UNITED STATES COURT OF APPEALS

UNITED STATES COURT OF APPEALS

FOR THE FIFTH CIRCUIT

No. 03-30227

KARL L. KAPPS, et al.,

Plaintiffs-Appellants,

v.

TORCH OFFSHORE, INC., et al.,

Defendants-Appellees.

On Appeal from the United States District Court

for the Eastern District of Louisiana

BRIEF OF THE SECURITIES AND EXCHANGE COMMISSION AMICUS CURIAE

IN SUPPORT OF APPELLANTS ON ISSUE ADDRESSED

GIOVANNI P. PREZIOSO

General Counsel

JACOB H. STILLMAN

Solicitor

Of Counsel

MEYER EISENBERG

Deputy General Counsel

MARK PENNINGTON

Assistant General Counsel

Securities and Exchange Commission

450 Fifth Street, N.W.

Washington, D.C. 20549-0606

(202) 942-0928 (Pennington)

TABLE OF CONTENTS

Page

TABLE OF AUTHORITIES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . iii

INTEREST OF THE SECURITIES AND EXCHANGE COMMISSION . . . . . . . 1

ISSUE ADDRESSED BY THE COMMISSION . . . . . . . . . . . . . . . . . . . . . . . . . . 2

STATEMENT OF THE CASE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3

A.

The Parties’ Contentions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3

B.

The District Court Decision . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4

SUMMARY OF ARGUMENT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5

STANDARD OF REVIEW . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8

ARGUMENT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9

A.

The Disclosure Required by the Securities Act in Securities

Registration Statements Is Determined by the Language of the

Statute, Which Does Not Restrict That Disclosure to Firm-Specific

or Non-Public Information. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9

A.

The Securities Act Requires the Material Disclosure in

Registration Statements to Be Truthful, to Contain All

Information Required by Law, and Not to Omit Information

Necessary to Make the Statements Therein Not Misleading . . . . . . . . 9

B.

It Is Not an Absolute Defense to the Securities Act’s Disclosure

Requirements That Information Is Not Firm-Specific or Is Publicly

Available. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12

-i-

TABLE OF CONTENTS (Continued)

Page

II.

The Disclosure of “Trends” Required by Item 303 Is Not Limited

to Firm-Specific or Non-Public Trends . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22

CONCLUSION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25

CERTIFICATES

-ii-

TABLE OF AUTHORITIES

Cases

Page

Affiliated Ute Citizens of Utah v. United States,

406 U.S. 128 (1972) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9

Auer v. Robbins, 519 U.S. 452 (1997) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8, 22

Basic Inc. v. Levinson, 485 U.S. 224 (1988) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18

Central Bank of Denver v. First Interstate Bank of Denver,

511 U.S. 164 (1994) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9, 12

Chevron U. S. A. Inc. v. NRDC, 467 U.S. 837 (1984) . . . . . . . . . . . . . . . . . . . 8, 13

Gustafson v. Alloyd, Co., 513 U.S. 561 (1995) . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9

Herman & Maclean v. Huddleston, 459 U.S. 375 (1983) . . . . . . . . . . . . . . . . . . . 11

Johnson v. Wiggs, 443 F.2d 803 (5th Cir. 1971) . . . . . . . . . . . . . . . . . . . . . . . . . . 17

Klein v. General Nutrition Cos., 186 F.3d 338 (3d Cir. 1999) . . . . . . . . . . . . . . . 19

Krim v. BancTexas Group, Inc., 989 F.2d 1435 (5th Cir. 1993) . . . . . . . . . . . 17, 19

Press v. Quick & Reilly, Inc., 218 F.3d 121 (2d Cir. 2000) . . . . . . . . . . . . . . . . . . 3

TSC Industries, Inc. v. Northway, 426 U.S. 438 (1976) . . . . . . . . . . . . . . 18, 19, 20

United States v.Mead Corp., 533 U.S. 218 (2001) . . . . . . . . . . . . . . . . . . . . . . . . . 8

Ward v. Succession of Freeman, 854 F.2d 780 (5th Cir. 1988) . . . . . . . . . . . . . . . 17

-iii-

TABLE OF AUTHORITIES (Continued)

Cases (Continued)

Page

Wielgos v. Commonwealth Edison, Co., 892 F.2d 509

(7th Cir. 1989) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14, 15, 16

passim

Commission Releases

Amendments to Annual Report Form, Related Forms, Rules, Regulations

and Guides; Integration of Securities Acts Disclosure Systems,

SEC Release No. 33-6231, 20 S.E.C. Docket 1059 (September 2, 1980) . . . . . . 23

Management’s Discussion and Analysis of Financial Conditions

and Results of Operations, SEC Release No. 33-6349,

23 S.E.C. Docket 962 (September 28, 1981) . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23

Statutes and Rules

Securities Act of 1933, 15 U.S.C. 77a, et seq.

