Amicus Curiae Brief — Gustafson v. Alloyd Co.

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JUN 29 1994

OLERS

edie

‘tn the Supreme Court of the Cnied rates q

OcToser TERM, 1993 : —

ARTHUR L. GUSTAFSON, ET AL., PETITIONERS ae

vy. | ; ce z

ALLOYD Co., INC., ET AL.

ON WRIT OF CERTIORARI mn.

TO THE UNITED STATES COURT OF APPEALS ,

> Fd .

ls BRIEF FOR THE SECURITIES AND EXCHANGE COMMISSION x

e. AS AMICUS CURIAE SUPPORTING RESPONDENTS

Drew S. Days, Ill “a

Solicitor General 2

SIMON M. LORNE . EDWIN S. KNEEDLER

PAUL GONSON MICHAEL R. DREEBEN a.

Solicitor Assistant to the Solicitor = 5

: iw D. BELLA! Washington, D.C. 20530

(202) 514-2217

QUESTION PRESENTED

Whether Section 12(2) of the Securities Act of 1933 is ap-

plicable to a privately negotiated resale of all the stock of a cor-

poration.

(I)

TABLE OF CONTENTS

Page

Interest of the Securities and Exchange Commission . . . l

| PITT TT EET ULIL ITE LITE TELE 2

ea 3

Argument:

Section 12(2) of the Securities Act of 1933 is ap-

plicable to the stock purchase agreement in this

A. The language of Section 12(2) covers private

sales and resale transactions as well as initial

ED GIONS ov oicceciccccccccccccccds 6

B. The structure of the Securities Act confirms

the scope of Section 12(2)’s coverage ........ 12

C. The textual reading of Section 12(2) is sup-

ported by the provision’s legislative back-

ground ‘and subsequent history ............ 15

D. Policy considerations provide no basis for a

narrow application of Section 12(2) ........ 23

Sa bis Sidhe ch WES He BEL BCA eeU Tere 0 cee. 26

EE Seate na Cbs wires web bee ds bide cos occ devs la

TABLE OF AUTHORITIES

Cases:

Aaron v. SEC, 446 U.S. 680 (1980) .............. "18

Adalman v. Baker, Watts & Co., 807 F.2d 359 (4th

ho GUUS s ecdeouwhic 02.05.04 23

Ballay v. Legg Mason Wood Walker, Inc., 925

F.2d 682 (3d Cir.), cert. denied, 112 S. Ct. 79

EES AE a ae ne 2, 14, 23

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

Beecham v. United States, 114 S. Ct. 1669 (1994) .. 7)

(III)

a .

F 4

ia? - . . ow war es — a 26 ‘ ry ie ieee Fd ail ,

ie tte i» i ee ia iD nT Tees ee sa ee ee ee yo ™

Cases — Continued:

Central Bank of Denver v. First Interstate Bank

of Denver, 1148S. Ct. 1439 (1994) .............

First Union Discount Brokerage Services, Inc. v.

Milos, 997 F.2d 835 (Lith Cir. 1993) ...........

Gould v. Ruefenacht, 471 U.S. 701 (1985) ........

Haralson v. E.F. Hutton Group, Inc., 919 F.2d

TS BUEN C60 p 6 2k Hc 6 bb don Cdcstcdiea

Herman & MacLean v. Huddleston, 459 U.S. 375

GN RPC Rb eels d cUceSis Seccbcceiee Gi dee

Jarecki v. G.D. Searle & Co., 367 U.S. 303

SY & oectuneecedanwe ik ebesteeuesi sects.

Lampf, Pleva, Lipkind, Prupis & Petigrow v. Gil-

bertson, 111 S. Ct. 2773 (1991) ...............

Landreth Timber Co. v. Landreth, 471 U.S. 681

di fa ek oa eel ee eo

Metromedia Co. v. Fugazy, 983 F.2d 350 (2d Cir.

1992), cert. denied, 113 S. Ct. 2445 (1993) ......

Musick, Peeler & Garrett v. Employers Insurance

of Wausau, 113 S. Ct. 2085 (1993) ............

National Organization for Women, Inc. v. Scheid-

i ee atéa

Nor-Tex Agencies, Inc. v. Jones, 482 F.2d 1093

(Sth Cir. 1973), cert. denied, 415 U.S. 977

GPE cinedintentesdadedchvedseteheosseehs

Pacific Dunlop Holdings, Inc. v. Allen & Co., 993

F.2d 578 (7th Cir. 1993), cert. granted, 114S. Ct.

Page

907, cert. dismissed, 114S. Ct. 1146(1994) .... 3, 22, 23

Pawgan v. Silverstein, 265 F. Supp. 898 (S.D.N.Y.

SUE WF chalbbhctocs cd bob aserGebccene boc cvc’s

Pinter v. Dahil, 486 U.S. 622 (1988) .............

Rodriguez de Quijas v. Shearson/American, Ex-

press, Inc., 490 U.S. 477 (1989) .... 2.2.0.6 6

Russell Motor Car Co. v. United States, 261 U.S.

PE aktecidcccedcecoassetiansadtanes

SEC v. Ralston Purina Co., 346 U.S. 119 (1953) ..

Cases — Continued: Page

Securities Industry Association v. Board of Gover-

nors of the Federal Reserve System, 468 U.S.

Be Ge oh0khe0dukce ss) csc dedancchuwiss ar 9

United Housing Foundation, Inc. v. Forman, 421

Sh Be ED os onbaiho bonnets bvedades db as 24

United States v. Naftalin, 441 U.S. 768 (1979) .... 11, 17

Wilko v. Swan, 346 U.S. 427 (1953) ............. 23

Woodward v. Wright, 266 F.2d 108 (10th Cir.

SOD cincddned icetetts he cittniasiabntenr 23

Wright v. National Warranty Co., 953 F.2d 256

Sy HEED 06. 6 00 c Webeide dond dbdeb deed chee 23

Statutes and regulations: —

Act of Aug. 10, 1954, ch. 667, § 3, 68 Stat. 683 ... 8

Investment Company Act of 1940, 15 U.S.C. 80a-1

et seq.:

§ 2(31), 15 U.S.C. 80a-2(31) ............... 11

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

OR BETES. FOP cccceestlbsdes cotewsecs 10

§ 2(10), 15 U.S.C. 77b(10) ........... 6, 7, 8, 10, la

§ 2(10)(a), 15 U.S.C. 77b(10)(a) ............ la

§ 2(10)(b), 15 U.S.C. 77b(10)(b) ........ la

Se ME oR Suns kp dude cseon coente 11

§ 3(aX(2), 15 U.S.C. 77e(a(2) ............. 6, 11, 19

Fe 4 Fes are 12, 13, 16

Fe Ye fF 4 ee ee 12

cr & C's | wy . Re foe 12, 13

Tf & | 8 ay Ferree 12, 13 ©

SD cen anedebbisces oda 7, 12, 13, 16

§ S(ay(1), 15 U.S.C. 7Jef{ap(l) ...... 2.6.0.6. 10

§ 5(b)(1), 15 U.S.C. 77e(b)(1) ..... 2... eee 10

PEE WEEE abcd cccvocccccceséapn 7, 10, 19

§ 10(a), 15 U.S.C. 77jfa) ....... 2... eee eee 10

Statutes and regulations — Continued: Page

AE Se eee 10

DBR Be te BUR 6 os ecoccvasy 14, 15, 16, 17, 24

Re AS Gikwenecacecssbidadi 14, 16, 17

SD ES SEED sic W, ciccetd indeed 14, 17

gf “~ , ) cy . SRE Selaee sper oes. passim

DE Ds el iivdivc cc oes ctcivccde 14

SD Pe che debb Goi cctiesedebs 4, 15,17

§ 17(a), 15 U.S.C. 77q(a) ............ 11, 12, 13, 19

Securities Exchange Act of 1934, 15 U.S.C. 78a ef

GEE WSs GCP eeN CRONE AT eC eU Eee cco ck cceodstéen 13, 18

es GPs DUI ocle'c cp'evcccevecceuc 24

Sie PEED 0 occ Wee cd vabeccide 24, 25

PE, BP is FUMED vec cccticcbweosedes 24

British Companies Act, 19 & 20 Geo. 5, ch. 23

EE ib AG aku i> dbs c cubes ch biowend 7

is tie ole ede be band oid 8

17 C.F.R.:

I nu kn odd uctiscadedesiewsn 25

RNS, ERP EE Ser ee cee, 24

Miscellaneous:

Black’s Law Dictionary (3d ed. 1933) ............ 7

3A Harold Bloomenthal, Securities and Federal

I rr er eer ee 22

2 Alan Bromberg & Louis Lowenfels, Securities

Fraud and Commodities Fraud (1992) ......... 22

Comment, Applying Section 12(2) of the 1933

Securities Act to the Aftermarket, 57 U. Chi.

ep EE db dnite dhs adoh av cee oh dec 22

Confidential Committee Print No. | (Apr. 19,

Sere ss CLS eee. Fo 15-16

Confidential Committee Print No. 1 (Apr. 21,

PP ARNE CEN des ncicc¥ee weccecctobsdcnes 16

FE es SD UD cetcccccceoccecoseses 16

Vil

Miscellaneous — Continued: Page

78 Cong. Rec. 8675-8695 (1934) ...........0065. &

Congressional Digest, Should the Federal Securities

Act of 1933 be Modified? (May 1934) ......... 21

Arthur Dean, As Amended: The Federal Securities

Act, 10 Fortune 80 (1934) ...............0.55. 20

Arthur Dean, The Federal Securities Act: I, 8

PORE FEE ch ncctncteneccds onncineee 20

William O. Douglas & George E. Bates, The Fed-

eral Securities Act of 1933, 43 Yale L.J. 171

GUDOED. ccccccccscccescsvseapecescesencvcess 19

Effective Dates of Securities Act of 1933 Are Ex-

plained, Securities Act of 1933, Rel. No. 3, 1933

SEC LEXIS 8 (June 2, 1933) .............055. 19

11 Fed. Reg. 10,964 (1941)... 2.0... cc cece ee 10-11

Felix Frankfurter, The Federal Securities Act: Il,

I «5 vase shine ose cocceas>. 20

H.R. 4314, 73d Cong., Ist Sess. (1933) .......... 15

H.R. 5480, 73d Cong., Ist Sess. (1933) .......... 15, 16

H.R. Conf. Rep. No. 152, 73d Cong., Ist Sess.

