How To Avoid A Section 11 Liability In A Stock-For-Stock Merger

John Jenkins at recently wrote about Section 11 claims being filed in state court by purchasers in stock-for-stock mergers.  Section 11 of the Securities Act of 1933 authorizes a cause of action against specified persons "in case any part of the registration statement, when such part became effective, contained an untrue statement of material fact or omitted to state a material fact required to be stated therein or necessary to make the statements therein not misleading . . . ".  

It occurred to me that state law could actually be used to avoid Section 11 claims in either state or federal court.  California is one of only a handful of states that offer the opportunity to take advantage of the Section 3(a)(10) exemption from registration under the Securities Act of 1933.  This exemption is most typically used by public issuers who wish to acquire a closely held companies in exchange for securities.  The statutory authority for the procedure in California is Section 25142 of the Corporations Code.  Relying on Section 3(a)(10) by undergoing a fairness hearing eliminates the possibility of Section 11 liability because no registration statement becomes effective under the Securities Act. 

Here are some resources regarding fairness hearings in California:

  • Securities & Exchange Commission Staff Legal Bulletin #3A
  • Fairness Hearings and Shell Companies, DOC Release No. 117-C (Jan. 18, 2006)
  • "Fairness" Hearings Under the Corporate Securities Law of 1968 After the Enactment of the National Securities Markets Improvement Act of 1996, DOC Release 102-C (Revised)
  • W. Anthony Colbert, "Fairness Hearings,"  California Business Law Practitioner 44 (Spring 2010)
  • Keith Paul Bishop, "California Fairness Hearings: A Low-Cost Alternative to Federal Registration in Acquisition Transactions,"  15 Insights 23 (Feb. 2001)

I even have video on the subject.

Elimination of Section 11 exposure, however, does not eliminate liability under other statutes, rules or the common law for false or misleading statements.  In a future post, I'll discuss why it is nevertheless advantageous to issuers to eliminate Section 11 exposure.