Caucus Distributors, Inc. v. Maryland Securities Commissioner

MURPHY, Chief Judge. The principal questions presented are whether certain promissory notes, issued by a nonprofit corporation, are within the definition of a “security” under the Maryland Securities Act (the Act), Maryland Code (1985 Repl.Vol.), §§ 11-101 through 11-805 of the Corporations and Associations Article; and whether, if they are securities, the Act’s regulatory provisions constitute an infringement upon the organization’s First Amendment rights of political speech and association. I. Caucus Distributors, Inc. (Caucus) is a nonprofit publishing and fundraising organization incorporated under the laws of New York, which espouses political- viewpoints consistent with those expressed by Lyndon H. LaRouche, Jr. Caucus is not registered or qualified to transact business in Maryland. Acting through unregistered agents, Caucus sold two of its uncollateralized promissory notes totalling $100,000 to Grace Lindeman, a 79-year-old woman living in a retirement community in this State.

The notes were to mature in 1 year from their issuance and carried an interest rate of 12% or over. When the issuance of the notes was brought to the attention of the Attorney General of Maryland, these proceedings were initiated pursuant to the provisions of the Act. (A) The Act, in § 11-201, creates a Division of Securities in the Office of the Attorney General of Maryland, the principal executive officer of which is the Maryland Securities Commissioner. Section 11-301 makes it unlawful for any person, in connection with the offer, sale, or purchase of any security, directly or indirectly, to ³¹⁷ “(1) Employ any device, scheme, or artifice to defraud; (2) Make any untrue statement of a material fact or omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they are made, not misleading; or (3) Engage in any act, practice, or course of business which operates or would operate as a fraud or deceit on any person.” A “security” is defined by § ll-101(o) to mean, inter alia, “any: (i) Note.” 1 Section 11-501 makes it unlawful for any person to sell any security in Maryland unless it is registered under the Act or is exempt from registration.

Section 11-601 sets forth a list of exempt securities which includes, in subsection (9), any security “issued by any person organized and operated: (i) Not for private profit but exclusively for religious, educational, benevolent, charitable, fraternal, social, athletic, or reformatory purposes____” Section 11-603 authorizes the Securities Commissioner to summarily deny or revoke, by order, any ³¹⁸ exemption specified in § 11-601(9) “pending final determination of any proceeding under this subsection.” Upon the entry of such summary order, the Commissioner is required to notify every interested party that it has been entered, the reasons for its entry, and that within 15 days “of the receipt of a written request, the matter will be set down for hearing.” Section ll-603(c) provides that if a hearing is not requested, or ordered by the Commissioner, the summary order will remain in effect unless modified or vacated by the Commissioner. If a hearing is requested, the Commissioner is enjoined to afford notice and opportunity for hearing to every interested person, and thereafter may modify or vacate the order, or extend it until final determination. Section 11-701 authorizes the Commissioner to conduct investigations to determine whether any person has violated, or is about to violate, any provisions of the Act. Section ll-701(a)(4) authorizes the Commissioner to “[ijssue a cease and desist order as to any practice or act found by the Commissioner to be in violation of this title provided that notice and opportunity for a hearing are given to each person named in the order.” Section ll-701(b) authorizes the Commissioner, in the course of any investigation, to take evidence under oath.

Section 11-704 provides that any person aggrieved by a final order of the Commissioner may obtain a review of the order “in conformity with the procedure prescribed in the Maryland Rules of Procedure and in the Administrative Procedure Act.” (B) Following an investigation into the sale by Caucus of promissory notes to Lindeman, the Securities Commissioner issued a cease and desist order on March 11, 1986; it directed that Caucus, and its unlicensed agents, Kathy Wolfe and Paul Gallagher, cease operating in violation of the antifraud provisions of § 11-301. The order further directed that Wolfe and Gallagher cease acting as agents of Caucus and that Caucus cease employing unregistered ³¹⁹ agents in the State. The Commissioner also summarily revoked the exemption of the sale of securities by Caucus under § 11-602(9) and directed it to show cause why an order permanently revoking its statutory exemption should not be entered. Finally, the cease and desist order provided that a failure by Caucus, Wolfe or Gallagher, to request a hearing within 15 days, as permitted by § ll-603(c), would result in the entry of a final order.

In a timely answer, Caucus denied the alleged violations of the Act. It claimed that the cease and desist order unconstitutionally deprived it of its right of political expression without a predeprivation hearing and it requested a hearing before the Securities Commissioner. Neither Wolfe nor Gallagher answered the cease and desist order nor requested a hearing, although each appeared and participated in the administrative hearing on June 6 and 9, 1986. The evidence at the administrative hearing conducted by a hearing examiner disclosed that Kathy S. Wolfe, a volunteer for Caucus and an employee of a publishing enterprise known as Executive Intelligence Review (EIR), contacted Lindeman on July 22, 1985 by telephone and sold her a subscription to EIR for $250.