Ee ey > ee puiciat ini 64 15, 18, 19

H.R. Rep. No. 85, 73d Cong., Ist Sess. (1933) .. 15, 17, 18

1 Thomas Hazen, The Law of Securities Regulation

of SB Pe reper or re eee et ee 22

17A J. William Hicks, Civil Liabilities: Enforce-

ment and Litigation Under the 1933 Act (1993) . . 22

1.B.A. Head Hits Securities Bill, Wall St. J., May

OR RN oSd 6 cobs picdUcetedstivcdibce sce 16

Investment Bankers Association of America ef al.,

Report on the Conferences with the Securities

and Exchange Commission and its Staff on Pro-

posals for Amending the Securities Act of 1933

and the Securities Exchange Act of 1934 (1941) . . 21

Investment Bankers Association Memorandum of

PT Ts BED 8c oben cconsspoeveccsccvcoccsioes 16

Vill

Miscellaneous — Continued:

James M. Landis, The Legislative History of the

Securities Act of 1933, 28 Geo. Wash. L. Rev. 29

(RFSOD 0c nhc this vn she Kies atiodesed Cites bes 7,

Louis Loss, Securities Act Section 12(2): A Rebut-

tal, 48 Bus. Law. 47 (1992) .......0.000.000084

Louis Loss, Securities Regulation (1951) .........

3 Louis Loss, Securities Regulation (1961) ........

Louis Loss & Joel Seligman, Securities Regulation:

POs FOE Sch ccccsccdciedpicunive

Vas WOOD ME ae icccccccvveccvebrede

Therese Maynard, Section 12(2) of the Securities

Act of 1933: A Remedy for Fraudulent Post-

distribution Trading?, 20 Sec. Reg. L.J. 152

GEESE wekbceseeeeeeabibscateceeeacieesc cl.

Opinion of General Counsel Concerning the Appli-

cation of the Third Clause of Section 4(1) in

Various Situations, Securities Act of 1933,

Rel. No. 2623, 1941 SEC LEXIS 346 (July 25,

COED dds» eintinias det nahes cnc awed cheats > 6a

Robert Prentice, Section 12(2): A Remedy for

Wrongs in the Secondary Market?, 55 Alb. L.

Bs Se te

Proposed Amendments to the Securities Act of

1933 and the Securities Exchange Act of 1934:

Hearings on H.R. 4344, H.R. 5065, and H.R.

5832 Before the House Comm. on Interstate and

Foreign Commerce, 77th Cong., Ist Sess. Pt. 1

SEE Soh pbbeadsubisdveksarchbbsat ede cose.

Robert F.’ Quaintance, Jr., Getting Comfortable

with “Public-Style” Rule 144A Offerings, \n-

es SEE cath do ndes ddubdbonbs ab abadse

Page

14, 15

Miscellaneous — Continued:

Robert Rapp, The Proper Role of Securities Act

Section 12(2) as an Aftermarket Remedy for Dis-

closure Violations, 47 Bus. Law. 711 (1992) ....

Report of the Committee on Securities Regulation

of the Chamber of Commerce of the United

Bonde EG. TIO oo ios c cvcvevccvcsveccevens

Report of the Special Committee on Amendments

to the Securities Act of 1933, 59 Rep. A.B.A.

SE ob CA Shs. ch 6 COSA ew Ste ce ndoowsones

S. 875, 73d Cong., Ist Sess. (1933) ..........0065

S. Rep. No. 47, 73d Cong., Ist Sess. (1933) .......

Securities Act of 1933, Rel. No. 54, 1933 SEC

LEXIS 59 (Oct. 13, 1933)... 0.0... cc eee ees

Harry Shulman, Civil Liability and the Securities

Act, 43 Yale L.J. 227 (1933) .........- cee eee,

Staff of House Comm. on Interstate and Foreign

Commerce, 77th Cong., Ist Sess., Report of the

Securities and Exchange Commission on the Pro-

posals for Amendments to the Securities Act of

1933 and the Securities Exchange Act of 1934

(Comm. Print 1961)... ccccccccccccesvvcces

Uniform Securities Act § 410(a)(2), 7B U.L.A.

ol. a er oe MEE OARS pO LE FR

Elliot Weiss, The Courts Have It Right: Securities

Act Section 12(2) Applies Only to Public Offer-

ings, 48 Bus. Law. 1 (1992)... ee ee ees

Page

In the Supreme Court of the United States

OCTOBER TERM, 1993

No. 93-404

ARTHUR L. GUSTAFSON, ET AL., PETITIONERS

Vv.

ALLOYD Co., INC., ET AL.

ON WRIT OF CERTIORARI

TO THE UNITED STATES COURT OF APPEALS

FOR THE SEVENTH CIRCUIT

BRIEF FOR THE SECURITIES AND EXCHANGE COMMISSION

AS AMICUS CURIAE SUPPORTING RESPONDENTS

INTEREST OF THE SECURITIES AND

EXCHANGE COMMISSION

The Securities and Exchange Commission (SEC or Commis-

sion) is responsible for the administration and enforcement of

the federal securities laws. This case involves the scope of Sec-

tion 12(2) of the Securities Act of 1933, 15 U.S.C. 77/2), the ex-

press private right of action for the sale of securities by means of

materially false or misleading representations. Private actions

under the securities laws serve as a necessary supplement to

Commission enforcement actions and provide compensation to

injured investors. The Commission therefore has an interest in

this case.

(1)

STATEMENT

1. In 1989, petitioners, the shareholders of Alloyd Co. (Old

Alloyd), a manufacturer of clear plastic blister packaging and

heat seal packaging equipment, decided to sell the company.

Petitioners retained KPMG Peat Marwick to solicit potential

purchasers. In response to the solicitation, respondent Wind

Point Partners II (Wind Point) expressed interest in acquiring

Old Alloyd. Following negotiations, Wind Point formed a cor-

poration called Alloyd Holdings, Inc., as a vehicle for acquiring

the stock of Old Alloyd. J.A. 10-11. Alloyd Holdings, Inc., and

petitioners then entered into a stock purchase agreement. J.A.

87-161. On December 20, 1989, the transaction closed, and the

name of the new company was changed to respondent Alloyd

Co.,; Inc. J.A. 12.

By February 1990, respondents learned that Old Alloyd’s

1989 earnings and year-end book value were significantly less

than the estimates used to calculate an adjustment payment at

closing. J.A. 12. That discrepancy led to the instant litigation.

2. On February 11, 1991, respondents commenced an action

against petitioners alleging a claim under Section 12(2) of the

Securities Act of 1933 (Securities Act or Act), 15 U.S.C. 772),

and a breach of contract claim. J.A. 12, 23-36, 81. The com-

plaint alleged that petitioners materially overstated Old Alloyd’s

1989 earnings, both orally and in the stock purchase agreement.

As relief, respondents sought to rescind the sale of Old Alloyd’s

stock. J.A. 32-33.

The district court granted summary judgment in favor of peti-

tioners and dismissed the complaint. J.A. 10-22. Relying on

Ballay v. Legg Mason Wood Walker, Inc., 925 F.2d 682 (3d

Cir.), cert. denied, 112 S. Ct. 79 (1991), the court held that Sec-

tion 12(2) applies only to initial public distributions of stock,

not to aftermarket trading. J.A. 20. The court also concluded

that the transaction was not comparable to an initial offering,

because the transaction had occurred about 30 years after Old

Alloyd had originally issued its «tock, and that, “unlike pur-

chasers in most initial offerings, the purchasers in this case had

direct access to financial and other company documents, and

had the opportunity to inspect the seller’s property.”!' J.A. 21.

3. While respondents’ appeal was pending, the court of ap-

peals issued its decision in Pacific Dunlop Holdings, Inc. v.

Allen & Co., 993 F.2d 578 (7th Cir. 1993), cert. granted, 114 S.

