Pleading under Section 11 of the Securities Act of 1933.

• Author: Turnquist, Krista L.

The Securities Act of 1933 ("Securities Act") requires full and fair disclosure of the nature of securities sold in interstate and foreign commerce.(1) Section 11 of the Securities Act prohibits false or misleading registration statements. It also provides buyers a private remedy for false or misleading statements against any signer of the registration statement, any partner or director of the issuer, any professional involved in preparing or certifying the statement, and any underwriter.(2) The rule appears simple: if there is a material misstatement or omission in the registration statement, the buyer may sue the seller.(3)

Courts disagree, however, over how a section 11 plaintiff must plead his or her claim.(4) Because neither fraud nor mistake is an element of a section 11 claim, courts have applied the liberal notice pleading standard of Rule 8(a)(2) of the Federal Rules of Civil Procedure.(5) Rule 8(a)(2) states that a plaintiff must plead only "a short and plain statement of the claim showing that the pleader is entitled to relief."(6)

The fear of strike suits, which are groundless claims filed as a pretext for discovery in order to induce settlement, has led some courts to interpret the Federal Rules more stringently.(7) To dissuade potential plaintiffs or to dispose of more complaints at the pleading stage, these courts have required securities plaintiffs to plead their claims with particularity under Rule 9(b) of the Federal Rules of Civil Procedure.(8) Rule 9(b) provides "[i]n all averments of fraud or mistake, the circumstances constituting fraud or mistake shall be stated with particularity. Malice, intent, knowledge, and other condition of mind of a person may be averred generally."(9)

The courts that have addressed whether section 11 plaintiffs must plead according to the heightened pleading standard of Rule 9(b) have taken three approaches: (1) Rule 9(b) does not apply to any section 11 claims;(10) (2) Rule 9(b) applies to only those section 11 claims that are "grounded in fraud";(11) and (3) Rule 9(b) applies to all section 11 claims.(12) Whether a section 11 plaintiff must plead his or her claim in accordance with Rule 9(b) affects a buyer's substantive rights under the securities laws and interferes with the regulatory scheme of the securities markets established by Congress.(13)

This Note argues that Rule 9(b) does not apply to claims filed under section 11 of the Securities Act, regardless of whether the claim "is grounded in fraud." Instead, section 11 plaintiffs must comply only with the liberal notice pleading standard stated in Rule 8(a)(2) of the Federal Rules of Civil Procedure. Part I argues that Congress intentionally set a low burden for section 11 plaintiffs because the purpose of the Securities Act is to protect purchasers of securities. The text, history, and purpose of the Securities Act, as well as the text and purpose of the Federal Rules of Civil Procedure, support imposing minimal pleading requirements on section 11 plaintiffs. Because securities lawsuits often contain claims under both section 11 of the Securities Act and section 10(b) of the Securities Exchange Act of 1934 ("Exchange Act"),(14) Part II posits that differences in statutory language and policy goals in these sections mandate applying a lower pleading standard to claims filed under section 11 than to those filed under section 10(b).(15) This Note concludes that Rule 8(a)(2) should apply to section 11 claims because applying the heightened requirements of Rule 9(b) would undermine section 11's inducement to carefully prepare registration statements in order to inform buyers of the character of securities.(16)

1. SECTION 11 PLACES A MINIMAL BURDEN ON PLAINTIFFS

   The statutory language and legislative history of the Securities Act indicate that Congress intended to minimize plaintiffs' burden of pleading under section 11. Section I.A argues that because section 11 does not specifically mention fraud or mistake, Rule 9(b) does not apply. Section I.B recounts the historical facts that prompted Congress to enact the Securities Act and argues that the purpose behind the Securities Act and section 11 in particular support a minimal pleading standard. Section I.C analyzes the purpose of the Federal Rules of Civil Procedure and concludes that because the policy reasons supporting Rule 9(b) do not apply to section 11 claims, such claims should be pleaded in accordance with Rule 8(a)(2).

