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Latham & Watkins ATTORNEYS AT LAW 555 Eleventh Street, N.W., Suite I000 Washington, D.C. 20004-I304 Telephone: (202) 637-2200 Fax: (202) 637-220I www.lw.com ____________________ Boston • Brussels • Chicago • Frankfurt • Hamburg • Hong Kong • London • Los Angeles • Moscow • New Jersey • New York Northern Virginia • Orange County • Paris • San Diego • San Francisco • Silicon Valley • Singapore • Tokyo • Washington, D.C. DC\553279.2 to: File date: file no.: November 15, 2002 900004-2093 from: John J. Huber Thomas C. Sadler Joel H. Trotter copies to: Kirk A. Davenport subject: The Section 11 Due Diligence Defense in the Permitted Absence of an Expert’s Consent I. INTRODUCTION This memorandum analyzes the legal standard required for an underwriter to establish a due diligence defense under Section 11 of the Securities Act of 1933, as amended (the “Securities Act”), in a registration statement containing financial statements audited by Arthur Andersen LLP (“Andersen”) in which Andersen’s consent has not been filed as permitted pursuant to a rule recently adopted by the Securities and Exchange Commission. 1 Specifically, the question presented is whether an underwriter can avail itself of the due diligence defense that applies to “expertised” parts of a registration statement in defending against a Section 11 claim based upon material misstatements or omissions in financial statements certified by Andersen that were included in a registration statement without Andersen’s written consent in compliance with Rule 437a under the Securities Act. 2 1 Andersen is a current client of Latham & Watkins. The views expressed in this memorandum do not reflect those of Andersen. On June 15, 2002, a jury in Houston, Texas, returned a guilty verdict against Andersen for federal obstruction of justice charges arising from the federal government’s investigation of Enron Corp. Andersen has indicated its intention to appeal the verdict. Following the conviction, the Commission issued a statement that, on an interim basis, the Commission will continue to accept financial statements audited by Andersen if Andersen is able to make certain representations to its clients concerning audit quality controls. See SEC Press Release 2002-89 (June 15, 2002); see also Regulation S-X, Article 3, Temporary Note 3T (specifying issuers’ required representations regarding Andersen financial statements). 2 Although neither Section 11 nor Section 12(a)(2) apply to initial purchasers in Rule 144A transactions, Rule 10b-5 under the Exchange Act does apply. The consensus of securities practitioners is that, where a Rule 144A initial purchaser has engaged in a due diligence process comparable to that of an underwriter in a public offering, the initial purchaser would have taken more than adequate steps to defeat a claim of scienter under Rule 10b-5. However, it has become market practice for initial purchasers in Rule 144A transactions to engage in a due diligence process substantially similar to that carried out by underwriters in public offerings. As a result, we believe the analysis in this memorandum may provide useful guidance to initial purchasers in Rule 144A transactions, notwithstanding the memorandum’s focus
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Apr 20, 2022

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Page 1: Latham & Watkins

Latham & Watkins AT TORNEYS A T LAW

555 Eleventh Street, N.W., Suite I000

Washington, D.C. 20004-I304 Telephone: (202) 637-2200

Fax: (202) 637-220I www.lw.com

____________________

Boston • Brussels • Chicago • Frankfurt • Hamburg • Hong Kong • London • Los Angeles • Moscow • New Jersey • New York Northern Virginia • Orange County • Paris • San Diego • San Francisco • Silicon Valley • Singapore • Tokyo • Washington, D.C.

DC\553279.2

to: File

date:

file no.:

November 15, 2002

900004-2093

from: John J. Huber Thomas C. Sadler Joel H. Trotter

copies to: Kirk A. Davenport

subject: The Section 11 Due Diligence Defense in the Permitted Absence of an Expert’s Consent

I. INTRODUCTION

This memorandum analyzes the legal standard required for an underwriter to establish a due diligence defense under Section 11 of the Securities Act of 1933, as amended (the “Securities Act”), in a registration statement containing financial statements audited by Arthur Andersen LLP (“Andersen”) in which Andersen’s consent has not been filed as permitted pursuant to a rule recently adopted by the Securities and Exchange Commission. 1 Specifically, the question presented is whether an underwriter can avail itself of the due diligence defense that applies to “expertised” parts of a registration statement in defending against a Section 11 claim based upon material misstatements or omissions in financial statements certified by Andersen that were included in a registration statement without Andersen’s written consent in compliance with Rule 437a under the Securities Act.2

1 Andersen is a current client of Latham & Watkins. The views expressed in this memorandum

do not reflect those of Andersen. On June 15, 2002, a jury in Houston, Texas, returned a guilty verdict against Andersen for federal obstruction of justice charges arising from the federal government’s investigation of Enron Corp. Andersen has indicated its intention to appeal the verdict. Following the conviction, the Commission issued a statement that, on an interim basis, the Commission will continue to accept financial statements audited by Andersen if Andersen is able to make certain representations to its clients concerning audit quality controls. See SEC Press Release 2002-89 (June 15, 2002); see also Regulation S-X, Article 3, Temporary Note 3T (specifying issuers’ required representations regarding Andersen financial statements).

2 Although neither Section 11 nor Section 12(a)(2) apply to initial purchasers in Rule 144A transactions, Rule 10b-5 under the Exchange Act does apply. The consensus of securities practitioners is that, where a Rule 144A initial purchaser has engaged in a due diligence process comparable to that of an underwriter in a public offering, the initial purchaser would have taken more than adequate steps to defeat a claim of scienter under Rule 10b-5. However, it has become market practice for initial purchasers in Rule 144A transactions to engage in a due diligence process substantially similar to that carried out by underwriters in public offerings. As a result, we believe the analysis in this memorandum may provide useful guidance to initial purchasers in Rule 144A transactions, notwithstanding the memorandum’s focus

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We conclude that, where the Commission authorizes a registrant to omit an expert’s consent, the parts of the registration statement prepared or certified by that expert should nonetheless remain expertised under Section 11(b)(3)(C) of the Securities Act for purposes of an underwriter’s due diligence defense.3 Our conclusion is based upon:

• the text of Section 11(a)(4), which makes an accountant liable under Section 11 only with his consent, and the text of Section 11(b)(3)(C), which does not require an expert to consent for another defendant, such as an underwriter, to avail itself of the due diligence defense;

• the text of Section 7(a), which permits the Commission to dispense with an expert’s consent under specific circumstances and allows the Commission to require disclosure of such circumstances without any apparent concomitant effect on the liability provisions of Section 11;

• the legislative history of the consent requirement, which indicates that Congress intended the requirement to put the expert on notice that he would be liable under Section 11(a), rather than to qualify the nature or meaning of the term “expert”;

• the English Companies Act of 1929, from which Congress derived Section 11 and under which experts could be relied upon by other defendants but were not required to consent;

• Rules 436 and 437, which the Commission adopted pursuant to Sections 7 and 19(a) under the Securities Act and which take different approaches to the liability matrix of Section 11, classifying certain information as nonexpertised (in the case of Rules 436(c) and 437(g)(1)), versus dispensing with the requirement of consent (in the case of Rule 437);

• Rule 437a, which specifically addresses Andersen and provides for an automatic dispensation from the consent requirement of Section 7 and Rule 436(a), under specific circumstances; and

• Section 19(a), which states that the Securities Act will not impose liability for any act done or omitted in good faith in conformity with any rule or regulation of the Commission.

In addition, despite the substantial reasons supporting our conclusion that an underwriter should not be subjected to the reasonable investigation standard of Section 11(b)(3)(A), we recommend that, depending on the facts and circumstances involved in each offering, an underwriter should consider taking additional steps to establish a due diligence defense under Section 11(b)(3)(C) with respect to such expertised material. The additional steps that we recommend for consideration are based upon:

on the Section 11 due diligence standard applicable to underwriters in registered offerings involving financial statements certified by Andersen and included pursuant to Rule 437a in a registration statement lacking Andersen’s written consent.

3 We have not identified any judicial precedent or any authoritative pronouncement of the Commission or its Staff that directly addresses the question presented. Our conclusion is based on our analysis in the absence of such precedent or pronouncement.

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• Section 11(c), which imposes a “prudent man” standard to determine what constitutes reasonableness under Section 11(b)(3); and

• specific considerations regarding an underwriter’s ability to reduce litigation risk related to this issue.

Our analysis of the points underlying our conclusion and recommendation follows a brief description of the statutory framework relating to Section 11 liability and its affirmative defenses.

II. THE STATUTORY FRAMEWORK

A. Liability under Section 11

Section 11 of the Securities Act provides an explicit cause of action to anyone who purchases a security issued under a materially misleading registration statement.4 An issuer of securities under a registration statement has absolute liability to Section 11 plaintiffs.5 Section 11(a) also imposes liability for the underwriters as well as the issuer’s directors, its principal executive officers and any expert (including an accountant) who “has with his consent been named” in the registration statement.6 Section 11, therefore, suggests that Andersen would have no liability under Section 11 for securities issued under a registration statement in which Andersen did not consent to being named as the auditor of the issuer’s historical financial statements.7 The issue is whether and to what extent the absence of Andersen’s consent pursuant

4 Any purchaser of a security issued under a registration statement that “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” is authorized to sue the issuer and other enumerated persons. Section 11(a).

5 See Section 11(b) (making affirmative defenses to Section 11(a) available to all of the parties named in Section 11(a) “other than the issuer”). Although the issuer’s liability is absolute, damages are limited by Section 11(e). Note that Section 11(a)(1) imposes liability for misstatements on “[e]very person who signed the registration statement,” which under Section 6(a) of the Securities Act reaches the issuer itself. 9 LOUIS LOSS & JOEL SELIGMAN, SECURITIES REGULATION 4251 (3d ed. 1992). Although all defendants, including the issuer, may assert a successful defense under Section 11(a) by proving that the plaintiff “knew of such untruth or omission” when the plaintiff acquired the security, this is a largely theoretical defense of little to no practical significance in the typical case. See RICHARD W. JENNINGS ET AL., SECURITIES REGULATION 913 (8th ed. 1998).

