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CALIFORNIA CORPORATE & SECURITIES LAW

Court Holds SEC Filing Is Not Public Disclosure

California has patterned its false claim law, Cal. Gov’t Code §§ 12650 et seq., after the federal False Claims Act.  As the names of these laws suggest, they are intended to protect the public fisc from false or fraudulent claims.  The CFCA empowers private parties to pursue actions for, and in the name of, the state provided certain procedural requirements are met, including notice to the California Attorney General.  Why would anyone do this?  The private plaintiff gets a cut of the proceeds, the amount of which will depend upon whether the state decides to intervene in the action.  To prevent “parasitic or opportunistic actions”, the CFCA bars private plaintiffs when there has been public disclosure of the information on which the action is based, unless the plaintiff was an original source of the information.  This is known as the “public disclosure bar”.

In State ex rel. Bartlett v. Miller, 2016 Cal. App. LEXIS 35 (Cal. Ct. App. 2016), an individual filed an action under the CFCA against a publicly traded owner of country clubs alleging that that the company had defrauded the State of California by failing to escheat club initiation deposits.  The California Attorney General successfully moved to dismiss the complaint based on CFCA’s public disclosure bar, arguing that disclosures regarding escheatment in the company’s registration statement on Form S-4 constituted public disclosure as a report.  The company’s registration statement disclosed that the company was subject to escheatment laws and was the subject of a multistate audit of its escheatment practices.  At the time, California’s statutory public disclosure bar applied to disclosures “in an investigation, report, hearing or audit conducted by or at the request of the Senate, Assembly, auditor, or governing body of a political subdivision, or by the news media . . .”.  Former Cal. Gov’t Code § 12652(d)(3)(A) [The current statutory exception for reports, which the Court did not apply, is limited to a “report, hearing, audit, or investigation of the Legislature, the state, or governing body of a political subdivision.].  The Court of Appeal, in an opinion written by Justice Dennis M. Perluss, reversed, finding that disclosure in a filing with the Securities and Exchange Commission, even though public, was not the type of public disclosure covered by the public disclosure bar.  The Court distinguished cases finding that the federal False Claims Act’s public disclosure bar included reports filed with the SEC:

Fundamentally, the two Acts are designed to protect against similar but distinct harms. The federal False Claims Act was intended to assist the federal government in identifying and prosecuting fraud committed against it and its agencies; CFCA, as discussed, was designed to do the same thing as to fraud committed against the State and its political subdivisions. The rationale for limiting the types of public disclosures that invoke the statutes’ disclosure bars is thus readily apparent: “Federal government officials will often have no reason to be aware of information that is disclosed in state and local proceedings. A person who brings that information to the federal Government may still be providing the Government information about which it is unaware and about which it is unlikely to learn.” (Sylvia, The False Claims Act, supra, § 11:39.) Likewise, state officials may be unaware of information disclosed solely to or by the federal government; and a relator with information about a state or local fraud, even if that misconduct has been publicly disclosed in a federal forum, may still be making a valuable contribution to state or local authorities that is properly rewarded under CFCA.

The Court of Appeal also rejected the argument that information filed with the SEC qualifies as public disclosure by the news media because those filings are accessible on EDGAR.  The Court acknowledged that “the advent of online news sites, blogs and social media has blurred the line between what has traditionally been considered news media and other forms of public discussion.”   However, it found “little difficulty” in concluding that disclosures in forms only available on EDGAR “are not disclosures by the news media no matter how broadly that term is interpreted”.

From a policy perspective, the result is problematical.  In this case, the State of California had been investigating the company’s escheatment practices long before the plaintiff had discovered the issue and filed his action.  Thus, Court of Appeal acknowledged that “it is difficult to imagine what benefit Bartlett’s [the private plaintiff] lawsuit adds to the State’s effort to discover and prosecute the alleged fraud against it”.  Given the disclosure imperatives of the federal securities laws, the result practically invites private plaintiffs to troll SEC filings in order to “discover” potential CFCA claims that have not been publicly disclosed even though they are available for all the world to see.

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