Garnatz v. Stifel, Nicolaus & Co., Inc.

• Decision Date: 01 November 1977
• Docket Number: No. 77-1048,77-1048
• Citation: 559 F.2d 1357
• Parties: Fed. Sec. L. Rep. P 96,219 Milton W. GARNATZ, Appellee, v. STIFEL, NICOLAUS & CO., INC., and Kingsley O. Wright, Appellants.
• Court: U.S. Court of Appeals — Eighth Circuit

Page 1357

559 F.2d 1357

Fed. Sec. L. Rep. P 96,219

Milton W. GARNATZ, Appellee, v. STIFEL, NICOLAUS & CO., INC., and Kingsley O. Wright, Appellants.

No. 77-1048.

United States Court of Appeals, Eighth Circuit.

Submitted Sept. 15, 1977.

Decided Nov. 1, 1977.

John R. Musgrave, St. Louis, Mo. (argued), Michael W. Forester of Coburn, Croft, Shepherd & Herzog, St. Louis, Mo., on briefs, for appellants.

Samuel J. Goldenhersh, St. Louis, Mo. (argued), Mark I. Bronson, St. Louis, Mo., on brief, for appellee.

Before VAN OOSTERHOUT and MATTHES, Senior Circuit Judges, and STEPHENSON, Circuit Judge.

MATTHES, Senior Circuit Judge.

Stifel, Nicolaus & Co., a brokerage firm, and Kingsley O. Wright, a vice-president of that firm, appeal from a judgment entered against them on a jury verdict awarding Milton W. Garnatz damages of $45,000 with interest and costs. Count I of plaintiff's complaint was based on defendants' alleged violations of Sec. 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. Sec. 78j(b); Rule 10b-5 promulgated thereunder, 17 C.F.R. Sec. 240.10b-5; and Sec. 17 of the Securities Act of 1933, 15 U.S.C. Sec. 77q. Count II of the complaint was a pendent state claim for common law fraud.

Defendants press various contentions regarding the measure of damages, the sufficiency of the evidence, and the statute of limitations. We hold that the damages in this case were correctly measured and were supported by the evidence, and that plaintiff's action was timely.

I

Garnatz is a man of limited education and modest means. His familiarity with the securities markets is characteristically that of the average, individual investor, not the sophisticated trader.

In November of 1972, plaintiff attended a series of investment seminars sponsored by Stifel, Nicolaus. On the basis of representations made at those seminars and at two personal meeting with Kingsley Wright, plaintiff agreed to participate in a special bond margin account program which was purportedly designed to maximize his income while preserving his capital. The representations plaintiff specifically relied on in deciding to join in the program were: (1) that all purchases had to be approved by the board of directors of Stifel, Nicolaus; (2) that the use of a margin account entailed no risk to plaintiff's capital; (3) that the bonds purchased would not decrease more than one percent in value; (4) that the interest rate on the margin account would never exceed eight percent; and (5) that defendants' recommended purchases would be without risk. Defendants do not seriously challenge the allegation that these representations were both false and material.

Plaintiff insisted on avoiding speculation, yet most of the bonds purchased for him were either low-rated or non-rated by Standard & Poors. Although safety was a key feature of defendants' sales pitch, in order to pay the interest rate on the margin account and still provide a sufficiently attractive return, it was apparently necessary to purchase high-yield, and consequently highly-speculative bonds. At no time was any bond purchase approved by the board of directors of Stifel, Nicolaus.

Plaintiff entered into the program in late 1972. By April of 1973, the market value of Garnatz' account had declined over one percent. As a result, plaintiff was forced to relinquish all income from the bonds to pay increased margin calls. During this period, Wright repeatedly reassured Garnatz that the drop was only temporary and strongly recommended that plaintiff stay with the program, which he did. In August of 1974, the interest rate on the margin account jumped from eight percent to thirteen percent, as permitted by a change in Missouri's usury law. Garnatz does not dispute the fact that by that time he was, or should have been, on notice of the fraud.

II

The implication of a private damage remedy for violations of the federal securities laws is based partly on the notion that the abrogation of a statutorily imposed duty is tortious. 1 A. Bromberg, Securities Law: Fraud Sec. 2.4 (1977). Following the model of the common law tort of deceit, in Sec. 10(b) and Rule 10b-5 actions 'the defendant is liable to respond in such damages as naturally and proximately result from the fraud . . ..' Estate Counselling Service v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 303 F.2d 527, 533 (10th Cir. 1962). Normally, federal courts measure those damages according to the out-of-pocket rule. Harris v. American Investment Co., 523 F.2d 220, 224-26 (8th Cir. 1975), cert. denied, 423 U.S. 1054, 96 S.Ct. 784, 46 L.Ed.2d 643 (1976). As applied to a fraudulently induced purchase of securities, that rule provides for the recovery of the difference between the actual value of the securities and their purchase price. Id. at 225. Recovery is also allowed for any consequential damages proximately resulting from the fraud. D. DOBBS, HANDBOOK ON THE LAW OF REMEDIES 601-06, 615 (1973); see Estate Counselling Service v. Merrill Lynch, Pierce, Fenner & Smith, Inc., supra. The rule was designed to provide plaintiffs with a compensatory recovery rather than allowing damages for a lost expectancy. D. DOBBS, supra at 595; see Harris, supra at 225. It works best in the typical situation where the defendant's fraud conceals the actual value of the item purchased, yet does not affect the overall market value of that item. See id. at 225-26.

