SEC FOR CLASS

Securities Class  How do corporations raise capital  How will I assist my client in raising capital A Security  Debt or Equity interest in a company  Stock or Note Life History of a Company that Goes Public  Issuer (Google) o Corps under the articles of incorporation the board of directors are allowed to issue shares  $ or IP in exchange for shares  Issue Options to there employees  Incentivise the employees by giving them a piece of the company  As options vest, there would be issuance of new shares to these employees  VC’s also make investments in the early state of the company Private Transactions  Founders  Employees  VC’s  Lawyers Public Transactions  Issuer issues new shares that have not been issued before  And sells them to a group of investors called Under Writers (wholesalers) (―UW‖)  Then the UW sells them to the public (retail) Google Currently Would Like To  Google to raise $4B by $285 * 14,159,265 shares  Possibly b/c Google has seen the price on the market and feels it is overpriced and wants to cash out (i.e. it like selling my Honda Civic for $100,000)  When Companies Feel there Stock is overpriced they o Buy other companies o Cash out by issuing new shares o As long as you tell the truth in selling your stock (securities) the govt will not step in and determine whether it is a good deal or not A company Goes Public Because  Company needs money to grow  Company needs to cash out early investors o In the prospective section they must tell what they are going to do with the money Process for Going Public  File a Registration o People that receive stock option in lieu of payment for services are exempted form the registration provision (i.e. private transactions above)  Registration statement must be filed with the SEC and must become effective in order to be allowed to sell stocks Mechanics and Economics of an IPO  Firm Commitment Offering - Issuer sells stock to the UW (that at some point is under contractual obligation to buy the shares of the company) o Agreement Among Underwriters  usually more than one UW will be involved in order to spread the risk  Syndicates of UW  Syndicates of Dealers o Firm Commitment Agreement  Agreement of the UW with the Issuer as to the price per share  A Best Efforts Under Writing – There is no firm commitment and the obligation and title runs directly from the company to the public and the UW is simply the broker receiving commission of every share of stock being sold (typically used for companies that will not be listed on the major exchanges) HYPO  Market Price is $20/s  Main UW pays 18/s to company + receive 0.40/s from syndicated UW  Syndicate UW pay 18.40/s effectively  Dealers will pay 19/s  Goes to market at 20/s World Wrestling Entertainment  Market Price 17/share  1.19 was UW discount  15.81/s is what UW paid/s Issuer  Meets with UW’s and once he picks one  Letter of Intent + negotiation of out of pocket expenses (however no one is obligated yet) Registration Statement (full disclosure document)  UW council and company Council get together and look over the documents o very time consuming process o very costly process   o May cost the companies operation b/c becomes many executives full time job Agreement Among UW’s – the UW’ agree to move ahead together Informal agreement that the company has need to be drafted into formal documents Prospectuses  Need to be free from material errors o Material Errors – errors or omissions that will effect investors purchasing decision  When the UW’s are satisfied that the prospectuses is complete and correct (i.e. all facts are reasonably verified o Prospectus is given to the SEC The SEC  Will look at the prospectus for obvious gaps, and make sure everything is there, but not check the facts o A letter of comments is returned – things that need to be done to the prospectues  You then file an amended registration statement – in compliance with the letter of comments o Another letter of comments is usually returned will less comments  You then print out a Preliminary Prospectus and get it out there to likely buyers (―Red Herring‖)  Final Registration is filed (WWE took 4 amendments, Google to 6-7 amendment) and were considered clean offerings Internet Bubble Period (98-00)  Anything that had to do with the internet would be wildly received (i.e. huge spikes in prices) o Globe.com went public at $9/share and closed at $97/share (10 fold in one day)  Corruption started creeping in o UW would sell IPO’S to ―the public‖ CEO’s the best customers  Only illegal if it was in exchange for future business (b/c undisclosed compensation to the UW’s  In order to be allocated shares of hot sotck, you had to buy in the open market at an artificially high price for the purpose of creating a mob mentality and stampeed the prices upward (illegal b/c securities violation) The Amended Registration Becomes Effective by the SEC  Pricing o Traditional  Then the UW sits down with the Issuer and negotiates a price, and once that document is signed the UW is on the hook o Dutch Auction  Selaed bids of potential buyers will reflect the highest bidding price that all stocks will be cleared at (indication of interest only b/c you cannot have sales before effective date)  Google Example  100,000 shares o A 50,000 shares at 125 o B 5,000 @ 85 o C 30,000 @ 95 o D 15,000 @ 105 o E 50,000 @ 80  Sell price will be the highest price that all shares can be sold at  This means that (A-D) will get their shares at $85/s  Even Google’s Process that came up with $85/s came up to $105 per share at the close of the first day The DOW JONES INTERNET INDEX  A weighted average of the internet companies  March of 2000 it was weighted at 500/share  Today it is worth 80/share  Diary of a bubble went from 500 to about 200 in the space of 3 months  The only people that lost money were the last buyers Should the Federal Securities Law allow this situation (YES)  Assuming no fraud  Assuming no breach of fiduciary duty (no obvious misuses of power)  Full disclosure, no Fraud – o as long as you tell me everything I need to know and do not lie to me about anything -> you have complied with the federal securities laws – o the federal gov’t does not investigate the fairness, or the merits of any business deal. (NO LAWS HAVE BEEN VIOLATED)  As long as full disclosure and no fraud -> no liability to anyone people are free to make their own business investment decisions The Depression followed the 1929 market crash  In the minds of many the crash and the depression were related (some what true)  Causes of the Stock Market Crash o Manipulation and Fraud by securities promoters o Lack of reliable market information causing them to lose confidence in the market (not enough info for investors to make an informed decision) o The bad people brought down the stock of good companies Roosenvelt’s Interpretation Federal Securities Law (Emphasis on Disclosure)  Full disclosure no fraud  Make all public companies disclose on the same form (so that investors know where to look for each type of information)  Supercharged federal penalties (criminal and civil penalties) for fraud, and favorable causes of actions for defrauded investors State Securities Statute (Blue Sky Laws)  Not adopted by Federal Gov’t but adopted by almost all states  The state will evaluate the merits of the company and the ―fairness‖ of the investment (this is an economic analysis of the company) o Essentially the gov’t make a business decision on your behalf (only if the govt feels the offering is fair will it allow the securities to be sold  California Securities Law 1968 § 25140 o Fair, Just and Equitable are needed for California to allow the securities to be sold Federal Securities Law rejects the merit approach and uses the disclosure approach  Federal permits states securities regulation law (disclosure approach preempts the merits approach) Reg D  506 -> Private Offerings (b/c exempts are also exempts from federal and state regulations) -> so no fairness standard  California Securities Law -> is usually preempted by federal law and only in a few situations will Cal. Sec. Law be used Why Go Public  Exit Strategy  Investors would like to realize their return on investment  Allow them to have liquidity (without selling shares at a deep discount)  Also get acquired by a publicly traded company in order to get liquidity  Also once public you can now access the public for more money (subsequent offerings, are much easier to get in order to raise more money)  Prestige – you want to own a company that people know of  Also may be cheaper form of raising money o WWE  170M + 8% / annum if you want a loan  Selling shares to the public  One time cost is expensive but you never need to pay the money back  Executives Recruitment  Estate Planning – Lack of liquidity if you control a company and then you die Rule 144    People who control shares of stocks Shareholders of the Issuer (owners of significant blocks of stock, directors, officers) These people can sell their shares in small increments over a period of time The Expense of Being a Public Company is significant  Every year you must file a 10-K  Plus under Sarbanes Oxley there are increased registrations and very large criminal penalties o You need independent audit committee to audit your financials o Limitations on personal loans  Cost of doing business as a publicly traded company has substantially increased Most UW agreement  The people that control the company + significant investors by contract generally cannot sell their shares for 180 days (180 day lockout)  It could be seen as an indication as a lack of faith in the company by management The Fish Bowl  Every significant event must be disclosed in the 10-K report  180M was stolen by Kagloski from Tyco  When Enron filed a form 8-K when you have an unusual occurance that is significant 10/16/01 – 1Billion dollars overstated earnings  10/17/01 – WSJ writes article about it  By 12/3/01 – Company went bankrupt (6 weeks) CLASS NOTES  General Review of the Framework  SEC