August 20, 2019

Colorado Court of Appeals: Trial Court Must Determine Whether Retrospective Competency Evaluation Feasible

The Colorado Court of Appeals issued its opinion in People v. Lindsey on Thursday, July 12, 2018.

Competency—Jury Instructions—Unanimity Instruction.

Lindsey persuaded six individuals to invest $3 million in new technology that would allegedly use algae-based bioluminescent energy to light signs and panels. Lindsey told his investors that he had contracts to sell his new technology. Neither the technology nor the contracts ever existed, and Lindsey allegedly spent the money on repaying other investors and on personal expenses. A jury convicted Lindsey of eight counts of securities fraud and four counts of theft.

On appeal, Lindsey contended that the trial court erred in refusing to order a competency evaluation where the issue was raised by his counsel’s motion before trial. Here, the trial court failed to comply with the statutory procedure. The motion was facially valid, and the trial court abused its discretion in concluding that a facially valid motion on competency did not fall under the competency statute.

Lindsey next argued that the trial court erred by (1) instructing the jury that “any note” constitutes a security, and (2) giving an improper unanimity instruction. As to the first argument, Lindsey’s trial was conducted before People v. Mendenhall, 2015 COA 107M. In the event of retrial, the trial court and parties should apply Mendenhall’s four-factor test in crafting new jury instructions. As to the second contention, regarding Count 6, which included three separate transactions, the unanimity instruction should be modified to specify that the jury must agree unanimously that defendant committed the same act or that defendant committed all of the acts included within the period charged.

The judgment was vacated and the case was remanded with directions.

Summary provided courtesy of Colorado Lawyer.

Colorado Court of Appeals: Jury Improperly Instructed that “Any Note” is a Security; Reversal Required

The Colorado Court of Appeals issued its opinion in People v. Mendenhall on Thursday, August 13, 2015.

Promissory Note—Securities Fraud—Colorado Securities Act—Jury Instructions—Testimony—Prosecutorial Misconduct.

Defendant was employed as a salesperson by an insurance company that specializes in low-risk insurance products for retirement-age persons. Defendant also was licensed to sell securities through an affiliated broker–dealer. Defendant obtained loans from clients or customers whom he had met through his employment to fund his personal real estate investments, giving each of them a promissory note. He was convicted by a jury of multiple counts of securities fraud and theft.

On appeal, defendant argued that the trial court erred in instructing the jury that any note is a security. One of the elements of securities fraud under the Colorado Securities Act (CSA) is that the defendant engaged in fraud in connection with a security. If there is no security, there cannot be securities fraud. The CSA defines “security” to include “any note.” Because sometimes notes are not securities, however, the court’s instruction constituted error. Because this instructional error was not harmless beyond a reasonable doubt, defendant’s securities fraud convictions were reversed.

Defendant also argued that the trial court erred in admitting the testimony of the district attorney’s investigator regarding his process for investigating someone suspected of criminal activity; under what circumstances he recommended pursuing criminal charges; and the specific investigation of, and decision to pursue charges against, defendant. Because probable cause to charge defendant was not at issue here, the investigator’s statements regarding how many potential cases he received each year and in how many of those cases charges were brought constituted inadmissible evidence. However, because there was overwhelming evidence that defendant was guilty of theft and the investigator’s comments were minimal, any error was harmless.

Defendant further contended that the prosecutor committed misconduct in closing argument when he likened defendant to Bernie Madoff and referred to the victims as members of the “greatest generation.” The Court concluded that the prosecution’s mention of Madoff was referencing a victim’s testimony, and referring to the victims as the “greatest generation” did not rise to the level of plain error.

Summary and full case available here, courtesy of The Colorado Lawyer.

Tenth Circuit: Opinion Reissued Upon Remand from U.S. Supreme Court

The Tenth Circuit Court of Appeals issued its opinion in National Credit Union Administration Board v. Nomura Home Equity Loan, Inc. on Tuesday, August 19, 2014.

