Garrison Family v. Mark And Michelle Garrison

IN THE COURT OF APPEALS OF THE STATE OF WASHINGTON

JACK M. GARRISON; the GARRISON No. 69625-4-1-1

FAMILY LLC, a Washington limited

liability company; LESA B. NEUGENT, DIVISION ONE

individually and as Trustee of the JACK

M. GARRISON AND CHARLOTTE L.

GARRISON REVOCABLE TRUST, the

JACK M. GARRISON SURVIVOR'S

TRUST, the CHARLOTTE L.

GARRISON MARITAL TRUST, the

CHARLOTTE L. GARRISON EXEMPT

MARITAL TRUST; the CHARLOTTE L.

GARRISON EXEMPT FAMILY TRUST

FBO MARK GARRISON, and the

CHARLOTTE L. GARRISON EXEMPT

FAMILY TRUST FBO LESA NEUGENT,

PUBLISHED OPINION

Appellants,

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SAGEPOINT FINANCIAL, INC., a i—

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Delaware corporation licensed to XT -- ~ "O r

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business in Washington, f/k/a AIG 33" co rn r-

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FINANCIAL ADVISORS, INC., —*- \ ~

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Respondent, CO Z.Z'1-

MARK M. GARRISON and MICHELLE

GARRISON, his wife, and their marital

community,

Defendants. FILED: July 14, 2014

Schindler, J. — Mark M. Garrison was a licensed investment advisor and co-

owner of a financial advice firm, Acumen Financial Group Inc. In 1999, Mark entered

No. 69625-4-1/2

into an independent contractor agreement with AIG Financial Advisors Inc. to act as a

registered securities representative (stockbroker).1 In 2002, Mark's grandparents Jack

and Charlotte Garrison established the Garrison Family LLC. In 2006, Jack and

Charlotte transferred all of the assets of the LLC to the Jack M. Garrison and Charlotte

L. Garrison Revocable Trust. The Revocable Trust designates Jack and Charlotte as

the co-trustees and income beneficiaries, and names Mark and his sister Lesa B.

Neugent as the remainder beneficiaries. The Garrison Family LLC and the Revocable

Trust held approximately $26 million in two brokerage accounts at Wells Fargo

Investments LLC. After Charlotte died in August 2006, Jack appointed Mark as the sole

manager and trustee of the Garrison Family LLC and the Revocable Trust.

In April 2011, Jack Garrison, Lesa Neugent, the Revocable Trust, and the trusts

created after Charlotte's death (collectively the Garrison Trusts), filed a lawsuit against

Mark and SagePoint Financial, formerly known as AIG Financial Advisors Inc., alleging

joint and several liability for the loss of more than $20 million and claims of breach of

fiduciary duty, negligent supervision, violation of the "Washington State Securities Act"

(WSSA), chapter 21.20 RCW, and respondeat superior. AIG filed a motion for summary

judgment dismissal arguing that under National Association of Securities Dealers

(NASD) Rule 3050, Transactions for or by Associated Persons (amended effective Oct.

15, 2002), AIG had no duty to supervise the transactions in the Wells Fargo accounts.

The Garrison Trusts filed a cross motion for summary judgment arguing AIG owed a

duty to supervise under NASD Rule 3040, Private Securities Transactions of an

Associated Person (amended effective March 23, 2004). In the alternative, the Garrison

1We refer to members of the Garrison family by their first names for purposes of clarity.

2

No. 69625-4-1/3

Trusts argued AIG had a duty to investigate and monitor the suspicious activity in the

Wells Fargo brokerage accounts. The court granted AIG's motion for summary

judgment and dismissed the claims against AIG. We affirm dismissal of the respondeat

superior claim against AIG. Because there are material issues of fact as to whether AIG

knew or should have known by October 2007 that Mark was acting as an investment

advisor for compensation triggering a duty under the NASD Rules to either supervise

the securities transactions in the Wells Fargo brokerage accounts or to investigate and

monitor the securities transactions in the Wells Fargo accounts, we reverse summary

judgment dismissal on the claims against AIG for negligent supervision and violation of

the WSSA.

FACTS

Mark M. Garrison was a licensed investment advisor registered with the United

States Securities and Exchange Commission (SEC). Beginning in 1995, Mark was co-

owner of a financial investment advice firm in Bloomington, Minnesota, Acumen

Financial Group Inc.

In 1999, Mark entered into an "Independent Contractor Agreement for Registered

Representative" with AIG Financial Advisors Inc.2 AIG is a securities broker-dealer

registered with the SEC and a member of the National Association of Securities Dealers

(NASD).3 As a licensed registered securities representative or stockbroker, Mark also

registered with the SEC.

2 AIG is now known as SagePoint Financial Inc.

3 In 2007, the two self-regulatory organizations, NASD and the regulatory arm of the New York

Stock Exchange (NYSE), merged and are now jointly known as the Financial Industry Regulatory

Authority (FINRA).

No. 69625-4-1/4

As part of the Independent Contractor Agreement with AIG, Mark agreed to

comply with "the statutes, rules, regulations and statements of policy of the [SEC], the

Conduct Rules of the NASD and any state securities and insurance laws and

regulations," and AIG policies and procedures. Mark agreed to notify AIG "in writing of

any outside business activity prior to engaging in such activity."4 The Independent

Contractor Agreement states, in pertinent part:

I will notify the Company in writing of any outside business activity prior to

engaging in such activity. I will not engage in any conduct which conflicts

with the business of the Company, nor will I engage in any conduct which

is not the business of the Company at the location where I conduct the

business of the Company without advising the Company of such business

activity in writing. I will not accept or retain employment or compensation

from any person or business or as a self-employed person as a result of

business activity outside the scope of my affiliation with the Company

without advising the Company in writing of such employment or

compensation. I agree to make books and records with respect to my

outside business activities available to the Company upon request.[5]

Mark's grandparents Jack M. Garrison and Charlotte L. Garrison owned a

shipping company. In 2002, Jack and Charlotte established the Garrison Family LLC,

transferring approximately $11 million to the LLC. Jack and Charlotte were the sole

shareholders and Jack was named the manager of the LLC. The Garrison Family LLC

assets were held in brokerage accounts at the Seattle branch of Wells Fargo

Investments. Jack worked with Wells Fargo registered securities representatives Jean

Adams and Rebbie Thomas.

In 2006, Jack and Charlotte established the Jack M. Garrison and Charlotte L.

Garrison Revocable Trust. Jack and Charlotte transferred their Garrison Family LLC

4 Emphasis added.

5 Emphasis added.

No. 69625-4-1/5

shares plus approximately $16 million into the Revocable Trust. The "Revocable Living

Trust Agreement" designates Jack and Charlotte as the co-trustees and lifetime

beneficiaries of the trust, and names their grandchildren Mark M. Garrison and Lesa B.

Neugent as the remainder beneficiaries with a 62 percent interest allocated to Mark and

a 38 percent interest to Neugent. The Revocable Trust directs the creation of several

other trusts upon the death of either Jack or Charlotte—an exempt marital trust, a

marital trust, a survivor trust, an exempt family trust for the benefit of Neugent, and an

exempt family trust for the benefit of Mark.6

Charlotte died on August 8, 2006. Shortly after her death, Jack was diagnosed

with dementia. On September 11, 2006, Jack resigned and appointed Mark as the

manager of the Garrison Family LLC and the trustee of the Revocable Trust.

