Lopes v. Vieira (488 F. Supp. 2d 1000, 2007)

United States District Court for the Eastern District of California 2007-05-30

Commerce and Trade

Citations

Full opinion text

ORDER GRANTING IN PART WITH LEAVE TO AMEND AND DENYING IN PART DEFENDANT GENSKE, MULDER & COMPANY’S MOTION TO DISMISS (Doc. 9) AND DEFENDANT DOWNEY BRAND LLP’S MOTION TO DISMISS (Doc. 11)

WANGER, District Judge.

Plaintiffs Manual and Mariana Lopes dba Lopes Dairy; Raymond Lopes, Joseph Lopes and Michael Lopes, individually and dba Westside Holstein; Alvarado Machado and Tony Estevan filed a Complaint on September 11, 2006. Defendants are George and Mary Vieira; California Milk Market, a California Corporation; Valley Gold, LLC, a California limited liability company; Genske, Mulder LLP, a California limited liability partnership; Anthony Cary; Downey Brand LLP, a California limited liability partnership; Central Valley Dairymen, Inc., a California Food and Agriculture Nonprofit Cooperative Association (CVD); and Does 1-100.

Defendants Genske, Mulder & Company (hereinafter referred to as Genske) and Downey Brand LLP (hereinafter referred to as Downey) have each filed motions to dismiss the Second Cause of Action (securities fraud), the Third Cause of Action (violation of California securities law), the Fifth Cause of Action(negligenee) and the Sixth Cause of Action (misrepresentation) for failure to state a claim upon which relief can be granted pursuant to Rule 12(b)(6), Federal Rules of Civil Procedure.

A. BACKGROUND.

The Complaint alleges the following summary as an introduction to more specific allegations:

1. Plaintiffs are all owners and operators of dairy farms located in Merced County, California. Through the machinations of George Vieira and his wife, Mary Vieira, facilitated by the gross negligence and/or participation of accounting, managerial and legal professionals, more than $20 million worth of milk produced by Plaintiffs’ farms was diverted from the proper supply channels into a criminal enterprise headquartered in New Jersey. As a result, Plaintiffs have unnecessarily incurred expenses and other damages, and Plaintiffs not been paid for the milk that they supplied; rather, the proceeds from the sale of their milk has been diverted to the criminal enterprise and to George Vieira and his wife, Mary Vieira, and their company California Milk Market, a California Corporation. George Vieira, Mary Vieira and California Milk Market, in turn, used the diverted proceeds to purchase real estate in at least Stanis-laus County, San Joaquin County and Tuolumne County. They have more recently attempted to shelter and hide their ill-gotten proceeds by transferring parcels of real estate to third parties, either acting as nominees or without payment of fair value.

2. The criminal enterprise that George Vieira, Mary Vieira and California Milk Market conspired with and used to divert milk payments from plaintiffs to themselves consisted of an affiliation of cheese manufacturers, bulk buyers of cheese products, and milk product brokers, together with the officers and owners who ran these businesses.

3. The criminal enterprise centered upon a publicly traded company called Suprema Specialties, Inc., and a concerted scheme to inflate the size, profitability, growth and inventory value of Supre-ma Specialties, Inc. Indeed, from 1996 to 2002, Suprema Specialties, Inc. reported annual double-digit growth in sales and revenues, and it used that reported growth to raise more than $150 million from two public stock offerings and from bank loans. These funds were then largely diverted to individual members of the criminal enterprise.

4. Suprema Specialties, Inc. created the appearance of rapid and steady growth by using fictitious invoices and fictitious purchase orders, in a scheme that the Securities and Exchange Commission dubbed “Round-Tripping.” Under the Round-Tripping arrangements, Suprema Specialties, Inc. would pretend to purchase milk and milk products from milk product brokers, ostensibly to manufacture into cheese. Suprema Specialties, Inc. would then issue checks to pay for these orders, but no product was physically shipped. Instead, the milk product brokers and bulk cheese buyers who participated in the criminal enterprise would turn around and pretend to order manufactured cheese products from Suprema Specialties, Inc., which Suprema Specialties, Inc. would report on its books to inflate its sales and accounts receivable. The milk product brokers and bulk cheese consumers would then use the payments that were sent to them from Suprema Specialties, Inc., after deducting commission payments for themselves, to make payments on the fictitious orders, so that Suprema Specialties, Inc. could show regular payments on its fictitious accounts receivable and keep the receivables current — a condition required for Suprema Specialties, Inc.’s large bank loans.

5. In 2001, Suprema Specialties, Inc. reported $420 million in revenues; a substantial portion of those revenues was fictitious. The Securities and Exchange Commission’s investigation found that from 1998 to February of 2002, at least $135 million of Suprema Specialties, Inc.’s reported revenue was fictitious.

6. In order to maintain the pretense of growth and profitability, Suprema Specialties, Inc. manufactured cheese and cheese products and it maintained warehouses of inventory. But the actual inventory based upon the actual volume of cheese that Suprema Specialties, Inc. manufactured was too small in relation to its reported volume of sales, and Suprema Specialties, Inc. accordingly cut the cheese with starch fillers and affixed false labels to the inventory, thus fraudulently inflating both the size and the value of the inventory.

7. Additionally, to mask its fraudulent activities, Suprema Specialties, Inc. used the same milk product brokers for its legitimate purchases of milk as it used for its fictitious purchases. This practice, and other steps taken by the criminal enterprise, directly led to plaintiffs’ catastrophic loss. The loss primarily falls into four categories.

SUPREMA’S BANKRUPTCY

8. Defendant George Vieira was retained by and controlled the day-to-day operations of and business planning for Central Valley Dairymen, an agricultural cooperative through which plaintiffs sold the milk produced by their dairy farms. From November 2001 through March 2002, Mr. Vieira was also the Chief Operating Officer of Suprema Specialties West, Inc., a wholly owned subsidiary of Suprema Specialties, Inc. In addition, Mr. Vieira and his wife Mary Vieira owned and controlled defendant California Milk Market, LLC, one of the milk product brokers that was a member of the criminal enterprise centered around Suprema Specialties, Inc.

9. As part of the criminal enterprise, Mr. Vieira regularly caused Central Valley Dairymen to sell its inventory of milk to Suprema Specialties, Inc., as well as to the related subsidiaries of Suprema Specialties, Inc., all routed through California Milk Market, LLC. Indeed, even when Suprema Specialties, Inc.’s stock was delisted, and after Suprema Specialties, Inc. filed for bankruptcy, Mr. Vieira still caused Central Valley Dairymen to sell its inventory of milk to Suprema Specialties West, Inc.

