I. The Sale of Unregistered Securities.
A. TSA ' 33A(1) prohibits the sale of securities in this state unless they are registered or exempt from registration: TSA ' 33A(1) provides in part: “A person who offers or sells a security in violation of Section 7 *** of this Act is liable to the person buying the security from him, who may sue in law or in equity for rescission or for damages if the buyer no longer owns the security.” Section 7 prohibits the sale of an unregistered security unless there is an available exemption from registration. Liability based on this type of claim is not dependent on fault or even causation in the traditional sense.
B. Definition of Securities. The term “securities” is broadly defined by TSA ' 4A:
“The term security or securities shall include any limited partner interest in a limited partnership, share, stock, treasury stock, stock certificate under a voting trust agreement, collateral trust certificate, equipment trust certificate, pre‑organization certificate or receipt, subscription or reorganization certificate, note, bond, debenture, mortgage certificate or other evidence of indebtedness, any form of commercial paper, certificate in or under a profit sharing or participation agreement, certificate or other evidence of indebtedness, certificate or any instrument representing any interest in or under an oil, gas or mining lease, fee or title, or any certificate or interest representing or secured by an interest in any or all of the capital, property, assets, profits or earnings of any company, investment contract or any other instrument commonly known as a security, whether similar to those herein referred to or not.”
C. Required Proof.
- A sale by the defendant. The requirement in ' 7 that the prohibited sale be made by a “dealer or agent” has been effectively read out of the statute by a broad interpretation of the term “dealer.” See I E 1(b), infra.
- To the plaintiff
- Of a security
- That is not registered
- And not exempt from registration.
D. Authorities. These required elements of proof are stated or implied in the following: TSA '33A(1) as applied to Section 7; Searcy v. Commercial Trading Corp., 560 S.W.2d 637, 639 (Tex.1978); Brown v. Cole, 291 S.W.2d 704, 707 (Tex.1956); Busse v. Pacific Cattle Feeding Fund #1, Ltd., 896 S.W.2d 807, 814 (Tex.App. -Texarkana 1995, writ denied); Jones v. Latham, 671 S.W.2d 612, 614 (Tex.Civ.App. -Eastland 1984, writ ref’d n.r.e.); Lintz v. Eastmam Dillon, et al, 568 S.W.2d 147, 151 (Tex.Civ.App. -Beaumont 1978, reversed on other grounds, 582 S.W.2d 394 (Tex.1979)); Ladd v. Knowles, 505 S.W.2d 662, 666‑667 (Tex.Civ.App.-Amarillo 1974, writ ref’d n.r.e.)(This case adds a non‑statutory defense of knowledge discussed in I H 2(b), infra.)
E. Plaintiff's Elements.
- Plaintiff must prove a purchase of an unregistered security from the defendant.
(a). Plaintiff must prove that he purchased a security from the defendant. This element can usually be proven by financial records. Plaintiff must also establish that the security was not registered with the Commission. This fact may be established by the records of the Commission and is seldom contested. The term “purchaser” is broadly interpreted by the courts to accomplish the remedial purposes of the Act. It is not uncommon in the sale of a security for someone other that the person who provided the funds for the purchase to be shown as the owner, such as a stock‑broker or other type of agent or nominee. A purchaser does not necessarily have to show that he is the record owner of the security after the sale in order to have standing to pursue a claim under TSA. Indeed, under the Act, an agent may also qualify as a purchaser. A good example of this dichotomy is where stock is purchased and held by a clearing house for the account of the broker‑dealer, commonly referred to as being held in “street name.” The transfer records of the company will show the broker‑dealer or Cede (the custodian for DTC, the largest clearing house) as the owner. Records kept by the broker‑dealer, however, will identify the true owner. In Summers v. WellTech, Inc., 935 S.W.2d 228, 233 (Tex.App.-Houston [1st Dist.] 1996, no writ), the purchase was paid for by someone other than the record owner; nevertheless, the record owner qualified as the purchaser. The court relied on federal case law to reach this conclusion, citing Lewis v. Walston & Co., 487 F.2d 617, 622 (5th Cir. 1973) and Monetary Mgmt. Group v. Kidder, Peabody & Co., 604 F.Supp. 764, 768 (E.D. Mo. 1985).
(b). Defendant must be a seller. This element will usually require proof from the plaintiff that identifies the person or persons he dealt with in the purchasing process. Although the prohibition in TSA ' 7 is directed at Adealers and agents,” the statutory definition of the term “dealer” is sufficiently broad that any person (or entity) selling an unregistered security will be subject to liability under this section of TSA. See Busse v. Pacific Cattle Feeding Fund #1, Ltd., 896 S.W.2d 807, 814 (Tex.App.-Texarkana 1995, writ den’d); Brown v. Cole, 291 S.W.2d 704, 707 (Tex. 1956); Cosner v. Hancock, 149 S.W.2d 239, 243 (Tex.Civ.App.-El Paso 1941, writ dism’d). But see Stone v. Enstam, 541 S.W.2d 473, 479 (Tex.Civ.App.-Dallas 1976, no writ). A vendor selling his own securities, however, may have an exemption if the circumstances satisfy TSA ' 5C(1)(limited sales by a non‑issuer). The federal definition of “dealer” includes a requirement that the dealer be in the business of selling securities. See 15 USCA ' 77b(c)(12). The Texas definition does not. See TSA ' 4
(c). At all events, under vintage case law, a seller could be anyone who participated as “a link in the selling process.” See Brown v. Cole, 291 S.W.2d 704, 708 (Tex.1956). In that case the Court held that a promoter‑investor was a “link in the selling process” and deemed to be a seller. In 1992, that holding was applied in Lutheran Brotherhood v. Kidder, Peabody & Co., Inc., 829 S.W.2d 300, 306 (Tex.App.‑‑Texarkana 1992, writ granted by agreement), 840 S.W.2d 384 (Tex. 1992) (court of appeals decision overturned without consideration of the merits). In Texas Capital Securities, Inc. v. Sandefer, 58 S.W.3d 760, 765‑766 (Tex.App.-Houston [1st District] 2001, petition denied), the latest case to consider this issue, the principles stated in Cole were applied to render a remote promoter liable for the sale of unregistered securities.
