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Labor + Capital = Wealth [all societies agree with this –capitalist, socialism etc) ii. Formation of capital is the life-blood of business [need capital to form and grow business] iii. Capital raising system – created by wealthy Europeans – Merchants- way to spread risk – mrchnt bank-corp. iv. EAST – India Tea Company – take European goods to America & trade for indigenous goods 1. Risk to take journey: [natives not want it, ship not make it]–if ship returns– pay captain crew, sell indig goods & split money left w/ equity owners (ship investors)–if ship not make it–investors lose (pick bad stk v. First Public Issuance of securities – Civil War. Union issue bonds to support war effort – paid off w/ 3% int. 1. Merchant banks not have enough – 2. Sec of Tres. –sell war bonds to public – to raise capital to finance war [so taxes & bonds finance war] 3. Confederate also sold bonds but b/m worthless – so south capital base wiped out vi. Industrial revolution (Rail, tele etc) – Co. need money& not enough from Merchant bankers so turn to public there was some fraudulent schemes but only remedy was CL tort fraud – not feasible so fraud went unchecked vii. 1920s states began to enact own securities laws (Blue-sky laws) – some success but public soon lost faith so stock market crash; 1. After Depression - Need capital to jump start the market – need investor confidence viii. FDR – campaign new deal – b/c knew if capital ceases- a capital system can’t function; All banks are bankrupt no money – only source of capital is American public but have no confidence 1. First 100 Days – FDR rushed to enact the securities act of 1933 – provides full disclosure & remedies ix. ALL SECURITIES LAWS about Disclosure – if instrument is defined as Security – get all sec laws
b. 4 Main Securities Laws – (all admin by SEC) i. Securities Act of 1933 – a consumer protection statute, rose from ’29 crash – main purpose is to mandate
disclosure (thru registration or exemptions) to investors so can make smart informed; full fair; decisions; 1. Deals with Selling & Issuance of securities to the public – Which is raising capital; 2. Also have disclosure forced to the SEC; and if insufficient disclosure easier to get damages then CL fraud 3. Regulates primary and secondary offerings----not secondary trading/transactions Securities Exchange Act of 1934 – is a regulatory statute – by SEC – regulates exchanges, broker/dealers, public Co., insiders, tender offers, and provides anti-fraud provisions 1. Created the SEC – incr. investor confidence; regulates how market runs & how broker/Deal run their bus 2. Regulates secondary transactions/trading (after market trading) Investment Company Act of 1940 – intended to target pre-crash abuses of investment pools – ’40 act regulates investment companies; mandates registration & has exemptions; dictates organization and operation rules; Regulates Mutual funds (pool investing) Investment Advisors Act of 1940 – regulates anyone who for value, gives investment advice as to the purchase & sale of securities; Act is regulatory & notably prohibits contingent fees based on performance; Blue Sky Laws – vary state by state, unlike SEC – states only merit review of offering – have a fair/just and equitable standard 1. National Securities Market Improvement Act – prempt from state review – variety of covered securities including those traded on Nasdaq, NYSE, AMEX
iii. iv. v.
c. Terminology i. Types of Bank 1. Merchant Bank – classical model of getting capital – an institution invests its own money in your firm to develop your product [put your money up] 2. Commercial Bank – institution takes deposits & uses it to make investments (ie loans); eg citi 3. Investment Bank – institution that goes out & finds the money to invest in firm–[puts 2 people together] ii. Broker/Dealer 1
iv. v. vi. vii.
Broker (NYSE) – exchange market – broker puts buyer and seller together and transaction is done; The buyer is privity to K w/ seller but it is privity w/ an anonymous person; B&S each call their brokers to make a transaction then brokers met on floor of exchange to complete txn and trades goes on ticker a. Broker gets a commission for this – need be licensed to get commission 2. Dealer (NASDAQ) – OTC market – Dealer sells out of its inventory (buyer privity of K w/ dealer) a. If sell MS, Merril – dealer – would buy it and take it as inventory and puts it on the shelf; if someone else want to buy MS; ML takes it off shelf & sells it to them; 3. Broker Dealer – someone does both exchange and OTC market 4. NYSE quotes the last trade price; 50 is last txn btwn buyer and seller that was made thru broker 5. NASDAQ – quotes what dealer is willing to pay for the security (bid price) and what dealer is willing to sell the security for (ask price); Bid –ask Spread /markup – Dealer – ML can make $$-constant Buy/sell DEBT – comes in three forms – each is loan to company – can be security 1. Notes – short term investment (I owe you) – promise/obligation to pay (1-4 years) 2. Debentures – Intermediate term investments (5-9 years) 3. Bonds –long term – (10-30 years) – generally secured by assets Equity – ownership interest in a company – (if stock – still need to do economic reality test to see if security) Securitization – taking something not a security and turn it into a security Registration of securities vs. Reg of transactions–you register an offering not a security and not a Company Initial capital–putting money up for Co. etc; (trading on exchange not put money into Co just change hands)
II. What Is a Security a. Overview: i. IF something is a security then the Fed. Securities laws apply – ’33 and ’34 act; Investors want the protection of the securities acts and if security easier for lawsuits and remedies in securities fraud then CL tort fraud; ii. A security is a security – not matter if public stock or closely held Co; not matter to security definition; iii. IF instrument is a security – no offer or sell unless registration or exemption [illegal to opt out sec laws] – sec14 of 33 act – any conditions on application of 33 act shall be void [pg 58 – policy – elective sec laws]
b. Statutory Definition of Security: [first place to start] i. ’33 Act §2(a)(1): The term "security" means any note, stock, treasury stock, security future, bond,
debenture, evidence of indebtedness, certificate of interest or participation in any profit-sharing agreement, collateral-trust certificate, preorganization certificate or subscription, transferable share, investment contract, voting-trust certificate, certificate of deposit for a security, fractional undivided interest in oil, gas, or other mineral rights, any put, call, straddle, option, or privilege on any security, certificate of deposit, or group or index of securities (including any interest therein or based on the value thereof), or any put, call, straddle, option, or privilege entered into on a national securities exchange relating to foreign currency, or, in general, any interest or instrument commonly known as a "security", or any certificate of interest or participation in, temporary or interim certificate for, receipt for, guarantee of, or warrant or right to subscribe to or purchase, any of the foregoing. c. Judicial Definition of Security (Investment K) i. Investment K–should be default (catch all) definition of security–starting point of analysis; Best way to see if instrmnt is a security is HOWEY Test; - All finan instruments & stocks start w/ Howey but not Notes (Reves) ii. SEC v. Howey –pg 21 US 1946 – right after WWII – first attempt of court to define security; no investor complained about Howey’s actions – people made money like Howey said, there was no ponzee etc but SEC sues b/c says can’t offer security unless register offering; Howey says its not a security: Howey bought land and sold strips of land with orange trees on it to the public (fee simple absolute ownership) but then Howey gave owners the option of entering a service/mngmt K with Howey to plant trees, pesticide, harvest & sell them as part of pool of oranges to the buyer and Howey Co. takes a certain percentage of sale for its mngmt and money left over is given to land owners based on how much land owned; 1. Howey states only selling land and offering service K if want; SEC says created investment K 2. Buyers of land didn’t really want actual oranges they wanted return on their investment – make a profit 3. Ct held that this was an investment K and should be registered under the 33 act; Look at the economic nature of the enterprise; substance over form; (land ownership combined w/ mngmnt K –expect profit) 4. RULE: “investment contract for purposes of securities act means a contract, transaction or scheme whereby a person invests his money in a common enterprise and is led to expect profits solely from the efforts of promoters or a third party” a. Solely was a mistake and subsequent cases read it out – b/c can just have land owner once a year pick a orange; so now substantial efforts of others;
iii. Howey Test for investment Ks [risk is irrelevant]– A security is any contract transaction or scheme whereby: 1. A person invests money (or something of value) [investment of money]
2. in a common enterprise, and 3. where expectation of profits and success depends on efforts of others a. (no more solely others; now predominantly or substantial—SEC v. Koscot) 4. [any instrument passing howy is a security; but if not meet howey it still maybe a security justify status as security in some other definitional matter] 5. [marine bank later added to this – better regulatory scheme and uniqueness exception] 6. [howey test -east india tea co. had these factors – people invest $$ in common enterprise where profits 3
depend on others efforts – this is Capitalist system – capital/labor dichotomy capital is passive)
iv. HOWEY TEST APPLIED:
-Forman extend Howey Test to all securities and maybe Marine bank and Landreth cut back Howey litle 1. Investment of Money–intention is $$ given over w/ expectation of profit or return on investment as 1˚ reason took action; if purchase for use /consumption then not an investment (passivity?) need to INVEST; a. United Housing Foundation v. Forman -pg29 – US 1975 – in order to buy an apt in Co-Op City- one needed to buy X shares of stock in the management company and when sold apt you would sell your shares back to the management company and get money back; P sued had problems and instead of state court sues in federal ct bc says mngmt Co sold stock w/o registration – so P can get securities fraud relief i. HELD–This is not a security even though stock is in the definition of securities look @ whats really going on (Economic Reality) & Consumption test & failed 1st prong of Howey(no invst
ii. Economic Reality Test – aka basic common sense test – no expectation of profit;
1. there was no investment of money, person was trying to buy an apt and any appreciation is in the apt not the stock; invest is give $ for profit; 2. Substance over form governs(like howey) …possible challenge - Landreth 3. NOT everything called a stock is stock/Security; - term is not dispositive; a. Here no rights of stock- non transferable, no pledge or encumber; no voting rights; b. “reject at outset any suggestion that the present transaction evidence by the sale of shares called stock, must be considered a security transaction simply b/c the statutory definition includes the words…any stock” 4. Int’l Brotherhood of Teamsters – noncontributory compulsory pension plan is not an investment K; economic reality – EE sells labor to make living, not an investment, and ER is the one contributing; also Pension covered by ILISA – so marine bank; iii. USE/Consumption Test – Can’t double dip – invest money and use it as well;; 1. If give $ to get goods or services in return that they intend to use it – it is not an investment and therefore not a security [jury question investment or consumption] 2. Foreman – bought apt to use – so no passivity so not investment ;
Jaguar example: pg 34 (Use/Consumption Test) – Jaguar need capital or car not get produced (take 2yrs), Car will be worth double the price once person gets it; IF this is a security depends: i. IF Jaguar rep goes to bank/people and says give us money and it will double in 2 years – if want the profit and not the car – it is an investment and a security; ie not even see if owners want the car, have licenses etc–just sell to them get capital & ownr will turn around and sell it ii. IF Jaguar goes to list of previous customers who own high end and say want this car – give us money now and get car if 2 years worth double the price you paid; IF person wants car not the profit then this is use/consumption and not an investment/security; iii. INTENTION of Jaguar [seller] matters & get Rep/Warranty from buyer that for use not profit iv. IF security for one person – security for all; c. SEC v. Edward – payphone franchise for prisons – structure with a fixed rate of return – This does not violate HOWEY and it can still be a security; whether fixed or variable irrelevant to Howey test
Common Enterprise (Commonality) – circuits split as to requisite commonality for Howey (Hor/Ver) a. HYPO: Ski Resort with 12 lodges; promoter goes to investor – if buy this lodge I will maintain it, insure it, rent it etc; (this is a security; say if you use it once a year – not consumption?) 4
SO now franchises are generally not securities e. i. CT held these were not investment Ks – there was investing of money and pooling money (common enterprise) for expected profit but no effort of others. iii. promoter gets 10% profit (90). both share in sucess 1. ---PROMOTER tells investor I will rent your lodge [individ. found that although there was an investment of $$.no money is pooled. b. Requires an enterprise and class of investors. 3. SEC v. Investors all rise & fall together. Fox Hills: Ps bought a timeshare for a condo at golf resort & ended up trading their share for another work. If not rent lodge promoter not get his % of profits but still gets expenses paid by investor – so promoter does not share in losses – ie share of expenses. (1st determine circuit – Broad vertical. but left their timeshare time to be rented out by the management co. all of whom share equally or generally in the success of the venture (Pooling of investors funds). Strict Vertical Commonality . Life Partners – pg 43 – 1996 DC Cir – D matched investors with AIDS patients. Koscot). & that Ps were relying on the efforts of the management co. the investor must rely predominantly on efforts of others(ie substantial efforts of others) –some invest particip not ruin sec d. Solely by efforts of others has been written out of Howey. Relationship] and take expenses and fees and then you get the profits. but only share in upside profits. The patients would receive $$ today in exchange for their life insurance policy to be assigned to them. Franchise – great investment – put $$ have others run but then F’OR being examined by SEC for selling security –b/c of HOWEY change model now need OWNER-OPERATED–no passive investment in franchise b/c F”OR (MCD) though provide support not want to be governed by securities laws i. Vertical Commonality – (easier to meet b/c always have promoter & investor link unlike horiz need many investors or possibility of many) – SO if promoter & at least 1 investor share in success or failure of business venture– commonality is met. (NO Lost interest) –only some effort on part of promoter for success 1. Ct. So pool success and risks. not # of investors. EFFORTS OF OTHERS – refer to the party investor is dealing with – not some 3rd party c. Efforts of Others: a. Strict vertical than Horizontal-least to most difficult)) Horizontal Commonality – (howey was this) – at least 2 investors who have similar relationship in the business enterprise – they all pool their investments and share the profits i. ONE investor problem:-need 2 for horizontal commonality but POSNER in Lauer – if circuit has horizontal com and 1 investor – not matter b/c it is character of investment vehicle that matters. Capitalism is passive investment of money to be used by others and then returned w/ profits. group of investrs all gave $ & promoter takes responsibility iii. Broad Vertical Commonality –some unity of interest – but here promoter need not lose money if investor loses. 810 to investor – STRICT vertical-if not rent lodge 100 expense still paid but promoter pays 10% of it b/c no rent to take the expense from – so share in upside and downside. ii. D would receive commission to match up.promoter and investor linked both make and lose money together – direct and proportionate rise and fall. if BROAD – if not rent – Investor pays all 100 expense & promoter pays nothing & gets nothing – bc no profit. Example–rent 1000/month. iv. 100 dollars expenses. Promoters – did work before investment but no sufficient efforts of others post investment. c. the scheme failed commonality b/c the other owners were not pooling their profits into together [fail horizontal commonality – no pooling of profits] d. so if theoretically can have multiple investors then requisite horizontal commonality is met vi. Wals v. If not rent lodge – still have expenses – so here promoter and investor both pay expenses pro rata – so both can lose money ii.b. (SEC v. so if investor has bad lodge screwed . i. Lodge – if your lodge bad spot never rented – not matter b/c pool all $ from all investors and split profits. 5 . and if one not rented – all get little less profit. Commonality btwn investors rather than investor and promoter(vertical) v.
v.Warren court – Sale of CDs insured by FDIC. Stock as Securities . ALSO risk has nothing to do w/ deciding if it is a security or not. EDWARDS – fixed income – still can be efforts of others. and 2. MARINE BANK: . Limitations of Howey: 1. not need publically traded – b/c many securities are not. a.maybe presumption for it to be security but still Howey and Forman 1..US 1982: .pensions not securities (law)have ERISA ii. then probably not a security. can’t be selling efforts of others [howey] so not investment BUT overruled by Landreth a. private vs.NOT matter if not come to mind when think of security – creative instrument can be security. -. ASSOCIATIONAL FORMALITIES: Interests in Corporations. and no prospectus delivered not matter b/c can have security w/o prospectus. So can pass howey and still not security. 1. b/c FDIC insured & banking laws c. HOWEY test – has nothing about risk – as risk is irrelevant and has nothing about the sophistication of the investor d. Uniqueness Exception – if offerings has uniqueness such that no other investor could take part in it.not a security even if pass Howey or 33 definition if i. b/c selling control. Landreth Timber Co v. 2. Daniel & Matassarin v. 2.. Teamsters v. i. Reves – even though note in security def – not all notes securities look at purpose of act f. Consistent with capitalism – need many investors 3. Held – CD not security even though met definition of security. WORK around – if sell 100% securities to buyer then securities transaction if sell all assets 6 . Marine bank barn investment very unique to parties – no other investor could share in. CASE FUMBLES –not matter if it is not something that comes to mind for it to be security – since creative instruments are fine. Also Unique not mean NOVEL – ie no one thought of it before. Better Regulatory Scheme Exception aka Alternative regulatory protection Test– if there is another regulatory body/law better suited to deal with a given transaction (banking laws) – then trump securities laws [but not fool proof] 1. Weaver pg 24 . that would be overreach by 33 act and inefficient “dissemination of information requirements of the acts are justified by economies of scale” that do not exist in unique transaction. Sale of Business doctrine–if there was a sale of 100% of stock of the business then not selling a security. Partnerships & LLCs as Securities: i. Lynch . Landreth–pg 46 US 1985–overrule SOBD said selling stock was stock so §2a1 security–but do not read this as overruling economic reality test of Forman & Howey which says look at substance over form – real intent is purchaser of 100% security is still protected by Securities laws and Landreth was really stock. just wait for people to die and get money – capitalist society give money and others do stuff SEC v.f. It was a business arrangement btwn parties involving lease of a barn. Economic reality (common sense test) – FORMAN – just b/c something is called stock does not necessarily mean that it is a security/stock – notwithstanding the lanaguage of §2(a)(1) that specifically includes stock b/c look at Substance over Form. e. public not matter b/c private can be security.b/c better reg scheme makes registration an onerous and unnecessary burden. b. Marine bank–CD issued by MB not security b/c FDIC & banking laws adequate protct 3. Marine Bank v. justified thru some other definitional matter. d. If an instrument no matter what it is called passes howey test it is a security but if not meet Howey it may still be a security.
commercial asset financing. bank financing. Case remanded b/c denied SJ – not say sec for sure need more info on level of control by investor v. Steinhardt v. BUT also investment of $ if 35K buy in is it investment to grow or is it just entry fee – more like forman – not investment of money. Citicorp – pg 50. to buyer than not a security transaction. issue was efforts of others. CT said efforts of others test was not met. 2. or otherwise restricted in occupancy or rental of the unit. General Partnership – are generally not securities b/c fail efforts of others prong. Partnership as Securities -§2(a)(1) – not mention partnership as list of securities definition but structure of partnership does have implication of whether or not it is a security1. (no black letter) i. Each GP manages the business & bind the partnership (or has right to) so GP interests are not considered securities a. unit must be offered for rental at any time in the year. Notes (IOUs) as Securities -2(a)(1) defines securities to include notes (debntres/bonds) but not mean all notes 1. but if GP not do mngmtn and senior partners do it – then maybe can. so LP interest is security – passes Howey: a. investment of $. HERE broker created the security even though developer had nothing to do with broker/agent. P sued D but wanted federal so under securities fraud. Forman Economic reality works both ways b. is there commonality. Dubois – pg 60 1989 – 9th cir – P buys condo in HI form owner in the secondary market – NOT from the developer. 2. Chinchila – farm got investors from all over country – called GPs but still was security b/c pass Howey – there is efforts of others b/c investors did nothing – not know about farm [sub over form] c. or expansion. & if owner used it once a year – still can be security – Forman – consumption/use and economic reality c. inventory financing – these notes are not securities 7 . general business interest. had rental pool agreement so passes Horizontal comm. TWO fundamental types of notes: SO Notes – look at intent of parties: a. and purchased w/ expectation of profit. BUT if called a GP but not really true general partnership since few attributes of GP only few do all managing–a security can be found (KOCH v. LP agreement gave P veto power (control etc while still preserving DE Limited liability). Again substance over form – like Howey and Forman economic realities – name not matter iii. Limited liability interests (LLCs) as securities–Howey test– if members have significant input then not security–fails efforts of others (ie member managed). Notes like stocks – very name in statutory definition may mean presumption it is a security but: do not abandon both the HOWEY test and economic reality test (forman). and is investor relying on efforts of others? 1. a. KEY – all things have to be offered in one package – the mgntmt agreement (to maintain thru maintenance fees).so this is not security – b/c P had veto power so not a passive investor – SO FORM – calling it LP not automatically mean securities. Investment Notes – these are securities (bonds/debentures) if business borrows money then – they are securities – ie notes for capital improvements. rental pool agreement – cannot get it separately b. Limited Partnership – generally considered securities b/c passivity requirement – have efforts of others b/c limited partners have no management control GP does that. Commercial Notes – NOT securities – used for commercial purpose – used to finance short term assets. ii. Hocking v.and liabilities of Co. if members are passive – then it is security iv. CT applied Howey – said it was security – created by broker in the aftermarket. Broker told P that the condo could be put in pool and rented out. offering of participation in a rental pool arrangement.(and vertical Comm). Hankins). SEC Release 5347: ANY the following will aid in a condo (purchased directly from a developer) being an investment contract: emphasis on economic benefits derived from managerial efforts. Real Estate as Securities – normally real estate transactions are not securities – but if more than simple txn and pass Howey test than can have security – LOOK at expectation of parties – intent to invest in business for profit. b. 2. Pg 56 – Law firm hires associate from other firm to join as GP – but finds out after joins firm is going down and now can sue in torts or K but wants to sue in securities fraud – if truly GP not satisfy Howey – efforts of others so can’t sue in federal. 1997 3rd cir – D wanted securitze non-performing loans to get off their balance sheet so dumped them in LP and sold LP interest to P. use an exclusive rental agent.
i. accounts receivable -people buy on credit– Business sell A/R at discount to bank to finance
business (pay EEs bills etc) can’t do it w/ A/R so borrow against it – this is commercial loan ii. Inventory – short term borrowing- dealer not own every car on lot – borrow against inventory 1. If only equity capital used to buy inventory – then limited but if more inventory can sell more so borrow against inventory and when sell inventory pay loan and buy more iii. Can’t require registration of all these notes – it would restrict business too much iv. SHORT term – usually 1 year max but expectation is pay back in 30 to 60 days
REEVES v. Ernest & Young- pg 67 US 1990 (differentiate investment vs commercial notes)– Family Resemblance Test: There is a presumption with respect to notes that they are a security but if the following four part test is met [all 4 parts] a note will not be deemed a security i. Motivation of the parties – 1. Buyer – is motivation of buyer an investment (earn profit) then security – or is it commercial purpose – short term financing (not security) 2. Seller – is it for commercial or consumer purpose (not security) or for general business purpose (security) ii. Plan of Distribution – to whom selling the notes/is instrument meant to be traded 1. To the general public – investment note (a security); 2. If to people in business of financing short term assets – commercial note – not security 3. Is note designed to be traded – investment often have ability – so security – and commercial notes almost never ability to trade – not security iii. What are the Reasonable Expectation of investing public (would finance world consider it investment note or commercial note) iv. Is there Another regulator scheme better suited to deal with the instrument (Teamster) [risk is relevant in Reeves – debt but not capital - Howey]
vi. Separate Security Issues (pass through security/trust) –make security out of basket of non security stuff –
creating security separate from mere ownership of something (ie the scotch) that is not security 1. Examples of Securitization – (making security out of something that doesn’t exist as security by selling interest in it) – Scotch, orange groves, credit cards, debt/home mortgage; a. Pass through – simple residential mortgage is not security – but pooling mortgages and selling undivided interests is a security, where value is derived from mngmtn of others 2. Scotch Example – 12 year tie up – can make a security out of common basket of non-security stuff (buying stuff that’s not a security but set up a trust using others money to buy those things and hold it -then interests in the trust are a security) – created a separate security then if meet Howey have a security – SO put scotch in trust and sell interest in the trust – created and sold securities a. Scotch needs to age in oak barrel distillery can’t age it in the bottle like wine – so Distiller has to keep scotch for 12 years and can’t sell it so can make security out of it b. Buying 50 barrels of scotch is not security but: if Setup a trust and sell interest in the trust – say 10 investors each 1000; The trust then buys the 50 barrels of scotch from the distiller and then distiller takes money and use it to make more scotch etc c. Once barrels ready and sold the trust pays off all expenses and returns money to investor at say double the money invested – This is securitization; and if pass Howy is security 3. Accounts Receivable Example – common security – MC/Visa – go to restaurant pay w/ card- the restaurant has no money but has to go buy new food etc and pay expenses, so they sell their A/R – to MC or AMEX etc – who buy their credit card receipts owed at a discount say 92cents/dollar and rip a check to the restaurant the next day so they can run their business and then AMEX/MC holds the receivables; BUT AMEX/MC need lots of money to do this – buy of credit receipts etc – so they put all the recievables and package them and securitize them and sell them to investors who buy into the trusts and if want out can 8
sell your interests; SO for MC/AMEX –need not wait for us to pay off our bills – securitize them to get the money; MC is selling interest – securitizing them but they are not securities for MC (the receipts) 4. Mortgage Example: - have 30 year mortgages can’t wait that long for payment – want to do more mortgages - so securitize them and setup trusts w/ all these mortgages and then sell interest in trusts to investors; The trust is divided into tranches, where the mortgages always to be paid on time are section A and their investors get lower interest rate then say the riskier mortgages of the pool say the bottom have – so their investors get higher interest rate; a. But 100% of the bottom defaults and investors got nothing and then no one started buying into the trust so couldn’t really trade it and sell out and so can’t value the trust either since not sellable – so banks now can’t get money to pay for other business b/c tied up in these assets that can’t be sold or valued; so illiquidity and gridlock; SO govt TARP – buying some of these assets to banks lend more b. Past Savings and Loans bank – kept the mortgages so slow growth b/c can’t lend more unless get more depositors – this would be equity loans only but leverage and securitization allows faster growth and more loans vii. REMEMBER: 1. Once a security always a security; and if investment says stock presumption it is security
III. THE Public Offering a. Overview – Offering securities – Issuer can 1. Sell it to the public (Ma and Pa America) or 2. Sell it privately. A company that wants to sell stock (a security) to the public goes to an underwriter (Ibank) to buy the stock. The underwriters are retail distributors of securities and distribute the stock to the public. b. Terminology: i. Issuer – any person (ie company, enterprise, entity) that issues securities 1. Like Co issue common stock, or partnership issue membership, or trust take on investors ii. Underwriter–more later–any entity that buys the securities from the issuer & then sells them to a distribution network (brokers). Underwriters are essentially the wholesalers of the securities industry (middleman) 1. Ie when MS wants sell securities to the public, not know who is interested so use underwriters who contact brokers who know who want to buy stock. iii. Primary Offering - any offering by issuer itself; when the issuer itself sells securities 1. IPO – initial public offering – first time issuer offers securities to the public – the first primary offering 2. Public offering – any time issuer offers securities after the IPO to the public 3. Private offering – a non-public offering 4. (IE Each time MS sells its securities it is a 1˚ offering, can only have one IPO, any other offer by issuer are just primary offerings) 5. Secondary offering – offering of securities by someone other than the issuer,(which requires registration) a. ie Insiders, control persons, affiliates (CEO, BOD, Majority SH) sell stock may need register b. If Gates wants to sell MS its secondary offering & may need registration. c. Generally these are statutory underwriters and affiliates under §2a11 but still must be concerned with §5 registration or seek exemption under 144, 4 (1/2) or Reg A. 6. Secondary Trading – after market trading- trading of securities in the open market by the average person. It has nothing to do w/ secondary offerings and the securities have already come to rest in the public. It is exempted from registration – a. ie buy/sell securities by persons other than issuer or person who must concern himslf w/ registrant 7. THE 33 act only concerns itself with primary and secondary offerings and Nothing to do with secondary trading/transactions. The 34 act is primarily concerned w/ secondary (after market) trading.
