448 F.3d 268 (4th Cir. 2006), 05-1217, Morris v. Wachovia Securities, Inc.

Docket Nº:05-1217, 05-1281.
Citation:448 F.3d 268
Party Name:Patrick V. MORRIS, Individually and on behalf of all others similarly situated, Plaintiff-Appellee, v. WACHOVIA SECURITIES, INCORPORATED, Defendant-Appellant. Patrick V. Morris, Individually and on behalf of all others similarly situated, Plaintiff-Appellant, v. Wachovia Securities, Incorporated, Defendant-Appellee.
Case Date:May 17, 2006
Court:United States Courts of Appeals, Court of Appeals for the Fourth Circuit

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448 F.3d 268 (4th Cir. 2006)

Patrick V. MORRIS, Individually and on behalf of all others similarly situated, Plaintiff-Appellee,

v.

WACHOVIA SECURITIES, INCORPORATED, Defendant-Appellant.

Patrick V. Morris, Individually and on behalf of all others similarly situated, Plaintiff-Appellant,

v.

Wachovia Securities, Incorporated, Defendant-Appellee.

Nos. 05-1217, 05-1281.

United States Court of Appeals, Fourth Circuit.

May 17, 2006

Argued Feb. 1, 2006.

Appeal from the United States District Court for the Eastern District of Virginia, at Richmond. Robert E. Payne, District Judge. CA-02-797-3

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COUNSEL

ARGUED:

James Alwin Murphy, LECLAIR RYAN, P.C., Richmond, Virginia, for Appellant/Cross-Appellee Wachovia Securities, Incorporated.

Arthur Raphael Miller, HARVARD LAW SCHOOL, Cambridge, Massachusetts, for Appellee/Cross-Appellant Patrick V. Morris, Individually and on behalf of all others similarly situated.

ON BRIEF:

Cameron S. Matheson, LECLAIR RYAN, P.C., Richmond, Virginia, for Appellant/Cross-Appellee.

Mark J. Krudys, Richmond, Virginia; Peter G. A. Safirstein, MILBERG, WEISS, BERSHAD & SCHULMAN, L.L.P., New York, New York, for Appellee/Cross-Appellant.

Before MICHAEL, SHEDD, and DUNCAN, Circuit Judges.

OPINION

MICHAEL, Circuit Judge:

An individual investor's securities fraud claims against a brokerage firm were rejected when the district court granted the firm a summary judgment and dismissal. The firm then invoked a provision of the Private Securities Litigation Reform Act of 1995 (Act or Reform Act), 15 U.S.C.

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§ 78u-4(c), contending that the investor's complaints and briefs violated Federal Rule of Civil Procedure 11(b) and that monetary sanctions were mandated. The district court found three Rule 11(b) violations, one in the investor's complaints and two in his brief opposing summary judgment. The court, however, declined to impose any sanctions. Both sides appeal. We affirm for the most part, but vacate the district court's order to the extent that it imposed no sanction at all. The Reform Act mandates a sanction in any private securities action where a party or lawyer violates Rule 11(b). Accordingly, we remand for the district court to enter an order that identifies and admonishes the lawyers responsible for the three Rule 11(b) violations committed in this action.

I.

Patrick V. Morris owned shares of The Proctor & Gamble Co. worth about $1.6 million when he retired from the company in 1999. Morris decided to sell the shares and invest the proceeds in a diversified retirement portfolio. In December 2001 he invested roughly $1.4 million with the Masters Program, an investment service offered by Wachovia Securities, Inc. The Masters Program allows investors with more than $100,000 to have their portfolios handled by money managers who usually work with accounts exceeding $1 million. Wachovia describes participation in the program as involving three steps: first, a Wachovia financial advisor helps the investor choose an investment strategy; second, the advisor recommends money managers who will implement the strategy by selecting and monitoring suitable securities; and third, the advisor and the investor periodically assess investment results.

Morris selected five money managers who had contracted with Wachovia to participate in the program. Morris signed several documents disclosing numerous fees associated with the program. Contrary to his expectations, Morris's initial account balance of approximately $1.4 million decreased by $300,000, or 21 percent, within "several months." Morris v. Wachovia Sec., Inc., 277 F.Supp.2d 622, 626 (E.D. Va. 2003).

A.

In November 2002 Morris sued Wachovia in the U.S. District Court for the Eastern District of Virginia. His complaint attributed his losses to Wachovia's operation of the Masters Program in violation of the securities laws (specifically, section 10(b) of the Securities Exchange Act of 1934 ("Exchange Act"), 15 U.S.C. § 78j(b), and the Securities and Exchange Commission's Rules 10b-5 and 10b-10). Morris amended his original complaint as a matter of right. See Fed.R.Civ.P. 15. The district court granted Wachovia's motion to dismiss the first amended complaint without prejudice, and Morris then filed his second amended complaint. Morris, 277 F.Supp.2d at 625. Wachovia filed a counterclaim against Morris seeking indemnity under one of the parties' agreements.