A sale is defined by TSA ' 4E as follows:
“The terms 'sale' or 'offer for sale' or 'sell' shall include every disposition, or attempt to dispose of a security for value. The term 'sale' means and includes contracts and agreements whereby securities are sold, traded or exchanged for money, property or other thing of value, or any transfer or agreement to transfer, in trust or otherwise. Any security given or delivered with or as a bonus on account of any purchase of securities or other thing of value, shall be conclusively presumed to constitute a part of the subject of such purchase and presumed to have been sold for value. The term 'sell' means any act by which a sale is made, and the term 'sale' or 'offer for sale' shall include a subscription, an option for sale, a solicitation of sale, a solicitation of an offer to buy, an attempt to sell, directly or by an agent, by a circular, letter, or advertisement or otherwise, including the deposit in the United States Post Office or mail box or in any manner in the United States mails within this State of a letter, circular or other advertising matter. Nothing herein shall limit or diminish the full meaning of the terms 'sale,' 'sell' or 'offer for sale' as used by or accepted in courts of law or equity.”
An issue inquiring whether the defendant “was a person who made a sale of a security to the plaintiff” or an inquiry “did defendant sell a security to the plaintiff,” satisfies the statutory requirements if the terms are properly defined. A decision from the Houston Court calls into question this expansive concept of “seller.” See Frank v. Bear, Stearns & Co., Inc., 11 S.W.3d 380, 383 (Tex.App.-Houston [14th Dist.] 2000, review denied). The Frank court held that, in addition to the actual seller who passes title to the plaintiff (privity), only those who control the seller or aid the seller, as those terms are defined in TSA ' 33F(1) and ' 33F(2), can be held liable on the same basis as a seller, relying on the Comments to the 1977 amendments to TSA. In this respect, however, the Comments inaccurately state the legislative history. Indeed, the Comment relied on by the Frank court was not submitted to the legislature with the proposed bill. See TSA '33, Draft 12‑November 21, 1976 (final‑as‑enacted). The accurate legislative history shows that the identification of a seller was to be determined by reference to federal law, and in 1977 the most widely utilized federal standard for determining seller status was a proximate cause or substantial factor test. See Bromberg, Civil Liability Under Texas Securities Act ' 33 (1977) and Related Claims, 32 S.W. L. J. 867, 884‑885 (1978); Huddleston v. Herman & MacLean, 640 F.2d 534, 551 (5th Cir. 1981). Frank is wrongly decided, but its progeny just growed and growed. See Millcreek Associates, L.P. v. Bear Stearns & Co., Inc., 205 F.Supp.2d 665, 676 (W.D. Tex. 2002).
(c). Security. As shown by the statutory definition this term potentially includes every type of monetary transaction in which the purchaser acquires a passive interest in an investment opportunity. A written document is not necessary to prove the existence of a “security.” See Tex Civ. Stat. Art. 581‑4 (Supp. 2003). The term includes items not commonly thought to be a security.
(1). What is a security?
(i). Stock is a security. In common parlance a traditional security is an investment medium where the purchase money for an ownership interest in an enterprise is used by the enterprise to make money without significant participation by the purchaser. See Busse v. Pacific Cattle Feeding Fund #1 Ltd., 896 S.W.2d 807, 814 (Tex.App.-Texarkana 1995, writ denied). Included are mineral interests and any certificate or interest representing or secured by any or all of the capital, assets, property, profits or earnings, of any company.
(ii). Investment contracts are securities. The existence of an “investment contract” is dependent on whether the efforts made by those other than the investor are significant and are “the managerial efforts which affect the failure or success of the enterprise.” See Searsy v. Commercial Trading Corp., 560 S.W. 2d 637, 641. (Tex. 1978). A limited partnership interest falls in this category.
(iii). Evidence of indebtedness is a security. The Searcy court defined “evidence of indebtedness” as “all contractual obligations to pay in the future for consideration presently received,” relying on the language in United States v. Austin, 642 F.2d 724, 736 (10th Cir. 1972). Id. at 641‑642. Included in this category are bonds, notes, mortgages, commercial paper, and debentures.(iv). Catch all. Any other instrument commonly known as a security is included whether similar to any of the listed items, or not.
(v). Most of the specific items listed in the definition of a security can usually be identified, and a sale of an interest in one of them will be considered the sale of a security. The exception to this generality is the determination whether a note or bill of exchange is a security. There is a presumption that notes and bills of exchange are securities. A contest on this issue will involve the use of the “family resemblance” test, which requires application of criteria developed by the federal courts to assist in the determination. See Grotjohn Precise Connexiones Int'l v. JEM Fin., Inc., 12 S.W.3d 859, 868 (Tex.App.‑‑Texarkana 2000, no petition) (citing Reeves v. Ernst & Young, 494 U.S. 56 (1990)).
(2). What isn’t a security?
(i) Joint venture is not a security. A joint venture interest or agreement is not a security. See Russell v. French & Assocs., Inc., 709 S.W.2d 312, 314 (Tex.App. Texarkana 1986, writ ref’d n.r.e.)
(ii). General partnership interest is not a security. A general partnership interest or agreement is not a security. Ibid.
(iii). Specific exclusions that are not securities. TSA ' 4(A), specifically excludes insurance policies, annuity contracts, endowment policies, and optional annuity contract, issued by a state supervised insurance company.
(d). Registration. Defendant did not register the security before selling it. This fact may be proven by records of the Commissioner. See McQueen v. Belcher, 366 S.W.2d 670, 672 (Tex.Civ.App.‑‑Amar. 1963, no writ). Indeed there is a specific provision in TSA permitting such proof. See TSA ' 30. There are three different ways to obtain authorization to sell a security in Texas: Qualification: TSA ' 7A, requires the filing with the Commissioner of substantial financial data and the company’s business plan. A prospectus must be provided to the purchaser. If the commissioner is satisfied with the provided documents, a permit will be issued. Notification: TSA ' 7B, is used by companies that have been in business for more than 3 years and show an operating profit. After reviewing the submitted data, the Commissioner will, if satisfied, enter an Order approving the registration, and the security will be deemed registered. Coordination: TSA ' 7C, is available to companies whose securities have been approved or submitted for approval by the SEC. This type of registration becomes effective on the date the SEC approves the federal registration.
