Notes Securities Regulation-1

8/3/2019 Notes Securities Regulation-1

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CHAPTER2.3.1 REALESTATEAS SECURITIES............................................................. 18CHAPTER2.3.2 BUSINESS INTERESTS AS SECURITIES .................................................. 18CHAPTER2.3.4 NOTES AS SECURITIES ....................................................................... 18CHAPTER2.3.6 STOCK AS ASECURITY ................................................................... 20

V. DISCLOSURE ANDMATERIALITY.................................................................................... 21CHAPTER3. MATERIALITY ......................................................................................... 21CHAPTER3.1 DEFINITIONOF MATERIALITY ................................................................... 21CHAPTER3.1.1 SUBSTANTIALLIKELIHOODTEST .................................................... 21CHAPTER3.1.2 REASONABLEINVESTOR.................................................................... 21CHAPTER3.1.3 RELATIONSHIPOF MATERIALITYANDDUTYTODISCLOSE .................. 21

CHAPTER3.2 MATERIALITYTYPES OF INFORMATION .................................................. 22CHAPTER3.2.1 HISTORICINFORMATION .................................................................... 22CHAPTER3.2.2 SPECULATIVEINFORMATION.............................................................. 23CHAPTER3.2.3 FORWARD-LOOKINGSTATEMENTS..................................................... 23CHAPTER3.2.4 INFORMATIONABOUTMANAGEMENTINTEGRITY ............................... 24CHAPTER3.2.5 SOCIAL/ENVIRONMENTALDISCLOSURE.............................................. 25

CHAPTER3.3 MATERIALITYINCONTEXT:TOTALMIXOF INFORMATION...................... 25CHAPTER3.3.1 TOTALMIXTEST ........................................................................... 26CHAPTER3.3.2 SAFEHARBORS FORFORWARD-LOOKINGSTATEMENTS...................... 27

VI. REGISTRATION OF SECURITIES OFFERINGS ................................................................... 29CHAPTER4.1 REGISTRATIONOF SECURITIESOFFERINGS ................................................ 29CHAPTER4.1.1 TYPES OF PUBLICOFFERINGS............................................................. 29CHAPTER4.1.2 PRICINGANDCOMMISSIONINAPUBLICOFFERING ............................. 29CHAPTER4.1.3 DOCUMENTATIONINAPUBLICOFFERING........................................... 30

CHAPTER4.2 REGISTRATIONOF PUBLICOFFERINGS....................................................... 31CHAPTER4.2.1 SECTION5OF THESECURITIES ACT.................................................... 31CHAPTER4.2.2 CONTENTS OFREGISTRATIONSTATEMENT ......................................... 32CHAPTER4.2.3 PREPARATIONOFREGISTRATIONSTATEMENT ................................... 33CHAPTER4.2.4 SECREVIEWOF THEREGISTRATIONSTATEMENT............................... 33SHELFREGISTRATION .................................................................................................. 34CHAPTER4.2.5 PURCHASESDURINGREGISTRATION .................................................. 35

CHAPTER4.3 MANAGEDDISCLOSUREDURINGREGISTRATIONGUNJUMPING........... 36CHAPTER4.3.1 PRE-FILINGPERIOD............................................................................ 37


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CHAPTER4.3.2 WAITINGPERIOD(AFTERFILING,BEFOREEFFECTIVENESS) ............... 40CHAPTER4.3.3 POST-EFFECTIVEPERIOD.................................................................... 42

VII. REGISTRATION UNDER THE EXCHANGE ACT ................................................................. 44CHAPTER8.3 REGULATIONOF PUBLICCOMPANIES ........................................................ 44CHAPTER8.3.1 REGISTRATIONUNDERTHEEXCHANGEACT ....................................... 44CHAPTER8.3.2 PERIODICDISCLOSURE ...................................................................... 45

VIII. EXEMPTIONS FROM SECURITIES ACT REGISTRATION.................................................... 47CHAPTER5. EXEMPTIONS ........................................................................................... 47CHAPTER5.1 EXEMPTSECURITIES (SECTION3).............................................................. 47CHAPTER5.2 TRANSACTIONEXEMPTIONS (SECTION4) .................................................. 48CHAPTER5.2.1 INTRASTATEOFFERINGS .................................................................... 49CHAPTER5.2.2 PRIVATEPLACEMENTS....................................................................... 49CHAPTER5.2.3 SMALLOFFERINGS ............................................................................ 51CHAPTER5.2.4 REGULATIOND ................................................................................. 51

IX. SECONDARYDISTRIBUTIONS.......................................................................................... 53CHAPTER7. SECONDARY ANDOTHERPOSTOFFERINGDISTRIBUTIONS...................... 53CHAPTER7.1 DEFINITIONS OF ISSUERS,UNDERWRITERS,ANDDEALERS ......................... 53CHAPTER7.1.1 AGENTFORISSUER ........................................................................ 54CHAPTER7.1.2 PURCHASERFROM ISSUERWITHAVIEWTODISTRIBUTE .................. 54CHAPTER7.1.3 UNDERWRITERFORCONTROLPERSON............................................ 55

CHAPTER7.2 SECTION 4(1):TRANSACTIONS NOT INVOLVING AN ISSUER,UNDERWRITER,ORDEALER............................................................................................... 55

CHAPTER7.2.1 RULE144:SECONDARYDISTRIBUTIONS INPUBLICMARKETS............. 56CHAPTER7.2.2 EXEMPTIONS FORSECONDARYPRIVATEPLACEMENTS........................ 57SECTION4(3). TRANSACTIONS BYADEALER.............................................................. 58

CHAPTER7.3 CORPORATEREORGANIZATIONS ANDRECAPITALIZATIONS ........................ 58CHAPTER7.3.1 ISSUEREXCHANGES........................................................................... 58CHAPTER7.3.2 FUNDAMENTALCORPORATETRANSACTIONSRULE145 ................... 59CHAPTER7.3.3 DOWNSTREAM SALES ANDSPINOFFS.................................................. 59CHAPTER7.3.4 WARRANTS,OPTIONS,ANDCONVERSIONPRIVILEGES ........................ 59

X. EQUAL ACCESS TO INFORMATION:INSIDERTRADING ANDREGULATION FD ............... 60CHAPTER10. INSIDERTRADING ................................................................................... 60CHAPTER10.1.INTRODUCTIONTOINSIDERTRADING ........................................................ 60


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CHAPTER10.1.1 CLASSICINSIDERTRADING .............................................................. 60CHAPTER10.1.2 MISAPPROPRIATIONOF INFORMATIONOUTSIDERTRADING............ 60CHAPTER10.1.3 THEORIES FORREGULATIONOF INSIDERTRADING............................ 60

CHAPTER10.2 RULE10B-5ANDINSIDERTRADING.......................................................... 61CHAPTER10.2.1 DUTYTOABSTAINORDISCLOSE .................................................. 61CHAPTER10.2.2 INSIDERTRADINGRULES ................................................................. 64CHAPTER10.2.3 OUTSIDERTRADINGMISAPPROPRIATIONLIABILITY....................... 65CHAPTER10.2.4 REMEDIES FORINSIDERTRADING..................................................... 66CHAPTER10.2.5 REGULATIONFD(FAIRDISCLOSURE)ANDSELECTIVEDISCLOSURE.. 67

XI. LIABILITY UNDERFEDERAL SECURITIES LAWS ............................................................. 69CHAPTER6.1 COMMONLAWOF MISREPRESENTATION ................................................... 69CHAPTER6.1.1 COMMONLAWDECEIT ...................................................................... 69CHAPTER6.1.2 EQUITABLERESCISSION..................................................................... 69

CHAPTER9.5 COMPARISONTOOTHERSECURITIES FRAUDREMEDIES............................. 70CHAPTER9.5.1 EXPRESS FEDERALREMEDIES FORSECURITIES FRAUD ....................... 70CHAPTER9.5.2 STATELAWREMEDIES ...................................................................... 75CHAPTER9.5.4 ARBITRATIONANDPRIVATEORDERING ............................................. 76

THEDUEDILIGENCEDEFENSE.......................................................................................... 77RULE176 REASONABLEINVESTIGATION ................................................................... 78ESCOTTV.BARCHRISCONSTRUCTIONCORP. ............................................................... 78INREWORLDCOM,INC.SECURITIESREGULATION ....................................................... 80

CHAPTER12. PUBLIC ENFORCEMENT........................................................................... 82CHAPTER12.1 SECINVESTIGATIONS .............................................................................. 82CHAPTER12.1.1 INVESTIGATIONS:FORMALANDINFORMAL ...................................... 82CHAPTER12.1.2 INVESTIGATIVEPOWERS .................................................................. 83

CHAPTER12.2 ADMINISTRATIVEENFORCEMENT............................................................. 83CHAPTER12.2.1 SECADMINISTRATIVEENFORCEMENTPOWERS ............................... 83CHAPTER12.2.2 DISCIPLINARYPOWERS.................................................................... 84CHAPTER12.3.3 EFFECTOF INJUNCTION.................................................................... 84CHAPTER12.3.4 MODIFICATIONORDISSOLUTIONOF SECINJUNCTIONS .................... 84CHAPTER12.3.5 STATUEOF LIMITATIONS ................................................................. 84

