Free Memorandum in Opposition to Motion - District Court of Connecticut - Connecticut

Case 3:03-cv-00644-CFD

Document 224-2

Filed 11/20/2006

Page 1 of 56

UNITED STATES DISTRICT COURT DISTRICT OF CONNECTICUT

____________________________________________ BRUCE CHARLES RYAN, RUSSELL ) WILLIAM NEWTON, ROBERT FTIZPATRICK, ) and MERIT CAPITAL ASSOCIATES, INC., ) Plaintiffs, ) ) v. ) ) NATIONAL UNION FIRE INSURANCE ) COMPANY OF PITTSBURGH, PA., and ) AIG TECHNICAL SERVICES, INC., ) Defendants. ) ____________________________________________) DAVID W. GWYNN, and RAQUEL GWYNN ) ) Plaintiffs, ) v. ) ) NATIONAL UNION FIRE INSURANCE ) COMPANY OF PITTSBURGH, PA., and ) AIG TECHNICAL SERVICES, INC., ) Defendants. )

CIVIL ACTION NO. 3:03CV00644(CFD)

CIVIL ACTION NO. 3:03CV01154(CFD)

November 20, 2006

THE RYAN PLAINTIFFS' LOCAL RULE 56(A) 2 STATEMENT Pursuant to Fed. R. Civ. P. 56 and Local Rule 56, plaintiffs, Bruce Charles Ryan, Russell William Newton, Robert Fitzpatrick and Merit Capital Associates Inc. (hereinafter collectively referred to as the "Ryan Plaintiffs") hereby submit this Local Rule 56(a) 2 Statement in opposition to the Motion for Summary Judgment filed by defendants National Union Fire Insurance Company of Pittsburgh, PA's ("NU") and AIG Technical Services, Inc.'s ("AIGTS") (hereinafter NU and AIGTS will be collectively referred to as "Defendants" or "AIG"). A. Response to AIG's Statement of Undisputed Material Facts:

Case 3:03-cv-00644-CFD

Document 224-2

Filed 11/20/2006

Page 2 of 56

The Ryan Plaintiffs pursuant to local rule 56 hereby provide their responses to the Local Rule 56(A)(1) Statement Of Undisputed Material Facts Submitted By Defendants National Union Fire Insurance Company Of Pittsburgh, Pa. And AIG Technical Services, Inc. In Support Of Their Motion For Summary Judgment (hereinafter "Defendants Statement"), as follows:

1.

AIG issued to Merit a Securities Broker/Dealer's Professional Liability Insurance

Policy numbered 473-36-20, with original effective dates of August 23, 2000 to August 23, 2001 ("Policy"). The Ryan Plaintiffs' Amended Complaint ("Ryan Complaint") at ¶ 15; the Gwynn Plaintiffs' Second Amended Complaint ("Gwynn Complaint") at ¶ 12. A true and correct copy of the Policy is hereto attached as EXHIBIT A. A true and correct copy of the Ryan Complaint is hereto attached as EXHIBIT B. A true and correct copy of the Gwynn Complaint is hereto attached as EXHIBIT C. RESPONSE: ADMITTED 2. Pursuant to Endorsement #5 of the Policy, the effective ending date of the

Policy's coverage was changed from August 23, 2001 to September 23, 2001, thereby making the Policy effective from August 23, 2000 to September 23, 2001. EXHIBIT A, Policy at ENDORSEMENT #5. RESPONSE: ADMITTED 3. At all times relevant hereto, Merit was a securities broker/dealer corporation

organized under Connecticut law with its principal place of business in Westport, Connecticut. EXHIBIT B, Ryan Complaint at ¶¶ 4,9; EXHIBIT C, Gwynn Complaint at ¶¶ 8-9. RESPONSE: ADMITTED

2

Case 3:03-cv-00644-CFD

Document 224-2

Filed 11/20/2006

Page 3 of 56

4.

At all times relevant hereto, Ryan was the President of Merit, and one of Merit's

two shareholders. EXHIBIT B, Ryan Complaint at ¶ 10; EXHIBIT C, Gwynn Complaint at ¶ 17. RESPONSE: ADMITTED 5. At all times relevant hereto, Newton was the Chairman and Chief Financial

Officer of Merit, and Merit's other shareholder. EXHIBIT B, Ryan Complaint at ¶ 11; EXHIBIT C, Gwynn Complaint at ¶ 17. RESPONSE: ADMITTED 6. At all times relevant hereto, Fitzpatrick was Merit's Compliance Officer and

General Counsel. EXHIBIT B, Ryan Complaint at ¶ 12; EXHIBIT C, Gwynn Complaint at ¶ 17. RESPONSE: ADMITTED 7. At all times relevant hereto, Gwynn functioned as Merit's Registered

Representative. EXHIBIT B, Ryan Complaint at ¶ 13; EXHIBIT C, Gwynn Complaint at ¶ 10. RESPONSE: DENIED. Although the Ryan Plaintiffs admit Gwynn was a registered representative of Merit, in many of the alleged dealings between Gwynn and Sowell Gwynn was not functioning as a registered representative of Merit. 8. Under the Policy, Merit was insured as the "Broker/Dealer." EXHIBIT B, Ryan

Complaint at ¶ 16; EXHIBIT C, Gwynn Complaint at ¶ 13. RESPONSE: ADMITTED 9. The Policy insured Ryan, Newton, Fitzpatrick, and Gwynn, in their individual

capacities as directors, officers, employees, and/or Registered Representatives of Merit. EXHIBIT B, Ryan Complaint at ¶ 16; EXHIBIT C, Gwynn Complaint at ¶ 13.

3

Case 3:03-cv-00644-CFD

Document 224-2

Filed 11/20/2006

Page 4 of 56

RESPONSE: ADMITTED 10. The Policy states in part the following: DECLARATIONS ITEM 1. BROKER/DEALER: MERIT CAPITAL ASSOCIATES, INC. * ITEM 2. * *

POLICY PERIOD: From: August 23, 2000 To: August 23, 2001 * * *

ITEM 6.

RETROACTIVE DATE: August 23, 1999

EXHIBIT A, Policy at DECLARATIONS, p.1. RESPONSE: ADMITTED except to the extent endorsement 5 extended the Policy period. 11. The Policy states in part the following: 1. INSURING AGREEMENTS A. BROKER/DEALER PROFESSIONAL LIABILITY INSURANCE (INCLUDING FAILURE TO SUPERVISE) This policy shall pay on behalf of the Broker/Dealer Loss arising from a Claim . . . for any actual or alleged Wrongful Act committed by the Broker/Dealer: 1. in the rendering or failure to render Professional Services by the Broker/Dealer; or in Failing to Supervise a Registered Representative in the rendering or failure to render Professional Services by such Registered Representative on the behalf of the Broker/Dealer; or in Failing to Supervise a Registered Representative in connection with an activity of the Registered

2.

3.

4

Case 3:03-cv-00644-CFD

Document 224-2

Filed 11/20/2006

Page 5 of 56

Representative OTHER THAN the rendering or failure to render Professional Services by such Registered Representative on the behalf of the Broker/Dealer. B. REGISTERED REPRESENTATIVE PROFESSIONAL LIABILITY INSURANCE This policy shall pay on behalf of a Registered Representative Loss arising from a Claim . . . for any actual or alleged Wrongful Act committed by the Registered Representative in the rendering or failure to render Professional Services on the behalf of the Broker/Dealer. C. DEFENSE, INVESTIGATION AND SETTLEMENT (INCLUDED IN THE LIMITS OF LIABILITY) 1. Defense The Insurer shall have the right and duty to defend, subject to and as part of the Limits of Liability, any Claim made against an Insured during the Policy Period or Discovery Period (if applicable) . . . EXHIBIT A, Policy at SECURITIES BROKER/DEALERS PROFESSIONAL LIABILITY POLICY, p. 1. RESPONSE: ADMITTED 12. The Policy states in part the following: 2. DEFINITIONS (a) "Approved Activity" means a service or activity performed by the Registered Representative on behalf of the Broker/Dealer which: (1) has been approved by the Broker/Dealer to be performed by the Registered Representative, and is in connection with the purchase or sale of a specific security, annuity or insurance product which has been approved by the Broker/Dealer to be transacted through the Registered Representative, and for which

(2)

5

Case 3:03-cv-00644-CFD

Document 224-2

Filed 11/20/2006

Page 6 of 56

(3)

the Registered Representative has obtained all licenses required by the Broker/Dealer or applicable law or regulation.