(e). Exemption. The party claiming an exemption from registration has the burden of proof on the issue. The defendant, therefore will be put to proof of an exemption after plaintiff establishes items 1‑4. See Brown v. Cole, 291 S.W.2d 704, 711‑712 (Tex. 1956); Tex. Capital Securities, Inc. v. Sandefer, 58 S.W.3d 760, 777‑778 (Tex.App.‑‑Houston [1st Dist.] 2001, review denied). But see Dean v. State, 433 S.W.2d 173, 178 (C.C.A. 1968). The securities that must be registered with the Commissioner are those not exempt under state law and not “covered” under federal law.
(1). What securities are “covered” under federal law.
(i). Listed securities are covered by federal law and are not subject to state registration or regulation requirements. All securities listed on a National Securities Exchange or on a Regional Exchange having listing requirements equivalent to those imposed by the National Exchanges are “covered” securities. See 15 USCA ' 77r(b)(1).
(ii). Exempt Securities are covered by federal law and are not subject to state registration or regulatory requirements. Securities exempt from federal registration by a federal exemption (excluding sales to accredited investors authorized by ' 77d(6)) granted under Section 3 or Section 4 of the Securities Act of 1933, 15 USCA ' 77c and ' 77d, are “covered” securities. See 15 USCA '77r(b)(4).
(iii). Any sale to a qualified purchaser or a registered investment company involves a covered security and is not subject to state registration or regulatory requirements. From a transaction standpoint any sale to a “qualified” purchaser involves a “covered” security as does any sale of securities to a registered Investment Company. See 15 USCA '77r(b)(3) and (b)(2), respectively. Securities exempt under '77d(6) (limited sales to accredited investors) are not “covered” securities under ' 77r. The recently proposed definition of “qualified purchaser” uses the same criteria that identify an accredited investor, and no significant expansion of federal immunity would occur. See Proposed Rule, SEC Release No.33‑8041, File No.87‑23‑01. This is so because sales by an issuer to sophisticated investors (a classification that, for all practical purposes, includes accredited investors) are already “covered” transactions if there is no public solicitation. See Section 4(2) of the 33 Act, 15 USCA ' 77d(2). If the SEC were to adopt a more expansive definition of “qualified purchaser” federal preemption could be dramatically increased.
(iv). These preemptive rules do not apply to remedies provided by the company’s state of incorporation. See 15 USCA ' 77r(a)(2)(13).
(2). What's left for the state to regulate? What is left for state regulation or registration requirements, from a federal exclusory standpoint, are securities sold under limited offering exemptions authorized by ' 77c(b) and intrastate sales under ' 77c(a)(11). These are securities marketed under Regulation A (17 CFR ' 230.251‑263); Regulation D (17 CFR ' 230.501‑508) (except Rule 506); and intrastate sales under Section 3(a)(11) of the 33 Act, 15 USCA ' 77c(a)(11). Federal law does not restrict state regulation of fraudulent conduct. See 15 USCA 77r(c)(1)
(f). State exemptions. Exemptions for types of transactions and types of securities are provided by the Act. See TSA ' 5 and ' 6. An in depth analysis of these state exemptions is reported elsewhere. See Crawford, Exemptions Update Under Texas Law, 35‑WRT Tex.J.Bus.Law 1 (1999) ( Ms. Crawford has been the Texas Securities Commissioner for more than ten years.). There is, however, considerable confusion over the registration requirements for private sales that do not involve the issuer. The exemption for private sales of this type under federal law is ' 4(1) and 4(12) of the 33 Act, although the latter section is a fictitious reference. The existing federal provision, Section 4(1), states that registration is not required for sales of securities by persons who are not issuers, brokers, or underwriters. See 15 USCA ' 77d(1). And see, Schneider, ' 4(12), Private Resales of Restricted or Controlled Securities, 49 Ohio St. L. Rev. 501 (1988), for a detailed review of the federal provisions. Texas does not have a similar exemption. Texas case law involving private sales by independent investors is sparse. One court has said that the Act is intended to cover the private sale of all of the stock in a corporation to an investor or investors. See Anheuser‑Busch Cos. v. Summit Coffee Co., 858 S.W.2d 928, 940‑41 (Tex.App.-Dallas 1993, review denied)(remanded for reconsideration, 514 U.S. 1001 (1995)(holding reaffirmed, 934 S.W.2d 705 (Tex.App.-Dallas 1996, writ dism’d by agreement). The Houston court indicated otherwise in Joachim v. Magids, 737 S.W.2d 852, 855 (Tex.App.‑‑Houston [1st ] 1987, writ denied). The fact is, however,that the only exemptions available to a typical owner of securities are TSA '' 5C, 5H, and 6F. But there is no reason why Texas could not use the same sensible approach used under the federal system. It is at least noteworthy that State Securities Board has adopted by regualtion an exemption for the sale of securiteis by an owner who is not an issuer. See TAC Title 7, Part 7, Chapter 139, Rule ' 139.14. This regulation is said to be authorized by TSA ' 5T, and it permits 15 sales by an owner during any 12 month period. I cannot think of any good reason why the regulation might be considered invalid, although I have found no reference to it in the court cases.
(g). While unlikely, it is possible that the non‑statutory defense recognized in Ladd v. Knowles, supra, 505 S.W.2d at 668, will be canonized in this state. If so there will be an additional issue whether the plaintiff knew or should have known that the securities had not been registered.
1. Actual damages. The Act permits rescission or damages based on rescission if the security is no longer owned by the purchaser, sometimes referred to as “out of pocket” damages. No recovery is authorized under the Act for “benefit of the bargain” damages. TSA ' 33D. The “benefit of the bargain” issue arises in a registration case only when a TSA claim is joined with a common law or statutory claim that does authorize such a recovery. Necessarily the misrepresentation or omission would relate to the registration or exemption of the security. If the buyer prevails on both damage theories, he will be required to elect between them. See, e.g., Formosa Plastics Corp. v. Presidio, 941 S.W.2d 138, 151 (Tex.1995).
