Portell v. Zayed

• Decision Date: 21 March 2019
• Docket Number: No. 18-CV-05414,18-CV-05414
• Parties: Theresa L. PORTELL, individually and on behalf of the class members described below, Plaintiffs, v. Nadim Khalil ZAYED a/k/a Dean Zayed, Brookstone Capital Management LLC, and Kaizen Advisory, LLC, Defendants.
• Court: U.S. District Court — Northern District of Illinois

375 F.Supp.3d 1025

Theresa L. PORTELL, individually and on behalf of the class members described below, Plaintiffs,

v.Nadim Khalil ZAYED a/k/a Dean Zayed, Brookstone Capital Management LLC, and Kaizen Advisory, LLC, Defendants.

No. 18-CV-05414

United States District Court, N.D. Illinois, Eastern Division.

Signed March 21, 2019

Alexander Nicholas Loftus, Ryan Frederick Moore, Stoltmann Law Offices, P.C. Commercial Litigation Group, Chicago, IL, Jared Matthew Schneider, John Sheridan Burke, Higgins & Burke PC, St. Charles, IL, for Plaintiffs.

Steven Marc Malina, Symone Danielle Shinton, Todd Edward Pentecost, Greenberg Traurig, LLP, Chicago, IL, for Defendants Nadim Khalil Zayed, Brookstone Capital Management LLC.

Thomas P. Cimino, Jr., Junaid A. Zubairi, Rebecca Lynn Dandy, Joshua David Nichols, Vedder Price PC, Chicago, IL, for Defendant Kaizen Advisory, LLC.

MEMORANDUM OPINION AND ORDER

John J. Tharp, Jr., United States District Judge

A group of self-described mom and pop investors brought a class action complaint in DuPage County Circuit Court against the defendants for breach of fiduciary duty in connection with investments in a mutual fund called "KZSIX." The complaint alleges that the defendants failed to disclose their conflicts of interest relating to the fund, misrepresented KZSIX's susceptibility to market downturns, and transferred the plaintiffs' investments into KZSIX without the investors' affirmative and informed consent to do so. As a result of being invested in KZSIX, the investors allegedly lost millions of dollars and incurred fees that were far greater than industry norms. The defendants removed the case to this Court, contending that the Securities Litigation Uniform Standards Act ("SLUSA") requires both removal and dismissal of the lawsuit. Eight of the nine plaintiffs voluntarily dismissed their claims without prejudice. Notice of Voluntary Dismissal, ECF No. 22. The remaining plaintiff, Theresa Portell, moved to remand, arguing that the lawsuit is based upon the mismanagement of an existing investment, not, as would be required for SLUSA preclusion, any material misrepresentation that induced investors to purchase, sell, or hold a security. Because the alleged misrepresentations and omissions of material facts are a linchpin of this suit and were made in connection with the purchase of the KZSIX shares, this case falls squarely within the ambit of SLUSA preclusion. Portell's motion to remand, ECF No. 17, is therefore denied and the defendants are granted leave to refile their motion to dismiss, as to which the Court deferred consideration pending resolution of the remand motion.

BACKGROUND

Portell invested funds with defendant Brookstone Capital Management, LLC ("BCM"), of which defendant Nadim Khalil "Dean" Zayed serves as president and CEO. Portell contends that BCM and Zayed owed her a duty to, among other things, "provide full and fair disclosure of all material facts" and "[d]isclose all conflicts of interest that might incline them, consciously or unconsciously, to render advice that is not disinterested." Notice of Removal Under 28 U.S.C. §§ 1441 and 1446 Pursuant to the Securities Litigation Uniform Standards Act, Ex. A, Class Action Complaint ("Compl.") ¶¶ 33–35, ECF No. 1-1.

Before August 10, 2015, Portell's funds were invested in BCM's ZEGA High-Probability Options Strategy ("HiPOS"). In 2014, Zayed formed defendant Kaizen Advisory ("Kaizen") and created a mutual fund called the "Kaizen Hedged Premium Spreads Fund" ("KZSIX"). Zayed owns at least 95% of Kaizen and is the sole beneficial owner of BCM. At all relevant times to this lawsuit Zayed was the "beneficial controlling person" of both BCM and Kaizen. Id. ¶ 42. KZSIX generally followed the same investment objective as HiPOS, except BCM claimed that KZSIX was a lower risk investment because it employed an additional hedging strategy intended to offset losses during market declines. In a July 2015 letter, BCM announced to its clients that Zayed and BCM would transfer some client investments from HiPOS to KZSIX unless the clients affirmatively opted out of the transaction. Defs.' Joint Resp. in Opp'n to Pls.' Mot. to Remand ("Defs.' Resp."), Ex. A, Form Letter from BCM to Clients dated July 10, 2015 ("July Letter") 1, ECF No. 26-1 ("If you accept this change there is nothing that you need to do as the account will automatically move to the KZSIX fund. Should you not want this change, please contact your Investment Advisor Representative to discuss other investment options.").¹ The following month, Zayed transferred Portell's funds from HiPOS to KZSIX.

