Hellum v. Breyer

• Decision Date: 20 July 2011
• Docket Number: No. A127660.,A127660.
• Citation: 11 Cal. Daily Op. Serv. 5141,123 Cal.Rptr.3d 803,2011 Daily Journal D.A.R. 6165,194 Cal.App.4th 1300
• Court: California Court of Appeals Court of Appeals
• Parties: Christian HELLUM et al., Plaintiffs and Appellants, v. James W. BREYER et al., Defendants and Respondents.

194 Cal.App.4th 1300

123 Cal.Rptr.3d 803

11 Cal. Daily Op. Serv. 5141

2011 Daily Journal D.A.R. 6165

Christian HELLUM et al., Plaintiffs and Appellants,

v.James W. BREYER et al., Defendants and Respondents.

No. A127660.

Court of Appeal, First District, Division 4, California.

April 29, 2011.

Review Denied July 20, 2011.

See Annot., Blue Sky Laws (1933) 87 A.L.R. 42;Cal. Jur. 3d, Securities Regulations, § 119; Cal. Civil Practice (Thomson Reuters 2011) Business Litigation, §§ 7:42, 7:47, 7:78; 9 Witkin, Summary of Cal. Law (10th ed. 2005) Corporations, § 449.

Green Welling, Robert S. Green, Brian S. Umpierre, San Francisco, The Rosen Law Firm, Lawrence M. Rosen, Redwood City, Counsel for Appellants.

Morrison & Foerster, Miriam A. Vogel, Los Angeles, Paul T. Friedman, Lawrence R. Katzin, San Francisco, Counsel for Respondents.

RUVOLO, P.J.

I.INTRODUCTION

In the aftermath of their failed investment in Prosper Marketplace, Inc. (Prosper), an online money lending service, Christian Hellum, and David Booth (plaintiffs) filed the instant class action lawsuit against Prosper and its corporate officers based on alleged violations of California and federal securities laws. Three of the named defendants who served as Prosper's outside directors, James W. Breyer, Larry W. Cheng, and Robert C. Kagle (collectively, the outside directors),¹ filed a demurrer arguing that plaintiffs had failed to plead sufficient facts to establish that the outside directors were liable on any of the three causes of action pled against them pursuant to Corporations Code section 25504² ( section 25504) and title 15 of the Securities Act of 1933, 15 United States Code section 77 o (Title 15 of the Securities Act).³

In seeking demurrer, the outside directors argued that in order to state a cause of action under each of plaintiffs' theories of liability, plaintiffs were required to plead facts showing that the outside directors asserted control over Prosper, the primary violator, and that plaintiffs had failed to allege sufficient facts establishing such control. Accepting this contention, the trial court sustained the outside directors' demurrer, and entered a judgment of dismissal in their favor. Plaintiffs appeal, contending that the judgment of dismissal entered in favor of the outside directors should be reversed because plaintiffs' complaint stated a claim under every theory of liability pled under both section 25504 and Title 15 of the Securities Act.

We agree with plaintiffs that under one of the many provisions of section 25504 establishing liability for specific classes of individuals, presumptive liability is imposed for directors and officers of any corporation that violates specified state securities statutes, regardless of whether the particular officers and directors actually exercised control over the corporation. Therefore, the trial court erred in imposing a control requirement where none existed, and in sustaining the outside directors' demurrer to this cause of action on the ground that plaintiffs had failed to allege sufficient facts demonstrating such control.

As for the remaining two theories of liability pled against the outside directors under Title 15 of the Securities Act and a different provision of section 25504, plaintiffs concede as to those claims, they must establish that outside directors were in a position of control. In examining the allegations relating to these separate causes of action, we conclude that plaintiffs' complaint alleged sufficient facts demonstrating that outside directors possessed such control. Accordingly, we reverse.

II.FACTS AND PROCEDURAL HISTORY

Prosper, a closely held corporation based in San Francisco, California, was formed in March 2005. Its sole business was the operation of an online lending program through its website, www. Prosper. com. Prosper's lending platform functioned like a double-blind auction, connecting individuals who wished to borrow money with individuals, like plaintiffs, who wished to purchase loans extended to borrowers. Lenders and borrowers were prohibited from dealing directly with one another. They registered on the website and created Prosper identities.

Potential borrowers could request unsecured loans in amounts between $1,000 and $25,000 by posting “listings” indicating the amount they wanted to borrow and the maximum interest rate they would be willing to pay. Prosper assigned borrowers a credit score based on a commercial credit score obtained from a credit bureau, but Prosper did not verify personal information, such as employment and income. Potential lenders bid on funding all or portions of loans for specified interest rates, which were typically higher than rates available from depository accounts at financial institutions. Each loan was usually funded with bids by multiple lenders. After an auction closed and a loan was fully bid upon, the borrower received the requested loan with the interest rate fixed by Prosper at the lowest rate acceptable to all winning bidders.

Prosper charged an origination fee from each borrower and a servicing fee from each lender. In return, Prosper administered the loan program by collecting and distributing payments to the lenders, and by initiating procedures to collect past due loans from borrowers, including the assignment of delinquent loan accounts to collection agencies.

As of October 2008, Prosper had initiated approximately $174 million in loans and had over 830,000 members, including both borrowers and lenders. On approximately October 14, 2008, Prosper announced that it would temporarily cease underwriting and selling loan notes on its website. On November 24, 2008, the Securities and Exchange Commission (SEC) imposed a cease-and-desist order against Prosper pursuant to “Section 8A of the Securities Act of 1933.” The SEC made a number of findings, including that “[t]he loan notes issued by Prosper ... are securities and Prosper, from approximately January 2006 through October 14, 2008, violated Sections 5(a) and (c) of the Securities Act, which prohibit the offer or sale of securities without an effective registration statement or a valid exemption from registration.”

Plaintiffs, who purchased loan notes through Prosper and who suffered losses, brought this lawsuit against Prosper and its corporate officials, including the outside directors, seeking to represent a nationwide class of lenders who participated in Prosper's online lending program. In plaintiffs' second amended complaint (SAC), the operational complaint for our purposes, plaintiffs alleged violations of state and federal securities laws arising out of the purchase and sale of approximately $174 million of nonexempt, unqualified, and unregistered loan note securities between January 1, 2006, and October 14, 2008. Plaintiffs claimed that as of July 2009, approximately $42.6 million worth of loan notes purchased by lenders had become worthless because the borrowers had not repaid the loans to Prosper.

Of the seven causes of action alleged in the SAC, three were leveled against the outside directors. The third and fourth causes of action alleged that the outside directors violated separate provisions of section 25504. Under the pertinent provisions of section 25504, the following persons are jointly and severally liable for selling unqualified securities, with those who have engaged in an unlawful practice: “Every person who directly or indirectly controls a person liable under Section 25501 or 25503, every partner in a firm so liable, every principal executive officer or director of a corporation so liable, ... unless the other person who is so liable had no knowledge of or reasonable grounds to believe in the existence of the facts by reason of which the liability is alleged to exist.” “Person” is defined as including individuals and corporations. (§ 25013.)

In the third cause of action, plaintiffs sought to hold the outside directors liable under the first provision in section 25504, spelling out liability for every person who “directly or indirectly controls a person liable under Section 25501 or 25503.” ⁴ The third cause of action alleged that the outside directors were liable under this provision because “ [b]y virtue of their executive positions, and/or Board membership ... these individuals had the power to influence and control and did influence and control, directly or indirectly, the decision-making of the Company, including the decision to offer and sell loan note securities in California without qualification or an exemption.”

In the fourth cause of action, plaintiffs sought to plead a cause of action under section 25504 based solely on the outside directors' status as directors of Prosper. So framed, the fourth cause of action alleged the outside directors were liable because they fell within the classification of “every principal executive officer or director of a corporation so liable.”

In the seventh cause of action, plaintiffs sought to hold the outside directors liable under Title 15 of the Securities Act, imposing joint and several liability upon persons for acts committed by those under their control that violate federal registration requirements. Specifically, Title 15 of the Securities Act provides: “Every person, who, by or through stock ownership, agency, or otherwise, or who, pursuant to or in connection with an agreement or understanding with one or more other persons by or through stock ownership, agency, or otherwise, controls any person liable under sections 77k or 77 l of this title [which deal with false statements or omissions in a registration statement] shall also be liable jointly and severally with and to the same extent as such controlled person to any person to whom such controlled person is liable, unless the controlling person had no knowledge of or reasonable ground to believe in the existence of the facts by reason of which the liability of the controlled person is alleged to exist.” Plaintiff...