10. For several years, Mr. Vieira actively concealed the implosion of Supre-ma Specialties, Inc. from plaintiffs, hid from plaintiffs his involvement in the criminal enterprise, and concocted false excuses to explain why plaintiffs had not received payment for the milk that they supplied to Central Valley Dairymen. Within the last year, plaintiffs have discovered the truth — that the milk was diverted without payment to a criminal enterprise, and that on January 7 of 2004, Mr. Vieira and other leaders of the criminal enterprise pled guilty to securities fraud and conspiracy to engage in mail fraud and bank fraud.

11. Because of the bankruptcy of Suprema Specialties, Inc. and Suprema Specialties West, Inc., caused by the criminal enterprise guided by Mr. Vieira, Plaintiffs have been denied payment for millions of dollars in milk supplied through Central Valley Dairymen to California Milk Market, Suprema Specialties, Inc. and Suprema Specialties West, Inc.

LOSS OF FUND PROTECTION

12. In 1987, the State of California established the Milk Producers Trust Fund to provide protection to dairy farmers like Plaintiffs. The fund guarantees that California milk producers will be paid for their milk as long as the milk is sold to a bonded California processor. However, the Fund does not cover milk sales that are handled by a broker; and the Fund does not cover milk that is sold to a processor in which the producer holds a beneficial interest.

13. Mr. Vieira, while purporting to act as a fiduciary agent for Central Valley Dairymen and its dairy farm members (including Plaintiffs), routed a substantial portion of the agricultural cooperative’s supply of milk through California Milk Market, a milk brokerage owned and controlled by Mr. Vieira and his wife. By routing milk through California Milk Market, these defendants caused Plaintiffs to lose the protection of the Milk Producers Trust Fund. This loss of Trust Fund protection only added to Plaintiffs’ staggering losses.

CHURNING

14. Additionally, as part of the Round-Tripping scheme centered around Suprema Specialties, Inc., California Milk Market engaged in the fictitious sale of milk on behalf of Central Valley Dairymen to Suprema Specialties, Inc. or its subsidiary, Suprema Specialties West, Inc. Because these fictitious sales did not actually occur, California Milk Market and Central Valley Dairymen maintained excess milk inventory that needed to be shipped to other processors.

15. To mask the fraudulent Round-Tripping scheme, California Milk Market and the criminal enterprise prepared false paperwork stating that the milk comprising the excess inventory had been shipped to Suprema Specialties, Inc. and its subsidiary, but that the milk failed to meet quality requirements, resulting in the milk being rejected by the processor and returned to Central Valley Dairymen. With the fictitious transaction masked in this fashion, California Milk Market and its owners and operators would then broker the milk to another legitimate processor.

16. With each transaction, however, California Milk Market collected a brokerage fee, and Plaintiffs are informed and believe, and thereon allege, that California Milk Market, George Vieira and Mary Vieira also created fictitious shipping invoices diverting to themselves payment for transport costs that in reality were never incurred. With the slew of fictitious transactions, California Milk Market accordingly collected fees that it had not earned, and diverted further sums that rightfully belonged to Plaintiffs into the hands of George Vieira and Mary Vieira.

CREATION OF VALLEY GOLD, LLC

17. In addition, the criminal enterprise centered around Suprema Specialties, Inc. was so lucrative and successful that Mr. Vieira decided in the summer of 2003, after the collapse of Suprema Specialties, Inc., to recreate the scheme. To do so, however, he needed to find or create a cheese manufacturer to replace Suprema Specialties’ role in the fraudulent scheme.

18. By mid 2003, it was clear that the artificially inflated sales of Suprema Specialties, Inc. and its subsidiaries could no longer be maintained. Indeed, in early 2003, George Vieira was already engaged in negotiations with the U.S. Attorney’s offices about pleading guilty to securities fraud for his participation in the criminal enterprise’s scheme to inflate the stock price of Suprema Specialties, Inc. through the use of fictitious Round-Tripping transactions. On March 28, 2003, the U.S. Attorneys Office sent a seven page letter to Mr. Vieira’s attorney stating the materials [sic] terms of the plea deal. Mr. Vieira signed the letter indicating his consent to the plea terms on August 26, 2003.

19. Seeing the inevitable end to the lucrative enterprise with Suprema Specialties, Inc., Mr. Vieira conceived of a new plan to repeat the scheme with a new captive cheese manufacturer.

20. In the summer of 2003, Mr. Vieira thus proposed to Plaintiffs and other members of Central Valley Dairymen that they form a new entity, defendant Valley Gold, LLC, and through that entity purchase the moth-balled Land-O-Lakes processing facility located in Gus-tine, California.

21. Mr. Vieira personally spearheaded this proposal, but he also enlisted the assistance of Genske-Mulder LLP and Downey Brand LLP. Genske-Mulder was and remains a professional partnership that specializes in providing complete accounting, tax and consulting services for he [sic] dairy industry. Their roster of clients included Central Valley Dairymen and many of its individual diary [sic] farm members, including Plaintiffs. They purportedly reviewed and helped prepare the business plan for Valley Gold, LLC, and recommended that Plaintiffs both invest in Valley Gold, LLC and supply Valley Gold, LLC with milk. Defendant Downey Brand LLP is a California law partnership, and it was retained by Mr. Vieira to assist in the formation of Valley Gold, LLC. Genske-Mulder and Downey Brand also prepared a prospectus and offering memorandum to market and sell shares of Valley Gold, LLC, including detailed financial forecasts, a detailed business plan, and disclosures required by Federal Securities law. A true and correct copy of one of the prospectuses is attached hereto as Exhibit A. A true and correct copy of the offering memorandum is attached hereto as Exhibit B.

22. Plaintiffs, individually and through Central Valley Dairymen, were induced to invest more than $1 million for the formation of Valley Gold, LLC; and Plaintiffs were also induced to supply milk to Valley Gold, LLC and to personally guarantee Valley Gold, LLC’s bank loans. The numerous representations made to Plaintiffs to induce this action, including those in the prospectus and offering memorandum, were materially false and misleading. Defendants did not even notify the Plaintiffs that Valley Gold, LLC was not bonded, or that by becoming investors in Valley Gold, LLC, any sale of Plaintiffs’ milk to Valley Gold, LLC would not be covered by the Milk Producers Trust Fund.

23. On January 7, 2004, George Vieira concluded his negotiations with the U.S. Attorney’s office and pled guilty for his criminal involvement in the scheme to inflate the apparent profitability of Suprema Specialties, Inc., and he was shortly afterward barred from working in the dairy and cheese business, including being barred from his role as the chief operating officer of Valley Gold, LLC. Mr. Vieira did not disclose this information but instead allowed Valley Gold, LLC to default on its bank loans and on its purchase obligations for the Land-O-Lakes facility. The facility was foreclosed, and the bank loans were placed in default.

