Ferry v. DF Growth REIT, LLC

Opinion

1 2 3 4 5 6 7 8 UNITED STATES DISTRICT COURT 9 SOUTHERN DISTRICT OF CALIFORNIA 10 11 MARK FERRY, VALERIE Case No.: 22-cv-02001-AJB-VET HAMERLING, IGOR KOROSTELEV 12 and RYAN KRAUSE, on behalf of ORDER GRANTING IN PART AND 13 themselves and all others similarly DENYING IN PART DEFENDANTS’ situated, MOTION TO DISMISS THE 14 SECOND AMENDED COMPLAINT 15 Plaintiffs, (Doc. No. 30) 16 v. 17 DF GROWTH REIT, LLC, 18 DF GROWTH REIT II, LLC, 19 DIVERSYFUND, INC., CRAIG CECILIO, and ALAN LEWIS, 20

21 Defendants. 22

23 Before the Court is Defendants DF Growth REIT, LLC, DF Growth REIT II, LLC, 24 DiversyFund, Inc., Craig Cecilio, and Alan Lewis’s (collectively, “Defendants”) motion to 25 dismiss Plaintiffs Mark Ferry, Valerie Hamerling, Igor Korostelev, and Ryan Krause’s 26 (collectively, “Plaintiffs”) Second Amended Complaint (“SAC”) pursuant to Federal Rules 27 of Civil Procedure 12(b)(1) and 12(b)(6). (Doc. No. 30.) The motion is fully briefed. (Doc. 28 1 Nos. 33, 34.) For the reasons set forth below, the Court GRANTS IN PART and DENIES 2 IN PART Defendants’ motion to dismiss with prejudice. 3 I. BACKGROUND1 4 This is a putative securities fraud class action brought by Plaintiffs against 5 Defendants: DF Growth REIT, LLC (“REIT I”), DF Growth REIT II, LLC (“REIT II”), 6 DiversyFund, Inc., Craig Cecilio, and Alan Lewis. 7 According to the SAC, REIT I and REIT II (collectively, “REITs”) are “blind pool” 8 companies that invest the proceeds of their securities offerings in real estate projects. (SAC, 9 Doc. No. 25, ¶¶ 7, 8.) REIT I’s and REIT II’s offerings are permitted under SEC Regulation 10 A, which allows companies to offer and sell securities to the public without having to 11 register the offerings with the SEC so long as the issuer fully complies with the regulation’s 12 requirements. (Id.) REIT I offered such securities from 2018 to November 2021. (Id. ¶ 7.) 13 REIT II offered such securities from August 2020 into 2022. (Id. ¶ 8.) 14 DiversyFund serves as the sponsor of REIT I and REIT II and owns 100% of REIT 15 I and REIT II’s manager, DF Manager, LLC (“DF Manager”).2 (Id. ¶ 7, 8, 10.) Cecilio and 16 Lewis founded and own DiversyFund. (Id. ¶¶ 11, 12.) They also co-own DF Manager. (Id.) 17 Cecilio is the Chief Executive Officer of DiversyFund and DF Manager. (Id. ¶ 11.) Lewis 18 is the Chief Investment Officer of REIT I, REIT II, DiversyFund, and DF Manager. (Id. 19 ¶ 12.) Plaintiffs allege Cecilio and Lewis have complete de facto control of REIT I and 20 REIT II. (Id. ¶¶ 11, 12.) 21 The SAC raises two causes of action under the California Corporations Code. (Id. 22 ¶¶ 178–87.) Plaintiffs allege that REIT I and REIT II violated Section 25401 of the 23 California Corporations Code “by making statements of material fact regarding (i) the 24 interdependency between REIT I and REIT II; (ii) the fees charged by REIT I and REIT 25 26

27 1 The following facts are taken from the SAC and assumed true for purposes of this motion. See Cahill v. Liberty Mut. Ins. Co., 80 F.3d 336, 337–38 (9th Cir. 1996). 28 1 II; (iii) the background of management; (iv) REIT I and REIT II’s lack of a need to raise a 2 minimum amount of capital; and (v) the status of REIT I and REIT II Class A Investor 3 shares as exempt from registration.” (Id. ¶ 180.) 4 As to interdependency, Plaintiffs claim that REIT I and REIT II misrepresented 5 themselves as separate investment vehicles because “if REIT II did not co-invest in certain 6 real estate deals alongside REIT I, the deals will fall through and REIT I will suffer a loss.” 7 (Id. ¶ 65.) As to fees charged, Plaintiffs allege that REIT I and REIT II represented that 8 there would be no management fees even though REIT II did collect such fees, and that 9 REIT I and REIT II were subject to developer and acquisition fees in excess of what 10 Defendants represented. (Id. ¶¶ 74–86.) As to the management’s background, Plaintiffs 11 claim that REIT I and REIT II misrepresented their management’s expertise by failing to 12 disclose certain Securities and Exchange Commission (“SEC”) investigations, as well as 13 the California’s Bureau of Real Estate’s (“BRE”) regulatory sanctions against Cecilio in 14 2017. (Id. ¶¶ 152–61.) As to the no-minimum-capital-amount misrepresentation, Plaintiffs 15 allege that REIT II represented to investors that there was no minimum amount that it 16 needed to raise, even though it needed more than the $11.3 million it had raised to be viable. 17 (Id. ¶¶ 64–67, 70.) Finally, Plaintiffs claim that REIT I and REIT II misrepresented to 18 investors that their offerings of DiversyFund Investor Shares were exempt from registration 19 under Regulation A, when in reality, Defendants had not adhered to the requirements of 20 Regulation A and REITs’ shares were not within a valid exemption from registration. (Id. 21 ¶¶ 133–51.) 22 The second cause of action is against DiversyFund, Cecilio, and Lewis. Plaintiffs 23 allege that DiversyFund, Cecilio, and Lewis are each jointly and severally liable as control 24 persons under Section 25504 of the California Corporations Code because they materially 25 aided in REIT I’s and REIT II’s Section 25401 violations. Plaintiffs seek an award of 26 rescission of the REIT I and REIT II investments purchased by the Plaintiffs and the Class. 27 (Id. ¶¶ 184–87.) 28 1 For the reasons set forth below, the Court GRANTS Defendants’ motion to dismiss 2 as to Plaintiffs’ Section 25401 cause of action with respect to alleged misrepresentations 3 regarding (i) the interdependency between REIT I and REIT II; (ii) the excessive 4 acquisition fees charged by REIT I and REIT II; (iii) the background of management; and 5 (iv) REIT I and REIT II’s lack of a need to raise a minimum amount of capital. 6 Defendants’ motion to dismiss is DENIED as to Plaintiffs’ Section 25401 claims 7 regarding (v) REIT II’s alleged misrepresentations about charging asset management fees; 8 and (vi) the status of REIT I and REIT II Class A Investor shares as exempt from 9 registration. Moreover, the motion is DENIED as to Plaintiffs’ second of cause of action 10 under Section 25504 alleging joint and several liability with respect to the two remaining 11 alleged Section 25401 violations. 12 II. LEGAL STANDARD 13 A. Rule 12(b)(1) 14 A motion to dismiss pursuant to Rule 12(b)(1) tests whether the court has subject 15 matter jurisdiction. Lack of Article III standing requires dismissal for want of subject 16 matter jurisdiction. Maya v. Centex Corp., 658 F.3d 1060, 1067 (9th Cir. 2011). To 17 establish Article III standing, a plaintiff must show (1) an injury in fact, (2) that is fairly 18 traceable to the defendant’s challenged action, and (3) that is likely to be redressed by a 19 favorable decision. Id. 20 “A Rule 12(b)(1) jurisdictional attack may be facial or factual.” Safe Air for 21 Everyone v. Meyer, 373 F.3d 1035, 1039 (9th Cir. 2004).3 “In a facial attack, the challenger 22 asserts that the allegations contained in a complaint are insufficient on their face to invoke 23 federal jurisdiction.” Id. The court “resolves a facial attack as it would a motion to dismiss 24 under Rule 12(b)(6): accepting the plaintiff’s allegations as true and drawing all reasonable 25 inferences in the plaintiff's favor, the court determines whether the allegations are sufficient 26

