Securities Regulation - John L. Latham and Jay E. Sloman

• Jurisdiction: United States,Federal
• Publication year: 1995
• Citation: Vol. 46 No. 4

Securities Regulationby John L. Latham^* and Jay E. Sloman^**

This Article surveys significant cases decided by the United States Court of Appeals for the Eleventh Circuit ("Eleventh Circuit") during 1993 and 1994 in the field of securities regulation. This Article also examines selected United States Supreme Court decisions during this survey period that affect Eleventh Circuit precedent.

I. The Application of Section 12(2)

Section 12(2) of the Securities Act of 1933¹ ("Securities Act") imposes civil liability for selling or offering to sell securities through the use of false communications.² In First Union Discount Brokerage Services, Inc. v. Milos,³ the Eleventh Circuit faced the issue of whether Section 12(2) applies to post-distribution, or aftermarket, securities transactions. The Eleventh Circuit had left the applicability of Section 12(2) to aftermarket transactions unresolved in its 1991 decision in Ryder International Corp. v. First American National Bank.*

In First Union, defendants Nick and Catherine Milos had invested heavily in put options through a nondiscretionary account with plaintiff First Union, a discount broker.⁵ After failing to meet a margin call⁶ necessitated by the stock market crash of October 1987, the defendants' securities positions were liquidated pursuant to agreements between the Miloses, First Union, and First Union's clearing broker.⁷ Plaintiff First Union liquidated the account and paid its clearing broker the remaining deficiency.⁸ First Union then brought suit to recover the deficiency from the Miloses, who counterclaimed and alleged First Union had made material false representations to them, in violation of Section 12(2) of the Securities Act.⁹ First Union responded that the defendants' counterclaim under Section 12(2) was subject to dismissal on the grounds, inter alia, that the prohibitions of Section 12(2) against false and misleading communications did not apply to aftermarket or secondary market transactions, which were at issue here. The district court agreed with First Union and granted that aspect of its motion to dismiss.¹⁰

On appeal, the Eleventh Circuit affirmed the grant of First Union's motion to dismiss.¹¹ The court agreed that Section 12(2) applies only to initial offerings and held that it does not apply to aftermarket transactions.¹² In reaching its decision, the court relied upon the United States Court of Appeals for the Third Circuit's ("Third Circuit") ruling in Ballay v. Legg Mason Wood Walker, Inc.¹³ The decision in Ballay was the first by a federal court of appeals to consider this issue.¹⁴ In Ballay, plaintiffs sued a full service broker for making certain false representations in connection with the recommendation and sale of stock. The Third Circuit held Section 12(2) did not apply to aftermarket transactions for three reasons.¹⁵

First, the Third Circuit found that the language of Section 12(2) is limited to initial securities distributions.¹⁶ The court stated that the placement of the phrase "oral communication" near the term "prospectus" suggested that the former, more general, term should be limited to conform to the latter, more restrictive, term.¹⁷ Therefore, the admonition of Section 12(2) against misleading oral communications should be limited to initial offerings because Congress denned and intended the term "prospectus" to relate to initial securities offerings.¹⁸

Second, the Third Circuit noted that Section 12(2) is positioned after Sections ll¹⁹ and 12(1)²⁰ of the Securities Act, which govern the registration of securities and create civil liability for sales of unregistered securities.²¹ Section 12(2) is also positioned before Section 13,²² which establishes a limitations period for Sections 11 and 12. The court determined that, because the section is placed between sections that deal exclusively with initial securities distributions, Section 12(2) must also be limited to initial distributions.²³

Third, the Third Circuit distinguished the Supreme Court's decision in United States v. Naftalin,²⁴ in which the Court held Section 17(a) of the Securities Act applies to aftermarket transactions.²⁵ The Third Circuit rejected the argument that Naftalin requires the application of Section 12(2) to the aftermarket transactions because Sections 12(2) and 17(a) have materially distinct language.²⁶ Section 17(a) prohibits conduct employed "directly or indirectly ... to obtain money or property by means of any untrue statement. . . ."²⁷ The court of appeals stated this language encompasses all types of conduct and not just conduct related to a "prospectus" or "oral communication."²⁸ The Third Circuit stated that the language of Section 17(a) is therefore expansive, while the language of Section 12(2) is restrictive.²⁹

