Capital Dist. Physician's Health Plan v. O'HIGGINS

• Decision Date: 11 September 1996
• Docket Number: No. 94-CV-61.,94-CV-61.
• Citation: 939 F. Supp. 992
• Parties: CAPITAL DISTRICT PHYSICIAN'S HEALTH PLAN, Plaintiff, v. Michael O'HIGGINS, d/b/a Michael O'Higgins & Co., and David Oberting, Defendants.
• Court: U.S. District Court — Northern District of New York

939 F. Supp. 992

CAPITAL DISTRICT PHYSICIAN'S HEALTH PLAN, Plaintiff, v. Michael O'HIGGINS, d/b/a Michael O'Higgins & Co., and David Oberting, Defendants.

No. 94-CV-61.

United States District Court, N.D. New York.

September 11, 1996.

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Iseman, Cunningham, Riester & Hyde, Albany, NY (Robert H. Iseman, of counsel), for plaintiff.

Thorn & Gershon, Albany, NY (Paul J. Catone, of counsel), for defendant.

MEMORANDUM-DECISION AND ORDER

MUNSON, Senior District Judge.

Now comes plaintiff Capital District Physician's Health Plan ("CDPHP") and defendant Michael O'Higgins ("O'Higgins") with cross-motions for summary judgment in a dispute involving a failed investment. Oral argument was heard at this court's motion term in Albany on October 31, 1995. What follows constitutes the court's memorandum-decision and order in this matter.

I. BACKGROUND

This case arises out of an investment management agreement between CDPHP and Michael O'Higgins. Plaintiff CDPHP is a health maintenance organization in the Albany area. Defendant O'Higgins is an investment adviser operating his own investment management company.

When CDPHP first began accumulating fund surpluses, it invested the excess reserves according to decisions made by members of its own staff. Collins Dep., Doc. 68, at 9. It invested primarily in short term (1-3 month), highly liquid investments in order to keep funds readily accessible for payment of claims. Id. at 11. In 1989, however, in the midst of falling interest rates, CDPHP's Finance Committee ("the Committee") discussed hiring an outside investment manager in order to maximize income while still securing capital. Id. at 16. After a preliminary search, the Committee selected three firms to give presentations. Id. at 19. Michael O'Higgins & Co. was one of the three firms. In his presentation, he let the Committee know that his investment style could often be described as contrarian; he would invest in securities based on assumptions that went against the prevailing conventional wisdom. Id. at 24-26. The Committee asked O'Higgins to prepare another model portfolio because of the riskiness of some of the investments in the first presentation. As a result, he presented a more conservative portfolio and was selected to receive half of CDPHP's long term surplus funds for investment. Id. at 39, 81-82. An Investment Management Agreement was signed by the parties on April 19, 1990. Am.Compl., Doc. 29, ¶ 10.

Soon thereafter, in October of 1990, the Committee sent O'Higgins a letter concerning a 30-year bond he had purchased. The bond was not in accordance with the Investment Policy promulgated by CDPHP in 1988. CDPHP Fin.Comm.Mins. ("FCM"), Oct. 19, 1990, at 5. The policy, in pertinent part, required investments (1) to have maturities of at most 10 years, (2) to be a fixed income security, and (3) to fall within one of seven types of securities (the only applicable category for the present action being "debt instruments of federal government agencies"). Ex. A att'd to Am.Compl., Doc. 29. O'Higgins was told that his definition of maturity did not comply with that of CDPHP and its investment policy and was instructed to divest CDPHP of the bond as soon as it became advantageous to do so. FCM, Oct. 19, 1990, at 5.

On January 26, 1993, O'Higgins purchased approximately $5.1 million in Planned Amortization Certificates-Interest Only ("PAC-IO"). Michael O'Higgins Dep., Doc. 67, at 127. PACs consist of a group of federally insured mortgages that are pooled together and then divided into different bonds that pay varying ratios of principal and interest. Interest-only PACs yield nearly all of their return (98% in this case) through interest payments. As a result, if mortgage holders decide to refinance (due to falling interest rates, for instance), the security stands to lose a substantial portion of its value. The market for the security is made by investment managers who trade them based on their assessments of the prepayment attrition rate forecasted by investment banks. The PAC-IOs are then bought and sold over the counter pursuant to individual price negotiations between dealers.

In defending his choice of that investment, O'Higgins explained that

I wanted to take a position against the bond market where I would profit from a decline in the bond market.... I mean that if the bond market declined in value, in other words, if interest rates rose, that I would make money, or my client would.

Id. at 127-28.

At the time, the prevailing consensus among most investors was that interest rates would remain stable or continue to decrease. As it turns out, interest rates did continue to fall. The investment's value declined to $4.1 million on February 2, 1993 and $3.8 million on March 18. FCM, Mar. 19, 1993, at 4.