6 Sections 11(a)(1)-(a)(5). In addition, persons who are “about to become” a director and are with their consent so named in the registration statement are subject to liability under Section 11(a)(3).

7 Section 11(a)(4) (imposing liability on experts who consent to being named as such in the registration statement); see also LOSS & SELIGMAN, supra note 5, at 4259 n.159 (citing U.S. Chromium, Inc., 6 S.E.C. 882, 889 (1940)) (explaining that “an expert cannot be held liable without proof of consent and such proof would be exceedingly difficult without the filing of a written consent”); William O. Douglas & George E. Bates, The Federal Securities Act of 1933, 43 YALE L. J. 171, 197 & 197 n.149 (1933) (noting that Section 7(a) empowers the Commission to waive the filing of an expert’s consent and that, “if their written consent is not so filed, they are not made liable unless the person suing can prove that such consent was in fact given, though it was not so filed” and that litigation under such circumstances “would be highly improbable in view of the difficulty of sustaining such proof”). Even if

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to Rule 437a will affect the availability of affirmative defenses under Section 11(b)(3) to underwriters and other persons who must answer to a plaintiff who sues under Section 11(a) for a misleading statement or omission in audited financial statements contained in or incorporated by reference into a registration statement.8 To resolve this question, we will first examine how the Section 11(b) affirmative defenses operate.

B. Due Diligence Defenses under Section 11

Section 11(b)(3) of the Securities Act provides different types of due diligence defenses to Section 11(a) liability. The level of diligence varies with the persons named in Section 11(a)(1) through Section 11(a)(5) as well as the specific parts of the registration statement and the person responsible for each part. Sections 11(b)(3)(A) and 11(b)(3)(C) apply to underwriters and other Section 11(a) persons who are not experts. These two provisions distinguish between those parts of the registration statement “not purporting to be made on the authority of an expert” on the one hand and those parts “purporting to be made on the authority of an expert” on the other.9 Thus, courts and practitioners considering questions of Section 11 liability divide the registration statement into “expertised” and “nonexpertised” parts.10

Andersen is not liable under Section 11 due to its lack of consent under Section 7, it could still face liability under the antifraud provisions of the federal securities laws, see, e.g., Section 10(b) of the Exchange Act and Rule 10b-5 thereunder, as well as under principles of common law fraud, see, e.g., Ultramares Corp. v. Touche, 255 N.Y. 170, 173, 174 N.E. 441, 442 (1931) (allowing a third party to assert a fraud action against an independent auditor based on defects in a balance sheet certified by the auditor in part because the auditor knew that “in the usual course of business the balance sheet when certified would be exhibited by the . . . Company to banks, creditors, stockholders, purchasers, or sellers, according to the needs of the occasion”).

8 Rule 437a was adopted pursuant to Section 7(a), which requires expert consent without exception if the registration statement names the expert as having prepared or certified “any part of” or any “report or valuation for use in connection with” the registration statement. In addition, Section 7(a) imposes a waivable requirement of expert consent if the registration statement names the expert as having prepared or certified material “which is used” in the registration statement but not as having prepared such material “for use in connection with” the registration statement. In other words, Section 7(a) mandates expert consent in all cases where the registration statement describes the expert’s report as having been prepared as a “part of” or “for use in connection with” the registration statement, whereas the provision authorizes the Commission to dispense with the requirement of consent in cases of impracticability or undue hardship, so long as the registration statement states merely that the expert’s report “is used” (rather than having been prepared “for use”) in connection with the registration statement. Thus, “[t]he Commission may dispense with the filing of such a consent as impracticable or involving undue hardship, but only when the expert is not named as having prepared or certified the report or valuation for registration purposes.” LOSS & SELIGMAN, supra note 5, at 4259 n.159. Where the Commission has dispensed with the requirement of expert consent, Section 7(a) requires the registration statement to “contain such other information, and be accompanied by such other documents, as the Commission may by rules or regulations require as being necessary or appropriate in the public interest or for the protection of investors.”

9 Section 11(b)(3)(C) applies also to experts with respect to portions of the registration statement purportedly made on some other expert’s authority, whereas Section 11(b)(3)(B) applies to each expert as to that portion of the registration statement regarding that expert’s report and is similar to the standard in

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For nonexpertised parts of the registration statement, Section 11(b)(3)(A) allows an underwriter or other defendant (besides the issuer) to establish a due diligence defense by proving that the defendant had, “after reasonable investigation, reasonable ground to believe and did believe” that the nonexpertised part was not materially misleading when the registration statement became effective. For expertised parts of the registration statement, however, Section 11(b)(3)(C) allows an underwriter or other defendant (besides the issuer or the particular expert whose report formed the basis of the expertised part at issue) to establish a due diligence defense by proving that the defendant had “no reasonable ground to believe and did not believe” that the expertised part was materially misleading when the registration statement became effective.

Thus, an underwriter’s due diligence defense for expertised parts of the registration statement is less exacting than the standard for nonexpertised parts. The chief difference is that Section 11(b)(3)(C) does not require an underwriter to conduct a “reasonable investigation” as to expertised parts of the registration statement. Another difference is that Section 11(b)(3)(A) expresses an affirmative obligation for nonexpertised parts,11 whereas Section 11(b)(3)(C) expresses a negative obligation for expertised parts.12 These and other elements of Section 11(b)(3) are summarized as follows.

Section 11(b)(3)(A) applicable to nonexperts with respect to nonexpertised portions of the registration statement. For example, Section 11(b)(3)(C) would enable a petroleum engineer to rely on the outside auditor with respect to the auditor’s report on the audited financial statements, whereas the more exacting standard contained in Section 11(b)(3)(B) would apply to the engineer itself with respect to the portion of the registration statement dealing with the engineer’s oil and gas report.

10 See, e.g., Escott v. BarChris Constr. Corp., 283 F. Supp. 643, 683 (S.D.N.Y. 1968) (defining the “expertised portion” as “the part of the registration statement purporting to be made on the authority of an expert” as described in Section 11(b)(3)(C)).

11 Section 11(b)(3)(A) (requiring an underwriter actually to possess both “reasonable ground to believe” and the actual belief that the statements at issue “were true and that there was no omission to state a material fact . . . necessary to make the statements therein not misleading”).

12 Section 11(b)(3)(C) (requiring an underwriter simply to have “no reasonable ground to believe” and no actual belief that the statements at issue “were untrue or that there was an omission to state a material fact . . . necessary to make the statements therein not misleading”).

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DUE DILIGENCE DEFENSES TO SECTION 11 LIABILITY

§ 11(b)(3) Subsection

Defendant

Part of Registration Statement

Elements of Due Diligence Defense

(A) Non-expert Non-expertised Defendant (i) had, after reasonable investigation, (ii) reasonable ground to believe and (iii) did believe that the statements (iv) were true and (v) did not omit information necessary to make the statements not misleading

(B) Expert Expertised by defendant

Either (1) the expert (i) had, after reasonable investigation, (ii) reasonable ground to believe and (iii) did believe that the statements (iv) were true and (v) did not omit information necessary to make the statements not misleading or (2) the statement at issue did not fairly represent the expert’s actual statement

(C) Non-expert* Expertised (by an expert other than defendant)

Defendant (i) had no reasonable ground to believe and (ii) did not believe that the statements were (iv) untrue or (v) omitted information necessary to make the statements not misleading or (vi) that the statement at issue did not fairly represent the expert’s actual statement

(D) Non-expert Statement of public official

Defendant (i) had no reasonable ground to believe and (ii) did not believe that the statements were (iv) untrue or (v) omitted information necessary to make the statements not misleading or (vi) that the statement at issue did not fairly represent the public official’s actual statement

* The defense available under Section 11(b)(3)(C) also applies to experts with respect to parts of the registration statement that were purportedly made on some other expert’s authority.

III. DISCUSSION

A. Statutory Text

Our analysis begins with the text of the statutory provision at issue, which is the starting point repeatedly emphasized and applied by the Supreme Court in approaching questions that arise under the Securities Act and other federal statutes.13

13 See, e.g., Gustafson v. Alloyd Company, Inc., 513 U.S. 561, 584-85 (1995) (Thomas, J.,

dissenting) (quoting Landreth Timber Co. v. Landreth , 471 U.S. 681, 685 (1985) (quoting Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723, 756 (1975) (Powell, J., concurring))) (“The starting point in every case involving construction of a statute is the language itself.”); Ernst & Ernst v. Hochfelder, 425 U.S. 185, 197 (1976) (quoting Blue Chip Stamps, 421 U.S. at 756 (Powell, J., concurring)); id. at 201 (citing United States v. Oregon, 366 U.S. 643, 648 (1961); Packard Motor Car Co. v. NLRB, 330 U.S. 485, 492 (1947)) (reiterating that “the language of a statute controls when sufficiently clear in its context”); see also Central Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A., 511 U.S. 164, 173-75 (1994); FTC v. Bunte Bros., Inc., 312 U.S. 349, 350 (1941).

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1. Text of Section 11(b)(3)(C)

The Section 11(b)(3)(C) defense applies to any part of a registration statement “purporting to be made on the authority of an expert.”14 By its terms, Section 11(b)(3)(C) provides a due diligence defense to underwriters and defendants other than the issuer or experts “as regards any part of the registration statement purporting to be made on the authority of an expert.” Although Section 11(b)(3)(C) makes no mention of consent, Section 11(a)(4) imposes liability on an expert only if that expert has consented to being “named as having prepared or certified any part of the registration statement.” Although Section 11(a)(4) appears to impose liability only on experts who actually consent to being named in the registration statement, there is nothing in the language of either Section 11 in general or Section 11(b)(3)(C) in particular that would condition the availability of a defendant’s Section 11(b)(3)(C) defense upon the expert having consented to be named as such in the registration statement.

