Dealers of investment contracts forced to disgorge sales commissions.

Warfield v. Alaniz, US App Lexis 13531 (2009)

The Mid-America Foundation, controlled by Robert Dillie, sold annuities promising to provide income for the life of a person in being, with the remainder delivered to the charity of their choosing after death. After $55 million in sales, and no charity ever receiving a benefit, Mid-America was outed as a Ponzi scheme. Upon the Security and Exchange Commission's filing a complaint against Dillie, Lawrence Warfield became the court appointed receiver of Mid-America.

Warfield successfully sued those who sold the annuities and recovered the commissions earned on the sales of Mid-America annuities. The defendants appealed, and the appellate court reviewed the trial court determination that the annuities were investment contracts. The court relied upon SEC v. Rubera, 350 F3d 1084, 1090 which defines an investment contract as, "(1) an investment of money; (2) in a common enterprise; (3) with an expectation of profits produced by the efforts of others." The Mid-America annuities fit into this definition and were held to be investment contracts, and the appellate court affirmed the trial court's decisio, disgorging the sales commissions from the annuity salespersons.

Broker-dealers, beware. Know what you are selling and for whom you are selling.

Proving a breach of fiduciary duty by a securities broker-dealer becomes easier.

Oravecz v. New York Life Ins. Co., 174 CA4th 174 (2009)

Court of Appeal of the State of California

Second Appellate District

Division One

Oravecz bought investment securities in Tradex through broker-dealer Steve Roth, allegedly an employee of New York Life Insurance Company. What Oravecz believed to be an offshore trading fund was actually a Ponzi scheme. When the Ponzi scheme collapsed, and Oravecz had lost the money invested in Tradex, Oravecz sued New York Life alleging several causes of action, including breach of fiduciary duty.

New York Life successfully demurred on each of Oravecz's causes of action and was awarded summary judgment. The trial court based its decision to sustain the demurrer on the breach of fiduciary duty cause of action because, under federal law [e.g., Independent Order v. Donald, Lufkin & Jenrette, 157 F3d 933 (1998)], a fiduciary duty only arises when the investor gives discretion to chose investments and control trading authority.

Oravecz appealed, and the appellate court held that the trial court had correctly ruled on the existence of summary judgment under the federal law, but under California common law the investor need not provide a showing of discretion or control by the securities broker. As such, the trial court erred in finding that Oravecz's allegations did not sufficiently allege a claim for breach of fiduciary duty.

The federal requirement that a broker-dealer have discretion and control over an investor's assets for a breach of fiduciary duty to be owed is a reasonable standard. If not for such a duty, negligent and careless decisions by broker-dealers failing to conduct reasonable due diligence would carry few consequences. That California has no such requirement of discretion and control in effect makes each broker-dealer a babysitter for each investor, and begins a shift of responsibility to conduct due diligence away from the party making investment decisions and onto the broker. The slope is steep and icy, broker-dealers, be careful where you step.

Prejudgment interest may be awarded under the Song-Beverly Consumer Warranty Act.

Doppes v. Bentley Motors, Inc. 174 CA4th 1004 (2009)

Court of Appeal of the State of California

Fourth Appellate District

Division Three

In 2001, Doppes bought a new Bentley Arnage from Newport Auto Center. Shortly after taking delivery of the vehicle, Doppes noticed an "obnoxious odor" inside the vehicle. After 171 days without his new Bentley, which the dealership was unable to deodorize, Doppes requested a replacement vehicle from Bentley Motors. Bentley Motors denied this request.

Doppes successfully sued Bentley Motors and the dealership on numerous causes of action, including the Song-Beverly Consumer Warranty Act. In awarding damages to Doppes, the trial court allowed for prejudgment interest of 7% per year from April 2002 when the vehicle was purchased until the entry of judgment. Eight months after the judgment was entered, Bentley moved to set aside the judgment under California Code of Civil Procedure § 473(d). Bentley based its motion on the argument that the Song-Beverly Consumer Warranty Act does not allow prejudgment interest, and thus the award exceeded the jurisdiction of the trial court. The trial court overruled Bentley's § 473(d) motion, and Bentley appealed.

