MOLLY A. HAYS vs. DAVID J. ELLRICH & others.
SJC-11753
Supreme Judicial Court of Massachusetts
June 10, 2015
471 Mass. 592 (2015)
Suffolk. February 3, 2015. - June 10, 2015. Present: GANTS, C.J., SPINA, CORDY, BOTSFORD, DUFFLY, LENK, & HINES, JJ.
In a civil action arising from losses incurred when a “hedge fund” became insolvent, the judge did not err in finding that the individual defendant‘s solicitation of the plaintiff to purchase the securities in question made him a seller within the meaning of the Massachusetts Uniform Securities Act,
There was no merit to a claim that a civil action arising from losses incurred when a “hedge fund” became insolvent was not timely brought within the four-year period of limitations set forth in
In a civil action arising from losses incurred when a “hedge fund” became insolvent, alleging, inter alia, common-law claims of fraud and breach of fiduciary duty, the evidence was more than sufficient to support the finding that the defendant‘s misrepresentations and omissions were material (in that they strongly suggested that the securities in question were a suitable investment for the plaintiff) [608-609], and that the securities were not a suitable investment for the plaintiff [609].
CIVIL ACTION commenced in the Superior Court Department on September 11, 2006.
Morgan Financial Advisors, Inc. (MFA), and U.S. Bank National Association (U.S. Bank). U.S. Bank is not a party to this appeal.
The Supreme Judicial Court on its own initiative transferred the case from the Appeals Court.
David B. Mack (Stephanie R. Parker with him) for the defendants.
Patrick J. Dolan for the plaintiff.
GANTS, C.J. In January, 2001, in reliance on the advice of her investment advisor, the plaintiff, Molly A. Hays, invested approximately three-quarters of her retirement savings in a “hedge fund” that became insolvent in 2003, resulting in the loss of her entire investment. In 2006, Hays filed suit in the Superior Court, alleging that her investment advisor, Morgan Financial Advisors, Inc. (MFA), and David J. Ellrich, the sole owner and officer of MFA, had, among other claims, violated the Massachusetts Uniform Securities Act (act),
On appeal, Ellrich and MFA claim that they were not “sellers” of securities within the meaning of
Background. We summarize the findings of fact made by the judge, supplemented where necessary by uncontested evidence in the record that the judge implicitly credited. See Commonwealth v. Isaiah I., 448 Mass. 334, 337 (2007), S.C., 450 Mass. 818
In approximately 1991, when Ellrich was employed by another investment advisory firm, Hays and her husband retained Ellrich as an investment advisor to manage some of their funds. Before her husband‘s death in 1993, Ellrich communicated almost exclusively with Hays‘s husband, and rarely with her. Shortly after her husband‘s death, Hays met with Ellrich to discuss the management of the individual retirement account (IRA) she had inherited, which totaled approximately $310,000 at the time.5 Hays told Ellrich that she needed income but wanted to remain at home with her five year old daughter. Ellrich told Hays, who was forty-one years old in 1993, that she could elect to make periodic withdrawals from the IRA without a tax penalty at the maximum rate permitted under
From 1993 to 1999, Hays directed Ellrich to employ a “moderate growth and income” investment strategy, which he implemented, maintaining an equities-to-fixed-income ratio of approximately seventy-five per cent to twenty-five per cent. Ellrich pursued a “market-timing” strategy for the equities portion of Hays‘s investment account, which, by 2000, was invested in funds at Rydex Series Trust (Rydex) and at Profunds Investments (Profunds). He pursued a “buy and hold” strategy for the fixed income portion, which was invested in long-term investment vehicles maintained by Fidelity Investments (Fidelity).7 Hays had no investment experience and had relied upon Ellrich as her financial advisor since her husband‘s death; during that time period, she made no investment without Ellrich‘s advice.
