California Corporations Code § 25401 prohibits offering or selling securities through written or oral statements that contain material misrepresentations or omit material facts necessary to make those statements not misleading.
The statute frequently applies to private placements, startup fundraising, venture capital transactions, and other securities offerings that are not publicly traded.
State securities investigations often focus on what investors were told before committing capital. Questions about valuation, customer growth, intellectual property, pending litigation, regulatory issues, and financial projections can become the foundation of allegations that investors were misled during a securities offering.
What Does California Corporations Code § 25401 Prohibit?
California Corporations Code § 25401 states that it is unlawful to offer or sell a security in California by means of any written or oral communication that includes an untrue statement of material fact or omits a material fact necessary to make the statements made not misleading.
Unlike simple business disputes between investors and founders, prosecutors must prove more than an investment that later lost value. They typically examine whether:
- A material fact was misstated
- Important information was intentionally omitted
- Investors relied upon the information during the offering
- The statement or omission occurred during the offer or sale of securities
The statute applies to many private offerings, including:
- Venture capital fundraising
- Angel investor rounds
- Seed financing
- SAFE agreements
- Convertible note offerings
- Limited partnership investments
- Real estate investment syndications
- Closely held corporate stock sales
What is Considered to be a "Material" Omission?
Not every inaccurate statement creates criminal liability. The issue is whether omitted or inaccurate information would have been important to a reasonable investor making an investment decision.
Examples may include failing to disclose:
- Pending government investigations
- Existing litigation against the company
- Significant customer losses
- Insolvency concerns
- Prior securities violations
- Undisclosed executive compensation
- Related-party transactions
- Intellectual property ownership disputes
- Significant regulatory compliance problems
- Existing debt obligations
Materiality is often one of the most heavily contested issues because investors, founders, accountants, and regulators may disagree about what information actually influenced an investment decision.
How Do These Investigations Typically Begin?
Many California securities fraud investigations originate from complaints filed by investors after a company underperforms or fails. Others begin after bankruptcy proceedings, whistleblower reports, civil litigation, regulatory examinations, or referrals from federal agencies. Investigators may seek:
- Private placement memoranda (PPMs)
- Subscription agreements
- Investor questionnaires
- Email communications
- Slack or Teams messages
- Board meeting minutes
- Financial statements
- Capitalization tables
- Bank records
- Due diligence materials
- Internal forecasts
- Communications with accountants or consultants
As investigators reconstruct fundraising activities, they often compare internal company communications with representations made to prospective investors.
Civil Liability Versus Criminal Prosecution
Corporations Code § 25401 may support both civil enforcement and criminal prosecution depending on the evidence gathered during the investigation.
Civil proceedings often seek:
- Investor restitution
- Rescission of securities sales
- Civil penalties
- Administrative sanctions
- Industry bars
Criminal prosecutions may seek penalties under California's Corporate Securities Law when prosecutors believe the evidence demonstrates intentional fraudulent conduct rather than negligent or mistaken disclosures.
Because the same documents frequently appear in both civil and criminal proceedings, statements made during regulatory investigations can become important evidence later.
What Evidence Do Prosecutors Rely Upon in Securities Fraud Cases?
Many securities fraud prosecutions rely almost entirely upon documents. Investigators frequently compare multiple versions of offering materials against internal communications. Evidence may include:
- Early drafts of investor presentations
- Emails discussing disclosure decisions
- Internal revenue forecasts
- Customer contracts
- Board presentations
- Auditor communications
- Financial models
- Text messages
- Due diligence questionnaires
- Recorded investor meetings
- Investor subscription files
The timeline of when executives learned particular information often becomes a significant issue. An omission may appear intentional only if prosecutors can establish that company leadership knew material information before investors committed funds.
Related Laws & Statutes
Understanding related state and federal laws is essential because private placement investigations rarely exist in a vacuum and often trigger overlapping criminal, civil, and regulatory exposure across multiple statutory frameworks.
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California Corporations Code § 25540 (Criminal Penalties for Securities Violations): Provides the criminal penalties—including substantial fines and state prison sentences—for willful violations of California's Corporate Securities Law, including fraud under § 25401.
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California Corporations Code § 25501 (Civil Liability for Material Misstatements): Establishes a private right of action permitting misled investors to sue for rescission or civil damages against anyone who violates § 25401.
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California Penal Code § 487 (Grand Theft by False Pretenses): Frequently charged alongside state securities violations when prosecutors allege that deceptive offering materials were used to unlawfully take investor funds exceeding $950.
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Securities Exchange Act of 1934 – Section 10(b) & SEC Rule 10b-5 (Federal Securities Fraud): The federal counterpart prohibiting manipulative devices, material misstatements, or omissions in connection with the purchase or sale of any security.
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18 U.S.C. § 1343 (Federal Wire Fraud): Commonly leveraged by federal prosecutors in tandem with securities inquiries whenever offering materials, subscription agreements, or investor funds cross state lines via email, phone, or electronic wire transfer.
Frequently Asked Questions (FAQs)
Reviewing frequently asked questions is critical for founders, executives, and investors to quickly identify the legal boundaries between standard business risk and actionable securities violations.
What is the legal difference between an ordinary business failure and securities fraud under California Corporations Code § 25401?
A business failure alone is not a crime; liability under § 25401 requires proof that an offer or sale of securities involved an untrue statement of material fact or a material omission that rendered the provided information misleading at the time it was made.
Can an executive or founder face criminal charges if they did not know a statement was false?
