Shaper v. Zadek

Background

Judith S. Shaper and the Judith S. Shaper Living Trust sued Robert A. Zadek, L.O. Annie, Inc., and Lenders Funding LLC. The plaintiffs alleged that the defendants solicited and received about $4 million through promissory notes. They claimed the notes were securities under federal and California law, that the defendants sold them without required registration, and that the defendants made material misrepresentations or omitted material facts. The plaintiffs also asserted state-law tort and contract claims.

The plaintiffs alleged, among other things, that Zadek described the investments as safe and secure and said Shaper could get her money back at any time, even though the notes were subordinated to senior debt and generally provided for payment of principal after 180 days from demand. They also alleged that the defendants failed to disclose investment risks, the subordination provisions, financial information, and information about the financial condition of borrowers. After the plaintiffs demanded repayment in March 2020, the defendants allegedly did not return all funds.

Federal securities claims

The court analyzed whether the promissory notes could qualify as securities under the framework from Reves v. Ernst & Young. That framework considers the parties’ motivations, the plan for distributing the notes, investors’ reasonable expectations, and whether another factor reduced the notes’ risks. The court concluded that the allegations were sufficient at the pleading stage to support the legal conclusion that the notes could be securities, although the factors did not clearly resolve the issue.

The court nevertheless dismissed each federal claim for other pleading deficiencies:

- Investment Advisers Act claim: The plaintiffs did not adequately allege that the defendants were in the business of giving investment advice or that they were paid for such advice. The court dismissed this claim with prejudice because the defendants had previously identified the deficiency and the plaintiffs had not added supporting allegations after receiving permission to amend. - Broker-dealer registration claim: The court concluded that the defendants issued the notes for their own account, not for the account of others, and that the plaintiffs had not plausibly alleged that the defendants were in the business of buying and selling securities. The court dismissed this claim with prejudice for the same reasons stated for the investment-adviser claim. - Section 10(b) and Rule 10b-5 claim: The court rejected the defendants’ argument that the alleged misrepresentations and omissions lacked sufficient detail. But it agreed that the plaintiffs had not pleaded facts creating a strong inference that the defendants acted with an intent to defraud or reckless disregard for the truth. The court also concluded that the plaintiffs had not adequately shown that the 2019 amendments caused their alleged injury, because the earlier notes already subordinated their interests to senior lenders. The court dismissed this claim with prejudice.

State-law claims and disposition

The court stated that the federal securities claims were the federal claims in the case. After dismissing those claims with prejudice, the court declined to exercise supplemental jurisdiction—the authority to hear related state-law claims—over the remaining state claims under 28 U.S.C. § 1367(c)(3). The opinion does not state that the state-law claims were dismissed with or without prejudice; it states that the court declined supplemental jurisdiction over them.

The order granted the defendants’ motion to dismiss in part, dismissed the federal securities claims with prejudice, directed the clerk to enter final judgment, and closed the file. Judge Edward M. Chen signed the order.