Among the allegations contained in the first amended complaint, but not the second amended one, was that Wachovia never disclosed that the firm profited by lending to third parties stocks held in Morris's account. SEC rules sharply constrain such lending, but permit it for stocks held by investors who have bought on margin. See 17 C.F.R. § 240.8c-1. Morris never bought any stocks on margin. His lawyers based the stock loan allegation on the knowledge that such lending takes place generally in the securities industry, but they had no evidence that Wachovia had lent any of Morris's stocks to third parties. The district court later determined that

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the stock loan allegation violated Rule 11(b).

The second amended complaint contained numerous claims under section 10(b) of the Exchange Act and section 206 of the Investment Advisers Act of 1940, 15 U.S.C. § 80b-6. The district court grouped the section 10(b) claims into four categories: (1) claims involving selection and monitoring of money managers; (2) those involving aggregation of trades; (3) those involving rounding up and passing along SEC fees to investors; and (4) those involving misrepresentation of securities prices and the failure to provide adequate periodic account information. Morris, 277 F.Supp.2d at 630-31. In August 2003 the district court granted Wachovia's motion to dismiss the claims in the first three categories, concluding that Morris did not satisfy the elements of a claim for relief under section 10(b) of the Exchange Act. Id. at 633, 637-38. The court allowed Morris to proceed with his section 10(b) claim as to the fourth category and with his Investment Advisers Act claim. Id. at 641-42, 644-45. Morris moved to certify a class action for money damages under Rule 23(b)(3) based on his surviving claims. The district court concluded that the common issues did not predominate over the individual ones and denied certification. Morris v. Wachovia Sec., Inc., 223 F.R.D. 284, 304 (E.D. Va. 2004).

B.

Wachovia moved for summary judgment. In his brief opposing Wachovia's motion, Morris (through counsel) made two contentions that the district court later determined were Rule 11(b) violations. The first contention concerned the deposition of Charles W. Baldiswieler, an executive at TCW Investment Management Co., one of the five money managers Morris selected. At one point in his deposition Baldiswieler was asked about a Wachovia questionnaire to TCW that used the phrase "commission recapture program." J.A. 1051. Baldiswieler testified that the phrase could have been a reference to a "soft dollar arrangement." Id. under such an arrangement an investment adviser directs its clients' brokerage transactions to a broker-dealer in exchange for products and services (other than transaction execution) ranging from research reports to client referrals. See u.S. Securities & Exchange Commission, Inspection Report on the Soft Dollar Practices of Broker-Dealers, Investment Advisers and Mutual Funds at Part II.A (Sept. 22, 1998) available at http://www.sec.gov/news/ studies/softdolr.htm.

However, Baldiswieler also testified in his deposition, "I believe Wachovia is not a soft dollar broker.... I don't believe they even have the apparatus to do soft dollars." J.A. 1052. Morris's brief quoted Baldiswieler's more tentative comment about soft dollars and argued that "[t]he logical and reasonable inference to be drawn" from this and other facts was that Wachovia selected only those money managers who would help Wachovia earn trade execution income, not those who would maximize client returns. J.A. 646. The brief never pointed out that Baldiswieler said specifically that he did not believe Wachovia was a soft dollar broker.

The second problematic contention in Morris's brief opposing summary judgment concerned the deposition of Wachovia executive Burt White. White described himself as "the only door that gets money managers into the Masters Program." J.A. 425. Asked whether Wachovia had any controls or policies "to ensure that financial advisors are paying attention to the portfolio construction in a way that maximizes their returns for the investors," White replied, "I don't know if there are

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any controls or not." J.A. 1026-27. Morris's brief cited this testimony as supporting the assertion that "Wachovia had no systems or controls in place to assure that the results of any research [on money manager performance] was received by . . . any financial advisors who were placing customers in the Masters Program." J.A. 652. White's lack of awareness about whether there were any controls for the review of investor accounts by Wachovia financial advisors, however, had little bearing on the claim that the advisors had no information about the performance records of the money managers they were recommending.

The district court granted Wachovia summary judgment as to all of Morris's remaining claims on August 2, 2004. On the same day, the district court entered an order dismissing Wachovia's counterclaim that had been based on Morris's express waiver of receipt of trade confirmation slips. A provision in the waiver purported to obligate Morris to indemnify Wachovia for any expenses arising from Wachovia's actions based on the waiver. The court concluded that the indemnity provision neither applied to Morris's suit nor...

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