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Securities Regulation
Yadav
Spring 2014

I. Introduction
a. Regulatory Rationales
i. Investor Protection
1. If you cant tell who is honest and who isnt, investors will
discount the whole market or leave the market entirely
(a) Stated goal, key rational for securities regulation
ii. Information Asymmetries
1. Curing information asymmetries
2. Information levels are not uniform, insiders have better
access to information
iii.Collective Action Problems
iv. Efficient and Fair Markets
1. We presume investors are rational, but they arent so we
need rules to control investor frenzies
(a) Control frenzies by slowing down the process, providing
info, and making sure people are aware of it.
2. International Perspective
(a) US seen as the premier venue to trade securities, more
money comes in and companies get a boost from
trading on well regulated and efficient markets
v. Corporate Governance
1. Reduces agency costs and encourages good corporate
governance
b. What is a Security?
i. Securities Act of 1933 2(a)(1) When used in this title,
unless the context otherwise requiresThe term security
means any note, stock, treasury stock, security future,
security-based swap, bond, debenture, evidence of
indebtedness, certificate of interest investment
contract
1. Foundational questionif not a security, the Sec Reg
Framework does not apply
2. Key phrases in this definition: investment contract and
unless the context otherwise requires
(a) Must determine if the instrument in question is:
(i) On the list
(ii) Could be considered an investment contract
(iii)
Or if this is an area the securities laws should
be applied (unless the context otherwise requires)

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ii. Investment Contract

1. Catch-all provision: intended to provide flexibility to the
framework
2. Jurisprudence has struggled to provide an exact definition
must make arguments
3. SEC v. Howey: 51 out of staters w/ no citrus knowledge are
sold orange, most of them have 10 year service contracts
W/o cancellation. The oranges are pooled, and function as
a singular farm. Are the land sale and service contracts
investment contracts?
(a) [A]n investment contract for the purposes of the
Securities Act means a contract, transaction or scheme
whereby a person invests his money in a common
enterprise and is let to expect profits solely from the
efforts of the promoter or a third party
(b)Howey Test:
(i) Investment of money
1. We care about money b/c we are concerned about
risk
(ii)
In a common enterprise
1. Proxy for collective action problems
(iii)
Led to expect profits
1. Profits create frenzies, proxy for capital markets
(iv)
Solely from the efforts of others
1. Proxy for sophistication, relying on others
indicates a lack of expertise
2. Implies depersonalized interactions, which also
implicates information asymmetries, agency
costs, and collective action problems.
(c) Didnt matter that not everyone got the service
contract, but merely that it was an offer of something
that is a security.
4. A person invest his money
(a) International Brotherhood of Teamsters v. Daniel: Daniel
is a truck driver with the teamsters who had a
compulsory and noncontributory pension that had
accumulated for 20 years, but then he got fired and lost
it. Court found that the pension plan was not an
investment contract b/c he did not invest money.
(i) Must be choice to contribute tangible and definable
consideration
1. Court isnt devoted to form, doesnt have to be
cash FN 12
(ii) Proportionality testwas the decision to accept and
retain employment driven primarily by his interest in

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a pension? Or was it rather an attenuated

relationship?
1. Daniel was working for his livelihood, not making
an investment. Amount of pension is dwarfed by
total payDaniel did not choose b/c of pension.
2. Defining characteristic is is this a real choice?
2. In a Common Enterprise
(a) Commonality, proxy for collective action problems
(i) Horizontal pooling from multiple investors who all
share, fortunes linked to each other
1. Most basic example is the selling of stock, where
individual investors money is pooled into the
resources of the company. The company then
makes a profit from that pot, and the individual
investors get a profit share relative to their
percentage of the investment. (pro rata
profit/loss).
2. Hardest for investors to prove, companies can get
around by keeping individual investors money
separate and identifiable.
a. Normally you need multiple people, but as long
as promoter offers to several people it doesnt
matter how many accept, one will suffice
according to SEC v. Lauer.
(ii) Broad Vertical well being of all the investors
dependent upon the promoters expertise, requires
only a connection between the efforts of the
promoter and collective successes or losses of the
investors.
1. Essentiallythe promoter and the investor do not
share risk, the promoter is compensated by a
fixed fee rather than a dependency on the success
of the venture.
2. You can have just one investor
(iii)
Narrow Vertical requires a direct relationship
between the success of the promoter and that of the
investors. Promoter exposed to the risk of the
investment, investors fortunes interwoven w/
promoters.
1. You can have just one investor
2. Basically, broad just looks for a vertical
relationship, while narrow looks for a link between
the entrepreneurs profit and the investors profit.
(b)SEC v. SG Ltd: Computer game called Stock Generation
where you buy virtual shares in a virtual companies.

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Privilege companies guaranteed 10% return, which were

paid for by new players coming in and contributing
money. Looks like a ponzi scheme.
(i) Court finds horizontal commonality, pooling and
sharing
1. Outcome orientated judgment based on
manipulative ponzi and pyramid scheme
2. Counter argument, no pooling b/c investors get
different returns
(ii) Wrongly decided?
1. Like in Daniel, consumption/entertainment value
of the game was the real reason for playing, not
an investment
3. Led to expect profits
(a) United Housing Foundation v. Forman: Large housing coop is operated by non-profit organization UHF. In order
to raise money for expenses, UHF issues stock and
makes its purchase a necessary prerequisite to owning a
housing unit. Stock is recoverable, non-transferable,
and has not voting rights. Tenants sue when monthly
costs go up.
(i) Court looks at substance and finds not a security
exchange, simply calling it a stock not enough
(ii)
Profits require capital appreciation or
participation in earnings, real money
1. No real way for tenants to make money, income
from parking spaces or laundry too speculative
and insubstantial, tax and low rent benefits arent
profit.
(iii)
Shares were purchased to use or consume, not
for financial reasons
1. Inducement was low cost housing, not profits.
Cant even sell shares for profit
(b)SEC v. Edwards: ETS sells pay phones w/ fixed return.
Investors bought and leased back to promoter who
promised $82 per month.
(i) Court finds investment contracts can have
fixed returns, no distinction from variable
returns.
1. Promises of fixed, low risk returns may prove
particularly attractive for vulnerable, less
sophisticated investors who may be most in need
of the protections of the securities laws.

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2. Doesnt fit perfectly w/ horizontal commonality,

but has been reconciled as a discrete return by
unit.
(ii) Warfield v. Alaniz: Charitable gift annuity promises
lifetime stream of income and then remaining
principle is donated to a charity of choice. The
scheme collapses w/ little to no charitable payments.
argues people werent investing money, never had
an expectation of profit b/c they were charitable
donations.
1. Court looks to what investor were promised,
looks at the promotional materials, which
emphasized investment and long-term
income production.
a. Marketed as an investment, presented as an
opportunity for financial gain
b. Also there is a potential for a profit if people
outlived the expected age
c. Court stretching to find this a security b/c of
the massive fraud that happenedalways look
at the underlying situation, can shed light on
how a Court will come out.
4. Solely From the Efforts of the Promoter or a Third
Party
(a) When you put your own efforts into the profit, you do
not get any protection because you control your own
risks. When the profits depend on the efforts of others,
you get protection because there are risks. (Agency
we care )
(b) However, Courts havent taken solely seriously,
actually looking for substantially through the
management of others
(i) Does the promoter or the investor provide essential
managerial efforts?
(ii) Only if the investors are also helping to manage the
business does the promoter escape this prong.
(c) General Partnership (less likely to be a security)
(i) Williamson v. Tucker: General partnership are
presumed not to be an investment contract b/c a
general partner typically takes an active part in
managing the business. However, this presumption
can be rebutted if partner has
1. No legal control, flawed distribution of power or
2. No capacity (not sophisticated) to control, or

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3. So dependent on unique ability to promoter that

he cannot be replaced, no practical control.
a. Any one of these factors renders the general
partnership a security
(d)Limited Partnerships (more likely to be a security, b/c
limited investors more likely to be passive. Looked at
Williamson test
(i) SEC v. Merchant Capital: Selling partnership interests
in company set up to buy delinquent credit card
debt. In theory, the partnership interests included
removal rights, right to approve obligations above
$5,000, and right to inspect books and records.
1. In practice, partnership interests had
nothing, never had the ability or opportunity
t exercise their rights
a. Court looks to substance over form
b. Court looks to specific knowledge about
business
(e) Franchise Agreements: presumption is not a security
b/c investors performs managerial functions, however
this can be overcome if can prove that the franchise
agreement was illusory.
(i) Montgomery Ward: Franchise agreements are
presumed not be securities b/c investor
performs mgmt. function.
(ii)
SEC v. Aquasonic: related to license
agreements to market dental products. Offered
franchise agreements to all sorts of folks to sell
dental products to customers. None of the investors
had experience, nor did they have access to the
customers, and delegated the selling back to
Aquasonic. Had no real control in substance.
1. Franchise agreements are securities if they
cant in fact operate independently
(f) Neither through the efforts of the promoter or investor
1. SEC v. Mutual Benefits Corp (11th Cir. 2005):
Viatical settlements, terminally ill sell their life
insurance payments for a lump some. Buyer
makes money if payout is more than lump sum
and loses money if insured lives longer than
expected and its less. Investors couldnt perform
their own medical evaluations. argues not an
investment contract b/c it depends on the
mortality of the insured, not the efforts of others,
wants distinction of efforts before and after
purchase.

