INTRODUCTION

A. A glossary of terms and Introduction:
1. Broker/ Dealers - There are essentially two markets in this country: a. The NYSE is an auction market . It is a broker market, in which the large companies act as brokers. b. The NASDAQ on the other hand is a dealer market . In these markets, those companies function as dealers. Registration of Securities vs. Registration of Transactions: You register an offering, not a security, and not a company. Issuer: is the company or enterprise that issues securities. They sell securities to the public. They can be any sort of entity, and need not be a corporation. Underwriter: are the middlemen in the securities business. They buy from the issuer and sell to the common person. Initial Public Offering (IPO): [an IPO can only be done once. It is the first time that an issuer offers securities to the public] Public Offering: [any time that the issuer offers securities after the IPO, it is a public offering.] Primary Offering: [likewise, every offering that occurs after the IPO is a primary offering] Secondary Offering: [Secondary distributions are done by someone other than the issuer, (generally, statutory underwriters and affiliates under §2(a)(11)), but whom still must be concerned with §5 – they must register, or seek exemption under 144, 4(1½), or Reg A. Such distributions should also be distinguished from secondary trading – which occurs only after these securities have come to rest in the public.] It is an offering only by insiders, but not by the company. When Bill Gates sells MSFT stock, it is a secondary offering. Microsoft the company can’t ever do a secondary offering. Secondary Trading: has nothing to do with the secondary offering. Secondary trading is merely the trading of securities in the open market by the average person (the securities have already come to rest in the public. Unlike most of the offerings above, it is generally exempted from regulation.

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10. Municipal Bonds: a.

General Obligation bonds : issued by a state, municipality or federal gov back by full faith and credit (taxing power) – they are treated as cash by businesses because the entire government is behind them – if the government can’t pay them off you have bigger problems then the debt. Revenue bonds : are not backed by full faith and credit, they are backed merely by the project the bonds finance. This permits the government to do many things at attractive interest rates without bankrupting the government if the project should happen to fail.

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B. A Brief History: Capital (money) was never raised from the public through most of history until the war bonds of the civil war. Prior, you would borrow money for ventures from large merchant banks. Back in the day, securities buyers had to beware – they were limited to common law redress, whereby there was almost no remedy. Some states began to enact laws to protect investors, but they were not effective. The 20’s were a time of great prosperity, but also great fraud. The big crash resulted, and federal regulation of securities followed.

C. The Big Four Securities Laws
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The Securities Act of 1933 [is a consumer protection statute that rose from the ashes of the ’29 crash – the main purpose of the act is to mandate disclosure (through registration, or alternatively, through carefully carved exemptions therefrom) to investors so that they will be able to make smart informed decisions. In addition, the act mandates certain disclosures be made to the SEC] : The basic idea after the crash was that investor’s had lost confidence in the market because of the 20’s. 1) The ’33 Act is a Consumer Protection Act. It deals with the selling and issuance of securities. 2) The Primary purpose of the ’33 act is disclosure. The theory is that if you sell securities with full disclosure, then investors will be able to make smart, informed decisions. 3) A secondary purpose is that disclosure is forced to the SEC. The Securities Exchange Act of 1934 : [Unlike the consumer protecting ’33 act, the ’34 act is a regulatory statute. In addition to creating the SEC, the ’34 Act also regulates multiple facets of the securities industry: exchanges, broker dealers, public companies, insiders, tender offers. Likewise, it provides for various anti-fraud provisions]. It was far different from the ’33 act. It is regulatory statute with a different philosophy – it actually tells brokers and dealers how to run their businesses, how people should conduct their affairs. 1) The ’34 Act created the SEC, the single most important element in the restoration of investor confidence. 2) The act regulated how the markets were run. They also regulate the broker/dealers that function in that market. The Investment Company Act of 1940 [intended to target pre-crash abuses of investment pools, the ’40 act regulates investment companies. This regulatory statute mandates registration and carves exemptions therefrom, and dictates organizational and operational rules and regulations.]: regulates mutual funds (pool investing) which had been one of the larger abuses during the 20’s. The Investment Advisors Act of 1940 [Subject to exceptions, it regulates anyone who, for value, gives investment advice as to the purchase and sale of securities. The Act is a regulatory statute, most notably prohibiting contingent fees based on performance.]

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D. A note on Blue Sky Laws: Blue Sky Laws vary tremendously from state to state. Unlike SEC review, some states have merit reviews of your offering, above and beyond merely requiring disclosure: they have a fair, just and equitable standard whereby they decide whether to approve an offering based on the company, who is involved, etc. They also may care if an insider paid too little for stock, dilution issues, or loans to officers.

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1. The real difficulty arises when you try go effective with both the SEC and the Blue Sky Jurisdiction at the same time (which you obviously need to). 2. In 1996, Congress passed the National Securities Market Improvement Act: preempting from state review a variety of covered securities, which includes those traded on the NASDAQ, NYSE, and AMEX.

DEFINING SECURITY
E. Intro : The ’33 and ’34 act all rely substantially on securities, but barely define it. 1. If the thing in question is not a security, then right off the bat the federal securities regulations have nothing to do with it, and cannot regulate it. 2. Likewise, plaintiffs can’t get the protections of the securities act and the remedies available therein unless the thing is first a “security”. 3. Back in the day, people pooled money for ventures. They got people to buy stock in the actual thing that was the venture (i.e. ship) and then they got a share of the profit later. 4.

Debt vs. Equity:
1) Debt: comes in three main forms, but the only real difference is the term of maturity – notes (shorter term of 3 years of less), debenture (medium term of 3-10 years), and bond (long term of 10-30 years). They may or may not be secured. Some debt is a security, some is not. 1) Debenture : is merely the instrument that gives debt it’s term. 2) Equity: A share of ownership is equity. 1) There is both preferred and common stock. They can also be convertible as between the two (or into debt). 2) A certificate of designation is a debenture for preferred stock – it gives it its term.

F.

Interpreting the ’33 Act’s Definition: The first place to start any analysis is the definition in §2(a)(1): “The term security means any note, stock, treasury stock, bond, debenture, evidence of indebtedness … investment contract ….” 1. “Investment contract” has become something of a catchall. Initially, the Howey Test was to determine what an investment contract is. But later cases like Forman applied the test to stock or any security being tested, reasoning that if it didn’t meet an investment contract analysis, it wouldn’t be a stock or whatever either. Any instrument, no matter what it is called, is a security if it meets the Howey Test. If it does not meet that test, it still may be a security, but you have to justify it in some other manner .

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Note that simply because something is called a certain type of enumerated security from the definitions in §2(a)(1), it isn’t automatically a security – in Reves the court notes that “the phrase ‘any note’ should not interpreted literally to mean any note, but must be understood against the backdrop of what Congress was attempting to accomplish in enacting the Securities Acts.

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4. They didn’t want the hastle or the consumer protection availed to the investors. (2) in a common enterprise (3) [predominantly] from the efforts of others. as an incidental but necessary facet of a transaction etc. Tweaking the Howey definition: a. b. any contract. simply put. in enacting the securities laws. W. The Howey company wanted to sell securities in their orange grove but they didn’t want to register them. 1) Co-Op city was a low income housing development where you had to buy shares in the development company to get an apartment. plays into the Howey test.a. acknowledging that the reality of what is an investment in form may not be in substance [Forman] Investors may be merely purchasing goods or services for consumption. 3. It is irrelevant that the shares in the enterprise are evidenced by formal certificates or by nominal interests in the assets employed by the enterprise.The Economic Reality / Investment Consumption Test : [Aka the investment consumption test or common sense test. It’s not a security because: 4 . the court in Marine Bank noted that “Congress.” So we can’t catch too much in the net. it satisfies the test – it need not be mandatory). The SEC claimed it was an investment contract: investors were giving money in exchange for a pro-rata share of the grove. So they divided up the land and entered into management agreements with investors saying Howey would manage their plots and sell the oranges and then they get a share of profits. if you’re offered the management agreement in Howey.] United Housing v. Similarly. SEC v. They were taking something of value in exchange for an expectation of a profit.. Expectations of Profit . Note that any of these things can be met simply by offering them (for instance. f. did not intend to provide a broad federal remedy for all fraud. The basic idea is that you give money to someone with an expectation of a return on that money based mainly from the efforts of another person or persons. but the court said simply calling something stock doesn’t make it a security. a. c. e. transaction or scheme whereby a person (1) invests money or something else of value with an expectation of profit.] The investor cannot be merely purchasing a commodity or some consumable service. The SEC brought the case even though nothing bad happened (other than not registering). but surely not for investment. 2) The ’33 Act does say any stock. d.J. Forman: reject nomenclature in favor of economic reality – substance governs over form. “Investment contract” involves a “flexible rather than a static principle”. is that a security is any contract. [but argue economic reality was possibly overruled in Landreth. Howey: The Howey test.

then it’s still a security.SEC vs. could not be pledged or encumbered. and it is the employer who makes the contributions to the investment. The purchase of the “stock” was just a requirement to get the house. They just waited for people to die. had no voting rights. Was it? a) It was clearly a scheme b) People were investing money c) The were pooling money. not on the stock in question. So we can take a look at a situation and see what is really going on. [SEC v. [Koch v. Koscot Interplanetary] 4) A note on LLC’s and Partnership Interests : Whether an interest in one of them is a security depends largely on the efforts of others test. The SEC claimed this was a security.a) The Economic Reality or common sense of the situation was that they weren’t investing. Life Partners: 1) Terminally ill patients who had life insurance would sell it to people who would then become the beneficiary. After the investment was made. a) General partnerships are not securities. They were not really iven the rights that usually come with stock. since every partner has a right to manage. c. if you set it up so that some general partners are really passive investors and they can’t possibly manage without letting others do the work (perhaps because of geography etc. not the employee. The profits you get are also not dependent on the efforts of others. they were just buying an apartment. d) They expected profit 2) But the venture did not involve the efforts of others. not success. not as an investment. Life Partners did nothing to increase the value of the investment. noncontributory compulsory pension plan is not an investment contract.). This generally boils down to how much input each member has to defeat the efforts of others test. 3) Note that the “solely” on the efforts of others language has been read out to mean “predominantly based on the efforts of others ”. Efforts of Others . Receipt of the fund had to do with external requirements. appreciation on the “investment” would be on the apartment. any . 5 . Hawkins]. b. b. they were not transferable to a non-tenant. International Brotherhood of Teamsters: a. The tax deductions you get off the home aren’t enough to satisfy “profit”. (1) even if someone did invest in the venture for profit. b) It fails the Howey Test: The court applied Howey and found that there was no expectation of a return on investment as profit. so it was a common enterprise. because of the economic reality – the employee sells his labor to make a living. (1) Of course.

that they all lose or make money from the efforts of the manager / promotor. but looking at the investment as is (you can’t just say split it) – in other words. advertised etc. 1) A share of a week in a condo is not going to generally be a security. Foxhill: individual bought timeshare in Fox Hills Villa condos (which is a big golf course in Wisconsin that he bought a week in February at. (1) Here. The guy next to you is irrelevant. you can buy it and sell it on your own and you are independent – no horizontal commonality. if your timeshare isn’t in the general pool. Horizontal Commonality: Note that the Supreme Court has never spoken to the circuit split on commonality. b) Vertical: it is enough to show that the success of the promotor / owner / developer and the investor are tied. Citicorp: limited partnership agreement found to not be security. Commonality – The basic idea of commonality is that the investors are dependent on either each other or the promoter for a return on their investment. how can you ever have a security if there is just one investor? The solution is that you ask whether there would be horizontal commonality had there been a second investor. that they are in the same boat. you need to consider whether the investment being offered could accommodate other investors if they were around. which means he doesn’t really wanna play golf there). Wals vs. d) But See Steinhardt v.b) Limited partners in LLP’s are security interests. Howey easily had horizontal commonality since they all made money at the orange grove together (or lost together). since they have no management voice. (1) Strict view: vertical commonality doesn’t exist unless the success of the promoter is contingent upon the profit of the 6 . (2) The problem of the individual investor : if the nature of horizontal commonality requires a second investor. and that makes it more of a security. but these a tradeable from a pool of other timeshares.) c) But is it a common enterprise? 2) Vertical vs. since the agreement granted enough rights to the members such that they were no longer passive investors. a) Horizontal: at least two investors must be in the same boat  you make money together or no one makes money. This is the toughest standard for commonality. c. c) LLC memberships are security interests in the same way since there is no management interest. a) There is an investment whereby they expect profit b) The value depends on the efforts of others (it needs to be maintained.

investor – they need to make money or lose money together and in proportion to one another – One way to see it is that it needs to be the actual return on the their investments. Moreoever, the promoter cannot have no downside risk (or else it’s just broad). (2) Broad view: as long as the promoter gets some benefit out of the arrangement (other than the initial investment obviously), there s vertical commonality. This is the easiest standard for commonality. Typically, this is a situation where promotor gets some benefit when investor makes money, but doesn’t lose money with investor. For investor, it may be a return on their investment, but for the promoter it may simply be residual income. 5. Other cases: a. Virtual Stock Exchange Case where the court said that simply called something a game doesn’t mean they are not offering securities. b. Smith v. Gross: sale of earthworms where seller promised to repurchase the reproduced worms and to market them to farmers deemed security. c. Koscot: sale of participation in a pyramid scheme where the seller conducted meetings and buyer received a commission for each person brought into the scheme deemed a security. 6.

BUT Better Regulatory Scheme or Adequate Protection Elsewhere? [where consumers are otherwise protected (by, as here, Banking laws), registration would impose an onerous yet unnecessary burden on issuers. Likewise, that regulatory scheme may be more effectively tailored to regulate the security in question. See Matassarin, Teamsters]
Note Teamsters v. Daniel and Matassarin v. Lynch: the SEC laws may not apply to something (so you can pass Howey but still escape categorization as a security) where there is a better regulatory scheme out there. These cases dealt with whether pensions were securities, but the court concluded that ERISA, the federal law that regulated pensions was better suited to deal with pensions.

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Uniqueness [is a factor that plays into Howey analysis: where an “offering” has a uniqueness such that no other investor could take part in it, it may be improper to label it a security, lest the ’33 act overreach and serve as remedy for any and all fraud in any transaction. [Weaver] Similarly, requiring registration for such a unique offering may simply be inefficient – “the dissemination of information requirements of the acts are justified by economies of scale” that do not exist in unique transactions. ]
Note: Marine Bank vs. Weaver – CD’s in banks were being questioned as to their status as securities, but the S.C., reinforcing the regulatory scheme notion, said banking laws were better to control this. Also, the court said there was a unique business relationship between the parties, so no security is involved, basically the transaction had unique attributes such that no other investor can share in it or be party to it. Uniqueness works like this: the arrangement has different values to various investors, and is therefore not suitable to public trading. b. But the case did fumble in that they said it wasn’t a security because it didn’t involve a prospectus and weren’t publicly traded. This has nothing to do with the test for a security. a.

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Real Estate as a Security: The standard sale of real estate is not a sale of a security. Investment contracts may be present, particularly in the sale of condos where the unit will not be occupied by the purchasers.
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SEC Release 5347 : ANY the following will aid in a condo (purchased directly from a developer) being an investment contract: 1) emphasis on economic benefits derived from managerial efforts 2) offering of participation in a rental pool arrangement 3) unit must be offered for rental at any time in the year, use an exclusive rental agent, or otherwise restricted in occupancy or rental of the unit. Hocking v. Dubois: broker helped Hocking buy Hawaii condo, involving an optional rental pool that he took part in, and he let someone manage the property for him. The court analogized the entire situation to Howey except that Hocking purchased the condo from another owner on a secondary market, not the developer themselves. 1) It was purchased as an investment with an expectation of profit 2) The rental pool creates horizontal commonality, the participants pool their assets and make money together. We need not get into vertical then. 3) The big problem is the efforts of others test, and it depends on the facts as to how little control he had over the investment. The general partner limited partner dichotomy provides guidance. 4) Everything must be offered as one package – the elements of the test are NOT met if you can go out and get the rental pooling or management agreement separately.

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Notes as a Security: Notes are tricky and may require a separate test – “To hold that a note is not a security unless it meets a test designed for an entirely different variety of instrument would … be inconsistent with Congress’ intent to regulate the entire body of instruments sold as investments.” [Reves]
Unlike stock, which is by nature something Congress intended to regulate, notes can be for investment (which we wanna regulate) and commercial (which we don’t). So a distinction is made between commercial notes and investment notes. a.

A commercial note IS NOT a security . Commercial notes are generally short term (30-60 days), but just because a note is short term doesn’t make it commercial. Common commercial notes are bank financing, commercial asset financing, inventory financing – they are not for investment so it fails Howey and the investment / economic reality test. An investment note (debenture, bond etc) is a security .
To distinguish between the two, Howey is still the relevant inquiry, but we also rely on The Family Resemblance Test [Reves v. E&Y - the ’33 Act defines security to expressly include any note, but only investment notes demand protection of securities laws – commercial notes are not securities. The test therefore sets forth four prongs to determine whether commercial or investment (and therefore security or not). Reves v. Earnst and Young: Reves tells us whether the security in question is a commercial note or an investment note. If it’s an investment note, it’s a security. If it’s a commercial note, it’s not.

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Term of the note: A short term duration however, is not dispositive, but it is indicative. Commercial notes are generally short term in nature, and investment notes are longer term. (9 months will establish presumption of note ) - the presumption can be rebutted by looking to the other prongs of the family resemblance test and being classified as a commercial note). 1) Motivations of the (BOTH) parties: is the buyer interested in the profit from the note as an investment (security) or is it merely some commercial purpose like short term financing (not security), for the seller is it more a particular commercial or consumer purpose (not security), or is it being offered for general business purposes (security). 2) Plan of distribution also comes up here - to whom are you selling the notes. If it is to the general public, it is almost always an investment note. If there exists common trading for speculation or investment it’s more likely for security. If it is more to people in the business of financing short term assets, it’s more likely a commercial note. 3) The Commercial Expectations of the Public: what would other people consider it? If it is advertised as investment, it may be a security. 4) Existence of some better regulatory scheme to provide protection: this is generally less important than the others d. The court said notes in commercial lending, those secured by a mortgage on a house, assignment of accounts receivable are not securities. 10. Sales of 100% ownership: It used to be, under the sale of business doctrine [had previously acknowledged the economic reality that incidental transfers of securities in a sale of 100% of a business were not securities offerings within the acts, but the doctrine was rejected in Landreth, where the court chose form (“stock is stock” over substance)] that if you sell 100% of ownership interest in a business, it is not a security – you can’t be relying on the efforts of others since you’re the only owner. a.

