The opinion of the court was delivered by: COOPER
The plaintiff in this action is a medical marketing researcher who began investing money in the stock market in 1979 or 1980. Defendant Thomson McKinnon Securities, Inc. ("Thomson") is a securities firm and broker-dealer registered with the Securities and Exchange Commission and is a member of the New York and American Stock Exchanges, the National Association of Securities Dealers ("NASD") and other broker-dealer organizations. Plaintiff had maintained a margin account
with the Nanuet, New York office of Thomson from August 1980 until February 1981 when her account was liquidated. The particular broker with whom she dealt was defendant Lester Kuznetz, an employed, registered representative of Thomson at all relevant times.
Plaintiff commenced this action for damages in December 1981 alleging that the manner in which her account had been handled by Kuznetz and Thomson violated section 10(b) of the Securities and Exchange Act of 1934, 15 U.S.C. § 78j(b) ("SEA"), Rules 10b-5 and 10b-16 promulgated under section 10(b); Regulation T, 12 C.F.R. § 220; Rule 405 of the New York Stock Exchange ("NYSE"); Article III, section 2 of the NASD Rules of Fair Practice; and the common law. Defendants counterclaimed for the unsecured debit balance in plaintiff's account when it was liquidated.
The trial to the Court was bifurcated, the issue of liability to be determined first; damages reserved pending our instant determination. Upon all the evidence adduced before us, we adopt plaintiff's findings of fact in their entirety and reject all conflicting of fact proposed by defendants.
After inheriting some stocks upon her mother's death, plaintiff opened a brokerage account with Haas Securities ("Haas") in 1979 or 1980, a discount brokerage house in New York City. Through that account, plaintiff purchased a total of six stocks at different times. She maintained a cash account and a margin account at Haas although she did not fully understand how the latter operated. (Tr. 122)
Haas Securities bought and sold stocks but did not offer investment advice. In July of 1980, plaintiff concluded she needed guidance on her investments since, as she testified, "I had suffered some losses from a divorce [and] I wanted quidance to try and reestablish those legal fees, and . . . [my fiance and I] were contemplating buying a house, and . . . the money would eventually be needed for closing of that residence." (Tr. 17)
Defendant Kuznetz was recommended to plaintiff and her then fiance (now husband), William Durkin, by a friend of Durkin's named Tom Piconi. On July 2, 1980, Durkin met with Kuznetz and Piconi to discuss the possibility of transferring plaintiff's account to Thomson. Durkin related plaintiff's dissatisfaction with the limited scope of business activities, especially the total absence of investment advice, at Haas and the reasons why plaintiff wanted expert guidance in the purchase and sale of securties. He expressed the belief that the stocks in plaintiff's portfolio were worth $7,000 to $7,500 cash value and gave Kuznetz a copy of plaintiff's latest Haas account statement. Durkin knew that Thomson usually required a minimum of $25,000 to open an account. (Tr. 186)
Kuznetz informed Durkin during the meeting that at that time there was no particular stock he could suggest because of the small size of plaintiff's portolio; that he would give the matter thought and call plaintiff. (Tr. 186-87) Kuznetz gave Durkin two agreements for plaintiff to sign and return: a customer's agreement (Ex. D) and a transfer account agreement (Ex. A). Kuznetz also gave Durkin a "stack" of other papers, the subject matter of which plaintiff was unable to recollect at trial. (Tr. 122-23) Durkin was impressed with Kuznetz and so advised plaintiff. Without apprising Kuznetz, she then signed the agreements and forwarded them to him. (Tr. 191-92)
The next day, July 3, Kuznetz telephoned her.She reiterated to Kuznetz her need and desire for investment guidance as well as her financial goals and told him she was "virtually ignorant as to what was happening." Plaintiff testified that Kuznetz repeated that "he really didn't know of anything that he could put me into," and advised plaintiff "that he would handle the transfer of the account by virtue of the instruments that [she] signed." (Tr. 17) What neither plaintiff nor Durkin knew was that on the afternoon of July 2, after Kuznetz's meeting with Durkin and a day before his telephone call to plaintiff, Kuznetz had purchased 1,000 shares of Health-Chem stock for plaintiff.
