Page 1 of 19 1933 Act (Purpose -full disclosure & no fraud) (Achieved by – registration & prospectus) Transactions Covered by 1933 Act Pre-filing Period 1. No offers (encompassing) a. No Conditioning the Market b. Dissemination of Information (ISSUER) i. EXCEPTIONS 1. Press Release a. Mandatory Item – i. “that the offering will be made only by means of a prospectus” b. Permissible Items – i. “title of the security, basic terms, time of the offering, name of the issuer c. Prohibited Items i. Identity of the UW 2. Information in the Normal Course of Business c. Dissemination of Information (UW) i. Only allowed to disseminated information that would be disseminated within the normal course of business (as long as does not interfere with the objectives of the 33’ act. 2. No Sales Activity a. Meeting with Analysts if not a regular event b. Forecasts and Projection b/c not factual 3. EXCEPTIONS a. Negotiations and agreements between the issuer and an UW b. Negotiations and agreements among Underwriters c. BUT NOT negations and agreements between UW and Dealers or Brokers PRE FILING PERIOD NEW RULES • Pre-Filing offers by WKSIs -Rule 163 – o Available only for WKSIs – all written and oral offers made by or on behalf of a WKSI before the filing of a registration statement are exempt from Section 5(c)’s prohibition on “offers” before registration statement is filed. Rule 163 is not available for underwriters. o Requirements of Rule 163 – include: the written communication must contain a prescribed legend; it must be filed with the SEC promptly upon filing of the registration statement for the offering • 30-day bright-line exclusion from gun-jumping -Rule 163A – o Available for all issuers – Rule 163A provides all issuers with a non-exclusive safe harbor for certain communications made during the period ending 30 days prior to the filing of a registration statement. Not considered offers – these communications are not considered prohibited “offers” under Section 5(c). o Requirements of Rule 163A – in order to use the safe harbor: Rule 163A communications must not refer to the securities offering that is the subject of the registration statement; the communications have to be made by or on behalf of an issuer – in other words, the issuer will need to authorize or approve Rule 163A communication and • communications authorized or approved by underwriters or dealers WILL NOT come within the safe harbor; • Safe harbor for factual business information and forward-looking information by reporting issuers -Rule 168 – (I.E. 34’ ACT REPORTING) o Rule 168 allows – continued regular release or dissemination of “factual business information” and “forward-looking information,” subject to certain conditions. o Rule 168 information may be released at any time – including before and after the filing of a registration statement. • Safe harbor for factual business information regularly released by non-reporting issuers -Rule 169 – (I.E. IPO) o Rule 168 factual business information – means: factual information about the issuer, its business or financial developments, or other aspects of its business; advertisements of, or other information about, the issuer’s products or services; dividend notices; and factual information set forth in the issuer’s Exchange Act reports. o Rule 168 forward-looking information – means: projections of an issuer’s revenues, income or loss, earnings or loss per share, capital expenditures, dividends, capital structure, or other financial items; statements about management’s plans and objectives for future operations, including plans or objectives relating to the products or services of the issuer; statements about the issuer’s future economic performance, including statements contemplated by MD&A discussion; and assumptions underlying or relating to the foregoing. o Information about the offering or information released or disseminated as part of offering activities – is not factual business or forwardloookin information. o Rule 169 allows – the continued release by or on behalf of an issuer of factual business information (but not forward-looking information). • WKSI’S may use a free writing prospectus before filing, -Rule 163. -o A free writing prospectus = any “written communication” that constitutes an offer to sell or a solicitation of an offer to buy securities relating to a registered offering, that is used after a registration statement has been filed, other than: a permitted preliminary or final statutory prospectus; and a communication delivered after effectiveness of a registration statement that is accompanied or proceeded by a statutory prospectus. Page 2 of 19 o “written communication” = includes any written or printed communication, any radio or TV broadcast (regardless of how transmitted), or any “graphic communication.” o “graphic communication” = includes all forms of electronic media, except for a communication that, at the time of the communication, originates live, in real-time to a live audience and does not originate in recorded form or otherwise as a graphic communication, although it is transmitted electronically. Exam Tip Thus, during the pre-filing period, issuers may not publicly disclose who will be underwriting the securities or any other information designed to procure or solicit advance interest in the securities, although they may announce that they will be making an offering by means of a prospectus, and include the title of the security, its basic terms, the time of the offering, and the name of the issuer. Issuers should always check pre-filing statements against SA rule 135. Post Filing /Waiting Period 1. NO Sales a. EXCEPTIONS i. Between the issuer and the underwriters or among underwriters 2. Offers Permitted a. UW negotiations and agreement with Dealers /Brokers allowed b. UW & Dealers may solicit offers to purchase c. Oral Communication d. Certain Written Communication Permitted i. Preliminary Prospectus ii. Red Herring iii. Tombstone Ads 1. Issuers Name 2. Kind of Security 3. Price 4. Identify of the person who will be executing purchase orders 5. from whom a prospectus may be obtained 6. statement that no offer to purchase can actually be accepted + ad itself does not a constitute a solicitation iv. Summary Prospectuses – used by companies that file under the 34’ act 3. NOT Permitted Offers a. NO “prospectus” where prospectus = almost any written communication (plus TV and Radio Ads) b. EXCEPTIONS 4. NO OFFERS MAY BE ACCEPTED until the registration statement has become effective. 