Oral Argument Preview: Are Custodians of Self-Directed IRAs Liable for Purchasing Illegal Securities? Cynthia Boyd; Thomas Flanders v. Kingdom Trust Company; PENSCO Trust Company; John Does 1-25

By Marianna Bettman on May 16, 2018

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

Read an analysis of the argument here.

On May 22, 2018, the Supreme Court of Ohio will hear oral argument in the case of Cynthia Boyd; Thomas Flanders v. Kingdom Trust Co., PENSCO Trust Co., 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 and his associates 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”), 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 15, 2014, the Investors filed a petition for involuntary bankruptcy against Apostelos under Chapter 7. 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 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 PENSCO’s 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 this order of dismissal to the Sixth Circuit Court of Appeals. Although neither 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?”

Votes to Accept the Case

Yes: Justices O’Donnell, French, Fischer, and DeWine.

No: Chief Justice O’Connor and Justice Kennedy.

*Then-Justice O’Neill did not participate.

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. 1707.431 (Claiming Exemption for Publicly Advertised Meeting.)

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 . . .”)

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.”)

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.”)

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.”)

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.”)

Ohio Ky. Oil Corp. v. Nolfi, 2013-Ohio-5519 (5th Dist.) (“Ohio state law permits only rescission as the measure of damages for state securities fraud.”)

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.”)

Investors’ Argument

This Court should answer the certified question in the affirmative. Beyond the substantive arguments in support of this answer, it should not be forgotten that the statute at issue—R.C. 1707.43—is a remedial statute that the General Assembly enacted to protect investors like Boyd and Flanders and the investing public.

In line with the intended protection of Ohio’s Security Act, this Court should not limit liability for the illegal sale of securities to the “primary actor,” Apostelos. The text of R.C. 1707.43(A) includes entities like the Custodians, which extends liability to “every person that has participated in or aided the seller in any way.” This does not require active participation, but instead applies to tangential participants and those indirectly involved in the sale. Despite the Custodians’ arguments to the contrary, it would be proper for this Court to follow the District Court’s rationale in Hardin v. Reliance Trust Co., which alluded to the possibility of a custodian’s role as purchaser being sufficient for liability under R.C. 1707.43. Although the Custodians downplay their involvement, their facilitation of this transaction is encompassed by the broad “in any way” language drafted by the General Assembly. The alleged “ministerial acts” of the Custodians do not fall under any of the exemptions to the statute.

Furthermore, since this appeal arose from a 12(b)(6) motion to dismiss, “[t]he allegations must be accepted as true and all reasonable inferences in the [Investors’] favor.” The allegations in the Investors’ complaint established the Custodians’ concerted action with Apostelos and was integral to the sale of illegal securities, all of which is sufficient for liability under R.C. 1707.43.

Therefore, this Court should allow this action to proceed, and answer in the affirmative, or “at least provide qualification that self-directed IRA’s could be liable.”

Custodians’ Argument

Although PENSCO and Kingdom filed separate briefs, the issues and arguments raised by the Custodians largely mirror each other, and as such will be addressed together.

This Court should answer the certified question in the negative. R.C. 1707.43 is inapplicable to the Custodians because that statute applies to sellers, not purchasers. They were not sellers and had nothing to do with the seller. They participated in the purchase of the securities at the direction of the investors. As passive IRA custodians, PENSCO and Kingdom did nothing more than hold the funds of their customers and follow their written instructions. They neither brought, evaluated, nor recommended any investments to their customers, and the customers are told this when the self-directed IRA’s are opened. The customers make the decisions about what to buy. Despite the Investors’ assertions that the Custodians acted in concert with Apostelos, this could not be further from the truth. Neither Custodian had anything to do with the decision of either Boyd or Flanders to invest with Apostelos. Apostelos sold the securities, and the Custodians only acted under the direction of the Investors to perform any required “ministerial actions.” The Custodians had no idea that Apostelos’ suggested investments were fraudulent.

