Schaffer v. Edward D. Jones & Co.

• Decision Date: 14 September 1994
• Docket Number: 18100,Nos. 18085,s. 18085
• Parties: Edward SCHAFFER, Jack Ehrich and June Ehrich, Plaintiffs and Appellees, v. EDWARD D. JONES & CO., Defendant and Appellant, and Bill Edwards and Marv Tebben, Defendants.
• Court: South Dakota Supreme Court

Page 921

521 N.W.2d 921

Edward SCHAFFER, Jack Ehrich and June Ehrich, Plaintiffs and Appellees, v. EDWARD D. JONES & CO., Defendant and Appellant and Bill Edwards and Marv Tebben, Defendants.

Nos. 18085, 18100.

Supreme Court of South Dakota.

Argued Oct. 5, 1993.

Decided Sept. 14, 1994.

Michael J. Schaffer and Timothy M. Gebhart of Davenport, Evans, Hurwitz & Smith, Sioux Falls, for plaintiffs and appellees.

Robert D. Hofer of Riter, Mayer, Hofer, Wattier & Brown, Pierre, and Bruce C. Oetter and Helen Paulin Gab, St. Louis, MO, for defendants and appellants.

AMUNDSON, Justice.

Edward D. Jones & Co. appeals a judgment entered by the trial court after a jury verdict for Edward G. Schaffer, Jack Ehrich and his wife, June Ehrich, on claims of fraud, deceit, and misrepresentation. We affirm in part, reverse in part and remand.

FACTS

Jones is a large brokerage firm headquartered in St. Louis, Missouri, with numerous branch offices throughout the nation, including many in South Dakota. In 1980, Jack and June Ehrich (Ehrichs) began investing with Edward D. Jones & Co. (Jones) through broker Marv Tebben (Tebben) of Aberdeen, South Dakota. Prior to that time, Ehrichs invested their savings in bank CDs, bonds, and with the Aid Association for Lutherans. Jack Ehrich has an eighth-grade education and was a sixty-two year old farmer at the time of trial. His wife, June, has a high school education and is a housewife. June handled most of the business with Jones through Tebben.

In 1981, Edward G. Schaffer (Schaffer), another Plaintiff, began investing with Jones through broker Bill Edwards (Edwards) of Aberdeen. Until that time, Schaffer primarily invested in bank savings accounts and Cds. Schaffer has an eighth-grade education and has farmed all of his life. At the time of trial, he was seventy years old and retired.

During approximately a decade of investing with Jones, Ehrichs and Schaffer experienced considerable financial success in over forty different security investments. According to Jones' records, Ehrichs' investments earned approximately $196,916.10, while Schaffer enjoyed earnings of approximately $55,931.87.

Ehrichs informed Tebben that they were conservative investors, interested in safe, low-risk investments. Tebben sold a $10,000 debenture of D.H. Baldwin Company (Baldwin) to Ehrichs over the telephone on December 27, 1982. ¹ Tebben represented to June that Baldwin returned thirteen and one-half percent interest and the interest would double in five years if left to compound.

Prior to selling Ehrichs the Baldwin debenture, Jones had substantial internal information which seriously questioned the soundness of Baldwin investments. In a May 1982 financial review, a Jones principal indicated that Baldwin had a negative net worth. Jones also received a report criticizing Baldwin's finances as: "An operating and net cash flow that continues to decline ... matched with a staggering debt load. In our opinion, this combination produces unjustifiable investment risks." This information was not provided to Ehrichs before their investment.

Before Ehrichs' purchase, Forbes magazine printed an article disclosing serious problems with Baldwin's financial condition. After receiving this information, Tebben contacted Jones' headquarters and was told that the information in the article was incorrect. Relying on this information, Tebben did not disclose the article to Ehrichs. Ehrichs testified that they would not have purchased the Baldwin debentures had they been advised of this financial information.

When offering securities, Jones provides its brokers with "blue sheets" on each security. These "blue sheets" contain important information about investments. Tebben relied on the "blue sheets" which showed Baldwin was financially sound. The "blue sheet" on Baldwin claimed the company had $7.7 billion dollars in assets and $2 billion dollars in cash. However, Jones' own documents showed Baldwin had a negative tangible net worth. The "blue sheet" showed Baldwin stock was rated "A" but omitted any reference to the "BBB-" rating on the debentures sold to Ehrichs. ² This information was not disclosed to Ehrichs. Although Jones knew Baldwin's Value Line safety rating was 4, this too was not disclosed when Ehrichs purchased the Baldwin debenture. ³

