Securities Regulations Outline Haft Spring 2oo6

1. GOALS OF SECURITIES REGULATIONS a. Consumer Protection i. Following sock market crash of 1929, congress saw two main problems 1. Investors were vulnerable in a manipulated marketplace 2. The lack of confidence in the markets prolonged the depressions ii. Today, the need for consumer protection is greater because a much higher percentage of the public invests b. Informational needs of investors i. Because of complexity of securities market, much more information is needed than in other markets ii. Haft says this is most important – securities laws were designed to provide full and fair disclosure for investors and the marketplace Allocative efficiency i. Theory says that federal securities laws ensure the accuracy of security prices – meaning stock prices confirm to the fundamental value of the companies traded ii. Disciplines poorly managed firms and rewards efficiently managed firms Corporate governance and Agency costs i. Argue purpose of the securities laws should be to reduce the SH’s cost of monitoring corporate officers by mandating disclosure of the use of corporate assets by managers. Economic Growth, Innovation and Access to Capital i. Economies that are stock market based allow greater entry into the market, incouraging innovation and increasing competition.





SECURITIES TRANSACTIONS: a. Issuer Transactions (Primary Market): i. Sales of securities by the issuer to investors ii. Means of raising capital iii. Public offering/Primary distribution/IPO 1. Selling efforts of a large amount of securities to the public 2. usually occurs through syndicated broker-dealers called underwriters iv. Private placement 1. Most expedient and get special regulation exemptions1 b. Trading Transactions (Secondary Market) i. Purchasing and selling of outstanding securities among investors (not the company) ii. Existence of a secondary market is critical to capital raising in the US 1. Secondary markets provide liquidity to investors which in turn invigorates primary markets. iii. Either privately negotiated or through public markets iv. Division of Security markets: bond, equity markets and derivative/options Two Kinds of Secondary Trading Markets i. Exchange Market: “auction market” 1. How it works: a. Only Members (Brokers) may trade on a stock exchanges floor, either for their own accounts or for customers. Limited number of members can trade, so their seat has value b. Specialist: a category of exchange member firms where the specialist is assigned one stock to trade and broker who wishes to trade will go to the specialist 2. NYSE



ii. Over the counter Market: “dealer market” 1. How it works a. Investor buys or sells in a transaction with the dealer, who quotes a bid/asked spread, with the dealer making money on the spread between the prices b. Transaction can also be with a broker who buys from a dealer and charges you a commission 2. NASDAQ (National Association of Securities Dealers Automated Quotations) a. Usually cos with smaller capitalization and computer and tech firms 3. Differences between OTC and Exchange Markets (See other outline un-important) 3. THE LEGAL FRAMEWORK OF SECURITIES REGULATION a. The Securities Act of 1933 (focuses primarily on issuer transactions) i. Goal: full and fair disclosure and prohibit fraudulent sale of securities 1. To provide investors with material financial and other information concerning new issues of securities offered for the sale to the public. 2. This is done through the registration statement which produces the prospectus, which provides all material information necessary to assess the merits of their purchase. ii. Covers: The issuance of securities to public investors by 1. requiring the filing of a registration statement; 2. mandating the dissemination of a disclosure document [“prospectus”] 3. and enacting liability scheme for misinformation or omitted information in the registration statement, prospectus, or during the distribution of new securities to public investors iii. Disclosure only statute: 1. Not a substantive, regulatory, paternalistic statute. However, there is significant enforcement behind it. Most onerous civil liability statute on the books. The Securities and Exchange Act of 1934 i. Requires continuous disclosure for companies required to register under its provisions (and restrict and penalize insider trading ii. Three categories of reporting companies 1. Companies that have securities listed on a national exchange (§ 12(b)) 2. Companies that have assets in excess of $10 million and have a class of equity securities held by at least 500 persons (§12(g) and Rule 12(g)(1)) 3. Companies that have filed a 33 Act registration statement that has become effective iii. Forms required to be filed 1. Annual report (10-K): extensive description of the company’s business and audited financials + management’s discussion and analysis of position and performance 2. Quarterly report (10-Q): un-audited interim financial statements + management’s analysis of financial operations and conditions. 3. Material developments (8-K) iv. Reporting companies must also comply with proxy rules of 14(a) v. Williams Act and Tender offer disclosures: Requires outsiders to make disclosures when 5% of a class of registered securities is or will be owned as a result of a tender offer c. Sarbanes Oxley i. Broad prescriptions for corporate governance: authorizes SEC to develop rules for professional conduct for lawyers: regulates areas that used to fall under state regulation. Blue Sky Laws i. State securities laws 1. Not exclusively disclosure oriented like federal laws: often into merit regulation standard whereby qualification depends on substantive merits of the offering ii. Not uniform, but § 18 of Securities Act exempts covered securities from states’ registration



2) Item 501(c) of Regulation S-K calls for a concise sketch of the terms of the offering. 3. b) Summary Information 1) Length and complexity of prospectus usually result in a summary provided under Item 503(a) of Reg S-K. e) Permits adoption of stock option plans.THE 33 ACT REGISTRATION STATEMENT. . the selling shareholders may cash in on part of their investment. b) Full disclosure obligations of reporting companies with respect to salaries. if not legal limitations on salaries and fringe benefits. d) Increased cost of administration and accounting due to reporting requirements of 34 act. 3) Preparing the registration stmt (a) Usually “quarterback” is the company attorney who drafts documents and performs due diligence.meaning that should disclosure even only a chance of being material. 189 a) Article covers the practice and procedure of going public in a step by step analysis order: 1) Selection of underwriter: important decision of deciding between prestige. g) May become target of takeover bid. (a) Managing underwrite will take lead in forming the underwriting syndicate. 5) Timetable (a) Average first offering takes 2-3 months Common disclosure pitfalls a) Cover page 1) Trend is to include an at glance description of transaction. f) Business decisions dictated by short-term fluctuations in stock price. 4. e) Business 1) Item 101 of Regulation S-K requires disclosure of general business developments of the issuer’s business. or other factors that must be uniquely appropriate to deal. 3) Reg stmts that omit pricing info in reliance on Rule 430A must include price range on cover page. transaction with mgmt. convertible debt. PRELIMINARY CONSIDERATIONS 1. Advantages of going public a) Raise funds for corporate purposes like increasing working capital. become better known and obtain wider market. Going Public: Practice. c) Loss of flexibility in mgmt arising from practical. (b) Lawyers have a duty to make sure reg stmt is accurate. or specialty. 2. (b) Underwriter will provide after-market support for the security being sold. (b) Consider number of shares offered and the offering price for the shares. 2) Must do a balanced presentation featuring favorable and unfavorable info. (c) Assist in getting other forms of financing as well. f) Give owners sense of financial success and liquidity Disadvantages of going public a) High expense of maintaining a public company. 4) Underwriting agreement (a) Company signs a letter of intent with managing underwriter detailing terms. c) May gain prestige. MANDATED DISCLOSURE. etc. d) Better position to acquire other businesses through issuance of stock instead of cash. d) MD&A 1) Intended to give investors an opportunity to “look at the issuer through the eyes of management. expanding plant b) If a secondary offering is included. e) Possible loss of control over dividend policy. warrants. h) Shares may sell at lower price than anticipated. c) Risk Factors 1) Item 503(c) of Regulation S-K calls for discussion of principal material risk factors.” 2) Address economic and business conditions 3) Item 303 of Regulation S-K adopts a more inclusive disclosure criteria than the Basic test . 2) Structure of offering (a) Questions of whether to offer common stock. DISCLOSURE GENERALLY A. conflict of interests. Procedure and Consequences p.

