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Houston v. Seward & Kissel

March 27, 2008

HOWARD HOUSTON, PLAINTIFF,
v.
SEWARD & KISSEL, LLP, DEFENDANT.



The opinion of the court was delivered by: Hon. Harold Baer, Jr., District Judge

OPINION & ORDER

INTRODUCTION

Howard Houston, an Oregon resident, ("Plaintiff") has sued a New York law firm, Seward & Kissel, LLP ("Defendant"), as an aider and abettor of securities fraud and the unlawful sale of unregistered securities in violation of Oregon's securities laws, ORS §§ 59.115(1)(a), (b), 59.135, 59.137. The Plaintiff alleges that the firm is responsible for his $2.75 million investment loss due to its role in connection with the offering documents which contained material misrepresentations and omissions for the Wood River Partners, LP ("Wood River"), a hedge fund in which Plaintiff had invested. Wood River's principal, John Whittier, has pleaded guilty to violations of federal securities laws and the Fund is now in receivership. The Defendant moves to dismiss the claims arguing that federal law preempts Oregon's securities fraud provisions, and in any event, these provisions run afoul of the Dormant Commerce Clause; and finally that the Wood River securities are specifically exempt from Oregon's securities registration requirements. Because I find that the Oregon securities fraud statutes are not preempted by federal securities law and do not violate the Commerce Clause, but that the Plaintiff has failed to properly allege that the Wood River securities are not federally covered securities, Defendant's motion to dismiss the claims is DENIED in part and GRANTED in part.

I. FACTUAL BACKGROUND

Wood River Partners, L.P. ("Wood River") is a hedge fund that was run by John Whittier. (Compl. ¶ 15(a).) In late 2004, Wood River sent a Confidential Summary about the Fund to the Plaintiff. It described the Fund and its investment strategy and goals. (Compl. ¶ 7.)

In January 2005, the Plaintiff received a prospectus, partnership agreement, and subscription agreement for a Wood River investment. (Compl.¶ 8.) The prospectus described the types and number of investments that Wood River would hold, including a representation that the Fund would be diversified. (Compl.¶¶ 8, 9.) Wood River also represented in its prospectus that it appointed American Express Tax and Business Services as its auditor, investors would receive quarterly financial reports prepared in accordance with Generally Accepted Accounting Principles, and its books and records would be audited annually. (Compl. ¶11.) Wood River listed Seward & Kissel as legal counsel and that its opinions as to the legality of the offering would be made available to investors. (Compl.¶ 10.)

After reviewing these materials, the Plaintiff decided to invest in Wood River. (Compl.¶ 10.) Although the Prospectus stated that the minimum investment was $1 million, Whittier allowed Plaintiff to make an initial investment of $250,000 with the understanding that he would make additional investments so long as the Plaintiff was satisfied with Wood River's performance. (Compl.¶ 13.) Following his initial investment in February 2005, the Plaintiff continued to invest in Wood River on a monthly basis through September 2005, for a total combined investment of $2.75 million. (Compl.¶ 13.)

In the beginning of 2004, Wood River began to accumulate stock in EndWave, a technology company and continued to do so until by the summer of 2005, 68% of Wood River's assets were comprised of EndWave stock, which contravened the representations that it would be a diversified fund that would not invest more than 10% of its portfolio in any one security. (Compl.¶ 15(b).) EndWave's share price began to decline and by mid-September had lost almost 50% of its value, resulting in a considerable decline in Wood River's total asset value. (Compl.¶ 15(e).) Wood River was unable to honor redemption requests due to this decrease in value. (Compl.¶¶ 15(e)-(f).) Consequently, Plaintiff lost his $2.75 million investment in Wood River.

Wood River and Whittier are parties to civil action by the Securities and Exchange Commission for fraud and misrepresentations.*fn1 The Fund was placed into receivership. (Compl. ¶ 1.) On July 10, 2007, Plaintiff filed this complaint against Seward & Kissel because the firm prepared the Fund's offering documents which allegedly contained false representations and omitted material facts about Whittier and the firm allowed its name to be used in the prospectus. (Compl. ¶¶ 2, 3.)

The Plaintiff makes three claims. First, the Plaintiff alleges that the Defendant participated in or materially aided in the fraudulent sale of securities to the Plaintiff because it drafted, edited and/or reviewed and approved the prospectus and marketing materials which allegedly contained material misrepresentations and omissions in violation of Oregon securities law ORS §§ 59.115 1(b)*fn2 and 59.135(1), (2), ( 3).*fn3 (Compl. ¶¶ 17-24.) Second, because it allegedly participated in or materially aided in the first claim, the Defendant is liable to the Plaintiff as purchaser of the security for actual damages including interest at 9% under ORS § 59.137(1).*fn4 (Compl. ¶¶ 25-29.) Third, the Defendant allegedly participated in or materially aided in the sale of unregistered securities in Oregon in violation of § 59.115(1)(a)*fn5 because the Wood River securities are not federally covered securities or otherwise exempt under ORS §59.055.*fn6 (Compl. ¶¶ 30-39.)

