Securities Act - Liability

Section 11

• standing

• “due diligence”

(last updated 14 Feb 13)

James M. Landis {}• HLS (1924)• S Ct clerk, Brandeis (1925)• Chair, FTC (1933-34)• Chair, SEC (1935-37) • Dean, HLS (1937-1946)

Thomas G. Corcoran {}• HLS (1926)• SCt clerk OWH (1927)• WS lawyer (1927-32)• Bureaucrat (1932-35)• Lobbyist par excellence

Benjamin V. Cohen {}• SJD HLS (1915)• FDR’s “brain trust” • Genl counsel PWA • Dumbarton Oaks (UN)

Drafters of Securities Act of 1933

Investor protection in public offering

• Disclosure (market protection)– Mandatory– Managed (“gun-jumping” rule)

• SEC oversight (regulatory protection)– Review and comment – Acceleration authority– Investigation / stop order /

enforcement (§17)

• Private liability (court protection)– §11: material misinformation in

RS– §12(a)(1): §5 violation (non-

exempt, unregistered sales)– §12(a)(2): other material misinfo

in offering

September 12, 1938

Compare §11 to Rule 10b-5?

Securities fraud action

Rule 10b-5• Transactional nexus• Plaintiff• Defendant• Elements

– Material misrepresentation or omission

– Scienter– Reliance– Causation– Damages

• Procedure

Who can be plaintiffs?

§11 Civil Liabilities on Account of False Registration Statement

(a) Persons possessing cause of action; persons liable. In case any part of the registration statement, when such part became effective, contained an untrue statement of a 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 … may, either at law or in equity, in any court of competent jurisdiction, sue--

§11 Civil Liabilities on Account of False Registration Statement

(a) Persons possessing cause of action; persons liable. In case any part of the registration statement, when such part became effective, contained an untrue statement of a 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 … may, either at law or in equity, in any court of competent jurisdiction, sue--

Krim v. pcOrder.com, Inc.(5th Cir 2005)

Petrick

Burke

Beebe

Issuer

Market(NASDAQ)

2.5 MM shs(IPO)

sell

buy

CEDE & Co.

Is “tracing” a hyper-technicality?

CEDE & Co.

250,000 shs(insiders)

§11 Civil Liabilities on Account of False Registration Statement

(e) Measure of damages. The suit authorized under subsection (a) of this section may be to recover such damages as shall represent the difference between the amount paid for the security (not exceeding the price at which the security was offered to the public) and … [depends on whether sold before or held through suit]

Who can be defendants?What is “due diligence” defense”?

Escott v. Bar-Chris Construction Corp.(SD NY 1968)

Issuer

Board ofdirectors

Signing officers

Market(plaintiffs)

Managing UW UW UW UW

Retail group

Accountant(auditor)

UW counsel

Companycounsel

Factor$$

notes

Bowlingalleys

notes

build

§11(a) Persons possessing cause of action; persons liable.

… any person acquiring such security … may … sue – (1) every person who signed the

registration statement;

(2) every person who was a director of … the issuer …;

(3) every person who, with his consent, is named in the RS as being … a director…;

(4) every accountant … who has with his consent been named as having … certified any part of the RS … with respect to the statement in such RS … which purports to have been … certified by him;

(5) every underwriter with respect to such security.

Escott v. Bar-Chris Construction Corp.(SD NY 1968)

Issuer

Board ofdirectors

Signing officers

Market(plaintiffs)

Managing UW UW UW UW

Retail group

Accountant(auditor)

UW counsel

Companycounsel

What is “due diligence” defense?

Expertised Non-expertised

Expert

After reas investigation, reasonably believes information is true

(ignorance no defense)

No liability

[see §11(a)(4)]

Non-expert

No reasonable ground to believe was untrue

(ignorance is excuse)

After reas investigation, reasonably believes information is true

(ignorance no defense)

Rule 176 -- Circumstances Affecting the Determination of What Constitutes Reasonable Investigation and Reasonable Grounds for Belief Under Section 11 of the Securities Act

In determining whether or not the conduct of a person constitutes a reasonable investigation or a reasonable ground for belief meeting the standard set forth in section 11(c), relevant circumstances include, with respect to a person other than the issuer.

(a) The type of issuer;

(b) The type of security;

(c) The type of person;

(d) The office held when the person is an officer;

(e) The presence or absence of another relationship to the issuer when the person is a director or proposed director;

(f) Reasonable reliance on officers, employees, and others whose duties should have given them knowledge of the particular facts ;

(g) When the person is an underwriter, the type of underwriting arrangement, the role of the particular person as an underwriter and the availability of information with respect to the registrant; and

(h) Whether, with respect to a fact or document, incorporated by reference, the particular person had any responsibility for the fact or document at the time of the filing from which it was incorporated.

Directors “Due diligence”?

“Inside” insiders• Russo (D / CEO)• Vitolo, Pugliese (Ds / founders)• Kircher (D / CFO)

“Outside” insiders• Birnbaum (D / secy)

“Inside” outsiders• Grant (D / outside counsel)• Coleman (D / UW partner)

“Outside” outsider • Auslander (D / banker)

Non-directors “Due diligence”?

Issuer

Underwriters• Drexel Burnham (managing UW)• Drinker Biddle (UW counsel)

–Ballard–Stanton

Accountant (expert)• Peat Marwick (auditor)

–Berardi

Break into five groups:1.Inside insiders2.Outside insiders3.Outsiders 4.Underwriters5.Accountant/auditor

What would youadvise each to do?

The end

Abbey v. Computer Memories, Inc(ND Cal 1986)

Mayer & Schweitzer(market maker)

DLJ(Pershing )

Fidelity Brokerage

Plaintiff

Issuer

Market(NASDAQ)

2 MM shs(of 11 MM shs outstanding)

sell buy

DepositoryTrust Co.

Is “tracing” a hyper-technicality?