“It’s Just Three Nines!” Protecting Against Securities Liability
by J. Mitchell Little
The year was 1976. That summer, The Omen was a hit at the box office. By October 1976, the film had been parodied in a skit on Saturday Night Live titled “The Ointment.” In the skit, the demon-child Damien’s family tries to discern why terrible and increasingly-violent “accidents” had befallen their family, coming up with increasingly-silly theories. The skit concludes with the family’s being informed by a priest that The Evil One is to blame, and that he can be identified by the appearance of the numbers “666” on his skin. Naturally, Damien is checked, at which point, his father realizes with relief, “Heyyy! It's alright! It's just three nines! Ahhh! Good boy, Damien!”
Did Damien’s father spend more time qualifying his son as The Evil One or disqualifying him? Before you or your law firm bring a new private securities offering screaming into the world, consider this: Have you spent more time qualifying or disqualifying your client? While the federal court system continues to chisel away at aider and abettor liability under the federal securities laws, Texas law still holds sway in this area.
Material Aider Liability
The Texas Securities Act creates joint and several liability for anyone (including professionals) “who directly or indirectly with intent to deceive or defraud or with reckless disregard for the truth or the law materially aids a seller, buyer, or issuer of a security.” Tex. Rev. Civ. Stat. Title 19, Art. 581-33(F)(2). In other words, a material aider gets treated exactly the same way legally as the individual or company that lies or tells half-truths in the sale of a security. Texas courts have interpreted this statute as requiring that a material aider have “rendered assistance in the face of a perceived risk that its assistance would facilitate untruthful or illegal activity by the primary violator.” Sterling Trust Co. v. Adderley, 168 S.W.3d 835, 842 (Tex. 2005). The court stated that this perception required that the aider become subjectively aware of his role in the improper activity.
In Your Right Mind
The fastidious securities lawyer traffics in a variety of information; information is the lifeblood and currency of his or her disclosure documents and memoranda. The question is not what to do with good information; the question is what to do with bad information. What types of information puts an attorney on notice that he is helping a bad client do a bad thing? Remembering that mere neglect does not create liability, we turn to the types of information that only a reckless attorney would ignore.
The Recalcitrant Seller
The Recalcitrant Seller says, “The SEC and Texas State Securities Board told me to do it this way, but I’m going to do it that way.” An attorney actively involved in advising a client in securities matters should take immediate, corrective action to resolve and disclose any regulatory disputes. These types of disputes put both your client and you on notice that things are going down an unacceptable path and that a new course is required.
The Lawyer Buffet
The Lawyer Buffet patron takes what he wants and leaves the rest, saying, “I’d like you to prepare my memorandum, but I don’t want your advice on anything else. You don’t need to know everything.” While it may be appropriate from time to time to assist a troubled client with curative filings or litigation, it is nearly impossible for an attorney to provide meaningful securities law advice without providing systems and procedures that will help ensure a client’s compliance with securities laws in the future. These topics range from what types of activity are acceptable in the sales process, to types of acceptable compensation to sellers, to how the company finds its investors. When a client attempts to over-narrow the scope of your engagement, consider this a warning sign.
The Unguided Missile
The Unguided Missile says, “I tried doing it your way, but it was too hard, so I did it my way.” The Unguided Missile is the most dangerous type of securities client and the most likely to create liability because the client puts you on notice that the client has heard and ignored your advice. There are only two solutions for dealing with this type of client: (1) obtain firsthand knowledge that the client has corrected its action and is now complying with your advice or (2) fire the client.
Sixes or Nines
The only solution for the cautious securities lawyer is to make sure to spend some percentage of your time looking for “sixes” and not just “nines.” Spend time—even unbillable time, if necessary—trying to understand your client’s processes, procedures, and controls and making sure they comport with your advice. Otherwise, don’t be surprised if terrible and increasingly-violent “accidents” begin to befall your practice.
J. Mitchell Little, of Scheef & Stone, L.L.P, can be reached at firstname.lastname@example.org.