Landreth v. Landreth: The Supreme Court rejects the sale of business doctrine, and said, whether 100% or not, you’re still buying stock and under §2(a)(1) that’s a security. 1) But most lawyers don’t see this as a repudiation of the economic reality test of Forman.

11. Note that we check the status of a potential security at its inception: you can’t change your involvement in a venture such that it becomes a security. Of course, if you try to set it up with plans for it to become one, then it’s still a security. 12. Creation of a Separate Security [securities can be created in interests that would otherwise not themselves be securities – scotch is not a security, but if you put the scotch in trust and sell interests in the trust, you’ve created and sold securities (provided such scheme otherwise satisfies Howey]: If you buy a thing, it is not a security. But if you set up a trust using other people’s money to buy that thing and hold it, the interests in the trust are a security. Purchasing many stocks with a trust is also known as a mutual fund . This is merely the creation of separate securities. Basically, if you take something that is not otherwise a security and sell instruments or interests in it, then a separate security has been created.

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2) BUT the flipside is that perhaps you can argue consumption rather than investment. b. f. such that everyone had to now be owner operators. there is an expectation of profit (assuming at least one person will sell it after they get it).000 he put into the firm. A sale of 100% of the assets in a company is not purchase of a security. e. and it sort of meets the efforts of others test since they are building the car with your money. 10 . Real Estate transactions generally do not involve the sale of securities. Suppose instead that Jaguar says forget giving you the car. d. and in a sense the rest of the act is simply commentary and exceptions to this section. they just make the car. Suppose Jaguar told customers to put down a deposit to get a special model car because otherwise they can’t produce it for you. the appreciation in value is to the car. Law firm offers partnership to Slick. Once the owner operates. entity. The fact that the market makes the car more valuable does nothing. REGISTRATION G.13. requiring a capital contribution of $35. Commodities are not securities. they are just commodities. Buying a house is not purchasing a security.000. this is a security: so when the case came out all franchises had to change the way that they operated. you fail the efforts of others test. For any “person”: Person under the securities act is a term of art meaning anything from human being. and that’s what they do. is there commonality. §5 of the 1933 Act – Registration Requirements: [is the entire essence of the ’33 Act is the §5 requirement that no security may be offered without registration. It shall be unlawful: The SEC has tremendous power to prosecute you 2. Suppose you buy a McDonalds and hire people to run them. But with something else. Jaguar’s efforts don’t change anything. g. Moreover. except that there is not really any investment here: his profits come from his own efforts. unless there is “something more”. They’ve just converted the transaction into a security. and we’ll send you much more in return when we sell it to collectors. 1) It’s a scheme. and collectors are waiting to pay far more than what you put in. This appears to meet the efforts of others test (he makes a substantial amount of profit from the other guys [predominantly efforts of others]). we need to look to the expectations of the parties (are they investing in a business enterprise).] 1. not from the $35. Examples: a. trust etc. c. and are they relying on the efforts of others. not in Jaguar stock. Slick’s income will be based on his productivity (hours). just send us the money to build them. Under Howey.

and overdisclosure is counter to the purpose of disclosure. The Supreme Court doesn’t seem to agree however (See Gustafson. It is used to later produce the prospectus to be distributed. and the accountants. Note: The SEC has no merit review authority – they only care (in theory) that everything is disclosed. then buys back the shares. Nor do they verify the statements that are made when you register. There is no such thing as a registered security – you register the offer. The entire idea is disclosure – you don’t just fill in the blanks. and involves underwriter’s counsel. through the use or medium of any prospectus [Conceptually. 1. and then decides to offer those shares back on the market. not the security. 3. To survive the challenge. The standard for drafting is not truth  the standard is two fold : 11 . S-2. issuer’s counsel. consisting of two parts – the main bulk is the prospectus. b. a. You can’t offer or sell a security in this country unless a registration statement has been filed with the SEC. offers stock. In reality they have tremendous discretion in their review.3. but they need to be answered in long form. b. The fundamental tension in drafting registration statements is that you must disclose everything and be truthful. Producing the form itself can take anywhere from 6 weeks to 3 months. you’ll need to file another registration statement as to the new offering. avoiding jargon and legalese. a security. 2) Part II is just housekeeping for the SEC. 5. The registration form itself is a series of questions. you’ll see inserted clauses for interstate commerce. 6. To use any means or instrumentalities or interstate commerce: back in 1933. There are 3 basic forms: S-1. 4. S-1 is what everyone who can’t fit into the short forms that are used only for established companies. and the second is largely SEC housekeeping stuff] has been filed. but you also want to sell the securities. unless a registration statement [the two part document called for by §5 for registered offerings. a prospectus is merely any document that provides disclosure of information to investors. You can’t sue on preliminary prospectus. H. there was a huge fight over the constitutionality of the ’33 Act. but SEC provides comments and you revise until final gets distributed to all investors] or otherwise. limiting definition of prospectus (and 12(a)(2) recovery) to those in registered offerings). It also cannot be too long. 1) Part I is the bulk of the statement (90%). To offer to sell or buy. S-4 is for mergers. a. If Microsoft files a registration statement. The Registration Process Itself : Registration is expensive and time consuming. There are two parts: Part I and Part II. Finding the balance is rather difficult. 2. S-3. Issuer’s counsel coordinates the entire thing. a. The registration statement must also be written in a simple manner (to the readership of the NY times – about 10th grade). 4.

and they get back to you with comments in a comment letter . You cannot rely on rely on management to provide you with the truth. Permissible “gun jumping” guidelines change with each phase of the registration process. and this can go back and forth for a while. underwriter negotiation (2(a)(3)) or Rule 135 permitted statements. to offer securities. You cannot omit any material which would make the registration misleading. but they have in no way signed off on the validity of what you say in it. 12 . Anything material must be included. it can still be misleading. 8. Note that the registration statement must include language that the SEC has not approved the securities – the SEC has reviewed the prospectus. The underwriter pushes the securities for you in one of two ways: 1) Best Efforts : they only purchase from the issuer if they have a buyer on the other side. Process: The statements are prepared and finally submitted electronically via EDGAR (electronic data gathering and retrieval system). even informally. but everything must accompany prospectus c. a. the day the registration statement becomes effective the underwriter buys the whole issue. The statements cannot be materially misleading in the totality of the registration statement: even if something is technically true. you go effective. You respond by filing an amendment. b. SEC vs. 2) Firm Commitment : here. prior to proper registration are deemed to be tantamount to making offers in violation of §5. Loeb. 7. you are “in registration” during the pre-filing period: [is a term of art that refers to a period before you’ve actually filed a registration statement and… 1) Conservative view [Jalil’s view]: you’re “in registration” when senior management has decided. and it is up to them to sell it at a profit. b. 2) Waiting Period: Only oral statements or oral offers. Here’s the deal: 1) In Reg . This means you can now lawfully use the prospectus to sell securities under §5. also underwriter negotiations.] a. The result is the prospectus. even indirect efforts to condition the market. Rhoades (1959): was an old underwriter that “touted” the company in press releases before it issued stock  this was conditioning the market. and once it has finally been approved. First.Consistent period: only consistent oral or written remarks. Gun Jumping [Efforts made to promote the sale of stock. the only writing can be preliminary prospectus. or Rule 135 3) Effective: free writing and oral. c. You need to investigate.a. b. Then the SEC reviews it. and the SEC is very sensitive to it.

so long as they are consistent with what you’ve done in the past. but YOU MAY NOT NAME THE UNDERWRITERS (it gives you certain credibility). 1) General Company remarks must be Consistent : you can make general statements about the company. don’t start now. you enter the waiting period. but privately held non-public companies have no real reason to do so unless they’re in the news for some other reason. you are in the “quiet” or “consistent” (Jalil prefers calling is consistent) period [the quiet period is more aptly called the consistent period – before you’ve filed your reg statement. [The SEC comments on the preliminary prospectus. even just talking about the company. c. 2) As to the offer itself . During the waiting period: 1) you may make written offers only through circulation of your preliminary prospectus (a red herring).2) Liberal View (dangerous): you’re not “in registration” until you have an actual deal (or letter of intent) with your underwriters.Whoever purchases from you needs to be sent a final prospectus. all of this is still subject to the antifraud provisions of the acts. Once this is done. and it may say no more than: b) The name of the issuer c) The Title. So nothing outside the prospectus can go out in writing. you can. The final prospectus results . Note that private plaintiffs can only sue on final prospectus under §11. amount and basic terms of the securities to be offered d) The amount of offering to be made by selling security holders e) The timing of the offering f) Whether the offering is directed to a particular class of purchasers g) A brief statement of the manner and purpose of offering. 13 . you can do anything permitted by the safe harbors permitted under Rule 135 : Under this rule. If you give press conferences. Note 135 provides safe harbor for things you can say. the SEC tells you what you can say during the quiet period: You must include a statement that the information you’ve issued is not an offer. and it gets widely circulated during the waiting period. but if the board never has spoken to the press. When you are in registration. Then you actually file the registration statement with the SEC. that an offer can only be made by prospectus. you cannot condition the market (broadly construed) in ways you haven’t before. ] 2) Both the issuer and underwriter can tout the company. a) Note SEC Release No.] This means you cannot do anything to promote the stock or condition the market which you haven’t done before. 3) Of course. BUT THEY CAN ONLY DO SO ORALLY . 5180 : public companies have a good reason to make announcements in the manner that they always disseminate information.

the issuer and underwriter can send information to whomever they want in any medium . works to get you effective ASAP b. d. and in return the SEC: a. This is in accordance with the doctrine of free writing. Rule 419 Blank Check Companies: some companies raise money with no particular purpose for that money in mind. who can file a shelf registration and keep their information current with the SEC. Then you go effective in the post-effective period. you must take time to re-circulate it. so long as they include or precede the statement with (or such communication is preceded by) a copy of the prospectus with anything they send. but you cannot take money from anyone or accept any offers. you need to have a good faith intention to go effective ASAP. when you file a registration statement. This is huge. One major exception is available only to mature companies. 3) Company’s VP sends the agreement with underwriters to NY office. gives you a choice as to the day and hour you go effective. but Company tells them they will get commissions anyway if they move their stock. 1) During this time. Under Rule 419. and they certainly can’t accept it. the final prospectus must look exactly as the last one that you sent out to everyone during the waiting period. since §2(a)(3) permits discussions with and among underwriters. 2) Company’s VP begins talking with I-Bank about the offering. 4) Company solicits more underwriters. This is fine under the §2(a)(3) exception. 10. You can gather indications of interest. when they had always previously advertised the company in BYTE. 5) Company is notified by some of the solicited underwriters that they will not participate. 12. This would be an illegal offer. Examples: a. but they need much longer than that to do everything they need to do. except for pricing information (that way there is no surprise).All of this is seen as gathering indications of interest from the marketplace. since everyone needs to know this in advance. and go effective whenever they want to issue securities. If it is different. it’s just communications within the company. An issue of timing : The SEC has 20 days by law to declare you effective. Shelf Filings : normally. 14 . the money must be kept in escrow until the purpose is disclosed to the investors and they approve of it. The offer is not legal. 2) You can also now solicit and accept offers and take money as well. permitted discussions with underwriters. That’s fine too. That’s fine. This would be gun jumping since it is inconsistent. regardless of whether it’s done interstate. In Pre-filing Period: 1) Company places ad with Business Week touting the company. 9. Under the SEC’s position. 11. 6) Carl hears of the offering and writes in offering to purchase. So everyone always agrees to voluntarily waive the 20 day period.

and they have otherwise complied with the law. This is no good. it may still be material and therefore you must include it. Instead. Now in the waiting period: 1) Company issues a press release announcing filing of the registration statement.7) Company’s I-Bank issues a statement disclosing that Company will do an offer. Now we’re effective: 1) Sally is mailed a prospectus by the underwriter. This is fine. Even though certain things aren’t asked for in the registration forms. 3) Broker now mails a form to someone with a note saying this is a good buy. 9) Company’s VP gives a speech that she was invited to give prior to their decision to make an offering. They can say whatever they want. There is no requirement that she is quiet. since it is technically unrelated. 8) Company sends out its annual report. For uncertain future events. Materiality : [Is a core concept to most securities laws. 15 . This is problematic. 2) A broker at one of the underwriters calls someone and tells her on the phone that she purchase shares. helping to ensure efficient and effective disclosure without burying the investor in minutia. the event’s materiality turns on both the magnitude of the event and the probability the event will occur [Basic]]. and gives a statement of earnings per share. But it can’t be a rouse to talk about the common stock they are offering. It also identifies their underwriter. and the purpose thereof. That’s fine. and how big it is. Likewise. This is no good – during the waiting period the only writing can be the prospectus. but they can’t identify the underwriter in the pre-filing period. as are her follow-up phone calls. 4) A check is sent to the broker. you can only solicit indications of interest during the waiting period. It is deemed a solicitation of an indication of interest. since they are not involved. 6) Company puts a hyperlink on their website to the report mentioned in the previous example: this is no good. b. if something in the registration statement is inaccurate. she puts in for 100 shares. MATERIALITY I. since any offers in this period must be by way of the prospectus. and she can announce the offering. That would all be ok under Rule 135. what it’s for. But it is “glossier” than usual. 7) One of the underwriters sends a letter to its customers describing other stock of Company and how it’s good stuff. This is no good. a plaintiff cannot sue on it under the securities regulations unless it was material. or orally. a fact is material if there is a substantial likelihood that a reasonable investor would consider it important (useful rule of thumb is 5% test). Black letter law is that you need only to act in good faith. c. just consistent. Under TSC. but she never receives it. as usual. This is fine. 5) A third party underwriter not involved in the offering places info on their website about the offering. the offering. 8) Broker mails a prospectus to everyone she knows. and sends her a preliminary prospectus.

4. I-bankers. whether things stand in the way of the merger. c. lawyers being hired. Buried disclosure is no disclosure at all. b. Exception: Under the Foreign Corrupt Practices Act. And giving up the company’s criminal acts can’t be good for share value. because material misstatements were made. these payoffs were a good thing for the company. b. Prospective Information: Basic v. As far as the company was concerned. what has been discussed. In the case of a merger we look to board resolutions. 2. but sophisticated investors who followed the company closely knew they couldn’t be true. 6. 16 . since it is the most important thing that can even happen to your company. 5. Similarly. 5% rule of thumb: If assets are affected by 5%. The SEC agrees. secret exchanges of info. buried disclosure is no disclosure at all. While shareholders might prefer you don’t disclose this info. You balance the probability that something will happen with the magnitude of the event if it occurs. since they were selling more beer as a result. rather. The test is not the investor who is bringing suit. a. certain things may not meet the 5% test but still be material – Schlitz: Schlitz was making payoffs to sell its beer. investors would want to know if you are selling goods in a country with bad politics. d. since that will bombard the investor with too much information. The magnitude out of 100 is 100. a.] You can’t err on the side of inclusion. But a reasonable investor would want to know if his company is engaging in illegal activity. Those things which are completely public knowledge need not be disclosed. This came up in the case. any and all payoffs internationally must be disclosed to investors. Other things can occur which increase the probability. A fact is material if a reasonable investor would consider it important in deciding how to invest. But who wants to take the chance. and other “indicia”. BUT investor notice [Weiglos]  certain things. b. Therefore.1. TSC Industries: Under TSC. you still have to. an absense of discretion as to materiality would be counter to the intent of disclosure requirements. 3. The Doctrine of Buried Materiality: [disclosure requirements are not satisfied by mere wholesale disclosure. but rather a reasonable investor. Social Issues and Disclosure : Of course. But the probability is more like 2. c. Suppose you’re drafting a prospectus and you play golf with the head of another company who casually mentions that you guys should merge. Levinson – Things which may occur in the future need to be disclosed on the basis of the probability / magnitude test : a. The Materiality Rule of Thumb : Any event or fact which could affect earnings or assets by 5% is likely material. no matter how material are so obvious to investors that they need not be disclosed. and at some point you need to disclose it (letter of intent definitely needs to be disclosed).

should the encumbrance be discovered before that. 8. an issuer can use: 3a11 [Rule 147] 4(2) [Rule 506] Rule 504 Rule 505 Reg A (only if non-public company) 3(a)(9) a control person can use: Rule 144 (only if public company) 4(1½) Reg A (only if non-public company) a reporting company can use: Rule 505 4(2) [Rule 506] 3a11 a private company can use: 4(2) [Rule 506] Rules 504 Rule 505 Reg A 3a11 d. for instance.7. Company has several plants. not the lawyers. ii. b. c. v. In the end. The 10-K is to be filed soon discussing the plants they have. Things i. If that’s not an option. b. iii. and the period for adverse possession on the encumbrance is a few weeks away. ii. Things i. then even if he finds something of the utmost importance. The best answer here is to put off the filing of the 10K until after the adverse possession period runs – that way you wait and once the land is yours there’s no issue at all. the investor in question has specific concerns that are not shared by other investors. Note that changes in the stock price after the statement is corrected or revealed may give us insight into the materiality of the misstatement or omission. the plant would have to be removed. The question is whether or not that misrepresentation would be material to a reasonable investor. Examples: a. If. iv. iii. However. ii. despite board members who don’t want to disclose this. not that particular investor. you should URGE disclosure. A brief listing : a. Things i. the final decision as to disclosure is up to the client. A misrepresentation is made to a particular investor. one of which encumbers a piece of land that is not property of the company. 9. v. iv. iii. 17 . EXEMPTED TRANSACTIONS 1. iii. vi. Things i. ii. it’s not material.

but certain exemptions contain a safe harbor such that offerings done 6 months apart are safe from integration. Consider two examples: 1) Company A does a registered offering and then a few months later does a Reg D (505) for the same exact stock and all. and over 1 year is generally safe. Integration [doctrine that prevents issuers from subverting securities laws and accomplishing piecemeal what they are otherwise prevented from doing in whole without registration. to be of one and the same offering. but now the registered offering has a gun jumping problem – they’ve consummated offers before they were effective. anything 6 months or closer will be integrated. c.e.” Whether to integrate “calls for an analysis of the specific facts and circumstances” [SEC Rule 155 Release] b. 4(2) [Rule 506] 2. tripping up sensitive exemption requirements or triggering gun jumping rules. a. But the registered offering is ok (no gun jumping problem since the Reg D was done after the registered offering. The Reg D is blown because the general solicitation you did (and perhaps the number of unaccredited investors you offered to) has blown the condition for the Reg D. 4) Is it for the same type of consideration to be received? a) Here you can argue about the intent of the investors (like long term debt investments vs. Five factors to determine if the offering you are doing will be deemed integrated by the SEC: 1) Are they part of a single plan of financing (what is the money being raised for? 2) Do they offerings involve issuance from the same class of securities 3) Whether the offerings have been made at or about the same time: a) Timing: As a rule of thumb. The Reg D is still blown because of the advertising and the unaccredited investors. 2) Company B does a Reg D (505) and then a few months later does a registered offering. 6 months to 1 year is arguable. equity) 5) Whether the offerings are made for the same general purposes? 18 . Investment companies can use: i. Timing is not dispositive. This does not mean they are treated as if they were done simultaneously. Integration considers two offerings. but it does treat them as if they were the same offering – which means that the properties of one become the properties of the other. The SEC provides guidance with 5 (really 4) factors that tell us whether 2 distinct offerings are to be treated as one and the same. but it’s very important. Such integration can taint offerings and blow exemptions. Integration “prevents an issuer from improperly avoiding registration by artificially dividing a single offering [so that] exemptions appear to apply to he individual parts where none would be available to the whole. though done at different (or the same) times.]: it’s always running a check on things.

