Arrington v. Merrill Lynch, Pierce, Fenner & Smith, Inc.

• Decision Date: 16 January 1981
• Docket Number: Nos. 77-3911,77-3924,s. 77-3911
• Citation: 651 F.2d 615
• Parties: Fed. Sec. L. Rep. P 98,237 Clyde O. ARRINGTON and Joy M. Arrington, Plaintiffs-Appellants and Cross- Appellees, v. MERRILL LYNCH, PIERCE, FENNER & SMITH, INC., a Delaware corporation, and James Richie, Defendants-Appellees and Cross-Appellants.
• Court: U.S. Court of Appeals — Ninth Circuit

Page 615

651 F.2d 615

Fed. Sec. L. Rep. P 98,237

Clyde O. ARRINGTON and Joy M. Arrington Plaintiffs-Appellants and Cross- Appellees, v. MERRILL LYNCH, PIERCE, FENNER & SMITH, INC., a Delaware corporation, and James Richie Defendants-Appellees and Cross-Appellants.

Nos. 77-3911, 77-3924.

United States Court of Appeals Ninth Circuit.

Argued and Submitted July 3, 1980.

Decided Jan. 16, 1981.

Ronald P. Arrington, Caldwell & Toms, Newport Beach, Cal., for arrington.

Robert H. Edwards, MacDonald, Halsted & Laybourne, Los Angeles, Cal., for Lynch.

Peter Brown Dolan, Overton, Lyman & Prince, Los Angeles, Cal., for defendants-appellees and cross-appellants.

Appeal from the United States District Court for the Central District of California.

Before WALLACE and SKOPIL, Circuit Judges, and EAST, ^* District Judge.

The opinion filed in this case on November 3, 1980 is withdrawn. The attached Amended Opinion is ordered filed. The mandate shall issue forthwith. Counsel shall hereafter direct all correspondence through the Clerk of the Court in accordance with the rules of the United States Court of Appeals for the Ninth Circuit, Rule 1.

AMENDED OPINION

SKOPIL, Circuit Judge:

INTRODUCTION

Plaintiffs lost a substantial amount of money in the stock market "crash" of 1974. They brought an action against their broker alleging securities fraud because they had been induced to convert their cash account into a margin account and invest in speculative stocks without being told the risks. After a bench trial, they were awarded damages. Plaintiffs appeal alleging error in the damages award. Defendants cross-appeal. They contest the finding of liability and the measure of damages employed.

We discover no error in the trial court's finding of liability, but remand for the inclusion of an additional element of damages.

FACTS

What follows is a summary of the facts as found by the district court.

In early 1974, plaintiffs Clyde and Joy Arrington had recently sold a small family business and retired. They took the proceeds of the sale, approximately $280,000, from a certificate of deposit in which they had originally invested it and asked Merrill Lynch to buy Western Airlines stock for them. James Richie, an account executive at Merrill Lynch, opened an account for the Arringtons and purchased 20,000 shares of Western Airlines stock for them.

After the account was opened, Richie and Clyde Arrington (Arrington) spoke on the phone daily about the stock market. Richie told Arrington that Gulf Oil, Syntex, Monsanto, and Stone & Webster stock were good quality securities. Richie said that Merrill Lynch analysts in New York were predicting substantial near term (three to six month) gains in these stocks. Richie recommended that Arrington purchase stock in these four companies whenever the price appeared favorable. Merrill Lynch analysts had never made the predictions Richie represented.

In April 1974, Richie asked Arrington if he had ever purchased securities on margin. Arrington said no and asked what margin was. Richie told Arrington that Merrill Lynch would lend the Arringtons money to buy stocks and Merrill Lynch would carry the investment. Arrington told Richie he did not want to borrow money.

Richie explained that the interest charged on the margin loan would be the prime rate on the date of purchase plus 1%. Arrington asked what risk was involved in the arrangement. Richie responded that there was little risk, and repeated the nonexistent predictions of spectacular near term gains.

On April 22, 1974 Richie recommended to Arrington that he buy 2,000 shares of Gulf Oil at the current price of $22 per share. He falsely stated that in the opinion of Merrill Lynch's analysts this was a favorable price. In reliance on Richie's representations Arrington authorized Richie to convert the account to margin and purchase the stock.

During May and June of 1974, in reliance on Richie's statements and recommendations, Arrington authorized the purchase on margin of 1,500 shares of Syntex, 1,000 shares of Monsanto, and 1,000 shares of Stone & Webster.

Richie misrepresented to Arrington the risks of purchasing stocks on margin, the recommendations of Merrill Lynch analysts regarding the four stocks he was pushing, and the increased risks of large margin accounts in the market decline he knew was occurring.

On July 15, 1974 Arrington purchased an additional 1,000 shares of Western Airlines on margin. This purchase was made without any recommendation by Richie or anyone else at Merrill Lynch.