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a. Court rejects distinction of managerial

efforts before and after the purchase,
investors dependent on the managerial
efforts of the promoter before their
purchase.
b. Departure from the DC Cir. in SEC v. Life
Partners, where court distinguished prepurchase efforts, the value of which had
already been impounded into the promoters
fees or purchase price, from post purchase
efforts.
i. If neither the promoter nor anyone else is
expected to make further efforts that will
affect the outcome of the investment, then
the need for federal securities regulation is
greatly diminished.
ii. Stock
1. Unlike investment contract, looking to see if instrument is
properly labeled.
2. Landreth Timber Company v. Landreth: buys all the stock
in a timber company from Landreth, keeps Landreth on as
a consultant, sells for a loss, sues under 33 and 34 Act.
(a) Labeled stock and has characteristics of stock
Securities
(i) If satisfy this, stocks are presumptively securities
No need to apply Howy to a traditional stock
(b) Characteristics of stock
(i) The right to receive dividends contingent upon an
apportionment of profits
(ii) Negotiability/transferability
(iii)
Ability to be pledged or hypothecated
(iv)
Conferring of voting rights in proportion to the
number of shares owned
(v) Capacity to appreciate in value
(c) Economic reality test and sale of business test are gone.
iii.Notes
1. Debt, some are securities, some arent.
2. Collective action problems are magnified in public debt
markets because b/c they are fewer rights, by the time
lenders come after the promoter its often too late
3. Commercial Paper Exception
(a) A short-term note (commonly called commercial paper)
is technically included in the definitional section of the

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33 Act, but it is exempted from registration

requirements under 3(a)(3). They are, however, not
exempted from the anti-fraud provisions of the 33 Act.
(i) On the other hand, a short-term note is categorically
excluded by a nuanced definition in the 34 Act. The
effect of this seems to be that lying on a note issued
can still bring liability under the 33 Act, but not in
any other circumstance
(b)The rationale for this exemption seems to be that the
purpose of short-term notes is to allow the continuation
of business. Commercial paper allows businesses to
raise quick cash for operational purposes (by taking a
loan). These loans are secured by collateral, meaning
the lender retains control over the risks. In other words,
the short-term exception is seen as shorthand way of
expressing the notion that loans where the party is not
at risk are not securities.
4. Reves v. Ernst & Young: Co-opt sold notes to raise money,
advertised them as safe and secure, called an investment,
went bankrupt, sues auditor.
(a) Court adopts modified family resemblance test,
notes are presumed to be a security if it is over 9
months, but presumption can be rebutted by balancing
four factors
(i) Motivation of the seller and buyer
1. If the issuer of the notes uses the proceeds for
general purposes, it is more likely a security.
2. If the issuer gives the note to buy consumer goods
or for some commercial purpose, it is more
likely not a security.
3. Note the resemblance to Howeys investment of
money.
(ii)
Plan of distribution
1. If the note is widely offered and traded, it is more
likely a security.
2. If the note is given in a face-to-face negotiation to
a limited group of sophisticated investors, it is
more likely not a security.
3. Note similarity to horizontal common enterprise.
4. Logical correlation: more likely the transaction
would be exempt from registration, the less likely
its a security to begin with.
(iii)
Reasonable expectations of the investing
public
1. If investors generally view the note as an
investment, it is more likely to be a security.

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2. Analogous to Howeys expectation of profits from

the efforts of others.
(iv)
Other factors reduce risk
1. If note is not collateralized and not subject to nonsecurities regulation, it is more likely a security.
2. This seems reasonably grounded in the source of
the differing treatment in the first place
(commercial money).
5. If an instrument isnt a security under the Reves test, does
the Howey test apply?
(a) Open question, Marshall suggests no in Reves, but
apply Howey on exam.

II. Public Offering Process

a. IPOs and Underwriters
i. Benefits of an IPO
1. Cash
2. Lower cost of capital
3. Prestige
ii. Risks of an IPO
1. Dilution of wealth and control
2. Liability from public misstatements
3. Vulnerable to market changes
4. Increased regulation, disclosure costs are internalized
5. IPO flop
iii. Underwriters
1. Underwriters offer guidance on structure, price, amount,
and disclosures.
(a) Offer credibility, recognition, and prestige
(b)Reduction of in the firm commitment model
(c) Provide access to their network, reputation, and balance
sheet.
(d)Provide technical expertise from their experience
2. In exchange underwriters receive fees, the proceeds on
selling on the secondary market, and prestige in the form
of Tombstones.
3. Underwriters work together through syndicates to diversify
risk and keep business w/in their tight knit group
iv. What does success look like?
1. Company goes live and then there is a pop in the stock
price.
(a) What does an IPO bump tell us?
(i) Initial price was too low, systemic underpricing
benefits the underwriters and their clients
v. Documentation
1. Letter of Intent

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(a) Nonbinding terms btw issuer and underwriter that

allows them to begin writing the underwriting
agreement
2. Underwriting Agreement
(a) Becomes binding the night before the IPO, determine
price as close to the last possible moment as possible
(b)Contains key clauses and conditions such as
(i) How executives can interact w/ shares, get
agreement they wont dump shares
(ii) Stipulates fees
(iii)
Indemnification provisions indemnify the
underwriter, but are hard to enforce and rarely work
(iv)
Contribution clauses allow for contributions
from issuer to underwriter, work better than
indemnification
vi. Techniques
1. Firm Commitment primary form, underwriter buys
entire issue and resells. Issuer gets its money and
underwriter assumes the risk of losing money. Investors
like it b/c it shows the underwriter believes in the issuer,
signal of confidence.
2. Best Efforts loserville, bank acts purely as a seller and
earns commission. Used for smaller, more speculative
issuers. Underwriters dont assume risk, risk goes to issuer
and investors. 3 different types of loser offerings
(a) Mini/Max issuers must sell enough to cross a certain
threshold, then the underwriter will show up and sell.
(b)All or Nothing the whole system shuts down and
investors are refunded unless every share is sold.
(c) Best Efforts classic, underwriter sells what they can,
not very common.
3. Direct Public Offering or Dutch Auction modern
invention, happens online, usually done w/ offerings to
existing shareholders. Tell investors how much you want to
sell for how much, and then investors counter w/ bids.
Issuers accepts price at which it can sell all the shares it
wants to sell and all the shares sell at that price. Bids are
confidential.
(a) Avoids underpricing, issuer leaves less money on the
table. Also provides lower fees. Google did it.
b. JOBS Act
i. Deregulation to facilitate raising capital passed w/ bipartisan
support, allows smaller start ups cheaper access to capital
markets and to avoid disclosures.
1. Eases up the IPO process

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2. Introduces crowdfunding
ii. Crowdfunding
1. Donation Modelfunders giving w/ no expectation of return
(a) Ex. Global giving
2. Perks Modelcontribute to venture in return for a small
reward like merchandise
(a) Is this a security?
(i) No expectation of profit
(b)Ex. KIVA, IndieGoGo, Kickstarter
3. Equity Funding Models- Encourage individuals to invest in
actual equity of small businesses, expect return.
iii. JOBS Act Crowdfunding 4(a)(6)
1. Can raise up to $1 million per 12 months, unless you are
already a public issuer, in which case you cannot use it at
all, small unregulated companies only.
2. Investors are capped on how much they can give based on
their income.
(a) Investors w/ either an annual income or net worth less
than $100,000, the investment may not exceed greater
of $2,000 or 5% of their annual income or net worth
(b)Investors w/ either an annual income or net worth of at
least $100,000, the investment may not exceed 10% of
their annual income or net worth up to a $100,000 max
aggregate amount
3. Necessitates that you need more information as you
attempt to raise more moneyabove 500k you need
audited financials
4. Need risk factors and basic business information
5. Liability under 10b-5
(a) Loosens the scienter requirementfrom
intent/knowledge to simple negligence
(b)Concerns about collective actionsmaller amounts of
moneywho will keep them liable?
6. Are we creating a market for fraudsters and suckers to
meet?
III. Gun Jumping Rules
a. 3 Questions
1. What kind of company are we dealing with?
(a) Non-reporting issuer
(i) Issuer that doesnt have to file reports with the SEC
(ie 10-k). Generally, any IPO will be a non-reporting
issuer as a first-time entrant into the market.
(b) Unseasoned issuer

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2.

