MEMORANDUM OF POINTS AND AUTHORITIES IN SUPPORT OF PLAINTIFFS’ OPPOSITION TO
DEFENDANTS’ MOTIONS TO DISMISS CONSOLIDATED AMENDED CLASS ACTION COMPLAINT
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Daniel C. Girard (State Bar No. 114826)
dcg@girardgibbs.com
Jonathan K. Levine (State Bar No. 220289)
jkl@girardgibbs.com
Amanda M. Steiner (State Bar No. 190047)
as@girardgibbs.com
GIRARD GIBBS LLP
601 California Street, 14th Floor
San Francisco, California 94108
Telephone: (415) 981-4800
Facsimile: (415) 981-4846
Lead Plaintiffs’ Counsel
[Additional counsel appear on signature page]
UNITED STATES DISTRICT COURT
CENTRAL DISTRICT OF CALIFORNIA
SOUTHERN DIVISION
JANA MCCOY, HENRY MITCHELL,
JEFF HUBER, ALVIN SABROFF, JUNE
SABROFF, JAMES MERRILL,
CHERYL MERRILL and DON
RIBACCHI, on behalf of themselves and
all others similarly situated,
Plaintiffs,
v.
CULLUM & BURKS SECURITIES,
INC., CAPWEST SECURITIES, INC.,
SECURITIES AMERICA, INC.,
AMERIPRISE FINANCIAL, INC.,
SECURITIES AMERICA FINANCIAL
CORP., NATIONAL SECURITIES
CORP., NATIONAL HOLDINGS
CORP., CAPITAL FINANCIAL
SERVICES, INC. and CAPITAL
FINANCIAL HOLDINGS, INC.,
Defendants.
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Case No. 8:09-CV-01084-DOC-RNB
MEMORANDUM OF POINTS AND
AUTHORITIES IN SUPPORT OF
PLAINTIFFS’ OPPOSITION TO
DEFENDANTS’ MOTIONS TO
DISMISS CONSOLIDATED
AMENDED CLASS ACTION
COMPLAINT
CLASS ACTION
Date: May 24, 2010
Time: 8:30 a.m.
Before: The Hon. David O. Carter
This document relates to:
ALL ACTIONS
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Case 8:09-cv-01084-DOC-RNB Document 70 Filed 03/31/10 Page 1 of 45
MEMORANDUM OF POINTS AND AUTHORITIES IN SUPPORT OF PLAINTIFFS’ OPPOSITION TO
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TABLE OF CONTENTS
I. INTRODUCTION ......................................................................................................... 1
II. FACTUAL BACKGROUND..................................................................................... 2
A. The Broker Defendants Offered and Sold Medical Capital
Notes...................................................................................................................... 2
1. The Notes ................................................................................................. 3
2. The Offer and Sale of the Notes to the General Public ................ 3
3. The Purported Exemption From Registration................................. 5
B. The Private Placement Memoranda Contained False and
Misleading Statements...................................................................................... 6
C. Medical Capital Defaults.................................................................................. 8
D. Plaintiffs’ Claims ............................................................................................... 9
III. LEGAL STANDARD................................................................................................. 10
A. Rule 9(b) Does Not Apply to Plaintiffs’ Claims ...................................... 10
B. Plaintiffs’ Claims Satisfy the Notice Pleading Standard of
Rule 8 .................................................................................................................. 14
IV. PLAINTIFFS STATE CLAIMS UNDER SECTION 12(a)(1)........................ 16
A. Defendants Do Not Dispute That Plaintiffs Have Adequately
Alleged the Elements of a Section 12(a)(1) Claim.................................. 16
B. Plaintiffs’ Claims Are Timely....................................................................... 18
V. PLAINTIFFS STATE CLAIMS UNDER SECTION 12(a)(2)........................ 19
A. The Broker Defendants Offered and Sold the Notes............................... 20
B. Plaintiffs Have Alleged That the Sale of the Notes Was By
Means of a “Prospectus” ................................................................................ 22
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C. Plaintiffs Have Sufficiently Alleged Material Misstatements
and Omissions of Fact..................................................................................... 23
1. This Court Already Considered The Misstatements and
Omissions in the SEC Case ............................................................... 23
2. Plaintiffs Allege Material Misstatements and Omissions
in the PPMs............................................................................................ 24
3. The Alleged Misstatements and Omissions Are Material ......... 26
4. The Purported Disclosures Do Not Insulate Defendants
From Liability ....................................................................................... 27
VI. PLAINTIFFS STATE CLAIMS UNDER SECTION 15 .................................. 29
VII. CONCLUSION ............................................................................................................ 34
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TABLE OF AUTHORITIES
Cases
ABN AMRO, Inc. v. Capital Int’l Ltd.
595 F. Supp. 2d 805 (N.D. Ill. 2008).............................................................18
Ashcroft v. Iqbal
129 S. Ct. 1937, 173 L. Ed. 2d 868 (2009)............................................. 14, 15
Basic Inc. v. Levinson
485 U.S. 224, 108 S. Ct. 978, 99 L. Ed. 2d 194 (1988) ................................26
Batwin v. Occam Networks, Inc.
2008 WL 2676364 (C.D. Cal. July 1, 2008) .................................... 29, 30, 32
Bell Atlantic Corp. v. Twombly
550 U.S. 544, 127 S. Ct. 1955, 167 L. Ed. 2d 929 (2007) ............... 14, 15, 16
Belodoff v. Netlist, Inc.
2009 WL 1293690 (C.D. Cal. April 17, 2009)....................................... 11, 15
Borden, Inc. v. Spoor Behrins Campbell & Young, Inc.
735 F. Supp. 587 (S.D.N.Y. 1990) ................................................................32
Carroll v. Fort James Corp.
470 F. 3d 1171 (5th Cir. 2006) ......................................................................21
Clinton v. Luke
2010 WL 114208 (C.D. Cal. Jan. 8, 2010)............................................. 14, 15
Cogniplex, Inc. v. Hubbard Ross, L.L.C.
2001 WL 436210 (N.D. Ill. Apr. 27, 2001)...................................................23
Cozzarelli v. Inspire Pharm. Inc.
549 F. 3d. 618 (4th Cir. 2008) .......................................................................13
Credit Suisse First Boston Corp. v. ARM Financial Group
2001 WL 300733 (S.D.N.Y. Mar. 28, 2001).................................................28
Employees’ Ret. Sys. v. Chubb Corp.
394 F.3d 126 (3d Cir. 2004) ..........................................................................13
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Erickson v. Pardus
551 U.S. 89, 127 S. Ct. 2197, 167 L. Ed. 2d 1081 (2007) ............................14
Eshelman v. Orthoclear Holdings, Inc.
2009 WL 506864 (N.D. Cal. Feb. 27, 2009).................................................17
Falkowski v. Imitation Corp.
309 F.3d 1123 (9th Cir. 2002) .......................................................................13
Fecht v. Price Co.
70 F.3d 1078 (9th Cir. 1995) .........................................................................26
Ferland v. Orange Groves of Florida, Inc.
377 F. Supp. 690 (M.D. Fla. 1974)………………………………………...25
Fisk v. SuperAnnuities, Inc.
927 F. Supp. 718 (S.D.N.Y. 1996) ......................................................... 22, 23
Fouad v. Isilon Sys., Inc.
2008 WL 5412397 (W.D. Wash. Dec. 29, 2008) ..........................................34
FTC v. Five-Star Auto Club, Inc.
97 F. Supp. 2d 502 (S.D.N.Y. 2000) .............................................................27
Gomez v. Toledo
446 U.S. 635, 100 S. Ct. 1920, 64 L. Ed. 2d 572 (1980) ..............................18
Gustafson v. Alloyd Co., Inc.
513 U.S. 561, 115 S. Ct. 1061, 131 L. Ed. 2d 1 (1995) ................................22
Hart v. Massaneri
266 F.3d 1155 (9th Cir. 2001)…………………………………………...…19
Hienergy Tech. Sec. Litig.
2005 WL 3071250 (C.D. Cal. Oct. 25, 2005)……………………….....30, 33
Hollinger v. Titan Capital Corp.
914 F.2d 1564 (9th Cir. 1990)……………………………………….....29, 33
Howard v. Everex Sys., Inc.
228 F. 3d 1057 (9th Cir. 2000) ......................................................... 29, 30, 33
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In re Alliance Equip. Lease Program Sec. Litig.
2007 WL 627950 (S.D. Cal. Feb. 23, 2007)..................................................17
In re Amgen Inc. Sec. Litig.
544 F. Supp. 2d 1009 (C.D. Cal. 2008).........................................................29
In re Charles Schwab Corp. Sec. Litig.
257 F.R.D. 534 (N.D. Cal. 2009) ............................................... 12, 20, 30, 32
In re Countrywide Fin. Corp. Sec. Litig.
588 F. Supp. 2d 1132 (C.D. Cal. 2008).................................................. 11, 30
In re Daou Sys., Inc.
411 F.3d 1006 (9th Cir. 2005) ................................................................ 10, 13
In re DDI Corp. Sec. Lit.
2005 WL 3090882 (C.D. Cal. July 21, 2005) ...............................................20
In re Digital Island Sec. Litig.
223 F. Supp. 2d 546 (D. Del. 2002) ..............................................................33
In re Downey Sec. Litig.
2009 WL 2767670 (C.D. Cal. Aug. 21, 2009) ..............................................34
In re Enron Corp. Sec., Derivative & “ERISA” Litig.
310 F. Supp.2d 819 (S.D. Tex. 2004)............................................................23
In re Giant Interactive Group, Inc. Sec. Litig.
643 F. Supp. 2d 562 (S.D.N.Y. 2009) ...........................................................29
In re Glenfed, Inc. Sec. Litig.
42 F.3d 1541 (9th Cir. 1994) .........................................................................12
In re Harmonic, Inc. Sec. Litig.
163 F. Supp. 2d 1079 (N.D. Cal. 2001).........................................................13
In re Heritage Bond Litig.
2004 WL 1638201 (C.D. Cal. July 12, 2004) ...............................................27
In re Immune Response Sec. Litig.
