Scalp & Blade, Inc. v. Advest, Inc.Scalp & Blade, Inc. v. Advest, Inc.
OPINION OF THE COURT
Plaintiffs commenced this action against defendants, an investment advisor/securities broker and his firm, seeking damages for defendants’ alleged mismanagement of plaintiffs’ trust fund or account, including alleged “churning” of the fund and investment of it in a manner unsuited to plaintiffs’ needs and purposes. On this appeal by plaintiffs, we address the appeal-ability and propriety of “an order in limine precluding plaintiffs from offering proof of additional profits [that] they claim their account would have earned if it had been invested in alternative securities, the performance of which they claim would have tracked the S&P 500 or other market indices.” We conclude that the order is appealable as of right and that plaintiffs are not precluded as a matter of law from recovering “market index” or other “lost profit” or “lost appreciation” damages.
I
Our recitation of the facts is based on the record now before us as well as the records underlying two prior appeals to this Court (Scalp & Blade v Advest, Inc.,
According to plaintiffs, during the initial years of Fr anger’s management of the fund, its assets were appropriately invested in a diversified mix of high-grade securities. However, plaintiffs allege that, beginning in 1995 and continuing throughout the rest of Fr anger’s tenure as plaintiffs’ financial advisor and account representative (i.e., until plaintiffs terminated that relationship in May 1998), Franger failed to diversify his investments of the fund’s assets and “engaged in an excessive number of transactions in speculative and risky investments that were completely unsuitable for Plaintiffs and their investment objectives.” Plaintiffs allege that Franger, trading as he saw fit, made numerous and frequent short-term trades resulting in financial losses and at one juncture had about 65% of the fund invested in three high-tech, small-cap stocks. Plaintiffs further allege that defendants failed to file paperwork properly earmarking the fund as a “discretionary account,” leading to a failure to subject the fund to the close scrutiny typically given to such accounts. In addition, plaintiffs allege that both the frequency of Fr anger’s reporting to plaintiffs and the level of detail provided diminished drastically beginning in 1995, with Franger thereafter concealing both the level of his trading activity and which particular securities he had purchased or sold. Plaintiffs allege that, as a consequence of defendants’ actions, the value of the fund fell from $205,000 to $106,000 between January 1996 and May 1998, a period during which more suitable and prudent investment of the fund, as mea
II
The second amended complaint alleges that Fr anger is liable for defalcations committed by him both as “the financial advisor and account representative for” the fund and as a member of the Board. Advest is alleged to be liable on theories of respondeat superior and failure to supervise Fr anger. The second amended complaint asserts six causes of action, including breach of Franger’s duties as trustee under EPTL 11-2.3 (a); breach of contract by both defendants; fraudulent misrepresentation by Franger; negligence on the part of Fr anger; negligence on the part of Advest; and the violation of General Business Law § 349 by both defendants. Plaintiffs seek $330,000 in compensatory damages, punitive damages, disgorgement of defendants’ gains, and counsel fees.