The Defendant moved to dismiss the Plaintiff's complaint on August 31, 2007. The Defendant argues that federal law under the National Securities Markets Improvement Act (the "NSMIA") preempts state regulation of offering materials in relation to securities, the Oregon securities laws violate the Commerce Clause because they impermissibly regulate out of state conduct, and the unregistered securities were expressly exempt from registration under Oregon law. In addition, the Defendant argues that the Plaintiff fails to plead fraud with the requisite particularity required under Fed. R. Civ. P. 9(b) and that the Plaintiff's complaint includes several legal conclusions fatal to its allegations. Argument on the motion was held on November 13, 2007. For the reasons noted below, I DENY the Defendant's motion to dismiss as to the Plaintiff's claims for aiding and abetting securities fraud under ORS §§ 59.115(1)(b), 59.135(1),(3), and 59.137(1) but GRANT the Defendant's motion to dismiss the claim for unlawful sale of unregistered securities under § 59.115(1)(a).

II. RULE §§ 12(b)(6) STANDARD AND RULE 9(b)

A motion to dismiss will not be granted unless it "appears beyond doubt that the plaintiff can prove no set of facts in support of his claim which would entitle him to relief." Conley v. Gibson, 355 U.S. 41, 45 (1957). In considering a motion to dismiss for failure to state a claim under Federal Rules of Civil Procedure 12(b)(6) and 9(b), this Court must view the factual allegations in the light most favorable to the non-movant. Gant v. Wallingfor Bd. Of Educ., 69 F.3d 669, 673 (2d Cir. 1995). The facts alleged in the complaint are assumed to be true. See Allen v Westpoint-Pepperell, Inc., 945 F.2d 40, 44 (2d Cir. 1991).

Rule 9(b) requires that "in all averments of fraud or mistake, the circumstances constituting fraud or mistake shall be stated with particularity." Fed. R. Civ. P. 9(b). Rule 9(b) requires the identification and circumstances constituting the fraud; mere conclusory allegations of fraud will not suffice, but statements of the time, place, and nature of the alleged fraudulent activities will. Riley, 612 F. Supp. at 677; see also SEC v. Lyon, 06cv14338, 2008 WL 53102, at *4 (S.D.N.Y. Jan. 2, 2008) (a complaint alleging fraud must "(1) specify the statements that the plaintiff contends were fraudulent, (2) identify the speaker, (3) state where and when the statements were made, and (4) explain why the statements were fraudulent").

III. DISCUSSION

At issue in this case is the application of Oregon Blue Sky Laws governing fraud and deceit to a law firm located in New York that prepared documents for a non-public stock offering and that may or may not have been aware of the offeror's wrongful acts. Oregon's Blue Sky laws create a private right of action for securities fraud and violation of registration rights, but also establish derivative liability for aiders and abettors. ORS §§ 59.115(1)(a), (b), (3). Defendants challenge any allegations of fraud based on two principal arguments. First, the securities here are "federally covered securities" and the Plaintiff's allegations that they do not qualify are mere legal conclusions and unsupported by any factual allegations. Therefore any and all statements made in offering materials are regulated exclusively by NSMIA and the Oregon blue sky laws are preempted. Second, the Oregon securities fraud regime is unconstitutional because it permits derivative liability against out-of-state parties who may not even be aware of the fraudulent acts or representations made by the principal wrongdoer and, thus, improperly regulates inter-state commerce and undermines an efficient national securities market.

But this case is about fraud by the principals, Whittier and Wood River, and NSMIA specifically preserves state power to regulate securities fraud for federally covered securities. Congress and the courts, most recently the Supreme Court in dicta,*fn7 have repeatedly recognized state authority to regulate and enforce its own fraud statutes in the securities realm independent of federal law. With respect to the sale of unregistered securities claim, the Defendant also relies upon federally covered status or in the alternative, Oregon's other exemptions to dismiss this claim. Again, the Defendant relies upon the Plaintiff's failure to allege any facts that the securities are not federally covered or any facts that eviscerate application of Oregon's own state-based exemptions.

A. NSMIA Does Not Preempt Oregon's Securities Fraud Statutes

1. Express Preemption

The Defendant argues that the Fund is covered by the NSMIA,*fn8 a federal statute, and the Oregon securities or Blue Sky laws at issue here are thus preempted. (Def. Mem. of Law in Supp. Mot. to Dismiss ("Def. Mem.") 9-10.) Though NSMIA was enacted to promote efficiency, competition, and capital formation in the capital market, and as well, to designate the federal government as the exclusive regulator of national offerings of securities, H.R. Rep. No. 104-622, at 16 (1996), I have found nothing in the history of the legislation that preempts state oversight of fraud or deceit in the securities realm.

A plain reading of the statute shows that NSMIA's preemption of state securities law is limited to precluding states from imposing disclosure requirements in prospectuses, traditional offering documents and sales literature relating to covered securities. Zuri-Invest A.G. v. Natwest Finance, Inc., 177 F. Supp. 2d 189, 192 (S.D.N.Y. 2001). NSMIA's scope of preemption is explicitly stated as follows:

(a) No law, rule, regulation, order, or other administrative action of any State or any political ...


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