27 3 Unless otherwise indicated, internal citations, quotation marks, and alterations are omitted from the case 28 1 as a legal matter to invoke the court’s jurisdiction.” Leite v. Crane Co., 749 F.3d 1117, 2 1121 (9th Cir. 2014). 3 By contrast, a factual attack “contests the truth of the plaintiff’s factual allegations, 4 usually by introducing evidence outside the pleadings.” Id. “In resolving a factual attack 5 on jurisdiction, the district court may review evidence beyond the complaint without 6 converting the motion to dismiss into a motion for summary judgment.” 7 Safe Air, 373 F.3d at 1039. “Once the moving party has converted the motion to dismiss 8 into a factual motion by presenting affidavits or other evidence properly brought before the 9 court, the party opposing the motion must furnish affidavits or other evidence necessary to 10 satisfy its burden of establishing subject matter jurisdiction.” Id. (quoting 11 Savage v. Glendale Union High Sch., Dist. No. 205, Maricopa Cnty., 343 F.3d 1036, 1040 12 n.2 (9th Cir. 2003)). “If the ‘existence of jurisdiction turn[s] on disputed factual issues,’ 13 and those ‘jurisdictional disputes [are] not intertwined with the merits of the claim,’ then 14 ‘it [falls] to the district court to resolve those factual disputes itself.’” Bowen v. Energizer 15 Holdings, Inc., No. 23-55116, 2024 WL 4352496, at *5 (9th Cir. Oct. 1, 2024) (quoting 16 Friends of the Earth v. Sanderson Farms, Inc., 992 F.3d 939, 944 (9th Cir. 2021)). 17 However, “when jurisdictional issues are ‘intertwined with an element of the merits of the 18 plaintiff’s claim,’ the court must treat the motion like a motion for summary judgment and 19 ‘leave the resolution of material factual disputes to the trier of fact.’” Id. (quoting Leite v. 20 Crane Co., 749 F.3d 1117, 1122 (9th Cir. 2014)). 21 B. Rule 12(b)(6) 22 A motion to dismiss pursuant to Rule 12(b)(6) tests the legal sufficiency of the 23 complaint. Navarro v. Block, 250 F.3d 729, 732 (9th Cir. 2001). “To survive a motion to 24 dismiss, a complaint must contain sufficient factual matter, accepted as true, to ‘state a 25 claim to relief that is plausible on its face.’” Ashcroft v. Iqbal, 556 U.S. 662, 678 (2009) 26 (citation omitted). Facial plausibility is satisfied “when the plaintiff pleads factual content 27 that allows the court to draw the reasonable inference that the defendant is liable for the 28 misconduct alleged.” Id. To determine the sufficiency of the complaint, the court must 1 assume the truth of all factual allegations and construe them in the light most favorable to 2 the plaintiff. Cahill v. Liberty Mut. Ins. Co., 80 F.3d 336, 337–38 (9th Cir. 1996). Although 3 a court must take all factual allegations in a complaint as true, it is not required to accept 4 conclusory statements. Iqbal, 556 U.S. at 678. 5 III. DISCUSSION 6 Defendants move to dismiss the entirety of the SAC, arguing that: (A) Plaintiffs have 7 failed to allege Article III standing because Plaintiffs have not pled any injuries resulting 8 from the alleged statutory violations; and (B) Plaintiffs fail to state their Section 25401 9 claims because they are time-barred, implausible, and fall short of Rule 9(b)’s heightened 10 pleading standard. 11 A. Rule 12(b)(1) – Lack of Article III Standing 12 Article III of the Constitution “confines the federal judicial power to the resolution 13 of ‘Cases’ and ‘Controversies.’” TransUnion LLC v. Ramirez, 594 U.S. 413, 423 (2021). 14 Article III standing to sue “is a doctrine rooted in the traditional understanding of a case or 15 controversy.” Spokeo, Inc. v. Robins, 578 U.S. 330, 338 (2016). The doctrine developed 16 “to ensure that federal courts do not exceed their authority as it has been traditionally 17 understood.” Id. The Supreme Court has explained the ‘“irreducible constitutional 18 minimum’ of standing consists of three elements.” Id. A plaintiff must have (1) suffered 19 an injury in fact, (2) that is fairly traceable to the challenged conduct of the defendant, and 20 (3) that is likely to be redressed by a favorable judicial decision. Id. At the pleading stage, 21 “the plaintiff must clearly allege facts demonstrating each element.” Id. Moreover, 22 “standing is not dispensed in gross; rather, plaintiffs must demonstrate standing for each 23 claim that they press and for each form of relief that they seek (for example, injunctive 24 relief and damages).” TransUnion LLC, 594 U.S. at 431. 25 At issue is whether Plaintiffs have alleged an “injury in fact,” the “first and foremost 26 of standing’s three elements.” Spokeo, 578 U.S. at 338. “To establish injury in fact, a 27 plaintiff must show that he or she suffered ‘an invasion of a legally protected interest’ that 28 is ‘concrete and particularized’ and ‘actual or imminent, not conjectural or hypothetical.’” 1 Id. at 339 (quoting Lujan v. Defs. of Wildlife, 504 U.S. 555, 560 (1992)). Defendants 2 contend that Plaintiffs have not pled injuries resulting from each of the alleged statutory 3 violations. (Motion to Dismiss (“Mot.”), Doc. No. 30-1, at 9, 14.) In response, Plaintiffs 4 state that they have “properly plead damages and other actionable injuries throughout the 5 [S]AC.” (Opposition (“Opp’n”), Doc. No. 33, at 14.) The Court will consider whether 6 Plaintiffs have Article III standing to assert each of the five alleged misrepresentations. 7 1. Misrepresentation re Interdependency between REITs I and II 8 Plaintiffs allege that “investors who invested in REIT I after the REIT II Offering 9 commenced . . . would have been misled by Defendants’ misstatements as to the 10 interdependence of the two REITs.” (SAC ¶ 72.) In November 2021, Defendants’ website 11 included a question and answer section that read: “Will launching REIT II impact my 12 original REIT investment in any way? No, REIT I will not be impacted by REIT II in any 13 way.” (Id.) Plaintiffs contend that in May 2022, “REIT I disclosed that in 2021 it had paid 14 $32,456 to Lex Nova for legal services to REIT II,” (id.), implying that REIT I paid REIT 15 II’s legal fees. However, the SAC does not allege that the misrepresentation existed at the 16 time when the named Plaintiffs invested in REIT I and REIT II,4 that any named Plaintiff’s 17 REIT I or REIT II investment decreased in value as a result, or that any named Plaintiff 18 was specifically harmed by the misrepresentations. Because Plaintiffs do not allege any 19 concrete injury traceable to a misrepresentation regarding the interdependency between 20 REIT I and REIT II, Plaintiffs have not satisfied Article III standing. See Weiss v. NNN 21 Cap. Fund I, LLC, No. 14-CV-2689-H-NLS, 2015 WL 11990929, at *5 (S.D. Cal. Apr. 3, 22

23 4 Plaintiff Ferry invested in REIT I in June 2020 and between July 2020 and January 2021, (SAC ¶ 6(a)), 24 and Plaintiff Hamerling invested in REIT I in June and August 2021, (id. ¶ 6(b)). The SAC alleges that Plaintiffs Korostelev and Krause “invested over $500 in DiversyFund Investor Shares [defined as 25 including both REIT I and REIT II] between 2018 and the present” without specifying exactly when 26 Korostrelev and Krause invested, or whether they invested in REIT I, REIT II, or both. (Id. ¶ 6 (c)–(d).) Defendants argue that because the Court cannot assume facts not alleged, the Court cannot assume that 27 Plaintiffs Korostelev and Krause are REIT II investors. (Mot. at 17 n.8.) Plaintiffs neither respond to Defendants’ arguments, nor do Plaintiffs clarify when Korostelev and Krause invested, and whether it 28 1 2015) (dismissing Section 25401 claim where plaintiff’s complaint failed to establish that 2 he suffered an injury traceable to Defendants’ actions). 3 2. Misrepresentation re No Minimum Capital Amount Required 4 REIT II’s offering materials represented that REIT II’s Regulation A offering “has 5 no minimum amount” it needed to raise such that it would “begin to deploy (spend) the 6 money we raise right away, no matter how much or how little we raise.” (SAC ¶ 64.) 7 Plaintiffs allege that, contrary to its representation, REIT II “did in fact have minimum 8 capital needs, and needed to raise far more than the total of $11.3 million it in fact raised 9 (before the SEC suspended REIT II’s offering on March 16, 2022) in order to be viable.” 10 (Id. ¶ 69.) The SAC additionally alleges: 11 [C]ontrary to the ‘no minimum amount’ representations, REIT II did in fact languish without access to additional investor capital–thereby causing the 12 REIT II investors significant actual injury to the funds that were invested. 13 REIT II incurred net losses of $1,829,170 in 2022, the last year for which its audited financial reports are presently available.” 14

