Securities Regulations Law Outline

Securities Regulation
INTRODUCTION
I. Purpose of regulating securities:
a. Protect investors from abuses by company insiders and professionals:
i. Gun Jumping: Provisions in securities laws before securities are sold prevents a company from
pumping & priming market. This drives up stock by excitement
ii. Securities are regulated by mandatory disclosures. Theses disclosures make sure there is
asymmetrical info b/t corporation/issuing stock company & the investor.
iii. Regulation of securities prevents fraud
II. Most common types of securities:
a. Common Stock: Residual right to what’s left when the corporation liquidates; the most typical
b. Preferred Stock: Better stock w/ a preference on liquidation. This is typically reserved and not for the
public
c. Bonds: Instruments granting a loan to a company that req’s repayment w/ interest at a certain time
III. Two types of transactions:
a. Primary: Issuer offers and sells own securities to investors – ’33 Act
b. Secondary: Investor resells securities of an issuer to another investor – ’34 Act
IV. Federal Security Laws:
a. Securities Exchange Act of 1934 (Exchange Act) (’34 Act)
i. Regulates secondary markets, req’s periodic reporting for publicly traded companies, investors
are given accurate and current info.
ii. Disclosures:
1. Periodic Reporting: 10-K, 10-Q
a. Descriptions of business, directors and officers, ownership structure, past
financial statements
2. 8-K
a. Major events; bankruptcy, change in control, removal or resigning chairman
iii. Antifraud Liability:
1. 10b-5: Prohibits fraudulent disclosures and insider trading
a. Encourages lawsuits
b. ∆s often settle non-meritorious claims to avoid a suit
c. The PSLRA was passed in response
b. Securities Act of 1933 (Securities Act) (’33 Act)
i. Regulates primary market transactions; regulated when the company becomes public
ii. Mandatory Disclosure Documents for IPO:
1. Registration statement
2. Prospectus
a. Disclosure req’ts are the same as those under the Exchange Act; Information on
business, property, material legal proceedings, directors and officers, financials
iii. Offering Procedure Regulated: Gun-Jumping
1. Purpose
a. Wide distribution of the prospectus
b. Sent to investors before other written info
c. Prohibits additional info
iv. Heightened Antifraud Liability
1. Material misstatements in IPO
a. Material misstatements
b. Omissions creating half-truths
c. Investment Company and Advisor Act of 1940
i. Regulates mutual funds
d. Trust Indenture Act of 1939
i. Regulates companies that issue public debt securities of more than $10M; bonds
e. Sarbanes-Oxley Act of 2002
i. The purpose is to protect investors as a result of Entron and Worldcom
1. Est’d Public Company Account Oversight Board to regulate accountants
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2. Req’s company audit committees
3. Req’s internal control structures
4. Increases fines and criminal penalties for white-collar crimes
f. Securities and Exchange Commission (SEC)
i. The main gov’g body of securities laws; sets regulations
1. Est’d by the Exchange Act
g. Self-Regulatory Organizations: NASDAQ and NYSE
i. Quasi-private regulatory entities that have separate regulations and rules
ii. Listing req’ts:
1. Minimum capitalization and assets
2. Minimum corporate governance
3. Establishment of audit committees, executive compensation committees, and director
nominating committees consisting of independent directors
MATERIALITY
I. What Matters to Investors?
a. The major premise is Disclosure
b. Materiality is used to determine what info is important enough to regulate
c. Materiality appears in 2 situations:
i. Anti-fraud provisions: 10b-5
ii. Disclosures measures: S-K
d. Regulation S-K of the ’34 Act:
i. States how companies must structure disclosures and what must be disclosed
e. Regulation S-1 of the ’34 Act:
i. Filed when a company goes public
f. GR: Companies must only disclosure material info (10b-5 Antifraud & S-K Mandatory disclosures)
i. Burden is on the π of SEC to prove the info was Material
ii. Non-material info doesn’t req disclosure b/c:
1. Disclosing too much info will bog down investors & make info useless
2. Nobody would read the info
3. It would be expensive
4. Companies wouldn’t go public
g. 10b-5: Duty to Disclose (442)
i. Covers disclosures filed w/ SEC and voluntary disclosures such as press releases
ii. Violation occurs if there is an untrue statement of material fact in connection w/ the purchase or
sale of any security
iii. Half-truths: Omitting to state a fact necessary to make the statements made not misleading.
iv. GR: There is no duty to volunteer info
1. X: If a statement is made, the company must disclose other related material statements
that may make the original statement misleading.
2. X: Insider Trading – Fraud of Pure Omission: Duty to disclosure all material facts before
buying and selling in the company’s securities
3. Statement made  Duty to tell the whole truth  Failure  10b-5 violations
h. Material Disclosures Beyond Antifraud Liability
i. SEC mandates disclosures in 10-K & 10-Q w/ Regulation S-K - ex ante materiality
ii. 12b-20: In addition to S-K, req’s that anything should be disclosed to not make any other
disclosed statements not misleading – half-truths (also Rule 408)
1. Securities Act Rule 408: Refers to S-1 (106)
a. Additional material info must be added to avoid making statement misleading
i. GR: What is Material?
i. Substantial likelihood
ii. Reasonable investor
iii. View disclosure of significantly altering the ‘total mix’ of info made available (Objective)
1. Who is reasonable, what is total mix, what is significantly altered?
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2. Policy:
a. What’s important to SHs
b. Avoid info overload
II. Forward-Looking Information
a. Basic v. Levinson
i. Is forward-looking info (something that may or may not happen) Material?
ii. Basic denied any merger negotiations. It tells the NYSE to suspend trading and announces that
another company has approached it. The next day, it endorsed a merger offer. Those who sold
stock after the first public statement and before the suspension sue for damages.
iii. Stockholders allege that they sold at artificially depressed prices affected by misleading
statements. If they had known the merger was to occur they would have purchased stock.
iv. Test Forward-Looking Information as Material: Texas Gulf Sulpher Standard
1. The probability of an event occurring; balanced w/,
2. The significance of the event/transaction
a. Very fact specific
b. Higher the probability and significant the transaction the more likely the
statements are material
b. Basic Note:
i. It isn’t necessarily good to disclose every negotiation of a merger:
1. Drive price upward
2. Companies would do fewer transactions
3. Investors would invest and the stock price could drop if the merger doesn’t happen
ii. To keep merger info silent w/o making a misleading statement the CEO could:
1. Say nothing or “No comment”
2. Once talking begins the speaker must be 100% truthful
iii. Typically, forward-looking info about a merger is material when a merger does occur & there was
info disclosed in the past (test applies only if merger occurs)
1. Built in bias that the event usually does occur
III. Objective Test of Materiality
a. Rule: Misstatements and omissions that account for less than 5% of earnings are presumptively
immaterial for the purpose of a motion to dismiss.
b. Must look at quantitative (5%) and qualitative factors:
i. Does it effect management compensation
ii. Any of the omissions conceal unlawful transactions or conduct
iii. Alleged omissions relate to a significant aspect of the company’s operations
iv. Was there a significant market reaction to public disclosure of alleged omissions
v. Did the alleged omissions hide a failure to meet analysts’ expectation
vi. Did the alleged omissions change a loss into income or vice versa
vii. Did the alleged omissions affect the company’s compliance w/ loan covenants or other K’l req’ts
c. Litwin v. Blackstone
i. Blackstone made an omission that a company that it owned was having problems. There company
was backing sub-prime mortgages and would result in claw-back resulting in less future revenue
ii. Regulation imposes a disclosure duty “where a trend, demand, commitment, event or uncertainty
is both [1] presently known to management and [2] reasonably likely to have material effects on
the registrant’s financial condition or results of operations” - SEC’s interpretative release
regarding Item 303 of Reg. S-K
iii. Well-known trend was the fact the sub-prime mortgage market was defaulting
iv. Court held that the omission wasn’t material b/c it was under 5%, but the qualitative factors were
relevant to state a claim for misrepresenting/omitting a material fact. Quantitative harm was less
than 5%, but paid a much bigger role in Blackstone b/c the segment company represented a large
portion of Blackstone
d. In re Merck & Co. Inc. Securities Litigation
i. Merk was taking its subsidiary Medco public. Medco was a pharmacy benefits manager and was
accounting co-payments as revenue, even though Medco never received co-payments
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ii. The S-1 filed by Medco disclosed that it recognized revenue as co-payments, but didn’t disclose
the total amount. After the disclosure the stock price went up
iii. Later, a Wall Street Journal publishes an article that stated Medco reported billions of $ in
revenue that it actually didn’t receive.
iv. Following this article the stock fell, and investors sued. They claimed that Medco failed to state a
material fact about the total revenue based on co-payments
v. There were omissions made, but were the omissions material?
vi. Court held that the statement wasn’t material. After the disclosure in the S-1 the stock price didn’t
drop. Months later, when the article was release, the stock fell
e. Efficient Market Theory: If there isn’t info being w/held, the market will function efficiently and the stock
price should be accurate and reflect the info disclosed
f. Note: Event Studies – Courts look at the date something happened and see if the market reacted. If the
market acts significantly the court will look to see if the movement is material. Typically court will look
at stock price from 1-3 days and how much it moved. Then they will look at how much it would have
moved had the statement not been made. Then the 2 #s are compared; the difference in the #s is called the
“Abnormal Return”
g. Matrixx Initiatives v. Siracusano et al
i. Zicam is a cold-relief product marketed by Matrix
ii. Studies were done that ingredients in Zicam were causing people to lose their since of smell.
iii. Zicam makes up 70% of the revenue
iv. Zicam was pumping up the sales stating that it is the only product that can eliminate the common
cold.
v. Investors sued for failing to disclose the research indicating Zicam will cause loss of smell, after
Martixx had knowledge of the side effect.
vi. Martixx stated that the earnings would increase, but failed to mention the studies
vii. Court held the info provided to Matrix by medical experts revealed a plausible causal relationship
b/t Zicam and loss of smell. Matrix had info indicating a significant risk to its leading revenue.
The facts that Matrix had were material
viii. Rule: Studies are important to gov’t agencies and the medical industry, therefore it would be
material to an investor.
ix. Decision of materiality turned on the significance in an industry, not on the Effect of the Market
IV. Historical Facts (CHECK)
a. Historical facts are definite but their materiality is still questionable, b/c they can be murky in areas such
as accounting
b. Application:
i. Magnitude of the misstatement
ii. Market Response (stock price movement)
V. Total Mix
a. Rule: Had the omitted fact been disclosed it would have altered the total mix of info a reasonable investor
would have considered. Info that’s normally significant may be immaterial if already part of the total mix
b. “Truth on the Market” Defense – Courts use “total mix” formulation to dismiss suits that they perceive to
be weak or non-meritorious
c. Longman v. Food Lion
i. Court applies the “truth on the market” defense
ii. ABC News broadcast a story about labor law abuses by Food Lion Grocery Stores. Stock price
fell. SHs sued alleging that Food Lion failed to disclose that their stock price was inflated due to
misrepresentations (and omissions) about some labor violations
iii. Issue – Did Food Lion make a false statement? (A factual statement or omission that is
demonstrable as being true or false.) Was it material?
iv. Definition of Materiality:
1. 1. Would have led a reasonable investor to consider the info important in deciding
whether to buy/sell the security (objective)
2. 2. Would have viewed the total mix of info to be significantly altered by disclosure
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v. Court held the material info about the food markets cleanliness was already in the market prior to
a ABC broadcast that subsequently drove the price of stock down
vi. “Puffery” statements are not material and can’t be relied upon
1. Price of stock not affected
2. No knowledge of the misstatement
vii. If the info is already in the market and apart of the “total mix” it isn’t material
VI. Management Integrity
a. In the Matter of Franchard Corporation
i. Glickman was an executive who owned the majority of the company’s stock. He pledged the
stock as collateral to invest in other ventures. He also w/drew funds from the company and
invested that money into a separate self-owned company.
ii. Court held that b/c the bank could call on the the collateral – which would reduce the value of the
stock – and the w/held info went straight to Glickman’s integrity – the IPO was based on his
experience – made the info material
iii. Rule: Disclosures relevant to an evaluation of management are material where securities are sold
largely on the personal reputation of a company’s controlling person
