Appeal from the United States District Court for the Northern District of Illinois, Eastern Division. No. 86 C 8003--George M. Marovich, Judge.
Before HARLINGTON WOOD, JR., and KANNE, Circuit Judges, and SHARP, Chief District Judge. *fn*
HARLINGTON WOOD, JR., Circuit Judge.
This securities fraud case charges a violation of Section 10(b) of the Securities Exchange Act of 1934 (the Act), 15 U.S.C. sec. 78j(b), and Section 20(a) of the Act, 15 U.S.C. sec. 78t(a). This panel is acquainted with the case, but different issues are raised in this second appeal. In the first appeal, 974 F.2d 873 (7th Cir. 1992), cert. denied, 113 S. Ct. 2994 (1993) (Harrison I), we affirmed in part and reversed in part. The case had come to us on the grant of summary judgment in favor of defendant Dean Witter with respect to the claim raised under Section 20(a) of the Act. We reversed the grant of summary judgment and remanded for trial concluding on the question of control that:
The alleged facts are sufficient to prevent our finding, as a matter of law, either that Dean Witter did not actually exercise control over the operations of Kenning and Carpenter in general or that Dean Witter did not possess the power or ability to control Kenning and Carpenter's transactions upon which the primary violation is predicated. Accordingly, it was error to grant Dean Witter's motion for summary judgment on the basis that Dean Witter was not a controlling person. We leave that determination to the factfinder. 974 F.2d at 881.
We further concluded on the issue of the conduct of Dean Witter that:
Under the alleged facts of the present case we cannot say, as a matter of law, that Dean Witter acted in good faith and neither directly nor indirectly induced the act or acts constituting the violation. This determination, too, must be left to the factfinder. Id. at 882.
As to Harrison's original respondeat superior theory of liability, which has now disappeared from the case, we held that the district court exercising its diversity jurisdiction had correctly found that Dean Witter was not liable under respondeat superior for the state law vicarious liability claim which Harrison raised. The statutory issue arising under the federal act is now argued by Dean Witter to be governed by the prior ruling of this court on the respondeat superior state claim. Also gone from the case is the claim for the alleged negligent hiring of the two employees of Dean Witter directly involved.
Since Harrison I, a jury has found on all issues against Dean Witter and assessed damages. We now review that final judgment.
Dean Witter raises three issues which must be addressed: First, Dean Witter argues that the district court erred in denying Dean Witter's motion for judgment as a matter of law on the question of control person liability. Dean Witter claims there was no legally sufficient evidentiary basis for the jury to find "control person liability" under Section 20(a) of the Act. In its view there was no showing that Dean Witter had the power or ability to control the particular transactions that allegedly violated Section 10(b) of the Act. Second, Dean Witter alleges the district court erred in denying its motion for a new trial on the basis that the evidence was insufficient for the jury to have found the justifiable reliance necessary to establish a primary securities fraud in violation of Section 10(b). Third, Dean Witter claims the district court erred in denying its motion for a new trial based on the exclusion by Judge Marovich of certain income tax evidence related to Harrison. Dean Witter argues that the excluded evidence was relevant to all three principal issues in this appeal.
In addition to the facts outlined in the first opinion reversing the grant of summary judgment, the jury in this case heard the fraud story in greater detail and, as always, had the opportunity to assess the credibility of the witnesses and to determine the weight to be accorded their testimony.
There is no dispute that Harrison was defrauded by John Kenning, a vice president of Dean Witter, and by John Carpenter, a registered salesperson for Dean Witter. Kenning, the more experienced in the brokerage business, was responsible for Carpenter, then twenty-seven years old, being employed by Dean Witter in 1983. When Kenning was hired by Dean Witter he insisted that Dean Witter also take his friend Carpenter as a "package deal." Richard Frost, Dean Witter's Boca Raton branch manager, bought that package, and trouble. Both Kenning and Carpenter worked closely together in that branch office. A couple of years after being hired, the two pleaded guilty in 1986 in federal court in Florida, admitting the fraud which constitutes the basis for this civil suit. *fn1 Over a hundred other persons besides Harrison were similarly defrauded, but Harrison's loss, the biggest of any of the defrauded investors, was found by the jury to be $3.4 million, to which the court added an additional $3.1 million prejudgment interest.