24. As a result, Plaintiffs again were left without payment for millions of dollars worth of milk; they lost their cash investment in Valley Gold, LLC; and they were sued by the banks on their personal guarantees.

25. Plaintiffs are unsophisticated dairy farmers, and they relied upon the professional advice and supposed expertise not only of Mr. Vieira, but also of Dow-ney Brand, Genske-Mulder and Anthony Cary. The professionals, however, all chose to parrot Mr. Vieira’s assurances that he was acting to protect Plaintiffs’ interests and maximize the value of their milk; and not a single professional had the courage to stand up and report the irregularities of Mr. Vieira’s proposals, the colossal and unnecessary risks involved in the proposed business venture, or even the fact that Mr. Vieira was actively negotiating with the U.S. Attorney’s office to plead guilty to securities and bank fraud.

26. Those who were charged with protecting Plaintiffs’ interests instead actively allowed Plaintiffs to be bilked out of more than $20 million.

Genske is alleged to specialize in providing complete accounting, tax and consulting services for the dairy industry and to have provided the following services to its clients, including CVD, Valley Gold and many of the Plaintiffs: (1) annual and long-term tax planning; (2) cash flow management; (3) breakeven analysis; (4) industry standards; (5) financial goal setting; (6) financial forecasts and projections; (7) management advisory services; (8) investment review; and (9) cash flow analysis for expansion or restructuring. ¶ 36. Genske is alleged to have received direct financial benefit from Plaintiffs, CVD and Valley Gold and, with the assistance of Defendant Anthony Cary, an attorney practicing in Sacramento, and Defendant George Vieira, “prepared financial projections for the purpose of attracting investors to VALLEY GOLD, and ... actively participated in the preparation of a prospectus to attract investors for VALLEY GOLD, including the preparation of grossly negligent financial forecasts for the operation of VALLEY GOLD.” ¶ 37. The Complaint alleges that Genske, with Vieira and Cary, “acted in an advisory capacity with regard to CVD’s investment in VALLEY GOLD, and the individual investments made in VALLEY GOLD” by Plaintiffs. ¶ 38.

Downey is alleged to have been “retained by CVD and/or VALLEY GOLD, particularly to take the lead in preparing a prospectus for the offering of securities for VALLEY GOLD and thereafter in creating a (blatantly illegal) proposal for Plaintiffs to forego payment for milk supplied to VALLEY GOLD in exchange for worthless additional ownership interests in VALLEY GOLD — at a time when it should have been clear to defendants that GEORGE VIEIRA’s plans for VALLEY GOLD were destined to fail.” ¶ 40.

B. GOVERNING STANDARDS.

A motion to dismiss under Rule 12(b)(6) tests the sufficiency of the complaint. Navarro v. Block, 250 F.3d 729, 732 (9th Cir.2001). Dismissal of a claim under Rule 12(b)(6) is appropriate only where “it appears beyond doubt that the plaintiff can prove no set of facts in support of his claim which would entitle him to relief.” Conley v. Gibson, 355 U.S. 41, 45-46, 78 S.Ct. 99, 2 L.Ed.2d 80 (1957). Dismissal is wárranted under Rule 12(b)(6) where the complaint lacks a cognizable legal theory or where the complaint presents a cognizable legal theory yet fails to plead essential facts under that theory. Robertson v. Dean Witter Reynolds, Inc., 749 F.2d 530, 534 (9th Cir.1984). In reviewing a motion to dismiss under Rule 12(b)(6), the court must assume the truth of all factual allegations and must construe all inferences from them in the light most favorable to the nonmoving party. Thompson v. Davis, 295 F.3d 890, 895 (9th Cir.2002). However, legal conclusions need not be taken as true merely because they are cast in the form of factual allegations. Ileto v. Glock, Inc., 349 F.3d 1191, 1200 (9th Cir.2003). Immunities and other affirmative defenses may be upheld on a motion to dismiss only when they are established on the face of the complaint. See Morley v. Walker, 175 F.3d 756, 759 (9th Cir.1999); Jablon v. Dean Witter & Co., 614 F.2d 677, 682 (9th Cir.1980). When ruling on a motion to dismiss, the court may consider the facts alleged in the complaint, documents attached to the complaint, documents relied upon but not attached to the complaint when authenticity is not contested, and matters of which the court takes judicial notice. Parrino v. FHP, Inc., 146 F.3d 699, 705-706 (9th Cir.1998).

C. DERIVATIVE ACTIONS.

Genske moves to dismiss the Complaint to the extent that Plaintiffs purport to bring derivative actions on behalf of CVD and Valley Gold.

The Complaint alleges that Defendant CVD “is a non-profit cooperative association ... formed ... pursuant to the provisions of Chapter 1, Division 20 of the California Food and Agricultural Code, the Capper-Volstead Act (7 U.S.C.A. §§ 291-292), and the Cooperative Marketing Act (7 U.S.C.A. § 451, et seq.).” ¶31. It is further alleged that “Defendant CVD, at all times material herein, marketed and brokered Plaintiffs’ product (milk), on Plaintiffs’ behalf, pursuant to CVD’s Bylaws, and statute” and that “[t]his agreement was created pursuant to the terms, conditions, and prevailing rates established by the California Department of Food and Agriculture.” ¶ 32. The Complaint further alleges in pertinent part:

DERIVATIVE RIGHTS

43.As a non-profit cooperative association formed pursuant to the provisions of Chapter 1 of Division 20 of the California Food and Agricultural Code, the Capper-Volstead Act (7 U.S.C.A. §§ 291-292), and the Cooperative Marketing Act (7 U.S.C.A. § 451, et seq.), CVD operates on behalf of and for the benefit of its member dairies, collecting proceeds from the sale of milk for the member dairies, and holding those proceeds in trust and for the benefit of the member dairies. CVD and its managers, consultants and employees thus are fiduciary trustees owing duties of care and loyalty directly to the members of CVD, including Plaintiffs.

44. Moreover, as a non-profit agricultural cooperative association, and pursuant to section 54173 of the California Food and Agricultural Code, CVD acted as the agent for its member dairies in marketing, selling, storing and handling the milk produced by the member dairies; and the directors, officers, consultants and professionals retained by CVD were accordingly subagents, owing direct duties of care and trust to the member dairies, including Plaintiffs.

45. In providing services to CVD, defendants GENSKE-MULDER, CARY, GEORGE VIEIRA and DOWNEY BRAND therefore assumed duties of care and loyalty directly to Plaintiffs, and each of them.

