“Mirror, Mirror” Securities Law Principles in a Parallel Universe.

MCCOY: Jim, I think I liked him with a beard better. It gave him character. Of course almost any change would be a distinct improvement.
KIRK: What worries me is the easy way his counterpart fitted into that other universe. I always thought Spock was a bit of a pirate at heart.
SPOCK: Indeed, gentlemen. May I point out that I had an opportunity to observe your counterparts here quite closely. They were brutal, savage, unprincipled, uncivilized, treacherous, in every way, splendid examples of homo sapiens, the very flower of humanity. I found them quite refreshing.
KIRK: I’m not sure, but I think we’ve been insulted. MCCOY: I’m sure.

Mirror, Mirror" Star Trek: The Original Series. original broadcast October 6, 1967.


While the Interstate Land Sales Act (“ILSA”) was modeled on the Securities Act of 1933, and the two may share the underlying principles of full disclosure and protection from fraud, ILSA occupies a different universe all its own. This is especially evident after Congress amended ILSA in 1979 to remove the reliance requirement of the anti fraud section of ILSA, listed as 15 U.S.C. §1703(a)(2). However, the disclosure requirements set forth in 15 U.S.C. §1703(a)(1) are consistent with § 12(a)(2) of the Securities Act of 1933.

ILSA is an anti-fraud statute utilizing disclosure as its primary tool. . . .” Winter v. Hollingsworth Props., Inc., 777 F.2d 1444 (11th Cir. 1985). The bulk of these disclosures occur through two major documents: a “statement of record” and a “property report.” See, e.g. 15 U.S.C. §§1703(a)(1), (c); 1704 through 1708. However, there are other important aspects of the statute: ILSA’s general anti-fraud provisions, 15 U.S.C. § 1703(a)(2), and its contractual language requirements. Sections 1709(a)(1) and (b)(2) of the pre-1979 statute, are discussed in a line of cases finding that reliance is not an element of claims arising under § 1703(a)(1), Burns v. Duplin Land Dev., Inc., 2009 WL 864208, *9-10 (E.D.N.C. Mar. 27, 2009) (§ 1703(a)(1)(C)); Dongelewicz v. First E. Bank, 80 F. Supp. 2d 339, 348 (M.D. Pa. 1999) (§ 1703(a)(1)); Gibbes v. Rose Hill Plantation Dev. Co., 794 F. Supp. 1327, 1334 (D.S.C. 1992) (§ 1703(a)(1)(C)), or its pre-1979 statutory predecessors, Hester v. Hidden Valley Lakes, Inc., 495 F. Supp. 48, 53 (N.D. Miss. 1980) (§ 1709(b)(2)); Bryan v. Amrep Corp., 429 F. Supp. 313, 317 (S.D.N.Y. 1977) (§ 1709(a)); Husted v. Amrep Corp., 429 F. Supp. 298,310-11 (S.D.N.Y. 1977) (§ 1709(a) and (b)(2)); Rockefeller v. High Sky, Inc.,394 F. Supp. 303 (E.D. Penn. 1975) (15 U.S.C. § 1703(a)(1) and (b)); Hoffman v. Charnita, Inc., 58 F.R.D. 86, 90-91 (M.D. Pa. 1973) (§ 1709(a) and (b)(2) prohibited the use of untrue statements in statement of record and property report, were the precursors of current § 1703(a)(1)(C). Similarly, former §§ 1703(a)(1) and (b), which forbade sales without statements of record or property reports, correspond to current § 1703(a)(1)(A) and (B).

These cases reason as follows: Section 1703(a)(1) was modeled §12(a)(2) of the Securities Act of 1933. Flint Ridge Dev. Co. v. Scenic Rivers Ass’n of Okla., 426 U.S. 776, 96 S. Ct. 2430, 49 L. Ed. 2D 205 (1976) (noting that ILSFDA “is based on the full disclosure provisions and philosophy of the Securities Act of 1933 . . .”); Paquin v. Four Seasons of Tenn., Inc., 519 F.2d 1105, 1109 (5th Cir. 1975). Section 12(a)(2) does not require reliance. Currie v. Cayman Res. Corp., 835 F.2d 780, 782 (11th Cir. 1988). As such, section 1703(a)(1) also does not require reliance. Burns, 2009 WL 864208, at *10. On these points, all courts appear to be in agreement. See id. at *9 (noting that “courts have uniformly concluded that a purchaser need not rely on the property report to establish liability under § 1703(a)(1)(C) (and its statutory predecessors)”).