CHAPTER12.5 CRIMINALENFORCEMENT........................................................................ 84CHAPTER12.5.1 USEOFCRIMINALLAWINSECURITIES ENFORCEMENT ..................... 84


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CHAPTER12.5.2 CRIMINALVIOLATIONS OF FEDERALSECURITIESLAWS.................... 84CHAPTER12.5.3 SECURITIES ACTIVITIES CREATINGCRIMINALLIABILITY................... 84CHAPTER12.5.4 NON-SECURITIES CRIMINALLAWAPPLIEDTOSECURITIES ACTIVITIES

84CHAPTER12.5.5 SENTENCINGOF INDIVIDUALANDCORPORATEOFFENDERS .............. 84CHAPTER12.5.6 PARALLELENFORCEMENT ............................................................... 84


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I. DEFINITIONSSECTION 2.DEFINITIONS

(1) Security means any note, stock, treasury stock, security future, bond, debenture, evidence

of indebtedness, certificate of interest or participation in any profit-sharing agreement, collateral-trust certificate, preorganization certificate or subscription, transferable share, investmentcontract, voting-trust certificate, certificate of deposit for a security, fractional undivided interestin oil, gas, or other mineral rights, any put, call, straddle, option, or privilege on any security,certificate of deposit, or group or index of securities (including any interest therein or based onthe value thereof), or any put, call, straddle, option, or privilege entered into on a nationalsecurities exchange relating to foreign currency, or, in general, any interest or instrumentcommonly known as a security, or any certificate of interest or participation in, temporary orinterim certificate for, receipt for, guarantee of, or warrant or right to subscribe to or purchase,any of the foregoing.

(3) Sale orsell shall include every contract of sale or disposition of a security or interest in asecurity, for value.

Offer to sell, Offer for sale, orOffer shall include every attempt or offer to dispose of,or solicitation of an offer to buy, a security or interest in a security, for value.

The terms defined shall not include preliminary negotiations or agreements between (i) an issueror its affiliates, and any underwriter; or (ii) among underwriters who are or are to be in privity ofcontract with an issuer or its affiliates.

(4) Issuer means every person who issues or proposes to issue any security.

(6)Territory means Puerto Rico, the Virgin Islands, and the insular possessions of the UnitedStates.

(7) Interstate Commerce means trade or commerce in securities or any transportation orcommunication relating thereto among the several States or between the District ofColumbia orany Territory of the United States and any State or other Territory, or between any foreigncountry and any State,Territory, or the District ofColumbia, or within the District ofColumbia.

(9) Write or Written shall include printed, lithographed, or any means of graphiccommunication.

(10) Prospectus means any prospectus, notice, circular, advertisement, letter, orcommunication, written or by radio or television, which offers any security for sale or confirmsthe sale of any security.

Except that (a) a communication sent or given after the effective date of the registrationstatement (other than a prospectus permitted under subsection (b) of section 10) shall not bedeemed a prospectus if it is proved that prior to or at the same time with such communication a


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written prospectus meeting the requirements of subsection (a) of section 10 at the time of suchcommunication was sent or given to the person to whom the communication was made , and (b) anotice, circular, advertisement, letter, or communication in respect of a security shall not bedeemed to be a prospectus if it states from whom a written prospectus meeting the requirementsof section 10 may be obtained and, in addition, does no more than identify the security, state the

price thereof, state by whom orders will be executed.

(11) Underwriter means any person who has purchased from an issuer with a view to , oroffers or sells for an issuer in connection with, the distribution of any security, or participates orhas a direct or indirect participation in any such undertaking, or participates or has a participationin the direct or indirect underwriting of any such undertaking; but such term shall not include aperson whose interest is limited to a commission from an underwriter or dealer not in excess ofthe usual and customary distributors' or sellers' commission.

(12) Dealer means any person who engages either for all or part of his time, directly orindirectly, as agent, broker, or principal, in the business of offering, buying, selling, or otherwise

dealing or trading in securities issued by another person.

(15) Accredited Investor shall mean:

(i) a bank whether acting in its individual or fiduciary capacity;

(ii) an insurance company;

(iii) an investment company registered under the Investment Company Act of 1940 or abusiness development company;

(iv) a Small Business Investment Company licensed by the Small Business Administration;

(v) an employee benefit plan, including an individual retirement account; or

(vii) any person who, on the basis of such factors as financial sophistication, net worth,knowledge, and experience in financial matters, or amount of assets under managementqualifies as an accredited investor.

RULE 405

Affiliate is a person that directly, or indirectly through one or more intermediaries, controls oris controlled by, or is under common control with, the person specified.

Control (including the terms controlling, controlled by and under common control with)means the possession, direct or indirect, of the power to direct or cause the direction of themanagement and policies of a person, whether through the ownership of voting securities, bycontract, or otherwise [Management Power].


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Person with the power to obtain the signatures of those required to sign a registration statement.[Registration Power]

Equity security means any stock or similar security, certificate of interest or participation inany profit sharing agreement, preorganization certificate or subscription, transferable share,

voting trust certificate or certificate of deposit for an equity security, limited partnership interest,interest in a joint venture, or certificate of interest in a business trust; any security future on anysuch security; or any security convertible, with or without consideration into such a security, orcarrying any warrant or right to subscribe to or purchase such a security; or any such warrant orright; or any put, call, straddle, or other option or privilege of buying such a security from orselling such a security to another without being bound to do so.

Free writing prospectus means any written communication that constitutes an offer to sell ora solicitation of an offer to buy the securities relating to a registered offering that is used after theregistration statement in respect of the offering is filed (or, in the case of a well-known seasonedissuer, whether or not such registration statement is filed).

Material, when used to qualify a requirement for the furnishing of information as to anysubject, limits the information required to those matters to which there is a substantial likelihoodthat a reasonable investor would attach importance in determining whether to purchase thesecurity registered.

Written communication means any communication that is written, printed, a radio ortelevision broadcast, or a graphic communication as defined in this section.


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II. SECURITIES TRANSACTIONSCHAPTER1. INTRODUCTION

Securities regulation is provided in federal laws and its objective is to protect investors.

CHAPTER1.1 SECURITIES MARKETS ANDPARTICIPANTS

CHAPTER1.1.1 PRIMARY ANDSECONDARY MARKETS

Two types of markets:

(a)Primary market. Sales of securities by issuers to investors.Is divided in public or private placements.

y Private Placements.Issue ownership interests to its founding members.

Issue stock to venture capitalist in exchange of an ownership position and amanagement role.

Public corporations issue trading-restricted securities (debt) to institutionalinvestors.

(b)Secondary market.Buy-sale transactions among investors.

Investors liquidate investments by selling securities to other investors in private or publictrading markets.

Exchange Market is the centralized location where buy and sell orders arrive and wherespecialists maintain book of orders.

Over-the-counter Market is the location where selling and buying occurs between securitiesfirms (on behalf of investors) through electronic means.

CHAPTER1.1.2 FUNCTIONS OF SECURITIES MARKETS

Securities markets have three basic functions:

(a)Capital formation.(b)Liquidity.Ability readily to sell and investment instrument(c)Risk Management. Diversity and hedge investments


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Derivative Securities are financial instruments whose prices are derived from pieces ofunderlying securities.

(a)Put Option. Promise to purchase at the option of the seller.(b)Call Option. Promise to sell at the option of the buyer.(c)Futures Contracts. Agreement to buy or sell a particular commodity at a fixed price on a

specific date.

CHAPTER1.1.3 PARTICIPANTS

(a)Investors. Persons who seek return of investments.Persons who own securities directly or indirectly.

Institutional Investors are persons who own securities on behalf of others (i.e. pension and mutual funds, insurance companies, financial institutions, state and localgovernments, securities firms and foreign investors.

(b)Issuers Individuals (through securitization), corporations, federal agencies, stateand local governments, non-profit organizations, and mutual funds.

(c)Financial Intermediaries are broker-dealers, investment advisors, investmentcompanies and investment banking firms.

CHAPTER1.1.4 INTERCONNECTION AMONG FINANCIAL MARKETS

Regulatory competition exists because investors and issuers migrate if the market is tooregulated. This is the reason why trading with institutional investors or debt issuance has becomemore popular.

Regulatory overlap states how different regulators assert jurisdiction over the samefinancial transaction (federal vs. blue sky laws).

CHAPTER1.2 EFFICIENCY OF PUBLIC STOCKMARKETS

Efficient Capital Market Hypothesis Prices of the stock are determined by the publicinformation known and assimilated by the market. Particular information affects the market priceof a stock as though everyone had the same information at the same time.

(a)Weak Efficiency. Stock patterns random, investors cannot draw charts of past prices norto extrapolate future prices.


