Hays v. Ellrich , 471 Mass. 592 ( 2015 )

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SJC-11743
MOLLY A. HAYS vs. DAVID J. ELLRICH & others.1
Suffolk. February 3, 2015. - June 10, 2015.
Present: Gants, C.J., Spina, Cordy, Botsford, Duffly, Lenk,
& Hines, JJ.
Uniform Securities Act. Securities, Sale. Fraud. Fiduciary.
Limitations, Statute of. Evidence, Fraud. Practice,
Civil, Fraud, Statute of limitations.
Civil action commenced in the Superior Court Department on
September 11, 2006.
The case was heard by Christine M. Roach, J.
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
1
Morgan Financial Advisors, Inc. (MFA), and U.S. Bank
National Association (U.S. Bank). U.S. Bank is not a party to
this appeal.
2
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), G. L. c. 110A,
§ 410 (a) (2), committed fraud, and committed a breach of their
fiduciary duty to her. After a jury-waived trial, the judge
ruled that Ellrich and MFA were liable under § 410 (a) (2), and
entered judgment in Hays's favor for $381,354.80 plus
interest.2,3 MFA and Ellrich appealed, and we transferred the
case to this court on our own motion.
On appeal, Ellrich and MFA claim that they were not
"sellers" of securities within the meaning of § 410 (a) (2), and
therefore cannot be liable under the act. They also argue that
2
The trial on liability proceeded against MFA only, because
David J. Ellrich had previously been defaulted for failing to
appear at a hearing on his attorney's motion to withdraw as
counsel of record, despite having been ordered by the court to
appear at the hearing, and despite having been notified by his
counsel of the date of the hearing.
3
The trial judge also found in Molly A. Hays's favor on her
common-law claims of fraud and breach of fiduciary duty, and
entered judgment "consistent with, but not duplicative of," the
statutory count under G. L. c. 110A, § 410. The judge found in
favor of the defendants on breach of contract claims and an
estoppel claim.
3
the claims on which Hays prevailed are barred by the statute of
limitations. In addition, they contend that the judgment must
be vacated because it is contrary to the great weight of the
evidence.4 We affirm the judgment.
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
(2008). We reserve certain facts that directly relate to the
legal issues we address.
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.
Hays told Ellrich that she needed income but wanted to remain at
home with her five year old daughter.5 Ellrich told Hays, who
4
Ellrich also claims that it was an abuse of discretion for
the trial judge to deny his motion to set aside the default.
5
Hays had worked for Pan American Airlines as a flight
attendant until approximately 1991. She has a bachelor's degree
4
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 § 72(t) of the Internal Revenue
Code -- seven per cent per year at the time.6 As a consequence,
Hays's investment portfolio needed to achieve an average annual
rate of return of more than 11.75 per cent: seven per cent to
cover the withdrawal rate, plus inflation, which averaged
approximately three per cent, plus Ellrich's management fee of
1.75 per cent. 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
in English Literature from the University of South Florida and a
master's degree in Library Sciences.
6
The wisdom or accuracy of this advice is not at issue in
the case.
7
With a "market-timing" strategy (in contrast to a "buy and
hold" strategy), an investor actively trades investments to time
5
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
advisor, Hays transferred her accounts to MFA, and executed
first a portfolio management and services agreement and later a
superseding investment advisory agreement with MFA. MFA was
designated as the registered investment advisor on all of Hays's
accounts, which totaled approximately $470,000 at the end of
2000.
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
the rise and fall of the markets. According to financial
statements Ellrich prepared for Hays, Hays's accounts at Rydex
Series Trust, Profunds Investments, and Fidelity Investments
together made up more than ninety-nine per cent of Hays's net
worth.
8
A "hedge fund" is a "specialized investment group --
[usually] organized as a limited partnership or offshore
investment company -- that offers the possibility of high
returns through risky techniques such as selling short or buying
derivatives." Marram v. Kobrick Offshore Fund, Ltd., 442 Mass.
43, 46 n.5 (2004), quoting Black's Law Dictionary 727 (7th ed.
1999).
6
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
7
found that, "by a combination of his words, his manner, and his
tone, Ellrich strongly implied to Hays . . . that Convergent
would be a suitable investment for her."9
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
9
Ellrich testified that he merely identified Convergent
Market Funds (Convergent) for his clients as an option for them
to consider, and that he informed Hays that he could not advise
her whether to invest in Convergent because it would create a
conflict of interest where he was Convergent's investment
advisor. But the trial judge credited Hays's testimony
regarding the conversation she had with Ellrich, finding that
"Ellrich did more than neutrally recite 'options' Hays could
consider."