3.
4.
5.

(i) Has undertaken a public offering, but is unable to use

Form S-3, meaning that it has a float of < $75M and
been in the market < 1 year.
(c) Seasoned issuer
(i) Public company that is able to use Form S-3, a float
of > $75M and been in the market > 1 year.
(d) WKSI (Well-Known Seasoned Issuer)
(i) Has a public float of more than $700M, or issued
$1Bil aggregate principle amount of non-convertible
securities, lots of leeway and perks b/c of public info.
(e) Emerging growth company
(i) New from JOBS Act, < $1 billion in revenue in the last
fiscal year, special dispensation to make things
easier, can apply to basically all non-reporting,
unseasoned, and seasoned.
Where are they in the process?
(a) Pre-filing Period
(i) Begins when issuer and underwriter reach an
understanding to go through with a public offering.
(SEC 5009). Most important aspect of this period is
5(c) prohibiting all offers. Ends with filing of the
registration statement.
(b) Waiting Period
(i) Begins with the filing of the registration statement
and allows oral offers, but prohibits any prospectus
unless it meets the requirements of 10. Effectively,
it prohibits written offers unless it is a 10
prospectus. Ends when registration statement
becomes effective.
(c) Post-effective Period
(i) Begins with the filing of the final registration
statement (includes price and underwriting spread)
Allowed to sell security
What is the Rule?
(a) Section 5 reference + Definition + SEC releases/ Cases
explaining
What are the safe harbors?
(a) Even though you are in breach of the rulehow has the
SEC allowed areas in which they wont pursue?
Apply the facts to each case.

Statute
5(a)(1)

Pre-Filing Period

Waiting Period

5(a)(1) Applicable
SALES PROHIBITED

Post-Effective
Period
N/A

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5(a)(2)
5(b)(1)

5(a)(2) Applicable
N/A

5(b)(2)

5(c)

5(c) Applicable
OFFERS
PROHIBITED

N/A
5(b)(1) Applicable
OFFERS MUST INVOLVE
PROSPECTUS THAT COMPLIES WITH
10
5(b)(2) Applicable
Sales must be
Accompanied by
a Prospectus
conforming to
10
N/A

b. Pre-Filing Period
i. SEC Release 5180: pre-filing period begins when youre in
registration, when the issuer and underwriter reach an
understanding to go through with a public offering
ii. Rules
1. 5(a) prohibits all sales until the registration statement
becomes effective
2. 5(c) prohibits the offer to sell or offer to buy a security
(a) Must be transmitted in interstate commerce, like the
internet
3. 2(a)(3) defines offer, but much of the meaning of what
constitutes an offer is found in SEC rulings and releases.
iii. Offer
1. 2(a)(3): The term offer 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.
(a) 2(a)(3) defines an exclusion from the definitions of
sale, offer to sell, and offer to buy both the
negotiations and agreements that the issuer has
with its underwriters, as well as the negotiations
and agreements among the underwriters to set up
the syndicate.
2. In the Matter of Carl M. Loeb: Offer encompasses all
communications that may condition the market for
sale of securities.
3. SEC Release 3844: Publication of information and
statements and publicity efforts, generally, made in
advance of a proposed financing, although not couched in
terms of an express offer, may in fact contribute to
conditioning the public mind or arousing public
interest in the issuer or in the securities of an issuer in a

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manner which raises a serious question, whether the

publicity is not in fact part of the selling effort.
4. SEC Release 5180: Forecasts, projections, or
predictions relating but not limited to revenues, income,
or earnings per share. Opinions concerning concerning
values.
(a) If advertising is the same as the ordinary course of
business, then it is usually ok. Uncharacteristic silence is
bad.
5. What kind of information conditions the market?
(a) Timing is important, points to motivation
(b)Mention of the underwriter
(c) Written information is particular troubling
(d)Mass distribution is bad
(e) Soft and forward looking information
iv. Safe harbors
1. Rule 163A - all issuers have a bright-line exception for
communications made more than 30 days before
filing a registration statement.
(a) Caveats
(i) Cannot mention or refer to the offering
(ii) Must be made by the issuer or those working on
behalf of the issuer, not the underwriter or dealer
(iii)
Issuer must take reasonable steps to prevent
further distribution or publication of the
communication during the 30-day period preceding
the filing of the registration statement.
2. Rule 163 - WKSIs can engage in unlimited oral and
written offers before a registration statement is
filed.
(a) Caveats
(i) Must be made by the issuer or those working on
behalf of the issuer, not the underwriter or dealer.
(ii) Must treat any treat any 163 communication as free
writing prospectus and file it with the SEC promptly
upon filing the registrations statement.
(iii)
Written communications must include a legend,
required by subsection (b)(1) of Rule 163, informing
investors about the formal statutory prospectus and
how to obtain it.
(iv)
Overshadowed by shelf registration
3. Rule 135 Tombstone Safe Harbor, allows for short
factual notices of a proposed registered offering, can
mention the issuer, the amount, and basic terms. Ex.
Twitters tweet. Exception to 2(a)(3).
(a) Caveats

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(i) Only makes the communication not an offer, does

not change whether it might be in the form of a
prospectus.
(ii) Cannot mention underwriter
(iii)
Making a Rule 135 statement alerts the SEC
and class action attorneys about your filing, puts the
pressure on.
4. Rule 169 non-reporting issuers can disclose factual
business information, but not forward looking
statements, and only if the intended audience is not
investors, but other parties like customers and
suppliers.
(a) Caveats
(i) Rule 169(b) defines factual business information
1. Rule 169(b)(1)(ii) includes advertising as factual
business information
(ii) Doesnt exempt forward looking information,
information about the offering (although it may be
allowed under Rules 135).
(iii)
Rule 169(d)(2) time, manner, and form in which
information is released must be consistent w/ past
releases
(iv)
Rule 166(d)(3) Can only release information to
customers and suppliers, not investors or in their
capacity as investors
(v) Only applies to statements by or on behalf of issuers.
5. Rule 168 - Exception for reporting companies that
allows them to continue to release factual business
information and forward-looking statements. Includes
periodic reports like 10-K.
(a) Caveats
(i) Only applies to statements by or on behalf of issuers.
(ii) 168(d)(2) time, manner, and form in which
information is released must be consistent w/ past
releases
(iii)
Expressly excludes any information about the
registered offering itself (although it may be allowed
under Rules 135).
6. 5(d) of Securities Act or 105(c) of JOBS Act Testing the
waters safe harbor, lets emerging growth companies talk
to qualified institutional investors during the quiet period to
get some indications of interest. Can use written and
electronic materials provided they stay within institutional
investor community.
(a) Caveats