Ct. 907, cert. dismissed, 114 S. Ct. 1146 (1994). In that case, the

court of appeals rejected the reasoning of Ballay and held,

based on the language, structure, and legislative history of the

Securities Act, that Section 12(2) applies not. only to initial

public distributions of securities, but also to secondary trans-

actions, including a privately negotiated stock purchase agree-

ment. 993 F.2d at 595. Based on its holding in Pacific Dunlop,

the court of appeals granted respondents’ motion to vacate the

district court judgment and to remand the case for further pro-

ceedings. J.A. 8-9.2 © :

SUMMARY OF ARGUMENT

- Section 12(2) of the Securities Act of 1933 provides a private

remedy for false-or misleading statements used by any person

who offers or sells a security “by means of a prospectus or oral

communication.” The Act specifically defines “prospectus” to

include “any prospectus, notice, circular, advertisement, letter,

or communication, written or by radio or television, which of-

fers any security for sale.” In light of the definition of “prospec-

tus,” Section 12(2) covers all communications in securities sales,

whether public or private, initial or secondary. Nothing in the

text of the Act limits Section 12(2) to initial public distributions

or exempts private or secondary market sales from that express

remedy. Nor does the context of the Act support a departure

from the defined term “prospectus” as used in Section 12(2).

The statutory structure strongly reinforces the conclusion

that Section 12(2) is applicable to misrepresentations and mis-

' Having dismissed the Section 12(2) claim, the court held that it lacked

jurisdiction over the breach of contract claim. J.A. 21-22.

2 On remand, a magistrate recommended, in light of Pacific Dunlop, that

petitioners’ motion for summary judgment on the Section 12(2) claim be

denied. J.A. 81-86.

leading statements in all types of securities sales. Congress

carved out exemptions for private sales and for ordinary after-

market trading from the registration requirements of the Act.

No similar exemption, however, was applied to Section 12(2).

That provision, like the antifraud provision enforced by the

government, was made applicable to all types of securities trans-

actions.

- Contrary to petitioners’ contention, the legislative history af-

fords no basis for restricting Section 12(2) to initial public distri-

butions. The drafting history of the Securities Act indicates, in

fact, that Section 12(2) was deliberately freed from exemptions

for private and aftermarket transactions that apply elsewhere in

the Act. While the committee reports make clear that the prin-

cipal focus of the Securities Act was on regulation of initial

public distributions, that was by no means the only focus of the

Act. The reports thus provide no basis for overriding the scope

of Section 12(2) suggested by its language and the Act’s struc-

ture. And Section 12(2)’s application beyond initial public

distributions is confirmed by contemporaneous commentators

and the consistent view of administrators of the Act.

Finally, policy concerns do not justify limiting Section 12(2)

to initial or public transactions. This Court has declined to con-

sult the general purposes of the Act when the meaning of

specific provisions can be determined from text, structure, and

history. In any event, the claim that Section 12(2) is unnecessary

in private transactions is unfounded; to the extent that Congress

believed that a relaxed form of regulation of private transac-

tions is appropriate, it provided that relief by exempting private

transactions from registration. And, to the extent that policy

concerns are raised by applying Section 12(2) to sales in the

public securities markets, the remedy for those concerns is

legislative or administrative action; the courts cannot fashion

exceptions to statutory provisions solely to accommodate per-

ceived policy considerations.

ARGUMENT

SECTION 12(2) OF THE SECURITIES ACT OF 1933 IS AP-

PLICABLE TO THE STOCK PURCHASE AGREEMENT IN

THIS CASE

From the enactment of the Securities Act of 1933 until the

1980s, it was well accepted that Section 12(2) applies not only to

initial public distributions, but also to aftermarket sales and pri-

vately negotiated transactions. That view has long been held by

the Commission; it is based in the language of Section 12(2),

which covers all types of securities sales made by means of false

or misleading written or oral communications; and it accords

with the statute’s structure and background. In the courts

below, petitioners’ main contention was that Section 12(2) is

limited to initial distributions and does not cover resale transac-

tions. In this Court, petitioners have shifted ground somewhat

and now argue that Section 12(2) does not apply to privately

negotiated transactions, such as the transaction in this case.‘ In

our view, both of those interrelated contentions are incorrect:

Section 12(2)’s remedy applies to false or misleading statements

in the sale of securities, whether the sale involves an initial

distribution to the public, a secondary transaction in the after-

market, or a privately negotiated sale.’

> See Defendants’ Memo. In Support Of Mot. For Summary Judgment

(filed Oct. 31, 1991, see J.A. 1), at 11-12 (“[T]he sale of Alloyd shares to

Holdings was a negdtiated resale—a secondary market transaction —not a

primary or initial offering of securities. Section 12(2) applies only to material

misrepresentations or omissions in the course of a pr. ary or initial offering

of securfttes to the public. Ballay v. Legg Mason Wood Walker, Inc. * * *.”).

« We note that the question presented by the petition encompasses not only

the issue of whether Section 12(2) applies to a “privately negotiated” sale of all

of a company’s stock, but also whether it applies to “resale” transactions. Pet.

i. In their merits brief, petitioners have narrowed the question presented to

focus on whether Section 12(2) applies to private negotiated transactions. Pet.

Br. i. While the courts of appeais have divided on whether Section 12(2) ap-

plies to secondary trading in the aftermarket, there is no circuit split on

whether Section 12(2) applies to private transactions; the courts have uniform-

ly held that Section 12(2) does apply to private transactions. See note 29, infra.

’ The Act does not contain definitions that explicitly distinguish among

various types of securities transactions that Section 12(2) covers. It is generally

A. The Language Of Section 12(2) Covers Private Sales And

Resale Transactions As Well As Initial Public Distributions

1. Section 12(2) of the Securities Act states that “[aJny per-

son who * * * offers or sells a security * * * by means of a pro-

spectus or oral communication” containing a material misrepre-

sentation or omission is liable to the purchaser for rescission of

the transaction or for dama,*s. 15 U.S.C. 7742). Section 2(10)

of the Act defines “prospecius” to mean “any prospectus,

notice, circular, advertisement, letter, or communication, writ-

ten or by radio or television, which offers any security for sale.”

1S U.S.C. 77b(10). The text of those provisions establishes a

private remedy for misrepresentation that comprehensively

covers securities sales.°®

Nothing in Section 12(2)’s language restricts the provision’s ap-

plication to securities’ sales in initial or public transactions. The

provision applies to all written or oral communications used in

offers or sales of securities — with a single express exception. The

Act provides that Section 12(2) does not apply to securities that

are exempted from the Act by Section 3(a)(2), 15 U.S.C.

77c(aX(2), which, generally speaking, are securities issued or

guaranteed by the United States, a State, a municipality, or

government instrumentality, and securities issued by national or

state banks. Apart from sales involving those exempt securities,

Congress did not restrict the remedy provided in Section 12(2) to

particular types of securities sales or transactions.

Petitioners seek to limit Section 12(2)’s broad coverage by

relying on the term “prospectus,” which, in their view, refers

only to a document used by an issuer to “solicit investments

understood, however, that an “initial offering” of securities is a sale of

securities by the issuer and a “secondary” sale is a subsequent transaction. Ini-

tial offerings are, generally speaking, of two types— public and private. An

“initial distribution” is understood to be a public offering of securities by the

issuer; a “private placement” is an issuer's sale of its securities not involving a

public offering. Secondary sales aso guncsaly slither public session of cisieh on

organized securities markets or private resales.

® The texts of Sections 2(10) and 12(2) of the Securities Act are set out in the

appendix to this brief.

from public investors,” and which therefore has the effect of

limiting Section 12(2) to initial public offerings. Pet. Br. 17; see

Securities Industry Association, Inc. (SIA) Amicus Br. 4-9. As

defined in the Act, however, the word “prospectus” has a wider

significance. Section 2(10) does define the term “prospectus” to

include “any prospectus” — and thus to include a document pre-

pared by or on behalf of an issuer to solicit the public to pur-

chase securities. See, e.g., Black's Law Dictionary 1451 (3d ed.

1933). Section 2(10), however, also defines a prospectus to in-

clude “any * * * notice, circular, advertisement, letter, or com-

munication * * * which offers any security for sale.” While one

of the functions of that |ist is to prevent issuers from circum-

venting the Act by calling a “prospectus” by another name, see

SIA Amicus Br. 7, the origins of Section 2(10) indicate that

Congress intended the defined term “prospectus” to go beyond

documents used in public distributions. ’

The poini of departure for the drafters of the Securities Act

was the British Companies Act, 19 & 20 Geo. 5, ch. 23 (1929).

See James M. Landis, The Legislative History of the Securities

Act of 1933, 28 Geo. Wash. L. Rev. 29, 34 (1959) (the drafters

of the Act “determined to take as the base of our work the

English Companies Act”);* see also SEC v. Ralston Purina Co.,

346 U.S. 119, 123 (1953) (characterizing the Companies Act as

’ Under the regulatory scheme of the Act, a public offering of securities by

an affiliate of the issuer through an underwriter is required to be registered

under Section 5 of the Act, and the Act requires the use of a formal prospec-

tus, described in Section 10 of the Act, in the offer or sale of those securities.

15 U.S.C. 77e, 77}. Thus, even in its narrowest usage, a formal prospectus is

not limited to a document used in offers or sales by the isswer, but also in-

cludes public sales by affiliates as well.