15 (Id. ¶ 73.) 16 Defendants argue that Plaintiffs are merely speculating the loss was caused by an 17 inability to raise new investor capital after the SEC suspended REIT II’s Regulation A 18 exemption. (Mot. at 16.) Further, Defendants assert Plaintiffs’ speculation is factually 19 incorrect, and that “[m]ost of the $1,829,170 [loss] was simply depreciation on real 20 property, a ‘paper loss’ that yields ‘tax benefits’ in the short term, and will never be realized 21 if the property is sold at a profit as expected.” (Id. (citing Declaration of Kevin Smith 22 (“Smith Decl.”), Doc. No. 30-2, ¶ 5; Doc. No. 30-10.)) REIT II’s publicly available, audited 23 2022 annual report states that the $1,820,170 net loss is comprised of general and 24 administrative expenses, fund management expenses, and unrealized investment loss. 25 (Doc. No. 30-10 at 19.) Plaintiffs do not dispute the accuracy of REIT II’s 2022 annual 26 27 28 1 report, or the content of the Smith Declaration that the property, if sold, would earn a profit 2 as anticipated. (See generally Opp’n.) 3 Because Plaintiffs do not counter Defendants’ jurisdictional factual attack, see Safe 4 Air, 373 F.3d at 1039, and do not allege facts showing that the REIT II’s net loss is traceable 5 to Defendants’ “no minimum amount” misrepresentations, Plaintiffs have not satisfied 6 their burden of demonstrating Article III standing to bring a claim regarding the “no 7 minimum amount” representation. See Weiss, 2015 WL 11990929, at *5. 8 3. Misrepresentation re Fees Charged by REIT I and REIT II 9 The Court previously found that Plaintiffs adequately pled Article III standing in the 10 First Amended Complaint with respect to misrepresentations concerning REIT II’s 11 management fees and REIT I’s and REIT II’s excessive developer and acquisition fees 12 because Plaintiffs alleged that they suffered monetary harm traceable to REIT I’s and REIT 13 II’s conduct that can likely be redressed by a favorable decision. (See Doc. No. 23 at 7–9.) 14 In response to the SAC, Defendants raise two additional jurisdictional challenges to 15 Plaintiffs’ allegations that Defendants misrepresented the nature and amount of fees 16 charged. First, Defendants bring a facial standing challenge to Plaintiff Hamerling’s 17 allegations that DiversyFund’s website misrepresented that REIT II would not charge asset 18 management fees when she alleges it did. (Mot. at 17.) Second, Defendants factually attack 19 Plaintiffs’ allegations that REIT I and REIT II charged exorbitant acquisition and developer 20 fees. (Id. at 18–19.) 21 i. Asset Management Fees 22 Plaintiffs allege that at the time Hamerling invested in REIT II, DiversyFund’s 23 website (DiversyFund.com) stated that DiversyFund had “no management fees.” (SAC 24 ¶¶ 62, 63, 74, 80, 81, 85.) Yet, Plaintiffs assert the advertisement was false because REIT 25 II’s Form 1-K disclosed, “[f]or the periods ending December 31, 2022, and December 31, 26 2021, REIT II paid $212,813 and $166,519 in asset management fees” to DiversyFund. 27 (Id. ¶ 80.) 28 1 Defendants make two arguments in support of dismissing Hamerling’s claim. First, 2 Defendants argue “[a] plaintiff who cared about fees could not decide to invest upon being 3 told one fee was not present: they would have to see what other fees exist, at what levels, 4 to decide if fees are acceptable.” (Mot. at 17.) Second, Defendants assert that Hamerling’s 5 allegations are impermissibly contradictory. (Id. at 18.) Specifically, Hamerling appears to 6 rely exclusively on Defendants’ website’s “no management fees” statement in support of 7 her management fees claim, but then relies on Defendants’ fee disclosures in support of 8 her separate claim regarding excessive acquisition and developer fees. (Id.; see SAC ¶ 25.) 9 The fee disclosures state that DiversyFund is entitled to charge an annual management fee 10 equal to 2% of the capital raised from the sale of Class A investor shares for REIT II. (Mot. 11 at 18.) Defendants argue “[s]he cannot claim she was duped by both [Defendants’ website 12 and its fee disclosures].” (Id.) Plaintiffs respond that to state a Section 25401 claim, 13 Plaintiffs need not plead reliance. (Opp’n at 17 (citing Cutler v. Rancher Energy Corp., 14 No. SACV 13-00906-DOC, 2014 WL 1153054, at *10 (C.D. Cal. Mar. 11, 2014) (“Section 15 25401 differs from common law negligent misrepresentation in that: (1) proof of reliance 16 is not required . . . .”)).) Plaintiffs assert that because the SAC alleges Defendants charged 17 Hamerling management fees in contravention of Defendants’ representations, Plaintiffs 18 have demonstrated a concrete injury of monetary harm that is traceable to REIT II’s 19 conduct and can likely be addressed by a favorable decision. (Id. at 15–16.) 20 Plaintiffs have satisfied Article III standing to bring a claim against REIT II. 21 Defendants present no support for the contention that a “plaintiff who cared about fees 22 could not decide to invest upon being told one fee was not present.” (Mot. at 17.) Further, 23 Defendants’ argument that Hamerling cannot be “duped” by both DiversyFund’s website 24 and REIT II’s fee disclosures is belied by Plaintiffs’ Section 25401 claim and actual 25 allegations. As an initial matter, Plaintiffs need not plead reliance to state a Section 25401 26 claim. See Brady v. Dairy Fresh Prod. Co., 974 F.2d 1341 (9th Cir. 1992). And in fact, 27 Hamerling does not—the SAC does not allege that Hamerling relied on REIT II’s fee 28 disclosures prior to investing. (See SAC ¶¶ 126–30.) Because the SAC indicates that REIT 1 II charged Plaintiffs management fees even though REIT II represented it would not, 2 Plaintiffs have demonstrated a recognizable concrete injury of monetary harm that is 3 traceable to REIT II’s conduct and can likely be redressed by a favorable decision. See 4 TransUnion, 549 U.S. at 437. Accordingly, Plaintiffs have Article III standing to bring 5 their management fees misrepresentation claim against REIT II. 6 Although Plaintiffs allege REIT I also misrepresented that there would be no 7 management fees, (SAC ¶ 74), the SAC does not allege that any such fees were ever 8 collected from REIT I. Because the risk of future harm on its own does not support Article 9 III standing, Plaintiffs have not established a concrete harm from this alleged 10 misrepresentation. See TransUnion, 594 U.S. at 441. Accordingly, Plaintiffs do not have 11 Article III standing to bring the no-management-fees claim against REIT I. (See Doc. No. 12 23 at 8.) 13 ii. Acquisition & Developer Fees 14 Plaintiffs also allege REIT I and REIT II paid acquisition and developer fees to 15 DiversyFund that exceeded the maximum amount Defendants disclosed would be paid— 16 generally no more than 8% of REIT I’s share of any project’s total cost, and no more than 17 4% of REIT II’s share of any project’s cost. (SAC ¶¶ 49–50, 58, 61–62, 86, 90, 91.) 18 Specifically, Plaintiffs allege Defendants overcharged acquisition and developer fees in 19 four investment projects: (1) REIT I’s project, DiversyFund Park Blvd, LLC (“Park 20 Boulevard”), (id. ¶ 52); (2) REIT I’s project, DF Summerlyn, LLC (“DF Summerlyn”), (id. 21 ¶¶ 102–03); (3) REIT I’s project, McArthur LG, LLC (“McArthur LG”), (id. ¶¶ 107–08); 22 and (4) REIT II’s project, NCP Dove, LLC (“NCP Dove”), (id. ¶¶ 59–62). 