46. In an abundance of caution, however, and to the extent that the claims asserted by Plaintiffs are derivative of the rights of CVD, then Plaintiffs pursue those rights on behalf of CVD and accordingly add CVD as an involuntary party to this lawsuit so that the full rights of CVD can be adjudicated and any recovery distributed, as the Court ultimately deems appropriate, to the members of CVD.

47. CVD continues to be controlled by GEORGE VIEIRA and/or his affiliates and those beholden to his desires, and it would thus be futile for Plaintiffs to make a demand upon CVD or its directors to pursue the relief sought in this lawsuit. Indeed, another group of former CVD member dairies has previously instituted legal proceedings based upon the general criminal scheme described above, and CVD has demonstrated its hostility to its own member dairies and its refusal to hold its managers, consultants, professionals and accountants responsible for their misdeeds and omissions by actively opposing the claims instead of cooperating in securing redress for its members.

48. VALLEY GOLD also continues to be controlled by GEORGE VIEIRA, and it would likewise be futile for Plaintiffs to make a demand upon VALLEY GOLD to pursue the relief sought in this lawsuit. Apart from GEORGE VIEIRA, Plaintiffs know of no person or entity that presently has any control over the operations of VALLEY GOLD.

49. To the extent that the claims asserted by Plaintiffs are derivative of the rights of VALLEY GOLD, then Plaintiffs pursue those rights on behalf of VALLEY GOLD and accordingly add VALLEY GOLD as an involuntary party to this lawsuit so that the full rights of VALLEY GOLD can be adjudicated and any recovery distributed, as the Court ultimately deems appropriate, to the members of VALLEY GOLD.

Plaintiffs point to the allegations in Paragraph 43 of the Complaint:

CVD operates on behalf of and for the benefit of its member dairies, collecting proceeds from the sale of milk for the member dairies, and holding those proceeds in trust and for the benefit of the member dairies. CVD and its managers, consultants and employees thus are fiduciary trustees owing duties of care and loyalty directly to the members of CVD, including Plaintiffs.

Plaintiffs assert that they have alleged derivative claims on behalf of CVD out of an abundance of caution “in the event that we were wrong, and that contrary to our belief, Central Valley Dairymen is treated as a normal corporation for purposes of derivative claims.” Plaintiffs further contend:

The problem with defendants’ [sic] motion is that it seeks to have it both ways. On the one hand, defendants [sic] agree that Central Valley Dairymen cannot sue them (and thus plaintiffs’ cannot sue derivatively on Central Valley Dairymen’s behalf). But on the other hand, they argue that their duties only were to Central Valley Dairymen, and not to the individual plaintiffs.

The law cannot be so fickle that it would wholly deny recourse for a fraud perpetrated on an agricultural cooperative. Of course, if defendants are willing to concede that their duties flowed to the individual plaintiffs, then there is no need for use to present derivative claims on behalf of Central Valley Dairymen. But otherwise, we stand by the pleading that we presented ‘in an abundance of caution.’

Chapter 1, Division 20 of the California Food and Agricultural Code, Sections 54001-54291, pertains to nonprofit cooperative associations. Section 54002 defines the term “association” to mean “any corporation which is organized pursuant to this chapter.” The term “member” “includes members of associations without capital stock and holders of common stock in associations which are organized with shares of stock.” Section 54003. Section 54040 provides:

The General Corporation Law (Division 1 (commencing with Section 100) of Title 1 of the Corporations Code) as added by Chapter 682 of the Statutes of 1975 and as heretofore or hereinafter amended and all powers and rights under such law applies to each association which is organized pursuant to this chapter; except where such provisions are in conflict with or inconsistent with the express provisions of this chapter. For the purposes of associations organized without shares of stock, the members shall be deemed to be ‘shareholders’ as the term is used in the General Corporation Law.

Sections 54081-54083 pertain to Articles of Incorporation; Sections 54111-54122 pertain to Bylaws; Sections 54141-54150 pertain to Directors and Management; Sections 54141-54182 pertain to the powers of the nonprofit cooperative association; and Sections 54231-54239 pertain to members or stockholders. “Nonprofit cooperative associations are similar to private corporations, in that they are distinct and separate entities, and except where specific provisions apply, they are governed by the general corporation law.” 44 Cal.Jur.3d, Marketing Associations, § 5.

These statutory provisions establish that under California law, CVD is treated as a corporation and that Plaintiffs’ contention that CVD is treated as a trust owing fiduciary duties as a trustee to its members is legally unsustainable.

California Corporations Code § 800 pertains to shareholder derivative actions. Section 800(a) defines the term “corporation” to include “an unincorporated association”; the term “board” to include “the managing body of an unincorporated association”; the term “shareholder” to include “a member of an unincorporated association”; and the term “shares” to include “memberships in an unincorporated association”. “The statute dealing with derivative actions by corporate shareholders, by defining ‘corporation’ to include an unincorporated association and ‘shareholder’ to include a member of an unincorporated association, is applicable to actions brought by members of unincorporated associations.” 7 Cal.Jur.3d, Associations and Clubs, § 56; see also Harl, 14 Agricultural Law, § 131.06[3].

Although no California case involving a derivative action on behalf of a member or shareholder of a nonprofit cooperative association within the meaning of the relevant provisions of the Food and Agricultural Code was discovered through independent research, by express statutory provision, CVD is treated as a corporation under California law and its members may bring a derivative action on its behalf of the cooperative if they allege compliance with the requirements of the California Corporations Code.

Corporations Code § 800(b) provides:

No action may be instituted or maintained in right of any domestic ... corporation by any holder of shares or of voting trust certificates of the corporation unless both of the following conditions exist:

(1) The plaintiff alleges in the complaint that plaintiff was a shareholder, of record or beneficially, or the holder of voting trust certificates at the time of the transaction or any part thereof of which plaintiff complains or that plaintiffs shares or voting trust certificates thereafter devolved upon plaintiff by operation of law from a holder who was a holder at the time of the transaction or any part thereof complained of; provided, that any shareholder who does not meet these requirements may nevertheless be allowed in the discretion of the court to maintain the action on a preliminary showing to and determination by the court, by motion and after a hearing, at which the court shall consider such evidence, by affidavit or testimony, as it deems material, that (i) there is a strong prima facie case in favor of the claim asserted on behalf of the corporation, (ii) no other similar action has been or is likely to be instituted, (iii) the plaintiff acquired the shares before there was disclosure to the public or to the plaintiff of the wrongdoing of which plaintiff complains, (iv) unless the action can be maintained the defendant may retain a gain derived from defendant’s willful breach of a fiduciary duty, and (v) the requested relief will not result in unjust enrichment of the corporation or any shareholder of the corporation; and (2) The plaintiff alleges in the complaint with particularity plaintiffs efforts to secure from the board such action as plaintiff desires, or the reasons for not making such effort, and further alleges that plaintiff has either informed the corporation or the board in writing of the ultimate facts of each cause of action against each defendant or delivered to the corporation or the board a true copy of the complaint which plaintiff proposes to file.

