Securities Act of 1933 Outline

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					SECURITIES ACT OF 1933 OUTLINE INTRODUCTION--The Framework of Securities Regulation Securities Transactions 1) Issuer Transactions a) Issuer Transactions are those involving the sales of securities by the issuer to investors. They are the means by which businesses raise capital—to develop, to grow, or simply to survive. b) By far the most expedient form of issuer transaction is the private placement of securities. This entails the issuer selling securities to a select number of investors. i) On the small scale, a private placement includes a partnership or closely held corporation adding new owners. ii) Large public corporations also engage in private placements when they raise large sums of capital through negotiated sales of securities to one or more financial institutions, such as an insurance company. (1) Public offerings are also available. In this case, it must make a public offering of securities to a large number of diverse investors. (a) This type of public offering is known as a primary distribution. (2) Whenever a large amount of securities is to be offered to the public, the selling effort usually occurs through a syndicate of broker-dealers, known as underwriters. (a) An offering on behalf of a company going public for the first time is called an initial public offering (IPO). 2) Trading Transactions a) Trading transactions are the purchasing and selling of outstanding securities among investors. i) Resale of securities may either be privately negotiated or occur through public markets. ii) Those who hold securities in a small firm for which no public market exists generally can only dispose of their shares by privately negotiating with an interested buyer. (1) An exception to this statement occurs when the amount of securities to be resold is so great as to support a public offering. This is called a secondary distribution and most frequently occurs when individuals who control the securities‘ issuer wish to sell some of their shares. b) The facilities through which outstanding securities are publicly traded are known as securities markets. c) American securities markets can be roughly divided among bond, equity markets, and derivative/options markets. i) Traders in bond markets are primarily large financial institutions. (1) Although trading in corporate debt instruments is in absolute amounts significant, all trading in such instruments is dwarfed by the magnitude of trading in U.S., state, and municipal bonds. (2) Even though trading in government securities, as well as original issues of government securities, involves significantly larger amounts than trading in and offerings of business issuers, government securities are exempt from disclosure regulations. (a) Regulation of government securities focuses upon those who sell government securities. (3) The corporate bond market dwarfs the equity market. The Legal Framework of Securities Regulation 1) The Federal Securities Laws a) The Securities Act of 1933 i) The first of the federal securities laws enacted was the Federal Securities Act of 1933, which regulates the public offering and sale of securities in interstate commerce. (1) Regulates the law when an issuer/company sells securities. (a) Investor Transactions (2) From Company to Investor. ii) The Act‘s disclosure demands apply to public offerings of securities that occur through the process of ―registering‖ such an offering with the Securities and Exchange Commission (SEC). (1) Registration Process [process by which the Act seeks to assure full and fair disclosure in connection with the public distribution of securities] (prospectus: given to investors—contains almost all information found in registration statement): (a) The information issuers are compelled to disclose in their registration statements is set forth in the SEC regulations and covers all significant aspects of the issuer‘s business (industry sensitive). (b) The registration statement must provide a thorough description of the issuer‘s business, property, and management. (c) Extensive financial information must be disclosed, including certified financial statements for the current and several previous years as well as revenues and earnings for each significant product line. (d) Management must also provide its analysis and review of the issuer‘s capital needs, solvency, and financial performance, including analysis of any variances in revenues or profits from the preceding year. (i) MD & A 1. Management discussion and analysis of financial conditions and results of operations. a. This is in addition to financial statements, a discussion of the financial statements, what the business does, future plans (forward looking statements). (e) Management
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(i) Who are they? (ii) Independence? 1. Conflicts of Interest a. Self-dealing Transactions (f) A detailed description of the rights, privileges, and preferences of the offered security, as well as the existing capital structure of the firm, must be set forth in the registration statement. (g) ―Risk factors‖ that make the offering speculative must be described. (i) Is there a market for this company? (ii) Industry specific risks. 1. Past performance in industry. (iii) Is the company in any lawsuits? (iv) Ex‘s: there is no pre-existing market for the security (i.e. an IPO), that the issuer has recently experienced substantial loses, and that the nature of the business the issuer is engaged in or proposes to engage in poses unusual risks. iii) Most of the registration statement‘s substantive information is also required to be disclosed in the prospectus. iv) The need for care and honesty in the preparation of the registration statement is underscored by the exposure of the issuer‘s underwriters, officers, directors, and certain experts to civil liability for omissions and misstatements in the registration statement. v) The objective of the registration process is the production of a prospectus that includes most of the information disclosed in the registration statement. (1) The prospectus is designed to provide all material information necessary for investors to fully assess the merits of their purchase of the security; the prospectus is the vehicle for stationing investors on as nearly an equal footing with the issuers and their underwriters as possible, with the hope their purchase is neither worthless nor overpriced. vi) The underwriters‘ selling efforts cannot commence until the registration statement has been filed with the SEC, and no sales or deliveries of securities may occur until the registration statement is effective. (1) Nevertheless, extensive selling efforts commence after the registration statement is filed, at which time investor interest is orally solicited. (a) Written offers during this period can only be made through a preliminary prospectus that embodies all the substantive information then contained in the registration statement. Once the registration statement becomes effective, written offers must be accompanied or preceded by a final prospectus that embodies the information current as of the date the registration became effective. Also, once the registration statement is effective, actual sales can be made, and the purchased securities can be delivered. vii) Numerous categories are exempt from the Act‘s registration requirements: securities issued by governmental bodies, bank, insurance companies (section 3), and securities sold in certain types of transactions (section 4). viii) Section 11 provides a private right of action for materially false statements in the registration statement, and Section 12 imposes civil liability upon those who sell securities in violation of Section 5‘s registration requirement as well as upon anyone who sells any security in a public offering by means of a materially misleading statement. (1) The SEC‘s enforcement powers include the power to issue administrative cease-and-desist orders under Section 8A as well as to prosecute violations civilly in the federal courts under Section 20. ix) The ‘33 Act is basically founded on a disclosure philosophy. If we give people enough information they can make an informed decision. (1) Disclosure protects investors and markets. (a) Who are you trying to satisfy, make understand? (i) Financial Advisors. (ii) Institutional Investor 1. Banks 2. School 3. Endowment Fund 4. Anyone who invests others money. a. Ex. Pension Fund, Mutual Fund (iii) These persons are expected to relay information to unsophisticated investors to properly invest their stocks. b) The Securities Exchange Act of 1934 i) In the Securities Act, Congress empowered the Federal Trade Commission (FTC) to discharge a specific and well-defined task; the registration of public offerings of securities not otherwise exempt from the Act. ii) Established the SEC iii) Involves investor-investor deals and broker-dealer regulation. iv) Continuous Disclosure and Other Disclosure Provisions (1) Whereas the Securities Act grapples with the protection of investors in primary distributions of securities, the Exchange Act‘s concern is trading markets and their participants. (2) An important contribution to efficient trading markets is the 34‘ Act‘s system of continuous disclosure for companies required to register under its provisions. (a) The three categories of companies that have a class of securities listed on a national securities exchange (Section 12(b)), companies that have assets in excess of $10 million and that have a class of equity securities held by at least
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500 persons (Section 12(g) and Rule 12g-1), and companies that have filed a ‘33 Act registration statement that has become effective (Section 15(d)). (i) These companies are called reporting companies. (3) Reporting companies are required to register with the SEC and thereafter make timely filings of the reports required by Section 13 of the ‘34 Act. Unlike the ‘33 Act‘s disclosure requirements, there is no additional requirement that ‘34 Act filings be forwarded to investors or market professionals. (a) All registrants (domestic and foreign) are required to file with the SEC their ‘33 Act registration statements and their periodic reports under the ‘34 Act in electronic format. (i) The most significant of the compelled reports is the annual report on Form 10-K, which is required to include an extensive description of the company‘s business, audited financial statements for the fiscal year, and management‘s discussion and analysis of the position and performance of the company. (ii) Quarterly reports on Form 10-Q are also required to be filed with the SEC. The disclosures on Form 10-Q include unaudited interim financial statements for the company as well as management‘s analysis of financial operations and conditions. (iii) A further report compelled by Section 13 if Form 8-K, which must be filed within a few days of the occurrence of a material development of the type specified in the form, for example, a change in control, credit downgrade, the acquisition of disposition of a significant amount of assets, the commencement of insolvency proceedings, a change in auditors, or the resignation of a director in a dispute over policy. (4) Anti-fraud provisions. The Act also requires those companies that are subject to the continuous reporting requirements because they fall within either Exchange Act Section 12(b) or Section 12(g), discussed above, to make full and fair disclosure whenever soliciting their stockholders‘ proxies and to otherwise comply with the numerous proxy rules the Commission has promulgated under Section 14(a). (5) Through the Williams Act Amendments in 1968, disclosure by an outsider is required when more than 5 percent of a class of registered equity securities is or will be owned as a result of a tender offer or purchase. Other tender offer practices are also regulated as a consequence of the Williams Act Amendments. v) Regulation of Exchanges, Broker-Dealers, and Market Abuses. (1) The Exchange Act embraces a strong, active role for a variety of self-regulatory organizations (SROs). (a) Two important types of SROs are each of the national security exchanges and the National Association of Securities Dealers (NASD). (i) The SRO‘s regulatory role is played under the Commission‘s watchful eye. (2) The Exchange Act also seeks to protect the integrity of capital markets and investors by arming the SEC, as well as private litigants, with its antifraud and investors by arming the SEC, as well as private litigants, with its antifraud and anti-manipulation provisions. c) Federal Regulation Beyond Disclosure: The Sarbanes-Oxley Act of 2002 i) Enacted in July 2002, the Act sets forth broad proscriptions for corporate governance, authorizes the SEC to develop rules for professional conduct for lawyers, and regulates areas that have always been the province of the states, such as loans to officers and directors. d) The Regulation of Investment Advisors and Investment Companies i) The Investment Company Act of 1940 and the Investment Advisors Act of 1940 were the culmination of a comprehensive four-year SEC investigation of investment companies and their advisors. (1) Investment Companies, simply defined, are companies formed for the purpose of buying, selling, and holding a portfolio of securities for investment, rather than for control purposes. (a) Common versions of investment companies are money market funds and mutual funds. (b) The Investment Company Act regulates the independence of the company‘s board of directors; requires annual review of any management contract between the investment company and its officers, directors, or affiliates upon approval by the SEC; and regulates the capital structure of investment companies. (c) Even though investment companies are required to register under the Investment Company Act, they remain subject to the registration and prospectus requirements of the Securities Act when they engage in a public offering of their securities. (d) They also are subject to the reporting requirements of the Exchange Act. (2) An investment advisor is one engaged in the business of rendering investment advice to others for compensation. (a) The Investment Advisors Act of 1940 requires advisors to register with the SEC, establishes a few minimum requirements for fair dealings by investment advisors, and prohibits fraudulent and deceptive practices by investment advisors. e) The Organizational Structure of the SEC i) The SEC is an independent, nonpartisan agency created by the Securities Act of 1934; the ‘33 Act, until the creation of the Commission, was administered by the FTC. ii) The Commission is composed of 5 commissioners appointed by the President to five-year terms, the terms are staggered so that one expires each June, and not more than three commissioners may be of the same party as the President. (1) One commissioner is designated by the President to serve as the chairman of the Commission. iii) The SEC operates through four principal divisions.

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(1) The Division of Corporate Finance has overall responsibility for administering the federal securities laws‘ disclosure requirements through its review of the registration statements for public offerings, quarterly and annual reports, proxy statements, tender offer statements, and other documents required to be filed with it. (2) The Division of Market Regulation has responsibility to oversee the operation of secondary trading markets, including the registration and behavior of exchanges and broker-dealers. (3) The Division of Investment Management has the responsibility for administering the Investment Company Act and the Investment Advisors Act. (4) The Enforcement Division conducts investigations and prosecutions. Enforcement actions can occur via an administrative proceeding or in the courts. Criminal prosecutions, however, are within the exclusive authority of the Department of Justice attorneys, usually through the appropriate U.S. Attorney‘s Office, with assistance of the SEC enforcement staff. f) The Mediums Through Which the SEC Speaks i) Through the exercise of its broad rulemaking power, the Commission formally makes its position known on regulatory issues. ii) In the releases that accompany its proposals and adoption of regulations, the SEC goes to great lengths to provide guidance regarding the content of the regulations it is considering. iii) The Commission, through its enforcement staff, plays an important role in expanding and refining the law through the enforcement actions it chooses to initiate and theories under which the suits are maintained. (1) Administrative proceedings. (2) Judicial Proceedings. iv) The Commission‘s positions are also presented in private litigation through amicus briefs the staff files on important issues. v) An especially important source of guidance occurs through its staff‘s issuance on no-action letters. (1) Since the SEC‘s creation, its staff has been willing to respond to individual inquires regarding the staff‘s interpretation of the federal securities laws‘ application to a specific transaction. (a) The staff‘s responses to such inquiries are known as no-action letters because the key expression in a favorable response to an inquiry states that the staff ―will recommend no action to the Commission‖ if the transaction is carried out as stated in the letter. (i) Because no-action letters express the views only of the staff involved with the day-to-day responsibility of administering that provision of the law, they do not represent the official view of the Commission 17 C.F.R. § 202.1(d). (b) A no-action letter is no binding on private parties, who can challenge the transaction. vi) The SEC‘s web site, www.sec.gov also contains guidance on regulatory issues. vii) Further guidance occurs individually by individual commissioners, division and office heads, and their assistants expressing their views and describing prevailing practices within the SEC in their speeches and during participation in securities programs. 2) Blue Sky Laws a) State securities laws are generally referred to as blue sky laws, an expression rooted in their initial objective of curbing promoters who would sell interests having no more substance than ―so many feet of blue sky.‖ i) An important difference between the federal and the state approaches to securities regulations is that the former is exclusively disclosure oriented, whereas many state jurisdictions include within their blue sky laws a so-called merit regulation standard whereby qualification depends on convincing the state blue sky administrator of the substantive merits of the offering. b) The lack of uniformity among the states is a problem, if not a nightmare; for the attorney ―blue skying‖ an offering that will be made in several states. c) Some relief in this area occurred in 1996 when Congress amended Section 18 of the Securities Act to exempt from the states‘ registration procedures several categories of securities, called ―covered securities,‖ including those that are listed (or that will be listed) on the NYSE, the AMEX, or Nasdaq. i) This minimizes the state power to compel registration of offerings under the blue sky laws to offerings that are not made to sophisticated investors. 3) Self-Regulatory Organizations a) The Securities Exchange Act is unique to the extent it prescribes a cooperative regulatory effort by the SEC and industrysponsored groups, called self-regulatory organizations. i) Currently, there are four types of SROs embraced by the Exchange Act: the national securities exchanges, the national securities association, registered clearing agencies, and the Municipal Securities Rulemaking Board (MSRB). b) Section 5 requires all exchanges to register as ―national securities exchanges.‖ i) The two truly nationwide exchanges are the NYSE and AMEX, and the others are smaller regional exchanges. ii) A national securities exchange must satisfy Section 6, which requires just and adequate rules to ensure fair dealing and to protect investors. c) Section 15A to the Exchange Act calls for creation of a ―national securities association.‖ NASD. The NASD is the largest of the SROs. The NASD‘s scope of responsibility is broad and includes overseeing the operation of the over-the-counter market and establishing and enforcing rules for its efficient and fair operation. i) Under § 15(a)(1), brokers or dealers must register with the SEC if they offer, sell, or purchase securities.
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ii) § 15(b)(8)-(9) makes it unlawful for any registered broker or dealer who is not a member of a national securities association to make any security transaction unless those transactions occur solely on an exchange in which he is a member. d) The listing requirements of the NYSE, AMEX and Nasdaq contain significant provisions regarding both good disclosure practices and corporate governance. MATERIALITY OF INFORMATION Importance of Materiality  Materiality is a controlling concept when there are allegations of fraud.  The fraud provisions of the federal securities laws do not impose a duty disclose information simply because it is material, they do require affirmative disclosure of material information in certain circumstances.  They bar both material misstatements and half-truths whenever information is given to investors.  10(b)(5) (p. 436), subsection (b), it is unlawful as a fraud to make a material misstatement.  Only material lies are fraud under federal securities laws.  Anti-fraud provision § 10(b)(5) (‘34 Act), § 11 and § 12.  Materiality determinations have an important role in defining the content of state and federal mandatory disclosure requirements. The content and format of disclosure made in filings with the SEC are governed by the specific instructions for each form or by Regulations S-X and S-K.  Most of this line-item disclosure is absolute in the sense that the elicited information must be disclosed and is not dependent upon a separate determination by the registrant or the Commission of the information‘s probable impact upon investors or stockholders.  At some point in the disclosure instructions, however, specific information is required to be disclosed only if it involves a material development or qualification.  Note: Before getting into a determination of materiality, consider whether there is an independent duty to disclose. Just because information is material, it does not necessarily have to be disclosed.  Note: An omission is actionable under the securities laws only when the corporation is subject to a duty to disclose the omitted fact.  Note: Sometimes information must be disclosed regardless of materiality. E.g. names of directors of the corporation.  Fraud: It is illegal to make a misleading statement of a material fact. Thus, if information is not material, there is no securities fraud. Determination of Materiality  Material is not defined by statute or in the rules. The SEC has not defined it. It is a matter of case law.  The SC has weighed in on what materiality is.  TSC, (definition 1) information is material if there is a substantial likelihood that a reasonable investor would consider it important in deciding how to act.  TSC, (definition 2) There must be a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the "total mix" of information made available.  Both definitions used as starting point.  This definition of materiality applies throughout the security laws.  Note: For information to be material, do not have to show that the information would have changed the investor‘s mind.  Application of Definition  What is material? Examine:  The amount of the contract.  The subject matter of the contract.  The term of the contract.  The form of the contract.  The conduct asked for in the contract.  Length, terms, price, obligations, major supplies, producers, etc.  This is an objective test, we are looking at the reasonable investor  Materiality determinations are a mixed question of fact and law.  Because it is facts and circumstances you cannot win on materiality at the pleading stage.  As such, materiality determinations have to proceed to the fact finder. This promotes litigation.  Omissions of material information are considered affirmative misrepresentations for purposes of §11 of ‘33 Act (imposing civil liabilities on account of a false registration statement). Speculative Information and Materiality  Basic v. Levinson  There is clearly a misrepresentation, was it material under the TSC test?  When merger discussions become known the stock price of the target rises, if these rumors always got out it would make it much more difficult to perform take-overs (more expensive).  The target would also let out that they were in play and sharks could come attack.  Issue was the standard of materiality applicable to preliminary merger discussions.
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Purpose of ‘33 Act: Full and fair disclosure. Basic‘s wish to disclose/not disclose the information is irrelevant. Costs of disclosure:  Might make it more difficult to find people to invest.  Extremely expensive to put a registration statement together. Have to pay underwriters, accountants to certify the financial statements, printing costs, etc.  Cost of liability. Company opens itself up to a securities fraud action.  Cost of litigation.  Holding  The TSC test is difficult to apply here due to the uncertainty of the possible merger. Basic says how is this material, it may not occur.  Probability/Magnitude Test. Materiality depends on the balancing of the probability that the event will occur and the anticipated magnitude of the event in light of the totality of the company activity.  Probability: Generally, in order to assess the probability that the event will occur, a factfinder will need to look to indicia of interest in the transaction at the highest corporate levels.  Common Sense: How probable is it. Have you hired financial investors and investment banks, how many iterations of the K has there been, who in the organization is talking about this, has the BOD been briefed on this, how much time has the law firm put in on this. Look to suspicious trading activity; board resolutions (no one would bother with the BOD if nothing is happening); instructions to investment bankers, and actual negotiations between principals or their intermediaries may serve as indicia of interest; how close in time the statements are made to the actual activity; who is involved (underwriters, etc.)  Magnitude: How important, how much of an event. Even if the event is not likely to occur, may be material if the magnitude is high. A fact finder will need to consider such facts as the size of the two corporate entities and of the potential premiums over market value. No particular event or factor short of closing the transaction need be either necessary or sufficient by itself to render merger discussions material.  You can have a high magnitude and low probability.  The SC here seems to indicate that anything involving mergers is of high magnitude due to the results of a merger.  Whether preliminary merger discussions are material will depend on the facts of the case. Materiality depends on the significance the reasonable investor would place on the withheld or misrepresented information.  No reason to exclude preliminary discussions from the definition of materiality. Reasonable investors know that mergers may or may not occur.  This test is a refinement of the TSC test, to be used concerning speculative information.  Speculative information is that information. Information concerning events or activities that will occur at a future date.  Ex. Earnings forecast, future product development, sale of assets/divisions, TWA Case – spinning off a subsidiary, whether certain legislation will be passed (federal legislation for cross state-line mergers).  Courts rarely require disclosure of internal forecasts and estimates, reasoning such types of information are not material unless ―it is substantially certain.‖ Methodology. Always start with the substantial factor test. If the event may or may not occur, use the probability/magnitude test.  Probability/magnitude test applies to any situation where something may or may not occur. E.g. a spinoff, whether a company is going to file for bankruptcy, whether a drug will be approved.

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SOFT INFORMATION Forward-Looking Information; The Materiality of Forward-Looking Information  Historical information is also known as hard information.  E.g. last year‘s earnings; what property the company owns; identification of company‘s employees.  Forward-looking information is also known as soft information.  Soft information describes events or activities that will occur, if at all, at some future date. E.g. projections; forecasts; evaluations; appraisals; statements of what the company is going to do in the future.  Earnings forecasts and projections (i.e. earnings per share, future stock price). Statements of future plans and objectives. Statement about a belief (product being rolled out or introduced).  Securities laws permit and encourage forward-looking information, but do not require it except in certain circumstances.  Fraud. In order to recover for fraud, P must prove that the forward-looking statement was a false or misleading statement of material fact.  When is a FLS false or misleading?  It must ultimately be false. When specific facts illustrate that the FLS lacked a reasonable basis.  We will allow you to incorrectly make a FLS as long as you have a reasonable basis to do so.  We want to penalize wrongful conduct, not misstatements.  What makes it wrongful?  When a C makes a statement and when they made the statement they did not believe it. See R. 175.  What about when someone believes their statement, but have no reasonable grounds to believe it? That is also false or misleading.
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A FLS is false or misleading if the person making it knows that the statement was false or misleading or has no reasonable grounds to believe that the FLS will come true.  When a company makes a statement, they make two representations:  We have reasonable grounds to make the forward-looking statement AND  We made the statement in good faith.  If either of the two factors are missing, the statement will be considered misleading.  Note: Just because the statement does not come true, does not make it misleading. When is a FLS material? If the standard of materiality is set too low, this will encourage strike suits.  Bespeaks Caution Doctrine  The application of bespeaks caution depends on the specific text of the offering document or other communication at issue, i.e., courts must assess the communication on a case-by-case basis. Nevertheless, we can state as a general matter that, when an offering document's forecasts, opinions or projections are accompanied by meaningful cautionary statements, the forward-looking statements will not form the basis for a securities fraud claim if those statements did not affect the "total mix" of information the document provided investors.  In other words, cautionary language, if sufficient, renders the alleged omissions or misrepresentations immaterial as a matter of law.  Of course, a vague or blanket (boilerplate) disclaimer which merely warns the reader that the investment has risks will ordinarily be inadequate to prevent misinformation.  To suffice, the cautionary statements must be substantive and tailored to the specific future projections, estimates or opinions in the prospectus which the plaintiffs challenge.  Must be meaningful cautionary language.  Consider the audience: here, the audience would be sophisticated and rich investors, such as mutual funds.  The ‗33 Act wasn‘t set up to be insurance.  The bespeaks caution doctrine can be used in the pleading stage, which will allow the court to get rid of meritless lawsuits in the pleading stage. Discovery is limited and companies will not be forced into settlements to avoid discovery.  It is used to weed out frivolous claims at the pleading stage.  Statutory Safe Harbor for Forward-Looking Statements  The Private Securities Litigation Reform Act of 1995 adds Section 27A to the Securities Act and a parallel provision in Section 21E to the Exchange Act, which provides a statutory safe harbor for certain forward-looking statements made by companies that are subject to the Exchange Act‘s continuous reporting provisions.  The safe harbors subsection (c)(1) shields persons specified in the provision from liability in private actions for forward-looking statements under one of two alternative safe harbors.  The first safe harbor (in addition to shielding any immaterial forward-looking statement) reaches a forward-looking statement that ―is accompanied by meaningful cautionary statements identifying the important factors that could cause actual results to differ materially from those in the forward-looking statement.‖  Alternatively, the safe harbor is available if the plaintiff fails to prove that the forward-looking statement ―was made with actual knowledge‖ it was misleading.  Because the absence of actual knowledge is a separate basis for the safe harbor‘s availability, the specter arises that private parties will be unable to recover from even a knowingly false forecast if that forecast is accompanied by ―meaningful cautionary‖ language.  The cautionary statements must convey substantive information about factors that realistically could cause results to differ materially from those projected in the forward-looking statement, such as, for example, information about the issuer‘s business . .  ―Important‖ factors mean the stated factors identified in the cautionary statement must be relevant to the projection and must be of a nature that the factor or factors could actually affect whether the forward-looking statement is realized.  Forward-looking statements will have safe harbor protection if they are accompanied by a meaningful cautionary statement. A cautionary statement that misstates historical facts is not covered by the safe harbor.  The statutory safe harbor also extends to oral forward-looking statements. When relying on the ―meaningful cautionary‖ prong, there is a further requirement that the oral statement identify where the listener can find the qualifying ―meaningful cautionary‖ information.  In addition to being restricted to reporting companies, the safe harbor is not available to forward-looking statements made in connection with certain types of transactions, such as initial public offerings, tender offers, and going-private transactions.

