# Petition — Blyth, Eastman Dillon & Co. v. Rolf

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## Record

- **Collection:** Supreme Court brief
- **Document type:** Petition
- **Published:** January 1, 1978
- **Citation:** 439 U.S. 1039

## Text

t ~~ Supreme Court, U.S,
ti FIL ED
}

OCT 2 i978 |

IN THE

Supreme Court of the Unite

October Term, 1978

No. 78% 95 (

BLYTH, EASTMAN DILLON & CO., INC.
and MICHAEL STOTT,
Petitioners,
v.

DAVID E. ROLP,
Respondent,
and

AKIYOSHI YAMADA,
Defendant.

PETITION FOR A WRIT OF CERTIORARI TO
THE UNITED STATES COURT OF APPEALS
FOR THE SECOND CIRCUIT

Breep, Assorr & MorGan
Attorneys for Petitioners
Blyth Eastman Dillon & Co.
Incorporated and Michael Stott
One Chase Manhattan Plaza
New York, New York 10005
(212) 676-0800

Of Counsel:
Tuomas W. KELLY
Rosert G. Kunpacu

TABLE OF CONTENTS

PAGE
Opinions Below UR i duck ceacestass 2
RA EE OF cs 2
Nee ec wcase quenseceonerseereevs 3
Statute and Rule Involved ......0....0.0....0...eees 4
orl cisnsceosssasrensesscscssesse: | 4
Reasons for Granting the Petition 0.0.0.0... 9
Ne alc iccesngionnssnsvecqssesees: 29

TABLE OF APPENDICES

A. Opinion of the United States Court of —
oc cevvvsssanceessasseacceseeccens Al

B. Order Amending Opinion of the United States
Court of Appeals for the Second Cireuit.........._ A39

C. Opinion and Order of the United States District
Court for the Southern District of New York ... A41

D. Order of the United States Court of Appeals for
the Second Circuit Denying Rehearing.............. A97

E. Order of the United States Court of Appeals for
the Second Circuit Denying Rehearing in Banc... A98

F. Statute and Rule Involved .........0....00.... A99

II

TABLE OF AUTHORITIES

PAGE

Cases:

Bosser v. Magazine, Fed. Sec. L. Rep. (CCH) 96,304
ers Ms SOD vi oks sik cocadescacecleae 11
Brennan v. Midwestern United Life Insurance Co., 259
F. Supp. 673 (N.D. Ind. 1966) and 286 F. Supp.
702 (N.D. Ind. 1968), ajf’d, 417 F.2d 147 (7th Cir.

1969), cert. denied, 397 U.S. 989 (1970) 10, 19
Bronner v. Goldman, 361 F.2d 759 (1st Cir. 1966),
cert. denied, 385 U.S. 933 (1966) ahaxy. 10

Buttrey v. Merrill Lynch, Pierce, Fenner and Smith,

Inc., 410 F.2d 135 (7th Cir. a denied, 396 U.S.
838 (1969) Ar Meteid co ae

Coleco Industries v. Berman, 567 F.2d 569 (3d Cir.
1977), petition for cert. filed, 46 U.S.L.W. 3766

(June 2, 1978) (No. 77-1725) 0000. 11
Crocker-Citizens National Bank v. Controls Metal
Corp., 566 F.2d 631 (9th Cir. 1977) 0.16
Ernst & Ernst v. Hochfelder, 425 U.S. 185 (1976) ....3, 9, 12,
19, 29
Kquity Funding Corp. of America Securities Litiga-
tion, In re, 416 F. Supp. 161 (C.D. Cal. 1976) 12
Goitreich v. San Francisco Investment Corp., 552
F.2d 866 (9th Cir. 1977) take 16
Gould v. American-Hawaiian Steamship Co. 535 F. 2d
room! As FS | A ois eee 10,11
Grimes, Hooper & Messer, Ine. vy. ay ec he 519 F.2d
1089 (9th Cir. 1975) . ES
Gross v. SEC, 418 F.2d 103 (Qa Cis. 1969). Poe Seat Sh 11
Hirsch v. duPont, 553 F.2d 750 (2d Cir, 1977) 11

Hochfelder v. Midwest Stock Exchange, 503 F.2d 364
(7th Cir.), cert. denied, 419 U.S. 785 (1974) ....10, 28

Itt

PAGE

Kerbs v. Fall River Industries, Inc., 502 F.2d 731
(10th Cir. 1974) . Fee Potted ct ro i

Landy v. Federal Deposit Insurance Corp., 486 F.2d
139 (3d Cir. 1973), cert. denied, 416 U.S. 960
(1974) PD eens 10,17
Lanza v. Drexel & Co., 479 F.2d 1277 (2d Cir. 1973) ...24, 25
Lowenschuss v. Kane, 520 F.2d 255 (2d Cir. 1975) ......11, 18

Monsen v. Consolidated Dressed Beef Company, Inc.,
et al., Fed. Sec. L. Rep. (CCH) 996,479 (3d Cir.),
petition for cert. filed, 47 U.S.L.W. 3168 (Sept. 8,

1978) (No. 78-404) ee SB:
Murphy v. McDonnell & Co., 553 F.2d 292 (2d Cir.

1977) . I : 11
Nees v. SEC, 414 F.2d 211 (9th Cir. 1969) 11

Nelson v. Serwold, Fed. See. L. Rep. (CCH) 196, 399
(9th Cir.), petition for cert. filed, 47 U.S.L.W.
3071 (July 26, 1978) (No. 78-182) 0... 11

John Nveeen & Co. v. Sanders, 425 U.S. 929 (1976) 26

Rochez Brothers, Inc. v. Rhoades, 527 F.2d 880 (3d
Cir.), cert. denied, 425 U.S. 993 (1976) 10, 11, 17
Rolf v. Blyth, Eastman Dillon & Co., 424 F. Supp. 1021
(S.D.N.Y. 1977) | seceecereedy 4y 6, 23
Rolf v. Blyth, Eastman Dillon & Co., 570 F.2d 38 (2d
Cir. 1978) es 2, 5, 6, 7, 8, 10, 12,
13, 16, 20, 22, 24
Rolf v. Blyth, Eastman Dillon & Co., Fed. See. L. Rep.
(CCH) 96,525 (2d Cir. 1978) aie: ..2, 7, 13, 21

Sanders v. John Nuveen & Co., 554 F.2d 790 (7th Cir.
ech lrecin cas ostsstbotevinauadaaiernesuan tnbeeiva ny 26, 27

Santa Fe Industries v. Green, 430 U. S. 462 (i6f7)....... B

SEC v. Coffey, 493 F.2d 1304 (6th Cir. 1974), cert.
denied, 420 U.S. 908 (1975)... teen 11, 14

IV

PAGE

SEC v. Coven, Fed. See. L. Rep. (CCH) 196,462

(2d Cir. 1978) , 11, 25, 26
SEC v. First Securities Co. of Chicago, 463 F.2d 981

(7th Cir.), cert. denied, 409 U.S. 880 (1972) ....10, 11, 28
SEC v. Management Dynamies, Inc., 515 F.2d 801

(2d Cir. 1975) Pee be pea ER. 11
Sennott v. Rodman & Renshaw, 474 F.2d 32 (7th

Cir. 1973) \nt of
securities accounts handled by registered representatives.

A438
Appendix C

This Court has jurisdiction over this action brought
to enforce liabilities and duties created under the Exchange
Act and by the rules and regulations promulgated there-
under pursuant to 15 U.S.C. §78aa.

In brief, plaintiff claims that the defendants churned
his account, that they severely altered the nature of his
securities portfolio by placing unsuitable securities therein,
that they failed to properly supervise his account, and that
they aided and abetted each other in these alleged viola-
tions. In sum, plaintiff claims that the defendants took
an account worth $1,423,000 in May of 1969 and returned
to him in January of 1971 an account worth only $225,000
as a result of their fraud. For damages, plaintiff seeks,
inter alia, a return of commissions and interest; an award
equal to the net trading losses claimed; and, although the
complaint states no cause of action under state law, puni-
tive damages of one million dollars.

At the trial of this action, plaintiff abandoned all claims
made against his investment adviser, defendant Akiyoshi
Yamada, in exchange for Yamada’s testimony against the
remaining defendants (see PX-19). Defendants Blyth
Eastman Dillon & Co. (‘“‘BEDCO’’) and its registered
representative Michael Stott assert that they are not liable
because plaintiff has not proved his claims, because
Yamada and not the other defendants controlled plaintiff’s

‘account, and because they breached no duty owed to the

plaintiff. In their answer defendants BEDCO and Stott

assert cross-claims against Yamada for indemnity.
Having heard all the evidence and having considered

the matter, the Court dismisses plaintiff’s churning claim,

A44
Appendix C

but finds defendants BEDCO and Stott liable for violations
of the NYSE and NASD rules, which violations involved
breach of defendants’ fiduciary duties tantamount to fraud.
The Court also finds defendant Stott liable for aiding and
abetting Yamada in the fraud which the investment adviser
perpetrated upon plaintiff in violation of Rule 10b-5 and
through breach of his own fiduciary duties. The following
shall constitute the Court’s findings of fact and conclusions
of law pursuant to Rule 52(a) Fed.R.Civ.P.

The Parties

Plaintiff David E. Rolf is a physician, surgeon and
ophthalmologist, residing in Shaker Heights, Ohio. Dr.
Rolf has practiced medicine since 1936, and at the time of
trial he was sixty-eight years old. Rolf began investing
his earnings in the stock market in 1950, and by 1962 his
portfolio was worth approximately $400,000. Plaintiff tes-
tified that he works long hours at the hospital, and that he
is on twenty-four hour call. During the period 1950
through 1962, plaintiff retained several different Cleveland
brokers, switching firms often because he felt that the
brokers were not sufficiently knowledgeable and that they
did not have his interests at heart. During this period
plaintiff maintained non-discretionary accounts, making bis
own decisions with respect to transactions in securities.
Rolf was an active follower of the stock market, primarily
through the Wall Street Journal. Prior to his first contact
with BEDCO in 1963, plaintiff had maintained accounts
at Merrill Lynch, Pierce, Fenner & Smith, Inc., Paine
Webber & Co., Hartzmark & Co., Prescott & Co., Bache &
Co., and finally, at Walston & Co. where Rolf first engaged
an investment adviser with discretionary authority over

A45
Appendix C

his securities. Rolf stated that during this period his in-
vestment objective was capital growth first and security
second. Plaintiff testified that he switched to discretionary
accounts in 1962 because he was too busy with medicine
to be in constant consultation with brokers, and because
he felt his portfolio was too large for him to handle.

In 1963, plaintiff took his securities to Kastman Dillon
Union Securities & Co., and entrusted their management
to S. Logan Stirling, a partner and a prominent invest-
ment adviser associated with that firm and with defendant
BEDCO, the successor corporation to Eastman Dillon
Union Securities & Co. BEDCO was at all relevant times
a registered broker dealer and a member of the New York
Stock Exchange and the National Association of Securities
Dealers. During the relevant period, BEDCO engaged in
corporate and municipal underwritings, maintained a large
research department, and employed a substantial retail
sales force. BEDCO dealt in listed and over-the-counter
securities for individual clients and as a market-maker
(Tr. 1005).