Under the clear text of R.C. 1707.43, liability is limited to those entities that participate in the sale, not the purchase of securities. The Generally Assembly gave these terms separate and distinct definitions, and it would run counter to the legislative intent for this Court to find no difference and extend liability beyond the language of the statute. Other sections of the Ohio Security Act, like R.C. 1707.01(J), support this interpretation, because those that pertain to sales and purchases mention both terms explicitly. Therefore, an affirmative answer to the certified question would mean this Court would be adding language to the statute.

On the other hand, the Investors’ statutory arguments fail to pass muster. “In any way” only expands the language present, “a sale,” and does not fundamentally change the statute to include activities relating to purchases. Similarly, the remedial nature of R.C. 1707.43 does not create liability beyond that mentioned in the language of the statute. Finally, Investors’ argument regarding R.C. 1707.431 exemptions ignores that other Ohio courts have declined to find liability in the absence of the cited exemptions.

More importantly, no case has extended liability under R.C. 1707.43 to buyers or someone acting at the buyer’s behest. Precedent limits liability to “sellers or person in active concert with sellers.” Investors’ reliance on Hardin is misplaced. The defendants in that case did not concede, nor did the court find that R.C. 1707.43 applied to IRA custodians. The issue before the court in Hardin was whether the claim was time-barred by the statute of limitations. This case dictum is an insufficient basis for upsetting the settled rule that an IRA custodian like PENSCO or Kingdom should not be subject to liability when only acting under the direction of the purchaser of the securities.

Alternatively, if this Court did extend R.C. 1707.43 to include the purchase in addition to the sale of securities, a financial institution that acts in its normal capacity, performing regular commercial banking functions, does not “participate” in the sale of securities under R.C. 1707.43.

Investors’ Proposed Proposition of Law No. 1

Purchasing illegal securities on behalf of the owner of a self-directed IRA is sufficient to create liability under ORC §1707.43 because the plain language of the statute provides liability for anyone who aids or participates in any way in the sale of illegal securities

Investors’ Proposed Proposition of Law No. 2

The procedural posture of this case and the additional allegations contained in the Complaint further underscore the appropriate response to the certified question is affirmative.

PENSCO’s Proposed Counter Proposition of Law No. 1

R.C. 1707.43 does not 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.

PENSCO’s Proposed Counter Proposition of Law No. 2

Facts outside of the certified question are not relevant.

Kingdom’s Proposed Counter Proposition of Law

R.C. 1707.43 does not impose liability on a self-directed IRA custodian who purchases securities sold in violation of Chapter 1707 for a customer’s self-directed IRA as directed by the customer.

Amicus in Support of Custodians

The Retirement Industry Trust Association (“RITA”) filed an amicus brief in support of the Custodians. RITA is a national profession trade association that includes regulated banks, trust companies, and other professionals in the industry, and serves custodians of self-directed IRAs, like the Custodians in this case. RITA also echoes the distinction between “sale” and “purchase,” and maintains R.C. 1707.43 liability is limited to the sale-side of security transactions. Since these custodians only act in a ministerial or custodial capacity at the direction of the account-holders, RITA requests this this Court not create derivative liability for custodians that “play no role in the offer or sale of securities . . .” It would be inherently unjust to allow liability against a custodian who only followed the directions of its customer. Therefore, this Court should answer the certified question in the negative.

Amicus in Support of Neither Side

The Public Investors Arbitration Bar Association (“PIABA”) filed an amicus brief in support of neither party. PIABA’s membership includes over four hundred attorneys who specialize in investor disputes regarding securities, and frequently involves itself in cases across the United States that involve the interests of public investors. PIABA does not take a position regarding blanket liability as posited by the Investors; however, it does request that this Court reject the interpretation of R.C. 1707.43 offered by the Custodians. PIABA argues that whether an IRA custodian participated in the sale, or aided the seller, is a factual determination and these custodians can be “liable where its conduct goes beyond the ‘normal commercial activity’ of a custodian.’” The wholesale immunity sought by the Custodians relies on the erroneous presumption that custodians always have a passive relationship with the customers, which is not the case. As such, a broad ruling could unfairly preclude liability in the future.

Therefore, PIABA requests the court to give the following answer to the certified question: “Yes, provided that the self-directed IRA custodian engages in conduct going beyond the ‘normal commercial activity’ of a custodian.”

Student Contributor: Jefferson Kisor