The U.S. Supreme Court granted certiorari to review the Tenth Circuit’s August 27, 2013 decision and remanded with instructions to reconsider in light of the Supreme Court’s decision in CTS Corp. v. Waldburger, 134 S. Ct. 2175 (2014). The Tenth Circuit, after receiving additional briefs and reviewing CTS Corp., reinstated its original opinion. Click here for the original summary.

HB 14-1215: Prohibits Receivers from Avoiding Obligations Regarding Collateral Under a Security Agreement

On January 30, 2014, Rep. Joann Ginal and Sen. Lois Tochtrop introduced HB 14-1215 – Concerning the Ability of a Federal Home Loan Bank to Enforce its Rights with Regard to Collateral Subject to a Security Agreement. This summary is published here courtesy of the Colorado Bar Association’s e-Legislative Report.

In statutes governing the disposition of the assets of insolvent insurers, the bill generally prohibits a receiver or liquidator from avoiding the obligations of the insolvent insurer to a federal home loan bank with respect to collateral under a security agreement or related agreement to which the bank is a party. The bill passed out of both houses and was sent to Gov. John Hickenlooper on March 14.

e-Legislative Report: March 17, 2014

CBA Legislative Policy Committee

For readers who are new to CBA legislative activity, the Legislative Policy Committee (LPC) is the CBA’s legislative policy-making arm during the legislative session. The LPC meets weekly during the legislative session to determine CBA positions on requests from the various sections and committees of the Bar Association.

The LPC did not meet on Friday, March 14.

At the Capitol—Week of March 10

A scorecard of the committee and floor work follows.

In the House

Monday, March 10

Passed 3rd Reading:

  • HB 14-1141. Concerning the confidentiality of social security numbers under the “Colorado Consumer Protection Act.” Vote: 63 yes, 0 no, and 2 excused.
  • SB 14-97. Concerning the immunity of public agencies against liability arising from the wildfire mitigation activities of insurance companies. Vote: 63 yes, 0 no, and 2 excused.
  • SB 14-138. Concerning civil immunity for community volunteers assisting at an emergency. Vote: 63 yes, 0 no, and 2 excused.
  • SB 14-121. Concerning financial assistance for local governments after a declared disaster emergency. Vote: 63 yes, 0 no, and 2 excused.
  • SB 14-96. Concerning renaming state veterans’ nursing homes to veterans community living centers to more accurately reflect the wide array of services provided to state veterans. Vote: 63 yes, 0 no, and 2 excused.

Tuesday, March 11

  • SJM14-1. Memorializing former Senator Ken Gordon. Vote: 63 yes, 0 no, and 2 excused. In a joint-session, the House and Senate met to consider SJM14-001 Memorializing former Senator Ken Gordon.

Wednesday, March 12

Passed on 3rd Reading:

  • HB 14-1136. Concerning exempting a continuing professional education program that is approved by a state professional licensing board from regulation by the division of private occupational schools in the department of higher education. Vote: 63 yes, 0 no, and 2 absent or excused.
  • HB 14-1216. Concerning required safety markings for certain towers over fifty feet in height that are located in unincorporated areas of the state. Vote: 63 yes, 0 no, and 2 absent or excused.
  • HB 14-1131. Concerning harassment against a minor by using an interactive computer service.Vote: 54 yes, 10 no, and 1 excused.
  • HB 14-1149. Concerning making acts related to the advertisement of children for the purposes of transferring their care to others trafficking in children. Vote: 64 yes, 0 no, and 1 excused.
  • SB 14-80. Concerning the elimination of the list of certain additional qualifications that apply to property valuation appeal arbitrators. Vote: 64 yes, 0 no, and 1 excused.
  • HB 14-1280. Concerning limits on liability for agritourism. Vote: 64 yes, 0 no, and 1 excused.

Thursday, March 13

Passed on 3rd Reading:

  • HB 14-1277. Concerning eligibility requirements for recipients of grants from the military family relief fund. Vote: 61 yes, 2 no, and 2 absent or excused.
  • SB 14-63. Concerning the mandatory review of existing executive branch agency rules conducted by each principal department. Vote: 63 yes, 0 no, and 2 absent or excused.

