Case Title: Fong v. Oh. ICA mem.op., filed 10/27/2006 [pdf], 112 Haw. 372. S.Ct. Order Accepting Application for Writ of Certiorari, filed 03/21/2007 [pdf]. S.Ct. Order of Correction, filed 12/19/2007 [pdf]. S.Ct. Order

Citation: 116 Haw. 187

Docket Number: 

State: hawaii

Court: Hawaii Supreme Court

Date: 2007-11-30T00:00:00Z

Document:
LAW UBRAAY
++ FOR PUBLICATION IN WEST'S HAWAI'I REPORTS AND PACIFIC REPORTER ***

IN THE SUPREME COURT OF THE STATE OF HAWAT'T

 

000.

 

 

CONNIE Y. FONG,
Respondent /Plaintif£/Counterclaim Defendant-Appellee

ve. 8
SEMIN OH and MYUNG HUI OH, 28 2 x
petiticners/Defendants/counterciainants/ ade
Crose-Claisante-Appellants eS F
Bros 6

and ae

CELIA OLAES BATLE, Defendant /Cro:

 

4
é
x

and

CLIFF ENTERPRISES, INC.; DAVID JON TAMURA? ANNE JU TAMURA; RENATO
VITO BATLE; MICHAEL TAMURA; and DOES 1-100, Defendants

 

and

SEMIN OH and MYUNG HUT OH,
Petitioners/Third-Party Plaintiffs-Appellants

KEITH M. KIUCHI,
Respondent /Third-Party Defendant-Appellee

No. 27635
CERTIORARI TO THE INTERMEDIATE COURT OF APPEALS
(CIV. No, 02-31-2007)

NOVEMBER 30, 2007

MOON, C.J., LEVINSON, NAKAYAMA, ACOBA, AND DUFFY, JJ.
*** FOR PUBLICATION IN WEST'S HAWAI'I REPORTS AND PACIFIC REPORTER ***

OPINION OF THE COURT BY DUFFY, J.

Petitioners Semin Oh and Myung Hui 0h seek review of
the Intermediate Court of Appeals’ (ICA) November 16, 2006
judgment affirming the November 2, 2005 judgment of the circuit
court of the first circuit.! We accepted the Ohs’ application
for @ writ of certiorari and oral argument was held on August 15,
2007.

‘The Ohs assert that the ICA gravely erred in vacating
in part and affirming in part the circuit court's judgment in
favor of Respondent/Plaintiff/Counterclaim Defendant-Appellee
Connie Fong and Respondent/Third-Party Defendant-Appellee Keith
Kiuchi. With respect to Fong, the Ohs assert that the ICA
jistakenly held that the anti-fraud provisions of Hawai" Revised

Statutes (HRS) chapter 485, known as the Uniform Securities Act,

 

do not apply to transactions in which “a party sels all, a
opposed to only a portion, of the stock of a corporation.” with
respect to Kiuchi, the Ohs assert that the ICA was mistaken in
its ruling that an escrow agent's duty of disclosure is limited
to agreenents or instructions imposing such a duty, and that

there was no evidence of any such agreement or instructions in

this case. Because we do not believe the ICA‘s conclusion with

 

le Gary W.B. Chang, presided over this matter.
 

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respect to Kiuchi was in error, we focus on the Ohs’ HRS § 485-25

 

Based on the following, we vacate the ICA’s judgment in
part and remand to the circuit court on the Ohs’ counterclaim
with respect to HRS § 485-25, and affirm the judgement of the ICA

in all other respects.

 

‘BACKGROUND
Although the initial transactions and lawsuits involved

six parties,’ the present appeal concerns four individuals: Mr.

and Mrs. Oh, Fong, and Kiuchi.

A. » Factual Backaround

1. Ownership and Operation of Cliff Enterpri

 

1 Ine.
Cliff Enterprises, Inc. (CEI) was incorporated on May
15, 2000 by Clifton Yamamoto, at Fong’s direction.? Yamamoto
subsequently transferred ali of the shares of stock of CEI to
Michael Tamura, who paid part of the purchase price with a
promissory note in favor of Fong. Ownership subsequently passed

to Batle in October 2000. Pursuant to an agreement between

+ these other parties include: Celia Betle, who filed for benkruptey
land against whom all claims vere as Michael Temura? Ann Tamura
(Wtichsel’s # and Davie Tamer

        

+ CEI obtained ite lesse and initial assets from another corporation
that opersted # store at the sane location. Feng had Losned £400,000 to the
owner of this prior store, and has had a financial stake in the

Involved since 1989." These details, not relevant to this sppesl,
Subsequent financial arrangements concerning CEI.

 

 

           

 

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Tamura, Fong, and Batle, a promissory note designating Fong as
the payee of a sum of $280,000 in monthly payments of $8,000 vas
signed in October 2000 by CEI (Batle signing as President),
Batle, Ann Tamura, and David Tamura. The note was secured by
mortgages on two condominiums owned by Ann and David Tamura, a
well as a mortgage on Batle’s house.

Under Batle’s ounership and operation, she sold
cigarettes to retail customers at discount prices, allegedly
because she was not paying the requisite Hawai'i excise tax of
five cents for each cigarette sold required by HRS § 245-3.”
Batle testified that she purchased cigarettes from the mainland
via a wholesale company she owned, and would resell them at the
store. This “gray market or illegal sales practice continued

until December 2000, after which she did not make further

 

2 HRS § 245-3 provides that every wholesaler or dealer of cigarettes

“shail pay for the privilege of conducting business... [an excise tax
equal £65.00 cents for each cigarette sold. « efter June 30, 1996." Prior
te dune 2000, cigarette bexes contained no indicia of whether of not the tex
had been paid; this schene sllowed sone merchants like Satle to “purcha
Cigarettes at wholesale prices . . . not pay the excise tox, and fell the
Cigarettes to shop owners and bor cuners at discount prices." In June 2000,
the legislature anended the law to require that all packs of cigarettes sold
In the state have affixed stamp showing that the excise tax had been paid,
and making it a erine to sell 2 package of cigarettes without stamps.” 2000
How. Sess. L, Act 245, § 1 st €16-19 (approved on June 19, 2000). The law
took effect on April i, 2003, HRS § 248-87 ("Beginning April 1, 2001. - =
"}, shortly before the date of Betle’s arrest.

