Griffin v. Jones et al

Filing 39

MEMORANDUM OPINION by Senior Judge Thomas B. Russell on 9/27/2013 re 21 Motion to Dismiss by Defendants Charles A. Jones, CA Jones Management Group, LLC, Global Book Resellers, LLC, and Technology Associates, Inc. For the foregoing reasons, Defendants' Motion to Dismiss is DENIED as to the above claims. cc: Counsel (CDR)

UNITED STATES DISTRICT COURT
WESTERN DISTRICT OF KENTUCKY
PADUCAH DIVISION
CASE NO. 5:12-CV-00163
DAVID GRIFFIN

PLAINTIFF

v.
CHARLES A. JONES, et al.

DEFENDANTS

MEMORANDUM OPINION
This matter comes before the Court on a motion to dismiss by Defendants Charles
A. Jones, CA Jones Management Group, LLC, Global Book Resellers, LLC, and
Technology Associates, Inc. (Docket No. 21). The Plaintiff Responded (Docket No. 23).
The Defendants replied (Docket No. 25). The Plaintiff filed a surreply (Docket No. 36).
Fully briefed, the matter is now ripe for adjudication. For the following reasons, the
Defendants’ motion is DENIED.

BACKGROUND
Plaintiff David Griffin (“Griffin”) brings suit against Defendants Charles Jones
(“Jones”), CA Jones Management Group, LLC, Global Book Resellers, LLC, and
Technology Associations, Inc. (collectively (“Defendants”).1 Griffin asserts six separate
causes of action against the Defendants.

Among Griffin’s allegations is that the

Defendants violated § 10(b) of the Securities Exchange Act, 15 U.S.C. § 78j(b), and Rule
10b-5 of the act’s implementing regulations, 17 C.F.R. § 240.10b-5, by making
fraudulent statements of material fact or omitting to state material facts in connection

1

Griffin has also named Sarah Jones (“Sarah”) as a defendant in this action. Sarah filed her own motion to
dismiss (Docket No. 22). That motion has been resolved by entry of a separate memorandum opinion and
order by the Court on this date.

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with the purchase of securities in a number of companies jointly owned by Griffin and
Jones.
As required when deciding a motion to dismiss, the Court presumes that the
allegations in the first amended complaint are true. Total Benefits Planning Agency v.
Anthem Blue Cross & Blue Shield, 552 F.3d 430, 434 (6th Cir. 2008). Taking them as
true, the relevant facts are as follows.
This action arises from a soured business relationship between David Griffin and
Charles Jones. Four interrelated businesses are at the center of this dispute. In 1993,
Jones founded Integrated Computer Solutions, Inc. (“ICS”) and installed himself as an
officer of the company. Some years later, in March 2008, Jones also formed Blackrock
Investments, LLC (“BRI), of which he was the controlling member. In May 2008, BRI
formed a subsidiary, SE Book Company, LLC (“SEB”) for the purpose of acquiring a
textbook company in Murray, Kentucky. Initially, SEB was wholly owned and managed
by its sole member, BRI. In July 2008, SEB’s operating agreement was amended, and
ICS was added as an eight percent member of SEB. In March 2009, College Book Rental
Company, LLC (“CBR”) was formed. ICS also owns an eight percent interest in CBR,
with the remaining interest held by BRI.

Further details of CBR’s formation are

discussed below.
An entity separate from ICS, BRI, SEB, and CBR also figures prominently into
the present dispute. In June 2008, Jones formed CA Jones Management Group, LLC
(“CJM”). As detailed herein, management responsibilities for ICS, BRI, SEB, and CBR
were eventually delegated to CJM, but CJM never had an ownership stake in any of those

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companies. CJM was paid management fees from the companies for its services, which
were allegedly paid to Jones and his wife as owners of CJM.
Griffin became involved in ICS, BRI, and SEB in 2008. Toward the beginning of
that year, Jones approached Griffin about investing in ICS. As a result of the solicitation,
Griffin bought fifty percent of the outstanding shares of the company for $2 million.
Later, in April 2008, Griffin also bought fifty percent of BRI in exchange for $100,000.
As alleged, “Griffin made his investments in BRI and ICS based on the expectation that
[Jones’s] undivided loyalty was devoted to BRI and ICS, and not to other competing
companies.” (Am. Compl., DN 18, ¶ 19.)
On February 11, 2009, Jones and Griffin began discussing the formation of CBR
for the purpose of renting textbooks to college students. During these discussions, Jones
provided Griffin with forecasts of sales, profits, inventory, and expenses for CBR’s first
six years of operation.

These forecasts allegedly predicted CBR making profits of

$940,000, $2.8 million, and $3.7 million during its first three years of operation,
respectively. (Id. ¶ 22.) Although the forecasts contained projected expenses, Griffin
alleges that Jones “omitted any specific allocation for fees to be paid by CBR to CJM”
for the purposes of managing the company. (Id.) CJM allegedly paid CJM management
fees of approximately $2.3 million in 2010 and $5.7 million in 2011. (Id.)
In addition to CBR, Griffin alleges that BRI, SEB, and ICS paid CJM significant
management fees. For example, BRI, SEB, and ICS paid CJM management fees totaling
$24,000, $2.7 million, and $600,000, respectively, in 2008 alone.

(Id. ¶ 30.)