BUT There are safe harbors for certain offering exemptions regarding integration. But it still applies to secondary offerings. the exemption is blown. The safe harbor is rule 147 which includes the triple 80% test. but it’s very important.). underwriter. The Intrastate Exemption : §3(a)(11) [by drafting error. Timing is not dispositive. 4) Is it for the same type of consideration to be received? Here you can argue about the intent of the investors (like long term debt investments vs. the SEC will consider the offering integrated. you can use unregistered underwriters . You can’t even offer to someone outside the territory (but you can advertise outside if you say it’s limited to people in a certain state). 3(a)(11) is listed as an exempt security. The SEC hates the exemption. and over 1 year is generally safe. The Intrastate exemption is a political compromise. and then are freely tradeable] – the ’33 Act registration provisions do not apply to any security which is part of an issue. mainly because state’s rights lobbies didn’t want the federal government regulation issues within a state. Integration will not be tolerated – people would offer what amounted to the same security in different states but do it under different names so as to utilize the exemption. underwriters. a. and the issuer does business within such territory. 3. you can advertise . b. etc. If you can qualify for the exemption. Where you try to do this.d. §2(a)(3) Underwriter Negotiations Permitted . while giving teeth to the statutory underwriter provisions of §2(a)(11). but it’s a transaction exemption that applies to offerings by issuers who are incorporated and do business in a state and offer securities solely to investors in that state. anything 6 months or closer will be integrated. [The provision carves the massive exemption for secondary trading.One major exception to the definition of “offer” permits an agreement between the underwriter and the issuer (or between underwriters) so that they may reach agreement before registration without violating the securities laws. b. and dealers. Five factors to determine if the offering you are doing will be deemed integrated by the SEC: Rule 147 (p.] The provisions of §5 shall not apply to anyone other than an issuer. It states that §5 applies only to issuers. We use the five factor test. Purchasers. you don’t have to disclose (but you better not make affirmative misrepresentations). If securities end up in the hands of one person out of state before permitted. 19 . and they interpret it strictly. 6 months to 1 year is arguable. it doesn’t apply to any secondary trading. 79 supp) 1) Are they part of a single plan of financing (what is the money being raised for)? 2) Do they offerings involve issuance from the same class of securities? 3) Timing: As a rule of thumb. So technically. c. after 9 months can resell the stock (not the case for other exemptions). but the exemption is strictly construed (SEC doesn’t like it). or dealer. equity) 5) Are the offerings made for the same general purpose? d. Securities must stay in state after offering for 9 months. offered and sold to persons resident within a single state or territory (commonwealths etc. (Typically 6 months) 2. 4. §4(1) – Exemptions: a.

Intrastate Exemption Safe Harbor – Rule 147 : The rule provides a safe harbor (you can still get by without it. The common stock is used to purchase equipment. 5) You must avoid integration of disparate offerings or other intrastate offerings (“every part of an issue” must comply with the intrastate offering requirements”): You can rely on the 5 prong test above for integration. and the note offering is to hire more salesman.§4-2: [Provides the private placement (non public offering) exemption for which 506 is the safe harbor. 5) The Securities must be held by for a certain period of time: a) Resales? Offerees must hold onto the offered security within state for at least 9 months. Private Placement Exemption . 2) Your principal place of business must also be in that particular state. (1) the investors must be sophisticated and (2) they must have access (access or you disclose it) to information allowing them to make a decision. 1) There is no monetary cap (but likely there is some amount) 2) Note that under Ralston you can’t even OFFER a security to the general public  you cannot therefore advertise (but argue that you are trying to boost the company or produce patrons. e. Defining the public as anyone who needs the protections of the securities laws. To argue that the two offerings should not be integrated (thus denying the benefit of 3a11 as to the common stock offering). 5. but it’s a fight). and the securities are restricted] The provisions of §5 (registration requirements) do not apply to transactions by any issuer not involving a public offering.Example: Suppose you offer common stock in NY in Sept. The only way to really ensure that is to escrow the stock for 9 months. 4(2) is limited to issuers. or simply the safe harbor of rule 147 whereby anything over 6 months away will not be integrated. but arguably some are making equity investments while others debt. The 9 months clock is tacked when investors sell intrastate. But you can advertise out of state. but they are offered at the same time. so long as you say on the ad that it’s limited to people in a certain state. based on domicile (or principal residence?) . b) But they can always resell the security to another resident of the state. They receive the same type of consideration. Then you also do a registered offering of notes the same day in all 50 states. under 3a11. 3) You must “do business” there under the Triple 80% test: a) 80% of your assets must be there b) 80% of its revenue must be there c) 80% of the use of proceeds from the offering must be within state 4) You must offer only to the residents of that state. a. 1) You need to be resident (incorporated) in a particular state. Private placements are fast and cost effective. Basically. They don’t involve the same security or class thereof. c) Purchasers who change their residence must do so in good faith. not investors since you’re getting investors privately) 20 . the court said investors in 4(2)’s need (1) financial sophistication and (2) access to information OR affirmative disclosure]. General Info on 4(2) placements. without blowing the exemption. They are not used for the same purpose. The guidelines for a valid 4(2) are set up by Ralston Purina.

Ralston Purina: Huge corporation wanted to sell securities without registering them. But the Supreme Court disagreed: anytime you sell securities to anyone who needs the benefit of the securities act (unsophisticated investors). By definition this was not public. So everything starts out as a small business at some point. these “sophisticated” investors need to have access to the information necessary to make a valid investment decision (contrast with 3a11 whereby you need make no such disclosure). they derive from §3(b). but not determinative. 4) Issuer must take precautions against resale – but the absence of such procedures won’t ruin the exemption provided no one resales. but not merely that they will answer questions if you want info (Doran v. c) Example: Suppose you are a secretary at a major company that has access to all their corporate records: you may have access but you’re still not sophisticated. The public is not the masses. it is anyone unsophisticated. 1) Sophistication : [Under Ralston Purina. Money alone doesn’t make you sophisticated (compare accredited investors under Reg D). Petroleum Management Corp. 506 is the safe harbor for Ralston Purina private placements. 6. 5) Must meet requirements of Ralston Purina as far as sophistication and access. so they offered the securities to employees. 504. it will be deemed a sale to the public . but no exempting rules may apply to transactions over $5 million. This is particularly true with small businesses: Small business initiatives – deal mainly with emerging (not just small) businesses. 21 .3) All offers must be made in conformance with the exemption – any single non-complying offer will bust the exemption. 505 and 506. this is knowledge and experience in financial and business and matters necessary to evaluate investments on their own. a) Defining sophistication (financially) is hard: education is part of it. rather. Regulation D : Private Placements (506) and the §3(b) Safe Harbors (504 and 505) [two 3(b) exemptions and the 4(2) safe harbor – these are three inexpensive and efficient ways to raise capital]: Regulation D contains three subrules. the exemption is blown) b. 6) The securities you get are restricted (which means if you improperly resell. Sophistication can also be industry specific. 1977). Reg D is part of the small business initiatives. b) A numerical limit has nothing to do with private placements. c) Being an insider does not mean you are sophisticated 2) Access or Disclosure : Likewise. Two ways to get investors information: a) Disclose it to them b) Provide them with access : Under 5th circuit definitions. which permits the SEC to carve out exempted transactions under $5 million. 504 and 505 have nothing to do with 4(2). a. 1) The SEC wants companies to be able to raise capital without the securities regulations being unduly burdensome. 5th Cir. access means you EITHER (1) need to be an insider or (2) have some connection whereby you can get information. Authorization: §3(b) of the ’33 act permits the SEC commissioner to promulgate rules regarding exempt transactions (though it says securities – typo).

investment funds.P. 1) If the entity was formed before the offering was known. trust or partnership with $5 million 22 . §501 Definitions: 1) The Accredited Investor : [§501 of Reg D sets up specific categories that parallel the sophistication requirement of R. corporations and partnerships will be treated as one purchaser – BUT If you form an entity for the purpose of purchasing securities. we only can do up to $4 million. the Reg tells us how to make judgments as to sophistication. we can only do another $1 million 505 within 12 months. and more than 40% of the org’s assets go into the investment]: You cannot form corporations and partnerships for the purpose of being counted as one party in the 35 purchasers limitation – Typically. 505 and Reg A) – when doing a 504 the other 3b’s offered in the last 12 months may not exceed $1 million. d. b. 4) Examples: a) Suppose we do $1 million today under 504. including: a) institutional investors: banks.] The reg refers many times to accredited investors. Formed for the Purpose Of Doctrine [prevents issuers from subverting caps on investors through the use of organizational form – mainly for Rules 505. §3b Offering Aggregation [aggregation enforces the $ caps on the §3(b) exemptions (504. This way we ensure they weren’t formed for the purposes of getting in on the investment. since we’ve already capped the $1 million under that with the 505 we did. if you integrate the two offerings. c. c) If we do a $4 million 505 today. by giving classes of people who will cut it. we CANNOT do a 504 within 12 months. That is. in calculating the dollar amounts set up by the SEC ($1 million for 504’s and $5 million for 505’s) we aggregate: 1) All dollar amounts from any §3(b) offering in the last 12 months (504.2) The SEC is very lenient when it comes to Reg D (in part because of the SBI’s). then we’re cool 2) If it’s questionable. 5) Note that aggregation occurs regardless of integration – they are different things. Note that all of Reg D is limited to Issuers (not control persons etc. insurance companies. 505 and Reg A) 2) Blown §5 violations that you’ve done in the last 12 months 3) Notice we do not include in the aggregation any §4(2) offerings. 505 the same amount not exceed $5 million. b) If we do a $4 million 505 today. Reg A’s only count previous Reg A’s in their $5 million cap. we check to make sure that a maximum of 40% of the assets of the entity are invested in the offering. but that wouldn’t cut it for R. we look through the entity to its members and count each and every one of them. Of course.P. you’re still screwed. except that it raises the problem of the moron millionaire (money alone can make you accredited. certain pension funds.] Beware that the dollar amounts in the 504 and 505 rules are subject to aggregation. 506 (limit of 35 unaccredited investors) and 3(c)(1) (limit of 100 investors) – an organization is “formed for the purpose of” when it was formed in questionable proximity to the offering. This means when we do a 505 within 12 months.) e. This is basically the sophistication requirement of Ralston Purina.

000 individually or $300. The financial info required gets more detailed for offerings of different amounts (under $2.If the issuer is a reporting company.Has a net worth that exceeds $1 million or . the employees are not necessarily protected.5 million). §502(a): Integration Safe Habor : Reg D presents particular problems because it too is subject to integration.b) 501(c)(3)’s c) Any director. . executive officer. $2. that you are permitted to approach. f.No disclosure is required for accredited investors . 2) Purchaser Representative : Under Rule 506. you’ve now corrupted the Reg D offering since it cannot involve advertising. . Trusts: so long as they have at least $5 million in assets. 1) Any offering done 6 months before or after will not be integrated as a matter of law (6 months from end of first and beginning of second).000 smallest. But if you integrate a Reg D offering with a 3(a)(11) that involved tremendous advertising. being rich doesn’t cut it as a matter of law. 1) The Requirements are 502: a) Beware of Integration b) Disclosure Requirements: . g.If the issuer is NOT a public company (Reporting company) the issuer must basically give the investor the same nonfinancial it would have given if it had filed a Registration Statement . Corporations. because 506 doesn’t require disclosure to accredited investors.5 to $7. unsophisticated investors are permitted to use a purchaser representative to meet sophistication requirements: a person who is not connected with the issuer (unless he or she is a relative of the investor) and has such knowledge and experience in financial and business matters to be capable in evaluating the merits and risks of investment.Issuer must give investors the opportunity to ask questions and receive answers 23 .5 million is another bracket. but they will be subject to the 5 prongs of the integration test. But under the exemption. All within 6 months will not necessarily be integrated either. Pre-qualified investors are those you know from before. and then above $7.Makes more than $200. it’s enough to meet sophistication.000 combined with spouse Note this is a weird exception : under Ralston Purina. how can you find accredit investors. However. §502: The Menu of Requirements – the other rules refer back and tell us which of these possible requirements need be met for each specific exemption. they are treated as if they have access. Likewise. it must give the investor copies of reports it has given to the SEC. e) Any individual who: . when there is nothing in there to indicate so. and the opportunity for 505 and 506 investors to ask questions and get answers. general partner of the issuer d) Partnerships. 3) Pre-qualified Investors: If you can’t advertise under the reg (except circumstances).000.

However. you need not make disclosures. Solicitation permitted. and the securities are restricted (unless you use state law exception). issuers (no secondary). but disclosure required for non-accredited. 4) You cannot be a reporting company under ’34 Act. If you do a 504 offering. which is the disclosure requirements. e) j.General solicitation defined: you can’t send to anyone you don’t have a pre-existing relationship with at all . gen.Watch out – even if you limit to 35 unaccrediteds in 505 and 506.c) No advertising or general solicitation of any kind . 5) You likewise cannot be an investment company (mutual fund) 6) And a) b) c) d) you must abide by the requirements under: 502(a): Integration 502(c): No general solicitation 502(d): Restricted Securities BUT EXCEPTION : You CAN advertise and the securities WILL NOT be restricted. and no quality or quantity restrictions on investors are imposed. You may sell to no more than 35 nonaccredited investors (subject to formed for purpose of) and unlimited accredited. 1) Can be done to anyone (no accredited investor requirement or cap) i. non-blank check co. 2) The offering is limited to $1 million (subject to aggregation) 3) You must be an issuer (no secondary offerings). securities restricted) 24 . §503: requires a one page thing to be filed with the SEC within 15 days after the first sale. use another state and then use the disclosure document in the state that doesn’t require it). not permitted. issuers may only raise up to $1 million (subject to aggregation). The rule is leniently construed by SEC. There are also no disclosure requirements. §504 (A §3(b) Safe Harbor) [is a 3(b) exemption. or a blank check company. There is no gen. Solic. IF: . contained in Reg D available to only non-public non investment co.(use accrediteds only) The securities are issued under a state law exemption that permits general solicitation and advertising so long as sales are made only to accredited investors (Reg D). No disclosure requirement: Notice that 504 skips 502(b) as a requirement. d) The securities that you receive though these offerings will not be freely tradeable (they are restricted securities) h. up to $5 million (subject to aggregation). you still may have approached them the wrong way and violated the general solicitation. OR .(disclose) The transactions are registered under a state blue sky law requiring public filing and delivery of a disclosure document before sale (if the state you’re in doesn’t require disclosure. §505 (A §3(b) Safe Harbor): [A 3(b) exemption in Reg D that permits offerings by issuers only. that will remain private but simply informs the SEC of what you’re doing (notice filing).