c. SECTION 5 of the ’33 Act - this is what the ‘33 act is all about. Everything else is commentary i. Intro: Absent some exception/exemption, it is unlawful to offer a security unless registration is filed w/ the
SEC & unlawful to sell/buy security unless registration statement is in effect. Registration is of the offering. 1. Theory – behind ’33 act is consumer protection and disclosure by the issuer every time sells securities so the investor can make an informed decision; Risk is irrelevant can sell risky securities just need to disclose 2. Registration statement: 2 parts: 1. Prospectus – is a disclosure document/sales brochure and 2. SEC forms (housekeeping); This registration statement is what every issuer must draft up and file with SEC. 3. ’33 and ’34 act are criminal statutes – says it is unlawful. 4. Section 4(1) - Section 5 not apply to any person other than ISSUER, UNDERWRITER and DEALER a. 4(1) exempts secondary trading (we buy/sell stock) from ’33 act–only concern is 1˚/2˚ offerings
ii. § 5(a): Unless a registration statement is in effect as to a security, it shall be unlawful for any person, directly
or indirectly-- 1. to make use of any means or instruments of transportation or communication in interstate commerce or of the mails to sell such security through the use or medium of any prospectus or otherwise; or 2. to carry or cause to be carried through the mails or in interstate commerce, by any means or instruments of transportation, any such security for the purpose of sale or for delivery after sale 10
1. unless registration stmt is declared effective by SEC its unlawful (criminal ramifications) for any person (not mean human being) to sell a security; Reg stmt expires after 9mos so need new reg to reissue after 9m iii. § 5(c): It shall be unlawful for any person, directly or indirectly, to make use of any means or instruments of transportation or communication in interstate commerce or of the mails to offer to sell or offer to buy through the use or medium of any prospectus or otherwise any security, unless a registration statement has been filed as to such security, or while the registration statement is the subject of a refusal order or stop order or (prior to the effective date of the registration statement) any public proceeding or examination under section 8 1. Once registration stmt is filed but even before it is effective can make offers to buy or sell. BUT Before registration is filed can’t offer to buy or offer to sell any security, iv. §5a/5c – interpretations: 1. Unlawful – so criminal statutory ramifications – jail, fine etc 2. Any person - §2(a)(2) – “person means an individual, a corporation, a partnership, an association..trust…” 3. Commerce clause language –if Constitutional challenge as to whether Congress has power to pass sec reg 4. 4(1)–sec 5 only applies to issuer, underwriter, and dealers; so any offering by them (ie sell stock) must be registered (have effective registration stmnt) and so secondary trading is exempt (not issuer/under/deal);
v. Registration Statement: bulk is prospectus other part is housekeeping stuff;
1. SEC thru regs tells what to include in registration stmnt; once effective can sell securities; a. Sue if registration statement is misleading/material omission; can’t sue on preliminary prospectus 2. Prospectus – a. a disclosure document/ sales brochure, whenever issuer/underwriter sells a security it must send prospectus to the potential buyer to inform them about the security; Finances etc; b. Prospectus must comply with §10. 3. Purpose is disclosure – a. good,bad,ugly to investor to make informed investment decision; risk irrelevant b. Buried disclosure is no disclosure at all 4. Reading Level: a. written in plain English at a NY Times reading Level (no legalizes/jargon) 5. Standard for Drafting: [TRUTH is not the standard] ----see Materiality SECTION pg 15 a. Statements can’t be materially misleading i. So if truth Chinese market for telephones is 1BN, can’t put that in prospectus for small company seeking to raise capital to make phones b/c misleading gives the impression he can play in that market but really can’t [can say idiot if buy stock no one sues but it is sales doc] b. Anything material must be included c. [tension – if disclose everything and too much bad stuff no one buys stock, if but if not disclose then sue later on if material] also drafter of reg statement needs to know all can’t rely on managers. 6. ’33 act sec 5 - Registration statement is registration of the offering not the stock/security – a. No such thing as registered security. Securities sold correspond to registration stmnt; SO if MS issues stock to public (stock cert 123) under a registration stmnt & MS wants to buy it back (treasury stock) & then resell to public some time later –MS can’t unless a registration stmnt is in effect to sell the security since old one is outdated, stock is not registered 7. Shelf Life is 9mos from date of latest financial information in the registration statement -info get old a. SO use latest financials in reg statement b/c if 6mos old only have 3 mos left on it b. Not mean it is better to buy stk from issuer not 2˚ trading b/c want all info &prospectus only from issuer offerings b/c 34 act requires prospectus type info be available to the public; so 2˚ trading is ok. 8. Fraud for prospectus is longer SOL than the 9mos– (3-5Years?) 9. FORMS for Registration Statement: a. Make disclosure easier–integrated disclosure forms–REG S-K (Co. info) & Reg S-X (accting inf b. S-1 = list of questions to be answered in prose, used by anyone who not qualify for short form, 11
(before could just offer 5(c)). Info wrt to the registrant i. Statutory and theoretical basis for prohibiting pre-conditioning of the market is found in the broad definition of “offer” of a security set out in §2(a)(3) of ‘33act. 4. So disclaimer says on prospectus SEC review not means sign off on everthing. Timing §8(a) – SEC has 20 days to declare registration statement effective a. 6. ie lawyers opinions. a. Exhibits: not part of prospectus. audited b. a.SEC doesn’t verify if all correct. Once registration statement is effective securities subject to that registration can be lawfully sold to the public under §5(a). SEC took position that pre-conditioning the market prior to the offering was a disguised offer b/c LR was garnering interest in the Co. S-2 = shorter form for more seasons companies S-3 = even shorter form for even more seasons companies – lots of info out there S-4 = for mergers S-K =complete package of questions -forms above reference S-K by stating which Qs to answer 10. director security ownership. Once Registration stmt drafted (by Sec Lawyers) submit it electronically via EDGAR (electronic data gathering and retrieval system).Descrip of business. Overview: gun jumping is any efforts/touting made to promote the sale of stock. S-X need financial stmts and income stmts.. vi. 5. Rhoades Co. hi/low prices. But every issuer that files registration statement makes a voluntary amendment waiving the 20 days for SEC benefit. f. Prefiling Hype = disguised offer of security. Every IPO uses S-1. 2. Loeb. just b/c declare registration effective not mean SEC signed off and verified all statements are true. 2. Guidelines change w/ each phase of the registration process. Everything else material to an investor and anything issuer believes investor should know c. articles of incorp e. Disclosure required by Forms/registration statement: a. Distribution of proceeds: underwriter describe agreement w/ issuer and use of proceeds c.when issuer. underwriter or dealer attempt to condition the public and arouse public interest in the issuer as a prelude to undertaking a public offering. SEC then reviews and comments on it (but not verification of mertis) – thru a comment letter. Securities of registrant–rights/privileges/ preference of securities offered. Can take weeks to months to prepare registration statement & is very expensive (ie 90K for 10MN offer) vii. which are subject to the upcoming offer. e. prior to registration – these are deemed to be tantamount to making offers in violation of §5(c) [illegal offers]. GUN JUMPING 1. SEC position: Pre-Conditioning of the market is in reality a disguised offer to sell securities. comp. Issuer responds by filing amendments – go back and forth for a while. once everything is ready to go effective near completion of review. Conditioning the market . S-K . (also get good faith working relationship w/ SEC). price disparity to dirctrs d.LR was going to underwrite an IPO and started advertising how great the security was BEFORE a registration statement was filed so getting the market excited about the offering. 1959. REGISTRATION PROCESS: 1. even indirect efforts to pre-condition the market. [timing offer is critical] 7.which established Companies use. NO Merit Review: . SEC v.if make all proper disclosure/amendments but can keep commenting. After all comments are incorporated and amendments filed – registration statement is declared effective 3. . b. even though the security was never mentioned 12 . SEC – can’t refuse to declare registration effective under statute and prevent sale. legal proceedings. And under §5(c) an offer to sell securities absent some exemption may be made only thru a prospectus (part of the filed registration statement).SEC not like 3. this is default form. d. Quid pro quo – in Return -SEC will allow the issuer to go effective on the date/time of his choosing.
Oral is Ok. ONLY allowed consistent remarks (oral/written). Prior to “in registration” can do whatever you want. Issuer is also called registrant. THUS once “in Registration” can do 135 PR. no conditioning market. public companies have a legitimate reason to disseminate info and make announcements. like no offer until filing b. 3. One has to worry about gun jumping when one is “IN REGISTRATION” i. 3. privately held (non-public) Co. RULE 135 –Safe Harbor – describes when a notice is not a disguised offer. (generally no obligation until day b/f offer) v. b. as they always disseminate information. (subject to fraud limitations) ii. 1. Consistency allowed: During Pre-filing pd an issuer should carry on as normal but should clear all public communications through securities counsel and refrain from giving forward looking stments or going just beyond the facts & normal advertising & running of the Co.“there is no basis in secrities acts or in any policy of the SEC which would justify the practice of non-disclosure of FACTUAL information by a publicy held company on the grounds that it is ‘in registration’. b/c all now know who underwriter is and that there is offering to be made ii. whether offer is directed to a particular class of purchases (public/private) brief purpose of offering. Once “in registration” rules as to what can be said and done. 1. Permissible items: can include no more than name of issuer.” a. “IN REGISTRATION”: TIME FRAME: a. Though can do normal self promotion but not was LR was doing as underwriter 4. [if no offer no 5c] 2. General remarks should be consistent w/ the past. [have SEC review & back/forth w/ SEC] i. iii. “in registration” have far less justification to make announcements/facts unless in news for some other reason. d. Can’t make direct or indirect offers. i. REGISTRATION PROCESS – 3 PERIODS: a. no appearance of offers ii.§5(a) until registration statement is effective iii. b. 5. anticipated timing of offer. So in registration at a later point. if not ordinary can be seen as disguised offer 2. iv. Pre-Filing Period aka Quiet / consistent period – the period between when the issuer is “in registration” & the filing of the registration statement i. and once find UW start Reg stmnt work. Example – issuer cannot launch a new marketing campaign. title. Conservative analysis -issuer is in registration once senior management has made a good faith firm decision to proceed with a registration (Jalil like this) c. Prohibited items: name of underwriters. Still can’t sell security . underwriter negotiations(2a3) or rule 135. 1. Liberal analysis – an issuer is not “in registration” until a letter of intent has been signed w/ an underwriter. offering price. amount of offering. “In Registration” begins in either case before registration statement has even been drafted or filed i. Not really quiet period b/c law only requires be consistent.by LR’s press releases etc – SO this was a violation of 5(c) and gave rise to concept of gun jumping. An issuer “in registration” may make a rule 135 Com/PR about upcoming offer which contains following 1. Gun jumping analysis changes-Generally NO written material allowed except PP. conduct business and communicate in normal manner and behind scenes negotiate w/ underwriter. Oral offers / Oral statements allowed – [no radio/tv – they are seen as prospectus?] 13 . a. amount and basic terms of securities to be offered. Mandatory: legend -Communications must state that an offer may be made only by a prospectus and that this information given is not an offer. Waiting Period (waiting for effectiveness From SEC) – the period after first draft of registration is filed and until Registration statement is effective. SEC 5180.
Final preliminary need circulate at least 48 hours b/f effectiveness and if final prospectus will materially differ from final PrePros – then have to Re-Circulate FINAL PROSPECTUS since not substantially same as PrePros and should wait 48 hours. Investment decisions usually based on preliminary prospectus b/c trades get done instantly once registration is effective iv. Communication Must include: following (if reg stmnt not effective): “A registration statement relating to these securities has been filed with the SEC but has not yet become effective. RED Herring – red legend – says Preliminary prospectus / incomplete prospectus and gives indications of possible changes b. [only pricing information should differ] d. This communication shall not constitute an offer to sell or the solicitation of an offer to buy nor shall there be any sale of these securities in any state in which such offer. letter or other communication published or transmitted to any person after a registration statement has been filed if it contains only the statements required or permitted: i. SEC position . Underwriter circulates this broadly to get interest Rule 134 2.1. Any sale consummated it must be accompanied or preceded by a final prospectus – unless shown that investor already has a copy of final prspct–like multiple sales to him ii. The term prospectus shall not include a notice. Formal offers can be made and accepted and sales may be consummated 1. Underwriter doing lot of oral sales efforts during waiting period and using PrePros 4. solicitation or sale would be unlawful prior to registration or qualification under the securities laws of such state. §5(b)(1) – requires that after registration statement is filed and effective. These securities may not be sold nor may offers to buy be accepted prior to the time the registration statement becomes effective. Preliminary Prospectus aka Red Herring: Written offers maybe only made thru preliminary prospectus – no statutory requirement that preliminary prospectus be distributed. Post Effective Period – after registration statement becomes effective – i. RULE 134 – tombstone ad – safe harbor of what can be included in an Communications not announcement regarding the offering to be made – once a registration statement has deemed prospectus been filed: a. 2. Usually if material diff. BUT: Offers subject to qualification – are to solicit “indication of interest” on part of the buyer and No binding offer or acceptance may be made (and no sales consummated. ad. circular. just Re-circulate PrePros and then wait another 48 hours before effective. full title of security and amount being offered ii. rule 134 1. Issuer/underwriter can choose effective date iii. Writing–3 things allowed Preliminary Prospectus. $$ accepted) until registration statement is declared effective. [reduce surprise when final prospectus comes with or prior to confirmation of order] a. No limitations on what can be said can make offers just can’t be accepted 3. Underwriter negotiations.” c. all written offers to 14 . (once effective either at or prior to confirmation of the sale customer must receive final prospectus) iv. Communication May include: name of issuer of security. Amendments – need to keep sending prospectuses out – SEC not grant effectivenes unless most recently circulated PrePros is substantially same as final c.it will not grant effectiveness to registration statement until it gets assurance from underwriters that PrePros in form closest to final prospectus was circulated to all investors who demonstrated indication of interests.
puts add in business week touting company but previous ads were in BYTE –not allowed 1.sell must be in connection with a prospectus that complies with §10 of ’33 act v. RULE 419 – must keep that money in escrow until the purpose is disclosed to the investors and they approve of it: 8. VP sends written agreement w/ underwriters to Co’s other office – fine w/in Co communications – not commerce clause power – even if interstate. Co. 9. Pre-filing period – i. DOCTRINE of FREE WRITING – once registration statement is declared effective can write/say whatever you feel so long as communications is accompanied by final prospectus 1. Need good faith that mailed prospectus vii. orally can say anything – no matter how strong armed but only written is PrePros 15 . vi. Co. §5(b)(2) . Waitng period no written comm. Underwriters and dealers – need to distribute prospectus so long as there are shares remaining in their allotment 3. Co sends out annual reports – fine if consistent but now say its glossier – problematic viii. and then could not do any offerings. Jane hears of offer and writes in offering to purchase – illegal offer and can’t be accepted vi. w/o this issuer would not be able to discuss offering w/ prospective underwriter b/c it would be considered an offer. SHELF REGISTRATION: . BLANK Check Companies .SEC will not accept registration statements and review them unless the issuer has good faith intent to make the offerings and go effective ASAP. PROSPECTUS DELIVERY 1. Except PP or rule 134 –but once effective -all free writings are no longer prospectuses (as were in past) so not need safe harbor 2.§2a3. §2(a)(3) – excludes any preliminary negotiations between the underwriters and the issuer or among underwriters who are or are to be in privity of K w/ issuer from the broad definition of “offer”. Waiting Period: i.RULE 419 – some companies raise money w/ no particular purpose for that money in mind. a. GUN JUMPING EXAMPLES: pg 172/179/186 a. Ibank issue statement disclosing Co will do offer and what its for and how big – OK rule 135 but can’t identify underwriter in pre-filing period vii. Need to remain consistent once in registration (good faith to do offering) ii. Co. Nonparticipating dealers – must deliver prospectus for 40 days after effectiveness 6. Co. Broker at underwriter calls jane and tells her to buy some stk and sends preliminary pros – OK as long as solicitation for indication of interest 1. i. v.requires final prospectus is required to be delivered w/ security when delivered 1. iii. Co. Rule 434 – do not need to send complete prospectus can send multiple docs which collectively contain all the necessary information. [so even pre-filing can do this] 7. VP starts talking to Ibank about an offering or solicits more Ibanks– Fine . Co issues PR announcing filing of reg stmnt and offering – no good b/c offers must be thru preliminary prospectus or orally – but rule 134 safe harbor can name underwriter ii. ISSUER must continue to deliver prospectus under §5(b) so long as they are offering security to the public 2. VP to give speech arranged prior to being in-registration – fine as long as consistent b. Exception – Rule 415 – Shelf Registration Act – certain large issuers that meet certain tests can file shelf registration statements in advance and keep their information current with the SEC and go effective whenever they want to issue the securities. NEGOTIATIONS with Underwriters: a. tells Ibank – will get commission if move their stock – illegal offer? iv.
Sally mailed a prospectus – she never sees it and puts in for 100 shares – THIS is ok just need good faith that mailed prospectus ii. Underwriter sends letter to Jane describing other stock in Co and how good it is – should be fine unless seen as rousing interest. viii. Broker send PrePros to all known – and follow up phone call – both fine Effective period og195 i. Can send anything post effective as long as accompanied by prospectus 16 .c. iii. Check sent to broker for shares – NO good – can only solicit offers – not sell v. Broker sends note to Jane says this is a good buy – NO good only writing is PrePros or 134 iv. Third party not involved in offering places info on website about offering – OK – can say whatever want if not involved vi. Co puts hyperlink on website linking to third party report – NO good vii.
if future event is uncertain or speculative what to include 7. Levinson-pg 584 US 1988 – Co was in merger discussions and did not mention it and argued that uncertain if it will occur so not discuss it. 5% Rule of Thumb . Northway) i. Even if the registration form not specifically ask for it – if it is material it must be included. b. C sues – not win – b/c must be material to a reasonable investor. 4. This is an objective standard – reasonable investor – not based on individual preference b. in Pro? a. Truth is not the standard – a true statement can be misleading a. 5. Buried disclosure is no disclosure at all. ON GOING DUTY TO DISCLOSE – once issuer has disclosed something must continue to disclose and reveal it. Pg 583 – disease resistant rose in prospectus – small part of business but C bought stock b/c very impt to him. IRRELEVANT to materiality if issuer to be harmed by disclosure – and thus must include if it is material information – see below f. PJ – assign number to both probability and magnitude if sum exceeds X then disclose it.something is generally material if it reflects 5% of earnings or income or net assets. Reasonable Investor Standard – “a fact is material if there is a substantial likelihood that a reasonable investor would consider it important in deciding whether to invest” (TSC v. or acquisition dept calls – farily low probabitly but if MS’s inv bank calls – now have high probability iv. ii. a. READABLE. i. SO Gates says in golfing takeover Co. OR above lie about age – not material if 59 instead of 57 FUTURE EVENTS and Materiality . Issue is if include something that not pass the test it can be misleading – like say we are thinking about merging -there is high magnitude but very low probability it will occur. There is no liability if the misstatement/omission is immaterial. Buried Disclosure doctrine – even if disclosed all material information. it was terminated and not told to C. can’t hide e. So if say 10K sq ft warehouse and actually 9998sqft – can’t sue – not material 2. and must be SUFFICIENTLY PROMINENT for its relative importance. [not bright line test – should not survive SJ] c. whether it is material and should be included depends at any given moment upon 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 i.viii. 17 . CT–paternalistic approach to materiality is no defense. MATERIALITY OF INFORMATION – standard prospectus are held to 1. g. It is material if substantial likelihood reasonable invesor would consider it important and significantly alters total mix of info available – adopts TSC position. What Rises to the Level of Materiality – (ie must be in prospectus) a. Basic v. iii. Market Test – effect on price should be measure of damages not measure of materiality – If we assume market is efficient and all reasonable investors then maybe if info comes out and stock goes down then info is material but Market is not reasonable investor? d. A prospectus will be actionable if a statement or omission is Materially Misleading. Examples: i. EXEMPTION of material disclosure – can go to SEC to exempt disclosing material info i. that information must be CLEAR. FLIP–high probability buy truck next yr-already have 200 trucks low magnitude no disclosre c. And if lie still cant sue unless material – so say director is 58 but he is actually 60 3. Probability magnitude test –to determine wrt contingent or speculative information or events.can’t be catering to each wacko ii. Ie if legitimate competitive reason not to disclose and if not affect totality of info. IF something happens after the prospectus-need to amend prospectus–Post Effective Amendments 6.
stock bought at 10 now 8–material & prospectus not say stk can go down – not need disclose ii.some facts are so obvious that even if they are material. the issuer doesn’t have to disclose them (if obvious or common knowledge) – i. Don’t have to disclose – trade secrets e. OBVIOUS FACTS: . SEC not want huge overloaded prospectus iv. Bribery . it happened so many times – so not need put in the prospectus iii. Need to disclose even if bad for SHs 1. Wieglos v. SOX §409 – each issuer under 13a and 15d (every public co) shall disclose to public on a rapid and current basis such additional info concerning material changes since the financial condition or operation of the issuer in plain English. Pg 592-11-2. Even if non financials not come to % mark – disclose if material – if reasonable investor would care. Commonwealth Edison Co – constructing powerplant – obvious it could have cost overruns. which may include trend. 5. A finds out her factory encroaches on neighbor & if find out will have factory torn down – so if disclose bad for SHs today but not matter b/c material info so must disclose in prospectus iii. qualitative determinative which would be necessary or useful to investors. Deals with integrity of mngmt if material to that want to know it 4.i. past could remain silent on material info btwn filings 10Ks ’34 act and disclose when file but SOX duty to keep disclosing material info in real time ii.to what extent must issuer disclose social concerns and social action and info not in best interest of company i. Foreign Corrupt Practices Act – any international payoffs must be disclosed ii. Also illegal activity. d.SCHLITZ – beer marker needs to pay of distributor or Co loses – so doing something to help company but still reasonable investor would want to know 2. Ex. Social issues –gray area – 1. 18 . TRUTH on MARKET – misstatment not material b/c savvy investor knew prospectus wrong and stock price moved accordingly – efficient market accounted for inaccurate info DISCLOSURE OF SOCIAL CONCERNS/Non quantifiable facts: . health issues all need be disclosed 3.
(both §4’s are exempted transactions) 5. (ie US treasury bond) iv. RESIDENCY REQUIREMENTS: a. §4(2) – registration reqs of §5 not apply to transactions by issuer not involving public offering 4. 80% of its gross revenue are derived from that state b. §2(a)(3) – underwriter negotiations and agreements permitted b/f registration – not an offer 2. TEST: a. DOING BUSINESS – issuer is doing business w/in a state if: (meet all?) a. if follow Rule SEC not come after you – only for issuer. iii. 4. ISSUER needs to be a resident of and doing business w/in the state or territory in which all offers and sales are made (at time of offering) and b. ii.IV. §3(a)(11) – Intrastate Exemption – “any security which is part of an issue offered and sold only to persons resident w/in a single state or territory. and therefore not need any disclosure or file registration stmnt but still cannot make affirmative misrepresentations (also state laws may require some disclosure) ii. 1. §4(1) – registration requirements of §5 only apply to issuer. §3b – plenary power up to 5MN b. “The rule shall not raise any presumption that the exemption provided by §3(a)(11) of the act is not available for transactions by the issuer which do not satisfy al of the provisions of the rule” 2. General partnership –is resident of the state where its principal office is located c. TYPES of exemptions: §5 can’t offer security w/o registration 1. Rule 147 is not the only way to satisfy 3a11 but since SEC strict stupid not to follow 147 iv. incorporated by and doing business w/in such state or territory” i. where the issuer of such security is person resident and doing business w/in or if a corporation. Overview: i. RULE 147 – safe harbor – for intrastate offering. TRANSACTIONS EXEMPT FROM REGISTRATION Things an issuer can use 3(a)(11) [Rule 147] 4(2) [Rule 506] Rule 504 Rule 505 Reg A (only if non-public co. There are Exempt securities – exempt b/c type of security being offered.) 3(a)(9) Things a control person can use Rule 144 (only if public co. There are Exempt transactions – exempt b/c manner in which security is being offered iii. §3 – exempted securities – but drafting error has both exempt securities and certain exempt transactions. Corporation & Limited partnership are residents in state in which they are incorporated/organized b. 80% of its assets are in that state c.) Things a reporting company can use Rule 505 4(2) [Rule 506] 3(a)(11) Things a private company can use 4(2) [Rule 506] Rule 504 Rule 505 Reg A 3(a)(11) Things investment companies can use 4(2) [Rule 506] a. This is an exempt transaction not exempt security. Ie §3a11 – intrastate exemption is an exempt transaction. a. Rationale: political compromise – states rights advocates in congress when ’33 act passed and act passed on commerce clause power. 80% of the proceeds of the offerings are to be used in that state 19 . Individuals – is resident of the sate where he has his principal residence is located. No part of the issue be offered or sold to non-residents w/in period of time specified by rule 3. SEC HATES §3a11 and will enforce it strictly – SO one offer or sale out of state and blown. underwriter and dealer wrt that offering – so not apply to secondary trading (but does to secondary offering – ie someone other than issuer offers) 3. Offering/sale exempt from registration process of §5 of ’33 act. 1.) 4 (1 ½) Reg A (only if non-public co.
4. IS the same type of consideration received? (ie one for cash other is securities exchanged for merger) 5. 7. Are the offerings made for the same general purpose? iv. Suppose you offer common stock in NY in Sept. Tacking: 9mos period tacks back to date of issuance so purchaser can sell to other residents during 9mos period and no new 9mos period ii. EXAMPLES: 1. There is no numerical limitation as to how many people can offer to and can do general solicitation. RULE of thumb – if offerings are a year or more apart – SEC will generally not integrate. ii. if offerings 6mos or less apart – SEC will probably integrate. Or have K – that says can’t resale for 9mos to nonresidents or consequences? iv. Security must be hold by residents of the state for 9mos (starting date of last sale or last pmt is received). Are the offerings made at or about the same time? a. (Residency req prevents doing intrastate exemptions in many states but so does integration) d. 6. There is no requirement to give any disclosure under 3a11 b/c not w/in §5. and §5 registered offering blown b/c had solicitation thru 3a11 offering prior to registration statement filed 2. TIMING / INTEGRATION: . Five Factors of Integration:(none dispositive) (prelim notes Rule147 & Rel 33-4434) – use if no safe harbor1. 6mos-1yr apart – look at factors 4. Can’t do intrastate exemption offering in NY as bulk and then same time do registered offering in other states. v. Do they involve the same class of securities? (ie common stock/debentures) 3.offers to sell and sales may be made only to persons resident of state or territory which issuer is resident. DOCTRINE OF INTEGRATION: . Advertising must be reasonably calculated to address the state in question and can advertise to antoher state as long as have legend noting offer is limited to this state residents a. Do a 3a11 and w/in 6mos do public registered offering – if SEC integrates them then in trouble b/c 3a11 exemption is blown b/c had interstate offering. and even if one person sells out of state exemption is blown (so no straw men) i. RESALE LIMITS: [restricted securities] a. Same resident rules above for the purchasers but – Corporations organized for specific purpose of acquiring part of the issue – will not be deemed to be residents of a state unless all the beneficial owners of the corp are residents of the state. IF purchaser moves out of state – depends on intentions to see if destroy exemption 9. [maybe state laws] 2. But can’t say advertise to all NY MDs b/c know not all live in NY 3. c.principal office or place of business is in that state. IMPLICATIONS OF §3(a)(11) 1. Newspaper – so can advertise to out of state – but need to use legend that states offer limited to people in certain state. Are the offerings part of a single plan of financing? (what is money raised for) 2.any offering 6 months apart (before or after) will not be integrated a. 5. Rule 147 is just a safe harbor if follow it – valid 3a11 exemption – but it is not the only way to satisfy 3a11 but sec is strict on 3a11 enforcement. iii. OFFEREES and PURCHASERS: . Then you also do a registered offering of 20 . Radio. but Follow Safe Harbors to avoid integ.on a §3(a)(11) – need not be a resident of state of offering (ie same state as issuer) 8. if certain factors are present. a. Integration depends on analysis of specific facts and circumstances. Best way to control – hold all shares in escrow for 9mos then allow investors to get them iii. Integration prevents and issuer from improperly avoiding registration by artificially dividing a single offering so that exemptions appear to apply to the individual parts where none would be available to the whole.SEC will integrate 2 or more separate offerings and treat them as one single offering. under 3(a)(11). ADVERTISING UNDER 147 – can use TV. UNDERWRITERS . i.
but they are offered at the same time. They are not used for the same purpose 21 . They don’t involve the same security or class thereof. The common stock is used to purchase equipment.notes the same day in all 50 states. but arguably some are making equity investments while others debt. and the note offering is to hire more salesman. They receive the same type of consideration. To argue that the two offerings should not be integrated (thus denying the benefit of 3a11 as to the common stock offering).
