In re Columbus Skyline Securities, Inc. - Ohio Supreme Court Opinion - Ohio Supreme Court Decision

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IN RE COLUMBUS SKYLINE SECURITIES, INC. ET AL.: HOLDERMAN, COMMR.,
APPELLANT, V. COLUMBUS SKYLINE SECURITIES, INC., ET AL., APPELLEES.
[Cite as In re Columbus Skyline Securities, Inc. (1996), ___
Ohio St.3d ___.]
Corporations -- Securities -- R.C. 1707.01(J) gives intrastate securities
dealers adequate notice that federal law may be applied to
calculate current market price of over-the-counter stock to
determine fraudulent conduct.
R.C. 1707.01(J) provides constitutionally adequate notice that federal
law may be applied to the conduct of licensed intrastate
securities dealers for the purpose of calculating the current
market price of over-the-counter securities and determining
fraudulent conduct.

(No. 94-1445 -- Submitted October 10, 1995 -- Decided
February 14, 1996.)
Appeal from the Court of Appeals for Franklin County, No.
93AP-790.

Appellee Columbus Skyline Securities, Inc. ("Skyline") is a
securities dealer based in Ohio. Appellant, Commissioner of the Ohio
Division of Securities ("Division"), revoked Skyline's administrative
license, and the licenses of its president and six of its sales staff, based
on alleged fraudulent conduct concerning the intrastate sale of the over-
the-counter common stock of FiberCorp International, Inc. ("FiberCorp")
in violation of R.C. 1707.44(G).

In revoking the licenses, the Division examined sales
confirmations issued by Skyline to its retail customers. The records
show that from late December 1990 to mid-March 1991, Skyline sold
over 135,000 shares of FiberCorp common stock to the general public
at a price of $1.00 per share. During this same time, Skyline purchased
503,957 shares of FiberCorp for a price ranging between $.15 and $.20
per share in a series of transactions with an SEC-registered dealer.
Skyline never disclosed to retail investors, who were charged $1.00 per
share, the $.15 to $.20 purchase prices.

2

The Division also examined the price at which Skyline sold
FiberCorp shares to other securities dealers. Between January 1991
and March 1991, Skyline sold 57,000 shares of FiberCorp to another
intrastate securities dealer at a price of $.25 per share, while selling
over 22,000 shares of FiberCorp to Ohio retail investors at $1.00 per
share. Skyline again failed to disclose to its retail investors the
existence of the $.25 per share dealer-to-dealer sales.

Based on its calculations of current market price ("CMP") for
FiberCorp common stock, the Division in effect determined that Skyline
sold FiberCorp securities to Ohio retail investors at prices up to 567
percent higher than the price at which Skyline was able to purchase the
stock from an interstate over-the-counter securities dealer, and up to
300 percent higher than the price at which Skyline sold FiberCorp to
another intrastate securities dealer. Moreover, Skyline did not inform its
investors of this price disparity.

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The Division alleged that Skyline violated R.C. 1707.44(G) by
selling FiberCorp common stock at an excessive price that bore no
reasonable relationship to the market price of the issued stock. The
Division contended that R.C. 1707.01(J) allowed it to apply both federal
and state case law for the purpose of determining whether the conduct
of Skyline was fraudulent. Skyline disagreed with the methods used by
the Division to calculate the current market price of the FiberCorp stock,
arguing that R.C. 1707.01(J) failed to give adequate notice as to what
standard would be applied in calculating the current market price of an
over-the-counter security.

The trial court affirmed the license revocation action as being
supported by reliable, probative, and substantial evidence and in
accordance with law. The Tenth District Court of Appeals reversed the
trial court, however, holding that the Ohio Securities Act ("Act") and its
companion rules were unconstitutionally vague because the Act did not

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give sufficient notice to Skyline that the Division may define fraud using
federal law.

This cause is now before this court pursuant to the allowance
of a discretionary appeal.
______________

Betty D. Montgomery, Attorney General, and Daniel A. Malkoff,
Assistant Attorney General, for appellant.

Lyman Brownfield, for appellees.

Albert L. Bell, Eugene P. Whetzel and Howard M. Friedman,
urging reversal for amicus curiae, Ohio State Bar Association.
______________

MOYER, C.J. This case presents the court with the issue of
whether R.C. 1707.01(J) gives intrastate securities dealers adequate
notice that federal case law may be applied to calculate the current
market price of over-the-counter stock to determine if the conduct of a

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dealer is fraudulent. For the following reasons, we answer that question
in the affirmative.

