UNITED STATES DISTRICT COURT MIDDLE DISTRICT OF FLORIDA TAMPA DIVISIO N. V. Case No. 8:01-cv-571-T-30EAJ

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1 FILED JAMES MAY, NELLIE SQUIRES, CHARLES R. CIESLIK, KAY CIESLIK, MERVYLE C. TOWNS, TRUDY TOWNS, and PHYLLIS L. ZIMMERMAN, UNITED STATES DISTRICT COURT MIDDLE DISTRICT OF FLORIDA TAMPA DIVISIO N 02FEB-6 AM P LT COURT zip :L~ Dig.~~lC f OF FLORIDA TAMPA. FLORID A Plaintiffs, V. Case No. 8:01-cv-571-T-30EAJ CHARLES E. EDWARDS, JASON EDWARDS, HAYES FINANCIAL GROUP, INC., CURTIS G. HAYES, OXFORD FINANCIAL OF PINELLAS, INC., STEVE RODD, ROBERT S. BALDWIN, EPIC PLANNING GROUP, INC., RICHARD SOUTHERLAND, SPRYNG T. SOUTHERLAND, and INSURANCE ASSOCIATES SERVICES, INC., Defendants. ORDER ON HAYES DEFENDANTS' MOTION TO DISMIS S This cause came before the Court on Defendant Hayes Financial Group, Inc., HFG Communications, Inc., Curtis G. Hayes and Jean E. Hayes' (hereinafter referred to as the "Hayes Defendants") Motion to Dismiss Pursuant to Federal Rules of Civil Procedure 9(b), 12(b)(6) and pursuant to 15 U.S.C. 78u-4, et seq. (Dkt. #9), supporting memoranda (Dkt. #10) and Plaintiffs' response in opposition thereto (Dkt. #37). Upon review of the motion, response, supporting and opposing memoranda, and the Court file in this matter, the Court hereby grants the Hayes Defendants' motion in part and denies it in part as set forth herein

2 FACTUAL BACKGROUND This case involves an investment entity offered by ETS Payphones Company, a Georgia corporation founded by Defendant Charles Edwards in Edwards was the primary shareholder and officer of ETS. Defendant Jason Edwards (Charles Edwards' son) served as the Chief Executive Officer of ETS from January, 1999, to present.' In May, 2000, Defendant James Blyth became President of ETS. ETS declared bankruptcy in September, Defendant Hayes Financial Group is a Florida corporation that entered into variou s agreements to sell and lease telephone investments offered by ETS. HFG Communications is a successor in interest to the Hayes Financial Group. Defendant Curtis Hayes was a primary shareholder and officer ofthe Hayes Financial Group and HFG Communications and allegedly participated in selling investments to investors in Florida. Defendant Jean Haye s is also an officer of HFG Communications who allegedly executed bills of sales on behalf of HFG Communications. Plaintiffs are Florida residents who were solicited by certain combinations of the Defendants to buy the pay telephone investments and as a result of those solicitations, purchased numerous payphone investments, with lease back agreements. Plaintiffs allege that these investments were part of a "ponzi scheme" in which investors' money was ' The Court recently granted a motion filed by the Edwards Defendants to compel arbitration. Z Plaintiffs voluntarily dismissed ETS from this action approximately one month after this suit was filed. Page 2 of 12

