People v. Schock

• Decision Date: 24 February 1984
• Citation: 199 Cal.Rptr. 327,152 Cal.App.3d 379
• Court: California Court of Appeals Court of Appeals
• Parties: , Blue Sky L. Rep. P 71,951 PEOPLE of the State of California, Plaintiff and Appellant, v. Darrell M. SCHOCK, Webster Van Blaricom and Robert Malone, Defendants and Respondents. AO 20015.

Page 327

199 Cal.Rptr. 327

152 Cal.App.3d 379, Blue Sky L. Rep. P 71,951

PEOPLE of the State of California, Plaintiff and Appellant, v. Darrell M. SCHOCK, Webster Van Blaricom and Robert Malone, Defendants and Respondents.

AO 20015.

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

Feb. 24, 1984.

Hearing Denied April 26, 1984.

John R. McCardle, Samuel Lawson, Jarvis & McCardle, Hayward, for schock.

Arthur L. Pretzer, Simonian & Pretzer, San Leandro, for Van Blaricom.

Jules F. Bonjour, Jr., Bonjour, Gough, Stone & Remer, Hayward, for Malone.

John J. Meehan, Dist. Atty., Greg R. Gibeson, Deputy Dist. Atty., Hayward, for plaintiff-appellant.

RACANELLI, Presiding Justice.

In this appeal we consider the novel issue whether a fractional interest in a promissory note and related deed of trust constitutes a non-exempt "security" within the meaning of the Corporate Securities Law of 1968, as amended. (Corp.Code, § 25000 et seq.) ¹

STATEMENT OF THE CASE

Defendants were charged with a number of violations of section 25110 (unlawful sale of unqualified security) and section 25401 (false statement in a security transaction) of the Corporate Securities Law arising out of their operation of a mortgage loan brokerage company. Following a preliminary hearing submitted on the basis of stipulated facts and documentary exhibits, the magistrate dismissed all but seven of the forty-nine counts of the felony complaint on the grounds that defendants' activities did not involve securities within the meaning of the Corporate Securities Law. The People now appeal the denial of their motion to compel reinstatement of the complaint. (Pen.Code, § 871.5.)

FACTS

The facts as stipulated on appeal reflect the following:

Golden State Home Loans (hereafter "GSHL"), a California corporation, is a mortgage brokerage company partly owned by defendant Schock, its president, and employing co-defendants Van Blaricom and Malone. GSHL's principal revenue was derived from brokerage fees and commissions charged to borrowers on loan transactions involving numerous lenders solicited generally through newspaper advertisements. Upon approval of loan applications, GSHL would offer the solicited lender a fixed rate of return until the loan repayment was due, secured by a deed of trust on the borrower's real property.

The transactions underlying the criminal charges involved loans to borrowers funded by many different lenders. Each lender who invested funds was given a "trust deed deposit" receipt reflecting the amount of money deposited with GSHL and the proportion of the total loan. When sufficient money was accumulated by GSHL to fund an approved loan, the funds were disbursed to the borrower in one of two ways: (1) the borrower would execute a promissory note and deed of trust in favor of the various lenders reflecting their proportionate undivided interests; or (2) the borrower would execute a promissory note in favor of Guarantee Equity Financial (hereafter "GEF")--a separate corporation also partly owned by defendant Schock--naming GEF as beneficiary of the deed of trust; GEF would then endorse the note and assign the deed of trust to the various lenders in a manner reflecting their proportionate undivided interests. ² Guaranteed Equities, Inc. (hereafter "GEI")--another corporation owned by defendant Schock--was named as trustee in all the deeds of trust.

Simultaneously, each lender entered into a loan servicing agreement with GSHL appointing Security National Bank to collect loan payments for distribution to the lenders, authorizing GEI to advance payments--subject to reimbursement--to lenders on delinquent loan installments and to bid the unpaid loan balance at any foreclosure sale in the event of default.

The question on appeal is whether the instruments used in the GSHL loan transactions constitute securities. We will conclude for the reasons we explain that the instruments used fall within the statutory definition of securities and are not exempt from regulation.

I

Security Transaction

Under the pertinent provisions of the Corporate Securities Law, a "security" is defined to include: "any note; ... evidence of indebtedness; ... investment contract; ... certificate of deposit for a security; ... or, in general, any interest or instrument commonly known as a 'security'; ..." (§ 25019.) ³

The parties offer diametrically opposing interpretations of the statutory language, neither of which is found determinative. On the one hand, defendants focus on the absence of any express reference in the statute to either a promissory note or deed of trust. On the other hand, the People argue that the instruments involved fall squarely within the conventional classifications of notes, evidence of indebtedness, investment contracts, or certificates of deposit for a security.