In the Senate

Monday, March 10

Passed on 3rd Reading:

  • SB 14-125. Concerning the regulation of transportation network companies, and, in connection therewith, requiring transportation network companies to carry liability insurance, conduct background checks on transportation network company drivers, inspect transportation network company vehicles, and obtain a permit from the public utilities commission; and making an appropriation. Vote: 29 yes and 6 no.
  • HB 14-1172. Concerning exempting certain public safety departments from certain statutory requirements related to the impact of a criminal conviction on state employment opportunities. Vote: 35 yes and 0 no.

Tuesday, March 11

  • SJM14-1. Memorializing former Senator Ken Gordon. Vote: 63 yes, 0 no, and 2 excused. In a joint-session, the House and Senate met to consider SJM14-001 Memorializing former Senator Ken Gordon.

Wednesday, March 12

Passed on 3rd Reading:

  • SB 14-32. Concerning elimination of restrictions on the ability of alternative health care providers to treat children. Vote: 18 yes and 17 no.
  • HB 14-1224. Concerning a set aside goal in state procurement for service-disabled veteran owned small businesses. Vote: 27 yes and 8 no.

Thursday, March 13

Passed on 3rd Reading:

  • Consent Calendar: Vote 33 yes, 0 no, and 2 excused.
    1. SB 14-51. Concerning access to records relating to the adoption of children, and, in connection therewith, making an appropriation.
    2. HB 14-1103. Concerning the criteria that certain securities must meet to qualify as legal investments for public funds.
  • SB 14-131. Concerning the removal of certain identifying information from a motor vehicle registration card. Vote: 33 yes, 0 no, and 2 excused.
  • SB 14-117. Concerning the reauthorization of the regulation of real estate appraisers by the board of real estate appraisers through a recreation and reenactment of the relevant statutes incorporating no substantive amendments other than those approved during the first regular session of the 69th general assembly. Vote: 30 yes, 3 no, and 2 excused.
  • HB 14-1077. Concerning an increase in the statutory cap on the two-year average of the unobligated portion of the oil and gas conservation and environmental response fund. Vote: 27 yes, 6 no, and 2 excused.

Friday, March 14

Passed on 3rd Reading:

  • SB 14-23. Concerning an authorization of the voluntary transfer of water efficiency savings to the Colorado water conservation board for instream use purposes in water divisions that include lands west of the continental divide. Vote: 25 yes, 9 no, and 1 excused.
  • HB 14-1152. Concerning passive surveillance records of governmental entities. Vote: 34 yes, 0 no and 1 excused.

Tenth Circuit: Defendant’s Sentence for Mail and Wire Fraud to be Recalculated

The Tenth Circuit Court of Appeals published its opinion in United States v. Evans on Tuesday, March 11, 2014.

Defendant-Appellant Thomas Evans pled guilty to one count of conspiracy to commit mail and wire fraud and was sentenced to 168 months’ imprisonment and five years’ supervised release. He appealed his sentence.

Mr. Evans challenged the district court’s loss calculation methodology and its failure to award him a third one-level acceptance of responsibility reduction. The Tenth Circuit found the district court erred on both points.

U.S. Sentencing Guidelines Manual § 2B1.1(b)(1) provides sentencing enhancements for fraud based on the amount of loss caused by the criminal conduct. In making that calculation, the fact that the securities had lost value due to a poor or unsustainable business model would not be chargeable to Mr. Evans. Mr. Evans was also correct that the district court should have considered the effect and foreseeability of non-fraud factors in determining loss. The court held this case called for a single, more complex inquiry: the reasonably foreseeable amount of loss to the value of the securities caused by Mr. Evans’ fraud, disregarding any loss that occurred before the fraud began, and accounting for the forces that acted on the securities after the fraud ended. On remand, the Tenth Circuit instructed the district court to determine whether Mr. Evans’ fraud was a “but for” cause of the investors’ loss, and whether it was the legal cause. In considering the latter, the district court had to account for the effect and  foreseeability of non-fraud factors, including the actions of the receiver to prolong the investments and the effect of the housing market on the value of the securities and the underlying properties. The court further instructed the district court to determine in the first instance the proper assignment of the burden of production regarding these non-fraud factors.

