Section 12(a)(1) Liability

Norwood Fabrication sold unregistered stock in an offering that failed a condition of the exemption it relied on. A purchaser whose investment has lost value sues under Section 12(a)(1). What must that purchaser prove about the issuer state of mind?

1. A.That the issuer acted with scienter when it failed to register the offering.Wrong. Scienter is an element of a Rule 10b-5 claim, not of a Section 5 claim.
2. B.That the offering memorandum contained a material misstatement on which he relied.Wrong. That is a Section 12(a)(2) or Rule 10b-5 theory, and Section 12(a)(1) requires no misstatement.
3. C.That the issuer knew at the time of sale that this purchaser was not accredited.Wrong. The purchaser status may defeat the exemption, but it is not an element the plaintiff has to prove.
4. D.Nothing about state of mind; the Section 5 violation itself supports rescission.Correct. Liability turns on the unregistered non-exempt sale, not on the seller intent.

Why: Section 12(a)(1) creates liability for offering or selling a security in violation of Section 5. As to the seller state of mind it is effectively strict: the plaintiff shows that a non-exempt security was sold without an effective registration statement and that he bought it. Scienter, reliance and even a misstatement are not elements, and the remedy is rescission, meaning return of the consideration with interest less income received. The seller escape is to establish an available exemption, and the burden of proving the exemption sits on the person claiming it.

The Securities Act provides three distinct civil liability provisions relevant to an unregistered or improperly disclosed offering: Section 11, Section 12(a)(1), and Section 12(a)(2). How do their triggering conditions differ?

1. A.All three provisions require proof that the defendant acted with intent to defraud investors, differing only in which category of defendant may be sued.Wrong. This imports a fraud/scienter requirement into provisions that do not require it, particularly Section 12(a)(1).
2. B.Section 12(a)(1) requires a material misstatement, Section 12(a)(2) requires only a bare registration violation, and Section 11 requires proof of intent.Wrong. This scrambles which provision has which actual trigger.
3. C.The three provisions are functionally identical, simply alternative labels counsel chooses among for strategic reasons.Wrong. The three provisions have materially different elements and defenses.
4. D.Section 11 addresses registration statement defects, Section 12(a)(1) is strict liability for a bare Section 5 violation, and Section 12(a)(2) addresses sale-communication misstatements subject to a reasonable-care defense.Correct. Each provision has its own distinct trigger and defense structure.

Why: Section 11 imposes liability for a material misstatement or omission in a registration statement, with a due diligence defense available to defendants other than the issuer. Section 12(a)(1) imposes strict liability simply for selling a security in violation of Section 5's registration requirement, with no misstatement or state of mind required. Section 12(a)(2) imposes liability for a material misstatement or omission made in connection with an offer or sale by prospectus or oral communication, subject to a reasonable-care defense.

Fernhaven Alloys sells under Rule 506(b) to thirty accredited investors and to one purchaser who is neither accredited nor sophisticated and who has no purchaser representative. Which statement best describes the consequence?

1. A.The exemption fails across the offering and all thirty-one purchasers may rescind.Wrong. The condition breached protects that one purchaser, so Rule 508 can preserve the remaining sales.
2. B.The exemption is unaffected, because a single non-conforming buyer is insignificant to the offering as a whole.Wrong. Insignificance to the offering cannot excuse the failure of a term meant to protect that very buyer.
3. C.That purchaser sale is exposed while the remaining sales can keep the exemption under Rule 508.Correct. Rule 508 is applied purchaser by purchaser, and only this buyer protection failed.
4. D.The issuer may cure the defect by delivering the Rule 502(b) information package after the sale.Wrong. That package is owed before sale and in any event supplies no sophistication.

Why: The nature-of-purchasers condition in Rule 506(b) is a term directly intended to protect that particular purchaser, so Rule 508 cannot save the sale to him however small the deviation looks against the offering as a whole. Rule 508 can, however, preserve the sales to the other purchasers, because it operates sale by sale: the first of its three questions asks whether the failure pertained to a term intended to protect that particular individual. The purchaser-count ceiling behaves differently, since a breach of it is deemed significant to the offering as a whole and would expose every sale. So the one unqualified buyer has a Section 12(a)(1) claim while the balance of the offering can stand.