Section 5(a), 5 U.S.C. 77e(a) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10

Section 5(b), 15 U.S.C. 77e(b) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10

Section 7(a), 15 U.S.C. 77g(a) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10, 13

Section 8(d), 15 U.S.C. 77h(d) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10

Section 10(a), 15 U.S.C. 77j(a) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10

Section 11, 15 U.S.C. 77k . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2, 3, 4

passim

Section 12(a)(2), 15 U.S.C. 77l(a)(2) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11

Section 17(a), 15 U.S.C. 77q(a) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11

Section 24, 15 U.S.C. 77x . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11

Rule Under the Securities Act of 1933, 17 C.F.R. 230.01, et seq.

Rule 175, 17 C.F.R. 230.175 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14, 15, 17

-iv-

TABLE OF AUTHORITIES (Continued)

Statutes and Rules (Continued)

Page

Rule Under the Securities Exchange Act of 1934, 17 C.F.R. 240.01, et seq.

Rule 10b-5, 17 C.F.R. 240.10b-5 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17

Regulation S-K, 17 C.F.R. 229

Item 103, Regulation S-K, 17 C.F.R. 229.103 . . . . . . . . . . . . . . . . . . . . . . 14

Item 303, Regulation S-K, 17 C.F.R. 229.303(a)(3)(ii) . . . . . . . . . . . . 4, 7, 8

passim

Miscellaneous

ALI, Federal Securities Code, Section 202(92), Comment (1) . . . . . . . . . . . . 12, 19

H. R. Rep. No. 85, 73d Cong., 1 st Sess. (1993) . . . . . . . . . . . . . . . . . . . . . . . . . 9, 10

Joel Seligman, Transformation of Wall Street (Rev. Ed. 1995) . . . . . . . . . . . . . . . 9

Restatement (Second) of Torts, Section 538(2)(a) . . . . . . . . . . . . . . . . . . . . . . . . . 19

-v-

INTEREST OF THE SECURITIES AND EXCHANGE COMMISSION

The Securities and Exchange Commission, the agency responsible for the

administration and enforcement of the federal securities laws, submits this brief as

amicus curiae to address the district court’s ruling on the securities registration

statement disclosure obligations imposed on issuers by the Securities Act of 1933,

15 U.S.C. 77a et seq. The district court held that the “[f]ederal securities laws do

not impose a duty on issuers to disclose industry-wide trends or publicly available

information,” so that the failure to disclose that information may never give rise to

a claim under Section 11 of the Securities Act, 15 U.S.C. 77k, the provision that

creates a private right of action for certain untrue statements and omissions in

registration statements. The district court’s ruling on actionable omissions is

incorrect, because it creates a per se defense to liability that is contemplated neither

by the statute, the Commission’s regulations thereunder, nor applicable Supreme

Court precedent.

If accepted as a correct view of the law, the district court’s ruling would

create substantial gaps in the fundamental protections extended to investors by the

Securities Act’s registration and disclosure requirements, gaps that were not

intended by Congress. Furthermore, some of the reasoning urged by the defendants

in the district court would lead to the conclusion that issuers could not only omit to

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include industry-wide or public information in their registration statements, but

that they could also make untrue statements about that information. Moreover,

although this case is a Section 11 private action, the principles enunciated by the

district court and urged by the defendants could also restrict the disclosure

obligations enforced by the Commission in its own proceedings. For these

reasons, the Commission submits this brief amicus curiae to address the district

court’s erroneous views.

ISSUE ADDRESSED BY THE COMMISSION

Section 11 creates a private damages action for any person acquiring a

security issued pursuant to a registration statement that “contained an untrue

statement of a material fact or omitted to state a material fact required to be stated

therein or necessary to make the statements therein not misleading (unless it is

proved that at the time of such acquisition he knew of such untruth or omission).”

The issue addressed by the Commission is whether it is an absolute defense to an

action under Section 11 that the untrue or omitted information is not specific to the

firm issuing the securities, or is publicly available.

-2-

STATEMENT OF THE CASE

A.

The Parties’ Contentions

The plaintiffs, purchasers in the initial public offering of shares in Torch

Offshore Inc., sued Torch, Torch officers and directors, and the underwriters of the

IPO under Section 11. Plaintiffs allege that in its discussion of the market price of

natural gas, an important determinant of Torch’s business prospects, the

registration statement for the offering made untrue statements of material fact,

omitted to state material facts required to be stated therein when it failed to

disclose a “trend” in the price of gas, and omitted to state material facts necessary

to make the statements therein not misleading.