A. Congressional Intent in the 1979 Amendments to ILSA Show: Claims arising under 15 U.S.C. § 1703(a)(2) Do Not Reflect 10b-5, 17 C.F.R. 240.10b-5, as well as its close relative, § 17(a) of the Securities Act, 15 U.S.C. § 77q(a)

The anti-fraud provisions of ILSA at §1703(a)(2) provides as follows:

It shall be unlawful for any developer or agent . . . (2) with respect to the sale or lease, or offer to sell or lease, any lot not exempt under § 1702(a) of this title –(A) to employ any device, scheme, or artifice to defraud; (B) to obtain money or property 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 in which they were made and within the context of the overall offer and sale or lease) not misleading, with respect to any information pertinent to the lot or subdivision; (C) to engage in any transaction, practice, or course of business which operates or would operate as a fraud or deceit upon a purchaser . . . .15 U.S.C. § 1703(a)(2).

The anti-fraud provisions of the Securities Act at 17 C.F.R. § 240.10b-5 provide:

Employment of manipulative and deceptive devices.

It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange, (a) To employ any device, scheme, or artifice to defraud, (b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or (c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security.

Whether the antifraud provisions of ILSA requires reliance is a more difficult question. A determination of whether reliance must be shown begins with a review of the statute’s plain language. Jimenez v. Quarterman, 129 S. Ct. 681, 685 (2009); Nguyen v. United States, 556 F.3d 1244, 1250 (11th Cir. 2009). The analysis of § 1703(a)(2) require: “in interpreting [ILSFDA], courts have applied the more comprehensively developed jurisprudence of securities cases.” U.S. Dep’t of Housing & Urban Dev. v. Cost Control Mktg. & Sales Mgmt. of Va., Inc., 64 F.3d 920, 924 (4th Cir. 1995). A review of subsection (a)(2) in light of securities law reveals that its progenitor is not § 12(a)(2), as in the case of subsection (a)(1); instead, the statutory language resembles Rule 10b-5, 17 C.F.R. 240.10b-5, as well as its close relative, § 17(a) of the Securities Act, 15 U.S.C. § 77q(a). Gilbert v. Woods Mktg., Inc. 454 F. Supp. 745, 748-49 (D. Minn. 1978) (noting the similarities and differences between Rule 10b-5 and the pre-1979 version. Gilbert’s analysis was slightly more nuanced, largely because §1703(a)(2)(B), prior to the 1979 amendments, did not encompass claims for material omissions of § 1703(a)(2)). Unlike § 12(a)(2), a private damages action under Rule 10b-5 generally requires a showing of reliance. Basic Inc. v. Levinson, 485 U.S. 224, 243, 108 S. Ct. 978, 99 L. Ed. 2d 194 (1988). The same is true for private actions under § 17(a), Kramas v. Sec. Gas & Oil Inc., 672 F.2d 766, 769-70 (9th Cir. 1982), where they are permitted, In re Washington Pub. Power Supply Sys. Sec. Litig., 823 F.2d 1349 (9th Cir. 1987)(finding no private cause of action under § 17(a)); Landry v. All Am. Assurance Co., 688 F.2d 381, 384-91 (5th Cir. 1982) (same). While there are similarities between these securities provisions and § 1703(a)(2), it would be inappropriate to interpret the ILSA provisions the same after the express removal of the reliance requirement in the 1979 amendment. Other courts have drawn an artificial distinction between 1703(a)(1) and (a)(2). Dongelewicz, 80 F. Supp. 2d at 349 (holding that subsection (a)(1) does not require reliance, but (a)(2) does); Gilbert, 454 F. Supp. at 748-49 (requiring reliance under subsection (a)(2) and following the presumption of reliance with respect to omissions).

There are recent ILSA cases where claims were thrown out because contractual provisions showed a lack of reliance. Those cases, however, merely assumed that reliance was an element without actually exploring the issue. See Garcia v. Santa Maria Resort, Inc., 528 F. Supp. 2D 1283 (S.D. Fla. 2007); Weaver v. Opera Tower, LLC, 2008 WL 4145520, *2 n.5 (S.D. Fla. Aug. 1, 2008)(1709(a) claim and reliance was required under § 1703(a)(2)(B)). See also Am. Savings Bank, F.S.B. v. UBS PaineWebber, Inc., 250 F. Supp. 2D 1254, 1259 (D. Haw. 2003) (employing similar reasoning with respect to a state statute). Cf. Gibbes, 794 F. Supp. at 1336 (suggesting, without explanation, that reliance is not required for either misleading statements or omissions under § 1703(a)(2)(A) or (C), but requiring reliance for affirmative misrepresentations under § 1703(a)(2)(B)).

