M & B Contracting Corp. v. Dale

• Decision Date: 17 July 1986
• Docket Number: No. 84-1871,84-1871
• Citation: 795 F.2d 531
• Court: U.S. Court of Appeals — Sixth Circuit
• Parties: Fed. Sec. L. Rep. P 92,846 M & B CONTRACTING CORPORATION, a Michigan corporation, Plaintiff-Appellant, v. David DALE and Merrill Lynch, Pierce, Fenner & Smith, Inc., a subsidiary of Merrill Lynch & Co., Inc., a Delaware corporation, jointly and severally, Defendants-Appellees.

Page 531

795 F.2d 531

Fed. Sec. L. Rep. P 92,846

M & B CONTRACTING CORPORATION, a Michigan corporation, Plaintiff-Appellant, v. David DALE and Merrill Lynch, Pierce, Fenner & Smith, Inc.,

a subsidiary of Merrill Lynch & Co., Inc., a

Delaware corporation, jointly and

severally, Defendants-Appellees.

No. 84-1871.

United States Court of Appeals,

Sixth Circuit.

Argued April 18, 1986.

Decided July 17, 1986.

Robert S. Krause, Dickinson, Wright, Moon, Van Dusen & Freeman, Detroit, Mich., Robert Kinchen (argued), for plaintiff-appellant.

Douglas G. Graham, Lead Counsel (argued), Butzel, Keidan, Simon, Myers & Graham, Detroit, Mich., Dennis K. Egan, for defendants-appellees.

Before LIVELY, Chief Judge and MERRITT and JONES, Circuit Judges.

LIVELY, Chief Judge.

In this case the plaintiff, M & B Contracting Corporation (M & B), sought damages from Merrill Lynch and its registered representative, David Dale, for alleged violations of federal securities laws. More specifically, the complaint charged Merrill Lynch and Dale with "intentional misrepresentations, omissions, acts, practices and course of dealing [which] constitute violations of Sec. 17(a) of the Securities Act, Sec. 10(b) of the Exchange Act and Rules 10b-5 and 10b-16 promulgated thereunder ... as well as other statutes, rules and regulations relating to the securities industry." Following a bench trial the district court entered a judgment in favor of Merrill Lynch.

I.

M & B is a successful Michigan corporation engaged in road building and other construction work. Prior to May 1980 M & B had kept most of its working capital invested in certificates of deposit. Both its chairman, Sebastian J. Mancuso, and its vice-president of finance, Peter Saputo, became interested in an investment plan that would yield more income while providing greater liquidity. Saputo had become acquainted with David Dale, and at Dale's suggestion M & B opened a Ready Assets trust, a money market account, with Merrill Lynch. In the beginning M & B deposited approximately $1.6 million of its $3 million in excess funds into Ready Assets. Shortly thereafter, on Dale's advice, M & B began buying utility bonds and stocks, and eventually began trading in large blocks of common stocks. In September 1980 M & B executed an Option Trading and Margin Agreement with Merrill Lynch. Much of the trading after that time was conducted on margin. From June to December 1980 M & B made frequent trades in 10,000-share lots of a large number of different stocks, often holding stocks for just a few days. Throughout 1980 this practice was profitable: M & B realized a gain of $482,000 in those six months.

The stock market turned down in early 1981 and M & B began experiencing losses. According to Merrill Lynch witnesses, Dale, Saputo and the Merrill Lynch branch manager had a conversation in January 1981 in which M & B was cautioned about the risk of margin trading in M & B's account. Nevertheless, the pattern of 1980 continued throughout 1981, with many high-volume, short-term trades being made on margin. The continuing weakness of the market produced margin calls that eventually forced M & B to liquidate its holdings at substantial losses. The account with Merrill Lynch was finally closed in July 1982 with M & B suffering losses that totalled more than $2 million.

II.

The district court, 601 F.Supp. 1106, filed a memorandum opinion containing extensive findings of fact. On appeal M & B contends that the findings on two aspects of its claim are clearly erroneous. The district court found that Dale did not "churn" the M & B account, that is, engage in transactions without regard for M & B's investment interests for the purpose of generating commissions. The district court also found that Dale did not make material misrepresentations or fail to advise M & B of information material to its investment decisions.

A.

