Davis v. Avco Corporation

• Citation: 371 F. Supp. 782
• Decision Date: 11 January 1974
• Docket Number: No. C 73-226.,C 73-226.
• Parties: Clevester DAVIS et al., Plaintiffs, v. AVCO CORPORATION et al., Defendants.
• Court: U.S. District Court — Northern District of Ohio

371 F. Supp. 782

Clevester DAVIS et al., Plaintiffs, v. AVCO CORPORATION et al., Defendants.

No. C 73-226.

United States District Court, N. D. Ohio, W. D.

January 11, 1974.

COPYRIGHT MATERIAL OMITTED

Russell A. Kelm, Advocates for Basic Legal Equality, Matt J. Kehoe, Toledo, Ohio, for plaintiffs.

Andrew E. Anderson, Spengler, Nathanson, Heyman, McCarthy & Durfee, Toledo, Ohio, for defendants.

MEMORANDUM AND ORDER

WALINSKI, District Judge.

This cause is before the Court on defendants' motions to dismiss the complaint for lack of subject matter jurisdiction and for failure to state a claim on which relief can be granted, and to dismiss the class action aspects of the complaint. Plaintiff has filed a motion for conditional certification as a class action and opposition to defendants' various motions. Plaintiff has also filed copious briefs in support of his contentions. The Court will first consider the motion to dismiss, for a favorable ruling thereon would obviate the need to consider the motion for conditional certification.

I. The Factual Allegations

The complaint, as yet unanswered, is a class action for damages, and injunctive and declaratory relief, brought under the Securities Act of 1933, 15 U.S.C. § 77a et seq., and the Securities Exchange Act of 1934, 15 U.S.C., § 78a et seq. Jurisdiction of this Court is invoked pursuant to 15 U.S.C., §§ 77l, 77v and 78aa.

Plaintiff begins by alleging¹ that in early 1971, he became the subject of repeated solicitations to participate in a "great investment opportunity" known as Dare To Be Great hereinafter DBG by investing $5,000 in what was called the "Adventure 4" level. Without going into plaintiff's allegations in great detail, suffice it to say that the solicitation efforts of DBG followed the pattern described by the Court in SEC v. Glenn W. Turner Enterprises, Inc., 474 F.2d 476, 479-480 (9th Cir. 1973), and in Note, Dare To Be Great, Inc!: A Case Study of Pyramid Sales Plan Regulation, 33 Ohio St.L.J. 676, 677-86 (1972). Plaintiff attended meetings which were conducted with a revivalistic fervor and held out the promise of great wealth if one would but participate in the DBG program at one of the various, and increasingly expensive, levels of participation. Plaintiff, and the members of the class he represents, were subjected to almost unrelenting pressure to participate in the scheme by DBG and its agents.

Actually, the DBG scheme was a pyramid operation, accompanied by hard-sell tactics, whose motivational, self-improvement course was of only nominal worth. The only possible value which was purchased by the unwitting participant was the right to sell the scheme to others, and this value was dubious because of the saturation and pyramiding inherent in the scheme.

Defendants were involved in this operation in several important aspects. The first mention of Avco Financial Services occurred at a "Success Adventure" meeting in Toledo during May, 1971, when the state director of DBG advised the prospective participants to contact Avco Financial Services in Toledo if they wished to finance the amount needed to participate. It then appears that after a period of daily pressure by DBG to sign up, the plaintiff was urged to contact defendant McCormick, the manager of one of defendant Avco Corporation's offices in Toledo, for the purpose of discussing financing. Unknown to plaintiff, DBG had already arranged in advance with Avco for plaintiff to take out a loan with Avco. Subsequently, plaintiff called McCormick and agreed to come in to see him.

At the meeting with McCormick (and an agent of DBG) in Avco's office, plaintiff expressed doubts concerning DBG. McCormick then assured plaintiff that DBG:

"* * * was a good investment, that McCormick had thoroughly investigated DBG, that McCormick had been to Success Adventure meetings in Toledo and on a `go-tour' to Indianapolis, that by the time the first payment was due to AVCO on the loan, plaintiff would have made enough money from DBG sale's commissions to pay off the entire loan, that plaintiff would make money from this investment, and that if plaintiff sold DBG to others who needed financing, AVCO would finance such subsequent purchasers."

The complaint further alleges that Avco and its agents and employees made similar statements and representations to all members of the class, and that these statements were false and misleading and designed to induce reliance by plaintiffs who did, in fact, rely on these representations. Thus, plaintiff was induced to sign a loan agreement with Avco Financial Services for $2,672.78, and to issue his own promissory note, styled a security, which was purchased "and underwritten" by Avco. The proceeds of the loan were then used by plaintiff:

"* * * to purchase for $2,000 a security underwritten by defendants, commonly known as Dare To Be Great Adventure 3, from DBG's agent."