In 2000, after Ellrich had registered MFA as an investment
Also in 2000, Ellrich was approached by Richard Furber about becoming the investment advisor to Convergent Market Funds (Convergent), a new “hedge fund” Furber was creating.8 Ellrich agreed in September, 2000, to become the investment advisor to one or more Convergent funds, and MFA executed an investment advisor agreement with Convergent‘s general partner, Emerging Health Capital Partners LLC (EHCP). Ellrich determined that, as Convergent‘s investment advisor, he would no longer “have the time or resources” to perform market-timing services for individual accounts, and needed to terminate MFA‘s advisory business for all of his individual market-timing accounts. In December, 2000, he spoke with each of his approximately 150 individual clients, including Hays, to tell them that those services would be terminating as of December 31, 2000.
During Ellrich‘s conversation with Hays, he explained to her that he was going to be the investment advisor to a new private fund, and encouraged Hays to transfer her funds to Convergent, telling her that he would personally be making the trades for Convergent and would employ the same strategies and techniques that Ellrich had always employed for her accounts. Ellrich did not explain to Hays what a hedge fund is or the distinctive risks of investing in a hedge fund. He did not speak with her about whether, in light of those risks, such an investment would be suitable for someone relying on her investments to produce a fixed income. He did not tell her that he had no experience trading for a private equity fund, or that Convergent had no track record. And he never provided Hays with a “full and practical explanation of... how the historical role he had played as Hays’ [s] investment advisor would change,” never telling her that he would no longer be considering her individual needs in making trades for Convergent. The judge found that, “by a combination
Hays told him that she wanted to invest in Convergent, relying entirely on Ellrich‘s encouragement. Nearly seventy-five per cent of Ellrich‘s individual market-timing clients also decided to invest in Convergent, contributing all but $30,000 of the $16.5 million that Convergent initially raised.
In December, 2000, EHCP sent a package of materials to Hays, including an offering memorandum for Convergent securities. The first pages of the offering memorandum warned, “AN INVESTMENT IN THIS PARTNERSHIP INVOLVES A SIGNIFICANT RISK OF LOSS,” and, “AN INVESTOR MUST BE IN A POSITION TO BEAR THE ECONOMIC RISK OF AN INVESTMENT IN THE PARTNERSHIP FOR A SIGNIFICANT PERIOD.” The offering memorandum identified EHCP as the general partner of Convergent and MFA as Convergent‘s investment manager, and disclosed the management fee MFA would be receiving from the general partner. It specified Convergent‘s investment goal as an “annual rate of return of at least 30%,” and explained that its investment strategy involved actively trading stock-indexed investments in an attempt to time the rise and fall of the stock market. It stated that neither MFA nor EHCP “have operated a partnership with the same objectives and portfolio strategy as” Convergent, and that Convergent “was a newly-formed entity with no history of operating performance.” It also identified investment risks “associated with [Convergent‘s] proposed activities,” including risks associated with short selling, the use of leverage, and the concentration of capital in single investments, industries, or sectors. Under the heading “Eligible Investors,” the offering memorandum explained that “[i]nvestors generally..., if natural persons, must (i) have a net worth of at least $1 million or (ii) income of at least $250,000 or (iii) entities with assets of at least $5 million.” Under the heading “Suitability,” the offering memorandum declared:
“Prospective investors should carefully evaluate whether an investment in [Convergent] is suitable for their particular circumstances and investment needs. In doing so, they should consult with such legal, tax, and financial advisors as they consider appropriate, and should avail themselves of the opportunity to ask questions of the [g]eneral [p]artner.”
It also declared that “each investor should have sufficient funds, beyond those he or she intends to invest in [Convergent], to meet personal needs and contingencies.”