2. No exemplary damage. The Act permits the recovery of exemplary damages only if provided by some other applicable remedy, like fraud. TSA ' 33M.
3. Equitable remedies other than rescission. A private litigant can not obtain injunctive or similar relief. Those remedies are available only to the Attorney General or the Commissioner acting on his own. See TSA ' 32A and B.
4. Interest. Recovery or payment (in the instance where money is owed to the defendant in the rescission process) of interest at the legal rate is authorized by the Act. TSA ' 33D. This legal rate is set by ' 302.002, Texas Finance Code. Currently the rate is 6% per annum.
5. Costs. Court costs are recoverable. TSA ' 33D(6).
6. Attorney fees. Attorney fees may be recovered if the court determines that such an award would be equitable. TSA '33D(7). These fees must be allocated appropriately as is required in other situations. See Geodyne Energy, etc. v. The Newton Corp., 97 S.W.3d 779, 883 (Tex.App.-Dallas 2003, petition denied).
7. Criminal conduct. Violations of TSA can lead to serious criminal charges. See TSA ' 29.
G. Jury Charge. There is no pattern jury charge for this cause of action, but there are only six possible inquiries under the statute. (1). Did Defendant sell (2) to Plaintiff (3) a security? If so, (4) was the security registered with the Commission? If not, (5) was the security exempt from registration? If not, (6) what damages did Plaintiff sustain? There is always a possibility that a defendant will dispute the plaintiff's underlying factual allegation that are evidentiary of a sale. In that event a jury issue may be necessary to resolve the conflict. For example, if the defendant denies that there was any solicitation involved in the transaction, an issue could be submitted to resolve that dispute. In the usual case where one or more elements of each of these ultimate facts is contested, the jury issues would be:
Issue No. 1: Did Defendant sell a security to the Plaintiff? “Sell” and “security” would be defined by the statutory definitions.
Issue No. 2: Was the security, if you have so found, registered with the Commissioner and a permit issued?
Issue No. 3: Has the Defendant proved that the security, if you have so found, was exempt from registration?
Issue No. 4: What are Plaintiff's damages? “Damages” would be defined in accordance with the statute.
See Bromberg, Civil Liability Under Texas Securities Act ' 33 (1977) and Related Claims, 32 S.W. L. J. 867, 901‑902 (1978). In a Registration case these issues should normally be questions of law.
(a). Limitations. Three years. A plaintiff has three years from the date of sale of the unregistered security to file suit if no offer of rescission is made. TSA ' 33H(1)(a).
(b). Offer of rescission. TSA contains provisions that are truly a trap for the unwary plaintiff. If the defendant makes an offer to rescind the transaction complying with TSA ' 33I or ' 33J, a plaintiff must reject the offer in writing within 30 days of its receipt, and the rejection must expressly state that the right to sue is reserved. Failure to do so terminates the plaintiff’s right to pursue a legal claim. If this occurs the sole remedy is to accept the offer. TSA ' 33H(1)(b). Even if rejected in writing the rejection of the offer initiates a one year limitation period for filing suit.TSA ' 33H(1)(c).
2. Non Statutory.
(a). Standing. While technically not a defense, a plaintiff must nevertheless qualify as a purchaser from the defendant or defendants (who must be a “sellers”) to have a cause of action under this part of TSA. In other words only the first wave of buyers may sue the seller or sellers. This “privity” requirement has been criticized but remains the only viable means to reduce a defendant’s potentially unlimited strict liability. See Goode, The Reduction of Seller Liability Under the Securities Act of 1933, Good News for Securities Professionals, 46 Wash. & Lee L. Rev. 627 (1989). The privity required is that between the purchaser and those who are “links in the selling process.”
(b). Plaintiff's Knowledge. Plaintiff's knowledge or sophistication is irrelevant. See Lintz v. Eastman Dillon et al, supra, 458 S.W.2d at 151. State securities laws are patterned after the federal securities laws that seek to establish and maintain an orderly market for securities and that require disclosure of material risks. The primary purpose of TSA, however, is to protect the investor by regulating the purchases and sales of securities in this State and to punish the defendant for violating the Act. See TSA ' 10(1)(b); Anheuser‑Busch Cos. v. Summit Coffee Co., supra, 858 S.W.2d at 940‑41. Thus, the purchaser’s knowledge that the securities were not registered or his failure to investigate to determine the registration status is irrelevant. See e.g., Stinner, Estoppel and in Pari Delicto Defenses to Civil Blue Sky Actions, 73 Cornell L.Rev. 448 (1988). Nevertheless, the court in Ladd v. Knowles, 505 S.W.2d 662, 668 (Tex.Civ.App. -Amarillo 1974, writ ref’d n.r.e.) held that actual knowledge, or knowledge that could have been acquired by the exercise of ordinary care, of the unregistered status of the security put plaintiff in pari delicto with the defendant and that disqualified him from relief under the Act. This was an alternative holding, and most other courts considering this issue have concluded otherwise. See Lintz v. Eastman Dillon et al, supra, 458 S.W.2d at 151. See Stinner, supra, 73 Cornell L.Rev. at p. 462. Stinner analyzes reported decisions from various states and concludes that knowledge of the violation without additional participation in management is, or should be, insufficient to defeat the claim. Id. at 462‑467. A case directly in point is Dunn v. Bemire Petroleum, Inc., 680 S.W.2d 304, 306‑307 (Mo.App.1984) (Defendant should not evade liability by simply telling the purchaser that the stock is not registered). E.g. Southwestern Drilling v. Parr, 1987 U.D. Dist. Lexis 16054 (W.D. Okla. 1987); Hall v. Johnston, 758 F.2d 421 (9th Cir. 1985); Caldwell v. Trans‑Gulf Petroleum Corp., 311 So.2d 80 (La App. 1975). Federal law is also inconsistent with Ladd v. Knowles. See e.g. Pinter v. Dahl, 486 U.S. 622, 639 (1988) (“[E]ven where a plaintiff actively participates in the distribution of unregistered securities, his suit should not be barred where his promotional efforts are incidental to his role as an investor.”) Be that as it may this decision by the Amarillo court has not been questioned by any later Texas case. But it has not been cited on this point either. There is a specific provision in TSA that could, if applicable, support the Ladd decision. The Ladd court in fact refers to it. TSA ' 33K makes unenforceable any contract that the person asserting contract rights knew would violate a provision of the Act. This provision, however, does not negate the statutory remedy. See Bromberg, supra, 32 S.W.L.J. at 911. It impacts only contract rights. Thus the purchaser could not force the seller to part with the unregistered security. The actual purpose of ' 33K appears to be to prevent enforcement of an underwriter's agreement to distribute the unregistered security or some similar contractual arrangement. The Ladd court cites this provision but fails to analyse it.