By August 1, 1974 the Arringtons' indebtedness in their margin account stood at $252,664 and interest charges had reached several thousand dollars per month. Arrington was following market reports in the newspaper and knew that prices for stock (including his) had fallen drastically. On August 23, 1974 Merrill Lynch mailed the Arringtons their first margin maintenance call. The Arringtons received it by August 26, 1974. By August 30, 1974 they received their second maintenance call. On September 3, 1974 they had received a third maintenance call and Arrington had talked to Richie who explained that Arrington had to either put up money or sell some stock in a three-to-one ratio to maintain the account.

The aggregate purchase price of the Gulf Oil, Syntex, Monsanto, and Stone & Webster shares bought on margin was $240,807. The market value of those shares on August 26, 1974 was $190,500.

In 1975 the Arringtons brought this action against Merrill Lynch and Richie for violations of the federal securities laws. After a bench trial the court found that the defendants had violated section 10(b) of the Securities Exchange Act of 1934 and rule 10b-5 of the Securities and Exchange Commission. The court also found, however, that plaintiffs had broken the chain of causation of their damages by not selling their margined stocks on August 26, 1974, when they knew or should have known of the fraud committed by Richie. Plaintiffs had judgment in the amount of $53,820 plus pre-judgment interest from August 26, 1974. Plaintiffs appealed and defendants cross-appealed.

DISCUSSION

A. The existence of a violation.

Merrill Lynch and Richie contend there was no violation of the securities laws on the facts of this case. They correctly point out that section 10(b) of the Securities Exchange Act of 1934 and rule 10b-5 of the Securities and Exchange Commission proscribe the use of any deceptive or manipulative device only "in connection with the purchase or sales of any security." 15 U.S.C. § 78j(b); 17 C.F.R. 240.10b-5. See also Mason v. Unkeless, 618 F.2d 597 (9th Cir. 1980). They assert that the fraud here was in connection with the method of financing the purchase of securities, not with the purchase itself.

The Supreme Court has said that section 10(b) is to be read flexibly. When there is a sale of a security and fraud "touches" the sale, there is redress under section 10(b). Superintendent of Insurance v. Bankers Life and Casualty Co., 404 U.S. 6, 92 S.Ct. 165, 30 L.Ed.2d 128 (1971). It does not matter that the fraud is not of the "garden variety" associated with securities sales. Id.

Misrepresentation of the risks of buying securities on margin in a declining market is fraud "in connection with" the purchase of the securities. Furthermore, the trial court found that Richie misrepresented not only the risks of financing stock investment through a margin account, but also the recommendations of Merrill Lynch analysts as to the four stocks involved. Misrepresentations of these recommendations is directly "connected with" the sale of the securities. Both misrepresentations made up a scheme to induce Arrington to borrow money from Merrill Lynch to engage in commission-producing securities purchases through Merrill Lynch. The trial court therefore properly found fraud "in connection with" the sale of securities.

B. Materiality and scienter.

Defendants attack the trial court's findings concerning the materiality of Richie's misrepresentations, his scienter, and Arrington's reliance. Defendants say there was insufficient evidence to support the court's findings on these matters.

Questions of materiality, scienter, and reliance are mixed questions of law and fact, but ones involving assessments peculiarly within the province of the trier of fact. TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438, 96 S.Ct. 2126, 48 L.Ed.2d 757 (1976). They are therefore reviewed under the "clearly erroneous" standard. F.R.Civ.P. 52(a). See Securities & Exchange Comm'n v. Mize, 615 F.2d 1046, 1053 (5th Cir. 1980); Keirnan v. Homeland, Inc., 611 F.2d 785 (9th Cir. 1980); Securities & Exchange Comm'n v. Arthur Young & Co., 590 F.2d 785, 788-89 (9th Cir. 1979); Nash v. Farmers New World Life Insurance Co., 570 F.2d 558, 561 & n.7 (6th Cir.), cert. denied, 439 U.S. 822, 99 S.Ct. 89, 58 L.Ed.2d 114 (1978); Rochez Bros., Inc. v. Rhoades, 491 F.2d 402, 408 (3rd Cir. 1974).

A finding is clearly erroneous only when, although there is evidence to support it, the reviewing court on the entire evidence is left with a definite and firm conviction that a mistake has been committed. United States v. United States Gypsum Co., 333 U.S. 364, 68 S.Ct. 525, 92 L.Ed. 746 (1948); Thomas v. S.S. Santa Mercedes, 572 F.2d 1331, 1335 (9th Cir. 1978).

Defendants contend that Arrington's handling of his stock shows that he was not concerned with short-term investments. They say this means that any misrepresentations about the short-term performance of the four recommended stocks were immaterial. Arrington's treatment of his Western Airlines stock is not probative of his intentions to handle all of his stocks as intermediate term investments. This showing does not convince us that clear error was committed when the district court found that Richie's misrepresentations about the predicted short term performance of Gulf Oil, Syntex, Monsanto, and Stone & Webster stock were material.

Defendants also fail...