(b)

"Broker/Dealer" means the Broker/Dealer designated in Item 1 of the Declarations and any Subsidiary thereof. "Claim" means the following brought by an Insured's customer or client in such capacity: (1) (2) a written demand for monetary relief; or a civil or arbitration proceeding for monetary or non-monetary relief which is commenced by: (i) service of a complaint or similar pleading; or receipt or filing of an arbitration demand or statement of claim. * * *

(c)

(ii)

(g)

"Interrelated Wrongful Act(s)" means Wrongful Acts which are the same, related or continuous, or Wrongful Acts which arise from the same, related or common nexus of facts regardless of whether such Claims involved the same or different claimants, Insureds or legal causes of action. . . . * * *

(i)

"Loss" means damages, judgments, settlements and Defense Costs . . . Loss arising from Claim(s) alleging the same Wrongful Act or Interrelated Wrongful Acts shall be deemed a single Loss under this Policy. . . . * * *

(k)

"Professional Services" means the following services if rendered in connection with an Approved Activity for or on

6

Case 3:03-cv-00644-CFD

Document 224-2

Filed 11/20/2006

Page 7 of 56

the behalf of a customer or client of the Broker/Dealer pursuant to a written agreement between the Broker/Dealer and the customer or client: . . . (l) "Registered Representative" means an individual who is registered with the National Association of Securities Dealers, Inc., including a registered principal, and who for compensation engages in the business of rendering Professional Services on behalf of the Broker/Dealer. * (n) * *

"Wrongful Act" means any act, error or omission by the Broker/Dealer, or by any director, officer, partner or employee thereof, or by any Registered Representative, in their respective capacities as such.

EXHIBIT A, Policy at SECURITIES BROKER/DEALERS PROFESSIONAL LIABILITY POLICY, pp. 2-6. RESPONSE: ADMITTED 13. The Policy states in part the following: 4. EXCLUSIONS The insurer shall not be liable for Loss in connection with any Claim made against an Insured: a) arising out of, based upon or attributable to the gaining in fact any profit or advantage to which the Insured was not legally entitled, including but not limited to any actual or alleged commingling of funds or accounts; arising out of, based upon or attributable to the committing in fact of: any criminal or deliberately fraudulent act, or any willful violation of any law of the United States or Canada, or any state, territory, county, political division or municipality thereof, or any rules or regulations promulgated thereunder; * * *

b)

7

Case 3:03-cv-00644-CFD

Document 224-2

Filed 11/20/2006

Page 8 of 56

e)

alleging, arising out of, based upon or attributable to any Wrongful Act occurring prior to the inception date of the first Securities Broker/Dealer's Errors and Omissions policy or Securities Brokers Professional Liability Insurance policy issued to the Broker/Dealer designated in Item 1 of the Declarations by the Insurer and continuously renewed and maintained in effect thereafter to the inception date of this policy, if on or before such date any Insured knew or could have reasonably foreseen that such Wrongful Act could lead to a Claim, or alleging, arising out of, based upon or attributable to any subsequent Interrelated Wrongful Act. alleging, arising out of, based upon or attributable to any Wrongful Act occurring prior to the Retroactive Date stated in Item 6 of the Declarations or arising out of any subsequent interrelated Wrongful Act; * * *

f)

r)

with respect to coverage provided under Coverage B only, alleging, arising out of, based upon or attributable to any activity of, or service provided by, the Registered Representative other than a covered Professional Service, including but not limited to "selling away"; alleging, arising out of, based upon or attributable to an Insured exercising discretionary authority or control with regard to management or disposition of assets; however, this exclusion shall not apply to any Insured's purchase or sale of no-loan investment company or variable annuities in which there is no initial or contingent sales charge or commission; alleging, arising out of, based upon or attributable to, or in any way involving, directly or indirectly, the formation, operation, administration or management by an Insured, in part or in whole, of any entity other than the Broker/Dealer including but not limited to limited or general partnerships, including but not limited to Claims arising out [of] an Insured acting as a general partner of any limited partnership and/or managing general partner of any general partnership . . . .

s)

t)

8

Case 3:03-cv-00644-CFD

Document 224-2

Filed 11/20/2006

Page 9 of 56

EXHIBIT A, Policy at SECURITIES BROKER/DEALERS PROFESSIONAL LIABILITY POLICY, pp. 6-9. RESPONSE: ADMITTED 14. On or about September 4, 2001, Michael A. Sowell ("Sowell") filed a Statement

of Claim before the National Association of Securities Dealers, Inc. ("NASD") against Merit, Ryan, Newton, Fitzpatrick, and Gwynn, as well as against Gwynn Financial Services, Inc. ("GFS"), an entity controlled by Gwynn, and the wives of Ryan, Newton, Fitzpatrick, and Gwynn. EXHIBIT B, Ryan Complaint at ¶ 29; EXHIBIT C, Gwynn Complaint at ¶ 25. A true and correct copy of the Statement of Claim is hereto attached as EXHIBIT D. RESPONSE: ADMITTED 15. On or about May 1, 2002, Sowell filed an Amended Statement of Claim before

the NASD naming Source Capital Group, Inc. ("Source") as an additional respondent. EXHIBIT B, Ryan Complaint at ¶ 47; EXHIBIT C, Gwynn Complaint at ¶ 42. A true and correct copy of the Amended Statement of Claim is hereto attached as EXHIBIT E. RESPONSE: ADMITTED, but the Ryan Plaintiffs deny that Source was properly joined in the NASD proceeding commenced by Sowell. 16. The wives of Ryan, Newton, Fitzpatrick, and Gwynn were named in the

Statement of Claim and Amended Statement of Claim (collectively, "Statements of Claim") because Arizona, where the Statements of Claim were filed, is a community property state. EXHIBIT D at ¶ 10; EXHIBIT E at ¶ 11. RESPONSE: ADMITTED

9

Case 3:03-cv-00644-CFD

Document 224-2

Filed 11/20/2006

Page 10 of 56

17.

In his Statements of Claim, Sowell alleged that in late 1997, he inherited assets of

his deceased mother, which he initially believed were worth a total of approximately $380,000. EXHIBIT D, Statement of Claim at ¶ 17; EXHIBIT E, Amended Statement of Claim at ¶ 18. RESPONSE: ADMITTED 18. Sowell alleged that because he did not know how to manage his inherited funds,

he sought financial planning assistance from Gwynn. EXHIBIT D, Statement of Claim at ¶ 18; EXHIBIT E, Amended Statement of Claim at ¶ 19. RESPONSE: ADMITTED 19. Sowell alleged that Gwynn offered to prepare a retirement plan for Sowell and his

wife, and to manage Sowell's financial portfolio. EXHIBIT D, Statement of Claim at ¶ 19; EXHIBIT E, Amended Statement of Claim at ¶20. RESPONSE: ADMITTED 20. Sowell alleged that in early February 1998, Gwynn met with Sowell and his wife

to gather information for the retirement plan. EXHIBIT D, Statement of Claim at ¶ 19; EXHIBIT E, Amended Statement of Claim at ¶20. RESPONSE: ADMITTED 21. Sowell alleged that Gwynn prepared a retirement plan for Sowell and his wife,

dated February 20, 1998, listing primary assets valued at $382,000 and a residence worth $130,000. EXHIBIT D, Statement of Claim at ¶ 21; EXHIBIT E, Amended Statement of Claim at ¶ 22. RESPONSE: ADMITTED

10

Case 3:03-cv-00644-CFD

Document 224-2

Filed 11/20/2006

Page 11 of 56

22.

Sowell alleged that the retirement plan prepared for the Sowells by Gwynn

emphasized the Sowells' need for an "efficient, diversified portfolio," and stated that the Sowells needed to "actively rebalance [their] investments throughout the planning horizon." EXHIBIT D, Statement of Claim at ¶ 22; EXHIBIT E, Amended Statement of Claim at ¶ 23. RESPONSE: ADMITTED 23. Sowell alleged that in addition to his inherited funds, Sowell's mother also left

behind several stock certificates ("Stock Certificates") in her desk that had never been deposited with a brokerage firm. EXHIBIT D, Statement of Claim at ¶ 18; EXHIBIT E, Amended Statement of Claim at ¶ 19. RESPONSE: ADMITTED 24. Sowell alleged that in April 1998, Sowell gave the Stock Certificates to Gwynn.

EXHIBIT D, Statement of Claim at ¶ 24; EXHIBIT E, Amended Statement of Claim at ¶ 25. RESPONSE: ADMITTED 25. Sowell alleged that at the time that he gave the Stock Certificates to Gwynn,

Sowell was unaware of their true value, which was in excess of $1 million. EXHIBIT D, Statement of Claim at ¶ 24; EXHIBIT E, Amended Statement of Claim at ¶ 25. RESPONSE: ADMITTED 26. Sowell alleged that Gwynn never revised the Sowells' retirement plan to reflect

the $1 million worth of Stock Certificates. EXHIBIT D, Statement of Claim at ¶ 25; EXHIBIT E, Amended Statement of Claim at ¶ 26. RESPONSE: ADMITTED

11

Case 3:03-cv-00644-CFD

Document 224-2

Filed 11/20/2006

Page 12 of 56

27.