5) Note on Duty to disclose: Need a duty (a) A corp is not required to disclose a fact merely b/c it is material. After the sale regulators gave Edison trouble in obtaining its licenses for the reactors (delays cost a lot) and ordered one to be dismantled. (billy – the projections did not alter total mix of market) c) In re Apple Computer Sec. (This item is responsive to item 102 of Regulation S-K which requires a brief description of the property and to tell if it is held subject to an encumbrance). this was S-3 company that had many analysts following it who knew that the company increased its estimated costs every year as the result of delays and newspapers reported this & Market price in P’s stock reflected this (ECMH). The stock price fell as a result and P. rather an omission is actionable under the securities law only when the corp is subject to a duty to disclose omitted fact (b) 33 Act context: Rule 408 requires that material facts be disclosed throughout the offering process (c) 34 Act Context: See duty to update and correct below. but statements about the products capabilities were within the manufacture’s knowledge so if misleading they would be ground for liability b/c not offset by info already in the public. When prospectus was issued TWC asked Goldman sachs what its financial options were with regard to TWA and 1/7of the options was to terminate the P/S relationship. even if material – so question is would this nondisclosed fact alter the total mix of info that is available. Firms eligible for Form S-3 also may register equity securities “for the shelf” under Rule 415(a)(1)(x). Though the incorporated documents were erroneous. (b) exemplifies idea that magnitude of an outcome with low probability of occurrence can also dominate the materiality determination.4) Kronfield v. Shelf Registrations allows the firm to hold stock for deferred sale. (c) Though under TWA case the encroachment could be considered a material fact 3. Info in the registration statement will be dated by the time for sale. Commonwealth Edison Co. 2) It is even possible for misleading disclosures not to be material if professional securities traders who set the market price know the disclosures to be wrong (Wieglos). These documents incorporated by reference estimated the total costs of building its nuclear reactors. 1) Statements that new computer sales were going to be huge were offset by more sober analysts reports.: Truth on the Market and TOTAL MIX PRONG (Efficient Markets) 1) Edison. Held That materially misleading for prospectus not to disclose that termination of TWC was under consideration. TRUTH ON THE MARKET: TOTAL MIX OF INFORMATION AND MARKET EFFICIENCY a) Generally: 1) Securities investors do not depend exclusively on mandatory disclosures. probability is so low + if find out then you lose property anyway. Due to ECMH info that is already known to the market is not actionable. but the SEC believes that the market price of large firms accurately reflects current information despite the gap between registration and selling dates. d) United Paperworks International 1) Co said proxy statement was not misleading because the omitted facts were in a 10K that were reported by 10 The SEC believes that markets correctly value the securities of well followed firms.11 They argued that the 2) Issue: whether the cost projections were misleading or whether the truth of their projections were on the market and incorporated into stock price 3) Held: The sales projections cannot be the basis of liability. Here. an S-3 corp sold stock on the shelf. a purchaser of the shelf offering. Lit. TWA: Magnitude of an outcome with low probability of occurrence (a) TWA Issued prospectus that discussed at length TWA’s relationship with its parent TWC. so that new sales may rely on information that had been digested and expressed in the security’s price. b) Wieglos v. files suit under § 11 and demanded the amount the securities declined. the tremendous effect the termination of TWA as a subsidiary would have on the value of the parent company’s stock overwhelmed the court’s consideration of slight probability of event happening. just a potential loss 11 . This has to be a § 11 claim because they did not sell their securities so there would be no loss. 10 The succinct RS incorporated other filings by reference. Just found out need 3 more months to get adverse possession (b) Don’t disclose though magnitude would be huge for company in totality if other company finds out. 6) Problem 11-2 (574) (a) Completing form 10K and describe firms only plant and its most valuable asset as located in a particular location and being owned in fee simple.

C. is named in RS as being or about to become a director or partner 5. so even someone who was completely unaware that the securities were part of the public distribution has standing 2) Damages reduced by causation: (a) Damages are reduced to the extent D proves damages resulted from the material misstatement or omission in the RS. § 11(a) d) No Causation or Injury required 1) Policy of § 11: (a) deterrence rather than just compensation is the goal. Every underwriter16 7. Directors (or persons performing similar functions) or partner at the time of filing 4. to be a § 11 D). Every person who. §11(e) e) f) P Need not show intent on the part of the D Requirements for complete § 11 action 1) Effective RS 2) Material misstatement or omission 3) Purchased through RS in question 4) Sue everyone on the list B. § 11 defendants need not be in privity with the Purchaser and need not have actually created or disseminated the challenged information. See Harden (holding a UW that performed due diligence on RS but did not purchase or sell. “Signatures” (Follows Item 17) Instruction 1 a) Registrant b) Principal executive officers or officer (CEO) c) Principal financial officers (CFO) d) Its controller or principal accounting officer e) At lease a majority of the board or persons performing similar functions f) If foreign registrant: must be signed by its authorized US rep g) If limited partnership: Must be signed by a majority of the board of directors of any corp gen partner signing RS 3. § 15 Control persons a) “an person who controls any person liable under § 11 or 12 shall also be liable jointly and severally with and to same extent as such controlled person. with consent.e.” b) Unless the controlling person had no knowledge of or reasonable grounds to believe in the existence of the facts by reason of which liability of the controlled person alleged to exist. DEFENSES TO SECTION 11 CLAIM GENERALLY a) Issuer has no defense (w/ exception) 1) Issuer is strictly liable regardless of its knowledge or negligence 2) Except issuer has defense of showing that P knew of the untruth or omission at time of purchase b) Non issuer Defendants (Have burden of proof) 1) Due Diligence: Have burden of proof to show their nonculpability 2) Whistleblowing: can always escape liability if you resigned and informed the SEC and the issuer in writing that you are not responsible for statements in the RS. Every Expert who consents to his opinion in RS a) i. . accounting firm that audited financials b) Note: Expert liability is limited to info prepared and certified by her 6. § 11(b)(1)-(2) 15 16 THIS IS EXCLUSIVE FOR TEST: NO AIDERS & ABETTORS Remember that there is an expansive definition of UW to include those directly or indirectly participating in the UW under § 2(a)(11). 2) Unless: person has acquired the security after the issuer has made generally available an earning statement covering a period of at least one year beginning after the effective date of the RS – Even then. Those who signed the RS: Form S-1. 2. SECTION 11 DEFENDANTS15 1. reliance may be proved without ever reading the RS.c) P normally need not prove reliance and the §11(a) exception 1) No reliance: No requirement that P show any type of reliance on the RS or the statutory prospectus – much less show reliance on the actual falsity or omission.

9. d) Competitive bidding and reduced incentives to conduct costly due diligence before being picked: 1) In Shelf registration offering under Rule 415.” 2) Held that SEC did not intend to alter UWs due diligence obligations and SEC rejected considerations of competitive timing and pressure when evaluating the reasonableness of UWs invest. UNDERWRITER DILIGENCE IN CONTEXT: ISSUES W/ SHELF REGISTRATION: ARE WE LOSING THE GATEKEEPER? a) Though Underwriters serve as gatekeepers the problem of its due diligence investigation is accentuated in the case of the UWs participation in offering that was registered for shelf b) Rule 415 Shelf Registration and Automatic Shelf Registration reforms (handout 11-12):21 1) Allows S-3 corps to File one short form RS for all future securities that may be offered in 2 year period. which were incorporated by reference into the RS. (a) SEC’s intent was to maintain high standards through the use of new strategies that were “equally thorough”: these would have to be anticipatory and continuous due diligence programs (reservoir of info) 3) Court notes that practitioners feel current regime of liability for UWs under § 11 no longer makes sense: Thus practioners call for reexamination of UWs liability under § 11 (and 12(a)(2)) since 1933 and 34 assumptions about issuers working with UWs in leisurely atmosphere are at odds with today’s competition by multiple UWs for high speed transactions. they cannot possibly do what she says (e) This was reasonable position for UWs in light of new Shelf registration (after opinion SEC passed automatic shelf) 21 22 For more on Shelf registration see supplemental info Not very strong argument because only says “relevant circumstances” . 4) Hafts Notes on Worldcom (a) Worldcom was one of the largest companies and due diligence is extremelely limited (b) Court said cannot rely on financials because there was a red flag – Haft says the fraud was simple but impossible to detect (even Arthur Anderson couldn’t detect it) (c) SEC tried to bring due diligence up to date with Rule 176 but judge said no (d) In practice UWs and Lawyers ignore this. Some say UW cannot afford to devote time and expense necessary to conduct due diligence review.reduces incentive to launch expensive investigation of issuers RS e) Problems Created by Rule 415 1) Inadequate disclosures: more of concern relating to integrated disclosures (a) Also remember that quality of Shelf Registration is much less than a full RS. UWs argued they were entitled to rely without further investigation on Worldcom’s Financial statements audited by Arthur Anderson as well as “comfort letters from the auditor. 3) Why for S-3: because of steady stream of info c) The mechanisms of incorporation by reference and Shelf registration 1) Significantly reduced the time and expense necessary to prepare public offerings thus enabling more “rapid access to capital” 2) This effected time UWs could perform their investigations of issuers and raised concerns about ability to undertake a reasonable investigation with respect to info incorp by reference. with reforms you can shelf register unlimited amount and have to renew it every 3 years 2) Purpose: reduce costs and allow access to favorable market conditions + SEC passed in order to make US UWs more competitive to foreign markets. Filing a 10K does not subject issuer to § 11 liability. issuer picks UW after reg statement becomes effective and therefore gets UWs on competitive basis -. with periodic due diligent sessions 4) In recognition SEC passed Rule 176 f) Rule 176 May provide Protections to UWs (it was adopted pursuant to concerns like these – see above)22 1) 176(g) allows to consider the type of UW for reasonable invest 2) 176(h) allows for consideration where fact misrepresented was incorporate by reference and whether particular party was responsible for the document g) But See Worldcom. 2) Insufficient due diligence: (a) With shelf there is fast time schedules. especially on documents that are incorp 3) Others say UWs do “new due diligence” by having continuous diligence programs. Inc Securities Litigation: UWs Due Diligence obligations in Shelf Registration & 176 1) Worldom Execs manipulated company’s filings.

