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CHAPTER 18
SECURITIES REGULATION
THE ELEMENTS OF SECURITIES—Corporate finance occurs mostly by the sale of
securities. An efficiently operating securities market is essential to the well-being of the
economy. Most pension funds are invested in the securities markets.
Corporate Finance—Securities are written documents that provide evidence of a) a debt or b)
an ownership interest. Bonds and notes are common types of debt instruments. Stock certificates
are the most common form of ownership, or equity, interest. Securities themselves (the pieces of
paper issued) are worthless; their worth arises from the value of future profitability (in the case
of stock) or the value of a promise to redeem a debt and pay interest (in the case of a bond) that
they represent.
Debt—A company may raise money by going into debt. Debt financing typically involves the
sale of bonds or the borrowing of money. Most bonds are alienable, or tradeable. Documents that
represent a company’s debt obligations typically specify: 1) the amount of the debt; 2) the length
of the debt period; 3) the method of debt repayment; and 4) the rate of interest charged on the
amount borrowed.
Equity—A company may raise money by selling ownership interests in itself. This is equity
financing. A company that sells stock sells the right to a share of the future profits of the
company. Equity financing carries with it no legal obligation to repay the investment of
stockholders (unless fraud is involved). Investors expect to receive a competitive rate of return
on their money or they will invest in other, more attractive investment opportunities. One-fifth of
all Americans own stock, most as a part of their retirement financing. Securities are valued at
over $8 trillion dollars; about half are publicly traded stock, the other half debt.
Origins of Securities Regulation—The sale of securities in the U.S. was originally unregulated
(although it was subject to the contract rules of the common law). State legislatures early in the
century became concerned with the problem of fiunscrupulous promoters and salesmen.” To
make investing in securities safer for its citizens, states passed securities laws called blue sky
laws.
Beginnings of Federal Regulation—After the stock market crash of 1929, many people
(incorrectly) blamed the economic plight of the Great Depression that followed on manipulative
behavior of Wall Street stockbrokers. Congress responded to public outcry by passing a series of
laws designed to supervise the issuance and sale of securities. The most important laws are the
Securities Act of 1933 and the Securities Exchange Act of 1934. The 1933 Act regulates the
initial public offering of securities. The 1934 Act regulates trading in stocks that are already
issued.
The Securities and Exchange Commission—The SEC is an administrative agency, created by the
Securities Exchange Act of 1934, whose chief task is to enforce the federal securities laws. The
five members of the Commission are appointed by the President for five-year terms. Besides
headquarters in Washington, D.C., the SEC has offices located around the country.
WHAT IS A SECURITY?—Concern over the ability of fraud peddlers to circumvent the
securities laws led Congress, in the 1933 Act, to write a laundry list definition of the term
fisecurities.” Despite the detail, new investment forms arise that did not fit in the specific
categories listed by Congress, so the focus at the courts and the SEC is to look at economic
realities when determining whether or not an instrument is a security. What something is called
matters less than what it is in fact.
Supreme Court’s Howey Test—In the 1946 case, SEC v. Howey, the Supreme Court devised a
test to determine when an investment instrument is a security for purposes of federal regulation
under the securities laws. This is still the key test.
Add. Case: SEC v. W.J. Howey Co. (S. Ct., 1946)--Howey owned large tracts of land in
Florida, much of it orange groves. He placed some grove acreage on the market for sale to the
public, mostly by newspaper ads. Buyers would obtain title to acres of orange groves (no fraud
was involved). Buyers of the land were offered service contracts, whose terms specified that the
defendant would do the work necessary to run the orange groves and split the profits with the
land owners. Most investors lived outside of Florida and most signed the service contracts along
with the land. The SEC sued, alleging the land sales contracts in conjunction with the service
contracts were securities and, therefore, should have been registered with the SEC before being
sold to the public.
Decision: Was the deal offered by Howey was a security within the meaning of the 1933 Act?
The Court articulated a four-part test to decide what instruments qualify as securities under the
Act. A security is: 1) an investment of money, 2) in a common enterprise, 3) that holds an
Add. Case: Nutek Information Sys. v. Arizona Corp. Comm. (Ct. App., AZ 1998)--Nutek
helped SMR, a Texas LLC, solicit membership interests. Some Arizona residents invested
$147,500. There were many LLCs under a common management agreement. The Arizona
Corporation Commission ruled that the membership interests in the LLCs were securities and
had been sold unregistered in violation of the state securities law. Promoters appealed.