III
Just before the scheduled start of trial, defendants moved in limine to preclude plaintiffs “from offering proof of additional profits they claim their account would have earned if it had been invested in alternative securities, the performance of which they claim would have tracked the S&P 500 or other market indices, on the ground that any award of damages based on such proof would be contrary to the law governing plaintiffs’ claims.” While conceding the existence of federal authority supporting plaintiffs’ demand for lost appreciation damages, defendants argued that, under New York law, the only proper and nonspeculative measure of damages is the value of the capital actually lost by plaintiffs, plus interest. For that proposition, defendants cited Matter of Janes (
Plaintiffs opposed the motion, asserting their right to seek recovery of market index damages and protesting any limitation of their recovery to the difference between the relevant beginning value of the fund ($205,000 in January 1996) and its value when defendants were removed from control over it ($106,000 in May 1998). Plaintiffs sought to distinguish Janes and instead cited Matter of Rothko (
Supreme Court ordered that “defendants’ motion for an order in limine precluding plaintiffs from offering proof of additional profits they claim their account would have earned if it
IV
We address first the issue of appealability. Defendants cite the oft-repeated propositions that “no appeal lies from an order adjudicating in advance of trial the admissibility of evidence” (Vesperman v Wormser,
The notion that no appeal as of right lies from an evidentiary ruling, whether made before or during trial, is certainly sound to the extent that the ruling has not been embodied in a formal order (see CPLR 5512; see also CPLR 5511, 5701). Otherwise, the proposition cannot be squared with the provisions of CPLR articles 55 and 57. CPLR 5512 (a), entitled “Appealable paper,” straightforwardly provides that “[a]n initial appeal shall be taken from the judgment or order of the court of original instance * * CPLR 5701 (a) (2) (iv) and (v) authorize an appeal as of right from any order (other than the three types specified in subdivision [b]) that “involves some part of the merits” or “affects a substantial right” (see Rondout Elec.,
The order in this case is far from advisory. Rather, it has a concretely restrictive effect on the efforts of plaintiffs to prove their case against defendants and recover certain damages from them, just as our reversal of the order would have “the very tangible effect of permitting the plaintiff[s] to seek full recovery of [their] actual damages” (Rondout Elec.,
“a party misuses a motion in limine as the procedural equivalent of a motion for partial summary judgment, and the court decides that motion, resulting in an order that limits the issues to be tried, that order is appealable. An order deciding such a motion clearly involves the merits of the controversy (see CPLR 5701 [a] [2] [iv]) and affects a substantial right (CPLR 5701 [a] [2] [v]) and thus is appealable (see Marshall * * *,277 AD2d 432 [2000]; see also Campaign for Fiscal Equity v State of New York, 271 AD2d 379 [2000]; Qian v Dugan,256 AD2d 782 [1998])” (Rondout Elec.,304 AD2d at 811 ; see also Wall St. Assoc.,295 AD2d at 262-263 ; MacMillan,267 AD2d 1014 ; Brown,250 AD2d at 320-321 ).
V
Concerning the substantive issue, plaintiffs contend that an award of lost profit or lost appreciation damages, including those based on a market index, is proper in a case alleging the unauthorized, unsuitable trading and the churning of the investment fund by the broker/trustee and his firm. The issue is whether plaintiffs’ loss (exclusive of interest) is properly measured merely against the value of the fund in January 1996, or also against the market’s general performance over the period in question, i.e., taking into account that Franger’s management of the fund resulted in a drastic and improbable diminution in its value over a period during which the overall market was appreciating markedly.
At the outset, we note that the second amended complaint is not limited to a cause of action for breach of fiduciary duty, but also includes causes of action for negligence, breach of contract, fraud, and the violation of General Business Law § 349. While the precise measure of damages may vary under each of those theories, there can be no doubt that, under all of them, the “object of compensatory damages” is the same, i.e., to make the plaintiff “whole” (Campagnola v Mulholland, Minion & Roe,
Even if plaintiffs alleged only a breach of fiduciary duty, the proper measure of damages would depend on the precise nature of the wrong or wrongs committed by defendants. As identified by the parties, the landmark decisions on this issue are those of the Court of Appeals in Rothko (
Rothko was a proceeding involving the estate of Mark Rothko, the abstract expressionist painter. The principal asset of the estate consisted of 798 paintings of considerable value, and the petition sought damages for the conduct of the three executors in consigning those paintings to art dealers for resale at inadequate prices and for excessive commissions, transactions in which two of the executors had a self-interest. Such conduct was “portrayed in the record and sketched in the opinions [as] manifestly wrongful and indeed shocking” (Rothko,
On appeal, the propriety of such lost appreciation or lost profit damages was an issue that divided the Appellate Division (see id. at 317-318, 320). However, a unanimous Court of Appeals rejected the contention that the award of such damages was legally erroneous and impermissible, contrasting the case before it from those in which the “ ‘breach of trust consisted merely in selling the property for too low a price’ ” (id. at 320). The Court wrote:
“ ‘If the trustee is guilty of a breach of trust in selling trust property for an inadequate price, he is liable for the difference between the amount he should have received and the amount which he did receive. He is not liable, however, for any subsequent rise in value of the property sold’ ” (id. at 320-321).
