Opinion
H043538
12-29-2017
LYNN BRIDGES, et al., Plaintiffs and Appellants, v. SANTA CRUZ COUNTY BANK, Defendant and Respondent.
NOT TO BE PUBLISHED IN OFFICIAL REPORTS
California Rules of Court, rule 8.1115(a), prohibits courts and parties from citing or relying on opinions not certified for publication or ordered published, except as specified by rule 8.1115(b). This opinion has not been certified for publication or ordered published for purposes of rule 8.1115. (Santa Cruz County Super. Ct. No. CV181834)
In this action for misrepresentation and related causes of action, plaintiffs sought to recover losses they had incurred as a result of a fraudulent investment scheme operated by three individual defendants and promoted by respondent Santa Cruz County Bank (the Bank). The superior court sustained the Bank's demurrer without leave to amend on the ground that plaintiffs' action was precluded by the Securities Litigation Uniform Standards Act of 1998 (SLUSA or the Act). (15 U.S.C. §78bb, subd. (f)(1); §77p, subds. (b), (f).) Plaintiffs maintain that SLUSA is inapplicable. We disagree and therefore must affirm the judgment of dismissal.
Procedural History
Plaintiffs are 21 individuals who were among more than 150 investors in the GLR Growth Fund (the Fund), formed in 2003 by John Arnold Geringer, Christopher Anthony Luck, and Keith Everts Rode. On June 5, 2015, plaintiffs filed a complaint in superior court against those individual defendants and the Bank. All four defendants were accused of conspiracy to commit fraud and breach of fiduciary duty; the Bank was additionally charged with aiding and abetting fraud, aiding and abetting breach of fiduciary duty, and negligent misrepresentation.
Plaintiffs had sued these defendants two years earlier, in federal court. Their complaint in Bridges v. Geringer (N.D. Cal. July 24, 2013, No. 12-CV-02663-LHK), 2013 U.S. Dist. LEXIS 103852 contained the same causes of action except for breach of fiduciary duty against all defendants, but it added a fifth cause of action for violating section 12, subdivision (a)(2), of the Securities Act of 1933, 15 U.S.C. § 77l, subdivision (a)(2). More than 50 other investors also sued defendants in superior court between February and May of 2015, in Strudley v. Santa Cruz County Bank, et al. (Super. Ct. Santa Cruz County, No. CV-181080); Paetau v. Santa Cruz County Bank et al. (Super. Ct. Santa Cruz County, No. CV-181473); and Panushka v. Santa Cruz County Bank, et al. (Super. Ct. Santa Cruz County, No. CV-181752).
In addition to these civil lawsuits, the three individual defendants were convicted in 2014 on criminal charges in connection with the fraudulent mismanagement of the Fund. (See United States v. Geringer, (9th Cir. 2016) 672 Fed.Appx. 651 [remanding for recalculation of Geringer's sentence]; United States v. Geringer (N.D. Cal. Feb. 27, 2017), 2017 U.S. Dist. LEXIS 103098 [denying Geringer's release pending resentencing].) The Securities and Exchange Commission (SEC) had also brought a civil enforcement action against the individual defendants and GLR Capital Management, LLC, the general partner of the Fund. (See SEC v. GLR Capital Mgmt. LLC (N.D. Cal. 2015, No. 12-CV-02663-EJD), 2015 U.S. Dist. LEXIS 43932.)
Plaintiffs' federal lawsuit was dismissed upon the Bank's motion because the only federal claim asserted, the violation of section 12(a)(2) of the Securities Act of 1933, was deficiently pleaded. The district court granted leave to amend the complaint but declined to address the state law claims, citing lack of jurisdiction. (Bridges v. Geringer (N.D. Cal. May 21, 2015, No. 13-CV-1290-EJD), 2015 U.S. Dist. LEXIS 66695.) When plaintiffs did not amend their complaint by the June 5, 2015 deadline, the court entered judgment dismissing the federal claim with prejudice and dismissing the remaining claims "without prejudice to [plaintiffs'] reasserting those claims in a competent court."
Plaintiffs had advised the district court that they had elected to "pursue alternative litigation in state court" rather than amend their complaint.
The four civil actions in superior court were consolidated on July 9, 2015, by stipulation of the parties. On July 27, 2015, the Bank demurred to the Bridges complaint.
On April 19, 2016, after extensive written and oral argument encompassing the issue of whether plaintiffs should be granted leave to amend, the superior court sustained the Bank's demurrer to the Bridges complaint without leave to amend and ordered that complaint dismissed with prejudice. Plaintiffs then filed this timely appeal. Meanwhile, on October 26, 2015, the court granted leave to amend in Strudley, Paetau, and Panushka, and one week later those plaintiffs voluntarily dismissed their cases so as to enable them to file in federal court.
The Strudley plaintiffs, now including Paetau and Panushka, filed their complaint in federal court on November 6, 2015. On December 23, 2015, after the Bank moved to dismiss on grounds of lack of subject matter jurisdiction and SLUSA preclusion, those plaintiffs filed a first amended complaint.