3) You can’t sell to more than 35 investors (excluding accredited investors). and you can’t have been disqualified under Reg A. open to invest co’s.EXCEPTION : You need not disclose anything to accredited investors c) 502(c): No general solicitation d) 502(d): Restricted Securities k. This makes them sophisticated. However. and must get disclosure) and unlimited accrediteds. 2) You must be an issuer (no secondary offerings) 3) You cannot be an investment company (mutual fund). note that you can offer to more unaccredited than that 35 – but the question becomes when you then violate the general solicitation issue. §506 (The §4(2) Safe Harbor) [the 4(2) safe harbor permits only issuers to do offerings to 35 unaccredited (subject to formed for purpose of. : Obviously. b) You can offer to an unlimited number of relatives 5) You must abide by the requirements under: a) 502(a): Integration b) 502(b): Disclosure . but they must be sophisticated or have purchaser rep as well [RP].1) The Offering is limited to $5 million (subject to aggregation). 1) There is no $ limit: Because it doesn’t derive from §3(b). and has such knowledge and experience in business and financial matters to be capable in evaluating the merits and risks of the investment. 4) There can’t sell to more than 35 unaccredited investors a) But you can offer to an unlimited amount of accredited investors – the question becomes when you’ve violated the general solicitation prohibition. no dollar limit. 25 . but the SEC may go after you. But you don’t need access. a) BUT even as to non-accredit investors: must have a financial sophistication to appreciate the risks and make decisions (the sophistication prong for Ralston Purina) . it’s not limited to the $5 million cap. a) But you can be a reporting company (unlike Rule 504). even if you can’t get into the §506 safe harbor. 2) You must be an issuer. So unsophisticated investors MUST use purchaser reps if they wanna be included in the 506. b) BUT unsophisticated investors can get sophistication by using a purchaser representative – a person who is not connected with the issuer (unless they happen to be a relative of the investor). you can still do a §4(2).

m. 7. or vice versa): “Because conditions in the securities markets may shift quickly. 2) The assets that we include in the determination of $1 million have to be set and true: we can’t rely on speculative things like art. must abandon.EXCEPTION : You need not disclose anything to accredited investors c) 502(c): No general solicitation d) 502(d): Restricted Securities l. you’re blocked from getting into the exemption by the advertising you did. 3) Lawyer is not by law a sophisticated investor. the SEC is concerned that issuers “use this integration safe harbor merely as a mechanism to avoid the private offering prohibition on general solicitation and advertising. 1) If you abandon one offering in good faith (by abandon it means you SOLD NO SECURITIES IN THE FIRST OFFERING and cease all activities under it) 2) Wait 30 days: a) If go private to public [Rule 155(b)]. This is part of the small business initiatives as well. you had accepted offers in the private which will violate gun jumping rules. 26 .” 4) You can offer the same security using some other mode of exemption (or you can do a registered one) without the troubling aspects of one corrupting the other. Rule 155 [“Because conditions in the securitires markets may shift quickly” the rule provides a safe harbor from integration and gun jumping. or vice versa (in good faith. If you had a registered deal and you had been taking indications of interest.The problem of integration frequently complicates abandoned offerings. n. Problems with Integration in Abandonment of Different Types of Exempted Offerings . You need to know much more. a. if the only people to whom you had offered were accredited (if not. Examples: 1) A VP of a large company wants to be included in a private offering. allowing a legitimate switch from registered to private offerings. if you go private to public. Title alone won’t do it. Rule 507: Disqualification of bad boys who fail to file a form D with the SEC – they may not use any of the Reg D exemptions.” companies may need to switch from private to public and vice versa. but then decide to tone it down to a private offering. the reg statement need be included in the private offering a) Obviously. then must wait 30 days) 3) If go public to private [Rule 155(c). Is she accredited? Not necessarily.4) You must abide by the requirements under: a) 502(a): Integration b) 502(b): Disclosure . The safe harbor ONLY APPLIES to when you go from a private offering under 506 or 4(2) to a registered. must wait 30 days. Likewise. need not wait 30 days before you file registration statement. or from a registered to 4(2) or 506. and must make certain disclosures)] Abandoned Offering Safe Harbor (Registered  Private 4(2) or 506. Rule 508 : Be sure to note that insignificant deviations from a term of Reg D is not fatal – so always argue that it might be minor enough to be caught by 508.

You can’t do a Reg A if you’re disqualified as bad boy (SEC don’t like you) e. and the Securities sold under a Reg A are freely tradeable. i. because of §3b. You can freely and do limited solicitation. Reg A . Reg A is often overlooked since a knee jerk reaction is to go to Reg D. all dealer made sales done 90 days after filing of SEC statement must include offering circular. Reg A offerings are limited to non-public companies (you cannot be a reporting company under the’34 Act). Reg A offerings are limited. The Reg requires “mini-registration”. f. 2) Preliminary or final offering circular must be furnished to prospective purchasers 48 hours before sales are confirmed. but imposes no requirements on the quality or quantity of investors (i. is NOT limited to just issuers . Reg A permits you to gun jump – so long as you do not make offers or sales. a. This is because you need to be able to test the waters to see if it’s worth your while. sophistication or numerical caps). This is so as to encourage capital formation.] (A §3B Exemption): you file a mini-registration statement with your local SEC and they approve it (or comment) and then you sell.8. and until you do so you can only make limited advertising and limited written offers. There is no sophistication requirement. b. and there is less concern since you’re still required to file disclosure documents anyway. Reg A securities are freely tradeable. unlike 504 and 505. you can solicit indications of interest. and §3(b) aggregation. Regulation A: Mini-Registration [is an underused §3(b) exemption that permits non-public companies to conduct exempted offerings under $5 million (or control people thereof up to $1. 2) You can’t quickly switch to a Reg D offering: there you must wait the 6 months safe harbor required to avoid the offerings being integrated.e. h. No investment companies. Reg A offerings have WEIRD integration exceptions: 1) They will NOT be integrated with any prior deal. integration.5 million for insiders). 27 . to $5 million in any 12 months period ($1.5 million). g. Reg A does have certain requirements: 1) You must file a form with the SEC. you’ve already gun jumped! But Reg A permits you to file your Reg A in good faith and then switch to a registered offering without violating the fun jumping rules: they disregard what you did. This arose out of the small business initiatives. d. and the Reg grants generous but limited protections from gun jumping (switch to reg). 1) You can switch to registered offering without trouble: If you plan to do a Reg A and then switch to a registered offering (because indications of interest show that you will be able to sell more than $5 million). c. 1) Note that this means that control people who use Reg A must be from non-public companies.

“directed selling efforts”] SEC Jurisdiction over Offshore Offerings : The general goal of Reg S is to protect U. or U. They are activities reasonably expected to have the effect of conditioning the market in the U. capital markets and their investors from flowback of unregistered securities from abroad. Regulation S : [To protect U. a) If you are Category I.S. issuers that offer securities in only one jurisdiction (where you fully comply with those laws) fall into Category I.S. if more than 20% of a magazine or newspaper in which you advertise circulates in the U. citizen living in the U. (or offers specifically targeted to a group of U.S. it will be aggregated for purposes of determining the allowable amount for the 505. An offering is not subject to jurisdiction of the United States SEC if it occurs ouside the U. 1) CATEGORY I: offerings of foreign issuers that really have no U. a) For instance.S.S.S. 2) there are no “directed selling efforts ” in the U. But if you do the Reg A first. A Reg S offerings will not be integrated with any domestic offering. 2) CATEGORY II: 28 . that is physically there. The SEC divides the world into 3 categories of issuers (based on the likelihood that securities will flow back to U.S.S. or if trade done on trading floor of foreign exchange.. a.S. j. capital markets and their investors. Even though Reg A offerings derive their authority from §3(b) authority. Also. and establishes safe harboresque guidelines for each (building on the core requirement that their offerings be “offshore” and use no U.S. 1) BUT – Reg A offerings count against another §3(b) offering: if you do a $5 million 505 and then the next month a Reg A.S.S. d.2) Reg A offerings will NOT be integrated with any subsequent REGISTERED deal. b) BUT tours of U. or anyone with a green card who is living here in the U. for these securities. c. U.S. The SEC divided the world into 3 categories of Issuers: the categories are based on the likelihood that the securities will flow back to the United States.S.S.S. facilities are not directed selling efforts. b.S. 9. then you’ve made directed selling efforts.S. person is defined as: any U.. it must be an offshore transaction and there must be no directed selling efforts in the U. you’re ok. citizens residing abroad): Directed selling efforts are activities undertaken for the purpose of conditioning the market in the U. Reg A only gets aggregated with other Reg A offerings.: 1) it is an “offshore” transaction: if buy order comes from outside U.). connection – there is no substantial market interest for their securities (defined mathematically).S. they do not get aggregated with the other §3(b) offerings (504 and 505). Non-U. Reg S more or less articulates the breadth of SEC jurisdiction internationally.S. or any subsequent private deal done at least 6 months later.

S. it must be an offshore transaction and there must be no directed selling efforts in the U.” the SU must either register or utilize some exemption himself. person for 40 days after the offering c) If you are offering equity. Such distributions should also be distinguished from secondary trading – which occurs only after these securities have come to rest in the public. companies they are stricter: you must take reasonable precautions like password protections before you can see the offering info on the internet. c) If you are Category II..S. a) Of course.S.S. this is a recommendation (they can’t make Non-U. your securities cannot be sold to a U. (generally.S. you must also take steps to make sure that your securities don’t wander back into the U.S.S. person for 40 days after the offering. Special Case of the Internet : SEC Release in 1998 – 1) For Non U. presence.S. equity securities of non-reporting foreign issuers (that have substantial U. The definition serves to prevent unregistered securities from reaching the public in exempted transactions through a middleman.S. Your Reg S securities cannot be sold to a U. The offerees must agree to it when they first buy into the offering.S. or Reg A. but they will come after you if you violate §5. 2) For U. The problem is that these secondary offerors have to concern themselves with securities laws: §4 says that §5 doesn’t apply to 29 . 4(1½). but whom still must be concerned with §5 – they must register. issuers do anything really). person for 1 year. issuers offering on the Internet. person still sneaks in. SECONDARY DISTRIBUTIONS 1.a) Offerings of equity securities (stock) by both U. you need to put disclaimers on your pages stating that they are not being offered in the U. statutory underwriters and affiliates under §2(a)(11).S.S. 3) CATEGORY III: Is everyone else – this includes offerings by U. market interest) a) If you are Category III. d) Because of your heightened U. AND b) If you are offering debt. Secondary Distribution : [Secondary distributions are done by someone other than the issuer. issuers who do not report under the ’34 Act. the SEC will let you slide. 3) But if you take precautions and act in good faith.S. e. you cannot have your securities sold to a U. and foreign issuers who are subject to the ’34 Act reporting requirements b) Offerings of debt securities by any foreign issuers that do not report under the ’34 Act.] §2(a)(11) Statutory Underwriter : [Under §2(a)11) this is any person who purchases securities with a view to distribution to the public. and a U. To sell these “restricted securities.S. or seek exemption under 144.S. it must be an offshore transaction and there must be no directed selling efforts in the U.

But this has to be really profound circumstances (you can’t just say the market went down). or find some exemption (like 144). you are golden and you’re not seen as having purchased it with a view to distribution. 30 . Where a person purchases securities in a Reg D exempted offering. using the “rear view mirror test”.] We are concerned with state of mind – but in reality. it determines intent to distribute from subsequent actions. d. or some exemption (but for different reasons). 4(2) or 4(1 ½) securities): any person (entity) who has purchased restricted securities from an issuer. by purchasing from the issuer with a view towards distribution by offering and selling for an issuer in connection with a distribution by participating in the distribution or underwriting effort by selling securities of the issuer on behalf of a control person by purchasing securities of the issuer from a control person with a view towards distribution Control persons and holders of restricted securities may not sell their securities into the public markets without registration of their offering. 3) EXCEPTION : if you purchase the securities and unforeseen circumstances arise. b. Likewise they screw the issuer who gave them the restricted securities in the first place . when the turn around and sell their securities to the public. Holders of Restricted Securities (mainly holders of 504. they are not the public. then they lose their automatic §4(1) exemption from registration. and 1-2 is argued either way.anyone other than an issuer or underwriter  if they become classified as an underwriter. b. 505. you should always argue they didn’t have a view to distribution. 1) The SEC seeks to characterize as underwriters those who “act as links in a chain of transactions through which securities move from an issuer to the public. This is the very reason that the securities you get in an exempted transaction are so frequently restricted  if you were able to turn around and sell them you would become an underwriter and you would need to register that sale. with a view to distribution [TO THE PUBLIC] (anyone who needs the protection of the securities Act under Ralston Purina) in the near future will be deemed an underwriter and therefore cannot offer to the public without registration or some exemption. 4) Of course. You can become an underwriter in one of the following ways: a. Rationale: we are concerned with regulating offerings of securities to the public. With a view to distribution : [this test is a component of classification as a statutory underwriter. c. Therefore. 06.” [Rule 144 Preliminary Note] 2) But there is a safe harbor: If you hold the securities you purchase for 2 years. 2 years or more is safe. they must register their securities. then you may be able to convince the SEC that you had the requisite intent when you bought it. Presumptions of intent can be rebutted by showing of profound circumstance. we judge state of mind by what you ended up doing. e. a. 2. Holding for 1 year or less creates presumption of intent.

argue they are not control persons. a. 4. or is under common control with the issuer. control person registration requirements are really somewhat prophylactic. issuers also include control persons  Control persons will be deemed one in the same as the issuer. Restricted sec. Always start out by arguing first they are not control people.5) Note that escaping the with a view to test isn’t enough – it’s in the disjunctive – you can still be an underwriter even if you escape the test. The classic definition was anyone who has the power to compel the issuer to register their offering. if you try to exercise control but get voted down. and ensure that their company is current in public filings (so not available to non-public company affiliates). but this is wrong – it’s anyone who is within a group of people that have that power. A seller shall be deemed NOT to be engaged in a distribution of securities (which means they aren’t underwriters) (144(b)) if : 1) 144(c): The issuing company MUST be a reporting company that files reports under the ’34 Act and the company must be current in their filings . holders may sell in regular broker transactions. The only safety is in the safe harbor. under volume limitations after 1 year holding period. e. b. or wait 2 years to sell without any restrictions. control persons must sell under volume limitations in regular broker transactions. you don’t count) are also control persons. Of course. 3. Generally. Control Person: [As a prophylactic measure. and therefore cannot sell to the public without registration or some exemption. Directors are definitely control people. d. and therefore must register or seek an exemption to offer their securities. a. Wolfson: “we didn’t have time because we’re busy executives” is not a valid defense. §2(a)(11) provides a definition based on control that would include control shareholders and directors. as is executive management (up to a point). is controlled by. c. Control Persons or Affiliate (Insider) : Under §2(a)(11). remember (and argue) that there are protections in place under 10(b)(5) that really achieve the goals of the SEC with regard to control persons – in a sense then. Rule 144 : [Provides a safe harbor for secondary offerings by control persons and statutory underwriters under §2(a)(11). provided company current in filings.] The Secondary Offering Safe Harbor (“Persons Deemed Not to Be Engaged in a Distribution and therefore Not Underwriters”) – Rule 144 provides a safe harbor for (1) when control people can sell stock without registration. They are therefore dubbed underwriters (as are anyone that purchases securities from them with an eye to distribution to the public) by the securities regulations. and (2) how and when holders of restricted securities may sell without registration. When discussing control persons.] The accepted definition is that an affiliate is a person who directly or indirectly controls. but the more accurate test would be anyone within a group of people who can compel the issuer to register. Significant controlling shareholders (it is a question of fact and depends on there being no other large controlling shareholders that comprise the rest of shareholders – for instance. 31 . f. control persons are deemed one and the same as the issuer.

need not use brokers. you cannot sell more than the greater of: .provided they do a notice filing (if necessary) c) After 2 years all restrictions fall away 32 . b) For control persons. no limitations on volume. if the company is up to date on its SEC filings. 6) 144(k): 2 year home free rule: a) For restricted securities holders. b) Control persons don’t have to worry about holding periods (unless they buy restricted securities) 3) 144(e): Volume limitations : We want to prevent dumping of the stock all at one time. b. the safe harbor is not available to private companies – and it means that control persons of non-public companies need to use 4(1 ½) b) This is why when companies offer stock options and other stock packages to their insiders. Summary : 1) Restricted Securities holders must: a) Hold their stock for at least one year at which point. and the seller cannot condition the market or pick who he sells it to. b) Note that person is defined in a way by 144 such that units like husband and wife’s sales of shares will be aggregated.the average of the weekly trading volume of that security during the four weeks preceding the sale. they often have to agree by contract to keep current on their filings (otherwise the securities they offer to employees are useless since they can’t be sold without registration). a) In one 3 month period. two years ends everything – two years after the purchase of a restricted security. Rule 144 is not available for private sales. 5) 144(h): If more than 500 shares of stock (or securities worth more than $10. you may sell those securities without regard to any other limitation in 144. They are not ever free from being control persons. 2) 144(d): Holding Period: a) Holders of restricted securities must hold them for at least one year. .a) Obviously then.they can sell under volume limitations .provided they do so in regular way broker transactions . 4) 144(f): Sold in regular way brokers transactions – they must be sold into the anonymous market through a routine broker transaction. This means 2 years after the company can be late in their filings. the provisions of 144 never fall away (the 2 years means nothing).1% of that class of securities that is outstanding .000) are sold in any 3 month period. a form 144 must be filed with the SEC – notice filing.

However. She can use rule 144 – the SEC is lenient in the interpretation and there is no requirement that you have securities from a valid Reg D.provided they do so in regular way broker transactions . Accordingly. a. a. but such institutions so often receive tailor made securities that are not traded by open markets. they can sell whenever they want. you’re going to be liable as well). Examples: a. So the SEC adopted 144a. The securities are restricted. Rule 144a Institutional Investors [Exempts large institutions from registration when selling large blocks of restricted securities to other large institutions.Insiders can do private offerings by abiding by the guidelines of Ralston Purina. Jess purchases stock in a 3a11 intrastate offering which he then wishes to resell.: Technically. This would normally be a problem. Technically. the exemption follows the requirements of Ralston Purina. BUT the securities must not be traded to qualify for the exemption. but apparently there is a risk in doing so because you risk putting yourself into a string of people who could eventually become underwriters (if the investor you give the security to ends up being caught as an underwriter. The main requirement is that the securities in question are not publicly traded] : Large investors want to be able to sell restricted securities in a more organized way but without incurring registration requirements as an underwriter: they normally cannot use 144. provided the company is up to day on their SEC filings (note this means control person of small company would have to use 4(1½) . a 4(1 ½) is also available to holders of restricted securities (a restricted security holder could possibly offer it to another accredited investor in a 4(1½). you can trade among yourselves and you will not be deemed an underwriter. 4(1 ½) is read into securities laws to permit private placements by insiders (144 prohibits privately negotiated transactions). which says if you buy large blocks and you’re an institution. at which point. While 144 prohibits privately negotiated transactions. This does not implicate Rule 144 in any way. 7.provided they do a notice filing (if necessary) 4) Control persons who hold restricted securities must: a) Hold their stock for at least one year. b. there were 47 nonaccredited purchases in that offering (which would blow the exemption). 33 . the §4(2) exemption is available only to issuers and not control persons.provided they do a notice filing (if necessary) b) After one year. just a Reg D. Z issued 2 million shares pursuant to a 505 exemption. subject to all the restrictions in 2). if the company is up to data on its SEC filings. The SEC therefore drafted §4½ .they can sell under volume limitations .provided they do so in regular way broker transactions .subject to volume limitations . b. this is exactly that 4½ is for. 6. Susan now wishes to sell her shares. c. The 4(1½) Exemption [another choice for Insiders] [Because 4(2) is limited to issuers. 5.2) Control persons can (these requirements never go away): [might be better to compel the company to register the offering of their stock on their behalf] a) Sell their stock at any time. . Note the securities you offer are restricted.

