Outline

Sunday, December 04, 2011 6:53 PM

I. The Definition of a Security A. Investment Contract 1. SEC v. W.J. HOWEY CO. (1946): Sale of a row of 48 citrus trees when the cultivation, harvesting, and meting of the fruit was handled by an affiliate of the seller, was deemed to be an investment contract. a. Investment Contract: Transaction in which (1) a person invests money (2) in a common enterprise and (3) is led to expect profits (4) solely from the efforts of others. Investment The investment, which can be of cash or noncash consideration, is expected to produce income or profit; the investor is looking for financial returns, not a consumable commodity or service. Commonality Multiple investors have interrelated interests in a common scheme - horizontal commonality. Or, according to some courts (a minority), it is sufficient if a single investor has a common interest with the manager of his investment - vertical commonality. The expected return (whether fixed or variable) must be the principal motivation for the investment. The return must come from the earnings of the enterprise or appreciation of the investment based on anticipated earnings, but not merely from additional contributions.

Expected Profits

According to Howey, profits must be derived "solely" from the efforts of others, though lower courts have generally accepted that the investor's efforts in the common enterprise may contribute to profits. The efforts of managers, however, must be predominant; the investors must be mostly passive 2. Marine Bank v. Weaver (1982): The Weavers pledged a bank certificate of deposit (CD) as collateral to guarantee a bank loan to Columbus Packing. When the bank reneged on its promise to deliver the loan proceeds to Columbus, which later went bankrupt, the Weavers claimed the bank had defrauded them under Rule 10b-5 when they pledged their CD. (The Weavers also claimed that their agreement with the owners of Columbus to share 50% of the company's profits was a "profit-sharing agreement," so that their guarantee was also in connection with this security.) a. The Court turned to the "unless the context otherwise requires" language of the statutory definition. The Court pointed out that, although bank CDs have many of the attributes of a long-term debt instrument, CDs are federally insured and subject to comprehensive banking regulation for the protection of depositors. That is, an alternative regulatory scheme renders securities regulation unnecessary. (The Court also designed in a much-maligned part of its opinion, that the profit-sharing agreement was not a security since the privately negotiated arrangement gave the Weavers significant control over the operation.) b. Rule: A CD issued by a national bank is not a security under the Exchange Act. 1. Private Versus Public Actions 2. The Howey Company's Checkered Past 3. Optional Service Contracts 4. The Relevance of Risk 5. Varying Approaches - State Regulation and the Risk Capital Test i. Risk Capital Test: Focuses on the extent to which the investor's initial outlay is subject to the risks of the enterprise, risks to which the investor
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Efforts of Others

ii.

outlay is subject to the risks of the enterprise, risks to which the investor has no managerial control. Silver Hills Country Club v. Sobieski (1961): State court treated membership in recreational club as a security if the memberships were to finance the club activities.

B. Howey Applied 1. Investment Versus Consumption - Noninvestment Stock a. United Housing Foundation, Inc. v. Forman (1975): A cooperative housing corporation required residents to buy "shares of stock" in the corporation to secure housing. Residents were entitled to one vote in the cooperative, regardless of the number of shares they held. The shares were nonnegotiable and operated as a refundable deposit; a resident on leaving the cooperative was obliged to resell her shares at their original price to the corporation. i. The Court held that there could be no Rule 10b-5 action by residents alleging fraudulent rent increases since the cooperative's "shares" were not securities. ii. The Court pointed out that the shares had none of the characteristics of a stock investment: 1) There was no right to dividends contingent on profits; 2) The shares were not negotiable; 3) Voting rights were not proportionate to the number of shares held; and 4) The shares could not appreciate in value. iii. Further, the Court applied the Howey test and concluded that the residents' intent in purchasing the "shares" was solely to acquire a place to live, rejecting the notion that tax deductibility, rental savings, or income to the cooperative from leasing of commercial space indicated an "expectation of profits." 1. Howey's Relevance to Cases Not Involving Investment Contracts 2. The Relevance of Profit Potential 3. Measuring Intent? 2. Common Enterprise and Profits Solely from the Efforts of Others a. SEC v. Edwards (2004): More than 10,000 people invested $300,000 in a scheme where purchasers were offered to buy a payphone, along with a five-year agreement for the management and then buyback of the payphone - an arrangement that nearly all investors chose. (The management company, in fact, never generated profits and instead funds from new investors were used to pay existing investors - a typical Ponzi scheme.) The purchasers, none of whom were involved in the day-to-day operation of the payphones they purchased, were promised a flat 14% return on their investment. The management company selected sites for the phones, installed the equipment, arranged the connections, collected coins, and maintained the phones. i. The Court concluded that a sale-leaseback arrangement for payphones can constitute an "investment contract" under Howey, even when the scheme involves a contractual promise to pay a fixed (not variable) rate of return. b. The Meaning of Common Enterprise c. Profits from the Managerial Efforts of Others i. SEC v. Life Partners, Inc. (D.C. Cir. 1996): Value of intermediary's services are already impounded in fees and purchase price of investment. C. Associational Formalities: Interests in Corporations, Partnerships, and LLCs as Securities 1. Stock as a Security - "Sale of Business" Doctrine a. Landreth Timber Co. v. Landreth (1985): Case involved the purchase of 85% of the common stock of a closely held business that failed to live up to the purchaser's expectations. i. The Court pointed out that the stock in the transaction had all the traditional indicia of corporate stock: dividend rights, liquidity rights,
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i. traditional indicia of corporate stock: dividend rights, liquidity rights, proportional voting powers, appreciation potential. ii. Choosing a literalist approach, the Court refused to look at the "economic substance" of the transaction or to assume the securities acts apply only to passive investors. Moreover, the Court pointed out there would be difficult line-drawing issues in acquisitions of less than 100% of a corporation's stock or when a purchaser arranged to have the seller stay on to manage the business, as had happened in Landreth. 2. Partnership and Limited Liability Company Interests as Securities a. Williamson v. Tucker (5th Cir. 1981): Held that general partners "acquired securities" when they invested in a real estate development in which all management functions (planning, acquiring, rezoning, financing, developing, renting, and selling the properties) had been left to the manager by agreement. Given the economic realities of the partnership, the court treated the partnership interests as investment contracts. i. Thus, a nominal general partner may claim that his interest is an investment contract by demonstrating that he was so dependent on the promoter that he actually could not exercise meaningful control. ii. The investor must show either: 1) No Legal Control - The partnership agreement leaves so little power in the investor's hands that the arrangement in fact distributes powers as would a limited partnership; or 2) No Capacity to Control - The partner is so inexperienced and unknowledgeable in business affairs that he cannot intelligently exercise his partnership powers; or 3) No Practical Control - The partner is so dependent on the unique managerial ability of the promoter that he cannot replace the manager or otherwise exercise meaningful partnership powers. b. United States v. Leonard (2d Cir. 2008): Focused on "reasonable expectation" of investor control in LLC. i. Limited Versus General Partnerships ii. LLC Interests as Securities iii. Is the Agreement Dispositive? SEC v. Merchant Capital, LLC (11th Cir. 2007): Found "investment contract" when experienced business people purchased partner interests in 28 LLPs engaged in business of purchasing fractional interests in non-performing debt pools. Focused on the relationship of the parties at the time of the investment. Concluded that partnership agreements did not give partners practical ability to remove managing partner, that investors were inexperienced in debtpurchasing business, and that investors had no practical alternative but to stay with managing partner. 3. The Policy Question: Should Investment Contract Status Be Elective? D. Notes as Securities 1. Reves v. Ernst & Young (1990): Court adopted a "family resemblance" test to judge whether notes are securities. Test begins with a rebuttable presumption that every note is a security unless it falls into a category of interests that are not securities. a. Notes used in consumer lending, notes secured by a mortgage on a home, and short-term notes secured by an assignment of accounts are in the "family" of nonsecurities. b. Factors to determine the "family" into which the note fits (no factor is sufficient or necessary, together they provide a "gestalt" sense of whether a note involves an investment or merely represents part of a commercial-consumer transaction): Motivation of If the issuer of the note uses the proceeds for general business Seller and purposes, it is more likely a security. If the issuer gives the Buyer note to buy consumer goods or for some "commercial"
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Buyer

note to buy consumer goods or for some "commercial" purpose, it is more likely not a security. (Compare to Howey "investment of money.") If the notes are widely offered and traded, it is more likely a security. 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. (Compare to Howey "[horizontal] common enterprise.")

