Friese v. Superior Court
2005 Daily Journal DAR 13852, 134 Cal. App. 4th 693, 36 Cal. Rptr. 3d 558 (2005)
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Rule of Law:
California's insider trading disgorgement statute (Corporations Code section 25502.5), which is part of the Corporate Securities Law of 1968, applies to officers and directors of a foreign corporation whose principal place of business is in California, as it serves broad public and regulatory interests in protecting the state's securities marketplace and deterring unlawful conduct, thus falling outside the purview of the internal affairs doctrine.
Facts:
- Peregrine Systems, Inc. (Peregrine) was a publicly traded Delaware corporation with its headquarters and principal place of business in San Diego, California.
- Peregrine's board of directors adopted a "sell-in" accounting method to record revenue, despite an admonition from its chief financial officer that it was not a preferred method.
- Peregrine's public announcements and Securities and Exchange Commission filings failed to disclose its use of the "sell-in" method and that without it, earlier revenue expectations would not have been met, contributing to a reported 123% increase in revenue in 1999.
- Between April 29, 1999, and February 28, 2001, former officers and directors of Peregrine (defendants) collectively sold over 10 million Peregrine shares, receiving approximately $299 million in proceeds.
- During this period, defendants allegedly failed to disclose critical information, including that indirect sales exceeded auditor maximums, intermediaries were unable to sell inventory, direct sales were low, and Peregrine was negotiating a merger likely to be negatively received by investors.
- In May 2002, Peregrine announced an internal investigation into potential accounting irregularities and the resignation of its chief executive officer, causing its stock price to drop 87% to 89 cents per share.
- Peregrine subsequently initiated bankruptcy proceedings, canceling its common stock and costing shareholders approximately $4 billion in equity; a restatement of revenue revealed over $500 million in overstated profits between April 1999 and December 2001.
- Robert C. Friese (the trustee) is the successor in interest to Peregrine and seeks to recover insider trading profits from the defendants.
Procedural Posture:
- Robert C. Friese (the trustee), as successor in interest to Peregrine Systems, Inc., filed a complaint in California superior court against former officers and directors of Peregrine (defendants), alleging violations of California insider trading laws (Corporations Code sections 25402 and 25502.5), among other claims.
- Defendants filed demurrers to the trustee's insider trading causes of action.
- The trial court sustained defendants' demurrers without leave to amend, concluding that Corporations Code section 2116 and the internal affairs doctrine precluded the application of section 25502.5 to the securities sales.
- The trustee filed a petition for writ of mandate with the California Court of Appeal, Fourth Appellate District.
- The Court of Appeal issued an order to show cause on the trustee's petition.
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Issue:
Does the internal affairs doctrine, as codified in California Corporations Code section 2116, preclude the application of California's insider trading disgorgement statute (Corporations Code section 25502.5) to former officers and directors of a Delaware corporation doing business in California, where the alleged insider trading occurred?
Opinions:
Majority - Benke, Acting P. J.
No, the internal affairs doctrine does not prevent the trustee from bringing claims against the defendants under California Corporations Code section 25502.5. The court reasoned that California's Corporate Securities Law of 1968, which includes section 25502.5, is designed to protect participants in California's securities marketplace and deter unlawful conduct occurring within the state, rather than to regulate the internal governance of a corporation. The court emphasized that California's securities laws have historically applied to foreign corporations doing business in the state or whose activities impact its securities markets, citing precedents such as Williams v. Gaylord (1902) and Western Air Lines, Inc. v. Sobieski (1961). It highlighted that section 25502.5 is a remedy for the insider trading prohibition in section 25402, serving broad public interests in maintaining investor confidence and punishing immoral conduct, which are distinct from protecting a corporation's narrow shareholder interests. The statute's allowance for treble profits further reinforces its deterrent purpose. The court distinguished the internal affairs doctrine, codified in section 2116, as typically applying to matters like dividends and bylaws, but not to 'blue sky laws' (securities regulations), an exception recognized by the Restatement Second of Conflict of Laws. The court found In re Sagent Technology, Inc. Derivative Litigation unpersuasive because it failed to consider this history and purpose.
Analysis:
This case clarifies the reach of state-level securities regulation, particularly in the context of insider trading by officers of foreign corporations with significant operations in the forum state. It establishes that 'blue sky laws' like California's anti-insider trading statutes serve broad public and regulatory interests beyond mere internal corporate governance, thus rendering the internal affairs doctrine inapplicable. This decision reinforces California's ability to protect its securities markets and investors, preventing foreign corporations from using their state of incorporation as a shield against accountability for unlawful conduct occurring within California. It has significant implications for officers and directors of any corporation, regardless of where it is incorporated, who conduct business and engage in securities transactions within California.