8
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."
9
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
10
These risks "include[d] the likelihood that [the]
investment [would] not generate current income or distributions
even if [Convergent were] successful, and the possibility that
some or all of the amount invested [would] be lost if
[Convergent were] not successful."
11
In the investor questionnaire, Hays stated that her
"[a]pproximate current portfolio value" was $500,000. Hays did
not complete the section of the investor questionnaire asking
whether she had relied on a "purchaser representative."
10
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
volatile but would correct itself eventually. In these
conversations, Ellrich did not distinguish between Hays's
Convergent investments and her Fidelity investments (which MFA
continued to manage for Hays), and did not tell her that he
could not advise her regarding her investment in Convergent.
Both the stock market and the value of Hays' investment in
Convergent continued to decline throughout 2002. Although Hays
was concerned, she "didn't do anything" because she trusted
Ellrich.
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,
12
Following her investment with Convergent, Hays also
periodically received a separate "Statement of Benefits" from
Ellrich. In 2002, Hays stopped receiving any written statements
from Ellrich, who began reporting Hays's balances to her by
telephone, with Ellrich claiming that personal difficulties
prevented him from preparing written statements.
11
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, G. L. c. 110A,
§ 410 (a) (2), a sale of securities in Massachusetts may be
rescinded if the person who "offers or sells a security"
misleads the buyer by making an untrue statement of a material
fact or by failing to state a material fact, unless the seller
proves that he or she did not know of the untruth or omission
and in the exercise of reasonable care could not have known.14
13
In late 2003 and early 2004, when Hays asked Ellrich
about her situation, Ellrich offered to trade for her on the
futures market, but Hays declined. He also told her that her
interests were being represented in a class action that Ellrich
was bringing in Federal court against U.S. Bank, but Hays did
not recover anything from that lawsuit.
14
The full text of G. L. c. 110A, § 410 (a) (2) states:
12
See Marram v. Kobrick Offshore Fund, Ltd., 442 Mass. 43, 52
(2004). Ellrich15 argues that he cannot be liable under the act
because he neither offered nor sold Convergent securities to
Hays.
Not all who solicit the purchase of securities are
"sellers" under the act, nor are they all "sellers" under
§ 12(a)(2) of the Securities Act of 1933 (Federal act), 48 Stat.
74, codified at 15 U.S.C. § 77l (2012) -- which is the Federal
counterpart to § 410 (a) (2) of the act.16 Neither Congress nor
"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."
15
For convenience, because Ellrich is the sole owner and
operator of MFA, we refer to both appellants as "Ellrich" here
and throughout the discussion section except where the context
indicates otherwise.
16
As we discuss further in part 2, infra, we consider
Federal law here because the Legislature has directed us to
13
the Legislature intended to impose rescission "on a person who
urges the purchase but whose motivation is solely to benefit the
buyer" of the security. Pinter v. Dahl, 486 U.S. 622, 647
(1988). See Stolzoff v. Waste Sys. Int'l, Inc., 58 Mass. App.
Ct. 747, 766 n.21 (2003). Under both of these statutes, a
person "offers or sells a security" if he "successfully solicits
the purchase motivated at least in part by a desire to serve his
own financial interests or those of the securities owner." Id.,
quoting Adams v. Hyannis Harborview, Inc., 838 F. Supp. 676, 686
(D. Mass. 1993), aff'd in part sub nom. Adams v. Zimmerman, 73
F.3d 1164 (1st Cir. 1996). See Pinter, supra at 647.
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
"coordinate the interpretation and administration of [G. L.
c. 110A] with the related federal regulation." G. L. c. 110A,
§ 415.
14
value -- was less than the 1.75 per cent he earned on Hays's
retirement funds before she invested them in Convergent.17
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,
17
Although Ellrich's investment management fee was three
per cent per year of Convergent's net asset value, he was
responsible for paying "sub-advisory fees" totaling
approximately 1.75 per cent per year of Convergent's net asset
value, leaving him only 1.25 per cent.
15
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 judge,
18
Convergent's offering memorandum declared that the
partnership was "seeking to raise Invested Capital in the
minimum amount of $15,000,000," which it characterized as the
"Minimum Offering."
