Update: On August 9, 2018, the Supreme Court of Ohio handed down a merit decision in this case.  Read the analysis here.

“What was it that the trust did that aided the seller in making the sale?”

Justice O’Donnell, to counsel for the Investors

On May 22, 2018, the Supreme Court of Ohio heard oral argument in the case of Cynthia Boyd; Thomas Flanders v. Kingdom Trust Company; PENSCO Trust Company; John Does 1-25, 2017-1336. At issue in this case is the certified state law question of whether Ohio’s Security Act imposes liability on a person who, acting as the custodian of a self-directed IRA, purchased illegal securities on behalf and at the direction of the owner of the self-directed IRA.

Case Background

Starting from January 2010 until October 2014, William Apostelos perpetrated a Ponzi scheme to defraud investors. These investors included Plaintiffs-Petitioners Cynthia Boyd and Thomas Flanders (“Investors”). As alleged in the Investors’ Complaint against Defendants-Respondents PENSCO Trust Company, LLC (“PENSCO”), Kingdom Trust Company (“Kingdom Trust”), and twenty-five other unnamed IRA custodians, Apostelos convinced Flanders and Boyd, among others, to open self-directed IRAs, whose custodians purportedly at the direction of the account owners, bought illegal securities sold by Apostelos. PENSCO was custodian for Flanders’ self-directed IRA; Kingdom Trust was custodian for Boyd’s self-directed IRA.

On October 29, 2015, Apostelos and his wife were indicted on multiple federal charges related to this Ponzi scheme. After pleading guilty to a number of criminal charges, Apostelos was sentenced to fifteen years in prison.

The Investors initiated this putative class action against the various custodians, seeking the full amount paid for the illegal securities, and arguing that the custodians participated in or aided the seller. U.S. District Court Judge Thomas M. Rose of the Southern District of Ohio granted the custodians’ motion to dismiss for failure to state a claim for violations of the Ohio Securities Act, R.C. 1707.01 et seq.

The Appeal and Certification

The Investors appealed the order of dismissal to the Sixth Circuit Court of Appeals. The parties to this appeal are Investors Boyd and Flanders and Custodians PENSCO and Kingdom Trust. Although no party raised the issue of certification, the Sixth Circuit sought review from the Supreme Court of Ohio sua sponte because the case turned on whether Ohio’s Security Act, specifically R.C. 1707.43 “extends joint and several liability to persons who aided in the purchase of illegal securities.” It later designated the Investors as the moving party. The Supreme Court of Ohio agreed to answer the following certified question:

• “Does Ohio Rev. Code Ann. § 1707.43 impose joint and several liability on a person who, acting as the custodian of a self-directed IRA, purchased—on behalf and at the direction of the owner of the self-directed IRA—illegal securities?”

Read the oral argument preview of the case here.

Key Statutes and Precedent

R.C. 1707.43 (Remedies of Purchaser in Unlawful Sale.)

(A) (“The person making such sale or contract for sale, and every person that has participated in or aided the seller in any way in making such sale or contract for sale, are jointly and severally liable to the purchaser.”)

R.C. 1707.01 (Securities Definitions.)

(C)(1) (Defining “Sale” to include “every disposition, or attempt to dispose, of a security . . .”)

(GG)(1) (Defining “Purchase” to include “every acquisition of, or attempt to acquire, a security . . .”)

Cleveland Elec. Illum v. Cleveland, 37 Ohio St.3d 50 (1988) (“In considering the statutory language, it is the duty of the court to give effect to the words used in a statute, not to delete words used or to insert words not used.”)

In re Columbus Skyline Securities, Inc., 74 Ohio St.3d 495 (1996) (Ohio’s Security Act should be liberally construed in order to serve its purpose of “prevent[ing] the fraudulent exploitation of the investing public through the sale of securities.”)

