California Ups the Ante for Securities Fraud Violations

In January, California’s Legislature stiffened the penalties for parties found liable for material misrepresentations or omissions in the sale of securities by amending California’s securities fraud statute to require courts to award attorney’s fees and costs to a prevailing defrauded purchaser or seller of securities. This provision was part of more extensive legislation that exempts from state securities qualification requirements certain crowdfunded equity offerings.

California’s securities anti-fraud provisions are set forth in California Corporations Code section 25401. California Corporations Code section 25501 specifies the remedies for violations of section 25401. Section 25501 was recently amended by California Assembly Bill 511, which became effective January 1, 2022.  The Public Investors Advocate Bar Association (“PIABA”) is listed with other organizations as supporting the amendment.

Among other provisions, the new legislation added the following to Corporations Code section 25501: “In addition to the relief described above, the court shall award reasonable attorney’s fees and costs to a prevailing purchaser or seller who succeeds in establishing a right to the relief provided by this section.” (Emphasis added.)

Questions may arise about whether the new provision for attorney’s fees will be applied retroactively, or only prospectively. Legislative enactments are presumed to be prospective in California, but the presumption is rebutted if the enactment clearly indicates a legislative intent that it be applied retroactively. There is nothing in the legislative history of Assembly Bill 511 indicating that the Legislature intended that the new attorney’s fees provision is to be applied retroactively. Awards of attorney’s fees for parties who obtain relief under Corporations Code section 25501 for violations of Corporations Code section 25401 should be available only in cases that are filed after January 1, 2022, the effective date of the legislation in the absence of any Court of Appeal decision holding that the new statute should be applied retroactively.

The amendment to section 25501 makes an award of attorney’s fees mandatory, and one-sided: the party charged with violating the anti-fraud provisions of Section 24401 is not entitled to an award of attorney’s fees and costs if it prevails in the litigation, representing a significant change in the law. Under the “American Rule,” a prevailing party in a lawsuit is entitled to recover attorney’s fees only if they provided for by statute or an agreement between the parties. The amendment will likely affect the value of claims because of its provision for a mandatory award of attorney’s fee and one-sided nature. Moreover, the California statute does not require “scienter” for proof of fraud but merely a material omission or misrepresentation. And the statute does not require reliance.  However, broker-dealers still have a “good faith defense” which is an affirmative defense that enables them to prove that in the exercise of reasonable care they did not or could not have known of the misrepresentation or omission.  (Corporations Code section 25504.)  This burden shifting provision places a premium on the thoroughness of the firm’s due diligence and supervision, which will form the basis for this affirmative defense.  As of the date of this article, no reported cases have yet been published addressing this new provision.

In valuing cases for trial, arbitration or settlement, depending on the specific facts, this new provision should be considered as it creates the risk that a relatively small damages case could have additional risk if the arbitration panel or court applies this mandatory, unilateral fee provision. We anticipate that Claimants lawyers in California securities arbitrations will argue for an expansive reading of this statute going forward.  

If you have any questions about how this change in legislation affects your active cases or your risk management, please do not hesitate to contact us.

Markun, Zusman & Compton LLP

Edward Zusman
Jeff Compton
Craig Hughes