Clark v. John Lamula Investors, Inc.

• Decision Date: 24 August 1978
• Docket Number: No. 32,D,32
• Citation: 583 F.2d 594
• Parties: Fed. Sec. L. Rep. P 96,539 Richard I. CLARK, as Executor of the Estate of Bernice C. Grupe, Plaintiff-Appellee, v. JOHN LAMULA INVESTORS, INC. and John J. Lamula, Defendants-Appellants. ocket 77-7098.
• Court: U.S. Court of Appeals — Second Circuit

Page 594

583 F.2d 594

Fed. Sec. L. Rep. P 96,539

Richard I. CLARK, as Executor of the Estate of Bernice C Grupe, Plaintiff-Appellee, v. JOHN LAMULA INVESTORS, INC. and John J. Lamula, Defendants-Appellants.

No. 32, Docket 77-7098.

United States Court of Appeals Second Circuit.

Argued Sept. 15, 1977.

Decided Aug. 24, 1978.

William F. Plunkett, Jr., New York City (Plunkett, Wetzel & Jaffe, New York City, New York), for defendants-appellants.

Robert M. Blum, New York City (Silberfield, Danziger & Bangser, New York City, for plaintiff-appellee.

Before GURFEIN and VAN GRAAFEILAND, Circuit Judges, and COFFRIN, District Judge. ^*

COFFRIN, District Judge:

This is an appeal from a judgment order entered by Judge Goettel, Southern District of New York, on November 29, 1976 in favor of plaintiff Bernice C. Grupe, ¹ against defendants-appellants John Lamula Investors, Inc. (JLI) and John J. Lamula. The judgment resulted from a special verdict in the form of special written findings of the jury made pursuant to Federal Rule of Civil Procedure 49(a) after an eight day trial. We affirm.

I

When the pertinent transactions occurred in 1974, appellee was a retired school teacher in her late fifties working on the staff of the New York State Senate Majority Leader. She had received a lump-sum divorce settlement from her second husband of $138,000, approximately $100,000 of which she desired to invest for a yield of $1,000 per month. Appellant JLI was a corporation engaged in the business of buying and selling securities. Appellant Lamula was president and director of JLI and the owner of a majority of its stock. Both appellants were registered with the National Association of Securities Dealers, Inc. (NASD).

In March, 1974 appellee was introduced to Lamula by a mutual friend to obtain help in formulating an investment plan. Appellee and Lamula met several times over the course of the next three months, and in late May, 1974, JLI purchased convertible debentures for $94,360 which it sold to appellee for $105,250. Thus appellants made a profit of $10,890, or greater than 11 percent, on the transaction with Mrs. Grupe.

According to the jury's answers to interrogatories, which are set out in the margin, ² the securities purchased for Mrs. Grupe were unsuited to her needs, appellant Lamula knew or reasonably believed they were unsuitable, he intended that she rely on his recommendation to purchase them and she did rely on him in buying them. ³ In the course of their dealings, Lamula failed to inform Mrs. Grupe of other suitable investment opportunities which were available for her consideration, of how the leading rating services rated the debentures, of the fact she could not expect $12,000 yearly income from her investments without buying speculative securities involving great financial risk, and of the extent of the risk involved in buying the securities which she eventually purchased. Had he informed her of these matters, she would not have purchased the securities. Although Lamula made no untrue statements about the debentures on which Mrs. Grupe relied, and did not conceal from her that he was selling them to her for his own account and as a market maker, he did purchase the securities with the specific purpose of selling them to her and charged her an excessive price for them. The jury found that Lamula acted with intent to deceive when he failed to inform her of other investment opportunities and charged her an excessive price for the securities.

Subsequent to the purchase, appellee made inquires concerning her investments and discussed them with her nephew, an investment advisor. As a result of her investigation she became convinced that the debentures were not of good quality. She then requested appellants to dispose of the debentures, and when they declined to do so, she sold them immediately through another brokerage firm at a loss amounting to $29,311.96. ⁴ That sale was in August, 1974, two days before President Nixon resigned and close to the bottom of a bear market.

Appellee subsequently brought this action against appellants for violations of § 17(a) of the Securities Act of 1933; §§ 10(b) and 15(c)(1) of the Securities Exchange Act of 1934; §§ 2, 4, 15 and 18, Article III, of the Rules of Fair Practice of NASD; and for common law fraud and breach of a fiduciary duty. The verdict on special interrogatories was for appellee on grounds of statutory fraud only.

