Friday, June 15, 2012

Securities Act Rule 159A—The “I Don’t Get No Respect” Rule

In 2005, as part of the securities offering reform rulemaking, the SEC adopted Securities Act Rule 159A. This rather straightforward rule may be the “Rodney Dangerfield” of securities rulemaking because it certainly doesn’t get much respect. The concern is not that the rule is routinely flouted by market participants. Rather, the concern is that courts dealing with the issue specifically covered by the rule regularly ignore it.

The rule states that for purposes of Section 12(a)(2) liability, in a primary offering of securities of the issuer, regardless of the underwriting method used to sell the securities, the term “seller” includes the issuer if the securities are offered or sold by means of among other communications, a preliminary prospectus or prospectus of the issuer relating to the offering required to be filed pursuant to Rule 424 or Rule 497.

The rule seems clear on its face, that issuers will not be able to avoid 12(a)(2) liability by using a firm commitment underwriting structure. Some courts have based issuer liability on the rule, and others have explained why they have not done so. What is most surprising, though, is that many courts discuss issuer liability in firm commitment underwritings while completely ignoring the rule.

In the adopting release, the SEC stated that it was adopting the rule because “unwarranted uncertainty as to issuer liability under Section 12(a)(2) for issuer information in registered offerings using certain types of underwriting arrangements. As a result, there is a possibility that issuers may not be held liable under Section 12(a)(2) to purchasers in the initial distribution of the securities for information contained in the issuer’s prospectus when an issuer registers securities to be sold in a primary offering, the registration covers the offer and sale of its securities to the public.” The expression of Commission intent seems clear.

According to the SEC, the issuer is selling its securities to the public, although the form of underwriting of such offering, such as a firm commitment underwriting, may involve the sale first by the issuer to the underwriter and then the sale by the underwriter to the public. The SEC stated that “[w]e believe that an issuer offering or selling its securities in a registered offering pursuant to a registration statement containing a prospectus that it has prepared and filed, or by means of other communications that are offers made by or on behalf of or used or referred to by the issuer can be viewed as soliciting purchases of the issuer’s registered securities.”

In enacting this rule, the Commission was reacting to a line of cases that interpreted the Supreme Court's decision in Pinter v. Dahl to find that issuers could not be liable as statutory sellers in firm commitment underwritings, in which the ultimate purchaser bought the securities from the underwriter rather than the issuer. These cases held before the enactment of the rule that issuers were not liable unless the plaintiff alleged that an issuer's role was not the usual one, as it went farther and became a vendor's agent.

Very few cases (less than 10) have even mentioned the rule in discussing issuer liability. Some district court cases have read Rule 159 as foreclosing this challenge to statutory seller status, such as Federal Housing Finance Agency v. UBS Americas, Inc. (SD NY, Dkt. No. 11 Civ. 5201 (DLC)) and Citiline Holdings, Inc. v. iStar Financial Inc. (SD NY, Dkt. No. 08 Civ. 3612 (RJS)).

We also have cases specifically rejecting Rule 159A with regard to issuer liability. As the U.S. District Court for the District of Massachusetts stated in 2012, “[w]hile an SEC regulation is, of course, entitled to consideration, it cannot countermand a contrary Supreme Court holding. Consequently, the court finds that, in accordance with Pinter and First Circuit precedent and despite SEC Rule 159A” that the non-underwriter defendants were not sellers. Massachusetts Mutual Life Insurance Co. v. Residential Funding Company, LLC (DC Mass 2012, Dkt. No. C.A. NO. 11-30035-MAP).

The largest number of cases, however, simply apply the Pinter analysis without mentioning the rule. For example, if one reads recent decisions such as In re Bare Escentuals, Inc. Securities Litigation (ND Cal 2010, Dkt. No. C 09-3268 PJH), Hoff v. Popular (DC PR 2010, Civil No. 09-1428 (GAG/BJM), In re Thornburg Mortgage, Inc. Securities Litigation (DC NM 2010, No. CIV 07-0815 JB/WDS) and In re Vonage Initial Public Offering (IPO) Securities Litigation (DC NJ 2009, Civil Action No. 07-177 (FLW)), you will not even realize that Rule 159A, an SEC rule adopted to deal with the specific issue before the courts, existed.

Poor Rule 159A might well indeed say that "I don’t get no respect."