Discussion
1. Standard and Scope of Review
Because this appeal arises from a dismissal following the sustaining of a demurrer, settled rules apply to this court's review. A demurrer is properly sustained when the complaint "does not state facts sufficient to constitute a cause of action." (Code Civ. Proc., § 430.10, subd. (e).) On appeal from the judgment of dismissal, this court examines the complaint de novo to determine whether it alleges facts sufficient to constitute a cause of action. Like the trial court, we assume the truth of all properly pleaded factual allegations, " 'but not contentions, deductions or conclusions of fact or law. [Citation.] . . . Further, we give the complaint a reasonable interpretation, reading it as a whole and its parts in their context." (Blank v. Kirwan (1985) 39 Cal.3d 311, 318 (Blank).) "We also consider matters [that] may be judicially noticed." (Serrano v. Priest (1971) 5 Cal.3d 584, 591.)
After reviewing the allegations of the petition, the accompanying exhibits, and the matters properly subject to judicial notice, we determine whether the petition states a cause of action as a matter of law. (Cf. Moore v. Regents of University of California (1990) 51 Cal.3d 120, 125.) Finally, if the lower court has sustained the demurrer without leave to amend, as here, "we decide whether there is a reasonable possibility that the defect can be cured by amendment. The burden is on the plaintiff to show that an amendment would cure the defect. (Schifando v. City of Los Angeles (2003) 31 Cal.4th 1074, 1081 (Schifando).)
With these principles in mind, we examine the factual allegations of the pleading at issue, plaintiffs' June 5, 2015 complaint. 2. Allegations of the Complaint
Plaintiffs generally alleged that the individual defendants, Geringer, Luck, and Rode, operated the Fund as a Ponzi scheme, by inducing plaintiffs and others to invest in the Fund through false and misleading marketing materials. Those defendants claimed, for example, that the Fund "returned between 17 [and] 25] percent every year by investing in companies tied to well-known stock indices such as the S&P 100 and 500, NASDAQ, and Dow Jones, as well as in oil, natural gas, and technology-related companies." They represented their trading strategy as one of conservative diversification, with nearly 75 percent of the Fund's assets being invested in low-risk, large-cap, U.S. public equities.
"The SEC defines a Ponzi scheme as 'an investment fraud that involves the payment of purported returns to existing investors from funds contributed by new investors.' " (SEC v. World Capital Mkt., Inc. (9th Cir. 2017) 864 F.3d 996, 1000, fn 1.) "A Ponzi scheme uses the principal investments of newer investors, who are promised large returns, to pay older investors what appear to be high returns, but which are in reality a return of their own principal or that of other investors. [Citation.] The entities used to perpetrate the scheme usually conduct little to no legitimate business operations. [Citation.] Since Ponzi schemes do not generate profits sufficient to provide their promised returns, but rather use investor money to pay returns, they are insolvent and become more insolvent with each investor payment." (Wiand v. Lee (11th Cir. 2014) 753 F.3d 1194, 1201; see also Sender v. Heggland Family Trust (In re Hedged-Investments Assocs.) (10th Cir. 1995) 48 F.3d 470, 471, fn 2. [defining term as "an investment scheme in which returns to investors are not financed through the success of the underlying business venture, but are taken from principal sums of newly attracted investments. Typically, investors are promised large returns for their investments. Initial investors are actually paid the promised returns, which attract additional investors."])
In addition, though the Fund was created in 2003, the marketing materials even claimed 25 percent returns in 2001 and 2002.
Through these false representations the individual defendants were able to raise more than $60 million between 2003 and 2012—more than $5.1 million from plaintiffs alone. However, instead of investing according to the promised strategy, those defendants put the money in two privately held technology start-up companies and three entities they held: GLR Capital Management; Geringer, Luck & Rode, LLC; and GLR Capital Advisors, LLC. They also used the money to pay Fund investors who were redeeming their principal and profits—thus generating the appearance of profitability—and to benefit themselves personally. Moreover, instead of generating the promised high returns, the Fund consistently lost money, a fact known to the individual defendants. They then concealed the poor performance of the Fund by falsifying the Fund's brokerage account records, using those records to prepare the Fund's tax returns, and distributing those false statements to investors to induce them to retain their money in the Fund and contribute more to it.
The Bank, which held the Fund's account, was implicated through its vice president, Chuck Maffia. The Bank allowed itself to be named as the "Banking Reference" in the Fund's marketing materials. Maffia, the Bank's contact person for the Fund, promoted both the Fund and the individual defendants. He not only actively solicited new investors but also persuaded existing investors to keep their money in the Fund. Maffia profited personally from the individual defendants' scheme.
Maffia had represented that he personally handled and oversaw all the transactions in and out of the Fund's accounts at the Bank, but he never took the opportunity to review the actual (as opposed to the falsely created) account statements. Plaintiffs believed that Maffia knew where the Fund investments were actually being directed and knew that the Fund consistently lost money, but the Bank never cautioned potential new investors or even asked to be removed as a banking reference; instead, Maffia continued to solicit new investors, including plaintiffs, by assuring them that the Fund was safe because it was invested primarily in conservative stocks. The Fund was "safer than a mutual fund," Maffia told potential investors; he knew that because the Bank provided "the utmost oversight" for the Fund, and he could see the money flowing to and from the Fund's accounts at the Bank. He also told them that Geringer was an "excellent investment manager," that clients had not had any losses, and that he himself was an investor making more than 25 percent each year. Because of Maffia's misrepresentations about the Fund's investment strategy and returns and the Bank's own inadequate oversight, plaintiffs lost "all, or substantially all, of their investment in the [Fund]." 3. The Demurrer and the Court's Ruling
The Bank asserted the following as grounds for its demurrer to each cause of action: (1) the alleged conduct was precluded by SLUSA; (2) the complaint failed to allege facts demonstrating that the Bank knew of the individual defendants' misconduct or agreed with them to perpetrate it; (3) as to six of the plaintiffs, the complaint failed to plead the time, place, or content of Maffia's communication, and they could not have reasonably relied on statements he made to others; and (4) Maffia's statements were true, or he believed them to be true.
