6.7 The Securities Act of 1933

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

6.7 THE SECURITIES ACT OF 1933

6.701 In General. The Securities Act of 1933 (the Securities Act) regulates the sale of securities by corporations and their controlling per-sons. ¹²⁵ These sales include original corporate issuances of securities in exchange offers, mergers, consolidations, and other reorganizations. The basic mechanism for regulating sales is the requirement for full disclosure through a registration statement and prospectus. The Securities Act's broad definitions of the terms "sale" and "security," as well as the concepts of an "issuer," "controlling persons," and "underwriters," make the Securities Act applicable to a wide range of transactions.

6.702 Liability in Registered Securities Distributions. If a security offering has to be registered under the Securities Act, section 11 of the Securities Act imposes liability on corporate directors (and certain other persons associated with the preparation of the registration statement) for material misstatements or omissions contained in the registration statement. Section 11 liability may arise if a registration statement, at the time it 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." For convenience, this formulation is sometimes shortened to the phrase "material misstatements or omissions." For purposes of section 11, a fact is material if it might have been considered important by a reasonable investor and if it might have had a significant propensity to affect the investor's decision whether to buy the security. ¹²⁶

If the material misstatement or omission exists in any part of a registration statement, including the prospectus, the primary defense of any person other than the issuing company to a claim under section 11 is a

[Page 562]

showing that the person was not negligent with respect to the preparation of the registration statement. ¹²⁷ The best evidence on which to base such a defense is that the person used due diligence in verifying the information contained in the prospectus. This "due diligence" defense will prevail if the person had reasonable grounds to believe, and did believe, that the registration statement contained no material misstatement or omission. The reasonable investigation required by section 11 is that which a prudent person would make in the management of his or her own property. ¹²⁸ The standard of investigation depends on the background and experience of each individual director. Whether he or she is an outside director or a director who is also an officer of the issuing corporation will be relevant. ¹²⁹

The Securities and Exchange Commission's (SEC) Rule 176 identifies certain circumstances bearing on the reasonableness of the investigation conducted to discharge a person's obligation under section 11 of the Securities Act. ¹³⁰ Rule 176 also lends guidance on what constitutes reasonable grounds for belief under that section. Relevant circumstances include the type of issuer, the type of security, the person's relationship to the issuer, the reasonableness of reliance on officers and employees whose duties should have made them aware of the particular facts, and the person's level of responsibility for the fact or document that is subsequently relied upon. ¹³¹

Directors and certain other persons are liable under section 11 to persons (other than those who knew of the material misstatement or omission) who acquire a security covered by the misleading registration statement. Whether the purchaser acquired the security from the issuing corporation is unimportant. Reliance on the material misstatement or omission is not an element of proof, unless the plaintiff acquired the security after the issuing corporation had published an earnings statement covering a period of at least 12 months from the effective date of the registration statement. Generally, the plaintiff may recover the difference between the

[Page 563]

price paid for the security (but not exceeding the price at which the security was offered to the public) and the value of the security at the time of the suit or the price at which it was sold. ¹³² The statute of limitations for a section 11 claim is one year after discovery of the material misstatement or omission was made or should have been made, but in no event more than three years after the security was first offered to the public. ¹³³

The purchaser of a registered security may have an action under section 12(a)(2) of the Securities Act as well as under section 11. Section 12(a)(2) is an antifraud provision that applies to the sale of any security (other than certain governmental securities) offered or sold by any means or instruments of transportation or communications in interstate commerce or...