Rule 23.1, Federal Rules of Civil Procedure, provides:

In a derivative action brought by one or more shareholders or members to enforce a right of a corporation or of an unincorporated association, the corporation or association having failed to enforce a right which may properly be asserted by it, the complaint shall be verified and shall allege (1) that the plaintiff was a shareholder or member at the time of the transaction of which the plaintiff complains or that the plaintiffs share or membership thereafter devolved on plaintiff by operation of law, and (2) that the action is not a collusive one to confer jurisdiction on a court of the United States which it would not otherwise have. The complaint shall also allege with particularity the efforts, if any, made by the plaintiff to obtain the action the plaintiff desires from the directors or comparable authority and, if, necessary, from the shareholders or members, and the reasons for the plaintiffs failure to obtain the action or for not making the effort. The derivative action may not be maintained if it appears that the plaintiff does not fairly and adequately represent the interests of the shareholders or members similarly situated in enforcing the right of the corporation or association. The action shall not be dismissed or compromised without the approval of the court, and notice of the proposed dismissal or compromise shall be given to shareholders or members in such manner as the court directs.

A shareholder seeking to vindicate the interests of a corporation through a derivative suit must first demand action from the corporation’s directors or plead with particularity the reasons why such demand would have been futile. In re Silicon Graphics Inc. Sec. Litig., 183 F.3d 970, 989 (9th Cir.1999). Rule 23.1, however, does not establish the circumstances under which demand would be futile. See Kamen v. Kemper Fin. Serv., Inc., 500 U.S. 90, 96, 111 S.Ct. 1711, 114 L.Ed.2d 152 (1991). The law of the state of incorporation determines these standards. In re Silicon Graphics, id. at 990.

Genske argues that the Complaint fails to allege that Plaintiffs made a demand on CVD or Valley Gold to assert the claims alleged and that the Complaint at Paragraphs 47-48 makes only the most cursory allegations that CVD and Valley Gold continue to be controlled by Vieira and, thus, a demand is excused by Section 800(b)(2).

As explained in Country National Bank v. Mayer, 788 F.Supp. 1136, 1144 (E.D.Cal.1992):

A derivative action is a suit brought on behalf of a corporation in order to redress a grievance suffered by the corporation ... Under California law, such an action ordinarily must be instituted by the directors of the corporation ... The so-called ‘business judgment rule’ provides that the judgment of shareholders and courts cannot supplant the decisions of the directors of a corporation relative to the day-to-day management of the corporation ... ‘Under this rule, a director is not liable for a mistake in business judgment which is made in good faith and in what he or she believes to be the best interests of the corporation, where no conflict of interest exists.’ ....

‘The business judgment rule applies to all discretionary decisions by the board, including the decision not to pursue a cause of action.’ ... Because of the rule, a shareholder must plead and prove that he has made a demand upon the directors to act and that they refused or failed to act ... If the board refuses in good faith and in the reasonable exercise of its business judgment to commence the action, the shareholder may not institute the action.

Plaintiffs argue that the Complaint adequately alleges that compliance with the demand requirement of Section 800 would have been futile with regard to CVD and Valley Gold. Plaintiffs cite Reed v. Norman, 152 Cal.App.2d 892, 898, 814 P.2d 204 (1957):

While it is the general rule that in a derivative action the plaintiff must plead a demand upon and refusal by the directors to act, it is equally well settled that such demand and refusal need not be alleged if the facts pleaded demonstrate such a demand would have been futile.

Judge Karlton in Country National Bank explains:

The precomplaint demand requirement may be excused when the plaintiff demonstrates that demand would be ‘futile’ ... Many decisions by the California courts interpreting the futility exception to the demand requirement are of little assistance in disposing of the matter at bar since they discuss the substantive requirements in light of California’s pleading standard. Nonetheless, upon close examination of California decisions, certain standards emerge. Without question, futility is demonstrated under California’s substantive law where the directors are involved or not disinterested in the actions for which plaintiff seeks relief ... Moreover, a case which preceded California’s current pleading requirement reveals that allegations of domination of the board by a president of a corporation who is adverse to plaintiffs position suffice to demonstrate futility. See Wickersham v. Crittenden, 106 Cal. 329[, 39 P. 603] ... (1895)(it was ‘averred in the complaint, as a reason for not making a request of the directors of the bank to bring this action that the directors were all under the control of Crittenden and acting in conjunction with him’); see also Miles v. McFarlane, 104 Cal.App. 513, 519[, 286 P. 507] ... (1930)(demand futile where plaintiff alleges corporation is in hands of hostile representative). When demand is excused, the court suspends deference to the directors’ business judgment because the board as a unit is unable to fulfill its role as the corporation’s decisionmaker.

788 F.Supp. at 1144-1145.

In Shields v. Singleton, 15 Cal.App.4th 1611, 1622, 19 Cal.Rptr.2d 459 (1993), the Court of Appeals explained:

[T]he general allegations which plaintiff here indiscriminately levels against all the directors of the Company are insufficient to establish that demand on the board would have been futile. As the court below noted, in order to evaluate the demand futility claim, the court must be apprised of facts specific to each director from which it can conclude that that particular director could or could not be expected to fairly evaluate the claims of the shareholder plaintiff. ‘The task of demanding action ... is not onerous. No policy recommends eviscerating the demand requirement as plaintiff would have us do.’ (Greenspun v. Del E. Webb Corp. (9th Cir.1980) 634 F.2d 1204, 1210).

The allegations in Paragraph 48 concerning the futility of a demand on Valley Gold satisfy the requirements of California law and Rule 23.1. It is alleged that Valley Gold is controlled by Defendant Vieira and that “Plaintiffs know of no other person or entity that presently has any control over the operations of VALLEY GOLD.”

However, the allegations in Paragraph 47 do not satisfy the requirements of California law and Rule 23.1 concerning futility. The allegations are conclusory. Plaintiffs must allege with specificity facts with regard to each director of CVD from which it may be inferred that the particular director could or could not be expected to fairly evaluate the claims that Plaintiffs seek to prosecute in a derivative action on behalf of CVD, and Plaintiffs must describe with more particularity the lawsuit allegedly brought by other members of CVD which CVD allegedly actively opposed.

The motion to dismiss the Complaint to the extent that Plaintiffs purport to bring derivative actions on behalf of CVD is GRANTED WITH LEAVE TO AMEND.

