California Court of Appeal Affirms Selling Away Defense
Attorneys: Edward Zusman and Kevin Eng
Disgruntled investors who have lost money frequently take a kitchen sink approach to liability, naming any and all investment professionals and firms who were even tangentially involved. Although the precise formulation can vary from case to case, there are some recurring themes. One of the most common themes is the allegation that broker-dealers and other financial services firms reap profits from investors, so the industry should bear the burden of making good on investors’ losses. One obvious problem with this proposition is that in circumstances where the firm has no relationship with the transaction, and there is no legal duty, the industry is made to be an insurer against investor loss.
One California appellate court was recently presented with such a situation, and rejected the investor’s attempt to impose liability against the broker-dealer. In Brad Markowitz v. LPL Financial, LLC, Cal. Ct. App. Case No. B253313 (Oct. 1, 2014), MZC represented LPL and the Court of Appeal affirmed the dismissal of the investor’s claims against LPL. The Plaintiff was an alleged victim of a Ponzi scheme that had been orchestrated by Michael E. McCready, who had at one point been an LPL registered representative.
During the hearing, the Plaintiff “argued that major financial firms have a duty to scrutinize the finances of their registered representatives. He contended the trial court ignored that duty when it tossed the case on grounds that LPL couldn’t be liable for Michael E. McCready’s damaging acts because his scheme didn’t involve the LPL-offered securities.” In seeking to hold LPL responsible for McCready’s acts, Plaintiff’s attorney also argued that “Mr. McCready ran rampant stealing money from his clients . . . .” (See ‘Outer Limits’ Writer Slams LPL Over Hollywood Ponzi Scheme, available at <http://www.law360.com/articles/580738/lpl-should-have-caught-8m-ponzi-scheme-victim-argues>.) In Plaintiff’s view, it was irrelevant that LPL had no involvement, did not authorize, and did not benefit from McCready’s conduct. Rather, Plaintiff argued that the mere fact that McCready’s misconduct occurred while he was an LPL registered representative was enough to state claims for vicarious liability and breach of fiduciary duty. Plaintiff argued in his appellate papers that LPL had the duty to delve into every aspect of McCready’s “personal and professional life” to uncover his fraudulent scheme, and because LPL did not apply “an intrusive investigative microscope” into every aspect of McCready’s affairs, LPL was liable.
The Plaintiff argued that liability should be imposed under Hollinger v. Titan Capital Corp. (9th Cir. 1990) 914 F.2d 1564. Plaintiff argued that, under that federal case, LPL was liable for McCready’s acts of misconduct. The Court of Appeal rejected Plaintiff’s argument, finding that Hollinger involved a claim under Section 20 of the Securities and Exchange Act of 1934, which was not relevant to Plaintiff’s common law claims. Moreover, the Court of Appeal noted that even under Section 20, broker-dealers are not liable for all actions taken by their registered representatives.
The court found that the case was governed by Asplund v. Selected Investments In Financial Equities, Inc. (2000) 86 Cal.App.4th 26 (“Asplund”). In the Asplund case, investors had purchased securities from a securities sales person, Joseph Tufo. Tufo was a registered representative with SIFE, a broker-dealer firm. However, Tufo’s sale of the subject investment did not involve SIFE. SIFE had no economic or other interest in the investment, which was a product that competed with the investments that SIFE offered. The Asplund court also reviewed federal law on the subject, and reviewed not only Hollinger, but a later Ninth Circuit decision, Hauser v. Farrell (9th Cir. 1994) 14 F.3d 1338 (“Hauser”) that refined Hollinger’s holding. The Hauser court held a transaction was outside the scope of the broker-dealer when (1) the transaction was not the type of transaction that could only be performed through the representative’s association with the broker-dealer; (2) the investment was unrelated to any of the securities offered by the broker-dealer through its registered agents; (3) the representative was not acting in his capacity as a registered agent of the broker-dealer in the transaction at issue; (4) the broker-dealer had no economic or other interest in the transaction; and (5) the broker-dealer had no knowledge of the transaction.
The Court of Appeal found that the trial court properly dismissed Markowitz’s claims against LPL. It affirmed the judgment, and awarded LPL its costs on appeal.