Sowell alleged that on May 1, 1998, Gwynn deposited Sowell's Stock Certificates

as the initial deposit in Sowell's Merit Account No. LFW-00053-A5 ("Merit Account"). EXHIBIT D, Statement of Claim at ¶¶ 23-24; EXHIBIT E, Amended Statement of Claim at ¶¶ 24-25. RESPONSE: ADMITTED 28. According to Sowell's Statements of Claim:

When Mr. Sowell opened his account, he signed a power of attorney giving Respondents [including Gwynn] discretionary control of the account. Mr. Gwynn told Mr. Sowell to sign the power of attorney so that Mr. Gwynn could make quick decisions and manage the account without having to bother Mr. Sowell. As it turned out, Mr. Gwynn did not consult with Mr. Sowell before making trading decisions. EXHIBIT D, Statement of Claim at ¶ 26; EXHIBIT E, Amended Statement of Claim at ¶27. RESPONSE: ADMITTED 29. According to Sowell's Statements of Claim:

Mr. Gwynn ignored his statements in the retirement plan regarding the need to create an "efficient, diversified portfolio" for Mr. Sowell and treated his discretionary power over the account as a license to churn. Mr. Sowell's account was traded in a helter-skelter fashion, which was characterized by excessive, inand-out trading in technology stocks. Mr. Gwynn also traded extensively on margin in Mr. Sowell's account. A review of Mr. Sowell's account statements reveals that Respondents utilized no meaningful investment strategy or plan. EXHIBIT D, Statement of Claim at ¶ 27; EXHIBIT E, Amended Statement of Claim at ¶28. RESPONSE: ADMITTED 30. Sowell's Statements of Claim state that "Mr. Sowell's account was a discretionary account and was unquestionably controlled by Mr. Gwynn." EXHIBIT D, Statement of Claim at ¶ 87; EXHIBIT E, Amended Statement of Claim at ¶105. RESPONSE: ADMITTED

12

Case 3:03-cv-00644-CFD

Document 224-2

Filed 11/20/2006

Page 13 of 56

31.

Sowell alleged that at Gwynn's request, Sowell made certain loans ("Charter

School Investments") to Novation Financial Corporation ("Novation"). EXHIBIT D, Statement of Claim at ¶¶ 31-64; EXHIBIT E, Amended Statement of Claim at ¶¶ 32-65. RESPONSE: ADMITTED 32. Sowell alleged that Novation was a predecessor to Charter Financial Network,

Inc. ("Charter"), now known as Charter 3, Inc. ("C3"). EXHIBIT D, Statement of Claim at ¶ 42; EXHIBIT E, Amended Statement of Claim at ¶ 43. RESPONSE: ADMITTED 33. Sowell alleged that Gwynn was, at all times relevant, a controlling shareholder,

officer, and director of Novation, Charter, and C3. EXHIBIT D, Statement of Claim at ¶¶ 34, 45, 56; EXHIBIT E, Amended Statement of Claim at ¶¶ 35, 46, 57. RESPONSE: ADMITTED 34. Sowell alleged, under "Count One (Violation of A.R.S. § 44-1841) (The Charter

School Investments)," that "[f]rom May 1998 through December 2000, Respondents [including each of the Plaintiffs] made, participated in or induced the unlawful sale of securities [i.e. the Charter School Investments] to Mr. Sowell." EXHIBIT D, Statement of Claim at ¶ 70; EXHIBIT E, Amended Statement of Claim at ¶ 88. RESPONSE: ADMITTED 35. Sowell alleged that "[o]n or about May 19, 1998, July 1, 1998, November 11,

1999, April 25, 2000, and July 21, 2000 Respondent Gwynn . . . issued Promissory Notes to Mr. Sowell." EXHIBIT D, Statement of Claim at ¶ 159; EXHIBIT E, Amended Statement of Claim at ¶ 177.

13

Case 3:03-cv-00644-CFD

Document 224-2

Filed 11/20/2006

Page 14 of 56

RESPONSE: ADMITTED 36. Sowell alleged that Gwynn had assured him that the Charter School Investments

were protected by the Promissory Notes. EXHIBIT D, Statement of Claim at ¶¶ 36, 40, 47, 4950, 52, 58; EXHIBIT E, Amended Statement of Claim at ¶¶ 37, 41, 48, 50-51, 53, 59. RESPONSE: ADMITTED 37. Sowell alleged that he never received any money or stock in satisfaction of the

Promissory Notes. EXHIBIT D, Statement of Claim at ¶¶ 41, 54, 63; EXHIBIT E, Amended Statement of Claim at ¶¶ 42, 55, 64. RESPONSE: ADMITTED 38. Sowell alleged that as the result of the Plaintiffs' wrongful acts, Sowell's

inheritance of over $1.4 million "disappeared." EXHIBIT D, Statement of Claim at ¶ 14; EXHIBIT E, Amended Statement of Claim at ¶15. RESPONSE: ADMITTED 39. Sowell alleged that the Ryan Plaintiffs were liable for Gwynn's wrongful acts

under theories of respondeat superior, failure to supervise, and as "control persons" of Gwynn, its Registered Representative. EXHIBIT D, Statement of Claim at ¶¶ 71-72, 82-83, 92, 97, 107, 116-120, 124, 132, 140, 147; EXHIBIT E, Amended Statement of Claim at ¶¶ 89-90, 101, 110, 115, 125, 134-138, 142, 150, 158, 165. RESPONSE: ADMITTED 40. On October 15, 2001, Conlin sent a letter to Ryan. A true and correct copy of the

October 15, 2001 letter is hereto attached as EXHIBIT F. RESPONSE: ADMITTED

14

Case 3:03-cv-00644-CFD

Document 224-2

Filed 11/20/2006

Page 15 of 56

41.

Conlin's October 15, 2001 letter acknowledged AIG's receipt of Sowell's

Statement of Claim and advised that AIG had assigned separate law firms to represent Merit and Gwynn. EXHIBIT F, October 15, 2001 Letter, pp. 1-3. RESPONSE: ADMITTED 42. Conlin's October 15, 2001 Letter indicated that several of the Policy's exclusions,

including (a), (b), (f), (r), and (s), could potentially exclude coverage. EXHIBIT F, October 15, 2001 Letter, pp. 3-7. RESPONSE: ADMITTED 43. Conlin's October 15, 2001 letter stated:

This letter is not to be construed as a waiver of any policy provision. [AIG] reserves all rights and defenses under the Policy, and at law, as to allegations which are not covered under the terms of the Policy. This includes the right to amend the foregoing Reservation of Rights in accordance with the policy provisions at any time. EXHIBIT F, October 15, 2001 Letter, p. 7. RESPONSE: ADMITTED 44. On January 24, 2002, Conlin sent a letter to Gwynn. A true and correct copy of

Conlin's January 24, 2002 letter to Gwynn is hereto attached as EXHIBIT G. RESPONSE: ADMITTED 45. Conlin's January 24, 2002 letter to Gwynn advised Gwynn that exclusion (s) of

the Policy precluded coverage for Sowell's Claims, and reiterated that AIG did not waive any policy provisions but reserved all rights and defenses in the event that it reevaluated the claim. EXHIBIT G, January 24, 2002 Letter to Gwynn, p. 1.

15

Case 3:03-cv-00644-CFD

Document 224-2

Filed 11/20/2006

Page 16 of 56

RESPONSE: ADMITTED except that the Ryan Plaintiffs deny that AIG had previously notified Gwynn of any reservation of rights on its duty to defend. 46. Conlin's January 24, 2002 letter to Gwynn stated:

During our investigation of this matter we uncovered the fact that Mr. Sowell signed a power of attorney dated March 7, 1998 giving [Gwynn] the "power to give an[d] place any and all orders." Accordingly, pursuant to exclusion (s) under your policy, coverage is not available for you in this matter. Consequently, and as I advised Mr. Thomason, AIG would neither be indemnifying you nor paying for any defense costs incurred after January 12, 2002. . . . If you have any information which would cause us to reevaluate this matter, please forward it to my attention as soon as possible and we will gladly review same. This letter is not to be construed as a waiver of any policy provisions. In the event facts and/or issues are brought to our attention which result in a reevaluation of this matter, [AIG] reserves all rights and defenses under the policy and at law as to allegations which are not covered under the terms of this policy and/or may be excluded from coverage under the terms of the policy. . . . EXHIBIT G, January 24, 2002 Letter to Gwynn, p. 1. RESPONSE: ADMITTED 47. On January 24, 2002, Conlin sent a letter to Ryan. A true and correct copy of the