Position with Issuer – have disclosure b/c of access to info thru one’s position w/ issuer. NO QTY limit i. §4(2) Exempted transactions “transactions by an issuer not involving any public offering” 3. Opposite of public offering is not private offering (its non-public). Courts approach to who is sophisticated (above saw ABA) pg 284 i. 3. §4(1) – section 5 does not apply to transactions by any person other than issuer. 1. SEC sued said offering was made to too many people (>35) to be considered non-public. dealer 1. Access to information: (if sophisticated w/o info – no good) can be satisfied in one of 2 ways: i. Sophistication of investor – stnd – relevant inquiry should be whether the investor can understand and evaluate the nature of the risk beyond the information supplied to him. (Sec v. 9th cir – sophistication is one of 4 factors – size etc – so not good test can have huge prvte P ii.d. COURT rejected both arguments & found that : a. If sell to 10000 business school professors offering is non-public . If sell to one financially unsophisticated person it is public offering and need to register ii. Old Test: SEC -4 factor test to see if exemption applies: 1. The relevant inquiry should not be whether the investor is knowledgeable on all latest nuances & techniques of corporate finance. 2. underwriter is defined different see below 2. Manner of the offering 4. Number of units offered. 5th cir – greater emphasis on disclosures than sophistication iv. the public (noun) is anyone who needs protection of the ’33 act i. §4(2) – Private placement (non-public offering) – issuer only ---RULE 506 is safe harbor for §4(2) 1. 1. Ie private placement memo c. Just because wealthy does not mean you’re a sophisticated investor for §4(2) iii. SO Issuer can go to Ibank and they can find investors that they know from previous experience are sophisticated – this way no general solicitation iii. (ABA) i. No General Solicitation – an issuer can’t generally solicit for non-public offering: i. Number of offerees (35) & their relationship to each other and the issuer. §4 EXEMPTED TRANSACTIONS i. business experience ii. Issuer can send questionnaire for investor to fill out. This is b/c can’t even make offer to a non-sophisticated person w/o blowing exemption so no general ads that say this is just for sophisticated persons – (need register to even offer) ii. Access to information abou the issuer c. 10th cir – persons of exceptional business experience iii. Overview: a. Disclosure – investor receives same disclosure had issuer prepared a registration statement – 1. It is a question of fact based on business acumen. Size of offering and number of people being offered to does not matter. Ie – directors or officers – can’t apply to any EE. lots use this exemption 2. Sophistication (wrt financial matters) 2. 8th cir – not require sophistication and emphasizes offerees access to information 22 . underwriter. ii. [RISK has nothing to do with it] e. Ralston Purina -pg 276 US 1953–D pet food store -offered securities to its EEs under the belief that it was not a public offering.Kenton take SSN chk bank no gd) b. RALSTON PURINA TEST FOR §4(2) – Non-Public Offering: 3 requirements: a. 4. SEC v. Size of the offering. this exemption allows secondary trading w/o registration ii. nor did D solicit the EEs to purchase shares (253 buy). MUST Reasonbly believe in good faith thru prior info or relation that they are sophisticated – SEC prefers had relationship w/ them prior so know sophisticated d. public is Financial unsophisticated person b. A person does not need protection if they have i.§4(2) exemption 5.
v. Others sophistication alone is not dispositive – need access to info 23 .
good faith investments 3. The Following are Excluded: i. if it finds that the enforcement of this title with respect to such securities is not necessary in the public interest and for the protection of investors by reason of the small amount involved or the limited character of the public offering.e. Two methods to adhere to §3(b) [Rule 504 & 505] which allows exemption of any kind of offering so long as its under 5MN. §3(b) The Commission may from time to time by its rules and regulations.000. and subject to such terms and conditions as may be prescribed therein. iii. & 2. Provides a safe harbor for §4(2) private placement (rule 506 for non-public offering following reasoning of Ralston Purina) 3. or other entity shall be counted as one purchaser unless: i. A Corporation. add any class of securities to the securities exempted as provided in this section. a trust or partnership or company having at least $5MN in assets b. Any Corp or Org where purchaser or persons related are collectively >50% equity interest iv. Corporation/partnsp. Any trust or estate in which purchaser and such relative or relatives collectively have more than 50% beneficial interest iii. or general partner of the issuer offering securities under REG D c. [so if formed 10 yrs ago no prob. if formed recently then see % assets invested in offering and % invested elsewhere. non-profits: an insurance company: a registered broker/dealer: an investment company (mutual fund): certain pension funds. REGULATION D (Rules 501 – 508) i. look@ nature&duration of prior activities. Natural person w/ net worth of or in excess of $1MN or having an income of $200K(300K w/sp) d. Banks. RULE 501 – Definitions: 1. executive officer. trying to mimic Ralston Purina but Moron Millionaires would not cut it under sophisticated person stnd of Ralston Purina but still would qualify under REG D ii. Any director. partnership. And certain other entities e.Calculation of the Number of Purchasers: [need in rule 505 and 506] a. 2. but if formed just for offering then no good] ii. proposed activites of enty size of capitalizn related to offering (505/506). whether equity owners can opt out. SEC has Plenary (absolute) power to exempt from §5 registration any offering so long as not >5MN 2. 40/60 Test -No more than 40% of the assets of the newly formed corp are invested in the 505/506Txn and 60% of the assets are invested in real. Introduction: 1. Any relative. [formed for purpose of doctrine] --To determine: Q of fact 1. Any Accredited Investor b. 501e. Regulation is just a collection of related rules 2. but no issue of securities shall be exempted under this subsection where the aggregate amount at which such issue is offered to the public exceeds $5. Balance protect investors w/ promote Small busin ii.000.. SEC can proscribe rules etc regarding this exempt offering of <5MN – RULES 504 and 505. was formed for the purposes of purchasing securities in the offering and is not an accredited investor. 501a -Accredited Investor a. spouse or relative of the spouse of the purchase who has the same principal residence as the purchaser ii. Therefore do not make equal accredited person w/ Sophisticated person stnd of Ralston Pur 2.Purchaser Representative: A person who is not “connected” with the issuer (unless he or she is a relative of the issuer) and has such knowledge and experience in financial and business matters to be capable of evaluating the merits and risk of the investment a. [accredited investors are types of persons & entities that do not need protection of Fed Sec Laws] i. 1. 501h. structure of entty.1. RULE 506 allows an unsophisticated investor to use a purchase representative to qualify for PPlc 3. then each beneficial owner of equity securities or equity interests in the entity shall count as a 24 . REG D – does double duty exemptions. REG D – developed by Congress as part of the Small Business Initiative to provide inexpensive efficient ways to raise capital & still respect the securities laws.
If disclosure is required the following rules must be followed: i. it is irrelevant b/c §3(b) not §4(2) b. If the issuer does not avail itself to the safe harbor.5MN. When REG D offering or sale is made the issuer shall file a notice on FORM D w/ the SEC no later than 15 days after the first sale of securities in the offering [Simple form gives notice to SEC did exempt offrng vi. Investors do not need to be sophisticated. Exempt from §5 – registration b/c of §3(b) c. If issuer is a reporting co. Solicitation -502c – no general solicitation (no ads in paper or TV like rule 147 in state offering) i. Qualification of Investors Can offer to anyone. [no strangers] 4. offerings may or may not be integrated i. RULE 504 – Exemption from Registration for Offerings under $1MN 1.Executive Officer: President. Rule 505 and 506 offerings may require disclosure to the investor (if non-accredited) c. 1. If integrate §3(a)(11) w/ REG D corrupt exemption b/c Rul 147 can generally solicit §4(2) cannot 2. subject to 13&15d of ’34 act (no public co like MS) b. 502b . ii. up to 7. Issuer must also give investors in Rule 505 and Rule 506 offerings the opportunity to ask Websites are questions and receive answers [not need in rule 504 b/c no disclosure requirement) tricky – not 3. RULE 502 – General Conditions To Be Met [that are applicable to Reg D each rule picks from this] 1. B/c there are size limits in 504 or 505 offerings if integrate separate offerings can blow exemption c. Implications: a. Issuers that are NOT an investment company (ie mutual funds) c.Information Requirements / Disclosure a. If the issuer is Not a reporting company (non-public) the issuer must give the investor the same information it would have given if it had filed a registration statement. Look at the facts of each case and weigh Five Factors discussed above (pg 18) b. [look thru] c. Integration-502a safe harbor can’t integrate offerings made > 6mos b/f or 6mos after this offer c. and no limit on number of people i. Rule 504 is to encourage Small business to be created/grow 2. Need progressive more detailed financial info as offering size increases: under 2MN. IF NOT above can offer up to $1MN in securities w/o registering 4. Overview-statutory authority is §3(b) which gives SEC plenary authority to exempt offering up to $5MN.5MN and over 7.d—no disclosure(b)] a. 502a -Integration – Offerings made more than 6 mos before start of Reg D and more than 6 mos after the completion of REG D offering will not be integrated (safe harbor) a. NO disclosure required b. REG D offerings are exempt transactions from registration so securities purchased in REG D offering cannot be resold w/o registration or exemption from registration.c. RULE 503 – Filing of Notice of Sales – FORM D 1. UP to $1MN in securities offerings . 502d -Limitations on Resale / Restricted Securities (502d) a. No blank check companies – Co w/ no business plan how to use the proceeds of the offering d. VP. So can’t send out info to anyone you don’t have a preexisting relationship with. If requirmnts are met phrase is “Doing a 504”. it must give the investors copies of reports it has given the SEC iii.separate purchaser for all provisions of Regulation D except as to (a) above. Issuer that are NOT a reporting company. Restricted Securities – 502d – so cannot be freely resold (follow certain rules ie rule 144) 25 . and no limits on number/character or purchasers 3. v. senior mngmt who performs similar policy making functions iv. Eligible Issuers: (Only a private company) a. There can be NO general solicitation or Ads in certain 504? & ALL rule 505 & 506 offerings pwd b. There are no disclosure requirements for certain 504 offerings & offerings to accredited investors b. 501f. Limitations/conditions: [Follow 501 and 502a. Can’t even offer to strangers – just sell to people known or introduced to d. A non-contributory benefit plan w/in title 1 of ERISA shall count as 1 purchaser where trustee makes all investment decisions for that plan 4. 502c -Limitations on the Manner of Offerings / No General Solicitation allowed unless a.
Aggregation: [to avoid abuses] i. NOTE: also for 504 and 505 – previous 3b offering date is the date of completion of the offering not start of offering. A reporting company (public Co like MS / GE) may use Rule 505. NO more than 35 Purchasers in Rule 506 Offering [rule 501e–accredited investors not count] pg 20 26 . RULE 505 – Exemption from Registration Offerings Not Exceeding $5MN 1.b. Number of Purchasers -35. [avoid abuses] i. Restricted Securities – 502d – so cannot be freely resold (follow certain rules ie rule 144) f. Eligible Issuers: a. Overview–statutory authority is §3(b) which gives SEC plenary authority to exempt offering up to $5MN 2. NOTE–only count §3b offerings in 504/505 so §4(2) offerings & §3(a)(11)–R 147 not count viii. Can still do 4(2) w/o Rule 506 but take a risk w/ SEC 2. Count against the $1MN offering limit all §3b offerings (504/505/A) w/in the previous 12 mo 1.c.d not apply – So there can be general solicitation and securities received will not be restricted e.i. corp is 1 b. NO limit on the amount of offering–so aggregation is not an issue here ¬ aggregte w/ 504/505 3. Aggregate offering price in Rule 505 can’t exceed $5MN w/o registration ii. then 502c.d] # of purchasers – a. ie did 250K 504 offer 1/3/08. Implications: a.follow rules laid on in rule 502b i. accred inv all don’t count.d] # of purchasers – a. Eligible Issuers: a. 4. Note: If state law of at least one state where securities sold requires filing w/ state & delivery of disclosure document to all purchasers even those in states w/o reqmnt or if state law allow general solicitation so long as sales are made to only accredited investors.(not offerees) Look at 501e i. if selling to accredited investor no disclosure [so if keep offering all accredited no disclsure] ii. If selling to non-accredited investor disclose per 502b. 4. Count against the $5MN offering limit all §3b offerings (504/505/A) w/in the previous 12 mo 1. statutory authority is §4(2) [non-public offerings] (not §3b) a. Overview–Rule 506 is the §4(2) safe harbor. so need count in previous 12 mos any completions iv. All Issuers may do a Rule 506 offering and utilize this safe harbor. Aggregation: aggregate offering price cannot exceed $1MN. pub SEC rpt d. Can offer up to $5MN in securities w/o registering i. Integration-502a safe harbor can’t integrate offerings made > 6mos b/f or 6mos after this offer c.b. NO more than 35 Purchasers in Rule 505 Offering [rule 501e–accredited investors not count] pg 20 1. Disclosure-502b . character not matter Look at 501e i.(not offerees). 505 offering may have unlimited accredited invstrs/relatives & 35 non-accredited invst 2. UP to $5MN in securities offerings 3. 506 states how to do a valid private placement (non-public offer) under Ralston Purina [sophistic] b. Did 504 offer for 1MN 12/1/08. Solicitation -502c – no general solicitation or advertisement e.like reg stmnt private co. Exempt from §5 – registration b/c of §3(b) b. Rules pg20–relative spouse trust/estate >50% BO. RULE 506 – Exemption from Registered Offerings w/o Regard to the Dollar Amount of the Offering 1. now its 7/1/08 – max 504 offering can be done is 750K vii. Exempt from §5 – registration b/c of §4(2) – non-public offering b. Issuers that are NOT an investment company (ie mutual funds) b. Implications: a.c. now its 9/1/09 and want to do 505 offer – max is 4MN iii. Limitations/conditions: [Follow 501 and 502a. Number of Purchasers -35. Limitations/conditions: [Follow 501 and 502a.
1. NO dollar limit in rule 506 b. Condition or Requirements of Reg D 1. IF VP of Co wants to participate in the private offering – still needs to prove sophistication or determine if VP is accredited b/c title alone is not enough – salary or net worth is all that counts 6.Need sophistication b/c can’t ignore Ralston Purina i.506. 505. RULE 505 and 506 – Key Differences: a. Rules pg20–relative spouse trust/estate >50% BO. Law makes assumption that all accredited investors are sophisticated ii. 506(b)(2)(ii). Restricted Securities – 502d – so cannot be freely resold (follow certain rules ie rule 144) 5.like reg stmnt private co. Can still do §4(2) – non public offering just can’t utilize the safe harbor b. Integration-502a safe harbor can’t integrate offerings made > 6mos b/f or 6mos after this offer d. RULE 508 – Insignificant Deviations from Term. x. Any Insignificant/immaterial deviations from the strict compliance of Reg D does not necessarily mean that the Reg D exemption is not still available for the given offering (ie not fatal to exemption) a. accred inv all don’t count. corp is 1 b. Nature of Investor: . If had 50 sophisticated investors but not accredited then can’t do 506 offrng b/c 35 purchaser max i. so can’t do future REG D offerings. pub SEC rpt e.If non accredited investor either alone (or if unsophisticated) through purchase representative must have such knowledge and experience in financial and business matters to be capable of evaluating the risks and merits of the investment 1. If selling to non-accredited investor disclose per 502b.follow rules laid on in rule 502b i. Examples/ Notes on 506: a. Can’t Mix and Match Rule 506 w/ §4(2) i. 505 offering may have unlimited accredited invstrs/relatives & 35 non-accredited invst 2. here SEC is more lenient 27 . Thus every non-accredited investor needs sophistication using tests above §4(2) c. Unlike rule 147 for §3a11 exemptions where any deviation is fatal. Disclosure-502b . RULE 507 – Disqualifications: (bad boy provision) Certain issuers who have gotten in trouble w/ the SEC in the past for failing to file FORM D may not use RULE 504. so if had 1MN net worth – you are an accredited investor but still not automatically qualify as sophisticated if doing a §4(2) outside of rule 506 c. For Rule 506 – all accredited investors are assumed sophisticated ii. Need to show a good faith reasonable attempt to comply and deviation is insignificant b. Need sophisticated investors in Rule 506 ix. But if doing a §4(2) offering not rule 506 then every investor needs to prove his or her sophistication. if selling to accredited investor no disclosure [so if keep offering all accredited no disclsure] ii. Solicitation -502c – no general solicitation or advertisement f.
However 504/505 offerings aggregate w/ all §3b offerings incl. Disclosure requirements under REG A are less stringent than those for registration statement 5. Any prior offerings/sales of securities [that are not Reg A (only have Reg A for aggregation)] ii. NOT a reporting company (No public company subject to §13&§15d of 34act) c. radio. How: An issuer may publish or deliver to prospective purchasers a written document or make scripted radio or TV broadcasts to determine whether there is any interest in a contemplated securities offering 3. Solicitation (251d): a. However 504/505 offerings aggregate with all §3b offerings including Reg A w/in previous 12mo ii. made in reliance on Rule 701 3. registered under §5 2. Overview: allows an issuer to test the waters to see if there is any interest in the offering before spending time and effort to do a REG A offering. Prepare an offering circular/statement and file w/ the LOCAL SEC office (not DC like norm reg) b.) a. Issuer prepares an offering statement FORM I-A and is filed with SEC local office (unlike reg file in DC) 4. Issuer requirements (251a): (private co. After Form I-A (offering statement) has been filed with the Local SEC office. Aggregation – a. for $5MN can still do $5MN Reg A Tues. Example: If do 505 offering Mon. Reg A w/in previous 12mos c. 2. can do oral and writer offers and advertisements (Print. Reg A offerings will NOT be aggregated w/ the other §3(b) offerings –504 or 505 offerings i. Once filed but before qualified (effective) can make offers and advertise (radio tv etc) c. Once form is qualified (effective) can make sales iii. Must be a US or Canadian Entity b. REG A Encourages general solicitation unlike REG D 6.5MN) 3.– Reg A not aggr d. 254d – Bona fide change of intention: (Reg A to registered offering) 28 . Thus REG A specifically encourages Gun Jumping b/c gathering interest before filing registration 2. NO offers shall be made unless a Form I-A has been filed w/ the SEC [except rule 254 below] b. No Blank Check companies (no business plan/purpose or plan is to merge w/ an unidentified Co 2. Mini registration is misleading b/c there is no registration just an offering statement. (insider and anyone else doing secondary offering can do Reg A up to $1. Example: If do $4MN Reg A offering on Mon. No investment companies (no mutual funds) d. 1. Amount of Offering (251b): offering price cannot exceed $5MN a. Integration (251c): a. made more than 6 months after the Reg A offering 6. Overview: Statutory Authority is §3(b) so REG A is an exemption from §5 registration under §3(b) offering 1.f. Unrestricted Securities –securities issued under Reg A are NOT restricted & may be resold immediately 5. RULE 254 – Solicitation of Interest – prior to an offering statement. or can determine if should do registered offering (waiting period) a. TV) so allowed general solicitation 7. Any later offerings/sales that are: 1. REGULATION A (Mini Registration) i. RULE 251: Public offer or sale of securities meeting the following will be exempt under §3(b) from registrn: 1. made in reliance upon Reg S 5. Since under §3b – the maximum offering amount is $5MN 3. Aggregation is odd – REG A only aggregates with other REG A offerings (ignores other §3(b) 504/505) a. Reg A offerngs will only be aggregated w/ other Reg A offerngs done w/in the previous 12 mos b. made pursuant to an employee benefit plan 4. can only do $1MN 505 offering Tues b/c aggreg 4. Reg A offerings will NOT be integrated with: i. Doing a REG A: a.
Bad-boy – Can’t do a Reg A if disqualified as a bad-boy vi.a. Needs to be bona fide change of intention – so good faith like requirement If there is little interest in REG A testing waters and now want to move to Reg D—issues: i. No accreditation or sophistication requirement for Reg A investors b/c under §3(b) 29 . 1. If at least 30 calendar days have passed can then do a §5 registered offering 1. While testing waters find out there is great demand in security being offered. RULE 260 – insignificant deviations from term. condition or requirements of REG A. May have to wait 6mos b/c integration safe harbor from Reg D. Issuer will not run afoul to gun jumping rules of §5 if wait the 30 days btwn solicitation of interest from Reg A and filing the registration statement. ii. iv. b. since 254 only speaks of safe harbor to move from REG A to Registered offering. These are not fatal just like Reg D v.can abandon Reg A i.
then the offering is subject to SEC requirements and SEC exerts jurisdiction (even if actual offering takes place offshore) iv. [OR] i. Then it is not deemed an offshore transaction &SEC has jurisdiction so follow sec laws /reg] 3. RULE 903 OFFSHORE OFFERING TEST: (if the 2part test is met then Reg S applies not Securities laws) 1. [if the offer is specifically targeted at identifiable group of US citizens abroad (ie military): i. distributor. the buyer is outside the United States. book pg 225 and rule 901/903) 1. Offshore transaction (902h) – transaction is offshore if: a. An offer or sale of securities by an issuer/distributor/affiliate is outside the US (and therefore outside of SEC jurisdiction) if: a. iii. foreign exchange located outside the US d.g. Foreign issuer engaged in an “overseas directed offering” [defined 903bii] 30 . If put add in US edition of foreign publication but <15K circulation still under SEC jurisdiction b/c it is directed selling efforts if ad in any US edition b/c printed primarily for distribution in the US. Categories of Offshore Offerings (903b): SEC created 3 categories based on likelihood these securities will flow back to the US. At time the buy order is originated. (Check handout. or has had. Exception: US Targeted Offering: any offshore person who directs/targets an offering at identifiable US citizens as a group anywhere in the world (ie living abroad). Foreign issuer that has “no substantial US market interest”(in the securities)[902j] OR ii. Test for Category I i. during the preceding 12 mos. No Directed Selling Efforts in the US (902c): a. (ie offer securities in Cayman and then next day resold back in the US) ii. Reg S 901 delineates when offerings occur in the US and are subject to SEC regulations from those offerings that occur outside the US and are beyond the scope of the SEC [§5 offer/sale only applies to those occur in US] 1. R901: §5 registration only applies to offrings that OCCUR w/in the US & Reg S defnes what occurs in the US 1. Overview: Offerings that occur outside the US are technically not subject to SEC regulations. Directed selling efforts includes placing an Ad in a publicatn w/ general circulation in the US ii. General Circulation: any publication that is printed primarily for distribution in the US. Issue: is to Define “occurs within the US” [Reg S defines what is not w/in US] 2. Example: iv.000 or more copies 1. No directed selling efforts in the US 2. Terminology: 1. affiliate) are activities undertaken for the purpose of or reasonably expected to have the effect of conditioning the US market for securities offered in reliance of Reg S i. or the seller reasonably believe that the buyer is outside the United States c. Category I (903b1) foreign issuer w/ little or no US connection (foreign issuer and no US Mkt interest) a. Directed selling efforts (of issuer. Reg S also purpose is to prevent a run around the securities laws by doing an offering abroad that is really meant to come back to the US. if Put Ad in Financial times even if targeted for UK citizen the offering is under SEC jurisdiction b/c it is directed selling efforts and fails offshore test b. an average circulation in the US of 15. The trade made on/thru a physical trading floor of an est. The offer or sale is made in an offshore transaction AND b. REGULATION S – Offshore Offerings: [handout] i. The offer is not made to a person in the United States AND (b or c) b. Offshore: means non US (even Mexico and Canada are offshore) iii. Not directed selling efforts (902c3 list nots) if the AD placed in foreign Newspaper is required under US or other law and contains no more information then legally required and has stmnt sec not offered in US or if US journalist attends foreign press conference v. SO if Foreign publ’n sells >= 15K copies w/in US it is directed selling effort in the US 2.
SEC says not w/in US 2. a. All offering material must bear legend that the securities have not been registered in the US and may not be sold in US w/o registration or exemption 4. Offering Restrictions: None d. Otherwise posting on web may constitute offer of securities to US vii. Distributions during this period must inform securities Profess. Test for Category III: i. Put prominent disclaimers on their pages stating not being offered in the US (or) ii. IF comply with conditions and offering restrictions – No SEC Jurisdiction 3. Conditions: Same as offshore test: Offshore Transaction and No directed selling efforts in US c. [need good faith compliance by issuer – if issuer does all needed and US fakes ID then not ruin it unless there is some indication that put issuer on notice that purchaser was US person – ie check drawn from US bank or gives US taxpayer ID number or SSN] 2. All other issuers not in categories one and two b. Implement protections to reasonably designed to guard against US participation in the offer (ie. Equity Securities: issuer must ensure equity securities will not be sold into the US for 1 year b. REG S not integrated w/ US offers viii. BUT if not do reasonable procedures to prevent sell in US for restricted period SEC may exert jurisdiction vi. IF comply with conditions and offering restrictions – No SEC Jurisdiction i.during 40 day period i. of restrictions on sale to US e. Each distributor must agree to conform to Reg S Safe Harbor and ii. IF comply with conditions and offering restrictions – No SEC Jurisdiction. Category III (903b3) Strong US connection a.(40 days debt. Non US issuers offering on internet should: i. f. Debt Securities: Issuer must ensure that debt securities will not be sold into the US for 40days c. No sales to the account of a US person ii. Domestic (reporting) or foreign (non-reporting) issuer offering debt ii. Foreign issuer offering equity who is already subject to ’34 act reporting reqs b. Purchasers must certify not a US person and not purchasing for US person d.b. Test for Category II: i. US public companies can do REG S and offshore offerings – like MS goes to Germany and offer same common stock sold here but just to Germans – that is fine – US and Offshore issuers can both use Reg S 31 . Transaction restriction . Each distributor must agree to conform to Reg S Safe Harbor and ii. If issuer takes appropriate (precautionary) measures that are reasonably designed to ensure that US persons do not participate in offshore internet offerings then the SEC will not assert jurisdiction a. Offering Restrictions: during distribution compliance period (40 days after offering): (902g) i. All offering material must bear legend that the securities have not been registered in the US and may not be sold in US w/o registration or exemption d. 1 year equity) a. Category II (903b2) medium US connection – can’t enter US for 40 days after issuance. Offering Restrictions: (same as category II) during distribution compliance period (40D/1YR): i. Shares must bear legend barring transfer except in accordance w/ reg S e. pwd protect website) iii. Conditions: Same as offshore test: Offshore Transaction and No directed selling efforts in US c. Conditions: Same as offshore test: Offshore Transaction and No directed selling efforts in US c. Issuer must require purchaser will not sell securities back into the US for 40 days (must provide reasonable procedures to prevent this) 1. All issuers must have provison in bylaws or elsewhere to empower it to bar transfers not in accordance to Reg S. Regulation S & Internet Foreign Offerings: (SEC Rel 7516-when is internet posting not directed to US) 1. Transaction restriction .