Defendants moved to dismiss. They contended that, read in context, the

statements challenged by plaintiffs were not untrue or misleading, and also that the

price changes plaintiffs identified did not have to be disclosed because they were

not a “trend,” but were instead only short term fluctuations in a volatile market.

These arguments, which were not addressed by the district court, are the sort of

fact-bound issues that the Commission ordinarily does not address in an amicus

brief, see e.g., Press v. Quick & Reilly, Inc., 218 F.3d 121, 128 (2d Cir. 2000)

(court notes that, in keeping with its usual practice, the Commission’s amicus brief

expressed no views on fact-bound issues involving the application of legal

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principles to the specific factual allegations in the complaint), and we do not

address them here.

Defendants also made a broader argument that the Securities Act requires

disclosure only of firm-specific information that is not available to the public.

Based on this premise, they urged that there can never be a duty to disclose

information that is not firm-specific, or that is publicly available, so that the

omission of that information from a registration statement can never be the basis

for liability under Section 11. They also contended that information that is not

firm-specific or that is publicly available can never be “material,” which would be

an additional ground for barring recovery under Section 11; the logic of this

argument would suggest that a lie about such information would also not be

actionable. Finally, they averred that the requirement in Item 303 of Regulation SK, 17 C.F.R. 229.303(a)(3)(ii), that the issuer disclose “any known trends” that

have had or that it reasonably believes will have a material impact on its finances,

is limited to firm-specific trends that are not available to the public.

B.

The District Court Decision

The district court granted the motion to dismiss. It did not specifically

mention materiality or Item 303, nor did it mention plaintiff’s allegation that, in

addition to omitting information that should have been included, defendants also

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made false statements. It ruled that the failure to disclose non-firm-specific or

publicly available information could not be the basis for a claim under Section 11:

Federal securities laws do not impose a duty on issuers to disclose

industry-wide trends or publicly available information. Information

concerning publicly traded commodities such as natural gas and

gasoline are readily available in the public domain, and therefore,

omission of such information is not actionable under Section 11. In

addition, non-disclosure of the industry wide-trend of drilling project

delays does not form the basis for a securities fraud claim. 1

Op. at 3 (citations omitted).

SUMMARY OF ARGUMENT

The Securities Act requires issuers of securities that are to be sold to the

public to disclose specified information in a registration statement that is filed with

the Commission, and in a prospectus that is delivered to investors. These

disclosure requirements are enforceable by the Commission and through private

rights of action, including Section 11 of the Act, which authorizes a suit for

recovery of damages whenever the registration statement contains an untrue

statement of material fact, omits a material fact required to be stated therein by

statute or Commission regulation, or omits to state a material fact necessary to

make the statements therein not misleading, unless it is proven that at the time of

the acquisition, the acquirer knew of the untruth or omission.

1

Plaintiffs alleged that Torch’s customers had delayed projects in

response to changes in the market price for gas.

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1. Neither the statute nor the Commission’s regulations provide that it is an

absolute defense to liability that omitted information is not firm-specific or is

publicly available. What the statute says about disclosure of material facts is that

all information required to be disclosed by the statute or Commission regulations

must be included; that no untrue statement may be made, whether the statement is

required or not; and that no information may be omitted if the omission would

make any of the statements in the registration statement misleading. If material

information is called for under this standard, it must be disclosed. There is no

blanket requirement that the information be firm-specific, or that it not be publicly

available. Indeed, as to public availability, the provision in Section 11 that liability

is defeated if the acquirer knew of the untruth or omission cannot be reconciled

with an absolute requirement that investors are required, as a matter of law, to

appreciate the need to search in other sources, and then to look in those sources –

which may be remote, technical, or otherwise difficult to obtain or apply – for

information necessary to correct incomplete or misleading statements in the

registration statement. Conversely, if material information is not required to be

disclosed, and if it may be omitted without making statements in the registration

statement materially misleading, it need not be stated, even if it is firm-specific or

is not publicly available.

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Nor is the definition of “material” under the Act strictly limited to

information that is firm-specific and non-public. Information is material if there is

a substantial likelihood that a reasonable investor would consider the information

an important part of the total mix of information made available when making an

investment decision. Because Section 11 is a remedy only when an untrue

statement or omission is material, to hold that industry-wide trends or publicly

available information can never be material would mean not only that issuers do

not have to disclose that information in their registration statements, but also that

they could make untrue statements about it. To restrict the definition with bright

line rules about firm specificity and public availability is directly contrary to the

philosophy of full and fair disclosure underlying by the Securities Act. That does

not mean that all material information must be included in the registration

statement, but it does mean that an issuer is not free to make material

misrepresentations, or to omit material information if it is required to be disclosed

by law or needs to be disclosed in order to prevent statements made from being

misleading.

