Working Paper No. 95-12:
The Scope of Section 12(2) of the Securities Act of 1993: A Legal and Economic Analysis
Date Posted: 1995
Availability: Citation only
Section 12(2) of the Securities Act of 1933 is the only provision of the federal securities laws that provides a broad, express remedy for fraud to purchasers of securities. Traditionally, section 12(2) was given broad scope with courts interpreting it to apply to public offerings, private transactions, and ordinary aftermarket trading so long as the purchaser could show, among other things, that the seller sold by means of a communication that included a material misstatement or omission. In Gustafson v. Alloyd Co., 115 S. Ct. 1061 (1995), however, the Supreme Court offered a radically altered vision of section 12(2). There, the Court departed from the traditional understanding of section 12(2) by interpreting section 12(2) to apply to public offerings by an issuer or a controlling shareholder, but not to private transactions among sophisticated parties or to ordinary aftermarket trading. The Court therefore concluded that section 12(2) did not apply to the privately negotiated stock purchase agreement at issue in the case. This paper analyzes section 12(2) from the perspective of law and from the perspective of economics. In doing so, it reaches a conclusion that differs both from the traditional view of section 12(2) and from the view espoused by the Supreme Court in Gustafson -- that section 12(2) should be applied to public offerings and to ordinary aftermarket trading, but not to private transactions. This implies that the Supreme Court was correct in holding section 12(2) inapplicable to private transactions like those involved in Gustafson, but that the Court should revisit the reasoning underlying its decision when it considers whether section 12(2) applies in factually distinct setting of ordinary aftermarket trading.