 

 

 

     

 

 

 

‘
 

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purchases from her mainland company but continued to sell the
renaining inventory.‘

Batle was arrested on April 3, 2001 for selling
cigarettes without the required stamps. Ten months later, on
vanuary 31, 2002, she was formally charged with selling
cigarettes without stamps, with one count against her
individually and one count against her as corporate
representative of CEI. Batle reached a plea agreenent with the

state, in which she would plead no contest, agree to a five year

 

+ Batle’s deposition contains the following testisony confirming this:
0. You would purchase the cigarettes from the Mainland through
your wholesele business called Discount Cigarettes, and you
Mould then sell those cigarettes at retell tnrough’ the D.C.
Lees store at 152 North Pauahi street) is that correct?
a. T'stopped’-* wait. 2 stopped the cigarette Business in
2000, end of 2000
So uwhavever i we just put there to sell

 

     

  

 

 

 

outa ves
So'then You say the end of 2000, are you talking about
December of 2000?

Yes:

©." ” Go for the period between October when you took over through
the end of Becesber, the cigarettes you were selling out of
the store were cigarettes which yoo obteines from the
Mainland, correct?

a Yen.

&." "After vecenter of 2000, you still had sone cigarettes left
Over that you had ebtained on the Mainland, Fight?

aA Yes.

Ane you continued to sell those through the store until they

Zan Gut; ie this correct?
a. Yee.

Based on this testinony, it appears that Batle continved to sli “liege?

Cigarettes” after Decencer of 2000, although it is unclear to what extent and

for how long. Batie elto purchased cigarettes from a Costco store located in

Rawat for ressle, slthough the dete this activity began and the relative

proportions of neinlanc-besed end Costco cigarette =: unclear.

 

 

 

 

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term of probation, and pay a $10,000 fine, in return for a
Gismissal of the charge against CET.
2. Sale of CEI to the ohe

Subsequent to her arrest in April 2001, Batle sought to
sell her interest in CEI and no longer work at the store. At
this point, Myung oh contacted Fong regarding purchase of the
store. At this time, CEI had the following assets: (1) a
commercial lease for premises located at 152 North Pauahi street
in Honolulu; (2) a liquor license, issued by the Honolulu Liquor
Commission, which allowed the sale of packaged liquor at the
stove; and (3) the food and liquor inventory located at the
store. Fong offered to sell the business to Mrs. Oh for
$228,000, the amount that was still owed to her on the promissory
note signed by Batle,

While negotiating the sale, Wr

 

Oh asked Fong about
the monthly income of the store. Fong referred Mrs. oh to Harry
Lee, the accountant employed by CEI, whom Mrs. Oh knew from prior

business dealings. Mrs. Oh spoke with Mr. Lee, who confirmed the

 

income of the store for the previous three months. Fong knew
that Batle sold cigarettes from the store and that she had a

wholesale cigarette business as well. Fong also knew that Batle

 

+ Although Fong wae not the owner of CEI, she was the mortgages of

Batle's house pursuant te pricy promissory note, snd uae to receive the
Purchasing funds as a discharge of Gatle’s cbligation to Fong,

«
 

$+ FOR PUBLICATION IN WEST'S HAWAT'T REPORTS AND PACIFIC REPORTER

had been arrested for selling cigarettes without the requisite
stamps.

On May 25, 2001, Mrs. Oh signed @ Stock Purchase
Agreenent, in which she agreed to purchase 1008 of the stock of
CEI for herself and her husband Semin as the sole shareholders.
Although Batle was the seller of the stock, payment would not be
made directly to Batle. Under the agreement, Mrs. Oh agreed to
pay $30,000 innediately as a non-refundable deposit and $50,000
at the time of closing, which funds were to be made to the
Client’s Trust Account of Kiuchi 6 Nakamate and disbursed
according to a separate agreenent between Batle and Fong. As
part of the agreement, Mrs. Oh also signed a promissory note in
favor of Fong in the anount of $148,000, payable at the rate of

$5,000 per month. The Stock Purchase Agreement also provided for

 

additional compensation for the food and Liquor inventory in
existence at closing of the stock transfer, the amount of which
was negotiated after the closing, Under the agreenent, Batle
assumed responsibility for all of CEI’s liabilities incurred
during her ownership of the corporation, except for those
specifically disclosed.

On the date of closing for the stock sale, May 30,
2001, Fong and the Ohs also signed a document entitled

“Disclosure Re: Stock Purchase Agreement.” Among the disclosures
 

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in this document were: (1) a statement acknowledging that Fong
makes no representations or warranties regarding the condition of
assets of CEI, which were to be accepted “as is,” and that the
Ohs agreed to indemnify Fong for any claims arising out of the

condition of the asset:

 

(2) @ disclosure that CEI had recently
eceived a citation from the Honolulu Liquor Commission for
selling liquor to a minor, for which Batle was deemed to be
responsible, accompanied by an agreenent to indemnify and hold
Fong harmless for any clains arising out of the violation? and
(3) an acknowledgment that Fong has not made any warranties
regarding the success or failure of the business, accompanied by
an agreement to indemnify and hold Fong harmless for any

liability arising out of the success or failure of the busines:

 

3. Keith Kiuchi’s Role

Kiuchi acted

 

Fong's attorney in the sale of Batle’s
stock in CEI to the Ohs. Kiuchi’s role as Fong's attorney was
@isclosed to the Ohs both orally and in writing in the Stock
Purchase Agreement:

The parties acknowledge that the law firm of Kiueht &
Nakamoto reprecente Connie Yon Fong and has previously
represented the Seller and the Seller's corporation. In
this transaction, however, the law firm of Kiuehi & Nokenote
represents only Connie Yon Fong and its only other duty will
be to act es escrow and to avaft docunents.” Seller and
Buyer Both acknowledge that they have the right to retain
Separate counsel te represent then and that the law firm of
Kivchi & Nakanoto does not represent them in this
transaction.

