Lecture 1

Basic questions

1. Social benefit of disclosure

2. Is legal regulation necessary/ are market forces sufficient
3. Does every investor need to be physically provided with the required information

Basic tools

1. Efficient market hypothesis

As a bit of information becomes available to anyone beyond a few insiders, it is immediately
fully reflected in the price of the securities.

As a result, average investor does not need to know the bit to participate in the market on a fair
basis. The information will not help her spot a winner, but the price is a fair one.

Price is related to future expected returns.

A price is fair if it is unbiased
An unbiased price is one equal to the mean expected return given all available knowledge.

2. Portfolio theory
3. The noise theory critique

Price accuracy

1. Price accuracy is the expected deviation between current price and actual value.
2. Price accuracy depends on the quantity and quality of information available about an issuer.

The importance of disclosure

1. The importance of disclosure depends on the importance of price accuracy.

2. How one views the importance of price accuracy depends on how one views the role of
securities markets in our economy.

3. Views of the role of securities markets.

The market as Las Vegas
The market as a place to store wealth
The market as the nerve center of the economy
More disclosure and price accuracy play a role in setting limits on managerial discretion.
They also play a role in the efficient allocation of societys scarce capital.
 A common assumption is that decisions that maximize share value are the ones that are in
societys best interests.

Managers will make decisions that are in their own best interests.
Whether decisions that are in managers own best interests are the ones that maximize share
value depends on the structure of incentives sticks & carrots.(Bankruptcy and Take over)

4. Limiting Managerial Discretion

Take over
Bankruptcy
The stock price based compensation (compensation package)

Portfolio
1. Investors
Like expected return
Dislike variability (gap)

2. Causes of variability

Systematic risk (generally) and unsystematic risk (Industry specific)

3. If an investors portfolio is sufficiently diversified, the historic variability due to unique factors
the unsystematic risk will be of no concern.

4. If a security is added that has a higher Beta than the portfolio as a whole, the portfolio becomes
more sensitive, hence more risky.

5. Investment portfolio. A fully diversified securities portfolio is unlikely to be the collection of

stocks that best counterbalances the risks associated with other investments.

Market Forces are more likely to lead to the Optimal Level of Disclosure than Government
Regulation
1. Management has an incentive to develop the reputation that it will provide the optimal level of
disclosure
2. With regulation, special interests are likely to capture the regulators and will pressure for more
disclosure than is optimal

The Market Failure

1. Disclosing negative information makes share price go down, not up. Admittedly, refraining from
disclosing negative information is a short-run strategy. Eventually the information will come out;
 the fact that the issuer refrained from disclosing it will hurt the issuers reputation and hence
further depress share price; sometimes, however, managers have a short-run time horizon.
2. Managers may prefer lower share prices to more disclosure
a) One of the primary reasons that managers want a high share price is to protect themselves from
hostile takeover.
b) Managers also can protect themselves from hostile takeover by disclosing less, thereby making
hostile bids more risky and hence less attractive.
c) Less disclosure may protect managers more than the higher price that results from more
disclosure.
d) Management buyouts (management purchasing the business they run) create incentives not to
release positive information
e) The inequality of private and social costs

3. Competitive Considerations
4. Regulation improves ease of communication with the market
Help develop a comparable information and a common language.
Certify the accuracy of information (accuracy requirement from regulators)
5. Disclosure as a subsidy to securities analysts

Implications of the Noise Theory Critique of the EMH: Two Starting Points

A. EMH (efficient market hypothesis), even if totally valid, has never by itself been a sound justification
for eliminating mandatory disclosure, only for eliminating information dissemination to individual
investors.

B. The good things that result from having more accurate share prices more efficient capital allocation
and better alignment of managerial and shareholder interests has nothing to do with the validity or
invalidity of noise theory.

In a noisy world, additional disclosure has a double barreled effect not only does it make the dividend
forecast more accurate, it also, by helping smart money combat noise, brings price closer to what that
forecast would call for.