iv. Rule: There isn’t a mandatory disclosure rule, but Rule 408 req’s disclosure of info to make other
statements previously made not misleading.
1. The registration statement indicated that Glickman owned all the shares, however the
bank did also. The fact that he pledged the stock as collateral is misleading if not
disclosed
v. Note: The personal health of executives might be material depending on the importance of the
executive and the condition.
b. SEC v. Fehn
i. Rule: Cant hide behind the 5th amendment as a defense to non-disclosure of material info even if
the disclosure is incriminating.
1. “I didn’t disclose b/c I would incriminate myself.”
DEFINITION OF “SECURITY”
Securities Act §2(a)(1) – definition of security
Any “note, stock, …, bond, …, investment K, … or … any interest … commonly known as a
security.”
Exchange Act §3(a)(10) – definition of security
Same as above, except “but shall not include … any note … which has a maturity at the time of
issuance of not exceeding 9 months”
I. Do Security Laws Apply?
a. Enumerated List: Stocks, Bonds, etc.
b. Catch-All Provision: Investment Contracts
c. Analysis: (For exam purposes)
i. (1) Is it a security?
ii. (2) Is it exempt?
1. If it is a security and is not exempt  security laws will apply
d. Tests:
i. If name unclear  go to Howey test (Investment K?)
ii. If name “stock”  go to Landreth/Forman – name generally dispositive.
1. Then to Howey if fails characteristics of stock.
iii. If name “note”  must see Reves factors before determining.
e. If classified as a security then several req’ts and other federal acts will apply:
i. ’34 Act – 10b-5 (SEC monitoring/enforcement/sanctions.)
ii. ’33 Act – registration, prospectus delivery and “gun jumping” rules in §5. §§11-12 Anti-fraud.
Public offering exemptions
f. Policy Question:
i. Should the securities laws apply to this transaction?
1. Historical justifications – Great Depression
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2. Information asymmetry
3. Strong national market
4. Mandatory disclosure
5. Investor irrationality
6. Many people seeking the same info
II. Investment Contract
a. Based on Economic Reality
b. Catch-all provision, defined by SCOTUS in Howey
i. Howey Test – Determination of Investment Contract: All factors must be met
1. Investment of Money
2. In a Common Enterprise
3. W/ the Expectation of Profits
4. Solely though the efforts of another
ii. Consider the Economic Reality (Objective)
1. Does it look like a typical security
2. Are the investors sophisticated or vulnerable
3. Is there fraud or are disclosures necessary
c. SEC v. W.J. Howey Co.
i. Howey was selling acres of citrus land.
1. Land sales Ks, warranty deed, services Ks.
ii. Howey has skilled personnel, and w/ service K, who harvest the orange grove. Purchasers have
no right of entry to market the crop w/o consent. Howey then allocates net profits.
iii. Issue: Do land sales K, warranty deed, and service K together quality as investment K, therefore
subject to SEC regulation?
iv. Holding: Offering here is the “opportunity to contribute money and share in profits of citrus
enterprise operated by another. Purchasers are residents living far away, w/ no equipment,
expertise or desire to cultivate or market. Purchasers are attracted solely by prospects of a
return. Individual return w/o the full organization is economically infeasible – common
enterprise essential for profits.
d. “A Person Invests His Money” (1st Element of Howey)
i. International Brotherhood of Teamsters v. Daniel
1. Facts: To qualify for pension benefits, EEs must work 20 yrs continuously. Was a 1-yr
gap where the π didn’t work and the company denied benefits. The π sues as a material
misstatement under 10b-5.
2. Issue: Is a pension plan a security?
3. Holding: No, not an investment K b/c the pension was noncontributory and EEs didn’t
pay into it. A security req’s that “a person invests his money.”
4. Rationale:
a. Look at the entire transaction to determine whether the plan a separate
investment
b. Look for whether there was a separable financial interest
c. What was the primary purpose of entering the K? Employment or investment?
d. What is the form of consideration – services, not cash
5. Rule:
a. Mandatory, non-contributory pensions are not securities
b. SEC believes that voluntary, contributory plans are securities
c. The type of consideration matters
e. “In a Common Enterprise” (2nd Element of Howey)
i. SEC v. SG Ltd.
1. Facts: SG Ltd’s “shares” existed only in cyberspace. The company was a fantasy
investment game that was developed as a Ponzi scheme. The company advertised shares
as a “Privileged investment” w/ no risk. The share price was supported by influx of new
owners. Eventually it fell apart. Investors want money back.
2. Issue: Is the company an enterprise?
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3. Rules:
a. The court rejects distinguishing b/t commercial investment Ks, and games.
Howey doesn’t make the distinction
b. **Nomenclature doesn’t matter
c. 2 types of commonality:
i. Horizontal Commonality –
1. Pooling of assets from multiple investors
2. That share in the profits and risks of the enterprise
ii. Vertical Commonality – Investor’s fortunes tied to promoter’s success (2
types of vertical)
1. Broad Vertical – Well-being of all investors dependent upon
promoter’s expertise. Promoter bears no risk.
2. Narrow vertical – investors’ fortunes dependent on efforts and
success of those seeking the investment or of third parties.
Promoter bears risk. (5th & 11th circuit)
4. Holding: The court endorses majority view – horizontal commonality
5. Rationale:
a. Horizontal comports w/ the fact pattern in Howey
b. Limits types of instruments covered under securities laws
6. Application:
a. Pooling –
i. SG advertised that all client funds were in a single account
b. Share in profits & risks –
i. (1) Ponzi schemes inherently have this feature.
1. The scheme depended on finding others for influx. Infusion of
capital implies sharing here.
ii. (2) SG devoted profits from website to prop up the stock. This bond ties
all investors together
7. Other elements:
a. Investment of money
i. Depends on whether invested for profit or entertainment.
8. Note:
a. Ex of Vertical Commonality
i. Leasing company maintains, manages, collects rent, and oversees sales
of real estate. Broad vertical commonality. Individual returns may differ.
Leasing company gets profit no matter what
f. “Is led to Expect Profits” (3rd Element of Howey)
i. What are the reasonable expectations of the individual offerees?
ii. 3 Situations:
1. Participation in earnings (Forman)
2. Capital appreciation (Forman)
3. Fixed return (Edwards)
iii. United Housing Foundation v. Formanan
1. Facts: Shares of stock entitled purchaser to lease a co-op. Operator is nonprofit. Sole
purpose of purchasing shares is to enable purchaser to get an apartment. Non-
transferable; tied to apartment; cannot be pledged or encumbered; no voting rights. Must
sell back to co-op board on termination
2. Holding: Shares of stock sold were not a security
3. Rule:
a. Calling it “stock” is not enough to fall under the securities law
b. Substance/Economic Reality over form
c. Characteristics of stock:
i. Right to dividends upon an apportionment of profits
ii. Negotiable
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iii. Can be pledged
iv. Confer voting rights in proportion to shares owned
v. Can appreciate in value
4. Application: Inducement to purchase was to acquire subsidized living space. Inducement
to purchase was not for profit.
5. When is real estate a security?
a. Is not a security when occupied & profit is generated by yourself
b. Is a security if you don’t occupy, there is a general partner managing, and a share
of the rent is paid to you
iv. SEC v. Edwards
1. Facts: Payphone sale-leaseback arrangements w/ a fixed return
2. Issue: If offered a fixed return, is it a security?
3. Holding: Yes, expands Forman to include fixed, K’l, rates of return as a security
4. Rationale:
a. Purpose – Regulate investments
b. Solely from efforts of others - profits investors see on investment
c. Low-risk investments are attractive to individuals vulnerable to fraud
d. Would allow fraudsters to structure investments as fixed returns to avoid
securities laws
g. “Solely from the Efforts of the Promoter or a 3rd Party” (4th Element of Howey)
i. Involves availability of asymmetrical info and how it causes a party to be in a position that req’s
security law protections
ii. Common Application:
1. Partnerships and Franchises – Investors are involved in management, but the level of
control varies
iii. Franchises – whether they’re securities depends on the terms
1. Franchisor sells right to est. business in a location, takes cut of profits
2. Franchisee typically invests startup costs and money to run the business
3. Franchisor spends money on advertising and oversight
4. Franchisee has day-to-day control, but maybe not over some national policies
iv. Limited Partnerships
1. Presumptively securities, unless LPs exercise effective control over the enterprise
v. SEC v. Merchant Capital, LLC
1. Facts: Merchant buys debt from a 3rd party. Merchant sets up registered LLP & begins
raising money by soliciting the general public
2. Issue: Whether partners of the registered limited liability partnership were led to expect
their profits solely from the efforts of Merchant
3. Rule: General Partnership Presumption - Partners have equal management rights and
therefore can’t rely on the efforts of others. Presumed not an investment b/c partners
aren’t limited by access to info
a. Rebuttable Presumption – Williamson Factors
i. An agreement among parties leaves little power in the hands of the
partner that the arrangement in fact distributes power as would a limited
partnership
1. Where removal is only for cause, and the investors have no other
ability to impact management, the interest is an investment K
ii. The partner is so inexperienced and unknowledgeable in business affairs
that he is incapable of intelligently exercising this partnership powers
1. If the partner is inexperienced in “business affairs” we will find a
relationship of dependency on the promoter supporting a finding
of investment K.
iii. Partner is so dependent on some unique entrepreneurial or managerial
ability of the promoter or manager that he cannot replace the manager of
the enterprise or otherwise exercise meaningful partnership powers
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4. The term “solely” isn’t going to be interpreted strictly
5. Holding: RLLP interest were investment Ks covered by securities laws
6. Rationale:
a. Factor 1: Partners didn’t have the ability to remove Merchant, and they had no
control of the info or power to enforce the results of voting ballots
b. Factor 2: Individual partners had no experience in the debt purchasing business &
were relying solely on Merchant to operate the business
c. Factor 3: Merchant effectively had permanent control over each partnership’s
assets
III. “Stock” – A security?
a. Rule: All investments named “stock” that bear its features are securities
b. Landreth Timber v. Landreth
i. Facts: Family owns 100% of stock in a timber company. Offers to sell to public. Before sale, fire
damages equipment. Family still sells, advising purchasers of damage but arguing that it could be
overcome.
1. Before purchasing the stock, there was an audit and inspection
ii. Issue: Is sale of all stock in a company a securities transaction?
iii. Holding: The sale of stock is a security
iv. Rule:
1. “Stock” is defined in the ’33 Act as a security. Issues arise when an instrument is labeled
a stock, but req’s a determination of whether the instrument is or isn’t actually a stock.
2. Only apply the Howey Test if the instrument is characterized as an “Investment Contract”
3. If there are characteristics of a “security”, regardless of the Howey test, it will be
characterized as a security.
a. Characteristics:
i. Right to receive dividends contingent upon an apportionment of profits
ii. Negotiability
iii. Ability to be pledged or hypothecated
iv. Conferring of voting rights in proportion to the # of shares owned
v. Capacity to appreciate in value
4. A stock can be a security merely b/c it purports to be.
5. To avoid the issue of being classified as a stock, don’t label the instrument “stock”
Y=
security Y= security
Y= stock
characteristics N= Investment
Labelled ? K? (Howey N= any N= not
"stock"? Test) other security
category
N of Y=
security? security
IV. “Note” – A security?
a. A note is defined in the ’33 Act as a security
b. If the instrument is labeled a “note” the Howey Test isn’t used
c. “Note” Security Test – “Family Resemblance” Test: A balancing test
i. List of Non-Securities
1. Note delivered in consumer financing”
2. Note secured by a mortgage on a home
3. Short-term note secured by a lien on a small business/some of its assets
4. Note evidencing a character loan to a bank customer
5. Short term notes secured by an assignment of accounts receivable
6. Note which formalizes an open-account debt incurred in the ordinary course of business –
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particularly if note is collateralized
ii. A note is presumed to be a security, and that presumption may be rebutted only be a showing that
the note bears a strong resemblance to one of the enumerated categories of instrument.
1. Balancing 4 factors:
a. Motivation of the buyer and seller
b. Selling the note widely to the public
c. Expectations of the public
d. Alternate regulatory schemes available to protect investors
2. If instrument is not sufficiently similar to an item on list, the decision whether another
category should be added is to be made by examining the same factors
iii. There is a presumption that any note w/ a term of 9 months or more is a security
Y = not a
security
Y = family
N = security
resembelance? N = less than 9
months/comm
Note? ercial paper?
Y = not a
security
Y = security
N = Investment
K? (Howey Test)
N = not a
security
DISCLOSURE & ACCURACY