is organized – division  Division of Corporate Finance – were registration statements are files o They give the comments to the  Division of Enforcement – investigates securities fraud civil / criminal o SEC does not prosecute crimes -> but will give the matter over to the DA o Where you have the requisite criminal intent o If you are trying to issue securities without first registration – can seek injunctive relief Six Statutues  Securities Act of 1933 (is a transactional requirement) o Coverage of the 1933 Act  Says that before stock is sold to the public a registration statements must become effective  Before stock is sold by the issuer, or person controlling the issuer (Larry and Sergie) a registration statement must become effective       You can not sell the stock until you have an effective registration Securities Exchange Act of 1934 o Securities are registered under the 1934 Act (can be common stock, preferred stock, debentures) o Securities are also registered under the 1934 act o From a functional point of view – it is the company that is being registered  The 1933 act registers the stock transaction where as 1934 act registers the company o What companies must be registered under the 1934 Act  Under sections 13 & 15 Requirments  If the stock is traded on a national stock exchange (national or regional) – then that stock / that company must be registered  OR when the company meets certain tests in regard to the size of the company / # of shareholders o 500 persons or more & the issuer has total assets of company exceeds $10M then the securities of that company must be registered under the 1934 act  The Consequences / Duties / Obligation of being registered under the 1934 act  The company is subjected to periodic and continuous reporting requirements / disclosure  Periodic reports that update the public about the affairs of the company There is a 3rd type of Company that is not registered under the 1934 act but must meet all the recording requirements of the 1934 requirments even though as a formal matter not required to be registered under the 1934 act o If the company has made a public offering of stock o Not traded on the national stock exchange o Does not have over 500 stockholders o But when  Basically when you offer shares to the public under the 1933 act you will have to meet the 1934 recording requirements whether or not you formally meet the 1934 recording requriments Form 10 – K must be filed with the SEC annually o Comprehensive report of the state of the company similar to the items in the registration statement (virtual identical) to the registration statement o B/c of the other periodic statements some things are often referred to by inference Annual Report o For Shareholders PR Annual Proxy o Independent auditors are approved by the shareholder o The board will be elected each year (can be staggered) o Election of directors o Election of independent auditors o Proxy form – to give power of attorney for named person to vote your shares Form 10 – Q (Quarterly Report)  Public Companies o Not audited earnings reports – it is a smaller disclosure document that discusses extrodinary business events Form 8 – K  Issued upon certain materially important events  Restatement of Earnings o Change in Control o Change in Auditors o Big acquisitions o Bankruptcy o Any events that the company deems of importance to security holders  Restatement of Earnings  Generally companies are of caution and will report even little things because you can only get criticized if you do not report The Bar of Reporting has been raised and the penalties for not accurate reporting are very high  Civil and Criminal Penalties for violation of the 1934 Act o If willfully and knowing makes false statements or omission of material fact -> criminal liability (I know its wrong but am going to do it anyway) o Civil – if you make a false or misleading statement (done negligently) you are still liable  Rule §10 (b) (5) o Is broader  If there material mistake / material omission in the sale of stock you have a violation that is both civil and criminal penalties 1934 Act  Governs dealers and Trading Markets 1933 ACT  The core of 1933 Act is Section 5 (this is the guts of our course)  5a, 5b, 5c looks simple but it is not Jurisdiction Section 5a1  Unless registration statement is effective than it is illegal for any person to sell a security by means of interstate commerce or by mail o So if you have a sale that is not used any form of mail and or communications interstate then you have not violated 5a1 o We are going to assume that everything is interstate / and mail  (i.e. all phone calls are considered interstate / mail is mail)  (i.e if you have used a piece of paper that was made in another state -> you have used interstate commerce)  Because it is so expansive we will assume that the this requirement is always made. o CA company that only sells to CA residents is exempt but not because of the above requirement (b/c we will always assume that interstate commerce was used) Structure of Section 5 – Compels full disclosure (section 2 will have all the definitions) o Filing with the SEC of Disclosure Documents o Have to have an effective registration statement before you can sell stock  Exemptions  Place restrictions on which offers can be made  On when offers can be made  The rules are straight forward, but the words have nuance meanings  Learn the outline of Section 5  Then focus on the defentions  Look at the definition in Section 2a1 o Securities 2a1 o Sale 2a3 o Offer 2a3 o Prospectus 2a10 o Underwriter 2a11 o Dealer 2a12 CLASS NOTES Section 5 (Restrictions and Premission of Offering of Sales of Stock to the public)  SEC – has been looking to possibly liberalize Section 5  Key to understanding section 5 is section 2 Section 2b is interesting  Whenever pursuit to this titles (that is the SEC) when they are engaged in rule making  SEC is enabled to by regulation take into account (efficiency, economy, and capital formation)  Interested in reducing barrier’s (However then we had Enron, World Com)  With Sarbanes Oxley Act – we have greatly expanded the power of govt to govern already publicly traded companies  About a year ago started considering provisions to simplify the offering process (less regulation – these provisions were adopted July 19, 2005 o They don’t change the basic outline / rules in section 5 o How to get the data to us A business lawyer  Sections 3 and 4 (the exemptions)  Sections 6 – 8 (registrations procedures)  Section 2b pg 38 Section 28 is a broad exemption authority Small business you want to find exemptions The Three Time Period Pre Filing -> (Filing) -> Waiting -> (Effective) – Post Effective It shall be unlawful – for any person to buy RULES SECTION 5  No OFFERS to sell stock before Filing date (thus during waiting you can make OFFERS)  No sales of securities prior Effective Date (thus after effective date you can make SALES  No person or entity can make an offer / sale SECTION 4(1) and exemption to the provisions in section 5  Issuers, Underwriters, Dealers – are the only persons included in section 5  What it says is that Issuers, Underwriters, & Dealers are the only ones not allowed to make OFFERS and SALES o Nobody else is restricted from making offers and sales of securities o The term Underwriter / Dealer have specialized meanings that have broader meanings than you may think SECTION 2a(11)  UNDERWRITER – any person who has purchased from an issuer with the intention of a public offering…..as used in this paragraph, and person controlling or directly controlled by the issuer (operational control of the company) any controlling shareholders will be considered Issuer SECTION 2a (3)  Every Attempt to dispose of, or solicitation for offer to buy, for value  Any step in the selling / buying of security for value o NOT include preliminary negotiations or even a contract between an issuer (or any person controlling the issuer) and underwriter CLASS NOTES REVIEW WHAT IS AN OFFER (not allowed before the effective date)  Every step in the selling process Loeb, Rhoades & Co.  This is a very general press release  Released information (names, underwriter, assets and liabilities, purpose) What can you do to advertise  Krispy Crème  Google  Saab (80’s) o All these companies indirectly started the selling process Pre Filing [5(a)(c)]  FILING Waiting [5(a)(b)]  EFFECTIVE Post Effective CLASS NOTES  Anything you do in the selling process will be viewed as offers (HOWEVER) o Anything that can be viewed as conditioning the public mind  What about product advertising & image advertising  Exactly what can you do during the waiting period  What about financial information that is forward looking (for publicly traded company)  What about other information that will effect an investors decision  34 act requires disclosure but 33 act require no selling  So the SEC provided a ―release‖ on it o SEC have the effect of law (presumptively law) o ―SEC release‖ does not have the same effect as law (it is the SEC’s written opinion of how the SEC views the law (very persuasive and important in practice) What can be Done by issuers and not be considered an offer by the SEC  Continue doing regular course of business (customary advertisement of products and services)  Continue to make announcements to the press about 8-K type events  Continue to make their quarterly reports o Easier for public companies / However harder for private companies  PRIVATE COMPANIES o Usually go on lock down mode and not talk to anybody NEW RULES (that cover pre filing publicity)  The underlying policy – is that the SEC is to have the authority to make rules in regards to securities (for the public interest and protection to investors) o These new rules exempt transactions and actions that will exempt things from being considered offers (in the electronic age the rules have become to rigid) o They are essentially granting narrow exceptions to the rule of NO OFFERS  163(a)  168  169 Issuers  Well Known seasoned issuers (already public)  Seasoned Issuer(already public)  Unseasoned reporting issuer(already public) o The filing requirements are reduced for a company that is already public b/c the information is already out there  Non reporting Issuer (IPO) o They are not public yet (500 shareholders and 10M in assets) o Have not filed an IPO before  Image advertising = offers  Granting interviews = offers o Quiet Period  Pre Filing -> Waiting but in the waiting period you can make restrictive offers o 163(a)  Safe Harbor period anything before 30 days before the registration is filed (as long as your statements do not reference to a securities offering) (but image and product advertisements is ok 30+ days before registration statement  As long as the statement made before the 30 day prior is ok  Anything within the 30 day period is not neccessarly suspect but the company needs to use reasonable care in the information that they give out o Statements cannot be made by underwriters / dealers about the company even if not directly about the offer (b/c there is no other reason that UW or dealers would be making statements about the company except to condition the public about an up coming offer RULE 169  Does not cover companies that are registered under the 34 act  For purposes of 5(a)(c) ―NO OFFERS‖  The REGULAR release by the issuers of factual business information is not deemed to be an offer o What is Factual Business Information  Factual Information about the issuer or financial information about the company  Advertisements of the companies business products or services  The Issuer must be the one releasing the information or agent but not an UW or Dealer  You give this information for a period of time  You give this information to creditors and others in order to convince them you are a solid company that they should be doing business with. (it has to be a pattern of release of information – the preexist the thought of going public and cannot be for the purpose of going public) o Regular Releases of information = OK o Not for the purpose of conditioning the public mind o Release used to show creditors + suppliers + customers to view the company as a solid company o No reference to a securities offering in the future RULE 168  Same as 169 but for publicly traded company  Can be any type of information that is released during the REGULAR course of Business o Factual Business information as required by the 34 Act Regulare o Forward looking information (projections, revenues, income) o Managmeent Plans, objectives o Statements about the economic performace  Cannot be released by UW or Dealer (must be released by the Issuer or agent)  Cannot release information about the offering that is coming 137, 138, 139 (121 – 122) (then read the rules)  Allow Broker and Dealer to make certain statements about the company Pre Filling /// (filing) Waiting ///(effective registration) Post Effective 5a   No sales before the effective registratioin During the waiting period offers can be made (however not offer before the registration statement is filed) o Waiting Period – you can make offers….but only certain types of offers are permitted o It shall be unlawful for any person to use the jurisdictional means to transfer any prospectus unless the prospectus meets registration 10  (i.e. if you use a prospectus to solicit offers you must meet the requirement of Section 10 DEF. Prospectus  Notice, circular, advertisement, letter or communication, written or by radio or TV, which offers any security for sale or confirms the sale of any security  Any Communication that is written, or by radio or TV communication IS A PROSPECTUES (and must meet the regulations in section 10) o Oral offers (word of mouth) may be used (i.e. telephones customers and ask if they are interested) (face to face or by telephone is not considered a prospectus)  EXCEPTIONS TO THE DEFINITIONS OF PROSPECTUS o Tombstone Prospectus – is written but is an exception (it has identified where a prospectus may be obtained + has only general information) Section 10  Is a prospectus one that has all the information between 1 – 28  Registration Statement (filed before the waiting period) o Part I ―prospectus‖ Items 1 – 28 in section a (this is the part intended for public circulation o Part II Items 29-32 (if included would be wheel-barrel over kill Preliminary Prospectus 430(a)  During the Waiting Period allowed as long as it meet the requirements of section 10  430a – will tell all the requirements for the prospectus that satisfy section 10 o Needs to contain SUBSTANTIALLY the same information that will be held in the final prospectus (but not all info) o But may leave out price related information – Rationale – price per share depends upon the market  We can make offers by way of preliminary prospectus during the waiting period o You have to put in substantially all the information  RULE – NO COMMUNICATION OF OFFERS OTHER THAN BY MEANS OF PRELIMINARY PROSPECUTES (OR TELEPHONE OFFERS, FACE TO FACE ORAL OFFERS) (i.e. six hour TV show about 6 hours long of someone reading) RULE 431  Allows summary prospectues – shall be deeded to be a prospectus under 10b  Is a summary prospectues for a company that is already registered under the 1934 Act  It refers to items by reference to other public documents (it is the equivilant of a preliminary prospectus just abbreviate by referencing information Section 2(a)(10)  It excludes written communication  Except Tombstone Ads are not prospectuses and can be given CLASS NOTES 2(10)(b) DEF. Prospectus  Notice, circular, advertisement, letter or communication, written or by radio or TV, which offers any security for sale or confirms the sale of any security  Any Communication that is written, or by radio or TV communication IS A PROSPECTUES (and must meet the regulations in section 10) o Oral offers (word of mouth) may be used (i.e. telephones customers and ask if they are interested) (face to face or by telephone is not considered a prospectus)  EXCEPTIONS TO THE DEFINITIONS OF PROSPECTUS o Tombstone Prospectus – is written but is an exception (it has identified where a prospectus may be obtained + has only general information) 5 Ways Offers Can be made during the waiting Period Untill December 1st 2006 Oral Offers Tombstone Ads as described in Identifying statement as in Rule 134 Preliminary Prospectuses (rule 430 section 10b) red herring Summary Prospectus (for companies already reporting under the 1934 Act) ANY OTHER OFFERS ARE FORBIDDEN BY THE 1933 ACT Standardized Offers Easier to Regulated Creates Expectation in the Minds of the Public No Sales – During the Waiting Period  Look at the definition of Sale  Term sale or sell shall include any contract for sales (thus executor contracts are sales) under the definition of sale  Solicitations for interest (offers are not sales) Free Writing  When you limit the types of offers  No Free Writing  There is a though that free writing should be allowed Rule 164a  A free writing prospectus (  Of the issuer or any other offering participation (i.e. UW or Dealer)  After the filing of Registration Statement  Rule 10b and 430 say that a 10b prospectus must have substantially the same information as required in the final prospectus Section 5b1  Since a free writing prospectus is considered a 10b prospectus (it is legal)  Can not use during the pre filing period, but may be used in the waiting period Conditions that must be met are in Rule 405  Free Writing Prospectus = o Writing Communication (Communication in written, printed, radio / tv broadcast or graphic communication) o Voicemails are not written communication unless widely distributed Graphic Communication  Road Shows = Oral Offers o You can have slides and charts (but has to be taken away with you) – no handouts = oral communications o You can use a microphone, you can use slides to illustrate your  As long as there are no take aways you have not become a free writing prospectus Until Dec the 1st NO FREE WRITING Road Shows  Oral offers made by the issuer and or UW or both  You go around to groups of people (institutional investors, high rolers)  An oral presentation is made by the company and or underwriter  Opportunity for Q and A  Visual aids are allowed during the road shows (however you could say that these visual aids are written offers ―free writings‖ but the SEC through administrative practice allows this, as long as there was no take away items The Free Writing Prospectus (as of Dec 1st) Stay anchored to the Laythmen and Watkins As long as the Free writing prospectus meets the requirements of section 10 it can be used after the (Filing / Waiting Period) What is a Free Writing Prospectus (rule 405 pg 40)  Written Communication (defined on pg 44) o Radio / TV, any graphic communication, all forms of electronic media L&W Memo on page 14 (examples of Graphic Communication)  You want it to be treated as a free writing prospectus (voicemail, website, emails, cds) b/c you can send it out  However live telephones call and road shows (real time, to a live audience) does not count as graphic communications, thus NOT a free writing prospectus o However if you tape the road show and then retransmitted it by website, dvd, tape record -> will be considered graphic communication and free writing  You want a free writing b/c it will be allowed as of dec 1st and it will allow more information to be given without having to be a full preliminary prospectus and not violate SEC rules You can use a free writing prospectus as long as you meet the requirements of RULE –  Also you can slip up with the filing requirements as long as the slip ups are o Immaterial and Unintentional 164e Ineligible Issuers    May not issue free writing prospectus Basically companies that are in trouble with the SEC (not current with their SEC registration requirements) Generally occurs when there is a dispute between the company and the auditors Rule 433 – Condititions to the premissable ―free writing prospectus‖  433b1 – WKSI and seasoned issuers  The