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(i) Written materials cannot escape from the meetings

could be in violation of 5(c)
(ii) Cant agree to any sales or deals, and you have to
file any promotional material with the SEC.
(iii)
Assumption is that institutional investors will
not go into speculative frenzyallows them to act as
another gatekeeper in the system
v. Penalty for violating 5(c)
1. 1st violation gets a delay of the offering, delays are
expensive and make everyone involved less confident
2. Further consequences include 12, which includes the right
of recession for purchasers.
vi. Purpose of pre-filing restrictions
1. Slow down the process to reduce frenzies
2. Acts a disciplining device, potential liability and basis for
litigation
c. Waiting Period
i. Begins with the filing of the registration statement, ends when
registration statement becomes effective
ii. Rules
1. 5(b)(1) - It shall be unlawful for any personto
transmit any prospectus relating to any security
with respect to which a registration statement has
been filed unless it meets the requirements of 10
(a) Every offer needs to be 10 prospectus
2. 2(a)(10) - The term prospectus means any prospectus
which offers any security for sale or confirms the sale of
any security. Defines prospectus as a written offer as
defined by 2(a)(3), Loeb, etc.
3. Rule 430 - Preliminary Prospectus
(a) 10(b) of the 33 Act gave the SEC power to adopt Rule
430, which must contain essentially the same
information as the final statutory prospectus,
with the exception of offering price, underwriter
and dealer compensation information, amounts of
the proceeds, conversion rates, call prices, and
other details connected with the final price.
(b)These prospectuses formed by SEC rules only satisfy the
requirements of Section 5(b)(1).
(c) Thus, under this rule, the registration statement with
certain omitted details is satisfactory as a preliminary
prospectusthe basic framework of the waiting period
is the registration statement.

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(d)These prospectuses must contain a legend that this it is

not a final prospectus and have a caption saying
Preliminary Prospectus.
4. Rule 473: Extension of time for registration statement
iii.Safe Harbors
1. Ordinary course of business safe harbors, Rules 168 & 169
still apply, can be used to argue there is no offer, so no
prospectus. Rule 136A no longer applies. Rule 135 still
applies, but Rule 134 is broader.
2. Rule 134 excludes communications from the definitions of
a prospectus and a free writing prospectus that violate
5(b)(1). Broader tombstone safe harbor. Permits 22
items including, disclosure of issuers identity and
business location, amount and type of security being
offered, business of the issuer, price of the security,
address, phone number and email address of the issuers
principal offices, geographic areas where it conducts
business, names of all the underwriters, etc.
(a) Caveats
(i) Rule 134(b) mandates the disclosure of certain
information, including a boilerplate legend indicating
that securities may not be sold prior to the
registration becomes effective. Also requires
disclosure of where an investor may obtain a 10
prospectus.
1. Mandatory disclosures arent required if
accompanied or preceded by a preliminary
prospectus.
3. Road Shows and Other Oral Offers oral offers and
roadshow pitches arent not prospectuses under
2(a)(10), so arent prohibited under 5(b)(1).
(a) Main mechanism for advertising in the waiting period,
visit big investor w/ your pitch.
(b)Telephone calls are fine, but it violates 5(b)(1) if you
follow up with an email.
(c) Pitch books delivered with presentation are still
considered oral communication
(d)Limitations
(i) Markets are now large and international and you
want to target everyone
(ii) No access for retail investors
4. Rule 433 Free Writing Prospectus
(a) Can only be used after the registration statement has
been filed, which means anytime for Seasoned and
WKSI.

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(b)Under Rule 164, a free writing prospectus that

meets the requirements of Rule 433 is treated as
a 10(b) prospectus for the purpose of 5(b)(1).
(i) Rule 433(b)(2) non-reporting and unseasoned
issuers free writing prospectus must be
accompanied or proceeded by statutory or
preliminary prospectus that satisfies 10.
(ii) Rule 433(c)(2) legend requirements (basically a
disclaimer)
1. Legend goes where it can be seen most clearly.
On top of page
(iii)
Rule 433(c)(1) consistency requirement, no
information inconsistent w/ filed statutory prospectus
or registration statement
(iv)
Rule 433(d) must file free writing prospectus
w/ SEC
(v) Rule 433(g) issuers and offering participants must
retain free writing prospectus they have used
for 3 years.
(vi)
Rule 433(d)(8) Online Roadshows
1. Can post one internet roadshow online w/o filing
with the SEC, but any power point or pitch book
that is included with must be a free writing
prospectus.
(vii)
Rule 433(f) allows use of mass media
1. Rule 433(f)(1)(i) Cant pay to play, no payment or
consideration, cannot initiate
2. Rule 433(f)(1)(ii) Must file communication or
transcript with SEC
(viii)
Rule 433(e) Makes website into a free writing
prospectus by hyperlinking to registration statement
5. 106 JOBS Act Confidential Filing
(a) Allows emerging growth company to file draft S-1
without getting to waiting period, only SEC can look at it
(i) Confidential review processnot subject to market
analysis
(ii) Must wait 3 weeks after it goes public to engage in
offering or roadshows
1. Watch out for Rule 136A, must be silent 30 days
before reveal and 21 days after reveal.
d. Going Effective and the Post Effective Period
i. Process
1. The process of going effective
(a) Set price the morning it goes live
(b)Finalize and signing underwriting agreement

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(c) Finalize and signing syndicate agreement

(d)Set listing
2. Under 8(a), a registration statement is supposed to
become effective 20 days after filing, but issuers dont
want their registrations to become effectively
automatically.
(a) Rule 473 delays effectiveness until the issuer is
ready
(b)Once the issuer and underwriter are ready, they file an
acceleration request w/ the SEC at least two days prior
to the offerings desired effective date.
(c) Rule 461 outlines the factors the SEC weighs in deciding
whether to grant the acceleration request.
3. What happens in the post effective period
(a) 5(a) nolonger applies, underwriters and dealers selling
shares
(b)Dissemination of information
(c) SEC wants material information distributed to keep
frenzy down
ii. Rules
1. 5(b)(2) final 10 prospectus must accompany or proceed
any sale
2. 5(b)(1) still applies, every written offer needs to be a 10
prospectus, including use of 433, 430A, 431, 169, 134, 135
like in waiting period
(a) 2(a)(10)(a) Traditional free writing prospectus
exemption to 5(b)(1) for all written or broadcast
materials that would be a prospectus, but nor comply w/
10. Must be proceeded or accompanied by final
statutory prospectus.
iii. How long does the prospectus delivery requirement persist
under 5(b)(2)
1. Issuers continue to be subject to the requirements of 5
for as long as they are offering the security to the public.
2. 4(1) exempts transaction not involving any issuer,
underwriter, or dealer from 5, exempts the vast majority
of secondary market transactions
3. 4(4) exempts brokers roles in secondary market
transactions
4. Underwriters and dealers are subject as long as their
allocation of shares remains unsold.
5. Dealers are still under 5 until they meet the statutory
exceptions of 4(3)A or Brokers are exempt from this
requirement if they are selling on behalf of other parties as
agents (in other words, if they did not solicit the interest in
the security) under 4(4).

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6. In order to meet 4(3), a dealerpretty much anyone

working as a professional principal in securitieshas to
wait until 40 days after the later of either (1) registration
statements becoming effective, or (2) securitys being
offered to the public. For an IPO, the period is ninety days
from the latest trigger.
iv. Exceptions to section 5(b)(2)s delivery requirement
1. Rule 172(a) allows written confirmations of sales to not be
considered prospectuses under 5(b)(1). Now a broker can
confirm a sale or inform an investor of the exact number of
shares they will be allocated in a distributed security
without having to provide the investor with a final
prospectus.
2. Rule 172(b) relaxes the delivery requirements of 5(b)(2)
by providing that the obligation is satisfied at the time of
delivery if the issuer has filed a 10(a) prospectus with the
SEC and the issuer is not under investigation.
3. Rule 173 requires issuers, underwriters, and dealers not
filing under an exception in 4(3) or Rule 174 to file either
notice that the sale was made pursuant to a registration
statement or a copy of the final prospectus within 2 days of
delivery.
4. Dealers Exceptions
(a) Section 4(4): A dealer who is acting as an agent for a
buyer is a broker and exempted under section 4(4).
(b)Must be unsolicited
(c) Section 4(3): A dealer can always be excepted from
compliance with 5(b)(2) if it falls under one of the
section 4(3) exceptions.
(d)Rule 174: Alternatively, a dealer that is not an
underwriter is completely relieved of the need to make
available a prospectus within the 40-day or 90-day
period if the issuer was a reporting company under the
34 Act prior to filing the registration statement. Rule
174(d) dispenses with the prospectus provision
requirement 25 days after the offering date if the
security is listed on a national exchange or interdealer
quotation system.
(e) Rule 153 excuses the dealers prospectus delivery
requirement at the time of sale if the security is
registered on a national exchange.
(f) Rule 172(c)(4) specifically excuses the prospectus
requirement at the time of delivery of the security for
dealers if the registration statement of the issuer is not
under investigation by the SEC.

