Dealers of investment contracts forced to disgorge sales commissions.

Warfield v. Alaniz, US App Lexis 13531 (2009)

The Mid-America Foundation, controlled by Robert Dillie, sold annuities promising to provide income for the life of a person in being, with the remainder delivered to the charity of their choosing after death. After $55 million in sales, and no charity ever receiving a benefit, Mid-America was outed as a Ponzi scheme. Upon the Security and Exchange Commission's filing a complaint against Dillie, Lawrence Warfield became the court appointed receiver of Mid-America.

Warfield successfully sued those who sold the annuities and recovered the commissions earned on the sales of Mid-America annuities. The defendants appealed, and the appellate court reviewed the trial court determination that the annuities were investment contracts. The court relied upon SEC v. Rubera, 350 F3d 1084, 1090 which defines an investment contract as, "(1) an investment of money; (2) in a common enterprise; (3) with an expectation of profits produced by the efforts of others." The Mid-America annuities fit into this definition and were held to be investment contracts, and the appellate court affirmed the trial court's decisio, disgorging the sales commissions from the annuity salespersons.

Broker-dealers, beware. Know what you are selling and for whom you are selling.

Proving a breach of fiduciary duty by a securities broker-dealer becomes easier.

Oravecz v. New York Life Ins. Co., 174 CA4th 174 (2009)

Court of Appeal of the State of California

Second Appellate District

Division One

Oravecz bought investment securities in Tradex through broker-dealer Steve Roth, allegedly an employee of New York Life Insurance Company. What Oravecz believed to be an offshore trading fund was actually a Ponzi scheme. When the Ponzi scheme collapsed, and Oravecz had lost the money invested in Tradex, Oravecz sued New York Life alleging several causes of action, including breach of fiduciary duty.

New York Life successfully demurred on each of Oravecz's causes of action and was awarded summary judgment. The trial court based its decision to sustain the demurrer on the breach of fiduciary duty cause of action because, under federal law [e.g., Independent Order v. Donald, Lufkin & Jenrette, 157 F3d 933 (1998)], a fiduciary duty only arises when the investor gives discretion to chose investments and control trading authority.

Oravecz appealed, and the appellate court held that the trial court had correctly ruled on the existence of summary judgment under the federal law, but under California common law the investor need not provide a showing of discretion or control by the securities broker. As such, the trial court erred in finding that Oravecz's allegations did not sufficiently allege a claim for breach of fiduciary duty.

The federal requirement that a broker-dealer have discretion and control over an investor's assets for a breach of fiduciary duty to be owed is a reasonable standard. If not for such a duty, negligent and careless decisions by broker-dealers failing to conduct reasonable due diligence would carry few consequences. That California has no such requirement of discretion and control in effect makes each broker-dealer a babysitter for each investor, and begins a shift of responsibility to conduct due diligence away from the party making investment decisions and onto the broker. The slope is steep and icy, broker-dealers, be careful where you step.