FEATURE
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Global Counsel
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Prospectus liability in
Europe and the US
Understanding the issues
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Depending on the jurisdiction, liability for misstatements in offering documents and other financial statements can fall on any number of entities,
including the issuing company and its directors
and officers. Julian COPEMAN, Alex BAFI, Denis
CHEMLA and Bettina FRIEDRICH examine
when such liability arises in Europe and the US,
and outline the remedies available for breach.
Shareholder activism is on the rise.
Particularly in the US, shareholders
are becoming increasingly aware of
their rights as investors, and are acting
to protect those rights. For instance,
securities class actions are on the increase in the US, with 224 suits filed in
2002, a rise of 31% over the previous
year (research conducted by Stanford
Law School, see http://securities.stanford.edu/litigation_activity.html).
While litigation on this scale is not
yet taking place in Europe, it is nev-
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39
CORPORATE: PROSPECTUS LIABILITY
ertheless essential that companies be
aware of the ways in which they and
their directors and officers can be
held liable for misstatements in offering documents and other financial
statements. This article addresses the
following issues to be considered regarding such liability in relation to
France, Germany, the UK (England
and Wales) and the US:
• Who may be liable for misstatements.
• The types of statements that may
give rise to liability.
• How a plaintiff can establish liability and the remedies that are available for breach.
• Any other issues regarding liability
that may arise.
France
In France, it is a criminal offence to
make misrepresentations in offering
documents. The criminal courts have
jurisdiction to deal with the civil consequences of such misrepresentations. In order to obtain damages,
victims usually participate in criminal
proceedings brought by the Public
Prosecutor, or commence criminal
proceedings in their own right, although civil damages claims are also
possible.
Who may be liable
Any person is prohibited from
spreading, by any means, false or misleading information related to the future prospects or actual state of a
company listed on a regulated market, or to the future prospects of a security listed on a regulated market, if
this information is likely to have an
influence on its price (article L.465-1
S4, Financial and Monetary Code
(FMC)). “Any person” is extremely
wide and includes:
• Issuers. Where officers act on behalf of their company, the company
itself is liable, but this does not exclude the liability of its officers, and
both may be prosecuted. Thus directors and officers of the issuer are included. Statutory auditors and shareholders may also be included.
40
• Persons with no direct link to the issuer, such as journalists, financial analysts, advisers, financial intermediaries, banks or competitor companies.
In fact there is no limit to who can be
prosecuted as the author of false or
misleading information so long as it is
shown that he was aware of the fact
that the information disclosed to the
public was false or misleading.
Types of statements
There is no limit to the type of document in which false or misleading information may be communicated to
the public. Case law gives examples
of prospectuses, commercial advertisements, and communications to
the general assembly of shareholders,
as well as publication of balance
sheets, press articles, press releases
and statements at press conferences.
Establishing liability and remedies
It is becoming increasingly common
for investors to bring both civil and
criminal proceedings, as recent case
law has improved victims’ ability to recover damages by way of civil actions.
Administrative authorities also have
specific powers to punish offenders.
Criminal liability. Criminal liability
arises where the false or misleading
information given concerns the future
prospects or the actual financial situation of the issuer, and must be sufficiently specific. Mere rumours do not
trigger criminal liability, but incomplete information may be treated as
false information. Examples of what
has been held to be “false or misleading information” include: a press release stating that the issuer was about
to improve its financial situation; and
false indications in a prospectus relating to a capital increase.
the information in fact caused any
damage. However, a civil victim
claiming in a criminal proceeding
(constitution de partie civil) must
show a causal link between the false
information and his losses in order to
obtain damages.
Criminal penalties can be high, and include up to two years’ imprisonment
as well as fines of up to EUR1.5 million
(about US$1.72 million). Where a
profit was made as a result of the misleading information, the fine cannot be
less than EUR1.5 million, and may be
up to ten times this amount. A convicted company can be fined five times
more than an individual.
An action is time-barred three years
from the date on which the information became public knowledge.
Civil liability. An investor can take
civil action to:
• Have a sale of securities declared
null, if he can show that the issuer itself wilfully misled investors in order
to encourage them to acquire securities. To succeed, the investor must
show that:
- in the absence of the misrepresentation, he would not have bought
the securities; and
- that the officers of the issuer acted
on behalf of the issuer, which benefited from their misbehaviour.