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(b)Semi-Strong Efficiency. Market promptly impounds all publicly available information.(c)Strong Efficiency.Information impounds as if received by everyone at the same time.


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III. SECURITIES REGULATIONCHAPTER1.3 FEDERAL SECURITIES REGULATIONOVERVIEW

The federal securities laws grew out of the public outcry for reform of the securities markets,

which had lost almost all of their value in the Great Depression. From 1932-1934 the SenateBanking Committee held hearings on securities market practices. President Franklin D.Roosevelt started his administration in 1933 and had the burden to fill the gaps in state law andWall Streets self regulation.

CHAPTER1.3.1 SECURITIES ACT OF 1933

The Securities Act was the first bill drafted by the Federal Trade Commission CommissionerHuston Thompson.

The Thompson Bill focused on informed investors rather than government paternalism.

The Securities Act was drafted as a disclosure statute over a weekend by a professor and 3former law students. The final statute maintained the Thompson Bill but inserted a disclosurescheme from the English Companies Act of 1929. Additionally, they drafted far-reachingliability for participants in securities offerings.

The Securities Act focused on disclosure through the registration/filing of a Prospectus. Failureto do so carried criminal penalties, administrative sanctions and private civil liability.

CHAPTER1.3.2 SECURITIES EXCHANGE ACT OF 1934

The Exchange Act covered a number of fronts:

y The creation of the SECy Regulation of the securities industry (StockExchange and Securities Firms)y Regulation of margin for the purchase of securitiesy Prohibition against price manipulationy Periodic disclosure (reports)y Regulation on proxy voting in public companiesy Regulation of insider trading

Integrated Disclosure

During 50 years, the Securities Act and the Exchange Act lived in separate worlds regardingdisclosure. In 1982, the SEC reached a unified approach to disclosure under both acts.Regulation S-Kfor non-financial disclosure and Regulation S-X for accounting information.


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Audited Financials

The Securities Act and the Exchange Act with a philosophy of leaving the responsibility forsound securities practices to self-regulatory private actors, call for financial statements to beaudited by public accountants.

The Sarbanes-Oxley Act created a new regulatory structure for accountants that audit financialstatements. A registry called the Public Company Accounting Oversight Board was created.

CHAPTER1.3.3 SPECIALIZEDSECURITIES LAWS

(a)Public Utility Holding Company Act of 1935Break up holding companies in the gas and electric utilities industry.

(b)Trust Indenture Act of 1939

Regulation of indentures (agreements) between the issuer of debt securities and theadministrator of debt issue (trustee, typically a bank).

(c) Investment Company Act of 1940Regulates investment companies.

(d)Investment Advisers Act of 1940Regulates broker-dealers.

CHAPTER1.3.4 SARBANES-OXLEY ACT OF 2002

Sarbanes-Oxley is an act that responded to the accounting and corporate scandals of the early2000s. It seeks to strengthen the integrity of the federal securities disclosure system and tofederalize specific aspects of public corporation law.

Pavlovian Response to Enron

Enron had to look for new ways to maintain its constantly growing profits due to competition. Itsexecutives devised two main techniques: (a)Enron entered into paper transactions with special-purpose related entities that created the appearance of revenues on Enrons financial statements,and (2)Enron financed these related entities with loans (secured by its high-priced stock) thatwere reported as debt on Enrons balance sheet.


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In 2001,Enron restated its financials for the previous four years, and reduced its income by$600M and increased its debt by $628M. Bankruptcy soon followed.

Disclosure vs. Corporate Governance

Sarbanes-Oxley moved into areas of corporate governance historically within the domain of statecorporate law. For example, the provisions that (1) specify the composition and responsibilitiesof the audit committees, (2) the restrictions on loans to corporate executives, (3) the forfeiture ofexecutive pay after financial restatements, and (4) limitations on trading by executives duringblackout periods.

Evaluation of Sarbanes-Oxley

Few enforcement actions have been brought under the Act.

The business, accounting and legal communities responded heavily to its many requirements.Empirical studies indicate that investors have responded favorably to some of the Actsinitiatives. Greater confidence in the information contained in SEC filings certified by companyofficers.

CHAPTER1.3.5 SECURITIES ANDEXCHANGE COMMISSION

The SEC is an independent agency, not part of the Presidents cabinet, created under theExchange Act and embodied with executive, legislative and judicial authority.

(a)Executive Authority. The SEC administers and enforces federal law. It has investigativepowers and may issue cease-and-desist orders, impose fines, and order disgorgement of profits in administrative proceedings. It may initiate court action or refer matters forcriminal prosecution.

(b)Legislative Authority. The SEC promulgates (i) rules, regulation and guidelines withforce of law, (ii) interpretative releases concerning view points of statutes (no force oflaw), and (iii) interpretative letters and no-action letters to provide views and guidance tosecurities transaction planners.

(c)Judicial Authority. The SEC has original jurisdiction and appellate jurisdiction (actionstaken by the stock exchanges,NASD and other self-regulatory organizations). The SECis headed by 5 commissioners appointed by the President and confirmed by the Senate.

Regulation and Technology

EDGAR (Electronic Data Gathering Analysis and Retrieval) is a computer system to filedocuments in electronic form.


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SEC Partnership with Securities Industry

The SEC is responsible for the big picture, whereas the day-to-day regulation of securities ishandled by firms themselves and by private membership organizations. Performs targeted

oversight while others regulate directly.

Plain English Initiative

The SEC enforces the Plain EnglishInitiative in disclosure documents for investors.

CHAPTER1.4 STATES SECURITIES REGULATIONBLUE SKY LAWS

Blue Sky Laws are state statutes establishing standards for offering and selling securities.

Most of such statutes are antifraud rules.

There are parallel statutes on state regulation to those on federal regulation.

Covered Securities are securities that may not be subject to state regulation. There are 4categories of covered securities:

(a)Listed Securities. Securities listed on a stock exchange or quoted on NASDAQ, no stateregistration, filings, reports or filing fees are permitted.

(b)Mutual Funds. Securities issued by registered investment companies.(c)Private Placements. Sales to QIBs.(d)Exempt Offerings. Unless the exemption anticipates states regulation.

On (b)-(d), States may require fees, consent to service of process and filings of sales reports andother documents similar to those filed with the SEC.

Class actions involving allegations of securities fraud in publicly traded securities must belitigated exclusively in a federal court.

Delaware Carve-out State cases alleging fiduciary breaches under state corporate law may bebrought before a state court.

CHAPTER1.5 SECEXEMPTIVE POWER

SEC may exempt particular persons and transaction from regulation under the federalsecurities laws.


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CHAPTER11. REGULATION OF SECURITIES INDUSTRY

Securities professionals (broker-dealers and investment advisers) are subject to an imposingarray of regulation to ensure honesty, integrity, competence, and financial capacity for theprotection of investors.

CHAPTER11.1 CAPACITIES OF SECURITIES PROFESSIONALS

Securities intermediaries act in three capacities pursuant to the definitions of the federalsecurities laws:

(a)Broker. A broker is any person (without including a bank) engaged in the regularbusiness of effecting securities transactions for the account of others.

(b)Dealer. A dealer is any person (without including a bank) engaged in buying andselling securities for his own account as part of his regular business.

(c)Investment Adviser. An investment adviser is a person who, for compensation,engages in the business of advising others on investing, buying or selling securities.


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IV. SECURITYCHAPTER2. DEFINITION OF A SECURITY

CHAPTER2.1 IMPLICATIONS OF DEFINITION

A transaction that involves a security triggers federal and state securities regulation.

CHAPTER2.2 TESTING FOR A SECURITY

Definition in Securities Act - Section 2.

CHAPTER2.2.1 INVESTMENT CONTRACTS (CATCH ALL)THE HOWEY TEST

SEC v. W.J. Howey Co. (328 U.S. 293)

Supreme Court defines an investment contract as any transaction in which (1) a personinvests money (2) in a common enterprise and (3) is led to expect profits (4) solely(predominantly) from the efforts of others.

(1)Investment. An investment, which can be cash or noncash consideration, is expectedto produce income or profit.

(2)Commonality.Horizontal (pools) - Multiple investors have interrelated interests in a commonscheme.Vertical Single investor has a common interest with the manager of its investment.

(3)Expected profits. The expected returns (either fixed or variable) must come fromearnings of the enterprise and must be the principal motivation for the investment.

(4)Efforts of others. Returns most derivesolely from the efforts of others; however,lower courts have accepted investors efforts may contribute to profits. The efforts ofthe managers, however, must be predominant (investors mostly passive).

CHAPTER2.2.2 RISKCAPITAL TEST

Used by State courts to identify when their blue sky laws apply to unorthodox transactions.

The risk capital test focuses on the extent to which the investors initial outlay is subject to therisks of the enterprise, over which the investor has no managerial control.

Neither the commonality nor the profits be derived from the efforts of others are considered inthis test.