3 funneled from earlier investors to succeeding investors after diverting a large portion of th e funds to Defendants for their personal use rather than for legitimate business operations. The process involved third parties, like the Hayes Defendants, who would locate potentia l investors to enter into agreements to purchase the pay telephones. Plaintiffs refer to thes e third parties as the "selling defendants." The Hayes Defendants contend that Plaintiffs ' complaint fails to allege that they were involved in the alleged ponzi scheme or that they knew that ETS was operating a ponzi scheme. In most cases, the investors would then lease the telephone back to ETS for a fixe d monthly rental payment. Those investors who had leaseback agreements had no involvement in the operation of the telephones. Generally, ETS also agreed to repurchase the pay telephones from the investors for the same purchase price within 180 days of the investor' s demand (through an "option-to-sell" agreement). Plaintiffs' complaint sets forth the following counts against Defendants for thei r conduct with the pay telephone investment programs : (1) violations of 12(1) and 15 of the Securities Act, 15 U.S.C. 771(l) and 77o ; (2) violation of 12(2) and 15 of the Securities Act, 15 U.S.C. 771(2) and 77o ; (3) violations of 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10(b)(5) ; (4) violation of the Florida Securities and Investment Protection Act (commonly referred to as Florida's "blue sky" laws), Fla. Stat.; (5) violation of the Florida Securities and Investment Protection Act, Fla. Stat. ; (6) violation of the Florida Securities and Investment Protection Act, Fla. Stat. ; Page 3 of 12

4 (7) violation ofthe Flo rida Securities and Investment Protection Act, Fla. Stat. ; (8) violation of Florida's Deceptive and Unfair Trade Practices Act ("FDUTPA"), , Fla. Stat. ; (9) breach of fiduciary duty ; and (10) conspiracy. STANDARD FOR DISMISSAL In ruling on a motion to dismiss, the court must accept plaintiffs well-pleaded fact s as true, and construe the complaint in the light most favorable to the plaintiff. See ual i Foods de Centro Am., S.A. v. Latin Am. Agribusiness Devel. Corp., 711 F.2d 989, (11th Cir. 1983); Rickman, 902 F.Supp. at 233, citing Scheuer v. Rhodes, 416 U.S (1974). A complaint should not be dismissed pursuant to Rule 12 (b)(6) "unless it appears beyond doubt that the plaintiff can prove no set of facts in support of his claim." Bracewel l v. Nicholson Air Services, Inc., 680 F.2d 103, 104 (11th Cir. 1982). See also Rickman v. Precisionaire, Inc., 902 F.Supp. 232,233 (M.D. Fla. 1995) citing Conley v. Gibson, 355 U.S. 41, 47 (1957). For Rule 12(b)6 purposes, the court considers as pa rt of the complaint any written instrument filed with it as an exhibit. See Rule 10(c) Fed. R. Civ. P. ("A copy of any written instrument which is an exhibit to a pleading is a part thereof for all purposes.") LEGAL ANALYSIS The Hayes Defendants seek dismissal of all fraud-based claims averred in Counts I through VII of the Complaint for: 1) failure to plead fraud with sufficient particularity i n accordance with Rule 9(b) of the Federal Rules of Civil Procedure and under the Privat e Securities Litigation Reform Act ("PSLRA"); 2) failure to allege with particularity the facts Page 4 of 12

5 that support the "information and belief" allegations; 3) failure to allege facts that woul d establish a strong inference that Defendants acted with scienter ; 4) failure to allege adequately that Defendants Curtis and Jean Hayes are subject to "controlling person " liability ;' and 5) failure to state a claim under Sections 12(2), 15, 10B, 20(a) or Rule IOb- 5 of the federal securities laws,' or under Florida's "blue sky" laws. The Motion also seeks dismissal of the FDUTPA count (Count VIII) on the basis that FDUTPA does not apply to sales of securities, and the conspiracy count (Count X), for failure to state a claim. Federal and State Securities Claims5 Rule 9(b) states that "[i]n all averments of fraud or mistake, the circumstances constituting fraud or mistake shall be stated with particularity." Courts recognize that a 3 Section 20(a) ofthe Exchange Act provides that "[e]very person who, directly or indirectly, controls any person liable under any provision of this chapter or of any rule or regulation thereunder shall also be liable jointly and severally with and to the same extent as such controlled person to any person to whom such controlled person is liable, unless the controlling person acted in good faith and did not directly or indirectly induce the act or acts constituting the violation or cause of action." " The United States District Court for the Northern District of Georgia held, on two occasions, that the sale and leaseback of pay telephones involves "investment contracts" and therefore "securities," under the analysis promulgated in the seminal case of SEC v. W. J. Homey Co., 328 U.S. 293, 301 (1946) (holding that an investment contract exists where there is 1) an investment of money; 2) in a common enterprise; 3) with the expectation of profits solely derived from the efforts of others). See SEC v. ETS Payphones, Inc., 123 F. Supp. 2d 1349 (N.D. Ga. 2000) (case is currently before the Eleventh Circuit Court of Appeals on an expedited appeal) ; SEC v. Phoenix Telecom, Case No. 00-cv-1070 (N.D. Ga. 2000). This Court agrees with the well-reasoned decisions of the North District of Georgia Court. 5 Defendants note that Plaintiffs' state law claims under Florida's "blue sky" laws include the federal securities claims under Fla. Stat. ("[t]he same civil remedies provided by laws of the United States for the purchasers and sellers of securities, under any such laws, in interstate commerce extend also to purchasers and sellers of securities under this chapter"), and argue that they should be dismissed, as should the federal claims, pursuant to Rule 9(b). Plaintiffs similarly contend that these claims should not be dismissed because they meet the requirements of Rule 9(b). Page 5 of 12

