Originally prepared by Deepa Sarkar of the Cornell Law School Securities Law Clinic.
Securities Act of 1933 (The Securities Act)
The Securities Act was Congress' opening shot in the war on securities fraud with Congress primarily targeting the issuers of securities. Companies which issue securities (issuers) seek to raise money to fund new projects or investments or to expand; thus, companies have an incentive to present the company and its plans in the rosiest light possible. The Securities Act serves the dual purpose of ensuring that issuers selling securities to the public disclose material information to investors, and that any securities transactions are not based on fraudulent information or practices. In this context, "material" means information that would affect a reasonable investor's evaluation of the company's stock. The goal is to provide investors with accurate information so that they can make informed investment decisions.
The Securities Act effectuates disclosure through a mandatory registration process in any sale of any securities. In reality, due to a number of exemptions for trading on the secondary market and small offerings, the Act is mainly applied to primary market offerings by issuers. Under Section 5 of the Securities Act, all issuers must register non-exempt securities with the Securities and Exchange Commission (SEC). Section 5 regulates the timeline and distribution process for issuers who offer securities for sale. The actual registration process is laid out in Section 6, under which registration entails two parts. First, the issuer must submit information that will form the basis of the prospectus, to be provided to prospective investors. Second, the issuer must submit additional information that does not go into the prospectus but is accessible to the public.
The SEC rules dictate the appropriate registration form, which depends on the type of issuer and the securities offered. Section 7 gives the SEC full authority to determine what information issuers must submit, but generally included are information about the issuer and the terms of the offered securities that would help investors form a reasoned opinion about the investment. The requirements are extensive, and include descriptions of the issuer's business, past business performance, information about the issuer's officers and managers, audited financial statements of past business performance, executive compensation, risks of the business, tax and legal status, and the terms and information about the securities issued. Often, the issuer will submit the prospectus with the registration statement. All of this information becomes public soon after filing with the SEC, through the SEC's online EDGAR system.
The SEC reviews registration statements to ensure that all required disclosures have been made. Barring glaring deficiencies or omissions, the registration statement is effective within 20 days, per Section 8. The SEC does substantively evaluate the registration statement and prospectus, and can issue "deficiency letters" suggesting changes. Thus, the SEC can aid in shaping disclosure to meet investor needs. Companies tend to comply because the SEC has the power to accelerate the effective date, which allows the company to sell its stock and raise capital earlier. The registration process protects investors in two ways. Issuers cannot offer to sell securities without disclosing information about the company, and developing and delivering a prospectus that the SEC has reviewed. In addition, issuers are liable for any material misstatements or omissions in the prospectus or registration statement, providing a way to enforce truth in disclosure.
SEC actions are the main mechanism for enforcing federal securities laws. The SEC can prosecute issuers and sellers who sell unregistered securities, and under Section 20(b) can seek injunctions if the Securities Act has been violated, or if a violation is imminent. Section 8A also allows the SEC to issue orders to issuers to cease and desist from certain activities, and bar officers and directors who have violated the Securities Act's anti-fraud provisions. Additionally, the SEC can seek civil penalties under Section 20(d) if a party violated the Securities Act, an SEC rule, or a cease-and-desist order.
The SEC may not bring actions on behalf of individual investors, but the Securities Act allows individual investors to bring civil actions under several provisions:
- Section 11 makes issuers liable for registration statements that contain "an untrue statement of a material fact or omit to state a material fact required...to make the statements there in no misleading." Under this provision, a purchaser of the security can bring suit under Section 11, even if he bought the security after the initial offering, on the secondary markets. As long as the purchaser can trace the purchase back to the initial offering and is within the statute of limitations, he can sue - there is no need to prove causation or reliance on the misstatements or omissions. Damages are limited to the difference between the offering price and value of the securities at the time of the lawsuit. Although the purchaser can sue the issuer, underwriter, or subsequent seller, all defendants but the issuer have a "due diligence" defense that they had no grounds to believe the statement had a misstatement or omission.
- Section 5 and Section 12(a)(1) allow purchasers to sue sellers for offering or selling a non-exempt security without registering it. As long as the purchaser can prove a direct link between the purchaser and the seller, and the suit is within the statute of limitations, the purchaser may obtain rescission with interest, or damages if the investor sold his securities for less than he purchased them.
- Section 12(a)(2) creates liability for any person who offers or sells a security through a prospectus or an oral communication containing a material misstatement or omission, is liable to the purchaser for rescission of the purchase or damages, provided that the purchaser did not know about the misstatement or omission at the time of the purchase. Court holdings imply that the cause of action only applies to purchasers in the initial offering, not secondary purchases, but this is not settled law yet. Investors suing under 12(a)(2) can only recover from sellers.
- Section 15 aids investors by making "control persons," or persons who "control" defendants liable under Sections 11 and 12 by owning stock or under agency principals, jointly and severally liable. This helps investors collect damages in cases where the defendant is insolvent or does not have enough money to pay the investor, a frequent situation in securities litigation (most investors sue after their investment has soured).
- Section 17(a) is a key anti-fraud provision in the Securities Act. It provides for liability for fraudulent sales of securities. Some courts have found an implied right of private action under this provision, though this is becoming a less favored position. However, some courts continue to accept private suits under this provision. Section 17(a) makes it unlawful to "employ any device, scheme, or artifice to defraud", "obtain money or property" by using material misstatements or omissions, or to "engage in any transaction, practice, or course of business which operates or would operate as a fraud or deceit upon the purchaser." This provision is closely tracked by Section 10b of the Securities Exchange Act and Rule 10b-5, which is used more widely by investors suing for fraud.