 
‘++ FOR PUBLICATION IN WEST'S HAWAI'I REPORTS AND PACIFIC REPORTER

 

While the Stock Purchase Agreenent provided that
certain payments be received by Kiuchi “as escrow,” the
undisputed evidence is that Kiuchi received no money to hold in
‘escrow as payments were made and received by the parties
directly. Kiuchi’s role was limited to drafting the transaction
docunents and facilitating their execution and exchange. Kiuchi

testified in his deposition as to his understanding of the

 

meaning of “escrow’

Escrow in a transaction such a2 this normally would be
that escrow drafts the docunents, Escrow may or may not
handle the money. But St ie not escrow ae me know it With 2
real estate transaction

‘ihenever 7 have referred to escrow, it’s simply to
draft documents. “It's to act really to make sure that stl
Socunents sre signed, that the parties have signed then.

Tn sone cases, it may oF nay not invelve handling
money. In this case, because of certain circumstances, it
Sic not involve us handling money,

 

 

 

 

The Ohs did not give any instructions to Kiuchi in connection
with the manner in which the documents should be drafted or the
money exchanged.

After Batle’s arrest for illegal cigarette sales,
Kiuchi contacted Deputy Attorney General Earl Hoke on Batle's

behalf

 

at the request of both Fong and Batle

 

apparently
seeking information regarding whether Batle would be charged with
a crime. Kiuchi's conversations with Mr. Hoke led Kiuchi to
believe that Batle would not be charged with eny crime.

According to Kiuchi, he did not tell the Ohs sbout the cigarette
 

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REPORTER ***

sales of Batle, “because based on [his] knowledge, [he]
believe(d] Celia Batle wasn’t going to be charged with any
crime.” Kiuchi further stated in his deposition: “I mean, what.
was disclosed was the sale (Batle] made to a minor and she was
going to be responsible for that. So I think at that point if ve
had any idea she was going to be charged or had been charged, we
would have disclosed that.” Batle vas charged with a violation
of HRS § 245-37(a) (2) on January 31, 2002, seven months after the
sale of CEI to the Ohs.

While Kiuchi attended several meetings between the
parties in April and May 2001, in which the transaction was
discussed, he did not make any representations regarding the
financial value of the business, nor did the Ohs make any such
inquiry of him.

4. Post:

 

Je events leading to litigation
The Ohs began operating the store on June 1, 2001.
Under their managenent, the monthly income of the store was
$22,000 to $23,000. Sometime in May or June of 2002, Mrs. Oh
called Fong regarding tax liabilities for the previous year of
‘about $30,000. The Honolulu Liquor Commission would not issue a
new liguor license to CEI unless all delinquent federal and state
income texes were paid. Fong was not willing to pay the taxes

owed.

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The Ohs did not pay the taxes, and the liquor license
was lost. In August 2002, the Ohs offered to convey all of the
CEI stock to Fong, which offer was refused. The Ohs subsequently
failed to make a payment owed to Fong under the promissory note.
Litigation ensued.
B. Procedural Background

1. Circuit Court Lawsuit

‘The procedural history of this case is summarized in

the ICA’s Memorandum Opinion:

men CEI defaulted on its debt to Fong, Fong sued Cet,
Myung, Senin, Davi Tamura, Anne Tamura, Michael Tamura,
Celia’ and Renato Vito Batle (Renato). Fong's complaint
alleges that Senin and Myung are “ebiigors” of approximately
5120, 000, and Davie Tamura, Anne Tamura, Hicheel Tenure,
Celia and Renato are "guarantors". It further states that
GEE owed Fong $120,000 secured by the assets of CET and
Celle's residence.

Semin and Myung counterclained against Fong."

 

  

    

 

Semin and Myung cross-clained against Celia.

Semin and Myung filed a Third-Party Complaint against
Kivens. i

‘Im thete opening brief to the ICA, the ohs claim that “the unpaid
corporate income taxes were a direct result of datle's cale of illegal
cigarettes.” Although the argument ie not clear, apparentiy Batle's failure
to pay the excise tax, a8 well as her choice of including the incone from
cigarette sales from her separste vnclesale business on ner gersonal income
tex return, left CEI with s net profit =~ because it was unable to effset the
Seoets of goods sold” from the cigarette purche:

tox that was net paid => resulting in the tax 1

 

 

The Ohe raised the following clains in their coaplaint:
(2) Violation of the Uniform Securities Act, HRS chapter 485; (2) Frau
Negligent Misrepresentation: and (4) Breach of Contract-

   

3

   

+ The Ohs raised the following elaine in their third-party complaint
(1) Viclaticn cf the Uniform Securities Act, ARS chapter 65; (2) Breach of
(cont inves.)

 

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REPORTER

on Decenber 17, 2003, the court entered 2 stipulated
judgnent_in favor of’ Fong and against Davia Jon Tamara and
Rane Ju Tonura in the amount of $112,000 "eogether with pre
Judgnant interest of ten percent (108) from April 16, 2001
through October 7, 20031."

 

On Novenber 15, 2004, Fong filed a motion for sumary
Judgment (HPS2). Although’ not clearly stated, it appears
Ghat Fong's FSI was against. {) Semin and Myung. On
Novenber 18,2004, Kiveni filed a MESS against Semin and
Myung.

 

fon January 3, 2005, in Light of Celia'e discharge in
bankruptcy, the court dismissed all claine by Fong, Sein,
and Myong against Celia, without prejudice.

On January 7, 2005, the court entered an order
granting Fong's WFSJ against Senin and Myung. On January
127"2008, Fong, Semin, and Myung stipulated that the ancunt
ue on the Promissory Note "including interest, but net
Gneavding costs, expenses and attorneys” fees, Ls

$136, 400-00[.)" On Janvary 18, 2005, the court entered an
Order granting Kiuchi"s MFSJ against Semin and Myung.

