Shivangi v. Dean Witter Reynolds, Inc.
| Decision Date | 27 August 1987 |
| Docket Number | No. 86-4370,86-4370 |
| Citation | 825 F.2d 885 |
| Parties | Fed. Sec. L. Rep. P 93,364, 8 Fed.R.Serv.3d 980, RICO Bus.Disp.Guide 6730 Dr. Sampat SHIVANGI and Dr. Udaya S. Shivangi, Plaintiffs-Appellants Cross-Appellees, v. DEAN WITTER REYNOLDS, INC., Thomas Aitken and James Y. Palmer, Defendants-Appellees Cross-Appellants. |
| Court | U.S. Court of Appeals — Fifth Circuit |
Satterfield & Allred, Michael Farrell, Gene D. Berry, Jackson, Miss., for plaintiffs-appellants cross-appellees.
William J. Fitzpatrick, New York City, for amicus curiae.
Thomas, Price, Alston, Jones & Davis, Kenneth A. Rutherford, Janice Holley Parsons, Jackson, Miss., for defendants-appellees cross-appellants.
Appeals from the United States District Court for the Southern District of Mississippi.
Before WISDOM, HIGGINBOTHAM and DAVIS, Circuit Judges.
Dr. and Mrs. Sampat S. Shivangi sued Dean Witter Reynolds, Inc., under SEC Rule 10b-5 for failing to disclose that Dean Witter's account executives receive higher compensation for principal trades of over-the-counter stocks in which Dean Witter is a market maker than for other sales. The district court denied the Shivangis' request during discovery for Rule 11 sanctions against Dean Witter, declined to certify the suit as a class action, denied leave for the Shivangis to amend their complaint to add a RICO claim, and finally granted Dean Witter's motion to dismiss at the conclusion of the Shivangis' trial evidence. The Shivangis appeal urging that the district court erred in these actions. Dean Witter attempts to appeal the district court's finding that information about account executive compensation is material. Noting that the district court's comments on materiality are dicta, we affirm.
In 1981, Dean Witter Reynolds, Inc., was a market maker in the over-the-counter market 1 for Keldon Oil stock. As a market maker, Dean Witter held itself out as being willing to buy and sell Keldon Oil stock for its own account on a regular or continuous basis, see 15 U.S.C. Sec. 78c(a)(38), according to quotations in National Association of Securities Dealers Automated Quotations, a computerized quotations system. NASDAQ lists bid prices and ask prices, or the prices at which a customer can sell and buy a stock, respectively.
Unless a retail customer requests Dean Witter to handle the transaction as an agent, Dean Witter handles as a principal over-the-counter trades in which it is a market maker--that is, Dean Witter sells the stock to its customer from its own account instead of acting as the customer's agent to buy the stock from another. 2 This does not mean that Dean Witter has in inventory the stock at a cost that makes the principal transaction profitable. It means that Dean Witter will acquire the stock long or short, or take it from inventory, and sell it to the customer at the prices quoted on NASDAQ. Dean Witter's Jackson, Mississippi, office handles as a principal approximately 75 to 80 percent of its over-the-counter trades in which Dean Witter makes a market.
When Dean Witter acts as an agent, it receives a commission and passes 30 to 40 percent of the commission to the account executive as his compensation. When Dean Witter acts as a principal, it sells the stock at the inside ask price--the lowest price any market maker asks--and then adds a "mark-up" to the price as its compensation. Dean Witter's mark-up never exceeds the amount the commission would be in an agency transaction. In fact, the customer pays less than he would in an agency transaction because Dean Witter rounds the mark-up to the nearest 1/16 below what the agency commission would have been. Dean Witter pays the account executive thirty to forty percent of the mark-up and also of the spread--the difference between the bid price and the ask price--sometimes resulting in higher compensation for principal transactions than for agency transactions.
Dr. Sampat S. Shivangi and his wife, Dr. Udaya S. Shivangi, opened an investment account with Dean Witter in the spring of 1981. On May 13, 1981, Thomas Aitken, the Shivangis' account executive at Dean Witter's Jackson, Mississippi, office, called the Shivangis to recommend that they purchase shares in Keldon Oil. Heeding the recommendation, the Shivangis purchased through Dean Witter 400 shares of Keldon Oil stock for 17 1/2 per share, or $7000.00 total.
At the time of the purchase, Keldon Oil stock had a market price of 15 bid and 17 1/8 ask, or a spread of 2 1/8. 3 The mark-up was 3/8. Aitken's compensation was forty percent of the mark-up and spread, or $400.00. 4 Dean Witter's normal commission on an agency transaction for 400 shares at 17 1/8 is $154.70, of which Aitken would have received thirty to forty percent, or $46.41 to $61.88, rather than the $400 he was paid.