January 24, 2002 Letter to Ryan is hereto attached as EXHIBIT H. RESPONSE: ADMITTED 48. Conlin's January 24, 2002 letter to Ryan advised Ryan that exclusion (s) of the

Policy precluded coverage for Sowell's Claims, and reiterated that AIG did not waive any policy provisions but reserved all rights and defenses in the event that it reevaluated the claim. EXHIBIT H, January 24, 2002 Letter to Ryan, p. 1. RESPONSE: ADMITTED 49. Conlin's January 24, 2002 letter to Ryan stated:

16

Case 3:03-cv-00644-CFD

Document 224-2

Filed 11/20/2006

Page 17 of 56

During our investigation of this matter we uncovered the fact that Mr. Sowell signed a power of attorney dated March 7, 1998 giving Mr. Gwynn the "power to give an[d] place any and all orders." Accordingly, pursuant to exclusion (s) under your policy, coverage is not available for you in this matter. Consequently, AIG would neither be indemnifying you nor paying for any defense costs incurred after January 12, 2002. . . . If you have any information which would cause us to reevaluate this matter, please forward it to my attention as soon as possible and we will gladly review same. This letter is not to be construed as a waiver of any policy provisions. In the event facts and/or issues are brought to our attention which result in a reevaluation of this matter, [AIG] reserves all rights and defenses under the policy and at law as to allegations which are not covered under the terms of this policy and/or may be excluded from coverage under the terms of the policy. . . . EXHIBIT H, January 24, 2002 Letter to Ryan, p. 1. RESPONSE: ADMITTED 50. On April 16, 2002, Angelina Palmieri of the AIG Claims Department ("Palmieri")

sent a letter to Gwynn, copied to Ryan. A true and correct copy of the April 16, 2002 Letter is hereto attached as EXHIBIT I. RESPONSE: ADMITTED 51. Palmieri's April 16, 2002 letter to Gwynn advised Gwynn that AIG had closed

Merit's claim file in the Sowell matter. EXHIBIT I, April 16, 2002 Letter. RESPONSE: ADMITTED 52. On May 17, 2002, Gwynn sent a letter to Conlin. A true and correct copy of the

April 16, 2002 letter is hereto attached as EXHIBIT J. RESPONSE: ADMITTED 53. Gwynn's May 17, 2002 letter to Conlin objected to AIG's closure of Merit's

claim file in the Sowell matter and informed Conlin that Gwynn was still in the process of

17

Case 3:03-cv-00644-CFD

Document 224-2

Filed 11/20/2006

Page 18 of 56

accumulating the information "requested several months ago" by AIG. EXHIBIT J, May 17, 2002 Letter. RESPONSE: ADMITTED 54. The Gwynn Plaintiffs allege that on January 3, 2003, John J. Nicgorski

("Nicgorski") of Mohr Hackett Pederson Blakely & Randolph, P.C., counsel for Gwynn, represented to AIG that "various facts in the record . . .established Sowell's account had not been discretionary, that the power of attorney had been revoked, and that Sowell retained all discretion over all of his accounts with Merit." The Gwynn Plaintiffs further allege that "Gwynn, through counsel, made a demand on [AIG] to resume the defense of [the Gwynn Plaintiffs], and to settle Sowell's claim within the policy limits. EXHIBIT C, Gwynn Complaint at ¶ 51. RESPONSE: ADMITTED 55. The Ryan Plaintiffs allege that they provided AIG with "information which

showed that Sowell's account had never been a discretionary account." EXHIBIT B, Ryan Complaint at ¶ 41. The Ryan Plaintiffs further allege that on January 7, 2003, Gwynn "demanded coverage, a settlement within the Policy limits, and an immediate resumption of the defense by [AIG]." EXHIBIT B, Ryan Complaint at ¶ 58. RESPONSE: ADMITTED 56. On January 6, 2003, Nicgorski sent a letter to Conlin. A true and correct copy of

the January 6, 2003 letter is hereto attached as EXHIBIT K. RESPONSE: ADMITTED 57. Nicgorski's January 6, 2003 letter advised Conlin that since the power of attorney

signed by Sowell in connection with the Merit Account was not notarized, it was invalid under

18

Case 3:03-cv-00644-CFD

Document 224-2

Filed 11/20/2006

Page 19 of 56

Arizona law. Thus, Nicgorski argued, the Merit Account was not discretionary. EXHIBIT K, January 6, 2003 Letter, p. 1. RESPONSE: ADMITTED 58. On January 7, 2003, the NASD commenced arbitration hearings concerning

Sowell's Statements of Claim ("Sowell Arbitration"). EXHIBIT B, Ryan Complaint at ¶ 59; EXHIBIT C, Gwynn Complaint at ¶ 43. RESPONSE: ADMITTED 59. The Ryan Plaintiffs were represented in the Sowell Arbitration by counsel that

they themselves had retained. EXHIBIT B, Ryan Complaint at ¶ 60; EXHIBIT C, Gwynn Complaint at ¶ 41. RESPONSE: ADMITTED Gwynn represented himself in the Sowell Arbitration. EXHIBIT B, Ryan Complaint at ¶ 61; EXHIBIT C, Gwynn Complaint at ¶ 55. RESPONSE: ADMITTED

60.

On January 10, 2003, Jeffrey King ("King") of Struckmeyer & Wilson, counsel

for AIG, sent a letter to Nicgorski. A true and correct copy of the January 10, 2003 letter is hereto attached as EXHIBIT L. RESPONSE: ADMITTED 61. King's January 10, 2003 letter confirmed a January 9, 2003 telephone

conversation between King and Nicgorski in which King conveyed AIG's offer to resume payment for Gwynn's defense. EXHIBIT L, King's January 10, 2003 Letter, p.1.

19

Case 3:03-cv-00644-CFD

Document 224-2

Filed 11/20/2006

Page 20 of 56

RESPONSE: The Ryan Plaintiffs can neither admit nor deny this statement because there is no evidence of the telephone conversation from either King or Nicgorski and the letter is hearsay evidence as to what did or did not occur in said telephone call. 62. King's January 10, 2003 letter noted that Gwynn had still not delivered the

documents as he promised he would in his May 17, 2002 letter. EXHIBIT L, King's January 10, 2003 Letter, p.1. RESPONSE: ADMITTED 63. On January 10, 2003, King sent an email to attorney William Federman, counsel

for the Ryan Plaintiffs in the Sowell Arbitration. A true and correct copy of the January 10, 2003 email is hereto attached as EXHIBIT M. RESPONSE: ADMITTED 64. King's January 10, 2003 email stated that "while AIG has not changed its position

on coverage for this claim at this time, it is offering to pay Merit's reasonable and necessary defense costs associated with the Sowell claim." EXHIBIT M, King's January 10, 2003 Email. RESPONSE: ADMITTED 65. On January 10, 2003, Frank. W. Moskowitz ("Moskowitz") of Berk &

Moskowitz, counsel for Sowell in the Sowell arbitration, sent a letter to Nicgorski. A true and correct copy of the January 10, 2003 email is hereto attached as EXHIBIT N. RESPONSE: ADMITTED 66. Moskowitz's January 10, 2003 letter stated Moskowitz's opinion that that the

Merit Account "was not a discretionary trading account." EXHIBIT N, Moskowitz's January 10, 2003 Letter, p.3.

20

Case 3:03-cv-00644-CFD

Document 224-2

Filed 11/20/2006

Page 21 of 56

RESPONSE: ADMITTED 67. Moskowitz's January 10, 2003 letter further stated:

Although we recognize that our Statement of Claim alleged that it was, we believe the true facts are otherwise. Facts, not allegations, dictate coverage. Of course, since AIG has not had a representative attend the hearing, it has no knowledge of the facts of this case. AIG's knowledge is limited to the mere allegations in the Statement of Claim. EXHIBIT N, Moskowitz's January 10, 2003 Letter, p.3. RESPONSE: ADMITTED 68. On January 13, 2003, King sent a letter to Nicgorski. A true and correct copy of

the January 13, 2003 letter is hereto attached as EXHIBIT O. RESPONSE: ADMITTED 69. King's January 13, 2002 letter confirmed that AIG would resume Gwynn's

defense in the Sowell Arbitration. EXHIBIT O, January 13, 2002 Letter. RESPONSE: ADMITTED 70. King's January 13, 2003 letter stated that "although AIG is providing Mr. Gwynn

with a defense, it has not changed its position with respect to coverage." EXHIBIT O, January 13, 2002 Letter. RESPONSE: ADMITTED 71. On January 13, 2003, attorney Maxine Polomski ("Polomski"), who had

previously been appointed by AIG to represent Gwynn, resumed Gwynn's defense in the Sowell Arbitration. NASD Sowell Arbitration Award ("Arbitration Award") at p.1. A true and correct copy of the Arbitration Award is hereto attached as EXHIBIT P. RESPONSE: ADMITTED

21

Case 3:03-cv-00644-CFD

Document 224-2

Filed 11/20/2006

Page 22 of 56

72.

