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*** Chapter Outcome ***
Discuss the potential civil liabilities under the 1933 Act.
Unregistered Sales
Section 12(1) of the act imposes express civil liability for
• the sale of an unregistered security that is required to be registered,
• the sale of a registered security without delivery of a prospectus,
• the sale of a security by use of an outdated prospectus,
False Registration Statements
Section 11 of the act imposes express liability on those who have included any
untrue statement of a material fact in the registration statement or who have
omitted any material fact from it. Material matters are those to which a
reasonable investor would be substantially likely to attach importance in
determining whether to purchase the security registered.
Liability is imposed on
(1) the issuer;
(2) all persons who signed the registration statement, including the principal
executive o-cer, principal &nancial o-cer, and principal accounting
o-cer;
CASE 43-2
ESCOTT v. BARCHRIS CONSTRUCTION CORP.
United States District Court, Southern District of New York, 1968
283 F.Supp. 643
http://scholar.google.com/scholar_case?case=13642266152052517214&hl=en&as_sdt=2&as_vis=1&oi=scholar
McLean, J.
This is an action by purchasers of 5½ percent convertible subordinated fifteen year debentures of
BarChris Construction Corporation (BarChris). * * *
The action is brought under Section 11 of the Securities Act of 1933. Plaintiffs allege that the
registration statement with respect to these debentures filed with the Securities and Exchange
Commission, which became effective on May 16, 1961, contained material false statements and
material omissions.
Defendants fall into three categories: (1) the persons who signed the registration statement;
(2) the underwriters, consisting of eight investment banking firms, led by Drexel & Co. (Drexel);
and (3) BarChris’s auditors, Peat, Marwick, Mitchell & Co. (Peat, Marwick).
* * *
* * *
In December 1959, BarChris sold 560,000 shares of common stock to the public at $3.00 per
share. This issue was underwritten by Peter Morgan & Company, one of the present defendants.
By early 1961, BarChris needed additional working capital. The proceeds of the sale of the
debentures involved in this action were to be devoted, in part at least, to fill that need.
The registration statement of the debentures, in preliminary form, was filed with the
Securities and Exchange Commission on March 30, 1961. A first amendment was filed on May
11 and a second on May 16. The registration statement became effective on May 16. The closing
of the financing took place on May 24. On that day BarChris received the net proceeds of the
financing.
* * *
The “Due Diligence” Defenses
Section 11(b) of the Act provides that:
* * * [N]o person, other than the issuer, shall be liable * * * who shall sustain the burden of proof—
* * *
(3) that (A) as regards any part of the registration statement not purporting to be made on the authority of
an expert * * * he had, after reasonable investigation, reasonable ground to believe and did believe, at the time
such part of the registration statement became effective, that the statements therein were true and that there was
no omission to state a material fact required to be stated therein or necessary to make the statements therein not
misleading; * * * and (C) as regards any part of the registration statement purporting to be made on the
* * *
I turn now to the question of whether defendants have proved their due diligence defenses.
The position of each defendant will be separately considered.
* * *
Kircher Kircher was treasurer of BarChris and its chief financial officer. * * * He was
thoroughly familiar with Bar- Chris’s financial affairs. * * *
Moreover, as a member of the executive committee, Kircher was kept informed as to those
branches of the business of which he did not have direct charge.
* * *
* * *
Birnbaum Birnbaum was * * * employed by BarChris as house counsel and assistant
secretary in October 1960. Unfortunately for him, he became secretary and a director of BarChris
on April 17, 1961, after the first version of the registration statement had been filed with the
Securities and Exchange Commission. He signed the later amendments, thereby becoming
responsible for the accuracy of the prospectus in its final form.