The first ground, preclusion by SLUSA, was the focus of the proceedings below. The Bank argued that this lawsuit met the definition of a "covered class action" within the meaning of 15 U.S.C. § 78bb, subdivisions (f)(1)(A) and (f)(1)(B), of the Securities Act of 1933 and 15 U.S.C. §77p, subdivisions (b)(1) and (b)(2), of the Securities and Exchange Act of 1934. Under these provisions an action alleging a misrepresentation or omission under state law, brought by more than 50 persons in a consolidated proceeding, could not be maintained if the alleged conduct was made "in connection with the purchase or sale of a covered security." (§78bb(f)(1)(A); see also §77p(b)(1) [denoting "untrue statement" instead of "misrepresentation"].)
All further statutory references are to 15 U.S.C. except as otherwise indicated. Letters and numbers in parentheses following section references are to subdivisions.
In their opposition plaintiffs relied primarily on Chadbourne & Parke LLP v. Troice (2014) ___U.S.___ (Chadbourne), where the United States Supreme Court addressed the meaning of "covered class action . . . by any private party alleging [¶] (A) a misrepresentation or omission of a material fact in connection with the purchase or sale of a covered security" in section 78bb(f)(1). Plaintiffs argued that their lawsuit did not satisfy the statutory criteria for preclusion by SLUSA, because the conduct of the defendants did not involve a "covered class action" or purchase of a "covered security." The superior court initially agreed with plaintiffs that Chadbourne made SLUSA inapplicable to the facts presented here. However, after reviewing post-Chadbourne federal cases cited by the Bank, the court concluded that the Act did preclude maintenance of this action. On appeal, the parties debate the lower court's application of those decisions to this case. 4. Applicability of SLUSA
SLUSA has a long legislative history. The United States Supreme Court has emphasized "the magnitude of the federal interest in protecting the integrity and efficient operation of the market for nationally traded securities." (Merrill Lynch, Pierce, Fenner & Smith Inc. v. Dabit (2006) 547 U.S. 71, 78 (Dabit).) The response to this concern, particularly in light of the 1929 stock market crash and ensuing Great Depression, was the enactment of the Securities Act of 1933, followed by the expanded regulatory provisions of the Securities Exchange Act of 1934. The 1934 Act extended the antifraud protections of purchasers of securities and established the SEC.
In the wake of the subsequent increase in private litigation by investors, Congress determined that abuses of the class-action device were harming the United States economy, and it enacted the Private Securities Litigation Reform Act of 1995 (PSLRA) "to curb these perceived abuses" of the 1933 and 1934 Acts. (Dabit, supra, 547 U.S. at p. 81.) The PSLRA included "limitations on recoverable damages and attorneys' fees, sanctions for frivolous litigation, stays of discovery pending resolution of motions to dismiss, numerous restrictions affecting the conduct of class actions, and onerous pleading requirements." (Criterium Capital Funds B.V. v. Tremont (Berm.), Ltd. (In re Kingate Mgmt. Litig.) (2d Cir. 2015) 784 F.3d 128, 138 (Kingate); see also Dabit, supra, at pp. 81-82.)
Specifically, Congress noted that "targeting of deep-pocket defendants, vexatious discovery requests, and 'manipulation by class action lawyers of the clients whom they purportedly represent' had become rampant in recent years. [Citation.] Proponents of the Reform Act argued that these abuses resulted in extortionate settlements, chilled any discussion of issuers' future prospects, and deterred qualified individuals from serving on boards of directors." (Dabit, supra, 547 U.S. at p. 81.)
These restrictions, however, led some plaintiffs' attorneys to circumvent the federal bar altogether and bring class actions under state law, often in state court. (Dabit, supra, 547 U.S. at p. 82; Kingate, supra, 784 F.3d at p. 138.) "To prevent that evasion of the PSLRA's restrictions" and its objectives, Congress enacted SLUSA in 1998. (Kingate, supra, at p. 138; Instituto de Prevision Militar v. Merrill Lynch (11th Cir. 2008) 546 F.3d 1340, 1345 (Instituto).) Its preclusive provisions amended both the 1933 and 1934 Acts. Thus, section 78bb(f) of the 1934 Act states: "No covered class action based upon the statutory or common law of any State or subdivision thereof may be maintained in any State or Federal court by any private party alleging— [¶] (A) a misrepresentation or omission of a material fact in connection with the purchase or sale of a covered security; or [¶] (B) that the defendant used or employed any manipulative or deceptive device or contrivance in connection with the purchase or sale of a covered security. [¶] (2) Removal of covered class actions. Any covered class action brought in any State court involving a covered security, as set forth in paragraph (1), shall be removable to the Federal district court for the district in which the action is pending, and shall be subject to paragraph (1)." (Italics added.)
As noted earlier, section 77p(b) of the 1933 Act was amended almost identically; it refers to allegations of "an untrue statement" rather than "a misrepresentation."
As defined in section 78bb(f)(5)(B) and explained by the United States Supreme Court, a "covered class action" "is a lawsuit in which damages are sought on behalf of more than 50 people." (Dabit, supra, 547 U.S. at p. 83.) The term "covered security," defined in section 78bb(f)(5)(E) and section 77r(b), is a security "traded nationally and listed on a regulated national exchange." (Dabit, supra, at p. 83.)