19
Ellrich's reliance on Cohen v. State St. Bank & Trust
Co., 72 Mass. App. Ct. 627 (2008), is misplaced. In that case,
the plaintiff contended that his investment manager had made
false statements and omitted material facts when the manager
transferred the plaintiff's funds from one State Street
investment account to two State Street subaccounts. See id. at
629, 635. The Appeals Court affirmed 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
16
therefore, did not err in finding that Ellrich's solicitation of
Hays to purchase Convergent securities made him a seller under
the act.
2. Statute of limitations. Ellrich contends that Hays's
claim under § 410 (a) (2) of the act, filed in September, 2006,
was not timely in light of the four-year limitations period in
§ 410 (e), which provides, "No person may sue under this section
more than four years after the discovery by the person bringing
the action of a violation of this chapter." Ellrich contends
that the limitations period began to run in December, 2000, when
Hays received Convergent's offering memorandum and signed the
agreement to become a limited partner (which included the
representation that she had "received and read" the relevant
agreements). Relying on dictum in Marram, 442 Mass. at 54 n.20,
quoting Kennedy v. Josephthal & Co., 814 F.2d 798, 802-803 (1st
Cir. 1987), Ellrich contends that the limitations period in
§ 410 (e) begins to run when the plaintiff is put on "inquiry
notice" of the violation, and he contends that the information
in the offering memorandum put Hays on "inquiry notice" in
December of 2000 that the investment was unsuitable for her,
because "inquiry notice" occurs when "a reasonable investor
would have noticed something was 'amiss,' e.g., when [she]
would attract assets from sources other than his former
investment clients and thereby substantially increase his
investment management fees.
17
obtained a prospectus." In Marram, however, the defendant who
solicited the plaintiff to invest in his hedge fund did not owe
the plaintiff a fiduciary duty; Ellrich, as Hays's investment
advisor, did owe her such a duty. And in determining when the
statute of limitations clock begins to run, that makes all the
difference.
Under the "fraudulent concealment" doctrine, codified at
G. L. c. 260, § 12, "[i]f a person liable to a personal action
fraudulently conceals the cause of such action from the
knowledge of the person entitled to bring it, the period prior
to the discovery of his cause of action by the person so
entitled shall be excluded in determining the time limited for
the commencement of the action." We have interpreted this
statute to mean that "[w]here a fiduciary relationship exists,
the failure adequately to disclose the facts that would give
rise to knowledge of a cause of action constitutes fraudulent
conduct and is equivalent to fraudulent concealment for purposes
of applying § 12." Demoulas v. Demoulas Super Mkts., Inc., 424
Mass. 501, 519 (1997), S.C., 428 Mass. 543 (1998), and S.C., 432
Mass. 43 (2000). See Doe v. Harbor Sch., Inc., 446 Mass. 245,
254-255 (2006); Patsos v. First Albany Corp., 433 Mass. 323,
328-329 (2001); Puritan Med. Ctr., Inc. v. Cashman, 413 Mass.
167, 175 (1992), and cases cited. In these cases, the statute
of limitations clock begins to run only when the plaintiff has
18
"'actual knowledge' . . . of the facts giving rise to his causes
of action," i.e., the facts which the fiduciary had failed to
disclose. Patsos, supra at 329 n.11. See Crocker v. Townsend
Oil Co., 464 Mass. 1, 9 (2012) ("the statute of limitations
begins to run when the plaintiff has actual knowledge of the
wrong giving rise to his cause of action"); Doe, supra at 254-
255, quoting Akin v. Warner, 318 Mass. 669, 675 (1945)
(limitations clock for tort claim alleging breach of fiduciary
duty begins to run only when plaintiff has "'actual knowledge'
that she has been injured by the fiduciary's conduct," which
occurs "[o]nly when the beneficiary's harm at the fiduciary's
hands has 'come home' to the beneficiary"); Demoulas, supra.
Therefore, under the fraudulent concealment doctrine, "inquiry
notice" of a violation by a seller of securities is not enough
to start the limitations clock running when the seller owes a
fiduciary duty to the purchaser.
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.
19
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 § 12(a)(2) of the Federal act. As Ellrich
correctly notes, G. L. c. 110A, § 415, provides, "This chapter
shall be so construed as to effectuate its general purpose to
make uniform the law of those states which enact it and to
coordinate the interpretation and administration of this chapter
with the related federal regulation." See Marram, 442 Mass. at
50 ("The Legislature has directed that we interpret the act in
coordination with the [Federal act]"). We therefore examine the
Federal standard and consider whether to apply it to the
limitations period under the act.