375 F. Supp. 2d 983 (S.D. Cal. 2005) .............................................. 20, 26, 28
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In re Infonet Services Corp. Sec. Litig.
310 F. Supp. 2d 1080 (C.D. Cal. 2003)………………………………...13
In re Leadis Technology, Inc.
2006 WL 496039 (N.D. Cal. March 1, 2006) ...............................................12
In re Musicmaker.com Sec. Litig.
2001 WL 34062431 (C.D. Cal. June 4, 2001)...............................................32
In re Prudential Sec. Ltd. Pshps. Litig
930 F. Supp. 68 (S.D.N.Y. 1996) ..................................................................28
In re Shoretel Inc., Sec. Litig.
2009 WL 248326 (N.D. Cal. Feb. 2, 2009)..................................................11
In re Stac Electronics Sec. Litig.
89 F.3d 1399 (9th Cir. 1996) .........................................................................13
In re UTStarcom, Inc. Sec. Litig.
617 F. Supp. 2d 964 (N.D. Cal. 2009)...........................................................31
In re Washington Mutual, Inc. Sec., Derivative & ERISA Litig.
259 F.R.D. 490 (W.D. Wash. 2009) ....................................................... 11, 30
Jacobson v. Schwarzenegger
357 F. Supp. 2d 1198 (C.D. Cal. 2004).........................................................18
Kearns v. Ford Motor Co.
567 F. 3d 1120 (9th Cir. 2009) ......................................................................21
Lewis v. Walston & Co.
487 F.2d 617 (5th Cir. 1973) .........................................................................17
Lone Star Ladies Inv. Club v. Schlotzsky’s Inc.
238 F.3d 363 (5th Cir. 2001) .........................................................................11
Lopes v. Vieira
488 F. Supp. 2d 1000 (E.D. Cal. 2007) .........................................................22
Lopes v. Vieira
543 F. Supp. 2d 1149 (E.D. Cal. Mar. 13, 2008) ................................... 18, 22
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Meckenstock v. International Heritage, Inc.
1998 U.S. Dist. LEXIS 21042 (E.D.N.C. Dec. 9, 1998)...............................26
Melder v. Morris
27 F.3d 1097 (5th Cir. 1994) .........................................................................13
Metzler Inc GMBH v. Corinthian Colleges, Inc.
540 F. 3d 1049 (9th Cir. 2008) ......................................................................31
Miller v. Thane Int’l, Inc.
519 F.3d 879 (9th Cir. 2008) ................................................ 12, 20, 26, 28, 29
Moore v. Kayport Package Exp., Inc.
885 F. 2d. 531 (9th Cir. 1989) .......................................................................21
Moss v. U.S. Secret Service
572 F.3d 962 (9th Cir. 2009) .........................................................................14
P. Stolz Family P'ship L.P. v. Daum
355 F.3d 92 (2d Cir. 2004)…………………………………...…………….19
Padilla v. Yoo
633 F. Supp. 2d 1005 (N.D. Cal. 2009).........................................................15
Patel v. Holiday Hospitality Franchising, Inc.
172 F. Supp. 2d 821 (N.D. Tex. 2001) ..........................................................12
Pinter v. Dahl
486 U.S. 622, 108 S. Ct. 2063, 100 L. Ed. 2d 658 (1988) ................. 2, 12, 21
R.J. Wolf v. Banco Nacional de Mexico
549 F. Supp. 841 (N.D. Cal. 1982)................................................................17
Safron Capital Corp. v. Leadis Technology, Inc.
2008 WL 1776407 (9th Cir. April 18, 2008).................................... 10, 11, 12
Schmidt v. Bassett Furniture Indus.
2009 WL 3380354 (E.D. Wis. Oct. 20, 2009)...............................................27
Schreiber Distrib. Co. v. Serv-Well Furniture Co., Inc.
806 F.2d 1393 (9th Cir. 1986) .......................................................................12
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Sears v. Likens
912 F.2d 889 (7th Cir. 1990) .........................................................................13
SEC v. Better Life Club of Am., Inc.
995 F. Supp. 167 (D.D.C. 1998)....................................................................27
SEC v. Medical Capital Holdings, Inc.
2010 WL 809406 (C.D. Cal. Feb. 24, 2010) .......................................... 24, 26
SEC v. Murphy
626 F.2d 633 (9th Cir. 1980) .........................................................................23
SEC v. Ralston Purina Co.
346 U.S. 119, 73 S. Ct. 981, 97 L. Ed. 1494 (1953) ................................ 2, 18
Shaw v. Digital Equip. Corp.
82 F.3d 1194 (1st Cir. 1994)..........................................................................11
Siemers v. Wells Fargo & Co.
2006 WL 2355411 (N.D. Cal. Aug. 14, 2006) ................................. 29, 32, 33
Smedley v. Reid
2010 WL 391831 (S.D. Cal. Jan. 27, 2010) ..................................................15
Steed Fin. LDC v. Nomura Sec. Int’l, Inc.
2001 WL 1111508 (S.D.N.Y. Sept. 20, 2001) ..............................................22
Swartz v. KPMG, LLP
476 F.3d 756 (9th Cir. 2007) .........................................................................12
U.S. v. AMC Entertainment, Inc.
549 F.3d 760 (9th Cir. 2008) ………………………………………………19
Vess v. Ciba-Geigy Corp. USA
317 F.3d 1097 (9th Cir. 2003) ................................................................ 10, 21
Wagner v. First Horizon Pharm. Corp.
464 F.3d 1273 (11th Cir. 2006) .....................................................................13
Webster v. Omnitrition Int’l, Inc.
79 F.3d 776 (9th Cir. 1996) .................................................................... 19, 26
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Western Fed. Corp. v. Erickson
739 F.2d 1439 (9th Cir. 1984) .......................................................................18
Williams v. WMX Tech., Inc.
112 F.3d 175 (5th Cir. 1997) .........................................................................12
Statutes
15 U.S.C. § 77e ........................................................................................................16
15 U.S.C. § 77l............................................................................................ 16, 18, 19
15 U.S.C. § 77o................................................................................................. 10, 29
15 U.S.C. §§ 77a ........................................................................................................9
17 C.F.R. § 230.405 .................................................................................................30
17 C.F.R. § 230.501 ............................................................................................ 5, 25
17 C.F.R. § 230.502……………………………………………………………...5, 6
17 C.F.R. § 230.506 ...............................................................................................5, 6
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I. INTRODUCTION
Lead Plaintiffs respectfully submit this omnibus memorandum in opposition
to motions to dismiss filed by defendants Capital Financial Services, Inc., National
Securities Corp., and Securities America, Inc. (collectively, “Broker Defendants”)
and defendants Capital Financial Holdings, Inc., National Holdings Corp.,
Securities America Financial Corp. and Ameriprise Financial, Inc. (collectively,
“Control Person Defendants”).
This action arises out of the collapse of an investment scheme in which
Medical Capital Holdings, Inc. (“MCHI”), between November 2003 and July
2009, raised approximately $2.2 billion from over 20,000 investors around the
United States. Plaintiffs sue Defendants as primary violators and control persons
under Sections 12(a)(1), 12(a)(2) and 15 of the Securities Act of 1933. Defendants
sold Plaintiffs promissory notes issued by special purpose corporations (“SPCs”)
affiliated with MCHI. Plaintiffs allege these note offerings constituted an
integrated offering, that the offering was not registered under the Securities Act,
and that no exemption from registration was available. Plaintiffs contend
Defendants’ sale to them of Medical Capital notes thus violated the Securities
Act’s prohibition on sales of unregistered securities. Plaintiffs also contend that
because each “Private Placement Memorandum” (“PPM”) distributed in
connection with the sale of Medical Capital notes contained materially misleading
statements about the sources and uses of funds, asset valuations and business
practices of MCHI and its affiliates, Defendants violated the Securities Act’s
prohibition on sales of securities by means of a misleading prospectus.
Defendants’ motions to dismiss are mainly based on their argument that
Plaintiffs have not sued the “proper defendants” and “attempt to stretch provisions
of the Securities Act … beyond the breaking point.” But Defendants are the proper
defendants because they fall squarely within the scope of “sellers” that Congress
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intended be held liable for violations of the Securities Act. The Act was designed
to protect investors by promoting the full and fair disclosure of information that
investors need to make informed decisions. See SEC v. Ralston Purina Co., 346
U.S. 119, 124, 73 S. Ct. 981, 97 L. Ed. 1494 (1953). Courts have recognized since
the passage of the Securities Act that Section 12 liability applies to brokers, who
are in a position to “control the flow of information” to investors and ensure they
are provided all material information before investing. Pinter v. Dahl, 486 U.S.
622, 646, 108 S. Ct. 2063, 100 L. Ed. 2d 658 (1988).
Defendants also seek to hold Plaintiffs to a heightened pleading standard
even though their claims are not fraud-based and Defendants cite no valid cases in
which a court has applied Rule 9(b) to a complaint alleging solely Securities Act
claims. Plaintiffs have pled a straightforward case against Defendants for selling
unregistered securities through the use of a misleading prospectus. Plaintiffs’
allegations easily satisfy the Rule 8 notice pleading standard. Defendants’
contention that Plaintiffs should be required to support their claims with
evidentiary details should be rejected, and Defendants’ motions to dismiss should
be denied.
II. FACTUAL BACKGROUND
A. The Broker Defendants Offered and Sold Medical Capital Notes
The Broker Defendants were part of a national network of broker-dealers
across the country that offered and sold Medical Capital promissory notes (“the
Notes”) to investors. The brokers received commissions based on the aggregate
principal amount of the Notes sold. ¶¶ 6, 81.1
1 All “¶ ” cites are to Plaintiffs’ Consolidated Amended Class Action Complaint
(Dkt. No. 38).