Statutory Definition:§2(a)(11) The term "underwriter" means any person who has purchased from an issuer with a view to.505. then <1 year resale and still will believe you that when you bought it you had a view to investment not distribution. So if sell 2 days after buying securities – even if say changed mind – SEC will say bought securities for distribution iii. or participates or has a direct or indirect participation in any such undertaking. if Co wants to do offering they use a middleman – GS.(since can’t do subjective above) 1. b. & to sell them need to register offering or find exemption–this is why those securities are restricted b/c can’t sell them free will (504.506 were not done thru underwriter b/c then would need to register b/c exemptions were for issuers for most part) 2. Once person resells he is underwriter and integration with original exempt offering – blows it b. ML who buys securities in bulk from from issuer and the sells them retail (they are doing an underwriter offering)—Normally register both txn issuer &UW 3. the distribution of any security. How long so SEC views purchase as investment and not distribution: Generally 1 year 1. Definition -Secondary Offering: offering done by someone other than the issuer. Can theoretically change your mind in one day and it is supposed to be intent based test but no court/SEC will believe you so use these tests. If distribution then you’re an underwriter ii. any person directly or indirectly controlling or controlled by the issuer. §4(1) underwriters/dealers must register their offerings §5 or seek exemption (144. Control persons (insiders and affiliates) ii. Intent based test. (ie kid got cancer and sold <1 Restricted securities also year SEC ok) called legendary stock – iv. Two groups of people that come under secondary offerings: 1.offerings by underwriters (unlike 1˚ offerings. or offers or sells for an issuer in connection with. UW purchase from issuer with a View To distribution [to the public]: a. or participates or has a participation in the direct or indirect underwriting of any such undertaking. Overview: i. in addition to an issuer. a. which are offerings by issuers) a. Intro – 1. Underwriters: i. 4 1 ½. If underwriter can’t resale w/o registration thus if issuer relied on exemption & it was resold to out of state resident or to an unsophisticated person that UW may blow the exemption of issuer b/c integration a.506. unforeseen circumstances. but such term shall not include a person whose interest is limited to a commission from an underwriter or dealer not in excess of the usual and customary distributors' or sellers' commission. Problems that may occur with underwriters and issuers:: 1. Turns on the state of mind of the purchaser when he bought the securities: i. (previous exempt offerings 504.rule 147) ii. UW. Reg A) 2. Can only judge what your intent was based on your subsequent actions. How can issuer ensure restricted securities are being purchased for investment purposes only: can also do escrow of securities? 32 . Are the shares being acquired with a view to distribution or as an investment? 1. SECONDARY OFFERINGS .144A.V.505. Thus if purchase & sell restricted securities <1 year then distribution and need to register but if hold onto restricted securities for >1 year then can sell and no longer registration? 2. 1. Holders of restricted securities 2. Subsequent Actions Test / Rear View Mirror Test: . As used in this paragraph the term "issuer" shall include. Only way SEC believe you and allow restricted security be sold into the market <1 year and it not be a view to distribution and require registration is if had profound. The ISSUE is who is an underwriter? iii. but whom still must be concerned with §5 registration 1. or any person under direct or indirect common control with the issuer. If purchased restricted securities [w/ view to distribute] then you are an Stat.
§2(a)(11) – last sentence: defines issuer as anyone in direct or indirect control of the issuer [for the purposes of determining who is an underwriter under §2(a)(11)]. Therefore anyone who purchases from a ”control person” is deemed to have purchased from the issuer and therefore is an underwriter 2. Greater than 50% owner is controlling shareholder – per se b. Insiders. iii. c. Once the public gets the security distribution is over so can’t be a underwriter if you are the public purchasing the security and trying to sell the security c.1. Control person is someone who has the power to compel the issuer to file a registration statement a. can’t sell w/ a view toward distribution to the public b/c once you have it distribution is over. This is a common formulation but is a misnomer – b/c every member of BOD is a control person even though one director alone may not be able to make compel issuer and make the decision to file i. Better test – is whether you are part of a control group. Why do this – b/c avoid abuse of Sec Laws – otherwise CO could sell all their stock to insider a sophisticated person and then he can sell it to the public – so raise money w/ no registration ii. Examples: i. Place a legend on the physical stock stating securities are not obtained under §5 ’33 act so anyone buying or selling them must concern themselves with statutory underwriter b. 3. 1. Can have firm commitment UW – GS agrees to buy 1MN shares of MS at 42/share so issuer gets capital and GS has to sell them. Implication of control person/insider/affiliate: 1. Controlling stockholder is considered a control person (Q of fact) a. the control person still cannot resell these securities w/o registration or an exemption from registration [b/c only the original offering was registered the securities can’t be registered. which is why the shares were restricted (no diff legally GS or stat UW) ii. a. IBank buys 100% stock – then control person – but has no view to distribution – and instead holds stock for 1 year & then sells it – not need to register that sale b/c not an underwriter (risk to hold) 3. Ask for investment representation letter–use §2a11 lang. Bought shares thru valid §4(2) or REG D & then resold them to ma pa America–You are a statutory underwriter. Distribution = distribution to the public [using the RP test (public = unsophisticated investor)] i. or Best efforts – GS tells MS not committing will only take what I can sell and there is market for (usually if mkt not strong) c. Anyone who purchases securities from a control person is deemed to be buying from an issuer §2a11 and thus is considered to be an underwriter (if have an intent to distribute) so they have to register to resell. your just a secondary trader – so no §5 d. Affiliates (for our purposes all 3 are same Control Person Insider & Affiliate) i. Directors and Senior Management are control people 2. & if Stat UW you must register 2. If a control person goes out into the public and buys securities that were sold in a registered offering. IF MS does registered offering and sells directly to you (an unsophisticated investor and member of the public) with prospectus etc and then you want to resell it to ma and pa America – you are not an underwriter. 4(1)(1/2). Dupont 25% GM owner other 75% diffusely held – CT – Dupont is control person. Control person cant sell securities their securities into the market place w/o registering their offering or exemption [144. it is as if the issuer is selling restricted securities b/c it makes any purchaser an underwriter and this is why control persons can’t just sell their stock at will w/o concerning w/ registrtin 33 . Reg A? no reg D or 4(2) bc have 4(1)(1/2) 2. THEREFORE – if I buy from an insider w/ a view to distribution or an affiliate sells his shares to an anonymous market. Ie if 1 director wants to sell his shares and other 10 on Board say we don’t want to file registration statement for you right now he is still control person but can’t compel registratin b. Control Persons. Who is a control person?:(Q of fact) 1.
US v. So anytime gates sells needs to file registration stmt or exemption c. Example: Bill gates–a control person of MSFT wants to sell his shares – he must file registration b/c Gates is treated as an issuer for §2a11 and therefore anyone who purchases from him w/ a view to distribution is an underwriter. Not register is in violation: 34 .b. Wolfson –pg 348 D – insider said technical procedure to register and can’t be bothered i.
key employees. Non-Affiliate for Reporting issuer i. Both restricted and unrestricted securities 2. Four types of Transactions for people holding restricted securities --see handout 1. No resales for one year for restricted securities 35 . Affiliate: person who directly or indirectly controls. Restricted securities for 144 include securities issued by: §4(2). No such holding period for non-restricted securities [requirements above still apply] iv. Reg D. all restrictions are gone: the securities are no longer “restricted securities” . and others a. Volume limitations (past 3M no more than >of 1% outstndng or avg weekly vol of4wk) 3. [Example: If gates buys MS stock on nasdaq – no holding period–can resell at will 144 reqs] v. Equity securities may only be sold in “regular way brokers’ transactions” (so anonymous) – can’t do private sale to public and use 144 4. Restricted securities of REPORTING Issuer (public Co.d. No resales for 6 mos for restricted securities. subject to §13&15d of ’34 act): a. 505. Must file Form 144 (if over 3 mos sell >5000 shares or $50000 aggregate)-simple frm iii. Rule 144 – is basically made up test to prove that your not an underwriter and intent at purchase was investment but for control persons even more impt b/c their restrictions never go away due to §2a11 – making them an issuer for underwriter purposes ii. Safe harbor under which non-affiliates who hold Restricted Securities (those obtained under §4(2). After 1 year – restrictions are gone – the securities are no longer “restricted” so unlimited public resales under rule 144 and need not comply with other 144 requirements b. [Example: If gates buys §506 MS stock – restricted so can’t resale for 6 mos after-144 reqs] 2. Definitions (144a): 1. After 6mos may resell in accordance to 144 requirements including: 1. b. and controlling shareholders) – like those from §2a11 2. is controlled by or is under common control with the issuer. 3a11 has own rules for restrictions rule 147 so no 144 3. Current public information (’34 act filings) 2. No resales for at least 6 months for restricted securities (per se rule) iii. From 6mos to under 1 year can sell to anyone if the reporting company is current in public information (all its ’34 act fillings) iv. No sales for one year for restricted securities iii. Debt securities – have no manner of sale limitations 5. Restricted securities of NON-REPORTING Issuer (private company): a. Affiliate for non-Reporting issuer i. Non-Affiliate for at least 3 months ii. Non-Affiliate for at least 3 months ii. After 1 year. ii.506. officers. Reg S. Non-Affiliate for non-Reporting issuer i. Rule 144 has specific criteria if followed then the person is deemed to not be engaged in distribution of securities and therefore is not an underwriter of the securities and thus can sell securities w/o registration. Q of fact if intent at purchase was investment if so not Stat UW and if mind changes can sell but since this may be challenged by SEC b/c intent is hard to prove – have rule 144 safe harbor to help 3. Affiliate for Reporting issuer: i.so unlimited public resales under rule 144 & need not comply w/ other 144 reqs (ie be current). Safe harbor by which control persons (affiliates/insiders) may sell securities to the public w/o registration a. RULE 144 (updated) Persons deemed not to be engaged in a distribution and therefore not underwriters i. Reg S) may sell those securities in public w/o registration a. 4. Overview: Does double duty – 1. (directors. Debt Security – security that is not equity(equity signifying ownership interest and debt being owed money but having no ownership interest) iii.
Must file Form 144 (if over 3 mos sell >5000 shares or $50000 aggregate)-simple frm iii. So if obtain regular MS stock in §506 offering – can’t use this exemption. Control person needs to rely on Ralston Purnia by analogy (b/c no safe harbor rule 506) b. If ma pa – ask for how long and see if restrictions are lifted b. EXAMPLE: Pres buys stock thru NYSE and now wants to sell – Pres still has restrictions b/c 2a11 equates the sale by the control person w/ sale by issuer and there is no such thing as buying registered stck e. Current public information 15c211 ’34 disclosure – to get info in public w/o registration 2. Equity securities may only be sold in “regular way brokers’ transactions” (so anonymous) – can’t do private sale to public and use 144 4.ii. IF control person – restrictions never lifted – have holding period (no resale) and post holding have 144 requirements: 5. b. Allows qualified institutional buyers (QIBs) who buys a Reg D securities to sell to other QIBs w/o being deemed underwriters and therefore w/o registration. ONLY way control person can sell stock of that firm w/o registration and prospectus is rule 144 or §4(1)(1/2) i. ANALYSIS – if restricted securities – first ask who owns it: a. Volume limitations (past 3M no more than >of 1% outstndng or avg weekly vol of4wk) 3. No general solicitation (so not public) c. Requirements: a. Example: GE pension fund buys MSFT PFD B thru 506 and next day sells it to AIG. SO IF FOLLOW the RULE then your not an underwriter under §2a11 so §4(1) and §5 not apply and therefore can sell securities w/o registration under §5 [also form 144 is not disclosure] 4. SO 4(1)(1/2) allows control persons to non-public offering: 1. Access to issuer information by virtue of position w/in Co (or) ii. Debt securities – have no manner of sale limitations 5. Tacking for Rule 144 – is back to original date of issuance not the 4(1)(1/2) resale date g. Creates an aftermarket in restricted securities for QIBs – so can purchase w/ intent to distribute w/o registering as underwriter as per §2(a)(11). Have been given disclosure iii. w/o these if Gates wanted to sell MS stock he must register and provide prospectus ii.5MN limit for control persons and Reg A by control is aggregated toward 5MN for issuer so only 3. GE not underwriter f. [Example If Co not have disclosure doc – affiliate can’t sell can’t use 144] 3. The issuer must make certain information available to any QIB who asks for it 3. The security in question cannot otherwise be a security that is already traded in the public market i. -also b/c view to distribute is to the public & QIBs are not distributing to public 4. No such holding period for non-restricted securities [requirements above still apply] iv.§4(1)(1/2) Exemptions . Limitations: a. Must have either: i.5MN left for issuer (if was nonreporting) for 12mos period.Extends non-public offerings to control persons – made up by SEC i. After 1 year may resell in accordance with rule 144 requirements including: 1. which normally is illegal. Qualified Institutional Buyers – an institution with more than $100MN in assets 2.(filed on behalf of the underwriter) 1. §4(2) – is limited to issuers and has no reference to affiliates/control persons and 2a11 – says treat as if issuer – so not really an issuer so can’t use §4(2) as control person or rule 506 – so SEC created 4(1)(1/2) ii. RULE 144A – Private Resales of Securities to Institutions i.stnds for sophisticaton) d. OR can do Reg A but only 1. Sell to sophisticated investors (RP definition – as to non-public. 36 .
IF there is no value in a sale. (see more below) d. AND ACQUISITIONS a. IRS Deductions are held not to be for value – so if donate securities just for deductions – its not for value under §2(a)(3) and therefore not need registration under §5 iii. then do not need to register under §5r ii. The recipient of security made an investment decision. OR 2. REORGANIZATION. Above – SH made no investment decision to get dividends.Warrants and Convertible Securities . (so offer for sale f. offer shall include every attempt or offer to dispose of or solicitation of an offer to buy. Statutes: i. Stock Dividends . 1. Coke wants to issue stock dividend to all its Shareholders (MNs people) – does Coke need to register a stock dividend by the issuer – NO. Example: 1. Once the warrant becomes exercisable or the convertible security becomes convertible. Above–Harvard made no investment decision stocks just came & assume no value received by Gates 2. c. Example dot. Free Stock –even though there is no investment decision on part of the recipient of free stock the offering/sale can still be for value if the distribution creates some benefit for the issuer or insiders (outside tax benefit) and therefore the free stock distribution may be for value (issuer gets benefit of instant market) and need registration i. §2(a)(3) .the term sale or sell shall include every contract of sale or disposition of security or interest in security for value iii. the convertible security and underlying common stock). for value. ii. Gates gifts $1MN in stocks to Harvard or his son – Must he register this – NO b. SEC said this was illegal – the company giving away free stock were creating an after market for its securities which was a benefit for the company so subject to §5 and a benefit to insiders who could then start selling the shares they owned thru say 144 and get money – so incentives to do this e. SEC position – the choice between a cash or stock dividend does not involve sale or offer to sell security despite the fact recipient is making investment decision ii. A dividend reinvestment plan: where stockholder may by prior agreement have their dividend applied toward the purchase of additional securities from the corporation at current market price (instead of receiving them) is considered a for value transaction b/c it is a continuous offering& thus subject to registration. To be for Value: 1.dividends are a disposition but are not considered value b/c the recipient has made no investment decision (dividend just shows up) therefore no registration needed.com Co gave away 1BN shares for free to any visitors of its website basically an IPO and it was unregistered offering. even if intangible value to Co etc 3.VI. So from giver’s point of view – does he get any value. ii.issue – must you register both the initial issuance of warrant/convertible security and the security into which it is converted? Is the underlying security for value under §2a3? i. then there must be 37 . Hypos:: i. §2(a)(3) – the term offer to sell. then SEC says that the underlying stock does NOT need to be registered at the time of the offering of the warrant or convertible security. offer for sale. FOR VALUE: i. a security or interest in a security. A request to change a dividend rate is a sale b/c the buyer is making an investment decision iii. RECAPITALIZATION. i. Not Immediately Exercisable or Convertible in the future: if the warrant is not immediately exercisable or the security is not immediately convertible. Issuer/seller must receive some value (then have a sale/offering) a. §5 states every sale or offer to sell securities must be registered ii. Immediately Exercisable or Convertible: if the warrant is exercisable or security is convertible immediately then SEC says that two separate securities are being offered so both must be registered absent an exemption (or the registration statement must cover both security and underlying security ie. Because there is no immediate investment decision for the investor he can only hold the warrant or convertible security 2.
A vote is typically required to change terms of bond and the vote is an investment decision – and therefore is for value. EVERGREEN – keep prospectus open for entire time conversion option is open. this is done thru amendments and keeping everything updated b/c only way to do conversion is have effective registration statement throughout entire conversion time period. Spinoffs – Have Company (ie holding company w/ many subsidiary businesses) and wants to get rid of one of the subsidiaries (one way is asset sale – no registration) but can also do a spinoff. If vote is required then it is an investment decision & disposition is a value transaction requiring registration ii. Intro – For years SEC held there was no value in a stock for stock merger and therefore no offer or sale and thus no registration under §5. even if the change is not passed. Rule 145 states each of the following transactions is an offer or sale of a security w/in meaning of §2(a) 38 . (or find exemption) iii. iii. [changing the terms of security then must register it as a new offer b/c offer for value] i. (ie change bond rate b/c Co is going bankrupt otherwise. so that each parent SH gets same amount of subsidiary shares as he has parent shares. RULE 145a – sets out the transactions that are subject of the Rule. where the parent who is actually just a SH of the subsidiary gives a stock dividend (subsidiary stock) to each of the parent shareholders pro rata. SEC sued and lost ii. Shareholders before owned shares in holding company and now own shares in holding company and the subsidiary. HOWEVER. SEC – reincorporation(change state of inc) provided there is no change to securities economic or voting rights is not sufficiently material to warrant change in security and does not need registration under §5. ii. Mergers / Acquisitions and Recapitalizations: i. SO each Shareholder still owns the same bundle of rights. which is why registration is needed b/c any material change in the bond is seen as offering a new security. there is an investment decision (whether to accept the change) & therefore a new security is being offered. i. Any transaction that is not one of those enumerated is outside the scope of rule 145 and the rule 145 inquiry ends. 1. Spinoff is not for value – there is no investment decision subsidiary shares just showed up but now there is a market for the subsidiary shares (but no value to the issuer if he has nothing to do with the stock) and so the spin off can be used to achieve the same results as a disguised IPO w/o registration.an effective registration statement or exemption in place covering the underlying (common) stock because the holder is now making an investment decision daily (to exercise/convert or hold warrant/convertible) a. 1. Once up for exercise the old registration statement is no good & at this point have offer do you want to own the common stock or not and its for value b/c it is an investment decision. RESULT: This can be regulated thru the ’34 act – secondary market activity of spun off shares – SEC forbid brokers from trading stock unless there public disclosure / adequate information in the marketplace j. Change in par value – NOT for value b/c no economic consequences to shareholder i. So even though there is an investment decision – do I want NY or DE corp no registration required iii. b. which is why need to have a registration statement which is effective at this future point covering the underlying security. Material change – is if modified in a material respect such that a reasonable investor would think it’s a new security / material change in the security. Reincorporation (change state of incorporation) and Amendments of Articles of Incorporation: i. Bonds–If there is a vote to make a material change in a bond. g. Rule 145 was designed to change this position (so stock for stock needs registration) but at the same time allow the parties to disclose certain information about the transaction without violating gun jumping rules. [if immaterial change then not make it a new security-no register] h. Therefore the new security must be registered. or change maturity date of bond) ii. Convertible security which is automatically converted at some point in future – this does not need a new registration statement covering the underlying security b/c the investment decision was made when bought the original convertible security which said will automatically convert in X years – so no investment decision in the future.
But not a stock split or change in par value ii. provided they are not parties to the transaction (other than the issuer. b.(3). The information allowed is similar to that allowed under rule 135: 1. Rule 145c – all parties to a rule 145 transaction (other than issuer) are underwriters and all affiliates of parties under rule 145 transaction are underwriters. who is A) or affiliates of the parties to the transaction. In the merger shareholders of B receive common stock of A in “exchange” for their shares of B. that was an “offer” and “sale for value”. (vote of a security holder is required in these transactions). Rule 145(d): Sales by Affiliates: Rule 145(d) gives a safe harbor as to how affiliates of the parties may sell stock they received in the merger 1. We know that when A issued it stock to stockholders of B. so it was necessary to register when company A offered company A stock to B stockholders in the merger in exchange for their company B stock. underwriters with respect to that stock? The former stockholders of B. that stock may be sold as long as the issuer (company A) is current in its filings under 144(c)) 39 . in the merger may be resold immediately accordance with the volume and manner of sale limitations of Rule 144: a. are not underwriters and may sell without registration. Who is an underwriter? Not Company A and its affiliates because the issuer is not an underwriter(and affiliates of acquirer not receive stock so can’t be underwriters) according to 145c. A vote taken on reclassification of securities (ie substituting one security for another. a. A vote is taken on transfers of assets involving the issuance of new securities (and involving new investment decisions) iii. not affiliates of B). i. Transactions that are subject to Rule 145 are: i. when they receive Company A stock. Exception if merger is just to change state of incorporation – the for value requirement is not met and Rule 145 does not apply iii. Meeting: the issuer can disclose the date. Rule 144(g): defining a broker’s transaction 2. Rule 144(e): the volume limitations of Rule 144 c. Are the former shareholders of B (public stockholders of B. Rule 144(f): requiring a broker’s transaction d. Any other information required by law: issuer can state any other info law requires iv. Rule 145(d)(2): if an affiliate of the target (company B) is not also an affiliate of the issuer (company A) and he has held the stock received (stock of company A) in the merger for at least one year. A vote is taken on mergers (business combination where new securities are exchanged for old securities – creation of new securities so it is a new investment decision) 1. Rule 145(d)(1): the stock received by affiliates of the target (affiliates of B). If they were parties (company B) to the transaction or affiliates of the parties (affiliates. RULE 145b Information allowed: 145b sets out what may be seen as a safe harbor for what can be said prior to filing the registration statement (and thus avoiding any problems w/ gun jumping). name of other parties and a brief description of their businesses 2. but since it’s the creation of a new security it’s a new investment decision) 1. they are underwriters and may not offer and sell without registration or an exemption. time and place of the meeting to vote on the transaction 3. Rule 144(c): there is current information about the acquirer b. Who is underwriter under rule 145c? –once registration is required the question of who may be underwriter becomes important b/c now there can be said to be a distribution and we know that underwriters must register their offers and sales §4(1) or find an exemption 1. SEC balance – concern of communication to the public prior to filing the registration statement while also encouraging free flow of information to the investing public. Example: B merges into A. Name of parties: issuer can state its name. a. Stockholders of the Parties: stockholders are not normally parties to a merger and are therefore are not deemed to be underwriters. insiders. Description of the transaction: issuer can provide a brief description of the transaction 4. unless they are affiliates of the parties (usually stockholders of the acquiror (company A) do not receive stock so affiliates of the acquiror (company A) who do not receive stock would not be deemed underwriters with respect to the merger) v. or control persons of company B).
iv. This is what is often done. iii. vi. If an affiliate of the target (company B) becomes an affiliate of the issuer (company A) subsequent to the merger. ii. the only requirement of Rule 145 he can rely on for resales of the stock received in the merger (company A stock) is Rule 145(d)(1). But he must wait three months after ceasing to be an affiliate of Company A to take advantage of Rule 145(d)(3) (assuming that the stock has been held for two years). Remember. he or she may immediately resell under 145(d)(1) after a year under Rule 145(d)(2) and after 2 years under Rule 145(d)(3). Notes: i. that an affiliate must always sell pursuant to a registration statement or some other exemption. If such person then leaves company A. such as Rule 145) 3. (Remember. he may use Rule 145(d)(2) (assuming that the stock (company A stock) has been held for one year). Then any affiliate of Company B may immediately re-sell without worrying about Rule 144(c) and (d) because their resale offers and sales are already registered. One way to avoid the resale issue entirely for the target is by registering their resales at the same time and in the same registration statement you use for the registration of the basic merger itself. then the stock may be freely sold without any consideration of Rule 144 or anything else a. if an affiliate of company B never becomes an affiliate of company A. even if he ceased being an affiliate of company A one day prior to the sale.Rule 145(d)(3): if the affiliate of the target (company B) is not also an affiliate of the issuer (company A) at the time of the sale (and has not been an affiliate of Company A for at least three months prior to a sale) and the stock of the issuer (company A) has been held for at least two years. 40 .
a. Exclusively Security for Security . The exchange offer has to be done by the issuer. Character or Exchanged Securities: the character of security received in a §3(a)(9) exchange is the same as the one given up (ie if give up restricted security then receive a restricted security in return and if you’re an underwriter if sold first security then underwriter in sale of second security) 4. Example – if do at same time a simultaneous 506 offering for pfd stock – SEC – says oferring pfd not exclusively to security –debenture holders and instead also offering to public under 506 so no 3a9 – violate exclusivity ii. which makes it a for value transaction – congress exempted it in §3(a)(9) a. §3(a)(9): EXEMPT TRANSACTIONS. c. it is new consideration and exclusivity requirement is blown 2. (ie say 12% bond killing issuer want to change it) 2. Sales Commission – cannot be paid in connection with exchange (exclusivity ruined) 3. §3(a)(9) Except with respect to security exchange in a case under title 11. TEST: IF issuer offers to exchange one security for another w/ its own security holders it is exempt if: a. 1. Exchange offer must be done exclusively [Double exclusivity test] i. Exclusive with respect to security holders–offer must be exclusively to the issuer’s security holders: (& only to one security holder ie only bond holder or only stock holder b/c intg) 1. [act does not apply] 1. send shares for debenture received – no problem stock need not be registered 3. Convertible Securities: the standard conversion feature of a security when exercised can be exchanged under §3(a)(9) so the conversion is exempt. 5 factor test would not help b/c for 3(a)(9) – need exclusivity? Also if solicit under 3a9 and integrate with other exempt offer then ruin exemption.k. Integration – problem with exclusivity arises if an issuer is doing another simultaneous offering. the exchanging security holder must find his own exemption for any subsequent sale of security received in the exempted exchange a. Example: If offer an existing security holder to exchange his security for another security the offer of the new security need not be registered. Resales of §3(a)(9) securities – since the exemption is only available to the issuser. Example – if do 3a9 have debenture holder and offer 10 shares pfd stock for every 1000 debenture. 2.there cannot be any other consideration for the security being exchanged (no boot) – just security for security. Intro: Shares issued in exchange offer under §3(a)(9) are listed as exempt securities but that is drafting error this is an exempt transaction [just like §3(a)(11)] and therefore needs no registration or disclosure 1. Issuers usually do 3a9 conversion b/c Co is in trouble and so tries to get some changes in bonds etc ii. it is exempt from registration under §5 even though it is an investment decision. Tacking – is generally available to help the holder in meeting the appropriate holding period (ie 1 year holding period for 144) 41 . Good faith requirement: SEC reads in 3rd prong–a good faith business purpose for the transaction. Issuer cannot even pay for legal or tax advice for the holder in connection with the exchange. If the offers are integrated. 2. Example – can’t offer bond holder 10 shares common stock plus $10 in exchange for its 1000 debenture b/c have additional consideration that’s not security – so no 3a9. If structure an exchange in accordance with §3(a)(9). Provided security is not immediately convertible–then offering 2 securities and need register both 3. then the exclusivity requirement is not met and the exemption may not be used b/c offers are now made to non security holders if integrate a. and b. 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. EXCHANGE OFFERS i.
