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Claims

Causes of action

Which causes of action can be asserted by claimants in relation to the offer and trade of securities and which are most commonly asserted?

Claims arising under Section 10(b) of the Securities Exchange Act 1934 are the most commonly asserted causes of action under the federal securities laws (see Paul, Hastings, Janofsky & Walker, LLP, Securities Law Claims: A Practical Guide, 2004, p 75). Although Section 10(b) does not specify a private cause of action, courts have held an implied private right of action under Securities and Exchange Commission (SEC) Rule 10b-5 (id). Section 10(b) and Rule 10b-5 impose civil liability on persons who intentionally make false and misleading statements that affect aftermarket trading in securities. Section 20 of the Securities Exchange Act imposes secondary liability on persons who control persons or entities held primarily liable under Section 10(b).

Claimants also regularly assert federal claims under the Securities Act 1933 – most commonly under Sections 11 and 12 of the act. While Section 11 imposes liability on issuers for material misrepresentations or omissions in a registration statement, Section 12 imposes liability on statutory sellers for:

  • selling an unregistered security (when the security must be registered); and
  • selling securities by means of materially false or misleading prospectuses or oral communications. 

Section 15 of the Securities Act imposes secondary liability on persons who control persons or entities held primarily liable under Sections 11 and 12.

Each state also has its own securities laws, which are commonly referred to as ‘blue sky laws’. Typically, these statutes also contain anti-fraud provisions that provide a private right of action for misrepresenting or omitting material facts in connection with the purchase or sale of securities.

Directors' and officers' liability

In what circumstances and to what extent can directors and officers be held liable for misrepresentations, omissions or other fraudulent conduct in relation to the offer and trade of securities?

In theory, a variety of state and federal laws could implicate the legal interests of officers and directors. However, in federal court, one useful starting point in assessing potential liability under the securities laws is Section 10(b) of the Securities Exchange Act. Under this provision, which imposes civil liability on persons who intentionally make false and misleading statements that affect aftermarket trading in securities, primary liability can be imposed only on the maker of the allegedly misleading statement (ie, the person or entity with ultimate authority over the statement, including its content and whether and how to communicate it) (see Janus Capital Group, Inc v First Derivative Traders, 564 US 135 (2011)).

Secondary liability is possible under Section 20 of the Securities Exchange Act if the director or officer controls the entity (15 USC Section 78t(a)) (see also 17 CFR Section 230.405, which defines ‘control’).

Directors and officers can also be held liable under the Securities Act. For example, Section 11 of the act imposes strict liability for registration statements that contain an untrue or misleading statement of material fact on:

  • every person who signed the registration statement;
  • directors or partners at the time of the filing of the registration statement;
  • every person who is named in the registration statement as being or about to become a director;
  • every expert who is named by consent as having certified or prepared any part of the registration statement; and
  • every underwriter (15 USC Section 77k(a)). 

Generally, each defendant is held jointly and severally liable, except that the liability of underwriters (other than the managing underwriter) is limited to the amount of their participation in the offering (15 USC Section 77k(e)) and an outside director’s liability for violations not committed knowingly is proportionate to the damages that the director caused (15 USC Section 77k(f)(2)(A)).

Can liability be limited in any way?

There are a variety of avenues for defending against claims under the securities laws. A useful starting point is to identify case law that may be used to refute one or more of the required elements of the cause of action at issue. In mounting a defence, one should also consider any statutory or other affirmative defences that may apply.

Secondary liability

In what circumstances and to what extent can secondary actors (eg, attorneys, auditors and underwriters) be held liable for misrepresentations, omissions or other fraudulent conduct in relation to the offer and trade of securities?

A number of state and federal laws could implicate secondary actors for misrepresentations, omissions or other fraudulent conduct with regard to the offer and trade of securities. However, in federal court, one useful starting point in assessing potential liability is Section 11 of the Securities Act. For cases brought under Section 11, liability may extend in certain circumstances to secondary actors, including the underwriters of the offering and any expert who consents to his or her opinion being used in the registration statement, such as an accounting firm that audited the company’s financial statements (15 USC Section 77k(a)).  

Generally, each defendant is held jointly and severally liable, except that the liability of underwriters (other than the managing underwriter) is limited to the amount of their participation in the offering (15 USC Section 77k(e)) and an outside director’s liability for violations not committed knowingly is proportionate to the damages that he or she caused (15 USC Section 77k(f)(2)(A)).

For cases brought under Section 10(b) of the Securities Exchange Act, liability is limited to the maker of the statement or the person or entity that had ultimate authority over the alleged misstatement (see Janus Capital Group, Inc v First Derivative Traders, 564 US 135 (2011)).  

Some courts have found Janus to prohibit liability of secondary actors, such as attorneys and auditors (see Derby City Capital, LLC v Trinity HR Services, 949 F Supp 2d 712 (WD Ky 2013) (holding attorney who prepared but did not file Securities and Exchange Commission (SEC) filings not liable under Janus); in re DVI Inc Sec Litigation, No 03-5336, 2013 WL 56073 (ED Pa Jan 4 2013) (same)).