I. Public Company Status
a. Considerations:
i. Reporting req’ts are expensive and time consuming
ii. Exposed to lawsuits
iii. Enormous amount of public scrutiny
iv. Risk of §16
v. Sarbanes Oxley req’ts
b. 3 ways to become a public company:
Section Trigger Req’ts Termination
- periodic filings
- proxy rules + annual report
Exchange
§ 12(a) - tender offer rules Delisting
listing
- insider stock transactions (§16)
- Sarbanes Oxley Act
- periodic filings Either:
> 2,000 holders - proxy rules + annual report (a) < 300 SHs (<1,200 for
§ 12(g)
+ - tender offer rules bank or BHC) ,
(Most
> $10 million - insider stock transactions (§ OR
Comp’s)
in assets 16) (b) < 500 SHs + < $10M
- Sarbanes Oxley Act in assets for 3 yrs
< 300 SHs + 1 yr after
offering (suspended)
Registered - periodic filings
§ 15(d) OR
public offering - Sarbanes Oxley Act
< 500 SHs + < $10M in
assets for 3 yrs
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c. What Must be Disclosed – Disclosure req’ts:

i. S-K: Non-financial
ii. S-X: Financing statements
1. S-1 and S-3
iii. SEC, acting under authority of § 13(a), req’s 3 principal disclosure docs:
1. 10-K - annual report
a. Periodic doc
2. 10-Q - quarterly report
a. Periodic doc
3. 8-K - material
a. Episodic doc
b. Filed on the occurrence of specified events deemed to be of particular importance
to investors
d. When Must a Public Company Disclose
i. Form 8-K
1. Sarbanes Oxley Act §409 amends ’34 Act to req’s rapid disclosure for certain changes in
financial condition or operations of a company
2. Companies have 4 days to file occurrence of a material event based on certain events
3. Events Req’g Current Disclosure:
 Entry into a material amendment to or termination of a
1. Registrant’s Business & Operations
“material definitive agreement,” defined as Ks outside the
- Material Definitive Agreements
ordinary course of business
 Completion of the acquisition or disposition of assets
constituting more than 10% of the registrant’s total assets
 Results of operations and financial condition (if they are
disclosed by press release before the filing of the 10-Q or
10-K).
2. Financial Info
 Creation or triggering of an off-balance sheet arrangement
 Costs associated w/ exit or disposal activities, including
termination benefits for EEs, K termination costs and other
associated costs.
 Material impairments to assets such as goodwill
 Receipt of a notice of delisting or a transfer of listing.
3. Securities & Trading Markets
 Unregistered sale of equity securities
- Affecting Investor Stock
 Material modifications to the rights of security holders.
 Changes in the company’s outside auditor (and the reasons
4. Matters Related to Accountants & for the change)
Financial Statements (Very Bad)  Notice that previously issued financial statements or audit
reports should no longer be relied upon
 A change in control of the registrant.
 Departure or election/appointment of directors and
principal officers
5. Corp. Governance & Management  Amendments to the articles of incorporation or bylaw
- Resignation of Directors & Mgmt  Changes in the company’s fiscal yr
- Code of ethics: Must explain why  Temporary suspension of trading under EE benefit plans
there isn’t a code of ethics;  Amendment to the registrant’s code of ethics or the waiver
encourages comps to draft ethics code of the req’ts of that code
 Change in the company’s shell company status
 Information related to submission of matters to a vote of
the company’s security holders
6. Asset-Backed Securities  Certain info and computation materials related to the ABS
 Change of servicer or trustee for the ABS
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 Change in credit enhancement or other external support for
the ABS
 Failure to make req’d distributions to holders of ABS
 Certain updating disclosures related to an offering of ABS
registered on Form S-3
 Any disclosure the issuer elects to disclose through Form
7. Reg. FD
8-K to comply w/ Reg. FD
8. Other Events
 Anything that the issuer, at its option, thinks would be of
- Anything else a company wants to
importance to its security holders.
disclose to the investors
 Including, among others, financial statements for
9. Financial Statements & Exhibits
businesses acquired by the registrant
4. In the Matter of Hewlett-Packard Co.

