Copy of Federal Preemption of State Blue Sky Regulations
Securities Fraud Claims under Utah Law
This article will examine a cause of action for securities fraud under Utah statutory law.
Please note that, while this article accurately describes applicable law on the subject covered at the time of its writing, the law continues to develop with the passage of time. Accordingly, before relying upon this article, care should be taken to verify that the law described herein has not changed.
I. Background of Securities Fraud in Utah
Over fifty years ago, Utah adopted the Uniform Securities Act as Title 61 of the Utah Code (“Code”). Also known as the state’s “Blue Sky” laws, the Code provides a means for investors to recover from securities fraud. Under the Code:
It is unlawful for any person, in connection with the offer, sale, or purchase of any security, directly or indirectly to:
1. employ any device, scheme, or artifice to defraud;
2. make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they are made, not misleading; or
3. engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person.
Utah Code Ann. § 61–1–1 (West 1997). On its face, Section 61–1–1 does not contain a private right of action—that comes later in Section 61–1–22. Subsection 61–1–22(1) of the Code imposes civil liability on any person who offers, sells, or purchases a security in violation of Subsection 61–1–1(2). Specifically, Subsection 61–1–22(1)(b) holds that the purchaser or buyer of a security may sue either at law or in equity to recover the consideration paid for the security, together with interest, costs, and attorneys’ fees, less the amount of income received on the security, upon the tender of the security, or for damages if the person no longer owns the security.
Aptly, because recoverable damages are measured by the consideration paid for the security, potential purchasers and mere offerees do not have a valid cause of action under the Code. Levitz v. Warrington, 877 P.2d 1245, 1246 (Utah Ct. App. 1994); see also IOSTAR Corp. v. Stuart, 2009 WL 270037, *11 (D. Utah Feb. 3, 2009) (holding that a potential purchaser of a security does not have a valid claim under the Code).
Similarly, a plaintiff does not have a valid claim for primary liability if the evidence does not show that the defendant actually sold the security. Wenneman v. Brown, 49 F. Supp. 2d 1283, 1290 (D. Utah 1999). While the Code is modeled after the federal Securities Exchange Act of 1934, it contains a more stringent standard for applying primary liability. Id. Indeed, the Code only imposes primary liability on the part of those who actually offer, sell, or purchase securities in violation of its provisions. Id. Because the Code requires this essential element of privity between the seller and buyer, primary liability is limited to actual “sellers” of securities. Id. (citing Gohler v. Wood, 919 P.2d 561, 562–66 (Utah 1996)). Secondary liability under the Code will be discussed infra.
The issue of whether a party is considered a “seller” under the Code is governed by the same standard that applies to claims of primary liability under Section 12(2) of the Securities Act of 1933. Id. (citing Fed. Sav. & Loan Ins. Corp. v. Provo Excelsior Ltd., 664 F. Supp. 1405 (D. Utah 1987)). Thus, a “seller” under Utah law is one who actually passes title to the security or who actively solicits the purchase motivated by a desire to serve his own financial interests or those of the security’s owner. Id.; see Provo Excelsior, 664 F. Supp. at 1411 (noting that Subsection 61–1–22(1)(b) includes only those persons who actually and directly participate in soliciting an investor’s purchase to extent that they are substantial factor in actual offer of sale).
Each subsection of Section 61–1–1 will be discussed in turn below, followed by an analysis of Section 61–1–22.
II. Subsections 61–1–1(1) and 61–1–1(3)
As mentioned, Subsections 61–1–1(1) and 61–1–1(3) do not contain an implied or express private right of action, nor does the rest of the Code contain such a right for their violation. See Milliner v. Elmer Fox & Co., 529 P.2d 806, 808 (Utah 1974) (holding that a Subsection 61–1–1(1) claim failed because while the subsection makes certain practices unlawful, it does not provide a private right of action for its violation). Thus, these subsections are left to governmental agencies to enforce.