SECTION 12 LIABILITY 1. 2. while 2) § 12(a)(1) applies to securities sold in violation of § 5 3) § 12(a)(2) takes over where § 11 left off. Dahl solicited some of his friends to purchaser shares.. Printer (P) counter claims. about investing in oil and gas leases in private offering. b/c he felt it was a good investment. not directors etc.only immediate purchaser can sue immediate seller c) Defendants 1) § 11 statutory Ds 2) § 12 Only the people who offer and sell the securities (i.) d) Damages 1) § 11 damages and very defined 2) § 12 Can sue for rescission or for damages e) Defenses under § 12 1) § 12(a)(2) says nothing about reasonable investigation (but it does require reasonable care – see below) 2) § 12(b) allows the D to reduce the amount recoverable under § 12(a)(2) by proving that the depreciation in value of the security was not caused by the material misrep or omission – called loss causation defense SECTION 12(a)(1) a) Generally 1) Section 12(a)(1) provides that any person who offers or sells a security in violation § 5 shall be liable to the purchaser for (a) Rescission when securities still owned: the consideration paid (with interest) less the amount of any income received on the securities or (b) Damages if purchaser no longer owns: difference between the price paid and the amount received by the P on the security before the suit was brought b) Typical violations that trigger (Liability is absolute for any violations of § 5) 1) Sale of unregistered security 2) Failure to deliver prospectus 3) Making illegal offer in pre-filing period c) P does not need to show 1) intent (this is strict liability 2) Injury (the goal is deterrence) d) All P needs to show 1) Violation of § 5 2) Interstate commerce 3) P made adequate tender of the security if it is still owned 4) The action has been brought within the time state din the SOL.e. seeking contribution from Dahl (D) alleging among other things that Dahl was a “seller” 2) Issue: Does liability under § 12(1) extend to a person who urges the purchase of a security but whose motivation is solely to benefit the buyer? 3) Definition of a seller (a) The language of § 12(a)(1) contemplates contractual buyer-seller privity. and allows purchasers in an offering to seek rescission from “sellers” if the offering was carried out “by means of prospectus or oral communication” (i. Ds brought suit seeking rescission under §12(a)(1) (they did not qualify for private offering). public offering § 10 prospectus) that is materially false or misleading29 b) Privty: 1) § 12 requires privity between the buyer and the seller . When the venture failed.e. Dahl) 1) The Person who actually passes title 2) The person who solicits the purchase (for their own personal gain or financial interests of owner) f) Pinter v. Dahl: Who is a seller for purposed of 12(a)(1) 1) Printer (D) met with Dahl (P). See § 13 e) Person must be a “seller” (or offeror) but who is a Seller for purposes (Pinter v. 29 Haft says for “sticker disclosures” may be able to sue under 12(a)(2) and not under § 11 . DIFFERENCES FROM § 11 a) Application 1) § 11 applies to material misstatements in RS.CIVIL LIABILITY CONTINUED A.

1) Howey holds that profits must be derived “solely” from effort of others 2) Lower courts have accepted that the investors’ efforts in common enterprise may contribute to profits – as long as the mangers efforts “predominate” (so can participate a little but not too much) (a) Courts made change recognizing promoters could circumvent the securities laws by merely requiring investors to nominally participate (b) SEC v. 5. their investment was in a specific apt differing from others (d) SEC v. 7th 1995) court found that an investment in high-yield securities was a security even though only sold to a single investor. negotiated on a face-to-face basis is not a security. Rather. 7th 1994) Facts: p bought a time share interest in a golf course condo and entered into agreement with developer to rent the unit on behalf of p. (127. Holding: court held no common enterprise because investors are not obtaining the same thing. Weber court held that a “unique agreement. though no pooling of interests (direct relationship between promoter’s efforts and investor’s success) (c) Strict Vertical: requires that the fortune/success of investor’s be tied to the fortune of the promoter. Turner: said that the critical inquiry is not literally the sole effort of others but whether the efforts made by those other than the investor are the undeniably significant ones. Fox Hills Development Corp.3) Potential reach of this case is huge 4) Note on face to face transactions: in Marine Bank v. those essential managerial efforts which affect the failure or success of the enterprise (c) Animal Breeding Case: Miller v.” 1) Horizontal (more restrictive): Multiple investors have interrelated interests in a common scheme (requires pooling of investors funds so all investors are sharing in the same pool) (a) Usually a pro-rata distribution of profit (b) Cannot involve single investor (but see Lauer) (c) Wals v. Lauer (131. Some courts say it is sufficient if a single investor has a common interest with the manager of his investor (a) Common Enterprise may exist even though no pooling of investor’s funds or interests (b) Broad vertical: a common enterprise when activities/efforts of promoter’s are the dominant factor in the investment’s success. the buyer is not buying a consumable commodity b) Commonality/Common enterprise (Split over horizontal or Vertical): there a few different approaches for analyzing whether there is common interest among investors. promoter and investors share risks). an undivided share in the same pool of assets.e. Rejected argument that because only single investor. (d) Haft says only place where vertical has bite is trading accounts -3) Example: Discretionary trading accounts managed by brokers (a) Broad vertical: common enterprise may exist b/c of dependence on the expertise and efforts of the broker for profit even if promoter doesn’t share in risk (b) Strict Vertical: no common enterprise if the promoter can continue to profit through commissions. HOWEY TEST FACTORS a) Investment 1) The investment can be of Cash or noncash consideration. 8th circuit disregarded the efforts actually expended by investors and focused on the promoters’ representations to potential investors that only minimal efforts would be required to care . “A common enterpirse is one in which the fortunes of the investor are interwoven with and dependent upon the efforts and success of those seeking the investment or of third parties. is expected to produce income. (United) d) Profits through Efforts of Others: Must be profits “predominantly” through efforts of others. rather than just the efforts (i. even though investor is losing (c) Horizontal: may deny security status to these arrangements b/c multiple investors are not joint investors in the same investment enterprise so no pooling of funds c) Expected Profits: 1) Expected returns must come from earnings of the enterprise. no horizontal commonality. not merely additional contributions and this return must be the principal motivation for the investment 2) This return must be the principal motivation for the investment not consumption (a) Where buyer is motivated by a desire to use or consume the item the securities laws do not apply. Central Chinchilla Group: Pyramid selling: Raise chinchillas and promoters would resell. Seems the intention to involve multiple investors can result in horizontal commonality (e) Critics: some argue that requirement of horizontal commonality is formalistic and lacks any relationship to the policy goals of 33 act 2) Vertical: whether the activities of the promoter are controlling factor in success or failure of the investment.

