The opinion of the court was delivered by: DUFFY
KEVIN THOMAS DUFFY, D.J.:
Plaintiff, Robert Saks Mechigian ("Mechigian"), brings this suit against various defendants alleging the following eight causes of action: (1) conspiracy to fraudulently induce investment; (2) violation of state security laws; (3) violation of federal security laws; (4) fraud, misrepresentation, and deceit; (5) innocent misrepresentation; (6) negligence; (7) breach of fiduciary duty; and (8) breach of contract. Defendants, Art Capital Corporation ("ACC") and Harris Shapiro, move to dismiss Counts Two and Three on the ground that, inter alia, these causes of action fail to state claims upon which relief can be granted. Defendants, American Contemporary Art, Inc. ("ACA"), Harry Gurwitch, F. Peter Rose, and Sigmund Rothschild, move to dismiss plaintiff's complaint in its entirety. Plaintiff opposes the motions and cross-moves for class action certification.
Plaintiff alleges in pertinent part the following facts in his class action complaint. On June 30, 1978, plaintiff purchased for $137,000 a lithographic plate for "Track Relay," an original artwork by defendant, Harry J. Schaare. Previously, "Track Relay" had been purchased from Schaare for $3,000 by the defendant promoters Shapiro, Marilyn Goldberg, and Gurwitch and their respective corporations, ACC, Marigold Enterprises, Inc., and ACA. These promoters arranged for two art appraisers, defendants Rothschild and Rose, to render their assessments of the fair market value of "Track Relay." At the June 30, 1978 closing, Rothschild and Rose stated that the current fair market value of "Track Relay" was between $165,000 and $175,000. The complaint suggests that the defendants advised the plaintiff that prints could be made from the original and could be sold for a profit. Plaintiff alleges that he was the victim of a deliberate conspiracy by all of the defendants to fraudulently induce him to purchase "Track Relay," whose actual value was in fact substantially less than $137,000. In addition, plaintiff alleges that "numerous other members of the general public constituting the class herein, entered similar transctions (sic) with defendants and purchased similar investments in a similar manner." Class Action Complaint at P28.
Following the purchase of "Track Relay," plaintiff entrusted entirely to defendants the marketing of the artwork. Plaintiff alleges that other members of the proposed class similarly relied upon the marketing efforts of defendants to produce profits.
Defendants move to dismiss plaintiff's state and federal securities causes of action on the ground that "Track Relay" is not a security and therefore the securities laws are not implicated. Section 2(1) of the Securities Act of 1933, (the "1933 Act"), 15 U.S.C. § 77b(1), defines a security as, among other things,
an investment contract. Plaintiff argues that his purchase of "Track Relay" meets the definition of an "investment contract" and thus constitutes the purchase of a security.
The elements necessary to a finding of an "investment contract" were set forth in Securities & Exchange Commission v. W.J. Howey Co., 328 U.S. 293, 298-99, 66 S. Ct. 1100, 90 L. Ed. 1244 (1946). The Supreme Court stated that "(a)n investment contract . . . means a contract, transaction or scheme whereby a person (1) invests his money (2) in a common enterprise and (3) is led to expect profits solely from the efforts of the promoter or a third party . . . ." Defendants argue that plaintiff's purchase does not constitute an investment contract because (1) it is not an investment in a "common enterprise" and (2) plaintiff was not led to expect his profits solely from the efforts of others. Because I find for the following reasons that plaintiff's purchase does not constitute an investment in a common enterprise, it is unnecessary to reach defendant's second argument.
When determining whether an investment has satisfied the "common enterprise" element of the Howey test, courts are divided on which of two basic approaches to apply: "horizontal commonality" or "vertical commonality." Courts which require "horizontal commonality," require plaintiff to show a pooling of the investors' interests in order to establish a "common enterprise." See Salcer v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 682 F.2d 459, 460 (3d Cir. 1982); Curran v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 622 F.2d 216, 222 (6th Cir. 1980), aff'd on other grounds, 456 U.S. 353, 72 L. Ed. 2d 182, 102 S. Ct. 1825 (1982); Hirk v. Agri-Research Council, Inc., 561 F.2d 96, 100-01 (7th Cir. 1977). "Horizontal commonality" clearly does not exist under the present set of facts. Nowhere does plaintiff allege that any of his funds were pooled with other investors' funds. Rather, plaintiff urges that this court adopt the second, more expansive definition of "common enterprise" and hold that "vertical commonality" is sufficient to satisfy this second prong of the Howey test. See Mordaunt v. Incomco, 686 F.2d 815, 817 (9th Cir. 1982), cert. denied, 469 U.S. 1115, 105 S. Ct. 801, 83 L. Ed. 2d 793 (1985); Securities and Exchange Commission v. Glenn W. Turner Enterprises, Inc., 474 F.2d 476, 482 n.7 (9th Cir.), cert. denied, 414 U.S. 821, 38 L. Ed. 2d 53, 94 S. Ct. 117 (1973).
