BILL ANALYSIS �
SENATE JUDICIARY COMMITTEE
Senator Noreen Evans, Chair
2011-2012 Regular Session
AB 2081 (Allen)
As Amended August 6, 2012
Hearing Date: August 15, 2012
Fiscal: Yes
Urgency: Yes
RD
SUBJECT
Securities Transactions: Qualification Requirements: Exemptions
DESCRIPTION
Existing law provides that it is unlawful for any person to
offer or sell any security in this state, unless such sale has
been qualified by the Commissioner of Corporations
(Commissioner), as specified, or unless the sale is covered by
an express exemption.
This urgency measure would authorize a new exemption for persons
seeking to offer securities using any form of general
solicitation or general advertising, including unsolicited
telephone calls to a person's residence or cell phone if the
issuer and the caller take reasonable steps prior to the
unsolicited phone call, to verify that the person (the potential
purchaser) is an accredited investor, as specified, and the
transaction meets certain requirements. Such requirements
include that the issuer obtain a completed offeree questionnaire
in a form to be adopted by the Commissioner, from the potential
purchaser of the security. The bill would, among other things,
also specify that the aggregate offering price for an offering
of securities made under the proposed exemption cannot exceed
one million dollars per 12 months.
The bill would also specify that a person may bring an action,
as specified, for contract rescission if the person purchases
securities in an offering that failed to meet all of the terms
and conditions of the proposed exception. The bill would, in
addition to other available remedies, require a court to award
attorney's fees and costs if the purchaser prevails in any such
(more)
AB 2081 (Allen)
Page 2 of ?
action.
BACKGROUND
In the early 1920s, "companies often sold stocks and bonds on
the basis of glittering promises of fantastic profits - without
disclosing any meaningful information to investors." By the end
of that decade, the United States economy was devastated in the
Stock Market Crash of 1929. (SEC, Q&A: Small Business and the
SEC, < http://www.sec.gov/info/smallbus/qasbsec.htm > �as of
August 9, 2012].) In response to the crash, the U.S. Congress
enacted the first set of federal securities laws, the Securities
Act of 1933 (Securities Act), and the Securities Exchange Act of
1934, and created the Securities and Exchange Commission (SEC)
to administer those laws, both of which contain specified
registration and disclosure requirements.
Under the Securities Act, any company that offers or sells its
securities must register the securities with the SEC unless it
qualifies for an exemption under federal laws and regulations.
Among the several exemptions created by federal law is an
exemption for "transactions by an issuer not involving any
public offering" under Section 4(2) of the Securities Act (a
private offerings exemption). Federal regulations, under
Regulation D, provides for three exemptions from the
registration requirements known as Rules 504, 505, and 506, of
which Rule 506 specifically operates as a "safe harbor" for the
private offering exemption-a company that meets the specified
requirements of Rule 506 thereby qualifies for the Section 4(2)
exemption. To qualify for Rule 506's safe harbor, no general
solicitation or advertising can be used in connection with the
securities offering. (15 U.S.C. Sec. 77d(a)(2); 17 C.F.R. Sec.
230.506.)
An exception to that prohibition on general solicitation or
advertising was recently created when the Jumpstart Our Business
Startups Act (JOBS Act) was signed into law by President Obama
on April 5, 2012. The JOBS Act sought to better enable small
businesses to raise capital, and required the SEC to adopt rule
changes within 90 days (which was July 3, 2012) to provide that
the prohibition against general solicitation or advertising does
not apply to offers and sales of securities made pursuant to
Rule 506, provided that all purchasers of the securities are
accredited investors. The JOBS Act also requires, however, that
issuers take reasonable steps to verify that purchasers of the
securities are accredited investors, pursuant to the SEC
AB 2081 (Allen)
Page 3 of ?
regulations that are to be adopted. While the regulations have
not yet been released, it has been reported that the SEC will be
considering rules at a meeting scheduled for August 22, 2012.
Similar to federal law, the California Securities Law of 1968
makes it illegal to sell an unqualified (i.e. unregistered)
security unless the security is exempted by statute or federal
law otherwise preempts securities registration requirements.
(Corp. Code Sec. 25110; see 57 Ca. Jur., Securities Regulations,
Sec. 13.) Like federal law, California law specifically
provides for numerous exemptions to the qualification
requirement, but those exemptions generally limit the scope of
both advertising and the individuals to which the securities may
be sold.
This bill, similar to Section 201 of the JOBS Act, seeks to
authorize a broad new exemption that would allow issuers to
offer or sell securities using any form of general solicitation,
general advertising, and allow unsolicited telephone calls to a
person's residence or cell phone, as long as the issuer and the
caller take reasonable steps prior to the unsolicited phone call
to verify that the person he or she is calling is an accredited
investor, as specified, and the transaction meets certain
requirements. This bill includes an urgency clause, which would
make the bill take effect immediately.