The unsolicited call and sale were part of a fundraising program for Caucus. Additional fundraising for Caucus was achieved by its issuance of interest-bearing promissory notes to an undetermined number of persons who acquired them in response to solicitation by Wolfe and other representatives of Caucus. Potential patrons of Caucus’s fundraising campaigns were identified through lists of thousands of names taken from telephone books for “conservative neighborhoods” and subscribers to conservative publications. Representatives of Caucus called up to three hundred names a day to discuss the teachings of Lyndon LaRouche and world affairs.

Lindeman’s name and telephone number were discovered in this general manner. Lindeman’s expressed interest in the political activities described by Wolfe during their telephone conversation prompted Wolfe to call her four days later. At this time, ³²⁰ she told Lindeman of Caucus’s need for money to translate into Spanish a book about an alleged connection between the International Monetary Fund and the international drug trade. The book was targeted for distribution in South and Central America.

Wolfe told Lindeman that while some funds belonging to Caucus had recently been impounded, investments in Caucus would be safer and pay a higher interest rate than would a bank. During this conversation, Wolfe asked Lindeman if she had money available to make an investment. Lindeman responded that she had a $64,000 certificate of deposit due to mature on November 2, 1985, which paid 10.8% interest. Wolfe told Lindeman that she could borrow against her certificate of deposit and the greater interest that Caucus would pay her would more than compensate for the interest she would pay on her loan with the bank.

Wolfe added that the higher rate of return was an incentive for Lindeman to invest with Caucus rather than a bank, and that she probably would not receive such a high rate if she merely reinvested the certificate of deposit. Wolfe also informed Lindeman that Caucus would generate the money to repay her investment through the sale of its publications. Wolfe did not tell Lindeman that payment of the notes would be made with money raised by the issuance of other promissory notes to other purchasers. Shortly after this telephone conversation, Lindeman sent a check for $10,000 to Caucus and subsequently acquired a loan for $50,000 from her bank, secured by her certificate of deposit, against which she wrote a $50,000 check to Caucus.

The 1-year note she received from Caucus was for $60,000 with an interest rate of 12.8%, payable quarterly. The uncollateralized note was due on July 31, 1986. On August 1, 1985, Wolfe and another volunteer for Caucus, Paul Gallagher, visited Lindeman in her home for the purpose of raising additional funds from her. Gallagher was an employee of the Fusion Energy Foundation, a political organization associated with Caucus.

Upon his suggestion, Lindeman contacted her bank and discovered ³²¹ she had $40,000 available in a trust fund drawing almost 8% interest. After Wolfe and Gallagher told Lindeman that Caucus would pay 12% interest on her $40,000 investment, Lindeman wrote Caucus a check for this amount, dated August 5, 1985. Lindeman received a 1-year $40,000 promissory note from Caucus, bearing an interest rate of 12%, payable quarterly. This note was also uncollateralized and was due on August 5, 1986.

The evidence disclosed that neither Wolfe nor Gallagher was registered as an agent of Caucus under the Act. There was no evidence that either provided Lindeman with financial information about Caucus or the names of its officers and directors. Nor did Lindeman receive any detailed information regarding the pending legal actions against Caucus in Massachusetts and New Jersey, although she was generally made aware of the litigation. Wolfe informed Lindeman that the source of repayment would be revenues derived from sales of Caucus’s literature and from additional contributions; however, she failed to disclose that Caucus’s ability to repay the loans depended in part upon its ability to borrow money from other persons through the issuance of other promissory notes.

Nor was there any evidence that Wolfe or Gallagher provided Lindeman with information regarding Caucus’s degree of dependence on several different sources of revenue or the extent to which Caucus’s ability to repay would be affected by the pending litigation in other states. Lindeman did receive written materials during the August 1, 1985 meeting with Wolfe and Gallagher, which expressed Caucus’s political views; but the material contained no significant information about Caucus’s management, its financial status, or its sources of revenue. Lindeman testified at the hearing that she viewed the transactions as an investment; that she would not have provided the money to Caucus as a gift, nor loaned the money at an interest rate lower, or for a longer period, than provided in the notes. She felt pressured to provide the money to Caucus due in part to the nature of the questions ³²² of Wolfe and Gallagher and the general circumstances of their meetings.

