Will a broker-dealer be liable when a financial advisor employed by the firm solicits investments as part of a fraudulent scheme, where the firm specifically prohibited the advisor from soliciting the investment, the fraudulent investment was made away from the firm, and the investors never became customers of the firm? The Eleventh Circuit recently answered that question with a resounding “maybe,” and clarified that the employer could be liable in negligence if it knew or should have known that its employee posed a risk of defrauding others.
In Owens v. Stifel Nicolaus and Co., et al, No. 15-12911 (11th Cir. May 27, 2016), the broker-dealer rejected the advisor’s request to add the investment at issue to the list of approved investments he was permitted to sell. Nevertheless, the advisor went forward with soliciting potential investors for that investment, identifying himself as an employee of the broker-dealer and using the email address and telephone number associated with the broker-dealer.
Ultimately, the plaintiff purchased two convertible promissory notes and executed a securities purchase agreement with the issuer. The transaction documents stated that the investment was not effected by or through a broker-dealer. The advisor likewise told the investor that it was not necessary for the investor to open an account with the broker-dealer in order to make the investments.
When the issuer failed to repay the promissory notes, the investor sued the broker-dealer asserting claims of fraud and negligence. The District Court dismissed the claims against the broker-dealer on motion for summary judgment, finding that the broker-dealer was not responsible for the fraud of its employee as a matter of law. An appeal to the Eleventh Circuit ensued.
On appeal, the Eleventh Circuit affirmed the dismissal of the fraud claim, but reversed the dismissal of the negligence claim, remanding the matter for trial on the issue of negligence.
Regarding the fraud claim, the Court noted that an employer can be held liable for the fraud of its employee where the employee is acting within the scope of his actual or apparent authority. Here, the advisor did not have actual authority to sell the investment in question because the broker-dealer had disapproved the investment, and maintained policies that prohibited the advisor from selling securities away from the firm. The broker-dealer had terminated the advisor’s employment when it learned he had sold investments outside of the firm.
The Court also determined that the facts were insufficient to establish that the advisor had apparent authority. Under the governing law of Georgia, an agent has apparent authority when the principal’s conduct leads a third party to reasonably believe that agent has the authority to act on the principal’s behalf. The Court of Appeals concluded that the broker-dealer’s employment of the advisor, and providing him with an email address, telephone number and an office, were insufficient to establish apparent authority where the broker-dealer did not receive any benefit from and did not directly participate in the alleged fraud, and the advisor’s conduct was solely for his own personal benefit.
As to the negligence claim, the District Court had also dismissed it, holding that the broker-dealer did not owe plaintiff any duty because it never became a customer of the broker-dealer. The Eleventh Circuit, however, reversed that holding, reasoning that a duty of care is not always limited to clients. As an example, the Court explained that an accounting firm that fails to warn of a slippery floor could not escape general tort liability by arguing that the plaintiff was not a client.
The Court further explained that under applicable law, an employer has a duty to use ordinary care not to hire or retain an employee the employer knew or should have known posed a risk of harm to others, where it was reasonably foreseeable from employee’s “tendencies” or “propensities” that the employee could cause the type of harm sustained by the plaintiff. Under such a standard of care, the investor sufficiently stated a claim that the broker-dealer breached its duty by hiring and retaining the advisor when the broker-dealer knew or should have known the he posed a risk of defrauding others. The Court also made reference to unspecified “red flags” in the advisor’s employment and investment management history, which the jury could consider in determining whether the broker-dealer acted negligently in hiring, retaining and supervising the advisor.
This case was governed by Georgia law. Accordingly, under the laws of other states, a court may reach a different result.