Cody v. Edward D. Jones & Co.

• Decision Date: 16 June 1993
• Docket Number: No. 17739,17739
• Citation: 502 N.W.2d 558
• Parties: Patrick R. CODY, Plaintiff and Appellee, v. EDWARD D. JONES & COMPANY, Defendant and Appellant.
• Court: South Dakota Supreme Court

Page 558

502 N.W.2d 558

Patrick R. CODY, Plaintiff and Appellee, v. EDWARD D. JONES & COMPANY, Defendant and Appellant.

No. 17739.

Supreme Court of South Dakota.

Argued Sept. 2, 1992.

Decided June 16, 1993.

Steven M. Johnson and Celia Miner of Johnson, Heidepriem, Miner & Marlow, Yankton, for plaintiff and appellee.

David A. Gerdes of May, Adam, Gerdes & Thompson, Pierre, for defendant and appellant.

AMUNDSON, Justice.

Edward D. Jones & Co. (Company) appeals the trial court's judgment on the jury's verdict for Patrick R. Cody (Cody) and against Company. We affirm.

FACTS

After graduating from Northern State College in 1973 with a degree in Business Administration, Cody became employed as the manager of the Elk Point Country Club. Thereafter, he worked at various jobs in sales and bookkeeping until he opened his own implement liquidation business in about 1980. Cody was successful in this business venture and remained in it until 1987 when he purchased a truck and trailer business in Yankton.

Based on this success, Cody sought investment advice from Company in 1981. Cody informed Company's agent, Jim Fitzgerald (Fitzgerald), his investment goals were growth and tax shelter.

Cody initially invested in the following oil and gas ventures: $40,000 in Louisiana General Services, $20,000 in Energy Management Company, and $10,000 in Petro Lewis. Cody was advised and recognized that these investments were risky and eventually lost his entire investment in these oil and gas ventures.

From 1982 to 1985, Cody, under the solicitatious advice of Fitzgerald, invested in four limited real estate partnerships through Company. The investments were as follows:

(1) 1982--Bonaventure, Groundsville, Texas--$76,570;

(2) 1983--Riviera Park, Phoenix, Arizona--$60,500;

(3) 1984--Fox Harbour, Indianapolis, Indiana--$61,600;

(4) 1985--McNeil 2851, Las Vegas, Nevada--$53,000.

Prior to investing in these partnerships, Cody reviewed each investment's prospectus and expressed concern to Fitzgerald about the risk factors mentioned in light of his past experience. Fitzgerald assured Cody each prospectus outlined risk in order to comply with the securities rules and regulations and that, in reality, the investments were not that risky. ¹

Before each investment was made, Fitzgerald was required to fill out an "Offeree Questionnaire" on Cody's qualifications for becoming an investor. In order to qualify Cody for the four partnership investments, Fitzgerald represented Cody's income on these questionnaires in excess of his actual income. ² Cody was not aware of these misrepresentations of his income when he signed the questionnaires, since Fitzgerald filled in the income figures after the questionnaires were signed by Cody.

Each questionnaire also called for Cody to appoint a "purchaser representative." A purchaser representative is to be a neutral party with no financial stake in the investment who is familiar enough with the purchaser's (Cody in this instance) financial condition to evaluate the offering in light of the purchaser's investment goals and financial ability. Fitzgerald never informed Cody that he was entitled to and required to have a purchaser representative review his investment; rather, Fitzgerald either improperly appointed himself as Cody's representative or indicated that Cody did not need one. ³

Each of the four investments subsequently failed and Cody brought an action against Company, alleging that Fitzgerald as agent of Company committed acts of fraud and deceit. The jury awarded Cody $228,594 in compensatory damages and $228,590 in prejudgment interest against Company. Company appeals, alleging the trial court erred by denying its motion for a new trial, excluding evidence of the income tax benefits Cody received, failing to have a pretrial hearing on punitive damages, submitting jury instructions on broker's duty to jury, and allowing testimony as to Fitzgerald's similar conduct in misrepresenting another client's suitability for a high-risk investment.

ISSUES

I. Whether the trial court erred in denying motion for j.n.o.v. or new trial?

II. Whether the trial court erred in excluding evidence of federal income tax benefits to plaintiff?

III. Whether the trial court erred in submitting the issue of punitive damages to the jury without a statutorily required pretrial hearing?

IV. Whether the trial court erred in giving jury instructions 14 and 15 on broker's duties?

V. Whether the trial court erred in permitting the testimony of Theresa Kattke concerning alleged improprieties associated with her account?