2. The relevant provision of Item 303 is not limited to disclosure of trends

that are firm-specific or that are not available to the public. Rather, under the plain

language of the Item, issuers must disclose “any known trends * * * that have had

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or that the registrant reasonably believes will have a material favorable or

unfavorable impact” on company finances (emphasis added). Many such trends

will be industry-wide or publicly available, but that does not excuse the issuer from

complying with the requirements of the Item.

STANDARD OF REVIEW

The Commission’s interpretation in notice-and-comment rulemaking of the

statutes it administers, including the scope of disclosure required by the Securities

Act, is entitled to Chevron deference, which is to say that the Commission’s

reasonable interpretation of the Act controls unless Congress has clearly and

unambiguously addressed the question. See, e.g., United States v. Mead Corp.,

533 U.S. 218, 226-27 (2001). The Commission’s interpretation in an amicus brief

of one of its own regulations, such as what “trend” means in Item 303 of

Regulation S-K, is controlling unless plainly erroneous or inconsistent with the

regulation. Auer v. Robbins, 519 U.S. 452, 461-63 (1997).

-8-

ARGUMENT

I.

The Disclosure Required by the Securities Act in Securities Registration

Statements Is Determined by the Language of the Statute, Which Does Not

Restrict That Disclosure to Firm-Specific or Non-Public Information.

A.

The Securities Act Requires the Material Disclosure in

Registration Statements to Be Truthful, to Contain All

Information Required by Law, and Not to Omit Information

Necessary to Make the Statements Therein Not Misleading.

Following the 1929 market crash, Congress ascertained that fully half of the

securities issued in the post-World War I decade were worthless. H. R. Rep. No.

85, 73d Cong., 1 st Sess. 2 (1933). One of the very first tasks taken up by the new

administration in the weeks after the inauguration in March, 1933, was to submit to

Congress a bill requiring full disclosure with respect to securities to be offered to

the public. See Joel Seligman, The Transformation of Wall Street, 50-72 (Rev. ed.

1995). This statute, which was enacted as the Securities Act of 1933, 15 U.S.C.

77a et seq., embraced as a fundamental purpose “‘to substitute a philosophy of full

disclosure for the philosophy of caveat emptor.’” Central Bank of Denver v. First

Interstate Bank of Denver, 511 U.S. 164, 171 (1994) quoting Affiliated Ute

Citizens of Utah v. United States, 406 U.S. 128, 151 (1972).

“The primary innovation of the 1933 Act was the creation of federal duties –

for the most part, registration and disclosure obligations – in connection with

public offerings.” Gustafson v. Alloyd, Co., 513 U.S. 561, 571 (1995). The Act

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requires issuers that wish to sell their securities to the public to file a registration

statement with the Commission that contains mandatory disclosures of material

information. 2 It also requires delivery to investors of a prospectus containing

essential information from the registration statement. 3 Congress intended that the

registration statement and prospectus would contain “the basic information by

which the public is solicited” to buy offered securities. H. R. Rep. 85 at 9.

The Act also creates a range of remedies for violations of its requirements.

Section 8(d), 15 U.S.C. 77h(d), for instance, authorizes the Commission to issue a

stop order suspending the effectiveness of any registration statement that “includes

any untrue statement of a material fact or omits to state any material fact required

to be stated therein or necessary to make the statements therein not misleading.”

2

See Section 5(a), 5 U.S.C. 77e(a) (unlawful to sell or deliver any

security by means of interstate commerce or the mails unless a

registration statement for that security is in effect); Section 7(a), 15

U.S.C. 77g(a) (registration statement must include information called

for by statute or Commission regulation); Schedule A (disclosure

requirements for registration of securities other than a security issued

by a foreign government or political subdivision thereof); Regulation

S-K, 17 C.F.R. 229 (disclosure requirements applicable to the content

of the non-financial statement portions of a registration statement).

3

See Section 5(b), 15 U.S.C. 77e(b) (prospectus complying with

Section 10 of the Act must be delivered to the purchaser of the

security either before or at the same time as delivery of the security);

Section 10(a), 15 U.S.C. 77j(a) (information required to be contained

in the prospectus).