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1. The Notes
The Notes were issued by special purpose corporations (SPCs) created by
Medical Capital Holdings, Inc. (“MCHI”). The SPCs were named “Medical
Provider Financial Corporation” or “Medical Provider Funding Corporation”
followed by sequential numerical designations, such as Medical Provider Financial
Corporation I (or “MP I”). Through wholly-owned subsidiaries and the SPCs,
MCHI purportedly provided financing to healthcare providers by purchasing their
accounts receivable and by making loans to them. This case involves the Notes
issued by MP III, MP IV, MP V and MP VI.2 ¶¶ 1-5, 30, 32, 38-41.
Medical Capital initially attempted to raise funds through a registered public
offering in December 2002, but withdrew the registration statement (without
having sold any securities) because it was unable to file audited financial
statements. ¶¶ 43-48. In September 2003, after abandoning its efforts to issue
registered securities, Medical Capital began offering the Notes through the SPCs.
The offerings were all structured and conducted in a similar manner: the Notes
were priced at $1,000 and were available in several classes with different maturity
dates and interest rates; the proceeds were to be used primarily to purchase
healthcare receivables; and the purchased assets were to serve as security for the
Notes. ¶¶ 45, 49-51.
2. The Offer and Sale of the Notes to the General Public
A nationwide network of more than 60 broker-dealers, including the Broker
Defendants, offered and sold the Notes to the public by advertising in newspapers,
mailing postcards that solicited potential investors to attend meetings, and
delivering sales pitches at seminars, meetings and dinners, without regard to the
investors’ sophistication or knowledge, or whether they qualified as “accredited
2 In this brief, “Medical Capital” refers to all of the Medical Capital entities.
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investors.” ¶¶ 66, 69. For example, in the Sarasota, Florida area, a Broker
Defendant and a Medical Capital representative hosted at least six dinner meetings
to pitch the MP III, MP IV and MP V offerings. The meetings were open to
interested investors who were encouraged to bring friends and other potential
investors. There was no effort made to limit attendance to accredited investors.
About 25 potential investors attended each meeting. ¶ 70.
In the Dallas/Fort Worth, Texas area, potential investors were solicited by a
Broker Defendant through newspaper advertisements highlighting the potential
returns investors would receive if they invested in the notes. Investors who
responded to the ads were invited to lunch and dinner meetings attended by the
Broker and a Medical Capital representative. More than 50 potential investors
attended each meeting, and there was no effort to limit attendees to accredited
investors. ¶ 71.
In the Boston, Massachusetts area, one of the Broker Defendants held dinner
seminars to provide information about the Medical Capital Notes. No effort was
made to limit attendance to accredited investors. Each seminar was attended by 80
to 100 potential investors. ¶ 72.
In the Los Angeles, California area, one of the Broker Defendants mailed
postcards to potential investors with whom it had no prior relationship or dealings.
The postcards solicited individuals to attend dinner meetings. The meetings, which
were attended by approximately 25-50 potential investors, included a presentation
on a variety of investments, including the Medical Capital Notes. The Broker
Defendant collected names and phone numbers from interested investors and
called them after the meeting to ask them to invest in the Medical Capital
offerings. ¶ 73.
Written materials about investing in the Notes were disseminated and made
available to the general public on the internet. These materials were essentially the
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same as PowerPoint presentations used by the broker-dealers during the seminars,
meetings and dinners that were conducted to solicit sales of the Notes. ¶ 74.
The nationwide sales effort worked. More than 20,000 investors from all
over the United States purchased more than $2.2 billion of Medical Capital Notes.
¶ 75. Many of the investors who were offered and sold Notes had no prior
relationship with the broker-dealers. ¶ 77.
3. The Purported Exemption From Registration
The Notes were issued and sold as purportedly private offerings exempt
from registration under Rule 506 of Regulation D. ¶ 51. But this exemption did
not apply because the Notes were offered and sold to the general public, including
unaccredited investors. ¶¶ 8, 76.
Rule 506 allows a company to sell an unlimited amount of unregistered
securities as long as they (1) are not marketed through any form of “general
solicitation” or “advertising” and (2) are sold to no more than 35 investors who are
not “accredited investors.” 17 C.F.R. § 230.501 (promulgated March 10, 1988); 17
C.F.R. § 230.506 (promulgated March 20, 1989). Examples of general solicitation
and advertising include “[a]ny advertisement, article, notice or other
communication published in any newspaper, magazine or similar media” and
“[a]ny seminar or meeting whose attendees have been invited by any general
solicitation or general advertising.” 17 C.F.R. § 230.502(c) (promulgated March
16, 1982).
An accredited investor is an individual with a net worth (alone or together
with a spouse) that exceeds $1 million or an income that exceeds $200,000 in each
of the two most recent years. 17 C.F.R. § 230.501(a).3 Rule 506 requires that any
3 Other types of “accredited investors” are banks, insurance companies, or
investment companies; certain employee benefit plans; charitable organizations
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purchaser who is not an accredited investor have “such knowledge and experience
in financial and business matters that he is capable of evaluating the merits and
risks of the prospective investment.” 17 C.F.R. § 230.506(b)(2)(i)-(ii).
Unaccredited investors must also be provided before their purchase with the same
kind of information required to be included in a registration statement, including
financial information about the business and the securities. 17 C.F.R.
§ 230.502(b).
Plaintiffs allege that the Notes were offered through forms of general
solicitation and advertising and that the Notes were sold to more than 35
unaccredited investors who lacked the financial sophistication to evaluate the
merits and risks of the Notes and were not provided required information about
Medical Capital and the Notes. ¶¶ 8, 69-80.
B. The Private Placement Memoranda Contained False and
Misleading Statements
The Broker Defendants and other broker-dealers sold the Notes using a
private placement memorandum (“PPM”). Although each offering had its own
PPM, they were substantially similar in all material respects. ¶ 83. The PPMs
described the SPCs as special purpose subsidiaries created primarily to purchase,
hold and collect healthcare receivables and other assets related to the healthcare
industry. The PPMs also described, among other things, the business operations of
the Medical Capital entities, the underwriting criteria for receivables, the
receivables acquisition process, the administration and servicing of the Notes and
related assets, and the manner in which the SPC would use investor proceeds.
¶¶ 84-85.
with more than $5 million in assets; a director, executive or general partner of the
seller; and certain trusts with assets in excess of $5 million. See 17 C.F.R.
§ 230.501.
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The PPMs contained false statements and omitted material facts that were
necessary to make the statements in the PPMs describing Medical Capital and the
SPCs not misleading to investors. ¶¶ 89-121. Among other things:
The PPMs did not disclose that accounts receivable were transferred
from older SPCs to new SPCs (known as “round-tripping”) at least 301 times,
amounting to over $829 million in sales of assets from one SPC to another. ¶¶ 94-
95.
The PPMs did not disclose that Medical Capital commingled funds
between entities and overpaid for assets. ¶¶ 98-99.
The PPMs did not disclose that certain receivables purchased by SPCs
did not exist at the time of purchase, and that the SPCs thus “purchased” non-
existent receivables. ¶¶ 96-97.
The PPMs did not disclose that Medical Capital mischaracterized non-
medical collateral as medical receivables. ¶¶ 100-101.
The PPMs falsely stated that administrative fees would be paid to
Medical Capital entities only if the “collateral coverage ratio” (the NCCR)
remained at 100% after all other required payments. ¶ 88.
The PPMs did not disclose that administrative fees were improperly
paid to a Medical Capital entity based on inflated collateral values and incorrectly
calculated NCCRs. ¶¶ 116-117.
The PPMs did not disclose that Medical Capital’s accounting records
did not comply with GAAP and that Medical Capital did not keep its records in a
GAAP-compliant manner. ¶ 92-93.
The PPMs did not disclose that Medical Capital’s collateral reports
(which were provided to the Trustees of the purported collateral for the notes)
overstated assets and resulted in improper payments of administrative fees to
Medical Capital entities. ¶¶ 102-104; 116-117.
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The PPMs did not disclose that Medical Capital overstated the amount
of investor proceeds used to purchase accounts receivable. ¶ 111.
The PPMs did not disclose that Medical Capital executives considered
themselves free to spend money raised from investors on investments and
purchases not reasonably discernible from the description of Medical Capital’s
business contained in the PPMs, as reflected in Medical Capital’s investments in a
mobile phone application venture, a pornographic website advertising firm, and an
unreleased film, and Medical Capital’s purchase of a $4.5 million, 118-foot luxury
yacht for executives to host private parties. ¶¶ 105-106.
In a section entitled “Restriction on Use of Proceeds,” the PPMs
falsely stated that investor proceeds would not be used to pay administrative fees
or service fees to Medical Capital entities. ¶ 86.
The PPMs did not disclose that Medical Capital misappropriated and
wrongfully used investor funds to pay administrative fees to Medical Capital-
affiliated entities. ¶¶ 107-109.
C. Medical Capital Defaults
Starting in August 2008, MP II, MP III, MP IV and MP V began to default
on payments of interest and principal to investors. The Broker Defendants and
other broker-dealers continued to offer and sell the Notes without disclosing the
defaults. The PPM for the MP VI offering, which began in August 2008, stated
that “[MP VI’s] affiliates have never defaulted in the payment of their obligations
on these debt securities, and all interest payments on those securities were made
when due.” ¶¶ 54-55, 118-121.
On July 16, 2009, the SEC initiated an enforcement action against Medical
Capital and its principals for securities violations. At the SEC’s request, the court
appointed a receiver. The receiver’s reports detail Medical Capital’s accounting
violations, improper use of investor proceeds, and inflated collateral valuations,
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among other things. ¶¶ 56-63. The revelations about Medical Capital’s operations
include:
MP II, MP III, MP IV and MP V were in default or late in paying
principal and interest on at least $992.5 million in notes since August 2008;
Medical Capital and its executives misappropriated more than $300
million of investor funds through the improper payment of purported
administrative fees;
MP II-MP VI were never profitable and resulted in losses totaling in
excess of $316 million;
$617 million of the $625 million of accounts receivables on the books
of the SPCs at the time the receiver assumed control of Medical Capital either were
too old to be collectible or the companies that owed the money no longer existed;
and
Loans and other assets with a claimed value of almost $1 billion were
transferred between and among the SPCs to pay improper administrative fees and
to pay earlier investors from new investors’ funds. ¶ 65.
