“The plain language of R.C. 1707.43(A) requires a person to have some nexus with the sale of illegal securities. The statute does not extend liability to persons whose only involvement in a transaction is the purchase of illegal securities.”

Justice French, court’s opinion

On August 9, 2018, the Supreme Court of Ohio handed down a merit decision in Boyd v. Kingdom Trust Co. 2018-Ohio-3156. In a unanimous opinion written by Justice French, the court answered this certified question from the U.S. Court of Appeals for the Sixth Circuit in the negative:

Does [R.C.] 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?

The case was argued May 22, 2018.

Case Background

Plaintiffs-petitioners Cynthia Boyd and Thomas Flanders are among those investors who were alleged victims of a Ponzi scheme perpetrated by William Apostelos, who is not a party to this case.  Apostelos allegedly persuaded Boyd, Flanders, and others to open self-directed IRAs and to invest in securities in companies he had formed as the conduits for offering illegal securities to investors. Boyd opened a self-directed IRA with defendant-respondent Kingdom Trust Company; Flanders with defendant-respondent PENSCO Trust Company (collectively, “the trust companies”).  Once these accounts were set up, Apestolos asked the investors to direct the trust companies to buy his securities with their IRA assets, or to give him powers-of-attorney to direct the trust companies to do so.  Instead, Apestolos allegedly used that money to perpetrate the Ponzi scheme. (While this is not in the court’s opinion, in June of 2017, Apestolos was sentenced to 15 years in prison by U.S. District Court Judge Thomas Rose, and ordered to pay over $32 million to his nearly 500 victims.)

Boyd and Flanders filed a class action lawsuit in the U.S. District Court for the Southern District of Ohio, Western Division seeking to hold Kingdom Trust and PENSCO Trust liable under the Ohio Securities Act for their alleged involvement in this scheme. The complaint alleges only that the trust companies purchased the illegal securities at the investors’ direction. It does not allege that the trust companies knew or had reason to know that Apostelos was perpetrating this fraudulent Ponzi scheme.

The district court granted a motion to dismiss filed by the trust companies, finding that in the absence of any allegations that the trust companies acted beyond routine banking activities, mere involvement in the transactions was not enough to impose liability on the trust companies under the Ohio Securities Act. The investors appealed to the Sixth Circuit, which resulted in the certified question in this case.

Read the oral argument preview of the case here and the analysis here.

Key Statutes and Precedent

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 . . .”)

R.C. 1707.43 (A) (“….every sale or contract for sale made in violation of Chapter 1707 of the Revised Code, is voidable at the election of the purchaser. 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 * * * for the full amount paid by the purchaser and for all taxable court costs * * *)

Federated Mgt. Co. v. Coopers & Lybrand, 137 Ohio App.3d 366 (10th Dist. 2000) (bank that directly participated in underwriting of investment and acted as financial adviser to issuer can be held liable under R.C. 1707.43.)

Boland v. Hammond, 144 Ohio App.3d 89 (4th Dist.2001) (defendant who relayed proposed terms of sale to investors, arranged meetings between seller and investors, and distributed promissory notes to investors can be held liable under R.C. 1707.43.)

Boomershine v. Lifetime Capital, Inc., 2008-Ohio-14 (2nd Dist.) (plaintiff failed to produce evidence that the bank played any active role in the alleged fraud, and thus was not liable.)

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

Merit Decision

Analysis

The purchase and sale of securities in Ohio is governed by the Ohio Securities Act, R.C. 1707.01, et seq. R.C. 1707.43(A), on which the certified question is based, provides that “[t]he 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 * * * for the full amount paid by the purchaser and for all taxable court costs * * *”. Limited liability companies are persons, for the purposes of the Act. Boyd and Flanders hang their hat on that “has participated in or aided the seller in any way” language.  The court doesn’t buy it.

The opinion starts with the plain language of the contested provision, finding that R.C. 1707.43(A) requires a person to have some nexus with the sale of the illegal securities, and does not extend liability to those whose only involvement is the purchase of those securities.

“Sale” and “Purchase” have separate and distinct definitions under the Ohio Securities Act. When the legislature intended to include both in any of the Act’s prohibitions, it expressly did so. Justice French provides some examples. R.C. 1707.43 does not do so.  In order to impose liability, there has to be some conduct that aided the seller in the sale of illegal securities, like acting in concert with the seller of the unlawful securities.  There was no such conduct here.  Mere participation in a transaction isn’t enough. The certified question is answered with a “no.”

A Small Bone For the Investors?

The investors had argued repeatedly that their complaint contained allegations that the trust companies acted in concert with Apostelos to effectuate the sale of his illegal securities. The court emphasized that nothing it its holding would protect a self-directed IRA custodian who did so, but emphasized that the certified question was limited to liability of a self-directed IRA custodian whose only alleged involvement was in the purchase of the illegal securities, at the owners direction. And since this case went off on a 12(B)(6) dismissal, and the Ohio high court left it to the appeals court to decide if the facts in the complaint were good enough to survive that dismissal at the pleading stage under the legal standard it announced in the case.

Concluding Observations

After argument, I predicted

“…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.”

This was an opinion which really followed the parties’ arguments. San Francisco lawyer Jahan P. Raissi, on behalf of PENSCO, was particularly effective in differentiating those provisions of the Ohio Securities Act intending to reach both sides of a transaction, from those that did not. Justice French really picked up on that in the opinion.

For the investors, Mr. Davies repeatedly cried foul that the investors hadn’t gotten a chance to develop the facts that would, according to him, show that the trust companies were complicit here. During argument, Justices DeGenaro and DeWine really pushed back on that in the context of this certified question.  Justice DeWine asked why the court shouldn’t just answer the question before it and let the district court consider the context of the particular case. Justice DeGenaro commented that the court had before it a very narrow question of law and statutory interpretation, asking how the facts could even be considered in deciding that.  The court’s opinion reflects these concerns, and leaves it to the Sixth Circuit to decide if the case goes forward. I doubt that anything will come of this.