Securities Law Prof Blog

Editor: Eric C. Chaffee
Univ. of Toledo College of Law

Wednesday, June 8, 2011

Second Circuit: Broker's Fiduciary Duty Based on Relationship of Trust & Confidence

The Second Circuit recently set forth its view of the nature of a broker's fiduciary duty in affirming the conviction of a broker for his involvement in a pump-and-dump scheme, U.S. v. Wolfson (2d Cir. June 7, 2011).  According to the court,

The evidence at trial showed that Wolfson artificially inflated the prices of certain thinly-traded securities in which he had amassed a substantial interest, and then unloaded those holdings on unsuspecting investors. Of particular relevance to Wolfson’s conviction, the scheme relied on corrupt stock brokers who sold the securities for prices far above their actual value. In exchange, Wolfson rewarded the brokers with exorbitant commissions. Some of the brokers failed to disclose the fact of the commissions to their customers. Others made affirmative misrepresentations about the size of these commissions.

On appeal, Wolfson argued that the brokers had no duty to disclose their commissions; accordingly, since his fraud convictions relied on the breach of that duty to establish a scheme to defraud, it must be overturned. In addition, Wolfson argued that, even if a duty to disclose might arise in some contexts, the district court gave an improper fiduciary duty instruction.  The court rejected both arguments.

On the fiduciary duty question, the court stated:

Although we have long held that there “is no general fiduciary duty inherent in an
ordinary broker/customer relationship,” we have also recognized that “a relationship of trust and
confidence does exist between a broker and a customer with respect to those matters that have
been entrusted to the broker.” ...[A] discretionary account is not the sole means by which a fiduciary duty may be created in the context of a broker-customer relationship; we have “recognized that particular factual circumstances may serve to create a fiduciary duty between a broker and his customer even in the absence of a discretionary account.”...Put otherwise, it is well settled in this Circuit that the presence of a discretionary account automatically implies a general fiduciary duty between a broker and customer, but the absence of a discretionary account does not mean that no fiduciary duty exists.

The appellate court also upheld the jury instructions, set forth below, as virtually identical to those in a previous dump and dump case:

Whether a fiduciary relationship exists is a matter of fact for you, the jury, to determine. At the heart of the fiduciary relationship lies reliance and de facto control and dominance. The relationship exists when confidence is reposed on one side and there is resulting superiority and influence on the other. One acts in a fiduciary capacity when the business which he or she transacts or the money or property which he or she handles is not his own or for his or her own benefit but for the benefit of another person, as to whom he or she stands in a relation implying and necessitating great confidence and trust on the one part and a high degree of good faith on the other part.

If you find that the government has shown beyond a reasonable doubt that a fiduciary relationship existed, such as between any one of the brokers and the customers you next consider whether there was a breach of the duties incumbent upon the fiduciary in the fiduciary relationship and specifically whether the defendant caused the broker or brokers to breach their fiduciary duties to customers. I instruct you that a fiduciary owes a duty of honest services to his customer, including a duty to disclose all material facts concerning the transaction entrusted to him or her. The concealment by a fiduciary of material information which he or she is under a duty to disclose to another, under circumstances where the nondisclosure can or does result in harm to the other is a [b]reach of the fiduciary duty and can be a violation of the federal securities laws, if the government has proven beyond a reasonable doubt the other elements of this offense, as I explained them to you.

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