 

  

 

 

on January 20, 2008, Senin and Myung filed » motion
for reconsideration’ (MFR) of both summary judgeent orders:
In the MPR, Senin and Hyung argued:

It 1s the position of (Semin and myung) that
both (Fong) and (Kivchi] may be held Liable to (Senin
ane Myung] fer fa1ling to disclose, prior to. (Senin,

and Myung's) purchase of the stock of (CEI) that the
Seller of the stock, (Celia}, was illegally selling

Untaxed cigarettes from the store premises leased by
{cet}. tn’ (Senin and Myung’s) view, the fact that «
signiéseant portion ef the incone fron the store wae
due to illegal sales is a "naterial fact" within the
purview of felevent Hauaii appellate court decisions.

Although Fong was not nominally the seller of
the stock, [Semin and Myung] contend that she may be
hel liable as an agent of the seller under the
provisions of the Uniform Securities Act, as well as
Eomeon law theories of fraud and negligent
Eisrepresentation, Riuchi's duty te disclose arose
from his underteking to act as “escrow” in the

the stock.

 

   
 

This MER was denied on March 21, 2008.

 

+s scontinued)
duty as escrow; (3) Breach of uty as crafter of documents; and (4) Conspiracy
to commit fracd,

2
 

 

sry 15, 2005, the court entered an order
‘granting Fong's request for attorney fees in the anount of
$34,000. Presumptively, this order is sgainst Semin and
Myung.

fon August 12, 2005, the court entered a default
Judgment in favor of Fong and against CEI for the following
amounts:

 

$148,000.00 principal

59,200.00 interest {5-30-01 to ¢-1-05)
attorney fees

248, €40.00 subtotal

150,000.00 payment
5°96; 640-00 Judgment.

on October 4, 2005, Fong voluntarily dismissed all
claims ageinst Michael. Tamura, and Renato Batle. On Novenber
212008, "the court entered » Final Judgnent in favor of Fong
‘and against CET for $98, 640; in favor of Fong and against
David Jon Tamura end Anse Jo Tenure (correct legal none is
Ann Ju 8) in the smount of $112,000 plus pre~Judgnent
Interest of 108 from April 26, 2002 through October 7, 20037
in favor of Fong and sgeinet Semin and Myung in the amount
‘of 622,679; and in favor of Kivchi and againet Semin and
Myeng.

 

 

      

eno Op at 7-9 (alterations in original). The Ohs appealed.
2, ICA Decision

On appeal, the ICA issued a final judgnent affirming
the circuit court in all respects except with regard to the ohs’
claim that Fong committed fraud when she collected one month's
rent on the representation that it was a security deposit. With
regard to the two issues raised by the ohs to this court, the Ica
affirmed the grant of summary judgment on the Ohs’ claim under

MRS § 485-25" as well

 

the ohs’ claim that Kiuchi breached a

* HRS § 495-25, entitled “Fraudulent and other prohibited practices,”

provides in relevant party
(continued. .

a
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CIFIC REPORTER ***

duty of care that he owed to the Ohs as “escrow” for the stock
purchase transaction.'*

With respect to the HRS § 485-25 issue, the ICA
summarily concluded that § 485-25 does not apply “when a party
sells all, as opposed to only a portion of, the stock of a
corporation,” relying on State v. Hawaii Market Center, Inc., 52
Haw. 642, 485 P.2d 105 (1971). Memo Op at 11.

With respect to the claim that Kiuchi has a duty as an
escrow by “failing to inform [the Ohs] of the illegal cigarette
sales made by [Batle],” the ICA found no such duty. Instead, the

court cited the following statement from Delello v,'Home Escrow,

 

The general rule is that an escrow depository cccups
Lisueiary relationship with the parties to the escrow
agreencnt or instructions and must comply strictly with the
provisions of such agreement or instructions. See 30K,

 

E.5.8. Escrows § & (1965); Noocworth v. Recwood Empire
Saxings 4 Loan Ass'n, 22 Cel. hp. 34207, 99 Cal. Rptr. 373
(is11)? Union Title Cossany v, Burs, 102 Ariz. 421, 432 Pr2d
433 (1567).

"1 sscontinuea)
(a) It is unlawful for eny person, in connection with the offer,
le, oF purchase (whether in a transaction described in
or otherwise) of any security (whether or not of = clase
Section 485-4), in the State, di
(a), 30! exploy any device,
(2) To meke any untrue statement of @ material fact or omit to
state a saterial fact necessary in order to make the
Statenente made, in the light of the circumstances under
wien they are nede, not misleadingy
(3) To engage in any act, practice, or course of business which
‘or would operate as 8 fraud of deceit upon any

     

    

 

 

 

the Ica
acsinst Feng.

 

50 rejected the Ohs’ negligent misrepresentetion claim

“u
 

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4 Haw. App. 41, 47, 659 P.2d 759, 763 (1983). The ICA concluded

“that there is no evidence of an agreement or instructions

imposing on Kiuchi a duty to take the steps to protect [the Ohs)

that [the Ohs] contend was his duty to take.” Memo Op at 20.
11. STANDARD OF REVIEW

We review the circuit court’s grant or denial of summary
Jocgnent de novo, davall isicl community Pederai credit

we. Hekay 94 Hewat 213, 221, 11 F-38 1, 9 (2000)
The standard for granting # notion for summary judgnent ie
settle

 

(Slumnary Judgment Le appropriate if the pleadings,
Gepositicns, answers to interregstories, snd
Scniseions on file, together with the affidavits, if
any, show thet there ss no genuine issue as to any.
Baterial fact and thet the moving party is entitled to
Sudgnent ass matter of law. A fact is material if

 

   

proof of that fact wosld have the effect of
stablishing or refuting one of the essential eles
oe ‘action or cefense asserted by the

parti Gvidence most be viewed in the Light

 

Rost favorable to the nob
words, we must view allo

 

joving party.” In other
the evidence and the

 

    

Unterences drawn therefren in the light most favorable
to the party opporing the action.

Id, (citations and internal quetaticn marks omitted).
and count 5 98 Mawas's 233, 244-45, «7

Pisa 38, 35)

  

#0 (2002) teacond siteration in original) «

, 104 Hawai'i 468, 474, 92 P.3d
477, 483 (2004).