Since they are exempt no registration is required. 3a11. Pension funds – c. 3(a)(2) – Government Securities. BUT have no full faith and credit of US – and money coming in may not be enough – so there are default risks. GOs can be issued by Federal. §3(a)(3) exempts any note. Trust Funds – interests in common trust funds maintained by banks are exempt securities under §3(a)(2). mini bonds a. §3(a)(3) – Short Term Notes (Commercial Paper Exemption) 9mos test i. local) allows IBDs to be issued to raise money for public works projects and are backed by revenue of the project (sewers. ii. Intro – Exempt securities are securities but are still exempt from §5 – the nature of the security itself rather than the manner of the transaction makes these securities exempt. exclusive of days of grace. b/c if tax exempt then the interest rate is that of equivalent corp bond less the marginal tax rate – so authorities pay lower interest ii. State and Local governments. FOR IBD bonds to be Exempt securities from §5: i. Has nothing to do w/ commercial notes & Reves (which have maturity for 1 yr. These notes are used by large companies to borrow for short terms to cover debts. i. 3b(504. IBD bonds – Gov’t (fed. b. Government Securities (Bonds) – securities issued or guaranteed by the govt These are exempt b/c the theory is governmental bodies should not regulate each other. Other types: Industrial Development Bonds (IBDs). Common. or Single Trust Funds i. dams. state. a. i. or any renewal thereof the maturity of which is likewise limited ii. IRS has lots regs on it 1. Bonds are Tax Free: IRS grants tax exempt status – so securities laws do not make the decision of whether to exempt bonds/securities from §5 registration. Disclosure statement must be given to investors (issuer not bound by disclosure – but the underwriter is – see above) iii. including foreign banks with US branches. 2 types of Government bonds 1. EXEMPT SECURITIES – (no registration under 5) a. US treasury backs US bonds can print money. Commercial paper exemption – is for “prime quality negotiable commercial paper of a type not ordinarily purchased by the general public” iii. Bank Securities and Collective. ie – IRS req. TO encourage these projects and allow raise money at a lower interest rate – these bonds can be issued tax exempt from the authority. 2. basically the big players – do this as overnight money. [better regulatory authority] iv. But ’34 15c2-12: if UW of municipal offering >1MN need official stmnt (disclosure doc) from issuer and make the document available to any prospective purchaser. §3 is called exempt securities but has both exempt transactions (3a9. highways). NO disclosure requirements –no registration under §5.(ie like NY sewer authority) i.Meet social public good requirement. (ie GE has 100MN cash so puts in Bank MS needs 100MN for next day payroll so borrows and then few days later MS gets earnings and pays off bank) – Bank rate is the Fed overnight rate? 1. General Obligation Bonds – are exempt and GOs are backed by the full faith and credit of the issuing government entity. NY state bonds backed by state and tax to get $$ b. bill of exchange. IF IRS determines bonds interest is tax exempt then the securities are exempt from §5 registration. ii. &used to by ma/pa) iv.. except in competitive UW bids. REQUIREMENTS: 42 .505.. banker’s acceptance which arises out of a current transaction or the proceeds of which have been or are to be used for current transactions and which has a maturity at time of issuance not exceeding nine months.regA)) rest of §3a are exempt securities: b. 1. banks must exercise “substantial investment responsibility and trust funds must not be sued as a vehicle for general investment by the public 1. draft.VII. Bank Securities: §3(a)(2) – exempts any security issued or guaranteed by a bank.
Issuers must also have IRS exemption: 2.. Applies to securities issued by a receiver or by a trustee or debtor in possession under federal bankruptcy law (rationale is that the bankruptcy court protects this). – pure lobbying g. Current transaction–proceeds must be used to fund current transactions. d. the railroad industry was the most powerful industry. homestead assoc. SEC lenient. charitable. fraternal. 4. 2. 3(a)(6): Interests Railroad Equipment Trust. §3(a)(4) . therefore. [institutions that are supervised and examined by state or federal authorities] i. By insurance commissioner.1. Securities w/ automatic rollovers may jeopardize the exemption 3. this covers assets easily convertible into cash & comparable to liquid inventories of an industrial or mercantile Co. (endowment policies) Are exempt because subject to supervision insurance Cos. inventory etc – which is a judicial developed test. or bank commissioner etc. 3(a)(8): Insurance Policies and Annuities. Prime Quality – Issuer must have the highest short term rating by recognized rating agencies a. a. v. Rating is of short term debt not the issuer. railroad equipment is exempt. private stockholders or individuals or security of a fund that is excluded from the definition of investment company 1. This is not family resemblance test of Reves for commercial notes to run business – buy A/R. or reformatory purposes and not for pecuniary profit and no part of the net earnings of which inures to the benefit of any person. h. 3(a)(5): Highly Regulated Industries – securities issued by a savings and loan association or building and loan association. Applies to any security issued by a savings and loan association which is supervised by the federal or state government (rationale is that S&L’s have their own regulatory system) f. e. 3(a)(7): Bankruptcy Exemption. Coops. Churches. This includes: Knights of Columbus. So they can issue notes to anyone and put ads in WSJ all w/o registration b/c exempt securities. §3(a)(4) Non-Profit Issuers: i. Exempts shares issued by a bank holding company 43 . benevolent. are already heavily regulated. educational. Manner of offering – commercial paper exemption is limited to securities not ordinarily purchased by the general public – this is enforced by requiring commercial paper to be issued only in large denominations prohibiting general solicitation and requiring investor sophistication. Nine months Maturity – commercial paper can’t have a maturity that exceeds 9mos. In 1933.3(a)(12): Bank Holding Companies. i.exempt security issued by person organized and operated exclusively for religious.
506? b. PRIOR to ’33 Act: if wanted to sue for Securities Fraud only relief for P was CL tort of fraud which required: i. Reg S. (daisy chain privity) i. 3a11. 2. or reliance. iii. “unless it is proved that at time of such acquisition he knew of such untruth or omission” 44 . Example – if 97% of outstanding securities were pursuant to faulty registration statement. ’33 Act is a consumer protection act – and does so thru disclosure but if fraud there are liabilities: b. Standard: any “untrue statement of material fact or omitted to state a material fact” a. §11(a) in case an part of the registration statement. Analysis: (§11(a)) 1. Material misleading misrepresentation or omission in registration statement will subject the issuer (subject to any due diligence defenses) & a variety of persons associated with the issuer or the distribution to damages in suit brought by any person who bought the securities pursuant to the registration statement. by definition §11 is available only for registered public offerings: i. Reliance (reliance on the fraud/misstatement to your detriment) vi. Scienter (intent to commit fraud) iii. Tracing Requirements: Any Plaintiff can sue but P must show that the securities bought were pursuant to the registration statement at issue. Reg D. So can’t sue for material misstatements or omissions in the preliminary prospectus. so if say warehouse is 10000 sq ft but is really 9980 sq ft – no case 3. 4(2). Causation iv. Reg A. NO need to show causation – of damages by material the misstatement or omission 6. d. This is the only thing to prove for P – that there is material misstatement or material omission i. [pg 22 of act] i. Who May Sue: (P limitations): a. P can’t just do statistical analysis and assume he had shares pursuant to faulty registration statement – he must trace the security. corporation cannot indemnify D/O for §11 violations 4. any person acquiring such security (unless it is proved that at the time of such acquisition he knew of such untruth or omission) may. scienter. Privity (P is in privity w/ D – no fraud thru hearsay) v. ok if never read prospectus &buys 5. 3b. 2. contained an untrue statement of a material fact or omitted to state a material fact required to be stated therein or necessary to make the statements therein not misleading. Section 11 – Civil Liabilities on Account of False Registration Statement. P had to prove each of these elements prior to the ‘33 act but the act made an action for securities fraud easier. If Plaintiff knew the statement was untrue or had omission – then he can’t sue i. b. when such part became effective. Privity – is required but the security not have to be acquired from the issuer – any person acquiring security can sue so long as shares purchased came through a direct chain from the initial offering (ie if bought in secondary market) – SO daisy chain is permitted. Damages c. So not available for 3a9. damages & privity) but do not need to have acquired the security from the issuer. any person who acquires the securities can sue as long as comes thru a direct chain from initial offering. Misstatement / fraud ii. DO NOT NEED TO SHOW causation. Can only sue when the registration statement b/m effective (no suit for preliminary prospectus) i. KEY to §11 is deterrence so if client loses $ then get prospectus & look for material misstatement/omissions iv. Liability Under the 33’ Act – (investor rights not provided by common law) a. Limitations: a. NO need to show reliance on the material misstatement or omission. NO need to show scienter – that the issuer intended to defraud (unlike 10b-5) 7. Intro – only for material misstatements in the registration statement ii.(just need material misstatement or omission.VIII. either at law or in equity…sue… 1.
Have to show did everything you could to ensure the registration statement wasn’t faulty a. is named in the registration statement as being or about to become director. Directors of or Partners in the Issuer at the time of filing: every person who was director of (or person performing similar functions) or partner in the issuer at time of the filing of the part of thre registration statement to which liability is asserted i. Expert signs off on his sectn of prospectus so if issuer put 10 & it is supposed to be 100 oil expert liable b/c signed off on his section f. §11(b) “no person other than the issuer shall be liable as provided therein who shall sustain the burden of proof” a. Signatories to the registration statement – Every person who signed the registration statement i. person performing similar function. e. if material misstatement but what if did all their procedures right? So have 11b. Issuer is liabile for the entire registration statement and has absolute liability even if it was a good faith mistake or typo. If material error w/ expert section can sue him. d. Lawyers are not considered experts unless issue a report on a legal issue such as complex litigation or antitrust and only liable for that part iii. Each person is personally liable c.8. Sue personally even though didn’t sign registration statement. at the time such part of the registration statement became effective. 2. Who may be sued: [each of them can be sued Personally] a. WHAT IS Reasonable investigation? Q of fact? 45 . shall be liable who “had after reasonable investigation. BUT NOT want underwriters to be personal guarantors of the issuer – since everyone will sue the deep pockets – have §11(b) v. appraisers) any expert who. This means if any prospectus errors underwriter is liable – any underwriter both commercial and statutory underwriter iii. Experts are personally liable for the portion of the registration statement attributed to them (the section they expertise) and not for the rest of the registration statement 1. per se liability – i. with his consent. No person other than the issuer. i. Sue these people personally even though they didn’t sign the registration statement. CFO. Imminent Directors of the Issuer: every person who w/ his consent. comptrollers ii. ie the issuer (b/c person is term of art). calls etc – create a report ii. Though doesn’t say due diligence that is what reasonable investigation is. directors. Intro – sec 11a is harsh – makes underwriter personal guarantor. Therefore they must take an interest in what they are underwriting [this is another section like 3a11 that almost broke the 33 act from passing] ii. interviews. Experts named in the registration statement. CEO. or partner i. President. that the statements therein were true and that there was no omission to state a material fact required to be stated” §11b3 1. engineers. Issuer is subject to strict liability for a material misstatement or omission of fact. reasonable grounds to believe and did believe. Prospectus have expertisized sections – need experts so others can value company – ie if oil and gas company need expert to do studies and determine how much oil is underground – the more oil the more valuable the company. Due Diligence Defense (never appears in section?): is available for all but issuer & is absolute defense: even if you’re wrong i. or Art Co – need expert to value inventory so can then determine value of company ii. Underwriters can be personally sued. 2. §11b . issuer is still liable b. (ie accountants. has been named as prepared or certified any part of the registration statement. Underwriters: every underwriter with respect to such security involved in the distribution i. Document all due diligence like reports. Issuer itself has no defenses [assuming misstatement cause stock drop if else cause drop no recy] b.Escaping Liability (due diligence/ whistleblower/ director unaware of effective registration) 1. and outside directors liable and experts.
To much is given much is expected. Outside directors need to make reasonable investigation to the best of their capabilities given their knowledge and experience in the industry. i.3. NOT valid due diligence defense that left it up to the lawyers (relied on lawyers). can’t just close your eyes as to the rest. court said the standard of care is not applied uniformly. BarChris – fleshes out the standard of care. iii. Keep a log of how followed industry standards ii. Relevant circumstances 46 . For Experts: . ie what would a reasonable geologist do? – get experts of industry to testify as to industry standards – like deans of schools or heads of organizations. Need to be sure to hire a reputable expert in order to rely on the experts section i. An objective standard of a reasonable person standard of their profession 1. all people called. ii. Each person will have to meet the due diligence standard based upon their position.Experts are held to the industry standard. expertise and function in the company (BarChris) v. The more knowledge you are presumed to have the higher the standards you are held to: 1. Act–Just provides sliding scale factor a. 4.Kern d. Reliance on Experts: everyone but issuer can rely on the expert information. Plastic Co has directors preparing prospectus once is Chemistry prof. VS. Example: 1. In determining whether or not the conduct of a person constitutes reasonable investigation or a reasonable ground for belief meeting the standard set forth in section 11(c). §11(c) – “in determining…what constitutes reasonable investigation and reasonable grounds for belief. questions asked etc – just be held to higher stnd for your section or area that you know more about but still need to due diligence/reasonable investigation on all of it. SO this is why underwriters are not guarantors they have to conduct due diligence (show did everything they could to investigate the Co’s info as accurate) and if do so then not liable. if 2 weeks after reg stmt which says have sales tied up for next 5 years a 40% customer pulls his sales stk plummets– now VP marketing higher stnd he lives to serve clients and should know about his biggest client – has higher burden to satisfy compared to VP production here. BUT REMEMBER all directors are responsible for not just their section but for all – so need to keep due diligence folder on all activities. If expert meets the industry standard and still gets it materially wrong – he is not liablie b/c he did his due diligence (reasonable investigation) and that is an absolute defense 1. Escott v. RULE 176-Circumstances affecting the determination of what Constitutes Reasonable investigation & Reasonable grounds for Belief under §11 of the Sec. c. §11(c) Standard for due diligence: How much do you have to do ? a. vi. 5. iv. Instead look at each defendant and ask “what reasonable care would I expect from that person” Therefore due diligence is a sliding scale – subjective test. other is travel agent. Standard of Care for all others liable: Due diligence is a Sliding Scale subjective test i. both as directors need to do due diligence and ask questions and investigate – but more is expected from the Professor when visits the plant and asks questions of experts. And if there is a mistake in the expert section can still rely on the experts information w/o further do diligence. which travel agent did not know 2. but if not reputable expert then others can’t rely on expert info w/o doing future investigation ii. the standard of reasonableness shall be that required of a prudent man in the management of his own property” b. 2 directors – VP marketing and VP production – there is a widget production problem not mentioned in prospectus – Markeitng says I asked VP production and some engineers and none said problem – this is probably enough for his due diligence but Production just asking engineer is not enough – he is responsible for plant activity and higher stnd.
and others whose duties should have given them knowledge of the particular facts 1. or c. and every person who becomes liable to make any payment under this section may recover contribution as in cases of contract from any person. the price at which the security shall have been disposed of in the market before the suit. the amount paid for the security. the particular person had any responsibility for the fact or doc. the value of the stock as of the time of the suit was brought. Resigned (or taken steps permitted by law to resign) and 2. Whether wrt a fact or document incorporated by reference. unless the person who has become liable was. The office held when the person is an officer v. and i. So Proportional liability to their negligence on due diligence b. The presence or absence of another relationship to the issuer when the person is a director or proposed director. The type of security iii. 7. “all or any one or more of the persons specified in subsection (a) shall be jointly and severally liable. §11(g) Upperlimit: in no case shall the amount recoverable under this section exceed the price at which 47 . Damages under §11: [can’t exceed offering and is difference in amt paid and resale price/value at suit] 1. vi. the type of underwriting arrangement. gave reasonable public notice that such part of the registration statement had become effective without his knowledge vi. §11(b)(1) -WhistleBlower Defense: a director can escape liability if before the effective date of the part of the registration statement with respect to which his liability is asserted. Reasonable reliance on officers. 2. He advised the SEC and the issuer in writing that he had taken such action and that he would not be responsible for that part of the registration statement. the role of the particular person as an underwriter & the availability of information wrt the registrant. in light of the fxns & responsibilities of the particular person wrt the issuer & the filing vii. who if sued separately. would have been liable to make the same payment. The type of person iv. The type of issuer [Does the person have expertise in that area] ii. a.include. Otherwise impossible to get outside directors – SEC likes outside directors –so only proportionate 3. Liability for Outside Directors (11(2A)): liability for outside directors in the absence of knowing misconduct is proportionate (contributory) as opposed to joint & several. he 1. or d. and in addition. Each D responsible for 100% dmgs can sue anyone for full amount & D’s can then deal w/ contribution 2. he acted and advised the SEC in accordance with §11b1 (above). §11(b)(2) Director did not know the registration became effective: escape liability if such part of the registration statement became effective without his knowledge. viii. §11(f) – Joint and Several Liability – for most §11 defendants. Indemnification – issuers may not indemnify any persons liable under §11 (against public policy – Globus) but the issuer may purchase D&O liability insurance that indemnifies directors from §11 liability viii. and the other was not. When the person is an underwriter. upon becoming aware of such fact. at the time of the filing from which it was incorporated. 6. guilty of fraudulent misrepresentation” 1. Underwriter liability – may not exceed the total price at which the securities written by him and distributed to the public were offered at to the public (see damages 11e) but with J&S can get 100% liablty vii. employees. (not exceeding the price at which the security was offered to the public) b. the price at which the security shall have been disposed of after the suit but before the judgment if such damages shall be less than the damages representing the difference between the amount paid for the security(not exceeding the price at which the security was offered to the public) and the value thereof as of the time of such suit was brought. with respect to a person other than the issuer: i. there is joint and several liability. §11(e) – P may recover damages equal to the difference between: a.
So the upper limit of damages is the amount the issuer sold the security for b. w/ computers–easier to trace that same stock certificate all the way back to specific registratin iii. So if D proves stock price declined for reasons other than material misstatement or material omission (faulty registration).the security was offered to the public a. the burden of proof shifts and the investor must show he relied on the material misstatement. peaked to $80 where some P’s bought etc. i. §11(e) – Negative Causation–“if the defendant proves that any portion or all of such damages represents other than the depreciation in value of such security resulting from such part of the registration statement. SO if bought in open market can’t sue unless shares were the ones issued from that registration statement w/ misstatement – iv. & What if fell to $11. with respect to which his liability is asserts…such portion of or all such damages shall not be recoverable” a. 48 . but if D proves Dow went down 30% $6 is attributable to the misstatement. SO if public co shares trading for long time – hard to trace to particular registration but if IPO all securities came form the registration statement – so easier to trace and find privity – ix. For underwriter the amount the underwriter bought and sold it for c. no recovery. so only liable for that. who bought from B. who bought from Issuer – i. The max amount recoverable is $1. Example: stock offered at $10. Statute of limitations : SOX extended SOL to no more than 3 years after the fraud was discovered and 5 years after the fraud took place (from 1yr and 3yrs respectively) §13 x. a. Thus causation need not be proved by P to recover but D can use causation as a defense. then the portion not attributed to faulty registration is not recoverable – so portion that went down anyway can’t be recovered i. Burden of Proof: if issuer publishes earnings statements generally covering the 12 mos period after registration . Hypo: Stock offered at 10. Need Privity – P has to prove that the security he lost money on came from the registration statement with the mistatment – (see above) – daisy chain privity is allowed – do not need to have P buy from issuer. then fell to $9 i. 4. now $1. dmgs is $9. So if P bought from C. 3. judge determines what portion of drop caused by extraneous circumstances b. & misstatement comes out when P has security – he can sue issuer –as long as can trace back ii.
Examples of 12(a)(1) violations: Failed Reg D. Sec 12–is for those that didn’t’ register their offering but should have. Direct privity required – only direct purchasers from issuer may sue a. 4. Damages: Recessionary statute – a. not misleading (the purchaser not knowing of such untruth or omission) and who shall not sustain the burden of proof that he did not know and in exercise of reasonable care could not have known of such untruth shall be liable subject to subsection b to the person purchasing such security from him. ii. (Pinter v. and the meaning of prospectus a. 2. §12(a)(2) – Offer or Sell – using prospectus or oral communications which have untrue statements of material fact or omission of material fact& didn’t prove that in doing due diligence he couldn’t have knwn 3. in terms of faulty registration b/c prospectus is big part of registration – but unlike §11 – §12 has recession instead of damages & §12 offer issuer due diligence defense. Gustafson v. b. less the amount of any income received thereon. Limiting 12(a)(2) – Gustafson v. Intro: This same thing as §11. 33 Act has nothing to do with secondary markets ONLY applies to ISSUERS and UNDERWRITERS (so SCOTUS logic makes no sense) i. Intro: This is a recessionary statute therefore only recover consideration paid – give up the security and get your money back. GOAL – put you in position as if transaction never happened. If P disposed of security – get recessionary damages i. causation. in light of the circumstances under which they were made. The SCOTUS said b/c the term prospectus only appears in the context of a registration statement that 12(a)(2) is available only for registered offerings and that there is no liability under §12(a)(2) for fraudulent 49 . Also need show that the stock they have was the one attached to the violation. (undo the tranasaction) 1. §12 – Civil Liabilities arising in connection with Prospectus and Communications: i. by means of a prospectus or oral communication. which includes an untrue statement of a material fact or omits to state a material fact necessary in order to make the statements. Dahl–only those in direct privity w/ buyer can be liable) c. if still own security–get consideration paid in original transaction + interest (less income received b. who may sue…to recover the consideration paid for such security with interest thereon. a. or for damages if he no longer owns the security 1. No where in §12(a)(2) is a mention of registration statement it only discusses prospectus therefore one would think that §11 is for registered offerings w/ faulty registration statements and §12 is for unregistered offerings w/ bad communications/prospectus – BUT Gustafon ruled that §12(a)(2) only relates to registered offerings since prospectus only appears in context of registered offerings ct says. which includes a blown exemption. §12a2 should’ve been for Unregistered offerings–especially b/c those are hard to value so give them their $$ back but b/c of bad reading of statute by Gustafson–§12 only applies to registered offering b. upon the tender of such security or for damages if he no longer owns the security 1. iii. 4(2). §12(a)(2) [misstatement in prospectus or oral communication] any person who offers or sells a security (whether or not exempted…) by use of any means or instruments of transportation or communication in interstate commerce or of the mails. So only direct purchaser can sue issuer underwriter or dealer for not registering. P relied on the broad definition of prospectus under §2(a)(10). less the amount of any income received thereon. Difference btwn price paid and amount received on subsequent sale (and income received) c. Strict liability provision for §12(a)(1) – (no scienter. Therefore only remedy for unregistered offerings (like nonpublic offering) is in the ’34 act 2.e. upon the tender of such security. who may … to recover the consideration paid for such security with interest thereon. no due diligence defense) 3. Alloyd Co. Alloyd Co – P sued under §12(a)(2) for material misstatement in a disclosure document in a private placement (couldn’t sue under §11 b/c only for registration stmnts). §12(a)(1) [failed to register] “any person who offers or sells a security in violation of section 5 shall be liable subject to subsection (b) to the person purchasing such security from him. Says “sells” is liable so that is why need privity with buyer – i. 3a11 offerings or failed 3a9 exchange. Sec 11 – was for faulty registration statement (but still was registered offering) 2.
disclosure documents other than prospectus in a registered offering. scheme or artifice to defraud. §17 Fraudulent interstate transactions –“It shall be unlawful for any person in the offer or sale of any securities…by the use of any means or instruments of transportation or communication in interstate commerce or by use of the mails. Remedy – is recession – (see above) 6. stipulation. This prevents people from hiding behind straw persons and let the straw get the blame for wrong doings – and congress wanted to avoid setting up dummy corps and judgment proof corps 2. Control person – Every person who controls any person is liable under §11 or §12 is also liable jointly and severally with and to the same extent as such controlled person to any person to whom such controlled person is liable (Q of fact if person is controlling person) 1. 2. 3. There is a due diligence defense for controlling persons (no knowledge of wrong and did their reasonable investigation) h. §15 – Liability of controlling persons: i.including issuer. Even the issuer can use due diligence defense (unlike §11 and §12(a)(1)). a. SO can’t waive rights of ’33 act g.. §12(a)(2) Due Diligence Defenses: available to anyone who offers or sells a security. rr ii. or provision binding any person acquiring any security to waive compliance with any provision of this title or of the rules and regulations of SEC shall be void i. But makes no sense b/c it is Recessionary statute so get your money back – so 12b has no meaning right now iv. 5. “unlawful” term of art so means criminal liability – can go to jail or fines under §17. To obtain money or property by means of any untrue statement of material fact or any omission to state a material fact…. §17 offers no private right of action – 1. directly or indirectly 1. practice. 1. or course of business which operates or would operate as a fraud or deceit upon the purchaser” i. 50 . 2. §12(b) Loss Causation – if in §12(a)(2) – D can prove negative causation (causation defense) –stock went down for another reason other than misstatement & than that portion is not recoverable – a. only SEC can bring action under §17. To engage in any transaction. Very broad language SEC can do whatever it wants iii.rrr 4.§14 Contrary stipulations void – any condition. Dissent(Thomas) relies on broad prospectus definition to cover this. Vs section 11 and 12 – SEC not use b/c they are for damages – so private actions. Statute of limitations : SOX extended SOL to no more than 3 years after the fraud was discovered and 5 years after the fraud took place f. to employ any device.
the Federal taxing power. Overview: the ’33 act is a consumer protection statute – disclosures from issuers (1˚&2˚ offerings). it is not practicable and not necessary or appropriate in the public interest or for the protection of investors to require such registration. Commissioners have staggered terms and one is a chairman. and they tried running internet trading – which was not open to any insiders of the company but SEC shut it down said securities market is one of national interest so we can regulate it – SO no exchange unless register with SEC. Created SEC and Attempt to depublicize SEC. It provides a comprehensive regulatory structure for the securities industry (exchanges. tender offers etc) and Created the SEC. in order to protect interstate commerce.National emergencies. §2(4) . I’ll withdraw your registration) 51 . which produce widespread unemployment and the dislocation of trade. … for the purpose of using any facility of an exchange within or subject to the jurisdiction of the US to effect any transaction in a security. unless such exchange (1) is registered as a national securities exchange under §6. unless you operate this way. public companies. §3 – Definitions and Applications. or to report any such transaction. Illegal in this country to operate a securities exchange w/out registering the exchange with the SEC changes everything (power to require registration is inherently the power to regulate. lots of fighting about this power but SCOTUS upheld it – so have power to regulate. to require appropriate reports. intensified. §2 – Necessity for Regulation – “…transactions in securities as commonly conducted upon securities exchanges and over-the-counter markets are affected with a national public interest which makes it necessary to provide for regulation and control of such transactions … and matters related… including transactions by officers. b. and which burden interstate commerce and adversely affect the general welfare. broker-dealers. c. §4 – Securities and Exchange Commission:“There is hereby established a Securities and Exchange Commission …to be composed of five commissioners to be appointed by the President … and consent of the Senate. SEC enforces securities laws e. Internet – is why really need this now – b/c say want to sell your GM stock – why not just eBay it not have to worry about commissions etc so cheaper. and prolonged by manipulation and sudden and unreasonable fluctuations of security prices and by excessive speculation on such exchanges and markets. ii.IX. Not more than three of such commissioners shall be members of the same political party. the national credit. & to insure the maintenance of fair & honest markets in such txns” i. insiders. and in making appointments members of different political parties shall be appointed alternately as nearly as may be practicable…Each commissioner shall hold office for a term of five year i. SECURITITES EXCHANGE ACT OF 1934 (aka ’34 act aka Exchange act) a. and industry. f. to remove impediments to and perfect the mechanisms of a national market system for securities … and the safeguarding of securities and funds …. [no cyberexchange] ii. in the opinion of the SEC. The ’34 Act is a regulatory statute that concerns secondary trading. and to impose requirements necessary to make such regulation and control reasonably complete and effective. dealer. directors. to protect and make more effective the national banking system & Federal Reserve System. no more than 3 from party so if D pres and have 3 Ds then have to appoint R. Thus – Securities market involves national public interest.§6 – National Securities Exchanges – registration of an exchange w/ the SEC under this section – and requirements for exchange to be registered. transportation. are precipitated. or exchange. So NYSE went from totally private to super regulated (to minute details like NYSE had fractional bids and SEC wanted it decimals so changed it) 2. §5 – Transactions on Unregistered Exchanges – “It shall be unlawful for any broker. and to meet such emergencies the Federal Government is put to such great expense as to burden the national credit ii. Unlawful for broker/dealer etc to trade unless exchange is registered. and principal security holders. by reason of the limited volume of transactions effected on such exchange. Exchanges must be registered with the SEC (and with registration comes regulation) or find exemption 1. or (2) is exempted from such registration upon application by the exchange b/c. d.” i.