In Fibro Trust, Inc. v. Brahman Fin., Inc., the Utah Supreme Court noted that successfully alleging a violation of Subsections 61–1–1(1) and 61–1–1(3) requires proof that the person “willfully” engaged in the prohibited conduct. 1999 UT 13, ¶ 14, 974 P.2d 288, 294. Therefore, a person violates Subsection 61–1–1(1) by “willfully employ[ing] any device, scheme, or artifice to defraud” and violates Subsection 61–1–1(3) by “willfully engaging in conduct which operates or would operate as a fraud or deceit upon any person.” Id. The Court recognized that applying a “willful” mental state to Subsection 61–1–1(1) amounted to a scienter requirement, i.e., willfully engaging in conduct designed to defraud. Id.; see State v. Larsen, 865 P.2d 1355, 1358 n. 3 (Utah 1993) (“To act willfully . . . means to act deliberately and purposefully, as distinguished from merely accidentally or inadvertently.”). Nevertheless, the Court held that Subsection 61–1–1(1) contains a scienter requirement but neither Subsection 61–1–1(2) or Subsection 61–1–1(3) have such a requirement. Id.
III. Subsection 61–1–1(2)
Unlike Subsections 61–1–1(1) and 61–1–1(3), Subsection 61–1–1 (2) contains a private right of action through Section 61–1–22. Accordingly, if a seller makes any untrue statement of a material fact or omits to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they are made, not misleading, a purchaser can sue the seller.
A “material fact” means something which a buyer or seller of ordinary intelligence and prudence would think to be of some importance in determining whether to buy or sell. S&F Supply Co. v. Hunter, 527 P.2d 217, 221 (Utah 1974); see Taylor v. Smith, Barney & Co.,
Inc., 358 F. Supp. 892, 896 (D. Utah 1973) (holding that a customer’s claim against his broker for failing to disclose that the broker was “making a market” for the security and acting as a dealer in the transaction presented questions of fact as to the materiality of the broker’s nondisclosures).
Purchaser’s Proof. The primary objective of Subsection 61–1–1(2) was to “moderate the requirements of common-law fraud and the difficulties involved in its proof, by imposing a higher standard of ethics and responsibility upon the sellers of securities in placing upon them the affirmative duty of making full disclosure of all material facts.” S & F Supply, 527 P.2d at 220–21. As a result, the Subsection reduces the buyer’s “burden of investigation and inquiry, and make[s] it easier for him to obtain redress on the basis of deception.” Id.
With this in mind, Utah courts hold that a buyer need only show by a preponderance of the evidence that the seller made an untrue statement or omission concerning a material fact, and that the buyer did not know of the untruth or omission. Id. On the other hand, courts recognize that imposing the remedy of rescission, which takes away the seller’s rights under the contract, must necessarily be predicated upon some blameworthy conduct on behalf of the seller. Id. Consequently, a buyer cannot “naively or blindly purchase” a security without concern for the truth or reasonableness of the representations made. Id. To that end, a buyer is held to the universal standard of duty imposed throughout the law: that of reasonable care and prudence under the circumstances. Id.; cf. Gohler, 919 P.2d at 563 (holding that a plaintiff alleging securities fraud need not prove “reliance” because the Code “says nothing about reliance” and merely requires that (i) defendants, in connection with the offer or sale of a security, either made an untrue statement of a material fact or omitted to state a material fact, (ii) plaintiffs did not know of the untruth or omission, and (iii) defendants knew or in the exercise of reasonable care could have learned of the untruth or omission).
Seller’s Mental State. In Larsen, the Utah Supreme Court held that a person violates Subsection 61–1–1(2) only if that person acts “willfully.” 865 P.2d at 1358. The Court reasoned while Subsection 61–1–1(2) does not have a “scienter” requirement, he or she must “willfully” misstate or omit material facts in order to be held liable. Id. (citing Ernst & Ernst v. Hochfelder, 425 U.S. 185, 96 S. Ct. 1375 (1976)). Ultimately, the Court observed that a person acts “willfully . . . when it is his conscious objective or desire to engage in the conduct or cause the result.” Id.
IV. Section 61–1–22
As mentioned supra, Subsection 61–1–22(1)(b) holds that violators of Subsection 61–1–1(2) can be held civilly liable for their actions on the basis of “primary liability.” However, Section 61–1–22 also establishes “secondary liability” as a method for recovery. This section will outline the relevant subsections of Section 61–1–22.