The Duty to Disclose Forward-Looking Information; MD&A  Company has a general obligation to make sure that its announcements are not materially misleading.  Information‘s materiality is a necessary, but not a sufficient condition to require its disclosure. Not only must information be material, but also there must be an independent duty requiring its disclosure.
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Two situations in which a company is required to provide forward-looking information:  Item 303 of Regulation S-K. Regulation S-K contains all of the general line item disclosure requirements for the MD&A section. Item 303 calls for a narrative discussion of a company‘s current financial condition and future prospects.  A registrant must disclose known material changes, trends, and uncertainties reasonably expected to have a material effect on the company‘s business prospects.  Requirements  (a)(1) Liquidity. Increase or decrease in liquidity.  (a)(2) Capital Resources  (a)(3) Results of Operations  You are identifying material trends or uncertainties. Not projections or forecasts, but you do have to talk about future trends in all three.  Purpose of having all disclosure requirements in MD&A section: Uniformity. Company must disclose historical financial information, liquidity, capital resources, results of operations, off-balance sheet arrangements, etc.  MD & A serves, primarily, for the public to see explanations for the current income statement and balance sheet – historical financial statements. MD & A forces company to explain the result of operations.  It also allows one to see if the current trends will continue in the future.  Since the line-item disclosures mandated by Regulation S-X and Regulation S-K for ‘33 and ‘34 Act filings do not independently require disclosure of soft information, and since many financial announcements are not the subject of SEC filings (e.g., an issuer‘s press release), the duty to disclose soft information generally arises from the overall obligation that announcements not be materially misleading.  When a statement is made there is a duty to make such additional disclosure as necessary to assure that the statements that are made are not misleading in light of the circumstances under which they are made.  In sum, the independent duty to disclose soft information arises from the overall disclosure rule that no half-truths should appear in filings with the SEC and public announcements.  In their superintendence of this standard, the courts continue to manifest restraint due to the private and uncertain character of the soft information. Hypo: Spandy becomes the target of a hostile takeover by Alliance. After Alliance announces its bid, Spandy‘s management launches an aggressive search for a white knight. Bethel makes a higher bid for Spandy than Alliance does. Spandy shares confidential forecasts and appraisals of Spandy‘s operations and assets with Bethel. Internal projections forecast a 43% increase in sales and asset appraisals reveal that $200 million could be raised by selling certain product lines to a third party. Forecasts and appraisals were prepared using highly conservative assumptions, information, and procedures. Must forecasts and appraisals be disclosed in a joint proxy statement prepared by Spandy and Bethel that seeks SH approval of the merger?  Information is material. Proxy statement tells SHs what they will get if they approve the merger. SHs would want to know that their stock may be worth more than they thought it was. However, just because the information is material, doesn‘t mean it has to be disclosed. Have to find an independent duty to disclose.  Argument for a duty to disclose. SHs‘ vote must be informed. Proxy statements purportedly include all of the information that the SHs need. SHs would argue that proxy statement that does not include forecasts and appraisals and therefore would only present a half truth. Only gave information required by the federal securities laws and left out important information—the 43% increase.  Argument against duty to disclose: Spandy might argue that the forecasts are not material. Spandy might also argue that they have a business reason for not giving information—want to attract Bethel. In addition, disclosure of information might increase competition with Spandy.  Courts are hesitant to find a duty to disclose forecasts and predictions. There are policy reasons for the courts‘ hesitation— information is usually highly confidential and sensitive information.

THE DEFINITION OF A SECURITY The Investment Contract as a Security Overview  When a financial instrument is termed a security, the full weight of the securities laws – including the registration and prospectus requirements, as well as the antifraud provisions – is brought to bear on the transactions underlying its marketing and sale.  A conclusion that a transaction involves a security not only introduces significant regulatory forces, but also may provide the investor disappointed by the returns of a business venture with a potent weapon in the quest to recover invested capital.  The ‘33 Act and the ‘34 Act have substantially similar definitions of a security.  They begin with a circumscribing phrase limiting applicability of the definition if ―the context otherwise requires,‖ which has provided an important basis for the exercise of judicial discretion concerning the proper scope of the securities laws. There follows a laundry list of examples, some of which seem, at first glance, straightforward (notes, stock, bonds, debentures, and certificates of deposit), and others of which are elusive and therefore susceptible to expansive interpretation (investment contracts, certificates of interest in profit sharing agreements, and interests commonly known as securities  ―Security‖ defined: §2(a)(1). Investment contract is a security. Congress knew that people might come up with ways to raise money that wouldn‘t fall into the common definition of securities. Securities laws may apply if investor can convince court that scheme to raise money is an investment contract.  § 2(a). Security:
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―unless the context otherwise required‖  May give the court an out. Even if the security meets the definition the court may find that it is not a security.  The courts may expressly or impliedly depend on the phrase.  (1)  List – known, undisputed securities.  Catch all provision – Investment Contract.  This has been left to the courts to define.  Analysis to determine if there is a security: check list, if not on list, is it an investment contract? SEC v. W.J. Howey  Facts: D presents an opportunity to investors to purchase acreage in a citrus grove. The contracts were both a land sale contract and service contract. The buyer is buying property and the right to have someone else service the citrus grove. You are buying a row of 48 trees. For the row to grow the tress have to be nurtured and nourished, generally taken care of.  SEC has brought suit. This is an enforcement action, arguing that there has been a violation of the security laws. SEC wants to enjoin the sale of the security to force Howey to register with the SEC so that there is proper disclosure for individuals interested in purchasing the property.  Violation of ‘34 Act by failing to register the security.  Is this a security?  Howey would argue that this is a land sale and service contract.  Land sale contracts are not regulated in the § 2 list.  Service contracts are not regulated in the § 2 list.  SEC argues that bundling together both items forms an investment K.  SC comes up with four part test, Howey test. SC adopts an expansive definition of an investment contract.  Definition of an investment contract under Howey: A contract, transaction or scheme whereby a person [1] invests his money in [2] a common enterprise and [3] is led to expect profits [4] primarily from the efforts of the promoter or a third party.  Analysis:  It was an investment:  A K or scheme for the placing of capital or laying out of money in a way intended to secure income or profit from its employment.  It was a common enterprise  Pooling. Everyone throws money together into a common pool.  You are all in it together, you either all make out or you don‘t. This goes into a pro-rate share of the profits.  With Expected Profits (two-parts – expectation and profits)  Sale of citrus will result in return. It was a pro rata distribution. If there were 100 rows and I own 1 row. I get 1% of the profit.  Expected profits. You have to expect making money out of this.  Led to expect profits by the promoter.  Solely from the profits of others.  A third-party serviced the crops.  Almost everyone used the service agreement.  Application: [1] Here, the investors invested their money in the units. [2] Investors and Howey shared in the profits no matter whose plot grew more oranges and all investors pooled their money. [3] Investors were led to expect profits. [4] Investors had nothing to do with making the citrus grove profitable. Private versus Public Actions  The SEC initiated the Howey litigation seeking to enjoin the marketing of securities without compliance with the registration provision of the ‘33 Act. There were no allegations of fraud or misrepresentation by the promoters, nor was there any evidence investors had lost money. More often, it is the investor who initiates a private cause of action asserting the existence of a security that should have been registered. See Securities Act § 12(a)(1). This claim is typically advanced in the hope of recovering capital invested in a bad business deal or as the basis of a defense asserting the invalidity of a contractual obligation to pay money. Some of the cases involve obvious fraud by promoters, while others simply represent ventures that failed to meet investors‘ original expectations. HYPO:  In 1989, Reuters carried a story describing Jaguar‘s plans to develop the XJ220, a 200 mph sports car, to be sold for 587K. Customers were being asked to put down a deposit of 80K but will have to wait until 1992 before the first models roll of the production line. The cars may be worth up to 1.6 million at that time. Is this an investment contract?  Whenever your client is getting money for something you should at least consider whether they are selling a security.  Investment is the opposite of consumption.  Consumption – you want to consume or use the product.  If I buy stock in a housing co-op (you buy stock in a housing cooperative that gives you shares in the co-op and gives you a proprietary lease in the apartment). People get say over who can move into your apartment. People can be turned down by the co-op.  The Co-Op has a board.
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 Condo – purchased apartment, where you pay into organization to cover common areas.  In Foreman there was no investment K because the purpose of buying co-op stock was to live there, to consumer. Likely many people will be buying these jaguars for investment purposes.  This is an argument that it is an investment. Pooling? Is the 80K going to your car or the company.  There is an argument that there is pooling, the money goes to build cars. Here, you could argue that the cars were also invested into for a profit. Capital appreciation?  Is that a profit. A profit is a return on your money. It is a common sense definition. It is a return, it can be variable, fixed, it can come from dividends, interest, capital appreciation, etc. Here the capital appreciation would result in profit upon sale of the car. Market forces – supply/demand will control the appreciation.  The profits here would come from market demand. Can you really say that the profits are solely from the efforts of others? The market determines the profits, not the efforts of others.  Also, you have to do a significant amount of work to do the profit. You have to sell the profit.  If the investor is putting in too much effort there is not going to be an investment K. You can argue that here the investor is putting in a great effort. You could also argue that Jaguar is promoting this and creating the investment. They are doing the work. The investor is doing little. ―Solely‖  Too definitive. If you are an investor and asked to do a single thing then it is no longer solely. It would give a license for a loophole.  Thus, the circuit courts have held that solely should be read as ―primarily.‖  Where are the profits primarily expected from?  The investor, the promoter, or some other third party.  Edwards – leaves off solely language. Ultimately, the court would likely not find this an investment contract.  We don‘t know if they really pooled this money.  Has the promoter really led us to expect profits – no sales pitch really made.

Investment versus Consumption  Howey requires that there be an investment of money. Issue arises when there is an element of consumption that motivates the investment. What happens if the returns on investment are in the form of benefits to be derived from the use or enjoyment of the underlying assets? Ask why the investor purchased.  United Housing Foundation, Inc. v. Forman  Co-op case. In order to live there you get stock in housing co-op.  Is stock in the housing co-op, stock for the federal securities laws.  Court says just because it is labeled stock does not mean it is automatically stock.  There are certain characteristics that show a stock to be a stock.  Those are:  Despite their name, they lack what the Court in Tcherepnin deemed the most common feature of stock: the right to receive "dividends contingent upon an apportionment of profits."  Nor do they possess the other characteristics traditionally associated with stock: they are not negotiable; they cannot be pledged or hypothecated; they confer no voting rights in proportion to the number of shares owned; and they cannot appreciate in value.  In this case there were no dividends. There was no capital appreciation. You had to sell back to co-op.  Supreme Court also held that there was no investment contract here. No actual investment—motivation in purchasing the shares was to consume. The tenants had purchased shares of the co-op housing corporation so that they could secure living quarters. They had not invested their money in the hope of receiving profit from the efforts of others, so Howey was not met.  Rule: To determine whether something labeled ―stock‖ is a security, look to whether it has the common characteristics of stock. If not, consider whether it is an investment contract under Howey. Common Enterprise and Profits Solely from the Efforts of Others  SEC v. Edwards  Facts: Defendant, Edwards, was the chairman, chief executive officer, and sole shareholder of ETS Payphones, Inc. (ETS). ETS, acting partly through a subsidiary also controlled by respondent, sold payphones to the public via independent distributors. The payphones were offered packaged with a site lease, a 5-year leaseback and management agreement, and a buyback agreement. All but a tiny fraction of purchasers chose this package, although other management options were offered. The purchase price for the payphone packages was approximately $7,000. Under the leaseback and management agreement, purchasers received $82 per month, a 14% annual return. In September 2000, ETS filed for bankruptcy protection. The SEC brought this civil enforcement action the same month. It alleged that respondent and ETS had violated the registration requirements of §§ 5(a) and (c) of the Securities Act of 1933.

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Issue: In this case, we must decide whether a moneymaking scheme is excluded from the term "investment contract" simply because the scheme offered a contractual entitlement to a fixed, rather than a variable, return.  Analysis:  "whether the scheme involves an investment of money in a common enterprise with profits to come solely from the efforts of others."  This definition "embodies a flexible rather than a static principle, one that is capable of adaptation to meet the countless and variable schemes devised by those who seek the use of the money of others on the promise of profits."  Thus, when we held that "profits" must "come solely from the efforts of others," we were speaking of the profits that investors seek on their investment, not the profits of the scheme in which they invest. We used "profits" in the sense of income or return, to include, for example, dividends, other periodic payments, or the increased value of the investment.  There is no reason to distinguish between promises of fixed returns and promises of variable returns for purposes of the test, so understood.  Two examples of investor interests that we had previously found to be "profits.‖  Those were "capital appreciation resulting from the development of the initial investment" and "participation in earnings resulting from the use of investors' funds."  Forman supports the commonsense understanding of ―profits‖ in the Howey test as simply ―financial returns on investments.‖  We hold that an investment scheme promising a fixed rate of return can be an "investment contract" and thus a "security" subject to the federal securities laws. Who was predominantly responsible for the profits here? Choices: (1) Promoter [if so, may be investment K]; (2) Investor [if so, no investment K]; or (3) Market Forces [if so, no investment K].  The pre-purchase services of the promoter cannot by themselves suffice to make the profits of an investment arise predominantly from the efforts of others, and that ministerial functions should receive a good deal less weight than entrepreneurial activities.  Market forces may be important in cases with artwork, silver bars, etc. SEC v. Glenn Turner (9th Cir. 1973): Critical inquiry in determining ―predominantly from the efforts of others‖ is whether the efforts made by those other than the investor are the undeniably significant ones, those essential managerial efforts which affect the failure or success of the enterprise. The Meaning of Common Enterprise  The circuits are split on the meaning of Howey‘s common enterprise test.  Some courts look to vertical commonality in evaluating the presence of a common enterprise. Under this approach, which emphasizes the relationship between the investors and the promoter, the principal inquiry is whether the activities of the promoter are the controlling factor in the success or failure of the investment, and a common enterprise may exist even though there is no pooling of investors‘ funds or interests.  Under an approach labeled broad vertical commonality, some courts look to the uniformity of the impact of the promoter and require only a connection between the efforts of the promoter and the collective success or losses of the investors.  Other courts opted for strict vertical commonality and require a direct relationship between the success (as opposed to the efforts) of the promoter and that of the investors; this requires the promoters and investors to share the risks of a venture. Under either approach to vertical commonality, a common enterprise arguably may exist even if there is only a single investor.  A more restrictive approach looks to the presence of horizontal commonality and requires a pooling of investors‘ funds. Although this typically will involve a pro rata distribution of profits or sharing of losses among investors, horizontal commonality may exist when promised returns are fixed rather than variable provided there is the requisite of investor funds.  In contrast to the vertical commonality tests, this approach emphasizes the common enterprise among investors, rather than the common enterprise between a promoter and investors. Because horizontal commonality presupposes multiple investors, it may seem reasonable to conclude that a common enterprise is not present if there is single investor.  It is the character of the investment vehicle, not the presence of multiple investors, that determines whether there is an investment contract.

Stock, Partnership Interests, and LLC Interests as Securities Stock as a Security  In Landreth, which involved the sale of all of the stock in a family-owned lumber business, the ―sale of business‖ doctrine was laid to rest. The Court stated:  Under the circumstances of this case, the plain meaning of the statutory definition mandates that the stock be treated as "securities" subject to the coverage of the Acts.  when an instrument is both called "stock" and bears stock's usual characteristics, "a purchaser justifiably [may] assume that the federal securities laws apply," id., at 850.  We identified those characteristics usually associated with common stock as (i) the right to receive dividends contingent upon an apportionment of profits; (ii) negotiability; (iii) the ability to be pledged or hypothecated; (iv) the conferring of voting rights in proportion to the number of shares owned; and (v) the capacity to appreciate in value.  We would note that the Howey economic reality test was designed to determine whether a particular instrument is an "investment contract," not whether it fits within any of the examples listed in the statutory definition of "security."  We cannot agree with respondents that the Acts were intended to cover only "passive investors" and not privately negotiated transactions involving the transfer of control to "entrepreneurs."
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Stock in a Close Corporation  Is it stock?  Dividends – rarely issue dividends/normally reinvest profits because most owners of close corporation work for corporation.  Transferability – typically there are restrictions on transferability of shares. Attempts to keep it in the family/group. You want restrictions on control.  Capital Appreciation – No active trading market. Thus, there may not be capital appreciation.  Would it make sense that stock in close corporations would not be regulated by federal securities laws?  The federal securities laws were enacted to protect our national market. There is no national market in close corporations, thus we could leave regulating these companies to the states.  What about investor protection?  Federal rules protect investors, so we may need federal regulation.  Also, the heart of the ‘33 Act is that anyone who sells securities must register with the SEC also they receive an exemption.  Most courts will find stocks in a close corporation to be stock.  However, there may be some exemptions that relieve these close corporations from some of the security laws.  The reasonable expectation of an investor may assume the stock is stock. Would the reasonable investor expect protection from the federal securities laws when buying this stock?  When buying common stock (no matter the C) the reasonable expectation may always be that you would be protected.

Partnership Interests as Securities  Have you bought a security? Is a partnership interest a security?  First, look to security act. Are partnerships listed as a security?  No.  Is it an investment K?  Use the Howey test.  If you buy a general partnership interest most courts would find that it is not a security, why?  The ―efforts of others‖ prong of the Howey test is not met. In general partnerships you are controlling.  General partnerships are thus usually not found as securities.  There are exceptions.  Look at Williamson factors to make argument that general partnership interest is a security because the person has no control.  A General partnership or joint venture interest can be designated a security if the investor can establish that (1) an agreement among the parties leaves so little power in the hands of the partner or venturer that the arrangement in fact distributes power as would a limited partnership; or (2) the partner or venturer is so inexperienced and unknowledgeable in business affairs that he is incapable of intelligently exercising his partnership or venture powers; or (3) the partner or venturer is so dependent on some unique entrepreneurial or managerial ability of the promoter or manager that he cannot replace the manager of the enterprise or otherwise exercise meaningful partnership or venture powers.  Although Williamson is often cited, relatively few cases have treated general partnership interests as securities.  Under the UPA the partners can vary the terms of the partnership agreement.  They can create a managing partner.  You may contract away your control. This argument usually loses but you can make the argument.  Limited Partnerships are generally found as securities  Most courts would find that LPs are IKs and therefore are securities because LPs do not have a lot of control. In an LP the GP has the control.  There are exceptions. See Steinhardt  Steinhardt  Bristol Oaks is an LP created by Citi.  The General Partner is Ontra  The Limited Partner is Steinhardt  Citi moves debt to Bristol. Steinhardt alleges Citibank misrepresented the value of the assets by at least 25 percent. Wants to sue under § 10(b)(5).  Generally speaking, LPs are securities.  See test for IK.  Limited partners are seen as passive investors.  The Court holds that this is not an IK. Steinhart was the majority partner and through that position they had a lot of control over what the managing partner could do.  For example, Steinhart had to consent to the GP basically doing anything that would make money.  Steinhart also approved the interim business plan and had the power to amend the plan. Steinhart also had the power to remove Ontra if they did not follow Steinhart‘s decisions as to material actions.  Thus, for partnerships you:  Look:
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Is it a GP or LP  If GP go to IK analysis and focus on #4.  Generally, in a GP prong four fails. You want to try to argue Williamson prongs – they normally lose.  If LP go to IK analysis and focus on #4.  Normally, a LP is a passive investor. LP‘s are normally IKs.  There are exceptions if the LP by contract exerts too much control over GP then the court will find that profits of the investor are primarily due to work of LP, making the LP not an IK. If it is an LP then you have to register unless you get an exemption.

LLC Interests as Securities  LLC offers its members the benefits of limited liability (a corporate attribute) and pass-through of tax income and losses (a partnership attribute). Generally, management of the LLC is vested in its members in much the same way that general partners manage a general partnership.  The statutes, however, typically allow members to opt out of the member-managed default form in favor of centralized management in a manager-managed LLC. Accordingly, member-managed LLC‘s resemble general partnerships, while manager-managed LLCs approximate limited partnerships, at least insofar as the attribute of centralized management is concern.  Go to look at security definition?  LLC not listed under federal securities laws.  Thus, if a security it has to be a IK.  The issue will revolve around prong 4.  Control.  Is the LLC member-managed or manager-managed.  Manager-managed has centralized control. Meets 4.  Member-managed is like a GP. Does not meet 4.  Courts often rule based on the management setup. Notes as Securities  Under what circumstances is a note a security? The definition of ―security‖ in §2(a)(1) includes ―any note.‖ Think about whether Congress really intended that every time you sign a note, it should be a security. There are all different kinds of notes—student loan notes, mortgages, car loan notes, etc.  Section 3(a)(3) then exempts from the registration requirements a note that ―arises out of a current transaction or the proceeds of which have been or are to be used for current transactions‖ and that will mature within nine months.  Section 17(c) makes it clear that this exemption does not extend to the ‘33 Act‘s antifraud provisions.  ―Context clause‖ qualification on the definition of a security: The preamble to the definition of ―security‖ states ―unless the context otherwise requires…‖ This is known as the ―context clause.‖ Gives the SEC the right to say that not all notes are securities, even though ―note‖ is included within the §2(a)(1) definition of a security.  Reves v. E&Y (1990): Issue was whether certain demand notes issued by the Farmer‘s Cooperative of AR and OK were securities. Usually when you purchase a note, you will have to repay the note within the maturity date. A demand note has no set maturity date. It is due whenever the lender decides to demand payment. Farmer‘s Co-op was selling demand notes to raise money for its business. Farmer‘s represented that they had sufficient money to repay the notes, but subsequently went bankrupt. Holders of the notes sued the auditors for improper treatment of Farmer‘s in the audit. Ps argued they would not have bought the notes if the audit was done right because Farmer‘s insolvency would have been apparent.  Co-op argues that the notes fall under an exception.  In the ‘33 Act (p.2), ‘34 Act (p. 260)  They look the same, except the definition of the ‘34 Act excludes notes that mature within 9 months. ―Short-term notes.‖  The ‘33 Act lacks that language, however, there is an exemption on p.7. This exemption in § 383 exempts notes that mature within 9 months.  This has been interpreted as an exemption for ―commercial paper.‖ A generic term for notes that are short-term, purchased by institutional investors and lacking security. It is not required to be registered under the ‘33 Act.  Why is it that commercial paper is exempted?  The need for federal security protection is mitigated by the fact that the note is high grade, low risk and deals with two highly sophisticated investors.  This exemption requires 9 months security, a blue chipper issuer, selling to sophisticated investors.  The ‘34 Act talks about a ―maturity date of less than nine months‖ but does not include ‘33 Act language ―current transactions.‖ The ‘34 Act does not really include the commercial paper language.  Does this exclusion, under the ‘34 Act, cover commercial paper?  The holding for this part was 4-1-4. Majority (4 on this issue), thought that the demand note had varying maturity dates (not necessarily within 9 months). Stevens argued it only applied to commercial paper. Dissent argued it applied to all notes maturing within 9 months.  So EY argues as the dissent does.  Majority did not really address the issue.
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Four factors to consider when determining whether a certain type of note should be included in the list: [Note: There is a presumption that a note is a security, but it is a rebuttable presumption]  Motivations of borrower and lender: If seller‘s purpose is to raise money for the general use of the business, and buyer is interested primarily in the profit the note is expected to generate, the instrument is most likely a security.  Borrower – is it cash flow problems or to raise capital  Lender – Solely for profit  If borrower you want money to raise capital – it is a security. If you borrow money to correct a cash flow problem that is not a security. If lender lends to make a profit then that is an investment. If it lends to sell then it is not a security.  Plan of distribution: If many people are buying, looks like a security. Consider whether there is common trading for speculation or investment.  Reasonable expectations of investing public: Court will consider instruments to be ―securities‖ on the basis of public expectations, even when an economic analysis of the circumstances of the particular transaction might suggest that the instruments are not ―securities‖ as used in that transaction.  Risk reduction: Consider whether some factor such as the existence of another regulatory scheme significantly reduces the risk of the instrument, thereby rendering application of the Securities Acts unnecessary. Court holds that the Farmer‘s notes are securities.  Motivation: Effort to raise capital; purchasers hoped to make a profit.  Although mortgagors and sellers make a profit when they lend you money to purchase a good, they are more interested in selling the good than making the profit.  Here, notes were sold at a variable interest rate always above the prevailing interest rates set at other banks  Plan of distribution: Here, the notes were publicly offered  Flip side to this argument would be that if you are only offering a note to one person, it would not be a security. Does this make sense?  Looks like the common enterprise prong of the Howey test  Reasonable expectations: If instrument has the characteristics of stock, people would have reasonable expectations that the federal securities laws would apply.  Risk reduction: no other regulation that would protect these investments. If court does not apply the federal securities laws, no protection for investors.  Looks like risk capital test  What reduces your risk of not getting paid back?  Secured note: whoever lends you the money will have a security interest in what you have. E.g. with a car loan, if you do not pay the loan, the bank will repossess your car. This opens the argument that a secured note is not a security.  Other laws out there regulating the transaction: alternative regulatory schemes. E.g. bank is insured by a federal regulatory agency. Insurance reduces the risk, making it unnecessary to have regulation under the federal securities laws. HYPO(s):  The notes we sign to get money to go to school, is that a security?  NO, our motivation for borrowing the money and the motivation to sell is not about investing.  That is not totally accurate, but primarily accurate.  What about when you go to CC and buy a tv and you buy it on credit and sign a promissory note to repay.  No, it is on list, notes for consumer financing not a note under federal securities laws.  ―Context otherwise requires.‖  Did not have in mind to federalize auto loans.  Dealership would be protected, not me anyway.  This is more of we will know it when we see it test.  They are loaning money to me to make a sale, not to make money off their investment.

THE SECURITIES MARKETS Introduction to Securities Markets; The Efficient Market Hypothesis  Exchange: Physical location auction system  Any transactions not on an exchange are OTC  Majority of stock owners are institutional investors  Weak: security prices only affect information embodied in the past prices of that security  Semi-strong: security prices reflect all publicly available information  Strong: security prices reflect all information, whether publicly available or not  The Efficient Capital Market Hypothesis  Theory that describes the relationship between significant information and changes in the stock price.  The idea is that significant disclosures would affect the price of stock to move.  Institutionalization and the efficient capital market hypothesis.  Institutional investors are ―sophisticated‖ and as such their reactions to disclosure cause immediate movement and the financial power to purchase a lot of stock, leading to an increase in stock price rapidly.
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 If you subscribe to the ECMH the price will adjust rapidly due to information disclosures or market disclosures. Why would a stock price increase gradually?  The company is not closely followed by analysts and thus the information disclosed is not as closely followed, utilized, recognized as important or invested in (less investors = less chance to affect price).  This could also represent an inefficient market.  Price did not change rapidly based on public disclosures.  Diverging Opinions. One analyst may read information as positive, another as negative.  The market may have already known of the price. Maybe the public news was actually old news. The market had already reacted weeks ago to this news. Thus, when the news does come out the affect is not as great.  Ex. The market already knows about your earnings – they anticipate your earnings. Thus, earnings reports will not greatly affect the market.  The EMH is a descriptive theory.  New information (significant) will lead to rapid changes in the stock price.  In order for there to be an EMH the stock has to be widely followed and held by several institutional investors.  NYSE is considered an efficient market.  NASDAQ is not. How does the EMH interact with Security Regulations  Once concern: the information is not publicly known. Pieces of the business sector and public learn of information bit by bit. However, a proponent of the EMH would say that it does not matter if everyone knows the information, only that the market knows of the information. The price of the stock is reflected by what the market knows about the stock, not what society knows.  Is the information disclosed reflected in the stock price?  If you assume the market is rational you would expect the price of stock is reflected in its current price.  There is a relationship between disclosures of new information and the price of stock.  The EMH says that the available information on a company creates its true value.  The EMH is premised on the idea that sophisticated investors are following the information released or available on each company.  What about overreactions to market announcements?  Is the actual value of stock presented immediately after the release of information.  What about the incorrect processing of information?  We assume the sophisticated investors are accurately processing available information.  The EMH is disputed.  Others argue that behavioral issues, irrational purchasers, noise, weather, etc. effect the market. Review  The EMH says that information directly affects the market.  What if information is false?  EMH would say that the fraud would increase the price. What happens at that point?  To sue for securities fraud you have to show a misleading statement of material fact, reliance, and damages.  Does the EMH have anything to do with the materiality of information?  Yes. If stock price goes up or down that is evidence that the information was significant. EMH says significant information effects stock price. Thus, materiality is shown.  Sophisticated investors are those expected to understand the market. The consensus of sophisticated investors set price.  If you believe the EMH is correct (believable) then should we require companies to disclose more or less information?  Those who believe it is fundamentally efficient, the true intrinsic price then you want more disclosure. 