a. HP didn’t state why a board member resigned
b. HP failed to comply w/ the 8-K and didn’t disclose the 5.02 req’t
i. 5.02: Departure of Directors:
1. Director resigns b/c of a disagreement w/ Co. on any matter
relating to the companies operations, policies/practices, or if a
director has been removed for cause  Co. must disclose why
c. Investors care about resignations of directors. Resignation could be result of a
disagreement w/ policies, operations, & procedures
d. Disclosure of health, retirement, moving, as reasons for resigning are not material
& therefore are not req’d to disclosure
ii. Form 10-K and 10-Q
1. 10-K: Annual Report
a. Most extensive disclosure doc
b. Requirements are laid out in Regulation S-K
c. Req’d info Includes:
i. Business
ii. Properties
iii. Legal proceedings
iv. Market for common stock
v. Management discussion and analysis of financial condition and results of
operation (MD&A)
vi. Directors and officers
vii. Executive compensation
viii. Security ownership of certain beneficial owners and management
ix. Certain relationships and related transactions
x. Principal accounting fees and servicers
d. Sarbanes Oxley req’s the CFO & CEO certify the 10-K & 10-Q
i. They have reviewed the report
ii. Based on the officer’s knowledge, the report doesn’t contain material
misstatements or omissions
iii. Based on the officer’s knowledge, the financial statements fairly present
in all material respects the issuer’s results and financial condition
iv. They are responsible for establishing and maintain internal control and
have:
1. Designed those controls to that material info is made know to
them
2. Evaluated the effectiveness of those control w/i 90 days of the
report
3. Presented the conclusion of their evaluation in the repot
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v. They have disclosed to the company’s auditors and audit committee any
weaknesses in those internal control and any fraud by person who have a
significant role in the issuer’s internal controls
vi. Any changes to internal control made subsequent to the evaluation are
disclosed in the report
e. Purpose
i. Focuses CEO/CFO on need for accuracy (personal liability)
ii. Reduces ability of CEO and CFO to claim ignorance of misstatements or
omissions
iii. By stating there are no misstatements, they make an additional
misstatement
II. Accuracy of Disclosure
a. Books and Records
i. Strict liability provisions; there are no intentional req’ts. Provision demand accurate books and
records
ii. ’34 Act § 13(b)(2)(B)(iii) Must have internal controls to prevent theft of assets
1. (iv) Procedures that reporting is done accurately
2. CEO & CFO must certify that there are procedures and policies in place
iii. Sarbanes Oxley
1. § 304 - Forfeiture of Certain Bonuses & Profits
a. CFO & CEO must return their bonuses if received w/i 12 months following a
financial statement that contains an error in it
b. Makes them liable for misconduct by any person in the company
2. § 404
a. Auditors have to specify that the financials are accurate and that the procedures
in place are to ensure that they are accurate
iv. In the Matter of Oil States International
1. 13(b)(2)(A): Requires public companies to make and keep books, records and accounts,
which accurately and fairly reflect the transactions and dispositions of the assets of the
issuer
2. 13(b)(2)(B): Devise and maintain a system of internal accounting controls sufficient to
provide reasonable assurances that:
a. (i) Transactions are executed in accordance w/ managements general or specific
authorization,
b. (ii) Transactions are recorded as necessary to permit preparation of financial
statements in conformity w/ generally accepted accounting principles and to
maintain accountability for assets
3. Inaccurate records and accounts violated the statute when the company failed to describe
the payments as bribes instead of expenses.
4. Strict liability applies to accurate books and records
b. Backdating Stock Options
i. “Strike Price” – The bar a company sets at which EEs can purchase stock
ii. “In the Money” – The stock price about the “Strike Price”
iii. “Out of the Money” – The stock price below the “Strike Price”
iv. SEC v. Brocade Communications Systems
1. CEO routinely granted “in the money” options and falsified the reports on the date he
granted the stock options
2. The company violated the books and records provision of §13.
c. Problem of Selective Disclosure
i. Regulation FD
1. Regulates the manner of how material info is disclosed, not what is disclosed. The
regulation prohibits selective disclosure.
2. 2 Types:
a. Intentional Selective Disclosure 100(a)(1)
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i. Must be released to the market immediately
b. Inadvertent Selective Disclosure 100(a)(2)
i. Must be released to the market w/i 24 hours
3. 4 step process:
a. Was it a disclosure of the issuer or OBO the issuer? Rule 100(a)
i. 101(c) Person Acting of Behalf of and Issuer:
1. An officer, director, EE, or agent of an issuer who discloses
material nonpublic info in breach of a duty of trust or confidence
to the issuer shall not be considered to be acting OBO the issuer
b. Was the info material non-public info
i. Material – Basic, Blackstone, Food Lion
ii. Non-public
iii. Must be intentional:
1. The person making the disclosure either knows, or is reckless in
not knowing, that the info communicated is both material and
nonpublic
c. Disclosure must be made to certain people in order to violate Regulation FD:
i. 100(b)(1) - Broker, dealer, or person associated w/ a broker or dealer
investment advisor, investment company, holder of issuer’s securities
d. Make sure that an X doesn’t apply
i. 100(b)(2) - person who owes a duty of trust to the issuer (e.g. attorney)
ii. Agreed to maintain the info in confidence
4. Regulation FD doesn’t cover foreign issuers
5. SEC v. Siebel Systems, Inc.
a. CFO disclosed in private meetings w/ investors that activity was good, and the
pipeline was growing
b. SEC argued that the statements were in contrast of the pessimistic tone of the
CEO several days before
c. Investors purchased stock after the meeting
d. Court held the disclosed info during the private meeting wasn’t materially
different than the info already disclosed to the public
e. 7 categories of info/events w/ a higher probability of being considered material:
i. Earnings info
ii. Mergers, acquisitions, tender offers, joint ventures, or changes in assets
iii. New products or discoveries, or developments regarding customers or
supplies
1. E.g. the acquisition or loss of a K
iv. Changes in control or in management
v. Change in auditors or auditor notification that the issuer may no longer
rely on an auditor’s audit report
vi. Events regarding the issuer’s securities
1. E.g. defaults on strict securities, call of securities for redemption,
repurchase plans, stock splits or changes in dividends, changes to
rights of security holders, public or private sales of additional
services
vii. Bankruptcies and receiverships
ii. Regulation FD Notes:
1. Imposed on issuers
2. Only selective disclosure to covered persons
a. Journalists, lawyers, fiduciaries, road shows, etc. are all excluded
3. Inadvertent disclosure may be corrected w/ a timely 8-K filing or press release
RULE 10B-5 ANTIFRAUD

§10(b) Exchange Act
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It shall be unlawful for any person, … by use of any means or instrumentality of interstate commerce … (b) to use
or employ, in connection w/ the purchase or sale of any security … any manipulative or deceptive device or
contrivance in contravention of such rules and regulations …
Rule 10b-5 – public and private antifraud liability in securities transactions
unlawful for any person … (b) to make any untrue statement of a material fact or to omit to state a material
fact necessary in order to make the statements made, in the light of the circumstances under which they were
made, not misleading … in connection w/ the purchase or sale of any security
§21E Exchange Act – Safe Harbor for Forward Looking Statements
I. Overview:
a. The purpose of this provision is to prevent fraud; very broad
b. There is a private CoA
II. Elements:
a. Material Misstatement - Basic
b. Scienter:
i. ∆s must have requisite state of mind – recklessness or actual knowledge of the statement
c. Reliance:
i. Π must demonstrate they relied on the fraud
d. Lost Causation:
i. Fraud must be casually linked to the loss suffered by the π
e. Damages
III. Rule 10b-5 Private Cause of Action
a. 10b-5 is the catch-all antifraud provision
b. There isn’t an explicit private CoA but has been implied through case law
c. § 9 of the Exchange Act:
i. Elements to a CoA under § 9(2)
1. Engaging in series of transactions in any security registered on a national exchange
creating actual or apparent active trading in such security, or raising or depressing the
price of such security
a. Series of transactions = as few as 3
2. Carrying out these transactions w/ scienter
3. Transacting for the purpose of inducing the purchase or sale of such security by others
d. § 11 of the ’33 Act:
i. Material misstatement or omission in the registration statement
ii. Individual purchased a security
iii. Individual has a private CoA
e. Trials are extremely rare, most settle
i. Companies want to avoid cloud over the company
ii. Avoid reputational harm, depositions, time and money
iii. Difficult to prove scienter
iv. If ∆ fails at the Motion to Dismiss, the company will settle b/c of the chance of enormous
potential damages.
1. results in weak cases getting settled
v. Many lawsuits have meritless claims
1. b/c of private CoA, πs are likely to bring claims w/ small chances of winning b/c
companies are likely to settle
IV. Private Securities Litigation Reform Act 1995
a. Its purpose is to reduce the # of frivolous lawsuits
b. There are hurdles to make to more difficult to bring these cases
c. 21D & E:
i. Req’s very specific pleadings
1. Plead w/ particularity to show a strong inference of scienter
ii. Company can file a motion to dismiss before subject to discovery rules
V. Standing and Class Representation – Who can Sue under Rule 10b-5
a. “In Connection W/” Req’t
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i. The fraud must be “in connection w/ the purchase or sale of any security”
ii. Blue Chip Stamps, et al. v. Manor Drug Stores
1. Blue chip down played the prospects of how much the stock was worth to avoid selling to
EEs. Many EEs didn’t purchase b/c of the down played statements. Later filed suit b/c of
these statements, realizing the stock was valued more than represented.
2. Rule: Must be a buyer or seller of stock/securities to make a 10b-5 claim for private
damages. Damages are limited to # of shares purchased/sold
3. Policy: The fear of further litigation allowing anyone to make a claim w/ or w/o buy or
selling the security
4. Holding: The π is bared form making a 10b-5 clime b/c he wasn’t a purchaser or seller of
the security
iii. Individuals who suffer fraud w/o buying and selling securities and won’t receive 10b-5 remedy:
1. SH who chose not to sell
2. Individuals who chase not to buy
3. Creditors
iv. SEC v. Zandford
1. Question: How close must the connection be b/t the fraud and the purchase/sale of the
security?
2. Facts: A stockbroker sold customer’s stock and used proceeds for his own benefit w/o
consent.
a. No Fraud – Selling the securities
b. Fraud – Stole the proceeds from the clients account
3. Issue: Does the stealing and then selling the securities violate 10b-5?
4. Holding: Deception of stealing money coincided w/ the sale of securities gives rise to a
10b-5 CoA
5. Rule: Fraud must coincide w/ the sell of the securities
v. Tests for “In Connection W/”
1. Affects intrinsic value of the securities
2. Contractual Privity
3. “Coincides w/” – Whether the securities transaction was a necessary step in completing
the fraud
vi. The interpretation of “in connection w/” is very broad
b. Summary:
i. Πs under 10b-5 must be either a seller or purchaser
ii. ∆s are any person who makes a material misstatement in connection w/ the purchase or sale of a
security.
VI. The Lead Π in a Class Action
a. Who will represent the victims of securities fraud
b. How does the court determine who should represent the class?
c. How does the court determine how much the attorney for the class will be paid?
§21D Exchange Act (Suppl. Pg. 406)
- (a)(3)(A) – early notice to class members. 20 days after complaint, mass publication req’d
- (a)(3)(B)(iii)(I) – rebuttable presumption for LP; most adequate π is person or group filing
complaint or responded to notice; has largest financial interest; satisfies
Rule 23 FRCP
- (a)(3)(B)(iii)(II) – may be rebutted by proof by class-member that π (aa) will not adequately
protect interests of class or (bb) is subject to unique defenses
- (a)(3)(B)(iv) Discovery – discovery for who is most adequate π limited unless moving party has
a reasonable basis to show inadequate (not best)
- (a)(3)(B)(v) Lead π gets to choose counsel, subject to court approval
- (a)(3)(B)(vi) – No Pro π’s Cannot be LP in more than 5 securities class actions in 3 yrs
- (a)(6) – Court reviews attorney’s fees for adequacy
i. In Re Cendant Corp. Litigation