Decision: Affirmed. fiWe do not hold that a membership interest in any limited liability company
constitutes a security; that question must be answered on a case-by-case basis.” These
membership interests were securities. The Howey test is met because most members were passive
Add. Case: Holden v. Hagopian (9th Cir., 1992)--Plaintiffs invested in a general partnership
that held interests in a horse breeding association. They claimed that decisions made by the
manager of the horse breeding operation were fraudulent under the federal securities laws. The
defendant argued that the general partnership did not meet the definitional requirements of a
fisecurity,” and, thus, the claims of securities fraud should be dismissed.
Decision: The defendant was correct; the general partnership did not meet the test for a security.
Investors retained fisignificant legal power and control over partnership matters”; they were
Add. Case: US v. Lilly (7th Cir., 1994)--Lilly was pastor of a church in Indiana. He sold
fiCertificates of Deposit” supposedly to finance church expansion and to build a retirement
center. He said the church would pay certificate holders between 12 and 16 percent interest until
maturity after five years. He told investors the certificates were tax-free because they were from
a church. The scam lasted several years because he made interest payments from funds
collected. Lilly spent $900,000 of the money for personal purposes. The church ended up
bankrupt, owing over $1.3 million to investors. Lilly was convicted of criminal violation of the
securities law and tax fraud.
Decision: Affirmed. Lilly has no defense under the First Amendment because of freedom of
Add. Case: Versyss Inc. v. Coopers & Lybrand (1st Cir., 1992)--Contel agreed to merge NDS
into a newly created Contel subsidiary. NDS stockholders were required to submit their stock to
receive new shares. After the merger, Contel decided that an earlier registration statement
prepared by NDS contained materially misleading information, certified by the accounting firm
of Coopers & Lybrand. Contel, through its subsidiary, sued the accountants under the 1933 Act.
The issue for the court was whether the stock certificates received by Contel from NDS
stockholders were securities within the meaning of the 1933 and 1934 Acts.
Decision: By the date of the merger, but before any NDS stock certificates were transferred to
Contel, NDS ceased to exist. Therefore, at the date of merger, the NDS stock no longer had the
fiessential characteristics” of securities. The plain language of the 1933 Act argued against the
The Four Elements—The Howey Court developed a four-part test to determine what qualifies as
a security within the meaning of the Securities Act of 1933. The elements of the test require 1)
that an investor turn money over to someone for investment purposes; 2) this money must be
pooled with the money of other investors so that a common enterprise is formed (the investment
is fiindivisible,” one owns a share of the whole that cannot be separated physically); 3) the
investor expects a positive return on his investment; and 4) the investor does not have direct
control over the operation of the investment (others do the work).
Add. Info: An example of an unhappy investor who sued and lost because his investment was not
a security within this meaning is International Brotherhood of Teamsters v. Daniel. In that case a
union member sued his union, claiming that his mismanaged union-operated pension fund
(which in turn invested in securities), should be considered a security. The Supreme Court held
that pension funds are not securities, but rather, deferred wages; thus, they do not meet the
Howey test.
Add. Case: Reves v. Ernst & Young (S. Ct., 1990)--A farmers’ Co-Op sold promissory notes to
raise capital for operations. The notes were neither federally guaranteed nor insured, but were
marketed as safe investments. Later the Co-Op filed for bankruptcy. The plaintiff bond holder
sued Ernst & Young, the accounting firm for the Co-Op, for securities fraud, claiming the firm
failed to follow generally accepted accounting standards in audits of the Co-Op. That failure led
investors to have an unjustifiably optimistic view of the financial well-being of the Co-Op,
encouraging them to buy notes. Defendant’s faulty accounting practices proximately caused the
financial loss suffered.
Decision: Were the notes securities? Applying the Howey test, the Court was first concerned
with whether the purpose of the investment was to raise money for the seller and produce profits
for the investor. Yes. Next, the Court examined if the instrument was part of a plan of ficommon
Add. Case: SEC v. Unique Financial Concepts (11th Cir., 1999)--Unique offered foreign
currency options. It advertised heavily, promising large returns. Customer agreements explained
that funds would be pooled and that Unique had sole discretion over investments. Unique reps
advised investors as to which currencies to invest in. Trades were made via companies in the
Bahamas. Of the $6.5 million invested in one year, only $2.5 million was sent to the Bahamas for
trades. The rest went to sales commissions, the heads of Unique, and overhead. The SEC
obtained an injunction against Unique from further operations due to securities law violations.
Unique appealed.