This type of action is subject to a time
bar of five years from the date the
misrepresentation was discovered.
• Claim damages from any person
who published misleading information. The investor must show:
One important limit to the scope of
criminal liability is that a failure to
correct another’s false information is
not an offence (article L. 465-1,
FMC).
- wrongful conduct of the same kind
as in a criminal proceeding; and
For a successful prosecution, the false
or misleading information must have
been capable of influencing prices,
but the actual consequences of the
false information are not relevant,
and it is not necessary to show that
A claim of this type is time-barred ten
years from the date the damage occurred.
- that the false or misleading statement caused the damages claimed.
Administrative liability. A regulation
issued by the administrative author-
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ity in charge of regulating and supervising the markets, the Commission
des Operations de Bourse (COB),
contains provisions similar to article
L. 465-1 of the FMC (Regulation n°
98-07). However, the scope of the regulation is even wider as issuers are under a permanent obligation to disclose any information likely to affect
prices. As a result, remaining silent or
not correcting false or outdated information amounts to a breach of the
regulation. The COB can effectively
suspend a listing where it considers
that the market has not been correctly
informed. It must call the state public
attorney’s attention to any fact likely
to give rise to criminal liability.
Administrative authorities (including
the COB) can impose sanctions of an
amount equal to the fine set by article
L.465-1 (see Criminal liability above).
Indeed, the same breach can give rise
to both administrative and criminal
sanctions (that is, fines under administrative and criminal law). Disciplinary measures are also available,
ranging from a mere warning to the
withdrawal of a licence.
Other issues
The calculation of damages by way of
compensation is currently uncertain.
In 1993, the French Supreme Court
decided that investors could recover
damages corresponding to the difference between the price paid to acquire shares in reliance on false information and the real value of those
shares at the time of purchase (Cass.
Crim. 15 March 1993, Bull. Crim. no.
113, p280). Subsequent decisions of
lower courts have, however, been
more favourable to investors, allowing the total amount actually paid for
the shares, and case law is therefore
not settled.
Germany
Since the 1980s, the civil courts have
dealt with a number of spectacular
cases regarding offering documents,
such as Beton & Monierbau (BGH
vom 26.3.1984 – II ZR 171/83 – BGHZ
90, 381), Sachsenmilch (BGH vom
9.2.1998 – II ZR 278/96 – NJW 1998,
2054) and Elsflether Werft (BGH vom
14.7.1998 – XI ZR 173/97 – BGHZ
139, 2) and have developed general
civil law principles for prospectus liability. There is also statutory liability
for prospectuses of marketable securities that are incomplete or incorrect
(sections 44 to 49, Stock Exchange Act
(Börsengesetz) (BörsG)). Civil case law
actions differ from statutory prospectus liability actions.
Who may be liable
Liability for statements in a published
prospectus attaches differently depending on the purpose for which the
prospectus was published:
• Liability is imposed on those who
assumed responsibility for the
prospectus and on persons
who initiated the issuance
of the prospectus (section
44, BörsG). The issuer and
the financial institution applying for the listing of the issuer
and participating in the distribution of the shares must sign the listing prospectus and are liable for materially misleading facts in, and
omissions from, prospectuses and
other public statements.
• The issuer’s directors and officers,
auditors and lawyers generally do not
assume responsibility for the
prospectus and are not deemed to initiate the issuance of a prospectus (sections 44 and 45, BörsG). They may,
however, be liable under general
principles of civil law for knowingly
suppressing or recklessly disregarding material omissions or misstatements.
• Control persons. The legislation is
intended in particular to cover parties
who have an economic interest in the
listing and, as a result, in the issuance
of the prospectus.
• Any person who appeared “in
charge of the investment” (founders,
managers, those who exercised directly or indirectly a significant influence during the preparation of the
prospectus, auditing firms and
lawyers) may be liable under general
principles of civil tort. A person who
causes damages to another person by
committing offences such as fraud or
investment fraud can be held generally liable (section 823(2), Civil Code
(BGB)). A person who wilfully and
intentionally causes damage to another in violation of public policy can
also be liable (section 826, BGB).