Next, Mr. Evans argued that the district court erred in refusing to award him a one-level reduction for acceptance of responsibility under U.S.S.G. § 3E1.1(b). On the record before the court, the government’s decision to refuse to request an acceptance of responsibility reduction was not rationally related to any legitimate government end. The court therefore concluded that the district court committed clear error in accepting the government’s refusal to request a third one-level sentence reduction under § 3E1.1(b), and that Mr. Evans was entitled to a three-level reduction for acceptance of responsibility, instead of a two-level reduction.

Because the district court erred in calculating loss, and failing to award an offense level reduction for acceptance of responsibility, the Tenth Circuit REMANDED for the district court to VACATE the sentence and RESENTECE.

Tenth Circuit: Issue of Fact Existed Concerning Whether Investments Were “Investment Contracts” Under Securities Law

The Tenth Circuit Court of Appeals published its opinion in SEC v. Shields on Monday, February 24, 2014.

The Securities and Exchange Commission (“SEC”) brought this civil enforcement action against Defendant-Appellees Jeffory D. Shields, GeoDynamics, Inc. (“GeoDynamics”), and several other business entities affiliated with Mr. Shields, alleging securities fraud in connection with four oil and gas exploration and drilling ventures Mr. Shields, as managing partner of GeoDynamics, marketed to thousands of investors nationwide as Joint Venture Agreements (“JVAs”). The district court granted defendants’ Fed. R. Civ. P. 12(b)(6) motion to dismiss. The SEC appealed, contending that despite their labels as JVAs, the investment agreements were actually “investment contracts” and thus “securities” subject to federal securities regulations as defined by the Securities Act of 1933 and the Securities Exchange Act of 1934 (collectively, the “Securities Acts”).

The central issue raised on appeal was whether the investments sold by Mr. Shields as managing partner of GeoDynamics were “investment contracts” and thus “securities” subject to federal securities regulations.

Congress painted with a broad brush in defining a “security.” Coverage of the antifraud provisions of the securities laws is not limited to instruments traded at securities exchanges and over-the-counter markets, but extends to uncommon and irregular instruments. Although the Securities Acts broadly define a security, neither act specifically defines an “investment contract.” The test is whether the scheme involves an investment of money in a common enterprise with profits to come solely from the efforts of others.

The parties confined their argument to whether the investment was premised on a reasonable expectation of profits to be derived from the entrepreneurial or managerial efforts of others. See SEC v. W.J. Howey Co., 328 U.S. 293 (1946). The joint venture agreements here were denominated general partnerships, and the Tenth Circuit applies a strong presumption that an interest in a general partnership is not a security, mainly because the partners – the investors – are ordinarily granted significant control over the enterprise. But presumptions are not per se rules, and the court recognized that the presumption can be rebutted by evidence that the general partners were rendered passive investors because they were somehow precluded from exercising their powers of control and supervision. Access to information about the investment, and not managerial control, is the most significant factor in determining whether investors are in need of the protections of the securities acts.

The Tenth Circuit agreed with the SEC that the allegations in the complaint were clearly sufficient to rebut the presumption that the purported general partnerships were not securities, and raised a fact issue concerning whether investors were relying on the efforts of Mr. Shields and GeoDynamics to significantly affect the success or failure of the ventures. The allegations also raised a fact issue as to whether the investors actually had the type of control reserved under the agreements to obtain access to information necessary to protect, manage, and control their investments at the time they purchased their interests. The allegations were sufficient to defeat a motion to dismiss on the issue of whether the investors lacked meaningful control over their interests. They raised a plausible claim that the joint venture agreements, in substance as opposed to form, actually distributed powers similar to a limited partnership, which is usually held to be a security.

Because it could not be said as a matter of law that the investments at issue were not “investment contracts,” the Tenth Circuit REVERSED and REMANDED for further proceedings consistent with this opinion.