Accordingly, Griffin alleges that Jones “deliberately channeled millions of dollars from
[ICS, BRI, SEB, and CBR] to CJM,” and ultimately into his own pockets as CJM’s

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managing member. (Id. ¶ 31.) Overall, Griffin alleges that Jones’s ultimate goal was to
convince Griffin to invest in ICS, BRI, SEB, and CBR; Jones would then siphon off those
investments for his own benefit through payment of management fees to CJM.
Griffin alleges that payment of the exorbitant fees to CJM would not have been
possible absent his continued investments in the companies. For example, beginning in
early 2009, Jones allegedly told Griffin that “SEB and CBR were unable to pay operating
expenses and did not have the funds necessary to purchase inventory.” (Id. ¶ 35.) To
remedy these shortfalls, Jones “asked Griffin for additional investment.”

(Id.)

In

response, “Griffin made additional investments in SEB and CBR in the form of over 100
wire transfers of funds to SEB’s and CBR’s accounts between April 2009 and June
2012.”

(Id.)

Griffin claims to have made these transfers in reliance “on

misrepresentations by [Jones] and CJM about the current financial health and inventory
value of SEB and CBR.” (Id.) For example, Jones allegedly represented to Griffin that
SEB would have net income of $2.1 million during the twelve-month period between
March 2009 and February 2010. (Id. ¶ 32.) Again, however, that projection allegedly
excluded any management fees to be paid to CJM during the same period. (Id.)
While Griffin was making wire transfers to SEB and CBR between April 2009
and June 2012, he alleges that Jones was increasing the management fees charged by
CJM. For example, Griffin claims that SEB paid CJM $2.4 million and $4.3 million in
management fees in 2009 and 2010, respectively, and that these fees far exceeded SEB’s
net earnings during those years. (Id. ¶¶ 39-40.) Similarly, CJM was allegedly paid $2.3
million in management fees by CBR in 2010, while the company had a net loss of
approximately $1.8 million. (Id. ¶ 41.)

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In December 2010, Jones asked Griffin to contribute an additional $10 million to
SEB and CBR. (Id. at 42.) Griffin expressed concern about the economic viability of the
companies in light of his already large investments. Prior to this request, a consulting
firm, Commonwealth Economics, had been hired to make recommendations for
improving the companies’ profitability.

In response to Griffin’s concerns about

additional investments, “Commonwealth Economics again provided recommendations to
[Jones] and CJM about ways to increase the profits of [ICS, BRI, SEB, and CBR] with
the goal of repaying all amounts owed to Griffin by 2012.” (Id.) Jones allegedly
represented to Griffin that he would implement the recommendations “in order to repay
Griffin all amounts he had invested in [ICS, BRI, SEB, and CBR] by 2012.” (Id. ¶ 43.)
In reliance on that promise, “Griffin invested another $9,353,000 in CBR and SEB during
the first six months of 2011.” (Id.) Again, Griffin alleges that Jones did nothing to
implement the recommendations and instead paid $5.7 million from CBR to CJM during
the first six months of 2011 as management fees. (Id. ¶ 45.) During this period, CBR
apparently operated at a net loss of $3.6 million. (Id.)
Based on the foregoing, Griffin alleges that his contributions and wire transfers to
ICS, BRI, SEB, and CBR were transactions in “securities” as that term is used and
defined in the Securities Exchange Act of 1934. (Id. ¶ 90.) He additionally claims that
he made his “investments” in reliance on material misrepresentations and omissions by
Jones and CJM. (Id.) Finally, he asserts that the Defendants intended to defraud Griffin
or were at least reckless in their representations to him regarding the companies’ financial
health and projections for future profit.

(Id.)

As a result, Griffin alleges that the

Defendants’ transactions in securities were fraudulent in violation of Section 10(b) of the

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Securities Exchange act and Rule 10b-5 of its implementing regulations. He moves the
Court to exercise its supplemental jurisdiction pursuant to 28 U.S.C. § 1367 to consider
his state law claims of breach of fiduciary duties, fraud, misappropriation, and unjust
enrichment. (Id. at 23-27). He urges the Court to find that the funds in question are held
on his account in a constructive trust. (Id. at 27.)
The Defendants move to dismiss the securities fraud claim as a matter of law and
ask the Court to decline to exercise supplemental jurisdiction over the state law claims.

STANDARD
The Federal Rules of Civil Procedure require that pleadings, including
complaints, contain a “short and plain statement of the claim showing that the pleader is
entitled to relief.” Fed. R. Civ. P. 8(a)(2). A complaint may be attacked for failure “to
state a claim upon which relief can be granted.” Fed. R. Civ. P. 12(b)(6). When
considering a Rule 12(b)(6) motion to dismiss, the Court will presume that all the factual
allegations in the complaint are true and will draw all reasonable inferences in favor of
the non-moving party. Total Benefits Planning Agency v. Anthem Blue Cross & Blue
Shield, 552 F.3d 430, 434 (6th Cir. 2008) (citing Great Lakes Steel v. Deggendorf, 716
F.2d 1101, 1105 (6th Cir. 1983)). “The court need not, however, accept unwarranted
factual inferences.” Id. (citing Morgan v. Church’s Fried Chicken, 829 F.2d 10, 12 (6th
Cir. 1987)). Additionally, “[w]hen a court is presented with a Rule 12(b)(6) motion, it
may consider the Complaint and any exhibits attached thereto . . . and exhibits attached to
the defendant’s motion to dismiss so long as they are referred to in the Complaint and are
central to the claims contained therein.” Bassett v. Nat’l Collegiate Athletic Ass’n, 528