REGISTRATION UNDER THE ‗33 ACT The Public Offering Process The Role of the Underwriter; The Initial Public Offering  Section 5 bars any offers to sell and sales of a security until a registration statement covering the security has become effective.  The registration statement contains information about the security‘s issuer, the security, the contemplated uses of the offering‘s proceeds, and the manner of its sale (e.g., its underwriters and the offering‘s proceeds, and the manner of its sale (e.g., its underwriters and their compensation), all with the intended purpose of facilitating informed investment decisions and discouraging the fraudulent promotion of worthless securities.  The prospectus must accompany any written offers to sell the registered security.  Role of an Underwriter: A company will engage the services of an underwriter to help it to sell securities to the public. Underwriter will give advice to the company, such as the offering price for the security and the mix of securities, and will help to make sure the company is in financial shape to go public.  Methods of Underwriting:  Firm commitment: One or more investment banking firms will agree to purchase the securities from the issuer for resale to the public at a specified public offering price.
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Cost of underwriting will be a little less than the public offering price. The difference between the cost of the underwriting and the public offering price is the spread.  Risk of finding the investors shifts to the underwriters. Issuer is guaranteed money.  In typical firm commitment offerings IBK firms organize an underwriting syndicate. Each member of the syndicate agrees to purchase from the issuer a specified amount of the securities and to resell those securities at a specified public offering price.  The syndicate is managed by a managing underwriter who, on behalf of the syndicate, executes with the issuer an ―underwriting agreement.‖  The underwriting agreement spells out the terms of the offering and that amount of securities that each syndicate member is committed to buy or underwrite.  The syndicate members also execute an ―agreement among underwriters‖ that establishes the obligations of each member.  Both the underwriters and the selected dealers agree to sell the securities to the public at a fixed public offering price. The difference between that price and the amount received by the issuer is known as the ―gross spread.‖  The spread may range in size from a fraction of 1 to 10% or more of the public offering price depending upon a number of factors, including the characteristics of the security, the risk to the underwriters, the amount of selling effort required and the cost of distributing the security.  Underwriters under firm commitment agreement have two risks:  Failure to resell.  That ties up capital. Shows you overvalued the stock.  These provisions are too protect the underwriter from failure to resell to the public.  This risk is protected through the market-out clause, Formation of syndicate, Lock-up Agreement  Section 11 risk. Misleading statements of material fact in registration statement. Underwriters do not want to be held liable for the false statements. Company would always be strictly liable, underwriters are liable unless they acted with due diligence.  The underwriting agreement tries to protect the underwriter from these risks: Comfort Letter; Indemnification; Contribution; Representations; Attorney Letters  Best efforts: Broker-dealers do not purchase the securities from the issuer but instead agree for a fee to use their best efforts to sell the securities on behalf of the issuer at the offering price.  Risk remains with the company  The Underwriter acts as an agent.  Straight Best Efforts: Any securities sold to investors remain sold. There is no minimum amount of securities that must be sold as a condition to the deal closing and the underwriter earning its commission. E.g. If the company wants to sell 10M shares, and the underwriter can only find interest for 6M shares, the 6M shares will get sold. If the company really needed the 10M shares, they are not in a good position, because suddenly they are a public company and are subject to the reporting requirements, have investors to keep happy, may be sued, etc.  Mini/Maxi Arrangement: Stipulated minimum amount of all the shares to be sold must be sold during a specific period of time before the offering can close. Proceeds of all sales are placed in escrow until the minimum number of shares is sold. If the minimum number is not sold, the deal falls through and the money held in escrow is returned to the potential purchasers.  All or None Offering: All of the securities must be sold before the deal is completed. The underwriter is still only acting as an agent. NOTE:  If you are unable to get a firm commitment, this usually shows the public that (signals to the public) that the stock may be more risky.  Other signals.  Lawyers used. Good companies get good lawyers.  Private Equity Groups.  Venture Capital Firms  Quality of the offering can be indicated by whether or not the underwriter has made a firm commitment. Best efforts are normally cheaper than a firm commitment, because with a firm commitment, the underwriter must be compensated for the risk of being unable to sell the stock.  Under §11, Congress created an express private right of action if the registration statement includes a material misleading statement of fact. Investor can sue signatories to statement, accountants, underwriters, directors of company, etc. for negligence. Thus, when an underwriter takes a company public, it becomes liable for the statements contained within the registration statement. Underwriter must also be compensated for the risk of being sued under §11.  How do you select an underwriter:  Reputation  Better Advice from better company  Relationship  Ability to publicize  Dutch Auctions

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Under the Dutch auction technique, the issuer solicits bids from institutions and broker-dealers for any amount of securities, each bidder wishes to acquire; the bidder states the amount of securities it wishes to purchase and the amount it will pay for those securities.  All bids are irrevocable offers to purchase that amount of securities (unless withdrawn before the preset time for closing all bids).  At closing, the bids are arrayed with the highest bid price first and lowest bid price last. The issuer first accepts the bid with the highest price for the amount of securities covered in that bidder‘s bid; other bids are accepted at successively lower prices for the amount of securities covered in such bid until the issuer has placed all the registered securities. The lowest price accepted by the issuer through this process is the price paid by all the bidders whose bids were accepted through the process.  The final underwriting agreement is an amendment not an exhibit to the registration statement. Why?  The underwriting agreement is not agreed to until the stock is registered. How can an underwriter contract to reduce risk?  Market Out Clause: Clause that permits the underwriters to withdraw at any time prior to the public offering if one of several exigent circumstances develops: (1) Government or an SRO imposes restrictions on the trading of securities in general; (2) there is a war or other national calamity; (3) there has been a material adverse change in markets (either generally or for the distributed security); or (4) here has been a material adverse event affecting the issuer [e.g. lawsuit for accounting fraud]  Market out clauses are almost never exercised. Hurts underwriter‘s reputation not to follow through with public offering. bad business to not follow through, hurts their reputation  Lock Up Agreement: E.g. If the underwriter determines that there is enough interest for the public to buy $10M shares, the underwriter will not want the company to sell additional shares to the public at the same time of the offering on their own. Directors and officers and employees might have purchased stock prior to the public offering. Don‘t want them to start selling their stock on the exchange at the same time as the offering, because will make it more difficult for the underwriters to sell their shares.  Indemnification/Contribution Provision  Indemnification: Requires the issuer to indemnify the underwriters for any liability they may incur under federal or state laws because the registration statement or prospectus is materially misleading. Standard indemnification clause usually makes an exception for omissions and misstatements of matters peculiarly within the knowledge of the underwriters.  Note: Court might decide not to enforce indemnification provision for public policy reasons. § 11 makes the underwriter potentially liable for misleading statements in the registration statement in order to encourage underwriters to be careful. Indemnification goes against this.  Contribution: If the underwriter cannot shift their liability by indemnification or by a comfort letter, their fallback position is a provision for contribution among those found liable under the registration statement. Underwriter can seek contribution from company for company‘s share of the liability.  Comfort Letter:  Underwriting agreement may require that prior to the registration statement becoming effective, certain individuals must provide the underwriter with comfort letters covering certain specified representations made in the registration statement. Issuer‘s counsel and accountants will be required to provide letters, as will outside counsel and underwriter‘s counsel. Comfort letters state that there are no material adverse judgments against the issuer, financial information is okay, comfortable with the deal, no misleading statements in the registration statement.  Comfort letter is a device by which the underwriters can recover on a theory of negligent or fraudulent preparation of the comfort letter for any liability the underwriters incur to investors, provided the sued-upon misrepresentations were the subject of the comfort letter.  Representations and warranties: E.g. issuer will warrant that the registration statement is free of materially misleading statements. Underwriter can sue for damages if the issuer breaches the representations and warranties.  Attorney Letters: At times the underwriters want lawyers to writer that there are no representations in making registration statements. Underwriters could then sue for negligence

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The Registration Statement  Registration Process  Going Public:  Get financial statements audited  Company may have to reincorporate in DE.  Recapitalize  Reorganize  Alter SH rights  Governance  Work with underwriters:  What securities issued  What percentage of company will we sell  Amount we want to raise.  Prepare a registration statement.  What information do investors want to know before purchasing the stock?
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 Information about the management of the company  Use of proceeds  What the company does (description of business)  Balance sheet information, e.g. statement of cash flows  Risk factors, e.g. things that might make a business unprofitable  What securities are being sold/offered, terms of the securities, how many shares  Capitalization of the company (has the company sold securities before?)  Who are the underwriters and how are they getting paid? Information that must be found in a registration statement:  Information bearing on the registrant  Detailed description of the registrant‘s business, property and management.  Summary and risk factors section are very useful to investors. These sections must be written in plain English.  Financial statements, including audited balance sheets, income statements, statements of change in financial position  Management‘s Discussion & Analysis of registrant‘s financial condition and results of operations. Management should identify trends and developments that it has reason to believe will affect the registrant  Any changes in or material disagreements with outside accountants over accounting or financial disclosures  Information about the distribution and use of its proceeds  Underwriters in privity with the registrant must disclose the general terms of their agreement and their compensation.  Net expected proceeds of the offering must be disclosed  Registrant‘s plans for the proceeds must be disclosed  More detailed disclosure of the proceeds‘ use is required if the proceeds will be used to discharge [pay off] indebtedness or to acquire assets other than in the ordinary course of business or to engage in acquisitions of other businesses.  A description of the securities of the registrant  Rights, privileges and preferences of the security being offered, including any provision that would subordinate their rights to the rights of other security holders or restrict the registrant‘s ability to incur indebtedness or the payment of dividends.  Substantial disparities between the public offering price for an equity security and the price certain insiders acquired the security for within the past five years  Various exhibits and undertakings that must be filed as part of the registration statement  Registrant‘s articles of incorporation, bylaws, attorney‘s opinion as to the legality of the securities registered, any 10-K or 10-Q reports incorporated by reference. The Registration Statement  Prepared by Company‘s L.  Generally speaking, however, it is outside counsel that does the work for them.  Why?  It is not their specialty; companies not public companies have attorneys not familiar with registration laws and disclosure requirements.  So much work, in-house does not have enough persons.  Underwriter/Underwriter‘s Attorneys  Involved in reviewing registration statement.  Forms of Registration Statements:  S-1  What information is generally found on the S-1  Two kinds of information:  Information about company  Who the company is; Business; Financial statements; Management  Information about the offering/transaction  Price  Process takes 2-3 months to get 1st draft of statement together.  Following completion of the Registration Statement what do you do:  File registration statement with SEC.  Federal Securities laws say that you cannot sell a security unless the (―registration statement‖) RS is declared effective.  Filed with division of corporation finance.  They will read the filing and give comments – Comment Letter  Comments are both picky and substantive.  Substantive:  Provide additional disclosure  Alter language to prevent misleading language  Provide back up information  Provide support for assertions  The SEC‘s involvement in the process is another pair of eyes.
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 They help to protect you from § 11 liability. For Companies that is strict liability.  Speeds up approval – there is importance in what date the registration statement becomes effective.  How does a company respond to a comment letter:  Make applicable changes and refile. This is known as filing an amendment.  You will then likely receive another comment letter.  File another amendment  Then possibly another comment letter. § 8(a) says registration statement becomes automatic after 20 days. This does not happen.  SEC gets out Comment Letter in 30 days.  How do we solve this problem?  In order to prevent the registration statement from becoming effective in deficient form automatically after the twenty-day statutory period, issuers include a legend, referred to as the "delaying amendment," on the facing page of the initial filing of the registration statement. The delaying amendment postpones the automatic effective date of the registration statement until the issuer has amended the registration statement to comply with the comments of the Commission's staff. Rule 473 provides for delaying amendments.  Also, Look to § 8 regarding Amendments. Every time you file an amendment it begins the 20 day clock again. When the issuer has finally amended the registration statement to the satisfaction of the Commission's staff and is ready to initiate the public offering, the issuer will then request that the Commission "accelerate" the effective date of the registration statement. Under Section 8 of the 1933 Act, the Commission has authority to set the effective date of a registration statement earlier than the twentieth day after filing of a registration statement or any pre-effective amendment. The Commission is authorized also to fix the effective date of an amendment to the registration statement filed after the registration statement has become effective. In practice, the effective date is accelerated to a date specified by the issuer by letter to the Commission received at least two days before the requested effective date.  You don‘t want this denied acceleration, thus you kindly work with the SEC until you need this. Registration statement is effective  Price is set  Stocks can be sold Pricing Amendment:  Make post-effective amendment R. 430A. Amended Prospectus with price.  The last piece of information filed is the price amendment; to have filed this information months or even days earlier would have subjected the underwriters to the unbearable risk that the market may turn against them before the effective date of the registration statement.  Rule 430A allows the registration statements covering an offering of securities for cash to become effective without price-related information, provided such information is made available by a supplement to the prospectus within 15 business days of the effective date. Price-related information provided more than 15 days after the effective date requires the filing of an amendment to the registration statement. As will be seen later in this chapter, a costly consideration for any post-effective amendment to the registration statement is that it resets the liability clock under Section 11. Thus, any information that was accurate when the registration statement initially became effective, but that is rendered false by a supervening event, can be the basis for liability under Section 11 if a post-effective amendment is made to the registration statement without correcting the information rendered false by the supervening event. Formal proceedings if registration statement is deficient or misleading  §8(b): SEC may issue an order refusing to permit the effectiveness of a registration statement if the registration statement appears to be incomplete or inaccurate in any material respect.  §8(d): After the registration statement has become effective, SEC may issue a stop order suspending the effectiveness of an effective registration statement if SEC determines that the registration statement includes an untrue statement of material fact or fails to state a material fact required to be stated or necessary to make the statements in the registration statement not misleading.

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S-3  Reporting Companies  They have filed 10-Ks and 10-Qs, proxy statements, etc.  Public companies have thus already produced a lot of publicly available information.  Thus, the company information is already out there. So, why file a registration statement that contains information about the company.  We still need information about the offering. Certain companies must file a registration statement that only discloses information about the offering – S-3 Form (short form registration statement).  At the back of the S-3 the document will incorporate certain materials by reference – those materials already disclosed.  Unseasoned Issuers (reporting issuers that fail to meet the eligibility requirements of Form S-3)  There are different types of S-3 issuers:
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Well-Known Seasoned Issuers (Super S-3)  In 2005 the SEC created a super subset of issuers eligible to use Form S-3, called "well-known seasoned issuer" (WKSI). Falling into this group are any issuer with a common stock market capitalization (excluding shares held by affiliates) of $700 million or, in the case of a debt offering, an issuer that in the prior three years has offered $1 billion in non-convertible securities other than common stock You can also be a WKSI eligible to use Form S-3 for an common stock offering if you meet to $1 billion non-convertible securities test and have common stock float of $75 million. For such issuers, the SEC provides the most flexible registration procedures, which it refers to as an "automatic shelf registration process."  Have to file S-3  BUT,  Registration statement is effective immediately on filing. SEC will not review filing. No need to worry about comment letters, review, etc.  Registration statement is effective for three years. (well-known shelf registration)  You can do several offerings in three years without having to file additional registration statements.  Cannot do this under S-1, nor can seasoned issuers.  This provides a big advantage:  IR change, shelf registration allows you to respond quickly and react to low interest rates. Sell notes when rates are low.  Register now and put them on the shelf and then sell later.  Seasoned Issuers (those that are not well-known seasoned issuers but can avail themselves to Form S-3 namely 12 months of timely Exchange Act Reports)  Provided on S-3 Form  2 requirements to be aware of:  (1)(A) Registrant Requirements: (1) Reporting Company for (2) 12 months in (3) financial soundness.  Company must be a reporting company  Companies who have securities traded on a national securities exchange -- NYSE  Companies with more than 500 equity security holders of record and more then 10 million in assets – like many of those on Nasdaq.  You must have been a reporting company for 12 months and timely filed reports.  You have to be in good financial health. Company must be paying bills. Can‘t have failed to pay a dividend.  (1)(B) Transaction Requirements: Public Float  (1)(B)(1)Primary offering by certain registrants  Public float of 75 million of more.  Float = Assume stock traded at 20, 13 million of common stock outstanding, 3 million held by corporate insiders. Public Float = 200 million [10 million shares at 20/share]  Why have public float rule? To ensure that we know that the company is being followed by the public/analysts.  Third Pseudo-Requirement: The issuer can‘t be an ineligible issuer  Companies the SEC felt should not be able to take advantage of rules.  Companies historically suspicious, blank check companies, shell companies, companies with involuntary bankruptcy filing against them, companies that have had SEC stop order, companies that have violated SEC fraud rules in last three years. We therefore see that the SEC through its forms and regulatory requirements has identified four distinct classes of issuers:  Well-Known Seasoned Issuers;  Seasoned Issuers (those that are not well-known seasoned issuers but can avail themselves to Form S-3 namely 12 months of timely Exchange Act reports);  Unseasoned Issuers (reporting issuers that that fail to meet the eligibility requirements of Form S-3); and  Non-reporting issuers (an issuer that is not required to file Exchange Act reports). Difference between a prospectus and registration statement  Registration statement is the document that gets filed with the SEC. It has all of the exhibits and includes information not required in the prospectus. Most documents are in both the registration statement and the prospectus. Investors get the prospectus—glossy cover—ends where it says ―Information not required in the prospectus.

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Communications During the Registration Process The Pre-Filing Period  Section 5's regulatory demands concern three stages:  Prefiling Period: Time prior to the filing of a registration statement  Waiting Period: Begins with filing of registration statement with SEC and continues until SEC says the registration statement is effective.  Post-effective Period
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Section 5(c) prohibits any offer to sell or offer to buy prior to the filing of a registration statement.  Even after a registration statement is filed, the constraints of Section 5(c) reappear if that registration statement "is the subject of a refusal order or stop order or (prior to the effective date of the registration statement) any public proceeding or examination under section 8." Under Section 5(a), no sales or deliveries of sold securities can occur until the registration statement is effective. After the registration statement is filed and even after it is effective, Section 5(b)(1) requires that all written offers to sell be in connection with a prospectus that complies with Section 10 of the Act. Section 5(b)(2), a final prospectus must accompany any transportation of the securities to investors. The jurisdictional reach of each of the provisions in Section 5 is the same, namely, the use of any means or instruments of transportation or communication in interstate commerce or the mails. Definition of interstate commerce in Section 2(a)(7)  It includes buying or selling securities over interstate commerce. If either the security is exempt or the transaction qualifies for an exemption, the regulatory demands of Section 5 do not apply. Gun Jumping  During pre-filing period you cannot offer to sell/buy a security. Why?  We want full disclosure of information that adequately presents risk of the security.  The basic principle of the Securities Act that the health of the capital markets requires that new issues be marketed upon the basis of full disclosure of material facts under statutory standards of accuracy and adequacy and in accordance with the procedural requirements of Section 5.  The only way people can make informative investment decision is to have that information filtered through our statutory requirements.  The breadth of this prohibition is assured by Section 2(a)(3)'s definitions of "offer to sell," "offer for sale," and "offer," which include "every attempt or offer to dispose of, or solicitation of an offer to buy, a security or interest in a security, for value."  SEC/Court Interpretation:  Communications used in conditioning the public mind or arousing public interest in the issuer or in the securities of an issuer in a manner which raises a serious question whether the publicity is not in fact part of the selling effort.  You do not need an express offer to meet this definition. Selling efforts consisting of press releases, press conferences and general publicity meets this.  How do you as an attorney decide whether the press release would violate any rules?  Stick to facts, don‘t mention offer. The SEC has issued releases of what it feels constitutes impermissible offers and what does not.  The closer you stick to just the facts the better you are.  Look at timing. Google, Playboy Magazine.  You may never disclose the name of your underwriter. That allows companies to know that there is an agreement in place, you know the prestige of the broker and know who to contact to get in on the offer.  If you tell someone simply that you are planning to go public is that a violation? Possibly, it depends on what you say. See 135. You can give facts about offering. You cannot attempt to drum interest about the offer.  Conditioning the Market  An issuer, underwriter or dealer may not legally begin a public offering or initiate a public sales campaign prior to the filing of a registration statement.  It apparently is not generally understood, however, that the publication of information and statements, and publicity efforts, generally, made in advance of a proposed financing, although not couched in terms of an express offer, may in fact contribute to conditioning the public mind or arousing public interest in the issuer or in the securities of an issuer in a manner which raises a serious question whether the publicity is not in fact part of the selling effort.  Cannot be designed to awaken an interest which later would be focused on the specific financing to be presented in the prospectus shortly to be sent to the same mailing list.  Information cannot be released that is in contemplation of a public offering by the issuer at or about the time of its delivery.  There is a specific line between releasing newsworthy information and conditioning the market.  If the line is crossed, the issuer has violated Section 5, which results in a revocation of broker-dealer registration and they may be expelled from membership in the NASD.  Arousing and stimulating investor and dealer interest by eliciting indications of interest from customers to dealers and from dealer to underwriters, to set in motion the processes of distribution.  Done through releasing descriptive material concerning the properties, business, plans and management. Furnishing reporters with price data, and registrants were named as the managing underwriters thus permitting, if not inviting, dealers to register their interest with them.  Section 5(c) is equally applicable whether or not the issuer or the surrounding circumstances have, or by astute public relations activities may be made to appear to have, news value.  Is Publicity an offer?  Timing of decision to undertake publicity.
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 Was decision to publicize made before or after decision to go public Think about whether advertising is a continuation of previous publicity or something different  Same advertisements in same mediums, to same size audience.  Distinguish between factual/promotional information.  If you stick to the facts you are going to be okay. What happens if a company ―jumps the gun?‖  SEC can refuse to accelerate the registration statement and will impose a 30-day cooling off period.  SEC can bring an enforcement action. Brokerage firm can have their license rescinded and be sanctioned.  Private right of action under §12: individual investors can sue for violations of §5. 4 New Rules -- Exemptions During Pre-Filing Period  30-day bright line exemption  163A  Well-Known Seasoned Issuer exemption  163  Public Company: Factual Information and FLS exemption  168  Non-public company: Factual information exemption.  169  NOTE: There is also R. 135, notice of offering during pre-filing period. 30-Day Brightline Exclusion.  Rule 163A provides all issuers a bright-line time period, ending 30 days prior to filing a registration statement, during which the issuers or those acting on its behalf can communicate without violating Section 5.  However, this protection is not without important qualifications.  First, the communication must be made ‗by or on behalf of the issuer‖ so that communications by other distribution participants are not shielded by Rule 163A, even if made more than 30 days prior to the filing of a registration statement.  Second, the communication cannot make any reference to the securities offering.  Third, the issuer must take reasonable steps to prevent further distribution or publication of the communication during the 30-day period immediately before filing the registration statement. The 30-day exclusion does not apply to certain types of offerings, such as blank check offerings or business combinations  NOTE: strictly factual information will not get you in trouble under 5(c), so this rule is for non-factual information. This rule lengthens the old quiet period (which began when underwriter was hired), now we just have to shut up for 30 days. Well-Known Seasoned Issuers.  Rule 163 permits such issuers to engage in unrestricted oral and written offers before a registration statement is filed.  Several important conditions.  First, it applies only to communications ―by or on behalf of‖ the issuer, thus eliminating communications by other distribution participants.  Second, to invoke Rule 163 a written offer made prior to the issuer filing a registration statement must be filed ―promptly‖ with the Commission when the registration statement is ultimately filed and must bear the legend required by subsection (b)(1) of Rule 163.  If the issuer has filed a registration statement, the written offer is treated as a ‗free writing prospectus,‖ discussed below, and must be filed with the Commission. Rule 163(b)(1)(iii) and (b)(2)(iii) excuse ‗immaterial or unintentional‖ failure to include the specified legend or the failure to file the communication with the SEC, respectively. The excuse is conditioned on there being a ―good faith and reasonable effort . . . to comply.‖ Reporting Company/Issuers:  Factual Business Information and Forward-Looking Statements.  New Rule 168 provides that announcements by reporting issuers that have engaged in the regular release of ―factual business information or forward-looking information‖ will not be treated as an offer to sell a security.  The rule defines factual business information to include factual information about the issuer, its business or financial developments as well as product advertisements.  Forward information refers to such items as forecasts or discussions of future business plans. Rule 168 is also conditioned on the information being of the type the issuer as previously released in the ordinary course of its business and that the manner of its dissemination should be similar to past releases of that type of information.  The protection for forward-looking information concerns such items as earnings forecasts, statements of management‘s plans or objectives, and statements about future economic performance.  Rule 168 applies only to statements issued by or on behalf of the issuer; it does not protect communications issued by the issuer‘s underwriters or other participants in the distribution.  Expressly excluded from the safe harbor is any communication of information about the registered offering itself, although some of this information about the offering is permitted under Rules 134 and 135 discussed below. 

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This protects FLS. Expressly excluded from the safe harbor is any communication of information about the registered offering itself, although some of this information about the offering is permitted under Rules 134 and 135 discussed below. Non-Reporting Company/Issuers:  Factual Information.  Non-reporting issuers enjoy a limited safe harbor in Rule 169 for their communication of ―regularly released‖ ―factual business information.‖  However, unlike the safe harbor discussed above for reporting issuers, the safe harbor provided in Rule 169 applies only to factual information (i.e., it does not extend to forward-looking information) and this type of communication is protected only if intended audience is not investors but others such as customers and suppliers. Rule 135.  Rule 135 provides it is not an offer to sell securities if the issuer (as well as those acting on its behalf) releases certain information about its operations and activities, even though the issuer is in registration.  For example, under paragraph (a) of Rule 135, issuers can disclose their intention to make a public offering and can announce such information as the amount and type of security as well as the manner and purpose of the offering.  On the other hand, Rule 135 prohibits the identification of the prospective underwriters or the security's offering price in the pre-filing release.  Requirements:  Legend  Limited notice content  Notice can include no more than: (1) Name of issuer; (2) Title; (3) Amount; (4) Basic terms; (5) Timing; (6) Brief statement of manner and purpose of offering; (7) Cannot name underwriters  This is a very formal release.  The exemptions like 135 and 168 may be used in conjunction, but we are not sure. We need to know how these exemptions work together. WKSI: Don‘t have to worry about gun jumping at all. S-3 companies can make offers. They are exempt from § 5 so long as they meet a few minimal requirements. How to attack press releases:  Identify period  State the Restriction  Go to 5(c) – cant make interstate offer to sell or buy during pre-filing period.  Identify potential offers  Look to see whether there is an available exemption. How to find an offer:  Remember, during pre-filing period you cannot make an offer, so the SEC will be overly critical when companies are attempting to drum up interest. Information is circulated to investors here.  Look for timing, look to whether they have done things before, who is receiving information.  Timing, format, audience, words, FLS, naming underwriters, etc.

