First Marblehead v. House

• Court: Court of Appeals for the First Circuit
• Decided: September 8, 2008
• Docket: 06-1114
• Status: Published

Opinion

United States Court of Appeals For the First Circuit

No. 07-2789

FIRST MARBLEHEAD CORPORATION,

Plaintiff, Appellee,

v.

GREGORY J. HOUSE,

Defendant, Appellant.

APPEAL FROM THE UNITED STATES DISTRICT COURT FOR THE DISTRICT OF MASSACHUSETTS

[Hon. Patti B. Saris, U.S. District Judge]

Before

Torruella, Lipez, and Howard, Circuit Judges.

Peter N. Wang, with whom Yonaton Aronoff and Foley & Lardner LLP, was on brief for appellant. Kenneth J. DeMoura, with whom Michael D. Riseberg, Colleen M. Nevin, and Adler Pollock & Sheehan P.C., was on brief for appellee.

September 8, 2008 TORRUELLA, Circuit Judge. Gregory J. House, a former

employee of First Marblehead Corporation, was unable to exercise

his incentive stock options because he failed to do so within three

months of his resignation. In a set of claims removed to federal

district court under diversity jurisdiction, House alleged, inter

alia, that he had relied on First Marblehead's negligent

misrepresentations that the options would be viable for ten years.

A jury found that House had reasonably relied on those negligent

representations. However, the jury concluded that House would not

have exercised those options during the three months after his

resignation and thus awarded no damages. House now appeals,

challenging the admission of certain expert testimony and the

district court's denial of his motion for a new trial. After

careful review, we conclude there was no error and affirm the

jury's verdict.

I. Background

The background facts in this case are generally

undisputed. In 1996, House was recruited by his friend and First

Marblehead Chief Executive Officer ("CEO"), Daniel Meyers, to work

at First Marblehead, a start-up student loan servicing company.

House was offered a position as President of First Marblehead Data

Services. House accepted the job and as part of his employment, he

-2- was granted incentive stock options to purchase 2,500 shares at a

strike price of $32 per share.1

First Marblehead's stock option plan ("the Plan")

provided that the options would have a duration of ten years.

Unbeknownst to House, the Plan also had a provision that in the

event of an employee's departure from the company, the options

would expire within three months of the date of resignation. House

attested, and First Marblehead does not seriously challenge, that

he did not receive a copy of either the Plan or the written

document memorializing the grant of the options. Furthermore,

communications between House and various First Marblehead

executives -- CEO Myers, Executive Vice President Ralph James, and

outside general counsel, Rod Hoffman -- reiterated that the options

would be good for ten years and made no mention of the three-month

expiration provision in the event of resignation.2

1 Stock options give the holder the ability to purchase a company stock at a set price. It would have cost $80,000 to exercise all 2,500 options. 2 Indeed, Hoffman testified that at some point, he realized that he had omitted the three-month expiration provision from the Plan. He authored a "Corrections and Amplifications" memo, which clearly stated that in the event of a resignation, the options must be exercised within three months:

I found that I had misstated one of the terms of the option in the summary memo . . . . Mea culpa. A copy of that revised memo is attached . . . . You will note that the change is to Section II.4 which describes what happens to the options upon termination of employment.

Although Hoffman testified that he delivered this revised memo to

-3- In February 1998, House resigned from First Marblehead;

no one at the company mentioned the three-month period within which

he would have to exercise his options. In 2001, First Marblehead

acquired the assets of a nonprofit student loan company, TERI. The

acquisition allowed First Marblehead to increase its loan volume

significantly. Due in part to the success of the TERI acquisition,

First Marblehead became a publicly traded company in 2003, which

resulted in a dramatic increase in the value of the company's

stock. Several months later, after hearing about the company's

successful initial public offering, House contacted Meyers and

inquired about exercising his options. House was then informed

that the options had expired in May 1998, three months after his

resignation.

House and First Marblehead initially attempted

negotiation; First Marblehead averred that the options had expired

and House asserted that his options were worth $7 million. At some

point, First Marblehead sought a declaratory judgment in

Massachusetts Superior Court that the options had expired three

months after his resignation. On the basis of diversity

jurisdiction, House removed the action to federal court and

asserted two counterclaims: breach of contract and promissory

estoppel. House then added a third claim for negligent

the company, the parties generally agree that House never received it.

