The California Court of Appeal has ruled that “subjective” knowledge of fraud is required to sue broker-dealers for fraud related to the transfer of securities.

The case of first impression has national implications on the U.S. Uniform Commercial Code Article 8, because the California Code at issue is based on the UCC.

The decision in Decker v. Yorkton Securities, Inc., was filed by California Court of Appeal, First Appellate District, Division Five Judge David A. Garcia on March 13, 2003.

The complete decision can be accessed online at http://www.courtinfo.ca.gov/opinions/documents/A096965.PDF.

“This ruling is of interest to all brokers, dealers and transfer agents across the United States who are concerned about how the industry’s increased focus on responsibility to clients and shareholders will apply to them,” said Dorsey Securities & Financial Litigation Practice Group co-chair Stewart Aaron, who orally argued the appeal. “It is the first time any U.S. court at this level has interpreted this provision.”

Dorsey client was Canadian investment dealear Yorkton Securities, Inc. Yorkton and other securities dealers were sued by InnovaCom, Inc., a Florida company born out of a merger.

Immediately prior to the creation of InnovaCom, executives from one of the merged entities fraudulently issued millions of dollars of InnovaCom stock certificates. Some of the certificates were then deposited with Yorkton, who forwarded them to the transfer agent for conversion into “street name,” and then these certificates were deposited with a securities depository in New York, to enable them to be sold in U.S. securities markets.

InnovaCom sued the former executives and transfer agent. InnovaCom also pursued the Canadian investment dealers, arguing that they should have acted as “gatekeepers” for the securities markets in detecting and preventing the transfers of the fraudulent certificates. Yorkton argued immunity to InnovaCom’s adverse interest claim pursuant to UCC Article 8, and the trial court agreed.

In this decision, the California Court of Appeal affirmed, clearing the defendants of liability, as they did not have knowledge of the fraud or, in other words, did not know facts that subjectively would have led them to believe there was an adverse claim.