Over the years, Jack had invested conservatively in the Wells Fargo brokerage

accounts. In September 2006, the assets in the Wells Fargo accounts for the Garrison

Family LLC and the Revocable Trust totaled approximately $26.5 million, consisting of

approximately $21.8 million in the LLC brokerage account, $4.6 million in the Revocable

Trust brokerage account, and $120,000 in the LLC checking account.

In compliance with NASD Rule 3050, on October 6, 2006, Wells Fargo sent a

letter requesting approval of Mark's appointment as "trustee, owner and manager on

accounts held with our firm." The letter states, in pertinent part:

This letter is to inform you that Mark M[.] Garrison, an employee of your

firm, has requested to be appointed trustee, owner and manager on

6 Upon the death of either Jack or Charlotte, the Revocable Living Trust Agreement also

designates "Specific Cash Gifts" in the amount of $200,000 each to "accountant and friend" Hal

Carrothers, Wells Fargo "financial advisor and friend" Jean Adams, and Wells Fargo "financial advisor

and friend" Rebbie Thomas.

No. 69625-4-1/6

accounts held with our firm. In order to execute his request, we must have

approval in writing from your Compliance Officer (Rule 407 letter).[7J

On October 16, 2006, Mark's assistant faxed the Wells Fargo letter to the AIG

Compliance Department. The cover sheet states, in pertinent part:

[Pjlease find a letter from the Seattle, WA office of Wells Fargo requesting

approval from your department for Mark Garrison to act as the trustee,

owner and manager on accounts held in a trust for Mark's grandparents.

Please forward your approval to the address shown on the Wells Fargo

letterhead.

On November 14, 2006, the AIG Compliance Department sent Mark a "Letter of

Understanding for Acting as Trustee/Owner/Manager on the Garrison Wells Fargo

Accounts." The letter states that AIG does not object to Mark acting as the

"trustee/owner/manager" on the condition that Mark does not act as a registered

representative/stockbroker, and that he complies with the requirements to disclose

annually his outside business activity on the AIG "Outside Business Activities

Questionnaire" (OBAQ). The November 14 letter states, in pertinent part:

Re: Letter of Understanding for Acting as

Trustee/Owner/Manager on the Garrison Wells Fargo

Accounts (#s W35823867, 745-1146604. & W29758675)

Dear Mr. Garrison:

This letter will serve as your record that AIG Financial Advisors, Inc.

("AIGFA") is aware that you are trustee/owner/manager on the above-

referenced Garrison accounts held at Wells Fargo. AIGFA does not object

to your participation in this activity as long as the following are met:

1. You sign and return the attached Indemnification Form;

2. You may not act as the representative of record for these or any

7 NYSE Rule 407, Transactions—Employees of Members, Member Organizations and the

Exchange (amended effective Dec. 15, 2008), is equivalent to NASD Rule 3050. See FINRA Regulatory

Notice 09-22, FINRA Reguests Comment on Proposed Consolidated FINRA Rule Governing Personal

Securities Transactions for or by Associated Persons (discussing consolidation of NYSE Rule 407 and

NASD Rule 3050).

6

No. 69625-4-1/7

other accounts of Garrison (held at Wells Fargo or elsewhere);

3. You are limited to acting solely as the trustee/owner/manager for

the above referenced accounts; you are otherwise prohibited from

acting in any capacity as the trustee/owner/manager for anyone

and/or any accounts outside of your immediate family;

4. Copies of statements for Garrison accounts should be maintained

in a centralized file in your OSJ [(Office of Supervisory

Jurisdiction)] Branch Office. It is not necessary for the Home

Office to receive duplicate statements;

5. You must maintain a copy of this letter as well as the amended

Indemnification Form (attached hereto and alluded to in item #1

above) in your office at all times; and

6. This activity must be disclosed on your Outside Business Activity

Questionnaire on an annual basis.[8]

On November 22, the AIG Director of Branch Supervision, Leslie Ayers, sent a

letter to Mark approving maintaining the brokerage accounts at Wells Fargo as the

trustee, owner, and manager subject to his compliance with NASD regulations and AIG

policies, receipt of duplicate "confirms and statements" from Wells Fargo for the

accounts, and monitoring by the First Line Supervisor. The November 22 letter states,

in pertinent part:

Re: Outside Account for W35823867, 745-1146604 & W29758675

Dear Mark Garrison,

The Compliance and Regional Management departments at AIG Financial

Advisors, Inc. do not object to Mark Garrison maintaining an account at

Wells Fargo. Please note that this letter addresses only the account

number provided above. Any additional accounts must be acknowledged

in writing by the Home Office prior to opening.

In order to comply with federal and NASD regulations, it is necessary for

the First Line Supervisor to monitor all Registered Representative-related

8 Emphasis in original.

No. 69625-4-1/8

accounts. In order to demonstrate and document compliance with these

rules, all parties must agree to abide by the following:

Mark Garrison agrees that:

• He will not participate in purchasing any securities in an Initial

Public Offering (IPO) as it is against AIG Financial Advisors'

policy.

• He will comply with AIG Financial Advisors' policies regarding

personal brokerage accounts and all other policies, including

but not limited to Anti-Money Laundering Policies which are

located in the Firm's Sales Practice Manual and Compliance

Journals.

• He must enter orders on the same side of the market for

clients ahead of orders placed for RR [(registered

representative)] in an identical security.

Please note: the firm will ensure that duplicate confirms and statements

are being received by the FLS [(First Line Supervisor)] for supervision

purposes.[9]

Attached to the letter is an addendum describing the "First Line Supervisor

Responsibilities for Outside Personal Brokerage Accounts." The addendum lists a

number of "[prohibited activities," including insider trading, prearranged trading,

adjusted trading, "Wash or Cross Transactions," "Front running," and "Freeriding." The

addendum also states, "If the RR has a large number of trades every month, the FLS

should perform a quarterly profit and loss analysis to determine whether the RR's

account has large losses (increasing incentive to churn their clients' accounts)." From

April 2006 through April 2009, Director of Branch Supervision Ayers was responsible for

"supervising the [AIG] personnel who monitored the transactions in personal brokerage

accounts in the name or for the benefit of [AIG] registered representatives, including

Mark M. Garrison, held at other broker-dealers." Michelle Nielsen reported to Ayers and

was the First Line Supervisor for the Wells Fargo brokerage accounts.

9 Emphasis in original.

No. 69625-4-1/9

In December 2006, Mark submitted his annual OBAQ to AIG for 2005 to 2006.

Mark states he is not an AIG "investment provider representative" but reports that he is

a registered investment adviser and owns Acumen, "an independent registered

investment adviser, separate from [AIG]." Mark states he is registered as an investment

advisor in approximately 20 states and receives compensation from commissions,

hourly estate planning fees, and asset-based fees. Mark also states he understands

"that with respect to investment advisory activities," he "must make clear to clients that

such investment advisory activities are separate from the broker-dealer [AIG] and are

not offered by the broker-dealer [AIG]." In the OBAQ, Mark states that the percentage

of time he spends as an investment advisor with Acumen is 26 to 50 percent and that

he receives compensation over $50,000.

Under the 2005 to 2006 OBAQ section "Other Activities," Mark states that "I have

been named the Trustee/Owner/Manager on accounts held at Wells Fargo Investments

in Seattle, WA, for my grandfather - Jack Garrison." Mark reports spending "0-25%" of

his time "conducting this activity" and receiving "[u]nder $10,000" annually.