Hardin v. Reliance Trust Co., No. 1:04-cv-2079, 2006 U.S. Dist. LEXIS 70822 (N.D. Ohio, Sept. 28, 2006) (Although dismissing the case as time-barred, the Court noted that the custodian’s actions, limited to purchasing, was “sufficient to form a possible basis for liability under O.R.C. 1707.43.”)

In re Nat’l Century Fin. Enters., Inc., 755 F.Supp.2d 857, 873 (S.D.Ohio 2010) (“A secondary actor need not commit fraud to be liable; the secondary actor need only participate in or aid the sales transaction.” Liability under R.C. 1707.43 “requires an act of participation or assistance in the sale and some form of remuneration, either direct or indirect.”)

Wells Fargo Bank v. Smith, 2013-Ohio-855 (12th Dist.) (Finding that a creditor bank’s normal commercial activities did not “equate to participating in or aiding the sale of securities.”)

Cruz v. PNC Bank, N.A., No. 17-3091, 2017 U.S. App. LEXIS 19591 (6th Cir., Oct. 4, 2017) (per curiam) (Affirming a 12(b)(6) dismissal where the plaintiffs “failed to allege any facts indicating that PNC participated in or aided Apostelos in selling unregistered securities to investors.”)

At Oral Argument

Chief Justice O’Connor was not present for the oral argument of this case.  Justice O’Donnell, senior associate justice, was Acting Chief in her absence, and announced that O’Connor would be watching the argument via live video stream and would participate in the decision.

Arguing Counsel

Scott S. Davies, Sebaly Shillito + Dyer LPA, Dayton, for Petitioners Cynthia Boyd et al.

Jahan P. Raissi, Shartsis Friese LLP, San Francisco, for Respondent PENSCO Trust Company Co. LLC

Frances Floriano Goins, Ulmer & Berne LLP, Cleveland, for Respondent Kingdom Trust Company

Investors’ Argument

The answer to the certified question in this case should be yes. The act of purchasing securities on behalf of the investor qualifies as participation in the sale of illegal securities and triggers liability under R.C. 1707. 43. What is crucial is that there is nothing inherent in the statute that prohibits someone on the buyer’s side of the transaction from being liable under 1707.43.

In order to answer the certified question, the context of this particular case has to be considered, because each case must be evaluated on its specific facts. This case was dismissed on a rule 12 motion, so there has been no chance to develop any definitive facts yet.  What is known is that the Respondents in this case aided and participated in the sale, because there was a relationship alleged between Apostelos, the Ponzi scheme perpetrator, and Kingdom Trust and PENSCO, that was independent of each of the individual investors. It doesn’t matter that the investors asked and instructed the custodian to make those purchases. Apostelos was in the middle of all of this. He brought the parties together. It is not known if he did anything more than that because the investors have never been given the opportunity to develop any actual facts in the case.

The investors in this case would put money into their accounts and the custodian would then send the cash to Apostelos, who would then replace it with a promissory note. The custodian then provided periodic statements with regard to the value of that account. Those were the actions they were involved with in this case.

R.C. 1707.43 has a long history of broad interpretation and is applied to many behaviors beyond simply the sale side of the transaction. The statute covers anyone who participates in or aids the seller in any way. It does not, as the Custodians argue, prohibit any buyer-side liability. Participation in the sale is exactly what we have here. There is nothing in the statute that says that just because you are on the purchaser side of the transaction, that somehow you are not open to liability.

Even if the rule of law in this case is not definitively yes, it should be yes, there can be liability under R.C. 1707.43, depending on the facts and circumstances of the case.

Custodians’ Argument

The Custodians divided their oral argument time.

PENSCO’s Argument

The 6^th circuit has put a very narrow question before this court, asking in essence whether an innocent commercial actor—here, the custodian of a self-directed IRA, who purchases securities at the direction of the account holder–can be liable under R.C. 1707.43, and the answer should be “no”.  There are circumstances under which such a custodian could be liable, if there were to be participation with the seller of illegal securities, like getting the parties together, or recommending the purchase of the securities.  But that is not the case here, where PENSCO’s only participation was on the purchaser side. PENSCO had no involvement whatsoever with Apostelos’ Ponzi scheme. The Sixth Circuit wants to know if there is liability when somebody is only acting on the purchaser side, and the answer is no. Liability has never been found in a purchaser-only side case.

