## Facts

- Carol O’Connor received a $200,000 divorce property settlement in 1975 and placed the full amount with R.F. Lafferty & Co. through broker Roy A. Foulke.
- O’Connor was an inexperienced investor, told Foulke the funds were virtually all of her assets, and needed investment income to cover living expenses and related taxes and fees.
- O’Connor gave Foulke and the firm complete discretion over the account; Foulke executed trades and provided trade confirmations and monthly statements.
- After her ex-husband’s alimony obligation ended in 1985, O’Connor relied on the account to generate roughly $2,100 per month.
- O’Connor later alleged that, from 1982 to 1987, defendants purchased securities unsuitable for her stated objectives and risk tolerance, including oil and gas limited partnerships and speculative corporate securities, causing loss of principal and little or no income.
- O’Connor sued asserting a federal “unsuitability” theory under § 10(b) and Rule 10b-5, common-law fraud, and additional state-law securities and tort claims (including negligence and intentional infliction of emotional distress).

## Issues

1. What elements must be proven for an “unsuitability” claim under § 10(b) and Rule 10b-5 based on fraud by conduct, and did O’Connor produce sufficient evidence of scienter to survive summary judgment?
2. Whether the district court properly compelled arbitration of the remaining state-law tort claims and properly confirmed the arbitration award.

## Decision

- The court held that a Rule 10b-5 unsuitability claim framed as fraud by conduct requires proof that the broker (1) controlled the account, (2) recommended or purchased unsuitable securities, and (3) acted with intent to defraud or reckless disregard for the investor’s interests.
- The court affirmed summary judgment for defendants on the § 10(b)/Rule 10b-5 unsuitability claim and on common-law fraud because O’Connor’s evidence did not permit a reasonable finding of the required scienter.
- The court affirmed in part and reversed in part the district court’s arbitration and award-confirmation rulings, and remanded for further proceedings consistent with its opinion.

## Legal Principles

- Unsuitability under § 10(b) and Rule 10b-5 may be pursued as “fraud by conduct,” but it is not established by poor performance, aggressive strategy, or negligence alone.
- A plaintiff must show broker control of the account and objectively unsuitable recommendations or purchases in light of the client’s stated objectives and circumstances.
- Scienter is required: the broker must have acted with intent to defraud or with reckless disregard of the investor’s interests; ordinary carelessness is insufficient.
- Unsuitability claims are analogous to churning claims in requiring both broker control and scienter, though churning focuses on excessive trading while unsuitability focuses on inappropriate security selection.

## Conclusion

The Tenth Circuit treated unsuitability as a fraud-based theory under Rule 10b-5 requiring account control, unsuitable investments, and proof of intent to defraud or recklessness; because the record showed, at most, negligent or misguided investing rather than scienter, it affirmed summary judgment on the federal securities and fraud claims while partially reversing and remanding aspects of the arbitration-related rulings.


O’Connor v. R.F. Lafferty & Co., 965 F.2d 893 (10th Cir. 1992)