Galarneau v. Merrill Lynch, Pierce, Fenner & Smith

• Decision Date: 12 October 2007
• Docket Number: No. 06-2410.,06-2410.
• Citation: 504 F.3d 189
• Parties: Deborah GALARNEAU, Plaintiff, Appellee, v. MERRILL LYNCH, PIERCE, FENNER & SMITH INC., Defendant, Appellant.
• Court: U.S. Court of Appeals — First Circuit

504 F.3d 189

Deborah GALARNEAU, Plaintiff, Appellee, v. MERRILL LYNCH, PIERCE, FENNER & SMITH INC., Defendant, Appellant.

No. 06-2410.

United States Court of Appeals, First Circuit.

Heard June 4, 2007.

Decided October 12, 2007.

Evan M. Tager, with whom Andrew Tauber, Mayer, Brown, Rowe & Maw LLP, James R. Erwin, Pierce Atwood LLP, and Eugene Volokh, UCLA School of Law, were on brief, for appellant.

Rufus E. Brown, with whom Brown & Burke, Michael A. Nelson, and Jensen Baird Gardner & Henry, were on brief, for appellee.

Before TORRUELLA, Circuit Judge, NEWMAN,^* Circuit Judge, and LYNCH, Circuit Judge.

TORRUELLA, Circuit Judge.

On January 6, 2004, Deborah Galarneau ("Galarneau") was fired from her job as a stockbroker at Merrill Lynch, Pierce, Fenner & Smith Inc. ("Merrill Lynch"). In a form submitted to the National Association of Securities Dealers ("NASD"), Merrill explained that "Ms. Galarneau was terminated after the firm concluded that she had (I) engaged in inappropriate bond trading in one client's account and (II) utilized time and price discretion in the accounts of three clients." Galarneau brought this action against Merrill Lynch in the United States District Court for the District of Maine, alleging defamation (among other claims). The jury found in favor of Galarneau, awarding compensatory and punitive damages. Merrill Lynch moved for judgment as a matter of law, challenging the finding of defamation and the award of special and punitive damages. The district court denied the motion. After careful consideration, we affirm the district court's denial with respect to the finding of defamation and the award of special damages, but reverse with respect to the jury's award of punitive damages.

I. FACTUAL BACKGROUND

Because Merrill Lynch challenges the sufficiency of the evidence, we recite the facts in the light most favorable to the verdict. See Wilson v. City of Boston, 421 F.3d 45, 48 n. 2 (1st Cir.2005). Deborah Galarneau was employed at Merrill Lynch's Portland, Maine branch office from February 1989, when she joined her husband Preston Galarneau at the firm, until she was terminated on January 6, 2004. Beginning in 1998, the Galarneaus worked as a team called the "Galarneau Group," as allowed by Merrill Lynch. Galarneau was successful as a financial advisor at Merrill Lynch, ranking in the first or second groupings of producing brokers in her office, qualifying for a $100,000 certificate bonus by growing her business by ten percent for ten consecutive years, and earning other recognition awards and trips.

The Amy Ford Account

Amy Ford became a client of the Galarneau Group in late 2000. Ford was a single woman in her fifties with a portfolio in excess of $2 million, which served as her primary source of income along with other investments not managed by Merrill Lynch. Her portfolio was heavily weighted in nonperforming equities, which Ford had inherited with a low tax basis. Galarneau testified that Ford had a history of spending more than she earned from her investment income. This practice led her to borrow from her investment account and sometimes required her to sell securities to pay off her debt, thereby incurring significant capital gains taxes.

According to Galarneau, she and her husband developed a three-pronged investment plan for Ford's account: first, to rebalance her portfolio to reduce the concentration in legacy stock and increase her investment in fixed income securities (primarily bonds); second, to generate more income for Ford to live on; and third, to minimize the capital gains taxes that would be incurred from the rebalancing.

Galarneau testified that she and her husband told Ford that this investment plan would require aggressive and active trading, including the use of an investment strategy called "tax advantage bond swap" when the occasions for doing so arose. Tax advantage bond swaps involve selling bonds that have declined in market value (in relation to their cost basis) and using the proceeds of the sale to buy replacement bonds of equivalent or superior investment value. The intended benefit of such a strategy is that the client take tax losses without sacrificing the quality of her investment portfolio. According to Galarneau, in applying this strategy to the Ford account, the Galarneaus expected to use the tax losses to offset any capital gains resulting from the sale of the legacy stock.

