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Securities Litigation and Enforcement
University of Georgia School of Law
Sachs, Margaret V.

Securities Litigation & Enforcement
Spring 2012
Introductory Material
The Federal Securities Statutes
–          The necessity of federal securities law stemmed from failure of state “blue sky” laws which were enacted to protect investors from selling stock worth only so many feet of blue sky.
–          Securities Act of 1933 (The Securities Act)
o   Emphasizes both the disclosure of info. and the prevention of fraud.
o   Primarily concerned with securities offerings by issuers and those who control them.
§  Applies to both IPOS and subsequent offerings
o   The Registration Requirement
§  If not exempted, issuer must file registration stmt. with SEC.
§  Provides detailed info. about company’s business and management along with terms of offering and certified financial statements.
o   Registration exemptions
§  Securities issued by the U.S. and by state or local governments as well as by banks and non-profit institutions are exempt.
o   Liability Provisions
§  §12(a)(1): right of rescission to private P’s who can establish a violation §5 of the Securities Act.
§  §11: purchasers in registered offerings may sue the issuer and numerous other D’s for material omissions and misstatements in the registration statement.
§  §12(a)(2): P may sue for material omissions and misstatements made by means of a prospectus or in some instances, orally.
§  §17(a): prohibits 3 sets of fraudulent acts in the offer or sale of a security.
·         No private action (express or implied)
–          Securities Exchange Act of 1934 (The Exchange Act)
o   Focuses on the secondary trading markets.
o   §10(b) and Rule 10b-5
§  10(b): makes it unlawful to use or employ, in connection with the purchase or sale of any security, any manipulating or deceptive device or contrivance in contravention of SEC rules.
§  10b-5: proscribes fraud in a manner virtually as wide-ranging as §10(b) itself.
·         As originally contemplated by their drafters, 10(b) and 10b-5 were to be enforced only by the SEC and DOJ.
·         Beginning in 1946, courts began recognizing an implied private action
o   §9(e) and §18(a):
§  §9(e): market manipulation, §18(a): material misstatements in reports filed with SEC
§  These are the only 2 express private actions in the Exchange Act
o   Disclosure Obligations: Reporting Companies
§  Reporting companies must comply with §13(a)
§  Reporting companies are companies that fall into any of the following 3 categories:
·         (1) Companies which, as provided by §12(b) have a class of securities listed on a national securities exchange.
·         (2) Companies which, as provided by §12(g) and rule 12g-1, have total assets exceeding $10 million and a class of equity securities held by at least 500 shareholders.
·         (3) Companies that do not fit either of the above 2 categories must nonetheless satisfy the Exchange Act’s reporting requirements if, as provided
·         by §15(d), they have filed a registration statement under the Securities Act that has become effective.
o   Proxy regulation
§  §14(a): broad mandate for SEC to adopt rules governing the solicitation of proxies.
·         14a-9: prohibits material omissions or misrepresentations in proxy solicitations.
v  Rule is enforceable by SEC, DOJ, and by investors (implied private action)
o   Tender Offer Regulation
§  §13(d), 13(e) and 14(d)-(f) (The Williams Act)
·         Disclosure of information
·         Regulating process of tender offers so as to reduce shareholder coercion
·         Prohibits fraud in connection with any tender offer
v  Modeled after 10b-5
v  Contained in 14(e)
§      Enforceable by SEC, DOJ, and by private parties (implied)
–          The Private Securities Litigation Reform Act of 1995:
o   Imposes numerous restrictions on private securities actions
o   Took aim at purportedly frivolous securities class actions which, in view of Congress, were filed by lawyers desirous of simply reaching a settlement and collecting a fee.
o   Substantive hurdles
§  Securities Act §27(a) and Exchange Act 21(e) give issuers a “safe harbor” which, when satisfied, shields them from claims that they made fraudulent forward-looking statements
§  Securities Act §12(b) and Exchange Act §21D(b)(4) : P’s must prove loss causation
§  Exchange Act §21D(e): an adjustment to calculation of damages
§  Securities Act § 11(f)(2) and Exchange Act §21D(f): replaces joint and several liability with a system of proportionate liability.
o   Procedural Hurdles
§  Exchange Act § 21D(b)(1)-(2): heightened pleading requirements mandating the setting forth of specific facts.
§  Securities Act §27(b) and Exchange Act §21D(b)(3): a stay on discovery pending resolution of D’s motion to dismiss on the pleadings.
o   Class actions specifically
§  Lead plaintiff requirement and lead counsel requirement
–          Sarbanes-Oxley Act of 2002
o   Heightens corp. disclosure obligations
o   Places accounting industry under oversight of a Board appointed by and under supervision of SEC
o   Requires SEC to adopt professional responsibility rules for securities lawyers
o   Establishes several new securities crimes
o   Toughens the penalty for some already existing securities crimes
o   Extends the statute of limitations for private actions for securities fraud
–          Dodd Frank Wall Street Reform and Consumer Protection Act of 2010
o   Dramatically increases the degree of Govt. supervision over large financial institutions and establishes new consumer financial protections
o   Created the Financial Stability Oversight Council to oversee the financial industry and address future financial crises.
o   Enhanced authority for the FDIC
o   Consumer Financial Protection Bureau
o   Enhanced SEC and CFTC Authority over Derivatives Trading
o   Registration of private equity and hedge funds
o   Credit Rating Agencies
o   Corporate Governance
o   Investor Protection
o   Rules, Studies, and Offices
The Courts
–          Federal Courts play a substantial role in shaping the substantive law of securities litigation.
o   Federal laws written in very broad language
o   Many important securities cases came to the court during times of judicial activism.
