Gale Encyclopedia Of American Law 3Rd Edition Volume 9 P9 docx

limitations to apply in a section 1983 case, the
Supreme Court has held that in the interests of
national uniformity and predictability, all sec-
tion 1983 claims shall be treated as tort claims
for the recovery of personal injuries (Wilson v.
Garcia, 471 U.S. 261, 105 S. Ct. 1938, 85 L. Ed.
2d 254 [1985]). If the state has various statutes
of limitations for different i ntentional torts, the
Supreme Court mandates that the state’sgeneral
or residual
PERSONAL INJURY statute of limitations
should apply (Owens v. Okure, 488 U.S. 235,
109 S. Ct. 573, 102 L. Ed. 2d 594 [1989]).
When a state does not specifically recognize
a
CAUSE OF ACTION brought under section 1983,
courts look to analogous state laws to determine
when the cause of action would accrue. In
Wallace v. Kato, 549 U.S. 384, 127 S.Ct. 1091,
166 L.Ed.2d 973 (2007), an arrestee brought an
action under section 1983, alleging that city
police detectives had unlawfully arrested him.
Illinois did not recognize unlawful arrest as a
tort, so the Court looked to the state’s statute of
limitations for
FALSE IMPRISONMENT. After con-
cluding that the claim’s limitations period
would have expired under state law, the Court
ruled that the arrestee’s claim had expired.
The Supreme Court has also held that state
tolling statutes, which provide a plaintiff with an

additional period of time in which to bring a
lawsuit equal to the period of time in which the
plaintiff was legally disabled, apply to section
1983 cases (Board of Regents v. Tomanio, 446 U.S.
478, 100 S. Ct. 1790, 64 L. Ed. 2d 440 [1980]).
Under section 1983, the statute of limitations
does not begin to run until the
CAUSE OF ACTION
accrues. The cause of action accrues when “the
plaintiff knows or has reason to know of the
injury which is the basis of the action” (Cox v.
Stanton, 529 F.2d 47 [4th Cir. 1975]). However, in
EMPLOYMENT LAW cases, the Supreme Court has
held that the cause of action accrues when the
discriminatory act occurs (Delaware State College
v. Ricks, 449 U.S. 250, 101 S. Ct. 498, 66 L. Ed. 2d
431 [1980]). Thus, if an employee is being
terminated for reasons that violate section 1983,
the statute of limitations begins on the day
that the employee learns of the termination, not
when the termination actually begins (Chardon v.
Fernandez, 454 U.S. 6, 102 S. Ct. 28, 70 L. Ed.
2d 6 [1981]).
The legal rules of
RES JUDICATA (claim preclu-
sion) and
COLLATERAL ESTOPPEL (ISSUE PRECLUSION)
apply to section 1983 claims. This means that
federal courts must give state court judgments the
same preclusive effect that the law of the state in

which the judgment was rendered would give.
Plaintiffs need to be careful to raise all potential
federal claims in cases brought in state court
because they will not be allowed to bring those
claims later in federal court after the state court
has rendered a decision on the issues before it.
A plaintiff may waive his or her right to sue
under section 1983, but such a waiver may be
deemed unenforceable if “the interest in its
enforcement is outweighed in the circumstances
by a
PUBLIC POLICY harmed by enforcement of the
agreement” Town of Newton v. Rumery, 480 U.S.
386, 107 S. Ct. 1187, 94 L. Ed. 2d 405 [1987].
FURTHER READINGS
“Federal Courts—Prisoner Litigation—Eleventh Circuit
Holds That a §1983 Action for DNA Access Is Not
the Equivalent of a Habeas Corpus Petition.” 2003.
Harvard Law Review 116 (June).
Hayman, Robert L. 2002. Ju risprudence. St. Paul, Minn.: West.
Schwartz, Martin A., and John E. Kirklin. 2003. Section 1983
Litigation: Claims and Defenses. 4th ed. New York:
Aspen Publishers.
Schwartz, Martin A., and George C. Pratt. 2009. Section 1983
Litigation: Jury Instructions. 2d ed. Austin, Tex.: Wolters
Kluwer.
Young, Gary. 2003. “9th Sees No Regulatory Relief in
§1983.” National Law Journal (July 21).
CROSS REFERENCES
Civil Rights; Remedy; Tort Law.

SECURE
To assure the payment of a debt or the performance
of an obligation; to provide security.
A debtor “secures” a creditor by giving him
or her a lien, mortgage, or other security to be
used in case the debtor fails to make payment.
SECURED CREDITOR
A category of favored creditor who holds some
special legal assurance of payment of a debt owed to
him or her, such as a type of mortgage or lien, as
the result of a specific agreement to that effect. The
secured creditor, as distinguished from an unse-
cured creditor, holds an advantage known as a
“security interest,” which it can assert in order to
claim payment as needed. The collateral tends to be
valued at an amount sufficient to cover the debt,
should collection ultimately become necessary.
The collateral tends to be valued at an
amount sufficient to cover the debt, should col-
lection ultimat ely become necessary. Collection
GALE ENCYCLOPEDIA OF AMERICAN LAW, 3RD E DITION
68 SECURE
may occur by compelling a sale (e.g., at auction)
or by keeping or taking repossession of the
collateral in question, in the event of default of
payment. In the event of bankruptcy, the
secured creditor enjoys the prospect of being
ahead of unsecured creditors in order of
payment (in case there are any assets with
which to pay the debts).