The evidence indicated that Lindeman was an unsophisticated investor, widowed from her husband who had handled the family’s finances. Her bank funds were managed by her attorney and bank personnel, and her children held powers-of-attorney for certain of her affairs. The hearing examiner, based on the evidence adduced at the hearings made the following proposed conclusions of law: “1. The Notes constitute securities within the meaning of section ll-101(o)(i) of the Act. 2.

The transaction between Caucus and Lindeman constituted an ‘offer’ and ‘sale’ of securities by Caucus within the meaning of sections ll-101(j) and (m) of the Act. • 3. Wolfe and Gallagher were issuer’s agents within the meaning of section ll-101(b)(l) of the Act, and they violated section 11-401 of the Act by transacting business in Maryland as agents without registration under the Act. 4. Caucus violated section 11-402 of the Act by employing Wolfe and Gallagher as agents in Maryland when Wolfe and Gallagher were not registered as agents under the Act.. . 5. By misrepresenting and failing to disclose material facts to Lindeman in connection with the offer and sale of securities to hér, Caucus, Wolfe, and Gallagher violated section 11-301 of the Act. 6.

The . actions of the Commissioner and the Division have not infringed upon Caucus’s constitutional rights of expression and association. 7. The issuance of the Cease and Desist Order, the Revocation Order and the Show Cause Order without a prior hearing did not deprive Caucus of its constitutional right of due process of law. 8. The Cease and Desist Order shall not be vacated or modified, but rather entered as final, and a final order ³²³ permanently revoking Caucus’s exemption under § 11-601(9) of the Act shall be entered.” The Securities Commissioner adopted the findings and conclusions of the hearing examiner and entered a final order in the case on January 16, 1987. As of that time, Lindeman had not recovered her principal or interest from Caucus.

On February 12, 1987, Caucus, Wolfe and Gallagher appealed to the Circuit Court for Baltimore City. The appeals by Gallagher and Wolfe were thereafter dismissed by the court as untimely filed. On June 16, 1989, the court (Kaplan, J.) affirmed the final order of the Securities Commissioner. Caucus, Wolfe and Gallagher then appealed to the Court of Special Appeals.

We granted certiorari prior to a decision by that court to resolve the important questions presented in the case.

II

The standard and scope of review of the Security Commissioner’s order is set forth in the Maryland Administrative Procedure Act, Code (1984), § 10-215 of the State Government Article. Subsection (g)(3) provides that a reviewing court may "reverse or modify the decision [of the agency] if any substantial right of the petitioner may have been prejudiced because a finding, conclusion, or decision of the agency: (i) is unconstitutional; (ii) exceeds the statutory authority or jurisdiction of the agency; (iii) results from an unlawful procedure; (iv) is affected by any other error of law; (v) is unsupported by competent, material, and substantial evidence in light of the entire record as submitted; or (vi) is arbitrary or capricious.” In determining whether an agency’s decision is supported by substantial evidence, we are mindful that ³²⁴ substantial evidence is such relevant evidence as a reasonable mind might accept as adequate to support a conclusion. State Election Bd. v. Billhimer, 314 Md. 46 , 548 A.2d 819 (1988). In applying the substantial evidence test, we must not substitute our judgment for the expertise of the agency, Supervisor v. Asbury Methodist Home, 313 Md. 614 , 547 A.2d 190 (1988), for the test is a deferential one, requiring “restrained and disciplined judicial judgment so as not to interfere with the agency’s factual conclusions.” Id. at 625 , 547 A.2d 190 .

This deference applies not only to agency fact-finding, but to the drawing of inferences from the facts as well. St. Leonard Shores Joint Ven. v. Supervisor, 307 Md. 441, 447 , 514 A.2d 1215 (1986). When, however, the agency’s decision is predicated solely on an error of law, no deference is appropriate and the reviewing court may substitute its judgment for that of the agency. Washington Nat’l Arena v. Comptroller, 308 Md. 370, 378-79 , 519 A.2d 1277 (1987); Ramsay, Scarlett & Co. v. Comptroller, 302 Md. 825 , 490 A.2d 1296 (1985).

In brief, so long as the agency’s decision is not predicated solely on an error of law, we will not overturn it if a reasoning mind could reasonably have reached the conclusion reached by the agency. In analyzing whether the promissory notes issued by Caucus in this case were “securities” under § 11-101 of the Maryland Act, we consider the interpretation of that same term by federal courts under substantially similar language contained in the Securities Act of 1933, 15 U.S.C. § 77b(l) and the Securities Exchange Act of 1934, 15 U.S.C. § 78c(a)(10). We note in this regard that § 11-804 of the Maryland Act mandates that “[t]his title shall be construed to effectuate its general purpose to make uniform the law of those states which enact it and to coordinate the interpretation and administration of this title with the related federal regulation.” The Securities Commissioner, after considering various test criteria formulated by a number of federal courts, found that the notes issued by Caucus were securities under the Maryland Act. The Supreme Court, in Reves v. ³²⁵ Ernst & Young, — U.S.-, 110 S.Ct. 945 , 108 L.Ed.2d 47 (1990), consolidated the criteria applied by the lower federal courts into a four-part test.

