133 Cal.App.4th 658, A104481, Peregrine Funding, Inc. v. Sheppard Mullin Richter & Hampton LLP

Docket Nº:A104481
Citation:133 Cal.App.4th 658, 35 Cal.Rptr.3d 31
Opinion Judge:[9] The opinion of the court was delivered by: McGuiness, P.J.
Party Name:Peregrine Funding, Inc. v. Sheppard Mullin Richter & Hampton LLP
Attorney:[7] Rogers Joseph O'Donnell & Phillips, Pamela Phillips, Sean M. SeLegue and John S. Throckmorton for Defendant and Appellant [8] Bartko, Zankel, Tarrant & Miller, John J. Bartko, Robert H. Bunzel and Howard L. Pearlman for Plaintiff and Respondent
Case Date:October 19, 2005
Court:California Court of Appeals

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133 Cal.App.4th 658

35 Cal.Rptr.3d 31

PEREGRINE FUNDING, INC., et al., Plaintiffs and Respondents,


SHEPPARD MULLIN RICHTER &amp HAMPTON LLP, Defendant and Appellant.


California Court of Appeal, First District, Third Division

October 19, 2005

Trial Court: Alameda County Superior Court, Super. Ct. No. RG03087483, Trial Judge: Ronald Sabraw

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Rogers Joseph O’Donnell & Phillips, Pamela Phillips, Sean M. SeLegue and John S. Throckmorton for Defendant and Appellant

Bartko, Zankel, Tarrant & Miller, John J. Bartko, Robert H. Bunzel and Howard L. Pearlman for Plaintiff and Respondent


McGuiness, P.J.

This case is one of several arising from the collapse of a large Ponzi scheme.1 Plaintiffs—investors who lost millions in the scheme and a bankruptcy trustee representing entities that were used to perpetrate the scheme—have sued the law firm Sheppard Mullin Richter & Hampton LLP (Sheppard), claiming its negligence and affirmative misconduct helped the perpetrators of the scheme avoid detection and prosecution by securities regulators. Sheppard filed a special motion to strike the complaint under Code of Civil Procedure section 425.16, subdivision (b)(1),2 which provides a means for early dismissal of unmeritorious claims that target the defendant’s constitutionally protected speech or petitioning activity. After the trial court denied its motion, the firm filed this interlocutory appeal. We conclude the

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motion to strike should have been granted in part because plaintiffs’ claims are partially based on protected activity and some plaintiffs did not establish the requisite likelihood of prevailing. Specifically, we conclude the bankruptcy trustee’s claims on behalf of one entity are barred by the doctrine of unclean hands and the investors’ claims are barred by the applicable statute of limitations. Accordingly, we reverse and direct the trial court to enter an order granting the motion to strike as to these plaintiffs.


While it lasted, the Ponzi scheme alleged in this case was disguised as a successful mortgage lending business. (See Union Bank of California v. Superior Court (2005) 130 Cal.App.4th 378, 384-385 [29 Cal.Rptr.3d 894] [describing the factual allegations of disgruntled investors in a related case arising from the scheme].) According to the first amended complaint,3 James Hillman and Michael Fanghella established PinnFund USA, Inc. (PinnFund) in the late 1990’s as a company to originate, purchase and sell sub-prime mortgage loans, with Fanghella serving as its chief executive officer. Hillman created three businesses—Allied Capital Partners, Grafton Partners and Six Sigma LLC (collectively, the Funding Entities)—to solicit funds for investment in PinnFund mortgages. These Funding Entities were all managed by Peregrine Funding, Inc. (Peregrine), a corporation owned and controlled by Hillman and his wife. Although contracts between PinnFund and the Funding Entities required all investor funds to be placed in a trust account and used for the sole purpose of funding loans, Hillman and Fanghella looted the account to pay fictional returns to earlier investors and to enrich themselves and other “insider confederates” with millions of dollars in phony commissions and fees. The scheme allegedly bilked investors of over $300 million and resulted in federal criminal charges against Fanghella and Hillman.

Attorney William Manierre represented Hillman, Peregrine and two of the Funding Entities beginning in 1995, and he continued to represent them after he joined the Sheppard firm in October 1997. In February 1999, Sheppard prepared two opinion letters for Hillman that plaintiffs claim contain negligent or reckless legal advice. In what the complaint refers to as the “IAA Comfort Letter,” Sheppard concluded Peregrine was not required to register as an investment advisor under applicable California or federal laws. Plaintiffs allege this advice was wrong and Sheppard issued it knowing the letter was intended to be used for the sole purpose of soliciting investors, in that its securities registration analysis apparently endorsed the legitimacy of the

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enterprise. In the “ICA Comfort Letter,” and an October 2000 update to this letter, Sheppard advised Hillman that the Funding Entities were not required to register as investment companies under federal securities law so long as they had fewer than 100 investors. Aware that Hillman sought to increase the number of PinnFund investors yet still evade registration laws, Sheppard advised that the law’s 100-investor limitation could be circumvented by the creation of a “ ‘super accredited investment entity.’ ” Thereafter, Hillman created a third company (Six Sigma LLC) for this purpose, allowing the scheme to raise—and lose—additional investment funds.