In order for the security interest to be fully
operational, it often must be “perfected,” or
registered formally with a governmental entity,
such as a financing statement filed publicly with
the office of the secretary of state in the
jurisdiction where the collateral is located. The
effect of perfection is to put other potential
creditors on notice as to the secured creditor ’s
position with regard to the particular assets. In
most states, security interests are governed by
Article 9 of the Uniform Commercial Code.
FURTHER READING
Hagedorn, Robert B. 2007. Secured Transactions in a
Nutshell. 4th ed. St. Paul, Minn.: West.
SECURED TRANSACTIONS
Secured transactions are business dealings that
grant a creditor a right in property owned or held
by a debtor to assure the payment of a debt or the
performance of some obligation.
A secured transaction is a transaction that is
founded on a security agreement. A security
agreement is a provision in a business transac-
tion in which the obligor, or debtor, in the
agreement gives to the creditor the right to own
property owned or held by the debtor. This
property, called collateral, is then held by either
the debtor or the secured party to ensure against
loss in the event the debtor cannot fulfill the
obligations under the transaction.
The purchase of a car through financing is an

example of a secured transaction. The car
dealership or some other lender pays for the
vehicle in return for a promise from the buyer to
repay the loan with interest. The buyer receives
the vehicle, but the lender retains the title to the
car as security against the risk that the buyer will
be unable to make the loan payments. If the
buyer defaults on the payments, the lender,
called the secured party, may repossess the car to
recover losses from the default.
If the same transaction was unsecured, the
buyer would receive the title to and possession
of the car, and the lender would receive only the
buyer’s promise to repay the loan. If the buyer
defaulted on the payments, the lender could sue
the buyer, but the simple remedy of taking the
property would not be available.
A security interest may be transferred, or
assigned, to a
THIRD PARTY. The party receiving
the assignment becomes the secured party, and
the original secured party no longer holds a
claim to the collateral.
The law of secured transactions varies little
from state to state because all 50 states plus the
District of Columbia and the U.S. Virgin Islands
have adopted Article 9, the secured transactions
portion of the
UNIFORM COMMERCIAL CODE (UCC).
The UCC is a set of model laws written by

lawyers, professors, and other legal professionals
in the American Law Institute. In 1999, the
institute, in conjunction with the National
Conference of Commissioners of Uniform State
Laws (NCCUSL), drafted a revised Article 9,
which was adopted uniformly on July 1, 2001.
The revisions marked the first comprehensive
overhaul of Article 9 since 1972. These revisions
expand the scope of property and transactions
governed by the UCC, clarify existing elements
of the article, and provide guidelines for dealing
with technological developments, including
software financing and
ELECTRONIC COMMERCE.
Common Forms of Secured
Transactions
Secured transactions come in many forms, but
three types are most common for consumers:
pledges,
CHATTEL mortgages, and conditional
sales. A pledge is the delivery of goods to the
secured party as security for a debt or the
performance of an act. For example, assume
that one person has borrowed $500 from
another. Assume further that the debtor gives
a piece of expensive jewelry to the creditor. If
the jewelry is to be returned to the debtor after
the debt is repaid, and if the creditor has the
right to take full ownership of the jewelry if the
debtor does not pay the debt, the arrangement

is called a pledge.
A
CHATTEL MORTGAGE is like a pledge, but in a
chattel mortgage transaction, the debtor is
allowed to retain possession of the property
that is put up as collateral. If the debtor fails to
repay the debt, the creditor may take ownership
of the property.
A third type of secured transaction, the
conditional sale, uses a purchase money security
GALE ENCYCLOPEDIA OF AMERICAN LAW, 3RD E DITION
SECURED TRANSACTIONS 69
interest. A purchase money security interest
arises when a creditor lends money to a
borrower, who uses the money to purchase a
particular item. To secure repayment of the
loan, the creditor receives a
LIEN on, or claim to,
the purchased item. The lien gives the creditor a
claim to the property that may be asserted if the
borrower does not repay the loan.
Common Forms of Collateral
Any property accepted as security by a creditor
can serve as collateral, but generally collateral falls
into one of five categories: consumer goods,
equipment, farm products, inventory, and prop-
erty on paper. Consumer goods are items used
primarily for personal, family, or household
purposes. Equipment consists of items of value
used in business or governmental operations.