Plan of Distribution

Reasonable If investors generally view the type of notes to be investments, Expectations of it is more likely a security. (Compare to Howey "expectation Investing of profits from the efforts of others.") Public Other Factors Reduce Risk If the note is not collateralized and not subject to nonsecurities regulation, it is more likely a security. If the note is secured or otherwise regulated (such as by banking authorities), it is more likely not a security. The Commercial Paper Exemption in the '33 Act Demand Notes The Relevance of Risk Regulation as a Risk-Reduction Factor Collateralization as a Risk-Reduction Factor Contractual Remedies as a Risk-Reduction Factor Beyond Reves: Loan Participations as Securities

1. a. b. c. d. e. f. II. The Public Offer A. Underwriters 1. 2(a)(11) defines underwriters a. Buys securities and issues to public - two ways: i. "Best Efforts" - Responsible for using best efforts to sell securities, but not on the hook to buy unsold. Signals lack of confidence in the issuer. ii. "Firm Commitment" - Responsible to personally buy all securities that it can't resell immediately. 1. Signals confidence in the issuer, but means a big risk for the underwriter because a "sticky" offering will tie up capital. 2. Syndicate to obviate these risks - "lead" underwriters make deals with smaller underwriters to be responsible for a smaller chunk of the offering. 3. "Market Out" Clauses allow underwriters to walk away from some offerings. b. Provides reputational capital to the issuer because the underwriter, being a repeat player, assures buyers of the quality of the securities. c. Gatekeepers of liability under 11. d. "Underwriting Spread" - Underwriter keeps a small portion of the offering price of securities they sell and remit the rest to the issuer. The difference is their fee, also known as the "underwriting spread." i. 7% is the usual spread, but for debt issuances or WKSI issuances, the spread is less because the need for reputational capital is less. ii. "Bought" Offering - Bidding down the spread for low-risk deals. e. "Green Shoe" Overallotment Option i. Customary to include an option in the Underwriting Agreement that allows underwriters to buy additional securities from the issuer if the offering is over-subscribed (limited to 15%). 2. Underwriter Risks a. How do underwriters limit risk? i. Improve the accuracy of pricing and disclosures
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i. Improve the accuracy of pricing and disclosures 1. Study the issuer 2. Pre-commitment oral canvassing of the market a. Communications are possible before the offering. i. Raises concerns for making misleading or fraudulent statement, or unduly conditioning the market. ii. Tension between getting out the information and improperly influencing the market. 3. "Dutch Auction" - Bid the security, then sell to the highest bidders in order from the top down. ii. Syndication - Underwriters are liable in proportion to their part of the offering. iii. "Market Out" Clauses iv. Indemnification by Issuer v. Comfort Letters from Auditors/Attorneys vi. Contribution Agreements 3. Actions to enhance investor demand a. Line up institutional or regular investors b. Limit supply i. "Lock Up" Agreements with Insiders ii. "In House" Purchase of Shares iii. Purchase shares in the existing market pursuant to Regulation M c. Other Actions i. Positive analyst reports (limited by the rules) ii. Pre-offering conditioning the market with favorable statements (gun jumping concerns) B. Registration 1. Issuer activities pre-filing a. 5(c) makes it unlawful for any person, to offer to sell or offer to buy through the use or medium of any prospectus or otherwise any security, unless a registration has been filed for such security. i. 2(a)(3) "offer to sell" shall include every attempt or offer to dispose of or solicitation to buy a security for value. 1. Designed to prevent "Conditioning the Market" 2. Does not extend to face-to-face meetings a. Sec. Rel. 3844 - But if face-to-face meetings are recorded and then posted or disseminated to anyone who wasn't physically present at the original, becomes non-oral. 3. Exempts preliminary negotiations with underwriters a. 2(a)(3) and negotiations among underwriters if they are or will become part of the syndicate. b. Smaller underwriters must fit into 2(a)(11) definition - "usual distributor's commission." 4. Includes phone calls across state lines 5. ANY use of the US postal service ii. 2(a)(10) Prospectus - means any prospectus, notice, circular, advertisement, letter, or communication, written or by radio or television, which offers a security for sale or confirms the sale (expansive definition) b. Exemptions From "Offer to Sell" i. Rule 163 - Exemption from 5(c) of the Act for Certain Communications by or on Behalf of WKSIs 1. For WKSIs, offers to buy/sell securities before the registration statement is filed are considered Free Writing Prospectuses and exempt if it satisfies the following conditions: a. Statement must be "by or on behalf of" the issuer. b. (b)(1)(i) written communications bear a legend.
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ii.

iii.

iv.

a. Statement must be "by or on behalf of" the issuer. b. (b)(1)(i) written communications bear a legend. c. (b)(2)(i) written communications made under this rule are filed with the SEC i. (b)(2)(iii) immaterial or unintentional delays are not a big problem if it is promptly filed and good faith and reasonable efforts were made. 2. Not necessary if: a. (b)(2)(ii) registration statement is filed Rule 163A - 30 Days Exemption 1. Communications made by or on behalf of the issuer more than 30 days before the date of the filing of the registration statement are exempt from 5(c) of the Act if: a. Communication does not reference a securities offering that is or will be the subject of a registration statement. b. Cannot identify prospective underwriter(s). c. The issuer takes reasonable steps within its control to prevent further distribution or publication of such communication during the 30 days immediately preceding the date of filing the registration statement. Rule 168 - Exemption from 2(a)(10) and 5(c) of the Act for Certain Communications of Regularly Released Factual Business Information and Forward-Looking Information (Reporting Companies) (a) Must be a 1934 Act reporting company or a foreign private issuer (under certain conditions) (b) Definitions (1) "Factual Business Information" means information released under 1934 Act filings, including: (i) Factual information about the issuer, its business or financial developments; (ii) Advertisements about the issuer's products or services; (iii) Dividend notices. (2) "Forward-Looking Information" the same as in the 1934 Act, which includes: (i) Projections of financial information; (ii) Management's plans for future operations; (iii) Future economic performance; (iv) Assumptions underlying projections. (c) Exclusion - No mention of IPO - excluded from this exemption. (d) Conditions to Exemption (1) Issuer has to have previously released this type of information in the usual course of business; (2) Timing, manner, and form are consistent with past practices; and (3) The issuer is not an investment company or a business development company. Rule 169 - Exemption from 2(a)(10) and 5(c) of the Act for Certain Communications of Regularly Released Factual Business Information (Non-Reporting Companies) (b) Definitions (1) "Factual Business Information" means information released under 1934 Act filings, including: (i) Factual information about the issuer, its business or financial developments, or other aspects of its business; and (ii) Advertisements of, or other information about, the issuer's products or services.
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products or services. (c) Exclusion - No mention of IPO - excluded from this exemption. (d) Conditions to Exemption (1) Issuer has to have previously released this type of information in the usual course of business; (2) Timing, manner, and form are consistent with past practices; (3) Information is intended to be used by persons, such as customers or suppliers, other than investors or potential investors; and (4) The issuer is not an investment company. Information must be factual; no interpretation or predictions are included in the safe harbor. N.B. NO FORWARD-LOOKING INFORMATION v. Rule 166 - Exemption from 5(c) for Certain Communications in Connection with Business Combination Transactions vi. Rule 135 - Notice of Proposed Registered Offerings (a) For purposes of 5 of the Act only, an issuer or a selling security holder that publishes through any medium a notice of a proposed offering to be registered under the Act will not be deemed to offer its securities for sale through that notice if: (1) Legend that states that the notice is not an offer of any security for sale; and (2) Limited Notice Content. Notice includes no more than the following information: (i) Name of issuer; (ii) Title, amount, and basic terms of the securities to be offered; (iii) Amount of the offering; (iv) Anticipated timing of the offering; (v) Brief statement of the manner and the purpose of the offering, without naming the underwriters; (vi) Whether the issuer is directing its offering to only a particular class of purchasers; (vii) Any statements or legends required by state or foreign law or administrative regulation; and (viii) Any other specific information (Rights Offering, Offering to Employees, Exchange Offers, Rule 145(a) Offering). (b) May correct information, but must do so by stating as little as possible to make previous statement accurate. N.B. Exclusive and restrictive list - may not include anything not on the list in a Rule 135 Safe Harbor Statement. Cannot name the underwriter(s). 2. Broker-Dealer Activities a. Rule 137 - Publications or Distributions of Research Reports by Brokers or Dealers that are NOT Participating in an Issuer's Registered Distribution of Securities i. Allows nonparticipating brokers/dealers to publish or distribute in the regular course of business, information or opinions and recommendations regarding securities. 1. Directed towards only one issuer ii. Broker/Dealer will not be deemed to participate/offer if: (a) Not participating in the offering (selling or underwriting). (b) Not receiving compensation from the issuer, a selling security holder, any participant, or any other interested person. BUT, "compensation" does not preclude payment of the regular price