During the Sowell Arbitration, securities industry expert Charles Abram Fath

("Fath") testified on Sowell's behalf before the Sowell Arbitration panel ("Arbitration Panel"). Sowell Arbitration hearing transcript ("Arbitration Transcript") at pp. 1249-66. A true and correct copy of the relevant portions of the Arbitration Transcript is hereto attached as EXHIBIT Q. RESPONSE: The Ryan Plaintiffs admit that Fath so testified but deny that testimony is relevant or admissible on this motion. 73. At the Sowell Arbitration, Fath explained that there was excessive trading activity

in the Merit Account. Specifically, Fath testified as follows: Fath: The excessive activity that I saw in the account is certainly unsuitable for an individual with a growth investment objective. Are there any particular months of activity in the account that you would like to highlight to the Panel as an example of the level of activity? Well, I mean, there was consistent activity really throughout the account. We could go through some ­ some months, and then we can look at some charts I've prepared. If you want to look at ­ we can start with December of `98 as an example. I think that was a statement we looked at earlier today ... Just on the cover page you'll see that at the end of this month, December of `98, there is a debit balance of $209,000. * * *

Q:

Fath.

Then if you'll skip over to page 3 of that monthly statement, if you just look down under the account activity, buys and sells that have taken place in the account. If you'll look down at the last, for instance, starting down on 12/9[/98], two lines up from the bottom, American Online is purchased. You see onto the next page, there's a series of purchase that are made in the account. If you'll drop down to the middle of this

22

Case 3:03-cv-00644-CFD

Document 224-2

Filed 11/20/2006

Page 23 of 56

page, you'll see there's a number of sales that take place beginning on 12/16 that go on down. And then on the 19th, there's another series of purchases. So if you continue on to the ­ on page 5 you'll see the same thing. You ­ there's purchases and sales taking place of ­ a number of which all take place on the same day, which, as I look at this, would give me pause to think, are these discretionary transactions? Did Mr. Gwynn talk to Mr. Sowell about each and every one of these transactions because obviously he's bunching orders, and I think we saw an exhibit the other day, Exhibit No. 162 where he was sending in a fax saying: Buy all of these securities and charge this amount of commissions. From a supervisory point of view, one of the first things you would look at when you see crunched orders like that is, you know, did the broker really talk with the customer about each one of these transactions. If you just go through these different months, you'll see repeatedly there's a whole slew of transactions on . . . different days. On one day there will be a bunch of buys. On another day there's be [sic] a bunch of sells. . . * * * At the end of the ­ this month, on page 6, you can see, according to this statement, there were purchases of $793,000 and there were sales of $520,000 * * *

Looking on page 6, again down at the bottom, you'll see, beginning with the purchase of . . . on January 11th, a whole series of purchases on the 11th. On the 13th, there's a whole series of sales. Then he buys back in some cases the various securities that he had sold earlier. Any--I mean, this pattern of trading certainly is not appropriate for a growth investment objective. This is purely a trading account, just by looking at the number of buys and sales and the total cost of the purchases for each month.

23

Case 3:03-cv-00644-CFD

Document 224-2

Filed 11/20/2006

Page 24 of 56

Again, looking at page 9, it summarizes, it shows that during this month there was $1,313,278 worth of purchases and a sale of . . . $1,633,978 that were done during that month. EXHIBIT Q, Arbitration Transcript at pp.1270-1273. RESPONSE: The Ryan Plaintiffs admit that Fath so testified but deny that testimony is relevant or admissible on this motion.

74.

In addition to this testimony, Fath presented a chart to the Arbitration Panel

demonstrating the excessive number of monthly "buys" and "sells" in the Merit Account from May 1998, prior to the Policy's Retroactive Date of August 23, 1999, through to May 2001. Sowell Arbitration Exhibit 26, pp. 4-5. A true and correct copy of Sowell Arbitration Exhibit 26 is hereto attached as EXHIBIT R. RESPONSE: The Ryan Plaintiffs admit that Fath so testified but deny that testimony is relevant or admissible on this motion.

75.

An excerpt from Fath's chart, detailing Gwynn's trading in the Sowell Account

from May 1998 through the to May 2001, is as follows:

Month May 98 Jun 98 Jul98 Aug 98 Sept 98 Oct 98 Nov 98 Dec 98

Number of Trades Buy Sells 6 3 2 25 5 6 9 37 38 25 17 32 28 42 31

Total 6 5 30 15 75 42 60 73

Cost of Purchases -025,278 313,931 66,124 777,691 432,912 388,518 793,044

Month End Equity 1,032,439 1,196,030 1,047,788 778,647 774,382 790,397 854,460 1,009,153

Debit Balance -0-0-0-0-0-0-0209,001

24

Case 3:03-cv-00644-CFD

Document 224-2

Filed 11/20/2006

Page 25 of 56

Month Jan 99 Feb 99 Mar 99 Apr 99 May 99 Jun 99 Jul 99 Aug 99 Sept 99 Oct 99 Nov 99 Dec 99 Jan 00 Feb 00 Mar 00 Apr 00 May 00 Jun 00 Jul 00 Aug 00 Sep 00 Oct 00 Nov 00 Dec 00 Jan 01 Feb 01 Mar 01 Apr 01 May 01

Number of Trades Buy Sells 45 45 24 14 25 20 22 27 26 24 24 17 22 18 29 34 25 16 12 20 29 27 21 27 26 15 32 51 14 22 22 30 19 15 16 20 11 11 11 -04 793 32 18 18 35 44 18 20 16 47 23 23 40 14 10 8 8 4 803

Total 90 38 45 49 50 41 40 63 41 32 56 48 58 33 50 86 58 40 42 46 66 38 39 60 25 21 19 8 8 1,596

Cost of Purchases 1,313,279 525,417 632,977 959,746 893,060 666,642 518,533 663,600 615,569 337,824 761,971 899,385 1,828,815 443,742 1,061,731 1,791,832 443,752 746,120 718,959 926,015 907,543 442,759 330,674 387,137 130,775 108,451 154,864 -023,582 22,032,252

Month End Equity 1,120,758 1,007,312 1,185,584 1,206,145 972,042 997,646 807,736 730,601 864,823 1,043,643 1,271,284 1,835,672 1,371,742 1,573,264 1,497,584 1,053,146 554,600 725,030 652,933 923,865 623,044 422,224 139,789 42,753 74,529 41,679 33,442 30,576 -0-0-

Debit Balance -0309,667 615,036 288,110 524,115 664,039 963,048 812,961 1,195,841 1,032,340 994,929 1,117,389 1,280,609 1,145,187 1,327,839 1,362,564 594,325 629,565 924,177 1,590,490 839,065 600,548 407,742 95,175 33,700 29,439 116,096 23,713 -0-0-

EXHIBIT R, Sowell Arbitration Exhibit 26, pp. 4-5. RESPONSE: The Ryan Plaintiffs admit that Fath so testified but deny that testimony is relevant or admissible on this motion.

25

Case 3:03-cv-00644-CFD

Document 224-2

Filed 11/20/2006

Page 26 of 56

76.

Fath's chart demonstrated to the Arbitration Panel the monthly and cumulative

commissions that Gwynn had received as a result of the excessive trading in the Merit Account during the period between May 1998 and May 2001, as well as Gwynn's commissions from the Merit Account as a percentage of his total commissions during the same period. EXHIBIT R, Sowell Arbitration Exhibit 26, pp. 2-3. RESPONSE: DENIED

77.