This bill was approved by the Senate Banking and Financial
Institutions Committee on August 7, 2012, by a vote of 4-2.
CHANGES TO EXISTING LAW
Existing federal law , among other things, makes it unlawful for
any person, directly or indirectly to offer or sell non-exempt
securities, unless registered with the Securities and Exchange
Commission (SEC). (15 U.S.C. Sec. 77e.) Existing federal law
provides for several exemptions from that registration
requirement. (15 U.S.C. Sec. 77d.) Existing federal
regulation, Regulation D, provides for three exemptions from the
registration requirements. (17 C.F.R. Sec. 230.501 et seq.)
Existing federal regulation , Rule 501 of Regulation D, defines
accredited investors as, among other things, financial
institutions, securities broker-dealers, large pension plans,
corporate entities with assets in excess of five million
dollars, and other large, financially sophisticated entities.
It also includes:
any natural person whose individual net worth, or joint net
AB 2081 (Allen)
Page 4 of ?
worth with that person's spouse, exceeds one million dollars
at the time of the purchase, exclusive of their primary
residence; or
any natural person with an individual income in excess of
$200,000 in each of the two most recent years, or joint income
with that person's spouse in excess of $300,000 in each of
those years, together with a reasonable expectation of
reaching the same income level in the current year. (17
C.F.R. Sec. 230.501.)
Existing federal regulation , Rule 502 of Regulation D, in
relevant part prohibits, except as provided in Rule 504(b)(1),
the offering or selling of the securities by any form of general
solicitation or general advertising including, but not limited
to, the following:
any advertisement, article, notice or other communication
published in any newspaper, magazine, or similar media or
broadcast over television or radio; and
any seminar or meeting whose attendees have been invited by
any general solicitation or advertising, as specified. (17
C.F.R. Sec. 230.502(c).)
Existing federal regulation , Rule 504 of Regulation D, exempts
from federal registration offers and sales of securities made by
specified issuers if, among other things, the offering meets
specified limitations on the manner of offering (general
solicitation and advertising limits) and specified limitations
on resale, and the aggregate offering price does not exceed one
million dollars, as specified. Rule 504(b)(1) also, however,
provides that the specified limitations do not apply if the
offer and sale of securities are made exclusively according to
state law exemptions that permit general solicitation and
general advertising, as long as sales are made only to
accredited investors, as defined. (17 C.F.R. Sec. 230.504.)
Existing federal regulation , Rule 506 of Regulation D, provides
that offers and sales of securities by an issuer that satisfy
specified conditions, shall be deemed to be transactions not
involving any public offering within the meaning of Section 4(2)
of the Securities Act of 1933. (17 C.F.R. Sec. 230.506.)
Existing law , California Securities Law of 1968, provides that
it is unlawful for any person to offer or sell in this state any
security in an issuer transaction, except as specified, unless
such sale has been qualified by the Commissioner of Corporations
(Commissioner), as specified, or unless the security or
AB 2081 (Allen)
Page 5 of ?
transaction is covered by an express exemption or is not subject
to qualification. (Corp. Code Sec. 25110.)
Existing law provides that specified securities under the
Securities Act (covered securities) and the Exchange Act are
expressly exempt from the qualification requirements. (Corp.
Code Secs. 25100.1, 25101.1.)
Existing law provides for numerous exemptions from the above
qualification requirement, including among others, an exemption
for:
Any offer or sale of any security in a transaction, as
specified, that meets the following criteria:
o sales of the security are made to no more than 35
persons, as specified;
o all purchasers either have a pre-existing personal or
business relationship with the offeror, as specified, or
can reasonably be assumed to have the capacity to protect
their own interests in connection with the transaction, as
specified;
o each purchaser represents that he or she is purchasing
for his or her own account; and
o the offer and sale of the security is not accomplished
through the publication of any advertisement.
Any offer or sale of any security in a transaction, as
specified, that meets the following criteria:
o the issuer is not a blind pool issuer, as that term is
defined by the Commissioner;
o sales of securities are made only to qualified
purchasers or other persons the issuer reasonably believes
to be qualified purchasers, as specified;
o each purchaser represents that he or she is purchasing
for his or her own account, and not with a view to or for
sale in connection with any distribution of the security;
o each natural person purchaser is provided with a
disclosure statement that meets the disclosure requirements
of federal Regulation D, at least five business days before
they purchase or commit to purchase the security;
o the offer and sale of the security is made by way of a
written general announcement only, which contains specified
information, including the anticipated suitability
standards for prospective purchasers; and
o telephone solicitation by the issuer is not permitted,
until and unless the issuer determines that the prospective
purchaser being solicited is a qualified purchaser. (Corp.
Code Secs. 25102(f), 25102(n).)