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5. Free writings are still valid under Rules 433 and 164.
e. WKSIs and Shelf Registration
i. Generally
1. The major development in recent years has been allowing
companies that issue periodic reports under the 34 Act to
incorporate the information from those reports in their 33
Act registrations.
2. Seasoned issuersas defined in Form S-1, but generally an
issuer that has provided at least one annual report to the
SEC and is current on filingscan use integrated Form S-1
for a great deal of its disclosure obligations
3. Well-known seasoned issuers (WKSI) have it even better. If
an issuer has a common stock market capitalization of
$700 million or, in the case of a debt or non-convertible
preferred stock offering, issuers that in the prior three
years have offered $1 billion in non-convertible securities
other than common stock, it qualifies. Alternative, an
issuer qualifies as a WKSI for a common stock offering if it
meets the $1 billion non-convertible securities test and has
a common stock float of $75 million.
4. The information that WKSIs must add to their integrated
disclosure is mostly transaction-specific.
ii. Shelf Registration
1. An issuer knows that variations in interest rates can greatly
affect the amount of capital raised by a public offering; it
therefore would have a huge incentive to use a system of
registration where the exact time of the offering is flexible.
2. Similarly, an issuer might want to have a reservoir of stock
that it can issue quickly in order to accomplish an
acquisition.
3. The rules have changed to accommodate these sorts of
circumstances: we now have a system of shelf registration
where shares of securities are registered and then offered
on a delayed or continuous basis.
4. The impetus for shelf registration was the development of
integrated disclosurenow that information is constantly
be pumped into the market, its much easier for issuers to
keep a registration statement current and on hold.
5. Rule 415
(a) The first parts of rule 415section (a)(1)(i) through
section (a)(1)(ix) called traditional shelf registration
works by allowing shelf registration, but requiring an
updated prospectus pursuant to Item 512(a)(1)(i) of
Regulation S-K. This updated prospectus is governed by
10(a)(3)s timing requirements, effectively meaning

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that the registrant has to update its financial statements

annually.
(i) Item 512(a)(1)(i) also requires disclosure of any
event representing a fundamental change to the
information presented in the registration statement
through means of a post-effective amendment.
(b)The second part of Rule 415 goes further. S-3 reporting
companies (WKSIs) are now permitted to register
securities with minimal limitations (name and class) so
long as they expect to sell them within two years. All
information from their periodic disclosures is integrated
by incorporation, so the company only needs to provide
issue-specific information.
(i) Can provide this by a supplement or an amendment:
1. Supplementsgo into effect immediately and
generally only used by WKSIs
2. Amendmentsreviewed by SEC, and used by
smaller companies
(ii) File base prospectus (like registration statement)
1. Then update with base prospectus and
amendments per issue (final prospectus)
(c) Under Rule 424(b)(2), S-3 reporting companies now
dont even have to file a prospectus supplement
containing the transaction-specific information until 2
days after a sale, so theres hardly a speed bump in the
process.
(d)The 2005 Amendments liberalized this even more,
creating automatic shelf registration for WKSIs. Form S3(D)
6. This system reduces costs on the issuers. It also generates
a signaling effect for its share price. Shelf registrations
drive stock prices down because of (1) dilution, and (2)
assumption that the price has peaked. If you are issuing
stock, the market takes this as a signal that prices are too
high.
7. Underwriters are not fans:
(a) Now have a speedier process
(b)More competition for the business
(c) Get smaller fees
(d)Still large amounts of liability (despite lower returns)
8. Post-Effective Amendments
(a) Correcting Material Inaccuracy
(i) The registration statement can be amended after
becoming effective. Under section 8(c), the
amendment becomes effective on the date that the
SEC chooses to make it so.

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(ii) By connecting the 10(a) requirement that a

prospectus contain the information in the
registration statement with the courts holding in
Manor Nursing, the SEC has effectively created an
affirmative duty for those involved in the offer to
constantly assess whether the prospectus used in the
distribution must be updated or otherwise changed
so as not to be materially misleading.
(iii)
Rule 424(a) sets out the rule that if the
prospectus used to sell the securitywhich will
presumably be updated to avoid anti-fraud charges
has a substantive change or addition, then the
party has an affirmative duty to add an amendment
to the filed registration statement.
(iv)
Rule 424(b)(3)-(5) allows a milder remedy if the
information is not a substantive change or addition
such information is added by adding a sticker to the
cover page of the prospectus. This is not considered
an amendment of the registration statement.
Stickering is also used after a seller has filed an
amendment to the registration statement under Rule
424(a) and is waiting approval by the SEC.
(v) The major impact of the amendment rule is to reset
the clock for 11 liability. When a post-effective
amendment is declared effective, the entire
registration statement is considered to be updated as
of the day of the amendment. If there are provisions
that are no longer accurate (even if they were not
substantive enough by themselves to need an
amendment), they now can be grounds for 11
liability. Furthermore, the statute of limitations for
11 runs from this day.
(vi)
Section 10(a)(3): if a seller uses a prospectus
to sell a security more than nine months after the
registration statement became effective, the
information may not be more than 16 months old.
Updating a prospectus to include more recent
information does not need to be filed as an
amendment to the registration statement.
(b)Supplementing Information that Is Permitted to Be
Omitted Prior to Effectiveness
(i) Rules 430A, 430B, and 430C lets the selling parties
omit the price information and other provisions from
the initial prospectus, meaning they no longer are as
dependent on acceleration, but they do have to
amend your prospectus for registration.

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(ii) Rule 424(b)(2) requires the pricing amendment to be

filed within 48 hours of the first use.
(iii)
These rules can have odd effects. Suppose a
seasoned company filed a registration statement in
January and then filed notice of sales and price in
September. Suppose further that between January
and September, there was a material change that
should have been reported in the registration
statement, but was not. By filing in September, the
company has opened itself up to 11 liability
because the registration statement is not correct on
that date. Note that this only applies to the portions
of the registration statement relevant to the
amendment.
9. Undertakings to Update:
(a) Rule 415 shelf registration requires filing post-effective
amendments to the registration statement when
(i) A prospectus is required by 10(a)
(ii) There has been a fundamental change in the
registration statements information
(iii)
Information about the plan of distribution has
undergone a material change or was omitted in the
first prospectus.
(b)An S-3 issuer can satisfy these requirements in its 34
Act periodic filings.
(c) Any other changes can be dealt with by stickering.
10.
Withdrawal of the registration statement
(a) Rule 477 allows an issuer to withdraw its registration
statement, effective immediately unless the SEC
objects.
(b)This rule complements Rule 155, which provides a safe
harbor for issuers abandoning an effort to have a public
offering and seeking an exemption from registering.
f. Gun jumping rules policy:
i. We need investor protection where the securities are unknown
hence the focus on IPOs
ii. As companies are recognized by the marketthe costs of gun
jumping rules goes up without a corresponding increase in
benefit
1. Shift to less restrictive process (ie shelf registration)
iii. Liability continues on the back end (with larger companies
we are less concerned they will completely flame out and
have no one to compensate investors)
1. Hence, large, well-known issuers can issue with very little
restriction, yet will continue to be penalized under 11 &