Decision: Affirmed. The Howey test was satisfied--there was a pooling of investors’ money into a
common enterprise with the expectation of profits. Unique asserted it was selling a ficommodity
pool” involving merging client money to trade foreign currencies. The details of the operation
Securities Exempt from Regulation—Certain securities are exempt from regulations under the
1933 Act. This includes government debt (which is also exempt from the regulations of the 1934
Act), securities issued by banks or religious/charitable organizations, insurance policies, and
annuity contracts. While exempted issuers may be relieved of the legal burden of complying with
federal registration and disclosure requirements, they are not free of the threat of civil and
criminal sanctions under the anti-fraud provisions of the federal securities laws.
Issue Spotter: What Are You Selling?
You may be marketing securities. There have been instances such as this where the SEC so ruled.
You have an investment of money with an intention of making a profit for the investors. The
investors are allowing your family to handle the operation, so they are passive investors. The
only possible out is if the investors own an undivided interest or not. Does an investor take title
to a cow that is bought? Is the risk of loss individual or collective–that is, if one cow dies, is the
loss spread among all owners, or suffered only by the owner of that cow? Even in that instance,
the SEC has been known to claim that securities are being offered–that is much like the Howey
case.
Cyberlaw: Securities Offerings on the Web
Securities trading on the Internet is coming to dominate. Offering new securities on the Internet
is also growing rapidly and is cheaper than hiring traditional underwriters, and gets much greater
exposure for small offerings. Such offerings can be subject to relatively little SEC regulation.
The greatest problem has been outright scams; Congress substantially increased the SEC budget
in 1999 to give it resources to attack scams on the Net.
OFFERINGS TO INVESTORS—Federal securities laws require disclosure of material
information before the initial sale of securities, and in subsequent periods during which the
securities are traded, because lack of such public information could lead to unscrupulous trading
by certain privileged or informed persons to the detriment of the ordinary investor. The Latta
case is an example of the many scams that occur in which securities laws are irrelevant ex ante.
CASE: Latta v. Rainey (Ct. App., NC, 2010)—Mobile Billboards of America (MBA) sold
fiinvestments” from 2001 to 2004. Sales reps had an fioffering circular” that appeared to comply
with federal and state regulations. Investors could buy fiunits” for $20k and lease the billboard
unit to Outdoor Media Industries (OMI), a shell company operated by MBA. OMI would fiplace”
the billboards for display. Rate of return was said to average 13.5%/yr. and after seven years, the
investment would be repaid. Investors were also given a fiTrust Secured Certificate” that claimed
to protect their principal through a fiReserve Guaranty Trust” that secured everything. Rainey, a
sales rep, sold the Lattas, a retired couple, a fino risk” investment of $100,000 (for which he
received a 16-20% undisclosed commission). In 2004, the NC Sec. of State issued a cease a
desist order to MBA operations. Rainey then told worried investors he would protect them as he
would sue MBA. Latta and others sued Rainey, who filed bankruptcy. Court found Rainey to
have breach his fiduciary duty and to owe compensatory and punitive damages (unlikely to ever
be paid) and held MBA sales violated federal and state securities laws. Rainey appealed.
Decision: Affirmed. Securities fraud existed. There were false representations made about the
Questions: 1. Do you think this kind of investment scam is uncommon?
There is not good data on the number of scams, but they crop up everywhere. It is not just
2. Do you think stronger securities regulations could prevent this from happening?
That would be nearly impossible unless regulators were empowered to check every transfer of
funds that occurs. Very sophisticated investors get suckered into scams. Bernard Madoff was
highly respected and, cleverly, did not promise real high returns—he just fibeat the market” by a
The Registration Statement—The registration statement, composed of the prospectus and the
items-and-answers document, provides such material information. It is composed of two parts:
the prospectus and another, more detailed disclosure. The purpose of the registration statement is
to provide potential investors with the information necessary to make an investment decision
based on full information.
The Prospectus—The prospectus discloses the legal offering of the sale. A shorter version
(pamphlet length) of the registration statement must be provided to all prospective purchasers.
Information covers the security issuer’s business interests and background, the purpose of the
offering, the planned use of the funds raised, the risks involved, the promoter’s history and
compensation, and detailed financial statements. The initial draft is known as a fired herring.”
Regulation S-K—This part of the registration statement is a more detailed review of the financial
history of the issuer and the plans. Specific information required by the SEC may be included;
kept on public file at the SEC, but not automatically given to prospective investors.