6

F.3d 426, 430 (6th Cir. 2008) (citing Amini v. Oberlin Coll., 259 F.3d 493, 502 (6th Cir.
2001)).
Even though a “complaint attacked by a Rule 12(b)(6) motion to dismiss does not
need detailed factual allegations, a plaintiff’s obligation to provide the grounds of his
entitlement to relief requires more than labels and conclusions, and a formulaic recitation
of the elements of a cause of action will not do.” Bell Atl. Corp. v. Twombly, 550 US.
544, 555 (2007) (citations omitted). Instead, the plaintiff’s [f]actual allegations must be
enough to raise a right to relief above the speculative level on the assumption that all the
allegations in the complaint are true (even if doubtful in fact).” Id. (citations omitted). A
complaint should contain enough facts “to state a claim to relief that is plausible on its
face.” Id. at 570. A claim becomes plausible “when the plaintiff pleads factual content
that allows the court to draw the reasonable inference that the defendant is liable for the
misconduct alleged.” Ashcroft v. Iqbal, 129 S. Ct. 1937, 1949 (2009) (citing Twombly,
550 U.S. at 556). If, from the well-pleaded facts, the court cannot “infer more than the
mere possibility of misconduct, the complaint has alleged — but has not ‘show[n]— that
the pleader is entitled to relief.” Id. at 1950 (citing Fed. R. Civ. P. 8(a)(2). “Only a
complaint that states a plausible claim for relief survives a motion to dismiss.” Id.
In addition to the foregoing, the pleading standard is higher for claims involving
allegation of fraud, like the securities fraud claims at issue in this case. When alleging
fraud, a plaintiff “must state with particularity the circumstances constituting fraud.”
Fed. R. 9(b). “A plaintiff’s complaint must ‘(1) specify the statements that the plaintiff
contends were fraudulent, (2) identify the speaker, (3) state where and when the
statements were made, and (4) explain why the statements were fraudulent.’” Louisiana

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Sch. Emps.’ Ret. Sys. v. Ernst & Young, LLP, 662 F.3d 471, 478 (6th Cir. 2010) (quoting
Frank v. Dana Corp., 547 F.3d 564, 569 (6th Cir. 2008)).
On top of the pleading requirements of Rules 8(a)(2), 9(b), and 12(b)(6), the
Private Securities Litigation Reform Act of 1995 (“PSLRA”) “imposes additional and
more ‘[e]xacting pleading requirements’ for pleading scienter in a securities fraud case.”
Id. (quoting Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308, 313 (2007)).
Under the PSLRA’s heightened pleading requirements, a plaintiff alleging that the
defendant made a false or misleading statement must:
(1)
specify each 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 information and belief, the complaint
shall state with particularity all facts on which that belief is
formed [and]
(2)
state with particularity facts giving rise to a strong
inference that the defendant acted with the required state of
mind.
15 U.S.C. § 78u-4(b)(1), (2). The PSLRA “requires plaintiffs to state with particularity
both the facts constituting the alleged violation, and the facts evidencing scienter, i.e., the
defendant’s intention to deceive, manipulate, or defraud.” Tellabs, 551 U.S. at 313, 127
S.Ct. 2499 (quotation and citation omitted).

DISCUSSION
I. Griffin’s initial investment and subsequent contributions are properly construed
as “securities” within the meaning of the Securities Exchange Act and Rule 10b-5.
Section 10(b) of the Securities Exchange Act renders it unlawful, in connection
with interstate commerce, to “use or employ, in connection with the purchase or sale of
any security . . . any manipulative device or contrivance in contravention of such rules

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and regulations as the [Securities Exchange] Commission may prescribe . . . .” 15
U.S.C. § 78j(b). The SEC has promulgated Rule 10b-5 as a result of Section 10(b). Rule
10b-5 makes it unlawful for any person, in connection with interstate commerce, “[t]o
make any untrue statement of material fact or to omit to state a material fact . . . in
connection with the purchase or sale of any security.” 17 C.F.R. § 240.10b-5(b). A
violation of Section 10(B) and Rule 10b-5 is referred to broadly as “securities fraud.”
“To state a securities fraud claim under Section 10(b), a plaintiff must allege, in
connection with the purchase or sale of securities, the misstatement or omission of a
material fact, made with scienter, upon which the plaintiff justifiably relied and which
proximately caused the plaintiff’s injuries.” Louisiana Sch. Emps.’ Ret. Sys. v. Ernst &
Young, LLP, 662 F.3d 471, 478 (6th Cir. 2010) (citation omitted).
The Defendants move to dismiss Griffin’s securities fraud claim as a matter of
law on at least two grounds. First, they argue that Griffin has insufficiently alleged that
they made any misrepresentations or omissions in connection with the purchase of
securities in ICS, BRI, SEB, or CBR. Second, they claim that Griffin’s “wire transfers,”
“contributions,” or “investments” in the companies do not fall within the definition of
“securities” as defined in the Exchange Act. The Defendants’ arguments in favor of
dismissal are best thought of as addressing two separate timeframes that encompass the
underlying facts. The first argument concentrates on Griffin’s initial investment, while
the second focuses on the additional money that he contributed to the companies.

