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Aldrich v. Thomson McKinnon Securities Inc.

February 21, 1985


Author: Lumbard

LUMBARD, Circuit Judge:

Thomson McKinnon Securities, Inc., a brokerage firm, and George Serhal, formerly a Thomson McKinnon account executive, appeal from a judgment of the Southern District that awarded Helen Aldrich $175,000 in compensatory damages, allocating $87,500 against each of the two defendants, $3,000,000 in punitive damages against Thomson McKinnon, and $12,500 in punitive damages against Serhal. The judgment was entered after a two-week jury trial, before Judge Duffy, at the conclusion of which the jury found that Thomson McKinnon and Serhal, as a consequence of fraudulent manipulation and churning in Aldrich's security account at Thomson McKinnon, were liable under § 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b) (1982), Rule 10b-5, 17 C.F.R. § 240.10b-5 (1984), promulgated thereunder, and under applicable principles of the New York common law for fraud and breach of fiduciary duty.*fn1

Although we see not error in the finding that defendants are liable for compensatory damages, we conclude that the punitive damage award against Thomas McKinnon is excessive and cannot stand. Accordingly, we remand with directions that the trial court enter an order for a new trial on all the issues, as to both defendants, unless Aldrich is willing to accept a judgment reducing the punitive damages against Thomson McKinnon to $1.5 million.


Aldrich met Serhal, then employed as an account executive at Thomson McKinnon, in early 1981, when she was considering transferring her brokerage account from Paine Webber. Her portfolio, initially worth approximately $300,000, to which $110,000 was later added, consisted principally of municipal bonds and some stock, which together generated an annual income that constituted Aldrich's principal means of support. At an initial meeting with Serhal to discuss her financial affairs, Aldrich explained that she was interested in increasing the income from her investment portfolio, in order to provide financial assistance to her elderly mother, but that she needed to maintain a large measure of safety in her investments.

Serhal then proposed an investment plan through which Aldrich could increase her annual income by selling her municipal bonds in order to purchase corporate utility bonds, which had a higher yield but were still within the category of conservative investments. The account executive consulted his branch manager at Thomas McKinnon in devising this investment strategy. According to Adlrich, Serhal then had her sign a blank option trading agreement, which Serhal later completed to inflate Aldrich's estimated annual income and falsely to characterize her investment objective as short-term trading, rather than safety of principal.

Commencing in March 1981, Serhal launched into a course of high volume, high risk trading in the Aldrich portfolio. More than 400 trades were undertaken in around 200 trading days. Total purchases in the account were $3,088,928.06, with sales also over $3 million. Serhal violated Thomson McKinnon internal guidelines concerning speculative trading on eight separate occasions between March and early October 1981. Specifically, Serhal disregarded the rule providing that no more than 50 uncovered option contracts are permitted in any one underlying security in a single account. Superimposed on the margin requirements for speculative trading in uncovered options, this flat rule concerning dangerously high-risk trading applied to all accounts, whatever the resources or trading objectives of the customer.

While Serhal flagrantly manipulated Aldrich's account, even earning commissions on trading that resulted in Aldrich again owning the identical option or stock that she just sold, Thomson McKinnon supervisors stood idly by. The supervisor who had advised Serhal on the bond swap initially contemplated for Aldrich never inquired about the discrepancy between this conservative investment strategy and the contents of papers such as the option trading agreement, which indicated that Aldrich was interested in speculative trading. Though Serhal was newly hired, and though one customer was providing the great bulk of his suddenly large income,*fn2 supervisors, for a period of seven months, failed to confront him with the daily, weekly, and monthly computer printouts recording patent trading abuses.

Serhal's immediate supervisors, who were responsible for monitoring Serhal's trading activities, indirectly profited from the churning of the account, as they were profited from the churning of the account, as they were compensated by a salary plus bonus, with the bonus at least partially dependent upon commissions generated by the office. The commissions "earned" during Serhal's 10 month stewardship of the Aldrich account totalled $143,854 -- almost half the value of Aldrich's portfolio.

Finally, in early October, when Serhal was maintaining an option position in Aldrich's account that thrice exceeded the house's guideline concerning the number of uncovered options in one security, Serhal's supervisor advised him to decrease his trading activity. By this point, Serhal had generated over $80,000 in commissions. Trading declined somewhat for the balance of October and during November, but then, in December, it increased, with the knowledge of Serhal's supervisor. The heaviest losses, including a single loss of $50,000 on Christmas Eve, occurred during December.

At the end of December, apparently because a $60,000 margin call had provoked inquiry from the margin department, Serhal advised his supervisor that the Aldrich account, worth over $400,000 less than 10 months previous, was entirely exhausted. On the same day, Serhal informed his supervisor that there had been unauthorized trading in Aldrich's account. Serhal was placed on leave of absence and later terminated from his employment. Twenty-five thousand dollars in commissions were withheld from Serhal and retained by Thomson McKinnon.


In view of the inexcusable and outrageous handling of Aldrich's account, it is not surprising that the appellants accept, with small complaint, the jury's award of compensatory damages -- only $175,000 for losses of at least $400,000. Instead, both Thomson McKinnon and Serhal argue that it was error to permit the jury to make any award of punitive damage.

Thomson McKinnon argues that the jury was instructed, contrary to New York law, that punitive damages could be imposed on the brokerage house vicariously. Thomson McKinnon also claims that the evidence was insufficient to support a punitive damage award against it.*fn3 Serhal asserts that the district court erred in permitting the award of punitive damages, as New York law allows such recovery for common law fraud or breach of fiduciary duty only when fraudulent conduct was aimed at the general public, a circumstance, he alleges, that was not shown here. Serhal also contends that the compensatory damage judgment of $87,500 against each defendant ...

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