When bank reneged on its promise to deliver the loan proceeds. 3) Haft criticizes this opinion saying that even if this is a private transaction it is still subject to the antifraud provisions General factors courts have considered a) Manner and offering and sale 1) Offering to the general public more likely a security while a two-party directly negotiated transaction is less 3. it is more likely a security (even if just sold to broad segment of public) (ii) If the note is given in a face-to-face negotiation to a limited group of sophisticated investors. Weaver (159. pledged a Certificate of Deposit (CD) as collateral to guarantee a bank loan. 3) Notes which are not securities include: (a) Notes used in consumer lending (b) Notes secured by a mortgage on home (c) Short term note secured by lien on a small business (d) Short term note secured by an assignment of accounts receivable (e) Note evidencing a character loan to a bank customer (f) Note formalizing an open account debt incurred in ordinary course of business (g) Notes of loans by commercial banks for currents operations. many extensions of credit do not have attributes of an investment and have not been deemed securities. 1982) . (ii) If the issuer gives the note to buy consumer goods. c) Reves v. Public: the agreement involved no prospectus and was not designed to be publicly traded. Although has attributes of a long-term debt instrument. See also § 3(a)(10) of 34. it is more likely not a security (Cite United v.CD not a security (case is right after Howey) 1) Facts: P. weaver. it is more likely a security. since uncollateralized and uninsured and instant liquidity doesn’t matter. . and buyer is interested primarily in profits it is more likely a security. (b) Private vs. it is more likely a security. (1) sold in effort to raise capital for business ops and purchasers wanted profits (there was high interest rate).mature within 9 Months (b) § 3(a)(10) (SEA 34) Excluded from the definition of security any note that matures within 9 months. * double check this (c) Hence. 6) See page 22 of notes. (2) sold to broad segment of public. (c) Reasonable expectations of investing public (i) If investors view the type of notes to be investments. (4) no risk reducing factor. Bank instruments as securities a) Marine Bank v. any note with a maturity exceeding 9 Months seems to come squarely within definition. 2) Holding: bank CD is not a security. Ernst & Young: Circumstances where note falls under Securities law Family resemblance test 1) Do not Apply howey to notes: (howey is for investment Ks) 2) First there is a rebuttable presumption that every note is a security unless it bears a “strong family resemblance” to a category of instruments that are not securities. Problem 3-10 (201) for examples of notes 2. The alternative regulatory scheme (banking laws) renders unnecessary securities regulations. (d) Purpose was to separate short term loans by commercial banks for consumable goods versus loans by investment banks 2) However. it is more likely not a security. (5) even though payable on demand does not fall w/in less than 9 month exception. Forman). (d) Other facts reduce risk (i) If the note is not collateralized and not subject to other types of securities regulation. 4) 4 factors to consider: (a) Motivation that would prompt seller and buyer to enter into it (i) if the issuer of the note uses the proceeds for general business purposes. minor asset or for some commercial or consumer purpose. (3) advertisement characterized notes as “investments” so people expected them to be. (b) Consider Plan of distribution to determine if it is instrument where there is trading for speculation (i) If notes are widely offered and traded. (ii) If the note is secured or otherwise regulated it is more likely not a security (cite Marine Bank which was subject to banking regulations) 5) Holding: note is a security. the court said: (a) Limited risk: that bank CD are federally insured and subject to comprehensive banking regulation. P claimed defrauded under 10b-5. (used “context” clause 3) Courts had applied a number of tests to determine.

Issuer (other than WKSI) must take reasonable steps to prevent further distribution of the communication during the 30 day period prior to RS. announcements of dividend. or shell companies in last three years c.42 (ii) Amount of flexibility created by rules is contingent on characteristics of issuer (1) Well known seasoned issuer: S-3 + current in reports + $700 mil of float or $1 bil non-convert (2) Seasoned: issuer eligible for shelf (3) Unseasoned: reporting co not eligible for shelf (4) Non-reporting issuer – duh (5) Ineligible issuers: RULES DO NOT APPLY a. c. Haft: this is all embracing of the efficient market theory – need not gag order them because so big and so covered we want them to release info all the time. 34 Act reports 44 forward looking: projections. The issuer must have previously released such info and the current release must be consistent with past releases (4) Rule 169: Non reporting issuers can only release factual business info not intended for investors. (i) The members excluded by this language are members of the selling group who absorb none of the offering’s risk. – SO UWs cannot make offers to selling group yet – See problem 4-6 2) Rule 135: permits the issuer (not the underwriter) to announce its intention to make a public offering by stating: (a) the amount and type of security to be offered. that will be in privity with the issuer. Requirements: billy.(h) SEC Offering Reform Rules July 19th 2005 (i) General: SEC felt that existing gun jumping rules were overly restrictive and were inconsistent with the capital formation process. assumptions 42 43 . (b) Who is excluded depends on who is an underwriter defined in §2(a)(11) so as to exclude those “whose interest is limited to a commission from the underwriter not in excess of the usual and customary distributors.don’t want to destroy market efficiency on outstanding shares by limiting available info on issuer via § 5) factual info: business info. Blank check. 4) Generally: These address the § 5 issues for investment professionals who regularly circulate investment recommendations to their clients. Haft: Still protected by antifraud!!!! (3) Rule 168: Reporting cos can at any time publish regularly released factual business43 info and forward-looking info44 a. Cannot reference the offering and b. advertisements. They can do this through a free writing prospectus (but may need to file with SEC) b. Reporting issuers that are not up to date b. Certain Issuers subject to bankruptcy in last three years f. Issuers convicted of felony or subject to decree for sec fraud (iii) General relaxation on Gun Jumping (See handout) (1) Rule 135: did not change. can still publicize specified limited info about a proposes offer (2) Rule 163: WKSI’s can engage at any time on oral or written communications (completely exempt can make oral or written offers to sell at any time) a. plans and objectives for future ops.. Limited partnerships offering securities other than firm commitment d. penny stock. c) Other Activities permitted during the waiting period 1) Prelim negotiations (a) § 2(a)(3) exempts from the definition of “offer” preliminary negotiations or agreements between the issuer and the underwriters. 5) Rule 137: (Nonparticipant recommendations). Registered investment companies e. or among underwriters. JUST KNOW THEY ARE THERE. (5) Rule 163A: All companies may talk for the period up to 30 days before filing a. and (b) the manner and purpose of the offering (see above) 3) Broker dealer activities: Investment letters (170) – note: for exemptions issuer must be reporting co HAFT SAYS NOT IMPORTANT FOR THIS COURSE. future performance (including MD&A).