free writing prospectus generally has to be attached by a preliminary prospectus o If you are a WKSI or seasoned investor you do not have to send them a free writing prospectus with a preliminary prospectus attached  However if the Issuer does not fall into (WKSI / i.e. smaller public company or IPO) -> then the free writing prospectus is connected to the issuer or offering participant…then it may be used if o Must be accompanied by or preceded by a preliminary prospectus  The primary offering document is still the preliminary prospectus o Free writing prospectus may be used after the effective date What information is required to be in the free writing prospectus (Rule 433c)  May include information that is not in the information statement….but may not conflict with information filed with the registration statement (b/c anit fraud) o No material omission or misleading statements o Free writing prospectus will summarize information in a more chat like information… you are summarizing…and selling 433(c)(2)(ii) 433 d Filing Requirements  You have to file by the date of first use (issuer free writing prospectus) (prepared for or by the issuer) or used and referred to by the issuer  Offering participants have the same requirements o You do not need to file free writing prospectus that is not intended for wide distribution use (but not an exception for issuers) (only for distribution participants) o FILING REQUIREMENTS  UW must file with the SEC and type of free writing prospectuses. However, does not need to be filed if not intended for wide spread use (i.e. calling voicemail existing customers) ROAD SHOWS (live road shows are not free writing prospectuses)  A road show that is an offering for an issuer  Recorded road shows = a free writing prospectus o Thus needs to be filed and accompanied / preceding preliminary prospectus o EXCEPTION – a recorded road show is a free writing prospectus however you do not need to file is with the SEC in advance o UNLESS – it is in an IPO  If your making different pitches to different people you need to file it with the SEC b/c you may be leaving something out  If you have only 1 general recorded road show -> you do not have to file Free Writing Prospectus  Allowed to be used during the waiting period  Summarizes information that is in the preliminary prospectus  Free writing Prospectus must be preceded by or accompanied by a preliminary prospectus o Must have a legend o Must be filed with SEC by the first day of its use o Cannot contradict information  If the issuer uses, prepares or refers to -> FWP  If the UW creates a FWP -> o Must be filed with the SEC o Unless there is no broad unrestricted dissemination o If the written material is not intended for broad dissemination then it does not need to be filed Road Shows Live road shows are not considered written communication….look upon as oral communication As long as they cannot be taken away they are only viewed a visual aids If they are considered writing then they would be FWP and need to meet all the requirements….which they would not NEW RULES Graphic communication is viewed as a written communication = FWP Graphic communication will not included live road shows -> not a FWP However recorded Road Shows are Graphic Communications = Written Communication = FWP -> need to meet all the requirements of section 10 More Liberal Rules – Road Shows EXCEPTION TO THE GENERAL RULE Unlike most FWP’s recorded road shows need not be filed with the SEC EXCEPTION Section 433(d)(8)(ii) Issuer that is not required to file reports with the SEC (i.e. not a public company) That issuer must file recorded road shows UNLESS the road show is available to any potential investor (i.e. recorded road show that is available on a web site -> does not need to be filed) Road Shows Must Meet the Requirement Must not be materially misleading or else Liberal Sanctions may be had Websites Issuer web site with a FWP You need to have a hyperlink to the preliminary prospectus File with the SEC by the day of use The hyperlink will be viewed as contemporaneous delivery Mere historical information is not considered FWP Historical Finanaical Information is not a FWP (thus need not be filed + need not be accompanied by / preceded by a prospectus / do not need a legend) But will be viewed as a written offer – b/c of the broad terms of an offer (thus be prohibited) However RULE 169 (b) Factual business Information Financial statements, product information, advertising, (regular course of business) Thus probably not even offers -> thus not restricted in any of the periods (pre filing, waiting, post effective) Media Free Writing Prospectus  Google had a Playboy Interview  Written offer that is illegal o This could be huge -> b/c investors could get there money back o This was another reason why it took Google longer to go public o The reason why the playboy interview was illegal b/c it was considered a written offer during the waiting period that was not a prospectus o Even though Google clearly violated the law -> New Rules on Media FWP (―the google rules‖)  Any written offer that an issuer or under the control of the issuer  Provided, authorized, approved information to someone who is in the business of publicly disseminated information -> that would be a FWP o And a FWP -> needs to meet requirements o However not all the requirements are needed  No contemporaneous / preceding preliminary prospectus  No need for a legend  No need for filing with the SEC  What do you have to do o Also no payment to the publisher (it cannot be a paid for by the issuer) o The media free writing must be filed within 4 days after issuer becomes aware of the article A FWP is a permitted as a 6th offering means during the waiting period as long as there is no conflict between the information in the FWP and the preliminary prospectuses / registration statement CLASS NOTES 1 Oral Offers 2 Identifying Statement 3 tombstone ads 4 Preliminary Prospectus (meeting the requirements of 10 5 Summary Prospectus (only if already public company 6 Free Writing Prospectus  Those are the six ways offers can be made during the waiting period  No sales can be made during the waiting period  Any other Free Writing is prohibited Requirements for Preliminary Prospectuses  There is no requirement that everybody who eventually buys the stock have received a preliminary prospectus  Wide distribution is highly recommended by the SEC (want investors to have a change to think about it) Rule 460  Taken reasonable steps to make the information contained in the registration statement widely available  Steps to make o Make information conveniently available to UW and dealers  Take the steps that are reasonable necessary to get the prospectuses out to dealers and underwriters (i.e. if the UW has 1000 potential customers then it would be unreasonable to send 3 prospectuses Acceleration of the Registration Statement Section 8(a)  20th day after the filing day of (when you file the registration statement it is effective in 20 days)  However if any amendment is made then the 20 day starts over o Why doesn’t the company’s just file and not amend and then start selling stock on the 20th day o Because the SEC looks at the registration statement for obvious gaps and inconsistencies and the SEC can enjoin the sale of the stock + you are likely to be open to the claim of an investor that you not provided full disclosure  The SEC and the registrant make believe that a constructive amendment is filed every twenty days When Filing of the last Amendment  Company asks SEC for acceleration for tomorrow….the SEC grants or denies  The SEC will usually grant it…as long as RULE 461 -> permit acceleration of effective date o Whether there has been a bonified attempt for a plain English requirement o Form of the preliminary prospectus has been sent to all UW and dealers o Comprehensive distribution of preliminary prospectus (declaration that it was done) Post Effective Period Declaration is deemed to be effective Once in the post filing period…sales can be made Section that applies 5(b)(2)  Accompanied or proceeded by prospectus that meets requirement of section 10(a)  Sales, delivery = OK  But there is a requirement that with the devliery of a security final prospectus needs to be proceeded or accompanied with the delivery of the security (basic requirement to the post effective period 2(a)(10)(a) Free writings are always permitted in the post effective period as long as they are preceded or accompanied by the final prospectus  Free Writings do not need to be filed The New Rules  They approximate what is possible in the post effective period can be done the waiting period  You can have a free writing in the waiting period as long as it is preceeded or accompanied by a preliminary prospectus (Maybe) Oral Offers Tombstone Ads Free Writing (as long as accompanied / proceeded by the final prospectus)  Can all be made in the post effective period CLASS NOTES WKSI – Well known Seasoned Investor 10(a) is a final prospectus 10(b) preliminary prospectus How long after the initial sale must prospectus be delivered?  