Securities Law - State Jurisdiction Issue

STATE SECURITIES LAW - JURISDICTION

Bulldog Investors and its principal, operating a group of hedge funds, by offering an unregistered security through Bulldog’s website and an email to a Massachusetts resident violated the Massachusetts Uniform Securities Act. Bulldog and its principal officer Goldstein denied violating the Act and asserted that its actions were protected under the First Amendment and that personal jurisdiction was lacking. The Administrative Hearing Officer stated that he lacked authority to consider the constitutional question. Bulldog then proceeded to court to enjoin the Secretary of State’s enforcement action. In the meantime, the Hearing Officer continued the administrative proceeding and found that Bulldog and Goldstein made an offer of an unregistered security that was not exempt. The hearing officer’s finding consisted of a cease and desist order and a $25,000 fine.

Plaintiffs’ in the Superior Court, Bulldog Investors General Partnership, et al v. Secretary of the Commonwealth Of Massachusetts, SJC 10589 (07/02/2010) asserted that the Secretary of State lacked personal jurisdiction and filed a motion for judgment on the pleading. The Court concluded that personal jurisdiction was appropriate and denied Plaintiffs’ motion.

The Bulldog Firm appealed and contended that the maintenance of a website and the sending of this email to a Massachusetts resident was not sufficient contact with the Commonwealth to create personal jurisdiction. The Court agreed with the Secretary Of State that the Massachusetts Uniform Securities Act authorized the Secretary Of State to exercise personal jurisdiction over non-residents in an administrative proceeding. According to the Court, the purpose of the Act, was to protect Massachusetts residents from offers of unregistered securities directed at them from other jurisdictions, and that the Secretary Of State’s authority to conduct investigations outside the Commonwealth would be meaningless if it did not have the authorization to subject non-residents to enforcement proceedings. Plaintiffs’ rights to due process were not violated according to the Court because Plaintiffs availed themselves of the privilege of conducting business activities in Massachusetts and came within the reach of its laws.

The Appellate Court declined to consider the First Amendment argument because the issue had not been raised on appeal. The Court reaffirmed that Plaintiffs’ email message to a Massachusetts resident offering a non-exempt unregistered security was a violation of the Massachusetts Uniform Securities Act.

Bulldog, by sending one email, voluntarily subjected itself to the Massachusetts Uniform Securities Act.

This case is significant because it illustrates how a company can become subject to a state securities law.

Look for an appeal by Bulldog to the United States Supreme Court. Bulldog would argue that there were insufficient contacts to allow Massachusetts to assert jurisdiction over it.

Edward X. Clinton, Sr.

Read More

Securities Law - Noncompetitive Trading

NON-COMPETITIVE TRADING

The United States District Court for the Northern District of Illinois froze the assets on records of a man who claims to be a Russia national after the Commodity Futures Trading Corporation (“CFTC”) charged him with trades on the Chicago Mercantile Exchange (“Exchange”) which were not competitive (CFTC v. Yunuso, N.D. Ill., 10-3619, Judge Bucklo). According to the CFTC, Yunuso controlled two firms: Open E Cry, LLC and Velocity Futures, LLC to enter a buy or sell contract for one of his accounts and then within seconds enter an opposite or equal quantity buy or sell contract for the other account. Because the commodities were thinly traded his orders were marketed against each other. Then Yunuso would enter orders to offset the initial position and complete an equal but opposite round turn trade for each account. His trading according to the Exchange resulted in more than $7.8 million in lawsuits and an approximate $7.2 million profit in the Velocity Futures, LLC account. At the end of the trading session, Yunuso had a debit balance of about $8,000 with Open E Cry, LLC and thus no money to cover the losses.

According to CFTC, Yunuso by consistently executing trades between the Open E Cry account and the Velocity account during periods of low volume, Yunuso in effect entered into transactions without intent to take a genuine bona fide position in the market.

The CFTC is seeking restitution, fines, a trading registration ban and a permanent injunction against Yunuso and his entities.

Read More

Securities Law - Illinois Securities Law Statute of Limitations

This case is interesting because the plaintiffs abandoned claims under the Illinois Securities Law - to avoid a dismissal on the ground that the action was time-barred.

Plaintiffs in the case captioned Carpenter, et al. v. Exelon Enterprises Company, LLC, and Exelon Corporation, Appeal No. 1-09-1222 (4th Circuit), sued Exelon claiming that Exelon abused its position as majority shareholder of InfraSource in such a way that the rights of the minority shareholders were violated and not represented fairly in a merger and sale transactions.