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CHAPTER2.3 SECURITIES IN VARYING CONTEXTS

CHAPTER2.3.1 REAL ESTATE AS SECURITIES

The sale of real estate (without any collateral arrangements with the seller) is not a securitiestransaction; nonetheless, courts have applied the Howey Testwhen the marketing to purchasersemphasizes the economic benefits to be derived from the managerial efforts of the promoter fromthe rental of units. E.g. Developer offers resort condos under an arrangement in whichpurchasers agree to make their property available for rental, with limited rights of occupancy,and to receive a pro rata share of net rental income from a pool of all rentals in the complex.

If there is no pooling of rents and condo purchasers have control over rental arrangements, theproperty sale does not involve a security.

CHAPTER2.3.2 BUSINESS INTERESTS AS SECURITIES

Whether ownership interests in a typical business organization are securities depends on the legalform:

Form Security Not Security

Corporation Common and Preferred Shares -

Limited Partnership Limited PartnerInterests General PartnerInterests

Partnership (Joint Venture) - PartnerInterestsCo-venturer interests

CHAPTER2.3.4 NOTES AS SECURITIES

A note evidences a borrowers promise to repay a debt (extension of credit ) and, as such,represents the creditors investment in the borrower.

ANote is included within the definition of Security under the Securities Act; however, many

extensions of credit do not have the typical attributes of an investment. Promissory notes underconsumer and commercial financing transactions should not be treated as securities.

Under the Securities Act, a note that arises out of a current transaction and that matures within 9months is exempt from registration under the Act. Such exemption is intended forcommercialpaper which are unsecured promissory notes issued by large, financially sound companies tofinance current operations and sold to institutional investors in large denominations.


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In order to know if a note is a security, it is important to focus on the economic realities of thetransaction, not merely in the maturity.

Reves v. Ernst Young (494 US 56)

Family Resemblance Test

It begins with a rebuttable presumption that every note is a security unless it falls into acategory of instruments that are not securities. Commercial notes are in the family ofnonsecurities.

Family Resemblance Testprovides four factors to determine the family into which a note fits:

a. Motivation of seller and buyer. If the issueruses the proceeds of the note for generalbusiness purposes, it is more likely a security. If it uses it to buy consumer goods or forcommercial purpose, it is more likely that it is not a security.

b.

Plan of distribution. If the notes are widely offered and traded, it is more likely asecurity. If the note is given in a face-to-face negotiation to al limited group ofsophisticated investors, it is more likely not a security.

c. Reasonable expectations of investing public. If investors generally view the type ofnotes to be investments, it is more likely a security.

d. Other factors reduce risk. If the note is not collateralized and not subject tononsecurities regulation, it is more likely a security. If the notes are secured or otherwiseregulated (such as banking regulation) it is more likely not a security.

Sale-Leaseback Financing

A financier agrees to nominally purchase an asset used by a business and receive fixed lease payments for a specific period, after which the lease terminates and the asset must berepurchased by the business.

Normally, a sale-leaseback is not viewed as a security, but instead as a form of securedfinancing.

SEC v. Edwards (540 US 389)

A sale-leaseback arrangement for payphones can constitute an investment contract under theHowey Test, even when the scheme involves a contractual promise to pay a fixed rate of return.In the case, more than 10,000 people invested in a scheme where purchasers were offered apayphone, along with a five-year agreement for the management and the buyback of thepayphone.


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An investor contract could involve one that promised a fixed rate of return, even though therewas no promise of capital appreciation or participation in business earnings.

CHAPTER2.3.6 STOCK AS A SECURITY

Must stocks are securities; however, the underlying economic basis must be analyzed.

The term stock is included in the Securities Act definition; however, courts have held that notall instruments labeled stock are securities.

Noninvestment Stock

United Housing Foundation v. Forman (421 US 837)

A security must reflect economic reality. Cooperative housing corporation which required

residents to buy shares. Residents were entitled to one vote regardless of the shares they held.At the end, residents were bound to sell their share back to the corporation at its original price.The Court ruled that the shares were not securities since it was not a stock investment since:(1)There was no right to dividends; (2) shares were not negotiable; (3) voting rights were notproportionate to the number of shares held; and (4) the shares could not appreciate in value.

Additionally the Courts applied theHowey Testand it lacked the expectation of profits.

Sale of Business Doctrine

Should a stock purchase acquisition be treated as a securities transaction?

Fredricksen v. Poloway (637 F.2d 1147)

During the 80s lower courts concluded that the transfer of a majority of the stock of a privatecompany is not a securities transaction. Under the sale of business doctrine, the courts lookedto Howeys emphasis on management to conclude that the sale of a majority interest passescomplete control to purchaser, who becomes an owner-entrepreneur and not an investor.

Golden v. Garafalo (678 F.2d 1139)

Stock is stock no matter how it is transacted.


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V. DISCLOSURE ANDMATERIALITYCHAPTER3. MATERIALITY

Material information is the only information required by the SEC in order to avoid overload of

information without suffering of scarcity.

CHAPTER3.1 DEFINITION OF MATERIALITY

CHAPTER3.1.1 SUBSTANTIAL LIKELIHOODTEST

A fact is material if there is a substantial likelihood that a reasonable investor would attachimportance in determining whether to purchase the security registered.

Substantial likelihood connotes that the information probably would have been important to

a reasonable investor.

CHAPTER3.1.2 REASONABLE INVESTOR

The SEC interprets reasonable investors as professional securities analysts, rather thanirrational investors.

Wielgos v. Commonwealth Edison Co. (892 F.2d 509)

The Court held that omitted information about regulatory proceedings that resulted in costlydelays for utilitys power plants was not material since securities analysts already knew of theproceedings and their risks.

CHAPTER3.1.3 RELATIONSHIP OF MATERIALITY ANDDUTY TODISCLOSE

Just because information is material does not mean it must be disclosed. Duty relates to whetherand when information must be disclosed; materiality relates to what information must bedisclosed.

Unless there is a duty to disclose, the materiality of the information is only of theoretical interest.

Disclosure duties under the federal securities laws can arise in essentially 2 ways:

(a)SEC Filing Obligations. Companies offering securities to the public and reportingcompanies that have publicly traded securities must provide line-item disclosure in SECfilings.


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Rule 408. SEC requires reporting companies to include in their filings any other materialinformation necessary to make required disclosure not misleading.

Rule 12b-20. In addition to the information expressly required to be included in astatement or report, there shall be added such further material information, as may be

necessary to make the required statements, in the light of the circumstances under whichthey are made, not misleading.

(b)Duty of Honesty. The antifraud provisions of the federal securities laws require completehonesty concerning material information whenever one speaks in connection with certainsecurities transactions. The duty of honesty includes (i) not making material false ormisleading statements; (ii) to correct materially false or misleading statements, and (iii)to update statements that have become materially false or misleading.

If a company does not speak and has no specific duty to speak, the federal securities laws permitmanagement to keep business information confidential (no matter how material).

CHAPTER3.2 MATERIALITYTYPES OF INFORMATION

Despite the prevalence of the substantial likelihood test, the SEC and the Courts take differentapproaches to materiality:

CHAPTER3.2.1 HISTORIC INFORMATION

When disclosure of past information coincides with abnormal changes in public stock prices,Courts assume it was material information. However, it sometimes does not affect because theinformation already had been absorbed by the market prior to a formal disclosure. Courts rejectarguments that materiality depends on particular quantitative benchmarks (i.e. 5% price change).

Off-Balance Sheet Disclosures

Sarbanes-Oxley mandates that the MD&A must include off-balance sheet arrangements andknown contractual obligations reasonably likely to have a material effect on the companysfinancial condition.

Market Reaction

A common test for the materiality of company information is whether the market price of thecompanys stock changes on the date the information is first disclosed (whether in a formalreport or by the media). Courts have relied on this measure of materiality.


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CHAPTER3.2.2 SPECULATIVE INFORMATION

When information is relevant because it portends a future event (mergers, discoveries, etc.),Courts have applied a special version of the substantial likelihood test, the probability-magnitude test:

Basic, Inc. v. Levinson. Materiality will depend on the financial significance of the event ,discounted by the chances of it actually happening. Information is material if its expected value,discounted by its uncertainty, indicates it would affect investor behavior.

Companies in merger negotiations may remain silent so long as they do not release false ormisleading information.

Puffery

One kind of speculative information is an overstatement of present circumstances , based on ahope that events will turn out well. Federal Courts have been reluctant to treat optimisticstatements as misleading. Eisenstadt v. Centel Corp. everyone knows that someone trying tosell something is going to talk on the bright side.

CHAPTER3.2.3 FORWARD-LOOKING STATEMENTS

Projections, estimates, or opinions that reflect a look into the future is the most valuable and themost perilous for investors.

Voluntary Disclosure of Forward-Looking Information

Rule 175. Rule 3b-6. SEC permits forward-looking information in SEC filings unless it is shownthe statement was made without reasonable basis or disclosed other than in good faith.

This forward-looking information disclosure focuses on a subjective testof what managementknows or should know of the future; and an objective test or disclaimers or cautions thataccompany future statements.