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for independent research. (c) Has published or distributed the research report in the regular course of its business. b. Rule 139 - Publications or Distributions of Research Reports by Brokers or Dealers Distributing Securities (Participating) (a) Will not be considered an offer to sell under 2(a)(10) if: (1) For Issuer-Specific Research Reports: Issuer is a 1934 Act reporting company AND Form S-3 filer, so long as Broker/Dealer has published/distributed reports about that issuer before; OR (2) The Report is an "Industry Report" (i) All issuers are 1934 Act filers. (iii) Research report contains similar information about a substantial number of issuers in the industry or sub-industry, or contains a comprehensive list of securities currently recommended by the Broker/Dealer; (iv) The analysis regarding the issuer's securities is given no greater attention than that given to other securities or issuers; and (v) The reports are published or distributed in the regular course of business and includes similar information as in the past. 3. "Waiting Period" Between Filing and Effective Date of Registration a. 5(a) Unlawful to sell securities or deliver securities through the mail for which a registration statement is not in effect. b. 5(b) Unlawful to carry or transmit a prospectus relating to any security for which a registration statement has been filed, unless it meets the requirements of 10. i. 5(b)(1) Unlawful to deliver security unless accompanied by 10 prospectus. c. 2(a)(10) "Prospectus" i. Basically includes anything in writing. ii. *Before 2005, the rules essentially confined exempted statements to oral statements, tombstone ads, preliminary prospectuses, summary prospectuses, and brokers' cards. iii. Post-2005, many more options: d. Rule 134 - Communications Not Deemed a Prospectus (a) Certain information can be communicated without being considered to constitute a prospectus so long as a registration statement containing a 10 prospectus has been filed. May include: (1) Factual information about the legal identity and business location of the issuer (e.g., name of the issuer and security, address, phone number, etc.); (2) The title of the securities and the amount or amounts being offered, including whether convertible, exercisable, or exchangeable; (3) Brief indication of the general type of business of the issuer, limited to the following: (i) Manufacturing company, general type of manufacturing, products, etc. (ii) Public utility company, general type of services rendered, area served; (iii) Asset-backed issuer, identity of key parties. (4) Price of the security or an estimate or method of calculating it; (7) Brief description of the intended use of proceeds of the offering, if then disclosed in the prospectus that is part of the filed registration statement; (8) Name of the person making the statement and the fact that they are participating or expect to participate in the offering; (9) Type of underwriting, if in registration statement;
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(9) Type of underwriting, if in registration statement; (10) The names of the underwriters and their roles within the underwriting syndicate; (11) Anticipated schedule for the offering; (13) - (15) Opinions of counsel regarding who can purchase the securities. (b) All communications used pursuant to this section must contain: (1) If the registration statement is not yet effective, the following statement: A registration statement relating to these securities has been filed with the Securities and Exchange Commission but has not yet become effective. These securities may not be sold nor may offers to buy be accepted prior to the time the registration statement becomes effective; And (b) Where a prospectus satisfying 10 requirements may be obtained. (c) (2) Not required if accompanied or preceded by a prospectus or summary prospectus (but required with a free writing) (d) Brokers' Card for Expression of Interest e. Rule 430 - Prospectus for Use Prior to Effective Date (Preliminary) (a) A form of prospectus filed as part of the registration statement deemed to meet the requirements of 10 for the purpose of 5(b)(1) if it contains substantially all required information, EXCEPT i. Need not contain information with respect to offering price, underwriting discount/commissions, discounts for dealers, other matters dependent on price. ii. Must include legend specifying that it is not an offer to sell the security and that no sales can occur until the registration statement becomes effective. Forms of prospectus satisfying this rule deemed to have been filed as part of the registration statement for purposes of 7 of the Act. f. Rule 431 - Summary Prospectuses g. Free Writing Prospectuses i. Rule 405 - Definitions of Terms i. "Free Writing Prospectus" is any written communication that constitutes an offer to sell or a solicitation of an offer to buy securities relating to a registered offering that is used after the registration statement is filed (for WKSIs, regardless whether registration statement is filed). ii. Rule 433 - Conditions to Permissible Post-Filing Free Writing Prospectuses (b) Eligibility: (1) Seasoned Issuers and WKSIs may use this rule for any communication that meets requirements (c) through (g). (2) Non-Reporters and Unseasoned Issuers may use under certain conditions: (i) IF: 1. The free writing was prepared by or for anyone else in the offer, 2. Consideration was paid for the dissemination of the free writing, 3. 17(b) requires disclosure of consideration, THEN: 1. A registration must have been filed that includes a prospectus that satisfies the requirements of 10 and the free writing must be accompanied by or
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(c)

(d)

(e)

(f)