Dean Witter sent the Shivangis a confirmation slip that complied fully with SEC Rule 10b-10, 17 C.F.R. Sec. 240.10b-10, by stating the purchase price, indicating Dean Witter's role as principal, and stating "DWR IS MARKET MAKER." At no time were the Shivangis told the account executive's compensation. 5
The market price of Keldon Oil stock rose about ten percent shortly after the transaction, then declined steadily. The Shivangis sold their shares in December 1981 at 7 1/4 per share, or $2,900.00 total.
On July 13, 1982, the Shivangis sued Dean Witter, Tom Aitken, and James Palmer, who was the branch manager of Dean Witter's Jackson office, alleging that Aitken made misleading statements of material fact about Keldon Oil stock and omitted other material facts in violation of the Securities Exchange Act of 1934, Sec. 10(b), 15 U.S.C. Sec. 78j(b), of SEC Rule 10b-5, 17 C.F.R. Sec. 240.10b-5, and of various state laws. When the Shivangis learned in discovery about the spread and the account executive compensation system, they amended their complaint to allege that the failure to disclose the compensation information violated Rule 10b-5 and state laws. They also sought to represent a class of similarly situated purchasers.
During discovery, the Shivangis sought production of certain SEC forms and NASD reports for a five-year period. Dean Witter submitted affidavits that the request was unduly burdensome, which the magistrate credited. The Shivangis later sought Rule 11 sanctions, claiming the affidavits were false and that Dean Witter failed to satisfy the duty of reasonable inquiry. The district court denied sanctions.
In November 1983, the Shivangis moved for class certification of their claims under Fed.R.Civ.P. 23(b)(3), suggesting a subclass for purchasers of Keldon Oil stock nationwide and a second subclass for Mississippi residents who purchased over-the-counter stocks from Dean Witter. Dean Witter opposed the motion and moved for summary judgment on all issues. The district court concluded that common questions of law and fact did not predominate over individual questions, and denied class certification. Shivangi v. Dean Witter Reynolds, Inc., 107 F.R.D. 313, 325 (S.D.Miss.1985). The district court granted Dean Witter's motion for summary judgment for the state-law claims, but denied the motion for the federal securities claims because the district court believed the information on compensation could be material. Id. at 321-23.
On October 1, 1985, the Shivangis sought leave to amend their complaint to allege a violation of the Racketeer Influenced and Corrupt Organizations Act, 18 U.S.C. Secs. 1961-68. The district court denied the motion. At the pretrial conference in April 1986, the Shivangis abandoned all claims except that based on the failure to disclose the account executive's compensation.
At the conclusion of the Shivangis' proof in the bench trial, Dean Witter moved to dismiss for the Shivangis' failure to prove scienter. The district court granted Dean Witter's motion, stating, "Although the Court considers Defendants' failure to disclose the compensation distinction between an agency and a principal transaction to Plaintiffs to be a material omission which would have affected Plaintiffs' decision to purchase Keldon Oil stock, Plaintiffs presented no evidence that the omission was made with any intent to deceive, manipulate, or defraud Plaintiffs." Shivangi v. Dean Witter Reynolds, Inc., 637 F.Supp. 1001, 1005 (S.D.Miss.1986). The Shivangis timely appeal the dismissal of their action, and also attack the denial of class certification, the denial of leave to file an amended complaint alleging a RICO violation, and the failure to impose Rule 11 sanctions. Dean Witter appeals, quarreling with the district court's statement that the omission of compensation information was material.
The Shivangis argue that the district court erroneously granted Dean Witter's motion to dismiss for failure to prove scienter because the Shivangis proved Dean Witter's knowing or reckless omission or because they proved Dean Witter intended to manipulate the market for Keldon Oil Stock. 6 When the district court grants a defendant's motion to dismiss for insufficiency of the plaintiff's evidence in a bench trial, we reverse the district court's findings only if they are clearly erroneous. Weissinger v. United States, 423 F.2d 795, 798 (5th Cir.1970) (en banc). We are not persuaded that the district court clearly erred in finding that the Shivangis failed to prove scienter.
Dean Witter knowingly failed to disclose the account executive compensation to the Shivangis, but knowledge of omitted facts does not itself establish scienter. See SEC v. Southwest Coal & Energy Co., 624 F.2d 1312, 1321 n. 17 (5th Cir.1980). Rather, the Shivangis must prove that Dean Witter acted with actual "intent to deceive, manipulate, or defraud," Ernst & Ernst v. Hochfelder, 425 U.S. 185, 193 n. 12, 96 S.Ct. 1375, 1381 n. 12, 47 L.Ed.2d 668 (1976), or severe recklessness, which is
limited to those highly unreasonable omissions or misrepresentations that involve not merely simple or...
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