On March 14, 2007, Mark sent an e-mail to Wells Fargo stockbrokers Jean

Adams and Rebbie Thomas and the accountant for the Revocable Trust, Hal

Carrothers, stating that he planned to hire Acumen to provide investment advice to the

Garrison Family LLC and the Garrison trusts, but that Wells Fargo would continue to

execute trades. The e-mail states, in pertinent part:

In addition to the TRUSTEE'S FEE of .80% annually (.20% quarterly)

which we have already established, I have decided to hire Acumen

Financial Group, Inc. [(AFG)] to provide INVESTMENT ADVISORY

SERVICES to the LLC and various trusts. Since Jack has a strong

relationship with Jean Adams and Rebbie Thomas at Wells Fargo, Iwill

leave the money/investments there for now to handle the execution on

No. 69625-4-1/10

trading within the accounts, and simply hire Acumen Financial Group, Inc.

for the investment advice. As you know, I am one of the owners of AFG.

AFG will charge 1.2% annually for Investment Advisory Services, or .30%

quarterly. . . .

SECOND, JEAN & REBBIE - To take advantage of current market

weakness, please invest an extra $100,000 into each of the existing

MUTUAL FUNDS in the LLC AND [REVOCABLE] TRUST. Do not add

anything more to [the other trusts] at this time. I may call in a trade today

or tomorrow ... but that will be separate from the $100,000 per existing

Mutual fund order. Sell enough bonds to cover these costs, PLUS enough

to cover all the checks above, any liquidity Hal might need, AND whatever

amount you expect to transfer over to the [Revocable] Trust from the LLC

as part of your regular quarterly program.

Do NOT show Jack any Excel Spreadsheets until further notice. I will give

you the "all clear" once the markets rebound, which I expect to be in 2-3

months.

On March 16, 2007, Mark wrote a check to Acumen in the amount of $65,524

from the Garrison Family LLC account for "Investment Advisory Services" in the fourth

quarter of 2006. Mark also wrote a check to Acumen in the amount of $13,905 from the

Revocable Trust account.

Mark submitted his 2007 annual OBAQ to AIG on October 30, 2007. Mark

reports his outside business activity and compensation as an independent registered

investment advisor and co-owner of his independent investment business Acumen. In a

separate section under "Other: Outside Business Activities," Mark reports that he is

"actively engaged" as the "named . . . Trustee/Owner/Manager on accounts held at

Wells Fargo Investments in Seattle, WA, for my grandfather - Jack Garrison." Mark also

reports it is an "[ilnvestment related activity"10 conducted by Acumen, a "Registered

10 Emphasis in original.

10

No. 69625-4-1/11

Investment Advisor." Mark states that he spends 16 hours per month and receives

annual compensation of "$25,000 to $50,000."

In late 2007, Mark submitted a written request to AIG seeking approval to open

personal brokerage accounts at TD Ameritrade. In December 2007, AIG approved the

request in writing for the "personal brokerage accounts held at TD Ameritrade in the

name of Mark Garrison including Account No. 789-930283, and ... an account in the

name of Michelle Garrison, Account No. 789-654167." AIG instructed Mark to provide

duplicate copies of "confirmation slips and account statements" for the TD Ameritrade

accounts.

On April 22, 2011, Jack M. Garrison, the Garrison Family LLC, and Mark's sister

Lesa B. Neugent, individually and as trustee of the Jack M. Garrison and Charlotte L.

Garrison Revocable Trust, the Jack M. Garrison Survivor's Trust, the Charlotte L.

Garrison Marital Trust, the Charlotte L. Garrison Exempt Marital Trust, the Charlotte L.

Garrison Exempt Family Trust for the benefit of Mark Garrison, and the Charlotte L.

Garrison Exempt Family Trust for the benefit of Lesa Neugent (collectively the Garrison

Trusts), filed a lawsuit against Mark and Michelle Garrison and AIG for "Securities Law

violations, Breach of Fiduciary Duty, Negligence and Other Claims, and for Declaratory

Judgment."

The Garrison Trusts allege that Mark transferred $9.6 million from the Garrison

Family LLC and the Revocable Trust brokerage accounts at Wells Fargo to personal

accounts at TD Ameritrade, that during 2008 and 2009 Mark paid Acumen over

$550,000 in investment advisory fees and paid himself more than $370,000 in trustee

fees, and that Mark's speculative and high-risk investments during 2008 resulted in a

11

No. 69625-4-1/12

loss of over $20 million, leaving the "combined net value of all of the Plaintiffs' accounts,

including the Garrison Family LLC, ... to just under $200,000."11 The complaint asserts

AIG is jointly and severally liable for the loss of over $20 million and alleges claims

against AIG for negligent supervision, violation of the Washington State Securities Act

(WSSA), RCW 21.20.010, and liability under a respondeat superior theory. The

complaint also asserts Wells Fargo is jointly and severally liable but states the

contractual duty to arbitrate precludes "nam[ing] Wells Fargo as a defendant in this

action."12

AIG filed an answer denying liability and a cross claim for indemnification against

Mark. AIG denied that it owed any duty to the Garrison Trusts and asserted it had no

notice that Mark acted as an investment advisor for the Garrison Trusts or participated

in private securities transactions in the Wells Fargo brokerage accounts.

AIG filed a motion for summary judgment dismissal of all claims. In support, AIG

submitted the declaration of expert witness David E. Paulukaitis, a Managing Director of

Mainstay Capital Markets Consultants Inc. Paulukaitis states, in pertinent part:

. . . [A]ll transactions subject to the notification requirements of [NASD]

Rule 3050 are excluded from the ambit of NASD Conduct Rule 3040,

whether or not the associated person receives selling compensation in

connection with those transactions.

. . . The transactions effected by Mark in the Wells Fargo Accounts and

11 Emphasis in original.

12 The complaint states, in pertinent part:

Wells Fargo Investments, LLC ("Wells Fargo") is a securities broker-dealer, registered

with the SEC and FINRA to sell securities and conduct a securities brokerage business.

The investment accounts at issue in this case were all held at Wells Fargo's Seattle,

Washington branch. Plaintiff contends that Wells Fargo is jointly and severally liable for

many of the losses of which Plaintiffs complain, but because the Plaintiffs all are bound

by contract to arbitrate their claims against Wells Fargo in an arbitration forum

administered by FINRA, Plaintiffs cannot name Wells Fargo as a defendant in this action.

(Emphasis in original.) The Garrison Trusts also state that Acumen is "judgment-proof."

12

No. 69625-4-1/13

the Ameritrade Personal Accounts were outside the scope of his

association with [AIG] but were not "private securities transactions" as

defined under NASD Conduct Rule 3040

... Securities industry rules and regulations place no duty on [AIG] to

supervise the activity in the Wells Fargo Accounts or the Ameritrade

Personal Accounts. [AIG]'s duty with respect to those accounts was

limited to monitoring the transactions in those accounts to ensure that they

did not conflict with the interests to [AIG] or [AIG]'s customers.

