47. What is liability under “Section 18” of the 1934 Act?
Section 18 of the ’34 imposes liability on any person “who shall make or cause to be made any false and misleading statement of material fact in any application, report, or document filed under the act”. Section 18 is based upon a theory of fraud. Unlike under rule 10(b)(5), however, Section 18 applies only to the documents required to be filed under the ’34 Act. This includes annual, quarterly, and special reports. A plaintiff must prove that:
• the defendant knowingly made a false statement,
• the plaintiff relied on the false or misleading statement, and
• the plaintiff suffered damages as a result of that reliance.
Unlike the sections 11 and 12 of the 1933 Act, the defendant’s good faith in making the written statement is a defense. Further, unlike sections 11 and 12, the Section 18 plaintiff must prove reliance by the plaintiff shareholder on that information.
• Note: The statute of limitations for bringing a Section 18 action was extended under Sarbanes-Oxley Act to 5 years from the wrongful act, and within 2 years of discovery.
• Discussion: Why do you think that Section 18 provides a specific cause of action for material misstatements in a public disclosure document? How do you feel about the availability of a good faith defense? What about the requirement that the plaintiff prove reliance on the statement?
• Practice Question: ABC Corp issues a Form 10-K annual report containing numerous material errors in the financial information. The errors drastically misstate the asset holdings of the company. If a group of shareholders learn of the misstatement and decide to bring a lawsuit, what must the shareholders show to hold ABC Corp liable under Section 18?