TIT, DISCUSSION
A. The Ohs’ HRS Chapter 485 Claim Against Fong

The Ohs contend that the ICA erred in applying the
standard from Heweii Market Center to conclude that the anti-

fraud provisions of Hewaii’s Uniform Securities Act, HRS § 485-

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25, do not apply when a party sells all, as opposed to only a
portion, of the stock of a corporation. Memo Op at 11. The ohs
make two arguments in support of this contention: (1) that the
ICA misinterpreted this court’s decision in Hawaii Market Center;
and (2) that the proper standard for what constitutes a
“security” should be supplied by Landreth Timber Co, v, Landreth,
471 U.S. 681 (1985), a United States Supreme Court case that
interpreted Section 10(b) of the Securities Exchange Act of 1934,
35 U.S.C, § 783 (b) (Supp. 2007), which has similar language to
the Hawai'i law.)

1. The statutory language

Analysis of whether HRS § 485-25 applies to this

transaction must begin with the statute itself, HRS § 485-25
makes it unlawful for any person to engage in various types of
fraudulent conduct or other prohibited practices “in connection
with the offer, sale, or purchase . . . of any security (whether
or not of @ class described in section 485-4), in the State,
Girectly or indirectly.” HRS § 485-25(a) (emphasis added) .
Among the provisions prohibiting certain conduct is Section 485-
25(a) (2), which makes it unlawful “(t]o make any untrue statement
of a material fact or omit to state a material fact necessary in

e State of Hewai'i Conissioner of Securities (the Commissioner)

filed an anicus curiae brief supporting the Ohe” position

   

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order to make the statements made, in the light of the

 

circumstances under which they are made, not misleading.

The chief dipute between the parties is whether this
section applies to the stock purchase transaction in this case;
ues, whether the transaction involved a “security.” “Security
is defined by HRS § 485-1(13), as follows:

“security” means any note, stock, treasury stock, bond,
debenture, evidence of indebtedness, certificate of interest
or participation in any profit-sharing agreenent,
Collatersletrust certificate, preorgenization certificate or
Stbseription, transferable share, investnent contract,
Soriable annuity contract, voting trust certificate,
certificate of deposit for a security, certificate of
interest in an oil, gas, or mining title or lease, option on
Conmodity futures contracts of, in general, any interest oF
[Seerument commonly know as a “eecority", or any,
Certificate of interest or participation in, tesporary or
interim certificate for, guarantee of, cr warrant or Fight
to subscribe to oF purchase, any of the foregoing.
NSecurity” does not include any insurance or endowment
policy of fixed snnoity contract.

 

 

 

 

HRS § 485-1(13) (1993) (emphases added)? The Ohs contend that
the security was “stock,” as denominated by the conveying

instrument.

 

tn addition, ERS chapter 485 indicates that its definitions are to
be construed literally. The definitions contained in HRS § 485-1 are prefaced
Wich the fellowing instruction: "when esed in this chapter the following
tems, ss y have the following meaning.” Cia.
Securities Exchange Act of 1934, 3a}, 15 U.S.C. Tela) (prefacing

inition of terme in Act with’ stetenent that “(a) . ... When used in this
chapter, unless the contest otherwise requires -- [enunerated terms wil be
Getines as folloKe)”) =

 

   

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- Hawaii Market Center: Does the risk capital approach
apply to all securities, or just “investment,
contracts"?

In its Memorandum Opinion, the ICA held that HRS § 485-

25 does not apply “when a party sells all, as opposed to only a

portion, of the stock of a corporation,” based on our decision in

Hawaii Market Center, which adopted the “economic reality”

approach to defining an investment contract. In reaching thi

 

conclusion, the ICA did not distinguish between “stock” and
“investment contracts” as different types of “securities” for
Purposes of HRS § 485-1(13) and applied Havaii Market Center
without further analysis.”

At issue in Hawaii Market Center was “whether the

*Founder-Menber Purchasing Contract Agr!

 

nts’ issued by Hawais
Market Center, Inc. . . . constitute[d] securities within the
meaning of . . . HRS § 481-1(12)." $2 Haw. at 643, 485 P.2¢ at
106. Although framed broadly in the first sentence of the
opinion, subsequent references make clear that the court's

analysis only concerned a subset of the “securities”

 

The ICA stated: “Based on the following Hawai'i precedent, the
anewer (to the Ohs question of whether HRS § 65°25 applies te the trencaction
et issue] is no." Meno Op at 11. This conclusion was followed by # lesgehy.
gutation from Hawaii Market Center, as well as a subsequent lengthy quctation
from Landreth, with regards to which the ICA opined: “Ine fact thet the
United States. Suprene Court sutsequently decided essentially the
opposite to the Hawai'i Suprene Court's decision does not authoriz
to contradict the Hawai'i Suprene Court's prececent.- Meno Cp at 13

 

    
 

    

 

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determination: whether the agreements at issue constituted

“investment contracts
‘Thus, after, setting out “the risk capital approach to
defining an investment contract,” id. at 648, 485 P.2d at 109
(emphasis added), this court concluded that the contracts in
question constituted such “investment contracts” within the
meaning of HRS $ 485-1(12). Under the risk capital approach
adopted by the court, an {nvestment contract is created whenever:

(2) An offeree furnishes initial value to an offeror, and

(2) a portion of thie initial value ie subjected to the
risks Of the enterprise, and

(3) the furnishing of the initial value i induced by the
offeror's promises or representations which give rise toa
Yessonable understanding that a valuable benefit of sone
ver and above the initial value, will accrue to the
‘ae a result of the operation of the enterprise, and

 

     

Sf the enterprise,

Id. at 649, 485 P.2d at 109 (emphasis added). In adopting this
test, the court rejected what it considered the overly-mechenical
approach to determining what constitutes an “investment contract”
enunciated by the United States Suprene Court in SEC v. WJ.
Howey Cou, 326 U.S. 293 (1946), which the court believed to be
based on a narrow concept of investor participation. The court

preferred the broader economic realities test because it

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(2) recognized the economic reality of a security," (2) was
considered broad enough to fulfill the remedial purposes of the
Securities Act,"* and (3) supplied “the necessary broad coverage
to protect the public from the novel as well as the conventional
forms of financing enterprises.” Hawaii Mkt, Ctr, 52 Haw. at
649, 485 P.24 at 109.

