VITERBI v. WASSERMAN










Filed 1/11/11





CERTIFIED FOR PUBLICATION


COURT OF APPEAL, FOURTH APPELLATE DISTRICT

DIVISION ONE

STATE OF CALIFORNIA

AUDREY VITERBI et al., Plaintiffs and Appellants, v. GENEVA WASSERMAN, Defendant and Respondent.

D055209 (Super. Ct. No. GIC866310)

APPEAL from a judgment of the Superior Court of San Diego County, Judith F. Hayes and Linda B. Quinn, Judges. Affirmed.
Frank E. Rogozienski, Inc., and Frank E. Rogozienski for Plaintiffs and Appellants.
Lawton Law Firm, Dan Lawton and Joseph C. Kracht for Defendant and Respondent.
In this case we are presented with an issue of first impression in California: Does the remedy of rescission in a securities fraud claim brought under Corporations Code sections 25504 and 25504.1[1] require privity of contract between the plaintiff and defendant‌ In other words, can a purchaser of securities sue for rescission under sections 25504 and 25504.1, which provide for liability against "control persons" and "aiders and abettors," if those persons or entities did not sell the security to the plaintiff‌ We conclude that privity of contract is necessary to maintain an action for rescission under sections 25504 and 25504.1, and therefore a purchaser of securities may not maintain such a claim against someone other than the direct seller. That is so because rescission requires the contracting parties to be placed in the position they were in prior to contracting, and a non-seller, who did not receive any money from the purchaser, cannot return that money to the purchaser. We affirm.
INTRODUCTION
This action arises out of plaintiffs Audrey Viterbi and Dan Smargon's (together, plaintiffs) purchase of $200,000 worth of securities from a company named Economic Inventions, LLC (EI), which held patents on "expirationless options," a type of derivative security. Plaintiffs sued EI, its president, Vergil Daughtery II, two board members, David Gleeson and Steven Wallman, and the defendant and respondent on this appeal, Geneva Wasserman. Wasserman is a former employee of Viterbi who worked as an analyst on Viterbi's biotech investments. It is undisputed that Wasserman did not sell the securities to plaintiffs. Rather, plaintiffs alleged that Wasserman failed to disclose to them that EI had granted an exclusive license to the patents to NexTrade Holdings, Inc. (NexTrade), which they assert made the stock worthless, failed to disclose her interest in EI, and misrepresented to them that her parents had invested in EI.
The court dismissed the action against Gleeson and Wallman based upon a lack of jurisdiction, and this court affirmed that dismissal. (Smargon v. Gleeson (Nov. 20, 2008, D050980) [nonpub. opn.].) EI and Daugherty filed for bankruptcy and the action was stayed as to them, leaving only Wasserman as a defendant.
The court granted Wasserman's motion for summary adjudication as to all claims except for constructive trust and for statutory securities fraud brought under sections 25504 and 25504.1. Thereafter, the court granted a nonsuit on the securities fraud claim, finding (1) plaintiffs had no damages remedy because they continued to own the securities; and (2) they could not seek rescission against Wasserman because she did not sell them the stock and therefore there was a lack of privity of contract. The court also ruled that its previous ruling granting summary adjudication eliminated any issue as to false representation, scienter, intent to defraud and causation/damages. The court ruled the constructive trust claim was stayed by EI's bankruptcy.
This appeal concerns only the court's grant of nonsuit as to the securities fraud claim. Plaintiffs allege the court erred in granting nonsuit on this claim because (1) sections 25504 and 25504.1 do not require privity of contract to obtain a "rescissionary" remedy; and (2) the court erred in relying on the findings it made on its previous summary adjudication ruling in granting nonsuit.
We conclude that because Wasserman did not sell the securities to plaintiffs, and thus was not in privity of contract with them, they have no remedy of rescission against her, and therefore the court properly granted a nonsuit in her favor on their securities fraud claim. Accordingly, we need not address whether the court erred in also granting nonsuit based upon the findings it made on Wasserman's summary adjudication motion.
FACTUAL AND PROCEDURAL BACKGROUND
Because we are concluding as a matter of law plaintiffs have no right to rescission in the case, we address the facts relating to the underlying dispute only to the extent necessary to understand the nature of the dispute between the parties.
A. The Parties
Viterbi has a doctoral degree in electrical engineering and computer science. She is the cofounder and partner in Linkagene and the Viterbi Group, companies that invest in private and public companies. Her partner in the Viterbi Group is her father, Andrew Viterbi, cofounder of Qualcomm, Inc. Viterbi is a venture capitalist and considers herself a sophisticated investor. Smargon is a securities trader who trades stock index futures.
Linkagene and Viterbi Group focused their investments in the areas of biotech, life sciences, "telecom and beyond that."
Viterbi and Wasserman met at a charity event in 2002 and became friends. Viterbi at the time was "looking for somebody to work on biotech investments with, and she seemed to have the necessary qualifications," which included an M.B.A., J.D., and an undergraduate degree in biology. Viterbi hired Wasserman as an analyst on biotech investments. Wasserman looked at potential investments and advised Viterbi on them.
B. The Investment in EI
Beginning in 2002, Wasserman received and forwarded to Viterbi various documents about EI. In an e-mail attaching information about EI, Wasserman identified herself as being a "shareholder/officer" of that company. Viterbi reviewed the business plan, as well as the private placement memorandum (PPM) and subscription agreement.
The PPM warned that:
"THESE SECURITIES ARE SPECULATIVE AND INVOLVE A HIGH DEGREE OF RISK. ONLY PERSONS WHO CAN AFFORD TO LOSE A PORTION OR ALL OF THEIR INVESTMENT AND HAVE NO NEED FOR A CURRENT RETURN ON THEIR INVESTMENT SHOULD CONSIDER THE PURCHASE."

