Opinion
No. X07 CV 10 6010227 S
September 7, 2011
MEMORANDUM OF DECISION
I
On April 21, 2010, the plaintiff, the state banking commissioner, Howard F. Pitkin, filed the instant action against the defendants, Westport National Bank (WNB), PSCC Services, Inc., a Connecticut corporation (PSCC), and Robert L. Silverman, PSCC's president and director. All of the plaintiff's allegations concern monies that PSCC's clients deposited with WNB that was invested with and subsequently lost by Bernard L. Madoff and his company, Bernard L. Madoff Investment Securities (BLMIS). Madoff and BLMIS are not defendants in this action.
The plaintiff seeks restitution, disgorgement and civil penalties, among other things, for alleged securities violations by the defendants. Specifically, the plaintiff alleges in the first count of the amended complaint, filed September 14, 2010, that WNB violated the Connecticut Uniform Securities Act (CUSA), General Statutes § 36b-4, by engaging in fraudulent and unethical practices; in the second count, that Silverman and PSCC violated § 36b-4 for somewhat similar acts; in the third count, that Silverman and PSCC violated General Statutes § 36b-6(c)(1) by acting as unregistered investment advisers in the state; in the fourth count, that Silverman and PSCC engaged in fraudulent and dishonest practices by failing to provide required disclosures pursuant to General Statutes § 36b-5(b)(1); in the fifth count, that all of the defendants violated General Statutes § 36b-16 by selling unregistered securities; and, in the sixth count, that Silverman violated General Statutes § 36b-6(a) and WNB violated General Statutes § 36b-6(b) by acting as unregistered agents.
Section 36b-4, in relevant part, provides: "(a) No person shall, in connection with the offer, sale or purchase of any security, directly or indirectly: (1) Employ any device, scheme or artifice to defraud; (2) make any untrue statement of a material fact or omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they are made, not misleading; or (3) engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person.
"(b) No person shall, in connection with the offer, sale or purchase of any security, directly or indirectly engage in any dishonest or unethical practice . . ."
Section 36b-6(c)(1), in relevant part, provides: "No person shall transact business in this state as an investment adviser unless registered as such by the commissioner as provided in sections 36b-2 to 36b-34, inclusive, or exempted pursuant to subsection (e) of this section . . ."
Section 36b-5(b)(1), in relevant part, provides: "It is unlawful for any investment adviser that is registered or required to be registered under sections 36b-2 to 36b-34, inclusive, to have, enter into, extend or renew any investment advisory contract, whether written or oral, unless it is signed by the client or clients and discloses in writing: (A) That the investment adviser shall not be compensated on the basis of a share of capital gains upon or capital appreciation of the funds or any portion of the funds of the client; (B) that an assignment of the contract may not be made by the investment adviser without the consent of the other party to the contract; (C) that the investment adviser, if a partnership, shall notify the other party to the contract of any change in the membership of the partnership within a reasonable time after the change; (D) the fee arrangement between the investment adviser and the client or clients; and (E) the services which the investment adviser will render . . ."
Section 36b-16 provides: "No person shall offer or sell any security in this state unless (1) it is registered under sections 36b-2 to 36b-34, inclusive, (2) the security or transaction is exempted under section 36b-21, or (3) the security is a covered security provided such person complies with any applicable requirements in subsections (c), (d) and (e) of section 36b-21."
Section 36b-6(a), in relevant part, provides: "No person shall transact business in this state as a broker-dealer unless such person is registered under sections 36b-2 to 36b-34, inclusive . . . No individual shall transact business as an agent in this state unless such individual is (1) registered as an agent of the broker-dealer or issuer whom such individual represents in transacting such business, or (2) an associated person who represents a broker-dealer in effecting transactions described in subdivisions (2) and (3) of Section 15(h) of the Securities Exchange Act of 1934 . . ."
Section 36b-6(b) provides: "No issuer shall employ an agent unless such agent is registered under sections 36b-2 to 36b-34, inclusive. No broker-dealer shall employ an agent unless such agent is (1) registered under sections 36b-2 to 36b-34, inclusive, or (2) an associated person who represents a broker-dealer in effecting transactions described in subdivisions (2) and (3) of Section 15(h) of the Securities Exchange Act of 1934. The registration of an agent is not effective during any period when such agent is not associated with a particular broker-dealer registered under sections 36b-2 to 36b-34, inclusive, or a particular issuer. When an agent begins or terminates a connection with a broker-dealer or issuer, or begins or terminates those activities which make such individual an agent, both the agent and the broker-dealer or issuer shall promptly notify the commissioner."