Reves involved uncollateralized and uninsured promissory notes issued by the Farmer’s Cooperative of Arkansas and Oklahoma to raise money for its general business operations; the question was whether the notes were securities within the meaning of § 78c(a)(10) of the Securities Exchange Act of 1934. The Court noted that there was a presumption “that any note with a term of more than nine months is a ‘security.’ ” Reves, 110 S.Ct. at 950 (emphasis in original). At the same time, it recognized that not all notes are securities and that courts had devised a list of notes that obviously were not securities. Therefore, the Court said that the presumption could be rebutted where the issuer showed “that the note in question ‘bear[s] a strong family resemblance’ to an item on the judicially crafted list of exemptions, or convinces the court to add a new instrument to the list.” Id., quoting in part from Exchange Nat’l Bank of Chicago v. Touche Ross & Co., 544 F.2d 1126, 1137-38 (2nd Cir.1976).

In determining whether an instrument belongs on the list, the Court said that it was necessary to first “examine the transaction to assess the motivations that would prompt a reasonable seller and buyer to enter into it. If the seller’s purpose is to raise money for the general use of a business enterprise or to finance sub-, stantial investments and the buyer is interested primarily in the profit the note is expected to generate, the instrument is likely to be a ‘security.’ If 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, on the other hand, the note is less sensibly described as a ‘security.’ ” Id. 110 S.Ct. at 951-52 . Second, the court examined the “plan of distribution” of the instrument to determine whether it is one in which there is common trading for speculation or investment. Id. at 952 .

Third, the reasonable expectations of the investing public ³²⁶ must be examined in considering whether instruments were “securities,” even where an economic analysis of the circumstances of the particular transaction might suggest that the. instruments are not “securities.” Id. Fourth, the Court said it was essential to examine whether some factor, such as the existence of another regulatory scheme, significantly reduces the risk of the instrument, thereby rendering application of the Securities Acts unnecessary. Applying these criteria, the Court concluded in Reves that the promissory notes before it were securities subject to regulation. In utilizing these principles, and finding that the Caucus notes were securities, the Security Commissioner found that Caucus was involved in the publishing and distribution of books and periodicals on a national and international scale; that it sought to raise money for its enterprise purpose, e.g., to translate one of its books into Spanish for the purpose of distribution in South and Central America; and that Lindeman, although interested in similar political objectives, was essentially motivated by the expected profit to be generated from the acquisition of the notes.

Indeed, the Commissioner found as a fact that Lindeman would not have donated the $100,000, nor invested it at an interest rate equal to or less than she was earning on her bank funds. As to these findings, Caucus claims that “the repayment of principal plus a fixed rate of interest is not an expectation of profits,” because it is “not contingent upon the entrepreneurial efforts of others,” relying indirectly on the test formulated in S.E.C. v. Howey Co., 328 U.S. 293, 298-99 , 66 S.Ct. 1100, 1102-03 , 90 L.Ed. 1244 (1946) (an investment contract, which is a “security” under the 1933 Act, is. “a contract, transaction or scheme whereby a person invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or a third party, it being immaterial whether the shares in the enterprise are evidenced by formal certificates or by nominal interests in the physical assets employed in the enterprise”). Reves, 110 S.Ct. at 951 , specifically rejected the application of the Howey test to notes. It determined that ³²⁷ “by ‘profit’ in the context of notes, we mean ‘a valuable return on an investment,’ which undoubtedly includes interest.” Id. at 952 n. 4, quoting in part from United Housing Foundation, Inc. v. Forman, 421 U.S. 837, 852 , 95 S.Ct. 2051, 2060 , 44 L.Ed.2d 621 (1975).

As to the second factor in Reves , we think the Securities Commissioner effectively concluded that the plan of distribution of the instrument existed in a circumstance of common trading for speculation or investment. As noted in S.E.C. v. Joiner Corp., 320 U.S. 344, 352-53 , 64 S.Ct. 120, 124-25 , 88 L.Ed. 88 (1943), cited with approval in Reves 110 S.Ct. at 952 : “The test ... is what character the instrument is given in commerce by the terms of the offer, the plan of distribution, and the economic inducements held out to the prospect.” In Joiner, the Supreme Court held that the sale of leasehold interests in land near a proposed oil well drilling were securities under the Securities Act of 1933, suggesting that “[i]n the