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Arei II Cases

California Court of Appeals, First District, Third Division

May 29, 2013


Superior Court of Marin County, No. JCCP 4730, Verna Adams, Judge., JCCP No. 4730

Counsel for Plaintiffs and Appellants: CAPPELLO & NOȄL LLP, A. Barry Cappello, Troy A. Thielemann, Matthew H. Fisher

Counsel for Defendants and Respondents: WINSTON & STRAWN LLP, Neal R. Marder, Nicole L. Herft

McGuiness, P. J.

Plaintiffs are investors who purchased tenant in common (TIC) ownership interests in a senior housing facility from Asset & Real Estate Investment Company. (AREI). AREI allegedly violated state securities law by failing to disclose that its sole owner was a convicted felon and by concealing the existence of a second loan that grossly overleveraged the property. Plaintiffs sued various parties associated with the transaction, including the defendant investment bankers, who structured joint ventures between AREI and various lenders but had no involvement in the sales of TIC interests to plaintiffs. According to plaintiffs, the investment bankers knew that AREI did not disclose its owner’s felony conviction or the second loan to potential investors. Plaintiffs alleged causes of action against the investment bankers for materially assisting in AREI’s violation of securities law and for fraud based upon a conspiracy. On appeal, plaintiffs contend the trial court erred in sustaining the investment bankers’ demurrer.

We conclude the operative second amended complaint (the complaint) does not state a cause of action against the investment bankers for materially assisting in a securities law violation under Corporations Code section 25504.1.[1] However, we also conclude the facts as pleaded are minimally sufficient to state a cause of action against the investment bankers for common law fraud based upon a conspiracy to defraud the investors.

Factual and Procedural Background

Because this appeal is from an order sustaining a demurrer, we take the facts from the complaint, the allegations of which are deemed true for the limited purpose of determining whether plaintiffs have stated a viable cause of action. (See Stevenson v. Superior Court (1997) 16 Cal.4th 880, 885.)

As set forth in the complaint, defendant James Koenig was the founder and sole owner of AREI, which promoted senior housing facilities to potential investors as secure and profitable investment opportunities.[2] AREI was in operation for about 10 years starting in the late 1990’s. Koenig is a convicted felon who was sentenced in 1986 to serve two years in prison after suffering a conviction for fraud in a gold-selling scam. AREI was allegedly little more than a criminal operation that acquired senior housing facilities through Ponzi schemes and other forms of investor fraud. In June 2008, the California Attorney General raided AREI’s offices and shut down its operations.

In 2004, AREI developed a structured transaction to acquire and manage senior housing facilities throughout the country. Ari Weinberger, vice-president of Shattuck Hammond Partners, a division of Morgan Keegan & Co., Inc. (collectively Morgan Keegan) assisted AREI in structuring the transaction. Morgan Keegan, which is a defendant below and the respondent in this appeal, is described as an investment bank. AREI’s plan was to solicit lenders to invest in the senior housing facilities, which were to be managed by AREI’s captive management company. A broker-dealer agreed to perform due diligence on AREI and to sell TIC interests in the properties to individual investors.

Morgan Keegan’s role in the overall transaction was to structure joint ventures between AREI and various lenders, and it took primary responsibility for drafting an offering memorandum to prospective joint venture partners. In response to efforts to secure partners in the joint venture, defendants CapitalSource, Inc. and CapitalSource Finance, LLC (collectively CapSource) agreed to enter into a $50 million joint venture with AREI for the purchase and management of senior housing facilities. Morgan Keegan negotiated the terms of the joint venture, which called for the sale of TIC interests to investors, with the remaining financing to be provided by CapSource in the form of first mortgages secured by the properties.

A senior housing facility in Roseville, California (the Roseville property) was one of the properties AREI marketed to potential investors through various broker-dealers and their agents. In or around August 2005, AREI circulated a private placement memorandum (PPM) to potential investors seeking approximately $17.2 million for the purchase of TIC interests in the Roseville property. The PPM disclosed that the Roseville property would be subject to a first mortgage from CapSource of approximately $7 million. The purchase price of the Roseville property was $18.8 million. The PPM also disclosed that AREI could seek additional financing for the Roseville property, if necessary, with the unanimous approval of the TIC investors. The PPM failed to disclose that Koenig, the sole owner of both AREI and the proposed management company, is a convicted felon.

In reliance on the representations in the PPM, over 30 investors purchased TIC interests in the Roseville property and invested a total of over $17 million in cash in the venture. In order to effectuate the purchase, the investors formed limited liability companies and entered into operating agreements, a master TIC agreement, and a master lease agreement providing for the management and operation of the Roseville property. The limited liability companies that invested in the Roseville property are the plaintiffs in the action below.

In furtherance of the transaction described in the PPM, representatives of AREI signed a promissory note, a deed of trust, and various other lending agreements with CapSource allowing it to record its $7 million first mortgage against the Roseville property. As noted above, AREI disclosed this loan in the PPM. In addition, while escrow on the transaction was still open, Koenig, CapSource, and lender Meecorp Capital Markets (Meecorp) entered into confidential negotiations to further leverage the nationwide joint venture with a $75 million “mezzanine” loan from Meecorp. These same parties also secretly agreed that Meecorp would provide an additional mezzanine loan of $5.1 million to help fund the acquisition of the Roseville property. Although the PPM specified that the investors in the Roseville property were required to unanimously approve any additional loans secured by the property, the Meecorp loan was not disclosed to plaintiffs and the loan documentation was executed without their authorization. In October 2005, Meecorp recorded a $5.1 million deed of trust against the Roseville property, purportedly without plaintiffs’ authorization. Morgan Keegan assisted in the structuring of the joint venture with Meecorp and the $5.1 million mezzanine loan secured by the Roseville property.

