NASD Dispute Resolution In the Matter of the Arbitration ... · decisions were made by Ted. Shortly...

AWARDNASD Dispute Resolution

In the Matter of the Arbitration Between

Name of Claimant

Ted Rudnicki and Ksawera Rudnicki

and 02-02395Phoenix, Arizona

Name of Respondents

Merrill Lynch Pierce Fenner & Smith IncThomas McDonald Rush

REPRESENTATION OF PARTIES

Ted Rudnicki and Ksawera Rudnicki ("Claimant") were represented by Nicholas P. lavarone, Esq.,Christopher L. Gallinari, Esq. and Steven Jones, Esq., Bellows and Bellows, Chicago, Illinois.

Merrill Lynch Pierce Fenner & Smith Inc ("Respondent MLPF & S") and Thomas McDonald Rush("Respondent Rush")(collectively as "Respondents") were represented by Tom Galbraith, Esq.,Meyer Hendricks & Bivens, P.A., Phoenix, Arizona.

CASE INFORMATION

The Statement of Claim was filed on or about April 24,2002. Submission Agreement of ClaimantTed Rudnicki and Ksawera Rudnicki was signed on April 18, 2002.

Statement of Answer was filed by Respondents Merrill Lynch Pierce Fenner & Smith Inc andThomas McDonaldRush on or about July 18,2002. Respondents1 Response to Claimants' HearingMemorandum was filed on or about September 25, 2003. Submission Agreement of RespondentMerrill Lynch Pierce Fenner & Smith Inc was signed on June 17,2002. Submission Agreement ofRespondent Thomas McDonald Rush was signed on July 15, 2002.

CASE SUMMARY

The following summary of the Complainants' case is drawn from the Statement of claim and theirHearing Memorandum that was submitted just prior to the opening of the hearing on September 10,2003.

Claimant Ted Rudnicki (hereinafter, Ted) opened an account with Dean Witter in 1997. Theaccount was opened with a mixture of his own money and assets transferred from an account

NASD Dispute Resolution, Inc.Arbitration No. 02-02395Award of 9

that he held with Noyes in Chicago. He was 68 years old at the time. The Noyes account wasactually set up and funded by Ted for his stepson to begin trading in the stock market, and he,not Ted, made all trading decisions. At the time, the Rudnickis were, and still are, operating a21 unit motel in Yuma, AZ, that also serves as their residence. Ted has a small pension fromhis employment as a union painter in Chicago, and there also is some Social Security income.Plus, there is a modest income from the motel, which also had a mortgage of approximately$350,000 at the time the Dean Witter account was opened.

Thomas Rush was the account executive for the Dean Witter account. When he moved over tothe Yuma office of Merrill Lynch in 2000, he "persuaded" Ted to move his account to MerrillLynch. At the time of the transfer, the account represented the entire savings/liquid assets forthe Rudnickis. Although the account was now a joint account (JTWROS), all operatingdecisions were made by Ted. Shortly after the account was opened at Merrill Lynch, asubsidiary margin account of $100,000 was set up for Ted. There was considerable trading inthe basic and the margin account. Most of the transferred assets were turned over and themargin account was immediately and almost completely invested in one high risk technologystock issue. Ted claims that these trades were either unauthorized in many instances, or he gavein to Rush (followed his advice and/or urgings) because he viewed Rush as a knowledgeableexpert, while he was an unknowledgeable novice.

The Merrill Lynch account initially lost money, reaching a low of $ 93,325 in May 31,2000,well below the initial investment barely 3 months before. However, the account reboundeddramatically, to the point that as of August 31,2000, it was worth about $ 260,000. Then by theend of September 2000, it had fallen to about $ 203,400, and continued to plummet to barely $77,000 at the end of the end of 2000. In March 2001, Ted closed out the account, netting $10,408. All the while, when Ted talked to Rush about whether he should "get out", he claimsthat Rush repeatedly assured him that the market would turn around (bounce back) and probablygo much higher.

