Holder Doctrine Not An Obstacle to Plaintiffs’ Claims Under Colorado Securities Laws

In a recent ruling, the U.S. District Court for the District of Colorado allowed a suit brought under the Colorado Securities Act where the plaintiffs neither purchased nor sold securities but instead relied on misrepresentations in deciding to retain their investment and lost $65 million as a result.  Agile Safety Variable Fund L.P. v. RBS Citizens, N.A., No. 09-cv-02786-WJM-BNB, D. Colo., May 31, 2011.  

The plaintiffs in the case are Agile Safety Variable Fund L.P. and Sky Bell Select L.P.  According to the allegations.  Agile invested in Lancelot Investors Fund L.P. and Lancelot Investors Fund II, L.P. in 2004.  By 2007, Agile was beginning to question its investments in Lancelot and decided to pursue additional due diligence.  As part of its due diligence, Agile talked to Charter One, one of the defendants and Lancelot’s financing bank.  Charter One assured Agile that it performed bi-annual, independent audits of Lancelot’s records, and also vouched for Lancelot’s manager, citing a long-standing relationship.  Swiss Financial, the other defendant and Lancelot’s fund manager, provided similar assurances to Agile, including personal assurances by the chief executive officer that Swiss Financial was comfortable with Lancelot following an investigation of the fund.

As a result of these assurances, Agile decided to retain its investment in Lancelot.  In September 2007, just one month after Charter One provided Agile with information regarding the field exam of Lancelot, Agile formed an additional entity, Sky Bell, solely to invest in Lancelot.  A year later, in September 2008, a federal grand jury indicted Lancelot’s principal, Thomas Petters, on allegations of fraud.  One month later, Lancelot filed for bankruptcy.

Agile and Sky Bell sued Swiss Financial and Charter One for negligent misrepresentation, negligence, and violation of Colorado’s securities laws.  Plaintiffs alleged that Swiss Financial never independently verified Lancelot’s assets and thus failed to uncover the fact that Lancelot had no assets.  The plaintiffs survived motions to dismiss on all three claims. 

With respect to the claim under the Colorado Securities Act, defendants sought dismissal asserting that plaintiffs had not, as a result of the alleged misrepresentations, purchased or sold securities.  Instead, the plaintiffs had acquired the securities before the alleged wrongdoing and, as a result, were precluded from recovery under the “holder doctrine.”  The doctrine precluded claims alleging material misrepresentations or omissions that merely caused investors to retain ownership of securities acquired prior to the alleged wrongdoing.  Such claims are not recognizable under the federal securities laws because of the inherently speculative nature of proving reliance and damages.  See Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723, 739-40 (1975).

The court held that the plaintiffs’ decision to retain their ownership interest in the securities as a direct result of the defendants’ misrepresentations was sufficient to satisfy the Act’s requirements.  The court noted that the policy concerns underlying the holder doctrine were inapplicable because unlike owners of common stock, the plaintiffs could not buy or sell their interests in Lancelot on an open market at will, removing the speculative element from their actions.  Moreover, the presence of direct communications and representations between the shareholder and the persons making the alleged misrepresentations provided evidence of actual reliance on the alleged misrepresentations.  The court concluded that “the evidence was sufficient to persuade a reasonable jury that Agile had every intention to redeem its Lancelot investments in early 2007, and not only was dissuaded from doing so by the Defendants’ affirmative misrepresentations, it was also induced to increase exposure in Lancelot through the reinvestment of its monthly returns.”

The court rejected the defendants’ argument that the plaintiffs’ failure to purchase their Lancelot interest through the defendants defeated the plaintiffs’ cause of action, because the Colorado Securities Act does not require privity.

The primary materials for this case may be found on the DU Corporate Governance website.