AB 2081 (Allen)
Page 6 of ?
Existing law provides for a private right of action for
violation of Section 25110 of the Corporations Code requiring
qualification with the Commissioner, or for violation of a
condition of qualification, as specified. Existing law also
provides for joint and several liability for specified parties
where such a violation has occurred, including, among others,
any person who materially assists in any such violation. (Corp.
Code Secs. 25503, 25504, 25504.1.)
This bill would exempt from California's qualification
requirements any offer of a security by an issuer using any form
of solicitation or general advertising, as specified, except
that an offer of security by means of a telephone or cell phone
call would only be permissible if the issuer and the caller take
reasonable steps, prior to the unsolicited phone call to verify
that the person he or she is calling is an accredited investor,
as specified, and provided that the transaction meets specified
requirements.
This bill would provide for specified requirements that must be
met to qualify for the exemption, including that:
the aggregate offering price for an offering of securities
shall not exceed one million dollars, less the aggregate
offering price for all securities sold within 12 months;
prior to selling any security to a person solicited pursuant
to this exemption, an issuer shall obtain from that person a
completed offeree questionnaire in a form adopted by the
Commissioner;
sales of securities shall be made only to a person who is, or
with respect to whom the issuer has taken reasonable steps to
verify is, an accredited investor immediately prior to the
sale;
the issuer has taken reasonable steps to verify that
immediately prior to the sale, the offering is suitable for
the potential purchaser based on that person's financial
status, objectives, investment experience, time horizon, risk
tolerance, and any other information that the issuer deems
relevant to determine whether the offering is suitable to that
person;
if the potential purchaser is a natural person, the amount of
consideration paid by the purchaser does not exceed 10 percent
of his or her net worth, or joint net worth with the
purchaser's spouse, immediately prior to the investment, and
each investors investment in the offering together with all
previous offerings under this exemption made during the
AB 2081 (Allen)
Page 7 of ?
previous 12 months does not exceed 10 percent of his or her
net worth, as specified. (The "net worth" calculation
excludes a person's primary residence in calculating their
assets, among other things);
the issuer can reasonably assume that the person has the
capacity to protect his or her interests in connection with
the offering due to his or her business or financial
experience, or the business or financial experience of his or
her professional advisor, who is unaffiliated with and not
compensated, directly or indirectly by the issuer or any
affiliate or selling agent of the issuer;
the issuer believes in good faith that the offer and sale are
exempt from registration under the Securities Act, as
specified, or the rules and regulations adopted by the SEC
under Section 3(b) (securities issued by small investment
company) or Section 4(2) (private offerings) of the Securities
Act;
the issuer specifies in all advertisements, communications,
sales literature, or other information that is publicly
disseminated, as specified, that the securities will be sold
to accredited investors only;
the issuer places on a legend on the cover of each disclosure
document or subscription agreement advising that the
securities described in the document or agreement will be sold
to accredited investors only; and
the issuer shall file with the Commissioner a notice, as
specified, and pay a specified fee within 15 days after the
first sale of the securities in this state.
This bill would provide that the issuer shall maintain, for a
period of four years, documentation sufficient to establish the
basis for its determination of suitability;
This bill would provide that dissemination of information
regarding the proposed offering to a person who is not an
accredited investor shall not disqualify the offering from the
exemption under this bill.
This bill would provide that a person who purchases securities
in an offering that fails to meet all of the terms and
conditions of this exemption may bring an action under
Corporations Code Sections 25503, 25504, and 25504.1 for
rescission of the purchase, and that in addition to the other
remedies provided for in those sections, the court shall award
attorney's fees and costs to a prevailing purchaser in any such
action.
AB 2081 (Allen)
Page 8 of ?
This bill would provide that the exemption is not available for
an offering by an issuer who is an investment company or a
development stage company, as specified.
This bill would also provide that the exemption is not available
to an issuer if any of the following apply within the five years
immediately prior to the first offer of the security to the
issuer or its predecessors, affiliates, directors, officers,
general partners, beneficial owners of 10 percent or more of any
classification of its equity securities, or any underwriter of
the securities to be offered, or any of the underwriter's
partners, directors, or officers:
the person has filed a registration statement that is the
subject of a currently effective stop order entered by any
state securities administrator or the SEC;
the person has been convicted of any criminal offense
involving fraud, deceit, or any offense concerning the offer,
purchase, or sale of any security;
the person is currently subject to a state or federal
administrative enforcement order or judgment entered finding
fraud or deceit in connection with the purchase or sale of any
security; or
the person is currently subject to any order, judgment, or
decree of any court of competent jurisdiction, that restrains
or enjoins the person from engaging in or continuing to engage
in any conduct or practice involving fraud or deceit in
connection with the purchase or sale of any security, except
if any of the following apply:
o the person is licensed or registered to conduct
securities-related business in the state in which the
order, judgment, or decree described in any of these
provisions was entered against the person;
o before the first offer of securities is made in reliance
upon the exemption under this subdivision, the state
securities administrator, the court, or the regulatory
authority that entered the order, judgment, or decree
removes, reverses, or vacates the order, judgment, or
decree; or
o the issuer, exercising reasonable care and based on
factual inquiry, establishes that it could not have known
of the existence of any of these circumstances.