A. Griffin’s initial investment

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The Defendants first argue that Griffin has insufficiently alleged any
misstatements or omissions in connection with his initial investment in the companies.
The Court disagrees and finds that Griffin has alleged particular facts that give rise to the
strong inference that Defendants acted with the requisite scienter in omitting those facts.
In the complaint, Griffin alleges that he initially invested in ICS and BRI in “early
2008” and in April 2008, respectively. (Am. Compl., DN 18, ¶¶ 17-18.) At that time, he
purchased a fifty percent interest in each company. (Id.) He invested in BRI and ICS
“on the expectation that [Jones’s] undivided loyalty was devoted to BRI and ICS, and not
to other competing companies.” (Id. ¶ 19.) In July 2008, it is alleged that Jones
“convinced Griffin to make additional investments in BRI and/or SEB in the forms of
lines of credit and/or wire transfers.” (Id. ¶ 20.) Griffin made these investments in
reliance “on representations made by [Jones] that such investments in BRI and SEB were
necessary for the growth of those Companies and would increase the value of Griffin’s
initial investments.” (Id.)
On February 11, 2009, Jones and Griffin first discussed forming CBR to rent
textbooks. (Id. ¶ 22.) A month later, in March 2009, Jones formed the company. (Id. ¶
16.) Jones allegedly “forecast profits for the first three years of CBR’s operation of over
$940,000, $2.8 million and $3.8 million, respectively.”

(Id. ¶ 22.)

He also made

forecasts for sales, inventory, and expenses. (Id.) All of the forecasts “were based on the
assumption of increasing investments by Griffin in the first three years of CBR’s
operations of $2 million, $4 million, and $8 million, respectively.” (Id.) Griffin was
induced to make those investments based on “the initial representations by [Jones] about
CBR’s expected revenues and later representations that CBR’s financial viability was

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constantly improving[.]” (Id. ¶ 23.) In the CBR forecasts, however, Jones “omitted any
specific allocation for fees to be paid by CBR to CJM.” (Id. ¶ 22.) The omission of the
fees to be paid to CJM is the entirety of the allegedly fraudulent acts made in connection
with Griffin’s initial purchase in CBR.
Griffin has adequately pled facts “giving rise to a strong inference that the
defendant acted with the required state of mind.” 15 U.S.C. § 78u-4(b)(2). “To qualify as
‘strong’ within the intendment of [§ 78u-4(b)(2)] . . . an inference of scienter must be
more than merely plausible or reasonable—it must be cogent and at least as compelling
as any opposing inference of nonfraudulent intent.” Tellabs, Inc., 551 U.S. at 314.
[T]o determine whether a complaint’s scienter allegations
can survive threshold inspection for sufficiency, a court
governed by [§ 78u-4(b)(2)] must engage in a comparative
evaluation; it must consider, not only inferences urged by
the plaintiff . . . but also competing inferences rationally
drawn from the facts alleged. An inference of fraudulent
intent may be plausible, yet less cogent than other,
nonculpable explanations for the defendant’s conduct.
Id. In the present case, Griffin alleged that he initially invested in BRI and ICS based on
the expectation that Jones’s undivided loyalty was to BRI and ICS rather than to
competing companies. (Am. Compl., DN 18, at ¶ 4.) Moreover, Griffin has alleged that
Jones provided misleading financial statements, balance sheets, and sales figures on a
regular basis, failing to disclose the funds directed to Defendants and the other entities
associated with them. (Id. at 33-34.) Furthermore, Griffin has adequately alleged that
Defendants failed to provide Griffin with information that they had a duty to disclose.
“[O]ne who fails to disclose material information prior to the consummation of a
transaction commits fraud only when he is under a duty to do so. And the duty to
disclose arises when one party has information that the other party is entitled to know

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because of a fiduciary or other similar relation of trust and confidence between them.”
Chiarella v. U.S., 445 U.S. 222, 228 (1980) (internal quotation omitted). Because Jones
and CJM owed fiduciary duties to Griffin, they may be liable for both omissions and
misstatements. Finally, Griffin alleges numerous fraudulent activities, including that
Defendants improperly diverted the companies’ funds and inventory for their own benefit
and that they were engaged in “chop-shop” operations in violation of copyright law.
(Am. Compl., DN 18, ¶¶ 62-677, 68-74.)
“The inquiry . . . is whether all of the facts alleged, taken collectively, give rise to
a strong inference of scienter, not whether any individual allegation, scrutinized in
isolation, meets that standard.” Tellabs Inc. v. Makor Issues & Rights, Ltd., 551 U.S.
308, 322-23.

Scienter includes not only the “knowing and deliberate intent to

manipulate, deceive, or defraud,” but also recklessness. See Frank v. Dana Corp., 646
F.3d 954, 959 (6th Cir. 2011). Recklessness means “highly unreasonable conduct which
is an extreme departure from the standards of ordinary care. While the danger need not
be known, it must at least be so obvious that any reasonable man would have known of it.
Id. (quotation omitted).

The allegations discussed above support the inference that

Defendants were reckless in misstating the companies’ finances and failing to provide
Griffin with material information in an effort to induce his purchases of securities.
The Court finds that Griffin has demonstrated a “strong inference” that Jones
acted with the requisite scienter at the time of Griffin’s initial investment. Accordingly,
Griffin has adequately stated a claim for securities fraud as it relates to this investment in
ICS, BRI, SEB, and CBR.

