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Garrison Family v. Mark And Michelle Garrison
Citation: Not availableDocket: 69625-4
Court: Court of Appeals of Washington; July 14, 2014; Washington; State Appellate Court
Original Court Document: View Document
Jack M. Garrison, the Garrison Family LLC, Lesa B. Neugent, and various trusts established by Jack and Charlotte Garrison filed a lawsuit against Mark M. Garrison and SagePoint Financial, Inc. (formerly AIG Financial Advisors, Inc.) for over $20 million in losses, alleging breach of fiduciary duty, negligent supervision, violation of the Washington State Securities Act (WSSA), and respondeat superior. Mark Garrison was an investment advisor and co-owner of Acumen Financial Group Inc. He entered into an independent contractor agreement with AIG in 1999 and managed the Garrison Family LLC and its associated trusts following Charlotte's death in 2006. The Garrison Family LLC and trusts held approximately $26 million in brokerage accounts. SagePoint filed for summary judgment, claiming it had no duty to supervise under NASD Rule 3050. The Garrison Trusts countered with a motion asserting a duty to supervise under NASD Rule 3040 and argued that SagePoint should have investigated suspicious activities in the accounts. The court granted SagePoint's motion, dismissing the claims against them. However, the appellate court affirmed the dismissal of the respondeat superior claim but reversed the summary judgment on claims of negligent supervision and WSSA violations, citing unresolved factual issues regarding SagePoint's knowledge of Mark’s activities that could trigger supervisory obligations under NASD Rules. AIG is now SagePoint Financial Inc. In 2007, NASD and the NYSE's regulatory arm merged to form FINRA. Under the Independent Contractor Agreement with AIG, Mark is required to adhere to SEC regulations, NASD Conduct Rules, state securities laws, and AIG policies. He must notify AIG in writing of any outside business activities before engaging in them and cannot accept outside employment or compensation without prior written notification to AIG. Mark's grandparents, Jack and Charlotte Garrison, established the Garrison Family LLC in 2002, transferring about $11 million to it. They later created the Jack M. Garrison and Charlotte L. Garrison Revocable Trust in 2006, transferring their LLC shares and approximately $16 million into the trust. The trust names Jack and Charlotte as co-trustees and lifetime beneficiaries, with their grandchildren Mark and Lesa as remainder beneficiaries, receiving 62% and 38% interests, respectively. Following Charlotte's death on August 8, 2006, and Jack's dementia diagnosis, Mark was appointed manager of the LLC and trustee of the Revocable Trust on September 11, 2006. As of September 2006, the total assets in their brokerage accounts amounted to approximately $26.5 million. In accordance with NASD Rule 3050, Wells Fargo requested written approval for Mark's appointment as trustee, owner, and manager of the accounts. On October 16, 2006, Mark's assistant submitted a request to the AIG Compliance Department for approval for Mark Garrison to act as the trustee, owner, and manager of accounts held in trust for his grandparents, accompanied by a letter from Wells Fargo. On November 14, AIG provided a "Letter of Understanding" allowing Mark to assume these roles, contingent upon certain conditions: he must not act as a registered representative/stockbroker, must disclose his outside business activities annually via the Outside Business Activities Questionnaire (OBAQ), and must sign and return an attached Indemnification Form. The letter also outlined limits on his role, stating he could only manage the specified Garrison accounts and could not act as trustee for anyone outside his immediate family. Additionally, he was required to keep account statements organized in his Office of Supervisory Jurisdiction (OSJ) and maintain copies of the approval letter and Indemnification Form. On November 22, AIG's Director of Branch Supervision approved Mark's management of the Wells Fargo accounts, emphasizing compliance with NASD regulations and AIG policies, the necessity for duplicate confirmations and statements, and supervision by the First Line Supervisor. It was noted that any new accounts would require prior written acknowledgment from the Home Office. Mark was also prohibited from participating in Initial Public Offerings (IPOs) and was required to adhere to AIG's policies regarding personal brokerage accounts and Anti-Money Laundering. He must prioritize client orders over his own orders in identical securities. The firm will ensure that duplicate confirmations and statements are sent to the First Line Supervisor (FLS) for oversight. An