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


General Ideas:

Justice Department is only entity that criminally prosecute
Large amount of private security litigation
33-34 Acts are what is known as hybrid civil criminal statute (HCCS)

Statute as to which the same provisions can be enforced criminally or civilly

Examples in other areas of law: Environmental law, anti trust, R.I.C.O.

Raise interesting questions as to what extent a proposition that emerges in a civil decision is immediately transferrable to the criminal and vice versa

34 Act has a couple of provisions that are solely criminal

34 Act is the main focus of this class

Christened as much by the SC
Courts will defer to the 2nd circuit
NY, V, Conn is in the 2nd circuit à where the stock exchanges, big NY law firms that represent corporate players
Judges have greater experience with securities litigation than a random other court in another location

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)

Emphasizes both the disclosure of info. and the prevention of fraud.
Primarily concerned with securities offerings by issuers and those who control them.

Applies to both IPOS and subsequent offerings

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.

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.

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.

Misrepresentation in solicitation filed w/ SEC
§11 doesn’t require scienter while 10(b)(5) does
§11 takes Virginia Bank Shares case and expands it through the guise

§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)

Main focus of this class
This is the act that led to the creation of the Securities and Exchange Commission (SEC)

Under the 1933 Act, the FTC was responsible for enforcing securities rules

This worried corporations b/c the FTC is consumer centric

Has been amended multiple times, these amendments become part of the original act (Dodd Frank, Jobs act, etc)

written in a way that make no mention of private actions
have implied right to private action as interpreted by the SC

Focuses on the secondary trading markets.
§10(b) and Rule 10b-5(Anti Fraud Statutes)

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.
Makes no mention of “private enforcement”
Beginning in 1946, courts began recognizing an implied private action

SC has continually upheld the implied private action

Interpretation Issues:

Broad language
Limited history
Multiple enforcement contexts
Shifting policies

§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

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.

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.

Rule is enforceable by SEC, DOJ, and by investors (implied private action)

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

Modeled after 10b-5
Contained in 14(e)

Enforceable by SEC, DOJ, and by private parties (implied)

The Private Securities Litigation Reform Act of 1995(PSLRA):

Imposes numerous restrictions on private securities actions

Generally thought of as anti private action
Created tone and atmosphere that gave the green light to the worse impluses of corporate executives

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.
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.

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.

Class actions specifically

Lead plaintiff requirement and lead counsel requirement

In Summary

Makes maintenance of private security actions much more difficult by stiffening the pleading requirements, providing safe harbor for fraud involving forward looking statements, establishing an affirmative requirement of loss causation, adjusting the calculation of damages, and creating a scheme of proportionate liability

Sarbanes-Oxley Act of 2002

Passed following Enron Scandal
Heightens corp. disclosure obligations
Places accounting industry under oversight of a Board appointed by and under supervision of SEC
Requires SEC to adopt professional responsibility rules for securities lawyers
Establishes several new securities crimes
Toughens the penalty for some already existing securities crimes
Extends the statute of limitations for private actions for securities fraud

Dodd Frank Wall Street

licly available that was not reflected in stock price.
Debates swirl about to what extent markets are efficient when investors trade based on psychological factors such as faddishness, overestimation or underestimation of risk.

Section 10(b) of the Exchange Act and Rule 10b-5

It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce or of the mails, or of any facility of any national securities exchange

(b) to use or employ, in connection with the purchase or sale of any security registered on a national securities exchange or any security not so registered, any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors.

Rule 10b-5: (adopted pursuant to §10b of the Exchange Act)

10(b)(5) has universal application

can be enforced in multiple contexts starting with SEC

SEC can bring civil action in court as well as admin actions
Justice Dept. can bring criminal actions
Private actions not expressed but implied

It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange,

(a) to employ any device, scheme, or artifice to defraud,

(b) to make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or

(c) to engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person

in connection with the purchase or sale of any security

Courts, not the SEC, have been primary interpreters of Rule 10b-5.
No mention of private enforcement of these actions but the Supreme Court has upheld an implied private action in Superintendant of Ins. V. Bankers Life & Cas. Co. and Janus Capital Group v. First Derivative Traders

Court observed that reason for implied private action was to supplement actions by the SEC and DOJ.

Broad language:

Few bright lines to go off of for the Court.

Limited History:

Not much was said in Congress during the enactment of the Exchange Act.

Multiple Enforcement Contexts

Enforceable in criminal actions as well as civil actions.
Interpretations in one context may have undesirable ramifications in the other.

Shifting policies:

Until the mid-1970’s Supreme Court gave §10(b) and Rule 10b-5 a relatively liberal reading in order to protect gullible investors from exploitation.
Thereafter, Court came to see some investors as puppets of lawyers who filed securities actions irrespective of their merit simply to reach settlement and collect a free.

Curtailing frivolous private actions thus became an important judicial policy.

Most recently, in Morrison v. National Australia Bank (2010), court interpreted 10(b) and 10b-5 very narrowly.