Of course, the out-of-pocket rule is not a talisman. Indeed, this court has shown no hesitation in varying that measure when necessary on the facts of a given case. See, e. g., Myzel v. Fields, 386 F.2d 718, 745 (8th Cir. 1967), cert. denied, 390 U.S. 951, 88 S.Ct. 1043, 19 L.Ed.2d 1143 (1968) (difficulty in ascertaining actual value). Our function is to fashion the remedy best suited to the harm.

In the present case, defendants urge strict application of the out-of-pocket rule. They would deny plaintiff any recovery at all, since the value of the bonds equalled their purchase price. But the fact that plaintiff got what he paid for does not mean he did not suffer any legally cognizable injury from defendants' fraud. It merely indicates that the fraud did not relate to the price of the bonds.

A similar problem was presented in Chasins v. Smith, Barney & Co., 438 F.2d 1167 (2d Cir. 1970). In that case, the defendant's failure to reveal its market-making status with respect to the securities it recommended to the plaintiff for purchase was held to be a material omission in violation of Rule 10b-5. Under a traditional application of the out-of-pocket rule, the plaintiff would have recovered nothing, since the price paid was equal to the fair market value of the stocks. However, the court recognized that

the evil is not the price at which [plaintiff] bought but the fact of being induced to buy and invest for some future growth in these stocks without disclosure . . ..

Id. at 1173. Since the plaintiff had sold his stock prior to discovering the fraud, the court allowed recovery of the difference between his purchase price and his resale price.

As in Chasins, the gravamen of the present action was not whether Garnatz bought the bonds for a fair price, but that he bought at all. Absent defendants' representations regarding the safety of the program, plaintiff's express disdain for speculation undoubtedly would have precluded his participation; but the fraudulent promise of a low-cost, income-maximizing, and risk-free investment package overcame plaintiff's caution. Under these circumstances, we believe that a rescissory damage measure, similar to that employed by the court in Chasins, is appropriate. See Cobine, Elements of Liability and Actual Damages in Rule 10b-5 Actions, 1972 Ill.L.F. 651, 672-73; Comment, The Measure of Damages in Rule 10b-5 Cases Involving Actively Traded Securities, 26 Stan.L.Rev. 371, 374-77 (1974). Such a measure seeks to return the parties to the status quo ante the sale. In effect, the plaintiff is refunded his purchase price, reduced by any value received as a result of the fraudulent transaction. As applied to the case at bar, plaintiff can recover the decline in value of his bonds until his actual or constructive notice of the fraud, as well as any other losses properly attributable to defendants' wrongdoing. ¹ That decline in value is determined by the losses taken on bond sales plus the losses sustained on bonds held, ² as long as all such losses were incurred prior to the date that plaintiff knew, or should have known, of the fraud.

Some would argue, as defendants have here, that a rescissory measure of damages allows recovery of losses due to market forces rather than the defendants' conduct. See Green v. Occidental Petroleum Corp., supra n. 1, at 1342. We recognize that neither Stifel, Nicolaus nor Kingsley Wright caused plaintiff's bonds to decline in value. But plaintiff's purchase of these low-rated and non-rated bonds was induced by defendants' wrongful concealment of the risks normally attendant to such transactions. Those risks should therefore rightly be borne by defendants. Moreover, since plaintiff's losses were natural, proximate, and foreseeable consequences of defendants' fraud, the causative connection is sufficient. Of course, the responsibility for losses incurred after actual or constructive notice of the fraud must fall to plaintiff.

III

We turn now to the evidence supporting the jury's verdict, drawing all reasonable inferences in plaintiff's favor.

A. Actual or Constructive Notice of the Fraud

Wright admitted that Garnatz suffered losses of $22,600 on the sale of three of his bonds in December of 1973. He further admitted, and documentary evidence established, that by August, 1974, the market value of Garnatz' other bonds had dropped nearly $17,000. Commissions ³ on the various transactions involved were over $6,000. Thus, plaintiff's losses as of August, 1974, totalled just over $45,000. As that is also the figure awarded by the jury and since the...