The PPM warned of several "primary risk factors," including (1) EI's "execution platform partner" failing "to perform"; (2) market disinterest in expirationless options; (3) a failure to meet projections of market volume; and (4) a failure to win regulatory approvals. The PPM stated that these risks could reduce or eliminate "patent residual payments," which were described as EI's "primary source of future income."
In her deposition testimony, Viterbi acknowledged that she read and understood these risk factors before investing in EI. She understood and acknowledged she could lose all her money. She acknowledged that that it was important to her to know what the risk factors are before investing money.
The PPM also warned that no investor should invest in the company unless "willing to entrust all aspects of the management of the Company" to its officers and directors. Viterbi did not contact any EI director or officer before investing. This was despite the fact Viterbi frequently spoke to CEOs or other corporate officers before investing funds in their companies.
Shortly before investing in EI, Viterbi "wasn't sold on the investment" and "wasn't enthused with making the investment." She sought advice from a childhood friend, who was a former employee of Bear Stearns. Her friend's advice was negative. In an e-mail sent to Viterbi a week before she invested in EI, her friend told her the following:
"I don't see any ability to get the kinds of revenues they are talking about. I am not sure what is the big deal here with their perpetual options, and the contention that issuing long-term options that extend beyond three years is being prohibited by their patent sounds laughable to me . . . . I am not a patent expert, but I can imagine all sorts of ways to create comparable instruments. So I would find other[] ways to lose money." (Italics added.)

