Securities Law | Expert Legal Commentary

November 16, 2009

Florida Takes the Lead in Boosting State Securities Fraud Enforcement Rights

Florida Investor Protection Act of 2009

By Josh Lawler of Zuber Lawler & Del Duca and Joel Ginsberg

Florida Takes the Lead in Boosting State Securities Fraud Enforcement Rights

When Florida’s governor signed into law that state’s new Investor Protection Act, effective July 1, 2009, Florida took a new lead among states in enacting enhanced state rights to pursue, enforce, and regulate securities fraud within their geographic boundaries. While states have played a significant role in investor protection over the last 100 years, state regulators have complained that the federal government has slowly taken over and preempted states’ rights in the arena of securities regulation since about 1996. In the wake of the current market crisis, marked by securities fraud and highlighted by the Madoff Ponzi scheme, the preemption debate has never been hotter.

Background

The states have adopted so-called “blue sky laws”—laws and regulations governing securities transactions with the state. Most states have adopted at least some part of the Uniform Securities Act of 1956 (though California and New York have not adopted any part of the Uniform Act), though interpretations of the Uniform Act vary from state to state.

Still, the blue sky laws of all states have a few elements in common: 1) they require registration of securities to be offered or sold within the state, unless they fall within specific exemptions from registration; 2) they require registration and licensing of firms and individual brokers that will sell securities within the state; 3) they include anti-fraud provisions that create liability for inaccurate and/or misleading statements and failures to disclose required information.

Most blue sky laws predated and were broader in scope than both the Securities Act of 1933 and the Securities Exchange Act of 1934, both of which include savings clauses that preserve the protections provided by state securities laws (and exempting from federal regulation certain transactions regulated primarily by the states), while adding complementary federal investor protection against interstate securities fraud. The savings clauses and the federal acts deliberately set up a system of dual regulation.

But most blue sky laws were effectively preempted in the late 1990s by federal acts – specifically, the National Securities Markets Improvements Act of 1996 (“NSMIA”) and the Securities Litigation Uniform Standards Act of 1998 (“SLUSA”). Based on the argument that the dual regulation system was needlessly redundant, costly, and ineffective, the NSMIA preempted state law in many areas of security regulation, particularly in the areas of registration and reporting requirements.  The SLUSA was enacted in response to the numerous securities class actions being brought in state courts following the federal enactment of the Private Securities Litigation Reform Act of 1995, which made plaintiff class actions more difficult to maintain in federal court. The SLUSA precluded state courts from adjudicating securities fraud class actions involving nationally or NASDAQ listed securities.

Primarily through the North American Securities Administrators Associations (“NASAA”), state securities regulators have complained about the federal preemption of their authority since the enactment of the NSMIA. Beginning in the early 2000’s, as capital markets were weakening in the wake of Enron and other corporate scandals that indicated inadequacy of federal laws, state regulators began to reassert themselves. One of the first major efforts was New York State Attorney General Elliot Spitzer’s enforcement of the broad anti-fraud provisions in New York’s blue sky laws against Merrill Lynch in 2002. Although the U.S. House Financial Services committee criticized Spitzer for his attempt to “undermine the national securities regulatory regime,” Spitzer justified his actions, saying that “the SEC was not doing enough.”

Also beginning in the early 2000’s, courts started recognizing more state authority to regulate and enforce their blue sky laws. For example, Rule 506 of SEC Regulation D is a “safe harbor” provision for private offering. A transaction is exempt from federal Securities Act registration if it meets the requirements set forth in this Rule, including (but not limited to): 1) the seller does not use general solicitation or advertising to market the securities; 2) the securities can be sold to an unlimited number of accredited investors and up to 35 non-accredited, but still sophisticated, investors; 3) purchasers receive “restricted” securities that cannot be traded freely in the secondary market after the offering; and 4) non-accredited investors must receive disclosure documents, as well as any documents provided to accredited investors.

A majority of courts now hold that if a transaction fails to satisfy the requirements of Rule 506, then federal preemption does not apply and the states may enforce state regulations against the issuer in their respective jurisdictions. See, e.g., Buist v. Time Domain Corp., 926 So. 2d 290 (Ala. 2005); Brown v. Earthboard Sports USA Inc., 481 F.3d 901 (6th Cir. 2007), and more. The same is true for other SEC exemptions as well – if a transaction cannot rely upon a Regulation D or other federal registration exemption, it remains subject to state regulations. See, e.g., Waterman v. Alta Verde Industries Inc., 643 F. Supp. 797 (E.D.N.C. 1986).

In the case Capital Research v. Brown, 147 Cal. App. 4th 58, 53 Cal. Rptr. 3d 770 (Cal. App. 2007), California’s Court of Appeals for the Second District analyzed the savings clauses of NSMIA and determined that Congress intended to allow states to police the conduct of those selling securities in their states, even if the offerings themselves were not subject to state review or approval. The court cited a U.S. Senate Committee report that stated: “The Committee believes that allowing the states to oversee broker-dealer conduct in connection with preempted offerings will ensure continued investor protection. As long as states continue to police fraud in these offerings, compliance at the federal level will adequately protect investors. In preserving this authority, however, the Committee expects the states only to police conduct – not to use this authority as justification to continue reviewing exempted registration statements or prospectuses. The Committee clearly does not intend for the ‘policing’ authority to provide states with a means to undo the state registration preemptions.” (Sen. Rep. No. 104-293, 2d Sess. (1996)).