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1. RULE: 2-step process for courts:
a. (1) Establish a presumptive Lead Π (By the Court)
i. Party must have filed the complaint or a motion to be Lead Π
ii. Party must have the largest financial stake in the suit
iii. Must otherwise satisfy req’ts of FRCP Rule 23 (prima facie showing)
1. Typicality
a. Are the circumstances or legal claims of LP markedly different
from the others?
2. Adequacy
a. Ability & incentive to represent the class vigorously
b. Obtained adequate counsel
i. They have the willingness and ability to select
competent counsel
AND
ii. to negotiate a fair retainer, sophistication, intention,
ability to monitor, negotiate reasonable fees
c. Question at this stage is only: Whether the choices made by
the movant w/ the largest losses are so deficient as to
demonstrate that it will not fairly & adequately represent the
interests of the class, thus disqualifying it from serving as lead
π at all?
iv. For group LPs (No hard & fast rule) - “rule of reason prevails”
1. Courts should generally presume groups larger than 5 members are too
large to work effectively
b. (2) Presumption may be rebutted by a putative member of the class
i. Show Lead Π cannot fairly or adequately protect class interests
1. ONLY after the court already established a LP
OR
ii. Is subject to unique defenses rendering such π incapable of adequately
representing the class.
VII. Elements of the Cause of Action
a. Πs have the burden to prove:
i. Material Misstatement
ii. Scienter
iii. Reliance
iv. Loss Causation
b. Misstatement of a Material Fact
i. Untrue statements of material facts
ii. Omission that, in light of the circumstances, make other statements misleading
iii. Materiality: Total mix of info, reasonable investor, significance
iv. Misstatement of fact or opinions: req’s deception
v. Duty to Disclose
1. Duty to update (Circuit split – If prior disclosure is still alive and has become misleading)
2. Duty to correct (If statements were misleading when made)
3. Duty to avoid “half truths” (10b-5 – Once you start speaking, you must tell the whole
material picture)
4. Periodic disclosure req’ts (10-K, 10-Q, 8-K)
vi. Deception
1. Proof of deception limits type of conduct actionable & list of potential ∆s
2. 10b-5 prohibits:
a. “Device, scheme or artifice to defraud”
b. “Any act, practice, or course of business which operates or would operate as a
fraud or deceit upon any person”
3. Santa Fe v. Green
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a. Facts: A short-term merger transaction was used to eliminate minority stock
interests. Santa Fe wished to acquire Kirby Lumber. The complaint asserted that
Santa Fe, knowing the appraised value of Kirby Lumber’s physical assets,
obtained a fraudulent appraisal and tried to give Kirby Limber’s SHs the false
impression that they were getting a fair price.
b. Issue: Whether 10b-5 is applicable
c. Holding: There weren’t material misstatements or omissions, and 10b-5 is not
applicable. Stockholder were furnished w/ all relevant info on which to base their
decision
d. Rule: The purpose of securities laws is to promote disclosure. Misstatement or
omission is necessary
e. Policy Consideration: Except where federal law expressly req’s certain
responsibilities of directors wrt stockholder, state law will govern the internal
affairs of the corporation
vii. Facts Versus Opinions
1. Virginia Bankshares Inc. v. Sandberg
a. Facts: First American Ban of Virginia was preparing to merge into Virginia
Bankshares. Minority SHs were given the right to vote. The π claims that the
directors didn’t believe that the price or merger was fair. The only reason the
recommendation was made was to stay on the board.
b. Issue: Whether a statement couched in conclusory or qualitative terms purporting
to explain directors’ reason for recommending certain corporate action can be
materially misleading?
c. Holding: Making knowingly false statements of reasons to merge may be
actionable even though conclusory in form
i. Disbelief or undisclosed motivation alone is insufficient to satisfy the
element of fact
ii. Opinions by themselves are not actionable
d. Rule: If the speaker has an opinion or statement of an opinion, it is actionable
under 10b-5 if:
i. It is disbelieved by the speaker
ii. The statement itself must be false
iii. Must prove the statement is related to a fact that can be verified by
objective evidence
viii. Duty to Update and Duty to Correct
1. If a statement is true when it was made there is not duty to correct
2. There is no req’t that companies must disclose everything
3. Gallagher v. Abbott Laboratories
a. Rules:
i. There is no duty for continuous disclosure
ii. If the 10-K is correct when filed, there is nothing in S-K that req’s
updating the info more than quarterly
iii. If statements are false when made and are materially misleading then the
company is req’d to update or correct the statement
iv. The class of people w/ standing to file suit ends when the statement is
corrected
ix. Forward-Looking Statements - PSLRA
§21E(a) – Applicability – it applies to exchange act or public company status issuers.
§21E(b) – Exclusions from (a) – IPOs, Tender Offers, Financial Statements (GAAP), offering of securities for a blank
check company, going private transactions, etc.
§21E(c) – Safe Harbor – 2 possible paths for written soft info (also covers oral)
- (A) – identify as forward looking statement and give “meaningful cautionary statements” identifying “important
factors” that could cause actual results to differ materially or the forward looking statement is simply immaterial
OR
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- (B) – π fails to prove that person making disclosure had actual knowledge - but SEC will interpret this as req’g
disclosure of principal risk, if you had intent to commit fraud
§21E(f) – Discovery Stay – Stay of discovery during pendency of motion to dismiss or summary judgment where
complaint based on forward-looking statements & exemption under 21E may provide relief
§21E(i) – Definitions – (A) financial projections, (B) plans & objectives of management for future operations, (c) statement
of future economic performance, (D) any statement of assumptions underlying statements
1. Statements about what might happen; forecasts
2. Safe Harbor – To protect against incorrect forward looking statements
a. 21E(a) – Who the safe harbor applies to
b. 21E(b) – What the safe harbor doesn’t apply to
c. 21(E)(f) – Grants a stay on discovery. Allows a motion for dismissal before
discover and litigation begins
d. 21(E)(i) – Definitions that help make since of the statute
3. Typically applies to statements w/ words such as: Should, may, we expect, might
4. Materiality: Would the info be important to a reasonable investor in deciding whether to
purchase or sell the security
5. Forward-looking statements are important b/c investors are looking for indication of
profitability
6. Asher v. Baxter International Inc.
a. Facts: There were allegations of materially misleading projections and no factors
were disclosed
b. Rule: 21E(c)(1)(A)(i) forecloses liability if the forward-looking statement is
“accompanied by meaningful cautionary statements identifying important factors
that could cause actual results to differ materially from those in the forward-
looking statement.”
i. Must identify some factors, but not all
ii. Boiler plate warning are not enough
c. Rule: Way to Avoid Liability – 21E(c)(1)
i. Companies get the benefit of both sub A and B. The provisions are
disjunctive and either will give safe harbor protection
c. Scienter
§21D(b)(1)
-(b)(1) Complaint must state w/ particularity of facts each false statement and explain why
it was misleading
- (b)(2) In any private action, you must prove or state w/ particularity facts giving rise to
a strong inference that the ∆ acted w/ the req’d state of mind.
- (b)(3)(A) Dismissed if req’ts in (1) and (2) not met
- (b)(3)(B) Discovery is stayed pending motion to dismiss, unless π pleaded
particularized facts
i. State of Mind
1. Actual Motive
a. Intend to defraud
2. Knowledge
a. Knowledge of facts & appreciation of how the market will be misled
3. Recklessness
a. “So highly unreasonable and such an extreme departure from the standard of
ordinary care as to present a danger of misleading the π to the extent … obvious
that the ∆ must have been aware of it.”
ii. Ernst & Ernst v. Hochfelder
1. Issue: Can a 10b-5 claim be brought w/o an allegation of intent to deceive, manipulate or
defraud? Is negligence enough to prove scienter for 10b-5?
2. Facts: Claimed Ernst failed to properly audit and they should have discovered the
improper practices of their client and that is why the value of stock decreased. There was
no allegation of intent
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3. Rule: Scienter req’s more than mere negligence
a. 3 ways show scienter in 10b-5:
i. Motive w/ intent to deceive
ii. W/ actual knowledge of misleading info
iii. Recklessness – So highly unreasonable and an extreme departure of
ordinary care
§20(a) – J&S liability for CP, and A&A violations