23 The Court previously found Plaintiffs satisfied Article III standing to bring their 24 claim because Plaintiffs alleged they suffered monetary harm from the overcharges that is 25 traceable to REIT I’s and REIT II’s conduct and can likely be redressed by a favorable 26 decision. (See Doc. No. 23 at 7.) Now, Defendants bring a factual attack, contending 27 Plaintiffs “seem to have misread the REITs’ disclosures, confusing one type of cost for 28 another and single investor projects for multiple investor projects; failing to account for 1 leverage in calculating percentages; etc.” (Mot. at 19.) Defendants assert that for each of 2 the four projects, “the fees assessed were within the range investors had been told would 3 be assessed.” (Id.) The Court addresses Defendants’ arguments with respect to each of the 4 four projects. 5 Park Boulevard – Citing a May 2019 SEC disclosure, Plaintiffs allege REIT I paid 6 approximately $1.25 million in developer fees on a $5 million investment in Park 7 Boulevard, where REIT I was a 52.62% equity owner in the project, violating Defendants’ 8 representation that developer fees should “not exceed 6%–8% of the Company’s share of 9 the total project cost.” (SAC ¶¶ 52, 90, 92–94.) Defendants assert the $1.25 million 10 developer fee in the May 2019 disclosure represents a projection of DiversyFund’s overall 11 developer fees from all investors over the life of the project, rather than a disclosure of a 12 fee actually assessed against REIT I. (Mot. at 19.) Defendants insist “no such fee was 13 assessed.” (Id.; see also Smith Decl. ¶ 6(b)–(c).) Plaintiffs do not dispute Defendants’ 14 contention, nor do Plaintiffs present any affidavit or evidence to support a finding of subject 15 matter jurisdiction. (See generally Opp’n.) Accordingly, Plaintiffs have not satisfied their 16 burden to demonstrate that they have suffered an injury in fact to establish Article III 17 standing for Park Boulevard. See Savage, 343 F.3d at 1040 n.2. 18 DF Summerlyn – REIT I’s 2019 annual report disclosed that in connection with the 19 acquisition of DF Summerlyn, DiversyFund “is entitled to receive up to 5.5% of the total 20 project cost including acquisition price, construction, or capital expenditure budget and 21 insurance and carrying costs.” (SAC ¶ 102.) Plaintiffs allege that the $540,088 acquisition 22 fee DiversyFund received for REIT I’s $1,324,500 investment in DF Summerlyn exceeded 23 the 5.5% of the total project cost to which it was entitled. (Id. ¶¶ 102–03.) Defendants argue 24 that Plaintiffs conflate “total project cost” with the project’s equity investment and 25 purchase price, but that “total project cost”—which includes acquisition price, 26 construction, insurance and carrying costs—necessarily exceeds the project’s initial 27 investment. (Mot. at 20.) Defendants also assert REIT I only paid $207,015.73 in 28 acquisition fees on the DF Summerlyn project, which Defendants initially calculated as 1 “2.18% of REIT I’s 38.33% share of the $9,480,772[.]94 total project cost for DF 2 Summerlyn.” (Smith Decl. ¶ 6(c).) Plaintiffs dispute the accuracy of Defendants’ 3 calculation, (Opp’n at 19), and Defendants later submitted that $207,015.73 equals 2.18% 4 of the $9,480,772.94 total cost of the project (without accounting for REIT I’s share), 5 (Second Declaration of Kevin Smith (“Second Smith Decl.”), Doc. No. 34-1, ¶ 4). 6 The merits of Plaintiffs’ misrepresentation claim depend on whether Defendants 7 paid more in acquisition fees to DiversyFund than what was disclosed to Plaintiffs. The 8 Court finds the parties’ disputes as to the amount of acquisition fees paid, the amount paid 9 by any one Defendant, and the total project costs are intertwined with the merits of 10 Plaintiffs’ misrepresentation claim. See Energizer Holdings, Inc., 2024 WL 4352496, at *5 11 (“[J]urisdictional issue[s] and substantive issues are deemed intertwined [when] the 12 question of jurisdiction is dependent on the resolution of factual issues going to the 13 merits.”) (quoting Safe Air, 373 F.3d at 1039). “[W]hen a court is faced with a factual 14 attack on standing . . . the court must leave the resolution of material factual disputes to the 15 trier of fact when the issue of standing is intertwined with an element of the merits of the 16 plaintiff’s claim.” Id. at *6. Based on the evidence presented to date, Plaintiffs continue to 17 have standing to bring their misrepresentation claim regarding DF Summerlyn. However, 18 for the reasons discussed below, Plaintiffs’ failure to plead DF Summerlyn’s total project 19 cost does not meet Rule 9(b)’s heightened pleading standard. 20 McArthur LG – Plaintiffs allege that the $549,842 acquisition fee DiversyFund 21 received for a $5,255,302 investment in the McArthur LG project “appears to exceed” the 22 5.5% of the total project cost to which it was entitled. (SAC ¶¶ 107–08.) Defendants again 23 assert that Plaintiffs have not alleged the total project cost of McArthur LG, which differs 24 from the initial investment, so Plaintiffs are only speculating as to whether the acquisition 25 fees paid to DiversyFund exceed the disclosed percentage of the total project cost. (Mot. at 26 20–21.) Additionally, in a sworn declaration, Defendants present that the actual acquisition 27 fee constituted 5.17% of the total project cost. (Smith Decl. ¶ 6(c)(iv).) Plaintiffs do not 28 dispute Defendants’ contention, nor do Plaintiffs present any affidavit or evidence to 1 support their claim. (See generally Opp’n.) Accordingly, Plaintiffs have not satisfied their 2 burden of demonstrating Article III standing to bring a claim regarding excessive developer 3 fees with respect to the McArthur LG project. See Weiss, 2015 WL 11990929, at *5. 4 NCP Dove – Plaintiffs allege that in REIT II’s 2021 annual report, REIT II reported 5 paying “$1,280,2126 [sic]” in acquisition fees to DiversyFund in conjunction with the NCP 6 Dove project, (SAC ¶¶ 61, 130), in which REIT II invested $5,014,216.07, (id. ¶ 62). 7 Plaintiffs assert that “$1,280,2126 [sic]” in acquisition fees on a $5,014,216.07 investment 8 “cannot have equaled less than 4% of REIT II’s share of the project expenses,” (id.), the 9 maximum percentage permitted in REIT II’s disclosures. On April 28, 2023, after this 10 litigation commenced, REIT II amended its 2021 annual report to reflect a reduction in the 11 reported acquisition fees for the NCP Dove project from “$1,280,2126 [sic]” to $530,106. 12 (Opp’n at 11; see Mot. at 20.) Defendants argue that Plaintiffs’ allegation is based on 13 “speculation from a typo” and that $530,106 in acquisition fees “on a 31.07% share in the 14 $46,370,000 cost for NCP Dove . . . is 3.68% . . . , well within the 4% allowed.” (Mot. at 15 20 (citing Smith Decl. ¶ 6(b)–(c); Doc. No. 30-6).) Plaintiffs question the accuracy of 16 Defendants’ reporting, responding that Defendants’ evidence is based on “unspecified 17 business records.” (Opp’n at 14.) Other than Defendants’ amended 2021 annual report that 18 reflects a reduction in NCP Dove’s acquisition fees from “$1,280,2126 [sic]” to $530,106, 19 Defendants do not present any other evidence or business records elucidating the basis for 20 the typo in REIT II’s disclosures, or the corrected figure. 21 The Court finds the parties’ disputes as to the amount of acquisition fees paid, the 22 amount paid by any one Defendant, and the total project costs are intertwined with the 23 merits of Plaintiffs’ misrepresentation claim. See Energizer Holdings, Inc., 2024 WL 24 4352496, at *5. Based on the evidence presented to date, Plaintiffs continue to have 25 standing to bring their misrepresentation claim regarding NCP Dove. However, for the 26 reasons discussed below, Plaintiffs’ failure to plead NCP Dove’s total project cost does not 27 meet Rule 9(b)’s heightened pleading standard. 