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Securities Regulation SMU Law Review Volume 56 Issue 3 Annual Survey of Texas Law Article 29 2003 Securities Regulation George Lee Flint Jr. Follow this and additional works at: https://scholar.smu.edu/smulr Recommended Citation George Lee Flint, Securities Regulation, 56 SMU L. REV. 1995 (2003) https://scholar.smu.edu/smulr/vol56/iss3/29 This Article is brought to you for free and open access by the Law Journals at SMU Scholar. It has been accepted for inclusion in SMU Law Review by an authorized administrator of SMU Scholar. For more information, please visit http://digitalrepository.smu.edu. SECURITIES REGULATION George Lee Flint, Jr.* ECURITIES regulation deals primarily with the laws preventing and providing remedies for fraud in the sale of stocks and bonds. Since business entities issue most of the securities, the prior annual Surveys treated securities regulation as a subset of corporate law.' This article initiates the separate treatment of the subject. Due to the minimal coverage of securities developments in past annual Surveys, this article will discuss previous years' changes as they impinge on current trends. Immediately before this Survey period, the 77th Texas Legislature passed Sunset Legislation with respect to the Texas State Se- curities Board (the Board). 2 This legislation's impact appears in the Board's new rules and enforcement proceedings. Past annual Surveys discussing developments for securities included developments in federal law.3 This article will similarly mention major federal statutory and regulatory developments since they impact Texas issuers. Congress passed the Sarbanes-Oxley Act of 20024 during the Sur- vey period. The Texas Legislature based portions of the Texas Securities * H. Andy Professor of Commercial Law, St. Mary's University School of Law, San Antonio, Texas; B.A., 1966, B.S., 1966, M.A., 1968, University of Texas at Austin; Nuc. E., 1969, Massachusetts Institute of Technology; Ph.D. (Physics), 1973, J.D., 1975, University of Texas at Austin. 1. See, e.g., Robert F. Gray, Jr. & Gregory J. Sergeshetter, Corporations,46 SMU L. REV. 1171, 1184 (1993) (two securities cases); Robert F. Gray, Jr. et al., Corporations,45 SMU L. REV. 1525, 1549 (1992) (federal and state securities cases, an amendment to the federal statute); Alan W. Tompkins & Ted S. O'Neill, Corporationsand Limited Liability Companies,51 SMU L. REV. 817, 830 (1998) (short section on Texas Securities Act amend- ments and federal securities cases). 2. Act of June 15, 2001, 77th Leg., R.S., ch. 1091, 2001 Tex. Gen. Laws 2399; see James R. Peacock, Il1, Changes to Business Organization Laws, E-Sign, and the Tax Code, 54 TEX. B.J. 741, 742 (2001) (providing a short explanation of the changes). 3. See, e.g., Simon Sokolow, Corporationsand Partnerships,39 Sw. L.J. 203, 232-36 (1985) (federal statute, Fifth Circuit cases, as well as Texas cases and State Securities Board rules); Robert Hamilton, Corporations and Partnerships, 38 Sw. L.J. 235, 277-79 (1984) (federal rules, Supreme Court decisions, as well as one paragraph on Texas State Securities Board); David Sokolow, Corporations and Partnerships, 37 Sw. L.J. 165, 178-88 (1983) (federal rules, Supreme Court and Fifth Circuit cases, as well as Texas State Securities Board rules and Texas cases). 4. Sarbanes-Oxley Act, Pub. L. No. 107-204, 116 Stat. 745 (2002). This article does not discuss those portions of the Sarbanes-Oxley Act relating to (1) creation of the Public Company Accounting Oversight Board, id. at 750-70; (2) accountants and auditing, id. at 770-77; (3) forfeiture of bonuses in certain circumstances, id. at 778; (4) analyst conflict of interests, id. at 791-93; (5) non-dischargeability of certain debts in bankruptcy, id. at 801; (6) the protection of "whistle blowers," id. at 806-04; and (7) tampering with records or otherwise impeding investigations. Id. at 807-09. 1995 1996 SMU LAW REVIEW [Vol. 56 Act on the federal statutes.5 As a result, Texas courts rely on federal decisions to interpret the corresponding sections of the Texas Securities Act.6 This article will also examine federal court developments in the Fifth Circuit. I. SCOPE OF THE SECURITY ACTS Definitions, especially those relating to personal liability and transac- tions constituting a security, determine the scope of the securities acts. The major change wrought by the sunset legislation of 2001 expanded criminal liability for corporations and civil liability for investment advi- sors. In fact, these legislative changes mandated corresponding Board rule amendments. The Texas courts, meanwhile, struggled with what evi- dence establishes a "control person" for liability and "evidence of indebt- edness" for a security. When the Texas Legislature extended most penalties applicable to indi- viduals to business entities in 1971, 7 it omitted corporate criminal liability because the penal code at that time did not provide for corporate crimi- nal liability. 