Plaintiffs take issue with the application of both of these elements. Their lawsuit is not a "covered class action," they contend, because each plaintiff in the consolidated actions (Bridges, Strudley, Paetau, and Panushka) "alleges unique facts that would never fulfill the commonality requirement for class certification." Moreover, plaintiffs argue, the legal issues are distinct between the 50 plaintiffs who had direct contact with Maffia and the 26 plaintiffs who did not. "Therefore, Plaintiffs do not constitute a 'covered class action' and there is no SLUSA preemption."
Plaintiffs repeatedly describe this case as one involving preemption, but that concept is inapposite here. "SLUSA does not actually pre-empt any state cause of action. It simply denies plaintiffs the right to use the class-action device to vindicate certain claims. The Act does not deny any individual plaintiff, or indeed any group of fewer than 50 plaintiffs, the right to enforce any state-law cause of action that may exist." (Dabit, supra, 547 U.S.at p. 87.) SLUSA is instead "a preclusion provision because it does not displace state law with federal law, but makes some state law claims nonactionable through the class action device in both federal and state courts. . . . Thus, once a court determines that SLUSA applies to a given state law action, the action cannot be maintained on a class basis in either state or federal court." (Wells Fargo Bank, N.A. v. Superior Court (2008) 159 Cal.App.4th 381, 385, fn. 2.)
We cannot agree. Under the statute, a "covered class action" consists in any of three alternative scenarios: "(i) any single lawsuit in which— [¶] (I) damages are sought on behalf of more than 50 persons or prospective class members, and questions of law or fact common to those persons or members of the prospective class, without reference to issues of individualized reliance on an alleged misstatement or omission, predominate over any questions affecting only individual persons or members; or [¶] (II) one or more named parties seek to recover damages on a representative basis on behalf of themselves and other unnamed parties similarly situated, and questions of law or fact common to those persons or members of the prospective class predominate over any questions affecting only individual persons or members; or [¶] (ii) any group of lawsuits filed in or pending in the same court and involving common questions of law or fact, in which— [¶] (I) damages are sought on behalf of more than 50 persons; and [¶] (II) the lawsuits are joined, consolidated, or otherwise proceed as a single action for any purpose." (§ 78bb(f)(5)(B); § 77p(f)(2)(A), italics added.) The statute does not require that the issues be identical or that the facts be the same; all that is called for is "common questions of law or fact." (Ibid.) Plaintiffs themselves point out that upon consolidation they totaled 76 individuals whose lawsuits were pending in the same court. That common questions of law and fact existed regarding the Bank's conduct is consistent with the allegations of the complaints in the four actions, the parties' arguments both before and after the federal court's dismissal, and the positions taken in favor of consolidation. The common issues in a group of lawsuits do not have to predominate over those unique to individual plaintiffs. (Cf. Instituto, supra, 546 F.3d at p. 1347 [after expressly urging consolidation, plaintiff "cannot now complain" that the lawsuits lack common questions of law or fact].) Thus, plaintiffs cannot avoid the application of SLUSA by a belated segregating of the plaintiffs into different classes in order to reduce their numbers below the "more than 50 persons" threshold. (§ 78bb(f)(5)(B); § 77p(f)(2)(A)(i)(I).)
Before consolidation, Paetau and the Strudley and Panushka plaintiffs alleged the same causes of action as the Bridges plaintiffs (conspiracy to commit fraud, breach of fiduciary duty, aiding and abetting fraud, aiding and abetting breach of fiduciary duty, and negligent misrepresentation), including allegations of intentional and negligent misrepresentation by the Bank.)
Plaintiffs further contest the application of the term "covered securities" to their purchases. A "covered security" is defined as "a security that satisfies the standards for a covered security specified in paragraph (1) or (2) of section 77r(b) . . . at the time during which it is alleged that the misrepresentation, omission, or manipulative or deceptive conduct occurred." (§ 77p(f)(3); see also § 78bb(f)(5)(E).) Under the referenced provision, section 77r(b), it is a security that is "listed, or authorized for listing," on a national securities exchange or is issued by a registered investment company.
The gravamen of plaintiffs' position on appeal is that they purchased only "limited partner interests in the GLR Fund: clearly 'non-covered securities.' " Plaintiffs rely heavily on the United States Supreme Court's 2014 decision in Chadbourne. In that case the Court held that SLUSA did not preclude claims brought by private investors who held a bank's certificates of deposit, having been falsely assured that the bank "maintained significant holdings" in what appeared to be covered securities — that is, " ' "highly marketable securities issued by stable governments [and] strong multinational companies." ' " (Chadbourne, supra, ___U.S. at p. ___ .) On the facts presented, SLUSA did not preclude the plaintiffs' lawsuit—but not, as plaintiffs here suggest, because the certificates themselves were not covered securities, but because the misrepresentation by the defendants was not made "in connection with" a purchase or sale of a covered security. "The phrase 'material fact in connection with the purchase or sale' suggests a connection that matters. And for present purposes, a connection matters where the misrepresentation makes a significant difference to someone's decision to purchase or to sell a covered security, not to purchase or to sell an uncovered security, something about which the Act expresses no concern." (Id. at p. ___ .) Furthermore, the "someone" who makes that decision must be "a party other than the fraudster. If the only party who decides to buy or sell a covered security as a result of a lie is the liar, that is not a 'connection' that matters." (Ibid.) Thus, the statute would apply where the victims of the fraud, not the fraudster, "took, who tried to take, who divested themselves of, who tried to divest themselves of, or who maintained an ownership interest in financial instruments that fall within the relevant statutory definition." (Ibid.)