Rush recommended stocks to Ted that were very high risk stocks - all but one carrying a "D"rating by Merrill Lynch that is their highest risk rating. The recommendations resulted in anunduly narrow concentration in high risk (speculative) technology securities with outdiversification into any other sector. Ted says that the stocks recommended to him wereunsuitable for him because of his age; they were all of his life's savings, and they were highlyleveraged through the use of a large margin account that was a multiple of the investments usedto open his account with Merrill Lynch. Further, they were contrary to his investmentobjectives (preservation of principal) as stated on his new account form that was completed byRush. Also, when the gains neared their peak, and then began to decline greatly and rapidly,Rush always assured him that he should not sell because the market was going to go back up.

Ted claims that both Merrill Lynch and their employee, Rush, violated fiduciary duties owedhim. Merrill Lynch failed to properly supervise Rush; failed to enforce its own Compliance


Manual and rules; and, in particular failed to comply with NASD Rule 2310 and the NYSE Rule2405 (405) - AKA, Know Your Customer and Due Diligence. Rush violated his fiduciaryduties by making trades (authorized and often unauthorized) that were contrary to the client'sstated investment objectives, not following the direction in The Merrill Lynch ComplianceManual, preparing inaccurate "New Account" forms; and failing to comply with NASD Rule2310 and NYSE Rule 2405 (405). Also, Rush was "lulling" the client, Ted, into incurringgreater losses than he would have if he had sold out on a few occasions when he wanted to.

The following summary of the Respondents' case is drawn from their reply to the claim and theirpre-hearing memorandum.

The essence of the dispute "is that Mr. Rudnicki is a disappointed investor, who - after the fact- wants to transfer the risk he undertook for his own benefit to the pension funds, mutual fundsinstitutional investors and other members of the American public who have invested theirmoney in the respondent, Merrill, Lynch, Fenner & Smith" [and Thomas Rush, who is a jointRespondent]. They deny that any unauthorized trades were made in Ted's account and that onlyone of the transactions (the purchase of B2B Internet HOLDRS) was the result of arecommendation by Rush.

Ted opened an account with Rush in 1998 at Dean Witter. Ted presented himself as areasonably knowledgeable investor and spoke with sophistication about his history in the stockmarket. The account was fully concentrated in the technology sector. When Rush moved overto Merrill Lynch, Ted moved his account over to Merrill Lynch in March 2000. Although theaccount at Merrill Lynch was opened as a joint account (JWROS), Ted did all of the trading.The assets deposited in the account had an approximate value of $ 213,000, with a basis ofapproximately $ 87,000. A month after opening the account, Ted converted it from a cashaccount to a margin account with a $ 100,000 credit line. Ted immediately had the credit lineinvested almost completely in Ariba, Inc.; he already held 200 shares of Ariba.

When Ted discussed changing from a cash account to a margin account, Rush stronglycounseled against opening a margin account. He explained in detail how a margin accountworks, including the increased risk of loss from leverage and margin calls. Ted said that he wasaware of all of that and insisted on opening a margin account. Because Rush thought a largemargin account was unwise for Ted, he adopted a policy of not making any stockrecommendations that would involve using the margin account.

Ted followed his investments carefully; spoke knowledgeably about them and the stocks that hewould propose for purchase or exchange. Rush had the impression that Ted had current newsabout his investments from outside sources on a continuing basis. Ted also was given monthlystatements with prominent, clear valuation statements and bar charts showing the changes invalue over the months. Rush also discussed the risks of each individual investment, includingincreasing risk by increasing an already high concentration in a particular stock, before making


the trade. Thus, the purchase of B2B instead of Ariba from the proceeds of the NEXTEL salerather buying only Ariba as Ted had initially proposed.

