## Facts

- BarChris Construction Corp., a rapidly expanding bowling-alley builder, faced significant liquidity pressure and relied on complex financing arrangements.
- In 1961 BarChris completed a registered public offering of 5½% convertible subordinated debentures due 1976.
- The registration statement became effective May 16, 1961 and included audited and unaudited financial and operational disclosures.
- The registration statement contained material misstatements and omissions, including overstated sales, net income, and earnings per share, and a misstated current ratio.
- It failed to disclose significant contingent liabilities and adverse developments occurring before the effective date, including serious customer defaults and operational problems.
- It misdescribed the use of offering proceeds by presenting a growth-oriented purpose while the company urgently needed funds to meet pressing obligations and stabilize deteriorating cash flow.
- After the offering, BarChris’s condition worsened; it filed for Chapter XI on October 29, 1962 and defaulted on debenture interest on November 1, 1962.
- Debenture purchasers sued under § 11 of the Securities Act of 1933 against the issuer, officers/directors, the underwriters, and the auditors; non-issuer defendants asserted the § 11 due diligence defense.
- The case proceeded as a representative action, was tried on liability and defenses, and addressed limitations, causation, and the adequacy of defendants’ investigations.

## Issues

1. Whether the registration statement contained an untrue statement of a material fact or omitted a material fact necessary to make the statements not misleading under § 11.
2. Whether non-issuer defendants proved the § 11 due diligence defense by showing reasonable investigation and reasonable grounds for belief in the statement’s accuracy.
3. Whether “reasonable investigation” varies by defendant category (issuer insiders, outside directors, underwriters, and expert auditors) based on role and access to information.
4. Whether the claims were time-barred under § 13 or defeated by lack of causation or loss causation.

## Decision

- The court held the registration statement was materially false and misleading, including misstatements of financial condition and omissions of liabilities, adverse developments, and the true use of proceeds.
- The court entered judgment for the plaintiffs against BarChris and most officers, directors, and underwriter defendants, finding they failed to carry the due diligence burden.
- The court held the accounting firm liable for deficiencies relating to the audited portions it certified and for failing to establish the expert due diligence defense.
- The court rejected defenses based on limitations and causation, treating § 11 as not requiring investor reliance and placing on defendants the burden to show losses were attributable to causes other than the disclosure defects.

## Legal Principles

- § 11 imposes liability when a registration statement, at effectiveness, contains material misstatements or omissions; materiality turns on whether the information would matter to a prudent investor’s decision.
- For non-issuer defendants, due diligence is an affirmative defense requiring proof that the defendant (a) conducted a reasonable investigation and (b) had reasonable grounds to believe, and did believe, the statement was true and not misleading.
- “Reasonable investigation” is role-sensitive: the expected inquiry increases with the defendant’s access to information, responsibilities, and claimed competence.
- Underwriters must do more than read the filing and accept management assurances; their function requires active, independent checking where warning signs exist.
- Officers and inside directors are expected to know the company’s condition and cannot avoid liability by shifting responsibility to others when they possess or should possess contrary information.
- Outside directors cannot satisfy due diligence by signing filings or amendments without meaningful review and inquiry.
- Reliance on counsel, auditors, or management is not a substitute for the defendant’s own reasonable investigation; each defendant must establish diligence independently.
- Expert defendants (such as auditors) must meet the standard applicable to expertised portions, including taking reasonable steps to prevent certified financials from being materially misleading in light of known or knowable facts.
- In § 11 actions, individual reliance is not an element; once a material defect is shown, defendants must prove any claimed loss was caused by factors other than the misstatement or omission.
- Claims are timely if brought within § 13’s one-year discovery period and within the statute’s outside limit measured from the offering’s effective date.

## Conclusion

The court held that material inaccuracies and omissions in BarChris’s debenture offering registration statement triggered § 11 liability for the issuer and most participants, and it construed due diligence as a demanding, role-based duty of independent investigation rather than passive reliance on others.


Escott v. BarChris Constr. Corp., 283 F. Supp. 643 (S.D.N.Y. 1968)