* Shortly after President Roosevelt sent a message to Congress urging the

adoption of securities legislation, Representative Sam Rayburn, through the

White House, requested assistance in drafting a bill. Landis, who was in 1933

a professor at Harvard Law School and who was later to become Chairman of

the Securities and Exchange Commission, was requested by then-professor

Felix Frankfurter to prepare a draft bill. Landis, along with Benjamin V.

Cohen and Thomas G. Corcoran, took principal responsibility for preparing

the initial draft of the House bill; that bill formed “|t}he core of the Securities

Act of 1933.” James M. Landis, supra, 28 Geo. Wash. L. Rev. at 33-34.

a “statutory antecedent[ }” of federal securities laws); 78 Cong.

Rec. 8675-8695 (1934) (reprinting in parallel columns the com-

paraiie provisions of the Securities Act and Companies Act).

The Companies Act defined “Prospectus” to mean “any pro-

spectus, notice, circular, advertisement, or other invitation, of-

fering to the public for subscription or purchase any shares or

debentures of a company.” 19 & 20 Geo. 5, ch. 23, § 380(1)

(1929). The drafters of the s*-urities Act borrowed the first four

terms in the definition ©f prospectus” from the Companies

Act, but then departed from it significantly. Rather than

limiting the term “prospectus” to an “offering to the public,” as

did the Companies Act, the Securities Act drafters omitted that

language and instead added the expansive phrase “any * * * let-

ter, or communication * * * which offers any security for sale.”

The new formulation suggests that, in deliberate contrast to the

Companies Act, the drafters of the Securities Act wanted the

term “prospectus” to include more than documents used in

public offerings.°

In an effort to confine Section 2(10) to documents soliciting

the public in an initial offering, petitioners invoke the canon

noscitur a sociis, “a word is known by the company it keeps.”

Jarecki v. G.D. Searle & Co., 367 U.S. 303, 307 (1961). Accord-

ing to petitioners, all of the words in Section 2(10) should be

read as applying only to initial public distributions because one

of them (i.e., “prospectus”) is so limited. Pet. Br. 19-21; see SIA

Amicus Br. 7-8. The canon on which petitioners rely is inappli-

cable here. The listed terms in Section 2(10) inciude such diverse

forms of offering a security for sale as notices, circulars, adver-

tisements, letters, written communications, and radio communi-

cations. To give all of those terms the narrow connotation asso-

ciated with the word “prospectus” stands noscitur a sociis on its

head: it is to construe every word in a list narrowly because of

* In 1954, Congress added two additional terms to the definition of “pro-

spectus”: “television” communications and communications that “confirm{ |

the sale of any security.” Act of Aug. 10, 1954, ch. 667, § 3, 68 Stat. 683.

Those additions confirm Congress's intention to embrace all forms of com-

munication that Occur in securities sales. -

the meaning of just one of its words. This Court has declined to

make such use of the canon of noscitur a sociis. See Russell

Motor Car Co. v. United States, 261 U.S. 514, 519 (1923) (re-

jecting argument that “inasmuch as the application of [one

word in a statutory list] must be confined to private contracts,

the other words associated with it must be likewise

restricted”). '° ‘

While Congress could have used other phrases in Section

12(2) to express an intention to cover all communications that

offer a security for sale, see Pet. Br. 21; SIA Amicus Br. 9, the

phrase “prospectus or oral communication” was a useful way to

underscore that Congress intended to cover not just written

communications, but also broadcasts and oral statements. Nor

should the phrase “prospectus or ora! communication” in Sec-

tion 12(2) be limited to initial or public transactions on the

theory that the phrase would otherwise be superfluous.'' Pet.

Br. 22. The Securities Act is characterized by the use of phrases

'© Noscitur a sociis has its greatest claim to application in response to a par-

ty’s assertion that one word in a list should be given a meaning that is unrelated

to the connotations shared by all of the words on the list. For example, in

Jarecki the Court considered a statute that gave special tax treatment to any

income resulting from “exploration, discovery, or prospecting”; the taxpayer

asserted that a new drug constituted a “discovery.” 367 U.S. at 307. The Court

rejected that reading of “discovery,” observing that the words “in conjunction

* * * all describe income-producing activity in the oil and gas and mining in-

dustries, but it is difficult to conceive of any other industry to which they all

apply.” /bid. Similarly, in Securities Industry Association v. Board of Gover-

nors of the Federal Reserve System, 468 U.S. 207, 218 (1984), the Court con-

strued the phrase “public sale” in light of the accompanying words “issue,

flotation, underwriting * * * or distribution,” which all have the common

feature of relating to underwriting activity. See also Beecham v. United States,

114 S. Ct. 1669, 1671 (1994). Here, the words in the list — prospectus, notice,

circular, advertisement, letter, written communication, and radio communica-

tion —do not all share the characteristic of being restricted to initial or public

transactions.

'! Petitioners refer to Section 410(a\(2) of the Uniform Securities Act, 7B

U.L.A. 643 (1985), which omits the phrase “by means of a prospectus or oral

communication,” as an example of how Congress might have drafted Section

12(2) more efficiently if it had desired the Section to reach beyond initial

public offerings. Pet. Br. 21. But the principal drafter of the Uniform Act has

intended to denote breadth and emphasis, even if a briefer for-

mulation might have been available. See, e.g., Section 5(a)(1) of

the Act, 17 U.S.C. 77e(a)(1) (prohibiting the selling of un-

registered securities “through the. use or medium of any prospec-

tus or otherwise”). The argument that the statute could have

been drafted more concisely does not justify overriding Con-

gress’s use of expansive terms; it would be paradoxical to view

Section 12(2) as covering only a narrow range of transactions,

when Congress used a group of words with a range of meanings

in Section 2(10) to define the term “prospectus” inclusively.

2. Section 2 of the Act states that its definitions are appli-

cable “unless the context otherwise requires.” 15 U.S.C. 77b.

Nothing in the context of Section 12(2) or the balance of the Act

requires a departure from the definition of “prospectus” for

purposes of Section 12(2). Some sections of the Act do use the

word “prospectus” to refer, in context, to the formal selling

documents associated with registered offerings of securities. For

example, Section 10(a), 15 U.S.C. 77j(a), refers to “a prospectus

[that] * * * shall contain the information contained in the regi-

stration statement”; Section 10(b), 15 U.S.C. 77j(b), refers to

“la] prospectus * * * filed as part of the registration statement”;

and Section 5(b)(1), 15 U.S.C. 77e(b)(1), refers to “any prospec-

tus relating to any security with respect to which a registration

statement has been filed under this title, unless such prospectus

meets the requirements of Section 10.”

The distinction between “prospectus” as broadly defined in

the Act to mean every kind of written communication that of-

fers a security for sale, on the one hand, and a formal prospec-

tus meeting the requirements of Section 10, filed by the issuer

with its registration statement, on the other, has long been

recognized. See, e.g., Opinion of General Counsel Concerning

the Application of the Third Clause of Section 4(1) in Various

Situations, Securities Act of 1933, Rel. No. 2623, 1941 SEC

LEXIS 346, at *4-*6 (July 25, 1941), reprinted at 11 Fed. Reg.

explained that Section 410(a)(2) has the same meaning as Section 12(2), and

that Section 12(2) applies to all types of securities sales. Louis Loss, Securities

Act Section 12(2): A Rebuttal, 48 Bus. Law. 47, 51-52 (1992).

10,964 (1941) (“[T]he term ‘prospectus’ as used in the Securities

Act covers more than the kind of formal document which the

layman ordinarily has in mind when he uses the term.”). Con-

gress explicitly recognized that distinction in the definition of

“prospectus” in Section 2(31) of the Investment Company Act

of 1940, 15 U.S.C. 80a-2(31):

“Prospectus,” as used in [section 22 of the Investment

Company Act], means a written prospectus intended to

meet the requirements of section 10(a) of the Securities Act

of 1933 * * * and currently in use. As used elsewhere,

“prospectus” means a prospectus as defined in the Securi-

ties Act of 1933. |

In contrast to other sections of the Act, Section 12(2) does not

contain language restricting “prospectus” to documents filed in

connection with registered offerings. In fact, Section 12(2) ex-

plicitly covers securities and transactions that are exempt from

registration.'? As to those exempt securities and transactions,

“prospectus” in Section 12(2) necessarily includes communica-

tions other than those used in initial public offerings registered

under the Act, because registration and the use of a formal pro-

spectus are not required for those securities and transactions.

The context of the Act as a whole provides no greater justifi-

cation for a limitation of Section 12(2) to public or initial sales.

While a principal purpose of the Act is to regulate initial public

offerings, see Pet. Br. 32-36, this Court recognized in United

States v. Naftalin, 441 U.S. 768, 777-778 (1979), that the Act

has other significant purposes as well. In Naftalin, the Court re-

jected the argument that Section 17(a) of the Act, 15 U.S.C.