B. Griffin’s subsequent contributions

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The Defendants seek dismissal of Griffin’s securities fraud claim relating to his
subsequent contribution to the companies on the grounds that the contributions do not
constitute purchases of “securities.” Absent a purchase of securities, one cannot maintain
a claim for securities fraud.
In the complaint, Griffin refers to his contributions to the companies between
April 2009 and June 2012 as “lines of credit” and “wire transfers.” See, e.g., Am. Compl.
¶¶ 20, 34, 36. He also describes his contributions as “investments.” See, e.g., Id. ¶¶ 20,
35, 36.

In all, Griffin alleges that the “lines of credit,” “wire transfers,” and

“investments” were made in “securities.” (Id. ¶ 90.) In his response brief, Griffin argues
that even if these wire transfers are considered “loans” to CBR and SEB, they
nonetheless qualify as purchases of securities because they are “notes.” (Pl.’s Resp., DN
23, p. 7.)
Under the definitions found in the Securities Exchange Act, “notes” are defined as
“securities.” 15 U.S.C. § 78c(a)(10) (“The term ‘security’ means any note . . . .”). But as
interpreted by the Supreme Court in Reves v. Ernst & Young, 494 U.S. 56, 62-63 (1990),
not every instrument labeled a “note” falls within the definition of “security” for the
purpose of the Exchange Act. The Defendants argue that Griffin fails to state a claim for
securities fraud because the “notes” he allegedly purchased with his additional
contributions are not the type of “notes” that fall within the Exchange Act’s definition of
“securities.” The Court disagrees and finds that the contributions are indeed “securities.”
In Reves, the Supreme Court set forth the test for determining whether a “note” is
a “security.” Known as the “family resemblance test,” it begins “with the presumption
that every note is a security.” Reves, 494 U.S. at 65. The Court went on to recognize that

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the presumption “cannot be irrebuttable.” Id. A note is not a security if it bears a “family
resemblance” to a list of notes that are not securities enumerated by the Court in Reves.
Notes that are not securities include:
[T]he note delivered in consumer financing, the note secured
by a mortgage on a home, the short-term note secured by a
lien on a small business or some of its assets, the note
evidencing a ‘character’ loan to a bank customer, short-term
notes secured by an assignment of accounts receivable, or a
note which simply formalizes an open-account debt incurred
in the ordinary course of business[.]
Id. (quoting Exchange Nat’l Bank of Chicago v. Touche Ross & Co., 544 F.2d 1126, 1137
(2d Cir. 1976)).
The Court agreed with the Second Circuit that the foregoing list is not “graven in
stone” and is “capable of expansion.” Id. at 66. Here, the wire transfers that Griffin
issued do not fall neatly into a category recognized in Reves so as to be excluded from
consideration as securities. However, instruments labeled as notes can be found not to be
securities if they bear “resemblance” to and share common characteristics of those on the
enumerated list. Id. at 65.
Four factors must be examined to determine if the instruments so strongly
resemble one of the enumerated categories that they nevertheless are not securities. First,
the “motivations that would prompt a reasonable seller and buyer to enter into” the
transaction must be examined. Id. at 66. Second, a court must consider any “plan of
distribution” involving the note. Id. Third, consideration of the “reasonable expectations
of the investing public” will aid in determining whether the note is a security. Id.
Finally, courts must consider whether another factor, such as a regulatory scheme
independent of the securities laws, “reduces risk in the instrument.” Id. at 67. The

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balance of these factors will determine whether the instrument at issue is a “note” within
the definition of “security” found in the Exchange Act.

Upon consideration and

application of these factors, the Court finds that the additional contributions, wire
transfers, lines of credit, and investments by Griffin most closely resemble those “notes”
that constitute “securities.” Each of the four factors is considered in the following
analysis.
1. Griffin’s motivations for the transfers weigh in favor of considering them
“securities.”
The Court first considers the motivations underlying Griffin’s additional
contributions to ICS, BRI, SEB, and CBR. “If the seller’s purpose is to raise money for
the general use of a business enterprise or to finance substantial investments and the
buyer is interested primarily in the profit the note is expected to generate, the instrument
is likely to be a ‘security.’” Id. at 66. But “[i]f the note is exchanged to facilitate the
purchase and sale of a minor asset or consumer good, to correct for the seller’s cash-flow
difficulties, or to advance some other commercial or consumer purpose . . . the note is
less sensibly described as a ‘security.’” Id.
Griffin argues that his “primary purpose in making [the] wire transfers to
Defendant was investment in the Companies with the expectation of generating profits.”
(Pl.’s Resp., DN 23, 8.) Accepting this purpose as true, the transfers are “notes” and
therefore “securities.” Although the transfers were made in response to Jones’s request
for additional funds to pay operating expenses and purchase inventory (Am. Compl., DN
18,¶ 35), Griffin’s additional contributions were made with the expectation of generating
profits, in addition to recouping his initial investments. This is akin to the factual
circumstances of Reves, where a co-op sold notes to the general public “in an effort to

15

raise capital for its general business operations, and purchasers bought them in order to
earn a profit in the form of interest.”

Reves, 494 U.S. at 67-69.

Because the

circumstances that prompted Reves to find that the notes were bought in expectation of
profit are also present in this case, this factor weighs in favor of finding that the “notes”
are “securities.”
Defendants assert that the transactions were made to correct the companies’ cash
flow difficulties rather than to seek a profit. They therefore conclude that the notes are
not properly described as “securities.” However, it is “the representations made by the
promoters, not their actual conduct, that determine whether an interest is an investment
contract (or other security).” S.E.C. v. Mulholland, 2013 WL 979423 at *4 (E.D. Mich.,
Mar. 13, 2013) (quoting S.E.C. v. Lauer, 52 F.3d 667, 670 (7th Cir. 1995)). Although
Defendants maintain that Griffin’s transfers were used to remedy the companies’ cash
flow, the Amended Complaint alleges that Defendants told Griffin that they would use
his funds to repay the amounts he had already invested and to generate new business. (Pl.
Am. Compl. ¶¶ 20, 43.) Griffin’s primary motivation was monetary gain, as was the case
in Reves.

