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?

Federal or state

FederalCourt

Rescission (up to offering $)

Pl BOP (O/P or rescission)(5) Damages

1 yr + 3 yrs2 yrs + 5yrsLimitations

Def BOP (“other than”)

Pl BOP (prox cause)(4) Causation

Def BOP (Pl “knew”) *

Pl BOP (unless FOM)(3) Reliance

Def BOP (“due diligence”)

Pl BOP (facts / strong E)(2) Scienter

Pl BOP (or omission)

Pl BOP (or duty to speak)(1) Mat’l misrep

List (I, Ds, Os, UWs, expert)

Primary violatorDefendant

Purchaser (tracing)

Purchaser or sellerPlaintiff

Part of RS“icw” purch/ sale

securityTransactional nexus

§12(a)(2)§12(a)(1)§11Rule 10b-5

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

ASSETS

•Cash

•Cap accounts

SH EQUITY•Retainedearnings

LIABILITIES

How did WorldCom account for “line costs”?

In re WorldCom Sec Litigation(SDNY 2004)

DATE EVENT

4/2000

2/2001

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

Expertised Non-expertised

Expert

After reas investigation, reasonably believes information is true

(ignorance no defense)

No liability

[see §11(a)(4)]

Non-expert

No reasonable ground to believe was untrue

(ignorance is excuse)

After reas investigation, reasonably believes information is true

(ignorance no defense)

In re WorldCom Sec Litigation(SDNY 2004)

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.

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)

In re WorldCom Sec Litigation(SDNY 2004)

The end