Tenth Circuit: Summary Judgment Affirmed in FDIC Collection Action

The Tenth Circuit Court of Appeals published its opinion in FDIC v. Arciero on Friday, December 20, 2013.

In an effort to save Quartz Mountain Aerospace, some of its investors and directors took out large loans from First State Bank of Altus (the Bank) for the benefit of the company. When the Bank failed in 2009, the Federal Deposit Insurance Corporation (FDIC) took over as receiver and filed suit to collect on the loans. This appeal concerns the challenge to those collection efforts by four of those liable on the notes (Borrowers). Borrowers raised affirmative defenses to the FDIC’s claims and brought counterclaims, alleging that the Bank’s CEO had assured them that they would not be personally liable on any of the loans. The district court granted summary judgment for the FDIC because the CEO’s alleged promises were not properly memorialized in the Bank’s records as required by 12 U.S.C. § 1823(e), a provision of the Financial Institutions Reform, Recovery, and Enforcement Act of 1989.

Borrowers argued on appeal that the district court erred when it denied their motion for more discovery before the court ruled on the FDIC’s motion for summary judgment. The Tenth Circuit disagreed as the Borrowers did not identify any documents that would establish a defense under § 1823(e). They already had the Bank minutes and no Borrower alleged they signed an agreement limiting their liability.

The court also rejected Borrowers’ argument that the district court should have granted their motion for reconsideration based on newly discovered evidence. The Oklahoma Department of Securities opened an investigation into the Bank, its affiliate Altus, and Doughty for selling unregistered securities, including the life-settlement contracts used to secure the loan to Borrowers. According to Borrowers, this evidence supported claims and defenses against the FDIC that would not be barred by § 1823(e) because they are based on securities violations rather than agreements with the Bank. The court held that this did not qualify as newly discovered evidence because the existence of an investigation is not admissible evidence of alleged misconduct. Learning of a new legal theory is not the discovery of new evidence.

The court affirmed.

Crowdfunding Securities Under the CROWDFUND Act

Andrew SchwartzBy Andrew A. Schwartz, Associate Professor of Law, University of Colorado

The “crowdfunding” of securities is poised to democratize the financing of startups, small businesses, farmers and others. Securities crowdfunding, defined as the sale of unregistered securities over the Internet to large numbers of retail investors, each of whom contributes a small amount, had previously been banned by federal law, but this prohibition was overturned by Congress in 2012. This new marketplace will go live once the SEC issues regulations to govern it. Although those rules were officially due in late 2012, they were just proposed on Oct. 23, 2013, and are likely to go into effect in 2014.

Securities crowdfunding has its origins in “reward” crowdfunding, practiced on websites like Kickstarter and IndieGoGo. In reward crowdfunding, artists, entrepreneurs and others ask “the crowd” to contribute capital to their ventures, generally in exchange for the fruits of the project, such as a book or CD. The investors never receive stock, bonds or other securities, however, because federal securities law effectively banned the crowdfunding of securities.

This all changed in 2012, when Congress amended the federal securities laws to overturn this prohibition. In Title III of the Jumpstart Our Business Startups (JOBS) Act—the “CROWDFUND Act”—Congress established a new exemption from the registration requirement for crowdfunded securities. President Obama signed the JOBS Act into law in April 2012, and it will go into effect once the SEC completes its rulemaking process.

The purpose of the CROWDFUND Act is twofold. First, it is designed to liberate startup companies, small businesses and others to use peer networks and the Internet to obtain modest amounts of business capital at very low cost. Second, Congress sought to democratize the market for financing speculative startup companies by allowing investors of modest means to make investments that had previously been offered solely to wealthy, “accredited” investors.

The new CROWDFUND Act has important limitations and places significant obligations on participants in this new marketplace. Under the statute, issuers may only raise up to $1,000,000 annually via securities crowdfunding. Issuers also must state a minimum amount and can only collect the proceeds of the offering if they reach or exceed that target.

