The Securities Exception to Section 75-1.1, Twice Revisited
Like the outcry against ham and pineapple on pizza, our courts have put forth several reasons why a case involving securities or capital-raising activity falls outside the ambit of section 75-1.1. We have covered these extensively in the past, but two separate 2021 decisions reinforce these points. This exception is so air-tight that even Jack Nicholson couldn’t litigate his way through it.
But before we dive into the main course of two recent Business Court decisions, how about an amuse bouche to refresh your palate on the securities exception?
The Two Stated Reasons for the Securities Exception
Why do courts hold that securities transactions do not fall within the scope of section 75-1.1?
First, several cases, including Skinner v. E.F. Hutton & Co., refuse to permit recovery under section 75-1.1 because securities transactions are subject to “pervasive and intricate” regulation under the North Carolina Securities Act, as well as both the federal 1933 Securities Act and the 1934 Securities Exchange Act. We have written about this pervasive-regulation rationale before.
Second, other cases, including HAJMM Co. v. House of Raeford Farms, also have held that securities transactions are not “in and affecting commerce,” as required to recover under section 75-1.1(a)’s plain language. After discussing Skinner and pervasive regulation, the HAJMM court went on to look at section 75-1.1(b)’s definition of “commerce” as including “all business activities, however denominated.”
As we’ve explained, the HAJMM court concluded that issuing securities and raising capital were not “business activities” because they were not the regular, day-to-day activities of the business at issue. The corporate defendant in HAJMM was a poultry-processing company, and the security at issue—a revolving fund certificate—was issued to raise capital for the company.
What About an Exception to the Exception?
This leads to an obvious follow-up question: what if the wrongful conduct was committed by an actor whose day-to-day business does involve capital-raising or securities transactions? Surely that would be “in or affecting commerce” under the statutory definition, right?
This issue arose in a recent decision from the North Carolina Business Court, Aym Technologies, LLC v. Scopia Capital Management LP.
Aym involved failed negotiations between Aym’s CEO, Lewis Quinn, and several companies in which he was considering investing. Aym is a software company that developed programs for intellectual- and developmental-disability providers in North Carolina. Scopia, one of the defendants, is an asset-management firm interested in acquiring smaller providers in Aym’s industry. Scopia formed a new entity, Community Based Care, LLC, to serve as a holding company for various Scopia-affiliated funds.
Quinn and Scopia initially discussed Aym investing in CBC, and later talked about selling Aym to CBC. As part of those discussions, Scopia told Quinn that it had recruited Brook Phillips to serve as an executive officer for CBC. Eventually, the negotiations broke down, and Aym filed suit. Scopia counterclaimed, alleging that Aym and Quinn had misrepresented their intention to invest in CBC for the purpose of gaining a competitive advantage. Scopia also complained that Aym hired Phillips knowing that CBC was recruiting him.
No Fraud Means No Recovery
The relevant part of the opinion addressed Aym’s motion for summary judgment on Scopia’s counterclaim.
The Business Court granted the motion as to the fraud counterclaim for two reasons. First, the defendants failed to comply with Rule 9(b) because they did not allege an affirmative misrepresentation claim with enough specificity. Second, they failed to identify a duty that could support their fraudulent-concealment claim. The court also granted summary judgment on the section 75-1.1 claim, since that claim rose and fell with the fraud claim.
But the court also took the time to discuss the securities exception. The court cited Skinner and HAJMM and looked at whether the transactions at issue were for the purpose of capital raising. The Scopia defendants repeatedly pleaded that their negotiations with Quinn and Aym were for the purpose of raising investment capital, so the court easily found that the securities exception applied.
But the wrinkle that we identified above arose when the court discussed the “not in or affecting commerce” rationale. The Scopia parties argued that because their day-to-day business activities involved capital-raising activities, this meant that their activities were in or affecting commerce under the statutory definition. In response, the court pivoted to the “pervasive and intricate regulation” rationale. It held that because the investment solicitation at issue was subject to extensive state and federal regulation, it could not form the basis of a section 75-1.1 claim.
Slattery v. AppyCity
The second case, Slattery v. AppyCity, LLC, arose out of a failed investment in a technology startup. The plaintiff, John Slattery (probably not that John Slattery), alleged that after meeting their founders, he was persuaded to invest $500,000 in several technology companies, including the Education App and AppyCity. Over the next few years, the founders repeatedly lied to Slattery about the companies’ prospects. These lies included outlandish promises such as a claim that Netflix was going to purchase AppyCity for $1.2 billion.
After demanding financial records from AppyCity, Slattery realized that his investment had been diverted to the founders individually. Indeed, they admitted as much to him, telling him that most of his investment had been converted to Bitcoin and could not be reached by a lawsuit or judgment.
Slattery asserted several claims against AppyCity and its founders, including fraud and violation of section 75-1.1. When the defendants did not appear to defend the claims, he moved for summary judgment. The court granted summary judgment on the fraud claim based on Slattery’s undisputed evidence. But it denied summary judgment as to the section 75-1.1 claim. Why?
The HAJMM Sandwich Toasted Slattery’s Claim
Like in Aym, the Business Court in Slattery cited HAJMM and Skinner for the proposition that “securities transactions are beyond the scope of N.C.G.S. § 75-1.1.” The court, citing Bucci v. Burns (a case we discussed here), noted that the North Carolina legislature did not intend for section 75-1.1’s treble damages to be available in securities transactions because they are subject to pervasive regulation under state and federal statutes.
Although Slattery’s investment entitled him to membership in the LLC, he had no control over the company’s day-to-day operations, which made it a passive investment and therefore a standard securities transaction, from the court’s point of view.
The Key Ingredients of the HAJMM Sandwich Are Here to Stay
Both Aym and Slattery confirm that when assessing whether the securities exception applies, the only question to answer is whether the transaction at issue involved securities or capital-raising transactions.
When the day-to-day business of a party involves capital raising or securities, that begs the question whether the activity is “in or affecting commerce” and within section 75-1.1’s scope. But these arguments fall flat because early decisions like Skinner created the exception due to the pervasive regulation of the securities markets by both federal and state laws. If the “in or affecting commerce” rationale doesn’t apply, the “pervasive regulation” rationale will likely swallow up the claim.
But what happens if the plaintiff has no remedy under the laws that regulate securities because, for example, the transaction falls under a regulatory exemption? Neither Aym nor Scopia considered that question. As we have discussed earlier, other decisions have found this point irrelevant in determining whether the “pervasive regulation” rationale bars a claim. The net result: A claimant could be left without a remedy under either the securities laws or section 75-1.1.
The lesson for parties litigating securities disputes is to make sure to order off of the right part of the menu when preparing your claims. No matter how attractive those South African red wines on page 75 of the wine list may be, the Argentinian Malbecs on page 78A are where you want to focus your claims about securities.
Like the chocolate that appears with the final bill, we wanted to share that we may learn more about the nature and scope of the securities exemption in the near future. The Nobel v. Foxmoor Group, LLC case that we wrote about last summer is currently before the North Carolina Supreme Court. A decision from the state’s highest court may provide further guidance on the exemption.
Author: Jamie Weiss