Exelon filed a motion to dismiss on the grounds that it was barred by the three-year Illinois Statute Of Limitations. The trial court denied Exelon’s motion to dismiss determining that the Illinois Securities Law limitation period was inapplicable and plaintiffs’ suit was therefore timely filed within the residual five-year limitation period found in § 13-205 of the Code Of Civil Procedure. However, the trial court stayed the proceedings and certified the issue of the appropriate statute of limitations for an interlocutory appeal.

Exelon filed a motion to dismiss on the grounds that the Statute Of Limitations under the Illinois Securities Law of three years was applicable and the case should be dismissed. The Plaintiffs did not respond to the motion choosing to voluntarily dismiss their initial complaint and they refiled an amended complaint. In the amended complaint, the plaintiffs abandoned their Illinois Securities Law claims and proceeded under Delaware law instead.

The amended complaint contained additional allegations of the conduct of Exelon and contained an explicit statement that it purported to be brought under Delaware law and did not allege that defendants’ conduct constituted a violation of the Illinois Securities Law. Plaintiffs sought damages in excess of $11,000,000. Exelon again filed a motion to dismiss complaining, notwithstanding the changes in the amended complaint, that the manner for which relief was sought was still provided under the Illinois Securities Law and it was therefore barred by the three-year statute of limitations. The trial court disagreed and found that the suit was properly filed within the five-year limitation of § 13-305 of the Code. The trial court entered an order denying Exelon’s Motion To Dismiss but stayed further proceedings and certified the following question for interlocutory appeal, as the trial court found this issue involving the question of law upon which substantial ground for difference of opinion existed:
“Whether plaintiffs’ claim that Exelon Enterprises Company, LLC, as majority shareholder of InfraSource, Inc., breached its fiduciary duties in connection with InfraSource, Inc.’s 2003 merger transaction is governed by the three year statute of limitations contained in the Illinois Securities Law of 1953, 815 ILCS 5/13(d).”

The trial court granted Exelon’s petition for leave to appeal the interlocutory order of the trial court denying the motion to dismiss.

The trial court made reference to of § 13 of the Illinois Securities Law which delineates the private and other civil remedies available for violations of the Law. It pointed out that of § 13(A) provides that every sale in violation of the provisions of the Act is voidable at the election of the purchaser and that § 13(B) and § 13(C) outline various notice and mitigation requirements that a purchaser must fulfill before electing the option of rescission. Subsection 13(D) provides a three-year statute of limitation.

Exelon cited various federal cases which held that the Illinois three-year statute of limitation provided a bar to certain claims for relief. On the other hand, Plaintiff states that the claim is one of minority shareholder oppression and not covered by the Illinois Securities Law or the statute of limitations.

The Defendant, Exelon, argued that of § 13(F) and of § 13(G) provides injunctive relief as well as a right of rescission to “any party in interest”. The Court while acknowledging a contrary holding by a federal court in Klein v. George G. Kerasotes Corp., 500 F.3d 669 (7th Cir. 2007) held that plaintiffs were not barred by the three-year statute of limitations.

The Appellate Court held that the three-year limitation contained in of § 13 applies to relief under § 13 for which relief is granted by § 13. Section 13 provides only for (1) a retroactive right of rescission to purchase under subsection 13(A) and (2) a prospective remedy to the Illinois Secretary Of State and “any party in interest” under of § 13(F) and of § 13(G). Section 13 does not concern retroactive common law damage claims for breach of fiduciary duty both by sellers of securities in general or minority shareholders in particular. For the three year limitation contained in § 13(D) does not apply does not apply to claims of the plaintiffs against Exelon. Therefore the certified question is answered in the negative. Such being the case, the five-year of limitations applies and the case is timely.

Abandoning a claim for relief under the Illinois Securities Law was successful.

Read More

Securities Law - Statute of Limitations Merck v. Reynolds

On April 27, 2010, the United States Supreme Court issued its decision in Merck & Co v Reynolds, 08-905. The issue was whether the plaintiff's claim was barred under the applicable statute of limitation. The Statute of Limitations for securities claims alleging fraud, deceit or contrivance is that the claim must be filed not later than 2 years after disclosure of facts constituting the violation or 5 years after the violation. 28 U.S.C. Section 1658(b).