The defendant bank was the Stanford International Bank, "later revealed to be a cog in the Ponzi scheme of one Allen Stanford." (Kingate, supra, 784 F.3d at p. 141.)
The Court elaborated on this point by distinguishing those cases in which it was the plaintiffs who had taken, maintained, or divested themselves of an ownership interest in covered securities. For example, in SEC v. Zandford (2002) 535 U.S. 813, the defendant broker had promised to invest the elderly victim's money conservatively, but as part of the broker's fraudulent scheme, he sold the securities in the investor's account and used the proceeds for his own benefit. Endorsing a flexible interpretation of "in connection with," the Court on that occasion regarded each sale, together with the pocketing of the proceeds, as part of the broker's "fraudulent scheme." (Id. at p. 820.) Accordingly, if the allegations of the complaint were true, the SEC was then entitled to relief under section 78j(b) (section 10(b) of the 1934 Act) and SEC rule 10b-5.
Examining the Zandford result later in Chadbourne, the Court emphasized that it was the victim's money that the broker promised to invest in covered securities. And in Dabit, the misrepresentations were alleged to have caused the plaintiffs to hold on to overvalued securities. In Chadbourne, by contrast, the element of a connection between the alleged misrepresentations and the plaintiffs' decision to purchase covered securities was insufficient, where the plaintiffs' purchase of the certificates of deposit was only tangentially related to covered securities through the defendants' representation that the certificates were a safe and secure investment because the Bank backed those certificates through its ownership of covered securities. Thus, a state law claim is preserved, as it was in Chadbourne, "when the fraud bears so remote a connection to the national securities market that no person actually believed he was taking an ownership position in that market." (Chadbourne, supra, ___U.S. at p. ___ .)
Plaintiffs maintain that the requisite connection is absent here because they did not make a decision to buy or sell covered securities; instead, it was Geringer who made that decision—in this case, not to buy covered securities—for the Fund rather than for plaintiffs. Plaintiffs' only purchase was of limited partnership interests in the Fund, not in covered securities.
In its order the superior court agreed with the Bank that post-Chadbourne federal decisions, particularly those of the Second Circuit, clarified the applicability of SLUSA in cases involving defendants whose conduct is essentially alleged to be tantamount to complicity in the fraud. In Trezziova v. Kohn (In re Herald, Primeo & Thema Sec. Litig.) (2d Cir. 2014) 753 F.3d 110 (Herald II), the Second Circuit denied rehearing of a pre-Chadbourne case in which it had upheld the district court's dismissal of claims under SLUSA. Plaintiffs had sued the managers of the offshore funds in which they had shares; the managers had represented that the funds would invest in covered securities, but instead, the proceeds were invested in Bernard L. Madoff Investment Securities (BMIS), operator of a notorious Ponzi scheme exposed in December 2008. (See Trezziova v. Kohn (In re Herald, Primeo & Thema Sec. Litig.) (2d Cir. 2013) 730 F.3d 112, 116 (Herald I).) Plaintiffs also sued JPMorgan Chase & Co. and Bank of New York Mellon, which served as bankers for BMIS. As in the present case, the Herald plaintiffs alleged that the banks knowingly assisted in Madoff's fraudulent scheme, which allowed his victims to believe they were taking an "ownership position" in covered securities. (Herald II, supra, at p. 113, quoting Chadbourne, supra, ___U.S. at p. ___ .)
The superior court also cited Kingate. Kingate presented facts similar to those of Herald: Plaintiffs purchased shares in offshore "feeder" funds that clearly were not covered securities, upon the representation that the funds would be invested in Standard & Poor (S&P) companies, which were covered securities. (Kingate, supra, 784 F.3d at p. 133.) Instead, they were funneled to BMIS, which produced false account statements showing profitable investment in covered securities. In an effort to recover the substantial losses they had sustained due to Madoff's fraud, plaintiffs sued the entities and individuals associated with the feeder funds. Reaching the same conclusion as in Herald, a different panel of the Second Circuit held that the plaintiffs had alleged falsity "in connection with" a purchase or sale of a covered security, to the extent that they claimed misrepresentations and misleading omissions about defendants' monitoring of the funds' investments and the value of the funds. These plaintiffs, "like the Herald plaintiffs, purchased the uncovered shares of the offshore Funds, expecting that the Funds were investing the proceeds in S&P 100 stocks, which are covered securities," thus satisfying the element of falsity "in connection with" a purchase or sale of a covered security for purposes of SLUSA preclusion. (Kingate, supra, at p. 142; cf. Marchak v. JPMorgan & Chase Co. (In re Marchak) (E.D.N.Y. 2015) 84 F.Supp.3d 197 [agreeing with defendants that no actual purchase was required for SLUSA preclusion; it was sufficient that plaintiffs were falsely promised investment in options and securities that they conceded were covered securities].)
