Securities Attorneys Get Additional Guidance On Pleading What Constitutes A Domestic Transaction In Other Securities

In 2010 the Supreme Court muddied the waters of the Securities Exchange Act of 1934, declaring it did not apply extraterritorially, after all, and rejecting the until then used test of “conduct and effects.” Now, securities attorneys have been given additional guidance about how to make adequate allegations in their complaint to pass the new test created by the Supreme Court to pass muster under Rule 12(b)(6), when making claims under Section 10(b) or Rule 10b-5.  

In Morrison v. National Australia Bank Ltd., 130 S.Ct. 2869 (2010), the Supreme Court held that Section 10(b) and Rule 10b-5 of the Exchange Act only applies to “transactions in securities listed on domestic exchanges and domestic transactions in other securities.” While the Court, in that case, was able to analyze the facts under the first test, regarding securities listed on domestic exchanges, it did not address the second test, and it remained significantly ambiguous what constituted a “domestic transaction in other securities,” after Morrison.

Therefore, it came as a relief to get additional guidance about this second test from the Second Circuit in the recent case of Absolute Activist ValueMaster Fund Ltd. v. Ficeto, decided on March 1, 2012.  In that case the plaintiffs were nine Cayman Island hedge funds who sued the defendant, their investment manager, Absolute Capital Management Holdings Limited, and several of its officers and employees (several of whom were not U.S. citizens nor located in the U.S.), basically alleging a pump and dump scheme resulting in losses of over $195 million. The plaintiffs purchased securities issued by U.S. companies however, and the deals were brokered through a U.S. broker dealer.

The case came before the Second Circuit who considered the issue of whether the allegations in the complaint were sufficient to allege a “domestic transaction in other securities,” to survive scrutiny under Federal Rule of Civil Procedure 12(b)(6). When considering these allegations the court provided very helpful guidance in determining what factors are, and are not, relevant in passing this test to see if Section 10(b) and Rule 10b-5 are applicable to the transactions.

The Second Circuit held that to sufficiently allege the existence of a “domestic transaction in other securities” the plaintiff must allege facts leading to the plausible inference that either irrevocable liability was incurred or title transferred within the United States. The court explained that the parties “incur irrevocable liability” basically when the contract is formed between the parties. The point of irrevocable liability can be used to determine the locus of a securities purchase or sale. Facts that can be alleged which make this plausible inference could include, but are not limited to, facts concerning the formation of the contracts, the placement of purchase orders, the passing of title, or the exchange of money.

The Second Circuit was also clear about what types of allegations would not be sufficient to constitute a domestic transaction in other securities. For example, the conclusory allegation that the transaction took place in the United States is insufficient. Further, the focus should be upon the locus of the purchases and sales of the securities, and not on the place where the alleged deception originated which constituted the securities fraud. Therefore, in making allegations, although these things may be relevant, they will not be conclusory: the identity of the parties, the type of security at issue, or whether each individual defendant engaged in conduct with in the United States.

The additional clarification by the Second Circuit in Ficeto will be of great help to securities attorneys who represent clients who have purchased or sold securities which are not listed on domestic exchanges. In such instances focusing on the locus of where the contract was formed, or title passed, can help determine whether the Exchange Act applies to the transaction, or not.

An Interesting Twist Where Broker-Dealer Seeks To Enjoin Customer From Arbitration In FINRA And Is Denied By The Second Circuit

An interesting case that securities arbitration attorneys should find ironic. In the case of UBS Financial Services, Inc. v. West Virginia University Hospitals, Inc., decided on September 22, 2011, the Second Circuit upheld the decision of the district court to dismiss a motion to enjoin arbitration in FINRA filed by a FINRA member, UBS, against its customer.

Although the more typical case involves a customer filing a securities fraud action in court, and having the defendant move to enforce an arbitration agreement, and remove the case to FINRA, in this recent case the tables were turned. Instead, it was the customer, West Virginia University Hospitals (WVUH) who wanted to bring an action against UBS in FINRA arbitration, and UBS fought tooth and nail to try to get it thrown out of arbitration and into court.