The Garrison Trusts filed a motion for partial summary judgment on the grounds

that AIG owed a duty to supervise the securities transactions in the Wells Fargo

brokerage accounts. The Garrison Trusts submitted the declaration of expert witness

John H. Chung, a Chief Compliance Officer at three NASD member firms. Chung

disagreed with AIG expert Paulukaitis. Chung states that when Mark acted as an

investment advisor for compensation, AIG had a duty to supervise under NASD Rule

3040. Chung also states that AIG had a duty under NASD Rule 3050 to exercise

"appropriate supervision." In his declaration, Chung states, in pertinent part:

When a registered representative is acting as an RIA [(registered

investment advisor)] for compensation and executes transactions at

another broker-dealer, his actions are private securities transactions within

the meaning of NASD Rule 3040. The rule cited by Mr. Paulukaitis, NASD

Rule 3050 (Transactions for or by Associated Persons), does not stand for

the proposition that such activity need not be supervised by the

employer/broker-dealer. Instead, the rule requires that registered

representatives maintaining personal or discretionary accounts at another

broker-dealer to notify their employer, and permits employers so notified to

elect to receive duplicate confirmations and account statements for

purposes of exercising appropriate supervision over such activity.

The court denied the Garrison Trusts motion for partial summary judgment and

granted the motion for summary judgment dismissal of the claims against AIG. AIG

agreed to dismiss the cross claim against Mark, and the parties stipulated to entry of a

final judgment under CR 54(b).

13

No. 69625-4-1/14

ANALYSIS

The Garrison Trusts contend the trial court erred by granting summary judgment

dismissal of the claims against AIG for negligent supervision, violation of the WSSA,

and respondeat superior.

We review summary judgment de novo and consider all the facts and reasonable

inferences in the light most favorable to the nonmoving party. Hearst Commc'ns. Inc. v.

Seattle Times Co., 154 Wn.2d 493, 501, 115 P.3d 262 (2005); Michael v. Mosquera-

Lacv, 165 Wn.2d 595, 601, 200 P.3d 695 (2009). Summary judgment is appropriate if

the pleadings, depositions, and affidavits show there is no genuine issue as to any

material fact and the moving party is entitled to judgment as a matter of law. CR 56(c).

A material fact precluding summary judgment is a fact that affects the outcome of the

litigation. Eicon Const.. Inc. v. E. Wash. Univ., 174 Wn.2d 157, 164-65, 273 P.3d 965

(2012). Where there are competing inferences that may be drawn from the evidence,

the issue must be resolved by the trier of fact. Johnson v. UBAR, LLC, 150 Wn. App.

533, 537, 210 P.3d 1021 (2009).

Negligent Supervision

The Garrison Trusts contend that under NASD Rule 3040, AIG had a duty to

supervise Mark's activities as an investment advisor for the Garrison Trusts. In the

alternative, the Garrison Trusts assert that the monthly statements and trading

confirmations received by AIG in accord with NASD Rule 3050 triggered the duty to

investigate and monitor the activity of the Wells Fargo accounts.13

13 The Garrison Trusts concede "breach, causation, and damages" are not at issue on appeal.

14

No. 69625-4-1/15

"The theory of negligent supervision creates a limited duty to control an

employee for the protection of third parties, even where the employee is acting outside

the scope of employment." Niece v. Elmview Grp. Home. 131 Wn.2d 39, 51, 929 P.2d

420 (1997). To establish a claim for negligent supervision, the Garrison Trusts must

show (1) Mark acted outside the scope of his employment with AIG; (2) he presented a

risk of harm; (3) AIG knew, or should have known in the exercise of reasonable care,

that Mark posed a risk to others; and (4) AIG's failure to supervise was a proximate

cause of the loss. LaPlant v. Snohomish County, 162 Wn. App. 476, 479-80 n.7, 271

P.3d 254 (2011). An employer is not liable for negligently supervising an employee

whose conduct was outside the scope of the employment unless the employer knew, or

in the exercise of reasonable care, should have known the employee presented a risk of

danger to others. Thompson v. Everett Clinic, 71 Wn. App. 548, 555, 860 P.2d 1054

(1993) (citing Peck v. Siau. 65 Wn. App. 285, 294, 827 P.2d 1108 (1992)). The

existence of a duty is usually a question of law that we review de novo. Sheikh v. Choe,

156 Wn.2d 441, 448, 128 P.3d 574 (2006). However, "where duty depends on proof of

facts that are disputed[,] summary judgment is inappropriate." Hymas v. UAP

Distribution, Inc., 167 Wn. App. 136, 150, 272 P.3d 889 (2012).

The Securities Exchange Act of 1934 and amendments create a detailed,

comprehensive system of federal regulation of the securities industry. Swirsky v. Nat'l

Ass'n of Sec. Dealers, 124 F.3d 59, 61 (1st Cir. 1997). The Security Exchange Act of

1934 (Exchange Act), 15 U.S.C. § 78a et seq., authorizes self-regulatory organizations

to promulgate their own governing rules and regulations subject to extensive oversight

and control by the SEC. Mavo v. Dean Witter Reynolds. Inc., 258 F. Supp. 2d 1097,

15

No. 69625-4-1/16

1101 (N.D. Cal. 2003). Congress granted the SEC broad supervisory responsibilities

over a system of supervised self-regulation in the securities industry. See S. Rep. No.

73-792 (1934). "[T]he congressional aim in supervised self-regulation is to insure fair

dealing and to protect investors from harmful or unfair trading practices." Merrill Lynch,

Pierce, Fenner & Smith, Inc. v. Ware, 414 U.S. 117, 130, 94 S. Ct. 383, 38 L Ed. 2d

348(1973).

NASD is a self-regulatory organization registered with the SEC. The Exchange

Act authorizes the NASD "to develop and enforce rules of professional conduct for its

member firms, subject to oversight by the SEC." Gurfel v. SEC, 205 F.3d 400, 400

(D.C. Cir. 2000) (citing 15 U.S.C. § 78o-3); see also 4 Thomas Lee Hazen, The Law of

Securities Regulation at 87, 89 (5th ed. 2005). With some limited exceptions, all

NASD Rules, policies, practices, and interpretations must be approved by the SEC.

See 15 U.S.C. § 78s(b)(1); Swirskv, 124 F.3d at 62; Fiero v. Fin. Indus. Regulatory

Auth.. Inc.. 660 F.3d 569, 572 (2d Cir. 2011). The SEC requires NASD Rules and

regulations conform to the Exchange Act. See 15 U.S.C. §§ 78f(b), 78o-3(b). Under

the Maloney Act of 1938, 15 U.S.C. § 78o-3 etseg., NASD is also responsible for

investigations of and commencing compliance with federal securities laws and

regulations, and for discipline proceedings against member firms and their associated

member representatives. Fiero, 660 F.3d at 571-72.

"[A] person cannot lawfully engage in the securities business unless he or she is

either registered with the NASD as a broker-dealer or as a person associated with a

broker-dealer." Hollinqer v. Titan Capital Corp., 914 F.2d 1564, 1573 (9th Cir. 1990).

As a condition of the right to engage in the securities business, broker-dealers and

16

No. 69625-4-1/17

registered representatives must abide by NASD Rules and regulations. As You Sow v.

AIG Fin. Advisors, Inc.. 584 F. Supp. 2d 1034, 1048 (M.D. Tenn. 2008); SEC v. Waco

Fin.. Inc., 751 F.2d 831, 832 (6th Cir. 1985) (broker-dealers "who belong to the NASD

are required to abide by NASD Rules of Fair Practice and to meet other NASD

requirements").

While NASD Rules do not create a private cause of action, courts have looked to

the Rules to define the scope of a common law duty such as negligent supervision.

