DeRance, Inc. v. PaineWebber Inc.
| Citation | 872 F.2d 1312 |
| Decision Date | 19 June 1989 |
| Docket Number | No. 86-2666,86-2666 |
| Parties | DeRANCE, INC., a Wisconsin not for profit corporation, Plaintiff-Appellee, v. PAINEWEBBER INCORPORATED, a Delaware corporation, and Paul Sarnoff, Defendants-Appellants. |
| Court | United States Courts of Appeals. United States Court of Appeals (7th Circuit) |
Jerold S. Solovy, Jenner & Block, Chicago, Ill., for defendants-appellants.
Jerrold E. Salzman, Freeman & Salzman, P.C., Chicago, Ill., for plaintiff-appellee.
Before EASTERBROOK, RIPPLE, and MANION, Circuit Judges.
Plaintiff DeRance, Inc. (DeRance), a not-for-profit charitable foundation, contracted with PaineWebber Incorporated (PaineWebber) and its agent Paul Sarnoff to trade a gold futures account on its behalf. Gold dropped and so did the account. DeRance sued and a jury awarded DeRance $7.7 million in compensatory damages and assessed more than $20 million in punitive damages. Defendants appeal from the district court's decision denying their motion for judgment n.o.v. or, in the alternative, for a new trial. Defendants contend that the trial was unfair because the district court erroneously precluded discovery, excluded evidence, misinstructed the jury, and permitted DeRance's counsel to make inflammatory arguments. After reviewing the entire record, we remit the punitive damages award against PaineWebber to $7 million. We otherwise affirm the district court's decision.
DeRance is a Wisconsin charitable foundation. In the early part of this decade, DeRance had assets of almost $200 million. DeRance's Board of Directors consisted of Harry John, who started DeRance with shares of Miller Brewing Company stock he had inherited, Erica John, then John's wife but since divorced, and Dr. Donald Gallagher, a former philosophy professor. Harry John controlled DeRance's investments.
Sarnoff is a vice-president of PaineWebber. PaineWebber is registered as a futures commission merchant with the Commodity Futures Trading Commission. PaineWebber is a subsidiary of PaineWebber Group, Inc. PaineWebber Group, Inc. is not a party to this lawsuit.
In late 1981, after reading an article about Sarnoff in a magazine, John called Sarnoff, then working for another company, and told him that he wanted to invest in gold. After moving to PaineWebber, Sarnoff called John in July, 1982, and suggested to him that the time was right to invest in commodity futures. 2 To win the account, Sarnoff boasted that he knew more about gold trading than anyone else in the country, and, according to notes John made in his business journal, that Sarnoff's trading "will provide us regular income." Sarnoff also told John about "all the diverse commodities he invested in, the metals and the T-bills," even though Sarnoff had no experience in trading commodities. Sarnoff's assistant at PaineWebber told John Miller, DeRance's outside counsel, that Sarnoff had invested in gold for other institutional investors. In line with John's recommendation, DeRance's board decided on August 20, 1982, to establish its "F Fund" with PaineWebber. This separate fund was so named to complement its stock portfolio, held in DeRance's "E Fund" (which was not invested through PaineWebber), which contained approximately $150 million worth of common stock. In the fall of 1982, DeRance delivered approximately $8 million to PaineWebber to establish the F Fund. PaineWebber put DeRance's money into treasury bills while the parties negotiated a trading agreement.
After several months of negotiations, DeRance entered into a Commodity Trading Advisor Agreement (Agreement) with Sarnoff and PaineWebber. The Agreement became effective February 23, 1983. The account would be a discretionary gold futures trading account with Sarnoff and PaineWebber serving as DeRance's trading advisor and broker. The Agreement stated in particular that "[t]he investment objective of DeRance is to acquire an inventory of physical gold bullion not in excess of 15,000 ounces and to earn premium money during the accumulation of such inventory." p 3(a). Thus, the purpose of this account was not just to accumulate gold but to earn money by trading. In the Agreement, DeRance gave PaineWebber and Sarnoff "discretionary authority concerning ... the purchase of gold bullion, the purchase and sale of gold futures contracts, and the granting and purchase of options for the purchase and sale of gold futures" in accordance with the trading plan, which was signed by John and Sarnoff and attached to the Agreement. The trading plan in turn describes six separate trading strategies that the parties agreed were appropriate to DeRance's objectives. DeRance did not know, however, that PaineWebber's senior management was skeptical of Sarnoff's trading plan. 3
The Agreement expressly sought to limit the amount of risk PaineWebber and Sarnoff could incur in trading the account by providing that PaineWebber could not:
(a) Write a gold call option on behalf of the Fund as grantor or enter a futures contract to sell gold unless the Fund has a sufficient inventory of gold to cover the call option and/or the futures contract except to the extent such obligation (or potential obligation) may be offset by a long futures contract or a put option held by the Fund.
