Die Verwandlung: How The Legislature Likely Raised The Bar On Securities Fraud Actions

With the availability of a private cause of action under SEC Rule 10b-5, is there any reason to include a cause of action under California Corporations Code Sections 25401 and 25501?  Until the most recent legislative session, there were significant differences between the federal rule and the California's securities laws.

California's scheme has not required a plaintiff to show scienter, see California Creates Complete Chaos By Rewriting Anti-Fraud Statute, But “We Are Against Fraud Aren’t We?”.  Just as significantly, California has not required a plaintiff to allege and prove reliance or causation. Bowden v. Robinson, 67 Cal. App. 3d 705, 715 (1977) (there is a limited defense based on plaintiff's knowledge of the misstatements).  The lack of any causation requirement is consistent with Section 12(a)(2) of the Securities Act of 1933 upon which Section 25401 was based.  The Recently enacted SB 538 (Hill) conforms Section 25401 to Rule 10b-5, which requires proof of: (1) material misrepresentation or omission, (2) scienter, (3) connection with the purchase or sale of a security, (4) reliance, often referred to as transaction causation, (5) economic loss, and (6) loss causation.  Nuveen Mun. High Income Opportunity Fund v. City of Alameda, 2013 U.S. App. LEXIS 19319 (9th Cir. Cal. Sept. 19, 2013).  These are high hurdles for plaintiffs bringing suits under Rule 10b-5 and many a securities fraud suit has come to grief because the plaintiff has failed to plead adequately scienter and/or causation.

Did the legislature intend to this change?  The legislative history suggests that it did:

The anti-fraud language in California’s securities law has failed to keep up with similar language in federal anti-fraud statutes. This bill updates our anti-fraud statutes to ensure consistency with more comprehensive, federal anti-fraud statutes.

Assembly Floor Analysis, September 3, 2013 and Senate Banking and Financial Institutions Committee Analysis, April 1, 2013.  The first sentence is at odds with reality.  Rule 10b-5 was written in 1942 while Section 25401 was enacted more than a quarter century later.  See The Unusual Administrative History of Rule 10b-5 by J. Robert Brown, Jr.  Thus, it can hardly be said that a later enacted statute "failed to keep up" with the earlier rule.  The second sentence will undoubtedly be cited in briefs as "legislative history" evidencing an intent to adopt Rule 10b-5, including its more rigorous requirements of reliance and causation.

Securities Act Metamorphosed into Sister Act

In short, SB 538 will transform Section 25401 from a statute based on the Section 12(a)(2) of the Securities Act into a statute based on a rule adopted under Section 10(b) of the Securities Exchange Act.