An excerpt from Fath's chart, detailing Gwynn's commissions from trading in the

Sowell Account from May 1998 through to May 2001, is as follows:

Month May 98 Jun 98 Jul 98 Aug 98 Sept 98 Oct 98 Nov 98 Dec 98 Jan 99 Feb 99 Mar 99 Apr 99 May 99 Apr 99 May 99 Jun 99 Jul 99 Aug 99 Sept 99 Oct 99 Nov 99

Commissions Monthly $3,927 6,285 11,194 3,053 13,535 10,210 10,950 16,625 23,920 7,665 12,465 23,806 15,075 23,806 15,075 11,264 9,396 12,581 9,640 10,400 16,515

Cumulative $3,927 10,212 21,406 24,459 37,994 48,204 59,154 75,779 99,699 107,364 119,829 143,635 158,710 143,635 158,710 169,974 179,370 191,951 201,591 211,991 228,506

Sowell's % of Gwynn's Gross Commission 85% 73% 80% 30% 85% 73% 87% 96%

Margin Charges Monthly Cumulative -0-0 -0-0 -0-0 -0-0-0 -0-0 -0-0 -0-0 1,152 42 2,545 4,086 2,238 4,086 2,238 3,188 4,769 6,945 5,793 10,263 8,677 1,152 1,194 3,739 7,825 10,063 7,825 10,063 13,251 18,020 24,965 30,758 41,021 49,698

52% 71% 77% 71% 77% 91% 87% 73% 75% 76% 77%

26

Case 3:03-cv-00644-CFD

Document 224-2

Filed 11/20/2006

Page 27 of 56

Month Dec 99 Jan 00 Feb 00 Mar 00 Apr 00 May 00 Jun 00 Jul 00 Aug 00 Sep 00 Oct 00 Nov 00 Dec 00 Jan 01 Feb 01 Mar 01 Apr 01 May 01

Commissions Monthly 17,700 27,128 9,350 16,717 28,469 17,700 14,625 13,250 13,426 22,424 12,873 13,410 18,849 8,285 7,275 6,764 2,408 1,716

Cumulative 246,206 273,334 282,684 299,401 327,870 345,570 360,195 373,445 386,871 409,295 422,168 435,578 454,427 462,712 469,987 476,751 479,159 480,875

Sowell's % of Gwynn's Gross Commission 88% 80% 60% 86% 88% 99% 98% 89% 73% 96% 98% 95% 83% 64% 94% 39%

Margin Charges Monthly Cumulative 8,222 57,920 10,154 9,901 11,575 11,860 10,582 9,563 8,579 8,382 15,031 6,489 4,723 3,957 923 442 140 506 132 68,074 77,975 89,550 101,410 111,992 121,555 130,134 138,516 153,547 160,036 164,759 168,716 169,639 170,081 170,221 170,727 170,859

EXHIBIT R, Sowell Arbitration Exhibit 26, pp. 2-3. RESPONSE: The Ryan Plaintiffs admit that Fath so testified but deny that testimony is relevant or admissible on this motion.

78.

According to the figures listed in the chart produced by Fath, Gwynn made at

least $179,370 in commissions from Sowell's Merit Account in the three months between the date that the Merit Account was first opened and the Policy's Retroactive Date of August 23, 1999. EXHIBIT R, Sowell Arbitration Exhibit 26, pp. 2-3. RESPONSE: The Ryan Plaintiffs admit that Fath so testified but deny that testimony is relevant or admissible on this motion. The Ryan Plaintiffs also deny that AIG has correctly

27

Case 3:03-cv-00644-CFD

Document 224-2

Filed 11/20/2006

Page 28 of 56

calculated the time period as stated since a correct calculation would appear to be 15 months not 3 months

79.

Fath's chart indicates that in the three months between the date that the Merit

Account was first opened and the Policy's Retroactive Date of August 23, 1999, there were approximately 358 "buys" and 301 "sells," and Gwynn derived about 80% of his total commissions from the Merit Account alone. EXHIBIT R, Sowell Arbitration Exhibit 26, pp. 45. RESPONSE: The Ryan Plaintiffs admit that Fath so testified but deny that testimony is relevant or admissible on this motion. The Ryan Plaintiffs also deny that AIG has correctly calculated the time period as stated since a correct calculation would appear to be 15 months not 3 months

80. Q.

Fath testified before the Arbitration Panel as follows: You mentioned I think in and out of trading. Can you tell the Panel what that is, and if there's evidence of that in this case? Well, there's ample evidence of that if you just look through the monthly statements. In-and-out trading is when you buy a stock ­ sell a stock and buy the same stock back again just for trading purposes. And again, that defeats the whole strategy of the investment objective of growth, just because of the commissions that are eating up the ­ eating up the account. What's churning? Churning is where a broker who is controlling the account effects excessive transactions in the account in light of the investment objective of the account, and he does it to the detriment to the

Fath.

Q. Fath.

28

Case 3:03-cv-00644-CFD

Document 224-2

Filed 11/20/2006

Page 29 of 56

customer and for his own benefit for the ability to generate commissions for himself. Q. Okay. Based on the testimony you've heard from both sides, is it evident (tape inaudible) who was controlling the account? In my opinion, after looking at the documents and hearing the testimony, it's my opinion that Mr. Gwynn was controlling the account.

Fath.

EXHIBIT Q, Arbitration Transcript at pp.1273-74. RESPONSE: The Ryan Plaintiffs admit that Fath so testified but deny that testimony is relevant or admissible on this motion.

81.

Fath testified before the Arbitration Panel as follows: [F]or a broker who's been in the business for a number of years, to have 80 percent of his commissions come from one customer, to me is very uncommon and certainly one that would send up red flags the very first month that would occur, to see the type of trading and who's controlling the account.

EXHIBIT Q, Arbitration Transcript at pp.1283-84. RESPONSE: The Ryan Plaintiffs admit that Fath so testified but deny that testimony is relevant or admissible on this motion.

82.

Sowell provided his own testimony during the Sowell Arbitration. During the

Sowell Arbitration, Sowell testified as follows: Q. It says here that you approved all the trades that occurred in the account. That's what it says. Is that true?

Sowell. Q.

29

Case 3:03-cv-00644-CFD

Document 224-2

Filed 11/20/2006

Page 30 of 56

Sowell.

No. I mean, I never told David to buy any stock, to sell and to buy it, do anything with it. The only stock that I asked him buy, he couldn't get. * * *

Q.

Did he ever call you to discuss buying or selling certain stocks and wanting your okay before he did it? No. * * *

Sowell.

Q.

Did Mr. Gwynn ever tell you the amount of commissions he made off the account? No. * * *

Sowell.

Q.

Did Mr. Gwynn ever tell you the number of times he turned over this account (tape inaudible) on an annual basis? No. Did anyone from Merit ever tell you? No. Did Mr. Gwynn ever tell you the return on investment that you needed to break even on your investments in your Merit account? No.

Sowell. Q. Sowell. Q.

Sowell.

EXHIBIT Q, Arbitration Transcript at pp. 892-95. 83. Q. Gwynn provided the following testimony during the Sowell Arbitration: . . . Now, you having been the broker on the account, did Mr. Sowell's ­ did the commissions generated through Mr. Sowell's account account for a very large percentage of your gross commissions? Yes. Okay. And as you sit here today, do you have any documents or information . . . to dispute [Fath's] calculation on a month-to-month basis?

Gwynn. Q.

30

Case 3:03-cv-00644-CFD

Document 224-2

Filed 11/20/2006

Page 31 of 56

Gwynn. Q.

I don't think so. So, it's fair to say, then, that for three years, most of your compensation through Merit was generated by Mr. Sowell's account? He was my largest and most active client. And far and away the largest and most active client. Yes.

Gwynn. Q. A.

EXHIBIT Q, Arbitration Transcript at p. 232. RESPONSE: The Ryan Plaintiffs admit that Sowell and Gwynn so testified but deny that testimony is relevant or admissible on this motion.

84.

According to a series of Promissory Notes made by Sowell to

Novation/Charter/C3, Sowell's investments in those entities commenced on May 1, 1998, prior to the August 23, 1999 Retroactive Date, and continued through July 24, 2000, amounting to a total of $275,000. Sowell Arbitration Exhibits 43-51. A true and correct copy of the Sowell Arbitration Exhibits 43-51 is hereto attached as EXHIBIT S. RESPONSE: ADMITTED 85. Details of the Promissory Notes made by Sowell to Novation/Charter/C3 between

May 1, 1998 to July 24, 2000 are as follows:
Arbitration Exh. No. 43 44 45 Promissory Note Full Recourse Promissory note for $50,000 dated May 19, 1998 by Gwynn for Novation, as Maker, and Sowell as Holder and Payee Full Recourse Promissory Note for $100,000 dated July 1, 1998 by Gwynn for Novation, as Maker, and Sowell as Holder and Payee. Full Recourse Promissory Note for $25,000 dated November 11, 1999 by Gwynn for Charter, as Maker, and Sowell as Payee

31

Case 3:03-cv-00644-CFD

Document 224-2

Filed 11/20/2006

Page 32 of 56

46 47 48 49 50 51

Amendment to November 11, 1999 Full Recourse Promissory Note, dated July 24, 2000 Full Recourse Promissory Note for $25,000 dated April 27, 2000 by Gwynn for Charter, as Maker, and Sowell as Payee. Amendment to April 27, 2000 Full Recourse Promissory Note, dated July 24, 2000 Full Recourse Promissory Note for $25,000 dated July 24, 2000 by Gwynn for Charter, as Maker, and Sowell as Payee. Full Recourse Promissory Note for $25,000 dated July 24, 2000 by Gwynn for Charter, as Maker, and Sowell as Payee. Full Recourse Promissory Note for $25,000 dated July 24, 2000 by Gwynn for Charter, as Maker, and Sowell as Payee.