6 "pleading is sufficient under Rule 9(b) if it identifies the circumstances constituting fraud s o that the defendant can prepare an adequate answer for the allegations." Semegen v. Weidner, 780 F. 2d 727, ( 9th Cir. 1985). Courts also carve out an exception to Rule 9's pleading requirements for cases of fraud where the details of the fraud lie within the contro l of the defendant. Whirlpool Financial Corp. v. GN Holdings, Inc., 873 F. Supp. 111 (N.D. Ill. 1995), aff d, 67 F. 3d 605 (7th Cir. 1995). As to securities cases, the PSLRA provides that "the complaint shall specify eac h statement alleged to have been misleading, the reason or reasons why the statement is misleading, and, if, an allegation regarding the statement or omission is made on informatio n or belief, the complaint shall state with particularity all facts on which that belief is formed." 15 U.S.C. 78-u 4(b)(1). And with respect to each act or omission, plaintiff must "state with particularity facts giving rise to a strong inference that the defendant acted with the require d state of mind." 15 U.S.C. 78-u 4(b)(2). See also Bryant v. Avado Brands, Inc., 187 F.3 d 1271 (11th Cir. 1999) ("allegations of motive and opportunity to commit fraud, standing alone," are not sufficient to establish scienter). Congress created the PSLRA to permit court s to use a more stringent pleading standard than the one set forth in Rule 9(b).' To state a "successful cause of action under Section 10(b) or Rule I Ob-5, plaintiff is required to prove (1) a misstatement or omission (2) of a material fact (3) made with scienter (4) upon which the plaintiff relies (5) that proximately caused the plaintiffs loss." 6 This is further supported by the fact that discovery is stayed until this test is met and the motion to dismiss is resolved. 15 U.S.C. 78-u 4(b)(3)(B). See Dkt. 58. Page 6 of 12

7 Theoharous v. Fong, 256 F. 3d 1219, 1223 (11' Cir. 2001), citing McDonald v. Alan Bush Brokerage Co., 863 F. 2d 809, 814 (1 lth Cir. 1989). Generally, under Florida 's securities law, a plaintiff must establish these same statutory requirements. But see In re Goldbronn, 263 B.R. 347 (M.D. Fla. 2001) ; Profilet v. Cambridge Financial Corp., 231 B.R. 373, 380 (S.D. Fla. 1999).' In their motion, Defendants contend that Plaintiffs have failed to establish scienter an d failed to plead fraud with the particularity required by Rule 9(b) and the PSLRA. Plaintiffs point to 46 of the complaint, which states : In addition, the Issuing and Selling Defendants represented that the Issuing Defendants would pay the investors the payments set forth above. This information was false and misleading, or omitted material information, in that ETS was unable to pay investors the promised returns because ETS was operating a "ponzi scheme," funneling investors money from succeeding investors to earlier investors, after diverting large portions ofthe funds to itself and its principals. Plaintiffs were not informed that the Issuing Defendants were losing significant amounts of money on the operation of the [payphone investments] and that they were totally dependent upon new investors to pay prior investors. Plaintiffs also contend that Defendants misrepresented that "ETS was a viable and profitabl e company, and that as the second largest payphone operator in the United States, it had th e ability to satisfy the Agreements at issue. These representations were false because th e Issuing Defendant lacked the ability to pay the promised retu rn." (Dkt. 37 at 4). ' In these cases, it appears that there are some differences between the statutes ; however, neither party addresses these differences as they relate to Plaintiffs' claims. Page7of 12

