California Court Limits the Reach of Securities Anti-Fraud Provisions

Although occasionally overlooked in favor of similar federal securities laws, California corporate law also contains anti-fraud provisions.  In a recent case, a California Court of Appeal limited their reach in an important way.  In the AREI II cases, plaintiffs acquired an interest in an investment interest in AREI II.  AREI II apparently failed to disclose that it was run by a convicted felon and was overleveraged, resulting in a violation of Corporate Code Section 25401.  Plaintiffs also sued the investment banking firm that structured the investment deal, arguing that it materially assisted in the violation of Section 25401 by structuring the deal and providing banking services.  Accordingly, plaintiffs asserted aiding and abetting liability pursuant to Corporate Code Section 25401.1 on the part of the investment bank.  Plaintiffs could not show that the investment bankers contributed to the actual disclosure violation.  The Court of Appeal clarified and limited the reach of aiding and abetting liability under California's securities laws by holding that it was not enough to allege that the investment bank aided the transaction that turned out to be fraudulent.  The aid provided had to be material aid for the securities violation. This holding should provide protection to bankers and professionals innocently associated with businesses and investments that turn out to be fraudulent.