printed. But the sending of the form to the customer is not a violation because it is allowed under Rule 134(d) (can send communication to investor asking them to express interest). h) Other Electronic communications and waiting period -. broadcast. You can’t put in any more than Rule 134 allows SEE RULE. (b) SEC view: email that are short. and are probably substitutes for telephone conversations are probably “oral in nature” and are permitted during waiting period. This is violation (saying it is a good buy) because it doesn’t meet requirements of § 10. Oral offer is ok. i) PROBLEMS PAGE 179 1) Problem 4-15: press release announcing that is has filed a RS for IPO of 2 million shares and other info. Much more liberal than Rule 135 (prefiling rule). This is probably a .fuzzy lines 1) E-mails .prohibited because = written communication? (a) Problem: email has characteristics of oral and written communication. Information about earnings per share in last two years is not allowed. (a) This could be a free writing prospectus and hyperlink to the preliminary 2) Problem 4-13: broker orally offer to a customer to purchase and sends her a preliminary prospectus. (c) What about rule in book that if you make road show available to limited investors and password protected it is not a prospectus? (179) (d) Haft Comments on Road Shows (i) SEC has democratized the Road show by treating it as a free-writing prospectus (ii) If you make it available electronically to any single investor. and graphic communications” but not “live real time communications to live audience” regardless of the medium (these are oral communications) (b) A road show can either be a oral communication or written and thus a prospectus (but a free writing prospectus that need not be filed*) (i) Oral and not prospectus that needs to be filed: Must be live communication to live audience (1) Graphic info presented at such a roadshow. But there are requirements for the form – needs to include statement that cannot buy until RS is effective & Needs to be proceeded or accompanied by a prospectus. and under Rule 430 preliminary/red herring prospectus is ok to send to customer.(iv) Press and public usually excluded. Rule 134 applies only during waiting period. 2) Web sites (a) Posting of a prospectus on web site has been considered ok. 2) Electronic Communications: Are road shows oral communications or written offers that need meet § 10 (a) As discusses above § 2(a)(10) defines prospectus as written communications including “written. need not be filed (2) Written info distributed needs to be filed as free writing prospectus (3) The oral communications are still subject to ANTIFRAUD PROVISIONS of §12(a)(2) and 17(a)(2) (ii) Written Communication and thus a free-writing prospectus: Those not live and that are graphically transmitted (1) Need not be filed with SEC unless non-reporting co in which case need not file if road show is readily available without restriction electronically to any potential investor. 3) Problem 4-14: broker sends a form to a customer and attaches a business card that says “this is a good buy”. 4) Problem 4-15: She sends note back to broker with money “put me down for 100 shares. this meets § 5(b)(1)’s requirement that need to send § 10 prospectus. (v) Attorneys often file meaningful cautionary language with the SEC to get protection of safe harbor for forward looking info under PSLRA. but dissemination of an offering document by e-mail to a broader audience is not cause more like written. it must be made electronically to the world (iii) This lets the molly goldberg’s to hear all the good things about the company above and beyond what is covered in the preliminary prospectus. (b) SEC has said issuer may not hyperlink its prelim prospectus to research reports by other firms cause like mailing additional written materials (and could be considered conditioning) Remember that those things that are not considered prospectuses still cannot contain misleading statements because they are still subject to antifraud. The press release is a violation of § 5 because it is a writing and is not within § 10 and it is not within Rule 134.

court held stock purchasers lacked this access and info and reg was required (absent such access employees just as much members of the investing public as their neighbors). are “able to fend for themselves. v. Inc. family. they lacked a privileged relationship with issuer. bargaining power) 6) Nature of offerees . (a) information access or disclosure (Doran) (i) By actually disclosing info to offeror (ii) By offeree having access to info based on relationship with issuer (insider. COURTS APPLYING § 4(2) a) Courts have interpreted § 4(2) not limit the dollar size of a private offering or number of investors b) Instead courts have formulated a sliding scale of investor sophistication and access to info. 3) This approach is consistent with the purpose of the act which is to protect investors by promoting full and fair disclosure of info necessary to informed investment decisions 4) Billy – this makes clear that an offer need not be open to whole world for it to be public d) Requisite Offeree Qualification: Sophistication and Access to information 1) Ralston emphasized that Access to information was the critical inquiry but also commented that an offering is not public when limited to those who could fend for themselves – these 5th circuit cases address the issues underlying private placement exemptions 2) Hill York Corp. Lacking such access to info they were in need of protections of registration regardless of their sophistication (soph no sub for info) 3) SEC v. SEC sued to require reg.” such as executive personnel with access to same kind of information that would be available in RS. Court suggested investors must have personal contacts with corporate officers. 5) Doran v. Must show that all offerees received info on co. the relationship between the issuer and offeree becomes critical to see if he could realistically have been expected to take advantage and he also need to be sophisticated enough to ask the right questions. and unlike insiders of a corp. But Doran explicitly said insider status not required. (c) Note: considered a “bombshell” – seemingly requiring offerees to have “insider” status. Hundreds of employees in variety of positions and purchased unregistered stock. c) SEC v. (1971) Sophistication no substitute for information (a) Facts: purchasers were sophisticated businessmen and attorneys who bought stock in fast food corp and only received misleading brochures.considered the key factor in applying exemption because 33 act is based on disclosure in registration process as best protection for investors. . Ralston Purina Co: Focus should be on the need of the offerees for protections of he act 1) Ralston Purina has policy of selling common stock to “key employees” . Continental Tobacco Co. Purchasers did not have opportunity to inspect corp records. Woolf SD Cohn & Co (1976) Sophistication but not insider (a) Court clarified that the § 4(2) exemption does not depend on insider status – sophisticated outsider can be qualified. regardless of their number. 5. the absence of a relationship between the issuer and offeree would not preclude a private offering (ii) If access to info is the measure. American Int’l Franchises. In this case. Petroleum Management Corp (1977) Sophistication and Disclosure or Access to info (a) Court held that investors must receive or have access to information comparable to that found in RS (b) A finding of sophistication does not end the inquiry because it does not eliminate the need for information (c) Availability of info means disclosure or access (i) If disclosure (equivalent to what is in RS and maybe more) is exercised. 4) SEC v. 2) Holding: § 4(2) exemption applies when offerees and investors. (b) Holding: court denied exemption because investors lacked sophistication. The offerees neither knew the issuer or its business. Court said that exemption requires investors (no matter how sophisticated) need access to info (b) Holding: court denied § 4(2).(b) Large number of units in small denominations (public) 3) Size of the offering: (a) Small = Private (initially § 4(2) meant for small offerings 4) Manner of Offering: (a) Effectuated through negotiations are better (b) Absolutely no general advertising or solicitation is permitted 5) Availability of information . (1972) Information but no sophistication (a) Facts: Ps received written prospectus and financial stmts and signed investment letters.without sophistication of the investor and ability to bear the economic risk of the investment (remember needs to be sophisticated (maybe) and have access to info).

e) Preclude integration of Reg A offering with either (See 321) 1) Any prior offering or 2) Later offerings that are registered. e) Requires “mini-registration” vs. 1) Written document to determine interest or oral communication allowed 2) Written offers must be made after offering statement is filed 3) Offers cannot be accepted until offering statement is qualified.of fed sec violations. 2) Not available to reporting company. etc. d) Issuer may test the waters prior to filing (allows for general solicitation. issuers whose execs had been subject to sanctions. national offerings to investors over the internet (322-23) (Can also alter course after testing and testing will not be seen as illegal solicitation). 1) Reg D may be used by both small issuers and giant public corporations. c) Reg D has no ceiling (at least under 506) on amount of securities that can be issued. Reg D versus Reg A a) Reg A results in the issuance of unrestricted securities as opposed to Reg D. they can be resold imediately b) Reg A may be conducted as a public offering without restrictions on manner of offering (can be general solicitation) or eligibility of offerees (doesn’t matter). made in compliance with Rule 701 or Reg S or made more than 6 months after the Reg A offering Substantial compliance defense available f) 3. d) Reg A also allows Secondary offerings by existing security holders up to $1.5 million while Reg D is for issuers. Reg D which requires no filings with the SEC (but need not print offering because can file and make offering on internet . 2) Reg A is mainly attractive to small business issuer because of $5 mill ceiling. investment companies etc. THIS IS HUGE!!!): Makes it useful for small. See Rule 262.

