6.8 The Securities Exchange Act of 1934

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

6.8 THE SECURITIES EXCHANGE ACT OF 1934

6.801 In General. While the Securities Act relates primarily to original distributions of securities by corporations and sales of securities by controlling persons, the scope of the Securities Exchange Act of 1934 ¹⁵⁴ (the Exchange Act) is broader. The Exchange Act addresses corporate disclosure responsibilities to existing security holders and to the markets in which the securities are traded. The Exchange Act (i) requires registration of certain outstanding classes of equity securities and periodic reporting of material information to update the registrants; (ii) regulates the securities transactions of insiders and 10-percent stockholders; (iii) imposes requirements on corporations with respect to proxy solicitations; (iv) regulates tender offers; and (v) chiefly through rules promulgated under section 10, proscribes fraud and any manipulative or deceptive practices in connection with securities transactions. Individuals injured by corporate violations of the Exchange Act may recover damages from directors and officers pursuant to an array of express and implied private actions.

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6.802 Exchange Act Registration and Periodic Reports. Registration of classes of securities under the Exchange Act is distinct from registration under the Securities Act. The Exchange Act registration provisions do not relate to a distribution of securities, as do the Securities Act registration requirements. Registration under the Exchange Act is necessary for (i) any class of securities that is listed on a national securities exchange (ii) any class of equity securities (other than an exempted security) held of record by either (a) 2,000 persons; or (b) 500 persons who are not accredited investors, and on the last day of an issuer's fiscal year, the issuer of those securities has assets exceeding $10,000,000; and (iii) issuers that file a registration statement under the Securities Act. ¹⁵⁵ In an Exchange Act registration, no prospectus is delivered to shareholders; however, a corporation with a class of securities registered under the Exchange Act is required to file periodic reports with the SEC to keep the information contained in the original registration current. ¹⁵⁶

The express remedy provided for material misstatements and omissions in the Exchange Act registration statements and periodic reports is set forth in section 18 of the Exchange Act. Because proxy statements must be filed with the SEC, section 18 may provide a remedy for misstatements and omissions in these documents. This remedy is in addition to those discussed in paragraph 6.802. A section 18 remedy is available to both purchasers and sellers of securities in the registered class.

Although intended to be the counterpart of section 11 of the Securities Act, section 18 is a less effective remedy from a plaintiff's point of view. Unlike section 11 of the Securities Act, which expressly extends liability to a broad class of persons (such as directors, officers, underwriters, and accountants) involved in a securities distribution, section 18 of the Exchange Act limits liability to "any person who shall make or cause to be made" the material misstatements and omissions in reports filed under the Exchange Act. Moreover, while section 20 of the Exchange Act contains a "controlling persons" counterpart to section 15 of the Securities Act, section 20 imposes liability only on controlling persons who are unable to show they (i) acted in

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good faith and (ii) did not directly or indirectly induce the acts constituting the violation.

A second difference between section 18 of the Exchange Act and section 11 of the Securities Act is that section 18 does not impose strict liability upon the issuing corporation for material misstatements or omissions. Furthermore, under section 18 a director or officer who prepared the registration statement or periodic report can avoid liability by showing he or she acted in good faith and did not have actual knowledge of the material misstatement or omission. Under section 11 of the Securities Act, a director or officer can avoid liability only by showing he or she acted without negligence. Finally, under section 18 plaintiffs must prove they actually relied on the material misstatement or omission and that they purchased the securities at a price affected by the material misstatements or omissions.

Section 18 of the Exchange Act does not require privity of contract between the plaintiff and the registered company. The statute of limitations for a section 18 action is one year after the discovery of the facts constituting the cause of action but no later than three years after the cause of action accrued.

6.803 Liability of Insiders and 10-Percent Shareholders. Section 16 of the Exchange Act is aimed at potentially abusive use of inside information by directors and officers of any issuer that has a class of equity securities registered under the Exchange Act who are beneficial owners of 10 percent or more of the registered class of equity securities (corporate insiders). Section 16(a) requires corporate insiders to report their shareholdings and all transactions in their corporation's stock, and section 16(c) prohibits short sales by insiders. Section 16(b) provides that any short-swing profit arising from the purchase and sale or sale and purchase by insiders of equity securities of their corporation within any six-month period inures to the corporation. While section 16(b) is aimed at misuse of inside information, liability exists regardless of whether the proscribed trading actually involved any use of insider information. Section 16(b) may be enforced either by the corporation or by a shareholder in a derivative action; the SEC does not have enforcement powers under section 16.

