Author: Dan Stroh, Associate Member, University of Cincinnati Law Review
On October 6, 2014, the Supreme Court denied a writ of certiorari in Moores v. Hildes, which involved the interpretation of § 11 of the Securities Act of 1933.[1] Section 11 protects investors by requiring disclosures regarding the purchase of securities and imposing liability on actors responsible for misstatements or errors in information regarding the securities.[2] By holding directors and other company leaders responsible for the accuracy of required statements, § 11 aims to instill confidence in securities investors. Generally, the Act does not require an investor to show he relied on misleading information in a company’s registration statements to impose liability on those responsible for the accuracy of the information.[3] However, the Eleventh and Ninth Circuits are split as to whether a plaintiff must show reliance on a misleading registration statement when the registration statement was issued after the shareholder entered a binding lock-up contract in a merger. By choosing not to review Moores v. Hildes, the Supreme Court refused to address the issue of reliance when an investor utilizes § 11 to enforce accountability for this type of error. Because § 11 is one of the few remaining areas of securities law where injured investors turn for protection from misstatements affecting the value of their investments,[4] the Supreme Court’s failure to affirm the ruling in Hildes will result in continued confusion, lack of protection for investors, and disparate rulings that vary by jurisdiction.
APA Excelsior and Hildes: Reliance Required or Not?
Section 11 provides remedies to investors when sellers of securities provide materially misleading statements or half-truths in a registration statement, which provides essential information regarding the securities and the issuer.[5] Injury in a § 11 claim occurs as a result of loss in value of an investment in the securities described in a particular registration statement. When misleading statements are present, the initial price of the security will be higher than its true value. Once these errors are discovered, the price of the security—and hence the plaintiff’s investment—decrease due to the disclosure of the misstatements in the registration statement. Plaintiffs seeking to prevail on a § 11 claim must prove four points: (1) jurisdictional competence; (2) purchase of a security pursuant to a registration statement; (3) materially misleading statements or half-truths in the registration statement when it becomes effective; and (4) a claim brought within the statute of limitations.[6] A plaintiff’s reliance on the registration statement is not required by statute as an element of a § 11 claim. Reliance generally requires that the plaintiff show they actually used the information as a part of their decision to purchase the security. In a situation involving § 11, a requirement of reliance would require an investor to show how they used the information contained in the registration statement in making their decision to purchase the securities offered for sale.
In spite of a lack of any requirement of reliance in the statutory language of § 11, in APA Excelsior III L.P. v. Premiere Techs the Eleventh Circuit held that investors could not bring a claim under § 11 when they had agreed to vote their shares for approval of a transaction via a lock-up agreement[7] prior to the filing of the registration statement.[8] The Eleventh Circuit required the plaintiffs to show reliance on materially misleading statements or half-truths found in the registration statement in order to permit possible recovery of any damages caused to the investor by the misleading or false declarations in a registration statement.[9] A lock-up agreement binding an investor to vote for a purchase prior to the issuance of a registration statement does not allow for an investor to change his vote after review of the registration statement. Thus, because investors agreed to the lock-up prior to issuance of the registration statement in APA Excelsior, the court held that it was impossible for the investors to rely on the false statements in their decision to vote for purchase of the securities in question.[10] The court held that without this reliance, there is no claim under § 11 and upheld summary judgment for the defendant.[11]
In Hildes, the Ninth Circuit held that reliance was not a necessary element of a Section 11 claim due to the commitment of a shareholder to vote for acquisition by another company prior to the issuance of the registration statement covering the acquisition.[12] In this case, the shareholder signed a lock-up agreement prior to the publication of the misleading registration statement to vote for the purchase, making reliance on the statement impossible. However, the Hildes court ruled that, despite the prior agreement of the shareholders to vote for approval of a merger, the transaction had not yet been completed. While there were some shareholders that had in effect voted “yes” to the merger via the lock-up agreement, there were still events that had to occur prior to an investor being irrevocably committed to an exchange of shares. As the injury in § 11 claims occurs at the time of purchase or exchange, prior to a binding agreement to exchange the shares in a merger, this injury can be avoided despite the presence of the lock-up agreement. Because the investor was not bound to the merger itself, the investor in Hildes was still in a position to avoid harm caused by a misleading registration statement under § 11, regardless of reliance upon the registration statement. Thus, unlike in the APA Excelsior decision, the court refused the defendants’ request for summary judgment based on the plaintiffs’ lack of reliance. . Although there was an attempt to distinguish APA Excelsior from Hildes, the main thrust of the Hildes decision acknowledged that reliance is not required as an element of a § 11 claim for losses resulting from misleading statements in a securities registration statement even when an investor has signed a binding lock-up agreement.[13]
Investors Are Not Required to Show Reliance in § 11 Claims
The plain meaning of § 11 does not require reliance to bring a claim under the statute, with only one very narrow exception.[14] The statute explicitly provides that only when an investor purchases the security more than twelve months after the publishing of an earnings statement must a plaintiff show reliance.[15] Per the principle of expressio unius est exclusio alterius, Congress clearly intended to exclude reliance as an element of all other § 11 claims. The Supreme Court confirmed this view in Herman & Maclean v Huddleston by stating that showing the presence of a material misstatement or half-truth in registration materials is all that is required to present a prima facie case under § 11.[16] In addition, the legislative history of § 11 contains discussion and outright rejection of reliance provisions in the law, which further demonstrates that reliance is not a required element of § 11 claims.[17] Thus, even in the context of a lock-up agreement, the plain meaning of the statute, Supreme Court precedent, and the legislative history all support the conclusion that § 11 does not require plaintiffs to demonstrate reliance to state a claim under the law.