In contrast to Kingate and Herald II, the First Circuit held, on facts more analogous to those of Chadbourne, that SLUSA did not apply, where the fund prospectus given to investors promised to invest primarily in uncovered securities, specialized notes issued by different international institutions. (Hidalgo-Vélez v. San Juan Asset Mgmt. (1st Cir. 2014) 758 F.3d 98, 108.) The court acknowledged that SLUSA preclusion did not depend on the classification of the fund itself as a covered security. But the "in connection with" requirement was not met there because the representations in the prospectus indicated that at least 75 percent of the fund's assets would be invested in the specialized notes. At most it suggested only "that some (relatively small) part of the Fund's portfolio might include covered securities." (Id. at p. 107.) Consequently, the Hidalgo-Vélez plaintiffs purchased their shares in the fund with the primary purpose of acquiring an ownership interest in uncovered, not covered, securities, based on marketing statements representing the fund as "a vehicle for exposure to uncovered securities." (Id. at p. 109.) In reaching this conclusion, the First Circuit cautioned, "courts must carefully consider whether and to what extent the plaintiffs sought to take an ownership interest in covered securities. The relevant questions include (but are not limited to) what the fund represents its primary purpose to be in soliciting investors and whether covered securities predominate in the promised mix of investments. Of course, an inquiring court should also look at the nature, subject, and scope of the alleged misrepresentation." (Id. at p. 108.)
Plaintiffs insist that the superior court should have followed the district court's decision in Spectrum Select, L.P. v. Tremont Group Holdings, Inc. (In re Tremont Sec. Law, State Law and Ins. Litig. (S.D.N.Y. Apr. 14, 2014, No. 08-CV-11117), 2014 U.S. Dist. LEXIS 52082 (Spectrum). In that case, which preceded Herald II and Kingate, the victims of a fraudulent investment scheme purchased funds that were limited partnership interests rather than securities. But the similarity to the present case ends there. In Spectrum, the defendants told plaintiffs that their investment would give them the ability to invest indirectly in securities managed by Bernard Madoff. Defendants made representations about the "quality of the investment strategy that the funds would employ, the due diligence that they would perform upon fund managers, and the funds' ongoing investment activities." (2014 U.S. Dist. LEXIS 52082, at p. 27.) After the plaintiffs entrusted their money to defendants, defendants continued to make false claims about the past and ongoing performance of the funds, which were said to be "achieving steady and consistent gains." (2014 U.S. Dist. LEXIS 52082, at p. 28.) The district court did not, however, identify any covered securities that plaintiffs believed they were acquiring by investing in the funds. Thus, even if the district court had had the benefit of the opinions in Herald II and Kingate, Spectrum is distinguishable on its facts and offers no support to plaintiffs here. (Cf. Goodman v. AssetMark, Inc. (E.D.N.Y. 2014) 53 F.Supp.3d 583, 590 [disagreeing with outcome in Spectrum].)
In this case, we agree with the superior court that the misrepresentations and omissions allegedly made by the Bank in marketing the Fund call into play the preclusion provisions of SLUSA. Unquestionably, as in Spectrum, the Fund itself was not a covered security. As in Kingate and Herald, however, in purchasing shares in the Fund plaintiffs relied on Maffia's representation that the investment was safe because the Fund "invested primarily in conservative U.S. stocks and S&P 500 stocks." The marketing materials themselves represented that 75 percent of the Fund assets were invested in the S&P 100 (20 percent), the S&P 500 (20 percent), the NASDAQ (20 percent), and the Dow Jones 30 (15 percent.) Consequently, plaintiffs purchased shares in the Fund intending and expecting that 75 percent of the Fund's assets would be invested in covered securities. By affirmatively recommending and actively promoting the Fund as a "safe, conservative" investment while knowing that the Fund was actually based on a Ponzi scheme, the Bank, through Maffia, misrepresented this "improper investment vehicle" and thus contributed to plaintiffs' losses. These alleged facts bring the lawsuit within the scope of SLUSA.
As noted, in both the Herald and Kingate cases the plaintiffs had purchased their interests in what were called "feeder funds," intermediary vehicles that were not themselves covered securities. Here, plaintiffs maintain that this fact should have led those courts to the opposite result, because their purchase of an ownership interest in an uncovered security, the Fund, should remove the action from the reach of SLUSA.
The plaintiffs in Herald I made a similar argument, which, the Second Circuit responded, "ignores the fact that, on the very face of plaintiffs' complaints, the liability of JPMorgan and BNY is predicated not on these banks' relationship with plaintiffs or their investments in the feeder funds but on the banks' relationship with, and alleged assistance to, Madoff Securities' Ponzi scheme, which indisputably engaged in purported investments in covered securities on U.S. exchanges." (Herald I, supra, 730 F.3d at pp. 118-119, italics added.) Reaffirming that conclusion in Herald II, the court noted that the defendant banks had allegedly furthered the fraudulent scheme to induce the victims to attempt to invest in covered securities through Madoff Securities. (Herald II, supra, 753 F.3d at p. 113.) Through the feeder funds, plaintiffs had tried to take an ownership position in the falsely promised covered securities. The court distinguished Chadbourne by noting that the plaintiffs in that case were induced to purchase uncovered securities (the certificates of deposit) through misrepresentations that included vague statements that the defendant Bank held investments in covered securities that made the certificates more secure. (Id. at p. 112.)
Plaintiffs insist that the post-Chadbourne authorities on which the superior court relied "simply got it wrong" and this court should not follow them. We cannot accede to that request. Insofar as Herald and Kingate resolved ambiguities in SLUSA that were not fully addressed in Chadbourne, we find them persuasive authority and apply their approach to the circumstances presented here.