–          Appellate courts of 9th and 2nd circuit are widely regarded as the most important
o   2nd circuit encompasses NYC
o   9th circuit in Silicon Valley
–          Composed of 5 commissioners appointed by the President and confirmed by Senate.
–          SEC has power to adopt rules that implement Federal Securities laws.
–          Has power to initiate administrative actions against securities law violators as well as power to adjudicate those actions.
–          SEC often files amicus briefs in private actions which it is not a party to.
–          Exclusive authority over criminal enforcement of federal securities laws.
–          Securities Act and Exchange act are “Hybrid civil-criminal statutes”
State Law
–          Each state continues to have its own blue sky laws and state officials may bring both civil and criminal actions under those statutes.
–          In 1998, Congress enacted the Securities Litigation Uniform Standards Act (SLUSA) which preempted class actions for securities law and statutes of all fifty states.
Social and Economic Forces
–          1930’s: Exchange Act and Securities Act enacted after Great Depression.
–          1970s: widespread concern over the extent of govt. regulation and the prevalence of litigation and judicial activism created a period of retrenchment where the Supreme Court restricted the scope of implied private actions.
–          When the market is booming, concern about protecting investors seems to take a back seat to other priorities such as curtailing excessive litigation.
–          The internet has created new ways to deceive.
–          Accounting scandals led to passage of SOX
Efficient Capital Markets Hypothesis
–          Weak
o   Commands virtually universal acceptance
o   Security prices are determined by currently available information rather than historical market trends.
–          Semi-strong
o   Widely accepted
o   Once information becomes public, it is quickly impounded into securities prices.
–          Strong
o   Highly controversial
o   Even nonpublic information is routinely impounded into security prices through leaks and insider trading.
–          Information efficiency
o   Only necessary that prices react quickly to new public information
–          Fundamental efficiency
o   It is necessary for price to reflect true value of shares
–          Markets become efficient as the result of heavy trading by sophisticated investors, many of them institutions, based on what they and their advisors cull from available public sources about the securities and the companies that issue them.
–          Not all public markets are efficient
o   Public markets that are thinly traded or have few or no institutional investors are unlikely to be efficient because they lack the ingredients of market efficiency.
§  IPO market is inefficient whereas the NYSE is efficient
–          There are arguments and skepticism about the EMH because of recent events such as Enron where there was negative information publicly available that was not reflected in stock price.

iscovery during the pendency of any such motion to dismiss (exception when court finds upon motion by any party that particularized discovery is needed to preserve evidence or to prevent undue prejudice to that party)
–          Mandatory Sanctions (added by PSLRA)
§21D(c): Requires the court to review every private action at the time of final adjudication to determine whether a party or attorney has committed a violation of rule 11(b) of the FRCP
o   Presumptive sanction is an award of the opposing party’s attorney’s fees and expense.
–          Burden of Proof:
o   Preponderance of the evidence (more likely than not)
The requirement of Manipulation or Deception
–          Statements that mislead by omission include half-truths. SEC v. Gabelli (2011)
–          D’s secret intention not to honor a promise may render other statements made by him materially misleading. Wharf Holdings v. United Int’l Holdings (2001)
–          Conduct itself may be deceptive. There need not be a specific oral or written statement before there could be liability under 10b or 10b-5. Stoneridge Inv. Partners v. Scientific-Atlanta (2008)
Santa Fe Industries, Inc. v. Green (1977) (“Mere” breaches of fiduciary duty)
–          P acquired 60% of another company (Kirby). Holding grew to 95%. P wanted to get 100% so they executed a short form merger which was allowed in Delaware and didn’t require consent by minority shareholders but they do have to provide 10 day notice. P obtained appraisals for the value of Kirby shares and bought minority out at $150/share. P did not give notice. D, minority shareholders of Kirby, refused their statutory right to an appraisal and instead sued P seeking to set aside the merger. They claim that P obtained a fraudulent appraisal in violation of 10b-5.
–          Court: A breach of fiduciary duty does not count as manipulation or deception. Here, shareholders are just claiming price was unfair which is a fiduciary duty issue.
o   Restricts scope of 10b-5. (we should expect this based on the date being after 1975)
o   Why didn’t shareholders just take their appraisal? Getting appraisal is pain in the ass.
o   Unfairness claims are traditionally a matter of state law
§  But, in 1970’s P’s in state court had no fiduciary duty clams when it came to mergers.
·         these didn’t come until 1983 in Weinberger v. U.O.P.
o   S.Ct. was signaling to state courts to create actions for these types of P’s in state court.
o   This decision is at war with itself: (famous footnote 14)
§  Court says they cant recognize a mere unfairness claim because it would intrude on state law. Shareholders had an omission claim, but the problem was that even if they had been made aware of the merger, there was nothing they could have done about it besides get an appraisal.
§  Under footnote 14, P might have a cause of action if they lose a state remedy because of an omission. If they had an alternative remedy under Delaware law, say to enjoin the merger, then this omission would be material and then they would have a 10b-5 action.
§  This kind of contradicts part IV of the opinion where Court states that they don’t want to get involved in state law, but this opinion would require them to look at all the state remedies before deciding if an omission was material.
–          Goldberg v. Meridor (2d Circuit) (1977)
o   Authored by Justice Friendly
o   §10(b)’s deception requirement encompasses a breach by directors of their fiduciary duty to minority shareholders regarding an impending corporate transaction in the situation where the directors misstated or omitted certain material information and because of that deception, the minority shareholders lost the opportunity to have the transaction enjoined under state law.