This bill is an urgency measure and would go into immediate
effect.
AB 2081 (Allen)
Page 9 of ?
COMMENT
1. Stated need for the bill
According to the author:
Today's small businesses face serious challenges in the form
of declining business income, newly restricted and sometimes
cancelled bank cards and equity lines, the shrinking asset
value of their homes, and banks' reduced appetite for risk.
California small businesses, especially women, minority and
disabled veteran businesses cannot often access "traditional"
sources for the less than $500,000 (though sometimes up to $1
million) in growth capital they need. The average small
business owner is not likely to have a broad circle of
relationships with high net worth individuals or investment
bankers willing to raise such modest amounts. . . .
Small Business California, the sponsor of this bill, adds that
"Assembly Bill 2081 would remove the preclusions from accessing
private capital by reversing the requirement in the federal
securities law that a business must either personally know each
Accredited Investor or hire an investment banker to bridge the
relationship gap."
2. Investor protections against fraud in the current bill are
arguably insufficient as successful savers are not necessarily
sophisticated investors
Existing law provides for numerous exemptions the state's
qualification requirements for securities. This bill would
authorize issuers to offer or sell securities using any form of
general solicitation or advertising, and allow unsolicited
telephone calls to a person's residence or cell phone, as long
as the issuer and the caller take reasonable steps prior to the
unsolicited phone call, to verify that the person he or she is
calling is an accredited investor, as specified, and the
transaction meets certain requirements.
As discussed in detail below, the public policy issue raised by
this bill is what steps should be taken to protect investors who
may invest a portion of their life savings in securities offered
under this broad exemption.
a. Insufficient investor protections
The Public Investors Arbitration Bar Association (PIABA), in
AB 2081 (Allen)
Page 10 of ?
opposition to this bill, writes that "�o]n a daily basis in
our practices, we see devastating losses resulting from
violations of investor protection laws and regulations that
govern the securities industry and issuers of securities.
Disproportionately, those losses fall on elderly and
vulnerable savers and investors. PIABA believes that allowing
general solicitation and advertising of exempt securities
offerings diminishes investor protection and likely will lead
to future losses for California investors. "
The author and sponsor contend however that there are investor
protections in the bill that include, among other things: that
the exemption is limited to one million dollars per every 12
months; the investor's investment is limited to 10 percent of
his or her net worth (excluding equity in his or her principal
residence); each investment, together with all offerings
during the previous 12 months based on this exemption, cannot
exceed 10 percent of the investor's net worth; the issuer must
obtain an offeree questionnaire from each investor verifying
his or her accredited investor status; the issuer cannot make
unsolicited phone calls unless the issuer and the caller take
reasonable steps to verify that, prior to the telephone call,
the person they are calling is an accredited investor; and all
advertisements, communications, sales literature, etc. must
state that the securities will be sold to accredited investors
only. Moreover, the proponents of this bill point to the fact
that the "investors have a private right of action against any
person who offers and sells securities in an offering that
fails to meet all of the terms and conditions of the
�proposed] exemption, and may be afforded reasonable
attorney's fees if he is the prevailing party. None of these
protections are included in the JOBS Act except the
requirement that each investor be an accredited investor and
no other federal or state exemptive statute or rule includes
all of the above investor protections or even a majority of
them." (Note: the bill provides that attorney's fees and
costs shall be provided to the prevailing purchaser-i.e. it is
not discretionary.)
Staff notes that these protections, which some may argue are
greater than those afforded under the JOBS Act (this is merely
a speculation as the SEC regulations are not yet completed),
still leave potential investors, and arguably the elderly in
particular, vulnerable to suffering significant, if not
devastating, losses, particularly where fraud is involved. As
noted by the opponents to this bill, a successful saver is not
AB 2081 (Allen)
Page 11 of ?
necessarily a sophisticated investor. Even the use of a
questionnaire would arguably be ineffective if the issuer
completes the form for the purchaser and then has the investor
sign the form without fully reviewing. Nor does the bill
provide any guidelines as to what types of answers signal a
sophisticated investor as opposed to a wealthy individual who
at some point their life has dabbled in securities. While
proponents have provided Committee staff with a sample of a
questionnaire that they suggest could be used by Department of
Corporations, the actual form of the questionnaire is unknown
at this time.