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The Waiting Period  Waiting period begins with filing the registration statement and ends when the registration statement becomes effective.  With the filing of a registration statement, Section 5(c)'s broad prohibitions against offers to sell and offers to buy disappear, and the registrant enters the waiting period.  Even though a registration statement has been filed, Section 5(a) continues to bar sales until the registration statement becomes effective; but with the filing of the registration statement, selling efforts can commence.  The form of all such selling efforts, however, is shaped significantly by Section 5(b)(1).  Section 5(b)(1) renders it "unlawful . . . to carry or transmit any prospectus relating to any security with respect to which a registration statement has been filed . . . unless such prospectus meets the requirements of section 10." When making selling efforts you must present § 10 prospectus.  What is a prospectus?  Prospectus is defined broadly in Section 2(a)(10), so that any written communication, as well as radio and television transmissions, is deemed to be a prospectus whenever a communication through such medium offers a security for sale or confirms such a sale.  Oral offers to sell are not within the definition of a prospectus.  What are the requirements under § 10?  Deals with final and preliminary prospectuses.  Cannot use unless it contains mandated information:  Should contain information in the registration  Only allowed to use prospectus unless it uses lots of information  What is a prospectus? § 2(a)  Statutory prospectus – meets requirements of § 10.  It differs from registration statement because the ―wrap‖ is gone.
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Definition of prospectus § 2(a)(10) is broader than that of statutory prospectus.  Communication (2 things concerned about):  Medium – written, radio, TV  Content – offers; or confirms the sale of a security In order to allow sufficient selling efforts to commence without those efforts being labeled prospectuses not in line with § 10, the Commission took the position that a written communication that included the information then on file as the issuer's registration statement was not an offer to sell. This regulatory flexibility thus permitted written offers to be made during the waiting period using a prospectus popularly known as a "red herring," an expression reflecting the legend printed in red on the cover page of the prospectus giving notice that the red herring was not an offer to sell a security, that the security described therein was not registered, and that no sales could occur until the registration statement became effective.  In sum, the Commission nimbly sidestepped Section 5 by rationalizing that distribution of the red herring was not a solicitation, but solely informational.  The use of the red herring was legitimized with the 1954 Amendments to the Securities Act, so that today Section 10(b) expressly empowers the Commission to adopt rules for prospectuses that either do not include all the information found in a final prospectus or summarize such information. Identify the Prospectuses.  If you are in the waiting period and broker send note to see if you want to buy, this is a prospectus. This is a ―free writing prospectus.‖ Can you use a prospectus during the waiting period?  Yes. If it contains the information contained in § 10  During the waiting period, no offers can be made unless they are accompanied by a statutory prospectus (§ 10(a) or 10(b))  Reason: Informed investor What can you do and what cannot you do during the waiting period?  Selling Efforts During Waiting Period  Oral Offers  Not within the definition of a prospectus  Tombstone Ad  Identifying Statement  Free Writing Prospectus  Those involved in the distribution frequently generally desire to circulate among potential investors information that is not contained in the registration statement. An example of such information is an analyst‘s report. Such supplementary information is generally referred to as ―free writing‖ and prior to the SEC‘s adoption in 2005 of Rules 164 and 433, free writing was possible only after the registration statement had become effective and even then was subject to fairly tight conditions.  As we have seen, Section 2(a)(10) deems any written communication to be a prospectus and Section 5(b)(1) mandates that distribution participants can only use a prospectus that meets the requirements of Section 10 (i.e., a preliminary or final prospectus or a summary prospectus). Absent any other exemptive language, this forecloses distribution participants from using any written communications to supplement the statutorily mandated prospectus.  Under new Rules 164 and 433, free writing is now possible during the waiting period for most issuers, provided certain conditions are satisfied.  Hypo: Company is in waiting period. A broker wants to drum up interest in the offering. The broker finds articles about the company, copies the articles and sends them to a client.  Before the new rules, was this a violation of gun jumping rules.  Is it a prospectus?  It is written  Concern is whether it is an implied offer  Do the positive news article arouse interest or condition the market? Probably  Prior to the new rules, it would be a violation b/c it doesn‘t contain all the info required in a preliminary prospectus under Rule 10(b). This used to be called Failed Free Writing  not allowed to circulate supplemental sales literature. Under old rules, flunks 5(b)(1)  Under new rules: Free writing during waiting period is permissible for most issuers so long as specific requirements are met. Rule 164(a)  164 provides a safe harbor if comply with 164 and 433, that writing will be deemed to meet the requirements of §10  Conditions to Rule 164  Depends on whether the issuer is a seasoned issuer or WKSI vs. a non-reporting company or unseasoned issuer  Rule 433 conditions  Delivery [to investors]  Unseasoned or non-reporting company. Can use free writing but the free writing prospectus must be accompanied by or preceded by a statutory prospectus. Physical delivery of prospectus.

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During the waiting period this would be either a preliminary prospectus or a summary prospectus and for non-reporting issuers and unseasoned issuers this requires that the prospectus includes the security‘s price range.  Such a need for a prospectus applies only when the supplementary material has been prepared by the issuer or offering participant or has been paid for by one of them.  Once the required statutory prospectus is provided to an investor, additional materials can be provided without having to provide an additional statutory prospectus, unless there is a material change in the most recent statutory prospectus.  Seasoned or WKSI company. Only need to provide a link: can access a copy of the prospectus by going to this website  Legend—must contain info. There is the universal condition that any free writing prospectus must include a legend indicating where the prospectus is available from the underwriters through a toll-free number and advising investors that registration materials can be accessed through the SEC‘s website.  Filing (with the SEC)  If you are using free writing during the waiting period, the issuer must file that free writing with the SEC  General rule for underwiters: don‘t have to file it Preliminary Prospectus—430  Rule 430 provides that prior to the effective date of a registration statement, Section 5(b)(1) is satisfied by the use of a prospectus that includes substantially the same information that will ultimately appear in the final prospectus under Section 10(a), except the preliminary prospectus may exclude the offering price, underwriter and dealer compensation, amount of the proceeds, and conversion rates, call prices, and other matters dependent on the offering price.  This prospectus is called a preliminary prospectus and bears a legend much like that of the old red herring as well as the caption "Preliminary Prospectus," each printed in traditional Commission red.  Determining what is a preliminary prospectus  The price is not listed on a preliminary prospectus. Red ink ―Subject to Completion.‖ Red legend: information is not complete and may be changed—red herring.  Why is this permitted? It is a writing, it is an offer to sell a security. Therefore it is a prospectus so long as it satisfies § 10.  How do we know this satisfies § 10? It contains all the info in reg. statement except for price information.  Rule 430: permits preliminary prospectus because meets 5(b)(1). 2(a)5(b)(1)10 430 Road Shows  Explaining to other participants of the offering what the security and company is about  Players:  Potential underwriters, Selling group members, Managing underwriter, Issuer, Institutional investors  These used to take place in person, but now they are sometimes electronically broadcast  In old fashion roadshows (everybody is sitting in the same room)  this is not a prospectus b/c it is oral and not by radio or television  Newer electronic road shows  broadcast live to another room  May be a prospectus under old rules  New Rules Clarify this  Graphic communication  considered in writing  Can be viewed at a later time, not in real time  If in writing, not a prospectus Hyperlinks to the Prospectus  During the waiting period, the issue is whether information on a web site is a "prospectus" because it conditions the market; if so, Section 5(b)(1) is violated if the web site information does more than replicate the information in the Section 10 prospectus.  Placing the preliminary prospectus on the issuer's or underwriter's web site does not itself import the web site's other information into the prospectus or render that information a part of the offering process.  However, hyperlinks between the prospectus and other web site information bundles the documents together so that for regulatory purposes they will be seen as an offer to sell the distributed security.  Absent a hyperlink, the outcome turns on the murky inquiries whether the web site's content is an "offer to sell" and whether the prospectus and other materials are in "close proximity" to one another.  The latter inquiry has come to be called the "envelope theory," because outcomes turn on analogies to the paper-based setting, where such questions are resolved by the prospectus and other forwarded information sharing the same delivery vessel.  When the web site contains both a prospectus and other information about the issuer, the SEC envisions a virtual envelope by admonishing that "the web site content must be reviewed in its entirety to determine whether it contains impermissible free writing.‖  This position is now embodied in Rule 433(e) so that the linked information is a free writing prospectus subject to the filing requirements of Rule 433(d).
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However, pursuant to Rule 433(e)(2), historical information about the issuer that is so identified and appears in a separate section of the website is not considered to be an offering of the security so that this information is not considered free writing.  Dealing with the Media  If the issuer or those acting on its behalf prepares, pays, or gives consideration for the preparation of a communication in the media, this is treated as a free writing prospectus and must satisfy all the conditions of Rule 433 (to the extent the information exceeds that permitted by Rule 134).  By Contrast, if the communication is not so prepared or paid for – as would be the case where the issuer simply grants an interview to a journalist when then writes a story for publication - Rule 433(f) does not require that there be delivery of a statutory prospectus and provides that the filing requirements of the rule are satisfied if a copy of the story is filed with the SEC within four business days after becoming aware of the publication. Alternatively, the issuer can file a transcript of the interview with the reporter or filing all the information that was provided in the interview. NOTE: 12(a)(2) anti-fraud is in play for materially misleading statements found in prospectus.

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Post-effective Period  You can now sell securities.  § 5 places restrictions on communications and other actions during post-effective period.  § 5(b)  (b)(1) Prospectus must comply with § 10. This section applies to waiting period and post-effective period.  You cannot use a prospectus unless it complies with § 10.  (b))(2) If issuer/broker delivers stock certificate to buyer they have to accompany or proceed that delivery with a final prospectus.  Many persons do not receive a stock certificate. You are the beneficial owner, not the record owner. Normally, the record owner is the broker.  3 main issues to be concerned with during post period.  Confirmation of sale  Delivery of a stock certificate or actual security  Free Writing (supplemental sales literature)  Confirmation of Sale  After security sold (security bought by investor), the broker will confirm trade through confirmation. This will memorialize the transaction. In the old days this was done by mail, now done by email.  The confirmation of sale can run afoul of 5(b)(1). If the confirmation is sent interstate and is a prospectus [2(a)(10) a prospectus is a communication (medium—television or radio)(content—in writing) that offers a security for sale or confirm the sale of a security] it violates § 5(b)(1) unless it meets requirements of § 10.  Under § 5(b)(1) you have to meet § 10. However, under the FWP rules, this type of information is permitted during the waiting period. What about the post-effective period?  Under old rules, the confirmation would have to be accompanied or preceded by a prospectus. See old § 2(a)(10). Under that section, the term prospectus states that a communication accompanied with a § 10(a) prospectus would be exempted from §5(b)(1). This was the old FWP exemption. Before the new rules the only way you could send out a confirmation of sale would be to send along a final prospectus. This is no longer necessary.  New R. 172(a).  Rule 172(a) exempts from Section 5(b)(1) written confirmations (as well as notices of allocations that will be made from a registered offering). Absent this exemption a written confirmation or allocation notice would have to be accompanied or preceded by a final prospectus. Now brokers can confirm a sale or inform an investor of the exact number of shares they will be allocated in a distributed security without having to provide the investor with a final prospectus.  It is enough that you filed the final prospectus with the SEC. 172 final prospectus must meet requirements of § 10(a).  The next significant change is Rule 172(b)‘s relaxation of the prospectus delivery requirements when the registered securities are to be transferred.  Recall that after a registered offering has become effective that Section 5(a) permits sales of registered securities to be consummated and that Section 5(b)(2) provides that registered securities cannot be carried in interstate commerce unless accompanied or preceded by a final prospectus.  Rule 172(b) provides that Section 5(b)(2)‘s obligation to forward a final prospectus when delivering securities is satisfied if the issuer has filed with the Commission a prospectus meeting the requirements of Section 10(a) – provided also that the registration statement is not then subject to a administrative enforcement.  During post-effective period if you see a question involving the confirmation of sale you:  (1) Confirmation is a prospectus under § 2(a)(10).  (2) Prospectus must meet § 10 under § 5(b)(1)  (3) To send confirmation of sale during post-effective period without sending prospectus you follow new R. 172.  § 2(a)(10) may now be obsolete. 172 no longer forces us to provide a physical prospectus, likely however, are there carve outs where only 2(a)(10) would work.
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Delivery of Stock Certificate  § 5(b)(2). Physical Delivery of Stock certificate. You cannot deliver stock certificate unless you accompany or proceed delivery of stock certificate with final prospectus.  172(b) tells us that § 5(b)(2)‘s obligation to forward a final prospectus when delivering securities is satisfied if the condition of paragraph (c) is met. The final prospectus has to be on file with the SEC. Free Writing  Supplemental sales literature (we have already learned that these items may be sent out during the waiting period). These efforts can continue during post-effective period.  However, there is a potential issue or concern in that the FWP may reflect  It may be a prospectus (§ 2(a)(10))—supplemental sales literature is a prospectus when it is in writing and offers/confirms securities for sale. This subjects us to §5(b)(1), which requires a prospectus to meet § 10 requirements. Most supplemental information will fail to meet § 10 statutory requirements.  To avoid having to send out a final prospectus. You have to meet free-writing conditions. § 164 and § 433 lay out conditions.  If you cannot meet the new rules, then you use § 2 (a)(10), which requires a physical copy of the prospectus to be sent to the investor. Exemptions  Exemptions exempt parties from § 5.  You can sell a security without registering with SEC.  You do not have to worry about gun-jumping provisions. §4 exemptions.  §4(1): Registration requirements of §5 do not apply to transactions by any person other than an issuer, underwriter, or dealer.  §4(2): Registration requirements of §5 do not apply to transactions by an issuer not involving any public offering  §4(3): Registration requirements of §5 do not apply to transactions by a dealer [including an underwriter no longer acting as an underwriter] except:  (B) transactions within first 40 days of post-filing period. After 40 days the exemption applies to dealers.  174 (p.80) broadens § 4(3).  In order to understand § 4(3) you have to read it in conjunction with R. 174.  A dealer must deliver a prospectus during the 40 days after the LATER OF the registration statement‘s becoming effective OR the security‘s being offered to the public.  If the issuer has not previously sold securities through a registered offering, dealer‘s duty to deliver a prospectus extends to 90 days [applies to IPOs].  (b) Public companies do not have to deliver a prospectus.  (d) Not a public company, but as of offering date is listed on NYSE or NASDAQ no prospectus need to delivered after 25 days after registration filed.  Prior to new rules, a broker had an obligation to deliver a prospectus to meet 5(b)(1) and 5(b)(2) for 25 days if It was an IPO and had no obligation if company was reporting company.  New Rules:  174(h). How long are there responsibilities to deliver under post-effective period?  By complying with R. 172 you meet 174(h) requirements.  172 allows sending of confirmation and transfer of security simply by filing final prospectus with SEC. (send confirmation of sale as long as there has been a filing of final prospectus with SEC).  Thus, if you filed a prospectus with the SEC it seems that so long as the issuer has filed a prospectus with the SEC the broker-dealer has no other delivery requirements.  During after-market period dealers can rely on 172 to satisfy any after-market delivery obligations. Thus, you don‘t really have to worry about § 4 or 174 any more.  During post-effective period, access=delivery for confirmation of sale and transfer of security (172 rules).  All obligations to deliver a prospectus during post-effective period now appear to be removed.  To understand  Post-effective period: confirmation of sale, delivery of stock certificate requires no prospectus if on file with SEC.  What about free-writing used by dealer under post-effective period. Seems that no prospectus is required via 174(h)/172.  §4(4): Broker‘s exemption: If a broker does not solicit her client‘s interest in a registered security, and acts purely in a ministerial function, then she is exempt. E.g. if you call your broker and tell her that you want to purchase a certain amount of shares in a certain company, broker does not have to accompany the confirmation of sale with a final prospectus. R 172 does not have to be met. Analysis for Registration Questions  (1) Identify Company/Issuer  (2) Identify Period  (3) State the Law  (4) Determine whether an offer is made/Identify Prospectuses
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(5) Is there an exemption available

Miscellaneous Registration Topics Shelf Registration  Shelf registration is the registration of securities to be offered on a delayed or continuous basis.  Up until now, have assumed that a company will sell all of its securities on the same day the registration statement becomes effective or within a short period thereafter.  Sometimes a company will want to make a delayed or continuous offering of the securities. The company will register all of the securities today and will sell them over a longer period of time, or sell them all at some point several months after the registration statement [registering the distribution of the securities] becomes effective.  Why would a company want to delay selling securities?  Wait for favorable market condition. Once the market is favorable, can move the securities quickly. (Interest rates (if selling debt, want to wait until interest rates are low) or price (if selling stock)).  Company might need money later. If a company wants to acquire another company, sometimes rather than using cash, the company will use its own stock. Company will want its stock to be all ready in storage for it to use for business combinations.  Stock as compensation. If giving stock as compensation, company will want to have it on hand; will not be able to wait to register it later.  Convertible stock. Company is selling one kind of security, but it is convertible to another kind of security. Company needs to have stock available to be able to comply with the conversion request. Bond/debenture can be converted to stock.  Warrants, options. Company will give someone an option which gives the person the right to exercise the option and buy stock later on. Company will need enough stock so that when the person exercises their right, the company can sell them the stock.  Dividend reinvestment. If investor reinvests his dividends and purchases more stock, the company will need to have stock on hand for reinvestment.  Takeovers. If companies want to use their stock for business combinations they will have stock on hand.  At first, the SEC was very restrictive in allowing this, why?  The registration statement could be ―stale.‖ When stock is on shelf, registration statement becomes older and financial statements, risk factors, future proceeds, and management may have changed. Lack of proper investor information.  Rule 415: Provides for delayed or continuous offering and sale of securities.  Requirements: Securities may be registered for an offering to be made on a continuous or delayed basis in the future, provided that registration statement pertains only to:  List of offerings:  (iii) options, warrants or rights  (iv) conversion  (viii) securities to be issued in business combinations.  Securities above may only be registered in an amount which the at the time the registration statement becomes effective, is reasonably expected to be offered and sold within two years from the initial effective date of the registration.  This is essentially a codification of the existing rules. Traditional self-registration.  Non-traditional self registration was also added.  (x) is a non-traditional self registration.  S3 companies can register now and sell later and don‘t have to give a reason for it. Any S3 company can register now and sell in future.  SEC says that if you want to use a S3 you have to update the information.  Companies registering securities on shelf have to update financials every year and all fundamental information.  They do a lot of this through reference. 10K, 10Q, etc. The S3 will simply deal with offering. They will reference the other items.  How do you register for the shelf?  S3 (P. 173), tells us to check the box if some of the securities to be registered are for the shelf you simply have to check the applicable box on the S3 form.  If you check the box, the registration is not automatically effective, the SEC will review it just like the S1. Once effective the company can sell the securities.  If company wants to use shelf registration, company must comply with Item 512 of Regulation S-K.  Company must file amendments to the registration statement to prevent registration from becoming stale. Any acts or events arising after the effective date of the registration statement that individually or in the aggregate represent a fundamental [major or substantial] change in the information set of the registration statement are required to be disclosed by a post-effective amendment to the registration statement.  Company [Registrant] must update its financial statements annually.  What about the prospectus. Company registers, then 18 months later wants to sell securities. To sell it needs a prospectus  Prospectus as filed with SEC 18 months will not have the price, type of security, amount of each security.  ―Universal Shelf Registration.‖ You can register securities without specifying the amount. They only register the dollar amount with which they want to register. Ex. 20 million dollars worth of securities.  The prospectus that is filed initially, the S3 prospectus is called a ―base prospectus.‖ This prospectus is governed basically on 430B. Base prospectus provided in initial registration statement.
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 The base prospectus can omit the price, the terms of the security, information based on the price of the security. What happens during offering process? Suppose you omit lots of information during filing period. If you take down the stock to sell you have to update the prospectus.  What information has to be updated?  You file the registration statement (shelf). You comply with rules by checking box. The prospectus being used at filing is a base prospect omitting lots of information. When the company takes down securities from shelf to sell, they are using a prospectus. What information has to be supplemented? 430B. Shelf registration benefits qualified companies. Sell securities faster, take advantage of business opportunities, much cheaper.  Underwriting commissions are cheaper in self registration.  Risk is reduced.  § 11 liability  Underwriters argue that the speed at which shelf registrations are completed don‘t give them a lot of time.  So it is not really that.  Failure to sell some of the stock  More of a market exists  The Bought Deal  The idea is that the issuer has leverage. The issuer can go to IIs and offer directly. This creates competition and competition between underwriters. This reduces price.  S3 shelf registrations are cheaper and give more flexibility to issuer. Down sides to shelf registration:  Quality of information. o Dilution of value of stock: If you are interested in buying stock in a company, and discover they have a shelf, you may be concerned that the company could issue the shares at any time and dilute the value of your stock.  To dilute this impact, SEC has said that company only has to register stock and disclose the aggregate amount of money it wants to raise. Public won‘t know the amount of stock the company will choose to issue. ―Universal registration statement.‖ o Disclosure:  Company may have changed, risk factors may have changed, information in company‘s registration statement may be stale. o Due diligence: Concern is that the underwriter will not have an adequate opportunity to conduct thorough due diligence investigation. Quality of information might not be good, because underwriter might not have time to do due diligence in the time period between which the company decides to take stock off of the shelf and when it sells the stock to the public. Underwriters got upset about this because they thought they would be liable for §11 violations for not doing adequate due diligence.  Rule 176(g): SEC has accepted that in a shelf registration, there will be less time for the underwriter to do due diligence. o Institutionalization/centralization of securities or underwriting industries.  S-3 shelf registrations: Who will be able to agree to underwrite a shelf registration within a week? The largest underwriting firms.  People feel that the problem with shelf registration is that it can only be used by the largest underwriting firms, which cuts the smaller underwriting firms out of the business. Bad for investors to cut out the regional/smaller underwriting firms. o Underwriters were concerned that the company would sell directly to institutional investors (mutual funds) and cut out the underwriter altogether.  Institutional investors will not have the benefit of due diligence, but theoretically should be able to take care of themselves.  SEC is afraid that the institutional investor will resell the securities to individual investors in the NYSE, and individual investors will be buying stock that has not been vouched for by an underwriter. WKSI.  New rules, 415, allow WKSI to have automatic shelf registrations. ―Automatic‖ means automatically effective, effective upon filing. You do not need SEC review to make it effective.  Under our automatic shelf registration process, eligible well-known seasoned issuers may register unspecified amounts of different specified types of securities on immediately effective Form S-3 or Form F-3 registration statements.  Unlike other issuers registering primary offerings on Form S-3 or Form F-3, the automatic shelf registration process allows eligible issuers to add additional classes of securities and to add eligible majority-owned subsidiaries as additional registrants after an automatic shelf registration statement is effective. They also can freely accommodate both primary and secondary offerings using automatic shelf registration.  Thus, these issuers have significant latitude in determining the types and amounts of their securities or those of their eligible subsidiaries that can be offered without any potential time delay or other obstacles imposed by the registration process. . . . 