HYPO – Want to buy 1000 shares $1/share but only have $100 – go to broker and give him 100 and ask for loan for 900 and so have $1000 to buy 1000 shares. other is register securities and now can regulate those securities (ie require disclosure etc) 52 .See below j. Broker is ok w/ it b/c loan is secured – have the shares and if you don’t pay back he can just sell the shares. (A) to effect any transaction in such security which involves no change in the beneficial ownership thereof. (false active trading not allowed) iii. §9 Manipulation of Security Prices – “It shall be unlawful for any person. margin call – broker asks for more equity b/c below the margin (equity requirements)) 1. ----. …” i. $900 is margin] a. IF stock goes to 2 dollars then can sell your stock get your 100 dollars pay back the 900 to the broker and get 1000 in profit. brokers. dealers – can’t trade on own account only take orders from customers – b/c need to get best price etc for them – own trading creates conflict of interest i. If stock goes down to $0. directly or indirectly… For the purpose of creating a false or misleading appearance of active trading in any security … or a false or misleading appearance with respect to the market for any such security.so limits how much you can leverage yourself and prevents panic selling by giving breathing room – so if 100 dollar investment can only get 100 dollars in margin – so 200 total investment and now if stock starts to fall – lots of room for broker to get his 50 dollars back. Leverage – abilty to use borrowed money to make or lose money. So federal reserve now sets margin rates and it varies – right now is 50%. §11 trading by members of exchanges.70 per share – now the 1000 shares only worth 700 so if you skip town – broker is out 200 even if he sells entire position – So if this occurs – Broker does Margin Call – for 200 dollars so have a total of 900 dollars in account when add equity and share value. If stock goes down to 1 dollar – have 100 in equity and 900 in margin and still 1000 value for stock – so if you walk away broker can still sell your holding and get his money c. Purpose –to prevent use of the market to manipulate the price of a stock by requiring all trades to be at arms length & fair so the price of the stock reflects its FMV – what willing buyer & seller agree to in good faith. Background – Stock market crash of 1929 – the market was highly leveraged – lots of stock bought on credit and then margin call snowballs – every one sell more margin calls crash – and bank failures b/c all these people bought on credit – SO Congress thought buying on credit bad. iv.g. . What is Margin: (Margin .but by selling stock the market goes lower and have even more margin calls b/c stock worth even less. §12 –Registration Requirement for Securities – this section creates a public company (reporting company) – for ’34 act need to register securities (but has nothing to do with §5 of ’33 act and registration of the offering) –SEC regulates secondary trading thru the ’34 act – one way is to register exchanges under §6.basically borrowed money. leverage can dramatically increase earnings. §7 – Margin Requirements –this is the only section of the securities laws which is not regulated by the SEC and instead is regulated by the Federal Reserve Bank – i. b. Purpose is to keep people from buying stock who do not have an equity interest in that stock iii. Criminal liability to manipulate the price of a security i. Snowball–if market is tanking then there are lots of margin calls b/c stock value is down but if investors not follow the margin call the brokers are screwed and sell the investors holdings to cut their losses. 2. Regulates trading on margin – by setting minimum equity requirements (ie can’t borrow more than 50% of the value of the stock) – There are rules as to how and when you can trade on margin ii. [$100 is equity in deal.SO at can only double your investment – right now. ii. No wash sales: 2 parties/brokers trade a thinly traded security back and forth so then drives up price and other investors will see and jump in and then the 2 brokers will get out at a high price and stock will fall b/c there is nothing to support the rise. h. §10 – manipulative and deceptive devices – Anti fraud statute . For brokers to trade on own acct need to use third party broker – k. a. if investor does not have the money – the broker is screwed – will have to cut their losses and sell your position (panic sell).
…. and such quarterly reports… 1. Must disclose on Form: i. want continued public disclosure for new security. after acquiring directly or indirectly the beneficial ownership of any equity security of a class which is registered pursuant to section 12…. Effect of registration – Once a security is registered: 1. 10K. 10-Q – quarterly unaudited financial information (mngmt’s opinion etc) c.8K vi. even ones that don’t trade 2. §13(a) Reports by Issuer of security . and filed with SEC” 1. IF issuer registers a class under §12(b) of the ’34 act – then he is a reporting/public company and must comply with the disclosure requirements of the ’34 act. §12g – Mandatory Registration – If an issuer has net assets of $10MN or more AND 500 or more Shareholders for a given class – then issuer must register that class of stock under §12. rr v. Registration is voluntary only if issuer wants his securities traded on exchange (adds liquidity) unless §12g iii. Summary/example –one must become a reporting/public company to trade their securities on an exchange – and there are three ways to become a reporting/public company – 1. Before a class of securities can be traded on any exchange. §15d – any issuer who registers an offering under ’33 act must register that class of securities for the year of the offering and the following year – even if don’t’ meet the mandatory registration requirements 1. within ten days after such acquisition. ie if MS wants to issue class of security for just 400 people – need not register that class b/c and test for mandatory (500 securities holders & 10MN in assets must register that class and therefore becomes reporting company). §13 – Periodical and other Reports – i. File form 10 or registration statement iv. §12(a) – General Requirement of Registration – “It shall be unlawful for any member. 10-K – Annual report – must be filed 90 days after close of fiscal year. The security may be publically traded – entire class of securities is registered. is directly or indirectly the beneficial owner of more than 5 per centum of such class shall. §15d – did a ’33 act registered offering. If acquire >5% of class of equity stock of reporting/public company – must file FORM 13D w/in 10 days of acquisition w/ the SEC.i. whether or not securities are traded (publically) – b/c this section is about reporting companies (public co is not proper term) 1. affirmative duty to disclose. voluntary register under §12a/b. Identity of the purchaser or group (so if few friends each own 2% if total >5% must file) ii.Any person who. has detailed financial information – disclosure is dictated by the SEC and financial statement must be audited by qualified accountant (SEC approved) – Use GAAP. §13d – Reports by persons acquiring more than 5% of certain classes of securities – Willams Act . ii.such annual reports …. send to the issuer of the security … to each exchange where the security is traded. Reporting requirements –issuer now obligated to make information publically available – (timely disclosure – if use EDGAR – instantly available to world) – required filings §13. the securities must be registered under §12b 2. SOX – §409 – duty disclose on a rapid and current basis any additional info concerning a material change int eh financial conditions or operations of the issuer – in plain English – so no longer waiting until the next periodic filing is due. To become a public company need to have at least one class of securities registered under §12. d. 3. Mandatory registration per §12g or 3. broker. a. also notify issuer and exchange where stock traded. 8-K – report events that happen with issuer b. ii. and 12b is voluntary/optional -- AND or OR distinction?! l. 2.10Q. 1. Reporting companies – ie have registered class of securities under §12 must file: a. Source of funds used to buy securities 53 . or dealer to effect any transaction in any security (other than an exempted security) on a national securities exchange unless a registration is effective as to such security for such exchange” 1.Every issuer of a security registered pursuant to section 12 shall file with the SEC…to ensure fair dealing in the security such information & documents…as the SEC shall require to keep reasonably current the information & documents required to be included in or filed with an application or registration statement filed pursuant to section 12.
IF not reporting co. iii. self addressed envelop w/ postage to return vote and proxy statement which has info for each voting decision.regulates the solicitation and execution of proxy statements and tender offers. §13f – Reports by institutional investor – Passive investors – if institutional investor w/ no intention of asserting control and pass 5% owernship of reporting company – then have a brief form to fill out (max 20%) m. FINRA does the day to day regulation . Where did you buy it iv. (unlawful to do so otherwise) ii. so if class of security w/ 490 holders no 12g mandatory& if not voluntary registr 12a/b then no need to file 2. ii. 1. Example – if Felon – then can’t work for broker / dealer but if want can ask for a hearing with FINRA who then will send all transcripts and FINRA recommendation to SEC b/c SEC has ultimate authority – o. and must offer all those that tender the same price. (SEC forms for Proxy statement) 2. NEED to file under Williams act before do TO. Intentions – what are the purchaser’s future intentions – ie take over company etc b. Even if the issuer is not a mandatory reporting company §12g and does not want to volunteer §12a/b – the issuer must still file reports b/c if recent offering and investors want to know what is happening to their $$. 1. §19 – deals with regulations of SROs v. ie buying large block of stock for the purposes of taking over the company. SEC has delegated broker/dealer regulation to FINRA (NASD merged into FINRA) which is a SRO – self regulatory organization.iii. MUST amend FORM 13D – for every 1% change in ownership – so can track creeping acquisitions. must file FORM TO with the SEC give disclosure and must pay all SHs in Tender offer the same price and must remain open for certain amount of time. 3.If any issuer went through a §5 ‘33act registered offering then the issuer must continue to make periodic reports for that calendar year (of offering) and the next year i. So in addition to register with SEC must file with FINRA. Already disclose under FORM 13D when purchase >5% but if wanted to do a tender offer – can’t creep around just file under Williams act before buy first share of tender offer. (ie not registered under §12 then no need to file frm 13D even if own >5%. iii. 54 . i.such as administer licensing tests.e – Tender offer – making an offer for certain % of outstanding shares of a company from the market. In order for anyone to solicit proxies from SHs of class of registered securities §12 (reporting company) he must send a proxy statement (disclosure statement) giving SHs detailed disclosure about what is to be voted on. At SH meeting (annual/special meeting) not all SHs attend to have a proxy who follows directions given to him by SHs via a proxy card. so SHs can make an informed decision. §15 Registration and Regulation of Brokers – Delegated to FINRA but SEC has ultimate authority i. Tender Offers – Williams Act . issue membership.§14d. iv. even before buy first share 4. Proxy: §14(a) – “It shall be unlawful for any person…in contravention of such rules and regulations as the SEC may prescribe …to solicit …any proxy or consent or authorization in respect of any security (other than an exempted security) registered pursuant to section 12 1. All brokers and dealers have to be registered/licensed with the SEC to trade/offer securities and need sufficient capitalization. n. Intentions is Q of fact – if start buying b/c not sure and file 13D and then decided that want to do Tender offer but already own say 25% probably in trouble. FINRA is also who public goes to if felt being cheated by their broker. §14Proxy Statements and Tender Offers: . Williams act – requires disclosure if want to do a tender offer – state you want to acquire x% at this price and what your intentions are for the company. Licenses actually come from SEC and SEC has ultimate authority by §15 and only delegated to FINRA. ISSUE – what is your intentions – did you try doing a creeping tender offer to avoid Williams act disclosure – that is no good. (ie so MS meeting proxy says I am proxy for 20MN votes – 18MN for gates and 2MN for Joe) [Proxy is bound by law to vote way SH wants him] a. 5. §15(d) –filing of supplementary and periodic information . Past if wanted to buy huge chunk of company say 51% can just buy in the market quietly and probably at different prices and as buy more shares price of shares goes up 2. So an individual investor receives: 3 things – proxy card to vote and sign. approve brokers etc.
ii.if 1 day after 6mos then fine. p. to make worst calculation for issuer . Also use to file any change in beneficial ownership? 3.O & >10% SH of a class i.O. Form 5 – Annual form. nor does state of mind matter – purely mathematical calculation. director. This has nothing to do w/ insider trading. or >10% stock holder of any class of any equity security (registered§12)– must file : 1. Theory – mangers are to mange for the long run d. of any equity security of such issuer (other than an exempted security) … w/in any period of less than 6 months…shall inure to & be recoverable by the issuer a.O or >10% SH (so all can track if CEO sells – in the past only had to disclose annual – so could sell after 1 mos and no one knows until end of year) a. Form 4 w/in 48 hours of any transaction by the D. After the 2 years time – then SEC can determine if meets 12g – mandatory reporting or the company wants to become voluntary reporting company. §16(a) – Any D. indicating their initial holdings (all shares owned and price bought them at). or officer by reason of his relationship to the issuer. 2. any profit realized by him from any purchase and sale. §16(b) Profits from purchase and sale of security w/in six months – SHORT SWING PROFITS RULE: 1. b. or any sale and purchase.O or >10% SH. If any 16a person buys/sells or sells/buys w/in 6mos the profit belongs to the issuer – if issuer not sue any SH can sue derivatively and recover his attorney fees.ii. For the purpose of preventing the unfair use of information which may have been obtained by such beneficial owner. c. §16 Directors. Form 3 w/ the SEC when become D. Officers and Principal stockholders: regulates disclosures & txn by D.otherwise if not meet 12g and Co not want to report (ie doesn’t care if its stock is not traded publically) – then no more continuous reporting requirements. Has to be registered stock? 55 .
(so allows class actions) iv. practice. or of any facility of any national securities exchange. in connection with the purchase and sale of any security . iii. b. reliance. and rumors 56 . so only recover difference. scheme. scienter.X. directly or indirectly. Review of CL fraud elements: a. 1. Fraud on Market Theory – need not prove reliance for each individual plaintiff but just that the entire market relied on the misstatement/omission – b/c efficient markets its all priced in. 2. by the use of any means or instrumentality of interstate commerce. causation. ii. unlike §11. Scienter – person needs to intend to fraud (make misstatement/omission). or course of business which operates or would operate as a fraud or deceit upon any person. adds causation. To make any untrue statemnt of a material fact or to omit to state a material fact necessry in order to make the statements made. NO Privity – need not be proved b/c says in connection w/ purchase or sale of any security – so need not be in privity w/ issuer – any purchases and sales are ok (like all 2˚ market trading) b. Texas Gulf Sulphur (pg654-2d cir ’68). in connection with the purchase or sale of any security. ii. Material Misstatement/omission –is required. This is the 5th rule formulated under section 10b of the ’34 act. To employ any device. 16 etc) b/c says in “contravention of such rules and regulations as the commission may prescribe” SO this just allows SEC to make a rule. 2. This is basically stolen from §17 of the 33 act. in the light of the circumstances under which they were made. 9. which is rule 10b-5. 3. or of the mails or of any facility of any national securities exchange. (Recklessness may be argued) iii. To engage in any act.this eliminates privity. D tries to mitigate damages if loses liability by saying entire market went down the day of misstatement 50%. any trade based on false statement is counted – so can be huge damages b/c all traders and their damages are counted (so not based on any issuance) 1. This section includes all securities both registered and unregistered with the ’34 Act.(b) To use or employ. 10b-5 –Needs material misstatement/omission. 14. and adds: If it is reasonably foreseeable that people would trade on the information then that person liable a. §10b It shall be unlawful for any person. It shall be unlawful for any person. by the use of any means or instrumentality of interstate commerce or of the mails. 4. 2. and §12 is recessionary statute so again just get money paid to issuer back vi. (reasonably foreseeable stnd to affect stk liable) ii. Causation – prove that misstatement caused the damages v. This section is not self executing (like § 7. in connection with the purchase or sale of any security registered on a national securities exchange or any security not so registered. unlike §11 max damages is the offering price even if stock to zero. RULE 10b-5 – Employment of Manipulative and Deceptive Devices – [main anti-fraud rule] i. or artifice to defraud. SEC v.…any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors i. Damages – are required and are unlimited. Find reasonable way to calculate damages (many ways). privity and damages. not misleading. damages (No privity) i. directly or indirectly. §11 – Needs material misstatement/omission. here need to prove intended to do it even though knew it was false. b/c its in connection with purchase or sale of any security. SECTION 10 – Manipulative and Deceptive Devices: a. Reliance – on the misstatement/omission has to be proven 1. or 3.TGS mining for minerals in Canada. Analysis of Rule 10b-5 1.
g.need deception or misrepresentation by issuer. Fact that D did not sell any securities does not matter b/c liable if misstatement is in connection with ANY purchase or sale of securities. Exception: aborted seller doctrine: someone about to buy/sell. all intentions to do so but then deception came preventing it from happening ii. or §12a so can have huge damages. NO Privity Requirement like §11. Ie. so offending party need not trade. article that drug works (but actually didn’t). So makes it harder for P to plead and prove securities fraud 9. Dura Pharm v. Thus it has to be someone that actually bought or actually sold a security (in reliance of the misstatement) to sue under 10b5 1. D was found liable for MNs–Pres is guilty but so should be GC who read it over b/c should have followed up to see if PR is true. Basic v. rather than unfair b. ie. mislead. (but also if put blinders on can satisfy intent) ii. e. b. Sante Fe – you need to defy. Central bank – must have wanted to defraud – (must be intentional – scienter) 7. if such assertions are false and misleading or are so incomplete to mislead…” ii. Mon morning TGS denies rumors & stock starts to drop but PR was lie–TGS hit motherload truth came out D sued 10b5. b. P must also show loss causation. Rule 10b-5 is a private right of action for anyone who purchases/sells securities in relation to info 6. Scienter a. WHO Can SUE under Rule 10b-5 a. iv.Plaintiff must allege and prove more to establish a claim under Section 10(b) claim than mere price inflation. 5. Levinson -SCOTUS – embraced fraud on market theory –P still has to plead reliance and causation but just easier to do w/ Fraud on market. Defraud: . CT if you violate 10b-5 and you reasonably assume people will trade on it. Reliance – a. i. as here. Broudo – pg 713 US . investors read article and traded – Ct it is reasonably foreseeable that buyers/sellers of securities would rely on trade magazines and read them. 10b-5 makes liable anyone who could reasonably foresee someone would trade on the info. Fraud on Market theory – basically relieves obligation to prove reliance or causation. Trade journal for neurologist. Hochenfelder – read into 10b5 a scienter requirement – so make it harder to sue b. by means of financial media. as long as someone traded in connection with misstatement. so reasonably foreseeable that their misrepresentation would be used in connection with someone’s purchase/sale of a security. NO privity requirement (w/ issuer) b. 8. Knew statement was false or material omission –intent i. i. a.start circulating that TGS made a huge mineral find so TGS stock start rising (Friday) by Sun. “in connection with the purchase or sale of any security” i. Causation – loss is proximate result of misstatement. 1. 4pm TGS execs wrote press release to make Mon papers said rumors about the significant mines were not true we still don’t know anything for sure & are just testing. Frustrated buyers cannot sue –ie “I would have bought but for the press release/misstatement” iii. a. Frustrated Sellers cannot sue either – so if held stock from before and never sold throughout the misstatement – can’t sue just b/c stock went down. Person works at Co for research & wins noble price for own research & Co stock keeps rising but then find out research false and stock goes down –liability need to ask if reasonable person could foresee that her own acts which led to noble price would affect stock of Co. need to do something deceitful. Some courts – scienter established w/ Recklessness standard 57 . ii. HOLD – “we hold that Rule 10b-5 is violated whenever assertions are made. in a manner reasonably calculated to influence the investing public. then satisfied in connection with.
58 .Disclosure: a. who made them… v. Limited to actual damages not punitive damages but can be huge b. P has burden to prove act/omission of D caused loss which P wants recover. P provide amt dmgs c. 10. Private Securities Reform Act of 1995 i. This did not touch 10b-5 and its requirements but instead is just a Civil Procedure statute which makes it harder to bring a 10b-5 action iii. Duty to correct – Once issuer has chosen to disclose then he has a duty to keep that info current b. SO can no longer wait until next 34 act filing to disclose 11. Affirmative duty to disclose – SOX have obligation to make timely disclosures of material facts i. Congress felt as though there was too much securities litigation and class actions against Corporations in 10b5 ii. Causation is a function of damages – misrep must have caused damages if not can limit damages c. Damages: a. Full and fair disclosure – via ’34 act filings c. All it did was to require Pleading with Specificity for 10b-5 violations iv. Vs past just said stock went down sue in 10b-5 and then use discovery to find out what is wrong. NEED to plead what statements are alleged to be misleading or what was omitted and why are they misleading. NYSE/Nasdaq – maybe contractual obligations to disclose d.
Insiders – anyone who owes fiduciary duties may not trade on material non-public info (chiarella) 1. a. Dirks – from issuer 2. 2nd by Rule 14e-3 – No one may trade on material non-public information regarding a tender offer. Capital markets would come to halt if there is a loss of consumer confidence b/c people would think the markets are rigged against you and not level playing field / not fair so will not participate. Chiarella v. INSIDER TRADING: . O’Hagan – from your employer 3. ???exception overheard in elevator?? d. Insiders – Directors. So need more than just trade on non-public info–need somethng else like breach of fiduciary duties (ct mde up ii. Rational for no insider trading is consumer confidence. their clerical staff. SEC discovers inside trading – thru computers – can see average volume of stock X and see if any changes and then see if an event occurs nearby. iii. Academic Debate – insider trading is good b/c it allows information to drive the price to reflect what the true value of the security is even if the public doesn’t know why. Summary: i. also D wasn’t a temporary insider b/c he was the printer for the bidder and the target was blind. Is the info Material iii. just leave out # of spaces required for target to fill in later b/c not want the target stock to move. Is the info Non-public ii. Rule 14e-3 Tender offer? b. Analysis: Ct–D is not guilty b/c mere possession of material nonpublic info is not in and of itself a bar to trade absent something else. How did you come upon the info? 1. RULE FOR INSIDER TRADING: The mere possession of material nonpublic information in and of itself is not a bar to trade. Once by O’Hagan and misappropriation theory b. b. Switzer/Electrician – accidently overheard 4. Temporary Insiders – lawyers. NEED Fiduciary Duty to someone somewhere. US – pg 881-1980 US – D was a type-line operator at Bowne. 1. even if find info on subway on TO can’t trade. 2. B/c insiders will sell to drive down price if too high and will buy if the think more to company and price will go up. accountants. there most be something else. 1. Phrase should be Non-public information NOT inside information. Who may Not trade on Material Non-Public information: i. He was typing a tender offer document but the name of target is kept a secret. 1. 16b is about short swing profits& has nothing to do w/ insider trading thus SEC goes to R10b-5 but really insider trading regulation is a product of judicial interpretation of Rule 10b-5. and if so will send questionnaire to those that traded – see if just got lucky or were they connected . a.also insiders file forms with SEC on trades. This case has been overruled twice – but the basic analysis still remains. he was going to jail but SCOTUS let him go. Who has Fiduciary duties? a. FD does not matter. INTRO There is no insider trading statute. But in the end – Securities laws are to instill faith in the market so can’t let people think its fixed iv.Trading on the basis of material “non-public information” a. i. consultants. tax planners. (can’t trade on advance notice of TO) – i. which is a breach of fiduciary duty [FD is not in statute] i. bankers Anyone that is told material nonpublic info to fulfill their duties – They hare held to have 59 . Here there was no Fiduciary obligation to anyone by D.XI. ii. Officers. Employees – anyone employed by issuser has fiduciary obligations to their employer/issuer and FD to shareholders. Therefore inside trading is illegal – and even though it goes on (just like crimes go on) people invest. If yes to both – What position do you have w/ the issuer? (chiarella-owe FD) iv. c. D figured out who the target was based on spaces left and bought the target stock and made 30K.
so broker got the contents before 60 . instruction. This is good law and is a question of fact for the jury but if insider shows he would have traded anyway and the motivating factor for the trade is not the inside information then there is no liability. 1. “(c)AFFIRMATIVE DEFENSES: (1i) person's purchase or sale is not "on the basis of" material nonpublic information if the person making the purchase or sale demonstrates that:” i. Entered into a binding contract to purchase or sell the security. regardless of what MS conditions are. Adler – D – pres of Co sold stock just before bad news was released and was sued by SEC. 1. ct agreed a. (C) Purchase or sale that occurred was pursuant to the contract. so no alterations or deviations from contract. in breach of a duty owed to the source of the information (ie owner of info) a. They adopt a written plan to sell. TEST: the “but for” / “on the basis of doctrine” i. instruction. Did not permit the insider/person to exercise any subsequent influence over how. this is how trade w/ no worries of insider trading ii. On Basis of -Insiders will probably always have non-public info – so how is an insider ever to trade – if an insider is not trading on the basis of such inside/non-public information then trading is not barred. the person had: 1. ii. as market would reflect what is said when it opens. Example: So if Joe finds CFO file left on subway that says unannounced earnings are low and shorts stock – he has material non-public info and trades on it but is ok b/c owed FD to no one. ie. iii. or plan described in paragraph (c)(1)(i)(A) of this Section: 1. or 3. D – author of the column told broker that he lived with what he was writing. and date the securities to be purchased or sold. price. plan. But for the information he would not have traded ii. (A) Before becoming aware of the information. or 3. 2. Specified the amount. D claimed he did not sell b/c of the bad news but for another reason so would have sold anyway. Most common affirmative defense by corporate execs. Included a written formula or algorithm. 2. Heard on the street is a column in the WSJ which had the ability to move the market. when. instructions e. iii.Fiduciary duties/obligations like insiders. NON-INSIDERS: who may not trade on material non-public information. If you owe a fiduciary duty (chiarella) and are in possession of material non-public information. Carpenter –pg897 2d cir-1986 –This is the true misappropriation theory case but SCOTUS denied cert. Judicial background: i. Adopted a written plan for trading securities. SEC presumes you have traded “on the basis of” material non-public information and shifts burden to Defendant to rebut the presumption thru the affirmative defenses Rule 10b5(1) provides: d. or computer program. He traded on the basis of such information b. i. RULE 10b-5(1) Trading “on the basis of” material non-public information in insider trading cases a. gates etc is RULE 10b5-1(c)(1)(i)(A)(3) i. SEC codified Adler to define what trading on the basis of inside information is: b. c. Gates sells 100 shares MS on the first of the month. or whether to effect purchases or sales. (B) The contract. SEC v. for determining the amount of securities to be purchased or sold and the price and date for it. US v. Instructed another person to purchase or sell the security for his account. Misappropriation theory–A person commits fraud ‘in connection with’ a securities transaction and violates 10b-5 when he misappropriates confidential information for securities trading purposes. HERE burden is on Defendant – does Adler backwards b/c D presumed inside trader. Remember rule 144 provides volume limitations on trades by insiders even if holding unrestricted stock c. or plan 1. Here the tests show that the burden is on P to show but for or on the basis (10b5(1) reverse it) 2. ii.
he conferred no benefit to insider. Whenever a person agrees to maintain information in confidence. The cooked books info finally b/m public& stock fell& SEC sued Dirks. Or if someone tells another in confidence and he trades – then liable 3. had feeling an insurance co. he cannot trade on that info. Misappropriation theory: Person commits fraud. Tippers and Tippees – as long as the tipee is not giving any benefit to the insider (tipper) providing the information. pattern. SEC -pg 900 US 1983 – Dirks. b. Any time person agrees to keep info confident then can be liable if trade on it 2. If give tickets to insider for info – then liable 2. SO if WSJ traded on the information it would not have been a 10b-5 violation. iii. violates 10b-5 when he misappropriates info. 2. Even though D got the tip from the insider. Whenever a person receives or obtains material nonpublic information from his or her spouse. goes up to SCOTUS& Dirks won. Chiarella would have been liable under the misappropriation theory 4. or the communication of. or sibling ii. Both Author and broker went to jail. material nonpublic information misappropriated in breach of a duty of trust or confidence” 1. WSJ owned the information and the author/broker stole information from WSJ 1. He then got info from former officer/insider that books were bad. So doesn’t just have to be FD to the issuer 3. US v. a "duty of trust or confidence" exists in the following circumstances. HELD – trading on information that does not belong to you is insider trading. securities broker. & the person to whom it is communicted have a history. i. Rule 10b5(2)–Duties of trust or confidence in Misappropriation Insider trading cases i. among others: a. O’Hagan -pg 889 US 1997 – this is the case that actually created the misappropiration theory but not good case for it b/c lawyers are considered temporary insiders (since denied carpenter SCOTUS was looking for something and took this) – D was lawyer whose firm was brought in to work on tender offer (but D did not work on deal) and he started buying up target stock and made money when TO announced. See above for rule adopted – b. which is in breach of the fiduciary duty owed by the person to the owner of the info. 1. was cooking the books. Jury question to believe you – that you told him in confidence. but GS can trade on that info. This expands Misappropriation theory to more than just Employer-Employee. Absent some benefit conferred to the insider there is no bar to trading…trading on material non-public info is not enough: ii. The benefit can be intangible – need not be pecuniary: 1. parent. child. daughter not suffer. ii. i. 2. Applies when: “purchase or sale of securities on the basis of. IF the tipper himself doesn’t care if the tippee trades or doesn’t trade – then no liability 61 . 1. IF GS analysts spends time doing research& writes a report. or practice of sharing confidences or c. a. CT adopted the misappropriation theory and said breached FD owed to his law firm b/c traded on material non-public information. before it becomes public b/c they own the information & if analysts traded he would have misappropriated info from GS and breached his FD to GS. then there is no bar to trading. If Dirks married to insider’s daughter and insider tells daughter to tell Dirks to sell – that is also insider trading by Dirks b/c benefit to insider. Whenever the person communicating the material nonpublic info.it was published and traded on the basis of that information and when article came out next day made money. He then advised all his clients to sell. Dirks v.
