Securities Fraud

Civil actions alleging fraud committed in the course of a securities transaction are commonly based upon one or more of the following statutes: Section 27.01 of the Texas Business & Commerce Code, Section 33 of the Texas Securities Act, Section 12(2) of the federal Securities Act of 1933, and Section 10(b) of the federal Securities Exchange Act of 1934 under which the Securities and Exchange Commission has promulgated Rule 10b-5. An additional provision, concerning the civil liability of investment advisers, was added as Section 33-1 of the Texas Act in 2001. Some of these statutes also include penal provisions, but particularly with respect to state (as opposed to federal) regulation of securities, civil liability has been the main tool for enforcement of the antifraud provisions. The National Securities Market Improvement Act of 1996 substantially preempted state power over ``covered securities,'' which consist mainly of those securities traded in the national marketplace. However, it left intact state authority to investigate and bring enforcement actions with respect to fraud or deceit, or unlawful conduct by a broker or dealer, in connection with securities or securities transactions.

In an opinion that was later withdrawn, the Texas Supreme Court held that the Deceptive Trade Practices Act did not apply to the sale of securities. The Texas Supreme Court later substituted another opinion for the first one and in this second opinion allowed recovery of damages under the DTPA. Although the stock brokerage house had argued that the DTPA was inapplicable to securities transactions, the Court held that the brokerage house had waived any error the trial court may have committed. The brokerage house had not presented the argument to the trial court and did not make the argument in the court of appeals until its second motion for rehearing in that court.

The federal courts have exclusive jurisdiction over suits brought pursuant to the Federal Securities Exchange Act of 1934, although state courts have sometimes permitted Rule 10b-5 and other claims pursuant to that statute to be raised defensively. An action under the Securities Act of 1933, other than a covered class action, may be brought in state court. But, as a general rule, the joinder of a claim based on the federal statute to a state law claim will not improve the plaintiff's overall case. As a practical matter, most lawsuits brought pursuant to the Securities Act of 1933 will be prosecuted in federal court.

Although cases involving securities fraud can theoretically be litigated as class actions, two federal acts severely inhibit the prosecution of most securities fraud actions in state court. Under the Private Securities Litigation Reform Act of 1995 and the Securities Litigation Uniform Standards Act of 1998, most securities class actions premised on violations of state law are preempted and made subject to federal law. The Uniform Act amends the Securities Act of 1933 and the Securities Exchange Act of 1934 to include provisions preempting class actions brought after the Uniform Act's enactment in which damages are sought on behalf of more than 50 persons to the extent such actions involve securities fraud claims ``in connection with the purchase or sale of a covered security''. The term ``covered security'' generally includes any nationally traded security. The Uniform Act provides that no such action ``based upon the statutory or common law of any state'' may be maintained in either state or federal court, and also provides for removal of such actions from state to federal court.

The Texas fraud statute makes two categories of acts involving stock in a corporation fraudulent:

• transactions in stock where a false promise to do an act is made, and transactions involving stock
• when a false representation of a past or existing material fact is made, when the false representation is:
  • Made to a person for the purpose of inducing that person to enter into a contract; and
  • relied on by that person in entering into that contract. When there is a duty to speak, silence may be as misleading as a positive misrepresentation of existing facts. Subsection (a) of Section 27.01 was not amended; therefore, its provisions concerning false representation and false promise remain unchanged. Among other changes, the amendments added a third type of fraud. A person who (1) has actual awareness of the falsity of a representation or promise made by another person, but (2) fails to disclose the falsity of the representation or promise to the person defrauded, and (3) benefits from the false representation or promise is also held to have committed the fraud described in subsection. Actual awareness may be inferred when ``objective manifestations indicate that a person acted with actual awareness''