Securities Regulation – Outlines

Definition of Securities

 § 2(a)(1)
 SEC v. W.J. Howey Co. (Howey test):
1. investment of cash or noncash consideration (e.g., goods and services)
2. common enterprise: horizontal/vertical
3. expectation of profit (not for one’s consumption)
4. effort of others (dominant managerial effort; minimal control by investors)
 Note: family resemblance; maturity of less than 9 months is not securities (§ 3(a)
(3))
 Agency cost; collective action obstacle

Materiality (Rule 408; Rules 10b-5, 12b-20)

 A fact is material if there’s a substantial likelihood a reasonable investor would

consider it important in making a securities-related decision. (TSC Industries
Inc. v. Northway, Inc.)
 Probability/magnitude test (Basic Inc. v. Levinson)
 Total mix of information; truth/fraud on the market (J. Easterbrook in Wielgos v.
Commonwealth Edison Co.)
 Buried facts doctrine
 MD&A (Item 303 of Regulation S-K): trends & uncertainties that are reasonably
likely to result in material changes to financial position; reconciliation of non-
GAAP to GAAP
 CD&A etc. (Subpart 400 of Regulation S-K)
 Forward-looking statements (Rule 175)
 Safe harbors for forward-looking statements
1. judicially created “bespeaks caution doctrine” (Rule 3b-6)
2. §27A(c): no actual knowledge; immaterial; or accompanied by
meaningful cautionary statement

Registration of Securities Offering

 Form S-1
1. detailed
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 2. for 1) non-reporting issuer; and 2) small/unseasoned reporting issuer
 Form S-3
1. Eligibility: large, seasoned issuers that have been reporting for at least 1
year; if offering new equity securities, “public float” of at least $75M. If
below $75M, 1) offering for cash; 2) offering amount during past 12 months
not exceeding 1/3 of market value; and 3) common stock listed on a national
stock exchange.
2. permits incorporating by reference info to other periodic reports
3. for 1) seasoned issuer; and 2) WKSI (well-known seasoned issuer):
automatic shelf registration (Rule 430B)
 Shelf registration (Rule 415): permitting registration of securities offering made
on a continuous or delayed basis for later sale, if undertaking to file post-effective
amendment disclosing any fundamental change of info in original registration
statement (Item 512(a) of Regulation S-K)
 Withdrawal: Rule 477; if converted to private offering, Rule 155(b)(c) provides
safe harbor against integration (due to sale to nonaccredited investors (private-
>public)/general solicitation (public -> private)) by 30-day waiting
 Regulation M: permitting bidding/purchasing/soliciting to bid during restricted
period by distribution participants (Rule 101) or for purpose of preventing decline
in market price/stabilization -> NOT deemed manipulation or deception; NOT
violating bar to purchase during distribution (Rule 104), etc.
 Gun-jumping: violation of §5:
1. (a) no (1) sale; (2) delivery of securities, until registration is effective
2. (b)(1) no prospectus unless complying §10; (2) no delivery unless
accompanied by prospectus
3. (c) no offer unless registration filed w/SEC
 Pre-filing period (safe harbors focused on “offer”)
1. Rule 135: Notice of proposed registered offerings – legend + limited
content (NO underwriters & price)
2. Rule 137: publications or distributions of Research Reports by Brokers
or Dealers that are not participating in and Issuer’s registered distribution of
securities
3. Rule 138: publications or distributions of Research Reports by Brokers
or Dealers about securities other than those they are distributing
4. Rule 139: publications or distributions of Research Reports by Brokers
or Dealers distributing securities
5. Rule 163: free writing prospectus (FWP) – legend + filing (any time by
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 WKSI, even not filed yet)
6. Rule 163A: preregistration communication (made more than 30 days
before filing)
7. Rule 168: regular communication (by reporting issuers) – factual
business info + forward-looking info regularly released previously in the
ordinary course of business
8. Rule 169: regular communication (by new issuers) - factual business
info regularly released previously in the ordinary course of business
 Waiting period (safe harbors focused on “prospectus”, yes or no are both OK)
1. permissible: oral offer (subject to antifraud provision); preliminary/red-
herring prospectus (Rule 430:prospectus for use prior to effective date, no
price and related matters); prospectus in a registration statement at the time of
effectiveness (Rule 430A: registration statement covering an offering of
securities for cash); summary prospectus (Rule 431: relic for reporting
companies of 36 months) – deemed “section 10 prospectus” for purpose of
5(b)(1)
2. Rule 134: announcement after filing: identifying statement/tombstone
ad. -> NOT prospectus; 134(b) legend; may indicating investors’ interest
(textbook P170) : not prospectus in 2(a)(10) and not “free writing
prospectus” under Rule 405, so no violation of 5(b)(1)
3. Rules 135, 168, 169
4. Rule 164: FWP deemed complying §10(b) if meeting Rule 433
conditions; immaterial or unintentional failure is ok but need to be good faith
and show reasonable effort to comply
5. Rule 433: (b) for non-reporting/unseasoned issuers, must accompanied
by preliminary prospectus (ok if hyperlinked); (c) consistent info + legend; (d)
filed w/SEC; (d)(8) road show – requiring filing of presentation of equity
offering by non-reporting issuers, unless bona fide electronic copy posted on
website without restriction by means of graphic communication (therefore a
prospectus); (e)(2) hyperlink; (f) media
 Post-effective period
1. Rule 153: for B&D confirmation, access = delivery
2. Rule 172: for confirmation/notice of allocation
3. Rule 173: final prospectus/notice of registration within 2 BDs after sale
4. Rules 134, 164/433, 168, 169