D. Plaintiffs’ Claims
Lead Plaintiffs filed this action on behalf of a class consisting of all persons
and entities who purchased or otherwise acquired Medical Capital Notes issued by
MP III, MP IV, MP V and/or MP VI that were offered and sold to them by any of
the Broker Defendants, or their affiliates, and were damaged. Plaintiffs allege that
the Broker Defendants violated Section 12(a)(1) of the Securities Act, which
prohibits the offer or sale of unregistered securities in interstate commerce, and
Section 12(a)(2), which prohibits the sale of a security by means of a prospectus
that contains an untrue statement of material fact or omits to state a material fact
necessary to make the statements not misleading. 15 U.S.C. §§ 77a(1) & a(2).
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Finally, Plaintiffs assert Section 15 claims against the Control Person Defendants,
which own and control the Broker Defendants. 15 U.S.C. § 77o.
III. LEGAL STANDARD
A. Rule 9(b) Does Not Apply to Plaintiffs’ Claims
The Broker Defendants fundamentally mischaracterize Plaintiffs’ claims by
arguing that the Securities Act claims “sound in fraud,” on the grounds that they
are based on the “unified course of fraudulent conduct perpetrated by the Medical
Capital entities.”4 Plaintiffs assert no claims against the “Medical Capital entities.”
They are not even parties to this case. Plaintiffs do not allege that any Defendants
participated in any of the fraudulent conduct that the Medical Capital entities may
have perpetrated. And Plaintiffs assert no fraud-based claims against Defendants.
Plaintiffs’ claims arise under the Securities Act. Because Securities Act
claims are not fraud-based, Rule 9(b) does not apply to Plaintiffs’ allegations. See
Safron Capital Corp. v. Leadis Technology, Inc., No. 06-15623, 274 Fed. Appx.
540, 2008 WL 1776407, at *1 (9th Cir. April 18, 2008). While courts have held
non-fraud-based claims to the higher Rule 9(b) standard if they “sound in fraud,” a
claim is deemed to sound in fraud only if a plaintiff chooses to allege “that the
defendant has engaged in fraudulent conduct,” or alleges “a unified course of
fraudulent conduct and rel[ies] entirely on that course of conduct as the basis of a
claim.” Vess v. Ciba-Geigy Corp. USA, 317 F.3d 1097, 1103 (9th Cir. 2003); see
also In re Daou Sys., Inc., 411 F.3d 1006, 1027 (9th Cir. 2005) (finding that the
plaintiffs’ complaint “sounds in fraud” because it alleged “a fraudulent scheme and
course of business by defendants” as “misrepresentations made by defendants, of
which defendants had full knowledge”). Neither basis for applying Rule 9(b)
applies to Plaintiffs’ allegations.
4 See Sec. Am. at 12; Cap. Fin. Serv. at 20-22.
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Plaintiffs do not allege that Defendants engaged in fraudulent conduct, as
Defendants themselves acknowledge.5 Courts reject the “sounds in fraud”
argument in cases like this one, where plaintiffs do not allege that the defendants
engaged in fraudulent activity. See, e.g., Leadis, 2008 WL 1776407, at *1
(reversing dismissal because the district court improperly applied Rule 9(b));
Belodoff v. Netlist, Inc., No. SACV 07-00677 DOC, 2009 WL 1293690, at *5
(C.D. Cal. April 17, 2009); In re Shoretel Inc., Sec. Litig., No. C 08-00271 CRB,
2009 WL 248326, at *2 (N.D. Cal. Feb. 2, 2009); In re Washington Mutual, Inc.
Sec., Derivative & ERISA Litig., 259 F.R.D. 490, 504 (W.D. Wash. 2009)
(“because it is possible for a defendant to participate in the dissemination of
fraudulent statements without awareness of the actual fraud, Rule 9(b) applies only
to those defendants also accused in the underlying fraud”); In re Countrywide Fin.
Corp. Sec. Litig., 588 F. Supp. 2d 1132, 1162-63 (C.D. Cal. 2008) (applying Rule
8 to claims against defendants who were not “alleged to have participated in the
fraud” because applying Rule 9(b) to those defendants would “eviscerate” Section
11). Other Circuits also hold that a properly pleaded complaint alleging only
Securities Act claims is subject to Rule 8, not Rule 9(b). See, e.g., Lone Star
Ladies Inv. Club v. Schlotzsky’s Inc., 238 F.3d 363, 368-69 (5th Cir. 2001); Shaw
v. Digital Equip. Corp., 82 F.3d 1194, 1222-23 (1st Cir. 1994).
Nor do Plaintiffs rely on an alleged unified course of conduct as the basis for
their claims. Plaintiffs’ claims against the Broker Defendants are based on their
status as offerors and sellers of the Notes. To “promote full and fair disclosure of
5 See Sec. Am. at 17 (“Securities America’s alleged role in devising the underlying
fraud scheme, or in preparing the documents containing the alleged
misrepresentations or omissions, is non-existent.”); Cap. Fin. Serv. at 6 (“CFS is
not alleged to have created or issued the PPMs or any other offering documents
issued by Medical Capital or the Medical Capital Entities.”).
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information to the public in the sales of securities,” the Securities Act imposes
liability on sellers for negligent or even innocent conduct. Pinter, 486 U.S. at 646;
see also Miller v. Thane Int’l, Inc., 519 F.3d 879, 886 (9th Cir. 2008) (“Section
12(a)(2) is a virtually absolute liability provision”). Plaintiffs’ claims against the
Broker Defendants are based on negligent conduct or the absolute liability imposed
by Section 12 of the Securities Act, and do not rely on any alleged unified course
of fraudulent conduct. See In re Charles Schwab Corp. Sec. Litig., 257 F.R.D.
534, 545 (N.D. Cal. 2009) (“This order declines to characterize the claims as
necessarily sounding in fraud where plaintiffs have not expressly pled fraud and
have pled non-fraud bases for liability.”).
Defendants cite only one Ninth Circuit case in which a court applied Rule
9(b) to a complaint asserting only Securities Act claims. But the district court’s
application of 9(b) in that case, In re Leadis Technology, Inc., No. C-05-00882
CRB, 2006 WL 496039 (N.D. Cal. March 1, 2006), was reversed by the Ninth
Circuit because the plaintiffs did not rely upon a unified course of fraudulent
conduct as the basis for their claims. Leadis, 2008 WL 1776407, at *1.
Defendants also cite cases that do not involve Securities Act claims. See Swartz v.
KPMG, LLP, 476 F.3d 756, 764-65 (9th Cir. 2007) (RICO and fraud claims);
Williams v. WMX Tech., Inc., 112 F.3d 175, 178 (5th Cir. 1997) (RICO and 10b-5
claims); In re Glenfed, Inc. Sec. Litig., 42 F.3d 1541, 1547-48 (9th Cir. 1994) (en
banc) (Section 10(b) claim); Schreiber Distrib. Co. v. Serv-Well Furniture Co.,
Inc., 806 F.2d 1393, 1401 (9th Cir. 1986) (RICO claim); Patel v. Holiday
Hospitality Franchising, Inc., 172 F. Supp. 2d 821, 824 (N.D. Tex. 2001)
(common law fraud claim).
Every other decision Defendants cite involve a complaint that asserts fraud-
based claims (such as a 10(b) Exchange Act claim or RICO) in addition to
Securities Act claims (or other statutory non-fraud claims), and bases both claims
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on the same factual allegations. See, e.g., Cozzarelli v. Inspire Pharm. Inc., 549 F.
3d. 618, 629 (4th Cir. 2008) (“plaintiffs’ [Securities Act] allegations … are exactly
the same as plaintiffs’ allegations of fraud under the Exchange Act”); Wagner v.
First Horizon Pharm. Corp., 464 F.3d 1273, 1278 (11th Cir. 2006) (applying Rule
9(b) where Securities Act and Exchange Act claims were based on the same
allegations, and declining to consider plaintiffs’ belated argument that Rule 8
should apply to the claims against the underwriter defendants who are not alleged
to have acted fraudulently); Daou, 411 F.3d at 1028 (“the complaint makes a
‘wholesale’ adoption of the securities fraud allegations for purposes of the
Securities Act claims”); Employees’ Ret. Sys. v. Chubb Corp., 394 F.3d 126, 160 &
n.24 (3rd Cir. 2004) (applying Rule 9(b) to Securities Act claims that incorporated
factual allegations of Exchange Act claims); Falkowski v. Imitation Corp., 309
F.3d 1123, 1133-34 (9th Cir. 2002) (applying Rule 9(b) to complaint that asserted
both Securities Act and Exchange Act claims); In re Stac Electronics Sec. Litig.,
89 F.3d 1399, 1405 n.2 (9th Cir. 1996) (“the gravamen of the complaint is plainly
fraud and no effort is made to show any other basis for the claims levied at the
Prospectus”); Melder v. Morris, 27 F.3d 1097, 1100 n.6 (5th Cir. 1994) (applying
Rule 9(b) to Securities Act claims “in light of the complaint’s wholesale adoption
of the allegations under the securities fraud claims”); Sears v. Likens, 912 F.2d
889, 892-93 (7th Cir. 1990) (applying Rule 9(b) to complaint alleging RICO,
Exchange Act and Securities Act claims); In re Infonet Services Corp. Sec. Litig.,
310 F. Supp. 2d 1080, 1094 (C.D. Cal. 2003) (applying Rule 9(b) because the
Securities Act and Section 10(b) claims “relie[d] on the same allegations”); In re
Harmonic, Inc. Sec. Litig., 163 F. Supp. 2d 1079, 1088-89 & n.8 (N.D. Cal. 2001)
(applying Rule 9(b) to Securities Act claims because the plaintiffs alleged that the
defendants knew statements in the prospectus were false in case also involving
Exchange Act claims).
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B. Plaintiffs’ Claims Satisfy the Notice Pleading Standard of Rule 8
Rule 8(a)(2) requires a complaint to state a “short and plain statement of the
claim showing that the pleader is entitled to relief.” The Supreme Court revisited
Rule 8 and Rule 12(b)(6) in Bell Atlantic Corp. v. Twombly, 550 U.S. 544, 127 S.