Under the Reves framework, this factor supports the conclusion that the

transactions were “securities.”

2. No “plan of distribution” existed involving the notes, counseling against
considering them “securities.”
Second, to determine whether Griffin’s contributions were notes, the Court
considers any “plan of distribution” involving the notes. Id. at 66. When conducting this
examination, the Court should look to “determine whether it is an instrument in which
there is ‘common trading for speculation or investment.” Id. (citing SEC v. C.M. Joiner

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Leasing Corp., 320 U.S. 344 (1943)). “This factor has historically been problematic in
application.” Bass v. Janney Montgomery Scott, Inc., 210 F.3d 577, 585 (6th Cir. 2000)
(noting that an arrangement negotiated one-on-one by the parties has been held not to be
a security, but paradigmatic securities, such as stocks, can be offered and sold to a single
person while remaining securities).
In the present case, Griffin makes no allegations of a plan to distribute the alleged
notes to a “broad segment of the public,” and neither were they traded on an exchange.
Reves, 494 U.S. at 68. This factor counsels against construing the would-be notes as
“securities.” However, this factor is not fatal to Griffin’s claim, and the Court will
consider the test’s remaining factors.

3. The reasonable expectations of the both the parties and of the public weigh in
favor of considering the notes “securities.”
Third, the Court considers the “reasonable expectations of the investing public”
and will consider instruments to be “securities” on this basis even “where an economic
analysis of the circumstances of the particular transaction might suggest that the
instruments are not ‘securities’ as used in that transaction.” Reves, 494 U.S. at 66. The
“fundamental essence” of a security is its character as an “investment.” Id. at 69.
Reasonable public expectations will govern an instrument’s characterization; this analysis
requires considereation of “the reasonable expectation of the public who invested, and
whether they would make money through investing.’” Mulholland, 2013 WL 979423 at
*6 (E.D. Mich., Mar. 13, 2013) (internal quotations omitted). Taking Griffin’s factual
allegations as true, Griffin conceived of the transactions as “investments” by which he
sought to secure a return.

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Although Defendant argues that the transactions are properly characterized as
loans rather than securities, Reves held that “Congress’ purpose in enacting the securities
laws was to regulate investments, in whatever form they are made and by whatever name
they are called. Reves, 494 U.S. at 61 (emphasis in original). Because Griffin invested
money expecting to get more in return, the third Reves factor is satisfied.

4. No independent regulatory scheme would otherwise govern the notes.
Finally, the Court examines whether another factor, such as a regulatory scheme
independent of the Securities Acts, significantly reduces the instrument’s risk so as to
make application of the Securities Acts unnecessary. Reves, 494 U.S. at 66. “This factor
factors Defendants only if they can demonstrate there is a scheme of regulation involved
that substantially eliminates the investors’ investment risk, and thus renders unnecessary
the protections provided by the securities laws.” Mulholland, 2013 WL 979423 at *7
(E.D. Mich., Mar 13, 2013) (internal quotations omitted). The notes, like those in Reves,
are apparently uncollateralized and uninsured.

Reves, 494 U.S. at 69.

Were the

Securities Acts not to apply, the notes would avoid federal regulation. See id. Therefore,
this factor counsels in favor of considering the notes to be “securities.”
According to the “family resemblance” test, a note is a presumed to be a
“security,” and this presumption is rebutted only by a showing that the note bears a strong
resemblance, in terms of the four factors discussed above, to one of the enumerated
categories of instruments. Griffin’s transfers survive the Reves analysis and are therefore
properly construed as securities within the meaning of the Exchange Act and its
accompanying regulations.

Therefore, the Defendants’ Motion to Dismiss must be

denied as to the federal securities claims.

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II. The Court retains supplemental jurisdiction over the remaining claims as part of
the same case and controversy.
Because the Court properly exercises jurisdiction over Griffin’s federal law
claims, it may exercise supplemental jurisdiction over the remaining state law claims
because they so relate to the federal claims as to form the same case and controversy. 28
U.S.C. § 1367. Griffin has sufficiently stated these claims as to survive Defendants’
Motion to Dismiss.

A. Breach of fiduciary duties
Griffin alleges that Jones, as an officer, member, and/or director, owed statutory
and common law duties of care and loyalty to BRI, ICS, and to Griffin personally as an
investor and creditor. (Am. Compl., DN 18, ¶ 95.) Griffin further alleges that as a
manger of BRI and ICS, CJM owed statutory and common law duties of care and loyalty
to the companies and to Griffin. Finally, Griffin alleges that CJM, as manager of SEB
and CBR, owed statutory and common law duties of care and loyalty to Griffin in his
capacity as an investor and creditor. (Id.)
Both BRI and SEB are Kentucky limited liability companies. CBR is a Wyoming
Limited Liability Company. In support of his claims for breach of fiduciary duties,
Griffin points to statutory duties discussed in the Kentucky Limited Liability Company
Act, KRS 275.001 et seq.; the Kentucky Business Corporation Act, KRS 271B.1-010 et
seq.; and the Wyoming Limited Liability Company Act, W.S. 1977 § 17-29-101 et seq.
BRI is a manager-managed LLC, of which Griffin and Jones are 50-50 members;
it is managed by CJM. (Am. Compl., DN 18, ¶ 18, 26.) Kentucky courts have held that a
member of a limited liability company owes a duty of loyalty to fellow members and the