3. 1) Explains that the § 5 terms “offer” “offer to sell” “sell” do not include offers and sales occurring outside the US. c) Regulations created to ensure that securities distributed and offered outside the US do not end up with US investors. SEC approved the creation by NASD of an electronic market to trade Rule 144A securities. 2) Divides issuers into three categories according to the relative likelihood that securities of that category of issuer will enter American trading markts d) Rule 904 .e. b) No direct selling efforts in the US: 1) Directed selling efforts are activities that are intended to. b) Category 1 . Haft: a) This is used a lot by WKSI’s. the execution of the transaction and delivery of the securities takes place outside the US and transactions is not pre-arranged with a buyer in the US. if not most. and (c) the degree of the US market interest in the securities offered. 4. 2. 144A offerings are coupled with Reg S offerings (for the foreign part) 6. or could reasonably be expected to. result in conditioning the market in the US for the securities offered.5. g) many. Basic principle a) Creates safe harbors for offshore distributions and resales of unregistered securities of US and foreign issuers b) Registration requirements of the 33 Act do not apply to offers and sales made outside the United States made either by foreign or domestic companies. Rule 903 – Issuer’s and distributor’s safe harbor (see page 220-21) a) General 1) The safe harbor for issuers is divided into three categories. REGULATION S – OFFERS AND SALES MADE OUTSIDE THE U. 2) For the purpose of 903 (issuer safe harbor).Safe harbor for resales by others General conditions a) Offshore transaction: the offer or sale must be made in an offshore transaction. b) Rule 902: definitions c) Rule 903 . the foreign issuer need comply only with the two general conditions.S. 2) Focuses on the relative likelihood of securities entering the US markets.Safe harbor for issuers and distributors 1) Compliance with the regulation means the transaction will be deemed to occur outside the US. Purpose is to allow US companies to tap foreign markets. B. (b) the issuer’s status as a 34 Act reporting company. after 1 year QIBs can sell outside the loop and into open market? f) This along with reg S are principle offerings for outside US. under Reg D) an unlimited dollar amount of securities for immediate resale to qualified institutional buyers who then are able to resell at any time in an active trading market within closed loop of QIBs c) Securities are “restricted” but can still resell within this closed loop d) makes these securities very liquid (unregistered to instantaneous) e) Good thing: if co is doing 144A offering of securities in a a US reporting co. Statutory structure a) Rule 901: sets out general stmt of the reg. PORTAL a) At same time adopted 144A. . the sale is made in. b) Allows companies to sell to UWs w/out registration (i. 1) Rule 902 defines as a transaction in which the buyer is outside the US at the time the buy order is placed. 903(b)(1) 1) If there is no substantial US market interest in the securities or foreign issuer that direct their offering to residents of a single country. on or through a physical trading floor of an established foreign securities exchange or 3) For the purposes of 904 (resale safe harbor).foreign issuers without substantial US market interest. depending on: (a) the nature of the securities offered. W/O REGISTRATION 1.

e. v.e. Purchasers deserved protection and info of registration. factors of the purchaser’s circumstances when he purchased the shares and b. (b) A person who purchases securities in a private placement and then resells in a public trading market is an UW if she purchased “with a view” to resell to public (view to distribution)51 2) Disposition of a security must be “for value” (i. granted not exempted how could they violate § 5 of did not offer to sell (they did) (i) § 2(a)(3) definition of offer includes solicitation of an offer to buy 3) Participating in offer or sale for issuer in connection with distribution (a) Can include director’s officer’s and promoters who have actively promoted an unregistered security. (b) UW retained to do due diligence on offering of another I-Bank’s securities was held to fall within the participates language of §2(a)(11) b/c it is broad enough to encompass all persons who engage in steps necessary to the dist of securities b) PURCHASER FROM ISSUER WITH A VIEW TO THE DISTRIBUTION: 1) Those who purchase from an issuer “with a view to the distribution of securities” (a) I. it is not necessary that the agent be compensated or that the issuer knows about the agent or authorizes the solicitation (d) Haft. in underwriting syndicate d) Participants in the underwriting purchase e) See also Control person rules THREE IMPORANT CATEGORIES OF UWS UNDER 4(1) a) Agent for issuer: Offers or Sales for issuer: Those who offer or sell “for an issuer” in connection with dist 1) I. c) Underwriters of underwriter: ie. illegal under § 5 of Securities Act.S. Molly Goldberg can sell b/c ordinary trading transaction but control persons cannot sell w/out registration b/c of their status offense (iii) U. Sherwood: (1) presumption in favor of investment if held for more than two years (2) Presumption in favor of distribution if share have been held for less than two years. giving unregistered securities to school as endowment makes the school a purchaser”).4.e. and person appeals without specific authorization by govt. 51 They act as a link in the chain of transactions through which securities move from an issuer to the public. newspaper ads. 3) Definition of a with a view to distribution (investment intent): With a view to security’s distribution suggest that a UWs status is assumed by one who acquired an unregistered sec for other than long term investment (a) Holding period: (i) holding period of two years establishes presumption of investment intent (ii) After two years. (c) Rule: to be considered an agent of the issuer. investment banker in a firm commitment UW that purchases from an issuer and resells its allotment to retail dealers or directly to investors. 2(a)(11) covers these continual solicitations which lead to distribution of unregistered securities. a change in circumstances after their purchase must negate any intent to distribute 5. whether or not issuer authorized or compensated the selling activities. Chinese Consolidated Benevolent Society (a) not for profit group of Chinese-Americans sought to encourage the purchase of China bonds through mass meetings. a. investment banker in best efforts offering. had no contractual relationship with the Chinese government and never charged purchaser or any corp (b) Holding: these activities by the association constituted transactions by an underwriter and. Committee acted on requests by purchasers. So who is an underwriter under language? a) Ordinary underwriter who for a commission promises to see that an issue is sold b) Underwriter that purchases issue outright and then sells. who for a fee entices investors who then purchase directly from the issuer 2) SEC v. because the bonds were not registered. Even if not UW this was an issuer transaction and Society participated. .

(f) is broker transactions. or any number of shares for an amount greater than $10K must file with SEC an notice. Wolson) Note: Can also have issuer register shares through piggybacking or demand rights (see E&E 239) SEE ALSO PROBLEMS 6-11 – 6-23 page 367 Securities week 8 SEE problem C sprats outline page 64 . OVERVIEW OF TRANSACTIONS EXEMPTED FROM SECTION 5 BECAUSE DO NOT INVOLVE “ISSUER.4) This means a transaction would be outside 144 (a) to privately negotiated transactions not involving a broker (b) where buyer’s interests were solicited by the broker (c) if seller’s adviser negotiated the same and received a substantial fee for her services greater than customary commission (d) Why have this provision? (i) underwriting necessarily requires promotion. (f) and (h)) as long as holder is not an affiliate or hasn’t been an affiliate for 3 months prior to the sale and two years have passed since the securities were acquired. UW. f) 4. e) Notice of intent to sell (Rule 144(h)) 1) Seller who intends to sell more than 500 shares. (h) is notice 4) This is really for venture capitalists so they are not locked into their securities for long time subject to limitations of the rule. want ordinary trading transactions. (e). DEALER a) Holders of restricted securities who wish to sell w/out registration 1) Wait till securities have come to rest (holding period – no view to dist???) – uncertain 2) Comply with rule 144 – safe harbor for secondary distributions 3) Avoid distribution and sell in non-public transaction b) Control persons who wish to sell w/out registrations 1) Claim that isolated sales into pub market are not distributions – dangerous 2) Comply with rule 144 3) Avoid using UW by selling in non-public transaction or even by selling directly on their own (cf. 3) (e) is sale limitations. Exemption from requirements for nonaffiliates/noncontrol persons (Rule 144(k)) 1) RESTRICTED SECURITIES and NON CONTROL ONLY!!!!!! 2) Restricted securities may be sold without complying with any of the requirements (Rule 144 (c). Want to make sure don’t have this promotional hype.

