Desist & Refrain Orders

 
Desist and Refrain Orders are issued in California by the Department of Corporations and the Department of Real Estate.  The Department of Corporations issues a Desist and Refrain Order when it believes there has been a violation of the California securities laws.  The Department of Real Estate issues a Desist and Refrain Order when it believes there has been a violation of the California real estate laws.


California Department of Corporations

The California Department of Corporations has the authority to issue Desist and Refrain Order whenever it believes the securities laws have been violated.  Typically, the Department of Corporations issues the Desist and Refrain Order without warning.  It usually does not send letters warning the respondent that suspect behavior might be a violation of securities law.  It just issues the Desist and Refrain Order.

These Desist and Refrain Order often appear on the first page of a Google search.  And they read like the respondent is the worst criminal, the most fraudulent offeror of securities that ever walked the face of this earth.

Under California law, a respondent who receives (has been served) with a Desist and Refrain Order has 30 days in which to contest the Desist and Refrain Order.  After that, the Desist and Refrain Order becomes a final order.  Before the 30 days expire, however, a respondent can request a hearing before an administrative law judge to challenge the Desist and Refrain Order.  By law, these hearings must be set within 15 business days, or about three weeks, of the date the Department of Corporations receives the request for a hearing.  When a respondent requests the hearing, he or she may waive that 15-business-day rule so that a hearing may be set farther down the road. 

The most common grounds we see for issuing Desist and Refrain Order are as a result of alleged general solicitation or alleged misrepresentations in the offering documents.  If general solicitation can be proved, it destroys a federal Regulation D, Rule 506 exemption.  Of course the purpose of getting a Regulation D, Rule 506 exemption is so that you do not have to register your offering in every state in which you solicit investors.  If the exemption is destroyed as a result of general solicitation, then you are no longer protected from having to register your offering with California and you could be found in violation of California securities laws. 

 Many times the Department of Corporations will issue a Desist and Refrain Order alleging general solicitation when it only has evidence of one telephone call to an alleged unqualified investor.  To us, “general solicitation” implies more than one telephone call and thus proof of more than one telephone call.  As of now, we do not have a definitive ruling on this point. 

Desist and Refrain Orders often allege misrepresentation as well.  Many times the Desist and Refrain Order will allege that the offering documents should have disclosed some fact which allegedly was not disclosed.  The test is whether there is a “substantial likelihood that, under all the circumstances, the omitted fact would have assumed actual significance in the deliberations of the reasonable shareholder. Put another way, there must be a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the ‘total mix’ of information made available.”  TSC Industries, Inc. v. Northway, Inc. (1976) 426 U.S. 438, 448-49.

What we have found, in our opinion, is that the Department of Corporations gets a little over-zealous in what it considers material.  Some incidents may have been disclosed in the offering materials, but the Department of Corporations believes more should have been disclosed.  Some incidents may be 10 years old or more.  The question, of course, is whether a reasonable investor would view the alleged misrepresentation as having significantly altered his opinion.  Would he or she have cared?  And how do we know what a “reasonable investor” thinks is material?

We have experience at all levels with Desist and Refrain Order issued by the California Department of Corporations.  We’ve tried several cases at the administrative hearing level.  If we have lost at the administrative hearing level, we’ve filed lawsuits at the trial court level seeking a writ of administrative mandamus.  When we beat the Department of Corporations at the trial level, they appealed to the court of appeal.  We got a unanimous decision at the court of appeal level, instructing the Department of Corporations about what constitutes an investment contract.


California Department of Real Estate

The California Department of Real Estate also issues Desist and Refrain Order.  Typically the Department of Real Estate issues these orders when it believes that a real estate agent or broker has violated California’s real estate law. 

A respondent who receives (is served with) a Desist and Refrain Order from the Department of Real Estate has 30 days in which to request an administrative hearing.  Unless the respondent waives time, the administrative hearing must start within 15 days (calendar, not business days) after the Department of Real Estate receives the request. 

Unlike Desist and Refrain Order issued by the Department of Corporations, the Department of Real Estate must issue its decision within 30 days after the hearing.