The materials Hays received from EHCP also included an investor questionnaire, which Hays filled out following a telephone conversation with Ellrich during which she asked Ellrich how to answer certain questions. By signing the investor questionnaire, Hays accepted certain terms and conditions, including that she “ha[d] carefully reviewed the... [o]ffering [m]emorandum,” and was “able to bear the economic risks associated with this investment.”10 Hays submitted the investor questionnaire to EHCP in December, 2000, and soon after, EHCP determined that she was an “eligible investor.”11
In January, 2001, Hays transferred all of her funds from her Rydex and Profunds accounts from MFA to Convergent, investing $381,354.80 in Convergent in total. Following Hays‘s investment, Ellrich continued to send her written reports on her net worth and portfolio holdings (now including her Convergent holding) as he had done previously.12
From January, 2001, to June, 2001, Hays‘s investment in Convergent declined in value by approximately seventeen per cent. Hays was aware of this decline at the time. In the period from 2001 to 2002, Ellrich spoke with Hays one-half dozen times by telephone, reassuring her that the market was by nature vola-
In April, 2003, after an overstatement by U.S. Bank of the balance in Convergent‘s accounts, Ellrich discovered that Convergent‘s net asset value was “approximately $0,” with the result that Convergent became insolvent. In September, 2003, Ellrich telephoned Hays and told her that a banking error had caused a total loss of Convergent‘s value. Ellrich also told Hays that an investigator from the securities division of the Secretary of the Commonwealth would be contacting her. Ellrich told her that he was working to recover the lost money, and that it was only a matter of time before he could do so. Although Hays believed him, she began “to prepare for [her] future based on no funds” by seeking employment in the real estate field, where she began working in 2005.13 Hays filed this action against Ellrich and MFA in the Superior Court on September 11, 2006.
Discussion. 1. “Seller” liability. Under the Massachusetts Uniform Securities Act,
Not all who solicit the purchase of securities are “sellers” under the act, nor are they all “sellers” under
Ellrich does not deny that he solicited Hays‘s purchase of Convergent securities, but he nonetheless argues that he cannot be deemed a seller under the act because he had no “financial interest” in Hays‘s purchase. In support of this argument, Ellrich notes that he did not receive a commission for Hays‘s purchase of Convergent securities; nor did he receive any other compensation directly tied to the sale of securities to Hays. He also notes that the rate he earned as Convergent‘s investment advisor — 1.25 per cent per year of Convergent‘s net asset value — was less than the
Ellrich‘s argument fails because the judge found that Ellrich solicited Hays to purchase Convergent securities “motivated at least in part by a desire to serve [his] own financial interests,” and we conclude that her finding is not clearly erroneous. Although “personal financial gain is clearest in cases where the defendant receives a commission or other direct remuneration from the sale,” we agree with the “many courts [that] have taken a more expansive view of financial gain that includes increased compensation tied to share price or company performance.” In re OSG Sec. Litig., 971 F. Supp. 2d 387, 404 & n.119 (S.D.N.Y. 2013). Here, Ellrich earned an investment advisory fee from Convergent that was calculated based on the net asset value of Convergent funds. Although his fee percentage from Hays‘s retirement funds was lower at Convergent than it had been at MFA, the judge found that Ellrich viewed Convergent as an “opportunity” for him in part because he expected that, if Convergent proved viable, Furber would solicit additional investments that would ultimately increase Convergent‘s net asset value and, consequently, Ellrich‘s advisory fees. In short, Ellrich was motivated at least in part by the potential for a long-term increase in his investment advisory fees if he could raise the funds necessary to launch Convergent as a hedge fund.18 Cf. In re Vivendi Universal, S.A. Sec. Litig., 381 F. Supp. 2d 158, 187 (S.D.N.Y. 2003) (defendant was seller of company‘s securities where his bonuses were tied to company‘s increased earnings); In re OSG Sec. Litig., supra at 404-405 (pleadings adequately alleged that defendants were sellers of company‘s securities where plaintiffs alleged that “the survival of the [c]ompany was at stake,” and that defendants’ solicitation was motivated by desire to keep their positions and salaries).19 The
2. Statute of limitations. Ellrich contends that Hays‘s claim under
Under the “fraudulent concealment” doctrine, codified at
the motion judge‘s ruling that State Street was not a “seller” under the act and the consequent grant of summary judgment for the defendants, because there was no evidence that the transfer of funds in any way affected the amount of investment management fees that State Street earned from the account. See id. at 635 & n.12. Here, by contrast, Ellrich‘s management fee was based on the net asset value of all of Convergent‘s accounts, not just the value of Hays‘s accounts, so he was motivated to urge her to transfer her funds to Convergent as part of his effort to reach the minimum offering amount and preserve the possibility that Convergent would attract assets from sources other than his former investment clients and thereby substantially increase his investment management fees.