Issuers must provide some very basic disclosures to the SEC, designated intermediaries, and potential investors. The financial disclosures depend on the size of the offering: For offerings of $100,000 or less, income tax returns for the last fiscal year and unaudited financial statements certified as accurate by the principal executive officer are required. For offerings of between $100,000 and $500,000, financial statements reviewed by an independent public accountant must be provided. And for offerings of between $500,000 and the maximum of $1 million, audited financial statements are mandated. Finally, following a crowdfunding round, an issuer must annually file with the SEC, and make available to investors, a report on the results of operations.

As for investors, the maximum annual aggregate amount of crowdfunded securities that any one investor may purchase depends on her wealth and income: If an investor’s net worth or annual income is under $100,000, she can invest the greater of $2,000, or five percent of her annual income, in crowdfunded securities each year. If her net worth or annual income is over $100,000, she can invest 10% of her annual income each year.

The Act provides that crowdfunding transactions may not be consummated directly between issuer and investor. Rather, they must be executed via a financial intermediary registered with the SEC as either a broker-dealer or a “funding portal,” a creation of the Act. The Act imposes a number of serious obligations on these financial intermediaries, such as a requirement that they take measures to reduce the risk of fraud, including obtaining a background check on officers, directors and substantial investors in crowdfunding issuers.

As for a secondary market, the Act provides that crowdfunded securities may not be transferred or sold by investors for one year after the date of purchase, unless being transferred to the issuer, an accredited investor, a family member of the purchaser, or as part of an offering registered with the SEC.

The CROWDFUND Act expressly pre-empts state law regarding registration or qualification of securities. That said, states must be provided with notice of crowdfunded offerings, and they retain the right to bring enforcement actions for fraud or other violations of state securities law not relating to registration.

To police fraudulent behavior, the Act expressly authorizes civil actions against an issuer, its directors and officers, if they make an untrue statement of a material fact. In addition, the SEC is granted examination, enforcement and other rulemaking authority over funding portals, and presumably retains authority to enforce the various statutory and regulatory mandates for both issuers and intermediaries.

How securities crowdfunding will play out in practice remains to be seen, and depends greatly on the rules that the SEC just proposed on October 23, 2013. Those proposed rules, called “Regulation Crowdfunding,” are available online, and the SEC invites comments from the public before they become final.

In short, the CROWDFUND Act represents an opportunity for enterprising and creative practitioners to shape a brand new market for securities.

Editor’s Note: This article originally appeared in the October 2013 CBA Business Law Section newsletter.

Andrew A. Schwartz is an associate professor of law at the University of Colorado, where he teaches and publishes on Contracts, Corporations and other aspects of business law.  He is a graduate of Brown University and Columbia Law School, where he served on the Columbia Law Review.  Prior to entering academia, he clerked for two federal judges and practiced with Wachtell, Lipton, Rosen & Katz in New York.  His most recent law review article is Crowdfunding Securities, published in the Notre Dame Law Review earlier this year.

The opinions and views expressed by Featured Bloggers on CBA-CLE Legal Connection do not necessarily represent the opinions and views of the Colorado Bar Association, the Denver Bar Association, or CBA-CLE, and should not be construed as such.

Tenth Circuit: Defendant’s Instruments in Ponzi Scheme Met Definition of “Securities” Under Family Resemblence Test

The Tenth Circuit Court of Appeals published its opinion in Sec. Exch. Comm’n v. Thompson on Friday, October 4, 2013.

This appeal arose out of a civil-enforcement action brought by the Securities and Exchange Commission (“SEC”) against Defendant-Appellant Ralph W. Thompson, Jr., in connection with an alleged Ponzi scheme Thompson ran through his company, Novus Technologies, L.L.C. (“Novus”). Novus made a total of 138 of its “loans” to around sixty holders.

The district court granted summary judgment in the SEC’s favor on several issues, including the issue of whether the instruments Novus sold investors were “securities,” as that term is defined under the Securities Act of 1933 and the Securities Exchange Act of 1934.