attached addendum outlines the responsibilities of the FLS regarding outside personal brokerage accounts, detailing several prohibited activities, including insider trading, prearranged trading, wash transactions, front running, and freeriding. It mandates that if a registered representative (RR) engages in a high volume of trades monthly, the FLS must conduct a quarterly profit and loss analysis to identify potential excessive losses that could indicate client account churning. From April 2006 to April 2009, Ayers, the Director of Branch Supervision, oversaw AIG personnel managing transactions in personal brokerage accounts for AIG registered representatives, including Mark M. Garrison. Michelle Nielsen was the FLS for Wells Fargo accounts. In December 2006, Mark submitted his Outside Business Activity Questionnaire (OBAQ) for 2005-2006, clarifying that he is a registered investment adviser, separate from AIG, and owns Acumen, an independent firm. He reported being registered in about 20 states and receiving compensation through commissions and fees, acknowledging the necessity of distinguishing his advisory activities from those offered by AIG. In the OBAQ, Mark indicated he spends 26 to 50 percent of his time as an investment advisor, earning over $50,000. He also stated that he is the Trustee/Owner/Manager of accounts for his grandfather, Jack Garrison, at Wells Fargo, dedicating 0-25% of his time to this role with an income below $10,000. On March 14, 2007, Mark emailed Wells Fargo brokers, indicating his intention to hire Acumen for investment advice for the Garrison Family LLC and trusts, while Wells Fargo would continue executing trades. He detailed a fee structure for Acumen's services and instructed the brokers to invest $100,000 into existing mutual funds, along with specific trading directives, while requesting that no financial documents be shown to Jack until further notice, signaling a planned communication delay until market conditions improve. On March 16, 2007, Mark issued a check for $65,524 from the Garrison Family LLC account to Acumen for investment advisory services and another for $13,905 from the Revocable Trust account. He reported his activity as an independent registered investment advisor and co-owner of Acumen in his 2007 annual OBAQ to AIG, disclosing his role as Trustee/Owner/Manager for accounts held for his grandfather, Jack Garrison, and stating he spent 16 hours per month on investment-related activities with compensation between $25,000 and $50,000. In late 2007, he requested AIG's approval to open personal brokerage accounts at TD Ameritrade, which was granted in December, with instructions to provide AIG with account confirmations and statements. On April 22, 2011, Jack M. Garrison, the Garrison Family LLC, and others associated with the Garrison Trusts filed a lawsuit against Mark, Michelle Garrison, and AIG for securities law violations, breach of fiduciary duty, negligence, and for declaratory judgment. They alleged Mark transferred $9.6 million from the Garrison accounts to personal TD Ameritrade accounts, paid Acumen over $550,000 in advisory fees, and received over $370,000 in trustee fees, resulting in investment losses exceeding $20 million. The lawsuit asserts AIG is jointly liable for these losses, claiming negligent supervision and violations of the Washington State Securities Act, while acknowledging that Wells Fargo's contractual arbitration duty prevents it from being named as a defendant. AIG denied liability, asserting it had no duty to the Garrison Trusts, claiming ignorance of Mark's role as an investment advisor for them. AIG filed for summary judgment, supported by expert testimony from David E. Paulukaitis, who stated that Mark's transactions at Wells Fargo and TD Ameritrade fell outside the scope of his association with AIG and were not classified as "private securities transactions" under NASD Conduct Rule 3040. Securities industry regulations do not impose a duty on AIG to supervise transactions in the Wells Fargo and Ameritrade accounts, limiting AIG’s responsibility to monitoring for conflicts with its interests. The Garrison Trusts sought partial summary judgment, arguing AIG had a supervisory duty over securities transactions in these accounts, supported by expert witness John H. Chung. Chung contended that under NASD Rule 3040, AIG was obligated to supervise Mark's activities as an investment advisor for compensation, and that NASD Rule 3050 mandates appropriate supervision for transactions conducted at other broker-dealers. The court denied the Garrison Trusts' motion for partial summary judgment and granted AIG's motion for dismissal of claims. AIG also agreed to dismiss its cross claim against Mark. The Garrison Trusts argue the