Thompson v. Smith Barney, Harris Upham & Co., Inc., 82-8247

• Decision Date: 18 July 1983
• Docket Number: No. 82-8247,82-8247
• Citation: 709 F.2d 1413
• Parties: Fed. Sec. L. Rep. P 99,414 John E. THOMPSON, Plaintiff-Appellant, v. SMITH BARNEY, HARRIS UPHAM & CO., INCORPORATED, Defendant-Appellee.
• Court: U.S. Court of Appeals — Eleventh Circuit

Page 1413

709 F.2d 1413

Fed. Sec. L. Rep. P 99,414

John E. THOMPSON, Plaintiff-Appellant, v. SMITH BARNEY, HARRIS UPHAM & CO., INCORPORATED, Defendant-Appellee.

No. 82-8247.

United States Court of Appeals, Eleventh Circuit.

July 18, 1983.

Carolyn T. Thurston, J.D. Humphries, III, Atlanta, Ga., for plaintiff-appellant.

Paul W. Stivers, Atlanta, Ga., for defendant-appellee.

Appeal from the United States District Court for the Northern District of Georgia.

Before FAY, HENDERSON and HATCHETT, Circuit Judges.

FAY, Circuit Judge:

The appellant filed suit against Smith Barney, Harris Upham & Co., Inc. alleging that the brokerage firm and its employee, Bruce Brookshire, failed to disclose to him risks inherent in options trading. He further alleged that Smith Barney churned his account in violation of sec. 10(b) of the

Securities Exchange Act of 1934, 15 U.S.C. sec. 78j(b), Rule 10b-5, 17 C.F.R. sec. 240.10b-5, and state common law. The district court granted Smith Barney's motion to dismiss the appellant's churning claim at the close of the appellant's case. After a full trial on the other counts, the district court found for Smith Barney and judgment was entered accordingly. We affirm the judgment of the district court and uphold the dismissal of the churning claim.

FACTS

The facts relevant to this appeal may be summarized as follows: The appellant opened a cash account with Smith Barney, Harris Upham & Co., Inc. in September 1977. Mr. Brookshire, an employee of Smith Barney, was the salesman handling the account. In December 1977, the appellant converted his account into a margin account. On December 8, 1977, Mr. Thompson signed an "option account agreement," which he mailed back to Smith Barney. The appellant and Mr. Brookshire never specifically discussed opening an option account, though they had mutually decided to seek more aggressive forms of investments for the appellant. The option account agreement that the appellant signed specifically states that he is aware that options are "inherently highly speculative," and that he agrees that options trading is not "an unsuitable activity" for him. The agreement also provided,

[i]n order to induce [Smith Barney] to effect transactions in Options from my account as I may request from time to time and in order to provide [Smith Barney] with reasonable grounds for believing that such transactions for my account are not unsuitable for me in light of my experience and knowledge and my investment objectives, financial situation and needs, have furnished to [Smith Barney] accurate information concerning my experience and knowledge and my investment objectives, financial situation and needs ....

Thompson v. Smith Barney, Harris Upham & Co., 539 F.Supp. 859, 861 (N.D.Ga.1982).

During the entire time of Mr. Brookshire's association with the appellant, there was never any discussion between the two as to the extent of appellant's financial resources or his prior dealings in the market. Mr. Brookshire never asked, nor did the appellant volunteer, any information concerning the appellant's salary, other income, net worth or experience in stock dealings.

In January 1978, Mr. Brookshire filled out an "Option Information Sheet" containing estimates of appellant's net worth and annual income, which he set at $150,000 and $75,000, respectively. Smith Barney's internal rules required that such information be obtained as a prerequisite for opening an option account. "Mr. Brookshire did not contact the appellant before filling out the sheet and made no effort to obtain any reliable information. Rather, he selected the referenced figures because they were adequate to satisfy [Smith Barney's] requirements." Thompson v. Smith Barney at 861.

In January 1978, Mr. Brookshire recommended to the appellant that he purchase 20 IBM July 240 puts. ¹ The two men discussed this proposed purchase, although the discussion was brief and general in nature. The IBM puts purchased were held for only three days, when they were sold for a 23% profit.

