Hirk v. Agri-Research Council, Inc.

Citation561 F.2d 96
Decision Date06 September 1977
Docket NumberAGRI-RESEARCH,No. 76-2011,76-2011
PartiesFed. Sec. L. Rep. P 96,167 William F. HIRK, Plaintiff-Appellant, v.COUNCIL, INC., John Burlington, and Glenn Andersen, Defendants-Appellees.
CourtUnited States Courts of Appeals. United States Court of Appeals (7th Circuit)

James L. Fox, Chicago, Ill., Richard E. Nathan, Commodity Futures Trad. Comm., Washington, D. C., for plaintiff-appellant.

Jacob N. Gross, Chicago, Ill., for defendants-appellees.

Before CUMMINGS, PELL and BAUER, Circuit Judges.

CUMMINGS, Circuit Judge.

Plaintiff, William F. Hirk, is appealing the dismissal of his amended complaint alleging violations of the Federal Securities Act of 1933 and the Commodity Exchange Act for failure to state a claim. 1 Count I of the amended complaint charged a violation of Section 5 of the Securities Act of 1933 (15 U.S.C. § 77e) and Count II charged a violation of Section 4b of the Commodity Exchange Act of 1936 (7 U.S.C. § 6b). 2 According to the plaintiff, the two individual defendants, brokers and dealers in securities, fraudulently induced him to enter into a trading agreement with defendant Agri-Research Council, Inc. (ARCO), a company engaged in managing discretionary futures trading accounts. Pursuant to this agreement, Hirk opened an account with Miller-Lane & Co., an ARCO futures commission merchant, placed $10,000 in the account, and executed a power of attorney appointing defendant Burlington as his agent and attorney-in-fact to trade in his account. Under this designation, Burlington made numerous transactions in Hirk's account, using Hirk's funds as margin deposits. Burlington is the vice-president of the corporate defendant ARCO; defendant Andersen is its president.

Hirk claims that during the course of Burlington's solicitation of the trading agreement, defendants concertedly made various misrepresentations to him regarding the profitability of their enterprise, the competency and experience of the professional analysts on their staff, and the information that would be sent to him regarding trading recommendations and futures trends. They also told Hirk that he would be provided with information concerning all the transactions in his account. Additionally, they made representations that Hirk would lose no more than $7,500 and that at no time would his account fall below $2,500. Notwithstanding that they knew he was inexperienced in commodity trading, they failed to advise him that this was a high risk venture in which substantial losses could occur. Moreover, they showed him profit and loss statements of other accounts which generally gave him the impression that all accounts managed by them were profitable.

Hirk claims he eventually lost his initial $10,000 investment and an additional $17,880 he was required to pay to cover losses in his account. In both federal counts, he sought $27,880 in actual damages and $100,000 in exemplary and punitive damages.

I. Applicability of Federal Securities Acts

In Count I of his original complaint, Hirk alleged that the discretionary futures trading agreement and the power of attorney which he executed constitute either "an investment contract" or "(a) certificate of interest or participation in (a) profit-sharing agreement," thus qualifying as a security under the Securities Act of 1933 (15 U.S.C. § 77b(1)) and the Securities Act of 1934 (15 U.S.C. § 78c(a)(10)). As securities, defendants were obligated to register them pursuant to Section 5 of the 1933 Act (15 U.S.C. § 77e) and to comply with the anti-fraud provisions of both those Acts (15 U.S.C. §§ 77q, 78j(b), 78o (c) and SEC Rules 10b-5, 15c1-2 and 15c1-7). He claims that their failure to do so makes them liable for his loss of over $28,000 under 15 U.S.C. § 77l.

Count I was dismissed on June 24, 1974, on the ground that the arrangement entered into by Hirk was not an "investment contract" and therefore not a "security" under 15 U.S.C. § 77b(1) and § 78c(a)(10) because the requisite element of "common enterprise" was lacking. Applying the Milnarik 3 test for determining an investment contract, the court found that Hirk's allegations of overlapping investment services and the similarity of concomitant transactions in various discretionary trading accounts by the defendants did not transform Hirk's single account, limited to his own investment, into a joint account with other investments. Mem. op. 3-5. Attempting to eliminate this flaw in his pleadings, Hirk filed an amended complaint alleging that the defendants treated all of the discretionary trading accounts in substantially the same manner and consequently that he shared pro-rata with the other accounts "as if" all the funds had been commingled. He further alleged that his investment monies were employed by the defendants to finance ARCO's operating expenses and the advertising scheme used to attract other investors. The district court dismissed this amended Count I on August 30, 1974, finding that the similar treatment afforded Hirk and other investors was insufficient to establish the requisite commonality, "especially in light of plaintiff's claim that such treatment was in direct contravention of defendants' representations and plaintiff's expectations" (mem. op. 3-5).