The Court further wrote, however,
“that where the breach consists of some misfeasance, other than solely for selling ‘for too low a price’ or ‘for too little’, appreciation damages maybe appropriate. * * * [T]he trustee may be held liable for appreciation damages if it was his or her duty to retain the property, the theory being that the beneficiaries are entitled to be placed in the same position they would have been in had the breach not consisted of a sale of property that should have been retained. The same rule should apply where the breach of trust consists of a serious conflict of interest — which is more than merely selling for too little. * * *
“Here, the executors, though authorized to sell, did not merely err in the amount they accepted but sold to one with whom [they] had a self-interest. * * * [S]ince the paintings cannot be returned, the estate is therefore entitled to their value at the time of the decree, i.e., appreciation damages. These are * * * damages intended to make the estate whole. Of course, as to [the executors and consignees], these damages might be considered by some to be exemplary * * * in that they serve as a warning to others * * *, but their true character is ascertained when viewed in the light of overriding policy considerations and in the realization that the sale and consignment were not merely sales below value but inherently wrongful transfers which should allow the owner to be made whole” (id. at 321-322).
Although noting the impossibility of appraising the current value of the unreturned works of art with absolute certainty, the Court of Appeals stated:
“[S]o long as the figure arrived at had a reasonable basis of computation and was not merely speculative, possible or imaginary, the Surrogate had the right to resort to reasonable conjectures and probable estimates and to make the best approximation possible through the exercise of good judgment and common sense in arriving at that amount * * *. This is particularly so where the conduct of wrongdoers has rendered it difficult to ascertain the damages suffered with the precision otherwise possible” (id. at 323).
In contrast to Rothko, Janes was a case in which the fiduciary merely wrongfully failed to diversify the portfolio, instead
“The proper measure of damages for a fiduciary’s negligent retention of assets is the value of the capital that was lost * * *[, which is] calculated by determining the value of the securities at the time they should have been sold, minus their value when ultimately sold or, if they are still retained by the estate, their value at the time of the accounting or the.court’s decision * * *. The court should subtract amounts received by the estate as dividends or other income attributable to the retained assets” (Janes,223 AD2d at 34 ).
We noted the line of cases rejecting, as “the proper measure of damages for improper retention of securities, * * * a measure of damages based upon lost profits or appreciation” and one “based upon the hypothetical performance of an investment of the proceeds of sale in the market” (Janes,
“Here, the fiduciary imprudently retained unproductive assets, as opposed to unlawfully selling productive assets, and there is therefore no basis for awarding damages based on lost appreciation” (Janes,223 AD2d at 36 ).
On appeal, the Court of Appeals upheld our rejection of the Surrogate’s measure of damages based upon a market index, stating:
“Where, as here, a fiduciary’s imprudence consists solely of negligent retention of assets it should have sold, the measure of damages is the value of thelost capital * * *. Thus, the Surrogate’s reliance on Matter of Rothko in imposing a lost profit’ measure of damages is inapposite, since in that case the fiduciary’s misconduct consisted of deliberate self-dealing and faithless transfers of trust property ( 43 NY2d, at 321-322 , supra)” (Janes,90 NY2d at 55 ).
VI
Many federal decisions, including some that address pendent state common-law causes of action as well as causes of action arising under federal securities law, support the award of lost appreciation (or excess depreciation)
“First, the district court should determine as near as possible the time when [the fiduciary] began to aid and abet [the cofiduciary’s] fraud and compute the market value of [the plaintiffs] portfolio on that date. Second, the district court should subtract the value of the portfolio on the date when [the fiduciary’s] participation in and assistance to the fraudulent scheme ceased from the value on the date when [the fiduciary] became an aider and abettor. This amount is [the plaintiffs] gross economic loss. * * * The district court should then reduce [the plaintiffs] gross economic loss by the average percentage decline in value of the Dow Jones Industrials, the Standard & Poor’s Index, or any other well recognized index of value, or combination of indices, of the national securities markets during the period commencing with [the fiduciary’s] aiding and abetting and terminating with its cessation. * * *
We also hold that [the plaintiff] is entitled to a return of commissions paid to [the fiduciary] and [the fiduciary’s employer], but only as to transactions falling within the aiding and abetting period, with interest thereon as determined by the district judge” (id. at 49-50 [citations omitted]).
