SecuritiesRegulation Quinn Spring2003

8/12/2019 SecuritiesRegulation Quinn Spring2003

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SECURITIES REGULATIONSpring 2003

Professor Quinn

PRELIMINARY MATTERS

I. Introduction Main Concerns of Sec. Reg.

o Regulate how companies get $ through investmento Maintain trading markets

Honest and fair w/out too much regulation Too much de-regulation = fraud Too much regulation = not enough risk so companies not get enough $

Statuteso Security Act of 1933 = regulate newly issued securities

Deals w/ (1) investment banking (2) IPOs How to file a registration statement w/ SEC Exemption to registration Liability provisions

o Securities Exchange Act of 1934 = Regs. for trading securities already issued Establish oversight through the SEC Has reporting requirements Sect. 10b-5 = fraud Market manipulation = scheme to drive up prices

Two Topics w/ 33 & 34o Security:

Common stock or Corporate Bonds = definitely securities not all stock or debt is security Some PRIVATE investment can be security too

(ie/ if you borrow $10 from a friend, it could be a security) Fraud = look to sec laws SAME DEFINITION for 33 and 34 acts

o Materiality: Material Information Info that a reasonable investor would think is important

II. Historical Backgrounda. Prior to 1933

i. Very little regulation, no federal except for the RRsii. State regulation (blue sky laws -1 st in KS in 1911), but these were weak

1. could be avoided if the offer was made interstate (offer made in onestate, accepted in another)

2. states not adequately fund regulatorsb. Stock Market Crash

i. Congressional hearing uncovered many problems in the industry.1. market manipulation

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2. borrowing on the margin3. failure to disclose financial information4. fraud

ii. Congress believed that dishonest practices of the securities industry caused the crashand the Great Depression, BUT it was the effect of the poor global economy

c. 1933 and 1934 Securities Exchange Acts passed to provide federal regulation

III.

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Key Provisions of the 1933 and 1934 Acts

a. Securities Act of 1933 :i. 3 & 4

1. exemptions to registration2. registration NOT required for transactions by

a. a person other than ani. issuer,

ii. underwriter,iii. dealer,

b. stock that does NOT require an IPO.ii. 5 new issues of securities have to be registered with the SEC prospectus too!

iii. 6 & 8 procedures for filing a registration statementiv. 7 & 10 information required in a registration statement and prospectusv. 11 & 12 private remedies rights of action for false registration statements and

prospectuses.vi. 13 statute of limitations = one year after discovery

vii. 15 controlling person is jointly and severally liable for people they control, whenthey violate 11 or 12.

viii. 17 general anit-fraud = prohibits fraud by any person who offers or sellssecurities

b. Securities Exchange Act of 1934: (much longer act)i. Registration

1. 7 & 8 margin requirements and borrowing and lending2. 15 Registration of brokers and dealers.

a. SEC can bring administrative actions against any person associatedwith a securities firm.

ii. Regulating Disclosures1. 12 registration required before transactions on a national securities

exchange2. 13 reporting requirements3. 14 disclosure requirements for proxies and tender offers

iii. Regulating trade of securities1. 10(b) (Rule 10b-5)

a. general anti-fraud provision b. deals w/ buying or selling of ANY secuity

2. 14 prohibits fraud with proxy and tender offers3. 16(b)

a. trading by corporate officers (officers, directors, SH w/ 10%)regulated b/c these people have material non-publicinformation

b. cannot make a profit w/in 6 month period

c. Sarbanes-Oxleyi. Biggest change in securities laws since 1930s

ii. Overrides much of state law 1. normally it would be controversial 2. w/ Enron = much easier to do

d. Other Securities statutes

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i. Public Utility Holding Act : to prevent abuse of power in the public utility market.ii. Investment Company Act of 1940 : regulates companies that hold and manage large

portfolios of securities for investors (mutual funds)iii. Investment Advisors Act of 1947 : regulates people who give investment advice for $

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STATUTORY DEFINITION OF SECURITY

5: unless a registration statement has been filed, it shall be unlawful for any person, directly orindirectlyto sell a security.

I. Why is this important? Arduous to register, and you must to sell securities (unless exempt)

o Expensiveo Must follow regulationo Right of recision = if not register, buyer can revoke sale

II. Statutory definition courts have held the definition is the SAME for both acts!!a. 2(a)(1) 1933 Act: any note , stock , treasury stock investment contract , put, call,

option entered into on a national securities exchange, any interest or instrumentcommonly known as a security

b. 3(a)(10) 1934 Act : same definition, construed in same way key term is INVESTMENT CONTRACT !!

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III. Investment Contractsa. SEC v. Joiner: Joyner Co. owns land and sold portions of it, saying they were going to drill for oil.

He sent letters to people, claiming all they had to do was buy the land and they would get the benefits ( passive investment ). SEC alleges securities fraud, claiming the oil interest was a securityand an investment contract. Joiner claimed he was just selling land.

i. SC held that it is an investment contract . (Test = (1) terms of offer, (2) plan of

distribution, (3) economic inducements held out) = VAGUEii. Joiners promise to drill and the oil made the land valuable (these were his efforts).Without the oil, the land was worthless. There was a possibility that the landowner andJoiner would lose out (common enterprise), so it is an investment contract.

iii. He promoted the land, through an advertisement, as an investment, specifically for passive investors. Court said that you cannot advertise something as an investment andthen later claim it is not an investment.

iv. Interests in oil and gas are securities b. SEC v. Howey : Howey was selling orange groves to the public. They also offered Howey in the

Hills to do the cultivating of the citrus groves. Possible investors were offered a land salescontract and a service contract, saying that it was not feasible to invest in the grove unless therewas a service arrangement. Mails were used and there was no registration statement filed.Purchasers were nonresidents of Florida, who lack knowledge and skill necessary to care for andcultivate citrus trees. They expected profits. SEC alleged this was an unregistered security.

i. Howey Test : An investment contract means a contract, transaction, scheme whereby a person invests his money in a common enterprise and is led to expect profits solelyfrom the efforts of the promoter or third party.

ii. SEC looked at state blue sky laws for the definition of security.iii. SC held that this is an investment contract. They offered an opportunity to contribute

money and to share in profits of a large citrus fruit enterprise managed and partly owned by respondents.

iv. NOTE: The Securities Act prohibits the offer as well as the sale of unregistered,nonexempt securities. Hence it is enough that the respondents merely offer the essentialingredients of an investment contract.

1. These investors were passive and should be protected by securities laws (theylived far away and had no knowledge of the business).

Howey Test

1) investment of money2) in a common enterprise3) w/ expectation of profits4) solely from the efforts of others

c. SEC Fraud vs. Common Law Fraudi. Reliance

1. Common Law fraud = must show RELIANCE 2. SEC fraud = NOT need reliance

ii. Material Omission 1. CL = can leave out information, as long as not lie 2. SEC = duty to not have a material omission

d. Investment of Moneyi. Elements

1. Must intend to invest for investing and making money

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2. Specific consideration = small portion of compensation that its not realexchange

3. Concerned less w/ livelihood than investment ii. International Brotherhood of Teamsters v. Daniel: Daniel was a truckdriver who was laid

off, went back to work and then left the company and was denied his pension. To get the pension, the K required he work 20 continuous years, which he had not done. The

pension plan was compulsory and noncontributory. The employer put the funds in. Is the pension plan an investment contract and therefore a security?iii. SC held this is not an investment contract because the employee makes no payment to the

plan, the employer does. Therefore, a non-contributory, compulsory pension isNOT an investment of money .

1. he did not give up specific consideration in return for a separable interest withthe characteristic of a security.

2. he was selling his labor to obtain a livelihood , not to make an investment in thefuture.

iv. through the efforts of other is likewise not met because it depended on how long heworked, not on the management of the company.

1. Majority of income generated came from the employers contributions and sodid not depend on the efforts of the fund managers.

v.

Also, ERISA was enacted, which regulates pension plans, so there is no need for the protection by the securities laws.

e. Common Enterprisei. Horizontal Commonality

1. investors in a profit generating enterprise are linked to each other. Money is pooled to fund the business and all investors share equally inthe profits .

1) Three circuits agree this satisfies common enterprise.2) Ex: everyone in a condo resort agrees to participate in the rental

pool. Each person gets 20% of the rental.ii. Vertical Commonality

Dfn = where an investors profit or loss is linked to the promoter ormanager. Each profit is independent, but tied to the promoter.

Ex: Each person pays a manager to rent your condo. There isno pool and no link between participants. There is onlya link between manager and each owner.