(c). Waiver. Substantive rights under the Act cannot be waived. TSA ' 33L.
I. Secondary Liability.
1. Control. The Act contains specific provisions for “control” liability. TSA ' 33F(1) states:
“A person who directly or indirectly controls a seller, buyer, or issuer of a security is liable under Section 33A, 33B, or 33C jointly and severally with the seller, buyer, or issuer, and to the same extent as if he were the seller, buyer, or issuer, unless the controlling person sustains the burden of proof that he did not know, and in the exercise of reasonable care could not have known, of the existence of the facts by reason of which the liability is alleged to exist.”
No definition is provided by TSA for the term “control” although a regulation has been adopted by the Commissioner defining it in the same way as the federal counterpart: “Control‑‑ The power to direct or influence the direction of the management or policies of a person, directly or indirectly, through the ownership of voting securities, by contract , or otherwise.” See TAC Title 7, Part 7, Chapter 113, Rule '113.14(b)(7). Compare the federal version at 17 CFR 230.405. In Busse v. Pacific Cattle Feeding Fund #1, Ltd., supra, 896 S.W.2d at 815, the court purported to apply federal law and held that there is a three‑part test to determine control. The first relates to the general power to control of the business entity. The second is the power to control the specific activity involved in the violation. The third requires that the defendant participate in the conduct that is the basis of the violation. All three must exist, said the court, for control to be found as a fact. The Busse court appears to have gone a little too far in characterizing the elements of control required by federal case law. See Ravkind, We New Wizards of Wall Street, 66 Tex.B.J. 120, 121‑129 (2003). An exhaustive analysis of the federal court decisions is provided by Bromberg. See Bromberg and Lowenfels on Securities Fraud & Commodities Fraud, ' 8:8.5(800), et seq. (2nd ed. 2002). Both the Houston and the Dallas Courts of Appeals have held that participation in the wrongful conduct is unnecessary for control liability to attach. See Barnes v. SWS Financial Services, Inc., 97 S.W.3d 759, 763 (Tex.App.-Dallas 2003, petition denied); Frank v. Bear, Sterns & Co., 11 S.W.2d 380, 384 (Tex.App.-Houston [14th Dist.] 2000, petition denied).
2. Aiding and Abetting. TSA ' 33F(2) provides:
“A person who directly or indirectly with intent to deceive or defraud or with reckless disregard for the truth or the law materially aids a seller, buyer, or issuer of a security is liable under Section 33A, 33B, or 33C jointly and severally with the seller, buyer, or issuer, and to the same extent as if he were the seller, buyer, or issuer.”
This section is the only one in TSA requiring proof of scienter for civil liability to attach, and the Supreme Court has recently addressed this section of TSA. In Sterling Trust Co. v. Adderley, 168 S.W.3d 835 (Tex. 2005), the Court reversed the Ft Worth court’s holding that knowledge of the underlying activity was not a necessary element for “aider” liability to attach. The Supreme Court reasoned that “general awareness” of some illegal conduct by the primary violator was necessary for the imposition of “aider” liability. And the Court further explained that the “aider” need not know of the specific wrong being perpetrated, but must subjectively realize that some character of wrongful conduct was being engaged in. Id. at 837. It is unclear whether the “aider” must realize that he is actually aiding a securities law violation; although it is clear that the conduct aided must be a violation of the securities law. Otherwise, of course, if there was no securities violation by the principal, the “aiding” provision would be inapplicable. In addition, there is a separate line of cases holding that the person providing the aid must be generally aware of his role in the violation. See Goldstein v. Mortenson, 113 S.W.3d 769, 776 (Tex.App.-Austin 2003, no petition.); Frank, supra, 11 S.W.3d at 384. That requirement was also disputed by the Ft Worth court in Sterling Trust Company v. Adderley, 119 S.W.3d 312, 318‑319 (Tex.App. Ft Worth 2003), reversed on other grounds, 160 S.W.3d 835 (Tex. 2005). The Court’s language doesn’t actually reject that concept:
“We therefore hold that the TSA's >reckless disregard for the truth or the law’ standard means that an alleged aider can only be held liable if it rendered assistance >in the face of a perceived risk’ that its assistance would facilitate untruthful or illegal activity by the primary violator. TEX. REV. CIV. STAT. ANN. art. 581‑33F(2); Kolstad, 527 U.S. at 536. In order to perceive such a risk, the alleged aider must possess a >general awareness that his role was part of an overall activity that is improper.' Gould, 535 F.2d at 780.”
Sterling Trust, supra, 168 S.W.3d at 842.
This language suggests that an “aider” need only know that the primary violator is engaging in some character of unwholesome conduct and that his (the “aider’s”) activity is assisting that conduct.
J. Related Matters.
1. Federal Case Law. Federal law also prohiits the sale of unregistered securities. See Section 12(1) of the 33 Act, 15 USCA ' 77l1). Aiding and abetting, however, is not an available private remedy. See Central Bank of Denver v. First Interstate Bank of Denver, 511 U.S. 164 (1994). Central Bank actually involves Section 12(2), but there is no question about the applicability of its rationale to a registration case. See Bromberg and Lowenfels on Securities Fraud & Commodities Fraud, supra, at '8.5(600).
