Theories of Stockbroker and Brokerage Firm Liability
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Theories of Stockbroker and Brokerage Firm Liability ver a lifetime, even modest savings, contributions to an IRA, or partici- By Robert C. Port pation in an employee pension plan can result in significant accumula- O tions of wealth.1 However, many individuals have neither the interest nor the desire to learn about financial markets and investments, nor do they have the time necessary to monitor their investments on an ongoing basis. Their aversion to and confusion about financial matters has been further accentuated by the “irrational exu- berance”2 of the “Internet bubble” of the late 1990s, and subsequent significant decline in the value of technology and telecommunications stock. As a result, many individuals turn to stockbrokers, investment advisors, financial planners, insurance agents, and oth- ers claiming to have the knowledge and experience to offer investment advice. Stockbrokers and other financial advisors are highly motivated to cultivate their clients’ trust and allegiance, and clients who lack knowledge and sophistication on financial matters have powerful incentives to believe that such advisors are trust- worthy and acting solely in the customer’s best interests.3 This trusting relationship creates an opportunity for exploitation by the advisor, which may form the basis for a vari- ety of legal claims. Common fact patterns associated with broker misconduct include mis- representation, churn- ing, unsuitable recom- mendations, unautho- rized trading, and fail- ure to supervise. Outright misrepresenta- tion and fraud may also be practiced on the unsuspecting and trust- ing client. Federal and state securities statutes and state common law typi- 12 Georgia Bar Journal cally govern civil liability in con- ates or would operate as a fraud inexcusable negligence, but an nection with losses arising from the or deceit upon any person, in extreme departure from the stan- purchase and sale of securities. The connection with the purchase or dards of ordinary care, and that self-regulatory rules of the sale of any security.6 present a danger of misleading National Association of Securities The essential elements of a Rule buyers or sellers which is either Dealers and the New York Stock 10b-5 claim are: (1) a misstatement known to the defendant or is so Exchange are also relevant to the or omission; (2) of a material fact; (3) obvious that the defendant must issue of whether a broker or finan- made with scienter, (4) upon which have been aware of it.”15 cial advisor owed or breached a the plaintiff relied; (5) that proxi- The plaintiff’s reliance must have duty to the customer. The follow- mately caused the plaintiff’s loss.7 been reasonable or justified.16 ing is a brief overview of common The standard for determining Relevant factors include: (1) the legal theories of liability that apply materiality is whether “there is a sophistication and expertise of the to broker misconduct.4 substantial likelihood that a reason- plaintiff in financial and security able shareholder would consider it matters; (2) the existence of long FRAUDULENT MIS- important” or “a substantial likeli- standing business or personal rela- REPRESENTATIONS hood that the disclosure of the omit- tionships between the plaintiff and ted fact would have been viewed by the defendant; (3) the plaintiff’s AND OMISSIONS the reasonable investor as having access to relevant information; (4) Material misrepresentations and significantly altered the ‘total mix’ the existence of a fiduciary relation- 8 omissions made in connection with of information made available.” ship owed by the defendant to the the purchase or sale of a security can “To constitute fraud, a misrepre- plaintiff, (5) concealment of fraud by violate federal and state securities sentation generally must relate to the defendant; (6) whether the plain- 9 statutes. Such claims may also pro- an existing or pre-existing fact.” A tiff initiated the stock transaction or ceed as common law fraud claims. misrepresentation of future profit sought to expedite the transaction; generally cannot constitute fraud, and (8) the generality or specificity Section 10(b) of the as it is a type of opinion and predic- of the misrepresentations.17 Securities Exchange Act tion of future events.10 “[O]utra- To prove the causation element, of 1934 and Rule 10b-5 geous generalized statements, not a plaintiff must prove both “trans- making specific claims, that are so action causation” and “loss causa- Section 10 of the Securities exaggerated as to preclude reliance tion.”18 Transaction causation is a Exchange Act of 1934,5 is an anti- by consumers” generally will be synonym for reliance, and is estab- fraud provision prohibiting the use deemed “puffing” rather than lished when the misrepresentations “in connection with the purchase fraud.11 Furthermore, the “in con- or omissions cause the plaintiff “to or sale of any security . any nection with” requirement