R.C. 1707.44(G), at the time relevant herein, provided that "[n]o
person in selling securities shall knowingly engage in any act or practice
which is, in sections 1707.01 to 1707.45 of the Revised Code, declared
illegal, defined as fraudulent, or prohibited." The definition for "fraud" as
used in the Act is found in R.C. 1707.01(J), which provides:

"`Fraud,' `fraudulent acts,' `fraudulent practices,' or `fraudulent
transactions' means anything recognized on or after July 22, 1929, as
such in courts of law or equity; any device, scheme, or artifice to
defraud or to obtain money or property by means of any false pretense,
representation, or promise; any fictitious or pretended purchase or sale
of securities; and any act, practice, transaction, or course of business
relating to the sale of securities which is fraudulent or which has
operated or would operate as a fraud upon the purchaser." (Emphasis
added.)

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The court of appeals below held R.C. 1707.01(J) to be
unconstitutionally void for vagueness. The court determined that
Skyline had inadequate notice that federal securities law standards
used in calculating current market price could be applied in enforcing
Ohio securities law. Moreover, it held that "[a] general rule stating that
federal securities law applies to Ohio intrastate securities trading would
be insufficient as it would be impossible for anyone to know what
standard applied." Consequently, the appellate court reversed the
judgment of the trial court and remanded the case because, in its view,
the Division's calculations in determining current market price based on
federal law could not be used to support the charges brought against
Skyline without violating substantive due process. We disagree.

It is well established that all legislative enactments enjoy a
strong presumption of constitutionality, and that any assertion of
unconstitutionality must be proved beyond a reasonable doubt by the
challenging party. State v. Collier (1991), 62 Ohio St.3d 267, 269, 581

7

N.E.2d 552, 553. Moreover, in order to prove that a statute is
unconstitutionally vague, "the challenger must show that upon
examining the statute, an individual of ordinary intelligence would not
understand what he is required to do under the law." State v. Anderson
(1991), 57 Ohio St.3d 168, 171, 566 N.E.2d 1224, 1226.

The Ohio Securities Act, generally referred to as Ohio Blue Sky
Law, was adopted on July 22, 1929 to prevent the fraudulent
exploitation of the investing public through the sale of securities. United
States. v. Tehan (C.A.6, 1966), 365 F.2d 191, 194. See, also, Hall v.
Geiger-Jones Co. (1917), 242 U.S. 539, 37 S.Ct. 217, 61 L.Ed. 480,
upholding the constitutional validity of the former Ohio Blue Sky Law in
regulating the sale of all securities. Many of the enacted statutes are
remedial in nature, and have been drafted broadly to protect the
investing public from its own imprudence as well as the chicanery of
unscrupulous securities dealers. See Bronaugh v. R. & E. Dredging Co.
(1968), 16 Ohio St.2d 35, 45 O.O.2d 321, 242 N.E.2d 572. In order to

8

further the intended purpose of the Act, its securities anti-fraud
provisions must be liberally construed.

The plain language of R.C. 1707.01(J) defines "fraud," in part,
as "anything recognized *** as such in courts of law or equity." We
acknowledge that R.C. 1707.01(J) does not state the precise method to
use to calculate current market price of securities sold in Ohio. The
statute does, however, clearly indicate that the definition of fraud is to
be derived from case law deciding this issue. Moreover, the General
Assembly did not limit the source of the definition solely to courts of
Ohio, or even to state courts generally, as it easily could have done.
Rather, the legislature broadly drafted R.C. 1707.01(J) to draw from all
securities case law defining fraudulent conduct in both state and federal
courts. Interpreting R.C. 1707.01(J) as not including federal securities
law as a defining source for "fraud" would require us to modify the
statute by inserting the word "Ohio" or "state" before the phrase "courts
of law or equity." We refuse to do so, for when construing a statute "it is

9

the duty of this court to give effect to the words used, not to delete
words used or to insert words not used." Cleveland Elec. Illum. Co. v.
Cleveland (1988), 37 Ohio St.3d 50, 524 N.E.2d 441, paragraph three of
the syllabus.

As with most statutes, R.C. 1707.01(J) was drafted to address
unforeseen variations in factual circumstances. Recognizing the
creativity of unscrupulous securities dealers intent on defrauding Ohio
investors, the General Assembly chose not to create a specific formula
for calculating CMP and determining fraudulent conduct. Instead, the
General Assembly drafted R.C. 1707.01(J) so that securities case law,
both state and federal, provides the appropriate standards. This is
sagacious for several reasons. First, the securities market is constantly
evolving. By incorporating into the statute a larger body of law by which
to define fraudulent conduct, the General Assembly has provided for
inevitable changes in market structure that might otherwise require
redrafting of the statute. This has the desirable effect of preventing
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Ohio securities law from developing in a vacuum, and furthers the goal
of unifying securities law.