Types of statements
The following types of statements
can give rise to liability:
• Prospectuses. BörsG regulations apply to listing prospectuses for trading
on the official market and other written statements that are not prospectuses (section 44), business reports for
listing on the regulated market (section
77) and sales prospectuses prepared
for public offerings (section 13, Sales
Prospectus Act (Verkaufsprospektgesetz) (VerkProspG)). For
the purposes of the
BörsG, the term “prospectus” relates to written material, prepared for the relevant
purpose. Statutory liability does
not apply to any other public ad
hoc statements, announcements or
publications.
• Other public statements. The term
“prospectus” has a broader meaning
under case law, including any written
material that is related to the marketing of the investment opportunity at
issue (for example, letters or advertisements).
Establishing liability and remedies
The elements of a civil law action for
damages due to incomplete or incorrect offering material differ from
statutory prospectus liability claims.
Statutory liability. To prove statutory liability the investor must establish:
• That the prospectus was incorrect
or incomplete in a material aspect;
and
• That he acquired the respective securities after the publication of the
prospectus. No showing of scienter
(some intent to defraud or manipulate) or causation is required.
Whether a fact is considered material
depends on the circumstances of the
specific case and must be judged from
the view of “an average person who is
able to comprehend the information
contained in a prospectus if he reads it
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CORPORATE: PROSPECTUS LIABILITY
Prospectus liability: who can be liable for what
France
To whom may liability attach?
Anyone spreading false or misleading information that may influence
the price of a listed security, which
may include:
• Issuers, their directors and officers and in some cases statutory
auditors and shareholders.
• Those with no direct link to the
issuer, such as, for example, advisers, financial intermediaries, banks
or competitor companies.
• The issuer and the financial
institution applying for the listing.
• The issuer's directors and officers, auditors and lawyers.
• "Control persons" with an economic interest in the listing.
• Any person who appeared "in
charge of the investment".
What types of statements may
give rise to liability?
There is no limit to the type of document that may give rise to liability. For example, liability may arise
from statements made in prospectuses, commercial advertisements
and communications to the general
assembly of shareholders.
• Listing prospectuses for trading
on the official market, written
statements that are not prospectuses, business reports for listing on
the regulated market and sales
prospectuses prepared for public
offerings (statutory liability).
• Other public statements such as
letters or advertisements (case law
claims).
Does the investor have to show
causation/reliance?
Must show a causal link between
the false information and the loss.
• No, in a statutory claim.
• Yes, in a case law claim.
Can a purchaser in the after
market claim on the basis of a
prospectus?
Yes, subject to the causal link.
For 12 months, statute assumes
that the purchase was made on the
basis of the "investment atmosphere" created by the prospectus.
thoroughly, is able to understand the
information contained in a balance
sheet but not having further knowledge or education” (BGH vom
12.7.1982 – II ZR 175/81 – NJW 1982,
2823 (2824)). The German Supreme
Court (BGH) has held that prospectus
liability can also be based on opinions
and projections unless reasonably
made and based on sufficiently hard
information (BGH vom 12.7.1982 – II
ZR 175/81 NJW 1982, 2823 (2824);
vgl.
Auch
Assmann/Lenz/Ritz,
Verkaufsprospektgesetz S 13 Rd. 31 f).
Even if the details are correct, a
42
Germany
prospectus may be considered incorrect if the overall picture of a company
appears in a more favourable light
than in reality, the standard being the
“true overall picture test”.
ciples and/or tort. A plaintiff bringing a claim under principles of general case law bears a heavier burden.
He must demonstrate each of the following elements:
The investor does not need to establish that he relied on the offering
document to invest. He must establish that he suffered losses, without
further establishing that the losses
were caused by the omitted information.
• The defendant knew or should
have known that the prospectus contained inaccurate or incomplete information, or, alternatively, that the
defendant acted with intent to cause
damage to the investor.
Liability under general civil law prin-
• The investor relied on the information.
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Other issues
The following issues regarding liability may arise:
UK
US
• Issuers.
• Directors.
• Those who accept and are stated
in the particulars as accepting
responsibility for, or who authorised
the contents of, the particulars. For
example, sponsors, experts, underwriters and professional advisers.
• Issuers.
• Underwriters, other professional
advisers and experts.
