Securities Fraud

The term ‘Securities fraud’ seems like a complicated crime, involving large amounts of money and executed by sophisticated criminals. The reality is totally different. You can unwillingly act contrary to California securities laws as an employee doing your regular job or as an entrepreneur seeking to raise capital for your business. Fortunately, LA Criminal Defense Attorney can help you avoid the huge fines and prison sentences associated with a securities fraud conviction. We are well versed in criminal defense and can maneuver within the justice system in Los Angeles, CA to your benefit.

What are Securities?

Securities are basically defined as a business arrangement where you get a certain percentage of ownership in business as well as a right to repay debt. It is a financial investment in the form of mutual funds, bonds, or stocks by different people in an enterprise with the intention of obtaining profits. Once you invest in the business through any of these forms, you acquire partial ownership of the business. If the business makes profits, your securities increase in value. As a shareholder, you make money by selling your shares at a price above the purchase price. If the business makes losses, the value of your securities decreases.

There are several types of securities protected by the California laws on Corporate Securities and Commodities. These include:

  • Stocks in a company

  • A note indicating that a given company owes money to you, the bearer of the note

  • A certificate indicating that you as the holder have an interest in a given profit-sharing agreement

  • A certificate indicating your profit-sharing agreement or your interest in a limited liability business or company

  • Your partner's interests in your limited liability partnership

California’s Laws on Securities Fraud

Securities fraud arises when you attempt to unlawfully manipulate the investment market. It happens when you make false assertions about a business or its stock value, and other people make financial decisions based on that falsehood. The false information may cause financial losses to private companies, financial institutions, investors and consumers.

Securities fraud is a type of white-collar crime where you fraudulently and deceitfully misrepresent the information given to investors when they are making critical investment decisions. This is despite your knowledge that the stock is either worthless or non-existent. Such misrepresentation includes falsifying or withholding essential information, revealing insider news and giving bad advice. Securities fraud also involves omission where you fail to give the investors all the information and facts they require to make informed decisions about the investment. If you are offering securities for sale, you are legally obligated to inform the investors about the costs and any risks associated with your securities. Having provided the buyer with a prospectus does not automatically shelter you from charges of securities fraud.

People who are often charged with securities fraud include:

  • Private investors and corporate executives acting on insider information

  • Financial advisors who often disclose inside information or offer poor advice

  • Dealers who mislead or advise clients based on insider information

  • Corporations who conceal or distort information

  • Business executives who falsify accounting entries

Securities are regulated by the Securities and Exchange Commission (SEC) and the National Association of Securities Dealers (NASD). The Attorney General safeguards the general public, investors and pension funds by enforcing California’s law on Corporate Securities and Commodities. This law permits the Attorney General to initiate legal action to guard investors against fraud and other malpractices and to prohibit illegal practices.

The Corporate Fraud Section has a Securities Unit responsible for investigating and prosecuting all alleged violations of the Corporate Securities and Commodities law. The investigations are based on complaints by the public and referrals from both state and federal regulatory and law enforcement agencies. If convicted, you may be fined or imprisoned.

California Corporations Code Section 25401 is the basic statute on securities antifraud. It prohibits you from offering or selling securities through oral or written communication containing misleading statements or omission of facts.

Section 25400 of the California Corporations Code makes it illegal for you to either directly or indirectly:

  • Trade in securities without any change in ownership

  • Place an order to purchase or offer to sell securities when you know that an order to sell or buy an equal amount of securities will be placed at the same time and the same price

  • Engage in transactions that create active trading with the intention to induce others to sell or purchase the securities

  • Initiate sale or purchase of securities by buying or selling them and circulating information insinuating that the value of the securities may increase or decrease, as a result of market operations which you conduct to purposely influence the price of those securities

  • Purchasing or offering to sell securities by deliberately making misleading or false statements or by omitting material facts with the intention of inducing other people to sell or purchase the securities

Section 25402 of the California Corporations Code, is the state’s statute on insider trading. This section makes it illegal for you to purchase or sell securities based on material information gained from your close relationship with the issuer but has not been publicized, and would affect prices of the securities. Such action is unlawful unless you reasonably believe that the other person is in possession of the same information.

Section 25540 of the Corporations Code outlines the various penalties for violating California’s laws on securities. Moreover, there are three statutes that create a civil liability if you violate Section 25401. These are;

  • Section 25501: You are liable to the person to whom you sell securities and to the person from whom you purchase securities.

  • Section 25504: If you are a broker-dealer, you are liable if you aid the violation materially or control the violator directly or indirectly.

  • Section 25504.1: You are liable if you assist the violation materially with the intention to defraud or deceive.

