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CALIFORNIA CORPORATE & SECURITIES LAW

Bill Aims To Negate Scienter

You can thank the Romans for science and the English for knowledge

The etymon of “scienter” is sciens which is the present participle form of the Latin verb meaning to know (scire).  The English word “know” is derived from the Old English verb, cnāwan, the present participle of which is cnāwende.  The roots of cnāwan can be traced back to the Proto Indo European root gno from which Ancient Greeks formed the verb γιγνώσκειν, from which the word “agnostic” is derived.

If ignorance is bliss, what is the negation of scienter?

In the law, liability often turns on whether scienter is, or is not, required.  Yet, the word does not appear even once in the Corporate Securities Law of 1968.  Now, California Assemblymember David Chiu has introduced a bill, AB 2178, that would put scienter in the CSL by amending Section 25501 as follows.

Any person who violates Section 25401 shall be liable to the person who purchases a security from him or her or sells a security to him, him or her, who may sue either for rescission or for damages (if the plaintiff or the defendant, as the case may be, no longer owns the security), unless the defendant proves that the plaintiff knew the facts concerning the untruth or omission or that the defendant exercised reasonable care and did not know (or if he had exercised reasonable care would not have known) of the untruth or omission. The plaintiff shall not be required to plead or prove that the defendant acted with scienter.

The addition of an express negation of scienter is likely to create confusion.  Section 25501 creates a private remedy for violations of Section 25401, which is California’s basic anti-fraud statute.  As has been discussed in prior posts, Section 25401 was modeled after Section 12(2) of the Securities Act of 1933 (now Section 12(a)(2)), not Rule 10b-5. However, scienter is not an element of a Section 12(2) claim.  Cohen v. NVIDIA Corp. (In re NVIDIA Corp. Sec. Litig.), 768 F.3d 1046, 1056 (9th Cir. Cal. 2014).  So, why introduce scienter to California’s statutory scheme almost fifty years later?

Coal to Newcastle?

When scienter is required, a plaintiff must plead that the defendant intentionally misled investors or was deliberately recklessness (at least in the Ninth Circuit under NVIDIA).  The “reasonable care” defense already found in Section 25501 is a tougher standard for defendants because it allows for liability when a defendant is merely negligent.  If the statute already imposes liability under a negligence standard, what purpose is there in saying that the plaintiff need not plead or prove scienter?

Will only natural persons be liable under Section 25501?

Finally, the bill adds the feminine pronoun “her” to the existing masculine pronoun “him”.  While it is certainly possible that women as well as men will become liable under Section 25501, this change creates ambiguity.  As it is now, the CSL defines “person” to include men, women and all manner of artificial persons.  Cal. Corp. Code § 25013 (“‘Person’ means an individual, a corporation, a partnership, a limited liability company, a joint venture, an association, a joint stock company, a trust, an unincorporated organization, a government, or a political subdivision of a government.”).  Further, the Corporations Code defines the masculine gender to include the feminine and neuter.  Cal. Corp. Code § 12.  It seems to me that if the legislature is going to ignore Section 12 and add a pronoun, it should add them all.

AB 2178 also creates a process for qualification by permit of offers and sales by crowdfunding.  I’ll have more to say about that in a future post.

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