Moreover, the proponent's sample questionnaire contains highly
sensitive information (such as the person's Social Security
Number, date of birth, tax ID number if relevant, and more)
without any measure to ensure confidentiality of that
information. The potential disclosure of that information
without appropriate safeguards raises serious issues as to
what may be done with information provided by prospective
purchasers. Staff also notes that other protections included
in the bill raise similar questions about whether they could
inadvertently facilitate abuse of the proposed exception. For
example, it is not clear why a person who was convicted of a
crime involving fraud or deceit or a person who is the subject
of a currently effective stop order by a state securities
administrator or the Securities and Exchange Commission should
be afforded the ability to use this exemption after five
years-particularly given significant concerns about potential
fraud.
Furthermore, other provisions in the bill that allow a
purchaser to invest up to 10 percent of his or her net worth
arguably authorize potentially high-risk business investments
that may result in serious financial losses for the investor
(especially if those funds were expected to support the
investor for many years to come). As noted above, the
sponsors are seeking the proposed exception because some small
businesses are unable to access traditional forms of capital -
thus, the proposed exception arguably seeks to allow those
businesses to raise significant sums of money when traditional
lenders are unwilling to lend (potentially due to the risk).
As noted by PIABA:
Ones status as an 'accredited investor' is based primarily
on an outdated computation of net worth. It offers no
guarantee or even likelihood of investment sophistical or
AB 2081 (Allen)
Page 12 of ?
the ability to evaluate risky but legitimate startup
ventures, let alone the highly speculative capital
formation programs that will no doubt spring up to take
advantage of the new exemption. Because it indicates far
less about investment sophistication than it does about
assets, accredited investor status correlates best with
age. Elderly retirees make up a disproportionately large
percentage of people who meet the definition of accredited
investors simply because their property has had longer to
appreciate, their savings have had longer to accumulate,
they have taken rollovers or lump-sum payouts of pension
assets that have accumulated through decades of hard work
and, sadly, many are widowed and hold the proceeds of their
spouses' life insurance policies. The funds they lose
cannot be replaced. They have neither the time nor the
employment prospects to do that. �Emphasis added.]
b. Amendments for this Committee to consider in addressing
the above concerns
To partially address these and other similar concerns, the
following amendments seek to increase investor protections,
but, as noted in Comment 4 below, none of these protections
ensure that an issuer will have sufficient funds to pay for
damages as a result of a violation:
To reduce potential losses to vulnerable investors -
limit investment by an individual to five (as opposed to
10) percent of his or her net worth.
To strengthen the bill's investor protections and
anti-fraud measures:
o prohibit issuers from solely relying on the
questionnaire in making the determination of whether the
potential purchaser is an accredited investor and of
suitability;
o ensure the confidentiality of the contents of the
questionnaire and prohibit any selling, distribution, or
other use of the information;
o require all publically disseminated documents,
disclosures, and advertising to state that the offering
is not subject to qualification requirements under the
proposed exemption;
o strike the provision that exempts information from
the disclosure requirements if it is publicly
disseminated to fewer than 100 persons;
o require issuers to maintain a copy of any
AB 2081 (Allen)
Page 13 of ?
advertisement or solicitation for four years, as the bill
requires issuers to do with suitability documentation;
o require that issuers provide the potential investor
specified written information, including information
detailing its business and the securities (such as any
material legal proceedings involving the company or its
officers and directors, the plan for distributing the
securities, and the intended use of the proceeds of the
offering); disclosure of all risk factors associated with
the offering; and a statement detailing the financial
condition of the issuer together with supporting
documentation;
o require a mandatory 24-hour waiting period after the
above information is provided to the investor before a
sale can be made; provide that investors shall have the
right to void the contract within the first 72 hours of
the sale; and
o strengthen the provisions in the bill that allow
persons involved in specified offenses more than five
years prior to the offer of security to use the proposed
exemption by, instead, requiring at least 10 years to
have passed; however, if the offense was the person was
convicted of a crime involving fraud or subject of a
judgment or decree finding elder or dependent financial
abuse, prohibit the individual from using the proposed
exemption.
3. Enforcement mechanism
To encourage enforcement of the above investor protections, this
bill would allow a person who purchases securities in an
offering that fails to meet all of the terms and conditions of
this bill to bring an action, as specified, for the rescission
of the purchase. The bill would also provide that in addition
to the other remedies, as specified, the court shall award
attorney's fees and costs to a prevailing purchaser in any such
action.
a. Attorney's fees
Generally, in the United States, the "American rule" is that
parties must bear their own costs of civil litigation. In
Alyeska Pipeline Co. v. Wilderness Society (1975) 421 U.S.
240, the United States Supreme Court held that it was the
province of the legislative branch to craft exceptions to the
American rule, and courts were not free to shift such costs
AB 2081 (Allen)
Page 14 of ?
absent express legislative authorization. (Id. at 269-270.)