Within a few days, Kuznetz called plaintiff again and recommended selling the 100 shares of Homestake stock which were in her portfolio from Haas since "gold stocks were not going to go anywhere." (Tr. 19) After talking to the specialist who Kuznetz said had given him this advice, plaintiff told Kuznetz she did not wish to sell the Homestake shares.Kuznetz proceeded to a subsequent conversation with the specialist, still believed the stock should be sold, and did in fact sell it on July 17. (Tr. 25) Upon learning this, plaintiff expressed to Kuznetz her dissatisfaction with the sale of Homestake stock. Kuznetz responded "[t]hat it was the best move [she] could make," to which plaintiff said "okay." (Tr. 28)
About the same time that Kuznetz sold the Homestake stock, he advocated the purchase of Health-Chem stock in which he believed there was "a great deal of opportunity." (Tr. 20) When plaintiff asked how the Health-Chem could be bought without Thomson having received her securities from Haas, Kuznetz assured her "he was going to take care of it." (Tr. 30) Kuznetz then spoke with Durkin about Health-Chem stating that an article had been written regarding Health-Chem products; Durkin said he would read it, then consider purchasing the stock for plaintiff's account. (Tr. 198) It must be borne in mind that at the time Kuznetz had these conversations with plaintiff and Durkin, he did not reveal he had actualy purchased the Health-Chem stock on July 2.
Approximately at the close of July or beginning of August, 1980, Kuznetz called plaintiff and told her the Health-Chem stock "wasn't reacting well;" that he had spoken with Durkin who agreed it should be sold, and he was going to sell it. Kuznetz answered affirmatively plaintiff's query concerning whether they had given Health-Chem enough time to appreciate in value. (Tr. 31)
Soon after this conversation with plaintiff, Kuznetz told her and Durkin about a stock called Reserve Oil: "that many of his customers had been put into it, that he felt very, very strongly about the stock, it was a stock that with pending legislation he thought was going to be a real winner and he would like to put [plaintiff and Durkin] into it. And that he would cover it again." (Tr. 33)
Durkin requested financial figures on Reserve Oil, but Kuznetz stated he did not have that information, whereupon Durkin looked up the company in Moody's OTC Industrial Manual and ordered a 10K form and an annual report. (Tr. 203) He assessed the stock as being a poor risk and called Kuznetz to express that opinion and to tell him that "I thought he was crazy." (Tr. 205) Kuznetz answered that his opinion was fortified by favorable information from a specialist. Soon after, in early August 1980, Kuznetz called Durkin and notified him that Kuznetz would be putting some Reserve Oil stocks into plaintiff's account. In response to Durkin's expression that it was not "right," Kuznetz said, "Don't worry." (Tr. 205-06) There were also two conversations about purchasing the Reserve Oil stock between plaintiff and Kuznetz prior to the latter's total purchase of 1500 shares of Reserve Oil for plaintiff made in three separate purchases of 500 shares each between August 5-8, 1980 at a total cost of about $49,000 - $50,000. (Ex. 4)
The regulation promulgated under the SEA which governs the extension of credit by brokers and dealers provides that brokers may loan no more than 50% of the current market value of a security to each customer. Regulation T, 12 C.F.R. § 220.8. At the time Kuznetz purchased the Reserve Oil, most of plaintiff's money was tied up in margin accounts. The Health-Chem stock had been sold for $13,145.98; since it was a margin account, one half of that amount, $6,572.99, was left to invest in other stocks. The Wometco margin stock which plaintiff had purchased while she was a customer at Haas was sold on August 4, 1980 for $2,142.99; 50% of the market value was $1,071.50. Kuznetz believed that 600 shares of the Threshhold Technology was still in plaintiff's margin account, but this was tied up in the stock -- not available as a liquid asset. In actuality, 300 shares had been sold for $2,735.69 (Ex. B) of which one-half, $1,367.85, belonged to Haas. (The proceeds of the sale were used to reduce plaintiff's margin debt.) (Tr. 172) Thus, the money in plaintiff's account which was available for other investments at the time that Kuznetz purchased the Reserve Oil was $6,572.99 plus $1,071.50 plus $1,367.85 -- a total of $9,012.34 plus some possible leftover proceeds in cash from the Threshhold Technology sale. Even if Kuznetz additionally calculated into this sum the other 300 shares of Threshhold Technology and the 100 shares of Texaco which then sold at about $40 per share, Kuznetz certainly should have been aware that after dividing all this by one-half, plaintiff's account would still be worth only approximately $12,380. See L. Loss, Fundamentals of Securities Regulations 719 n.48 (1983). Yet Kuznetz purchased more than five times this amount of Reserve Oil. Needless to add, the purchase was in excess of the 50% requirement of the SEA.
On cross examination, in response to the question of whether plaintiff accepted the purchase of Reserve Oil, she testified, "Yes, I did." (Tr. 159) However, she realized that she could not afford the purchase. She called Kuznetz and told him that "[w]e can't do this and buy our house," (Tr. 37-38), and that she was upset because she blindly trusted him with money and future security (Tr. 40). She informed him that she and Durkin wanted to "close on" the house (in which they were then living) based on a 12% mortgage rate given them by a bank and that she wanted to use some of the stock money to cover at least part of the closing costs (Tr. 44). Kuznetz told her he would "take care of it;" "[you] can always put [the stock] back in [my] account;" (Tr. 37-38) "we will worry about it when the time comes. Nobody is bothering me yet . . .;" (Tr. 40) "[you and Durkin will] get out of the stock in time to go to closing on [your] home." (Tr. 45) Plaintiff hung up on Kuznetz.
Kuznetz also spoke to Durkin several times subsequent to the initial purchase of Reserve Oil. Durkin expressed plaintiff's dissatisfaction and asked why Kuznetz had acted without authorization. Kuznetz again resorted to his frequent reassurance: "Don't worry about it." After a number of similar telephone calls, including two in which Durkin requested the stock be sold, Kuznetz slammed the telephone down on Durkin once and in a second conversation used extremely foul, filthy words (Tr. 212) to Durkin. Finally, in late September 1980, Durkin consulted with an attorney on the matter; no action was action. (Tr. 208-12)
Kuznetz called plaintiff later that month a few times to "touch base" with her. He informed her that he had not yet received her account from Haas and assured her that as long as he did not receive the transfer, he could protect the position she was in. (Tr. 49) He further told her that due to his purchase of Reserve Oil for many of his customers, "nobody wanted to talk to him." (Tr. 48, 50) Plaintiff informed him that her house closing had been postponed and she was frightened about the prospect of losing the opportunity to purchase the house. (Tr. 50)
Soon after this conversation, plaintiff wrote a letter to Kuznetz asking what he was going to do about her situation. (Ex. 6) Kuznetz, who testified that he never received the letter, did not answer it.
Around late December 1980 or early January 1981 Kuznetz called plaintiff at least once to inform her that the volume in the Reserve Oil stock was active and the stock was performing well.(Tr. 105-06) In fact, as plaintiff knew, the stock had returned at that time to approximately the price at which Kuznetz had purchased it for plaintiff.
The next conversation between plaintiff and Kuznetz took place during the week of February 18, 1981 when Kuznetz told plaintiff to give him the money owing from a margin call on plaintiff's account if she did not want her account to be liquidated. Plaintiff protested, saying she did not want the stock in the first place and Kuznetz had known plaintiff's portfolio was less than the minimum amount Thomson usually required. (Tr. 55)
A few moments later Mr. Sandhaus, a vice president of Thomson and a branch manager at the Nanuet, New York office, called plaintiff back and told her that if she did not pay the money due, her account would be liquidated. He claimed that Kuznetz acted in her best interests and that she knew what she had been doing. (Tr. 58) Within a few days plaintiff received two confirmations from Thomson addressed to her documenting the sale of her 1500 shares of Reserve Oil and her 100 shares of Texaco (which had been transferred from her account at Haas in November, 1980). (Tr. 59)
The liquidation of the account left an unsecured debit balance of $13,007.32.
Kuznetz's testimony parts company with that of plaintiff and Durkin in several respects. Kuznetz contends: that at their July 2nd meeting, Durkin stated that plaintiff's only reasons for transferring her account were Haas' poor execution of its accounts and the couple's desire to make money (Tr. 237-39); that plaintiff and Durkin agreed to the purchase of the Health-Chem stock (Tr. 243); that Durkin gave Kuznetz an order for the purchase of the first and second 500 shares of Reserve Oil (Tr. 245, 249); that Durkin never protested the purchase of the Reserve Oil stock and Kuznetz never had to reassure Durkin (Tr. 250); that since the stock increased in price within two days of the purchase of the 1,000 shares, Durkin and plaintiff agreed to sell the Health-Chem and take a small loss in order to buy another 500 shares of Reserve Oil (Tr. 252); that Durkin and Kuznetz talked two to three times per week throughout September, October and November 1980 and more often in December 1980 and January 1981 (Tr. 256); that Kuznetz never said that if plaintiff encountered problems with the Reserve Oil stock he would move it into his own account (Tr. 264); that Kuznetz's only reference to "covering" for plaintiff was in the context of saying her Haas account, which was being transferred, would cover her Reserve Oil purchases (Tr. 265); and that Kuznetz never hung up the telephone on Durkin or used curse words when speaking to him (Tr. 266-67).