Mandatory Disclosure of Forward-Looking Information

SEC requires the presentation of forward-looking statements in the MD&A of certain SECfilings, such as annual reports and Prospectuses. The MD&A must describe:

(a)Trends and uncertainties that are reasonably likely to result in material changes to thecompanys financial position. The idea is to present information through the eyes ofmanagement.


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(b)Information that keeps management up at night.(c)Description of the quality and potential variability of earnings, so investors know whether

past performance is indicative of future performance.

(d)Information on the adoption of accounting policies and accounting estimates underlyingfinancial statements.

Actionability of Forward-Looking Statements

The SEC and Federal Courts have treated opinions, forecasts, projections, and generalexpressions of optimism as actionable under the federal securities laws. A forward-lookingstatement carries a number of testable factual assertions: (1) the speaker genuinely holds his position; (2) there exists a reasonable basis for his opinion; and (3) there is nothing that

contradicts the opinion. Forward-looking statements can be seen as false if one of these implicitassertions is false.

CHAPTER3.2.4 INFORMATION ABOUT MANAGEMENT INTEGRITY

Managements experience and integrity are often critical for investment.

SEC requires information about [Regulation S-K]:

(a)Management Incentives.Compensation, conflicts-of-interest transactions, loans.(b)Management Integrity. Lawsuits involving personal insolvency, criminal

convictions, stock fraud.(c)Management Commitment to the Company. Stock ownership, stock pledges as

security for personal loans.

In Re Franchard, 42 SEC 163 (1964)

SEC asserted materiality of information while stopping a securities offering for not disclosingserious defalcations and suspicious stock pledges of the controlling shareholder. Yet, SECconcluded that disclosure of how the board carried out its state-mandated oversight duties wasnot matter for federal securities laws.

In general, federal securities laws mandates disclosure of compliance with other non-securitiesnorms only if non compliance is clear and would have a financial significance.

SEC does not require disclosure of executives criminal behavior unless it has resulted in anindictment or conviction in the last 5 years. [Item 401,Regulation S-K]

SEC does not require disclosure of fiduciary breaches, unless management misfeasance is clear.


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SEC has heightened disclosure duties regarding management self-dealing such as disclosure ofretirement benefits for board members or officers.

Whether a company can withhold material information that it has a duty to disclose where the

information incriminates company executives.

SEC v. Fehn (97 F.3d 1276)

Mandatory securities disclosure is not aimed at undermining the Fifth Amendment privilegesince it does not target groups inherently suspect of criminal activities.

Code of Ethics

Sarbanes-Oxley requires that every public company (domestic or foreign) disclose whether it has

a code of ethics covering its principal executive and financial officers. Such code must promotehonest and ethical conduct and reporting and disciplining of code violation.

Any waiver of the companys ethic code must be reported promptly on Form 8-K.

The NYSE&NASDAQ require that all listed companies have a code of ethics and specify itscontents.

CHAPTER3.2.5 SOCIAL/ENVIRONMENTALDISCLOSURE

SEC disclosure policy focuses on the financial relevance of business information to investors,rather than its social and environmental relevance to the public.

Several groups have urged the SEC to include social/environmental and civil rights informationas required (e.g. global warming, environmental impact, etc).

Reporting companies must disclose pending environmental proceedings (private or public) thatinvolve potential damage, penalties, and litigations costs of more than 10% of current assets[Instruction 5 to Item 103,Reg. S-K]

Potential liability need not be disclosed.

CHAPTER3.3 MATERIALITY IN CONTEXT:TOTAL MIX OF INFORMATION

Disclosure is contextual. Information revealed in one part of a disclosure document may betempered or disclaimed in another part.


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CHAPTER3.3.1 TOTAL MIXTEST

Supreme Courts definition of materiality:

There must be a substantial likelihood that the disclosure of the omitted fact would have beenviewed by the reasonable investor as having significantly altered the total mix of informationmade available.

TSC Industries, Inc. v. Northway, Inc., (426 U.S. 438)

An omission is not material (even if the information is important to investors) if reasonableinvestors already know or can infer the omitted information from other disclosure.

Total Mix in an Efficient Market

Securities investors do not depend exclusively on mandatory disclosure.

In fact, as discussed in the Efficient Capital Market Hypothesis, SEC filings often merelyconfirm information that is known to securities analysts and already impounded the marketprices; thus, material information that is already known to the market is not actionable.

Longman v. Food Lion, Inc. (197 F.3d 675)

The court assumed that the market was aware of labor violations since they were widely reportedin the press; even though the information came from the companys labor union and was deniedby the company.

Wielgos v. Commonwealth Edison Co. (892 F.2d 509)Truth on the Market Doctrine

It is possible that false or misleading disclosure on important company matters is not material ifprofessional securities traders who set the market price know the disclosure to be wrong.

O ptimistic cost estimates disclosure, through lacking reasonable basis, were not materiallymisleading because professional traders surely deduced what was afoot and knew to discountmanagements consistently biased optimism. In short, managers can lie if the market knows itsdealing with liars.

Buried Facts Doctrine

Disclosure can be misleading if it contains material information that is inaccessible or difficult toassemble.


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Kohn v. American Metal Climax, Inc. (322 F. Supp. 1331)

Proxy statement to be materially misleading for prominently disclosing an investment advisersfavorable opinion, but burying in an appendix that the adviser had failed to evaluate the firmsassets.

If a company discloses both accurate and inaccurate information in the same document, the courtwill consider whether the document as a whole is misleading.

DeMaria v. Andersen (318 F.3d 170)

Inaccurate graphs that summarize revenues are cured by accurate financial tables. However, truthdoes not neutralize falsity if the truth is hidden or discernible only by sophisticated investors.

CHAPTER3.3.2 SAFE HARBORS FORFORWARD-LOOKING STATEMENTS

Forward-Looking Statements include (i) projections of revenues and other financial items; (ii) plans and objectives; (iii) statements of future economic performance, including MD&Astatements of financial conditions and results of operation; and (iv) assumptions underlying thesestatements.

Federal courts have recognized that cautioning statements that identify risks temper forward-looking statements, sometimes rendering them immaterial.

Bespeaks Caution Doctrine (Judicial Safe Harbor)

Cautionary disclosure (beyond boilerplate warnings) can negate the materiality of or reliance onoptimistic prediction. A misleading statement can be discredited by an accompanying truestatement.

Luce v. Edelstein (802 F.2d 49)

Offering memorandum warned that the projections were necessarily speculative and not sureto be realized.

Kaufman v. Trumps Castle Funding (7 F.3d 357)

Hopeful statements in a prospectus that operation would be sufficient to cover all of the issuersdebt service were considered immaterial due to extensive cautionary statements includedelsewhere in the prospectus.


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Private Securities Litigation Reform Act (PLSRA) Safe Harbor (Statutory Safe Harbor)

The PSLRA immunizes public companies and their executives from civil liability (but notadministrative liability) for forward-looking statements that turn out to be wrong. It applies onlyto reporting corporations not to Partnerships orLLCs. The PSLRA provides 3 safe harbors:

(a)No actual knowledge. The plaintiff fails to prove the defendant had actual knowledgethat the forward-looking statement, either oral or written, were false; and immunizesreckless or negligent statements from private liability.

(b)Immateriality. The forward-looking statement was immaterial. It allows the bespeakscaution doctrine as a separate basis for immunity.

(c)Cautionary Statements. The forward-looking statement is identified as a forward-looking statement and is accompanied by meaningful cautionary statements identifyingimportant factors that could cause actual results to differ materially from those projected.

Safest safe harbor since it does not consider knowledge or materiality. Boilerplatecautions are not applicable.

Statutory safe harbors do not apply to IPOs, tender offers, going private transactions, beneficialownership reports under Section 13(d) or offerings by blank check companies.

Asher v. Baxter Intl, Inc. (377 F.3d 727)

Courts have stated that forward-looking statements made with actual knowledge of their falsity

are actionable, even if they are accompanied by cautionary statements.


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VI. REGISTRATION OF SECURITIES OFFERINGSCHAPTER4.1 REGISTRATION OF SECURITIES OFFERINGS

CHAPTER4.1.1 TYPES OF PUBLIC OFFERINGS

(a)Standby Underwriting. The issuer offers securities to the public and the underwriterbuys the securities not purchased by the public.

(b)Best Efforts Underwriting. Issuer offers and underwriter seeks for investors on a bestefforts basis. There may be all or none or minimum percentage underwriting. Thisform is used by small underwriters not willing to risk buying the offered securities andnot being able to sell.

(c)Firm Commitment Underwriting. The underwriter buys securities from issuers andresells to the public. Underwriters earn the spread among the price they paid and the

price to which they sold the securities. Normally, risk is allocated on an underwritingsyndicate under the leadership of a managing underwriter.

(d)Auctioning Securities. Investors bid for the number and price of the securities offered. Dutch Auction. When auction finishes, the issuer sets the price at the lowest bid thatclears the offering. All of the investors buy at clearance price. The issuer sells to thehighest bidders until if fills the offer. Highest bidders get the securities they offered tobuy and the clearance price bidders get the remainder on apro rata basis.