1. Strict vertical commonality : each investors profit or loss is linked to the promoters profit or loss.

2. Broad vertical : manager gets a flat fee whether an apartment is sold ornot.

courts disagree on which to accept!!iii. Brodt v. Bache: Bache solicited appellants to open commodities trading accounts. They

sold their portfolios and invested in the accounts with Bache. Bache said they would reap profits. They lost money and the company was insolvent. Bache gets a commission fromtrading individual accounts.

1. There is an investment of money and an expectation of profit.2. SC held that there is NOT an investment contract because there is no vertical

commonality . The broker gets a commission whether the client gets a profit or aloss. There is no vertical commonality because Baches success did not dependclients.

f. w/ expectation of profiti. want profit!!

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g. solely from the efforts of others

i. If you do SOME of the work, is it still efforts of others? YES (see below)

Counterarguments1) This raises costs for businesses to raise $ b/c have to look for who you

are selling toi. To public = either

1. MORE regulation b/c public at large2. LESS regulation b/c seeking neutral investors

who might be expertsii. Have to discover if expert or not

2) Do you want bright line or flexible testsi. Bright line = more regulation for legit business but its

easy to engage in more questionable activities b/c you goright up to it w/out going over

ii. Flexible = easier for regulators but harder for businesses

ii. SEC v. Glenn Turner Enterprises: Glenn Turner formed an organization called Dare to beGreat, which ran seminars on how to get rich. It was a pyramid scheme , in which youcould recruit others and get a percentage of their membership fee. (Doomed to collapseand a big fraud because you have to keep recruiting more people in order to make a

profit).1. Turner argued that it is not an investment contract because the investor has to

recruit to get money, therefore it is not from the efforts of others. Also, youare not a passive investor, they have to do something, so the investors aredifferent from those in Howey.

2. 9th Circuit held that the plans were securities . The court is not going to readsolely from the efforts of others literally.

1) TEST : whether the efforts made by those other than theinvestor are undeniable significant ones, thoseessential managerial efforts which affect the failureor success of the enterprise .

2) The investor has to exert some effort, but the significantdecisions come from others.

iii. SEC v. Aqua Sonic Products1. AS would sell licensees the right to sell Steri Products. Ultrasonic Corp. was

responsible for all sales of Steri for the benefit of the licensee. Licensee couldcancel. Ultrasonic performed all significant marketing functions. The licenseeswere told that if they entered the agreement, they would derive substantial tax

benefits. 50 licensees entered the agreements and had no experience sellingAquaSonic. It collapsed.

2. 2d Circuit held that i t was an investment contract1) makes same argument as Glenn Turner.2) The decision to enter the agreement was optional . But the fact that it is

an option is not inconsistent with the scheme being an investmentcontract. Court finds that it is not really an option because there isdoubt that the investor would have made money if they did not enterthe agreement.

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3) Solely should NOT be taken literally. Significant decisionswere made from the efforts of others.

iv. SEC v. SG, Ltd. 1. D had a virtual stock market game. D set the price of the stocks and people

bought it. SG said one company was great and raised the price by 215% peryear. D stopped people from pulling out their money, but kept letting others in.

D said not investment K, its just a game. 2. Court Held = it WAS a security 1) It was a Ponzi Scheme (people invest $, and get return from the new

investors the schemer recruits). 2) NOT game b/c (1) no term (2) no chance on which companies go up or

down. 3) Fantasy football = you pick the players, they perform by chance!

h. Schemesi. Pyramid = Glenn Turner

ii. Ponzi = SEC v. SG Ltd.

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IV. Which Business Ventures Are Securities:

a. General Partnerships

i. Usually not an investment contract/security because1. EACH GP has extensive rights to manage the business and have equal

rights to the profits.2. So, the profits are not solely from the efforts of others.

what if some gps have no say in the GP

ii. TESTS: Its an INVESTMENT if1. partner is so inexperienced and unknowledgeable in business affairs

that he is incapable of intelligently exercising his partnership or venture powers. (Koch )

2. If investors have no voice in management because 1) Specific provisions in the partnership agreement that leaves so

little power in the hands of the investor , that power isdistributed as it would be in a limited partnership

2) The investors inexperience in business matters , makes the business have to be from the efforts of others

3) The investors dependence on the unique skills of thepromoter

3. Other courts say1) Investment = if you are experienced in oil, but invest in real

estate, the GP might be an investment contract because you dontknow anything about real estate.

2) Not Investment = you have the power and ability to research, soyou should not invest unless you know about it.

b. Franchises : not an investment contract because not form the efforts of others.

c. Limited Partnerships : generally held to be securities because LPs cant participate inmanagement and are relying on the efforts of others. (Goodman v. Epstein).

i. Koch v. Hankins : GPs set up to sell jojoba. The investors (partners) had a vote. Theycould not show that they were left with so little power as to place them in the same

position as a limited partner. They had no experience in jojoba, but they hadexperience selling pistachios. They were not relying on others, but had to figure outhow to make their plan work, so it is not an investment contract.

1. Held = In a GP investment contract, you should know what you are doing, soyou dont need to rely on others. So, it is not an investment contract ,usually.

ii. Williamson v. Tucker: Joint ventures each of which owned an undivided interest in realestate. Each participant retained control over the prospect, pursuant to the joint ventureagreement.

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1. Here, there is no security , but the court discusses when a GP could be asecurity.

d. Stocksi. United Housing Foundation v. Forman: sale of stock in a nonprofit cooperative

housing corporation. When you bought stock, you were allowed to live there. When

you left, you had to sell your stock, but only at the price you bought it for (no profit).1. SC held that it was not a security. They rejected the literal approach thatanything called stock was automatically a security.

2. This stock did not conform to the characteristics of stock .1) They were not investing for a profit, but to acquire a place to live.2) the stock did not confer the rights that normally accompany stock. It

was not transferable, could not be pledged, no voting rights, and had to be offered back to the co-op at their initial selling price.

3. It was not an investment contract either because there was no expectation of profit.

4. SC says you have to focus on the economic reality ONLY inunusual circumstances (see below) of what was going on.

1) Not characteristics of stock

2) No expectation of profitii. Landreth Timber Co. v. Landreth: Landreth family owned all stock in their company.

They offered it for sale, but then a sawmill caught on fire. Dennis bought the stock andtried to rebuild it. Rebuilding cost more than anticipated and they sold it at a loss.Petitioner claimed that the stock was sold, but unregistered. If it is a security, it is subjectto the antifraud provisions and they claim fraud.

1. District Court held that this was a sale of 100% of the stock, so it was acommercial venture and not an investment, for the purposes of the 33 Act.

2. Held = it was security .

1) Supreme Court rejects sale of business doctrine :i. the idea that the incidental transfer of stock to manifest a

sale of a closely held business is NOT a security to thosewho are entrepreneurs and not passive investors.

ii. Basically, since Landreth sold all stock, it was a sale andthey did not have to register the stock.

iii. Not accept at 100%, but what about if its at 90%? NO,its rejected in ALL contexts.

2) this stock , unlike Forman, possessed all the characteristicsidentified in Forman as traditionally associated withcommon stock .

3) Respondents want court to look at the economicsubstance/reality of what was going on.

i. They were not purchasing stock to earn profits, but to buy a company that it could manage and control. Theywere not passive investors, but active entrepreneurs, sothe Acts do not apply to them.

ii. The Court held that the economic reality of thetransaction will only be looked at when theinstruments involved are unusualnot easilycharacterized as investments

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4) Forman does not eliminate the Courts ability to hold that an

instrument is covered when its characteristics bear out the label.5) People trading in stock have a high expectation that their

activities are governed by the Act, so if we were to saysomething that looked like stock was not actually stock, peoplethat thought they were protected would not be, which would notmake sense.

3. The Landreth Stock had all the characteristics traditionally associatedwith common stock :

1) the right to receive dividends contingent on profits2) negotiability3) ability to be pledged or hypothecated4) confers voting rights5) capacity to appreciate in value

V. Notesa. The statutory definition says any note is a security.

i. A note is a written promise to pay back in the future, which is very broad.ii. commercial investment test

1. Lower courts held that it cannot be read literally, Congress could nothave intended security laws to cover every single note.

2. Dfn = look at notes on a case by case basis. If it is used as a commercialinstrument, then not a security , but if used as an investment, then it is asecurity.

iii. Supreme Court adopts FAMILY RESEMBLANCE TEST ( Reves v. Ernst &Young)

1. A note is presumed to be a security , and the presumption can berebutted only by a showing that the note bears a strong resemblance to

one of the enumerated categories of instruments(not securities ).