5. Distribution of Preliminary Prospectus a. No Acceleration -(from 20 day amendment period) unless the preliminary prospectus has been distributed to all UW and Dealers who can Rx be expected to participate in the distribution b. No Acceleration for new Issuer – UNLESS UW & Dealers have sent Preliminary Prospectuses to all persons who are Rx expected to become purchasers 6 TYPES OF OFFERS CAN BE MADE DURING THE WAITING PERIOD (as long as there is no conflict between Free Writing Prospectus and the Preliminary Prospectus /Registration statement) 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 WAITING PERIOD NEW RULES • Expanded safe harbor for communications after filing -Rule 134 o advertisements of, or other information about, the issuer’s products or services. o As amended, Rule 134 permits the following – in addition to the information currently allowed under the Rule: certain basic factual information about the legal identity and business location of the issuer, including contact details; information about the business segments through which the issuer operates; greater information about the securities offered; the names of all underwriters participating in the offering and their roles in the underwriting syndicate; the anticipated schedule for the offering, and a description of marketing events; a description of the procedures by which the underwriters will conduct the offering and information about procedures for opening accounts and submitting indications of interest; expanded disclosure regarding credit ratings (although a bona fide price range, in the case of a non-reporting issuer, must be included in the registration statement before including this in a Rule 134 communication); certain additional information, including the names of selling securities holders, certain email addresses, the exchanges on which the securities will be listed and the ticker symbols; and a shortened legend. • Allow issuers and underwriters to make written offers by way of a “free writing prospectus” after a registration statement is filed. -Rule 164 & 433 o A free writing prospectus = any “written communication” that constitutes an offer to sell or a solicitation of an offer to buy securities relating to a registered offering, that is used after a registration statement has been filed, other than: a permitted preliminary or final statutory prospectus; and a communication delivered after effectiveness of a registration statement that is accompanied or proceeded by a statutory prospectus. o “written communication” = includes any written or printed communication, any radio or TV broadcast (regardless of how transmitted), or any “graphic communication.” Page 3 of 19 o “graphic communication” = includes all forms of electronic media, except for a communication that, at the time of the communication, originates live, in real-time to a live audience and does not originate in recorded form or otherwise as a graphic communication, although it is transmitted electronically. • Under Rule 164 – once a registration statement has been filed, a free writing prospectus of the issuer or any other offering participant will not violate Section 5(b)(1)’s prohibition on the use of a nonconforming prospectus prior to effectiveness if: o The additional conditions of Rule 433 are met. • Rule 433 – prospectus-delivery requirements o WKSI’S -In connection with offerings by WKSIs and seasoned issuers – a free writing prospectus may be used by WKSIs and seasoned issuers without delivering a statutory prospectus. In the case of seasoned issuers, a statutory prospectus must first be on file with the SEC. o IPO’S -Non-reporting and unseasoned issuers – a statutory prospectus, including a price range when required (as in the case of an IPO), must accompany or precede a free writing prospectus, with two exceptions: • Rule 433 – information and legend requirements o A free writing prospectus may include information – the substance of which is not included in the registration statement. o But the information in a free writing prospectus must not “conflict with” – the information in the registration statement or an issuer’s Exchange Act reports. Legend – the free writing prospectus must contain a legend in prescribed form. Disclaimers of responsibility or liability that are impermissible in a statutory prospectus are also impermissible in free writing prospectuses. • Rule 433 – filing requirements o All issuers – must file, on or prior to the day the free writing prospectus is used: any “issuer free writing prospectus” which is defined as: a free writing prospectus prepared by or on behalf of the issuer; or a free writing prospectus used or referred to by the issuer; o Information is provided “by or on behalf” – if the issuer or its agent or representative authorizes the communication or approves it before use. o Underwriters – an underwriter must file any free writing prospectus it uses or refers to, and is distributed in a manner reasonably designed to lead to its “broad unrestricted