'2 Section 12(2) applies to “a security (whether or not exempted by the pro-

visions of [Section 3}, other than [Section 3(a)(2)}).” Section 12(2) thus ex-

plicitly applies to all but one of the categories of exempt securities in Section 3,

15 U.S.C. 77(c), including, inter alia, short term commercial paper, securities

issued by charitable or non-profit enterprises, securities of certain savings and

loan associations, securities subject to regulation by the Interstate Commerce

Commission, and securities issued by a bankruptcy trustee, as well as to tran-

sactions exempted by Section 4. Section 12(2) is inapplicable only to govern-

ment and bank securities and other securities specifically enumerated in Sec-

tion Ma)(2).

77q(a), the antifraud provision enforced by the government, does

not apply to aftermarket trades because the Act was “ ‘preoccu-

pied with’ the regulation of initial public offerings of securities,

and * * * Congress waited until the Securities Exchange Act of

1934 to regulate abuses in the trading of securities in the ‘after-

market.’ ” 441 U.S. at 777. While recognizing that the Act is “pri-

marily concerned” with new offerings, id. at 777-778, the Court

noted that the Act is not limited to that purpose, and that Section

17(a) “was intended to cover any fraudulent scheme in an offer or

sale of securities, whether in the course of an initial distribution

or in the course of ordinary market trading.” /d. at 778. Section

12(2), like Section 17(a), addresses misstatements in connection

with the sale of securities, and Naftalin’s observation about Sec-

tion 17(a) is equally applicable here: the provision “makes no

distinction between” initial public distributions and sec ondary

market sales. 441 U.S. at 778.

B. The Structure Of The Securities Act Confirms The Scope Of

Section 12(2)'s Coverage

The application of Section 12(2) to private transactions and

market trading, as well as to initial public distributions, draws

significant support from the structure of the Securities Act.

That structure indicates that, when Congress wished to restrict

the Act’s requirements to initial distributions, it did so through

specific exemptions. No such exemptions are applicable to Sec-

tion i2(2). » af

1. The heart of the Securities Act is the registration require-

ment. Pinter v. Dahl, 486 U.S. 622, 638 (1988). Section 5S(a) of

the Act prohibits the sale of any security “[u)nless a registration

statement is in effect as to [that] security.” 15 U.S.C. 77ef(a).

Section 4, however, expressly exempts from the requirements of

Section 5 both “transactions by an issuer not involving any

public offering,” Section 4(2), 15 U.S.C. 77d(2), and most sec-

ondary sales after an initial public offering, Sections 41), 43),

and 44), 15 U.S.C. 77d(1), (3), and (4).'? If Congress had

') Section 4(1) exempts “transactions by any person other than an issuer,

underwriter, or dealer”; Section 4(3) exempts ordinary trading transactions by

intended to exclude private or secondary market sales from the

reach of Section 12(2), it would have made the Section 4 exemp-

tions applicable, not only to the registration requirement of Sec-

tion 5, but also to the private cause of action under Section

12(2), As this Court reasoned in Landreth Timber Co. v. Lan-

dreth, 471 U.S. 681, 692 (1985), in rejecting the argument that a

private sale of all of a company’s stock was not a transaction in

securities, “although § 4(2) of the 1933 Act, 15 U.S.C. § 77d(2),

exempts transactions not involving any public offering from the

Act’s registration provisions, there is no comparable exemption

from the antifraud provisions.” The “antifraud provisions” in-

volved in Landreth were those in the Securities Exchange Act of

1934, not Section 12(2) of the Securities Act of 1933. See 471

U.S. at 684. A companion case to Landreth Timber, however,

did involve a claim under Section 12(2). Gould v. Ruefenacht,

_ 471 U.S. 701, 703-704 (1985). Gould held, “{fjor the reasons

stated in [the Court’s] decision” in Landreth Timber, that the

stock sale in Gould involved “securit[ies)” within the meaning of

the federal securities laws, notwithstanding the private character

of the transaction. Gould, 471 U.S. at 704.

The drafters of the Act limited the exemption of the transac-

tions identified in Section 4 to the registration requirements in

Section 5 in order to subject those transactions to the private

right of action in Section 12(2), as well as to the antifraud provi-

sion in Section 17(a), which is enforced by the government.

James M. Landis, the Act’s principal drafter, see note 8, supra,

explained that the Section 4 exemptions “are only from Section

5 and not the other provisions of the bill” because:

Upon section 5 is made to depend practically all the lia-

bilities, whether criminal or civil, that fiow from the fact of

non-registration or registration. Dealings in securities may,

however, be violative of the provisions of the bill, even

though they are not related to the fact of registration. (See

e.g. Section 12(b) (sic; Section 12(2)}; Sect. 16 [Section 17

a dealer not involving a distribution; and Section 444) exempts unsolicited

brokers’ transactions executed upon customers’ orders on any exchange or in

the over-the-counter market. 15 U.S.C. 77d(1), (3), and (4).

as enacted]; Sect. 18 [incorporating state blue sky laws,

deleted before enactment].

James M. Landis, Reply to Investment Bankers Association Ob-

jections of May 5, 1933, at 5.'*

2. There is no merit to the view that the structure of the

Securities Act shows that Section 12(2) is concerned only with

initial public offerings and not private or aftermarket sales, be-

cause it is placed after Sections 11 and 12(1), 15 U.S.C. 77k and

771), and before Section 13, 15 U.S.C. 77m, and because that

cluster of provisions deals only with initial distributions. See

Ballay v. Legg Mason Wood Walker, Inc., 925 F.2d 682, 691

(3d Cir.), cert. denied, 112 S. Ct. 79 (1991); SIA Amicus Br.

9-10. Section 13 provides the statute of limitations for the

private rights of action created in Sections 11 and 12; the issue

of whether that provision deals solely with initial public

distributions depends on whether Section 12(2) is so limited.

Section 11 (which imposes liability for false or misleading

registration statements) was placed adjacent to Section 12 be-

cause those provisions contain the Act’s only private rights of

action. And Section 12(2) was placed in the same section as Sec-

tion 12(1) (which imposes strict liability for selling securities in

violation of the Act’s registration requirement) because both

create actions against the seller and both share the same

remedial provisions (i.e., rescission or, if the security has been

sold, damages). The arrangement of those provisions is thus not

indicative of any intention to restrict Section 12(2) to initial or

public distributions. '°

'4 Landis collected various intermediate drafts and other materials pertain-

ing to the legislative history of the Act under the title The Genesis of the 1933

-. Securities Act (Genesis) (Harvard Law School Library). James M. Landis,

supra, 28 Geo. Wash. L. Rev. at 29 n.1. Those materials are also collected in

volumes in the Commission’s library entitled Legislative History of the

Securities Act of 1933, 73d Cong., Ist Sess., 1933, Vols. |-V1 (SEC Legislative

History). Landis’s Reply is reproduced in Genesis, Item No. 33, and in SEC

Legislative History, Vol. 11, Item No. 3.

'S No; does Section 12(2)’s provision of a remedy only for securities pur-

chasers indicate that Congress believed that it was limited to initial public

distributions. Pet. Br. 27. The antifraud provision enforced by the govern-

C. The Textual Reading Of Section 12(2) Is Supported By The

Provision’s Legislative Background And Subsequent History

Because the scope of Section 12(2) can be gleaned from the

language and structure of the Act, only the clearest legislative

history could warrant a departure from that meaning. See, e.z.,

National Organization for Women, Inc. v. Scheidler, 1148S. Ct.

798, 806 (1994). In fact, the legislative drafting process that pro-

duced Section 12(2) lends further support to the conclusion that

the provision does not exempt private or aftermarket trans-

actions. Discussions in committee reports do not contradict that

conclusion, and, significantly, both contemporary commen-

tators and agency officials considered Section 12(2) to cover the

entire range of securities transactions.

1. Evolution of Section 12(2). The drafting history of the

Securities Act makes clear that Congress intended Section 12(2)

to apply to all types of securities sales, not only to public or ini-

tial sales. The bill that eventually became the Securities Act

(H.R. 5480, 73d Cong., Ist Sess. (1933)) was drafted in the

House.'* In early drafts of the House bill, the remedy for mis-

representations in a prospectus was included in Section 11

(which applied only to registered securities) and was limited to .

misrepresentations in a prospectus filed with a registration state-

ment; in addition, private and secondary market sales were

generally exempted from the provisions of the Act.'’ A subse-

ment, Section 17 of the Act, is also limited to frauds in the offer or sale of

securities, but that provision is clearly. applicable to private transactions and

aftermarket trading as well as to initial distributions. See United States v. Naf-

talin, supra.

'® The first House bill (H.R. 4314, 73d Cong., Ist Sess. (1933)) was the Ad-

ministration bill, which was introduced simultaneously with President Roose-

velt’s message to Congress recommending securities legislation. (The message

is quoted in H.R. Rep. No. 85, 73d Cong., Ist Sess. 1-2 (1933)) That bill, like

its Senate counterpart (S. 875, 73d Cong., Ist Sess. (1933)) expressly provided

that the remedy for securities purchasers based on misrepresentations was not

applicable in private or aftermarket transactions. Neither of those bills, how-

ever, formed the basis for the Securities Act or the Section 12(2) remedy that

Congress ultimately enacted. See James M. Landis, supra, 28 Geo. Wash. L.

Rev. at 30-49; H.R. Conf. Rep. No. 152, 73d Cong., Ist Sess. 24 (1933).

