James French v. Merrill Lynch, Pierce, Fenner & Smith, Inc., a Corporation, R. James French v. Merrill Lynch, Pierce, Fenner & Smith, Inc., a Corporation, Defendant

Citation: 784 F.2d 902Docket: 85-1653

Court: Court of Appeals for the Ninth Circuit; March 5, 1986; Federal Appellate Court

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In the case of James French v. Merrill Lynch, the Ninth Circuit addressed an appeal stemming from an arbitration decision by the Pacific Stock Exchange (PSE) that held Merrill Lynch liable for negligent misrepresentation regarding a large order of Heublein call options. The arbitration panel awarded French $52,925 in compensatory damages, interest, and $275,000 in consequential damages for lost profits. The district court confirmed the compensatory damages and interest but vacated the consequential damages. Both parties appealed.

The court affirmed the district court's confirmation of the compensatory award and interest but reversed the vacation of consequential damages. The factual background indicates that French, acting as a marketmaker on the PSE, misinterpreted an order from Merrill Lynch's broker, who mistakenly classified it as a closing order when it was an opening order. This miscommunication led to significant financial losses for French when trading was subsequently suspended and a takeover announcement increased the stock price.

French initially filed a complaint in federal court against Merrill Lynch for misrepresentation, seeking various forms of damages and attorney's fees. Merrill Lynch's motion to compel arbitration was based on PSE rules allowing arbitration of disputes between members. The case highlights issues of liability in securities trading and the proper avenues for dispute resolution within financial exchanges.

On January 14, 1983, the parties agreed to submit their claims to arbitration per the PSE's constitution and rules, executing a Uniform Submission Agreement that included a statement of claim. Merrill Lynch indicated it understood the claim would be the existing District Court complaint, reserving rights to revoke the agreement if this was incorrect. Two days before the hearing, French announced his intention to seek consequential damages due to lost trading capital, prompting Merrill Lynch to request dismissal of this claim. However, the Panel permitted the amendment and allowed evidence on consequential damages, postponing the hearing for further discovery.

On July 27, 1984, the arbitration panel found Merrill Lynch liable for negligent misrepresentation, awarding French $52,925 in compensatory damages, interest at the broker-call rate, and $275,000 in consequential damages. On November 1, 1984, the district court reviewed motions to confirm and vacate the arbitration award. While it confirmed the compensatory damages, it vacated the consequential damages, determining they were outside the arbitration scope. French appealed the vacatur, and Merrill Lynch cross-appealed the confirmation. 

Key issues for appellate review include the finality of the district court's order, the correctness of the confirmed compensatory award linked to misrepresentation, the appropriateness of the interest awarded, the justification for vacating consequential damages, and whether French should receive attorney's fees for responding to what he claims is a frivolous cross-appeal.

Both parties argue that 28 U.S.C. Sec. 1291 does not mandate the dismissal of this case, and the court concurs, asserting jurisdiction over the appeal due to a final decision made by the district court. The court clarifies that although the district court could have evaluated whether French was entitled to consequential damages, French did not claim the right to litigate this matter if deemed non-arbitrable. Therefore, Judge Vukasin's order is regarded as resolving all issues presented.

Regarding compensatory damages, California law categorizes negligent misrepresentation as a form of deceit, requiring a misstatement of a material fact for liability. Merrill Lynch challenges the validity of the Panel's compensatory award, arguing that the open/close information was not a material fact upon which French could reasonably rely. The court emphasizes that awards must be confirmed despite any erroneous factual findings or legal interpretations, highlighting the deference owed to arbitrators' decisions. An award will not be overturned for legal or factual errors unless it is wholly irrational or demonstrates a blatant disregard for the law.

California law defines a "material fact" as one likely to influence a reasonable person's actions regarding a transaction. The Panel's finding of materiality is supported by evidence, including testimony from French, who explained that opening orders increase risk and closing orders decrease risk, particularly in volatile markets influenced by takeover rumors. Expert witnesses corroborated that Merrill Lynch's misrepresentation was material, and other traders sought clarification about the order type and attempted to rescind trades upon discovering the misrepresentation. Merrill Lynch's assertions regarding the immateriality of open/close information do not consider the unique circumstances of July 22, 1982, and the Panel correctly determined that such information was material in this context.