This Ohio statutory scheme has separate and different definitions for a “sale” and a “purchase.” Some statutes use both words when the intent is to reach both sides of a transaction; here the legislature only used “sale” language. The statutory scheme of the Ohio Securities Act, other states’ blue sky laws, and the federal securities laws all set up a distinction between purchase side activities and sale side activities. For example, the 1934 Securities Exchange Act includes purchases and sales of securities, while the 1933 Securities Act just applies to sales and sellers.

The petitioners in this case are alleging conduct entirely on the wrongdoer’s side. There is no allegation that PENSCO, as custodian, following the directions of its client, had any knowledge of the fraud or in any way was participating with or assisting the seller. PENSCO acts at the direction of its clients, in writing, doing only what it is told to do.

Kingdom Trust’s Argument

The petitioners would have this court hold that every self-directed IRA custodian who is only doing its job, would be liable under this statute for aiding the seller or participating in the sale, but the petitioners have conflated the term “sale” with the term “transaction.” There are certainly circumstances where a custodian could step over the line, but that is not this case.

What is at issue here is putting liability on the purchaser in the transaction, which is contrary to the plain wording of the statute.  As the 6^th Circuit noted in its opinion, the complaint does not allege that the respondents knew or had reason to know that Apostelos was perpetrating a fraud, or that they were in any way involved with his Ponzi scheme.  Now petitioners are suggesting there was such a relationship, but there was not. The answer to the certified question should be a simple “no”.

What Was On Their Minds

Where to Draw the Line

What about the day trader who trades a stock and sells it over an exchange, not knowing who the buyer is. Is that person liable, asked Justice Fischer? If the person holding it didn’t know it was illegal? What about if I hear about a company—it’s a Ponzi scheme but I don’t know it.  I call up e-trade or one of those, and tell them to buy it. They buy it for me but they don’t know anything about the company either, whether it’s a penny stock or a pink slip. Are they liable?  What about the IT person that hooked up the computers that did the sale, didn’t that person aid in the sale? What’s the line here? Does there have to be a relationship between the custodian and the “bad guy” in order for there to be liability?

Can a custodian ever be liable, asked Justice DeWine? What circumstances would that require? What if there simply is knowledge of what the seller is doing? If they know it’s a Ponzi scheme?

Should the Facts Even Be Considered?

We have a very narrow question of law and statutory interpretation, commented Justice DeGenaro. How can we consider the facts in making that determination? Isn’t the only issue before us whether the motion to dismiss should have been granted, and yet the investors are asking us to consider the facts, she commented later.

Why don’t we answer the question before us and let the district court consider the context of the particular case, asked Justice DeWine? Isn’t that the way it works?

Is this an area that the Supreme Court of Ohio should opine on so that we clarify this for others, asked Justice O’Donnell? Or is it an area that is generally not confused? As usual, he asked both sides what the court should write if it agreed with their respective positions.

Purchaser Liability? How Was the Seller Aided?

Where is the caselaw supporting the Investors’ proposition, asked Justice DeGenaro?

Does it make any difference that the purchase was made at the behest or direction of the purchaser, asked Justice O’Donnell? How could the trust that made the purchase aid the seller in any way in making the sale? It didn’t advertise it, broadcast it, or issue offers to purchase—it just made a buy, he commented.  Since a purchaser can’t be liable to himself, can the agent of the purchaser be liable? For doing what the purchaser told him to do? Would the facts and circumstances have to show some collusion between Apostelos and the purchaser? Is that the essence of the Investors’ case? That in order to establish liability, an illicit relationship between the trust and Apostelos must be established? (Mr. Davies took exception to the word “illicit”, suggesting merely participatory would do.) Does the fact that Apostelos, being the author of the Ponzi scheme, directed the accounts to be opened with these custodians makes them liable? How do we write something that says purchasers aren’t sellers and vice versa?

