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Securities and Investment Law

The Laws That Govern the Sale of Securities


The sale of securities are regulated by both Federal and State law. As discussed below, California securities laws, although based on the federal statutes, provides investors with especially strong legal protections. 


Compliance with State and Federal Securities law is essential for any person or company engaged a securities transaction. Failure to comply could mean investors are taking on risks that they do not understand and exposes issuers (sellers) to substantial liability, including complete rescission of the investment, damages, and attorneys fees.


Federal Securities Laws


The Federal Securities Laws are comprised of a series of statutes, which in turn authorize a series of regulations promulgated by the government agency with general oversight responsibility for the securities industry, the Securities and Exchange Commission.


The two main statutes involved in the Federal Securities laws are the The Securities Act of 1933 and the The Securities Exchange Act of 1934. The '33 Act is often referred to as the "truth in securities" law. Generally the securities laws have two basic objectives:

  • require that investors receive financial and other significant information concerning securities being offered for public sale; and
  • prohibit deceit, misrepresentations, and other fraud in the sale of securities.

As stated elsewhere, be sure to consult an attorney before relying on those rules, and the text, and the interpretations of those rules are in a constant state of flux.


Section 10b-5 and Rule 10b-5


The most well known securities regulation is Rule 10b-5, promulgated pursuant to Section 10b of the ’34 Act. The Rule is the most often used Rule in the area of securities law, and most every securities fraud case involves, in one way or another, Rule 10b-5.


And for that reason alone, Section 10(b) demands a full quotation herein:

15 USC Sec. 78j

 Sec. 78j. Manipulative and deceptive devices

 It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce or of the mails, or of any facility of any national securities exchange –

 (a) To effect a short sale, or to use or employ any stop-loss order in connection with the purchase or sale, of any security registered on a national securities exchange, in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors.

 (b) To use or employ, in connection with the purchase or sale of any security registered on a national securities exchange or any security not so registered, any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors.


Rule 10b-5, and Section 10b are known as the Anti-Fraud provisions of the 34 Act, and most regulations flow from this rule. The rule has been the subject of extensive litigation, and later revisions to this article will address some of the significant aspects of those matters, including insider trading, market manipulation, fraud in connection with public offerings and takeovers, and fraud in connection with dealings with customers.


State/California Law

Each State has its own set of laws governing Securities Fraud.  California's law is called the "Corporate Securities Law of 1968" which can be found at Corporations Code Section,  25000, et seq.


An important feature of the California law is that is provides a remedy of rescission (you give back the stock and get your money back) under certain circumstances for those who have purchased securities that are not properly registered under Corporations Code Section 25110.  Corporations Code Section 25503 imposes liability for the money back plus interest upon a person violating Section 25110.   The statute provides for a measure of damages to be paid to the investor if he or she has already sold the security.  


This is a claim solely based upon whether or not certain technical registration, qualification or exemption requirements have been met by the issuer of the security.  Such a case must be filed in Court within two years of the date of sale.  However, if the technical requirements of registration or exemption were not met, investors can recover the money paid for the securities without having to prove fraud.   This type of case must be filed within two years of the violation or within one year after discovery thereof, "whichever shall first expire" pursuant to Corporations Code Section 25507, subd. (a).  


California law also prohibits fraud in the offer and sale of securities, under Corporations Code Section 25401.  Section 25401 makes it illegal to offer, sell or purchase securities through untrue statements or omissions of a material fact.  Section 25501 gives a victim of such fraud the right to sue to recover damages or rescission.   


Of special significance to investors who were defrauded is the fact that the requirements to prove a case under Sections 25401 and 25501 are not as difficult to prove as a claim for fraud under the Federal Securities laws or under the rules for ordinary fraud.   


Under California law, Corporations Code Sections 25401 and 25501 do not require that the investor prove that he or she actually relied upon a untrue statement or material omission.  Under the federal rule, an investor must normally show that he or she read or heard of the facts that were false, believe them to be true, and that these were important in the decision to invest.   This is a requirement gives the defense an opportunity to conduct a witch hunt into the education, background, knowledge and sophistication of the investor, which often is offensive and an invasion of the privacy of the investor.   It is a great benefit that it is not part of the California scheme of securities protection for investors.  


Even more importantly, it is not necessary to prove that the fact that was misrepresented actually caused the damages suffered by investors.   This is a huge benefit to defrauded investors.  This element, which is known as "loss causation" is a requirement of the Federal Securities laws under the Securities Exchange Act of 1934 aka Rule 10b-5, and it is a very difficult element to prove in many cases and it permits promoters to get away with outright lies, so long as the lies do not directly cause economic harm to the investor.  


A classic example of this rule is where investors in a shipping venture involving a single freighter are falsely told that the ship has far greater freight capacity than is actually the case.  By this misrepresentation, the promoters are able claim that greater profits can be expected from the investment than is really the case.  However, it is disclosed in the prospectus that the ship is uninsured.  


When the ship sinks in a storm, causing a total loss to investors, they sue, claiming that they would never have invested if the actual size of the vessel had been disclosed, and if they had never invested, they would not have suffered losses.   


Under the federal rule of loss causation, the Court might find that the misrepresentation regarding the capacity of the ship was material, and that investors might not have invested if the actual size of the ship had been disclosed.  Therefore, "transaction causation" was established.   However, since the size of the ship had nothing to do with its sinking, and nothing to do with the reason for the loss, the claim fails for lack of loss causation.  This is an example of a case in which someone who could sue and win under the California Corporate Securities Law of 1968 would probably lose under the analogous federal law.


Because the California Corporate Securities Law of 1968 does not require proof of reliance on the facts that were fraudulently misrepresented and does not require proof of loss causation, it is far easier for a defrauded investor to win under the California law than under the Federal law.


In order for a securities fraud claim to be governed by the California Corporate Securities Law of 1968, the offer to sell must emanate from California or the offer to buy must be accepted in California. See, California Corporations Code Section 25008(a) and (b).  It is not necessary for the investor to be in California, or to be a resident of California, in order to sue under the California Corporate Securities Law of 1968.


Claims for relief under for securities fraud under Corporations Code Sections 25401 and 25501 are governed by the statute of limitations in Corporations Code Section 25506, which requires that the case must be filed within five years after the act or transaction constituting the violation, or within two years after the discovery by the plaintiff of the facts constituting the violation, whichever shall first expire. 


The Law Offices of Nate Kelly specialize in handling investor claims under the Federal and State Securities Laws, recovering millions of dollars for clients over the last decade. Contact us today to schedule a free consultation!  


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