35. What is civil liability under “Section 11” of the ’33 Act?
Sections 11(a) and (b) of the ’33 Act provide for strict liability (tort liability) for issuers who make material misstatements or omissions in the issuance of securities. This provision primarily applies to omissions and errors in disclosure pursuant to a public offerings. For example, an error in a private placement memorandum or registration statement could give rise to Section 11 liability.
Requirements for Liability
To be liable for a Section 11 violation, the issuer must make a material misstatement or omission of information in the transaction. An individual may be liable if the final registration statement contains any:
• untrue statement of material fact;
• omits material facts required by a statute or government regulation; or
• omits information that makes the stated information materially misleading.
The plaintiff does not have to demonstrate or prove any reliance on the statement. It is sufficient to demonstrate that the information was erroneous or misleading. The limitation is that the purchaser must not know that the information is erroneous or misleading at the time of purchase. Lastly, the securities the plaintiff purchased must be traceable to the registration statement or disclosure document at issue. This requirement is easy to meet in an IPO, but it may be difficult in subsequent purchases of shares issued in private offerings.
Who is Potentially Liable?
The issuer is potentially liable under Section 11. Further, Section 15 makes any person or entity that controls an issuer potentially liable. This provision provides for joint and several liability for the controlling person or entity under agency principles. Liability extends to those who endorse or signe their names (“signer”) to assert the veracity of the information. This generally leads to potential liability for corporate directors, underwriters, and others who take part in the preparation of the registration statement or prospectus. Any “signer” has a due diligence defense, though an insider CEO and CFO will have hard time asserting this defense. The due diligence defense regards the amount of effort and care the signer exercised in verifying the erroneous or omitted information. Section 11(e) provides for rescission of the transaction (along with interest) or damages suffered (losses sustained) from the later sale of the securities.
• Discussion: What do you think about Section 11 liability for omissions or errors in disclosure? Do you think these provisions adequately make officers accountable for public disclosures? Why or why not?
• Practice Question: ABC Corp is going through the registration process. It files the S-1 containing all relevant financial and non-financial information. It also translates this information into a prospectus that it distributes to potential purchasers. What is ABC Corp’s potential liability if some of the revenue calculations are erroneous in the accompanying financial statements?