Thompson’s sole claim on appeal was that the district court ignored genuine disputes of material fact on the issue of whether the Novus instruments were securities, and that he was entitled to have a jury make that determination. The Tenth Circuit concluded, under the test articulated by the Supreme Court in Reves v. Ernst & Young, 494 U.S. 56 (1990), that the district court correctly found that the instruments Thompson sold were securities as a matter of law.

In Reves, the United States Court adopted a version of the Second Circuit’s “family resemblance” test, under which a note is presumed to be a “security,” and that presumption may be rebutted only by a showing that the note bears a strong resemblance to one of the categories of instrument identified by the Second Circuit in Exchange Nat’l Bank of Chicago v. Touche Ross & Co., 544 F.2d 1126, 1137 (2d Cir. 1976).

To provide guidance to courts considering whether an instrument “bears a strong resemblance” to the instruments on the list, the Court prescribed application of the following four factors: (1) the motivations that would prompt a reasonable seller and buyer to enter into the transaction; (2) the ‘plan of distribution’ of the instrument, with an eye on whether it is an instrument in which there is common trading for speculation or investment; (3) the reasonable expectations of the investing public; and (4) whether some factor such as the existence of another regulatory scheme significantly reduces the risk of the instrument, thereby rendering application of the Securities Acts unnecessary. The factors are to be considered as a whole. The court held that, in the context of a civil case where the “security” status of a “note” is disputed, the ultimate determination of whether the note is a security is one of law.

After applying the four factors, the court held that the instruments Thompson sold were securities.  Thompson could not rebut the presumption that the Novus Instruments were securities.


Tenth Circuit: FIRREA’s Extender Statute Applies to Allow NCUA’s Cases on Behalf of Failed Credit Unions to Go Forward

The Tenth Circuit Court of Appeals published its opinion in National Credit Union Administration Board v. Nomura Home Equity Loan on Tuesday, August 27, 2013.

U.S. Central Federal Credit Union (“U.S. Central”) was the largest federally chartered credit union in the country before it failed in 2009. In 2006 and 2007, U.S. Central invested in RMBS. RMBS are created through securitization by pooling residential mortgage loans and offering prospective investors the opportunity to invest in a loan pool through purchase of RMBS certificates granting ownership of a slice of the loan pool. Investors can buy, sell, or hold RMBS certificates. When homebuyers pay back their loans, investors receive a positive return through payment of dividends and the increased value of the certificates.

U.S. Central purchased 29 RMBS certificates. When U.S. Central made these purchases, nearly all certificates were assigned the highest possible investment rating, indicating they were low-risk investments. But over the next four years, most of the certificates performed so poorly that their credit ratings were downgraded to well below investment grade. In other words, the certificates were reclassified to a credit rating commonly referred to as “junk” grade.

The RMBS of Corporate Federal Credit Union (“WesCorp”) were also highly rated at the time of purchase, but experienced a surge in borrower delinquencies and defaults, resulting in significant losses and a collapse of their credit ratings. This resulted in staggering losses for both credit unions, and losses from these failed investments contributed to the demise of both organizations.

After taking over the credit unions, The National Credit Union Administration (“NCUA”) investigated the RMBS. NCUA concluded that the offering documents contained materially false and misleading statements about the credit worthiness of the mortgage borrowers and the underwriting practices used by originators of the mortgages. NCUA claimed these materially false and misleading statements concealed underwriters’ shoddy practices and systematic disregard of the guidelines and industry standards.

NCUA placed the two credit unions into conservatorship and sued 11 defendants on behalf of U.S. Central, alleging federal and state securities violations. In a separate case, NCUA sued one defendant on behalf of U.S. Central and WesCorp, alleging similar violations.

The cases were consolidated in the United States District Court for the District of Kansas. Defendants moved for dismissal, arguing that NCUA’s claims were time-barred. The district court denied the motion, concluding that the so-called Extender Statute applied to NCUA’s claims. See 12 U.S.C. § 1787(b)(14). Defendants moved for an interlocutory appeal for the Tenth Circuit to determine whether the Extender Statute applied to NCUA’s claims.