1) Notes delivered for consumer financing2) The note secured by a mortgage on a home3) The short term note secured by a lien on a small business4) Note evidencing the character of a loan5) Notes evidencing loans by commercial banks6) Note that formalizes an open account debt incurred in the

ordinary course of business

2. FACTORS to consider in determining whether it resembles or not:1) motivations that would prompt a reasonable seller and buyer to

enter into the transactioni. if to raise money for the general use of a businessenterprise security

ii. if purchased to buy an asset not a security2) plan of distribution of the of the instrument

i. Is there common trading for speculation or investment?ii. Were the notes offered to the public?

3) what are the reasonable expectations of the investing public?

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i. Are the notes advertised to the public or marketed as aninvestment?

4) Is there another regulatory scheme that reduces the risk of theinstruments (making application of the SEC Act unnecessary).

b. Reves v. Ernst & Young: Facts: Agricultural cooperative with 23,000 members. To raise money,the Co-op offered notes under a scheme called an Investment Program. Co-op filed for

bankruptcy. Noteholders sued auditor Arthur Young, claiming they did not value one of the assetshigh enough. If not a security, then the fraud provisions do not apply.

i. Notes must be looked at in terms of what Congress expected the Act to do.ii. Family resemblance Test (2d Cir): presume it is a security, but it can be rebutted if

issuer can show that it bears a resemblance to the exceptions.iii. Howey test (8th Cir): Applied Howey to notes.

1. Court rejects the Howey test because it would make the enumeration of thetypes of instruments in the definition of security, meaningless. The Howey testwas designed for investment contracts, not notes. To apply it to notes wouldeliminate the distinction between notes and investment contracts.

2. Court also rejects the Landreth test, that if the note had the characteristics of anote, it is a security. Notes are used in a broader variety of settings, some

commercial and some involving investments.

c. Great Rivers v. Farmland Industriesi. Class action against Farmland that the capital credits were securities. Are the capital

credits notes?ii. Court does not apply the Reves Test because capital credits are not listed in the

statutory definition.iii. Court applies the Howey Test

1. they did not expect profits, but to reap the benefits of the relationship. They became members of a group

2. The credits were not issued to raise money for general business use.3. No dividends and no liquidity4. Similar to Forman, where they just invested to get an apt.5. The court was blurry on what test they were using, Reves or Howey.

iv. They do not share any characteristics with a security, so NOT A SECURITY

d. Marine Bank v. Weaver: COD was issued by a federal bank. SC said that the note was not asecurity because the Fed. Banking regulation and FDIC prevents loss. There is no investment risk,and so no need for Fed. Securities laws.

i. CDs in FDIC banks do NOT apply b/c banking laws do!!ii. Securities are usually instruments that can be publicly traded and a unique profit sharing

agreement, negotiated one on one is not a security .iii. Congress did not intend to provide a broad federal remedy for all fraud

VI. Options and Futures

a.

Derivative Instrumentsi. Financial instrument whose value depends on something else (e.g. currencyswaps)

ii. Not necessarily a security1. SEC regulates securities,2. CFTC regulates commodities and futures

b. Optionsi. Its a SECURITY

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ii. If company is trading at 20$, you think the price will go up. You buy an optioncontract (an option to buy 100 shares of Z at any time before the expiration datein the K). If stock price goes up, you make money and if it goes down, you loseyour premium.

iii. Used by people who want to hedge, have a speculation. If you have a hunch andyou want to gamble, you make a lot more money in options than in stock.

iv. Used by inside traders. If you know the price is going to go up because you havenonpublic information, you buy an option and can make a lot of money.

v. a call option - the holder is hoping that the price will rise. It is a contract inwhich the holder of the call option has the right to call the underlying stockaway from the option writer at the exercise price at any time prior to theexpiration date.

vi. a put option - the holder is hoping that the price of the security will fall. It is acontract under which the option holder has the right to sell the underlying stockto the option writer at the designated exercise price any time prior the expirationdate.

c. Futuresi. Contract for future delivery at a specified price on a definite date. Obligated to

buy.ii. Not securities = regulated by CFTC

iii. Soy beans, orange juiceiv. Chicago Mercantile v. SEC:

1. Commodity Futures Trading Commission (CFTC) has authority to regulatetrading of futures contracts and options on futures contracts.

2. SEC has authority to regulate trading of securities and options on securities.3. If security and futures contract, the CFTC regulates .4. If future and an option on a security, then SEC regulates.

VII. Exempt Securities -- 3(a)a. Exempt from registration under the 1933 Act.

i. Not subject to registration and disclosure requirements, butii. still subject to antifraud provisions and civil liability provisions.

b. Listed in 3(a)i. (2): securities issued by the state or federal government

ii. (4): securities issued for religious or charitable purposes iii. (8): insurance or endowment policy or annuity contract

iv. SEC v. Life Partners: LPI is a promoter facilitating the sale of life insurance policies fromAIDS victims to investors. The viatical settlements permit AIDS patients to receivefunds for medical bills while the investor received the benefits of the policy when thevictim died.

1. District Court held that the promotion and repackaging of insurance into theseviatical settlements constitutes an investment contract and was not exempt fromregistration as an insurance product under 3(a)(8).

2. D.C. Circuit REVERSED. It is not a security because LP does not do anythingsignificant after they bought interest in the policy. Therefore, the profits are notfrom the efforts of others.

VIII. Securities that Do NOT EXISTa. Investment schemes that dont exist SEC brings case

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b. ie = Prime Bank Notes = fake $1M notes where person tries to get people to invest inDont existSEC has power to enforce against the selling party

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MATERIALITY

I. Applicable Statutes and Regulationsi. Sect. 11 of 33

ii. 34 Actiii. Regulation FD = can NOT selectively disclose material information

(ie/ not tell some investors material information and not others)

II. You can LIE, but NOT about MATERIAL information!!

III. Test: material if :a. a reasonable shareholder would consider it important in making an investment

decision OR

b. if there is a substantial likelihood that the disclosure of the omitted fact would havebeen viewed by the reasonable investor as having significantly altered the total mixof information made available.

c. An objective test standard of a reasonable investori. Not whether a particular investor would consider it important, but whether a

reasonable person would.ii. Depends on context and circumstances/overall picture

IV. Qualitative Information = Rule 408 = just b/c law not specifically mention an action you have to disclose, there

is still info you MUST disclose too You can lie = just not about MATERIAL information

o Fair Price Rule (Basic) Proxy solicitations = cant make false or misleading statements Rule 14(a)(9) If you quote a price that you belief is wrong, but it turns out to be

fair no liability

o Speculative Features not plainly evident to reasonable investor (Uni Camera )o Minor Material Information = no matter how big, as long as its material

(Schlitz)o Illegal Activity (even its a small amount) (SEC v. Schlitz)

SEC v. Schilitz = D bribed Spanish company violating Spanish law, but itwas a relatively small number.

Court held = MUST disclose .o Integrity of management = Franchard Corp.

Highly Material Evaluation of management Essential ingredient of informed investment decision Guide to future basic performance

o Past business experienceo Past performance

What is typically disclosed?o Benefits paid or proposed to be paid to management

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o Material transactions btwn corp AND officers/directors/10% SHs

Information important b/c Showed strained financial position Integrity of management Motive for corp to pursue policies which allow

o High distribution rateso High price for shares

Show warnings of changes in management

a. CASES b. Universal Camera Corp.: Universal was manufacturing cameras, but switched to

binoculars. They offered a new class of stock and filed a registration statement.i. The shares were offered as a speculation.

1. Where there is speculation, the registrant is under a duty todescribe the speculative features of the offering in theregistration statement and the prospectus so clearly that they

will be plainly evident to the ordinary investor .2. Explain the speculation in plain, ordinary terms. Plain EnglishRule.

ii. Universal omitted:1. difference between the book value and the offering price.

This meant that it would take an experienced analysts tofigure out that it would take many years to make anearning.2. product development3. nature of the market4. did not disclose that the products were not patented.

c. Franchard Corpi. Glickman established control of registrant by acquiring 450,000 of its

600,000 shares. He was a dominant role in the management of registrantsaffairs as president and chairman. Two days after filing, Glickman begantransferring funds from registrant to Venada. Neither the prospectuses northe filing reflected these transactions.

ii. Omissions1. The 1960 prospectus failed to reveal that Glickman intended to use

Franchards funds for the benefit of Venada.2. Also failed to show that he was using his stock to make personal

loans.iii. These things reflect in the business ability, integrity and motivaiton of the

management.iv. These were highly material disclosures to an evaluation of the competence

and reliability of registrants management.v. Quality of management is of cardinal importance in any business.

Disclosures relevant to the quality of management are particularly importantwhen the securities are sold on the reputation of the controlling person.INTEGRITY IS A MATERIAL FACTOR . So personal issues of thedirector/pres. will be material.