Craighead v. E.F. Hutton & Co.. 899 F.2d 485, 493 (6th Cir. 1990) ("We agree with the

district court that NYSE [(New York Stock Exchange)] Rule 405 does not imply a private

right of action cognizable in federal court."); As You Sow, 584 F. Supp. 2d at 1048-49

("violations of NASD rules alone do not give rise to actionable claims" but NASD Rule

3040 and other NASD Rules "assist Tennessee and other courts in defining the extent

of a legal duty at common law"); McGraw v. Wachovia Sec. LLC, 756 F. Supp. 2d 1053,

1075 (N.D. Iowa 2010) (recognizing duty based on NASD Rules); Colbert &Winstead,

PC 401 (K) Plan v. AIG Fin. Advisors Inc., No. 3:07-1117, 2008 WL 2704367, at *10

(M.D. Tenn. July 8, 2008) ("the NASD may define the scope of a duty of a broker

dealer"): Cf. Milev v. Oppenheimer & Co.. 637 F.2d 318, 333 (5th Cir. 1981) (NYSE and

NASD Rules are "excellent tools" to assess reasonableness of broker's conduct); Piper.

Jaffrav & Hopwood Inc. v. Ladin. 399 F. Supp. 292, 299 (S.D. Iowa 1975) (concluding

NASD and NYSE Rules are "admissible as evidence of negligence"); Mihara v. Dean

Witter& Co.. 619 F.2d 814, 824 (9th Cir. 1980) (NASD and NYSE Rules "reflect the

standard to which all brokers are held.").

17

No. 69625-4-1/18

The crux of the dispute in this case is the scope of AIG's duty to supervise Mark's

outside business activity as an investment advisor directing transactions in the Wells

Fargo brokerage accounts. The Garrison Trusts argue the supervisory requirements of

NASD Rule 3040 apply. AIG contends only the supervisory requirements of NASD Rule

3050 apply and under the plain language of NASD Rule 3040, NASD Rule 3050

transactions are excluded.

As a general overarching rule, NASD Rule 3010, Supervision (amended effective

Dec. 19, 2007), requires a brokerage firm to establish, implement, and maintain a

system that includes written procedures to supervise the activities of each registered

representative and other associated persons reasonably designed to achieve

compliance with applicable securities laws, regulations, and NASD Rules.14

NASD Rule 3030, Outside Business Activities of an Associated Person (effective

Oct. 13, 1988), prohibits a registered representative from participating in outside

business activity unless the employer member receives "prompt written notice." NASD

Rule 3030 states:

No person associated with a member in any registered capacity

shall be employed by, or accept compensation from, any other person as

a result of any business activity, other than a passive investment, outside

the scope of his relationship with his employer firm, unless he has

provided prompt written notice to the member. Such notice shall be in the

14 NASD Rule 3012, Supervisory Control System (amended effective Feb. 14, 2006), also states,

in pertinent part:

(a) General Requirements

(1) Each member shall designate and specifically identify to NASD one or more

principals who shall establish, maintain, and enforce a system of supervisory control

policies and procedures that (A) test and verify that the member's supervisory procedures

are reasonably designed with respect to the activities of the member and its registered

representatives and associated persons, to achieve compliance with applicable securities

laws and regulations, and with applicable NASD rules.

Emphasis in original.

18

No. 69625-4-1/19

form required by the member. Activities subject to the requirements of

Rule 3040 shall be exempted from this requirement.

NASD Rule 3040, "Private Securities Transactions of an Associated Person,"

addresses private securities transactions of a registered securities representative for

compensation. "Selling compensation" is broadly defined to include "any compensation

paid directly or indirectly from whatever source in connection with or as a result of the

purchase or sale of a security." NASD R. 3040(e)(2). NASD Rule 3040(a) states that

"[n]o person associated with a member shall participate in any manner in a private

securities transaction except in accordance with the requirements of this Rule." NASD

Rule 3040(b) requires the registered securities representative to provide written notice

to the employer member prior to engaging in any private security transactions. NASD

Rule 3040 states, in pertinent part:

(b) Written Notice

Prior to participating in any private securities transaction, an

associated person shall provide written notice to the member with which

he is associated describing in detail the proposed transaction and the

person's proposed role therein and stating whether he has received or

may receive selling compensation in connection with the transaction.1151

After receiving notice of a private securities transaction, the employer member

must approve or disapprove the proposed participation in private securities transactions

in writing. NASD R. 3040(c)(1). NASD Rule 3040(c) states, in pertinent part:

(2) If the member approves a person's participation in a transaction

pursuant to paragraph (c)(1), the transaction shall be recorded on the

books and records of the member and the member shall supervise the

person's participation in the transaction as ifthe transaction were

executed on behalf of the member.

(3) If the member disapproves a person's participation pursuant to

paragraph (c)(1), the person shall not participate in the transaction in any

manner, directly or indirectly.

15 Emphasis in original.

19

No. 69625-4-1/20

NASD Rule 3050, "Transactions for or by Associated Persons," also addresses

outside business activities and expressly applies to "an account or order in which an

associated person has a financial interest or with respect to which such person has

discretionary authority." NASD R. 3050(e). Under NASD Rule 3050(c) and (d), prior to

engaging in any transactions, a registered representative who opens an account or

places an order for a securities transaction at another financial institution must notify the

employer member in writing of the intent to open the account or place an order.

The other financial institution or executing member has an obligation to notify the

employer member. NASD R. 3050(b). If the employer member approves engaging in

transactions under NASD Rule 3050, upon written request from the employer member,

the executing member must provide copies of confirmations, account statements, and

other information regarding the account. NASD R. 3050(b)(2). NASD Rule 3050 states,

in pertinent part:

(c) Obligations of Associated Persons Concerning an Account with

a Member

A person associated with a member, prior to opening an account or

placing an initial order for the purchase or sale of securities with another

member, shall notify both the employer member and the executing

member, in writing, of his or her association with the other member;

provided, however, that ifthe account was established prior to the

association of the person with the employer member, the associated

person shall notify both members in writing promptly after becoming so

associated.

(d) Obligations of Associated Persons Concerning an Account with

a Notice-Registered Broker/Dealer, Investment Adviser, Bank, or Other

Financial Institution

A person associated with a member who opens a securities

account or places an order for the purchase or sale of securities with a

broker/dealer that is registered pursuant to Section [78o(b)(11)] of the

[Exchange] Act ("notice-registered broker/dealer"), a domestic or foreign

20

No. 69625-4-1/21

investment adviser, bank, or other financial institution, except a member,

shall:

(1) notify his or her employer member in writing, prior to the

execution of any initial transactions, of the intention to open the

account or place the order; and

(2) upon written request by the employer member, request

in writing and assure that the notice-registered broker/dealer,

investment adviser, bank, or other financial institution provides the

employer member with duplicate copies of confirmations,

statements, or other information concerning the account or order;

provided, however, that if an account subject to this paragraph (d)

was established prior to a person's association with a member, the person

shall comply with this paragraph promptly after becoming so associated.

The purpose of NASD Rule 3050 is to prevent "potential and actual conflicts of

interest raised through registered representatives' personal trading activities." Dep't of

Enforcement v. Ng. No. 2009019369302, at 10 (Fin. Indus. Regulatory Auth. Nat'l

Adjudicatory Council Apr. 24, 2013).16 NASD Rule 3050 states, in pertinent part:

(a) Determine Adverse Interest

A member ("executing member") who knowingly executes a

transaction for the purchase or sale of a security for the account of a

person associated with another member ("employer member"), or for any

account over which such associated person has discretionary authority,

shall use reasonable diligence to determine that the execution of such

transaction will not adversely affect the interests of the employer member.