'’ Private and aftermarket sales were not exempted from the antifraud pro-

vision enforced by the government. See, e.g., Confidential Committee Print

quent draft of the House bill deleted those limitations on the

private remedy for misrepresentations in a prospectus. The

drafters removed the buyer’s remedy for a false or misleading

prospectus from Section 11 and placed it in Section 12, where it

was not limited to registered securities. And the drafters nar-

rowed the exemptions in Section (including those for private

and aftermarket sales) to become exemptions only from Section

5’s registration and prospectus-delivery requirements. '*

Those simultaneous changes had only one purpose: to make

the buyer’s remedy that is now Section 12(2) applicable to all

types of securities sales. The Investment Bankers Association

(IBA), the SIA’s predecessor, which had participated actively in

commenting on drafts of H.R. 5480, immediately publicized

that fact, stating that Section 12(2)

refers to any sale by anyone in interstate commerce of any

security by means of any prospectus, notice, circular,

advertisement, letter or communication, written or by

radio, or any oral communication. There are no exemp-

tions and no exempted transactions. Every individual, in-

cluding every private investor, comes under this section.

IBA Memorandum of May 5, 1933, at 5 (emphasis omitted)

(Genesis, Item No. 32; SEC Legislative History, Vol. 1V, Item

No. 10). The IBA, with others, spearheaded a campaign to con-

vince the House-Senate Conference Committee not to adopt the

provisions of the pending legislation on this and other points —a

campaign that ultimately failed.'®

2. Legislative history. Particularly in light of that drafting

record, the legislative history cannot be read to support peti-

No. 1, §§ 4(a) and (b), 11(f), 14(b) (Apr. 19, 1933) (Genesis, Item No. 5; SEC

Legislative History, Vol. U1, Item No. 1).

'® See Confidential Committee Print No. 1, §§ 4, 12 (Apr. 21, 1933)

(Genesis, Item No. 6; SEC Legislative History, Vol. Ill, Item No. 3).

'* See 1.B.A. Head Hits Securities Bill, Wall St. J., May 12, 1933, at 4

(statement of IBA President Frank H. Gordon); Letter of May 6, 1933, to IBA

membership, with attached Memorandum (Genesis, Item No. 32; SEC

Legislative History, Vol. IV, Items No. 10 (memorandum) and 13 (letter)); see

also 77 Cong. Rec. 3801 (1933) (remarks of Sen. Fletcher, the Senate manager

of the bill).

tioners’ claim that Section 12(2) has a narrower scope than its

language provides. Pet. Br. 35-36; SIA Amicus Br. 14. Peti-

tioners rely on language in a section of the House Report titled

“General Analysis,” which states:

The bill affects only new offerings of securities * * *. It

does not affect the ordinary redistribution of securities

unless such redistribution takes on the characteristics of a

new offering by reason of the control of the issuer pos-

sessed by those responsible for the offering.

H.R. Rep. No. 85, 73d Cong., Ist Sess. 5 (1933). That statement

is an accurate description of the registration provisions of the

Act, but it does not capture the bill’s full scope. The actual pro-

visions of the bill made the exemptions for secondary trading

and private transactions applicable only to the registration re-

quirement —not to the remedy provided in Section 12(2) or to

the government antifraud remedy provided in Section 17.2° See

pp. 12-14, supra; United States.v. Naftalin, supra. The Commit-

tee Report’s two-sentence synopsis of the bill is not a substitute

for the bill’s detailed provisions.

Nor does the House Report’s description of the civil liability

provisions of the bill provide a sound basis for construing Sec-

tion 12(2)’s coverage. See Pet. Br. 35 n.13; SLA Amicus Br. 15.

The Report states that Sections 11 and 12 apply only to

“securities sold upon a registration statement.” H.R. Rep. No.

85, supra, at 9. That statement is true of Section 11, but the

rights of action created under Section 12 also apply expressly to

persons who sell securities in transactions that are not

registered. The Report further states that liability is restricted to

untruths or omissions “in the registration statement or the pro-

spectus.” H.R. Rep. No. 85, supra, at 9. Section 12(1),

however, is not based on misrepresentation at all, and Section

12(2) explicitly applies to misrepresentations in a “prospectus

2° Indeed, the report specifically noted, in the general description of the bill

following the paragraph quoted in the text, that “[t}he Commission may apply

to the courts to enjoin any device, scheme, or artifice to defraud, employed in

connection with the sale * * * of any securities, whether new or already out-

standing.” H.R. Rep. No. 85, supra, at 6 (emphasis added).

or oral communication.”?' The imprecise language in the House

Report’s overview-of the bill thus underscores that the Report

does not control the language of the bill as enacted.*? —

The SIA also relies on the fact that the Senate bill, and its ac-

companying report, S. Rep. No. 47, 73d Cong., Ist Sess. (1933),

contained exemptions that limited the civil remedy for pur-

chasers to initial distributions. SLA Amicus Br. 16-18. The short

answer to that contention is that the language of the Senate bill

did not form the basis for the Securities Act in general or for

Section 12(2) in particular. See note 16, supra. And there is no

significance to the fact that the conference committee’s report,

H.R. Conf. Rep. No. 152, 73d Cong., Ist Sess. (1933), did not

specifically note that the conferees had adopted the broader

coverage provided by the Section 12(2) remedy in the House

bill. See SIA Amicus Br. 17-18. As this Court has noted, see

Aaron v. SEC, 446 U.S. 680, 699 n.17 (1980), the Conference

Report’s stated purpose was to identify differences between “the

2! Similarly, petitioners (Br. 26) and the SIA (Amicus Br. 15) highlight the

Report's explanation for eliminating the reliance requirement in Section 12(2).

The Report explained that proof of reliance was unnecessary because “[t}he

statements for which [the persons liable] are responsible, although they may

never actually have been seen by the prospective purchaser, because of their

wide dissemination, determine the market price of the security.” H.R. Rep.

No. 85, supra, at 10. The Act, however, does not impose a requirement of

“wide dissemination” in order for a purchaser to sue under Section 12(2), and,

in any event, the Report’s logic is not limited to registration statements. Many

representations made in connection with secondary trading also receive wide

dissemination and affect the market price of a security. See Basic Inc. v.

Levinson, 485 U.S. 224, 246 (1988)...

22 The SIA notes that several Members of Congress pointed out that the

Securities Act would not provide full protection for investors in post-distribu-

tion securities trading and that further legislation was needed. SLA Amicus Br.

15-16. Those comments provide no basis for concluding that Section 12(2)

does not reach securities sales beyond the distribution context. Congress did

enact comprehensive legislation governing the secondary markets in the

Securities Exchange Act of 1934, 15 U.S.C. 78a ef seq., and it is farfetched to ,

infer that because legislators saw the need for that detailed regulatory scheme

(which, among other things, created the SEC as a specialized agency to en-

force the securities laws), they must have believed that the private right of ac-

tion in Section 12(2) did not apply to the secondary markets.

House bill and the substitute agreed upon by the conferees.”

H.R. Conf. Rep. No. 152, supra, at 24.

3. Subsequent interpretations. Significantly, commentators

in the months immediately following the enactment of the

Securities Act noted that the Section 12(2) remedy applies to all

types of securities sales. William O. Douglas, who was later to

serve as a Chairman of the Cammission, co-authored an in-

fluential and comprehensive review of the Act, which repeatedly

recognized that Section 12(2) is not limited to initial or public

transactions.?? Other persons who were deeply involved in the

drafting and implementation of the Act also expressed the view,

at the time of its enactment and afterwards, that Section 12(2)

applies to aftermarket transactions.

One week after the Securities Act was signed into law, the

Federal Trade Commission (FTC), which was initially charged

with enforcing the Act, issued a release explaining the effective

dates of various provisions of the Act. The release states that

both Sections 12(2) and 17(a) “apply to outstanding securities as

well as to new issues which are to be placed in the market after

registration.” Effective Dates of Securities Act of 1933 Are Ex-

plained, Securities Act of 1933, Rel. No. 3, 1933 SEC LEXIS 8,

at *2 (June 2, 1933). A few months later, in its release of the rule

governing advertising of securities, the FTC reiterated that Sec-

tion 12(2) applied to securities that were outstanding before the

effective date of the Act, even though those securities were not

required to be registered:

The rule applies only to the advertising of securities

which are or should be registered under the Act. Those

securities which were sold or offered before July 27 of this

year may, therefore, continue to be advertised in any form,

2) William O. Douglas & George E. Bates, The Federal Securities Act of

1933, 43 Yale L.J. 171, 183 (1933) (noting that, except for transactions in

securities exempt under Section 3(a)(2), no securities or transactions are ex-

empt from Section 12(2)); id. at 189-190 (Section 12(2) applies to “every writ-

ten communication or advertisement offering a security for sale,” not only to

prospectuses meeting the requirements of Section 10); id. at 207-209 (brokers

can be liable under Section 12(2) for sales that are not part of an initial

distribution).

subject only to the limitations of Sections 12(2) and 17 im-

posing civil and criminal liability for material misstate-

ments and omissions.

Securities Act of 1933, Rel. No. 54, 1933 SEC LEXIS 59, at

*1-*2 (Oct. 13, 1933) (emphasis added).

