Pollack v. Laidlaw Holdings, Inc.

• Decision Date: 22 June 1994
• Docket Number: D,No. 1149,1149
• Citation: 27 F.3d 808
• Parties: Fed. Sec. L. Rep. P 98,248 Stephen J. POLLACK, et al., Plaintiffs-Appellants, v. LAIDLAW HOLDINGS, INC., et al., Defendants-Appellees. ocket 93-7993.
• Court: U.S. Court of Appeals — Second Circuit

Page 808

27 F.3d 808

Fed. Sec. L. Rep. P 98,248

Stephen J. POLLACK, et al., Plaintiffs-Appellants, v. LAIDLAW HOLDINGS, INC., et al., Defendants-Appellees.

No. 1149, Docket 93-7993.

United States Court of Appeals, Second Circuit.

Argued March 10, 1994.

Decided June 22, 1994.

Steven M. Edwards, New York City (Davis, Scott, Weber & Edwards, P.C., Ellen Wahl Parker, Jonathan A. Greenberg, of Counsel), for plaintiffs-appellants.

Richard G. Cushing, New York City (David T. Eames, G. Wade Leak, Bodian & Eames, of Counsel), for defendants-appellees.

Simon M. Lorne, General Counsel, Jacob H. Stillman, Associate General Counsel, Eric Summergrad, Principal Asst. Gen. Counsel, Randall W. Quinn, Sr. Litigation Counsel, Paul Gonson, Sol., of Counsel, Securities and Exchange Com'n, Washington, DC, amicus curiae.

Before LUMBARD, FEINBERG and MINER, Circuit Judges.

FEINBERG, Circuit Judge:

This is an interlocutory appeal, pursuant to 28 U.S.C. Sec. 1292(b), from an order issued in January 1993 in the United States District Court for the Southern District of New York, Peter K. Leisure, J., dismissing claims brought under the federal securities laws, RICO and state law. Plaintiffs-appellants are two doctors, the son of one of them, the personal retirement plans of the doctors (and their employees) and a family trust of one of the doctors (collectively, Pollack or appellants). Defendants-appellees are corporate entities in the securities and investment counselling business and the officers of these corporations (collectively, Laidlaw or appellees). Pollack claims that Laidlaw fraudulently invested Pollack's funds in "uncollateralized, speculative participations in mortgages," some of which were "fictitious and oversubscribed," resulting in a loss of more than one million dollars. After the district court's January 1993 order, Pollack requested the court to certify the order for interlocutory review under 28 U.S.C. Sec. 1292(b). The court granted the request in a brief opinion, which described the "controlling question of law" as whether the participations constitute "securities" under federal law. For reasons set forth below, we answer the question in the affirmative, reverse the order of the district court and remand for further proceedings.

I. Background

The order appealed from dismissed Pollack's securities claims pursuant to Fed.R.Civ.P. 12(b)(6). For the purpose of this appeal, therefore, we accept as true all of the factual allegations in the complaint, and draw all inferences in favor of Pollack. The following statement of facts is taken from the amended complaint and from the opinion of the district court.

A. Factual Allegations

Appellants are passive, unsophisticated investors, who relied on professionals to manage their money. In the 1970s, they began dealing with Walter L. Twiste, a broker and investment advisor. This relationship continued beyond 1977, when Twiste began an association with the companies that allegedly became the Laidlaw corporations. As of May 1990, appellants' accounts with Laidlaw exceeded $3.5 million. This money was in discretionary accounts, and Laidlaw received an investment management fee on the portfolio as well as commissions on executed transactions. Appellants received by mail written confirmation of all transactions, as well as monthly statements.

Appellants' standing instruction to Laidlaw was to pursue conservative, low-risk investments. For example, appellants' portfolio consisted mostly of investment grade bonds and other debt instruments, rather than equities or "junk" bonds. Appellants allege that in 1985 they noticed references to "promissory notes" connected to various properties. Twiste told appellants that these were mortgages, primarily short-term bridge loans for construction and cooperative conversions, and that the mortgages were "sound, guaranteed and secured," consistent with appellants' investment objectives.

In June 1990, appellants learned that Twiste had left Laidlaw and had been admitted into a mental institution; Laidlaw informed them that Twiste had committed "serious acts of fraud," including stealing money from clients' accounts. At approximately the same time, appellants found out that the mortgage investments were the result of transactions with Eagle S.A. Funding Company (Eagle), an entity of whom appellants had never heard. In May 1990, one of the Eagle partners had committed suicide and the company had gone into bankruptcy. Allegedly, Laidlaw had failed to investigate the mortgage investments obtained through Eagle, and Twiste was receiving commissions from Eagle as well as from Laidlaw. Appellants also found out that the mortgage participations, which had terms of approximately one to three years, were not secured, as represented by Twiste. Many of the underlying mortgages were unsecured and unrecorded. Appellants' interests in the mortgages were uncollateralized and speculative at best, and "fictitious and/or oversubscribed" at worst, but from 1985 to 1989 appeared to provide satisfactory returns because funds of new investors were used to make payments on existing accounts. Although Eagle stopped making payments in May 1989, Laidlaw continued to send appellants portfolio evaluations from May 1989 to June 1990 showing allegedly fictitious interest and principal payments.