2. Federal Statutory Law. In the mid to late 90’s Congress enacted a number of statutes that restricted available state class action remedies for securities violations. SLUSA (Securities Litigation Uniform Standards Act), PL 104‑353; PSLRA (Private Securities Litigation Reform Act), PL 104‑67; NSMIA (National Securities Market Improvement Act), PL 104‑290.
II. Sale of Securities by Means of Misrepresentations or Omissions.
A. TSA ' 33A(2) prohibits the use of misrepresentations or omissions of material facts in the sale of securities:
“Untruth or Omission. A person who offers or sells a security (whether or not the security or transaction is exempt under Section 5 or 6 of this Act) by means of an untrue statement of a material fact or an omission to state a material fact necessary in order to make the statements made, in light of the circumstances under which they are made, not misleading, is liable to the person buying the security from him, who may sue either at law or in equity for rescission, or for damages if the buyer no longer owns the security.”
B. Required Proof.
1. Defendant sells
2. To plaintiff
3. A security
4. By means of a misrepresentation or omission
5. Of a material fact
C. Authorities. These elements of proof are stated or implied in Tex.Rev.Civ. Stat. art. 581‑33A(2)(TSA ' 33A(2); Geodyne Energy Income Production PartnershipI‑E v. Newton Corp., 97 S.W.3d 779 (Tex.App. Dallas 2003, petition denied); Tex. Capital Securities, Inc. v. Sandefer, 58 S.W.3d 760, 776 (Tex.App.-Houston [1st] 2001, review dism’d); Duperier v. Tex. State Bank, 28 S.W.3d 740, 753 (Tex.App.-Corpus Christi 2000, petition dism’d); Hendricks v. Thornton, 973 S.W.2d 348, 360 (Tex.App.-Beaumont 1998, petition denied); Weatherly v. Deloitte & Bache, 905 S.W.2d 642, 649‑650 (Tex.App.-Houston [14th Dist.] 1995, writ dism’d w.o.j.); Anheuser‑Busch Cos., Inc. v. Summit Coffee Co., 858 S.W.2d 928, 936 (Tex.App.-Dallas 1993, writ denied), remanded for reconsideration 514 U.S. 100 (1995), reaffirmed 934 S.W.2d 705 (Tex.App.-Dallas 1993, writ dism’d by agreement).
D. Jury charge. There is no pattern jury charge for this cause of action. In Duperier v. Texas State Bank, 28 S.W.3d 740 Tex.App.-Corpus Christi 2000, writ dism’d by agreement), the trial court charged the jury as follows:
“Special Question No.1: Did the defendants violate the Texas Securities Act in the sale of the World Bank Notes to Texas State Bank? A person or entity violates the Texas Securities Act by offering or selling a security by means of either: (a) an untrue statement of material fact; or (b) an omission to state a material fact necessary in order to make the statements made, in light of the circumstances under which they are made, not misleading. A prediction in connection with a sale of a security may constitute a material fact if: (a) the speaker does not genuinely believe the statement is accurate; (b) there is no reasonable basis for the speaker’s belief that the statement is accurate; or (c) the speaker is aware of any undisclosed facts that would tend seriously to undermine the accuracy of the statement.” Id. at 746.
The last portion of this instruction relates to fraudulent intent. See TSA ' 4F. And fraudulent intent is relevant only with respect to criminal violations. See TSA ' 29C(1). The application of that standard to a civil violation is inappropriate.
The trial court in Duperier also instructed the jury:
“A fact is material if there is a substantial likelihood that it would have assumed actual significance in the deliberations of a reasonable investor, in that it would have been viewed by the reasonable investor as significantly altering the total mix of information made available. No violation *** occurred if (defendant) has proved by a preponderance of the evidence that (plaintiff) knew of the untruths or omissions or *** (defendant) did not know, and in the exercise of reasonable care could not have known, of any such untruths or omissions.” Ibid.
This instruction mirrors the one used by the federal courts. See Granader v. McBee, 23 F.3d 120, 123 (5th Cir. 1994). The federal definition, however, was developed to apply in cases where reliance, foreseeability and proximate cause are necessary elements of proof. Texas law does not require these elements for liability to attach. E.g., Geodyne, supra, 97 S.W.3d at 783‑785. In Geodyne, in Texas Capital Securities, Inc. v. Sandefer, supra, 58 S.W.3d at 776, and in Weatherly v. Deloitte & Touche, supra, 905 S.W.2d at 649, the courts held that reliance was not an element of proof in a TSA case and approved an instruction of material fact that is perhaps easier for a jury to interpret: “A fact is material if a reasonably prudent investor would want to know about it in making an investment decision.” In Anheuser‑Busch Companies, Inc. v. Summit Coffee Co., 858 S.W.2d 928 (Tex.App.‑‑Dallas 1993, writ denied), the court stated: “An omission or misrepresentation is material if there is a substantial likelihood that a reasonable investor would consider it important in deciding to invest.” Id. at 936. The language approved in Duperier could be misinterpreted as suggesting that foreseeability or causation are elements of this cause of action.
E. Plaintiff's elements.
1. Plaintiff purchased a security from the defendant. To prove an action for violation of TSA ' 33A(2) plaintiff must establish that he purchased a security from the defendant and that the defendant used misrepresentations or omissions in the selling process. (a). Plaintiff. As in a registration case, the plaintiff must purchase a security from the defendant, and the same criteria discussed in part I, above, will satisfy the plaintiff’s burden to establish his status as a purchaser. This relationship is sometimes loosely referred to as the parties being “in privity.”
(b). Defendant. The Plaintiff must prove that the defendant was a seller of the security. That could include any person (or entity) who was a link in the selling process or there could be a more stringent standard applied depending on the outcome of the disagreement described in part I H 2(b), above.
(c). Security. Plaintiff must prove that the transaction involved the sale of a security. The same broad definition of a security applicable in a Registration case is applicable to this cause of action.