1. Disclosures would have showed that the company was in a strainedfinancial position. The diversion of funds would have shown theintegrity of the management. The investor needs to be able toevaluate the management of the company .

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vi. Glickman argued that these disclosures would invade his privacy . But, acorporation asking for public funds must relinquish part of its privacy withrespect to his financial affairs which impinge on the affairs of the company.

d. In re Caterpillari. Caterpillar did not report a greater than usual profit of Caterpillar Brazil because

the profit contribution of each subsidiary had not been used for big decisions(personnel, product etc.). The previous losses were due to economic policies inBrazil. Since Brazil was not a separately reported business segment,Caterpillars financial statement did not disclose the disproportionate impact thatBrazils profits had on the parent companys profits and financial condition.

ii. Caterpillar should have described the unusual events or transactions (thatBrazils economy was unstable) in the 10K/MD&A/Form S-K.

1. The 10K requires a registrant to discuss the liquidity, capital resourcesand results of operations of the registrant and to provide otherinformation about changes in the financial condition.

iii. They had left investors with an incomplete picture of the investment.e. Virginia Bank Shares v. Sandberg

i. Freezeout merger. The investment bankers say 42$/share is a good price. Mostminority shareholders took the offer. Sandberg did not and claims the proxy wasmisleading.

ii. Is the statement, that the price is fair, a material fact?iii. An opinion can be material. To avoid liability, need to back up your opinion

with facts .iv. Mere disbelief is not enough for liability under 14(a) (misleading proxy

statement). Without a factual demonstration that the proxy statement wasfalse or misleading .

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VI. Projections

a. bespeaks caution doctrine i. common law doctrine

ii. if there is a meaningful cautionary statement included, then it is not materialiii. tell what could possibly go wrong = youre cleariv. allows for forecasting.

b. What a reasonable person should know (need license for nuclear reactor) = NOTmaterial

c. Sales Puff (saying an auction is going well) = NOT material

i. Wielgos v. Comm. Edison1. Comm. Edison owns nuclear reactors. Wielgos buys 500 shares. Byron 1 is a

reactor, but cannot operate without a license. The ASLB denies the license,stock price drops. P claims that the Comm Ed. Underestimated the cost ofreactors and the company failed to disclose the application for the license .

2. Court held:a. Cost: it is reasonable to look to past experience to calculate cost.

Company based on past experience, but it turned out to be too low.They were made in good faith.

b. License: everyone knows that the license denial could happen. Thereasonable investor would know the denial was a possibility .

c. NOT MATERIAL3. High burden on investors.

ii. Rule 175: forward looking statements made in SEC filings cannot be bases for liability aslong as they have a reasonable basis.

1. It is reasonable for a corp. to rely on the past2. Projections that were accurate, even if not accurate at time it becomes effective,

are okay.iii. Eisenstadt

1. Corp. makes announcement that they are going to sell. They go into privatenegotiations and offerees offer a lower than expected price. Despite this, they

announce that the auction is going well . 2. Court held this is just SALES PUFF, and NOT MATERIAL

a. everyone knows that the sellers will say the auction is going well because if you dont the auction would really do poorly.

3. Corps do not have to disclose the obvious, but what is obvious to the public?Possibility of making the wrong assumptions.

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SECURITIES ACT OF 1933

*** Absent an exemption, all offers or sales of securities must be registered pursuant to Section 5 of the1933 Act

Quick Outline1. Registration

a. The Process of Going Forward b. Dissemination of Info during Regis.c. Specific Disclosure Requirements Regis. Stmnt.d. SEC Review

2. Exemptions From Registrationa. Non-public Offerings

b. Reg A &c. Reg Dd. Secondary Transactions

3. Civil Liabilitiesa. Sect. 11 standing; damages

b. Sect 11 due diligencec. Sects 12(a)(1) & 12(a)(2)

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PROCESS

I. The Process of Going Public

a. Going Public: all public offerings have to be registered unless an exemption applies .i. This includes

1. initial public offerings and2. offerings of securities by existing companies.

ii. Advantages:1. raise capital, cheaper than borrowing from a bank2. makes the stock liquid:

a. can use it to acquire other companies and b. can compensate employees (stock options)

3. people can cash in and make millions4. ego/status/prestige

iii. Disadvantages 1. cost of initially registering ($1M) and maintaining reporting

requirements2. give up privacy of financial data (the price of disclosure)3. excessive focus on

current performance, dictated by the market > instead of long term business strategy

b. Process: Firm Commitmenti. underwriter gives a letter of intent to issuer so issuer can proceed with organizing

etc.ii. Issuer (the Corp.) sells an issue of securities to ibankers

1. Usually at a discount2. Ibankers bear all the risk3. Prefiling, only negotitations between issuer and underwriter are allowed.

iii. issuer and ibanker negotiate and agree that it will not be binding.iv. They price the stockv. usually there is one managing underwriter and additional syndicates.

1. Managing underwriter determines how much the syndicate can sell.2. agreement among underwriters is signed by syndicate, which says that

managing underwriter has authority over the offering process.3. All in syndicate will offer at same time and price

vi. sign an underwriter certificate with the issuervii. Issuer and managing underwriter draft a registration statement. Issuer has

independent accountant to provide financial statements.1. Issuer wants the highest price.2. Underwriter wants high price too, but also wants to get rid of the stock,

so they tend to have a lower price.3. If issuer goes broke, the shareholders will go after the underwriter

because they have deep pockets. The issuer barely has any money.viii. SEC reviews registration statement, gives comments, amendments

ix. File registration statement with preliminary prospectus1. Prelim. Prospectus: includes company history etc. minimal information.

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x. Underwriters send out a preliminary prospectusxi. Underwriter pitches deal, holds roadshows.

xii. Underwriter can get out of the deal once it is signed if there are exceptionalcircumstances. (market out clauses in agreement)

1. National security, war, suspension of market, material adverse change2. Walken Medical Services: decline in stock price is not an adverse market

condition that will allow underwriter out of deal.xiii. ISSUER UNDERWRITER DEALER PUBLIC

1. Underwriter: 2(11) any person who has purchased from an issuer witha view to, or offers or sells for an issuer

2. Dealer: 2(12) any person who engages as agent, broker or principal inthe business of offering, buying, selling or otherwise trading or dealingin securities issued by another person.

c. Best efforts: companies that are not well established are not apt to find an underwriterthat will give a firm commitment and assume the risk. So, they use firms that pledgetheir best efforts.

i. The securities house does not buy from the company and resell, but they act asagents and get a commission.

ii. Issuer still bears the risk

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II. Dissemination of Information During Registrationa. The securities must be registered before sale to assure availability of adequate reliable

information about securities that are offered to the public.b. Three time periods:

i. Prefiling [ 5(c) (no offers); and 5(a) (no sales)]1. time before registration statement made2. starts when registrant thinks about selling securities

ii. Waiting Period [can offer; 5(a) (no sales); and 5(b)(1) (no prospectusunless meets 10, can use R 430 (prelim prospectus))]

1. Filing registration statement UNTIL2. RS becomes effective

iii. Post-Effective1. time registration is effective UNTIL2. sell the initial offering

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v. 5(b)(1) applies : it is unlawful to transmit any prospectus, relating to any securitywith respect to which a registration statement has been filed unless such

prospectus meets the requirements of 10 .1. Prospectus ( 2(10)) : any communication that is written or by radio or

tv that offers a security for sale2. not a prospectus ( 2(a)(10)) : a notice, circular, advertisement, letter

in respect to a security that does no more than identify the security, statethe price, and state who will execute orders.

a. Rule 134: Tombstone ads are okay .i. Written communication is not a prospectus if it states

where you can get a prospectus and only limitedinformation.

ii. Names underwriter (where they can get a prospectus), #of shares, price.

b. Does not prohibit oral offers . ( 5(b)(10)) i. Can have Road Shows

ii. Can call people over the phoneiii. Can NOT close the deal

c. Should not initiate publicity, but can respond to inquiries .3. Should receive preliminary prospectus 48 hours before the effective date.

vi. 10 of the 1933 Act: Information Required in a Prospectus 1. 10(a): what goes into the prospectus (info required)2. 10(b): Commission can make rules that omit or summarize what is

otherwise required by 10.a. Rule 430:

i. Allows you to send preliminary prospectus in waiting period (aka Red Herring )

ii. preliminary prospectus has to contain substantially thesame info as final prospectus, but certain info can be

omitted if it is not available yet.a. i.e. price can be omitted.

b. Underwriter can be named.c.

b. Rule 15c2-8i. Requires broker/dealers to deliver Prelim. Prospectus to

their investors. ii. SEC has no control over issuers

iii. Prelim Prospectus is available at www.sec.gov for FREE

3. Free Writing Forbiddena. free writing = ads, brochures, etc

b. NOT send during waiting period b/c free for investors and getinfo

4. BOTTOM LINE: in waiting period, you can distribute a preliminaryprospectus (red herring) or tombstone ad.

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e. Post-effective Period (after registration statement is declared effective)i. After effective, underwriters and dealers can make sales to anyone. BUT, a final

(statutory) prospectus must be sent too

ii. 5(a) no longer applies because registration statement has been filed.

iii. 5(b) still applies.1. 5(b)(2): shall be unlawful to carry or transmit any security for sale

unless accompanied or preceded by a prospectus that meets requirementsof 10(a).

