Xaphes v. Merrill Lynch, Pierce, Fenner & Smith, Inc.

• Decision Date: 02 April 1986
• Docket Number: Civ. No. 80-0132-P.
• Citation: 632 F. Supp. 471
• Court: U.S. District Court — District of Maine
• Parties: John F. XAPHES, Plaintiff, v. MERRILL LYNCH, PIERCE, FENNER & SMITH, INC., Tucker Anthony & R.L. Day, Inc., and Mark B. Billings, Defendants.

632 F. Supp. 471

John F. XAPHES, Plaintiff, v. MERRILL LYNCH, PIERCE, FENNER & SMITH, INC., Tucker Anthony & R.L. Day, Inc., and Mark B. Billings, Defendants.

Civ. No. 80-0132-P.

United States District Court, D. Maine.

April 2, 1986.

John J. O'Leary, Jr., Jeffrey D. Curtis, Portland, Me., for plaintiff.

Thomas H. Allen, Portland, Me., for Merrill Lynch.

James E. McGuire, Boston, Mass., for Tucker Anthony.

Thomas Wheatley, Thomas Schulten, Portland, Me., for Billings.

OPINION

GENE CARTER, District Judge.

I. Findings of Facts

In this action Plaintiff seeks to recover damages from Defendants under various provisions of the securities laws of the United States and the common law. Specifically, Plaintiff alleges that his stockbrokers, Defendant Billings and nonparty Ronald Stephens, engaged in unsuitable and excessive trading of Plaintiff's accounts at Merrill Lynch and Tucker Anthony and that they also made material misrepresentations and omissions in connection with Plaintiff's purchase and sale of securities.

The events which give rise to this case began in 1954 when Plaintiff's father died, leaving to Plaintiff, then a law student, stocks and bonds worth approximately $112,000. Plaintiff graduated from law school in 1956 and was admitted to the bar in 1957. From that time until October 1979, he conducted a small, unprofitable law practice in Biddeford. He supported himself entirely from the dividends and interest on the stock he had inherited from his father. In the period 1957 to 1971 Plaintiff was politically active, running unsuccessfully for public office several times on the Republican ticket. In 1961 Plaintiff was appointed Treasurer of the City of Biddeford, and he served in that part-time position for two years at a salary of $1500 per year. Mr. Xaphes' principal duties as city treasurer were to supervise collection and disbursement of money by the different city departments and to sign for city loans.

Plaintiff lived with his mother in the family homestead in Biddeford until her death in 1971. When she died, she left Plaintiff stocks which she had inherited from her husband, an office building on Graham Street in Biddeford, and a one-half interest, as a tenant in common with his brother, in the family summer house on the ocean at Pine Point in Scarborough, Maine. Plaintiff also inherited one-half of his mother's one-third joint interest in a condominium in Fort Lauderdale, Florida, in which he and his brother already owned the other two-thirds interest. Shortly after his mother's death, Plaintiff, with his brother, bought a house on a lot abutting their property at Pine Point.

Plaintiff also married in 1971. Although Mrs. Xaphes worked until late 1977, her earnings were placed in savings, and Plaintiff supported himself and his wife on the dividends and interest from his inherited portfolio. He and his wife lived at Pine Point in the summer, in Florida in the winter, and in the family home in Biddeford, then owned by Plaintiff's brother, in the spring and fall.

Prior to 1976 Plaintiff did not trade his stocks and he had no stockbroker. He kept all his stock certificates in a safe in the cellar of the family home in Biddeford. Plaintiff regarded his stock as an heirloom, and he testified that he intended to keep the portfolio intact because he was emotionally attached to his stocks and because they were a good source of income. Moreover, sale of the stocks would result in his payment of high capital gains taxes. By June 1976 Plaintiff's stock had appreciated in value to approximately $525,000.

While in Florida in 1976, Plaintiff heard about options trading from his brother and as a result went to Merrill Lynch's Fort Lauderdale office. He met there with his brother's broker, Ben Doyal, in April 1976. Doyal explained options to Plaintiff, who at that time signed a Merrill Lynch standard option agreement and filled out a Merrill Lynch option information form (1014). On the form that Plaintiff filled out, he indicated that the value of his portfolio was $525,000, a figure that was accurate to within a few hundred dollars. This indicates to the Court, without doubt, that Plaintiff followed stock prices and could price out his portfolio. Doyal also gave Plaintiff a copy of the Options Clearing Corporation (OCC) prospectus, which described the risks of option trading.¹ Although Plaintiff wanted to use Doyal as his broker for trading options, when Doyal learned that Plaintiff was from Maine he suggested that he open his account at Merrill Lynch in Portland.