On November 1, 2010, Silverman and WNB filed motions to strike the counts of the amended complaint as they applied to them. The defendants both argue that the plaintiff fails to state claims upon which relief may be granted because the allegations against them do not involve securities and are, therefore, not violations of CUSA. WNB further maintains that the counts against it are preempted by federal law.
PSCC has not filed an appearance in this action and, therefore, the "defendants" in this memorandum of decision refers to Silverman and WNB.
The plaintiff filed memoranda in opposition on December 17, 2010 arguing that the amended complaint properly sets forth causes of action involving securities. He further maintains that these counts are not preempted by federal law because false and misleading statements during the offer of the sale of securities are not authorized by federal law and because his prosecution of his claims does not interfere with the federal regulatory scheme. On February 2, 2011, the defendants filed reply memoranda. The court heard oral argument on the motions to strike on May 23, 2011.
On March 31, 2011, Silverman filed a notice of bankruptcy. While the court temporarily stayed proceedings, Silverman filed a pleading on April 28, 2011 acknowledging that the automatic stay provision of 11 U.S.C. § 362 did not apply to these proceedings. On May 13, 2011, Silverman filed an appearance in lieu of counsel.
Silverman did not appear at argument.
II
"A motion to strike challenges the legal sufficiency of a pleading . . . and, consequently, requires no factual findings by the trial court . . . We take the facts to be those alleged in the complaint . . . and we construe the complaint in the manner most favorable to sustaining its legal sufficiency . . . [I]f facts provable in the complaint would support a cause of action, the motion to strike must be denied . . . Thus, we assume the truth of both the specific factual allegations and any facts fairly provable thereunder. In doing so, moreover, we read the allegations broadly . . . rather than narrowly . . . If facts provable in the complaint would support a cause of action, the motion to strike must be denied." (Citations omitted; internal quotation marks omitted.) Sturm v. Harb Development, LLC, 298 Conn. 124, 130, 2 A.3d 859 (2010).
"[A] motion to strike is essentially a procedural motion that focuses solely on the pleadings . . . It is, therefore, improper for the court to consider material outside of the pleading that is being challenged by the motion." (Internal quotation marks omitted.) Dlugokecki v. Vieira, 98 Conn.App. 252, 256, 907 A.2d 1269, cert. denied, 280 Conn. 951, 912 A.2d 483 (2006). "Where the legal grounds for such a motion are dependent upon underlying facts not alleged in the plaintiff's pleadings, the defendant must await the evidence which may be adduced at trial, and the motion should be denied." Liljedahl Bros., Inc. v. Grigsby, 215 Conn. 345, 348, 576 A.2d 149 (1990). "A 'speaking' motion to strike (one imparting facts outside the pleadings) will not be granted." Doe v. Marselle, 38 Conn.App. 360, 364, 660 A.2d 871 (1995), rev'd on other grounds, 236 Conn. 845, 675 A.2d 835 (1996).
III
Because all of the counts against WNB are alleged to be violations of CUSA, it argues that the amended complaint should be stricken because the plaintiff's proposed application of CUSA conflicts with, and is therefore preempted by, federal law. It also maintains that the investment vehicles utilized by WNB do not constitute securities under CUSA. Silverman joins in the latter argument.
The plaintiff alleges the following additional, relevant facts in his amended complaint. Silverman, who holds a master's degree in actuarial science and has worked as an actuary, created the predecessor of PSCC in 1969 to manage pension and employee benefits for small businesses. In 1986, he had a relationship with another, unrelated bank, Westport Bank and Trust Company (WEBAT), in which clients pooled monies and invested with Madoff. In 1996, WEBAT merged with Lafayette American Bank and Trust Company (Lafayette) and Lafayette merged with Hudson United Bank (Hudson) in 1999. Hudson decided to leave the institutional custodial market and Silverman incorporated PSCC which entered into a formal agreement with WNB in July 1999.