2. 4(1): exempts sales by anyone not an issuer, underwriter or dealer.3. 4(3): exempts dealers.

iv. Under 10(a) , prospectus means a registration statement (final prospectus).1. Rule 434: if a preliminary prospectus was already sent , you can just

send a term sheet with the price and whatever was omitted in the preliminary prospectus.

2. Rule 174: if dealing w/ and ESTABLISHED COMPANY, dont have todeliver final prospectus b/c there are already periodic reports that haveall the info.

v. free writing: sending an advertisement/written materials IS allowed. But,you need to be sure they have a prospectus FIRST.

1. Sometimes it is viewed as a prospectus and you would not be registeredand then be held liable.

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III. Disclosure Requirementsa. Three Types of Forms: S-1, S-2, S-3b. Form S-1

i. All IPOs must file.ii. No incorporation by reference

iii. Any companies that do not qualify for S-2 or S-3 must file an S-1c. Form S-2 = skip it b/c no one uses it! d. Form S-3 (most desirable)

i. Abbreviated formii. Issuers do not have to repeat information that is in the registration statement

iii. Incorporation by reference to 10K can be used.iv. Two requirements (restricts who can use it)

1. Issuer requirement : must be a US company and filed with the SEC inthe last year (so no IPO)

2. Transaction requirement : if cash offering then persons not affiliatedwith the issuer must hold stock with issuer worth 75,000,000.

e. Registration Statement i. 7(a) 1933 Act : the registration statement shall contain information required by

Schedule A. (describes what must be included in the RS) 7 says that SEC can require more or less info if it wants

ii. 2 Parts of the RS

iii. Part I = Form S-1 info required in the prospectus. Part I is the prospectus.Refers to Reg. S-K.

1. Reg S-K:a. Item 10(b): allows use of predictions and forecasts if there is a

reasonable basisi. Materiality

ii. Rule 175 = safe harbor for projections b. Item 10b3: you must disclose material pending proceedings

against the companyc. Item 303: Management Discussion & Analysis (MD&A)

i. MUST include known trends and uncertainties thatcould affect future operations

ii. This is supposed to give investors an opportunity to lookat the company through the eyes of the management by

providing for a short term and long term analysis of thecompanys business.

iii. Should include material changes in advertising, purchaseor sale of major assets.

iv. Cant be too optimistic or pessimistic (no bright line)d. Item 304: if change accountants, must notifye. Item 501(b)(7): must put on the cover SEC has not approved or

disapproved of this securityi. The govt has no opinion about the security/investment.

They are just looking at the disclosure, not the merits ofthe security.

f. Item 503:i. Prospectus summary

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ii. risk factors as to the securities being offered

2. Other Disclosure Requirements a. Rule 408:

i. registration statement must include such MATERIALinformation as necessary to make the requiredinformation not misleading.

ii. Injects English-style principles into American law b. Rule 421: Plain English Rule. Prospectus should be intelligible

to people that are not professionals.

3. Small Business forms =a. Regulation S-B (equivalent of Reg S-K)

i. Reg S-B 1 andii. Reg S-B2 :

b. Disclosure rules for small businesses (simpler and less expensivethan Reg S-K)

c. Requirementsi. US and Canadian Companies

ii. $25M year in revenueiii. $10M in offering

4. Misc. Formsa. F-1, F-2, F-3 = foreign issuers

b. S-4 = Mergers and Acquisitionsc. S-8 = Employee Benefit Plansd. S-11 = Real Estate Companies

iv. Part II Form S-1 : items not required in prospectus but are available for publicinspection in the SEC files.

f. Who has to sign the registration statement?i. 6 of 1933 Act : issuer, officers, financial officer, accounting officer and

majority of its Board.1. important because under 11, whoever signs is liable.

g. Shelf Registration : Corp. can register securities now to be issued in the future (up to 2years) so they can wait for more favorable market conditions.

i. Rule 415 : list of who can use shelf registration. Any company that can use an S-3can use shelf registration.

ii. Must comply with 512(a) of Reg S-K.

1. you have to file a post effective amendment that discloses facts thathappened after the registration statement that represent a fundamentalchange.

2. But, if S-3, you do not need to do this because you would already have tofile the amendment under the S-3 rules.

h. Rule 512(a) i. When selling securities, have to file post-effective statement

include facts that have had a fundamental change since registrationii. Fundamental Change NOT Material Change

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1. which is higher?2. No one knows!

i. 1998 Proposed Reformsi. aircraft carrier = 1000 Westlaw pages

ii. Release 706(a) = NOT ADOPTED1. allow offers in pre-filing of IPO

a. up to 30 days before filing (30 days to cool off before IPO) b. allows company to determine interest in stock

2. Waiting period would allow for free writing (just send it to SEC)3. Prospectus Delivery

a. Require preliminary prospectus 3 days BEFORE pricing thestock

iii. Industry like #1 and #2, but HATED #3

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IV. Process of SEC Reviewa. 8 of the 1933 Act: gives the SEC authority to review.

i. 8(a): once registration is filed, it becomes effective 20 days later. Every time itis amended, the 20 day period starts again.

1. BUT, 20 days after filing is too short and 20 days after amendment is toolong.

a. Rule 473 delaying amendment solves the too short problem b. Rule 461 acceleration rule solves the too long problem by

providing acceleration. Must be filed in GOOD-FAITH!

ii. 8(b): if registration statement is incomplete, they can issue a refusal order , only 10 days after the filing

iii. 8(d): if untrue statement, SEC can issue a stop order . = order anytimeiv. 8(e): SEC can investigate = order anytime

b. SEC Review :i. Not review all public offerings

ii. Review ALL IPOsiii. Sarbanes-Oxley = requires SEC to review public offerings every 3 years

c. Doman Helicopters:i. Corp. said they had an existing operational prototype helicopter, which was an untrue

statement. SEC issued a stop order. The corp did not make a good faith effort to complywith registration requirements. The conduct must be really egregious for the SEC toissue a stop order.

d. Las Vegas Hawaiian Development Corp v. SEC:i. LVH files an S-11 with a delaying amendment. The SEC returned the registration

statement because of deficiencies. LVH filed another RS, without a delaying amendment.So, technically, it would be effective in 20 days. SEC ordered an examination under 8(e).

ii. LVH claims the SEC has prevented registrant from having a hearing. SEC argued that theRS became effective, so the SEC is not harming LVH.

iii. The SEC issued its investigation order before the effective date of the RS, so the plaintiffs do feel the action in a concrete way.iv. Congress did not put a time limit on the duration of an 8(e) investigation, so the plaintiff

has to use the remedies provided for by the APA.v. But, a district court can compel the SEC to make a determination within a

reasonable time whether to notice a hearing on the issuance of the stop orderwhen the SEC has ordered the examination prior to the effective date .

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Exemptions from Registration

I. Introduction

a. Party invoking the exemption has the burden of proving they satisfy the exemption.b. Exempt Securities vs. Exempt Transactions

vi. 5 says you must register securities for interstate commerce.

vii. 3(a)(2)-3(a)(8) : Exempt Securities = if you resell them = still exempt!!a. insurance, endowment, annuity, security issued by a savings and

loan, issued by the US

viii. 4 Exempt Transactions = if resell = need ANOTHER exemption1. Section 3 Exempt Transactions

a. 3(a)9 b. 3(a)10 c. 3(a)11 =

i. Intrastate Exemptionsii. Rule 147 = safe harbor for this rule

2. Section 4 Exempt Transactionsa. 4(a)(1): transactions by any person other than issuer,

underwriter, or dealer b. 4(a)(2): transactions not involving a public offering-therefore, it

is a private offering i. NOTE : the antifraud provisions still apply even though

it is a private offeringii. Regulation D = Safe Harbor

c. 4(a)(3): transactions by a dealer

ix. Entire offering needs to fit in one exemption.1. Cant be 80% intrastate and 20% private2. If one offering does not comply, the entire offering will be

invalidated.