The appellate court affirmed the overruling of the § 473(d) motion on the grounds that California Civil Code § 3287 allows for any person awarded damages to recover interest on those damages "from any such debtor" and the Song-Beverly Consumer Warranty Act at California Civil Code § 1794 allows a customer damaged by violations of the Act to bring an action for damages, costs, expenses, reasonable attorney fees and civil penalties.

This decision is important for all business owners because the Song-Beverly Consumer Warranty Act potentially applies to every sale of consumer goods sold at retail in California. The Act is very strict about the type of formalities with which a manufacturer, distributor and retailor must comply to circumvent the implied warranty of fitness, less any party in the stream of commerce be liable not only for damages, but prejudgment interest on those damages.

CAVEAT VENDITOR; LET THE SELLER BEWARE.

Banks may charge fees on accounts containing public benefit money.

Miller v. Bank of America, 46 CA4th 630 (2009)
Court of Appeal of the State of California
First Appellate District
Division Three

In this class action lawsuit, class representative Miller was a recipient of Supplemental Security Income (SSI) and other public benefit money which was directly deposited in his Bank of America account. In January 1998, Bank of America erroneously deposited $1,799.83 into Miller's account. Upon realizing its error in April 1998, Bank of America debited Miller's account for the $1,799.83, leaving a negative balance in Miller's account. The bank took funds from Miller's May SSI direct deposit to settle the negative balance, leaving Miller unable to pay his rent and other living expenses.

When Miller objected to Bank of America's actions, the bank opened a second account for Miller's SSI direct deposit, and credited the new account for the May SSI payment it previously captured, but also informed him that Miller he was still responsible for the first account's negative balance. In June and July, Bank of America again seized and later restored SSI funds from Miller's second account to satisfy the negative balance in his first account. Bank of America also charged Miller's second account with Non-Sufficient Funds (NSF) fees related to overdrafts caused by fund seizures.

Miller sued Bank of America in 1998 bringing a host of allegations, including violation of the Consumers Legal Remedies Act (CLRA). Relying upon Kruger v. Wells Fargo Bank, 11 CA3d 352 (1974), the jury awarded $75 million in compenatory damages to Miller and the other class members on a finding that Bank of America violated CLRA by falsely representing the right to use public benefit money to pay overdraft fees.

On an appeal upheld by the Supreme Court of California, Kruger was found to not apply to debits of overdrafts and charging NSF fees because the instant case was distinguished from Kruger in that Miller's debt was not a past debt but arose from activity in a single account. Further, under California Financial Code 864, "debt" is defined to exclude "charge for bank services or...for an overdraft of an account."

This case is a victory for businesses in California. It is hard to believe Miller "did not notice" almost $1,800 extra in his account while he required SSI pay his rent and living expenses. That he did not call the extra money in his account to the attention of his banker is one thing, but that he spent the money and then complained when Bank of America corrected the error is another. When banks take losses on deadbeat accounts, the true victims are the account holders with positive balances who pay higher fees fees and earn less interest to offset the bank's loss.

Securities professionals are criminally prohibited from indicating specialization in serving senior citizens in a misleading manner.

California Corporations Code § 25243.5

California Corporations Code § 25243.5 became operative on July 1, 2009. Under the provisions of §25243.5, securities professionals are criminally prohibited from using a certification, credential, or professional designation which indicates specialization in serving senior citizens and retirees in a misleading manner.

Under § 25243.5, the prohibited use of these certifications, credentials, or professional designations includes, but is not limited to, the use of a certification, credential, or professional designation:

• By a person who has not actually earned or is otherwise ineligible to use the certification, credential, or designation;

• That is nonexistent or self-conferred;

• Indicating or implying a level of occupational qualifications obtained through education, training, or experience that the person using the certification, credential, or professional designation does not have.