D. SECOND CAUSE OF ACTION FOR SECURITIES FRAUD.

The Second Cause of Action is alleged by Plaintiffs individually and on behalf of CVD against Genske, Downey, Cary, Valley Gold, Vieira and Does 21 through 40. After incorporating all preceding allegations, the Second Cause of Action alleges that these Defendants prepared a prospectus in late April 2003 that was used to market and sell security interests in Valley Gold, including to Plaintiffs. ¶ 63. The “prospectus”, which is captioned “Valley Gold, LLC Business Plan”, is attached to the Complaint as Exhibit A. Defendants are alleged to have also prepared an Offering Memorandum that was provided to potential investors. The Offering Memorandum, captioned “Confidential Private Offering Memorandum” is attached to the Complaint as Exhibit B. Id. The interests procured from Plaintiffs in the form of membership interests in Valley Gold are alleged to constitute securities within the meaning of the Securities Act of 1933 and the Securities Exchange Act of 1934 “because Plaintiffs were induced to invest their money (and later their rights to payment for milk) into a common enterprise from which they expected to earn profits through the efforts and acumen of others, namely GEORGE VIEIRA and the other officers and employees of VALLEY GOLD.” ¶ 64. Defendants are alleged to have been “sellers” within the meaning of the Securities Act of 1933 and the Securities Exchange Act of 1934,

65. ... because the injury suffered by Plaintiffs by purchasing security interests in VALLEY GOLD flowed directly and proximately from the actions and representations of these defendants. These defendants also actively participated in the sale of ownership interests in VALLEY GOLD to Plaintiffs and were motivated by a desire to serve their own financial interests. GEORGE VIEIRA was motivated to secure the income from being an employee and the managing member of VALLEY GOLD as well as from his plan to use VALLEY GOLD as a vehicle to continue the fraudulent Round-Tripping transactions that he had so lucratively engaged in with the criminal RICO enterprise discussed above. GENSKE-MULDER was motivated by its anticipation of securing income as a paid consultant and as the primary accounting firm for VALLEY GOLD — an anticipation that was cemented by the close relationship between GEORGE VIEIRA and equity partners of GENSKE-MULDER. Defendant DOWNEY BRAND was motivated by the anticipation and promise that it would be attorneys for and be paid for the rendition of legal services to VALLEY GOLD and because GEORGE VIEIRA was using the funds of CVD to pay for the services in forming and soliciting investors for VALLEY GOLD, a payment source that could only be justified as a legitimate business expense for CVD if VALLEY GOLD was successfully formed, launched and sufficiently funded to begin operations.

66. In addition to the purchases of VALLEY GOLD as part of its initial formation, in or about late September of 2003, defendants GEORGE VIEIRA, GENSKE-MULDER, CARY and DOES 41 through 50 also induced Plaintiffs and CVD to enter into illegal and unlawful agreements to exchange milk (or accounts receivable owed to them for milk) for additional equity ownership interests in VALLEY GOLD.

67. The reason the “milk for equity” contracts were illegal and unlawful is because California Food and Agricultural Code sections 62191, 62196 and 62200 require (a) that milk producers be paid for milk solely in cash or with checks that are reduceable to cash in no more than one business day; (b) that payment be made in very short time periods (roughly 15 days); and (c) that failing to abide by these requirements and endeavoring to use any other payment arrangement is an unlawful business practice.

68. In inducing Plaintiffs to enter into contracts to exchange milk for equity (in the general form of the contribution agreement attached hereto as Exhibit C and the assignment agreement attached hereto as Exhibit D), defendants GEORGE VIEIRA, GENSKEMULDER [sic], CARY and DOES 41 through 50 falsely represented to Plaintiffs:

(a) that the contracts were proper and lawful;

(b) that CVD was contractually required to supply milk to VALLEY GOLD and if Plaintiffs stopped supplying their milk to CVD and switched to another agricultural cooperative, they would be violating the law and subject to substantial fines and penalties;

(c) that VALLEY GOLD was doing well and had sizeable orders that ensured that Plaintiffs would earn significantly more from their increased ownership in VALLEY GOLD than they were owed for their milk.

69. These representations were false, and were made be [sic] defendants in order to induce Plaintiffs and CVD to purchase additional equity ownership interests in VALLEY GOLD in exchange for milk.

70. Defendants GEORGE VIEIRA, CARY, GENSKE-MULDER, DOW-NEY BRAND and DOES 21 through 40 were also “sellers” within the meaning of the Securities Act of 1933 and the Securities Exchange Act of 1934 because they actively solicited Plaintiffs to purchase interests in VALLEY GOLD.

71. In violation of the Securities Act of 1933, the Securities Exchange Act of 1934, Exchange Act Rule 10b-5 enacted under the regulatory authority of the Securities and Exchange Commission and the Sarbanes-Oxley Act of 2002, the prospectus and the Offering Memorandum and the related materials and communications supplied by these defendants to Plaintiffs, including the materials used to induce plaintiffs to enter into the “milk for equity” contracts, contained material misrepresentations and omissions of material facts that caused the communications to Plaintiffs to be materially misleading, and constituted a fraudulent and deceitful manipulation and contrivance of the regulatory requirements enacted under the Federal Securities laws for the protection of parties like Plaintiffs.

72. The prospectus and the Offering Memorandum and the related materials and communications supplied by these defendants to Plaintiffs, including the materials used to induce plaintiffs to enter into the “milk for equity” contracts contained, [sic] served as manipulative and deceptive devices and contrivances intended to contravene the rules and regulations of the Securities and Exchange Commission as necessary and appropriate for the protection of investors, and thus violated section 10(b) of the Securities Exchange Act of 1984 (15 U.S.C. § 783(b).)

73. Plaintiffs purchased securities in VALLEY GOLD, both individually and through CVD, in direct reliance upon the misleading, false, incomplete and deceptive prospectus and Offering Memorandum and related communications supplied by these defendants, including the materials used to induce plaintiffs to enter into the “milk for equity” contracts, aquicint [sic] securities in VALLEY GOLD directly from VALLEY GOLD as the issuer of the securities.

