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GRANOFF v. MERRILL LYNCH & CO.

September 30, 1991

GARY GRANOFF, INDIVIDUALLY AND DOING BUSINESS AS GRANOFF RESOURCES, PLAINTIFFS,
v.
MERRILL LYNCH & CO., INC., MERRILL, LYNCH, PIERCE, FENNER & SMITH, INC., THE GROWTH & GUARANTY FUND L.P., MERRILL LYNCH OPTIONS/FUTURES MANAGEMENT, INC., AND MERRILL LYNCH FUTURES, INC., DEFENDANTS.



The opinion of the court was delivered by: Robert P. Patterson, Jr., District Judge.

OPINION AND ORDER

Defendants move pursuant to Rule 56 of the Federal Rules of Civil Procedure for summary judgment on plaintiff's three claims for relief in this diversity action alleging breach of contract, misappropriation of plaintiff's idea for a financial product, and fraud and misrepresentation. The Court denied the defendants' first motion for summary judgment without prejudice, by memorandum of October 11, 1989, on the ground that sufficient discovery had not yet taken place. No. 89 Civ. 0159, 1989 WL 260227, 1989 U.S.Dist. LEXIS 12173. Since that denial, exhaustive discovery of the facts pertaining to liability has been completed and the motion for summary judgment has been renewed. Defendants claim that there is no genuine issue of fact on two issues which are dispositive of all three claims: (1) that plaintiff's idea was not novel, and (2) that the financial product of defendant was developed independently of plaintiff, without misappropriation, use or knowledge of his idea.

For purposes of this motion, the following facts alleged by plaintiff and defendants are undisputed.

BACKGROUND

I. Granoff's Contact with Merrill Lynch

Plaintiff Gary Granoff ("Granoff") claims that he approached defendants (collectively, "Merrill Lynch") in 1986 with an idea for a financial product called "Portfolio Protection Insurance." He claims that his conception of the idea was based on his experience as an insurance actuary, his study of financial products used in business, and his experience managing his own investment portfolio of "several tens of thousands of dollars." Deposition of Gary Granoff of February 1, 1991 ("Granoff Dep.") at 200. With the assistance of his Merrill Lynch broker in Florida, Granoff was able to set up a meeting with two Merrill Lynch employees in New York, Michael J. Galbreath ("Galbreath") and Kenneth J. Nixon ("Nixon"). Galbreath was then employed in Merrill Lynch's Capital Markets Group and Nixon was a tax lawyer in its legal department. Before the meeting, Granoff sent Galbreath a letter dated June 13, 1986, in which he suggested a letter agreement to safeguard the confidentiality of his proposal and stated he would be available to meet on July 1, 2 or 3, 1986. Exhibit C to Affidavit of Gary Granoff sworn to February 1, 1991 ("Granoff Aff.").

Although Granoff states that the meeting took place on June 30, 1986 and Galbreath states that it took place on July 1, 1986, it is undisputed that, at the meeting, Galbreath gave Granoff a letter dated June 30, 1986, based on the draft letter agreement Granoff had sent Galbreath earlier. In the letter, Galbreath, on behalf of Merrill Lynch, agreed to keep confidential their discussions and any written materials provided by Granoff and agreed to decide, on or before September 1, 1986, whether Merrill Lynch would pursue Granoff's idea. The letter also recited that if Merrill Lynch decided to pursue the proposal, it would not take further action before entering into a formal agreement with Granoff. Exhibit D to Granoff Aff.

At the meeting, Granoff gave Galbreath and Nixon a written proposal and discussed his idea with them. As more fully described therein, the proposal was that Merrill Lynch offer to its customers a partial guarantee against losses in their security portfolios. Galbreath and Nixon state he gave them two type-written pages which describe a proposal titled "Portfolio Protection Insurance" ("PPI"). Exhibit B to Granoff Aff. Granoff states he gave them those pages and four more pages which he took from a proposal which he had originally submitted to Marsh & McLennan in 1984. Exhibits B and E to Granoff Aff. After reviewing the Granoff proposal, Nixon sent a memo to Galbreath, to which the two-page proposal was attached, analyzing the idea and questioning its feasibility and novelty. Exhibit F to Granoff Aff. Among Nixon's concerns was that securities brokers/dealers who are not subject to regulation by state insurance departments generally are not authorized to issue what might be defined as insurance contracts or policies. Deposition of Kenneth J. Nixon of December 20, 1989 ("Nixon Dep.") at 89.