In the wake of the savings and loan crisis of the 1980s, Congress passed the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (“FIRREA”). FIRREA’s purpose is to strengthen government regulation of federally chartered or insured financial organizations. FIRREA contains provisions often referred to as “extender statutes,” which extend the time period for a government regulator to bring “any action” on behalf of a failed financial organization. One applies to NCUA, 12 U.S.C. § 1787(b)(14). It reads in part:

(A)     In general
Notwithstanding any provision of any contract, the applicable statute of limitations with regard to any action brought by the Board as conservator or liquidating agent shall be—
(i) in the case of any contract claim, the longer of—
(I) the 6-year period beginning on the date the claim accrues; or
(II) the period applicable under State law; and
(ii) in the case of any tort claim, the longer of—
(I) the 3-year period beginning on the date the claim accrues; or
(II) the period applicable under State law.

Further, Sections 11 and 12(a)(2) of the Securities Act of 1933 impose liability on certain participants in a registered securities offering that involves material misstatements or omissions. Section 11 applies to registration statements, and Section 12(a)(2) applies to prospectus materials and oral communications. For private litigants bringing a claim under Sections 11 or 12(a)(2), two deadlines must be satisfied. Both appear in Section 13 of the Securities Act. First, a claim must be brought within one year from the date the violation is discovered or should have been discovered through the exercise of reasonable diligence. Second, a claim is subject to a three-year limit, which provides that “[i]n no event” shall a claim under Section 11 be filed “more than three years after the security was bona fide offered to the public,” and no “more than three years after the sale” in the case of a Section 12(a)(2) claim.

Defendants made two arguments that NCUA’s claims were untimely. First, they argued that the Extender Statute did not apply to repose periods and that Section 13’s three-year period was a repose period. A statute of repose is a fixed, statutory cutoff date, usually independent of any variable, such as claimant’s awareness of a violation. In a statute of repose, the bar is tied to an independent event.

The court applied a plain meaning analysis. The Tenth Circuit concluded that the Extender Statute time periods’ application to “any action” indicated that the Statute supplanted any other time periods that otherwise would apply to NCUA claims. The court held that the Extender Statute applied to Section 13’s three-year repose period and affirmed the district court’s conclusion on this issue.

Second, Defendants argued that the Extender Statute covered only state common law claims. Under this theory, the Extender Statute would not apply to any of NCUA’s claims—all of which were statutory. The court held that applying the Extender Statute to statutory claims served the statute’s purpose by providing NCUA sufficient time to investigate and file all potential claims once it assumes control of a failed credit union. For the same reasons, statutory purpose supported the Extender Statute’s application to federal actions. FIRREA’s stated purpose includes facilitating recoveries by NCUA on behalf of failed credit unions.


Tenth Circuit: Whether a Note is a Security in Securities Fraud case is for Jury to Decide

The Tenth Circuit Court of Appeals published its opinion in United States v. McKye on Tuesday, August 20, 2013.

Defendant-Appellant, Brian William McKye, was charged with eight counts of securities fraud, in violation of 15 U.S.C. § 78j(b), and one count of conspiracy to commit money laundering. At trial, McKye tendered an instruction that would have permitted the jury to decide whether the investment notes at issue were securities under the federal securities laws. The district court refused to give McKye’s instruction, instead instructing the jury that the “term ‘security’ includes a note.” The jury convicted McKye on the conspiracy charge and seven of the fraud charges.

McKye argued the jury instruction was an incorrect statement of law because not all notes are securities, according to Supreme Court precedent holding notes are only presumed to be securities. Certain notes are not securities and a note “bearing a family resemblance” to those notes are also not securities. McKye also argued the jury should have decided whether the notes were securities, not the judge.

The Tenth Circuit held that “because the question of whether a note is a security is a mixed question of fact and law and because this jury was instructed that the Government was required to prove the instruments issued by Global West were securities as an element of its case, the district court erred when it instructed the jury that notes are securities.” The court found that the error was not harmless and reversed McKye’s conviction.