CHAPTER4.1.2 PRICING ANDCOMMISSION IN A PUBLIC OFFERING

The price of the securities depends on whether there exists and established market for suchsecurities. For securities already offered, the offering price is typically set below the market priceto assure the issue clears (save LOBs orTenderOffers).

(a)Inefficient Pricing of IPOs. Underwriters underprice IPOs to ensure the issue clears andcreate profit opportunities for initial purchasers. In the long-term, IPOs are regularlyoverpriced.

IrregularIPO activities:

Flipping is wheninitial investor sells on the first day of an IPO.

Spinning is when the underwriter allocates the securities offered to preferentialinvestors for future business.

Quid pro quo Arrangements are arrangements where the underwriter allocatessecurities to investors who at the same time pay big commissions.


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Laddering is when the underwriter allocates securities offered with the promise ofbuying the securities back while in the aftermarket.

CHAPTER4.1.3D

OCUMENTATION IN A PUBLIC OFFERING

(a)Letter of Intent. Executed among the issuer and the underwriter.(b)Issuer Housekeeping. Adapt companys structure, capital and financial information to

that required by the SEC.

(c)Registration Statement. Describes through the means of a Prospectus the issuer and theoffering to be made.

(d)Comfort Letters.Underwriters demand comfort letters from accountants (typically forunaudited financial statements included in the prospectus) and from lawyers (typicallyregarding due incorporation, authorization of the offer and issuance of securities and noundisclosed contingencies).

(e)Agreement among Underwriters. Agreement among the syndicate of underwritersproviding for compensation and liabilities.

(f) Underwriting Agreement. Agreement among issuer and managing underwriter providing for specific price, amount of securities to be offered and each participatingunderwriters allotment.

Green Shoe Option (Over-allotment option). Underwriter may buy additionalsecurities from the issuer if demand exceeds the initial offering capped to 15% of thetotal offering. This option helps stabilize prices if underwriter buys back securities in theaftermarket.

(g)Selling-Group Agreements. Agreement among the underwriters and securities firmswho will act as retail dealers in the offering.


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CHAPTER4.2 REGISTRATION OF PUBLIC OFFERINGS

Before securities can be offered or sold to the public, the issuer must file a registration statementwith the SEC and provide investors a detailed Prospectus.

The Exchange Act on the other hand, calls for the registration of any class of publicly tradedequity securities and operates to register public companies.

CHAPTER4.2.1 SECTION 5 OF THE SECURITIES ACT

(a)Sale or delivery after sale of unregistered securitiesUnless a registration statement is in effect as to a security, it shall be unlawful for any person,directly or indirectly:

1.

to make use of any means or instruments of transportation or communication in interstatecommerce or of the mails to sell such security through the use or medium of anyprospectus or otherwise; or

2. to carry or cause to be carried through the mails or in interstate commerce , by any meansor instruments of transportation, any such security for the purpose of sale or for deliveryafter sale.

(b)Necessity of prospectus meeting requirements of section 10It shall be unlawful for any person, directly or indirectly:

1. to make use of any means or instruments of transportation or communication in interstatecommerce or of the mails to carry or transmit any prospectus relating to any security withrespect to which a registration statement has been filed under this title, unless suchprospectus meets the requirements ofSection 10; or

2. to carry or cause to be carried through the mails or in interstate commerce any suchsecurity for the purpose of sale or for delivery after sale, unless accompanied or precededby a prospectus that meets the requirements ofSection 10(a).

(c)Necessity of filing registration statementIt shall be unlawful for any person, directly or indirectly, to make use of any means orinstruments of transportation or communication in interstate commerce or of the mails to offer tosell or offer to buy through the use or medium of any prospectus or otherwise any security,unless a registration statement has been filed as to such security, or while the registrationstatement is the subject of a refusal order or stop order or (prior to the effective date of theregistration statement) any public proceeding or examination underSection 8.


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Section 5 separates registration process in to 3 periods:

(a)Prefiling Period.Issuer prepares for the offering.(b)Waiting Period.Registration statement is filed with the SEC, but is not yet effective.(c)Posteffective Period.Period after the registration statement has become effective and

until the offering finishes.

CHAPTER4.2.2 CONTENTS OF REGISTRATION STATEMENT

Section 7 provides that the registration statement of a security to be offered by a domestic issuermust contain and be accompanied by the documents specified in Schedule A. Regarding foreignissuers, the information and documents provided in Schedule B.

If any person whose profession gives authority to a statement made in the registration statement,the written consent of such person shall be filed with the registration statement.

The registration forms under the Securities Act vary in the detail they require, as well as thelatitude they give registrants to incorporate by reference information contained in other SECfilings. The forms are the following:

Form S-1 (F-1 for foreign issuers)

Form S-1 is the most detailed set of instructions and must be used by non-reporting issuers(making and IPO), or small or unseasoned reporting issuers. Regarding reporting issuers,information may be incorporated by reference if they are current with theirExchange Act filings.

Form S-3 (F-3 for foreign issuers)

Available to large, seasoned companies that have been reporting for at least 1 year and, ifoffering new securities, that have a public float of at least $75M.

Public Float is the aggregate market value of the companys equity securities held by publicinvestors who are not insiders or affiliates of the company.

Also available to issuers (that are not shell companies) with less than $75M public float if (i)have been a reporting company for 12 months, (ii) their common stock is listed on a nationalstock exchange, and (iii) they issued more than 1/3 of their public float in a 12-month period.

The form permits the prospectus to incorporate by reference information from the companysannual report and other period reports under the Exchange Act. Investors only receive aprospectus describing the particular offering.


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Form S-4

Special form for securities issued as a result of a merger or acquisition.

CHAPTER4.2.3 PREPARATION OF REGISTRATION STATEMENT

Prospectus:

(a)Must contain SEC requirements and must disclose information.(b)Is a selling document, thus it must contain information of the issuer and of the securities

being offered.

(c)Must be written with an eye to litigation (litigation document).

Rule 421. Presentation of Information in Prospectuses

(a) Information may be provided in any order, however, must be set forth in such a fashion as tonot obscure any of the required information or any information necessary to keep the requiredinformation from being incomplete of misleading.

(b) Plain English must be used in the front and back pages, the summary, and the risk factorsection of the Prospectus; however, plain English is normally used throughout the wholeProspectus.

Plain English

1. Short Sentences.2. Everyday language3. Active voice4. Tabular presentation of complex material5. No legal jargon6. No multiple negatives

CHAPTER4.2.4 SECREVIEW OF THE REGISTRATION STATEMENT

Under Section 5, securities may be sold once the registration statement becomes effective. Thestatutory scheme of the effectiveness of the Registration Statement is as follows:

(a)Effectiveness. The registration statement becomes effective automatically 20 days afterits filing, unless the SEC determines an earlier effective date.


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(b)SEC Review. After the filing, the SEC has 10 days to review the registration statementfor incomplete or misleading disclosure and may issue a refusal order that keeps theregistration statement from becoming effective.

(c)SEC Oversight. Before or after its effectiveness, the SEC can begin a nonpublicadministrative investigation. After its effectiveness, the SEC may issue astop orderif itnotices a defect in the disclosure. No offering activities are permitted when a refusalorstop orderis outstanding or the SEC is investigating a registration statement.

In practice, the SEC rarely issues refusalorstop orders, rather it issues delaying amendments tothe registration statement.

Rule 473. To accomplishSEC complete review, registrants stipulate to a delaying amendment intheir registration statements, creating a charade that the issuer is continuously amending theregistration statement, thus continuously delaying effectiveness until (i) an amendment is filedby the issuer providing that such registration statement shall thereafter become effective; or (ii)

the registration statement becomes effective as determined by the SEC.

The SEC makes the registration statement effective when the issuer addresses its comments , andis satisfied that (i) disclosure is adequate; (ii) there has been sufficient circulation of thepreliminary prospectus with underwriters and potential investors; (iii) underwriters meet the netcapital requirement under the Securities Act; and (iv) the NASD does not disapprove pricing orconcessions to securities firms participating in the offering.

SHELF REGISTRATION

Rule 415.

Shelf Registration permits registration of securities for later sale if the registrant undertakesto file a post-effective amendment disclosing any fundamental change in the informationprovided in the original registration statement.

Conditions:

(a) If issuer does not qualify for forms S-3 or F-3, shelf registration is only available forofferings involving preexisting obligations, business combinations, and continuousofferings lasting more than 30 days.

(b)Only issuers who qualify for forms S-3 or F-3 may delay their offerings and choose whento sell off the shelf .

(c)Time Limit.a. Indefinitely for shelf offering involving preexisting obligationsb. 2 years for business combinations


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c. 3 years for mortgage-backed debt offerings, continuous offerings lasting morethan 30 days, and offering by S-3/F-3 issuers.

(d)S-3/F-3 must register every 3 years. Any unsold allotments under an old registrationstatement may be rolled over into the new registration statement.

