Oliver v. Bostetter

• Decision Date: 14 February 1977
• Docket Number: Civ. No. B-75-478.
• Parties: Julian L. OLIVER, Sr. and Julian L. Oliver, Jr. v. Martin V. B. BOSTETTER, Jr.
• Court: U.S. District Court — District of Maryland

426 F. Supp. 1082

Julian L. OLIVER, Sr. and Julian L. Oliver, Jr. v. Martin V. B. BOSTETTER, Jr.

Civ. No. B-75-478.

United States District Court, D. Maryland.

February 14, 1977.

Alan Richard Sachs, Baltimore, Md., for plaintiffs.

Paul N. Sameth, Baltimore, Md., for defendant.

MEMORANDUM AND ORDER

BLAIR, District Judge.

Plaintiffs in this action have filed a five count complaint alleging two violations of the federal securities acts and three claims for relief on state law grounds. The essential allegations are that the defendant fraudulently induced the plaintiffs into entering a contract for the sale of certain corporate stock by the plaintiffs to the defendant in settlement of an earlier lawsuit between the parties. Plaintiffs aver that the defendant never performed, never intended to perform, and never was financially capable of performing, his obligations under the contract.

The defendant has moved to dismiss, setting forth seven grounds for relief and, in the alternative, has moved for a more definite statement. Pursuant to Local Rule 6, this court finds a hearing unnecessary. This Memorandum and Order will treat each of the defendant's contentions in the order presented in his motion. In so doing, this court is mindful of the admonition in Conley v. Gibson, 355 U.S. 41, 45, 78 S.Ct. 99, 102, 2 L.Ed.2d 80 (1957), that:

a complaint should not be dismissed for failure to state a claim unless it appears beyond doubt that the plaintiff can prove no set of facts in support of his claim which would entitle him to relief.

I.

Count I of the complaint alleges a violation of Section 17 of the Securities Act of 1933, 15 U.S.C. § 77q.¹ The thrust of defendant's motion to dismiss this count is that Section 17 provides relief only to defrauded purchasers and plaintiffs are sellers. Plaintiffs dispute the contention that Section 17 applies only to purchasers, but argue primarily that they are in fact purchasers. They make this argument by observing that under the terms of the contract of sale the defendant was to pay for the plaintiffs' stock with a promissory note, promissory notes being securities within the meaning of the Act. Plaintiffs are, therefore, purchasers, with respect to this "security."

A.

There is ample authority for the proposition that promissory notes are securities within the purview of the Act. First, both the 1933 Act and the Securities Exchange Act of 1934 specifically define a security to include "any note." 15 U.S.C. §§ 77b(1) and 78c(a)(10). Although the 1934 Act definition goes on to exclude certain notes from its definition of security,² while the 1933 Act contains no such exclusion from its definition,³ the two definitions have come to be viewed by the courts as co-extensive. See Tcherepnin v. Knight, 389 U.S. 332, 335-36, 88 S.Ct. 548, 19 L.Ed.2d 564 (1967).

Despite the "any note" language the case law makes clear that not every note is a security. E.g., CNS Enterprises, Inc. v. G & G Enterprises, Inc., 508 F.2d 1354 (7th Cir.), cert. denied, 423 U.S. 825, 96 S.Ct. 38, 46 L.Ed.2d 40 (1975); McClure v. First National Bank, 497 F.2d 490 (5th Cir. 1974), cert. denied, 420 U.S. 930, 95 S.Ct. 1132, 43 L.Ed.2d 402 (1975). Accord, Zabriskie v. Lewis, 507 F.2d 546, 550 (10th Cir. 1974). The courts have predicated these decisions on a combination of what they consider to be the Congressional purpose in enacting the securities acts and the statutory preface to the definitional section, "unless the context otherwise requires."

The source of this line of decisions lies in lawsuits seeking to invoke federal jurisdiction over cases involving notes of all types including what the courts have characterized as notes issued in conjunction with ordinary commercial — as opposed to investment — transactions. The problem typically arises in fraud cases because fraud is easier to prove under the anti-fraud provisions of the securities acts than under the common law. Comment, Notes as Securities under the Securities Act of 1933 and the Securities Exchange Act of 1934, 36 Md.L.Rev. 233 (1976). Citing the Congressional purpose in enacting the acts as the protection of investors, and extrapolating therefrom, the courts have concluded that Congress did not intend to give the federal courts jurisdiction over every lawsuit involving a note. Garden-variety common law promissory notes, especially those issued by individuals in conjunction with consumer transactions are not within the purview of the acts. The courts have generally justified this denial of federal jurisdiction by citing the prefatory "unless the context otherwise requires" language of the statute.

