Suit Against Hutton Moves Toward Trial : Judge Rules That Jury, Not Arbitrator, Can Hear Multi-City Claim of Bad Investments
A jury--not an arbitration panel--must decide whether Shearson Lehman Hutton violated federal securities laws when it entered into investment agreements with the city of San Marino, a San Gabriel Valley water district and three other cities and municipal agencies, a federal judge has ruled.
Hutton lawyers argued that the highly publicized case should be arbitrated, but U.S. District Judge Pamela Rymer ruled that the cities and municipal agencies will have their day in court to try to prove that the brokerage firm acted fraudulently and that those actions cost them millions of dollars.
The ruling was only a partial victory for the plaintiffs. Rymer, in the 20-page decision, also ruled that the plaintiffs’ allegation that the investment agreements themselves were void must go to arbitration.
“We’re delighted,” William Wynder, the plaintiffs’ attorney, said Wednesday. “It would be nice to have the case all in one forum so we don’t have this dog and pony show twice . . . but we may end up getting two bites of the apple.”
Hutton Considers Appeal
Hutton attorney Stephen Young said his client was studying the judge’s decision to determine if it could be appealed and, if so, whether to do so. A hearing is scheduled for Feb. 16 to determine how the trial should proceed.
Although a major portion of the case is expected to be heard in court, Young did not view the ruling as a setback for Hutton. He said Hutton is convinced it will not only win in the arbitration matter, but will prevail in federal court as well.
“I think the best analogy is that we asked for a whole loaf of bread, and we got a half loaf of bread,” Young said.
Stung by millions of dollars in lost investments managed by Hutton, the cities of San Marino, Lawndale and Palmdale, the Three Valleys Municipal Water District in the San Gabriel Valley, and Palmdale’s Redevelopment Agency and filed suit a year ago in U.S. District Court in Los Angeles.
The lawsuit, which seeks $8.4 million in compensatory damages and $16 million in punitive damages, accuses two brokerage companies, Hutton and First Investment Securities Inc., and six individuals of violating federal and state securities laws.
Lawyers for the plaintiffs say the the FBI and Securities and Exchange Commission are investigating the allegations. Those agencies have declined to comment.
Last spring, Hutton moved to force the matter to arbitration, arguing that the plaintiffs lost their right to trial because their investment agreements called for disputes to be settled out of court through arbitration.
The company has declined to comment on the allegations, except to say that the losses were caused by a decline in the bond market in 1987.
Under arbitration, which is commonly used to settle disputes between brokers and clients, the case would be heard by five people: three representatives of the public and two with some connection to the brokerage community.
Unlike a verdict, the arbitration panel’s decision could not be appealed on issues of fact, and there would be no written record of the proceeding. Fact-finding procedures are more limited in an arbitration than they are in a court proceeding.
Wynder, the local government attorney, has maintained that the arbitration clause is invalid because the agreements were not explicitly approved by city council mem bers or, in the case of the Palmdale Redevelopment Agency, the board of directors. State law requires such approval, he has asserted.
Wynder said the judge reasoned that even though arbitration was the proper arena to determine whether the agreements were valid, the plaintiffs should be allowed to go to court to settle issues dealing with federal securities laws.
When the agreements were signed, Wynder maintains, the law stated that arbitration was not required in any dispute over federal securities laws and that a plaintiff could take a broker to court. The law was revised in favor of arbitration after the agreements were signed, he said.
San Marino and the Three Valleys Municipal Municipal Water District sustained losses of more than $3 million before joining in the complaint, filed Jan. 20, 1980.
$2 Million Lost
San Marino lost $2 million of its $7-million reserve fund in margin investments in 1986, and fired City Treasurer Ray Wood in the first week of October, 1987.
City officials said Wood had violated city investment policy by buying government bonds on margin. Wood said, in an interview then, that he did not know the transactions were illegal when he made them in September, 1986. “I made an error in judgement,” he said.
Three Valleys lost the entire $1.5 million it invested with Hutton in November, 1986. The funds were managed by broker William Parodi.
Monthly reports sent by the brokerage firm to Three Valleys indicated the district’s portfolio was losing value from the start, but General Manager Richard W. Hansen has said water district officials were deceived by Hutton brokers.
Unaware of Losses
Hansen said he was unaware the district’s reserves had been used to purchase zero-coupon bonds on margin until an April, 1987, meeting with Hutton representatives. At that time, Hansen said, he did not understand that the district’s entire portfolio was at risk.
The Three Valleys board of directors, elected by voters to oversee the water district’s operation, was not informed of the losses until September, 1987, when the district began receiving “margin calls” from Hutton. A margin call is a request for permission to sell off securities or to invest more money to repay money loaned to buy the bonds.
Initially, Hansen told the board it appeared the district had lost $900,00 in margin trading. A month later, he announced that the entire investment had been lost.
The losses were made public by board member William Koch, who had been the only board member to oppose making the investments. After he became the board’s president earlier this month, Koch sought to have Hansen fired for failing to keep the board informed of the losses. His effort was not supported by other directors.
Three Valleys serves as a water broker, buying water from the Metropolitan Water District of Southern California and selling it to water providers in the eastern San Gabriel Valley.
Hutton Returns Fees
San Marino and Three Valleys each received more than $100,000 from Hutton in 1987. Hutton returned $104,000 in brokers’ fees to the district, but deducted $58,000 from it to cover a debit in the Three Valleys account. Hutton returned $106,000 to San Marino.
City and water officials said Hutton explained in a letter that the money represented brokerage fees received during the time it handled their accounts. The letter said the return of the money was not an admission of guilt and had “no strings attached,” according to the officials.
Hutton officials have said the company received proper authorization for all investments made.
Times staff writers Mary Barber and Jeffrey Miller contributed to this story.