One court, in construing an analogous state law, has strongly suggested that § 1703(a)(2) does not require reliance. Disandro v. Makahuena Corp., 588 F. Supp. 889, 895 (D. Haw. 1984). This assertion was drawn from the legislative history of subsection (a)(2)(B). Id. The original 1968 version of § 1703(a)(2)(B) generally paralleled the current statutory language but with two significant differences: no omission liability and an express reliance requirement. See 15 U.S.C. § 1703(a)(2) (1976). In 1979, the ILSFDA was amended “to conform more closely to the language found in securities laws.” H. Rep. No. 96-154, at 34 (1979), as reprinted in 1979 U.S.C.C.A.N. 2317, 2350-51. As such, omission liability was added and the phrase mandating reliance was deleted from §1703(a)(2)(B). See Pub. L. No. 96-153, § 403, 93 Stat. 1101, 1127-28 (1979). Cf. 15 U.S.C. § 77q(a). According to the House Report and the House Conference Report, the deletion was made so that “the purchaser’s actual reliance would no longer have to be an element of proof. . . .” H. Rep. No. 96-154, at 34-35 (1979), as reprinted in 1979 U.S.C.C.A.N. 2317, 2350-51; H.R. Conf. Rep. No. 96-706, at 83 (1979), as reprinted in 1979 U.S.C.C.A.N. 2402, 2442. Rather, reliance issues were to be subsumed into the general materiality inquiry. H. Rep. No. 96-154, at 34-35, as reprinted in 1979 U.S.C.C.A.N. at 2350-51; H.R. Conf. Rep. No. 96-706, at 83, as reprinted in 1979 U.S.C.C.A.N. At 2442. A copy of relevant portions of that report are found here. You will notice that Congress notes that no reliance is required under the heading of “Fraud and Misrepresentation” in the report. Congress was directly referring to 15 U.S.C. §1703(a)(2) as §1703(a)(1) never required reliance.

Further support that reliance is not required is that it is not an element of criminal suits or civil enforcement actions brought by the SEC under Rule 10b-5 or § 17. S.E.C. v. Rana Research, Inc., 8 F.3d 1358, 1363-64 (9th Cir. 1993) (Rule 10b-5); S.E.C. v. Wolfson, 539 F.3d 1249, 1260 n.17 (10th Cir. 2008) (§ 17); United States v. Ashdown, 509 F.2d 793, 799 (5th Cir. 1975). This suggests that reliance is a judicial creation designed to restrict the scope of implied actions rather than an element derived from the statutory language. See Rana Research, Inc., 8 F.3d at 1363-64. Nevertheless, regardless of the origins of the reliance element in securities laws, private actions under Rule 10b-5 and § 17 are not the proper analogue for construing 15U.S.C. § 1703(a)(2). In short, § 1703(a)(2) as adopted in 1979 cannot be construed in accordance with the securities laws it was originally modeled on that hold that reliance is a requirement.

In addition, even if § 1703(a)(2) required reliance, omissions by the developer would still be actionable. The Supreme Court has found that “positive proof of reliance” is still not required where “a duty to disclose material information has been breached. . . .” Basic Inc., 485 U.S. at 243, 108 S. Ct. 978, 99 L. Ed. 2d 194 (citing Affiliated Ute Citizens v. United States, 406 U.S. 128, 153-154, 92 S. Ct.1456, 31 L. Ed. 2d 741 (1972)). In such cases, a rebuttable presumption of reliance arises. Stoneridge Inv. Partners, LLC v. Scientific Atlanta, 128 S. Ct. 761, 769, 169 L. Ed. 2d 627 (2008). Thus, even when § 1703(a)(2)(B) expressly required reliance (and did not expressly protect against material omissions), courts permitted omission claims to go forward under § 1703(a)(2) without a showing of reliance. See Bryan, 429 F. Supp. At 320 (citing Affiliated Ute and noting, in the class certification context, that “to the extent that plaintiff proves violations of § 1703(a)(2)(A), (C) by evidence of a complete omission of a material fact, proof of reliance is not required . . .”). This would be true of HUD’s sales regulations that explicitly requires the disclosure of written materials following an oral assertion regarding the investment potential of a lot. 24 C.F.R. 1715.20(h). Thus, when a material omission exists, reliance should be presumed under any theory.