court erred in granting summary judgment for AIG regarding claims of negligent supervision, violation of the Washington Securities Act (WSSA), and respondeat superior. The court reviews summary judgment de novo, focusing on whether there are genuine issues of material fact. The Garrison Trusts assert that AIG’s receipt of monthly statements and trading confirmations under NASD Rule 3050 triggered a duty to investigate the Wells Fargo accounts, while they concede that breach, causation, and damages are not contested on appeal. Negligent supervision involves a limited duty to control employee actions for the protection of third parties, even if outside the scope of employment. To prove a claim for negligent supervision against AIG, the Garrison Trusts must demonstrate that Mark acted outside his employment scope, posed a risk of harm, that AIG was aware or should have been aware of this risk, and that AIG's lack of supervision was a proximate cause of the loss. Employers are not liable for negligent supervision of employees acting outside their employment scope unless they had knowledge or should have reasonably known of the risk posed by the employee. The determination of duty in such cases is generally a legal question, but if factual disputes exist, summary judgment is not appropriate. The Securities Exchange Act of 1934 establishes a regulatory framework for the securities industry, allowing self-regulatory organizations to create rules under SEC oversight. The SEC has broad supervisory authority to ensure fair dealing and protect investors. The NASD, as a self-regulatory body, is tasked with enforcing rules of conduct for its members, which must be approved by the SEC and comply with the Exchange Act. Engaging in securities business requires registration with the NASD, and broker-dealers must adhere to its regulations. While NASD rules do not provide a private cause of action, they can help define common law duties like negligent supervision. The NYSE Rule 405 does not imply a private right of action in federal court. Violations of NASD rules do not automatically lead to actionable claims; however, NASD Rule 3040 and related rules help courts, including those in Tennessee, define a broker-dealer's legal duty. The case centers on AIG's duty to supervise Mark's outside business activities as an investment advisor for Wells Fargo accounts. The Garrison Trusts argue that NASD Rule 3040's supervisory requirements apply, while AIG asserts that only NASD Rule 3050's requirements are relevant, claiming Rule 3040 explicitly excludes Rule 3050 transactions. NASD Rule 3010 mandates that brokerage firms establish a system to supervise their representatives to comply with securities laws and regulations. NASD Rule 3030 requires registered representatives to notify their employer in writing before engaging in outside business activities, with exceptions for activities governed by Rule 3040. Rule 3040 specifically regulates private securities transactions for compensation, necessitating written notice to the employer prior to participation. The employer must then approve or disapprove the participation in writing; if approved, the transaction is recorded and supervised as if executed by the member. If disapproved, the representative cannot engage in the transaction. NASD Rule 3050 governs transactions involving associated persons and their outside business activities. It mandates that any registered representative intending to open an account or place an order at another financial institution must notify their employer member in writing beforehand. The executing member must also inform the employer member. Upon request from the employer member, the executing member is required to provide copies of confirmations, account statements, and other relevant information regarding the account. Specifically, Rule 3050(c) requires associated persons to notify both their employer member and the executing member in writing prior to opening an account or executing a transaction, except in cases where the account was established before their association with the employer member, in which case notification must occur promptly after the association. The rule aims to mitigate potential and actual conflicts of interest arising from personal trading activities of registered representatives. It also places obligations on executing members to ensure that transactions for accounts associated with an employer member do not adversely affect the employer member's interests. This includes notifying the employer member of the intention to open or maintain such accounts and providing necessary documentation upon request. Notably, AIG acknowledged compliance with NASD Rule 3050 from 2006 to 2007. Wells Fargo, adhering to NASD Rule 3050, obtained