* * *
One of Birnbaum’s more important duties, first as assistant secretary and later as full-fledged
secretary, was to keep the corporate minutes of BarChris and its subsidiaries. This necessarily
informed him to a considerable extent about the company’s affairs. * * *
* * * [Birnbaum] made no investigation and relied on the others to get it right * * * He
should have known that he was required to make a reasonable investigation of the truth of all the
* * *
In considering Auslander’s due diligence defenses, a distinction is to be drawn between the
expertised and non-expertised portions of the prospectus. As to the former, Auslander knew that
Peat, Marwick had audited the 1960 figures. He believed them to be correct because he had
confidence in Peat, Marwick. He had no reasonable ground to believe otherwise.
As to the non-expertised portions, however, Auslander is in a different position. * * *
Auslander made no investigation of the accuracy of the prospectus. * * *
It is true that Auslander became a director on the eve of the financing. He had little
opportunity to familiarize himself with the company’s affairs. * * *
* * *
Section 11 imposes liability in the first instance upon a director, no matter how new he is. He
is presumed to know his responsibility when he becomes a director. He can escape liability only
by using that reasonable care to investigate the facts which a prudent man would employ in the
management of his own property. In my opinion, a prudent man would not act in an important
matter without any knowledge of the relevant facts, in sole reliance upon representations of
persons who are comparative strangers and upon general information which does not purport to
cover the particular case. To say that such minimal conduct measures up to the statutory standard
would to all intents and purposes, absolve new directors from responsibility merely because they
are new. This is not a sensible construction of Section 11, when one bears in mind its
fundamental purpose of requiring full and truthful disclosures for the protection of investors.
* * *
* * *
The purpose of Section 11 is to protect investors. To that end the underwriters are made
responsible for the truth of the prospectus. If they may escape that responsibility by taking at
face value representations made to them by the company’s management, then the inclusion of
underwriters among those liable under Section 11 affords the investors no additional protection.
To effectuate the statute’s purpose, the phrase “reasonable investigation” must be construed to
require more effort on the part of the underwriters than the mere accurate reporting in the
prospectus of “data presented” to them by the company. It should make no difference that this
data is elicited by questions addressed to the company officers by the underwriters, or that the
underwriters at the time believe that the company’s officers are truthful and reliable. In order to
make the underwriters’ participation in this enterprise of any value to the investors, the
underwriters must make some reasonable attempt to verify the data submitted to them. They may
not rely solely on the company’s officers or on the company’s counsel. A prudent man in the
Antifraud Provision
Rule 10b-5 of the 1934 Act applies to the issuance or sale of all securities, even
those exempted by the 1933 Act. The 1933 Act also contains two antifraud
provisions: Section 12(2) and Section 17(a).
Section 12(a)(2) — imposes express liability on one who offers or sells a
security by means of a prospectus or oral communication that contains an
untrue statement of material fact or an omission of a material fact.
The seller may avoid liability by proving that he did not know, and in the exercise
of reasonable care could not have known, of the untrue statement or omission. If
the purchaser still owns the security, the seller is liable to the purchaser for the
Criminal Sanctions
The 1933 Act imposes criminal sanctions on any person who willfully violates any
of the provisions of the act or the rules and regulations promulgated by the SEC
pursuant to the act. Conviction may carry a &ne of not more than $10,000 or
imprisonment of not more than 5 years, or both.
Moreover, under the Federal Alternative Fines Act, if any person derives
pecuniary gain from the o%ense, or if the o%ense results in pecuniary loss to a
person other than the defendant, the defendant may be &ned up to the greater
of twice the gross gain or twice the gross loss.
NOTE: See Fig. 43-3: Registration and Liability Provisions of the 1933 Act.
II. THE SECURITIES EXCHANGE ACT OF 1934
The 1934 Act deals mainly with the resale of securities; it establishes rules for
market operations and prohibits fraudulent and manipulative practices.
*** Chapter Outcome ***
List which provisions of the 1934 Act apply only to publicly held companies
and which apply to all companies.