(a) Unless sole purpose of transaction is change in domicile. consolidations. must be registered and that transfer limitations must be placed on the stock received by certain SH of acquired or recapitalized corp. that involves the substitution or exchange of one security for another is subject to Rule 145. Requires detailed info about the proposed transaction. b) Transactions covered 1) General: Makes it clear that proposals for certain business transactions that require the approval of SH of the selling company are offers under the 33 Act and that consummation of such transfers is a sale under that Act. The good news is that Form S-4 includes proxy disclosure. or change in par value. They typically include notice of proposed action or notice of a meeting of sh and Rule 135 stuff. previously exempted from § 5 by rule 133. (b) Delivery of prospectus: a prospectus must be given to all those who are security holders of record in the acquired company in a rule 145 transaction and who are entitled to vote on the proposed transaction. sh of acquired corp receive a combined proxy stmt/ prospectus on Form S-4. 3) Mergers or consolidations: Rule 145 applies to statutory merger. (SEC saw this as similar to spinoff) . M&A OF ASSETS Generally a) Business combinations and recaps trigger § 5 concerns whenever they involve the issuance of securities b) Former rule 133 provided that securities issued pursuant to a combination structured as mergers or purchase of assets were beyond § 5 b/c the submission to acquisition by SH vote was deemed not to involve a sale of acquiring corp’s shares (haft says was idiot rule because was offer of acquiring cos stock and SHs needed info) c) Today Rule 145 extended reg reach of § 5 when securities are issued in connection with business combinations (mergers. 2) Reclassification: any reclassification of securities. d) UWs in Rule 145 transaction: Rule 145 affiliates “persons deemed to be engaged in distribution” (145(c)) 1) Control persons of the acquired corp prior to the transaction covered by Rule 145 are deemed to be UWs when publicly offer securities received from acquiring corp and as such are restricted in subsequent transfers of the securities they receive in a Rule 145 transaction (a) The UW status applies even though after the acquisition the holder is not a control person of the acquired or recap corp. 3) Unique aspect 145 affiliates: is it treats control persons of in the acquired or recapitalized corp UWs who have to follow resale restrictions in the rule. 2. reclassifications. RULE 145: RECLASSIFICATIONS OF SECURITIES. (a) Form of registration: Form S-4 is the proper registration form to be used in rule 145 transactions. 4) Transfer of Assets: A transfer of assets by one corp to another is subject to Rule 145 if: (a) Plan calls for dissolution of target corp (b) Plan calls for pro rata distribution of the exchanged securities (c) The BOD of corp adopts resolutions relative to dissolution or distribution within one year after the taking of such vote or consent (d) Subsequent dissolution or distribution is part of the pre-existing plan for distribution c) Registration under rule 145 1) SEC has provided a form for registration of securities issued in business combination transactions. (i) Proxy info: Statutory merger and acquisition of assets requires the shareholders of a target company to vote which means a proxy statement that contains full disclosure is needed. These communications are listed in Rule 145(b). (145(c)) Provisions: a) Rule 145 provides that securities issued in certain corporate reorganizations. 2) Communications not subject to prospectus requirement: certain written communications made to Sh of the selling company are not deemed to be a prospectus or offer to sell. 2. Also requires info about the acquiring company and acquired. (b) Why? Prevent abuses that may occur when controlling person of target co tries to resell the securities of the acquiring corp. acquiring corp that is offering securities to acquired corp SHs is required to register absent exemption 2) 3(a)(9) only applies to SHs of issuer so 3(a)(10) may apply. and asset acquisitions) unless there is an exemption 1) Now in merger or acquisition of assets. or 1 company.D. or similar acquisitions of one corp by another. consolidation. in which shares held by A’s security holders will become exchanged for shares of B. Generally. Level of detail depends on whether each company would be a S-3. other than a stock split. 1. reverse stock split.

which demands that management must disclose risks or trends.not rendered false when world turns otherwise c) Duty to UPDATE: Cases indicate Split: statement is true and correct when issued and subsequent events make it materially misleading or false. not merely when the information completely negates the public statements b) Gallagher v. but courts hold liable. Quaker Oats) 4) Times when CLEARLY have to update: Offering of securities (a) Rule 10b-5 at a minimum does impose duty to keep information in prospectus or private offering Memo fresh during offering of securities 5) Haft on Duty to update (a) Duty to update is beyond materiality b/c would have to update everything (b) Need very Stringent Bright line Rule (highly material special significance) (c) You can only stay silent 90 days due to quarterly filing but 8K makes it 30 days (i) Form 8K needs to be filed monthly if there is a triggering event and SEC expanded the list d) Duty To CORRECT 1) Duty to correct statements materially57 false when issued and company discovers falsity subsequent 2) False statements by 3rd parties: (a) No duty to correct false statements made by 3rd parties unless company is entangled with the 3rd statement in which event you need to correct or are liable (i) Company reviews research reports by analysts and revises parts of it – it adopts it (ii) Company distributes false reports (iii) Hyperlink to website (even if put blanket warning about statements by third parties) (b) In a way this is aiding and abetting. Duff) May also have affirmative disclosure obligations under listing standards 1) NYSE states that a listed co is expected to release quickly to public any news which might affect market for sec – These laws have not teeth f) 57 When addressing duty to update or correct IT MUST BE MATERIAL – DON’T FORGET THIS ON TEST . Abott Laboratories: No Duty to update continuously 1) Abott received letter from FDA insisting on penalties but Abott did not disclose to public until it was in compliance and settling. Ps said that Abott had absolute duty to disclose all information material to stock price as soon as it became available. Ps point to Item 303 of Reg SK. 2) Held: No general duty to update continuously (a) § 13 requires issuer to file annual and periodic reports not continuing disclosure (need not update form 10K or disclose regulatory issues in 10Q) (b) There is only a duty to correct statements that were incorrect when made and nothing in report was so requiring a running narrative would be updating not correction (c) See Also example on no duty to correct projections -.(b) Did not need to disclose the problems with strategic alliance because statements suggested hope that would find partners so not definitive projections that need later correcting (c) Had duty to update when company began to seriously consider alternative method of financing that was would place the alliance under different light 3) Rule: a duty to disclose (update) whenever secret information renders prior public statements materially misleading. e) Duty to disclose may exist if have some pre-existing fiduciary relationship 1) Normally silence is not actionable under rule 10b-5 2) Bank as transfer agent for SHs corp had a relationship of trust that compelled it to speak fully about selling options (Affiliated Ute) 3) A duty to speak arises when a closely held corp deals with SH employees (Jordan v. it assumes duty to revise or update if the forward looking statement is “still alive” in marketplace and has became inaccurate– still being relied upon (b) Some limit to statements of important company policy (i) Duty to update alternative method financing (Time Warner) (ii) Company stated its policy to maintain stable debt to equity ration came under duty to disclose negotiations of merger that would have added significant new debt (Weiner v. 1) Mere possession of non-public information by an issuer by itself does not give rise to a duty to update 2) Some statements that become inaccurate b/c of subsequent events courts require update (Time) 3) Possible duty to update if statement remains alive (a) Some courts hold that even when statement is true when released. it had duty to update/correct the 10K when later got the letter. and though 10K did say Abott had been subject of regulation.

some of whom sold their holdings. children and siblings (unless show that under this relationship no duty of trust or confidence existed) The Role of disclosure: Forecloses liability b/c only secretive breaches are violations 1) If Fiduciary discloses to the source of the information that he plans on trading on the information. there is no deceptive device and thus no §10b liability 2) This means the source of the information can authorize it or can just tell that they are trading 3) May be liable under state law 4) Policy Concerns: why look to relationship with employer and employee (a) Limits to secretive breaches Not sensible given basic purposes of the insider trading prohibition because definitions of wrongfulness rest on purely private considerations that have nothing to do with the harm to the investor but to the party from which the info was obtained (b) This is just criminalizing private info f) 8. parents. 1) Once substantial step toward a tender offer made. c) No reference to breach of fiduciary duty: 1) O’Hagan held that SEC did not exceed its rulemaking authority by adopting rule 14e-3(a). tipped Dirks that the corporations overstated its assets. which proscribes trading on undisclosed information in the tender offer setting. O’Hagan 1) O’Hagan was a partner in a law firm. Held: In the absence of a breach by tippers (who received no monetary or personal gain) there was no derivative breach by dirks: 2) Dissent: gain to tipper is irrelevant. Ohagan did not work on the deal. & violation for fraudulent trading in connection with a tender offer of 14(e). 2) It is a fraudulent deceptive or manipulative act for any person who is in possession of material info relating to the tender offer to purchase or sell any of the target’s securities if the person knows or has reason to know that the information is: (a) Is nonpublic and (b) was acquired from the bidder. he uses the information to purchase or sell (deception through non disclosure is central to this theory) (b) this is so even though the person the missappropriator defrauds is not the party with whom the miss trades but. Dirks discussed the info he obtained with a number of clients and investors. non pub info from spouse. O’Hagan began buying call options for Pillsbury (not the clients stock but the bidders so not temp insider). He was charged with violations of 10b. retained counsel etc. 3) Rules: (a) No general duty to disclose before trading on material nonpublic information (Mere possession not enough . Sec: tippee liability 1) Secrist. While investigating. but is instead the source of the info – he gains his unfair advantage through deception (c) 10b-5 requires deception “in connection with” not deception of an identified purchaser or seller 4) Rules From O’hagan (a) A person who trades in securities for personal profit. using confidential information misappropriated in breach of fiduciary duty to the source of the information is guilty of violating § 10(b) and Rule 10b-5. Grand Met retained the firm as counsel regarding a potential tender offer of Pillsbury (both parties took precautions for confidentiality). a) Dirks v.d) United States v. e) Rule 10b5-2 sets out 3 nonexclusive situations in which a person has a duty of trust for miss 1) Agrees to maintain information in confidence 2) History or pattern or practice of sharing confidences 3) When receives or obtains material. or any person associated with either one of these b) anti-tipping provision 1) bars the communication of material nonpublic information concerning a tender offer to persons where it is reasonably foreseeable that such communication is likely to result in unlawful trading. 2) Deceptive device: (a) missappropriator deceives the source of the info by feigning loyalty while secretly converting to personal use (disclosure makes for no deceptive device) 3) “in connection with sale of security”: (a) fraud consummate not when acquires. TIPPERS AND TIPPEE LIABILITY 9. RULE 14E-3 a) SEC’s response to Chirarella—makes conduct in Chiarella a violation of the Williams Act b/c most prevalent and profitable form of insider trading. the target. even in the absence of a duty to disclose d) Substantial step: having meetings with target. SEC said he aided and abetted violation of Rule 10b-5. look to consequence on the shareholder. but when without disclosure to his source.