(b) Obligations of Executing Member

Where an executing member knows that a person associated with

an employer member has or will have a financial interest in, or

discretionary authority over, any existing or proposed account carried by

the executing member, the executing member shall:

(1) notify the employer member in writing, prior to the

execution of a transaction for such account, of the executing

member's intention to open or maintain such an account;

16 Available at http://www.finra.Org/web/qroups/industrv/@ip/@enf/@adi/documents/nacdecisions/

p249257.pdf.

21

No. 69625-4-1/22

(2) upon written request by the employer member, transmit

duplicate copies of confirmations, statements, or other information

with respect to such account; and

(3) notify the person associated with the employer member

of the executing member's intention to provide the notice and

information required by subparagraphs (1) and (2).

The Garrison Trusts concede that from 2006 to 2007, AIG complied with NASD

Rule 3050. The concession is well taken. There is no dispute that in compliance with

NASD Rule 3050, Wells Fargo as the executing member expressly requested written

approval from AIG to allow Mark to act as the "trustee, owner and manager" of the

Garrison trusts and Garrison Family LLC for the brokerage accounts at Wells Fargo. In

response, on November 14, 2006, AIG did not object to Mark acting "solely as the

trustee/owner/manager," but instructed Mark that he could not act in any other capacity

for the accounts. The November 22 letter from AIG requests monthly account

statements and trading confirmations from Wells Fargo for the brokerage accounts and

specifically states that NASD Rule 3050 requires the First Line Supervisor to monitor

the Wells Fargo accounts.

However, the Garrison Trusts claim that when Mark hired Acumen in March 2007

to provide investment advice for a fee for the Wells Fargo brokerage accounts, AIG had

a duty to supervise under NASD Rule 3040. AIG asserts the language of NASD Rule

3040 excludes all transactions subject to NASD Rule 3050. AIG contends that under

the plain language of NASD Rule 3040, if "private securities transactions" are subject to

NASD Rule 3050, the supervisory requirements of NASD Rule 3040 do not apply. The

Garrison Trusts argue that only the transactions "for which no associated person

22

No. 69625-4-1/23

receives any selling compensation"17 under NASD Rule 3050 are excluded from the

requirements of NASD Rule 3040.

Interpretation of statutes and regulations is a question of law this court reviews

de novo. Skinner v. Civil Serv. Comm'n of City of Medina. 168 Wn.2d 845, 849, 232

P.3d 558 (2010). NASD Rule 3040 applies only to "private securities transactions."

Rule 3040 defines "private securities transaction" as transactions outside the scope of

employment, and excludes three discrete categories of transactions from the definition:

"Private securities transaction" shall mean any securities transaction

outside the regular course or scope of an associated person's

employment with a member, including, though not limited to, new offerings

of securities which are not registered with the Commission, provided

however that transactions subject to the notification requirements of Rule

3050, transactions among immediate family members (as defined in Rule

2790), for which no associated person receives selling compensation, and

personal transactions in investment company and variable annuity

securities, shall be excluded.

NASD R. 3040(e)(1).18

The definition of "private securities transaction" clearly excludes three distinct

categories of transactions: (1) transactions subject to the requirements of NASD Rule

3050, (2) transactions among immediate family members, and (3) personal transactions

in investment company and variable annuity securities. NASD R. 3040(e)(1). The

question is whether the phrase, "for which no associated person receives any selling

compensation," applies only to the immediately preceding phrase, "transactions among

immediate family members," or to both of the preceding phrases excluding NASD Rule

17 NASD R. 3040(e)(1).

18 NASD Rule 2790, Restrictions on the Purchase and Sale of Initial Equity Public Offerings

(amended effective Sept. 5, 2007), defines "immediate family member" as "a person's parents, mother-in-

law or father-in-law, spouse, brother or sister, brother-in-law or sister-in-law, son-in-law or daughter-in-

law, and children, and any other individual to whom the person provides material support." NASD R.

2790(i)(5). The definition of "immediate family member" does not include grandparents. The parties do

not contend this exclusion applies.

23

No. 69625-4-1/24

3050 transactions and immediate family member transactions. See NASD R.

3040(e)(1).

Under the "last antecedent rule" of statutory construction, "[w]here no contrary

intention appears . . . , relative and qualifying words and phrases, both grammatically

and legally, refer to the last antecedent." In re Sehome Park Care Ctr.. Inc.. 127 Wn.2d

774, 781, 903 P.2d 443 (1995); Davis v. Gibbs. 39 Wn.2d 481, 483, 236 P.2d 545

(1951); see Flowers v. Carville, 310 F.3d 1118, 1124 (9th Cir. 2002) (last antecedent

rule disfavors an interpretation that would have words "leaping across stretches of text,

defying the laws of both gravity and grammar"). Under the last antecedent rule, we

conclude that the phrase, "for which no associated person receives any selling

compensation," modifies only the phrase that immediately precedes it: "transactions

among immediate family members," and not transactions subject to the requirements of

NASD Rule 3050.19

In the alternative, the Garrison Trusts rely on NASD Notice to Members (NTM)

94-44, Board Approves Clarification On Applicability Of Article III. Section 40 Of Rules

Of Fair Practice To Investment Advisory Activities Of Registered Representatives, and

NASD NTM 96-33, NASD Clarifies Rules Governing RR/IAs [(Registered

Representative/Investment Advisors)], to argue AIG had a duty to supervise Mark's

activities as an investment advisor receiving selling compensation and directing

securities transactions in the Wells Fargo brokerage accounts.

In a number of NASD NTMs, NASD has addressed the application of NASD Rule

3040 where an associated registered representative is also acting as a registered

19 NASD R. 3040(e)(1).

24

No. 69625-4-1/25

investment adviser. Courts may give substantial deference to NASD's interpretation of

its own rules. Dawson v. N.Y. Life Ins. Co.. 135 F.3d 1158, 1168 (7th Cir. 1998); Ronav

Family Ltd. P'ship v. Tweed. 216 Cal. App. 4th 830, 842, 157 Cal. Rptr. 3d 680 (2013);

Siegel v. SEC. 592 F.3d 147, 155 (D.C. Cir. 2010); see also York Research Corp. v.

Landgarten. 927 F.2d 119, 123 (2d Cir. 1991).

In NASD NTM 91-32, Reguest for Comments on Compensation Arrangements

for Activities of Registered Representatives Who Are Also Registered With the

Securities and Exchange Commission as Investment Advisers. NASD concluded that

NASD Rule 3040 "should apply to all investment advisory activities conducted by

registered representatives other than their activities on behalf of the member that result

in the purchase or sale of securities by the associated person's advisory clients." NASD

NTM 91-32 states that "to conclude otherwise would permit registered persons to

participate in securities transactions outside the scope of the oversight and supervision

of the employer member and of a self-regulatory organization to the potential detriment

of customers."

NASD NTM 94-44 states that "[i]n clarifying its previous position in Notice to

Members 91-32. the Board [of Governors] focused primarily upon the RR/RIA's

[(registered representative/registered investment advisor's)] participation in the

execution of the transaction—meaning participation that goes beyond a mere

recommendation." NASD NTM 94-44 describes an example of where the transaction of

a registered representative acting as a registered investment advisor would trigger the

requirements of NASD Rule 3040:

An example of a RR/RIA clearly participating in the execution of trades is

where he or she enters an order on behalf of the customer for particular

25

No. 69625-4-1/26

securities transactions either with a brokerage firm other than the member

they are registered with, directly with a mutual fund, or with any other

entity, including another adviser, and receives any compensation for the

overall advisory services.

