Rescission Liability After Gustafson

• Publication year: 1995
• Pages: 2329

24 Colo.Law. 2329 Colorado Lawyer 1995.

1995, October, Pg. 2329. Rescission Liability After Gustafson

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2329

Vol. 24, No. 10, Pg. 2329

Rescission Liability After Gustafson

by Michael M. Schmidt

The Securities Act of 1933 ("Act")(fn1) was passed during the Great Depression in reaction to fraudulent and abusive trading in the securities markets. The Act compels full and fair public disclosure of all information material to an investor's evaluation of the real worth of securities to prevent fraud in the sale of securities. In combination with the Securities Act of 1934,(fn2) the Investment Company Act of 1940(fn3) and the Trust Indenture Act,(fn4) the Act provides the regulatory environment within which the securities markets function

This article discusses the U.S. Supreme Court's recent clarification of when investors may invoke the favorable remedy provisions of § 12(2) of the Act, including the exercise of rescission rights. In resolving the § 12(2) issue, the Court also determined when disclosure documents constitute a prospectus.

Background

A prospectus is distributed to the public as the primary marketing or solicitation document for the securities offering. It constitutes merely one of several parts of a registration statement, which also includes a facing page, cross-reference sheet, signatures and financial statements. Issuers are required to file registration statements with the SEC to avoid § 5 liability under the Act.

Section 12(2) of the Act,(fn5) an antifraud provision that provides for civil liability, grants purchasers an express cause of action for rescission or rescissory damages against issuers that make material misstatements or omissions by means of a prospectus. To establish a prima facie case, the aggrieved purchaser must establish that the issuer: (1) offered to sell or sold a security, (2) by use of the mails or interstate commerce, (3) by means of a prospectus or oral communication, (4) that contained a materially false statement or omitted a material fact and (5) the purchaser was not aware of the misstatement or omission. If the issuer cannot sustain a due diligence defense that it "did not know, and in the exercise of reasonable care could not have known, of such untruth or omission,"(fn6) the purchaser is entitled to rescission or to rescissory damages.

Section 12(2) affords an aggrieved purchaser two significant advantages that other antifraud provisions do not offer:

1. Rescission: As noted above, § 12(2) allows for rescission or rescissory damages(fn7) even if the purchaser has disposed of the stock. Sections 12(1) and 12(2) are the only provisions in the Act that provide for rescission.(fn8)

2. Scienter, reliance and causation: A plaintiff who brings suit under § 12(2) need not establish scienter, reliance or causation. This stands in stark contrast to the stringent requirements for these elements of proof in Rule 10b-5 of the 1934 Act.(fn9)

In essence, § 12(2) operates as a negligence statute that places the burden of proof on the defendant. Due to the minimal burdens it places on plaintiffs, § 12(2) has been characterized by some courts as providing for "strict liability."(fn10)

Securities lawyers have generally considered the scope and reach of § 12(2) to be shrouded by uncertainty. The predominant interpretation seems to be that § 12(2) applies to all...