On September 23, 2013, Governor Jerry Brown signed into law
Senate Bill 538—which overhauls the anti-fraud provision of
the California Securities Law of 1968, and will likely make it more
difficult for would-be plaintiffs to maintain lawsuits for
securities fraud.
Specifically, SB 538 revises California Corporations Code §
25401 to make it unlawful, in connection with the offer, sale, or
purchase of a security, to: (a) employ a device, scheme, or
artifice to defraud; (b) make an untrue statement of a material
fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which they
were made, not misleading; and (c) engage in an act, practice, or
course of business that operates or would operate as a fraud or
deceit upon another person.1
In its historic form, the statute did not include clauses (a) and
(c).2 According to bill sponsor Senator Jerry Hill (San
Mateo County), the changes were intended to bring California's
anti-fraud provision in line with federal law.3 And,
indeed, the U.S. Securities and Exchange Commission's Rule
10b-5—an essential anti-securities fraud rule promulgated
under Section 10(b) of the Securities Exchange Act of 1934—is
fundamentally identical to the modified California
statute.4
Interestingly, however, the original version of § 25401 was
already based on federal law.5 Section 12(a)(2) of the
Securities Act of 1933 creates liability for any person who offers
or sells a security through a prospectus or an oral communication
containing a material misstatement or
omission6—virtually the same as clause (b), which
more or less survived the recent rewrite of § 25401, with the
exception that clause (b) also imposes liability on buyers and
those who offer to buy.
To sue under Section 12(a)(2) and the previous version of §
25401, a plaintiff in a civil case would not have to allege that
the defendant made a material misstatement or omission
intentionally or negligently.7 Similarly, a plaintiff
would not have to allege that he or she relied on the misstatement
or omission when determining whether to buy or sell a security, or
that there was a causal connection between the material
misstatement or omission and any damage suffered.8
Now that the California legislature has remodeled § 25401
based on Rule 10b-5, it stands to reason that courts may interpret
the new version in a way consistent with how the federal courts
have interpreted Rule 10b-5. Unlike for Section 12(a)(2) claims,
plaintiffs bringing a claim under Rule 10b-5 must allege scienter,
reliance, and causation.9 Accordingly, if the California
courts import federal courts' Rule 10b-5 jurisprudence in their
interpretation of the revamped § 25401, they may end up
creating a new pleading hurdle for theoretically aggrieved
investors (and their counsel)—and a ground for demurrer if
plaintiffs do not plead what they must.
Additionally, to the extent that Rule 10b-5 has been interpreted
by the federal courts to impose liability for insider
trading,10 the overhaul of § 25401 may have
rendered somewhat redundant § 25402 of the California
Corporations Code—which itself already prohibits insider
trading. Thus, we can expect that plaintiffs who pursue insider
trading causes of action under both the new § 25401 and the
existing § 25402 will face motions to strike at least one of
the causes of action as duplicative.
Footnotes
1 S.B. 538, 2013 Leg., Reg. Sess. (Cal. 2013); see also
SB-538 The Corporate Securities Law of 1968, California Legislative
Information (Oct. 2, 2013), http://leginfo.legislature.ca.gov/faces/billNavClient.xhtml?bill_id=201320140SB538
.
2 The Corporate Securities Law of 1968, Cal. Corp. Code §
25401 (amended 2013).
3 S.B. 538 (stating that the bill intended to broaden anti-fraud
provision); see also Bill Analysis: Assembly Committee on Banking
and Finance, Assemb. 2013, Reg. Sess., at 2 (Cal. 2013), available
at http://www.leginfo.ca.gov/pub/13-14/bill/sen/sb_0501-0550/sb_538_cfa_20130607_121212_asm_comm.html
("[T]his bill . . . [e]nsures consistency with federal law by
updating anti-fraud provisions in the Securities law. . . .");
Bill Analysis: Senate Banking & Financial Institutions
Committee, S. 2013, Reg. Sess., at 1 (Cal. 2013), available at http://www.leginfo.ca.gov/pub/13-14/bill/sen/sb_0501-0550/sb_538_cfa_20130401_115747_sen_comm.html.
4 Compare 17 C.F.R. 240.10b-5 (2013) with Cal. Corp. Code §
25401 (2013).
5 Marsh & Volk, Practice Under the California Securities Laws,
§ 14.03[1].
6 The Securities Act of 1933 § 12(a)(2), 15 U.S.C. §
77l.
7 Marsh & Volk, Practice Under the California Securities Laws,
§ 14.03[3][a]. Section 25501 of the California Corporations
Code provided—and Section 12(a)(2) is generally consistent in
providing—a defense to the action that proves that the
plaintiff knew the facts concerning the untruth or omission; or
that the defendant exercised reasonable care and did not know (or,
if he or she had exercised reasonable care, would not have known)
of the untruth or omission. Id.
8 Marsh & Volk, Practice Under the California Securities Laws,
§ 14.03[7]; see also Cal. Corp. Code § 25501.
9 See, e.g., Dura Pharms., Inc. v. Broudo, 544 U.S. 336, 341
(2005); Lentell v. Merrill Lynch & Co., Inc., 396 F.3d 161, 172
(2d Cir. 2005); Paracour Fin., Inc. v. Gen. Elec. Capital Corp., 96
F.3d 1151, 1157 (9th Cir. 1996) (en banc). Plaintiffs may also
establish fraud on the market, which does not require that they
prove that they directly relied upon the defendant's
misrepresentations but only that they relied on the integrity of
the price of the stock as established by the market. Basic Inc. v.
Levinson, 485 U.S. 224, 243-44 (1988).
10 U.S. v. O'Hagan, 521 U.S. 642, 647 (1997) (accepting
misappropriation theory and holding that a person who
misappropriates confidential information in breach of a fiduciary
duty is liable for violating Rule 10b-5).
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