6.804 Proxy Rule Violations. Section 14 of the Exchange Act prohibits any person from soliciting proxies with respect to any class of securities registered under the Exchange Act in violation of rules and regulations promulgated by the SEC. Proxy solicitation rules apply primarily to matters requiring shareholder approval such as election of directors, ratification

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of transactions involving management, mergers, and sales of assets, re-classifications, and amendments to articles of incorporation. ¹⁵⁷

Rule 14a-9, ¹⁵⁸ promulgated under section 14, provides that no proxy solicitation is to be made with documents that contain material misstate-ments or omissions. In J.I. Case Co. v. Borak, ¹⁵⁹ the Supreme Court held that shareholders have implied personal and derivative causes of action under the Exchange Act for violations of Rule 14a-9 for material misstatements and omissions in proxy solicitation materials prepared on behalf of the manage-ment. ¹⁶⁰ In addition to money damages, remedies available to plaintiffs in such actions include rescission. ¹⁶¹

To establish a private cause of action for Rule 14a-9 violations, a shareholder must establish the materiality of the misstatement or omis-sion. ¹⁶² The Supreme Court has used different tests for materiality in various decisions. In Basic Inc. v. Levinson, ¹⁶³ attempting to end the confusion caused by previous opinions, the Court adopted, "for the 10(b) and Rule 10b-5 ¹⁶⁴ context," the standard of materiality set forth in TSC Industries, Inc. v. Northway, Inc. ¹⁶⁵ Under the TSC Industries test, an omitted fact is material

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if a substantial likelihood exists that its disclosure would have been considered significant by a reasonable investor. ¹⁶⁶ While TSC Industries arose under Rule 14a-9, Basic Inc. v. Levinson¹⁶⁷ was a Rule 10b-5 case. As a result of the Levinson Court's endorsement of TSC Industries, lower courts probably must apply the TSC Industries test for materiality in cases under both rules. While materiality of the misrepresentation is necessary to recover under section 14(a), the plaintiff need not have relied upon the misrepre-sentation. ¹⁶⁸

In merger situations involving proxy solicitations regulated by the Exchange Act, some interaction occurs between Securities Act and Exchange Act remedies. Where the shareholders of the target corporation in a merger have to vote on the merger, the proxy statement for the merger is both a proxy statement (as to the shareholders' meeting) under the Exchange Act and a prospectus (as to the stock of the acquiring corporation to be issued in the merger) under the Securities Act. Shareholders of the acquired corporation may assert Exchange Act Rule 14a-9 remedies against their corporation and its management for material misstatements and omissions, as well as remedies against the acquiring corporation and its management for the same misstatements and omissions under section 11 and section 12 of the Securities Act. The Securities Act remedies are available in addition to the Rule 14a-9 remedies because the acquiring corporation's issuance of securities in exchange for the securities of the acquired corporation involves a "sale" of securities within the meaning of the Securities Act. ¹⁶⁹ Plaintiffs also may attempt to assert liability against directors and officers of the participating corporations under Rule 10b-5. ¹⁷⁰ In Rule 14a-9 actions, however, unlike Rule 10b-5 actions, a showing of negligence alone is sufficient. ¹⁷¹

6.805 Tender Offers. Tender offers involve attempts by a corporation or a group to take control of another corporation by offering cash or securities directly to the shareholders of the target corporation. The enactment of the Williams Act in 1968 ¹⁷² created a comprehensive federal regulatory

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scheme with respect to tender offers. Before 1968, securities tender offers or exchange offers were subject to Securities Act requirements, and cash tender offers were subject to limited regulation through the application of Rule 10b-5. ¹⁷³

Under section 13(d)(1), which was added to the Exchange Act by the Williams Act, securities acquisitions preliminary to a tender...