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 ( ) Chair, SEC ( ) Dean, HLS ( ) Thomas G. Corcoran {}{} HLS (1926) SCt clerk OWH (1927) WS lawyer ( ) Bureaucrat ( ) 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. (5 th 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 of directors Signing officers Market (plaintiffs) Managing UWUW Retail group Accountant (auditor) UW counsel Company counsel Factor $$ notes Bowling alleys 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 of directors Signing officers Market (plaintiffs) Managing UWUW Retail group Accountant (auditor) UW counsel Company counsel

What is “due diligence” defense?

ExpertisedNon-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 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.section 11(c) (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 insiders 2.Outside insiders 3.Outsiders 4.Underwriters 5.Accountant/auditor What would you advise 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) sellbuy Depository Trust Co. Is “tracing” a hyper- technicality?