Updating and Correcting a Registration Statement  Pre-Effective Amendments to Registration Statement
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 Make amendment, SEC gets back with comments, make amendment, comments, etc…  issuer is making amendment before R/S becomes effective Post-effective Amendments. SEC has declared the registration statement effective, and then the issuer amends the registration statement. o Under §8(c), a post-effective amendment shall become effective on such date as the SEC determines. o §10(a) links the contents of the registration statement with the contents of the prospectus. §10(a) provides that a prospectus shall contain the information in the registration statement. Sales of securities made by means of a materially deficient prospectus expose their sellers to liability under §12(a)(2) of the ‘33 Act. o Post-effective amendment resets the clock for liability under §11 (liability for selling a security using a registration statement which contains an untrue statement of material fact). o Issuer is strictly liable under §11 for misleading statements. o As of the post-effective amendment date, everything in the registration statement is restated. This means the issuer will have to recheck all of the facts contained in the registration statement and make sure that all information is not stale and still is complete and accurate. For this reason, issuers resist making a post-effective amendment to the registration statement. When would an issuer make a post-effective amendment to the registration statement? o A post-effective development.  Post-effective developments. R/S was accurate when went effective, but something has happened.  Company will always amend the prospectus to avoid §12(a)(2) liability (liability for selling a security using a prospectus which contains an untrue statement of material fact). o Correct mistake in registration statement.  E.g. registration statement wasn‘t accurate when filed. Issuer wants to close the potential class of people who could sue under §11. o If required to.  E.g. in a shelf registration (Rule 415Item 512). Company that offers securities to public in shelf registration must file post-effective amendment to inform public about any material changes. What requires a post-effective amendment?  Concerned with liability. Source of liability is § 11(a)  For false or misleading material facts in a R/S at t he time the R/S became effective  Issuer is concerned with liability under § 11  Strictly liable for any material misleading statements in R/s when it became effective  For the people who purchase the security before the misstatement is found, they can sue the issuer under § 11.  Any purchaser of the security after the post-effective amendment is made, will not be able to sue for liability under § 11  at least for that issue  Source of duty to correct = § 11  Post-effective amendment closes the class (of those who can sue) Problem, Page 205, 4-34 Problem: Alpha Co.‘s registration statement became effective on July 12, and reported that Alpha owned 900,000 acres of uncut OR timberland and that the company would soon obtain permits to log the timberland. On July 18, with less than one-half of the Alpha offering sold, 350,000 acres of Alpha‘s OR timberland was lost to forest fires. What is the source of Alpha‘s duty to amend its registration statement? Can the SEC compel Alpha to amend its registration statement? o Generally: o SEC is concerned that investors will make investment decisions based on information that is no longer accurate. Alpha is still circulating a prospectus that says Alpha owns 900,000 acres of timberland, which is no longer true. o Prospectus MUST be amended in order to avoid §12(a)(2) liability.  Rule 424(b) tells a company when it must amend its prospectus. Company will always amend the prospectus if the post-effective development is material.  ―Stickering‖ the prospectus. Company will place a sticker on the front of the prospectus containing the new information. o Must a conforming amendment be made to the registration statement? Alpha will resist, because if they amend the registration statement, this will reset the clock for §11 liability.  Judgment call as to when company will make a post-effective amendment to the registration statement.  More detailed analysis:  Does the company have to make a post-effective amdenment to their R/S? Must make amendment under second theory. No § 11 liability b/c it was accurate on the date it went effective. This is a post-effective development.  If company is still selling their securities, and people are getting final prospectuses. Is this prospectus accurate anymore? No, b/c it says 900,000 acres; not 550,000 acres  what they have left.  One what grounds can the buyer sue?  § 12(a)(2)  offers or sells a security in interstate commerce, by means of a prospectus or oral communication, which includes a false or misleading statement may sue  This is false or misleading.  What do you do?  Amended the prospectus, certainly
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How do you do it?  May be as easy as putting a sticker on the cover of the prospectus. This makes the prospectus no longer false or misleading  Just b/c you amend the prospectus, do you also have to amend the R/S?  Not necessarily. Don‘t always have to amendment the R/S  Why would you not want to amend the R/S?  SEC becomes involved which may require comments  Can you still continue to sell stock during time of filing post-effective amendment?  § 11 liability . Strict liability on the effective date. When the post-effective amendment goes effective, it resets the clock. It is in essence reaffirming everything that it said in the original prospectus.  If something else happened in the intervening period, that people didn‘t know had changed, § 11 liability again  Hypo: in the meantime, CEO resigns. They amend the R/S to reflect the loss in acrage, but didn‘t change the management. So, somebody could sue for § 11 liability for false or misleading management. Gives companies exposure to two types of § 11 laibility: when first went effective and when went effective under post-effective amendment  What is the point of strict liability in this case, whereas in most other areas of Securities law there is a requirement of fraud/scienter?  Congress wanted to put pressure on the companies to stand behind and guarantee everything they put in their R/S  How do you decide whether to make a post-effective amendment or not?  SEC‘s argument  § 10(a)(1)  Require conformity between prospectus and R/S  This is not how it is though.  What kinds of changes lead to a post-effective amdenment to the R/S?  Tests for when a company will make a post-effective amendment to the registration statement:  Substitution v. Addition Test:  Substitution: If information is substituted—i.e. some information is taken out of the prospectus and is replaced with other information—in the prospectus, the company has to amend the registration statement because the documents are no longer the same.  Addition: If information is added to the prospectus, company does not have to amend the registration statement.  Test is difficult to apply because post-effective fire could be seen as additional information, rather than as substitute information.  Fundamental Change Test: If information is fundamental (different standard than material) to the offering, company has to amend the registration statement. E.g. if company has to restate earnings; if there is a change in company‘s use of proceeds (plan of distribution, change in interest rate).  If selling timber is Alpha‘s main business, loss of timber would affect its ability to make a profit, so loss would be fundamental to investors. If Alpha has other businesses, maybe loss of timber is not so fundamental.  Fudamental changes  things that go to the heart of the offering. Need to make amendment to R/S  More than material things  Fundamental things  Company has to restate financial statements  Anything to do with the plan of distribution  Changing underwriter, price, use of proceeds  Anything dealing with the terms of the securities  Interest rate changes on debt security Refusal Orders and Stop Orders: SEC‘s Power to Enforce. If company determines it does not have to file a post-effective amendment to its registration statement, and the SEC disagrees, what can the SEC do? o §8(b) Refusal Order: SEC must issue within 10 days of registration statement being filed. Only applies to patent misstatements and omissions in a registration statement. Only applies where the misleading feature of the registration statement is apparent on the face of the registration statement—i.e. it does not apply where the misleading character of the registration statement can only be discerned from conditions or facts not appearing in the registration statement. o §8(d) Stop Order: SEC may issue a stop order if it appears at any time that the registration statement includes any untrue statement of a material fact. Stop order serves as notice to the investing public that the SEC has found the issuer‘s registration statement disclosures materially misleading. Company will not be able to sell its stock anymore if SEC stops the effectiveness of the registration statement.  Stops the effectiveness of a R/S  Says R/S is no longer effective  Cannot sell the security anymore  If already sold the security, it is notice to the public that something is wrong  Signal to people to stop buying securities
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Ancilary Effects: WKSI can become an ineligible issuer  a company that has had a stop order issued against it  Misleading statements must be as of the date the statement became effective. SEC does not have stop order power for post-effective events. o Ceast and Desist Order: SEC may bring a cease and desist order to prevent a company from violating the federal securities laws. o Injunction: SEC can ask a court for an injunction preventing the sale. o Private right of Action: Under §12(a)(2), an investor will have a private right of action if the company does not sticker its prospectus. Not § 11. Withdrawal of a R/S  Why might a company that has filed a R/S and spent a lot of money doing it, why might they want to withdrawal the R/S?  Something has changed that the company doesn‘t want to become a reporting company anymore  Change in interest rates, and now cost of capital is too high  Something terrible has happened – people who were planning to go public soon after 9/11  Company may have uncovered massive fraud  Can a company simple withdrawal a R/S?  If the company has not yet sold securities (i.e., in waiting period), it is easier to withdrawal it  Rule 477  General Rule: there is no automatic right to withdrawal  Generally, have to ask SEC and they will decide whether to grant request  (b) – Last sentence  if in filing stage and hasn‘t gone effective, can withdrawal unless SEC objects  If already sold securities, can only withdrawal if there is no public concern  In post-effective period, there are interests to be taken into consideration (i.e., the buyers)  If you sell securities, there is a public interest, the SEC must make a finding that it is in the public interest to allow the withdrawal

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International Public Offerings; Regulation S  Regulation S – Foreign IPOs  International Security Regulations. Two points:  Foreign issuer making a public offering here. Section 5 says ―any person‖ must register the offering if offering here.  A Foreign private issuer is issuing stock here they will use a F1-F3.  The SEC has granted accommodations to foreign private issuers. Under S forms companies have to include financial statements prepared in accordance with GAAP. Foreign issuers do not have to follow GAAP. They only have to follow their own home law in disclose the differences between their financial practices and ours.  This is a nice advantage.  US company selling securities in foreign countries. Or non-US companies selling in foreign countries. § 5 does not differentiate between foreign and domestic issuers or between foreign and domestic sales. § 5 is broad enough to capture sales by US company overseas. It appears that, as long as Interstate Commerce provision is met, a German company‘s sale to English residents would even be met. For example, German company selling securities in London using US broker.  In 1990, the SEC made clear that § 5 did not extend as far. Regulation S.  Regulation S – US Registrations  Offering by a U.S. company or non-U.S. company outside the U.S.  Interstate commerce relates to communications between a foreign country and the U.S. §5 has a very broad jurisdictional reach.  When should §5 apply to sales of securities outside of the U.S.?  Regulation S: Territorial approach to application of §5 outside of the U.S. SEC will protect the U.S. capital markets.  Rule 901: For the purposes of §5, the terms ―offer,‖ ―offer to sell,‖ ―sell,‖ ―sale,‖ and ―offer to buy‖ shall be deemed to include offers and sales that occur within the U.S. and shall be deemed not to include offers and sales that occur outside the U.S. [i.e. §5 does not apply to offers and sales ―outside the U.S.‖]  Rule 903 Safe Harbor: If you meet the requirements of Rule 903, offer will be deemed to have been made outside of the U.S. and §5 will not apply. What does ―outside the U.S.‖ mean? Look to the three categories of issuers—set forth based on relative likelihood that securities of that category of issuer will enter U.S. trading markets:  Three Sets of Restrictions to § 903.  General Restrictions:  Offer and sale must occur in ―an offshore transaction.‖  Offer and sale occurs outside the United States.  There can be no directed selling efforts in U.S.  You cannot try to market the sale in the US. You cannot advertise the sale  Offering Restrictions (depends on the category)  Transaction Restrictions (depends on the category)
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903(b)(1): Foreign issuers for which there is no substantial U.S. market interest in their securities; or foreign issuers that direct their offering to residents of a single country other than the U.S.  E.g.: Foreign issuer. No substantial U.S. market interest. Foreign company only selling securities in a foreign country.  903(b)(2): U.S. issuers that are ‘34 Act reporting companies offering debt securities; foreign issuers that are reporting companies offering equity securities; foreign issuers whether or not a reporting company offering debt securities.  E.g.: IBM selling its debt overseas.  Debt: People who are interested in buying debt are usually sophisticated institutional investors.  IBM is a reporting company, so already a lot of information about IBM. Even if flowback does occur, okay because information is available about the company and institutional investors can protect themselves.  903(b)(3): All other issuers.  Securities that are mostly likely to come back into the U.S.  E.g.: U.S. company selling securities overseas—e.g. IBM stock.  ALWAYS must meet these conditions to get protection of safe harbor:  ―Offshore Transaction‖: no offers be made to persons in the United States and that either: (i) the buyer is (or the seller reasonably that the buyer is) offshore at the time of the origination of the buy order, or (ii) for purposes of the issuer safe harbor, the sale is made in, or through a physical trading floor of an established foreign securities exchange, or (iii) for purposes of the resale safe harbor, the sale is made in, on or through the facilities of a designed offshore securities market, and the transaction is not pre-arranged with a buyer in the US.  Offer must be made to a non-U.S. person (someone not resident in the U.S. (note, residence does not turn on citizenship)) AND the sale must be made outside the U.S. (―offshore transaction‖).  ―Directed Selling Efforts‖: Directed selling efforts are activities undertaken for the purpose of, or that could reasonably be expected to result in, conditioning of the market in the US for the securities being offered.  Directed selling efforts cannot be made in the US in connection with an offer or sale of securities made under a safe harbor.  No ―directed selling efforts‖ in the U.S. E.g. company can‘t take out ads in a U.S. newspaper publicizing an offering and can‘t try to drum up interest for the offering. Other conditions, depending on what type of issuer you are.  Flowback concern: Flowback is the major policy reason behind Reg. S. SEC is concerned that company will sell its securities overseas, not register them, and then overseas investors will resell in the U.S. The more likely it is that a security is going to flow back into the U.S., the more restrictions there are on the issuer‘s use of Reg. S.  For certain types of offers there is a greater chance for flowbacks than other offers.  What offers should would be concerned with:  Equity v. Debt  SEC believes more sophisticated people are likely to buy equity.  Is the issuer a U.S. or Foreign issuer  U.S. issuers issue equity abroad – that is the most likely type of security to flow back.  This is, in part, category three.  Domestic issuers selling equity  Any security that can be converted into equity.  Foreign issuers whose securities trade here.  Greater likelihood of flowback.  Category 2.  Foreign issuers are broken down in two ways  Offering debt or equity  Reporting company or not.  We are more about non-reporting companies.  No information out there.  Hypo: Company makes a Reg. S offering in Germany, and German citizen sells securities purchased in the Reg. S offering to a U.S. citizen two days later. SEC must ask why the security came back. If the co. did everything they were supposed to, Reg. S still applies. If there is flowback within a certain time period (distribution compliance period), the sale is a problem. If it looks as if the company did not follow the offering restrictions, company loses Reg. S safe harbor altogether. The more likely it is that the securities will come back into the U.S., the greater the concern is. Depending on the reasons why the securities are coming back into the U.S., may be a violation of Reg. S.  Transactional Restrictions: Require that the securities sold under the safe harbor period, prior to the expiration of a distribution compliance period [begins to run on the later of the date of the closing of the offering or the date the first offer of the securities to persons other than distributors is made], not be offered or sold to or for the benefit or account of a U.S. person.
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If company is relying on 903(b)(2) it must ensure that any person who they sell to is a non-U.S. person and is not purchasing for the account or benefit of a U.S. person.  Offering Restrictions: Procedures that must be adopted with regard to the entire offering by the issuer, distributors, their respective affiliates, and all persons acting on behalf of any of the foregoing, in order for the transaction to be in compliance with 903(b)(2) or (b)(3). People involved in distribution have to sign a statement saying that they understand the offering is a Reg. S offering and that they will not sell to U.S. residents. Purchaser of securities must certify that they are not a U.S. resident. Legend on certificate that you cannot sell back to U.S. Analysis:  Who is the issuer: foreign or U.S.  Is the issuer a foreign or reporting company  What is the security involved: equity or debt (2) Same (3) Same

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903(b)(1) Conditions to be satisfied: Must be: (a) ―offshore transaction‖ and (b) No ―directed selling efforts‖ in the United States 903(b)(1) Qualifications (i) A foreign issuer that has no ―substantial interest‖ or (ii) A foreign issuer engaged in an ―overseas directed offering‖

(2) (i) A domestic reporting company or foreign issuer offering debt; (ii) A foreign issuer subject to Exchange Act‘s reporting requirements offering equity

Offering Restrictions: (1) None

Transaction Restrictions: (1) None

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(3) Distribution compliance period is 40 days for debt and one year for equity (a) Purchasers during period must certify they are not a US person and are not purchasing for such person; (b) Equity purchasers during restricted period must agree only to sell or hedge in accordance with Regulation S, a ‘33 Act registration, or an exemption therein; (c) Shares of domestic issuer must bear legend barring transfer except in accordance with Regulation S; and (d) All issuers must have a provision in bylaws or elsewhere empowering it to bar transfers not in accordance with Regulation S. ―Substantial U.S. Market Interest‖: a substantial US market interest in a class of a foreign issuer‘s equity securities is defined to exist where at the commencement of the offering (a) the securities exchanges and inter-dealer quotation systems in the US in the aggregate constitute the single largest market for such securities in the shorter of the issuer‘s prior fiscal year or the period since the issuer‘s incorporation or (b) 20% or more of the trading in the class of securities took place in, on or through the facilities of securities exchanges and inter-dealer quotation systems in the US and less than 55 percent of such trading took place in, on or through the facilities of securities markets of a single foreign country in the shorter of the issuer‘s prior fiscal year or the period since the issuer‘s incorporation.  Substantial U.S. market interest for debt securities is measured differently, determined in part by 20% or more being held by 300 or more US persons, provided the amount so held is at least $1 billion.
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(2) During the distribution period (a) Each distributor agrees to conform efforts to requirements of safe harbor; and (b) All offering material will bear a legend that securities have not been registered in the U.S. and many not be offered or sold in the U.S. without either registration or an exemption (2) During the 40-day distribution compliance period: (a) No sales to the account of a ―U.S. person,‖ and (b) Distributors during the period must inform securities professionals of the restrictions on sale to U.S. persons

(3) All other issuers Domestic issuers selling equity Debt securities of non-reporting US issuers Equity securities of non-reporting foreign issuers for which there is substantial US market interest (3) Same as (2)

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―Overseas Directed Offerings‖: The concept of ―overseas directed offering‖ is the requirement that such offerings be directed at a single country. US Person‖: [902(o)] U.S. residency is the principal factor in the test of a natural person‘s status as a U.S. person under Regulation S, not citizenry. ―Measurement of the Distribution Compliance Period‖: The period begins to run on the later of the date of the closing of the offering or the date the first offer of the securities to persons other than distributors is made. The issuer safe harbor is available for issuers, distributors, their respective affiliates, and persons acting on behalf of any of the foregoing. Contemporaneous US and Offshore Offerings  Offshore transactions made in compliance with Regulation S will not be integrated with registered domestic offerings or domestic offerings that satisfy the requirements for an exemption from registration under the Securities Act, even if undertaken contemporaneously. Statement of the Commission Regarding Use of Internet Websites to Offer Securities Offshore  The purpose of this interpretation is to clarify when the posting of offering or solicitation materials on Internet Web sites would not be considered activity taking place ―in the United States.‖  Procedures Reasonably Designed to Avoid Targeting the US  When offerors (assuming the internet site contains an offer of securities) implement adequate measures to prevent US persons from participating in an offshore Internet offer, we would not view the offer as targeted in the US and thus would not treat it as occurring in the US for registration purposes. What constitutes adequate measures will depend on all the facts and circumstances of any particular situation.  Web site contains prominent disclaimer that offer not directed to US  Web site implements procedures that are reasonably designed to guard against sales to US persons. Like ascertaining the purchaser‘s residence.  If Issuer is American, they would need to implement a password-type procedure to ensure only non-US persons can obtain access to the offer.  Just as an issuer must take reasonable steps to avoid offers of unregistered securities in the US, so too must persons acting on behalf of the issuer, such as underwriters or distributors. Press Coverage for Foreign Issuers  See 135E. Special Rule. US journalists can attend foreign issuers press conference and here about PO and the information is exempt if the press conference is held outside the US and the security offering will not occur solely in the US. Offerings Falling Outside Regulation S  Europe and Overseas Commodity Traders v. Banque Paribas London  Carr, the sole SH and agent of EOC, a Panamanian company, commenced discussion in London with Arida, an English company, regarding a substantial investment EOC could make through Arida.  Carr took a holiday in London, while there he approved the purchase by EOC of shares of Arida.  Does this transaction fall under the requirements of § 5? None of the exemption in Regulation S apply.  The conduct and effects test was developed by the courts in the absence of clear Congressional guidance as to the jurisdictional reach of the antifraud provisions of the securities laws. To discern "whether Congress would have wished the precious resources of the United States courts and law enforcement agencies to be devoted to" such transactions courts have looked to the underlying purpose of the anti-fraud provisions as a guide. In outlining the extraterritorial reach of these provisions, courts have reasoned that Congress would not want the United States to become a base for fraudulent activity harming foreign investors, or "conduct," and that Congress would want to redress harms perpetrated abroad which have a substantial impact on investors or markets within the United States, or "effects." However, because it is well-settled in this Circuit that "the anti-fraud provisions of American securities laws have broader extraterritorial reach than American filing requirements," the extent of conduct or effect in the United States needed to invoke U.S. jurisdiction over a claimed violation of the registration provisions must be greater than that which would trigger U.S. jurisdiction over a claim of fraud. To adapt the conduct and effects test for use in interpreting the registration provisions, we must take into account Congress's distinct purpose in drafting the registration laws.  This conduct, in turn, has the effect of creating interest in and demand for unregistered securities. To avoid this result, in keeping with Congress's purpose, the registration provisions should apply to those offers of unregistered securities that tend to have the effect of creating a market for unregistered securities in the United States; and by "creating a market" we do not mean to imply that the conduct must be directed at a large number of people.  The nearly de minimis U.S. interest in the transactions presented in the instant case precludes our finding that U.S. jurisdiction exists under the more limited conduct and effect standard appropriate under the registration provisions of the 1933 Act. Under the facts as alleged by EOC, there was conduct in the United States because Arida called Carr here and Carr executed his order here. However, the conduct was not such as to have the effect of creating a market for those securities in the United States. Carr's presence here was entirely fortuitous and personal, and the actual purchaser of shares in the Fund was an offshore corporation without a place of business here.  Although Conditions are not satisfied, the US interest is so de minimis the 2nd Circuit grants an exception.  Under the conduct/effects test we want to prevent a trading market with not enough information. That would not happen here.  This is the rare case where you flunk the safe harbor literally, but the jurisdictional needs test is not applied.
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Neither § 5 nor 903 applies.

Debate Over Mandatory Disclosure  Pro Mandatory Disclosure  Companies may not voluntarily disclose  Investors may not demand disclosure  Managers might lie to artificially elevate price  Anti-Mandatory Disclosure  Investors will demand disclosure  Management cares  Fear of job loss.  Easier to raise capital in future  May own stock in corporation  Managers lie even with mandatory disclosure  Keep job and prevent takeovers  High costs  Time  EE cost: reviewing, developing, disclosing  Loss of competitiveness  Printing costs  Filing fees  Accounting and legal fees  Increased liability  Only institutional investors benefit from disclosure, and they demand it anyway  Companies will voluntarily disclose.  No information = bad news in minds of consumers  Investors want information to evaluate stock  More information = higher prices.  There is an inherent conflict of interest of management/owners  Are they making decisions to benefit company or self?  Mandatory Disclosure, Criticisms:  Focus on historical information. Exs. Registration statements, financial statements. Very little emphasis/requirements for FLS or future information. Companies may choose to do so voluntarily. But there is a very weak requirement for soft information (especially negative information).  Every time you require disclosure for an item you create additional liability.  What if we just reduced liability for FLS?  Didn‘t we already do this?  Bespeaks caution doctrine. Insulates companies. 27A. So long as company makes FLS surrounded by adequate cautionary language insulates them.  NOTE: this doctrine does not apply in public offerings.  Safe harbor for FLS during filing period.  What if we didn‘t make them liable for § 11 liability?  This presents the opportunity for abuse.  Some companies already make voluntary FLS and give earnings reports, do we need more?  Do people look at information. Brokers are not always used. Unsophisticated investors are not using a broker, investing based on available information that they don‘t understand.  Over-regulated  ‘33 Act regulates offerings and not companies.  Offerings are registered (unless there is an exception). Doesn‘t it make better sense to regulate the company.  Regulate companies. Company registration. SEC pushed for this and it crashed and burned. Some argue that WKSI things like automatic shelf registration is actually company registration in disguise.  Over-information.  Legalese.  Pushes people out of the market.  Costs  Negative information is not necessarily commanded to be disclosed EXEMPTIONS FROM REGISTRATION Sales by Issuers: Exempt Transactions  The Intra-State Offering Exemption
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§ 4 Exempted Transactions § 3 Exempted Securities  Difference between a §3 & §4 exemption? §3 advantage of exempted securities provisions of §5 do not apply at all. § 3 Exemptions Generally: If exemption applies, issuer does not have to comply with §5. §3 exemption will attach to the security— permanent exemption from registration. Some of the §3 exemptions are for:  Commercial Paper  § 3(a)(3) Commercial Paper  Reves--Note as a security.  Whether the exemption of § 3(a)(3) applies.  Note, draft, bill of exchange, or banker‘s acceptance is exempt.  What kinds of securities are exempted under § 3?  Short term. Less risky. less than nine month maturity date (e.g. notes).  High Quality. Blue Chip companies. Companies with very little risk of defaulting. In Reves the co-op was no blue chip company.  Who is the buyer—sophistication of buyer  Commercial paper purchased by institutions—sophisticated investors.  3(a)(2): Government securities are exempt. Why?  Low risk. Hopefully government will not default on their offering.  3(a)(4): Religious, benevolent, charitable organizations issuing securities. Why?  Although it could be very risky we are attempting to benefit the public interest. People who are purchasing securities in a charitable organization are not doing it for the investment purposes, but for the benefit to the public.  If government made charities register with them, the money distributed to charities would be reduced because the cost of registration is high. § 4 Exempted Transactions  4(3): Dealer exemption  4(4): Broker exemption  4(1): Trading transaction exemption.  Transactions by any person other than an issuer, underwriter, or dealer.  Why exempt these transactions? (note: these are unique transactions, not securities)  The original transaction was likely registered. Purpose of the ‘33 Act is to regulate sales from company to investor. It regulates the initial issuance of securities. ‘34 Act regulates resales.  ‘34 Act provides 10K, 10Q, AK, which provides the necessary information. §3(a)(11): Intrastate Offering Exemption: Any security which is part of an issue offered and sold only to persons resident within a single State or Territory, where the issuer of such security is a person resident and doing business within, or, if a corporation, incorporated by and doing business within, such State or Territory.  Requirements  [1] Securities offered and sold only to residents of a single state,  If there is an offer/sale to one person that is not a resident the issue is no longer exempt. The exemption is ―blown.‖  If the exemption is blown, you have violated § 5. SEC can bring enforcement action. Individual investors can bring action under 12(a)(1) for rescission.  You have to wait for the issue to ―come to rest‖ before you resell. This is a fact sensitive inquiry.  Rule 147 provides a safe harbor in the form of a nine-month holding period before securities may be sold to nonresidents. Outside of the safe harbor, an early operating rule of thumb, suggested by none other than the SEC, was that a one-year holding period establishes a presumption of investment intent. Not surprisingly, this guideline neither precludes the possibility that securities have not come to rest, even after one year, nor discourages ―investors‖ from arguing that they have come to rest shortly after their purchase.  Ensuring all you sell to are residents of the state.  Ask the offerees. Look at ties with PA. Driver‘s license, where registered to vote, where living.  Creates several issues.  [2] By issuer incorporated in that state,  [3] Doing business in that state.  Performing a substantial (predominant) amount of business in the state.  Does the substantiality requirement make sense?  Familiarity.  The substantiality requirement creates several issues.  Note: If I buy securities through an intrastate offering, and resell them out of state, my resale will not be exempt. Although the intrastate offering is called a §3 exemption, it is really more of a transaction exemption.  Justification for Exemption: If the company is a local company, investors will be familiar with the company and its management. Investors will not need a disclosure document because they will already know all they need to know about the company.
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Note: Registration requirements still exist for state. This is a secondary justification. We don‘t need federal involvement, the states will be involved. The company will have to register with PA authorities.  Note: Can you advertise and use 3(a)(11)? Allows general advertisement.  Note: Is there a written materials/prospectus requirement? No.  Note: Congress is also sensitive to federalism issues—issues that are properly within the jurisdiction of the state. Federal government can step away and not regulate because the state division of securities will regulate the offering. Rule 147 Safe Harbor: Most companies that want to use the intrastate offering exemption will try to use the statutory safe harbor of Rule 147. If issuer meets Rule 147, it will be deemed to meet §3(a)(11).  Note: The preliminary notes to this rule are very good.  Note: If the issuer does not meet R. 147, it may still argue that it meets §3(a)(11).  Test  ―Residence‖: Issuer shall be deemed to be a resident of the state or territory in which it:  Is incorporated [if a corporation]  Principal office of issuer is located within such state at the time of the offer and sale.  Has its principal office [if a general partnership]  Has its principal residence [if an individual]  ―Doing business‖: Issuer shall be deemed to be doing business within a state or territory if:  The issuer derived at least 80% of its gross revenues and those of its subsidiaries on a consolidated basis…from operation of business located within the state [note, issuer must have gross revenues in excess of $5,000 for past 12 months]  The issuer has…at least 80% of its assets and those of its subsidiaries on a consolidated basis located within the state  The issuer intends to use and uses at least 80% of the net proceeds to the issuer from sales made pursuant to rule in connection with the operation of a business or of real property in the state  Resale: Creates a 9-month hold period before securities may be sold to nonresidents.  9-month ―come to rest‖ period.  Resale may begin after 9-month period.  Integration safe harbor. 147(b). [this test is more closely examined under the Integration of Offerings section]  The Commission has generally deemed intrastate offerings to be ―integrated.‖ Two offerings are viewed as one offer.  Facts and circumstances test.  Nonissuer Transactions  Although the Preliminary Notes to R. 147 state the ―rule provides an exemption for offers and sales by the issuer only,‖ Release No. 5450 includes the following statement: ―Persons who acquire securities from issuers or affiliates in transactions complying with the rule would acquire unregistered securities that could only be reoffered and resold pursuant to an exemption from the registration provisions of the Act.‖ Problem, p. 264, 5-1  Potential issues/problems?  Breadth of issue may be too broad. Internet offering is troublesome. You are offering out of state. Anyone from any state has offering to website. Boston Globe has a national circulation, this creates issues.  Advertisements could have a disclaimer that the offer is only for Mass. Residents. The SEC has allowed this, otherwise we would undercut the use of 3(a)(11).  If you don‘t have disclaimer language you are basically done. You have the burden of proving the offer was intrastate. How can you do this without placing limiting language on your offers? You really can‘t. It doesn‘t take much to have a disclaimer, otherwise it is a factual question as to whether you offered out of state.  Mailing List. Just because you have a Mass. Office does not mean that you live in Mass. You have to make sure that they are residents of Mass.  How long does resident have to hold onto security before resale, which may be considered as part of issuance. The Mass. Resident viewed as conduit to getting out offer to other states.  Very fact sensitive.  There has to be a point where the issuer‘s offering is done, but this it not a hard and fast rule.  The issue at some has to ―come to rest.‖  Has the issue come to rest, has the offering come to rest?  3 years later, likely okay. One week later, likely not okay.  Is the issuer‘s offering done?  If so, subsequent resales will not harm the issuer.  The SEC says maybe a year is enough, but this has not been solidified.