000 shares of Microsoft to his son as a gift. Stock Dividends (even with choice) not for value: Companies will often pay out more stock as a dividend on existing stock  if that is a disposition or sale for value. Convertible Stock : Convertible stock involves a sale of two securities. 1) When you register a convertible stock. you probably can’t and don’t need to do it right away). while others not for value are regulated by alternate means (i.you must satisfy either test 1) Either party to the transaction. since the ability to convert into another form of stock is for value. She has held them for 14 months. even though under the for value concept it was perfectly ok. Bill instead hires a broker to sell his shares. Stock giveaways are for value: Companies (dot-coms) were giving their stock away. where stockholders are given a choice between stock and cash as a dividend this is an investment decision and it is for value. cannot receive any sort of tangible benefit (the joy of gift giving is not a tangible benefit). 2. both giver and receiver. sales of securities must for value under §2(a)(3) def of sale. c. However. corporate spinoffs). it’s not a sale by definition and therefore not subject to the §5 registration requirements. 34 . because they are late in their filings. the SEC said that the companies that were giving away stock were getting instant markets in return. But the SEC has taken an anomalous position whereby this is deemed NOT for value. stock dividends). or the recipient must be presented with some investment decision. c. a control person of O company is looking to sell his control block to A. you must register the initial issuance as well as the security into which it is convertible (but if it is convertible after time. b. it does not require registration. certain for value situations are exempted from being for value (i. For instance. it requires registration. Defining For Value: a. A company has been late in their filings. This is an ok 144. 1) Technically. Tests . either party to transaction must receive some tangible benefit. If it is not a sale (under §2(a)(3) for value. 2) This is particularly odd since DRIPS (dividend reinvestment plans) are considered for value. 1) To get around the concept. d. C has restricted A shares and wants to resell them. All discussions have been on a direct and personal basis so far. a. if Bill Gates gives 100. which MUST BE FOR VALUE. instead. This would be improper  he can’t use 144 to do it since it has to be a regular brokered transaction. e. For Value [To be caught by the acts. which was a tangible benefit.e. d. The SEC deemed it illegal.] The concept of For Value is one that is key to securities laws  §5 deals with offers and sales. But the SEC has held this is not a sale for value.e. She can’t do it until 2 years. “FOR VALUE” 1. 2) There can be no investment decision (decision between two forms of economic benefit) on the part of the recipient  BUT just because there is no investment decision doesn’t guarantee that it is not for value. which creates markets in their stock – they were going public overnight without any registration or IPO. this would be a 4½. To be for value.Bill.

4) Integration : is a problem here. Changing the terms of debt or equity: If you change the terms. c) Company wants to do an exchange offer as well as a registered offering. with no consideration other than exchanged shares. If the security they are offering to the new investors is the same as that they are offering in the 3a9. But there is 3(a)(9) – a transaction exemption for exchange offers – [provides an exemption whereby issuers may offer securities to their own shareholders in exchange for existing shares. it will be integrated. b) exclusively with the exchanged securities c) exclusively with no other consideration (Where no commission or other remuneration is paid or given directly or indirectly for soliciting such exchange) 3) Status of 3a9 securities : The status of securities you get when you exchange are the SAME as the securities you give up. and pass that stock off to the shareholders. and involving no other securities. you need not register. 2) Instead. they say that brokers cannot trade the security (with a provision under the ’34 act). it wil be integrated and you will blow the 3a9 exemption. 1) BUT if the changes are immaterial mechanical changes (like changes in the timing of payments without changing maturity). And now you’ve probably blown the 506 as well.Exclusivity does triple duty: a) it must be done exclusively with existing shareholders. Corporate Spinoffs are NOT for value (but regulated under the ’34 act): Company X often has a business Y which it wants to spinoff as a separate subsidiary. 35 . and we blow the 3(a)(9) because now you’re not offering exclusively anymore. Then it distributes the stock to its own shareholders. f. since you likely exceeded the number of accredited investors or engaged in general solicitation. h. it will be exempt. To do this the company drops the business into a wholly owned subsidiary. If you use 3(a)(9) to offer the debenture holders the stock that you are offering in 506. If you have a debt security out there and you are doing a 506 offering of common stock.e. holding the stock as a corporation. In this way they accomplish a ’33 act regulation through the ’34 act. you must register it as a new offer  it is an offer for value. g. exchanges of one security for another would be for value. 1) The SEC is driven crazy by this: like the dot-com giveaways. it creates a market in the stock of the subsidiary without registration. Exchange Offerings : Technically. This violates 3a9 since it is extra remuneration. The standard is materiality: whether a reasonable investor would consider the change to be a material change in the security. b) Extra money given: no good. The exchange must be done exclusively .] 1) If an issuer offers to exchange one security for another with it’s own securities holders . 5) Examples: a) Company offers tax advice to help it’s existing security holders who take other securities instead. Changing the state of incorporation: the SEC has taken a position that changing the state of incorporation doesn’t change anything. and follows the following rules. provided such offering is done exclusively with existing shareholders.

a) Parties defined: the entities involved in the transaction (but not the issuer). and the their affiliates. but not a stock split or change in par value b) a merger where new securities are exchanged for old securities c) certain kinds of asset transfers involving the issuance of new securities 2) Gun Jumping Safe Harbor: But under that interpretation. c) Example : in a standard merger where A issues stock and gives it to B shareholders in exchange for their B stock. as are all affiliates (control persons) thereof. we have a big problem with gun jumping: many of the information leading up to the merger announcement (and the announcement itself) is material information that needs to be disclosed. they had a change of heart. 36 . 1) 145(a) : sets out transactions subject to the rule – those where a vote of security holders is taken [required] regarding: a) a reclassification of securities. (it’s not protected under 3(a)(9) because you’re not offering securities to your own shareholders. classic exchange of stock mergers must be registered because they are for value. The solution is 145(b): The information that can be disclosed (similar to 135): a) the issuer can state its name b) the names of other parties to the transaction c) a brief description of the businesses. No shareholders are parties except insiders and control persons. Under rule 145. this has nothing to do with the shareholders or affiliates of A.3. however. With the adoption of rule 145. except the issuer. The affiliates of B are also underwriters. But the actual shareholders of B are not a party to the transaction. for a long time. B is clearly a party to the transaction and is an underwriter of A stock that it receives. the time and place of the meeting to vote on the transaction e) a brief description of the proposed transaction f) any statements required by law 3) The Underwriter Merger Problem ? 145(c) says all parties. READ UP ON THIS a. to a 145 transaction are underwriters. d) the date. b) Defining the former control people as underwriters is relevant because they may no longer be control people after the merger – but we want to prevent them from freely offering the securities. been that mergers (whereby shareholders of Company A receive new shares of Company B in exchange for their stock) was not an offer for value. A is the issuer. Mergers and For Value Problems : Rule 145 [4 things: (1) codifies SEC reversal of position such that exchange of stock mergers are now deemed for value and must be registered [145(a)] (2) provides a safe harbor for gun jumping regarding statements necessary to disclose material information to merger party shareholders [145(b)] (3) imposes resale restrictions on target company and it’s affiliates now deemed underwriters under 145(c) (4) carves safe harbor for resales by such parties [145(d)] – The position of the SEC had. This basically means that the target company and their affiliates are the underwriters for purposes of rule 145(c). However. so they can freely resell.

especially if they don’t quit until after the two years (they will have to wait 3 months). 37 . 3) 145(d)(3) : Company B affiliates who have not been Affiliates of Company A for at least 3 months (3 months cleansing period) may resell stock provided: (1) they hold the stock for 2 years. EXEMPTED SECURITIES 1. §3 Exempts various types of securities from registration altogether – Exempted Securities: [these securities would otherwise meet the Howey test. a. but have been wholly exempted from registration. in particularly because they are control people of the stock they are trying to sell. 2) 145(d)(2) : Company B affiliates who are not affiliates of Company A at the time of the sale in question. If it’s been registered. then none of this matters at all.d) Perhaps the best solution is to simply register the affiliates resales when you register the exchange itself. We’re maintaining their control person status whether or not they’re not control people of the new company – we treat them as if they were. provided they follow 144(c) [current public info as to issuing company]. 5) Note that affiliates of B who become affiliates of A but then leave can use 145(d)(2) as soon as they can satisfy the requirements thereof (for instance. 6) Note that affiliates of B who become affiliates of A but then leave must wait 3 months after they leave until they can rely on 145(d)(3) [because the company isn’t current on public filings]. This sucks for them. 1) 145(d)(1) : Company B or affiliates of B whether or not now newly employed as affiliates of A may resell the issued company A stock they received. 144(e) [volume limitations]. and 144(f) [brokers transactions].S. This was necessary to prevent government entities from regulation one another. must use 145(d)(1). 4) Note that affiliates of B who become affiliates of A through the merger and are at the time of sale affiliates of A. can resell without registration if (note no volume or broker limitations): .Company A has public information available. that it’s been 1 year from the merger). 144(d)(2) or 144(d)(3) to resell their securities: but it may make more sense just to register the re-sales when you register the merger.They hold the stock for at least 1 year . or any state thereof (municipal bonds). 4) Affiliates Resale Safe Harbor: Affiliates caught by the rule can use either 144(d)(1). §3(a)(2): Any security issued by the U. for example government bonds] But they are still subject to the anti-fraud and other provisions – exempted securities are only exempt from registration. and it’s been at least 2 years since the merger.

building and loan association. the less careful you were the more if showed you lacked intent to deceive). or reformatory purposes and not for profit. benevolent. This left people with very limited recourse – the average person would never show these things. Privity of contract: there needed to be some privity between the tortfeasor and the aggrieved party d. j. e. d. §3(a)(6): Any interest in a railroad equipment trust (they were a strong lobby when the ’33 Act passed). it is exempt from registration. g. draft. Misstatement: something had to simply be said incorrectly b. Causation: you had to show the misstatement or fraud was the cause of your loss e. fraternal. §3(a)(12): equity issued in connection with the acquisition of a holding company of a bank under Bank Holding company Act. c. charitable. §3(a)(10): Any security issued by court order i. or optional annuity contract issued by a corporation. b. bill of exchange which arises out of current transactions or the proceeds of which are to be used for current transactions. Scienter: you couldn’t commit common law fraud unintentionally. 38 .1) The determination as to what exactly is exempt is left to the IRS  if it is exempt for tax purposes. So the IRS has stringent requirements as to what is exempt. that has a maturity not exceeding 9 months. or companies excluded under Investment Company Act. educational. §3(a)(4): Securities issued for religious. A word on common law fraud (why the ’33 Act rocks): Before the ’33 Act you had to rely on common law fraud claim (argue it as backup for exam). §3(a)(8): Insurance or endowment policy. trustee or debtor in bankruptcy case. annuity contract. h. and surely no incentive to be careful (in fact. cooperative bank.Any note. or similar. In turn. Reliance: the buyer had to show he relied on the fraud c. §3(a)(5): Any security issued by a savings and loan association. §3(a)(13): A security issued by or any interest in any church plan. f. §3(a)(7): Certificates issued by a receiver. SECURITIES LIABILITY 1. this left no disincentive to be commit fraud. §3(a)(3): Commercial Paper . and the SEC goes by those. and you needed to show: a. 2) BUT the SEC still is able to regulate these securities under the ’34 Act – brokers cannot underwrite or sell a municipal bond offering exceeding $1 million without some form of disclosure statement.

common law) Reliance – you don’t even need to show that you read it. and prevent recovery. You cannot sue on a preliminary prospectus: this is why the SEC was always so concerned about making sure you have a prospectus out there in final form (so there is something to sue on). a. 4(2) – those all require something else as a basis for suit. Who may be sued under §11: 1) You can sue any person who signs the registration statement. This will typically include the issuer themselves (company). Scienter: you can sue even if it was a mistake Causation: you need not show that the loss was caused by the misstatement. CFO. 3a9. b. §11 Registration Statement Liability : §11 only applies to registration statements themselves. CAO. and a specific limit within a syndicate 39 . But sometimes tracing can be a bitch. the CEO.You must not know of the untruth or omission at the time you purchase securities – we don’t want people buying lawsuits. You need to show that the stock you’re holding and suing on is the same stock that came from the registration statement in question. c. Requirements: 1) It must contain an untrue statement of material fact under TSC (that a reasonable investor would consider it important) OR it must omit a material fact that makes the statement misleading. Liability under §11 is Joint and Several : except more recent amendments say that directors can sue one another for contribution.2. (Probabilities won’t cut it – can’t proportion liability based on proportions of stock out there). a) It is against SEC policy for the issuer to indemnify anyone who is personally liable (Globus) 2) Underwriters are liable as well: they get the same liability as the issuer – which serves its purpose  underwriters are as a result very careful about what they do. 3a11. D. and all the directors (whether they call themselves advisory board or whatever. 3) What a) b) c) you don’t need (vs. a) Instead. 2) Privity not really needed (contrast §12): The purchaser must simply be able to trace his shares back to the IPO through a chain of other securities holders. It does not apply to Reg. whether they actually sign or not). a) BUT Standing . they just take large commissions to cover the risk b) They are only liable up to the amount they underwrite. or even have resigned [don’t want you to put big names on reg statement without liability to them] who can all be sued personally. d. and outside directors may be given proportional liability under §11(f)(2)(a). whether they are about to become directors or already are.

) provided they can provide that: 1) After reasonable investigation (so you build a big file together for each person involved to show diligence 2) They had grounds to believe.Director was in similar boat. .Kirsher was the CFO and a CPA – it was impossible that with a tiny bit of digging he wouldn’t have found out. Those with certain responsibilities will be subjected to a higher standard in that area of responsibilities (sales vs. (1) The varying standard doesn’t excuse anyone. but is not liable when didn’t know about 40 . finance). underwriters etc. and did believe. provided they didn’t know it was a wrong statement and they used a reasonable expert in his field. 5) Standard : those claiming due diligence defense will be held to the standard of a reasonably prudent man in the management of his own property (except for experts – different standard). §11(b)(3) Due Diligence Defense : No person (other than the issuer.Lawyers should have known certain contracts not legally binding. who is always liable) can’t be liable for the expert’s statements. and he made all the arrangements – highest standard for due diligence defense. that the statement made was not untrue. a) Standard: the expert needs to do the thorough job that would be the standard for a prudent expert in that field. but the SEC makes them agree to potential liability). 4) You can rely on experts. BUT Defenses : e. Russo was CEO and on executive committee and knew everything that went on. If they are a recognized expert. . but it may make a difference when it’s a close call. (2) BarChris: Bowling alley goes belly up because of bad financials. 3) Can’t use due diligence defense if you left disclosure up to the lawyers like in Kern. people who are liable for the statement (except issuer. need to know obligations under statute. so long as they are reasonable experts. b) Likewise. there is no liability. . Outside directors without expertise probably less stringent standard than outside one with expertise. directors. who will always be liable if something is wrong) shall be liable for statements or omissions (so this covers the CEO’s. and less than CEO and CFO.3) Experts can be liable: Experts are liable for the section they provide an opinion on (they don’t actually sign the prospectus. they act in good faith (believe they were right) and do what they are supposed to. a) BUT each person is held to a slightly different standard. c) Lawyers may get squeezed into this liability. but only if they expertise something.

§11(b)(1) Person Withdrew and informed SEC : Note that under §11(b)(1)(b) directors who resign must also inform the SEC why they have resigned in order to escape liability under §11. then it drops to $8. you might wanna try to use §10(b)(5) because it will allow for greater recovery (not limited to what falls below offering price). – he has to visit the plant and ask questions to the experts that the travel agent didn’t know about. f. 3) Note that provided you can show reliance and scienter (which may be hard). 6) Rule 176: Not a safe harbor. then no damages. You’re ok for the other 500 (though the 500 that didn’t get prospectuses can sue you under §12(a)(1). Both will have to ask questions and investigate. h. but cannot claim he thought they covered everything when a little bit of digging would show otherwise) (3) Example: plastics company has two directors and they are preparing prospectus – one is college chem. b) Damages can never exceed the offering price. and you buy in at $90. but lists relevant circumstances in determining when the conduct of a person is reasonable (not exhaustive). 3. and in 500 instances you forget to send prospectus. §12 Direct Privity is required: Only direct purchasers may sue (and only those who show that the stock they bought was attached to the violation) 1) Example: suppose you sell stock to 1000 people. 2) New amendments permit the defendant to argue for a limitation on damages where the stock price went down for reasons other than the securities violation. If IPO for $10. If it went to $11.You can’t waive compliance with any provisions §12 Liability: a. in no case more than 3 years. §14 . a) If the price of the stock went up despite the discovery of the misstatement. 2) Minority view: you can set up a chain of privity 41 .- financial transactions (was entitled to rely on financial statements prepared by accountants) Outside director not liable for expertised portions (entitled to rely on experts. §11(e) Damages : 1) The amount of damages under §11 is the difference between the amount paid for the security (AT THE OFFERING PRICE) and the value of the stock at the time the suit is brought. Statute of Limitations : is very short . Prof and the other is a travel agent. i.§11 must be brought within 1 year of discovery of the cause of action. g. but more is expected of the prof. no damages. you can sue for $2.

