5th Circuit Court of Appeals Confirms Limitations on Shareholder Suits Over Public Offering Registration Statements

March 03, 2005

DALLAS – Haynes and Boone, LLP, lead defense counsel in the case, announced that the United States Court of Appeals for the Fifth Circuit has issued a decision earlier this week that limits how public companies may be sued for shareholder losses arising from allegedly false registration statements that accompany public stock offerings.

The opinion by Circuit Judge Patrick E. Higginbotham affirms a lower court’s dismissal of claims by shareholders who could not show that the shares they bought in the stock market could be traced to an offering that had an allegedly false registration statement.

The record in the case focused on the modern securities market in which the origin of an individual share of company stock cannot be identified once it mixes in the market with shares from other sources.  The Court also held that shareholders who purchase in the “aftermarket” of mixed securities cannot use mere statistical probabilities to gain standing to sue on a public offering.

This ruling substantially limits the potential scope of a shareholder class complaining of offering registration statements under Section 11 of the Securities Act of 1933.  It is the first ruling by a Federal Court of Appeals providing a detailed examination of the requirement that shares be directly traced to the challenged offering shares and rejects the use of statistics to trace these shares.

A claim under Section 11 avoids the actual high burdens of pleading and proof applicable in other federal securities laws, and imposes virtually “strict liability” on companies even for innocent misstatements in offering registration statements.  Recovery may still be available for aftermarket purchasers under other provisions of the federal securities laws which, unlike provision, require a demonstration of intent to defraud and shareholder reliance on a purported misstatement.

“The ruling forecloses a potential significant loophole for lawsuits that try to use this statute to create a large class action of those who did not buy shares directly from a public offering but instead simply bought in the open market,” according to Noel Hensley of Haynes and Boone, LLP, lead defense attorney in the case.

In the case (styled Jerry Krim vs. pcOrder.com, Inc.), plaintiffs were shareholders who had claimed losses from two registration statements of pcOrder.com for a March 1999 initial public offering and a secondary offering nine months later.  Because stock from the offerings was mixed in the market with stock from other sources, there was no reliable way to show that the plaintiffs bought stock from those offerings, the Court of Appeals held. 

The plaintiffs had acknowledged they could not trace shares but instead offered statistical probabilities to argue that purchasers of shares had likely bought at least one share of stock from each offering.  Both the district judge and the Court of Appeals ruled that statistics were inadequate.  Mere probabilities “cannot be squared with the statutory language--that is, with what Congress intended,” the Court said. “We decline the invitation to reach further than the statute.”

“Had statistics been accepted as sufficient proof that an individual bought offering shares, every time a share of stock was flipped in the market, virtually every later purchaser could have made a Section 11 claim,” Hensley said.

A copy of the opinion is available at http://www.ca5.uscourts.gov/opinions/pub/03/03-50737-CV0.wpd.pdf

Haynes and Boone, LLP is an international law firm with nine offices throughout Texas, Washington, D.C., Mexico City and New York, providing a full spectrum of legal services to clients around the world. With more than 450 attorneys, Haynes and Boone is ranked among the largest law firms in the nation by National Law Journal.  The firm was recognized in the 2004-2005 edition of Chambers USA: America’s Leading Business Lawyers as being No. 1 in Texas and in the top eight in the United States for Insolvency and Corporate Bankruptcy work.  The firm has also been recognized as one of the “20 Best Law Firms to Work For” (Vault.com, 2004), one of the “Best Corporate Law Firms in America” (Corporate Board Member Magazine, 2001-2004) and recipient of the Minority Corporate Counsel Association’s 2002 Thomas L. Sager Award for commitment to diversity.

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