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Buckham, Brian R.

Securities Outline (Spring 2005) -- Professor Macdonald
Brian Buckham

Section 1 – Introduction to Securities

I.

The Framework of Securities Regulation
A.

B.

C.

Introduction
1.
Business Associations v. Securities
a)
BA = formation and management of various business entities.
b)
Securities = capital raising and trading.
2.
Value of a Security – the ―Information Problem‖
a)
A security is worthless, except to the extent that it represents an ownership interest in something else or an
obligation.
(i)
This makes it a perfect breeding ground for fraud.
3.
Dual Focus of Securities Law:
a)
Disclosure
(i)
Must occur before the issuer can sell the securities to the investor. Tries to prevent people from
investing in things they do not know about.
b)
Anti-Fraud
(i)
Provides remedies after-the-fact.
4.
Closely Held v. Publicly Held Businesses
a)
Closely Held = the same people that own the business run the business.
(i)
Have an identity between ownership and management.
b)
Publicly Held = the people that own the business do not run the business.
(i)
Have a separation between ownership and management.
(ii)
Ownership is commonly very diffuse.
Issuer and Trading Transactions in Securities
1.
Generally
a)
Securities are bought and sold in two principle settings: issuer and trading transactions. The federal securities
laws are structured differently for each of the two settings.
b)
The mechanics, practices, and rules for disclosure, as well as other activities, differ significantly for primary
distributions (issuer transactions) and trading transactions.
2.
Issuer Transactions
a)
Issuer transactions = those involving the sale of securities by the issuer to investors.
(i)
This is the means by which the company raises capital.
(ii)
Most expeditious form is the private placement, where the issuer sells directly to a select number of
investors. On the other end of the spectrum, a primary distribution is a public offering to a large
number of diverse investors (IPO).
3.
Trading Transactions
a)
Trading transactions = the purchasing and selling of outstanding securities among investors.
(i)
Can be either privately negotiated or occur through public markets.
(ii)
Secondary distribution = a sale of a large amount of securities by an individual, large enough to
support a secondary public offering.
(a)
Most frequently occurs when someone who controls much of the issuer corporation
wishes to sell some of his shares.
b)
Securities Markets = the facilities through which outstanding securities are publicly traded.
(i)
Can be roughly divided between bond, equity market, and derivative/option markets.
Legal Framework of Securities Laws and Regulation
1.
Note on the “Revolving Door”
a)
―Revolving Door‖ concept – the regulators and the regulated companies involve persons who go back and forth
between industry and government regulatory positions  Ex: CEO of Freightliner becomes Head of Dept. of
Transportation.
(i)
Part of the rationale is that we want experts in these positions.
2.
Federal Securities Laws
a)
Securities Act of 1933 (“Securities Act”)
(i)
Enacted in response to the market collapse of October 1929.
(ii)
Regulates the public offering and sale of securities in interstate commerce. The Act’s
disclosure demands apply to public offerings of securities that occur through the process of
“registering” such an offering with the SEC.
(iii)
Requires the preparation of a registration statement to assure full and fair disclosure.
(a)
The Registration Statement
i
Contents of the statement are industry-specific and spelled out by regulation, but
must generally contain a thorough description of the issuer’s business, property,
and management. Must disclose extensive financial information, and provide a
management analysis and review. Must disclose the rights, privileges, and
preferences of the security, as well as the existing capital structure. Must disclose
any risks.

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Buckham, Brian R.

The information filed by an ―unseasoned‖ issuer with the SEC
undergoes several drafts and reviews under the demanding eye of the
SEC’s Corporate Finance staff.
ii
Most of the registration statement’s substantive information is also required to be
disclosed in the prospectus.
(b)
The underwriter’s selling efforts cannot commence until the registration statement has
been filed with the SEC, and no sales or deliveries of securities may occur until the
registration statement is effective.
(iv)
Exemptions from Registration
(a)
Section 3 of the ’33 Act exempts numerous categories of securities from the Act’s
registration requirements. Section 4 exempts certain types of transactions.
(v)
The ’33 Act provides both public and private remedies to ensure compliance.
Securities Exchange Act of 1934 (“Exchange Act”)
(i)
Generally
(a)
The Exchange Act is in large part a laundry list of problems with the markets at the time
it was enacted. Congress, through Section 4 of the Exchange Act, created the SEC and
delegated to it the task of grappling with the listed problem areas. This makes the
regulations to the ’34 Act very important.
(ii)
Continuous Disclosure Provisions
(a)
While the Securities Act deals with protecting investors in primary distributions, the
Exchange Act’s concern is trading markets and their participants.
(b)
Three categories of companies subject to the 34 Act’s continuous disclosure requirements
(called ―Reporting Companies‖):
i
Companies that have a class of securities listed on a national exchange (§12(b));
ii
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 12g-1); and
iii
Companies that have filed a ’33 Act registration statement that has become
effective.
(c)
Reporting companies are required to register with the SEC and make timely filings of the
reports required by Section 13 of the ’34 Act.
i
Unlike the ’33 Act, the disclosures under the ’34 Act need not be sent to the
investors or market professionals. Filing w/ the SEC is done electronically or via
physical delivery in electronic form.
ii
Reports: 10-K, 10-Q, 8-K, etc.
iii
―Integrated disclosure‖ for established, large companies:
(a)
Certain companies registering securities under the ’33 Act can fulfill
many of the ’33 Act requirements by incorporating into the ’33 Act
registration statement information from their ’34 Act (e.g., 10-K)
filings.
(i)
Reduces the cost and delay that accompanies registering
securities.
(d)
The ’34 Act also imposes rules on full and fair disclosure when the company solicits their
stockholder’s proxies. Also imposes, through the Williams Act Amendments, rules
regarding disclosure in tender offers when an outsider acquired more than 5% of a class
of registered equity securities.
(iii)
Regulation of Exchanges, Broker-Dealers, and Market Abuses
(a)
The Exchange Act arms the SEC with the ability to oversee SRO’s and gives the SEC
antifraud and anti-manipulation protection abilities, through both public and private
enforcement.
Sarbanes-Oxley Act of 2002
(i)
Generally
(a)
SOX sets forth broad prescriptions for corporate governance, authorizes the SEC to
develop rules for professional conduct for lawyers, and regulates areas that have always
been the province of the states, such as loans to officers and directors, among other areas.
(b)
SOX does not change the core features of the securities laws, but SOX introduces
important procedural and substantive requirements for public companies as additional
safeguards to protect investors.
(a)

b)

c)

d)

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Regulation of Investment Advisors and Investment Companies [Not discussed in class]
(i)
The Investment Company Act
(a)
Investment Company = a company formed for the purpose of buying, selling, and holding a portfolio
of securities for investment, rather than for control purposes.
i
Common versions are money market funds and mutual funds.
(b)
The Investment Company Act regulates the independence of the company’s board of directors,
requires annual review of management contracts between the investment company and its
investment advisor, places conditions on certain internal transactions upon approval by the SEC, and
regulates the capital structure of the company.
(ii)
Investment Advisers Act of 1940
(a)
Investment Advisor = one engaged in the business of rendering investment advice to others for
compensation.

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(b)

3.

4.

Buckham, Brian R.
Investment Advisers Act of 1940 requires advisors to register with the SEC, establishes a few
minimum requirements for fair dealings by investment advisors, and prohibits fraudulent or
deceptive practices by investment advisors.

e)

Organizational Structure of the SEC
(i)
Generally
(a)
SEC is an independent, nonpartisan agency created by the ’34 Act.
i
Note: the ’33 Act, until the creation of the SEC under the ’34 Act, was
administered by the FTC.
(b)
SEC is composed of 5 commissioners appointed by the President, on staggered terms of 5
years, and not more than three can be from the same party as the President.
(c)
Generally get high marks for a government agency. Seems fairly balanced between
needs of investors on one hand and corporations on the other. But…
(ii)
Criticisms of the SEC:
(a)
’33 and ’34 Acts are substantially unchanged since originally promulgated. Some argue
that the system is overkill. They are still reacting to 1929.
(b)
SEC has a disinclination to adopt bright-line rules.
i
But this makes sense because people will find ways around bright-line rules. The
SEC does not want a lot of bright line rules, so it can keep the ability to go after
new schemes that people develop.
(c)
The SEC policymaking role is dominated by lawyers.
i
But it probably should be this way.
(iii)
SEC operates through 4 principal divisions: Division of Corporate Finance; Division of Market
Regulation; Division of Investment Management; Enforcement Division.

f)

Mediums of Action by SEC
(i)
Mechanisms to Act:
(a)
Rulemaking
(b)
Releases accompanying proposals to rulemaking
(c)
Enforcement actions
(d)
Amicus briefs filed in certain litigation
(e)
No-action letters
i
SEC staff responses to individual inquiries regarding the staff’s interpretation of the federal
securities laws’ application to a specific transaction.
ii
Called a ―no action letter‖ because in a favorable response toe staff states it will
―recommend no action to the Commission‖ if the transaction is carried out as stated.
iii
Are NOT the official view of the SEC. 17 CFR §202.1(d). But, the SEC will not challenge
the transaction as a violation of the law. Securities Act Release No. 4553 (1962).
Nonetheless, a no-action letter is not binding on private parties, who can challenge the
action. The SEC can reconsider its position on the no-action letter, and the no-action letters
are not judicially reviewable because they are not ―orders‖ of the Commission.
iv
SEC refuses to provide no-action letters in certain areas. Securities Act Release No.
6253(1980).
v
No-action letters are not binding on the courts, and it does not prevent a private litigant
from suing.

Blue Sky Laws
a)
Blue sky laws are state securities laws.
(i)
The Uniform Securities Act was used by 39 states in enacting their state securities laws, but states
vary widely in their deviations.
b)
Blue sky laws focus on the ―Merit‖ of the Investment
(i)
The SEC doesn’t care much about the merit of the investment. If it is a bad investment idea, it is
irrelevant to the SEC, so long as it is disclosed.
(ii)
By contrast, most blue sky laws embrace some form of merit review, looking at whether to qualify a
security based on the substantive merits of the offering, rather than basing it on full disclosure.
c)
Federal Exemption of Some State Law Areas
(i)
In 1996, Congress amended Section 18 of the Securities Act to exempt from the states’ registration
procedures several categories of securities, called ―covered securities,‖ including those that are or
will be listed on the NYSE, American Stock Exchange, or NASDAQ. As a result of the legislation,
the power of the states to compel registration of offerings is largely restricted to relatively small
offerings that are not made to sophisticated investors.
Self-Regulatory Organizations
a)
Generally
(i)
SROs are industry-sponsored groups.
(ii)
Gov’t delegates some of the functions that the gov’t could be doing to an SRO. SEC delegates a
portion of its responsibilities to these SROs.
(a)
These SROs also have regulatory responsibilities.
(b)
Problem w/ Delegation to SROs:
i
By delegating responsibilities, the voters do not control and the SRO is not
accountable.
ii
On the other hand, the SROs have expertise.
(iii)
The SEC has been willing to defer to SROs in many subject areas, and especially in the development
of procedures for the functioning of securities markets.

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Buckham, Brian R.

b)

5.

Four Types of SROs:
(i)
National securities exchanges (NYSE, AMEX)
(a)
Section 5 of the Exchange Act requires all exchanges to register as ―national securities
exchanges.‖ The national securities exchanges must also satisfy Section 6 regarding fair
dealing to protect investors.
(ii)
National securities association (NASD)
(a)
Section 15A of the Exchange Act requires creation of a national securities association to
prevent fraudulent and manipulative acts among over-the-counter brokers.
(b)
The NASD is the only such association, and it operates the NASDAQ, an OTC exchange.
(iii)
Registered clearing agencies, and
(iv)
Municipal Securities Rulemaking Board (MSRB)
Liability for Securities Acts Violations
a)
’33 Act imposes strict liability on issuers (the company itself) in shareholder suits based on misrepresentations
in a registration statement. The remedy is rescission of the transaction.
(i)
The individuals involved (officers, directors, underwriters, lawyers), however, are NOT strictly
liable – they have a due diligence defense.
b)
’34 Act imposes liability only for intentional or reckless conduct.

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Buckham, Brian R.

Section 2 – Definition of a “Security”

I.

The Definition of a Security
A.

Introduction
1.
If it is not a ―security,‖ then the impact is to alleviate the burden of many regulations.
2.
If it is found to be a security, failure to register the security gives the investors a potent weapon, in that the investors
have the right to rescission of the transaction! The regulations also provide private causes of action for violations of the
regulations, such as fraud.
a)
Generally it is a private litigant that brings the suit claiming it was a ―security.‖ P uses this in hope of
recovering capital invested in a bad business deal or as a defense asserting the invalidity of a contractual
obligation to pay money.
b)
The remedy of rescission is likely to lead the company to insolvency and bankruptcy. The company is
incapable of giving back the money they raised because they likely invested it in their operations.
c)
Used For Fraud
(i)
The reason why plaintiffs (investors) want to use the securities laws for fraud instead of common
law remedies is that the securities laws are much more plaintiff-friendly.
3.
Two Ways to Avoid Registration:
a)
Structure the deal so it does not involve ―securities.‖
b)
Fit into one of the exemptions under the ’33 Act.
(i)
Of course, the issuer is still not exempt from anti-fraud provisions of the Act.

B.

Definition of “Security” in the ’33 and ’34 Acts
1.
Definition of ―security‖ is substantially the same in both Acts. §2 of the ’33 Act provides a laundry list of examples
such as notes, stocks, bonds, debentures, CDs, investment contracts, certificates of interest in profit sharing agreements,
and interests commonly known as securities.
a)
This leaves great room for ambiguity. What is a ―profit sharing agreement‖ or what specifically qualifies as a
―note.‖ The term ―investment contract‖ seems extremely broad.
b)
The term ―investment contract‖ has been the subject of the most debate.
2.
Intentionally Broad
a)
What Congress is trying to regulate with its definition of ―security‖ is all the various types of schemes being
used to separate people from their money. This is an infinite variety that seems to defy categorization. We
don’t want a solid definition of a security because people would engineer transactions to take advantage of such
a bright-line rule.

C.

Opting Out of Securities Treatment
1.
Should buyers and sellers be able to exempt transactions from the securities laws by opting-out via contract?
a)
§14 of the ’33 Act  any conditions, stipulation, or provision for a person buying any security which waives
compliance w/ the securities laws is void.
b)
Parties can still avoid securities laws treatment by using certain types of entities. If corporate stock, limited pship interests, and interests in manager-managed LLCs generally are securities, while general p-ship interests
and interests in member-managed LLCs generally are not securities, promoters may control application of the
securities laws through the expedient of choosing one form of association over another.
(i)
This opt-out possibility is difficult to square with the anti-waiver provisions of the securities acts.

D.

“Security” Definition in State Law
1.
States often use the ―risk capital test.‖ Some states, however, may use the Howey test.
a)
Idaho has used both in years past.
2.
The “Risk Capital” Test
a)
Risk capital is capital that gets something up and running.
b)
A security will not exist under the risk capital test unless capital provided by investors is at substantial risk
and the capital is economic capital placed subject to the risk of loss through operation of the scheme in
question.
(i)
Does NOT require a common enterprise among investors.
c)
The risk capital test is not used in federal securities law, but is employed by some states in blue sky laws.

E.

Defining an “Investment Contract”
1.
SEC v. W.J. Howey Co.
a)
Background on Howey
(i)
Involved the offering of units of a citrus grove development combined with a contract for
cultivating, marketing, and remitting the net proceeds to the investor.
(ii)
Each investor was offered both an installment land sale contract and a service contract (not all
investors entered into the service contract). The service contract gives a corporation a leasehold
interest and full and complete possession of the investor’s tract. The corporation is accountable only
for an allocation of the net profits of the entire citrus grove to the investors (a portion of the net
profits to each investor).
b)

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Definition of “Investment Contract”
(i)
Elements:
(a)
A contract, transaction, or scheme
(b)
Investment of money in a common enterprise
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2. (a) The 4th Circuit holds that a security is not present if the investors were attracted primarily by the prospect of acquiring use and not by financial returns on their investment. it fell outside the realm of a mere real estate contract because there was an arrangement where the investor expects a return and becomes a ―passive investor. but may exist when promised returns are Securities Outline 7/8/2015 1:59 PM 6 . rather than just the ultimate purchasers.‖ Two approaches are used to determine if there was a common enterprise: (a) Vertical Commonality i Emphasizes the relationship between the investors and the promoter. Consumption a) Investment – Consumption Distinction (i) Issue: (a) What result if the expected returns are not in the usual form like dividends or price appreciation.‖ It is not meant to define any of the other items listed as a security in ’33 and ’34 Acts. Howey Applies to ―Investment Contracts‖ Only (i) The definition in Howey is meant only to define an ―investment contract. Risk/Speculation is Not a Factor (Traditionally) (i) It is immaterial whether the enterprise is speculative or non-speculative or whether there is a sale of property with or without intrinsic value.). (a) Under this principle. Common Enterprise a) The Meaning of “Common Enterprise” (i) Howey requires that there be a ―common enterprise. a common enterprise may exist even though there is no pooling of investors’ funds or interests. (a) While Howey said that risk was not a factor.‖ Anytime you have a passive investor where returns are based on the efforts of others.‖ Courts are split. ii Two Approaches: (a) Strict Approach (i) Requires some risk sharing between the company and the investor. There must be a direct relationship between the success (as opposed to the efforts) of the promoter and that of the investors. Passivity is a Red Flag (i) In Howey. Offer of Components of a Security is Sufficient (i) It is enough that the promoters merely OFFER the essential ingredients of an investment contract. (United Housing Foundation v. ii Requires a pooling of investor funds. at the very least. but instead involve some other benefit derived from use or enjoyment of the underlying asset? (ii) General Rule: (a) Investment = security (b) Consumption = not a security i When a purchaser is motivated by a desire to use or consume the item purchased – ―to occupy the land or develop it themselves. Formal Certificates Not Necessary (i) It is immaterial whether the shares in the enterprise are evidenced by formal certificates or by nominal interests in the physical assets employed in the enterprise. and the Supreme Court has not resolved the question. Only a distinct minority accept broad vertical commonality. (c) (d) c) d) e) f) g) F. This is a red-flag. (ii) Strict vertical commonality is the majority rule. (ii) It is a violation of the registration provision to make an unregistered sale OR an unregistered ―offer.‖ the securities laws do NOT apply.‖ You have to look at the offerees. then there is probably a security. Brian R. (Landreth Timber Co.Buckham. subsequent courts appear to consider risk as a factor. as to what relationship is the relevant one for a ―common enterprise. Forman). The principal inquiry is whether the activities of the promoter are the controlling factor in the success or failure of the investment. Investment in an Enterprise v. (b) Horizontal Commonality i Emphasizes the common enterprise among investors/offerees. For an expectation of profits “Solely” from the efforts of others. Howey Applied 1. (b) Broad Approach (i) Courts look to the uniformity of the impact of the promoter and require only a connection (but not necessarily risk) between the efforts of the promoter and the collective successes or losses of the investors. (a) This will typically involve a pro rata distribution of profits or sharing of losses among investors.

In any event. and (v) The capacity to appreciate in value. then sold the interest). (iii) The ability to be pledged or hypothecated. a franchise should be a red flag as something to check out. Under State Securities Laws a) But. fixed rather than variable. at least one case held that a single investor is sufficient. The fact that returns are contractually guaranteed does not take them out of the realm of securities. 2. G. too. H. Requiring multiple offerees makes some sense in that we may not want securities law treatment when there is only one offeree. provided there was an original intention to involve multiple investors. and LLCs as Securities 1. and the statutes also have an anti-fraud section. nominal participation by the investor does not circumvent application of the securities laws. 3. When a franchisee is expected to work on-site as a manager. Interests in Corporations. The efforts must continue after the sale or else the element is not satisfied – the investor must be relying on the efforts of others in the future in getting the profit. because the investor’s participation is too great to be ―from the efforts of others.. b) “Solely from the Managerial Efforts of Others” (i) Generally (a) Over time. If it becomes a relationship where there are multiple offerees. (i) Calling an instrument ―stock‖ alone does not make it a security. i Examples: (a) Was a security: (i) Promoters used a pyramid scheme of selling chinchillas to persons and would then buy the offspring at inflated prices to be resold. in states that use the risk capital approach for their blue sky laws. ii The fact that investors have bargained for a return on their investment does not mean that the return is not also expected to come solely from the efforts of others. it can be a security. Brian R. (iv) The conferring of voting rights in proportion to the number of shares owned. it is clearly not a security. (b) (c) 3. a) The question is whether the franchisee is required to make significant efforts in the enterprise in order to get the expected profit. A strict approach would require more than one investor. (ii) Negotiability. Profits Solely from the Efforts of Others a) “Profits” (i) Fixed Returns Can Be ―Profits‖ (SEC v. Securities Outline 7/8/2015 1:59 PM 7 . Franchises as Securities 1. Partnerships. (a) Thus. the company found the AIDS patient. (i) But. the word ―solely‖ has been taken out of the definition. a one-on-one relationship. b) Factors of stock: (i) The right to receive dividends contingent upon an apportionment of profits. i. Edwards) (a) There is no reason to distinguish between promises of fixed returns and promises of variable returns for purposes of the Howey test.e. if the franchisee does not actively participate. The fact an investor makes some effort does not take it out of the realm of securities. it may more likely be a security because the capital was provided by the investor (franchisee) to the franchisor at substantial risk. (ii) The critical inquiry is whether the efforts made by those other than the investor are the undeniably significant ones.‖ It is a mixture of franchisee and franchisor’s efforts. (b) Generally not a security: (i) Most franchise and distributorship arrangements. Majority of franchises are not securities.e. Participation by investors is relatively large. i By ―profits. Stock as a Security a) Some types of stock are not securities. provided there is the requisite pooling of investor funds. then secured the life insurance rights and paid the AIDS patient X% of the face value of the insurance. then it invokes the securities laws.‖ the Howey court meant profits that investors seek on their investment. But. b) Some states have special sections regarding franchises in their state statutory law – they have state franchise laws that are much like securities laws and require certain disclosures to people who are going to invest in franchises.. (iii) Managerial Efforts Prior to Promotion/Sale to Investors (a) What if the ―efforts of others‖ occurred before the ―investment contract‖ was sold? i Ex: Viatical Settlements – the ―efforts of others‖ element was not satisfied when the efforts of others occurred and ended prior to the sale (i.Buckham. those essential management efforts which affect the failure or success of the enterprise.

memberships in country clubs).): (a) If a limited partner has meaningfully participated in the management of the partnership in which it has invested such that it has more than minimal control over the investment’s performance. (i) An example is the marketing of resort condos that will not be occupied by the purchasers. If the money given by the investor gives more than access to the club. it is more likely to be considered a security. Brian R. Dubois Securities Outline 7/8/2015 1:59 PM 8 . 2. 3. limited partners are often successful at claiming the interest was a security. But.Buckham. (ii) Very few cases have treated general partnership interests as securities. there is a specific unit-byunit allocation of the income to each unit owned by an investor. LLC Interests as Securities a) In evaluating whether LLC interests are investment contracts. Another red flag is marketing. rather than pooling all the income and dividing it. Real Estate as Securities 1. can transmute it into a securities transaction. Club Memberships as Securities 1. the analysis parallels that of general and limited partnerships. In a no-action letter. b) General Partnerships (Williamson v. c) Sale of a Wholly-Owned Business (i) Old Rule  Sale of all or substantially all of the stock in a closely held corporation is exempt from the securities laws. and said that this type of arrangement takes it out of the realm of securities. ii Applied the Forman factors. (a) ―X‖ is commonly such things as rent pooling agreements. a minority of courts will not look beyond that fact and will say it is not a security. This becomes a question of whether there is a common enterprise (commonality). J. some courts will look beyond the operating agreement and see how it is actually managed. ―Rotational Allocation Systems‖ a) In a ―rotational allocation system‖. b) A standard real estate transaction in the form of a sale or lease of property does NOT involve the offer of a security. but is rather seed money to get the property up and running. (ii) Landreth Timber  It may still be a security when a person sells all or substantially all of the stock of a closely held corporation. (a) Landreth eliminated the ―sale of a business doctrine. not the sale of the stock itself). whereas manager-managed LLC interets approximate limited partnerships and are thus more likely to be considered securities. 3. not just the stock (the substance was the sale of the business. 3. it is stock. X was the service contracts. (ii) If the operating agreement says the LLC is member managed.‖ whether it be a pooling agreement. it is not a security. c) Limited Partnerships (i) Given the passive investor status of limited partners. however. If it is marketed and sold as a buy now and sell higher later (like a membership to a country club that you can buy and sell) then it may be considered a security. Membership in purely social organizations or clubs are not normally construed to be ―securities‖ (e. (i) The add-on ―X. (i) Member-managed LLC interests are more likely to not be securities. 2. an investment contract may be present. etc. Citicorp. We look at substance over form. or (b) The partner or venturer is so inexperienced in business affairs that he is incapable of intelligently exercising his partnership or venture powers. service contract. the argument still exists for vertical commonality. (ii) General Rule (Steinhardt Group v. Tucker) (i) A general partnership or JV interest can be a security if the investor can establish that: (a) An agreement among the parties leaves so little power in the hands of the partner or venturer that the agreement in fact distributes power as would a limited partnership. But. the SEC distinguished these from pooling.‖ i If it has the characteristics of stock. Example Case: Hocking v. Generally a) The red flag is: Real Estate + X.. 2. When the seller offers collateral arrangements promising postacquisition income to the buyer or arrangements such as rent pooling agreements. but memberships in clubs that have some business aspect are generally held to involve the sale of securities. You are buying the whole business. This is true regardless of the form of the transaction. the issue in the partnership cases centers on the presence of an ―investment contract‖ under the Howey definition. looking at the day-to-day role of the investors in the management. I. considering that different investors are not all in the same position. In Howey.g. or (c) The partner or venturer is so dependent upon some unique entrepreneurial or managerial ability of the promoter or manager that he cannot replace the manager of the enterprise or otherwise exercise meaningful partnership or venture powers. etc. Partnership Interests as Securities a) Introduction (i) Because partnership interests are not among the items enumerated in the statutory definition of a security. (a) This was the ―sale of a business doctrine.‖ (b) It would not be treated as a securities deal.