C is liable. the issuer shall make public disclosure (ma and pa America) of that information as provided in §243. OVERHEARING: if accidentally overhear then fine trade but if intentionally overhear (put yourself in a position to overhear) then can’t trade – (ie can’t go breaking in places to get info b/c you owe no FD to anyone) 62 . he has to call Pres and lawyer who follow REG FD and need to promptly disclose that non-public info to promptly – Press release iv. Benefit can be traced – Chain: -once the chain is tainted from the original tipper (b/c they expected a benefit or misappropriated) it is tainted all the way down the line provided you can prove each person knows where the info originally came from 1. Ct said simply overhearing information is not a bar to trading. SEC v. i. A is liable (dirks). But if tycoons wanted to be overheard b/c wanted some trading then Dirks – insider trading b/c benefit to Tipper so all liable ii. in case of an intentional disclosure OR 2. Just like if find info on train or overhear on a plane – can trade as long as accidentally overhear. B tells C for no benefit.101(e): 1. So he puts himself in position to go to offices etc where not supposed to be doing electrician duties and then traded on information overheard. c. OVERHEARING INFORMATION: a. Example: Insider tells A for benefit. and there was no misappropriation (no connection btwn tycoons and him) 1. Not want to encourage this behavior so person is liable – HE would have breached a FD if he worked for the company but he is Independent contractor so no breach in FD but still make him liable. Switzer – D. §234.Dallas coach at game overhears 2 tycoons talking about a merger and D traded on that information.so REG FD iii. but only because he traded. 1. B is NOT liable – he didn’t trade. Example: IF CFO has lunch w/ analysts and accidently lets slip material non-public info that sales are down. not any benefit to the tipper. Jury question – did you accidently overhear if so then no problem b/c mere possession of nonpublic info is not a bar to trading iii. i.assuming tipper not trade himself.100 – whenever an issuer. b. Promptly as soon as reasonably practical (but no later than 24 hrs or start of next days trading) ii. Analysis – D is not insider no FD. iv. Example: if it was intentional non-public info disclosure need to tell all simultaneously – ie thru internet or conference call b. he didn’t give any benefit to A before he tipped. so not encourage people to snoop around. and he received no benefit as well. in the case of a non-intentional disclosure a. Simultaneously. and only because he knows where the info came from. A tells B without receiving benefit. who trades and knows where info came from. or any person acting on its behalf. REGULATION FD –Rules regarding selective disclosure – (dirks was the genesis) i. This was done to level the playing field b/c dirks – not liable if give info and no benefit incurred so if give info to favorate analyst and get no benefit (no tickets etc) that is fine but then the smaller analysts all were screwed only big analysts getting info. Promptly. Electrician case – D is working in an office bldg and realize people talking in front of him etc. Can trace benefit back – so if 10th person to trade but there is benefit to the original tipper in some shape or form – then you can’t trade on it v. 3. CT – D is liable – Cannot intentionally put yourself in a position to hear non-public information. discloses any material non-public information regarding the issuer or its securities to any persons described in (b)(1) of this section (securities professionals).
63 . §21(A) – SEC can sue you for civil penalties – damages up to 3 times profit made or loss avoid– treble damages – money paid to US treasury. Total amount of damages shall not exceed the profits gained or lost avoided by the person/insider ii. Damages: can be sued by SEC and any private P who qualifies under 10b5 (can recover difference in purchase price and market price after material info is known) except that: i. 20(A) private suits for insider trading: 1.e. no privity requirement liable to everyone who purchased and sold even though no idea who you are 2.
64 . instrumental to the crime and intends to assist “the getaway car driver” – but for him the crime would not have happened. Aiders and Abettors are the accountants etc – their negligence in preparing financial statements facilitated the crime. (qualitative) ii. Congress in SOX told SEC to study whether congress should pass law allowing private right of action against aiders and abettors: b. SEC may bring actions and damages/fines against all three – under criminal and civil liability statutes. There is a private right of action against primary violator ii. Aider and abettor do not have scienter. c. There is a private right of action against the secondary violator iii. 1. Summary: i. Controlled persons of these are also liable under the ’34 act b/c not want straw violators but they do have affirmative defenses i. unless the controlling person acted in good faith and did not directly or indirectly induce the act or acts constituting the violation or cause of action. Aider and Abettors – (helps/facilitates) – Not Liable (in private action) even if integral to crime commission “the guy that looked the other way” – sees bank being robbed but does not call 911. Secondary Violators – the person who helped. helped the fraud along – they didn’t ask the right questions – but that is not enough for liability they did not have the scienter: 4. the person that lied or committed the fraud “the bank robber” – (must be an affirmative doer) 1. SEC had Identified Three Potential Defendants: i. controls any person liable under any provision of this title or rules … also be liable jointly and severally with and to the same extent as such controlled person to any person to whom such controlled person is liable. Actor must be actively doing something positive silence and acquiescence is not enough – if not do anything then aider and abettor not primary or secondary iii. Aider and abettor is just in the wrong place at the wrong time 3. Aiders and abettors – Does not have the scienter – does not intend for the violation/fraud (unlike primary and secondary violators who both have the scienter and intend to defraud) 2. which primary and secondary have. (must know/intend and be an affirmative doer) 1. SEC can still sue aiders and abettors 6. OR if substantial participation . Who Can You Sue (under the ’34 Act) – Private rights of actions under the ’34 Act: a. 5. Every person who. How to distinguish: i. Primary Violators – the person with the scienter. d.less stringent then bright line test above where need actively do something to be primary or secondary.XII. directly or indirectly. Private right of action (sue and hold liable) against Primary and secondary violators ii. NO private right of action against aiders and abettors.
For fairness purposes – SEC must show their proof to the justice dept and they will decide whether or not to bring criminal actions: 2. ii. SEC may bring enforcement actions against primary violators.XIII. 1. SEC must act on all complaints received: 4. Also does not have to tell issuer/person they are target of an investigation. IF during informal investigation the staff thinks there is something more. SEC division of enforcement – since it has power to investigate has many investigators and lawyers on staff who either investigate on their own or investigate complaints sent to them.can just ask for information and you can send it if you want 1. SEC now advises issuer/person that you’re the target of a formal investigation (or tells lawyer his client is the target) iv. SEC Investigations: a. During and informal investigation – SEC does not have to tell you/lawyer whether your client is the target for investigation . SEC now has subpoena power and therefore information submission is no longer voluntary b/c if not comply can send subpoena and then criminal if not comply 1. The 5 commissioners then hold a vote to bring an action and need 3 out of 5 to vote for action 1. you can informally talk to them and send over info / proof voluntarily if want to iii. Even during formal investigation the client can remain silent – ie plead the 5th – but must give over documents subpoenaed unless again constitutional issue (5th??) v. IF civil SEC deals with everything. Only give exactly whats asked for – no extra info or dates of data iii. Most complaints are handled this way. both SEC and FBI can go after same person/scheme. whistle blowing etc. a. BUT in order to maintain fairness and so the commissioners do not make decision just based on 1 side of the story – the client/person liable may make a “Wells submission” to the commissioners to tell his side of story and try to convince commissioners not to take action d. SEC has the power to call upon the FBI (if something criminal is also involved must call FBI) b. secondary violators and aiders& abettors i. Informal investigation i. b. Wells Submission – last chance for the target before an enforcement action is possibly brought. Enforcement: . SEC ENFORCEMENT OF SECURITIES LAWS: a. not required to submit any information – there is no subpoena power. First thing SEC does if gets a complaint is to all the issuer/lawyer and says just got a complaint what is going on here.’33 and ’34 act are also criminal statutes but there are several steps in order to get a criminal indictment (which can only be brought by the Justice department). 3. B/c Internal SEC rules – all complaints must be acted on even if stupid but most are handled thru informal investigations v. a. iv. Formal investigation i. SEC and FBI both are investigatory – FBI just writes a report and recommends enforcement. SEC Division of Enforcement has investigatory powers but the SEC has no criminal authority a. But SEC can’t bring criminal actions can only bring Civil actions – criminal go to DOJ iii. the staff can petition the 5 commissioners for a formalized complaint (the commissions hold a vote to determine) ii. UPON completion of formal investigation: the SEC enforcement division (staff) will make a recommendation of whether to bring an action or not i. SEC just asks questions and everything is voluntary at this point. [can ask sec if formal or informal investigation] c. The enforcement staff cannot bring any action (not even civil) so they give recommendation to the commissioners ii. 65 .
SEC can bring action in US district court: 6.settlement that says w/o admitting or denying we will not do X. e. fines. MANY CASES settle at this point—SEC loves settlement. i. and SEC can turn that into an injunction so if you breach then criminal violation. ii. If still lose after wells submission then action will probably be brought against you. . OR ask for full sentences in law if criminal – but DOJ needs to bring Civil Enforcement: .Target must give SEC enough information to convince them not to bring the action – that nothing was wrong but Target must keep in mind that everything disclosed in a wells submission to the SEC may be used against the target if the action proceeds: i. ii. if violate injunction then SEC will sue on injunction and can face criminal liability b. fine. cease and desist order (stop what your doing). 5. injunction (don’t do it again). §21 – Investigations and actions: 7. SO should run the wells submission by the white collar criminal lawyers at firm just don’t’ let SEC know this – so they don’t think your criminal. Letter of reprimand. consent orders etc. censure.SEC can bring on its own if commissioners vote for action – and again ask for injunctions. Remedies: a. Settlements can be conditioned on redoing last few years of financials b/c accounting records not done to SEC standards etc. 66 .
Thus. ETHICAL OBLIGATIONS OF SECURITIES LAWYERS (what if client from hell and not listen or if lawyer gets too involved in the registration etc ) a. SEC sues everyone including the LAWYERS involved. Acquiring lawyer said did nothing wrong followed his client – in the end court not sanction him – old retired felt bad for him but language of case resonates: 1. Securities lawyers owe a duty to both his/her client and the investing public a. SOX §307–Rules of Professional Responsibility for Attorneys--Commission shall issue rules. SEC v. setting forth minimum standrds of professional conduct for attorneys appearing &practicing b/f the Commission in any way in the representation of issuers. SEC is the one that nudged this language the court adopted. So w/in scope of ethics for lawyers you must fight vigoursly for your client and obligations just to your client except in securities lawyers – must also consider the investing public. ii. based on review there is nothing that differentiates this quarter from previous quarters – so not buying a falling knight). in the public interest& for the protection of investors. As the closing progressed soon learned that accountants would not give a comfort letter and closing could not take place with out it. “They knew… shareholders and the investing public were unaware of the adjustments and the inaccuracy of the financials. All happy merger went thru but few months later NSM goes under and drags entire new company. 67 .he was also a director – but made the decisions as a lawyer and not update when there was a material change in situation – but SEC problem with that – and also issue – when lawyer is making materiality decisions and not giving materiality advice.XIV. Charlie Johnson had all his proof that told correct advice and client not listen but SEC kept saying obligation to make the client follow the rules. CLIENT tells lawyer I want this deal closed. SO SEC holds lawyers to high standards and are going after them for ethical concerns: 2. if the counsel or officer does not appropriately respond to the evidence (adopting. “the commission’s allegations of aiding and abetting…failure of the attorney defendants to take any action to interfere in the consummation of the merger…The court concurs with regard to the attorneys’ failure to interfere wit the closing” 3. [vote by SHs etc all based on having a comfort letter at closing]. The case was dismissed on a technicality so the question still remains what a lawyer must do 1. Despite the obvious materiality of the information…each knew that it had not been disclosed prior to the merger and stock sale transactions. they just wouldn’t follow. In Re George Kerns – there needs to be some distance btwn securities lawyer and the issuer – here issuer left all disclosure obligations and decisions to S&C lawyer . this is not a situation where the aider and abettor merely failed to discover the fraud” 4. b. IF client not listen – go to the board and if board refuses to follow advise for proper disclosure (so intentionally evading sec laws now) then alternative is resignation – noisy one. b. especially in light of the experience of a securities lawyer. “due to the obvious nature of the misleading information. White and case lawyer calls client at 330 or so and says no comfort letter but can give letter with language similar to just not exact. as necessary. They already had a proxy vote for the merger and the vote ws to expire so had to close that day. In Re Carter & Johnson – had a client from hell – client wouldn’t make the proper disclosure even though the attorney gave proper legal advice to the board. Statutes: i. Cases: SEC brought – provide some insights on how to ethically guide lawyers: [pg 831] i. when things went wrong -(filings/prospectus wrong despite correct legal advice) . Target lawyer settled. and 2. (comfort letter is by accountants says cold comfort with the financials. the ethical obligations of the lawyer required the lawyer to take steps to ensure that the information was disclosed to the shareholders” 2. lawyer trying to say not my problem that SHs proxy vote was based on having comfort letter and argues should be management at fault only but court says NO lawyer as well 5. National Student Marketing – pg803 DDC ’78 – there was a merger by NSM which had to close by 4pm on a certain day or it wouldn’t happen. so close w/ letter as is. including a rule— 1. iii. requiring an attorney to report evidence of a material violation of securities law or breach of fiduciary duty or similar violation by the company or any agent thereof. to the chief legal counsel or the chief executive officer of the company (or the equivalent thereof). SEC took action against the lawyer.
…an attorney does not reveal client confidences or secrets or privileged or otherwise protected information related to the attorney's representation of an issuer. Normally local state bar sets ethical standards but here have 1st federalization of prof. If the CLO determines no material violation has occurred. he or she shall notify the reporting attorney and advise the reporting attorney of the basis for such determination. this part shall govern. RULE 205 –Standard of professional conduct for attorneys appearing and practicing before the commission in the representation of an issuer: [code means securities lawyers] adopted b/c SOX §307. and shall advise the reporting attorney thereof. Also says if conflict these standards control: 2. or agent of the issuer. Where the standards of a state or other United States jurisdiction where an attorney is admitted or practices conflict with this part.REPORTING UP . is ongoing. (2) The CLO shall cause such inquiry into the evidence of a material violation as he or she reasonably believes is appropriate to determine whether the material violation described in the report has occurred. a. …Otherwise take all reasonable steps to cause the issuer to adopt an appropriate response. By communicating such info. even though must disclose etc – and report – findings atty client privilege is very strong can only breach to stop a murder or protect yourself and the only can be good lawyer is if you know everything that happened ii. The audit committee of the issuer's board of directors. (b) duty to report evidence of a material violation: . (3) Unless an attorney who has made a report under (b)(1) of this section reasonably believes that the CLO or the CEO of the issuer has provided an appropriate response within a reasonable time. ii.appropriate remedial measures or sanctions with respect to the violation). These standards supplement applicable standards of any jurisdiction where an attorney is admitted or practices and are not intended to limit the ability of any jurisdiction to impose additional obligations on an attorney not inconsistent with the application of this part. 68 . (a)Representing an issuer. employee. is ongoing. [so after enron and early 2000 fallout – lots of talk about accountants and SOX but also see SOX had impt function for lawyers – how could lawyers let this happen – So lot of NSM language made it to SOX – only discusses public interest and investors – not client obligations. (1) If an attorney becomes aware of evidence of a material violation by the issuer or by any officer. ethics stnds b. they need their own attorneys. In lieu of causing an inquiry a CLO may report it to qualified legal compliance committee iii. the attorney shall report such evidence to the issuer's chief legal officer or to both the issuer's CLO and its CEO. or to the BODs 3. An attorney …before the SEC in the representation of an issuer owes his or her professional and ethical duties to the issuer as an organization. Atty client privilege only applies to client the corp so if directors and officers tell you stuff it is not covered by the privilege. Therefore the corporation is who your client and who you owe duties to.MANDATORY i. ii. requiring the attorney to report the evidence to the audit committee of the BODs of the issuer or to another committee of the BODs comprised solely of directors not employed directly or indirectly by the issuer. Rule 3: Issuer as a client: a. directors. director. the attorney shall report the evidence of a material violation to: 1. Appearing and practicing before the commission means representing the issuer… 3. or is about to occur. That the attorney may work with and advise the issuer's officers. or is about to occur. b. or employees in the course of representing the issuer does not make such individuals the attorney's clients i. Sum: Lawyer shall (must) report up and may report out [if not can get civil/criminal violations] 1. SOX 307 then gave SEC 180 after SOX passage to act on it and so did thru Rule 205] 4. Rule 1 – Purpose and Scope: This part sets forth minimum standards of professional conduct for attorneys appearing and practicing before the Commission in the representation of an issuer. Rule 2 – Definitions: a.
by the issuer and are not. he has to go up the latter if CLO tells him to stop] 6. directly or indirectly.. Subordinate shall take reasonable steps if believes supervising attorney is not complying with this section. [Summary – so junior atty can’t say I was told to stop by partner.Directly to the audit committee or BOD v. without the issuer's consent. An administrative disciplinary proceeding initiated by the SEC…may result in an attorney being censured. c. [summary – so may report out and not violate atty client privilege issues but it is optional so if unsatisfied with internal response that is that unless you want to report out and also has some constitutional chilling effects – but will this apply to enforcement actions – SEC yes. . A subordinate attorney shall comply with this part notwithstanding that the subordinate attorney acted at the direction of or under the supervision of another person b.Another committee of the issuer's board of directors consisting solely of directors who are not employed…by the issuer & are not. "interested persons") iv. 2.] – last 3 just depends on what issuer has in place. "interested persons"(if the issuer's board of directors has no audit committee). regardless of whether the attorney may also be subject to discipline for the same conduct in a jurisdiction where the attorney is admitted or practices. To prevent the issuer from committing a material violation that is likely to cause substantial injury to the financial interest or property of the issuer or investors. suborning perjury. substantial injury to the financial interest or property of the issuer or investors in the furtherance of which the attorney's services were used. reporting up: Lawyer Chief Legal Officer and/or CEO [audit committee of the board committee of outside directors BOD. ii. in the case of a registered investment company. The issuer's board of directors (if the issuer's board of directors has no committee consisting solely of directors who are not employed. [If any securities lawyer b/ms aware of evidence of material violation then he must report up to CLO and/or CEO and then CLO must inquire and notify the securities lawyer of his finding and basis for it if no violation – so CLO must justify to the nobody securities lawyer or if CLO does response what it is and IF securities lawyer not belive that is appropriate or feels it is even futile to deal with CEO/CLO – he must go to the BOD audit committee or the independent BOD or BOD themselves] 1. To rectify the consequences of a material violation by the issuer that caused. RULE 6 – Sanctions and Disciplines: a. Bar – no esp if criminal] 4. An attorney … who violates any provision of this part is subject to the disciplinary authority of the SEC. he has independent responsibility under Rule 205. or 3. the attorney may report such evidence as provided under (b)(3) of this section. in the case of a registered investment co. or committing any act that is likely to perpetrate a fraud upon the SEC. c. RULE 4 – Responsibilities of Supervising attorneys (CLO) a. Rule 5 – Responsibilities of Subordinate Attorneys: a. confidential information related to the representation to the extent the attorney reasonably believes necessary: 1. A violation of this part by any attorney … shall subject such attorney to the civil penalties and remedies for a violation of the federal securities laws available in an action brought by the SEC b. An attorney … may reveal to the SEC. (4) If an attorney reasonably believes that it would be futile to report evidence of a material violation to the issuer's CLO and CEO under paragraph (b)(1) of this section. or being temporarily or permanently 69 2. To prevent the issuer. in a SEC investigation or administrative proceeding from committing perjury. Must comply with the reporting requirements and must make sure subordinate attorneys comply 5. (d) – Issuer confidence – Reporting OUT – optional: i. or 3. or may cause.
that’s what he wants 70 . in Section 307 of Sarbanes Oxley. it required the SEC to establish a system for lawyers to report wrongdoing up the corporate chain of command or ladder and to establish other “minimum standards of professional conduct. c. “What is the lawyers role when acting as a responsible professional and public citizen today?” 2. Reporting out – is permissive right now but in future – Harvey Goldschmidt says we are headed to make it mandatory. 3. or should he say no more if made lots of them. d. iv. There is conflict btwn obligation to public and obligation to the client b/c client should be able to tell lawyer anything and now if make them tell SEC there is issue 2. Lawyers role in corporate governance: 1. including a responsibility for protecting the institution.”” iii. THEN SOX said rules for public interest and to protect investors iii. SPEECH by Harvey Goldschmidt – RULE 205 already foreshadows reporting out but its not required – Harvey would have probably made reporting out mandatory instead of optional.disclosure of any violations iv. THEN RULE 205 – mandatory reporting up by lawyers . this was virtually unanimous view of Congress when. This is open debate right now. Noisy withdrawal – stop being attorney b/c client does bad stuff and won’t listen but make noisy withdrawal to alert others? Like put in WSJ. 205 makes it so junior associate making these subs may have to go to the partner and now partner has to find out and report back. Lawyers must not assist or participate in client committing fraud v. HE says reporting out – is something bar is not against b/c break privilege if bodily harm or to protect yourself and therefore now more important to protect investing public then to have confidentiality 1. Started with NSM – owe obligation to client and investing public ii. Harvey – is previous SEC commissioner and now back to teaching ii. SUMMARY OF ETHICAL OBLIGATIONS OF SECURITIES LAWYERS: i. “There is. An attorney who complies in good faith with the provisions of this part shall not be subject to discipline or otherwise liable under inconsistent standards imposed by any state or other US jurisdiction where the attorney is admitted or practices. THIS came out after enron scandals etc – which happened b/c all losses were being put in offshore corps that the lawyers kept making.denied the privilege of appearing or practicing before the SEC. c. and must enforce the securities laws. d. i. I believe a broad consensus that lawyers should play a critical gatekeeping role in large public corporations. SO says lawyers are gatekeepers protect the corporation and responsibility element. Certainly. Many offshore subsidiaries for enron – issue if client asked lawyer to set up offshore sub would it have been lawyers obligaton to ask why. [Summary – so can have civil and criminal liabilities and may be barred to practice before SEC but if comply with rule in good faith and it is inconsistent w/ state laws etc – you are not liable] iii. The term “gatekeeper” suggests a guardian with independent professional responsibilities.
d. Public confidence is based on the independence of auditors – auditor has public responsibility 2. Additionally Public companies must have an independent audit committee (usually independent directors) and at least one member of the audit committee needs to be financially sophisticated 1. Need investor confidence in capitalist system w/o it no capital comes in and system collapses – 33 and 34 act were aimed to provide investor confidence. PCAOB – requires registration of an accounting firms that audits public companies b/c the power to require registration is the power to regulate. worldcomm. PCAOB sets standards that the accounting firms must follow. How can a major accounting firm get it wrong and say a company is worth billions in net worth but actually is broke – thus confidence in reporting companies finance statements are gone. which are the lifeblood of disclosure then confidence falters. Also there is 1 year cooling off period for any accountant who worked on a client audit and now wants to work for the client. Past auditing service was very low dollar amount compared to the consulting services the accounting firm would provide the client – like tax advice. 1. 3. Sarbanes Oxley (SOX) – [post enron.(AUDITOR INDEPENDENCE) 1. 71 . if you can’t quiet that auditing issue we won’t give you any of our other business (which is much more profitable for the accounting firm then the auditing business) also these accounting firm partners were given lots of perks from public companies (enron etc) iii. First thing congress did was to establish the Public Company Accounting Oversight Board 1. Must pre-approve any non-audit services 3. c. SOX is not an act – instead it is amendments to the existing securities laws. SOX gave them power to set standards for the entire accounting industry – ii. Unless an accounting firm is registered with this board it may not audit a public company. The annual accounting fee must go thru the audit committee –(so management can’t buy out an accounting firm etc for faulty audits) 4. so an entire cycle will pass just in case the auditor was actually bribed – there is time to see any faults in the audit. b. RELEVANT PROVISIONS OF SOX: i. Purpose: i. (b/c once registered firms have to follow PCAOB’s rules) a. b. Management was already liable or faulty disclosure thru the 33 and 34 act but SOX has a certificate for management to sign which holds them out even more – certify financials are correct and have internal controls allowing for escalation if there are any problems. tyco. the Company would say we only hire team players. Every SOX was provisions in response to some perceived wrong doings or defects in the system – in order to encourage consumer confidence after this bad era – by showing them that these things are illegal. SOX makes it unlawful for an registered public accounting firm conducting an audit of a public company to contemporaneously do any non-audit services .XV. § 101 – Established a Public Oversight Accounting Board – oversees the audit of public companies. SOX also makes management personally liable for the financials reported – 1. The accounting firm must give the audit committee all correspondences btwn the auditors & management iv. One major area needed to be addressed was the accounting profession – if the public cannot rely on independent public accountant audits. vi. and securities laws always reactive to problems. PCAOB regulates auditors. Only the audit committee can hire and fire accountants 5. Therefore if there was an irregularity in an audit. PCAOB also regulates the ethics of accountants. iii. Adelphi etc] a. They must keep records of all complaints related to auditing matters 2. due diligence on acquisitions etc. Creates Accounting oversight: i. ii. This is an attempt to increase consumer confidence – PCAOB is an independent committee subject to SEC oversight 2. Every 5 years the auditors must send a new audit partner to the public company – prevents any auditor from getting to cozy v.
every public company must now hire outsiders to assess the controls 72 . Presents fairly the financial condition of the company. Auditors should be at arms length of the client 1. vii. iii. $5M fine or 20 years in jail. v. Based on their knowledge it does not contain or omit a material misleading fact. IN the past. AT least one must be sophisticated and knowledgeable in financial or accounting matters iv. b. §301 – Every publicly traded company must have an audit committee a. ii. iv. you can go to jail. §306 – Insider Trading during pension fund black out periods – Prior to announcement of the earnings.any bonus paid on the basis of financial statements found to be fraudulent must be repaid. (have always signed the registration statement under the ’33 Act). § 403 – Disclosure of Txn involving management and principal stock holders: officers/directors have to report their trades in the issuer’s securities to the SEC.SEC shall prescribe rules and regulations requiring each annual report under the ’34 Act to contain an internal control report which shall state the responsibility of the mgmt for establishing and maintaining an adequate internal control structure and procedures for financial reporting and contain an assessment as of the end of the most recent fiscal year of the effectiveness of those controls 1. but now if financials discovered to be wrong – disgorgement – have to pay back the bonuses.… x. Past management would overstate earnings etc b/c gets performance based comp. You have to certify: i. 1. §402 – Enhanced conflict of interest provisions: It is unlawful for any public company to lend money to officers or directors. §204-the auditors must report to the audit committee – critical accounting policies. alternative treatments and material written communications w/ management. viii. § 303 –improper influence on conduct of audits: it shall be unlawful for any officer or director of any issuer or any other person acting under the direction thereof to take any action to influence. Responsible for implementing internal control to create procedure to filter the information up to the signing officers. §302 – Every ’34 Act filing must be certified personally be the CEO that he/she finds noting material or misleading in it. So avoid Enron problems vi. §404 – Management assessment of internal controls: demonstrates the breadth of SOX . Even if try then in violation vi. mislead any independent or CPA engaged in the performance of an audit 1. § 201 – Auditor independence: It shall be unlawful for a registered public accounting firm to provide the audit services with any non-audit services. 2. major corporations would issue loans to D&O that were not reported as compensation because they were a loan. coerce. [some exceptions] 1. arrangments. Certifying that there are no 10n-5 violations. Every public company must have an audit committee that is made up of at least 2 or 3 outside (non-management) directors. Likewise senior management can’t trade during the period. iii. employee pension or benefit plans cannot trade b/c 10 days before the earnings come out people know what earnings are going to be like. (that you have designed transparent internal controls) v.ii. and then later forgive the loans or used loans to buy up stock and then price goes up sell the stock keep proceeds and pay back loans xi. §401 – Disclosures in periodic reports – (j) – off balance sheet transactions – all annual and quarterly financial reports filled with the SEC shall disclose all material off-balance sheet transactions. If you sign the report and you lied. They have reviewed the report. 1. must be reported within 48 hours so that it will be viewable on the SEC website within 72 hours. manipulate. xii. §304 – forfeiture of certain bonuses and profits . §307 – Rules of professional responsibility for attorneys – see above ix. §404 reqs each annual report under the '34 act to contain an internal control report which shall state the responsibility of management for establishing and maintaining an adequate and internal control structure and procedures for financial recording containing an assessment as of the end of the most recent fiscal year as to the effectiveness of those internal controls.