II

Appellants make several arguments on appeal, their first being that a violation of the NASD Rules does not constitute an actionable wrong under federal securities laws. Because we find that the jury's findings support a judgment of violation of § 10 of the Securities Exchange Act, we need not decide whether the NASD Rules create an independent cause of action. Accord, Rolf v. Blyth, Eastman Dillon & Co., 570 F.2d 38 (2d Cir. 1978). ⁵

Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), makes it unlawful for a person to use or employ any manipulative or deceptive device or contrivance in contravention of the rules and regulations prescribed by the Securities and Exchange Commission. SEC Rule 10b-5, 17 C.F.R. § 240.10b-5, provides:

It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange,

(a) To employ any device, scheme, or artifice to defraud,

(b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or

(c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person,

in connection with the purchase or sale of any security.

The case was presented to the jury on two theories of liability: (1) knowingly recommending unsuitable securities and (2) taking excessive mark-ups on securities purchased for and sold to a client. Because we hold the specific findings of the jury support a judgment for plaintiff on the first theory, we need not consider arguments concerning excessive mark-ups. ⁶

In order to recover on a private cause of action under Rule 10b-5, a plaintiff must show two things: first, that the rule has been violated, and second, that it was violated with scienter, that is, with intent to deceive, manipulate or defraud. Ernst & Ernst v. Hochfelder, 425 U.S. 185, 96 S.Ct. 1375, 47 L.Ed.2d 668 (1976). ⁷

It is clear from the jury's answers to the interrogatories, that appellants violated Rule 10b-5. The jury specifically found that the debentures were unsuited to appellee's needs, that appellant Lamula knew or reasonably believed they were unsuitable, but that he recommended them to her anyway. In addition, the jury found that Lamula failed to inform her (1) how the leading rating services rated the debentures, (2) that she could not expect to acquire $12,000 annual income from her investments unless she bought speculative securities involving great financial risk, and (3) the extent of the risks involved in purchasing the securities. The jury found further that had appellant Lamula informed her of these matters, including other investment opportunities, she would not have purchased the securities. Thus, there can be no doubt but that appellant Lamula engaged in an act, practice or course of business which operated as a fraud or deceit upon Mrs. Grupe and omitted to state facts material to an informed purchase by her.

Further, the jury's answers to interrogatories, taken in light of the trial judge's charge, support a finding that appellants violated the scienter rule. In addition to finding that appellant intended to deceive Mrs. Grupe when he failed to inform her of other investment opportunities, the jury also found by clear and convincing evidence that appellants purchased the securities with the specific purpose of selling them to Mrs. Grupe, charged her an excessive price for them, and did so with intent to deceive her.

Although perhaps the judge's charge might have been clearer because it is open to the interpretation that either a sale of unsuitable securities or a violation of an NASD Rule is a per se violation of Rule 10b-5, there is no question that looking at the charge as a whole, the jury was adequately instructed on the requirement of scienter and that appellants, who made no objection to the charge before the jury retired, are not now entitled to a reversal under the plain error doctrine.

The judge's charge on unsuitable securities and NASD Rules was as follows:

In dealing with suitability you must determine whether Mr. Lamula understood or reasonably should have understood Mrs. Grupe's investment objectives, and then you must determine whether the debentures which Mr. Lamula sold to her were suitable in light of such objectives, as the defendants claim, or whether they were, as plaintiff claims, vastly unsuited to her needs.

Article II, Section 2, of the National Association of Securities Dealers Fair Practice Rules prohibits the sale to a customer by a broker or dealer of unsuitable securities. The rule which I believe was read to you several times in court is as follows:

"In recommending to a customer the purchase, sale or exchange of any security, a member shall have reasonable grounds for believing that the recommendation is suitable for such customer upon the basis of the facts, if any, disclosed by such sustomer (sic) as to his other security holdings and as to his financial situation and needs."

Mr. Lamula, therefore, was required to have reasonable grounds to believe that the securities sold were suitable for Mrs. Grupe.

Tr. 1138-39. The trial judge also charged the jury:

The rules of fair practice of the National Association of Securities Dealers may be considered by you as an expression of the security industry itself concerning...