• Directors, officers and principal
shareholders.
• "Control persons" with power to
direct the management or policies
of others directly liable for the disclosure.
• Listing particulars and prospectuses (statutory claim).
• Documents on the basis of which
investment decisions will be made,
or where the maker owes a duty of
care to the recipient, for example,
listing particulars, prospectuses,
general corporate announcements
and accounts.
• Registration statements (section
11, Securities Act).
• Prospectuses (section 12(a)(2),
Securities Act).
• Other public statements, such
as press releases and financial
reports (Rule 10b-5, Exchange
Act).
• Yes, in a common law claim.
• An FSMA claim requires loss to
be suffered as a result of the misleading statement or omission, but
query how this must be proved in
practice?
• No, in a claim under section 11
or section 12 (a)(2) (but defendant
may show absence of causation).
• Yes, in a 10b-5 claim, although
courts will presume reliance if the
misstatement is material and the
securities are traded on an established market.
• Yes, in an FSMA claim, but
query for how long?
• No, in a misrepresentation claim.
• Arguable in a negligent misstatement claim.
Yes.
• The reliance on the misstatement
or omission caused the investor’s
loss.
Investor claims based on general
principles of civil law are comparatively rare and only under very specific circumstances based on these
sources of liability. In addition, class
actions cannot be brought.
Criminal offences. Any person (issuer’s directors, officers or accountants auditing the issuer’s financial
statements) who wilfully makes in-
correct favourable statements or conceals unfavourable information in a
prospectus which is relevant to an investment decision will be punished by
fines or imprisonment (section 264a,
Criminal Code (StGB)). If someone is
convicted for violating his professional duties, the court can prohibit
him temporarily or permanently
from engaging in his profession or
trade (section 70a, StGB).
Investors cannot attempt to obtain
restitution for losses in a criminal trial
or via an administrative procedure.
• Negligence and standard of care. In
statutory liability claims for an incorrect or incomplete prospectus, only
gross negligence triggers liability. This
entails showing that the defendant
knew of the problem and failed to rectify it. The burden is on the defendant
to prove that he was not grossly negligent. In a civil case law claim, the normal standard of negligence applies.
The investor need only show that the
issuer knew or should have known
that the prospectus was incorrect or incomplete or that the information he
provided was incorrect.
• Causation. Causation is not problematic in statutory liability claims.
For a 12-month period after the initial
issue of the securities it is assumed by
statute that any purchase of the securities is on the basis of the prospectus (or
the “investment atmosphere” created
by the prospectus). It is for the defendant to prove that the prospectus was
in fact irrelevant to the investment decision. This is difficult, but may be
possible if the defendant can demonstrate that the “investment atmosphere” ended before the investment
with the publication of information
updating the information contained in
the prospectus (such as annual or
quarterly reports, ad hoc reports, massive stock loss or insolvency). By contrast, in a civil law claim the investor
must prove that he reviewed the offering document and that the investment
decision was based on that document.
Both statutory and civil case law
claims will fail if the defendant can
show that the investor knew the
prospectus was wrong or misleading,
but still purchased the securities.
• Calculation of damages. In statutory liability claims, the investor is
entitled to reimbursement of the purchase price to the extent that this does
not exceed the initial issue price, as
well as the “usual costs” related to
such an acquisition. The investor
must return the shares. In civil law
claims, the investor is entitled to full
damages, including interest and dividend payments that he would have
received.
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CORPORATE: PROSPECTUS LIABILITY
• Time limits. Statutory claims are
time-barred 12 months from the date
that the purchaser was made aware of
the incorrect or incomplete particulars, and in any event three years after
the prospectus was published.
UK
The publication in the UK (England
and Wales) of offering documents
exposes those responsible for their
preparation and publication to potential liability for misrepresentation or negligent misstatement. Potentially simpler statutory liabilities
arise under the Financial Services
and Markets Act 2000 (FSMA), previously contained in the Financial
Services Act 1986. Criminal liability
may also arise, as well as liabilities
under the Listing Rules or other selfregulatory schemes.
In practice, without clear
evidence of fraud, such
claims are not clear cut,
and may face complex issues, particularly in relation
to causation and reliance, in
showing that the misleading information in fact caused the damage, or that the investor in fact relied
on the misleading information in entering into the investment. This is
presumably why few cases have
reached trial in recent years. Faced
with technical difficulties on one side,
and publicity issues on the other,
claims usually settle long before trial.
Who may be liable
Liability may attach as follows:
• Issuers are always subject to liability for misleading or false statements
in offering documents.
• Directors must sign a confirmation
letter in relation to prospectuses that
all information required by the
FSMA is included. They may therefore be liable.
• Those who accept and are stated in
the particulars as accepting responsibility for, or who authorised the contents of, the particulars are subject to
statutory liability. This may include
sponsors, experts, underwriters and
professional advisers.
44
• Documents on the basis of which
investment decisions will be made,
such as listing particulars, prospectuses, pathfinders, offering memoranda and circulars.
their professional advisers would reasonably require or expect to find in
listing particulars for the purpose of
making an informed assessment of
the company and of the rights attaching to the securities to be listed. This
is an ongoing duty, which may require submission of supplementary
listing particulars.
• General corporate announcements, accounts and other financial
statements.
The investor has a right to seek compensation from the responsible person where he has (section 90, FSMA):
Establishing liability and remedies
Liability of the following types may
arise:
• Acquired the securities which are
the subject of the particulars; and
Types of statements
Liability can arise in relation to the
following types of statements:
• Statutory liability claims can be
brought in relation to listing particulars and prospectuses.
• Liability in misrepresentation or
misstatement for incorrect information may arise in relation to
the publication of documents detailing a company’s
performance,
changes in the structure of a
company, or fund raising, either where the document is intended to induce an investor to
purchase securities or where the
maker owes a duty of care to the recipient.
In addition, criminal liability may
arise under the FSMA or the Theft
Act 1968 for behaviour such as:
• Knowingly or recklessly making a
misleading or false statement or forecast in a listing particular.
• Dishonestly concealing any material facts.
• Creating a false or misleading impression as to the market in or value
of an investment intending to induce,
and inducing, someone to subscribe
for or underwrite that investment.
Statutory liability. The FSMA,
backed up by the Listing Rules, imposes disclosure duties on those responsible for listing particulars. This
includes all information within the
knowledge of responsible persons, or
which it would be reasonable for
them to obtain, which investors and
• Suffered loss in respect of those securities as a result of any untrue or
misleading statement, or as a result of
the omission of any matter required
by the FSMA to be included in the
statement.
An investor can also claim compensation where he acquired relevant securities and suffered loss as a result of a
failure by the issuer to submit supplementary listing particulars when required.
A claimant must have acquired the
relevant securities. This includes a
person who has contracted to acquire
the securities or an interest in them
(section 90(7), FSMA). This covers
owners of shares held through a nominee, but leaves open note holders. In
the case of notes, the registered holders will be settlement systems such as
Euroclear and Cedel with individual
investors holding securities via account holders there. The investor
does not hold specific notes, but has
an interest in the relevant part of a
whole issue. It is unclear whether a
noteholder would, therefore, have title to sue for compensation under the
FSMA.
The FSMA compensation claim is
available to purchasers in the after
market (Lightman J, obiter, in Possfund Custodian Trustee Limited v.
Diamond [1996] 2 All ER 774).
Misrepresentation. Where there is a
material misrepresentation of fact in
an offering document on which a purchaser relied, which was inaccurate,
and which caused the purchaser loss,
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CORPORATE: PROSPECTUS LIABILITY
the purchaser can seek rescission or
damages. A statement of opinion is
not actionable unless it can be said to
be a statement of fact. Since FSMA
duties of disclosure do not apply to
such a claim, a claim for omission is
only possible if the omission can be
shown to make the remaining text inaccurate and misleading.
Related information
This PLCGlobal Counsel article can be found on PLCGlobal Counsel Web at
www.practicallaw.com/A32108. The following information can also be
found on www.practicallaw.com:
Know-how topics
Securities markets and regulation
www.practicallaw.com/T889
A claim in misrepresentation is limited to the initial purchaser because a
prospectus, issued with a view to inducing people to purchase the securities, is actionable only by those who
were so induced at the time of the issue.