74. Among other material misrepresentations and material omissions of material facts, these materials:

a.Stressed that VALLEY GOLD’S success was dependent upon the unique “experience and abilities of Mr. [George] Vieira [and two associates]” without disclosing that Mr. Vieira’s unique experience was not formed in the successful production of cheese products, but rather in the concoction of fictitious cheese products and cheese diluted with starch fillers manufactured not for commercial success with consumers, but rather to inflate the apparent inventory value and sales volume of a by then bankrupt cheese manufacturer, for the sole purpose of perpetuating a hundreds of million dollar securities fraud on securities investors situated similarly to Plaintiffs;

b. Disclosed that Mr. Vieira had been contacted by the U.S. Attorney’s Office as part of its investigation into the bankruptcy of Suprema Specialties, Inc., without disclosing that GEORGE VIEIRA was already actively involved in negotiations with the United States Attorney’s Office to plead guilty to securities and bank fraud;

c. Failed to disclose that VALLEY GOLD was unbonded and not qualified to participate in the Milk Producers Trust Fund, which was a standard requirement for securing reliable supplies of milk product — necessary for legitimate cheese production facilities (but less important for sham facilities organized to fleece investors and banks without ever achieving commercial success);

d. Failed to disclose that if Plaintiffs became investors in VALLEY GOLD, their supplies of milk to VALLEY GOLD would in any event fail to qualify for the protections of the Milk Producers Trust Fund;

e. Included financial projections supplied by GENSKE-MULDER that vastly exceeded the performance of any startup cheese manufacturer, with the possible exception of Suprema Specialties, Inc., whose dramatic reported growth was by then known in the financial community (but not to Plaintiffs) to have been the result of smoke, mirrors and a fraudulent Round-Tripping scheme orchestrated by a criminal enterprise headquartered in New Jersey.

75. Plaintiffs are informed and believe, and thereon allege, that GENSKE-MULDER, GEORGE VIEIRA and DOWNEY BRAND and DOES 21 through 40 all actively collaborated on preparing the prospectus and the Offering Memorandum that was supplied to Plaintiffs and that were instrumental in inducing Plaintiffs and CVD to purchase initial equity interests in VALLEY GOLD. Indeed, Plaintiffs have very recently discovered that some or all of these defendants participated in meetings and electronic communications to discuss the best way to conceal from Plaintiffs and CVD that GEORGE VIEIRA had, one month earlier, reached an agreement with the office of the United States Attorney to plead guilty to securities fraud and to a conspiracy to commit bank and mail fraud— the active criminal conspiracy centered on the Round-Tripping scheme that led to the collapse of Suprema Specialties, Inc. and its subsidiaries.

76. The terms of the negotiated plea bargain were spelled out in a seven-page letter dated March 28, 2003 from the U.S. Attorney’s Office to GEORGE VIEIRA’s attorney. And the plea deal (that was formally entered on January 4, 2004), barred GEORGE VIEIRA from acting as an officer or director of any company issuing registered securities under the Securities Exchange Act of 1934.

77. In the prospectus, however, defendants disclosed none of this vital information. Indeed, in the prospectus, defendants pretended that the implosion of Suprema Specialties, Inc. and its subsidiaries provided an advantage for the proposed business of VALLEY GOLD because as “one of the larger producers of ricotta in the state” a market void and thus a market opportunity was created when “Suprema Specialties, Inc. ceased operations in 2002.” The prospectus failed to mention that Suprema Specialties ceased business because its fraudulent practices, inflated sales and falsified inventory forced it into bankruptcy; and the prospectus failed to mention that as much as 87% of the purported cheese production by Suprema Specialties that led defendants to characterize it as a large producer was fictitious, as reported by the Securities and Exchange Commission’s investigation.

78. The Offering Memorandum provided a brief disclosure concerning Supre-ma Specialties’ bankruptcy, but did so in a way to minimize the importance of the information and in a manner that created the impression that GEORGE VIEIRA’s sole involvement with Supre-ma Specialties occurred because he “was, for a short period of time, an officer of Suprema West, Inc .... a subsidiary of Suprema Specialties, Inc.” The Offering Memorandum did not disclose that GEORGE VIEIRA was not just any officer, but was the Chief Operating Officer and was thus directly responsible for fraudulent financial transactions that government officials were investigating. The Offering Memorandum also did not disclose that GEORGE VIEIRA had reached an agreement with the United States Attorney’s Office to plead guilty to securities fraud and conspiracy to commit bank and mail fraud. And the Offering Memorandum did not disclose that in addition to being an officer of Suprema Specialties West, Inc., GEORGE VIEIRA and his wife MARY VIEIRA were also officers and owners of CMM, which was also a subject of the criminal investigation as well as a probable broker for any cheese produced by VALLEY GOLD.

79. The Offering Memorandum stated at page 7 that VALLEY GOLD was negotiating with a “cheese distributor in New Jersey” to produce substantially all of VALLEY GOLD’S production for its first two years. The Offering Memorandum then stated that the negotiations had resulted in a contract, and that “the total amount of cheese to be purchased under this contract [is estimated] to be between 14 and 25.5 million pounds.” The Offering Memorandum further disclosed that if the New Jersey distributor “for any reason [could] not fulfill its commitment to purchase the Company’s product, there is no assurance that the Company would be able to find an immediate customer ... and such a disruption could have a material adverse effect on the Company’s business, operations and finances.”

80. Plaintiffs are informed and believe, and thereon allege, that the New Jersey Cheese Distributor referred to in the Offering Memorandum was either Bat-taglia & Company, Inc. or Packing Products, Inc., companies owned and operated by Robert Quattrone, all being members of the criminal RICO enterprise, and all being under active investigation by the United States Attorney’s Office and the Securities and Exchange Commission. Indeed, Robert Quattrone pled guilty to securities fraud and conspiracy to commit bank and mail fraud at the same time in the same court and on the same day as GEORGE VIEIRA, and Plaintiffs are informed and believe, and thereon allege, that the plea terms had, as with GEORGE VIEIRA, been finalized in March of 2004, before the Offering Memorandum was prepared.

81. Despite mentioning that a “contract” and “commitment” had been reached with the New Jersey distributor, the Offering Memorandum failed to disclose the identity of that distributor. Plaintiffs are informed and believe that this omission was the result of a deliberate choice by defendants GENSKE-

MULDER, GEORGE VIEIRA, DOW-NEY BRAND and DOES 21 through 40 to conceal the true nature of the government’s investigation, the plea deals that had been negotiated, and the near certainty that the result of Mr. Quattrone’s plea deal would bar him from distributing any cheese produced by VALLEY GOLD, all of which were material and adverse facts that, if disclosed, would have caused Plaintiffs and CVD to elect not to invest in VALLEY GOLD.

