What Do It [§ 25501.5] Mean?

I’ve received several responses to my post last week concerning the meaning of California Corporations Code Section 25501.5.  Alan Parness, Chairman of the ABA Business Law Section’s Committee on State Regulation of Securities, observes that the remedies of rescission or damages can be “legislative overkill”.  He notes that investors will typically pursue these remedies only if the value of the security has declined, and that the performance of the security is unlikely to have any relationship to the broker’s license status.

Providing investors with more than a refund of their brokerage fees and commissions may amount to a windfall.  Alan points out that the district court in Stimmel v. Shearson, Hammill & Co., 411 F. Supp. 345 (D. Ore. 1976) shared this view.  The plaintiffs, residents of Oregon, had made trades by phone and correspondence through a broker-dealer in San Francisco which was registered in California and Oregon.  The broker-dealer’s salespeople, however, were not registered in Oregon, and the plaintiffs brought an action for rescission under the Oregon Blue Sky law on that basis.  Although the court  found that the plaintiffs were entitled to rescission, it was less than pleased with the result:

I am offended by the required result.  The defendant's offense is nothing more than a simple technicality from which plaintiffs are allowed to reap an enormous benefit.

Alan also notes that this type of remedy creates an opportunity for investors to “cherry pick” trades – seeking rescission only for the losing trades, while keeping the profits from the winning ones.

I'm also reminded that Lee Petillon and Mark Hiraide have written an excellent article on the use of non-registered broker-dealers in private placement transactions.  The article appears in the Spring (2005) edition of the Business Law Update for the Los Angeles County Bar Association Business & Corporations Law Section.