In this situation where the investor has been defrauded out of
potentially devastating amounts of money and the cost of
litigation can be cost-prohibitive given the nature of the
action, it does not appear unreasonable to allow for
attorney's fees where the investor prevails. This is
particularly true where the potential harm is not limited to
one individual - it is likely that a person misusing this
exemption has harmed or may harm other parties. By litigating
the issue, therefore, it arguably does provide a significant
benefit to the general public in prohibiting further abuse of
the securities market by that issuer.
b. Contract rescission remedy
In addition to the above allowance for attorney's fees, this
bill would permit a person who purchases securities in an
offering that fails to meet all of the terms and conditions of
this bill to bring an action, as specified, for rescission of
the purchase.
With respect to the contract rescission provision in this
bill, that right is already one afforded to individuals under
several sections of the Corporate Securities Law of 1968. For
example, Section 25401 makes it unlawful for any person to
offer or sell a security in this state or buy or offer to buy
a security in this state by means of a communication which
includes an untrue statement of a material fact or omits to
state a material fact necessary in order to make the
statements made, as specified. Under Section 25501, where
such violation occurs, the sale is subject to rescission, or
if the plaintiff or defendant no longer owns the security in
question the latter is liable in damages, unless the defendant
proves that the plaintiff knew the facts concerning the
untruth or omission or that the defendant exercised reasonable
care and did not know (or if he had exercised reasonable care
would not have known) of the untruth or omission. Moreover,
Civil Code Section 1689 provides for contract rescission by a
party to the contract in specified cases, including, among
others: (1) where the consent of the party rescinding was
given by mistake, or obtained through duress, menace, fraud,
or undue influence, as specified; and (2) where the contract
is unlawful for causes which do not appear in its terms or
conditions, and the parties are not equally at fault.
In light of those considerations, the ability to rescind the
AB 2081 (Allen)
Page 15 of ?
purchase under this bill does not appear inconsistent with
existing law. The following amendment is suggested, however,
to correct a drafting error.
Suggested Amendment :
On page 19, line 17, strike "recession" and insert
"rescission"
c. Additional enforcement tools required
Similar to the investor protections discussed in Comment 2(a),
the enforcement tools contained in the bill appear to be
arguably incomplete given the potential for serious financial
damage if an issuer violates the requirements of the
exemption. For example, it appears arguably appropriate for
any issuer using the proposed exception to bear the burden of
proof to demonstrate that the offering or sale complied with
the requirements described above. From a policy standpoint,
placing the burden on the issuer is arguably appropriate since
that person or entity chose to use the exemption, without
oversight, and essentially self-certified that the exemption's
requirements were met. Furthermore, given the lack of
oversight, it appears appropriate to enact strong penalties to
deter any issuer who contemplates violating the proposed
investor protections, and to ensure individuals who are the
victims of fraud are able to seek appropriate relief for those
bad acts.
Accordingly, the Committee should consider the following
amendments to improve the enforcement measures and remedies
available to an investor:
provide that the issuer (who used the exemption) has the
burden of proof to demonstrate that the offering complied
with the requirements of the exemption;
clarify that the investor may bring an action for any
remedy currently provided for under the law, including
fraud, and clarify that the court shall award attorney's
fees and costs to a prevailing purchaser in any such action
and may award treble or punitive damages; and
require that issuers utilizing this proposed exemption
also pay a $5 fee to be placed in the Victims of Corporate
Fraud Compensation Fund, which corporations pay into and is
used to pay restitution to victims of corporate fraud who
are unable to get judgments fulfilled by the judgment
AB 2081 (Allen)
Page 16 of ?
debtor corporation for various reasons.
4. Fundamental issues regarding ability of purchasers to seek
redress
Although the amendments discussed in Comments 2(b) and 3(c)
arguably increase investor protection, any purchaser who loses a
significant amount of his or her net worth due to an
unscrupulous issuer could face difficulty in recovering the
damages owed pursuant to this bill. That difficulty arises from
the reality that any investor is unlikely to question a
transaction as long as the business is successful (and there is
a return on investment). If a business that was portrayed as
promising suddenly fails (thus leaving the person with a
valueless security), investors may at that point seek legal
advice to examine the transaction. Thus, any investor seeking
to bring an action for violation of this bill likely would be
doing so against a business that is having serious financial
trouble and after a potentially significant amount of time. Due
to the lack of assets and potential lapsing of the applicable
statute of limitations, those injured investors would appear to
face significant difficulties in recovering any damages lawfully
owed to them under the enforcement provisions of this bill.
With respect to this issue, the Committee should consider
whether the above increased investor protections sufficiently
protect an investor given the potential difficulties that
individuals may face when seeking to enforce those protections.