The courts have also adopted a test for determining whether a particular note is within the purview of the Act. This test is the commercial-investment distinction already alluded to. Most of the circuits have adopted this test, e. g., CNS Enterprises, Inc. v. G & G Enterprises, Inc., supra (7th Cir.); Zabriskie v. Lewis, supra (10th Cir.); McClure v. First National, supra (5th Cir.); but the Fourth Circuit seems not yet to have considered the issue. It appears likely to this court that the Fourth Circuit, if given the opportunity, would adopt the commercial-investment dichotomy of the other circuits, in all likelihood tempered by the investment contract analysis enunciated in SEC v. W. J. Howey Co., 328 U.S. 293, 66 S.Ct. 1100, 90 L.Ed. 1244 (1946) and United Housing Foundation, Inc. v. Forman, 421 U.S. 837, 95 S.Ct. 2051, 44 L.Ed.2d 621 (1975), and advocated by the author of Comment, Notes as Securities, 36 Md.L. Rev., supra. Therefore, the court will analyze the present situation according to the commercial-investment distinction, utilizing the analysis suggested by United Housing.

Although the courts have uniformly applied the commercial-versus-investment test, they have been less than uniform in the standards they apply to meet the test. The courts frequently start with their notion of what a commercial note is and compare the note under scrutiny with that notion. A much better approach is suggested by the Supreme Court's opinion in United Housing Foundation v. Forman, supra. See Comment, Notes as Securities, 36 Md.L. Rev., supra. This approach would examine the note sub judice for its investment aspects. If the note meets the test set forth in SEC v. W. J. Howey, supra, for determining whether an investment contract is a security, then the note is a security; if it fails to meet the Howey test, it is not a security within the purview of the 1933 and 1934 Acts, and this basis of federal jurisdiction fails.

In Howey, the Supreme Court enunciated the test to be applied in determining whether a financial arrangement is an investment contract and hence a security within the securities acts:

The test is whether the scheme involves an investment of money in a common enterprise with profits to come solely from the efforts of others.

328 U.S. at 301, 66 S.Ct. at 1104. In United Housing, the Court faced the problem of whether the holders of "stock" in a co-operative housing project were holders of securities within the meaning of the 1933 and 1934 Acts, which defined "security" to include "any stock." The Court stated, inter alia:

The basic test for distinguishing the transaction from other commercial dealings is the Howey test. This test, in shorthand form, embodies the essential attributes that run through all of the Court's decisions defining a security. The touchstone is the presence of an investment in a common venture premised on a reasonable expectation of profits to be derived from the entrepreneurial or managerial efforts of others.

421 U.S. at 852, 95 S.Ct. at 2060. The Court expressly rejected the notion that just because the transaction involved was evidenced by shares called "stock" it must be within the statute under the "any stock" language. 421 U.S. at 848, 95 S.Ct. 2051. Citing its earlier decision in Tcherepnin v. Knight, supra, the Court observed (1) that the Securities Acts were promulgated to eliminate abuses in the previously unregulated securities market, (2) that the focus of the Acts is on (a) the capital markets of the free enterprise system — the sale of securities to raise capital for profit-making purposes — and (b) the prevention of fraud and the protection of investors, and held (3) that Congress intended the application of the Acts to turn on the "economic realities" of the underlying transactions.

Upon analyzing the economic realities in the case, the Court in United Housing held that the transaction was not within the purview of the Securities Acts. The shares purchased by the plaintiffs did not "represent any of the `countless and variable schemes devised by those who seek the use of the money of others on the promise of profits,' Howey, 328 U.S. at 299, 66 S.Ct. at 1103, and therefore did not fall within `the ordinary concept of a security.'"⁴ 421 U.S. at 848, 95 S.Ct. at 2058. Rather, the case before the Court was a consumer transaction, motivated by a "desire to use or consume the item purchased"; in such cases "the securities laws do not apply." 421 U.S. at 853, 95 S.Ct. at 2060. The co-op purchasers sought to obtain decent homes at attractive prices, an economic interest which characterizes every form of commercial dealing. "What distinguishes a security transaction — and what is absent here — is an investment where one parts with his money in the hope of receiving profits from the efforts of others, and not where he purchases a commodity for personal consumption or living quarters for personal use." 421 U.S. at 858, 95 S.Ct. 2063.

In reaching this conclusion, the Court in United Housing analyzed the facts according to the Howey test. The "investors" were attracted "solely by the prospect of acquiring a place to live, and not by financial returns on their investments." 421 U.S. at 853, 95 S.Ct. at 2061. Nor was "the prospect of profits resulting from the efforts of the promoters or third parties" the...