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The Private Placement Exemption  §4(2) Private Placement Exemption: The provisions of §5 shall not apply to transactions by an issuer not involving any public offering.  Think about OFFEREE suitability [NOT purchaser suitability]  Considerations:
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Court looks at exemption and examines justification underlying the exemption:  Purpose of ‘33 Act is to ensure that investors have enough information to make an insured investment decision.  Purpose of exemption is to exempt sales where we do not need to worry about giving investors information—don‘t have to worry about protecting them. Ralston Purina test for a private placement: Must meet both parts of the test.  [INFORMATION]Whether the particular class of persons needs the protection of the ‘33 Act.  Persons who are able to get the information from somewhere other than a mandatory disclosure document.  Information from registration statement is the protection.  Most people refer to this question as the registration prong.  Information = Protection  Access to information/actual disclosure: SEC will not require disclosure if the offeree has access to information OR or if the company actually hands over a private placement memorandum  How do you meet the information prong?  Actual Disclosure/Voluntary disclosure, actual disclosure through a ppm (Private Placement Memo).  Circular  Effective Access: In Purina they said if you make offering to persons who have access to the information that would be found in a registration statement that is enough.  They have access to the relevant information and may ask questions to persons in company pertaining to uncertainties they may have.  Whether access is enough, inevitably, depends on whether the person who if had access and could ask question could understand information and receive answers that are on point and understood.  See Doran  What people have effective access?  Position in company  Family—The President‘s wife or son, etc.  Economic bargaining power  VCs.  Information determination:  Provided with private placement memorandum, would that be enough? Probably not if investor can‘t understand what is in the memorandum.  Advised to seek counsel before purchasing stock? This would not be enough.  Provide counse? Might be enough.  [SOPHISTICATION]Whether the persons are able to fend for themselves.  Inquiry into the sophistication of the offerees/purchasers. This is the sophistication prong.  Sophistication: People who need the protection of the mandatory disclosure are those who may not know what questions to ask, or who may not have sufficient leverage to get answers.  Some circuits have been forgiving of sophistication requirement if an offering is made to a lot of people, and one offeree is not sophisticated. Court may hold that the offer to the one unsophisticated person will not blow the exemption.  Sophistication determination: SEC will look to objective criteria.  Career/Profession  Previous investment history  What they invested in  Safe stocks  Private placements  Income/Wealth  Shows resilience to loss of risk  Doesn‘t stand alone  Education level  Knowledge of the Industry  Age  Presence of/Relationship to investment professional(s)  Safe harbor to 4(2) explicitly recognizes this.  Advisors, lawyers, purchaser representatives: is someone giving offeree advice about how to invest his money? What other factors may the court consider:  The # of offerees.  Large=Public  Small=Private  Monetary size of offering  Not as important  # of units offered  Has some degree of importance.
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Small # of units are deemed private in nature. Large # of units are deemed public in nature.  Worried about creating a secondary market. When you sell so much you expect resale, a secondary trading market.  We don‘t want you using a private offering as a conduit to a public offering.  The Manner of Offering  Direct negotiations  Public Advertisements  This is important.  Relationship of offerees to the issuer and to each other.  Used to be that in order to use private placement, offerees had to be insiders. SEC rejected this position. If you are an insider, however, this strengthens the argument that you can use §4(2).  This element addresses offeree suitability. Suitable offerees are ones who do not need the protection of the ‘33 Act and can fend for themselves. Institutional investors, venture capital firms, and sales to incorporators will usually meet the §4(2) requirements. Access: Venture capital firms have leverage to get lots of information, some of which may not even be included in the prospectus. They will get information or they won‘t invest. Venture capital firms are definitely sophisticated. No question, because it is their business to invest in small companies. No general advertising or solicitation. No general notices in papers, because company will not be able to evaluate the sophistication of the potential offerees. Offerees may need the protection of the ‘33 Act.  Note: Often, small companies will hire someone to find purchasers for them for the private placement. The finder has a series of clients who they have done business with before, and know they are sophisticated. The clients are pre-screened. NOTE: If you make an unregistered offering to 50 people and two persons, retrospectively, are found to have not met the sophistication prong, do you meet the exemption?  Likely No. Most courts say that when you make one offering to an unsophisticated investor you blow it.  There is a healthy dissent that does no put as much weight on the investor‘s sophistication. NOTE: We are looking at those persons offered, not just sold to.  Why focus on offerees, what if the only persons not sold to where actually the ineligible persons. This would allow the sophisticated persons to sue?  Using Purina standard is dangerous, sophistication is fact based.  Whether someone is sophisticated is a difficult argument. Note: Placement Agents:  They have customers on file that they know meet the sophistication requirement of § 4(2) under Purina or the requirements of Regulation D.  The issuer outsources the duty of finding investors to the placement agents (usually placement agents are underwriters) Through Wolf & Doran the 5th Circuit explained that:  Sophistication, in short, does not eliminate the need for the information. As to haw an information standard is to be satisfied, Doran concluded that avaialability of information means ―either disclosure of or effective access to the relevant information.‖ 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. If access to information is the measure, on the other hand, the relationship between the issuer and the offeree becomes the critical question:  Such access might be afforded merely by the position of the offeree or by the issuer‘s promise to open appropriate files and records to the offeree as well as to answer inquiries regarding material information.  It must be shown that the offeree could realistically have been expected to take advantage of his access to ascertain the relevant information. Similarly, the investment sophistication of the offeree assumes added importance, for it is important that he could have been expected to ask the right questions and seek out the relevant information. Professor Fletcher identifies a number of themes in cases finding a party to a securities transaction is sophisticated; the professional status and investment experience of the party; the age, intelligence, wealth, and income of the party; and the specific activities of the party, such as regular consultation with investment professionals, membership or participation in investment groups or seminars, and personal review of account statements and recommendations. Bottom line: Consider factors. Two most important factors are the factors in Ralston Purina.

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Regulation D: The Limited Offering Exemption Maximum Amount of Money Raised $1 Million (statutory basis is §3(b)— Congress may add to securities that are Sophistication of Purchasers Purchasers do not have to be sophisticated. Limitation on Number of Purchasers No limitation on number of purchasers. Restrictions on Resale Yes. Securities acquired in a Reg. D offering cannot be Disclosure Obligations Ban on General Advertising Ban on general advertising.

Rule 504

No disclosure obligations.

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Rule 505

$5 Million (statutory basis is §3(b))

Purchasers do not have to be sophisticated.

Maximum of 35 purchasers. **Accredited investors don‘t count toward maximum number of purchasers**

resold without registration or without an exemption. Yes.

Rule 506

Unlimited. (statutory basis is §4(2))

Purchasers must be sophisticated. **Accredited investors are deemed to be sophisticated**

Maximum of 35 purchasers. **Accredited investors don‘t count toward maximum number of purchasers**

Yes.

Affirmative disclosure. Disclosure obligation does not apply to accredited investors. Information requirements differ depending on whether company is a reporting company or not. If not a reporting company, must provide most recent copies of annual report and prepare offering circular that has most of the information included in the registration statement. Same as for Rule 505.

Ban on general advertising.

Ban on general advertising.

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Regulation D provides three exemptions (R. 504-06) that, taken together, cover the vast majority of offerings exempt from registration. Rules 504 and 505 were promulgated on the basis of § 3(b), which authorizes the SEC to develop exemptions covering offerings up to $5 million in amount when registration is not necessary to protect the public interest or investors. R. 506 represents a nonexclusive safe harbor for the private offering exemption of § 4(2). Accredited Investors  When purchasers are accredited, the sophistication and affirmative disclosure standards are lifted, and there is no limitation on the number of accredited purchasers.  There may be an unlimited number of accredited investors in a Rule 505-506 offering.  If all purchasers are accredited investors, the exemptions accorded b y the rules are not conditioned upon affirmative disclosures by the issuer.  Accredited investors are conclusively presumed to be sophisticated.  501(a) defines accredited investor:  8 types of accredited investors  3 Broad Categories  Market Professionals  Broker-dealers, Institutional Investors (ex. pension fund), VCs, Banks, Life Insurance Companies, Insurance Companies  Corporate/Company Insiders  Corporate Insiders  Need to be insiders, do not need to meet wealth requirements.  Goes back 4(2) factors – relationship to investor.  Sophistication, access to information.  Corporate Insiders are born from the Purina standards.  #5,6: Wealthy Persons  Net worth of at least 1 million  Or  People who make 200K a year or more  Why are wealthy persons accredited investors:  Taking sophistication out of the analysis makes it easier to make offering.  They can afford to lose money, absorb loss from risk.  How do you determine income?  Tax Returns/W2  How do you determine net wealth  Bank statement, Tax return, W2, House The Sophistication Standard of Rule 506
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Rule 506 is alone among the Regulation D exemptions in requiring that either (1) each purchaser who is not an accredited investor, alone or with a representative, have such knowledge and experience in financial and business matters to be able to evaluate the merits and risks of the prospective investment; or (2) the issuer reasonably believes this it the case. Calculating the Number of Purchasers  Accredited Investors are not counted  A corporation, partnership, or other entity that is not accredited is counted as a single purchaser unless it was formed for the purpose of purchasing securities in the offering. Limitations on the Manner and Scope of an Offering  502(e) limits the process by which purchasers are solicited by prohibiting an issuer or any person acting on its behalf from offering to sell securities by any form of general solicitation or general advertising.  When is a communication a general solicitation or general advertisement?  Mass mailings are the easy cases.  In a series of no-action letters, the SEC has sought to distinguish limited from general communications; the former are permitted, while the latter are proscribed. Staff interpretations consistently emphasize the importance of a pre-existing relationship between the issuer (or person acting on its behalf) and the offeree in establishing the limited nature of a communication.  The types of relationships with offerees that may be important in establishing that a general solicitation has not taken place are those that would enable the issuer (or a person acting on its behalf) to be aware of the financial circumstances or sophistication of the persons with whom the relationship exists or that otherwise are of some substance and duration.  How to get around no general solicitation rule?  Pre-qualify persons. Kenton.  What prevents a general advertisement? A relationship.  You have to show that there was pre-existing relationship between the issuer and investor.  You have to have a relationship before soliciting person that would enable solicitee to be aware of the financial circumstances or sophistication of the persons with whom the relationship exists or that otherwise are of some substance and duration.  Should you knowledge be actual or reasonable. Should you know their financial circumstances and sophistication or reasonably believe they are suitable to invest.  You could always hire someone to that has an existing relationship with qualified offerees to sell for you.  Professor thinks that the SEC would want to see that the offerror actually knows that the offeree is qualified.  Regulation D, when dealing with accredited investors, it is enough to reasonably believe that the Investor is qualified or actually know that the person is a suitable offeree. Activities by Broker Dealers  Issuers in Regulation D offerings solicit the marketing assistance of broker-dealers. In such cases, a pre-existing relationship between a qualified offeree and the broker-dealer (rather than the issuer) will suffice to render communication limited under R. 502(c).  Hutton proposed to send written literature on the offerings to two classes of individuals: (1) those who had within the last three years invested in public or private offerings sponsored or sold by Hutton and (2) those who had prequalified on the basis of a Suitability Questionnaire and New Account Form. The prequalifying form eliecited information concerning the client‘s investment objectives, net worth, annual income, level of sophistication, and history of investment choices. Hutton argued that obtaining information through use of the form satisfied the requisite pre-existing relationship with Hutton, even if no sales had occurred. The SEC agreed.  Although the relationship between Hutton and the offerees may be substantive, is it pre-existing?  As any such relationship may have been established as a result of general solicitation or advertising, it is important that there be sufficient time between establishment of the relationship and an offer so that the offer is not considered made by general solicitation or advertising. In the Division‘s view, if the relationship was established prior to the time Hutton began participating in the Regulation D offering, an offer could be made to the person with whom the relationship was established without violating Rule 502(c).  In another no-action letter, the staff provided somewhat more specific guidance on what broker-dealers need to do to ensure sufficient time has elapsed between the establishment of a relationship with a client and the offering of securities to the client.  The SEC reviewed a scenario where:  New clients would not be sold securities currently being sold or scheduled to be sold at the time of their recruitment, and under no circumstances would any offering materials be sent for a period of at least 45 days after the first mailing. Noting in particular that (1) the initial solicitation would be generic in nature and would not identify specific investments the firm was offering or would be offering and (2) the firm would implement procedures to ensure no persons solicited would be offered securities the firm was offering or contemplating offering at the time of the solicitation, the SEC staff concluded the program was not a general solicitation within the meaning of Rule 502(c). Disclosure Obligations in Offerings Under Rules 505 and 506  Regulation D does not impose affirmative disclosure obligations if the only purchasers are accredited investors. Any nonaccredited investors in a R. 505 or 506 offering, however, must be given specified information ―a reasonable time prior to
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sale.‖ In addition to specified disclosures, nonaccredited investors must be given ―any material written information concerning the offering that have been provided by the issuer to any accredited investor.‖ See R. 502(b)(2)(iv).  The nature of disclosures required is specified in R. 502(b) and depends upon the size of the offering and the nature of the issuer.  If the issuer is a reporting company, the affirmative disclosure obligation may be satisfied by providing purchasers with designated filings made with the SEC pursuant to the 1934 Act reporting requirements. See R. 502(b)(2)(i).  For reporting companies they can provide copies of report provided to SEC – copy of 10K. Financial statements already audited. In addition, they must provide some sort of description of offering and use of proceeds.  If the issuer is not a reporting company, Rule 502(b)(2)(i) prescribes certain disclosures to the extent material to an understanding of the issuer, its business, and the securities being offered.  General rule for non-reporting companies, they are going to have to provide information similar to that of that filed in a registration statement and an audited financial statement. Filing Form D  Easy to prepare  Serves as notice. Substantial Compliance  R. 508 provides that failure to comply with a term, condition or requirement of Regulation D would not cause a loss of the exemption for any offer or sale to a particular individual or entity if the person relying on the exemption were to demonstrate that (1) the term, condition or requirement violated was not directly intended to protect the complaining party, (2) the failure to comply was insignificant to the offering as a whole, (3) a good faith and reasonable attempt was made to comply with all of the regulation‘s terms, conditions, and requirements.  Rule 508 provides that any failure to comply would, nevertheless, be actionable by the Commission. Aggregation: Determining the Aggregate Offering Price in Offerings Under R. 504 and 505  Rules 504 and 505 limit the maximum aggregate offering price on securities during any twelve month period.  504: 1 million (no more than 500K is attributable to securities not registered in a state). 504(b)(2)  505: 5 million without regard to state registration.  The aggregate offering limitations for offerings under either rule are reduced by the aggregate offering price of securities sold within the previous 12 month in reliance upon any of the § 3(b) exemptions or in violation of the registration requirements of §5(a).  Aggregation is a principle often confused with integration. Integration means that two ostensibly distinct offerings will be treated as one for purposes of determining the availability of an exemption from registration requirements.  P. 306-07 offer examples.  The aggregation provisions of R. 504(b)(2) and 505(b)(2) restrict the ability of an issuer to avoid the monetary limitations on § 3(b) by staggering the offering and selling of securities over a relatively short period of time.  Calculating the Aggregate Offering Price  R. 501(c) defines aggregate offering as the sum of all cash, services, property, notes, cancellation of indebtedness, and other consideration the issuer receives for the securities.  Also count securities sold in violation of § 5.  R. 501(c) directs the determination of aggregate offering price on the basis of the price at which the securities are offered for cash. Thus, if half of the securities were offered for cash, the cash purchases are doubled to yield the aggregate offering price for the entire issuance.  Also count securities sold in violation of § 5.  If the securities are not offered for cash, valuation difficulties are unavoidable. In these cases, R. 501(c) directs the calculation as determined by bona fide sales made within a reasonable time or, if there are no sales, ―fair‖ value as determined by an accepted standard.‖  Relevant Amount and Time Period  Two time period are relevant in applying the aggregate offering limitations of either R. 504 or R. 505: (1) the twelve-month period preceding the commencement of the offering under R. 504 or 505 and (2) the period of time during the offering of the securities under the applicable rule. The second of the two relevant time-period limitations is needed to prevent an issuer with no offerings during a preceding twelve-month period from commencing a R. 504 or 505 offering simultaneously with a second offering purportedly exempt under § 3(b).

Integration of Offerings  Integration: Issue is whether the two offerings that look like two offerings should be integrated into one offering. Whenever offerings are close in time, should ask whether there is an integration issue.  Rule 502(a) Safe Harbor: Any securities sold six months after the completion of a Regulation D offering and six months before the start of the Regulation D offering will not be integrated into the offering  Like R. 147, the safe harbor for intrastate offerings under § 3(a)(11), Rule 502(a) or Regulation D provides a six-month lookforward and look-backward guideline for defining when another offering by the issuer will not be regarded as part of the same issue in measuring compliance with eth conditions of the safe harbor.  Securities offered less than six months before the start or six months after the completion of a Regulation D offering may be integrated with the offering if it is part of the same issuer.

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Rule 147 Factors[intra-state offering exception]: Has parallel safe harbor to Rule 502(a). If the sale does not meet the safe harbor, court will consider factors below. Note, there is no rule on whether one factor is more important than the others, or how many factors you need to meet to integrate.  Are the offerings part of a single plan of financing?  Most Important.  A ―single plan of financing‖ is sometimes referred to as the presence of absence of the other four factors, other times the inquiry focused on the purposes of the offerings, the intent of the issuer at the time of the offering may prove dispositive.  Do the offerings involve issuance of the same class of securities?  Are the offerings made at or about the same time?  If offerings are separated by a substantial period of time, the spacing is sufficient to create a presumption against integration. A 6 month lapse appears sufficient to create a rebuttable presumption. The presumption may become irrebuttable if offerings are separated by at least a year. Conversely, the proximity in time of two offerings normally will not, of itself, create a conclusive presumption that the offerings should be integrated.  Less than 6 months = rebuttable presumption for integration.  Is the same type of consideration to be received?  Since the most common form of consideration is cash, the fact that two offerings involve cash is not a factor supporting integration.  The use of noncash consideration in one offering and cash in the other also suggests the offerings should not be integrated. Noncash consideration of a similar type, on the other hand, increases the possibility that multiple offerings will be integrated.  Are the offerings made for the same general purpose?  Suggests a level of generality to the integration analysis. The important point here is that each drilling project was designated to stand or fall on its own merits. Look to see if it is a common enterprise.

Registration under the State Blue Sky Laws  The ‗33 Act was not meant to supplant the state securities laws.  Registration under state blue sky laws. Every state has its own regulation. There is a Uniform Securities Act, but states have made many exceptions to it and not all states have adopted it (incl. NY and CA); states that have adopted have made many changes. 1956 version is probably the most widely adopted.  If not preempted you have to register: notification or qualification.  § 1-201 of the USA says that the sale of all securities must be registered. You cannot sell a security unless registered, unless there is an exemption. Here, if the security, falls under § 18 of ‘33 Act, it is preempted from state regulation. Any state law requiring registration or qualification of securities is preempted if the security is a ―covered security‖ or will be a ―covered security‖ upon completion of the transaction.  Three types of registration under state blue sky laws:  Notification  Disclosure: company will file a statement with the state that it qualifies for registration by notification. Company will include some basic information about the offering, and a copy of the offering prospectus.  Most companies do not meet the eligibility requirements for registration by notification because the earning requirements are very high.  No merit review. State registration becomes effective on the second day following the filing (basically becomes effective automatically). Not enough time for the state securities administrator to do a merit review.  MOST STATES HAVE DONE AWAY WITH THIS  Coordination  Disclosure: Company will file a copy of its registration statement and any amendments to it.  Merit review: State registration becomes effective at the same time the federal registration becomes effective. Can take a while, so plenty of time to do a merit review.  This is probably the most used. Available only for issuers that have filed a registration statement with the SEC under the ‘33 Act.  Qualification  Disclosure: Company is not filing a registration statement with the federal government, so will have to file a registration statement in each state where the offering will be made.  Merit review: State registration becomes effective whenever the state securities administrator orders it effective. Plenty of time to do a merit review.  Used when a company is selling securities and does not have to register with the SEC. E.g. when selling securities under a ‗33 Act federal exemption (no registration filing requirement) and there is no state exemption (if there were a state exemption, would not have to file with the state).  E.g. PA business selling to PA residents solely in PA. Business wouldn‘t have to do federal registration because of ‗33 Act intrastate offering exemption. Would then have to consider whether there is a state exemption. There probably won‘t be, so have to file by qualification.  What does merit review address?  Merit Review (always occurs under qualification, probably will occur under coordination, does not occur under notification)
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What is it?  Goes beyond disclosure review. State security administrators are going to look at the merits of the offering.  They look at whether the offering is fair/unfair. Is the offering meritorious or not.  State administrator will look at offering price, cheap stock, put proceeds in escrow so you can‘t blow it, limitations on the amount of money you can pay underwriter (excessive underwriter payment, indicates higher risk/lesser merits of security/offering, security is not that valuable).  P. 242 lists things  They may decide that the issue price is too high.  May demand a reduction in price.  Cheap stock—you are selling stock to public at 10, but sold to insiders at 5. State may make you sell to all at 5.  So for state you have disclosure and merit review.  NOTE: You have to register in any state that you are going to offer securities in.  If it is a national offering you will offer in all 50 states and DC.  the securities laws in each state are not uniform.  Coordinated Equity Review (COE)  One jurisdiction will be the coordinating state. They will make one state the state to give disclosure comments, one state to give merit review. Thus, rather than to negotiate and respond to 51 jurisdictions, the issuer will only have to deal with 2. The other 49 will register accordingly.  Price at which company is selling its stock to insiders. If price is less than the price at which the company is selling stock to the public, state might not like this. Seems to be unfair to the public. Transfer of wealth to insiders.  If a company does not pass merit review, the state securities administrators may block the sale of the company‘s securities in that state. If the company really wants to sell in that state, may have to lower its price. This would mean that company would have to lower its price in all states because it can‘t sell the same stock at different prices in different states.  Note: Contrast state securities regulation with federal securities regulations: With a federal securities regulation, it is up to the investors to decide whether or not they want to invest in the security. SEC just wants to make sure there is enough information out there so the investors can make an informed investment decision. SEC won‘t look to substance of offering like states. Criticism of Blue Sky laws: Time consuming and expensive. Company must figure out the state law; pay the state filing fee; hire a lawyer to do Blue Sky work; pay printing expenses. All of the comments from the states may be in conflict and it is expensive for the company to try to resolve the conflicts. Benefits of Blue Sky laws:  Blue Sky laws are needed because states are the only ones who are focusing on the merits of the offering. States are trying to protect their investors by not focusing simply on disclosure but looking to merits of offering  Disclosure: Federal prospectus or disclosure document filed with states. States have a period to make comments. Benefit is that the state is another set of eyes and can help improve the quality of the disclosure. Coordinated review: Rather than having different states make comments, and make different merit reviews, with coordinated review, one state makes comments and one state makes merit review. This cut down on costs. National Securities Markets Improvement Act of 1996: Congress was convinced that dual registration was unduly burdensome. When you impose a lot of costs, makes it more expensive for companies to raise capital, which can be bad for the economy. Congress amended §18 of the ‘33 Act to preempt the power of the states to require issuers to register offerings of ―covered securities.‖  Covered securities: The National Securities Market Improvement Act (NSMIA) amended § 18 of the Securities Act to preempt the power of the states require issuers to register offerings of ―covered securities.‖  ―Covered securities‖ are defined to include securities that are or will be listed on the NYSE, the AMEX, or NASDAQ. The SEC has exercised its rulemaking power to add securities traded on the Pacific Exchange, the Philadelphia Exchange, and the Chicago Board of Options Exchange.  Securities of investment companies (mutual funds) are also covered securities.  Also included as a covered security are securities offered pursuant to some of the Securities Act‘s exemptions, such as SEC safe harbors for private offerings pursuant to § 4(2), as well as those sold pursuant to the Commission‘s authority to exempt offerings to ―qualified purchasers.‖  ―Qualified purchasers‖ defines as under Regulation D‘s accredited investor.  Thus, the scope of the blue sky registration is considerably narrower after 1996.  Each state continues to have power to enforce its antifraud provisions with respect to covered securities. And states can continue to require the issuer to file a notice with the state and can impose a fee in connection with such an offering within the state.  State disclosure/filing and state merit review are preempted by Act.  Nationally traded securities are still subject to exchanges‘ review.  State filing fees do not apply to covered securities.  The only requirement under state law is a notice filing (we are selling securities in your state) and a filing fee.

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In most states, the many registration burdens have been greatly lifted for small offerings because of their adoption of the Small Corporate Offerings Registration (SCOR), which was developed by the NASAA. SCOR differs from the ordinary registration form because it uses a question-and-answer, fill-in-the-blanks format. The form is limited to offerings that do not exceed 1 million.  Most states do not permit SCOR to be used if the shares‘ offering price is less than 5 dollars or the offering is by an issuer that cannot describe either the business it will engage in or the property it will acquire.  Available for 504. The Uniform Limited Offering Exemption (ULOE)  Congress authorized the development of a uniform federal/state exemption system. See Securities Act §19(c). The federal half of the uniformity equation is reflected in Regulation D. The adoption of Regulation D was followed by NASAA approval of the ULOE.  The ULOE incorporates Rules 501-03 and establishes an exemption for offerings made in compliance with 505 and/or 506.  The more important of these include limitations on commissions to other persons other than registered broker-dealers or agents, expanded bad-boy qualifiers, and suitability requirements applicable to all nonaccredited investors.  The ULOE imposes a suitability requirement in that all sales to nonaccredited investors must satisfy either of the following conditions:  The investment is suitable for the purchaser upon the basis of the facts, if any, disclosed by the purchaser as to his other security holdings and as to his financial situation and needs. For the purpose of this condition only, it may be presumed that if the investment does not exceed 10 percent of the investor‘s net worth, it is suitable.  The purchaser either alone or with his/her purchaser representative(s) has such knowledge and experience in financial and business matters that he/she is capable of evaluating the merits and risks of the prospective investment. Cost/benefit of preemption:  A small corporation trying to raise capital will most likely sell its securities subject to exemptions. Its securities will not be covered and it will have to file in the state.  A lot of the benefits of preemption go to larger corporations.  Congress made a policy choice with preemption and said that federal government should regulate nationally traded securities. States still have power to regulate non-nationally traded securities.  Fraud: Congress did not preempt the right of states to enforce their fraud provisions. States can continue to bring enforcement actions.  Notice filings: Congress also preserved notice filings. So, states can still require companies to file a notice that the company is selling securities in the state. To do Blue Sky Problem  First, determine if security is exempted from Blue Sky Laws under § 18.  Where State Blue Sky laws do not apply, states will not review stock. The only requirement under state law is a notice filing (we are selling securities in your state) and a filing fee.  Nationally traded securities.  State law exemptions demand planned out structures.  There is an isolated transaction exemption. There are other exemptions.  25 people and general advertisement solicitation.