“Consumer/Commercial” a) The dichotomy between commercial or consumer v. Weaver – Court held that a bank CD was not a security because ―holders of the bank CD are abundantly protected by the federal banking laws. In theory. the investment in the mortgages was a security. or (vii) Notes evidencing loans by commercial banks for current operations. (v) Short-term notes secured by an assignment of accounts receivable. Another court held that where the bank allowed investment in the mortgages via a broker to the general public. a) One court held that the loan participations at issue were not securities because the investors were corporate and institutional entities rather than the general public. Ask what the public would perceive about the note – did they think of it as an ―investment?‖ (d) Risk-Reducing Factors i Examine whether some factor such as the existence of another regulatory scheme significantly reduces the risk of the instrument. Generally a) The securities acts define a ―security‖ to include ―any note. consumer installment purchases.‖ But.‖ and that presumption may be rebutted only by looking at the four factors below (provided it didn’t fit into one of the Stage 1 categories). The key factor as to whether these are securities is who they are offered to. Derivative Securities and Synthetic Investments as “Securities” [Not Discussed in Class] 1. If the seller’s purpose is to raise money for the general use of the business enterprise or to finance substantial investments and the buyer is interested primarily in the profit the note is expected to generate. (p. (iv) Note evidencing a character loan to a bank customer. (ii) Four Factors: (a) Motivation for Transaction i Examine the transaction to assess the motivations that would prompt a reasonable seller and buyer to enter into it. it is not a security. and ordinary commercial financing involve securities.e. 2. (vi) Note which formalizes an open account debt incurred in the ordinary course of business. financing a house). b) Commercial Paper Exemption (i) The ’33 and ’34 Act differ slightly in their treatment of notes. but are still subject to the provisions of the ’34 Act other than the registration provisions. 3. to correct the seller’s cash-flow difficulties. This was the offering of a ―security. If the note is exchanged to facilitate the purchase and sale of minor assets or consumer good. Analysis for Whether a Note is a Security – the “Family Resemblance Test” a) Stage #1: If the transaction involves any of the following. ―unless the context otherwise requires…‖ This provides the court with the ability to say the term ―note‖ in the definition can be limited. (ii) If the note is issued in a consumer/commercial transaction (i. Notes as Securities 1.‖ (a) Common trading does not require trading on an exchange. the differing treatment means that short-term notes (< 9 months) are exempt from the ’34 Act. it looks more like a security. (i) If the note is issued in an investment context. (iii) Short-term note secured by a lien on a small business or its assets. thereby rendering the protections of the Securities Acts unnecessary. it is NOT a note (this list is growing over time): (i) Notes delivered in consumer financing. the instrument is likely a security. (b) Offer and Sale to a Broad Segment of the Public i Examine the ―plan of distribution‖ of the instrument to determine if it is an instrument for which there is ―common trading for speculation or investment. (ii) Note secured by a mortgage on a home. Securities Outline 7/8/2015 1:59 PM 9 . despite what an economic analysis suggests.Buckham. M. Generally a) Derivative = financial instruments that derive value from other assets to which their values are linked. A real estate agent in Hawaii informed P that a rental pool arrangement would be available if he bought a condo in Hawaii and leased it to tourists. ii Ex: Marine Bank v. (a) Most courts and commentators have been unwilling to conclude that transactions such as home mortgages. it is not a security. (c) Reasonable Investor Inquiry i Examine the reasonable expectations of the investing public.. ―investment‖ will often be determinative of whether it is a security or not. Banks often package mortgages and create undivided interests in a pool of mortgages and offer those publicly.‖ even where the company offering the rental pool agreement was not related to the real estate agent’s business. b) Stage #2: If the transaction is not one of the above-listed transactions. (i) ―Context Clause‖ §2(a) starts off to say. 62). courts have limited this definition. a) K. analyze the following elements: (i) Presumption (a) A note is presumed to be a ―security. Brian R. or to advance some other commercial or consumer purpose.‖ “Loan Participations” as Securities 1. L. Rule of Thumb for Notes – “Investment” v.

and other fund decisions. Introduction to Securities Markets 1. II. Citibank countered that the transactions were beyond the reach of the securities laws because it had not sold Caiola ―securities. But. b) These pass-throughs may be securities under an investment contract (Howey) or a note (Reves). etc. the activities of an intermediary in packaging financial instruments may create a security out of something that is not. how the individual notes will be serviced and managed. however. where it took a small position in the underlying Philip Morris stock. 80) (a) Caiola and Citibank entered into a synthetic transaction whereby they used an equity swap combined with synthetic options (the transactions did not involve the actual securities. and Caiola alleged violations of §10(b) and Rule 10b-5. abandoning the agreed upon delta hedging strategy. Citibank also employed a delta hedge. that gives the investor the economic equivalent of a position in a certain security or option on a security without the investor actually buying that security or option. iii It does not matter that one can distinguish between cash-settled and physically-settled options. (iii) The Commodity Futures Modernization Act (CFMA) amended the ’33 and ’34 Acts and restricts SEC jurisdiction over swaps and other derivatives.‖ (b) The Synthetic Options: i They were securities. Almost any kind of income-producing instrument can be pooled and packaged for sale as a ―pass through. Review: Markets and Their Efficiency A.Buckham.‖ (i) Ex: Many institutions will obtain mortgages. then create a pool of such mortgages. Citibank began to purchase large blocks of Philip Morris. Final Note: Macdonald’s Red Flags 1. The synthetic options were simply cash-settled over-the-counter options on Philip Morris stock and therefore are securities.). who agrees to make floating payments in return. Synthetic Transactions (i) A contractual agreement between an investor and a counterparty. (i) (ii) Options Swaps (a) (b) A negotiated arrangement between two parties in which each promises to make a payment to the other. Citibank (p. Simplest is the interest rate swap (aka ―plain vanilla‖ swap) where one party agrees to make fixedrate payments to the other party. transfer them to a trust. with the payments occurring at different times and determined under different formulas. Over time. The Structure of Trading Markets a) Exchanges v.‖ 2. (ii) Ex: Caiola v. Separate Securities and Pass-Throughs as Securities 1. They are securities because any profits realized by the investors are derived from the managerial efforts of those who run the pool and make such decisions as determining which mortgages shall be in the pool. Brian R. b) N. and cause the trust to sell undivided interests in itself to large numbers of investors. ii The term ―option‖ is not limited to conventional exchange-traded options. This caused the market price to fluctuate greatly. (c) The Equity Swap: i They were not securities. whereas the mere simulated transactions would not. O. but just simulated purchases and simulated options transactions). Four types of deals that should always be red-flags: a) Tax shelters – anything marketed and sold as a tax shelter. Generally a) A bank CD and a note issued in a consumer transaction are not securities. but an option based on the value of a security (a synthetic option) is also covered. nor that one can distinguish between options documented as swaps as opposed to some other fashion. often a bank. c) Syndications – anything marketed and sold as a real estate syndicate (multiple investors. Caiola did not want Citibank to take a larger position because it would have affected the actual trading price of the security. b) Oil and gas deals and alternative energy deals. An option on a security is clearly covered by the Act. OTC Markets (i) Exchanges Securities Outline 7/8/2015 1:59 PM 10 . d) Any get-rich-quick schemes and ―passive investments.

The policies are based on the audience. retail investors compose a very small percentage of bond trading. The Efficient Market Hypothesis 1. b) Two types of derivatives: (i) Options  rights to buy (call) or sell (put) securities from or to another person at some predetermined price or date. (b) Total bond market underwritings vastly exceeds equity underwritings. (ii) Specialists = a designated dealer in a particular stock who has an inventory in that stock. with respect to specific information. investors cannot extrapolate a security’s future price from a series of past prices. (a) But. not price. (a) ―Price and Information‖ is the relationship. Derivative Markets a) Derivatives are financial instruments whose value depends on the price of some underlying instrument. (b) Used to maintain liquidity for transactions that cannot be matched from normal market orders. Companies will work to do the least possible. Specialists are required to maintain a balance between buyers and sellers. (b) Exclusive jurisdiction over futures is given to the Commodities Futures Trading Commission. (i) A potential problem w/ globalization is that it may result in US corporations making a ―race to the bottom‖ with regard to compliance with environmental and labor regulation. (iii) Market makers = used in OTC markets. Companies seem to see some protection for themselves with increased securities regulations. not the shape of the curve from the past. which determines the price today. (iv) Broker v. Three Levels of Market Efficiency: a) Weak Form (i) Exists when security prices reflect all the information embodied in the past prices of that security. companies do not seem to react this way to increased securities regulation. (v) Bond Markets (a) Bond markets are almost exclusively an institutional market. an efficient market is the result of their collective investment decisions. (a) Thus. (i) The % of total equity held by US institutions has increased from 7% in 1950 to 50% in 2003. its heavy security regulations. 3. Dealer (a) Broker = a middleman operating as an agent for buyers and sellers. (a) Usually settled in cash rather than the underlying commodity. Securities Outline 7/8/2015 1:59 PM 11 . 2. (a) B. ii Based on volume. to the contrary. b) Semi-Strong Form (i) Exists if security prices reflect all publicly available information. (ii) We are looking at the relationship between the price of the security (and its movement over time) and the availability of information on the other. Capital seems to be attracted to the US because of.000+ shares. (ii) Futures  contracts that call for future delivery of some commodity at a fixed price and date. (ii) Given that institutions hold much of the securities. Institutionalization and Globalization a) Institutionalization = the idea that institutions are owning and trading a large percentage of securities. (i) This does not mean that everyone has the same opinion as to the price. (ii) OTC Markets (a) Involves broker-dealers and market-makers. b) Other Terms (i) ―Block trades‖ = institutional trades involving 10. (a) Used to maintain liquidity for transactions that cannot be matched from normal market orders. dealing out of their own inventory. General Thesis: a) A security’s price can be seen as being established in an efficient market if.Buckham. (a) Come into play when there are more orders to buy or more orders to sell. The transaction has to be executed at the market price. Brian R. 2. b) Globalization = technology has contributed to globalizing the capital markets. These are ―auction markets‖ because buy and sell orders are executed at a central location at the best available price. i Must take care of imbalance by buying for his own account or selling out of his own inventory. this should influence the SEC disclosure policy. but the specialist will have to sell or buy to make the transaction # of shares the same. or despite. the price that exists for the security is the same as the price it would have if everyone had the same information. (b) It assumes equality of information on both sides of the deal. b) Random Walk Theory (i) It is the information presently available. (b) Dealer = acting as a principle.

Notes on Disclosure a) A fundamental purpose of the securities acts was to substitute the philosophy of full disclosure for the philosophy of caveat emptor and thus to achieve a high standard of business ethics in the securities industry. c) If this is what people are really doing (the herd trading). Brian R. and then trickles down to the retail investors. (i) We have shifted from caveat emptor (buyer beware) to caveat vendor (seller beware).Buckham. There is also evidence supporting the proposition that publicly available information does in fact also affect investor trading. pursuing strategies based on the belief that stocks are mispriced. 5. and pursuing stocks they believe are fads or fashions.―Noise‖ a) Some theorists believe that ―noise‖ – pricing influences not associated with the rational expectations about an asset value – plays a significant role in stock market behavior. 4. This is because full and fair disclosure is the requirement. (iv) Some believe that stock trades on a herd instinct. (i) Evidence of this is in the form of market participants who behave as though securities are not efficient. b) To Whom is Disclosure Made? (i) Are we making disclosures directed to the ordinary public. b) Allocation efficiency = the allocation of resources to their best or highest use. more than efficient markets would require. Some use the ―creep-down‖ or ―filter-down‖ theory to suggest it goes first to analysts. whether that information is publicly available or not. (ii) This is where the battle-ground is today. (i) We want capital to go to relatively higher and more productive uses. (ii) Without informational efficiency. is additional evidence. or to sophisticated analysts? This determines the tone we use in the disclosures. rather than on fundamentals. (ii) Excessive trading. they is disclosure to these people a waste of time? (i) No. then investors cannot generally beat the market by examining publicly available information for determining what stocks are under or overvalued. c) Strong Form (i) Exists when security prices reflect all information. Allocation Efficiency a) Information efficiency = the speed with which market prices adjust to new information. Challenging the Efficient Market Hypothesis -. Securities Outline 7/8/2015 1:59 PM 12 . we won’t get allocational efficiency. Disclosure will not rationalize the market. We want the companies and industries that are more efficient and higher uses to get the resources. but it will add to rationalization and information-based decision-making. b) Behavioral finance has been developed to try to explain stock price movements. Not all investor trading is irrational. If this is the case. (i) Markets will be more efficient with mandated disclosure so that there is somewhat of an even informational field. (iii) Investors appear to routinely overreact and underreact to corporate announcements. Information v. (a) 3.

(b) The gross spread is composed of three parts: i The management fee charged by the underwriter. (b) Three Types: i Straight (a) There is no minimum amount that must be sold as a condition to the deal closing. ii Mini/Maxi (a) A minimum amount must be sold. Section 3 – Registration and the Public Offering I. b) Relevant Underwriting Agreements (Discussed in Detail Below) (i) Letter of Intent (ii) Underwriters Agreement (iii) Agreement Amongst Underwriters (iv) Selected Dealer Agreements (v) Standby Agreement c) Compensating Underwriters (i) The Gross Spread (a) The underwriters sell the securities to the public at a fixed public offering price. Brian R. and iii The selling concession received for any securities sold to the public by any broker-dealer participating in the distribution. Underwriting and Underwriters 1. iii All or None (a) All securities must be sold for the deal to close. (c) All members of the syndicate must sell the offered security to the public at a fixed price that is stated in the registration statement and accompanying prospectus. the bids are arrayed from highest to lowest. If the minimum is not sold. it falls within the intrastate exemption.‖ i Public pays $100  Underwriters keep $5  Issuer gets $95. or via options (―cheap stock‖). (d) Underwriters may be paid by the spread. The issuer first accepts the bid with the highest price for the amount of securities covered in that bidder’s bid. (b) Usually involves a syndicate of investment banking firms and an ―underwriting agreement‖ with the issuer and an ―agreement among underwriters‖ that establishes the obligations of each member of the syndicate. d) Stabilization (i) The managing underwriter will elect to ―stabilize‖ the market by having one member of the syndicate bid to purchase the security at or just under the public offering price. for example. then it (and the underwriters) must comply with the rules that NASD sets.Buckham. Those securities sold remain sold. the money is returned to the potential purchasers. (b) If a company wants its shares listed on a public exchange regulated by NASD (an SRO). by a fixed percentage of the offering proceeds. e) Dutch Auctions (i) Issuer solicits bids from institutions and broker-dealers for any amount of securities each bidder wishes to acquire. Proceeds are placed in escrow until the minimum is sold. i Note: Does this unwillingness of the underwriter to make a ―firm commitment‖ signal something about the quality of the securities being issued and/or the proposed price? Some commentators believe so. (ii) Review of Underwriters’ Compensation by the NASD (a) The NASD reviews underwritings to ensure that the terms are fair and reasonable (the amount the underwriter charges the issuer). All bids are irrevocable offers to purchase that amount of securities. via warrants. the bidder states the amount of securities it wishes to purchase and the amount it will pay for those securities. Introduction to Underwriting a) Two Types of Underwriting: (i) Firm Commitment (a) One or more investment banking firms agree to purchase the securities from the issuer for resale to the public at a specified public offering price. The gross spread is $5. The difference between this price and the amount received by the issuer is the ―gross spread. (c) Review by the NASD of member underwriters is required even if the offering is otherwise exempt from registration with the SEC because. At closing. (a) Must comply with Rule 104 when conducting stabilizing activities. ii The underwriting compensation received by the underwriter. other bids are accepted at successively lower prices for the amount of securities covered in each bid until the issuer has placed Securities Outline 7/8/2015 1:59 PM 13 . (ii) Best Efforts (a) Broker-dealers agree for a fee to use their best efforts to sell the securities on behalf of the issuer at the offering price. The Public Offering A. This facilitates an orderly distribution by preventing a marked decline in the price of the security.

iii Customary Terms: (a) ―Allotment‖ = the amount of shares given to each underwriter. i Gives the managing underwriter a power of attorney over the transaction. Securities Outline 7/8/2015 1:59 PM 14 . It results in an overallotment. c) Stage 3: (i) Underwriters Agreement is executed. Overview of the Underwriting Process a) Stage 1: (i) Company finds a managing underwriter and signs a letter of intent. (b) ―Shoe‖ = the shares that were allocated in excess of what the syndicate was obligated to sell. (ii) Summary of Sections: (a) §5(c)  Prohibits any offer to sell or buy prior to the filing of a registration statement. (c) Anti-Flipping Clause (i) Imposes a penalty on syndicate members if flipped shares are traced to their allotment. (ii) NASD limits the permissible overallotment to 15% of the shares the underwriters are obligated to purchase. (b) The final underwriting agreement will not be signed until the very last moment before the registration statement becomes effective. This is where the existing shareholders have the right to purchase shares below price. It is non-binding. Introduction a) Three Relevant Period (i) Pre-filing (§5(c)) ---|--. Indemnification Clause (a) Requires the issuer to indemnify the underwriters for any liability they may incur under federal or state laws because the registration statement or prospectus is materially misleading. the standby agreement says the underwriter will pick up the excess shares not purchased by the existing shareholders. ii Sets forth the compensation for the managing. It contains terms such as the amount and type of securities to be issued. and post-effective periods. In such case. etc. underwriting. (a) The managing underwriter will seek out a syndicate. the price to be paid the issuer. waiting. Market Out Clause (a) Provision that permits the underwriters to withdraw any time prior to the public offering and/or settlement date if one of several exigent changes in circumstances develops. because it turns the underwriting into a mere best efforts underwriting. Stages of the Public Offering: 1. identification of the syndicate members. b) Stage 2: (i) Agreement Among Underwriters is executed. The lowest price accepted by the issuer though this process is the price paid by ALL the bidders whose bids were accepted through the process. and selling efforts in connection with the offering. and this agreement is the formal understanding among the members of the syndicate. Brian R.―Waiting Period (§5(b)(1)) ---|---Post-Effective Period (§5(b)(2)) b) Application of §5 of the ’33 Act to Registration (i) Section 5 of the Securities Act is relevant in the pre-filing.Buckham. time of payment. (a) The letter of intent is used between the managing underwriter and issuer as a preliminary understanding. (ii) Such agreements are rare except in a rights offering. Comfort Letters (a) Certain persons must provide the underwriter with comfort letters covering certain specified representations (e. when investor interest is very high. obligations of the issuer. 2. all the registered securities. (a) The Underwriters Agreement is executed immediately before the registration statement becomes effective. Contribution Clause (a) Provides for contributions among those liable under a misleading registration statement. during the 180 days following the public offering. (i) SEC holds that some market out clauses are inappropriate in firm commitment underwritings. that the corporation is validly incorporated) made in the registration statement. f) Standby Agreements (i) A standby agreement says the underwriter will buy whatever the public does not buy in the offering.g.. (i) A ―green shoe‖ is an option by the syndicate to sell more shares than obligated to sell. (b) Customary Terms: i Insider Lock-ups (a) Provision limiting senior management’s ability to sell any of their shares ii iii iv v B.