While Dr. Rolf did not come into contact with BEDCO’s
Michael Stott until 1969, Stott had been a registe ed repre-
sentative with that firm since 1958, and in 1963 Stott was
branch manager of BEDCO’s Paterson, New Jersey, office.
Later Stott became branch manager of BEDCO’s Newark
office; at each branch office one of his primary respon-
sibilities was supervision of the registered representatives
(Tr. 757). In the fall of 1967 Stott returned to BEDCO’s
New York office as a registered representative. By 1969,
Stott was handling approximately 150 individual and in-
stitutional accounts at BEDCO, earning one-third of all

eee ae

A46
Appendix C

commissions on the securities he traded (Tr. 914-15). That
year Stott first met a young and ambitious investment
adviser Akiyoshi Yamada.

Yamada, the son of a wealthy Japanese industrialist,
had attended Harvard Business School for one year prior
to 1965 when he joined the investment banking firm of
Kuhn Loeb & Co. (Tr. 557). Yamada described Kuhn
Loeb as a conservative and prestigious firm which gen-
erally handled ‘‘triple-A’’ clients (Tr. 509). At Kuhn
Loeb, Yamada eventually became an officer of the firm
purportedly with expertise in research and ‘‘special situ-
ations’’. In 1969, at the age of 26, Yamada left Kuhn Loeb
to form an investment partnership; during the period of
the complaint he was not associated with any research
firm or brokerage house (Tr. 558).

Yamada was described at trial by John P. Cione,
BEDCO’s chief compliance officer, as one of a ‘‘new breed”’
of young money-managers who emerged as highly success-
ful in the stock market during 1969 and 1970. Yamada
was committed to ‘‘special situations’? and was one of a
number of young advisers who were making mutual funds,
hedge funds, and assorted speculative ventures very profit-
able (Tr. 1111). During the period of the complaint
Yamada was handling six sizeable portfolios, three insti-
tutional and three individual, of which Dr. Rolf’s was the
largest individual account. Yamada traded plaintiff’s
stocks on a discretionary basis from April 1969 through
January 1971 (Tr. 1041-42).

In 1972, defendant Yamada was enjoined by the Secu’ -
ties and Exchange Commission from engaging in fraudu-
lent and manipulative practices in connection with the

i

A47
Appendix C

purchase and sale of securities. On December 21, 1972, at
the age of thirty, Yamada pleaded guilty before Judge
Irving Ben Cooper of this Court to a criminal conspiracy
to violate the federal securities laws as set forth in Count
One of Indictment 72 Cr. 363, in connection with the sale
of Lady Goldie Bracelet Co. securities. On May 18, 1973,
Yamada plended guilty to two further violations of 18
U.S.C. §371 set forth in criminal informations 73 Cr. 426
and 73 Cr. 427, in connection with a securities fraud in-
volving Microthermal Applications, Inc., and a manipula-
tion of Health Evaluation Systems, Inc., the stock of the
latter being one involved in this action. On June 26, 1973,
Judge Cooper sentenced Yamada to two years in prison,
five years on probation, and fined him $30,000. Thereafter,
on April 15, 1974, Yamada pleaded guilty to submitting
false statements to Judge Cooper in support of a motion
to reduce or suspend his sentence, in violation of 18 U.S.C.
§1001. For this crime, Judge Morris Lasker of this Court
sentenced Yamada to one year, later reduced to six months,
consecutive to the previously imposed period of imprison-
ment. (See DX-VV). Yamada admitted each of these
convictions at trial, and further admitted that he had
perjured himself before the Securities and Exchange Com-
mission (Tr. 695).

The foregoing discussion raises questions regarding Ya-
mada’s credibility as a witness in this action. However,
the Court finds that on many points Yamada’s testimony is
supported by that of Rolf or by documentary evidence.
Further, the Court finds that it cannot credit the whole of
the testimony of either of the other two principal witnesses,
Dr. Rolf and Michael Stott.

A48
Appendia C

Plaintiff’s Investment Intent

Dr. Rolf’s claim that he was an unsophisticated investor
is undereut both by the events leading up to and those
during the period of the complaint. First, as noted, plain-
tiff in earlier years had engaged a series of brokerage firms
ona non-discretionary basis. Further, plaintiff makes no
complaint concerning the securities bought for his account
by S. Logan Stirling of BEDCO from 1963 through March
1969, and there is substantial evidence that certain of those
stocks were aggressive investments.

The best evidence of Rolf’s investment intent during the
Stirling period is contained in a letter from the plaintiff
to Stirling dated June 14, 1967:

‘“My objective is to double my equity. It will be inter-
esting to see how long it takes.”’ (DX-C)

Plaintiff testified that during the Stirling period, he
would have been happy with an annual growth rate of ten
percent, but that he would have been dissatisfied with any-
thing less (Tr. 315).

There is substantial evidence that Dr. Rolf kept careful
watch over his securities, During the period of the eom-
plaint, plaintiff checked the published prices of his seecu-
rities three or four times per week (DX-III). He also
employed a bookkeeper to keep track of his holdings and
their value, both during the Stirling period and during the
period of the complaint (Tr. 307: PX-24),

Further, although Rolf gave Stirling complete disere-
tionary authority over his account (DX-P), the doctor tele-
phoned Stirling’s office as many as six times per week (‘T'r,
741). Rolf testified that he was fully satisfied with Stirling’s

ee

A49
Appendix C

handling of his BEDCO account, and pleased by the fact
that the size of the portfolio more than doubled in the six
years between 1963 and 1969.

In mid-March 1969, S. Logan Stirling took ill and left
BEDCO, having suffered a brain tumor which proved
fatal. Plaintiff claims, but the evidence does not support
the conclusion, that Stirling was incapacitated as early
as late 1968. However, the Court does conclude that
from March through early May 1969, Rolf’s million-
dollar account went unattended by anyone at BEDCO.
BEDCO’s compliance officer admitted not only that the
account was ‘‘dormant’’ during the period between’ Stir-
ling’s illness and Rolf’s selection of Yamada, but further
that during April 1969 some unidentified person at BEDCO
sold one thousand shares of Talcott National Corp., pur-
chased one thousand shares of Asamera Oil Corp., and sold
one thousand shares of Occidental Petroleum Corp. (Tr.
1069-71; see DX-UU). This apparent indifference to plain-
tiff’s investment needs at BEDCO is further illustrated by
the manner in which Akiyoshi Yamada came to be selected
as Rolf’s investment adviser.

Michael Stott testified that following Stirling’s depar-
ture from BEDCO, Mr. Schlesinger, a BEDCO partner,
assigned the Rolf account to him. In late April 1969, Stott
telephoned Rolf and offered to handle his account. Rolf
stated that he wanted an investment adviser, and that Stott,
while a capable and experienced broker, was just not an
analyst with sufficient expertise to direct his investments.
However, Rolf was willing to keep the account at BEDCO,
and he asked Stott to recommend an investment adviser,

OE RT ne ee

A50
Appendix C

Stott testified flatly that he never knew what Rolf’s
investment objectives weve (Tr. 881-82), and further, that
he did not even look at the stocks in plaintiff’s portfolio
prior to their first contact (Tr. 941-48), Accordingly, the
Court concludes that Stott recommended two advisers, Aki-
yoshi Yamada and Donald Geddes, knowing nothing about
the plaintiff beyond the fact that Rolf’s account had been
handled by Mr. Stirling.

While Stott’s trial testimony on the point is somewhat
inconsistent with his deposition (see Tr. 888-89), it appears
that Stott did little more than give plaintiff two names and
two telephone numbers.

Dr. Rolf testified that Stott told him Geddes had eXx-
perience with large accounts; however, according to the
plaintiff, Yamada wa: more fully described. Stott told
Rolf that Yamada had a Harvard Business School back-
ground, that he was from an illustrious and wealthy Jap-
anese family and that he was a brilliant analyst. Rolf
travelled to New York shortly thereafter to interview the
two.

Rolf and Yamada met in a New York restaurant to dis-
cuss plaintiff’s investments. Rolf thought Yamada both
brilliant and capable, but was somewhat wary of Yamada’s
youth (Tr. 31). When Rolf spoke of an interest in pre-
serving his equity, Yamada assured him that none of his
clients had ever lost a penny (Tr. 30).

Yamada’s testimony concerning Rolf’s objectives is con-
sistent with the rest of the evidence in the case. While
Yamada stated that Rolf was unsophisticated and ** grop-
ing’’ for guidance, it was clear to Yamada that Rolf wanted

A51
Appendix C

a very aggressive investment program, and that he was
willing to engage in extensive trading in order to ‘‘double
his equity’? (Tr. 511, 514; PX-3),

Yamada’s testimony to the effect that Rolf was inter-
ested in special situations, new issues, and aggressive trad-
ing is confirmed by a letter written by Rolf to Yamada much
later. In that letter dated September 2, 1970, Rolf referred
to his original investment intent as follows:

‘*As you recall, we started out with roughly $2,000,000.
of Securities which could be used for trading. ... It
was my impression that we would wind up with 3.5 to 5
million in a years time.”? (PX-3)

In brief, Dr. Rolf decided that Yamada would be an
appropriate investment adviser, and although he also inter-
viewed Geddes, plaintiff settled on Yamada.

Rolf and Yamada agreed that Yamada would receive
compensation equal to ten percent of plaintiff’s capital
gains. Rolf requested that trading be done through BED-
CO and Stott, if at all possible. Rolf testified repeatedly,
and the Court credits the statements, that Rolf sought to
balance Yamada’s youth and zeal with BEDCO and Stott’s
reliability and supervision. Indeed, in the plaintiff’s mind,
by the combination of Stott and Yamada, he was obtaining
a “‘Stirling-type’’ operation (Tr. 35). Rolf told Stott that
he expected BEDCO to look after his account, and that he
didn’t intend to keep his commission business at BEDCO
without receiving something in return (Tr. 34). On May 9,
1969, Rolf executed a trading authorization granting to Ya-
mada full discretionary authority over his BEDCO ac-

count:

|

A52
Appendix C

‘*Messrs. Eastman Dillon,
Union Securities & Co.

‘*Gentlemen:

‘“‘T hereby authorize Axr Yamapa to buy, sell, in-
cluding short sales, and trade in, for my account and
risk and in my name, stocks, bonds and any other
securities .... You will kindly follow his instructions
in every respect concerning my account with you...
as he may order and direct. In all matters and in all
things aforementioned he is authorized to act for me
and in my behalf in the same manner and with the same
force and effect as J might or could do... .”? (DX-B)

The Stocks

It is clear from the evidence that in May 1969, Rolf
expected Yamada to take substantial risks for capital gains,
but at the same time to preserve the million dollar portfolio
which Rolf had built up over the years through his own
earnings and efforts and through the efforts of prior brok-
ers. Indeed, since Rolf had no pension or retirement plan,
his stocks represented his main security for his later years
(Tr. 19).

It is also clear that Rolf expected BEDCO to supervise
his account and Rolf understood that Stott was to look
after his interests. As Rolf testified, he made this clear
to Stott at the outset:

‘*T said, ‘Mike, I can take this account any place. I am
going to leave this account here,’ but I said, ‘Look, I
want you to watch this. After all, you are going to
be compensated for this, you are going to get all the
commission business, and when T am back in Cleveland
and busy, you keep your eye on things,’ ”’ (Tr. 34)

A53
Appendia C

Contrary to his expectations, Rolf received from Ya-
mada only the substantial risks and he received no super-
vision by BEDCO. The explanation lies in how Stott and
Yamada saw their respective roles and in the very effective
methods they used to shuffle Rolf between the two of them.

On May 9, 1969, the date when Rolf gave Yamada the
trading anthorization, Rolf’s margin account contained
twenty-three issues, all but one of which had been pur-
chased by Stirling:

Loew’s Theatres Wis.
Leasco Data Processing Wts.
Anaconda (Co.

Asamera Oil Corp.

Avnet Ine.