As part of the arrangement, WNB opened a brokerage account and options account with BLMIS in WNB's name. WNB created two investment vehicles, known as BLM 1 and BLM 2, to pool together the monies of PSCC clients for investment with BLMIS through WNB's accounts with BLMIS. WNB entered into a custodian agreement with each of PSCC's clients which provided, among other things, that the client chose "BLMIS to receive and to invest [the client's] funds, and has not relied on [WNB] to give BLMIS full discretionary authority." Clients received "shares" or "units" of the funds in proportion to the amount of money that was invested. Pursuant to the agreement, WNB sent monies deposited by PSCC's clients to BLMIS, collected fees for doing so and provided statements to PSCC's clients concerning their investments.
The plaintiff alleges that BLM 1 was used for clients investing through an employee benefit plan while BLM 2 was used for clients investing through individual retirement accounts.
The custodian agreement and the "Description of Investment Process" agreement that the plaintiff refers to in his amended complaint are conspicuously not annexed to it. The defendants take exception to this pointing out that the plaintiff quotes highly selective provisions of the custodian agreement in the complaint and they comment that the plaintiff, as a public official, should maintain a higher standard. The defendants urge the court to take judicial notice of the agreements and to look to sensible federal court authority for the proposition that such critical documents should be considered in deciding motions such as the one at issue here. See Mangiafico v. Blumenthal, 471 F.3d 391, 398 (2d Cir. 2006) ("[e]ven where a document is not incorporated by reference [in the complaint], the court may nevertheless consider it where the complaint relies heavily upon its terms and effect, which renders the document integral to the complaint" [internal quotation marks omitted]). Nevertheless, Connecticut courts have yet to adopt this practice and this court is constrained to consider the motion to strike based only on the allegations of the amended complaint. See Sturm v. Harb Development, LLC, supra, 298 Conn. 130; Oxer v. Milani, Superior Court, judicial district of Stamford/Norwalk at Stamford, Docket No. 93 0130487 (October 12, 1994, Mottolese, J.) ( 9 C.S.C.R. 1161, 1161) (refusing to consider contract that was not part of complaint in ruling on motion to strike).
A.
The plaintiff alleges that the defendants engaged in improper and fraudulent practices related to the creation, offer and sale of securities in violation of CUSA. The defendants move to strike the counts of complaint on the grounds that the plaintiff fails to state claims against them because the investment vehicles, i.e., BLM 1 and BLM 2, were not securities, but were simply record keeping designations. In response, the plaintiff argues that the defendants have filed a speaking motion to strike. This court agrees with the plaintiff — the court cannot look beyond the pleadings at this time to determine whether BLM 1 or BLM 2 were merely record keeping designations. See footnote 11 of this opinion. Nevertheless, it analyzes whether the plaintiff has alleged securities.
General Statutes § 36b-3(19) of CUSA defines security as "any note, stock, treasury stock, security future, bond, debenture, evidence of indebtedness, certificate of interest or participation in any profit-sharing agreement, interests of limited partners in a limited partnership, collateral-trust certificate, preorganization certificate or subscription, transferable share, investment contract, voting-trust certificate, certificate of deposit for a security, fractional undivided interest in oil, gas or other mineral rights, put, call, straddle, option, or privilege on any security or group or index of securities, including any interest in or based on the value of such security, group or index, put, call, straddle, option or privilege entered into on a national securities exchange relating to foreign currency, or, in general, any interest or instrument commonly known as a 'security,' or any certificate of interest or participation in, temporary or interim certificate for, receipt for, guarantee of, or warrant or right to subscribe to or purchase, any of the foregoing. 'Security' includes (A) a certificated and an uncertificated security, and (B) as an 'investment contract,' an interest in a limited liability company or limited liability partnership, but does not include any insurance or endowment policy or annuity contract issued by an insurance company that is subject to regulation by the Insurance Commissioner." (Emphasis added.)
"When construing a statute, [o]ur fundamental objective is to ascertain and give effect to the apparent intent of the legislature . . . In other words, we seek to determine, in a reasoned manner, the meaning of the statutory language as applied to the facts of [the] case, including the question of whether the language actually does apply . . . In seeking to determine that meaning, General Statutes § 1-2z directs us first to consider the text of the statute itself and its relationship to other statutes. If, after examining such text and considering such relationship, the meaning of such text is plain and unambiguous and does not yield absurd or unworkable results, extratextual evidence of the meaning of the statute shall not be considered . . . When a statute is not plain and unambiguous, we also look for interpretive guidance to the legislative history and circumstances surrounding its enactment, to the legislative policy it was designed to implement, and to its relationship to existing legislation and common law principles governing the same general subject matter . . ." (Internal quotation marks omitted.) Mayfield v. Goshen Volunteer Fire Co., 301 Conn. 739, 744, 22 A.3d 1251 (2011).
