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Wash. Ruling Highlights States’ Clashing Securities Decisions

By  Ian Ross

(Originally featured by Law360 at: https://www.law360.com/articles/1223069)

Last month, the Washington Supreme Court held in Federal Home Loan Bank of Seattle v. Credit Suisse Securities USA LLC that a plaintiff suing for securities fraud under the Securities Act of Washington[1] does not need to prove reliance.[2]

Although the court acknowledged that its decision did not align with decisions in federal courts or other states,[3] it found that the plain language of Washington’s blue sky law[4] does not require an investor to show that he or she relied on a misstatement when buying the security. Instead, the court held that a plaintiff seeking rescission for a misstatement made in connection with the purchase of a security only needs to show that the misstatement was material.[5]

Two years ago, an appellate court in Florida reached the opposite conclusion with respect to Florida’s blue sky law, the Florida Securities and Investor Protection Act.[6] In J.P. Morgan Securities LLC v. Geveran Investments Ltd., the appellate court found that a plaintiff seeking rescission under FSIPA was required to show not only that a misstatement was material, but also that the plaintiff actually relied on the misstatement when purchasing a security.[7]

The appellate court found that its interpretation of the statute’s plain language was supported by a 1989 Florida Supreme Court decision holding that FSIPA’s anti-fraud provisions, because they provide for rescission as a remedy, should be analogized to a common law rescission claim.[8]

Florida common law rescission claims, the Florida Supreme Court had found, require proof of reliance.[9] Thus, the Geveran court held that rescission under FSIPA likewise requires an investor to show that it relied on a material misrepresentation.[10]

These two different outcomes underscore that the scope of seller liability under many state blue sky laws remains uncertain.[11] This uncertainty arises principally from the fact that although many states have adopted the Uniform Securities Act,[12] some have also enacted remedial provisions that appear to track provisions from the federal securities regulations, specifically, Rule 10b-5.[13]

The Uniform Securities Act, in its original form, does not appear to require reliance.[14] Reliance, however, is an element of a cause of action under Rule 10b-5.[15] State court decisions interpreting blue sky laws have consistently turned on whether the court found that the state legislature intended adopt the remedial language in the Uniform Securities Act or the federal securities regulations.

State courts that have found that their legislature intended to adopt the remedial provisions of the Uniform Securities Act have usually concluded that their blue sky laws are broadly intended to protect investors after a misrepresentation occurs.[16] These courts have found that a requirement that a plaintiff proves reliance is inconsistent with this purpose, and the result has been to find that their legislature adopted something akin to a strict liability statute.

Under these decisions, an investor is able to seek rescission simply by demonstrating that a material misrepresentation was made, even if the investor never saw or relied on that misrepresentation, and even if the misrepresentation was made unintentionally or without knowledge.[17] 

But where state courts have found that the anti-fraud provisions in their blue sky laws were intended to track the remedies available under Rule 10b-5, they have been more likely to find that reliance is an element of a fraud claim under the statute.[18] These courts have reasoned that the remedies provisions in blue sky laws similar to Rule 10b-5 can be distinguished from blue sky laws with language similar to Section 12(a)(2) of the Securities Act of 1933 — which does not require reliance.[19]

This distinction, state courts have observed, is justified because many blue sky laws apply to any misstatement or omission made in connection with any sale of securities, whereas Section 12(a)(2) is limited to certain misstatements made by sellers, such as misstatements made in connection with a prospectus or oral communication.[20]

The Washington Supreme Court ultimately found that its Legislature modeled the Washington Securities Act on the Uniform Securities Act, and that the federal securities laws were not persuasive in its analysis.[21] The court observed that the neither the term “reliance” nor the concept appeared in the statute, nor “does reliance appear in the identical section in section 101 of the Uniform Securities Act of 156, on which this provision is modeled.”[22]

A holding that reliance was not an element of a private claim against a seller, the court found, “ensures that those harmed when a seller misrepresents material facts can recover … irrespective of their reliance on that activity.”[23]

In response to the seller’s argument that this ruling would create a form of absolute liability, the court emphasized that materiality is not a showing to be taken lightly, and thus “prevents the creation of open-ended liability for any misstatement of fact by the defendant.”[24]

Prior to the Credit Suisse Securities decision, many practitioners took the view that Washington employed a modified version of the Uniform Securities Act that required reliance as an element.[25] In fact, the Washington Supreme Court in Credit Suisse Securities acknowledged that one of its prior decisions had included reliance as an element[26] — it was forced to refer to this prior language as dictum.[27]

So perhaps the most important lesson from the Credit Suisse Securities decision is that, even in states where courts have ruled on the scope of their blue sky laws, things are not as settled as they may seem. Efforts to achieve national uniformity have failed, and in jurisdictions where a state supreme court has not addressed the scope of its blue sky laws, advocates may have a real opportunity to use that uncertainty to advocate for change or clarification, even where the law appears settled.[28]

The Credit Suisse Securities decision may have clarified the scope of seller liability under Washington’s blue sky law, but the decision is a useful reminder that uncertainty persists in many other jurisdictions. 

Ian Ross is a partner at Stumphauzer Foslid Sloman Ross & Kolaya PLLC.