the free writing must be accompanied by or preceded by that prospectus. 2. Hyperlink to prospectus is ok. UNLESS: 1. The person has already received the prospectus and it is not materially different. 2. A final prospectus has already become available. Information in a Free Writing Prospectus (1) May include information not contained in registration statement, but may not conflict with: (i) Information contained in filed registration statement, any prospectus or prospectus supplement; (ii) Information in issuer's periodic and current reports filed with the Commission pursuant to 13 or 15(d) of the 1934 Act. (2) Legend (i) Must contain a legend; must contain URL or hyperlink to the registration statement on file with the SEC. (ii) Legend may provide e-mail address to request documents or make documents available on issuer website. Filing Conditions (8) Road Shows (presentations made with the issuer and the underwriters to drum up interest in the security) i. Traditional road shows are made orally and thus fall outside 5. ii. Road shows that are recorded and posted on a website or given via webinar may be used as a free writing prospectus, provided a "bona fide" road show is posted on the website without restriction so that anyone can view it. Treatment of Information on, or Hyperlinked from, an Issuer's Web Site (1) Offer that is found on website must be filed with the SEC under paragraph (d) of this rule. i. "Envelope Rule" - Anything that is linked is considered "inside the envelope," and adopted by reference. (2) Historical information is not considered a free writing prospectus if: i. Identified as historical; ii. Located on separate part of website, or iii. Has not been incorporated into prospectus or referred to in connection with an offering. Free Writing Prospectuses Published or Distributed by Media Media stories are free writing prospectuses, but won't be considered an offer if (1): (i) No payment is made for the communication; (ii) Issuer or participant filed with SEC within four days. (2) Filing requirements also include: (i) Not required to file a free writing prospectus if substance of that free writing prospectus has previously been filed with the Commission; (ii) Supplementing filing if necessary to correct the communication; and (iii) May file transcripts of the communication (interview, etc.). (3) Issuer that is also in the publishing business may rely on this if: (i) Publisher of general and regular circulation or bona fide
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(3) Issuer that is also in the publishing business may rely on this if: (i) Publisher of general and regular circulation or bona fide news broadcaster; (ii) Established policies and procedures for independence of content; and (iii) Makes communication in the ordinary course of business. If interview or article is subsequently posted on issuer's website, or distributed by the issuer, would have to fulfill all of the requirements of a Rule 433 prospectus. (g) Record Retention WKSIs may use a free writing at any time. iii. Rule 164 - Post-Filing Free Writing Prospectuses in Connection with Certain Registered Offerings (a) If it meets Rule 405, it satisfies 10(b) for purposes of 5(b)(1). (b) Immaterial or unintentional failures to file or delay in filing will not violate 5(b)(1) (excused) if (1) made in good faith and (2) free writing prospectus is filed as soon as practicable after discovery of the failure to file. (c) Immaterial or unintentional failure to include the necessary legend will not violate 5(b)(1) or loss of the ability to rely on the rule so long as (1) good faith and reasonable effort was made to comply with legend condition; (2) free writing prospectus is amended to include or correct the legend as soon as practicable; and (3) if transmitted without the legend, the free writing prospectus is retransmitted with the legend in substantially the same way and to the same potential purchasers who received the original free writing prospectus. Issuer or "Any Other Offering Participant" may use free writing prospectus after the registration statement has been filed that includes a prospectus compliant with 10(b) (but not a prospectus that comes under Rules 433 or 431). 4. Posteffective Period (After Registration Statement is Effective) a. Rule 430A - Prospectus in a Registration Statement at the Time of Effectiveness (a) Prospectus filed with the registration statement may omit information with regard to offering price and other price-dependent items, IF (1) Securities to be registered are offered for cash (2) Registrant follows requirements of Regulation S-K Item 512(i); and (3) Omitted price information is supplemented within 15 days following effective date. N.B. May decrease volume and price so long as it would not materially change the disclosure in the registration statement (20% is bright line; any more requires post-effective amendment). b. Rule 172 - Delivery of Prospectuses (a) After effective date of registration statement, if a prospectus is on file with the SEC, then written confirmations of sale and notice of allocation of securities are exempt from 5(b)(1). i.e., Confirmations are not prospectuses if there is a prospectus on file with the SEC. (b) Transfer of the Security If the prospectus is on file with the SEC, then obligations under 5(b)(2) to send prospectus with the security have been met. (c) Conditions: (1) Registration statement is effective and not the subject of any pending proceeding or examination under 8(d) or 8(e); (2) Issuer, Underwriter, Participating Dealer are not the subject(s) of a pending proceeding under 8A in connection with the offering; and (3) Prospectus is "filed" when filed with the SEC or good faith effort to
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(3) Prospectus is "filed" when filed with the SEC or good faith effort to file such is made. Bottom Line: Sending prospectus requirement is satisfied by filing it with the SEC and giving notice that it is on file with the SEC. Rule 173 may require dealer to give notice of the final prospectus to purchasers*** c. Rule 173 - Notice of Registration (a) If Issuer, Underwriter, or Dealer transacts a sale that is not otherwise excluded under 4(3) or Rule 174, then must provide a final prospectus within 2 days or give notice that the sale was pursuant to a registration statement on file with the SEC. d. 4(3)(B) i. All transactions by dealers are exempt except: (A) Dealers who sell securities within 40 days of a public offering of unregistered securities; (B) 40 days of registered offering, 90 days of an IPO; and (C) Dealer is also an underwriter with unsold allotment. ii. Rule 174 - Delivery of Prospectus by Dealers; Exemptions Under 4(3) of the Act - No need to provide statement if issuer: 1. Reporting company and dealer is not a participant in the offering. 2. Non-reporting company if traded on NASDAQ limited to first 25 days after issuance. e. 4(4) Brokers' Exemption i. Makes a broker's transaction not subject to 5 if the broker did not solicit the client's interest, i.e., if the buyer places an order with the broker and the broker executes, there is no prospectus delivery obligation. f. Rule 153 -Definition of "Preceded by a Prospectus" as Used in 5(b)(2), in Relation to Certain Transactions (b) Conditions (1) Securities of the same class are traded on a national exchange; (2) Registration statement is effective and not the subject of SEC action under 8(d) or 8(e); (3) Issuer, Writer, Participating Dealer are not the subject of a pending 8A proceeding in connection with the offering; and (4) Issuer has filed or will file a prospectus satisfying 10(a). Compliance with conditions relieves selling Broker or Dealer of obligation to provide prospectus. III. THE 1933 ACT REGISTRATION STATEMENT A. Forms 1. S-1 - The default form for IPOs and other issuers. 2. S-3 - Shorter form that incorporates by reference the 1934 Act filings of an issuer. a. Policy is that these companies are already known to the market and are already in the habit of making disclosures, so no need to duplicate efforts. B. Process of Registration 1. Pre-Registration Work: a. Reorganization - Fixing Articles of Incorporation, bylaws, employee agreements, shareholder agreements, etc., that would be more complicated after going public. b. Drafting - Financial and management projections (usually led by corporate counsel). C. Filing the Registration Statement 1. 8(a) - Registration statement is effective 20 days or earlier after filing. a. Rule 473 Delaying Amendments delay effectiveness of the registration statement while the SEC comments and the issuer responds so that everybody is happy with the registration statement that goes into effect. But, most issuers don't want to wait 20 days after the last amendment of
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 But, most issuers don't want to wait 20 days after the last amendment of the registration statement to be effective. 2. Rule 430A Allows Omission of Price Information a. Allows registration statement to go into effect before pricing is finalized (thus allowing issuers to take advantage of swings in the market). b. Available for cash offers only. c. Requires filing of a supplemental prospectus once pricing is set. i. Failure to do so can require a Posteffective Amendment, which resets the liability clock under 11. 3. Rules 460/461 - SEC Accelerated Registration a. SEC can accelerate the effectiveness of the registration statement if: i. Rule 460(b)(1) Issuer has taken reasonable steps to provide information. ii. Rule 461(b) (1) Prospectus is in concise, readable English; (2) No apparent errors that would require supplementation; (6) Underwriter compensation is acceptable. iii. Requires providing a preliminary prospectus within 48 hours to everybody with whom expected to confirm a sale. iv. *Basically the flip side of a delaying amendment, and what makes the same attractive. D. Shelf Registration 1. Rule 415 - Delayed or Continuous Offering and Sale of Securities a. (a)(1)(x) Authorizes Shelf Registration for S-3 Issuers i. "Universal" Shelf Registration - Only need to identify the possible classes of securities and their aggregate amounts in the registration statement. ii. Able to offer securities later and supplement the base registration/prospectus. b. N.B. Non-Issuers may use shelf registration by complying with Form S-K Item 512(a), provided: i. Issuer to provide financial information (by reference of 1934 filings); ii. Use of the prospectus used during the issuance of the shares, as supplemented with current information if the issuance of the securities was more than 16 months prior. 2. Rule 462(e) Automatic Shelf Registration for WKSIs a. Registration statement effective upon filing. b. May add or change potential securities to be offered. IV. TRANSACTIONAL EXEMPTIONS FROM 5 1. 1933 Act provides ability to issue stock without registration under 5 for certain transactions. 2. N.B. The policy connection between the exemption and the purpose of the Act is important (fending for self, etc.). 3. Integration Think about this whenever there are sales of securities close together. a. Factors i. Single plan of financing 1. Were both offerings contemplated when deciding how to capitalize the company? ii. Issuance of the same class of securities iii. Made at or about the same time 1. Exactly contemporaneous, or closer to the 6-month window? 2. "Intent" is the big thing - Is it obvious that they were trying to raise fast cash, or was the second offering not even contemplated at the time of the first? iv. Involving the same type of consideration 1. Not considered when talking about cash, but is a factor if it is noncash consideration.