In First Union, The Eleventh Circuit adopted the reasoning in Ballay.³⁰ In adopting the Third Circuit's reasoning, the Eleventh Circuit recognized that other courts³¹ and commentators³² have argued Section 12(2) should be applied to aftermarket transactions.³³ The Eleventh Circuit, however, agreed with the Third Circuit in saying '"the language and legislative history of section 12(2), as well as its relationships to sections 17(a) and 10(b) within the scheme of the 1933 and 1934 Acts, compel [the] conclusion that section 12(2) applies only to initial offerings and not to aftermarket trading.'"³⁴

The Eleventh Circuit holding appears to be consistent with the intent of the Securities Act and follows the trend of narrowly construing the securities laws.³⁵ After the survey period ended, on February 28, 1995, the Eleventh Circuit reasoning was impliedly approved by the United States Supreme Court.³⁶ In Gustafson v. Alloyd Co.,³⁷ the Court held that Section 12(2) is limited to initial public offerings.³⁸ In so ruling, the Court stated the term "prospectus" was a term of art which refers to a document that describes a public offering of securities.³⁹

II. The Application of Rule 10b-5

A. Contribution

Section 10(b) of the Securities Exchange Act of 1934 ("Exchange Act")⁴⁰ and Rule 10b-5 of the Securities and Exchange Commission⁴¹ are silent on whether defendants in a suit based on an implied private right of action under Section 10(b) or Rule 10b-5 may seek contribution from joint tortfeasors. Prior to 1993, the federal courts of appeals were split on this issue.⁴² In Mustek, Peeler & Garrett v. Employers Insurance of Wausau,⁴³ the Supreme Court resolved this split and held an implied right to contribution does exist in actions under Section 10 and Rule lOb-5.⁴⁴ Respondents were insurers who funded the settlement of a lawsuit in which stock purchasers alleged violations of Sections .11 and 12 of the Securities Act.⁴⁵ The suit was brought against the issuer of the security, Cousins Home Furnishings, Inc. ("Cousins"), the parent company, various officers and directors of Cousins, and the two lead underwriters.⁴⁶ Respondents brought their lawsuit seeking contribution from petitioners, the attorneys and accountants involved in the public offering.⁴⁷ The question of whether the insurers had a right to contribution was not discussed in the lower court proceedings, in which the United States Court of Appeals for the Ninth Circuit ("Ninth Circuit") ruled in favor of the insurers.⁴⁸ After the Ninth Circuit's ruling, the United States Court of Appeals for the Eighth Circuit rendered a contrary decision in Chutich v. Touche Ross & Co.,⁴⁹ which prompted the attorneys and accountants in Mustek to petition the Supreme Court to resolve the conflict among the courts of appeals.

The Supreme Court began its analysis by noting the private right of action under Rule 10b-5 was implied by the judiciary on the theory that courts should recognize private remedies to supplement federal statutory duties, and not on the theory Congress had given an unequivocal direction to the courts to do so.⁵⁰ The Court stated federal courts have accepted and exercised the principal responsibility for the continuing elaboration of the scope of 10b-5 rights and the definition of the duties they impose.⁵¹ Furthermore, '"where a legal structure of private statutory rights has developed without clear indications of congressional intent,' a federal court has the . . . power to define 'the contours of that structure.'"⁵²

The Supreme Court then proceeded to examine the contours of a 10b-5 action to determine whether a right of contribution did exist. The goal of the Court was to "attempt to infer how the 1934 Congress would have addressed the issue had the 10b-5 action been included as an express provision in the 1934 Act."⁵³ The Court noted the language of Section 10(b) does not reveal any inference of congressional intent regarding contribution among joint tortfeasors.⁵⁴

The Supreme Court then analogized Sections 9⁵⁵ and 18⁵⁶ of the Exchange Act to Section 10b because Sections 9 and 18 are close in structure, purpose, and intent to a 10b-5 action.⁵⁷ Both Section 9 and 18 confer an explicit right of action in favor of private parties, and in doing so, disclose "a congressional intent regarding the definition and apportionment of liability among private parties."⁵⁸ The Court stated these express causes of action are significant in determining how Congress would have resolved the question of contribution had it provided for an express private cause of action under Section 10(b).⁵⁹ First, Sections 9 and 18 are significant in that both '"target the precise dangers that are the focus of Section 10(b) . . . ."'⁶⁰ Second, the intent underlying all three Sections is the same, that is, one '"to deter fraud and manipulative practices in the securities market, and to insure full disclosure of information material to investment decisions.'"⁶¹

The Supreme Court noted additional similarities between Sections 9, 10(b), and 18:

All three causes of action impose direct liability on defendants for their own acts as opposed to derivative liability for the acts of others;⁶² all three...