Developer's Mortg. Co. v. Transohio Sav. Bank

Decision Date14 February 1989
Docket NumberNo. C-2-88-0034.,C-2-88-0034.
Citation706 F. Supp. 570
PartiesDEVELOPER'S MORTGAGE COMPANY, Plaintiff, v. TRANSOHIO SAVINGS BANK, Defendant.
CourtU.S. District Court — Southern District of Ohio

COPYRIGHT MATERIAL OMITTED

Edward V. Miller, Columbus, Ohio, for plaintiff.

S. Ronald Cook, Jr., Porter, Wright, Morris & Arthur, Columbus, Ohio, for defendant.

OPINION AND ORDER

KINNEARY, District Judge.

This matter comes before the Court to consider the motion of the defendant, TransOhio Savings Bank ("TransOhio"), for dismissal for failure to state claims upon which relief can be granted, Fed.R. Civ.P. 12(b)(6). The plaintiff, Developer's Mortgage Co. ("DMC"), alleges that the defendant violated sections 12(2)1 and 17(a)2 of the Securities Act of 1933, Rule 10b-5 under the Securities Exchange Act of 1934,3 and the Racketeer Influenced and Corrupt Organizations Act ("RICO").4 In addition, the plaintiff set out a number of state law claims.5

These violations allegedly occurred when the defendant's predecessor sold the plaintiff a participation in a loan that it had made to Jack and Geraldine Sowles ("Sowles") for the purpose of purchasing land in Houston and of constructing twenty buildings on the land pursuant to a project known as Harlequin Square ("the Project"). That is, DMC paid the defendant a percentage of the value of the loan in exchange for the right to receive a portion of the payments from Sowles in proportion to the percentage DMC paid. The defendant's predecessor, Dollar Savings Bank, merged with TransOhio at a time after it had signed the Loan Participation Sale and Trust Agreement ("Sale and Trust Agreement") with the plaintiff.6

The Sale and Trust Agreement simply provides for the sale of "participating ownership interests" in loans to be named in attached "Participation Certificates." In the DMC-TransOhio Sale and Trust Agreement, the parties incorporated only one Participation Certificate, the one which pertained to the Sowles loan. Through the Sale and Trust Agreement and the Participation Certificate, then, TransOhio transferred to DMC a participation in the Sowles loan.

The plaintiff now disputes the particulars of the procedures to be followed pursuant to the parties' agreement in the event Sowles defaulted. According to the Complaint, the defendant represented during negotiations that it had arranged for a Stand-By Permanent Take Out Loan ("Take-Out Loan") for Sowles. The Take-Out Loan would permit Sowles to pay the plaintiff any of the remaining balance due to it if Sowles could not "market the project." See Complaint at 2-4. The plaintiff claims that the Take-Out Loan did not adequately protect its interests and that the defendant had no intention to invoke the Take-Out Loan's protection on behalf of the plaintiff. It lists a number of misrepresentations in connection with the deal and with the Take-Out Loan. After the Project turned sour and the defendant refused to liquidate, the plaintiff filed this suit.

The defendant now moves for dismissal for three reasons. First, the defendant claims that the plaintiff's participating ownership interest in the loan was not a "security" within the meaning of the Securities Act of 1933 ("the '33 Act") and the Securities Exchange Act of 1934 ("the '34 Act"). Therefore, it contends that Counts II and III fail to state a claim upon which relief can be granted under sections 12(2) and 17(a) of the '33 Act and Rule 10b-5 under the '34 Act. Second, the defendant argues that Counts XIII and XIV fail to state a claim under RICO since the plaintiff failed to allege a "pattern of racketeering activity," a requirement under RICO. Finally, the defendant asserts that the Court should dismiss the remaining Counts, since they are based solely on state law. With no independent basis for federal jurisdiction, the defendant urges the Court to refrain from invoking pendent jurisdiction.

In its reply brief, the plaintiff claims that the Sale and Trust Agreement and the Participation Certificate representing DMC's participation ownership interest in the Sowles loan were indeed "securities" which were involved in this transaction. It did not mention the participation ownership interest itself, although the Complaint mentions only the participation as the alleged "security." The Court will consider the possibility of whether any of these three items were "securities."

Moreover, the plaintiff contends that it does allege a "pattern of racketeering activity" by setting forth claims of multiple criminal episodes of fraud; TransOhio allegedly defrauded Hollywood Federal Savings and Loan Association as well as DMC. Finally, the plaintiff urges the Court to invoke pendent jurisdiction, since it posits that it successfully alleges claims under the securities laws and RICO, independent bases for federal jurisdiction.

The Court will address each of the issues raised by the defendant in turn: (1) whether Complaint successfully alleges that the transaction involved a "security" within the meaning of the securities laws; (2) whether the Complaint alleges a pattern of racketeering activity to satisfy RICO; and (3) whether the Court should exercise pendent jurisdiction over the plaintiff's state claims.