8 Although this paragraph points out something that appears to be false, that ETS coul d not and did not pay Plaintiffs the promised returns (instead filing for bankruptcy), it fails to provide any particular facts as to how or when or why these Selling Defendants would hav e known that these facts were false. It also fails to provide any factual basis for the allegation that the Selling Defendants, such as the Hayes Defendants, represented to Plaintiffs that th e Issuing Defendants would pay them as promised. It merely lumps these Defendants into the same general allegations. The Court further notes that Plaintiffs fail to provide adequate factual support fo r other allegations. A portion of a brochure is quoted in 35 ; however, it is neither attached nor attributed to a specific defendant (that is, which defendant issued the brochure thereby making the representations). Even if the Court assumes that this brochure is part of the alleged "written offering documents" used to induce buyers or as part of the Defendants ' "uniform and standardized sales presentation," Plaintiffs do not allege these facts and th e Court finds the allegations are insufficient to survive a motion to dismiss under the PSLRA and Rule 9(b). In sum, it is difficult to ascertain from many of the particulars regarding the misrepresentations or omissions and to which specific defendant each allegation pertains. Plaintiffs also contend that they have adequately plead scienter in ("Defendants acted with scienter in that they held themselves our as being knowledgeabl e in the solicitation of capital from investors") and speculate that "Defendants knew or acte d extremely reckless in selling these Agreements to the investors under these circumstances, " Page 8 of 12

9 especially where one holds oneself out as a specialist. (Dkt. 37 at 6). Plaintiffs allege that as a Control and Selling Defendant, the Hayes Defendants "knew, or in the exercise o f reasonable care and due diligence, should have known, that such statements and omissions were misleading and material." (Complaint, 71). These allegations, without further factual support or particular details, fail as a matte r of law. For example, there are no facts that would connect the Plaintiffs' contention that these defendants "knew or should have known" of the alleged misrepresentations an d omissions. The PSLRA specifically requires that a plaintiff must "state with particularity facts giving rise to a strong inference that the defendant acted with the required state o f mind." The Court finds that Plaintiffs' allegations of scienter are lacking under the rigorous standards of the PSLRA and the case law of this Circuit. As to the issue of the Hayes Defendants' "control person" liability, Plaintiffs allege that Curtis and Jean Hayes possessed and exercised "substantial authority" over the sale of the pay telephone investments through their positions as officers, directors, or shareholder s and possessed the "authority and ability to directly and indirectly exercise control over th e policies and decision-making with regard to the sale and the manner in which the [pa y telephone investments] were sold." The Hayes Defendants claim that these allegations of control and authority are insufficient as a matter of law. In order to state a 20(a) claim for "control person" liability, a plaintiff must alleg e that the defendant violated l Ob (or Rule 1 Ob-5) of the Exchange Act ; that the defendant had Page 9 of 12