(e) Issuers must update public information when securities are taken off the shelf. Issuersmust file a prospectus if there are fundamental changes or when securities are taken offthe shelf more than 9 months after the effective date.

U pdating requirements do not apply to S-3/F-3 issuers if their information is in anExchange Act filing incorporated by reference or a prospectus supplement is filed underRule 424(b).

Well Known Seasoned Issuers (WSKIs) may file an Automatic Shelf Registration whichregistration statement becomes effective when filed with the SEC, without SEC review. WSKIs

can register an unspecified amount of securities and only need to name the class of securities to be offered and even add new classes of securities to the offering, without filing a newregistration statement. To take securities off the shelf WSKIS must only file a prospectussupplement that includes any omitted information, within 2 business days after the offer is pricedand sold.

Withdrawal of Registration

Rule 477 permits easier movement among public to private markets and vice versa. Thewithdrawal is automatically effective upon filing unless the SEC objects within 15 days.

Rule 155(c)

If the public offering is abandoned before any sales, the issuer can wait 30 days and made aprivate offering.

Rule 155 (b)

An issuer that has begun and abandons a private offering before making any private sales maycommence a public offering by (1) disclosing this in its prospectus; (2) waiting 30 days to filethe registration statement if any offers had been made to non-accredited investors.

CHAPTER4.2.5 PURCHASESDURING REGISTRATION

Regulation M prohibits price manipulation during a distribution by forbidding each participantin a distribution from bidding or purchasing securities that, because of their terms, can affect theprice of the securities being distributed. Regulation M exempts purchases by securities firmsparticipating as underwriters, if the issuer is a large public company and its securities are actively


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traded. It also creates an important exemption to the prohibition against purchases during adistribution and permits stabilizing purchases. The stabilizing purchases must be for the purposeof preventing a decline in the market place.

CHAPTER4.3 MANAGED

D

ISCLOSURED

URING REGISTRATIONGUNJ

UMPING

Violations of Section 5 during the registration period are known as gun jumping.

Section 5 provides:

(a)You cannot make offers until a registration statement is filed with the SEC.(b)Once the registration statement is filed, you cannot use a prospectus unless it satisfies

the conditions of Section 10.(c)You cannot make sales or deliveries until the registration statement becomes

effective, and then the deliveries must be accompanied by a final prospectus.

Three periods under Section 5:

(a)Pre-filing Period. After the company is in registration, but before the registrationstatement is filed. Quiet Period. No offers, no sales, no deliveries.

(b)Waiting Period. After the registration statement is filed, but before it becomes effective.No sales, no deliveries, no prospectus (unless it complies with Section 10(b)).

(c)Post-effective Period. After the registration statement becomes effective, until thedistribution ends and the issuer is no longer in registration. No prospectus (unless itcomplies with Section 10), no delivery unless accompanied by a prospectus.

Jurisdictional Means

Section 5 reaches only activities that use means or instruments of transportation orcommunication in interstate commerce or of the mails.

State offers may exist, but it would be almost impossible to carry out a public offering withoutusing jurisdictional means.

Kerbs v. FallRiver Industries, Inc. (502 F.2d 731)

Intrastate phone calls involve the use of an instrument of communication in interstatecommerce.Additionally, payment of securities by check will be construed as instrument ofcommunication in interstate mails.


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Electronic Offerings

Issuers and securities firms provide information to investors using electronic means.

The SEC has also certified that merely including information on a Web site in close proximity to

a Section 10 prospectus does not, by itself, make the information an offer to sell .

An issuer can even become responsible for third-party information if its Web site links to thatinformation.

Issuer Categories under the 2005 Reforms

The 2005 Public Offering Reforms identify 4 categories of issuers. The activities permittedduring the registration period vary greatly depending on which category the issuer falls becauseof the degree of market presence of the issuer:

(a)Non-reporting issuer. Not required to file under the Exchange Act.(b)Unseasoned reporting issuers. Required to file under the Exchange Act, but not eligible

for Form S-3.

(c)Seasoned reporting issuers. Required to file under the Exchange Act that are eligible toForm S-3 (more than one year since going public and a $75 million public float).

(d)Well-known seasoned reporting issuers (WKSIs). Seasoned reporting issuers that haveeither (i) $700 million worldwide public float; or (ii) if issuing non-convertible debt, $1billion in debt issues in the last 3 years. Distinction due to efficiency of the market.

Reporting companies that are not current with Exchange Act filings, blank-check companies,penny-stock issuers and shell companies are ineligible to use the communication exemptions.

CHAPTER4.3.1 PRE-FILING PERIOD

Prohibitions

(a)No sales or deliveries. No disposition of a security for value.(b)No offers. No offer to sell or offer to buy.

Section 2(a)(3) defines offer as every attempt or offer to dispose of, or solicitation of anoffer to buy, a security or interest in a security, for value.


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SEC release: any publicity that may contribute to conditioning the public mind orarousing public interest in the offering constitutes an offer; considering the followingfactors:

i. Arranged after a financing decisionii.

Was broadly disseminatediii. Included forward-looking information of the issuer or its business

iv. Mentioned the planned offeringIn re Carl M. Loeb, Rhoades & Co. (38 SEC 843)

Disciplinary proceeding against 2 underwriters that issued press releases concerning acompany that proposed a public offering before the company had filed a registrationstatement. The underwriters were sanctioned for violating Section 5 and arousing andstimulating investor/dealer interest.

Permissions (except Investment Companies)

(a)Preregistration Communications (Rule 163A). Communications by or on behalf of anissuer (other than prospective underwriters or dealers) are permitted when made morethan 30 days before the registration statement is filed, provided that (i) the proposedoffering is not mentioned, and (ii) the issuer must take reasonable steps to ensure thesepreregistration communications are not further distributed or published within the 30-dayperiod.

(b)Regularly-Released information (Rule 169). Not initiate publicity, but continue toadvertise products and services, to make periodic and other disclosures under theExchange Act, issue factual press announcements, and respond to regular inquiries. Allwhile avoiding future-looking statements and valuation opinions. Dissemination must beintended to persons other than investors (the public). Rule 168.Reporting companies canalso continue to release forward-looking information about the companys operations andfinances, including to investors. Limited to regularly-released information. It is a use safeharbor, an issuer cannot use this information in a road-show or as offer material. Release5180. Issuers may continue ordinary course communication, including advertisingproducts, filing Exchange Act reports, without including forward-looking statements(except Rule 168).

(c)Preliminary Negotiations. Negotiations between issuers and potential underwriters.Includes financial due diligence of issuer by underwriter. Talks to internal sales people ofthe underwriter.

(d)Research Reports. SEC safe harbor rules give guidance to securities firms and theiranalysts to permit the flow of information to securities markets when an issuer is inregistration:


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a. Nonparticipant research reports (Rule 137). Securities firm not participating inthe distribution:(i) the report is in the regular course of the firms business; (ii)the issuer is not a blank-check, shell or penny-stock company, and (iii) thesecurities firm has received no special compensation directly or indirectly fromthe issuer (or a potential investor) related to the report.

b. Issuers non-offered securities (Rule 138). Securities firm (even participating inthe distribution) may publish reports about the issuers (reporting issuer or foreignissuer; not a blank check, shell or penny stock) common stock (or preferred stockconvertible into common stock), if the offering is for fixed-income securities andvice versa; provided that reports are in the regular course of the firms business.

c. Participant research reports (Rule 139(a)(1)). Securities firm participating inthe distribution may issue company-specific research reports if it appears in aregular publication and either (i) the issuer is a seasoned reporting companyeligible for Forms S-3 or F-3: (ii) a WKSI; or (iii) a foreign issuer either seasoned

on a foreign stock market or has a $700 million global public float. Securities firmmust have covered the issuer or its securities, and cannot reinitiate coverageduring registration.

May as well issue industry research reports that include reporting companies thatare in registration (Rule 139(a)(2). Must have had included the issuer in previousreports and include a substantial number of other issuers, giving no greaterprominence to the issuer.

(e)Company Announcements (Rule 135). The issueror security holders may, directly orindirectly, announce (i) the amount and type of security to be offered, and (ii) the timing,manner, and purpose of the offering. May not include information regarding prospectiveunderwriters or pricing and must contain a legend that such notice does not constitute anoffer. Available until the filing becomes effective.

Chris-Craft Industries, Inc. v. Bangor Punta Corp. (426 F.2d 569)

Announcement by underwriter that company would offer a package of securityvalued at $80 or more violated Section 5 because it went beyond disclosurepermitted byRule 135.

(f) WKSI Communications (Rule 163). WKSI may make oral offers during registrationand can make written offers that bear a legend (where to get prospectus, along withadmonition to read it) and are filed with the SEC Free Writing Prospectus. WKSIcommunications remain subject to antifraud regulation and selective disclosures underRegulation FD. Available until filing.