Criminal prosecution under California securities law generally requires establishing a willful or intentional violation, so inadvertent mistakes or reasonable reliance on inaccurate external data often serve as key defenses against criminal liability.
Does California Corporations Code § 25401 apply to private offerings like SAFEs, convertible notes, and angel rounds?
Yes, the statute applies broadly to virtually all offers and sales of securities in California, including early-stage venture instruments, private placements, convertible debt, and closely held stock sales.
What standard determines whether an omitted fact is considered "material"?
An omission is deemed material if there is a substantial likelihood that a reasonable investor would have considered the omitted information significant when deciding whether to commit capital.
Can a company correct or cure an inaccurate statement made in an earlier private placement memorandum?
Supplemental disclosures, revised disclosure decks, and written investor updates provided before subscription agreements are finalized can show investors had accurate, updated facts before committing funds.
How do state securities investigations under § 25401 typically get started?
Investigations usually begin after disgruntled investors file complaints following financial losses, through whistleblower reports, via referrals from civil or bankruptcy proceedings, or following inquiries by regulatory bodies like the California Department of Financial Protection and Innovation (DFPI).
Can the same private placement lead to both California state and federal securities fraud charges?
Yes, if an offering involves interstate communications, out-of-state investors, or electronic wire transfers, state authorities and federal agencies such as the SEC or DOJ can conduct parallel investigations under their respective statutory authorities.
What role do standard risk disclaimers in offering materials play in defending against § 25401 allegations?
While boilerplate disclaimers cannot insulate a party from outright false statements of existing fact, comprehensive, tailored risk disclosures help show that investors were fully advised of the venture's specific uncertainties and forward-looking risks.
Common Defense Issues in Private Placement Investigations
Every securities offering involves business judgment, projections, and risk assessments. Determining whether an optimistic statement crossed the line into criminal fraud requires careful examination of the underlying facts. Potential issues may include:
- Whether the omitted information was actually material
- Whether investors already possessed the information
- Whether statements were opinions rather than factual representations
- Whether disclosures adequately described investment risks
- Whether projections reflected reasonable assumptions when made
- Whether later business failures are being judged with hindsight
- Whether another individual prepared or modified offering documents
- Whether investors conducted independent due diligence
Hypothetical Case Study: Venture Capital Offering and Undisclosed Customer Loss
A Southern California software company raises $18 million through a private placement led by institutional investors and several high-net-worth individuals. The private placement memorandum states that annual recurring revenue remains strong and identifies several long-term enterprise customers as the foundation of future growth.
Several weeks before closing the financing round, two major customers notify company leadership that they will not renew their contracts.
Internal forecasts are revised downward, but the company does not incorporate the updated information into the offering materials. After the company later experiences financial difficulties, investors file complaints with regulators, prompting a DFPI investigation under Corporations Code § 25401.
Investigators obtain board presentations, executive emails, and draft revisions of the private placement memorandum. One executive argues that customer negotiations were ongoing and that management believed the contracts might still be renewed.
Another employee tells investigators that revised projections were prepared before the company accepted investor funds.
Our attorneys at Eisner Gorin LLP analyze the timing of every communication, the company's disclosure practices, investor due diligence materials, and contemporaneous business records.
Our firm identifies evidence showing management continued negotiating contract renewals in good faith while simultaneously providing investors with updated risk disclosures through supplemental communications before several subscription agreements became final.
We also demonstrate that institutional investors independently questioned customer concentration during due diligence and received additional financial information beyond the original offering memorandum.
Taken together, the evidence supports the position that investors had substantially more information than prosecutors initially alleged.
Following additional document review and witness interviews, prosecutors determine the available evidence cannot establish that material information was intentionally withheld in violation of Corporations Code § 25401.
Prosecutors decline criminal charges, and the remaining regulatory issues are resolved through administrative proceedings without a criminal filing.
Can Parallel Federal Investigations Occur?
Yes, a California investigation involving Corporations Code § 25401 may proceed alongside a federal inquiry if the offering involved interstate communications, investors from multiple states, wire transfers, or conduct potentially covered by federal securities laws.
State and federal agencies may exchange information, even when they pursue different legal theories.
Parallel investigations do not necessarily mean every agency will pursue enforcement. Each evaluates the available evidence under its own statutory authority and evidentiary standards.
Federal securities statutes that are frequently discussed in connection with private offerings include the Securities Act of 1933, the Securities Exchange Act of 1934, and SEC Rule 10b-5.
California prosecutors, however, may proceed independently under Corporations Code § 25401 when they believe a misleading statement or material omission occurred during an offer or sale of securities.
Issues That Arise in Defending Allegations Under Corporations Code § 25401?
Private companies often operate in rapidly changing markets. Financial projections evolve, customers are gained and lost, financing terms are renegotiated, and regulatory issues may develop while fundraising is underway.
Those realities do not eliminate disclosure obligations, but they do require investigators to examine the context in which statements were made. Several recurring issues arise in these cases:
- Whether a statement was factual, forward-looking, or opinion-based
- Whether the allegedly omitted information actually existed when investors received the offering materials
- Whether later events are improperly being used to judge earlier disclosures.
- Whether subsequent investor updates cured an earlier omission
- Whether investors received additional information through due diligence sessions, management meetings, or data rooms
- Whether multiple executives shared responsibility for preparing disclosure documents
- Whether accountants, outside counsel, consultants, or investment bankers participated in drafting the offering materials
Your best chance for a positive outcome is with an experienced California criminal defense attorney at Eisner Gorin LLP. To schedule a consultation, call (818) 781-1570 or use the contact form. Our law firm is based in Los Angeles.
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