Gervase v. Superior Court, C017925

• Decision Date: 26 January 1995
• Docket Number: No. C017925,C017925
• Citation: 37 Cal.Rptr.2d 875,31 Cal.App.4th 1218
• Court: California Court of Appeals Court of Appeals
• Parties: , RICO Bus.Disp.Guide 8732 Stephen GERVASE et al., Petitioners, v. The SUPERIOR COURT of San Joaquin County, Respondent; PRUDENTIAL SECURITIES, INC., et al., Real Parties in Interest.

Page 875

37 Cal.Rptr.2d 875

31 Cal.App.4th 1218, RICO Bus.Disp.Guide 8732

Stephen GERVASE et al., Petitioners, v. The SUPERIOR COURT of San Joaquin County, Respondent;

PRUDENTIAL SECURITIES, INC., et al., Real Parties in Interest.

No. C017925.

Court of Appeal, Third District, California.

Jan. 26, 1995.

Review Denied June 1, 1995.

Law Office of Archibald M. Mull III, Archibald M. Mull III and Allan S. Haley, Sacramento, for petitioners.

Steefel, Levitt & Weiss, Michael J. Lawson, Michael D. Early and Bruce C. Judge, San Francisco, for real parties in interest.

SPARKS, Acting Presiding Justice.

The petitioners are plaintiffs in an action pending in the superior court based generally upon alleged fraud in the sale of securities. ¹ After several attempts at pleading the trial court sustained, without leave to amend, the defendants' demurrer to plaintiffs' federal Racketeer Influenced and Corrupt Organizations Act (RICO) cause of action. (18 U.S.C. § 1961 et seq.) We issued an alternative writ of mandate in order to determine whether plaintiffs have sufficiently alleged a RICO cause of action in their third amended complaint. We conclude that they have and shall issue a peremptory writ of mandate directing the superior court to overrule the demurrer as to that cause of action. ²

FACTUAL AND PROCEDURAL BACKGROUND

The question raised by a demurrer to the complaint is simply whether it alleges sufficient facts to state a cause of action.

                (Johnson v. Clark (1936) 7 Cal.2d 529, 536, 61 P.2d 767;  Brousseau v. Jarrett (1977) 73 Cal.App.3d 864, 870-871, 141 Cal.Rptr. 200.)   A demurrer is not concerned with the likelihood that the plaintiffs will prevail, nor even whether they have evidence to support their allegations.  (Alcorn v. Anbro Engineering, Inc.  (1970) 2 Cal.3d 493, 496, 86 Cal.Rptr. 88, 468 P.2d 216;  Accardi v. Superior Court (1993) 17 Cal.App.4th 341, 346, 21 Cal.Rptr.2d 292.)   Instead, a demurrer admits, provisionally for purposes of testing the pleading, all material facts properly pleaded, however improbable they may be.  (Potter v. Arizona So.  Coach Lines, Inc.  (1988) 202 Cal.App.3d 126, 130-131, 248 Cal.Rptr. 284;  McHugh v. Howard (1958) 165 Cal.App.2d 169, 174, 331 P.2d 674.)   Accordingly, we will draw our recitation of the facts, which we accept as true for purposes of this proceeding, from plaintiffs' third amended complaint. 3
                

The plaintiffs are individuals and related entities who are primarily concerned with the business of poultry ranching. ⁴ Defendant Prudential Securities, Inc. (hereafter PSI), is a corporation engaged in the securities brokerage business. ⁵ Defendant Michael Baker was a registered representative employed by PSI as assistant manager and then manager of the PSI Stockton branch.

During the period from 1984 to 1988, the plaintiffs were customers of PSI at its Stockton branch. Plaintiffs' accounts were managed and controlled by Charles Smith, who at that time was a registered securities representative employed by PSI. Smith had been plaintiff Agnes Gervase's broker for a number of years prior to 1984. Between 1984 and 1988, PSI, through Smith and with the approval and supervision of defendant Baker, sold plaintiffs numerous interests in limited partnerships at a cumulative cost exceeding $532,190. The limited partnership interests were highly speculative and risky investments, suited only to sophisticated investors with surplus wealth. These interests have ceased to be worth the sums plaintiffs paid for them. As a result of these investments plaintiffs lost their investment capital.