8 Recently, organized crime has engaged in fraudulent securi- ties schemes. 9 They perpetrate fraud by having a corporation hire employees to replace any employees removed by securities regulators, thereby circumventing traditional securities enforcement. 10 The Sunset Commission feared Texas would become a haven for this type of fraud," because it is the only state that does not provide for corporate criminal liability for securities fraud. So the Sunset Legislation added corporate 12 criminal liability to the Texas Securities Act. In the past the Board regulated investment advisors. Since investment advisors maintain a continuous relationship with the investor and influ- ence investor decisions, breaches of fiduciary duties through conflicts of interest and fraudulent advice with respect to their services occur more frequently than with dealers. But since the Texas Securities Act did not 5. See, e.g., COMMI1rrEE ON SECURITIES AND INVESTMENT BANKING OF THE SECTION ON BANKING AND BUSINESS LAW OF THE STATE BAR OF TEXAS, COMMENT-1977 Amend- ment, following TEX. REV. CIv. STAT. ANN. art. 581-33 (Vernon Supp. 2002). 6. See infra note 179 and accompanying text (using this principle to interpret TEX. REV. Civ. STrAT. ANN. art. 581-33 (Vernon Supp. 2002) on civil liability for fraud). 7. Act of Apr. 15, 1971, 62nd Leg., R.S., ch. 235, 1971 Tex. Gen. Laws 1085 (amend- ing TEX. REV. Civ. STAT. ANN. art. 581-4B to include corporations and other business entities for purposes of civil liability under TEX. REV. CIv. STAT. ANN. art. 581-33). 8. That situation changed in 1974 when the legislature amended the penal code to permit corporate criminal liability. Act of May 16, 1973, 63rd Leg., R.S., ch. 399, § 1, 1973 Tex. Gen. Laws 883, 885 (adding TEX. PEN. CODE § 7.21ff (1994)). 9. See, e.g., Organized Crime on Wall Street: Hearing Before the U.S. Congress, House Commerce Committee Subcommittee on Finance and Hazardous Materials, (state- ment of Bradley W. Skolnik, Indiana Securities Commissioner and President of the North American Securities Administrators Association, Inc.). 10. SUNSET A)VISORY COMM'N, STAFF REPORT ON STATE SECURITIES BOARD 11 (2000). 11. Id. 12. Act of June 15, 2001, 77th Leg., R.S., ch. 1091, § 3.11, 2001 Tex. Gen. Laws 2399, 2427 (adding TEX. REV. Civ. STAT. ANN. art. 581-29-3). 20031 SECURITIES REGULATION 1997 provide for civil liability for investment advisors, as did the acts in twenty- eight states, the Board could only impose a criminal penalty. 13 In 1999, the Board used the threat of criminal penalties to secure restitution of $13 million for investors. t4 But investors could not sue to recover fees or losses associated with the fraudulent advice under the Texas Securities Act.' 5 Investors might sue under the Texas Deceptive Trade Practices Act and collect multiple damages if they could prove scienter, almost on a strict liability basis.' 6 However, the statute's application to a transaction otherwise covered by the Texas Securities Act remains doubtful. 17 So the Sunset Legislation added a civil penalty for investment advisor's defalca- tions with the same due diligence defense and statute of limitations that apply to dealers.' 8 Now investors as well as the Board, can enforce liabil- ities against investment advisors. The Board amended its rules to comport with the prior year's legisla- tion by adding definitions for "rendering services as an investment advi- sor" and for "federal covered investment advisor." 19 Prior Board regulation of investment advisors encompassed these terms in the defini- tion of dealer as did the Texas Securities Act.20 The Sunset Commission noted that the functions of investment advisors differed from those of dealers. 21 The confusion caused by mingling investment advisors with dealers allowed investment advisors to argue that certain provisions of the Texas Securities Act did not apply to them because the provision ap- plied to the functions of a dealer, not an investment advisor. 22 So the sunset legislation placed Texas with the forty-four other states that distin- 13. SUNSET ADVISORY COMMISSION, STAFF REPORT ON STATE SECURITIES BOARD 12 (2000). 14. Id. 15. Id. 16. TEX. Bus. & COM. CODE ANN. §§ 17.50 (for sale of goods or services) & 17.506 (damages and defenses) (2002). 17. See Portland Sav. & Loan v. Bevill, Bresler & Schulman Gov't Sec., Inc., 619 S.W.2d 241 (Tex. App.-Corpus Christi 1981, no writ) (securities are not goods because not tangible); compare Allais v. Donaldson, Lufkin & Jenrette, 532 F. Supp. 749 (S.D. Tex. 1982) (investment advice is not a service to a consumer due to coverage by the Texas Securities Act with its due diligence defense), with Frizzell v. Cook, 790 S.W.2d 41 (Tex. App.-San Antonio 1990, writ denied) (investment advice is a service, but the due dili- gence defense of the Texas Securities Act is allowed); see generally Mark C.
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