Sales by Nonissuers: Resales of Securities The Trading Exemption; The Definition of Underwriter  §4(1): §5 shall not apply to transactions by any person other than an issuer [company that is issuing the securities], underwriter or dealer [person or company that purchases or sell securities for the accounts of others].  What is the goal of the broad exemption?  The intent is to exempt all trading transactions. Sales that occur on the secondary market.  § 5 applies to all security sales, but § 4(1) exempts most to this rule.  § 34 Act regulates the trading market, broker-dealers, the investors.  ‘33 Act regulates primary issues.  With trading transactions there is existing public information (continually public disclosure – ‘34 Act steps in) on the security or the security was claimed exempt the first time around.  Any company that sells publicly has to put out annual 10Ks, 10Qs and AKs.  Thus, information on these companies is always available.  If you go public you have an obligation to continue to report.  The trading transactions are covered under the ‘34 Act.  Identify the potential underwriters.  §2(a)(11): Definition of an underwriter:  Any person who purchases from an issuer with a view to the distribution of a security; or  Firm Commitment Underwriter  Any person who offers or sells for an issuer in connection with distribution;  Best Efforts Underwriter  Any person who participates or has a direct or indirect participation in the activities covered by 1 or 2 above; or
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Any person who assists a control person in the distribution of the CP‘s securities.  Any person who participates or has a participation in the direct or indirect underwriting of any such undertaking.  This is essentially a rephrasing of 1 and 2. Difficult decision: natural person buys and resells a security. Are they an underwriter?  The only exemption is 4(1). All other exemptions are for issuers.  A person wanting to resell securities, generally, the only exemption is § 4(1). If the natural person is defined as an underwriter then they do not fall under § 4(1). §4(1) is a potential resale exemption for investors. However, a court must consider whether the investor purchased securities with a view to distribution and hence is an underwriter under §2(a)(11).  Resales concern issuers because resales can blow issuer‘s exemption  Issuers can prevent resales by:  Making investors sign ―no resale contracts‖  Issuing stop order transactions that say that investor cannot transfer without the company‘s approval Analysis  When examining problems involving natural person‘s sales of stock the analysis you would take is:  Is it a natural person under § 4(1) or an underwriter?  First, was the purchase from the issuer?  P. 345 top of page  Second, is it a distribution (p. 348)?  How do we know whether a resale constitutes a distribution?  Distribution is not defined.  Courts say that a distribution is a sale to those who ―cannot fend for themselves.‖ The term distribution is equated with a public offering. Transactions that do not involve public offerings are those found in § 4(2). § 4(2), the private placement exemption, tells us what is not a public offering. If you are trying to show that a natural person has not sold securities in connection with a distribution then the resale must to be proven to be a sale akin to a private placement.  Third, did she purchase with a ―view to‖ distribution?  Investment Intent (p. 345)  Did you purchase with a view to resell or invest?  Look at hold period. If someone has purchased securities and held for at least three years they have established their investment intent and are not underwriters. Where not an underwriter, chances are that you can rely on 4(1).  3 years conclusively establishes investment intent.  If you hold for 2 years, the ―bendpoint,‖ there is a rebuttable presumption that you have investment intent.  Between 2 and 3 years is probably safe. 2 years probably establishes investment intent.  Consideration must then be given to the circumstances surrounding the shares‘ purchase as well as any change in the purchaser‘s circumstances after their purchase.  If you hold for less than that, there is no presumption.  Exceptions: doctrine of changed circumstances.  Note: It is only when the resale violates the criteria of the exemption under which the issuer sought to avoid registration that the resale gives rise to a distribution.  Always keep in mind the safe harbors created by 147 and 502(a), which protect resales.  No view to distribution if exempted by safe harbor.  Basis behind this rule: has the security come to rest. Was the subsequent resale consistent with the original sale? Problem: Sixteen months ago Beatrice purchased 1,000 unregistered common shares through a private placement. Beatrice has just been admitted to an expensive graduate program. If she sells her shares to pay the tuition deposit for the program, will she violate §5?  Investment Intent: Court will look to how long Beatrice held her securities to determine whether she purchased the securities to resell or to invest.  Holding period: Longer you hold the securities, the more likely it is that you purchased the securities to invest  Presumption of investment intent if the investor has held the securities for 3 years.  If the securities have been held for less than 2 years, presumption is that they were purchased with a view to distribution.  Factors of purchaser‘s circumstances when he purchased the securities and a change in circumstances after their purchase must negate an inference of intent to distribute.  If the securities have been held for more than 2 years, presumption of investment intent.  If the securities have been held for less than 2 years, but more than 3 years, factors of purchaser‘s circumstances when he purchased the securities and a subsequent change in circumstances will not support an inference of an intent to distribute.  Note: Beatrice might be able to resell to a person who meets Ralston Purina. In this case she will not blow the issuer‘s §4(2) exemption. It is only when the resale violates the criteria of the exemption under which the issuer sought to avoid registration that the resale gives rise to a distribution.
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Distribution. Whether you are an underwriter depends on whether your resale is a distribution.  Hypo: Issuer sells to JOH in a §4(2) private placement. JOH holds security for one month and then resells to X.  JOH has not established her investment intent, because she has only held for one month. However, she will not be deemed an underwriter UNLESS her sale to X is a distribution.  A distribution is a public offering. No real test for public offering, but we know that if the offering is not a public offering, it is a private placement. The test for private placement comes from Ralston Purina.  If the purchaser is able to fend for themselves and does not need the protection of the ‘33 Act, there is no distribution. Distribution exists if sales are made to those who cannot fend for themselves.  Look to who purchaser is. Ask if issuer could have sold directly to X in a private placement. If issuer could have sold directly to X, okay to use JOH as a conduit. If X were a venture capital firm, for example, would have been okay to sell directly to X.  What if JOH resells to X, who is not sophisticated?  JOH did not establish investment intent because only held for one month.  When JOH sells to X, there is a distribution because X does not meet Ralston Purina. Does not make sense to permit issuer to sell to X using JOH as a conduit.  JOH is an underwriter, so she is subject to §5 liability under §4(1).  Issuer is in an awkward position when they make a private placement because they are essentially held hostage to what the person they sell to does. Issuer can avoid this by putting restrictions on resale; issuing stock transfer orders; putting a legend on the securities.  Bottom line: If there is no distribution, there is no underwriter involved. This is because the distribution requirement is in each of the definitions of underwriter.

Control Person Distributions; The Section 4(1-1/2) Exemption  The reach of § 5 of the Securities Act is broadened significantly by the second sentence of § 2(a)(11): ―As used in the paragraph the term ‗issuer‘ shall include, in addition to an issuer, any person directly or indirectly controlling or controlled by the issuer, or any person under the direct or common control with the issuer.‖  Thus, one who purchases from a control person, or sells for a control person, or otherwise participates, directly or indirectly, in a distribution of the control person‘s securities is an underwriter.  Distributions by control persons are subject to regulation similar to that applied to issuers.  Control persons, as a distributor, are in the position of controlling the issuer and thus able to furnish the information demanded by the bill.  § 2(a)(11) provides that a control person is an issuer, but only for the purpose of determining whether the person who purchases from or sells for the control person is an underwriter. A control person is not an issuer for other purposes of the Act because the control person is not included within § 2(4)‘s definition of an issuer.  The only exemption, generally, available for natural persons is § 4(1).  What prevents a natural person from using § 4(1). If they are labeled an issuer or control person. The last sentence of § 2(a)(11) says that control persons will be treated as an issuer only for § 4(1).  Who is a control person?  ‘33 Act defines control (p. 94). One who directs (or has the power to direct) the management and policies of the issuer, whether through stock ownership, position, contract, or otherwise (this is the SEC‘s understanding).  This would include the CEO, members of BOD or other senior officers. Large stockholders, directors or senior managers are always conceivably control persons.  Congress defines control as one who has power to obtain the signatures of those required to sign a registration statement (this is the one Congress likely had in mind).  The definition of an underwriter thus includes a person assisting a control person in a distribution of a control person‘s securities. No distribution = no underwriter.  Alice purchased 1 million shares of common stock from Issuer in a Section 4(2) private placement. Alice is a control person of Issuer. One month after this sale, Alice called her broker and resold her common stock on the New York Stock Exchange. Does this resale violate Section 5 of the ‗33 Act?  Control Person: Yes.  Distribution: Yes. Sold on NYSE, which is inconsistent with Ralston Purina.  Who is/are the potential underwriters:  The broker (one who assists to sell a distribution) could be an underwriter. Here, the broker is an underwriter.  Alice is also an underwriter (under #1). She held for only a month and sold on NYSE a distribution. Alice is also considered an issuer to find broker an underwriter.  If I bought from Alice through NYSE with a view to distribution, could I be considered a underwriter?  No. You don‘t know who bought from on NYSE  But if you did know that you bought from an issuer and if you bought without investment intent and as a distribution then you could be considered an underwriter.  For noncontrol persons when the stock hits the NYSE the stock is considered cleansed, there is not taint.  Hypo: Assume Wolfson purchased his stock in a §4(2) private placement and held the stock for 5 years. He now wants to resell his stock on the NYSE.
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Is Wolfson an underwriter? Probably not. He has established his investment intent by holding his stock for 5 years. Any other potential underwriters? The broker dealer. Wolfson is a control person because he is a large individual shareholder and is in a position to set policy. Have to look for whether the broker/dealer is assisting Wolfson in a distribution of Wolfson‘s securities. There is a distribution because Wolfson is selling his stock on the NYSE. No attempt made to determine whether purchasers satisfy Ralston Purina.  Look to §4(1): §5 does not apply to transactions by any person other than an issuer, underwriter, or dealer. Wolfson is not an issuer—he is a control person. But the transaction involves an underwriter—the broker dealer.  §4(4) exemption: Broker who acts in a ministerial function (e.g. his client calls him up and asks to sell securities) is okay. Note that control person cannot use broker‘s exemption to avoid §5 liability.  If Wolfson had not used a broker dealer, and had sold his stock in front of the NYSE to pedestrians, he would have been okay. He would not have been deemed an underwriter because he would have established his investment intent by selling securities after 5 years of holding. Bottom line is that if you can structure a transaction where there is no intermediary, this is okay.  What if Wolfson only held his securities for 1 month? There would be no investment intent because he held his securities for a short time. There would also be a distribution because Wolfson would be selling to random people who might not meet Ralston Purina. Wolfson would be an underwriter.  Assume Wolfson is not a control person. He purchases 6,000 shares from the issuer, and a month later resells to pedestrian walking in front of NYSE. Wolfson would be an underwriter. He purchased his securities from an issuer. He would not have established his investment intent because he only held for one month. There would also be a distribution because Wolfson would be selling to random people who might not meet Ralston Purina.  Assume Wolfson is not a control person. He purchases 6,000 shares from the issuer, and 5 years later he resells to a pedestrian walking in front of the NYSE. Wolfson would not be an underwriter because he held for 5 years and established investment intent. ‗33 Act does not apply to trading transactions; it is only concerned about sales from the company. Here, this is a true resale because Wolfson has held for 5 years. While the pedestrian is entitled to information, and there is a distribution (because pedestrian may not be a suitable offeree), the ‗33 Act does not address this. The 5 years makes a difference. May fall under the ‗34 Act. RECAP:  If person has not established investment intent, but there is no distribution, person is not an underwriter—PERSON IS SAFE  If person has established his investment intent, and there is a distribution, person is not an underwriter—PERSON IS SAFE because ‗33 Act will not apply in this case. Issuer (company) is not involved anymore.  If the person selling is a control person, look to whether someone is helping the control person sell. This person might be an underwriter.  ’33 Act disfavors control persons. Anyone who assists a control person in selling their securities is potentially an underwriter  Hypo: Issuer sells to CP in a §4(2) private placement. CP sells to X using a broker.  Two potential underwriters: CP and X.  If CP held for 5 years, he no longer an underwriter because he has established his investment intent.  When the CP calls the broker and asks the broker to resell the securities on the NYSE, the broker may be in trouble. The broker is helping the CP.  Ask if there is a distribution. Here, there is a distribution because broker has no idea whether X or anyone else would meet the R/P test. When someone sells on the NYSE, will always be a distribution.

The Rule 144 Safe Harbor for Resales of Control and Restricted Securities  Work horse exemption. This is the first point of resell. Always examine first.  (a) is the definitional section  (b) is the substantive law. Safe-harbor. If you meet 144 there is no distribution. No distribution = no underwriter, which allows us to use 4(1)  If the sale is made in accordance with all the provisions of Rule 144, any person who sells restricted securities shall be deemed not to be engaged in a distribution of such securities and therefore is not an underwriter thereof.  Rule 144 also provides that any person who sells restricted or other securities on behalf of a person in a control relationship with the issuer shall be deemed not to be engaged in distribution of such securities and therefore not to be an underwriter thereof, if the sale is made in accordance with all the conditions of the rule.  144 applies to:  Resales of restricted securities  Resales of unrestricted securities by control persons (―control securities‖)  Resales of controlled restricted securities  Restricted securities (p. 58) (a)(3) defines restricted securities. Securities sold pursuant to private placement exemptions (4(2)), securities sold pursuant to regulation D, Regulation Securities. [3(a)(11) and 147 securities are not restricted securities]. You want securities to be restricted under this rule.  Control securities: securities resold by control person, can be restricted or unrestricted [3(a)(11) and 147 are unrestricted, so control persons can resell them under the 144 safe harbor.  Controlled restricted securities: restricted securities resold by control person.  Noncontrol and restricted stock:
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Holding period: 1 year [Note: all conditions are lifted if a noncontrol holder of restricted securities has held them for at least two years under 144(k)]  Trickle: greater of 1 percent of outstanding securities or average weekly trading in any three-month period  Sale method: broker‘s transactions  Information: publicly available information about issuer  Filing: disclosure on Form 144 (if sell more than 500 or more than 10K) Control (and by broker) of restricted stock:  Holding period: 1 year  Trickle: greater of 1 percent of outstanding securities or average weekly trading in any three-month period  Sale method: broker‘s transactions  Information: publicly available information about issuer  Filing: disclosure on Form 144 (if sell more than 500 or more than 10K) Control (through broker) of unrestricted stock:  Holding period: none  Trickle: greater of 1 percent of outstanding securities or average weekly trading in any three-month period  Sale method: broker‘s transactions  Information: publicly available information about issuer  Filing: disclosure on Form 144 (if sell more than 500 or more than 10K) Resell of restricted securities by noncontrol person X Resale of unrestricted securities by CP X Resale of restricted securities by CP X

Adequate current public information available— 144(c) Holding period X X Limitations on amount sold-- X X X Notice filing X X X Termination of restrictions X under 144(k) Brokers transaction X X X  Availability of Public Information  The rule provides that there shall be available adequate current public information with respect to the issuer of the securities. This provision is deemed satisfied if an issuer has been subject to the reporting requirements of § 13 or 15(d) of the Exchange Act for a period of at least 90 days immediately preceding the sale of the securities and has filed [during the 12 months preceding the sale] all reports required by that Act and rules and regulations. 10K and 10Qs.  In case of companies which are not subject to the reporting requirements, the companies must produce information required by clauses i, xiv, and xvi of paragraph (a)(5) of Rule 15c2-11 of the Exchange Act.  This information includes, among other things, the exact name of the issuer, the address of its principal executive office, the exact title and class of the security, the number of shares or total amount of the security outstanding, the nature and extent of the issuer‘s facilities and the product or service offered, and financial information concerning the issuer including its most recent balance sheet and profit and loss statement, which shall be reasonably current.  Holding Period  Minimum of one year.  Limitation on Amount of Securities Sold  Shall not exceed the greater of 1 percent of the number of shares of that class of security outstanding or the average weekly reported trading volume in such security during the preceding four calendar weeks.  SEC concerned with health of market. We don‘t want to flood the market. Lots of supply with limited demand will kill prices.  The impact on the trading market.  Manner of Sale  Brokers Transactions  Transactions where a broker does no more than execute a sell order as agent and receives no more than the usual and customary commission. The broker may not solicit buy orders. In addition, the rule provides that the broker shall make a reasonably inquiry to ascertain whether the seller is engaged in a distribution.  Notice of Offering  Must file for sales greater than 500 shares or other units or 10K whichever is more.  Bona Fide Intention to Sell  In order to avoid persons filing any notice of offering ―for the shelf,‖ the rule provides that a person shall have a bona fide intention to sell.  Why doesn‘t 144 demand a hold period for the resale of unrestricted securities by a CP?  CP is not acting as a conduit trying to help sell the issuers offering, distribution because it is likely bought off of NYSE. There is no underwriter involved in these circumstances.

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The holding period in 144, one year, assumes that you are holding with investment intent. Holding period is intended to help you establish investment intent.  Once you establish that he purchased from an issuer you know that he is not an underwriter.  Control person—intermediary—distribution. There is no analysis required for investment intent. There is no restricted securities sold.  NOTE: a distribution is defined by 4(2).  The requirement is to show investment intent. Resale of unrestricted securities does not require investment intent. 144(k)  2 year holding period. All conditions are lifted if a noncontrol holder of restricted securities has held them for at least two years.  Only noncontrol persons can use it.  Don‘t have to know about aggregation issues for holding period. Brokers transactions  Unsolicited trade executed by broker (sale on customer orders) without any extra compensation. Typical, vanilla, broker transactions.  not a brokers transaction if the potential purchaser has been solicited or broker paid additional money.  What is the purpose of requiring broker transactions?  4(1) is supposed to exempt trading transactions. Usually, they are accomplished through brokers. If you have to hire someone to find you a purchaser that is not a trading transaction anymore, you are attempting to find a buyer. Also, the SEC is worried about filtration, information dissemination. Problem:  Bob purchased 1 million shares of common stock from Issuer in a Section 4(2) private placement. Bob is a control person of Issuer. Five years after this sale, Bob called his broker and resold his common stock on the New York Stock Exchange. Does this resale violate Section 5 of the ‗33 Act?  Are they restricted securities?  Yes.  Part I:  All requirements met.  Part II: No. There is no 144(k) exception for CPs.  For an exam, if you see a situation where the CP is holding for more than two years you have to point out that 144(k) does not apply. Problem:  Consolidated, Inc., a Delaware corporation, has 10 million shares of common stock outstanding. Consolidated‘s stock trades on the New York Stock Exchange. Since it became a ‗34 Act reporting company in 1990, Consolidated has timely filed all relevant periodic and other reports with the Securities and Exchange Commission. Patrick is the President and Chief Executive Officer of Consolidated. On September 1, 1999, Patrick purchased 150,000 shares of Consolidated common stock on the NYSE. He owns no other Consolidated common stock. In May 2000, Patrick developed unexpected financial problems and decided to sell his Consolidated common stock to raise some money. He called his broker, who promptly executed the sell order on the NYSE. The average weekly reported trading volume in Consolidated common stock during the four weeks preceding Patrick‘s sale was 200,000 shares. Has Patrick sold unregistered securities in violation of Section 5 of the ‗33 Act? Consider both Rule 144 and Section 4(1). Analysis  Does 144 apply at all?  This is a control person. Explain why.  NOTE: If he was a non-control person the stock would be cleansed in this case and the sale would be exempt as a true trading transaction. But, the broker would be an underwriter.  Yes. These are controlled unrestricted securities.  Information met.  This is a broker‘s transaction.  He can sell not more than the greater of 200K or 100K (obviously use 200K because it is more). So he is okay.  Not a restricted security, so no holding period.  Assume filing met.  So, 144 would exempt Patrick, which is good because 4(1) would not have worked otherwise. See below.  § 4(1) would not exempt Patrick here, see below. Thus we need 144.  Under § 4(1) transactions by persons other than issuer, underwriter or dealer are always exempt.  Potential underwriters here:  Broker.  Under last sentence of 2(a)(11), for purposes of this section a control person is considered an issuer. Thus, intermediary‘s who help control person‘s purchase a security are potentially and underwriter. The broker, however, has to be involved in a ―distribution.‖  Is there a ―distribution.‖  A ―distribution‖ is a public offering or non-private offering.

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Go through Ralston Purina. You are selling through NYSE. Thus, Ralston Purina is not met. Ralston Purina involves securities who could fend for themselves. Sophisticated investors with knowledge.

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Patrick.  He is not an underwriter. Patrick did not purchase from an issuer. So he did not purchase or sell for an issuer with a view to distribution.  Does ―change in circumstances‖ doctrine affect this fact pattern?  It would not help here, however, we don‘t care about investment intent. This doctrine can be used to help investment intent, but not here. We don‘t need it.  Patrick would violate 4(1) here because the broker is an underwriter and therefore the transaction is an underwriter. The broker and Patrick both violate § 5.  The broker could rely on 4(4) to absolve themselves here. Patrick would still be in violation.  In this situation, Patrick could possibly resell in this circumstance under 4(1) if they did not use a broker or if they used a broker but sold through private placement (411/2 exemption). NOTE: Control persons have so many restrictions on their sales because Congress does not want the control persons to use their exemptions to effectuate a distribution. A control person can potentially own a large % of the corporation. But for the tough restrictions on control persons, they could use the exemptions to basically effectuate a distribution. Congress‘s concern is with people owning a lot of stock dumping their stock without having to register. This prevents issuers from using control persons as a conduit. The primary purpose is to allow the purchaser to make an informed investment decision. The concern is that we do not want to allow control persons to sell stock without causing the company to register. The control person has the power to make the company register, so why allow them to get away selling stock to an unsophisticated investor where there is no investment intent. Ackerberg v. Johnson (8th Cir. 1989): Vertimag sold shares to Johnson in a §4(2) private placement which Johnson sold to Ackerberg. Johnson held the shares for 3+ years. Johnson was a control person. He had ability to affect policy because he was the Chairman of the Board of Vertimag, was one of the founders of Vertimag, and was Vertimag‘s largest SH. PJH (brokerage firm) acted as a finder for Johnson and found Ackerberg. PJH gave Ackerberg a 99-page private placement memorandum which contained detailed information about Vertimag.  Potential underwriter[s]: (1) PJH and (2) Johnson.  Why couldn’t 144 be used here? There was no brokerage transaction. Here, PJH was soliciting potential investors. Brokerage transactions are when broker is acting in a purely ministerial function. Also, Johnson was probably selling too much and would have exceeded volume limitation of Rule 144.  Definition of an underwriter: (1)Purchase from an issuer (2) with a view to (3) distribution.  Johnson had established his investment intent. His securities had come to rest. Johnson had not purchased with a view to distribution because he held the securities for more than 3 years. If someone holds securities for more than 3 years, they have conclusively established their investment intent. Johnson was not an underwriter.  Definition of an underwriter: Any person who assists a CP in reselling a CP‘s securities in a distribution: PJH was a potential underwriter. PJH would be an underwriter if there was a distribution.  §4(1 ½ ) analysis: Think about whether there is a distribution. Courts have defined distribution to mean the same thing as a public offering. Courts look to Ralston Purina line of cases which tell you what a public offering isn‘t. If the act would have passed Ralston Purina there is no distribution and PJH is not an underwriter.  Does Ackerberg need the protections of the ‘33 Act?  Information: Ackerberg got actual disclosure—the private placement memorandum.  Sophistication: Ackerberg is sophisticated because he is a professional investor.  No distribution. PJH is not an underwriter, so Johnson can resell to Ackerberg using §4(1).  Why is it called §4(1 ½ )? Can‘t really use §4(2) analysis because §4(2) covers transactions by an issuer and Johnson is not an issuer. But court uses §4(2) analysis to find out whether Johnson is an underwriter for purposes of §4(1).  Basically, when talking about whether you have done a §4(1 ½ ) analysis, asking whether you have had to analyze a distribution using Ralston Purina. Using §4(2) to inform your analysis of the definition of distribution under §4(1). §4(1 ½ ) just describes the relationship between §4(1) and §4(2).  §4(1 ½ ) analysis just means using Ralston Purina to determine whether there is a distribution to determine whether there is an underwriter for purposes of §4(1). Hypo: Vertimag sells to Johnson, Johnson holds for 6 months, Johnson resells to Ackerberg.  Vertimag‘s sale to Johnson has not come to rest. So when Johnson resells to Ackerberg, trying to figure out whether the §4(2) private placement is blown.  Could Vertimag have sold directly to Ackerberg? Yes, because Ackerberg is sophisticated. So there would be no violation of §4(2).  Whenever you are asking yourself whether there is a distribution, and are using Ralston Purina, you are conducting a 4(1 ½ ) analysis. If Johnson has established investment intent, would not have to do a 4(1 ½ ) analysis. (Note, would still want to do this on the exam).