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1. cash consideration. 2. Is everybody exchanging land in a particular area in each offering? Might make it seem like one plan of financing. v. Made for the same general purpose 1. "Raising capital" is too general - Is it all to finance opening one new plant, or a new product line, or are there radically different purposes contemplated? A. 3(a)(11) Intrastate Offering Exemption a. Requires that the issuer: i. Is doing business in the state ii. Uses the proceeds of the offering in the state iii. All Offerees and Purchasers are from the state 1. A newspaper solicitation is fine even if it goes out of state, so long as the ad states that it is directed only to residents of issuing state. iv. Resales are limited to persons within the state 1. "Coming to Rest" with residents of issuer state. 2. 1 year, give or take. v. Must be part of the issue. b. Chapman v. Dunn (6th Cir. 1969): Rejected argument that "doing business" is to be measured by service of process standards. Held: In order to qualify for 3(a)(11) exemption, the issuer must offer and sell his securities only to persons resident within a single state and the issuer must be a resident of that same state. In addition, the issuer must conduct a predominant amount of his business within the same state. i. SEC v. McDonald Investment Co. (D. Minn. 1972): Exemption is not available when issuer sells to Minnesota residents if the proceeds will be used to make loans to land developers outside Minnesota. c. Failed offerings - rescission remedy. d. SEC Release No. 4434 (1961): Securities that have actually come to rest in the hands of resident investors who purchased without a view to resales to nonresidents may be resold without jeopardizing the exemption. Note, an offering may be so large, however, "that its success as a local offering appears doubtful from the outset." 1. "Substantial Operational Activities" Test of the exemption's doing business requirement. Chapman and later cases require in-state business of the issuer to be "predominant." 2. Busch v. Carpenter (10th Cir. 1987): Merely maintaining an office, books, and records in a state is not sufficient to make prima facie showing of compliance with the intrastate offering exemption. Reorganization following intrastate offering resulting in issuing a controlling block of stock to out-of-state resident and most of the proceeds transferred out of state does establish exemption. e. Secondary Distributions : 3(a)(11) most commonly used as an Issuer's exemption, however, Release No. 4434 indicates it may also be used for secondary offerings by persons in control of the issuer if the exemption would be available to the issuer for a primary offering in the state; the residency of the controlling person will not affect the availability of the exemption in a secondary distribution. 1. Some interpretations of the release add another requirement that the securities being resold are part of an issue originally qualifying under 3(a)(11). f. Resale Restrictions a. Once the securities come to a rest, they may be resold in compliance with 5. b. Outside of Rule 147 safe harbor, early rule of thumb that a one-year holding period establishes a presumption of investment intent (versus
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holding period establishes a presumption of investment intent (versus resale intent). 1. Rule 147 "Part of an Issue," "Person Resident," and "Doing Business Within" for Purposes of 3(a)(11) a. N.B. An offering can fail the safe harbor and still be exempt under 3(a)(11), but there is no safe harbor bright line protection to rely upon (no adverse presumption, either). a. Important to come within the bright lines of Rule 147 safe harbor to avoid problems if the exemption is lost and the offering is recast as a 3(b) exempt (Rule 504/505) offering that causes other offerings to exceed aggregate offering limits. b. No "substantial compliance" provision, even if innocent or immaterial deviations, Rule 147 protection may be lost (unlike Reg D). b. Because the exemption is the issuer's to prove, the issuer needs to be prepared and document its actions and to whom it made offers to establish eligibility. c. Important to put transfer restrictions both on the shares of stock and with transfer agents (condition sale of stock on continued compliance with 3(a)(11) and Rule 147). d. N.B. No disclosure requirement in Rule 147. 2. Measuring Level of Business Activity in a State a. Rule 147 Nature of the Issuer: i. (c)(2) Issuer shall be deemed to be doing business within a state if: (i) 80% gross revenue generated in the state; (ii) 80% assets in the state; (iii) 80% net proceeds used in the state; and (iv) Principal office/place of business within the state. ii. (d) Offerees and Purchasers: Person Resident (mere presence insufficient) iii. (e) Limitation of Resales - No resales to non-residents for 9 months. iv. (f)(1)(i) Legend that includes transfer restrictions. 9 month resale restrictions, but this does not mean that the shares must "come to rest." 1-year guidepost still applies. 3. Integration a. Just one other contemporaneous offering may destroy the entire exemption by creating non-compliance with 3(a)(11). i. Ex: 3(a)(11) offering in Wisconsin and at the same time a registered offering in Minnesota. b. Not automatic; factors (see above). c. Rule 155(c) - Abandoned Registered Offering Followed by a Private Offering An offering for which the issuer filed a registration statement will not be considered part of a later commenced private offering if: (1) No securities were sold in the registered offering; (2) Issuer withdraws the registration statement under Rule 477; (3) Neither the issuer nor any person acting on its behalf commences the private offering earlier than 30 days after the effective date of the withdrawal of the registration statement under Rule 477; (4) The issuer notifies each offeree in the private offering that: (i) The offering is not registered under the Act; (ii) The securities will be "restricted securities" (defined in Rule 144(a) (3)) and may not be resold unless registered under the Act or an exemption from registration is available; (iii) Purchasers in the private offering do not have the protection of 11; and (iv) A registration statement for the abandoned offering was filed and withdrawn, specifying the date of the withdrawal; and (5) Any disclosure document used in the private offering discloses any changes in the issuer's business or financial condition occurring after the
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changes in the issuer's business or financial condition occurring after the issuer filed the registration statement that are material to the investment decision in the private offering. d. Rule 152 - Private Followed by Public Offering i. 3(a)(11) may be considered a subsequent "public offering" for purposes of Rule 152 protection from integration for the earlier private offering under 4(2). ii. Look out for 3(a)(11) aggregation problems, not integration problems. B. 4 EXEMPTIONS 1. 4(2) exempts offerings by an issuer not involving any public offering. a. Scope of the Exemption - Securities Act Release No. 285 (1935): 4 Factors: i. Number of Offerees and Their Relationship to Each Other and to the Issuer - preliminary negotiations or conversations with a substantial number of offerees will cause the offering to be public in nature. Also important is the relationship between the offerees and the issuer; if the offerees are members of a class having special knowledge of the issuer, the case for a private offering is strengthened. ii. Number of Units Offered - the issuance of securities in a large number of units of small denominations is an indication the issuer anticipates subsequent trading in the securities. Conversely, an issuance of a small number of units in large denominations is evidence of a private offering. iii. Size of the Offering - exemption intended to apply chiefly to small offerings. iv. Manner of the Offering - transactions effectuated through direct negotiations are more likely to be private offerings than those effected through the use of the machinery of public distribution (such as advertising). b. SEC v. Sunbeam Gold Mines Co. (9th Cir. 1938): Court found public offering where Sunbeam solicited pledge loan agreements from 530 individuals, all of whom were stockholders of it or the corporation whose assets were to be acquired. c. SEC v. RALSTON PURINA CO. (1953): d. Investor Qualification: Sophistication and Access to Information i. Lower courts interpreting 4(2) have focused on both (1) the investor's ability to evaluate the investment (given his business and investment sophistication) and (2) on his access to information about the investment (based on the availability of information or the issuer's actual disclosure). ii. Sophisticated, But Not Informed Hill York Corp. v. American International Franchises, Inc. (5th Cir. 1971): Denied a 4(2) exemption when sophisticated investors (businessmen and attorneys) in a franchise received no disclosure document or other access to information, and likewise lacked a privileged relationship with the issuer (or any prior relationship). The exemption requires that investors (no matter how sophisticated) have access to information about the issuer. iii. Not Sophisticated, But Informed SEC v. Continental Tobacco Co. (5th Cir. 1972): Denied a 4(2) exemption when investors received information comparable to that of a registration statement, but many lacked investment sophistication. Court suggested qualified investors must have personal contact with corporate officers. Later cases interpret this holding as NOT requiring insider status as a condition of the exemption. iv. Sophisticated, But Not Insider Wolfe v. S.D. Cohn & Co. (5th Cir. 1975): clarified that the 4(2) exemption does not depend on insider status - sophisticated outsiders may be qualified. v. Access to Information, But No Actual Disclosure
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v. Access to Information, But No Actual Disclosure Doran v. Petroleum Management Corp. (5th Cir. 1977): Sophistication alone is insufficient - there must be a sufficient basis of accurate information upon which the sophisticated investor must be able to exercise his skills. Availability of information means "either disclosure of or effective access to the relevant information." Thus: 1. If the disclosure option is exercised, the absence of a relationship between the issuer and the offeree would not preclude a finding that offering was private. 2. If access to information is the measure, the relationship between the issuer and the offeree becomes the critical question. a. Must be shown that the offeree could realistically have been expected to take advantage of his access to ascertain the relevant information. b. Also, the investment sophistication of the offeree is important to show that he could have been expected to ask the right questions and seek out the relevant information. vi. SEC v. Kenton Capital, Ltd. (D.D.C. 1998): e. Other Requirements i. Offering circular that is basically a registration statement must be distributed to all offerees. ii. Precise records need to be kept regarding the sophistication and materials received by each offeree (i.e., number materials to track recipients and whether materials exchanged hands). iii. Limit solicitation to people who are clearly sophisticated investors (document evidence of sophistication). iv. Limit resales both contractually and with transfer restrictions. f. Resale Restriction i. Investors who purchase in a private placement cannot resell to unqualified investors. 2. REGULATION D - LIMITED OFFERING EXEMPTION i. Rules 504 and 505 are 3(b) exemptions (and therefore under $5 million) ii. Rule 506 is unlimited a. Rule 501 - Definitions and Terms Used in Regulation D (a) "Accredited Investor" b. Rule 502 - General Conditions to be Met i. (a) Integration ii. (b)(1) Information Requirement 1. 504 - no information requirement 2. 505/506 a. (b0(2)(i) if not subject to the 1934 Act, furnish (A) Certain non-financial information (B) Certain financial information dependent on size of offering b. (b)(2)(ii) if subject to the 1934 Act, then shall provide those filing and not any material changes to the information contained in them iii. (c) Limitation on Manner of Offering 1. Prohibits making offering by means of a "general solicitation" a. Needs to be some exclusivity to the group being offered i. Relationship between seller and buyer ii. "substantive and preexisting" iii. No numerical test, but looks for a small group or at least a group with significant independent ties to the issuer b. Doesn't necessary require continually making sure that a person remains accredited, but this would probably make the
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c. d.