NASD NTM 96-33 specifically reiterates that a dually licensed registered

representative and investment advisor must provide prior written notice to the member

before engaging in any investment advisory activity for a fee. NASD NTM 96-33 states,

in pertinent part, "A member must receive prior written notice from an RR/IA requesting

approval to conduct investment advisory activities for an asset-based or performance-

based fee on behalf of each of his or her advisory clients." NASD NTM 96-33 states the

prior written notice "must include details such as:"

• [A] declaration that the individual is involved in investment

advisory activities;

• the identity of each customer to whom the notice would apply;

• the types of securities activities that may be executed away from

the firm;

• a detailed description of the role of the RR/IA in the investment

advisory activities and services to be conducted on behalf of

each identified customer;

• information regarding the RR/IA's discretionary trading authority,

if any;

• compensation arrangements;

• the identity of broker/dealers through which trades away will be

executed; and

• customer financial information.

NASD NTM 96-33 also specifically directs a registered securities

representative/investment advisor such as Mark to provide the employer member with

"a subsequent written notice that details" the change in his role. NASD NTM 96-33

26

No. 69625-4-1/27

states, in pertinent part:

Only after written approval from the NASD member may the RR/IA

engage in the disclosed activities. Ifthere is a change in the RR/IA's

proposed role or activities for any customer from what the member initially

approved, the RR/IA must provide the member with a subsequent written

notice that details the changes and requests the member's further

approval to conduct advisory activities on behalf of the customer. The

employer member must thereafter record subsequent transactions on its

books and records and supervise activity in the affected accounts as if it

were its own.

Here, the undisputed record shows that Mark did not comply with the

requirement to obtain prior written approval before hiring Acumen in March 2007 to

provide investment advice for the Wells Fargo brokerage accounts. Nor did Mark

comply with the requirement to provide AIG with written notice that his role had changed

from trustee and manager of the Garrison trusts and the Garrison Family LLC to

investment advisor. The undisputed record shows that Mark acted as an investment

advisor receiving selling compensation and directed private securities transactions in

the Wells Fargo brokerage accounts. The dispositive question is whether AIG knew or

should have known that Mark's role had changed from trustee and manager of the

Garrison trusts and Garrison Family LLC to acting as an investment advisor directing

transactions in the Wells Fargo brokerage accounts, triggering the requirements of

NASD Rule 3040.

The Garrison Trusts rely on the annual OBAQs Mark submitted to AIG for 2005

to 2006 and 2007 to show AIG had notice triggering the duty to supervise under NASD

Rule 3040. The Garrison Trusts contend the difference between the two OBAQs

provided AIG notice that Mark was acting as an investment advisor and receiving selling

compensation.

27

No. 69625-4-1/28

In the 2005 to 2006 OBAQ, Mark reported he was "Trustee/Owner/Manager" for

the Wells Fargo accounts and stated he received "[u]nder $10,000" for this activity. The

2005 to 2006 OBAQ states, in pertinent part:

VI. Other Activities

1. Are you involved in any other Outside Business Activities?

Yes.

1.1. What is your full title?

- Trustee/Owner/Manager

1.2. Please disclose, in detail, all of your duties and

responsibilities in this position:

- I have been named the Trustee/Owner/Manager on accounts

held at Wells Fargo Investments in Seattle, WA, for my grandfather

- Jack Garrison.

1.4. Please indicate the percentage of time you spend conducting

this activity:

0-25%

1.5. Please indicate the average annual dollar amount of

compensation that you receive:

Under $10,000.t2°]

By contrast, in the 2007 OBAQ dated October 30, 2007, Mark reports not only

that he is the "Trustee/Owner/Manager" on the accounts held at Wells Fargo, but also

that it is "an Investment related activity" conducted under his independent financial

advice business Acumen.21 The October 30, 2007 OBAQ submitted by Mark states, in

pertinent part:

1. Please select the category for this activity: (If you are

currently not participating in any of these below activities,

please select "No Activity")

Other

20 Emphasis in original.

21 Emphasis in original.

28

No. 69625-4-1/29

1.2. Is this an Investment related activity?

Yes

1.3. What is the name of the business this activity is conducted

under?

- Acumen Financial Group, Inc.

1.4. What is the nature or structure of the business? Please select

from the following:

- Registered Investment Adviser

1.6. What is your position/title for this activity? Please select from

the following:

Owner

1.7. Please enter the date you started this activity:

- 10-16-1995

1.8. Please enter the approximate number of hours/month you

spend on this activity:

-16

1.9. Please enter the approximate number of hours you spend on

this activity during securities trading hours:

-16

1.10. Please provide a description of your duties:

- I have been named the Trustee/Owner/Manager on accounts

held at Wells Fargo Investments in Seattle, WA, for my grandfather

- Jack Garrison.

1.12. Please indicate the average annual dollar amount of

compensation that you receive:

$25,000 to $50,000.[22l

22 Emphasis in original.

29

No. 69625-4-1/30

Because the OBAQ submitted in October 2007 does not comply with the written

notice requirements set forth in NASD Rule 3040(b) and NASD NTM 96-33, the 2007

OBAQ alone may not have provided AIG with notice that Mark's role had changed in

March 2007 and that he was acting as the investment advisor for compensation rather

than solely as the trustee and manager of the Garrison trusts and Garrison Family LLC

brokerage accounts at Wells Fargo. However, when coupled with the directive in the

"AIG Financial Advisors Sales Practice Manual," there are genuine issues of material

fact as to whether AIG knew or should have known that by October 2007, Mark was

acting as an investment advisor for the Wells Fargo brokerage accounts and receiving

selling compensation. The AIG manual states that "[o]n an annual basis, RRs are

required to disclose to the Firm, via the OBAQ, any outside business activities prior to

engaging in such activity." Viewing the evidence in the light most favorable to the

Garrison Trusts, the excerpt from the AIG manual appears to require a registered

representative to use the OBAQ to disclose outside business activities.

The Garrison Trusts assert that even if AIG did not have notice triggering the

supervisory requirements of NASD Rule 3040, the monthly statements and trading

confirmations AIG received under NASD Rule 3050 revealed suspicious circumstances

or "red flags," triggering the duty to investigate or monitor the transactions in the Wells

Fargo brokerage accounts. Under NASD Rule 3050, both Wells Fargo as the executing

member and AIG as the employer member had an obligation to review the monthly

account statements and securities transaction confirmation slips for the Wells Fargo

brokerage accounts, not only for insider trading and conflicts of interest, but also for

unapproved outside business activities and suspicious circumstances.

30

No. 69625-4-1/31

In McGraw. the plaintiffs alleged the employer member Wachovia owed them a

duty to supervise the outside activities of an associated stockbroker. McGraw. 756 F.

Supp. 2d at 1058-59. The court cites the general rule that absent notice," 'a broker-

dealer owes no duty to a non-customer who has invested money through an

independent investment advisor,'" but notes " 'this general proposition of non-liability is

far from a per se rule.'" McGraw. 756 F. Supp. 2d at 107223 (quoting Bear Stearns &

Co. v. Buehler. 23 Fed. App'x. 773, 775 (9th Cir. 2001)). The court describes the well-

defined exception to the general rule as follows:

"Where there is additional involvement by the broker-dealer, a duty may

be found. In Software Design, the court noted that 'sufficiently suspicious'

circumstances may place a broker-dealer on notice that her customer is

perpetrating fraud on non-customer investors. [Software Design &

Application. Ltd. v. Hoefer & Arnett. Inc.. 49 Cal. App. 4th 472, 483, 56

Cal. Rptr. 2d 756 (1996)]. Once aware of troublesome 'red flags,' the

broker-dealer may have a duty which runs to non-customers to monitor

and investigate any unusual account activity. [Software Design, 49 Cal.