In an accompanying footnote, the court discussed which market index might be utilized:
“If the district judge should determine that, when the aiding and abetting period began, the quality of stocks in the portfolio was such that a broad-based index would not be representative of those stocks, then he may select a more appropriate gauge, perhaps a portion of an index, perhaps a composite of indices, perhaps expert opinion” (id. at 49 n 22).
Similarly, in Miley v Oppenheimer & Co., Inc. (637 F2d 318 [1981], reh denied 642 F2d 1210 [1981]), another case involving allegations of churning and unsuitable investments, the Fifth Circuit permitted the plaintiff to recover both for the commissions and interest paid as a result of the excessive trading and for the decline in the value of her account in excess of the average decline in the stock market over the period of the defendant broker’s management of the account. Rejecting the argument that there had been a double recovery, the court observed:
“[T]here are in fact two distinct harms which may be proximately caused by the broker’s churning of an account. It is necessary to remedy both harms in order to fully compensate the victimized investor.
“First, and perhaps foremost, the investor is harmed by having had to pay the excessive commissions to the broker [,] the ‘skimmed milk’ of the churning violation.* * * [Such harm occurs] regardless of whether the investor’s portfolio increased or decreased in value as a result of such trading. Second, the investor is harmed by the decline in the value of his portfolio!,] the ‘spilt milk’ of the churning violation[,] as a result of the broker’s having intentionally and deceptively concluded transactions, aimed at generating fees, which were unsuitable for the investor. * * * [Such harm occurs] regardless of the amount of the commissions paid to the broker. In sum, once a juryfinds that the broker has churned an investor’s account, it may also find that the investor would have paid less commissions and that his portfolio would have had a greater value had the broker not committed the churning violation” (id. at 326).
The court further observed that a victim of churning may be damaged by having to pay the brokerage commissions on both purchases and sales, by missing dividends, by incurring unnecessary capital gains or income taxes “and, most difficult to measure, [by losing] the benefits that a well-managed portfolio in long-term holdings might have brought him” (id.).
The Miley court then addressed whether damages should be measured by a market index. The court noted the “difficulty in accurately measuring the loss in portfolio value proximately caused by the excessive trading and unsuitable transactions,” as well as the impossibility of computing “the exact amount of trading losses caused by the. churning of an account” (id. at 327). The court nevertheless held the plaintiff to be “entitled to recover the difference between what he would have had if the account ha[d] been handled legitimately and what he in fact had at the time the violation ended” (id.). The court stated:
“In order to approximate the trading losses caused by the broker’s misconduct, it is necessary to estimate how the investor’s portfolio would have fared in the absence of* * * such misconduct. The trial judge must be afforded significant discretion to choose the indicia by which such estimation is to be made, based primarily on the types of securities comprising the portfolio. However, in the absence of either a specialized portfolio or a showing by either party that a different method is more accurate, it seems that the technique discussed * * * in Rolf * * * and employed by [the District Court] in this case is preferable. * * * This mode of estimation utilizes the average percentage performance in the value of the Dow Jones Industrials or the Standard and Poor’s Index during the relevant period as the indicia of how a given portfolio would have performed in the absence of the broker’s misconduct” (id. at 328 [citations omitted]).
The court upheld a charge requiring the jury to compute the damages sustained by plaintiff by ascertaining the amount of her original investment and subsequent dividends thereon, subtracting therefrom any withdrawals received by her and
VII
Based on the foregoing, we hold that in a case such as this, involving claims of churning, investment unsuitability, or other acts of unauthorized trading by defendants, an appropriate measure of damages is plaintiffs’ “gross economic loss, adjusted for the overall market’s performance” (In re Drexel Burnham Lambert Group, Inc.,
Pigott, Jr., P.J., Pine and Wisner, JJ., concur.
It is hereby ordered that the order insofar as appealed from be and the same is unanimously reversed, on the law, with costs, and defendants’ motion is denied.
Notes
The principal federal decisions, unlike this case, involve defalcations committed during a bear market.