To summarize: (1) a § 1703(a)(2) violation does not require a showing of reliance, (2) even if reliance was required, reliance is presumed where a claim is premised on a material omission, and (3) as explained more fully below the boilerplate disclaimers in the Purchase Contract cannot act to disclaim reliance or rebut the “omission” presumption of reliance as a matter of law.

B. 15 U.S.C. §1712 of ILSA Echoes 15 U.S.C § 77n of the Securities Act of 1933

In Florida, the Purchase Contract generally contains a merger clause and in accordance with Fla. Stat. §718.503 admonishes the purchaser, in all capitals, that “oral representations cannot be relied upon . . . .” Purchase contracts in Florida provides that, “Buyer acknowledges, warrants, represents and agrees that this Agreement is being entered into by Buyer without reliance upon any representations concerning any potential for future profit,any future appreciation in value, any rental income potential, tax advantages, depreciation or investment potential and without reliance upon any monetary or financial advantage.

The provision of 15 U.S.C. §1712 is nearly identical to the language at 15 U.S.C § 77n of the Securities Act of 1933:

15 U.S.C. § 1712 : Contrary stipulations void

Any condition, stipulation, or provision binding any person acquiring any lot in a subdivision to waive compliance with any provision of this chapter or of the rules and regulations of the Secretary shall be void.

§ 77n. Contrary stipulations void

Any condition, stipulation, or provision binding any person acquiring any security to waive compliance with any provision of this title [15 USCS §§ 77a et seq.] or of the rules and regulations of the Commission shall be void.

I have yet to find any recent case law where the courts have given credence to 15 U.S.C. § 1712. Case law examining the mirror image securities provision repeatedly demonstrate that a buyer may not involuntarily and unknowingly waive rights under the securities laws by virtue of a clause in a contract. In re Cohen’s Will, 51 F.R.D. 167 (S.D.N.Y. 1970) (general arbitration clause in contract for sale of securities invalid as waiver "in futuro" of potential rights); Pearlstein v. Scudder & German, 429 F.2d 1136 (2d Cir. 1970), cert. denied, 401 U.S. 1013, 28 L. Ed. 2d 550, 91 S. Ct. 1250 (1971) (stipulation by which plaintiff-customer acquiesced in defendant-broker’s continuing violation of federal margin requirements held void); and Cohen v. Tenney Corp., 318 F. Supp. 280 (S.D.N.Y.970), quoting extensively from the latter. As the court in stated in Weinraub v. International Banknote Co., 433 F.upp. 1092, (S.D.N.Y. 1977):

“Although releases of the type involved herein are enforceable, ‘[judicial] hostility toward waivers generally requires that the right of private suit for alleged violations be scrupulously preserved against unintentional or involuntary relinquishment.’ Cohen v. Tenney Corporation, supra, 318 F. Supp. at 284. Such agreements require a scrupulously careful examination of the facts and circumstances surrounding their execution. Murtagh v. University Computing Co., supra, 490 F.2d at 816. Accordingly, there are material issues of fact which are unresolved and which foreclose summary judgment at this stage of the proceedings.”

In Special Transp. Services, Inc. v. Balto, 325 F. Supp. 1185, 1187 (D. Minn. 1971) the court denied a motion to dismiss: “Thus, to the extent that the contractual remedy sought by defendant to be substituted for the statutory remedies for an understatement of net worth would operate to diminish plaintiff’s recovery for such an understatement, it is clearly void under Section 78cc(a) above.” Pearlstein v. Scudder & German, 429 F.2d1136 (2d Cir. 1970), and Schine v. Schine, 254 F. Supp. 986 (S.D.N.Y.1966), illustrate the proposition that parties to a contract for the sale of securities,which sale would otherwise be subject to the federal securities laws, cannot agree to exempt their transaction from the coverage of those laws. “This general principle, as embodied in § 78cc(a), certainly applies a fortiori to a contract which does not expressly waive statutory liabilities but operates to do so by indirection. A buyer of securities cannot contract to waive, release, or compromise subsequently maturing claims under the federal securities laws, whether that waiver is conscious or inadvertent.” Allied Artists Pictures Corp. v. Giroux, 312 F. Supp. 450 (S.D.N.Y. 1970). “Thus, as a matter of construction, the contract may not in fact have been intended to waive all statutory liabilities merely by the existence of the provision of Paragraph 8A for adjustment but in any event and even if the contract can be read to contemplate such a waiver, §78cc(a) renders it to that extent void. A separate order has been entered denying defendant’s motion to dismiss.” Here, recent court rulings found that reliance was unreasonable as a matter of law due to the disclaimers found in the purchase agreement results in a de facto waiver of the coverage of ILSA and its associated regulations. This result is contrary to the 15 USC §1712 and its counterpart in the securities laws. Dismissing claims for violations of ILSA as a matter of law for “boilerplate” disclaimers is contrary to Congressional intent even when viewed through the prism of securities regulation.