As we have already indicated, we adopt as true and convincing the version of the facts revealed by plaintiff and the proof adduced in her behalf. We make short shrift of Kuznetz's testimony: We declare it totally unpersuasive and unconvincing. We unhesitatingly reject it in toto. The testimony of the other witnesses for the defendants was unimpressive.
The trial record compels our firm conclusion that throughout the time period during which he handled plaintiff's account, Kuznetz disclosed an appalling shoddiness and lack of sensitivity; he reached a high point of deplorable inconsiderateness. His knowledge of the intricacies of the business gave him an enormous advantage over her, and in another sense, enabled him to take advantage of her.
Despite our considered estimate of the totality of the proof adduced, we must painstakingly hold, as a matter of law, that plaintiff may not recover her losses from the defendants; neither is she liable for the debit balance in her account when it was liquidated.
Plaintiff alleges that Kuznetz's acts of buying the Health-Chem and the Reserve Oil stocks and selling the Homestake stocks without authorization and of continually assuring that he would "take care" of the situation constituted violations of section 10(b) of the SEA and Rule 10b-5 promulgated thereunder; NYSE Rule 405; and Article III, section 2 of the NASD Rules of Fair Practice. Plaintiff further claims that Thomson's rules and policies concerning margin accounts were not furnished in writing to plaintiff, and the company therefore violated Rule 10b-16 promulgated under section 10(b) of the SEA as well as Rule 10b-5. Third, it is alleged that the excessive margin debts incurred in plaintiff's account despite plaintiff's protests and lack of approval violated Regulation T, 12 C.F.R. § 220. Finally, plaintiff complains that the acts by the defendants hereinabove mentioned constituted common law fraud and breach of fiduciary duty and caused plaintiff to suffer severe emotional distress.
Congress enacted the SEA in order to encourage public participation in the stock market by protecting investing members of the public from fraud and manipulation of stock prices, see Ernst & Ernst v. Hochfelder, 425 U.S. 185, 195, 96 S. Ct. 1375, 1382, 47 L. Ed. 2d 668 (1976); Palmer v. Thomson & McKinnon Auchincloss, Inc. 427 F. Supp. 915, 921 (D. Conn. 1977), and to provide "a high standard of business ethics . . . in every facet of the securities industry." United States v. Naftalin, 441 U.S. 768, 775, 99 S. Ct. 2077, 2082, 60 L. Ed. 2d 624 (1979) (quoting SEC v. Capital Gains Research Bureau, Inc., 375 U.S. 180, 186-87, 84 S. Ct. 275, 280, 11 L. Ed. 2d 237 (1963)); United States v. Newman, 664 F.2d 12, 18 (2d Cir. 1981); E.F. Hutton & Co., Inc. v. Penham, 547 F. Supp. 1286, 1295 (S.D.N.Y. 1982). In accordance with these goals, section 10(b)
of the Act, 15 U.S.C. § 78j(b), and Rule 10b-5
promulgated thereunder by the Securities and Exchange Commission, 17 C.F.R. § 240.10b-5 (1979), were designed to prohibit fraudulent, manipulative and deceptive schemes in connection with the purchase or sale of any security.
The elements requisite to a claim under rule 10b-5 are: (1) a misrepresentation or omission of material facts by a defendant; (2) in connection with the purchase or sale of a security; (3) detrimental reliance by plaintiffs on the misrepresentations or omissions; and (4) scienter on the part of defendants in making the misrepresentations and omissions.
See First Virginia Bankshares v. Benson, 559 F.2d 1307, 1314-15 (5th Cir. 1977), cert. denied, 435 U.S. 952, 98 S. Ct. 1580, 55 L. Ed. 2d 802 (1978); Penham, supra, at 1295; Savino v. E.F. Hutton & Co., Inc., 507 F. Supp. 1225, 1231 (S.D.N.Y. 1981); Drasner v. Thomson McKinnon Securities, Inc., 433 F. Supp. 485, 503 (S.D.N.Y. 1977). We will examine each element separately to determine whether Kuznetz and Thomson violated section 10(b) and Rule 10b-5.
The first factor requires the defendants to have misrepresented or omitted material facts to the plaintiff. A misrepresentation may be defined as a false statement; an omission is constituted by silence when a defendant has a duty to speak. See First Virginia Bankshares, supra, at 1314; Coons v. Kidder, Peabody & Co., Inc., 539 F. Supp. 1145, 1146 (S.D.N.Y. 1982). It is also essential that the misrepresentation or omission concerns material facts. Materiality is established when "a reasonable man would attach importance to the alleged omissions [or misrepresentations] in determining his course of action." In re New York City Municipal Securities Litigation, 87 F.R.D. 572, 579 (S.D.N.Y. 1980) (quoting Titan Group, Inc. v. Faggen, 513 F.2d 234 (2d Cir.), cert. denied, 423 U.S. 840, 96 S. Ct. 70, 46 L. Ed. 2d 59 (1975)).