The Galarneaus anticipated that the proposed investment plan could be expensive for Ford if she paid commissions on each trade. Galarneau testified that she and her husband advised Ford of the Merrill Lynch Unlimited Advantage ("MLUA") pricing option, a program through which a client could pay a flat annual fee for trading instead of paying commissions on each transaction. According to Galarneau, Ford declined this option and the parties arranged a discount for the commissions for trading in the Ford account.

Merrill Lynch's Review of the Trading in the Ford Account

Galarneau testified that at the outset, she and her husband approached Edward Coppola, then the compliance officer for Merrill Lynch's Northern New England Complex, to discuss the investment strategy for the Ford account. At that time, Coppola did not raise any objections to the proposed investment strategy.

The trading in the Ford account in 2001 and 2002 was very active. During that period, the financial markets were "unusually volatile" in part because of the consequences of the terrorist attacks of September 11, 2001 and corporate accounting scandals. According to Galarneau, these conditions provided opportunities for tax advantage bond swaps, but also required trades that would not otherwise have been made. In addition, Ford's personal spending was three times in excess of her investment income.

Such active trading triggered management review within Merrill Lynch. The firm uses a computer-generated monitoring system called Armor review, which automatically notifies the Merrill Lynch compliance officers of accounts with unusually active trading. The Armor alert may be accessed from either a financial advisor's computer or a compliance officer's computer. It provides background information about the targeted account, including a summary of the frequency and dollar value of trades (with links to data for individual trades), a comparison of the value of trades versus the commissions earned on the account (the "velocity" of trading), and the commissions for the trading.

The first Armor review took place in July 2001. Coppola asked Galarneau for an explanation of the production credits, the performance, and the strategy. Galarneau provided this information, and Coppola signed off on the trading in the account. According to Galarneau, Coppola never indicated that the trading in the Ford account was inappropriate in any way. Before he left the firm, Coppola reviewed the account again in August 2001 and commented that the account had already been reviewed the previous month.

An Armor review was again triggered the next year, in July 2002, when Richard Heller became the new compliance manager for the Portland, Maine office of Merrill Lynch. Pursuant to the review, Heller specifically asked the Galarneaus about the "high velocity" in the Ford account. According to Galarneau, the Galarneaus explained the investment strategy for the Ford account, and Heller approved the trading.

This time, as recommended by Merrill Lynch's Policy Manual, Heller sent an "activity letter" to Ford dated September 10, 2002, drawing her attention to (1) the substantial volume of trading in her account, (2) the relatively high level of costs associated with that trading ($29,042) in relation to her portfolio value, and (3) the sizeable level of her margin account¹ ($203,542). In the letter, Heller asked Ford to confirm that the account was being managed in accordance with her investment objectives and offered to meet with her about the account. Ford never responded. According to Galarneau, she and her husband met with Ford to go over the activity letter, at which point Ford indicated that she was satisfied with how the account was being managed.

A fourth Armor review of the Ford account was triggered in November 2002, which again focused on the substantial volume of trading in the account, including the "high turnover" rate of 6.81%, a very high level of trading. The Galarneaus again explained their strategy of taking as many losses as feasible to offset gains from the sale of legacy stock. Heller checked the box on the Armor review form marked "approved," and noted, "Taking losses, margin debt decreasing, Letters sent 9-13-02."

This was the last substantive Armor review of the Ford account. By 2003, the level of trading went down, and most of the margin debt incurred by Ford to accelerate the rebalancing had been paid off.

According to Galarneau, the strategy proved successful: The Ford account earned $101,000 from the fixed income investments purchased for Ford, saved more than $36,000 in tax liability as a result of the bond swap strategy, and (as of the time Galarneau was terminated) increased in value by $65,000.

The Ford Complaint

Ford sent Merrill Lynch a letter on June 7, 2003, accusing the Galarneaus and Merrill Lynch of "churning" her account.² Ford copied her complaint to the Maine Securities Division, which promptly opened an investigation into Galarneau, her husband, and Merrill Lynch. In response to this investigation, Merrill Lynch's Office of General Counsel ("OGC") became involved, with Kathleen Durning taking line responsibility, supervised by First Vice President and Assistant General Counsel Andrew Kandel.

Merrill Lynch's Response

After receiving explanatory materials from Galarneau and consulting with her, Durning responded to the Maine Securities Division's initial inquiry with a letter defending the trading in the Ford account. The letter provided detail about the context of the trading in the...