Farm products are items such as crops, livestock,
or supplies used or produced in a farming
operation. Under the revised Article 9, agricul-
tural liens can also be considered collateral.
Inventory consists of goods held for sale or lease
or furnished under contracts of service, raw
materials, works in process, materials used or
consumed in a business, and goods held for sale
or lease or furnished under contracts of service.
Paper collateral consists of a writing that
serves as evidence of a debtor’s rights in
PERSONAL PROPERTY. Stocks and bonds are exam-
ples of paper collateral. Another common form
of paper collateral is
CHATTEL PAPER . Chattel
paper is a writing that indicates that the holder
is owed money and has a security interest in
valuable goods associated with the debt. For
example, assume that a car dealership has sold a
car on financing to a buyer and has retained the
title as security. The dealership may then use the
security agreement with the buyer as collateral
for a loan of its own from the bank. The revised
Article 9 also recognizes “electronic chattel
paper.” This allows for the validity of so-called
electronic signatures, which Article 9 refers to as
“authenticated records.” The electronic screens
in some retail stores that allow customers to
sign with a special stylus are thus just as valid as
a signature in ink on a paper document.

Among the new areas governed by the
revised Article 9 are commercial deposit
accounts, promissory notes, and commercial
tort claims. Healthcare insurance receivables are
also covered, which allows doctors and hospitals
to include claims against insurance companies
for services to their patients as part of the
collateral they offer to healthcare lenders.
The Formalities
To be valid, a secured transact ion must contain
an express agreement between the debtor and
the secured party. The agreement must be in
writing, must be signed by both parties, must
describe the collateral, and must contain
language indicating a grant of a security interes t
to the creditor. Furthermore, something of
value must be given by one party to the other
party. This can be a binding commitment to
extend credit, the satisfaction of an already
existing claim, the delivery and acceptance of
goods under a contract, or any other exchange
of value sufficient to create a contract. Once
these formalities have been completed, the
security associated with the principal agreement
is said to attach. Attachment simply means that
the security side of the agreement is complete
and lega lly enforceable.
To completely secure a secured transaction,
or perfect the security, the secured party should
file a financing statement with the local public

records office,
SECRETARY OF STATE,orother
appropriate government body. Perfecting the
security makes the secured party’s claim official,
puts the rest of the world on notice as to the
creditor’s rights in the property, and gives the
creditor the right to take advantage of special
remedies in the event the debtor does not repay
the loan. A financing statement is a document
that fully describes the secured transaction. The
2000 amendments to Article 9 included a national
financing statement form and designated the
debtor’s location as the place to file against most
tangible and intangible collateral. A state may
require the secured party to file a financing
statement in addition to a copy of the agreement.
In most states financing statements are
effective only for a limited duration, such as
five years. A
SECURED CREDITOR may extend the
length of perfection by filing a continuation
statement before the designated time period has
expired. If a secured creditor fails to continue
the perfection, the security is not lost, but other
creditors may claim the property. The secured
creditor may file another financing statement,
but this would require another signature from
the debtor.
Amendments may be made to a financing
statement. A secured party may file a statement

GALE ENCYCLOPEDIA OF AMERICAN LAW, 3RD E DITION
70 SECURED TRANSACTIONS
of release on some of the collateral once the
debtor has made payments equal in value to the
value of the released collateral. If the amend-
ment adds collateral, the security for the new
collateral is effective from the date of the
amendment and not the date of the filing of
the original financing statement.
One exception to the filing rule occurs when
the secured party has possession of the
collateral. In this situation the creditor’s security
is complete once the parties have agreed to the
primary transaction. Another exception is the
purchase money security interest in consumer
goods other than building fixtures and motor
vehicles. The filing of a purchase money security
interest for such consumer goods is optional. If
a secured party to a conditional sale does not
record or file the agreement, however, he may
lose the security if the buyer sells the goods to a
third party.
Failure to perfect the security may have
drastic consequences for the secured party who
does not possess the collateral, although such
failure does not automatically mean that the
security will be lost. If, however, another party
later stakes a claim to the collateral and files the
proper papers, the secured party may lose his or
her claim to the property because claims that

have been properly recorded or filed have
priority. Thus a secured party is wise to file a
financing statement and other required docu-
ments to perfect the security and protect against
claims by other creditors of the debtor.
Article 9 of the UCC is primarily concerned
with protecting the secured party’s right to the
collateral. Many sections of Article 9 delineate
who has the first right to a debtor’s property if
multiple claims arise. Precisely who has the first
right to the debtor’s property depends on a
number of factors, including whether the
security was perfected, who the other claima nt
is, and the time that the claims arose.
If a security interest has not been perfected,
the secured party’s claim to the collateral
property may be subordinate to any number
of creditors. A person who has a lien on the
property takes before the secured party, as does
a person who has received a court order for
attachment of the property. If a person buys the
collateral from the debtor while not knowing of
the security interest, the secured party loses the
property if the security was not perfected. This
is true only if the buyer purchases the property
in the ordinary course of business from a person
who is in the business of selling goods of that
particular kind. A pawnbroker, for example, is
not such a seller because a pawnbroker will sell
almost anything if the profit is worth the time