I. DEFINING A "SECURITY"

In order to prove a violation of the securities laws, the plaintiff must show that a "security" was involved; and in order to ascertain whether the transaction involved a "security," the Court must turn first to the language of the relevant statutes, International Bhd. of Teamsters v. Daniel, 439 U.S. 551, 558, 99 S.Ct. 790, 795, 58 L.Ed.2d 808 (1979).

Under section 2(1) of the '33 Act, the definition of a security is quite broad. 15 U.S.C. § 77b(1) (1982).7 The statute states that the definition of "security" encompasses "any note ... or any ... participation in" a note. Id. The broad definition of "security" in section 3(a)(10) of the '34 Act contains the same language. 15 U.S.C. § 78c(a)(10) (1982).8 In fact, the definitions of "security" in the two acts are "virtually identical," Tcherepnin v. Knight, 389 U.S. 332, 336, 88 S.Ct. 548, 553, 19 L.Ed.2d 564 (1967); and the Court will read both statutes to define "security" in the same way, see, e.g., 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. Analysis of the Statutory Language

In order to support the claim that the Sale and Trust Agreement and the Participation Certificate are "securities," the plaintiff relies on the statutory language. Since the statutes include "any note ... or any ... participation in" a note, the plaintiff argues that the two documents are, "ipso facto," "securities." For support, the plaintiff reads Landreth Timber Co. v. Landreth, 471 U.S. 681, 105 S.Ct. 2297, 85 L.Ed.2d 692 (1985), to hold that if the name of the instrument is contained in the statutes' list of kinds of securities, then the instrument must be a "security."

This argument fails for two reasons. First, the language "any note ... or any ... participation" encompasses only the participation itself, not the documents which transfer the participating ownership interest from a purchaser to a seller: in this case, the Sale and Trust Agreement and the Participation Certificate.9 Therefore, this language does not, by itself, bring these two instruments within the definition of a "security."

Second, the plaintiff misread Landreth. The Landreth Court noted that the fact that the instruments in question might bear a label included in the statutory list does not make them "securities" per se. See id. at 686, 105 S.Ct. at 2301.10 Instead, this Court must determine whether the instruments in question "possess `some of the significant characteristics typically associated with'" those instruments of the same name which are, in fact, "securities." Id. After all, the parties to a transaction could name an instrument anything, such as "stock" or some other label traditionally associated with securities, whether or not such a label corresponds with the true characteristics of the instrument.11See United Housing Found., Inc. v. Forman, 421 U.S. 837, 95 S.Ct. 2051, 44 L.Ed.2d 621 (1975). Accordingly, the name which the parties bestow upon an obligation is not dispositive of its possible status as a "security."12

Moreover, both the '33 and '34 Acts provide that the definitions are to apply only if the context does not otherwise require a different definition, 15 U.S.C. §§ 77b(1), 78c(a)(10) (1982). Union Planters Nat'l Bank v. Commercial Credit Business Loans, Inc., 651 F.2d 1174, 1180 (6th Cir.), cert. denied, 454 U.S. 1124, 102 S.Ct. 972, 71 L.Ed.2d 111 (1981). The Court must read the definitions of "security" in light of the purpose of the legislation and the context. Id.; see Landreth, 471 U.S. at 687, 105 S.Ct. at 2302; American Bank & Trust Co. v. Wallace, 702 F.2d 93, 94 (6th Cir.1983).

In sum, then, the Court cannot conclude that the loan participating ownership interest in the Sowles loan was a "security," solely by virtue of the language in the statutes referring to participations in notes. Nor is it possible to include as "securities" the documents which transfer the participations on the same basis. The label given to the instrument is simply not dispositive of its status as a "security."

B. Case Law Tests for the Presence of "Securities"

Having rejected the notion that the title given to the instruments involved controls the determination of whether an obligation is a "security," the Court must conclude that the plain language of the statutes is insufficient to reveal whether or not the instruments and obligation involved were "securities." With scant legislative history on point for guidance, the Court must turn to judicial interpretations of the statutes. Certain tests propounded in the case law provide useful approaches to resolving the issue.

Two tests have arisen as means for determining whether an instrument is a "security." First, some cases hold...

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  • In re Leslie Fay Companies, Inc.
    • United States
    • U.S. Bankruptcy Court — Southern District of New York
    • 22 Abril 1994
    ...sweeping and unwarranted averments of fact, such as the label given to this transfer. See e.g., Developer's Morg. Co. v. TransOhio Sav. Bank, 706 F.Supp. 570, 573 (S.D.Ohio 1989) ("label given to the instrument is simply not dispositive of its status as a security"); Wayne H. Coloney Co. v.......
  • Miller v. Consolidated Aluminum Corp., C-2-84-1056.
    • United States
    • U.S. District Court — Southern District of Ohio
    • 31 Enero 1990
    ...parties are excluded), cert. denied, 484 U.S. 986, 108 S.Ct. 503, 98 L.Ed.2d 502 (1987); see also Developer's Mortgage Co. v. TransOhio Sav. Bank, 706 F.Supp. 570, 579 n. 25 (S.D.Ohio 1989) (quoting 2A N. Singer, Statutes and Statutory Construction § 47.23, at 194 (C.D. Sands ed. 1984) ("en......

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