Let's review the white-collar crime of securities fraud to better understand the California Corporate Securities Law of 1968, which regulates all offers and sales of securities.
Of note is that all securities offered or sold have to be either qualified with the Commissioner of the Department of Financial Protection and Innovation or they have to be exempted from qualification by a specific law or Rule of the Commissioner.
Any exemption from qualification does not limit issuer liability for fraud, either civil or criminal exposure, but only exempts the offer or sale from the cost and regular formalities of qualification.
The federal Securities Act of 1933 and the Securities Exchange Act of 1934 are separate laws that cover issuing and secondary sales of securities. The Corporate Securities Law of 1968 covers offers and sales of securities from both issuers and secondary sellers.
Like other federal securities laws, it's designed to protect the public from fraud and deception involving securities transactions. It accomplishes this by providing statutory remedies along with common law remedies for anyone harmed by securities transactions that violate the Corporate Securities Law of 1968.
Because there are so many ways greedy individuals and corporations can use securities to defraud the public, the laws regulating securities in the U.S. are many and complicated—to the point that if you trade any kind of securities, it can be challenging to know when something is illegal.
However, if you're a business owner or entrepreneur in California, the law that most applies to you—and the one you're most likely to run afoul of—is the California Corporate Securities Law of 1968.
The law itself is complex, but the following overview gives you a basic understanding of what it says and how you can comply with it. Let's review this law in more detail below.
What Are Securities?
The California Corporate Code Section 25019 offers a lengthy, confusing definition of what constitutes a security. It says in part, “Security means any note; stock; treasury stock; membership in an incorporated or unincorporated association; bond; debenture; evidence of indebtedness; certificate of interest or participation in any profit-sharing agreement; collateral trust certificate; preorganization certificate or subscription; transferable share; investment contract; viatical settlement contract or a fractionalized or pooled interest therein….”
For our purposes, think of a security as a stake in a business venture or a right to repayment of a debt.
This can include any note, stock, treasury stock, bond, debenture, evidence of indebtedness, or other instruments commonly known as a security, as well as any certificate of interest or participation in any profit-sharing agreement or any oil, gas, or mineral royalty, or in any such program.
At the most basic level, if you're starting a business and selling stock to raise capital, you're selling securities.
What Does the Law Say?
California Corporate Securities Law of 1968 is embodied in California Corporate Code Sections 25000-25707 and attempts to regulate all sales of securities.
Under this law, any sale or offer of securities must be qualified with the California Department of Financial Protection and Innovation, formerly known as the California Department of Business Oversight, unless the sale qualifies for an exemption under the law.
The process of qualifying securities involves a considerable amount of paperwork, and simply failing to fill out the paperwork can result in criminal charges and possibly serious penalties.
The California Corporate Securities Law of 1968 applies to any security offered for sale or sold in the state, regardless of whether it's issued by a corporation based in California or headquartered elsewhere.
It also applies to any sale outside the state if they are intended to be sold in California or the offer is made to a resident of California.
In essence, this law seeks to protect investors by regulating the issuance and trading of securities in California, ensuring that offerings are properly registered and preventing fraud.
This means that if you're offering some security—debt instruments, stocks, bonds, or other investment vehicles—in California, you must adhere to this law's provisions, or you may face serious criminal charges.
What Are the Exemptions from Qualification?
As with any rule, there are exceptions. California Corporate Code Section 25102 lists numerous criteria for securities sales that do not have to be qualified by the DFPI.
For most business owners or entrepreneurs, a security sale does not have to be qualified if the following criteria are met:
- Securities are sold to no more than 35 people. Married couples count as one person for purposes of this rule;
- The securities were not publicly advertised;
- Buyers of the securities did so as their investment, such as not intending to re-sell or give them to others; and
- Buyers of the securities had a prior personal or business relationship with the owner or enough business experience to protect their interests. In other words, they understood the risks.
What Are Some Examples of Securities Fraud?
EXAMPLE 1: Tom launches a new online business and recruits 20 friends by word-of-mouth to invest in it through private stock sales, promising them a percentage of the profits. Tom does not have to register this sale with the DFPI because the sale is less than 35 people with whom he has a personal relationship.
EXAMPLE 2: The same scenario, except Tom advertises his new business to get new investors. Only 30 people respond to the ad. Although the sale was less than 35 people, Tom would have needed to qualify his securities with the DFPI because he advertised the sale. If he did not, he is guilty of securities fraud.
Even if you go through the proper channels to qualify your securities, you could still commit securities fraud if you don't follow the selling rules. These include, but are not limited to:
- Selling unqualified securities that are not legally exempt;
- Selling securities that vary from the terms listed in the qualification paperwork; or
- Using false or misleading information in the sale of securities.
What Are the Penalties for Securities Fraud?
If you're charged with securities fraud under California law, you could face significant penalties if convicted. Securities fraud is a "wobbler" offense, meaning it can be charged either as a misdemeanor or a felony.
If convicted at the felony level, simply failing to comply with qualification rules can get you up to three years in jail and fines of up to $1 million.
More serious offenses like providing misleading information could be up to 5 years in prison and up to $10 million in fines. In addition, you could also face federal charges for securities violations.
Defending a federal securities fraud charge is possible, but you need an experienced federal defense lawyer. Federal prosecutors must be able to prove certain elements of the crime to obtain a conviction.
Contact our law firm by phone or contact form to review the details and legal options if you are under a criminal investigation or have already been indicted for securities and commodities fraud. Eisner Gorin LLP is located in Los Angeles, California.