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12(a)(2) as well as 10b-5 if they commit fraudulent

actions
iv. Balance between investor protection and issuer flexibility
1. We want the US market to be the most adaptable and
flexible to attract companies to its markets
(a) We trust private analysts and auditors more than the
cumbersome SEC.
(i) Thus, when the risk of investor fraud is lowwe put
more faith in back end liability rules to keep issuers
honest
(b)With unknown companiesneed SEC b/c only player
able to evaluate new market entrants
v. Must remember that SEC and securities regulation doesnt
exist in a vacuumwhere the private market can regulate
itself, the SEC should let it
1. Where it cant, the SEC needs to take controlhence the
bifurcated process to the gun jumping rules.
IV. Private Placements
a. 4(2) exempts transactions by an issuer not involving any public
offering.
b. What is a private offering?
i. Securities Act Release No. 285 Factors to determine if an
offering is private and exempt under 4(2)
1. Number of offerees and their relationship to each
other and issuer
(a) Critical inquiry
(b) The more offerees, the more likely its public
(i) Proxy for collective action problem and informational
asymmetries
(c) Do they have access to insider info?
2. Number of units offered
(a) Large number of units w/ small denomination makes
more public and prone to frenzy
(i) Proxy for collective action problem
3. The size of the offering
(a) Smaller, more private
(b) The greater the denomination, greater likelihood only
a small number can buy it and they will be more
sophisticated
4. The manner of the offering
(a) Direct negotiations v. general announcements
(i) The more individual and private the offering is, the
more likely its private

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(b)The more discretely you can do it, the less likely it will
be public
ii. SEC v. Ralston Purina: are Purinas treasury stock offerings to
key employees public? No, court finds the offering is public
b/c the offerees arent the kind of people who can fend
for themselves.
1. Court leaves open what qualifies someone as being able to
fend for themselves, but gives the example of executive w/
access to insider info
2. What is sophistication?
(a) Circuits are spilt on what it is and if it matters.
(b)Doran v. Petroleum Management Corp. (5th Cir. 1977):
5th circuits answer to sophistication. Investor in oil
drilling LP had previously invested in 26 oil and gas
properties and had a net worth in excess of $1 million,
including holdings in 26 properties. Ultimately
remanded to the lower court to decide.
(i) Sophistication necessary but is not enough.
Need access to relevant info to bring
sophistication to bear.
(ii) Looking at the number offerees, the information
itself, and the ability to gain access to the info
1. Availability is either disclosure or effective access
(iii)
Sophistication is still an element,
especially important in access.
(iv)
Not only whether you can understand the
information given to you, but also whether you
actually had the informationor were in a position to
ask for it.
c. Basic Features of private offering
i. Sophisticated buyer that can fend for themselves
ii. Small number of offeree
iii. Offerees are insiders w/ strong relationship to offeror
iv. Small number of units offered
v. Discrete manner of offer, not general solicitation
vi. Large denomination
d. What is Sophistication?
i. Fend for oneself
ii. Access to info and ability to process
e. Regulation D
i. Generally
1. Rules 501-508
(a) Rules 504, 505, and 506 are the nonexclusive safe
harbors
(b)Rules 501, 502, 503, 507, and 508

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2. Safe Harbor to the 4(2) exemption, far more predictable

than 4(2) exemptions
ii. Rule 504
1. Aggregate offering limit of $1 million for 12 months
2. No limit on purchasers
3. No specific disclosure requirements, only if state law
requires
4. No restrictions on manner
5. Passed pursuant to 3(b)
(a) Authorized the SEC to develop exemptions covering
offerings up to $5 million when registration is not
necessary to protect the public interest or investors.
(b)No sophistication requirement
iii.Rule 505
1. Aggregate offering limit of $5 million for 12 months
2. Limited to 35 purchasers, unlimited accredited investors
3. Specific disclosures required by 502(b)(2) when there are
non-accredited investors
4. General solicitations banned by 502(c)
(a) In the Matter of Kenman Corp: sold securities w/o
registration statement, mailed unknown number of
offers. In determining what constitutes a general
solicitation, the existence and substance of pre-existing
relationships between issuer and offerees is key.
5. Passed pursuant to 3(b), like 504
iv. Rule 506
1. Unlimited aggregate offering limit
2. Limited to 35 sophisticated purchasers, unlimited
accredited investors
(a) The ambiguity of sophistication leads many Rule 506
offerings to only go to accredited investors
3. Specific disclosures required by 502(b)(2) when there are
non-accredited investors
(a) Recommended you disclose to accredited investors if
youre already disclosing to non-accredited investors
under 502(b)(2), otherwise youll be exposed to
antifraud liability according to 502(b)(1)
4. General solicitations banned by 502(c)
(a) Until JOBS ACT, Rule 506(c) allows general
solicitations if all investors are accredited.
5. Promulgated under the private offering exemption of 4(2).
(a) Thus, if miss 506can go back to 4(2)
v. Rule 501(a) Accredited Investor
1. Any person or comes within any of the following
categories, or the issuer reasonably believes comes within
any of the following categories at the time of the sale.

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(a) 501(a)(1)(3) Banks, investment companies, and

other financial institutions
(b)501(a)(4) Director, execute officer, or general
partner of the issuer
(i) 501(f) Executive officers perform a policy making
functions
(ii) Insiders
(c) 501(a)(5) People w/ individual or joint net worth
of w/ spouse that exceeds $1 million
(i) 501(a)(5)(i)(A) Persons primary residence shall not
be included as an asset
(d)501(a)(6) People w/ individual income in excess of
$200,000 in each of the two most recent years, or
joint income w/ spouse in excess of $300,000
(e) 501(a)(7) Trusts w/ assets over $5 million, not
formed for this specific purpose, directed by a
sophisticated person
2. 502(b)(2)(iv) non-accredited investors can request all the
info given to accredited investors
vi. 501(e) Calculating the Number of Purchasers
1. 501(e)(1) additional purchasers are excluded from
calculating the number of purchasers
(a) 501(e)(1)(i) - Any relative, spouse or relative of the
spouse of the purchaser who has the same
primary residence as the purchaser are excluded from
the number of purchasers
(b)501(e)(1)(ii) Any trust or estate in which the
purchaser or relative have more than 50%
beneficial interest
2. 501(e)(2) Each corporation or other entity counts a one
purchaser, unless the entity is set up for the specific
purpose of investing in the securities and not an accredited
investor, then each investor counts
vii. 501(h) Purchaser Representatives
1. Sophisticated person can buy on behalf of an
unsophisticated person as a purchaser representative if
(a) 501(h)(2) has actual knowledge and expertise in
financial and business matters
(b) 501(h)(3) unsophisticated purchaser acknowledges
in writing
(c) 501(h)4) Disclosure
(d) 501(h)(1) Cannot be an affiliate, director, officer, or
other employee of the issuer
(i) 501(h)(1)(i) - Unless they are a relative by blood,
marriage, or adoption

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viii. Determining Aggregate Offering Limits Under Rule

504 and 505
1. Rules 504 and 505 have limits on the aggregate offering
price
(a) Issuers must reduce the offering price ceiling
by the amount of securities sold in the previous
12 months under a 3(b) exemption (including
rules 504 and 505) or a violation of 5.
(b)Rule 501(c) defines the aggregate offering price as the
sum of all value the issuer receives for the security.
Shares offered as consideration are calculated at their
sales value.
ix. Integration
1. Prevents issuers from undertaking repeat offerings under
different headings of Reg D by characterizing offers
strategically.
2.
(a) Ex. Doing two 506 offerings w/ 35 non-accredited
investors each, would make the rule irrelevant.
3. Securities Act Release No. 4552 Factors to determine if
seemingly separate offerings that should be treated as one
(a) Whether the sales are part of a single plan of
financing
(i) Sonnenblick No Action letter said this is the most
important factor b/c its a matter of intent that
demonstrates intentional skirting rules
(b) Whether the sales involve issuance of the same
class of security
(c) Whether the sales have been made at or about
the same time
(d) Whether the same type of consideration is
received
(e) Whether the sales are made for the same general
purpose
4. Rule 502(a) Integration Safe Harbor safe harbor from
integration applies 6 months prior to the start of the
offering and 6 months after the end of the offering
(a) Sales outside the window are deemed separate
5. Consequences
(a) If we integrate, have to try to fit the offerings
under Reg. D, if we cant, the try to fit in under
4(2), if we cant, then weve violated 5
(i) 5 penalty purchasers can sue for rescission

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(ii) Reg. D penalty - aggregate offering price ceiling

reduced
V. Re-sales
a. Secondary market transactions are made possible by exemptions
to 5
i. 4(1) exempts transactions from 5 as long as no issuer
underwriter, or dealer is present in the transaction.
ii. 2(a)(11) defines underwriter as any person who purchases
from an issuer with a view to distribution or offers or
sells for an issuer in connection with a distribution
1. Disjunctive analysis, have to do both to be an underwriter
(a) view to Intent
(i) How do we establish intent?
1. Time reduces intent
a. After 2 years there is a presumption that the
securities have come to rest and werent
bought with an intent to distribute, after the 3
years its conclusive.
2. Changed circumstances
a. Gilligan, Will & Co v. SEC: bought convertible
debentures and sold then when the company
did poorly. Court found he had intent to sell,
bought with a view to distribution.
i. Intent to retain if profitable is the
equivalent to the intent to distribute.
ii. Only the investors change in
circumstances matter, not the issuers.
iii. Arguing change in investors circumstances
is a very high bar.
(b)distribution
(i) Connection btw distribution in 2(a)(11) and public
offering in 4(2)
1. Allows for secondary private placement to
those who can fend for themselves under
4(2).
2. By offering or selling for an issuer in connection with a
distribution
(a) SEC v. Chinese Consolidated: charity collecting money
to buy Chinese bonds to fight the Japanese invasion of
China. didnt have any relationship w/ Chinese govt or
receive any commission. Court holds that the defendant
was an underwriter because it was offering or selling
for an issuer and therefore liable for the securities.
(i) Court found solicited offers for value, which was
the key distinction.

