There are several common bases of liability for violating federal securities laws in a securities transaction. Under section 12(a)(1) of the Securities Act, parties who improperly offer or sell securities in violation of section 5 of the Securities Act are strictly liable to the purchaser regardless of whether such purchaser’s loss was related to the violation. Recovery under section 12(a)(1) is limited to either rescission or, if the plaintiff no longer owns the security, to monetary damages in an amount equal to the difference between the purchase price and the sale price of the securities.
Section 11 of the Securities Act imposes liability on, among others, an issuer, its directors and the underwriters when a registration statement contains an untrue statement of a material fact or omits to state a material fact necessary to make the included statements not misleading. A fact is ‘material’ if there is a substantial likelihood that a reasonable purchaser would consider such fact to be important in making his or her investment decision. If such untruths or omissions exist, any purchaser may bring a civil suit, and he or she need not prove either a causal relationship between the material misstatement or omission and the decline in value or that he or she relied on the misstatement or omission in purchasing the security. The plaintiff is also not required to prove intent on the part of the defendant. Under section 11, the defendants may escape liability by proving that the plaintiffs knew of the disclosure deficiency when purchasing the security. Defendants (other than the issuer) also have an affirmative ‘due diligence’ defence under section 11 whereby they can escape liability by showing that, after reasonable investigation, they had reasonable grounds to believe that the information contained in the registration statement was true and that nothing was omitted. With respect to the ‘expertised’ portions of the registration statement (eg, the audited financial information of the issuer), affirmative diligence is not required - such defendants need merely show that they had no reasonable ground to believe, and did not believe, that there was a material misstatement or omission at the time of effectiveness. The WorldCom decision, in re WorldCom Inc Securities Litigation, 346 FSupp 2d 628 (SDNY 2004), has introduced some uncertainty into the distinction between ‘expertised’ and ‘non-expertised’ portions of the registration statement for purposes of the due diligence defence. A plaintiff who prevails on section 11 grounds is entitled to monetary damages in an amount equal to the difference between the price paid for the securities (but not greater than the public offering price) and the price of the securities at the time of suit or the price at which the securities were disposed.
Another basis for liability in securities transactions is section 12(a)(2) of the Securities Act, which provides that any person who offers or sells a security by means of any oral or written communication that contains an untrue statement of a material fact, or omits to state a material fact necessary to make the included statements not misleading, is liable to the purchaser for damages. As under section 11, the plaintiff is not required to prove intent, but the plaintiff must show that he or she was not aware of the misstatement or omission and that the misstatement or omission somehow affected his or her decision to purchase the securities. Section 12(a)(2) liability extends only to those who offer and sell the securities, though courts have interpreted this to include officers, directors and principal stockholders of the issuer, where such persons authorise the promotional efforts of the underwriters and help prepare the offering and other selling documents. The SEC has also confirmed that issuers of securities constitute ‘sellers’ under section 12(a)(2), regardless of the form of underwriting arrangement entered into. Defendants have an affirmative defence if they can prove that they did not know, and reasonably could not have known, of such misstatement or omission. Unlike section 11, no duty to investigate is required. Plaintiffs who still own the securities are entitled to rescission. Plaintiffs who no longer own the securities are limited to recover damages actually caused by the false statements or omissions. Section 12(a)(2) liability attaches at the time an investor becomes committed to purchase securities and enters into a contract of sale (ie, when the investor makes the investment decision). Information conveyed after the contract of sale, for example, in a subsequently delivered final prospectus, would not be considered in evaluating section 12(a)(2) liability at the time of the contract of sale.
Additionally, section 15 of the Securities Act provides that any person who controls any other person who is liable under either section 11 or 12 of the Securities Act will also be liable, jointly and severally, to the same extent as the controlled person (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).
Private placements and unregistered secondary market transactions do not trigger either section 11 or section 12(a)(2) liability. Instead, the anti-fraud provisions of the Exchange Act, in particular rule 10b-5, provide the basis for liability for material misstatements and omissions in such offerings and sales. The key difference in liability under rule 10b-5 as opposed to section 11 or section 12(a)(2), however, is that the plaintiffs must prove that the defendant had intent to defraud, deceive or manipulate investors, as well as reliance on the defendant’s wrongful conduct in purchasing the security.
Although rule 10b-5 also applies to registered offerings, these heightened burdens to establishing liability generally result in plaintiffs relying instead on Securities Act liability claims in such offerings. Similar to sections 11 and 12(a)(2), however, the class of defendants can extend to the issuer, its officers and directors, the underwriters and anyone else who directly or indirectly committed the fraud. Plaintiffs who prevail in claims relying on rule 10b-5 may generally recover out-of-pocket losses. As with section 12(a)(2), liability under rule 10b-5 attaches at the time an investor becomes committed to purchase securities and enters into a contract of sale.
Whether section 10(b) of the Exchange Act and rule 10b-5 promulgated thereunder apply extraterritorially has been at issue in recent years. In April 2012, the SEC released a study of the issue mandated by Dodd-Frank as part of its response to the US Supreme Court’s decision in Morrison v National Australia Bank, 561 US (2010). Morrison reversed lower court precedent by holding that section 10(b) applies only to securities fraud in transactions in securities listed on a US exchange and to transactions in any other security that occur in the US. The SEC’s study lacks a definitive recommendation, but does provide Congress with certain options for consideration, including reinstatement of a narrower version of the ‘conduct and effects’ test, which lower courts applied to section 10(b) actions before Morrison or enactment of a clarified version of the ‘transactions’ test set out in Morrison.
Amendments to the securities laws as part of Dodd-Frank expanded the SEC’s ability to bring ‘aiding and abetting’ enforcement actions previously allowed under the Exchange Act by allowing the SEC to also bring aiding and abetting enforcement actions under the Securities Act, the Investment Advisers Act of 1940 and the Investment Company Act of 1940. Dodd-Frank did not, however, provide a private cause of action for aiding and abetting claims, though it did require the Government Accountability Office (GAO) to conduct a study concerning what effect introducing such a cause of action might have.
The GAO report sets forth arguments for and against authorising such a cause of action, but did not offer a conclusion or recommendation on the advisability of doing so. To date, no such legislation has been proposed or adopted and US courts continue to reject liability claims predicated on aiding and abetting.
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