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,
20
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
21
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 that were contradicted or corrected
by the prospectus. Federal courts have repeatedly held that
receipt of the prospectus constitutes a "storm warning" even
where the plaintiff was unsophisticated. See Dodds v. Cigna
Sec., Inc., 12 F.3d 346, 350 (2d Cir. 1993), cert. denied, 511
U.S. 1019 (1994); Kennedy, 814 F.2d at 802-803 ("We are faced
here with the great glowering clouds of the offering
memorandum," where, "[f]or each oral representation that [the
defendant] made and upon which appellants claim they relied,
there was a direct refutation by the plain language of the
offering memorandum"). Although "subjective" factors are
relevant in applying the second part of the test, Federal courts
have rejected the argument that unsophisticated plaintiffs'
reliance on defendants excused the plaintiffs from reasonable
diligence after storm warnings were present, even where the
defendants had committed a breach of fiduciary obligations
towards them. See Maggio, 824 F.2d at 129 ("Even assuming that
defendants owed plaintiff a fiduciary duty, . . . plaintiff's
prolonged failure to investigate the possibility of fraudulent
conduct in light of the abundant facts known to him . . . can
hardly be characterized as due diligence"); Kravetz v. United
States Trust Co., 941 F. Supp. 1295, 1303-1309 (D. Mass. 1996).
22
See also J. Geils Band Employee Benefit Plan v. Smith Barney
Shearson, Inc., 76 F.3d 1245, 1259-1260 (1st Cir.), cert.
denied, 519 U.S. 823 (1996), quoting Cook, 573 F.2d at 696 n.24
("Even assuming that [defendants] owed [plaintiffs] a fiduciary
duty, an investor 'must apply his common sense . . . in
determining whether further investigation is needed' . . . [and]
[w]hile we recognize, and are genuinely troubled by, the
possibility that the [plaintiffs] were such unsophisticated
investors that they were not in a position to heed the storm
warnings, . . . plaintiffs cannot shroud themselves in ignorance
or expect that their unsophistication will thoroughly excuse
their lack of diligence or failure, here, to even inquire"). In
short, under Federal law, where clients have invested in
securities based on the false statements or omissions of an
investment advisor who owes them a fiduciary duty, the clients
are still required to act with reasonable diligence if the
information in the prospectus suggests that their reliance on
the investment advisor may be misplaced, and the limitations
clock begins upon their failure to do so, even if they have no
actual knowledge that they had been misinformed.
We decline to adopt this Federal standard as our own under
the act for two reasons. First, the actual knowledge standard
recognizes the trust that an investor is entitled to place in a
fiduciary's advice regarding investment decisions. See Doe, 446
23
Mass. at 255 ("[T]he actual knowledge standard recognizes the
dependent status of the beneficiary vis-à-vis the fiduciary, and
protects the beneficiary's legitimate expectation that the
fiduciary will act with the utmost probity in all matters
concerning the relationship"). It also recognizes that
unsophisticated investors who are advised by their fiduciary
that an investment is suitable for them are unlikely to read a
prospectus with an eye towards testing the wisdom of that
advice, especially where they might not understand the
information that is relevant to such investment decisions and
might not perceive the significance of "storm warnings." The
argument that financial information in a prospectus addressed to
sophisticated investors will alert the investor to the
possibility that his or her fiduciary is untrustworthy, and
should impose on the investor a duty to make an independent
inquiry into the fiduciary's trustworthiness, is contrary to the
relationship of trust implicit in any fiduciary relationship.
See id. at 256 n.13 ("a beneficiary is entitled to approach [a
fiduciary's representations] without skepticism . . . and is not
required to ascertain the absence of foul play").
Second, although G. L. c. 110A, § 415, directs that courts
"coordinate the interpretation and administration of this
chapter with the related [F]ederal regulation," it does not
mandate that courts adopt the interpretation of comparable
24
Federal securities statutes, especially where doing so would
conflict with our interpretation of other Massachusetts
statutes, such as G. L. c. 260, § 12, which codifies our
fraudulent concealment doctrine. Moreover, the Legislature
cannot have intended that the limitations period under the act
would be the same as the limitations period under the Federal
act where the Legislature provided Massachusetts plaintiffs a
much more generous limitations period under the act (four years)
than Congress provided under the Federal act (one year), and
where the Legislature failed to impose the three-year statute of
repose included in the Federal act. Compare G. L. c. 110A,
§ 410 (e), with 15 U.S.C. § 77m (2012).20
Applying the actual knowledge standard to the facts of this
case, we conclude that where an investment advisor owes a
fiduciary duty of disclosure to his or her client and violates
the act by misleading the client regarding the suitability of an
investment, Massachusetts law deems it fraudulent concealment
for the fiduciary to fail to reveal to the client that the
investment was not suitable, and the limitations clock begins to
run only when the client has actual knowledge of the
20
Title 15 U.S.C. § 77m (2012) provides, in relevant part,
"No action shall be maintained to enforce any liability [under
§ 12(a)(2)] unless brought within one year after the discovery
of the untrue statement or the omission, or after such discovery
should have been made by the exercise of reasonable diligence,"
and, "In no event shall any such action be brought . . . more
than three years after the sale."