§406 – Code of Ethics for Senior Financial Officers: requires every public company to have a management code of ethics and establishes standards to promote the honest and ethical conduct for the handling of actual or apparent conflicts of interest. §905. and iii.the SEC can issue rules xv. xiv.Disclosure of Audi Committee Financial Expert . xvii. Will consider past material misstatements. Reg FD gets rid of good old boy network too. S-O affirmative duty to disclose any material change 3. requiring that the broker who is involved in the investment banking of a firm may not retaliate against or threaten against any securities analysts as a result of an unfavorable research report that may adversely affect the investment banking relation xviii. 2. 1. Must be in plain English.Amendment to sentencing guidelines related to certain white collar offenses – allow sentencing commission to review and update sentences to reflect the serious nature of the offenses. In the past. the SEC has to establish rules to protect the objectivity and independence of securities analysts by: i. §408 – enhanced review of periodic disclosures. § 407. 73 . limiting the supervision and compensatory evaluation of securities analysts to officials employed by the broker or dealer who are not engaged in investment banking activities. Congress wanted the SEC to do more review.Conflict of interest for Security analysts recommend equity securities– there must now be a wall between the analysts and i-bankers. every public company must adopt a code of ethics and adhere to them xiii.2. §501 . Now up to 10 years in prison and 1MN fine and if willfully up to 20 years in prison past used to just be 35 years. analysts bonuses would be pegged to the results of bankers performance. §409 – Real Time Issuer Disclosures . restricting the prepublication clearance or approval or research reports by persons employed by the broker who are engaged in investment banking activities ii. xvi.Each issuer reporting under §13 or §15 shall disclose to the public on a rapid and current basis (now there is a duty to disclose to the public in a rapid and timely manner) such additional information concerning material changes in the financial condition or operations of the issuer in plain English as necessary or useful for the public interest or protection of investors 1. Created an incentive for the analysts to lie in financial prospectuses of certain stocks to help generate revenue for the company Don’t want to create a conflict of interest between the two groups 1.
Subjective test: §3a1A . it is hereby found that investment companies are affected with a national public interest” 1.2 main problems with this: i. The 40 act largely regulates mutual funds – even though the phrase is never mentioned in the act and instead they are referred to as investment companies [these funds are also subject to 33 act registration] ii. §1 Findings and Declaration of Policy: upon the basis of facts disclosed by the SEC…."investment company" means any issuer which is or holds itself out as being engaged primarily. or trading in securities. Investment companies (pools) can effect the market – they have lot of money and securities in their ownership so they can affect the market and in past they were extremely leveraged so more effect on the market and if there were margin calls – by dumping these huge stocks can really move markets and cause spirals of margin calls – (these companies wielded more money then the richest people in the world d. or proposes to engage primarily.generally more impt is §3 iii. PURPOSE: i. This can trap unwary issuers – if Co had extra money and investing is not their business but they do some of it and >40% assets in securities then you’re an investment company and must register but have some exceptions: 74 . Instead put stock & securities in a pool & sell interest in them – that is a mutual fund. Investment companies (pools) fleeced investors – they had poor disclosures. Problems leading to crash and in 30s are these investment Pools where people would pool their money and buy securities as a group: .PROVISIONS of the Investment Company Act of 1940 i. Past discussions with Howey – can take barrels of scotch sell interst in them and create a security b. . in the business of investing. since affects national public interest they can be regulated. f. yet they are an investment company b/c hold themselves out as one. Two Tests to determine if IC: a. Why have the 1st test if have 2nd since most people don’t want extra regulation anyway: i. The act serves to regulate investment companies to protect investors(so don’t get screwed by people running the fund) but also to protect the capital markets – especially given the amount of $$ these companies wield.subjective test. 2. holding. NOTES – subjective is hold your self out but in object not matter if don’t’ hold yourself out as long as doing it and >40% of your total assets is securities: a. Its just a securitization of securites c. so they were engaging in every risky behavior (but that is not want investors signed up for) 1. .8MN to buy a bldg and computers etc and only invest 200K in secuirites – they do nto meet the objective test – 40% of total assets is not securities. So a private company that raises money to buy securities instead of making widgets is matter of public interest and therefore no longer free to do what it wants (it was challenged in court and act upheld) ii. reinvesting. money disappearing. §2 – Definitions . and owns or proposes to acquire investment securities having a value exceeding 40 percentum of the value of such issuer's total assets (exclusive of Government securities and cash items) on an unconsolidated basis 2. Investment Company Act of 1940 (aka ’40 Act) a. And riskyness is allowed but only if have proper disclosure so investors know your investing risky ii. Objective test: §3a1C .this was in past separate stocks with ownership in the separate stocks. §3 – Definition of an Investment Company: This is the critical inquiry b/c if you fall under this definition and are an investment company then the entire act applies to you. (and must register as IC) lots regs 1."investment company" means any issuer which is engaged or proposes to engage in the business of investing.XVI. b. owning. or trading in securities. reinvesting. shady characters running it – saying they were investing in blue chip and instead putting money in foregn country commodities etc. b. Example – Mutual fund just opened gets 2MN capital and since mutual fund hold themselves out as primarily in the business of investing in securities but if they take say 1. Since investment pools got such a bad rep –they changed their name to mutual funds e. but now w/ pooling treat the entire pool as a different security i.
owning. holding. Congress said they didn’t want to regulate groups of old ladies getting together and investing their money (ie bearstown ladies). directly or thru a wholly-owned subsidiary or subsidiaries. (2)Any issuer which the Commission. b. or reformatory purposes-a. they didn’t know brokers or do their own trades so they invested in mutual funds and mutual funds industry exploded: . and the SEC can exclude you. Since lots of regs – congress gave SEC power to exclude at risk of overregulation. Investment club – group of people would pool their money and invest together. benevolent. reinvesting. in a business or businesses other than that of investing. (1)Any issuer primarily engaged. RULE 506 has no dollar limit 75 . educational. late 40s lots of people coming back and started investing money. HEDGE FUNDS – HUGE EXCEPTION TO INVESTMENT COMPANIES: a.after the war. SO if <100 investors and not making a public offering then the 40 act does not apply ii. 4. “through a wholly-owned subsidiary” – so if you’re a holding company like Citigroup – 100% of its assets are securities (100% stock in Citibank. owning. which is or maintains a fund described in §3(c)(10)(B). these clubs are basically partnerships – not need a written agreement to form and they hold themselves as primarily investing in securities and 100% of their assets are securities but they are not investment companies b/c: b. or trading in securities either directly or (A) through majority-owned subsidiaries or (B) through controlled companies conducting similar types of businesses. or b.(10)(A) Any company organized and operated exclusively for religious.Some people read the act and then used §3c1 – to create hedge funds – by having 100 investors but having high investment requirements – like 10MN per person – can have a 10BN hedge fund w/ the 100 investors ---SO all hedges are is a totally unregulated mutual fund (investment company) b/c they kept the # of investors @100. i. [also see §6 below] i. ii. no part of the net earnings of which inures to the benefit of any private SH or individual. Background: . Citigroup is not an investment company despite the fact it passes the test b/c if thru subsidiary engaged in business other than holding trading securities – then still have the operating company exception: 1. (but can’t just have all that securities and buy 1 hot dog stand and say really are an operating company) iii. This is the Operating company Exception (operative provision overlay) ii. Congress gave SEC plenary (complete) authority over the investment company act – so can plead to the SEC that even though you meet the test your not an investment company. fraternal. the non-public offering safe harbor – sell to accredited and max 35 sophisticated investors. holding or trading in security i. 100% stock in travelers etc)–so §3a1C . upon application by such issuer. §3(c)(1) – Notwithstanding §3(a) none of the following persons is an investment companyAny issuer whose outstanding securities (other than short-term paper) are beneficially owned by not more than one hundred persons and which is not making and does not presently propose to make a public offering of its securities. reinvesting. Citigroup’s subsidiaries are engaged in business other than investing and so the holding company Citigroup thru its subsidiaries is not an investment Co. finds and by order declares to be primarily engaged in a business or businesses other than that of investing. §3(c)-Further Exemptions. 5. Next dilemma for hedge funds is getting money/capital by definition they can’t do a public offering and So they raise money thru RULE 506 offering. §3b – Exemptions from Provisions: Notwithstanding §3a1C (>40% assets is securities) none of the following persons is an investment company: a. charitable.>40% total assets is securities and engaged in holding securities – HOWEVER.3. Must show in good faith that you really are an operating company b/c sometimes you can pass the threshold – say raising capital to build new factory – if have lots of cash invest in securities while waiting to build and may pass the threshold but can still avoid IC.
This is why only allow rich investors so can max out your Fund. Hedge funds – Number of investors: i. ii. Caveat – if any entity owns more than 10% of the 3c1 then look thru unless it is an operating company – so if MS owns 40% of 3c1 – no look thru (exception to the exception) and only counts as 1 investor.natural person with $5MN in investments or person who controls $25MN in investments (institutions) 2. 4. SEC is trying to adopt regulations for hedge funds – under advisors act? e. A 3(c)(1) fund can own another 3(c)(1) fund as long as own <10% of that fund. HEDGE fund operators – get all the rewards and zero risks – b/c regardless of what happens get 2% of the base and if take crazy risk and it works get 20% of the upside. which raises money thru a 506 offering and can have up to 499 investors if all QPs otherwise just 100 investors and its statutory basis is §3c1. But can also do 35 purchasers as long as sophisticated and need not be wealthy – but hedge not want to waste spot on person that is not wealthy – which is why people say hedge fund for the rich. a. So if it is a 1BN dollar hedge fund – the fund operator gets 20MN base and if the fund made 10% profit (which is nothing extraordinary) 100MN –gets 20% = so another 20MN – So gets 40MN in 1 year. Hedge funds are 2 components the hedge fund itself–which holds the money/securities and a hedge fund operator (an LLC which is a management co.) which has contract with the hedge fund. 100 investors max b/c of §3(c)(1) 1. 2. Qualified Purchasers: . . If an entity is formed for the purpose of investing in the fund – then look through and count each investor in the entity as a separate investor in the fund. 2. then only count as 1 person (beneficial owner count as 1 person) but if own >10% of the fund then must look through and count each individual so ruins it. 3.so can raise as much as they want [vs Reg A or 505–5MN cap] HEDGE FUND description: an unregulated investment company (mutual fund). If entity formed while back – say family company – then can invest in fund and only count as 1 investor – no look thru a. ii. which allows for 2% of the base as management fee & 20% of the profit.so takes less risks (comp around 1% of overall portfolio) iii.So incentive is to take risks.totally unregulated and can have up to 100 investors or have up to 499 qualified purchasers – but entire fund needs to be exclusively QPs and reason <500 is so not have disclosure and become reporting company under §12g f. §3(c)(7) – If an issuer (fund) the outstanding securities of which are owned exclusively by Qualified purchasers and you do not make a public offering – then there is no limit for qualified purchasers: 1. (2/20 split) 1. Investment Companies – fees to management are regulated and cannot be performance based. Hedge funds – Why so lucrative: i. Practically speaking all hedge funds limit themselves to 499 investors b/c if have 500 SHs and 10MN in assets then must register under §12g of the ’34 act – as a Reporting company and therefore are subject to regulations and disclosures and last thing hedge fund wants to do is disclose info) 3. SUMMARY: . .7. 76 . MULTIPLE Hedge Funds: Can a hedge fund operator (management company) bypass the number of investor requirement by opening and managing many funds each with 100 investors? c. and 506 says any wealthy person is accredited investor and can have unlimited accredited investors in 506. and it can’t do public offerings in either statute to be exempt – so use 506 d. This was passed in 96/97 b/c hedge funds complained about the 100 investor limit iii.
5. (sell correct % of each so composition still same) b. Promoter is allowed to sell units in the static fund on a pro rata basis to create cash for to pay out the redemption. [often run by corp but can be LLC or partnership]. But if multiple §3(c)(1) funds that are same then they are integrated 2.not need to act for long term capital management and therefore can do short selling and buy on margin which investment companies cannot. all which pay interest. If investor calls often have a check w/in 3 days. Answer is it depends: ii. This is intended to prevent playing with the NAV. So no after market trading just NAV following day. Portfolio is static but if people require redemption how does the promoter/management get funds to provide the investor? a. Net Asset Value (NAV) – is the price for redemption – all UITs are valued once a day at 4pm the close of the market. energy fund – then that is fine – no integration and so 1 hedge fund management company can run them all. 1. iii. If funds have different investment strategies – ie biotech fund. BY statute – Congress allows hedge fund operator to manage identical §3(c)(1) and §3(c)(7) funds without integration 1. IF funds look similar then integrate and so exemption is ruined b/c >100 investors 2. ii. IF multiple §3(c)(7) funds that are the same then they are integrated.i. risk. UITs have a finite limit – so all terminate 6. Benefits to not being registered under the 40 act: . 6. muni. It is redeemable every single day at the NAV price at 4pm. primarily retired people b/c know exactly what they are buying. value. 3. Management Investment Company – has a dynamic portfolio – so constant buying and selling – and running money – The disclosure just provide type of fund – ie growth. So if call at 3pm get the 4pm price when interest is sold. of 40act TWO Co. by the promoter (does so by pulling the price of each of the units in the UIT a the close of the market) 2. 4. if call at 401PM Monday get the Tuesday 4pm price. Integration Test: would a reasonable investor view the separate funds as different investments. g. Forward Pricing – If call for redemption. class A debt securities). Static portfolio – a promoter buys X MN units of stocks/bonds/securities and once completes the portfolio will not change (the pool of investments and the % of each security in the pool will not change). the person gets the forward price (NAV) – the future 4pm price is the selling price. Market for UIT – is huge market. but diff redemption 77 . If TOO much redemption can have lots of selling and depression in market b. since all interest are redeemed at the NAV. that fit the definition of an investment company and are subject to the regulation a. The securities are put into the pool and the management company sells interest in the trust/fund/pool (ie so each investor owns say 1/1000th of the trust if sells to 1000 investors). Since the fund is created and does not change each investor knows exactly what securities are in the fund from the disclosures since this is a 33 act – selling security – have registration/disclosure statement. 1. The bonds etc are staggered in the trust so that the retiree can get monthly checks of dividends/interest corresponding to their share in the trust (management company does take its fee). 1. biotech. Redeemable Security – Each undivided beneficial interest in the trust/pool/fund must be redeemable. Unit Investment Trust (UIT) – [generally is trust but does not need to be can be corp] i. There are 2 types both dynamic port. And often the trust/pool is made up of not common stock but instead bonds (govt.
6. open and close ended funds etc – and then takes a management fee from each of these funds. IF investment company – then must register under 40 act – see below. smaller companies. or transactions. The Commission. securities. Open ended not have secondary market b/c any investor can redeem at will and get the NAV so no need. if the economy is going down there are a lot of redemption requests and the fund must sell the stocks to get cash for redemption (even if stock is a great deal) and therefore the fund managers can move the market – esp if too much selling. the fund has liquid assets for redemption at will. At the close of trading – the close end management company pulls the NAV of the fund and the papers will report bid/ask and NAV of each of the funds. 2. Congress gave SEC a safety valve – very broad exemptive authority – SEC even on own motion can exempt anyone from the act – which is big deal. and register under ’33 act section 5 to raise capital from public (register the offering) and register the class of securities under the ’34 act. unless registered under section 8 shall directly or indirectly…offer/sell securities. by rules and regulations upon its own motion. SO no redemption just After market trading b. – so like snowball effect b/c sell and market drops and then more selling b/c more redemption requests. 4. may conditionally or unconditionally exempt any person. Since securities are non-redeemable – liquidity is not as much a concern so can invest in thinly traded companies. no need to sell for less and buy for more. engage in any business etc 78 . if and to the extent that such exemption is necessary or appropriate in the public interest and consistent with the protection of investors and the purposes fairly intended by the policy and provisions of this title 1. or transaction. Liquidity is of concern – b/c money is needed for redemption requests – management company must be sure to have liquid assets in the fund b/c mngmt co needs to sell the securities in the fund to get money/cash for redemption– 5. This is after market trading b/c need the NAV to be pulled and money is received by the investor selling his fund position (unlike open ended where fund manger actually redeems the investor) a. security. and always willing /required to redeem so not need to sell and find buyers and NAV is the market price.–fidelity is the management co.there is no real manger at the fund/investment co. or any class or classes of persons. Closed End Management Company: issues non-redeemable securities. Vast majority of mutual funds are open end management companies.[usually get check w/in 3 days] Must offer investors ability to get money back – redeemable securities Redemption is based NAV at 4pm has Forward pricing. 1. Back to provisions: iv. Example: Fidelity – a public company – sets up many investment companies – UITs. §6(c) – Exemption of persons. 3. or by order upon application. b/c fund will give you NAV. v. securities or any class or classes of persons as necessary and appropriate in public interest. Secondary Market for Trading – since an investor cannot get his money back from the fund – in order to get money back there is market for these securities just like stocks. 1. Open End Management Company: Issues redeemable securities Similar to UIT in terms of redemption. 7.i. from any provision or provisions of this title or of any rule or regulation thereunder. for all them. ii. and the fidelity staff runs all of them 8. §7 – transactions by unregistered investment companies: (a) No investment company organized or otherwise created under the laws of the US or of a State and having a board of directors. can invest more long term illiquid situations 2.
registered unit investment trust.get like 1% of base compensation ) b. . so broker cannot be affiliated w/ the investment company. Need a different (unaffiliated) broker then the fund company /operator – so no churning a. 11. It shall be unlawful for any of the following persons to serve or act in the capacity… of any registered investment company. Long – hold asset/stock – profit if go up b. and register under ’33 act section 5 to raise capital from public (register the offering) and register the class of securities under the ’34 act.1. viii. 8. a. 3. vi. any person who. Power to register is power to regulate vii. §8 Registration of an Investment Company: . 1. 6. Can only register if have at least 100. is permanently or temporarily enjoined by order. No performance based bonuses and limits compensation from funds to advisors to say (1%) 7. INVESTMENT Company BOD 79 . b. which also has a fund fee and keep doing it – then takes away all money from investors just becomes all fees. Can’t take on more debt than 300% of assets. or decree of any court of competent jurisdiction from acting as …securities person. 3. Short – sell borrowed shares – profit if go down. Illegal for investment company to make personal loans – to like management etc 5. If meet these – marketing advantage call your self a diversified investment. IF investment company – then must register under 40 act – see below. 75% of assets are invested in security but ii. Illegal to sell short a. do not hold 10% of voting power of one company b. IF deemed an investment company. IF want to be called a diversified investment company have SEC required parameters of diversification: i.000 in capital 2. §9 – ineligibility of certain affiliated persons and underwriters: 1. or principal underwriter for any registered open-end company.tells you how to register – long painful process 3-6mos. NO real regulations on investment but must stay w/in the parameters of your strategy and can’t change investment policy w/o a majority vote of investors. Charge fund fee to run fund and then take all money of that fund invests in fund b. not assignable. Each investment company has a K w/ an investment advisor – the management company that charges a fee to manage the fund (ie fidelity growth mutual fund is managed by investment advisor fidelity. SO no RIC investing in another RIC (outside of exception) 4. then can’t do business unless register the company with the SEC. any person who within 10 years has been convicted of any felony or misdemeanor involving the purchase or sale of any security or conduct as a securities person. by reason of any misconduct. b. Illegal to have fund of funds–b/c advisors fee would accumulate–(certain exception–3% in another fund) a. Need to have a different(unaffiliated) underwriter then fund company/operator b/c can’t pay yourself 10. Illegal to purchase securities on margin (so can’t use leverage like hedge funds) 2. K can’t be more than 2 years in length – in writing. must be approved by independent directors.b/c if stock goes up need to cover that and to get cash need to sell other stocks under management. who is buying selling to get the commission b/c then would do unnecessary trades. or registered face-amount certificate company a. judgment. RESTRICTIONS if INVESTMENT COMPANY: 1. Not want the fund. Can only K with registered investment advisors a. no more than 5% of assets in any one company iii. 9.
Exception: [open ended] No load fund (no sales load) 1. 80 . BOD must be composed of at least 60% of directors unaffiliated with the advisors (management company/advisors – so unaffiliated to fidelity) i.a. Sales load is a sales commission to join the fund – class is 2% fee of investment 2. IF there is no sales load rationale to not require unaffiliated board is that investors can easily enter the fund and leave the fund if not like what getting b/c they didn’t ay a fee that makes them hang on longer.
analyses. as to the value of securities or as to the advisability of investing in. compensation is problem b/c there is an inherent conflict and also self dealing issues. iii. or who. Summary – have broad definition – advises for compensation – then lots of exceptions. §202. 1.Definitions: 1. §203 – Registration of investment advisors –(a) it shall be unlawful for any investment adviser. Basically your background and philosophies. any nationally recognized statistical rating organization. but does not include: a. FORM ADV – 2 parts –Part 1 asks a number of questions about you. any felonies – though probably can’t even register 3. the persons who own and control you.XVII. for compensation. Past had to register both SEC under advisors act and state b. You must continue to amend your brochure. 81 . Advises on purchase of govt bonds: f. e. As before – investment advisors are a national concern so that means they can be regulated ii. any broker or dealer whose performance of such services is solely incidental to the conduct of his business as a broker or dealer and who receives no special compensation therefor. issues or promulgates analyses or reports concerning securities. either directly or through publications or writings. any person whose advice. such other persons not within the intent of this paragraph. bank or bank holding company [even though banks advise securities better regulatory authority] b. SEC no exam (just forms) some states have exams. as the Commission may designate by rules and regulations or order i. deliver it to prospective clients. Registration is simple (unlike RIC) – fill out FORM ADV – file with the SEC who acts w/in 45 days a. State vs. Can’t be in business unless register with the SEC 2. the publisher of any bona fide newspaper. 2. news magazine or business or financial publication of general and regular circulation. or selling securities. engages in the business of advising others. and the persons who provide investment advice on your behalf. and annually offer it to current clients b.. it is hereby found that investment advisers are of national concern. giving advise is only incidental to main job as broker and gets no comp for advise d. If you advise 25MN or more (or advise a registered investment company) then must register with the SEC only under the advisors act and not home state federal preemption c. accountant. g. engineer. to make use of the mails or any means or instrumentality of interstate commerce in connection with his or its business as an investment adviser 1. i. or reports relate to no securities other than securities which are direct obligations of or obligations guaranteed as to principal or interest by the US. Lots of wise guys try to give investment advise and say only selling newsletter – turns on facts is it general circulation. or securities issued or guaranteed by corporations in which the US has a direct or indirect interest which shall have been designated by as exempted securities under §3(a)(12 of ’34 act i. purchasing. for compensation and as part of a regular business. Provisions: i. unless registered under this section. i. or teacher whose performance of such services is solely incidental to the practice of his profession [advice is incidental to main duties] c. §201 – Findings: Upon the basis of facts disclosed by the record and report of the SEC … and facts otherwise disclosed and ascertained. Part II is your current brochure. Federal registration: a. IF advise less than 25MN register under the state govt and not under Advisors act. your business practices.Investment adviser means any person who. Investment Advisors Act of 1940 – aka Advisors Act: a. any lawyer. d. (a)(11) . defined in section 3(a)(62) of the ’34 act unless recommends securities. So anyone else SEC wants to exempt.
can’t have direct dealings w/ client? vi. v. then exempt from registration under advisors act 1. Not advise a registered investment company ii.4. ??UNLESS all qualified investors in fund – invests 750K or net worth over 1. Not hold self out as investment advisor 3. GOLDSTEIN Case – sued SEC – SEC lost – not have power to do make the change – and so allowed all hedge fund mangers to withdraw registration . any investment advisor registered with the commodities future trading commission iv. §203(b) Investment advisors who need not be registered (Exemptions) a. 82 . There are 2 exceptions: where hedge funds can still take performance fee: a. §205 Investment Advisors Contracts 1.each hedge fund that a hedge fund operator / management company advises/manages is only 1 client. For new clients if performance comp – need clients to be Qualified investors – invests 750K or has net worth over 1. 1. (a) compensation – no investment advisor may receive compensation based on capital gains a. d. c.5MN – then advisor can take performance based fee. all of whose clients are residents of same state as his business and he does not furnish advice with respect to securities on any national securities exchange. NO performance based compensation – its illegal – b/c not want risky speculative investments b. any investment adviser who during the course of the preceding twelve months has had fewer than fifteen clients and who neither holds himself out generally to the public as an investment adviser nor acts as an investment adviser to any investment company registered under title I of this Act i. any investment advisor. any investment adviser that is a charitable organization e. if less than 15 clients 2. unlike hedge funds very liquid – so some hedge funds told clients locked into investment so reorg more like venture capital. BUT what about hedge funds – SEE above they are exempt from registration as investment advisor – so even thought the fund operator gives advice for compensation they again avoid the laws – so can receive compensation based on performance: c. Registration needs to be updated yearly – annually amend brochure etc? 5. Advisors act contains restrictions on self-dealing – can’t do transactions which defraud. Few years ago – SEC changed regulations and said each fund is not just 1 client but instead look thru the hedge fund and all investors in the fund are clients of the hedge fund operator – so no longer qualify for exemption from the advisors act. can’t buy/sell securities on other side of trade w/o disclosing – so can’t tell client to sell and you as advisor are buying it. Grandfathered if trading before 2006 – all clients etc b. if had to register as an advisor there would be no performance fees.5MN [so even registered advisors can do this] 2. This is the hedge fund exception: . so 1. b. ALSO Venture Capital EXEMPTION – same section as hedge fund exemption discusses business development exemptions – but VCs are illiquid investments but long term. iii.but ½ did not b/c it is marketing tool. pensions etc liked that registered investment advisor and suggested to keep it and they can still get 2/20 b/c grandfathered from past or only take on QIs as clients. any investment adviser whose only clients are insurance companies.
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