Disclaimer: Ross was on the litigation team representing appellant Lighting Science Group in J.P. Morgan Securities v. Geveran Investments while he was a shareholder at Greenberg Traurig PA.

 [1] See Wash. Rev. Code § 21.20.010, et seq.

[2] See Federal Home Loan Bank of Seattle v. Credit Suisse Securities (USA) LLC, et al., 449 P.3d 1019, 1028 (Wash. 2019).

[3] See 449 P.3d at 1024 (“Uniformity of the states’ laws cannot be achieved by our actions; the states employing the Uniform Securities Act are split on the issue of reliance.”) (citations omitted).

[4] “Blue sky laws” is a term used colloquially to refer to the set of securities laws states use to regulate certain securities activities. Researchers have noted that the origin of the term “blue sky law” is uncertain, although the earliest uses often appeared in connection with the first state blue sky laws in Kansas. See, e.g., Jonathan R. Macey and Geoffrey P. Miller, Origin of the Blue Sky Laws, 70 Tex. Law. R. 347, 359-60 n. 59 (1991). A plausible explanation, they have suggested, is that the term “had long been in use … to describe some other type of fraudulent conduct outside the securities area, most likely fraudulent land promotions during pioneer days.” Id.; see also Duncan A. Bonjorni, Nebraska Blue Sky Law and Oil and Gas Interests, 37 Neb. L. Rev. 383, 383 (1958) (term credited to a remark by one of the sponsors of the original Kansas securities act that ‘some companies sought to capitalize the blue skies’”) (internal citations and quotations omitted). 

[5] The Washington Supreme Court observed that the Washington Securities Act still curtailed the possibility that “all purchasers of securities merely unhappy with their return on investment” could sue, noting that its blue sky law had a three-year statute of limitations, and that the materiality inquiry prevented a plaintiff from recovering for “a minor misstatement that is not of actual import.” 449 P.3d at 1028.

[6] See Fla. Stat. § 517.011, et seq.

[7] 224 So. 3d 316, 324 (Fla. App. Ct. 2017). The author of this article was counsel for appellant Lighting Science Group Corporation in Geveran while he was a shareholder at Greenberg Traurig, on an appellate team led by Greenberg Traurig shareholders David A. Coulson, Barry Richard, and Alan T. Dimond.

[8] See E.F. Hutton & Co. v. Rousseff, 537 So. 2d 978, 979 (Fla. 1989) (finding that the remedies provisions in FSIPA “appear to be patterned after the common law contract cause of action termed rescission”).

[9] Id.; see Kashner Davidson Secs. Corp. v. Desrosiers, 689 So. 2d 1106, 1107 (Fla. 2d DCA 1997) (holding that the elements of statutory securities fraud in Florida are “(1) a misrepresentation; (2) of a material fact; (3) on which the investor relied”). 

[10] Florida courts recognize three types of reliance: actual reliance, justifiable reliance, and reasonable reliance. Billington v. Ginn-La Pine Island, Ld. LLLP, 192 So. 3d 77, 81 n.4 (Fla. App. Ct. 2016). The Geveran court found that, because the “exhaustive statutory scheme created by the FSIPA” evidenced an intent to “encourage investors to rely on representations from a seller of securities,” it would not require a plaintiff to show that its reliance was justifiable. See 224 So. 3d at 326 n.22.

[11] The scope of and uncertainty around the blue sky laws has been the subject of considerable discussion in law reviews and legal journals. See, e.g., Rutheford B. Campbell, Jr., The Role of Blue Sky Laws After NSMIA and the JOBS Act, 66 Duke L. J. 606 (2016); Danielle Beth Rosenthal, Navigating the Stormy Skies: Blue Sky Statutes & Conflict of Laws, 2 Stan. J. Complex. Litig. 96 (January 2014); Ashwini K. Agrawal, The Impact of Investor Protection Law on Corporate Policy: Evidence from the Blue Sky Laws (working paper) (June 2009), available at http://w4.stern.nyu.edu/finance/docs/pdfs/Seminars/091f-agrawal.pdf (last visited Nov. 8, 2019). 

[12] The National Association for Fixed Annuities maintains a state-by-state survey of the adoption of the Uniform Securities Acts. See National Association for Fixed Annuities, United States Survey: Adoption of Uniform Securities (June 15, 2012), available at http://nafa.com/wp/wp-content/uploads/2012/07/20120920-NAFA-Uniform-Security-Act-Adoption_At-A-Glance.pdf (last visited Nov. 8, 2019). A number of states have not adopted a version of the Uniform Securities Act, and instead have adopted their own system. Marc I. Steinberg and Chris Claassen, Attorney Liability under the State Securities Laws: Landscapes and Minefields, 3 Berkeley Bus. L. J. 1 (2005); see also Philip Y. Brown, Adam M. Welsberger and Jared J. Bedrick, The Dark Cloud of Seller Liability Under State Blue Sky Laws, U.S. Law (Spring/Summer 2012), available at https://web.uslaw.org/wp-content/uploads/2013/06/uslaw_magazine_spr_sum_2012.pdf (last visited Nov. 8, 2019) (“Many [states] have adopted some form of the uniform laws, while a handful of states, such as New York, Florida and Illinois have opted for their own system.”).