and trouble.
The identity of the buyer may influence the
outcome of a dispute between a buyer of secured
goods and the secured party. Generally, a
merchant, or a buyer who purchases property
for a business, is held to a higher standard than a
person who buys an item for personal use.
Merchants are more familiar with markets than
are ordinary consumers, and they may be
expected to know that a seller was insolvent and
that the goods being sold were subject to claims
from other parties. In any case, if any buyer
knows that another party has a security interest in
the property at the time the buyer made the
purchase, the secured party retains the first claim
to the property and may keep the property out of
that buyer’s possession until the debt associated
with the secured property is fully paid.
If two parties have a security interest in the
same property, the party who filed first takes
first. If the competing security interests are both
unperfected, the party who was first to attach
the property as collateral has priority.
Other creditors of a debtor may have the
first claim on secured property. However, the
federal government has priority in some
instances for collection of federal tax liens.
Most states have artisan’s lien statutes, which
give servicers of property the right to hold the
property in their possession as security for

payment of the service bill. If the bill remains
unpaid, the servicer has priority even over a
secured party who has perfected his or her
interest. Once a servicer or repairperson is paid
for his services, he must release the goods to
either their owner or the party with the security
interest in the goods.
If the debtor to a secured party defaults, the
secured party who has failed to perfect
the security interest may lose first claim to the
secured property to a receiver or an assignee for
the benefit of creditors. A receiver is a party who
is appointed by the
BANKRUPTCY court to manage
the finances of the debtor for the benefit of the
debtor’s creditors. An assignee for the benefit of
creditors is a person chosen by the debtor to
manage all or substantially all of the debtor’s
property and to distribute it to creditors.
GALE ENCYCLOPEDIA OF AMERICAN LAW, 3RD E DITION
SECURED TRANSACTIONS 71
A secured party who has perfected the security
interest has priority over an assignee or a
receiver, but even a secured party who has
perfected may not receive all of the debt owed
under a security agreement by a bankrupt
debtor. Federal bankruptcy laws are designed
to distribute the assets of an insolvent debtor in
a fair and
RATABLE manner among all of the

debtor’s creditors.
Satisfaction of the Secured Debt
Once a secured debt is repaid in full, the secured
party must, upon written request by the debtor,
send a termination statement to the debtor and
file a termination statement with all offices that
hold the financing statement. A termination
statement serves as evidence that the debt has
been paid in full. If the debtor makes a written
request for the termination statement, the
creditor must send the statement within ten
days of the date of the req uest. Even if the
debtor does not so request, the secured party
must send a termination statement to offices
that hold the financing statement within 30 days
of the satisfaction of the debt.
Default
If a debtor defaults on his obligations under a
secured transaction, the secured party may
foreclose on the security interest.
FORECLOSURE
can be accomplished in different ways. The
secured party may calculate the amount of the
debt owed and sue the debtor without taking
possession of the property. Alternatively, unless
the parties have agreed otherwise, the secured
party may take possession of the collateral
property and either keep it or sell it. In either
case, if the value received by the secured party
does not fully satisfy the debt, the secured party

may sue the debtor for the deficiency.
In most states a secured party may take
possession of the collateral without judicial
involvement if doing so can be accom plished
without a
BREACH OF THE PEACE. For example, the
secured party may repossess a vehicle if it is
parked outdoors. If, however, the agent of the
secured party must break into a garage to
repossess the vehicle, such action would be a
breach of the peace because it would require
breaking and entering, a criminal offense.
If a consumer has defaulted on a secured
transaction but has paid 60 percent or more on
the debt, most states prohibit a secured party
from taking the security and keeping the
windfall. In such cases the secured party may
either sue in court for the money outstanding or
take the property and return part of the money.
In other situations a secured party may be
entitled to any excess value or income that
results from the debtor’s default.
The retention of collateral by a secured
party after the debtor’s default is called
STRICT
FORECLOSURE
. If a secured party decides to keep
collateral in satisfaction of a debt, the secured
party must send written notice to the debtor. In
transactions involving collateral other than

consumer goods, a secured party may be
obliged to send notice of the strict foreclosure
to any other parties who have security in the
collateral property. If a party objects to the strict
foreclosure, the secured party must sell or
otherwise dispose of the collateral. If no other
party objects to the strict foreclosure, the
secured party may keep the collateral.
A secured party who sells or leases collateral
after a debtor defaults may charge the debtor for
reasonable expenses incurred in the sale or
lease. This charge can include attorneys’ fees
and court costs. The money made from a sale of
collateral rarely satisfies a debt because such
sales do not bring favorable prices. If there is a
surplus of money after the collateral is sold, all
expenses are accounted for, and the sale or lease
is applied to the debt, other parties holding a
security interest in the collateral must be paid
with the surplus money.
Unless the parties have agreed otherwise, a
debtor who is in possession of the collateral and
who has defaulted on the obligations in a
secured transaction has the right to redeem the
collateral before the secured party takes action.
To avoid foreclosure of the security interest by
the secured party, the debtor may pay the
unpaid balance of the debt secured by the
collateral, as well as any reasonable expense s
incurred by the secured party in taking, holding,