Churning consists of three elements, all of which must be present: (1) the trading must be excessive in light of the customer's investment objectives; (2) the broker must exercise control over the account; (3) the broker must act with intent to defraud or with willful and reckless disregard of the customer's interests. Arceneaux v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 767 F.2d 1498, 1501 (11th Cir.1985). The critical finding in this case related to the element of control. After reviewing the backgrounds of the parties and the course of their business relationship, the district court stated:

Crucial to decision is the testimony of Dale and Saputo. There is no question that, over all, Dale was extremely evasive and tried so hard to put his testimony in the best possible light that he lost much of his credibility. There is also no question that Dale was anxious to keep the account moving, and that he encouraged much of the trading. His testimony did not help the defendant. M & B was Dale's best customer, and it is obvious that he was trying to make as many trades as he could to gain commissions. By the same token, Dale was impressed with Saputo's knowledge and experience, and spoke truthfully of his impression of Saputo as a capable, informed businessman with a very successful company. At one point, he stated that Saputo was probably the best informed client in the office.

It is clear to the Court that Saputo was most responsible for what happened here. As chief financial officer, he had an obligation to watch the investments like a hawk, and there is no question but that he did. The Court does not find his testimony credible when he says that he placed his complete trust in Dale and simply went along with Dale's recommendations without any independent inquiry. Nor does the Court accept his protestations of ignorance about the market and his total reliance upon Dale's recommendations. Saputo maintained extremely careful records, and had an extensive background in business. He was careful and conscientious in all of his financial duties with M & B. The records he kept of the sales and purchases were extremely detailed, and they enabled him to determine, at any given moment, the exact condition of the account. He was a CPA with extensive experience in business. Every trade made by Dale was approved by Saputo, and he generally did not approve transactions until he had obtained the approval of Senior [Mancuso].

It is significant that he felt the reasons given him by Dale for each and every transaction made sense. It is clear that Saputo was in control of the account since he made an independent evaluation of each recommendation. He testified at one point that when M & B moved out of the ready asset account and into common stocks it was an exciting time because the market was moving up. He kept meticulous records, talked with Senior almost daily about the activity of the account, and was very involved in and informed about the account from the start.

His protestations that he did not thoroughly understand margin accounts and option trading are not credible. He may not have been an expert in the market, but he knew enough to know that trading on margin and in options was very risky. It is undisputed that he understood the concept of margin trading, and he must have realized that by the time margin trading began M & B's account had come a long way from the conservative liquid investment account he testified had been M & B's initial investment objective.

In fact, Saputo's entire testimony about M & B's investment objectives is hard to believe. He claims that its initial goal was a safe, readily available liquid investment that would earn a respectable and consistent return, and he claims that objective never really changed. This is refuted completely by the facts. M & B went into a pattern of short term, roller coaster, in-and-out, margin and option trading that was about as far from a safe, readily available liquid investment as possible. There is little question that he knew exactly what he was doing. This is borne out by months of careful record keeping and reports to stockholders, hundreds of conversations between him and Dale, and almost daily conversations between him and Senior.

* * *

* * *

It is clear to the Court that M & B, through Saputo and Senior, maintained control over this account. Saputo was a sophisticated businessman and a CPA, well acquainted with financial matters. Senior had become a tremendously successful builder, graduating, as he said, from the "school of hard knocks." M & B's officers were not naive regarding financial matters. In addition, the relationship between M & B and Dale was one of strictly business. Saputo and Senior viewed the relationship as a professional one, and there is no question that Saputo and Dale dealt on an arms-length basis. Dale did not take advantage of Saputo because of their former relationship on the softball team. Nor was there usurpation of control by Dale, since he always had M & B's prior approval. Finally, there was regular consultation between the parties as to the trades. At no time was a trade made without consultation.

(Footnote omitted).

Though the district court dwelt primarily on control, it also found specifically that there was no excessive trading in light of the customer's objectives and that the proof failed to show a reckless disregard for M & B's interests or that Dale sought to defraud M & B. The district court found that M & B's investment goals changed radically sometime after the relationship with Merrill Lynch began, but that Saputo and Mancuso understood at all times the risks they were taking. The district court found that the conversation to which Dale testified took place on January 19, 1981, involving Dale, Saputo and Russell Mann, the branch manager of the Merrill Lynch office where Dale was employed. During this conversation Mann "reviewed the status of the account, including the margin debt, the equity and losses, and ... whether M & B could afford the risk of its positions." The district court...