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Section 11, the provision at issue in this case, authorizes a suit for damages

by any person who acquires a security issued pursuant to a registration statement

that contains any of these same defects, “unless it is proved that at the time of such

acquisition he knew of such untruth or omission.” 4 Section 11was designed “to

assure compliance with the disclosure provisions of the Act by imposing a

stringent standard of liability on the parties who play a direct role in a registered

offering.” Herman & Maclean v.. Huddleston, 459 U.S. 375, 382(1983). A

plaintiff who acquires a security issued pursuant to a registration statement need

only show a material misstatement or prohibited omission to establish his prima

facie case. Once he has done so, “[l]iability against the issuer of a security is

virtually absolute, even for innocent misstatements. Other defendants bear the

burden of demonstrating due diligence.” Id. 5

4

The Act also contains other remedies for untrue statements or

prohibited omissions of material fact. See Section 12(a)(2), 15 U.S.C.

77l(a)(2) (creating purchaser’s right of action for untrue statement or

misleading omission in prospectus); Section 17(a), 15 U.S.C. 77q(a)

(prohibiting fraud in the offer and sale of securities, including

obtaining money or property by means of an untrue statement or

misleading omission); Section 24, 15 U.S.C. 77x (criminal liability for

willfully making an untrue statement or misleading omission, or

omitting required information in a registration statement).

5

In addition to the issuer, other possible defendants include every

person who signed the statement, directors of the issuer, and the

underwriter of the security.

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The protections of the Act are broad, reaching not only an affirmatively

untrue material statement, but also a literally true statement that is nonetheless

misleading because of material information that is omitted – a half truth, in other

words, “which is, of course, a lie.” ALI, Federal Securities Code, Section 202(92),

Comment (1). And Section 11 makes it clear that there is no duty on the part of the

investor to make a reasonable inquiry into information available outside the

registration statement. Rather, where a misrepresentation or omission is material,

the investor’s recovery may be defeated only if “it is proved that at the time of such

acquisition he knew of such untruth or omission” (emphasis added).

B.

It Is Not an Absolute Defense to the Securities Act’s Disclosure

Requirements That Information Is Not Firm-specific or Is Publicly

Available.

The disclosure duties imposed by the federal securities laws, like all the

substantive requirements of those laws, are embodied in the statutes and the

regulations adopted thereunder, and issues about the scope of those duties must be

resolved in accordance with the language of the applicable provisions. See, e.g.,

Central Bank of Denver v. First Interstate Bank of Denver, 511 U.S. at 164 (with

respect to the issue of “the scope of conduct prohibited by §10(b), the text of the

statute controls our decision”). As we have seen, nothing in the language of

Section 11 supports an absolute defense based on the fact that the information is

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publicly available or pertains to industry wide trends. Indeed, to hold that liability

for a material misstatement or omission may be defeated as a matter of law by

proving that corrective information could have been obtained by examining

industry wide trends or other public information is contrary to the express statutory

defense that plaintiff may recover unless it is proved that the person acquiring the

security “knew” of the untrue statement or omission.

Moreover, in keeping with the language and purpose of the Act, the

Commission’s regulations have never treated registration disclosure obligations as

being limited strictly to information that is firm-specific and that is not publicly

available. As discussed in more detail below, a Commission rule requires the

issuer to disclose certain “trends” that could affect its business, and that

requirement extends to disclosure of industry-wide trends and to those that may in

some way be public. The Commission’s determination in a notice-and-comment

rulemaking that this disclosure is necessary or appropriate in the public interest, or

for the protection of investors, even though it is not limited to information that is

firm-specific or that is not publicly available, is an interpretation of the Securities

Act that is entitled to deference under Chevron U. S. A. Inc. v. NRDC, 467 U.S.

837 (1984). See Section 7(a) of the Securities Act, 15 U.S.C. 77g(a) (registration

statement shall contain such other information “as the Commission may by rules

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and regulations require as being necessary or appropriate in the public interest or

for the protection of investors”).

Yet the district court in this case held that the “[f]ederal securities laws do

not impose a duty on issuers to disclose industry-wide trends or publicly available

information” and that “[i]nformation concerning publicly traded commodities such

as natural gas and gasoline are readily available in the public domain, and

therefore, omission of such information is not actionable under Section 11.” The

court seems to have based these conclusions, not on the language of the statute, but

on certain remarks made by the court of appeals in Wielgos v. Commonwealth

Edison, Co., 892 F.2d 509 (7 th Cir. 1989), and on cases citing that case. The

beginning place for our analysis, therefore, is what the Seventh Circuit did, and

what it did not, say in Wielgos.

The two issues in that case, which sought recovery under Section 11, were

(a) whether the defendant’s cost projections complied with the safe harbor for

forward-looking statements contained in Commission Rule 175, 17 C.F.R.

230.175, and (b) whether the disclosure made in the registration statement with

respect to a pending license application before a branch of the Nuclear Regulatory

Commission satisfied Item 103 of Regulation S-K, 17 C.F.R. 229.103, which

requires disclosure of material pending legal proceedings. 892 F.2d at 512. The

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court did not resolve either of those issues on the ground that an issuer can never

have a duty to disclose information that is not firm-specific or that is in the public

domain. Rather, it decided the case based on the application of the specific

language of Rule 175 and Item 103 to the allegations in the complaint. 892 F.2d at

512-17.