-4- misrepresentation. On First Marblehead's motion for summary

judgment, the district court dismissed the case entirely. On

appeal, we upheld summary judgment on the breach of contract and

promissory estoppel claims, but vacated and remanded for further

proceedings on the negligent misrepresentation claim. First

Marblehead Corp. v. House, 473 F.3d 1 (1st Cir. 2006).

As the case proceeded to trial, First Marblehead made it

known that it intended to call Robert Sherwin as an expert witness

and submitted his expert report. House objected to Sherwin's

report and anticipated testimony, arguing that it was irrelevant

and that Sherwin was not a qualified expert. The district court

declined to rule and reserved the issue for trial.

At trial, House testified that had he known of the three-

month expiration, he would have exercised his options during that

period: "There's zero chance . . . in the God's green earth that I

was going to let [the options] lapse into worthlessness. That

would not have happened." He claimed, without equivocation, that

he would have paid the $80,000 necessary at the time to exercise

all 2,500 of his options. He maintained that the company's success

was "nearly guaranteed." According to House's calculations, had he

exercised his options within the three-month period, the 2,500

shares would have eventually amounted to 150,000 shares of common

stock (as a result of subsequent stock splits) and, had he

-5- continued to keep his shares through the company's public offering,

the value of his stock would have been worth $8.4 million.

First Marblehead argued, contrary to House's testimony,

that the company's success was not such a foregone conclusion. As

of House's resignation in 1998, the company had lost money during

each of the first seven years since its inception; the market value

of the stock had dropped from $32 per share in 1997 to $20 per

share in 1998. Meyers and James both testified that the company

struggled to obtain necessary financing and it was in a precarious

financial situation until the successful acquisition of TERI in

2001 and the company's initial public offering of stock. First

Marblehead submitted a 2005 e-mail from House to his brother in

which he wrote that in 1998, shortly before leaving the company, he

had attempted to sell his options back to the company at a

substantial discount; House stated that "the options were not worth

a great deal." In the e-mail, House went on to say: "Seven years

later, in October of 2003, the company, lo and behold and to my

great surprise, went public."

At issue in this appeal is the testimony of First

Marblehead's expert witness, Robert Sherwin, who testified over

House's objection. Sherwin is a certified public accountant, with

a bachelor's degree in economics and a law degree from the

University of Chicago. At the time of trial, he was employed by

Analysis Group, a consulting company that specializes in economics,

-6- finance, and strategy consulting. He concentrates in two areas of

economics: financial economics and industrial organization.

Sherwin testified that during the three-month period in

which House would have had to exercise his stock options (had he

known of their expiration), the "stock was not worth $80,000, or

worth at best $80,000." He further testified that in his opinion,

it would not have made financial sense for House to exercise the

options at that time for several reasons. First, House would not

have obtained an immediate financial gain because the stock was not

worth more than the $80,000 House would have had to pay to obtain

them. Second, First Marblehead was, at the time, a private company

and it would have been more difficult to sell those private shares

than shares in a publicly traded company. Third, such a

significant investment in one stock would be risky and contrary to

the principle of diversification. Fourth, Sherwin testified that

House's own financial position at the time made such an investment

even riskier: "House at the time was going through a divorce, had

limited assets in the bank, he had no stock that he owned . . .

[$80,000 worth of stock] would probably be more than a hundred

percent of [his investable assets]."

On July 23, 2007, the jury returned a verdict in which it

found that House had reasonably relied on the negligent

misrepresentations of First Marblehead regarding the expiration of

his incentive stock options. However, the jury concluded that even

-7- if House had been aware of the three-month expiration period, he

would not have exercised the options; the jury thus awarded House

no damages. The district court denied House's motion for a new

trial. House now appeals.