Review by the SEC—The SEC may require issuers to make clear and highlight major risks
inherent in the investment instrument. Odd business arrangements may need to be identified. The
SEC has the power to issue a stop order, which will slow the registration process until an issuer
completes the registration statement to its satisfaction.
The Costs of Registration—SEC registration is a costly operation that involves the time and
skills of a number of professionals: attorneys, investment bankers, accounts, printers, etc. Costs
before under-writing may exceed $100,000 even for a small offering. An underwriter often
charges 5% of the value of new stock sold in an issue as its commission for selling the security.
Commissions are higher for smaller offerings, especially for unknown firms that want guarantees
of equity revenues.
Add. Case: Hertzberg v. Dignity Partners (11th Cir., 1999)--Soon after Dignity issued stock,
bad news caused the stock to collapse in price soon after the initial offering. Some investors
sued the promoters for misstatements and omissions, contending they knew the negative
information before they made the public offering. The court dismissed the claims. Investors
appealed.
Decision: Reversed. Misstatements and omissions made in the registration statement, and that
are the basis of stock purchases that are beyond the initial public offering, may be the basis of a
Add. Case: Kaufman v. Trump’s Castle Funding (3rd Cir., 1993)--Donald Trump and others
sold $675 million in mortgage investment bonds. The prospectus stated: fiThe Partnership
believes that funds generated from the operation of the Taj Mahal [casino in Atlantic City] will
be sufficient to cover all of its debt service (interest and principal).” Other statements warned of
possible cash flow problems, the riskiness of the industry, and that if problems developed, neither
interest nor principal would be repaid. When Trump’s casino ran into problems, the bond
holders sued, claiming securities fraud because the statements were misleading and omitted
material information.
Decision: Dismissal affirmed. The statements in the prospectus were cautious and warned of the
Exemptions from Registration—Some securities, as noted earlier, may be exempt from the
registration requirements of the federal securities laws (government bonds are the most
prominent example). This exemption lasts only as long as the securities meet the requirements of
the exemption. Again, although securities may be exempt from the registration requirements they
are never exempt from the federal securities laws. Many states also have issued securities laws
which apply differently in differing circumstances.
Private Placement—If a new security is not offered for sale to the fipublic” it may not need to be
registered with the SEC prior to sale. Private placement sales usually involve the sale of large
blocks of securities to sophisticated institutional investors, but some may be only under state
regulations.
Add. Case: Secretary of State v. Tretiak (Sup. Ct., Nev., 2001)--RFCA is a Nevada company. It
made a public offering of $1 million, registered with the Nevada Small Corporate Offering
Registration program. Two years later, the Securities Div. of the Nevada Sec. of State filed a
complaint against RFCA. It determined the prospectus for the offering was fifalse, incomplete,
and misleading in material respects.” Funds raised were not used for the purposes proposed in
the prospectus. The Div. ordered RFCA to stop violations, revoked the company’s broker-dealer
license, and barred the CEO from working as an investment adviser. The finding was appealed.
Decision: Affirmed. The record supported the finding of many securities violations. The
company clearly violated Nevada’s securities law. Contrary to RFCA’s position, fireliance and
Rule 144A. This rule exempts both U.S. and foreign security issuers from SEC registration
requirements for sales of securities to institutions (such as banks and insurance companies)
holding portfolios valued at $100 million or more. This is a widely used exemption.
Regulation D. This regulation covers the private placement exemption. Sales must be to
fiaccredited investors”—investors presumed sophisticated enough to make sound investment
decisions without a prospectus, and whose assets ($2.5 million minimum) and income ($200,000
minimum individual; $300,000 per couple) are sufficient to bear the risk of potential loss. Small
Corporate offering Registration (SCOR), under Rule 504, are for offerings to raise up to $1
million with minimum stock price of $5. Rule 505 is for offerings of $1 to $5 million and Rule
506 is for offerings over $5 million. The SEC must be notified of these offerings and investors
must be given private-placement memorandum rather similar to a prospectus. Resale of such
securities is subject to certain restrictions. State registration rules must be followed too.
Add. Case: U.S. v. Johnson (11th Cir., 2005)—Johnson formed a company to compete with
FedEx and raised over $15 million in a private placement stock offering. He blew through the
money leading the high life and then formed a new delivery company and got shareholders to
covert old worthless shares for shares in the new company for a fee. That company collapsed too
and he was convicted of fraud, perjury and money laundering. He appealed.