Despite the efforts and findings against complete preemption, some federal administrative agencies have adopted regulations that NASAA claims extend preemptive efforts even beyond those allowed under the Constitution. (See letter from Fred Joseph, President of NASAA, to President Barack Obama, dated June 9, 2009, applauding the President’s May 20, 2009 “Memorandum for the Heads of Executive Departments and Agencies,” which states an administration policy “that preemption of State law by executive departments and agencies should be undertaken only with full consideration of the legitimate prerogatives of the States and with a sufficient legal basis for preemption.”)

The scope of Florida’s Investor Protection Act

On June 29, 2009, Florida Governor Charlie Christ signed into law the Investor Protection Act (“IPA”), Florida House Bill 483, a law designed to strengthen the state’s investor protection laws. Recent waves of alleged securities fraud scams, including Bernie Madoff’s famous $65 billion Ponzi scheme, profoundly impacted the assets of many families and charitable organizations in Florida and elsewhere.

In response, Florida decided to better arm itself to investigate and pursue securities fraud by enhancing the authority of the state Attorney General and government agencies to crack down on fraudulent schemes.  Specifically, the IPA authorizes the Attorney General, with permission from the state’s Office of Financial Regulation (the “OFR”), to investigate and bring securities fraud actions – criminal and/or civil—against anyone violating the anti-fraud provision under the Florida Securities and Investor Protection Act (“SIPA”). The AG has the ability to seek restitution for victims and obtain other civil penalties. The Florida Department of Law Enforcement has the ability to pay rewards for original information in money laundering investigations under the new law.

The new law authorizes the OFR to require fingerprints as part of the registration process and request records from those accused of SIPA violations. The OFR can now suspend the registrations of any persons and firms who fail to produce requested documents or conform with other requirements.

How Florida law will fare against claims of preemption

Florida’s IPA has yet to be tested in court. It’s possible that a firm or broker-dealer offering securities in Florida and impacted under this new law will file a court action claiming that federal laws preempt the state’s efforts against it. If the court follows the analysis of Capital Research v. Brown, supra (though it has no precedential value in Florida), the Florida law may be upheld, as it arguably focuses on policing the conduct of brokers and dealers operating within the state without commenting on or judging the offerings themselves.

The Florida law may become the basis of a test case that other states watch for guidance on how far they can go with state regulatory efforts in light of preemptive statutes. Some other states have made less bold forays into asserting their regulatory power – Wisconsin and Kansas, for example, have increased filing fees and registration/ licensing fees, while Indiana has elevated the felony level of certain types of securities fraud.

About the Authors

Joel Ginsberg is Deputy General Counsel at Guidance Software, an industry leader in digital investigative solutions.

Image Credit: ©iStockphoto.com/bedo

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Josh Lawler
Joel Ginsberg

Companies Mentioned

Also See:

Amgen Inc. v. Connecticut Retirement Plans & Trust Funds: Supreme Court Sides with Investors in Securities Fraud Class Action

Gabelli v. SEC: Unanimous Supreme Court Rejects Extending Statute of Limitations in SEC Enforcement Actions

In re Rigel Pharmaceuticals, Inc.: Ninth Circuit Increases Difficulty for Investors to Sue Drug Companies Based on Clinical Trial Results

Mastick v. TD Ameritrade, Inc.: Court Upholds Use of California Arbitration Act in Contracts Governed by California Law

Lawson et al. v. FMR LLC: Sarbanes-Oxley’s Whistleblower Protection Is Limited to Employees of Publicly Traded Companies

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Companies Mentioned

Securities Law

The following companies are mentioned in Securities Law Updates:

Securities and Exchange Commission

Harris Associates, L.P.

Citicorp USA, Inc.

Banc of America Securities LLC

The Public Employees’ Retirement System of Mississippi

Morgan Stanley & Co., Inc.

Jan Charles Finance S.A.

Park East, Inc.

CIBC World Markets Corp.

Citigroup Inc.

Barclays Capital Inc.

Citigroup Global Markets, Inc.

Calyon Securities (USA), Inc. f.k.a. Credit Lyonnais Securities (USA) Inc.

Calyon New York Branch (successor by operation of law to Credit Lyonnais New York Branch)

Salomon Smith Barney, Inc.

JPMorgan Chase & Co.

Dynex Capital Inc.

Citigroup, Inc.

JPMorgan Securities Inc.

Merit Securities Corp.

Scotia Capital (USA), Inc.,

Teamsters Local 445 Freight Division Pension Fund

Aetna, Inc.

Cowen & Co., LLC f.k.a. SG Cowen Securities Corp.

Societe Generale

SunTrust Bank

TD Securities (USA), Inc.

BMO Nesbitt Burns Corp. n.k.a. Harris Nesbitt Burns Corp.

Buchanan Ingersoll & Rooney Professional Corporation

Consolidated Leasing Hugoton Joint Venture #2

W. R. Huff Asset Management Co., LLC

Consolidated Leasing Anadarko Joint Venture

ABN AMRO Bank N.V.

Guardian Capital Management

Free Enterprise Fund

Banc of America, N.A.

Vesta Insurance Group, Inc.

Beckstead and Watts, LLP

Barclays Bank PLC

Torchmark Corp.

Public Company Accounting Oversight Board

BNY Capital Markets, Inc.

KPMG Peat Marwick, LLP

Deloitte & Touche LLP

Credit Lyonnais Securities (USA) Inc.

Florida State Board of Administration

Credit Suisse Securities (USA) LLC

Deutsche Bank AG

The Cleaners & Caulkers Local 1 Pension Fund

Credit Suisse, New York Branch

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