and preparing the foreclosure. This does not
mean the debtor must pay the entire amount of
the debt; rather, the debtor must make those
payments that are in default. Some security
agreements have an
ACCELERATION CLAUSE that
makes all payments due immediately upon
default, but a court may hold that such a clause
should not be enforced if the debtor has
brought the payments up to date before the
secured party has acted on the delinquency. A
secured party who violates default provisions
GALE ENCYCLOPEDIA OF AMERICAN LAW, 3RD E DITION
72 SECURED TRANSACTIONS
may be liable to the debtor for losses resulting
from that conduct.
FURTHER READINGS
Brook, James. 2002. Secured Transactions: Examples and
Explanations. 2d ed. New York: Aspen Law & Business.
Dalton, Elizabeth. 1986. “The Consequences of Commer-
cially Unreasonable Dispositions of Collateral: Haggis
Management, Inc. v. Turtle Management, Inc.” Utah Law
Review.
Epstein, David G., Steve H. Nickles, and Edwin E. Smith.
2003. Nine Questions: Secured Debt Deals in the 21st
Century. St. Paul, Minn.: Thomson/West.
Huffaker, John. 2000. “Good News and Bad News: Revisions
to UCC Article 9.” Texas Banking (August).
CROSS REFERENCES
Attachment; Bankruptcy; Collateral; Consumer Credit;

Express; Obligor; Security; Sales Law.
SECURITIES
Securities are evidence of a corporation’s debts or
property.
Securities are documents that merely repre-
sent an interest or a right in something else; they
are not consumed or used in the same way as
traditional consumer goods. Government regula-
tion of consumer goods attempts to protect
consumers from dangerous articles, misleading
advertising, or illegal pricing practices. Securities
laws, by contrast, attempt to ensure that investors
have an informed, accurate idea of the type of
interest they are purchasing and its value.
Types of securities include notes, stocks,
treasury stocks, bonds, debentures, certificates
of interest or participation in profit-sharing
agreements, collateral-trust certificates, preorga-
nization certificates or subscriptions, transferable
shares, investment contracts, voting-trust certifi-
cates, certificates of deposit for a security, and a
fractional undivided interest in gas, oil, or other
mineral rights. Under certain circumstances,
interests in oil- and gas-drilling programs,
interests in partnerships,
REAL ESTATE CONDOMI-
NIUMS AND COOPERATIVES
, and farm animals and
land also have been found to be securities.
Certain types of notes, such as a note secured

by a home mortgage or a note secured by
accounts receivable or other business assets, are
not securities.
Both federal and state laws regulate securi-
ties. Before 1929, companies could issue stock at
will. Bogus corporations sold worthless stock;
other companies issued and sold large amounts
of stock without considering the effect of
unlimited issues on shareholders’ interests, the
value of the stock, and ultimately the U.S.
economy. Federal securities law consists of a
handful of laws passed between 1933 and 1940,
as well as legislation enacted in 1970. The
federal laws stem from Congress’s power to
regulate interstate commerce. Therefore, the
laws are generally limited to transactions
involving transportation or communication
using interstate commerce or the mail. Federal
laws are generally administered by the
SECURITIES
AND EXCHANGE COMMISSION
(SEC), established
by the Securities Exchange Act of 1934 (15
U.S.C.A. §§ 78a et seq.). Securities regulation
focuses mainly on the market for common
stocks. The
SARBANES-OXLEY ACT OF 2002 (Public
Company Accounting Reform and Investor
Protection Act), Pub. L. 107-204, 116 Stat.
745, makes securities

FRAUD a serious federal
crime and also increases the penalties for
white-collar crimes. In addition, it created an
oversight board for the accounting profession.
Securities are traded on markets. Some, but
not all, markets have a physical location. The
essence of a securities market is its formal or
informal communications systems whereby
buyers and sellers make their interests known
and execute transactions. These trading markets
are susceptible to manipulative and deceptive
practices, such as manipulation of prices or
“insider trading,” that is, gaining an advantage
on the basis of nonpublic information. To
prevent such fraudulent practices, all securities
laws contain general antifraud provisions.
Exchange markets, of which the New York
Stock Exchange is the largest, have traditionally
operated in a rigid manner by careful delinea-
tion of numbers and qualifications of members
and the specific functions members may
perform. Conversely, over-the-counter markets
(OTC) are less structured and typically do not
have a physical location.
Based upon dollar volume, the bond market
is the largest. Bonds are the debt instruments
issued by federal, state, and local government, as
well as corporations. The bond market attracts
mainly professional and institutional investors,
rather than the general public. In addition,

many of these obligations are exempt from
direct regulatory provisions of the federal
securities laws and consequently usually receive
little attention from SEC regulators. However,
in the mid-1980s, a debacle occurred in the
JUNK
GALE ENCYCLOPEDIA OF AMERICAN LAW, 3RD E DITION
SECURITIES 73
BOND market, which included INSIDER TRADING
charges. (Junk bonds are highly risky bonds with
a high yield.) The scandal, which involved the
investment firm of Drexel Burnham Lambert
Inc. and trader Michael R. Milken, attracted
much attention and a flurry of SEC enforce-
ment activ ity.
Securities Act of 1933
The first significant federal securities law was
the Securities Act of 1933 (15 U.S.C.A. §§ 77a
et seq.), passed in the wake of the great
STOCK
MARKET
crash of 1929. This law is essentially a
disclosure statute. Although the 1933 act applies
by its terms to any sale by any person of any
security, it contains a number of exemptions.
The most importa nt exemption involves securi-
ties sold in certain kinds of transactions,
including transactions by someone other than
an issuer, underwriter, or dealer. In essence, this
provision effectively exempts almost all second-

