Securities Fraud in Texas
As most people know by now, Texas state Attorney General Ken Paxton was indicted in Collin County for two counts of Securities Fraud in Texas and one count of Failing to Register. Further, as is the case in every significant political prosecution, discussions of whether the cases are bona fide prosecutions or politically motivated hatchet-jobs swirl with many people on both sides weighing in.
However, for the neutral citizen who is trying to form his or her own opinion as to the seriousness of Mr. Paxton’s actions and his fitness to serve in such a high office, this question becomes more complex than a typical prostitution, DWI, or even bribery charge. This is because securities fraud cases involve somewhat foreign terminology and details of investment activity that are not necessarily in the scope of most people’s daily lives. With a couple definitions and a look at the indictments, however, the case can become a bit clearer.
First, the term ‘security’ is a ‘term of art’ under the law and within businesses. In most cases, the term simply means either an ownership interest in a company, such as a stock, or loaner’s interest in either a company or a public project, such as corporate or municipal bonds. There are also securities relating to the right to collect revenue from a mine or oil rig.
Second, the term misrepresentation means just what it sounds like. That is, when someone sells any type of security that person has a duty under the law to avoid misleading investors. This is because the law acknowledges the complexity of securities transactions as well as the lack of familiarity persons have in this arena.
Third, a broker is simply someone who arranges the sale of securities to customers.
Fourth, the terms customer and investor are virtually identical in this area of the law.
So how does this apply to the case against the Attorney General?
Texas Securities Law
Specifically, the Texas Securities Act requires brokers to ensure that their license to sell securities does not lapse. This is cited under section 29(i) of the Texas Securities Act. Further, the Act also requires brokers to avoid misleading investors. This is cited under 29(e) of the Act. This means that Texas treats the discussions, representations, promises, and written materials within the sale of a security as secularly sacrosanct. That is, such conversations should not include deception or ambiguity. Also, under TEX.REV.CIV.STAT. ANN. art. 581–29(C) it is illegal to (1) engage in any fraud or fraudulent practice; (2) employ any device, scheme, or artifice to defraud; or (3) knowingly make any untrue statement of a material fact or omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they are made, not misleading.
Federal Securities Law
Federally, deceptive conduct regarding securities is also prohibited. Under 18 USC 1341 and 1343, it is illegal to deceive persons using mail or wire systems. While mail and wire fraud are not exclusively used to prosecute deceptive securities transactions, they certainly could be. Also, the Securities Exchange Act under 15 U.S.C. § 78j(b) states:
It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce or of the mails, or of any facility of any national securities exchange…(b) To use or employ, in connection with the purchase or sale of any security registered on a national securities exchange or any security not so registered, any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the [Securities and Exchange] Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors.”
Kent Schaffer, one of the special prosecutors on the cases against Paxton, said Paxton is accused of encouraging others to invest more than $600,000 in a company called Servergy Inc. without telling them he was making a commission and misrepresenting himself as a fellow investor. The grand jury also charged him with failing to register with state securities regulators for soliciting clients for Mowery Capital Management in return for fees.
In a nutshell, the Attorney General is accused of telling investors he owned stock in a company called Servergy when he was soliciting sales for that company. Such a representation would presumably signal confidence on the part of the Attorney General. Prosecutors will argue that this representation led two separate investors to buy stock in the company. Obviously, the prosecutors will also argue that this representation was not true.
He is also accused of failing to tell investors that he stood to make a commission if they bought Servergy stock. Once again, prosecutors will argue that this omission misled investors by failing to inform them of the Attorney General’s interest in the sale because people often distinguish sales conversations from objective advice.
If these allegations are proven to be true, they are crimes in Texas. How serious are they? In Texas and under federal law, the sentence and penalty range is dictated by the level of investment. That is, how much money was transacted as a result of the fraud. In Mr. Paxton’s case, he is accused of soliciting two investments each of which were for more than $100,000. As that amount is the threshold for a first degree felony in Texas, he faces two counts of first degree Securities Fraud.
With respect to his failure to keep his license current, the Attorney General faces a third degree felony charge which carries a range of probation up to 10 years imprisonment.
All of these charges carry a fine of between $0-$10,000.
Obviously, the trial has not happened and Mr. Paxton is presumed not guilty under the law.
Nonetheless, a quick understanding of securities law can hopefully bring more clarity about the nature of the charges.