The Ohe argue that Hawaii Market Center should not
control this case, for two reasons. First, the Ohs contend that
the Hawaii Market Center test applies only to determine whether
an “investment contract" exists, not whether the instrument is a
“security.” the ohs argue that @ stock is by definition a
“security.” Secondly, the Ohs argue thet this court should apply
the reasoning set out by the United States Supreme Court in
Landreth, which analyzed whether a stock was a “security” within
the meaning of the Securities Exchange Act of 1934.

The United States Supreme Court's analysis in Landreth,

although not binding as to the interpretation of our state law,

M As the court stated, “The salient feature of securities sales is the
poblic solicitation of venture capital to be used in a Dasine
enterprise... This subjection of the investor's money to the risks of an
fenterprive over which he exercises no managerial control ie the basic economic
reality of 3 security trancsction.”” Hawaii Wkt. Ctr, 2 Haw. at 648, 485
Pizd at 109 (estations omitted)

 

 

B The court cited two such purposes: (2) te prevent fraud, and (2)
to protect the public egainst the imposition of unsubstantial schenes bY
Tegulating the transactions by which proncters go to the public for ritk
cepital.” ld.

 

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provides guidance on both arguments raised by the Ohs. In

Landreth, the Court was asked to consider whether the sale by a

 

father and his sons of all the common stock of a lumber business
they operated was the sale of a “security” within the meaning of
the federal securities laws. The Court held that when an
instrument is both labeled “stock” and “possesses ‘some of the
significant characteristics typically asseciated with’ stock
+++ ‘@ purchaser justifiably (may) assume that the federal
securities laws apply.'" Landreth, 471 U.S. at 686 (quoting
nited Hous. Found., Inc. v. Forman, 421 U.S. 837, 50-51
(1975))." Those characteristics are: “(i) the right to receive
dividends contingent upon an apportionment of profits: (41)
negotiability; (iii) the ability to be pledged or hypothecated;
(iv) the conferring of voting rights in proportion to the nunber
of shares owned: and (v) the capacity to appreciate in value.”
Id. (quoting Forman, 421 U.S. at 851). Under Landreth, the

“investment contract” analysis of Howey is only used, therefors

 

 

“ on the sane cay it decided Landreth, the United States Suprene Court
leo handed down Gould v. fustenacht, in which it restated Landreth’ s primary

 

holding in this manner?

here an instrunent bears the Label “stock and possesses a11 of the
Characteristics typically asecciated with stock, s court will not be
Eequired to look Beyond the character of the instrument to the economic
abstance of the transaction to deternine whether the stock is 2
security" within the meaning of the Acts

472. 9,8. 702, 704 (2985)

 

 

 

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for instruments unlike stock that do not bear these
characteristics. The Court therefore rejected the “sale of a
business” doctrine, followed by various courts prior to Landreth,
according to which the sale of a business via a stock transfer
was not covered by the federal securities laws.

The Court in Landreth discussed three reasons why an
econonic reality analysis need not apply to a sale of stock that
has the characteristics of stock. First, the Court distinguished
prior cases thet applied an economic reality test, stating that
those cases “involved unusual instruments not easily
characterized as ‘securities(,)'" such that an economic reality
epproach was appropriate to determine “that the instruments were
actually of a type that falls within the usual concept of a
security.” Id, at 690. Secondly, the Court noted that “the
Howey economic reality test was designed to determine whether a
Particular instrument is an ‘investment contract,’ not whether it
fits within any of the examples listed in the statutory
definition of ‘security.'” Id. at 691. Lastly, the Court
rejected the contention that the securities acts were “intended
to cover only ‘passive investors’ and not privately negotiated
transactions involving the tranefer of control to
ventrepreneurs,’" id, at 692, based on the purposes of the Act:

The 1936 Act contains several provisions specifically
governing tender offers, disclosure of transactions By

   

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corporate officers and principal atockholders, and the
Fecovery of short-swing profits gained by such persons.
Eliminating from the definition of “security” instruments
involved in transactions where control passed to the
Purchaser would contravene the purposes of these provisions.

  

Id. (citations omitted).

The logic of Landreth applies with equal force to
Interpretation of Hawai'i law in this case. As described in
Landreth, the instruments in Hawaii Market Center constituted

“unusual instrument(s] . . . not easily characterized as

 

curities,’” see Landreth, 421 U.S. at 690. Specifically, they
were “Founder-Menber Purchasing Contract Agreenents” issued by
Hawaii Market Center, under which individuals who purchased from
Hawaii Market Center certain goods (at highly-narked up prices)
gould become either founder-member distributors or founder-member
supervisors entitled to certain commissions and fees for their
activities in promotion of the company. Second, like the

Howey case, Hawaii Market Center (which discussed Howey in some
detail) involved the question of whether an instrument was an
“investment contract,” not the broader question of whether it fit
into any of the types of “securities” delineated in HRS § 485-
1(12). Specifically, the four-point risk-capital approach was
adopted by the court to determine whether “an investment contract,

is created,” 52 Haw. at 549, 485 P.2d at 103, not as a general
 

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rubric for determining whether a “security” exists.”
Furthermore, HRS chapter 485 provides for registration of certain
securities when offered for sale to menbers of the public, and
nothing indicates that the legislature intended to limit these
provisions to security transactions that do not pass control to
the purchaser. Therefore, Landreth supplies convincing reasoning
to hold that the Hawaii Market Center test should not apply to
every security described in chapter 485.

