United States v. Skelly and Gross, Docket No. 05-4261-cr (L) (2d Cir. March 21, 2006) (Newman, Katzmann, Rakoff (by desig’n)): A rather rambling opinion by one SDNY judge affirming a judgment of conviction rendered by another SDNY judge following a jury trial convicting the two defendants of various counts of securities fraud. The Government’s primary theory at trial was that Skelly and Gross, the principals of Walsh Manning Securities (a registered broker / dealer), engaged in a pump-and-dump scheme wherein they (and the registered reps they employed) “used manipulative techniques to artificially inflate the price of certain thinly-traded securities in which they held a substantial interest, and then used fraudulent and high-pressure tactics to unload the (largely worthless) securities on unsuspecting customers.” Op. 2. This theory was, we are told, “amply supported by the evidence.” Id.
Employing the “kitchen sink” mode of litigation so in favor at One St. Andrew’s, however, the prosecutor threw in another theory of liability in his summation. Shifting gears entirely, the prosecutor told the jury that it could also convict the defendants based on the fact that when the company’s registered reps recommended the stock to its customers, the reps failed to tell the customers that they were being paid “huge commissions for recommending . . . and selling that stock.” Op. 3. “[T]that’s fraud under the securities law,” the prosecutor asserted. Id.
Not so. On the contrary, liability under a “material omission” theory exists only where the registered rep had a fiduciary relationship with the customer. Op. 4-5. “[N]o SEC rule requires the registered representatives who deal with the customers to disclose their compensation,” the Circuit stated, and under the general anti-fraud provisions of the securities laws (under which the defendants were indicted), “a seller or middleman may be liable for fraud if he lies to the purchaser or tells him misleading half-truths, but not if he simply fails to disclose information that he is under no obligation to reveal.” Op. 4.
In charging the jury, the district judge first correctly stated the law on this new theory. He told the jury that it could “only convict a defendant on a ‘failure to disclose’ theory if the broker had assumed a ‘fiduciary duty’ to disclose such information.” Op. 5. This was a proper statement of the law. And while “there is no general fiduciary duty inherent in an ordinary broker / customer relationship,” Independent Order of Foresters v. Donald, Lufkin & Jenrette, Inc., 157 F.3d 933, 940 (2d Cir. 1998), a fiduciary relationship can arise under particular factual circumstances. For instance, the Circuit has held that a broker has a fiduciary duty to a customer “where a broker has discretionary authority over the customer’s account.” Op. 6; see also Op. 5-6 (fiduciary relationship exists “between a broker and a customer with respect to those matters that have been entrusted to the broker”).
The court then erred, however, in defining when such a duty can arise. The court “for reasons unclear from the record, limited the instruction on this point to a single sentence: ‘One acts in a fiduciary capacity when the business which [sic] he transacts or the money or property which [sic] he handles is not his or for his own benefit, but is for the benefit of another person as to whom he stands in relation impl[ying] and necessitating great confidence and trust on the one part, and a high degree of good faith on the other part.” Op. 7. This instruction was faulty, the Circuit found, because it “omitted the elements of ‘reliance and de facto control and dominance,’ which are required to establish a fiduciary relationship.” Id.
But all’s well and everyone can sleep soundly: The errors were of no moment because the defendant failed to lodge a proper objection to the charge and because, in any event, the evidence of guilt on the principal theory of liability advanced by the Government was (so we are told) overwhelming. Op. 8-9.
The Circuit also rejects the defendants’ claim that the Government’s alternative theory of liability constituted a constructive amendment of the indictment. This was because the indictment generally charged the defendants with “causing retail brokers employed by Walsh Manning . . . to employ a variety of fraudulent and illegal sales practices in order to induce customers to buy the securities,” and this “general language was more than sufficient to encompass [both theories of liability] as well as to put the defendants on fair notice that all their practices used to promote the house stocks were included in the charge.” Op. 9-10.