FINANCIAL SERVICES CLIENT ADVISORY GROUP
Intermediaries in Securities Transactions Changes Under the Dodd-Frank Wall Street Reform and Consumer Protection Act
Law Alert
By: Harriet B. Alexson
714.384.6578
halexson@bmkalaw.com
©2011. All Rights Reserved.
The recent Supreme Court decision in Janus Capital Group, Inc. v. First Derivative Traders addressed Rule 10b-5 of the Securities Exchange Act of 1934 and held intermediaries in securities transactions could not be found liable for the issuer’s or seller’s violation of that rule. However, the Dodd-Frank Wall Street Reform and Consumer Protection Act will change the liability exposure of intermediaries in the sale of securities, as follows.
Under Rule 10b-5, adopted by the SEC in 1942 pursuant to Section 10(b) of the 1934 Act, it is unlawful “to make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading” in connection with the purchase or sale of securities. This clearly applies to issuers and sellers, but the question before the Court in Janus Capital has been the extent to which intermediaries in a securities transaction can be found liable for the issuer’s or seller’s primary violation.
The Supreme Court decided Janus Capital Group, Inc. v. First Derivative Traders, No. 09-525, on June 13, 2011. The Court held in Janus Capital that the investment adviser to the Janus Funds could not be liable in a private action under Rule 10b-5 for false statements in prospectuses issued by the Funds, even though the investment adviser wrote the prospectuses and the employees of the Funds were also employees of the investment adviser. The Court ruled that only the “maker” of a false statement can be liable under Rule 10b-5 and the “maker” is “the person or entity with ultimate authority over the statement, including its content and whether and how to communicate it.” The Court concluded that the mutual fund itself was the entity with “ultimate authority” over the prospectuses because it had the statutory obligation to file the prospectuses with the SEC.
New Section 9(a)(4) of the 1934 Act makes it unlawful for any broker, dealer or other person selling or offering to sell (or purchasing or offering to purchase) any security other than a government security, “to make. . . for the purpose of inducing the purchase or sale of such security, . . . any statement which was at the time and in the light of the circumstances under which it was made, false or misleading with respect to any material fact, and which that person knew or had reasonable ground to believe was so false or misleading.” Previously, Section 9 of the 1934 Act applied only to securities traded on an exchange. Now it applies to any securities, excluding government securities—another change that was part of the Dodd-Frank Act.
Dodd-Frank also added new Section 9(f) to the 1934 Act, which says that anyone who “willingly participates” in an act or transaction in violation of Section 9(a) is liable to the person who bought the security. “Willingly participates” is not defined. There is no requirement in Section 9(f) that the willing participant have knowledge of the false statement, an intent to misrepresent a material fact, or even a careless disregard of the facts given to offerees. It allows the “willing participant,” if found liable, to seek recovery from any other violator of Section 9(a). Presumably, this allows the plaintiff to seek recovery from the willing participant, rather than an issuer who may be insolvent, and gives the willing participant a right to sue its own client for a recovery.
What should a placement agent or other intermediary do under the Dodd-Frank provision? Any party working in this area should conduct a proper due diligence investigation for the offering. Large investment banking firms, when acting as underwriters in public offerings, conduct very thorough due diligence investigations. This is the means of establishing a defense against liability under Section 11 of the Securities Act of 1933 (i.e., there is no liability if the underwriter “had, after reasonable investigation, reasonable ground to believe and did believe, at the time such part of the registration statement became effective, that the statements therein were true and that there was no omission to state a material fact required to be stated therein or necessary to make the statements therein not misleading”). However, small broker-dealers offering private placements may not conduct a full investigation, based upon the cost of such an investigation.
The best way to reduce the risk of liability for false statements in an offering document is through a properly conducted and properly documented due diligence investigation.
For further information about this interesting topic please contact:
Harriet B. Alexson
Chair Financial Services Practice Group
Bohm, Matsen, Kegel & Aguilera, LLP
695 Town Center Drive, Suite 700
Costa Mesa, CA 92626
Tel: 714.384.6578
halexson@bmkalaw.com
info@alexsonlaw.com
www.alexsonlaw.com
Actual resolution of legal issues depends upon many factors, including variations of fact and state laws. This article is not intended to provide legal advice on specific subjects, but rather to provide insight into legal developments and issues. The reader should always consult with legal counsel before taking action on matters covered by this article.