There have been division in the circuits on when a claim accures and whether a plaintiff had to have notice of scienter. Scienter has been defined as a mental state embracing intent to deceive, manipulate, or defraud. Ernest & Ernest, .v Hochfelder, 425 U. S, 185. In a 10b-5 case the plaintiff must prove that a defendant made a material misstatement with intent to deceive, not merely innocently or negligently.

The case arose out of the controversy involving the drug Vioxx. The District Court held that the state of Limitations barred the claim because investors were placed on inquiry notice of the claim more than 2 years before they filed suit. Inquiry notice exists when the victim is aware of facts that would lead a reasonable person to investigate and consequently acquire knowledge of the defendants misrepresentations, Great Rivers Cooperative v Farmland Industries, Inc. 120 Fed. 3rd 893

In September 2001 the FDA released a letter that stated that Merck had misstated the safety of the drug. The District Court referred to various press articles to support that proposition because of the widespread adverse publicity the investors were on notice more that 2 years before the lawsuit was filed The Third Circuit reversed and said that was not sufficient t to establish inquiry notice. The Court also stated that Merck at about the same time issued notices describing the drugs safety.

The Supreme Court granted certiorari and said that a plaintiff was required to discover facts of scienter. It started with the statutory language that the limitations period begins to run once there has been discovery of facts constituting the violation and noted that scienter was both a fact and an element of a Sec.10 (b) 5 violation. The Court concluded that facts of scienter can be distinct from establishing that there has been a material misrepresentation because an incorrect prediction does not show whether the speaker deliberately lied or just made an in an innocent error. The Court held that the statute of limitations does not begin to run until the plaintiff discovers or a reasonably diligent plaintiff would have discovered facts constituting the violation. Thus, the plaintiff's claims were not barred by the statute of limitations.

The Supreme Court affirmed the decision of the Third Circuit to the effect that Plaintiff’s claim was not barred by the statute of Limitations.

The case is also interesting because the decision of the Supreme Court was unanimous.

Edward X. Clinton, Sr.
www.clintonlaw.net

Read More

Corporate Law - Agent Lacks Authority to Bind Company

CORPORATE LAW - COURT HOLDS THAT PURPORTED AGENT LACKED AUTHORITY TO BIND CORPORATION TO SUSPICIOUS TRANSACTIONS WHICH WERE HARMFUL TO THE CORPORATION.


Herbert W. Fritzsche, et al. v. Gregory LaPlante and M. Christine Rock, 2-09-0329, Illinois Appellate Court Second District.

This issue raised in this case is whether or not a corporate officer had the authority to bind the corporation to some highly unusual transactions. The backstory is that the corporate officer was the daughter of the founder and President of the company and that she was apparently involved a feud with her siblings.

M. Christine Rock, acting as secretary/treasurer of a family corporation, Fritzsche Industrial Park (FIP) and as holder of a power of attorney for her father, Herbert W. Fritzsche, signed a lease agreement with her live-in boy friend, Gregory LaPlante. The lease named the Industrial Park as lessor and Gregory as lessee. The premises included 16 properties within the Industrial Park. Christine Rock owned 60 shares of a total of 1,000 shares that were issued and outstanding. Her father owned the majority of 685 shares. Christine Rock, at about the same time, also signed a promissory note in favor of Gerald Shaver in the principle amount of $450,000. The maker of the note was listed as Fritzsche Industrial Park and Park National Bank as Trustee under a Land Trust.

Plaintiffs, the corporation and other family members, filed this lawsuit alleging that Christine acted without Corporate authority and entered into the lease and note and without any authority as her father’s power of attorney in entering into the Lease Agreement. Because Christine refused to furnish records of rents and expenses, the shareholders informed her that she would be removed as Secretary/Treasurer. The suspect transactions were entered into after Christine learned that she would soon be removed as Secretary/Treasurer.

Plaintiffs filed a motion for summary judgment alleging that even if Christine had been the true Secretary/Treasurer of FIP and Herbert’s power of attorney, she still would not have had the authority to enter into the lease or the note. Plaintiffs allege that Christine did not have the authority to enter into the lease under either the common law or a statute. An affidavit was attached to the Plaintiff’s Motion For Summary Judgment which stated that at no time did the shareholders of FIP or the Board meet to vote on the lease or the note and that the Board never authorized Christine to act on behalf of FIP with regard to the lease or the note. Because there was no approval by the Board of Directors Ms. Rock lacked authority to cause the corporation enter into the lease or the note.

Ms. Rock and her boyfriend argued that Board approval and other corporate formalities were not required in order to allow Christine to execute the lease. Defendants stated that some of the properties included in the lease were not owned by Fritzsche but were owned by Herbert or some other member of the Fritzsche family and, therefore, corporate formalities were not necessary.

