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Civil Liability and the Securities Laws

Civil Liability and the Securities Laws. Section 12(a)(1) Liability. Section 12(a)(1) Liability. §12(a)(2). C/L. §10(b). §11. §12(a)(1). Misstat. or Omission. yes. yes. yes. no. yes. yes. yes. Materiality. no. strict liability. State of Mind. strict liability. scienter.

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Civil Liability and the Securities Laws

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  1. Civil Liability andthe Securities Laws

  2. Section 12(a)(1)Liability

  3. Section 12(a)(1) Liability §12(a)(2) C/L §10(b) §11 §12(a)(1) Misstat. or Omission yes yes yes no yes yes yes Materiality no strictliability State ofMind strictliability scienter scienter tracingrequirement transactioncausation yes no Reliance (losscausation) loss causation yes Causation no offeringprice unlimited unlimited rescission Damages

  4. Section 12(a)(1) Liability • Section 12(a)(1) • Any person who – • (1) offers or sells a securityin violation of section 5... . shall be liableto the person purchasing such securityfrom him ... torecover the consideration paidfor such security with interest thereon, less the amount of any income received thereon, upon thetender of such security, or for damages if he no longer owns the security.

  5. Section 12(a)(1) Liability • Section 2(a)(3) • The term 'sale' or 'sell' shall include every contract of sale or disposition of a security or interest in a security, for value. The term 'offer to sell', 'offer for sale', or 'offer' shall include every attempt or offer to dispose of, or solicitation of an offer to buy, a security or interest in a security, for value.

  6. Section 12(a)(1) Liability • Pinter v. Dahl unregisteredsecurities Dahl $310,000 Pinter counter-claim claim helps investors completesubscription agreement does not receive commission AdditionalInvestors $7500

  7. Section 12(a)(1) Liability • Pinter v. Dahl The test: “liability extends only to the person who successfully solicits the purchase, motivated at least in part by a desire to serve his own financial interests or those of the securities owner.”

  8. Section 12(a)(1) Liability • Pinter v. Dahl 2. The Pinter court rejects including “substantial participants” as potential § 12(a)(1) defendants in part because this class of defendants is “unpredictably defined.” Is the class of defendants who help “solicit” the offers more definite?

  9. Section 12(a)(1)Damages and Defenses

  10. Section 12(a) Remedy 1. Rescission (upon tender of the security): Consideration (plus interest) – Income Received 2. Rescissionary Damages (if sold security): Consideration (plus interest) – Amount Realized – Income Received

  11. Section 12(a)(1) Liability InterPhone • InterPhone (Hypothetical 8) Bird 100 shares @ $20/sh never received prospectus Will Bird pursue her§ 12(a)(1) right to obtainrescission if prices riseto $30 / sh? If prices drop to $10 / sh?

  12. Section 12(a)(1) Liability InterPhone • InterPhone (Hypothetical 8) Rosita investor in IPO received final prospectus Can Rosita bring suit for§ 12(a)(1) right to obtainrescission for failure to sendBird a final prospectus?

  13. Section 12(a)(1) Liability sparrow InterPhone securities • InterPhone (Hypothetical 8) Kermit $10/SH Resale $18.60/SH Firm Commitment Purchase Bird $20/SH Public Offering

  14. Section 12(a)(1) Liability sparrow InterPhone securities • InterPhone (Hypothetical 8 Bonus) Robert Kermit $30/SH Resale $18.60/SH Firm Commitment Purchase $10/SH Resale Bird $20/SH Public Offering

  15. Section 12(a) Statutory Seller InterPhone IPO Price = $20 Integration: All transactions have violated § 5 Underwriters in firm commitment offering Forgot to send § 10 prospectus with § 2(a)(10)(a) free writing Mkt P = $10

  16. Section 12(a) Statutory Seller InterPhone After 1 day of trading: $40/share (initial investors “flip” their shares) Underwriters in firm commitment offering IPO Price = $20 Price drifts down to $5/share in secondary market

  17. Section 12(a)(1) Liability • Summary • 1. Any violations of § 5 actionable • Strict liability • No loss causation defense • Defendant must be a “seller” • Passing title • Soliciting investment for defendant’s or issuer’s benefit

  18. Section 12(a)(2)Misstatements

  19. Section 12(a)(2) Misstatements • Section 12(a)(2) • Any person who – ... (2) offers or sellsa security ... by means of aprospectus or oral communication, which contains anuntrue statement of material fact... (the purchaser not knowing the untruth or omission), and who shall not sustain the burden of proof that hedid not know, and in theexercise of reasonable care could not have known, of such untruth . . . • shall be liable to the personpurchasing such security from him...

  20. Section 12(a)(2) Misstatements • Section 12(a)(2)(b) • Loss Causation – In ... subsection (a)(2), if the person who offered or sold such security proves that any portion ... of the amount recoverable ... representsother than the depreciation in value... from such part of the prospectusor oral communication, with respect to which the liability ... is asserted ... , ... such portion ... shall not be recoverable.