II. Discussion

We review the district court's decision regarding the

admissibility of expert testimony for abuse of discretion. See

Wilder v. Eberhart, 977 F.2d 673, 676 (1st Cir. 1992) (citing Int'l

Adhesive Coating Co., Inc. v. Bolton Emerson Int'l, 851 F.2d 540,

544 (1st Cir. 1988)); see also Rodríguez v. Smithkline Beecham, 224

F.3d 1, 8 (1st Cir. 2000). Our deference to the district court's

judgment is consistent with the discretion given to the district

court by the Federal Rules of Evidence, which "afford district

courts substantial latitude in the admission or exclusion of

opinion evidence." Crowe v. Marchand, 506 F.3d 13, 16 (1st Cir.

2007); see also Espeaignnette v. Gene Tierney Co. Inc., 43 F.3d 1,

11 (1st Cir. 1994) ("A trial judge's rulings in this sphere should

be upheld unless manifestly erroneous." (quoting United States v.

Sepúlveda, 15 F.3d 1161, 1183 (1st Cir. 1993) (internal quotation

marks omitted))). Moreover, even if an evidentiary ruling is

deemed erroneous, we will not disturb the jury's verdict if "it is

highly probable that the error did not affect the outcome of the

case." McDonough v. City of Quincy, 452 F.3d 8, 19-20 (1st Cir.

2006).

-8- Federal Rule of Evidence 702 requires that before giving

testimony as an expert, a witness must be "qualified as an expert

by knowledge, skill, experience, training, or education" and

provide such knowledge that "will assist the trier of fact to

understand the evidence or to determine a fact in issue."

Furthermore, the expert's testimony must be "based upon sufficient

facts or data" that result from the application of "reliable

principles and methods." Fed. R. Evid. 702. The purpose of these

requirements is to "ensure, as a condition of admissibility, that

proffered expert testimony rests on a sufficiently trustworthy

foundation." Crowe, 506 F.3d at 17 (citing Daubert v. Merrell Dow

Pharms., Inc., 509 U.S. 579, 597 (1993)).

House challenges Sherwin's qualifications to testify as

an expert and also argues that the substance of his testimony was

improper. With respect to Sherwin's qualifications, House contends

that Sherwin's experience is limited to industrial organization and

securities pricing, and he therefore lacks the expertise to testify

about how individuals choose investments and arrange portfolios.

House argues that such testimony would have been appropriate from

a certified financial planner, which Sherwin is not.

First Marblehead rejects House's myopic view of Sherwin's

credentials. Sherwin has nearly two decades of experience as a

consultant in economics, finance, and strategy consulting. With

respect to his testimony regarding investment diversification,

-9- Sherwin works on the 401(k) committee at his consulting firm and

advises employees in their various investments. Additionally, he

testified that his experience includes providing investment advice

to accredited investors. While a certified financial planner who

focuses entirely on individual investment decisionmaking would also

have been qualified to provide this testimony, we are unconvinced

that Sherwin's own credentials are such that he is unqualified to

testify as an expert in this case.3 See United States v. Vargas,

471 F.3d 255, 262 (1st Cir. 2006) ("It is not required that experts

be 'blue-ribbon practitioners' with optimal qualifications" (citing

United States v. Mahone, 453 F.3d 68, 71 (1st Cir. 2006))). We

thus conclude that the district court's decision to find Sherwin

qualified to testify as an expert falls well within the district

court's "broad discretionary powers in determining the

qualification . . . of expert witnesses." Diefenbach v. Sheridan

Transp., 229 F.3d 27, 30 (1st Cir. 2000) (quoting Richmond Steel

Inc. v. Puerto Rican Am. Ins. Co., 954 F.2d 19, 20 (1st Cir.

1992)).

3 House also argues that the district court should have provided him with the opportunity to conduct a voir dire of Sherwin outside the hearing of the jury. We are unmoved by this argument; our Rule 702 inquiry does not demand that the district court follow any particular procedure. See United States v. Díaz, 300 F.3d 66, 73- 74 (1st Cir. 2002) (citing Daubert, 509 U.S. at 594; Kumho Tire Co. Ltd. v. Carmichael, 526 U.S. 137, 152 (1999)). Moreover, in this case, despite ample opportunity to do so, House made no request for a voir dire until Sherwin began his testimony.