Gustafson: Sale of stock in private transaction. 3) The case confuses IPO. you need to have been one of the people for whom §5 was violated. gun jumping. This means that 12(a)(2) may or may not cover 504. Defense tried to assert that a Reg D offering (where disclosure documents are required but it is not a genuine full blown prospectus) is not covered by 12(a)(2) liability because not “by means of prospectus. the violator is ok.” The court actually bought it. But to have standing. since the word prospectus in the Act is being strictly construed so as to mean a prospectus for a registered offering. 1) Remedy: purchaser gets his money back plus interest (that’s it). But everyone is wrong since they say that only public offerings require disclosure (when in reality almost all private placements also require some form of disclosure) Ginsburg knows the deal. 1) By a strict reading of Gustafson. 3a11. The dissent is actually correct (Thomas) when he points out that the majority is reading the word prospectus in the statute too narrowly. Statute of Limitations : is very short . and a bunch of other terminology. since they cut 12(a)(2) down to do exactly what §11 already does.she says.§12 must be brought within 1 year of discovery of the cause of action. This basically sets up liability for the prospectus or oral statements that accompany it. 1) Remedy: purchaser gets his money back plus interest (that’s it). §12(a)(2) : any person who offers or sells a security by means of a prospectus or oral statements relating to it that contains a material misstatement (or material omission). but it would surely exclude something like Reg D offerings. This basically just gives teeth to the requirements of §5. §12(a)(1) : any person who offers or sells a security in violation of §5 – this covers blown exemptions. 4) There is no reliance requirement. 42 . Likewise. failure to deliver prospectus. failures to register. what about private offerings boys? a) By that reading. A’s of a public nature. 2) The case seems to say that only registered offerings would be covered.. or Reg. made by anyone selling the stock. c. 2) But §12(a)(2) has a due diligence defense (that IS available to issuers as well [compare §11 due diligence defense not available to issuers]). and that makes no sense (be sure to include this on exam). This is ridiculous. 2) Note there is no scienter. d. 12(a)(2) is limited in its reach to registered offerings by issuers and their control persons. then you’re ok. Limiting 12(a)(2) . If an issuer has used a bad prospectus but has done reasonable investigation in preparing it. primary offering. e. oral communications must relate to that prospectus. no causation. §12(a)(1) is a strict liability provision.b. there is no remedy. in no case more than 3 years. 3) 12(b): §12(a)(2) indirectly requires a showing of causation – if the stock went down for some reason other than the misstatement. etc. and no due diligence defense. if you had a fraudulent disclosure under Rule 506.

doesn’t say where you have to make it).). d. you can attach control person liability.b) Likewise. shall also be jointly and severally liable with that person.) Even where there are no damages under a private right of action (price didn’t go below offering price). It is very broad : It shall be unlawful (you can end up in jail. Control Person Liability : Once you find liability for the issuer or other person. Backup Liability – Respondeat Superior: control people are liable like in any other tort action for the acts of people they control (but that’s state law) 1) Advantange: RS is useful where the control person escapes liability of §15 or §20 because of the exception for lack of knowledge or reasonable belief – you can still get them on RS. fined. Note there is no state of mind requirement for control person liability – you simply need derivative liability. §15 of the ’33 Act– “every person who controls a person who is liable under §11 or §12. shadiness etc. they are just liable. Rationale : control people ought to have some responsibility for people they control. impropriety. Exception : good faith defense . 2) To satisfy the burden you need to have checks and balances in place. §20 of the ’34 act covers. The defenses of §11 and §12 are not there. b. there is no liability. §17: The SEC Liability Section: §17 casts a very broad coverage for the SEC to impose liability on issuers and other parties – but there is no private right of action under §17 – it is limited to the SEC only. b. you can’t stick your head in the ground – if you control a company. Control person liability is necessary to catch the people who would otherwise slip through the cracks (for instance. to engage in any fraud (broad. 5. c. there is SEC liability and they will bring action against you. 4.if the control person has no knowledge. to make any untrue statement (broad. a. you need to control it (but you only need to be reasonable). they can attach liability to any fraud. but there is some language regarding scienter in §17 – which may provide a similar type defense for the defendants. majority controlling shareholders or officers who didn’t have to sign the registration statement). ENFORCEMENT 43 . a. and then the control person is liable (except defense). you need to do what you can to make sure these things don’t happen. it means it doesn’t cover secondary trading. and didn’t have reasonable grounds to believe (knew or should have known standard).” They need not do anything wrong at all. injunctions etc. 1) Basically. It is the means by which the SEC brings actions under the ’33 act. c. It also prevents senior management from being able to set up a fall guy.

While the ’33 Act was primarily a consumer protection statute (that sought such protection by requiring complete disclosure). If so. a. or disclose too much that they know there’s a problem. a. At this point. They may call you and ask about clients. They can also use the FBI (also dept. THE SECURITIES EXCHANGE ACT OF 1934 1. censures. a. 3. Injunctions: are powerful. but they also can get injunctions. You also need to ask whether your client is a target : but the SEC DOESN’T need to answer that one. c. d. Counsel also may be able to quickly eliminate areas of concern and focus the staff’s attention on relevant information. and may be forced to make a more limited presentation of information. they issue a formal order of investigation. counsel may wish to prevent a wholesale disclosure of broadly identified corporate info. The fundamental tension is disclosing enough to get them off you back. you automatically have committed a criminal offense – they’ve taken a civil remedy and made it criminal. Note that the SEC is not very influenced by the use of political muscle to try to head off an action. Oddly enough. 4. the SEC has no criminal enforcement abilities – they defer to the Justice Department for criminal prosecution. Ferrara and Nerkle – Overview of an SEC Enforcement Action – “Counsel’s preliminary responsibility in the preliminary investigation is to assess tactical considerations for responding to an informal inquiry – counsel must balance the corporation’s interest. 2. There is great incentive to provide the information necessary to allay the staff’s suspicions of violation without graduating to a formal investigation. There is a big problem with these – how much information do you give to the Wells Commission (and you obviously can’t lie) to head off an action while still retaining ammo for he defense. fines. since they get injunctions saying you won’t violate securities laws anymore – and if you do. b. the target can issue a Wells Submission [Before commission begins their formal investigation. The staff at the division of enforcement at the SEC begins by opening a file on you – they take their complaints from the public very seriously – but at this stage things are very informal. The staff now goes to the commissioners and they vote on whether to issue formal investigation. The SEC has no subpoena power at this power.1. the ’34 is actually a regulatory statute – it tells business and people alike how to conduct their affairs. The SEC has to tell you if it is. The SEC loves to settle. 5. Now they have the power of subpoena to get all the info they need (it’s a big deal). 44 . while retaining ammo for defense and without incriminating self] . But it worked in Wheeling Pittsburg Steel. This is tricky since you should cooperate to the point that it helps your client. At this point you need to ask whether this is a preliminary investigation. Always have your white collar defense lawyers review your submission – but don’t have them sign it (it makes it look like you’re admitting something is up). suspensions. target can submit disclosure of information to head off action – the tension is providing enough info to get them off your back. On the other hand. of Justice) for their services. or cease and desist orders against you.

d. Abusive Practices : §9 . 2) This covered Wash sales. b. Margin Trading : Used to be you could purchase stock using the stock itself as collateral for a loan you used in the purchase. a self regulatory organization that must report back to the SEC but handles applications for new broker dealers and regulates existing ones. broker dealers. §11 – those acting as brokers cannot trade against the market – a broker on an exchange can only take orders for his customers. public companies. 4) In theory. The SEC is a 5 commissioner body appointed by the president and approved by Congress – except that not more than 3 of such commissioners can be of the same political party. c. everything must now be a bona fide arms length transaction – you cannot manipulate or set price. in between ’33 and ’34 you registered with the FTC. The ’34 Act Created the SEC [Unlike the consumer protecting ’33 act. which were now prohibited (trading back and forth between involved parties to drive the price up. a republic comes on.2. 4) The actual day to day regulation of the broker dealers is deferred to the NASD.It shall be unlawful for any person to use the securities exchange for the purposes of creating a false and misleading appearance of active trading with false prices or false orders. 6. 3) §15 – to form a broker dealer you must have significant capitalization – we don’t want them going belly up. In addition to creating the SEC. This was a response to many of the abuses that led to the ’29 crash. §6 – all exchanges must be registered. insiders. b. this means that the prices in the market are a true reflection of the value of the stock that the whole anonymous market attaches to it. In practice this means that when one democrat comes off. the ’34 Act also regulates multiple facets of the securities industry: exchanges. 2) Exception: Of course. 1) The concern is that the broker is supposed to negotiate for you the best price on the stock purchase or sale – if he’s in there for himself there is an inherent conflict of interest. 3) Basically. 1) §7 sets up a series of rules as to how and when (if at all) you can trade on the margin. 3. One thing the ’34 Act Regulates is Exchanges and the way you trade in one: a. 45 . tender offers. it provides for various anti-fraud provisions]. Likewise. This was intended to de-politicize regulation and instill confidence back in the market. As a purely historical note. a. he cannot trade for his own account. the ’34 act is a regulatory statute. The ’34 Act also set up and authorized filings under EDGAR . The ’34 Act also regulates Broker / Dealers : a. §5 – it shall be illegal for anyone to trade securities in an unregistered exchange. brokers can trade on their own accounts (big banks do it all the time) so long as they use a third party broker that anyone else would use.

Where an issuer desires his securities be publicly traded. then you are subject to the reporting requirements of the ’34act. b. They need to be licensed by the SEC. there are other requirements: 1) §13 : you must make periodic filings (10K is yearly and gives audited financials. 10Q simply gives unaudited financials and both give info about the company including how much execs get paid. periodic filing requirements and §16 insider regulation (as to registered stock). they have put info out there in the public eye about themselves.a) §19 regulates SRO’s and establishes their authority. Once the company files the form 10. 1) You only need to register securities if you want them to be publicly traded – if it’s not then no need to register. 7. (2) NOTE: even if you register the offering under the ’34 act but then only 2 people buy. how much stock execs have. any issuer with more than $10 million in assets and 500 equity shares must register as the same)]: a. which subjects them to. you still have to register the security under the ’34 Act. In order for a public company to have its stock traded on a registered exchange (or if it is above a certain size). which brings reporting company status to the issuer (also. your preferred stock obviously cannot be publicly traded. The ’34 Act also regulates public companies / reporting companies ( §12) [Companies who are required to register under the ’34 act. you still need to remain a public company for one year (at the end of the year you test to see if you are still a public company) – that way those 2 who bought in aren’t left in the shit. For instance. you must register your securities with the SEC. such security must be registered under the ’34 act. it must register that stock (using form 10. The ’34 Act requires a type of registration for public companies (totally different from registering offering of securities). Once you’ve registered as a public company. a) If you register a class of stock. 2) Just registering one security makes you a public reporting company. (1) So if you do a Reg D for 501 accredited investors. inter-alia. 3) Reason is simple: we don’t want securities traded unless people can easily found out about them. a) Exception: if your company has more than $10 million in assets AND more than 500 equity shareholders . b) BUT where the provisions of the ’34 act that are specific to a class of stock are specific to what you register. even if you have multiple classes of stock. whether or not you want the stock publicly traded. a public document that publicly discloses certain info [and financials] about the company). if you only register common stock. but it also means that the §16(a) and (b) provisions do not apply with respect to the preferred. and all relevant 46 .

a. b) Note [CHECK] that you can still use 144 even if you are required to file a 13(d). management decisions etc.). §16(b): Short swing trading – every 16(a) person who buys and sells or sells and buys the company’s security within a 6 month period and makes a profit must turn that profit over the company. 3) Proxy Regulation : §14 strictly regulates solicitation and execution of proxies. c. a. The ’34 Act also regulates Insiders: BUT ONLY IF THE SPECIFIC STOCK IN QUESTION HAS BEEN REGISTERED UNDER THE ’34 ACT. – all within 5 days. you gotta give it up. 2) Note that §16(a) is the least enforced provision in the securities regulations. Rule 10b-5: It shall be unlawful for any person. You must also file the 8K updates. If you trade nothing you file a form 5 re-updating your position at the end of the year. (1) Exception – 13(f): Institutional investors who purchase less than 20% of public company can merely file the 13(d) equivalent at the end of the year as a 13(f). they need to file a 13(d) with the SEC disclosing why they’re buying. 8. but this is sort of prophylactic. scheme. §16 also says it is illegal for 16(a) people to sell their stock short. they must file a form 4. or artifice to defraud 47 . if these same people make trades. This is because they just buy a lot of stock and it would be a pain in the ass. §10 of the ’34 Act: Is perhaps the most sued on section of any federal securities law. the SEC adopted Rule 10b-5 (note that rules under the ’33 act are numbered and those under the ’34 Act numbered based on section they come from). 1) If you buy at 10 and sell at 15 5 months later. directly or indirectly. Under the authority of §10(b). 2) The Williams Act . to: (a) employ any device.facts about company. 2) Theory: the SEC doesn’t want insiders trading their own stock – there are rules for insider trading. §16(a): Filing Requirements : every director. and 10% shareholder must file a form 3 alerting the SEC of who they are and how much stock they own. Sell at 10 and buy at 5 2 months later – give it up. a) You cannot solicit proxies unless you also mail a 10K. where they got the money from. b. 1) every month. 9. principal executive officer. if they want to affect control etc. b) You cannot solicit proxies unless you also mail with the solicitation a proxy statement (drafting is regulated by §14 – it’s easier than a prospectus but still a pain). §13 also imposes requirements for public companies under §13(d): a) §13(d): If anyone purchases more than 5% of sock in a public company. If it was not regulated there would be tremendous potential for abuse – shady issuers wouldn’t give all the info before they took your vote.

Who can sue ? 10b-5 permits a private right of action. this stratifies the reliance requirement – you need to have actually purchased in reliance of the false statement (or relied on the lack thereof in cases of omissions b) For sellers this is more complicated – Mere Diminution in value is not enough – this is not covered [Blue Chip Stamps] – if you want to be able to recover if the stock value goes down. 2) that the conduct in question was “in connection with the sale of a security”: a) We first have to find the thing in question is a security. (1) But if you purchase a stock and then sell it high when the glossy misstatement is made (before it’s uncovered) – you have no damages to sue for. Therefore. 3) Aborted Purchaser Doctrine: isn’t certain to exist. every time someone loses a sale because of a misstatement. and they walk away from the deal because of that misstatement. the doctrine treats the sale as consummated to enable suit in such instance (which is why §3 defines sale as contract for sale)]: someone who was about to buy but didn’t because of the ugly misstatement is treated as if they had bought – otherwise. b) This is why the ’34 act defines sale in §3 as any contract for sale. A private plaintiff suit under 10b-5 requires: 1) that the misstatement was material. a) The aborted seller doctrine comes up mainly in the case of mergers – if you were about to have a merger where some company was going to purchase all of your shares in a merger.(b) make any untrue statement of material fact or omit to state a material fact necessary in order to make the statement not misleading under the circumstances (c) engage in any act. and a material misstatement (negative) is made in the info given to purchaser. 4) But the defendant need not have purchased or sold. the seller wouldn’t be able to sue. you need to sell. In connection with the purchase or sale of any security b. you have no one to sell to before you can sue. and then sue. 2) BUT Aborted Seller Doctrine [Because rule 10(b)(5) requires a violation be in connection with the purchase or sale of a security. But you can sue under aborted seller doctrine. Anyone who purchases or sells securities in relation to the information can sue. but presumably would cover those who claimed they would have purchased if they had known glossy information that was improperly omitted. those injured in connection with a sale may not be able to consummate such sale (because buyer walked away due to misstatement or other fraud). c. practice or course of business which operates or would operate as a fraud or deceit upon any person. [See above] 48 . 1) You must be a purchaser or a seller: a) For purchasers. But the person who buys from you in reliance of those statements has a cause of action.

we have read the in connection with requirement out of the statute. [In Re. Basically. c) 10b-5 is violated when assertions are made in a manner reasonably calculated to influence the investment public [Carter Wallace]. d) All we need. Investors brought a 10(b)(5) suit against the company – does this satisfy the in connection with? The court here found it was in connection with [Carter Wallace]. is that any person. and the price dropped. investors who purchase securities in the market do so in reliance on the integrity of the price. a) BUT Fraud on the Market Theory : is an exception to reliance theory – you need not provide individual reliance if you can show that the market price of a security is determined by the available material information [Basic v. of Am. 5) 10b-5 requires scienter : may be inferred 49 . and should have questioned why the CEO wanted to issue the statements he did. is this in connection with – at some point it gets too remote.b) Texas Gulf Sulfur: They found mother load of minerals but didn’t issue a statement. Shareholders Litigation]. then issued a misleading statement – but they didn’t buy or sell securities. even though the info was in medical journals and not business magazines – it is not a requirement that the information be directed at the public. only that it was reasonably calculated that they can take hold of it and use it. f) Note that Jalil thinks the villain here is the lawyer – he is the one who was giving advice. it gets too remote [In Re Financial Corp. e) But if we get too broad. The drug later proved unsafe and was withdrawn form market. The only requirement is that the statement “touched” in connection with the purchase or sale of ANYONE’s security – the offending party doesn’t have to trade. g) Problems: (1) Company places a series of ads in medical journals for a new drug they developed. Other people did. (2) Anderson was retained to give advice for a company as to accounting practice for issue. Financial Corp. Levinson]. 4) 10b-5 requires causation – the loss had to be the proximate result of the material misstatement in question. whether connected to the transaction or not. The advice they gave it turns out was wrong. But at some point. makes a material misstatement. 3) 10b-5 requires reliance – the plaintiff needs to show that they relied on the misstatement in question when they bought or sold (except in cases of omission – where you shouldn’t have to prove you relied on silence). of America Shareholders Lit].

parallel trades etc. a) It used to be joint and several liability. e) Example: company officials deny that they have a contract that they do – this is scienter: even though you’d argue under materiality that it was good for the company to deny. b) Scienter can be inferred from course of conduct. who made it etc. The reforms have made it harder to sue – the plaintiff has to plead specifically what the violation is. reliance etc. you can say nothing. is scienter. But even actual damages can far exceed the fraud you committed.]. regardless of the purpose. You don’t necessarily have a duty to disclose. It is better addressed by state corporate law. since it greatly limited how easily you could sue [contrast with §11 which doesn’t require scienter. [try to parallel argument]. 50 . whether it’s the same subject etc. but the reform act wrote in proportional liability. Breaches of fiduciary duty not actionable under 10b-5: Sante Fe: case drew the line – there is a distinction between state law for fiduciary duty breach and federal securities laws – even though the breaches of duty may affect stock price. Note that if the company knows something but keeps one person in the dark to make their statements so that they can’t meet scienter requirement – it’s still scienter. d. e. Obviously you need to argue what is “broaching the subject”. but the courts read in the same one from the ’33 Act – one year after discovery and never more than 3 years. 6) Damages: are limited to actual damages – there can be no punative damages. d) Intentionally putting on blinders satisfies scienter requirement. This was huge. Violations Based on Omissions .Affirmative Duties to Disclose: The basic rule is that the mere possession of material information does not require disclosure – companies discuss things in private all the time. Statute of Limitations : Congress never adopted a statute of limitations. Recent reforms to 10b-5 – The Private Securities Litigation Reform Act (PSLRA ) : there has been mounting concern over strike suits that result from 10b-5  people were pretty much suing whenever the stock price went down. At all times other than below. c) A grossly reckless disregard of the truth can also satisfy scienter requirement. Intent to make a false statement. hoping they would just find some violation in discovery. it was false and they made it on purpose knowing it was false.a) Hochfelder: Read into 10b-5 a requirement of scienter. It doesn’t have to be scienter to defraud the public or affect stock price. g. and if asked you can say “no comment” [Basic v. they are not deceptions within the meaning of 10b-5. Levinson]– EXCEPT: 1) When you trade your own stock 2) Once you’ve already mentioned the topic you must give updated details and discuss how the issue or matter changes. f.