Within 90 days of opening the account with Merrill Lynch, its value had dropped to only a few$1,000 over the basis of the stocks transferred in. Ted decided to stay with his holdings. Hemade this same decision month after month as the market peaked and his account reached about$ 260,000 at the end of August 2000, and after the market fell through the end of December to apoint where the account was now about $ 10,00 less than the basis of the account when it wasopened 9 months before. He consciously continued to hold his positions through February2001. He finally liquidated in March 2001 when his account had shrunk to less than $ 11,000.

Respondents raise several issues of law in this action that they believe work in their favor andthe disfavor of the Complaints:

1. A broker's fiduciary duty in unsolicited trades is to exercise reasonable care in executingorders as instructed;

2. The broker's duty on solicited trades requires only a reasonable basis for arecommendation;

3. Recovery for B2B is barred by Prospectus disclosure and the "Bespeak Caution" Rule;4. The customers' duty to read their statements, prospectuses, confirmation statements and

due diligence to at least inquire about what they do not understand or otherwise question;5. A broker is not liable for a customer's decision to trade unwisely.

Respondents further claim that Claimants' cannot show loss causation nor a basis for punitivedamages.

RELIEF REQUESTED

Claimant requested compensatory damages in the amount of $221,071.42, plus punitive damages ofat least $100,000, plus whatever additional relief the panel deems just. During closing argument,Claimants added a specific request for attorney fees and costs.

Respondents requested that the Panel dismiss the claimants' Statement of Claim in its entirety,expunge the individual registration record of Tom Rush maintained by the Central RegistrationDepository, assess all costs and forum fees against claimants, and award Merrill Lynch its attorneys'fees. Merrill Lynch also prays for such other and further relief as is deemed just and proper.

OTHER ISSUES CONSIDERED & DECIDED

On January 6,2003, Respondents requested a Stipulation and Protective Order concerning discoverythat may involve discussion or production of confidential business and financial information. TheProtective Order was approved on January 13 by the Panel Chair.

On February 4, 2003, Claimants filed a Motion to Compel that Respondents1 answers to 6 (six) of


their discovery requests were deficient. A timely answer was filed on March 3 by Respondents thatdisputed the scope, propriety and the undue burden of the requests. Four requests were denied andtwo were greatly reduced in their breadth and burden by order of the Panel. Shortly before thescheduled hearing in April, Respondents requested a postponement because of a medical emergencyfor their attorney. The Panel found good cause and the hearing was postponed to July 2003. TheClaimants' then requested another postponement due to calendar conflicts, but that request wasdenied. However, the Panel Chair failed to properly record the new dates on his calendar and failedto appear on the first hearing date. The hearing was rescheduled for September 10-12, 2003. As aresult, Claimants engaged in some additional discovery and filed a second Motion to Compel. ThatMotion was denied on condition that Respondent provide certain documents that it had promised bythe afternoon of the Thursday preceding the start of the evidentiary hearing on September 10. Theevidentiary hearing was held on September 10 though 12, 2003.

As soon as the hearing was officially opened, Respondents objected to Claimants' HearingMemorandum because it was untimely and, in part, constituted an untimely and unfair amendment ofthe Statement of Claim by raising an issue of "negligent supervision". The Memorandum had beenpresented to the Respondents only a few minutes before the hearing was opened on September 10,2003. After a brief executive session, the Panel ruled that while the Memorandum was untimelyfiled, it had no evidentiary weight -just as a Party's Opening Statement had no evidentiary weight.Further, the Panel took the matter of a new issue - negligent supervision - under advisement afterdiscussing its view that the amount and quality of supervision was likely a proper element of prooffor the originally pled claim of violation of fiduciary duties owed to the Claimants' by theRespondents. Therefore, any factual testimony or other evidence on the supervision given to Rushwould be admitted during the first day, subject being stricken if the Panel ruled in favor of theRespondents' Motion. The Panel also advised the Parties that it would hear oral argument on themotion to strike the issue of negligent supervision at 9 A.M. the next morning and then rule. Thenext day, having considered the oral arguments and the initial pleadings, the Panel ruled that theClaimants' were not amending their claim to include a specific allegation/issue of "negligentsupervision", but were offering testimony and other evidence on the quantity and quality ofsupervision given to Rush as material elements for determining whether, and to what extent, MerrillLynch had violated its fiduciary duties owed to Rudnicki. Therefore, Respondents' Motion to bartestimony and other evidence about the supervision of Rush was denied and whatever testimony ordocuments received on the previous day would not be stricken.