There is a split in the courts that have applied the "vertical commonality" approach regarding precisely what is necessary to satisfy this standard. The courts applying the more restrictive definition state that "vertical commonality" exists where "the fortunes of the investor are interwoven with and dependent upon the efforts and success of those seeking the investment or third parties." Securities and Exchange Commission v. Glenn W. Turner Enterprises, Inc., 474 F.2d at 482 n.7 (9th Cir.), cert. denied, 414 U.S. 821, 38 L. Ed. 2d 53, 94 S. Ct. 117 (1973). Thus, the Ninth Circuit appears to require merely that there be a "direct relation between the success or failure of the promoter and that of his investors." Mordaunt v. Incomco, 686 F.2d at 817 (9th Cir. 1982), cert. denied, 105 S. Ct. 801 (1985). However, absent such a direct relation, the Ninth Circuit will not find "vertical commonality." See Meyer v. Thomas & McKinnon Auchincloss Kohlmeyer, Inc., 686 F.2d 818, 819 (9th Cir. 1982) (No "vertical commonality" in situations where "the promoter continued to profit through commissions even as the account lost money . . . (and), had the account been successful, the promoter would not necessarily have shared the benefits because (the investor) could elect to withdraw profits as they accrued."), cert. denied, 460 U.S. 1023, 75 L. Ed. 2d 495, 103 S. Ct. 1275 (1983); Brodt v. Bache & Co., 595 F.2d 459, 461 (9th Cir. 1978) ("Vertical commonality" does not exist where the brokerage house for a discretionary commodities trading account "could reap large commissions for itself and be characterized as successful, while the individual accounts could be wiped out.")
A broader definition of "vertical commonality" seems to have been articulated by the Fifth Circuit which has held that "the requisite commonality is evidenced by the fact that the fortunes of all investors are inextricably tied to the efficacy of the (promoter's efforts)." Securities & Exchange Commission v. Continental Commodities, 497 F.2d 516, 522 (5th Cir. 1974) (quoting Securities & Exchange Commission v. Koscot Interplanetary, Inc., 497 F.2d 473, 479 (5th Cir. 1974). Thus, rather than requiring a tie between the fortunes of the investors and the fortunes of the promoters, as is necessitated under the restrictive definition of "vertical commonality," the broader definition merely requires a link between the fortunes of the investors and the efforts of the promoters. Judge Robert J. Ward of this court has noted that the application of this broader definition of "vertical commonality" essentially eliminates the "common enterprise" prong of the Howey test because the only inquiry required is whether the success or failure of the investment is dependent upon the promoter's efforts -- i.e. the third prong of the Howey test. Savino v. E.F. Hutton & Co., Inc., 507 F. Supp. 1225, 1237-38 n.11 (S.D.N.Y. 1981). Because, as a practical matter, the broad definition of "vertical commonality" renders the second element of the Howey test meaningless, I must reject it as untenable. I fully concur with Judge Ward's observation that "(a)ssuming that the courts have been correct in fastening on Howey's 'common enterprise' language as an independent component in the test for the existence of an investment contract, the Court has little doubt that the broad version of vertical commonality is inconsistent with Howey." Id.
Although plaintiff asserts that "(i)t is well settled in the Second Circuit that vertical commonality alone is sufficient to create a common enterprise," Plaintiff's Memorandum Of Law In Opposition To Motions To Dismiss ("Plaintiff's Memorandum") at 17, he is unable to cite a single Second Circuit opinion in support of this proposition. Moreover, the cases which have addressed this issue in the Southern District are divided on whether "horizontal commonality" or "vertical commonality" is required, compare Darrell v. Goodson (1979-80) Fed. Sec. L. Rep. (CCH) § 97,349 at 97,325 (S.D.N.Y. 1980) ("horizontal commonality" or a "pooling of the monies of various investors . . . (is) necessary to the existence of a 'common enterprise.'") with Savino v. E.F. Hutton & Co., Inc., 507 F. Supp. at 1238 ("a 'common enterprise' should be found to exist within the meaning of Howey where there is vertical commonality . . ."); additionally, those courts which have approved of the "vertical commonality" approach are split as to whether the narrow or broad definition should be applied, compare Savino v. E.F. Hutton & Co., Inc., 507 F. Supp. at 1238 n.11 ("the Court has little doubt that the broad version of vertical commonality is inconsistent with Howey ") with Troyer v. Karcagi, 476 F. Supp. 1142, 1147-48 (S.D.N.Y. 1979) (discretionary securities trading accounts which satisfied only the broad definition of vertical commonality held "sufficient to satisfy the common enterprise component of the Howey test.")