Regarding the interest award, Merrill Lynch challenges the calculation of interest at the broker-call rate from August 1, 1982, until payment. California Civil Code Section 3287(a) allows interest recovery when damages are certain and vested, which applies here as French's right to recover was established when he filed his complaint, and damages could be calculated based on his short sale costs. Merrill Lynch’s argument that liability disputes create uncertainty in damages is incorrect. 

Merrill Lynch also points out that the broker-call interest rate exceeds California's prejudgment legal rate of 7%. California law caps post-judgment interest at 10% per annum, suggesting the Panel should have limited interest rates accordingly. However, it's possible the Panel intended the broker-call rate as an award for consequential damages, which is permissible. Consequently, the entire interest award is affirmed.

The district court determined that the award of consequential damages was beyond the authority of the arbitration panel, a finding reviewed de novo. A party cannot be compelled to arbitrate disputes unless agreed upon, meaning an arbitrator's powers are limited to the parties' agreement. Any award outside that agreement is invalid, but ambiguities should favor arbitration. In this case, the arbitration agreement between French and Merrill Lynch included provisions for potential amendments to the claims as permitted by the PSE Rules. Thus, the agreement allowed for the arbitration panel to address consequential damages, leading to the conclusion that the district court's finding of non-arbitrability was incorrect.

Merrill Lynch argued that the panel could not consider damages not specifically included in French's original complaint. However, the parties’ stipulation and the associated agreements indicated that claims were submitted in accordance with the relevant rules, which allowed for amendments at the panel's discretion. The district court should have recognized the legitimacy of any amendment necessary for awarding consequential damages. The award was not irrational or in manifest disregard of the law, and under California law, damages for lost profits can be awarded if there is a satisfactory basis for estimating potential earnings. Consequently, the reinstatement of the panel's award of consequential damages was warranted.

French's request for attorney's fees under Fed. R. App. P. 38 is denied because Merrill Lynch's arguments regarding the interest award were not deemed "frivolous." The court emphasized that an appeal is considered frivolous only when the outcome is obvious or the arguments are entirely meritless. French's stipulation regarding the meaning of "open/close" information raises questions about the arbitrator's decision but does not render it irrational. 

The court affirms the district court's confirmation of the compensatory damages award and the assessment of interest, while reversing the vacation of the consequential damages award. The Panel's award is to be reinstated in full. Furthermore, the district court's failure to issue a separate judgment does not affect jurisdiction, as the judgment was appropriately recorded in the clerk's docket. Even if consequential damages were tried, the appellate review of the Panel's decision would remain de novo, meaning the district court's findings would not receive special deference.

The Panel's conclusion that Merrill Lynch's misrepresentation regarding the nature of the transaction was material to French's trading decision is characterized as a factual finding. This aligns with relevant case law that regards materiality as a mixed question of law and fact, typically determined by the trier of fact. Materiality is defined in federal law as a fact that would be significant to a reasonable person in making a decision regarding a transaction.

Merrill Lynch highlights several "uncontroverted facts": 1) open/close information is merely a bookkeeping entry for clearing; 2) marketmakers typically do not request this information on option exchanges; 3) there is no rule mandating its disclosure by option exchanges; 4) prior attempts to rescind trades due to errors in this information lack formal records; and 5) the frequency of such errors makes consideration of this factor unreasonable for marketmakers. The argument surrounding Cal. Civ.Code Sec. 3287(a) is challenged by case law indicating its applicability beyond contract actions, citing relevant cases that support recovery of interest in various contexts, including negligence and tort actions.

The court must confirm the Panel's decision unless it is "completely irrational" or shows "manifest disregard of the law," thereby adopting the interpretation of the Panel's interest award that aligns with confirmation. Merrill Lynch references a February 4, 1983, letter reserving the right to revoke the Submission Agreement, suggesting an understanding that the complaint could not be amended. However, this reservation does not explicitly prevent amendment, and Merrill Lynch did not attempt to revoke the agreement regarding French's complaint. Even if amendments were precluded, French would still prevail as PSE Rule XII, Sec. 1(a) requires arbitration for disputes arising in securities business. French's amendment can be interpreted as a request for arbitration regarding consequential damages, which put Merrill Lynch on notice and aligns with PSE Rule XII's lack of formal requirements for arbitration requests, thereby entitling French to have his claim heard by the Panel.