Before addressing each issue before it, however, the Wielgos court offered

its thumbnail view of the general way in which the securities disclosure regime

works. 6 The district court treated the Wielgos court’s general statements as laying

6

First, discussing the safe harbor created by Rule 175, the court

observed:

Issuers need not “disclose” Murphy’s Law or the Peter

Principle, even though these have substantial effects on

business. * * * Securities laws require issuers to disclose

firm-specific information; investors and analysts combine

that information with knowledge about the competition,

regulatory conditions, and the economy as a whole to

produce a value for stock. Just as a firm needn’t disclose

that 50% of all new products vanish from the market

within a short time, so [defendant] needn’t disclose the

hazards of its business, hazards apparent to all serious

observers and most casual ones. (892 F.2d at 515

(citation omitted).)

Then the court made a similar statement in the course of rejecting the

claim that details of the licensing proceeding had not been adequately

disclosed:

Issuers of securities must reveal firm-specific information.

(continued...)

-15-

down the absolute rule that the securities laws never require disclosure of any

information that is not firm-specific or that is publicly available, thereby creating

an absolute defense to liability under Section 11 for the omission of that sort of

information from a registration statement.

The district court’s ruling in this regard was error. As has been mentioned,

for instance, the Commission requires the issuer to disclose certain “trends” that

could affect its business, and this requirement is not restricted to trends that are

firm-specific, or not publicly available. Certainly, the court in Wielgos did not

suggest that an issuer is free to ignore this requirement, or any other requirement

that is set forth in statute or regulations, just because the information was not firmspecific or was in the public domain.

Furthermore, it may be that a statement in the registration statement is

materially misleading unless other statements are also included. In that event, the

issuer is not free to omit the necessary additional disclosure – as a matter of

absolute legal defense – simply because the information is not firm-specific, or

6

(...continued)

Investors combine this with public information to derive

estimates about the securities’ value. It is pointless and costly

to compel firms to reprint information already in the public

domain. (892 F.2d at 517).

-16-

because the investor, if alerted to the need to check, could find it out if he or she

looked to some other source.

In addition to Wielgos, the district court also cited this Court’s decision in

Krim v. BancTexas Group, Inc., 989 F.2d 1435, 1446 (5 th Cir. 1993), which quoted

one of the statements from Wielgos. This Court in Krim, however, like the court in

Wielgos, did not decide the case on the broad ground that there could never be a

duty to disclose non-firm-specific or publicly available information, but on the

ground that the disclosure challenged in that case complied with the Rule 175 safeharbor. (Krim did hold that certain omitted information was not material, but it did

so on the ground that the substance of the information was adequately set forth in

the prospectus, not on the ground that the information was not firm-specific or was

publicly available.) 7

7

In the district court, Torch also cited Ward v. Succession of Freeman,

854 F.2d 780, 792-93 (5 th Cir. 1988), a case brought under Rule 10b-5

under the Securities Exchange Act of 1934, 17 C.F.R. 240.10b-5, in

support of the proposition that there can never be a duty to disclose

public information. While it may well have been that the specific

omissions in that case were not misleading, the Court’s reasoning is

unclear – it cited in connection with its statement that the information

was in the public domain only Johnson v. Wiggs, 443 F.2d 803 (5 th

Cir. 1971). But Johnson was an insider trading case, in which one of

the elements of plaintiff’s claim is that the defendant bought or sold

securities while in possession of non-public information. Thus, it is

true that information that is publicly known cannot be the basis of an

insider trading violation, but that does not mean that the failure to

(continued...)

-17-

In the district court, the defendants suggested that the limitation of required

disclosure to firm-specific and non-public information is to be found in the

definition of “material.” As noted, only material untrue statements and omissions

are actionable, but the concept of material information is not restricted as

defendants suggest.

A fact is “material” “if there is a substantial likelihood that a reasonable

shareholder would consider it important” in making an investment decision. Basic

Inc. v. Levinson, 485 U.S. 224, 231, 234 (1988), quoting TSC Industries, Inc. v.

Northway, 426 U.S. 438, 449 (1976). For an omission to be material, “there must

be a substantial likelihood that the disclosure would have been viewed by the

reasonable investor as having significantly altered the ‘total mix’ of information

made available.” Id. at 231-32. In other words, the “role of the materiality

requirement” is “to filter out essentially useless information that a reasonable

investor would not consider significant, even as part of a larger ‘mix’ of factors to

consider in making an investment decision.” Id. at 234. This Court has explained

that the issue is whether “the information allegedly omitted or misrepresented in

the prospectus was material, in the sense that it would have altered the way a

7

(...continued)

disclose information that is publicly available can never be the basis

of any claim under the securities laws.