Exemption Transactions
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 Integration: (safe harbor of 6-month; meaning, treating several offering as a
single one)
1. Rule 147(b)(2) – intrastate offering (5-factor test)
2. Rule 152 – private placement under §4(2) (including Rule 506 offering)
is NOT integrated with subsequent public offering
3. Rule 155(b)(c) -> 30-day cooling-off period
4. Rule 251(c) of Regulation A
5. Rule 502(a) of Regulation D -> 5-factor test; offshore offering
(Regulation S) is NOT integrated with domestic offerings!
 Intrastate offerings - §3(a)(11)
1. by in-state issuer to in-state resident
2. NO limitation on offering amount, sophistication, frequency
3. Rule 147: (c) incorporation/principal business/doing business; (d) actual
principal residence; (e) “come to rest” safe harbor – resell within 9-month
from last sale shall be made to in-state residents + legend
 Private placement - §4(2)
1. “fend for themselves” (SEC v. Ralston Purina Co.) – informed +
sophisticated (whether insider or not)
2. Rule 506: < 35 nonaccredited investors; sophistication
 Small offering - §3(b)
1. Regulation A (Rules 251-264): note integration and aggregation
(1) < $5M during any continuous 12-month period
(2) non-reporting U.S. or Canadian issuer and not “bad boy” (Rule 262)
(3) simplified disclosure: filing + offering circular
(4) unaudited financial info is ok
(5) test the water before filing offering statement; change of intention (Rule
254)
2. Regulation D (non-exclusive safe harbor)
(1) Note to Rule 502(b)(1): disclosure to nonaccredited investors
(2) Rule 502(c): prohibiting general solicitation/advertising; ok if pre-
existing relationship (because of knowing sophistication and financial
circumstance of offerees) and Rule 135
(3) Rule 502(d): restricted securities, so can’t be resold without registration
or further exemption -> reasonable inquiry, disclosing restricted nature and
legend
(4) Rule 504: non-reporting issuer; < $1M (note aggregation – safe harbor
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 of 12-month; meaning, accumulatively calculating of amount in different
offerings in 12-month period)
(5) Rule 505: “bad boy” disqualification (Rule 262); < $5M (note
aggregation); < 35 nonaccredited investors
(6) Rule 508(a): incomplete compliance, must be insignificant
3. Rule 701: non-reporting companies offering employee stock
compensation plan; < $1M or 15% outstanding securities/asset during any
consecutive 12-month period (meaning, not integrated but could be
aggregated)

Secondary Distributions – Control /Restricted Securities

 Definition of underwriter: §4(1); §2(a)(11) -> very broad!

- purchase from issuer/control person (Rule 405) with a view to distribution
1. distribution means offer or sale to public investors
2. investment intent – Rule 144: 1-year holding period for non-reporting
and 6-month for reporting
3. possible argument - change in circumstances? (rejected by SEC)
- offer or sale for issuer/control person (SEC v. Chinese Consolidated Benevolent
Association: whether authorized or compensated); or
- participate or directly or indirectly participate/underwrite
 Rule 144: a safe harbor for utilization of the exemption in §4(1); NOT resale
exemption
- Non-affiliate: (b)(1); (c) public info; (d) holding period
- Affiliate or on behalf of: 144 (b)(2); (c) public info; (d) holding period
(applicable only to restricted) + payment method; (e) amount ceiling (note
aggregation!); (f)(g) manner of sale + brokers’ transaction (non-restricted); (h)
filing
 Exemptions for secondary private placement
- Rule 144A: sale of restricted securities to QIBs
1. (d)(2) reasonable step to ensure buyers knowing Rule 144A exemption
2. (d)(3) eligibility: not listed or quoted on national exchange -> not fungible
3. (d)(4) financial info
- §4(11/2): Ackerberg v. Johnson
1. 5-year holding -> no distribution -> not UW -> not public offering so no need
for registration
2. sophisticated + access to info -> no need of protection (Ralston: “fend for
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 themselves”)
- Spinoff distribution: Sale! because §2(a)(3): for value. If spinning off subsidiary
without business purpose -> registration!
- §3(a)(9): issuer exchange
- Rule 145 (gateway to Rules 165, 166): business combination transaction ->
exempt of gun-jumping prohibitions, provided filing + legend