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b. Control Person Resales

i. Under 2(a)(11) control persons are issuers for the purposes
of defining underwriters
1. A person purchasing from a control person, selling for a
control person, or otherwise working with a control person
is an underwriter for the purpose of the securities laws.
2. The effect is that dealers and brokers who help control
persons of an issuer get rid of stock are underwriters under
the securities laws, and thus create distributions.
ii. Rule 405 defines control, power to control or direct mgmt. and
policies, essentially a controlling shareholder.
iii. United States v. Wolfson: owned 40% of Continental for 10
years, not registered. He tries to sell securities through
brokers to the public. Court holds that as a control person,
he is an issuer within the meaning of 2(a)(11), so
brokers are underwriters not entitled to 4(1)
exemption.
iv. In real life everyone uses Rule 144, whether youre a control
person or not
c. Rule 144 Resale Safe Harbor
i. If you comply w/ Rule 144 youre not an underwriter under
2(a)(11)
ii. Depends on the presence of an affiliate or non-affiliate, and
the presences of restricted or unrestricted securities.
1. Rule 144(a) affiliate is a person who controls or is
controlled by the issuer, a conventional control person
2. Rule 144(a)(3) restricted security is one that is not
registered, not acquired through a public offering
iii.Rule 144 two prongs
1. Is there enough info in the market?
(a) Easy inquire for reporting companies making regular
filings
(b) For non-reporting, disclose the info you were given
(c) Affiliates have the extra burden to make sure info is
current at all times.
2. How long have you held the security for long enough?
(a) Reporting restricted 6 months
(b) Non-reporting restricted 1 year
(c) Unrestricted no holding period

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Restricted
Securities of
Reporting Issuers

Restricted
Securities of NonReporting Issuers

Affiliate or on
Behalf of an
Affiliate
During 6 month
holding period no
resales permitted
under 144

Non-Affiliate

After 6 month
holding period
may resell in
accordance w/ all 144
requirements
including:
Current public
info
Volume limits
Manner of sale
requirements
Filing form 144

After 6 month
holding period but
before one year
unlimited public
resales under 144,
current public info
requirement still
applies.

During 1 year
holding period no
resales permitted
under 144
After 1 year holding
period may resell in
accordance w/ all 144
requirements
including:
Current public
info
Volume limits
Manner of sale
requirements
Filing form 144

During 6 month
holding period no
resales permitted
under 144

After 1 year holding

period - unlimited
public resales under
144, no need to
comply w/ any other
144 requirements
During 1 year
holding period no
resales permitted
under 144
After 1 year holding
period - unlimited
public resales under
144, no need to
comply w/ any other
144 requirements

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VI.

Liability Rules

a. Section 11
i. Material misstatements and omissions in registration
statements
ii. No reliance, causation, scienter requirement
iii. Major limiting factor is the standing requirement
1. Tracing Requirement
(a) must show that the specific shares they purchased
were sold as part of the public offering under the
registration statement that contained the alleged
misstatement.
(i) Due to the ease of proving the cause of actionmake
the procedural requirements of standing much more
difficult. In practical terms, the standing requirement
puts the brakes on this expansive provision.
1. Also given the limited damages available under
the cap, ensures they go to the right people.
(b)Krim v. pcOrder.com: Plaintiffs purchased securities after
offering public offering, but before a later seasoned
offering. Chances that their shares came from the IPO
were like 94% and probability that even 1 share came
from the IPO was nearly 100%. However, Court says
that you must demonstrated all stock for which
they claim damages was actually issued pursuant
to the defective statement.
(i) Rejection of the idea of statistical tracing and a
slight loosening of the tracing requirement. Need to
be able to trace each individual stock back to the
issue in order to have standing for a 11 claim.
(ii) You can only bring a 11 claim if there has only
been one offering, once there are subsequent
offerings the pool is tainted.
1. Effectively only targets non-reporting IPO
companies.
iv. Measuring damages under 11
1. 11(e) Damages are equal the difference between
the price the paid and the value at the time of
the lawsuit, but they cannot exceed the offering
price.
2. When is value at the time of suit measured from?
(a) If the sold their shares before filing suit, the value at
which they were sold
(b)If the still owns the shares at the time of the
judgment, the value at the time of filing the suit

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(c) If the sold shares after filing, but before judgment, the
value at which the disposed of the shares if greater
than their value of the filing
3. What is the value?
(a) Not the same as market price, contestable claim
(i) will argue the value is higher than the market price
and the will argue the value is lower than the
market price
1. Beecher v. Able: claimed that the value of the
stock at the time of suit was lower than market
value b/c the market didnt know all the bad stuff.
claimed that the value was higher than the
market price b/c the market was depressed by
panic selling.
a. Court finds that overall value was above what
the market price was on the day of the suit.
v. Defenses
1. 13 imposes statute of limitations of one year from
discovery and 3 years from sale.
2. 11(a) provides a defense for s who can show had
actual knowledge of the alleged fraud at the time of the
purchase.
3. 11(b)(1) may be a defense for who resigns and notifies
the SEC.
4. 11(e) Loss Causation Defense - can reduce damages by
showing that the loss in value was due to external
circumstances, not due to the misstatement in the
registration statement.
5. 11(b) Due Diligence Defense
(a) Individual s can argue the due diligence defense

Expert

Non-Expert

Non-Expertised
Section
No liability 11(a)(4)

Reasonable
investigation,
reasonable ground for
believing, and did
believe 11(b)(3)(A)
(b)11(a) provides hit list of s
(i) Issuer

Expertised Section
Reasonable
investigation,
reasonable ground for
believing, and did
believe 11(b)(3)(B)
Reasonable ground for
believing, and did
believe 11(b)(3)(C)

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1. No defense available, SL
(ii) Every person who signed the registration statement
11(a)(1)
(iii)
Directors 11(a)(2)&(3)
(iv)
Accountant and other experts 11(a)(4)
(v) Underwriters 11(a)(5)
(vi)
Control persons
(c) Escott v. BarChris: Which of the s can exercise the due
diligence defense? The more of an insider you are, the
less you can exercise the due diligence defense
(i) CEO ultimate insider, couldnt have reasonably
believed expertised or nonexpertised portions, no
due diligence defense
(ii) Founders, VP & President - couldnt have reasonably
believed expertised or nonexpertised portions, no
due diligence defense
(iii)
Treasurer & CFO - couldnt have reasonably
believed expertised or nonexpertised portions, no
due diligence defense
(iv)
Inside Director Reasonable belief for
expertised portions could rely, didnt make
reasonable investigation into non-expertised
portions, no due diligence defense.
(v) Outside Director - Reasonable belief for expertised
portions could rely, didnt make reasonable
investigation into non-expertised portions, no due
diligence defense
(vi)
Underwriters - Reasonable belief for expertised
portions could rely, didnt make reasonable
investigation into non-expertised portions, no due
diligence defense
(vii)
Accountants (expert) - didnt follow accounting
industry standards, liable for the expertised portion,
not liable for the nonexpertised portion)
(d)Due Diligence and underwriters
(i) Reporting companies may incorporate by
reference to previously filed SEC documents. Its
quicker than drafting new documents, but the
information incorporated by reference becomes part
of the registration statement and subject to 11
liability.
(ii) In re Worldcom: Court says underwriters are special,
cant rely on experts if there are red flags. They are
the gatekeepers for the marketneed them to have
an incentive to be very careful.