EXHIBIT S, Sowell Arbitration Exhibits 43-51. RESPONSE: ADMITTED 86. The Arbitration Panel received evidence that on July 27, 1999, Merit and Newton

submitted to the NASD a letter of Acceptance, Waiver and Consent ("AWC") in connection with an earlier NASD investigation into Merit's activities. Sowell Arbitration Exhibit 111. A true and correct copy of Sowell Arbitration Exhibit 111 is hereto attached as EXHIBIT T. RESPONSE: ADMITTED 87. Through the AWC, Merit and Newton accepted and consented to the following

findings of the NASD under the heading "Supervision failures": During the period from about January, 1996 to about April, 1997, Merit Capital acting through Russell W. Newton its Registered Principal and Chairman, failed to establish and maintain a system to supervise the activities of each registered representative and associated person that is reasonably designed to achieve compliance with applicable securities laws and regulations with the Rules of this Association . . . EXHIBIT T, Sowell Arbitration Exhibit 111 at pp. 3, 5-6. RESPONSE: ADMITTED

32

Case 3:03-cv-00644-CFD

Document 224-2

Filed 11/20/2006

Page 33 of 56

88.

Pursuant to the AWC, Merit and Newton consented to the imposition of a

$180,000 fine, as well as to the implementation of corrective actions to be recommended by an independent consultant retained by Merit to review its procedures. EXHIBIT T, Sowell Arbitration Exhibit 111 at pp. 6-7. RESPONSE: ADMITTED 89. According to the AWC, Merit and Newton acknowledged that the AWC would become part of their permanent disciplinary records and could be considered in any future actions brought by the NASD against them, and that the AWC would be made available in response to public inquiries through the NASD's public disclosure program. EXHIBIT T, Sowell Arbitration Exhibit 111 at p. 1. RESPONSE: ADMITTED 90. On February 25, 2003, three-and-a-half years after Merit and Newton submitted the AWC, the NASD panel in the Sowell Arbitration entered an award in the amount of $1,125,000 ("Arbitration Award") jointly and severally against each of the Plaintiffs, as well as against GFS. EXHIBIT B, Ryan Complaint at ¶75; EXHIBIT C, Gwynn Complaint at ¶72; EXHIBIT P, Arbitration Award at p.7. RESPONSE: ADMITTED 91. According to the Arbitration Award, the Arbitration Panel found Merit, Newton, Ryan, and Fitzpatrick "jointly and severally liable for failing to supervise Gwynn." EXHIBIT P, Arbitration Award at p. 7. RESPONSE: ADMITTED

33

Case 3:03-cv-00644-CFD

Document 224-2

Filed 11/20/2006

Page 34 of 56

The Arbitration Panel found that Merit had ordered a certain Sandra Logay to supervise Gwynn despite the fact that an earlier January 28, 2000 SEC decision had "concluded `it is in the public interest to bar Logay from acting in a proprietary or supervisory capacity with any broker, dealer, or municipal securities dealer.'" EXHIBIT P, Arbitration Award at p.8 (emphasis in original). RESPONSE: ADMITTED

92. The Arbitration Panel found that each of the Plaintiffs: [K]nowingly facilitated the apparent violation of the SEC order . . . by ordering Sandra Logay to "visit" Respondent David Gwynn in Scottsdale, Arizona on October 17, 2000 [which] constituted supervisory activity. . . . EXHIBIT P, Arbitration Award at p.8. RESPONSE: ADMITTED 93. The Arbitration Award states the following:

After considering the pleadings, the testimony, and the evidence presented at the hearing, the undersigned arbitrators have decided in full and final resolution of the issues submitted for determination as follows: 1. The panel finds that Respondents [Merit, Fitzpatrick, Newton, Ryan, Gwynn, Raquel Gwynn and GFS] shall be and hereby are jointly and severally liable to claimant for selling unsuitable investments, selling unregistered securities, acting negligently, making negligent misrepresentations, breaching their fiduciary duties to claimant, breaching their contractual obligations to claimant, engaging in conduct falling below the securities industry standard of care, and showing an overall reckless indifference to claimant's interests. The panel also finds that Respondents, and each of them, are jointly and severally liable for churning claimant's account.

2.

34

Case 3:03-cv-00644-CFD

Document 224-2

Filed 11/20/2006

Page 35 of 56

3.

The panel further finds that Respondents Merit, Newton, Ryan and Fitzpatrick, and each of them, are jointly and severally liable for failing to supervise Respondent Gwynn. The panel specifically finds that Respondent Fitzpatrick failed to alert Claimant to the excessive and inappropriate trading activity in his account, specifically the excessive trading, the trading was not consistent with Claimant's investment objectives, the high commissions, and the heavy use of margin. The panel awards damages to Claimant in the total sum of $1,125,000.00. In reaching its decision, the panel makes the following findings of fact concerning Respondent David Gwynn: Respondent engaged in excessive trading, approximately 1,596 trades in thirty-seven (37) months from May 1998 to May 2001, coupled with the fact that Respondent derived approximately 80% of his gross income from Claimant's account over the same period of time; Respondent engaged in excessive trading of the same securities (in and out trading, high frequency of trades in the same securities); Respondent engaged in the churning of Claimant's account, resulting in a Looper turnover of 8.5, and a cost maintenance factor of approximately 25%. Respondent engage in a pattern of unsuitable trading activity that was contrary to the stated investment objectives of Claimant, to wit; "long term growth." Respondent, a registered representative, engaged in a variety of inappropriate activities including: i. Soliciting Claimant (his client) to raise large sums of money for highly speculative venture capital propositions; Soliciting Claimant (his client) to purchase unregistered securities; Failing to disclose serious conflicts of interest with Claimant when soliciting money for highly speculative venture capital propositions, including Respondent's own

4.

5.

6.

7.

8.

9.

10.

ii.

iii.

35

Case 3:03-cv-00644-CFD

Document 224-2

Filed 11/20/2006

Page 36 of 56

personal stake in the venture capital propositions and the fact that large sums of money raised from Claimant were to be paid directly to Respondent. iv. Respondent was not registered under the Investment Advisors Act of 1940 and was unable to verify that he was a "registered investment advisor" in the State of Arizona. Accordingly, Respondents' conduct in the preparation and dissemination of the documents identified a Claimant's Exhibits "32" ["Financial Planning/Advisory Disclosure Agreement"] and "33" ["Financial Planning/Investment Advisor Agreement"] raises serious questions of fraud and misrepresentation.

11.

The panel also makes the following findings of fact concerning Respondents Merit, its principals Ryan and Newton, and its Compliance Director Fitzpatrick: Each of said Respondents knowingly facilitated the apparent violation of the SEC order referred to in an SEC decision dated January 28, 2000 in SEC file No. 3-8969, identified as Claimant's Exhibit "113", by ordering Sandra Logay to "visit" Respondent David Gwynn in Scottsdale, Arizona on October 17, 2000. The SEC concluded "it is in the public interest to bar Logay from acting in a proprietary or supervisory capacity with any broker, dealer, or municipal securities dealer." ... Incidental to the above finding, the panel finds that Respondent Merit's employee, Sandra Logay's "visit" to Respondent David Gwynn in Scottsdale, Arizona on October 17, 2000 constituted supervisory activity in violation of an SEC decision dated January 28, 2000 in SEC file No. 3-8969, identified as Claimant's Exhibit "113".

12.

13.

EXHIBIT P, Arbitration Award at pp. 6-8. RESPONSE: ADMITTED 94. Plaintiffs allege that:

Nothing in the [Arbitration] Award is predicated on or even refers to any claim or evidence that Sowell's account was discretionary or managed through a power of attorney, and in fact, the Award notes specifically that Respondents had asserted "Sowell exercised control over his account at Merit."

36

Case 3:03-cv-00644-CFD

Document 224-2

Filed 11/20/2006

Page 37 of 56

EXHIBIT B, Ryan Complaint at ¶ 78; EXHIBIT C, Gwynn Complaint at ¶ 73. RESPONSE: ADMITTED 95. AIG ultimately paid $1,000,000 to Sowell in exchange for a full and final

adjudication of Sowell's claims against Plaintiffs and GFS. EXHIBIT B, Ryan Complaint at ¶ 88. RESPONSE: ADMITTED 96. The Arbitration Award was vacated on September 9, 2003. Vacation of

Arbitration Award. A true and correct copy of the Vacation of Arbitration Award is hereto attached as EXHIBIT U. RESPONSE: ADMITTED 97. Plaintiffs do not maintain that they were damaged by AIG's resumption of their

defense and payment to vacate the Arbitration Award; rather, they claim that they were damaged because AIG's resumption of their defense and payment to Sowell as "belated." EXHIBIT B, Ryan Complaint at ¶ 71; EXHIBIT C, Gwynn Complaint at ¶ 68. RESPONSE: DENIED

98.