Similarly, within months of the Act’s passage, Arthur Dean,

who had consulted closely with the House Commerce Commit-

tee during the drafting process, and then-Professor Felix Frank-

furter, the organizer of the team that drafted the Act, published

articles describing the Act. Dean unequivocally stated that Sec-

tion 12(2) applies to ordinary market trading as well as to initial

public distributions.?4 Likewise, Professor Frankfurter stated

that the Act “seeks to terminate the facilities of the mails and of

interstate commerce for dishonest or unfair dealings in the sale

of all private or foreign government securities, new or old. If

any person makes an untrue statement of a material fact or

omits to state a fact without which the facts stated would really

be misleading, he is subject to a suit for rescission or damages.”

Felix Frankfurter, The Federal Securities Act: JI, 8 Fortune 53,

108 (1933). Critics of the Act concurred with that view. Soon

after the Act became law, calls went out for its amendment, par-

ticularly with respect to its civil liability provisions. Those urg-

ing the Act’s amendment consistently recognized that Section

12(2) applies to market transactions.*°

24 Dean, who was counsel for the Investment Bankers Association, wrote

that Section 12(2) covers “anyone selling any security including outstanding

securities, registered securities, or securities exempt from registration * * *, by

means of a prospectus or oral communication” that includes a material mis-

representation. Arthur Dean, The Federal Securities Act: I, 8 Fortune 50, 102

(1933). After the Act was amended in 1934, Dean wrote another article ex-

plaining the revised Act, He reiterated that Section 12(2) imposes liability “on

everyone whether Banker Rich or Widow Poor who sells a security by means

of a prospectus or oral communication that misstates or omits material facts in

the light of the circumstances under which the statements are made.” Arthur

Dean, As Amended: The Federal Securities Act, 10 Fortune 80, 81 (1934).

25 For example, an American Bar Association committee recommended

placing a duty of reasonable care on the plaintiff because Section 12(2) “is not

confined to those sellers who have special sources of information but applies

Se ee ee ee ee ee ae te het 8) he

The comprehensive coverage of Section 12(2) sparked later

proposals to amend the Act as well. In 1941, in discussing a pro-

posal that enjoyed both industry and SEC support, both the

Commission and industry representatives stated that Section

12(2) applies to market transactions.?6 SEC Commissioner Gan-

son Purcell reaffirmed that view later in 1941 when he informed

a House committee of a joint recommendation by the Commis-

sion and industry representatives to amend Section 12(2) in

order to tailor its requirement of reasonable care to the varied

types of transactions it covers. Commissioner Purcell noted that

Section 12(2) “is very important in the daily routine of the

security business,” because it applies “to statements made in the

formal prospectus required by the Securities Act”; “to state-

to all sellers of securities.” Report of the Special Committee on Amendments

to the Securities Act of 1933, 59 Rep. A.B.A. 565, 578 (1934). Similarly, the

Committee on Securities Regulation of the Chamber of Commerce of the

United States also understood that “any person, even one acting in a private

capacity, who sells a security —that is not specifically exempted by the Act —

either in interstate commerce or by the use of the mails by means of a prospec-

tus or oral communication” containing a materially misleading representation

is liable to the purchaser. Congressional Digest, Should the Federal Securities

Act of 1933 be Modified? 136, 138 (May 1934), quoting Report of the Com-

mittee on Securities Regulation of the Chamber of Commerce of the United

States (Mar. 1934).

** See, ¢.g., Staff of House Comm. on Interstate and Foreign Commerce,

77th Cong., Ist Sess., Report of the Securities and Exchange Commission on

the Proposals for Amendments to the Securities Act of 1933 and the Securities

Exchange Act of 1934, at 14(Comm. Print 1941) (“Section 12(2) of the act per-

mits a purchaser to recover from a person who has sold securities to him on the

basis of untrue statements or misleading omissions. It does not distinguish be-

tween sellers engaged in a distribution subject to registration and those selling

outstanding securities.”); Investment Bankers Association of America ef a/.,

Report on the Conferences with the Securities and Exchange Commission and

its Staff on Proposals for Amending the Securities Act of 1933 and the

Securities Exchange Act of 1934, at xi, 149 (1941) (Section 12(2) does not dif-

ferentiate among “the several situations in which securities are sold”; it applies

both to new securities subject to the registration process and “to statements

made by brokers seeking to execute customers’ orders to sell” where “the

security is an outstanding security not subject to those information re-

quirements”; and Section 12(2) perhaps applies as well to “statements made by

brokers in the solicitation from their customers of orders to buy”).

ments by individual private owners in disposing of their securi-

ties”; and “to brokers who sell securities on behalf of their

customers.”?’

With few exceptions, commentators have also expressed the

view that Section 12(2) is not limited to initial distributions to

the public.2* Courts have also universally applied Section 12(2)

to private transactions; and until quite recently, no court had re-

fused to apply the provision to secondary market transactions.*?

2” Proposed Amendments to the Securities Act of 1933 and to the Securities

Exchange Act of 1934: Hearings on H.R. 4344, H.R. 5065, and H.R. 5832

Before the House Comm. on Interstate and Foreign Commerce, 77th Cong.,

ist Sess. Pt. 1, at 806-807 (1941) (Joint Statement of SEC and Industry Repre-

sentatives, presented by Commissioner Purcell).

2 Professor Louis Loss early voiced that view, and has consistently adhered

to it. See, e.g., Louis Loss, Securities Regulation 996-997 , 1006-1008 (1951); 3

Louis Loss, Securities Regulation 1699, 1712 n.89 (1961); 9 Louis Loss & Joel

Seligman, Securities Regulation, 4217-4222 (3d ed. 1992). Other treatise

writers agree. See 3A Harold Bloomenthal, Securities and Federal Corporate

Law § 8.05{3}, at 8-43 to 8-44.8 (1993); 2 Alan Bromberg & Louis Lowenfels,

Securities Fraud and Commodities Fraud § 5.2, at 600 (1992); | Thomas

Hazen, The Law of Securities Regulation § 7.5, at 318 (2d ed. 1990); 17A J.

William Hicks, Civil Liabilities: Enforcement and Litigation Under the 1933

Act § 6.013}, at 6-12 to 6-39 (1993). Several recent articles reach the same con-

clusion. See Therese Maynard, Section 12(2) of the Securities Act of 1933: A

Remedy for Fraudulent Postdistribution Trading?, 20 Sec. Reg. L.J. 152

(1992); Comment, Applying Section 12(2) of the 1933 Securities Act to the

Aftermarket, $7 U. Chi. L. Rev. 955 (1990); Robert Rapp, The Proper Role of

Securities Act Section 12(2) as an Aftermarket Remedy for Disclosure Viola-

tions, 47 Bus. Law. 711 (1992). Contrary views have been expressed by Elliot

Weiss, The Courts Have It Right: Securities Act Section 12(2) Applies Only to

Public Offerings, 48 Bus. Law. | (1992), and Robert Prentice, Section 12(2): A

Remedy for Wrongs in the Secondary Market?, 5S Alb. L.: Rev. 97 (1991).

Professor Weiss is apparently the only commentator to suggest that Section

12(2) does not apply to private transactions. m

2% Every court that has considered the issue has ruled that private place-

ments are subject to Section 12(2), even though such placements need not be

registered. See Pacific Dunlop Holdings, Inc. v. Allen & Co., 993 F.2d 578,

$87 (7th Cir. 1993), cert. granted, 114 S. Ct. 907, cert. dismissed, 114 S. Ct.

1146 (1994); Metromedia Co. v. Fugazy, 983 F.2d 350, 360 (2d Cir. 1992),

cert. denied, 113 S. Ct. 2445 (1993); Haralson v. E.F. Hutton Group, Inc., 919

F.2d 1014, 1032 (Sth Cir. 1990); Nor-Tex Agencies, Inc. v. Jones, 482 F.2d

These dong hehé ciguin om the coupe and coverage cf the ict by

scholars, securities practitioners, and the agency charged with

its enforcement are entitled to considerable weight.

D. Policy Considerations Provide No Basis For A Narrow Appli-

cation Of Section 12(2)

Although petitioners rely heavily on policy arguments, this

Court has declined to permit the general purposes and policies

of the federal securities law to override the language of specific

provisions. See Central Bank of Denver v. First Interstate Bank

of Denver, 114 S. Ct. 1439, 1453-1454 (1994); Pinter v. Dahl,

486 U.S. at 654. In any event, rather than suggesting that Sec-

tion 12(2) should be found altogether inapplicable to private or

secondary market securities sales, policy considerations rein-

force the longstanding interpretation of the provision.

One of the central purposes of the federal securities laws was

to remedy perceived deficiencies in the common law. Herman &

MacLean v. Huddleston, 459 U.S. 375, 389 (1983). Section

12(2) serves that purpose by providing securities purchasers in-

jured by the seller’s misrepresentations or misleading statements

1093, 1099 (Sth Cir. 1973), cert. denied, 415 U.S. 977 (1974); Woodward v.

Wright, 266 F.2d 108, 116 (10th Cir. 1959); Pawgan v. Silverstein, 265 F.