CUSA does not define the term "investment contract." "[A]n investment contract for purposes of the Securities Act means a contract, transaction or scheme whereby a person invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or a third party . . . It permits the fulfillment of the statutory purpose of compelling full and fair disclosure relative to the issuance of the many types of instruments that in our commercial world fall within the ordinary concept of a security . . . [Such a definition] embodies a flexible rather than a static principle, one that is capable of adaptation to meet the countless and variable schemes devised by those who seek the use of the money of others on the promise of profits." (Citation omitted.) S.E.C. v. W.J. Howey Co., 328 U.S. 293, 298-99, 66 S.Ct. 1100, 90 L.Ed. 1244 (1946); see also United States v. Leonard, 529 F.3d 83, 88 (2d Cir. 2008).
In the amended complaint in paragraph twenty-eight, the plaintiff alleges that BLM 1 and BLM 2 were two funds "in which WNB pooled together the funds of clients for ultimate investment with BLMIS." Reading this allegation broadly, the court construes BLM 1 and BLM 2 as securities as they conceivably fall under the definition of investment contract — a scheme in which PSCC's clients pooled their monies through WNB expecting to profit from the third party efforts of BLMIS. Therefore, the plaintiff has alleged that BLM 1 and BLM 2 were securities.
Nevertheless, WNB argues that the court should not consider the investments to be securities because the definitions in § 36b-3 are all qualified by the phrase "unless the context otherwise requires." It maintains that BLM 1 and BLM 2 should not be considered securities in context.
"Although CUSA and the federal securities laws are not identical, in interpreting CUSA it is instructive to look to rulings of the federal courts interpreting federal securities law, particularly where the language of CUSA is similar to that of the federal law." Rota v. Colonial Realty/USA Corp., Superior Court, judicial district of Hartford, Docket No. CV 92 0505840 (July 16, 1996, Aurigemma, J.), citing Connecticut National Bank v. Giacomi, 233 Conn. 304, 322, 659 A.2d 1166 (1995). In Marine Bank v. Weaver, 455 U.S. 551, 558-59, 102 S.Ct. 1220, 71 L.Ed.2d 409 (1982), the court addressed the definition of "security" and the clause "unless the context otherwise requires" under § 3(a)(10) of the Securities Exchange Act of 1934, as set forth in 15 U.S.C. § 78c(a)(10), in a case involving certificates of deposit insured by the FDIC. In context, the court held that the certificates of deposit were not securities under the Exchange Act, even though the definition of "securities" included the term "certificate of deposit." Id., 559. The court was examining, however, the facts of the case in connection with a motion for summary judgment. Id., 554. The court qualified its holding in dicta, "It does not follow that a certificate of deposit or business agreement between transacting parties invariably falls outside the definition of a 'security' as defined by the federal statutes. Each transaction must be analyzed and evaluated on the basis of the content of the instruments in question, the purposes intended to be served, and the factual setting as a whole." (Emphasis added.) Id., 560 n. 11.
Section 3(a)(10) of the 1934 Act, as set forth in 15 U.S.C. § 78c(a)(10), provides: "(a) . . . When used in this chapter, unless the context otherwise requires . . .
"The term 'security' means any note, stock, treasury stock, security future, bond, debenture, certificate of interest or participation in any profit-sharing agreement or in any oil, gas, or other mineral royalty or lease, any collateral-trust certificate, preorganization certificate or subscription, transferable share, investment contract, voting-trust certificate, certificate of deposit for a security, any put, call, straddle, option, or privilege on any security, certificate of deposit, or group or index of securities (including any interest therein or based on the value thereof), or any put, call, straddle, option, or privilege entered into on a national securities exchange relating to foreign currency, or in general, any instrument commonly known as a 'security'; or any certificate of interest or participation in, temporary or interim certificate for, receipt for, or warrant or right to subscribe to or purchase, any of the foregoing; but shall not include currency or any note, draft, bill of exchange, or banker's acceptance which has a maturity at the time of issuance of not exceeding nine months, exclusive of days of grace, or any renewal thereof the maturity of which is likewise limited."