A. No Investment Contract

On appeal, Hirk challenges the district court's holding that this discretionary trading account is not an investment contract and hence that the anti-fraud provisions of the Federal Securities Acts are not applicable. He realizes that because of the virtual identity of the definitions of security contained in the two federal securities laws, any determination that the arrangement qualifies as a security under one statute will control the disposition of that issue with respect to the companion law. Tcherepnin v. Knight, 389 U.S. 332, 335-336, 88 S.Ct. 548, 19 L.Ed.2d 564. He is also aware that unless this Court overrules its prior decision in Milnarik v. M-S Commodities, Inc., 457 F.2d 274 (7th Cir. 1972), certiorari denied, 409 U.S. 887, 93 S.Ct. 113, 34 L.Ed.2d 144, holding that a discretionary trading account is not a security, or that the alleged facts in this case are distinguishable from those in Milnarik, his attempts to reverse the district court's decision on Count I must fail. For the following reasons, this Court affirms this portion of the district court's decision.

The Milnarik court was guided in the construction of the term "security" by several important principles: first, the purpose of the federal security laws is remedial in nature; second, the legislature has directed that these laws be construed liberally and flexibly to effectuate their purpose (Tcherepnin, supra, 389 U.S. at 336, 88 S.Ct. 548, 553); and third, "form should be disregarded for substance and the emphasis should be on economic reality" (id. ). Within this tripartite framework, Milnarik applied the well-recognized definition of an investment contract established in SEC v. W. J. Howey, 328 U.S. 293, 301, 66 S.Ct. 1100, 1104, 90 L.Ed. 1244, "(t)he test is whether the scheme involves an investment of money in a common enterprise with profits to come solely from the efforts of others," and found that the element of commonality was lacking. Judge Stevens (now Justice Stevens) reached this conclusion because the investors in Milnarik did not expect to obtain profits from the operation of all the discretionary trading accounts managed by their common broker, but rather from their individual trading accounts independently of all others. Indeed, he concluded that all that was created by the discretionary arrangement was an agency-for-hire relationship. 457 F.2d at 276-278. Accord, Wasnowic v. Chicago Board of Trade, 352 F.Supp. 1066, 1069 (M.D.Pa.1972), affirmed without opinion,491 F.2d 752 (3rd Cir. 1974), certiorari denied, 416 U.S. 994, 94 S.Ct. 2407, 40 L.Ed.2d 2407; Stuckey v. duPont Glore Forgan, Inc., 59 F.R.D. 129, 131 (N.D.Cal.1973); contra, SEC v. Continental Commodities Corp., 497 F.2d 516 (5th Cir. 1974); Marshall v. Lamson Bros. & Co., 368 F.Supp. 486, 487 (S.D.Iowa 1974); Berman v. Orimex Trading, Inc., 291 F.Supp. 701, 702 (S.D.N.Y.1968); Maheu v. Reynolds & Co., 282 F.Supp. 423 (S.D.N.Y.1968).

Hirk argues that the Milnarik definition of "common enterprise" as requiring both multiple investors and a pooling of their funds erodes the remedial potential of the securities acts and accordingly should be reexamined. He recommends that this Circuit adopt the contrary position of the Fifth Circuit in SEC v. Continental Commodities Corp., 497 F.2d 516 (5th Cir. 1974). This we decline to do for the following reasons:

In Continental Commodities, the Fifth Circuit restated its endorsement of the Ninth Circuit's formulation of a common enterprise as "one in which the fortunes of the investor are interwoven with and dependent upon the effort and success of those seeking the investment or of third parties." 497 F.2d at 522 (quoting SEC v. Glenn W. Turner Enterprises, Inc., 474 F.2d 476, 482 n.7 (9th Cir. 1973), certiorari denied, 414 U.S. 821, 94 S.Ct. 117, 38 L.Ed.2d 53). Although this formulation superficially appears co-terminous with the Milnarik definition of common enterprise as "joint participants in the same investment enterprise" (457 F.2d at 277), the Fifth Circuit's interpretation differs from this Circuit's. In the Fifth Circuit's analysis, the critical factor is whether or not "the fortunes of all investors are inextricably tied" to the success of the trading enterprise. 497 F.2d at 522 (quoting SEC v. Koscot Interplanetary, Inc., 497 F.2d 473, 479 (5th Cir. 1974)). By stating so, it acknowledged that it was expressly rejecting the necessity of a pooling of investments or investor remuneration on a pro-rata showing of profits, citing the following cases to substantiate its position: Blackwell v. Bentsen, 203 F.2d 690, 691-692 (5th Cir. 1953), certiorari dismissed, 347 U.S. 925, 74 S.Ct. 528, 98 L.Ed. 1078; SEC v. Glenn W. Turner...

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