Fraudulent actions by customers and suppliers are not actionable under Section 10(b) and the SEC Rule 10b-5 (see Stoneridge Investment Partners v Scientific-Atlanta, 552 US 148 (2008)).  Secondary liability is possible under Section 20(a) of the Securities Exchange Act if the secondary actor is found to control the entity (15 USC Section 78t(a); see also 17 CFR Section 230.405 (defining ‘control’)).

Can liability be limited in any way?

There are a variety of avenues for defending against claims under the securities laws. A useful starting point is to identify case law that may be used to refute one or more of the required elements of the cause of action at issue. In mounting a defence, one should also consider any statutory or other affirmative defences that may apply.

Eligible claimants

Who may file securities claims? Are there any restrictions on foreign claimants? Who are the most common claimants (eg, pension funds, institutional investors)?

Generally, in both state and federal courts, private litigants must be able to plead and prove that they have legal standing to sue. In other words, they must show that:

  • they have an ‘injury in fact’ – that is, an invasion of a legally protected interest which is:
    • concrete and particularised; and
    • actual or imminent, not conjectural or hypothetical;
  • there is a causal connection between the injury and the conduct complained of; and
  • it is likely (as opposed to speculative) that the injury will be redressed by a favourable decision (see Lujan v Defenders of Wildlife, 504 US 555, 560-61 (1992)).  

In the federal court system, securities claims are a creature of statute. Therefore, claimants must meet the specific requirements of the law under which they wish to bring suit. For example, with regard to claims brought under the antifraud provisions of the Securities Exchange Act, such as Section 10(b), claimants must be the purchaser or seller of securities in the transaction complained of (seeBlue Chip Stamps v Manor Drug Stores, 421 US 723 (1975)).

For cases brought in federal courts, there are no restrictions on foreign claimants asserting claims based on securities purchased on a US-based exchange; however, foreign claimants are prohibited from bringing claims based on securities not purchased in domestic transactions (see Morrison v National Australia Bank, 561 US 247 (2010)).

For putative class actions brought in federal court under the Securities Act and the Securities Exchange Act, the most common claimants are pension funds and other institutional investors.  This is largely due to certain procedural requirements that were enacted as part of the Private Securities Litigation Reform Act 1995. These rules govern the selection of lead plaintiffs in certain class actions.

Pleading and evidentiary standards

What pleading and evidentiary standards apply to securities claims, including with regard to:

(a) Proof of reliance on the relevant misrepresentation, omission or other fraudulent conduct?

For claims brought under Section 10(b) of the Securities Exchange Act and SEC Rule 10b-5, plaintiffs must prove actual reliance on the defendant’s misstatement. For claims involving omissions, proof of reliance is unnecessary if the omitted facts were material (seeAffiliated Ute Citizens of Utah v United States, 406 US 128 (1972)). 

For claims involving false or misleading representations on a public trading market, courts will find a rebuttable presumption of reliance based on a ‘fraud on the market’ theory. This theory assumes that if the alleged truth had been disclosed, investors would not have traded the securities at issue at the same price (see Basic Inc v Levinson, 485 US 224 (1988)). A defendant can rebut the presumption by showing that:

  • the purported misrepresentation did not affect the stock price; or
  • the plaintiff knew the alleged truth (id at 248 to 249).

For claims brought under Section 11 of the Securities Act, the plaintiff is not required to show proof of reliance in most circumstances. However, the plaintiff must show proof of reliance if the stock was acquired after the issuance of a 12-month earnings statement (15 USC Section 77k(a)).

(b) Proof of loss causation?

For claims brought under Section 10(b) of the Securities Exchange Act and SEC Rule 10b-5, plaintiffs must prove that the challenged act or omission caused their loss (15 USC Section 78u-4(b)(4)). The courts apply a two-pronged causation analysis:

  • First, plaintiffs must prove transaction causation – that “but for” the fraudulent misrepresentation, the investor would not have purchased or sold the security (see Basic Inc v Levinson, 485 US 224 (1988)).
  • Second, plaintiffs must show loss causation – that “the act or omission of the defendant alleged to violate [the Securities Exchange Act] caused the loss for which the plaintiff seeks to recover damages” (15 USC Section 78u-4(b)(4)). 

The loss causation prong takes into consideration the presence of any intervening or superseding causes, as well as the lapse of time between the behaviour complained of and the loss (see Dura Pharmaceuticals, Inc v Broudo, 544 US 336, 342-43 (2005)).

For claims brought under Section 11 of the Securities Act, plaintiffs are not required to plead loss causation. However, the defendant may raise the lack of causation (or ‘negative causation’) as an affirmative defence. Under the negative causation defence, the defendant can avoid or reduce liability by demonstrating that the depreciation in value was due to factors other than the alleged misstatements or omissions (see Hildes v Arthur Andersen LLP, 734 F3d 854 (9th Cir 2013)).

(c) Materiality requirements?