Second, federal standards for determining CMP are more well
developed than state standards. Federal courts and administrative
tribunals like the Securities and Exchange Commission have a greater
experience with, and a more continuous exposure to, the complicated
field of securities fraud cases and, consequently, provide a more
extensive body of law to draw from in defining fraud. Therefore, we hold
that R.C. 1707.01(J) provides constitutionally adequate notice that
federal law may be applied to the conduct of licensed intrastate
securities dealers for the purpose of calculating the current market price
of over-the-counter securities and determining fraudulent conduct.

Furthermore, we disagree with the suggestion that R.C.
1707.01(J) states a standard that is "impossible" for a reasonable
securities dealer to discern. Many federal securities cases exist that
provide a clear and workable method of calculating CMP, and set the
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standard for what constitutes an excessive price markup amounting to
fraudulent conduct. See, e.g., Charles Hughes & Co. v. SEC (C.A. 2,
1943), 139 F.2d 434; In the Matter of Alstead, Dempsey & Co., Inc.
(1984), SEC File No. 3-6135, 47 S.E.C. 1034. A review of the pertinent
case law indicates that to determine current market price one of three
methods is to be used, and is dependent on whether the dealer is a
market maker.1 If the dealer is a market maker, then CMP should be
calculated using the price at which the dealer trades with other dealers.
If the dealer is not a market maker, then absent countervailing evidence,
the contemporaneous cost to the dealer for the security is the best
indication of current market price. The underlying policy behind both of
these approaches is that a dealer is assumed to have expertise in the
securities markets and will generally trade securities in dealer-to-dealer
transactions for the prevailing market price. Finally, if no actual sales or
contemporaneous prices are available, then pricing quotations,
commonly referred to as "Pink Sheets," are a useful source to determine
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CMP, provided the price quotations are demonstrated to be reliable.
Alstead at 1035-1036, 1038.

In addition to clearly identifying the method for calculating
current market price, federal securities case law also establishes the
acceptable standard for a dealer markup. Typically, a dealer will
purchase a security through a dealer-to-dealer transaction and then sell
the security to a retail security investor at the current market price of
that security plus a commission. This markup, or "spread," is the profit
realized by the dealer from the trading of the security. See Bank of
Lexington & Trust Co. v. Vining-Sparks Securities, Inc. (C.A.6, 1992),
959 F.2d 606, 613. A markup of five to ten percent above the current
market price for an over-the-counter security is deemed acceptable by
the SEC, and securities case law limits a dealer's spread to near that
amount. Charles Hughes & Co., Inc. v. SEC, 139 F.2d at 437, fn.1;
Barnett v. United States (C.A.8, 1963), 319 F.2d 340, 343.
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The record indicates that by calculating the current market
price of FiberCorp over-the-counter stock based on dealer-to-dealer
transactions, either under the contemporaneous sales method or the
contemporaneous costs method, Skyline sold FiberCorp securities to
Ohio retail investors at a price of 300 percent to 567 percent over the
current market price for the stock and failed to disclose to its investors
either the current market price of the FiberCorp stock or the exorbitant
markup. Skyline contends that the CMP of an over-the-counter stock
should be determined by whatever price the dealer is able to sell the
security to the investing public. This concept ignores the central
objective of all securities legislation of providing protection for those
unfamiliar with market conditions from the dishonesty of those who do.
"`The best element of business has long since decided that honesty
should govern competitive enterprises, and that the rule of caveat
emptor should not be relied upon to reward fraud and deception.'"
14

Charles Hughes & Co. at 437, citing FTC v. Std. Edn. Soc. (1937), 302
U.S. 112, 116, 58 S.Ct. 113, 115, 82 L.Ed. 141, 145.

The judgment of the court of appeals is reversed, and the trial
court's judgment is reinstated.
Judgment reversed.

DOUGLAS, WRIGHT, RESNICK, F.E. SWEENEY, PFEIFER and COOK, JJ.,
concur.

FOOTNOTES

1 Although the Act and the Ohio Administrative Code do not
define "market maker," it is widely accepted that a market maker is a
dealer who holds itself out to the public as willing to buy and sell
securities as a principal, risking its own capital, and is willing to sell to
both the public and other dealers.

The trial court assumed arguendo that Skyline was a market
maker. Due to the egregiously excessive markup of FiberCorp stock by
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Skyline, however, the trial court suggested that under any method of
calculation, Skyline would be considered to have sold securities at a
price not reasonably related to the market price.

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