  21. Section 12(a)(2) Misstatements §12(a)(2) C/L §10(b) §11 §12(a)(1) Misstat. or Omission yes yes yes yes no no yes yes yes yes Materiality strictliability State ofMind strictliability scienter scienter (negligence) tracingrequirement transactioncausation yes no no Reliance (losscausation) (losscausation) loss causation yes Causation no offeringprice unlimited unlimited rescission rescission Damages

  22. Section 12(a)(2) Misstatements • Gustafson v. Alloyd $18,709,000 plus a$2,122,219 adjustment Alloyd Wind PointPartners LLP stock Gustafson et al. (sole shareholder) Purchase Agreement - representation re financial statements

  23. Section 12(a)(2) Misstatements • Section 10(a) • Except to the extent otherwise permitted or required ... (1) a prospectus related to a security ... shall contain theinformation contained in the registration statement, but it need not include the documents referred to in paragraphs (28) to (32), inclusive of Schedule A.

  24. Section 12(a)(2) Misstatements • Section 2(a)(10) • The term "prospectus" means any prospectus, notice, circular, advertisement, letter, or communication, written or by radio or television, which offers any security for sale or confirms the sale of any security;

  25. Section 12(a)(2) Misstatements • Structure §12(a)(2) §11 §12(a)(1) misstatementsin the registrationstatement failure toregister apublic offering misstatementsin selling apublic offering

  26. Section 12(a)(2) Misstatements • Gustafson v. Alloyd • What other remedies does Alloyd Holdings have available to it? • How do these remedies differ?

  27. Section 12(a)(2) Misstatements • Gustafson v. Alloyd • If the word “prospectus” has one consistent meaning in the Securities Act, why is § 5(b)(1) necessary?

  28. Section 12(a)(2) • Section 5(b) of the 1933 Act • (b) It shall be unlawful for any person • to ... transmit anyprospectusrelating to any security with respect to which a registration statement has been filed under this title, unless such prospectus meets the requirements of section 10; or • to carry ... any such security for the purpose ofsaleor for delivery after sale, unlessaccompanied or preceded by a prospectusthat meets the requirements of subsection(a) of section 10.

  29. Section 12(a)(2) Misstatements • Gustafson v. Alloyd 3. Suppose that InterPhone engages in a private placement under Rule 506 for the sale of $50 million of its common stock. During the selling effort, InterPhone’s representatives tell potential investors orally that InterPhone expects its new ad campaign will “increase revenues by 50%.” Assuming such oral representations are materially misleading. Can investors in the private placement bring suit under § 12(a)(2)?

  30. Section 12(a)(2) Misstatements • Gustafson v. Alloyd 4. After Gustafson, may an investor in a Regulation A offering sue under § 12(a)(2) for fraud in a Regulation A offering circular?

  31. Section 12(a)(2) Misstatements • InterPhone (Hypothetical 9, Scenario 1) Can Bird bring a § 11 suit? Yes, Bird is able to trace to the seasoned public offering. A § 12(a)(2) suit? Yes, Bird receives the final prospectus (and read it!). Bird buys directly from the seasoned offering after reading the final prospectus.

  32. Section 12(a)(2) Misstatements • InterPhone (Hypothetical 9, Scenario 2) Can Ernie bring a § 11 suit? Yes, Ernie is able to trace to the seasoned public offering. A § 12(a)(2) suit? Yes, Ernie receives the prospectus after making the investment decision.(Valence Technology) Ernie buys directly from the seasoned offering without reading the final prospectus (but he receives a copy).

  33. Section 12(a)(2) Misstatements • InterPhone (Hypothetical 9, Scenario 3) Can Rosita bring a § 11 suit? Yes, Rosita is able to trace to the seasoned public offering, even though she bought shares in the secondary market. (Hertzberg) A § 12(a)(2) suit? No, Rosita did not receive a final prospectus as a result of the prospectus delivery requirement.(Valence Technology) Rosita buys shares from Bird after the offering,two months after reading the final prospectus (which she got from Ernie).

  34. Section 12(a)(2)Elements of COA

  35. Section 12(a)(2) Misstatements • Sanders v. John Nuveen & Co. exclusive underwriter John Nuveen Winter & Hirsch commercialpaper Investors

  36. Section 12(a)(2) Misstatements • Sanders v. John Nuveen & Co. • Sanders says that: “A prospectus that reports on the issuer’s financial condition affects that price. In the case at bar, publication of WH’s true financial condition would have caused a total collapse of the market for its notes.” • Is it true that a prospectus containing the truth would have caused a “total collapse” of the market? If so then not revealing the truth may in fact have caused the investors to purchase the notes. How could such a total collapse occur?

  37. Section 12(a)(2)Defenses

  38. Section 12(a)(2) Misstatements 1.How does the § 12(a)(2) defense apply to “expertised” portions of the prospectus?

  39. Section 12(a)(2) Misstatements 2.Is there any reason to impose different standards of care under §§ 11 and 12(a)(2) for third party gatekeepers?

  40. Section 12(a)(2)Damages

  41. Section 12(a)(2) Misstatements • Summary • Only available in connection with a public offering • Defendant must be a “seller” • Defense of reasonable care • 4. Rescission damages • a. Loss causation defense available

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