California Corporations Code Section 25019 gives the definition of a security. Since the statute does not have a provision on how to consider an action as security fraud, the issue has to be determined on a case by case basis. To make the determination, courts consider that the sole purpose of securities fraud law is to shield the public from manipulation through illegal, fraudulent and unsubstantial stock and securities investment schemes.

Statute of Limitations

In California, the criminal procedure rules also referred to as 18 USC 3282 require that your trial, prosecution or punishment for a non-capital offense like securities fraud be instituted within five years after the offense occurs. However, you may face far-reaching repercussions and be prosecuted for other crimes resulting from the original offense, even after the expiry of the statute of limitations.

Common Forms of Securities Fraud

There are a variety of ways in which you can commit securities fraud.

Corporate fraud

This happens when you are a director or an officer of a company and you inaccurately report the corporation’s financial reports to the shareholders. You may do this by deliberately concealing or skewing information, disguising inappropriate expenditure and faking financial records for the company to appear financially healthy to the shareholders. These reports increase the value of the company’s stocks artificially and encourage investors to buy shares in an unhealthy company.

If the company goes bankrupt, the shareholders lose their investment. Your execution of corporate security fraud may involve a few or many players. It depends on how informed the employees are about the company’s accounting practices.

Insider trading

You are an insider if you have confidential information on the financial status of the company, and you only have that information because you have a special connection to the company. You could be a senior employee, an employee in the finance department or a family member of an employee who has inside information.

Insider trading is a serious crime that occurs when you decide to gain an unfair advantage by buying or selling stocks based on information that is yet to be disclosed to the public. This confidential information is the kind that would lead to a change in prices of securities if it is made public.

It is only illegal if you trade in securities based on information you acquire as a result of a special relationship between you and the company. If you did not get the information due to a unique association with the business, you are not guilty of insider trading.

Fraudulent misrepresentation

There are several types of fraudulent misrepresentation. The most common is the “pump and dump” which has two phases. In the first phase, you find a small company with cheap stock, buy its shares in large amounts then use false information to encourage others to buy the stocks, which drives up the stock prices. In the second phase, you sell off your stock once the price is high enough and “dump” the stock on the market. The value of the stock decreases rapidly causing other investors to lose their money.

The second form of fraudulent misrepresentation is where you make a misleading or false statement to induce another person into a contract. If you are entering into a business agreement, both you and the other party must be in agreement for the contract to be valid. If you make false statements in writing, verbally, through a gesture or silence about key facts, and it has a material effect on the agreement, you are guilty of fraudulent misrepresentation. Even if you made the representation without information whether it was true, but made the claim recklessly to persuade the other party to enter into a business agreement, your actions constitute fraudulent misrepresentation.

Under the California Corporations Code, it is illegal for you to trade securities in a way that manipulates the securities’ market. This includes trading with no real change of ownership with the intention to make a false impression. For example, if you buy large amounts of stock from a company that you own, many investors will be interested in that company and the share price will increase.

You will also have committed securities fraud if you trade securities with the knowledge that another person will place an order to trade the same amount of securities. Heavy trading can lead to increased stock prices, which in turn attracts investors. This form of price manipulation is unlawful.

Other types of misrepresentation are; negligent misrepresentation where you fail to ensure the accuracy of the information, and innocent misrepresentation where you are neither negligent nor fraudulent. It is important to note that a misrepresentation only leads to legal proceedings if it has a material effect on a business contract.

Non-compliance with securities qualification requirements

Before selling securities, the California Department of Corporations may require you to qualify the securities. This involves declarations about the business establishment offering the securities and extensive paperwork. Failure to complete the paperwork may lead to serious penalties including jail time. Fortunately, qualification is not required for all securities sold. You do not need to qualify your securities if:

  • You sold or offered securities to a maximum of 35 people - a husband and wife are considered as one person.

  • Everybody who bought the securities did not plan to resell or distribute them to other people

  • You did not publish an advertisement on the sale of securities

  • Everybody who was offered or bought the security either had a previous business or personal relationship with you or has significant financial or business experience to safeguard their own interests.

You are only criminally liable if you willfully fail to comply with the requirement to qualify your securities.

Additionally, your sale of securities must be consistent with the information you provide in the qualifications documents. For example, if you indicate that no employee will receive bonuses for sale of the stock, you may face criminal proceedings for securities fraud if you do not abide by that provision.

Investment scams

There are several investment scams which constitute securities fraud. The most common are Ponzi Schemes and High Yield Investment Programs (HYIP) where you promise investors high returns with little or no risk. In these schemes, you pay existing investors with money from new investors and retain a portion for yourself.