Buttes Gas & Oil Co.

CNA Financial Corp,

Cities Service Co.

Ebasco Industries Ine.

Glen Alden Corp.

INA Corp.

International Industries Ine.
General Electric Co.
Leesona Corp.

Levin Townsend Computer Corp.
Loew’s Theatres Inc.
National General Corp.
Occidental Petroleum Corp.
Penn Central (Co.

Pittson Co.

Raytheon Corp.

Scientific Resources Corp.
Teledyne Ine.

(DX-UU at 2)

A54
Appendia C

With the exception of the two warrants, each of the
above securities were listed on the American or the New
York Stock Exchange. Eighteen were issued by companies
that had enjoyed continuous profits for five years or longer.
Sixteen paid cash dividends. Yamada characterized six
of the issues as ‘‘blue chip’’ and plaintiff’s expert witness
made similar observations. Yamada described the war-
rants as ‘‘aggressive’’ investments and two of the stocks
as ‘‘racy’’. As of May 9, 1969, after reducing the value
of the portfolio by the debit balance, plaintiff’s margin
account was worth $1,423,000 net.

Both Yamada and Rolf testified that they agreed in
April 1969 to make certain changes in the account. Yamada
was of the opinion that many of the stoeks involved had
seen their day, and that it was time to move on to newer
and more profitable investments. However, Yamada stated
that Rolf did not agree to liquidate the account; that de-
cision was made by the adviser alone. Between May 1969
and January 1970, Yamada sold all 23 issues, 14 at a loss.
Plaintiff made no complaint.

The evidence in this case most fraught with hazards
concerning credibility is the testimony of Stott and Yamada
regarding their relations with each other. However, it
is clear that the two were in contact by telephone several
times daily." Further, Stott continually conveyed to
Yamada the recommendations of BEDCO’s research de-
partment with respect to certain issues, and many of those
stocks were subsequently purchased for Rolf’s account.

1. Stott testified in his deposition that he spoke to Yamada only
twenty or thirty times during the entire one and one-half year period.
However, at trial Stott admitted that he was in daily contact with
Yamada (Tr. 775, 817).

A55
Appendix C

While Yamada and Stott met socially only on occasion,
it is clear that their business interests were intertwined.
Yamada stated that he relied upon Stott for reeommenda-
tions with respect to oil and gas stocks; Stott’s testimony
on this point is equivocal... There is no dispute that Stott
had family connections with the management of two oil
companies whose issues were purchased for Rolf, Standard
Oil of New Jersey and West Coast Production.

Stott testified that he handled a total of six accounts
referred to him by Yamada, but he stated that these ac-
counts produced only a small proportion of his commission
income (Tr. 794-95). Of the forty-one issues purchased
for Rolf by Yamada and Stott during the complaint period,
thirty-five were at some point traded through BEDCO
(PX-24). Yamada testified that Stott recommended a
total of twelve of the issues involved (Tr. 518-530) ; Stott
admitted to recommending six of these.

With respect to the stocks which he did admit he recom-
mended to Yamada, Stott testified that he did not spe-
cifically recommend the stocks for Rolf. Rather, Stott
maintained that he simply gave Yamada the results of
BEDCO’s research, and that the recommendations were in
actuality for Yamada’s more speculative ventures, such as
Takara Partners and the hedge funds (Tr. 780-81). The
Court does not find this attempted distinction credible,
particularly in light of the fact that Stott himself continu-
ally executed purchases and sales in these very stocks for
Rolf’s account; in these circumstances, there can be little

2. When asked if oil stocks were one of his specialties, Stott
answered “not really” (Tr. 965). Stott did admit that Yamada
bought Rolf oil stocks “partially” on his advice (Tr. 965).

A56

Appendix C

doubt that Stott realized that Yamada was, at least in part,
relying on the recommendations made by Stott and by
BEDCO research in determining what to buy for the plain-
tiff; indeed, Stott admitted as much (Tr. 965).

Moreover, BEDCO’s cross-index of all securities traded
by Stott reveals that as to seven, not six, of the issues,
Stott was at the time in question recommending and buying
the stocks for his non-diseretionary accounts of other cus-
tomers (see PX-25). With regard to three more of the
stocks listed by Yamada, the cross-index shows that Stott
bought the issues for other investment advisers as well as
for Yamada. Finally, as to one issue which Yamada
claimed Stott was recommending, defendants report that
there is no record in the cross-index as to whether or not
Stott bought this issue for others (see PX-25). While
PX-25, standing alone, doe not establish that Stott ree-
ommended each of the twelve issues for Rolf, the docu-
ment does serve to credit the testimony of Yamada to the
effect that Stott was involved with the decision to purchase
the issues.* Accordingly, in light of all of the findings
hereinabove, and weighing all the evidence on the question,
including the Court’s observation of the demeanor of the
witnesses, the Court concludes that Stott either recom-
mended or was somehow involved with the decision to pur-
chase the following twelve securities for plaintiff:

Simplex Wire & Cable Co.
Teradyne, Ine.
Standard Oil, N. J.
Reading & Bates Offshore
3. The Court notes that Yamada’s testimony as to the twelve

issues allegedly recommended by Stott was given before defendants
produced the documents constituting the cross-index, PX 25.

A57
Appendix C

Intertherm, Inc.

Food Fair Properties
International Funeral
Natomas Corp.
Asamera Oil Corp.
Carter Wallace, Ine.
West Coast Production
Equity Funding Corp.
(PX-25; Tr. 518-530)

Accordingly, contrary to his testimony at trial, the
Court finds that Stott was indeed involved with the man-
agement of the Rolf account, particularly during the first
eight months of the complaint period. '

One internal regulation at BEDCO prevented the trad-
ing of certain stocks through the firm. According to
BEDCO’s compliance officer, BEDCO would not solicit
stocks which were selling at less than $5.00 per share (Tr.
978-79). For this reason, as well as for reasons of his
own, between May 1969 and March 1971, Yamada opened
no less than eight other accounts in plaintiff’s name at
eight different brokerage firms. Plaintiff stated that he
was almost completely ignorant as to why all these other
accounts were being opened. Upon inquiry, he learned
that in some cases, Yamada had opened the accounts to
give other broker associates some business; in other cases,
Yamada opened the accounts to buy stocks from the firms
that were engaged in underwriting new issues which
BEDCO would not handle.

Despite these new accounts and the purchase and sale
of stocks through those houses, Dr. Rolf was under the
impression that BEDCO was looking after his portfolio

A58
Appendix C

as a whole. Indeed, the BEDCO account was a custody
account, and in the great majority of cases where stocks
were bought elsewhere by Yamada, Stott nevertheless re-
ceived confirmation slips and the securities were delivered
into BEDCO. Even though BEDCO received no commis-
sions on these outside purchases, in a few cases the stocks
were subsequently sold through BEDCO, producing com-
missions for Stott and his employer. According to Dr.
Rolf, Stott assured him that BEDCO could still oversee
the account since the stocks were often delivered in, and
since confirmation slips were sent to Stott.

As Yamada’s liquidation program quickly resulted in
a wealth of new issues, many of which were over-the-counter
stocks, Dr. Rolf was apparently both excited by the chal-
lenge of speculation and concerned over the strange names
of the new issues. Beginning in July 1969, Rolf began
calling Stott for assurance and for information about the
new stocks. Stott testified that Rolf called him six or seven
times per month from July 1969 through May 1970. There-
after, Stott or his secretary called Rolf every day to give
him quotations on the over-the-counter prices. There is no
evidence that Rolf and Yamada were in such frequent
contact.

The testimony is consistent that Rolf called Stott to
complain about the amount of trading and the nature of
the stocks in the account. Stott stated that he simply told
Rolf to speak to Yamada. However, plaintiff’s version of
the calls, which is supported by certain documentary evi-
dence and by the testimony of Yamada, is that Stott con-
tinually assured Rolf with respect to Yamada’s competence
and ability, and that Stott repeatedly stated that if Yamada

A59
Appendix C

had decided to buy a stock, then Stott was sure that it was
okay. Yamada referred to this arrangement as a procedure
whereby if Rolf called him to complain, Yamada would call
up Stott and tell Stott to speak to Rolf and ‘‘hold his
hand.’’ (Tr. 545). The Court finds that this was exactly
what occurred.

Rolf believed that Stott was intimately involved with
the management of the account. Indeed, since Stott and
Yamada were in daily contact discussing securities which
ended up in the plaintiff’s account, Rolf’s was a reasonable
belief. It was moreover a correct belief; Stott was involved
with the management of the account.

The period between May 1969 and January 1970 was
characterized by the sale of the listed stocks and the pur-
chase of very different issues. While there was some short-
swing trading in U. S. Natural Resources between May 22
and 26, 1969 (DX-UU at 3), and while there was one short-
swing trade of International Funeral Services in December
1969 (DX-UU at 17), Yamada’s program during that period
was a gradual liquidation of the Stirling securities and the
purchase of large quantities of unlisted and even restricted
stocks. By the completion of the transformation in Janu-
ary 1970, the account stood as follows:

Delanair, Ine. (restricted)
Food Fair Properties, Ine.
Holobeam, Inc.

Monarch Industries, Inc.
Synchronex Corp.

West Coast Production Co.
Benquet Consolidated Corp.
Equity Funding Corp.

A60
Appendix C

Outlet Company
Simplex Wire & Cable Co.
(DX-UU at 20)

In eight months, the value of Rolf’s securities had
dropped by over $700,000. Further, while his net position
was approximately $712,000, $338,000 of this was invested
in Delanair, a restricted stock through which plaintiff was
clearly defrauded by Yamada.

In August of 1969, Yamada persuaded Rolf to invest
nearly $400,000 in stock, calls and warrants of Delanair,
Inc. The securities were purchased through BEDCO, but
the parties all agree that the stock was initially Yamada’s
idea and that Stott received no commissions on the pur-
chase. Rolf was concerned that the investment would tie
up too large a portion of his money, so he telephoned Stott
after he had spoken with Yamada but before the funds had
been committed. Stott stated that if Yamada had recom-
mended the transaction, then it must be okay; in effect,
Stott said to go through with it (Tr. 82). The Court does
not accept Stott’s statement to the effect that he never
discussed the stock with anyone.

The lure of the Delanair investment was Yamada’s rep-
resentation to plaintiff that there would be a secondary or
a public offering of the stock in six months and that Rolf
would double or triple his investment thereby. Rolf stated
at trial, and the Court finds, that Yamada’s promise of a
secondary offering was fraudulent.

Delanair never did achieve a secondary offering, and
plaintiff found himseif with restricted stock which rapidly
declined in value. In 1972 Rolf brought a civil action

A61
Appendix C

against Delanair, Yamada, D. H. Blair & Co., and others;
in 1973 that action was settled for $175,000. BEDCO was
not a party defendant to that action (DX-NN through DX-
QQ). When asked to assess the quality of the Delanair
issue, plaintiff’s expert witness described the stock as the
‘*lowest of the low’’.

Four of the issues in plaintiff’s BEDCO account as of
January 1970 were, as the Court has found, bought on
Stott’s recommendation or with his participation: Food
Fair, West Coast Production, Equity Funding, and Simplex
Wire. Each of these stocks was eventually sold at a loss,
the total amounting to over $65,000. However, there is no
evidence that any of these four stocks were unsuitable for
Rolf.

Monarch Industries was another substantial investment
made by Yamada for Rolf in an obscure issue which re-
sulted in a substantial loss. The stock was both bought and
sold through brokerage houses other than BEDCO. A\l-
though Yamada stated that he discussed the stock with
Stott between May and June 1969, he testified that the
investment was his own decision. Rolf lost $159,000 on the
transaction (PX-24). Plaintiff’s expert witness rated Mon-
arch as ‘‘low quality’’.