Pre-Filing Period a) Introduction (i) In addition to the activities regarding the registration statement. Information about the distribution and use of its proceeds. and (i) Must set forth the rights. the regulatory demands of §5 do not apply. when the statement is being reviewed by the SEC staff. i Four General Categories (the first three must be reproduced in the prospectus – the prospectus is a key part of the registration statement. and any 10-Q or 10-K reports incorporated by reference in the registration statement. ii Through various sections of the ’33 Act. if any. frequency and amount of dividends. so considerable work must be done in order to reorganize the various entities by mergers. significant efforts are afoot to promote the offering. (b) (iii) 2. property. and preferences of the security being offered.Buckham. A thorough discussion of the registrant’s business. If either the security is exempt or the transaction qualifies for an exemption. etc. is the lawyer helping sell the securities or helping them insure against something? (i) Really it should focus on insuring. privileges. you have to play-down certain things. 15 . liquidations. or S-3. The prospectus should not be considered a sales document. b) Registration of the Unseasoned Issuer (i) Generally (a) Section 5 of the ’33 Act restricts the freedom of the issuer and underwriters to promote the offering until the registration statement is filed. attorney’s opinion as to the legality of the securities registered. Must disclose the net expected proceeds and plans for the proceeds. S-2. the SEC has broad power over the form and content of the registration statement and prospectuses. the business must be conducted by a single corporation or a parent with subsidiaries. Brian R. the underwriting agreements. In some cases. security ownership by executives. etc. (a) So. the lawyer is torn between putting his client’s best foot forward and providing a candid view of the risks the issuer is facing. (i) Underwriters must disclose the general terms of the underwriting agreement. (c) §5(b)(1)  After the registration statement is filed but not yet effective. (d) Electronic Filing i All registrants must file their ’33 Act registration statements and periodic reports under the ’34 Act pursuant to EDGAR. A description of the securities of the registrant. bylaws. (a) A recapitalization almost always is required so that the company will have an appropriate capital structure for the public offering. Preparing the Registration Statement for Filing (a) Pre-Offering Clean-Up Work i To have a vehicle for the offering. (i) (b) (c) (d) (c) (iii) Securities Outline 7/8/2015 1:59 PM Registration Forms i Registration of securities is made on Form S-1 (the default form). but it is not the whole thing): (a) Information bearing on the registrant. §5(a)  No sales or deliveries of sold securities can occur until the registration statement is effective. all written offers to sell must be in connection with a prospectus that complies w/ §10 of the ’33 Act or Rule 430. (b) Contents of the Registration Statement (Regulation S-K says what must be in the forms). In drafting the statement. high and low security prices. ii Each item on the form directs the preparer to Regulation S-K for detailed guides on what precisely must be disclosed with respect to that item. are prepared in the pre-filing period. (ii) Introduction to the Registration Statement (a) Generally i The central objective of the ’33 Act is the preparation of a registration statement for securities offered to the public. The manner and protocol for making electronic filings are set forth in Regulation S-T. there is not such a neat package. (e) Role of the Prospectus: Selling or Insuring? i The burden of assuring the registration statement and prospectus is compliant falls on the registrant’s attorney. Various exhibits and undertakings. and capital contributions. (i) Must include the articles. and management. (b) Section 5 also states that in the period between the filing of the registration statement and its becoming effective (the waiting period). In many cases.

rewrite the articles and bylaws. They can use Forms SB-1 and SB-2 provided certain criteria are met. etc. revise leases. made in advance of a proposed financing. cancel shareholders’ agreements. or solicitation of an offer to buy. and S-3 (a) Form S-1 i Used by registrants who have not been in the reporting system for over three years. i The idea is to not have to repeat the company-specific information. just like the S-1 or S-2. Form 10-KSB and 10-QSB are sued. Specialized Rules (a) The Small Business Issuer System i For ―small business issuers. (b) Why prohibit offers before the effective date? i We don’t want any investment decisions being made on something other than the most reliable information that we can get into the hands of investors.Buckham. The SEC reviews the registration statement and issues its ―letter of comments‖… See below. (c) Form S-3 i Will have transaction-specific information. transfer real estate. (a) The SEC has interpreted ―offer to sell‖ VERY expansively. or ambiguous statements. ii The one certain area where the lawyer does in fact opine on the validity of a fact represented in the registration statement is that the securities being offered have been validly authorized. and their guidelines for completion are in Regulation S-B rather than S-K. unclear. for value. (b) (b) (c) (iv) c) d) Securities Outline 7/8/2015 1:59 PM Recapitalization is necessary so that after the offering the existing shareholders still have working control. a security or interest in a security. which requires certain disclosures. grant options. (ii) Pre-Filing “Conditioning of the Market” as Gun Jumping (a) Generally i Because of §2(a)(3)’s definition of ―offer to sell. (b) Examples: 16 . eliminate preemptive rights and cumulative voting rights.‖ §2(a)(3). may be considered an offer of sale. ii Information in the 10-K is incorporated by reference into the prospectus. ii We don’t want people arousing public interest so as to condition the public interest on the basis of incomplete information. After the registration statement is filed w/ the SEC. Brian R. Gun Jumping in the Pre-Filing Stage (i) Generally – the “Offer to Sell” (a) §5(c)  Prohibits any offer to sell or buy prior to the filing of a registration statement. (b) Blank Check Companies i Blank check companies are those who are without any specific business plan or purpose or whose plan is to engage in acquisitions of an unidentified company. Use stock splits. A separate continuous reporting system. Integrated Disclosure for the Seasoned Company (i) Generally (a) Integrated disclosure involves the coordination of the disclosures required under the ’33 and ’34 Acts such that large publicly traded companies can satisfy the ’33 Act registration requirements for company-specific information by incorporating by reference information from their current ’34 Act filings. the waiting period begins. The publication of information and statements.‖ an underwriter or dealer cannot begin a public offering or initiate a public sales campaign prior to the filing of a registration statement.‖ those whose revenues are less than $25 million or whose FMV is less than $25 million. and publicity efforts. Requires complete disclosure. ii The company must also adopt stock option plans. different share/voting classes. (i) ―Offering‖ is construed broadly to even include things conditioning the market (sometimes referred to as ―preselling‖ the securities). Lawyer’s Role i The lawyer should be careful to dispel any impression that his assistance in drafting the registration statement can ensure that it will be free from all misleading. or some other mechanism so that before the offering the existing shareholders still have enough shares to keep control. but the prospectus will not present any information concerning the registrant’s business unless there has been a material change since the last ’34 Act report. They are subject to Rule 419 of the ’33 Act. (b) Form S-2 i For registrants who have been in the reporting system for over three years. rearrange stockholdings of insiders. S-2. or by any registrant who chooses to use it. (ii) Forms S-1. or during the waiting period. but instead to only re-file the transaction-specific information. i ―Offer to sell‖ = every attempt to offer to dispose of.

etc. i This does not go beyond the issuer-underwriter relationship. Brian R. Public corporations have obligations to make timely disclosure of newsworthy information. You can keep doing what you have been doing. 172) (i) Problem 4-1: (a) One issue is whether we are even ―in registration‖ yet. and between underwriters. the §5(c) prohibition does not apply. The SEC provides both informal consultation and no-action letter guidance to gun jumping questions. (a) So. (a) Rule 137 allows broker-dealers keep doing what they do: buy. 17 . but it may also be seen as a solicitation while the issuer is ―in registration. hold. Providing two news releases regarding development plans for a real estate venture.‖ Permissible Information Releases i Rule 135  it is not an ―offer to sell‖ securities (and thus does not violate §5(c)) if the issuer releases certain information about its operations and activities. While not mentioning the issuer company. (a) For example. i But.i ii (c) (d) Buckham. and then mailed out numerous brochures to investors on the growth prospects of the uranium industry. answers to unsolicited inquiries about business matters. ratings. (iii) Problem 4-3: (a) This also falls in the §2(a)(3) exception.‖ i If the broker-dealer is not involved in the deal. manner/purpose of offering. News v. they are still okay because they are just general advertisements about the products. we need to be a little worried about the quote regarding Omega being a ―emerging industry leader…‖ Are they now hyping their company instead of their product. Rule 137 is triggered. (a) Rule 139 permits the broker-dealer to issue opinions and recommendations concerning an issuer so long as it does so in the ordinary course of business and the issuer is entitled to file a Form S3. An investment banking firm violated §5 when it was approached by a mining company. (ii) Problem 4-2: (a) In essence. there is a solicitation/offer of sale of securities here. the company can still make releases about the company’s products and services. This is true even if you file the final underwriting agreement (and in firm commitment underwriting. If not. i This does NOT extend to discussions with broker-dealers. iii Notes: (a) Numerous SEC releases provide clarification as to what types of information can be released. the investment banking company’s name was on the brochure. (a) The SEC determined the news releases aroused the market with the intent to set into motion the plan of distribution. Not an ―offer for sale‖ because §2(a)(3) provides the equivalent of an exception for discussions and agreements between an issuer and the underwriter. (b) If this is ―in registration. business and financial developments. the company can release its intent to make a public offering. It’s interesting that they moved the ad from a computer magazine to a business magazine. the amount and type of security. so long as the communications about the issuer are in the ordinary course of business and the broker-dealer doesn’t receive any commission from the transaction.‖ and the company gave out the press releases. ii Disclosure of a material event would not ordinarily be subject to restrictions under §5 of the Securities Act if it is purely factual and does not include predictions or opinions. even though the issuer is in the registration process.‖ it is a very hypersensitive time. ii Whether the broker-dealer is involved in the deal. Much of the permissible communications are based on whether the broker-dealer is a ―participant in the distribution. including the announcement of the financing plans and the upcoming filing of a registration statement. Arrangements With and Among Underwriters NOT Gun Jumping (a) §2(a)(3) excludes from the definition of ―offer to sell‖ negotiations and agreements between the issuer and underwriter. sell. (iv) Problem 4-4: (a) This also falls in the §2(a)(3) exception. etc. ii Always be wary that when you are ―in registration. was a violation of §5. Pre-Filing Problems (p. etc. Conditioning i There is a blurry line between releasing newsworthy information and conditioning the market for the offering. Rule 139 is triggered. (b) The SEC rejected the contention that it was merely a ―news‖ publication. the actual sale of the securities to the underwriter!!!). (b) (iii) (iv) e) Securities Outline 7/8/2015 1:59 PM Gun Jumping of a “Participant in the Distribution” (a) Rules 137 and 139 provide insight into what communications regarding an issuer a broker-dealer may make.

Rule 137 is triggered. It will then issue an order declaring the registration statement effective. this annual report is questionable. Rule 139 permits the broker-dealer to issue opinions and recommendations concerning an issuer so long as it does so in the ordinary course of business and the issuer is entitled to file a Form S-3. the basic terms of the security offered. Problem 4-7: (a) When the broker makes an offer to purchase (soliciting upstream) the Omega shares. issuers include a legend. under §8(a) the registration statement can. (c) Note: An individual who is not a dealer. Brian R. become effective 20 days after filing. (ii) If the Registration Statement is Not Complete or Unsatisfactory to SEC (a) Under §8(b). While §8 of the ’33 Act has the 20 day automatic effectiveness concept. (b) Rationale: i The underwriter could accept the offers to buy in their order of priority and thus put pressure on dealers to rush their orders to buy w/o adequate considerations of the security being offered (because there was no prospectus yet).‖ (b) The SEC will review the statement to determine its compliance w/ the informational requirements of the ’33 Act and the forms. Release 5180 talks about allowing the company to provide factual information. (b) §8 provides the standard to be met in order for the SEC to accelerate the effective date. ratings. (b) Under §8(d). it can often take much longer than 20 days. (b) Whether the broker-dealer is involved in the deal. §2(a)(3) exception for underwriters doesn’t apply. (iv) ―Delaying Amendments‖ (a) To prevent the registration statement from becoming effective in deficient form automatically after the 20 day statutory period. It allows retail brokers to keep doing what they do: buy. So. Problem 4-8: (a) Rule 135 permits. Rule 473 does away with this automatic effectiveness by permitting ―delaying amendments. (v) ―Acceleration‖ of the Effective Date (a) After the issuer has complied w/ the letter of comment. he is liable under §5(c) for making an ―offer to buy‖ the security. It is in the Rules only. Then we need to look at Rules 137 and 139. But. But. and the company can commence the public offering. dealers cannot. Filing and Waiting Period a) Review of the Registration Statement by the SEC’s Staff: The Letter of Comment (i) Filing and Effective Date of Registration Statement. (iii) The SEC ―Letter of Comment‖ During the Waiting Period (a) The SEC may issue a detailed letter of comment advising issuer’s counsel of any deficiencies in the registration statement that the staff believes need correction. Delaying Amendments (a) Upon filing of the registration statement with the SEC and paying the filing fees. Problem 4-10: (a) Possibly a violation. and policies of the staff. Problem 4-6: (a) This is a retail dealer. regulations. 162 seems to suggest that the SEC will be upset because of the forecasts. hold. sell. called the ―delaying amendment‖ on the facing page of the initial filing of the registration statement. barring any other actions. thereby postponing the automatic effective date until the issuer has amended the registration statement to comply with the letter of comment. anyway. Problem 4-9: (a) This seems to go beyond the ordinary course of business reporting. (b) If the dealer will be participating. Securities Outline 7/8/2015 1:59 PM 18 . In any event. then the underwriters cannot communicate with the dealer. the dealer/underwriter/issuer CANNOT issue the securities. or underwriter CAN make an offer to buy before there is as registration statement (§4(1)). ii Companies readily comply with the letter of comment. the issuer will request that the SEC accelerate the effective date of the registration statement. A ―broker‖ is included in the definition of ―dealer‖ in §2(a)(12). etc. the SEC can issue a stop order for a registration statement that has become effective. so §5 does apply to brokers. not an underwriter in the syndicate. They made it significantly better than last year’s reports.(v) (vi) (vii) (viii) (ix) (x) 3. (b) The remedy: The SEC might deny acceleration for this deal. during the pre-filing period. an issuer or a selling security holder to disclose certain things about the offering. the issuer’s failure to respond carries with it the implied threat of a formal stop order proceeding under §8(d) or the effect of §8(b) (delaying of the effective date). issuer. Should have counseled the client not to use any numbers. What they cannot do is disclose who the underwriter is. the SEC may issue an order refusing to permit the effectiveness of the registration statement if it appears incomplete or inaccurate. Example 7 on p. (b) Rule 473 governs delaying amendments. etc. Problem 4-5: (a) If the broker-dealer is not involved in the deal. i While there are no legal consequences for failing to respond to the letter. But. i The concept of ―delaying amendments‖ and ―acceleration‖ (infra) do not show up on the face of §8 of the ’33 Act itself. including the name of the issuer. Buckham.

(b) §5(a) states that no ―sales or deliveries of sold securities‖ can occur until the registration statement is effective. ii Exceptions: (a) Tombstone Ads and Identifying Statements – Rule 134 (i) Under Rule 134. (b) Limited Written Communications Permitted i General Rule: (a) Written communication must be accompanied by or preceded by a prospectus meeting the requirements of §10. and that all offers are only preliminary. (iii) Selling Practices Permitted During the Waiting Period (a) Generally i Significant promotional efforts occur outside the regulatory reach of §5 during the waiting period.‖ (iv) The tombstone ad must indicate where prospective buyers can get a prospectus. Any written communication. expressly providing an exception to §5(b)(1)’s mandate that a prospectus meet the requirements of §10. (§5(b)(1)). These selling efforts are primarily oral. (b) Rule 430A permits the price to be excluded from the registration statement for some offerings. (b) If there are hyperlinks on the website and a prospectus. only very limited types of prospectuses can be used to satisfy §5(b)(1) [see rules below]. or provide only a range. (b) Preliminary Prospectus (Red Herring) is Sufficient (Rule 430)  Written offers may be made during the waiting period through the use of a ―red herring‖ (aka ―preliminary prospectus‖). the prospectus has a legend saying that there can be no acceptances. the SEC may consider it all together. The rule also permits a change in the number of securities offered (up to 20%). (iii) Rule 134 also permits the issuer to include a brief description of the business. No acceptance is permissible until the registration statement is effective. if so. §5(b)(1) is violated if the website information does more than replicate the information in the §10 prospectus.‖ ―Red Herring‖ – in red ink. as are limited written offers via a prospectus. and the waiting period starts.‖ (ii) Hyperlinks to the Prospectus (a) During the waiting period. except it may exclude certain items. Gun Jumping in the Waiting Period (i) §5(a) Triggered Upon Filing (a) After filing the registration statement. (iii) The only difference between this preliminary prospectus and the final prospectus is usually the numbers. §5(a) is triggered. This information can be excluded from the registration statement if included in the prospectus. (vi) The Pricing Amendment (a) The pricing amendment is the last piece of information filed. (vii) Liability (a) §11 imposes liability on certain persons if the registration statement contains a material misrepresentation when it becomes effective. the issue is whether information on a website is a ―prospectus‖ because it conditions the market. §5(b)(1) is satisfied by the use of a prospectus that includes substantially the same information that will ultimately appear in the final prospectus under §10(a). (i) Prior to the effective date of the registration statement (but after it is filed). 19 . ii The term ―prospectus‖ in §5(b)(1) is defined very broadly in §2(a)(10). Oral offers are permitted. b) Securities Outline 7/8/2015 1:59 PM (c) Rule 461 governs acceleration of the effective date. Brian R. during the waiting period publicity can be given through a tombstone ad without violating §5(b)(1). (ii) Rule 134 lists 14 categories of information that can be contained in a tombstone ad. (d) The SEC has discretion whether to accelerate the effective date. But. Despite the broad definition. and Rule 430/431 permit a preliminary prospectus to be sufficient. though Rule 134 does permit some limited written communication. this is called an ―identifying statement. Though §5(c) doesn’t apply. §5(c)’s broad prohibitions on offers to sell and buy disappear. selling efforts can commence during the waiting period. i The form of the selling effort available in the waiting period is dictated by §5(b)(1). Rule 430 authorizes this communication. are deemed to be a prospectus whenever a communication through such medium offers a security for sale or confirms a sale. (ii) This is called the ―red herring. as well as radio and TV transmissions.Buckham. (a) Oral offer to sell are not within the definition of ―prospectus.

which says you can have some communications. If you use the website to intermix the prospectus and the glowing report. the SEC has approved the increasing use of electronic media. then it is not permitted. (c) Clearly we have a prospectus here in 2(a)(10). as are limited written offers. ii The commercial benefit of soliciting oral offers is that it allows significant sampling of investor interest in the offering. called ―book building. See p. §5(a)(1) (b) Not okay. Problem 4-20 (a) ―Wired Ventures. but it later expanded to include institutional investors. §2(a)(10). So. (b) SEC Release No. though the password makes it more difficult. Problem 4-17 (a) ―Envelope theory‖ i Analogizes the link on the website back to the old-school written communications. oral offers are permitted in waiting period. §10 Problem 4-18 (a) Rule 138 (b) Here they are talking about the preferred stock instead of the common stock being offered. 176. Post-Effective Period a) Generally (i) Once the registration statement is effective. (b) §5(b)(1). i Rule 138(a) says it will NOT be considered an offering of the common stock! (a) The theory is that there is a different market for other forms of stock.‖ Have to put the boilerplate legend on it. Rule 134(d) (b) NO oral or written offers are permitted in the pre-filing period. §5(a)(1) no longer prohibits the sale. §10. like the web and video teleconferencing. Problem 4-19 (a) ―Cold Calls‖ (b) There is no limit on oral offers. it is permissible to solicit via oral offers during the waiting period. (c) (d) c) Problems: (i) (ii) (iii) (iv) (v) (vi) (vii) (viii) 4. Road Shows i Roadshows are traditionally gatherings attended by potential underwriters. but you can’t say ―This is still a good buy. The company withdrew its registration statement and dropped the offering when this happened. Brian R. But. b) Gun Jumping in the Post-Effective Period (i) Generally (a) When in the post-effective period. the sale still cannot be consummated at this time. §5(b)(2) requires. that the security be accompanied by or preceded by a prospectus (final) that meets the requirements of (a) of §10. ii In a series of no-action letters.Buckham. ii Outcomes turn on analogies to paper-based settings. Problem 4-14 (a) §2(a)(10). the duty to deliver a prospectus eventually terminates under §4.‖ case. since the brokerage firm is not participating. The brokerage firm should not accept the $. Oral Communications i Because oral offers to sell are not within the definition of ―prospectus‖ under §5(b)(1) (it includes only written or radio or television communications). §5(b)(1). with the trade confirmation or offers. to make available to prequalified investors a password so they can view a video of the road show. or has not already sent a prospectus. we look at Rule 134(d). (a) But. such as preferred stock. (ii) At some point during the post-effective period. Inc. however. Is it liberalized to talk about another class of stock of the same issuer? Rule 138 explicitly addresses this issue. and under §5(a)(2) the security can be delivered to the purchaser. Problem 4-21 (a) §5(b)(1) – ―road show‖ (b) This is probably an acceptable road show. so long as there is not a sale until after the effective date.‖ (a) The targets of the oral selling efforts do not need to be provided w/ a prospectus. §5(b)(1) and (2) are violated if the prospectus delivery requirement is still in effect and the person does not send a prospectus. since no sales are permitted. and you would get busted if you sent it in one envelope instead of two separate envelopes. Only offers are permitted! Brokerage firm should return the check along with a copy of the boilerplate language in Rule 134(d)! Problem 4-16 (a) Rules 137 and 139 (b) Rule 137 says something like this would not even be an offer. but is not a §10 prospectus. Problem 4-15 (a) Rule 134(d). Securities Outline 7/8/2015 1:59 PM 20 . 4968 and Rule 15c2-8 place certain restrictions on this.

underwriters. which is civil liability for anyone who offers or sells a security in violation of §5. it is under §12(a)(1). and thus does not have to be updated with material changes after the effective date. Anyone not falling in one of these three classes is free of the prospectus delivery requirements. and mail with their confirmation a term sheet that includes all the earlier omitted information as well as any material changes in the earlier circulated preliminary prospectus. If it is a hyperlink in an e-mail. Rule 174 (b) §4(4) = brokers. use a preliminary prospectus that omits price-dependent information. brokers who do not solicit their client’s interest are exempted from the prospectus requirement. (c) This shows the need for absolute literal compliance with the rules. and thus a violation of §5(b)(2) [and therefore liability under §12(b)(1) is triggered]. Rule 434 (b) Access to the term sheet on a website is not sufficient to be ―delivery‖ of the term sheet. this obligation is only for issuers. But. Post-Effective Period Problems (i) Problem 4-22 (a) §5(b). (b) Under §4(3)(C). The issuer can’t just add a term sheet to the summary prospectus. Diskin (b) If there is any remedy. including the limitation that the prospectus can only be sent electronically with the specific consent of the customer. i Various restrictions apply. (v) Duration of the Prospectus Delivery Requirement . (ii) Problem 4-23 (a) §12(1) liability. (ii) Rule 434 ―Term Sheets‖ Permitted (a) Rule 434 facilitates the delivery of information to investors by allowing the required disclosures. Brian R. Only a preliminary prospectus can have a later term sheet used.Buckham. 21 . (c) The rule distinguishes between offerings on an S-3 and other offerings. (c) §4(3) and Rule 174 = dealers and underwriters. an issuer is obligated to reflect posteffective developments in a prospectus via amendment or supplement. ii Free writing permits participants in the offering to prepare and circulate their own materials promoting the offered security. (See Manor Nursing). (iii) Electronic Delivery (a) The prospectus delivery requirements can be satisfied by encoding in electronic format the §10 prospectus and sending it electronically to the customer’s computer (whether via e-mail or on the issuer’s website). however. underwriters are subject to the prospectus delivery requirements of §5(b) as long as their allotment or subscription in the distribution is unsold.‖ (b) Free writing is permitted in the post-effective period only if those materials are accompanied or preceded by a final prospectus. (iii) Problem 4-24 (a) This is the ―free writing‖ idea. and dealers. to be delivered to investors in more than one document. §2(a)(10). (b) Access to the term sheet on a website is not sufficient to be ―delivery‖ of the term sheet. Duty to Update the Prospectus (i) Though the registration statement speaks as of the day it becomes effective. §4(3). c) d) Securities Outline 7/8/2015 1:59 PM i Rule 434 loosens the burden of this somewhat… (b) The type of free-writing that is used in trading markets can now be used in the posteffective period as long as it is accompanied or preceded by the final statutory prospectus. (iv) Problem 4-25 (a) §4(4).§4 (a) §5 centers on the obligation to deliver a prospectus. §2(a)(10) provides an important exemption to the meaning of ―prospectus. (Release 7856). Failure to do the updates makes the prospectus non-compliant with §10(a). (§4(1)). (c) Under §4(4). for example.‖ The impact is as follows: i If the underwriter is aware that its offeree has already been sent a final prospectus. (v) Problem 4-26 (a) Note even the Rule 434 sheet would be sufficient. (b) Is the hyperlink analogous to something going out in an envelope together with the prospectus? i Most sources seem to suggest that this would be okay – it would be considered to be sending the prospectus with the report to the customer. orally solicit investors’ orders to buy during the waiting period. (a) The use of the supplementary selling materials is called ―free writing. i The basic rule is that free writing is okay as long as it is preceded or sent with a prospectus. including pricing information. (b) Pursuant to Rule 434 the underwriters can. it need not send another. (iv) Free Writing (a) Though §5(b)(1) continues to regulate written selling efforts. it may be permissible.

b) §12(a)(1) (i) Any person who offers or sells a security in violation of §5 is liable. or for damages if the person no longer owns the security. it would be a good idea to go ahead and send a few boxes of them to the brokers. Remedies for Failure to Comply with §5 -.SEC v. has an untrue statement of material fact or omitted a material fact. a) §11 (i) If any part of the registration statement. §12(a)(2). But. any person who bought the security may bring suit. or for damages if the person no longer owns the security. (iii) §11 is only for registered offerings. not necessarily delivered. c) §12(a)(2) (i) Any person who offers or sells a security with an untrue statement or omission of material fact is liable. it is exempt. (ii) The suit is to recover damages. Relevant Sections: §11. D. Manor Nursing 1. Brian R. Problem 4-29 (a) Rule 15c2-8(g) and (h): seem to suggest that HH must send the prospectuses to the brokers only if the brokers request them. (ii) The suit is to recover the consideration paid for the security less the amount of income received. when it became effective. Buckham. Conducting Public Offerings Through the Internet Securities Outline 7/8/2015 1:59 PM 22 . §12(a)(1). since there is no promotional work being done by the broker here.(vi) (vii) (viii) C. (ii) The suit is to recover the consideration paid for the security less the amount of income received. So. (iii) §12(a)(2) applies whether it is a registered offering or not. Problem 4-28 (a) This is a §4(4) transaction. Problem 4-27 (a) §2(a)(1) and §5(b)(2) require only that it be sent.

