Loss Causation Seen in Unsuitable Options Purchase

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By Phyllis Diamond

A securities firm and a broker caused their customer’s losses by purchasing unduly risky options in his discretionary account, a federal appeals court said--even though there was no evidence the options were mispriced ( Patel v. Wagha , 2017 BL 278187, 7th Cir., No. 16-2905, 8/9/17 ).

“The difference between how the options faced and how the instruments the Dealers should have bought fared, is a loss caused by the securities fraud,” the U.S. Court of Appeals for the Seventh Circuit said Aug. 9. It said the district court erred when it dismissed the suit for failure to show loss causation.

Investment Goals

Ketan Patel saved approximately $560,000 to purchase a 7-Eleven franchise, according to Judge Frank Easterbrook. He parked the money in a discretionary account with Portfolio Diversification Group while waiting for the deal to close.

Mahendra Wagha invested Patel’s money in options, speculating—incorrectly—that the market would rise. By the time Patel needed the money, the market had fallen, causing him substantial losses. The district court awarded Patel $136,000 for breach of contract, but declined to enter judgment on a $64,000 jury award for securities fraud, saying Patel didn’t show loss causation.

The dealers appealed, saying the district court, having dismissed the federal claim, should have dismissed the state-law breach of contract claim as well for lack of subject matter jurisdiction. “That’s wrong,” the appeals court said.

Moreover, it said, the federal claims shouldn’t have been dismissed. The securities laws aren’t concerned only with inaccurate pricing, but prohibit fraud in all aspects of a securities transaction. The appeals court also said that even though Patel’s agreement with the dealers allowed them to purchase a number of instruments, including options, that doesn’t mean he agreed to take on extra risk. Rather, it means “agreement to the sort of options trading suitable to the client’s investment goals.”

Because Patel didn’t appeal, the court said, it can’t reinstate the full jury verdict.

To contact the reporter on this story: Phyllis Diamond in Washington at pdiamond@bna.com

To contact the editor responsible for this story: Seth Stern at sstern@bna.com

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