Johnson v. John Hancock Funds

• Decision Date: 30 June 2006
• Docket Number: No. M2005-00356-COA-R3-CV.,M2005-00356-COA-R3-CV.
• Citation: 217 S.W.3d 414
• Parties: Annie E. Hyde JOHNSON et al. v. JOHN HANCOCK FUNDS et al.
• Court: Tennessee Court of Appeals

217 S.W.3d 414

Annie E. Hyde JOHNSON et al. v. JOHN HANCOCK FUNDS et al.

No. M2005-00356-COA-R3-CV.

Court of Appeals of Tennessee, at Nashville.

December 13, 2005 Session.

June 30, 2006.

Permission to Appeal Denied by Supreme Court November 20, 2006.

H. Naill Falls, Jr., Nashville, Tennessee, for the appellants, Annie E. Hyde Johnson, Linda D. Johnson, and Mary Anne Howland.

Hugh C. Howser, Jr. and Kevin C. Baltz, Nashville, Tennessee, for the appellee, Signator Investors, Inc.

OPINION

WILLIAM C. KOCH, JR., P.J., M.S., delivered the opinion of the court, in which PATRICIA J. COTTRELL and FRANK G. CLEMENT, JR., JJ., joined.

This appeal involves a dispute between a registered investment advisor and three of its clients regarding the investment advice the clients received from one of its agents. The clients filed suit against the advisor in the Chancery Court for Davidson County. The trial court dismissed the clients' Tennessee Consumer Protection Act claim for failure to state a claim upon which relief can be granted. After excluding the testimony of the clients' financial expert, the trial court also granted the advisor a summary judgment dismissing the investors' claims based on common-law fraud and misrepresentation, negligence, and breach of fiduciary duty. The investors have appealed. We have determined that the trial court erred by dismissing the investors' Tennessee Consumer Protection Act claims, by excluding the testimony of the plaintiffs' expert, and by granting a summary judgment dismissing the investors' remaining claims. Accordingly, we vacate the orders and remand the case for further proceedings.

I.

Marcus Henderson is a financial advisor who owns and operates the Henderson Financial Group in Nashville, Tennessee. He possesses the licenses and certification required to solicit orders for any type of security, to act as an investment advisor, and to sell life and health insurance, as well as mutual funds and annuities. Throughout his professional career, Mr Henderson has been affiliated with Signator Investors, Inc., formerly known as John Hancock Distributors, Inc. (Signator Investors), a retail broker-dealer and registered investment advisor of the John Hancock Financial Services network. Mr. Henderson sells various John Hancock products, including life insurance and securities through Signator Investors.

Signator Investors markets three classes of John Hancock mutual fund shares. Class A shares are front-loaded but do not require the payment of annual distribution fees. Class B shares are back-loaded and require the payment of an annual distribution fee. Class C shares are not front-loaded but may impose redemption fees. Determining which class of shares is appropriate for a particular investor requires careful consideration of the fees and expenses associated with each share class during the period of time the investor is planning to hold the investment, taking into account the possibility of redemption of the shares and the anticipated appreciation in the value of the shares. Generally, an investor seeking to purchase shares worth at least $100,000 will incur the fewest fees by purchasing Class A mutual fund shares.

The sale of Class B mutual fund shares has been the subject of regulatory and enforcement actions since at least 1998.¹ The Securities and Exchange Commission (SEC) has fined companies for selling Class B mutual funds in amounts in excess of $100,000 per transaction because these transactions subject the client to unnecessarily high fees.² Likewise, the National Association of Securities Dealers has established guidelines explicitly forbidding broker dealers such as Signator Investors from selling Class B mutual fund shares in excess of $100,000 per transaction and has also fined members for engaging in such transactions. Even Signator Investment's own internal policies state that a broker should not engage in selling Class B mutual fund shares in excess of $100,000 per transaction. Despite these regulatory actions, Mr. Henderson continued to sell his clients John Hancock Class B mutual fund shares in transactions in excess of $100,000.

In 1999, Mary Anne Howland, the owner of a small business in Nashville, sought Mr. Henderson's assistance to plan for her retirement and to pay for her son's college education. Mr. Henderson recommended that Ms. Howland purchase John Hancock Class B mutual fund shares and, eventually, assisted Ms. Howland in purchasing over $300,000 in Class B shares. Ms. Howland purchased $175,000 in Class B shares in a single transaction in 2002. Ms. Howland also followed Mr. Henderson's advice to purchase a variable annuity for her retirement. Ms. Howland acknowledged in writing that she had received prospectuses regarding these investments.

