San Diego Corporate Law: Revisiting What is a Security and Securities Fraud

Offerings and sales of securities in California are governed by both federal and California securities laws — the Corporate Securities Law of 1968 (Corp. Code, §§ 25000-25707) and the federal Securities Act of 1933 (15 U.S.C. § 77b).

If you are offering or selling or promoting any sort of corporate or financial investment type vehicle, you should be wary of committing security fraud. You will need the advice and legal counsel of an excellent California corporate attorney with experience in the sale/offering of securities, with private placement memoranda, and with various exempt securities transactions. Here is an update on California securities law for early 2018.

San Diego Corporate Law: Securities Fraud

In general, to sell or offer securities as an initial sale or offering, you must register your securities under federal and California securities statutes. Failure to register is generally a crime. However, there are some exemptions for private sales to certain qualified investors under certain dollar amounts, etc.

Whether your sale/offering is registered or done pursuant to an exemption, the seller/offeror must avoid committing securities fraud. California Corporations Code §§ 25401 and 25540 make it a crime to sell or offer securities for sale using false or misleading statements or omitting material facts in oral or written communications. As the courts have held, securities fraud can be committed, not only by making “an untrue statement of a material fact,” but also by omitting or failing to state a material fact necessary to make the statements made not misleading. A fact is “material” if there is a “substantial likelihood that a reasonable investor would consider it important in reaching an investment decision, under all the circumstances.” See People v. Butler, 212 Cal.App.4th 404 (Cal. App. 2012).

A recent unpublished case decision, People v. Dunham, No. D068100 (Cal. App. 4th Dist. February 7, 2018), identifies the following as examples of false statements and omissions:

  • Dunham claimed that he was very experienced and qualified to manage the proposed real estate investment project; in truth, he had never managed a real estate project and had spent 90% of his adult career selling insurance.
  • Dunham said he would be able to increase property values after running a marketing campaign; in truth, others had exclusive marketing contracts related to the real estate and Dunham did not even have complete control over the inventory of lots. Dunham omitted that information.
  • Dunham said he could sell the lots for a significant profit; in truth, thousands of lots were available by others at much lower prices; Dunham omitted that information.
  • And more.

Mr. Dunham was convicted of 20 counts of securities fraud. The California Court of Appeals affirmed the convictions on all grounds.

San Diego Corporate Law: What is a Security?

According to California statute, a “[s]ecurity” is an investment contract. The statute provides a long, non-exhaustive list. See Corp. Code, § 25019. As we discussed here, in general, the key idea behind a “security” is making a passive investment with your money at risk where you expect to make a profit from the work/expertise of others. Another key aspect is the “tradeability” of the investment, or put another way, the “public-ness” of the sale/offering. Stocks purchased on stock exchanges are classic examples. The shares are publicly available. You buy a few shares of Apple, Inc. stock, for example. You hope to make money, but are passive; you are busy with other aspects of your life and are not engaging in any actual work to make Apple more profitable, etc. Likewise, you can sell your stock at will. Whether a particular instrument is “security” is a question to be determined in each case by the jury. The Apple stock is clearly a security.

Where an investment contract is unique and not intended for resale — not intended as a “public” offering — then the investment contract is likely not a “security.” This is the result of a recent California case. See People v. Black, 8 Cal. App. 5th 889 (Cal. App. 6th Dist. 2017). In that case, the two investment contracts were uniquely drafted for the two investors. There was no expectation of resale or any sort of “public” offering. The court noted these features:

  • One-on-one negotiations
  • Only two investors
  • Unique contracts — not pre-printed contracts
  • Neither Black nor the two investors expected to resell the contract — no expectation of “public” sale
  • Separate collateral to enforce payment under the promissory notes that were part of the investment

According to the court, this final element was the key to determining that the investment contracts were not “securities.” Because of the collateral, the money being invested was not “at risk,” which is a traditional hallmark of a security.

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.

You Might Also Like:

Private Placements: Advantages of Using 506(c)

Private Placement Memoranda

California Corporate Securities Law of 1968

Bad Actors Under Rule 504 of Securities Regulation D

Are Cryptocurrencies “Securities”?

What is a Security and Securities Fraud?


Schedule a Consultation: 858.483.9200