Joseph K. Leahy
Nearly forty-five years after it was decided, Escott v. BarChris Construction Corp. remains the landmark case on the due diligence defense under the Securities Act of 1933.
BarChris is universally understood to require that underwriters independently verify all material facts in the issuer’s registration statement if independent verification is practicable. No judge or scholar has ever challenged this holding. BarChris also opined that an underwriter who markets the issuer’s securities to the public must nonetheless take an adverse role to the issuer during due diligence. Courts have deemed underwriters well suited for this role, despite the obvious conflict; recent commentators have, with one notable exception, ignored this conflict.
This Article analyzes both BarChris’s mandate that underwriters perform independent verification whenever practicable and BarChris’s dictate that underwriters be impartial in due diligence. As it turns out, both are “irrepressible” myths – fundamentally flawed, but deeply entrenched in the jurisprudence.
BarChris’s unyielding independent verification requirement was never correct, because sometimes it is reasonable to trust rather than verify. BarChris’s demand that underwriters play “devil’s advocate” to the issuer may have made sense years ago, but no longer – and particularly not for the global banks that underwrite securities for massive corporations. Underwriters today are mostly dependent “gatekeepers.”
As a result, the law of due diligence ought to change. So long as an underwriter concludes, after a reasonable investigation, that the issuer is objectively trustworthy or sufficiently solvent to cover a judgment under the Securities Act, the underwriter should not be required to check every material fact in the registration statement. What’s more, courts ought to consider an underwriter’s independence when assessing the reasonableness of its due diligence investigation. In some cases, regulators (or courts) should require that an independent underwriter be hired to perform due diligence. Yet, in many cases, unconflicted due diligence may not be worth the price.