(a) GF defense for J&S liability – “Every person who, directly or indirectly, controls any
person liable under any provision of this title … shall also be jointly and severally
liable … to any person to whom such controlled person is liable, unless the CP acted in
GF and did not directly or indirectly induce the … acts constituting the violation.
iii. Pleading Req’ts to Get Passed Motion to Dismiss Under 21D – Private Securities Litigation
Statute
1. Tellabs, Inc. v. Makor Issues & Rights
a. (b)(2): Πs must state w/ particularity facts giving rise to a strong inference that
the ∆ acted w/ the req’d state of mind
b. The goal is to avoid frivolous law suits while preserving investors ability to
recover on meritorious claims
2. These cases are difficult to get past a motion to dismiss b/c it is hard to prove that scienter
existed or infer that it did.
d. Reliance
i. SEC doesn’t need to prove, but private πs must
ii. Reliance  Transaction Causation
1. If Omission  Rebuttable presumption of reliance
2. If Misstatement  Fraud-on-the-Market rebuttable presumption
iii. Afflilated Ute Citizens of Utah v. United States
1. Facts: ∆s failed to tell πs about another market which would give higher returns
2. Holding: There is no reliance in an omission case, b/c there is no statement to rely on
3. Rule: In a face to face transaction, once it is proven that the omission is material and a
duty to disclose, showing reliance isn’t req’d
a. FOTM creates a rebuttable presumption  you don’t need reliance in fraud of
omission (Basic and Haliburton 2)
b. To rebut  show that the π would have continued their course of conduct had he
known the omission
iv. Fraud-on-the-Market (FOTM):
1. Reliance is presumed, b/c there is a presumption that when you look at the stock price on
the market today it reflects all the info out there (including the misrepresentation).
2. Elements:
a. Public misrepresentation
b. The misrepresentation was material
c. Shares are traded on an efficient market
d. Π traded shares b/t the time of the misrepresentation and revealing the truth
3. If elements are met  π has created a rebuttable presumption of reliance
4. Haliburton: ∆ could then rebut this presumption by showing the alleged
misrepresentation didn’t actually affect stock’s price (no price impact)
a. ∆ has the burden to defeat the presumption by showing there is no impact on
price.
i. Burden: ∆ must severe the link b/t the misrepresentation and the market
price
1. 1st way  prove the market wasn’t deceived
a. The statement itself wasn’t material b/c the stock price
didn’t change
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2. 2nd way  show that the person who bought or sold was not
relying on the market
a. Liquidating
b. Divesting
5. Effect of Haliburton: Issuers, private companies, and ∆s can now introduce evidence that
the misrepresentation didn’t cause price impact.
6. Summarized: The π has the burden of alleging fraud on the market, but the presumption
is rebuttable and may be rebutted by severing the link b/t the misrepresentation and the
market price
Face-to-face Open Market
Omission w/ Duty to Disclose No reliance req’t (Affiliated Ute) No reliance req’t (Affiliated Ute)
Presumption of reliance  FOTM
Affirmative Misrepresentation Investor must show individual reliance creates a rebuttable presumption of
reliance (Basic)
e. Loss Causation
i. Whether the π’s loss is something the ∆ should be liable for or is it the risk of investing in the
market
ii. π has BoP to prove the act or omission of ∆ proximately caused economic loss
iii. §21D(b)(4)
1. “In any private action arising under the Exchange Act, the π shall have the burden of
proving that the act or omission of the ∆ alleged to violate the Act caused the loss for
which the π seeks to recover damages”
iv. Dura Pharmaceuticals, Inc. v. Broudo
1. Facts: Individuals bought stock in Dura Pharmaceuticals. Dura then made false
statements concerning its profits and FDA approval of a device. Dura later announced
that its earnings would be lower than expected. The stock then lost half its value. 8
months later, Dura announced that the FDA wouldn’t approve the device. The stock price
dropped but recovered w/i a week.
2. Issue: Can π satisfy the economic loss element by alleging the price of the security on the
date of purchase was inflated b/c of misrepresentation
3. Holding/Rule: No, inflated purchase price alone will not constitute or proximately cause
the relevant economic loss.
a. The misstatements must cause the loss
VIII. Rule 10b-5 ∆s
§21D(f) – Proportionate Liability
(2)(A) – Joint and several liability if “knowingly violated”
(2)(B) – Proportionate liability if not.
(3)(A) – Determination of Responsibility.
a. Secondary Liability
i. Typically reliance is difficult to prove
ii. There is NO aiding & abetting liability in 10b-5 PRIVATE ACTIONS
iii. For SEC enforcement, Aiding & Abetting must be done KNOWINGLY - §20(e)
1. Substantial Assistance & Participation in making the statement
iv. 3rd party’s relationship w/ fraudsters (Descending order of possible liability)
1. Control person w/ full knowledge
2. Full knowledge but veto power over only some deal aspect
3. Full knowledge but only K’l relationship
4. Full knowledge but no K’l relationship
5. No knowledge of the fraud or risk of fraud
6. Stoneridge Investment Partners, LLC v. Scientific-Atlanta Inc. (Reliance)
a. Facts: Charter participated in a multitude of fraudulent practices in order for its
quarterly reports to meet Wall Street expectations. Scientific-Atlanta agreed to
alter their customer arrangements in order to help Charter. Charter tricked its
auditor into authorizing inaccurate financial statements
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b. Claim: Investors claimed that by participating in the transactions Scientific
Atlanta violated 10b-5. That they reckless disregarded Charter’s intention to
utilize the transactions to exaggerate revenues and were aware of the resulting
financial statements
c. Holding: “Aiders and Abettors” of fraud cannot be held secondarily liable under
the private CoA under 10b.
d. Rationale: The πs didn’t rely on statements made by Scientific-Atlanta, and their
actions didn’t make disclosure necessary. Scientific-Atlanta didn’t owe a duty to
Charter’s investors
e. Rule: Such πs can only be liable if their OWN conduct satisfied each element of
10b
i. Π must prove reliance.
1. Π’s decision to purchase stock based on a material
misrepresentation or omission by a ∆
7. Janus Capitol Group, Inc. v. First Derivative Traders
a. For purposes of 10b-5, the maker of a statement is the person or entity w/
ultimate authority over the statement, including its content and whether and how
to communicate it.
i. w/o control, a person or entity can merely suggest what to say, not
“make” a statement in its own right
b. 4 Theories of Liability to Attorney’s by 10b-5 (Private CoA)
i. Aiding and Abetting
1. SEC must bring suit, not an individual (Central Bank)
ii. Scheme liability
1. Attorney help make the 10K (Stoneridge shows this is not likely)
iii. Attorney made the statement
1. Very difficult to show
iv. Indirectly made statement
1. The court is unlikely to expand
b. Control Person Liability
i. Individual subject to liability as a “control person” under §20(a)
1. Every person who, directly/indirectly, controls any person who is liable shall also be
liable jointly & severally to the same extent as the controlled person
a. X: Unless the controlling person acted in GF and did not induce the act that
constituted the violation
ii. Analysis:
1. First, must prove there was a 10b-5 violator 
2. Look to 20(a) to determine control of the violator to bring in more ∆s
iii. “Control” (12b-2)
1. 2 Tests:
a. Potential Control Test (Majority View)
i. See Listgraaf v. Behrens
b. Culpable Participation Test (2nd, 3rd, 4th Circ.)
i. Π must show:
1. Control of the primary violator by the ∆
2. Alleged controlling person was a culpable participant in the
specific fraud perpetuated by the primary violator
iv. Lustgraaf v. Behrens
1. Potential Control Test: At pleading stage, π must prove:
a. That a primary violator violated the federal securities law
i. Involves fraud and scienter 10b-5 factors
ii. Harder to prove b/c of the heightened standard
b. The alleged control person actually exercised control over the general operations
of the primary violator
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i. Alleging control, not fraud
c. The alleged control person possessed – but didn’t necessarily exercise – the
power to determine the specific acts or omissions which the underlying violation
is predicated
i. Alleging control
2. Once proven, the burden shifts to the ∆s to show that they acted in GF (Defense to the
claim)
IX. Damages (28(a))
a. Under 10b-5, punitive damages are not given. πs are limited to actual damages; will not receive more than
owed
b. 2 situations:
i. Open-Market:
1. Out-of-pocket: Difference b/t the price paid and the value of the security at the time of
the purchase
a. Money paid (-) True value
b. Issue: Showing true value but-for the misrepresentation  use experts to
describe event studies
c. 21D(e) Limit on Open Market Damages
i. Award of damages to π shall not exceed the difference b/t the
purchase/sale price paid or received by the π for the security and the
mean trading price of that security during the 90-day period beginning on
the date on which the info correcting the misstatement or omission
d. Purpose of Compensation
i. Deter management from committing fraud
ii. Deter investors from expending resources to discover fraud
ii. Face-to-Face Damages (Broker Dealings)
1. Courts aren’t limited to out-of-pocket measure of damages
2. Rescissionary:
a. Broker defrauded the investor;
b. Investor gets their money or security back;
c. Puts π back in the position they would have been had the fraud not taken place
(Fraud in the Inducement)
3. Restitution:
a. The ∆ gives the π whatever profit she made from the securities transaction
iii. Garnatz v. Stifel, Nicolaus & Co., Inc.
1. π was defrauded by the company who induced him to purchase bonds
2. Broker wanted out-of-pocket damages. The result would be zero damages, b/c the bonds
were worth what the ∆ said they were.
3. Transaction was Face-to-Face and applied rescissionary damages. The π is returned to the
position he would have been in had he not been induced to purchase the fraudulent
securities
c. Proportionate Liability
i. 21D(f) Proportionate Liability – 3rd Party ∆s
1. Joint and several liability if the violation is done knowingly
2. Otherwise, no joint and several liability. Proportionate liability will be determined by a
jury once liability and amount of damages is determined (If reckless – proportionate
share)
a. Victory for accountants
3. If there is an uncollectable share, each ∆ shall be jointly and severally liable for the
uncollectible share if the π can establish:
a. π’s damages are more than 10% of their net worth, and
b. π’s net worth is equal to or less than $200,000
4. Jury will have no knowledge as to whether a certain party is unable to pay when they
assess damages and proportionate liability
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INSIDER TRADING
I. Insider trading under 10b-5 – There is no insider trading statute
II. Includes Insiders and Outsiders
III. Economics of Insider Trading
a. 2 Theories:
i. Classical – Buying or selling based on nonpublic info by someone w/ a fiduciary
ii. Misappropriation Theory – (O’Hagan) Think about attorneys – Extends insider-trading liability to
outsider who do not have a fiduciary duty, but the courts have crafted liability based on agency
concepts.
1. Possessing info & trading  violates 10b by not being loyal to their principal
IV. Insider Trading at Common Law
a. Strong v. Repide
i. Facts: ∆ owned the majority of stock. Company was in land sale negotiations but the ∆ was
holding out for a higher price. ∆, acting as an undisclosed principal, hired an agent to acquire the
remaining stock from the π. There is an offer for the land, and the agent purchases the stock from