Kenning explained his view of how their successful fraud worked, for awhile. Kenning told his victims that because of his position as vice president at Dean Witter, and Carpenter's as salesperson, they were allowed to buy municipal bonds at advantageous prices through a special municipal bond investment program offered by Dean Witter for its large brokers. It was claimed by Kenning and Carpenter that the municipal bonds which could be bought through them were very good investments. When originally issued, he explained, the bonds had been discounted. Furthermore, when the municipal bonds would later be called, sometimes at a premium, it would be on a tax-free basis. Kenning further testified that he led Harrison to believe that he was able to take down large blocks of municipal bonds which he could share with Harrison because of his high production for Dean Witter, his general stockbroker ability, and because of his position as vice president.
Carpenter's account at Dean Witter though not also in Kenning's name played a part in their fraudulent activities. Kenning and Carpenter were investing their clients' money through this account, which they labelled a "trading account," but not in municipal bonds as they pretended. Instead, they were investing in riskier "put" options for themselves. They hoped to achieve greater returns through these personal riskier option investments. That might permit them, as they saw it, to keep both themselves and their special clients happy. As evidence of their clients' ostensible municipal bond investments, their special clients, including Harrison, were given promissory notes signed first by Carpenter, but later also by Kenning. Those notes purportedly showed the high returns expected, in this instance by Harrison, with enticing annualized interest rates of approximately eighteen to sixty percent on short maturities.
Kenning pretended to be a big player in the bond market and to be making his income from their nonexistent municipal bond transactions. Harrison testified that he was given to understand that he could not receive the benefits of these special municipal bond deals offered by Kenning and Carpenter if he opened his own personal account with Dean Witter. He understood from Kenning that Dean Witter had a special program for their large brokers, which Kenning and Carpenter claimed to be, allowing these top Dean Witter producers to profit by buying certain municipal bonds on the bid side of the market. If the blocks of municipal bonds available under this special arrangement were bigger than Kenning and Carpenter could handle themselves, they explained to Harrison, then they would share these municipal bond investment opportunities with their special customers. According to Kenning and Carpenter, they were able to discount their usual commissions and to avoid the usual markup of Dean Witter, all for their own and their clients' benefit. Their special clients were instructed, however, that because of these special circumstances not available to Dean Witter's lesser producing brokers and their clients, they were to do business only with Kenning and Carpenter personally, not with Dean Witter directly.
Only a little of the income enjoyed by Kenning and Carpenter came from the commissions they occasionally generated for themselves on their own risky option investments or from their regular clients. Their Dean Witter trading account was in Carpenter's name only, but they considered it to belong to them both. There was evidence that the activity generated in their personal trading account was much higher than the industry average for employees of stock brokerage firms.
Carpenter appears to have spent most of his time looking after his and Kenning's personal option investments. Indeed, during his tenure at Dean Witter, Carpenter opened no more than five accounts for any of his other customers. Consequently Carpenter earned a minimum of commissions for almost three years, which the evidence suggested did not exceed $71,000. Yet Kenning and Carpenter paid into Dean Witter through their option investing in the trading account a little under two million dollars. Dean Witter allegedly profited from commissions on that activity in excess of $400,000.