Two other stocks bought in this period merit discussion,
for they indicate the beginning of Yamada’s trading for
Rolf in securities which Yamada knew were being manipu-
lated. The evidence is equivocal with respect to whether
Holobeam, bought in January 1970, was manipulated, but
Yamada testified that Synchronex Corp., purchased in Octo-

4. Thus, here plaintiff seeks damages of $225,000 only by reason
of the Delanair matter

A62
Appendix C

ber 1969, was a manipulated security. It is clear that
neither Stott nor Rolf knew that these stocks were being
used as vehicles to defraud others. Plaintiff’s expert de-
scribed the quality of these two stocks as ‘‘lowest of the
low’’.

While there were many fewer trades in February and
March 1970 than there had been in prior months, the market
values of Delanair, Holobeam, Monarch and Synchronex de-
clined drastically. On March 29, 1970, the net value of
Rolf’s account had fallen to $446,000, nearly half of which
was still in Delanair. (See DX-UU at 22-24). Rolf by
this time was becoming highly disturbed about his stocks,
and as noted above, he began calling Stott on a regular
basis. In early April 1970, Rolf called Stott and com-
plained that there had been in excess of five million dollars
in transactions in the account since May 1969. For the first
time Stott responded in writing, and for the first time Stott
began to maintain that he was only an ‘‘order taker’’. In
a letter dated April 10, 1970, Stott wrote to Rolf as follows:

‘*As you know, I have absolutely nothing to say over
the management and handling of this account. When
you signed your contract with Aki it gave him com-
plete discretion. All I am with this account is basically
an order taker.

**T think what you should do is sit down with Aki
and spell out a complete program to help you recoup
the losses that have been incurred in this account in
the past year or so.’’ (DX-E).

Yamada stated that in his opinion this letter was false
since Stott was much more than an order taker (Tr. 548).

A63
Appendix C

This was also Rolf’s view as is seen from a letter written
to Stott by Rolf in reply, dated April 15, 1970:

‘*Since you work closely with Aki, these are his plans
for the near future:

1. The utilization of warrants and options as
they come up.

2. A take out on Monarch Industries.

3. Placement of Delanair when the Secondary

comes out.
* * *

‘*In the meantime, I would appreciate your doing the
following:

1. Have your secretary get a daily quote on my
O-T-C securities.

2. Notify me promptly if there is a significant
change up or down.

3. Keep me informed regarding any information
you consider pertinent.’’
(PX-1)

Stott testified that while he did not make a written
reply to this letter, he did call Rolf and stress that Yamada,
and not the broker, was the one handling the account.
However, it is clear from the correspondence that followed
in the fall of 1970 that Rolf failed to get the message. In
September, he sent Stott another letter detailing Yamada’s
plan for recouping losses (PX-2, PX-3). On October 7,
1970, Rolf wrote a letter to Stott which ended with the ad-
monition: ‘‘Remember—you’re my man in N.Y. Please
keep the program on target.’’ (PX-4).

A64
Appendix C

Finally, on December 14, 1970, Rolf wrote to Stott
asking him to ‘‘please keep your pulse on the situation
and also keep me informed.’’ (PX-5). Stott never wrote
back to correct that which he now maintains was a con-
tinuing misimpression on Rolf’s part as to BEDCO’s
duties.

Despite the fact that Yamada had opened eight new
accounts for him, Rolf apparently was not content to leave
the management of all of his securities to his adviser. In
June 1969, Rolf had opened a non-diseretionary account at
Hornblower & Weeks Hemphill, Noyes, and over the fol-
lowing months he bought five issues there. The stocks
were as follows:

American Scientific Corp.

Dasa Corp.

Data Network Mega Systems, Inc.
Ampex Corp.

Mohawk Data Science

(DX R, DX R-1)

Rolf testified generally that he did not really know any-
thing about these stocks. Indeed, plaintiff’s own expert
witness, on cross-examination, testified that Dasa Corp.
was a ‘‘low quality”’’ issue.

During this period, Yamada turned to even more specu-
lative issues in order to make some profits for the plaintiff.
He also began investing in issues which he testified were
manipulated. According to Yamada, during the Delanair
and Monarch ventures, Stott became concerned that there
was a lack of trading in the account, and thus a lack of
commissions. It is clear that Yamada had no interest in

A65
Appendix C

commissions for himself; his compensation was to come
from a percentage of capital gains and further, Yamada
was given the opportunity to employ Rolf’s account as
‘‘buying power’’ for his own manipulations.

According to Yamada, in April 1970 Stott informed
him that his superiors at BEDCO were becoming con-
cerned about the Rolf account. However, this statement
is not supported by any other evidence and thus the Court
is not inclined to credit the testimony. Nevertheless, the
Court does give some weight to Yamada’s statement that
Stott referred to the stocks in the Rolf account as ‘‘junk.’’
(Tr. 542-44).°

In brief, the Court concludes on this point that Stott
did indeed consider many of the securities to be ‘‘junk’’
and that he told this to Yamada. However, it is clear that
he never made such a statement to Rolf, and all parties
agree that Stott never recommended against any purchase.

During 1970, Yamada bought for Rolf the following
securities which Yamada knew were being manipulated,
either before or shortly after the dates of purchase:

Visual Sciences, Inc.
Health Evaluation Systems
Hair Extension Centers
GPI Enterprises, Inc.

MH Studios

Tranquilaire Mental Health
Creative Polymer Products

5. Again, Stott’s testimony on the point is equivocal ; Stott denied
that he had ever threatened to tell Rolf about the “junk” in the ac-
count unless Yamada gave him more commis:ions; however, Stott
stated that he did not know if he ever used the term “junk” to de-
scribe low quality securities (Tr. 842).

A66
Appendix C

Plaintiff’s expert testified that in his opinion each of
these stocks were ‘‘lowest of the low’’ quality. Many were
new issues; all were highly speculative; public information
was unavailable as to the majority of the issuers. Stott
denied that he recommended any of these stocks, and Ya-
mada testified that he traded in these stocks on his own.
Five of the stocks were traded at other brokerage houses,
and there is no credible evidence that Stott was aware of
the fact that Yamada was using these stocks as vehicles to
defraud. Further, Rolf was not the vietim of the manipu-
lations; Yamada made fairly substantial profits for Rolf
on short-term trading in six of the seven manipulated
stocks. Indeed, Yamada testified that in his opinion these
stocks were suitable for Rolf (Tr. 696-702). For the rea-
sons discussed within, the Court concludes otherwise.

Yamada also undertook further schemes in an attempt
to recoup losses for Rolf through speculative ventures.
Yamada and Rolf decided to sell Monarch Industries at a
significant loss and invest the proceeds in the Takara Part-
ners hedge fund. Yamada also continued to assure the
plaintiff that Delanair would some day come through with
its secondary offering. As late as September 1970, Rolf
still apparently believed that he could regain his lost capital
by speculative ventures, including ‘‘special situations’’,
‘new issues’’ and ‘‘founder’s stock’’ (see PX-3). He
wrote to Yamada by letter dated September 2, 1970, and
indicated that he was continuing to discuss with Stott the
question of Yamada’s competence to achieve plaintiff’s in-
vestment goals. In this letter Rolf began to once more
emphasize the need for preservation of capital:

A67
Appendix C

‘‘For future endeavors in the years to come, it is ob-
vious that we must again regain the same substantial
base we started from. The old rule that the preserva-
tion of capital is the first rule of investment has never

peen more true.’’
(PX-3)

Through the end of the year 1970, as plaintiff’s net posi-
tion declined to $225,000, Rolf continually sent to Stott
copies of his correspondence with Yamada. It was during
this period that Rolf referred to Stott as his ‘‘man in New
York’’ and asked Stott to keep his pulse on the situation.
However, in late January 1971, Rolf took the step of pur-
chasing four conservative listed bank stocks through an-
other broker at BEDCO. Shortly thereafter, the SEC
investigation of Yamada became public knowledge. BED-
CO was visited by representatives of the Commission.
BEDCO’s chief compliance officer called Stott in and in-
formed him that BEDCO wonld take no further orders
from Yamada for the Rolf account. Shortly thereafter
plaintiff was informed of the SEC investigation. The
balloon of Yamada’s manipulations was collapsing.

In his testimony at trial, Yamada described the func-
tional aspects of the several manipulations involved in this
lawsuit. Generally, Yamada along with a group of other
money managers and underwriters would seek to obtain
control of new, thinly-traded, over-the-counter securities.
Once the group had purchased the great majority of the
outstanding shares, they would begin to trade the stock up,
by selling to each other at gradually higher and higher
prices. Thus, the market price would be manipulated up-
wards, and other investors would become interested in the

A68
Appendix C

stock, thinking that the price rise was due to legitimate
factors. At the end of the manipulation, the conspirators
would sell out, leaving an unsuspecting group of investors
with a large amount of artificially-inflated stock. Often,
once the manipulaters left the scene, the price of the stock
would plummet, as was the case with Health Evaluation
Systems (Tr. 624-25).

Yamada testified that he often assured Stott that these
stocks were ‘‘under control’’ and that the price would ‘‘go
up’’. Similarly, Yamada stated that he told Stott there
was a ‘‘box’’, a term Yamada used to encompass not only
control over a given security, but also an illegal manipula-
tion (T'r. 600-27). Stott testified that he knew nothing
wrong about any of these stocks, in effect denying that he
ever knew of the manipulations. Stott aiso denied ever
hearing the term ‘‘box’’ used to imply or indicate a manip-
ulation (Tr. 842-57). Faced with this direct conflict be-
tween Yamada and Stott’s testimony, the Court chooses to
discredit the allegations made by the investment adviser.
However, as noted above, the Court does find that Stott
knew these stocks were highly speculative, that they were
‘thigh-fliers’’ and that for the most part, they were ‘‘junk’’.

At trial, Stott described what he believed were his duties
to Rolf during the period in question. In brief, Stott
claimed that he was no more than an ‘‘order taker’’ whose
job it was to add up the debits and the credits. Stott saw
himself as a ‘‘bookkeeper’’ (Tr. 814) and he limited his
supervisory activities to a five-minute monthly review of
the plaintiff’s statements (Tr. 821). Stott testified that he
believed the phrase ‘‘my man in New York”’ in Rolf’s Octo-
ber 1970 letter (PX-4) to mean that Rolf expected Stott to

A69
Appendix C

act as a diligent order taker (Tr. 835). He stated that to
him, the phrase ‘‘please keep your pulse on the situation’’
in PX-5 meant that Rolf expected him to add up the debits
and the eredits accurately (Tr. 836). Stott stated that he
never knew plaintiff’s investment intent (Tr. 881-82). Stott
also stated that he never sent Health Evaluation or Hair
Extension through BEDCO research to determine whether
either was an appropriate investment for plaintiff (Tr.
901).

Stott and his employer maintain that they are relieved
of almost every regulatory and fiduciary duty owed to Rolf
solely because of the trading authorization executed by
Rolf for Yamada. When asked by the Court to describe
his view of his duties to a enstomer where the account was
being traded by an investment advisor, Stott responded as
follows:

‘*Unless there was something blatantly wrong with the
order that I got from an investment advisor, or I had
knowledge that this was, you know, something illegal
was going on in the security, and if my firm permitted
the order to be executed, I felt it was perfectly all right,
yes. That is what I had been told.’ (Tr. at 863)

The testimony of BEDCO’s chief compliance officer,
John P. Cione, was to the same effect. As far as BEDCO
was concerned in 1969-1970, if an investment advisor was
in the picture, the brokerage firm was relieved from (1)
the duty to investigate trading that appeared to be exces-
sive; (2) the suitability of transactions made for the cus-
tomer through the firm; and (3) the general duty to know
the customer and learn the essential facts about him and
his needs (see Tr. 1095).

