Time for a Closer Look: New Developments Prompt a Review of
the “10b-5”
by Adam W. Glass, Partner
April 2005
Part 1 -- Introduction.
The “opinion” that isn’t an opinion. The “10b-5 opinion,” a staple of securities offerings including all
U.S. public securitizations and most, if not all, Rule 144A/Regulation S securitizations for which a
disclosure document is produced, is a bit of an odd beast. To begin with, it is not a legal opinion, but a
statement of fact by a lawyer. More precisely, it is a statement concerning the absence of facts. In a
typical formulation, the “opinion” states:
Nothing that has come to our attention has caused us to believe that the [offering document], as
of its date or as of the time and date of delivery of this letter, contained any untrue statement of a
material fact or omitted to state a material fact [required to be stated therein or] necessary in
order to make the statements therein, in light of the circumstances under which they were made,
not misleading.
The “10b-5” that isn’t a 10b-5. Even the “10b-5” portion of the name is something of a misnomer. The
principal purpose of the “opinion,” at least historically, has been to assist in creating a defense to
underwriter liability under Sections 11 and 12(a)(2) of the Securities Act of 1933 (the “Securities Act”),
not to deal with issues arising under Rule 10b-5 under the Securities Exchange Act of 1934 (the
“Exchange Act”).
Job security (a brief digression). In a way, I owe my current job to the 10b-5. Linklaters, a global firm
with its origins in London, began its practice of U.S. law 10 years ago as the U.S. capital markets
opened to foreign issuers, principally as a result of the promulgation of Rule 144A under the Securities
Act. With the increasingly popular use of Rule 144A to sell portions of international securities offerings
into the U.S., Linklaters’ underwriter clients wanted the firm, when acting as their counsel or as
transaction counsel, to be able to give the 10b-5. To avoid having to cede these transactions to U.S.
competitors, Linklaters commenced its U.S. law practice. Now the firm has over 120 U.S. lawyers
practicing in a full range of fields, including mine, structured finance and derivatives. But the U.S.
practice began with the hiring of U.S. securities lawyers experienced in doing the work required to
provide a 10b-5.
Of course, the 10b-5 in this context is shorthand for U.S. trained lawyers capable of writing U.S. style
disclosure for issuers and conducting the due diligence necessary to assist in establishing an
underwriter’s defense of reasonable care under Sections 11 and 12(a)(2). Implicit in this task is the
requisite knowledge of U.S. securities laws, industry and commercial practice, and accounting
principles, as well as the sophistication to understand where the issues may lie in presentation of
financial results or the use of non-standard accounting treatments, all considered in light of historical
and current SEC positions and standards of practice among sophisticated U.S. capital markets
participants.
That’s negativity. Because the heart of the 10b-5 is the statement that “nothing has come to our
attention,” most experienced securities laws practitioners refer to the 10b-5 “opinion” as a “negative
assurance letter.” That is, the deliverer of the letter assures the recipient of the absence of his
awareness of facts that would cause the disclosure to be misleading. This phrase is hardly warm and
friendly. Like “ethical wall” or “firewall” as substitutes for “Chinese wall,” it has never really caught on
among non-lawyers. Most letter recipients continue to speak of the “10b-5 opinion,” or simply “the 10b5.” I will use the expression “10b-5 letter” or “the 10b-5” for the rest of this article.
The hornet’s nest. Recent developments have focused attention on the purpose, wording and limits of
the 10b-5. Two important articles have come out in the last year: the American Bar Association report
on “Negative Assurance in Securities Offerings,” published in the August 2004 edition of The Business
Lawyer (the “ABA Report”), and “Securities Offerings: Negative Assurance in Securities Offerings,” by
Donald W. Glazer (“Glazer”), published in Insights, Volume 18, Number 10, October 2004. In addition,
a potentially landmark opinion arising out of summary judgment motions in the WorldCom securities
fraud case was published in December 2004, putting renewed scrutiny on the underwriters’ due
diligence defense.
In the case of initial public offerings and certain high yield financings, traditional due diligence still holds
sway. But the fast pace and streamlined process of offering registered securities today in “take-downs”
of shelf registrations means that in practice, underwriters may no longer carry out more traditional due
diligence in such offerings. Nevertheless, the WorldCom opinion holds that underwriters are still subject
to the same standard of care that applied in slower moving times. Perhaps not coincidentally, 15 banks
have settled out of the WorldCom case for approximately $3 billion in total since the opinion was
published.
Like Gaul, this article is divided in three parts.
In the first section of the article (installments 1-3), I review the underwriter’s due diligence defense under
the Securities Act, early case law interpreting its requirements in the context of registered public
offerings, and the expansion of the use of negative assurance outside the registered offering context.
This part quotes or paraphrases liberally, with permission, from Johnson & McLaughlin, Corporate
Finance and the Securities Laws (3d ed. 2004), although for convenience quotation marks are omitted.
I also discuss the concept that delivery of the 10b-5 letter is only appropriate to a recipient who can
potentially use it in a meaningful way to establish a diligence defense from liability under the federal
securities laws, and apply this principle to some non-conventional recipients.
In the second section (installments 4-5), I discuss whether the giving of negative assurance ALWAYS
implies the conduct of an investigation made specially for the purpose of due diligence to support giving
the letter.
In the third section (installment 6), I focus specifically on the 10b-5 letter as it is used in securitizations,
discussing relevant differences between securitizations and corporate offerings, highlighting the relative
lack of guidance specifically aimed at lawyers providing negative assurance in securitizations, and
proposing, as a small step toward remedying this situation, an investigation checklist to be used in the
context of offerings of collateralized debt obligations (“CDOs”).