28 / / / 1 4. Misrepresentation re Management’s Background and Expertise 2 Plaintiffs allege that REIT I and REIT II misrepresented their management’s 3 expertise by failing to disclose certain SEC investigations into DiversyFund, as well as the 4 2017 BRE regulatory sanctions against DiversyFund’s CEO, Cecilio. (SAC ¶¶ 152–61.) 5 Plaintiffs allege that “in the absence of material negative information that rendered 6 Defendants’ statements false and misleading,” Plaintiffs “have suffered injury by being 7 dispossessed of the funds that they were induced to invest in DiversyFund Investor Shares.” 8 (Id. ¶¶ 165, 169.) Defendants argue that Plaintiffs’ allegations of harm are conclusory and 9 hypothetical, and that “[i]f the parting from investment funds were enough, every investor 10 would automatically have standing for any theory under the sun.” (Mot. at 15.) 11 To satisfy the “concrete injury” requirement of Article III standing, Plaintiffs can 12 allege physical or monetary injuries, as well as “[v]arious intangible harms.” TransUnion 13 LLC, 594 U.S. at 425. “Chief among them are injuries with a close relationship to harms 14 traditionally recognized as providing a basis for lawsuits in American courts.” Id. In the 15 context of securities fraud, courts have traditionally recognized harm to an investor at the 16 time the investor enters a transaction. See Volk v. D.A. Davidson & Co., 816 F.2d 1406, 17 1412 (9th Cir. 1987) (“In a securities fraud case, the cognizable injury occurs at the time 18 an investor enters, or if he currently owns stock, decides to forego entering a transaction as 19 a result of material misrepresentations. This constitutes the injury giving rise to a cause of 20 action, even if an actual monetary loss is not sustained until later.”) Plaintiffs allege that 21 Defendants’ omissions induced Plaintiffs to invest in DiversyFund Investor Shares, which 22 led them to enter a transaction, transforming their cash into a more “illiquid” form “of 23 REIT I and REIT II” shares. (SAC ¶ 164.) Plaintiffs seek recission to recoup the funds they 24 paid for the shares, in exchange for their shares. (Id. ¶¶ 183, 187.) Accordingly, Plaintiffs 25 have alleged a concrete injury to satisfy Article III standing to pursue their 26 misrepresentation claim regarding Defendants’ failure to disclose the SEC investigations 27 into DiversyFund and the BRE sanctions against Cecilio. However, for the reasons 28 discussed below, Plaintiffs’ claim centered on BRE’s 2017 sanctions against Cecilio are 1 time-barred. Additionally, Plaintiffs’ claims regarding undisclosed SEC investigations fail 2 to satisfy the heightened Rule 9(b) pleading standard. 3 5. Misrepresentation regarding REIT I’s and REIT II’s Exemptions 4 from Registration 5 Plaintiffs allege that REIT I and REIT II repeatedly misrepresented to the SEC and 6 to the public that their offerings fell within the Regulation A exemption under 17 C.F.R. 7 230.251 et seq., when instead, both REIT I and REIT II were illegally offered and sold 8 without any applicable offering exemption. (SAC ¶¶ 13, 133–136, 138.) Defendants’ 9 alleged violations precipitated two SEC investigations, culminating in the SEC 10 permanently suspending the REIT II offering. (Id. ¶¶ 37–39, 138; see also Doc. No. 25-2). 11 Plaintiffs allege that Defendants’ violations led to the premature termination of REIT II, 12 which “caused REIT II to incur significant costs and losses totaling over $1 million as of 13 February 10, 2023.” (SAC ¶¶ 139, 144.) Plaintiffs also purport to have suffered an actual, 14 concrete injury as a result of REIT I and REIT II’s misrepresentation “in that they parted 15 with their funds and were charged fees thereon in reliance on DiversyFund Investor Shares 16 being exempt from registration . . . .” (Id. ¶ 150.) Plaintiffs allege “[g]iven the illiquid 17 nature of the DiversyFund investments, a favorable decision in this litigation ordering 18 recission would provide the Plaintiffs and the Class the redress they require by returning 19 their funds to them in exchange for their shares.” (Id. ¶ 151.) 20 Defendants argue Plaintiffs’ allegations are conclusory and hypothetical and that 21 parting with funds is insufficient to allege a concrete injury. (Mot. at 15–16.) Defendants 22 also assert “[t]he REITs had no resulting injury from securities counsel’s errors [regarding 23 Defendants’ noncompliance with Regulation A], and are doing well.” (Id. at 16.) 24 Specifically, Defendants contend the SAC’s allegation that “costs and losses, totaling over 25 $1 million to date,” (SAC ¶ 144), “were all paid by DiversyFund, not the REITs,” and that 26 any harm stemming from the SEC’s investigation and actions taken against the REITs 27 “were suffered by DiversyFund (and . . . its principals, Mr. Cecilio and Mr. Lewis).” (Smith 28 Decl. ¶¶ 3–4.) 1 Plaintiffs have Article III standing to bring this claim. At the time of the alleged 2 misrepresentation that REIT I and REIT II were exempt from Regulation A, Plaintiffs 3 “parted with their funds and were charged fees thereon.” (Id. ¶ 150.) Plaintiffs’ allegations 4 that they parted with their funds and entered a transaction based on a misrepresentation 5 constitute a concrete injury in a securities fraud case to satisfy standing. See Volk, 816 F.2d 6 at 1412. Accordingly, Plaintiffs have alleged a concrete injury to satisfy Article III standing 7 to pursue their misrepresentation claim regarding the REITs’ registration exemption. 8 * * * 9 In evaluating Article III standing, the Court finds Plaintiffs have not sufficiently 10 alleged an injury in fact as to their claims alleging misrepresentations about the 11 interdependency of REIT I and REIT II, no minimum amount required to meet capital 12 needs for REIT II, no management fees for REIT I, and excessive acquisition and developer 13 fees for Park Boulevard and McArthur LG. See Spokeo, 578 U.S. at 338 (“Where, as here, 14 a case is at the pleading stage, the plaintiff must clearly allege facts demonstrating each 15 element.”). Accordingly, the Court DISMISSES these claims for lack of Article III 16 standing WITH LEAVE TO AMEND. 17 Because Plaintiffs have adequately pled Article III standing with respect to the 18 alleged misrepresentations concerning excessive acquisition and developer fees for DF 19 Summerlyn and NCP Dove, as well as management fees for REIT II, management’s 20 background and expertise, and failure to adhere to Regulation A, the Court DENIES the 21 motion to dismiss these claims on constitutional standing grounds. 22 B. Rule 12(b)(6) – Failure to State a Claim 23 Defendants additionally argue that Plaintiffs’ remaining claims should be dismissed 24 under Rule 12(b)(6) because Plaintiffs’ claims are barred by the statute of limitations, 25 Plaintiffs do not plead their misrepresentation claims with the particularity required by 26 Rule 9(b), and that the alleged misrepresentations are immaterial and implausible. 27 / / / 28 / / / 1 1. Statute of Limitations 2 California Corporations Code Section 25506 stipulates that Section 25401 claims 3 must be “brought before the expiration of five years after the act or transaction constituting 4 the violation or the expiration of two years after the discovery by the plaintiff of the facts 5 constituting the violation, whichever shall expire first.” Cal. Corp. Code § 25506. 6 “[I]inquiry notice is sufficient to trigger the running of the limitations period under section 7 25506.” Deveny v. Entropin, Inc., 139 Cal. App. 4th 408, 423 (2006). “Inquiry notice arises 8 in a securities action when circumstances suggest to an investor of ordinary intelligence 9 the possibility that he has been defrauded.” Id. at 428. These circumstances can include 10 “whenever there are ‘any financial, legal, or other data, such as public disclosures in the 11 media about the financial condition of the corporation’ that would tend to alert a reasonable 12 person to the likelihood of fraud.” Id. (quoting In re Infonet Servs. Corp. Sec. Litig., 310 13 F. Supp. 2d 1106, 1114 (C.D. Cal. 2003)). 