Ct. 1955, 167 L. Ed. 2d 929 (2007) and Ashcroft v. Iqbal, 129 S. Ct. 1937, 173 L.
Ed. 2d 868 (2009). The Court held that a well-pleaded complaint “does not require
‘detailed factual allegations,’” but must include “sufficient factual matter…to
‘state a claim to relief that is plausible on its face.’” Iqbal, 129 S. Ct. at 1949
(quoting Twombly, 550 U.S. at 570); see also Clinton v. Luke, No. CV 08-4179-
DOC (OP), 2010 WL 114208, at *3 (C.D. Cal. Jan. 8, 2010). A complaint need
only state “enough facts to raise a reasonable expectation that discovery will reveal
evidence” to prove the claim. Twombly, 550 U.S. at 556.
Defendant Securities America characterizes Twombly as “usher[ing]” in a
new “fact-intensive test” for assessing the sufficiency of a complaint. Sec. Am. at
6. On the contrary, as the Ninth Circuit recently observed, the decision “should not
be read as effecting a sea change in the law of pleadings.” Moss v. U.S. Secret
Service, 572 F.3d 962, 968 (9th Cir. 2009). While a court need not accept “a legal
conclusion couched as a factual allegation,” Iqbal, 120 S. Ct. at 1949-50 (quoting
Twombly, 550 U.S. at 555), the Supreme Court made it clear that a complaint
“should not be found deficient even if it is apparent ‘that a recovery is very remote
and unlikely.’” Moss, 572 F.3d at 968 (quoting Twombly, 550 U.S. at 556).
Moreover, “[s]pecific facts are not necessary” to satisfy the requisites of Rule
8(a)(2). Erickson v. Pardus, 551 U.S. 89, 93, 127 S. Ct. 2197, 167 L. Ed. 2d 1081
(2007); see also Clinton, 2010 WL 114208, at *3 (citing Erickson, among other
cases, for the standards on a Rule 12(b)(6) motion).
Recent decisions of this Court and other courts in this Circuit have followed
Twombly’s guidance. See, e.g., Clinton, 2010 WL 114208, at *3 (a “complaint
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does not need detailed allegations”); Smedley v. Reid, No. 08cv1602 BTM (BLM),
2010 WL 391831, at *7 (S.D. Cal. Jan. 27, 2010) (a pleading is not deficient
“merely because ‘recovery is very remote and unlikely’”) (quoting Twombly, 550
U.S. at 557); Padilla v. Yoo, 633 F. Supp. 2d 1005, 1018-19 (N.D. Cal. 2009) (“To
survive a motion to dismiss, a complaint need not provide detailed factual
allegations.”).
On a Rule 12(b)(6) motion, a court “must accept as true all factual
allegations in the complaint and must draw all reasonable inferences from those
allegations, construing the complaint in the light most favorable to the plaintiff.”
Belodoff, 2009 WL 1293690, at *3 (citations omitted). A claim is sufficient for
purposes of Rule 12(b)(6) when its “factual content … allows the court to draw the
reasonable inference that the defendant is liable for the misconduct alleged.”
Iqbal, 129 S. Ct. at 1949 (citing Twombly, 550 U.S. at 556). Plaintiffs’ pleading
burden is simply to allege facts, accepted as true, from which reasonable inferences
can be drawn to plausibly support the elements of their claims. Twombly, 550 U.S.
at 562 (“a complaint … must contain either direct or inferential allegations
respecting all the material elements necessary to sustain recovery under some
viable legal theory”) (citation omitted); see also Clinton, 2010 WL 114208, at *3
(a court must determine whether the “factual allegations and reasonable inferences
from them plausibly support a claim for relief”).
In an effort to escape the “virtually absolute” liability imposed by the
Securities Act, Defendants misapply Twombly by arguing that an “equally
possible” and “certainly plausible” interpretation of the facts is that Plaintiffs lost
their investments “through no fault of any” Defendant. See Sec. Am. at 16; Cap.
Fin. Serv. at 13-14. But Plaintiffs are not required to allege facts or otherwise
demonstrate that their right to recover is “more plausible than not” or more
plausible than any inference the Defendants may propose. See Twombly, 550 U.S.
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at 570 (complaint must allege “only enough facts to state a claim to relief that is
plausible on its face” but “[a]sking for plausible grounds . . . does not impose a
probability requirement at the pleading stage”); Clinton, 2010 WL 114208, at *3
(the “plausibility standard is not a probability requirement”). The plausibility
analysis is not comparative, but instead addresses whether the allegations “nudge[]
[the] claims across the line from conceivable to plausible.” Twombly, 550 U.S. at
547.
Plaintiffs’ factual allegations easily satisfy the Rule 8 pleading standards and
Defendants’ motions should be denied.
IV. PLAINTIFFS STATE CLAIMS UNDER SECTION 12(a)(1)
A. Defendants Do Not Dispute That Plaintiffs Have Adequately
Alleged the Elements of a Section 12(a)(1) Claim
Section 12 of the Securities Act creates liability for the sale of unregistered
securities. Section 12(a)(1) holds sellers strictly liable for the unlawful sale of an
unregistered security:
Any person who … offers or sells a security in violation of
section 77e of this title ... shall be liable ... to the person
purchasing such security from him, who may sue either at law or
in equity in any court of competent jurisdiction, to recover the
consideration paid for such security with interest thereon, less the
amount of any income received thereon, upon the tender of such
security, or for damages if he no longer owns the security.
15 U.S.C. § 77l(a)(1) (emphasis added). Section 77e states, in relevant part:
It shall be unlawful for any person, directly or indirectly, to
make use of any means or instruments of transportation or
communication in interstate commerce or of the mails to offer to
sell or offer to buy through the use or medium of any prospectus
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or otherwise any security, unless a registration statement has
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15 U.S.C. § 77e(c) (emphasis added).
Plaintiffs’ burden in pleading a violation of Section 12(a)(1) is modest.
Plaintiffs must allege: (1) that the securities were not registered; (2) the offer or
sale of the securities; and (3) the use of interstate transportation or communication
or the mails in connection with the offer or sale. See, e.g., In re Alliance Equip.
Lease Program Sec. Litig., Civ. No. 98cv2150 J(NLS), 2007 WL 627950, at *3
(S.D. Cal. Feb. 23, 2007); see also R.J. Wolf v. Banco Nacional de Mexico, 549 F.
Supp. 841, 853 (N.D. Cal. 1982), rev’d on other grounds, 739 F.2d 1458 (9th Cir.
1984) (“Liability under this section is ‘absolute’; a purchaser may recover damages
‘regardless of whether he can show any degree of fault, negligent or intentional, on
the seller’s part.’”) (quoting Lewis v. Walston & Co., 487 F.2d 617, 621 (5th Cir.
1973)).
Defendants do not argue that Plaintiffs have insufficiently pled any of these
elements of their claims. They do not dispute that the Notes were unregistered,
that the Broker Defendants offered or sold the Notes, or that interstate
transportation or the mails were used in connection with the offer and sale of the
Notes.
Instead, Defendants argue that Plaintiffs have insufficiently alleged that the
Notes should have been registered at the time Plaintiffs purchased them. Sec. Am.
at 9. In the only case they cite to support this argument, the court found that the
plaintiffs lacked standing to pursue a Section 12(a)(1) claim because the plaintiffs
alleged that the sale “became illegal after they made the purchases.” Eshelman v.
Orthoclear Holdings, Inc., No. C 07-1429 JSW, 2009 WL 506864, at *11 (N.D.
Cal. Feb. 27, 2009) (emphasis added). The court dismissed the claim because
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“[t]here is no allegation in the complaint that the Plaintiffs themselves were offered
or sold securities in violation of the registration requirements.” Id.
Unlike Eshelman, Plaintiffs do allege that, at the time of their purchases,
they were sold securities in violation of the registration requirements. See ¶ 16
(“Prior to the time of Mr. Mitchell’s purchases of MP V Notes, a violation of
Section 5 of the Securities Act had occurred.”); see also ¶¶ 15, 17-20. Plaintiffs
have also alleged that the Notes were sold publicly by at least the time of the first
offering at issue in this case, MP III. See ¶ 70.
Defendants characterize Plaintiffs’ allegations as conclusory, but in making
this argument Defendants are trying to evade their own burden of proving that the
notes were exempt from the registration requirement. Defendants have the burden
of proving a valid registration exemption as an affirmative defense. See, e.g.,
Ralston Purina, 346 U.S. at 126-27; Western Fed. Corp. v. Erickson, 739 F.2d
1439, 1442 (9th Cir. 1984) (granting summary judgment for plaintiff); Lopes v.
Vieira, 543 F. Supp. 2d 1149, 1170 (E.D. Cal. Mar. 13, 2008) (“Plaintiffs are not
required to allege that the offering failed to meet the safe harbor requirements of
Rules 505 or 506 because the burden of claiming an exemption to the registration
requirements falls on the Defendants, not the Plaintiffs.”). “[E]xemption is an
affirmative defense” and Plaintiffs “need not anticipate affirmative defenses” in
their complaint. ABN AMRO, Inc. v. Capital Int’l Ltd., 595 F. Supp. 2d 805, 833
(N.D. Ill. 2008); see also Jacobson v. Schwarzenegger, 357 F. Supp. 2d 1198, 1217
(C.D. Cal. 2004) (“Federal pleading rules generally do not require a plaintiff to
anticipate and plead around an affirmative defense”) (citing Gomez v. Toledo, 446
U.S. 635, 640, 100 S. Ct. 1920, 64 L. Ed. 2d 572 (1980)).
B. Plaintiffs’ Claims Are Timely
Defendants contend that Plaintiffs’ claim is time barred because the first
complaint was filed more than one year after the Plaintiffs’ purchases of the Notes.
