Corporations Code Section 25401 prohibits misstatements and omissions of material facts. Section 25401 explicitly covers persons who “buy” or who “offer to buy” a security. California’s insider trading statute, Section 25402, also reaches purchases. Although not California cases, two recent examples of buyers running afoul of the securities laws caught my eye.

Recently, the Nevada Secretary of State issued this press release announcing the arrest of an individual who allegedly offered to purchase securities utilizing “misrepresentations, omissions, and/or acts or practices which were fraudulent or deceitful. Here’s a copy of the criminal complaint. It’s probably not helpful for the defendant that the state is alleging that this misconduct occurred while the defendant was scheduled to begin serving a sentence for similar offenses.

Perhaps a more interesting case is that of Xun Energy, Inc. v. Kennedy, 2013 U.S. Dist. LEXIS 39934 (S.D. Ill., March 22, 2013) in which an issuer sued a purchaser for breach of contract for failing to buy $10 million in common stock. In opposing the plaintiff’s motion for summary judgment, the defendant raised several affirmative defenses, including that the contract violated the Securities Act of 1933 ”because Kennedy [the defendant] was not an accredited investor”. The plaintiffs prevailed, however, because Judge J. Phil Gilbert found that “based on the evidence provided by Xun Energy [the plaintiff] and the lack of evidence presented by Kennedy, no reasonable jury could conclude that it was unreasonable for Xun Energy to believe that Kennedy had a net worth in excess of $1,000,000.” Here’s the Judge Gilbert’s description of that evidence supporting the plaintiff’s reasonable belief:

Xun Energy points to the fact that Kennedy approached Xun Energy with the offer to purchase $10,000,000 worth of stock. In support of the proposition that Xun Energy believed that Kennedy was an accredited investor, Xun Energy also provides the affidavit of Mikolajczyk in which he attests that he believed Kennedy had $10,000,000 to invest, Kennedy had informed him that she had $300,000,000 in Panama and $500,000,000 in Turkey, and that Kennedy’s biography and emails indicated she had the money and experience to be a “sophisticated investor.” Doc. 59. To support the reasonableness of this belief, Xun Energy attaches the affidavit of Guibert in which she attests that she believed Kennedy had the funds to make the transaction and was a “sophisticated investor.” Doc. 58. Further, Xun Energy attaches emails from Kennedy in which she states, “I work with accounts and clients all over the world,” and explaining that she is in the process of transferring funds to New York from funds “parked in Euros in London.” Doc. 59-11. Kennedy also provided to Xun Energy a copy of a contract between herself and Buyer Group International, Inc., in which she purportedly engaged in a transaction worth $10,000,000.

Section 201(a)(1) of the JOBS Act, of course, directed the Securities and Exchange Commission to amend Rule 506 of Regulation D to provide that the prohibition against general solicitation contained in Rule 502(c) does not apply to offers and sales of securities made pursuant to Rule 506, as so amended, provided that purchasers of the securities are accredited investors. The statute goes on to provide that “Such rules shall require the issuer to take reasonable steps to verify that purchasers of the securities are accredited investors, using such methods as determined by the Commission.” Last fall, the SEC proposed amendments to Rule 506 to implement this mandate. Under the SEC’s proposal, the determination of “reasonableness” would be an objective test based on the following factors:

  • the nature of the purchaser and the type of accredited investor that the purchaser claims to be;
  • the amount and type of information that the issuer has about the purchaser; and
  • the nature of the offering, such as the manner in which the purchaser was solicited to participate in the offering, and the terms of the offering, such as a minimum investment amount.
How do you think the issuer in Xun Energy would have fared under the SEC’s proposed construct?