This view is consistent with judicial applications of Section 11(b)(3)(C) to underwriters asserting a due diligence defense. Reported cases on this point uniformly apply Section 11(b)(3)(C) to certified financial statements contained in the registration statement.15

14 At the most basic and fundamental level, the term “expertised” is a misnomer. Courts and

practitioners use the term to refer to parts of the registration statement that are subject to the affirmative defense contained in Section 11(b)(3)(C), but that provision by its terms does not strictly require the actual involvement of an expert. The Section 11(b)(3)(C) standard applies to “any part of the registration statement purporting to be made on the authority of an expert.” Section 11(b)(3)(C) (emphasis added). Of course, the lack of bona fide expert involvement in preparing an expertised part of the registration statement would raise substantial factual questions about whether a defendant could satisfy the standard of care required in Section 11(b)(3)(C), but it is important to bear in mind — notwithstanding the fact that “expertised” is a shorthand term used to refer to parts of the registration statement that are subject to the Section 11(b)(3)(C) affirmative defense — that the availability of that defense actually turns on whether the part of the registration statement at issue was “purporting” to be made on an expert’s authority. See, e.g., Escott v. BarChris Constr. Corp., 283 F. Supp. 643, 683 (S.D.N.Y. 1968) (defining the “expertised portion” as “the part of the registration statement purporting to be made on the authority of an expert” as described in Section 11(b)(3)(C)). Strictly speaking, Section 11(b)(3)(C) does not by its terms require the actual involvement of a bona fide expert, much less an expert who has actually consented pursuant to Section 7(a) and Rule 436(a) to being named in the registration statement.

15 See, e.g., In re Software Toolworks Inc. Sec. Litig., 50 F.3d 615, 623 (9th Cir. 1994) (emphasizing that underwriters “need not conduct due diligence into the ‘expertised’ parts of a prospectus, such as certified financial statements”); In re Worlds of Wonder Sec. Litig., 35 F.3d 1407, 1421 (9th Cir. 1994) (“Because the audited financial statements were ‘certified’ by Deloitte within the meaning of Section 11, every defendant other than the auditor can escape Section 11 liability for the statements by establishing that they had ‘no reasonable ground to believe . . . that the [‘expertised’] statements therein were untrue or that there was an omission to state a material fact required to be stated therein or necessary to make the statements therein not misleading.” (alteration in original)); BarChris, 283 F. Supp. at 697 (imposing liability on the underwriters based upon “those portions of the prospectus which were not made on the authority of Peat, Marwick as an expert” (emphasis added)).

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2. Text of Section 7(a)

The conclusion that the Section 11(b)(3)(C) defense does not require the relevant expert’s consent is consistent with Section 7(a) of the Securities Act. Section 7(a), which specifies the contents of a registration statement, generally requires a registrant to obtain the consent of any expert whose report is used in the registration statement.16 However, Section 7(a) further provides that a registrant need not file the consent of an expert where the Commission “dispenses with such filing as impracticable or as involving undue hardship on the person filing the registration statement.”17 Historically, such exceptions have been exceedingly rare.18 Without the Commission’s express authorization to dispense with the requirement of a consent, the registration statement would not satisfy the requirements of Section 5(b) and thus could not become effective in the first instance.19

Although Section 7(a) does not use the term “expert,” the description in Section 7(a) is the same as that used for the term “expert” in Section 11(a)(4) (namely, “accountant, engineer, or appraiser, or any person whose profession gives authority to a statement made by him”). In addition, Sections 7(a) and 11(a)(4) both include the requirement of a consent, which raises a potential interpretive issue with respect to Section 11(b)(3)(C), which uses the term “expert” without further elaboration. Specifically, the issue is whether “expert,” as that term is used in each subsection of Section 11(b)(3), somehow incorporates the requirement of a consent when Sections 7(a) and 11(a)(4) do not do so by their express terms.

However, to impose the requirement of a consent as part of the term “expert” in Section 11(b)(3) would ignore the express language of Section 7(a), which permits the Commission to dispense with the consent requirement and directly contemplates the possibility of a person who has not consented but is nonetheless an expert. Section 7(a) expressly refers to an expert who has not consented:

“If any such person is named as having prepared or certified a report or valuation . . . which is used in connection with the registration statement . . . the written

16 Section 7(a) (“If any accountant, engineer, or appraiser, or any person whose profession gives

authority to a statement made by him, is named as having prepared or certified . . . a report or valuation (other than a public official document or statement) which is used in connection with the registration statement . . . the written consent of such person shall be filed with the registration statement . . . .”); see also Rule 436(a) (setting forth specific requirements regarding such consents); Regulation S-K, Item 601(b)(23).

17 See Section 7(a); see also Rule 437 (adopted 1947) (governing applications to dispense with the Section 7(a) consent requirement).

18 See LOSS & SELIGMAN, supra note 5, at 4259 n.159 (citing U.S. Chromium, Inc., 6 S.E.C. 882, 889 (1940)) (noting that Rule 437 applications to dispense with the requirement of filing an expert consent “will not be granted lightly” because, under Section 11(a)(4), “an expert cannot be held liable without proof of consent”).

19 Thus, a defendant would be able to assert a Section 11(b)(3)(C) defense in the absence of a Section 11(a)(4) person being liable with respect to the relevant part of the registration statement only when the Commission had acted under Section 7(a) to authorize that outcome.

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consent of such person shall be filed . . . unless the Commission dispenses with such filing.”20

By specifically referring to instances where a registration statement need not include the consent of “any such person” (i.e., an expert), the language and logic of Section 7(a) compel the conclusion that a consent is not a requirement for a person to be considered an expert under the Securities Act.

B. Legislative History

1. The Securities Act’s Consent Requirement

The more reasonable reading of Section 11(b)(3)’s use of the term “expert” is that Congress used the term in the Securities Act in the same way that the term generally was used at the time. The legislative history of Sections 7 and 11 clearly indicates how the term “expert” was used when Congress enacted the statute, and that usage demonstrates that the term “expert” is conceptually distinct from the consent requirement. During the events leading up to the Securities Act’s passage, the House had proposed a bill that added experts to the persons subject to Section 11 liability, in contrast to the Senate bill, which had not included experts as Section 11 persons. The Senate accepted the House version but modified it to require the expert’s consent as a prerequisite to Section 11 liability:

“The House bill imposed liability upon the underwriters and also upon the experts, such as accountants, appraisers, and engineers, who gave the authority of their names to statements made in the registration statement. The Senate accepted the provisions of the House bill with reference to this matter, but with the modification that, to protect an unauthorized use of the expert’s name, written consent to the use of his name, as having prepared or certified part of the registration statement or as having prepared a report to which statements in the registration statement were attributed, should be filed at the time of the filing of the registration statement.”21

Moreover, in his first-hand account of the legislative history of the Securities Act, James M. Landis, one of its principal drafters, states:

“Four drafts of the bill found their way into print before the final draft was accepted. There were numerous changes made, of which the significant ones are noted in the Statement of the House Managers contained in the Conference Report as submitted to the House. The more important were . . . the exclusion of any liability with respect to experts named in the registration statement unless they consented to the use of their names . . . .”22

20 Section 7(a) (emphasis added). 21 H.R. CONF. REP. NO. 73-152, at 26 (1933) (emphasis added). 22 James M. Landis, The Legislative History of the Securities Act of 1933, 28 GEO. WASH.

L. REV. 29, 46-47 (1959) (emphasis added).

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Thus, the legislative history reaffirms the conclusion apparent from the language of the statute and indicates that consent is not part of the definition of “expert” as that term is used in the Securities Act. First, Congress added the consent requirement after it imposed liability on experts who are named in registration statements to prevent an expert from being subjected unknowingly to liability under Section 11. Second, in discussing its reasons for doing so, Congress referred to the terms “expert” and “consent” as conceptually distinct, indicating that whether a person is an expert does not depend upon whether that person consents to being named as an expert. Thus, the consent ordinarily required under Section 7(a) provides notice to the expert, rather than constituting an element of what an expert is.

2. Historical Background under the English Companies Act

This conclusion finds further support in the Securities Act’s historical antecedents. Congress modeled portions of the Securities Act generally, and Section 11 in particular, after provisions in the English Companies Act of 1929.23 The drafting team of the Securities Act, according to one of its members, “determined to take as the base of our work the English Companies Act,” and in particular, the Securities Act’s provisions imposing civil liability on the registrant were “drawn generally” from the English statute.24 Indeed, the drafters’ reliance on the English Companies Act is “most evident” in Section 11 of the Securities Act, as recognized both by judicial precedents25 and by legal commentary. 26

The English Companies Act not only provides the historical context in which Congress enacted the Securities Act but also contains a key provision, Section 37, on which Congress modeled Section 11 of the Securities Act.

Reference to Section 37 of the English Companies Act confirms, as indicated in the legislative history of the Securities Act, that the terms “expert” and “consent” are conceptually independent.

23 19 & 20 Geo. 5, ch. 23. 24 Landis, supra note 22, at 34-35. 25 See, e.g., Lanza v. Drexel & Co., 479 F.2d 1277, 1296-97 (2d Cir. 1973) (noting that “Congress

explicitly relied upon similar provisions in the English Companies Act” in enacting the Securities Act and that “Section 11 was closely patterned after Section 37 of the English Companies Act”); In re The Gap Stores Sec. Litig., 79 F.R.D. 283, 297 (N.D. Cal. 1978) (noting that Section 11 of the Securities Act was “[m]odeled on the provisions of the English Companies Act”); cf. Gustafson v. Alloyd Company, Inc., 513 U.S. 561, 582 (1995) (“Far from suggesting an intent to depart in a dramatic way from the balance struck in the [English] Companies Act, the legislative history [of the Securities Act] suggests an intent to maintain it.”); id. at 599 (Ginsberg, J., dissenting) (noting that the Securities Act’s drafters used the English Companies Act as a model); SEC v. Ralston Purina, 346 U.S. 119, 123 (1953) (relying on cases decided “under comparable exemptions in the English Companies Act” to determine the meaning of “public offering”).