the SEC can proceed formally against a registrant under §8(b) or §8(d) (usually when the registrant has shown a careless disregard for the rules). Refusal Orders and Stop Orders a) Generally (i) Deficiencies and problems with a filed registration statement are generally handled through the letter of comment procedure. which requires the prospectus to contain the information in the registration statement. d) Rule 415 does not state what form (S-1. Shelf Registration Under Rule 415 1. issue a cease and desist order or invoke §20 to obtain orders in the federal courts to prevent a violation of any provision of the Act. c) Rule 415(a)(4) requires that when an issuer shelf registers equity securities for a trading market. is applied in practice to require a full post-effective amendment to the registration statement only when the post-effective information is to be substituted for. (b) Does not apply where the misstatement is not apparent on the face. Generally a) There are situations where an issuer will find it desirable to register securities that either it does not presently intend to offer for sale (to use in later acquisitions. But. the issuer will wish to amend the prospectus used in the offering. if the issuer is qualified to use an S-3. The Clearing House then sends a final prospectus to the customer. §5(c)’s bar applies if any public proceeding or examination under §8 has been initiated. information appearing in the registration statement. Updating and Correcting the Registration Statement 1. Confirmation of the sale. The customers can place preliminary offers through the website. under authority of §8A. Example (Wit Capital): a) An internet based dealer of securities was permitted to participate in IPOs by including in a special section of its website a Rule 134 notice and a copy of the prospectus for the issuer.1. b) §8(b) Refusal Order (i) SEC refuses to let effectiveness occur. and if the registration statement has not become effective. (i) If it is New Information  Use a ―Sticker‖ (a) Information that does not portent the type of substantive change or addition referred to in Rule 424(a) can occur w/o the filing of an amendment to the registration statement (usually this occurs by merely placing a sticker with the new information on the prospectus). (iii) Can even be issued after all the registered securities have been sold and distributed. it may only do so. is sent to the customer via email if the customer was allocated any shares. inter alia. (ii) If it is Substitute Information  Use a Full Amendment (a) On the other hand. after the effective date. but there is reason to believe that a sale is not likely to occur. (d) SEC must give notice of a hearing. The form used is based on the offering’s ability to satisfy the particular form’s eligibility requirements. however. however. There is no link between the offering information and the dealer’s home website.) must be used by the issuer to register the shelf registration. etc. E. (b) The SEC can. but not added to. etc. c) §8(c) Stop Order (i) Empowers the SEC to act if it appears that the registration statement includes any untrue statements of material fact. the issuer must update its financial statements annually as well as amend the registration statement for any ―fundamental‖ changes in the information in the registration statement. give buyers of an offering a remedy if the registration statement becomes misleading subsequent to the effective date. Thus. Buckham. §10(a).) or that it is presently offering for sale. (c) Must be issued before the registration statement becomes effective. Post-Effective Amendments of the Registration Statement a) The registration statement can be amended after it has become effective. it is e-mailed to the customer. F. d) Result of Refusal or Stop Order (i) Under §5(c). Brian R. S-3. If a prospectus is amended. (a) §12(a)(2) does. b) The shelf registrant must do an ―undertaking‖ to file post-effective amendments to the registration for the purpose of updating the information in the registration statement and prospectus. The dealer sends an e-mail with the Rule 134 information to its customers notifying them of the offering and availability of an electronic prospectus. The principal purpose is to correct any material inaccuracy in the registration statement when it became effective. (i) Rule 415(a)(3) indicates the shelf registrant must comply with Item 512(a) of Regulation S-K. (ii) Notes: (a) Reaches only patent misstatements and omissions in the registration statement. Full Amendment Securities Outline 7/8/2015 1:59 PM 23 . b) Result of Sticker v. (ii) Stop order authority exists only if the registration statement contained a material misrepresentation at the time if became effective. shares convertible into common stock at a later date. Registration of such securities to be offered on a delayed or continuous basis is referred to as ―shelf registration. 2.‖ which is authorized by Rule 415. Thus. Rule 415 a) The shelf offering is authorized for transactions falling within Rule 415(a)(1)(i)-(xi). such as the antifraud provisions of §17(a). 2. no offers to buy or offers to sell can be made when a refusal or stop order has been issued against a registration statement.

the Philadelphia Exchange. (ii) Restricted to firms who have operated for the past 5 years and have not defaulted. Generally a) The trading practice rules are meant to reduce the temptations by the issuer and its underwriters to influence the secondary trading market for the security being distributed (so that the distribution occurs more quickly and possibly at a higher price). Item 502(d). A complex set of rules under Rule 104 of Regulation M evolved. H. Why prefer the sticker route over the amendment route? (a) Because post-effective amendments (that are not done via sticker to the prospectus) to the registration statement do not become effective w/o action of the SEC. It also includes some securities offered pursuant to some of the ’33 Act exemptions. Regulation S-K. The Trading Practice Rules 1. c) One primary limit on stabilization is that the bid by the underwriter buying to stabilize the deal cannot exceed the offering price of the security. b) Each state continues to have power to enforce its antifraud provisions with respect to covered securities. and a copy of the offering prospectus. b) Prohibition against bids and purchases during a distribution applies until the regulated person has completed his participation in the distribution. and the CBOE. 2. b) The Small Corporate Offering Registration is available for companies with <$1 million raised. NASDAQ. Withdrawal of the Registration Statement a) Rule 477 permits an issuer to withdraw its registration statement. Securities Outline 7/8/2015 1:59 PM 24 .‖ (i) Covered securities = those listed on the NYSE. Registration Under State Blue Sky Laws 1. (ii) Often entails a review of not only the information in the disclosure. Disclosure is quite extensive. c) Regulation M exempts certain transactions from the prohibition on trading activity on the ground that they are unlikely to affect the market price of the distributed security. (iii) Used by issuers who are not eligible for registration by notification or coordination. or any amendment thereto. (iv) Registration does not become effective until the state administrator so orders. b) These transactions are seen as beneficial. AMEX. Exemption for ―Covered Securities‖ a) The NSMIA amended §18 of the ’33 Act to preempt the power of the states to require issuers to register with the states ―covered securities. Brian R. 3. and it is effective immediately. Stabilization a) Stabilization is the fixing of a security’s market price through purchases or bids for the limited purpose of preventing a decline in the security’s price during a public offering of the security. c) Qualification (i) Entails filing a registration in each state where the offering will be made. G. (ii) Restricted to firms who have filed a registration statement w/ the SEC.Buckham. it opens the door to §11 liability w/ a new statute of limitations. b) Coordination (i) Entails filing a copy of the federal registration statement and any amendments with the state administrator. Also. (a) Offers registered by qualification are those that have escaped registration with the SEC because of an exemption provided by the ’33 Act. Merit Review a) The NASAA is a set of model ―merit‖ standards that many blue sky administrators follow in evaluating the merit of an offering. Three Methods of State Registration a) Notification (i) Entails filing a statement demonstrating that the issuer is eligible to register through notification. (i) 3. some basic information about the offering. requires that disclosure of the stabilization be made on the inside cover of the prospectus. Thus. the Pacific Exchange. 2. 3. but also a ―merit‖ review. Purchases During a Distribution a) Rules 100 to 102 of Regulation M regulate trading activities by issuers and distribution participants during a distribution. such as SEC safe harbors for private offerings under §4(2).

Rule 147 intrastate offerings. 2. iii §3(b). (b) If the two potentially separate issuance are within six months within each other. Exemptions are Not Perpetual a) Having an exemption at one time does not mean the securities or a later transaction will be exempt at a later date. since it aids in delineating the boundaries of the §3(a)(11) exemption.Exemptions I. (ii) Securities placed under the transaction exemption remain subject to both the ’33 and ’34 Acts and cannot be resold unless either they are registered or there is another exemption available at the time of the later re-sale. Local enforcement can quickly discover and respond to offering violations. (iii) The Temporal Aspect (a) Rule 147(b)(2) has a safe-harbor saying that six months on either side of the issuance is not an integration (not part of the same issue). Section 4 . Generally 1. (iii) Two Kinds: (a) Trading Exemptions i §4(1) ii §4(4) iii Others (b) Issuer Exemptions i §3(a)(11). D iv Others b) Exempt Securities (i) Exempt from registration and can be sold free of the registration burden. or if a corporation it is incorporated and doing business within. Generally a) §3(a)(11) exempts any security which is ―a part of an issue offered and sold only to persons resident within a single state. securities exempt under a transaction exemption cannot be resold unless the shares are registered or there is an exemption for them again. 3. to a limited extent. c) Rationale for the Exemption: (i) State regulation of truly local issuances adequately protects investors. outlined in Rule 147. the state. or transactions from all or part of the ’33 Act. the antifraud provisions of the ’33 and ’34 Acts. II.‖ b) Despite its placement in §3.Buckham. securities. 2. Exempt Transactions A. e) Securities offered via intrastate exemption must have the legend and place restrictions stated in Rule 147(f). d) Rule 147 provides a great deal of clarification on the exemption by making more objective what would otherwise be a very broad statutory provision. (ii) Local people are likely to be more familiar with the issuer’s business. where the issuer of the security is a person resident and doing business. (i) For example. b) “Part of an Issue” Requirement (i) The SEC will look at whether the offerings were made at or about the same time. 4. it is seen as a transactional exemption (it was a legislative mistake to put it in §3). Three classes of exemptions: a) Exempt Transactions (i) Provide an exemption from §5 of the ’33 Act. (ii) The entire issue of shares must be offered only to residents. There are additional factors. The Intrastate Offering Exemption: §3(a)(11) 1. ii §4(2) private offerings. c) Section 28 Exemption (i) Authorizes the SEC to exempt persons. If any part of the issue is offered or sold to nonresidents. Brian R. Reg. the exemption is unavailable to both residents and nonresidents. Every single offer or sale of securities needs either registration or an exemption. Sections 3 and 4 of the 1933 Act set forth a series of exemptions relieving those involved in securities transactions of the need to comply with the registration provisions of the ’33 Act and. Exemptions – Introduction A. then we go to the 5-factor approach: i Are the offerings part of a single plan of financing? ii Do the offerings involve issuance of the same class of security? iii Are the offerings made at or about the same time? iv Is the same type of consideration to be received? v Are the offerings made for the same general purpose? c) Doing Business Within a State Securities Outline 7/8/2015 1:59 PM 25 . Scope of the Exemption a) Generally (i) It is important to always look at Rule 147.

then it is indeed integrated. (a) The buyer is supposed to be taking it for investment. (iv) Rule 147 Safe-Harbor: The ―Triple-80% Test‖ (a) Rule 147(c)(2) i The issuer shall be deemed to be doing business within the state or territory if: (a) 80% of revenues are from the state. (ii) A single offer or sale to a nonresident destroys the availability of the exemption regardless of whether the mistake was in good faith. since the Rule 147 safe-harbor is ambiguous on the matter. not as underwriting for resale. Chapman case said that ―the issuer must conduct a predominant amount of its business within the same state [as the investors]. the resale can occur on December 1. Residence Within a State (i) Mere presence within the state by the buyers is insufficient. But. (iii) Problem 5-3 (a) No-action letter said this was still an intrastate offering. Brian R. 259). Not just the investment. Use of the Mails and Facilities of Interstate Commerce (i) The exemption does not depend on whether the mails or telephones were used. There needs to be some form of holding period. ii See Rule 147(c)(2)(i)-(iii). Rule 147(c). (b) 80% of assets are in the state. He still had a house in Minnesota and still intended to be in Minnesota. although not conclusive. (ii) Some cases say the issuer must conduct a ―predominant amount of his business within the same state. Problems in Text: (i) Problem 5-1 (a) An offering may be so large that its success as a local offering appears doubtful from the outset.Buckham. (a) Securities that have actually come to rest in the hands of resident investors who purchased without view of resales to nonresidents may be sold w/o jeopardizing the exemption. Using the Boston Globe and the website cause more problems. (vi) Problem 5-6 (a) The re-sale can occur nine months after the date of the last sale by the issuer of the securities. there are some no-action letters saying two-tier structures could work if the top tier has operations out of state. So. But. since these may reach outside of Massachusetts. (iv) Problem 5-4 (a) This is an ―integration‖ question. provided the interstate business is all ―from‖ the relevant state. Resales (i) Residents can resell their securities to nonresidents. then the resales by persons to non-residents after that 9 months will not destroy the exemption. (c) Another problem is that there may be resales to people outside the state. (b) But. and (c) 80% of net proceeds are planned to be used in the state. this is again a close case. The exemption is not dependent upon nonuse of the mails or instruments of interstate commerce in the distribution. If convertible to common stock. it may support an inference that the original offering had not come to rest in the state. It’s a close case. This is not an automatic killer that people outside Massachusetts will see the ad in the Boston Globe. (ii) Release 4434: The exemption may also be utilized for secondary offerings by person in control of the issuer if the exemption would be available to the issuer for a primary offering in the state. (v) Problem 5-5 (a) Rule 147(c)(2)(i) is phrased to suggest you can do interstate business.‖ The fact it is a Washington entity is not good enough. (vii) Problem 5-7 26 . (b) Rule 147 Safe-Harbor i Rule 147(e) – If the stock stays in the hands of a resident after sale for at least 9 months. (i) d) e) f) g) Securities Outline 7/8/2015 1:59 PM Can only be satisfied by the performance of substantial operational activities in the State of incorporation. but instead all of the business has to be within the same state as the investors. because the performance of substantial operational activities is not in Washington. (b) Not acceptable. if the securities are resold a very short time after the distribution to residents. From the no-action letters regarding multiple-tier structures looks like form will win over substance in some cases. the residency of the controlling person will not affect the availability of the exemption in a secondary distribution. Substantially all of the proceeds of the offering must be put to use within the state. and that the resale therefore constituted a part of the process of primary distribution. (ii) Problem 5-2 (a) Problem is that they are not doing business in the state of Washington. (b) The big problem is that some of these doctors may not be a resident of Massachusetts. We have to look at the 5 factors above.‖ (iii) The SEC may look at whether proceeds from the offering are to be employed in the same state. They must actually be residents. They can use a disclaimer on the ad (p.

Buckham. The court held that the applicability of §4(2) depends on whether the particular class of persons affected needs the protection of the Act. or by having the investor give a promissory note for the security. The Private Offering Exemption: §4(2) 1.‖ (i) The exemption is meant to permit an issuer to make a specific or isolated sale of its securities to a particular person or small number of persons. b) But. 2. §4(2). the private offering cannot be used as a subterfuge for a public offering by making a private placement to a small group of individuals who then proceed to sell the securities to the public. The number of persons offered to is not the relevant inquiry – there is no quantity limit for the exemption (but it is a useful factor). Just go all the way. (ii) Inscribe the securities to disclose that the securities are unregistered and a transfer may take place only under specified conditions. rather than as an investment. and if they inquired. (a) (viii) B. In the event the issuer can find an exemption.‖ rather than when the last installment payment was made. c) Issuers often do three things to protect themselves: (i) Require purchaser to sign statements of investment intent. Ralston Purina (i) Purina allowed ―key‖ employees to inquire about buying treasury stock. The “Naked” §4(2) Approach a) The Primary Case: SEC v. c) Securities Outline 7/8/2015 1:59 PM Effect of Doran Case (i) Can satisfy §4(2) “access to information” by either by: (a) Disclosure. b) Two Approaches: (i) An issuer may rely on the ―naked‖ statute itself. this could have been a public offering requiring registration under Ralston. you must have 3 years of GAAP. There must be a prior relationship w/ the issuer. they must still use GAAP and rounding up is not permitted. (ii) Continental Tobacco (a) The offerees need the relationship of an ―insider‖ to qualify for the exemption. To have a public offering. For purposes of the holding period. (iii) Problem 5-10 (a) Result in 1973 i Even though to only one person. Introduction a) §4(2): ―The provisions of §5 shall not apply to transactions by an issuer not involving a public offering. no-action letter said there is no actual ―sale‖ until all of the installment payments have been made. and this would accelerate the date of the sale back to the time the securities were actually ―sold. OR i Of course. the SEC said the company could just provide for substantial penalties for default. Problem 5-8 (a) This is based on the 80% tests. (b) Change of residence of one of the purchasers before the entire sum was paid off was a violation of the exemption! (c) To make the time period end fast. (b) Hill York and Continental would require him to have a prior relationship and insider status. and (iii) Put into effect stop-transfer orders instructing the transfer agent not to process any transfers of restricted shares without the consent of the issuer. and Continental. resales are still permitted. (ii) The issuer may use Regulation D. (b) Access i Access is given by the position of the offeree or by the issuer’s promise to open appropriate files and records to the offeree as well as to answer inquiries regarding material information. Offers were made to approximately 500 persons per year. they could purchase stock at the market price directly from the company. Resale of Securities Acquired in a Private Offering a) Because §4(2) is transactional in nature. D disclosures. (a) Ralston is all about access to information. if you go the disclosure route. Hill York. He does not have access to information in this case. it would make more sense to simply just do the Reg. which provides a safe-harbor for the otherwise ambiguous statute. audited statements. (ii) The court did note that some employee offerings may come under §4(2) if they are made to executive personnel who because of their position have access to the same kind of information that the act would make available in the form of a registration statement. Brian R. The critical inquiry is whether any of the purchasers acquired the securities with a view to their distribution. b) Other Early Decisions [Overruled]: (i) Hill York (a) Sophistication of offeree’s and purchasers in and of itself is not enough to qualify for the exemption. 3. 27 . (a) This is discussed further below. This is not met here.

D provides 3 exemptions (Rules 504. c) Rule 506 (i) No limit on maximum aggregate offering price.Buckham. because offerees must be able to ask the right questions. (ii) No more than 35 purchasers (not counting accredited investors). (a) ―Accredited investors‖ are not included in the count. Regulation D and the Limited Offering Exemptions 1. D a) Rule 504 (i) Available only for offerings of < $1 million. can still use the naked §4(2) statute. (b) Number of offerees. It is a nonexclusive safe harbor for §4(2). 505. closely held corporations with offerings to corporate insiders. d) 9th Circuit Approach Under the Naked §4(2) (i) In determining whether it is a public offering. e) Three Safe Naked §4(2) Transactions: (i) Small. Securities Outline 7/8/2015 1:59 PM 28 . But. (a) ―Accredited investors‖ are not included in the count. Availability of information means either disclosure of or effective access to the relevant information. This case overruled the Hill York and Continental Tobacco case rulings. institutional investors. 2. (ii) Rule 506  Nonexclusive safe-harbor for the private offering exemption under §4(2). we had to worry about the sophistication of the ―offerees. we only worry about the sophistication of the purchasers. It is a nonexclusive safe harbor for §4(2). look at: (a) Sophistication of the investor(s). can still use the naked §4(2) statute. (the acquirer) could offer shares to the shareholders of Y Corp. (iii) Affirmative disclosure obligation exists when there are any non-accredited investors. i The point of reference is thus Schedule A. Notes on ―Access‖ or ―Disclosure‖ (a) Sophistication does not eliminate the need for information. Must show that the offeree could realistically have been expected to take advantage of his access to ascertain the relevant information. (iv) Non-accredited investors must meet sophistication requirements. b) Rule 506 was enacted under §4(2). (v) Resale is restricted. (iv) Resale is restricted. Generally a) Reg. b) Rule 505 (i) Available only for offerings of < $5 million. Brian R. i If the disclosure option is exercised. there need not be a ―prior relationship‖ or ―insider‖ status. (a) Recall that under §4(2).‖ Under Reg. i Because it is nonexclusive. Overview of Reg. C. D Rule 506. (iii) Small acquisition deals – X Corp. (iv) No sophistication requirement. respectively. absence of a relationship between the issuer and the offeree does not necessarily mean it is a public offering. (i) Rules 504 and 505  Special exemptions for offerings < $1 million and < $5 million. (v) Resale is restricted. (c) Size and manner of offering. (d) Relationship of the offerees to the issuer. (ii) Offerings to large. Sophistication is still important. the person receiving the security need only receive disclosure or access to information. (c) See more information on this below. can also use Rule 506. (b) Permits the purchaser OR the purchaser’s representative to have the requisite sophistication. which lists 32 items that must be in the registration statement. and 506). ii If access to information is the measure. But. can also use Rule 506. (b) Courts have held that access to information means access to information equivalent to that which would have been provided in a registration statement. (iii) Affirmative disclosure obligation exists when there are any non-accredited investors. (a) Rule 506 was enacted under §4(2). the relationship between the issuer and the offeree becomes the critical question. (iii) No affirmative disclosure requirements. (i) Because it is nonexclusive. (ii) No more than 35 purchasers (not counting accredited investors). After Doran. This is the safe-harbor alternative to using naked §4(2) for the private offering exemption. ii (ii) (iii) 4. The Rule 506 Approach to Private Offerings a) See below for a discussion of Rule 506. (ii) No limitations on the # of purchasers. (a) Rules 504 and 505 were enacted under §3(b).

OR who the issuer ―reasonably believes‖ meets the net worth requirement. Problem 5-16 (a) No impact. i These include the president. (ii) Accredited investors are conclusively presumed to be sophisticated. These advisors are termed ―purchaser representatives. If she is an ―executive officer‖ under the rule. (d) Corporations and other organizations exceeding a certain size (> $5 million).Buckham. Calculating the Number of Purchasers Securities Outline 7/8/2015 1:59 PM 29 . c) Reasonable Belief is Sufficient (i) Rule 506 says that the investor must meet the sophistication requirements OR that the issuer ―reasonably believe‖ the investor meets the requirements. Rule 501(a) says the person must meet the net worth requirement. The risk is really to the issuer. What we are really concerned about is the liability of the issuer with respect to the offering. (b) Pension plans. b) Imputed Sophistication of Advisors (i) If an unsophisticated investor is represented by a knowledgeable and disinterested expert. or the issuer reasonably believes prior to making any sale that such purchaser comes within the description. and in calculating the number of investors in Rules 505 and 506. (b) a) This one is fine.‖ (a) Rule 501(h) defines a purchaser representative. (b) Fortunately. accredited investors are assumed to be ―sophisticated‖ under Rule 506(b)(2)(ii). regarding knowledge in financial and business matters. (b) This ONLY applies in Rule 506. The investors qualified. (h)(1)(i) saves this since they are related by marriage. and (g) Entities owned by accredited investors. This person probably does not satisfy the definition. Under Rule 501(h)(4) and Note 3 require disclosure of the relationship. Problem 5-15 (a) The worry is that the financial statements may be incorrect.‖ (i) General classes of accredited investors: (a) Financial institutions. VP in charge of the principal business unit. the sophistication of the expert can be imputed to the offeree. 3. (b) (ii) (iii) (iv) 4.‖ must have such knowledge and experience in financial and business matters that he is capable of evaluating the merits and risks of the prospective investment. Brian R. however. d) Some issuers limit their Rule 505 and 506 offerings to accredited investors in order to avoid inquiries into sophistication (under Rule 506) and affirmative disclosure obligations under Rule 502(b). (c) Venture capital firms. she is an accredited investor. Sophistication Standard of Rule 506 a) Applicable Standard for ―Sophistication‖ (i) Each non-accredited investor. e) Problems on Accredited Investors (i) Problem 5-14 (a) Rule 501(a)(4) and (f) applies. (c) b) This is troubling under Rule 501(h)(1). (e) Insiders of the issuer.‖ d) Problems on Sophistication: (i) Problem 5-18 (a) Status as a lawyer in and of itself is not determinative. For Rule 506. Problem 5-17 (a) We have to look to Rule 501(h). Problem 5-20 (a) Rules permit this. and any other person who performs a policymaking function for the issuer. But. b) Rule 501(a) defines ―accredited investor. “Accredited Investors” in Rule 505 and 506 a) Generally (i) Status as an accredited investor is important in determining the disclosure obligations in Rules 505 and 506 (no disclosure is needed if all investors are accredited). either by himself or with his ―purchaser representative. (f) Natural persons with wealth or income exceeding threshold standards ($1 million net worth or annual income of greater than $200k for each of the last 2 years). That the issuer did not check to make sure is not relevant under Rule 501(a). Problem 5-19 (a) Liability of attorney who acts as a purchaser representative who is not qualified: not much unless there is some breach of fiduciary duty or fraud. either alone or with his ―purchaser representative. since he is an insider. c) Reasonable Belief is Sufficient (i) Rule 501(a) says that the investor must meet the accredited investor requirements OR that the issuer ―reasonably believe‖ the investor meets the requirements. since she is not really involved in the policymaking function of the company. since they are estimates and unaudited. You still must satisfy Rule 501(h)(2) (ii) (iii) 5.