The majority of states with laws similar to Hawaii's
Uniform Securities Act (so-called “blue sky laws”) have also
followed the reasoning of Landreth to require that a stock

“characterization” test be applied to determine whether an

 

* this application of the risk-capital approach to investment
contracts has been maintained in subsequent cases of this courts “In
‘Tnivectra z, Ushiiina, this court stated:
Tn Hawaii Mic, Cor,, $2 Naw, €42, 405 P.24 105, this court articulated a
four-pronged test to determine when 2 schene oF trancaction involved
‘within the purview of the Uniform
Securities Act, KS ch. {05, helcing that, for purposes of the act, an
investment contract is created whenever.
112 Hawai'i 30, 98, 144 P.3d 1, 9 (2006) lempheats added). Throughout its
subsequent ansiysis, the court in Zrivectra discussed Hanaii Market Center as
a tet to determine whether an investment contract is formed, not a security
Sn general.” The “securities” at issue in Trivectra were contracte in which
Trivectra sold online “shopping malls" that allowed private individuele to
host a customized website containing links to brand name retailers, for which
menbers peid $79.00 for three months of service, and allowed then to make
hnoney through sales conmissions and recruitment of future purchasers of online
shopping mails. Jd, at 94, 14¢ Psd at 5. This court concluded that the
contracts were “investnent contracts” under the Hausl{ Market Center test,
thereby affirming the circuit court, which had affirmed the sane conclusion
arrived at by the Conmissicner of Securities of the State of Hewat
Department of Commerce and Consuner Affaire. Id. at 101, 144 Pe3d at 22
Therefore, Trivectia only spplied the Havaii Market Center test to determine
whether eh unusual type of contract constituted @ Tzecurity,” and did ner eal
with stock or the definition of “securities” in a nore general sense.

 

 

 

 

   

 

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instrument labeled stock is considered a ™:

N. Rapp, Blue Sky Redulation, § 2.02, at 2-18 to 2-19 (2006)

curity.” See Robert

(citing cases from Georgia, Kensas, New Hampshire, Michigan,
Alaska, North Dakota, Minnesota, and Washington); see, e.g,

‘chen v. Wi: 2, 423 S.B.2d 231, 233 (Ga.
1992) (“Landreth Timber provides appropriate guidance in
resolving issues of whether particular ‘stock’ is a security
under [the Georgia Securities Law]. In applying the Landreth
stock characterization test to. . . transaction(s] . . . we will
use a balancing test. The appropriate test to be employed is
whether the . . . stock bears such characteristics usually
associated with conmon stock that a purchaser justifiable may
assume that appropriate security laws apply.”). Nevertheless,
some courts have rejected the Landreth approach. See, e.g,
Anderson v. Heck, $54 So, 2d 695 (La. Ct. App. 1989) (declining
to follow what it termed “the literalist approach” taken by the
court in Landreth, and therefore finding that Louisiana Blue Sky
law did not apply to transaction in which 1008 of the stock of a

closely held corporation was sold to the purchaser, because the

 

purchaser had free access to and ample opportunity to examine the
financial records, assets, and other matters relating to the
business enterprise); Saunders, Lewis & Rav v. Evans, 512 N.E.2d

59 (111. App. Ct. 1987) (refusing to extend coverage of blue sky

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law rescission remedy to an individual who, simultaneously with
Purchasing what was undeniably corporate stock, was elected to
the corporation's board of directors and made an officer).

Against this majority of opinion, Fong argues that
economic conditions in Hawai'i and the long-reign of the Hawaii.
Market Center approach counsel against adoption of the Landreth
approach to “stock” under our law. Instead, Fong maintains that
an economic reality test should govern business sales in Hawai'i,
because although many transactions take the form of a stock
transfer, they are often arms-length transactions among small
businesses owners for which common law remedies are adequate to
Protect against fraud. Fong also suggests that adoption of a
Landreth test would unsettle expectations and lead to an
explosion of litigation by small business purchasers disappointed
by businesses failure.

in its

 

‘The Commissioner, on the other hand, argu
amicus brief that applying a test based on managerial control to

stock tran:

 

tions would produce uncertainty for investors and
lead to Litigation over whether @ given stock transaction
actually conveyed managerial control to a shareholder. The same
concern was expressed by the United States Supreme Court in
andreth. See Landreth, 471 U.S. at 696 (“[I]£ applied to this

case, the sale of business doctrine would also have to be applied

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to cases in which less then 1008 of a conpeny's stock was sold.
This inevitably would lead to difficult questions of
Line-drawing. The Acts’ coverage would in every case depend not
only on the percentage of stock transferred, but also on such
factors as the nunber of purchasers and what provisions for
voting and veto rights were agreed upon by the parties. -
[Cloverage by the Acts would in most cases be unknown and
unknowable to the parties at the tine the stock was sold. These
uncertainties attending the applicability of the Acts would
hardly be in the best interests of either party to a
transaction.”).

It is noteworthy that no decision of this court has
applied the Hawaii Market Center test to bona fide stock
transactions." Although many business sales take the form of
stock sales, it Ss not incongruous, as Fong suggests, to apply
HRS chapter 485 to such transactions when consummated through

stock purchases as opposed to asset sales. The purchase of

 

the United States OLetrict Court for the District of Hawai'i, in a
pre-Landreth decision interpreting Hawai'i law, applied the Hawaii Marker
Eggcer cest to the transfer of sheres nade in connection with = corporate

Feorganization.  fiawai's Comp, v, Crossley nce Hawal's Corot, 567 F. Supp.
603 {D. Haw. 1983). It should be notea that the court in Hewat Corp, also

 

found the transfer of shares in thet case not to qualify as a “security” under
the federal securities laws, besed cn the United States Supreme Court decision
in Forman. Ae later expleined by the court in Lancreth, the relevant question
onder Forman is not simply whether an inetrunent ie Llebeled “stock,” but also
Whether the inetrunent conteine characteristics typically associated with
[Stock so as to gain protection under the securities laws. See intra Section
III.A.3. “We ere not bound By Havaii Core., and do not find it persvasive in
Light ‘of eubsequent decisions of the United States Supreme Court.

 

 

 

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securities entails greater risk than asset purchases, because the
purchaser assunes all debts and liabilities of the company in
addition to its physical inventory. It is the purpose of the
Uniform Securities Act to protect against fraud in such a
transaction, so long as it involves a “security.