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1. Short-term and shelf registration do not relax the

due diligence requirements for underwriters
(e) Rule 176 attempts to clarify what constitutes a
reasonable investigation and reasonable grounds for
belief under 11(b).
(i) The rule codifies the sliding scale approach of
BarChris
b. Section 12(a)(1)
i. Private cause of action for violations of 5 gun-jumping
rules, such as selling unregistered securities or making an
unintended offer. Nothing to do with antifraud.
ii. No reliance, causation, scienter requirement SL
iii. Only need to show a 5 violation involving a security they
purchased and they can seek rescission.
iv. Limited by standing, Any person who offers or sells a security
in violation of 5 shall be liable to the person purchasing the
security from him.
1. Privity Requirement: In order to have standing, must be
in privity with the seller of the security.
(a) likely to be institutional investors bringing claims
against sellers and solicitors.
(b)Printer v. Dahl: Investors in an unsuccessful oil and gas
venture sued under 12(a)(1) to get money back from
the seller. The seller then counterclaimed for
contribution from a major investor in the venture who
had told other investors about it.
(i) 12(a)(1) extends liability to sellers who passes
title and to people who solicits offers to buy,
but not to those that simply gratuitously urge.
1. Must by motivated by own financial interest
or those of the securities owner to be liable
for solicitation.
a. Courts generally dont count purely
administrative or ministerial functions as
solicitation
v. No defenses
1. 13 imposes statute of limitations of one year from
discovery and 3 years from sale.
vi. Damages are rescission
1. Purchaser may rescind the transaction and get his money
back with interest or recover rescissionary damages if he
has resold his stock
vii.Prima facie case: (a) the defendant sold you the security; and
(b) there was a violation of 5, (c) the facilities of interstate

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commerce were involved (jurisdictional means) and (d) action

has been brought w/n time stated in the SoLs found in 13.
1. Shifts the burden: If Plaintiff shows the elements above,
that shifts the burden of proof onto the defendant to
establish the availability of an exemption from 5.
c. Section 12(a)(2)
i. Private right of action for misstatements or omissions
in the prospectus or oral communication
ii. Only those who purchased the security have standing to sue,
courts have applied 12(a)(1) analysis from Printer
1. Privity requirement
(a) Can only bring claim if youre in initial distribution
2. Can bring suit against seller and solicitor
3. Rule 159(a) makes issuer liable for any 12(a)(2) violation,
making it slightly broader than 12(a)(1)
iii.What is a prospectus for purposes of 12(a)(2)?
(a) Gustafson v. Alloyd: Court starts w/ 10, which sets
forth the requirements of a prospectus, and then read
2(a)(10) consistently w/ 10.
(i) 12(a)(2) only applies to public offerings, not
private transactions.
(ii)
Only applies to oral communications that
relate to the prospectus
(iii)
Includes Rule 433A Free Writing
Prospectus
iv. Most litigation comes from misleading advertising in the form
of Freewriting Prospectuses
v. Defenses
1. 13 imposes statute of limitations of one year from
discovery and 3 years from sale.
2. Defense for s who can show had actual knowledge of
the alleged fraud in the prospectus at the time of the
purchase.
3. The due diligence defense for 12(a)(2) doesnt include an
investigation element like 11
(a) escapes liability if they prove they didnt
know of untruth or omission, and couldnt have
known in the exercise of reasonable care.
4. 12(b) Loss Causation - can reduce liability by showing
the drop in price was due to factors unrelated to the fraud.
vi. Damages are rescission
1. Purchaser may rescind the transaction and get his money
back with interest or recover rescissionary damages if he
has resold his stock

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d. Rule 10b-5
i. Allows a common-law fraud action for Plaintiffs harmed in
connection with the purchase or sale of a security.
ii. Kardon v. National Gypsum: federal court creates judicially
implied private cause of action
iii. Herman & MacLean v. Huddleston: not an exclusive remedy,
can be combined w/ other claims
1. Creates incentive for lawyers to bring 11 despite the
damage cap.
iv. Elements:
1. Standing
2. Material Misstatement or Omission
3. Scienter
4. Reliance
5. Loss Causation
v. Standing
1. Limited to actual purchasers and sellers of security
(a) Blue Chip Stamps v. Manor Drug Stores: allege that
overly pessimistic appraisal led them not to buy. Court
rejects, 10b-5 limited to actual purchasers and sellers.
vi. Material Misstatement or Omission
1. Requires material misstatement or omission
(a) Limits actionable conduct and potential s
(b)Wharf Holdings v. United: can be written or oral
statement or omission
(c) Santa Fe v. Green: told the truth, they told the SHs
that they were not paying full value for the shares.
Plaintiffs did not state a claim under 10(b) simply by
attacking the fairness of a short-form merger. There
must be deceptive or manipulative conduct for a
10b-5 case, not a breach of fiduciary duties.
2. Knowingly false opinions may be actionable under
10b-5
(a) Virginia Bankshares v. Sandberg: Opinions are
actionable if they rest on a factual basis. An opinion is
based on fact if it is objectively verifiable, and not
totally subjective.
(i) Matter of degree based on verifiability and context
(ii) argues statement was merely a subjective opinion
vii. Scienter (Intent)
1. Requires intentional wrong doing, not mere
negligence
(a) Ernst & Ernst v. Hochfelder: alleged negligence, not
sufficient, scienter required.
(b)What evidence do you look for?
(i) Smoking gun

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(ii) Actions and moves that you gleam together to show

had actual knowledge
(c) When do you plead scienter?
(i) Plead particularized facts giving rise to the strong
inference acted w/ the required state of mind at the
very onset.
(d)Circuit courts have held recklessness is enough, but
Supreme Court declined to address in FN 12 of Ernst.
viii. Reliance
1. Basic v. Levinson: Court looks to the efficient capital
markets theory to support assumption that market price
includes all available information of a particular security.
Individual reliance is substituted by fraud on the
market, only have to show market is efficient, not
individual reliance.
(a) Cramer v. Bloom: Market Efficiency Factors
(i) High volume
(ii) Analyst coverage
(iii)
Responsive to meaningful information, not
volatile
(iv)
National Exchange
(v) Size of Company, WKSI, S-3 filers, filings are
incorporated by reference
(b)Once you establish security is traded on efficient
market, youre done with reliance. can use the same
factors to argue market wasnt efficient
(i) What kind of companies tend to trade on
inefficient markets?
1. Small companies
2. Newly public companies
3. Private companies
(c) Halliburton II: under consideration now, trying to
overturn the fraud on the market theory based on
deficiencies of the efficient capital markets theory. May
survive simply b/c it is expedient and there are few
alternatives.
2. How to attack reliance, argue
(a) Market makers already knew the truth and the market
reflected this
(i) Prove w/ analyst testimony
(b)Individual already knew truth and didnt rely
(i) Difficult to prove b/c of multitude of s
(c) Argue market wasnt efficient
(i) Prove w/ factors above and econ professors
ix. Loss Causation

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1. Not an affirmative defense like in 11 or 12, part of the

case the has to make
2. Have to show s loss was actually caused by s material
misstatement or omission
3. Dura Pharmaceuticals, Inc. v. Broudo: Need to prove that
the loss is in fact caused by the misstatement, show price
was in fact depressed as a result of the fraud
x. Policy
1. Two basic goals of 10b-5: Deterrence and Compensation
(a) Compensation:
(i) Investors only get back an average of 2 of any $1
lost
(ii) Investors with a diversified portfolio end up as a
washinvested in s and s.
(iii)
s attorneys fees range from 17% to 30%
2. Deterrence:
(i) Officers committing offence often are indemnified by
D&O Insurancenot personally liable for fraud
(ii) Proceeds from the profit may exceed the penalty
imposedmoney making proposition
3. Who is harmed by fraud?
(a) Existing investorshave to sell as a discount
(b)Other companiesfolks think they are also committing
fraud (not just those who buy from a company)
(c) Lenderspotentially losing out on risk capital
(d)However, only people who can recover are those who
purchased or sold during fraud period.