Noise theory suggests that the market forces are more impaired than may previously have been
thought.

Lecture2
Part 1. Financing the Corporation
Part 2. Definition of security and materiality
SEC v. W.J. Howey Co., 328 US 293 (1946) defined investment contract as any transaction in which a
person invests money in a common enterprise and is led to expect profits solely for the efforts of others

Howey test requires a contract, transaction or scheme and four other elements:

1. A person invests his money

2. In a common enterprisepooling of assets of from multiple investors in which all share profits &
risks

3. Is led to expect profits

4. Solely from the efforts of the promoter or 3rd party

There are some odd expectations, however, which are considered securities, such as timeshare
interests, pyramid scheme, and some types of franchise arrangements

Is Real Estate as a Security? Hocking v. Dubois, 885 F.2d1449 (9th Cir.)rental condo with collateral
management agreement could constitute investment contract (hard case, but 9th Cir confirmed
arrangement)

Are Business Interests Securities? Test developed in Williamson v. Tucker, 645 F.2d 404(5th Cir. 1981)\

-1. No legal control (agreement leaves little room)

-2. No capacity to control (partner inexperienced)

-3. No practical control (partner dependent on managerial ability of promoter etc)

When are Pension Plans considered Securities? International Brotherhood of Teamsters v. Daniel, 429

US 551 (1979) (applied Howey test to find that employer-funded pension plan in which employees make
no direct contribution and their participation is compulsory is not a security)

Plan benefits were fixed and depended not on returns as eligibility under the plan

Plans regulated by ERISA making securities regulation less crucial

But, defined contribution plans are securities (because employees choose to invest or participate)

Can Notes be Securities? Securities Act 2(1) includes any note.

But extensions of credit do not have characteristics of an investment

Thus, notes given in consumer/financial transactions are not treated as securities because the context
otherwise requires

When is a note considered a security? Commercial paper (arises out of a current transaction and that
matures w/in 9 months is exempt under Exchange Act 3(a) (10))

Supreme Court adopted test to determine when notes are securities

 Reves Testbegins with rebuttable presumption that every note is a security unless it falls into a
category of instruments that are not securities

Notes used in consumer lending, secured by a mortgage on a home and short-term notes secured by
an assignment of accounts receivable are non-securities.

Reves test sets out four factors to determine if note is security

Motivation of the lender (which is to make a profit from the loan) and the borrower (issuer of note)
[Howey: investment in money]

Compare with Howey Test (did not ask whether the issuer was selling securities to make a profit for
itself; it only asked whether the investor expected a profit)

Plan of distributionwhether an instrument will generate common trading (must be offered and sold to
broad segment of public for it to be security) [Similar to Howey test (horizontal common enterprise)]

Reasonable expectations of investing publicif investors generally view the type of notes to be
investments, its more likely to be security [Howey asks just whether particular investors expect to
make profit]

Other Factors reduce riskif note is not collateralized and not subject to securities regulation, it is more
likely a security. In contrast, if it is secured or regulated, it is more likely not a security.

Normally sale-leaseback is not a security, but SEC v. Edwards 540 US 389 (2004), the Court found that it
can constitute a security under the flexible Howey test

CD (bank instrument) issued by national bank is not a security (Marine Bank v. Weaver, 455 US 551
(1982)) (CDs are federally insured and subject to banking regulation for protection of deposits and
profit-sharing aspect of agreement was not security since it was privately negotiated agreement gave
Weavers significant control)

Synthetic Investments Current US system defines cash-settled synthetic options as securities

Even though they involve no right to acquire underlying security (Caiola v. Citibank, N.A. 295 F.3d312
(2d Cir 2002) (Exchange Act defines security to include options on index of securities which are only
cash-settled)

NB: interest rate swaps are not securities (Proctor & Gamble Co v. Bankers Trust Co., 925 F. Supp.
1270(S.D. Ohio 1996) (option includes right to purchase security)

Legislation has helped, cf. Commodity Futures Modernization Act 2000 (excluded swap agreements)

ABS (mortgage-backed security) SPV(Special Purpose Vehicle)

Pro rata
Part 3. Materiality
Definition: a fact is material if there is substantial likelihood a reasonable investor (with basic level of
financial sophistication) would consider it important in making a securities-related decision (TSC
Industries v. Northway, Inc., 426 US 438 (1976)

Affirmative statements: antifraud liability and in case of disclosures in SEC filings, Rule 408 and Rule
12b-20 require the affirmative statement is materially accurate and complete. A material misstatement
is actionable under 10b-5

Omissionthere is no general duty to disclose. Even if omission is material, the omission is by itself
not actionable under antifraud liability or any other violation of the securities laws

Types of information:
1. Historical information

If disclosure of past information coincides with abnormal changes in share price, courts will find
that information disclosed was material

2. Off-balance sheet Disclosure (MDA Management's discussion and analysis)

3. Speculative Information.
Information gives insight about a future event, courts employ substantial likelihood test
Materiality will depend on balancing both the indicated probability that the event will occur and
the anticipated magnitude of the event in the light of the totality of the company activity.
4. Soft Information (opinions) SEC limits disclosure of soft information to verifiable historical
information (safe harbor rules permit forward looking information in filings unless it has been
shown to be made without reasonable basis
5. Information about Management Integrity

Total Mix of Information

Disclosure requires a substantial likelihood that the disclosure of the omitted fact would have been
viewed by the reasonable investor as having altered the total mix of information available

Omitted information that is already known by the market is not actionable, even if material
(Longman v. Food Lion, Inc. 197 F.3d 675 (4th Cir 1999)

Safe harbors

1. Bespeaks caution doctrinemay serve to limit or negate the materiality of or reliance on an

optimistic prediction. Misleading statements can be discredited by an accompanying true statement
such that the probability of risk is zero [Virginia Bankshares v. Sandberg, 501 US 1083 (1991)]

2. PLSRA Safe Harborlegislation designed to ensure that issuers disclosed forward-looking

information, whether voluntary or not, provides immunity for company and its executives from civil
liability for forward looking statements that comply with the Acts safe harbor provisions

3. Applies to: projections of revenues, plans and objectives for future operation; statements of
future economic performance, including MD&A statements and assumptions underlying these
statements

PLSRA Safe Harbor

1. No actual knowledgeapplies to oral and written forward looking statements and immunizes
reckless and negligent statements from private liability

2. Immaterialitysafe harbor focuses on whether statement is too soft to be material and paves
the way for judicial bespeaks caution doctrine as separate basis for immunity

3. Cautionary statementsmay have suit dismissed without an inquiry into knowledge or

materiality, avoiding discovery if accompanied by meaningful cautionary statements identifying
important factors that could cause actual results to differ materially from those projected by
forward looking statement. Must show more than going through the motionscaution must convey
information.

More about materiality

In Omicare Inc. v. Laborers District Council Construction Pension Fund, Supreme Court expanded the
reasonable investors role in securities litigation, holding that whether an omission of a material fact
renders a statement misleading must be judged from the reasonable investors perspective.
Disclosure as commitment device
1. Information disclosure systems provide:
(1) A way to specify the content of a commitment.
(2) A credible and accurate enforcement mechanism that plays an important role in
facilitating commitment by issuers.
2. Additional issuer disclosure produces benefits by improving:
Investor choices

Filings requirement of Public Company

Company may de-list from the exchange (the issuer must certify that number of security hollers is
less than 300 or the number of security holders is less than 500 and the issuers total assets are less
than 100M for three years )

Twi types of filings:

Filings to keep registration current and filings of annual, quarterly or special information that
provide ongoing information.
Stock option problem

Stock options provide incentives for illegal behavior

Backdating (to make something retrospectively effective)

Post-Enron, Forms 10-k & 10Q are required to be certified by the CEO and CFO

Actions brought against false or misleading filings?

Moving parties must show purchased securities (or sold) in reliance on defective filing, the price at
which they transacted was affected by the defected filing, and which was the proximate cause of their
damage.

Defendants can defend against claims by showing they acted in good faith and no knowledge that filing
was defective.
Duty to update: a firms silence between its required and episodic reports may be actionable (Why
Omission is no actionable?)

To ensure accurate disclosure

EA 13(b) (2) requires company to make and keep records and accounts, in reasonable details, accurately
and fairly reflect the transactions and dispositions of issuer.

No materiality issue (simple inaccuracy can trigger liability)

No knowledge or negligence requirement

Only SEC can enforce the requirements of 13b2

Sarbox: The sections of the bill cover responsibilities of a public corporations board of directors, adds
criminal penalties for certain misconduct, and required the Securities and Exchange Commission to
create regulations to define how public corporations are to comply with the law.
Gatekeepers: 10-k must be audited by independent auditor.

Whistleblowers

In breach of lawyers ethic?

SECs disciplinary powers:

Authority extends to industry participants including: broker-dealers, lawyers and accountants.

ALJ (ADMINISTRATIVE LAW JUDGE)

Elements of 10b-5 Claim

Plaintiff must be purchaser/seller of securities

! Materially misleading statement/ omission
! Scienter
! Reliance (transaction causation): FOTM (fraud on the market)
! Causation (loss causation)
! Damages

Types of 10-b 5 cases

! Customer-broker claims securities brokers engage in deceptive or unprofessional conduct in

connection with trading by or for their customers.

! Corporate trading manager induces firm to engage in securities transaction that is disadvantageous

! Corporate disclosuresfirm issues false or misleading information to public regarding its securities or
remains silent when has a duty

! Insider trading corporate insiders use corporate information to enter into securities transactions or
tip 3 parties who trade on tip.

! Outsider trading outsiders use confidential information about firm, entrusted to them, to trade firms
securities.

! Securities tradingtransaction involving party giving false or misleading information to other party to
induce party or remains silent where party has duty to disclose

Who can sue under 10b-5

(Birnbaum v. Newport Steel Corp, 193 F.2d 461 (2d Cir 1952).

Standingonly purchasers or sellers are able to recover damages in private action under 10b-5

Blue Chip Stamps v. Maynard Drug StoresS.C. Finds language of Sec 10b and Exchange Act covers only
actual sales and purchases policyattempt to stem speculative actions from non-purchasers.

SEC v. Zandford, 535 U.S. 813 (2002) (respondents fraud coincided with sales themselves)
Fraud in Connection with Securities Transactions
10(b) and 10b-5 action prohibit deception in connection with the sale or purchase of securities

Privity not required in such actionsactionable even if firm is not trading so long as it is foreseeable that
misstatements are likely to affect securities transactions; also cases where company does not believe its
statements will trigger reliance

Misstatement of Material Fact: Forward Looking Safe Harbor

21E (b) Exclusions Among others, IPOs, Tender Offers, Financial Statements(GAAP), offering of
securities for a blank check company, going private transaction

Two possible paths for written & oral soft information.

(A) identify as forward looking statement and give meaningful cautionary statements identifying
important factors that could cause actual results to differ materially or the forward looking statement is
simply immaterial; or

(B) Plaintiff fails to prove that person making disclosure had actual knowledge.

Reliance: Basic v. Levinson

ECMH (efficient capital market hypothesis)

Fraud-on-the-market cause of action developed by the lower courts suit blessed by the Supreme Court
in Basic v. Levinson in 1988

Reliance: Halliburton

Traditional causation: but for. At a minimum plaintiff must have been aware of the misstatement.

New: ECMH

Per se (by itself)

Loss causation: Dura

Rules should be designed in a way that minimizes the conflict, and then chooses the appropriate point of
tradeoff, between two important social goals:

Enhancing share price accuracy, in particular by deterring corporate misstatements" Controlling the
transaction costs associated with civil litigation, including, but not limited to, those associated with
strike suits
Ex Ante Thinking (5 dollars loss) Concern is with the laws effects on the structure of incentives of the
various actors involved at the time the plaintiff enters into the transaction

Two elements to be established:

Where there is a market adjusted price drop immediately after the unambiguous public announcement
of the truth (or increase immediately after the misstatement), and Sale is after the public
announcement of the truth.

Blanket rule that loss causation can never be established is too harsh.

An immediate significant increase in share price following a misstatement is as good evidence that the
misstatement inflated price as a significant price drop following a public announcement of the falsity of
the misstatement. (Other evidences are also possible)

10b-5 defendants
Stoneridge Investment Partners v. Scientific- Atlanta: Supreme Court held that a Rule 10b-5 plaintiff
cannot sue vendors who allegedly facilitated the issuer's deceptive accounting treatment of certain
transactions.

In Stoneridge, it was alleged that defendants had directly participated in the issuer's fraud by
committing deceptive actsthe transactions themselveswhose very existence communicated
information on which the marketplace relied. The Court stated that without communication to the
public, these contracts by themselves could not support any reliance factor.

(PSLRA) gives the SEC sole authority to bring actions against aiders and abettors (An aider and abettor is
a party to a crime and may be criminally liable as a principal, an Accessory before the fact, or an
accessory after the fact.).
Insider trading
Strong v. Repine, 213 US 419((1909)

Core Insiders:

Texas Gulf Sulphur: sets forth disclose or abstain approach, i.e., insiders must choose between either
disclosing their informational advantage or abstaining from trading

A short swing rule restricts officers and insiders of a company from making short-term profits
at the expense of the firm. It is part of United States federal securities law, and is a prophylactic
measure intended to guard against so-called insider trading.

Rule 10b-5: antifraud provision prohibiting insider trading, prohibiting manipulation, fraud, and
deception

Does not distinguish between corporate and non-corporate insiders

Trading on material nonpublic information is not per se illegal

Must be linked illegal activity like a breach of fiduciary duty or misappropriation of information.

Chiarella v. US, 445 US 222 (1980) Duty to disclose or abstain.

Rule 14e-3 makes it illegal to trade in the securities of a company that is going to be a target of a tender
offer based on information obtained from: the bidder; the target; anyone connected to the bid (No
requirement of fiduciary breach of duty)

Mere possession of material, non-public information about a pending tender offer gives rise to a duty to
disclose.

Tipper/Tipped Dirks, US VS Newman

Only investors who owe fiduciary duties to shareholders.
Tipee is aware or should be aware that there has been a breach and have knowledge of the personal
benefit received by the tipper.
Misappropriation Theory
Applies when information that is subject to a fiduciary duty of confidentiality is used for trading in
securities without disclosing the owner of the information that the information is being used for trading.

Carpenter v. US

US v. OHagan Facts: OHagan was a litigation partner at Dorsey and Whitney. Grand Met had retained
the firm in a takeover attempt of Pillsbury. OHaganwho was not directly involved in the
acquisitionlearned of the takeover attempt and purchased both Pillsbury call options and stock. He
convicted by a jury of violating Rule 10bG5 and Rule 14eG3. The 8th Circuit reversed.

Section 16

Requires: Reporting of trades to the SEC by designated insiders;

Persons who are beneficial owners of 10% or more of any class of securities

Section 16b is the short swing rule

Requires disgorgement of profits made from (Purchase and subsequent sale within six months; a sale
and a subsequent purchase within six months)

Why do firms go public?

Raise capital.

Easier to be spotted by investors

Diversified investors are willing to pay a higher price.

Open new sources of financing

Provide an exit for investors

Further equity issues

Monitoring by stock market

Improved access to debt markets

But,

Direct costs (underwriter + lawyers, etc) = 11% of money raised

Underpricing
Information and disclosure requirements

Limits on managerial decisions;

Reduction in control and secrecy

The term underwriter means any person who has purchased from an issuer with a view to, or offers or
sells for an issuer in connection with, the distribution of any security, or participates or has a direct or
indirect participation in any such undertaking, or has participation in the direct or indirect underwriting
of such undertaking; but such term shall not include a person whose interest is limited to a commission
from an underwriter or dealer not in excess of the usual and customary distributors or sellers
commission.

Firm commitment: the underwriter agrees to purchase the whole issue from the firm at a particular
price for resale to the public. The investment bank bears the cost of failure. Used in 65% of IPOs.

Best efforts: firms usually state the maximum number of shares necessary to be reached for the entire
issue not to be withdrawn. Investment bank acts only as a marketing agent and issuer bears cost of
failure. Used in35% of IPOs.

Auction

SEO (secondary/seasoned equity offering)

Private placement: an issuer privately negotiates the sale of stock to qualified investors. Resale of stock
is generally restricted to other qualified investors for one year.

Direct public offering: issuer sell the equity directly to investors, without the use of a bank as a financial
intermediary

Procedure for an IPO

Hire Underwriter: Negotiate terms & capital raising details

Hire other advisors, to aid with financial and registration details. Supply audit statements (detailed
level varies by country)

With Underwriter, complete & file SEC registration statement

Wait out Cooling Off Period (usually 20 days); apply to list on exchange

During Period, distribute Preliminary Prospectus or red herring to clients

 Go on Road Show to get indications of interest from potential investors

The SEC issues deficiency memorandum requesting any changes

The issuer completes the review process and details of the offering are decided in the price meeting:
offering price and size, underwriters compensation, overallotment options, firm commitment or best
efforts

The final prospectus is filed with the SEC and the registration is declared effective

Forms SB-1; SB-2 allow small firms simplified disclosure (firms with less that 75M in public float; less
than $50M in revenues in last fiscal year

Pre-filing: 5 (c) prohibits any offer to sell or offer to buy before a registration statement is filedno offer
may be made to dealers (preliminary negotiations permitted, however); but issuing company permitted
to solicit preliminary interest.

Companies are permitted to pre-register securities for later sale if conditions are satisfied (post-effective
amendment filing any changes in material information set forth in original registration statement)

Gun Jumping Rules

SaleSection 2(a)(3)

The term sale or sell shall include every contract of sale or disposition of a security or interest in a
security for value. The term offer to sell, offer for sale, or offer shall include every attempt to offer or
dispose of, or solicitation of an offer to buy, a security or interest in a security, for value .

Section 5 (b)

It shall be unlawful for any person

(1) To ... transmit any prospectus relating to any security with respect to which a registration statement
has been filed under this title, unless such prospectus meets the requirements of section 10; or

(2) To carry ... any such security for the purpose of sale or f, unless accompanied or preceded by a
prospectus that meets the requirements of subsection (a) of section 10.
Free Writing Prospectus (Rules164, 433)

After the float, underwriter will stabilize the price of shares

Must disclose (Reg M)

Buys shares in the after market

Doses so in the event of pressure for the share price to fall (below the issue price, for example) and to
sell more shares (either at IPO or after)

Support linked to an over-allotment option to the investment banking

Size of options (10% to 15% of issue size)

Reduce downward preussure on prices (can last 30 days)

 When price is determined, syndicate breaks up (usually within week of IPO)

After-market services syndicate members can provide1) making market in stocks liquidity,
2)continue to provide analyst coverage of the company and 3) raise additional finance in the future

Money left on the table

Global equity offerings are considerably smaller than global debt offerings

Emerging growth companies are given exemptions from section 5 (PROHIBITIONS RELATING TO INTERSTATE
COMMERCE AND THE MAILS).

Idea of FIA (fostering innovation act) to raise the bar for non-accelerated fillers from $75 million to
$250 million; Also idea of this law is that companies who have low revenues ($ 100 million) regardless
of public float would be considered as non-accelerated filers.

Types of investments:

Buy out

Venture

Grow capital: minority investments in mature companies.

 Under Sec 2(a)(11) SA underwriter is any person who:

Purchases from an issuer with a view to, or offers or sells for an issuer in connection
with, the distribution of any security;

Participates or has a direct or indirect participation in any such undertaking;

Participates or has a participation in the direct or indirect underwriting of any such

undertaking.

If an underwriter is present, Sec 4(1) no longer exempts the transaction from Sec 5.

Sec 2(a)(11) defines underwriter to include those working on behalf of a control person with
respect to distribution of a security

4(1) exemption from section 5. Sec 4(1) depends on lack of an underwriter

Gilligan, Will & Co. v. SEC

US v. Wolfson

Wolfson was the guiding spirit and single large shareholder of Contintental Enterprises. Wolfson
sold shares in CE through six brokerages houses. They did not register the sale of their shares
pursuant to sec 5. Issue: Can Wolfson take adantage of sect 4(1)s exemption from sec 5?

Held: sec 4(1) did not apply, court rejected Wolfsons defense that he was above details.

Reasoning: 4(1) exemptions transaction and not classes of persons (2) here there is an
underwriter involved; (3) the exemption under sec 4(4) for unsolicited brokers transactions did
not applysec 4(4) only protects brokers (who must be unaware of the sale of unregistered
security) and not issuers.

If investors can fend for themselves, there is no public offering and hence no distribution. Thus
any intermediary assisting the control person is not an underwriter. The control person may
take advantage of the sec 4(1) exemption.
Ackerberg v. Johnson

Held: Johnson is exempt under sec 4(1)

Rule 144
Resales of restricted securities to protect the selling investor from being treated as an
underwriter for the issuer

Resales of restricted and unrestricted securities to protect anyone assisting an affiliate from
treatment as an underwriter for the affiliate

Holding period

Sale is of restricted securities

The sale is of unrestricted securities by affiliates

Rule 144A exemption from Sec 5 for resales (enable foreign issuers in particular to sell securities in
unregistered offering that would enjoy a limited market for immediate resale. Also, it was designed to
assist institutional investors in reselling restricted securities purchased in private placements).

Section 11 Misstatement Liability

Tracing requirement (investors must be able to trace securities to defective registration statement)

ABBEY & COMPUTER MEMORY

Krim v. pcOrder.com

Defendants:

Those who signed registration statement

Directors (11 (a)(2)(3))

Various experts (sec 11(a)(4))

Underwriters (section 11(a)(5))

 Controlling persons of any of the above (Rule 405-9: controlling, controlled by and under common
control)

Elements of Cause of Action

Section 11: misstatement; materiality(loss causationdefense)

Rule 10b-5: higher burden required (scienter; reliance and loss causation)

Differencessome differences not important (10b-5 can be met by using fraud on market for
companies with an active secondary market, excludes most IPO issuers); plaintiffs do not have to show
loss causation in Sec 11; but must 10b-5; under PSLRA, scienter is required (made prior to discovery)

PSLRA only partially applies to Sec 11 claims

Defenses
While sec 11 eliminates many of elements required for cause of action under 10b-5, many of these
elements reappear as defenses

MisstatementsPs burden; D can show P knew of misstatement at time P acquired security;

MaterialityPs burden

Scienternone for issuer; other defendants may show DD

Reliancerelease an earning statement covering a year after effective date of registration statement
(shifting burden to P to show reliance)

Loss causationdemonstrate that the drop in share price from offering price is due to other causal
factors, reducing amout of damages (11(e))
kacchi biryani
Securities market price accuracy disclosure