Dispute resolution and litigation
www.practicallaw.com/T69
Rescission of the contract may be
possible, leading to the return of the
purchaser’s original investment, but
not where there is any delay or where
circumstances change, such as a sale
of the shares. Otherwise damages are
available, being the difference between the price of the securities and
their “true” value at the time of the
purchase if the misrepresentation had
not been made (not if the misrepresentation had been true).
Negligent misstatement. If the investor
can show that there was a misstatement by the maker of a statement in
the offering document who owed him
a duty of care, the investor can claim in
negligence (Hedley Byrne v. Heller
[1964] AC 465). This point has not
been tested in relation to public issues.
Given that the FSMA remedies do not
require proof of negligence, investors
will, where possible, sue under the
FSMA rather than in negligence. However, a negligence claim might be available against a wider group than those
treated as being responsible for the
particulars under the FSMA.
In order to establish the duty of care,
a claimant must show foreseeability
of damage, and proximity of relationship between the claimant and defendant. This means considering:
• The purpose for which the statement was made.
• The defendant’s knowledge.
• The reasonableness
claimant’s reliance.
of
the
Handbooks
Dispute resolution
www.practicallaw.com/disputehandbook
Articles
Responding to shareholder activism
www.practicallaw.com/A24160
Certification of financial reports:
applying the new requirements
www.practicallaw.com/A26882
Class actions
www.practicallaw.com/A21592
His master’s voice: shareholder activism
set to increase
www.practicallaw.com/A26750
Practice notes
Verification: rights issues
Misleading statements and market
manipulation
The claimant must also show that it is
reasonable to impose a duty of care.
Given the difficulty in establishing a
duty of care in relation to an unascertained class of people, it is thought
that no duty of care is owed to after
market purchasers (Al Nakib v.
Longcroft [1990] 3 All ER 321), although it has since been held to be arguable in a case where a purchaser
showed that the prospectus had also
been intended informally to encourage after market investors (Possfund,
supra).
Other issues
In all claims, the claimant must prove
causation, that is, that the loss was
caused by the breach. In the case of a
claim under the FSMA, the loss must
be suffered “as a result of” the untrue
or misleading statement or omission
(section 90). The precise test of causation is unclear. Loss is not suffered directly as a result of a misleading statement or omission, but the
misstatement or omission may influence the decision to purchase or the
price.
If, as with a misrepresentation claim,
causation were based on the state-
www.practicallaw.com/A2922
www.practicallaw.com/A20710
ment influencing the decision to purchase, then it would seem that the investor would need to show that he
read and relied on the particulars.
This would not reflect the way in
which the market operates, and
would reduce the availability of a
statutory compensation claim. This
point has not been tested in the
courts, but under the old section 67 of
the Companies Act 1985, a claimant
had to show that he had bought securities on the face of the prospectus
and had suffered loss by reason of an
untrue statement included in it. In the
FSMA the wording appears to be deliberately wider. It may, therefore, be
that the claimant must simply show
that the market and the price of securities were affected by the misleading
statement, and that his reliance on
that caused his loss.
Causation becomes more problematic for purchasers in the after market
(who can claim under the FSMA, and
possibly in negligence, but not in misrepresentation). An after market purchaser needs to show that the misleading statement in the particulars
still influenced the market when he
bought. Clearly the particulars cannot have an indefinite effect. There is
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45
CORPORATE: PROSPECTUS LIABILITY
no statutory presumption that a
prospectus is effective for a particular
period of time after publication, but
presumably the court would seek to
answer the factual question of when
the listing particulars can be said to
have been superseded. Subsequent
publication of annual or interim accounts would make it difficult for a
claimant to assert that he had relied
on earlier listing particulars, since the
market’s perception of the value of
the securities would have been influenced by publication of more up-todate financial information.
US
Many on Wall Street believe the
growth in securities claims in the US
is driven by plaintiffs’ law firms,
which depend on the substantial fees
reaped from these claims. Investors’
lawyers take most of these class action cases on a contingency fee basis,
and generally receive up to 33% of
any recovery. Although a 1995 law
made it more difficult for plaintiffs to
initiate spurious suits at the first sign
of a drop in stock prices, declining
markets have proven a boon to securities class action lawsuits.
In addition to the economic climate,
several other factors make litigation
generally far more attractive in the US
than in Europe:
• Mass litigation class actions are a
practical means of representing investor interests under federal law.
