People v. Graham

• Decision Date: 24 January 1985
• Docket Number: Cr. 13834
• Citation: 210 Cal.Rptr. 318,163 Cal.App.3d 1159
• Court: California Court of Appeals Court of Appeals
• Parties: , Blue Sky L. Rep. P 72,190 The PEOPLE, Plaintiff and Respondent, v. Lawrence E. GRAHAM, Defendant and Appellant. D000086.

Page 318

210 Cal.Rptr. 318

163 Cal.App.3d 1159, Blue Sky L. Rep. P 72,190

The PEOPLE, Plaintiff and Respondent, v. Lawrence E. GRAHAM, Defendant and Appellant.

D000086.

Cr. 13834.

Court of Appeal, Fourth District, Division 1, California.

Jan. 24, 1985.

John K. Van de Kamp, Atty. Gen., Keith I. Motley and M. Howard Wayne, Deputy Attys. Gen., for plaintiff and respondent.

WIENER, Associate Justice.

Lawrence E. Graham appeals from the judgment entered on a jury verdict convicting him of a single count of violating the Corporate Securities Law of 1968. (Corp.Code, §§ 25000 et seq., 25540.) ¹ The jury found Graham made a public offer to sell an unqualified security under section 25110. ² Graham contends the evidence is insufficient to support the conviction. We disagree and affirm the judgment.

Factual and Procedural Background

Robert Chapek, a modern day alchemist and Graham's codefendant at trial, wished to promote a "Midas" machine purportedly capable of extracting gold from mine water. In January 1977 Robert Krueger, a Marine Corps captain, invested $2100 in an Arizona mining operation using Chapek's machine. Krueger's investment did not turn to gold. Nevertheless, with unflagging optimism, Krueger stayed in touch with Chapek. In November 1980 Chapek introduced Krueger to Graham, his partner in another venture promoting the use of the same machine. Remarkably, the machine could now detoxify chemical wastes. Chapek gave Krueger a nine-page brochure describing the machine's new capabilities and explained Graham would handle the business end of the venture while he (Chapek) provided technical expertise. Chapek and Graham suggested Krueger assist them by recruiting up to 25 investors from the San Diego military community. Graham showed Krueger a blank copy of a limited partnership agreement he could use to sell points in six of Chapek's machines, at $10,000 per point and 100 points per machine.

His suspicions aroused, Krueger did some modest research on chemical detoxification and waste disposal and then decided it would be prudent to contact the FBI. After a preliminary investigation, the FBI transferred the case to the district attorney. (See § 25533.)

Krueger reported his continuing contacts with Chapek and Graham to the district attorney's office. In addition to numerous telephone conversations with each of them, Krueger had two business meetings with Graham and then visited Chapek's and Graham's office and warehouse facility in March 1981 to inspect Chapek's chemical detoxification machine. Krueger recognized the machine as the same one he had previously invested in. Chapek gave Krueger a detailed explanation of the machine's detoxification operation so he could repeat the information to prospective investors. Graham gave Krueger an "operating copy" of the venture's limited partnership agreement with Krueger's name filled in as a general partner.

After the meeting to inspect Chapek's multifarious and versatile machine Krueger met Graham several times for lunch to plan a presentation to a prospective investor. Pursuant to those plans, Chapek, Graham and Krueger met with Harry Grady on March 18, 1981. Grady, an investigator for the district attorney's office, played the part of the interested investor and surreptitiously taped the entire meeting. During the course of the meeting Graham gave Grady a copy of Chapek's brochure about his chemical detoxification machine and showed Grady a copy of the limited partnership agreement to which his name would be added as a limited partner. Chapek and Graham also presented descriptions of the technical and business aspects of their venture. Grady repeatedly expressed interest in their venture and suggested he begin with a $10,000 investment. He also mentioned he thought some of his retired military friends might be interested in investing. Chapek and Graham each suggested Grady could promote their venture among his friends. They parted with plans to meet again in two days, when Grady would deliver a $10,000 cashier's check payable to Graham and Graham would detail Grady's role in promoting Chapek's machine. At their next meeting, instead of delivering the money, Grady delivered Graham to another district attorney investigator who arrested him.

Discussion

Section 25110 is designed to prevent the offer for sale or sale of unqualified securities. (See ante, fn. 2.) Former section 25102, subdivision (f) provided an exemption from section 25110 if the offer to sell certain types of unqualified securities was not a "public" offer. It was not disputed at trial that Graham and Chapek made no attempt to qualify the limited partnership interest they offered to sell to Harry Grady. Graham contends on this appeal, however, that the partnership interest was not a "security" within the meaning of section 25110 because the anticipated return on Grady's investment involved his personal participation in the venture. Graham also argues that the offer to Grady was not "public" within the meaning of former section 25102, subdivision (f), and was thus exempt.

I.

It must first be determined that a defendant offered to sell a "security" before liability under section 25110 can attach. Section 25019 defines a "security" by illustrative example rather than attempting to set out an all-inclusive formula. ³ (See People v. Syde (1951) 37 Cal.2d 765, 768, 235 P.2d 601.) Nonetheless, it is clear the Legislature intended that the term have a broad scope "to protect the public against spurious schemes, however ingeniously devised, to attract risk capital." (Silver Hills Country Club v. Sobieski (1961) 55 Cal.2d 811, 814, 13 Cal.Rptr. 186, 361 P.2d 906.)

Both the People and Graham agree that Graham offered to sell Grady a limited partnership interest in the venture. Although limited partnership interests are not mentioned in section 25019, they may nonetheless constitute securities under appropriate circumstances. (See, e.g., People v. Woodson (1947) 78 Cal.App.2d 132, 135-136, 177 P.2d 586; see also Comment, Limited Partnerships and the California Securities Law: Restricting the Sale of Limited Partnership Interests (1980) 13 U.C.D.L.Rev. 618, 619-630 [hereafter Public Sale Comment ].) The question is what are appropriate circumstances. ⁴

Considerable scholarly debate has ensued on the proper definition of a "security." In Securities and Exchange Com'n v. W.J. Howey Co. (1946) 328 U.S. 293, 299, 66 S.Ct. 1100, 1103, 90 L.Ed. 1244, the United States Supreme Court suggested the following definition: "a contract, transaction or scheme whereby a person invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or a third party...." ⁵ The final prong of the Howey test, requiring that profits be derived "solely" from the efforts of others, has proved to be a troublesome one. Some courts have interpreted the requirement quite literally, holding that any investor participation, whether or not of a managerial nature, is sufficient to take the transaction out of the "security" category. (See, e.g., Bruner v. State (Tex.Crim.App.1970) 463 S.W.2d 205, 215; Gallion v. Alabama Market Centers, Inc. (Ala.1968) 213 So.2d 841, 845-846; ⁶ see also California and Federal Definitions, op. cit., supra, 16 Santa Clara L.Rev. at pp. 330-331.) In Securities & Exchange Com'n v. Glenn W. Turner Ent., Inc. (9th Cir.1973) 474 F.2d 476, 482, the Ninth Circuit proffered a more liberal construction:

"Strict interpretation of the requirement that profits to be earned must come "solely" from the efforts of others has been subject to criticism. See, e.g., State of Hawaii v. Hawaii Market Center (Haw.1971) 485 P.2d 105. Adherence to such an interpretation could result in a mechanical, unduly restrictive view of what is and what is not an investment contract. It would be easy to evade by adding a requirement that the buyer contribute a modicum of effort.... Rather we adopt a more realistic test, whether the efforts made by those other than the investor are the undeniably significant ones, those essential managerial efforts which affect the failure or success of the enterprise." (Fn. omitted, emphasis added.)

(See also Securities & Exch. Com. v. Koscot Inter., Inc. (5th Cir.1974) 497 F.2d 473, 479-484.) ⁷

Relying on an unmodified Howey, Graham argues for a strict interpretation of the "solely" requirement. He points to evidence in the record suggesting that Graham and Chapek anticipated that Grady would actively participate in recruiting investors for the venture. ⁸ The People, on the other hand, contend that Howey as interpreted in Glenn Turner allows for such investor participation because it does not constitute "essential managerial efforts."

Both parties ignore the fact that the Howey test, whether modified or not, may well not be the means by which a "security" is defined in California. Since the California Supreme Court's decision in Silver Hills Country Club v. Sobieski, supra, 55 Cal.2d 811, 13 Cal.Rptr. 186, 361 P.2d 906, California courts have generally applied what is known as the "risk capital" test. ⁹ (See Hamilton Jewelers v. Department of Corporations (1974) 37 Cal.App.3d 330, 335, 112 Cal.Rptr. 387; see also California and Federal Definitions, op. cit. supra, 16 Santa Clara L.Rev. at p. 324.) That test recognizes that the purposes of Corporate Securities Law regulation are implicated whenever investors provide capital which will be risked in the promoter's venture or enterprise. (Silver Hills, supra, 55 Cal.2d at p. 815, 13 Cal.Rptr. 186, 361 P.2d 906; see also Hamilton Jewelers, supra, 37 Cal.App.3d at pp. 334-335, 112 Cal.Rptr. 387.)

Silver Hills involved an offer to sell memberships in a country club, the proceeds from which were to be used to finance the construction and improvement of the club. Upon payment of monthly dues, members became entitled to use all of the club's facilities. The crucial issue was whether the lack of an entitlement...