10 the power to control the "general business affairs" of the entity ; and, that defendant "had th e requisite power to directly or indirectly control or influence the specific corporate polic y which resulted in primary liability." Theoharous v. Fong, 256 F. 3d. 1219, 1227 (1 lth Cir. 2001), citing Brown v. Enstar Group, Inc., 84 F. 3d. 393, 396 (11th Cir. 1996). The burden is on the plaintiff to show that a defendant is a control person. See Brown, 84 F. 3d at 396. Inherent in establishing control person liability, the plaintiffmust establish that the controlle d person violated the securities law. Id. The Court finds that Plaintiffs have, pursuant to its ruling above with regards to th e l Ob and Rule 1 Ob-5 securities violation, sufficiently alleged that these defendants have th e requisite control over the business affairs and policies of the Hayes entities. Accordingly, Plaintiffs are permitted leave to amend their claims to state a claim for securities fraud under 10b or Rule I Ob-5. The Hayes Defendants' motion as to Plaintiffs' securities claims is granted as set forth above. FDUPTA Claims The Hayes Defendants also argue that Plaintiffs' FDUPTA claims should be dismissed because they are preempted by federal law. Plaintiffs point out that the statute is designe d to cover a number of activities under the broadly defined term "trade or commerce" and that the count is pled in the alternative. Defendants urge the Court to following the holding in Crowell v. Morgan Stanley Dean Witter Services Co., 87 F. Supp.2d 1287 (S.D. Fla. 1997), in which the court found, as a matter of first impression in Florida, that this statute did not Page 10 of 12

11 apply to securities transactions. Plaintiffs point to other states in which the DUTPA statutes have been applied to securities transactions. See e.g. Denison v. Kelly, 759 F. Supp. 199 (M.D. Pa. 1991). At this stage, and in part because some Defendants have asserted that the payphon e investments are not securities, the Court is not convinced that these claims should b e dismissed and declines to follow the holding of Crowell. The Hayes Defendants' motion i s therefore denied on this count. Conspiracy Claim Finally, Plaintiffs adequately allege, for purposes of a motion to dismiss, all elements of a conspiracy claim. The elements of a conspiracy are : "1) an agreement between two or more parties; 2) the doing of an unlawful act or a lawful act by unlawful means ; 3) the doing of some overt act in the pursuance of a conspiracy ; 4) damage to the plaintiff as a result o f the acts done under the conspiracy." Haskin v. R. J. Reynolds Tobacco Co., 995 F. Supp. 1437, 1440 (M.D. Fla. 1998). In Count X of the Complaint, Plaintiffs allege that al l Defendants participated in the schemes or agreements, that Defendants' acts constituted an unlawful course of conduct, that Defendants made misrepresentations or omissions and tha t Plaintiffs have been damaged. Provided Plaintiffs can adequately state a claim for securitie s fraud, as set forth herein, the Hayes Defendants' motion is denied on this count. Page 11 of 12

12 CONCLUSIO N It is therefore ORDERED and ADJUDGED that Defendant Hayes Financial Group, Inc., HFG Communications, Inc., Curtis G. Hayes and Jean E. Hayes' Motion to Dismiss Pursuant to Federal Rules of Civil Procedure 9(b), 12(b)(6) and pursuant to 15 U.S.C. 78u- 4, et seq. (Dkt. #9) is hereby GRANTED in part and DENIED in part as set forth herein. Plaintiffs are permitted twenty (20) days from the date of this Order to file an amende d complaint consistent with this Order. DONE and ORDERED in Tampa, Florida on this day of February, Copies furnished to : Counsel/Parties of Record J S S. MOODY, JR. ED STATES DISTRICT JUD Page 12 of 12

13 F I L E C O P Y Date Printed : 02/07/200 2 Notice sent to : Steven P. Seymoe, Esq. Ausley & McMulle n 227 S. Calhoun St. P.O. Box 391 Tallahassee, FL Michael K. Wolensky, Esq. Kutak Rock LL P 225 Peachtree St. N.E., Suite 2100 Atlanta, GA Ethan H. Cohen, Esq. Kutak Rock LL P 225 Peachtree St. N.E., Suite 2100 Atlanta, GA H. Michael Dever, Esq. Friedman, Dever & Merlin, LLC Suite 2150, Tower Plac e 3340 Peachtree Road, N.E. Atlanta, GA Vincent M. D'Assaro, Esq. D'Assaro and Hall, P.A. 111 N. Orange Ave. Suite 1575 Orlando, FL Christopher S. Jones, Esq. Becker & Poliakoff, P.A Stirling Rd. Ft. Lauderdale, FL