That approach, however, demands a further analysis which the superior court may not have undertaken in this case. In Kingate, the court noted that only some of the allegations predicated the defendants' liability on acts of misrepresentation by those defendants (as opposed to those by Madoff). Only the claims charging defendants with their own intentional misrepresentations, negligent misrepresentations, and aiding and abetting fraud based on intentional or negligent misrepresentation were subject to dismissal under SLUSA. Claims based on breach of contract and breach of fiduciary and other duties, on the other hand, did not require a showing of false conduct by the defendants; accordingly, those claims were not precluded by SLUSA. (Kingate, supra, 784 F.3d at p. 152.) In so holding, the court rejected the reasoning of the Third and Sixth Circuits, which had approved of dismissal of an entire action where only certain counts were for misrepresentation. (See Rowinski v. Salomon Smith Barney Inc. (3d Cir. 2005) 398 F.3d 294, 305 [plain meaning of SLUSA demands "preemption" of actions, not individual counts or claims]; see also Atkinson v. Morgan Asset Mgmt. (6th Cir. 2011) 658 F.3d 549, 555 [suggesting that SLUSA bars entire complaint if any claim alleges misrepresentation but finding issue moot, since all plaintiffs' claims included allegations of fraud].)
The Kingate court remanded the case to permit the district court to dismiss the precluded claims and proceed with the others. Upon remand, the district court analyzed each claim and dismissed those that, on the facts alleged, met the standard of preclusion defined by the Second Circuit panel on appeal. The district court ultimately dismissed the causes of action for fraud, negligent misrepresentation, constructive fraud, and aiding and abetting fraud, but it retained plaintiffs' allegations of negligence, aiding and abetting breach of fiduciary duty, and breach of contract. The district court reasoned that none of the retained claims required fraud by the defendants or defendants' knowledge of or complicity in Madoff's fraud. (In re Kingate Mgmt. Ltd. Litig.) (S.D.N.Y. Sept. 21, 2016, No. 09-CV-5386), 2016 U.S. Dist. LEXIS 129882, at p. 86.)
Also consistent with the Second Circuit's Kingate analysis was the district court's ruling in Yale M. Fishman 1998 Ins. Trust v. Phila Fin. Life Assur. Co. (S.D.N.Y. May 3, 2016, No. 11-CV-1283), 2016 U.S. Dist. LEXIS 58862 (Yale Fishman). Following the guidance of the Kingate court's classification of precluded and nonprecluded claims, the district court found precluded the claims of common law fraud, negligent misrepresentation, and violation of a New York law prohibiting deceptive business acts and practices (N.Y. GBL § 349). The plaintiffs' multiple tort claims, including breach of fiduciary duty, were not precluded, though they were dismissed for failure to state a claim under New York law. (Yale Fishman, supra, 2016 U.S. Dist. LEXIS 58862 at p. 24; see also Anwar v. Fairfield Greenwich Ltd. (S.D.N.Y. 2015) 118 F. Supp. 3d 591 [applying Kingate analysis to find claims of negligent misrepresentation, but not negligence, precluded by SLUSA]; R.W. Grand Lodge of Free & Accepted Masons of Pa. v. Meridian Capital Partners, Inc. (2d Cir. 2015) 634 Fed. Appx. 4, 10 [affirming district court where all state claims were premised on defendants' false representations]; Rayner v. E*Trade Fin. Corp. (S.D.N.Y. 2017) 248 F. Supp. 3d 497, 505 [applying Kingate in dismissing claims based on "deceptive and manipulative conduct"].)
This court requested, and received, supplemental briefing on the applicability of the Kingate analysis to the second and fourth causes of action of plaintiffs' complaint, breach of fiduciary duty and aiding and abetting breach of fiduciary duty. Kingate calls for a determination, on a "claim-by-claim basis," of whether an alleged misrepresentation is "necessary to or extraneous to liability under the state law claims. If the allegation is extraneous to the complaint's theory of liability, it cannot be the basis for SLUSA preclusion." (Kingate, supra, 784 F.3d. at pp. 142-43.) And, as noted earlier, only those claims that predicate liability on the defendant's false conduct will be precluded. By the same token, a theory that does not assert falsity will still compel SLUSA preclusion where the defendant's "falsity nonetheless is essential to the claim." (Id. at p. 140.)
Our review of the complaint convinces us that preclusion is applicable to the second and fourth causes of action as well as those based on fraud and negligent misrepresentation. Following the Kingate analysis, we cannot overlook the allegation in the second cause of action that Maffia, representing the Bank, "made material misrepresentations to Plaintiffs" to induce them to purchase interests in the Fund. And in the fourth cause of action, plaintiffs alleged that the Bank knew that Geringer, Luck, and Rode were breaching their fiduciary duty, knew that the returns claimed by Geringer were false, knew that the Fund was consistently losing money, and knew that the Fund was an "improper investment vehicle." Despite this knowledge — and even while attempting to pull his own money out of the fund—Maffia continued to solicit new investors for the Fund, continued to give it his "unqualified recommendation, and "continued to extoll the security and results of the GLR Fund." Thus, according to plaintiffs, Maffia not only omitted the true facts regarding the fund but affirmatively told them that the Fund was a "safe investment vehicle" and that it "had not sustained any losses." Moreover, the Bank's conduct was alleged to have been "done maliciously, oppressively, and with the intent to defraud." These allegations, supplemented by plaintiffs' arguments in opposition to the demurrer, were material and sufficient to charge the Bank with "a misrepresentation or omission of a material fact" (and, arguably, a "manipulative or deceptive device or contrivance") within the meaning of SLUSA. Accordingly, we conclude that all of plaintiffs' causes of action were precluded by the Act. 5. Leave to Amend
In their opposition plaintiffs reaffirmed their position that the Bank, through Maffia, supplied false information to them, citing specific allegations in support of their cause of action for breach of fiduciary duty.