While the courts have viewed the statutory enumeration as merely illustrative (see Berman v. Dean Witter & Co., Inc. (1975) 44 Cal.App.3d 999, 1005, 119 Cal.Rptr. 130 [futures contract in foreign currency as security]; Clejan v. Reisman (1970) 5 Cal.App.3d 224, 233-235, 84 Cal.Rptr. 897 [ownership interest in ranch a security] ), a literal interpretation has been uniformly eschewed when to do so would appear to exceed any legitimate legislative purpose. (See People v. Davenport (1939) 13 Cal.2d 681, 685-686, 91 P.2d 892; Hamilton Jewelers v. Department of Corporations (1974) 37 Cal.App.3d 330, 334-335, 112 Cal.Rptr. 387; Nicholl v. Ipsen (1955) 130 Cal.App.2d 452, 457-460, 278 P.2d 927.) "[I]t plainly was not the legislative intent that 'every' note or evidence of indebtedness, regardless of its nature and of the circumstances surrounding its execution, should be considered as included within the meaning and purpose of the act." (People v. Davenport, supra, 13 Cal.2d at p. 686, 91 P.2d 892.)

Thus, the determination of whether a particular instrument constitutes a security must be made on an ad hoc basis upon a review of the surrounding facts and circumstances and in light of the regulatory purposes to be served under the Corporate Securities Law. (People v. Syde (1951) 37 Cal.2d 765, 768, 235 P.2d 601; Sarmento v. Arbax Packing Co. (1964) 231 Cal.App.2d 421, 424, 41 Cal.Rptr. 869; Oil Lease Service, Inc. v. Stephenson (1958) 162 Cal.App.2d 100, 107-108, 327 P.2d 628.) Ultimately, any determination must be resolved as a question of law. (People v. Skelton (1980) 109 Cal.App.3d 691, 712-713, 167 Cal.Rptr. 636, cert. den., 450 U.S. 917, 101 S.Ct. 1361, 67 L.Ed.2d 343.)

Neither party cites, nor has our independent research revealed, a factually parallel California case. A review of existing California case law offers no clear guidance as to what constitutes a security within the statutory meaning: The test generally employed by the California courts in assessing the elusive concept is the so-called "risk capital" test announced in Silver Hills Country Club v. Sobieski (1961) 55 Cal.2d 811, 13 Cal.Rptr. 186, 361 P.2d 906. "Section [25019] defines a security broadly to protect the public against spurious schemes, however ingeniously devised, to attract risk capital.... '[A]s a general rule, the sale of "securities" that is condemned by the courts involves an attempt by an issuer to raise funds for a business venture or enterprise; an indiscriminate offering to the public at large where the persons solicited are selected at random; a passive position on the part of the investor; and the conduct of the enterprise by the issuer with other people's money.' (Dahlquist, Regulation and Civil Liability Under the California Securities Act, supra, 33 Cal.L.Rev. 343, 360.) .... [The] objective [of the Corporate Securities Law] is to afford those who risk their capital at least a fair chance of realizing their objectives." (Id., at pp. 814-815, 13 Cal.Rptr. 186, 361 P.2d 906; accord: Fox v. Ehrmantraut (1980) 28 Cal.3d 127, 138, 167 Cal.Rptr. 595, 615 P.2d 1383 [public sale of investment units to finance construction of subdivision held securities where the investors remained passive and were entitled to share in profits upon completion and sale of the project]; Smith v. Sherman (1962) 206 Cal.App.2d 93, 95, 23 Cal.Rptr. 487; see also People v. Park (1978) 87 Cal.App.3d 550, 561-563, 151 Cal.Rptr. 146.)

The mere expectation of a return on an investment, together with the right of repayment, does not--without more--subject the transaction to security regulation. (People v. Davenport, supra, 13 Cal.2d 681, 690, 91 P.2d 892.) But a public offering of unsecured promissory notes repayable with interest falls within the statutory purpose. Thus, in People v. Walberg (1968) 263 Cal.App.2d 286, 69 Cal.Rptr. 457 [officer of nonprofit religious corporation solicited funds at large for refurbishing a hotel to be used for missionary purposes], the court found the issued promissory notes to be securities despite the appearance of a loan transaction: "The Corporate Securities Act is designed to regulate the transactions by which promoters go to the public for risk capital." (Id., at p. 294, 69 Cal.Rptr. 457.) However, a finding of inadequacy of collateral, in addition to the investors' dependency on the promoter's success for a return on the investment, will subject the superficial loan transaction to security regulation. (See People v. Leach (1930) 106 Cal.App. 442, 290 P. 131, app. dism., 283 U.S. 808, 51 S.Ct. 646, 75 L.Ed. 1427 [public sale of notes to develop subdivision, secured by lot parcels of small value] approved in In re Leach (1932) 215 Cal. 536, 546, 12 P.2d 3, app. dism., 287 U.S. 579, 53 S.Ct. 313, 77 L.Ed. 508.)

But where the investor receives adequate collateral, no risk capital is contributed to the managerial efforts of the promoter and such business transaction does not come within the corporate securities law. (See Hamilton Jewelers v. Department of Corporations, supra, 37 Cal.App.3d 330, 112 Cal.Rptr. 387.) In Hamilton the plaintiff promoted the sale of unmounted...