A70
Appendix C

Although BEDCO employed a computer-assisted pro-
gram to detect excessive trading, and although that sys-
tem was able to detect any monthly trading in any account
which would exceed 3.5 if computed for an annual period,
Cione testified that once the compliance officer determined
that the trading was occurring in an investment advisory
account, no further questions would be asked (Tr. 1074).
Further, said Cione, even had the officer gone further and
spoken to Stott, the fact that Yamada was the adviser
would have itself foreclosed further inquiry, due to Yam-
ada’s reputation at the time.

BEDCO did no study of any of the stocks bought for
Rolf elsewhere and delivered into the custody account.
While the firm did require that any stock with a rating
below B-plus receive special research approval before a
broker could recommend it, BEDCO did not apply any
such ‘‘suitability’’ standard to stocks purchased in dis-
cretionary accounts run by investment advisers (Tr. 1049).
Thus, despite the fact that many of the stocks bought for
Rolf were not even listed in any rating manuals at all,
and despite the fact that many of them were ‘‘high-flying’’
new issues which Yamada was manipulating, BEDCO
never identified as unsuitable any security purchased for
Rolf.

Thus, with the exception of the recommendations made
by Stott in the early part of the period, it appears that the
only services rendered to Dr. Rolf by Stott and BEDCO
were trading the account and dutifully mailing to plaintiff
confirmation slips. For these efforts the defendants
BEDCO and Stott received commissions in a total amount

A71
Appendix C

of approximately $42,000. Stott testified that his one-third
share was only a small percentage of his total income in
1969-1970.

Discussion

The Duties of Brokers

The registered representative of a broker dealer oc-
cupies a unique position in the scheme of securities regu-
lation. Since he as broker is the person who actually
trades securities for the investing public, his very employ-
ment is ‘‘in connection with the purchase and sale of
securities.’’ (Rule 10b-5). Indeed, a broker such as the
defendant Stott conducts himself and carries out his daily
routine through the instrumentalities of the national seeu-
rity exchanges and the over-the-counter market. (Rule
10b-5; Rule 15cl-2).

For these and related reasons, courts have concluded
that the broker, by virtue of his position, owes a fiduciary
duty to his customer. Moscarelli v. Stamm, 288 F.Supp.
453 (K.D.N.Y.1968); Lorenz v. Watson, 258 F.Supp. 724
(E.D.Pa.1966). See Carras v. Burns, 516 F.2d 251, 258
(4th Cir. 1975); Hanly v. SEC, 415 F.2d 589, 597 (2d Cir.
1969). Since brokers are traditionally compensated by
commissions in direct proportion to purchases and sales,
the opportunity to take advantage of the client is always
present. To ensure that the broker fulfills his fiduciary
duty, and to protect against frauds upon the customer, the
broker and his employer are made subject to a series of
obligations, the fraudulent breach of which may render

A72
Appendia C

them liable to the investor in damages. See Zweig v.
Hearst Corp., 521 F.2d 1129, 1135 (9th Cir.), cert. denied,
423 U.S. 1025, 96 S.Ct. 469, 46 L.Ed.2d 399 (1975); Jacobs,
The Impact of Securities Exchange Rule 10b-5 on Broker
Dealers, 57 Cornell L.Rey. 869 (1972). Among the possible
liabilites involved in the instant action are damages for
alleged violations of Rule 10b-5 and Rule 15cl-2, and of the
rules of the New York Stock Exchange and of the National
Association of Securities Dealers.

Rule 405 of the New York Stock Exchange provides in
part as follows:

‘‘Kvery member organization is required through
a general partner, a principal executive officer or a
person or persons designated under the provisions of
Rule 342(b)(1) to

**(1) Use due diligence to learn the essential facts

relative to every customer, every order, every cash or

margin account accepted or carried by such organiza-

tion and every person holding power of attorney over

any account accepted or carried by such organization.
[and to]

**(2) Supervise diligently all accounts handled by
registered representatives of the organization.’’
Article III, Section 2 of the Rules of Fair Practice of the
National Association of Securities Dealers, Ine., provides

as follows:

‘*In recommending to a customer the purchase, sale
or exchange of any security, a member shall have rea-
sonable grounds for believing that the recommendation
is suitable for such customer upon the basis of the

AZ73
Appendix C

facts, if any, disclosed by such customer as to his other
security holdings and as to his financial situation and
needs.”’

These rules and others impose a series of duties upon
brokers which may be enforced through SEC enforcement
actions and, increasingly, through private actions. While
the rules of the NYSE and the NASD set forth duties
which, by the language of the rules, appear to sound in
negligence, when their breach operates in a manner tanta-
mount to fraud, liability under Rule 10b-5 may be present.
See Buttrey v. Merrill Lynch, Pierce, Fenner & Smith,
Inc., 410 F.2d 135, 143 (7th Cir.), cert. denied, 396 U.S. 838,
90 S.Ct. 98, 24 L.Ed.2d 88 (1969).

The broker/customer relationship is rife with implied
representations as to the broker’s honesty, diligence and
com,etence. It has been suggested that the failure to
comply with the implied representations of due diligence
and suitability can constitute a device or scheme actionable
under Rule 10b-5. See Starkman v. Seroussi, 377 F.Supp.
518, 524 (S.D.N.Y. 1974). (Weinfeld, J.). As Judge Timbers
wrote, albeit in an enforcement proceeding:

‘*Brokers and salesmen are ‘under a duty to inves-
tigate, and their violation of that duty brings them
within the term ‘‘willful’’ in the Exchange Act.’ Thus,
a salesman cannot deliberately ignore that which he
has a duty to know and recklessly state facts about
matters of which he is ignorant. ... The fact that
his customers may be sophisticated and knowledgeable
does not warrant a less stringent standard.’’ (Hanly
v. SEC, 415 F.2d 589, 595-96 (2d Cir. 1969) (footnote
omitted) ).

A74

Appendix C

In this case Dr. Rolf claims that the defendants Stott
and BEDCO breached fiduciary duties owed to him by vir-
tue of their position. Rolf also asserts Rule 10b-5 liability
for churning, and secondary liability for aiding and
abetting. Defendants’ primary defense is the trading au-
thorization.

Through their witnesses and in their submissions, de-
fendants have argued that the trading authorization ex-
ecuted by Rolf operated to immunize BEDCO and Stott
from all liability, and that it relieved them of the various
regulatory and fiduciary duties described above. How-
ever, despite all these protestations and opinions rendered
by the defendants with respect to the matter, the Court
must note that defendants have cited absolutely no federal
authority to support their argument that the presence of
a trading authorization operates to relieve a member firm
of its NYSE and NASD duties to its customers.

Rather, as Professor Jacobs has written, ‘‘contractual
privity is not a sine qua non of broker liability.” J acobs,
supra at 876.

License revocation proceedings before the Securities
and Exchange Commission provide the most persuasive
authority on the question. In Jn re William I. Hay, 19
S.E.C. 397 (1945), an investment adviser holding a power
of attorney engaged in cross-trading and self-dealing,
defrauding a number of clients whose stocks were traded
through respondent’s brokerage house. Further, the ad-
viser bought for his clients large quantities of hopelessly
speculative securities. In that proceeding, the brokers
asserted the identical defense heard here—that they were

AT75
Appendia C

fully authorized to accept directions from the adviser, that
they never directly advised the clients, and that the
power of attorney insulated them from all direct brokerage
duties to the clients. The Commission found the argument
to be without merit.

Starting from the proposition that the respondent must
have known of the adviser’s frauds because they were self-
evident, the Commission placed upon the brokers a duty of
full disclosure to the customer. See 19 S.E.C. at 406-07.
Further, the Commission concluded that the brokers had a
duty to inform the clients concerning the speculative and
financially unsound nature of the investments. The only
alternative open to the respondents, the Commission con-
cluded, was to refuse to accept further orders from the

adviser.

‘‘Respondents adopted neither course. The result was
that the customers were utterly without protection—
served by two agents, one with discretionary power
over their account acting faithlessly, and the other a
broker, knowing of the faithlessness yet claiming to be
free of any duties.’’ (Jd. at 407).

A similar principle was announced by the Commission
a few years later. In re Moore & Co., 32 S.E.C. 191 (1951),
involved a situation where the adviser, one Furlong, manip-
ulated the accounts of his clients through one Mrs. Ross, a
broker with the respondent firm. Although she had en-
gaged in cross-trading, simultaneous buying and selling,
and other fraudulent transactions at Furlong’s direction,
the broker testified that she believed the adviser was au-
thorized to engage in such activities. The Commission re-

AT76
Appendia C

jected the notion that Mrs. Ross was relieved of her usual
duties as a broker:

‘*Furlong’s power of attorney to deal on behalf of his
customers, rather than leading Mrs. Ross to believe,
as she contends, that they authorized Furlong’s con-
duct, should have made her realize that he was subject
to a high standard of fiduciary responsibility and loy-
alty with which the transactions in question were on
their face inconsistent. Under such circumstances, she
could have insulated herself from responsibility only
by making the fullest disclosures to his customers or
by making certain that his conduct was actually author-

ized by his customers. She did neither.’’ (32 S.E.C.
at 196).

Drawing an inference of willfulness from the circum-
stances, the Commission determined that the broker’s regis-
tration should be suspended.

Against the rather substantial thrust of these decisions,
defendants present only a single case on point, Carroll v.
Doolittle, 21 Mise.2d 203, 191 N.Y.S.2d 398 (1959). There
the state trial court determined that a broker had no state
law fiduciary duty to enquire behind the decisions of an
investment adviser. This Court is constrained to reject
Carroll and to accept the view of the Securities and Ex-
change Commission. While the precedent of SEC actions
is not controlling in this civil suit for damages, the Court
does find the Commission’s decisions persuasive.

As the federal agency charged with the multifaceted
duties of registration and regulation of broker dealers, as
well as with the primary responsibility for enforcement
of securities laws designed to protect the investor, the Com-

AT77
Appendix C

mission must be afforded the appropriate degree of defer-
ence and its administrative judgments accorded great
weight. See SEC v. Chenery Corp., 332 U.S. 194, 209, 67
S.Ct. 1575, 91 L.Ed. 1995 (1947).

In this case there are additional reasons supporting the
conclusion that the execution of the trading authorization
did not operate to relieve Stott and BEDCO of their usual
duties as brokers or to insulate them from liability under
the securities laws. Here Dr. Rolf had for six years re-
ceived from BEDCO the services of an investment adviser
and a broker, through the offices of S. Logan Stirling.
During that period BEDCO placed Rolf into aggressive but
high quality investments. Rolf clearly expected, and the
Court concludes he had a right to expect, that BEDCO
would continue to exercise some informed judgment on his
behalf during the Yamada period. Indeed, during this
period Rolf had working for him at BEDCO one of the
firm’s largest producers, Stott, who had been a branch
manager at two different BEDCO offices.

In addition, it was BEDCO, not Yamada, that was a
member of the Stock Exchange and of NASD during the
period in question. BEDCO, as a large firm in a highly
regulated business, was required to implement a series of
safeguards to protect its customers. Yamada was associ-
ated with no brokerage firm and, as far as the Court is
aware, had no direct access to any research department.
Despite his credentials and his reputation at the time, Ya-
mada was not in any position and had no express obligation
to perform for Dr. Rolf each of the assorted duties im-
posed upon broker dealers by the NYSE and NASD rules.