In this manner, the defendants herein, and DBG is not a party, participated directly and indirectly in the financing and distribution of DBG as a security; and Avco Corporation and DBG conspired for DBG to issue, and Avco Corporation to underwrite and finance, DBG as a security.

Finally, Avco failed to advise plaintiffs of the potential infirmities of the saturation and pyramiding of DBG, or of the true financial position of DBG (and of Glenn W. Turner Enterprises). Avco either knew or should have known that the statements of McCormick were false, misleading, and failed to state material facts; and these statements were part of a scheme and course of business to defraud plaintiffs. Defendants also knew that the contracts and security agreements executed by plaintiffs violated federal securities laws and were thus void.

II. The Motion To Dismiss

Defendants assert two grounds for dismissing the complaint herein:

a) The promissory notes issued by the plaintiffs do not constitute securities within the meaning of § 2(1) of the Securities Act of 1933, or § 3(a)(10) of the Securities Exchange Act of 1934, and therefore this Court lacks subject matter jurisdiction.

b) The complaint fails to state a claim on which relief can be granted because defendants are not "underwriters" or "dealers" as defined by the acts.

a) Subject Matter Jurisdiction

It is clear that this contention turns solely on whether plaintiffs' promissory notes constitute "securities" as defined by § 2(1) and § 3(a)(10). Section 2(1) states that "security" means "* * * any note, stock, treasury stock, bond, debenture, evidence of indebtedness * * *." 15 U.S.C., § 77b(1). Emphasis added. Section 3(a)(10) contains virtually the same language except that the words "evidence of indebtedness" are omitted. 15 U.S.C., § 78c(a) (10).

It can be seen that the literal definitions begin with the word "note." Plaintiff thus argues that the words "any note" mean exactly that — any note — and that this Court should adopt a literal interpretation of those definitional sections. Defendants argue that while notes are literally covered by the acts, the Congress intended, and the courts have usually required, some showing of the commercial setting in which the alleged transactions took place, and that these notes could not possibly be securities in view of the purely consumer financing nature of the transactions which are the subject matter of the complaint. Therefore, they argue, since the notes are not securities, nothing herein is covered by the federal securities laws, and thus this Court is without subject matter jurisdiction.

The Court is mindful that the federal securities laws are remedial in nature and thus should be broadly construed so as to effectuate their purposes. Tcherepnin v. Knight, 389 U.S. 332, 336, 88 S.Ct. 548, 19 L.Ed.2d 564 (1967). It should also be noted that past decisions have indeed indicated the need to take into account the economic realities of the transactions which are the subject of the case in identifying a security. See e. g., SEC v. W. J. Howey Co., 328 U.S. 293, 298, 66 S.Ct. 1100, 90 L.Ed. 1244 (1946).

"The test * * * is what character the instrument is given in commerce by the terms of the offer, the plan of distribution, and the economic inducements held out to the prospect." SEC v. Joiner Corp., 320 U.S. 344, 352-353, 64 S.Ct. 120, 124, 88 L.Ed. 88 (1943).

However, Howey involved the definition of "investment contract", Joiner involved oil leases, and Tcherepnin involved withdrawable capital shares in a Savings and Loan Association, none of which fit within the literal meaning of notes, stocks or bonds, which are the commonest forms of securities. The use of the economic realities test when the device fits within one of the literal definitions is not so clear.

Professor Coffey takes the position that the more desirable approach is to give the economic realities test "primacy over literal coverage." Coffey, The Economic Realities of a "Security": Is There a More Meaningful Formula?, 18 Western Reserve L.Rev. 367, 407 (1967). The reason for this primacy is that:

"If * * * courts also adopt a practice of liberally defining the terms `stock,' `bond,' `note,' or `evidence of indebtedness,' any examination of `economic realities' might well be foreclosed with respect to the majority of alleged `security' transactions." Id. at 406.

The danger of such a foreclosure of examination is said to be that it inevitably leads to curious results which the drafters of securities fraud statutes did not envision. See, e. g., Strauss v. State, 113 Ga.App. 90, 147 S.E.2d 367 (1966). Money order held to be security.

This Court is persuaded by Professor Coffey's proposition that the term "security" be viewed as:

"* * * a transaction whose characteristics distinguish it from the generality of transactions so as to create a need for the special fraud procedures, protections, and remedies provided by the securities laws." Coffey, loc. cit. supra, at 373.

Thus, as applied to this case, the promissory notes herein are securities...