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CHAPTER4.3.2 WAITING PERIOD(AFTERFILING,BEFORE EFFECTIVENESS)

Prohibitions

(a)No sales or deliveries. No disposition of a security for value. The common practice is forparticipant in an offering to collect indications of interest from investors, but not to takechecks or otherwise accept orders. Condition precedent upon effectiveness of filing is notacceptable in Purchase Agreements.

(b)No prospectus. No use of prospectus unless it meets the requirements of Section 10.Prospectus means any communication written or by radio or television, which offersany security for sale. A selling effort in writing.

Permissions

(a)Oral Offers. Oral selling offers are subject only to antifraud prohibitions. Allowed undera constitutional perspective (Freedom of Speech; even though that in the Prefiling Periodis not allowed).

(b)Preliminary Prospectus. Section 10(b) authorizes the SEC to permit the use during thewaiting period of an incomplete prospectus. Rule 430 (in connection with Section 10(b))allows a preliminary or red herring prospectus which includes a marginal legend thatcautions the securities cannot yet be sold. The preliminary prospectus includes allinformation except pricing and underwriting.

(c)Summary Prospectus (Rule 431). Rarely used.(d)Tombstone Ads. Advertisements (typically made in the financial press using tombstone-

like border) that state from whom a prospectus may be obtained and do no more thatidentify the security, states its price, and name the underwriters.

(e)Identifying Statements (Rule 134). You can give specified written information aboutthe issuer, the underwriters, and the offering (more detailed than a tombstone ad) if itincludes a legend that the registration statement is still not effective and explain who isselling the securities and where to obtain a preliminary prospectus or hyperlink apreliminary prospectus.

(f) Free writing prospectus. Any written or graphic communication by the issuer or in itsbehalf (including web postings, mass e-mails, but not live PowerPoint presentations) thatsatisfies certain conditions: (professorDef: its a second type of 10 (b), not a 10 (A) nor(B) or a sale literature) ( no content are required in it ).

a. Consistent Information and Legend (Rule 433(c)(1)). May includeinformation beyond that found in the prospectus, but it must not conflict it orother information filed with the SEC. Rule 433(c)(2) Must include a legend


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that advises reading the prospectus and how to obtain a copy. ( cant conflictwith )

b. Filing (Rule 433(d)). Must be filed with the SEC. No later than the day offirst use (if prepared by the issuer). No filing requirement if prepared by the

underwriter and shown in a face-to-face basis with clients.

c. Prospectus Accompaniment (Rule 433(b)(2)). For non-reporting andunseasoned issuers it must be preceded by a preliminary prospectus (Section10(b)) or the hyperlink to access it (in IPOs it must include price range). Forseasoned and WKSIs, the prospectus accompaniment condition is eliminated.

A communication that satisfies these conditions is deemed a prospectus under Section10(b) and may be used during the waiting period.

Subject to liability under Section 12.

Rule 164 Post-filing free writing prospectuses

A free writing prospectus of the issuer or any other offering participant , including anyunderwriter or dealer, after the filing of the registration statement will be a section 10(b)prospectus for purposes of Section 5(b)(1).

Rule 433(f) Free writing prospectuses published or distributed by media.

Any written offer for which an issuer or any other offering participant provided , authorized, orapproved information that is prepared and published or disseminated by the media would beconsidered at the time of publication or dissemination to be a free writing prospectus. The issueror other offering participant must file the written communication with the SEC within 4 businessdays after the issuer or other offering participant becomes aware of the publication.

Prospectus Dissemination

It is entirely possible for an investor to get an oral offer during the waiting period, place an order(written or oral) contingent on the registration statement becoming effective, but never receive apreliminary prospectus. SEC has plug this regulatory hole by making prospectus dissemination acondition to acceleration of the effective date:

(a)Rule 460. SEC binds the issuer to ensure that preliminary prospectuses have been madeavailable to all participating underwriters and dealers.


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(b)Rule 15c2-8(c), (e). In the case ofIPOs (non reporting issuers) brokers or dealers shalldeliver a copy of the preliminary prospectus to any potential investor at least 48 hoursprior to sending a sale confirmation.

(c)SEC requires offering participants (if issuer not a reporting company) to send preliminaryprospectuses to any investor who is expected to buy (48 hrs. before confirmation of theirpurchase).

CHAPTER4.3.3 POST-EFFECTIVE PERIOD

Prohibitions

(a)No prospectus unless Final Prospectus (Section 10).(b)No deliveries, unless accompanied by Final Prospectus.(c)Written offers must include Prospectus (Section 10).

Permissions

The regulatory game in the post-effective period is prospectus delivery, considering that access(filing prospectus and its availability in the SECWeb site) equals delivery.

(a)Expanded Prospectus types. Section 5(b)(1) permits dissemination of a prospectusthat complies with Section 10, however, the SEC allows:

a. Not-yet-final prospectus (Rule 430A). Cash offerings can omit price-relatedand offering-related information, provided it is filed within 15 days aftereffectiveness.

b. Shelf Registration prospectus (Rule 430B)c. Not-yet-final prospectus (Rule 430C). For non-cash offerings.

(b)Free Writing (Selling Literature). Communications in the posteffective period whichare accompanied by the final prospectus are not deemed a prospectus.

(c)Confirmations. Section 2(a)(10) includes any writing that confirms the sale of anysecurity within the definition of prospectus, unless it is accompanied by a prospectusmeeting the requirements of Section 10. A confirmation is necessary to finalize salesunderExchange Act rules and applicable state statute of fraud.

(d)Securities Deliveries. Section 5(b)(2) requires final prospectus delivery when thesecurities are delivered. Prospectus delivery can be accomplished with a Rule 173 notice.Access equals disclosure.


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Form of Final Prospectus

The prospectus-delivery requirements were to be satisfied by a full and final prospectuscontained in the effective registration statement. To allow flexibility, the SEC now permits thefinal prospectus to omit price-related information. Issuers have 15 business days after theeffective date to the registration statement to file a prospectus containing the price-relatedinformation. Rule 173:All that is required is that issuers, underwriters, and participating dealers provide their purchasers a notice which provides that the securities are part of a registeredoffering within 2 days after completing the sale.

Incorrect Disclosure

When posteffective events make the prospectus misleading it is necessary to analyze whether itis a substantive or a fundamental event. If it is a substantive, the registrant can place a sticker onthe prospectus with the new information and then file it with the SEC. If the event isfundamental, the issuer must amend the registration statement and wait for the SEC to declarethe amendment effective.

Rule 172. Delivery of prospectuses.

(a) Sending confirmations and notices of allocations.

After the effective date of a registration statement, the following communications are exemptfrom the provisions of section 5(b)(1) and 5(b)(2) of the Act, if the issuer has filed the prospectuswith the SEC:

(1) Written confirmations of sales (if made pursuant to Rule 10b-10) and otherinformation customarily included (including notices provided pursuant to Rule 173; and

(2) Notices of allocation of securities sold or to be sold, including informationidentifying the securities, pricing, allocation and settlement, and information incidentalthereto.

Rule 415. Delayed or continuous offering and sale of securities.

(a) Securities may be registered for an offering to be made on a continuous or delayed basis inthe future, provided, that:

(1)The registration statement pertains only to:


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(x) Securities registered (or qualified to be registered) on Form S-3 or Form F-3 whichare to be offered and sold on an immediate, continuous or delayed basis by or onbehalf of the registrant, subsidiary or controlling person.

VII. REGISTRATION UNDER THE EXCHANGE ACTCHAPTER8.3 REGULATION OF PUBLIC COMPANIES

Companies whose shares are publicly traded must register with the SEC thus making themsubject to the Exchange Act regulation:

(a)Registered companies must file periodic disclosure documents with the SEC [known asreporting companies].

(b)Registered companies must keep records and maintain a system of internal accountingcontrol.

(c)Registered companies are subject to SEC proxy regulation.(d)Any person who makes a tender offer for securities of a registered company must make

disclosures to the SEC, to the companys management and to solicited shareholders.

(e)Directors, officers, and 10% shareholders of registered companies must disclose theirtrading in the publicly traded equity securities of the company and are liable to thecompany if they make profits (or avoid losses) from such trading during a 6 month periodafter purchasing the securities.

CHAPTER8.3.1 REGISTRATION UNDER THE EXCHANGE ACT

There are 3 triggers that compel a company to register with the SEC and plug itself into theExchange Acts regulation:

(a)[Section 12(a). Listing on Exchange. It shall be unlawful for any member, broker, ordealer to effect any transaction in any security (other than an exempted security) on anational securities exchange unless a registration is effective as to such security for suchexchange.]

(b)Section 12(b). Listing on Exchange.Companies whose securities are listed on a stockexchange are compelled to register with the SEC.

(c)Section 12(g). Size Thresholds. Companies whose class of equity securities are held bymore than 500 shareholders and have total assets exceeding $10M must register with theSEC. The issuer must register within 120 days after the end of the fiscal year when boththresholds are crossed.


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(d)Section 15(d). Registration Statement Filing. Companies who file a registrationstatement which has become effective pursuant

Documents

Notes Securities Regulation-1