibit 2. Even though he denied it at trial, this fact was known to Dublirer. Hutton's automatic blocking procedure failed to spot the incompleteness of Penham's option agreement, and allowed the defendant to accumulate significant liability. These purchases, inclusive of commissions, amounted to a total indebtedness of $240,782.55. At the time of these substantial trades, Penham's own account had a balance of $67,812.24 and the defendant was without other means to cover these trades. Trial Transcript at 397. This fact was also known to Dublirer and apparently to the higher management of Hutton. Defendant's Exhibit 67, Trial Transcript at 367, 530-34. Penham maintains that the greater number of these trades were made for the benefit of Dublirer. One member of Hutton management, Robert Schulman, the regional director of option sales for the Atlantic region, had received a complaint from Penham in November about trades being placed in his account for the benefit of Dublirer, prior to the trades giving rise to this action. Trial Transcript at 593.

 On December 4, 1980, Penham was called into Irwin Dublirer's office to discuss the Kerr-McGee purchases in question. After conceding that he did not have the money readily available, Penham requested that Dublirer not liquidate the trades and not call in Jerry Miller, Hutton's Regional Vice-President. Trial Transcript at 33-34. Dublirer ignored the defendant's requests and called in Miller for resolution of the problem. Miller ordered immediate liquidation of Penham's positions and immediate notification of Penham's problems to the legal department despite defendant's protestations. Trial Transcript at 36. This is the same Jerry Miller who less than two months earlier had written in a memo to Penham that his "career at E.F. Hutton is off to a flying start as exemplified by the excellent month you have just completed. Keep up the hard work and this month will become only one of many in which I expect will be a long line of notable achievements." Defendant's Exhibit 15.

 A later meeting was held on December 4th in Miller's office between Penham, Dublirer, two representatives of Hutton's legal department and Miller. Penham was fired during this meeting because Hutton "did not believe I [Penham] could pay for purchases which I had made in my own account. . . ." Trial Transcript at 456. The defendant's requests that the positions remain intact to allow the value of the Kerr-McGee options to increase were rebuffed. Penham was given until the following morning to raise the money needed to cover his liabilities. Not surprisingly, the brief reprieve was not sufficient time for Penham to raise the necessary funds and his positions were subsequently transferred to the Hutton option department for liquidation. Trial Transcript at 40.

 After Penham left Hutton's employ, the defendant's customers were referred to Irwin Dublirer. Mr. Dublirer, testified at trial that Stephen Null, Burton Crow, Harriet Hitman, Abraham and Bertha Teitel, Arthur Bellone, Douglas Sloan, Stephen Silk and Merrick Gagliano all informed him that Penham executed unauthorized trades in their accounts. *fn3" At trial, however, only Burton Crow, Merrick Gagliano and Stephen Silk testified as to allegedly unauthorized trades in their accounts.

 Penham assumed the account of art director Gagliano after this customer's former account executive left Hutton. Gagliano, a candid and credible witness, fully understood the risks of option trading. He closely and anxiously followed his trades. In his efforts to profit off the volatile option market, Gagliano authorized Penham to buy on November 13, 1980, 20 Motorola January 70 Puts at a price of 3-1/8. Trial Transcript at 243. Penham's liquidation of these positions on December 2, 1980 at a price of 10 at 1 and 10 at 1-1/16 was, however, unauthorized. A distraught Gagliano received the confirmation of these unauthorized sales and immediately called Penham at home to confirm that these unauthorized sales had in fact been effected. Penham, having just been fired, advised Gagliano to tell Hutton that both the purchase and sale of the Motorola options were unauthorized at which point Hutton might void the entire transactions and wipe out Gagliano's loss. Soon thereafter Gagliano called Dublirer to relay his distress and told him that only the sale of the options was unauthorized. Dublirer, even though he fully realized that the purchase of the Motorola Puts was authorized, decided in the name of "customer relations" to void the entire transaction though this had not been requested. Trial Transcript at 244, 362-63, Plaintiff's Exhibit 53.

 Mr. Burton Crow, a present graduate student at Teacher's College, Columbia University who at the time of the transactions in question was director of student aid at Teacher's College, opened his option trading account at Hutton with Penham in July, 1980. Crow was an inexperienced investor who relied on Penham for advice on profit-making trades yet understood the real possibility of losing his entire investment on any given trade. Penham had success with Mr. Crow's account from August through October, 1980. Plaintiff's Exhibit 19. On November 13, 1980, Penham purchased 25 Motorola January 70 Puts at 3-3/4 which debited Crow's account $9,648.26. Plaintiff's Exhibit 16. Penham sold this position on December 2, 1980 for $2,302.28 resulting in a loss of $7,345.98. Plaintiff's Exhibit 18. During this same period of time, Penham also purchased for Crow's account 20 Kerr-McGee January 100 Calls, 8 at 3-1/8 and 12 at 3, for a total price of $3,727.32. Crow testified that these Kerr-McGee and Motorola losing trades, which appear normal on their face, were unauthorized. This witness testified that because he was housesitting in Leonia, New Jersey during the times these trades were effected, his mail was not forwarded from his New York City home and he never received the Hutton confirmations. The implication was made that if Crow had received the confirmations he would have called Hutton sooner to complain. Trial Transcript at 262-63. Crow's testimony is contradicted by objective evidence. Mr. Crow's monthly Hutton statement reflects his New York City address for the months of August and September, 1980. Plaintiff's Exhibit 19. The monthly statement, however, was amended in October, 1980 to reflect Mr. Crow's residence in Leonia, New Jersey. The New Jersey address is on the monthly statements listing the trades in question and Crow acknowledged receiving the monthly statement. Trial Transcript at 274. The confirmations for the challenged trades also reflect the Leonia, New Jersey housesitting address, (Plaintiff's Exhibits 16, 17 and 18), and consequently cast serious doubt on the testimony of Mr. Crow. As was developed on cross examination, Mr. Crow first learned of Penham's termination when he called Hutton during the first week of December. Crow was not calling to complain about the trades recorded on ...


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