B. Proceedings in the District Court

After some initial cooperation from Laidlaw, followed by failed settlement discussions, appellants determined that they had suffered a loss of $1,093,924. In September 1990, Pollack filed the original complaint. Laidlaw moved to dismiss the complaint based mainly on lack of particularity under Fed.R.Civ.P. 9(b).

Prior to the disposition of that motion, appellants took Twiste's deposition. Twiste admitted to misrepresenting the mortgage interests, receiving kickbacks and making fictitious entries in appellants' statements, and he described the mortgage interests in greater detail. Appellants then filed an amended complaint in June 1991. ¹

Count I of the complaint alleged the sale of unregistered securities in violation of Secs. 5(a), 5(c) and 12(1) of the Securities Act of 1933, 15 U.S.C. Secs. 77e(a), 77e(c) and 77l (1). Count II alleged misrepresentations and omissions in violation of Sec. 12(2) of the 1933 Act, 15 U.S.C. Sec. 77l (2). Count III alleged securities fraud in violation of Sec. 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. Sec. 78j(b), and SEC Rule 10b-5, 17 C.F.R. Sec. 240.10b-5. Counts IV and V alleged violations of RICO, 18 U.S.C. Sec. 1962(c), and counts VI through X alleged pendent state claims based on breach of fiduciary duty, conversion, fraud and deceit, negligent misrepresentation and misrepresentation. Appellants requested not less than $1,093,924 in damages or as a part of a rescission remedy, $10 million in punitive damages, interest income, treble damages under RICO and costs.

The Laidlaw defendants again moved to dismiss, and in January 1993 the district court granted the motion. The district court ruled that: (1) the securities claims should be dismissed pursuant to Fed.R.Civ.P. 12(b)(6) because the mortgage participations were not securities; and (2) the RICO claims should be dismissed pursuant to Fed.R.Civ.P. 9(b) for failure to plead fraud with particularity on the part of Laidlaw, and pursuant to Rule 12(b)(6) because under RICO Laidlaw could not be held liable for Twiste's acts on a theory of respondeat superior. The district court declined to exercise supplemental jurisdiction over the state law claims, but granted appellants leave to file an amended complaint to replead the RICO counts as well as the pendent claims.

Appellants then moved to file a second amended complaint to cure the Rule 9(b) defects. At the same time, appellants sought to add one count under the Employee Retirement Income Security Act (ERISA), 29 U.S.C. Sec. 1001 et seq., and moved for certification of the January 1993 order. Laidlaw did not oppose certification.

In June 1993, the district court issued an opinion and order granting the motion for certification. The district court held that the securities issue was appropriate for certification, noting that "[w]hether the mortgage participations purchased on behalf of the plaintiffs were securities is an issue that is on the fringe of the law in this developing area." However, the district court did not certify the issue of vicarious liability under RICO, both because appellants were granted leave to replead to establish Laidlaw's direct liability under RICO and because the district court believed that there was not "substantial ground for difference of opinion" as to its holding that there is no vicarious liability under RICO. ²

In September 1993, this court permitted the appeal. Thereafter, the SEC sought, and obtained, permission to file an amicus brief in support of appellants' view that the interests sold in this case are securities.

II. Discussion

This appeal requires us to engage again in the difficult task of applying the legislative definition of "security." See Louis Loss & Joel Seligman, 2 Securities Regulation 869-71 & n. 5 (3d ed. 1989) (noting dissatisfaction with judicial efforts in this area). Appellants and the SEC argue that the district court erred in dismissing their claims under the federal securities laws, because the mortgage participations were securities under both section 2(1) of the 1933 Act, 15 U.S.C. Sec. 77b(1), and section 3(a)(10) of the 1934 Act, 15 U.S.C. Sec. 78c(a)(10). Specifically, appellants allege that the mortgage participations were notes and investment contracts, two types of instruments regulated under the federal securities laws. ³ While the definitions of securities in the 1933 and 1934 Acts are not identical, the definitions are treated as identical in "decisions dealing with the scope of the term." Landreth Timber Co. v. Landreth, 471 U.S. 681, 686 n. 1, 105 S.Ct. 2297, 2301 n. 1, 85 L.Ed.2d 692 (1985).

A. The Reves...