The trial court granted summary judgment for the plaintiffs - the corporation and Herbert W. Fritzsche.

Defendants appealed the grant of summary judgment. The Appellate Court affirmed the grant of summary judgment in all respects. The Appellate Court held that the Trial Court was correct in ruling that Christine did not have authority to enter into the lease or the note.

Under common law, the mere fact that a corporation has the power to make a certain type of contract does not, of itself, clothe even the highest officer of the corporation with the apparent authority to bind the corporation to such a contract. Corn Belt Bank v. Lincoln Savings & Loan Ass’n, 19 Ill.App. 3d 238, 245 (1983). Further, officers have no apparent authority to make unusual or extraordinary contracts on behalf of a corporation. Corn Belt Bank, 119. Ill.App. 3d at 245. “’If the president of a corporation were authorized to make contracts of this character without action of the directors and without notice to or knowledge of anyone, the directors would not at any time know whether it was headed for bankruptcy.’” Sacks v. Helene Curtis Industries, Inc., 340 Ill. App. 76, 91 (1950), quoting Warszawa v. White Eagle Brewing Co., 299 Ill. App, 509. Plaintiffs further argued that the Lease of the entire industrial park was an extraordinary transaction and that Illinois common law and its statutes prohibit an officer from entering into extraordinary and unusual contracts and/or contracts involving substantially all of the corporations assets, outside the ordinary course of business, without the board's consideration and approval.

The Court concluded that the Lease was an extraordinary transaction and, it implied, one that no rational corporation would approve. "Here, FIP/Christine transferred numerous properties contained int he Fritzsche Industrial Park to Gregory, a nonfamily member and a nonofficer/nonshareholder. The Lease does not specify Gregory's obligations to FIP's existing tenants. Although the Lease includes properties under trust, no trustees ever signed the Lease. Although the Lease involved 26 different properties (PINs), it seems no professionals, such as attorneys or realtors, were involved in drafting the Lease; defendants are the only signatories and/or witnesses to the Lease. Perhaps most strangely, the Lease seems to provide Gregory profit with little to no risk or investment. If he generates income, he pays a relatively small percentage of that income to the corporation; if he generates no income, he pays the corporation only taxes due to the government. As such, under common law, the Lease is the sort of transaction that would require authorization by the Board."

The Court also made specific reference to the Illinois Compiled Statutes, § 805 ILCS 5/11.55 which provides that where a sale, lease or exchange of assets involves, 'all, or substantially all, the property and assets ...of a corporation,' the board of directors must adopt a resolution recommending the transaction, whereupon said resolution shall be submitted to a vote by the shareholders at a meeting. § 805 ILCS 5/11.60(1).

The court held that the Lease essentially put the corporation out of business and, thus, was an extraordinary transaction.

In regard to the note that was executed, the Court made specific reference to Fritzsche’s by-laws entitled “Contracts, Loans, Checks and Deposits” which states “No loan shall be conducted on behalf of the Corporation and no evidence of indebtedness shall be issued in its name unless authorized by a resolution of the Board of Directors." Of course, the promissory note was never submitted to the Board for its consideration. The Court held that Christine was not permitted to bind the corporation by executing the note and that the note was void and unenforceable.

Thus, the Appellate Court found that Christine was not authorized to enter into the lease or make the note and, accordingly, affirmed the Trial Court’s grant of summary judgment to plaintiffs. The opinion contains a through discussion of corporate formalities and the need to comply.

Edward X. Clinton, Sr.

Read More

Securities Law - Wells Notice

A Wells Notice advises a public company or a principal officer of a public company that the Securities & Exchange Commission is considering enforcement action because of some alleged violation of the Securities Laws. The company or individual is given a chance to respond and explain why enforcement action should not be brought. Not all Wells’ Notices lead to enforcement action. The term “Wells Notice” is named after Senator John Wells, who in 1972 chaired a committee to review SEC enforcement procedures.

Goldman Sachs received a Wells Notice in July 2009 in connection with the sale by Goldman Sachs of a synthetic collateralized debt obligation known as Abascus 2007-AC-1. The notice was not disclosed to shareholders or otherwise made public. Corporate lawyers believe that it depends on the facts whether a Wells Notice should be disclosed. Plaintiff’s lawyers generally take the position that such notices should be disclosed because they are material. In other words an SEC investigation has proceeded to the point that the staff is considering proceeding against the company or a principle officer. Two class actions have been filed so far against Goldman Sachs alleging, among other things, that the Wells Notice was concealed from investors.

