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August 7, 1990


The opinion of the court was delivered by: Robert L. Carter, District Judge.


This proceeding and determination are expected to bring this prolonged controversy to a final termination. The history of this case is set forth in detail in the court's prior opinions — 602 F. Supp. 511 (1984); 603 F. Supp. 370 (1985); 629 F. Supp. 860 (1986); No. 83 Civ. 6291, slip op. (June 2, 1988) (as amended, 1988 WL 49056, 1988 U.S. Dist. Lexis 5059); 709 F. Supp. 70 (1989); 109 B.R. 605 (1989) — with which familiarity is assumed. Accordingly, only those facts necessary to understand the damages and set-off issues now being addressed will be regurgitated in this opinion.

In 1983, Harry Binder, majority shareholder and president of Modern Settings, Inc., decided that the company should expand into the finished goods side of the jewelry business and he aggressively solicited orders for the coming Christmas season. His efforts produced orders in hand of about $800,000, and he testified that the jewelry business is such that had he filled these orders, he would have been able to generate additional orders of some $2,400,000. However, due to actions of defendants Prudential-Bache Metal Co., Inc. and Prudential-Bache Securities, Inc. (together, "Prudential-Bache"), this anticipated business growth did not come to fruition.

The origin of this dispute is centered on an agreement between the parties whereby Modern Settings obtained gold on consignment from Prudential-Bache and in turn maintained a margin securities account (the "account") with it, the value of the securities account being 120% of the value of the consigned gold. See, Modern Settings v. Prudential-Bache Sec., supra, 602 F. Supp. at 512-13. The facts show that Prudential-Bache misvalued Modern Settings' account by some $300,000, and until August, 1983, Modern Settings thought its account was worth $300,000 more than it actually was. At this same time, Prudential-Bache was wrongfully trading in Modern Settings' account. These matters came to a head on August 23, 1983, when Modern Settings' account was wrongfully liquidated and it, along with Binder's personal account and those of other family members, was frozen until February 15, 1985. Because of these actions, Modern Settings was unable to obtain the gold it needed to fill the orders in hand, and the projected expansion into the finished goods area was doomed. Instead, there was a steady contraction of business and a succession of name changes — first, Mr. Wemmick, Ltd., doing business as Modern Settings/Findings/Strikings/Castings, and, later, The Mod Set Ltd. — until bankruptcy was declared in 1985.

The court has determined that Modern Settings is entitled to recover for unauthorized trading in its account and the parties have stipulated that these damages come to $134,849.69.

The court also has determined that Modern Settings is entitled to recover for wrongful liquidation. Here the parties are at odds as to the amount of damages. Prudential-Bache contends that the court should apply the traditional measure of damages utilized for recovery for this wrong: the difference between the price obtained at liquidation and the highest intermediate price between notice of conversion and a "reasonable period" thereafter, where the "reasonable period" is construed to mean a time span of three to five days. Gallagher v. Jones, 129 U.S. 193, 200, 9 S.Ct. 335, 337, 32 L.Ed. 658 (1889); Katara v. D.E. Jones Commodities, Inc., 835 F.2d 966, 972 (2d Cir. 1987). The parties have stipulated that the allowable damages under this formula amount to $105,000.

The rationale for this formulation is to approximate the price at which the injured investor might have sold his positions profitably, absent the involuntary liquidation, and to reflect his duty to mitigate damages "taking into account that the [investor] has no assurance that he would have been able to repurchase during the reasonable period for less than the highest intermediate price." Letson v. Dean Witter Reynolds, Inc., 532 F. Supp. 500, 503 (N.D.Cal. 1982), aff'd. sub nom. Shearson Loeb Rhoades, Inc. v. Bryant, 730 F.2d 769 (9th Cir. 1984) (mem) (citing, inter alia, Arrington v. Merrill Lynch, Pierce, Fenner & Smith, 651 F.2d 615, 620 (9th Cir. 1981); Havlik v. Merrill Lynch, Pierce, Fenner & Smith, [1977-1980 Transfer Binder] Comm.Fut.L.Rep. (CCH) ¶ 20,544 at 22,243 (CFTC 1978)).

In theory, the "reasonable period" represents the time during which the investor is involuntarily removed from the market and is presumably attempting re-entry. The underlying assumption is that any decision not to reinvest is a voluntary one, based on an assessment of the post liquidation market. See, Chipser v. Kohlmeyer & Co., 600 F.2d 1061, 1067-68 (5th Cir. 1979) (holding that failure to reinvest after discovery of the wrongful liquidation constituted a decision to get out of the market rather than risk further loss and that no damages were permitted for increases in the value of the commodities after plaintiff was deemed to have decided to leave the market).