14 Here, because Plaintiffs filed their initial complaint on December 16, 2022, (see Doc. 15 No. 1), Plaintiffs can only bring claims first noticeable on or following December 16, 2020. 16 See Cal. Corp. Code § 25506. Defendants take issue with the timeliness of each of 17 Plaintiffs’ remaining claims. (Mot. at 21–23.) Plaintiffs respond that all of their claims were 18 brought within two years of the time when they could have discovered them—and within 19 five years after the REITs’ offerings began—making all claims timely. (Opp’n at 7.) 20 i. Asset Management Fees 21 Defendants assert that REIT II’s December 3, 2020, Offering Circular stated that 22 REIT II would charge “an asset management fee equal to 2%” and other fees, (Mot. at 22; 23 Doc. No. 30-5), placing Plaintiffs on inquiry notice that REIT II would charge management 24 fees. Yet, Plaintiffs allege that Defendants’ website stated, “no management fees” “through 25 2020 and most of 2021,” (SAC ¶ 79), and REIT II did not charge management fees until 26 August 2021, (id. ¶ 80). At issue is at what point a reasonably prudent investor would have 27 been on inquiry notice that Defendants possibly engaged in fraud. Deveny, 139 Cal. App. 28 4th at 423. If REIT II’s December 2020 Offering Circular put Plaintiffs on inquiry notice 1 of potential fraud, then Plaintiff Hamerling’s claim is time-barred because Plaintiffs filed 2 their complaint more than two years after December 3, 2020. However, if an investor 3 reasonably relied on Defendants’ website, and would not have been on notice until 4 Defendants charged REIT II management fees, then Plaintiff Hamerling’s claim is timely. 5 “The question of what a reasonably prudent investor should have known is particularly 6 suited to a jury determination.” Mosesian v. Peat, Marwick, Mitchell & Co., 727 F.2d 873, 7 879 (9th Cir. 1984); see also Livid Holdings Ltd. v. Salomon Smith Barney, Inc., 416 F.3d 8 940, 951 (9th Cir. 2005). Accordingly, the Court DENIES the motion to dismiss Plaintiffs’ 9 claims regarding the management fees charged by REIT II as untimely at the motion to 10 dismiss stage. 11 ii. Excessive Acquisition Fees 12 Defendants do not dispute the timeliness of Plaintiffs’ claim regarding excessive 13 acquisition fees paid in conjunction with NCP Dove. (Mot. at 21–23.) The only remaining 14 claim regarding excessive acquisition fees Defendants contend is time-barred relates to DF 15 Summerlyn. Plaintiffs allege that in the Form 1-K annual report for the 2019 fiscal year, 16 dated June 16, 2020, REIT I disclosed that DiversyFund received $540,088 in connection 17 with the acquisition of DF Summerlyn, which Plaintiffs assert “appears to exceed the 5.5% 18 of REIT I’s share of the total project cost” given the initial $1,324,500 investment in DF 19 Summerlyn. (SAC ¶ 99, 102–03.) 20 Defendants argue that the statute of limitations prevents Plaintiffs from raising a 21 substantive claim of excessive fees based on June 2020 disclosures about DF Summerlyn. 22 (Mot. at 22.) Plaintiffs respond that the offering circulars, stipulating that the REITs “will 23 be entitled to receive from the Project Entity the fees described,” “would not have alerted 24 a reasonable investor to the probability that DiversyFund had collected more than the 25 maximum percentages of the REIT[s’] share of the total project cost set forth in the REITs’ 26 SEC filings more than two years before Plaintiffs’ claims were filed[.]” (Opp’n at 9.) Given 27 that Plaintiffs filed their claim within 5 years of the alleged overcharge, and “[t]he question 28 of what a reasonably prudent investor should have known is particularly suited to a jury 1 determination,” Mosesian, 727 F.2 at 879, the Court DENIES the motion to dismiss 2 Plaintiffs’ claim regarding DF Summerlyn’s acquisition fees as untimely. 3 iii. Management’s Background & Expertise 4 Defendants assert, and Plaintiffs do not dispute, that Plaintiffs are time-barred from 5 bringing a misrepresentation claim related to BRE’s 2017 regulatory sanctions against 6 Defendant Cecilio because Plaintiffs were on inquiry notice since 2017, when the sanctions 7 became public on the California Department of Real Estate’s website. (Mot. at 22 (citing 8 Smith Decl. ¶ 2; Doc. No. 30-9).) Because Plaintiffs did not file their original complaint 9 until 2022, beyond the two-year inquiry notice limitations period, see Cal. Corp. Code 10 § 25506, the Court dismisses Plaintiffs’ claim regarding Defendants’ failure to disclose the 11 2017 BRE sanctions against Cecilio. Defendants do not challenge the timing of Plaintiffs’ 12 misrepresentation allegations regarding Defendants’ nondisclosure of the SEC 13 investigation (“SEC Investigation No. LA-5069”) into DiversyFund, (SAC ¶¶ 30, 155– 14 161), so that portion of Plaintiffs’ misrepresentation claim is not time-barred. 15 iv. Failure to Adhere to Regulation A 16 Defendants do not dispute that Plaintiffs’ misrepresentation claim regarding REIT 17 I’s failure to comply with Regulation A is timely. However, Defendants argue that REIT 18 II’s December 2020 Offering Circular warned investors that although the securities were 19 “offered pursuant to an exemption from registration,” the SEC “has not made an 20 independent determination that the securities offered hereunder are exempt.” (Mot. at 23 21 (quoting Doc. No. 30-5 at 3).) Plaintiffs respond that they could not have learned of REIT 22 II’s alleged violations of Regulation A until May 3, 2022, when REIT II disclosed in its 23 public SEC filings that its offering was not within a valid exemption from registration. (Id. 24 at 14.) Given that Plaintiffs filed their misrepresentation claim within 5 years of 25 Defendants’ alleged failure to disclose noncompliance with SEC Regulation A, and “[t]he 26 question of what a reasonably prudent investor should have known is particularly suited to 27 a jury determination,” Mosesian, 727 F.2 at 879, the Court DENIES the motion to dismiss 28 Plaintiffs’ claim regarding Defendants’ noncompliance with Regulation A. 1 * * * 2 The Court finds the two-year inquiry notice limitations period prevents Plaintiffs 3 from bringing a misrepresentation claim related to Defendants’ failure to disclose BRE’s 4 2017 regulatory sanctions against Cecilio. Accordingly, the Court DISMISSES this claim 5 as time-barred. Plaintiffs’ misrepresentation claims regarding REIT II’s management fees, 6 REIT I’s and REIT II’s excessive acquisition fees, nondisclosure of SEC Investigation No. 7 LA-5069, and failure to adhere to Regulation A, are timely. 8 2. Plausibility & Particularity 9 The Parties dispute whether Federal Rule of Civil Procedure 9(b) applies to 10 Plaintiffs’ Section 25401 misrepresentation claims. Rule 9(b) stipulates, “[i]n alleging 11 fraud or mistake, a party must state with particularity the circumstances constituting fraud 12 or mistake.” Fed. R. Civ. Proc. 9(b); see also In re Finjan Holdings, Inc., 58 F.4th 1048, 13 1057 (9th Cir. 2023) (“[I]f a plaintiff chooses to allege in the complaint that the defendant 14 has engaged in fraudulent conduct, then the pleading of that claim as a whole must satisfy 15 the particularity requirement of Rule 9(b).”) (internal quotation marks and citation 16 omitted). Defendants assert that Plaintiffs have not pled their Section 25401 claims with 17 particularity to meet the Rule 9(b) standard. (Mot. at 13, 20, 31.) Plaintiffs counter that 18 there is a split of authority as to whether the Rule 9(b) applies to Section 25401 claims and 19 that the Court should apply Rule 8(a). (Opp’n at 22.) Plaintiffs further assert that even if 20 Rule 9(b) applies, Plaintiffs’ allegations are sufficient. (Id.) The Court first addresses 21 whether Plaintiffs’ Section 25401 claims are subject to Rule 9(b) and then whether 22 Plaintiffs have adequately pled the Section 25401 claims under the applicable standard. 