C. Developers Cannot Hide Behind Boilerplate Disclaimers: Disclaiming Sale as a Security is Analogous to Disclaiming ILSA Application in the Sales Contract

Sellers often argue, regardless of the circumstances surrounding the transaction, the plain language of the Purchase Agreement makes clear that the sale of a unit to a buyer is not based upon a promise of increase in value. Purchase Agreements routinely state that the sale of the condominium unit consists of no other agreements and that buyer has not relied upon any representations outside of those specifically expressed in the Purchase Agreement. According to Developers, these disclaimers are clear and unambiguous and thereby sufficiently preclude any findings that the sale of its condominium unit to a buyer is subject to federal regulation. This argument wholly ignores the fundamental principle in securities law of substance over form which should also be imputed to claims under ILSA. See, e.g.,S.E.C. Release No. 33-5347 (noting that, in determining whether a transaction constitutes a security, “substance should not be disregarded for form, and the fundamental statutory policy of affording broad protection to investors should be heeded”); Tcherepnin v.Knight, 389 U.S. 322, 336 (1967) (“[l]n searching for the meaning and scope of the word‘security’ in the [1933 Securities] Act, form should be disregarded for substance and the emphasis should be on economic reality.”); S.E.C. v. Friendly Power Company, LLC, 49 F. Supp.2d 1363, 1368 (S.D. Fla. 1999) (“Economic substance, not form, governs whether a given investment is a security.”). In essence, it is the act of selling an unregistered security that creates liability, and not the agreement or arrangement on which the sale may be predicated. See, e.g., Adams v. Zimmerman, 73 F.3d 1164(1st Cir.1996); In re NBW Commercial Paper Litigation, 826 F. Supp. 1448 (D.C. Cir. 1992).  Accordingly, “in determining the existence of an investment contract, courts have looked beyond boilerplate disclaimers to the economic reality and character the transaction is given in commerce.” Rodriguez, 727 F. Supp. at 767 (emphasis added). The disclaiming statements included in a Purchase Agreement ignore the economic substance of the transaction and a seller should not be permitted to rely on such statements to circumvent its obligations under federal anti fraud laws. Allowing sellers to escape liability with mere boiler-plate disclaimers would undermine the policy of substance over form that is axiomatic in both federal and state securities laws and ILSA. Logically, a developer could not credibly argue that parties to an illegal transaction could legalize their conduct by disclaiming the illegal nature of the transaction. ILSA like the Securities laws should not be overruled by boilerplate language. Rodriguez, 727 F. Supp. At 767

In many instances it is helpful to examine securities laws, as the case law is more developed than that of ILSA. However, one should not lose sight of the differences. What should worry all of us is when ILSA is overlaid the easy way into its counterpart from “that other universe.” Last, to understand ILSA application, one has to be a bit of a pirate at heart. Just don’t expect me to don the goatee anytime soon.

This article, and the comments posted in response, do not constitute legal advice or the formation of an attorney-client relationship, and is not for re-publication without express permission of the author.

About Timothy Powers O'Neill

Timothy O’Neill, an attorney with the firm of Cohen Norris practices in the areas of business litigation, real estate litigation, and intellectual property litigation. Timothy received his Bachelor of Science Degree from the University of Evansville and graduated from the University of Missouri-Columbia School of Law in 1997. Following law school, Timothy clerked for two years in the State of Florida's Fifteenth Judicial Circuit in Palm Beach County, and served as a law clerk in the United States District Court for the Southern District of Florida. Timothy serves as an executive board member of the Busch Wildlife Sanctuary, a non-profit entity dedicated to preserving Florida’s wildlife through rehabilitation and education. Timothy is admitted to practice before all of the state courts of Florida as well as: The Supreme Court of the United States; United States Court of Appeals, Eleventh Circuit; United States Court of Appeals, Ninth Circuit; United States District Court, Southern District of Florida; United States District Court for the Middle District of Florida, United States District Court of Colorado, and is a member of the Palm Beach County, Florida, and Federal Bar Associations.

One Response to ““Mirror, Mirror” Securities Law Principles in a Parallel Universe.”

  1. Terrific! I really believe this site is speaking the truth. Keep it up. Clare Johnson

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

%d bloggers like this: