Knieriemen v. Bache Halsey Stuart Shields Inc.

Murphy, P. J. (concurring).

I agree with Justice Lynch that, under Louisiana law, the negligence cause of action is barred by plaintiff’s contributory negligence. To the extent that the verdict was premised upon the negligence cause, it was erroneous. Furthermore, the submission of the negligence cause may have confused the jury and prevented a fair consideration of the "churning” cause. Even if that negligence cause were governed by New York law, the trial court erred in refusing to charge on the issue of contributory negligence. That issue was relevant, if for no other reason, in calculating damages under New York’s rule of comparative negligence.

I also agree with Justice Lynch that the contract cause is governed by New York law and that the defendant acquiesced in the application of New York law to the "churning” cause. I would further find that the defendant acquiesced in the application of New York law to the fraud cause. Thus, the remaining three causes will be explored under New York law.

With regard to the contract cause, the record indicates that the plaintiff had a nondiscretionary account with the defendant. There is no dispute concerning the fact that all transactions were submitted to the plaintiff for his approval and that he did approve all transactions. Hence, the evidence does not disclose any patent breach of the contract by the defendant. For this reason, the contract cause should have been dismissed as a matter of law.

*298 In charging breach of contract, the trial court also permitted the jury to find that the defendant had violated the "suitability” rule of the National Association of Securities Dealers (NASD). There was conflicting evidence in the record as to the date on which the plaintiff signed a "suitability letter” with the defendant. Even if that "suitability letter” was signed by the plaintiff after the subject account was opened with the defendant, the trial court should not have charged the "suitability” rule of the NASD. The plaintiff has not shown that commodities trading is controlled by any "suitability” rule or regulation of (i) the Commodity Futures Trading Commission, (ii) the NASD, or (iii) the national stock exchanges. This "suitability” charge may have further confused the jury and is an additional ground for reversal.

The trial court submitted this case to the jury on the additional theory of "common-law fraud”. Conceptually, a party may seek to recover on the bases of both "common-law fraud” and "churning”. (Cf. Van Alen v Dominick & Domin ick, 441 F Supp 389 , affd 560 F2d 547.) However, in order to recover for fraud, the plaintiff must show, inter alia, that the defendant misrepresented a material fact. The plaintiff did not demonstrate that the defendant misrepresented any of the transactions approved by him. Consequently, common-law fraud was not the proper vehicle for recovery on the facts in this case. The jury correctly rejected that cause in its verdict.

The fourth cause submitted to the jury was "churning”. This cause has been defined as follows (Newburger, Loeb & Co., v Gross, 563 F2d 1057, 1069, 1070, cert den 434 US 1035 ): " 'Churning’ occurs when a securities dealer abuses his customer’s confidence for personal gain (e.g. to create commissions) by inducing transactions in the customer’s account which are disproportionate to the size and character of the account. Churning has been held to be a deceptive device within § 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5, for which a private cause of action for damages will lie. See, e.g., Ruskay v. Waddell, 552 F.2d 392 , 393 n. 2 (2d Cir. 1977); Carras v. Burns, 516 F.2d 251, 258 (4th Cir. 1975); Landry v. Hemphill, Noyes & Co., 473 F.2d 365 , 368 n. 1 (1st Cir.), cert, denied, 414 U.S. 1002 , 94 S.Ct. 356 , 38 L.Ed.2d 237 (1973); Hecht v. Harris, Upham & Co., 430 F.2d 1202, 1206-07 (9th Cir. 1970); Powers v. Francis I. DuPont & Company, 344 F.Supp. 429, 431 (E.D.Pa. 1972); Moscarelli v. Stamm, 288 F.Supp. 453, 457 (E.D.N.Y. 1968); see generally Note, Churn *299 ing by Securities Dealers, 80 Harv.L.Rev. 869 (1967). In order to recover, the customer must show that the dealer effectively exercised control over trading in the account and manipulated the account to his benefit. Where, as here, the account is non-discretionary (i.e., the dealer may not make trades in the account, without the customer’s authorization), the plaintiff must show that he relied extensively on his broker’s advice and that the broker abused the plaintiff’s trust. Thus, if a customer is fully able to evaluate his broker’s advice and agrees with the broker’s suggestions, the customer retains control of the account. See Carras v. Burns, supra, 516 F.2d at 258-59 .”

In most instances, a party will attempt to recover for "churning” in the Federal court system (see, e.g., Newburger, Loeb & Co. v Gross, supra). However, a party may also seek to recover damages for "churning” in the State systems. In an action brought in the State system, a party cannot recover for any violation of the Securities Exchange Act or the regulations promulgated thereunder. (Pierce v Ellis & Co., 62 Misc 2d 771, 773 ; McCollum v Billings, 53 Misc 2d 661 .) Nonetheless, he may seek to show that there has been a breach of a fiduciary relationship constituting constructive fraud. (Cf. Twomey v Mitchum, Jones & Templeton, 262 Cal App 2d 690, 712-713.) The charge in this proceeding should have been limited to the thrust of plaintiff’s proof, viz., "churning”. In passing, it should be observed that the defendant does not maintain that the "churning” cause is time barred nor does the evidence otherwise establish that fact. (See CPLR 203, subd [f]; 213, subds 1, 8.)

In cases where it has been held that a stockbroker or dealer engaged a customer’s securities account in excessive trading, one factor considered has been the broker’s or dealer’s control over the customer’s account. Although such control is established by the existence of a formally contractual discretionary account, sufficient control has been established by the nature of the relationship between the parties, often combined with a lack of financial or investment sophistication on the part of the customer. (Stockbroker—"Churning”—Liability, Ann. 32 ALR3d 635, 640.) The plaintiff testified at trial that, during the entire period the subject account was open with the defendant, he was never sober. He maintained that, by reason of his alcoholism, he was so incompetent that he could not give meaningful approval to any of the commodities transac *300 tions. Plaintiff further contended that Newman realized that he was incompetent and unfairly took advantage of the situation by excessively trading in the account.

Upon proper proof, an alcoholic has been found incompetent and has been relieved of his contractual responsibilities. (See, generally, 41 Am Jur 2d, Incompetent Persons, §§ 7, 68, 75, 76, 77, 78.) As a theoretical proposition, I am prepared to find that a party’s alcoholism could, in a particular case, shift effective control of an account to a broker and thus permit the broker to churn even a "nondiscretionary” account. However, it is difficult to credit plaintiff’s testimony that he did not have one lucid moment while the account was active. Nonetheless, on this appeal, it would be improper to substitute such an evaluation of the evidence for that of the jury. Therefore, upon a retrial, the "churning” cause should be submitted to the jury.

At the new trial, compensatory damages should be calculated on a "quasi-contractual” theory. (Stevens v Abbott, Proctor & Paine, 288 F Supp 836, 849-851 ; see, generally, Stockbroker—"Churning”—Liability, Ann. 32 ALR3d 635, 648 et seq.) Under that theory, plaintiff would be able to recover commissions, taxes, transfer charges and miscellaneous ex-pénses flowing from the excessive trading (Carras v Burns, 516 F2d 251, 259). He would not be permitted to recover the speculative damages permitted under the "out-of-pocket” or "loss-of-bargain” theories.

Under proper circumstances, New York law would permit punitive damages with regard to the "churning” cause. Nonetheless, there is no indication in the record that the defendant’s alleged wrong was aimed at the general public. (Newburger, Loeb & Co. v Gross, 563 F2d 1057, 1080, cert den 434 US 1035 .) Therefore, I would not permit the plaintiff to recover punitive damages at the new trial. Parenthetically, I note that, if this case had been tried in the Federal court system on the theory that Federal law had been breached, punitive damages could not have been recovered (Carras v Burns, supra, at p 259 ). Thus, I see no reason for allowing punitive damages in an action brought in the State court system.

Summarizing, the trial court erred in submitting to the jury the causes based upon negligence, contract and fraud. Even if those causes should have been submitted, the court should have charged on contributory negligence and should not have *301 charged on "suitability”. The jury was improperly instructed on the correct measure of compensatory damages and it should not have been allowed to find punitive damages. Accordingly, a new trial should be ordered limited to the cause of action for churning.

Ross and Markewich, JJ., concur with Lynch, J.; Murphy, P. J., and Kupferman, J., concur in an opinion by Murphy, P. J.

Judgment, Supreme Court, New York County, entered on June 13, 1979, reversed, on the law, and vacated, and a new trial directed with respect to the cause of action for churning, without costs and without disbursements.