According to an article in the Wall Street Journal dated April 10, 2010, five Senior Executives of Goldman Sachs Group Inc., including the firm’s co-general counsel, sold $65.3 million worth of stock after the firm received notice of possible fraud charges, which later drove its stock down 13%. There is no suggestion in the article that those executives had any knowledge of the Wells Notice.

The SEC has alleged in the well-publicized case against Goldman Sachs that the firm made misrepresentations and material omissions in the marketing in 2007 of a collateralized debt obligation known Abascus 2007 AC-1.

The public will learn much more about Wells Notices after there is further disclosures by either Goldman Sachs or the SEC.

Ira Schochet, a partner in the New York law firm of LaBaton, Sucharow LLP, responded to the argument that disclosing Wells Notices just repeats unproven allegations.
However, Schochet stated that if there is a substantial defense, issuers can disclose that as well. Schochet is also President of the National Associations of Shareholder and Consumer Attorneys, a group of about 100 law firms that represent investors and consumers.

Read More

Business Debts - The Bankruptcy Court Will Not Discharge A Debt Where The Underlying Loan Was Procured Through Fraud

In Ojeda v. Goldberg, No. 09-2008, the Seventh Circuit affirmed a determination of the District Court (Judge Gottschall) that a debt was not dischargeable because the underlying loan was procured through fraud.

This case is of interest even to those who do not practice in the bankruptcy area as bankruptcy considerations often govern corporate transactions.

Facts:

The Goldbergs were creditors of Ernest and Beverly Ojeda. The parties executed a short-term high-interest-rate loan in August 1998. The Ojedas were unable to pay the principal when the loan came due. However, they obtained numerous extensions of the loan's maturity date until January 2006 when the Ojedas defaulted.

In February 2006, the Ojedas filed for bankruptcy. Gail Goldberg filed an adversary proceeding against the Ojedas seeking a declaration that the $600,000 loan was not dischargeable because it was procured fraudulently.

The Ojedas owned (through corporations) two McDonald's restaurants. The Ojedas later sold the McDonald's franchises.

When the loan came up for renewal, the Ojedas did not disclose to the Goldbergs that they had sold the McDonald's restaurants. The District Court held that the entire debt $600,000 should be exempt from discharge because the Ojedas led Gail Goldberg to believe that they still owned the McDonald's restaurants when they did not. In fact, the district court noted that the Ojedas continued to use the checkbook for the McDonald's restaurants to pay interest long after the restaurants were sold.

The Seventh Circuit, in an opinion by Judge Kanne, affirmed. The legal standard is as follows:

For a creditor to receive an exception from discharge under 11 U.S.C. Section 523(a)(2)(A), the creditor must show that (a) the debtor made a false representation; (b) that the debtor knew was false and was made with intent to deceive; (c) upon which the creditor justifiably relied.

The Seventh Circuit agreed with the Bankruptcy and District Court that the Ojedas had made false representations with the intent to deceive the Goldbergs. The more difficult question was whether Gail Goldberd had justifiably relied on the Ojedas representations that they still owned the McDonald's restaurants. As the Court noted, "justifiable reliance is a less demanding standard than reasonable reliance" and Ms. Goldberg met that standard.

The Court noted that the Ojedas continued to use checks bearing the McDonald's information. Unless the Plaintiff possessed outside information, "there was no conceivable way that [Ronald Goldberg] could have been alerted to the sale (of the restaurants) when the Ojedas continued to give the impression that the sale never occurred." In sum, the Seventh Circuit was satisfied that the sale of the McDonald's restaurants was concealed and that the Goldbergs justifiably relied on the misrepresentations.

The Seventh Circuit further held that "a fraudulently induced forbearance constitutes an extension or renewal of credit for purposes of Section 523." The Goldbergs met their burden of proving that the forbearance was fraudulently induced in that (a) they had valuable collection remedies at the time of the misrepresentation; (b) they did not exercise those remedies based upon the misrepresentation; and (c) the remedies lost value during the extension period." Opinion at page 13.

Comment: Clients often believe that filing bankruptcy will wipe away their debts. However, bankruptcy courts often scrutinize transactions to determine if they were fair to all parties. Here, the debtors' trickery (hiding the fact that two fast food restaurants were sold) proved to be their undoing.


Edward X. Clinton, Jr.

Read More