25
unsuitability of the investment. Here, the facts giving rise to
Hays's cause of action under § 410 (a) (2) of the act are that
Convergent was an unsuitable investment for Hays, and that
Ellrich, as her fiduciary, failed to disclose to her its
unsuitability in soliciting her to purchase Convergent
securities. Therefore, in the context of this case, the
limitations clock for Hays began when she had actual knowledge
of the unsuitability of Convergent securities -- for instance,
knowledge that investing in Convergent was substantially riskier
than the investments that Ellrich had previously made for her.
The judge found that, even though the value of Convergent
securities declined after Hays purchased them, "a reasonable
client in Hays'[s] position could not have ascertained, without
expert advisor advice, how the Convergent risk compared to the
risks she had been taking historically, particularly in a
volatile market." Further, the judge found that "a reasonable
investor in Hays'[s] position . . . could not reasonably have
noticed that something (other than market forces) was amiss
prior to, at the earliest, September, 2003," when Ellrich
informed Hays that Convergent was insolvent and that an
investigator from the securities division of the Secretary of
the Commonwealth would be contacting her.21 We conclude that
these findings are not clearly erroneous.
21
The trial judge relied on Marram, 442 Mass. at 54 n.20,
26
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 that Ellrich had made.22 It is true that a sophisticated
investor who carefully read and considered the offering
memorandum would have recognized that the investment was not
suitable for a person in Hays's financial position. But a
sophisticated investor in Hays's financial position who
carefully read and considered the offering memorandum would also
likely not have invested in Convergent. The fact that Hays did
invest in Convergent supports the judge's finding that, despite
having received the offering memorandum, she was not
sophisticated enough to have actual knowledge of the
unsuitability of the investment at the time she invested.
Ellrich alternatively contends that Hays had actual
knowledge by June, 2001, when she knew that her investment in
in applying an "inquiry notice" standard to the issue whether
Hays's statutory claim was timely, finding that Hays was not on
inquiry notice of the statutory violation by Ellrich at any time
prior to 2003. Although the trial judge did not apply an actual
knowledge standard, as we do here, the judge implicitly found
that Hays did not have actual knowledge before 2003 by finding
that Hays was not on inquiry notice before 2003.
22
Hays does not contend that the offering memorandum
contained material misrepresentations or omissions.
27
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,
28
and when she signed the offering memorandum. We need not
address whether the actual knowledge standard applies to a claim
against a person who once was a fiduciary but who subsequently
terminated the fiduciary relationship, because the judge found
(and the evidence supports her finding) that Ellrich did not
explain to Hays his potential conflict of interest -- that is,
he did not explain that "he would no longer be considering
Hays'[s] individual needs with respect to those trades, and that
he would no longer have any obligation to ensure that any of the
securities purchased for the Convergent portfolio was an
appropriate investment for Hays; and that [he] was no longer
obliged to monitor for Hays the assets held by those funds."
The judge further found, based on Ellrich's omissions and his
conduct, that he "continued to provide advisory services to
Hays, and accordingly Hays reasonably continued to trust [him]
to do so." In short, Ellrich's fiduciary relationship with Hays
regarding the funds she invested in Convergent should have ended
once she made that investment, but Ellrich never told her that
it did, and she reasonably understood that he continued to serve
as her investment advisor for these funds and continued to make
market-timing investments on her behalf.
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
29
under the act, and because we conclude that the judge was not
clearly erroneous 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
30
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
23
We need not consider Ellrich's claim that the judge
abused her discretion in denying Ellrich's motion to set aside
the default earlier entered against him, where the judge made
findings of fact and law as if he were not a defaulted party,
and these findings provide an adequate and independent ground
for the judgment against him. Nor need we consider whether the
judge's allowance of the common-law claims would independently
support the award of rescissionary damages where those damages
were awarded under the act, and the judge did not award any
damages beyond those available under the act.
31
Conclusion. For the foregoing reasons, the judgment in
favor of Hays against Ellrich and MFA is affirmed.
So ordered.