Aftermarket Purchaser Standing under Sec 11 of the Securities Act of 1933
Murray, Brian, St. John's Law Review
Following the collapse of the financial markets in the United States in October 1929, Congress enacted the Securities Act of 1933 (the "1933 Act").1 It was a cataclysmic change in the nature of the securities markets. Before the 1933 Act an attitude and legal climate of caveat emptor applied to purchasers of securities.2 With its passage, Congress provided a remedy of strict liability against an issuer of public securities, which issued a materially false and misleading registration statement pursuant to which its securities were sold to the public.3
Although Congress would pass the Securities Exchange Act of 1934,4 which applies to any securities transaction, the focus of the 1933 Act concerned the initial registrations of securities.5 As noted in the legislative history of the 1933 Act, billions of dollars worth of securities were brought to market in the 1920s, over half of which had become completely worthless by 1933.6 In signing the 1933 Act into law, President Franklin Delano Roosevelt stated that Congress was putting "the burden of telling the whole truth on the seller" in order to "give impetus to honest dealing in securities and thereby bring back public confidence."7 In order to put teeth into this idea, two civil liability provisions were built into the 1933 Act, in the hope that this would facilitate the raising of capital by deserving companies.8
The first provision, Sec 11, provides for strict liability and monetary damages for an issuer found to have sold securities pursuant to a materially false or misleading registration statement, and lists four categories of other defendants who are also liable.9 Section 11 has no reliance requirement and no requirement that a plaintiff even prove damages; rather, a prima facie case consists solely of proving a material misstatement10 or omission11 in a registration statement or prospectus.12 The burden of disproving the elements of a Sec 11 case is on the defendants. As part of their affirmative defenses they are allowed to prove that the drop in the price of the stock was not caused by the misstatements or omissions, or that in the exercise of due diligence13 they could not have known about the false statement or omission.14 The second provision, Sec 12, provides for a remedy of rescission against the seller of securities, sold pursuant to a materially false or misleading prospectus (and included in a registration statement).15
In order to avail oneself of the protection of Sec 11 of the 1933 Act, a plaintiff must plead, and eventually prove, that the securities he or she purchased were issued pursuant to the defective registration statement.16 A purchaser who buys directly on an initial public offering from an underwriter unquestionably has standing to sue under Sec 11.17 Generally, courts have allowed aftermarket purchasers18 who allege the securities they bought were traceable to the registration statement at issue to have standing to sue under Sec 11.19 If other securities of the same type at issue in a case were traded prior to the issuance of the false or misleading registration statement, tracing securities purchased in the open market back to the registration statement is very difficult.20 Despite the widespread acceptance of tracing as a means of establishing entitlement to the protection of Sec 11,21 the tracing theory has been under attack since the Supreme Court's decision in Gustafson v. Alloyd Co.,22 a case involving Sec 12(2)23 of the 1933 Act. This article will discuss the continued viability of the tracing theory for a Sec 11 claim after the Gustafson opinion.
1. PRE-GUSTAFSON CASELAW CONCERNING THE TRACING THEORY
For the past thirty years, the law has been settled in the Second Circuit, and most other jurisdictions, that purchasers in the secondary market who can trace their stock back to an initial public offering ("IPO") have standing to sue for violations under Sec 11.24 In Barnes v. Osofsky,25 the Second Circuit was faced with the issue of whether a purchaser of stock who bought on the open market and could not trace the stock back to an offering should be entitled to damages even though purchasers who purchased during the same time period, but could trace back, would be so entitled. …