Although plaintiff does not argue that his purchase satisfies the "horizontal commonality" test, he does apparently take the position that he meets the requirements of the narrow version of "vertical commonality." Without passing on the issue of whether the narrow definition of "vertical commonality" is sufficient to meet the "common enterprise" prong of the Howey test, or whether "horizontal commonality" is required, I find that plaintiff's purchase does not satisfy the narrow definition of "vertical commonality" and can only possibly satisfy the broad definition of "vertical commonality," I conclude that plaintiff's purchase of "Track Relay" did not constitute the purchase of a security.
With respect to the narrow version of "vertical commonality," plaintiff argues that "(t)he utilization of non-recourse financing based upon an artificially inflated purchase price created a commonality of interest between buyer and seller in the actual success of the venture." Plaintiff's Memorandum at 17. However, I am simply unpersuaded by plaintiff's reasoning that mere payment through a non-recourse note should be sufficient to catapult an ordinary purchase of art into the purchase of a security with all the concomitant ramifications of such a purchase.
Plaintiff argues that payment on this type of note "amounts to profit-sharing." Id. at 18. However, none of the cases cited by plaintiff held that a common enterprise existed because the plaintiff executed a non-recourse note. In fact, in the only Second Circuit case cited by plaintiff, the "common enterprise" issue was not even presented to the court. See Securities and Exchange Commission v. Aqua-Sonic Products Corp., 524 F. Supp. 866, 877 (S.D.N.Y. 1981), aff'd, 687 F.2d 577 (2d Cir.), cert. denied, 459 U.S. 1086, 103 S. Ct. 568, 74 L. Ed. 2d 931 (1982).
Plaintiff contends that because "the purchase price was artificially inflated over the actual value for tax purposes, and the long-term note did not reflect true economic value or consideration, payments thereon constitute actual profit to the seller, rather than a mere repayment of consideration." Plaintiff's Memorandum at 19. Plaintiff asserts that "the promoters created the false illusion of a 'pay-back' of the investment, but which in substance amounts to a sharing of profits." Id. His reasoning logically implies that good bargains will be purchases of artworks and poor bargains will be purchases of securities. I disagree. Assuming, as I must, that plaintiff's assertion that the purchase price was artificially inflated is correct, I conclude that all the plaintiff has is a bad deal possibly resulting from a fraudulent scheme by defendants.
The non-recourse note merely represents the consideration plaintiff owes defendants for the "Track Relay" and does not represent a profit-sharing arrangement simply because plaintiff feels he has been cheated. In addition, the narrow definition of "vertical commonality" requires plaintiff to show not only that the defendants' and his fortunes rise together, but also that their fortunes will fall together. See savino v. E.F. Hutton & Co., Inc., 507 F. Supp. at 1237 (narrow theory of "vertical commonality" requires "that the investment manager's fortunes rise and fall with those of the investor." (citation omitted) (emphasis supplied)). Plaintiff does not contend that defendants' fortunes will fall with his; apparently, defendants could do no worse than maintain their position after the purchase.
Thus, at best, plaintiff may only be able to satisfy the broad definition of "vertical commonality" espoused by the Fifth Circuit which merely requires the fortunes of the investor to be inextricably tied to the promoter's efforts. Given that I reject this broad version of "vertical commonality," plaintiff cannot be considered the purchaser of a security.
In sum, as plaintiff has not met either the "horizontal commonality" test or the narrow definition of "vertical commonality," he has not satisfied the "common enterprise" prong of the Howey test for investment contracts. Accordingly, plaintiff's purchase of the "Track Relay" did not constitute the purchase of a security and therefore his second and third causes of action for state and federal securities laws violations are dismissed.
The expansion of the scope of the securities laws sought by the plaintiff herein seems to me to be unwarranted and even perhaps detrimental to the common good. In our mercantile economy, we should not try to turn every "thing" which might be purchased and sold into a "security." If we did, every commercial contract would end up being enforced in the Federal Courts in what some plaintiffs and their attorneys would ...