Granoff states that after the meeting, he called Galbreath several times to discuss the proposal and was repeatedly told that Merrill Lynch was still reviewing the idea for possible implementation and had not yet made a decision. Galbreath informed Granoff during mid-August 1986 that Merrill Lynch had decided not to pursue his proposal.

II. Development of the Growth and Guarantee Fund

In June, 1987, Merrill Lynch published a prospectus offering a fund called the Growth and Guarantee Fund ("the Fund"), which Granoff claims was based upon the proposal he submitted to Merrill Lynch. Defendants offer unrebutted affidavits which show that the Fund was created as a result of several years of work by Merrill Lynch employees based on a concept first outlined in a report issued in 1984. It was then described internally as the "Price Guarantee Program" ("PGP") and was the project of a Merrill Lynch Task Force on derivative products (the "Task Force"). As described in an internal Merrill Lynch document, the May 1984 Task Force Report, the PGP was originally conceived as a means of providing the retail customer with protection against investment risk. Exhibit S to Granoff Aff. The May 1984 Task Force Report entitled "Derivative Products Strategy"*fn1 described its contemporaneous concept of its proposed PGP as follows:

  Program Description: Provide customer, who is
  interested in a given stock (or other financial
  instrument or portfolio of instruments) but wants
  to limit his down side risk, a method to limit his
  potential losses by paying a premium to insure
  against losses larger than those which he is
  willing to tolerate. This program may be used by
  either a customer who is about to purchase the
  instrument, or one who is currently holding the
  instrument. The customer determines which stock he
  wants to hedge, how much loss in price

  he is willing to tolerate (possible minimum: 10%)
  and for what number of months he wants a
  guarantee. The AE keys this information into his
  terminal and instantly receives a firm quote
  (possibly expressed as a % of the value of the
  security). If the quote is acceptable to the
  customer, the AE handles like [sic] any other
  order.
  Pricing: Based on a model that includes both market
  and instrument outlook, Merrill Lynch would provide
  customer with a "Guarantee Premium" grid according
  to time (in months) and percent at risk.
  Additional Comments: Limits for eligibility, time,
  types of instruments covered would have to be
  defined.
  Appropriate model would have to be developed and
  fully tested.
  Merrill Lynch would use the derivative products to
  hedge its position in the guarantee program, yet
  provide both the AE and customer a simple "risk
  alleviation" program, and thus help satisfy this
  definite need in the market place. The use of
  Derivative Products will help make this a viable,
  attractive, profitable program for Merrill Lynch,
  yet the derivative products, per se, need not be
  understood by either the AE or the customer in
  order to satisfy their needs. (emphasis in
  original).*fn2

Exhibit S to Granoff Aff. A later report, dated May 14, 1985, contains specific examples of what would happen to a customer's holdings under the proposed PGP. Exhibit U to Granoff Aff. One example is a situation where a client buys 100 shares of blue chip stock at $100. The client also buys a "unit of protection for 3 months assuring client of nothing more than a 15% stock decline to a price of 85 during that period." Id. The example envisions a scenario in which the stock price falls below 85 during the three-month period and stays there. Merrill Lynch would "take over" the stock at 85; the client's account would be credited with $8500. Merrill Lynch would attempt to lock in a price level of 85 to control its own loss on the stock. It would do this by hedging with equivalent stock index futures "so that a further decline in the price of the stock below 85 would result in a corresponding gain in the value of the futures." Id. The May 14, 1985 report describes the specific action to be taken as follows:

  As soon as a stock hits the price of 85, the
  overall ML hedge position (possibly comprised of
  stock index futures short positions, short sales
  of stock and synthetic shorts using options) is
  increased in an amount commensurate with the
  volatility and assessed risk factor of the stock
  at that market level. The overall hedge position
  is continually managed.

Id. The comments attached to the May 14, 1985 report note the relative ease of hedging stocks which correlate well with the Standard and Poor's 500 and can be shorted easily and are optionable, and it notes the difficulty of controlling the hedge risk for more volatile stocks. The comments also state that as envisioned, "[t]here is the possibility that we could pay a client the dollar difference at the end of 3 months between the price of the stock then and a price of 85." Id.

In spring of 1986, after two years of research and feasibility studies, Merrill Lynch decided its exposure to risk would be too great under the plan as envisioned and that the transaction costs might outweigh its benefits such that it would not be an attractive product.*fn3 The Task Force therefore began to ...


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