Furthermore, the Committee may wish to consider whether it would
be appropriate to amend the bill in order to allow a court to
equitably toll the statute of limitations, and, to specifically
provide that individuals directly involved in the violation are
personally liable for their actions.
5. Potential preemption issues
The issue has been raised that this bill may be preempted by
federal law, given the passage of the Jumpstart Our Business
Startups Act of 2012 (JOBS Act), and other existing provisions
of federal securities laws and regulations that limit the
authority of states over covered securities.
The issue of federal preemption under the Supremacy Clause in
the U.S. Constitution is one of both express preemption (when a
federal statute explicitly confirms Congress's intention to
preempt state law) and implied preemption (which can arise in
AB 2081 (Allen)
Page 17 of ?
two ways: where the federal law is so pervasive as to imply that
Congress intended to "occupy the field" in that area of law or
where there is a conflict between federal and state law).
As background, the federal government has passed numerous Acts
providing for federal securities laws and regulations, starting
with the Securities Act of 1933 and leading up to the JOBS Act.
At the same time, every state has its own securities laws,
called "Blue Sky Laws," that are designed to protect investors
against fraudulent sales practices and activities. While these
laws can vary from state to state, most states' laws, including
California's Corporate Securities Law of 1968, typically require
companies making small offerings to register offerings before
they can be sold in that state.
Where federal law exempts registration of certain securities,
Blue Sky Laws requiring registration or qualification are
expressly preempted under the National Securities Market
Improvement Act (NSMIA) of 1997. Thus, the issue arises as to
whether the exemption created by the JOBS Act and its
corresponding regulations would preempt any state laws
attempting to provide for similar, but potentially conflicting,
exemptions. A corporate attorney advising the author and sponsor
of this bill writes that "Rule 506 of Regulation D is the only
private offering exemptive rule promulgated by the SEC for which
state regulation is pre-empted by Section 18. . . . AB 2081 is
specifically authorized by federal rule 504(b)(1)(iii) which
provides:
'(b) Conditions to be met. (1) General conditions. To qualify
for exemption under this �Section] 230.504, offers and sales
must satisfy the terms and conditions of �Sections] 230.501
and 230.502 (a), (c) and (d), except that the provisions of
�Section] 230.502 (c) and (d) will not apply to offers and
sales of securities under this �Section] 230.504 that are
made: . . .'
'(iii) Exclusively according to state law exemptions from
registration that permit general solicitation and general
advertising so long as sales are made only to "accredited
investors" as defined in �Section] 230.501(a).'
Therefore, AB �2081] is not pre-empted by any law or rule . . .
."
Despite this assertion, it remains unclear why Rule 506 and the
impending regulations could not be construed by some to preempt
AB 2081 (Allen)
Page 18 of ?
this bill. To the extent that this bill is attempting to
provide an alternative to the recently enacted federal law and
unknown pending regulations, the determination of whether or not
this bill is preempted is ultimately for the courts.
6. Sunset date needed to evaluate abuse as the result of
authorizing exemption
To allow the Legislature to evaluate the effects (including
abuse) of the proposed exemption, and to provide an opportunity
to review this law in light of the impending SEC regulations,
the following amendment is suggested to add a three-year sunset
to this exemption:
Suggested Amendment :
On page 20, after line 27, insert "This subdivision shall
remain in effect only until January 1, 2016, and as of that
date is repealed, unless a later enacted statute, that is
enacted before January 1, 2016, deletes or extends that date."
7. Chaptering-out issues
As noted in the Senate Banking and Finance Committee Analysis,
SB 978 (Vargas) would also amend Section 25102 of the
Corporations Code, among other things. The author may wish to
add double-jointing amendments to avoid chaptering out of this
bill's provisions in the event that both bills are enacted.
8. Suggested amendments
The following would effectuate the amendments suggested in
Comments 2 and 3:
Suggested Amendments :
On page 17, line 27, after "(3)" insert "(A)"
On page 17, after line 30, insert "(B) an issuer shall not
solely rely on the questionnaire in making the determination
of whether the person is an accredited investor and the
offering is suitable to that person.
(C) The issuer shall maintain the confidentiality of any and
all information in the questionnaire and not otherwise sell,
distribute, or use the information in that questionnaire for
AB 2081 (Allen)
Page 19 of ?
any other purpose than to assist in establishing the
suitability of that investor for that particular offering.
Violations of this paragraph shall result in disqualification
of the offering and from the future use of this exemption
under this subdivision by the issuer."
On page 18, after line 3, insert "(6) (A) The issuer shall
provide to the person, in writing, at minimum the following:
(i) information detailing its business, its properties, its
competition, the identity of its officers and directors and
their compensation, material transactions between the company
and its officers and directors, material legal proceedings
involving the company or its officers and directors, the plan
for distributing the securities, and the intended use of the
proceeds of the offering; (ii) disclosures of all risk factors
associated with the offering, including, but not limited to,
lack of business operating history, adverse economic
conditions in a particular industry, lack of a market for the
securities offered, and dependence upon key personnel, and
(ii) a statement detailing the financial condition of the
issuer and supporting documentation.