In support of their claim that AIG's defense was "belated," Plaintiffs allege that

AIG "admitted it had a duty to defend" when it resumed Plaintiffs' defense on January 10, 2003. EXHIBIT B, Ryan Complaint at ¶ 64; EXHIBIT C, Gwynn Complaint at ¶ 60. RESPONSE: ADMITTED

37

Case 3:03-cv-00644-CFD

Document 224-2

Filed 11/20/2006

Page 38 of 56

99.

Plaintiffs maintain that Gwynn irretrievably damaged their respective cases by the

time that Gwynn's counsel resumed his defense during the Sowell Arbitration. EXHIBIT B, Ryan Complaint at ¶¶ 58-59; EXHIBIT C, Gwynn Complaint at ¶¶ 61-63. RESPONSE: ADMITTED 100. In support of their claim that AIG's defense was "belated," Plaintiffs allege that

AIG "admitted it had a duty to defend" when it resumed Plaintiffs' defense on January 10, 2003. EXHIBIT B, Ryan Complaint at ¶ 64; EXHIBIT C, Gwynn Complaint at ¶ 60. RESPONSE: ADMITTED

101.

Plaintiffs maintain that Gwynn irretrievably damaged their respective cases by the

time that Gwynn's counsel resumed his defense during the Sowell Arbitration. EXHIBIT B, Ryan Complaint at ¶¶ 58-59; EXHIBIT C, Gwynn Complaint at ¶¶ 61-63. RESPONSE: ADMITTED

B.

The Ryan Plaintiffs Counter Statement of Material Facts Not In Dispute

1.

The professional activities of the Ryan Plaintiffs' were regulated by the National

Association of Securities Dealers ("NASD"). Affidavit of Robert Fitzpatrick ("Fitzpatrick Affidavit") at ¶ 1. The Fitzpatrick Affidavit with all attached exhibits is being simultaneously filed with the Ryan Plaintiffs' Rule 56(a)(2) Statement and Memorandum in Opposition to Summary Judgment.

38

Case 3:03-cv-00644-CFD

Document 224-2

Filed 11/20/2006

Page 39 of 56

2.

David Gwynn ("Gwynn") was licensed by the NASD to sell securities. At

relevant times, Gwynn worked as a Registered Representative for Merit. Fitzpatrick Affidavit at ¶ 2. 3. Gwynn Financial was a company owned and controlled by Gwynn and was used

by him to provide financial planning services to certain of his customers, including some individuals who had accounts at Merit. Fitzpatrick Affidavit at ¶ 3. 4. In exchange for an additional premium, NU later extended the coverage period of

the Policy one month to September 23, 2001 while it considered Merit's application to renew the coverage for another year. Fitzpatrick Affidavit at ¶ 4. 5. The Policy covered all of the Ryan Plaintiffs and the Gwynn Plaintiffs.

Fitzpatrick Affidavit at ¶ 5. 6. Merit paid NU a total in excess of $70,000 in premiums on the Policy. Fitzpatrick

Affidavit at ¶ 6. 7. Michael A. Sowell ("Sowell") was customer of Gwynn's and Sowell had done

business with Gwynn both through Merit's brokerage accounts and otherwise for several years. Fitzpatrick Affidavit at ¶ 7. 8. On or about September 4, 2001, Sowell commenced an NASD arbitration against

Merit and Gwynn (the "Sowell Arbitration") by filing a statement of claim pursuant to the NASD arbitration rules August 31, 2001 (the "Sowell Claim"). Fitzpatrick Affidavit at ¶ 8; Defendants' Statement at Exhibit D, Sowell Statement of Claim. 9. Sowell claimed that in 1998 he contacted Gwynn for his assistance in creating a

retirement plan and Pursuant to his conversations with Gwynn, Sowell provided Gwynn with

39

Case 3:03-cv-00644-CFD

Document 224-2

Filed 11/20/2006

Page 40 of 56

securities and/or funds for Gwynn to deposit in certain securities accounts, including a trading account, at Merit (the "Merit Account"). Fitzpatrick Affidavit at ¶ 9; Defendants' Statement at Exhibit D, Sowell Statement of Claim at ¶ 14-24. 10. In the Sowell Claim, Sowell asserted claims against the Gwynn Plaintiffs, Merit

and the Individual Ryan Plaintiffs and their wives. Fitzpatrick Affidavit at ¶ 10; Defendants' Statement at Exhibit D, Sowell Statement of Claim at ¶ 5-10. 11. In the Sowell Claim, he alleged statutory and regulatory violations against Gwynn

for Gwynn's alleged conduct, including allegations of churning the Merit Account, advising Sowell improperly, making inappropriate trades and committing fraud and much of Sowell's claim was addressed to separate business investments that Gwynn and Sowell had planned apart from Merit and Sowell's account at Merit. Fitzpatrick Affidavit at ¶ 11; Defendants' Statement at Exhibit D, Sowell Statement of Claim. 12. In Count Four, Sowell specifically alleges negligence including negligence in

failing to properly advise Sowell on facts pertaining to his account and investments. Fitzpatrick Affidavit at ¶ 12; Defendants' Statement at Exhibit D, Sowell Statement of Claim at ¶ 94-98. 13. In Count Seven of Sowell's claim, Sowell specifically alleges that the Ryan

Plaintiffs were liable for their failure to supervise Gwynn. Fitzpatrick Affidavit at ¶ 13; Defendants' Statement at Exhibit D, Sowell Statement of Claim at ¶ 117-120. 14. In Count Nine Sowell expressly alleged violation of NASD rules as a result of

recommendation of investments to Sowell that were not suitable. Fitzpatrick Affidavit at ¶ 14; Defendants' Statement at Exhibit D, Sowell Statement of Claim at ¶ 129.

40

Case 3:03-cv-00644-CFD

Document 224-2

Filed 11/20/2006

Page 41 of 56

15.

The losses Sowell claims to have suffered began in 2000. Fitzpatrick Affidavit at

¶ 15; Defendants' Statement at Exhibit D at ¶ 29-30. 16. On September 21, 2001, Merit, seeking defense and coverage, submitted notice of

the Sowell Claim to its local insurance broker, who forwarded that notice to an NU broker in New York. Fitzpatrick Affidavit at ¶ 16. 17. After receiving notice of the claim, on September 22nd, NU was represented by

AIGTS in all subsequent aspects of the handling of the Sowell Claim with regard to the Ryan Plaintiffs and the Gwynn Plaintiffs. Fitzpatrick Affidavit at ¶ 17. 18. In early October, 2001, based on the allegations contained on the face of the

Sowell Claim, AIG decided to provide a defense to the Ryan Plaintiffs and AIG, through its claims analyst Brian Conlin ("Conlin"), issued a reservation of rights letter to the Ryan Plaintiffs, which confirmed that AIG had retained an Arizona law firm to defend the Ryan Plaintiffs, subject to that reservation of rights. Fitzpatrick Affidavit at ¶ 18; Defendants Statement at ¶40, Exhibit F. 19. Soon thereafter, AIG retained another law firm to defend the Gwynn Plaintiffs

thereby acknowledging the existence of a conflict between the Gwynn Plaintiffs and the Ryan plaintiffs which necessitated separate counsel for the two groups of respondents to the Sowell claim. Fitzpatrick Affidavit at ¶ 19. 20. AIG neglected to issue a reservation letter to the Gwynn Plaintiffs. Fitzpatrick

Affidavit at ¶ 20. 21. AIG, through Conlin, confirmed its right and duty to defend the Gwynn Plaintiffs

when he rejected Gwynn's request to hire a lawyer he knew to be experienced in NASD matters

41

Case 3:03-cv-00644-CFD

Document 224-2

Filed 11/20/2006

Page 42 of 56

to represent his interests and Conlin specifically asserted AIG had the right to select counsel for the defense, a right it would only have if AIG admitted to having a duty to defend under the Policy. Fitzpatrick Affidavit at ¶ 21; Defendants' Statement ¶ 11, Exhibit A Policy. 22. For the next two months, the Ryan Plaintiffs cooperated with AIG by providing

Conlin with all the information he requested. Fitzpatrick Affidavit at ¶ 22. 23. One document that the Ryan Plaintiffs provided to AIG was a power-of-attorney

signed by Sowell, but that power-of-attorney was not notarized or witnessed. Fitzpatrick Affidavit at ¶ 23. 24. At AIG's request, the Ryan Plaintiffs advised Conlin that they understood that the

power-of-attorney had been provided for Gwynn's use in the event Sowell was unreachable but as far as the Ryan Plaintiffs knew the power-of-attorney had never been used. Fitzpatrick Affidavit at ¶ 24. 25. The Ryan Plaintiffs also advised Conlin that according to the