ANALYSIS

Motion for j.n.o.v. and New Trial

Company claims the trial court erred in denying its motions for j.n.o.v. and new trial because the evidence was insufficient to support the jury's verdict finding company liable for fraud and deceit. Whether a new trial should be granted is left to the sound discretion of the trial court, and this court will not disturb the trial court's decision absent a clear showing of abuse of discretion. Kusser v. Feller, 453 N.W.2d 619, 621 (S.D.1990). In determining whether the trial court abused its discretion in denying an application for new trial, this court views the evidence in the light most favorable to the verdict. Stoltz v. Stonecypher, 336 N.W.2d 654, 656 (S.D.1983).

Our review of the record reveals the evidence, when viewed favorably to the jury's verdict, supports the finding of fraud on the part of Company. This evidence, if believed by the jury, disclosed that Fitzgerald assured Cody that high risk partnership investments were safe investments, sold Cody investments for which Cody was not financially suited, and falsified Cody's income on offeree questionnaires to make it appear as though these were appropriate investments for Cody. Additionally, Fitzgerald failed to disclose to Cody that he was entitled to a purchaser representative for an independent, impartial review and advisement on this investment decision. Therefore, in light of this evidence, we cannot say that the trial court abused its discretion in denying the motions.

Tax Benefits

Company urges that any award to Cody should be reduced by the tax benefits that Cody received as a result of his investments. The trial court excluded any evidence of tax benefits after considering the motion in limine. The leading case addressing deduction of tax benefits from an award is a securities fraud case. Randall v. Loftsgaarden, 478 U.S. 647, 106 S.Ct. 3143, 92 L.Ed.2d 525 (1986). In Randall, respondents were charged with violations of Sec. 10(b) of the Securities Exchange Act of 1934 and Sec. 12(2) of the Securities Act of 1933. The Court held that neither act authorized the reduction of the trial court's award by the tax benefits the investor received through his tax shelter investment. Id. at 667, 106 S.Ct. at 3155, 92 L.Ed.2d at 544. In reaching its decision, the Court relied on the clear intent of the language of the statutes.

However, in deciding not to reduce the damage award by the tax benefits the plaintiff received, the Randall court also considered the application of the "tax benefit rule" which makes "the recovery taxable as ordinary income." Id. at 664, 106 S.Ct. at 3153, 92 L.Ed.2d at 542. The tax benefit rule is a judicially developed principle that is codified in part in the Internal Revenue Code, 26 U.S.C.A. Sec. 111 (West 1988), and prevents plaintiffs from reaping multiple recoveries. DePalma v. Westland Software House, 225 Cal.App.3d 1534, 276 Cal.Rptr. 214, 218 (1990) (citing Mertens, Law of Federal Income Taxation (1990) Sec. 7.74, p. 175). "The tax benefit rule allows the government to recapture past tax benefits awarded to a taxpayer if in a later year an event occurs which changes the basis, or is 'fundamentally inconsistent with the premise upon which the deduction was initially based.' " DePalma, 276 Cal.Rptr. at 218 (citing Hillsboro National Bank v. Commissioner, 460 U.S. 370, 383, 103 S.Ct. 1134, 1143, 75 L.Ed.2d 130, 146 (1983)). An event is considered "fundamentally inconsistent" when "if that event had occurred within the same taxable year, it would have foreclosed the deduction." Hillsboro, at 383-84, 103 S.Ct. at 1143-44, 75 L.Ed.2d at 146.

Allowing Cody to recover his initial investments in the limited partnerships equates to Cody never having made the investments in the first place. If Cody had never invested in the partnerships, he would not have qualified for partnership's losses as a tax deduction. "Under the tax benefit rule, plaintiffs will be required to report any damages recovered in this action as taxable income, resulting in a recapture of their tax benefits, and any prior tax benefits will thereby be disallowed." Fullmer v. Wohlfeiler & Beck, 905 F.2d 1394, 1402 (10th Cir.1990). Therefore, any of the losses which Cody initially recorded as tax deductions must now be recorded as taxable income as a result of his recovery in this case and will, therefore, offset the tax benefits originally received.

Since the Randall decision, numerous courts have applied its reasoning and refused to reduce damage awards by tax benefits the plaintiff has received prior to the successful prosecution for this damage claim. Astor Chauffeured Limousine v. Runnfeldt Inv. Corp., 910 F.2d 1540 (7th Cir.1990); Fullmer, 905 F.2d 1394 (10th Cir.1990); DePalma, 225 Cal.App.3d 1534, 276 Cal.Rptr. 214 (1990); Billings Clinic v. Peat Marwick Main & Co., 244 Mont. 324, 797 P.2d 899 (1990). These cases did not limit Randall 's application to cases involving a claim of security fraud, but refused to reduce awards by tax benefits in cases where recovery was sought on state law fraud, negligence, negligent misrepresentation, breach of contract, and breach of professional duty. Id.

Company, on the other hand, cites to opposing authority wherein the courts reduced awards by tax benefits. See Bridgen v. Scott, 456 F.Supp. 1048 (S.D.1978); Froid v. Fox, 132 Cal.App.3d 832, 183 Cal.Rptr....