In such cases. trusts and corporations of a certain ownership %. Integration (a) Aggregation is a 504 and 505 problem only. If it has some other purpose. including accredited investors. and 506. the SEC seems to be more liberal with general solicitations and advertising. Integration is relevant to 504. (iii) Relevant Amount and Time Period (a) Aggregation occurs with respect to offerings pursuant to any of the §3(b) exemptions that take place within the 12 month period preceding the start of the offering under Rule 504 or 505. less the aggregate offering price for all securities sold within the 12 months before the start of and during the offering of securities under this Rule 505 in reliance on a §3(b) exemption. the offering amounts will be ―aggregated‖ to determine the total offering amount for purposes of Rules 504 and 505. services. (ii) Problem 5-22 (a) Rule 501(e)(2) governs. a pre-existing relationship between a qualified offeree and the broker-dealer (rather than the issuer) will suffice the render the communication limited under Rule 502(c) (and thus will not be a prohibited general solicitation). the answer is 1. and in 505 and 506 offerings. and adds them together for purposes of the aggregate offering price limits in Rules 504 and 505. 505. cancellation of indebtedness. (d) Source in Statute: i Aggregation is in sections like Rule 505(b)(2)(i). and others. b) Activities by Broker-Dealers Not a ―General Solicitation‖ (i) Issuers in Reg. under Rule 501(e)(1)(i). i It is not relevant in Rule 506 offerings. 6. as far as the internet is concerned. i But. D (Rule 504 and 505) Offerings a) Generally (i) Generally (a) Aggregation is important with respect to calculating the offering price amount. but not all 504 offerings. which says that ―shall not exceed $5 million. 7. since there is not limit on the offering amount. Securities Outline 7/8/2015 1:59 PM 30 . (b) Rules 504 and 505 limit the aggregate offering price on offerings within any twelvemonth period. Limitations on the Manner and Scope of a Regulation D Offering a) Restrictions on ―General Solicitations‖ or ―General Advertising‖ (i) Rule 502(c) – limits the process by which purchasers are solicited by prohibiting an issuer or any person acting on its behalf from offering to sell securities by any form of general solicitation or general advertising. c) Problems on General Solicitations (i) Problem 5-24 (a) Based on the SEC’s idea about the necessity of pre-existing relationships.Buckham. If the offering is made within that twelve month period. D offerings often solicit the marketing assistance of broker-dealers. b) Problems on Calculating the Number of Purchasers (i) Problem 5-21 (a) Rule 501(e) would count the following as non-accredited investors: i Priscilla ii Priscilla’s father (the father and Priscilla are not counted as just one because they have different residences) iii The corporation (under 501(e)(1)(iii)). They are grouped into one. property. (c) Aggregation looks to how much each offering during a twelve month period was. and provides a set of five factors. this appears to be a violation of the general solicitation requirement.‖ ii Integration is in Rule 502(a). Brian R. We have to ask if there are pre-existing relationships with the issuer here. (a) Applies in most. the answer is 11. a) Rule 501(e) provides that certain types of investors are excluded for purposes of the calculation. The answer depends on whether the purpose of the partnership is to acquire the securities. (ii) Pre-Existing Relationship Required to Not be a General Solicitation (a) The SEC has interpreted 502(c) to require some form of pre-existing relationship between the issuer and the offeree to establish the limited nature of a communication. notes. (ii) Aggregation v. If that is its purpose. (b) Integration looks at what offerings are related to one another such that they should be considered just one offering. (iii) Problem 5-23 (a) Probably only one unaccredited investor. and other consideration the issuer receives for the securities. which talks about integrating offerings 6 months before and 6 months after the current offering. Aggregation of Reg. (iv) Calculating the ―Aggregate Offering Price‖ (a) Defined: i Rule 501(c) defines ―aggregate offering price‖ as the sum of all cash.

condition. Additional Regulation D Requirements and Features a) Substantial Compliance Standard (i) A failure to comply with a term. if the person shows: (a) The failure to comply did not pertain to a term. 505. There is a 6 months safe harbor. 128 provides insight. (i) If the issuer is not a reporting company. and then later recharacterize it as a Rule 506. Says that if you can characterize it as something other than a 3(b) rule. or 506 will not result in the loss of an exemption from the requirements in §5 (rescission) for any offer or sale to a person who relies on the information. fair value of the non-cash is used. (a) (b) (c) b) The maximum aggregate offering price is lowered by the amount of any other securities sold within specified time periods in reliance upon any of the §3(b) exemptions. but that’s it. i It is fine to sell $500k during 5/1 to 6/1 of year 2. If all you have is non-cash consideration.Buckham. 1. but also 5 factors that can be used if there are multiple offerings within the 6 month period (Rule 147). its business.April 1 (b) There are rolling 12 month periods. condition.e. triple the cash amount to determine the aggregate offering price). Non-Cash Payment for Shares i If the issuer receives only non-cash. Aggregation Problems (i) Problem 5-29 (a) Jan 1 ---.Jan 1 ---. (b) Proper lawyering in such a setting is to make sure there are appraisals or something in the file that documents/establishes the value of the non-cash items paid for the shares. if 1/3 cash and 2/3 property. etc. (ii) Items that are always significant: Securities Outline 7/8/2015 1:59 PM 31 . can you get away without aggregating? That is. You could then sell as much as you want from 6/1 to 7/1 of year 2. then you then you use the reasonable fair value of the non-cash. Objective. 9. can you recharacterize it after the fact? i Note 3 on Supp. (c) Under 504 or 505(b)(2). or requirement of Rules 504. You then begin the Rule 504 on May 1 of Year 2 and it ends on July 1 of Year 2. (ii) Problem 5-30 (a) This question asks only about aggregation. the aggregate offering price is determined by reference to the cash (i. Brian R. b) The nature of the disclosures required is specified in Rule 502(b) and depends upon the size of the offering and the nature of the issuer. d) Rule 502(b)(v) requires the issuer to give each purchaser an opportunity to ask questions and receive answers concerning the terms and conditions of the offering. (b) Basic problem is the overlap.Safe Harbor c) ―Issuer Integration‖ (i) Integration of issuers arises when offerings by ostensibly distinct and separate issuers are integrated and treated as an offering by a single issuer. and (b) The failure to comply was insignificant. (a) Safe Harbor ----| 6 months – Offering – 6 months |---. (ii) Presumption of non-Integration if no other offerings within 6 months on either side. (b) If you start out as a Rule 504 (which is a §3(b). The potential problem here if you don’t have good records is that you may have exceeded the $5 million during the one month time period of overlap (5/1 of Year 2 with 6/1 of Year 1). (iv) Rule 5-32 (a) Rule 501(c) – base the value of the non-cash on the cash amount.‖ c) Rule 502(b)(iv) requires the issuer to provide nonaccredited investors with a summary of material written information that has been given to any accredited investor. Rule 502(b)(2)(i) prescribes certain disclosures ―to the extent material to an understanding of the issuer. (a) This is things like separate partnerships. and it ends on June 1. Rule 505 begins Jan. or requirement that was directly intended to protect that individual entity. because they appear to be part of the same issuance. the 100% safe answer for a new offering would be April 1 of year 2. 10. b) ―Issue Integration‖ (i) This is where several issuances are combined into one. 8. Cash + Non-cash Payment for Shares i If the issuer receives a mix of cash and non-cash. Integration of Offerings a) Generally (i) Integration is the idea that what appears to be separate financings could be treated by the law as one transaction. (iii) Problem 5-31 (a) Rule 506 and §4(2) deals are not aggregated. then you don’t have to worry about aggregation. which means it must be aggregated w/ any 505s (which are also §3(b)). and the securities being offered. subsidiaries. Disclosure Obligations in Offerings Under Rules 505 and 506 a) Any nonaccredited investors in a Rule 505 or 506 offering must be given specified information a reasonable time prior to sale.April 1 -----------------.

5 million. directors. 505(b)(2)(i). E. Regulation D Miscellaneous Problems a) Problem 5-13 (i) Probably best to use Rule 505 and only raise $3 million (because only want to offer to accredited investors and thus won’t have to do disclosures). Can the issuer say that this substantial compliance. D. b) Maximum offering of $5 million per year. 2. 505. Exemption for ―Covered Securities‖ Securities Outline 7/8/2015 1:59 PM 32 . impact a later offering. promulgated under §3(b). It has great potential for use in internet offerings. the issuer must make affirmative disclosures. however. d) Rule 701 is not available for ―reporting companies. and advisors. (a) (iii) b) c) d) 11. partners. or (iii) 15% of the outstanding securities of that class. State Exemptions 1. 504(b)(2). 2. but now it is still used to reinforce the idea that you can limit it to accredited investors and get away with a lot. Overview a) Regulation A is Rules 251-264. so they can be resold immediately. It may. officer. 502. §4(6) Exemption 1. F. Brian R. Regulation A isn’t used too much. D. One of the accredited investors wants to rescind. Must always remember that states have concurrent jurisdiction over securities laws. (i) Available also for secondary offerings up to $1. 506(b)(2)(i). it is not subject to rescission if the only failure was the failure to file an after-the fact Form D. Generally a) This is another section that is somewhat redundant because of Reg. f) Rule 254 permits some ―testing of the waters‖ by soliciting interest from prospective investors prior to filing the Offering Statement. etc. Generally a) Rule 701 exempts from the registration requirements of the ’33 Act offers and sales under certain compensatory benefit plans or written agreements relating to compensation. (i) Ever since Reg. file it under §4(2) instead of 505. It was passed prior to Reg. (i) No Integration/Aggregation  Rule 701(f) further provides that sales exempt under the rule are deemed to be part of a single. officers. (ii). despite offering to one non-accredited investor and not making required disclosures? ii 508(a)(2) tells us what is considered per se ―substantial.‖ Limitations on Resale (i) Rule 502(d) requires that the issuer use care that the persons who receive the shares comply w/ the resale restrictions. trustees. D. e) Requires the filing of an ―Offering Statement‖ (Form I-A) before the offering can commence.) has engaged in certain conduct violative of federal securities laws. Regulation A: Mini Registration 1.‖ e) Amounts sold under Rule 701 do not affect the aggregate offering price limitations for other offerings that may occur under one of the §3(b) exemptions. Problems on Substantial Compliance (a) Problem 5-33 i For the first offering. b) Restricted to a maximum sales of the greatest of: (i) $1 million. (b) Problem 5-34 i We had only one individual who was non-accredited in a 506 offering. Employee Benefit Plans and Contracts Relating to Compensation: Rule 701 1. or 506. ii For the later offering. if you limit the offer solely to accredited investors. This is largely redundant of what you can do under 505 and 506. D. (ii) 15% of the issuer’s total assets. c) Securities sold under the exemption are not restricted. there are a few advantages of Regulation A. The exemptive scope covers securities offered or sold under a plan or agreement between a non-reporting (―private‖) company (or its parents or majority-owned subsidiaries) and the company’s employees.Buckham. c) If the sales in a 12 month period exceed $5 million. Rule 505 and the ―Bad Boy‖ Disqualifiers (i) Rule 505 is unavailable for the securities of any issuer described in Rule 262 of Regulation A. This limitation arises if the issuer or person related to the issuer (including a director. discrete offering and are not subject to integration w/ any other offers or sales. f) Need to make sure the corporate resolutions allowing the offering make some mention to the fact that the stock is being issued as compensation. consultants. d) The offerings will not be integrated w/ offerings made under Rule 701. Form D (i) Rule 503 requires the filing of Form D with the SEC no later than 15 days after the first sale of securities under Rules 504. (ii) But. Prospective purchasers must be provided with an Offering Circular. G.

a distribution.” (b) It is not a ―distribution‖ if the resale to the new person would not make the second unregistered offering otherwise violative of the exemption used in the original offering by the issuer. If the resale destroys the exemption. or (iii) Any person who participates or has a direct or indirect participation in the activities covered by the two above. a) Thus.‖ and securities qualifying for an exemption under Rule 306. but secondary ―distributions‖ are not. In this setting. b) §4(1) is the central transaction exemption in the ’33 Act. we are trying to determine whether a particular resale is a “trading” transaction eligible for §4(1) or instead a “distribution” (secondary) that is NOT eligible for §4(1) (and thus must be registered). The problem is that the term “underwriter” is broad under §2(11). Introduction 1. It exempts everyone except issuers. Resales Under the §4(1) Exemption (the “Underwriter” Concept) 1. Generally a) This section concerns the ability of persons to sell their restricted shares into the public markets. and Rule 505. All the persons in the secondary distribution. NSMIA amended §18 of the ’33 Act to exempt from state registration requirements ―covered securities. i Thus. Rule 504.Buckham. and dealers. §3 and §4’s exemptions are irrelevant—there is a registration statement in effect and thus no exemption is needed from §5. 2. then there is an offering that has to be registered under §5. (i) Absent Rule 144.‖ as opposed to selling with a ―view to distribution.‖ 2. (b) The length of time the purchaser has held the shares before reselling them plays a pivotal role in determining whether the purchaser acquired the shares with a view to their distribution.‖ (ii) §4(1) looks at whether the buyer had ―investment intent. that is. (iii) Investment Intent (a) Investment intent is the key to showing that it was a trading transaction. e) Basic distinction for §4(1) purposes is between ―distributions‖ and ―trading. ―distribution‖ includes an offering of a security that is required to be registered because the issuer’s offering did not come to rest only with investors who satisfy the criteria of a single exemption from registration. a) Remember. 3. An intermediary would be used simply as a conduit. NOTE: IN THIS SETTING WE ARE RESELLING PUBLICLY via secondary transactions (offers/sales to a large group of people from someone other than the issuer). “Trading transactions” are exempt from §5 (registration). underwriters. since §5’s prohibitions against sale only applies when there is no registration statement effective with respect to the shares.(§2(a)(11)) a) Generally (i) Individual investors who are not professionals in the securities business may be considered ―underwriters‖ within the meaning of that term as used in the Act if they act as a link in the chain of transactions through which securities move from an issuer to the public.‖ (i) ―Trading‖ means there is no §2(a)(11) ―underwriter. (c) Changes in Circumstances Securities Outline 7/8/2015 1:59 PM 33 . a) III. are implicated if there is no exemption. b) Four roles that qualify someone as an underwriter: (i) Any person who purchases from an issuer w/ a view to the ―distribution‖ of a security. Transactions involving registered securities are also exempt from being registered again.‖ but there is no definition in the statute. EVERY sale (including resale) must be either registered or exempt. the answer to this question turns on §2(a)(11)’s definition of an ―underwriter. c) “Distribution” (i) Generally (a) To be an underwriter.‖ which include such things as listed securities. Secondary Distributions A. the activity must be ―in connection w/ a distribution. B. or (ii) Any person who offers or sells for an issuer in connection with a distribution. or (iv) Any person who participates or has a participation in the direct of indirect underwriting of any such undertaking.‖ c) The reason we have the secondary transactions rule is because we don’t want issuers to use an exemption on one transaction as a conduit to get the shares into the public without registering in a second transaction. This does not affect offerings under some key exemptions such as Regulation A. including the seller and the brokers. d) The basic premise is to avoid being classified as a §2(a)(11) underwriter. (ii) The Meaning of ―Distribution‖ (a) A “distribution” exists if there are sales to those who cannot “fend for themselves.‖ (ii) We also run into problems when the reseller is a ―control person. not a distribution. Brian R. Resale by “Underwriters” . when there are registered securities. securities sold to ―qualified purchasers.

(c) Solution is to sell it to a person that qualifies for the original exemption that the issuer used for its original offering. Problem 6-1 (a) Carl could be considered an underwriter because of his participation in the offering. Chinese Association) (a) The test in the case was the participation of the Association in the offering. And. then he may be locked-in and may not have the §4(1) exemption. Problem 6-3 (a) Is the bank’s resale arguably a distribution? The note at the bottom of p. he can freely resell the stock into the market. §5 problems only arise when the security being resold has not been registered. not the company’s. (b) We are okay on the change in circumstance doctrine. We could even take out the 500 shares paid to him and he could still be an underwriter under the Chinese Association case. (c) The same shares had different resale status based on whose hands they are in – control persons and non-control persons. Resales by Control Persons Under §4(1) a) Generally (i) One who purchases from a control person.‖ Problem 6-4 (a) Burt i Question is whether he purchased w/ a view to distribution. Participation Underwriters (i) Participation Requirement (SEC v. if Burt is not a control person. and Burt is not a control person.‖ (iii) Two exceptions: Securities Outline 7/8/2015 1:59 PM 34 . (b) If Janice had been a control person. but only for the purpose of determining whether the person who purchases from or sells for the control person is an ―underwriter. even though the shares were registered. it may not be a “distribution. (b) If it had been 3 years. it could be a ―distribution‖ not exempt from §5. instead of into the public market. 347 holds that a pledgee (the foreclosing lender) could be an underwriter under facts like these. which changed. If a control person sells shares. Problem 6-2 (a) How will we gauge her investment intent? This turns on whether there is a change in circumstances.Buckham. (ii) §2(a)(11) provides that a control person is an issuer. if it is a trade. she is an underwriter. Problem 6-5 (a) Sale into any market is not consistent with the private placement exemption! So. (c) If bank had sold it to one identifiable person.‖ then it is a trade. sale into this market is fine. by advertising the offering. and is thus an ―underwriter. Anyone who sells for a control person is a statutory underwriter.‖ If not a ―distribution. Regardless of her intent. (b) If Burt is instead a control person. Brian R.‖ (b) Good faith of the bank is not relevant. it would not be a ―distribution. or other promotional efforts can easily be considered to have ―participated‖ in the issuer’s distribution. or otherwise participates in a distribution of the control person’s securities. is an “underwriter. (v) Registered Shares (a) Provided the seller is not a control person. Privity is not required. because of the §2(a)(11) exemption. i d) e) One question that arises is when some change in circumstances could support a resale before 2 years… (d) Change in Circumstances Doctrine i When circumstances have changed. Then he is an underwriter.” ii The change of circumstances has to be the circumstances of the reseller. or sells for a control person.‖ Problems (i) (ii) (iii) (iv) (v) (vi) 3. because it was Beatrice’s circumstances that changed. the seller is not an ―underwriter. research reports. This is because the shares are not restricted shares. she is not selling them in a ―distribution‖ because the circumstances have changed. If so. (b) Carol i Problem is whether Carol participated in such a distribution.‖ A control person is not an issuer for other purposes of the Act because the control person is not included within §2(4)’s definition of an ―issuer. don’t do this. Problem 6-6 (a) If the shares had been sold to him as part of a registered offering. (iv) Foreclosing Lenders (a) Lenders who foreclose and sell unregistered securities as their collateral may be considered ―underwriters. (ii) Officers and Directors (a) Anyone who has arranged for public trading of an unregistered security or has stimulated investor interest in such a security through advertisements. it would make a big difference.” and thus not exempt from §5 under §4(1)’s exemption. not the issuer. whether under Rule 144 or in the plain §4(1) exemption.

(a) Also. 2. he is selling to people who can’t meet the Ralston-Purina standards. her resale of the shares is problematic because of the last sentence of §2(a)(11). But. whether through the ownership of voting securities. 4. (i) Possession. Generally a) This is the safe-harbor to the §4(1) exemption. they can’t be underwriters in that way. (ii) §4(1) and Rule 144 is used for sale of stock (restricted or unrestricted) by a CONTROL PERSON or affiliate into the public market. Would need to look at various factors to determine if it is a distribution or not. contracts. Control person can sell an ―exempt security‖ without violating §5. Resales Under Rule 144 – Safe Harbor (to §4(1)) for Resales of Control and Restricted Securities 1. there is no problem with the resale. Rule 405 gives guidance on the definition of ―control. b) Securities offered under §3(a)(11)’s intrastate offering exemption are NOT restricted securities. Here. (c) Bob (broker)  May get §4(4) exemption as a broker. whether it is a distribution or a trade. and thus underwriters. It also disqualifies for the §4(4) exemption because of solicitation. that person is not an ―underwriter. of the power to direct or cause the direction of management and policies of a person. The question will thus become when he sells Alice and Carl’s shares.Buckham. direct or indirect.§4(4) (a) The broker’s transactions exemption of §4(4) protects only the broker executing the transaction. (Rule 147(f)). Problem 6-8 (a) The §4(4) brokers exemption is only necessary if you don’t qualify for the §4(3) dealer’s exemption.‖ and is thus exempt from §5 via the §4(1) exemption. there is no argument they took ―with a view to distribution. Requirements of Rule 144 a) Availability of Public Information (i) There must be available adequate public information with respect to the issuer of the securities. (a) The fact the §4(4) broker has an exemption for the resale does NOT mean that the reselling individual has an exemption. Control person’s resale of an unregistered security may occur under circumstances that are consistent w/ the criteria of the exemption from §5 that the issuer sought. Two Key Factors: a) Whether someone is a control person. Scope of Rule 144 a) Rule 144 provides a safe harbor for resale of “Restricted Securities. the broker’s client must seek his own exemption for a resale. US v. since it is not a §2(a)(11) “distribution” and §5 has been satisfied (by registration). b) In broad overview. So. Rule 144 provides objective criteria for determining whether the purchaser has met the ―investment intent‖ which permits the purchaser to resell without becoming an ―underwriter. Each member of the board is usually considered a control person. including the number of shares. A person can still become an underwriter under the last sentence of §2(a)(11).e. Rule 147 has certain limits on resale of those securities. Problem 6-9 (a) Just because someone is called a broker does not make it a §4(4) exempt transaction. but it very likely would include directors of the corporation.‖ So. Brian R. D or §701 or §4(6) of the Act. she is probably a control person. they may still be control persons. (d) Carl  Same issue as with Alice. §4 (1 ½) comes into play. .‖ Here. for a control person to sell privately.‖ If the reseller meets the terms of Rule 144. (e) Note: There can be more than one control person. 3. b) Whether the shares are restricted. but he appears to have less control. But. Everyone involved in a resale needs to identify its own separate exemption. (ii) Brokers Exemption for Reselling Shares . Rule 405 is vague. or (ii) Securities issued pursuant to Reg.. Wolfson (i) If a person sells into the public market. (a) If the shares are registered. (a) ―Otherwise‖ has been read to include directors and high executive officers. via the §4(2) exemption). Securities Outline 7/8/2015 1:59 PM 35 C. (b) Alice  If she is a control person.” which includes: (i) Privately offered securities acquired directly or indirectly from the issuer or a control person in a transaction not involving a public offering (i. or otherwise. since the 90 day requirement for the dealer’s exemption has not been met yet. c) Two Uses of Rule 144 (i) §4(1) and Rule 144 is used for sale of restricted stock by a holder (not the issuer) into the market. (a) (b) b) c) d) Problems (i) (ii) (iii) Problem 6-7 (a) There is no §2(a)(11) ―distribution‖ problem here because the shares were registered and held for four years. “Control” = defined functionally in terms of a person’s or group’s influence over management and business policies. it would violate §5 unless the brokers exemption is available. and thus no exemption would be necessary for those shares. ―restricted securities‖ are those acquired from an issuer in an unregistered offering. d) Resales Are to Public Market (i) §4(1) and Rule 144 do not apply unless the shares are being sold into a public market. since she had power over the Board.