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II. Non-Public Offerings 4(2)x. Section 5 (registration) shall not apply to transactions by an issuer not

involving any public offering ( PRIVATE OFFERING must be an offer from the issuer). safe harbor

1. Can be used bya. private companies

i. want to raise $ w/out going publicii. start-up raise capital w/out expense of regulation

b. public companies .i. public companies use private offerings to sell debt

ii. BONDS2. Two ways to structure exemption from 5 for private offerings:

a. comply with 4(2) b. Comply with terms of safe harbor provision of Reg. D.

3. Issuer cannot engage in solicitation or advertising4. certain limits on number of offers apply5. Rule 155 = safe harbor provision for PUB PRIV

a. If you have a public offering & not doing well, and want tochange to a private offering

a. w/ public, all info is on SEC b/c filedregistration statement

b. info to whole world already b. If meet conditions of Rule not worry about abandoned offering

being combined w/ new offeringsc. Wait 30 days

xi. SEC v. Ralston Purina:1. Ralston made private offerings to key employees, without registering it and

used the mail. They claimed the private offering exemption and claimed that all

employees were key employees.2. Are offerings of treasury stock to key employees covered by the exemption in 4(2)?

3. Public does not mean that it is open to the whole world.4. Exempt transactions are those as to which there is no practical need for the Acts

application, so whether it is exempt under 4(2) depends on whether the class of persons affected need the protection of the Act .

5. These investors are considered part of the investing public and need the protection of the Act.

a. Some employee offerings will be exempt under 4(2) (i.e. an offering tothe executive employees that have access to registration statements).This burden is on the issuer.

6. Absent these special circumstances, employees are just as much members of theinvesting public as any of their neighbors in the community .

7. If all offerees have access to the same kind of information that the act wouldmake available if registration were required.

xii. Rules after Ralston:1. Availability of information:

a. people need access to the same information that would have beendisclosed in a registration statement

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b. company gives the info to people INSTEAD of worrying aboutthem getting it on their own.

c. Relationship between Issuer and Offerees for Information:i. is there a relationship that affords the investors access to

or disclosure of the information about the issuer thatregistration would reveal?

ii. Here, Murphy refused to give information.2. Investor sophistication:

a. Do they have knowledge, experience, on financial matter toaccurately assess the risks?

b. Wealth of the investorc. can have representatives who are sophisticated when you are notd.

3. Number of investors & size of investment:a. No bright line rule

b. Fewer looks private = More looks publicc. Money = if small and direct offering, then probably private.d. Technically, the rule applies to any size, but smaller is more

likely to be exempt.

4. Private offering : SOPHISTICATION AND ACCESS (from Doran) a. sophistication of one offeree is not enough.

b. All need to be sophisticated.c. Sophistication is not necessarily a substitute for access to info a

registration would disclosed. Each offeree must have access to information.

i. Rule 146 : disclosure of information or effective accessto information is sufficient.

e. Knowledge and wealth cannot substitute for access.

NOTE: A person may NOT separate parts of a series of related transactions,the sum total of which is really one offering, and claim that a particular partis a non-public transaction.

5. Integration Factors (Murphy)a. relevant to determining whether the offering is part of a larger

offering made or to be made: b. When a person organizes or sponsors the organization of limited

partnerships and is primarily responsible for the success andfailure of the venture for which the partnership is formed, he will

be considered an issuer for purposes of determining theavailability of the private offering exemption.

c. Issuers BURDEN to prove it is NOTd. Number of Offerees: Integration Doctrine : consider eachoffering of partnership interests in the aggregate, as oneintegrated offering.

Should offers be integrated?? FACTORS 1. whether the offerings are part of a single plan of financing (here, all to

finance Intertie)2. whether the offerings involve issuance of the same class of securities

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3. whether the offerings are made at about the same time4. whether the offerings are made for the same general purposes.6. whether the same type of consideration is to be received

xiii. Casesxiv. SEC v. Murphy

1. Murphy formed Intertie and was Chairman of the Board. Intertie promoted 30limited partnerships. Murphy would buy a cable tv company, finance it and thensell to one of the partnerships. Intertie engaged a securities brokerage firm tofind investors who wanted to buy interests in the cable companies. Thesesecurities were not registered, and Murphy claimed they were exempt under4(2). Murphy did not assure that the securities were offered to only a smallnumber of sophisticated investors. He was heavily involved in the offerings.

2. Court focuses on the relationship between the issuer and the offerees.a. Not clear who the issuer was. There is no company issuing securities,

but a group of individuals. b. Intertie was so involved that investors needed information about

Intertie in making their investment decisions.3. When a person organizes or sponsors the organization of limited partnerships

and is primarily responsible for the success and failure of the venture forwhich the partnership is formed, he will be considered an issuer for purposesof determining the availability of the private offering exemption.

4. Since he is an issuer, does 4(2) apply between him and the offerees? Burden on Issuer to fit the exemption. Was it a private offering???

i. 5. Held: it is one integrated offering and the investors were not sophisticated, so

Murphy is not exempt under 4(2) and must register. xv. Doran v. Petroleum Management

1. Interests in LP that managed oil wells were offered to eight people and fouraccepted. They were not registered. P was sophisticated. He signed a note for113,000 to a supplier which was to be paid by Ps production royalties. Theroyalties were unable to pay for the note and noteholder sued P. P sued fordamages to rescind his purchase of the interest, claiming D did not register.

2. Private offering : SOPHISTICATION AND ACCESS a. sophistication of one offeree is not enough. All need to be

sophisticated. Here, they were all sophisticated. b. Sophistication is not necessarily a substitute for access to info a

registration would disclosec. Each offeree must have access to information.

i. Rule 146 : disclosure of information or effective access toinformation is sufficient.

d. Knowledge and wealth cannot substitute for access.xvi. Hill York v. American International Franchise

1. Investors all got information about the offering and were all sophisticated, smallnumber of offerees.

2. Court held that they are not exempt because the information was misleading .

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f. Regulation D = (exemption from 4(2))i. Safe Harbor for 4(2) exemptions

ii. Rule 501-508 (most important are 504, 505, 506).iii. 3(b) Additional Exemptions: allows the SEC to issue rules to add exempted

securities, but no issue of securities shall be exempted under this subsectionwhere the aggregate amount at which such issue is offered to the public exceeds5 million.

a. Rule 504 and 505 fit under this provision

iv. Rule 504 : (for small start ups fewest conditions) 1. offerings not exceeding 1 million dollars in a 12 month period .2. not available to companies that have to register under the 1934 Act3. no limit on the number of ivestors4. comply with 502(a), (c), and (d).

a. 502(a): Integration provision : Offerings that are separated bymore than six months are not deemed part of the same offering.Whether offerings within six months of each other will beconsidered part of the same offering depends on application ofthe five factors.

i. Are they part of a single plan of financing ?ii. Involve the same class of securities

iii. Are made at the same time iv. Involve the same consideration v. Are they made for the same general purpose

b. 502(c): Manner of Offering: cannot be advertised or generalsolicitation

c. 502(d): Limitation on resale: cannot be resold by purchaser,unless another exemption applies or you register.

i. Issuer shall exercise reasonable care to assure that the purchasers are not underwriters.

a. Underwriters (2(11)) are those who buy with a view towards distribution ,not investment.

b. How?i. Buyer signs letter swearing its

for investment, not re-saleii. Restriction on stock = not allow

it to be soldii. Is the buyer a conduit for the securities to reach the

public?v. Rule 505:

1. offerings of up to 5 million in any 12 month period .

2. 502(a) (no integration), (c) (no general solicitation) and (d) (restrictionon re-sale) apply 3. Limit on number of purchasers (35)

a. 35 purchasers and unlimited accredited investors.i. purchaser defined in 501(e): excludes accredited

investors.ii. Accredited Investor: 501(a) bank, person with net worth

of 1 million or more, income of 200,000. Presumed they

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have access to information about the issuer . AccreditedInvestor: defined to include:

a. any bank, savings and loan association,credit union, insurance company,investment company, or employee

benefit plan, b. any business development company,c. any charitable or educational institution

with assets of more than $5 million, aswell as corporations, partnerships, and

business trust with more than $5 millionin assets,

d. any director, executive officer or general partner of the issuer,

e. any person with a net work of more than$1 million, and

f. any person with an annual income ofmore than $200,000 (or annual jointspousal income of $300,000)

iii. If there are any unaccredited investors, the information prescribed by Rule 502 must be furnished to them.

4. 502(b) applies: information to be disclosed:a. type of information depends on size of the offering.

b. Disclosures required only for purchasers.c. No information required to disclose to an AI.

vi. Rule 506:1. no limit on dollar amount of the offering.2. can sell to 35 purchasers and unlimited accredited investors.

a. BUT, purchasers must have knowledge and experience infinancial and business matters that enables them to evaluate the

risks. b. No limit on number of offerees, but there is a limit to purchasers.

