3.9 Liability for Violations of Securities Laws

• Library: Corporations and Partnerships in Virginia (Virginia CLE) (2016 Ed.)

3.9 LIABILITY FOR VIOLATIONS OF SECURITIES LAWS

3.901 Governmental Actions.

A. Criminal Penalties. Section 24 of the Securities Act ³⁵⁰ and section 32(a) of the Exchange Act ³⁵¹ impose criminal penalties for the willful violation of either Acts' provisions or of any rule or regulation promulgated pursuant thereto. Also unlawful is the making of any untrue statement or the omission of a material fact in any application, registration statement, report, or document required to be filed under the provisions of either Act. Penalties include fines and imprisonment.

B. Investigations and Hearings by the SEC. Section 19 of the Securities Act ³⁵² and section 21 of the Exchange Act ³⁵³ empower the SEC to

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conduct investigations and to hold hearings to determine whether any person has violated or is about to violate any of the provisions of the Acts. If the SEC finds a willful violation of either Act, it may impose sanctions ranging from censure to permanent suspension of registration as a broker-dealer or permanent suspension of trading of securities.

C. SEC Civil Proceedings. Section 20(b) of the Securities Act ³⁵⁴ and section 21(d) of the Exchange Act ³⁵⁵ provide that whenever it shall appear to the SEC that any person is engaged in, or is about to engage in, any acts or practices that constitute a violation of the Acts' provisions, the SEC may at its discretion bring an action in a court of competent jurisdiction (as defined in the Acts). These acts or practices may be enjoined and, upon a proper showing, a permanent or temporary injunction or restraining order is to be granted without bond. To grant an injunction, the court must find that it is reasonably likely that the securities laws will be violated and that in equity an injunction should issue. The SEC may also seek monetary penalties ³⁵⁶ or request that a person be barred from serving as a director or officer of a company required to file SEC reports. ³⁵⁷ The SEC also has the authority to issue cease and desist orders through administrative action in certain circumstances. ³⁵⁸

D. Penalty Reduction Policy. Pursuant to the Small Business Regulatory Fairness Act enacted in 1996, the SEC has published a penalty reduction policy for small businesses. ³⁵⁹

3.902 Private Actions Under the Securities Act.

A. False or Misleading Registration Statement. Section 11 of the Securities Act ³⁶⁰ provides that where a registration statement contains an untrue statement of a material fact or omits to state a material fact required or necessary to prevent the statement from being misleading as of the time it becomes effective, any person acquiring the security may sue various designated persons for damages sustained because of the untrue statement or

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omission unless the plaintiff knew of the untruth or omission. The persons against whom action may be brought under section 11 are (i) any person who signed the registration statement; (ii) any person who was a director of the issuer at the time of filing or any person performing functions similar to those of a director; (iii) any person who, with his or her consent, was named in the registration statement as about to become a director; (iv) any accountant, engineer, or appraiser or any person whose profession gives authority to a statement made by that person and who has with his or her consent been named as having prepared or certified any part of the registration statement or having prepared or certified any report or valuation that is used in connection with the registration statement; and (v) any underwriter with respect to such security. ³⁶¹ Liability is joint and several, and each person is entitled to seek contribution against the other persons. ³⁶²

1. No Reliance Required. Reliance upon the truth of an untrue statement is not an element underlying the right to recover under section 11 unless the issuer has made generally available to its security holders an earnings statement covering a period of at least 12 months beginning after the effective date of the registration statement. ³⁶³

2. No Responsibility for Registration. Except for the issuer, who is always subject to absolute liability, no person will be liable if the person can sustain the burden of proof that certain specified conditions existed. ³⁶⁴ Thus, an officer or director will not be liable if the officer or director can show that before the effective date he or she had resigned from, had taken steps permitted by law to resign from, or had ceased or refused to act in every office, capacity, or relationship with the issuer in which the person was described in the registration statement. The officer or director also must have advised the SEC and the issuer in writing of the action taken. ³⁶⁵

3. Due Diligence Defense. A person, other than the issuer, may also escape liability if he or she can sustain the burden of proof that he or she had reasonable grounds to believe, and in fact did believe, that the registration statement was true and that it did not fail to state a material

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fact. ³⁶⁶ This is the "due diligence" defense. ³⁶⁷ In the course of preparation of registration statements, it is customary for attorneys, on behalf of their respective clients, to undertake "due diligence" investigations. Due diligence standards and the usefulness of due diligence meetings are discussed at length in Securities Act Release No. 5275. ³⁶⁸ The Release notes the obligation on the part of directors and officers to conduct on their own behalf a due diligence inquiry notwithstanding the use of a professional underwriter. ³⁶⁹

4. Measure of Damages. Section 11 damages are based on restitution. The plaintiff may recover the difference between the amount he or she paid for the security (not to exceed the public offering price) and:

a. The value of the security at the time suit is filed;

b. The price at which he or she disposed of the security before the time suit is filed; or

c. The price at which he or she disposed of the security after suit was filed but before judgment was entered if that measure of damages would be less than the damages recoverable under (a) above.370

The amount of damages proved by the plaintiff under this formula, however, is subject to reduction if the defendant can prove that "any portion or all of such damages represents other than the depreciation in value of such security" due to the misleading information in the registration statement. ³⁷¹ Thus, if the defendant can prove that the decrease in value sustained by the...