The parties have agreed that the Award in this matter may be executed in counterpart copies or that ahandwritten, signed Award may be entered. In either case, the parties have agreed to receiveconformed copies of the award while the original(s) remain on file with the NASD DisputeResolution (the "NASD").


After considering the pleadings, the testimony, and the evidence presented at the hearing and thepost-hearing submissions, if any, the undersigned arbitrators have decided in full and final resolutionof the issues submitted for determination as follows:

1. Claimants set forth several grounds for and causes of action all relating to the managementby Rush of their account with Merrill Lynch. Near the end of the hearing, Claimants wiselywithdrew their claim of unauthorized trading. Merrill Lynch argues that even if there wereviolations of their internal Compliance Manual rules, that does not create any liability forthem or Rush. The Panel disagrees. However, the Panel finds that the amount of liabilitymust be significantly less than what the Complaints request. Further, the Panel does notfind any basis for punitive damages and Claimants' request for punitive damages is denied.

2. Rush failed to properly apply Merrill Lynch's suitability rules and other provisions ofMerrill Lynch's Compliance Manual. He failed to ask for any help or guidance from hissupervisor(s) or the Compliance Unit in Tucson. He set up an unsuitably large marginaccount for Rudnicki and made transactions in extremely high risk securities concentratedin the very high risk technology sector because that is what Rudnicki asked for. Therefore,Rush is hereby required to disgorge his share of the commissions collected from Rudnickiduring the life of the account with Merrill Lynch. The amount has been determined to be $2,349, which Rush is individually to pay to Rudnicki.

3. Merrill Lynch failed to provide adequate supervision of Rush. It failed to enforce their ownCompliance Manual, especially the suitability rules and determinations. It approved severalpurchases of stock that were unsuitable for Rudnicki and the establishment of an unsuitablylarge margin account based on an inadequately and inaccurately completed "New AccountForm". There was only one perfunctory call to Rush from the Compliance Unit in Tucsonregarding a purchase of almost $ 100,000 of Ariba stock. Therefore, Merrill Lynch ishereby required to disgorge its share of the commissions collected from RudnicM during thelife of the account with Merrill Lynch, as well as the fees and interest it collected for theoperation of Rudnicki's margin account. The amount has been determined to be $ 3,525 incommissions and $ 8,481.08 in margin account fees and interest for a total of $ 12,006.08,which Merrill Lynch is individually to pay to Rudnicki.

4. No attorney fees are awarded to any of the parties.

5. To the extent not specifically awarded or otherwise provided for above, all other claims andrequests for relief by any party hereto are denied with prejudice.


6. Other than the Forum Fees noted below, the parties shall each bear all other costs andexpenses incurred by them in connection with this proceeding, including but not limited toattorneys fees.

FEES

Pursuant to the Code, the following fees are assessed:

Filing Fees

NASD Dispute Resolution will retain or collect the non-refundable filing fees for each claim:

Initial claim filing fee = $300.00

Member Fees

Member fees are assessed to each member firm that is a party in these proceedings or to the memberfirm(s) that employed the associated person(s) at the time of the event(s) giving rise to the dispute.In this matter, the member firm is Merrill Lynch Pierce Fenner & Smith Inc.