the question is whether you still believe the stock’s price reflects the original news. 51 . public or private. the information must be made available to all analysts. Economists think the laws of insider trading are stupid – Jalil doesn’t agree. but then weeks later find out that it doesn’t do what its supposed to – you have to disclose the new information. e) Example: suppose a new drug was developed last year and you made many announcements regarding it – but a year later you find out it was no good – there comes a point when you no longer need to give updates from the original statement. §16 only applies to stocks that are registered under the ’34 act. 10. c) BUT there comes a time when you no longer need to update – the question is whether the stock price is still based on the original news. This is meant to level the playing field. d) Example: you tout a product. whereas 10(b)(5) applies to ANY STOCK. (1) Note that for some companies. the value of their stock may be based entirely on one statement (like for one product they are based on). The idea is that the average investor really believes the playing field has been leveled – once you lose it you take all the integrity from the securities markets. or disclose why the volatility is occurring. 5) By contract with the exchange : if there is significant trading volatility the company must issue a statement saying either that it doesn’t know why the stock is trading so much (if they really don’t). 4) When you’ve selectively disclosed already. you need to disclose if the situation changes . 3) If something gets out there accidentally and its wrong . Be sure to consider that you can’t simply sue under §16(b) short swing profits – since that might be easier – of course. Basically the days of the good old boys network are over.a) Once you’ve broached the subject [once you’ve touched the tar baby]. b) This can push issuers into difficult situations: shady traders who hear about a possible merger may trade the stock a lot in order to get you to announce the merger. A year probably meets the cut. a) NYSE has these contracts. you have a duty to correct the misunderstanding or misstatement. and b) Once you’ve broached the subject [once you’ve touched the tar baby]. you must disclose to the marketplace [reg FD] . Insider Trading : Insider trading liability is a cousin of 10(b)(5) – it stems from the market manipulation prong of 10(b)(5). but only if it somehow came from the company (in which case it’s the same as broaching the subject and having to immediately update). you have a duty to correct rumors that are false. but the NASDAQ doesn’t.Regulation F(d) : where an issuer has made info available to any analyst (intentionally or inadvertently).

Chiarella had no fiduciary duty to anyone – he was just a printer. 2) Who has the fiduciary obligation: under Chiarella you must be trading the stock of the company in which you are a fiduciary (but Jalili believes that the notion of temporary insiders includes people on both sides of a deal). officers. Was there scienter on the part of the defendant? d. it’s never been an issue). he would have been put away (or with misappropriation theory had it been in effect then 3) Note that the in possession of defense doesn’t apply to 14e-3 (or at least. This can potentially run all the way down the line. clerical help – people who have access to the information as fiduciaries of the company. a) Fiduciaries : Anyone who receives the insider information in the course of their employment with the issuer has such an obligation: directors. 2) Try to argue that the information they knew of was simply an opinion or a prediction and therefore less likely to be material. secretaries. 3) It need not have changed their investment decision. it simply needs to have affected the “total mix of information” [Basic]. or that if the insiders had disclosed all this info it would overwhelm shareholders – too much info (rejected in Basic). b) The court ruled that absent some fiduciary duty to someone. it is material (but would a reasonable investor consider it important). c. 2) Had this rule been in place during the time of Chiarella.Approach: a. and they are incredibly important – the rule has been upheld by the courts. Is it related to a Tender offer ? Rule 14e-3: it is illegal to trade on inside information with respect to a tender offer.000. the mere possession of insider information is not a bar to trading. a) Chiarella was a printer who figured out what company was being taken over. regardless of whether or not you have a fiduciary obligation. and made $30. 1) Try to argue that because the insiders were trading on it. People who work at companies always have more info about a company than outsiders – but not all of it is material. 52 . b. 1) It is too hard to police tender offers. What is your position in relation to the company? 1) Chiarella: The mere possession of material insider information is not a bar to trading . Was the information material ? The information obviously must be material before it triggers insider trading prohibitions. traded on the information.

which can be employer. This is textbook misappropriation. any specific confidentiality agreement breached. does digging and finds info – they can’t trade on it either.” [O’Hagan] b) Better example is Carpenter: Column in wall street journal where they write about stuff heard on the street. d) Former employees may be included – otherwise everyone could just quit their jobs to trade without liability. c) SEC Rule 10b-5-2: codifies misappropriation – a non-exclusive listing of circumstances for misappropriation. investment banking firms. (2) Suppose analyst for G.S. G. but not – insider trading). codified in 10b-5-2) This filled the gap (trading by those other than fiduciaries or temporary insiders) left by Chiarella. 53 . technically you’re not liable under misappropriation. c) But try to stretch argument that information didn’t come to them as their role as fiduciaries. Doesn’t matter whether you try to talk them out of trading – if they trade they’re liable. better ex.e.this includes law firms.S.)(O’Hagan. But the analyst can’t herself trade (but probably can if she gets permission from source of info). employment). Employees took the info and traded on it before it was published. Breach of fiduciary duty requirement is satisfied if you misappropriate confidential (non-public) information you gain in some relationship of trust (i. spouse. Carpenter. Lawyers in this case were given info by the company as part of the legal work. (1) Note: If the owner of the journal had traded on the info it would be fine (it’s still manipulation of the market. You must trade to be covered by misappropriation (there can be a chain of misappropriation). child sibling. It’s a relationship included in the rule – it’s misappropriation. a) O’Hagan: Jalil doesn’t like this case because it’s not really a misappropriation case. since that’s the point of having the analysts work for them. (1) “in breach of a duty owed to the source of the information. which makes them temporary insiders in terms of Chiarella. parent. 3) Misappropriation Theory [Trading on material non-public info gained in breach of “a duty to the source of the info” (course of employment. can trade on it. (1) Example: Suppose son tells father info about son’s company and father trades on it. d) But if you tell the source that you’re going to trade. relationship of trust etc. It includes any relationship of trust of confidence. but the court decided to use misappropriation.b) Temporary Insiders : People who get the info on a need to know basis so that they can perform services for the issuer . but the Supreme Court was looking for one. accounting firms.

1) Dirks: was a trader who heard rumors about a company so he investigated by going to the company and interviewing someone. Dirks presents a problem: the SEC has a tension whereby they want to encourage the flow of information from companies – but there are also concerns for tipping and insider trading. you can do it without violating insider trading prohibitions. One way to do this is to set up a stock sale or purchase plan. (2) you instructed another person to buy or sell securities. he’d be liable as a tippee. (3) adopted a written plan for trading securities. Why are you buying or selling the stock? 1) Exceptions: Insiders need some way to be able to trade stock  hence the distinction between trading on the basis of material insider information vs. (1) The rule (b) creates a presumption in (b) that you’re trading on the basis of unless you can prove otherwise. 54 . merely possessing it [Insider trading liability requires trading on the basis of material non-public info – yet insiders are frequently (if not always) in the mere possession of such info]. f. b) Dirks didn’t trade on his own account – so there is no misappropriation theory to be applied here – so what kind of liability is there? Dirks was innocent – if you got the information from the insider and the insider neither received nor expected any benefit from giving the info (dispassionate conveyance). e) Example: law firm finds out information about a company they do work for. a) Adler: If it can be shown you were going to trade anyway. c) SEC Rule 10b-5-1: codified and limited Adler. (2) The defenses (c): you have to demonstrate that before you became aware of the info. d) Adler had to sell stock because of a financial predicament.Tipper-Tippee Liability: The test depends on whether the tipper has himself breached a fiduciary duty (by receiving a personal benefit) by divulging info.e. So you need to show an affirmative defense to prevail. and they had just put in an order to sell the stock (the info is damaging) – you need to be able to show that you put in the order before you came into the information (or perhaps argue it’s not material information). there is no violation. a) As a preliminary matter. not because of material information. you (1) entered into some binding contract to trade. He called all his clients and told them to dump the stock based on the info. so you have a presumption that you’re trading for reasons other than the material information. How you got the information . Had Dirks made promises of benefit to the tipper. b) Also try to argue some legitimate purpose in the trading – need to raise money etc.

55 . you want to be a hero as an analyst – that’s all enough. it contaminates the whole chain. (2) BUT only those who actually either trade or tip with expectation of benefit will be liable in the chain after the original taint. d) Note that once the chain is tainted from the original tipper (because they expected benefit or if they misappropriate the information).(1) The gain need not be pecuniary: you can expect future business. so long as you didn’t intentionally spy on them . you’re liable for misappropriation (wholly separate liability). The person you told is now liable under Dirks and O’Hagan – and anyone on the chain after them is also liable (provided it can be shown that they knew it was misappropriated in the first place). being pissed off at your boss and wanting to talk to screw the company. 2) Recall you can also have chains that are tainted by misappropriation (maybe – not yet decided by Supreme Court). If you spy. it could be giving the info to a relative so they can do well for themselves. Those who have traded are liable under Dirks. (1) The chain can be tainted from any point along the chain forward . a) Electrician case: electrician is doing work in building and intentionally sets his schedule and positions himself so as to hear more things to trade on. That’s misappropriation. 4) “The trip wire for Dirks is very slight” [Jalil] – if you give an interview and tell them info so that you’ll get favorable reviews in the future. c) GET QUOTE FROM DIRKS ON how otherwise it would have inhibiting impact on the market. But in any event. we can’t use misappropriation on him. 3) Schritzer: Overhear you can trade – But you cannot intentionally spy Suppose you’re on an elevator and you overhear people talking about a merger – you can trade on it. once you’re caught by Dirks. the problem is really those who haven’t traded. provided the people beyond the point of taint know of it . It’s a free country (so long as it’s not covered by 14e-3). it becomes common rumor and people don’t know where it’s from – they aren’t liable]. e) Dirks is used to get the tipper who doesn’t trade – because he has not traded. it’s tainted all the way down the line – provided you can prove that each person knows where the information originally came from and that it was a Dirks violation [eventually. that’s probably enough of an expectation of a benefit. 5) Dirks liability chains can begin with O’Hagan Misappropriation: suppose you tell someone in confidence information that you merely overheard (you had no duty whatsoever) – and then they tell other people.by either a financial benefit. or any misappropriation.

the SEC can sue you for up to 3 times the money you made (or kept / didn’t lose) – this is basically treble damages. Liability [Chiarella] 2) Insider has law firm. h. Primary / Secondary / Aider and Abbetors a. a) A is liable (see above). A tells B without receiving benefit. but was somehow not the person who received any benefit from the transaction. but didn’t get any of the payoff – he acted intentionally with malice aforethought. he’s liable under Dirks (obviously he meets the requirement of knowing where it came from and that it was tainted. but did so for his own good purposes. but it is someone who knowingly helped the primary violator. EXCEPT THAT: 1) SEC Suits: under §21(a) of the ’34 act. b) Rationale: as a trend. Secondary Violator [Someone who knowingly helped the primary violator. he didn’t give any benefit before he tipped. You can recover nothing. b) If A tells others. Examples: 1) Insider trades on material non-public information. b. a) If A does nothing. there is a growing prejudice against private securities litigation – the idea here is to let the SEC take care of business. 2) Private Suits: the damages recovered by the SEC get deducted from any possible recovery by private plaintiffs. b) B is NOT liable – he didn’t trade. This is the culprit himself. 56 . and he gave the benefit to A). if he tips for no gain. and they can recover the difference between the price they purchased or sold at and the market price after the material information is made known. and he received no benefit as well. B tells C for no benefit. He had malice aforethought and acted intentionally. and only because he knows where the info came from. for which we rely on the brightline and substantial participation tests (easier standard). he had already given benefit to get the info) c) If A trades. You sue and are able to recover $1 million. he’s caught. but only because he traded.g. ACCESSORY LIABILITY 1. whether for gain or not. Insider is liable as tipper under Dirks. but didn’t get any payoff. Damages: you can be sued by both the SEC (and you can go to jail) and any private plaintiff who qualifies under 10b-5. Only primary or secondary violators can be sued by private plaintiffs. who trades and knows where info came from. no liability. a) Example: suppose the SEC gets you for $3 million. He’s the bad guy who violated the law without question. c) C is liable. 4) Insider tells A for benefit.] the law is gray. Primary Violator [Primary violators are the culprits themselves – they re the ones who actually violated the law in question]. He does it for his own good purposes. he’s liable as a tipper under Dirks (if he does it for gain. and lawyer trades. The difficulty is distinguishing secondary from aider and abettor. Liability [Chiarella] 3) Insider tells A of info in exchange for benefit.

we can use brightline or substantial participation test (easier standard). E&Y]: a. If they had the intent to cause a violation. The announcement includes audited and unaudited financial statements. a) The theory of the holding was that if you were really going to require scienter in 10b’s. Substantial Participation Test : is less stringent that brightline standard. then you couldn’t have liability for those who lacked genuine intent (though recklessness probably still satisfies intent). so under a consistent reading the SEC shouldn’t be able to bring aider and abettor liability at all. and it later followed that the SEC had to show the same. but without necessarily intending a violation (if they intended. but they do so without necessarily intending to allow a violation. they didn’t intend the ramifications of what they did. a) But try to argue there should be no aider and abettor liability under 10(b)(5) at all: Hochfelder read scienter as a requirement into any 10(b)(5) violation for private litigants. The price of shares then plummet. B’s management had previously falsified its records (but A didn’t know). 57 . – It’s a strict statutory construction. In short. (1) The other theory was reliance – this would mean defendants were liable even where plaintiff never relied on the actions of the aider and abettor. they’d be secondary violators. and merely requires that someone substantially participated in the fraud – which leaves open what that means. Example : A announces it intends to acquire B. 2) Under this test. To distinguish from secondary violator. Brightline Test : a defendant must actually make a false or misleading statement to be held liable – they must be active in the fraud. gross negligence or recklessness may satisfy “knowing” you were aiding. and shareholders sue B’s management and A’s management. 1) Central Bank of Denver : limited liability for aiders and abettors – because there is no private right of action against them. They must be an active participant. A discovers it and discloses it. 2. c.c. they’d be secondary violator). b. Note that private plaintiffs cannot sue aiders and abettors: they facilitate. the SEC can still sue aiders and abettors. Aider and Abettor [Someone who facilitates the primary violator. (2) “The absence of 10(b) aiding and abetting liability does not mean that secondary actors in the securities markets are always free from liability under the securities Acts. The Supreme Court has reaffirmed this (as has Congress in the PSLRA). 1) Critics of the test say it reads out important distinctions of Central Bank. The requirement of scienter is the basis for Central bank. B’s management once again overstates the firm’s combined earnings in the announcement. How do you distinguish between them [Wright v. 2) Of course.

If you apply the substantial participation test they may be liable as secondary violators (and they’ve used unaudited financials. DUTIES OF THE SECURITIES LAWYER 1. so the question remains – what do you do? b. and if they don’t listen the only alternative is noisy resignation. c. The merger went through and everyone was happy. The SEC brought action against the lawyers. because the client wouldn’t follow securities laws. 4. a. then we move up a notch – they surely pass muster under the substantial participation test. But the court seemed to buy the theory that securities lawyers owe a duty to the investing public (maybe) . but they may even pass under the brightline test – now they’ve done something which is pretty much reckless disregard of the truth. a. Problems of attorney client privilege: In Re Carter & Johnson: the client wouldn’t make proper disclosure. except that he took possession of the outcome – instead of reporting the outcome and letting the issuer decide. The leave it to lawyers mentality sucks. Kerns defended that he was applying the Basic test – this would be fine. A’s management however has the questionable liability – they are definitely aider and abettors. they haven’t actually done anything. There was tremendous financial pressure on everyone to get the deal closed. In this particular case he was also a director. 58 . a. The SEC holds lawyers to a high standard. they just felt bad for the lawyers here so they let them off. but some did fight it to the end and won against the SEC. but then the company went under and everyone sued. 3. the best person to see is the ethics prof at your school. 2. But there were problems and they couldn’t issue the letter – everyone looked to the lawyers to close the deal anyway.1) B’s management is obviously the primary violator here. Most settled so we won’t know the outcome. If the board refuses to follow your advice as to proper disclosure (in which case they are intentionally evading securities laws). The SEC took action against the lawyer. The case was eventually dismissed on a technicality. There need be a distance between securities lawyer and the issuer. who they claimed owed a duty to the general public as securities lawyers. That’s wrong. not as director. not the lawyer. First – go to the board of directors. so that is perhaps substantial participation) – But under the brightline test. Note that when you have these difficulties. but it couldn’t close until a comfort letter was issued by accountants (saying we don’t that things aren’t kosher). but may not be secondary. National Student Marketing: there was a merger that had to close by 4PM on a certain day or it wouldn’t happen. 2) If instead B’s management had been convicted of falsifying the records. Kern: company left their disclosure obligations and decisions to the securities lawyer (S&C) – it is not the job of the securities lawyer to decide what is disclosed. and they will visit the sins of the client on the securities attorney. b. These are decisions for the issuer. b. he actually did the test and then decided. They said you had an obligation to make the client follow the rules. but he made those decisions in his capacity as a lawyer. SEC v.

re-investing or trading in securities. a.their role in these tests needs to be as an investor to meet the tests (they need to be on the investor side of the securities in the tests below). Investment pools today are more commonly known as mutual funds . in a business other than investing. Despite the subjective test (issuer holding himself out as primarily engaged in trading securities). Conceptualize the test as – is the company’s business primarily being an investor .Holding Company Exception [you’re not an investment company if you can qualify under §3(a)(1) if you are engaged. the SEC position under rule 3(a)(1) is that you’re not an investment company if less than 45% of assets are in securities. It is an extremely complicated and detailed set of regulations for the investment companies.INVESTMENT COMPANIES 1. through a subsidiary. the ’40 act requires that you meet characterization as an investment company. In order to discuss any of these tests to see if you’re an investment company. the objective test (issuer engaged in trading securities and investing more than 40% of its assets in securities). you’re an investment company a) Rationale: every company has cash that at some point they put into securities – this protects them from being caught by the definition. 59 .] Like the ’34 act. it’s a company whose primary business is investments in securities. the ’40 act is a regulatory act (contrast the consumer protection nature of the ’33 act). an issuer is NOT an investment company if: a) less than 45% of its assets are in securities. This basically exempts holding companies from having to register under the ’40 Act.] Just as the ’33 act requires your instrument to be a security before it’s regulated. directly or indirectly. There are three real “tests”: 1) Subjective test: Any issuer which is or holds itself out as being engaged primarily in the business of investing. After the crash of ’29. 2) Objective test: Any issuer which is engaged in the business of investing or reinvesting or trading in securities. 3) SEC Rule 3(a)(1) : Notwithstanding the objective test. Congress was also concerned with investment pools – the potential for abuse created by such pooling investment arrangements was rather large – both in organization and implementation. and owns or proposes to acquire securities having a value in excess of 40% of its assets – if 40% of your assets are in securities. you need to first decide if the things you hold or trade are even first securities – you need to first define the thing in question as a security . but the term is nowhere in the ’40 act. and less than 45% of income comes from the same.]: You’re still not an investment company if b. 2. the ’40 act regulates investment companies. AND b) less than 45% of its income is from trading of securities 4) §3(b) . §3 – Defining an Investment Company [Conceptually. This regulatory statute mandates registration and carves exemptions therefrom. Investment Company Act of 1940 (’40 Act) [intended to target pre-crash abuses of investment pools. and dictates organizational and operational rules and regulations.

