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California Private Security Exemptions: What is a Preexisting Relationship?
Sales of securities in California are governed by the California Corporate Securities Law of 1968 codified at Cal. Corp. Code, § 25000 et seq. Violation of the law can lead to criminal, civil, and administrative proceedings.
San Diego Securities Law: Private Security Exemption
Section 25110(a) of the California Securities Law states that “[i]t is unlawful for any person to offer or sell in this state any security in an issuer transaction . . . unless such sale has been qualified under Section 25111, 25112 or 25113 . . . unless such security or transaction is exempted or not subject to qualification.”
One of the exemption referenced in section 25110 is the “private security exemption,” which is found in section 25102(f). That provision exempts from the qualification requirement, any offer or sale of any security, where each of the following four criteria are met:
- Sale to no more than 35 persons
- ALL purchasers must have EITHER a preexisting personal or business relationship with the offeror or be a “sophisticated investor” by reason of their business or financial experience such that they can be reasonably assumed to have the capacity to protect their own interests in connection with the transaction
- Each purchaser represents that the purchaser is purchasing for the purchaser’s own account and not with a view to or for sale in connection with any distribution of the security
- The sale is not advertised
San Diego Securities Law: What is a Preexisting Relationship for Purposes of § 25102(f)?
Focusing on the second point above, California courts have defined “preexisting relationship” as something more than mere acquaintance. The exemption provided by section 25012(f) is designed to protect unsophisticated investors and, consequently, for the preexisting relationship test to be satisfied, the relationship must be one of sufficient duration and nature that the purchaser has been able to become aware of the character, honesty, trustworthiness, business acumen, and general business and financial circumstances of the offeror/seller.
A case law example explains how the courts apply facts to the question. See The People ex rel DuFauchard v. O’Neil, B209612 (Cal. App. 2nd Dist. 2009) (unpublished). As shown in the O’Neil case, the court will examine the facts related to each investor. These were the investors discussed in O’Neil and how the court resolved the issue:
- Reed: She knew the offeror for many years, but had “lost touch” — she said they “just kind of remained friends” — court held not of the sort of relationship that would enable a reasonably prudent investor to assess the general business and financial circumstances of defendant
- Belisle: Only knew offeror because she was a greeter at their church — he “seemed like a nice man” — not sufficient for her to be able to assess honesty and competence
- The Cofields: Heard offeror give a financial seminar at their church and used defendant to refinance a mortgage — not sufficient
- The Canns: Belonged to same church — court held that, as a matter of law, “all members of the same church do not … have the necessary personal relationship with each other to establish the private security exemption.”
- Grayson: Same
- The Browns: No personal relationship; had mortgage refinanced; during refinance, was convinced to invest — not sufficient personal preexisting relationship
- Hadrick: Same
- Stoute: Same
- The Wards: No personal relationship at all
When planning a securities sale or offer in San Diego or anywhere in California, you need skilled and experienced legal counsel. Who is a qualified buyer for a 25102(f) exemption is crucial. ALL of your investors must meet the criteria. Get it wrong and you get sued. Get it intentionally wrong, and you might go to jail.
Contact San Diego Corporate Law
For further information, contact Michael Leonard, Esq., of San Diego Corporate Law. Mr. Leonard provides legal services related to private securities offerings/sales, the sale/purchase of a business and for mergers and acquisitions. Contact Mr. Leonard by email or by calling (858) 483-9200.
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