The ―For Value‖ Requirement  §2(a)(3): Definition of Sale. The term ―sale‖ or ―sell‖ shall include every contract for sale or disposition of a security, for value.  §5 applies to all sales. So if anyone wants to resell a security, and they don‘t want to register it, have to have an exemption.
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Issue with trying to sell under §4(1) is that you may be an underwriter. Determine whether there are any potential underwriters. Try to fit under Rule 144. If you meet conditions of Rule 144, there is no distribution. If no distribution, then no underwriter. What is a sale? There are many instances when a company issues securities and does not get any money in return:  Stock dividend (no money changing hands—company is issuing stock, but not to raise capital)  The dividend is a gift, free to SHs.  Conversion privileges (company may issue convertible debt which may be converted to common stock or preferred stock. If someone exercises conversion privilege, they don‘t get money in return.)  Ex. Bonus. Stock bonuses. Stock as part of compensation. Used to compensate and motivate EEs.  Mergers (when company issues its stock to buy another company).  Ex. Merger combinations. Often consideration is a companies stock in connection with a merger.  Mergers, sale of substantially all assets, tender offers. Does §5 apply to all of the above? Three possible outcomes:  The ‘33 Act won‘t be implicated at all because there is no sale.  The ‘33 Act will be implicated because there is a sale, but there‘s an exemption available so the company does not need to register the securities.  The ‘33 Act will be implicated because there is a sale, no exemption will be available, and the company will have to register the securities.  If you determine that the stock was not issued for value, there is no sale. If no sale, company does not have to worry about §5.  When do you have to worry about § 5 in issuing stock?  To consider:  Is there a sale?  § 5 says anyone ―selling‖ securities has to register. If there is a sale. Securities have to be registered unless there is an exemption.  IF NO  No § 5 worry.  IF YES  Go On.  Is there an exemption?  3(a)(9), 3(a)(10). Private Placement exemption, etc.  If YES  No § 5 worry.  IF NO  § 5 applies. Value is not always what it seems  Ex. After purchasing all the shares of some 69 private companies the promoters made gifts to 275 to 900 persons through the US and retained a controlling block of shares in each company, which they later sold for a handsome profit. The Commission found the respondents had violated § 5, reasoning that ―for value‖ depends ―not only on whether the recipient of the security gives something of value . . . but also on whether value is received from any other source.‖ The Commission concluded the respondents received value in the form of the public market their gifts of shares had fostered.  When many Internet startup companies awarded free stock to individuals who visited the company‘s web page, the SEC reasoned the companies were violating § 5; the staff reasoned that the issuance of securities in consideration of a person‘s registration on or visit to an issuer‘s Internet site fell within the meaning of § 2(a)(3). Stock Dividends.  Because there is no consideration from those who receive the stock dividend, the typical stock dividend does not involve the sale of a security.  A choice between cash or a stock dividend does not involve the sale of, or offer to sell, a security.  On the other hand, dividend reinvestment programs, in which SHs may by prior agreement have their dividends applied toward the purchase of additional shares from the corporation at current market prices, are subject to registration under the Securities Act. Warrants and Convertible Securities  Bonds, warrants, and options are each specifically identified as securities in § 2(a)(1) and must be registered unless an exemption is available.  Whether the underlying security –the security that may be acquired through conversion or the exercise of a warrant or option—must be registered depends upon when, by the instrument‘s terms, the holder can acquire the underlying security through conversion or exercise of the warrant or option.  If the conversion features or the warrant‘s or the option‘s terms provide that it can be exercised immediately, two distinct securities are then being offered, so that each must be registered or qualify for an exemption from registration.  On the other hand, if by the terms of the instrument the holder cannot convert or exercise the warrant or option until some future date, the underlying security is not ―offered for sale‖ until that future date, and the underlying security‘s registration is not required at the time the convertible security, warrant, or option is being offered.Shelf registration Amendments and Indentures and Reincorporation.  The corporation‘s articles of incorporation set forth the rights, privileges, and preferences of each class of a corporation‘s stock.  The rights of bondholders are set forth in the bond‘s indenture, which also prescribes the procedures that must be followed to alter the bondholder‘s rights.
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Whether an amendment to the articles of incorporation or bond indenture is subject to Section 5 of the Securities Act is determined by resolving two separate questions:  (1) whether a sale of the security is involved; and  (2) whether that sale involves the type of exchange of securities exempted under § 3(a)(9).  Extending the maturity date on a bond‘s indenture at the individual bondholder‘s option is a sale under the Public Utility Holding Company Act of 1935‘s broad definition of sale.  The court reasoned that lengthening the maturity date is functionally equivalent to surrendering the old security for a new one. Even though the certificates were never physically exchanged, the modification was deemed a sale of a security.  The SEC, in its response to no-action letter requests, is fairly consistent in viewing all material changes in a security‘s economic or voting rights as entailing the sale of a new security.  On the other hand, a sale is not involved if the change involves no economic consequences to the holders, such as altering the share‘s par value.  SH‘s rights are also altered through the entity‘s reincorporation in a jurisdiction whose corporate law accords security holders different sets of rights than in its former corporate domicile.  No sale is involved when SHs of an operating company received the same proportionate interest in a newly created holding company.  No sale was involved where the issuer sought the alteration of its indenture obligation to comply with all federal laws. Bona fide gifts are not sales  Note: SEC will look for ways to find value in an alleged gift.  True bona fide stock dividends are a gift Option: you purchase the right to buy or sell the security in the future. Convertible securities present a sale of two securities for sale. The security and the security it can be converted into.

Securities Issued in Business Combinations  Rule 145, 165 and 166 regulate much of the scope of § 5 when securities are issued in connection with most business combinations.  There are three types of R. 145 transactions that are prescribed in paragraph (a) of the Rule, provided each involves a vote or consent of the SHs: recapitalizations, mergers and certain transfers of assets (e.g., where the selling company is required to dissolve or distribute the securities received from the transfer within one year).  Rules 165 and 166 apply only to transactions that fall within R. 145.  Business Combinations under 145 include mergers, sale of assets and reclassifications where there is a vote. 165 includes those three and tender offers.  Merger  Look to state corporate law merger statute. State laws will require certain filings  Worry about tax consequences  Consideration: may be a security (e.g. acquiring corp. issues its stock to the corp. it is acquiring)  Stockholders of both corporations generally have to approve a merger, because it is considered a fundamental change to the corp. Acquired company is dissolved by operation of law and the securities issued as consideration for the merger are issued directly to the SHs of the acquired company.  With stock for stock combination, for value requirement will be met  ―No Sale‖ Doctrine: For a long time, the SEC said there was no sale in a merger. SEC considered the sale to be an involuntary operation of law; a vote to approve a merger was not the same as an informed investment decision.  SEC‘s logic was flawed, because if SH votes in favor of a merger, consequence will be that SH will get company A‘s stock in exchange for his stock in company B. So, SH would absolutely want to know information about company A so he can cast an informed vote.  SEC rescinded ―no sale‖ doctrine in Rule 133.  Sale of all or substantially all of the selling corporation’s assets to the purchasing corporation  Vote of SHs of selling corporation is required.  Tender offer [only for 165]: Acquiring company offers to acquire some or all of the outstanding shares of another company.  Offer of securities of the acquiring company is made directly to the SHs of the acquired company.  Rule 145: An ―offer,‖ ―offer to sell,‖ ―offer for sale,‖ or ―sale‖ occurs when there is submitted to security holders a plan or agreement pursuant to which such holders are required to elect, on the basis of what is in substance a new investment decision, whether to accept a new or different security for their existing security.  Rescinds Rule 133: Stock issued pursuant to a merger will be treated as a sale of stock.  If company wants to issue stock pursuant to a merger, it will have to register the stock or find an exemption.  Exemptions: Technically, all of the exemptions can be used in a business combination.  Form S-4: Assume no exemption is available and A corp. decides to register the securities it is issuing to the T corp. The Form S-4 is a specialized form of registration statement for stock issued in a business combination.  You need a different type of information. You need information on appraisal rights, voting rights and the value of the stock you are receiving and its comparative value to your stock/assets.  Note: The S-4 can also be used as a proxy statement.

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Communications in the pre-filing period: Communications made in connection with or relating to a business combination that will be registered under the ‘33 Act may be made under Rule 135, 165 or 166.  5(c) places restrictions (gun-jumping) on the ability to communicate pre-filing. Cannot offer a security during the pre-filing period. However, there are carve outs for communications made during a business combination. There are special rules for that under 165 and 166. The SEC reformed some of these gun jumping rules in 1999 (165 and 166).  In 1999, SEC came up with Rules 165 and 166. Only apply to registered offerings. SEC made changes to make it easier for people to enter into business combinations. Gun jumping rules restrict companies in how they present information. ‘33 Act is all about providing information: want more information to flow to people. Rule 165 signifies a huge shift in how the SEC thinks.  Ex. Acquisition is announced, Board is trying to get together and send letter to SHs to explain transaction. Letter sent to B SHs to try to convince them to sell assets for stock. 165 provides an exemption for this letter, as long as filed.  This letter is not enough to make an informed decision. But this is a registered offering, thus the B SHs will eventually receive a prospectus.  The letter will contain a legend.  Oral communications do not have to be filed and they are okay.  Rule 165: Registrant may make an offer or solicit an offer to buy securities during the pre-filing period, so long as any written communication is filed. If you have written communications, you must file with SEC. §5(c) will not apply.  Written communications must be filed with the SEC  Communication must have a legend urging investors to read the documents filed and that they are free at SEC website.  Tender offer/proxy rules must be met.  Written communications must be filed beginning with the first public announcement of the business combination transaction. For purpose of determining when a filing obligation is incurred under the exemptions, ―public announcement‖ means any communication by a party to the transaction, or any person authorized to act on a party‘s behalf, that is reasonably designed to, or has the effect of, informing the public or security holders in general about the transaction. 165(f)(3).  Does not require oral communications to be put down in writing and filed; however, there are very few oral communications that are not put down in writing—if you are reading from a script, the script would have to be filed.  Internal written communications provided solely to parties to the transaction, legal counsel, financial advisors and similar persons need not be filed.  Business information that is factual in nature and relates solely to ordinary business matters, and not the pending transaction, would not be filed.  Registrant may make an offer or solicit an offer to buy securities after the registration is filed if there is a legend on the prospectus urging investors to read the documents filed and that they are free at SEC website and tender offer/proxy rules must be met.  NOTE: fraud provisions remain available.  Rule 166: Deals with the time before the first public announcement.  NOTE: These exemptions are only available in business combinations (3 types—listed in 145). Liability for communications: Both oral and written communications made in reliance on the Securities Act exemption would be offers subject to § 12(a)(2) liability, based on the belief that his level of liability adequately protect investors without chilling communications. Rule 165 states that an immaterial or unintentional failure or delay in filing will not result in a loss of the exemption from § 5(b)(1) or (c), so long as good faith and reasonable attempt to file the written communications is made and the communication is filed as soon as practicable after discovery of the failure to file. Rule 145(c): Resale issues.  Rule 145(c) expands the scope of the definition of ―underwriter‖ to include any party to a business combination other than the issuer and control persons of Target. Rule 145(d): Special resale provisions. Underwriters may not resell under § 4(1), but there is some relief. There are three ways for to resell under 145(d), but it Only applies to people who acquired registered securities.  (1) The target company, the target company‘s affiliates, and the control persons of the target company will be deemed to NOT be underwriters if they meet the requirements of Rule 144(c), (e), (f) and (g):  Current public information  Limitation on amount of securities sold  Manner of Sale  Broker‘s transaction  (2) The person or party reselling is not an affiliate of the target company and at least one year has elapsed since the date the securities were acquired from the target company, and there is adequate current public information about the target company.  No broker requirement  Note: If I own 90% of stock of T, give up my stock, and become a SH of A, I may or may not be an affiliate of A depending on how many A shares are. I can still use Rule 145(d)(2) so long as 1 year has elapsed and A meets the current public information requirements.  (3) The person or party reselling has not been an affiliate of the target company for at least three months, and at least two years have elapsed since the date the securities were acquired from the target company  Can sell free of restrictions. This is similar to 144(k). Issuer exemptions found in § 3(a)(9), 3(a)(10) and 4(2) are not affected by R. 145.
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Hypo: What if I was a SH of T and I acquired my A stock using in a §4(2) private placement [securities will thus be unregistered.]? I will be a Rule 145 underwriter, but I will not be able to use the Rule 145 safe harbor because the safe harbor only applies to stock that is registered. So how may I resell?  Possibly, they can rely on the exemption they used to buy the stock, 4(2) in this scenario if the issue has not come to rest.  If it has, they can rely on the 4(1) exemption.  Go to 144. The securities are restricted (4(2) and Regulation D).  Follow typical 144 resale.  Or use 4(112) exemption. Summary: If you get stock in a business combination, this is a sale. Stock will have to be registered or you will have to find an exemption. Must look to Rule 145, which will tell you how to communicate without violating the gun jumping rules, makes certain people underwriters and creates resell issues. There are resale safe harbors in Rule 145(d) which look like Rule 144.

Exchanges under Section 3(a)(9); Reorganizations under Section 3(a)(10); Reorganizations under Bankruptcy Law  Exemptions that apply specifically to reorganizations: §3(a)(9) and §3(a)(10).  §3(a)(9): Exempts any security [1] exchanged by the issuer [2] with its existing security holders exclusively where [3] no commission or other remuneration is paid or given directly or indirectly for soliciting such exchange.  The traditional format of the § 3(a)(9) exchange involves the issuer‘s offer to swap a new security for its old security.  NOTE: Exemption does not apply to securities exchanged under BC.  When to use §3(a)(9?  Conversion: I own convertible preferred stock that can be converted to common stock in 5 years. Does issuer have to register the underlying security (the common stock) at the same time it registers the convertible security (the preferred stock)? No. This transaction is exempt. I am not entitled to a prospectus when I convert my security.  Rationale: If I am an existing security holder, I am informed about the company already.  §3(a)(9) is supposed to help a financially distressed company restructure outside of bankruptcy. [Original purpose—note, companies still use it even if they are not in financial distress].  Swap: I own preferred stock of the company and the company says they will give me common stock in return for preferred stock. Exchanging one security of the company for another security of the company.  Requirements of §3(a)(9):  Exchange must be with the same issuer. E.g. give up common stock in Company A and receive preferred stock in Company A.  If A in its acquisition of B assumes all the duties and obligations under B‘s outstanding debentures, A in effect is beta, so that a later offer to exchange A common for the outstanding B debentures fall w/in § 3(a)(9).  Ex. Holding Company/Operating Company exchange.  Exchange must be exclusively with existing security holders only.  No commission or other remuneration may be paid for soliciting the SHs. This is the big issue.  SEC is concerned if the issuer is paying commissions to solicit the SHs, because §3(a)(9) is not supposed to be a hard sell exemption.  E.g. putting SH together with company counsel who will explain why exchange is good for the SH might violate this condition.  If a publicly held corporation wants to do an exchange offer and wants to communicate with SHs, may they hire a proxy agent to tell the many SHs about the exchange? The corporation has paid the proxy agent, but has not paid for his advice or opinion. If the corporation hires someone to perform purely ministerial duties, this is okay. If the proxy agent is trying to get SHs to change their minds, probably not okay.  No paid solicitation, but paying for assistance in mechanical aspects is okay.  Has to be a true exchange—SHs can’t pay any additional consideration.  The Commission interprets the exclusivity limitation as barring only new consideration begin paid, so that the exemption is not lost because the security holders as part of the exchange offer‘s terms must surrender voting rights, accrued dividends or interest, or collateral for their debentures. And the holders‘ agreement as part of the exchange transaction to drop their securities fraud action against the issuer was not seen by the SEC‘s staff as a cause to lose the exemption.  Resales of § 3(a)(9)  § 3(a)(9) is a transaction exemption. It exempts only the issuer‘s exchange; the exchanging security holder must find her own exemption for any subsequent sale of a security received in the exempted exchange.  Commentators disagree whether securities acquired in the exchange falling w/in § 3(a)(9) are restricted when the exchange is functionally a private exchange involving a small number of holders, even when the securities given up have been registered.  Key NOTES – GOOD FOR ENTIRE EXAM  SEC says that when there is a bona fide gift the stock ―retains the taint.‖ If you give a gift of restricted stock it remains restricted stock.  Tacking: When there is a gift you can add on previous time periods where other people have held shares.  § 4(2): Look out for founder‘s transactions, they are often § 4(2) private placements.  NOTE: There are 6 available exemptions for issuers: 4(2), regulation D, 3(a)(11), 147, 3(a)(9), 3(a)(10)  §3(a)(10): Exempts the issuer‘s exchange of securities for outstanding securities, claims, or property, provided the transaction‘s fairness has been approved, after a hearing, by a court, agency, commission, or other governmental authority.  The approving tribunal can also be a foreign court.
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 The exemption does not apply to Chapter 11 Bankruptcies. Thus there are no 3(a)(9) requirements like: Same issuer; Same existing SH; SHs may not give money, extra consideration; Ban on commission used to solicit sale.  The fairness hearing is a substitute for registration.  Exemption does not apply until after hearing. Hearing must be preceded by notice. Any notice of the plan of exchange is an ―offer to sell‖ under § 2(a)(3) and R. 135 does not apply because it reaches only announcements of offers in registration.  What governmental agencies do fairness hearings?  Judge  Most states regulate certain industries:  Banking  Insurance  A state authority will have to pass on the merger of companies within these industries.  Blue Sky officials/State Blue Sky administrators often have explicit Blue Sky authority to pass on a transaction to exempt it under 3(a)(10).  E.g. someone sues a company, and they settle. The settlement is that the company will pay the person in stock. If you give up your claim and get stock in exchange, this is a sale because it meets the for value requirement.  §3(a)(10) would be a possible exemption. You will not get any information, even though you are not an existing security holder. This is because there is a fairness hearing.  If a court is involved, SEC will assume that the court is protecting you. Judicially approved settlement substitutes for a prospectus. Fairness determination takes the place of the disclosure investor would normally get.  §3(a)(10) is even broader than just court settlements. Can cover non-judicially supervised exchanges—e.g. highly regulated industries such as banking and insurance who have commissioners that may pass on the fairness of the exchange.  Flexibility: §3(a)(10) requires a court hearing, but it is much easier to meet than §3(a)(9)—no requirement of existing SH, no requirement of no commission/renumeration or no additional consideration. Gives more flexibility, but for the fact that you have to have a hearing (may be used to raise cash).  Resale:  Concern for resales arises because § 3(a)(10) exempts only the exchange transaction; it is not a securities exemption. The SEC‘s staff maintains that restrictions on resale apply to securities issued in a transaction exempt under § 3(a)(10) only for securities held by those who either before or after that transaction are affiliates of any party to the transaction.  Those who are affiliates before or after the transaction must resell their securities pursuant to R. 145(d) so that certain holding period limits and possible other restrictions in R. 144 have to be satisfied.  An issuer may rely upon a fairness hearing conducted under state securities law to perfect an exemption under § 3(a)(10) for securities that otherwise would be deemed covered securities. Note: §3(a)(9) and §3(a)(10) do not apply to bankruptcy proceedings.  In a bankruptcy, the company may ask people to exchange their notes (which won‘t be paid because the company is in bankruptcy) for common stock. This looks like a sale, which would mean that the company would normally have to comply with §5 unless there is an exemption.  § 1125 requires that there be adequate disclosure accompanying the solicitation of the debtor‘s claimants‘ approval of the reorganization plan.  Quality of disclosure much lower then under ‘33 Act.  Bankruptcy Code §1145 [see p. 1869 Supp.] trumps the ‘33 Act.  § 1145 exempts from § 5 any securities issues under a CH11 reorganization plan if they are issued principally in exchange for the debtor‘s existing debts and securities. While the exemption allows the debtor‘s claimant to pay cash for the new security, the consideration they pay must ―principally‖ be their claim against, or interest in, the debtor. The exemption is not available if securities are sold to others to raise fresh capital.  § 1145 applies not only to the debtor but also to its affiliates that are joint participants in the reorganization and will issue the affiliates‘ securities in exchange for the claims and interests others have in the debtor.  There is another policy at stake with the Bankruptcy Code other than the disclosure policy of the ‘33 Act. The policy is to allow the company to emerge from bankruptcy.  Bankruptcy Code does not use the term ―prospectus‖ or ―registration statement‖ but rather ―adequate information.‖ Adequate information is much less than information disclosed in a registration statement. Resales of Securities Received in a CH11 Reorganization  If securities were issued pursuant to § 1145(a), their resales must comply with § 1145(b).  Under 1145(b)(3) ordinary trading transactions in securities received in the reorganization may be made immediately upon their receipt by security holders who are not affiliates. Similar to 4(4) exemption.  Any 1145(a) security held by a control person may be sold only through registration because they are deemed underwriters by 1145(a). The control person may not use the 4(11/2) or 144 exemption.  When the debtor resells securities it owns in another issuer, the debtor may use standard securities act exemptions. If they do not apply, the debtor undergoing a reorganization may resell limited quantities of stock to certain qualified issuers pursuant to § 1145(a)(3).  Conditions:  Debtor owned security when petition filed.  Issuer must be a company subject to the reporting requirements of securities act 
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Issuer must be current in its filings under the Act Debtor may sell only up to 4% of that class of security outstanding in the two years following the pertition‘s filing and may sell an additional 1 percent every six months thereafter.

LIABILITY UNDER THE ‗33 ACT  Enforcement  What happens when there is a violation of securities laws?  § 11.  4 Separate liability provisions in 33 Act.  § 11  12(a)(1)  12(a)(2)  17  § 11 provides liability for false or misleading statements appearing in a registration statement.  12(a)(1): express private right of action for violations of § 5. Any person who purchases a security in violation of § 5 can sue to rescind sale of security.  Violations of § 5.  Company fails to register security.  Gun-jumping violations  12(a)(1) is strict liability. Company that has made gun-jumping violation in selling securities is strictly liable.  12(a)(2): unlawful and people can sue if an issuer issues securities with a prospectus containing false or misleading statements.  Different from (1) in that it is a prospectus.  Negligence standard (not strict liability).  § 17: Fraudulent Interstate Transactions. Not an express private right of action. Simply says that it shall be unlawful that for a person in offer or sale of security to commit fraud. SEC can sue under § 17 (bring an enforcement action). Will courts imply a private right of action?  Not available for investors. Only the SEC can sue under § 17. This used often by SEC. It has been interpreted, in (2) and (3), to simply require negligence. So, SEC normally uses (2) and (3), not (1).

Section 11: Misleading Statements in Registration Statements  §11: Civil Liabilities on Account of False Registration Statement  Post-effective developments: Company will want to sticker prospectus, but may or may not be required to amend the registration statement.  §11 freezes time. Test truth or falsity as of the date the registration statement became effective. If accurate as of the day it became effective, and then 2 days later, something happens, no §11 liability because registration statement is accurate as of the date it became effective.  §11: Express Private Right of Action. Any purchaser of a security issued pursuant to a false registration statement can sue people who are significantly involved in the registration:  Every person who signed registration statement  Every director  Every person who is named in registration director as about to become a director  Accountants can be sued for financial statements  Underwriters  Note: Lawyers are not one of the enumerated defendants.  Note: Issuer is not an enumerated defendant, but get them through §11(a)(1), every person who signed the registration statement. Under §6(a), each issuer must sign the registration statement. Issuer, CEO, and CFO and Chief Accounting Officer all must sign the registration statement, so they are all liable under §11.  Issuers are strictly liable under §11.  Everyone else has a due diligence defense. Negligence standard. If you are negligent, you can be liable under §11.  Who has standing to sue?  P must show an untrue statement of material fact and that P was a purchaser.  No reliance requirement. Ordinarily, P would have to show reliance, but reliance is presumed under §11.  §11 is meant to deter—motivation was to protect investors from being gypped. Statute is supposed to scare people who are involved in the process into ensuring that the registration statement is complete and accurate.  Hertzberg v. Dignity Partners, Inc. (9th Cir. 1999): Dignity was in the business of buying the rights to life insurance proceeds from people with AIDS. Shortly after Dignity‘s public offering, the fact that AIDS patients were living longer than expected because of new AIDS treatments became public knowledge. District court held that the P did not have standing to sue. Ps had purchased securities on the open market more than 25 days after the IPO, but before the news of the longer life expectancy or large losses became public knowledge. Court of Appeals held that the Ps had standing to sue because they purchased the securities issued under the original misleading registration statement. ―Any person‖ should be interpreted broadly.  Timing Issues under §11:
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Hypo: On the first day a company goes public, I purchase securities in the company. Two weeks later, the company makes a statement that there were misleading statements in the registration statement.  Hypo: I purchase securities 11 months after the company‘s registration statement goes effective. Two weeks later, company makes statement that there were misleading statements in the registration statement.  Can I sue in either of the above cases?  §11 just says any person acquiring such security.  This includes investors who have already bought and sold the security.  But, 11 months later, I am really purchasing on the open market, so does it make sense to allow me to sue under §11?  Think about the damages that the company would have to pay to all of the people who purchased in 11 months on the market. Some courts are going to do a cost/benefit analysis to limit potential class of plaintiffs.  Circuit Split: Some courts say that there comes a point where a person loses their standing to sue. In Hertzberg, the district court had picked 25 days after the IPO as the cut off time. Why the 25-day period? Underwriter must circulate a prospectus for 25 days following the registration statement‘s effectiveness. Idea is that the offering is still ongoing and people are relying on information in the registration statement. After 25 days, looks more like a trading transaction and people are purchasing in the open market, rather than directly from the issuer. Tracing Requirement: I am a purchaser of IBM securities in an S-3 registration statement. I find out that the registration statement was false. How can I show that the stock was issued pursuant to the defective registration statement rather than an earlier registration statement that was fine?  SEC has adopted a strict tracing requirement. Have to trace purchase back to the false registration statement.  Statistical certainty: Some courts have stated that even if the purchaser can show a 97% certainty, this is not enough.  Courts are suspicious of Ps suing under §11 and want to somewhat protect the companies. However, the courts‘ attitude may make §11 not that effective. Perhaps the courts need to figure out a better way for Ps to sue under §11.  Underwriters, to reduce their risk of being sued under §11, request comfort letters from company, etc. Due Diligence Defense: §11(b)(3)  Nonexpertised/non-expert, Unexpertised portion of the registration statement: §11(b)(3)(A)  Financial statements are an expertised portion of the registration statement. Any part of the registration statement that is not the financial statements is unexpertised—not prepared by an accountant.  Must show reasonable investigation AND following reasonable investigation, person must show that they reasonably believed and actually believed there were no false or misleading statements.  Expertised/Expert: §11(b)(3)(B)  Accountant has a due diligence defense if they can show they made a reasonable investigation and following the investigation they reasonably believed and actually believed there were no false or misleading statements.  Experts are only liable for the expertised portion that they worked on  Need to meet industry standards  Conduct reasonable investigations  Need reason to believe accuracy (OBJECTIVE)  Reasonable belief in accuracy (SUBJECTIVE)  Expertised/Non-Expert: §11(b)(3)(C)  Director does not have to make a reasonable investigation into the registration statements  Non-expert has a qualified right to rely on the financial statements. Not required to double check the work of their accountants.  You have a qualified right to rely on the financial statements. So long as there was no red flags you do not have to do anything else.  Non-expert cannot turn a willful blind eye to inaccuracies or untrue statements or material omissions in prospectus.  Unless put on notice, okay to rely on the financial statements in the expertised portion of the registration statement.  Can delegate your duty to make a due diligence investigation to a law firm.  Lawyer must verify that which is easily verifiable. This means that if the registration statement says, e.g., this is the compensation we are paying the CEO, lawyer should look to pay stubs, ask CEO what he is making, look for board resolutions, employment contracts. Board has opportunity to read the due diligence memorandum.  Not an absolute obligation—a sliding scale  More expected from some defendants than others  Less expectations of outside directors  Inside directors are almost guarantors  More expected from people with different skill sets  More expected from drafting attorney  Expectations from underwriter derive from adversarial position  Timing considered Due diligence: What is required of people varies. The people with special expertise have more of a burden to prove due diligence— lawyers who are on the board, insiders. Look to what is reasonable under the circumstances. Very difficult for underwriters and inside directors to get off the hook for [A] and [C].  DUE DILIGENCE DEFENSE REQUIRES PEOPLE TO VERIFY THAT WHICH IS EASILY VERIFIABLE

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