-10- Second, with respect to whether the testimony was helpful

to the jury, House makes two somewhat inconsistent arguments for

why the district court erred: (1) Sherwin's testimony was

irrelevant because the jury is tasked with determining what House

-- and not a reasonable investor -- would have done with the

options had he known about the three-month expiration period; and

(2) by testifying as to what a reasonable investor would have done,

Sherwin's testimony improperly invaded the province of the jury.

With respect to the issue of relevance, "expert testimony

must be relevant . . . in the incremental sense that the expert's

proposed opinion, if admitted, likely would assist the trier of

fact to understand or determine a fact in issue." Ruiz-Troche v.

Pepsi Cola of P.R. Bottling Co., 161 F.3d 77, 81 (1st Cir. 1998)

(citing Daubert, 509 U.S. at 591-92). In this case, Sherwin's

testimony was proffered by First Marblehead to explain to the jury

how stock options function and how an investor would think about

exercising those options. Those are not topics ordinarily within

the knowledge of the jury and thus are appropriate for expert

testimony. See United States v. Shay, 57 F.3d 126, 132-33 (1st

Cir. 1995) ("The fundamental question that a court must answer in

determining whether a proposed expert's testimony will assist the

trier of fact is 'whether the untrained layman would be qualified

to determine intelligently and to the best degree, the particular

issue without enlightenment from those having a specialized

-11- understanding of the subject matter involved.'" (quoting United

States v. Montas, 41 F.3d 775, 783 (1st Cir. 1994)).

Sherwin testified that based on House's financial

circumstances in early 1998 and the uncertainty surrounding First

Marblehead's financial future, it would not have made financial

sense for someone in House's position to exercise the options.

Sherwin testified that:

the stock would have been worth no more than the amount [House] would have had to have paid, potentially less than that . . . . [and] the stock would not be particularly suitable for someone in Mr. House's position in terms of the risk and the liquidity and the diversification areas of financial performance.

Sherwin explained that an incentive stock option plan provides an

employee with the opportunity to purchase stock at a set strike

price and, potentially, realize an immediate financial gain if the

value of the stock is higher than the purchase price. In 1998 when

House would have had to decide whether or not to exercise the

options, he would have had to pay $80,000 for stock that was worth

-- at most, $80,000; House would not have enjoyed any immediate

financial gains. Sherwin further explained that based on House's

financial position -- House's salary at the time was $70,000, he

had only $50,000 in personal assets, and he would have had to

borrow around $30,000 in order to purchase the options -- such a

large investment in one privately held company was risky. The

district court's conclusion that Sherwin's testimony was relevant

-12- and provided helpful context for the jury was well within the

court's broad discretion.

Testimony that provides a necessary context and

framework, especially in cases involving complex or unfamiliar

concepts, can be appropriate for expert testimony without

improperly interfering with the jury's assessment of credibility.

Cf. United States v. Brien, 59 F.3d 274, 276-77 (1st Cir. 1995)

(observing that in the context of identification, expert testimony

could "give the jury background information about the mechanism of

memory, types of errors, error rates, and other information not

commonly possessed by the jury"). Our review of the record makes

clear that Sherwin's testimony was careful to provide the jury with

the information to evaluate House's assertions as to what he would

have done in 1998, and stopped short of giving Sherwin's own

opinion as to what he believed House would have done. At no point

did Sherwin opine on the credibility of House's testimony; his

comments were limited to expressing an opinion on the financial

risk involved in the decision. The determination of whether House

was credible or not was appropriately left to the jury.

We therefore conclude that the district court's decision

to admit Sherwin's expert testimony was not an abuse of discretion.

House also appeals the denial of his Rule 59 motion on the sole

basis that the admission of Sherwin's testimony was substantial

error and highly prejudicial. Given our determination that the

-13- district court did not err in deeming Sherwin qualified and his

testimony relevant, the district court did not abuse its discretion

in denying House's motion for a new trial. See Crowe, 506 F.3d at

19.

III. Conclusion

For the foregoing reasons, we affirm the district court's

decision to allow the expert testimony and affirm the district

court's denial of the motion for a new trial.

Affirmed.

-14-