(b) Write a put option on behalf of the Fund as grantor or enter a futures contract to buy gold unless the Fund has sufficient cash resources to cover the put option and/or the futures contract except to the extent such obligation (or potential obligation) may be offset by a short futures contract or a call option held by the Fund.
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* * *
(e) Acquire any gold futures contract, acquire any gold futures option contracts, write any gold futures option contracts on behalf of the Fund as grantor, purchase any gold bullion or make any other investment contrary to the provisions hereof or contrary to any written instruction given to [PaineWebber] by DeRance....
In addition, the Commodities Futures Trading Commission (CFTC) requires brokers to file a report when the number of open contracts in a commodity future that they hold exceeds a certain number set by regulation. 17 C.F.R. Sec. 15.00(b) (1981). The Agreement required PaineWebber to notify DeRance when it obtained or held positions in gold futures and options that were in excess of those reportable limits, p 2(f), and to provide DeRance with certain specific information on transactions during the time it holds a reportable position.
The Agreement further required PaineWebber to send DeRance "monthly reports in such form as may be mutually acceptable showing all transactions effected for the account of the F Fund." Paragraph 6(j)(iii) in turn required DeRance to review the transactions of the F Fund as reported in PaineWebber's statements and to advise PaineWebber promptly of any problems:
De Rance shall review reports and information provided to it by [PaineWebber] and shall advise [PaineWebber] promptly of any impermissible investment of the Fund of which De Rance has knowledge or which creates a likelihood of a subsequent improper or impermissible investment of the Fund and De Rance shall assist [PaineWebber] in correcting or avoiding the same.
PaineWebber sent DeRance two types of reports: daily transactions slips and monthly summary reports. PaineWebber sent its daily slips directly to Harry John at DeRance. DeRance does not claim that it did not receive a slip for every daily transaction in the account. John passed those slips on to Mr. Wagner, DeRance's in-house accountant, and Cecil Sanders, its outside consulting accountant.
PaineWebber sent its monthly reports directly to John and Dr. Gallagher, to Sanders, the outside consulting accountant, to John Miller, DeRance's outside counsel, and to the Arthur Young & Co. partner serving as DeRance's outside auditor. The monthly statements were also reviewed by Mr. Wagner, the internal accountant at DeRance. Sanders used PaineWebber's monthly statements to prepare a monthly report to DeRance's Board of Directors.
Sarnoff began trading on DeRance's behalf on February 23, 1983, the date on which the Agreement became effective. On that date, the $8 million in T-bills had grown to more than $8.3 million with interest. On August 25, 1983, after six months of trading, during which time the price of gold had declined, Sarnoff wrote to John that the account had had a "gain of $2,201,103.57." In a handwritten note dated August 9, 1983 to Howard Berg, a PaineWebber executive vice-president then in charge of its commodities division, Ryan, the compliance director whose earlier prophesies of doom had gone unheeded, characterized Sarnoff's August 25 letter as "totally misleading." That same day, Ryan wrote to Clarke Young at PaineWebber with copies to Berg and Sandridge, recommending that PaineWebber send a revised letter to DeRance and conduct an independent audit of the account "to ensure that Mr. Sarnoff's accounting is accurate." But PaineWebber did not confront Sarnoff with this, and Sarnoff never corrected his assertion.
Around September, 1983, PaineWebber changed the format of its monthly reports. The new format contained a profit and loss number that included unearned premiums from options transactions and therefore could mislead persons unsophisticated in commodity trading. In addition to falsely stating the profits on the account, the monthly reports were replete with errors. During the trial, PaineWebber's own inside counsel was, on cross-examination, unable to determine from the monthly account statements on which days, if any, PaineWebber and Sarnoff had violated the Agreement.
At the end of 1983, Arthur Young & Co., in its routine annual year-end audit, concluded that PaineWebber and Sarnoff were...
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