• US courts refrain from punishing
defeated plaintiffs with defendants’
legal fees.
• The role of US juries in determining materiality often pushes deeppocket corporate defendants into settlement negotiations.
Settlement amounts may also be on
the rise. The gamble of a jury trial and
the expense of discovery have long
made pre-trial settlement an attractive option for companies under fire.
In class action lawsuits, settlement
amounts are generally higher when
the suits are accompanied by SEC investigations, an increasingly common
phenomenon post-Enron.
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This glut of litigation is not a mere
fluke, nor solely the result of a powerful trial lawyers’ lobby in Congress.
The federal securities laws are intended to guarantee the flow of accurate information to investors, and
therefore provide ample opportunities
for private claimants to seek remedies
through the US courts in civil actions.
Allowing investors to sue under federal law lessens the regulatory burden
on government agencies, as it allows
private parties to seek recourse
through the courts. Although remedies
may also be available to investors under state securities laws or common
law principles of fraud or negligence,
private litigants are likely to be prohibited from asserting state law claims in
large securities class action suits.
Who may be liable
Liability under the federal securities
laws is far-reaching and broad and
potentially affects the following:
• Issuers in public offerings are generally subject to liability for materially misleading disclosure and omissions from registration statements,
prospectuses, or other public statements. Under the broad anti-fraud
provisions of Rule 10b-5 of the Securities Exchange Act of 1934 (the Exchange Act), issuers may also be liable to those who purchase or sell in
the secondary market.
• Underwriters and other professional advisers may be liable for materially misleading statements or
omissions made in a registration
statement or prospectus if they are
viewed as the direct seller (such as in a
firm commitment underwriting).
Named experts (including accountants, engineers and appraisers) who
prepare or certify a portion of the registration statement, or any report
supporting the registration statement, are likewise subject to liability
for the portions they prepare. Unlike
issuers, underwriters and experts
have a “due diligence” defence (see
Establishing liabilities and remedies
below). Finally, underwriters and
other professional advisers (including
lawyers and accountants) may be
subject to liability under Rule 10b-5
for knowingly or recklessly making
material omissions or misstatements.
• Directors, officers (those required
to sign the registration statement)
and selling shareholders of the issuer
may be liable for misleading disclosure.
• “Control persons” are those who
have the power, directly or indirectly,
to direct the management or policies
of others directly liable for the disclosure violation. Any control persons,
including directors, officers and principal shareholders, may be directly liable for disclosure violations committed by an entity under their
control.
Types of statements
Federal securities laws provide remedies for misleading disclosure for a
broad range of misleading public
statements, both written and oral:
• Registration statements. Registration statements filed with the SEC (including the prospectus contained in
the registration statement) can be a
source of liability for untrue statements of material fact and materially
misleading omissions (section 11, Securities Act of 1933 (the Securities
Act)).
• Prospectus liability. A seller may
be liable for a prospectus (or oral
communication) containing untrue
statements of material fact or materially misleading omissions made in
connection with a public offering,
whether or not the offering is made
pursuant to a registration statement
filed with the SEC (section 12(a)(2),
Securities Act).
• Other public statements. Rule 10b5 provides one of the most significant
remedies for disclosure violations,
even extending to secondary market
trading. Rule 10b-5 lawsuits may
spring from material misstatements
or omissions relied upon by investors,
including press releases, financial reports and even analyst reports posted
on an issuer’s website. Investors may
also sue sellers under section 12(a)(1)
of the Securities Act if securities were
offered in violation of the registration
requirements of that Act. A successful
suit under section 12(a)(1) gives the
investor a “put right” which refunds
the purchase price of the securities.
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CORPORATE: PROSPECTUS LIABILITY
Sections 11 and 12(a)(2) and Rule 10b5 do not provide the only statutory
remedies for improper disclosure in
connection with securities offerings.
For instance, section 17(a) of the Securities Act contains a broad anti-fraud
provision similar to Rule 10b-5, which
would apply to both public and private
offerings as well as secondary trading.
Section 17(a) does not, however, provide a private right of action, and suits
can only be initiated by the SEC. This
article therefore focuses only on those
remedies provided by sections 11 and
12(a)(2) and Rule 10b-5.