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In the Ninth Circuit, however, “[c]laims under §§ 12[(a)](1) and 12[(a)](2) of the
Securities Act of 1933 (15 U.S.C. §§ 77l(1) and 77l(2)) must be brought within one
year of the plaintiff’s discovery of the allegedly illegal sale or false statement,
respectively.” Webster v. Omnitrition Int’l, Inc., 79 F.3d 776, 788 (9th Cir. 1996)
(emphasis added). Plaintiffs could not have discovered the illegal sale of the Notes
until, at the earliest, July 16, 2009, when the SEC filed its case against Medical
Capital for securities violations. See ¶¶ 55-56, 120-21. This is well within one
year of the filing of the first complaint on September 18, 2009.
Unlike Webster v. Omnitrition, the cases Defendants cite from other circuits
are not binding precedent. See Sec. Am. at 8; Cap. Fin. Serv. at 9. See also Hart v.
Massaneri, 266 F.3d 1155, 1170-71, 1180 (9th Cir. 2001); U.S. v. AMC
Entertainment, Inc., 549 F.3d 760, 771 (9th Cir. 2008) (“it goes without saying that
we expect our pronouncements will be the final word within the Ninth Circuit’s
geographical area, subject only to en banc or Supreme Court review.”). P. Stolz
Family P’ship L.P. v. Daum is also distinguishable because it addresses the three-
year statute of repose, not the one-year statute of limitations. 355 F.3d 92, 98-99
(2d Cir. 2004).
V. PLAINTIFFS STATE CLAIMS UNDER SECTION 12(a)(2)
Section 12(a)(2) imposes liability on any person who offers to sell or sells a
security by means of a prospectus containing untrue statements or material
omissions. 15 U.S.C. § 77l(a)(2). To state a Section 12(a)(2) claim, Plaintiffs
must plead: (1) an offer or sale of a security, (2) by the use of a means or
instrumentality of interstate commerce, (3) by means of a prospectus or oral
communication (4) that includes an untrue statement of material fact or omits to
state a material fact that is necessary to make the statements not misleading. See
Miller, 519 F. 3d at 885; In re Immune Response Sec. Litig., 375 F. Supp. 2d 983,
1038 (S.D. Cal. 2005).
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The Broker Defendants do not challenge the first two elements of Plaintiffs’
claim (an offer or sale of a security and use of interstate means). They assert only
that the PPMs were not “prospectuses” and that the PPMs did not contain
misstatements or omissions of fact. As discussed below, Plaintiffs sufficiently
allege each of the elements of a Section 12(a)(2) claim and the motions to dismiss
this claim should be denied.
A. The Broker Defendants Offered and Sold the Notes
The Broker Defendants do not contest their status as “offerors” and “sellers”
of the Notes, nor can they. Plaintiffs allege that the Broker Defendants offered and
sold the Notes in interstate commerce. See ¶¶ 15-20; 66-80, 131-151. Although
not required to, Plaintiffs have also alleged which Broker Defendant sold the Notes
to each of the named Plaintiffs. ¶¶ 15-20. Plaintiffs have also filed certifications
with this Court that identify the dates of Plaintiffs’ purchases, the amounts
invested, the price per Note, and the number of Notes purchased. See Dkt. No. 15,
Exs. B-G. Nothing more is required. See Schwab, 257 F.R.D. at 549-50
(allegation “that defendants ‘actively solicited the sale of the fund’s shares’ and
that certain defendants were involved in marketing the fund” was sufficient); see
also In re DDI Corp. Sec. Lit., 2005 WL 3090882, at *19-20 (C.D. Cal. July 21,
2005) (at the pleading stage, “Plaintiffs need not allege ‘which underwriter sold
securities to each plaintiff’”).
The Broker Defendants nonetheless assert that they are not the “proper
defendants,” pointing to the Medical Capital defendants in the SEC case. See Sec.
Am. at 1; Cap. Fin. Serv. at 2. The Broker Defendants misconstrue the nature of a
Section 12 claim. Brokers fall squarely within the scope of the “sellers” that
Congress intended to hold liable. “The applicability of § 12 liability to brokers and
others who solicit securities purchases has been recognized frequently since the
passage of the Securities Act.” Pinter, 486 U.S. at 646; see also Moore v. Kayport
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Package Exp., Inc., 885 F. 2d. 531, 536 (9th Cir. 1989) (Section 12 claim was
stated against brokers who allegedly “distributed sales promotion data”). As the
Supreme Court recognized, this is due to the broker’s critical role in a securities
purchase: “The solicitation of a buyer is perhaps the most critical stage of the
selling transaction. It is the first stage of a traditional securities sale to involve the
buyer, and it is directed at producing the sale.” Pinter, 486 U.S. at 646. Brokers
are “well positioned to control the flow of information to a potential purchaser,
and, in fact, such persons are the participants in the selling transaction who most
often disseminate material information to investors.” Id. The broker’s sale to an
investor is “the stage at which an investor is most likely to be injured, that is, by
being persuaded to purchase securities without full and fair information.” Id. at
646-47.
Because brokers may be held liable under Section 12 even if they had no
role in drafting the material misstatements or omissions at issue, Capital Financial
Services’ argument that Plaintiffs failed to identify which Broker Defendant “made
material misstatements or omissions” in the PPMs is irrelevant. See Cap. Fin.
Serv. at 21-22. Equally misplaced is Defendants’ argument that Plaintiffs must
specify the “time” and “place” of the alleged misrepresentations, for which they
cite Rule 9(b) cases that do not address Securities Act claims. See, e.g., Kearns v.
Ford Motor Co., 567 F. 3d 1120, 1125 (9th Cir. 2009) (the plaintiff alleged “that
Ford engaged in a fraudulent course of conduct” in violation of California law);
Carroll v. Fort James Corp., 470 F. 3d 1171, 1174 (5th Cir. 2006) (addressing
plaintiff’s common law fraud claim); Vess, 317 F. 3d. at 1101 (allegations of a
fraudulent conspiracy under California law).
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B. Plaintiffs Have Alleged That the Sale of the Notes Was By Means
of a “Prospectus”
Defendant Capital Financial Services argues that “Section 12 of the
Securities Act applies to a prospectus (i.e., public offering), not a private
placement as in this matter.” Cap. Fin. Serv. at 10. But the self-serving label an
issuer may place on a purportedly private offering is not dispositive. Gustafson v.
Alloyd Co., Inc., 513 U.S. 561, 569, 115 S. Ct. 1061, 131 L. Ed. 2d 1 (1995); see
also Fisk v. SuperAnnuities, Inc., 927 F. Supp. 718, 730 (S.D.N.Y. 1996). In
Gustafson, the Supreme Court held that Section 12(a)(2) liability may arise from
any document that would be required to contain the information in a registration
statement, but for the operation of a valid registration exemption. 513 U.S. at 584.
In other words, any offering document is a “prospectus” if it is used to offer
securities in either a registered offering or an offering that should have been
registered. See Lopes v. Vieira, 488 F. Supp. 2d 1000, 1024 (E.D. Cal. 2007).
Plaintiffs allege that the Medical Capital PPMs—although labeled “private
placements”—were used to offer the Notes to the public. See ¶¶ 69-74. Plaintiffs
also allege that the offerings were not registered and did not qualify for exemption
under Rule 506 of Regulation D. See ¶¶ 8, 15-20, 69-80. Courts uphold Section
12(a)(2) claims where a complaint, like Plaintiffs’ complaint, alleges that the
purported private placements were in fact unregistered public offerings. See, e.g.,
Lopes, 543 F. Supp. 2d at 1169 (denying motion to dismiss because plaintiff’s
allegation that the defendants “approached a large number of potential investors in
a fashion that constituted ‘general solicitation or advertising’” sufficiently pled a
public offering); Steed Fin. LDC v. Nomura Sec. Int’l, Inc., No. 00 CIV 8058
(NRB), 2001 WL 1111508, at *6 (S.D.N.Y. Sept. 20, 2001) (denying motion to
dismiss because “while the offering pursuant to the PPM here was structured on its
face to come within the Section 4(2) exemption,” it is premature to reach
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“conclusions at this stage”); Fisk, 927 F. Supp. at 730 (denying motion to dismiss
where the plaintiff alleged that purportedly exempt offering was not “a bona fide
private placement”).
Courts also widely recognize that determining whether an offering was
public or private involves “fact-intensive inquiries” that “are not appropriate …
under a motion to dismiss,” particularly because the burden of proving an
exemption is on the defendant. In re Enron Corp. Sec., Derivative & “ERISA”
Litig., 310 F. Supp.2d 819, 866 (S.D. Tex. 2004) (“discovery and submission of
evidence are essential before such a determination can be made”); see also SEC v.
Murphy, 626 F.2d 633, 644-48 (9th Cir. 1980) (applying a “flexible test” for
determining whether private offering exemption applies and affirming summary
judgment for SEC because the defendant failed to meet his burden of proof);
Cogniplex, Inc. v. Hubbard Ross, L.L.C., 2001 WL 436210, at *12 (N.D. Ill. Apr.
27, 2001) (because the “public/private offering determination requires a careful
analysis of all facts and surrounding circumstances,” which is not appropriate for
resolution on a motion to dismiss, “we think it prudent to allow discovery to go
forward so that we may conduct the intensive factual analysis warranted under the
case law”).
C. Plaintiffs Have Sufficiently Alleged Material Misstatements and
Omissions of Fact
1. This Court Already Considered The Misstatements and
Omissions in the SEC Case
In the related SEC action, this Court held that the SEC had sufficiently
alleged false and misleading statements in the PPM and Supplemental Private
Placement Memorandum for MP VI:
The FAC [First Amended Complaint] [] specifically sets forth
statements made in those documents that were false at the time they
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were made and how the documents were misleading through a failure
to disclose certain information. See, e.g., id. ¶ 28 (the SPPM
misrepresented how the note offering’s proceeds had been used); ¶ 33-
34 (PPM misrepresented the default history of prior offerings).
SEC v. Medical Capital Holdings, Inc., No. SACV 09-0818 (DOC), 2010 WL
809406, at *2 (C.D. Cal. Feb. 24, 2010).