e.

f.

g. h.

remains accredited, but this would probably make the relationship seem less substantive; best practice to continually check. c. Rule 155(c) - no general solicitation where a registered offering is abandoned, 30 days elapse, and an exempt private offering is begun. 2. Investor Data Banks/Click Through Accreditation a. Three criteria before a website won't be considered a general solicitation: i. Questionnaire is generic, that is, is not geared towards a specific offering or situation ii. Website is password-protected iii. Only able to participate in offerings made after the relationship begins b. No obligation to make sure people remain qualified, but one of the hallmarks of a substantive relationship is keeping in touch with potential investors. Rule 503 - Filing and Notice of Sales i. Must file a notice of sales containing information required under Form D Rule 504 - Exemption for Limited Offerings and Sales of Securities Not Exceeding $1,000,000 (3)(b) i. (a)(1) not available for 1934 Act reporting companies ii. (b) Conditions (1) must satisfy 501/502/503 (2) aggregate offering price can't exceed $1 million in any 12 month period a. Valuing Non-Cash Consideration b. Rolling time period (12 months from that moment backwards) c. Also counts offerings under Rule 505 Rule 505 - Exemption for Limited Offers and Sales of Securities Not Exceeding $5,000,000 3(b) i. $5 million dollar aggregate limit within 12 month period ii. (b) Conditions 1. (1) must satisfy 501/502 2. (2)(i) Aggregation 3. (2)(ii) No more than, or reasonable belief that there were no more than 35 purchasers a. Accredited investors don't count 4. Information requirement of 502(b) Rule 506 - Exemption for Limited Offers and Sales Without Regard to Dollar Amount of Offering 4(2) i. (b) Conditions 1. (1) must satisfy 501/502 2. (2)(i) no more than, or reasonable belief that there are no more than, 35 purchasers 3. (2)(ii) Nature of purchasers a. Each purchaser and their representative, excluding accredited investors, must be sophisticated (knowledge and experience in financial matters) 4. Information requirement of 502(b) Rule 508 Insignificant Deviations from a Term, Condition, or Requirement of Regulation D 2007 Proposed Amendments to Regulation D i. New Rule 507 (invoking general exemptive authority under the 1933 Act 28). 1. Creating a class of "large accredited investors."
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1. Creating a class of "large accredited investors." 2. Doubling existing $$ minimums. 3. Allowing limited written advertising (easing the "general solicitation" prohibition." 4. Permit sales only to "large accredited investors." ii. Amend the existing "Accredited Investor" definition. 1. Add a test based on "investments" (excluding real estate for personal residence) - $750,000 minimum. 2. Building in inflation adjustment beginning in 2012. iii. Shorten anti-integration safe harbor to 3 months. 3. REGULATION A - CONDITIONAL SMALL ISSUES EXEMPTION "Force Field" Exemption from 3(b) (under $5 million) a. Rule 251 - Scope of Exemption (a) Issuer of the securities is not subject to the 1934 Act (b) Sum of cash and other consideration shall not exceed $5 million ($1.5 million for non-issuer selling security holders) (c) Integration (2-sided force field) 1. Won't be integrated with any prior sales 2. Won't be integrated with later sales that are a. Registered b. Rule 701 c. Employee benefit plan d. Regulation S e. More than 6 months later (d) Offering Conditions (1) Offers (i) No offers can be made unless for 1-A offering statement is filed with SEC (ii) After form 1-A is filed i. Oral offers ii. Written offers under Rule 255 iii. Ads, if they state from whom an offering circular or final offering circular can be received from (iii) After offering statement has been qualified, written offers may be made, but only when accompanies or preceded by final offering circular (2) Sales (i) No sale shall be made until (A) Form A-1 has been qualified (B) Preliminary or final offering circular has been furnished to the purchaser 48 hours prior to confirmation of sale (C) Final offering circular is delivered with confirmation of sale, unless it was already sent (ii) Sales by a dealer within 90 days can be made only if the dealer delivers a copy of the current offering circular (3) Continuous offerings may be made under Reg A in compliance with shelf registration b. Rule 252 - Offering Statement (a) Offering statement consists of Form 1-A and any information necessary to make it not misleading (b) Shall be signed by the CEO, CFO, majority of BOD (e) File 7 copies with SEC (g) Qualified automatically after 20 days, but can include a delaying amendment until agreement with SEC is reached. c. Rule 253 Offering Circular (a) Shall include narrative financial information required by Form 1-A.
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(a) Shall include narrative financial information required by Form 1-A. (d) Cover page must contain a legend. (e) Offering Circular shall be revised as necessary whenever it contains something false or misleading. d. Rule 254 - Solicitation of Interest Document for Use Prior to an Offering Statement i. "Testing the Waters" e. Rule 255 - Preliminary Offering Circulars f. Rule 259 - Withdrawal g. Rule 260 - Deviations 4. Regulation A vs. Registered Offerings a. Benefits i. Permits "testing the waters" before filing anything. 1. May solicit interest in securities without having filed any registration or qualification materials. 2. Also permitted to use a written document, so long a b. Drawbacks 5. Regulation A vs. Regulation D a. Regulation A has no prohibition against general solicitations. i. Can be written, oral, general, public, etc. ii. Subject to filing. b. Regulation A has no resale restrictions. c. Regulation A is available C. Reselling Exempt Offerings 1. 4(1) Exempts resales from Section 5 unless they are by an issuer, underwriter, or dealer. i. 2(a)(11) "Issuer" 1. Who is a control person? 2. No intermediary, no issuer problem ii. 4 (1 1/2) permits Control Person to resell through an intermediary if the buyer is sophisticated a. 2(a)(11) Underwriter is one who purchases from an issuer with a view to distribution i. From an issuer ii. View to a distribution iii. Distribution 1. Resale that is inconsistent with the issuer's exemption 2. To determine whether it is a distribution, see Ralston Purina - go through the factors: 3. If there is a distribution, the conduit (underwriter) essentially falls out of transaction for purposes of determining if resale is a distribution 4. Can't use a broker or dealer to effectuate the sale, because then it becomes a "transaction involving an issuer, writer, or dealer," and again, not subject to 4(2) protection 2. Other ways to become an underwriter a. Cheering from Sidelines i. Chinese Consolidated ii. Rule 137 3. Integration Concerns D. Rule 144 a. Reporting/non reporting b. Affiliate/non-affiliate (a) Definitions (1) "Affiliate" (2) "Person" (3) "Restricted" Securities