• Obtained from a designating, credentialing, or certifying organization where: (1) The organization is primarily engaged in the business of instruction in sales marketing; or (2) The organization does not have reasonable standards or procedures for assuring the competency of individuals to whom it grants a certification, credential, or professional designation; or (3) The organization does not have reasonable standards or procedures for monitoring and disciplining individuals with a certification, credential, or professional designation for improper or unethical conduct; or (4) The organization does not have reasonable continuing education requirements for individuals with a certification, credential, or professional designation in order to maintain the certificate,credential, or professional designation.

All businesses, not just brokers, should be keep informed of changes in laws regulating their industry. What might have been standard operating procedure yesterday might today be the commission of a crime.

Any person who claims to have been denied the right to vote may challenge the election of a director.

Haah v. Kim, 175 CA4th 45 (2009)
Court of Appeal of the State of California
Second Appellate District
Division Four

Many of the facts in this case were contested at trial, but based solely on the appellate court's decision the story is that Galleria Plus, Inc. (GPI) was formed by incorporating attorney Yoon Han Kim on behalf of Francis Key. Key sought to own and operate a supermarket with GPI. Yoon Han Kim prepared, and Se Heon Yoon signed, a statement of information naming Se Heon Yoon the sole director and officer of GPI. Later, Se Heon Yoon left GPI, and Yoon Han Kim prepared another statement of information, this one naming Donghyuk Kim sole director and officer of GPI. Donghyuk Kim signed this statement of information. When Key's supermarket project encountered financial trouble, Key gave 25% of GPI's stock to Stephan Haah in consideration for finding investors to purchase other blocks of GPI stock.

After Haah successfully found investors and Key sold blocks of GPI stock to these investors, Key requested Yoon Han Kim sign an action naming Key as director of GPI. Soon after, Key asked Stephan Haah to act as sole director. Haah agreed, but protested when Key modified the action naming Key as director to with correction fluid so the document read as an action naming Haah as director. Later during the same day, Key produced another action naming Haah as the sole director of GPI, and appearing to be signed by Yoon Han Kim.

Haah acted as GPI's sole director until Key died, and Donghyuk Kim disputed Haah's directorship, alleging that the Yoon Han Kim's signature on the action appointing Haah as director was a forgery. Haah agreed to step down, allowing Donghyuk Kim sole directorship of GPI, on the condition that Donghyuk Kim honor some agreements Haah had entered into on behalf of GPI. Donghyuk Kim did not honor the agreements as promised, and Haah had Yoon Han Kim void the action he had signed making Donghyuk Kim a director.

Unfazed, Donghyuk Kim continued to act as GPI's director, and Haah began holding his own shareholder meetings. At Haah's shareholder meetings, Donghyuk Kim's directorship was renounced and Haah and others were elected directors.

Haah filed suit under California Corporations Code § 709 Donghyuk Kim appealed the trial court's decision on the grounds that:

• The court erred in overruling his demurrer;

• Haah lacked standing to bring the cause of action;

• The trial court abused its discretion by appointing directors.

The appellate court noted that the California Code of Civil Procedure does not contain a provision allowing a party to join in a demurrer, and as such Donghyuk Kim may not challenge the trial court’s overruling because the demurrer was not his motion, and his one-page “joinder” was merely “a cheerleading effort” in support of the motion.

The legislative history of § 709 was considered by the appellate court in evaluating Donghyuk Kim’s argument that Haah lacked standing to bring the cause of action under § 709. The appellate court found an action may be brought under § 709 by, “any shareholder” and “any person who claims to have been denied the right to vote.”

Finally, in regard to Donghyuk Kim’s assertion that the trial court abused its discretion in appointing directors for GPI, the appellate court pointed out that no objection was made by Donghyuk Kim or Donghyuk Kim’s counsel at the hearing to appoint directors, thus waiving the right to appeal.

Clear documentation of stock transactions, including clear specification of transaction effective dates, could have saved everyone involved in this case from years of costly litigation. While corporate formalities often take a back seat to more "pressing" demands on the time of business owners, this case and its tale of two, self-appointed boards of directors is a fine illustration of why keeping up with those formalities is so important.

Foreword

Welcome to the San Diego Corporate Law blog. Since I read most of the federal and California court decisions related to business law, I thought it might be useful to summarize some of those decisions for general dissemination.

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