High court narrows securities fraud law

March 01, 1995|By Lyle Denniston | Lyle Denniston,Washington Bureau of The Sun

WASHINGTON -- Splitting 5-4, the Supreme Court ruled yesterday that a tough 1933 law against fraud in offering stocks applies only when the securities are first put up for sale to the public, not when they are resold on the market or sold in private placements.

The court, in narrowing a section of the 62-year-old Securities Act, disagreed with the Securities and Exchange Commission and a number of lower courts.

At issue in the case was the scope of a ban on using falsity, misleading statements or factual omissions in offering a stock through "a prospectus or oral communication."

The court majority, focusing on the meaning of "prospectus," ruled that the ban applies only to a document offering securities "sold to the public by an issuer" in an "initial distribution."

Thus, the court made clear, a private placement of stock, or the re-sale of stocks in the open market, is not covered by that part of the 1933 law. Congress, it added, intended that law to protect investors against misleading documents "of wide dissemination."

The decision, Washington securities lawyer John F. Olson said, fits a pattern the court has followed in the past decade of "not looking to expand federal remedies under the securities laws." He said the court appeared willing to have investors rely on remedies they would have under state law rather than turning to federal courts under U.S. securities laws.

Mr. Olson noted that many state laws provide protection against misleading statements in contract dealings, such as a two-party private contract of sale of securities.

The law that was given a limited scope by yesterday's ruling provides one of the toughest remedies available for securities fraud: a right, when fraud has been proved, to get back the money in a stock transaction and to wipe it off the books.

Justice Anthony M. Kennedy, who wrote the majority opinion, said the case involved "a very sweeping remedy" because, when it is available, the investor does not even have to prove that he or she relied on the fraudulent statements in deciding to buy a stock.

The decision came on an appeal by three Chicago businessmen who owned Alloyd Holdings Inc., a maker of plastic packaging and heat-sealing equipment. They decided to sell the company in a private placement.

After the stock sale had been completed by a private contract, the buyer discovered that the company's earnings were much lower than had been estimated in the contract of sale. The buyer sued for securities fraud under the 1933 law's ban on misleading or false prospectus or oral statements.

A federal appeals court allowed them to sue on that theory. The Supreme Court overturned that result yesterday. Justices Ruth Bader Ginsburg and Clarence Thomas wrote separate dissenting opinions.

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