Viterbi read that e-mail and acknowledged that it was "very negative." Nevertheless, Viterbi did not follow up with her friend. She did not vet EI's concept with anyone else.
In May 2003 Viterbi and Smargon bought membership interests in EI for $200,000 in cash. They both signed the subscription agreement. That subscription agreement recited that they had obtained "independent professional advice with respects to the risks inherent" in their investment; the suitability of the investment based on their objectives and financial needs; their ability to lose the money invested; their access to "full and complete information regarding the Company . . . to [their] satisfaction, or [have] waived the opportunity " to have such access; and their recognition of the "high degree of risk" inherent in the investment.
It is undisputed Wasserman did not sell the securities to Viterbi and Smargon. Wasserman did not receive any money from them.
C. Alleged Securities Fraud
Before plaintiffs purchased their shares in EI, EI entered into an exclusive license agreement with NexTrade. Plaintiffs allege they were not aware of this agreement, or its terms, and did not receive a copy of the agreement until 2005. They alleged the terms of the agreement were not disclosed in the offering documents, and the statement therein that EI was "the exclusive licensor" of its patents was false given the exclusive license already given to NexTrade.
They alleged the terms of the agreement with NexTrade were "a disaster" for EI. The agreement gave to NexTrade in perpetuity a worldwide royalty free exclusive license, thereby stripping EI of the rights necessary to commercialize the patents. The agreement gave to NexTrade all the intellectual property owned by EI for no fee or royalty. It granted to NexTrade all rights to patents arising from EI's existing patent for no fees or royalties. The agreement gave NexTrade the right to sublicense the patents to third parties.
The only thing EI received in return was one-half of any sublicense fees and one-half of any net income NexTrade received from use of the patents. The agreement did not require any performance or diligence obligations of NexTrade, which plaintiffs allege are essential, customary and standard in patent licenses.
According to plaintiffs, EI has received no money from the agreement and has no income. EI is bankrupt, with assets of $100 and liabilities of approximately $3.9 million.
Also according to plaintiffs, Wasserman knew of the agreement and its problematic terms, but did not disclose them to plaintiffs prior to their investment.
Plaintiffs also allege the offering documents falsely stated the founders of EI had invested over $900,000 in EI. In fact, the founders of EI invested approximately $5,000.
Plaintiffs allege that, before they made the investment, Wasserman falsely represented to Viterbi that her (Wasserman's) parents had invested in EI. According to plaintiffs, Viterbi knew Wasserman's parents and did not believe Wasserman would put her parents in a problematic investment.
D. Wasserman's Involvement with EI
Wasserman represented herself to be an officer, director and member of the advisory board of EI, and led its fundraising efforts. She was also its in-house attorney. She was a shareholder in EI, having been given 300,000 units for $100. Wasserman was employed by EI and maintained an e-mail account with them.
As a result of her efforts in getting plaintiffs to invest $200,000 in EI, she received a 6 percent "finder's fee" and an additional 20,000 units in EI at no cost to herself.
E. Plaintiffs' Continued Ownership of EI Stock
According to plaintiffs, the securities they purchased are not marketable and are worthless. They are restricted and there is no trading market. Thus, they continue to own the securities.
F. Wasserman's Summary Adjudication Motion
Wasserman moved for summary judgment on the claims for fraud, negligent misrepresentation, constructive trust, accounting, and securities fraud. The court granted summary judgment as to Smargon on all causes of action and granted summary adjudication as to Viterbi on the causes of action for fraud, negligent misrepresentation, accounting and securities fraud. The court found there was no evidence of an actionable statement by Wasserman, no evidence of scienter, no triable issue of fact as to causation or damages, and that Wasserman lacked authority to perform an accounting. The court denied the motion as to the cause of action for constructive trust, finding there was conflicting evidence as to her "responsibility, if any, for an alleged diversion of EI's corporate assets."
Plaintiffs brought a motion for reconsideration and for new trial. The court granted the motion for reconsideration as to the cause of action for securities fraud, finding that "relevant disputed evidence" precluded summary adjudication on that claim.
G. Trial and Motion for Nonsuit
Shortly before trial, Wasserman brought a motion for nonsuit as to the cause of action for securities fraud, arguing (1) plaintiffs had no claim for damages as they still owned the stock; (2) rescission, plaintiffs sole remaining remedy, was unavailable as a matter of law because of a lack of privity of contract; and (3) the court's prior grant of summary judgment eliminated any issues as to false statements, scienter, materiality or causation.
The court issued a tentative ruling, granting the motion. The court found that "[t]he remedy of rescission is not available against a defendant who is not a party to the contract sued on. Privity of contract is an essential element of any cause of action seeking rescission. The parties are not in privity of contract. Plaintiffs continue to own the shares of [EI] that are the subject of the litigation. Under the allegations of the Sixth Cause of Action, only rescission is available to Plaintiffs as a remedy. As rescission cannot be ordered against defendant [Wasserman], the motion is granted."
Thereafter, the court heard plaintiffs' opening statement and further argument of counsel. The court then supplemented its tentative ruling to find that its findings on the motion for summary adjudication disposing of the fraud claims, to the extent the same evidence was presented at trial that was presented in opposition to that motion, would also preclude the securities fraud claim.
After hearing oral argument, the court issued its final ruling, confirming its initial tentative ruling. However, the court reversed itself on the supplemental tentative ruling regarding the findings made in granting summary adjudication, stating those findings "are not incorporated into its ruling on Defendant's Motion for Non-suit."
Thereafter, the court entered judgment in favor of Wasserman. This timely appeal follows.
DISCUSSION
A. Principles of Rescission
Plaintiffs do not dispute that because they still own the EI stock, their only remedy on their cause of action for securities fraud is rescission. A prerequisite to any claim for rescission is a contract between the parties. (4 Witkin, Cal. Procedure (5th ed. 2008) Pleading, § 542, p. 668.) This is because rescission requires each party to the contract to restore to the other everything of value received under the contract: "[T]o effect a rescission a party to the contract must, promptly upon discovering the facts which entitle him to rescind if he is free from duress, menace, undue influence or disability and is aware of his right to rescind: [¶] (a) Give notice of rescission to the party as to whom he rescinds; and [¶] (b) Restore to the other party everything of value which he has received from him under the contract or offer to restore the same upon condition that the other party do likewise, unless the latter is unable or positively refuses to do so." (Civ. Code, § 1691, italics added.)
It is undisputed that in this case there is no privity of contract between the plaintiffs and Wasserman. The contract was between EI and plaintiffs. Wasserman did not sell the stock in EI to plaintiffs and did not receive the $200,000 from them. Thus, Wasserman cannot restore to plaintiffs the $200,000 investment and place the parties in their precontractual positions. Under ordinary contract principles Wasserman cannot be held liable to plaintiffs for rescission.
Nevertheless, plaintiffs assert that under the securities laws, they were not required to prove privity of contract to obtain what they call "rescissionary" relief. This contention is unavailing.


TO BE CONTINUED AS PART II….


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