ary trading, which involves securities bought
and sold after their original issue. Certain small
offerings are also exempt.
Although the objective of the 1933 act’s
registration requirements is to enable a pro-
spective purchaser to make a reasoned decision
based on reliable information, this goal is not
always accomplished. For example, an issuer
may be relucta nt to divulge real weaknesses in
an operation and so may try to obfuscate some
of the problems while complying in theory with
the law. In addition, complex financial infor-
mation can be extremely difficult to explain in
terms understandable to the average investor.
Disclosure is accomplished by the registration
of security offerings. In general, the law provides
that no security may be offered or sold to the
public unless it is registered with the SEC.
Registration d oes not imply that the SEC
approves of the issue but is intended to aid the
public in making informed and educated deci-
sions about purchasing a security. The law
delineates the procedures for registration and
specifies the type of information that must be
disclosed.
The registration statement has two parts:
first, information that eventually forms the
prospectus, and second, information, which
does not need to be furnished to purchasers
but is available for public inspection within SEC

files. Full disclosure includes management’s
aims and goals; the number of shares the
company is selling; what the issuer intends to
do with the money; the company’s tax status;
contingent plans if problems arise; legal stand-
ing, such as pending lawsuits; income and
expenses; and inherent risks of the enterprise.
A registration statement is automatically
effective 20 days after filing, and the issuer may
then sell the registered securities to the public.
Nevertheless, if a statement on its face appears
incomplete or inaccurate, the SEC may refuse to
allow the statement to become effective. A
misstatement or omission of a material fact may
result in the registration’s suspension. Although
the SEC rarely exercises these powers, it does
not simply give cursory approval to registration
statements. The agency frequently issues “letters
of comment,” also known as “deficiency
letters,” after reviewing registration documents.
The SEC uses this method to require or suggest
changes or request additiona l information.
Most issuers are willing to cooperate because
the SEC has the authority to permit a registra-
tion statement to become effective less than
20 days after filing. The SEC will usually
accelerate the 20-day waiting period for a
cooperative issuer.
For many years an issuer was entitled only
to register securitie s that would be offered for

sale immediately. Since 1982, under certain
circumstances an issuer has been permitted to
register securities for a quick sale at a date up to
two years in the future. This process, known as
shelf registration, enables companies that fre-
quently offer debt securities to act quickly when
interest rates are favorable.
The 1933 act prohibits offers to sell or to
buy before a registration is filed. The SEC takes
a broad view of what constitutes an offer. For
example, the SEC takes the position that
excessive or unusual publicity by the issuer
about a business or the prospect s of a particular
industry may arouse such
PUBLIC INTEREST that
the publicity appears to be part of the selling
effort.
Offers but not sales are permitted, subject to
certain restrictions, after a registration statement
has been filed but before it is effective. Oral offers
are not restricted. Written information may be
disseminated to potential investors during the
waiting period via a specially designed prelimi-
nary prospectus. Offers and sales may be made to
anyone after the registration statement becomes
GALE ENCYCLOPEDIA OF AMERICAN LAW, 3RD E DITION
74 SECURITIES
effective. A copy of the final prospectus usually
must be issued to the purchaser.
The 1933 act provides for civil liability for

damages arising from misstatements or omis-
sions in the registration statement or for offers
made in violation of the law. In addition, the
law provides for civil liability for misstatements
or omissions in any offer or sale of securities,
whether or not the security is registered. Finally,
the general antifraud provision in the law
makes it unlawful to engage in fraudulent or
deceitful practices in connection with any offer
or sale of securities, whether or not they are
registered.
In general, any person who acquires an
equity whose registration statement, at the time it
became effective, contained an “untrue statement
of a material fact or omitted to state a material
fact” may sue to recover the difference between
the price paid for the security (but not more than
the
PUBLIC OFFERING price) and the price for which
it was disposed or (if it is still owned) its value at
the time of the lawsuit. A purchaser must show
only that the registration statement contained a
material misstatement or omission and that he
or she lost money. In many circumstances the
purchaser need not show that he or she relied on
the misstatement or omission or that a prospec-
tus was even received. The SEC defines material
as information an average prudent investor
would reasonably need to know before purchas-
ing the security.