(d). Misrepresentations or omissions. Plaintiff must prove that the sale involved the use of misrepresentations or omissions of material facts by the defendant.
(1). What is a “fact?” When the subject matter is an existing circumstance it is reasonable easy to distinguish a fact from opinion or puffery. When the subject matter relates to a future event or circumstance the distinguishing features between fact, opinion and puffery become more obscure. The specificity of the statement (can the statement be determined as true or false) and the relative knowledge of the parties (does the defendant have superior knowledge or has she pretended to have superior knowledge) are the two most referenced criteria for differentiating fact from opinion or puffery. See Marshall v. Kusch, 84 S.W.3d 781, 785 (Tex.App.‑‑Dallas 2002, rev. denied).
(2). What is a material fact? A material fact is one that a reasonable investor would want to know before investing. The applied standard is an objective one, and it is based on what a reasonable investor would want to know.
(e). Must the plaintiff prove scienter, reliance or proximate cause. The short answer is “no.” Case law establishes that the plaintiff need not show that he would have acted differently had he known the true facts. See Summers v. WellTech, Inc., supra, 935 S.W.2d at 235; Anheuser‑Busch Companies, Inc. v. Summit Coffee Co., supra, 858 S.W.2d at 936. Scienter is not required. See Busse v. Pacific Cattle Feeding Fund # 1, LTD., supra, 896 S.W.2d at 815. Nor is reliance a required event. See Weatherly v. Deloitte & Touche, supra, 905 S.W.2d at 649. In Geodyne, supra, 97 S.W.3d at 783‑785, the court discusses all of these issues. There are a few Texas cases stating that the misrepresentation must induce the sale of the security. See Crescendo Investments, Inc. v. Brice, 61 S.W.3d 465, 475‑76 (Tex.App.-San Antonio 2001, no petition). These cases are wrongly decided. Liability is predicated on the misrepresentation of a material fact. And a “material fact” is one that a reasonably prudent investor would want to know. Causation is, therefore, subsumed in the finding of materiality.
F. Remedies. The same remedies available in a registration case are available for this type of claim.
(a). Plaintiff's knowledge. The defendant can escape liability by showing that the plaintiff knew the true facts. If the purchaser has actual knowledge of the true facts that are being misrepresented or omitted her recovery is barred. See TSA ' 33A(2). Imputed knowledge will not suffice. Plaintiff has no duty to investigate the representations or the omissions. See Duperier v. Tex. State Bank, 28 S.W.2d 740, 745 (Tex.App.-Corpus Christi 2000, review dism’d by agreement). This same statement can be found in fraud cases. See, e.g., West v. Carter, 712 S.W.2d 569, 755 (Tex.App.-Houston [14th Dist.] 1986, writ ref’d n.r.e.). At the same time, however, the courts in fraud cases have required a plaintiff to exercise ordinary care after completion of the transaction to uncover the fraud for limitations purposes. See Little v. Smith, 943 S.W.2d 414, 420 (Tex.1997). These differing duties are not inconsistent, however. The language in TSA’s limitations provisions applicable to misrepresentation cases embodies the requirement that plaintiff exercise reasonable care to discover the wrong. See TSA ' 33H(2)(a). But this diligence requirement is applicable only to the limitations issue and comes into play only after the sale or purchase has occurred. See Geodyne, supra, 97 S.W.3d at 786 n. 6; Summer v. WellTech, Inc., supra, 935 S.W.2d at 234.
(b). Defendant's lack of knowledge. The defendant can escape liability if he can show that he did not know the statements made were false and could not have known of their falsity by exercising ordinary care. See TSA ' 33A(2) (c). Limitations. Three or five years. Suit must be brought within three years of discovering the misrepresentation or omission and ordinary care must be used in the discovery process. Five years from the date of the sale is the maximum time period for filing suit. See TSA ' 33H(2)(a) and (b). If an Offer of Rescission is made complying with ' 33H or ' 33I, plaintiff must reject the offer in writing within 30 days of its receipt and specifically state in the written response that her right to sue is reserved in order to preserve her right to sue. See TSA ' 33H(2)(c). Suit must be initiated within twelve months of the rejection of the offer unless the general time limit sooner expires in which event the suit must be brought within the time afforded by the general time limit. See TSA ' 33H(2)(d). The Commissioner has disputed this interpretation provided by the 1977 Comments . She asserts that a plaintiff should have not less than one year to file a claim after rejection of the rescission offer. See Rowley, The Sky is Still Blue in Texas‑State Law Alternatives to Federal Securities Remedies, 50 Baylor L.Rev. 99, 204 n. 80 (1998). A number of courts have regarded the Comments as authoritative. The fact is, however, that the Comments reflect the thoughts of a subcommittee of the State Bar and represents, therefore, only the view of a lobbyist.
2. Non Statutory.
(a). Unclean hands or in pari delicto. This defense is already part of the statute. See part II G 1(a), above.
H. Secondary liability. Vicarious or secondary liability is the same here as described in part I.
I. Related matters. Indirect Fraud. A very interesting question is whether a purchaser may recover for indirect fraud or “fraud on the market” under TSA. Obviously there is no privity between the purchaser and the person commiting the fraud in these types of claims. A cause of action under TSA for indirect fraud was recognized in Texas Capital Securities, Inc. v. Sandefer, 58 S.W.3d 760 (Tex.App.‑‑Houston [1st Distr.] 2001, review denied). An exhaustive contrary view can be found in a New Jersey case. See Kaufman v. I‑Stat Corp., 754 A.2d 1188 (N.J. Sup. Ct. 2000). It may be that this type of claim should simply be viewed as a one falling under the Restatement (2nd) Torts ' 531. See Ernst & Young, LLP v. Pacific Mut. Life Ins. Co., Inc., 51 S.W.3d 573 (Tex. 2001). “Fraud on the market” is a concept announced in Basic, Inc. v. Levinson, 485 U.S. 224, 241‑242 (1988). Its primary purpose is to establish a presumption of reliance when misrepresentations occur that impact the price of a security and the substance or circumstances of the misrepresentations are of a type that the injured investor would be unaware of them. A number of state courts have declined to recognize or apply this presumption while others have responded to it more favorably. See Sanderson, A “Basic” Misunderstanding: How the United States Supreme Court Misunderstands Captial Markets, 43 S. Tex. L. Rev. 743 (2002). Sanderson fails to cite the state case in which a state court reacted somewhat favorably to the holding in the Basic case. See Gohler v. Wood, 919 P2d 561 (Utah Sup. Ct. 1996). In that case the court stated that reliance was not a necessary element of proof under Utah's Blue Sky Law so a presumption of reliance was unnecessary. That same situation exists in Texas, but our courts have not yet had occasion to rule on the issue.