Subsection 61–1–22(4)(a)
In addition to primary liability, the Code provides a defrauded investor access to secondary liability as well. Specifically, the Code allows an investor to recover from those who were able to exert control and influence over the policies and decisions of the defrauding entity. See, e.g., Utah Code Ann. § 61–1–22(4)(a) (West 2007); Wenneman, 49 F. Supp. 2d at 1291 (“[T]he Utah Act provides for secondary liability on the part of one who directly or indirectly controls a ‘seller’ who is primary liable . . . .”). The Code imposes liability on “[e]very person who directly or indirectly controls a seller . . . , every partner, officer, or director of such seller . . . , every person occupying a similar status or performing similar functions, every employee of such a seller . . . who materially aids in the sale . . ., and every broker-dealer who materially aids in the sale” unless the person “sustains the burden of proof that [he]. . . did not know, and in exercise of reasonable care could not have known, of the existence of the facts by reason of which the liability is alleged to exist.” Utah Code Ann. § 61–1–22(4)(a).
Thus, a partner, officer, director, person of similar status or function, or seller of securities is liable for violations committed by the entity unless that person proves the affirmative defense that he lacked knowledge of the unlawful acts. Steenblik v. Lichfield, 906 P.2d 872, 876–77 (Utah 1995). Notably, the Code deviates from the federal Securities Act of 1934 by expressly imposing liability on these parties. Id. In fact, under the Code, a plaintiff need not demonstrate that such a person was even able to control the transaction. Id. Rather, if it is established that the defendant functioned in or occupied one of the aforementioned positions, the defendant has the burden of proving that he did not know and, in the exercise of reasonable care, could not have known of the violation of the Code. Id. (citations omitted); see generally Utah Code Ann. § 61–1–22(3) (West 2007) (“A person who offers or sells a security in violation of Subsection 61–1–1(2) is not liable under Subsection (1)(a) if the purchaser knew of the untruth or omission, or the seller did not know and in the exercise of reasonable care could not have known of the untrue statement or misleading omission.”).
For example, in Steenblik, the Utah Supreme Court held that the vice president of a financial planning company was liable for company actions proscribed by the Code. 906 P.2d at 876. The Court noted the vice president was sufficiently involved with the company and with the plaintiff’s investments to hold him liable under the Code. Id. The Court reasoned that despite the vice president’s ignorance of the plaintiff’s investment in the company in which he had a personal interest, he was still liable because he knew the investor was being fraudulently enticed into making investments. Id.; see also Ball v. Volken, 741 P.2d 958, 960 (Utah 1987) (holding that the president of a corporation, which sold securities in violation of the Code, could be held personally liable for the sale).
Subsection 61–1–22(2)
Subsection 61–1–22(2) provides that “upon a showing that the violation was reckless or intentional” or “was negligent[] and it is demonstrated by clear and convincing evidence that the violation involved an investment by a person over whom the violator exercised undue influence,” the court may award treble damages, i.e., three times the consideration paid for the security, plus interest, costs, and attorneys’ fees.
Interestingly, a court may consider awards for punitive and treble damages unduly duplicative. See Steenblik, 906 P.2d at 875 (holding that an award of punitive and triple damages under the Code was improperly duplicative, because both awards were based on same conduct: defendant’s “reckless and intentional” acts in violation of the Code were the same “malicious” acts for which jury awarded punitive damages). Thus, a successful plaintiff may have to be satisfied with one or the other.
Subsection 61–1–22(7)
In securities fraud cases, the Code imposes a statute of limitations of either five years from the date of the act or transaction constituting the violation or two years after discovery of the facts constituting the violation, whichever expires first. A “statute of limitations” is a mandatory time-frame within which a plaintiff must file a lawsuit. If a plaintiff fails to adhere to the statute of limitations, his or her claim will be dismissed. See, e.g., DOIT, Inc. v. Touche, Ross & Co., 926 P.2d 835 (Utah 1996) (dismissing plaintiffs’ securities fraud claims which were filed over two years after the plaintiff discovered the facts constituting the securities violations because the claim was untimely filed); Brown v. Producers Livestock Loan Co., 469 F. Supp. 27, 33 (D. Utah 1978) (holding that a claim was time barred due to statute of limitations).
A Defendant’s Defense
Section 61–1–22 prescribes a series of specified defenses—none of which encompass equitable considerations. See, e.g., Utah Code Ann. § 61–1–22(4)(a) (instituting a reasonable care defense for those with control person liability); id. § 61–1–22(3) (providing, as a defense to securities fraud, that the purchaser “knew of the untruth or omission” or that the “seller did not know and in the exercise of reasonable care could not have known of the untrue statement or misleading omission”); id. § 61–1–22(7)(a) (imposing a statute of limitations that incorporates a discovery rule). Notably, “the expression of these defenses can be read as an exclusion of others.” Legacy Res., Inc. v. Liberty Pioneer Energy Source, Inc., 2013 UT 76, ¶ 41, 322 P.3d 683, 693 (citation omitted). Thus, Utah courts hold that unexpressed equitable defenses are not available under the Code. Id.