Securities Exchange Act of 1934
The Securities Exchange Act of 1934 addresses
many areas of securities law. Issuers, subject to
certain exemptions, must register with the SEC
if they have a security traded on a national
exchange. This requirement should not be
confused with the registration of an offering
under the 1933 act; the two laws are distinct.
Securities registered under the 1933 act for a
public offering may also have to be registered
under the 1934 act.
To provide the public with adequate infor-
mation about companies with publicly traded
stocks, issuers of securities registered under the
1934 act must file various reports with the SEC.
Since 1964 this disclosure requirement has
applied not only to companies with securities
listed on national securities exchanges but also
to companies with more than 500 shareholders
and more than $5 million in assets. False
or misleading statements in any documents
required under the 1934 act may result in
liability to persons who buy or sell securities in
reliance on these statements.
Under the 1934 act, the SEC may revoke or
suspend the registration of a security if after
notice and opportunity for hearing it determines
that the issuer has violated the 1934 act or any
rules or regulations promulgated thereunder.
Moreover, the 1934 act authorizes the SEC to

suspend trading in any security for not more
than ten days, or, with the approval of the
president, to suspend trading in all securities for
not more than 90 days, or to take other measures
to address a major market disturbance.
Proxy Solicitation The 1934 act also regulates
PROXY solicitation, which is information that
must be given to a corporation’s shareholders as a
prerequisite to soliciting votes. Prior to every
shareholder meeting, a registered company must
provide each stockholder with a proxy statement
containing certain specified material, along with a
form of proxy on which the security holder
may indicate approval or disapproval of each
proposal expected to be presented at the meeting.
For securities registered in the names of brokers,
banks, or other nominees, a company must
inquire into the beneficial ownership of the
securities and furnish sufficient copies of
the proxy statement for distribution to all the
beneficial owners.
Copies of the proxy statement and form of
proxy must be filed with the SEC when they are
first mailed to security holders. Under certain
circumstances preliminary copies must be filed
ten days before mailing. Although a proxy
statement does not become effective in the same
way as a statement registered under the 1933 act,
the SEC may comment on and require changes in
the proxy statement before mailing. Proxies for

an annual meeting calling for election of directors
must include a report containing financial
statements covering the previous two fiscal years.
Special rules apply when a contest for election or
removal of directors is scheduled.
A security holder owning at least $1,000,
or 1 percent, of a corporation’s securities may
present a proposal for action via the proxy
statement. Upon a shareholder’s timely notice
to the corporation, a statement of explanation is
included with the proxy statement. Security
holders will have an opportunity to vote on the
proposal on the proxy form. The device is
GALE ENCYCLOPEDIA OF AMERICAN LAW, 3RD E DITION
SECURITIES 75
unpopular with management, but shareholders
have used this provision to change or challenge
management compensation, the conduct of
annual meetings, shareholder voting rights,
and issues involving
DISCRIMINATION and pollu-
tion in company operations.
A company that distributes a misleading
proxy statement to its shareholders may incur
liability to any person who purchases or sells its
securities based on the misleading statement.
The U.S. Supreme Court has held that an
omitted fact is material if a “substantial
likelihood” exists that a reasonable shareholder
would consider the information important in

deciding how to vote. Mere
NEGLIGENCE is
sufficient to permit recov ery; no evil motive or
reckless disregard need be shown. Oftentimes,
an appropriate remedy might be a
PRELIMINARY
INJUNCTION
requiring circulation of corrected
materials; it may not be feasible to rescind a
tainted transaction after voting. Courts have,
however, sometimes ordered a new election of
directors, but such action must be in the best
interests of all shareholders.
Takeover Bids and Tender Offers Since the
1960s, increasing numbers of takeover bids and
tender offers have resu lted in bitter contests
between the aggressor and the target of the bid.
A corporate or individual aggressor might
attempt to acquire controlling stock in a publicly
held corporation in a number of ways: by buying
it outright for cash, by issuing its own securities in
exchange, or by a combination of both methods.
Stock may be acquired in private transactions, by
purchases through brokers in the open market, or
by making a public offer to shareholders to tender
their shares either for a fixed cash price or for
a package of securities from the corporation
making the offer.
Takeover bids that involve a public offer for
securities of the aggressor company in exchange

for shares of the targeted company require that
the securities be registered under the 1933 act
and that a prospectus be delivered to solicited
shareholders. For many y ears, however, cash
tender offers had no SEC filing requirements.
The
WILLIAMS ACT of 1968 (15 U.S.C.A. §§ 78l,
78m, 78n) amended many sections of the 1934
act to address prob lems with tender offers.
Although most
LITIGATION under the Williams
Act is between contending parties, courts
generally focus on whether the relief sought
serves to protect public stockholders.
Pursuant to the Williams Act, any person
or group who takes ownership of more than
5 percent of any class of specific registered
securities must file a statement within ten days
with the issuer of the securities, as well as with
the SEC. Required information includes the
background of the person or group; the source
of funds used and the purpose of the acquisi-
tion; the number of share s owned; and any
relevant contracts, arrangements, or under-
standings. The issue of whether an acquisition
has taken place, thereby triggering the filing
requirement, has been the subject of litigation.
Courts have disagreed on this issue when
confronted with a group of shareholders who
in the aggregate own more than 5 percent and

who agree to act together for the purpose of
affecting control of the company but who do
not act to acquire any more shares.
Restrictions also apply to persons making a
TENDER OFFER that would result in ownership of
more than 5 percent of a class of registered
securities. Such a person must first file with the
SEC and furnish to each offeree a statement
similar to that required of a person who has
obtained more than 5 percent of registered
stock. A tender offer must be held open for
20 days; a change in the terms holds an offer
open at least ten more days. In addition, the
offer must be made to all holders of the class of
securities sought, and a uniform price must be
paid to all tendering shareholders. A share-
holder may withdraw tendered shares at any
time while the tender offer remains open.
Moreover, if the person making the offer seeks
fewer than all outstanding shares and the
response is oversubscribed, shares will be taken
up on a
PRO RATA basis.
The 1934 act also requires every person who
directly or indirectly owns more than 10 percent
of a class of registered equity sec urities, and
every officer and director of every company
with a class of equity securities registered under
that section, to file a report with the SEC at the
time he acquires the status, and at the end of