Plaintiffs identify largely the same misstatements and omissions that this
Court has already found to be actionable. Although the SEC action only concerned
MP VI, the PPMs are “substantially similar in all material respects.” ¶ 83.6 For
the same reasons stated in its SEC Order, the Court should hold that Plaintiffs have
sufficiently alleged material misstatements and omissions of fact in the PPMs.
2. Plaintiffs Allege Material Misstatements and Omissions in
the PPMs
Plaintiffs have identified specific material misstatements and omissions of
fact contained in the PPMs that were distributed to investors at the time of their
purchases. These misstatements and omissions concerned, for example, the
business operations of the SPCs, Medical Capital’s accounting irregularities and
failures, improper investments in pet projects and waste of corporate assets on
personal luxuries, and the misuse of investor proceeds to pay administrative fees.
¶¶ 89-122.
Contrary to Securities America’s argument, Plaintiffs have pled sufficient
details to show that these misstatements and omissions were false or misleading
when made. See Sec. Am. at 19-20. For example, Plaintiffs allege that the PPMs
failed to disclose Medical Capital’s accounting irregularities and failures, including
6 The MP III, MP IV and MP V PPMs that Capital Financial Services filed with its
motion confirm the substantial similarity of the PPMs.
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the fact that its accounting records did not comply with GAAP. ¶¶ 91-93. This
fact is specific, existed at all times relevant to the offerings at issue in the case, and
is readily discernable from the PPMs for those offerings, none of which disclose
Medical Capital’s lack of compliance with GAAP. ¶ 93. The complaint provides
specific examples of the GAAP violations, including at least 301 sham “round-
trip” transactions among SPCs totaling more than $829 million that were used to
inflate accounts receivables. ¶ 94.
Capital Financial Services argues that the PPMs could not have included
false or misleading statements about GAAP violations because each SPC was a
“new entity” with “no” or “limited” prior operating history. See Cap. Fin. Serv. at
16. As Plaintiffs allege, the SPCs were wholly-owned “subsidiaries” of Medical
Capital and the “private placements” constituted an integrated offering under the
securities laws. ¶ 67. A single Medical Capital affiliate (MCC) served as the
“Administrator” for all of the SPCs and another (MTSI) provided related
administrative services for the SPCs. ¶¶ 36-41, 43-53, 66-67. The historical
failure of Medical Capital entities to maintain GAAP-compliant accounting records
was material information that should have been disclosed. See ¶¶ 47, 91-93, 100.7
Plaintiffs have pled their complaint in accordance with Rule 8’s notice
pleading standards and therefore did not include all of the information and
evidence available in the Receiver’s reports and the SEC complaint. Exhibit 2 to
the Receiver’s August 14, 2009 report, for example, sets forth the details of each of
7 Although Securities America asserts in a footnote that Plaintiffs’ claim fails “to
the extent that” Plaintiffs do not provide proof of the falsity of “forward-looking
statements,” Securities America does not identify any allegations as forward-
looking and cites only a case that was decided after a full evidentiary hearing and
has no application to this motion. See Sec. Am. at 15 n. 6 (citing Ferland v.
Orange Groves of Florida, Inc., 377 F. Supp. 690, 692-93 (M.D. Fla. 1974)).
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the 301 “round-trip” transactions, which date back to November 2003—well
before the first PPM at issue in this case was disseminated.8 Defendants contend
that Plaintiffs’ complaint should include such evidentiary detail. Should the Court
find additional details are required, Plaintiffs request leave to amend.
3. The Alleged Misstatements and Omissions Are Material
Securities America also challenges the materiality of the false and
misleading statements that Plaintiffs have identified. See Sec. Am. at 19-20. But
“[a]ssessing materiality is a ‘fact-specific inquiry’ that ‘depends on the
significance the reasonable investor would place on the withheld or misrepresented
information.’” Miller, 519 F.3d at 889 (quoting Basic Inc. v. Levinson, 485 U.S.
224, 240, 108 S. Ct. 978, 99 L. Ed. 2d 194 (1988)) (noting that “[t]he district court
received testimony from both sides’ experts on the question of materiality”).
Whether a document is misleading “may be determined as a matter of law only
when reasonable minds could not disagree as to whether the mix of information in
the document is misleading.” Fecht v. Price Co., 70 F.3d 1078, 1082 (9th Cir.
1995). Therefore, the determination of “whether a statement is misleading …
should be left to the trier of fact.” Immune Response, 375 F. Supp. 2d at 1039.
Numerous courts have concluded that the fact one is investing in a Ponzi or
pyramid scheme is material to a reasonable investor. See, e.g., Omnitrition, 79
F.3d at 785 (reversing summary judgment of plaintiff’s securities claims because
“a company which promotes an inherently fraudulent pyramid scheme ‘omits to
state a material fact’ for purposes of § 12(2) when it does not explain that the
program is bound to collapse”); Meckenstock v. International Heritage, Inc., No.
5:98-CV-237-BR(2), 1998 U.S. Dist. LEXIS 21042, at *14-15 (E.D.N.C. Dec. 9,
8 SEC v. Medical Capital Holdings, Inc., Central District of California Case No.
SACV 09-818 DOC, Docket No. 40.
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1998) (addressing motion to dismiss Section 10(b) claim: “[A] reasonable investor
could consider the existence of a pyramid scheme and Defendants’ failure to
comply with SEC requests as material to the decision to invest …. Therefore,
whether Defendants’ alleged misstatements and omissions were material is a
question for the jury to decide.”); SEC v. Better Life Club of Am., Inc., 995 F.
Supp. 167, 177 (D.D.C. 1998) (holding that “there is no question” that the fact that
an investment was a pyramid scheme is material to a reasonable investor); see also
In re Heritage Bond Litig., No. 02-ML-1475 DT, 2004 WL 1638201, at *4 (C.D.
Cal. July 12, 2004) (certifying a class of investors in an alleged Ponzi scheme
because “the existence and nature of the material omissions/false and misleading
statements in the Official Statements and the question of whether these bonds
could have been marketed at all if the truth was known present nearly identical
issues”); Schmidt v. Bassett Furniture Indus., No. 08-C-1035, 2009 WL 3380354,
at *13 (E.D. Wis. Oct. 20, 2009) (finding that plaintiffs’ allegation that defendants
failed to disclose the existence of a “Ponzi-like scheme” was a material fact for
purposes of fraud conspiracy claim); FTC v. Five-Star Auto Club, Inc., 97 F. Supp.
2d 502, 53233 (S.D.N.Y. 2000) (failure to disclose existence of pyramid scheme
was a material omission for purposes of the FTC Act).
4. The Purported Disclosures Do Not Insulate Defendants
From Liability
Defendant Capital Financial Services’ argument that all of the alleged
misstatements and omissions were disclosed or the subject of “warnings” in the
PPMs cannot be resolved on a motion to dismiss. Citing no case law, Capital
Financial Services makes a fact-intensive argument that the “disclosures” render
the misstatements and omissions not misleading as a matter of law. See Cap. Fin.
Serv. at 15-20.
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None of the identified disclosures or warnings comes close to alerting
investors that they are buying into a Ponzi scheme. “[D]isclosures of risk provide
‘no protection to someone who warns his hiking companion to walk slowly
because there might be a ditch ahead when he knows with near certainty that the
Grand Canyon lies one foot away.’” Credit Suisse First Boston Corp. v. ARM
Financial Group, 2001 WL 300733, at *8 (quoting In re Prudential Sec. Ltd.
Pshps. Litig, 930 F. Supp. 68, 72 (S.D.N.Y. 1996)). And “reasonable minds” could
disagree about whether the statements and omissions Plaintiffs have identified
were misleading in the context of the general disclosures in the PPMs. For
example,
the statement that an SPC may purchase receivables at “greater or less
than fair market value” did not adequately disclose that “non-existent
receivables” were purchased;
that statement that accounts may be sold among Medical Capital
“affiliates” did not adequately disclose the transfers of $829 million
worth of receivables from older to new SPCs, at least 301 times; and
the statement that investments may be made in “non-healthcare” assets
did not adequately disclose an investment in a pornography advertising
enterprise, the purchase of a 118-foot yacht, and a foray into film
production.
The assessment of the nature and extent of the cautionary language and
whether disclosures are adequate “should be left to the trier of fact.” Immune
Response, 375 F. Supp. 2d at 1039. Moreover, “literal truth is not the standard for
determining whether statements in a prospectus are misleading.” Miller, 519 F.3d
at 886 (9th Cir. 2008). “Some statements, although literally accurate, can become,
through their context and manner of presentation, devices which mislead
investors.” Id. (citation omitted). In addition, “[i]ncomplete statements are …
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misleading if they affirmatively create an impression of a state of affairs which
differs in a material way from the one that actually exists.” In re Amgen Inc. Sec.
Litig., 544 F. Supp. 2d 1009, 1034 (C.D. Cal. 2008) (internal citation omitted).
Whether disclosures are adequate is “measured not by literal truth, but by the
ability of the material to accurately inform rather than mislead prospective buyers.”
Miller, 519 F.3d at 886 (citation omitted); see also Siemers v. Wells Fargo & Co.,
No. C 05-04518 WHA, 2006 WL 2355411, at *5, *7 (N.D. Cal. Aug. 14, 2006) (an
“affirmative statement” may constitute a “half truth” and be “materially misleading
because of a failure to make additional disclosure”). “At best, Defendants have
raised a factual issue as to the adequacy of the disclosures that cannot be resolved
on this motion to dismiss.” In re Giant Interactive Group, Inc. Sec. Litig., 643 F.
Supp. 2d 562, 570, 571 (S.D.N.Y. 2009) (denying motion to dismiss Section
12(a)(2) claim where disclosures “failed to disclose the extent ... and full scope of
[the] impact” of certain of defendant’s business practices).
VI. PLAINTIFFS STATE CLAIMS UNDER SECTION 15
Section 15 of the Securities Act imposes liability on “[e]very person who, by
or through stock ownership, agency, or otherwise … controls any person liable
under sections [11 or 12].” 15 U.S.C. § 77o. To state a control person claim under
Section 15, a plaintiff must allege (1) a primary violation of federal securities laws
and (2) that the defendant exercised actual power or control over the primary
violator. Howard v. Everex Sys., Inc., 228 F. 3d 1057, 1065 (9th Cir. 2000). 9 The
Rule 8(a) notice pleading standard governs. See Batwin v. Occam Networks, Inc.,
No. CV 07-2750 CAS, 2008 WL 2676364, at *24 (C.D. Cal. July 1, 2008);
9 The Ninth Circuit has instructed that “the controlling person analysis is the
same” under Section 15 of the Securities Act and Section 20 of the Exchange Act.
See Hollinger v. Titan Capital Corp., 914 F.2d 1564, 1578 (9th Cir. 1990).
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Washington Mutual, 259 F.R.D. at 504 (citation omitted). Accordingly, a
defendant’s control over the primary violator need only be “plausible.” Schwab,
257 F.R.D. at 550 (upholding Section 15 claim and stating “[i]t is a plausible
inference … that [the defendants] were in a position to exercise power and
control”); Countrywide, 588 F. Supp. 2d at 1184 (holding that the “§ 15 defendants
… are plausible control persons”).
The Ninth Circuit follows the SEC’s definition of control, which is the
“possession, direct or indirect, of the power to direct or cause the direction of the
management of the policies of a person, whether through ownership of voting
securities, by contract or otherwise.” Howard, 228 F.3d at 1065 n.9 (quoting 17
C.F.R § 230.405). Traditional indicia of control are “having a prior lending
relationship, owning stock in the target company, or having a seat on the board.”
Batwin, 2008 WL 2676364, at *25 (citation omitted). However, resolving control
person liability is “an intensely factual question” not appropriate on a motion to
dismiss. Id. (quoting Howard, 228 F.3d at 1065); see also Hienergy Tech. Sec.
Litig., No. SACV04-1226 DOC, 2005 WL 3071250, at *13 (C.D. Cal. Oct. 25,
2005) (“The question of who is a control person is tremendously fact intensive”).
Plaintiffs sufficiently state a Section 15 claim against Securities America
Financial, Ameriprise, Capital Financial Holdings, and National Holdings (the
“Control Person Defendants”). Plaintiffs allege the Broker Defendants’ primary
securities violations (Section 12 of the Securities Act). ¶¶ 131-151 (Counts I and
II). Plaintiffs also allege the Control Person Defendants’ control over the Brokers.
Plaintiffs allege that each of the Control Person Defendants “had the power to
influence and control” and “actively used this influence and control” over its
subsidiary. ¶ 154.
In addition, Plaintiffs allege that Securities America Financial is a “Direct
Owner” of Securities America (owning at least 75% of the stock), while
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Ameriprise “wholly owns” Securities America Financial and “direct[s] the
management or policies” of Securities America. The companies also share critical
executive officers, including the President and COO. ¶¶ 24- 25. For example,
Steven F. McWhorter serves as Securities America Financial’s Chairman, CEO
and President and as Securities America’s Chairman and CEO. James Delwyn
Nagengast serves as Securities America Financial’s COO, CFO and Treasurer, and
Securities America’s COO and CFO. ¶ 25.
Plaintiffs also allege that National Holdings and Capital Financial Holdings
wholly-owned and controlled their respective subsidiaries. ¶¶ 26-29. Public
records, which may be considered on a motion to dismiss, support Plaintiffs’
control allegations. See, e.g., Metzler Inc GMBH v. Corinthian Colleges, Inc., 540
F. 3d 1049, 1064, n. 7 (9th Cir. 2008) (finding that district court properly took
judicial notice of publicly available documents and SEC filings). Capital Financial
Holdings’ 2009 Form 10-K and a Capital Financial Services report generated by
the Financial Industry Regulatory Authority (FINRA) reveal that the two
companies share important executive officers and directors: Bradley P. Wells is
Capital Financial Holdings’ President, CEO and CFO, and is also a Director and
Treasurer of Capital Financial Services; and Vance C. Castleman is a Director of
both entities. See Plaintiffs’ Request for Judicial Notice, Ex. A at 20; Ex. C at 7-8.
The Capital Financial entities also share the same address and phone number. Id.,
Ex. A at 1, Ex. C at 3. Publicly available documents also show that National
Holding and National Securities share important executive management—Mark
Goldwasser serves as Chairman and CEO of both entities. Id., Ex. B at 34; Ex. D
at 6.
Parent corporations are control persons in regards to their wholly-owned or
majority-owned subsidiaries. See In re UTStarcom, Inc. Sec. Litig., 617 F. Supp.
2d 964, 979 (N.D. Cal. 2009) (parent was subsidiary’s “largest shareholder”);
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Batwin, 2008 WL 2676364, at *26 (“allegations that the VC defendants’ majority
stake in Occam enabled them to control decisions”); In re Musicmaker.com Sec.
Litig., No. CV00-2018 CAS, 2001 WL 34062431, at *17 (C.D. Cal. June 4, 2001)
(“at the time of the IPO, Virgin held a majority interest in Musicmaker” and even
after the IPO, when Virgin held less than 40% of Musicmaker, its “stake in
Musicmaker was sufficient to make it a controlling person”); Borden, Inc. v. Spoor
Behrins Campbell & Young, Inc., 735 F. Supp. 587, 591 (S.D.N.Y. 1990)
(“Plaintiffs’ allegation that defendants were sole shareholders of SBCY clearly
meets this standard”).
In Schwab, for example, the court upheld a control person claim in the
parent/subsidiary context on a motion to dismiss. The plaintiffs asserted a Section
15 claim against certain Schwab “parent companies” of a fund. The court rejected
the defendant’s assertion that the parent companies were “completely separate”
from the fund, calling it a “factual rebuttal inappropriate for a motion to dismiss.”
257 F.R.D. at 550. The court stated that while the defendants “may ultimately
establish” their separateness, that conclusion was not the only “inference drawn
from the allegations in the complaint.” Id. The court held that Section 15 claims
should be sustained where the plaintiffs provide “fair notice” of the claims to the
defendants and allege an “inference” of control (even if other inferences are
possible). Id.
In Siemers, the plaintiff asserted a Section 15 claim against the parent bank
based on acts of the bank’s indirect subsidiaries. 2006 WL 2355411, at *13. The
court summarized:
The complaint alleges that Wells Fargo & Co. “is the ultimate
parent of all Defendants.” H.D. Vest is alleged to be “an
affiliated non-bank subsidiary of Wells Fargo & Company.”
Wells Fargo Funds Management is an “indirect, wholly-owned
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subsidiary of Wells Fargo & Company.” Wells Fargo & Co. is
alleged to be a control-person of the other defendants by virtue
of its position of operational control, operational management,
ownership and/or “direct and supervisorial involvement” in their
operations.
Id. The court upheld the control person claim on the grounds that these allegations
of ownership were sufficient under Rule 8. Id. at *14.
Plaintiffs’ allegations that the Control Person Defendants are parent
companies that either wholly-own or have a majority ownership of their
subsidiaries are sufficient to state a Section 15 claim under Rule 8. The Control
Person Defendants cite no case law holding otherwise.
Instead, Capital Financial Holdings asks this Court to apply a standard that
the Ninth Circuit has rejected. See Cap. Fin. Hold. at 7-8. The Ninth Circuit does
not require that control persons be “culpable participants” in the underlying
violations. See Hollinger, 914 F.2d at 1575 (“The statute does not place such a
burden on the plaintiff”); Howard, 228 F.3d at 1065 (“Plaintiff need not show that
the defendant was a culpable participant”); see also Hienergy, 2005 WL 3071250,
at *12 (“To plead under Section 20(a), the plaintiff need not allege the controlling
person’s scienter or that they were a culpable participant in the alleged
wrongdoing.”). It is the parent company’s affirmative burden to demonstrate good
faith and a failure to directly or indirectly induce the violations. See, e.g.,
Hollinger, 914 F.2d at 1575; Hienergy, 2005 WL 3071250, at *12 (defendants may
“rebut liability . . . if they can show they acted in good faith and did not induce the
act or acts constituting the violation.”).
The cases cited by Securities America Financial and Ameriprise are also
inapposite. The court in In re Digital Island Sec. Litig., 223 F. Supp. 2d 546, 560-
61 (D. Del. 2002), applied heightened particularity standards not followed in the
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Ninth Circuit on control person claims. In re Downey Sec. Litig., No. CV-08-
3261-JFW, 2009 WL 2767670, at *15(C.D. Cal. Aug. 21, 2009), concerned an
attempt to implicate individual officers and directors as control persons. Fouad v.
Isilon Sys., Inc., No C07-1764 MJP, 2008 WL 5412397, at *12-13 (W.D. Wash.
Dec. 29, 2008), concerned allegations of collective ownership by multiple venture
capital firms.
None of Defendants’ cases supports their motions to dismiss to Plaintiffs’
Section 15 claims, and their motions should therefore be denied.
VII. CONCLUSION
Plaintiffs request that the Court deny each Defendant’s motion to dismiss.
Dated: March 31, 2010 Respectfully submitted,
GIRARD GIBBS LLP
By: /s/ Daniel C. Girard
Daniel C. Girard
Jonathan K. Levine
Amanda M. Steiner
Todd I. Espinosa
601 California Street, 14th Floor
San Francisco, California 94108
Telephone: (415) 981-4800
Plaintiffs’ Co-Lead Counsel
ZWERLING, SCHACHTER &
ZWERLING, LLP
Robin F. Zwerling
Stephen L. Brodsky
Stephanie E. Kirwan
41 Madison Avenue
New York, New York 10010
Telephone: (212) 223-3900
Facsimile: (212) 371-5969
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- and -
Dan Drachler
1904 Third Avenue, Suite 1030
Seattle, Washington 98101
Telephone: (206) 223-2053
Plaintiffs’ Co-Lead Counsel
KOHRMAN JACKSON &
KRANTZ, PLL
Ari H. Jaffe
One Cleveland Center, 20th Floor
1375 East Ninth Street
Cleveland, OH 44114
Telephone: (216) 696-8700
Facsimile: (216) 621-6536
Plaintiffs’ Counsel
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