Decision: Affirmed. There was plenty of evidence of securities fraud and other criminal
Add. Case: Gustafson v. Alloyd Co. (S.Ct., 1995)--Gustafson, sole shareholder of Alloyd, sold
its stock to buyers in a private sale. The agreement stated that if the end-of-the-year audit
showed the value of the company to be lower than expected, Gustafson would refund a percent of
the purchase price, which was what happened. Buyers sued, claiming violation of the securities
law for material misstatements in the prospectus. Court granted Gustafson’s motion for summary
judgment. Court of appeals reversed, holding that the law applied to communications made in
private securities sales.
Decision: Reversed. A prospectus, as referred to in the securities law, has a specific meaning.
The information provided in a private security sale is not a prospectus; there was no offer made
Add. Case: Pacific Dunlop Holdings v. Allen & Co. (7th Cir., 1993)--Allen filed a SEC
registration statement in preparation for a public offering. It never occurred because Allen sold
the stock in a private sale to Pacific. The contract warranted the information in the unused
registration statement. It said that the company was in compliance with all relevant
environmental laws and not subject to any litigation. Pacific discovered that the company was
subject to many environmental claims. Pacific sued to rescind the deal; Allen refused. Pacific
sued for securities fraud based on the false information in the unused prospectus. The court
dismissed the complaint.
Decision: Reversed. The securities antifraud provisions applied to such a private sale; although
there was no formal prospectus, the sale was tied to a contract that contained serious
WKSIs—Most securities (by dollar total) are offered by well-known seasoned issuers (WKSIs)
who have issued at least $1 billion in securities before or have a public-equity capital value over
$700 million. These firms may issue securities the day they file registration statements and may
use a free-writing prospectus that allows continuous updates on the Web. They also fall under
shelf registration, which allows them three years to peddle the issue.
Issue Spotter: Can New Start-Up Firms Issue Securities?
A public offering is almost impossible unless a company is backed by people with good
reputations, which usually is already associated with money. An underwriter is very unlikely to
peddle stock from an unknown. A private offering is more likely to work than a public offering
but seed capital is very difficult to come by. Most start-up firms rely on personal funds from
those who start the company, which often involved borrowing from family members and a
couple friends who believe in the venture. Assuming you are not from a rich family, this is a
struggle. Finding a financial fiangel” is tough and those who take the risk usually demand a big
chunk of future profits, if any are produced. A private placement offering may avoid SEC
registration, but the costs are not trivial. For legal protection, a document similar to a registration
statement should be produced by a securities attorney to attempt to limit liability in the likely
chance the business goes bust. These can be promoted on the internet, but the likelihood of
rounding up funds from accredited investors who happen to find the internet-based offering is
slim. Rather, the firm is likely to look like an LLC, which may be a more sensible way to go
anyway than trying a stock offering unless something bigger and better evolves.
REGULATION OF SECURITIES TRADING—Under the 1934 Securities Exchange Act,
companies that have registered securities under the 1933 Act or that are traded publicly (called
publicly held companies) are subject to reporting requirements. Companies with less than 500
shareholders that do not allow their securities to be publicly traded are called private companies;
their financial information is not public. Public companies must file an annual report known as
the 10-K report, which provides extensive audited financial information about the issuer;
quarterly 10-Q reports that contain unaudited financial information; and monthly 8-K report must
be filed if a significant financial development occurs. The purpose of these reports is to make
investors aware of important financial information about the issuer. Failure to disclosure material
information concerning an issuer’s possible environmental problems may lead to liability under
Rule 10b-5, or under the "line item" disclosure requirements of the 1933 Act.
Regulation FD—Adopted in 2000, Reg FD requires companies to reveal information that is
being made public to the public at once, rather than selectively presenting the material, such as to
favored stock analysts, which was common practice. More information is not required; it only
requires a filevel playing field” in information when released.
Proxies and Tender Offers—Through the 1934 Act, the SEC regulates certain features of the
shareholder voting process in publicly-traded companies. The SEC also regulates certain aspects
of friendly and hostile mergers or takeovers.
Proxies—It would be impractical for most shareholders to attend corporate meetings at which
they may vote their shares. Hence, companies use proxies to facilitate voting at corporate
meetings. A proxy gives someone other than the shareholder the right to vote the shareholder’s
shares as instructed by the shareholder. Shareholders vote on such issues as the election of
members of the board of directors, amending company bylaws, and proposed mergers. SEC
regulations specify the timing and the form of proxy solicitations.
Add. Case: Koppel v. 4987 Corp. (2nd Cir., 1999)--A corporation that owned and managed real
estate was in financial trouble. Shareholders were asked to approve restructuring the company.