As long as the issuer is deliver the stock the issuer must give final prospectus at or prior to the delivery of the security  Pretty easy for typical transaction b/c the issuer sells directly to the UW and gives him prospective  However, when we have a direct public offering the Issuer is never exempt from the final prospectus delivery requirement The UW  Person who buys directly from the issuer and then turns around and sells directly to the public  As long as the UW is making its first sale to the public of its allotted number of shares -> it must give a final prospectus at or prior to delivery  After the sale to the public -> dealers cannot further make transaction without giving final prospectus at or prior to delivery (40 days) – a company that has issued stock to the public and then for some reason is not longer required to register under the 34’ act o However if it is an IPO -> you must continue to give Prospectus delivery requirement (90 days) o Hover if IPO & (NYSE or NASDAQ) = 25 days o However companies that are already reporting under the 34 Act = 0 days RULE 174(d) If securities are offered for cash Firm Commitment offering Size of offering (# of shares * price per share) The size offering does not deviate by more that 20% total proceeds Then the maximum used to file the registration fee for the SEC A final prospectus in modern practice is rarely a single book  Preliminary prospectus with a term sheet that has the missing information -> not as elegant, but it saves another round of printing expenses  Preliminary Prospectus + Term Sheet = Final prospectus Old Rules  Prior to or simultaneously with the sale / delivery of securities final prospectus must be delivered  Delivery of any confirmation and any free writing must be preceded or accompanied by a final prospectus  No prospectus needed prior to the sale (but prior to or accompanied by in the delivery) -> too late to help in the buying decision -> however the preliminary prospectus is used in order to help in the buying decision o REMEMBER that in order to get acceleration -> you need wide distribution of preliminary prospectus New Rules (DEC 1, 2006)  Requirement of Final Prospectus after the buying decision is already made (is ridiculous)  Term Sheet was a step by the SEC a few years ago to help this situation out o Term Sheet + Preliminary Prospectus = Final Prospectus o Term Sheet could be stuck to the preliminary prospectus (but do not necessarily need to be delivered together) After the EFFECTIVE date  Written confirmations – no longer has to meet the preceding / or prior to requirement  Transfer of Security – o Effective Date o No disciplinary Actions against Broker / Dealer o Filed with the Commission – Final Prospectus Do not actually have to deliver final prospectuses to purchasers that (proceed or simultaneously) to make written confirmation / delivery  Just need to file it with the SEC  B/C the buying decision has already been made (so what good is it to require a delivery of a bunch of pieces of paper  Access = Delivery What do you have to deliver to the Purchaser  If you have an issue of sale (issuer -> UW or Dealer) or (UW -> Dealer)  And or any sale that does not have an exclusion for the devlivery  When Issuer sells -> must deliver  When UW sells their original Allotment -> must delivery  When must final prospectus must be delivered when A sells to B o 90 - In an IPO -> 90 days simult / or prior to o 40 - a company that has issued stock to the public and then for some reason is not longer required to register under the 34’ act o 25 - However if IPO is registered with NASDAQ or NYSE -> 25 days o 0 – If already a public company -> 0 days  NEW RULES o Does not change the rules but it changes what it means to delivery a final prospectus (prior to or simultaneously) o You can now delivery up to 2 days after the sale o In lieu of delivery of final prospectus you can delivery a notice that the sale was made pursuant to effective registration statement o Also these notices themselves are exempt from 5b1  NEW RULES o A purchaser may request that a final prospectus be sent (must be done)  NEW RULE 174 o The requirement to deliver anything with the confirmation has been eliminated o However notice needs to be prior or simultaneously with delivery Use of Electronic Media  The 33’ act was drafted in the era of paper  With the electronic age – is an email / website / website hyperlink equivalent to a writing o You have to deliver final notices / final prospectuses -> how can those delivery requirements be satisfied o You get as much information as you would get with paper o & you can prove you delivered o 4 Requirements need to be held  Notice – if you are going to send notice to someone electronically you need to send them independent notice that electronic transmission will be sent  Access - Ability to be Received - If it is to be sent -> it must be able to be received (i.e. mother has never used the computer)  Consent – Somehow the purchaser must have consented  Evidence of Receipt - The recipient must be able to retain a copy WKSI (big companies)  Well known seasoned investors  Company that is registered under the 34 act  World wide common stock exceeding $700 (non affiliates) (within 60 days) o Traded by people who do not control the company Shareholders owning 10%+ of a companies shares o Issue debt -> borrowing money through notes (debenture)  OR - It has registered 1B dollars of preferred stock or debentures  30% of companies that are registered on the exchanges will qualify o These 30% of companies control 95% of the money out there Any private company that wants to go public will not be a WKSI Rule 163  Wksi’s – are well known by the investing public, not only are they filed with the public at large….they are followed by multiple analyst’s…b/c there is so much information out there….we do not need to restrict the information dissemination for these companies TRULY REVOLUTIONARY  You cannot make offers or sales during the pre filing period  However WKSI’S can make offers during the pre filing period (re written 5(c)) for wksi’s Oral offers can be made REASONABLE DILIGENCE  Defense to personal liability for the officers and directors  But still the company is liable and will have to pay for the share if tendered back by the investor Class Notes HW Read Section 11, 12, 17 (Remedies) Barcurus Case ESCOTT v. BARCHRIS CONSTRUCTION CORP. 293 F.Supp. 643 (S.D.N.Y. 1968). FACT SUMMARY: Various principals and professionals involved in the preparation of a registration statement on behalf of BarChris (D) contended that they were excused from liability for errors contained therein because they had exercised due diligence in its preparation. RULE: Those responsible for an erroneous registration statement may be excused from liability if they exercised due diligence in its preparation. FACTS: BarChris Construction Corp. (D) was in the business of constructing bowling alleys. Several different financing arrangements were utilized in the sale of alleys to buyers. Triangular sales and sale-leaseback arrangements were often utilized. The nature of these sales tended to create a need on the part of BarChris (D) for constant replenishment of working capital.  In 1961, BarChris (D) raised capital by the issuance of 15-year debentures. Pursuant to law, a registration statement was prepared, covering BarChris' (D) finances for 1960 and the first quarter of 1961.  It turned out that the statement contained numerous misstatements. It seriously overstated sales, net income, and earnings per share. It also failed to disclose certain outstanding debts, customers' delinquencies, and certain operational aspects of BarChris (D).  BarChris (D) eventually became insolvent and filed for bankruptcy. A class of purchasers of the debentures brought an action seeking rescissionary damages under § 11 of the Securities Act. The various defendants moved to dismiss.  [The court made extensive factual findings as to each defendant. These may be summarized as follows: o Kircher (D) was the treasurer and chief financial officer of BarChris (D). He knew that a portion of the 1960 auditing figures were incorrect; that there was a customer delinquency problem; that loans were taken by officers; that one project, Capital Lanes, had not been sold, although the statement had said otherwise; and that the backlog of customers' orders was overstated. In short, he knew all the relevant facts. o Bimbaum (D) was house counsel and assistant secretary. He signed amendments to the statement. He had no personal knowledge of the books or financial transactions. He did rely on statements of Kircher (D) with respect to nonaudited portions of the statement. o Auslander (D) was a nonofficer-director. He signed the amendments to the statement without reading them, relying on assertions by Kircher (D) that they were correct. o Grant (D) was a director and outside attorney for BarChris (D). He prepared the registration statement. He relied, for 1960 figures, on an audit by Peat, Marwick (D). With respect to nonaudited figures, he accepted the word of various BarChris (D) officers as to the veracity thereof. He did not make an investigation of BarChris' (D) books or contracts. o Drexel & Co. (D) was the lead underwriter; Coleman (D) was a partner thereof and a director of BarChris (D); Ballard (D) was an attorney with Drexel (D).  They all relied on Kircher's (D) assurances as to the truth of the nonaudited portions of the statement, without making an independent inquiry. o Peat, Marwick (D) was the auditor of the 1960 figures. It did not comply with generally accepted auditing standards, or even its own internal standards. It failed to discover that one project had not been sold, and thus that sales had been overstated and liabilities understated.] ISSUE: May those responsible for an erroneous registration statement be excused from liability if they exercised due diligence in its preparation? YES HOLDING AND DECISION: (McLean, J.) Yes. Those responsible for an erroneous registration statement may be excused from liability if they exercised due diligence in its preparation.  Section 11(b) of the Securities Act exempts from liability under the section if an individual can prove, with respect to portions of a registration statement prepared by an expert, that he had no reasonable basis for believing it contained errors or omissions in portions beyond his expertise. If he conducted a reasonable investigation and had no grounds for believing the statement to have been in error, he may invoke the subsection.  