(ii) Has to meet the requirements: (a) Holding period. the fact that shares are restricted or unrestricted is irrelevant. so there was no full payment yet. (d) Etc. 36 .” e) Notice of Offering (i) A person desiring to sell securities in reliance upon the rule must file with the SEC a notice to that effect. Problem 6-14 (i) This implicates Rule 144. The control person cannot sell unless they meet Rule 144. Can only sell 1% per three months or the average weekly trading volume. These cannot be dumped into the market w/o a broker w/o raising the issue of whether they qualify for the §4(1) exemption or not. It is an automatic tacking. including a 9 month holding period. Problem 6-19 (i) Rule 144(d). Rule 147 will govern whether he can sell the shares. Brian R. Problem 6-20 (i) Rule 144(e) places a limit on the amount that can be sold. Problem 6-16 (i) Rule 15c2-11 discusses this issue. Holding Period (i) A minimum of one year must have elapsed between the acquiror’s payment of the purchase price of the restricted securities to the issuer and the present holder’s sale of the securities. We don’t look at the shareholder’s holding period.000 in April. After the failed Rule 505 offering. This transaction is not even described in Rule 144(b). She can sell 80. Rule 144(b) says that an ―affiliate‖ (an “affiliate” is a “control person”) who sells for his account. since they were sold under §3(a)(11). (b) Must go through a broker. Here we only have a private sale. the sale must be made in transactions directly with a “market maker” or in “brokers transactions. f) Bona Fide Intention to Sell (i) A person must have a bona fide intention to sell the securities within a reasonable time after the filing of the notice. (a) ―Holding period‖ is a bad term to use. (ii) If he is not a control person. via the ―from the issuer‖ language for the holding period. (c) Has a volume limitation. c) Limitation on Amount of Securities Sold (i) The amount of restricted securities sold cannot within the preceding 3 months exceed the greater of: (a) 1% of the number of shares in that class. since the relevant time is the time that elapses any time after the issuer sells the securities. we look at the time it was issued. (ii) This will raise the 4 (1 ½) exemption concept. Problem 6-12 (i) Here we have a failed Rule 505 exemption. d) Manner of Sale (i) To be under Rule 144’s safe harbor. It is a moving three month timeframe. infra.‖ in that they were offered under a §4(2)/Reg. Someone is selling for the account of a control person and it is a 144(f) broker’s transaction. but control persons are still subject to Rule 144 even when they are unrestricted securities! (ii) Note that the holding period in Rule 144(d) does not apply to unrestricted securities. D private offering. 6. under Rule 144(k). or (b) The average weekly reported trading volume in such security during the preceding 4 calendar weeks.Buckham. Problem 6-13 (i) This is NOT a Rule 144 transaction. the holder is not impacted. because the required information is not on file! Then. (iii) Alice does have Rule 144(c) problems. It is unrestricted stock. Problem 6-15 (i) Rule 144(d)(1) says that a one year term is used. (i) See problem 6-17. Problem 6-11 (i) These are not restricted securities. which we will see later. The one year period runs from the date the shares are acquired from the issuer. Control Persons a) If someone is a control person. by getting around John’s problem. Problem 6-18 (i) Rule 144(d)(2) says his holding period has not even started to run! His only collateral for the note was the shares. She still has restricted securities. (ii) Rule 144(k) – certain restrictions on resale are terminated upon certain periods (2 years after the original purchase from the ISSUER). Can the bank sell? Bank should be able to sell these. Rule 144 transactions apply only to brokers’ transactions into a public market. The company was thus deprived of its exemption. b) 5. Problem 6-17 (i) She is probably a control person. Problems a) b) c) d) e) f) g) h) i) j) k) Securities Outline 7/8/2015 1:59 PM Problem 6-10 (i) These are ―restricted securities. it waives some of the requirements if they have been held for two years.

satisfying Rule 144 is more than sufficient to qualify the resale under most state blue sky laws. (c) Any corporation or partnership meeting the $100 million requirement. (ii) Uses the 4(1) exemption based on 4(2) criteria. courts have looked to §4(2) private offering exemption for control persons. The §4(1 ½) Exemption for Control Persons a) Generally (i) Since §2(a)(11) defines an ―underwriter‖ as any person who has purchased from an issuer with a view to the distribution of any security.‖ or other problems. Securities Outline 7/8/2015 1:59 PM 37 . which refers to issuers. COULD HAVE USED §4(2) ORIGINALLY TO GET IT TO THE ACCREDITED INVESTORS. c) Note: In 2001. b) Eligible Purchasers from the Reseller (i) An institution must have at least $100 million in securities of issuers that are not affiliated w/ the institution. Problem 6-21 (i) Have to include those sold by the donee (Cornell). b) Generally there is a view that there is also an information requirement for the exemption. Rule 144A a) Provides a non-exclusive safe-harbor from the registration requirements of §5 for the resale of restricted securities to specified institutions by persons other than the issuer of the securities. (ii) Rule 144(e)(3)(vii) says there are certain protections against integration. It is probably okay here under (g)(2)(i) and can still be a ―broker’s transaction.‖ (ii) Gives more liquidity to restricted securities.l) m) n) o) Buckham. since it allows the shareholders to sell their restricted securities to ―qualified institutional buyers‖ (QIBs). b) Rule: (i) Resale is permitted under the auspice of §4(1) by control persons so long as the purchasers would have qualified under Ralston Purina (the 4(2) criteria for the private offering exemption).‖ and thus the reseller is not an ―underwriter. and says there can be no solicitation except as stated. the question of whether there is a §4(1) exemption is whether there has been a public offering. d) USED ONLY FOR RESALES. so the answer is 180-120 = 60. Have to subtract that from her permissible 180. This can include: (a) Banks and S&Ls (must also have net worth of > $25 mm) (b) Registered Broker-Dealers (w/ $100 mm reduced to $10 mm). thus. D. F. Rule 144A Exemption for Resales to Institutional Investors 1. the control person will not likely qualify for the §4(1) exemption. Generally a) Because of the number of shares offered. The Section 4 (1 ½) Exemption for Resales by Control Persons 1. Advertising a) Broad solicitation and advertising is believed to be inconsistent w/ the §4(1 ½) exemption.000 shares. Buyer Sophistication a) One of the most uncertain areas under §4(1 ½) is whether the control person’s buyers must be sophisticated. (ii) Rule 144(g)(3) does require the broker to make some reasonable inquiry into the circumstances. a control person may in some cases be unable to bring his sale within Rule 144.‖ 2. (a) Whether it is a public offering turns on the need of the investors of the protection of registration. Problem 6-24 (i) Question is whether these two transactions will be integrated. Brian R. the lack of a ―broker’s transaction. (i) It provides that the transactions are not ―distributions.000 shares. $480 billion in securities were sold under Rule 144A. 3. b) Control persons have a problem because they are covered in the last sentence of §2(a)(11) (the definition of ―underwriter‖). 4. E. and since a distribution requires a public offering. Resales Under State Blue Sky Laws 1. combined somewhat with §4(1)’s exemption of persons who are not ―underwriters. 144A IS FOR THE SHAREHOLDERS TO GET IT TO THE INSTITUTIONS (ESSENTIALLY ACCREDITED INVESTORS) IN A RESALE. This is where the §4(1 ½) exemption comes into play. Thus. Federal laws with respect to resales are often more stringent than state laws.‖ Problem 6-23 (i) Even though the brokers themselves get the §4(4) exemption. Problem 6-22 (i) Rule 144(g)(2) applies here.

Securities Outline 7/8/2015 1:59 PM 38 . Brian R.Buckham.

in some circumstances. Recapitalizations.Buckham. Reorganizations. a sale is not involved if the change involves no economic consequences to the holders. (iv) Problem 7-4 (a) Registration under §5 is not required when a company reincorporates since it is a mere change in form. the holder can acquire the underlying security through conversion or exercise. the security must be registered or qualify for an exemption. such as altering the share’s par value. there is an acquisition involving issuance of shares in an acquisition. (a) The rationale is that the shareholder’s interest in the corporation does not change when there is a stock dividend. b) Dividends (i) The typical cash dividend does not involve the offer for sale of a security. c) Warrants and Convertibles (i) Whether the underlying security (the securities obtained when the warrant or convertible is exercised) must be registered depends on when. and thus it is a sale ―for value. the transaction may not really involve a ―sale‖ of securities (for value). b) Regulation of Spinoffs in the ’34 Act (i) Rule 15c2-11 governs spin-offs. Though the shares may have been issued. not substance. (ii) Problem 7-2 (a) If the stock is cumulative. (iii) A choice between taking cash or stock as a dividend does not involve the offer for sale of a security. etc.‖ b) Thus. (ii) Subject to certain exceptions. e) Example Problems (i) Problem 7-1 (a) A choice between taking cash or stock as a dividend does not involve the offer for sale of a security. On the other hand. (b) The SEC has held that this constitutes giving value for the securities. d) Amendments to Articles of Incorporation (i) The SEC is fairly consistent in viewing all material changes in a security’s economic or voting rights as entailing the sale of a new security. IV. (b) Registration under §5 is not required when a company reincorporates since it is a mere change in form. the company is in effect incurring a debt. In this case. Generally a) Securities are ―issued‖ when a corporation declares a stock dividend. (ii) The typical stock dividends in the form of stock does not implicate §5. Securities Outline 7/8/2015 1:59 PM 39 . not substance. but not a sale. as well as whether the spinoff was accompanied by adequate information (―information statement‖) available about the spunoff company. 3. whereby the stockholders may by prior agreement have their dividend applied toward the purchase of additional shares from the corporation at current market prices. Shells and Spinoffs: Creating ―Value‖ a) Spinoffs and the ’33 Act (i) Spinoffs may be deemed a sale of a security under §5 of the ’33 Act. such as altering the share’s par value.‖ The conversion is treated as new consideration. the rule prohibits a broker or dealer from submitting a quotation for a security in a quotation medium unless it has in its records specified information concerning the security and the issuer and. since there was no value given. are subject to registration under the ’33 Act. there is a share conversion. by the terms of the instrument. The “For Value” Requirement 1. (ii) The focus is on whether there is a proper business purpose for the transaction. (i) Stated differently. Value Is Not Always What It Seems a) Gifts of Securities (i) A gift of securities is still considered ―for value‖ when the gifts appear to be given with an eye toward distribution. It is an issuance of stock. (iv) Dividend reinvestment programs. If it does not. (a) SEC requires all sales of spunoff shares to comply with Rule 144. the company is converting this ―debt‖ into equity. On the other hand. (ii) Registration under §5 is not required when a company reincorporates since it is a mere change in form. the result is the same – no value given so no sale so no §5 implications. and Acquisitions A. not every ―issuance‖ is a ―sale‖ of securities for purposes of §5. (iii) Problem 7-3 (a) The SEC is fairly consistent in viewing all material changes in a security’s economic or voting rights as entailing the sale of a new security. If the conversion terms provide that the second security can be obtained at any time. a sale is not involved if the change involves no economic consequences to the holders. only when there is a sale or offer to sell ―for value‖ is there a §5 issue in the case of any given transaction. It just divides the pie into more pieces. not substance. But. furnishes the information to the interdealer quotation system two days before publication of the quotation. then we don’t need to worry about §5. (b) The SEC ruling on this matter seems to suggest that even when there are different classes of shares involved.‖ §2(a)(3) defines ―sale‖ to involve ―every attempt … to dispose of … a security … for value. 2. §5 operates only when there is an ―offer for sale. Brian R.

General Notes a) Form S-4 is used to register securities issued in mergers and business combinations. accrued dividends. Mergers.” (i) The traditional §3(a)(9) transaction is an issuer’s offer to swap a new security for its old security (e. which hold that persons acquiring shares in such a setting are ―underwriters. b) Three Types of Rule 145 Transactions: (i) Recapitalizations (ii) Mergers (iii) Certain Transfers of Assets c) Rules 165 and 166 apply only to transfers that fall within Rule 145. 165. c) The exemption is lost if the security holders must.. and §4(2). Rules 165 and 166 a) The Rules permit parties to communicate freely about a planned business combination transaction before a registration statement is filed. such as exchanging shares with its current shareholders. 5. Rule 145 Transactions a) Business combinations and recapitalizations trigger §5 concerns whenever they involve the issuance of securities.c) Buckham. (b) Because they are not restricted securities. common stock for preferred stock). but the securities here are not restricted securities. so long as their written communications (except mere internal communications between the parties) used in connection w/ or relating to the transaction are filed beginning with the first public announcement and ending with the close of the proposed transaction. and then B liquidates and gives the A stock to its shareholders. 2. Example Problems (i) Problem 7-5 (a) This company is a ’34 Act company because it has high assets and 7k shareholders. This then becomes a ’34 Act problem. Today. C. (iii) Problem 7-7 (a) Broker needs to be assured that the ’34 Act reports are made. as a condition of the exchange. (ii) This is a broad exemption for recapitalizations. (c) Consolidation = A and B form a new corporation C. Introduction a) Types of M&A Under IRC §368(a)(1) (i) A  Statutory (state statutes) merger or consolidation (a) Shareholders of the acquired company give up their shares and take shares in the other corporation. It is a negotiated deal. Brian R. (11). there are no holding period requirements. (b) Merger = A acquires B and A remains. (i) These rules greatly relax the §5 rules against release of deal-related information. and Recapitalizations 1. not a tender offer. it must be exclusively offered with the security holders of the issuer. it must be a reporting company. pay any consideration in addition to their old securities. So. (iv) Tender Offers (a) A solicits B’s shareholders directly. Rules 145. (iii) C  Stock-for-asset exchange (a) A gives stock to B to purchase B’s assets. (i) This raises concerns with integration of several transactions. as well as during the waiting and post-effective period. (ii) B  Stock-for-stock exchange (a) A gets control of B by directly exchanging its stock with the B stockholders. 4. Alasko need not register its shares. (ii) Problem 7-6 (a) No. (iii) This is an intra-organizational recapitalization. (i) Loss of voting rights. Acquisitions.g. b) For an exchange to qualify for the exemption. b) Offers in connection w/ business combinations are ―continuing offers‖ and hence must comply with the shelf registration requirements of Rule 415(a)(1)(viii). 3. (10). d) Rule 145 does not affect the following statutory exemptions available under the ’33 Act: §3(a)(9). B.‖ This then leads to Rule 144’s rules. Exempt Exchanges Under §3(a)(9) 1. Securities Outline 7/8/2015 1:59 PM 40 . and 166 regulate much of the scope of §5 when securities are issued in connection w/ most business combinations. Ability to Resell into a Public Market a) Rule 145(c) and (d) govern. Generally a) §3(a)(9) exempts “any security exchanged by the issuer with its existing security holders exclusively where no commission or other remuneration is paid or given directly or indirectly for soliciting such exchange. or interest or collateral does not destroy the exemption.

2. 2. Securities Outline 7/8/2015 1:59 PM 41 . and Similar Organizations e) §3(a)(8)  Insurance Policies and Annuities (i) The debate is whether the insurance contracts are even securities at all. b) Unlike §3(a)(9)..Buckham. and Collective. Introduction a) These are any securities of the government below the level of the federal government. b) Types of Municipal Securities: (i) General Obligation Bonds (a) Backed by the taxing authority of the government. V. but also owners of the securities need no exemption in order to resell their securities. these would clearly be securities. since they are probably already not securities. disclosures must be made by an underwriter by means of a document called the Official Statement. if the maturity at the time of issuance does not exceed 9 months. b) §3(a)(3)  Short-term Notes (―Commercial Paper‖) (i) There is an exemption for any note. Nonbankruptcy Reorganizations a) §3(a)(10) exempts the issuer’s exchange of securities for outstanding securities. d) e) D. Not backed by the taxing authority of the government. the exemption is available for a reorganization involving two or more companies. Bank Securities. (a) Supererogation = doing more than duty requires. only from a limited source. or Single Trust Funds (i) Municipal bonds. Exempt Securities A. regulation of the area is focused on what brokers and dealers can do with respect to municipal securities offerings. 2. The exemption is from registration. Exempting them appears to be more than necessary. rather than the security. however. c) The instrument may not represent an ―investment‖ (e. claims. (i) State sovereign immunity is one reason. Overview of §3 a) §3(a)(2)  Government Securities. by a court. and in these cases the exemption does not extend to resales. Brian R. Bankruptcy Act Collision w/ Securities Laws a) §1125 of the Bankruptcy Act requires that there be adequate disclosure accompanying the solicitation of the debtor’s claimants’ approval of the reorganization plan. (ii) Revenue Bonds (a) Repaid. c) Restriction on resale applies only to ―affiliates.g. if at all. b) Note: A number of §3’s exemptions pertain to the transaction. provided the transaction’s fairness has been approved. Common. or d) Political or constitutional considerations that makes registration problematic (e. or property. c) §3(a)(4)  Nonprofit Issuers d) §3(a)(5)  Securities Issued by Savings and Loans. not only are issuers of exempt securities free from the burden of registration. As a result. (ii) §3’s exemptions do not exempt the securities from the ’33 and ’34 Acts in entirety – the antifraud and some other provisions remain. 11 reorganization plan if they are issued principally in exchange for the debtor’s existing debts and securities. Policy justifications for exempting securities: a) Character of the issuer (government). Disclosure a) The SEC does not require municipal securities to be registered or have a prospectus.. The exemption is only for the issuer’s exchange. commission. Generally a) Applicability of the Exemption (i) Exempt securities are permanently exempt from registration under §5. after a hearing. municipal securities). or other government authority. B. b) Existence of a regulatory regime that adequately protects investors. an exchanging security holder must find his own exemption for any subsequent sale of a security received in the exempted exchange. Exempt Reorganizations Under §3(a)(10) 1. Introduction 1. etc. 3. (a) This is done via Rule 15c2-12. QUESTION: Can’t every M&A transaction fit into this exemption? (i) NO! This is only for intra-organization exchanges. draft. which is a very rough counterpart to the corporate prospectus. agency. are still subject to the restrictions in Rule 15c2-12. Cooperative Banks. Focus on Municipal Securities 1. (a) Were it not for the exemption.g. securities of non-for-profit issuers). b) Disclosure by Underwriters (i) For the sale of municipal securities. b) §1145 of the Bankruptcy Act exempts from §5 of the Securities Act any securities issued in an Ch.‖ Non-affiliates who obtain shares through the §3(a)(10) exemption hold unrestricted securities. (i) The rational is that federal regulation may cause Constitutional law problems.

(ii) If the deal is competitively bid. b) Rule 131 (i) If the ultimate payback revenue will come from the private activity itself. there is no enough time to prepare a preliminary official statement. c) Obligation of Broker-Dealers -. the preliminary official statement is required. (b) Standards for disclosure are outlined in the Government Finance Officers Association’s Disclosure Guidelines for State and Local Government Securities. Industrial Development Bonds a) IDBs finance projects owned and operated by a private-sector party. mandatory disclosure is not required. (i) Example: municipal bonds to build a sports stadium. Competitively Bid Deals (i) Some issuances are negotiated between the municipality and the underwriter. If it is a negotiated deal. so there is an exemption for having to prepare it.Buckham. Brian R. but distributed by underwriters and broker-dealers. 42 . Rule 15c2-12(b)(2). Problems a) b) Securities Outline 7/8/2015 1:59 PM Problem 8-1 (i) Rule 15c2-12(b)(2) governs. then there is a ―separate security. (ii) Requires underwriters to provide any potential customers who so request with a copy of the issuer’s most recent preliminary official statement.‖ Rule 131 governs this.Rule 15c2-12 (i) Requires underwriters participating in a primary offering to obtain and review an official statement that an issuer of such securities deems final. Then. there may be an integration problem in this case. (ii) If a municipal security is insured. d) Negotiated v. 4. In other cases. The Official Statement is prepared by the municipality. (a) 3. the underwriters may engage in competitive bidding for the underwriting. They build the stadium at public expense for the benefit of the private sector. Problem 8-2 (i) Rule 15c2-12(a) has a $1 million dollar limit.

Maximum damages are $5 under §11. or in no event after three years after the security was offered to the public. b) General Rule (i) A material misrepresentation or omission in a registration statement will subject the issuer and (subject to a due diligence defense) a variety of persons associated with either the issuer or the distribution to damages in a suit brought by any person who bought securities issued pursuant to that registration statement. Introduction a) Relevance (i) Section 11 liability comes into play only in the context of an actual registered deal in a public offering. If you DO register but do so poorly. (Via §13). i ―Value‖ is the term used. Liability Under the ’33 Securities Act A. then liability is under §12(a)(1). (iii) Maximum Damage Cap (a) Damages will be computed always with reference to the public offering price at the time of the IPO. c) Limit of §11 Liability . But. b) Standing (i) Generally (a) Any person who bought shares under a defective registration statement has standing. (v) Alternatives (a) If P cannot get standing. Section 5 – Liability Under the ’33 Act I. (iv) Causation Defense Securities Outline 7/8/2015 1:59 PM 43 . (b) This can be problematic. Most people don’t even take actual possession of their stock certificates. it will have to seek a remedy under other sections of the Act. since it allows P to argue that the market price at the time the suit was filed was improperly inflated. then runs up to $30. §12(a)(1) (i) If you should register but do not. §11 Case Elements a) Material Misstatement or Omission (i) There must be a material misstatement or omission in the registration statement. it gets very difficult (unless there was only one class of shares and one offering). d) Cf.§11(g) (i) Liability of the issuer is up to the amount of money raised pursuant to the registration statement in the offering. but no more. The only limit is that P must trace the shares he bought back to the registration statement some time in the past. it does not matter whether the shares were acquired by the P in an issuer or trading transaction. including §10b-5. each of these has hurdles.Buckham. Thus. §12. i Example: (a) IPO at $10. when P acquires stock in the secondary trading market. which does NOT include a ―diminished gain‖ argument. and §17. (iii) Reliance Not Necessary (a) P does not have to show reliance on the misrepresentation. liability is under §11. (ii) Tracing (a) The person has to be able to trace the shares they purchased to the registration statement. i As long as the shares were originally sold under the defective registration statement. §11 Liability  Misrepresentations in the Registration Statement 1. e) Statute of Limitations (i) No action can be brought after one year after the discovery of the falsity or omission. Brian R. 2. (a) Thus. since shares are fungible and there may be some shares trading in the market in addition to those issued under the registration statement. (ii) ―Diminished Gain‖ Insufficient (a) Must show monetary loss. Maximum damages will be based on this amount. then falls to $5. c) Damages (§11(e)) (i) Generally (a) P’s are entitled to recover the difference between the original purchase price (not exceeding the price at which the security was offered to the public) and the value of the stock at the time of suit. P didn’t have to get it directly in the underwriting market – he could have got it through a series of trading transactions. And. and the person will still have standing. the share sold under the registration statement could be bought and sold numerous times. (iv) Lack of Knowledge Required (a) P will have to show that he did not have knowledge of the defective portion or misrepresentation in the registration statement. it is a narrow yet important provision.