It involved three major proposals that were bundled into one item on a proxy statement. A
dissenting shareholder sued, claiming that under the Exchange Act, each proposal was a matter
to be voted upon separately. Court rejected this contention; shareholder appealed.
Decision: Reversed. SEC rules are specifically intended to fiunbundle management proposals.”
While one matter that shareholders vote upon may depend on passage of another proposal being
Tender Offers—When one company wants to buy another company or a controlling interest in
the company, it uses a tender offer (it fitenders” an offer to buy stock). The acquiring company
will offer shares in itself, or cash, for shares of the target company. Tender offers must be
registered with the SEC, which plays a significant role in the merger and acquisition process.
Add. Info: False information in proxy statements tend to matter most when the proxies are
sought in a takeover. The Delaware supreme court noted (in Arnold v. Society for Savings
Bancorp) that a proxy statement is misleading when it provides some history leading to a merger
agreement but does not disclose a bid that was for more than the merger price. The proxy
statement, asking shareholders to vote for a merger, mentioned that there were other, earlier
discussions that failed before this merger, but did not reveal that a bid for $275 million was
rejected in favor of a $200 million deal. That was significant information that shareholders had
the right to have.
SECURITIES FRAUD—Failure to follow the disclosure requirements of the 1933 or 1934 Act
may result in an allegation of securities fraud. The use of false or misleading information in
registration materials or in later disclosures can lead to a charge of securities fraud.
Basis for Securities Fraud—A sale of securities involves a contract of sale. Investors who are
victims of fraud in securities dealing may bring suit for common law fraud or for fraud based on
the securities laws. The elements of common law fraud are tougher to prove, so suits for fraud
based on the statutes are much more common. The securities act provides for civil liability for
misleading statements or material omissions in registration materials. Liability applies to all
securities, registered and unregistered; any damaged party who relied on the misinformation may
have a cause of action. Likewise, misleading information or material omission occurring in
disclosure materials produced pursuant to the 1934 Act may lead to civil liability for securities
fraud.
Add. Info: Materiality: In TSC Industries v. Northway (426 U.S. 438), the SCt held that fiAn
omitted fact is material if there is a substantial likelihood that a reasonable shareholder would
consider it important in deciding how to vote.... Put another way, there must be a substantial
likelihood that the disclosure of the omitted fact would have been viewed by the reasonable
investor as having significantly altered the ‘total mix’ of information available.” Materiality is a
mixed question of law and fact, fiinvolving as it does the application of a legal standard to a
particular set of facts.”
Rule 10b-5—The SEC adopted this rule to enforce Section 10(b) of the 1934 Act. The rule
provides a broad base for imposing liability for securities fraud. Securities fraud is committed if
a person uses any manipulative or deceptive device or practice in order to contravene the federal
securities laws. All securities, registered and unregistered, are subject to this rule.
Add. Case: Dura Pharmaceuticals v. Broudo (S.Ct., 2005)--Plaintiffs owned stock in Dura
Pharmaceuticals. They sued, contending they lost money due to false statements by company
executives about possible future profits and, especially, the financial benefits of possible
approval by the FDA of a new medicine. FDA approval did not occur and the stock fell. The suit
claimed the losses were due to misstatements that the plaintiffs relied upon. District court
dismissed, noting that plaintiffs failed to show causation between alleged misstatements and the
losses suffered. The Ninth Circuit Court of Appeals reversed, holding that loss causation has
been established if plaintiffs owned stock during the time the events in question happened. Dura
appealed.
Decision: Reversed. An inflated purchase price will not, by itself, constitute or proximately cause the relevant
economic loss needed to allege and prove "loss causation." The basic elements of a private securities fraud
Add. Case: Bryant v. Avado Brands (11th Cir., 1999)--Shareholders brought a class action suit
against a corporation and several of its officers, claiming the officers had made false and
misleading statements and material omissions to inflate the value of company stock. The court
refused to dismiss the suit; defendants appealed that ruling.
Decision: Reversed. For securities fraud under Rule 10b-5, plaintiff must show: 1) misstatement
or omission, 2) of material fact, 3) made with scienter; 4) on which plaintiff relied, 5) that
Liability for Securities Law Violations—Issuers who commit securities fraud may be sued by
injured investors for damages. Damages are the difference in price between what the investor
paid for the security and what the security was worth when it was sold. Investors may sue any
party connected with the preparation of the disclosure materials including: directors of the
company, executives of the company, as well as accountants, lawyers, or other professionals who
aided in preparation of materials.