Portell alleges that the defendants "promoted" the KZSIX fund to its HiPOS clients, Compl. ¶ 76, and transferred client assets into the fund to enrich themselves rather than their clients. More specifically, the complaint alleges that BCM (and by extension Zayed) incurred trading expenses under HiPOS, but the structure of the KZSIX investment allowed them to push those expenses onto the fund investors. Investing in the KZSIX fund also allowed Zayed to obtain additional fees from fund investors because he was able to "double-dip" by obtaining fees from both BCM and Kaizen due to his ownership of both entities. Id. ¶¶ 71–73, 82–84. It also allowed the defendants to use the plaintiffs as unknowing "guinea pigs" to test the viability of the KZSIX strategy before marketing it to new potential clients. Id. ¶ 110. And the test didn't go well. The complaint alleges that "KZSIX was dramatically more susceptible to the volatility experienced by the broader markets than BCM represented it to be." Id. ¶ 101.

The defendants allegedly failed to disclose these conflicts arising from Zayed's ownership of both BCM and Kaizen to Portell and the other HiPOS investors before executing the KZSIX transactions. And investors who bought shares of KZSIX, she maintains, "could not have discovered the conflicts of interest of BCM, Kaizen Advisory, and Zayed inherent in their KZSIX transactions through a reasonable inquiry or inspection."Id. ¶¶ 112, 124, 135. The complaint alleges that Zayed and BCM breached the fiduciary duties they owed to their HiPOS investors by "concealing [their] conflicts of interest from Plaintiffs at all times" and "[f]ailing to receive affirmative informed consent from Plaintiffs and the Class to waive" those conflicts. Id. ¶¶ 110, 122. Kaizen allegedly aided and abetted the breach by providing Zayed with an entity through which to engage in self-dealing.

The complaint defines the proposed class to include "[a]ll persons who were investment advisory clients of [BCM] at some point from August 1, 2015 until August 20, 2015; were invested in [HiPOS] prior to August 3, 2015; and held shares in [KZSIX] as of August 20, 2015." Id. ¶ 18. The defendants removed this case from DuPage County Circuit Court pursuant to the Securities Litigation Uniform Standards Act, 15 U.S.C. §§ 77p and 78bb. Portell moved to remand, arguing that the Complaint alleges only state-law breach of fiduciary duty and aiding-abetting claims. For their part, the defendants maintain that removal was proper and that SLUSA requires dismissal of the complaint.

DISCUSSION

I. SLUSA Preclusion

The Securities Litigation Uniform Standards Act ("SLUSA") requires that covered class actions based upon state law that allege fraudulent conduct in connection with the purchase or sale of a covered security be removed from state to federal court and dismissed. 15 U.S.C. § 77p(b) – (c) ; see also 15 U.S.C. § 77bb(f)(1)-(2). In 1995, Congress passed the Private Securities Litigation Reform Act ("PSLRA"), 15 U.S.C. §§ 77z-1 and 78u-4, which imposed heightened pleading requirements in securities fraud actions. See 15 U.S.C. § 78u-4(b). Congress then enacted SLUSA to authorize removal (and require dismissal) of covered class actions alleging securities fraud filed in state court in order to "prevent plaintiffs from migrating to state court in order to evade rules for federal securities litigation in [the PSLRA]." Brown v. Calamos , 664 F.3d 123, 124 (7th Cir. 2011) (citation omitted).

SLUSA provides:

No covered class action based upon the statutory or common law of any State or subdivision thereof may be maintained in any State or Federal court by any private party alleging—

(1) an untrue statement or omission of a material fact in connection with the purchase or sale of a covered security; or

(2) that the defendant used or employed any manipulative or deceptive device or contrivance in connection with the purchase or sale of a covered security.

15 U.S.C. § 77p(b) ; see also 15 U.S.C. § 78bb(f)(1). Subsection (c) further provides:

Any covered class action brought in any State court involving a covered security, as set forth in subsection (b), shall be removable to the Federal district court for the district in which the action is pending, and shall be subject to subsection (b).

15 U.S.C. § 77p(c) ; see also 15 U.S.C. § 78bb(f)(2). Portell does not dispute that her lawsuit qualifies as a "covered class action," that her claims are based upon state law, or that the securities at issue qualify as "covered" securities. See Pls.' Mem. in Supp. of Mot. for Remand ("Mem.") 6, ECF No. 18. The question for the Court's consideration is therefore limited to whether the complaint alleges "an untrue statement or omission of a material fact in connection with the purchase or sale of a covered security." 15 U.S.C. § 77p(b)(1) ; see also 15 U.S.C. § 78bb(f)(1)(A).² If the answer is yes, SLUSA requires both removal and dismissal of the lawsuit. If the answer is no, then Portell's motion to remand must be granted because the Court would not have jurisdiction over Portell's state law breach of fiduciary duty claims.³

SLUSA "is designed to prevent persons injured by securities transactions from engaging in artful pleading or forum shopping in order to evade limits on securities litigation that are designed to block frivolous or abusive suits." Holtz v. JPMorgan Chase...