Plaintiffs further allege that they invested in the limited partnership interests as a result of inducements by PSI and its representatives that sound in fraud and misrepresentation. Plaintiffs assert that they are comparatively unsophisticated investors with relatively modest investment capital. Their investment objectives, communicated to defendants, were to invest in securities that were safe, did not involve significant risk, and that would be dependable income-producing and principal-preserving investments. Plaintiffs allege that with respect to each limited partnership interest they purchased the defendants falsely represented that the investment was well suited to their investment objectives, involved little or no risk, and had long-term potential for excellent appreciation. Plaintiffs did not discover the falsity of these representations until much later, in part due to continuous reassurances by PSI and in part because PSI sent monthly account statements falsely reflecting that the investments continued to be worth their cost.

That is the gist of plaintiffs' complaint; fleshing it out becomes rather complicated. Plaintiffs allege that during the relevant period there was within the broad Prudential conglomeration a business unit known as the Direct Investment Group (the DIG) headed by one James Darr. The limited partnership interests purchased by the plaintiffs were designed and packaged by the DIG for sale through PSI. Despite the speculative and risky nature of the limited partnerships, PSI purposely marketed the interests to investors for whom they were ill-suited, such as the plaintiffs.

In order to induce brokers to favor the sale of limited partnership offerings over other forms of investment, PSI and the DIG structured the offerings so that brokers would receive commissions from the sale of limited partnerships that were up to eight times greater than the commissions that would be received from the sale of a comparable dollar amount of stocks, bonds, or mutual funds. In addition, PSI promised to pay "residuals" to brokers who sold at least $25,000 worth of any particular partnership and remained with PSI. These residuals were to represent half of the net earnings of Prudential affiliates as general or special limited partners in connection with the offering. Fact sheets distributed by PSI and the DIG on limited partnership offerings would estimate the value of residuals that could be earned for each unit sold. PSI provided periodic reports to brokers estimating the amount of residuals they could expect from sales made. And PSI awarded fully paid trips and vacations to high-producing brokers.

The various limited partnership offerings were accompanied by prospectuses containing thousands of pages of dense and complicated legalese. Brokers were told to disregard the prospectuses and rely upon fact sheets prepared by the DIG. The fact sheets failed to disclose the speculative and risky nature of the investments and were intended to keep customers ignorant of those risks. In addition, the DIG prepared, and PSI distributed to brokers, certain "scripts" setting forth a sales approach to be used by brokers in selling limited partnership offerings to modest investors, like plaintiffs, for whom the investments were ill-suited. These scripts contained the misleading and false representations that were made to plaintiffs in inducing them to purchase limited partnership interests.

In all the plaintiffs purchased at least 39 limited partnership interests. For purposes of setting forth the representations used to induce them to make the purchases, the plaintiffs divided their purchases into two broad categories which they delineate (1) the real estate, aircraft leasing and film limited partnerships and (2) the energy income and energy growth fund limited partnerships. They allege that with respect to each type of purchase Smith made certain uniform representations pursuant to the scripts prepared by the DIG and supplied by PSI.

With respect to each of the real estate, aircraft leasing and film limited partnerships, plaintiffs allege that Smith, pursuant to the script, made the following false representations to them: the investment was suited to their investment objectives; the investment was low risk with long-term potential for excellent appreciation while producing a tax-advantaged cash flow; the investment had been fully researched by Prudential and was endorsed and sponsored by PSI; PSI had a very good track record with similar investments; the sponsor affiliated with PSI in the offering was knowledgeable and reputable in the field and had a very good track record with similar investments.

With respect to each of the energy income and energy growth fund limited partnership interests, plaintiffs allege that Smith, pursuant to the scripts, made the following false representations to them: the investment was as safe and secure as a certificate of deposit (CD) with a far better return; the investment was solid, low risk, with long-term potential for excellent appreciation while producing a tax-advantaged cash flow; the partnership had been fully researched by PSI and was endorsed and sponsored by PSI; PSI had a very good track record with similar investments; the sponsor affiliated with Prudential in the offering was knowledgeable and reputable in the field; Prudential had independent expertise in the field and would In addition to the false representations made by defendants, plaintiffs allege that defendants failed to disclose the following relevant information: the limited partnership investments were highly unsuited to plaintiffs' investment objectives; the limited partnerships were highly risky and speculative with no long-term potential for excellent appreciation due to the high front-end loads (commissions) charged by PSI; the limited partnerships had not been fully researched by PSI but had been chosen because Darr and others in the DIG stood to gain through secret arrangements and kickbacks from the partnerships' sponsors and management; neither PSI nor Prudential had a good track record with similar investments; and the sponsors of certain limited partnerships were chosen not for their expertise but because Darr and the DIG stood to benefit most from the arrangements and packages negotiated with them.

contribute to the oversight of the investment;...