Supp. 898, 900 (S.D.N.Y. 1967). See also Wright v. National Warranty Co.,

953 F.2d 256, 259-261, 262 (6th Cir. 1992) (Section 12(2) action for misrepre-

sentation in private placement); Adalman v. Baker, Watts & Co., 807 F.2d 359

(4th Cir. 1986) (same). Petitioners’ claim that there is a conflict in the courts of

appeals on whether Section 12(2) applies to private sales is incorrect.

On the other hand, there is a split of authority on whether secondary market

transactions are covered. While it appeared unquestioned that Section 12(2)

covered secondary market trading when the Court decided Wilko v. Swan, 346

U.S. 427 (1953) (predispute arbitration clause does not bar a judicial action

under Section 12(2) by a customer against a broker), and the view continued to

be prevalent as of Rodriguez de Quijas v. Shearson/American Express, Inc.,

490 U.S. 477 (1989) (overruling Wilko and enforcing arbitration clause cover-

ing Section 12(2) claim against a broker), the Third and the Eleventh Circuits

have recently held that Section 12(2) is inapplicable to secondary trading.

Ballay v. Legg Mason Wood Walker, Inc., supra; First Union Discount

Brokerage Services, Inc. v. Milos, 997 F.2d 835, 842-843 (1 1th Cir. 1993). The

Seventh Circuit reached the contrary conclusion in Pacific Dunlop, supra.

with a federal cause of action, in which the purchaser need not

show reliance and the seller must establish that he did not know

and in the exercise of reasonable care could not have known of

the misstatement or omission.*° None of the other express

remedies in the Securities Act or the Securities Exchange Act of

1934 provides a private cause of action for misstatements in the

sale of securities in private or secondary market sales.*' Because

one of Congress’s primary focuses in enacting the federal

securities laws was the “need for regulation to prevent fraud and

to protect the interest of investors,” United Housing Founda-

tion, Inc. v. Forman, 421 U.S. 837, 849 (1975), it is “almost in-

conceivable” that Congress failed to provide a private remedy

for investors based on misstatements in the sale of securities in

market transactions.*? 9 Louis Loss & Joel Seligman, Securities

Regulation 4220 (3d ed. 1992).

worked a radical change in the common law obligations a seller owed a buyer

or turned every seller into a fiduciary. At common law, rescission was

available for innocent material misrepresentations, and an action for deceit

was available in som jurisdictions to remedy even negligent misrepresenta-

tions. See generally 7 Louis Loss & Joel Seligman, Securities Regulation

3421-3424 (3d ed. 1991); 9 id. at 4125-4128, 4197-4207. For a contemporane-

ous review of the common law remedies and Section 12(2)’s relationship to

them, see Harry Shulman, Civil Liability and the Securities Act, 43 Yale L.J.

227 (1933).

3! Section 11 of the Securities Act, 15 U.S.C. 77k, applies to misstatements

and omissions in a registration statement. Section %e) of the Exchange Act, 15

U.S.C. 78i(e), creates a right of action in favor of investors affected by

manipulation on a national securities exchange against any person who will-

fully participates in proscribed acts. Section 18(a) of the Exchange Act, 15

U.S.C. 78r(a), creates a right of action in favor of investors affected by false

or misleading statements, made in bad faith, in filings with the Commission.

32 The implied cause of action under Section 10(b) of the Exchange Act, 15

U.S.C. 78j(b), and Rule 10b-5 of the Commission, 17 C.F.R. 240.10b-5, does

apply to fraud in private and aftermarket sales of securities. That implied

remedy. was not recognized until 1946, however, and this Court has “made no

pretense that it was Congress’ design to provide the remedy afforded.” Lamp/,

Pleva, Lipkind, Prupis & Petigrow v. Gilbertson, 111 S. Ct. 2773, 2779, 2780

(1991); see Musick, Peeler & Garrett v. Employers Insurance of Wausau, \13

S. Ct. 2085, 2088-2089 (1993). Contrary to petitioners and the SIA’s assertions

Petitioners and the SIA raise policy concerns about the appli-

cation of Section 12(2) to the private transaction at issue in this

case.*? According to petitioners, Section 12(2) protection is un-

necessary (and counterproductive) in private transactions be-

cause the buyers in such transactions can protect their interests -

through negotiated terms. Pet. Br. 38-41; SIA Amicus Br.

26-29. In some private placements, however, the transaction is

offered through a prepared selling document and there are no

negotiations between buyer and seller.*4 Yet there is no evidence

that Congress intended some private sales to be subject to Sec-

tion 12(2) and others not, based on whether the parties engaged

in negotiations. Rather, Congress’s response to the special

nature of private transactions was to exempt private placements

from registration; it was not to withdraw a purchaser’s right to

rescind a transaction tainted by false or misleading statements.

The SIA also raises policy concerns about application of Sec-

tion 12(2) to ordinary trading in the public securities markets.

Amicus Br. 18-26. As noted’above, in 1941 the Commission ex-

pressed somewhat similar concerns about the appropriate stand-

ard of liability to be used in secondary market transactions, and

it proposed legislative amendments to Section 12(2) to address

that issue. The Commission and the industry agreed at that time

that the answer to those policy concerns was not to eliminate

Section 12(2) liability for secondary market transactions.

(Pet. Br. 8, 32; SLA Amicus Br. 3 n.3), the existence of the implied cause of ac-

tion under Section 10(b) therefore sheds no light on Congress’s intentions with

respect to the scope of Section 12(2).

*? The dissent in Landreth Timber advanced similar policy arguments in op-

posing the view that the sale of all of a company’s stock in a private transac-

tion is a sale of securities. Landreth Timber Co. v. Landreth, 471 U.S. at

697-700 (dissenting opinion). This Court, however, see id. at 694 n.7, declined

to rely on those policy considerations to cut back on the coverage of the

Statutory language.

** That has been increasingly the case since the SEC’s adoption in April 1990

of Rule 144A, 17 C.F.R. 230.144A, relating to private resales of securities to

institutions. See Robert F. Quaintance, Jr., Getting Comfortable with

“Public-Style” Rule 144A Offerings, \nsights, at 8 (Sept. 1993). The protec-

tions of Section 12(2) are particularly important in those transactions.

on ce ee ee ee ee = . ea ine

~~ Se eee ee ee

a ¢

26 _ APPENDIX

| a Section 2(10) of the Securities Act of 1933, 15 U.S.C. 77b(10),

Rather, it was to clarify the proper application of the — provides:

‘ 27, supra, and accom text. ;

pan eine rai possible re action, in- [Unless the context otherwise requires—* * * [t]he term

cluding clarification of what constitutes reasonable care under “prospectus” means any prospectus, 7 notice, circular,

the circumstances. The responsibility for remedying any flaws in advertisement, letter, or communication, written or by

Section 12(2) lies with Congress and the Commission; the courts radio or television, which offers any security for sale or

may not rewrite the provision to temper effects of its clear confirms the sale of any security, except that

language. (a) acommunication sent or given after the effective

date of the registration statement (other than a pro-

CONCLUSION spectus permitted under subsection (b) of [Section

10}) shall not be deemed a prospectus if it is proved

als should be affirmed.

The judgment of the court of appeals shou that prior to or at the same time with such com-

Respectfully submitted. munication a written prospectus meeting the require-

ments of subsection (a) of [Section 10] at the time of

Drew S. Days, III such communication was sent or given to the person

Solicitor General to whom the communication was made, and

arte Suan a Seluter General (b) a notice, circular, advertisement, letter, or com-

PAUL GONSON MICHAEL R. DREEBEN munication in respect of a security shall not be

Solicitor Assistant to the Solicitor deemed to be a prospectus if it states from whom a

Jacop H. STILLMAN General written prospectus meeting the requirements of [Sec-

Associate General Counsel tion 10] may be obtained and, in addition, does no

BRIAN D. BELLARDO more than identify the security, state the price there-

Assistant General Counsel of, state by whom orders will be executed, and con-

MARK PENNINGTON tain such other information as the Commission, by

Special Counsel rules or regulations deemed necessary or appropriate

Securities and Exchange in the public interest and for the protection of in-

Commission vestors, and subject to such terms and conditions as

may be prescribed therein, may permit.

Section 12(2) of the Securities Act of 1933, 15 U.S.C. 772),

provides:

JUNE 1994

Any person who—* * * offers or sells a security (whether

or not exempted by the provisions of [Section 3], other

than paragraph (2) of subsection (a) of said section), by the

use of any means or instruments of transportation or com-

(la)

munication in interstate commerce or of the mails, by

means of a prospectus or oral communication, which in-

cludes an untrue statement of a material fact or omits to

state a material fact necessary in order to make the state-

ments, in the light of the circumstances under which they

were made, not misleading (the purchaser not knowing of

such untruth or omission), and who shall not sustain the

burden of proof that he did not know, and in the exercise

of reasonable care could not have known, of such untruth

or omission, shall be liable to the person purchasing such

security from him, who may sue either at law or in equity

in any court of competent jurisdiction, to recover the con-

sideration paid for such security with interest thereon, less

the amount of any income received thereon, upon the

tender of such security, or for damages if he no longer

owns the security.

wy U.S. GOVERNMENT PRINTING OFFICE: 1994—301-157/86167

oO. le ee ee

we 7 %

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This is a copy of a public record, reproduced as it was published. It is not legal advice, and it may not be the version a court would rely on. Check the official source before you cite it.