In ascertaining whether any defendant met the standard of § 11 (b), each defendant must be separately analyzed. o Kircher's (D) inability to rely on § 11(b) was apparent; he knew all the relevant facts and that both the expertised and nonexpertised portions of the statement were incorrect. o Because Bimbaum (D), on the other hand, did not know that the expertised portion was wrong, he could invoke §11(b) as to that. However, as to the nonexpertised portion, he did not make a reasonable investigation; he merely relied on Kircher's (D) averments. This did not constitute due diligence, making § 11 (b) unavailable. o Auslander's (D) position was similar to that of Birnbaum (D). While he could rely on § 11 (b) as to expertised portions, he did not make a reasonable investigation, and therefore could not so rely as to the nonexpertised portions.  o Grant (D), as the main preparer of the statement, had a higher duty to make a reasonable investigation. He relied on Peat, Marwick's (D) audit as to the 1960 figures and did not know them to be wrong. He could therefore invoke § 11(b) as to these portions. However, with respect to the nonexpertised portions, he was under an affirmative duty to investigate BarChris' (D) books to ascertain the veracity of the figures given him by BarChris (D) officers. He did not do this, and therefore he could not invoke § 11(b). o Drexel & Co. (D), as underwriters, had a duty to make a reasonable investigation. This it did not do, and therefore could not invoke §11(b). This was also true for the individual defendants associated with Drexel (D), Coleman (D), and Ballard (D). o Peat, Marwick (D) was obligated by § 11(b) to conduct an audit in compliance with generally accepted auditing principles. It did not do this, and therefore could not invoke the protection of the section. In summary, none of the parties seeking §11(b) protection exercised sufficient diligence to come within the protection of § 11(b). Motions denied. EDITOR'S ANALYSIS: Section 11 is a long, complicated provision and is most comprehensible when studied from the perspective of each type of defendant.  The issuer has absolute liability for false and misleading statements of material fact in a registration statement. There are some defenses provided in the statute, but these were not at issue in BarChris. Usually, the issuer will be in financial difficulties when a §11 violation is alleged. For this reason, a plaintiff will endeavor to join more solvent defendants, as in BarChris.  Outside of the issuer, the defendants will either be classified as experts or nonexperts. They may raise the affirmative defenses of due diligence and/or reliance on an expert. The standard required to meet the burden of proof for these defenses will vary both on the expert or nonexpert label of the defendant and the location of the false statement in an expertised or nonexpertised portion of the registration statement.  Determining who is an expert and what are the expertised portions becomes very important as shown in BarChris. The common practice is to clearly preface those portions of the registration statement made upon the authority of an expert. Whether such acts of self-labeling will hold up in court has not been tested.  An important aspect of the BarChris decision is the exclusion of the attorney's work product from the expertised portions. An attorney who passes upon the legality of the particular security is providing a type of expertise; however, the court deemed Grant (D), the attorney, and his contribution as nonexpert. The nonexpert classification in BarChris resulted in the loss of a due diligence defense for all those defendants who relied upon the advice of counsel.  Underwriters: In BarChris, the underwriters were found lacking in their investigation and thus failed to establish a due diligence defense. The court notes that the underwriter's reputation often is a persuasive factor to investors and therefore it cannot maintain a passive role in the distribution. It is not unreasonable to require the underwriter to assume some of the policing duties    since they occupy an indispensable role. Traditionally, the underwriter would hold a "due diligence" meeting shortly before the effective date at which time they would ask pertinent questions to the officers and directors. BarChris makes it clear that this is not a reasonable investigation. Since BarChris, underwriters have been endeavoring to contractually shift the ultimate liability back onto the issuer's officers and counsel. An underwriter will generally require an opinion in writing from these parties, warranting the truthfulness of the registration statements. Accountants and other experts are perhaps the most vulnerable to§ 11 liability since they must make complicated and exhaustive investigations of the issuer's finances. As seen in BarChris, the issuer may attempt to cover-up financial difficulties and for this reason, cannot be relied upon. A particularly precarious area is the S-1 review which accounts for material changes between the last audit and the effective date. No formal audit is performed and an accountant must rely heavily on the issuer's veracity while at the same time risk liability for failing to discover misrepresentations. The attorney-defendant will probably share the same liability as a director. Frequently, the attorney is a director as in BarChris. Today, an attorney may shun a directorship while the issuer is in registration, but with cross-claims for malpractice it is unlikely that the attorney will avoid liability. Section 11 makes no distinction between inside and outside directors. BarChris held that Auslander (D) was liable even though he was outside and new. It seems clear that the more involved a director is the more he will have to do to preserve his due diligence defense. CLASS NOTES Any violation of § 5 (the registration rules) § 24 any willful violation = felony § 12a(1)  Strict liability provision  Any person who— o offers or sells a security in violation of section 5 (offers / sells) o shall be liable to the buyer for the amount of consideration paid (i.e. IPO price) o No fault needs to be involved § 11 § 17 - shall be unlawful  Fraud or Deceit  Material misstatement or Omission Rule 10(b)(5)  You must show willful deception (―scienter‖) 903 – 909 183 – 188 231 – 241 Forms of the Registration Statement Registration Statement  Part I – Prospectus  Part II – Other Information (matter of public record) Form S1 Form S2 Form S3 Form S11 (real estate companies REIT) -> needs additional and different types of information to be submitted 1933 Act 1934 Act – companies that are already public 10-K S-3 6383 231-241 (forecasts and managements discussion of analysis) ENRON  Ken Lay  Jeff Fastow -> hedging transactions -> to out right fraud o Thousands of transactions that had no substantial economic substance that counted for a majority of Enron’s economic earnings for the previous 4 years o (i.e. Southwest hedged by buying futures in oil prices) Targets of the Sarbanes Oxley Act  Gets on top executives from saying that they have been defrauded  Accountants -> got on them that the accounting rules were to W.J. Howe and the Hills   Selling Orange Groves o HELD – that it was an investment contract and therefore was a security What was sold (Land and Services) o Land o Service Contract     Rows of Trees was being sold and bought by investors (metes and bounds of description) grant deed was given Then you had the opportunity to enter into a service contract -> 85% entered into the service contract Real Estate -> is not defined as a security by the SEC The Sale of Services -> is not defined as a security by the SEC FINAL EXAMINATION  Review Session on the last week of class  Section 5 review with the 2005 amendments (you do not have any textual overlay)  Generally -> go over one of the question in the 2004 Exam o Give us his approach to it  The Exam basically reflects the course and will look a lot like last years example  Open Book Open Note  Race Horse Exam SEC v. W.J. Howey Co FACTS – After Howy sold small strips of land in its citrus groves to purchasers who entered into a simultaneous service contract with Howey D, the SEC sought an injunction preventing Howey’s use of interstate commerce to promote the arrangement on the ground that it constituted the sales of securities unregistered with the SEC RULE – A security is a document or documents which evidence the  investment of money  in common enterprise  Expectation of profits  with profits to come solely form the efforts of others Investment Contract = Security SEC v. Koscot Interplanetary, Inc FACTS – Company conducted ―sales campaign‖ for beauty products by distributing shares in its enterprise in turn for which purchasers brought in new ―sellers‖ of the products RULE – An investment contract will be found where the efforts of those other than the investor are the essential and significant managerial efforts, which affect the failure or success of the enterprise as a whole.  The critical issue -> is whether the efforts made by others are the ―undeniably significant‖ efforts made by others  The court holds that the friend bring was important but not undeniable significant o The court holds that the sales presentation and the pressure is what are the undeniable services provided. Class Notes  A typical franchisee is not a security b/c the efforts do not come solely from the efforts of others  Pyramid Scheme – when the profits are substantially or solely dependent upon the recruitment of new members What is Common Enterprise? (based upon jurisdiction – 3 views – to find an investment contract)  Broad Vertical Commonality – o Likely to Hold Commonality Exists is when: Broadest View -> Resulting in finding an investment contract  The efforts of the promoter are linked to the fortunes of the investor or investors.  (i.e. the promoter is going to make money regardless even if the investor does not) = broad Vertical Commonality  EXAMPLE -> promoter and investors do not share in the net profits overall  + the investors do not need to be pooled with other investors (i.e. broad vertical: 1 investor and 1 promoter Strict Vertical Commonality – o The fortunes of the promoter are linked to the fortunes of the investor (i.e. they share a % of profits and losses with each other) -> Resulting in finding an investment contract Horizontal Commonality – o Must be a pooling of investors profits (must have more than 1 investor & have them pooled together)-> resulting in finding an investment contract   CLASS NOTES  LLC DO NOT SELL STOCK – LLC, LLP, -> Do not Sell Stock  Corporations profits are taxed twice  General Rule – General Partners –not solely from the efforts of others LLC  Do not Sell Stock – Like Heaven and Hell (no inbetween General Partners  Do not Sell Securities – b/c General Partners manage (thus do not derive income solely from the efforts of others Limited Partners  Used to be that LP’s are not selling securities  Not liable unless takes part in the efforts of the business o The only rights they have is to be able to inspect records o Have on demand  o LP -> buys this limited liability But now we look to see if this a security Solely from the efforts of others  You must look at the facts and make your arguments United Housing Foundation, Inc. v. Forman FACTS – United Housing (UHF) (D) the developer of Co-op City, required that prospective purchasers (P) buy shares of stock in order to occupy an apartment in the development RULE – Commercial transactions in stock do not constitute securities under the Securities Acts where the purpose of the transaction is not to invest for profit ISSUE – Do Commercial transactions involving the sale of stock constitute securities where the purpose is not to invest for profit? NO  Commercial transactions do not constitute securities under the Securities Acts where the purpose is not to invest for profit.  HYPO – would this be considered a security if there was the possibility of profit on the sale of the co-op interest (DOES NOT CONSTITUTE A SECURITY IF YOU ARE BUYING ―PRIMARLY‖ FOR A PLACE TO LIVE) Pg 336 STEINHARDT GROUP, INC. v. CITICORP FACT SUMMARY: Assets were highly overvalued in a structured securitization agreement between a corporation (0) and an investor (P) in a limited partnership. RULE OF LAW: Partnership interests in a limited partnership constitute an investment contract only where a partner's rights and powers are limited to those of a passive investor. ISSUE: Does a highly structured securitization transaction negotiated between a corporation and an investor in a limited partnership constitute an investment contract under Howey? NO FACTS:  Citicorp (D), facing a severe financial crisis, conceived of a securitization transaction to remove nonperforming assets from its financial books and replace them with cash. To implement this transaction, Citicorp (D) formed Bristol Oaks, L.P. ("Bristol"), a limited partnership, to purchase the nonperforming assets.  Bristol contracted with Ontra, Inc., an independent third party experienced in loan servicing and workout, to manage and liquidate the loans. Citicorp (D) provided bridge financing to cover 90% of the purchase price of the loans, the remaining 10% to be paid by Bristol from cash derived from the sale of a limited partnership interest for $42 million to an affiliate of the Steinhardt Group, Inc. (P), the sole limited partner.  Citicorp (D) made a series of written and oral presentations to the Steinhardt Group (P) in which they overpriced assets. Despite warnings to Citicorp (D) that the assets were overpriced, in order to induce the Steinhardt Group (P) to invest, Citicorp (D) failed to inform Steinhardt that the assets were overpriced. HOLDING AND DECISION: (Mansmann, J.) No.  The Steinhardt Group (P) approved the business plan of the partnership, retained a limited power to amend the plan, a power to remove and replace the general partner without notice, and a power to object to any material action.  Because the Steinhardt Group (P) had pervasive control over the management of the partnership, its rights and powers directly affected the profits received from the partnership.  Thus, the securitized transaction here fails the third prong of Howey.  Affirmed. EDITOR'S ANALYSIS:  In litigation involving the definition of a security, plaintiffs generally lose when the issue concerns general partnership interests (plaintiffs prevail in only 25% of these cases), but they typically win when they are holders of limited partnership interests (triumphing at a rate of 80%). CLASS NOTES Securities  RE = not security  Multi Level Marketing = security  The four factor test Corporate Forms  General Partnership – all are on the line  Limited Partnership – limited = limited, but one general partner has unlimited  LLC – taxed as one person + losses, all are limited in liability GREAT LAKES CHEMICAL CORPORATION v. MONSANTO COMPANY FACT SUMMARY: Great Lakes Chemical Corporation (Great Lakes) (P) purchased NSC Technologies Company, LLC (NSC) from Monsanto Company and STI (D), and thereafter sued the sellers (D) under the Securities Exchange Act of 1934, alleging that they had failed to disclose material information in conjunction with the sale. The sellers (D) moved to dismiss on the grounds that the interests sold were not "securities." RULE: Interests in a Limited Liability Company (LLC) that are neither stock, investment contracts, nor interests commonly known as securities are not securities as defined in the Securities Exchange Act of 1934. ISSUE: Are interests in a Limited Liability Company (LLC) that are neither stock, investment contracts, nor interests commonly known as securities, securities as defined in the Securities Exchange Act of 1934? NO FACTS:  Great Lakes Chemical Corporation (Great Lakes) (P) purchased NSC Technologies Company, LLC (NSC) from Monsanto Company (Monsanto) (D) and STI (D). NSC is a Limited Liability Company (LLC).  Thereafter, Great Lakes (P) sued the sellers (D) under the Securities Exchange Act of 1934 (Act), alleging that they had violated § 10(b) and Rule 10b-5 promulgated thereunder by failing to disclose material information in conjunction with the sale. The sellers (D) moved to dismiss for failure to state a claim on the grounds that the interests sold were not "securities" as defined by the Act. HOLDING AND DECISION: (McKelvie, J.) No.  Interests in a Limited Liability Company (LLC) that are neither stock, investment contracts, nor interests commonly known as securities, are not securities as defined in the Securities Exchange Act of 1934.  LLCs are hybrid entities that combine the characteristics of corporations and limited and general partnerships. The threshold issue here is whether the interests transferred were "securities" under federal law, because to prevail Great Lakes (P) must show that any misconduct involved a purchase or sale of "securities." To be a security, the interests must be stock, an investment contract, or any interest or instrument commonly known as a security.  An "investment contract" has three elements: o (1) an investment of money; o (2) in a common enterprise; and o (3) with profits to come solely from the efforts of others.  As for stock, that has five common features: o (1) the right to receive dividends contingent on an apportionment of profits; o (2) negotiability; o (3) the ability to be pledged or hypothecated; o (4) voting rights in proportion to the number of shares owned; and o (5) the ability to appreciate in value.  Where a transaction involves the sale of an instrument called "stock," as where a 100% interest in a closely held corporation is transferred, and the stock bears the five common attributes of stock, the transaction is covered by the securities laws.  Other cases involving LLC interests have held that the LLC interests are not investment contracts where the LLC members retained substantial control over the enterprise, but are investment contracts where the interests otherwise satisfy the three-element test for investment contracts.  Here, although the interests in NSC are like stock, they are not stock. To some degree, the interests in NSC have the five common attributes of stock, and are even called "equity securities" in the LLC Agreement.            However, the primary goal of the securities laws is to regulate investments, and not commercial ventures. Here, the NSC interests are not traditional stock, so that the rule that transactions involving traditional stock are covered by the securities is inapplicable. Therefore, the court must determine whether the sale of NSC can be characterized as an investment transaction—in which case it is covered by the securities laws— or as a commercial transaction, in which case it is not. To make this determination, the court will first decide whether the sale constituted an "investment contract." A key element of an investment contract is investment of money in a common enterprise. o Here, Great Lakes (P) bought the entirety of NSC without pooling its contributions with those of other investors.  Thus, there was no horizontal commonality. o After the sale, Monsanto and STI (D) retained no interest in NSC, so the fortunes of Great Lakes (P) were not linked to those of the sellers (D) as required for vertical commonality.  Because the sale here did not involve the formation of NSC, the fact that Monsanto and STI (D) pooled their contributions in the formation of NSC does not change the character of the sale of NSC to Great Lakes (P)—it was not an investment in a common enterprise. o Also, the profits from the enterprise were not to come entirely from the efforts of others. It is inapposite to look to partnership laws to determine whether an LLC investor's profits will come solely from the efforts of others because membership interests in LLCs are distinct from those in general and limited partnerships. The primary difference is that members of LLCs are entitled to limited liability, and an LLC member, unlike a limited partner, may be an active participant and still retain limited liability. Therefore, there is no basis to presume that LLC members are passive investors. Whether an LLC member is active depends on the LLC's operating agreement, which will determine if the LLC interest will be protected by the securities laws. Here, the members of NSC had no authority to directly manage NSC's business. However, the members had the power to remove any manager with or without cause, and to dissolve the LLC. Because Great Lakes (P) had the authority to remove NSC managers, which power was not diluted by the presence of other ownership interests, Great Lakes (P) had the power to directly affect the profits it received from NSC, so its profits would not come directly from the efforts of others. Accordingly, the interests in NSC are not investment contracts. Finally, Great Lakes (P) argues that even if the interests in NSC do not constitute investment contracts, they should be deemed "any interest or instrument commonly known as a security." o This argument is rejected because in either case, the basic test is the same. The motion to dismiss is therefore granted. EDITOR'S ANALYSIS:  Currently, there is no bright-line rule as to whether LLC interests are covered by the federal securities laws.  