in Rule engage in the transaction in ques- manipulative or deceptive device 10b-5 is not satisfied by any misrep- tion.”19 Loss causation is more dif- or contrivance.” Rule 10b-5 prom- resentations or omissions that occur ficult to prove: the misrepresenta- ulgated by the Securities Exchange after the claimant purchases or sells tion must have caused the loss suf- Commission amplifies these prohi- the security in question.12 fered by the claimant. Loss causa- bitions by making it unlawful: The Supreme Court has express- tion is satisfied “only if the misrep- (a) To employ any device, ly left open the question of whether resentation touches upon the rea- scheme, or artifice to defraud, the scienter requirement encom- sons for the investment’s decline in (b) To make any untrue state- passes not only intentional con- value.”20 Proof of loss causation is a ment of a material fact or to omit duct, but also reckless conduct.13 statutory requirement.21 to state a material fact necessary The rule in the 11th Circuit is that a in order to make the statements Section 12(2) of the showing of “severe recklessness” made, in the light of the circum- satisfies the scienter requirement.14 Securities Act of 1933 stances under which they were “Severe recklessness is limited to Section 12(2) of the Securities made, not misleading, or (c) To those highly unreasonable omis- Exchange Act of 1933 provides that engage in any act, practice, or sions or misrepresentations that any person who offers or sells a course of business which oper- involve not merely simple or even security by use of an oral or written April 2004 13 communication that contains an ments made, in the light of the cir- municate. “The obligation to com- untrue statement of material fact or cumstances under which they are municate may arise from the confi- omits to state a material fact neces- made, not misleading.”25 Liability dential relations of the parties or sary in order to make the statement will not be found however, if “(1) from the particular circumstances not misleading is liable to the pur- [t]he purchaser knew of the untrue of the case.”32 Under Georgia law, chaser, unless the seller can show statement of a material fact or omis- “a confidential relationship impos- that he did not know and in the sion of a statement of a material fact; es a greater duty on the parties to exercise of reasonable care could or (2) [t]he seller did not know and reveal what should be revealed, not have known of the untruth or in the exercise of reasonable care and a lessened duty to discover omission.22 Scienter is not an ele- could not have known of the untrue independently what could have ment of a Section 12(2) claim. statement or misleading omission.”26 been discovered through the exer- Although the scope of liability The remedies provided under the cise of ordinary care.”33 under Section 12(2) is potentially Georgia Act are available only to a Not all representations by a bro- broad, its reach for broker miscon- buyer of securities.27 Because there ker are actionable by an investor. duct nonetheless is limited by four is very little case law construing the For example, an investor is not jus- factors. First, the claimant is limited Georgia Securities Act, the courts tified in relying upon representa- to rescission or rescessionary dam- often look to analogous federal tions consisting of mere expres- ages (the purchase price of the secu- statutes for interpretive assistance. sions of opinion, hope, expectation rity, plus interest, less income For example, although the language and puffing.34 Thus, speculations received thereon) and must tender of the Georgia statute does not or puffing as to future performance the security back to the seller. If the appear to require scienter, courts and statements that a particular claimant no longer owns the securi- have construed the section in accor- security is a “safe investment” are ty, he may seek damages represent- dance with Rule 10b-5 as requiring generally not actionable.35 ing the difference in the purchase proof of scienter.28 One of the price and the sale price. Second, only advantages of a claimant proceeding CHURNING purchasers may assert claims under under the Georgia Act, however, is “Churning occurs when a securi- Section 12(2), and they may assert provision for recovery of attorney’s ties broker buys and sells securities 29 them only against sellers and per- fees, interest, and court costs. for a customer’s account, without sons who control them. A “seller” is Common Law Fraud regard to the customer’s investment one who either transfers title to the interests, for the purpose of generat- Under Georgia law, fraud is security or who solicits the sale and ing commissions.”36 Churning is a shown when (i) a representation of receives a benefit from doing so or violation of Section 10(b) of the material fact is made (or there is a acts with the intent to benefit the Securities Exchange Act of 1934 and 23 failure to disclose a material fact); owner of the security.