§11(b)(3) Due Diligence Defense for Persons Other Than the Issuer a) Generally (i) §11(b)(3) provides a due diligence defense to persons. that the statements therein were complete and accurate. not on the basis of the statute itself. “Non-Expertised” Portions (i) Generally (a) ―Expertised‖ portions: i The expert is liable for misstatements or omissions unless he had.Buckham. They were not entitled to rely on anyone else. after reasonable investigation. 4. i D has the burden of proof to show that the losses were cause by other reasons. But. If D can prove the drop in price was caused by something other than the material misstatement. For example. Reasonable investigation requires more than just reporting what the issuer gave them. the damages may be lowered or could be eliminated entirely. Timing Issue i Suppose X is the effective date and Y is the disclosure of the misrepresentation date. Brian R. (iv) §11(b)(3)(C)  Standard of Non-Expert for Expertised Portions (a) If a portion was prepared by an expert. non-experts may rely upon the statements of the experts. as long as there were no reasonable grounds to believe and the person did not believe the statements were untrue. (a) This came out of the case. (ii) The statute does not differentiate as to how it classifies similar groups of persons. i Query whether the only decline that is compensable would be the amount of decline after an announcement of the misstatement. §11(b)(3)(C). each director that signs the registration statement is liable. The issuer is strictly liable for all material misstatements or omissions in its registration statement. reasonable ground to believe and did believe. except the issuer. 44 Securities Outline 7/8/2015 1:59 PM . The theory of Akerman and Beecher is that only the decline AFTER the disclosure of the misrepresentation is relevant for purposes of determining the damages. (ii) Liability of the Underwriters (a) The underwriter must conduct a lot of due diligence. b) Three Key Subsections and “Expertised” v. To the extent the D can prove the loss was attributable to something unrelated to the misrepresentation in the prospectus.‖ d) Example Liability (i) Liability of CEO and CFO (a) Potential liability of the CEO and CFO approach the absolute liability of the issuer. (b) Non-expertised portions: i Persons who are not ―experts‖ have a duty to investigate and can raise the due diligence defense only if after reasonable investigation they had reasonable ground to believe and did believe that the statements in the registration statement were true and correct. at the time the registration statement became effective. (a) The theory is that any other declines must be attributable to some other information. though it may be possible. Problem 9-2 (a) There would not be any damages under the Akerman and Beecher cases. It is very difficult to get the (b)(3) defense for the top officers. Akerman and Beecher cases say ―yes. (a) (b) (c) (v) 3. then damages will be reduced or nonexistent. since that was all pre-announcement. Clearly the drop from $10 to $7 cannot be recovered. Strict Liability for the Issuer a) There is no defense for an issuer with respect to culpability. c) Sliding Scale Idea of §11(b)(3) (i) There is a sliding scale developed in the BarChris case. (iii) §11(b)(3)(B)  Standard of Expert for Portion Prepared by that Expert (a) An expert must do a reasonable investigation and have reasonable grounds to believe that there were no untrue statements in the portion that he expertised. But. (ii) §11(b)(3)(A)  Standard of Non-Expert for Non-Expertised Portions (a) A non-expert must do a reasonable investigation and have reasonable grounds to believe that there were no untrue statements in the non-expertised portions. case law holds that there is a sliding scale of liability for those directors – more is expected of an inside director to show his due diligence defense than is required of an outside director. Outsiders will get more slack as to what is ―reasonable reliance. They were held liable in BarChris even for the material in the expertised portions. it is possible that the court will take into account the fact the company carefully timed its misstatement announcement with the announcement of its new major government contract.‖ ―Negative Causation‖  This is the §11(e) ―Provided That‖ section.

the difference between the price paid and the amount received in the subsequent sale. and C can recover from B. Dahl a) §12(a)(1) says any person who offers or sells a security in violation of the ’33 Act registration requirements is liable to the person purchasing such securities from him. Remedy = Recission a) An illegal offer creates a right of rescission. (c) Require a check of matters that are easily verifiable. (i) §21D(f) supersedes §11(f) when it is a class action. (iii) Grant’s (from BarChris) Checklist (a) Do not accept the assurances of the executive officers. (d) Conduct mini-audits. Who is a ―Seller‖ in §12(a)(1)? – Pinter v.e. (i) If A sells to B.‖ (ii) Rule 176 (a) Factors determining whether there was ―reasonable investigation‖: i Type of issuer. c) §21D(f) of the ’34 Act (i) Imposes ―proportionate liability‖ in class actions. (i) If P sold the shares. 5. v Presence or absence of another relationship to the issuer. There is also no requirement that P show an injury. it is strict liability. Contribution (i) Indemnification = getting 100% off-the-hook. This is true even if the person is not the person passing title to the shares (i. (b) Test oral information by examining the original written record. b) There is no state of mind element. 2. It also results in companies underpricing their IPO. Net to the company is thus lower. employees. Instruction goes to jury to apportion the liability between and among the defendants. Brian R. Perhaps investors would be willing to allow reduced due diligence to make sure more money gets to the company in the issuance. Securities Outline 7/8/2015 1:59 PM 45 . the person hit with the full damages will be entitled to an apportionment from the other tortfeasors or breachers. The only defense is to be able to show some exemption from registration. (ii) §21D applies to both the ’33 and ’34 Act. (ii) Being merely a ―substantial factor‖ in causing the sale of unregistered securities is not sufficient in itself to render a D liable under §12(a)(1). 3. b) §12(a)(1) liability is imposed only on a person who successfully solicits a purchase. and B sells to C. §2(a)(3) has a broad definition. (ii) Contribution = natural outcome of joint and several liability. iii Type of person. Policy Problem of §11 a) Due diligence is expensive. the Securities law is anti-indemnification and pro-contribution. iv Office held when the person is an officer. vii Type of underwriting arrangement (if an underwriter). (i) Thus. 5. 6. (e) Make inquiry into questionable items. This is the Pinter case. each for the amount of the loss. Generally a) Applies ONLY to unregistered offerings. (i) A person can also be a ―seller‖ even if that person does not pass title. which even includes a person who solicits an offer to buy. an agent of the owner can be a ―seller‖). and the underwriters will want a larger share of the amount to compensate for their risk. 4. Section 12(a)(1) Liability  Unregistered Offerings 1. and viii Who had responsibility for the document or fact. vi Reasonable reliance on officers. Issue is who is a ―seller‖ for §12(a) purposes.Buckham. e) B. Problems a) Problem 9-3 (i) §12(a) is a ―seller‖ liability provision. which indicates that the person need not pass title to be a ―seller‖ under §12(a)(1). (i) §12(a)(1) liability is triggered by any offer or sale in violation of §5 (fails to register the offering when it should be registered). then B can recover from A. if necessary. AND is motivated at least in part by a desire to serve his own financial interests or those of the securities owner. b) Item 512(i) of Regulation S-K says that indemnification agreements must be approved by the court unless counsel opines that the propriety of that agreement is settled by controlling precedent. d) §11(f) of the ’33 Act imposes joint and several liability. No Defense a) It is strict liability. Indemnification and Contribution Under §11 a) Indemnification v. ii Type of security. the standard of reasonable investigation is ―the standard of reasonableness required of a prudent man in the management of his own property. What is ―Reasonable Investigation‖ (i) §11(c) (a) Under §11(c).

however.‖ and if so. (i) It has even been extended to apply to an individual investor who defrauds his broker in a trading transaction. Problem 9-6 (i) Bob can recover $3 from Alice. scheme. It could be a close call. c) §17(a)(3) (i) Prohibits any person to engage in any transaction. Introduction a) Applies ONLY to registered offerings (Gustafson). or artifice to defraud. (ii) b) C.‖ about the falsity or omission. b) §12(a)(2) extends the rescissionary remedy of §12(a)(1) to situations where a person offers or sells a security by the means of a false or misleading prospectus or oral communication. Relevant Sections a) §17(a)(1) (i) Makes it illegal to employ any device. (a) Thus.‖ 2. 2. Section 12(a)(2) Liability  Sale or Offer of Security With Misrepresentations or Omissions 1. aftermarket purchasers cannot bring suit. Recall that privity is required under §12(a)(1). (a) No scienter element. practice. or course of business which operates or would operate as a fraud or deceit. (iii) Duff & Phelps are not liable under §12(a)(1). §17(a) does not create a private cause of action.e. (a) This includes an obligation to undertake a reasonable investigation. 4. Problems a) Problem 9-7 (i) Alice can get her $5 from Ecto. based on the definition of ―prospectus‖ applies only to issuer transactions (IPOs). 3. b) §17(a)(2) (i) Prohibits any person from obtaining money or property by means of any untrue statement of a material fact or any omission to state a material fact. (i) Some courts hold that ―the right of rescission in §12(a)(2). and it also does not apply to issuer transactions that are not public offerings (i. whether she can use the ―reasonably did not know‖ defense. for similar violations. Liability a) Defense (i) A defense based on lack of culpability is available if the D ―did not know and could not have known through reasonable care. such as private placements). and Alice can recover $5 from Ecto. even if the purchaser can trace the share to the IPO. Securities Outline 7/8/2015 1:59 PM 46 . (i) §10(b) of the ’34 Act does provide a private right of action. But. It does not apply to resale transactions. (a) This requires knowing and intentional misconduct. but Bob is likely out of luck either because he is not asserting a claim from the b) D. Brian R. not trading transactions. b) §17(a) does NOT give a private right of action. Problem 9-8 (i) Have to wonder if she is a ―seller. Extents a) Court has held that §17(a) is not limited to fraud in the process of a distribution of securities. 3.Buckham. original issuance or because Alice may have a ―did not reasonably know‖ defense. Scope of the Rule: a) Applies ONLY to registered offerings (Gustafson). b) Defendants are not liable for any portion of the rescissionary measure of damages that represents a decline in the value of the security unrelated to the subject of the misrepresentation or omission.. Section 17(a) Liability  Defrauding 1. b) Some courts hold it applies only to issuer transactions. (a) No scienter element. Ruffa & Hanover firm is probably not liable under §12(a)(1). c) Suit can be against any ―seller. Introduction a) §17(a) is very similar to §10(b) of the ’34 Act. though the contingent fee arrangement does seem to make it possibly within the Pinter range.

3. and (b) Requires a system of internal accounting control. 2. Can’t (ii) 4. and PCAOB is funded by fees paid to the SEC from registrants (used to be governed privately by CPA firms).Buckham. Once a company has registered its securities. unless the person sued can prove he acted in good faith and had no knowledge that the statement was false or misleading. (ii) §13(b)(2) does two things: (a) Requires recordkeeping. manipulate the situation to avoid the ’34 Act requirements. in reasonable detail. The goal of disclosure under the ’34 Act is to ensure the company ―fairly presents‖ its financial position and operations. b) §18 is largely dead because it has various procedural disadvantages. C. and requires registered or reporting companies to: (i) Make and keep books and records that. §10(b)(5) and Rule 10b generally provide a better cause of action. Court would not look at substance over form – Court would not look at the reason for the creation of the trusts. Liability Under the ’34 Act a) There is a private right of action in §18 of the ’34 Act. Brian R. Recovery is permitted by anyone who. and Culture A. Introduction 1. The SEC has encroached upon state law corporate governance. SOX and Accounting a) One thing SOX tried to do is improve the processes by which the financial information is originally generated within the company. in reliance on such statement. and (ii) Have in place a system of internal accounting controls sufficient to provide reasonable assurances that transactions are executed and reported properly. Bacardi case. b) GAAP governs the internal accounting. 8-K. Exchange Act’s Periodic Reporting Obligations a) The ’34 Act requires that certain securities be registered with the SEC. (a) This is a substance over form situation. it is subject to continued reporting under the Act and to regulation of many of its other activities. the company must also disclose other information contained in Regulation S-K. c) Notes: Securities Outline 7/8/2015 1:59 PM 47 . Origins and Metrics for Financial Information a) Although the SEC has authority to pronounce accounting rules. Financial Reporting: Mechanisms. c) In addition to financial information. has purchased or sold a security which was impacted by the statement. We don’t know the solution to this. Reliable Records and the Foreign Corrupt Practices Act 1. however. This goes beyond the area of outside auditors. But the facts here are the reverse – they want 100 trusts to make sure the ’34 Act registration remains. in accordance with GAAS (promulgated by the PCAOB). b) §13(b)(2) of the ’34 Act was added by the FCPA (the FCPA is large. and only part of it is in the securities laws). e) Problem 10-1: (i) Rule 12g5-1(b)(3) suggests the persons cannot make the trust to avoid application of the securities laws. ii PCAOB has power over GAAS. 10Q. Section 6 – The ’34 Act I. (a) This is a ―federalization‖ of corporate governance (taking it away from the states). etc.) c) §13’s reporting obligation is triggered if the issuer meets one of the following tests: (i) Exchange-Traded Company Test (ii) Over-the-Counter Stocks Test (iii) §15(d) for Registered Companies d) Foreign Issuers (i) Relief from the ’34 Act registration requirement is available only to issuers that have not chosen to use the facilities of the American securities marketplace. which are promulgated by FASB (and supplemented by the AICPA). (i) Liability is incurred by anyone who makes or causes to be made a false or misleading statement in a filing under the Act. b) §13 of the ’34 Act contains a list of events for which the company must file with the SEC (such as a 10-K. including requiring outside directors to act as internal auditors. with rare exception it defers to GAAP. Disclosure Requirements of Public Companies 1. (b) Other examples of federalization from SOX: i Federal government funding of FASB via fees paid to the SEC from registrants (used to be funded privately by the private sector). accurately and fairly reflect the transactions and dispositions of assets of the issuer. B. said the determining factor for the number of shareholders was the number of shareholders on the records in the company’s books. and instead looked at form over substance. Introduction to the FCPA (§13(b)(2) securities law section) a) Overview: (i) Requires companies to have internal systems to provide integrity to the ultimate financial statements that come out of the system. b) ―Federalization‖ (i) SOX has resulted in the SEC having a stake in the way corporations govern their affairs. Duties. and the SEC further requires that the financial statements filed be certified by an independent auditor.

c) Audit committee is directly responsible for the oversight of the independent auditor’s work. though the auditing firm need not be rotated. b) Independence of Outside Auditors (i) §10A(g) makes it unlawful for an auditing firm to contemporaneously provide certain non-audit services. diversity of operations. c) CEO and CFO must certify financial statements under Item 601(31) of Regulation S-K. Securities Outline 7/8/2015 1:59 PM 48 . Thus. d) The independent auditors must report to the audit committee regarding the quality of the financial statements. Total reliance on the auditors is not good enough – there must be some independent assessment. should avoid the FCPA provisions in §13(b)(2). among other things. but not conclusive. There is no scienter requirement in §13(b)(2)(A). (ii) The accounting control systems need not be fail-safe. b) §10A requires that each listed company have an audit committee comprised exclusively of independent directors.The lead audit partner for a client must be rotated every 5 years. inadvertent errors. It is persuasive. d) Rules 13a-15 and 15d-15 require registrants to establish an overall system of disclosure controls and procedures. i Ultimate legal standard is still being determined. such as investment banking services. It is hugely vague. c) Independence of Internal Auditing Committee (i) §10A(m)(3) – Each member of the audit committee must be a member of the board of directors and shall otherwise be independent. 3. The SEC and Governance 1. (ii) §10A(j) -. Auditor Independence a) Generally (i) The need for auditor independence was prompted by the rising importance of non-auditor services in the overall financial operations of the auditing firms. whether through misfeasance. (i) 2. (d) The CFO and CEO must undertake some independent review. (a) A notable exception is tax services. (c) Proof of compliance with GAAP is evidence which may be persuasive but not necessarily conclusive that they acted in good faith. d) What is Sufficient to Prosecute? (i) The SEC has formally taken the position that enforcement action is warranted only with respect to: (a) Unreasonable deviations from an ideal of accurate books and records or internal controls. that they believe the financial statements fairly present the firm’s financial position. We don’t have enough cases or opinions yet to determine the total obligation of the CFO and CEO. (ii) That to the certifying officer’s knowledge it does not contain an untrue statement of material fact. it is questionable whether any company is practically within technical compliance with the section. Audit Committees a) Audit committees are made up of the company’s directors and have as their central function oversight of the company’s audit and financial reporting practices.Buckham. b) §30A prohibits corrupt payments to foreign officials in order to gain business. lack of adequate supervision. (ii) Essentially there is prosecutorial discretion here. CEO/CFO/Director Certification a) The “Fairly Presents” Requirement (i) The CEO and CFO are required on each quarterly and annual report filed w/ the SEC to certify. not whether it accurately reported the operations. The business size. and that the facts as certified were not materially misleading or false. Simon (a) The critical test is whether the financial statements as a whole fairly presented the financial position of the company. (a) Thus. etc. can all influence the level of control needed. b) Rules 13a-14 and 15d-14 require the CEO and CFO to certify each quarterly and annual report with the SEC: (i) That the officer has reviewed the report. Brian R. and (c) Failures that are something more than occasional.US v. Other Provisions of the FCPA a) Rules 13b2-1 and 2  Impose upon persons an obligation to avoid falsification of books and records and require officers and directors to provide accurate information to accountants for preparation of financial statements. not whether it accurately reported the operations. only outside directors can be members of the audit committee. The motivations of those who erred is not relevant. (b) Situations where top management is involved. (b) The critical test is whether the financial statements as a whole fairly presented the financial position of the company. (ii) What Does ―Fairly Present‖ Mean -. (iii) That the report fairly presents the financial condition. 2. or failure to take corrective action. no matter how small. It is a reasonableness standard. D. (iii) Level of Review Required (a) Does compliance with GAAP itself satisfy the ―fairly present‖ requirement? NO. (a) But no organization.

but subjective reasonableness has been used in cases involving defendants who have a closer relationship to the company. annual report..Basic Inc. c) Signature Requirement (i) Whether it be the registration statement. B. (ii) Ask whether there is a substantial likelihood that the omitted fact would have been viewed by the reasonable investor as having significantly altered the “total mix” of information made available. an omission is actionable only when the corporation is subject to a duty to disclose the omitted fact. Once you get past the line-item disclosures that must be made (Regulation S-K. it is material. Rather. in following the command of NEPA.). (a) This can lead to liability. that involve material amounts and relate to the environment.‖ A similar requirement applies to all ’34 Act filings through the operation of Rule 12b-20.‖ (i) If something rises to a reasonable person of decisional magnitude. ―Materiality‖ Defined (TSC Industries) a) An omitted fact is material if there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote (or whether to invest or make some other decision). (i) The arrangement must be reported only if events are ―reasonably likely to occur‖ that will have a current or future effect on the registrant’s financial condition. The SEC and the Environment a) The SEC. v. Pro Forma Financial Statements a) Pro forma statements are financial statements for part of a quarter or year that are not audited. whether judicial or administrative. b) Must discuss the trends and risks that have shaped the past and are reasonably likely to have an impact on the future long-term or short-term liquidity. Introduction 1. and directors have to sign. Rule 408 requires that registrants include in their ’33 Act registration statement ―such further material information as may be necessary to make the required statement not misleading. 2. Duty to Disclose Required a) A corporation is not required to disclose a fact merely because a reasonable investor would very much like to know that fact. Materiality of Merger Negotiations (A New Standard?) 1. etc. under some circumstances the merger negotiations could be material. “Materiality” A. in that the transaction may never be consummated. II. in that it would affect the vote or investment decision. since unsophisticated persons may believe they are real numbers. have to reconcile the pro formas with GAAP. But. E. 2. d) The events that trigger the need for Form 8-K filings was also increased. For example. (i) Ask whether the omitted fact would have assumed actual significance in the deliberations of the reasonable shareholder. 3. saying that if we had applied GAAP principles to the pro forma statements. b) Pro forma statements need not conform to GAAP. b) Duty arises from providing information (like having a registration statement with omissions in it) or when some statement is made and something material needs to be said to make it now not misleading. CEO. and (v) That the officer has brought to the audit committee’s attention any significant deficiencies in the internal controls. they would look like this… (iv) 4. The Probability/Magnitude Test -. they are not ―material‖ under the TSC Industries standard.Buckham. That the officer is responsible for maintaining the firm’s internal controls and evaluated them in the last 90 days. Defining the “Materiality” Standard 1. etc. Brian R. Levinson a) Generally (i) Where preliminary merger negotiations are based on a contingent and speculative outcomes. c) Objective reasonableness is the usual standard. CFO. Generally a) The MD&A portion of the SEC filing is set forth in Item 303 of Regulation S-K and calls on management to provide narrative explanations of the financial statements for the purpose of increasing the transparency of a company’s financial performance and of providing overall better disclosure to investors. b) TSC Industries standard seems to look at ―facts of decisional magnitude. MD&A of SEC Filings 1. Securities Outline 7/8/2015 1:59 PM 49 . ―Buried Facts‖ Doctrine a) Renders misleading a document in which all the substantive information has been set forth. d) Regulation G – Requires a reconciliation. c) Companies are required to report off-balance-sheet financing arrangements. c) This has led to a lot of abuses. (i) Assessing probabilities and magnitudes of the undisclosed event are a means of assessing whether information currently in the public domain needs to be corrected or updated. but in such a manner that the mosaic can only be assembled with great difficulty and only with advanced knowledge that the whole picture requires a great deal of assembly. C. materiality becomes the key to disclosure. requires that registrants disclose pending government proceedings. (ii) Has to be enough to shift a decision.

(a) Despite the statements being erroneous. Commonwealth Edison needn’t disclose business hazards that are apparent to all serious observers and most casual ones. 5992 was a change in the SEC’s position. so maybe the probability/magnitude test doesn’t apply. (ii) b) c) 2. E. c) The SEC permits and sometimes requires forward-looking information. (ii) Is the information MATERIAL? (a) Probability/Magnitude Test or TSC Industries Test i Probability the other person will assert a claim to the strip of land is very low. said its test of probability/magnitude does not apply to soft information when determining whether information is ―material. Generally a) ―Soft Information‖ = forward-looking information. and the market had already factored that into the price. Materiality of Forward-Looking (aka “Soft”) Information 1. D.Buckham. generally worded statements of optimism can be deemed immaterial because they are understood as mere puffery. the magnitude of the problem if the event occurs is very large. standard of whether or not the information is material. and we only look to the total mix standard of TSC Industries. whether optimistic or pessimistic. since the market knows that computer products do not last long in the market. given that the market already knew that estimates in the nuclear power market are low. (ii) Ex: A computer manufacturer did not need to disclose that its new product would have a shelf life of only six months. so there is no duty to disclose based on correcting something already said. with a very large public company with lots of public information in the market. This standard came from Texas Gulf Sulphur. to be published. there was no liability because information that was in the market likely eliminated the potential of the information to mislead and was incorporated into the price.‖ Problem 11-2 a) Whether the item is ―material‖ depends on the TSC Industries or Basic. in the circumstances of this case. (a) Should not count on taking this holding any further than this setting. influence a reasonable investor to pay more for the stock than he otherwise would. the court moved away from it and adopted a standard based on probability/magnitude factors. The “Total Mix” of Information and Market Efficiency 1. since the plant has been there for 20 years. b) Old rule was that the issuer should not provide forward-looking information. Cental Corp. Does NOT Apply to Soft Information (i) Basic. this is not a merger case. not TSC Industries! Probability/Magnitude Test: (i) Materiality depends on a balancing of both the indicated probability that the event will occur and the anticipated magnitude of the event in light of the totality of the company activity. After reciting and expressly adopting the TSC Industries standard. But. SEC Release No. but instead whether the forecast was accompanied by meaningful cautionary language. Inc. 2. Puffery (Eisenstadt v. ii Of course. In 1978. (i) Ex: A nuclear reactor builder need not state that its cost estimates would probably be revised. Truth on the Market a) This doctrine holds that some statements need not be made when the information is fairly obvious. b) Case Example: (i) Nonspecific representations that an auction process is going well could not. Brian R. and thus has likely has already been incorporated into the market and countered by the market price. (b) But. e) Two Protections for Companies: (i) The Bespeaks Caution Doctrine Securities Outline 7/8/2015 1:59 PM 50 . b) Recall that this is a two-step analysis: (i) Is there a DUTY to disclose? (a) No statements have yet been made here. d) The standard is usually not the preparer’s efforts. i So. It is NOT an all-purpose defense. (a) Whether merger discussions in any particular case are material depends on the facts. and the market had already factored that into the price.) a) Rule: (i) Vague. Must also look at the magnitude of the transaction to the issuer. i Could argue they need to correct the earlier 10-K filings that had the omission. Probability that the event will occur can be assessed by looking at indicia of interest in the transaction at the highest corporate levels. It is a potential contingent liability. Inc. b) Limited to Specific Situations (i) This ruling is limited to soft information that was disclosed earlier but has become dated with time in an active public trading market. there may be a duty to disclose in the MD&A section (Item 303) or under Item 102.