But the scheme began to collapse in September 2000 when a large investor withdrew its $22 million in capital. Two months later, the Securities and Exchange Commission (SEC) commenced an investigation, and in February 2001 the SEC served subpoenas on Hillman, PinnFund, Peregrine and the Funding Entities. The complaint alleges that in February and March 2001, Sheppard counseled Hillman and the Funding Entities about whether to cooperate with the government’s demands, and on behalf of these clients refused to produce subpoenaed documents and witnesses.

On March 21, 2001, the SEC filed suit against Hillman, Fanghella, PinnFund and the Funding Entities for violation of federal securities laws. During this time, the complaint alleges Sheppard continued to represent the Funding Entities and Peregrine but acted to their detriment in serving the needs of its co-client Hillman. Specifically, Sheppard opposed provisional relief sought by the government and fought the appointment of a receiver. In addition, “Sheppard advised government lawyers in late March 2001 that Hillman would not testify, and if the government insisted that he testify, Sheppard ‘would put the Funding Entities into bankruptcy’ in order to derail or disrupt the SEC action.” To this end, Sheppard consulted with bankruptcy counsel in March 2001. On April 2, 2001, after the SEC obtained a temporary restraining order freezing the assets of Hillman and the Funding Entities, and shortly after the SEC began deposing Hillman, the Funding Entities filed a voluntary petition for bankruptcy and Sheppard filed a notice withdrawing as their counsel. The firm continued to represent Hillman through the duration of the SEC action, however, and was his counsel of record in the federal criminal case that was later brought against him.

Plaintiff Richard M. Kipperman was appointed the bankruptcy trustee of Peregrine and the Funding Entities in September 2001. Although Kipperman asked the firm to turn over all documents and files pertaining to its representation of these clients, the complaint alleges Sheppard provided only a small portion of the materials requested “in willful concealment of its misconduct.”

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Plaintiffs4 filed a complaint against Sheppard on March 19, 2003, and an amended complaint on May 12, 2003. The complaint asserts two causes of action—professional malpractice and aiding and abetting a breach of fiduciary duty—based on Sheppard’s registration analysis and advice in 1997 through early 2001 and its allegedly conflicted representation of adverse parties in the 2001 SEC action. Plaintiffs claim Sheppard’s advice in the IAA and ICA comfort letters was a substantial factor in causing investor losses because it enabled Hillman to evade registration requirements that would have alerted regulators and investors to the perpetrators’ illegal activities. Plaintiffs also claim they were damaged by Sheppard’s representation of Hillman in the SEC action in that the firm: (1) blocked the SEC’s investigation and delayed provisional relief; and (2) assisted Hillman’s exit from the Ponzi scheme by helping him implement a so-called “dividend reinvestment program” that recycled investor returns instead of distributing them to investors.

In response, Sheppard filed a special motion to strike the complaint as a SLAPP suit, pursuant to section 425.16.5 Sheppard argued the suit fell under section 425.16 because both of plaintiffs’ claims arose from the firm’s protected speech and “ ‘litigation activity’ ” on behalf of its clients, and plaintiffs could not establish the requisite likelihood of success because the investors’ claims were barred by the statute of limitations and the trustee’s claims were barred by standing rules and the equitable doctrine of unclean hands.6 The trial court denied the motion, however, concluding section 425.16 was not triggered because plaintiffs’ claims did not arise from any acts by Sheppard in furtherance of its right of petition or free speech in connection with a public issue. While noting this finding did not require it to reach the second prong of a section 425.16 analysis, the trial court’s order proceeded to observe that plaintiffs had stated and substantiated legally sufficient claims against Sheppard and the court could not conclude, on the record presented, that the claims were barred by any of the defenses asserted by Sheppard.

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I. Section 425.16 Applies to Claims Partially Based on Protected Activity

Section 425.16 provides for the early dismissal of certain unmeritorious claims by means of a special motion to strike. (See Mann v. Quality Old Time Service, Inc. (2004) 120 Cal.App.4th 90, 102 [15 Cal.Rptr.3d 215]...

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