Fraud on the Market

Although the Oregon securities law statute does not on its face require proof of scienter (intent to manipulate, deceive or defraud), the Oregon Court of Appeals read the requirement into the statute if the theory for relief is fraud on the market.

Copy of the decision: 150211-Oregon-v-Marsh-&-McLennan

In 2003 the legislature amended the Oregon securities law to provide a good faith defense from securities law violations for secondary violators (one who materially aids or is a control person) and to eliminate the defense for sellers and all those in a fraud on the market case. The court reasoned the legislature did not provide a good a good faith defense for those who material aid (or control the issuer) in a fraud on the market case because it assumed that federal securities law applied. That meant the participants are liable because of their culpable intent to defraud and a good faith defense would not make sense.

Even though ORS 59.137 does not require scienter by its terms, that is what it means. In a fraud on the market case, Oregon law is the same as federal law under SEC Rule 10b-5.

Whatever one thinks of the Oregon Court of Appeals “correcting” the words of the statute, there is a troubling use of language in the case. The court distinguishes fraud on the market from “direct, face-to-face securities transactions”. This is not a valid description of the distinction. Either type of securities transaction can occur in face-to-face situations. Telephones have been available in Oregon for over 100 years and private issuer transactions are often sold over the phone without any face-to-face meeting.  One of the most common fraud on the market schemes involves the purchase of a shell corporation by insiders. The sale usually  includes the transfer of most of the stock of the company to the purchasers (often over 90%). The insider places the stock in numerous stock accounts with brokerages around the world. The accounts are held in various names to disguise the common ownership. A common tactic in pump-and-dump schemes is for the officer of the company to meet “face-to-face” with the investor and encourage a market purchase. What the investor does not know is that the officer directly or indirectly controls the accounts which are selling the stock into the market. There are face-to-face fraud on the market transactions and there are over-the-phone issuer transactions.

The court came close to the real distinction when it quoted Robert Stoll in the legislative history as distinguishing fraud on the market from “initial offerings”.1at 49 The true distinction is determined by the flow of money. Did the money go to another investor in a market transaction or did it go directly or indirectly to the issuer?

It is interesting to follow the genesis of the “direct, face-to-face” language. This case accurately cites a prior decision in this case2State v. Marsh & McLennan Cos., 353 Ore. 1, 12 (Or. 2012) which cites inaccurately cites another prior decision3State v. Marsh & McLennan Cos., 241 Ore. App. 107, 114 (Or. Ct. App. 2011) by adding the word “direct”. That case cites Everts v. Holtmann464 Ore. App. 145, 152-53, 667 P.2d 1028, rev den, 296 Ore. 120, 672 P.2d 1193 (1983). for its quotation. The Everts court did not use the phrase.

Fraud on the Market

Footnotes   [ + ]

1. at 49
2. State v. Marsh & McLennan Cos., 353 Ore. 1, 12 (Or. 2012)
3. State v. Marsh & McLennan Cos., 241 Ore. App. 107, 114 (Or. Ct. App. 2011)
4. 64 Ore. App. 145, 152-53, 667 P.2d 1028, rev den, 296 Ore. 120, 672 P.2d 1193 (1983).

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