III. Sale of a registered security by means of misrepresentations or omissions in registration or prospectus material provided by a non‑selling issuer.
A. TSA ' 33C prohibits the use of misrepresentations or omissions in registration or prospectus materials.
1. Sale by a third party (A non‑issuer or non‑affiliate)
2. To the plaintiff
3. Of a security
4. Misrepresentations or omissions in registration or prospectus materials
5. Of material facts
6. Issuer (the company) is liable to the Plaintiff.
C. No Texas case is found that specifies the required elements.
D. Jury charge. There is no pattern jury charge for this cause of action. The language discussed in part II can be adapted to fit this cause of action.
E. Plaintiff's elements. Plaintiff must prove that he purchased a security from a third party and that there were misrepresentations or omissions of material facts in the registration or prospectus materials.
1. Plaintiff. Plaintiff must show that he was a purchaser. The same definition of a purchaser discussed above is applicable here. See part I a(1)
2. Defendant‑third party seller. Plaintiff must show that he purchased the security from someone other than the issuer or an affiliate of the issuer. It is very likely that a defendant will stipulate that he is not the issuer or an affiliate of the issuer.
3. Security. Plaintiff must prove that he purchased a security.
4. Misrepresentation or omission in the offering documents filed with the Commissioner or the SEC. Plaintiff must prove that the filed documents contained material misrepresentations or omissions.
F. Remedies. Remedies available under this cause of action are the same as those available under the causes of action discussed above.
(a). Plaintiff's knowledge of the true facts: If the plaintiff knows that the representations in the registration or prospectus materials are false or that there are omissions of material facts, he can not recover under TSA ' 33C. No defense is afforded the non‑selling issuer for lack of knowledge even if he is totally unaware of the falsity of the misrepresentation or the omission. TSA ' 33C(2).
(b). Limitations: The limitations provision applicable to a misrepresentation or omission case applies to this cause of action.
2. Non statutory. To date no non‑statutory defenses have been recognized by the courts, but, if Ladd v. Knowles is the law in Texas, it would be reasonable to assume that the plaintiff in a case under this subsection would have to exercise diligence to determine that there were no misrepresentations or omissions in the prospectus materials before making the purchase.
H. Secondary liability. Vicarious or secondary liability is the same under this cause of action as in a registration case.
I. Related matters. Section 12(2) of the 33 Act, 15 USCA 77j(2), is substantially similar to this cause of action.
IV. Purchase of a security by means of misrepresentations or omissions.
A. TSA ' 33B prohibits the purchase of a security by means of misrepresentations or omissions. Texas is one of a handful of states recognizing this cause of action.
B. Elements of proof.
1. Purchase of a security by the defendant
2. From the plaintiff
3. By means of misrepresentations or omissions
4. Of a material fact
C. In all other respects the discussion in part II is applicable here.
V. Sale of securities in this State by unregistered salespersons.
A. TSA ' 33A(1) also prohibits the sale of securities in this State by any person not registered as required by TSA ' 12.
B. Elements of proof.
1. Sale of a security
2. To a purchaser
3. By someone not registered as required byTSA ' 12
4. And the transaction is not exempt under TSA ' 5
C. These elements of proof may be found in: TSA ' 33A(1). No Texas case has been found that discusses the elements of this type of claim. Citizens Ins. Co. v. Hakim Daccach, 105 S.W.3d 712 (Tex.App.‑‑Austin 2003, petition granted), involves this cause of action, but the issues on appeal were related to the propriety of a class action certification.
D. Jury issues. There is no pattern jury charge for this cause of action. The discussion on this subject in part I, above, concerning unregistered securities is applicable here.
E. Plaintiff's elements. Plaintiff must establish that he purchased a security from a non‑registered seller.
1. Plaintiff. Plaintiff must prove that he was a purchaser. The same considerations stated in part I, above, are applicable here.
2. Defendant. Plaintiff must prove that the defendant was the seller or sellers. See part I.
3. Security. Plaintiff must prove that he purchased a security. See part I.
4. Unregistered Seller. Plaintiff must prove that the defendant was not registered to sell securities in this state. This fact can be proved by the records of the Commissioner.
5. Exemption. Once plaintiff has proved items 1 through 4, the defendant will need to prove that an exemption existed and that registration was not required. Otherwise, the seller or sellers will be liable for damages.
F. Remedies. The same remedies discussed above are available for this cause of action.
(a). Limitations. The same limitations provision applicable to a registration case are applicable here.
(b). Exemptions provided by TSA ' 5. The transaction exemptions are the same as for registration cases. However, the registration exemptions provided by TSA ' 6 for particular types of securities are not available to the seller as a defense to this cause of action.
2. Non statutory. The court's decision in Ladd v. Knowles, supra, 505 S.W.2d at 662, authorizing a defense of plaintiff's knowledge, actual or constructive, in a registration case could be applicable here.
H. Secondary liability. Secondary liability is the same here as is provided for the other causes of action contained in TSA.
VI. Sales in violation of orders issued by the Commissioner or violation of the restrictions on expenses incurred in an offering.
The other causes of action provided by TSA ' 33A(1) relate to violations of '' 9, 23A, 23C and 23‑1. These sections involve special orders entered by the Commissioner that suspend the sale of a registered security or impose escrow requirements for the funds collected in the offering. TSA ' 9 also imposes a ceiling on the costs incurred in the offering. In all respects a cause of action for violation of one of these orders would be the same as is provided for the sale of an unregistered security.