Quick Answer
Two separate liability standards apply to a bad securities sale. Selling in violation of the registration requirement (an unregistered, non-exempt offering) creates liability regardless of disclosure quality, with rescission as the remedy. Selling by means of a prospectus or oral statement containing a material misstatement or omission creates a second, separate liability, and this one carries a reasonable-care defense.
The exam rewards knowing which standard governs a given fact pattern, since one turns purely on whether a valid exemption or registration existed and the other turns on the truth of what was said.
What Liability Attaches to Selling Without Registration or an Exemption?
Anyone who offers or sells a security in violation of the registration requirement, meaning an unregistered, non-exempt offering, is liable to the purchaser.
The purchaser's remedy is rescission: return of the consideration paid, with interest, less any income received, or damages if the purchaser no longer owns the security.
What Liability Attaches to a Material Misstatement or Omission?
Anyone who offers or sells a security by means of a prospectus or oral communication containing an untrue statement of a material fact, or omitting a material fact necessary to make the statements made not misleading, is liable to the purchaser.
This liability reaches a security whether or not it is exempt from registration, with narrow exceptions for government and bank securities and for security-futures products. An exempt private placement is squarely inside it.
The seller has a defense here: proving it did not know, and in the exercise of reasonable care could not have known, of the untruth or omission.
The purchaser's starting recovery is the same as under the registration liability: the consideration paid, with interest, less any income received, upon tender of the security, or damages if the purchaser no longer owns it.
Material-misstatement liability has one more limit, and it is separate from the reasonable-care defense.
The seller can prove that part or all of the recoverable amount is not the loss in value caused by the untrue or misleading statement. Examples are a broad market decline or a change in the issuer's business that has nothing to do with the statement. The seller must prove it. Whatever the seller proves is not recoverable.
This is called loss causation. It reduces the damages. It does not end the liability, and it does not move the purchaser to a rescission claim. The seller stays liable for the part of the loss the misstatement caused. The registration liability has no such reduction.
Exam Tip: Gotchas
- Reasonable care and loss causation are two different tools. Reasonable care asks what the seller knew or could have known, and if it succeeds the seller owes nothing. Loss causation asks what caused the loss, and it only removes the part of the loss the seller proves came from something else.
- Rescission liability does not turn on disclosure quality. It turns on whether the registration requirement was violated at all, and the seller has no reasonable-care defense against it.
- Material-misstatement liability turns on the truth of what was said, not on registration status. Here the seller can raise a reasonable-care defense: proving it did not know, and in the exercise of reasonable care could not have known, of the untruth or omission.
What Should You Check on Exam Day?
- Identify whether a fact pattern is about an unregistered or non-exempt sale (rescission liability) or a misstatement in offering communications (material-misstatement liability).
- Remember rescission liability carries no reasonable-care defense, while material-misstatement liability does.
- Confirm the purchaser's remedy: return of consideration with interest, less income received, or damages if the security is no longer held.
- If the seller proves part of the loss came from something other than the misstatement, such as a market decline, that part is not recoverable under material-misstatement liability. The rest stays recoverable.