Securities Act - Liability • Reliance vs. due diligence Section 11

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Securities Act - Liability

Section 11

• Due diligence in “shelf” offering

• Shelf registration (Rule 415)

• Role of underwriter

• Reliance vs. due diligence

(last updated 14 Feb 13)

Compare Securities Act liability to Rule 10b-5?

Transactional nexus

Plaintiff

Defendant

(1) Mat’l misrep

(2) Scienter

(3) Reliance

(4) Causation

(5) Damages

Court

Limitations

Rule 10b-5 § 11

“icw” purch/ sale security

Part of RS

Purchaser or seller

Primary violator

Pl BOP (or duty to speak)

Pl BOP (facts / strong E)

Pl BOP (unless

FOM)

Pl BOP (prox cause)

Pl BOP (O/P or rescission)

Federal

Purchaser

(tracing)

List (I, Ds, Os,

UWs, expert)

Pl BOP (or omission)

Def BOP (“due diligence”)

Def BOP (Pl

“knew”) *

Def BOP

(“other than”)

Rescission (up to offering $)

Federal or state

§ 12(a)(1)

2 yrs + 5yrs 1 yr + 3 yrs

§ 12(a)(2)

Due diligence

(in shelf registration)

In re WorldCom Sec Litigation

(SDNY 2004)

• Accounting fraud

• Shelf registration

– Nature

– Role of UW

• Due diligence defense

– Audited financial

– Unaudited financials

• Advice to UWs in “shelf”

BALANCE SHEET

LIABILITIES ASSETS

• Cash

• Cap accounts

SH EQUITY

• Retained earnings

How did WorldCom account for “line costs”?

In re WorldCom Sec Litigation

(SDNY 2004)

DATE

4/2000

2/2001

EVENT

WorldCom files10-K (ratio?)

UWs dowgrade WorldComm credit

3/2001 UWs help restructure credit facility

4/2001 UWs buy credit default swaps

4/2001 Cravath (UW counsel) due diligence

4/2001 Andersen (auditor) gives comfort letter

5/2001 Note offering ($11.9 B) under R 415

6/2002 Restatement ($3.8B) + bankruptcy

In re WorldCom Sec Litigation

(SDNY 2004)

Expert

Expertised

After reas investigation, reasonably believes information is true

( ignorance no defense )

Nonexpert

No reasonable ground to believe was untrue

( ignorance is excuse )

Non-expertised

No liability

[see § 11(a)(4)]

After reas investigation, reasonably believes information is true

( ignorance no defense )

Reliance

(audited financials)

Due diligence

(comfort letter / unaudited financials)

Rule 176 -- Circumstances Affecting the Determination of What

Constitutes Reasonable Investigation and Reasonable

Grounds for Belief Under Section 11 of the Securities Act

In determining whether or not the conduct of a person constitutes a reasonable investigation or a reasonable ground for belief meeting the standard set forth in section 11(c) , relevant circumstances include, with respect to a person other than the issuer.

(a) The type of issuer;

(b) The type of security;

(c) The type of person;

(d) The office held when the person is an officer;

(e) The presence or absence of another relationship to the issuer when the person is a director or proposed director;

(f) Reasonable reliance on officers, employees, and others whose duties should have given them knowledge of the particular facts ;

(g) When the person is an underwriter, the type of underwriting arrangement, the role of the particular person as an underwriter and the availability of information with respect to the registrant; and

(h) Whether, with respect to a fact or document, incorporated by reference, the particular person had any responsibility for the fact or document at the time of the filing from which it was incorporated.

SEC (1981): Underwriters should arrange their due diligence procedures over time for the purpose of avoiding last minute delays [in shelf offerings] … Nothing compels underwriter to do deal without due diligence.

In re WorldCom Sec Litigation

(SDNY 2004)

Underwriters may not rely on an accountant’s comfort letters for interim financial statements. … Comfort letters do not “expertise any portion of the RS”

(1) Audited: prudent man in management of own $$

(2) Unaudited: look at context

(WorldCom deteriorating)

Judge Denise Cote

(SDNY)

The end

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