However, as a practical matter the position of the Letson court and others that "[f]ailure to reenter within the reasonable time period is deemed to be a decision to stay out," Letson, supra, 532 F. Supp. at 503, seems unrealistic in cases such as this one where the investor is without funds to reinvest due in part to the wrongful acts of the defendant. Given that Modern Settings' decision not to reinvest was mandated by Prudential-Bache's freezing of its account, fairness suggests that the "reasonable period" must be linked to Modern Settings' ability to reinvest. Moreover, the Court of Appeals has expressly refused to establish a definite time span as the "reasonable period" in every case. Katara v. D.E. Jones, supra, 835 F.2d at 973 ("[w]e decline at this juncture to provide a hard and fast rule on this question, since the appropriate time period varies somewhat with the facts of the case."); Schultz v. Commodity Futures Trading Com., 716 F.2d 136, 140 (2d Cir. 1983) ("[t]hus, what constitutes a reasonable period between the act complained of and the time when re-entry into the market would be both warranted and possible will vary from case to case . . ."). See also, Cauble v. Mabon Nugent & Co., 594 F. Supp. 985, 996 (S.D.N.Y. 1984) (Sofaer, J.) (court implicitly recognized that where a defendant's wrongdoing prevents the plaintiff's reinvestment and the plaintiff lacks the financial resources to invest with new funds, the period for measuring damages would be extended).

However, regarding this case, it is significant that the primary purpose of the account was to enable Modern Settings to obtain the gold it needed to run its business, not to enable it to invest. With disclosure of the $300,000 error in its account, Modern Settings was below the $900,000 minimum in equity it was required to maintain in the account at all times pursuant to the gold consignment agreement in order to maintain the 1500 ounce consignment of gold. Although, as indicated above, Modern Settings was prevented from reinvesting until February 15, 1985, when the account was unfrozen, this did not so much prevent Modern Settings from investing in the market as prevent the accumulation of gold for maintenance of the business as a going concern. This, however, involves a different measure of damages, discussed below, and, accordingly, the three (3) to five (5) day "reasonable period" seems appropriate in this case and damages of $105,000 are awarded for wrongful liquidation. The guiding principle regarding damages in this area is to provide compensation for actual loss, see, e.g., Gallagher v. Jones, supra, 129 U.S. at 200, 9 S.Ct. at 337; Schultz v. Commodity Futures Trading Com., supra, 716 F.2d at 139, and $105,000 meets that yardstick.

The final item of damages, the diminution in the value of Modern Settings' business, is the most controversial. Both sides presented expert testimony on the issue and, while there was agreement on methodology, the final figures presented varied significantly. Modern Settings' expert valued Modern Settings at over $3,000,000, while Prudential-Bache's expert valued it at $1,420,000.

Modern Settings' expert reached his conclusions by using three accepted approaches to valuation: the income approach, the market approach and the net worth approach. Prudential-Bache's expert used only the income approach and the net worth approach. The testimony at trial centered chiefly on the income approach, a methodology using a discounted cash flow analysis in which net cash flows are forecast for a number of years and then discounted back to present value. The extreme difference in the conclusion of each side as to the final value of the company is attributable in part to disagreement as to the correct sales growth rate (15% for 1984, 1985, 1986, and 12% for 1987 and 1988 according to Modern Settings, and only 8% according to Prudential-Bache) and as to the correct cost of goods sold percentage (58% according to Modern Settings and 66% according to Prudential-Bache). The two sides also quarrelled over the appropriate discount rate (23% according to Modern Settings and 25% according to Prudential-Bache) and regarding whether to use net cash flow or gross cash flow to determine terminal value.

The sales growth rate of 15% and 12% used by Modern Settings appears to be a far fairer assessment than the 8% suggested by Prudential-Bache which took no account of inflation. The 66% cost of goods sold figure suggested by the defendants seems far more accurate than the figure suggested the plaintiff. The court uses net cash flow to determine terminal value, since the use of gross cash flow would result in expanding terminal value unrealistically.

In its original opinion, the court based its calculations on the wrong exhibit — Modern Settings' Exhibit 30 in which the estimate of sales was extremely high.*fn1 These sales figures were revised downward in plaintiff's Exhibit 31, which plaintiff's expert presented as a more accurate and more reliable formulation than Exhibit 30 and which the court should have used, rather than Exhibit 30, as a base in reaching its determination on this phase of the case. Defendants have provided the court with a modified version of Exhibit ...

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