We find that Kuznetz made two material misrepresentations to plaintiff. First, Kuznetz's call to plaintiff on July 3, 1980 in which he told her that he did not yet have any ideas concerning stocks which would be appropriate for her, when in actuality he had purchased the Health-Chem the day before, was a material misrepresentation. Indeed, if plaintiff knew before she opened an account with Thomson that Kuznetz would invest her money in a manner unsatisfactory to her, she might very well have taken her business elsewhere. Second, Kuznetz's statements to plaintiff and Durkin implying that plaintiff could afford the Reserve Oil purchases because Kuznetz would "cover" for her or because plaintiff could put the stock in his account, or because plaintiff's account had not yet been received from Haas, were misrepresentations, the truth of which, had it been known, very likely may have altered plaintiff's actions. These two purchases, therefore, violated the first prong of the Rule 10b-5 test.
We do not find that Kuznetz's sale of the Homestake stock was a material misstatement or omission. Plaintiff did not prove that Kuznetz's poor opinion of Homestake was a misrepresentation; the fact that the stock went up soon after Kuznetz had sold her shares is part of the gamble any stock market participant takes, whether investor or broker.
Plaintiff also claims that defendant failed to inform her of Thomson's market-maker status regarding the Reserve Oil stock.
If plaintiff was correct, such an omission would be material. Chasins v. Smith, Barney & Co., 438 F.2d 1167, 1171-72 (2d Cir. 1970) (brokerage firm's statement in confirmation slips that it was acting as principle for its own account without stating that it was "making a market" in the securities was material omission in violation of Rule 10b-5). However, Thomson's position as a market-maker was written on the account statements plaintiff received at the end of each month. (Ex. 4 and 8) We find that this procedure was enough to alert plaintiff of Thomson's market-maker status.
The second element necessary to a finding of liability under Rule 10b-5 is that the misrepresentation or omission be in connection with the purchase or sale of a security. The Supreme Court has found that the "in connection with" phrase must be construed liberally to encompass practices "touching" the sale of securities. Superintendent of Insurance v. Bankers Life & Casualty Co., 404 U.S. 6, 12, 92 S. Ct. 165, 168, 30 L. Ed. 2d 128 (1971). Following the Court's guidance, our Circuit Court has held that where the achievement of a fraud is directly related to the trading process, the "in connection with" requirement is met. United States v. Newman, 664 F.2d 12, 18 (2d Cir. 1981); Competitive Assocs., Inc. v. Laventhol, Krekstein, Horwath & Horwath, 516 F.2d 811, 815 (2d Cir. 1975); see Natowitz v. Mehlman, 567 F. Supp. 942, 946-47 (S.D.N.Y. 1983). Since Kuznetz's material misrepresentations directly concerned the purchase of the Health-Chem and Reserve Oil stocks, the "in connection with" requirement is clearly satisfied.
The material misrepresentations must be in connection with the "purchase or sale of a security." Under the SEA, a purchase is "any contract to buy, purchase or otherwise acquire" securities, 15 U.S.C. § 78(c)(13)(1976) and a sale is "any contract to sell or otherwise dispose of" securities, 15 U.S.C. § 78c(a)(14)(1976). Technically, therefore, Kuznetz's purchase of the Health-Chem stock prior to the receipt by Thomson of plaintiff's copy of the customer agreement, i.e., before plaintiff ever actually contracted with Kuznetz or Thomson, did not constitute a purchase under the statute; the stock was not bought pursuant to "a contract to . . . acquire" securities. However, the Supreme Court has declared on several occasions that the SEA is to be construed flexibly. Superintendent of Insurance, supra, 404 U.S. at 12, 92 S. Ct. at 169; SEC v. Capital Gains Research Bureau, 375 U.S. 180, 195, 84 S. Ct. 275, 284-85, 11 L. Ed. 2d 237 (1963); see Penham, supra, at 1295; Gross v. Diversified Mortgage Investors, 431 F. Supp. 1080, 1093 (S.D.N.Y. 1977), aff'd, 636 F.2d 1201 (2d Cir. 1980). To find that the purchase of Health-Chem was not the type of "purchase" contemplated by the SEA (plaintiff testified that she accepted the purchase after being informed of it (Tr. 159) and when it was a ...