This does not mean that the limitations clock begins only when the plaintiff understands that she has a legal claim, that is, when she realizes that the defendant has violated a law that entitles her to sue to recover damages. Doe, supra at 256-257. Rather, the clock begins when the plaintiff has “actual knowledge” of the wrong committed by the fiduciary, rather than “knowledge of the consequences of that [wrong] (i.e., a legal claim against the fiduciary).” Id.
Ellrich contends that the actual knowledge standard should not govern when the limitations clock starts to run for claims under the act, and that we should instead apply the Federal standard governing when the limitations clock starts to run for claims under
Where the defendant is not the fiduciary of the plaintiff, the long-standing Federal rule of fraudulent concealment mirrors the Massachusetts rule. “Fraudulent concealment tolls the statute of limitations even without affirmative acts on the part of the defendant unless the plaintiff, through reasonable diligence, discovered or should have discovered the fraud.” Kennedy, 814 F.2d at 802. Compare with Passatempo v. McMenimen, 461 Mass. 279, 293-294 (2012), quoting Koe v. Mercer, 450 Mass. 97, 101 (2007) (“Under [the] discovery rule, the statute of limitations starts when the plaintiff [1] discovers, or [2] reasonably should have discovered, that [he or she] has been harmed or may have been harmed by the defendant‘s conduct“). In determining when the limitations clock under the Federal act begins, two questions are asked relating to when the plaintiff “should have discovered the fraud.” The first is an “objective” question asking whether there were “sufficient storm warnings to alert a reasonable person to the possibility that there were either misleading statements or significant omissions involved in the sale.” Kennedy, supra, quoting Cook v. Avien, Inc., 573 F.2d 685, 697 (1st Cir. 1978). See Maggio v. Gerard Freezer & Ice Co., 824 F.2d 123, 128 (1st Cir. 1987). “‘[S]torm warnings‘... trigger a plaintiff‘s duty to investigate in a reasonably diligent manner,” so the second, “more subjective” question asks whether “a plaintiff actually exercised reasonable diligence.” Id., quoting Cook, supra. The existence of a fiduciary relationship is relevant only with respect to this second inquiry, and only as one of “the circumstances of the particular case, including the existence of a fiduciary relationship, the nature of the fraud alleged, the opportunity to discover the fraud, and the subsequent actions of the defendants.” Maggio, supra.
Federal courts have applied this two-part test to circumstances like those here, where unsophisticated investors received a prospectus that disclosed the risks of the investment, and where the investors failed to make any inquiry into the risks of the investment because they relied on oral statements by the defendants
We decline to adopt this Federal standard as our own under the act for two reasons. First, the actual knowledge standard recog-
Second, although
Ellrich argues that Hays‘s action is time barred because Hays received Convergent‘s offering memorandum in December, 2000 (approximately six years before her action was filed), and the information in that offering memorandum contradicted the misrepresentations and corrected the omissions that the judge found
Ellrich alternatively contends that Hays had actual knowledge by June, 2001, when she knew that her investment in Convergent had declined by approximately seventeen per cent in the first five months. But actual knowledge of an investment loss is not sufficient by itself to constitute actual knowledge that the fiduciary falsely represented the investment‘s suitability, especially when the loss comes at a time when the over-all stock market is declining. The knowledge required to commence the limitations clock is knowledge that she purchased Convergent securities based on a misrepresentation by Ellrich of their suitability for her, and, in essence, the judge found that this did not occur before September, 2003, when she learned that she had lost her entire investment in Convergent.