-18-

reasonable investor would have perceived the total mix of information available in

the prospectus as a whole.” Krim, 989 F.2d at 1435.

These formulations of the standard do not absolutely limit materiality to

information that is firm-specific or that it not publicly available. What is more, in

TSC Industries, 426 U.S. at 445, the Court noted that the definition of materiality it

accepted for the securities laws was the standard that was followed in the common

law, see Restatement (Second) of Torts, Section 538(2)(a),8 and also that was

found in the proposed Federal Securities Code, see ALI, Federal Securities Code,

Section 202(92). 9 Neither of these sources defines “material” in such a way as to

limit the concept exclusively to firm-specific or non-publicly available

information.

The district court did not expressly mention materiality in stating its rule that

omission of information that is available in the public domain is not actionable

under Section 11, but it did cite a case holding that certain omitted information was

not material, Klein v. General Nutrition Cos., 186 F.3d 338 (3d Cir. 1999). The

8

A matter is “material” if “a reasonable man would attach importance

to its existence or nonexistence in determining his choice of action in

the transaction in question.”

9

“A fact is ‘material’ if there is a substantial likelihood that a

reasonable person would consider it important under the

circumstances in determining his course of action.”

-19-

court of appeals in Klein, however, by no means endorsed the proposition that nonfirm-specific or publicly available information can never be material. Instead, the

court observed that “[a] determination of ‘materiality’ takes into account

considerations as to * * * [the information’s] availability in the public domain”

(emphasis added). 186 F.3d at 342.10

Rather than turning on bright-line rules, the question of whether an omission

is materially misleading requires consideration of all the relevant facts and

circumstances. That question may be resolved on the pleadings if plaintiff failed

sufficiently to allege that the omissions were material misleading, and summary

judgment may be granted if reasonable minds cannot differ on the question of

whether they were so; otherwise, the issue is for the trier of fact. See TSC

Industries, 426 U.S. at 438.

The result of applying a per se rule that any information that is not firmspecific or that is publicly available can never be material would be quite harmful

to investor protection. Not only may information that is not material be omitted by

the issuer without incurring Section 11 liability; an issuer will not be held liable

10

It is worth noting that the court in Wielgos explicitly stated that it was

not addressing the question of whether the omitted facts were

material, but was ruling on whether the disclosures complied with

applicable Commission rules. 892 F.2d at 517 (“Our case may be

decided, however, without regard to materiality. We think that

Commonwealth Edison revealed all that Item 103 requires.”).

-20-

even if it makes untrue statements about non-material information. See Basic, 485

U.S. at 249 (Court rejects “the proposition that ‘information becomes material by

virtue of a public statement denying it’”) (internal quotation marks omitted). Thus,

under the logic of defendants’ argument, it would have been lawful, without

regard to any other facts and circumstances, for Torch to state that the price of

natural gas had gone up steadily for the last ten years, even thought that was false;

to fail to disclose market trends that it knew would vitally affect its business; and

to present information about gas prices in clearly misleading ways; all on the

theory that this information was industry-wide, and that an alert and diligent

investor could have found it if the investor looked for corrective information in

other sources.

It is particularly inappropriate to say that investors are required as a matter

of law – and entirely at their peril – to check the accuracy and completeness of

representations in a registration statement (or prospectus) so long as the statements

are not firm-specific, or if the truth could be tracked down in some publicly

available source, given the registration statement is the key document in the

registration and disclosure regime created by the Securities Act. (It would be even

more inappropriate to conclude, on the same reasoning, that issuers may lie about

such information in that document). Furthermore, as noted in the discussion of the

-21-

scope of duty to disclose created by the Securities Act, holding the investor liable

for any information he could have found upon further investigation contradicts the

express statutory provision that a plaintiff may recover unless it is proven that he

“knew” of the untruth or omission.

II.

The Disclosure of “Trends” Required by Item 303 Is Not Limited to

Firm-Specific or Non-Public Trends.

Defendants’ assertion in the district court that a company never has a duty

under Item 303 of Regulation S-K (Management’s Discussion and Analysis (MD

& A)), to disclose industry-wide or publicly known trends is incorrect. The

Commission’s interpretation of its regulations, including its interpretation in

notice-and-comment rulemaking or in an amicus brief, governs unless that

interpretation is inconsistent with the language of the regulation or clearly

erroneous, Auer, 519 U.S. at 461-63.