CDPHP asked O'Higgins to appear before the Committee at its March 19, 1993 meeting. At that meeting, O'Higgins defended the selection of the PAC-IO investment and also outlined the possible future of the investment. If interest rates stayed low or continued to drop, even more money would be lost; if interest rates rose, interest income would resume and CDPHP could sell the security for a profit; and if market value did not return, interest payments still would continue. O'Higgins considered the first and last predictions unlikely. FCM, Mar. 19 1993, at 4. In answer to O'Higgins statement that he was considering buying more of the PAC-IOs, Diane Bergman, Director of CDPHP, told O'Higgins not to purchase any more of the security until the Committee determined that it was a legal investment for an HMO under New York insurance laws. Id.; Collins Dep., Doc. 68, at 58.

Later that evening, O'Higgins told Tom Collins, a member of the Finance Committee, that he would be resigning, and he did so officially on March 31, 1993. Id. at 59-60. After hiring First Albany Corporation to take over O'Higgins' CDPHP portfolio, one half of the PAC-IO was sold August 4 at a loss of $1.3 million and the other half was sold on September 1 at a loss of $1.1 million. Am.Compl., Doc. 29 ¶¶ 58-59. Suit was commenced on January 18, 1994.

Cross-motions for summary judgment have been made on the first and fourth causes of actions, those being the breach of contract and section 10(b)/rule 10b-5 claims, respectively. Defendant O'Higgins has moved for summary judgment on the seventh, eighth, and tenth causes of action, viz. the control person liability, vicarious liability, and negligence claims. Defendant David Oberting, O'Higgins employee and codefendant, has moved for summary judgment on the third and fifth causes of action, the breach of fiduciary duty and section 10(b)/rule 10b-5 violations claims, respectively. In addition, plaintiff has moved for summary judgment on the second and ninth causes of action, i.e. those for breach of fiduciary duty and for Investment Adviser Act violations, respectively. The court is now prepared to rule on these motions.

II. DISCUSSION

A. Standards

The standards for granting summary judgment pursuant to Fed.R.Civ.P. 56 are governed by a familiar triumvirate of 1986 Supreme Court cases. The movant bears the initial burden of persuading the court that the record demonstrates "the absence of a genuine issue of material fact." Celotex Corp. v. Catrett, 477 U.S. 317, 323, 106 S.Ct. 2548, 2553, 91 L.Ed.2d 265 (1986). Genuine issues exist if "there is sufficient evidence favoring the nonmoving party for a jury to return a verdict for that party." Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 249, 106 S.Ct. 2505, 2511, 91 L.Ed.2d 202 (1986). Once a movant has carried her initial burden, the respondent "must do something more than simply show that there is some metaphysical doubt as to the material facts." Matsushita Elec. Indus. Co. v. Zenith Radio, 475 U.S. 574, 586, 106 S.Ct. 1348, 1356, 89 L.Ed.2d 538 (1986). In evaluating a summary judgment motion, the court must view the facts in the light most sympathetic to the nonmovant. Matsushita, 475 U.S. at 587, 106 S.Ct. at 1356 (quotation omitted). The district judge's inquiry is whether a triable issue exists with respect to the claim being moved upon — that is, whether there is enough of a material dispute over key facts that the finder of fact could reasonably decide either way. See Anderson, 477 U.S. at 250, 106 S.Ct. at 2511.

Analysis commences below, beginning with CDPHP's theory under the Investment Advisers Act.

B. Rescission of Contract for Violation of Brochure Rule

The court first turns to a discussion of plaintiff's motion for summary judgment upon its ninth cause of action. See Am. Compl., Doc. 29, ¶ 115-18. Plaintiff argues that it is entitled to rescission of the investment advisory contract and the return of fees paid to defendant O'Higgins because he failed to comply with certain rules promulgated by the Securities and Exchange Commission pursuant to its authority under the Investment Advisers Act of 1940. Pl.'s Mem. Law, Doc. 62, at 46-49.

The Investment Advisers Act, ch. 686, tit. II, 54 Stat. 847 (codified as amended at 15 U.S.C. § 80b-1 et seq.) regulates that profession, imposing registration and disclosure requirements upon advisers, and empowering the SEC to sanction those who violate the Act's provisions. See generally 2 Thomas Lee Hazen, The Law of Securities Regulation ch. 18 (2d ed.1986). To help effectuate and clarify the Act, the SEC is expressly tasked to develop rules to supplement it. See, e.g., 15 U.S.C. §§ 80b-3, 80b-6(4), & 80b-11. The SEC's authority to enforce these rules is concomitant with its authority to police the Act's statutory requirements. Id. § 80b-9.

Plaintiff alleges defendant has failed to comply with one such regulation known as the "brochure rule." 17 C.F.R. § 275.204-3. The brochure rule requires an investment adviser to "furnish each advisory client and prospective advisory client with a written disclosure statement which may be either a copy of Part...