As amended by the JOBS Act, it requires registration of all securities listed on
national exchanges, as well as equity securities of companies (1) whose assets
exceed $10 million and (2) whose equity securities include a class of equity
securities held by either (a) two thousand or more persons or (b) &ve hundred or
A. DISCLOSURE
The 1934 Act requires the &ling of securities registrations, periodic reports,
disclosure statements for proxy solicitations, and disclosure statements for
tender offers, as well as compliance with the accounting requirements imposed
by the Foreign Corrupt Practices Act. In 1992 the SEC developed a new series of
forms for qualifying issuers to use for registration and periodic reporting. Also in
1992, the SEC imposed new compensation disclosure rules designed to provide
shareholders with annual and long-term compensation for senior executives. In
*** Chapter Outcome***
Explain the disclosure requirements of the 1934 Act.
Registration Requirements for Securities
All regulated publicly held companies must register with the SEC. These
one-time registrations apply to an entire class of securities. Thus, they differ
from registrations under the 1933 Act, which relate only to securities in a speci&c
offering.
Registration requires disclosure of
• the company’s organization, &nancial structure, and nature of the
business;
• the terms, positions, rights, and privileges of the different classes of
Periodic Reporting Requirements
After registration, an issuer must &le annual (10-K) and periodic (10-Q and 8-K)
reports to update information contained in the original registration. Also subject
to the periodic reporting requirements are issuers who have &led a 1933 Act
registration statement with respect to any security unless, in any subsequent
year, the securities are held by fewer than three hundred persons.
effective in early 2010, the SEC adopted new requirements for disclosure of
(1) the quali&cations of directors and nominees for director, and the reasons why
that person should serve as a director of the issuer;
(2) any directorships held by each director and nominee at any time during the
past &ve years at any public company or registered investment company;
(3) the consideration of diversity in the process by which candidates for director
are considered for nomination by an issuer’s nominating committee;
The Sarbanes-Oxley Act requires that issuers disclose in plain English to the
public on a rapid and current basis such additional important information
concerning material changes in the &nancial condition or operations of the
issuer.
The Act, as amended by the Dodd-Frank Act, requires that each director, each
o-cer, and any person who owns more than 10 percent of a registered equity
security &le reports with the SEC within ten days after he or she becomes such
Proxy Solicitations
A proxy is a writing signed by a shareholder authorizing a named person to vote
her shares of stock at a speci&ed shareholders’ meeting. The 1934 Act regulates
proxy solicitation, so that shareholders have adequate information upon which to
vote. Solicitation of a proxy is prohibited unless each person solicited has been
furnished with a written proxy statement containing speci&ed information. A
solicitation includes any request for a proxy, any request not to execute a proxy,
or any request to revoke a proxy. The SEC has issued comprehensive and
detailed rules prescribing the solicitation process and the disclosure of
information about the issuer.
Proxy Statements — A proxy statement describes all material facts concerning
the matters being submitted to security holders for a vote, together with a proxy
form on which the security holders can indicate their approval or disapproval of
each proposal. In an election of directors, proxy solicitations by a person other
than the issuer are subject to similar disclosure requirements. The issuer in such
an election also must include an annual report with the proxy statement.
effective in early 2010, the SEC requires in proxy materials relating to election of
directors that the issuer disclose the quali&cations of nominees for director, and
proxy statements information that shows the relationship between executive
compensation actually paid and the &nancial performance of the issuer, taking
into account any change in the value of the shares of stock and dividends of the
issuer and any distributions. Third, the SEC must issue rules requiring the
disclosure of (1) the median of the annual total compensation of all issuer’s
employees except the CEO, (2) the annual total compensation of the CEO, and
Shareholder Proposals — Where management solicits proxies, any security
holder entitled to vote has the opportunity to communicate with other security
holders. On written request from the security holder, the corporation must mail
the communication at the security holder’s expense or, at its option, promptly
furnish to that security holder a current list of security holders.
If an eligible security holder entitled to vote submits a timely proposal for action,
management must include the proposal in its proxy statement along with a brief
statement explaining the shareholder’s reason for making the proposal.