At a Farmers Union Convention in March 1983, Ehrichs listened to a presentation by the president of Baldwin United. The president told the audience the company was encountering financial difficulties. Upon returning from the convention, Ehrichs read a newspaper article which explained Baldwin was in financial trouble. June then contacted Tebben so their Baldwin investment could be sold. Tebben reassured June that Baldwin investment was sound and recommended Ehrichs keep their investment with Baldwin. Tebben based his assurances on information he received from Jones. Ehrichs did not sell the Baldwin debenture because of Tebben's representations. Evidence shows that if they had, most of their investment would have been returned. Approximately six months later, Baldwin filed bankruptcy. At trial, Jones' records indicated Ehrichs' $10,000.00 Baldwin investment had a disposition value of $2,353.63.

Tebben also sold Ehrichs a $5,000.00 interest in Natural Resource Management (NRM) in May 1983. This sale was consummated over the telephone. NRM is an oil and gas income limited partnership investment. ⁴ Tebben represented the investment as low risk and would return fifteen percent annual interest. He explained the investment could be sold after two or three years and, as farmers who use a lot of oil and gas, it was something in which they should invest. Ehrichs never received a prospectus on the NRM investment and Tebben never disclosed his commissions. According to Jones' records, Ehrichs' $5,000.00 NRM investment had a disposition value of $6.24 at the time of trial.

In September 1983, Edwards sold Schaffer a $15,000.00 investment in NRM over the telephone. Edwards told Schaffer NRM was a low-risk investment and the price of oil should keep going up because of problems in the Middle East. Schaffer was also told to expect fifteen percent annual interest for two years and maybe more in the future.

After purchasing the limited partnership interest, Schaffer received a brochure indicating the NRM investment was safe as a bond and a low-risk conservative investment. Schaffer also received a prospectus which he attempted to read but found difficult to understand. Schaffer thought the commissions were high and the investment was riskier than Edwards had represented. When Schaffer asked Edwards to sell the NRM investment, Edwards informed him the investment could not be sold because it was a limited partnership. Schaffer received approximately fifteen percent return on his investment for about one and one-half years before the distribution began decreasing. The limited partnership was eventually rolled into a master-limited partnership and then converted into a stock called Edisto. As of June 1, 1992, Schaffer's $15,000.00 investment was worth $16.50.

Jones was the principal and primary brokerage firm selling the NRM limited partnership interests. In January 1983, Jones, through an affiliated subsidiary, purchased a one-third ownership interest in NRM Corporation. Jones paid $5 million dollars for its ownership interest in NRM, consisting of $1 million dollars in cash and a $4 million dollar promissory note.

During July 1983, Jones sent its own employees to NRM headquarters as part of a due diligence investigation required by the Securities & Exchange Commission. After inspecting NRM's finances, these employees drafted a memorandum which stated: "[T]his is a highly leveraged company. This high degree of leverage manifests itself in an unacceptable absence of liquidity and a capital structure with a severe inability to withstand any potential negative business development. This situation is especially disturbing for a company on the risky end of an unpredictable oil industry." The memorandum also indicated NRM had a $2 million dollar collateral shortfall due in October 1983 with "no intentions, or ability, to actually repay" debt without borrowing additional funds. This memorandum was never disclosed to Jones' brokers or clients.

In selling these limited partnerships, Jones represented that Schaffer and Ehrichs would receive a fifteen percent return. This representation occurred even though Jones was aware NRM's overhead exceeded its revenues by $700,000.00 per month. NRM invested the money raised from investors in CDs and T-bills at interest rates well below the fifteen percent promised investors. Jones' own review of NRM's financial condition disclosed that NRM was having difficulty meeting the fifteen percent return. ⁵ In fact, in the July memorandum, Jones suggested legal counsel review "a possible bankruptcy of the general partner on the individual limited partnership and their investors."

By March 1985, the promised fifteen percent distribution had decreased and the value of the partnerships began falling as well. In November 1985, Jones sold its interest in NRM but did not advise its clients to do the same. The oil market collapsed between January and March 1986. By that time Jones had sold its interest in NRM, but its customers, including Schaffer and Ehrichs, were still holding a financial interest in the company.

In total, Jones sold approximately $160 million dollars of these NRM limited partnership interests and collected about $20 million dollars in commissions and fees from these sales.

After these investments proved less than conservative, Ehrichs and Schaffer brought an action against Jones to recover their investment on claims of fraud, deceit, intentional misrepresentation and negligent misrepresentation. A jury trial was held and the jury unanimously returned verdicts awarding Schaffer compensatory damages of $25,000.00 and punitive damages of...