Establishing liability and remedies
The causes of action provided to private litigants described above are not
mutually exclusive. Rule 10b-5,
which addresses cases where there
have been misstatements or omissions in the sale of any security, public or otherwise, generally provides
the broadest and most significant
remedy for private litigants. 10b-5
claims are more difficult to establish
than liability under section 11 and
section 12(a)(2), which address misleading disclosure in registration
statements and prospectuses in public offerings. In each case, a plaintiff
bringing a claim must prove that the
defendant made a “material” misstatement or omission, meaning that
there is a substantial likelihood that
a reasonable investor would consider it important in making an investment decision. The main differences between these causes of action
are as follows:
Actions under section 11. A plaintiff
bringing a claim under section 11 is
not required to show scienter (intent
to defraud or manipulate) by the defendant, and defendants have the burden of proving an absence of causation. Defendants who are not issuers
may escape liability by showing that
they exercised “due diligence” in determining that the registration statement contained no material misstatements or omissions. If successful,
plaintiffs are generally entitled to
damages, although defendants may
seek to reduce damages by showing
that losses were attributable to factors other than the disclosure violations.
A plaintiff bringing a section 11 claim
will have to prove reliance on the misstatement or omission if the purchase
was more than one year after the effective date of the registration statement and the issuer has made available to its security holders an
earnings statement covering at least
12 months after the effective date of
the registration statement.
Actions under section 12(a)(2). As in
section 11 claims, a plaintiff bringing
a claim under section 12(a)(2) is not
required to show scienter. Defendants have the burden of proving an
absence of causation. Defendants, including issuer defendants, may escape
liability by showing they exercised
“reasonable care” in determining that
the information released to the public
contained no misleading material
misstatements or omissions.
If successful, plaintiffs are generally
entitled to rescission, if the plaintiff
still owns the securities, or damages if
the plaintiff no longer holds them.
Damages may be reduced if the defendant shows the losses were attributable to factors other than the disclosure violation.
Rule 10b-5 claims. Plaintiffs bringing
a claim under Rule 10b-5 generally
bear a heavier burden and, in addition to establishing materiality, must
demonstrate each of the following elements:
• Reliance. The plaintiff must prove
that it relied on the misstatement or
omission. However, under the “fraud
on the market theory”, US courts will
presume reliance on a material misstatement or omission if the securities
are traded on an established trading
market. Under this theory, a material
misstatement or omission will be
deemed to have affected the market
price of the stock, and courts will presume that the plaintiff traded in reliance on the integrity of the price set
by the market (Basic v. Levinson, 485
U.S. 224 (1988)).
• Causation. A plaintiff must
prove that reliance on the misstatement or omission caused the plaintiff’s loss.
• Scienter. The plaintiff must prove
that the defendant made the material
misstatement or omission with some
intent to defraud or manipulate. US
courts have held that recklessness may
constitute scienter (Citibank, N.A. v.
K-H Corp., 968 F.2d 1489 (2d Cir.
1992)), but mere negligence will not
(Aaron v. SEC, 446 U.S. 680, 690, 695
(1980)).
If successful, private litigants in Rule
10b-5 claims may be awarded damages, or may seek to rescind the transaction and obtain a refund of the
original purchase price.
Other issues
Under the Sarbanes-Oxley Act,
claims alleging fraud, deceit, manipulation, or contrivance must be
brought within two years after the
discovery of the facts constituting the
violation, and not more than five
years after the date of the alleged violation. Wilful violation of the securities laws can lead to criminal penalties, including imprisonment of up to
20 years.
Julian Copeman and Alex Bafi are partners in
Herbert Smith’s London office, working in the
UK and US practices respectively. Denis
Chemla is a partner with Herbert Smith, Paris
and Bettina Friedrich is a partner in the
Frankfurt office of Herbert Smith’s
alliance firm, Gleiss Lutz.
THIS ARTICLE FIRST APPEARED IN THE SEPTEMBER 2003 ISSUE OF PLCGLOBAL COUNSEL MAGAZINE AND IS REPRODUCED WITH THE
PERMISSION OF THE PUBLISHER. PLEASE SEE WWW.PRACTICALLAW.COM/GLOBAL FOR MORE DETAILS.
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