Deconstructing Section 11: Public Offering Liability in a Continuous Disclosure Environment

Abstract

DONALD C. LANGEVOORT [*] I INTRODUCTION Shortly after the Securities Act of 1933 [1] (1933 Act) became law, critics from the securities industry charged that the civil liability provisions created by Section 11 of the Act made it excessively draconian. Mandatory disclosure and prospectus delivery, even pre-clearance by a federal agency, were troublesome enough. However, strict liability to investors for issuers, and failure of liability for underwriters, accountants, officers, and directors for material misstatements in a registration statement, were quite another matter--making Section 11 the bete noire, in Louis Loss's words, of the legislative scheme. [2] Opponents ominously warned that the legislation would dry up American capital-raising. [3] Even though they were eventually proven wrong in that particular prediction, [4] the industry was right to see the threat of private civil liability as the engine that drives the 1933 Act. [5] Estimates in the finance literature suggest, for example, that a sizable portion of the unde rwriters' spread is a liability risk premium, [6] and lawyer-disseminated fear of liability casts a harsh shadow over the due diligence process. [7] In the late 1970s and early 1980s, concerns about the relationship between liability and capital-raising efficacy reappeared. Large, seasoned issuers were moving significant capital-raising transactions offshore, into the so-called Eurodollar market. Delays associated with the Securities and Exchange Commission (SEC) review and limits on publicity and marketing of domestic offerings were blamed. In response, the SEC introduced registration for large capitalization issuers via Form S-3 and modernized and expanded the availability of shelf registration, thereby permitting large issuers to move quickly to take advantage of market opportunities without excessive regulatory delays. [8] In the political process and in academic debates, however, the principal risk associated with speeding up the distribution process was readily identified. Disclosure quality is threatened by the de facto loss of opportunity for external due diligence by underwriters and others associated with the issuance from the ti me the decision to sell is made to the time securities are purchased by investors. [9] Underwriters thus found themselves in a world of de jure liability if there were misstatements or omissions; only a vague Commission rule, coupled with some informal suggestions for ex ante due as protection, seemed to suggest a more permissive standard of due diligence in such settings. [10] Today, few suggest that we should, or can, backtrack on liberalization of the 1933 Act. [11] Instead, regulatory efforts all point to the opposite: further expansion of the speed and limited disclosure responsibilities associated with large company capital-raising. [12] Yet, this simply focuses all the more attention on liability, and to this point, the Commission has suggested only minimal reform: clarifying the due diligence responsibilities associated with short-form offerings to take account of practicability concerns. Indeed, to the consternation of many, the Commission suggested expanding the kinds of issuer-generated information that would otherwise be subject to negligence-based civil liability under the 1933 Act. [13] This article is an effort to rethink civil liability in capital-raising transactions by large capitalization issuers. [14] After a brief digression about who should set liability standards, the article then addresses two related questions. The first deals with a natural question: Should not the primary regulatory effort for large issuers be to assure continuous disclosure in the secondary marketplace, given the far larger volume of such trading in that market compared to that in primary transactions? [15] Second, if we have developed a satisfactory regime of disclosure responsibilities for this setting, what more, if anything, in terms of liability protection, is needed when such issuers sell new stock into an existing market for their securities? …