23 i. Rule 9(b)’s Applicability to Cal. Corp. Code § 25401 Claim 24 Ninth Circuit precedent does not directly address whether Rule 9(b) applies to 25 Section 25401 claims. Moreover, district courts have diverged in requiring Section 25401 26 claims to meet the Rule 9(b) pleading requirements depending on whether the claim sounds 27 in fraud or in negligence. Compare SIC Metals, Inc. v. Hyundai Steel Co., No. 28 SACV1800912CJCPLAX, 2018 WL 6842958, at *4 (C.D. Cal. Nov. 14, 2018) (“As with 1 all claims sounding in fraud, section 25401 claims for fraudulent conduct are subject to 2 Rule 9(b)’s heightened pleading standards.”), and Yee v. NIVS IntelliMedia Tech. Grp., 3 No. CV1108472DMGAJWX, 2012 WL 12886829, at *1 (C.D. Cal. Sept. 7, 2012) 4 (requiring plaintiff to meet Rule 9(b) pleading standard for Section 25401 claim because 5 “[b]y requiring a false statement or material omission, section 25401 ‘concern[s] the 6 fraudulent sale of securities’” (quoting Stewart v. Ragland, 934 F.2d 1033, 1047 (9th Cir. 7 1991) (emphasis added)), and Olenicoff v. UBS AG, No. SACV081029AGRNBX, 2009 8 WL 481281, at *6 (C.D. Cal. Feb. 24, 2009) (dismissing Section 25401 claim where 9 plaintiffs failed to meet Rule 9(b) pleading requirement), with Cutler v. Rancher Energy 10 Corp., No. SACV 13-00906-DOC, 2014 WL 1153054, at *6 (C.D. Cal. Mar. 11, 2014) 11 (“Claims alleging a violation of Section 25401 need not satisfy Rule 9(b) if grounded on 12 only negligent behavior.”), and Openwave Sys. Inc. v. Fuld, No. C 08-5683 SI, 2009 WL 13 1622164, at *4 (N.D. Cal. June 6, 2009) (Section 25401 claim need not comply with Rule 14 9(b) because complaint alleged negligent behavior, not fraudulent conduct). Even if fraud 15 is not an element of a claim, if the complaint “sounds in fraud,” Rule 9(b) applies. See Vess 16 v. Ciba-Geigy Corp. USA, 317 F.3d 1097, 1103–04 (9th Cir. 2003). 17 Here, because Plaintiffs’ claims sound in fraud, they are subject to Rule 9(b)’s 18 heightened pleading standard. See Hayes v. Scherer, No. 821CV00389SSSADSX, 2023 19 WL 5507072, at *3 (C.D. Cal. July 3, 2023). The Court finds the reasoning in Hanna v. 20 Sierra Network, Inc., No. CV 19-211 DSF (FFMX), 2019 WL 12361302, (C.D. Cal. Apr. 21 1, 2019), persuasive. The Hanna court determined, “[b]ecause Plaintiff has asserted 22 Individual Defendants violated California’s securities laws when they made false 23 statements and withheld material information, the claim sounds in fraud. Therefore, 24 Plaintiff’s complaint must satisfy Rule 9(b).” 2019 WL 12361302, at *4. Similarly, here, 25 Plaintiffs base their Section 25401 misrepresentation claims on allegations that Defendants 26 made false and misleading statements of material fact, which sound in fraud. (SAC ¶¶ 20, 27 67, 69,72, 80, 98, 104, 114, 117, 122, 125, 165, 169, 180, 181.) Additionally, both 28 Openwave Systems, Inc. and Cutler, which declined to apply Rule 9(b) to Plaintiffs’ section 1 25401 claims, are distinguishable. There, the complaints only alleged defendants’ 2 negligence, not fraud. Openwave Sys. Inc., 2009 WL 1622164, at *4; Cutler, 2014 WL 3 1153054, at *6. Because Plaintiffs’ claims sound in fraud, Rule 9(b)’s heightened pleading 4 standard applies. See Vess, 317 F.3d at 1103–04; see also Hollifiel v. Resolute Cap. 5 Partners Ltd., LLC, No. 2:22-CV-07885-SB-RAO, 2023 WL 4291524, at *7 (C.D. Cal. 6 May 12, 2023). 7 ii. Whether Plaintiffs’ Section 25401 Claims Satisfy Rule 9(b) 8 “To satisfy Rule 9(b), a pleading must identify the who, what, when, where, and how 9 of the misconduct charged, as well as what is false or misleading about [the purportedly 10 fraudulent] statement, and why it is false.” Cafasso, U.S. ex rel. v. Gen. Dynamics C4 Sys., 11 Inc., 637 F.3d 1047, 1055 (9th Cir. 2011). 12 a. Asset Management Fees 13 Plaintiffs satisfy their burden under Rule 9(b) to allege a violation of Section 25401 14 with respect to DiversyFund’s website’s representation that REIT II charged “no 15 management fees.” Plaintiffs allege that “as least as late as November 30, 2021,” 16 DiversyFund’s website represented REIT II had “no management fees,” when “[f]or the 17 periods ending December 31, 2022 and December 31, 2021, the Company [REIT II] paid 18 $212,813 and $166,519 in asset management fees to the Sponsor [DiversyFund].” (SAC 19 ¶¶ 80, 85.) Plaintiffs further allege that “[i]t was only in December 2021, after the SEC 20 called the inaccuracy of its website to DiversyFund’s attention, that DiversyFund removed 21 the ‘no management fees’ representations from its website.” (Id. ¶ 82.) Additionally, 22 Plaintiffs identify that Plaintiff Hamerling was dispossessed of her investment funds “under 23 the auspices of the ‘no management fee’ misrepresentations,” even though she was later 24 “charged asset management fees.” (Id. ¶ 84.) These allegations specify the “who, what, 25 when, where, and how” of the alleged fraudulent statement, as well as “what is false or 26 misleading about [the purportedly fraudulent] statement, and why it is false.” See Cafasso, 27 U.S. ex rel. 637 F.3d at 1055. Accordingly, Plaintiffs have met the Rule 9(b) pleading 28 burden to allege a claim against REIT II’s “no management fees” misrepresentation. 1 b. Acquisition Fees 2 Plaintiffs’ allegations that Defendants received inflated acquisition fees for projects 3 DF Summerlyn and NCP Dove fall short of Rule 9(b)’s pleading requirements. In both 4 instances, Plaintiffs conflate Defendants’ initial project investments with overall project 5 costs. With respect to DF Summerlyn, REIT I disclosed that DiversyFund is “entitled to 6 receive up to 5.5% of the total project cost.” (SAC ¶ 102.) Plaintiffs allege that REIT I 7 invested $1,324,500 into DF Summerlyn, so “the $540,088 acquisition fee appears to 8 exceed 5.5% of REIT I’s share of the total project.” (Id. ¶ 103.) Plaintiffs do not plead the 9 actual or estimated total project cost of DF Summerlyn—Plaintiffs only plead the initial 10 $1,324,500 investment. (See id.) Accordingly, the Court is unable to infer that DF 11 Summerlyn’s $540,088 acquisition fee exceeds “5.5% of the total project cost.” (Id. 12 ¶¶ 102–03.) 13 Plaintiffs similarly do not plead NCP Dove’s total project costs. REIT II represented 14 that DiversyFund would charge an acquisition fee “between 1% and 4% of the total project 15 costs.” (Id. ¶ 129.) Plaintiffs plead that REIT II invested $5,014,216.06 into NCP Dove, so 16 REIT II’s disclosure that it “paid $1,280,2126 [sic] in acquisition fees” to DiversyFund 17 “cannot have equaled less than 4% of REIT II’s share of the property purchase price.” (Id. 18 ¶¶ 129, 130.) The SAC conflates “property purchase price” with “total project costs.” (Id.) 19 Because the SAC does not allege the actual or estimated total project costs of NCP Dove, 20 the Court is unable to discern whether the acquisition fees exceed “4% of the total project 21 costs.” (Id. ¶ 129.) Further, Plaintiffs concede that REIT II’s amended 2021 annual report 22 revised NCP Dove’s acquisition fees for the yearly period ending December 31, 2021, from 23 “$1,280,2126 [sic]” to $530,106, which is “below the maximum 4% of REIT II’s share of 24 the acquisition price that REIT II represented would be charged.” (Opp’n at 11–12.) 25 Because Plaintiffs fail to allege the total project costs for DF Summerlyn and NCP 26 Dove, the SAC does not adequately allege why Defendants’ disclosures are false. See 27 Cafasso, U.S. ex rel. 637 F.3d at 1055. Accordingly, the Court DISMISSES the claims 28 1 regarding excessive acquisition fees for failing to satisfy Rule 9(b)’s heightened pleading 2 standard. 