Richard Frost, who had hired Kenning and Carpenter, was Dean Witter's Boca Raton branch manager with oversight responsibilities. He routinely received each month the statements of Carpenter's Dean Witter trading account. Dean Witter's rules required that these statements be reviewed by management. Carpenter's trading account statements revealed the unusually high amount of account activity, specifying the gains and losses. The account statements also showed Kenning and Carpenter often trading at the limit through that account. The energetic activity in the trading account, however, generated profits for Dean Witter. Dean Witter recognized those profits with letters of commendation to Kenning and Carpenter and even gave them a plaque in acknowledgement of their outstanding broker accomplishments. Periodically compliance officers of Dean Witter visited the branch office and among other accounts reviewed their trading account. Neither Kenning nor Carpenter, however, had any recollection of ever having been asked by a Dean Witter compliance officer about the very substantial losses they often sustained in their risky option investments, whether those losses could be handled by the two of them, and particularly where all the money was coming from for their trading account. If they were asked any pertinent questions, however, their answers appear to have been accepted without further investigation by Dean Witter.
Around the time Harrison got involved in the fraud, Carpenter had already paid Dean Witter about $800,000 to cover their net losses in the trading account. At one time Carpenter gave Dean Witter bad personal checks from his own personal bank account totaling over $100,000, supposedly to cover the substantial losses exceeding $300,000 in the Dean Witter trading account. Kenning and Carpenter had a good explanation to cover their NSF check problem, blaming it on the timing of their deposits, bad checks to them, and their withdrawals at the bank--a bookkeeping matter. Dean Witter then took steps, however, to protect itself from similar NSF checks. There was, nevertheless, Kenning explained, continual pressure from Frost to keep generating those profitable commissions for Dean Witter.
Harrison never opened an individual account at Dean Witter, nor did he ever receive a Dean Witter statement, nor did he have any correspondence with any Dean Witter personnel other than Kenning and Carpenter. Meanwhile Dean Witter had comprehensive and specific internal rules governing the business operations and the conduct of its employees. Frost and the compliance officers had the duty to enforce the rules. Those rules specifically prohibited employees from engaging, as here, in securities transactions outside the usual course of business of the firm. To prevent rule violations, for instance, incoming office mail was opened and any checks enclosed were taken out in the cashier's office. Harrison, however, sent his investment funds to Carpenter's home or to Carpenter's personal bank account. The promissory notes Harrison received from Kenning and Carpenter bore no reference to Dean Witter. When from time to time Harrison received some return on his supposed bond investments, it was by a personal check of Carpenter, or in cash given to him by Kenning or Carpenter and delivered somewhere other than in Dean Witter's office. Carpenter supplied Harrison with IRS Form 1099s which identified Carpenter, not Dean Witter, as the source of the income. *fn2 Harrison sometimes had contact with Kenning and Carpenter's secretaries at Dean Witter, who identified the called number as "Dean Witter." The evidence shows Harrison telephoned Kenning and Carpenter as many as forty to fifty times at their Dean Witter offices. On one occasion Harrison was shown the Dean Witter office.
Kenning testified that in their big activity days Carpenter did not even have a net worth. Carpenter was facing bankruptcy. Much of their clients' money and any profits Kenning and Carpenter occasionally managed to make for themselves all evaporated in their risky personal investments and expenses, including (in addition to their option investments) a horse farm, private start-up companies, other personal expenditures, and, of course, their Ponzi scheme repayments which kept their fraud on life support. *fn3 About forty percent of all cash Kenning and Carpenter received was being recirculated through their Ponzi scheme. Their investments, unfortunately, were all losers. There is no allegation by Harrison or anyone else that Dean Witter had actual knowledge of this scam. This Kenning-Carpenter Ponzi scheme, however, lasted over thirty months in and around the branch office without being detected by Dean Witter.
Finally, and not surprisingly, this whole phantom securities operation collapsed around Kenning and Carpenter. They resigned from Dean Witter. It is not necessary to set forth here all the details of their fraudulent scheme which the jury heard, some of which could be deemed favorable to Dean Witter, and some not. The jury heard not only from Kenning, but also from Carpenter, Harrison, Frost, various personnel from Dean Witter, outside experts, and others. After weighing that evidence the jury resolved whatever evidentiary and credibility conflicts there may have been and found for Harrison under the jury instructions given by the trial court. Those instructions have not been made an issue in this appeal. We ...