In their opposition to the Bank's demurrer, plaintiffs requested leave to amend their complaint "to plead additional facts that the Bank had a direct pecuniary interest in soliciting Plaintiffs' investment in the [Fund]." The trial court initially declined to decide whether to grant leave to amend because a challenge was pending under Code of Civil Procedure section 170.3, subdivision (c)(1). After the resolution of that challenge and further argument by the parties, however, the court addressed the merits of the issue and denied leave to amend.
At the same time, the court granted leave to amend in the Strudley, Panushka, and Paetau cases.
As noted earlier, the denial of leave to amend after the sustaining of a demurrer is reviewed under an abuse of discretion standard. (Schifando, supra, 31 Cal.4th at p. 1081.) Accordingly, "we must decide whether there is a reasonable possibility the plaintiff could cure the defect with an amendment. [Citation.] If we find that an amendment could cure the defect, we conclude that the trial court abused its discretion and we reverse; if not, no abuse of discretion has occurred." (Ibid; City of Dinuba v. County of Tulare (2007) 41 Cal.4th 859, 865.) Furthermore, "leave to amend is liberally allowed as a matter of fairness, unless the complaint shows on its face that it is incapable of amendment. [Citations.]" (City of Stockton v. Superior Court (2007) 42 Cal.4th 730, 747 ["second amended complaint does not on its face foreclose any reasonable possibility of amendment"].) However, " '[l]eave to amend should be denied where the facts are not in dispute, and the nature of the plaintiff's claim is clear, but, under the substantive law, no liability exists.' [Citations.]" (Kilgore v. Younger (1982) 30 Cal.3d 770, 781.) It is not the reviewing court's role to figure out how a complaint can be amended; rather, the burden is "squarely on the plaintiff" to show a reasonable possibility that amendment will cure the defect. (Blank, supra, 39 Cal.3d at p. 318; Goodman v. Kennedy (1976) 18 Cal.3d 335, 349 [plaintiff seeking to amend must show "in what manner he can amend his complaint and how that amendment will change the legal effect of his pleading"].)
In their supplemental argument to the trial court, plaintiffs urged the court to grant leave to amend just as it had to the Strudley, Panushka, and Paetau plaintiffs. Plaintiffs renewed their assertion that their case was not subject to SLUSA because it was not a covered class action and did not involve the purchase of covered securities. Plaintiffs also pointed out that when they originally filed their complaint in federal court, they were only 21 in number; and now, after dismissal of the related case, they again numbered fewer than 50. Consequently, plaintiffs argued, their action did not exceed SLUSA's 50-plaintiff threshold and SLUSA did not apply.
The trial court was unconvinced. It observed that plaintiffs had not proposed an amendment, but had relied instead on the reduced number of their group to resurrect their claims. The court found persuasive the result in In re Lehman Brothers Sec. & ERISA Litig. (S.D.N.Y. 2015) 131 F.Supp.3d 241 (Lehman Brothers) where the district court rejected the argument that the elimination of some plaintiffs by settlement took the case out of the reach of SLUSA. Although settlement meant that the case was no longer "pending," the original cases nonetheless had been "filed in . . . the same court," within the meaning of section 78bb(f)(5)(B)(ii) and therefore met the definition of a "covered class action" under the Act. The Lehman Brothers court further explained that when a plaintiff's state law claims were dismissed against the individual defendants under SLUSA, the action could no longer be maintained against the nonmoving corporate defendant, either. "If the court were to conclude that the RHF Plaintiffs' state law claims still were viable now, it necessarily would mean that those claims had been 'maintained' between December 2012 [when dismissal was granted to the individual defendants] and the present date. That is not a permissible outcome under SLUSA." (Lehman Brothers, supra, at p. 268.)
Like the trial court, we find the Lehman Brothers reasoning persuasive and reach the same conclusion. Although the Bridges plaintiffs originally filed a complaint in federal district court, that action was dismissed, and the present action was then separately filed in state court. Once it was consolidated with the related lawsuits, it met the "more than 50 persons" threshold for SLUSA preclusion (§ 78bb(f)(5)(B)) and thereafter was "pending in the same court" within the meaning of the term "covered class action" (§ 78bb(f)(5)(B)(ii)), "maintained" in state court, and "based upon" state law. (§ 78bb(f)(1).)
Plaintiffs suggest no other amendment to the complaint that would take their action outside the purview of SLUSA. Their remaining argument seeks only to plead, "with precision," that SLUSA does not apply because the interests plaintiffs purchased in the Fund were not "covered securities" within the meaning of the Act. We have already addressed this contention and concluded otherwise, and plaintiffs do not propose to dispense with their allegations of misrepresentation. Because SLUSA precludes plaintiffs' state-law action, we agree with the trial court that demurrer was properly sustained without leave to amend.
As the Kingate court cautioned, "plaintiffs should not be permitted to escape SLUSA by artfully characterizing a claim as . . . a theory other than falsity when falsity nonetheless is essential to the claim." (Kingate, supra, 784 F.3d at p. 140.) --------
Disposition
The judgment is affirmed.
/s/_________
ELIA, Acting P. J. WE CONCUR: /s/_________
PREMO, J. /s/_________
MIHARA, J.