For example, Subsection 61–1–22(9) provides that “[a] condition, stipulation, or provision binding a person acquiring a security to waive compliance with this chapter . . . is void.” This anti-waiver provision does not equate with the equitable argument that a person should lose the protection of the Code by his or her knowledge of an existing violation. Legacy Res., 2013 UT 76, ¶ 42, 322 P.3d at 693 (citation omitted). Thus, because an express waiver is void, a constructive waiver triggered by a party’s knowledge is “foreclosed a fortiori.” Id. Indeed, “[w]ith such defenses, sellers could avoid liability under the registration provisions by informing would-be purchasers that the securities were unregistered. This would defeat the purpose of our blue sky laws.” Id. (quotation omitted).
Similarly, the statutory bar on enforcement of Subsection 61–1–22(8) is unconditional and categorical—without exception, the provision renders any “person” engaged in the performance of “any contract in violation of this chapter” unable to “base a suit on the contract.” Id. Together, these provisions are an ample “indication” that Subsection 61–1–22(8) was “intended to protect parties who themselves were engaged in violations.” Id. at ¶ 44.
V. Other Pertinent Code Sections
Section 61–1–22 also applies to a person who offers or sells a security in violation of:(A) Subsection 61–1–3(1);(B) Section 61–1–7;(C) Subsection 61–1–17(2);(D) a rule or order under Section 61–1–15, which requires the affirmative approval of sales literature before it is used; or(E) a condition imposed under Subsection 61–1–10(4) or 61–1–11(7). Utah Code Ann. § 61–1–22.
Under Subsection 61–1–3(1), “[i]t is unlawful for a person to transact business in [Utah] as a broker-dealer or agent unless the person is licensed under this chapter.”
Under Subsection 61–1–7, “[i]t is unlawful for any person to offer or sell any security in [Utah] unless it is registered under this chapter, the security or transaction is exempted under Section 61–1–14, or the security is a federal covered security for which a notice filing has been made pursuant to the provisions of Section 61–1–15.5.”
Under Subsection 61–1– 17(2), “[i]t is unlawful to make, or cause to be made, to any prospective purchaser, customer, or client any representation inconsistent with [the fact that an application for registration or a registration statement has been filed nor the fact that a person or security is effectively registered constitutes a finding by the division that any document filed under this chapter is true, complete, and not misleading].”
Under Subsection 61–1–15, the state securities division “may by rule or order require the filing of any prospectus, pamphlet, circular, form letter, advertisement, or other sales literature or advertising communication addressed or intended for distribution to prospective investors, including clients or prospective clients of an investment adviser unless the security or transaction is exempted by Section 61–1–14 or is a federal covered security.”
Subsections 61–1–10(4) and 61–1–11(7) deal with various registration requirements.
VI. Recovery
Subsection 61–1–22(10) of the Code asserts that the rights and remedies prescribed by statute “are in addition to any other rights or remedies that may exist at law or in equity.” Id.
Thus, rescission of the securities sale is an available option for a defrauded plaintiff. See Mayer v. Rankin, 91 Utah 193, 211–12, 63 P.2d 611, 619 (1936) (holding that rescission of a securities sales contract is an available remedy for a defrauded plaintiff). Peculiarly, a plaintiff need not set aside all transactions with the particular defendant; rather, a purchaser has the option of rescinding selected transactions, while keeping others. Piantes v. Hayden-Stone, Inc., 30 Utah 2d 110, 112, 514 P.2d 529, 530 (1973).
As stated supra, in order to rescind a contract under the Code, a plaintiff need only show by a preponderance of the evidence that the seller, in selling the securities, made untrue statements or omissions concerning a material fact and that the buyer did not know of untruth or omission. S & F Supply, 527 P.2d at 221. If the buyer satisfies this initial burden, the burden of proof shifts to the seller to show that he did not know, and in exercise of reasonable care could not have known of the untruth or omission. Id.
VII. Conclusion
In summary, a purchaser of securities in Utah has a valid civil claim against the seller if the seller made any untrue statement of a material fact or omitted to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading.