Securities Act - Liability Section 11 Due diligence in “shelf” offering Shelf registration (Rule 415) Role of underwriter Reliance vs. due diligence (last updated 14 Feb 13)

Compare Securities Act liability to Rule 10b-5?

Federal or state Federal Court Rescission (up to offering $) Pl BOP (O/P or rescission) (5) Damages 1 yr + 3 yrs2 yrs + 5yrs Limitations Def BOP (“other than”) Pl BOP (prox cause) (4) Causation Def BOP (Pl “knew”) * Pl BOP (unless FOM) (3) Reliance Def BOP (“due diligence”) Pl BOP (facts / strong E) (2) Scienter Pl BOP (or omission) Pl BOP (or duty to speak) (1) Mat’l misrep List (I, Ds, Os, UWs, expert) Primary violator Defendant Purchaser (tracing) Purchaser or seller Plaintiff Part of RS “icw” purch/ sale security Transactional nexus §12(a)(2)§12(a)(1)§11Rule 10b-5

Due diligence (in shelf registration)

In re WorldCom Sec Litigation (SDNY 2004) Accounting fraud Shelf registration –Nature –Role of UW Due diligence defense –Audited financial –Unaudited financials Advice to UWs in “shelf” BALANCE SHEET ASSETS Cash Cap accounts SH EQUITY Retained earnings LIABILITIES How did WorldCom account for “line costs”?

In re WorldCom Sec Litigation (SDNY 2004) DATEEVENT 4/2000 2/2001 WorldCom files10-K (ratio?) UWs dowgrade WorldComm credit 3/2001UWs help restructure credit facility 4/2001UWs buy credit default swaps 4/2001Cravath (UW counsel) due diligence 4/2001Andersen (auditor) gives comfort letter 5/2001Note offering ($11.9 B) under R 415 6/2002Restatement ($3.8B) + bankruptcy

ExpertisedNon-expertised Expert After reas investigation, reasonably believes information is true (ignorance no defense) No liability [see §11(a)(4)] Non- expert No reasonable ground to believe was untrue (ignorance is excuse) After reas investigation, reasonably believes information is true (ignorance no defense) In re WorldCom Sec Litigation (SDNY 2004) Reliance (audited financials) Due diligence (comfort letter / unaudited financials)

Rule Circumstances Affecting the Determination of What Constitutes Reasonable Investigation and Reasonable Grounds for Belief Under Section 11 of the Securities Act In determining whether or not the conduct of a person constitutes a reasonable investigation or a reasonable ground for belief meeting the standard set forth in section 11(c), relevant circumstances include, with respect to a person other than the issuer.section 11(c) (a)The type of issuer; (b)The type of security; (c)The type of person; (d)The office held when the person is an officer; (e)The presence or absence of another relationship to the issuer when the person is a director or proposed director; (f)Reasonable reliance on officers, employees, and others whose duties should have given them knowledge of the particular facts ; (g)When the person is an underwriter, the type of underwriting arrangement, the role of the particular person as an underwriter and the availability of information with respect to the registrant; and (h)Whether, with respect to a fact or document, incorporated by reference, the particular person had any responsibility for the fact or document at the time of the filing from which it was incorporated. SEC (1981): Underwriters should arrange their due diligence procedures over time for the purpose of avoiding last minute delays [in shelf offerings] … Nothing compels underwriter to do deal without due diligence.

Underwriters may not rely on an accountant’s comfort letters for interim financial statements. … Comfort letters do not “expertise any portion of the RS” (1)Audited: prudent man in management of own $$ (2)Unaudited: look at context (WorldCom deteriorating) Judge Denise Cote (SDNY) In re WorldCom Sec Litigation (SDNY 2004)

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