[13] 17 C.F.R. § 240.10b-5. 

[14] See Uniform Securities Act (1956), available at https://www.nasaa.org/wp-content/uploads/2011/08/UniformSecuritesAct1956withcomments.pdf (last visited Nov. 8, 2019).

[15] See Basic Inc. v. Levinson, 485 U.S. 224, 243 (1988) (“We agree that reliance is an element of a Rule 10b-5 cause of action. Reliance provides the requisite causal connection between a defendant’s misrepresentation and a plaintiff’s injury.”) (citations and quotations omitted).

[16] See, e.g., Federal Home Loan Bank of Seattle, 449 P.3d at 1023 (the main purpose of the Washington Securities Act” to protect investors,” and “[once] a misrepresentation is revealed, the investor is harmed”); Gohler v. Wood, 919 P. 2d 561, 565-66 (Utah 1996) (finding that Utah act was modeled on the Uniform Securities Act). 

[17] The Uniform Securities Act does allow a seller to avoid liability in some circumstances based on a “lack of knowledge” defense. See Uniform Securities Act § 410(a). This is an affirmative defense where the seller bears the burden of showing that “he did not know, and in the exercise of reasonable care could not have known, of the untruth or omission.” Id. Some state courts have found that this defense is available under their blue sky laws. See, e.g., Marram v. Kobrick Offshore Fund Ltd., 809 N.E. 2d 1017, 1028 (Mass. 2004) (affirmative defense for lack of knowledge available). 

[18] Geveran, 224 So. 3d at 326; Carney v. Mantuano, 554 N.W.2d 854, 857 (Wisc. Ct. App. 1996) (finding federal securities law persuasive, “[for] if the purchaser knew that the seller’s statement was untrue, as Wisconsin law describes, then this purchaser could not have legitimately ‘relied’ on the statement, as federal law describes”); Green v. Green, No. M2006-02119-COA-R3-CV, 2008 WL 624860, at *5 (Tenn. Ct. App. 2008) (finding that the Tennessee Securities Act of 1980, because the language “continues to closely follow federal securities law Rule 10b-5, requires reliance”); Brown v. Earthboard Sports USA Inc., 481 F.3d 901, 917 (6th Cir. 2007) (same for Kentucky blue sky law); Keogler v. Krasnoff, 601 S.E.2d 788, 791 (Ga. Ct. App. 2004) (same for Georgia blue sky law). 

[19] See, e.g., Green, 2008 WL 624860, at *5 (“There are cases in other jurisdictions interpreting the security acts of other states in accordance with Section 12(2) of the Securities Act of 1933 and holding that those statutes do not require proof of reliance. These cases, however, involve statutes that contain language similar to Section 12(2) and that have been deemed to be analogous to Section 12(2).”); Keogler, 601 S.E.2d at 791 (finding that reliance is required because that the elements for proving fraud under the Georgia blue sky law are the same as the elements for providing fraud under Rule 10b-5). 

[20] See Green, 2008 WL 624860, at *5 (“Section 12(2) of the Securities Act of 1933 applies only to those who offer and sell securities, holding them to a high level of responsibility with respect to prospectuses or oral communications use in the sale of securities.”). 

[21] Federal Home Loan Bank of Seattle, 449 P.3d at 1022 (“we should not rely so heavily on federal law while interpreting our own Securities Act”). The court also noted that the commentary to the Uniform Securities Act “expressly ruled out reliance as a requirement for a private cause of action.” 

[22] Id.

[23] Id. at 1024.

[24] Id. at 1028.

[25] See Brown, Welsberger and Bedrick, supra note 11, at 29 (“Georgia, Tennessee, and Washington have modified the language of section 410 [of the Uniform Securities Act] to require reliance”); Joseph C. Long, 12A Blue Sky Law § 9:26 n.2 (“in the State of Washington, the court of appeals has issued a series of decisions that reliance is required under the Washington Act”). 

[26] See Hines v. Data Line Sys. Inc., 787 P.2d 8, 12 (1990) (“investors need only show that the misrepresentations were material and that they relied on the misrepresentations.”). 

[27] Federal Home Loan Bank of Seattle, 449 P.3d at 1028 (“‘need only show’ is not the same as ‘must show’”). 

[28] The continuing uncertainty in state securities laws is not limited to the scope of potential seller liability: As many sellers know, state courts have also disagreed on the enforceability of choice-of-law provisions, see Rosenthal, supra note 10, and exculpatory language or non-reliance clauses in securities transactions. See, e.g., Ian Ross, Reframing the Question: Why Florida Courts Should Enforce Nonreliance Clauses, 93 Fla. B. J. 16 (January/February 2019), available at https://www.floridabar.org/the-florida-bar-journal/reframing-the-question-why-florida-courts-should-enforce-nonreliance-clauses/ (last visited Nov. 8, 2019); David O. Blood, There Should be No Reliance in the “Blue Sky”, 1998 BYU L. Rev. 177 (1998). 

Wash. Ruling Highlights States’ Clashing Securities Decisions