Koenig allegedly embezzled the loan proceeds and investor capital for his own personal use or to fund other projects. Further, AREI’s management companies mismanaged the Roseville property and skimmed over $1 million from a capital account provided by plaintiffs. The facility fell into disrepair, its licensure lapsed, vendors went unpaid, and regulatory complaints were issued for health and safety violations. After plaintiffs learned that the CapSource and Meecorp loans had fallen into default, they removed the management company and attempted to refinance the property with another lender to avoid losing their investments. Despite plaintiffs’ efforts, Meecorp issued a notice of default on the $5.1 million mezzanine loan and pursued a nonjudicial foreclosure on the Roseville property.

Plaintiffs filed suit in Los Angeles County Superior Court against Koenig, AREI, CapSource, Meecorp, and numerous other individuals and entities associated with the sale of TIC interests in the Roseville property. Plaintiffs added Morgan Keegan as a defendant in a first amended complaint. The action was transferred to Marin County and coordinated for trial with other, similar complaints against AREI in Judicial Council Coordination Proceeding No. 4579, Asset Real Estate and Investment Company and Advisors (AREI) Cases). The trial court sustained Morgan Keegan’s demurrer to the first amended complaint with leave to amend, noting that plaintiffs offered to include further allegations supporting causes of action against Morgan Keegan.[3]

In the operative second amended complaint (which we refer to herein as the complaint), plaintiffs assert various causes of action against Koenig and AREI, including, as relevant here, the first cause of action for material misrepresentation or omission in a securities transaction and the ninth cause of action for common law fraud. Plaintiffs allege they were induced to purchase the TIC interests in the Roseville property based on misrepresentations contained in the PPM. According to plaintiffs, the PPM contained two major misrepresentations or omissions of material fact in that it failed to disclose Koenig’s felony conviction and the existence of the $5.1 million Meecorp mezzanine loan. Plaintiffs assert secondary securities liability claims against lenders CapSource and Meecorp as well as the broker-dealers who marketed and sold the TIC interests to plaintiffs.

Plaintiffs assert two causes of action against Morgan Keegan—the third cause of action for joint and several liability of persons who materially assist in a securities violation, in violation of section 25504.1, and the tenth cause of action for fraud based upon a conspiracy. As support for their claims, plaintiffs allege that Morgan Keegan structured the debt financing for the joint ventures and gained detailed, insider knowledge about AREI’s operations and Koenig’s background, including knowledge of Koenig’s felony conviction. It is further alleged that Morgan Keegan reviewed PPM’s for several of AREI’s senior housing facilities and thereby learned that a fraud was being committed upon potential investors due to the failure to disclose the fact Koenig is a convicted felon. Plaintiffs assert that Morgan Keegan took primary responsibility for preparing an offering memorandum directed to prospective joint venture partners that failed to disclose Koenig’s criminal background. Plaintiffs allege that Morgan Keegan initially agreed with AREI to conceal Koenig’s criminal conviction from potential joint venture partners, although plaintiffs acknowledged that CapSource learned of Koenig’s felony conviction before funding the joint venture. Morgan Keegan purportedly knew the information contained in the offering memorandum would be used to complete several securities offerings and would provide the basis for a due diligence report. Further, Morgan Keegan allegedly acted as a “go-between” for background checks on Koenig and the potential viability of AREI’s projects. Morgan Keegan assisted in the structuring of the Meecorp mezzanine loan and allegedly knew the loan was not disclosed to plaintiffs. Plaintiffs further allege that Morgan Keegan knew AREI intended to conceal Koenig’s criminal background from the investing public, including plaintiffs. Morgan Keegan charged over $500, 000 for its work structuring and closing the joint venture transactions.

Morgan Keegan demurred to the complaint, arguing the cause of action for violating section 25504.1 failed to state a claim because there were no allegations that Morgan Keegan had knowledge of the securities violation, intended to defraud plaintiffs, or took any action materially assisting in the violation. Regarding the cause of action for fraud, Morgan Keegan contended the complaint failed to plead knowledge of the fraud, the existence of an agreement to engage in a conspiracy to defraud, or that Morgan Keegan engaged in any illegal actions in furtherance of the conspiracy.

The trial court sustained Morgan Keegan’s demurrer without leave to amend. In its order sustaining the demurrer, the trial court concluded the complaint did not state a cause of action for materially assisting in a securities violation, reasoning as follows: “The only acts [Morgan Keegan] is alleged to have committed are to arrange the original and mezzanine financing between the seller/owner AREI and the lenders, CapitalSource and Meecorp, respectively. Playing an instrumental role in these legitimate transactions between seller and lenders did not involve [Morgan Keegan] in materially assisting AREI in the violation, i.e., selling or offer[ing to sell] securities by means of untrue statements or omissions of material fact.” In sustaining the demurrer to the cause of action for fraud and conspiracy, the court concluded that plaintiffs had ...

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