Plaintiffs must prove materiality in federal securities actions. The courts apply a reasonable investor standard, which requires the plaintiff to prove a “substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the ‘total mix’ of information made available” (see TSC Indus, Inc v Northway, Inc, 426 US 438, 449 (1976) (setting forth materiality standard under Section 14(a) of the Securities Exchange Act); Basic Inc v Levinson, 485 US 224 (1988) (expressly adopting the TSC Industries materiality standard for Section 10(b) and Rule 10b-5 claims); Matrixx Initiatives, Inc v Siracusano, 563 US 27 (2011) (reaffirming that materiality must be evaluated in light of the ‘total mix’ of information); and Litwin v Blackstone Group, 634 F3d 706, 716-17 (2d Cir 2011) (applying the same standard to claims brought under Sections 11, 12(a)(2) and 15 of the Securities Act)).

A material fact “need not be outcome-determinative”; rather, the “information need only be important enough that it ‘would have assumed actual significance in the deliberations of the reasonable shareholder’” (see Folger Adam Company v PMI Industries, 938 F2d 1529, 1533 (2d Cir 1991)). Materiality is judged as of the time that the investor makes the investment decision (id at 1532 n2).

(d) Scienter requirements?

For claims brought under Section 10(b) of the Securities Exchange Act, plaintiffs must plead particular facts giving rise to a strong inference that each defendant acted with scienter (ie, a culpable state of mind) as to each act or omission alleged. A plaintiff must prove that each defendant made a deliberate or reckless misstatement with the “intent to deceive, manipulate, or defraud” the buyers or sellers of securities (see Ernst & Ernst v Hochfelder, 425 US 185 (1976)).

For claims brought under Section 11 of the Securities Act, plaintiffs need not prove scienter.  However, defendants other than the issuer can establish one or more of the affirmative defences codified at 15 USC Section 77k(b)(3), including what is commonly referred to as the ‘due diligence’ defence. Generally, under this defence, defendants (other than the issuer) can preclude liability by proving that they had reasonable grounds for believing, and did in fact believe, that there was no misrepresentation or omission of material fact in the registration statement at issue (15 USC Section 77k(b)(3)).

(e) Any other requirements, standards or considerations?

The following requirements, standards or considerations are worth bearing in mind for some common federal securities law claims:

  • All claims brought under the Securities Act and the Securities Exchange Act are subject to statutes of limitations and statutes of repose (see 15 USC Section 77m and 28 USC Section 1658(b)).
  • Plaintiffs and defendants should assess the applicable personal and subject matter jurisdiction requirements (see 15 USC Sections 78aa(a) and 77v(a)).

In federal court, claims may also be subject to heightened pleading requirements. For example, federal securities fraud claims brought under Section 10(b) of the Securities Exchange Act must comply with the more stringent pleading demands of the Private Securities Litigation Reform Act.

Disclosure

What pre-trial disclosure/discovery mechanisms are available to support claims, if any?

Generally, both state and federal courts have liberal pre-trial discovery requirements. Although these rules may vary depending on the jurisdiction in which the action is pending, typically litigants can use a variety of discovery devices to obtain relevant information from both parties and non-parties to the litigation. These discovery mechanisms include:

  • document requests;
  • oral depositions;
  • interrogatories; and
  • requests for admissions.

Some jurisdictions (eg, all federal district courts) may also have automatic disclosure requirements.

What rules and standards govern non-disclosure of documents on the grounds of professional privilege or other confidentiality considerations?

Generally, the Federal Rules of Evidence and law of the jurisdiction in which an action takes place govern the appropriate circumstances for withholding documents on privilege grounds. Confidentiality considerations are largely determined by court order or the judge’s individual rules and may vary based on, among other things:

  • the scope of the case;
  • the underlying materials; and
  • the motions and stipulations of the parties.

Interim relief

What interim measures are available to claimants in securities cases?

Interim measures such as injunctions are governed by the procedural rules of the federal district or state in which the action takes place and may require showing elements, such as a high likelihood of success on the merits by the party seeking the injunction and irreparable harm in the absence of court intervention, which securities actions seeking money damages may lack.

In federal court, interim appeals are generally not permitted – generally, an order must be final to be appealed, although other decisions may be reviewed by the same judge under a motion for reconsideration. One notable form of interim relief which may be available in the class action context (although it is by no means specific to securities cases) is a permissive interlocutory appeal of certain class certification decisions under Federal Rule of Civil Procedure 23(f).

State court rules may differ.

Statute of limitations

What is the statute of limitations for filing claims?

Under 28 USC Section 1658(b), plaintiffs must bring claims under Section 10(b) of the Securities Exchange Act before the earlier of “2 years after the discovery of the facts constituting the violation” or “5 years after such violation”.

Under Section 13 of the Securities Act, actions under Sections 11 and 12(a)(2) of the act must be brought within one year of the date of actual discovery or when such discovery “should have been made by the exercise of reasonable due diligence”. There is also a statute of repose:

  • three years from the date on which the security was offered to the public for Section 11 claims; and
  • three years from the sales date of the security for Section 12(a)(2) claims (15 USC Section 77m).

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