Due Diligence and Securities Registration

Corporations that sell securities must register the securities offering with the Securities and Exchange Commission as required by the Securities Act of 1933. The registration statement, which is the document that is filed, provides information about the corporation to potential purchasers of the securities so that they can evaluate the merit of the securities.

The information disclosed in the registration statement has to be accurate because investors and purchasers of securities rely on it to make their purchasing decisions. The Securities Act holds individuals who help to prepare the registration statement on behalf of the corporation responsible for any misrepresentations in the statement. Most of those individuals can assert the defense of due diligence if it is applicable.

Responsible Parties

Section 11(a) of the Securities Act, 15 U.S.C. 77k(a), provides that in the event of a material misstatement or omission in a registration statement, an investor may sue:

  • Anyone who signed the registration statement
  • Directors or partners of the issuer
  • Professional people who helped to prepare the registration statement
  • Underwriters with respect to such security

The parties responsible for the registration statement include the following:

Issuer—Only the issuer can register securities. It may do so on its own behalf (a ''primary offering'') or on behalf of selling security holders (a ''secondary offering''). Every issuer in a registered offering is required by 6(a) of the Securities Act, 15 U.S.C. 77f(a), to sign the registration statement and is absolutely liable under Section 11(a) of the Act for material misstatements or omissions in the registration statement, regardless of good faith or the exercise of due diligence.

Directors and Officers—A majority of the issuer's board of directors, as well as its principal executive officer or officers, principal financial officer, and its comptroller or principal accounting officer, must sign the registration statement. The entire board of directors and the officers previously mentioned are subject to potential civil liability under 11(a) of the Act for material misstatements or omissions in the registration statement. In addition, any person who controls the issuer or any other responsible party is subject to liability.

Directors, officers and controlling persons can avoid liability by relying on the defense of ''due diligence,'' provided they can demonstrate that after a reasonable investigation they had a reasonable basis for their belief that the registration statement was accurate and adequate. The standard of reasonableness is that required of a careful man in the management of his own property.

The following circumstances are relevant in determining whether the defense of due diligence can be relied upon:

  • The type of issuer
  • The type of security
  • The type of person
  • The office held when the person is an officer
  • The presence or absence of another relationship to the issuer when the person is a director or proposed director
  • Reasonable reliance on officers, employees, and others whose duties should have given them knowledge of the particular facts (in light of the functions and responsibilities of the particular person with respect to the issuer and the filing)
  • When the person is an underwriter, the type of underwriting arrangement, the role of the particular person as an underwriter and the availability of information with the respect to the registration
  • Whether, with respect to a fact or document incorporated by reference, the particular person had any responsibility for the fact or document

These criteria suggest that the depth of a person's investigation will depend on a variety of factors, and that some persons (such as officers and inside directors) will have to make a more complete investigation than others.

Sellers—In the case of a registered offering, selling stockholders can be held liable for any material misstatements or omissions in the registration statement. Such persons, however, may rely on the due diligence defense if it is available.

Underwriters—Every underwriter involved in a registered securities offering is subject to liability for material misstatements or omissions in the registration statement, absent an ability to rely on the due diligence.

Experts—Experts, such as accounting firms, are subject to potential liability for material misstatements or omissions in any part of a registration statement purporting to be based on their authority as experts. Experts can be held liable only if they are named with their consent in the registration statement as having prepared or certified any part of the registration statement or any report or valuation mentioned therein.

Counsel—The person who normally coordinates the preparation of the registration statement is an attorney engaged for this purpose by the issuer. Counsel's function is to assist the issuer and its management in preparing the registration statement and performing the investigation necessary to support the disclosures therein. Counsel's function is limited, and counsel does not take responsibility for the accuracy or completeness of the registration statement.

If you are going to issue securities for your corporation, you will need the assistance of counsel to help guide you in that process.

Questions for Your Attorney

  • Who is the issuer of corporate securities?
  • What is due diligence and why is it important?
  • Can the purchaser of shares in my corporation sue me if information in the corporation's registration statement is wrong?
Related Resources on lawyers.comsm

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