ALI-ABA Course of Study Regulation D Offerings and Private Placements

Transcription

1 427 ALI-ABA Course of Study Regulation D Offerings and Private Placements Cosponsored by the Securities Law Committee of the Federal Bar Association March 12-14, 2009 Scottsdale, Arizona Private Placements: Civil Liabilities under the Federal Securities Laws By J. William Hicks Indiana University-Bloomington School of Law Bloomington, Indiana

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3 429 I. Primary Liability PRIVATE PLACEMENTS: CIVIL LIABILITIES UNDER THE FEDERAL SECURITIES LAWS By J. William Hicks Sellers of securities in unregistered offerings can encounter primary civil liability for two types of unlawful activity: violations of the registration and prospectus delivery requirements under Section 5 of the Securities Act of 1933 (1933 Act) and violations of the anti-fraud provisions of the 1933 Act and the Securities Exchange Act of 1934 (1934 Act). A seller of an unregistered security violates Section 5 of the 1933 Act where he or she is unable to prove that the security or the transaction, of which the unregistered offer or sale was a part, was exempt. The SEC may seek administrative or judicial relief, including, where appropriate, civil penalties, against any person who violates Section 5. See, e.g., S.E.C. v.berry, 2008 WL , at **1-5 (N.D. Cal. 2008); S.E.C. v. Fisher, 2008 WL , at **3-6 (E.D. Mich. 2008). Section 12(a)(1) of the 1933 Act provides the express right of action for certain purchasers of unregistered securities to recover damages from the seller who violates Section 5. Sellers of unregistered securities risk primary liable to purchasers for material misrepresentations or omissions of fact that they make in connection with the offer and sale of the securities. Section 12(a)(2) of the 1933 Act and Section 10(b) of the 1934 Act, and Rule 10b- 5 thereunder, are the basis for such causes of action. Purchasers of unregistered securities can be liable for damages to sellers if they violate Section 10(b) and Rule 10b-5. Section 17 of the 1933 Act and Section 10(b) of the 1934 Act each provides a statutory basis for SEC sanctions against persons who engage in fraudulent securities activities. A. Section 12(a)(1) of the 1933 Act 1. Introduction Section 12(a)(1) imposes civil liability on "[a]ny person who offers or sells a security in violation of section 5..." Where successful, a purchaser may recover rescissory damages. In order to state a prima facie case under Section 12(a)(1) a plaintiff who purchased unregistered securities must prove: (1) A registration statement covering the securities was not in effect; (2) The defendant offered or sold the security to the plaintiff; 1

