ON APPEAL FROM THE UNITED STATES DISTRICT COURT FOR THE EASTERN DISTRICT OF PENNSYLVANIA, D.C. Civil No. 82-0542.
Gibbons and Garth, Circuit Judges and Teitelbaum, District Judge.*fn* Garth, J., dissenting.
Arthur Bowley, a former customer of Stotler and Co., a commodities broker, appeals from an order denying his motion for judgment notwithstanding the verdict or a new trial, in his action seeking money damages from Stotler and Co. and John Mulach, a registered commodities broker employed by Stotler. Bowley's complaint alleges that Mulach engaged in churning of his account in violation of section 4b(A) of the Commodity Exchange Act as amended by the Commodities Futures Trading Commission Act, 7 U.S.C. § 6b(A) (1982).*fn1 A jury returned a verdict in favor of the defendants on the churning count.*fn2 Bowley contends that a new trial should be granted because the court erred in instructing the jury. We reverse and remand for a new trial.
I. The Evidence and the Verdict
Bowley was solicited by Mulach to open a commodities trading account with Stotler and Co., and did so on July 26, 1977, with an initial deposit of $2,000. A customer's agreement form was signed by Bowley, in which, in consideration of Stotler and Co. carrying an account as his broker for the execution of orders on various commodities exchanges, he made certain undertakings. Although the customer's agreement is silent on the issue, the evidence suggests and the parties agreed that the broker was to execute Bowley's orders, not to trade in his own discretion. The broker was, however, permitted to, and did, recommend trades. Under Mulach's guidance Bowley initially succeeded. The account grew from $2,000 to approximately $90,000 at the end of 1978. During that year, however, the type of trading changed. The number of commodities traded multiplied. The account reflected sophisticated marketing maneuvers such as spreads, straddles, and "scaled up" orders. It also reflected "day trades," which permitted control of more contracts of greater value without increasing margin deposits, because margin determinations were made at the close of a trading day. The extent of Bowley's knowledge of and participation in making these trades was disputed at trial. It is clear, however, that he received daily confirmation slips of executed orders, and monthly composite statements. Moreover, Mulach and Bowley communicated frequently by telephone.
The commission earned by Stotler & Co. in 1978 was $28,880. In 1979 commissions grew to $115,065. During the entire life of the account commissions were paid on 3,855 "round turn" contracts, of which 2,101 were "day trades." By July 10, 1980, when Bowley's account was closed, it had decreased in value to less than $5,000. Stotler's commissions between July 26, 1977 and July 10, 1980 totaled $159,935.50.
The jury found that Mulach did not violate the Commodities Exchange Act, and a judgment was entered accordingly.
The Commodity Futures Trading Commission, the federal regulatory agency responsible for the administration and enforcement of the Commodities Exchange Act, 7 U.S.C. § 1 et seq. (1982), defines churning as "the excessive trading of an account by a broker with control of the account, for the purpose of generating commissions, without regard for the investment or trading objectives of the customer." In the Matter of Lincolnwood Commodities, Inc. of California, 2 Comm. Fut. L. Rep. (CCH) para. 21,986, at p. 28,246 (Jan. 31, 1984). Under Section 4b of the Act it is unlawful for a broker to cheat or defraud a customer, and both the courts and the Commission hold that churning amounts to such cheating or defrauding. Johnson v. Arthur Espey, Shearson Hammill & Co., 341 F. Supp. 764, 766 (S.D.N.Y. 1972); Hecht v Harris, Upham & Co., 283 F. Supp. 417, 432 (N.D. Cal. 1968), modified in other respects, 430 F.2d 1202 (9th Cir. 1970); Smith v. The Seigal Trading Company, Inc. [1980-82] Comm Fut. L. Rep. (CCH), para. 21,105 at p. 24,453 (1980). The parties do not dispute that there is a private right of action for violations of section 4b of the Act, and on appeal they agree on the definition of churning.*fn3 That definition includes two elements: control of an account by a broker, and excessive trading. Bowley contends that the trial court erred in its charge on each element.