3 c. SEC Investigation (Investigation No. LA-5069) 4 Plaintiffs fail to satisfy Rule 9(b)’s pleading requirements regarding Defendants’ 5 failure to disclose SEC Investigation No. LA-5069, which closed in January 2020. 6 Plaintiffs allege that REIT I’s October 2018 circular stated that REIT I was not “currently 7 the subject of any investigation or proceedings by any governmental authorities,” (SAC 8 ¶ 158), so its failure to disclose SEC Investigation No. LA-5069 in subsequent disclosures 9 misled investors. (Id. ¶¶ 155–161.) Defendants argue that Plaintiffs do not allege when 10 Defendants became aware of SEC Investigation No. LA-5069, and Defendants could not 11 disclose an investigation they did not know about. (Mot. at 28 n.15.) Defendants further 12 assert they had no duty to update the October 2018 circular because it only stated that REIT 13 I was not “currently” the subject of an investigation, and the duty to update “applies only 14 to statements that are clear, factual, and forward-looking, such that some continuing 15 representation remains alive in the minds of investors when circumstances change[.]” (Id. 16 (quoting Seaman v. Cal. Bus. Bank, No. 13-cv-02031-JST, 2013 WL 5890726, at *5 (N.D. 17 Cal. Oct. 30, 2013)).) Plaintiffs do not directly respond to Defendants’ arguments. 18 The Court agrees with Defendants that Plaintiffs have not sufficiently stated a claim 19 that Defendants’ omissions were false or misleading, or that Defendants had a duty to 20 correct or update the October 2018 circular that only stated that REIT I was not currently 21 under investigation. Plaintiffs only allege when the SEC Investigation No. LA-5069 22 concluded and fail to assert the period under which Defendants were under investigation 23 or when they could have disclosed it. Accordingly, the Court GRANTS the motion to 24 dismiss as to this claim. 25 d. Failure to Adhere to Regulation A 26 Plaintiffs satisfy their burden under Rule 9(b) to allege a violation of Section 25401 27 with respect to Defendants’ misrepresentation of Regulation A registration exemption. 28 Plaintiffs allege that REIT I and REIT II described their offerings of DiversyFund Investor 1 Shares in SEC filings as being within an exemption from registration under Regulation A, 2 but failed to disclose that REIT I (beginning on or about March 26, 2021) and REIT II 3 (beginning on or about January 31, 2021) had not adhered to the requirements of 4 Regulation A. (SAC ¶ 133.) Thus, Plaintiffs allege, REITs’ shares were not within a valid 5 exemption from registration. (Id.) Specifically, Plaintiffs allege REIT II violated 6 Regulation A by delaying its offering by at least seven months and by filing a circular 7 supplement, instead of a new offering statement or amendment, when it increased its 8 maximum offering amount. (Id. ¶ 136.) Plaintiffs allege REIT I similarly violated 9 Regulation A by filing an offering circular supplement rather than a new offering statement 10 or post-qualification, as required by Rule 253(b). (Id. ¶ 137.) These violations resulted in 11 the SEC’s temporary suspension of—and ultimately, permanent suspension of—REIT II’s 12 Regulation A exemption from registration. (Id. ¶ 31.) Defendants argue that because 13 Plaintiffs admit that any error was “technical and inadvertent,” Plaintiffs do not state a 14 claim. (Mot. at 29.) However, “a civil claim for violation of §§ 25401 and 25501 does not 15 require a showing of intent.” I-Enter. Co. LLC v. Draper Fisher Jurvetson Mgmt. Co. V, 16 LLC, No. C-03-1561 MMC, 2005 WL 3590984, at *27 (N.D. Cal. Dec. 30, 2005). Plaintiffs 17 have satisfied Rule 9(b)’s requirements to state a Section 25401 claim for Defendants’ 18 alleged misrepresentation regarding Regulation A exemption. 19 * * * 20 The Court finds that Plaintiffs did not plead their Section 25401 misrepresentation 21 claims regarding excessive acquisition fees and Defendants’ failure to disclose SEC 22 Investigation No. LA-5069 with the particularity required under Rule 9(b). Accordingly, 23 the Court DISMISSES these claims. Plaintiffs’ claims regarding Defendants’ 24 misrepresentations regarding REIT II’s asset management fees and the status of REIT I 25 and REIT II Class A Investor shares as exempt from Regulation A registration remain. 26 C. Secondary Liability 27 Plaintiffs bring a second cause of action under California Corporations Code Section 28 25504 to allege that Defendants DiversyFund, Cecilio, and Lewis are secondarily liable for 1 violations under Section 25401 for providing “material aid [that] included . . . the 2 development, oversight, approval, and distribution of the advertising and marketing 3 materials used in connection with the offer and sale of the DiversyFund Investor Shares, 4 along with the execution of the various Regulation A offering circulars.” (SAC ¶ 186.) 5 Plaintiffs additionally allege that Cecilio and Lewis had “complete de facto control of REIT 6 I and REIT II,” (id. ¶ 11), and each “directed the day-to-day management of DF Manager, 7 REIT I and REIT II, (id. ¶ 185). Defendants move to dismiss this claim, asserting secondary 8 liability cannot exist if primary liability is not established; that Plaintiffs, in seeking 9 rescission and not damages, may only sue the REITs; and that the SAC only includes 10 conclusory allegations about control, which are insufficient to state a claim. 11 First, because the Court has determined that Plaintiffs state a claim under Section 12 25401 regarding misrepresentations of REIT II’s asset management fees and Regulation A 13 exemption for REIT I and REIT II, Plaintiffs can plead a claim for secondary liability 14 related to these underlying causes of action. Second, the Court agrees with the reasoning 15 in Moss v. Kroner, 197 Cal. App. 4th 860 (2011), that while “ordinary principles of 16 rescission require strict privity in order to rescind contracts,” the text of Section 25504 17 “demonstrate[s] the Legislature’s choice to expand liability, in limited circumstances, 18 beyond the strict privity, direct buyer and seller liability . . . to other, secondarily 19 responsible participants in securities fraud.” 197 Cal. App. 4th at 878. As was the case in 20 Moss, Plaintiffs can seek recission as relief while seeking secondary liability against 21 Defendants DiversyFund, Cecilio, and Lewis. See id. at 875–79. Third, courts have 22 interpreted “the plain language of section 25504” to mean “that principal executive officers 23 and directors are presumptively liable for their corporation’s issuance of unqualified 24 securities, regardless of whether they participated in the transactions at issue, or controlled 25 the issuer.” Hellum v. Breyer, 194 Cal. App. 4th 1300, 1310 (2011). Construing the facts 26 alleged in favor of Plaintiffs, the Court finds they adequately state a claim that Defendants 27 DiversyFund, Cecilio, and Lewis are secondarily liable for the remaining claims regarding 28 1 || alleged misrepresentations regarding REIT II’s asset management fees and Regulation A 2 ||exemption for REITs I and I. 3 CONCLUSION 4 Accordingly, for the reasons stated herein, the Court GRANTS IN PART and 5 || DENIES IN PART Defendants’ Motion to Dismiss the SAC. Considering leave should be 6 || freely given, the Court GRANTS Plaintiffs LEAVE TO AMEND the SAC. 7 If Plaintiffs seek to file a Third Amended Complaint (“TAC”), the TAC must be 8 || filed, along with a redline version attached, no later than January 10, 2025. The Court 9 || directs that prior to filing any subsequent motion to dismiss, counsel must meet and confer 10 || and discuss the intended motion, in an attempt to resolve issues without court intervention, 11 appropriate. 12 13 IT IS SO ORDERED. 14 15 Dated: December 6, 2024 © ¢ 16 Hon. Anthony J.Battaglia 7 United States District Judge 18 19 20 21 22 23 24 25 26 27 28 AO