A78
Appendia C

Further, even if in the abstract a trading authorization
relieves the broker from his usual supervisory and due
diligence duties, here the conduct of the defendant Stott
resulted in his direct participation in the management of
the account. While Yamada had the authorization, the
Court has found that Stott influenced Yamada’s decision-
making and recommended to Yamada stocks for Rolf. By
these actions, Stott himself pierced the veil of any protec-
tion the power of attorney might have given to him or to
BEDCO. A broker cannot recommend stocks to an invest-
ment adviser at will and then back off and claim he was no
more than an ‘‘order taker’? when such judgments are
challenged.

Finally, the Court notes that defendants are unable to
point to any language in the NYSE rules which indicates
that the duties of a broker are lessened when an investment
adviser handles the account. Indeed, the language of Rule
405(1) which requires the broker to discover all pertinent
facts with respect to the adviser indicates to this Court
that due diligence is required in this situation also.

Accordingly, under the facts and circumstances herein,
and upon the authority of the decisions discussed above, the
Court concludes that the execution of the trading authori-
zation in this ease did not relieve BEDCO or Stott from
their duties to supervise the account and to employ due
diligence with respect thereto.

Churning

When a broker engages in excessive trading in disregard
of the customer’s investment objectives for the purpose of

A79
Appendix C

generating commission business, the customer may hold
the broker liable for ‘‘churning’’ the account in violation
of Rule 10b-5. See Carras v. Burns, 516 F.2d 251, 258 (4th
Cir. 1975) ; Greenfeld v. D. H. Blair & Co., [1975-76] CCH
Fed.Sec.L.Rep. 95,239 (S.D.N.Y. 1975). As part of his
proof, plaintiff must also demonstrate scienter, that is, that
the broker acted with intent to defraud or with a willful
and reckless disregard for whether his actions constituted
fraud. Ernst € Ernst v. Iochfelder, 425 U.S. 185, 193, 96
S.Ct. 1875, 47 L.Ed.2d 668 (1976); Lanza v. Drexel & Co.,
479 F.2d 1277, 1306 (2d Cir. 1973) (en bane); see Arthur
Lipper Corp, v. SEC, 547 F.2d 171 at 180 (2d Cir. 1976).

To prevail on this claim, plaintiff must show not only
that the trading in his account was excessive under the
cases, but further that the amount of the trading was un-
justified in light of his investment objectives. Van Alen v.
Dominick & Dominick, 71 Civ. 5438 (S.D.N.Y. December
22, 1976); Newburger, Loeb & Co. v. Gross, 365 F.Supp.
1364, 1371 (S.D.N.Y. 1973) ; Hecht v. Harris, Upham & Co.,
283 F.Supp. 417, 435 (N.D.Cal. 1968), modified on other
grounds, 430 F.2d 1202 (9th Cir. 1970).

Here the plaintiff has failed to establish the first ele-
ment of churning, that of excessive trading. During the
period of the complaint, the annual turnover rate, even as
calculated by the plaintiff, was never any higher than 1.85.
This is not excessive under the decisions. See Van Alen
v. Dominick &€ Dominick, supra; Moscarelli v. Stamm, 288
F.Supp. 453 (H.D.N.Y. 1968); Hecht v. Harris, Upham &
Co., supra. Indeed, it is the view of at least one commen-
tator that an annual turnover rate will not be considered

A80
Appendix C

excessive unless it begins to approach six. See Note, Churn-
ing by Securities Dealers, 80 Harv.L.Rev. 869 (1967).

The Court’s finding that the turnover was not excessive
is confirmed by the other circumstances present in the case.
First, much of the turnover during the. year 1969 came as
a result of Yamada’s liquidation of the Stirling securities,
a major overhaul of the account which plaintiff approved.
Further, it is clear that plaintiff expected that the pro-
ceeds of the liquidation would be used for ‘‘trading’’ rather
than for long-term investment. See PX-3. As the fore-
going factual discussion indicates, plaintiff’s primary goal
was capital growth; he was willing to take the risks in-
volved in short-term trading, and he never instructed Ya-
mada not to engage in short-swing trades. Plaintiff’s twice-
stated investment intent was to double his equity ; indeed, in
1969 he expected his equity to double in approximately one
year. In brief, the Court concludes that Dr. Rolf was a
trader, not an investor, and that he is now estopped from
maintaining that there was excessive trading in his ae-
count. See Landry v. Hemphill, Noyes & Co., 473 F.2d 365
(1st Cir. 1973).

While the presence of Yamada does not operate to re-
lieve Stott and BEDCO of their duties as brokers, the fact
that the adviser made the majority of the investment and
trading decisions militates against any finding that Stott
traded the account in order to generate commission busi-
ness. At trial, Yamada set forth his own reasons for many
of the transactions hereii, and while Yamada’s reasons
were not entirely legitimate—involving as they did ‘‘free-
riding’’ stock manipulations—it is clear that the trades
were not without some investment purpose. Further, Stott

A81
Appendix C

did not have exclusive control over the buy and sell deci-
sions, even though he had some influence upon Yamada’s
decision-making process. A finding that the broker had
virtually exclusive control over the trading is a necessary
prerequisite to liability for churning. See Carras v. Burns,
516 F.2d 251, 258 (4th Cir. 1975); Greenfeld v. D. H. Blair
& Co., supra; Hecht v. Harris, Upham & Co., supra, 283
F.Supp. at 433; see also Newburger, Loeb & Co. v. Gross,
[Current Binder] CCH Fed.Sec.L.Rep. 195,649 (S.D.N.Y.
July 8, 1976). Accordingly, the churning claim must be
dismissed.

Rules Violations

Since the Court has concluded that the defendant Stott
was not aware of the manipulations in the Rolf account
and that Stott did not churn the account, plaintiff’s only
remaining claims are based upon alleged violations of the
NYSE and NASD rules. Accordingly, the Court must en-
quire into the open question of whether or not an investor
may prevail in a private cause of action based upon viola-
tions of the regulatory rules.

In Colonial Realty v. Bache & Co., 358 F.2d 178 (2d Cir.
1966), the court concluded that no private cause of action
could be brought under the Exchange Act to hold a broker
liable in damages for failure to employ ‘‘just and equita-
ble’’ principles of trade, as required by the NASD rules.
The court reasoned that such liability would too closely
parallel the common law, and that the concept of ‘‘just and
equitable’’ principles of trade was so vague and broad that
enforcement would be impossible. However, the Second
Cireuit in Colonial Realty did not foreclose the possibility

A82
Appendia C

that NYSE or NASD rules might support a federal securi-
ties action in this court; indeed, the court indicated that in
considering the question, one must look to the nature of the
particular rule and its place in the regulatory scheme.
Further, the court stated that the case for implication of
a right of action would be strongest where the rule set
forth a duty unknown at common law. 358 F.2d at 181-83.

_ Applying these or comparable principles, a series of
decisions have accepted the proposition that in an appropri-
ate case, violations of exchange rules designed for investor
protection might give rise to a private cause of action.
See Ocrant v. Dean Witter & Co., 502 F.2d 854, 858 (10th
Cir. 1974); Buttrey v. Merrill Lynch, Pierce, Fenner &
Smith, Inc., 410 F.2d 135, 141 (7th Cir.), cert. denied, 396
U.S. 838, 90 S.Ct. 98, 24 L.Ed.2d 88 (1969) (NYSE Rule 405
held actionable); Avern Trust v. Clarke, 415 F.2d 1238,
1242 (7th Cir. 1969), cert. denied, 397 U.S. 963, 90 S.Ct. 997,
25 L.Ed.2d 255 (1970) (NASD rules actionable).

While the parties have not cited, and the Court’s
research has not found, any reported decision which has
held a broker liable solely for the violation of NYSE or
NASD rules, a series of district court decisions have ac-
cepted the proposition that such liability may lie, and the
cases have fashioned the contours of liability for rules vio-
lations.

In this district, Judge Weinfeld has expressly held that
violations of NYSE rules 345 and 405 are actionable. See
Starkman v. Seroussi, 377 F.Supp. 518 (S.D.N.Y. 1974).
Another decision refused to find actionable one NASD rule
that imposed the duty to keep proper books, reasoning that
the NASD rule, like that considered in Colonial Realty, was
too vague to be enforceable. Gurvitz v. Bregman & Co.,

A83
Appendia C

379 F.Supp. 1283 (S.D.N.Y. 1974). Another decision in this
district dismissed claims of rules violations where the al-
legations of the complaint did not set forth a claim of
fraud. Bellv. J.D. Winer & Co., 392 F.Supp. 646 (S.D.N.Y.
1975) (Tyler, J.). A recent decision by Judge Newman in
the District of Connecticut has concluded that violations of
the NYSE and NASD rules are not actionable. Plunkett v.
Dominick & Dominick, Inc. [Current Binder] 414 F.Supp.
885 (D.Conn. 1976); see also Zagari v. Dean Witter & Co.
[Current Binder] CCH Fed.See.L.Rep. 195,777 (N.D.Cal.
Sept. 27, 1976).

The starting point of the analysis is an inquiry into the
place which the specific rules occupy in the entire regulatory
scheme. In this regard, the Court notes that the Securities
and Exchange Commission has enacted regulations compar-
able to the suitability and the supervisory rules of the
NYSE and the NASD; see 17 C.F.R. §§240.15b10-3 and
240.15b10-4 (1976) ; Plunkett v. Dominick & Dominick, Inc.,
supra, 414 F.Supp. at 890 n. 5. With respect to the types of
duties imposed by the language of the NYSE and NASD
rules themselves, the Court agrees with Judge Weinfeld’s
reasoning in Starkman v. Seroussi, supra, and concludes
that NYSE Rule 405 and Article III, Section 2 of the NASD
rules are sufficiently precise to sustain a cause of action.
Further, there can be no doubt that the purpose of these
rules is to protect the investor. Finally, since particularly
in this action the duties imposed upon the defendants may
be unknown at common law, see Carroll v. Doolittle, supra,
the Court concludes that this action presents a strong case
for the implication of a civil right of action under the NYSE

and NASD rules.

A84
Appendix C

Since Rule 10-5 and 15cl-2 of the Exchange Act are
directed essentially at fraud, any definition of what is ac-
tionable under NYSE Rule 405 and Art. III (2 of NASD
should be narrowly drawn. See Hecht v. Harris, Upham
& Co., supra, 283 F.Supp. 417, 480. Indeed, each court that
has considered the question has concluded that mere negli-
gent violations of the NYSE or NASD rules are not action-
able in federal court; rather, to form the basis for liability
in damages, the broker’s violations of the rules must be
‘*tantamount to fraud’’. See Buttrey v. Merrill Lynch, su-
pra, 410 F.2d at 148; Bell v. J. D. Winer, supra; Geyer v.
Paine Webber Jackson & Curtis, Inc., 389 F.Supp. 679 (D.
Wyo. 1975) (mere negligence insufficient) ; Wells v. Blythe
& Co., 351 F.Supp. 999, 1001 (N.D.Cal. 1973) (rules viola-
tions not ‘‘per se’’ actionable) ; McCurnin v. Kohimeyer &
Co., 347 F.Supp. 573 (E.D.La. 1972) (plaintiff must prove at
least a knowing and callous disregard for the rules).