Therefore, based on (1) the Landreth case and the many

 

state courts who have adopted its interpretation with respect to
their state securities laws, (2) the inclusion of “stock” within
the definition of “security” in HRS § 485-1 and the intent of the
legislature that definitional terms hew to the text of Hawaii's
Security Act, see supra note 12, and (3) the remedial purposes of
Hawaii's Uniform Securities Act, ses Hawaii Mkt. Ctr., 52 Haw. at
648, 485 P.2d at 109 (discussing the “remedial purposes of the
Securities Act;” noted supra at note 18), there are convincing
Feasons to apply the Landreth test to determine whether an
instrument labeled stock is a security under Hawas's law.
Accordingly, the ICA erred in applying the Heuaié Market Center

not intended.

 

test to a type of instrument for which it w

 

4 It should be noted that neither the ICA nor the circuit court made
any rulings relevant te whether HRS § 425-25 would have been violated if the
Anstronent in question was determined to be a security

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Did the instrument in this case have the traditional
characteristics of stock such that it qualifi a
“security” under ERS § 425-1(12)?

 

 

 

As the above analysis makes clear, whether the anti-
fraud provisions of HRS chapter 485 apply to the stock purchase
in this case depends on whether it had the traditional
characteristics of stock. See Landreth, 471 U.S. at 686 ("(i)
the right to receive dividends contingent upen an apportionment
of profits: (41) negotiability; (111) the ability to be pledged
or hypothecated; (iv) the conferring of voting rights in
proportion to the number of shares owned; and (v) the capacity to
appreciate in value.” (Quoting Forman, 421 U.S. at 852.)).

Furthermore, an ingtrument may qualify as “stock” under the

Landreth test even if the corporation is a close corporation,
see, €.a., Sulkow v. Crosstown Appare]l Inc., 807 F.2d 33, 37 (24

Cir. 1986) (“The fact that Crosstown was a close corporation,
with the Shareholders’ Agreement envisioning some limitations on
the stock's negotiability and pledgeability, is insufficient to
negate the character of the stock as a security. Limitations on
the transfer of stock in close corporations are common, but
neither the snall size of the corporation nor the restrictions on
transferability remove such @ corporation's stock from the reach
of Rule 10b-5."), or if the buyer purchases 1008 of the common
stock of the corporation and intends to manage the business. See

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Golden v. Garafalo, 678 F.2d 1139, 1146 (2d Cir. 1982) (*So far

as the anti-fraud policies of the Acts are concerned, the
possibilities of fraud and the ability to protect oneself through
contract are the same as to a ‘passive’ investor buying 308 of a
corporation's shares from a sole shareholder or an ‘active’
purchaser taking 100% and expecting to manage it directly... .
In truth, purchasers of a business rightly regard themselves as
investors as well as managers. Transfers of corporate control
frequently are motivated by a hope for capital gains resulting
from improved management, and it is altogether artificial to
classify such transactions as exclusively conmercial.”) .

Fong's motion for summary judgment sought dismissal of
the HRS chapter 485 claim on the grounds that the stock purchase
agreement was not @ “security” under the Hawaii Market Center
test for investment contracts. The circuit court granted this
motion without explaining its basis and the ICA affirmed on the
grounds that the Hawaii Market Center test controls.

Because this basis is incorrect, and Fong has not
demonstrated that the stock purchasing agreement does not have
the characteristics of stock explicated in Forman and Landreth,
there remain genuine issues of material fact regarding whether
the instrument qualifies es stock. Fong’s motion for summary

judgment did not allege that the instrunent lacks the

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characteristics of stock, nor has Fong shown an absence of any
genuine issue as to the material facts regarding this
characterization.”

Therefore, Fong has not met her burden on summary
judgment to show the absence of any genuine issue as to all
material facts regarding whether the transaction at issue
involved the sale of security. Accordingly, the ICA erred by
affirming the circuit court's judgment granting summary judgment
‘to Fong on the Ohs’ HRS chapter 485 claim.

B. ‘ons? Kivet

The ICA affirmed the circuit court's grant of summary
judgement in favor of Kiuchi on the basis that an escrow agent’s
duty of disclosure is limited to agreements or instructions
imposing such a duty, and there is no evidence of any such
agreement or instructions in this case. We agree that Kiuchi did
not owe @ duty of disclosure to the Ohs under the facts of this

case. See supra Sections I.A.3 and I.B.2. However, we caution

 

In Fong's answering brief subaitted to the ICk, Fong presents a
brief argurent that responds to the Ohs’ contention thet the instrument
Guelifies as 8 security because it 1s stock. Quoting Forman, Fong states that
Ske Ouner-cperators, the One cbviously were not expecting “divicends."” See
Forman, 421 0.8. et 651. (describing ost common feature of stock”

pen Spportionnent of profite,’™
359 (1967)).. However, the
Goestion is not one of expectation, but of what rights are associated with the
Fistronent labeled “stock.” Regardless, however, this argusent ~~ raised for
the first time on sppecl -- does not extinguish ol] gencine issues about
Whether the dnetrunent in this case qualifies as “stock.”

 

 

 

    

   

 

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attorneys about the potential for conflicts of interest in
situations such as this where an attorney for one party also
purports to act “as escrow” for the transaction between the
attorney's client and another party. See Hawai'i Rules of
Professional Responsibility Rule 1.7(b).
Iv. conewstoN

Therefore, the November 16, 2006 judgment of the ICA is
vacated in part and the case is renanded to the circuit court for
further proceedings in light of this opinion. In all other
respects, the ICA’s judgnent is affirmed.

‘Thomas T. Watts
(of Kemper & Watts)

for petitioners/defendants/
counterclaimants/cross-

claimants/third-party
plaintiffs-appellants HeLa ar
Semin Oh and Myung Hui Oh

David J, Gierlach iB a
for respondent/plaintiff/ ® ree

counterclaim defendant

appellee Connie ¥. Fong aooeeey

Keith K. Hiraoka (of Rosca,
Loule @ wlraoka) for respendent/ Yume. Aap he
third-party defendant-appellee

Reith #. klochi

on the brief:
Patricia J. Moy
for amicus curiae State of

Hawai'i Commissioner of
Securities

32