3. 505(d) has a disclosure requirement to those who are not accreditedinvestors. Rule 502(b) applies. Disclosure requirements apply.

4. Form D must be filed.5. No advertising or solicitation, offers to large numbers of offerees may be

viewed as advertising, resulting in loss of exemption.vii. Rule 508:

1. failure to comply with 504-506 requirements will not result in the loss ofthe exemption if the person relying on the exemption shows a good faithand reasonable attempt to comply.

viii. No Action Letter

1. To know how these Regs are interpreted, send the SEC a no action letter.2. Explain in the letter what you want to do and then the SEC will respondwith what you need to do to avoid prosecution.

3. They are not binding, no precedential value, but they support your case.

g. Intrastate Offeringsi. Less important now b/c of National Securities Improvement Act of 1996

1. Congress pre-empted most state registration2. 18

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a. if covered security, than exempt from state registration b. Covered Security = on a national exchange

3. NOT pre-empt state anti-fraud provisions4. States CAN still charge fees

ii. 3(a)(11): Any security which is part of an issue offered and sold only to persons resident in a single state or territory, where the issuer is a personresident and doing business within such state or territory.

1. Early Release 4434: the entire issue of stock must be offered and sold toresidents of the state. If any buyer is a nonresident, no exemption.Therefore, just one sale outside the state screws up everything.

2. Rationale:a. The investor is in the same state as the issuer

b. State regulator has power over business in their state3. Steinberg book : rationale for the exemption is based on the probability

that investors in local enterprise will have adequate familiarity withenterprises and an acknowledgment that local issuers will be relativelysmall and less able to bear the burden of federal registration.

4. SEC v. McDonald Investment Corp.a. Minnesota corp. sells securities to residents in Minnesota. But, the

proceeds from the sales go to make loans to land developers outsideMinn. Can they be exempt from registration? (no)

b. P claims the income producing operations of D are located outside thestate.

c. Was doing business in state?d. Held: securities are not exempt. The strength of the notes depends on

activities outside of Minnesota. Court looks to the Dunn case, whichheld that substantial business must be done in the state too.

5. Busch v. Carpentera. First sale to nonresident occurred seven months after the offering.

b.

bears the burden of showing they are exempt.c. For the intrastate exception, the securities must have come to rest inthe hands of resident investors and not with a view to furtherdistribution or for the purposes of resale.

i. has the burden of proving the stock had not come to rest ina state, but was sold only to people who intended to resell itoutside the state.

ii. Here, there was nothing questionable about the offering, thesecurities came to rest.

d. Doing business: means more than just having an office in the state. iii. Rule 147 safe harbor

1. Provides rules for intrastate offerings, to know when it applies.2. Integration applies:

a. Five Factors3. Issuer qualifications:a. incorporated or organized in the offering state

b. Must be doing business in the state4. Defines residence: state where business has principal office and where

person has principle residence5. Defines doing business: 80% TEST

a. 80% of revenue is earned from property or services in state and-

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b. 80% of corps assets are in state and-c. 80% of proceeds from the offering are used in state for operation

of the business6. Applies not only to issuer, but also shareholders who want to resell

a. Resales:i. 9 month test, if held for nine months, it has come to rest.

ii. Resell to resident has no restrictions, but resale tononresident only after it has come to rest in the state.

7. Advantages of intrastate a. there is no dollar amount limit like there is in Reg. A.b. there is no disclosure requirement like in 505 and 506.

8. Disadvantages a. there is a very strict view that even one offer to an out of state

person disqualifies you.

h. Foreign Offerings in US Securities - Offerings that are made outside the U.S. that arentgoing to immediately find its way back into the U.S.

i. Reg. S1. provides a safe harbor2. Rules 901-905

a. 5 registration requirements will not apply if offerings are madein an offshore transaction and there are NO directed sellingefforts in the U.S.

i. an offshore transaction means thata. there is no offer made to a person in the

U.S. (it doesnt matter if that person is aU.S. citizen, that person simply cannot

be physically within the U.S.) b. the buyer is either outside the U.S. or

the transaction takes place on a foreign

securities exchange.ii. a directed selling effort - to anything in the U.S. (cannot

generate interest in the U.S.) b. cannot be a RUSE to outside the US and bring them BACK to

the US3. If you look at Reg. S, you will see that it is an attempt to stop companies

from selling securities abroad with the intention of having them come back to the U.S.

4. Anti-fraud provisions are BROADERa. Fraudulent conduct IN the US

b. Fraudulent conduct outside the US w/ EFFECTS reaching theUS

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1. control person : anyone who has power to direct management and policies of the issuer

(a) directors, officers and owners of 10% are presumed to becontrol person. (

(b) look to intent of the buyer iv. Selling for an issuer or control person with a view to

distribute

CASES4. SEC v. Chinese Consolidated Benevolent Assoc.

a. Chinese govt issues bonds to sell in US. is a nonprofit organizationthat advertised the offering of the bond, collect money from people andtransmit it to CCB. receives no compensation for the service.

b. Ct finds they are an underwriter and must register, 4(1) exemptiondoes not apply to them.

i. was an essential cog in the offeringii. participation in an indirect offering

iii. no intent required5. United States v. Sherwood

a. Sherwood purchased shares from the issuer. He owned 8% of theoutstanding stock and held it for two years.

b. Is he a statutory underwriter? NO .i. He is not a control person. He bought from a control person,

but he is not a control person. He owned 8%, but he could notget a place on the Board and he had a falling out with Doyle,who controlled the management decisions.

ii. He held onto the stock for two years, so there is no intent todistribute.

6. SEC v. Guild Films: Guild issued to WR Corp 400,000 shares of stock. Theydid not register, under the 4(2) exemption. The CEO used the shares ascollateral for bank loans. When he defaulted, the bank tried to sell the shares.Guild refused to sell shares, claiming it would violate the 33 Act. Court agreed

that selling the stock would violate the 33 Act.

iii. 4(3) Exemptions1. 5 applies to DEALER 2. Unless

a. Less than 1 year holding b. By/through underwriterc. Part of a larger deal

iv. 4(4) Exemptions1. Brokers transactions, executed on customers orders, in an over-the-

counter market2. NOT on solicitation of ordersa. you can call a broker who is NOT controlled by an issuer and

want to buy stock, its OK can NOT have a broker ask YOU

v. CASES 1. Ira Haupt & Co.

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a. Shulte was in control of Park & Tilford. He told Haupt to sell some ofhis stock. Haupt sold and was charged with violating section 5 becausethe stock was not registered. claims he is exempt from registration.

b. claims he is exempt under 4(3) and 4(4) which exempts transactions by a dealer

i. Broker transactions executed on customers ordersc. Is he an underwriter?

i. Sells for an issuer (includes control person) .ii. Yes, he sold for a control person, but claims that he was not

intending to sell in connection with a distribution, which thedefinition of underwriter requires.

a. Distribution : the entire process by whichin the course of a public offering the blockof securities is dispersed and ultimatelycomes to rest in the hands of the investing

public. b. Court found there was a plan of distribution.

So, he is not exempt and must register.c. 4(3) and (4) do not exempt brokers from

section 5 when they act as underwriters in adistribution plan.

2. United States v. Wolfsona. Wolfson is control person of Continental Enterprises. sold 55% of

their holdings without registration. US brought criminal charges.i. Wolfson is an underwriter because he is a control person .

So, he is not exempt under 4(1).ii. Court rejects this. is an underwriter

b. claims that they are exempt because of 4(4) which exempts brokersfrom transactions made on customers orders.

i. 4(4) is unavailable because it is designed only to exempt the brokers part in securities transactions, not a control persons.

vi. Rule 144: Persons Deemed Not to be Engaged in the Distribution and therefore Not Underwriters .

1. Restricted Security = security acquired by a 3 rd Person from the issuerthat has no registration statement b/c no public offering

2. safe harbor,a. provides clear guidelines of who is and who is not

i. an underwriter. b. Must comply too

i. An affiliate (control person) of the issuer, orii. a sale of restricted securities (private)

3. Steinberg book : those who are NOT underwriters are: distributors anddealers who receive a commission from an underwriter not in excess ofusual and customary commission.

4. Requirements:a. There must be adequate information about the issuer.

can use 34 Act reports b. Holding Period: the person can resell restricted securities if you

hold them for one year.