written approval from AIG for Mark to serve as the trustee, owner, and manager of the Garrison trusts and Garrison Family LLC for their brokerage accounts. AIG, in its November 14, 2006 response, allowed Mark's role but prohibited him from acting in any other capacity for the accounts. AIG's November 22 letter requested monthly account statements and trading confirmations, emphasizing that NASD Rule 3050 mandates monitoring by the First Line Supervisor. The Garrison Trusts argue that AIG had an obligation to supervise Mark's hiring of Acumen for investment advice in March 2007 under NASD Rule 3040, which AIG disputes, claiming that transactions subject to NASD Rule 3050 are exempt from the supervisory requirements of Rule 3040. The Garrison Trusts contend that only transactions where no associated person receives selling compensation are excluded from Rule 3040's requirements. The interpretation of these regulations is a legal question reviewed de novo. NASD Rule 3040 pertains exclusively to "private securities transactions," defined as transactions outside an associated person's employment scope, with three exemptions: 1) transactions covered by NASD Rule 3050, 2) transactions among immediate family members, and 3) personal transactions in investment company and variable annuity securities. The critical issue is whether the phrase "for which no associated person receives any selling compensation" applies solely to transactions among immediate family members or also to transactions governed by NASD Rule 3050. The definition of "immediate family member" is specified, excluding grandparents, which is not contested. The statutory construction principle of the "last antecedent rule" applies here, indicating that unless stated otherwise, the phrase should be interpreted in context. Relative and qualifying words and phrases in legal texts are interpreted according to the last antecedent rule, which dictates that modifiers apply only to the nearest phrase they follow. This principle suggests that the phrase "for which no associated person receives any selling compensation" modifies only "transactions among immediate family members," excluding transactions governed by NASD Rule 3050. The Garrison Trusts further argue that AIG had a duty to supervise Mark's investment advisory activities, referencing multiple NASD Notices to Members (NTMs) that clarify the application of rules to registered representatives who also act as investment advisors. Courts may defer to NASD's interpretations of its rules. NASD NTM 91-32 asserts that NASD Rule 3040 applies to all investment advisory activities by registered representatives outside their member activities, highlighting the importance of oversight to protect clients. Additionally, NTM 94-44 emphasizes that registered representatives acting as investment advisors engage in transactions that require adherence to NASD Rule 3040, particularly when they directly execute trades on behalf of clients and receive compensation. Finally, NTM 96-33 mandates that dual-licensed representatives must provide prior written notice to their member firm before engaging in any fee-based investment advisory activities. A member must obtain prior written permission from their registered representative/investment advisor (RR/IA) before engaging in investment advisory activities for an asset-based or performance-based fee for each advisory client. According to NASD NTM 96-33, this notification must include specific details: a declaration of involvement in advisory activities, identification of clients affected, types of securities activities to be executed outside the firm, a description of the RR/IA's role, discretionary trading authority, compensation arrangements, broker/dealer identities for trades, and customer financial information. The regulation also mandates that if there are changes to the RR/IA's role, a subsequent written notice detailing those changes must be provided to the employer member for further approval. The record indicates that Mark failed to obtain required prior written approval before hiring Acumen in March 2007 for investment advice related to Wells Fargo accounts. Additionally, he did not notify AIG of his role change from trustee and manager of the Garrison trusts and Garrison Family LLC to investment advisor. Evidence shows that Mark acted as an investment advisor, receiving compensation and directing private securities transactions without proper authorization. The critical issue is whether AIG was aware or should have been aware of Mark's change in role, which would invoke NASD Rule 3040's supervisory requirements. The Garrison Trusts assert that annual Outside Business Activity Questionnaires (OBAQs) submitted by Mark for 2005-2006 and 2007 provided AIG with the necessary