Roy B. Oser, Esq.

By the alternate Eldercountry Lawyer, Janice A. Oser, Esq.

Our daughter’s friend had confided to our daughter that something very unfortunate had happened to the friend's father, a doctor. He had been swindled out of his retirement investment portfolio by a very troubled, not to say twisted, investment adviser by the name, it happens, of Twiste.

The investment advisor had become associated along the way with a brokerage firm, which could provide the “deep pocket” that could make a lawsuit worthwhile. Mr. Twiste had bought mortgage participations for the doctor and other parties to the suit. Attorneys for the doctor and the other complainants, the plaintiffs in a suit against the brokerage company, argued that the mortgage participations, which turned out to be worthless, were “securities” for purposes of the federal securities laws, which would make it possible to sue the brokerage firm under these laws.

The case made the New York Times (“Investors’ Suit Allowed,” November 1, 1994) when the United States Supreme Court let stand the holding of a Federal appeals court that securities laws apply to mortgage participations, particularly when they were purchased on behalf of unsophisticated investors who expected their broker to rely on safe, conservative securities.

The case, Pollack v. Laidlaw Holdings, Inc., presented a colorful set of factual allegations, taken as true by the United States Court of Appeal for the Second Circuit for purposes of an appeal from an order by the United States District Court for the Southern District of New York dismissing the doctor’s claims. The District Court certified for appeal the question of whether or not the mortgage participations constituted “securities” for purposes of the federal securities laws.

The facts alleged included that the doctor (and the other complainants, “appellants” for purposes of this appeal) had begun dealing with Mr. Twiste in the 1970’s. The relationship continued beyond 1977, when Twiste began an association with the companies that allegedly became the Laidlaw corporations.

In June 1990 the doctor learned that Twiste had left Laidlaw and had been admitted to a mental institution. At approximately the same time, he and the other appellants found out that the mortgage investments were the result of transactions with Eagle S.A. Funding Company, an entity of whom they had never heard. In May 1990, one of the Eagle partners had committed suicide and the company had gone into bankruptcy.

From 1985 to 1989, however, the doctor’s interests in the mortgages appeared to provide satisfactory returns because funds of new investors were used to make payments on existing accounts (a Ponzi scheme, one might say). Although Eagle stopped making payments in May 1989, Laidlaw continued to send appellants portfolio evaluations from May 1989 to June 1990 showing allegedly fictitious interest and principal payments.

The Second Circuit disagreed with the District Court, and held that the mortgage interests were “notes,” hence, securities, within the meanings of the federal securities acts, and sent the case back to the District Court for further proceedings. Presumably the case was then settled, and it’s reasonable to assume that the doctor and his fellow complainants were recompensed, at least to a large extent, for their losses. The Second Circuit opinion in Pollack is a repeatedly cited in securities litigation involving the definition of “security,” under the Federal securities laws.

The most important of these Federal securities laws (there are also state securities laws) are the Securities Act of 1933 and the Securities Exchange Act of 1934. These Acts were passed in response to fraud in securities markets and a perceived lack of public information about the stock markets. Their aim was to ensure vigorous market competition by mandating full and fair discloser of all “material” information (roughly information that matters) in the marketplace.

Congress defined “security” expansively in these Acts, enabling the government to attack investment schemes not explicitly within the statute. The case law is inconsistent and confusing as to what constitutes a “security” for purposes of these Acts. In addition, Congress did not explicitly provide for private law suits in the securities laws that grew out of the Depression, but it did not rule them out, either. The United States Supreme Court eventually found, in a series of decisions, that the right to bring private law suits was implied.

These days, however, someone in the position of our daughter’s friend’s father who was defrauded by his broker would be unlikely to be able to sue the broker in a court of law. That is because any broker who could conceivably be a “deep pocket” worth suing will have a clause in its contracts with its customers requiring the customer to submit any dispute to arbitration. The bases for the arbitrators’ decisions are not made public and, unlike decisions of a court of law, these decisions do not have value as legal precedents.

The right of brokers to require customers to submit disputes to arbitration was upheld by the United States Supreme Court in 1987, and again in 1989. In claims involving smaller dollar amounts, an arbitration panel can decide a dispute without holding a hearing, simply by reviewing all the documents submitted by the opposing parties. Even without a hearing, however, arbitration can be difficult for non-lawyers to handle. If the claim is for a sufficiently large amount, a lawyer may be found who will take the case on a contingency-fee basis (that is, for a portion of any amount recovered).

Assisting clients of limited means whose claims are for relatively small amounts are an increasing number of securities arbitration clinics at law schools around the country. These clinics, however, can take on only a small proportion of the cases submitted to them. One of these clinics, the Fordham University School of Law, is headed by the subject of our Spotlight feature, Professor Romaine L. Gardner.