In April 2000, 76-year-old Annie Johnson also sought Mr. Henderson's investment advice. She owned a funeral home that was operated by her daughter, Linda Johnson, and had previously purchased life insurance from Mr. Henderson in 1996.³ Annie Johnson had recently received $389,000 from the sale of her house and desired Mr. Henderson's assistance in investing these funds. The exact substance of the conversations among Mr. Henderson and the Johnsons is disputed. Annie Johnson and Linda Johnson insist that they informed Mr. Henderson that the funeral home did not generate much income for Annie Johnson. They also insist that they informed Mr. Henderson that they desired to use the proceeds from the sale of the home to ensure the payment of the expenses for Annie Johnson's care and assistance for the rest of her life. Accordingly, Annie Johnson did not desire to make risky investments and intended that any funds remaining at her death would be divided among her children.

Mr. Henderson's version of his conversation with the Johnsons is vastly different. He insists that Annie Johnson told him that she desired to grow the proceeds as much as possible. He also insists that Annie Johnson told him that she did not need the money during her lifetime and that the funds would be used at her death to enable Linda Johnson to purchase her siblings' interests in the funeral home.

Mr. Henderson established a joint account for Annie Johnson and Linda Johnson and used all of the proceeds from the sale of Annie Johnson's home to purchase John Hancock Class B mutual fund shares. Like Ms. Howland before them, the Johnsons acknowledged in writing that Mr. Henderson had provided them with a prospectus regarding the investment. The value of the investment declined significantly during the next two years. By December 2002, less than $190,000 remained in the account. When Linda Johnson finally redeemed the account on March 11, 2003, its redemption value was $149,021.87.

In March 2003, Ms. Howland and the Johnsons filed suit in the Chancery Court for Davidson County against Mr. Henderson, Signator Investors, and three other related John Hancock companies. The complaint sought damages based on common-law fraud and misrepresentation, negligence, breach of fiduciary duty, and violation of the Tennessee Consumer Protection Act. Ms. Howland and the Johnsons asserted that the investments that Mr. Henderson purchased on their behalf were excessively risky in light of their stated investment goals and that the purchase of the Class B mutual fund shares resulted in their payment of fees higher than those they would have paid had they purchased Class A mutual fund shares. Ms. Howland also alleged that the annuity Mr. Henderson recommended was unsuitable for her needs.

Ms. Howland and the Johnsons eventually voluntarily dismissed their claims against the three John Hancock defendants. On September 2, 2004, the trial court dismissed their Tennessee Consumer Protection Act claims regarding the sale of the Class B mutual fund shares but declined to dismiss Ms. Howland's Tennessee Consumer Protection Act claim regarding the sale of the annuity.⁴ One week later, on September 9, 2004, Ms. Howland and the Johnsons voluntarily dismissed their claims against Mr. Henderson, leaving Signator Investors as the only remaining defendant.

Ms. Howland and the Johnsons engaged Edward O'Neal, a professor at Wake Forest University's Babcock Graduate School of Management, as their expert with regard to Mr. Henderson's advice and the investment products purchased through Signator Investors. Dr. O'Neal is a registered securities advisor and a published author regarding Class B mutual fund shares. He has also appeared as a witness for the SEC in cases involving Class B mutual fund shares. In a deposition given on September 21, 2004, Dr. O'Neal testified that Ms. Howland and the Johnsons paid higher fees by purchasing Class B mutual fund shares than they would have paid had they purchased Class A shares. He also testified that the portfolios Mr. Henderson established for the Johnsons were too aggressive for their stated investment goals and that the annuity purchased for Ms. Howland was unsuitable because it required more fees but offered no additional tax savings than those afforded by her existing Individual Retirement Account.

On October 8, 2004, Signator Investors filed a motion for summary judgment to dismiss the remaining claims of Ms. Howland and the Johnsons. One week later, it filed a second motion requesting the trial court to exclude Dr. O'Neal's expert opinions. Following a hearing, the trial court entered an order on November 12, 2004, granting both motions without explanation. On this appeal, Ms. Howland and the Johnsons take issue with the Tenn. R. Civ. P. 12.02(6) dismissal of their Tennessee Consumer Protection Act claims, the exclusion of Dr. O'Neal's testimony, and the summary judgment dismissing their remaining claims.

II. THE APPLICABILITY OF THE TENNESSEE CONSUMER PROTECTION ACT TO THE SALE OF SECURITIES

Ms. Howland and the Johnsons take issue with the trial court's dismissal of the Tennessee Consumer Protection Act claims. They insist that ...