Here, the survival of the counts of the amended complaint as all of the counts are alleged to be violations of CUSA depend on whether the investments were securities on the basis of the content of the agreements and in the context of the facts as a whole. See id. As explained above, the court cannot examine the content of the agreements or the facts at this stage. Therefore, the defendants' motions to strike are denied.
B.
WNB also argues that the plaintiff cannot assert his claims because his application of CUSA conflicts with federal law. More specifically, WNB maintains that the plaintiff cannot seek to punish WNB under state law for something it is allowed to do as a federally chartered bank pursuant to federal law. The plaintiff counters that false and misleading statements during the offer of the sale of securities are not authorized by federal law and that prosecution of his claims does not interfere with the federal regulatory scheme.
As a threshold issue, the plaintiff argues that the court should not address preemption until a later date as General Statutes § 36b-21(g) provides that "the burden of proving an exemption, preemption, exclusion or an exception from a definition is upon the person claiming it." Courts have considered, however, preemption prior to the summary judgment stage. See, e.g., Farina v. Nokia, Inc., 625 F.3d 97, 134 (3d Cir. 2010) (affirming dismissal of state law claims that conflicted with federal regulations); Iowa Public Employees' Retirement System v. MF Global, Ltd., 620 F.3d 137, 145 (2d Cir. 2010) ("[a]n affirmative defense may be raised by a pre-answer motion to dismiss . . . if the defense appears on the face of the complaint" [internal quotation marks omitted]); see also Violano v. Fernandez, 280 Conn. 310, 321, 907 A.2d 1188 (2006) ("[w]here it is apparent from the face of the complaint that the municipality was engaging in a governmental function while performing the acts and omissions complained of by the plaintiff, the defendant is not required to plead governmental immunity as a special defense and may attack the legal sufficiency of the complaint through a motion to strike" [internal quotation marks omitted]).
"The question of preemption is one of federal law arising under the supremacy clause of the United States constitution . . . Determining whether Congress has exercised its power to preempt state law is a question of legislative intent . . . The Supreme Court has limited preemption to three circumstances . . . First, state law is preempted when Congress has made its intent known through explicit statutory language . . . Second, a state law implicitly is preempted when it regulates conduct in a field that Congress intended the [f]ederal [g]overnment to occupy exclusively . . . The intent to occupy a particular field may be inferred from a scheme of federal regulation . . . so pervasive as to make reasonable the inference that Congress left no room for the [s]tates to supplement it, or where an [a]ct of Congress touch[es] a field in which the federal interest is so dominant that the federal system will be assumed to preclude enforcement of state laws on the same subject . . .
"Third, and finally, a state law may be preempted when it is impossible for a private party to comply with both state and federal law . . . and where under the circumstances of [a] particular case, [the challenged state law] stands as an obstacle to the accomplishment and execution of the full purposes and objectives of Congress . . . What is a sufficient obstacle is a matter of judgment, to be informed by examining the federal statute as a whole and identifying its purpose and intended effects." (Citations omitted; internal quotation marks omitted.) Connecticut Coalition Against Millstone v. Connecticut Siting Council, 286 Conn. 57, 69-71, 942 A.2d 345 (2008).
WNB argues conflict preemption, but in order to address that argument the court must examine the facts of the case to determine if, under the facts presented here, CUSA is an obstacle to federal banking law regarding custodian agreements. See id. Specifically, it must be determined whether BLM 1 and BLM 2 were securities and/or whether WNB was only involved in the administration of custodian agreements, which WNB argues it was authorized to do under federal law. The court cannot assume, however, such facts and reach this argument on a motion to strike. See Liljedahl Bros., Inc. v. Grigsby, supra, 215 Conn. 348.
Accordingly, the defendants' motions to strike are denied.
WNB also argues that the plaintiff failed to plead that the investments at issue "would have been subject to CUSA's registration requirements had they been securities" as to the fifth count; that WNB employed Silverman or was its agent as to the sixth count; and that "WNB's allegedly fraudulent conduct was anything more than a breach of contract between private parties" as to the first count. Construing the amended complaint broadly, these facts are implied. See Violano v. Fernandez, supra, 280 Conn. 318 ("[w]hat is necessarily implied [in an allegation] need not be expressly alleged" [internal quotation marks omitted]).