notice of his advisory role and compensation. In the earlier OBAQ, Mark identified himself as "Trustee/Owner/Manager" and reported minimal compensation for that role, failing to disclose his subsequent advisory activities. Mark reported a low percentage of time (0-25%) spent on investment-related activities, receiving compensation under $10,000. In a 2007 Outside Business Activities Questionnaire (OBAQ), he identified himself as the Trustee/Owner/Manager of accounts at Wells Fargo, indicating this was part of his independent financial advisory business, Acumen Financial Group, Inc., which he had operated since 1995. He claimed to spend 16 hours a month on this role, earning between $25,000 to $50,000 annually. The 2007 OBAQ did not meet the notice requirements outlined in NASD Rule 3040(b), potentially failing to inform AIG of Mark's change in role to investment advisor for compensation as of March 2007. However, the combination of the OBAQ and AIG's internal sales practice manual suggests there may be genuine issues regarding AIG’s awareness of Mark's advisory activities and associated compensation. According to the AIG manual, registered representatives must disclose outside business activities annually via the OBAQ. The Garrison Trusts argue that AIG had a duty to investigate based on monthly statements and trading confirmations received under NASD Rule 3050, which required monitoring for unapproved activities and suspicious circumstances related to the Wells Fargo accounts. Plaintiffs claimed Wachovia had a duty to supervise stockbroker McGraw's outside activities. The court acknowledged that generally, a broker-dealer does not owe a duty to non-customers who invest through independent advisors unless notified of potential issues. However, this is not an absolute rule; a broker-dealer may be liable if they have additional involvement or become aware of suspicious circumstances indicating potential fraud against non-customers. The court referenced cases illustrating that if a broker-dealer notices “red flags,” they may have a duty to monitor unusual account activities, even for non-customers. In this case, AIG followed NASD Rule 3050, approving Mark as trustee for Garrison trusts and receiving monthly account statements from Wells Fargo starting in 2006. AIG also approved personal brokerage accounts for Mark and Michelle Garrison at TD Ameritrade from 2007 to 2009. Evidence from AIG's Sales Practice Manual outlined the responsibilities of First Line Supervisors in monitoring outside business activities and indicated that they should investigate potential unapproved activities if red flags arise. The court found that there are factual issues regarding whether suspicious activities warranted AIG's investigation of Mark's transactions in the Wells Fargo accounts, particularly concerning the October 2007 OBAQ submission. AIG's internal policies could serve as evidence of the standard of care expected, potentially indicating negligence. Mark altered the investment strategy of the Garrison Trusts between January 2007 and November 2008, transferring over $9.6 million from Wells Fargo to his personal TD Ameritrade accounts by November 2008. The Garrison Trusts assert that AIG qualifies as a "control person" under the Washington Securities Act (WSSA), specifically RCW 21.20.430(3), and argue that genuine issues of material fact exist that prevent the dismissal of this claim. Under the WSSA, engaging in fraudulent activities related to securities transactions is prohibited, and certain individuals may be held secondarily liable for violations. The Washington State Supreme Court's decision in Hines v. Data Line Systems established a two-prong test for determining control person status: 1) the defendant must have participated in the corporation's operations, and 2) must have had the power to control the specific transaction related to the violation. The plaintiff is not required to prove the defendant’s culpable participation to establish liability. There are factual disputes regarding AIG’s awareness of Mark's role as an investment advisor versus merely a trustee, which raises questions about AIG's potential control over the transactions. Regarding the Garrison Trusts' claim of respondeat superior, which holds employers liable for employees' torts within the scope of their employment, the court found no error in dismissing this claim. Mark acted outside the scope of his employment as a registered investment advisor, and an AIG supervisor was responsible for overseeing Mark's outside business activities. Consequently, the court upheld the dismissal of the respondeat superior claim against AIG but reversed the dismissal of claims for negligent supervision and violations of the WSSA, remanding those issues for trial.