the π for 10x less than its worth.
ii. Issue: Whether there was a duty to report info about offer and value of the stock
iii. Holding: Yes, was a legal obligation to make disclosure. ∆ had overwhelming influence over the
company. If the land were to be sold it would be his decision.
iv. Rationale: Was active concealment. ∆ knew that had the π known about the ∆ purchasing the
stock, then the π would have known the stock price was going up
v. Rule: “Special Facts” Doctrine
1. Active concealment of the ∆’s identity, depriving the π-SH of a basis for inquiring about
the transaction.
a. Only happens in face-to-face transactions
V. Classical Theory of Insider Trading
a. If an officer/director violates 10b-5 by trading in their own companies securities using material nonpublic
info.
i. Is special relationship of trust b/t the insider and SH
ii. Scope of insider trading is limited to the existence of a fiduciary relationship
iii. Duty to extends to existing and prospective SHs
iv. Insider trading has no statutory rule. It fits under 10b-5 and applied in cases
b. Unresolved Issues:
i. Non-Insiders who receive info from insiders (tippers and tipees)
VI. Core Insiders
a. Chiarella v. United States
i. Facts: The ∆ worked for a financial printing co. He handled announcements of corporate takeover
bids. The identity of the bids was concealed and the true names were sent to the printer on the
night of final printing. ∆ was able to identify the name of the target company before printing, and
w/o disclosing this knowledge, purchased stock in the target company. ∆ sold the shares
immediately after the takeover was public, and made $30,000. He was indicted for violating 10(b)
and 10b-5, and he was convicted
ii. court reversed the ∆s judgment
iii. Rule: CL (Classical), one who fails to disclose material info prior to consummation of a
transaction commits fraud only if he is under a duty to do so
1. Duty arises when 1 party has info that the other party is entitled to know b/c of a
fiduciary or other similar relation of trust & confidence b/t them
iv. 10(b) duty to disclose does not arise from mere possession of nonpublic info
v. Rationale: Silence in connection w/ the purchase or sale of securities may operate as a fraud, but
such liability is premised upon a duty to disclose arising from a relationship of trust and
confidence b/t parties to a transaction
b. § 20(d) Liability for Trading in Securities While in Possession of Material Nonpublic Info
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i. Wherever communicating, purchasing, or selling a security while in possession of material
nonpublic info, such conduct in connection w/ the purchase or sale of a put, call, straddle, option,
privilege or security-based swap agreement shall violate and result in comparable liability
VII. Tipper/Tippee Liability
a. Dirks v. SEC
i. Facts: Former officer of EFA gave Dirks, a broker, and info about fraud in EFA. The officer tried
to disclose to others but nobody believed him. Dirks investigated and disclosed the info to his
clients. The clients begin dumping the stock before the fraud is revealed to the public. The stock
price began to drop and the SEC brought an action against Dirks for disclosing info to his clients
ii. Issue: Whether Dirks violated 10b-5
iii. Holding: No, Tippee liability derives form insider breach of duty, but insider has only breached a
duty where the insider gets a personal benefit
1. Financial
2. Reputational
3. Gift-giving
iv. Rationale: The duty to not trade arises only if there is a fiduciary duty. Dirks didn’t have the duty
b/c he was just a broker
v. Rule: The Tippee has the duty to not trade on material info if:
1. Insider/Tipper has breached a fiduciary duty to the SHs by giving info to the Tippee; and
2. Tippee knew or should have known there was a breach (Newman)
a. Breach: The Insider/Tipper breaches their duty if a personal benefit is received
from delivering info to Tippee.
vi. Newman Addressing the Elements
1. Tippee is only liable if the person whom they received info from is liable
2. Gov’t must prove beyond a reasonable doubt that the insider received an actual benefit
3. A Tippee must know that the Tipper received a benefit
a. Look at why the Tipper gave the Tippee info
b. What if they are friends?
i. Being a friend/socializing isn’t enough to breach
vii. Policy: If the rules on insider trading were too restrictive trading securities would be difficult.
Every trade would req a showing that the trade wasn’t based on material non-public info, and it
would reduce the effectiveness of market analysts
b. Affirmative Defenses 10b5-2(c)
i. A person’s purchase or sale is not “on the basis of” material nonpublic info if the person making
the purchase or sale demonstrate that:
1. Before becoming aware of the info, the person had:
a. Entered into a binding K to purchase or sell the security
b. Instructed another person to purchase or sell the security for the instructing
person’s account, or
c. Adopted a written plan for trading securities
VIII. Misappropriation Theory (Think Lawyers)
a. Applies to outsiders
b. The theory is based on agency by misappropriating info
c. United States v. O’Hagen
i. Facts: O’Hagen was a partner is a law firm. His firm was hired to represent a company in a tinder
offer. Before the info about the tender offer went public, O’Hagen began purchasing the acquired
companies stock. When the tinder offer went public O’Hagen sold his share and profited $4.3
million.
ii. Holding: Criminal Liability under 10(b) may be predicated on the Misappropriation Theory. The
misappropriation meets the statutory req’t of “deceptive” conduct “in connection w/” securities
transaction
iii. Rule:
1. “Classical Theory”:
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a. Insider trading liability when a corp. insider trades in securities of his corporation
on the basis of material, nonpublic info
b. This info qualifies as a “deceptive device” under 10(b) b/c a relationship of trust
& confidence exists b/t the SHs of a corporation and those insiders who have
confidential info by reason of their position w/ that corporation. That relationship
gives rise to a duty to disclose or to abstain from trading b/c of the necessity of
preventing a corporate insider from taking unfair advantage of uniformed
stockholder.
c. applies not only to officer, directors & other permanent insiders, but also to
attorneys, accountants, consultants & others who temporarily become fiduciaries
of a corporation
2. “Misappropriation Theory”:
a. person commits fraud when he misappropriates confidential info for securities
trading purposes, in breach of a duty owed to the source of the info. A fiduciary’s
undisclosed, self-serving use of a principal’s info to purchase or sell securities, in
breach of a duty of loyalty and confidentiality, defrauds the principal of the
exclusive use of that info
3. Duties of Trust or Confidence in Misappropriation Insider Trading Cases 10b5-2(b)
a. Recipient of info owes a duty to the source:
i. Whenever a person agrees to maintain info in confidence
ii. Whenever the person communicating the material nonpublic info and the
person to whom it is communicated have a history, pattern or practice of
sharing confidences
iii. Whenever a person receives or obtains material nonpublic info from his
or her spouse, parent, child, or sibling. Unless, the recipient can show no
reasonable expectation of confidentiality
4. Disclose of Abstain from Trading Requirement 14e-3(a)
a. Shall not trade on the basis of material info concerning a pending tender offer
that he knows or has reason to know has been acquired from an insider of the
offeror or issuer, or someone working on their behalf. This is a disclosure
provision that doesn’t req a preexisting fiduciary duty.
d. SEC v. Rocklage
i. Facts: CEO of Biotechnology Company tells wife that one of the company’s drugs failed the
testing, and she tells her brother about it. Brother trades on the info and she knew he would. It
was her deception to her husband that allowed her to receive material, non-public info.
ii. Issue: Whether the wife engaged in conduct under 10b-5
iii. Holding: Yes, wife employed a manipulative/deceptive device when she gave info to her brother.
There was a scheme to deceive her husband to acquire confidential info
iv. Rule: 10b5-2(b) Enumerated “duties of trust or confidence”
1. There is a fiduciary duty b/t family members
v. Rationale: She had two schemes of deception as to her husband:
1. She deceived her husband into giving her continuous info
2. She actually tipped her brother
e. In misappropriation case, look at duty owed to the person recipient received the info from
f. SEC v. Cuban
i. Issue: Whether there is a duty of trust or confidence.
1. Exist by virtue of family relationship
2. Exist by one keeping confidence.
ii. Facts: CEO tells Cuban he is giving him info if Cuban keeps it confidential. Cuban is told about a
Private Investment of Public Entity (PIPE) offering. He now believes that he’s unable to sell his
shares and thinks the shares will be diluted. He then requests more info about the offering. Then,
he tells his broker to sell all of his stock in the company to save from a loss
iii. The point of the case is to show that there is a separate way to get to the breach of the duty of
confidence
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g. SEC v. Opus
i. Elements for Tipper liability:
1. Actual tip
2. Of material info
3. In breach of a duty of confidentiality owed to SHs (classical theory) or in breach of a
duty owed to the source of the info (misappropriation theory)
4. For the personal benefit of the Tipper (Newman to determine benefit)
ii. Req’s Scienter:
1. Tipper: The tip must be made recklessly or deliberately, and the info is material and non-
public.
iii. Tipee liability:
1. Must know there was a breach of the fiduciary duty to SHs when receive the info
IX. Section 16
a. Directors, certain execs, & individuals that own 10% of the company, are req’d to report:
i. Form 3 – Ownership when purchasing shares
ii. Form 4 – Changing ownership
iii. Form 5 – Annual statement
b. Short-Swing Profits
i. Realizing profits by purchasing company stock and then selling it w/i 6 months
ii. All profit realized w/i the 6 months of purchase must be disgorged.
iii. Is a ban on short-swing profits to prevent individuals from betting against their own company
EXEMPT OFFERINGS
I. §4(2) Offerings
a. Offerings exempt from §5 – Prohibitions Relating to Interstate Commerce and the Mails (Requires
Registration Statement)
b. Factors for a “Public Offering”: (SEC 1935 Opinion)
i. # of offerees
ii. relationship of the offerees to each other and to the issuer
iii. # of units offered
iv. size of the offering
v. manner of the offering
c. Ex:
i. Selling $100M of shares to 1M random investors  Public Offering  Subject to §5
ii. Raising $2M thru officers of company via internal communication  5 people, related, attempt to
raise money internally  fits §4(a)(2)  Exempt from §5
§4(2)
- §5 does not apply to transactions by an issuer not involving any public offering
(Is an exempt transaction)
Issuer defined in §2(a)(4): “every person who issues or proposes to issue a security.”
Definition of “Public Offering” is unclear
d. SEC v. Ralston Purina Co.
i. Facts: Ralston Purina distributes $2MM of treasury stock to 500 “key EEs”. (Of the 7,000 EEs
who took initiative to ask about the stock). All of the “key EEs” have various types of jobs
1. Issue: Whether the sale of securities qualifies as an X under 4(2). (A Public Offering?)
2. Rules:
a. An offering to all EEs is a public offering
b. Offering to select EEs:
i. If offerees can fend for themselves, they don’t need protection of §5
1. Determined by knowledge of the offeree – Execs w/ access to the
kind of info that registration would disclose, but other EEs do
no.
2. Execs can fend for themselves b/c they have info & wouldn’t
need a registration statement
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c. BoP is on the party claiming the exemption