Another type of investment scam is affinity fraud where you target members of a specific group. You exploit the goodwill and trust of the group by enlisting their leaders to spread the word about the scheme. You may also be liable for securities fraud if you commit advance fee fraud. This involves asking investors to pay additional fees before they get any stocks, warrants or money.

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Penalties for Securities Fraud

In California, crimes of securities fraud are wobblers. This means that they are prosecuted as either misdemeanors or felonies at the prosecutor’s discretion. Additionally, the sentencing guidelines are complicated and the penalties are surprisingly harsh. If convicted, you can be imprisoned and pay enormous fines. Although each securities fraud offense may result in incarceration, it is always difficult to determine a fine or restitution amount that fairly reflects the damage your actions cause.

If you willfully offer securities for sale without complying with the qualifications requirements or you violate the qualifications terms, you may face:

  • Fines of up to $1,000,000,

  • A jail term of between 16 months to three years, or

  • A fine and a jail term.

If you deliberately manipulate the market, make a misleading or false statement or participate in insider trading, you may face steeper penalties which include:

  • A maximum fine of $10,000,000

  • A jail term of two, three or five years

  • Both

If you are a director of an issuer of securities and are convicted for securities fraud, the penalties may include

  • Fines up to a maximum of $25,000,000

  • Two, three or five years of incarceration

  • Both fines and imprisonment

An issuer company is defined under the Sarbanes-Oxley Act of 2002 as a company that:

  • has securities registered under section 12 of the act (15 U.S.C. 78l),

  • must file reports under section 15(d) of the act (15 U.S.C. 78o(d)

  • has filed or files a registration statement that is yet to be effected under the Securities Act of 1933 and has not withdrawn

Securities fraud is both a California crime and a federal crime. If you are charged with the crime in California, you are likely to face federal charges as well. If you willfully violated the federal laws on securities fraud, you may be incarcerated for not more than twenty years in federal prison.

Additionally, you may face a civil lawsuit from people who may have suffered due to your actions. If the lawsuit is successful, the damages can exceed the fines you would pay for your criminal offense. You may also receive civil penalties from the California Department of Corporations for violating securities fraud laws. However, these penalties are set at a maximum of $25,000 for each violation. The penalty is assessed and recovered through a civil action initiated by the commissioner in any court with adequate jurisdiction.

Under California law, securities fraud is considered a crime of moral turpitude. This basically means that if you are a legal resident, you may be removed or deported if convicted of the crime. Additionally, any professional license you hold may be suspended or revoked following your conviction of securities fraud.

What the Prosecutor Needs to Prove

Prosecution for securities fraud may happen in both state and federal courts. To prove your case of securities fraud, the prosecutor must demonstrate that:

  • You willfully violated the securities fraud laws by acting deliberately, intentionally or recklessly to secure an unfair advantage. The prosecutor must present information to substantiate your knowledge of securities regulations and laws

  • You participated in a scheme to fraudulently influence offers and trade of securities, or that you directly or indirectly allowed false or misleading statements to be released

  • You deliberately omitted or misrepresented material facts that could be reasonably expected to influence investors’ decisions

  • The misrepresentation or omission directly affected the decisions made by investors to purchase the securities

  • The investors lost money as a result of relying on facts that you misrepresented or omitted

Possible Defenses Against Securities Fraud Charges

If you are accused of securities fraud, there are several legal defenses that can help you fight the charges. They include:

Lack of intent

Since securities fraud involves complex business transactions, you can easily be entangled due to accidental or negligent actions. Under the California law on Corporate Securities, you can only be convicted of securities fraud if you acted willfully. You must have known what you were doing and acted intentionally. If your actions were unintentional, you cannot be liable for securities fraud.

No knowledge of securities laws

California law has a no knowledge provision that allows you to be considered not guilty if you did not intentionally commit the fraud. If you can prove that you did not know that your actions constituted fraud, you cannot be held accountable for the fraud.

False accusation

It is a common occurrence for people to be accused falsely. If someone else is responsible for the fraud, you can bring evidence to prove your innocence. Additionally, there must be enough evidence against you to sustain your criminal charges.

Non-fraudulent or true statements

False statements are not necessarily fraudulent. For you to be convicted, there must be evidence of fraudulent misrepresentation relating to material facts. Additionally, you can provide evidence to prove that your intentions were founded on truth.

No justifiable reliance or loss to investors

One of the elements of securities fraud is the reliance on the information you provide and a subsequent loss of money by investors. If the investors did not make their investment decisions based on the information you gave to them, or no money was lost, then you cannot be charged with securities fraud.

If you are being charged with a crime feel free to contact our Los Angeles Criminal Defense Lawyer for a free consultation.