A. The Charge on Control of the Account
This case involves alleged churning of a non-discretionary account; that is, an account over which the broker was not formally granted by the customer sole authority to make trading decisions. Thus Bowley attempted to prove that he had effectively surrendered de facto control to Mulach. In doing so he relied on case law to the effect that a finding of control is not dependent upon the account being formally labeled discretionary, but is based on who in fact is making the trading decisions. E.g., Newburger, Loeb & Co., Inc. v. Gross, 365 F. Supp. 1364, 1371 (S.D.N.Y. 1973); Hecht v. Harris Upham & Co., supra, 283 F. Supp. at 432-33. Bowley therefore requested that the court charge:
The question for you to decide is "who, in fact, was making the decisions" in the account. The following are factors you may take under consideration which may tend to demonstrate control, but the list is not meant to be exhaustive:
1. A lack of customer sophistication;
2. A lack of prior commodity trading experience on the part of the customer and a minimum of time devoted by him to his account;
3. A high degree of trust and confidence reposed in the Associated Person by the customer;
4. A large percentage of transactions entered into by the customer based upon the recommendation of the Associated Person;
5. The absence of prior customer approval of transactions entered into on his behalf;
6. The education and experience of the customer and the Associated Person; and
7. The opportunity and availability of the parties to trade.
A 65 (citation omitted). Throughout the trial the defendants vigorously opposed the adoption of a de facto test for control, and they opposed Bowley's requested instruction to that effect. The court declined to give Bowley's instruction in the form requested. Instead the court instructed:
But the key to whether or not Mr. Bowley or Mr. Mulach had control, it seems to me, is whether the person you consider with the right to say, "Go forward," also had the right to refuse a trade.
Did the person who had the right to say, "trade," also have the right to refuse, or did that rest in someone else? Did Mr. Bowley, in effect, give that over to Mr. Mulach by rubber-stamping everything? Or did Mr. Mulach never accept in any trading circumstance the right to refuse to trade?
But, the right to refuse, alone, will not be sufficient. It is the right to refuse coupled with a willingness to exercise it if under all the circumstances the objectives of the customer would not be fulfilled. That is the true test.
The right to refuse to trade, coupled with a willingness to exercise that right to refuse if upon consideration of the objectives and all the factors it would not be in the best interest of those objectives to go forward. Whoever had the right to refuse to trade coupled with that willingness is the person in control, and that is what you have to decide.
Did Mr. Bowley, in addition to having knowledge of the objectives, did he consider all the factors? Did he have a right to refuse to trade ? And was he willing to say, "Don't trade, don't sell," if he thought his objectives wouldn't be served? If you think he possessed that authority, he had control of the account.
If, on the other hand, he agreed to everything that Mr. Mulach recommended, and Mr. Mulach had the right to refuse and was willing to exercise that decision -- do not sell or do not buy at a price, or that month or that commodity -- and he had a willingness to do that if he thought Mr. Bowley's objectives wouldn't be served, then Mr. Mulach had control.
A 83-85 (emphasis supplied).
Bowley, and the Commodities Futures Trading Commission, amicus curiae, contend that this charge was erroneous, because it emphasized that the key element in determining control was "the right to refuse to trade." In a nondiscretionary account, they urge, a broker never has the right to refuse to trade, but must place an order if his customer directs him to do so. Thus under the court's test for control, they contend, a broker never could exercise de facto control over an account, regardless of the broker's relationship with the customer or the customer's capacity to exercise independent judgment.
The emphasis upon the broker's non-existent right to refuse to trade is not the sole objection by Bowley and the Commission to the court's instruction on control. They contend, as well, that by refusing to instruct as Bowley requested the court failed to instruct the jury to consider all of the relevant factors tending to show de facto control of the account. Although requested to do so, the court did not direct the jury to consider Bowley's sophistication in commodity trading, his background, education, and prior experience in commodities trading, or the time and attention he devoted to trading in the account. The requisite instruction tracked the list that the Commission has identified as factors that the finder of facts should consider as tending to demonstrate control. Ball v. Shearson Hayden Stone, Inc. [1980-82] Comm. Fut. L. Rep. (CCH) para. 21,184 at p. 24,874 (1981); Smith v. The Siegel Trading Co., Inc. [1980-81], Comm. Fut. L. Rep. ...