3. Holding: EEs weren’t able to fend for themselves; therefore, the exemption doesn’t apply
e. Doran v. Petroleum Management Corp.
i. Facts: A sophisticated investor purchased a limited partnership interest in an oil-drilling venture.
A broker advised the investor of the opportunity, and he received drilling logs and technical maps
of the proposed drill site. The investor agreed to contribute $125K, and he wishes to rescind his
investment after he expected less of a return. There was no registration statement filed.
ii. Issue: Whether the sale was part of a private offering exempted by §4(2) from the registration
req’ts
iii. Holding: Remanded to determine that offerees had available info a registration statement would
have afforded a prospective investor in a public offering
iv. Rule:
1. Each offeree must have been furnished w/ info about the issuer that a registration
statement would have disclosed (or had effective access)
2. Evidence of a high degree of business or legal sophistication is not dispositive –offeree
muse have info requisite of a registration statement
a. Sophistication is not a substitute for access. The investor must have data to use
skills.
b. Effective Access – Doesn’t req info to be furnished directly, but in a position
relative to the issuer to obtain registration info
i. Factors to consider:
1. Position of offeree
2. Bargaining power
3. Ability to question
a. Promise to open files and records to offeree, and answer
questions
ii. ∆ MUST show that the offeree can realistically be expected to take
advantage of access to ascertain relevant info
1. Relationship to the issuer + sophistication
f. Analysis:
i. 4(a)(2)  Factors from SEC 1935 Opinion
1. # of offerees
2. relationship of the offerees to each other and to the issuer
3. # of units offered
4. size of the offering
5. manner of the offering
ii. Look to whether the investor can fend for themselves (Ralston Purina)
1. Sophisticated? AND
2. Investment Info?
a. Access to info? OR
b. Was info disclosed to them
iii. If not exempt under 4(a)(2), SEC 1935 Opinion Factors, and Ralston Purina  Look to whether
Reg. D applies
II. Regulation D – Bright Line Rules - Objective
a. Safe Harbor
i. 504, 504, 506
b. Transactions exempted from the registration req’ts of §5 of the ’33 Act.
c. Regulation D: Rules 501-508
i. 501 – Definitions and Terms
1. Accredited Investor 501(a)(1)-(6)
ii. 502 – General Conditions to be Met
1. Integration
2. Info
3. Limitations on the manner of offering
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a. No general solicitation in connection w/ any offering
i. Cannot advertise
ii. Post advertisements
4. Resale restrictions
a. Cannot be resold w/o registration or an exemption
iii. 503 – Filing of Notice of Sales
1. File 4 copies of Form D w/ the SEC w/i 15 days of first sale
iv. 504 – Exemption for Limited Offers and Sales of Securities Not Exceeding $1M
1. Cap is at $1M
2. No limit of investors
a. Limited by ‘general solicitation’
v. 505 – Exemption for Limited Offers and Sales of Securities Not Exceeding $5M
1. Cap is $5M
2. Sell to 35 or fewer
vi. 506 – Exemption for Limited Offers and Sales W/o Regard to Dollar Amount of Offering –
Unlimited
1. Cap is unlimited
2. Sell to 35 or fewer and/or unlimited # of accredited investors
a. Accredited Investor 501(a)(1)-(6)
vii. 507 – Disqualifying Provision Relating to Exemptions Under 504, 505, & 506
viii. 508 – Insignificant Deviations from a Term, Condition or Req’t of Reg. D
ix. Regulation D Preliminary Notes:
1. Exemption from §5, NOT antifraud. Issuers are obligated to provide material info to
make furnished info not misleading
2. Can claim §4(2) even if not any of the above
3. Available only to the issuer
d. Determining if Regulation D applies:
i. How much money is being raised?
ii. Who are the buyers of the securities?
III. Aggregate Offering Price
a. 504 - $1M
b. 505 - $5M
c. 506 – Unlimited
i. Issues arise when a company wants to raise $5M in Jan. & another $5M in Feb.  504/505 looks
at sales 6 months before & 6 months after. See Integration
IV. Number of Purchasers
a. Definition Rules:
i. 501(e)(1)(iv) – Don’t count accredited investors
ii. 501(a)(1)-(6) – Defines accredited investor
1. Banks
2. Charities
3. Directors & officers, and general partners of the issuer
4. Individual net worth, or joint net worth w/ spouse > $1M
5. Individual income > $200K, or joint income w/ spouse > than $300K
6. Any trust w/ assets > $5M
7. Any entity in which all owners are accredited investors
8. Dodd Frank Act –net worth doesn’t include value of primary residence
a. The purpose is to provide more protection for investors
b. Adding a residence to net worth would classify a significant # of people as
“accredited investors”
b. Number of Purchasers:
i. 504 – Unlimited # of people
1. Limited by the idea of general solicitation
ii. 505 – Must sell to 35 or fewer people
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iii. 506 – May sell to 35 or fewer people w/ purchaser sophistication and an unlimited # of accredited
investors
1. Can raise an unlimited amount of money by selling to an unlimited # of people so long as
they are accredited investors
c. Purchaser Sophistication
i. 506 (b)(2)(ii):
1. Those who aren’t accredited (35) must have purchaser sophistication.
a. Knowledge and experience to understand the risks associated w/ an investment
(Subjective)
i. Avoid if possible and go w/ all accredited investors b/c this test is
subjective and difficult to determine
2. If there is a reasonable belief that an investor is accredited then the exemption is satisfied,
even if the investor happens to be unaccredited. Have investors fill out questionnaire to
determine net worth.
d. General Solicitation
i. 502(c) Bans general solicitation from 505, 506
1. Under 504 – If the issuer sells exclusively in a state that provides for state registration,
req’s public filing and delivery prior to sale, then the issuer is exempt from solicitation
req’t
a. Provides an indirect limit on # of people issuer is able to solicit
2. JOBS Act – X to general solicitation
a. If offering under 506 and selling to all accredited investors, then general
solicitation is permitted
b. Standard for determining whether investors are accredited under this X is higher.
Must take reasonable steps to verify.
i. Collecting bank statements, contact accountant, etc. Self verification
doesn’t satisfy verification
ii. In the Matter of Kenman Corp.
1. Facts: There was a sale of unregistered securities (meaning registration statement hasn’t
been filed). There were 2 offering the ∆ claimed were exempt from registration under
§4(2) & 506. A private placement agent sent mailing to:
a. A list of people that participated in prior offerings
b. Name of 50 officers from Fortune 500 companies
c. List of people who previously invested $10K in real estate offerings by other
issuers
d. List of physicians in California
e. List of managerial engineers
f. Selected names of company presidents from the County Industrial Directory
2. Rule:
a. FN6 – Solicitation req’s pre-existing relationship, otherwise the solicitation
violates 502(c)
i. By violating 502(c) the offering falls out of 505/506 registration
exemption
3. ∆ could still prove offering qualifies as a 4(a)(2) X – Not involving a public offering
e. Disclosure
i. 502(b) – The info that must be given to investors in a Regulation D investment
1. 502(b)(2) – Offer under 504 doesn’t req issuer to give any info.
a. Issuers typically give info to avoid fraud
2. 502(b)(1) – Issuer isn’t req’d to give info to accredited investors
a. Issuers typically give info to avoid fraud
f. Resale Restriction 502(d)
i. 502(d) – Regulation D securities are restricted securities and cannot be resold w/o registration or
exemption
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1. Issuers must make a reasonable effort to discourage investors from reselling the securities
w/o registration or exemption
a. However, §4(1) will exempt the entire transaction if it doesn’t involve an issuer,
underwriter or dealer.
g. Rule 504
i. Allows issuers to avoid the general solicitation (502(c)), disclosure (502(b)) and resale restriction
(502(d)) req’ts
ii. Mini-Public Offering
1. Good for small, less well-followed issuers. $1M cap keeps it down
2. If investors are sophisticated, they will demand all the disclosure anyway
3. To avoid general solicitation and resale restrictions – must comply w/ state law
registration req’ts.
h. Integration
i. 2 Tests to Determine whether Integration is Necessary:
1. (1) Safe Harbor in 502(a)
a. If no offering 6 months prior to start date, and 6 months after end date  any
offering outside that window falls under safe harbor
b. If issuer sells securities during those two six-month periods, then loses safe
harbor entirely
c. Losing the safe harbor doesn’t mean integration is req’d  Must consider factors
2. (2) Factors to Consider
a. Are sales part of a single plan of financing
b. Do sales involve issuance of same class of securities
c. Have sales been made at or about the same time
d. Is same type of consideration received
e. Are sales made for same general purpose
i. Innocent and Insignificant Mistakes
i. 508 – Forgives some mistakes from failure to comply w/ 504, 505, 506 exemptions if the issuer
acts in GF
1. Only shields issuer from private actions for violating §5, but doesn’t shield issuer from
SEC enforcement actions
2. Will ot excuse situations where failure to comply pertains to a term, condition, or req’t
directly intended to protect the particular (suing) individual
3. The protection will be unavailable, unless the issuer’s failure to comply was
insignificant wrt the offering as a whole
a. Things that are significant:
i. General solicitation
ii. Aggregate offering price limitation
iii. Purchaser limitation
j. Form D
i. 503 req’s filing w/i 15 days after the first sale of securities in the offering
ii. Contains basic identification data, info of the offering, the offering price, # of investors, expenses,
use of proceeds
iii. Failure to file means the issuer loses its exemptions
k. Disqualification
i. 505(b)(2)(iii) – “Bad Boy Provisions”
1. Most people don’t do 505 offerings, b/c they don’t want to be subject to disqualification
l. Crowd Funding (Kickstarter.com)
i. § 4(a)(6) – Registration Exemption
1. Can’t raise more than $1MM
2. Limitation on how much each person can invest
3. Must work through a “portal” which is register w/ the SEC
m. Regulation A – Exemption
i. Can raise up to $5MM
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ii. Securities are freely tradable
iii. Very few people use this b/c issuers have to deal the state security administrators  A long of
work for little money
n. § 3(b)(2) - Exemption
i. Can raise $50MM
ii. Requires audited financial statements
iii. Must file annual financial statements
1. Few choose b/c its expensive and many restrictions
o. Interstate Offering Exemptions
i. The SEC and Federal gov’t has no authority over activities contained w/i a state
ii. § 3(a)(11) - Security of an issuer that was formed in a state, does business in the state and is sold
only to customers in the state is exempt from SEC req’ts
1. No federal jurisdiction
2. All the shares you sell have to come to rest in one state
3. Company must be incorporated and have its operations in that state
a. Difficult b/c so many are incorporated in Delaware but not operated in Delaware
4. Proceeds of that offering must be used in that state
iii. Rule 147 Safe Harbor (Companion Rule)
1. If securities aren’t satisfied under 147  can still qualify under 3(a)(11) see p. 71-75 of
supplement
iv. There are few of these offerings in the real world b/c the amount of effort needed to satisfy the
exemption req’ts
32

Securities Regulations Law Outline

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DISCLOSURE & ACCURACY

c. What Must be Disclosed – Disclosure req’ts:

4. In the Matter of Hewlett-Packard Co.

RULE 10B-5 ANTIFRAUD

i. In Re Cendant Corp. Litigation

§20(a) – J&S liability for CP, and A&A violations

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