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(2) "Person" (3) "Restricted" Securities (b) Conditions to be met (1) Non-affiliates i. IF ISSUER IS REPORTING COMPANY ii. IF ISSUER IS NOT A REPORTING COMPANY (2) Affiliates (c) Current Public Information (d) Holding Period for Restricted Securities (1) General Rule (i) If the issuer has been a 1934 Act reporting company for at least 90 days prior to the sale, then at least 6 months must have passed between the issuance of the restricted securities and resale. (ii) If the issuer is not a 1934 Act reporting company, then at least 1 year must have passed between the issuance of restricted securities and resale. (e) Volume Limitations on Sales (f) Manner of Sales (g) Brokers' Transactions E. Rule 144A - Sales to Qualified Institutional Buyers F. PIPE Offerings V. Liability Under the 1933 Act 13 makes the statute of limitations for 1933 Act violations 1 year A. 11 - Civil Liabilities on Account of False Registration Statement (a) if the registration statement contained an untrue statement of a material fact or omitted a material fact necessary to make that statement not misleading i. People who can sue 1. Not limited to purchasers in a public offering, but Herzberg ii. Persons liable (b) no person, other than the issuer, shall be liable who sustains the burden of proof (c) Reasonableness shall be that which is required of a prudent man in the management of his own property (d) Effective date of the registration statement (or the last of any post-effective amendments) fixes the date for liability; persons joining after are not liable (e) Measure of damages (f) Joint and Several Liability (g) Offering price to public is the maximum amount recoverable 1. Essentially, everyone except the lawyers are liable for a misstatement of material fact. a. Issuer is strictly liable, but directors, underwriters, auditors, etc. are able to argue 11(b) due diligence and reliance defenses i. Due Diligence ii. Reliance on Expertised Sections b. Directors can cover their liability through D&O insurance or indemnification agreements with the corporation c. Underwriters and Auditors attempt to spread their liability out by using a syndicate 2. Due Diligence Defense a. Essentially is the defendant arguing "what more could I have done?" b. No shifting standard of diligence i. Ex: In re WorldCom ii. What is a reasonable investigation? 1. Independent research and asking questions of management 2. Ex: Escott v. BarChris iii. Subject to 1 year statute of limitations, no requirement that the plaintiffs have bought the shares directly from the issuer, just that they bought pursuant to the registration statement iv. Negative Causation Defense B. 17 Anti-Fraud Provision
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B. 17 Anti-Fraud Provision C. 12 Civil Liabilities Arising in Connection with Prospectuses or Communications (a) Any person who: (1) Offers/sells a security in violation of 5 (2) Offers/sells a security by means of a prospectus or oral communication that includes an untrue statement of material fact or omits a material fact and who does not sustain the burden that he did not know and in the exercise of reasonable care could not have known of such untruth or omission 1. No requirement that the defendant acted with intent or scienter 2. Who is a "seller?" 3. What transactions come under 12(a)(2)? a. Private sale transactions do not b. 12(a)(2) "Public Offering" 4. Remedies 5. Defenses a. Causation b. Rule 159A c. "Reasonable Investigation" VI. Exchange Act of 1934 A. Periodic Reporting Under the Exchange Act 1. Key Issues a. What brings an issuer into the system i. Listing on an national exchange ii. 12(g)/Rule 12g-1 - 500 shareholders and more than $10 million in assets iii. 15(d) Registered Public Offering b. How does an issuer get OUT of the system? i. Below 300 shareholders (Rule 12(g)(4)) c. What disclosures does the system require? i. Rule 13a-1 Annual report on Form 10-K ii. Rule 13a-13 Quarterly reports on Form 10-Q iii. Rule 13a-11 Current reports on Form 8-K d. What mechanisms does the system establish to ensure the quality of periodic reports? i. Skeptical groups 1. Internal accounting staff 2. Senior officers (through MD&A and executive certifications under SOX) (Rules 13a-14/15d-14) e. Gatekeepers put in charge of the process i. Outside Auditors ii. Outside Directors who make up the audit committee 1. 10A - SOX gives the audit committee a lot of power 2. 10A - boosting auditor independence a. 10A(g) restricts in what other non-audit work you are able to get b. Some arrangements (e.g., doing work for CEO and for the company) aren't illegal, but not a good idea either c. 5 year auditing partner rotation (not firm, just the person working with the company) d. "Revolving door" ban 3. 10A-M-4 iii. Lawyers f. 13(b)(2) Foreign Corrupt Practices Act recordkeeping & internal controls i. World Wide Coin ii. Books & Records 1. 13(b)(2)(A) iii. Internal Controls
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g.

h. i. j. k. l.

Internal Controls 1. 13(b)(2)(B) 2. Encompasses a broad range of responsibilities 3. SEC will pursue in cases of "unreasonable deviations from ideal internal controls" Sarbanes-Oxley Act of 2002 i. 404 ii. Adds tremendous compliance costs iii. Huge burden on management iv. Pro Forma financial reports Financial reporting Non-Financial Reporting Pro Forma Financial Statements Obligations to Provide Current Disclosures Management Discussion & Analysis i. Item 303 of Form S-K ii. Designed to get management to talk about the financial statements in a way that explains to those using the statements what they mean and how they are calculated iii. Discussions of 1. Liquidity 2. Capital resources 3. Results of operations a. In re Caterpillar b. In re Coca Cola 4. Off balance sheet transactions

iii.

B. Materiality N.B. Materiality does not create a requirement to disclose - the disclosure obligation must be independent. Only when mandated by a periodic reporting interval is materiality raised. "Material" Facts Omitted Facts "Soft" or Forward-Looking Information a. Looks at projections and predictions b. Two questions i. When is forward-looking information material (and required to be disclosed on periodic report)? 1. TSC Rule ii. If it is disclosed, but is incorrect, when is the issuer not liable? 1. "Bespeaks Caution" Doctrine 2. Statutory Safe Harbor for Forward-Looking Statements a. Rule 3b-5/175A b. Rule 23e/27A - PSLRA reforms Liability for False or Misleading Statements 9 - Manipulation of Securities Prices 16 - Directors, Officers, and Major Stockholders 18 - Liability for Misleading Statements 10 - Manipulative/Deceptive Devices a. Rule 10b-5 b. Transactional Scope c. Standing to Sue d. Standard of Culpability i. Scienter is required 1. "Knowingly" false or misleading 2. Two ways to evaluate: a. Did the person know, or was it foreseeable that disclosing the
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1. 2. 3.