The case deals with auction rate securities (ARS), which UBS persuaded WVUH to use as the vehicle for a large financing project, where UBS would serve as both the underwriter and the broker-dealer in the auction services. Unknown to WVUH, UBS, as the broker-dealer, would place additional bids on all its auctions to make sure they did not fail, which concealed the true risks of liquidity of this made-up market which collapsed in February 2008 during the financial crisis. This collapse caused WVUH to have to pay much higher interests rates on the debt until it could refinance several months later.

Therefore, WVUH filed an arbitration Statement of Claim against UBS, alleging that UBS had violated the Securities Exchange Act of 1934 and the Uniform Securities Act by advising WVUH to issue ARS while withholding critical information about the ARS market and UBS’s role. Further, WVUH alleged that UBS fraudulently induced it to purchase auction services, while UBS withheld critical information about the ARS market and UBS’s role. Interestingly, in all the agreements between the parties there were no documents which contained an arbitration clause, and none referred to any provisions of the FINRA code.

UBS is a member of FINRA, and as such when it joined it agreed to comply with FINRA’s rules. One of those is Rule 12200 of the FINRA Code, which obligates UBS to arbitrate a dispute with a “customer” at the customer’s demand, if the dispute arises “in connection with” the business activities of the member. This is the rule WVUH used to initiate arbitration. UBS argued this rule did not apply because WVUH was not a “customer,” but the Second Circuit determined, as a matter of law, that WVUH was a customer of UBS when it served as a broker-dealer for the ARS auctions. The court further determined that a “customer” is a non-broker or non-dealer who purchases, or undertakes to purchase, a good or service from a FINRA member.

This case is interesting for all securities arbitration attorneys to note, because it turns the tables on the normal considerations in FINRA arbitration cases. Normally FINRA arbitration is seen as a shield for the broker-dealers, who invoke their arbitration clauses to stay away from the court. However, as this case demonstrates in certain instances customers who wish to can use this FINRA rule as a sword to compel a FINRA member into arbitration even without an arbitration agreement in place, if they so desire.

Self-Directed IRA Fraud: Are You A Victim?

What Are Self-Directed IRAs?

Self-directed IRAs are a type of financial instrument which allows a person to invest in a larger range of assets than a traditional IRA. Many of us are familiar with IRAs that invest in stocks, bonds, mutual funds, and certificates of deposit, but self-directed IRAs expand from these more traditional investing avenues, and also allow someone to invest in promissory notes, real estate, precious metals, private placement securities, tax lien certificates, and other investments which may not be registered.

This type of IRA is becoming increasingly popular in the United States, with about $94 billion of retirement funds invested in them. They are completely legal, when used correctly. However, some of the inherent characteristics of this financial instrument have not only attracted legitimate investments, but in addition scammers and fraudsters who use the patina of the self-directed IRAs legality to defraud investors of their life savings.

What Are The Inherent Characteristics Of Self-Directed IRAs That Make Them Susceptible To Fraud?

As with all IRAs, a self-directed IRA must be held by a trustee or custodian. However, with the more traditional IRAs the custodians are typically banks and broker-dealers who only allow investment in firm approved stocks, bonds, mutual funds and CDs. However, with a self-directed IRA the trustee or custodian has no responsibility to investigate the securities offered for investment, or the background of the promoter. Further, they also do not need to keep accurate records or perform audits. With these laxer requirements it is easy to see why those wishing to engage in fraud would be interested in using this financial instrument to perpetrate it.

The fact that this type of IRA allows investment in a broader range of assets can increase the likelihood of fraudulent behavior. For example, unregistered securities are permitted in this type of IRA. There is typically less investigation into this type of security, with less information easily available, and further there is no guarantee that any information provided has been audited. Therefore, in a situation in which more due diligence is typically required there is less opportunity to review accurate information to perform that due diligence.

In addition, the broader range of assets allowed for self-directed IRAs can create unique risks for investors that should be considered, such as lack of liquidity and difficulty in valuing assets. The result of the characteristics of these assets means that the self-directed IRA custodians will often list the value of the assets as the original purchase price, plus any gains as determined arbitrarily by the promoter. These values that are told to investors may not reflect the true value of the investment if sold on the open market. Further, because the custodians don’t have to evaluate the quality or legitimacy of the investments, and have no responsibility for investment performance, these self-promoting statements may go unchecked and unquestioned.

Finally, the fact that self-directed IRAs are a tax-deferred account can impact psychologically how much oversight an investor has over this type of investment instrument. The fact that there is a financial penalty for early withdrawal means people tend to invest in these types of accounts for the long term, when more prudent investors in these types of investments may more actively manage such accounts. This same mind set may also allow the person committing the Ponzi type scheme or other fraud to conduct their fraud longer before their misdeeds are detected.

Scott Starr, a partner in this firm, has stated, “Some of these investment advisors and stockbrokers are clearly committing malpractice and breaching their fiduciary duties” when directing individuals to invest in these self-directed IRAs. Further, he states that “It is not uncommon for these individuals to place their clients in investments that are either too high risk, carry a time horizon that is too far in the future, or fail to properly diversify these portfolios.”

Examples Of Self-Directed IRA Fraud Close To Home

Although fraudulent actions surrounding self-directed IRAs can, unfortunately, happen anywhere in the country the state of Indiana, and surrounding states, have had several instances of this type of fraud coming to light.

1.     Randell Morrison - Indiana

One of the most recent cases of self-directed IRA fraud reported in Indiana is the case of Randell Morrison, which has been reported extensively in the  Fort Wayne, Indiana Journal Gazette. http://www.journalgazette.net/article/20111120/LOCAL/311209934 On November 10, 2011, Mr. Morrison was sentenced to six years in prison, followed by a year of home detention and then one year of probation for bilking 15 investors in Indiana, mainly in the Allen County area, out of $1.4 million.

Mr. Morrison was a businessman in the community, and used his personal associations with fraud victims, including being a friend of the family, and attending country clubs, churches and social clubs with them, to gain their trust over several years. He then convinced these investors to roll their more traditional IRAs and life insurance proceeds into a self-directed IRA custodial company, called Equity Trust, with which he was associated. His victims thought they were investing their money in conservative and traditional investments, but instead once he gained control of the money he used it for his own personal use and for his businesses.

The Indiana Secretary of State, Charlie White, said, “Randell Morrison preyed on those who considered him a friend. He didn’t just gamble with their life savings, he squandered their life savings.” Many of the victims of this scheme were close to retirement age, and have now lost their entire retirement account and life savings. They have suffered not only financial losses, but also emotional and even physical distress because of the fraud perpetuated against them.

2.     Jerry Smith and Jason Snelling - Indiana

Another case in Indiana that is currently pending involves Jerry Smith and Jason Snelling, who are accused of conducting a long-running Ponzi scheme, defrauding investors in three states, Indiana, Ohio and Kentucky, of over $4.5 million. Smith and Snelling were allegedly selling unregistered securities, and neither was licensed to sell them.  

In this case the accusation is that investors were convinced and encouraged to roll over their traditional IRA accounts into self-directed IRAs at a trust company. Then, Smith and Snelling allegedly took the funds from the accounts and used them for their own personal use. The investors had no idea their money was no longer available, since they still received regular statements from the trust company, and even were billed fees on the accounts.

Smith and Snelling are charged with over 50 counts of violations of the Indiana Uniform Securities Act, and charges are pending in both Franklin County and Dearborn County, Indiana.

Things To Consider To Determine If You May Be A Victim Of A Fraudulent Self-Directed IRA

The U.S. Securities and Exchange Commission’s Office of Investor Education and Advocacy (OIEA) and the North American Securities Administration Association (NASAA) have jointly issued an Investor Alert about the potential risks associated with investing in self-directed IRAs. You can find this short PDF here. http://www.sec.gov/investor/alerts/sdira.pdf In addition, here is information you should consider if you’re concerned you may be a victim of self-directed IRA fraud.

• Verify the information in the self-directed IRA. Many of the investments that can be purchased through one of these financial instruments can be hard to value, since they are illiquid. Therefore, the statements provided will often state their value as the price you paid for it, or what the promoter is valuing it at. However, that does not necessarily reflect what the investment could actually be sold for on the open market, which may be a much lower amount.

• Was your choice to get a self-directed IRA the result of an unsolicited investment opportunity from a total stranger, or even a friend? As stated previously, self-directed IRAs are legal and there are some which may produce high rates of return for investors. However, if someone, unsolicited, asked you to invest in such a financial instrument red flags should be raised to determine if they are a legitimate individual, or instead a fraudster.

• Were you promised a guaranteed gain or rate of return, or a low-risk, high reward investments? Similarly, when someone promises you something too good to be true, it usually is. Almost nothing in life is guaranteed, and if there were legitimate low risk, high reward investments out there lots more people would be rich than are today. Too good to be true promises such as these should also raise red flags in your mind, to investigate further about whether you are the victim of self-directed IRA fraud.

• Is the self-directed IRA promoter registered in the state they are doing business, and in addition are the investments they are selling licensed? Many states, including Indiana, have laws and regulations in place which require those selling securities to be registered with the state. Further, only certain types of investments are deemed registered securities. While unregistered securities are permitted to be included in self-directed IRAs they are much riskier, and their inclusion may still violate state law, if not federal law. It is best to make sure what you are purchasing through your self-directed IRA is licensed, and the person you’re purchasing it from is registered to sell you these types of products.

• Have you contacted another professional yet for a second opinion, such as an investment advisor or attorney? Many of the investments that can be purchased through a self-directed IRA are not ones that can be purchased through a traditional IRA, generally for the reason that they are even more inherently risky, illiquid, or complex. Therefore, before investing in such financial instruments it is a good idea to get a second opinion from an independent professional, such as an investment advisor or attorney, to help you determine whether this is a good investment for you.

If You Think You May Be A Victim Of Self-Directed IRA Fraud Call A Securities Fraud Attorney

If you think you may be a victim of fraud using this financial instrument you should act quickly to try to minimize further losses, and potentially try to reclaim money you’ve lost already. To do this, it is best to contact a knowledgeable securities fraud attorney in your area to see if you have a case, and determine the best course of action for you.

If you have lost money in a fraudulent investment scheme involving a self-directed IRA or a third-party custodian or trustee, or have information about one of these scams, you should contact Starr Austen & Miller LLC to learn more about the self-directed IRAs and report your experiences. Our attorneys, Mario Massillamany and Mark Fryman are available for direct live chat every Wednesday at 5 pm.

Indiana Law Firm Investigating Securities Fraud Stemming From Self-Directed IRA Schemes

Fishers, IN, January 3, 2012 - Mario Massillamany of the Indiana law firm of Starr, Austen & Miller, LLP, announces an investigation into securities fraud scams involving self-directed IRAs.  A self-directed IRA is an IRA held by a trustee or custodian that permits an investment in a broader set of assets than is permitted by most IRA custodians. 

Most IRA custodians are banks and broker-dealers that limit the holdings in IRA accounts to firm-approved stocks, bonds, mutual funds and CDs.  Custodians and trustees for self-directed IRAs, however, may allow investors to invest retirement funds in other types of assets such as real estate, promissory notes, tax lien certificates, and private placement securities.  $94 billion of IRA retirement funds are held in self-directed IRAs making them a favorable scam for fraud promoters

Fraud promoters who want to engage in Ponzi schemes or other fraudulent conduct may exploit self-directed IRAs because they allow investors to hold unregistered securities.  Additionally, the custodians or trustees of these accounts have no responsibility to investigate the securities or the background of the promoter.  Furthermore, self-directing IRAs do not typically require the trustee or custodian to keep accurate records or perform audits.

"Some of these investment advisors and stockbrokers are clearly committing malpractice and breaching their fiduciary duties in the way they are advising their clients to invest in their self directed retirement programs such as IRA’s and 401k’s," said attorney Scott Starr.  “It is not uncommon for these individuals to place their clients in investments that are either too high risk, carry a time horizon that is too far in the future, or fail to properly diversify these portfolios."

The self-directed IRA custodial process gives the aura of protection for the investor but it is elusive. A few ways to avoid fraud with self-directed IRAs is to verify information in self-directed IRA account statements, avoid unsolicited investment offers, ask questions from the promoter, be mindful of “guaranteed” returns, and seek advice from a trained professional. 

About the law firm:

The law firm of Starr Austen & Miller LLC has over 90 years of experience in securities and class action litigation. The firm has earned a national reputation among litigators by handling cases ranging from personal injury caused by exposure to toxic chemicals to mass and class actions against national brokerage firms for securities fraud.

Legal Resources for Impacted Investors

If you have lost money in a fraudulent investment or scheme involving a self-directed IRA or a third-party custodian or trustee, or have information about one of these scams, you should contact www.starrausten.com to learn more about the self-directed IRAs and report your experiences.

Source/Contact:

Mario Massillamany

574-722-6676

mario@starrausten.com

Schrenker v. State, 919 N.E.2d 1188 (Ind. Ct. App. 2010)

In Schrenker v. State, Michelle Schrenker and her husband Marcus were the subjects of an action by the Indiana Securities Commissioner.  Marcus Schrenker was registered as an investment advisor with the Indiana Securities Division, and he and Michelle were principals in investment firms called Heritage Wealth Management (HWM), Heritage Insurance Services (HIS), and Icon Wealth Management (Icon).  The offices were leased to both Marcus and Michelle, and Michelle kept the books and was chief financial officer (CFO) for the three firms. She was paid $ 11,600 monthly, and the State asserts she “did not consider her position as CFO to be simply a title”  She was the majority shareholder and a director of HWM.  She handled the books, recordkeeping, and accounting for HWM and Icon, and had the authority to write checks and withdraw money from the HIS account.

The Indiana Securities Commissioner sought the appointment of a receiver over Michelle Schrenker’s assets.  The trial court granted the appointment.  The appointment was premised on the trial court’s conclusion that the advisor materially aided her husband and his corporations in violating the Indiana Securities Act and she was jointly and severally liable with and to the same extent as her husband and his companies by virtue of her position as Chief Financial Officer of three companies.   The advisor had access to one of the company’s checking account.  There was a substantial casual connection between the advisor’s culpable conduct, in the form of withdrawing investor funds from one company account, and the harm the investors suffered in the form of lost money.  She materially aided her husband in violating the Securities Act.  The appellate court affirmed the trial courts appointment of the receiver stating that it did not abuse its discretion.

Police Report and Officer Testimony Admissibility in Indiana

Whenever you are involved in a truck accident a police report is typically created by an investigating officer. This report is made by an officer who is only at the scene after the accident occurs. He or she interviews witnesses, takes down information about the accident itself, and may or may not make a conclusion as to who caused the accident and/or issue a citation to the person that he or she concludes was at fault.

As you can imagine, the conclusions of a police officer as to who caused an accident can be quite persuasive to a jury, convincing them a defendant caused the accident, or conversely that it was plaintiff’s fault and he or she should not receive damages from the defendant. Therefore, there is often litigation concerning whether the police report, the conclusions it draws, and the investigating officer’s testimony, are admissible evidence in a truck accident lawsuit, and what each side argues is typically related to who the officer says caused the accident.

Investigative Reports by Police and Law Enforcement Personnel Are Hearsay

Although a general exception to Indiana’s hearsay rule is for public records and reports Indiana Rule of Evidence 803(8)(a) makes an exception to the exception, declaring that “investigative reports by police and other law enforcement personnel” are still hearsay. That means that these accident reports, and the evidence they contain, are typically not admissible into evidence in Indiana.

However, the investigative officer is often called to testify in car and truck accident lawsuits, meaning that there are typically some parts of the officer’s testimony which are admissible. Below are some examples of the types of things an officer can testify about, and what he cannot. What follows discusses some general rules of law, but there are always exceptions and factual distinctions between cases which could result in a different outcome. This is especially true in evidentiary law, some of which is based on the discretion of the court regarding the issue of undue prejudice, which is why an experienced truck accident attorney should be consulted.

Officer Can Testify As To Observations He or She Made At Accident Scene but Generally Not the Cause of the Accident If They Didn’t Observe It Personally

One of the reasons courts have given for not allowing an officer to testify about the issue of causation, i.e., who caused an accident, is because they did not typically observe the accident themselves. Typically, investigative officers come to the scene of the accident only after it has occurred, and rely on eye witness statements to make their conclusions. That is exactly what a jury is supposed to do, so since they didn’t actually see it themselves police officers aren’t generally allowed to share their conclusion about who caused the accident, or how the accident occurred.

On the other hand, an investigating officer is often asked to testify about what he did observe at the scene of the accident as a neutral third party. This can include the position of the vehicles and other post-accident information. In addition, there may be questions about observations the officer made of the injured parties, and what they said about how they felt right after the accident, such as any complaints of pain and in what areas of their body.

Often statements of the witnesses are considered hearsay, and the officer cannot testify about them. However, there are quite a number of exceptions to this hearsay rule, and if one applies an officer may testify as to those statements too. One of the most common of these include when a person admits fault for an accident. Since this an admission against interest, and a statement by a party opponent, it is not considered hearsay at all and an officer can testify about what a party said on this subject.

Sometimes Police Officers Can Be Qualified As an Expert and Provide Conclusions about Causation

There is one exception, when an officer is qualified as an expert witness, when he or she is able to testify as to his or her conclusions about who caused the accident. Typically, the court will consider the officer’s years of experience and any training he has had in accident reconstruction in determining whether he can be qualified, and it is in no way guaranteed that all officers will qualify.

If a police officer does qualify as an expert witness he can provide opinions as to the ultimate issue of fact before the jury – who caused the accident. Typically, the opinions of the police officer as an expert cannot be based solely on witness statements, because a jury can decide based on those statements without a police officer’s opinion. Instead, the police officer’s expert opinion must be based on more, such as his own observations at the accident scene, such as by examining the skid marks, the weather and light conditions right after the accident, etc. This information, plus his knowledge of accident reconstruction, can allow in some instances for him to testify as to who he believed caused the accident to occur.

The Importance of Evidence in the “Black Box” For Truck Accident Litigation

Often in truck accidents there is a lot of conflicting testimony between the truck driver’s version of events and that of the injured person regarding such important issues as speed, acceleration and braking. Some of this conflict may come from a bias of protecting one’s own interests, but in addition these accidents often happen so quickly, and so many things happen in quick succession that it can be difficult to accurately remember or even notice all relevant pieces of information.

That is where a heavy truck’s Event Data Recorder (known in the industry as an “EDR”), and often commonly referred to as a “black box” can be very useful. This piece of electronic equipment, while not required by law to be present in all vehicles, at this time, often is present and can be very helpful in accident reconstruction.

The Types of Data That May Be Recorded in a Truck’s EDR That Help in Accident Reconstruction

There are many types of EDRs, and therefore they do not all record exactly the same type of information in exactly the same manner, although NHTSA (National Highway Traffic Safety Administration) does have some standards and rulings for these recording devices.

Some of the types of data that an EDR may record, and which may be helpful for accident reconstruction, include the following:

• Speed
• Acceleration rate
• Engine revolutions per minute (RPMs)
• Gear selection and/or clutch application
• Engine malfunction information
• Airbag deployment information
• Measured changes in forward velocity (Delta-V)
• Engine throttle
• Brake application
• Steering angle
• Whether seatbelts were on or off
• Sudden stops
• Low oil pressure
• Coolant loss
• Cruise control status
• Fuel economy
• Idle time
• Average travel speeds

Passenger Vehicles Often Have an EDR Too

Not only do many heavy trucks have these black boxes, but often many passenger vehicles may have them as well. Typically, but not always, these EDRs record less information than those within heavy trucks, but still tend to include information used to calculate airbag deployment and seat belt tensioner calculations, for example.

Just as attorneys for injured victims in truck accidents may request the information from an EDR, so too can plaintiffs receive requests to have their data downloaded and analyzed. It can be important for injured parties to have legal representation in such instances to determine what is, and is not, relevant and admissible evidence and what must be provided during discovery.

Expert Testimony Necessary to Interpret and Present This Evidence in Court

The information contained in the black boxes can be used for accident reconstruction, and it is typically downloaded directly from the vehicle(s) involved in the accident soon after the accident occurs. It is important to make sure you obtain legal representation as soon as reasonably possible after an accident occurs to make sure all relevant data is downloaded before it becomes unavailable, lost or destroyed.

Once the information is downloaded into a report it must be analyzed and interpreted by an expert in accident reconstruction to understand what the data means, and to draw conclusions about how the accident occurred (and potentially why it occurred). An experienced truck accident attorney will be able to contact such experts to evaluate the data involved in your case.

Courts often hold that this EDR data is generally accepted and reliable, which meets the requirements for its admission into evidence. However, there are often legal arguments on both sides regarding what the expert can, and cannot say, in regard to conclusions based on the data retrieved. This requires an understanding of evidentiary law, as it relates to expert testimony, to determine which conclusions are appropriate for a jury to hear from an expert.