(2) Broker dealers may not recommend securities without having an adequate basis for their recs. EX: high risk options trading is unsuitable for retired school teacher looking for “safe” investment (2) In the end case may depend on how extreme the facts are. (3) Failure to investigate and subsequent recommendation becomes a fraud (ii) Hanley v. (4) Other notes a. including ability to asses risk . He must disclose facts which he knows and those which are reasonably ascertainable. Held that by his recommendation. and needs. just a breach of trust to customer since antirfraud provisions cover only misrepresentations (not unfair conduct) made intentionally (not negligently) c) Fictional Judicial interpretation filled in the gap to find fiduciary duties between BDs and custoemrs d) Two lines of authority 1) Some courts apply traditional fiduciary principles so that breach of duty acts as fraud on the customer– though much confusion over this 2) All lower fed courts have accepted the Shingle Theory to find a fraud that permits SEC to impose sanctions and gives a rise to PRA under 10b-5 e) SPECIFIC RULE 10B-5 THEORY: THE SHINGLE THEORY 1) Generally (a) Under theory courts have assumed that a broker dealer who engages in a securities business hangs out a shingle impliedly representing that he will deal fairly. trading purpose. and the nature of the securities they recommend. and customers place their confidence in this implied representation.2. cannot recommend a security unless there is an adequate and reasonable basis for such recommendation. SEC : (1) BD recommended security of co that was insolvent. and any breach of that duty can easily be deemed fraudulent since it involves an implied representation (c) Implied representation to deal fairly is different from disclosure – not like 33 Act and need more than disclosure although disclosure may cure some violations. Made recommendations after friend mentioned it to him + gave him confidential report about license acquisition + confirmed by co president + really strong affirmative represenations like “this is a winner” (2) Court used the duties outlined under the shingle theory to hold the broker dealer liable for fraud. See 17. the applicability of 10b-5 is clear. a.4 (d) Scienter: Rule 10b-5 requires scienter which is evil intent/recklessness and Sct seems to think disclosure is enough so we will see when they rule on Shingle theory – we have seen them overrule longstanding rules (e) Reliance: Relationship itself creates reliance but courts reluctant when sophisticated (Banca) 2) Specific Duties which are under Rubric of Shingle Theory. he implied that he conducted a reasonable investigation when he did not. risks. THE SHINGLE THEORY AND FIDUCIARY OBLIGATIONS a) When Broker actually lies to customer about a particular fact.15 (iii) Nature of the investigation: (1) Not full due diligence but Cannot rely blindly on statements by managers (b) FORSAKE THE UNSUITABLE & KNOW THY CUSTOMER: PRA AVAILABLE (i) Generally (1) As part of knowing their customer and the securities they recommend broker dealers must have reasonable grounds for believing a particular securities transaction is suitable for a particular customer given his financial situation. he implies that a reasonable investigation has been made. (3) Duty to Investigate a. Notes that private actions probably could not be brought under the shingle theory b. and competently with his customers. which is under Rule 10b-5 (a) KNOW THY SECURITY: DUTY TO INVESTIGATE OR BECOMES FRAUD: NO PRA UNDER THIS DUTY (i) Generally (1) Broker dealers must investigate the issuer and the terms. honestly. See problem 7. Stocks were OTC so info not readily available so higher duty possibly c. (b) theory creates a duty of fear dealing. fraudulently inducing a purchase or sale in order to generate commission. By his recommendation. b. b) Not so clear when there is not an obvious form of deceit.

SEC said they had duty to squeal to SEC – Court said nothing on this ii. IN RE CARTER AND JOHNSONS. they were required to speak out at the closing concerning the obvious materiality of the info and require that merger not be closed until the adjustments were disclosed and SHs were re-solicited. we would have over-disclosure that would result in excessive costs etc --. Resigning e. Approaching outside directors iii. SEC did not levy highest penalty which is permanent disbarment 2. Haft: The standard is not negligence. Lawyers failed to object when client gave its sh overstated projections. faced with illegal nondisclosure by a client. e. National Student Marketing and In re Carter Johnson SEC V. According to SEC. Court noted premature resignation does not serve the end of effective lawyer-client relationship and that lawyer’s continued involvement will best lead to corrective action (as long as laywer acts in good faith and is not co-opted. No duty to undo merger after it was closed – beyond scope of sec laws v. In Sum: Counsel had a duty to the interstate SHs to delay the closing of the merger pending disclosure and resolicitation with corrected financials. Note on resignation i.these steps includes: i. though advised to disclose. Elements of Aiding and Abetting: i. But best result is not possible in every situation and there may be a situation where conduct is so irretrievable that lawyer must resign. abets the nondisclosure if he does not act to stop it. Ds need to provide knowing substantial assistance to the violation: c. Ds need to be generally aware of the fraudulent activity iii. Silence was not only a breach of this duty to speak. if have bad client. Rule: An attorney.lawyers are paid well to balance not to be wimps. d. SEC has often taken the position that Sec lawyers have a special responsibility to the public and that a lawyer who knowingly assists a client in a securities fraud becomes subject to civil and criminal aiding and abetting liability – Two leading cases are SEC v. Approaching the BOD or other senior mgmt ii. but also lent legitimacy to the closing d. b. it is recklessness – if not. c. GENERALLY: a. For such aiding and abetting to occur there must be intent on the part of the attorney to intend to aid the violation through action or inaction in conscious disregard to an attorney’s ethical obligations with respect to disclosure. SEC THIS WAS COMMISSIONS APPROACH BEFORE § 205 a. NATIONAL STUDENT MARKETING CORP a. 3. Court required them to take steps to ensure that the info would be disclosed to the SHs – At the very least. There needs to be a primary violation ii. ii. The SEC concluded that a lawyer who is aware that her client is engaged in the substantial and continuing failure to meet disclosure requirements violates professional standards if she does not take prompt steps to end the client’s non-compliance. must take more steps then just counseling to disclose -. SEC Wanted court to go further i. SEC said they had duty to inform SHs – Court did not require this iii. . Several lawyers were found guilt of aiding and abetting violations of 10(b). Rule 10b-5 and § 17(a) who allowed a merger to go forward after the accountants had told the lawyers that the proxy statement for the merger contained misleading financial information (law firm was vicariously liable) b. Held: Silence constituted substantial assistance so they aided and abetted violation. i. SEC said: faulted the lawyers for not ensuring that their disclosure advice was not followed and for failing to investigate troubling information. Facts: two partners of law firm assisted a financially strapped client to negotiate a loan agreement. Courts willing to consider inaction as a form of substantial assistance when the accused aider and abettor had a duty to disclose ii. and that breach of duty constituted a violation of the antifraud provisions through aiding and abetting the merger transaction. iii. SEC said lawyers for both companies had duty to withdraw their opinions – Court did not hold on this basis and said opinion did not substantially assist since both sides knew of the problems iv. iii.DUTIES OF SECURITIES LAWYERS 1.