any month in which he acquires or disposes of
these securities. This provision is designed to
prevent short-swing profits, earned when an
individual with inside information engages in
short-term trading.
Antifraud Provisions One impetus for enact-
ment of the 1934 act was the damage caused by
pools, w hich were a device used to run up the
GALE ENCYCLOPEDIA OF AMERICAN LAW, 3RD E DITION
76 SECURITIES
prices of securities on an exchange. The pool
would engage in a series of well-timed transac-
tions, designed solely to manipulate the market
price of a security. Once prices were high, the
members of the pool unloaded their holdings
just before the price dropped. The 1934 act
contains specific provisions prohibiting a variety
of manipulative activ ities with respect to
exchange-listed securities. It also contains a
catchall section giving the SEC the power to
promulgate rules to prohibit any “manipulative
or deceptive device or contrivance” with respect
to any security. Although isolated instances of
manipulation still exist, the provisions manage
to prevent widespread problems.
Section 10(b) of the 1934 act contains a
broadly worded provision permitting the SEC to
promulgate rules and regulations to protect the
public and investors by prohibiting manipula-
tive or deceptive devices or contrivances via the

mails or other means of interstate commerce.
The SEC has promulgated a rule, known as rule
10b-5, that has been invoked in countless SEC
proceedings. The rule states:
It shall be unlawful for any person,
directly or indirectly, by use of any means or
instrumentality of interstate commerce, or of
the mails, or of any facility of any national
securities exchange, (1) to employ any
device, scheme, or artifice to
DEFRAUD, (2)
to make any untrue statement of a material
fact or to omit to state a material fact
necessary in order to make the statements
made, in light of circumstances under which
they were made, not misleading, or (3) to
engage in any act, practice, or course of
business which operates or would operate as
a fraud or deceit upon any person, in
connection with the purchase or sale of any
security.
In the 1960s and early 1970s, the courts
broadly interpreted rule 10b-5. For example, the
rule was applied to impose liability for negligent
misrepresentations and for breach of
FIDUCIARY
duty by corporate management and to hold
directors, lawyers, accountants, and underwri-
ters liable for their failure to prevent wrongdo-
ing by others. Beginning in 1975, the U.S.

Supreme Court sharply curtailed this broad
reading. Doubt exists as to the continued
viability of the decisions in some of the prior
cases. Nevertheless, although rule 10b-5 does
not address civil liability for a violation, since
1946 courts have recognized an implied private
RIGHT OF ACTION in rule 10b-5 cases, and the
Supreme Court has acknowledged this implied
right (Superintendent v. Bankers Life, 404 U.S. 6,
30 L. Ed. 2d 128, 92 S. Ct. 165 [1971]).
Rule 10b-5 applies to any purchase or sale,
by any person, of any security. There are no
exemptions: it applies to registered or unregis-
tered securities, publicly held or closely held
companies, and any kind of entity that issues
securities, including federal, state, and local
government securities.
Clauses 1 and 3 of rule 10b-5 use the terms
fraud and deceit. Fraud or deceit must occur “in
connection with” a purchase or sale but need
not relate to the terms of the transaction. For
example, in Superintendent v. Bankers Life, the
U.S. Supreme Court found a violation of rule
10b-5 when a group obtained control of an
insurance company then sold certain securities
and misappropriated the proceeds for their
own benefit. In another case a publicly held
corporation made missta tements in a press
release. Even though the company was not
engaged at that time in buying or selling its own

shares, a U.S. court of appeals ruled that the
statements were made “in connect ion w ith”
purchases and sales being made by shareholders
on the open market.
Insider Trading Rule 10b-5 protects against
insider trading, which is a purchase or sale by a
person or persons with access to information
not available to those with whom they deal or to
traders generally. Originally, the prohibition
against insider trading dealt with purchases by
corporations or their officers without disclosure
of material, favorable corporate information.
Beginning in the early 1960s, the SEC broad-
ened the scope of the rule. The rule now
operates as a general prohibition against any
trading on inside information in anonymous
stock exchange transactions, in addit ion to
traditional face-to-face proceedings. For exam-
ple, in In re Cady, Roberts & Co., 40 S.E.C. 907
(1961), a partner in a brokerage firm learned
from the director of a corporation that it
intended to cut its dividend. Before the news
was generally disseminated, the broker placed
orders to sell the stock of some of his
customers. In another case officers and employ-
ees of an oil company made large purchases of
company stock after learning that exploratory
drilling on some company property looked
extremely promising (SEC v. Texas Gulf
Sulphur, 401 F. 2d 833 [2d Cir. 1968]). In these

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SECURITIES 77