C. Civil 1. 2. 3. 4.

e. f.

g.

h.

2. Two ways to evaluate: a. Did the person know, or was it foreseeable that disclosing the information would mislead potential buyers/sellers? b. Recklessness can prove scienter sometimes 3. Pleading a. 21D(b)(2) b. Tellabs c. Insider trading really bolsters the scienter inference d. Incentive compensation policies can also contribute to management having a motive to fudge the numbers e. 4 factors to guide i. Show that defendants 1. Benefitted in a concrete and personal way from the fraud 2. Engaged in deliberately illegal behavior 3. Knew facts or had access to information suggesting that their public statements were not accurate 4. Failed to check information that they had a duty to monitor f. Corporate Scienter Non-Disclosure Reliance (Transactional Causation) i. Necessary element of the 10b-5 cause of action ii. Was previously a very easy term to define iii. "Fraud on the Market" 1. Premised on the idea that buyers purchase securities based on the pricing that the market provides and that when the market has less than accurate information, the security cannot be priced correctly a. Only valid if the market is efficient i. What makes efficiency? 5 factors: 1. Extent of weekly volume 2. How many stock analysts are following 3. Number of market makers/arbitrageurs 4. Status as S-3 issuer 5. Date showing close connection between release of information and prompt changes in stock price b. So, if the market is efficient and it has received misinformation, then it can be presumed that purchasers, in relying on the market, also relied on the misinformation c. Thus, reliance on the price is presumed to be reliance on the information underlying the market's pricing d. Remember that reliance is a hollow term of art in these cases even throwing a dart in an efficient market avails itself to a presumption of reliance, even though that isn't' anyone's definition of reliance 2. Rebuttable Damages (Loss Causation) i. Measurement ii. Loss Causation 1. 21D(b)(4) 2. Dura Pharmaceuticals v. Broudo Damages i. Assessing damages when the market responds to both a corrective disclosure and other disclosures ii. "Bounce Back" Rule iii. So, if the market bounces back stronger than ever and the stock trades ahead of the purchase price, this can throw a case our of court for lack of
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ahead of the purchase price, this can throw a case our of court for lack of damages i. Who can be sued/Parties Liable i. Primary Violators 1. Two competing views a. "Substantial Participation" b. Bright Line (majority rule) ii. Aiders/Abettors 1. Central Bank 2. "Scheme" Liability j. Proportional Liability under 21D(f) i. For plaintiffs' lawyers, the name of the game is finding a deep pocket; so suing the issuer or the officers, in most cases, are not attractive options ii. 21D(f)(2) - Liability for damages 1. A - Joint and several liability for all knowing violators 2. B - proportional liability a. Generally, violators who don't meet the "knowing" standard are only liable for damages allocable to their percentage of responsibility. b. "Covered Persons" can recover attorneys' fees against other if successful in defending suit. iii. 21D(f)(3) - Determination of Responsibility iv. Uncollectable Shares D. Insider Trading a. e.g., SEC v. Texas Gulf Sulphur Co. (2d Cir. 1968): Geologist insiders purchased shares in their own company all the while making false/misleading disclosures that they had not just found a large mineral deposit. 1. Solutions to Insider Trading a. Agency Law 2. Federal Securities Regulation a. 16 b. 10b-5 Influences on Insider Trading i. Classical Theory - Duty to Abstain or Disclose ii. What about non-insiders trading on inside information? 1. Chiarella iii. How far does the idea of an "insider" go? 1. "Temporary insiders" (contractual fiduciaries) 2. 10b5-1 Boundary a. Possession presumption b. Doesn't reach inaction, but that is probative of the plan being a sham c. Requires i. A - before being aware of the information, the person had ii. B - contract, instruction, or plan must iii. C - insider can't disregard the plan 3. Tippers/Tippees a. Switzer b. Dirks v. SEC c. Regulation FD 4. Addressing Chiarella a. Fraud in Connection with a Tender Offer i. Rule 14e-3 1. Requires 2. Who is liable? b. Misappropriation Theory of Insider Trading i. United States v. O'Hagan
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i. United States v. O'Hagan ii. Misappropriation concerns in PIPE transactions E. Proxy Solicitation 1. Beyond regulation of purchases and sales: regulating solicitation of voting shares (proxies) 2. Statutory framework ( 14(a) (now 14(a)(1)): 1. Delegation of substantive rules to SEC 2. Limitation to '34 Act-registered issuers 3. Key substantive provision is Rule 14a-3 a. No "solicitation" of proxies unless: i. Formal written proxy statement (per Schedule 14A) prepared ii. Proxy statement delivered to each person solicited, before or concurrent with solicitation iii. "Prior Restraint" - Rule 14a-3 10-day rule (except for routine stockholder meetings) b. Note burdens (preparation/filing/delivery) c. Note scope of "solicitation" definition in Rule 14a-1(l)(1)(iii) i. Defined broadly, to include virtually any communication that is reasonably calculated to result in the procurement of a proxy. + Annual Report to Shareholders (similar to 10-K) d. Doesn't just apply to issuer i. Shareholders can solicit proxies, but must foot the bill for all required statements, mailing, countinghuge burden (also when just opposing) e. Long Island Lighting Co. v. Barbash (2d Cir. 1985): Court accepted the possibility that a newspaper ad attacking a company's nuclear energy policy may be a solicitation. Ads were designed to condition the market, therefore should have been accompanied by proxy statement. f. Includes oral statements g. Rule 14a-2(b) rules do not apply to: (2) Solicitations where total number of persons solicited is < 10 h. Very few proxy contests due to huge costs . . . Unfair imbalance? 4. Exemptive Reforms a. Concerns: Cost of inter-shareholder communications; institutional investor fear of liability for ordinary discourse among stockholders. b. Key 1992 reform: i. Rule 14a-2(b): amended, (largely) exempting non-management solicitations where solicitor doesn't seek a proxy at the time Limitations: a. Filing requirement for large shareholders (> $5 million) Rule 14a-6(g) b. Antifraud Rule still applies - Rule 14a-9 c. MONY Group v. Highfields Capital (2d Cir. 2004): Exception unavailable where an institutional investor opposed management's solicitation and sent to each recipient a blank duplicate copy of management's proxy card, on the grounds that the most likely purpose of the blank card was to encourage shareholders to revoke votes previously cast in management's favor. ii. Other 1992 reforms: a. The definition of "solicitation," Rule 14a-1(I)(2)(iv), was amended to specify that a shareholder can publicly announce how it intends to vote and provide the reasons for that decision without having to comply with any of the proxy rules. b. Rule 14a-3 was amended to add a new paragraph (f), exempting solicitations conveyed by public broadcast or speech or publication from the proxy statement delivery requirements, provided a definitive proxy statement is on file with the commission. 1. Available to management as well as shareholders.
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proxy statement is on file with the commission. 1. Available to management as well as shareholders. iii. 1999 "M&A" reform - Rule 14a-12 a. Any solicitation can precede proxy statement 1. Need to identify solicitor participants, note future proxy statement 2. Filing requirement for written solicitation material iv. 2007 "Notice and Access" Rule (14a-16) a. Substantive (Non-Disclosure) Rules 1. Stockholder access to proxy machinery i. Rule 14a-8: free riding on management/company proxy statement ii. Exclusion by management: no-action letter process; private right of action to assert right to use Rule 14a-8 iii. Bases for Exclusion a. Beyond stockholder power under state law b. "ordinary business operations" c. Binding/mandatory proposals (by-law amendments) vs. precatory proposals iv. Form of Proxy - Rule 14a-4 a. (a)(2) requires that proxy card be dated b. (b)(1) opportunity to check boxes: for; against; abstain (under state law, don't have to give shareholders choice) v. Rule 14a-7: duty to turn over shareholder list or mail dissident materials vi. 2010: 14A/Rule 14a-21 - "Say on Pay" vii. 2010: the rise and fall of Rule 14a-11

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