App. 4th at 483]; see also City of Atascadero v. Merrill Lvnchf. Pierce.

Fenner & Smith. Inc.]. 68 Cal. App. 4th 445, 483-84, 80 Cal. Rptr. 2d 329

(1998) (finding trustee-investors, who had no direct contact with Merrill

Lynch, could nonetheless state a claim for breach of fiduciary duty if

Merrill Lynch actively participated in broker's fraud)."

McGraw. 756 F. Supp. 2d at 1072 (quoting Bear Stearns. 23 Fed. App'x. at 776).

Accordingly, the court held:

Although brokerage firms generally are not responsible for

supervising any outside business activities or private securities

transactions engaged in by their representatives, unless they have

received notice of or have approved those activities, they do have a duty

to monitor and investigate activities for which they have had no proper

notice, ifthere is evidence of "red flags" that would alert the brokerage firm

to the possibility of undisclosed outside activities.

McGraw. 756 F. Supp. 2d at 1075.

23 Emphasis in original.

31

No. 69625-4-1/32

Here, it is undisputed that AIG complied with the requirements of NASD Rule

3050 and approved Mark acting as the trustee and manager of the Garrison trusts and

Garrison Family LLC for the Wells Fargo brokerage accounts. Beginning in 2006, AIG

received monthly account statements and confirmation slips for trading transactions

from Wells Fargo. In December 2007, AIG also approved Mark and Michelle Garrison's

personal brokerage accounts at TD Ameritrade and from early 2008 to April 2009, AIG

received confirmation slips and account statements for Mark and Michelle's personal

brokerage accounts at TD Ameritrade.

An excerpt from the AIG Financial Advisors Sales Practice Manual describes the

First Line Supervisor's responsibility for monitoring outside business activities and the

annual OBAQ report. The manual appears to require the First Line Supervisor to not

only review the OBAQ "for any potential conflict with the Firm's business," but also to

"[qjuestion RR regarding potential unapproved outside business activities referenced in

OBAQ/ACQ [(outside business activities questionnaire/annual compliance

questionnaire)] or other red flags or indications of misunderstanding of Firm or

Regulatory policies."24

Viewing the evidence in the light most favorable to the Garrison Trusts, there are

material issues of fact as to whether suspicious activity or red flags required AIG to

investigate and monitor Mark's activity in the Wells Fargo accounts. For example, there

are material issues of fact as to whether the information Mark submitted in the October

2007 OBAQ required the AIG First Line Supervisor to investigate potential unapproved

24 AIG's internal manual is evidence of the standard of care. Joyce v. Dep't of Corrections, 155

Wn.2d 306, 324, 119 P.3d 825 (2005) ("Internal directives, department policies, and the like may provide

evidence of the standard of care and therefore be evidence of negligence.").

32

No. 69625-4-1/33

outside business activity as an investment advisor for the Garrison trusts and the

Garrison Family LLC. The Garrison Trusts also presented evidence that Mark changed

the nature of the investments between January 2007 and November 2008, and that by

November 2008, Mark had transferred more than $9.6 million from the Wells Fargo

accounts to his personal brokerage TD Ameritrade accounts.

WSSA

The Garrison Trusts contend that as a matter of law, AIG is a "control person"

under the WSSA, RCW 21.20.430(3). In the alternative, the Garrison Trusts contend

material issues of fact preclude dismissal of the "control person" claim.

Under the WSSA, it is unlawful to engage in fraud or deceit in connection with the

offer, sale, or purchase of any security. RCW 21.20.010. RCW 21.20.430(3) states that

certain persons may be secondarily liable for a violation of the act.

Every person who directly or indirectly controls a seller or buyer liable

under subsection (1) or (2) above, every partner, officer, director or person

who occupies a similar status or performs a similar function of such seller

or buyer, every employee of such a seller or buyer who materially aids in

the transaction, and every broker-dealer, salesperson, or person exempt

under the provisions of RCW 21.20.040 who materially aids in the

transaction is also liable jointly and severally with and to the same extent

as the seller or buyer, unless such person sustains the burden of proof

that he or she did not know, and in the exercise of reasonable care could

not have known, of the existence of the facts by reason of which the

liability is alleged to exist.

RCW 21.20.430(3).

In Hines v. Data Line Systems. Inc.. 114Wn.2d 127, 787 P.2d 8(1990), our state

supreme court established a two-prong test to establish whether a defendant is a

"control person:"

"[F]irst, that the defendant. . . actually participated in (Le., exercised

control over) the operations of the corporation in general; then he must

33

No. 69625-4-1/34

prove that the defendant possessed the power to control the specific

transaction or activity upon which the primary violation is predicated, but

he need not prove that this later power was exercised."

Hines. 114 Wn.2d at 13625 (quoting Metge v. Baehler. 762 F.2d 621, 630-31 (8th Cir.

1985)). The plaintiff does not need to show that the defendant "culpably participated" to

establish control person liability. Hines. 114 Wn.2d at 137. Because there are material

issues of fact as to whether AIG knew or should have known Mark was acting as an

investment advisor rather than as only the trustee and manager, we conclude there are

also genuine issues of material fact as to the extent to which AIG could exercise control

over the transactions in the Wells Fargo accounts. See also Hollinger, 914 F.2d at 1574

("The broker-dealer's ability to deny the representative access to the markets gives the

broker-dealer effective control over the representative at the most basic level.").26

Respondeat Superior

The Garrison Trusts also contend the court erred by dismissing its claim that AIG

was liable based on respondeat superior. We disagree.

Respondeat superior, or vicarious liability, imposes liability on an employer for

the torts of an employee who is acting on the employer's behalf within the scope of

employment. Niece. 131 Wn.2d at 48. Respondeat superior is analytically distinct and

separate from a cause of action for negligent hiring, retention, and supervision. Niece.

131 Wn.2dat48.

25 Emphasis in original, alteration in original, internal quotation marks omitted.

26 The Garrison Trusts also cite Hollinger, 914 F.2d at 1564, to argue that a broker-dealer is

always a control person of a registered representative under the WSSA. We disagree with that argument.

The two-prong test in Hines determines whether AIG was a "control person." See Hines, 114 Wn.2d at

136.

34

No. 69625-4-1/35

Here, it is undisputed that Mark's actions as a registered investment advisor were

outside the scope of his employment with AIG. Nonetheless, the Garrison Trusts

contend AIG is liable under a respondeat superior theory because as an AIG branch

office manager, Mark was responsible for supervising his own outside business

activities. But the undisputed record establishes an AIG First Line Supervisor was

responsible for supervising and reviewing Mark's outside business activities as the

trustee and manager of the Garrison trusts and the Garrison Family LLC, as well as the

TD Ameritrade personal accounts. We conclude the court did not err by dismissing the

respondeat superior claim.

In sum, we affirm summary judgment dismissal of the respondeat superior claim

against AIG but reverse summary judgment dismissal of the claims for negligent

supervision and violation of the WSSA, and remand for trial.27

^HZu^l,

WE CONCUR:

^ _ C.TT

y^^^C.TT. ^ J

27 Because we reverse, we need not address the argument that the court erred in denying the

motion for reconsideration.

35