Securities Act Liability

 §11: joint and several liabilities re false registration statement, except for UWs (e)
and outside directors (f)
- Defendant to prove culpability, reliance and causation
- Defendant: signatories (e.g., issuer, CEO, CFO), directors, UWs, experts
- Plaintiff: tracing requirement (hard if bought in aftermarket); limited to actual
purchaser
- §27A/E§21E: safe harbor for forward-looking statement (NOT applicable to IPO)
- Free writing: if not becoming a part of prospectus -> beyond the reach of §11
- Due diligence defense: reasonable investigation and ground to believe
1. expertised portion:§11(b)(3)(B), (C)
2. non-expertised info: §11(b)(3)(A)
3. Rule 176: sliding scale of reasonableness -> in shelf registration, UW should
have a reservoir of knowledge of issuer by 1) keeping abreast of analyst
reports and 2) hiring law firm as counsel for continuous DD (In re
WorldCom, Inc.)
4. Escott v. BarChris Construction
5. DD task assigned? Still bound by the assignee’s failure!
- Reliance: §11(a) -> to be proved by defendant that plaintiff knew; OR to be
proved by plaintiff if buying after 1 year from effectiveness
- Loss causation: negative causation defense (Akerman v. Oryx)
- Damages: §11(e) -> value/sales price minus purchase price (capped at public
offering price)
 §12(a)(1): in violation of §5
- Seller: Pinter v. Dahl, including who 1) passes title; and 2) solicits sales, except
for not for his own financial interest; NOT including aiders and abettors
 §12(a)(2)
- Gustafson v. Alloyd Co.: applied only to public offering -> note that certain
exempt transactions have public characteristics, e.g., Rule 505 offering
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 - Seller: same as §12(a)(1), including retail broker-dealer and selling shareholders
(but not issuer)
- Culpability: reasonable care defense
- Reliance: NO need; but note Rule 159 (based on info known at the time of sale)
- Loss causation: §12(b) -> affirmative defense, similar to §11
- Scienter: NO need
 §15: joint and several liability of control person -> good faith defense
 §17: NOT an implied private right of action! v. Rule 10b-5

Securities Exchange Act of 1934

 E§10A: audit requirement; (m) audit committee

 Regulation M (Rule 104): price stabilization
 E§12: registration of securities -> reporting companies
 E§13: periodical report -> annual (Form 10-K)/quarterly (10-Q)/special (8-K)
 Regulation S-K/Rule 12b-20: itemized info; avoiding half-truth and including
material facts necessary to be not misleading
 Rule 13a-14/15d-14: certification of corporate officers -> applicable only to
periodical report (10-K; 10-Q), NOT 8-K
 Regulation FD: selective disclosure -> furnish (no liability under E§18) or file 8-
K!
 E§15(d): reporting obligation also apply to companies that issue securities at a
registered offering
 E§30A: prohibiting corruptive payment to foreign officials to gain business
(FCPA)
 Regulation 14A: proxy rules
- Rule 14a-1(l): definition of “solicitation” -> request for a proxy or to execute or
not; furnishing info reasonably calculated to result in proxy procurement, etc.
Exceptions:
1. Rule 14a-1(l)(2)(iv): shareholder can publicly announce how it intends to
vote and provides reasons
2. Rule 14a-2(b): exempting communication with shareholders
3. Rule 14a-3(f): exempting solicitations conveyed through public methods
- Rule 14a-3: disclosure -> proxy statement + info/annual report (election of
directors)
- Rule 14a-6: filing
- Rule 14a-7: mail solicitation materials for or provide current list of shareholders
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 to requesting shareholder
- Rule 14a-8: shareholder proposal, with exceptions (e.g., ordinary business
operations)
- Rule 14a-9: prohibiting proxy fraud -> injunction + private right of action
(negligence; materiality; loss causation)
- Rule 14a-12: solicitation before furnishing proxy statement -> not seeking actual
voting authority + filing
 E§13(d): stock accumulation -> must file Schedule 13D within 10 days (allowing
buying more stock!) after acquiring beneficial ownership of > 5% (early warning
system); including “group” - members combined in furtherance of common
objective (Rules 13d-1, 13d-2)
 Rule 13d-5(b): group formed by agreeing to act together shall be deemed
ownership acquired!
 E§13(g): statement of equity security ownership > 5%; “group” for the purpose of
acquiring, holding or disposing of securities
 Rule 13e-3: going-private transaction -> mandatory disclosure (Schedule 13E-3)
because liquidity is lost; test of fair dealing
 E§14(d): tender offer -> must file Schedule TO on the day of commencement
 E§16: filing by directors, officers and > 10% shareholders -> preventing unfair
use of info