7) BUT : Rule 3(a)(2) Transient Investment Company Doctrine [Upon liquidation. 2) How do you get securities in the hedge fund to the 100 people in the first place? You use 506 accredited investors. to hedge funds : they typically can get into the billions. b) Of course. you’re NOT an investment company for one year (grace period).you’re an issuer that is . and now they are an investment company. whose sole operation is to hold securities and would otherwise be caught by the §3(a) definitions. c. so long as you have a good faith intention of doing something with the cash other than investing it in securities. This is huge. if they themselves are an operating company (like a bank etc. But for the ’40 act exemption itself. companies have a one year grace period from being declared an investment company subject to registration requirement. 1) This led. the SEC can selectively exempt you if you apply to them with what they believe is good reason. a) Exception : it is ok for the 10% or more holder. if any issuer investment company has less than 100 owners. It’s a de minimus exemption. an individual can own 50% without any problems – they’ll still always be one person. we don’t care about the character of the investors. it is not an investment company. 60 . so you can offer the securities in your Hedge fund to as many as you want – so long as you don’t sell more 100. 5) §3(b) SEC Discretionary Exemption: Even if you get caught by any of the above definitions. The SEC brought action against them – more than 40% of their assets were in securities. you’re not an investment companies. Initially intended to cover small scale investment clubs. 6) Inadvertent Investment Companies: Fifth Avenue Coach Lines – bus companies used to be privately owned – they sold all their busses and got out of the bus business. a) Basically. directly or indirectly through wholly owned subsidiaries. but they simply make sure they keep it under 100 investors and avoid registration as investment companies. 3) BUT The 10% Test : Any entity which owns more than 10% of a §(3)(c) (1) gets looked through for purposes of the 100 investors. most notably. b) This exempts holding companies.] Notwithstanding §3(a). provided you have a good faith intention to do something with their money other than investing it. and they will not be looked through. §3(c)(1) – Investment Club / Exemption [Issuers that have 100 or less owners (subject to formed for purpose of doctrine and 10% test) will not be investment companies and are therefore exempt from ’40 Act registration.) – our concern with the 10% is merely to prevent funds of funds. primarily engaged in a business OTHER than investing. if through your subsidiaries you’re engaged in a business (by meeting the tests set up above [we look through the parent and check the percentages based on the sub or subs] other than trading securities. this exemption “backfired” and led to billion dollar hedge funds. but instead of dissolving they held their cash and decided to invest it.] Notwithstanding the definitions above.

7) Recall however that two years later Long Term Capital (hedge fund) almost single handedly brought down the securities markets. it’s one of two types of permitted registered investment companies. UIT’s are characterized by a static. we statutorily permit clone funds – you can have a 3(c)(1) and a 3(c)(7) together without them being integrated – it’s a specific exception to integration. no more than 40% of their assets can go into this §3(c)(1) investment – 60% must be in something else. provided all of them are qualified purchasers. For the 100 person count to the exemption. a) Must be a static portfolio – on the day you form the fund. 61 . and invested elsewhere in good faith. or b) Any institution that invests $25. And creative ways to get around it are unacceptable. you can’t take things our or add. d. An integration exemption permits parallel trading of a 3(c)(1) and 3(c)(7) (clone funds): a) Any individual who has more than $5. unmanaged portfolios. that are readily redeemable under forward NAV pricing] : often times called a bond fund. This permits you to have your 100 any person 3(c)(1).000. institutions that invest in excess of $25 mill). 8) BUT Integration : applies to §(3)(c)(1) – if you try to organize several different §3(c)(1)’s to get around the 100 person rule. we apply the formed for the purpose of doctrine – if entities were formed for the purpose of counting as just one investor. and run a 3(c)(7) of all qualifieds on top of it as clone fund.000 overall. you can’t trade. a) If they were recently formed. This is the mechanism by which you can have your 100 person 3(c)(1) and unlimited amount of qualified investors above it. 6) In order to permit 3(c)(1) to work with 3(c)(7) properly.000. Normally that would violate integration.000. 5) §3(c)(7) made it even easier for hedge funds: it permits a 3(c)(7) hedge fund [similar to as 3(c)(1)] to be an unlimited amount of investors .4) BUT Formed for the purpose of doctrine applies for purposes of the §3(c)(1) exemption. §4 Types of Permissible REGISTERED Investment Companies: You must be one of these two types of companies if you want to operate as a registered investment company: 1) Unit Investment Trust (UIT) [Often called a bond fund. they will be treated as one §3(c)(1) and now you have exceeded the number of investors allowed. you must add to it the shares that are to be included in it. a) Cloning Funds Exception: it is permissible to organize a §3(c)(1) and a §3(c)(7) that trade identically. 3(c)(7) permits exempted investment companies with an unlimited number of owners provided they are all qualified purchasers (indiv’s with $5 million. So a 3(c)(7) would be a fund of all qualified purchasers [expanding on 3(c)(1)’s exemption of investment companies with less than 100 owners. and that’s it – it’s not managed. but it’s ok in this particular instance. we’ll see through it.

§7 – The Registration Requirements: You cannot operate an investment company (so it’s good to escape the definition by using the exceptions) unless you register with the SEC as a licensed investment company (costs much time and money).000 – this isn’t for amateurs. This is true mutual fund. willing. and then you need to register under ’33 Act to do your offering of securities in the fund itself. Once you have a registered investment company. since they must always be liquid since they worry about redemption. with no market for them) and closed end (not redeemable / illiquid. 2) You cannot even organize for registration unless the sponsors put up $100. so they are totally illiquid. developed market for them. 1) Registration as an investment company is wholly separate from registration to do a securities offering – this means that you first need to register the investment company under the ’40 Act. They are actively managed funds. b) Closed End Fund : they cannot redeem their shares. and then buys and sells stocks every day – it actually manages the portfolio. But the lack of redemption permits them to create more long term investment strategies (no worry about liquidity). c) Forward Pricing: Redemption must occur at the price of closing that day (NAV (Net Asset Value) – if you call to redeem at 10AM. you cannot be on the board (unless you go to the SEC for a “pardon”) 62 . This creates a problem. But of course. a) Open End Fund : you must stand ready and willing to redeem securities at the NAV under forward pricing. permits long term investment strategy)] Sells shares in the fund to get money. f. There is no market for open ended funds because you can redeem them whenever you want. 3) If you want to call yourself a diversified management company (by statute) [A Management company whereby not more than 5% of management company’s assets are in a single issuer. with two main types: open end (readily redeemable at forward NAV pricing. : a) No more than 5% of your assets can be in a single issuer AND b) You can’t own more than 10% of a single company e. since they don’t worry about investment. it’s one of two permissible types of registered investment companies. you will get redeemed at the closing price for the next day. 2) Management Company [Often called a mutual fund.b) You must be ready. there are tons of rules: 1) The board of the investment company a) If you’ve been convicted of a felony in the last 10 years. and able to redeem it for the investors. there is a massive market for them. If you call at 4:01PM. AND the management company can’t own more than 10% of any single issuer]. they will redeem you at closing at whatever price it’s at. The investors must be able to get their money back whenever they feel like it.

2) 3) 4) 5) 6) 7) 8) 9) 3. d. and we don’t want conflicts of interest. c) You must use outside brokers to make sure the sponsor wouldn’t just churn the fund for commissions. a. Advice on sale of crude oil or real estate is not investment advisor – but advice on something like variable insurance policies is gray area. If you put an ad in the paper or your name in your lobby. It is illegal for investment funds to take a portion of the gain (otherwise. most notably prohibiting contingent fees based on performance. Investment advisors cannot collect payment based on performance of advised investments. Amount of money they can spend on ads is regulated. Note however that hedge funds can do whatever they want. b. b) The majority of directors must be unaffiliated with the sponsor – This is because everything is contracted to the management company. they would make speculative investments since they make money either way). you yourself must register as an investment advisor no matter what (contrast with people who escape ’40 act registration) Exemptions: 1) Any investment advisor whose clients are all insurance companies 2) Any investment advisor with less than 15 clients. First thing. you may not be exempted – depending on how you interpret it. 63 . The Act is a regulatory statute. and does not hold himself out of the public as an investment advisor. you must register. for value. Investment Advisors Act of 1940 (Advisors Act) [Subject to exceptions. The acts work together – if you have a client which is registered under the ’40 act. it has to be related to securities – which brings us back to definition of securities. 5) Publishers of bona fide publication of general circulation is exempted – but there is a concern for the Lowell Case – if you give out your advice in a newsletter. Management fees are regulated by statute (contrast with hedge fund – where they can take whatever commissions or management fees they want). Note that one Hedge fund with 100 members is still one client. You can’t borrow money except in limited circumstances – we don’t want the fund to be leveraged You can’t do short sales You must make it clear to investors what your investing policies and plans are The contract with the management company can’t be for more than 2 years – we don’t want locking up of contracts. but not on no load fund). c. RELEVANCE? 3) Banks are exempted by statute. gives investment advice as to the purchase and sale of securities. so are lawyers and accountants provided they are giving the advice in the course of their profession. Commissions on buy-ins are heavily regulated (commissions get charged on buy in with a load fund. it regulates anyone who. 4) Anyone who advises a charitable organization is exempt.] a.

but no other restrictions. If less. there is little in the way of licensing requirements – must be over 18. Despite registration requirements. you must register with the SEC. f.e. If you have more than $25 million under management as advisor. 64 . you register with a state – obvious exception – if any of your clients are registered investment companies.

....................9 Damages............................5 Electrician case.....31 Control Person Liability............35 4(1½) Exemption.....................45 Broker/ Dealers................49 General Obligation bonds...............................................................................................22 Aider and Abettor......................................37 Expectations of Profit......................................................................16 Carpenter.62 comment letter...............................................................................................................................59 Horizontal Commonality..................................................................40 Family Resemblance Test..........5 65 ...................42 hedge funds.......................45 Access............4 investment contract......54 diversified management company.....2 Brightline Test..........................................51 Integration.......................................................................................................................................33 Aborted Seller Doctrine............................................21 Accredited Investor..............................6 consistent period........................................................................3 Chiarella.......................................................................................................................55 Equity..........3 directed selling efforts..........................1 Insider Trading............................................................................................... 59 Investment Consumption Test..........49 in registration...............................12 individual investor..................................................................................................................................................48 Abusive Practices................3(a)(9)................13 Control Person.....................................58 In Re Financial Corp.7 Koscot Interplanetary.........5 Internet........................................22 Fraud on the Market Theory.........................................35 Exempted Securities............................................ Dubois.............................. of America Shareholders Lit.................2............................................................................................................................................. Levinson.........8 Fifth Avenue Coach Lines....................................................................................................41 Debt..............................................................................................................................................................1 Buried Materiality..12 common law fraud.................57 certificate of designation....................52 clone funds..........................54 Affiliate............60 Hochfelder....12 Blank Check.................6 Howey...........................53 Carter Wallace...........................61 Formed for the Purpose Of Doctrine......49 Central Bank of Denver........ 63 Investment Club / Exemption....................................................62 Due Diligence Defense..................................................16 Best Efforts..................................................................19 Investment Advisors Act of 1940...................................12 For Value...45 Efforts of Others..................................................................3 In Re Carter & Johnson..........3 investment decision..........................................................................................................................34 investor notice...............8 Holding Company Exception.................................34 Corporate Spinoffs..............................................................................................................................12 Gustafson..................................................................61 Closed End Fund..........................60 Investment Company......2....................................................................................60 Firm Commitment...........4 Experts.......................................6 Initial Public Offering.........14 Blue Chip Stamps................31 Aggregation.....38 Commonality..........................34 Foreign Corrupt Practices........40 Economic Reality...50 Hocking v.............................59 Investment Company Act of 1940...........................................................................................................................................35 Creation of a Separate Security...............57 Basic v...........58 Koscot...................................................................16 Forman............4 Formed for the purpose of doctrine.......................28 Dirks...............57 Broker / Dealers........................3 Exchange Offerings.....16 Joint and Several.....1 Globus...............................29 Intrastate Exemption..................................................................43 Convertible Stock.........................18 International Brotherhood of Teamsters........................................22 Adler...................................................................................48 Blue Sky Laws...........................................................39 Kern...................................................39 Gun Jumping..............................................4 EDGAR......

...................................................................... Gross.......................................31 Rule 144a........7 Unit Investment Trust.....................................................................16 Uniqueness...............8 Registration......................................................................................................7 Matassarin v..............43 Restricted Securities...............33 Rule 145...............13 Primary..................29 Stock Dividends.........5 preliminary investigation................................... Landreth......................58 Notes as a Security...........13 Ralston Purina................................................46 Public Offering.............................................................................Landreth v......................................................................52 Rule 155.......................................60 Tipper-Tippee Liability.......11 Proxy Regulation.....................................1 Reves v..............................................26 Rule 176.....................49 SEC vs..15 Mergers....................12 Secondary....................................................21 Real Estate........30 Revenue bonds..............5 LLC’s........................................51 Regulation S..............47 Small business initiatives................................................................13 Rule 144........................................................................................................21 Smith v.....................53 Rule 135................................7 Sophistication........................50 Schlitz...........56 Secondary Distribution.........46 Respondeat Superior.....................................1 Secondary Trading..................................................................27 Regulation D.......56 Primary Offering.........61 vertical commonality................................................................................14 Short swing trading........................9 Life Partners................................10 Regulation A...............................................................................7 reporting companies....................................................8 Rule 10b-5.................2 Securities Exchange Act of 1934.......................................20 Privity...................................................................29 Secondary Offering.........................35 Statutory Underwriter.............................................................53 Tender offer...............................................................................................28 Open End Fund.....................................................................................................................................................................................8 O’Hagan....................................................................................21 state of incorporation...........................6 66 ..................................................................................................................................................................................................45 National Student Marketing............52 Texas Gulf Sulfur.45 Marine Bank...............7 material.......39 prospectus............................................23 quiet period.....55 scienter..............................................47 PSLRA.........................................1 Purchaser Representative........20 Rule 14e-3.........................................62 Margin Trading.......49 The 10% Test.................................................................48 NASD................ Rhoades...............................5 Management Company...4 Marine Bank vs......................................................................................................44 preliminary prospectus......................................................................................26 sale of business doctrine.54 TSC Industries......................................................41 Rule 508..........................53 Municipal Bonds......................................................................................34 Substantial Participation Test......................................................................57 target.............................9 Sante Fe...............54 Rule 10b-5-2..............................................................53 Offshore Offerings..................1 Private Placement Exemption..................................................... Loeb..............................27 Misappropriation Theory... Lynch.................................36 Mini-Registration.. Earnst and Young...............................................50 public companies.............................................................................................................................................................................................................................................................................................................28 Regulatory Scheme...........52 Materiality............... Weaver...............44 Partnership Interests......................................47 Rule 10b-5-1..........44 Temporary Insiders............................................62 order of investigation.............................................21 Regulation F(d)..................................................................................1 Securities Act of 1933.........36 Rule 147..............2 Shelf Filings..........1 n connection with the sale of a security...........16 Schritzer...

.............61 §4-2.....42 §12(a)(2)..........44 Wheeling Pittsburg Steel........... The SEC Liability Section........................................... Foxhill............................45 §10.........................................................................47 §11 Registration Statement Liability.20 §4(1).......................................47 §16(b................24 §506......................................41 §12(a)(1).........................................................60 §3(c)(7).....................................................................42 §16(a).................29 §3(a)(11)....................................................31 Wright v....................19 §3(c)(1)............................................................................16 Wells Submission..................................................................................................30 Virtual Stock Exchange.........view to distribution..............................................................................24 §505................................................43 §2(a)(11)..............................................47 §17\.................39 §12 Liability...............................................................................................................................................................................19 §504...............6 Weiglos................................................................47 Withdrew and informed SEC....................7 Wals vs........................................................................................................................25 67 ............57 ’34 Act.....................................................44 Williams Act.......................................................... E&Y...............................................................41 Wolfson..........

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