82.In addition, and beginning in or about March of 2003, Defendants GEORGE VIEIRA with the assistance of GENSKE-MULDER and DOES 21 through 40, and knowing these representations to be false and with the intent to deceive the Plaintiffs, and to induce them into investing in VALLEY GOLD, further falsely and fraudulently represented to the Plaintiffs that:

(a) CVD had suffered financial difficulty and had defaulted on obligations to pay Plaintiffs for milk because there were limited markets for CVD’s milk (when in reality, the reason CVD had suffered financially was because of the Round-Tripping scheme and the churning of commissions by CMM);

(b) By investing in the formation of VALLEY GOLD, Plaintiffs and CVD would solve the problem of limited demand for CVD’s milk because VALLEY GOLD would purchase the bulk of CVD’s milk and process it into cheese, for which there was purportedly a strong market demand (when in reality, the apparent market demand for cheese was materially distorted by the Round-Tripping scheme and the fictitious cheese sales publicly reported by Suprema Specialties, Inc. and its subsidiaries, and the purported demand for cheese from the unnamed New Jersey distributor was illusory);

(c) GEORGE VIEIRA was a “hands-on” owner of VALLEY GOLD;

(d) GEORGE VIEIRA was “Chief Operating Officer” and was going to be responsible for the day-to-day management of VALLEY GOLD;

(e) VALLEY GOLD committed itself to selling only to reputable buyers with solid financial standing;

(f) GEORGE VIEIRA could use his contacts to “sell more cheese than VALLEY GOLD could ever produce”;

(g) With the ownership of VALLEY GOLD, Plaintiffs MANUEL LOPES, MARIANA LOPES, JOSEPH LOPES and RAYMOND LOPES would “hold all the keys to financial success”;

(h) VALLEY GOLD would not need to invest excessive resources to make the plant operable;

(i) VALLEY GOLD would make payments for milk received (from Plaintiffs MANUEL LOPES, MARIANA LOPES, JOSEPH LOPES and RAYMOND LOPES):

1. In accordance with the announced in-plant usage and pricing at the time of delivery

2. Producer payments would be made on or before the 28th day of the month for milk received during the first 15 days of the month, and on the 13th day of the month for milk received during the remainder of the month;

(j) Milk payments were dictated by the State of California and, as such, not negotiable;

(k) “By having owners that live in short proximity to the plant and with one of the owners (GEORGE VIEIRA) being the Chief Operating Officer, the personnel at VALLEY GOLD will see first hand the company’s commitment to quality”

(l) MANUEL LOPES, MARIANA LOPES, JOSEPH LOPES and RAYMOND LOPES’ individual ownership would not be diluted by allowing fellow members or others to contribute capital monies at any time; and

(m) In the event that VALLEY GOLD needed additional capital, it would offer additional ownership interest to existing members, first, and all other (outside) parties, second.

83. Defendants also actively encouraged Plaintiffs to invest individually in VALLEY GOLD and to agree to CVD’s investment in VALLEY GOLD, while the Defendants knew of GEORGE VIEIRA’s criminal activities outlined above. In addition, VALLEY GOLD never intended to and never committed itself to selling only to reputable buyers with solid financial standing. Instead, VALLEY GOLD dealt with members of the criminal RICO enterprise manipulated by GEORGE VIEIRA and with which he was affiliated, and whom Defendants knew were incapable of paying for millions of dollars worth of VALLEY GOLD cheese.

84. Further, GEORGE VIEIRA’s negative and toxic reputation in the cheese industry, which should have been disclosed to the investors, made it difficult for VALLEY GOLD to market and sell its cheese, and it made it difficult to obtain financing and quickly led to VALLEY GOLD’S collapse.

85. Plaintiffs were never aware of any facts that made them suspicious of the veracity of Defendants’ representations, and did not begin to discover the fraud, deceit and misrepresentations of Defendants as herein alleged until less than one year ago.

86. Plaintiffs only purchased equity interests in VALLEY GOLD because of the false and misleading representations contained in the prospectus and the Offering Memorandum and the accompany [sic] false and misleading statements and omissions of defendants GEORGE VIERRA [sic] and GENSKE-MULDER and DOES 21 through 40. Further, Plaintiffs only consented to allow CVD to purchase equity interests, and CVD only purchased equity interests in VALLEY GOLD because of the false and misleading representations contained in the prospectus, the Offering Memorandum and the accompany [sic] false and misleading statements and omissions of defendants GEORGE VIERRA [sic] and GENSKE-MULDER and DOES 21 through 40. Those equity interests are now worthless.

87. As a result of defendants’ violations of the Federal Securities Laws, including the Securities Act of 1933, the Securities Exchange Act of 1934, Exchange Act Rule 10b-5 enacted under the regulatory authority of the Securities and Exchange Commission and the Oxley Sarbanes-Oxley Act of 2002, Plaintiffs have incurred damages by investing millions of dollars into a doomed enterprise and supplied millions more in milk to that enterprise&emdash;milk for which plaintiffs have not been paid, resulting in damages to Plaintiffs in a sum exceeding several million dollars.

1. SECTION 12 OF THE SECURITIES ACT OF 1933, 15 U.S.C. § 771(a) (2).

Defendants argue that the Second Cause of Action does not state a claim upon which relief can be granted under Section 12 of the Securities Act of 1933 because the Complaint does not allege that the securities were sold to Plaintiffs in a public offering.

Section 12(a)(2) of the Securities Act, 15 U.S.C. § 77i(a)(2), provides in pertinent part:

Any person who ... offers or sells a security ... by the use of any means or instruments of transportation or communication in interstate commerce or of the mails, by means of a prospectus or oral communication, which includes an untrue statement of a material fact or omits to state a material fact necessary in order to make the statements in light of the circumstances under which they are made, not misleading (the purchaser not knowing of such untruth or omission), and who shall not sustain the burden of proof that he did not know, and in the exercise of reasonable care could not have known, of such untruth or omission, shall be liable ... to the person purchasing such security from him, who may sue either at law or in equity in any court of competent jurisdiction, to recover the consideration paid for such security with interest thereon, upon the tender of such security, or for damages if he no longer owns the security.

In Gustafson v. Alloyd Co., 513 U.S. 561, 115 S.Ct. 1061, 131 L.Ed.2d 1 (1995), the Supreme Court considered specifically the question of whether Section 12(a)(2)’s right of rescission “extends to a private, secondary transaction, on the theory that recitations in the purchase agreement are part of a ‘prospectus.’ ” Id. at 564, 115 S.Ct. 1061. In interpreting the term “prospectus” as used in Section 12, the Supreme Court looked to Section 2(a)(10) of the Securities Act, 15 U.S.C. § 77b(a)(10), which defines a “prospectus,” and Section 10 of the 1933 Act, 15 U.S.C. § 77j, which sets forth the information which must be contained in a prospectus. The Supreme Court ruled that a “prospectus” must have the same meaning in both Sections 10 and 12 and that “the term ‘prospectus’ refers to a document soliciting the public to acquire securities.” Id. at 574, 115 S.Ct. 1061. The Supreme Court ruled:

[T]he word ‘prospectus’ is a term of art referring to a document that describes a public offering of securiti