A Bad Bill Becomes Law When There Is More Interest In Enacting A Fix Than Fixing the Problem

by Allen Matkins

In 2002, the Legislature enacted AB 55 creating the victims of corporate fraud fund.  Since the fund was created, it has collected about $15 million and nearly 800 claims have been submitted.  In a devastating article published last fall by the Sacramento Bee, Dan Morain reported that only 10 people had been paid with a total payout of $112,496.  His verdict on the fund was “little more than a lie sanctioned by the state of California . . .”.   To make matters even worse, the state in the last budget year borrowed $10 million of the fund’s balance.  The state funds the fund with one-half of the $5 fee imposed on annual statements filed with the Secretary of State by California by corporations and foreign corporations qualified to transact intrastate business here.  Cal. Corp. Code §§ 1502(i) and 2117(d).  This brings in approximately $1.5 million annually.

Senator Ted W. Lieu introduced SB 1058 to address these concerns.  Unfortunately, the bill is riddled with errors and problems, even though I had pointed many of these errors out while the bill was being heard.  I can only conclude that there was more interest in enacting a fix than actually fixing the problem.  This week, Governor Brown signed the bill into law.

Here are just a few of the substantive problems that I see with SB 1058:

  • A victim must be a resident of California at the time of the fraud.  See new Corporations Code Section 2281(a).  This seems an obvious attempt to protect Californians while stiffing everyone else, but does it make any sense?  Assume that a California corporation commits fraud in California against two victims, Jane and Jack, who are both physically present in California at the time that the fraud is committed.  Jane is a resident of California at the time of the offense and Jack becomes a resident shortly thereafter.  Does anyone see an equal protection (U.S. Constitution, Article XIV, Section 1 and California Constitution, Article 1, Section 7(a)) problem with this?  Doesn’t this unequal treament run afoul of Article 1, Section 20 of the California Constitution which guarantees noncitizens the same property rights as citizens?  To the extent that a criminal restitution order is involved, doesn’t this contradict Article 1, Section 28 of the California Constitution which declares that it is the “unequivocal intention of the People of the State of California that all persons who suffer losses as a result of criminal activity shall have the right to restitution” (emphasis added)?
  • A victim must obtain a judgment in “a court of competent jurisdiction” which is defined as a state or federal court situated in California.  Corporations Code Sections 2281(e) and 2282(a).  Suppose that a California corporation engages in widespread fraud that victimizes people in several states.  If a class action suit is filed in another state, the victims may be out of luck.  Some have pointed out that it would be possible to obtain entry of a judgment awarded in another state and have that judgment entered here pursuant to the Sister-State Money Judgment Act (Code of Civil Procedure Section 1710.10 et seq.).  However, the statute literally requires that the judgment be obtained (not entered by) in a court situated in California.  Accordingly, this requirement also raises serious constitutional concerns.
  • Victims of securities fraud will not be protected unless they can prove common law fraud.  See Corporations Code Section 2282(c)(7)(C)(i).
  • Spouses and immediate family members of employees, officers, directors, managing agents, and other principals of the corporation may not recover but the principals themselves can!  Corporations Code Section 2282(c)(7)(A).

The bill is also subject to numerous technical and other drafting errors.

As a matter of public policy, it was a mistake for the legislature to have burdened the Secretary of State’s office with such an ill-considered program. The Secretary of State’s office is already overburdened with essential responsibilities.  Given that decisions by the Secretary of State may be contested by both claimants and the corporations, the Secretary of State will need to comply with the procedural provisions of the California Administrative Procedure Act as well as the due process requirements of the United States and California Constitutions.


DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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