(B) Upon providing this information to the investor, there
shall be a mandatory 24 hour waiting period before a sale can
be made and the investor shall have the right to void the
contract within the first 72 hours of the sale."
On page 18, line 5, renumber "(6)" to "(7)" and continue
renumbering.
On page 18, lines 6 and 10, strike "10 percent" and insert "5
percent"
On page 18, line 7, after "spouse" insert "or domestic
partner"
On page 18, line 34, after "only" insert ", and the offering
is not subject to qualification with the Commissioner of
Corporations under the exemption provided in Corporations Code
Section 25102(r)."
On page 18, lines 34 through 37, strike "For purposes of this
subdivision 'publicly disseminated' means communicated to 100
or more persons or otherwise communicated, used, or circulated
in a public manner."
AB 2081 (Allen)
Page 20 of ?
On page 19, line 3, after "only" insert ", and the offering is
exempted from the qualification requirements of Section 25110
of the Corporations Code under the exemption provided for in
Section 25102(r)."
On page 19, before line 9, insert "(13) An issuer shall
maintain a copy of any advertisement or solicitation, and any
other offering material, for four years."
On page 19, line 9, renumber "(12)" to "(14)" and continue
renumbering.
AB 2081 (Allen)
Page 21 of ?
On page 19, line 12, after "securities in this state." insert
"Upon filing of this notice, the issuer shall also pay a $5
fee to be directed to the Victims of Corporate Fraud
Compensation Fund."
On page 19, line 14, after the newly renumbered "(15)" insert
"(a) A person who purchases securities in an offering that
fails to meet all the terms and conditions of this subdivision
may bring an action under Sections 25503, 25504, and 25504.1
for rescission of the purchase and any other remedy provided
in those sections.
(b) Any purchaser of a security pursuant to this subdivision
may bring an action against anyone who employs, directly or
indirectly, any device, scheme, or other artifice to defraud
in connection with the offer, purchase or sale of any security
issued under this subdivision.
(c) A person who purchases securities in an offering under
this subdivision that fails to meet all the terms and
conditions of this subdivision may also bring an action to
seek any other remedies available at law.
(d) In any action by a purchaser under this subdivision, the
issuer shall have the burden of proof to demonstrate that the
requirements of the exemption under this subdivision were met.
(e) The court shall award attorney's fees and costs to a
prevailing purchaser in any such action and may award treble
or punitive damages."
On page 19, strike lines 14-19.
On page 19, line 21, renumber "(14)" to "(16)" and continue to
renumber through the end of the bill.
On page 19, lines 34-35, strike "Within the 5 years" and
insert "Within the 10 years"
On page 19, lines 39-40, strike "Within the five years
immediately prior to the first offer of the security, the" and
insert "The" and on page 20, line 2, after "security" insert
", or is subject to any order, judgment, or decree of any
court of competent jurisdiction involving the commission of
elder or dependent adult financial abuse"
AB 2081 (Allen)
Page 22 of ?
On page 20, lines 4-5 strike, "within the five years" and
insert "within the 10 years"
On page 20, lines 9-10 strike, "within the five years" and
insert "within the 10 years"
Support : None Known
Opposition : American Association of Retired Persons; Public
Investors Arbitration Bar Association
HISTORY
Source : Small Business California
Related Pending Legislation : None Known
Prior Legislation :
SB 875 (Price, 2010) was substantially similar to prior versions
of this bill and would have exempted offerings or sales of
securities that used general solicitation or advertising if the
transaction met specified requirements, and the issuer believed,
after reasonable inquiry, that the person was an accredited
investor, as defined. The bill died in the Senate Banking and
Financial Institutions Committee without a hearing.
AB 1674 (Campbell and Briggs, 2001) was similar to AB 875
(Price, 2010) and contained several requirements similar to
those that are in this bill. The bill died in the Assembly
Banking and Finance Committee.
Prior Vote :
Senate Banking & Financial Institutions Committee (Ayes 4, Noes
2)
Senate Banking & Financial Institutions Committee (Ayes 6, Noes
0), Reconsideration vote
Senate Banking & Financial Institutions Committee (Ayes 2, Noes
2), Failed passage
Assembly Floor (Ayes 69, Noes 4)
Assembly Appropriations Committee (Ayes 17, Noes 0)
Assembly Banking & Finance Committee (Ayes 7, Noes 1)
AB 2081 (Allen)
Page 23 of ?
Assembly Banking & Finance Committee (Ayes 5, Noes 0), Failed
passage, Reconsideration granted
**************