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company. Patmon v. Hobbs, 280 S.W.3d 589 (Ky. Ct. App. 2009). Patmon held that “a
partner has a duty to share with the partnership those business opportunities clearly
related to the subject of its operations.” Id. at 594. Just as partners owe good faith to
each other, so too do members of limited liability companies. Id. at 595. Patmon
remains valid law; see Pixler v. Huff, Case No. 3:11-cv-00207-JHM, Mem. at 20 (W.D.
Ky. July 30, 2012) (“In Kentucky, managers and members of an LLC owe a fiduciary
duty to one another.”) (citing Patmon, 280 S.W.3d).
The same analysis applies to the allegations of breach of fiduciary duty related to
ICS, a Kentucky corporation of which Griffin and Jones are 50-50 shareholders and
directors.

KRS § 271b.2-020(d) explains that entities may limit or eliminate “the

personal liability of a director to the corporation or its shareholders for monetary
damages for breach of his duties as a director . . . .” It stands to reason, then, that in the
absence of such limitation or elimination, directors owe duties to companies and their
shareholders. See Brewer v. Lincoln Int’l Corp., 148 F. Supp. 2d. 792, 813 (W.D. Ky.
2000) (explaining that Kentucky law requires corporate officers and directors “to act in
good faith, on an informed basis, and in a manner [they] honestly believe[] to be in the
best interests of the corporation.”).
Further, CJM owed fiduciary duties of loyalty to the members of the companies it
managed. Kentucky law holds that an LLC’s manager owes a duty of loyalty to its
members. Patmon v. Hobbs, 280 S.W.3d 589, 595 (Ky. Ct. App. 2009). “The [fiduciary]
relation[ship] may exist under a variety of circumstances; it exists in all cases where there
has been a special confidence reposed in one who in equity and good conscience is bound
to act in good faith and with due regard to the interest of the one reposing confidence.”

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Id. at 593 (quoting Steelvest, Inc. v. Scansteel Service Center, Inc., 807 S.W.2d 476, 485
(Ky. 1991)). A breach of loyalty claim is based on the fiduciary duty between principals
and agents. In manager-managed LLCs, “every manager is an agent of the limited
liability company for the purpose of its business or affairs.” Id. at 594 (citing KRS
275.135(2)(b)). Consequently, CJM was bound to act not only in the interests of the
companies, but also owed them a basic duty of faithfulness and loyalty. Id. at 594. The
duties of faithfulness and loyalty extend to
A similar duty applies to the management of SEB, as Wyoming law imposes
similar duties of loyalty and care upon members of member-managed LLCs. Members
owe fiduciary duties both to the company and to their fellow members. The law requires
a manger to act with the care that one in a like position would reasonably exercise under
like circumstances and in a manner that he reasonably believes to be the in best interests,
or at least not opposed to the best interests, of the company. W.S. § 17-29-409(c) and
(g)(i). A member may bring a direct action against another member or manager for
violations of such duties. W.S. § 17-29-901. (“[A] member may maintain a direct action
against another member, a manger or the limited liability company to enforce the
member’s rights and otherwise protect the member’s interests, including rights and
interests under the operating agreement or this chapter or arising independently of the
membership relationship.”).
Griffin alleges that Jones, both individually and by delegating manger duties to
CJM, acted contrary to the company’s best interests. Taking Griffin’s allegations as true,
the Court finds that Griffin has adequately stated claims for breach of the duty of care as
to Jones and CJM.

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2. Directors owe fiduciary duties to the shareholders of their companies.
K.R.S. § 271b.2-020(d) explains that entities may limit or eliminate “the personal
liability of a director to the corporation or its shareholders for monetary damages for
breach of his duties as a director . . . .” It stands to reason, then, that in the absence of
such limitation or elimination, directors owe duties to companies and their shareholders.
See Brewer v. Lincoln Int’l Corp., 148 F. Supp. 2d. 792, 813 (W.D. Ky. 2000)
(explaining that Kentucky law requires corporate officers and directors “to act in good
faith, on an informed basis, and in a manner [they] honestly believe[] to be in the best
interests of the corporation.”).

3. Griffin may properly raise the fiduciary duties owed by Defendants.
As discussed supra, Jones and CJM owed fiduciary duties to the members of BRI,
SEB, and CBR. Accordingly, Griffin, a member of BRI, has adequately stated a claim as
to this entity. However, as discussed above, Griffin purchased and held SEB and CBR
securities by way of his transferring funds. Furthermore, courts have held that fiduciary
duties owed by directors of wholly owned subsidiaries run to a parent and its
shareholders or members. See, e.g., Anadarko Petroleum Corp. v. Panhandle E. Corp.,
545 A.2d 1171, 1174 (Del. 1988). If a plaintiff stockholder of the parent company pleads
particularized facts explaining how the directors of a wholly owned subsidiary breached
their duty of loyalty, he may raise a duty of loyalty claim. Hamilton Partners, L.P. V.
Englard, 11 A.3d 1180, 1208-1210 (Del. Ch. 2010).