Ellrich also contends that his fiduciary relationship with Hays regarding her equity investments ended when she liquidated her Rydex and Profunds accounts and transferred those funds to Convergent. Once that occurred, he contends, his fiduciary duty extended only to her fixed income investments that she held with Fidelity. He supports this contention by arguing that, having become the investment advisor for Convergent, he could no longer serve as Hays‘s investment advisor regarding her equity investments, because his fiduciary duty to the general partner of Convergent would potentially be in conflict with a fiduciary duty to any limited partner investor in Convergent. There is no dispute that Ellrich served as her fiduciary for all her retirement funds when he advised her to invest in Convergent, and when she signed the offering memorandum. We need not address whether the actual knowledge standard applies to a claim against a person
Because we embrace the actual knowledge standard where an investment advisor owes his or her client a fiduciary duty in determining when the limitations clock commences for claims under the act, and because we conclude that the judge did not clearly err in finding that Hays did not have actual knowledge of a violation of the act before 2003, we affirm the judge‘s finding that Hays timely filed her action under the act.
3. Remaining claims on appeal. We need not dwell long on Ellrich‘s remaining claims. We reject his contention that the judgment against him should be vacated because it is contrary to the great weight of the evidence. The evidence is more than sufficient to support the judge‘s finding that Ellrich‘s misrepresentations and omissions were material in that they strongly suggested that Convergent was a suitable investment for Hays to invest three-quarters of her retirement savings, where it was not. Even if we were to accept Ellrich‘s argument that the offering memorandum contradicted or corrected all his false oral assertions and omissions, that would not negate the materiality of his oral statements. “The test whether a statement or omission is material is objective: ‘there must be a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the “total mix” of information made available.‘” Marram, 442 Mass. at 57-58, quoting Craftmatic Sec. Litig. v. Kraftsow, 890 F.2d 628, 641 (3d Cir. 1989). The judge did not err in finding that, given the long-standing relationship of trust between Ellrich and Hays, Hays reasonably viewed Ellrich‘s advice regarding the suitability of the Convergent investment as significantly altering the “total mix” of information available to her. Cf. Marram, supra at 48, 55-59 (claim under act alleging false oral statements regarding suitability of investment survived motion to dismiss even though subscription agreement included integration clause that stated that it superseded all prior understandings, written or oral).
The evidence is also sufficient to support the judge‘s finding that Convergent was an unsuitable investment for Hays based on the expert testimony regarding the unsuitably high risk posed by investing in a hedge fund such as Convergent, and the offering memorandum‘s statements that eligible investors — unlike Hays — should have had a net worth of at least $1 million, an income of at least $250,000, or entities with assets of at least $5 million, and should have had sufficient funds apart from those invested in Convergent to meet personal needs and contingencies.23
Conclusion. For the foregoing reasons, the judgment in favor of Hays against Ellrich and MFA is affirmed.
So ordered.
GANTS, C.J.
Notes
“Any person who... offers or sells a security by means of any untrue statement of a material fact or any omission 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, the buyer not knowing of the untruth or omission, and who does not sustain the burden of proof that he did not know, and in the exercise of reasonable care could not have known, of the untruth or omission, is liable to the person buying the security from him, who may sue either at law or in equity to recover the consideration paid for the security, together with interest at six per cent per year from the date of payment, costs, and reasonable attorneys’ fees, less the amount of any income received on the security, upon the tender of the security, or for damages if he no longer owns the security. Damages are the amount that would be recoverable upon a tender less the value of the security when the buyer disposed of it and interest at six per cent per year from the date of disposition.”