Some commentators have argued that the securities laws should inherently not apply to general partnerships and LLCs, but should presumptively apply to corporations and limited partnerships, on the theory that this would give investors a clear choice through their selection of organizational form. CLASS NOTES  Court holds that there is not commonality (vertical commonality) Great Lakes bought 100% of the interest and therefore there was not pooling of assets in order to receive profits (i.e. no co-investors) -> therefore not horizontal commonality  Even if we had horizontal commonality b/c the P owned 100% and could fire at will -> then horizontal commonality doesn’t count LANDRETH TIMBER CO. v. LANDRETH FACT: Landreth Timber Company (P) purchased all the stock in a timber mill from Landreth (D), and sued under the securities laws. RULE: A sale of shares of stock will be covered by the securities laws, irrespective of the nature of the stockholder's role in managing the corporation. ISSUE: Will a sale of shares of stock be covered by the securities laws, irrespective of the stockholder's role in managing the corporation? YES  Where a transaction involves the sale of an instrument called "stock," as where a 100% interest in a closely held corporation is transferred, and the stock bears the five common attributes of stock, the transaction is covered by the securities laws. FACTS:  The Landreths (D) offered to sell the stock of their lumber business. Dennis and Bolten became interested and formed Landreth Timber Co. (P), which acquired 100% of the stock of the lumber company.  Landreth (D) was retained as a consultant.  The offering of stock was of an interstate nature and was not registered per the 1933 Securities Act. The business did not do as well as anticipated, and Landreth Timber Company (P) filed a suit under securities laws seeking rescission and damages.  The district court held the transaction to be the sale of a business rather than securities, and the court of appeals affirmed. HOLDING AND DECISION: (Powell, J.) Yes.    A sale of shares of stock will be covered by the securities laws, irrespective of the nature of the stockholder's role in managing the corporation. Section 2(1) of the 1933 Act clearly defines a security as "any... stock." It does not make distinctions based on the role of the purchaser in managing the corporation. o The Court, in SEC v. W. J. HoweyCo., 328 U.S. 293 at 299, defined a security in terms of a passive investment without managerial control. In that case, however, it was the sale of an unusual investment not easily recognizable as a security that was at issue. o The Court's Howey test only applies to such unusual investments. Stock, on the other hand, is the investment that most readily comes to mind when one mentions "security," and this fact, coupled with the clear statutory language, necessitates the holding that all stock sales are covered by securities laws. Reversed. EDITOR'S ANALYSIS:  Wherever somebody sues based on securities laws, an attempt is almost always made to come under federal securities laws.  Procedural advantages often exist in federal court.  More importantly, if a violation of the 1933 Act is found, the plaintiff is absolutely entitled to rescission, without having to prove damages. CLASS NOTES  Lower Court Holding - Sale of Business Doctrine – even when you sell ―stock‖ when you are selling 100% of the stock of a closely held corporation doesn’t count as a security o Also – another exemption is the selling of stock of a co-op = not a security  Sale of a business can be done by Corp -> selling 100% of stock -> P  Or Corp -> Selling 100% of the assets -> P  In either way the purchaser owns 100% of the corporation  Thus this is a substance over form analysis o However -> if you have a sale of assets along with a service contract could be viewed as the sale of a security  HOLDING – If it is called a stock with all the rights of a stock then we do not need to look to substance over form, but in fact it is a stock, thus the sale of a security (and you do not need to meet all of the requirements “usual characteristics of stock” to have a stock be a stock) o When you have a traditional stock – that is the end of the analysis o Thus the court rejects the ―Sale of Business Doctrine‖ REVES v. ERNST & YOUNG FACT: Reves (P), on behalf of various purchasers of payable-on-demand notes purchased from an agricultural cooperative, argued that the notes were securities within the meaning of the 1934 Securities Exchange Act. RULE OF LAW: Notes that are payable on demand offered by an organization to support its general operations are securities within the meaning of the 1934 Securities Exchange Act. ISSUE: Are notes that are payable on demand and offered by an organization to support its general operations securities within the meaning of the 1934 Securities Exchange Act? YES CLASS NOTES  It was a way for the members to pool their products and share in the profits FACTS:  The Farmers Cooperative (Coop) of Arkansas and Oklahoma offered, as part of an "investment program," o Promissory notes and sold them to its members and the general public, as well. o The notes paid a high variable interest rate, o were unsecured and were not of a fixed term, o but payable on demand.  The capital raised form the sale of the notes went to support the Coop's general operations.  The Coop went bankrupt, and Reves (P) and other purchasers of notes brought an action against Ernst & Young (D), the Coop's accountant, alleging that Ernst & Young (D) had intentionally inflated the value of the Coop's assets and failed to follow generally accepted accounting principles in violation of the 1934 Securities Exchange Act and Arkansas securities laws.  Reves (P) prevailed at trial on both the federal and state claims, obtaining a $6.1 million judgment. Ernst & Young (D) appealed, arguing that the demand notes were not "securities" within the meaning of the 1934 Act.  The Eighth Circuit Court of Appeals accepted Ernst & Young's (D) argument and reversed the district court.  The Supreme Court granted certiorari. HOLDING AND DECISION: (Marshall, J.) Yes.  Notes payable on demand offered by an organization to support its general operations are securities.  The federal statute defining "securities," §3(a)(10) of the 1934 Securities Exchange Act, includes "notes."  However, based upon the recognition that not all notes come within the commonly understood notion of what a security is, this being an investment of money in a common enterprise managed by others in the expectation of receiving a profit, some judicially created exceptions exist.        If the note is given to facilitate the purchase of a particular asset, it will not be considered a security. Examples of this include home mortgages and promissory notes secured by a new automobile. Also relevant to this analysis is the reasonable expectation of the note holder. In view of this mode of analysis, there can be little question here but that the instruments at issue were securities. They reflect investments in the general operations of the business in question, the principal and interests to be repaid out of the business' general operations. This, despite the absence of ownership interest, is not dissimilar from common stock, the paradigm of a security. For these reasons, the Eighth Circuit was incorrect. Reversed. CONCURRENCE: (Stevens, J.) The statute specifically excludes from its ambit notes maturing in less than nine months. Demand notes may be redeemed within less than nine months. However, this exclusion applies only to commercial paper, not investment instruments. CONCURRENCE AND DISSENT: (Rehnquist, C.J.) As demand notes may be redeemed within less than nine months, the less-than-nine-month maturity exclusion found in §3(a)(10) of the 1934 Act should apply. EDITOR'S ANALYSIS:  As noted in the dissents, §3(a)(10) includes as securities "notes." However, any note payable within less than nine months is specifically excluded.  The dissent of the Chief Justice thought this applicable. The majority reasoned that since the notes could be demanded over nine months from issuance, the exclusion was not available. EDITOR'S ANALYSIS:  To reach its decision, the Court adopted the four-point "family resemblance" test created by the Second Circuit. o 1. First, a court should assess the motivations behind the transaction that prompted the seller and buyer to enter into the transaction.  For example, if the seller is raising money for a general business enterprise and the buyer is seeking primarily to profit on the note, the instrument is more likely to be a "security." o 2. Second, the "plan of distribution" of the instrument must be examined to see whether there is "common trading for speculation or investment." o 3. Third, the court should examine the reasonable expectation of the parties. o 4. Fourth, the existence of any other regulatory scheme should be explored to see whether application of the Securities Acts is rendered unnecessary. Security exemptions. Pp. 386-391. Figure out the Causes of Actions