Liability Under The Securities Act - Securities Regulation

Liability Under the Securities Act

1. § 11 (Stat. Supp. pp. 23-25)

   1. "Section 11 provides that where a material fact is misstated or omitted from a registration statement accompanying a stock filing with the Securities and Exchange Commission, 'any person acquiring such security' may bring an action for losses caused by the misstatement or omission." Hertzberg v. Dignity Partners, Inc. (pg. 481)

      1. § 11(a) provides the following:

         • In case any part of the registration statement, when such part became effective, contained an untrue statement of material fact or omitted to state a material fact required to be stated therein or necessary to make the statements therein not misleading, any person acquiring such security (unless it is proved that at the time of such acquisition he knew of such untruth or omission) may, either at law or in equity, in any court of competent jurisdiction, sue-

           • (1) every person who signed the registration statement;

             • "The registration statement shall be signed by the registrant, its principal executive officer or officers, its principal financial officer, its controlling or principal accounting officer and by at least a majority of the board of directors or persons performing similar functions." Form S-1 (Stat. Supp. pg. 206)

           • (2) every person who was a director of (or person performing similar functions), or partner in, the issuer at the time of the filing of the part of the registration statement with respect to which his liability is asserted;

           • (3) every person who, with his consent, is named in the registration statement as being or about to become a director, person performing similar functions, or partner;

           • (4) every accountant, engineer, or appraiser, or any person whose profession gives authority to a statement made by him, who has with his consent been named as having prepared or certified any part of the registration statement, or as having prepared or certified any report or valuation which is used in connection with the registration statement, with respect to the statement in such registration statement, report, or valuation, which purports to have been prepared or certified by him;

           • (5) every underwriter with respect to such security.

             • It is important to make sure that the person falls within the definition of an "underwriter" here. SEE "The UnderWriter Concept BELOW

If such person acquired the security after the issuer made generally available to its security holders an earning statement covering a period of at least twelve months beginning after the effective date of the registration statement, then the right to recovery under this subsection shall be conditioned on proof that such person acquired the securities relying on such untrue statement in the registration statement or relying upon the registration statement and not knowing of such omission, but such reliance may be established without proof of the reading of the registration statement by the person.

2. Who can Sue? - Standing

   1. Anyone who buys stock issued pursuant to a defective registration statement has standing to sue under § 11.

   2. There is NO requirement of reliance

      • EXCEPT in the atypical case where a person has acquired the security after the issuer has made generally available an earnings statement covering a period of at least one year beginning after the effective date of the registration statement.

   3. The plaintiff does NOT have the burden of showing causation or injury.

      • Deterrence, rather than just compensation, is the principal objective of the § 11

   4. Limits:

      • (1) The plaintiff must not have been aware of the truth at the time he purchased the securities.

      • (2) The statute of limitations from § 13 applies: no action may be maintained unless brought within one year after discovery of the falsity or omission was or should have been made, and in any event, no more than three years after the security was offered to the public.

      • (3) The plaintiff must show that the securities purchased were issued pursuant to the registration statement in question.

        • "[T]his limitation only means that the person must have purchased a security issued under that, rather than some other, registration statement." Hertzberg v. Dignity Partners, Inc. (pg. 481)

          • "As long as [the plaintiff] is suing regarding this security, he is 'any person purchasing such security,' regardless of whether he bought it in the initial offering, a week later, or a month after that." Hertzberg v. Dignity Partners, Inc. (pg. 482)

        • When the challenged offering is an IPO, there should be little question that a plaintiff who purchases securities in an open market is "a person acquiring such security" for purposes of § 11 standing.

          • BUT where a plaintiff purchases a security on the open market sometime after a public distribution of additional securities of a class already outstanding, the courts have read § 11 literally to require a tracing requirement on the plaintiff.

            • But, this is nearly impossible today.

              • In Krim v. pcOrder.com, the court determined that statistical tracing was not enough and that actual tracing was required:

              • "[G]eneral statistics say nothing about the shares that a specific person actually owns and have no ability to separate those shares upon which standing can be based from those for which standing is improper." (pg. 483)

              • Moreover, in In re Exodus, Inc. Securities Litigation, the court relied on an expert's declaration that tracing is impossible "because shares of the same class have the same cash flow and governance rights, making them virtually indistinguishable from each other." (pg. 483)

   5. Considerations re when the registration statement becomes effective

      • Under Item 512 of Regulation S-K, any post-effective amendment and any subsequently filed 10-K are deemed the filing of a new registration statement thus resetting the effective date of the registration statement for § 11 liability.

      • Under Rule 430B, the filing of a prospectus supplement in connection with a shelf takedown resets the effective date for liability purposes to the earlier of the date of its first use or of its first sale, BUT ONLY for purposes of assessing issuer or underwriter liability.

        • Other defendants are not subject to that effective date extension except when the filing is pursuant to § 10(a)(3) or reflects a fundamental change with respect to the issuer.

        • As a result, these other defendants may escape liability imposed on the issuer and the underwriters.

      • A free writing prospectus will not be a part of the registration statement and thus is NOT within the purview of § 11 liability.

   6. Aiding and abetting

      • There is no aiding and abetting liability under § 11

   7. Control Person Liability

      • There can be control person liability under § 11

      • § 15 imposes joint and several liability upon any person who controls a primary violator "unless the controlling person had no knowledge of or reasonable ground to believe in the existence of the facts by reason of which the liability of the controlled person is alleged to exist."

   8. Materiality

      • The plaintiff must establish the Materiality of the misstatement or omission. (See below for Materiality standard)

   9. NOTE: Gustafson's reasoning re § 12(a)(2) DOES NOT apply to § 11.

3. Due Diligence Defense

   1. § 11(b)

      • (1) The issuer

        • There is no due diligence defense for the issuer.

      • (2) The signatories of the registration statement

        • With respect to expertised portions of the registration statement, a non-issuer non-expert defendant may raise the defense that they "had no reasonable ground to believe, and did not believe" that there was any inaccuracy or omission.

          • The burden of investigation lies solely upon the expert; the others have a qualified right to rely on the expert's efforts.

        • With respect to non-expertised portions of the registration statement, the signatories of the registration statement, the directors, and the underwriters may raise the due diligence defense only if "after reasonable investigation" they had "reasonable ground to believe and did believe" that the statements therein were true and complete.

          • Thus, there must (1) a reasonable investigation, and (2) after such investigation, no reason to doubt the accuracy of the registration statement.

          • "In determining . . . what constitutes reasonable investigation and reasonable ground for belief, the standard of reasonableness shall be that required of a prudent man in the management of his own property." § 11(c) (Stat. Supp. pg. 25)

        • There is a distinction between insiders and outsiders. See Escott v. BarChris Construction Co.

          • Less due diligence is expected of outsiders BUT an outsider is still expected to conduct due diligence. See BarChris Construction Co.

        • The CEO is presumed to know all that is going on in the company. See BarChris Construction Co.

          • The CEO is essentially a guarantor of the registration statement. See BarChris Construction Co.

        • The court in Feit v. Leasco Data Processing Equipment Co. went so far as to suggest that insiders are virtual "guarantors" of the registration statement. (pg. 501)

        • A defendant who knows that portions of an expertised portion of the registration statement is false is not entitled to shut his eyes to the facts and rely on the expert. See BarChris Construction Co.

        • § 11(b)(1) provides an "out" for an officer or a director who is named in the registration statement when it is filed, but who thereafter becomes dissatisfied with the disclosure.

          • That person is not liable under § 11 if, before the registration statement becomes effective, the required steps to resign the position with...