In early 1978, the appellant told Mr. Brookshire that he was having difficulty understanding his monthly statements. The appellant and Mr. Brookshire met personally In July of 1978, the appellant authorized Mr. Brookshire to purchase 50 IBM October 260 puts at 6 3/4 each for his account. Within a few days of this authorization, however, Mr. Brookshire realized that he had made an error regarding the amount of money available in the appellant's account to pay for the 50 IBM puts. He advised the appellant that he had sufficient funds in his account to pay for only 25 of the 50 puts. Mr. Brookshire also informed the appellant that the price of the IBM puts was down slightly from their purchase price. After being so informed, the appellant agreed to supply the additional $14,000.00 necessary to purchase the remaining 25 puts.

in February 1978 to review the appellant's account records. At this time Mr. Brookshire addressed any questions the appellant had about his account. In the following months, a number of successful short-term investments were made in the appellant's account, including a purchase of 50 General Motors October 260 puts, which were sold for a profit of 33% after being held for only one month, a purchase of 2,000 shares of Yates Industries stock, which were sold for a $1,538.13 profit after being held for approximately five weeks, and a purchase of 4,000 shares of King's Department Stores stock, of which 600 shares were sold for a profit of approximately $551.00 after being held for less than a week.

Almost immediately after the purchase, the value of the IBM puts began declining. The appellant called Mr. Brookshire's office on Friday and discovered that the price of the puts had declined into the $4.00 to $5.00 range. Mr. Brookshire called the appellant the following Monday, July 31, and told him that the price of the puts had fallen below $4.00, but recommended against selling them. The next day, however, Mr. Brookshire changed his mind and advised the appellant to sell the puts. The appellant refused, although Mr. Brookshire and the other customers to whom he had recommended the purchase of these puts did so. The appellant persisted in his refusal to sell, and, at an August fifteenth meeting, the appellant advised Mr. Brookshire that he would henceforth handle his own account. The appellant finally sold thirty of the IBM puts at 3/8 and the remaining twenty at 5/16, on September 7, 1978, for a total loss of $32,652.00.

DISCUSSION

Churning Claim

The trial court granted the appellee's motion to dismiss the appellant's churning claim at the close of the appellant's case. Appellant asserts that this was error as a matter of law. We disagree.

Churning occurs when a securities broker buys and sells securities for a customer's account, without regard to the customer's investment interests, for the purpose of generating commissions. McNeal v. Paine, Webber, Jackson & Curtis, Inc., 598 F.2d 888, 890 n. 1 (5th Cir.1979). ² To establish a cause of action for churning under section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. sec. 78j(b), and S.E.C. Rule 10b-5, ³ an investor must establish that "(1) the trading in his account was excessive in light of his investment objectives; (2) the broker in question exercised control over the trading in the account; and (3) the broker acted with the intent to defraud or with willful and reckless disregard for the investor's interest." Miley v. Oppenheimer & Co., Inc., 637 F.2d 318, 324 (5th Cir.1981).

At trial, the litigants' versions of the events giving rise to this litigation were similar to the contentions of opposing parties in most churning cases. The appellant, like most churning plaintiffs, argued that he was an unsophisticated investor with limited financial resources, and that his investment objectives were merely conservative in growth in order to insure the safety of his principal. "As in most churning cases, [the appellant] then had an expert testify that in light of these conservative investment objectives, the transactions in the account were excessive in size and frequency." Miley at 325.

As to be expected, Smith Barney presented a different picture of the broker-client relationship at issue. Like most churning defendants, Smith Barney characterized their client as an experienced investor who was interested in quick, short-term gains; they argued that the appellant's investment goal was speculation, not capital conservatism, and that the transactions in the account were quite reasonable in light of these speculative objectives.

The trial court in this case, as in similar churning suits, was faced with the difficult task of choosing between these two scenarios. "Moreover, it is indeed possible, and, perhaps, probable that the truth lay somewhere in between the two conflicting stories. [The appellant] may, in fact, have been somewhat disgruntled at having lost at what was clearly a gambler's game, while [Smith Barney] may, in fact, have tended to err on the side of entering into, rather than of passing up, a somewhat risky investment in order to earn the related commissions." Miley, at 325. With the wide disparity of the stories presented by the opposing parties, the trial court's task was to make credibility choices and find the facts accordingly. Our review of the trial court's findings of fact is limited by the "clearly erroneous" standard. ⁴

The trial court dismissed the appellant's churning claim on the ground that the account had not been excessively traded. We recognize that "[t]he structure and investment objective of an account must be considered to determine whether trading is excessive." Carras v. Burns, 516 F.2d 251, 258 (4th Cir.1975). On this point, the trial court specifically found that the appellant was a trader "playing the market" who desired frequent trading of the sort effected in his account. The court also found that the appellant knew that...