Chapter 8

• Jurisdiction: United States

Chapter 8 Civil Liability Under the 1933 Securities Act

There are two main liability provisions in the 1933 Act: Section 11 and Section 12(a).¹ We will consider both in this chapter.

Section 11

This is a very straightforward section that authorizes a private right of action by a purchaser who purchased securities that were offered pursuant to a registration statement that contained an untrue statement of material fact or omitted to state a material fact required to be stated therein or necessary to make statements therein not misleading at the time the registration statement became effective.

Yet however straightforward Section 11 may appear to be, there are ambiguities that courts have struggled to resolve. The statute states: "In case any part of a registration statement when such part became effective, contained an untrue statement of material fact or omitted to state a material fact required to be stated therein or necessary to make the statements therein not misleading, any person acquiring such security . . . may, either at law or in equity sue. . . ." (emphasis added). What does "such security" mean? Note that the phrase has no antecedent in the statute. The courts have held that "such security" means that the person must have purchased a security issued under a specific registration statement, rather than under some other registration statement. See, e.g., In re Century Aluminum Co. Sec. Litig., 729 F.3d 1104 (9th Cir. 2013). This interpretation has given rise to the so-called "tracing" obligation in which to establish standing the plaintiff must be able to "trace" the purchased share back to the offending registration statement. In IPOs, that is not difficult to do, since there is only one registration statement and one issue of stock. But in other offerings, it is nearly impossible to do.

In the leading case, Barnes v. Osofsky, 373 F.2d 269 (2d Cir. 1967), Judge Henry Friendly resolved the ambiguity in the statute by adopting a narrow interpretation of Section 11. In this case, the issuer had conducted a secondary offering—the company's stock was already publicly traded under a previous registration statement—and the company filed a new registration statement so that it could sell more stock. The plaintiffs alleged that the new registration statement contained material misrepresentations. The Second Circuit held that the plaintiffs had no standing because they could not prove that the shares they purchased had been issued under the new registration statement. Under the Second Circuit's interpretation, which has been widely followed ever since, "such security" meant a security purchased under the registration statement that is being challenged.

Another ambiguity concerns the phrase "In case any part of the registration statement, when such part becomes effective . . ." This seems to suggest that different parts of the registration statement can become "effective" at different times. In fact, courts have held that that is true. For example, the filing of a post-effective amendment both includes the amendment in the registration statement and establishes a new effective date for the information for purposes of Section 11 liability. The remainder of the registration statement is still judged as of the original effective date and is not reset absent some specific reason for resetting the date.² Issuers must amend registration statements when "fundamental changes" occur in a shelf registration unless the issuer qualifies for Form S-3. Professors Choi and Pritchard remind us that the calculation of the "effective date" is somewhat complicated by the SEC's Rule 430B, promulgated in 2005, with respect to shelf takedowns.³

Who Is Liable Under Section 11?

There are five categories of possible defendants in a Section 11 case:

1. "Every person who signed the registration statement;
2. Every person who was a director of (or performing similar functions) or partner⁴ in the issuer at the time of the filing of the part of the registration statement with respect to which liability is asserted;
3. Every person who, with his [or her] consent, is named in the registration statement as being or about to become a director, person performing similar functions, or partner;
4. Every accountant, engineer, or appraiser, or any person whose profession gives authority to a statement made by him [or her], or who has, with his [or her] consent been named as having prepared or certified any part of the registration statement, or as having prepared or certified any report or valuation which is used in connection with the registration statement, with respect to the statement in such registration statement, report, or valuation, which purports to have been prepared or certified by him [or her]; and
5. Every underwriter with respect to such security."

Note that there is no explicit liability for lawyers based either on their drafting of the registration statement or their investigation of its accuracy, although in cases brought by the SEC, "aiding and abetting" liability is probably available.⁵

There are two requirements for a prima facie case of liability: the existence of at least one material misstatement or omission in the registration statement, and that the purchased shares can be traced to the registration statement. Although the statute does not say explicitly that the plaintiff must have either purchased shares in the public offering or is able to trace the purchase directly to the public offering, the Supreme Court has held that the words "such security" refer to securities purchased pursuant to a registration statement.

As noted, tracing shares that have been purchased on the open market or elsewhere back to the registration statement is difficult unless the offering was an initial public offering. In Krim v. pcOrder.Com, Inc., an enterprising plaintiffs' lawyer attempted to do so by proving that as a matter of mathematical probability, there was a 1-(1-0.9958) to the 3,000th power probability that the lead plaintiff in a class action owned at least one share that could be traced to the registration statement out of the 3,000 shares he purchased. The Fifth Circuit was unimpressed and ruled that "statistical tracing" was unavailable. The plaintiff must prove that the purchased security was in fact part of the public offering. "Statistical tracing is not up to the task." The court recognized that "[w]hen Congress enacted the Securities Act of 1933, it was not confronted with the widespread practice of holding stock in street names. . . . That present market realities, given the fungibility of stock held in street name, may render Section 11 ineffective as a practical matter in some aftermarket scenarios is an issue properly addressed by Congress."⁶

There is no requirement in Section 11 for proof of scienter or causation, nor is there a requirement that the plaintiff relied on the misstatement or omission.⁷ The plaintiff need not prove that he or she actually read the prospectus. Thus, the statute can be said to be one creating "strict liability."

Section 11 creates liability for false statements of fact and for omissions of discrete factual representations. What are they? A fact is "a thing done or existing . . . or an actual happening" whereas an opinion is "a belief, a view, or a sentiment which the mind forms of persons or things."⁸ But what if the statement contained in the registration statement is one of opinion? It has long been held that statements of opinion are not actionable so long as the speaker truly holds the stated opinion. See, e.g., Virginia Bankshares, Inc. v. Sandberg, 501 U.S. 1083 (1991).

However, that rule was substantially modified by the Supreme Court in Omnicare, Inc. v. Laborers Dist. Council Constr. Indus. Pension Fund, 135 S. Ct. 1318 (2015). Omnicare's registration statement included the following two statements:

1. " We believe our contract arrangements with other health care providers . . . are in compliance with applicable federal and state laws."
2. "We believe that our contracts . . . are legally and economically valid." (Emphasis added.)

In a class action brought under Section 11, the plaintiffs alleged that those statements were incorrect because the company's receipt of payments from drug manufacturers violated anti-kickback laws and that the company therefore "omitted to state material facts necessary to make its representations not misleading." It was conceded that the opinions were honestly held. The Supreme Court took the case to "consider whether the omission of a fact can make a statement of opinion like Omnicare's, even if literally accurate, misleading to an ordinary investor." The Supreme Court held that it could. "[W]hether an omission makes an expression of opinion misleading always depends on context. . . . Investors do not, and are right not to, expect opinions contained in those statements to reflect baseless, off-the-cuff judgments, of the kind that an individual might communicate in daily life." The Supreme Court remanded the case for further review, while noting that in order to prevail, "the investor must identify particular (and material) facts going to the basis for the issuer's opinion—facts about the inquiry the issuer did or did not conduct or the knowledge it did or did not have—whose omission makes the opinion statement at issue misleading to a reasonable person reading the statement fairly and in context. That is no small task for an investor."

What Defenses Are Available in a Section 11 Case?

The defenses set forth in Section 11(b) are somewhat confusing. Recall that under Section 11(a), there is a limited list of potential defendants, all of whom have some connection to the registration statement. The available defenses set forth in the statute can be better understood as applying to two categories of defendants: experts and all others.

First, all defendants, including experts, may escape liability by proving that the plaintiff "at the time of the acquisition...