(ii) Does the probability/magnitude approach apply here? (a) Maybe it applies. (iii) If a list has both facts and forward-looking information. Inc. (ii) A statement about a company. or projections are accompanied by meaningful cautionary language. d) What is ―forward looking?‖ (i) Announcements of projections. Management Integrity a) Disclosure of Management ―Integrity‖ Securities Outline 7/8/2015 1:59 PM 51 . (iii) What standard applies to this soft information? (a) The independent duty to disclose soft information comes from the idea that no half-truths should be made. do the materiality standards change from context to context? i Some commentators say the standard of materiality should change from context to context. (ii) The duty to disclose soft information generally arises from the overall obligation that announcements not be materially misleading. or going-private transactions. does it necessarily follow that it is material or not in the insider trading context? Or. plans. Cautionary language. (a) When a statement is made there is a duty to make such additional disclosure as necessary to assure that the statements that are made are not misleading in light of the circumstances under which they are made. the whole list will be considered forwardlooking. But.Buckham. §27A and §21E Safe-Harbors Problem 11-5 (i) This is soft information – management forecasts and appraisals. Problems a) b) F. (ii) The plaintiff fails to prove that the forward-looking statement was made with actual knowledge it was misleading. Problem 11-6 (i) Does the approach of ―materiality‖ change from context to context? (a) The issue is if it was material in the disclosure context. the cautionary statements must be substantive and tailored to the specific future projections. the information must be not only material. but there must also be a duty to disclose the information. or opinions in the prospectus which the P’s challenge. Duty to Disclose Forward-Looking Information a) Duty to Disclose Required (i) In order to require disclosure. The SEC and Corporate Governance 1. do not generally rise to the level of themselves being meaningful cautionary language. the truth of which is discernable only after it is made is considered a forward-looking statement. Materiality in mergers should be different from materiality in insider trading. as opposed to boilerplate. or (a) ―Meaningful‖ means the cautionary statement was specifically tailored to the deal. tender offers. the forward-looking statements will not form the basis for a securities fraud claim if those statements did not affect the “total mix” of information the document provided investors. said its test of probability/magnitude test does not apply to soft information. Mere disclosure of assumptions. b) Rule: (i) When an offering document’s forecasts. (iv) This is a hard problem to decide. Statutory Safe-Harbor for Forward-Looking Statements a) §27A of the ’33 Act and §21E of the ’34 Act provides a statutory safe-harbor for certain forward-looking statements made by companies that are subject to the ’34 Act’s continuous reporting requirements. There may be a duty to disclose here if there were prior statements said previously. (ii) 2. Brian R. c) ―Meaningful‖ = Tailored to the Transaction (i) To suffice. 4. estimates. however. 5. Basic. renders the alleged omissions or misrepresentations immaterial as a matter of law. if sufficient. b) Courts are reluctant to deem disclosure of soft information misleading. The “Bespeaks Caution” Doctrine for Forward-Looking Statements a) Generally (i) This is a defense to liability for forward-looking statements that turn out to not be true. e) ―Misleading‖ (i) Disclosure of assumptions underlying a forward-looking statement can itself prevent the statement from being misleading. b) The safe-harbor shields persons from liability in private actions if: (i) The statement is accompanied by meaningful cautionary statements identifying the important factors that could cause actual results to differ materially from those in the forward-looking statement. and statements of future economic performance are forwardlooking. c) Safe harbor is not available to forward-looking statements made in connection with IPOs. since it is a merger deal. 3. opinions.

c) Problem 11-11 (i) Clearly have to disclose every ―adjudicated‖ violation. An example is paying bribes that result in a positive effect on the bottom line.‖ or only those that have a financial impact. or explain why it does not have one. d) Duty to Correct Securities Outline 7/8/2015 1:59 PM 52 . (d) Item 401(f) of Regulation S-K requires certain civil and admin.Buckham. Generally (a) Subpart 400 of Regulation S-K requires disclosure of information that bears on the incentives. The balance used to be heavily in favor of the plaintiffs bar. Brian R. such that there were abusive strike suits being filed only hours after a price decline based on nothing more than a decline in stock price. Duty of Disclosure [MOSTLY SKIPPED IN CLASS] a) Possession (i) All courts agree that the mere possession of nonpublic information does not by itself give rise to a duty to disclose.. It isn’t like §11 of the ’33 Act which provides the elements of the cause of action. Rule 10b-5 1. (iii) It is an implied cause of action. Materiality of Illegal Transactions a) Generally (i) Suppose an executive violates the law with respect to the company. Introduction a) Generally (i) This is the most important liability provision in the securities laws.‖ But. etc. (a) §21D(b)(3)(B)  allows a stay of discovery when a defendant alleged to violate Rule 10b-5 files a motion to dismiss. (c) Item 406 (came from SOX) requires the corporation to describe its code of ethics for executives. so long as they are not attributable to the issuer. b) Half-Truths (i) When voluntary statements are made. but violates the FCPA. Only when he has been adjudicated to have violated the law does it become ―material. (a) The abuse was the expensive discovery process that was initiated and the pressure on the company to settle. Rule 408 could come into play and require more. Must this be disclosed? b) Are illegal actions always ―material. Fraud in Connection with the Purchase or Sale of a Security A. b) Disclosure of Executives’ Personal Information (i) Should the company have to disclose the terminal illness of one of its executives? (a) This is debatable. which requires disclosure of any information (even if not listed in the statute or rules) as may be necessary to make the expressly required statements in a registration statement not misleading. it applies in any context where securities change hands. (iv) This cause of action is used in a lot of different contexts. there is a duty to disclose completely. (ii) Private Securities Litigation Reform Act of 1995 was in response to all of the ―strike suits‖ brought. intending to get a settlement despite speculative merits (but involved massive discovery). the claim is only currently in litigation. illegalities are not necessarily something that must be disclosed. actions against certain personnel to be disclosed if the claims have been adjudicated. 2. unless it is a specific line-item in the disclosure rules. (i) 2. accountants. (ii) So. the elements have developed via case law. c) Duty to Update (i) Some courts indicate that when an issuer makes a statement that is true when released. No half-truths can be given. Here. the elements of 10b-5 are absent. This is true even if the market is filled w/ rumors. (ii) Specific Provisions (a) Certain conflict-of-interest transactions must be disclosed under Item 404. and commitment of the registrant’s management. or none at all? (i) Ninth Circuit said that a company did NOT need to disclose an illegal transaction (paying bribes) because the SEC is not in the business of enforcing that type of claim – shareholders have sufficient state law claims against those executives and directors that made the decision. b) Attitude Toward 10b-5 (i) Draconian liability from massive suits has curbed the favorability toward Rule 10b-5. it assumes a duty to revise or update that statement to reflect subsequent events so long as the original statement remains ―alive‖—that is. So. integrity. (ii) Applicable to the purchase or sale (buyer or seller) of ANY security. Another example is that the CEO is a notorious pot-smoker. (b) Disclosures relevant to an evaluation of management are particularly pertinent where securities are sold largely on the personal reputation of a company’s controlling person. is still being relied upon in the marketplace. III. Thus. (b) Disclosure about management integrity could sometimes be required by Rule 408. i This is great for the defendant. as an implied cause of action.

Deception (i) The behavior that is cognizable under 10b-5 does NOT include every type of corporate mismanagement. the standard is not that high. ii The majority view is that it is enough the D was aware of the true state of affairs and appreciated the propensity of the untrue statement or omission to mislead. then it is not a 10b-5 violation.‖ had I known. Pleading Scienter (a) To bring a suit under 10b-5. Aiders and Abetters a) There is no aider and abetter liability in 10b-5 cases. held that these publications could be ―in connection with. i Thus. manipulate. (a) If the person does not buy the securities. Scienter requires more than negligence. not at investors. (iv) Problem 12-1 (a) Is the falsity or misleadingness ―in connection with the purchase or sale of a security?‖ (b) The test is whether it was ―reasonably calculated to influence the investing public. (b) Scienter requires “awareness” of the behavior beyond negligence. §21D(b)(2). (ii) ―Investment‖ aspect. i The ―strong inference‖ standard is satisfied by a showing of either actual factual data or a strong “motive and opportunity” to commit fraud. Brian R. must be the basis of the wrongful act. Was she in violation of 10b-5? ii Should Ferguson be held to be aware that there was a propensity to mislead? We don’t ask whether she intended to mislead. (ii) The SEC always has standing for public actions against the violator. the stock was not used for the ―investment aspect‖ of the wrongful act. Basic breaches of fiduciary duty. (a) Ex: Fraud on a bank to get a loan was ―not in connection with‖ even though stock was pledged as collateral in the loan. an actual purchase and sale of securities by the company or insiders is not required. ATI (the Company) i Does the idea of ―corporate scienter‖ make sense? ii At least one of the parties w/ primary responsibility for the information had to have been acting w/ scienter. these bystanders do not have standing to sue. But. not necessarily the motive to mislead. (b) Ex: If the press releases were about geology. If a company makes a statement that is false at the time. Scienter (i) Defined (a) Scienter essentially refers to ―a mental state embracing intent to deceive. not to affect the buying and selling of securities. there is NO standing for that person. if someone says ―I would have bought‖ or ―I would have sold. however. (Central Bank of Denver) Elements of the 10b-5 Cause of Action: a) [Wrongful Activity] “In Connection With” the Purchase or Sale of Any Security (i) Texas Gulf Sulphur: Rule 10b-5 is violated whenever assertions are made in a manner reasonably calculated to influence the investing public if such assertions are false and misleading or are so incomplete as to mislead. (a) Thus. Should she have had enough doubt in her mind that she was being reckless? iii This is a close case. or does not sell them. (iii) It is not necessary to show that the purpose of the misleading statement was to influence investors – only that a material misstatement was disseminated in a medium on which investors rely. 53 .Buckham. 4. The use of the stock was too tangential.‖ The journal (i) 3. (ii) The ultimate wrong has to involve some sort of informational deception. w/o deception. rather than an incidental result of the transaction. D need not be doing it for a self-serving purpose. (iii) Problem 12-3 (p. (c) b) c) d) Standing (i) Standing to sue in private actions under Rule 10b-5 is limited to actual purchasers or sellers of securities. or defraud. 651) (a) Ferguson (CEO) i Ferguson signed off on the release without saying anything about the acquisition and the (b) (iv) Securities Outline 7/8/2015 1:59 PM where the ad was published appeared to be directed at doctors. the fact the SEC was investigating suggests she was reckless in signing off on the financials without investigating. P must include in their complaint enough substance to give rise to a ―strong inference‖ of a violation of 10b-5. 2nd Circuit. (c) Many courts hold that recklessness is enough to satisfy the scienter element. the company has an obligation to disclose the truth when it learns the truth. based on the information. but it didn’t know the statement was false and didn’t intent to mislead.‖ (ii) Standard (a) Negligence in misleading is NOT good enough for a 10b-5 claim. are not 10b-5 issues.‖ SEC investigation. She took for granted the outside auditor’s statement that the company would be vindicated. i Don’t have to show actual motive to cheat the plaintiffs.

requiring at a minimum particular facts giving rise to a strong inference of deliberate or conscious recklessness. There need not be a presumption of reliance in misrepresentation cases. (iii) Presumption of Causation in Omission Cases (a) Affiliated Ute Presumption i Omission Cases v. however. But. ii §21D(b)(4) requires loss causation: ―P shall have the burden of proving that the act or omission … alleged to violate this title caused the loss for which the P seeks to recover damages. This goes to loss causation… (c) Loss Causation = i Requires that the loss P suffered was caused by the wrongful conduct. (ii) Transaction Causation v. there is a presumption of reliance. not transaction causation. is ―whether the fraud actually caused the loss P complains of. (iv) Fraud on the Market Theory (a) Now. when they became known as false. (a) The alleged fraud induces the person into the transaction. intent to cause harm is not required. just by showing the materiality of the omission. ii e) Securities Outline 7/8/2015 1:59 PM (a) Intent to cause harm is not required. P would not have entered into the transaction had they known the fraud. (a) Have to show that when the misrepresentation became known to the public. ii The problem. How will the P prove reliance when the allegation of the wrong is an omission? The person claims to be relying on something the person was never presented with! (b) There is a presumption of reliance/causation in an omission case. (ii) This is not required in misrepresentation cases. the price fell because of the public’s realization that there had been a misrepresentation. Causation (and Reliance) (i) Introduction (a) Difference Between Reliance and Causation i The real element that must be established is CAUSATION. Showing that P relied on the misrepresentation is the easiest and strongest way to do that. Loss Causation [ON EXAM] (a) Introduction i Loss causation requires greater evidence of the connection between the wrongdoing and the loss than does transaction causation. must P show actual reliance on the misrepresentation/omission. but there is one in omission cases. (i) If you establish the materiality of what was omitted. assuming P pleads loss causation adequately. Misrepresentation Cases (a) It is one thing to rely on something that was affirmatively stated or misstated. not because of some other event. (b) This is purely ―but for‖ thinking. where the bad stuff is on the face of the document. or can the P take advantage of another presumption – the fraud on the market theory? 54 . (a) Something other than the fraud could cause the price to go down. ii Should transaction causation be enough for showing causation in 10b-5? (b) Transaction Causation = i Requires that the wrongful conduct was a “but for” cause for the P’s to enter into the transaction. Brian R. (a) Reliance is just one way to establish causation. (e) Pleading Loss Causation i Will have to plead that the market actually reacted to the wrongful misrepresentation or omission. there is a logical problem when there is an omission case and someone claims to have relied on an omission. but not the only way. caused damages.Buckham.‖ (d) Standard: i Congress and the Courts both require loss causation as the standard. iii The holding is very defendant-friendly. We just need a nexus between the alleged wrongdoing and the damages. ii The Dura holding seems to suggest that management can put misrepresentations into the market intentionally and then not have liability if it can’t be shown that those misrepresentations. 9th Circuit is more strict. (a) Because ―recklessness‖ is the standard.

(i) ―Primary‖ defendants. It is difficult to maintain a federal securities law not in conflict w/ state corporate laws. §21D(b)(4) suggests that the out-of-pocket measure is proper. 3. the judicial preference for the out-of-pocket measure is clear. 2. This allows the defrauder to keep the windfall (profits it earned from defrauding). The Enforcement of the Securities Laws [A variety of items that come up in the enforcement of securities laws] A. The efficient market and resulting ―fraud on the market‖ theory is enough to create a presumption that there was reliance on the misrepresentation/omission. the statute says nothing about damages. SOL = An implied SOL under 10b-5 is no later than the earlier of: a) 2 years after discovery of the facts constituting the violation. 690) (a) Raises some of the problems with the fraud on the market theory in this setting. Can the court apply a rebuttable presumption of reliance because of the fraud on the market theory (that purchasers need not rely directly on misstatements because the company’s stock is automatically affected by the misstatement)? Time Period: i Any person trading in the market between the time of the misrepresentation and the time it became known to the public is presumed to have relied on the misrepresentation. More on the Private Enforcement of the Securities Laws 1. or b) 5 years after the violation.Buckham. To have a federal securities law claim is distinct from bringing a mere breach of fiduciary duty state corporate law case. Class Actions a) Generally (i) Recent changes to class action litigation have been the result of abuses in securities class actions. 6. a) Ex: SOX federal statute requiring corporations to have internal audit committees and independent board members. (i) ―Secondary‖ defendants. not simply unfairness of breach of a fiduciary duty. a) The securities law case requires misleading information under 10b-5. Introduction a) Punitive damages are NOT available in federal securities law violations. b) Proportionate liability (only liable for the % of responsibility) applies to persons who did not act knowingly. Problem 12-6 (p. (ii) Exception: (a) Sometimes disgorgement of profits made by the defrauder are appropriate. But. We have to ask whether we want to be compensatory or whether we want to deter certain behavior. Damages Under the ’34 Act 1. The subsequent events seem to suggest that the out-ofb) IV. 2. Federalism and Rule 10b-5 1. Brian R. There must be some deception. i This is plaintiff-friendly. C. ii One form of rebuttal is to show that the P would have traded anyway. not the disgorgement of profits. the presumption is rebuttable. Problem 12-8 (p. b) Since 10b-5 is an implied cause of action. b) Damages are measured by the difference between the price at which each investor traded and the ―fair‖ value of the security as of the date of the trade. and equity should give the profits to the defrauded person. D. But. (ii) Ex: accountants and lawyers. 5. Statute of Limitations Under 10b-5 1. 4. b) Defrauded Buyers (i) Difference between the amount the defrauding seller paid for the security and its actual value as of the time of the transaction. Face-to-Face Defrauding a) Defrauded Sellers (i) What seller received – FMV seller would have received from the sale had there been no fraudulent conduct. 666) a) Question is whether the profits should be kept by the wrongdoer. J&S and Proportionate Liability a) Joint and several liability applies to persons who acted knowingly. even if he had known the truth. Securities Outline 7/8/2015 1:59 PM 55 . then again. and that plaintiff gets to select lead counsel. Open Market Defrauding a) In the situation where the D is neither a buyer or a seller. it looks like it took two years of efforts by the defrauding brother to make the profits. pocket idea is not good enough. i (b) (c) (v) B. i Don’t worry about FMV – look at profits D made. P does not state a federal claim simply by attacking the fairness of a merger. b) Selection of Lead Counsel (i) §21D – The presumptive lead plaintiff is the plaintiff with the biggest stake in the litigation.

a) Battle is to what extent the securities lawyer has a public duty to assure compliance w/ the securities laws and a private duty to advance the interests of the client. or agent of the issuer. Brian R. after Central Bank. banks. Primary and Secondary Liability a) Generally (i) Primary v. there is no aiding and abetting liability. NSMC Case 1. (a) The secondary actor must actually make a false or misleading statement. unless the attorney believes that the chief legal officer or CEO of the issuer has provided an appropriate response within a reasonable time. Liability of Secondary Participants (i) Generally (a) Secondary actors (like accountants and lawyers) cannot be liable in a private action for aiding and abetting a violator. Held that lawyers can be violators of 10b-5 (this was pre-Central Bank. The court found that the attorneys knew there were problems in the financials. (b) Merely reviewing and approving a misstatement is not sufficient. More on the Duties of a Securities Lawyer (802-817) A. and the comfort letter thus did not conform with the merger agreement. appearing and practicing before the Commission in the representation of an issuer. the primacy of the legal ethics code may clash w/ notions of public responsibility derived from the federal securities laws. (Central Bank). b) Aiding and Abetting (i) There is NO aiding and abetting liability under Rule 10b-5 when a private litigant brings a suit. But. (b) SEC prefers this view. (a) Applies to any suit with 50 or more persons in the class. but they may be liable as ―primary violators‖ if all the requirements for primary liability under 10b are met. they have proportionate liability. employee. c) Federal Courts Get Exclusive Jurisdiction (i) §28(b) of the ’34 Act confers on the federal courts the exclusive jurisdiction over most securities class actions. 2. lawyers. Generally 1. (a) Looks like a run-around the Central bank holding. (iii) Secondary violators do not have joint and several liability. they must disclose it to the audit committee or board of directors. becomes aware of evidence of a material violation by the issuer or by any officer. If the corporation does not take remedial steps. the person cannot be considered a primary participant. but the secondary actor need not be the direct communicator. the attorney shall report such evidence to the issuer’s chief legal officer or to both the issuer’s chief legal officer and its chief executive officer. (ii) Two Approaches to Liability for Secondary Participants (Making them Primarily Liable) (a) Bright-line test i Unless the person has actually made the misrepresentation. Securities Outline 7/8/2015 1:59 PM 56 . Accountants’ Duty to Blow the Whistle a) §10A of the ’34 Act imposes affirmative duties on accountants when they become aware of an ―illegal act‖ of their auditing client. New Rules Regarding Discovery in Securities Suits a) PLSA bars discovery until after the D’s motion to dismiss and raises the pleading standard to require pleading a “strong inference” the D has committed a violation. i Ex: accountants. SEC’s Rules of Professional Conduct 1. When lawyers represent clients in securities matters. V. b) The attorney must also raise the concern with the audit committee or the full board of directors. the person cannot be considered a primary participant. so now the aiding and abetting liability is not a concern). outside directors. (b) Substantial Participation test i Unless the person has substantially participated in the misrepresentation. The secondary actor must know that the representation would be communicated to investors. to be liable. 2. This was a very big case in the corporate finance world. (a) Thus. not merely review and pass-off on a statement made by another person. the accountant must report it to the SEC. (ii) The SEC DOES have authority to bring a suit for aiding and abetting. secondary violators are not liable for aiding and abetting. Secondary Violator (a) Primary = commits an act prohibited by the Act/Rules. director. SOX Part 205: Standards of Professional Conduct for Attorneys a) If an attorney. If it will have a material impact on the financial statements. 3. B. including a material misstatement on which a purchaser or seller of securities acts.Buckham. (b) Secondary = assists or supports the primary violator. underwriters. c) 4. C.

because a tippee who is outside the corporation does not owe a duty to the corporation. c) ―Temporary Insider‖ (i) Treated the same as an ―insider. (iv) Only an illegal tippor if he makes a disclosure of material nonpublic information to a friend. O’Hagan is not a temporary insider because he owes no duty to the issuer (he traded in Pillsbury. If you do not disclose it or you don’t abstain from trading. non-public information.‖ Considered to still owe a duty. Used when the information comes not from the issuer corporation. b) Pre-Existing Duty Rule: (i) Must have a preexisting duty to the issuer in order to be held liable if you trade. ii Misappropriation would say law clerk is liable in deceiving the company. Brian R. so no liability. What is a breach? – improper personal benefit. Insider Trading Under the ’34 Act (849-76. (ii) Tippor liable if breaches duty to the issuer. officer. Clerk has no information from the issuer. (ii) Liable for trading on material. or in the expectation that through tipping the tippor will receive.‖ 2. he has an obligation to the corporation. ―fraud on the source.Zones: 1. employee) learns information through that relationship about that corporation and uses it to purchase or sell the stock of that corporation. no tippor/tippee liability because no duty to Pillsbury. VI. and there is really no tippor. he got it from the judge. Elements of Insider Trading 1. not associated w/ the issuer. or if it would result in a violation of the rules of professional conduct. Insiders a) ―Insider‖ (Chiarella – the photocopy guy) (i) D must be someone who. not necessarily everyone who knowingly trades on insider information is going to get nailed. (similar to aiding and abetting). Withdrawal a) Attorney must withdraw if representing the client would have the effect of assisting the client in a continuing crime or fraud. Generally a) Same as for 10b-5. Tippor / Tippee Liability a) Tippor Liability (i) An improper personal benefit is required to be held liable as a tippor for giving the tip. 3. (iii) Tippor is an insider or temporary insider. not Grand Met). but he is not the one making the purchase or sale of a security. (i) Examples: (a) Law clerk finds out from a judge that a big award will be given. Theories of Liability . and it is a clear violation of law. What the ABA Says: a) Lawyer who knows of the violation of a legal obligation to the organization or a violation by the organization. the lawyer shall refer the matter to the highest authority… c) When the higher authority fails to respond. (a) So. and the lawyer reasonably believes the violation is reasonably certain to result in substantial injury to the organization. b) Tippee Liability (i) Not like garden-variety. but only to the extent necessary to prevent substantial injury to the organization. Misappropriation (part of 10b-5) a) A. relative. neither is tippee. non-public information before trading only by someone in a fiduciary relationship to the corporation or whose stock the insider is trading. Also. Elements of Insider Trading a) Misstatement or Omission b) Purchase or sale c) Nonpublic Material info d) Causation between purchase/sale and the disclosure B. The question is whether we can impose some derivative liability on the tippee because he helped someone else who had a duty to the corporation. except ―material misstatement‖ is replaced with ―Material. (a) Telling random people will not likely result in liability to tippor. b) Unless the lawyer reasonably believes it is not necessary in the best interests of the organization to do so. Minus Chiarella & Dirks) A. then the lawyer shall proceed as is reasonably necessary in the best interest of the organization. If tippor is not liable. i Misappropriation says the attorney is liable. you are liable.a. (iii) It is derivative liability.Buckham. Gifts and quid-pro-quo are good enough. 3. but from someone else who is unconnected with the issuer corporation. 2. nonpublic information only when he is NEGLIGENT in not knowing that the tippor breached a duty. by virtue of a relationship with a corporation (director. (a) There is a duty to disclose material.k. 2. trades on information acquired by breaching a duty to a third party who is not the issuer. He would be a temporary insider if he traded in Grand Met stock. b) An outside. then the lawyer may reveal information relating to the representation. a pecuniary gain or a reputational benefit. (b) O’Hagan gets information from the law firm regarding a transaction. directly or indirectly. So. like a regular insider. i Chiarella says law clerk owed no duty to issuer.‖ Defrauding a third-party unrelated to the issuer. Securities Outline 7/8/2015 1:59 PM 57 .

2. C. etc. D. Cannot selectively disclose information to some persons but not others. Brian R. Reg. §20A §21A impose both civil and criminal liability on insider trading via treble damages. FD 1. b) If there are short-swing profits obtained by the insiders within a certain period (6 months). those profits are to be given back to the company. New ’34 Act Statutes (884-894) 1. 884-894. 436-438 (but not responsible for the details… just the textual description). Securities Outline 7/8/2015 1:59 PM 58 . §16 – short-swing profits idea. a) Have to publicly disclose all transactions in the company’s stock if they are certain insiders. READ: 877-881.Buckham.