In brief: liability for securities law violation in USA

Liability

Who may be primarily liable for securities law violations in your jurisdiction?

Only after the trier of fact finds that a plaintiff has satisfied each element and precondition for liability (primary violators), may the defendant be held liable under section 10(b) of the Securities Exchange Act of 1934 (the Exchange Act); the statute does not extend to individuals who only aid or abet violations (Stonebridge Investment Partners, LLC v Scientific-Atlanta, 552 US 148 (2008)). In 2019, however, the US Supreme Court called into question the dividing line between primary and secondary violators, holding that section 10(b) is sufficiently broad to include the dissemination of false or misleading information with the intent to defraud, even if the individual did not ‘make’ (have actual authority over) the statement (Lorenzo v SEC, 139 S Ct 1094 (2019)).

Plaintiffs may pursue section 11 claims under the Securities Act of 1933 (the Securities Act) against a wide range of participants in drafting a registration statement, including underwriters, experts, auditors, officers and directors of the issuer, and the issuer itself. By contrast, section 12(a)(2) of the Securities Act permits claims only against a ‘seller’ of securities who makes a misrepresentation orally or through a prospectus (a document that describes a public offering of securities).

Are the principles of secondary, vicarious or ‘controlling person’ liability recognised in your jurisdiction?

Section 20(a) of the Exchange Act and section 15 of the Securities Act provide for the liability of ‘control persons’ (ie, individuals who exercise actual power or control over primary violators of section 10(b) of the Exchange Act and sections 11 and 12(a)(2) of the Securities Act, respectively). Courts are split on what must be shown to establish ‘control’. Some courts require proof that the control person was a ‘culpable participant’ in the violation, but others have held that control over the primary violator is sufficient for liability, regardless of whether the control person acted culpably.  

A control person can avoid liability if, as to section 10(b), that person acted in good faith and did not induce the violation and, as to sections 11 and 12(a)(2), the person lacked a reasonable basis to know of the facts giving rise to the violation.

What are the special issues in your jurisdiction with respect to securities claims against directors?

Directors do not face liability under the securities laws simply by virtue of their status as directors of a company that commits a violation; rather, the elements of the specific claim must be satisfied as to each director. It is difficult to hold non-management directors liable under section 10(b) of the Exchange Act, because they rarely act publicly on behalf of the corporation. It also may be difficult to establish that a director had sufficient knowledge of the circumstances surrounding the misstatement to have acted with recklessness or fraudulent intent. By contrast, directors can be liable under section 11 of the Securities Act for a misstatement in a registration statement, but may defeat such a claim by proving that they exercised due diligence. Directors rarely face liability under section 12(a)(2) of the Securities Act, which only reaches actual ‘sellers’ of securities offered pursuant to a false or misleading prospectus or oral communication. 

Directors likewise do not automatically face ‘control person’ liability for violations committed by a company. Several US courts of appeals require ‘culpable participation’ in the misconduct for plaintiffs to successfully assert control person liability. This standard is difficult to prove for directors, as plaintiffs must prove a culpable state of mind in addition to actual power or control over the primary violator.

Any defence costs or costs of settlement incurred by a director likely will be reimbursed by a company-provided insurance policy that covers directors and officers or through a right of indemnification from the company.

What are the special issues in your jurisdiction with respect to securities claims against underwriters?

Underwriters can be liable under section 10(b) of the Exchange Act if they meet all elements of the claim (eg, by knowingly making a material misstatement or omission in connection with the sale of a security). 

An underwriter may face liability under section 11 of the Securities Act for false or misleading statements contained in a registration statement, but can avoid liability by showing that it acted with due diligence.

Underwriters may also fit the definition of ‘sellers’ under section 12(a)(2) of the Securities Act. In a firm commitment underwriting, underwriters purchase shares from issuers to sell to investors in an offering. In this form of underwriting, underwriters can be liable as sellers under section 12(a)(2). An underwriter, however, may avoid liability by showing that it was unaware the statement was false and could not have reasonably uncovered the falsity of the statement.

What are the special issues in your jurisdiction with respect to securities claims against auditors?

An auditor can be liable under section 10(b) of the Exchange Act, but generally only for its own statements and not those of the issuer. There is no liability under section 10(b) for those who merely aid and abet the making of a misstatement (Stonebridge Investment Partners, LLC v Scientific-Atlanta, 552 US 148 (2008)). Additionally, because of the scienter requirement of section 10(b), an auditor must have acted with extreme recklessness or actual knowledge of fraud, which generally requires proof that the auditor knew of, and ignored, red flags indicating fraud. Evidence that an auditor merely breached applicable accounting principles or performed an audit poorly does not suffice. 

Auditors whose statements appear in a registration statement can be liable under section 11 of the Securities Act, which does not have the scienter requirement of section 10(b). An auditor can avoid section 11 liability by showing it acted with due diligence (eg, by showing that it complied with applicable accounting principles).