26 Ernest L. Folk, III, Civil Liabilities under the Federal Securities Acts: The BarChris Case, 55 VA. L. REV. 1, 13-14 (1969) (“The magnetic force of the English model, sufficiently strong to attract the draftsmen away from the more obvious local patterns readily at hand in the state blue sky laws, is most evident in section 11.”); see also H.R. REP. NO. 73-85, at 9 (1933) (comparing Sections 11 and 12 to “similar safeguards in the English Companies Act”).

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First, Section 37 did not include experts as persons subject to liability, just as earlier drafts of the Securities Act did not include experts in Section 11(a).27 Thus, when Congress added experts as Section 11(a) persons under the Securities Act, it added the corollary requirement that experts must consent to be named in the registration statement.

Second, although the English Companies Act did not make experts themselves liable, it did provide for affirmative defenses to officers and directors that were similar to Section 11(b)(3) with respect to liability for a “part of the registration statement purporting to be a statement by an expert.” Unlike the Securities Act, however, the English Companies Act includes a definition of an expert. That definition (“engineer, valuer, accountant, and any other person whose profession gives authority to a statement made by him”) tracks Congress’ use of the term in both the Securities Act and its legislative history. 28 Thus, it is reasonable to conclude that when Congress enacted the Securities Act, the drafters of the statute did not understand the term “expert” to mean only a person who has with his consent been named as such in the registration statement.

C. Rules of the Commission

1. Rules 436 and 437

In two key respects, Rule 436 governs information in registration statements that would otherwise be information “purporting to be made on the authority of an expert” within the meaning of Section 11(b)(3)(C).

First, Rule 436(c) provides that unaudited interim financial information “shall not be considered a part of a registration statement prepared or certified by an accountant . . . within the meaning of Sections 7 or 11,” despite the fact that such information is reviewed by the registrant’s accountants, who would otherwise be considered experts under the Securities Act. The Commission adopted Rule 436(c) to provide that accountants who consent to being named in a registration statement that includes SAS 71 unaudited financial reports are not considered

27 See English Companies Act Sections 37(1)(a)-(d). Similarly, Section 37 of the Companies Act

did not impose liability on underwriters, but Congress added underwriters as Section 11(a) persons. See Douglas & Bates, supra note 7, at 198 (“Where the Companies Act holds responsible in addition to directors and certain promoters only such persons as ‘authorised the issue of the prospectus,’ the Securities Act imposes liability upon all ‘underwriters.’”). Congress sought specifically to hold underwriters liable and to adopt a liability structure that was, at a minimum, no less demanding than England’s. See H.R. REP. NO. 73-85 at 2-3 (referring to the need for reform in light of the “complete abandonment by many underwriters and dealers in securities of those standards of fair, honest, and prudent dealing”); id. at 9 (noting that the liability provisions of Sections 11 and 12 derive from the English Companies Act and that “[w]hat is deemed necessary for sound financing in conservative England ought not be unnecessary for the more feverish pace which American finance has developed”).

28 Compare English Companies Act Sections 37(4) (defining “expert” to include “engineer, valuer, accountant, and any other person whose profession gives authority to a statement made by him”) with Securities Act Section 7(a) (referring to “any accountant, engineer, or appraiser, or any person whose profession gives authority to a statement made by him”) and Securities Act Section 11(a)(4) (referring to “every accountant, engineer, or appraiser, or any person whose profession gives authority to a statement made by him”).

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“experts” with respect to the unaudited financial reports.29 In the adopting release, the Commission expressly stated its expectation that, with respect to SAS 71 reports, “directors and underwriters will continue to exercise due diligence in a vigorous manner” and that directors and underwriters “should not be able to rely” on SAS 71 reports “as statements ‘purporting to be made on the authority of an expert’” under Section 11(b)(3)(C). Instead, the Commission explained, Section 11(b)(3)(A) would apply to such parts of the registration statement.30 Thus, in the case of Rule 436(c), which deems certain unaudited financial reports not to be “a part of a registration statement prepared or certified by an accountant” (and therefore not expertised), the Commission clearly stated the effect of the rule in the adopting release.

Second, Rule 436(g)(1) allows a registrant to include in its registration statement the rating assigned by a nationally recognized statistical rating organization (“NRSRO”) without obtaining the NRSRO’s consent under Section 7. As with Rule 436(c), the rating by the NRSRO under Rule 436(g)(1) is not considered “a part of a registration statement prepared or certified by a person within the meaning of Sections 7 and 11.” In adopting Rule 436(g)(1), the Commission did not discuss Rule 436(g)(1)’s effects on an underwriter’s or other Section 11(a) person’s due diligence defense. The Commission noted that commentators had “expressed concern” that the NRSROs’ exemption from Section 11 liability might affect the liability of underwriters and other Section 11(a) persons, and, in response, the Commission pointed out that “disclosure of ratings is optional and, in any event, issuers may seek to obtain an NRSRO’s written consent.”31

In 1947, the Commission adopted Rule 437, which governs applications to dispense with a written consent of an expert under Section 7(a) of the Securities Act.32 Rule 437 requires the application to be “supported by an affidavit or affidavits establishing that the obtaining of such consent is impracticable or involves undue hardship on the registrant,” and the Commission must approve the application “prior to the effective date of the registration statement.” In general, however, Rule 437 applications “will not be granted lightly” because, under Section 11(a)(4),

29 Accountant Liability for Reports on Unaudited Interim Financial Information under Securities

Act of 1933, Release No. 33-6173, 1979 WL 169953, at 3 (Dec. 28, 1979). This release, which adopted Rule 436(c), addressed an auditor’s review of interim financial information, which was then governed by SAS 24 and was later superseded by SAS 71. See Statements on Auditing Standards (SAS) No. 37, 1 American Institute of Certified Public Accountants, AICPA Professional Standards AU Section 711.06 (March 2002) (noting that, under unspecified “rules” of the Commission, “an independent accountant’s report based on a review of interim financial information is not a report by the accountant within the meaning of section 11” and that “the accountant does not have a similar statutory responsibility for such reports as of the effective date of the registration statement”).

30 Id. at 4. This apparently was due to the fact that an accountant’s “reasonable investigation” under Section 11(b)(3)(B) “must be premised on an audit” and “cannot be accomplished short of an audit.” Id. at 3 n.8 (citing Codification of Statements on Accounting Standards, AU Section 630.02).

31 Adoption of Integrated Disclosure System, Release No. 33-6383, Release No. 34-18524, 1982 WL 90370, at 24 n.58 (Mar. 16, 1982).

32 Commission Action Adopting Changes to Regulation C, 12 Fed. Reg. 4074 (June 24, 1947).

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“an expert cannot be held liable without proof of consent and such proof would be exceedingly difficult without the filing of a written consent” along with the registration statement.33

Significantly, Rules 436(c) and 436(g)(1) embody a different approach to Sections 7 and 11 than the approach codified in Rule 437. Under Rule 436(c) and 436(g)(1), the information, whether an accountant’s SAS 71 review or an NRSRO’s security rating, is not considered to be a part of the registration statement prepared or certified by a person under Sections 7 and 11. Thus, in both situations, the pertinent parts of the registration statement are not considered to be statements “purporting to be made on the authority of an expert” within the meaning of Section 11(b)(3)(C). Because interim financials and NRSRO ratings are not expertised, the information, if included in the registration statement, is subject to the reasonable investigation standard of Section 11(b)(3)(A). Absent the exclusions contained in Rules 436(c) and 436(g)(1), the accountant or the NRSRO, as the case may be, would be an expert whose consent would be required under Section 7. Thus, the adopting release for Rule 436(g)(1) emphasizes that non-NRSRO ratings included in a registration statement would require the consent of the non-NRSRO rating organization. 34

In contrast to the approach embodied in Rules 436(c) and 436(g)(1), Rule 437 does not operate by defining the pertinent information as not being a part of the registration statement prepared or certified by a person under Sections 7 and 11. Instead, Rule 437 merely dispenses with the expert’s consent if the conditions of the rule are met. There is no implication in Rule 437, as there is in Rules 436(c) and 436(g)(1), that the person is not an expert or that the information is not expertised. The key distinction between the two approaches is that Rule 437, when operative, dispenses with an expert’s consent, whereas Rules 436(c) and 436(g)(1), applied to interim financials and NRSRO ratings, dispense with the status of the accountant or NRSRO as an expert altogether.

2. Rule 437a

In March 2002, the Commission adopted Rule 437a as part of its Release addressing issues faced by clients of Andersen. 35 By its terms, Rule 437a allows any registrant filing a registration statement with financial statements in which Andersen had been the independent

33 LOSS & SELIGMAN, supra note 5, at 4259 n.159 (citing U.S. Chromium, Inc., 6 S.E.C. 882, 889

(1940)); see also Douglas & Bates, supra note 7, at 197 & 197 n.149 (noting that Section 7(a) empowers the Commission to waive the filing of an expert’s consent and that, “if their written consent is not so filed, they are not made liable unless the person suing can prove that such consent was in fact given, though it was not so filed”).

34 Adoption of Integrated Disclosure, supra note 31, at 24 n.54 (stating that “a rating assigned by a non-NRSRO in a Securities Act registration statement . . . would require the filing of the written consent of the rating organization under Section 7”); id. at 24 n.58 (explaining that “if a registrant includes a rating assigned by a rating organization that is not an NRSRO, it should include the written consent of such organization as required under Section 7”).

35 Requirements for Arthur Andersen LLP Auditing Clients (Temporary Final Rule and Final Rule), Release No. 33-8070, Release No. 34-45590 (Mar. 18, 2002) <http://www.sec.gov/rules/final/33-8070.htm> [hereinafter “Andersen Requirements”].

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public accountant to dispense automatically with the requirement to file Andersen’s written consent pursuant to Section 7(a) where the registrant:

• has not already obtained the consent; • is not able to obtain the consent after reasonable efforts; and • discloses clearly any limitations on recovery by investors posed by the lack of

consent (which presumably refers to the notion that “an expert cannot be held liable without proof of consent” under Section 11(a)(4) of the Act).

Rule 437a follows the approach of Rule 437 by dispensing with the consent. The only difference between the two rules is Rule 437a is self-executing. For issuers that meet the conditions of Rule 437a, the dispensation is automatic and requires neither application by the issuer nor further Commission action.

Rule 437a does not change the status of the financial statements as having been certified nor does it exclude Andersen’s audit report from being considered a part of the registration statement prepared or certified by a person under Sections 7 and 11, as Rules 436(c) and 436(g)(1) do with respect to an accountant’s SAS 71 review and an NRSRO’s security rating. Thus, Rule 437a, like Rule 437, does not by its terms change the expertised nature of the information included in the registration statement or the status of the person who prepared or certified such information as Rules 436(c) and 436(g)(1) do.

D. Section 19(a)

Rule 437a should not change the due diligence defense available to any person named in Section 11(a) with respect to an issuer that uses Rule 437a to file a registration statement without a consent because the person subject to Section 11(a) may “rely in good faith upon the rules and regulations of the Commission.”36 Here, an underwriter would be relying on Rule 437a to conclude that the financial statements are still expertised and that, with respect to the financial statements, which remain audited despite the lack of a consent,37 the underwriter remains subject to Section 11(b)(3)(C), rather than Section 11(b)(3)(A). Section 19(a) provides:

“No provision of this title imposing any liability shall apply to any act done or omitted in good faith in conformity with any rule or regulation of the Commission, notwithstanding that such rule or regulation may, after such act or

36 Report of the Committee on Federal Regulation of Securities, Current Issues and

Developments in the Duties and Liabilities of Underwriters and Securities Dealers, 33 BUS. LAW. 335, 357 (1977) (statement of Kenneth J. Bialkin) (suggesting that reliance upon the Commission’s “adoption of Form S-16 and the limited disclosure necessitated by the use of that form” would be “a sufficiently stable basis upon which to rest a due diligence defense”).

37 The “Experts” section of a prospectus typically contains disclosure that the financial statements were included in the registration statement in reliance on the report of the issuer’s independent accountants and that the report was given on their authority as experts in auditing and accounting.

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omission, be amended or rescinded or be determined by judicial or other authority to be invalid for any reason.”38

Unlike Rule 437, in which the Commission has dispensed with the consent requirement on a case-by-case basis and only rarely after a specific application has been made, Rule 437a dispenses with the requirement automatically for over two thousand companies if specified conditions are met. Given Rule 437a’s automatic operation and specific conditions, we believe that, had the Commission intended to depart from Section 11’s existing liability matrix, Rule 437a would have contained guidance to that effect beyond the vague statement in paragraph (b)(3), which apparently refers to the operation of Section 11(a)(4) rather than Section 11(b)(3).

Applying Section 19(a) would appear to support the position that an underwriter can rely on Rule 437a to avail itself of the defense in Section 11(b)(3)(C):

“No provision of this title imposing any liability [i.e., Section 11(a)] shall apply to any act done [i.e., the filing of a registration statement without a consent as otherwise required under Section 7(a)] or omitted [i.e., the “reasonable investigation” required under Section 11(b)(3)(A) but not included under Section 11(b)(3)(C)] in good faith in conformity with any rule or regulation of the Commission [i.e., Rule 437a, which merely dispenses with the requirement of consent without specifying any concomitant change in the status of financial statements as a part of the registration statement “purporting to be made on the authority of an expert” under Section 11(b)(3)(C)] . . . .”

Consistent with this reasoning, cases applying Section 19(a) to a defendant who has relied in good faith on a rule or regulation of the Commission uniformly apply that section to prevent the imposition of liability.39

38 Section 19(a). 39 See, e.g., Wielgos v. Commonwealth Edison Co., 892 F.2d 509, 512-13 (7th Cir. 1989)

(applying Section 19(a) to affirm summary judgment for defendants on a Section 11 claim alleging materially erroneous statements made in a prospectus in reliance on Rule 175 governing forward-looking statements); Spicer v. Chicago Board of Options Exchange, Inc., Fed. Sec. L. Rep. ¶ 97,322, 1992 WL 380929, at 3-4 (N.D. Ill. 1992) (granting summary judgment to defendants on a Section 12 claim alleging material omissions in an options disclosure document that the prospectus had incorporated by reference based on defendants’ good faith compliance with Form S-20, which required reference to the options disclosure document); SEC v. Cenco Inc., 436 F. Supp. 193, 198 (N.D. Ill. 1977) (finding that Section 19(a) provided shield from liability regarding disclosure obligations if defendants had “in good faith disclosed everything known to them or reasonably within their ability to discover at the time”); cf. C.R.A. Realty Corp. v. Goodyear Tire & Rubber Co., 705 F. Supp. 972, 978 n.7 (S.D.N.Y. 1989) (recognizing that Section 19(a) precludes liability for acts done or omitted in good faith reliance on a rule or regulation of the Commission and granting on other grounds the defendants’ motion to dismiss); Byrnes v. Faulkner, Dawkins & Sullivan, 550 F.2d 1303, 1312-13 (2d Cir. 1977) (recognizing that Section 19(a) provides immunity from liability for persons whose conduct conforms to a rule or regulation of the Commission, but declining to extend Section 19(a) to “an elaborately reasoned interpretation directly contrary to literal language” contained in an opinion of the Commission’s general

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We believe Section 19(a) provides additional support for the conclusion that an underwriter can rely on Rule 437a without subjecting the underwriter to additional liability that it would not have faced in the absence of such reliance. The Commission adopted Rule 437a for the express purpose of allowing “issuers filing registration statements audited by Andersen” to “dispense with the requirement for the registrant to file the written consent of Andersen as required by Section 7 of the Securities Act” where the issuers meet the requirements of the rule.40 In doing so, the Commission did not indicate, directly or indirectly, that Rule 437a would deprive underwriters of the benefit of Section 11(b)(3)(C) because the registrant’s financial statements would no longer be a part of the registration statement “purporting to be made on the authority of an expert.” Although Rule 437a requires registrants to disclose “clearly any limitations on recovery by investors posed by the lack of consent,”41 we view that requirement as intended to inform investors of the inability to hold experts liable under Section 11(a)(4) without their consent, given that no other “limitations on recovery” are discernably “posed by the lack of consent.” Moreover, ample reasons exist independent of Rule 437a for concluding that Rule 437a was not intended to, nor does it, change an underwriter’s ability to rely on Section 11(b)(3)(C) with respect to certified financial statements. Therefore, Section 19(a) should enable an underwriter to rely on Rule 437a without changing the standard of the due diligence defense available to the underwriter.

counsel); cf. Section 23(a) of the Exchange Act (providing that no provision of the Exchange Act “imposing any liability shall apply to any act done or omitted in good faith in conformity with any rule or regulation of the Commission”); see also Gerstle v. Gamble-Skogmo, Inc., 478 F.2d 1281, 1293-94 (2d Cir. 1973) (finding that Section 23(a) immunized a defendant’s omission from its merger proxy statement of asset appraisals due to the Commission’s “general policy” against including such appraisals); Greene v. Dietz, 247 F.2d 689, 692-95 (2d Cir. 1957) (determining that defendants were not liable in an action to recover short-swing profits under Section 16(b) based on defendants’ “good faith reliance on a valid construction of Rule X-16B-3,” despite “doubt as to the Commission’s power to promulgate Rule X-16B-3”); Colema Realty Corp. v. Bibow, 555 F. Supp. 1030, 1039-40 (D. Conn. 1983) (relying on Section 23(a) to grant summary judgment for defendants in an action to recover short-swing profits in connection with insiders’ alleged violations of Section 16(b) of the Exchange Act, based on defendants’ good faith reliance on Rule 16b-3); Van Aalten v. Jurley, 176 F. Supp. 851, 854-856 (S.D.N.Y. 1959) (granting summary judgment in favor of defendants in suit under Section 16(b) for recovery of short-swing profits based on defendants’ good faith reliance on Rule X-16B-3 despite judicial precedent casting doubt on Rule X-16B-3’s validity and despite a later determination of invalidity); Emerson Elec. Mfg. Co. v. O’Neill, 168 F. Supp. 804, 805 (E.D. Mo. 1958) (holding that Section 23(a) shielded defendants from liability as a matter of law based on their reliance on Rule X-16B-3 “even if that rule is invalid”).

40 Andersen Requirements, supra note 35, at II.B.5; see also SEC Press Release 2002-89 (June 15, 2002) (stating that the Andersen Requirements continue to remain in effect so as to “minimize any potential disruption to the capital markets and the affected issuers while those issuers complete certain pending or future filings, offerings and other activities”). Similarly, in 1991, the Commission permitted issuers to dispense with the requirement of obtaining the consent of Laventhol & Horwath, a public accounting firm that filed for bankruptcy in November 1990. See Staff Accounting Bulletin No. 90, at 9 (Jan. 31, 1991) (announcing that the Staff would dispense with requiring a consent from Laventhol & Horwath where a Rule 437 applicant had met certain requirements).

41 See Rule 437a(b)(3).

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E. Additional Steps to Consider

1. Section 11(c)

Notwithstanding the availability of Section 11(b)(3)(C), under some circumstances an underwriter may have to take additional steps with respect to the expert’s report so that the underwriter will have “no reasonable ground to believe” that the registration statement is misleading or omits a material fact under that subsection. Specifically, Section 11(c) provides that, in determining what constitutes a “reasonable ground for belief” (as well as “reasonable investigation”) under Section 11(b)(3), “the standard of reasonableness shall be that required of a prudent man in the management of his own property.”

Section 11(c) thus involves a fact- intensive inquiry. In general, the extent of an underwriter’s due diligence under Section 11(c) as it applies to Section 11(b)(3)(C) will vary according to the particular circumstances, including the nature of the available information. In the absence of any reason to doubt the accuracy of an expert’s report, a “prudent man in the management of his own property” might well rely solely on the expert without doing anything more. However, if information comes to an underwriter’s attention that raises potential red flags, Section 11(c) may require the underwriter to conduct additional diligence even under Section 11(b)(3)(C).

In re Software Toolworks, Inc. Securities Litigation42 provides a useful model for an underwriter to establish on summary judgment that the underwriter satisfied Section 11(c)’s requirement that the underwriter had a “reasonable ground for belief” that the registration statement was not misleading with respect to audited financial statements that had been called into question in advance of the offering. 43 Specifically, the plaintiffs alleged that the underwriter could not establish a due diligence defense because it had “blindly relied” on the issuer’s auditor “in spite of numerous ‘red flags’” regarding the issuer’s financial condition. 44 In response, the court pointed out that underwriters “need not conduct due diligence into the ‘expertised’ parts of a prospectus, such as certified financial statements.”45 Instead, the court explained, the issue is whether the underwriters’ reliance on the expertised financial statements is “reasonable.”

To determine the reasonableness of the underwriters’ reliance on the expertised financial statements, the court examined the underwriters’ conduct with respect to the particular red flag at issue, which involved revenue recognition relating to a backdated contract. The plaintiffs

42 50 F.3d 615 (9th Cir. 1995). 43 Although Software Toolworks involved a number of distinct issues, the appellate court affirmed

the trial court’s grant of summary judgment in favor of the underwriters with respect to their satisfaction of Section 11(c) as it applies to Section 11(b)(3)(C). Software Toolworks, 50 F.3d 621, 623-24 (citing Sections 11(b)(3)(C) and 11(c)) (determining that “the Underwriters’ reliance on the expertised financial statements was reasonable as a matter of law”).

44 Id. at 623. 45 Id.

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alleged that, upon discovering the backdated contract, the underwriters could no longer rely on the auditor as an expert.46 The court disagreed:

“If the Underwriters had done nothing more, the plaintiffs’ contention might be correct. The plaintiffs, however, ignore the significant steps taken by the Underwriters after discovery of the memorandum [about the backdated contract] to ensure the accuracy of Deloitte’s revenue recognition. The Underwriters first confronted Deloitte, which explained that it was proper for Toolworks to book revenue in fiscal 1990 . . . . The Underwriters then insisted that Deloitte reconfirm, in writing, the [backdated] agreement and Toolworks’ other OEM contracts. Finally, the Underwriters contacted other accounting firms to verify Deloitte’s OEM revenue accounting methods.”47

The court found that the underwriters had discharged the Section 11(c) standard of reasonableness because, when a red flag appeared, the underwriters:

• confronted the auditor for an explanation; • required the auditor to reconfirm the matter in writing; and • contacted other accounting firms to verify that the matter had been resolved

properly.

Thus, the court determined that the underwriters had not “blindly relied” on the auditors and that the underwriters’ investigation in response to the red flag was reasonable as a matter of law. Accordingly, the court upheld the trial court’s grant of summary judgment in favor of the underwriters on this Section 11 claim.48

46 Id. at 624 (“The plaintiffs claim that, after discovering this memorandum [about the backdating

of the contract], the Underwriters could no longer rely on Deloitte because the accountants had approved revenue recognition for the transaction [covered by the contract].”).

47 Id. 48 The court reversed the trial court’s grant of summary judgment and remanded the case for trial

on the merits of other Section 11 claims. Id. at 625. The court found that a genuine issue existed for trial on whether the underwriters responded adequately to new developments that arose after circulation of the preliminary prospectus but before effectiveness of the registration statement. Id. These events involved a Barron’s article questioning the issuer’s “aggressive accounting,” further review of the preliminary prospectus by the Commission and the inclusion of sales in the issuer’s interim financial information that were eventually reversed when the issuer’s financial statements were audited. Id. Although the court affirmed the grant of summary judgment with respect to the underwriters’ response to the Barron’s article because they had contacted other retailers to “confirm the strength of the market” and their “reliance on Deloitte’s accounting decisions was reasonable as a matter of law,” the court reversed the decision below and remanded the case for trial on the merits of whether the underwriters deliberately deceived the Commission or unreasonably relied on management with respect to the transactions reported as part of the interim financial information. Id.

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2. Risk Mitigation Factors

Ultimately, despite substantial reasons supporting the conclusion that an underwriter should have a due diligence defense under Section 11(b)(3)(C) available to it where the registrant omits Andersen’s consent in compliance with Rule 437a, any underwriter facing this situation must satisfy itself in advance that the risk of litigation can be sufficiently mitigated to proceed with the proposed public offering. One particular cause for concern, in addition to the lack of binding precedent on the specific issue under consideration, is that a court could reach a result completely at odds with what anyone who is conversant with the Securities Act’s provisions would expect.49

Here, the risks of litigation generally and of unorthodox judicial determinations in particular can be mitigated in two respects. First, the approach outlined in Section E.1. of Part III above will allow an underwriter to discharge its obligations under Section 11(c) by following additional steps such as those in Software Toolworks to address issues that may arise in connection with the financial statements. Second, the underwriter can work with the registrant to ensure that the registration statement includes adequate disclosure of the circumstances surrounding the lack of consent, the reliance on Rule 437a and possible limitations on recovery as required by Rule 437a(b)(3).

49 E.g., Gustafson v. Alloyd Company, Inc., 513 U.S. 561 (1995) (construing the Securities Act’s

broad definition of “prospectus” to be coterminous with the type of prospectus described in Section 10); see DAVID L. RATNER, SECURITIES REGULATION 89 (6th ed. 1998) (calling Gustafson a decision that “surprised almost everyone”); see also LARRY D. SODERQUIST & THERESA A. GABALDON, SECURITIES LAW 1 (1998) (explaining that, in Gustafson, “some very bright Supreme Court justices, and their equally intelligent law clerks, evidently attempted to figure out the Securities Act on their own — and they failed miserably”); id. at 48 (asserting that “the decision was based on an exceedingly flawed understanding of the Securities Act”); id at 101-02 (identifying some of Gustafson’s logical failings). Rather than looking to the statute’s text, logical structure and legislative history, a court could instead focus on the possible effects on the plaintiff. If Andersen is not liable under Section 11(a)(4) because it has not consented, and if the underwriter establishes a due diligence defense under Section 11(b)(3)(C), then Section 11 liability would attach only to the issuer and its officers and directors. If those persons are bankrupt and insurance coverage is unavailable, a plaintiff could be unable to recover any damages under Section 11. Notwithstanding the substantive merits of the legal analysis, a court in these circumstances may be tempted to apply Section 11(b)(3)(A), rather than Section 11(b)(3)(C), to an underwriter with respect to financial statements audited by Andersen that were included in a registration statement without a written consent pursuant to Rule 437a. Alternatively, and perhaps more likely, a court would focus on the actions taken by the underwriter in light of the absence of a consent, as discussed infra in this Section E.2 of Part III. In addition, the disclosure made in compliance with the requirements of Rule 437a and otherwise may affect the outcome of the possible litigation scenarios.

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Factors that an underwriter may consider in these circumstances include, but are not limited to, the following:

• whether the issuer received Andersen’s consent on the most recently audited year’s financial statements with respect to any prior filing with the Commission;

• the underwriter’s relationship with the issuer prior to the time at which Andersen became unable to provide its consent (i.e., whether the underwriter has conducted multiple offerings for the issuer in recent years, on the one hand, versus whether this is the underwriter’s first offering involving the issuer, on the other);

• whether the underwriter has research analyst coverage of the issuer and/or the issuer’s particular industry, and the extent of the research analyst’s prior access to the issuer and its accounting team;50

• whether the Andersen engagement partner for the issuer went to the issuer’s new auditor and is available to be interviewed by the underwriter;

• whether the underwriter has obtained additional representations from the issuer’s chief financial officer, comptroller, treasurer or other members of the issuer’s financial management team;51

50 Cf. Rule 176(g) (including, among other factors for determining whether a person has a

“reasonable ground for belief” under Section 11(c), “the type of underwriting arrangement, the role of the particular person as an underwriter and the availability of information with respect to the registration”). Rule 176 was adopted to establish “certain circumstances bearing upon the reasonableness of the investigation conducted to discharge one’s obligation under section 11(b) of the Securities Act and upon what constitutes reasonable grounds for belief under that Section.” Adoption of Integrated Disclosure, supra note 31, at 2. The Commission emphasized that the “important point” under Rule 176 “is that each subject person should evaluate the surrounding facts, including the extent of his prior relationship with the registrant, and utilize techniques of investigation appropriate to the circumstances of the offering.” Id. at 35. Moreover, the Commission noted that judicial interpretations of Section 11 “have confirmed the principle that what constitutes reasonable investigation and reasonable ground for belief depends on the circumstances of each registration.” Id. As an example, the Commission predicted that “a court would not expect the investigation undertaken in connection with a short form registration of a seasoned company to be the same as that which would be reasonable in connection with an initial public offering.” Id. at 35 n.101. A similar point made in a related context is that the investigation required should reflect the extent of the person’s involvement in the offering. See James M. Landis, Liability Sections of Securities Act Authoritatively Discussed, 18 AM . ACCT . 330, 332 (1933) (“The type of investigation which can reasonably be demanded of the sponsoring or principal underwriters is one thing; that which the [Securities] Act requires of the small participating underwriter in order that he shall satisfy its requirements is another thing, while an even less[er] standard of investigation would be demanded of the dealer selling on commission who, because of his relationship to the issuer, is considered as an underwriter by the [Securities] Act.”); see also LOSS & SELIGMAN, supra note 5, at 4258 (recognizing that “the ordinary director or small participating underwriter might be able to satisfy the burden of proof more readily than the chairman of the board or the managing underwriter”).

51 In addition, the underwriter should consider the advisability of maintaining a list, rather than a detailed description, of steps taken during the course of its due diligence investigation for purposes of addressing the lack of an Andersen consent.

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• whether the issuer is a foreign private issuer (because, in the case of foreign private issuers, the entire audit firm that was previously a foreign affiliate of Andersen typically has become a foreign affiliate of a different U.S. audit firm);

• the availability of a SAS 71 review of the most recent interim financial statements by the issuer’s new auditors; 52

• the ability to negotiate agreed-upon procedures between the underwriters and the issuer’s new auditors, which may depend on the new auditor’s ability to issue a comfort letter under SAS 72;

• the underwriter’s use of a different accountant to conduct a review of one or more critical accounting policies53 or otherwise examine portions of the financial statements;54

• whether the underwriter has conferred with other accounting firms with respect to specified accounting issues; and

• whether any changes in accounting policies or subsequent events would require changes to the Andersen financial statements in order to comply with generally accepted accounting principles.55

52 The procedures for a SAS 71 review are similar to the standards applicable to an auditor for

granting its consent to being named in the registration statement. See Statements on Auditing Standards (SAS) No. 37, supra note 29, Section 711.

53 E.g., revenues from contracts accounted for by the percentage of completion method or other critical accounting policies described in the Commission’s recent discussion of such policies. See Release No. 33-8098 at 14 & 14 n.53 (May 10, 2002).

54 The different accountant may be another accounting firm or a forensic accountant that is retained directly by underwriter’s counsel in a context that is subject to the attorney-client privilege.

55 The Auditing Standards Board recently issued an interpretation discussing the effects upon a successor auditor’s report where current-period audited financial statements are presented for comparison with prior-period financia l statements audited by an auditor that has discontinued operations, such as Andersen. See AU 508 Interpretation 15, “Reporting as Successor Auditor When Prior-Period Financial Statements Were Audited by a Predecessor Auditor Who Has Ceased Operations,” based upon AICPA Professional Standards AU Section 508, Reports on Audited Financial Statements. The ASB interpretation addresses changes to financial statements audited by Arthur Andersen. Specifically, it identifies three situations in which an issuer can include prior-period financial statements in filings with the Commission without a full reaudit of the financial statements for the prior period: (1) inconsequential revisions of prior-period financial statements (e.g., editorial modifications to footnote disclosures or non-material reclassifications made for comparative purposes in financial statements); (2) revisions of prior-period financial statements involving the addition of disclosures, rather than the restatement of amounts; and (3) adjustments requiring the reaudit of only the item that is the subject of the adjustments, rather than a full reaudit of the financial statements for the prior period. The judgment of the auditor is critical in making the determinations in the second and third categories. Thus, if the new auditor is uncomfortable in concluding that limited procedures are adequate to address an adjusted item, a full reaudit may be the only possible resolution of the issue. In addition, a full reaudit of the prior-period financial statements will be required for (1) certain types of adjustments (e.g., correction of an error, reflection of a change in

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In addition to factors such as those described above, an underwriter should consider including in the registration statement additional disclosure that augments the disclosure made pursuant to Rule 437a(b)(3) concerning the absence of Andersen’s liability. For example, disclosure could be made to the effect that a plaintiff may have no recourse under Section 11 against an underwriter that satisfies a due diligence defense under Section 11(b)(3)(C). If disclosure is made, it could serve the dual role of putting investors on notice and thereby ameliorate the risk that a court would reach a different result than that described in this memorandum as well as protect investors by informing them of the operation of Section 11’s liability matrix under circumstances in which Andersen has not consented.56

Finally, if the factors described above do not enable an underwriter to resolve the issues raised by any red flags with respect to the financial statements, it should consider requesting that the registrant’s new auditor reaudit the most recent fiscal year. In these circumstances, a reaudit of the most recent fiscal year could allow the underwriter to resolve the issues raised by any red flags and thus to determine, consistent with Section 11(c) as applied to Section 11(b)(3)(C), that the additional steps it has taken with respect to the Andersen financial statements would establish that the underwriter has “no reasonable ground to believe” and does not believe that the registration statement is misleading or omits a material fact under Section 11(b)(3)(C).

IV. CONCLUSION

Although our research has identified no reported decision on the issue, and the Commission has not taken a position on the matter, the preceding analysis demonstrates that, where the Commission authorizes a registrant to omit an expert’s consent, the parts of the registration statement prepared or certified by that expert should nonetheless remain expertised under Section 11(b)(3)(C) of the Securities Act for purposes of an underwriter’s due diligence defense. Even though the underwriter should not be subjected to the reasonable investigation standard of Section 11(b)(3)(A), the underwriter may have to take additional steps, depending on the relevant facts and circumstances, to be able to establish a due diligence defense under Section 11(b)(3)(C) that will be sufficient to support a summary judgment motion. Although the specific steps required to satisfy Section 11(c)’s “prudent man” standard for establishing that the underwriter had “no reasonable ground to believe and did not believe” will vary according to the particular facts and circumstances involved in a given offering, the factors outlined in Section E

reporting entity, retroactive accounting changes that significantly impact previously reported amounts or that affect previously reported net income or net assets, reporting discontinued operations and changes affecting previously reported net income or net assets); and (2) situations where the new auditor has not completed an audit of the issuer’s current-period financial statements but is asked to report on restatement adjustments to the prior-period financial statements.

56As Louis Brandeis stated, “Sunlight is said to be the best of disinfectants.” See Disclosure to Investors: A Reappraisal of Federal Administrative Policies under the ’33 and ’34 Acts 50 (1969) (Wheat Report) (quoting LOUIS D. BRANDEIS, OTHER PEOPLE’S MONEY 92 (1913)); Theodore Sonde & Harvey L. Pitt, Utilizing the Federal Securities Laws to “Clear the Air! Clean the Sky! Wash the Wind!,” 16 HOWARD L.J. 831, 844 (1971) (quoting LOUIS D. BRANDEIS, OTHER PEOPLE’S MONEY 92 (1913)) (“In essence, the [Securities Act and the Exchange Act] adopted and borrowed the disclosure philosophy so eloquently emphasized by Mr. Justice Brandeis.”).

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of Part III above should provide useful guidance to an underwriter seeking to perform the level of investigation necessary to establish a due diligence defense under Section 11(b)(3)(C).

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APPENDIX _____

SELECTED STATUTORY PROVISIONS AND RULES

_____

SECURITIES ACT OF 1933

Section 7. Information required in registration statement

(a) The registration statement, when relating to a security other than a security issued by a foreign government, or political subdivision thereof, shall contain the information, and be accompanied by the documents, specified in Schedule A, and when relating to a security issued by a foreign government, or political subdivision thereof, shall contain the information, and be accompanied by the documents, specified in Schedule B; except that the Commission may by rules or regulations provide that any such information or document need not be included in respect of any class of issuers or securities if it finds that the requirement of such information or document is inapplicable to such class and that disclosure fully adequate for the protection of investors is otherwise required to be included within the registration statement. If any accountant, engineer, or appraiser, or any person whose profession gives authority to a statement made by him, is named as having prepared or certified any part of the registration statement, or is named as having prepared or certified a report or valuation for use in connection with the registration statement, the written consent of such person shall be filed with the registration statement. If any such person is named as having prepared or certified a report or valuation (other than a public officia l document or statement) which is used in connection with the registration statement, but is not named as having prepared or certified such report or valuation for use in connection with the registration statement, the written consent of such person shall be filed with the registration statement unless the Commission dispenses with such filing as impracticable or as involving undue hardship on the person filing the registration statement. Any such registration statement shall contain such other information, and be accompanied by such other documents, as the Commission may by rules or regulations require as being necessary or appropriate in the public interest or for the protection of investors.

* * *

Section 11. Civil liabilities on account of false registration statement

(a) Persons possessing cause of action; persons liable

In case any part of the registration statement, when such part became effective, contained an untrue statement of a material fact or omitted to state a material fact required to be stated therein or necessary to make the statements therein not misleading, any person acquiring such security (unless it is proved that at the time of such acquisition he knew of such untruth or omission) may, either at law or in equity, in any court of competent jurisdiction, sue —

(1) every person who signed the registration statement;

(2) every person who was a director of (or person performing similar functions) or partner in the issuer at the time of the filing of the part of the registration statement with respect to which his liability is asserted;

(3) every person who, with his consent, is named in the registration statement as being or about to become a director, person performing similar functions, or partner;

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(4) every accountant, engineer, or apprais er, or any person whose profession gives authority to a statement made by him, who has with his consent been named as having prepared or certified any part of the registration statement, or as having prepared or certified any report or valuation which is used in connection with the registration statement, with respect to the statement in such registration statement, report, or valuation, which purports to have been prepared or certified by him;

(5) every underwriter with respect to such security.

If such person acquired the security after the issuer has made generally available to its security holders an earning statement covering a period of at least twelve months beginning after the effective date of the registration statement, then the right of recovery under this subsection shall be conditioned on proof that such person acquired the security relying upon such untrue statement in the registration statement or relying upon the registration statement and not knowing of such omission, but such reliance may be established without proof of the reading of the registration statement by such person.

(b) Persons exempt from liability upon proof of issues

Notwithstanding the provisions of subsection (a) of this section no person, other than the issuer, shall be liable as provided therein who shall sustain the burden of proof —

(1) that before the effective date of the part of the registration statement with respect to which his liability is asserted

(A) he had resigned from or had taken such steps as are permitted by law to resign from, or ceased or refused to act in, every office, capacity, or relationship in which he was described in the registration statement as acting or agreeing to act, and

(B) he had advised the Commission and the issuer in writing that he had taken such action and that he would not be responsible for such part of the registration statement; or

(2) that if such part of the registration statement became effective without his knowledge, upon becoming aware of such fact he forthwith acted and advised the Commission, in accordance with paragraph (1) of this subsection, and, in addition, gave reasonable public notice that such part of the registration statement had become effective without his knowledge; or

(3) that

(A) as regards any part of the registration statement not purporting to be made on the authority of an expert, and not purporting to be a copy of or extract from a report or valuation of an expert, and not purporting to be made on the authority of a public official document or statement, he had, after reasonable investigation, reasonable ground to believe and did believe, at the time such part of the registration statement became effective, that the statements therein were true and that there was no omission to state a material fact required to be stated therein or necessary to make the statements therein not misleading; and

(B) as regards any part of the registration statement purporting to be made upon his authority as an expert or purporting to be a copy of or extract from a report or valuation of himself as an expert, (i) he had, after reasonable investigation, reasonable ground to believe and did believe, at the time such part of the registration statement became effective, that the statements therein were true and that there was no omission to state a material fact required to be stated therein or necessary to make the statements therein not misleading, or (ii) such part of the registration statement did not fairly represent his statement as an expert or was not a fair copy of or extract from his report or valuation as an expert; and

(C) as regards any part of the registration statement purporting to be made on the authority of an expert (other than himself) or purporting to be a copy of or extract from a report or valuation of an expert (other than himself), he had no reasonable ground to believe and did not believe, at the time such part of the registration

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statement became effective, that the statements therein were untrue or that there was an omission to state a material fact required to be stated therein or necessary to make the statements therein not misleading, or that such part of the registration statement did not fairly represent the statement of the expert or was not a fair copy of or extract from the report or valuation of the expert; and

(D) as regards any part of the registration statement purporting to be a statement made by an official person or purporting to be a copy of or extract from a public official document, he had no reasonable ground to believe and did not believe, at the time such part of the registration statement became effective, that the statements therein were untrue, or that there was an omission to state a material fact required to be stated therein or necessary to make the statements therein not misleading, or that such part of the registration statement did not fairly represent the statement made by the official person or was not a fair copy of or extract from the public official document.

(c) Standard of reasonableness

In determining, for the purpose of paragraph (3) of subsection (b) of this section, what constitutes reasonable investigation and reasonable ground for belief, the standard of reasonableness shall be that required of a prudent man in the management of his own property.

(d) Effective date of registration statement with regard to underwriters

If any person becomes an underwriter with respect to the security after the part of the registration statement with respect to which his liability is asserted has become effective, then for the purposes of paragraph (3) of subsection (b) of this section such part of the registration statement shall be considered as having become effective with respect to such person as of the time when he became an underwriter.

(e) Measure of damages; undertaking for payment of costs

The suit authorized under subsection (a) of this section may be to recover such damages as shall represent the difference between the amount paid for the security (not exceeding the price at which the security was offered to the public) and (1) the value thereof as of the time such suit was brought, or (2) the price at which such security shall have been disposed of in the market before suit, or (3) the price at which such security shall have been disposed of after suit but before judgment if such damages shall be less than the damages representing the difference between the amount paid for the security (not exceeding the price at which the security was offered to the public) and the value thereof as of the time such suit was brought: provided, that if the defendant proves that any portion or all of such damages represents other than the depreciation in value of such security resulting from such part of the registration statement, with respect to which his liability is asserted, not being true or omitting to state a material fact required to be stated therein or necessary to make the statements therein not misleading, such portion of or all such damages shall not be recoverable. In no event shall any underwriter (unless such underwriter shall have knowingly received from the issuer for acting as an underwriter some benefit, directly or indirectly, in which all other underwriters similarly situated did not share in proportion to their respective interests in the underwriting) be liable in any suit or as a consequence of suits authorized under subsection (a) of this section for damages in excess of the total price at which the securities underwritten by him and distributed to the public were offered to the public. In any suit under this or any other section of this subchapter the court may, in its discretion, require an undertaking for the payment of the costs of such suit, including reasonable attorney's fees, and if judgment shall be rendered against a party litigant, upon the motion of the other party litigant, such costs may be assessed in favor of such party litigant (whether or not such undertaking has been required) if the court believes the suit or the defense to have been without merit, in an amount sufficient to reimburse him for the reasonable exp enses incurred by him, in connection with such suit, such costs to be taxed in the manner usually provided for taxing of costs in the court in which the suit was heard.

(f) Joint and several liability; liability of outside director

(1) Except as provided in paragraph (2), all or any one or more of the persons specified in subsection (a) of this section shall be jointly and severally liable, and every person who becomes liable to make any payment under this section may recover contribution as in cases of contract from any person who, if sued separately, would have

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been liable to make the same payment, unless the person who has become liable was, and the other was not, guilty of fraudulent misrepresentation.

(2) (A) The liability of an outside director under subsection (e) of this section shall be determined in accordance with section 78u-4(f) of this title.

(B) For purposes of this paragraph, the term “outside director” shall have the meaning given such term by rule or regulation of the Commission.

(g) Offering price to public as maximum amount recoverable

In no case shall the amount recoverable under this section exceed the price at which the security was offered to the public.

* * *

Section 19. Special powers of Commission

(a) The Commission shall have authority from time to time to make, amend, and rescind such rules and regulations as may be necessary to carry out the provisions of this title, including rules and regulations governing registration statements and prospectuses for various classes of securities and issuers, and defining accounting, technical, and trade terms used in this title. Among other things, the Commission shall have authority, for the purposes of this title, to prescribe the form or forms in which required information shall be set forth, the items or details to be shown in the balance sheet and earning statement, and the methods to be followed in the preparation of accounts, in the appraisal or valuation of assets and liabilities, in the determination of depreciation and depletion, in the differentiation of recurring and nonrecurring income, in the differentiation of investment and operating income, and in the preparation, where the Commission deems it necessary or desirable, of consolidated balance sheets or income accounts of any person directly or indirectly controlling or controlled by the issuer, or any person under direct or indirect common control with the issuer. The rules and regulations of the Commission shall be effective upon publication in the manner which the Commission shall prescribe. No provision of this title imposing any liability shall apply to any act done or omitted in good faith in conformity with any rule or regulation of the Commission, notwithstanding that such rule or regulation may, after such act or omission, be amended or rescinded or be determined by judicial or other authority to be invalid for any reason.

* * *

RULES AND REGULATIONS UNDER THE SECURITIES ACT OF 1933

Rule 437. Application to Dispense with Consent

An application to the Commission to dispense with any written consent of an expert pursuant to section 7 of the act shall be made by the registrant and shall be supported by an affidavit or affidavits establishing that the obtaining of such consent is impracticable or involves undue hardship on the registrant. Such application shall be filed and the consent of the Commission shall be obtained prior to the effective date of the registration statement.

[Reg. C, 12 FR 4074, June 24, 1947]

Rule 437a. Written Consents

(a) This section applies only to registrants that:

(1) Are not a “blank check company” as defined in Rule 419(a)(2); and

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(2) Are filing a registration statement containing financial statements in which Arthur Andersen LLP (or a foreign affiliate of Arthur Andersen LLP) had been acting as the independent public accountant.

(b) Notwithstanding any other Commission rule or regulation, every registrant eligible to rely on this section may dispense with the requirement for the registrant to file the written consent of Arthur Andersen LLP (or a foreign affiliate of Arthur Andersen LLP) as required by Section 7 of the Act where:

(1) The registrant has not already obtained the written consent that would be required if not for this section;

(2) The registrant is not able to obtain the written consent after reasonable efforts; and

(3) The registrant discloses clearly any limitations on recovery by investors posed by the lack of consent.

[67 FR 13518, 13537, Mar. 22, 2002]

* * *

ENGLISH COMPANIES ACT, 1929 19 & 20 GEO. 5, CH. 23

Section 37. Liability for statements in prospectus

(1) Where a prospectus invites persons to subscribe for shares in or debentures of a company —

(a) every person who is a director of the company at the time of the issue of the prospectus; and

(b) every person who has authorized himself to be named and is named in the prospectus as a director or as having agreed to become a director either immediately or after an interval of time; and

(c) every person being a promoter of the company; and

(d) every person who has authorised the issue of the prospectus,

shall be liable to pay compensation to all persons who subscribe for any shares or debentures on the faith of the prospectus for the loss or damage they may have sustained by reason of any untrue statement therein, or in any report or memorandum appearing on the face thereof, or by reference incorporated therein or issued therewith, unless it is proved —

(i) that having consented to become a director of the company he withdrew his consent before the issue of the prospectus, and that it was issued without his authority or consent; or

(ii) that the prospectus was issued without his knowledge or consent, and that on becoming aware of its issue he forthwith gave reasonable public notice that it was issued without his knowledge or consent; or

(iii) that after the issue of the prospectus and before allotment thereunder, he, on becoming aware of any untrue statement therein, withdrew his consent thereto, and gave reasonable public notice of the withdrawal, and of the reason therefor; or

(iv) that —

(a) as regards every untrue statement not purporting to be made on the authority of an expert or of a public official document or statement, he had reasonable ground to believe, and did up to the time of the allotment of the shares or debentures, as the case may be, believe, that the statement was true; and

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(b) as regards every untrue statement purporting to be a statement by an expert or contained in what purports to be a copy of or an extract from a report or valuation of an expert, it fairly represented the statement, or was a correct and fair copy of or extract from the report or valuation; and

(c) as regards every untrue statement purporting to be a statement made by an official person or contained in what purports to be a copy of or extract from a public official document, it was a correct and fair representation of the statement or copy of or extract from the document:

Provided that a person shall be liable to pay compensation as aforesaid if it is proved that he had no reasonable ground to believe that the person making any such statement, report or valuation as is mentioned in paragraph (iv)(b) of this subsection was competent to make it.

. . . .

(4) For the purposes of this section —

The expression “promoter” means a promoter who was a party to the preparation of the prospectus, or of the portion thereof containing the untrue statement, but does not include any person by reason of his acting in a professional capacity for persons engaged in procuring the formation of the company:

The expression “expert” includes engineer, valuer, accountant, and any other person whose profession gives authority to a statement made by him.