Originally published March 8, 2005
All authors are attorneys at Haynes and Boone, LLP
The Fifth Circuit has issued an important opinion on Section 11 of the Securities Act which may limit the potential exposure of issuers and other participants for alleged misrepresentations and omissions in public offering registration statements. The Court’s opinion in Krim v. pcOrder.com, Inc., is the first Circuit Court opinion to address whether evidence of statistical probability can be used by aftermarket purchasers to "trace" their securities to a public offering to gain standing to sue under Section 11. Haynes and Boone, LLP, acted as lead litigation counsel in this matter, and argued for all defendant parties before the Fifth Circuit Court of Appeals, representing Trilogy Software, Inc., the parent company of pcOrder.com.
Section 11 imposes liability for even innocent material misstatements in registration statements, and does not contain the elements of intent and reliance required under Section 10(b) of the Securities Exchange Act and Rule 10b-5 thereunder. Class action plaintiff attorneys have long urged an expansive application of Section 11, seeking to certify shareholder classes of not only original investors in the challenged offering, but also aftermarket purchasers. While several federal courts have limited Section 11 to initial offering distributees, a larger number, including the Fifth Circuit, have adopted an interpretation that provides for Section 11 standing where a plaintiff can "trace" his aftermarket shares back to the challenged offering. Tracing of shares is virtually impossible in the modern market, however, where stock from multiple offerings by the same company is held electronically in a fungible mass.
In Krim v. pcOrder.com, 402 F.3d 489 (5th Cir. March 1, 2005), the Fifth Circuit addressed plaintiffs’ attempt to avoid the difficulties of tracing aftermarket shares by resorting to statistical probabilities suggesting that at least some shares each purchased in the market were attributable to the challenged offerings. Using statistics, they sought to establish standing by demonstrating a high probability, exceeding 99% in some instances, that each had purchased at least some shares attributable to those offerings. The district court had rejected these arguments at the class certification stage and had subsequently dismissed individual plaintiffs’ claims.
On appeal, the Fifth Circuit strongly rejected the suggestion that mere probability calculations can demonstrate Section 11 standing. The Fifth Circuit upheld the dismissal and ruled that "‘statistical tracing’ would impermissibly expand the statute’s standing requirement." The Court articulated a few instances in which aftermarket purchasers might be found to have Section 11 standing: (1) where only one offering has occurred and no privately-held shares have been sold into the market; or (2) where the plaintiff has purchased more shares than have entered the market from non-offering sources (although the Court declined to consider the effect that short-selling may have on this determination). The Court also suggested that certain aftermarket purchasers might be able to demonstrate Section 11 standing by combining statistical evidence with other evidence linking their shares back to the challenged offering.
The Krim decision is important news for public companies. The rationale underlying the Krim decision – that shares from mixed sources cannot be untangled and traced -- points to an important event in a public company’s early days: the first Rule 144 sales by insiders of previously private shares and secondary offerings. Following the reasoning in Krim, once these shares have begun to be sold into the market, Section 11 tracing by aftermarket investors becomes a virtual impossibility and the scope of any Section 11 class may be cut short. In a volatile market context, the exclusion of these aftermarket purchasers as Section 11 claimants may potentially decrease a public company’s exposure by hundreds of millions of dollars.
A copy of the Fifth Circuit’s opinion is available at:
http://www.ca5.uscourts.gov/opinions/pub/03/03-50737-CV0.wpd.pdf.
The authors were lead counsel of record in this matter.
This article is for informational purposes only and is not intended to be legal advice. Transmission is not intended to create and receipt does not establish an attorney-client relationship. Legal advice of any nature should be sought from legal counsel. For more information about Haynes and Boone and our practices, please visit www.haynesboone.com
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©2005 Haynes and Boone, LLP
