## Facts

- Rolando and Anita Cheng opened a non-discretionary options account at Merrill Lynch through broker William J. Grace, Jr., under an agreement requiring the Chengs’ prior approval for each trade.
- Grace was also expected to monitor the account so the Chengs’ potential options liability would not exceed the account’s balance.
- The Chengs’ initial investment grew substantially, and Rolando instructed Grace to buy additional IBM options only if the account could afford them.
- On May 5, 1986, relying on an erroneous system indication of available funds, Grace purchased additional IBM options that exceeded the account balance by more than $119,000 and were not authorized under the prior-approval arrangement.
- The trade moved against the Chengs, producing an approximate $119,000 loss and a large debit balance.
- Grace advised Rolando either to sell the options at a loss or to deposit additional funds, but did not disclose that the purchase was unauthorized or that Rolando could reject the trade.
- Rolando directed Grace to sell the options and sent $40,000 to reduce the deficit; a remaining debit balance (plus interest) persisted.
- Merrill Lynch sued to collect the debit balance; the Chengs counterclaimed against Merrill Lynch and brought third-party claims against Grace alleging breach of fiduciary duty, negligence, fraud, and securities-law violations.
- The district court ruled for the Chengs on a fiduciary-duty theory despite the non-discretionary nature of the account.

## Issues

1. Whether a broker handling a non-discretionary options account owes broad fiduciary duties comparable to those arising in discretionary accounts.
2. How to characterize and assess liability for a broker’s unauthorized trade and failure to disclose the customer’s right to reject the trade in a non-discretionary account relationship.

## Decision

- The D.C. Circuit reversed in part and remanded.
- The court held that a broker’s relationship with a customer in a non-discretionary account does not, by itself, create broad fiduciary duties of the kind associated with discretionary accounts.
- The court accepted that Grace breached a duty by transacting without prior authorization, but concluded that this duty breach was not properly treated as a broad fiduciary breach premised on discretionary-type control.
- The case was remanded for further proceedings consistent with the narrower characterization of the broker’s duties.

## Legal Principles

- A broker generally owes comprehensive fiduciary duties when the broker has discretionary authority over the customer’s account; that fiduciary status does not automatically arise in a non-discretionary account requiring customer authorization for each trade.
- In non-discretionary accounts, enforceable broker duties commonly include executing authorized orders with due care, following customer instructions, making required disclosures in connection with recommendations, and refraining from misrepresentation and unauthorized trading.
- Unauthorized trading breaches the broker’s duty to obtain customer authorization, but the existence of that duty does not necessarily convert the entire broker-customer relationship into a broad fiduciary relationship.
- Mislabeling non-discretionary broker obligations as broad fiduciary duties is legal error because it treats an authorization-based relationship as one of ongoing control and heightened trust.

## Conclusion

The D.C. Circuit limited the fiduciary-duty theory applied to a broker managing a non-discretionary options account, holding that unauthorized trading remains actionable but does not, without discretionary control, support imposing broad fiduciary obligations on the broker and firm.


Merrill Lynch, Pierce, Fenner & Smith, Inc. v. Cheng, 901 F.2d 1124 (D.C. Cir. 1990)