Member surcharge = $1,700.00Pre-hearing process fee = $ 750.00Hearing process fee = $2,750.00

Adjournment Fees

Adjournments requested during these proceedings:

Hearing Date(s) of April 22 and 23, 2003 adjournment requested by Respondents - $1,125.00

Forum Fees and Assessments

The Arbitration Panel assesses forum fees for each hearing session conducted. A hearing session isany meeting between the parties and the arbitrator(s), including a pre-hearing conference with thearbitrators), that lasts four (4) hours or less. Fees associated with these proceedings are:

One (1) Pre-hearing session(s) with a single arbitrator x $450.00 = $450.00Pre-hearing conference(s): September 3, 2003 1 session

One (1) Pre-hearing session(s) with Panel x $1,125.00 = $1,125.00Pre-hearing conference(s): October 29, 2002 1 session


Seven (7) Hearing sessions x $1,125.00 = $7,875.00Hearing Date(s): July 15,2003 1 session

September 10, 2003 2 sessionsSeptember 11, 2003 3 sessionSeptember 12. 2003 1 session

Total Forum Fees = $9,450.00

The Arbitration Panel has assessed $0.00 of the forum fees to Ted Rudnicki and Ksawera Rudnicki.

The Arbitration Panel has assessed $8,325.00 of the forum fees to Merrill Lynch Pierce Fenner &Smith Inc.

The Arbitration Panel did not assess forum fees ($1,125.00) for the hearing session conducted onJuly 15,2003, at which the Chairman failed to appear.

Fee Summary

Claimants, Ted Rudnicki and Ksawera Rudnicki, shall be and hereby are jointly and severallyliable for:

Initial Filing Fee = $ 300.00Forum Fees =$ Q.QOTotal Fees =$ 300.00Less payments =$1,475.00

Balance to be refunded by NASD Dispute Resolution = $1,175.00

Respondent, Merrill Lynch Pierce Fenner & Smith Inc, shall be and hereby is liable for:

Member Fees =$ 5,200.00Adjournment Fee =$ 1,125.00Forum Fees =$ 8325.00Total Fees =$14,650.00Less payments = $ 5,200.00

Balance Due NASD Dispute Resolution = $ 9,450.00

All balances are due to NASD Dispute Resolution

ARBITRATION PANEL

Timothy P. Walker, Esq. - Public Arbitrator, Presiding ChairDavid C. Rupley - Public Arbitrator

Stephen L. Przewlocki - Non-Public Arbitrator


Concurring Arbitrators:

/s/Timothy P. Walker October 22, 2003Timothy P. Walker, Esq. Signature DatePublic Arbitrator, Presiding Chair

/s/David CRuplev October 21, 2003David C. Rupley Signature DatePublic Arbitrator

/s/ Stephen L. Przewlocki October 22.2003Stephen L. Przewlocki Signature DateNon-Public Arbitrator

OGt 23 03 07:21aUM:*V

Tim Ualker

NASD Dispute Resolution, jlnc.Aibitratton No. 02-02395Award JPage9ojf9

505-522-0314

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Concurring Aibitralors— ^

Timothy P, WaiKcr, Ea i.Public Arbitrator, Presi iing Chair

David C. RupleyPublic Arbitrator

Stephen L. PrzewlockiNon-Public Arbitrator

Signature Date |

Signature Date

Signature Date ],

DRUID C. RUPLEY1*0/21/2003 14:57 FAX

Fax : 602-993-03601NA&IJ

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NASD Dispute Resolution,Arbitration No. 02-02395Award Pagft 9 of 9

Concurring Arbitrators

Timothy P. Walker,Public Arbitrator, Presi

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Chair

David C, RupleyPublic Arbitrator

Stephen L. PrzewlockiNon-Public Arbitrator

Signature Date

Signature Date <

Signature Date

1B/21/2BB3_ 1_5:_23 52B3268BB1

10/21/3003 I5:li FAX

LEGEND

NASD

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Eac.

Concurring Arbitrators

Timothy P. Walker, Ea (.Public Arbitrator, Pnesi fing Chair

David C. RupleyPublic Artjiirator

Stephen L.Non-Public Actritmtor

Signature Date

Signature Date

_L~ (-Signature Date I

NASD Dispute Resolution In the Matter of the Arbitration ... · decisions were made by Ted. Shortly...

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