Accordingly, the Court concludes that under the circum-
stances of this case, plaintiff may assert a cause of action
for violation of the ‘‘know your customer’’ requirement
of NYSE Rule 405, and the supervision and suitability
requirements of that Rule and of Art. III §2 NASD and
may prevail upon such a claim if he proves by a preponder-
ance of the evidence that the actions of Stott and BEDCO
constituted violations of the applicable rules ‘‘tantamount
to fraud’’. To meet this standard in this case would mean
that the violations operated as a fraud upon the plaintiff
and that the defendants acted with scienter, that is, with
intent to defraud or with willful and reckless disregard
for the truth or falsity of their representations or of

A85
Appendix C

whether there [sic] actions constituted a fraud. See Lanza
v. Drexel & Co., supra; see also Arthur Lipper Corp. v.
SEC,, supra.

The Court readily concludes that the actions of the three
defendants operated as a fraud upon Dr. Rolf. Initially,
the Court has found that Yamada’s actions with respect to
Delanair operated as a fraud upon the plaintiff. Further,
the Court concludes that Yamada’s handling of the Rolf
account was generally of a fraudulent nature. Indeed, on
the facts of this case, the Court has no doubt that the seeuri-
ties purchased by Yamada as a part of his manipulative
schemes were unsuitable for the plaintiff. Finally, the
complete transformation of the Rolf account from one con-
taining 23 listed issues of reputable quality to an account
made up of the likes of Hair Extension Centers, Health
Evaluation Systems, and M. H. Studios evidences a breach
by Yamada of his investment advisory duties which is
doubtless ‘‘tantamount to fraud’’.

In such circumstances, where the plaintiff was being
disserved by a faithless investment adviser, who was inter-
ested in his account only for its ‘‘buying power’’, the
‘thand-holding’’ operation successfully accomplished by
Stott was, under the circumstances, a fraud upon the plain-
tiff.

First, Stott admitted that he never knew plaintiff’s in-
vestment intent, and that he had no idea what type of inves-
tor this customer was when he recommended Yamada to
Rolf. These admissions alone could suffice to form the basis
of a violation of NYSE Rule 405(1) tantamount to fraud.
Contrary to the clear requirements of that Rule, Stott
totally failed to learn the essential facts relative to Rolf and

A86
Appendix C

Rolf’s account. Stott also failed to learn every essential
fact relative to Yamada, since he did not learn whether
Yamada would be a suitable adviser for Dr. Rolf.

Second, Stott’s practice of continually voicing his con-
fidence in Yamada and in Yamada’s investment decisions
constituted a fraud upon Dr. Rolf, who sincerely believed
that Stott had some basis for his statements. The state-
ments of support and the assurances which were repeatedly
made were made with willful and reckless disregard for
whether they were true or false. While Stott may have had
a strong belief in Yamada’s money-making abilities, he cer-
tainly knew, as the Court has concluded, that Yamada was
continuing to invest plaintiff’s money in ‘‘junk’’ even after
plaintiff had lost three-quarters of a million dollars through
such ventures. The evidence is clear that Stott never once
recommended that Rolf reconsider any transaction. Stott
never recommended against any investment. Stott never
suggested to Rolf that perhaps Yamada was too speculative
for the plaintiff’s investment needs. Stott totally failed
to perform the duties placed upon him, as a registered rep-
resentative and as an employee of a member firm, to take
adequate steps to protect the interests of a customer who
had entrusted his securities account to BEDCO for six
years. Accordingly, the Court concludes that Stott’s actions
were tantamount to fraud, since they deceived plaintiff into
thinking that BEDCO was protecting his interests, and
since they operated to help conceal from Rolf the fraud
being perpetrated by Yamada.

For the same reasons, the Court concludes that plaintiff
has proved by a preponderance of the evidence that Stott

A87
Appendia C

acted with the requisite scienter. Stott recommended a
number of issues for Rolf’s account without ever knowing
Rolf’s investment intentions. He recommended Yamada
without any knowledge about plaintiff’s account. He con-
tinually held Dr. Rolf’s hand and assured him, without
any basis in fact, that Yamada’s decisions were good for
Rolf. The Court finds that these factors constitute a know-
ing, willful and reckless disregard for the truth, a callous
and knowing disregard for the requirements of the NYSE
and NASD rules involved herein, and proof of the scienter
element by a fair preponderance of the credible evidence.
This conclusion is based upon all the evidence in the ease,
as well as upon the Court’s assessment of Stott’s demeanor
and eredibility.

Even had Stott never assured the plaintiff with respect
to Yamada, Stett’s total failure to speak out nevertheless
would suffice to render him liable for violations of the rules.
Stott not only failed to learn about Rolf, but he totally
failed to investigate the stocks in the account or to tell
Rolf what he now claims—that he really didn’t know any-
thing about those stocks. Ifa broker acts only as an order-
taker, he must not offer advice. If he begins to offer advice,
he must not fail to make full disclosure. Carrass v. Burns,
516 F.2d 251, 258 (4th Cir. 1975). It is apparent that Stott
‘*deliberately closed his eyes to facts he had a duty to see

. or recklessly stated as facts things of which he was
ignorant.’’ Dlugash v. SEC, 373 F.2d 107, 109 (2d Cir.
1967).

A broker must not allow his silence to be taken as a
recommendation. If he cannot or will not investigate the

A88
Appendix C

security being purchased, he must disclose the facet to the
customer and warn the customer of the risks of making in-
vestments without full knowledge of the issuer. He must
satisfy himself that not only the security but also the type
of transaction is suitable for the customer. See Hanly v.
SEC, 415 F.2d 589, 597 (2d Cir. 1969); Jacobs, supra at
887-93. It is apparent that ‘securities issued by smaller
companies of recent origin . . . require more thorough
investigation.’’ //anly, supra at 597. Here, Stoft testified
that he never sent Yaniada’s speculative investments
through BEDCO research to determine whether they were
suitable.

For the foregoing reasons, the Court concludes that
Stott is liable to the plaintiff in damages for violations of

NYSE Rule 405 and Art. IIT 62 of the NASD Rules.

Aiding and Abetting

Plaintiff’s complaint further asserts that Stott is liable
to the plaintiff for aiding and abetting the fraud Yamada
perpetrated upon the plaintiff. In order to sustain this
claim, the plaintiff must prove that an independent wrong
existed, that the alleged aider and abettor had knowledge
of the wrong, that he acted with scienter, and that he
rendered substantial assistance to the primary wrongdoer.
Lowenschuss v. Kane, 520 F.2d 255, 268 n.10 (2d Cir. 1975) ;
SEC vy. Coffey, 493 F.2d 1304 (6th Cir. 1974); IZ. L. Feder-
man & Co. v. Greenberg, 405 F.Supp. 1332 (S.D.N.Y. 1975) ;
Rosen vy. Dick [1974-75] CCH Fed.Sec.L.Rep. 194,786 (S.D.
N.Y. Sept. 3, 1974).

A89
Appendix C

As the Court has observed above, the plaintiff has
proven that Yamada defrauded the plaintiff through the
Delanair transaction and that he breached his own fiduciary
duties owed to the plaintiff by reason of his investment
advisory agreement. These violations were not merely
“tantamount to fraud’’ but rather, constituted a gross
fraud. Thus, plaintiff has established an independent
wrong by Yamada in violation of Rule 10b-5.

The Court has concluded that Stott knew of the nature
of the securities which were being purchased in the account.
Stott was aware that Yamada was purchasing highly un-
suitable stocks, or ‘‘junk’’, even after such transactions
had resulted in the loss of half of plaintiff’s money. Even
though Stott did not know of the direct frauds which
Yamada was perpetrating on Rolf—such as Delanair—he
must have known of the egregious violations by Yamada
of the suitability rule. Accordingly, the Court concludes
that plaintiff has established Stott’s knowledge of the
wrongful acts.

For the same reasons as detailed in the previous section,
the Court concludes that Stott acted with scienter; that is,
he made representations to the plaintiff with willful and
reckless disregard for their truth, and he acted with a
callous and knowing disregard for the requirements of
the NYSE and NASD rules.

Finally, there can be little doubt that Stott afforded
substantial assistance to the primary wrongdoer Yamada.
By continually holding Rolf’s hand and assuring him that
Yamada’s decisions were appropriate, Stott substantially
diminished any opportunity for an earlier discovery by
Rolf of Yamada’s true intentions. By failing to reeommend

A90
Appendix C

against any venture and by failing to encourage Rolf to
question Yamada’s suitability as an adviser, Stott con-
tributed to the perpetration of the depletion of Rolf’s ac-
count and the accumulation of unsuitable securities therein.
By trading the stocks through BEDCO with nary a thought
as to their suitability or their legitimacy, Stott gave to
Yamada what he needed: access to a large portfolio which
could be used as a tool in his manipulations. Accordingly,
the Court concludes that Stott is liable to the plaintiff for
aiding and abetting Yamada’s fraudulent violations of his
own duties as an investment adviser.

BEDCO’s Liability

Plaintiff further asserts that defendant BEDCO is liable
for failure to supervise Stott and the Rolf account, either
under the doctrine of respondeat superior or as a con-
trolling person liable under Section 20 of the Exchange Act.

Four circuit courts have concluded that a brokerage
firm may be liable to a defrauded customer under the com-
mon law principle of respondeat superior. See Holloway
v. Howerdd, 536 F.2d 690 (6th Cir. 1976); Fey v. Walston
& Co., 493 F.2d 1036 (7th Cir. 1974); Lewis v. Walston &
Co., 487 F.2d 617 (5th Cir. 1973) (Wisdom, J.); John [sic]
Hopkins University v. Hutton, 422 F.2d 1124 (4th Cir.
1970), cert. denied, 416 U.S. 916, 94 S.Ct. 1622, 40 L.Ed.2d
118 (1974). In this Cireuit, two decisions have indicated a
growing willingness to hold a brokerage firm liable, at least
in enforcement actions, on the basis of the common law
principle. See SEC v. Geon Industries, Inc., 531 F.2d 39
(2d Cir. 1976) (Friendly, J.); SEC v. Management Dy-
namics, Inc., 515 F.2d 801 (2d Cir. 1975) (Kaufman, C. J.).

A91
Appendix C

Management Dynamics expressly disapproved of one dis-
trict court decision which held respondeat superior inap-
plicable to a brokerage house, SEC v. Lums, Inc., 365 F.
Supp. 1046 (S.D.N.Y. 1973). See 515 F.2d at 811-13. Fur-
ther, it has been suggested that certain language in Geon
Industries, supra, signals the application of respondeat
superior to brokerage firms in damages actions. See Plun-
kett v. Dominick & Dominick, Inc., supra, 414 F.Supp. at
899 (concluding that the common law principle applies).

On the basis of this discussion and the thrust of the
cases, this Court concludes that defendant BEDCO is liable
to plaintiff under the rule of respondeat superior. There
ean be no doubt that Stott’s actions were within the course
of his employment. See Lewis v. Walston & Co., supra,
487 F.2d 617 (5th Cir. 1973); Restatement of the Law of
Agency (2d) §229; see also Goodman v. H. Hentz & Co.,
265 F.Supp. 440 (N.D.Ill. 1967).

The Court also finds BEDCO liable for failure to super-
vise the account, pursuant to Section 20 of the Exchange
Act. The difference between respondeat superior and con-
trolling person liability is ‘‘not entirely esoteric’’ since
there is a good faith defense to the latter charge which is
unavailable at common law. See Plunkett v. Dominick &
Dominick, supra.