Rule 10b-5: general antifraud prohibition

 Plaintiff: Birnbaum rule/standing to sue -> actual purchasers or sellers

 Defendant:
- Primary violators
- Scheme liability? No! (Stoneridge v. Scientific-Atlanta)
- E§20(a) -> control person (unless good faith: showing affirmative effort to
prevent)
- E§20(e) -> aiders and abettors in SEC enforcement actions (knowingly providing
substantial assistance to violator)
 “in connection with” sale or purchase
 Material misinformation
- Materiality: probability/magnitude test
- Manipulation
- Duty to speak: relationship of trust and confidence/failure to correct actively
circulating misinformation/insiders trading based on insider info
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 - Duty to update: when forward-looking statements which are relied on by the
market become inaccurate (In re Time-Warner)
 Scienter: intention to manipulate, deceive or defraud -> know or reckless in not
knowing (good faith defense)
- Negligence: subjective recklessness (extreme departure from standards of ordinary
care)
- Pleading scienter: strong inference of convincing and compelling scienter
(Tellabs v. Makor); dissenting: probable cause should be enough!
 Reliance: “reasonable” link between misinformation and buy-sell decision;
presumable if duty to disclose
 Causation: link between misinformation and loss
 Damage: punitive damages NOT available; limited liabilities for unknowing
violators

SEC Enforcement Actions

• SEC Investigation: §19(b); E§21(a)

 Authority to censure: E§4C
 Cease-and-desist order: §8A; E§21C; sufficient risk of future violation is required;
after notice and opportunity to be heard
 Prohibition from acting as director or officer: §8A(f); E§21C(f)
 Suspension and disbarment: Rule of Practice 102(e)
 Judicial enforcement: §20(b); E§21(d)
- bars from holding corporate office: §20(e); E§21(d)(2)
- reasonable likelihood of future violation (SEC v. Common Wealth)
- types of relief:
1. injunctions – asset freeze (E§21C(c)(3))
2. disgorgement (Sarbanes-Oxley Act §308)
3. monetary penalties – tiered system (§20(d); E§21(d)(3))
4. change of corporate management – substantial unfitness (§20(e); E§21(d)(2))
 Effect:
- disclosure in periodical filing
- “bad boy” disqualification (not including administrative cease-and-desist order) in
Regulation A and Rule 505 offerings
- collateral estoppel and binding in subsequent private litigation (Parklane v.
Shore)
 Lawyers liability
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 - SEC v. National Student Marketing Corp.: aiding and abetting the fraud by not
telling the other party’s shareholders the financial info in proxy statement is
misleading
- §307/ROP §205
1. “up the ladder” reporting obligations on evidence of material violation and
material breach of fiduciary duties: general counsel (or both GC and CEO) ->
audit committee or other committees consisting of independent directors or
BOD -> may reveal to SEC
2. supervising attorneys to ensure subordinate attorneys’ aware of reporting
obligation
3. subordinate attorneys to report by telling their supervisors
4. censure and supension, but NO monetary fines or private right of action
 Model Rules
1. ask to reconsider
2. report to higher/highest authorities
3. may disclose client confidences

Forms

S-1 Registration statement under Securities Act of 1933

for 1) non-reporting issuer; and 2) small/unseasoned reporting issuer
S-3 Registration statement under Securities Act of 1933
for 1) seasoned issuer; and 2) WKSI (well-known seasoned issuer)
10-K Annual report pursuant to Section 13 or 15(d)
10-Q General form for quarterly reports under Section 13 or
15(d)
8-K Current report pursuant to Section 13 or 15(d)
3 Initial statement of beneficial ownership of securities
Initial statement of beneficial ownership of securities —
general instructions
When becomes beneficial owner of > 10%
E§16(a)(2)(B)
4 Statement of changes in beneficial ownership of securities
Initial statement of beneficial ownership of securities —
general instructions
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 beneficial owner of > 10% reports change of holding
E§16(a)(2)(C)
10 General form for registration of securities pursuant to
Section 12(b) or (g)

Schedules:

13D Rule 13d-1

When becomes beneficial owner of > 5%/Amendment to Schedule 13D
when change of intent/1% holding
Statement of beneficial ownership
13E-3 E§13(e); Rule 13e-3
Going-private transaction by the issuer and affiliates

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