   1. Statutory Language of Section 11

      Because the text of section 11 imposes a minimal burden on the buyer, it would contravene congressional intent to read the heightened pleading standard of Rule 9(b) into section 11 claims. This Section argues that there are two reasons on the face of the statute to apply the notice pleading standard of Rule 8(a)(2) to section 11 claims. First, because the plain language of section 11 does not include fraud or mistake as an element of the claim, the heightened pleading standard of Rule 9(b) does not apply; and therefore, by default, the liberal notice pleading standard of Rule 8(a)(2) applies. Second, section 11's inapposite treatment of buyers and sellers also supports imposing the liberal notice pleading standard of Rule 8(a)(2) on section 11 plaintiffs.

      The plain language of section 11 supports requiring a plaintiff to comply with the more liberal notice pleading standard because section 11 does not include fraud or mistake as an element of the claim. When interpreting a statute, the Supreme Court has instructed lower courts that "[w]here ... resolution of a question of federal law turns on a statute and the intention of Congress, we look first to the statutory language and then to the legislative history if the statutory language is unclear."(17) In this case, the Federal Rules and the statute are clear.(18) Rule 9(b) imposes a heightened pleading standard in only two instances: averments of fraud or mistake.(19) Because section 11 includes neither of these, it does not fall within the scope of Rule 9(b).(20)

      To plead a claim under section 11, the plaintiff must allege the following: (1) that the registration statement contained a misstatement or omission when it became effective; (2) that the misstatement or omission was material; and (3) that the plaintiff purchased the security pursuant to such statement.(21) After establishing a prima facie case, the plaintiff may recover damages.(22) The plaintiff must also comply with the statute of limitations.(23)

      Whether the claim is "grounded in fraud" should not affect what a section 11 plaintiff must plead in the complaint. By definition, fraud is "a knowing misrepresentation of the truth or concealment of a material fact to induce another to act to his or her detriment."(24) Section 11 does not require proof of scienter or reliance;(25) therefore, it is meaningless to distinguish cases upon whether or not they are "grounded in fraud." Allegations of fraud would be mere surplusage and could be deleted from the complaint by the plaintiff before filing the complaint, or by the court upon a motion to dismiss, without affecting the plaintiff's substantive claim.(26) Even if a court dismissed the allegations of fraud from the plaintiff's complaint for failure to plead with particularity under Rule 9(b), the heart of a plaintiff's section 11 claim -- that the registration statement contained false or misleading information -- should not be dismissed.(27)

      Because section 11 does not require a showing of fraud or mistake, applying Rule 9(b) to section 11 claims conflicts with judicial interpretation of the notice pleading standard under the Federal Rules.(28) In Leatherman v. Tarrant County Narcotics Intelligence and Coordination Unit,(29) the Supreme Court explicitly limited the scope of Rule 9(b) and stated that courts cannot add to the Federal Rules merely for policy reasons.(30) In that case, the Court acknowledged the fact that "[t]he Federal Rules do address in Rule 9(b) the question of the need for greater particularity in pleading certain actions."(31) The Court went on to say, "perhaps if Rules 8 and 9 were rewritten today, [additional claims] might be subjected to the added specificity requirement of Rule 9(b)."(32) But because Rule 9(b) applies a heightened pleading standard only to averments of fraud or mistake and not to cases involving a material misstatement or omission, it should not be expanded to apply to section 11 claims.(33)

      An analysis of the treatment of buyers and sellers under section 11 further supports a minimal pleading standard for section 11 plaintiffs. Section 11 treats buyers and sellers differently by mandating minimal requirements for a plaintiff's prima facie case, but requiring strict compliance with the Securities Act's disclosure provisions and reasonable investigation for a defendant to raise an affirmative defense.(34)

      Congress made it easy for buyers to bring a claim under section 11. To state a claim, a buyer must allege that he purchased a security from a seller pursuant to a registration statement containing a material misstatement or omission.(35) A buyer does not have to establish reliance, which means that the buyer need not have relied upon the registration statement or even have seen the registration statement to collect damages.(36) Because section 11 does not include a scienter requirement, a buyer may recover damages for an innocent misstatement or omission.(37) Representative Sam Rayburn emphasized the importance of the absence of a scienter requirement in the legislative history of the Securities Act when he stated that, "[e]very lawyer knows that with all the facts in the control of the [seller] it is practically impossible for a buyer to prove a state of knowledge or a failure to exercise due care on the part of the [seller]."(38) Therefore, it would be unreasonable to require a buyer to plead with particularity if the buyer did not even have to read the registration statement to recover in...