Tender Offers
A tender offer is a general invitation to a company’s shareholders to purchase
their shares at a speci&ed price for a speci&ed time. In 1968 Congress enacted
the Williams Act, which amended the 1934 Act to extend reporting and
disclosure requirements to tender offers and other block acquisitions. The
purpose of the Williams Act is to provide public shareholders with full disclosure
by both the bidder and the target company, so that shareholders may make an
informed decision.
Disclosure requirements — These apply to three situations:
(1) when a person or group acquires more than 5 percent of a class of voting
securities registered under the 1934 Act,
(2) when a person makes a tender offer for more than 5 percent of a class of
registered equity securities, or
company or to make major changes in the corporate structure,
(4) the number of shares owned, and
(5) the terms of the transaction; and
(6) any relevant contracts,.
Required Practices — The tender offer must be kept open for at least 20
business days. Shareholders who tender their shares may withdraw them at any
time during the offering period. The tender offer must be open to all holders of
the class of shares subject to the offer. All shares tendered must be purchased
for the same price; if an offering price is increased, both those who have already
tendered and those who have yet to tender will receive the bene&t of the
increase. A tender offeror who offers to purchase less than all of the outstanding
Defensive Tactics — Confronted by an uninvited takeover bid — directly or
potentially — the target company’s management may decide to oppose the bid
or to seek to prevent it. A company may use defensive tactics to make the
takeover very difficult or expensive.
State Regulation — In the 1980s, when the availability of junk bonds vastly
increased the number of attempted takeovers of public companies, state
legislatures reacted with alarm. More than forty states have enacted statutes
regulating tender offers, most of which protect the target company from an
unwanted takeover.
• Some statutes empower the state to review the merits of the offer or the
adequacy of disclosure.
Foreign Corrupt Practices Act
The FCPA was enacted by Congress in 1977 as an amendment to the 1934 Act,
and the FCPA was itself amended in 1988 and 1998. Act (1) imposes internal
control requirements upon issuers with securities registered under the 1934 Act
and (2) prohibits all U.S. persons, and certain foreign issuers of securities, from
bribing foreign governmental or political o-cials
The FCPA requires accounting requirements
*** Chapter Outcome ***
Explain the potential civil liabilities under the 1934 Act.
B. LIABILITY
Sanctions under the 1934 Act include civil liability to injured investors and
issuers, civil penalties, and criminal penalties.
The 1995 Reform Act imposes the on a plainti% burden of proving the act or
omission caused the loss for which the plainti% seeks damages. It also limits the
damages (which are based on the market price of a security) which can be
recovered under the 1934 Act. Thirdly, it provides a “safe harbor” from civil
liability for certain “forward-looking statements” made by issuers.
Misleading Statements in Reports
Section 18 imposes express civil liability on any person who makes or causes
Short-Swing Profits
Section 16(b) of the 1934 Act imposes express liability upon insiders — directors,
o-cers, and any person owning more than 10 percent of the stock of a
corporation listed on a national stock exchange or registered with the SEC — for
all pro&ts resulting from their “short-swing” trading in such stock. In that case,
Antifraud Provision
Section 10(b) and SEC Rule 10b-5 make it unlawful for any person using the
mails or facilities of interstate commerce in connection with the purchase or sale
of any security
(1) to employ any device, scheme, or arti&ce to defraud;
(2) to make any untrue statement of a material fact;
(3) to omit a material fact without which the information is misleading; or
(4) to engage in any act, practice, or course of business that would operate
as a fraud or deceit upon any person.
Requisites of Rule 10b-5 — Recovery of damages requires proof of (1) a
misstatement or omission (2) that is material, (3) made with scienter (i.e., made
knowingly), and (4) relied upon (5) in connection with the purchase or sale of a
security. This rule differs from common law fraud in that Rule 10b-5 imposes an
a-rmative duty of disclosure.
A misstatement or omission is material if a reasonable investor would be
substantially likely to consider it important in deciding whether to buy or sell the