Following Doyal's advice, Plaintiff went to Merrill Lynch in Portland on June 10, 1976. There he met Defendant Mark Billings, a Merrill Lynch registered representative. Knowing that options trading requires the deposit of stock certificates, Plaintiff had brought some with him, and he told Billings that he wanted to write options. Plaintiff chatted with Billings about his financial status, mentioning his real estate holdings and stating that he had a "substantial" portfolio, valued at slightly less than half a million dollars. Plaintiff told Billings that he was a part-time lawyer who spent winters in Florida. He also told Billings that he wanted to write options to increase the income from his portfolio, but did not want to sell his heirloom portfolio. Billings gave Plaintiff another copy of the then current OCC prospectus and told him to read it. Indeed, Plaintiff's cross-examination makes it clear that he did read the prospectus. During that first meeting, while discussing some of the risks of options trading, Billings told Plaintiff that he could write covered options against his portfolio without great risk of selling the stocks because he could buy back an option if it appeared that the option would be exercised.

Billings did not ask Plaintiff direct questions about his income and other financial means. After the meeting, however, without having obtained specific financial information, Billings filled out a new account form for Xaphes. That form included various pieces of inaccurate information such as that Plaintiff's approximate annual salary was $75,000 and that his net worth was approximately $3,000,000. In fact, Plaintiff had no salary but had an annual income of about $23,000 from his investments. His net worth was $671,000, exclusive of equity in his home. Billings also stated on the new account form that Plaintiff had been dealing with Merrill Lynch in Florida for five years. That assessment was incorrect; Xaphes had visited Ben Doyal once, a year previously, to sell a warrant and then again in April of 1976 when he inquired about options trading. Without verifying what he testified were just random guesses based on his conversation with Plaintiff, Billings submitted the new account form to David Mowry, the branch manager, for approval.

Merrill Lynch policy required that customers wishing to trade options sign a standard option agreement. Such an agreement was not signed until July 20, 1976, after Plaintiff's account had already begun trading options. Also, although Merrill Lynch policy required filing and managerial approval of an options information form (1014) in order to open an options account, Billings did not file that form until almost a year later. Mowry approved the opening of Plaintiff's options account based solely on the inaccurate information provided by Billings and without the required form. The opening of Plaintiff's account was accomplished, therefore, in violation of express Merrill Lynch policy concerning determinations of suitability. The testimony at trial made it clear, however, that Plaintiff was, in fact, suitable for options trading and would, without doubt, have been approved for opening an options trading account if the true information concerning his financial status and experience as of June 1976 had been presented to the approving authorities.²

Plaintiff signed a margin agreement on July 6, 1976, allowing him to borrow money from Merrill Lynch to buy stock. He did not begin buying on margin at that time, however. Billings had told Plaintiff that for the sake of greater safety to his heirloom stock, Plaintiff might want to be able to buy stock on margin in case of exercise of outstanding calls. It is clear that Plaintiff understood and was concerned about the risk to his heirloom stock of possible exercise of the options. The Court is satisfied from the cross-examination of Plaintiff that he knew, before any stock was bought on margin in late September 1976, that he was pledging his stock as collateral for the debt accrued on margin and that it was possible that his margin stock might decline in value or become worthless, threatening his account's collateral. Plaintiff also knew that he would have to pay interest on his debit balance for as long as the loan was outstanding.

During the summer of 1976 Plaintiff wrote covered calls on seven securities in his portfolio. Except for one, those transactions were profitable. In late September 1976 Plaintiff wanted to make his portfolio work harder, so he adopted a "buy-write strategy," proposed by Billings. This plan entailed writing options on six issues of "blue chip" stock, bought on margin³ for approximately $69,000, and was to run from September 30, 1976 to April 1977, at which time the options would expire. In a work sheet, Billings projected for Plaintiff the profits to be gained if the market (and margin stock prices) rose and the stock was exercised away from Plaintiff. These profits did not materialize because five of the six stocks purchased on margin did not increase in value and the options were not exercised. Plaintiff decided, with Billings' advice, to hold on to the margin stocks until he could break even or make a profit on them.

From the time he opened his account at Merrill Lynch, Plaintiff remained in close contact with Billings, either by phone or in person. In these conversations Billings discussed with Plaintiff the prices...