B. Fraud

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Griffin argues that Jones and CJM made to him material misrepresentations of
fact and concealed material facts from him regarding the operations, financial status, and
expenses of the companies with the intent to defraud him. (Am. Compl., DN 18, ¶ 99.)
He further argues that Jones and CJM shifted the companies’ assets to entities within
their control exclusively for Jones’s personal use and gain. (Id.) Griffin argues that three
of Jones’s various positions confer him with a duty to provide Griffin with material facts.
First, he points to Jones’s status as an officer of ICS and CJM; next, he points to Jones’s
status as a member of BRI and Chief Executive Officer of CJM; finally, he points to
Jones’s status and that of CJM as managers of the companies. (Id.)
Griffin has pleaded claims alleging both fraud by misrepresentation and fraud b
omission claims. Rule 9(b) requires a complaint alleging fraud “(1) to specify the
allegedly fraudulent statements; (2) to identify the speaker; (3) to plead when and where
the statements were made; and (4) to explain what made the statements fraudulent.”
Republic Bank & Trust Co. v. Bear Stearns Co., Inc., 683 F.3d 239, 247 (6th Cir. 2012)
(citation omitted). Griffin has satisfied these requirements in his Complaint; see Am.
Compl., DN 18, ¶¶ 20, 32-35, 38, 43-44, 52, 58, & 82. Taking Griffin’s allegations as
true, he has adequately stated a claim for fraud by misrepresentation.
Furthermore, Griffin’s claim for fraud by omission withstands Defendant’s
motion. “[A] fraud by omission claim is grounded in a duty to disclose. To prevail, a
plaintiff must prove: (1) the defendant had a duty to disclose the material fact at issue;
(2) the defendant failed to disclose the fact; (3) the defendant’s failure to disclose the
material fact induced the plaintiff to act; and (4) the plaintiff suffered actual damages as a
consequence.” Giddings, 348 S.W.3d at 747 (citations omitted). A duty to disclose may

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arise where a fiduciary relationship binds the parties, where a statute imposes such a duty,
or where a defendant has partially disclosed material facts but created the impression that
he fully disclosed them. Rivermont Inn, Inc. v. Bass Hotels & Resorts, Inc., 113 S.W.3d
636, 641 (Ky. App. 2003).
Because the Amended Complaint alleges facts sufficient to ascertain the
Defendants’ fiduciary duties to Griffin, the first element is satisfied. The Amended
Complaint also satisfies the second element by alleging that the Defendants withheld and
failed to disclose material facts to Griffin. Finally, Griffin alleges that the Defendants’
omissions induced him to act, resulting in actual damages. Therefore, the Amendment
Complaint’s allegations sufficiently state a claim for fraud by omission.

C. Misappropriation
Griffin next argues that the Joneses, CJM, Global Book, and as-yet unnamed
entities misappropriated the assets that Griffin provided “in order to increase the value of
[his] investments” for their own benefit. (Id. ¶ 107-109). Griffin further argues that TAI
misappropriated ICS’s assets, decreasing the value of Griffin’s ownership in ICS.
Although such claims are typically raised as derivative actions, Kentucky courts have
permitted shareholders to sue other shareholders for misappropriation when material
disputed facts exist as to whether the co-owners utilized corporate assets for their
personal gain. See, e.g., Lowder v. Lowder, 2008 WL 1757529 (Ky. App. Mar. 11,
2009).
Griffin’s Amended Complaint alleges that Griffin provided funds and bought
securities in the companies that Defendants operated. He further alleges that Defendants
misappropriated funds from these purchases for their own personal benefit. Taking

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Griffin’s allegations as true, he adequately states a claim of misappropriation against
Defendants.

D. Unjust Enrichment
Griffin alleges that the Joneses’ and CJM’s “false and misleading statements and
omissions” caused him to transfer money to the companies. He further argues that this
money was ultimately used in furtherance of the fraudulent schemes of the Joneses and
the various entities they operated. (Am. Compl., DN 18, ¶ 111-117.) Griffin argues that
the Joneses and the associated entities were unjustly enriched by obtaining funds from
Griffin by fraud, and that TAI was unjustly enriched by accepting money owed to ICS by
its customers.
Defendants note that Defendants allegedly took money from the companies rather
than from Griffin personally. (DN 14-1 at 34). However, Kentucky law provides that
“[f]or a party to prevail under the theory of unjust enrichment, they must prove three
elements: (1) benefit conferred upon defendant at plaintiff’s expense; (2) a resulting
appreciation of benefit by defendant; and (3) inequitable retention of benefit without
payment for its value.” Jones v. Sparks, 279 S.W.3d 73, 78 (Ky. App. 2009). Here,
Griffin provided funds for the benefit of the companies at issue, not for the Defendants.
Griffin’s allegation that Defendants wrongfully withdrew money from the companies for
their own benefit and at Griffin’s expense sufficiently states a claim for unjust
enrichment.

E. Constructive Trust

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Griffin urges the Court to find that because his funds were fraudulently obtained,
they are held in constructive trust on his behalf and he is entitled to their recovery. ((Am.
Compl., DN 18, ¶ 1118-123.) Griffin’s pleading of the basis for this equitable remedy is
sufficient to withstand Defendants’ Motion to Dismiss.

CONCLUSION
For the foregoing reasons, Defendant’s Motion to Dismiss is DENIED as to the
above claims.

September 27, 2013

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