Is the mere purchase by the custodian all that is necessary asked Justice DeWine? Is that the investors’ position? No other facts are needed? (answer: that’s correct.)

The statute says “every person that has participated in or aided the seller in any way,” noted Justice Fischer. That’s pretty broad, isn’t it? Wasn’t the custodian involved in a contract for sale?

Different Answer for Non-Self-Directed IRA?

Would the answer here be different or should it be different, if this were not a self-directed IRA, asked Justice DeGenaro? Would there then be a question of fact as to whether the custodians gave advice, which would then make them liable? If the custodians advised the plaintiff to buy a particular stock in a non-self-directed IRA, because they recommended the purchase of that stock, would they then be aiding the seller in any way in entering into a stock contract?

How It Looks From The Bleachers

To Professor Emerita Bettman

Like the court is going to answer the question “no,” and not go much beyond that. Mr. Davies, who clearly is looking to recoup some of the losses for his clients who were conned by Apostelos, the man behind the Ponzi scheme, clearly wants to develop facts to show enough of a connection for liability to attach to the custodians under the broadly-worded statute. But he faced considerable skepticism from the justices, mostly because these were self-directed IRA’s, and the custodians here just did what the account owners directed them to do.  Mr. Davies kept insisting that the Investors hadn’t had any chance to develop the facts, but I thought under these days of heightened pleading standards in federal court, complaints are supposed to be more fleshed out these days.

A number of hypotheticals were spun, especially by Justice Fischer, where liability might be imposed on custodians. For his side, Mr. Raissi deflected these with considerable elegance, conceding that there were circumstances where there could be liability, but squarely placing this case outside any such circumstances.

Justice DeGenaro zoomed in on the significant difference between a self-directed IRA and one that wasn’t.  And Justice Fischer really pressed Mr. Davies on how far liability could be extended under his view of the statute, even to an IT tech who set up a computer with which a sale was executed.  Justice DeWine clearly doesn’t see the facts as pertinent—as he said, the district court is supposed to develop those after the certified question is answered.  Justice O’Donnell pressed both sides about how much the court should write, but I think the court might not do much more than say no, the statute only extends to sellers and those who aid sellers, and the custodians were simply purchasers, or acting on their behalf.

To Student Contributor Jefferson Kisor

Initially, I found the Investors’ arguments to be compelling, particularly in light of the “in any way” language present in the statute, not to mention the victimization of the Investors by Apostelos’ Ponzi-scheme. However, as the Custodians pointed out, the broad and remedial construction of R.C. 1707.43 does not obviate the clear distinction between sellers and purchasers in the statute. Here, the Custodians aided and assisted the Investors, who were on the purchaser-side of the transaction.  I believe Ms. Goins, for Kingdom Trust, said it best when arguing that the Investors erroneously conflated a transaction with a sale, and essentially seek to turn the statutory language on its head.

As for the Investors’ argument, I was surprised that Mr. Davies appeared to be caught off guard by Justice Fischer’s questioning on the scope of liability, if the court extended it to purchasers like the Custodians. It seemed that an affirmative answer to the certified question could open a Pandora’s box of liability, especially when Davies’ answer, defaulting to the special “facts and circumstances” in this case, was not very illuminating. It did not appear to be that palatable to court either, particularly to Justice DeWine. Hardin does offer the Investors a “life-line,” but the court seemed reluctant to base its decision on the dicta in the case.

Although Justice O’Donnell somewhat hinted at a ruling that “opined” on the issues at large with the statute, I believe the court’s ruling will be narrow when it responds in the negative to certified question. I predict it will find no liability for Custodians making purchases on the direction of its clients. That is not to say there should never be liability, but the Custodians in these self-directed IRAs did not appear to have invited liability by actively soliciting the transaction.