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i. If less than 2 years, there is a limit on the volume youcan sell.

ii. If more than 2 years, resell w/out limits except cannot beCP 3 months prior to sale

c. Volume Restriction = Cant sell more thani. 1% of issuers securities.

ii. Average weekly trading volumed. Notice of sale must be filed with SECe. Issuer must be subject to requirements of 34 Act.

vii. Section 4(1 )1. Deals with affiliates and nonaffiliates who want to sell securities in a

routine private transaction after a short holding period. Allows affiliatesto sell if some of 4(1) and 4(2) requirements are met.

2. If you fail 4(1): you are an issuer, underwriter or dealer, but you dontwant to register your securities for resale.

3. Look at 4(2):a. Would it be a private offering?

Do the investors have access to info?Is it a small offering?Is there investor sophistication?

b. Basically, you are failing under 4(1), but winning under 4(2) andRegulation D caselaw (Ralston).

4. If you participate in a distribution, you become a statutory underwriter.5. Distribution is the equivalent of a public offering, so if no public

offering, no distribution. So, make it a private offering (sophisticated,small number, access to info, only sell to those who do not need

protection of the acts). Then, you are not distributing and do not need toregister it.

6. Elementsa. Buyer needs access to information through Registration

Statement b. Buyer meets 4(2) caselawc. If too many 4(1) Exemptions = possible distribution

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Civil Liabilities

The Securities Act of 1933 11

12(a)(1)

12(a)(2)

V. Introductiona. Overview:

i. Purpose : to create incentives for the people who have control over theregistration statement to make it accurate; so investors can make informedinvestment decisions based on disclosure of information about the issuer.

ii. For a material misstatement or omission 1. Under common law, had to show

a. reliance and scienter, which was very hard to do.b. You had to show D had an intent to file a false or incorrect

registration statement.c. Also, had to show a reliance on the misrepresentations.iii. Provisions

1. Section 11 : persons liable, reasonableness for material misstatements oromissions

2. Section 12(a)(1) : any person who sells in violation of 5 (offer/sale) isliable to the purchaser.

3. Section 12(a)(2): person who offers or sells a security w/ a materialmisstatements or omissions in a registration statement is liable to the

purchaser4. Section 17 ~ 10b-5 : general anti-fraud provision in offer or sale of

security. No private right of action (for priv right, use 10b-5).

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VI. Section 11

(I) Standinga. If any part of the registration statement contained an untrue statement of material

fact or omitted a material fact required to make statements not misleading, any personacquiring such security may sue.

i. Requirements 11:1. privity, scienter and reliance are NOT necessary .

These are basically strict liability provisions.2. NO showing of causation3. Statute of limitations: 1 3 years 4. must show materiality

b. No reliance required by buyer, unless there has been an earning statement filed in the last12 months

i. in that case, the has to prove that they relied on the untrue statement or did notknow of the omission

ii. For reliance, the does not need to prove they read the registration statement .

c. Who can bring the suit?i. 11(a) : anyone purchasing the security, unless it can be shown that at the time

of the purchase, the purchaser knew of the misstatement or omission . ii. aftermarket purchaser

1. has standing to pursue a claim under section 11 so long as he can provethe securities he bought were those sold in an offering covered by thefalse registration statement.

2. Joseph v. Wiles : The purchaser didnt purchase at the initial offering, instead, he purchased on the secondary market.

a. The issue is aftermarket purchasers have standing to sue under 11.b. The court holds that an aftermarket purchaser has standing to pursue

a claim under section 11 so long as he can prove the securities hebought were those sold in an offering covered by the false registrationstatement .

c. The ambiguity of any person and such security is resolved by thecourt as meaning that the buyer must have purchased a security issuedunder the registration statement at issue, rather than some otherregistration statement.

d. NOTE: If A gets from the initial offering and then trades to B, B tradesto C, and C trades to D, arguably, they might all have standing.

d. Who is liable?i. 11(a)(1) : anyone who signed the registration statement, anyone who was

director or partner at the time of the filing.

1.

6 says that people who must sign are issuer, officers, financialofficer, accounting officer, majority of Boardii. 15 : Control Persons: any person who controls any person liable under section 11

is also liable to the same extent as that person.iii. 11(a)(4): every accountant, engineer, appraiser, or any person whose

profession gives authority to a statement made by him in the RSiv. 11(a)(5): every underwriterv. anyone who is about to become a control person

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e. Statutory Provisions i. 11(a): purchaser cant recover if he knew of the misstatement or omission.

ii. 11(b): provides defenses for everyone EXCEPT THE ISSUERiii. 11(g): caps total damages; shall not exceed the offering price.

f. Case Lawi. Section 11 is only available to those who can trace their shares back to the

falsely registered shares ( Barnes ) applies only to after-market purchasers

ii. After-market purchasers CAN sue under Sect. 11 IF they can prove purchasedsecurities were sold in an offering covered by false RS ( Joseph v. Wiles )

1. How do you trace back ? a. Show you dealt w/ either UW (if wealthy) or broker retailer (if

normal) b. UW or broker shows you RS and asks if you want to buy

i. You say yes after looking at it ii. You keep records of this conversation and transaction

2. NOT need privity for Sect. 11 a. 12(2) (Gustafson) = needs privity no tracing there!

iii. Barnes v. Osofsky:1. sued underwriters under 11 for failing to disclose the misstatements in the

registration statement. There was a settlement and appellants objected to it because it limited benefits of the settlement to persons who could establish thatthey purchased securities issued under the 1963 registration statement. (Limitedrecovery to those who could trace their shares back to the registered shares).This eliminated those who purchased after the issuance but could not trace their

purchases.2. They were bought on the market and could not be traced to the original issuance.3. Issue: Does 11 only apply to purchases of newly registered shares?

a. Any person acquiring, or any person acquiring pursuant to a

registration statement b. Appellants argue that an overly optimistic prospectus will affectsecurities that are already issued. Also, it is difficult to determine whichsecurities are old and new (tracing), when most trading is done through

brokers.4. Court held that a broad reading (any person acquiring a security) is

inconsistent with the statutory scheme. If they did not require tracing, theamount of plaintiffs would be huge.

a. Only those that can trace back to the RS can recover.5. Section 11 is only available to those who can trace their shares back to the

registered shares .a. technically, 11 is available for purchasers in the initial offering and

the aftermarket. But, in the aftermarket, the shareholders have to tracetheir shares to the deficient RS, arguing that they purchased shares

pursuant to the deficient statement.i. This is difficult to do, so the tracing requirement has nullified

many 11 aftermarket claims.iv. Joseph v. Wiles

1. facts = P bought debentures in a secondary market with a false RS.2. Hold = after-market purchasers CAN sue under Sect. 11 IF prove bought

securities in an offering covered by false RSa. Other fed circuits agree

b. Text = any person acquiring SUCH security

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c. Leg History = Sctn. 11 amended to say must prove reliance, andprice offered to the public not necessary unless secondary market b/cuse purchase price.

d. Tracing theorye. Gustafson

g.

Elements of the Claim:i. Misrepresented facts must be MATERIAL What an average, prudent investor ought reasonably to be

informed about before he can make an intelligent, informeddecision whether to buy the security or not.

1. Escott v. BarChris:a. bring suit against BarChris under 11 for material misrepresentations

in the registration statement. BarChris was inadequately financed anddefaulted on the payment of the interest on the debentures. claiminadequacies and omissions in the prospectus.

b. For a 11 suit, the facts allegedly misrepresented must be material. c. 1961 statements: Court finds that the misstatements about the condition

of the company were material.d. 1960 statements: debentures were characterized as speculative and probably would not have deterred an investor and they were notmaterial.

h. Damages/Causation Defense:i. How are damages calculated ?

1. 11(e): damages shall represent the difference between the(A) amount paid for the security AND (B)

1) the value at the time the suit was brought, OR 2) the price at which such security shall have been disposed of

before suit OR 3) the price at which security shall have been disposed of but

before judgment was brought if less than #1.

ii. Negative Causation Defense:

show the drop in value was due to something else.(Was the stock price fall the same for all in the industry?)

1. If the defendant can show that there were reasons other than materiallyfalse statement that caused the loss, this will offset the damages that the

plaintiff can receive.a. 11(e) says: . . . if the defendant proves that any portion or all of

such damages represents other than the depreciation in value ofsuch security resulting form such part of the registrationstatement, with respect to which his liability is asserted, not

being true or omitting to state a material fact required to bestated therein or necessary to make the statements therein not

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misleading, such portion of or all such damages shall not berecoverable .

b. has the burden of proving that any portion of the damagesclaimed by represents damage other than the depreciation invalue of such security resulting from the misstatement.

2. Beecher v. Able: Court found had issued securities under a materially false prospectus. How are damages calculated?

a. 11(e): damages shall represent the difference between the amount paidfor the security and 1) the value at the time the suit was brought, o

Documents

SecuritiesRegulation Quinn Spring2003