However, here BEDCO’s compliance officer stated that
all of the firm’s control precedures to guard against churn-
ing and against unsuitability were jettisoned in the face of
an investment adviser—any investment adviser. Under the
decisions of the SEC in In re William I. Hay, 19 S.E.C. 397
(1945) and In re Moore & Co., 32 8.E.C, 191 (1951), the
Court concludes that BEDCO’s system of supervision dur-

A92
Appendia C

ing the time in question was wholly insufficient to guard
aga'nst fraud by the investment adviser or by the broker
who was trading for an investment adviser.

‘*With considerable unanimity, the reported cases
have required that to satisfy good faith it must be
shown that the controlling person maintained and en-
forced a reasonable and proper system of supervision
and internal control over controlled persons so as to
prevent, so far as possible, violations of Section 10(b)
and Rule 10b-5.’’ (Zweig v. Hearst Corp., 521 F.2d
1129, 1134-35 (9th Cir.), cert. denied, 423 U.S. 1025, 96
S.Ct. 469, 46 L.Ed.2d 399 (1975) )

Although BEDCO did not have actual notice of the
fraud, its acknowledged policy with respect to the firm’s
duties where an investment adviser is present, its complete
failure to supervise any such accounts, and its laxness
which went so far as to permit Stott to recommend an in-
vestment adviser with no knowledge of Dr. Rolf’s account
and even further to allow some unidentified person to trade
in Rolf’s account during April 1969, all lead the Court to the
conclusion that BEDCO did not, during the period in ques-
tion, establish even minimally sufficient safeguards to pro-
tect the investor from the type of fraud present in this case.
Accordingly, the good faith defense has not been estab-
lished. See Barthe v. Rizzo, 384 F.Supp. 1063 (S.D.N.Y.
1974).

Damages

Plaintiff has established that the acts of the defendants
were a substantial or proximate cause of the placing of un-
suitabie securities in his BEDCO account. Stott’s conduct

A93
Appendix C

and BEDCO’s failure to supervise created a continuous
and active potential for harm to the plaintiff, see Miller v.
Schweickart, 413 F.Supp. 1062 (S.D.N.Y. 1976), and it is
clear that plaintiff was damaged as a proximate result of
the defendants’ fraud.

However, a persistent damages question in cases such as
this one is whether the plaintiff can recover his net losses
from the broker who failed in his duties. Having carefully
considered the matter, the Court determines that the meas-
ure of damages for violation of the suitability and super-

vision rules should be the same as that applied by the

federal courts in awarding damages for churning; i.e., the
quasi-contractual theory whereby the defeudants are di-
rected to return to the plaintiff all commissions earned and
interest paid. See Hecht v. Harris, Upham & Co., 480 F.2d
1202 (9th Cir. 1970); Stevens v. Abbott Proctor & Paime,
288 F.Supp. 836 (E.D.Va. 1968).

The Court concludes that it would be inappropriate to
award the damages sought by the plaintiff—the net trading
losses claimed. Although this measure has been granted by
two state court decisions, Twomey vy. Mitchum, Jones &
Templeton, Inc., 262 Cal.App. 690, 69 Cal.Rptr. 222 (1st
Dist. 1968) and Pierce v. Richard Ellis & Co., 62 Mise.2d
771, 310 N.Y.S.2d 266 (Civil Ct. N.Y. Cnty. 1970), the Court
is unaware of any federal court which has ever applied this
damage theory. Further, both Twomey and Pierce involved
unsuitability and churning; only the former is present here.
The Pierce decision has not been followed by the New York
courts, see Lehman v. Merrill Lynch, Pierce, Fenner &
Smith, Inc., (Sup. Ct. N.Y. Cnty. Feb. 24, 1976), and this

A94
Appendix C

Court finds itself in agreement with the criticism of the
Twomey case set forth in Stevens vy. Abbott, Proctor &
Paine, supra, 288 F.Supp. 836, 849.

Since much of the damage suffered by the plaintiff here
was as a result of poor investment decisions and as a result
of a bear stock market (see DX-WW, DX-XX), it would be
highly inappropriate to allow plaintiff to recover all his
losses by assessing them against Stott and BEDCO. A
much more logical measure of damages is to require the de-
fendants to return all the benefit which they received, since
they failed to give to plaintiff the consideration due him—
supervision and diligence as to the account. Under the cir-
cumstances of this case, all other measures of damage are
rejected as wholly speculative with respect to actual injury
found by the Court to have been caused by the defendants’
actions.

Plaintiff’s complaint alleges that during the period in
question, the defendants were paid by plaintiff commissions
in the amount of $42,541.80 and interest on the margin
account of $13,448.20. These figures were mentioned by
the various witnesses at trial, and the sums are compiled
from BEDCO statements (PX-12, PX-13, PX-14). The
Court considers an award of commissions and margin ac-
count interest to be proper in this case, sinee it restores
to the plaintiff all monies paid to the defendants Stott and
BEDCO during the period in question.

Plaintiff also makes a post-trial claim for punitive
damages, but the Court declines under the cireumstances
to grant such an application. First, there is no dispute that
plaintiff’s eumplaint set forth no cause of action under state

A985
Appendix C

law; despite the decisions cited by the plaintiff, see Zenry
v. United States, 424 F.2d 677 (5th Cir. 1970), the Court
would not be willing to grant an application to amend the
pleadings at this late date. In any event, the point is aca-
demic since the Court does not find that an award of ex-
emplary damages should be granted in this case.

First, there is substantial doubt as to whether a plaintiff
can ever receive punitive damages for violations of federa!
securities laws. See (Green vy. Wolf Corp., 406 F.2d 291
(2d Cir. 1968), cert. denied, 395 U.S. 977, 89 S.Ct. 2131, 23
L.Ed.2d 766 (1969) ; Myzel v. Fields, 386 F.2d 718 (8th Cir.
1967), cert. denied, 390 U.S. 951, 88 S.Ct. 1043, 19 L.Ed.2d
1143 (1968). Kven assuming that there was no procedural
or statutory obstacle to the grant of punitive damages, the
Court would not make such an award based upon the ra-
tionale stated by the Court in Stevens v. Abbott, Proctor
& Paine, supra:

‘*The Court finds that the conduct engaged in in the
instant case results from the failure of the defendants
to abide by their legal responsibilities, but finds no rea-
son to believe that by awarding exemplary or punitive
damages, actions in the future similar to those which
give rise to the instant suit would be any more deterred
than by virtue of the fact that the suit itself has ac-
complished that very result.’’ (288 F.Supp. 836, 848)

Accordingly, plaintiff shall recover commissions and in-
terests paid on the margin account, plus interest from the
date of the entry of judgment herein. See Stevens v. Abbott,
Proctor & Paine, supra.

A96
Appendix C

The Cross-Claims Against Yamada

The Court concludes that a broker and his employer
should not be permitted to receive indemnity from the ecus-
tomer’s investment adviser where the broker and his firm
have failed in their duty to protect the interests of the
customer, in violation of NYSE and NASD rules and in
violation of Rule 10b-5. To allow indemnity in this case
would be to encourage flouting the policy of the securities
laws. See Globus v. Law Research Service, Inc., 418 F.2d
1276, 1288 (2d Cir. 1969), cert. denied, 397 U.S. 913, 90 S.Ct.
913, 25 L.Ed.2d 93 (1970). Accordingly, the cross-claims

against Yamada are dismissed.

Conclusion

Judgment should be entered for the plaintiff David E.
Rolf against defendants Blyth Eastman Dillon & Co., Inc.,
and Michael Stott for damages in the amount of $55,790.00
plus interest from the date of judgment, in accordance with
the decision of the Court herein. Judgment should further
be entered dismissing plaintiff’s claims against the defend-
ant Akiyoshi Yamada in accordance with the stipulation and
order entered at the conclusion of trial, and dismissing the
cross-claims of defendants BEDCO and Stott against
Yamada. Counsel for the plaintiff is directed to submit an
appropriate order of judgment on three days’ notice.

SO ORDERED.

A97

APPENDIX D

Order of the United States Court of Appeals for the
Second Circuit Denying Rehearing
UNITED STATES COURT OF APPEALS
Seconp Circuir

At a Stated Term of the United States Court of Appeals,
in and for the Second Circuit, held at the United States
Court House, in the City of New York, on the third day of
July, one thousand nine hundred and seventy-eight.
Present :

Hon. J. Josep Smirn,
Hon. Watrer R. Mansrrexp,
Hon. James L. Oaxgs,
Circuit Judges.
Docket No. 77-7104
a

Davi E. Ro tr,
Plaintiff-Appellant-A ppellee,

Vv.

BiytH Eastman Ditton & Co., Inc.,
Axryosut Yamapa and Micuag. Srort,
Defendants-A ppellees-A ppellants.

ee

A petition for a rehearing having been filed herein
by counsel for the defendants-appellees-appellants, Blyth
Eastman illon & Co., Ine.,

Upon consideration thereof, it is

Ordered that said petition be and hereby is denied.

[SEAL] , A. DawiEet Fusaro,
United States Court of Appeals 1
FILED Clerk
JUL 3 1978

A. DANIEL Fusaro, Clerk
SECOND CIRCUIT

‘ A, I ia ita i ai ei

A98

APPENDIX E

Order of the United States Court of Appeals for the
Second Circuit Denying Rehearing in Banc

UNITED STATES COURT OF APPEALS
Seconp Circuit

Ata Stated Term of the United States Court of Appeals,
in and for the Second Circuit, held at the United States
Court House, in the City of New York, on the third day of
July, one thousand nine hundred and seventy-eight.

Docket No. 77-7104 —
Ee
Davin E. Ro tr,
Plaintiff-A ppellant-A ppellee,

Vv.

BiytH Eastman Ditton & Co., Inc.,
Axkryosut YAMADA and MicnHak. Storr,
Defendants-A ppellees-A ppellants.
EE
A petition for rehearing containing a suggestion that
the action be reheard en bane having been filed herein by
counsel for the defendants-appellees-appellants, Blyth East-
man Dillon & Co., Inc., and Michael Stott, a poll of the
judges in regular active judges having been taken and there
being no majority in favor thereof,
Upon consideration thereof, it is
Ordered that said petition be and it hereby is denied.
Judges Mansfield, Mulligan, Gurfein and VanGraafei-
land dissent in the denial.
/3/ Irvine R. Kaurman

Irvine R. Kaurman, Chief Judge

[SEAL]
United States Court of Appeals
FILED
JUL 3 1978
A. DANIEL Fusaro, Clerk
SECOND CIRCUIT

A99

APPENDIX F
Statute and Rule Involved

Section 10(b), 15 U.S.C. §78j(b):

It shall be unlawful for any person, directly or indi-
rectly, by the use of any means or instrumentality of inter-
state commerce or of the mails, or of any facility of any
national securities exchange—

* * *

(b) To use or employ, in connection with the pur-
chase or sale of any security registered on a national
securities exchange or any security not so registered,
any manipulative or deceptive device or contrivance
in contravention of such rules and regulations as the
Commission may prescribe as necessary or appropriate
in the public interest or for the protection of investors.

Rule 10b-5, 17 C.F.R. §240.106-5:

It shall be unlawful for any person, directly or indi-
rectly, by the use of any means or instrumentality of inter-
state commerce, or of the mails, or of any facility of any
national securities exchange,

(a) to employ any device, scheme, or artifice to
defraud,

(b) to make any untrue statement of a material
fact or to omit to state a material fact necessary in
order to make the statements made, in the light of the
circumstances under which they were made, not mis-
leading, or

(c) to engage in any act, practice, or course of busi-
ness which operates or would operate as a fraud or
deceit upon any person, in connection with the pur-
chase or sale of any security.

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Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/brief%3Amicro_IA40385005_1829%3A1. Public record. Not legal advice.