4 430 (3) The mails or facilities of interstate commerce were used in connection with the offer or sale, (see, e.g., Swenson v. Engelstad, 626 F.2d 421, 424 (5th Cir.1980)); and (4) The action is timely under the statute of limitations in Section 13. (see, e.g., Piper Acceptance Corp. v. Slaughter, 600 F. Supp. 169, 172 (D. Colo. 1985)). Once the plaintiff has presented its case, the burden shifts to the defendant to prove the availability of an exemption. The defendant must demonstrate that it satisfied all of the terms and conditions of an exemption for each transaction. Where a seller breaks an offering into small pieces in order to avoid the requirements of Section 5, the doctrine of integration allows a court to decide whether the offers and sales constitute a single transaction and to test the entire plan of financing against the conditions of an exemption. See Donohoe v. Consolidated Operating & Prod. Corp., 982 F.2d 1130, 1140 (7th Cir. 1992) (integration not required); SEC v. Melchior, 1993 WL 89141, [ Transfer Binder] Fed. Sec. L. Rep. (CCH) 97,356 (D. Utah 1993)(offerings integrated for purposes of Regulation D); Johnston v. Bumba, 764 F. Supp (N.D. Ill. 1991)(integration); Walker v. Montclaire Housing Partners, 736 F. Supp. 1358, (M.D.N.C. 1990)(integration for purposes of blue sky law). 2. The Seller Requirement Section 12 requires a plaintiff to plead the seller status of the defendant. This requirement is found in language common to Sections 12(a)(1) and 12(a)(2), which extends liability to "[a]ny person who offers or sells a security" and makes that person liable "to the person purchasing such security from him." Recently, the Supreme Court stated that Section 12(a)(1) "liability extends only to the person who successfully solicits the purchase, motivated at least in part by a desire to serve his own financial interest or those of the securities owner." Pinter v. Dahl, 486 U.S. 622, 647, (1988). The Court expressly rejected the substantial factor test adopted by a majority of circuits. It opted instead to create a standard based on strict privity and financial benefit. See, e.g., Harelson v. Miller Financial Corp., 854 F.2d 1141 (9th Cir. 1988), cert. denied sub nom. Wilson v. Harelson, 488 U.S. 917 (1988). Under Pinter, a complaint will be dismissed unless it contains an allegation of direct and active participation in the solicitation of the immediate sale. See, e.g.,maher v. Durango Metals, Inc., 144 F.3d 1302, 1307 (10th Cir. 1998); In re Westinghouse Sec. Lit., 90 F.3d 696, 717 n. 19 (3rd Cir. 1996); Silva Run Worldwide Limited v. Gaming Lottery Corp., 1998 WL (S.D.N.Y. 1998). The Seventh Circuit has held that attorneys who furnish advice are not "sellers" for Section 12 purposes. Ackerman v. Schwartz, 947 F.2d 841 (7th Cir. 1991). 3. Statute of Limitations (a) Introduction 2

5 431 Section 13 imposes two limitations on Section 12(a)(1) actions that are cumulative. First, a Section 12(a)(1) action must be brought within one year of the violation. Second, in no event may the Section 12(a)(1) action commence any later than three years after the security was offered to the public. Compliance with the statute of limitations is a matter of substance, not procedure. Toombs v. Leone, 777 F.2d 465, 468 (9th Cir. 1985); Shotto v. Laub, 635 F. Supp. 835, 837 (D. Md. 1986). This means that the plaintiff's complaint must set forth the date upon which the defendant allegedly violated Section 5 and the date that the security was bona fide offered to the public. (b) Within One Year of Violation The one year statute of limitations required by Section 13 begins to run from the date of the violation. Section 12(a)(1) imposes liability on any person who violates the registration and prospectus delivery requirements of Section 5. The Section 5 obligations extend to an offer, sale and delivery of a security. For purposes of Section 13, a Section 12(a)(1) claimant should first determine at which of the three stages -- offer, sale or delivery -- the defendant violated Section 5. Where a violation occurs at more than one stage in the transaction, many courts have used the most lenient standard to measure the limitation period. If the plaintiff's complaint was filed within one year of the last of these events, the statute of limitations is not a bar. See, e.g., Doran v. Petroleum Management Corp., 576 F.2d 91, 93 (5th Cir. 1978); Folse v. Combined Equities, 592 F. Supp. 559, 562 (W.D. La. 1984). (c) No More Than Three Years Not only must the plaintiff file a Section 12(a)(1) claim within one year of the violation, he must also file it "no more than three years after the security is bona fide offered to the public." P.Stolz Family Partnership L.P. v. Daum, 355 F.3d 92 (2d Cir. 2004); LeCroy v. Dean Witter Reynolds, Inc., 585 F. Supp. 753, 760 (E.D. Ark. 1984). The language of Section 13, as it pertains to the three year limitation, appears to have no application to non-public offerings. Courts have not interpreted the language so narrowly, however. The three year limitation begins to run from the date of the first offer of a security that is connected with the transaction of which plaintiff's purchase is a part. Assume, for example, that on February 1, Limited Partnership L makes its first offer to sell unregistered limited partnership interests to a prospective investor who does not accept. L's first sale occurs on February 10. The plaintiff, P, purchases an interest on February 21. The offering is fully subscribed by March 10. The one year limitation on P's Section 12(a)(1) claim commenced on February 10 but the three year limitation began on February 1. (d) Equitable Tolling 3