The relevant portion of Item 303 requires a company to describe:

known trends or uncertainties that have had or that the registrant reasonably

expects will have a material favorable or unfavorable impact on net sales or

revenues or income from continuing operations. Item 303(a)(3)(ii).

The language of the Item does not limit disclosure to firm-specific trends, or

to trends that are not known to the public. Indeed, with respect to many trends that

would have a material effect on a company’s finances, it is difficult to conceive

how the company could meaningfully disclose the anticipated consequences

-22-

without also disclosing information about non-firm-specific aspects of the trend, as

well as information that is publicly available.

The absence of those limitations is not accidental. Rather, in the 1980

adopting release for the amendments to Regulation S-K that added this MD & A

trend disclosure requirement, the Commission articulated its concern that preexisting disclosure requirements were too narrow, and it recognized a “growing

need to analyze an enterprise’s liquidity and capital resources, in addition to its

revenues and income.” Amendments to Annual Report Form, Related Forms,

Rules, Regulations and Guides; Integration of Securities Acts Disclosure Systems,

SEC Release No. 33-6231, 20 S.E.C. Docket 1059, 1072 (September 2, 1980).

The Commission’s concerns specifically evolved from its recognition that macro

events affecting all public companies were not being accounted for in company

disclosures. As the Commission subsequently explained, the 1980 changes

reflected its “concerns about the economic climate of the time. High interest rates

and inflation were significant problems and the revised MD&A was designed to

foster disclosure of trends and uncertainties arising from these and other factors.”

Concept Release on Management’s Discussion and Analysis of Financial

Condition and Operations, SEC Release No. 33-6711, 38 S.E.C. Docket 219, 220

-23-

(April 21, 1987). Therefore, economy-wide concerns were driving expansive

changes in the regulatory disclosure requirements.

Part of the expanded MD&A required disclosure about the impacts of

inflation and changing prices on individual registrant businesses. As the

Commission stated: “In this regard the Commission believes that Management’s

Discussion and Analysis should contain information which changes the potentially

confusing situation involving inflation impact disclosure into a meaningful

discussion of the effects of changing prices on the registrant’s business.” SEC

Release No. 33-6231, 20 S.E.C. Docket at 1071. In order to present that

information, an issuer would have to describe macro economic conditions –

information that is not firm-specific and that is publicly available. In other words,

contrary to defendants’ claim, Item 303 may call for disclosure of publicly known

and industry-wide trends, where that information is relevant to an explanation of a

given company’s financial condition and comparative performance from reporting

period to reporting period.

-24-

CONCLUSION

For the foregoing reasons, this Court should reject the contention that it is an

absolute defense to an action under Section 11 of the Securities Act that the

misstated or omitted information is not firm-specific, or is publicly available.

Respectfully submitted,

GIOVANNI P. PREZIOSO

General Counsel

JACOB H. STILLMAN

Solicitor

MARK PENNINGTON

Assistant General Counsel

Of Counsel

MEYER EISENBERG

Deputy General Counsel

Securities and Exchange Commission

450 5th St. NW

Washington, D.C. 20549-0606

202-942-0928 (PENNINGTON)

June 2003

-25-

CERTIFICATE OF SERVICE

I hereby certify that on June 5, 2003, I caused two copies of the

proposed amicus brief of the Securities and Exchange Commission (with electronic

copy on diskette), and one copy of the Commission’s motion for leave to file that

brief to be served by overnight delivery on

Steven M. Jupiter

Leblanc and Waddell LLC

201 Saint Charles Ave.

Suite 3204

New Orleans, LA 70170-3204

504-523-9900

Andrew M. Schatz

SCHATZ & NOBEL

330 Main St.

Hartford, CT 06106

860-493-6292

COUNSEL FOR PLAINTIFFS

Robert L. Redfearn, Jr.

David S. Sterling

Simon, Peragine, Smith &

Baker Botts LLP

Redfearn, LLP

One Shell Plaza

th

30 Floor, Energy Centre

Houston, TX 77002

1100 Poydras St.

New Orleans, LA 70163-3000

504-569-2030

COUNSEL FOR ISSUER DEFENDANTS

Thomas K. Potter

Jones, Walker, Waechter, Poitevent

Carrere & Denegre, LLP

201 St. Charles Ave.

New Orleans, LA 70170

504-582-8000

COUNSEL FOR UNDERWRITER DEFENDANTS

________________________

Mark Pennington

CERTIFICATE OF COMPLIANCE WITH FRAP 32(a)(7)

I hereby certify that the brief of appellee Securities and Exchange

Commission complies with FRAP 32(a)(7). It is produced in 14 point Times New

Roman type, and contains 5624 words, as counted by the word processing program

Corel WordPerfect 9.

________________________

Mark Pennington