In Hildes, a majority shareholder in the company being acquired agreed to vote for a merger by signing a lock-up agreement prior to the publication of the registration statement. Despite it being impossible to show reliance on the registration statement, the Ninth Circuit ruled that the shares covered by the lock-up agreement were not actually traded until after the registration statement, when the shareholders voted for the merger. By showing a material misstatement in the registration statement, the plaintiffs presented a prima facie case for a § 11 claim, eliminating the possibility of summary judgment for the defendants on this basis. These falsified numbers later caused the value of the stock exchanged in the merger to plummet, resulting in the exact financial harm § 11 seeks to avoid. To require reliance in this situation would allow for injuries that the drafters of § 11 intended to prevent to occur simply due to the presence of a lock-up agreement. By allowing the case to proceed, the Ninth Circuit affirmed the reasoning behind § 11, giving investors a right and remedy when there are misleading statements or omissions regarding the issuer in securities registration statements.
The Supreme Court Should Have Granted Certiorari and Cleared Up the Confusion
By denying certiorari, the Supreme Court left open the issue of a mandatory reliance requirement in § 11 claims when a shareholder has agreed to vote for a transaction prior to the issuance of a registration statement. Lock-up agreements are common with mergers because they protect the acquiring company from surprises late in a voting process. Due to the frequency of lock-up agreements, the extent of § 11 protection for investors in this situation needs clarification. The Eleventh Circuit and Ninth Circuit have a split that will go unresolved until addressed by the Supreme Court. In an effort to resolve the confusion regarding this issue, the Supreme Court should have granted certiorari and affirmed the ruling in Hildes. By affirming Moores v. Hildes and stating that reliance is not required for Section 11 claims, the Supreme Court would have preserved one of the last remaining investor protections under § 11. When a § 11 claim involving a lock-up agreement inevitably comes in front of the Supreme Court again, as it almost assuredly will, hopefully the Court will take the opportunity to assure investors of the protections of the statute that Congress intended to provide.
[1] Moores v. Hildes, No. 13-791, 2014 WL 4956866, at *1 (U.S. Oct. 6, 2014); on petition for certiorari from Hildes v. Arthur Anderson 734 F.3d 854, 859 (9th Cir. 2013).
[2] 15 USCS § 77k.
[3] 15 USCS § 77k. A plaintiff must prove reliance only when the purchaser of securities in question made the purchase after an earnings statement of more than 12 months from the effective date of the registration statement.
[4] Marc I. Steinberg & Brent A. Kirby, The Assault on Section 11 of the Securities Act: A Study in Judicial Activism, 63 Rutgers L. Rev. 1, 3-4 (2010)
[5] See 15 USCS § 77g; 15 USCS § 77aa.
[6] Steinberg & Kirby, supra note 4, at 10; 15 USCS § 77k.
[7] A lock-up agreement in the context of a merger is when a purchasing party contracts with individual shareholders to create a binding agreement that the shareholder will vote for approval of a transaction when it is presented to shareholders. This allows for a purchasing party to have stability when approaching the agreement and ensure that the transaction will pass through a vote so that no surprises may occur when the agreement is presented for a vote.
[8] 476 F.3d 1261, 1273.
[9] Id. at 1276.
[10] See Steinberg & Kirby, supra note 4, at 14-15.
[11] APA Excelsior, 476 F.3d 1261, at 1277.
[12] Hildes v. Arthur Andersen LLP, 734 F.3d 854, 859, (9th Cir. Cal. 2013) (stating that reliance is only necessary as a part of a claim when the purchase was made 12 months after the filing of the registration statement); 15 USCS 77k.
[13] Lyle Denniston, U.S. urges review of investment cases, SCOTUSblog (Sep. 16, 2014, 11:36 PM), http://www.scotusblog.com/2014/09/u-s-urges-review-of-investment-cases/
[14] Supra note 3 and comments.
[15] 15 USCS §77k.
[16] 459 U.S. 375, 382, (U.S.1983) “If a plaintiff purchased a security issued pursuant to a registration statement, he need only show a material misstatement or omission to establish his prima facie case.”
[17] Assault on Section 11 at 18-26. The legislative history here is in regards to a general reliance provision excluding the exception mentioned previously and found in 15 USCS §77k.