dissemination.” But an email to customers or a website restricted to customers will not require filing. o Exceptions to filing – these include: issuers and other offering participants do not need to file a free writing prospectus that does not contain “substantive changes from or additions to” a previously filed free writing prospectus; issuers do not need to file issuer information contained in a free writing prospectus prepared by or on behalf or used by any other offering participant if that information is already included in a previously filed statutory or free writing prospectus relating to the offering; and issuers and other offering participants do not need to file a free writing prospectus that is a preliminary term sheet, although a free writing prospectus that is a final term sheet must be filed by the issuer within two days of the later of establishing the terms and the date of first use. • Rule 433 – road shows o Road shows that are written communications – are free writing prospectuses. But with one exception these do not need to be filed. o Live road shows – are not written communications, even if simultaneously retransmitted to other locations. Nor are road show slides, if not handed out. o Pre-recorded electronic road shows – are written communications and hence free writing prospectuses. These must be filed if used in connection with an IPO, unless one version of a bona fide electronic road show is made available electronically without restriction to any person (e.g., by posting the road show on an unrestricted website). • Rule 433 – website information o Issuer website information – offers of securities contained on an issuer’s website or hyperlinked from an issuer’s website to a third-party website are free writing prospectuses that must be filed. Historical information about an issuer, however, that is identified as such and is located in a separate section of an issuer’s website will not be considered a free writing prospectus if that information has not been incorporated by reference into or otherwise included in a prospectus for the offering, or otherwise used or referred to in connection with the offering. • Rule 433 – media free writing prospectuses o Media free writing prospectuses – any written offer that includes information provided or authorized by an issuer or one of its underwriters that is prepared and disseminated by an unaffiliated media third party is an issuer free writing prospectus. o Nevertheless, the requirements for prior or current prospectus delivery (in the case of non-reporting and unseasoned issuers), legending and filing that would otherwise apply to these free writing prospectuses will be deemed satisfied if: no payment is made or other consideration is given for the publication by the issuer or its underwriters; and the issuer or underwriter files the media free writing prospectus within four business days after publication or dissemination (provided that the media free writing prospectus need not be filed if the substance of the written communication has previously been filed). o Filing may include – corrections. Also, a transcript may be filed in lieu of filing the article. • Rule 433 – record retention o Issuers and underwriters – must retain all free writing prospectuses they have used and that have not been filed for three years from the initial bona fide offering of the securities. • Rule 137 – publication of research by non-participating broker-dealers o available only to brokers and dealers who are not participating in the registered offering of the issuer’s securities and have not received compensation from the issuer • Rule 138 – publication of research by an underwriter on other securities of an issuer o The regular course requirement – does not mean that the broker or dealer must have a history of publishing research reports about the particular issuer or its securities. Instead, the research report must cover the “same types of securities.” • Rule 139 – publication of research about the securities being offered by an underwriter o the broker-dealer will have to publish issuer-specific research reports in the regular course of its business. Exam Tip Be sure to remember that, unless the effective date is accelerated, a registration statement is not effective for 20 days after any amendment is filed, including the pricing amendment. The S.E.C. will not accelerate the effective date of an offering unless the issuer has distributed a preliminary prospectus to all underwriters and dealers expected to participate in the distribution and, if the issuer has never before issued securities, to all persons reasonably expected to become purchasers. Because acceleration is a practical necessity, due to market price fluctuations, the effect is that all issuers must distribute preliminary prospectuses. Page 4 of 19 Post Effective Period 1. Registration is declared effective 2. Actual Sale of registered securities allowed a. Purpose -see that all purchasers receive complete disclosure i. Final Prospectus (aka statutory prospectus) ii. Preliminary Prospectus + additional disclosure docs = final prospectus b. Distribution of Statutory/Final Prospectus Accompanied of Preceded by Allows the Following i. Free Writing Allowed – as long as it is accompanied by or preceeded by a copy of the final prospectus (statutory prospectus) 1. STATUTORY ANALYSIS – Free writing is not a prospectus if it is accompanied or preceded by a statutory prospectus ii. Written Conformations of Sale iii. Delivery of Securities 1. EXEMPTIONS a. For Dealers – once the “distribution period” is over, dealers need not deliver a prospectus with the security (i.e. finished selling their allotment) c. Rule 434 & the “Piecemeal” statutory/final prospectus i. Permits issuers in certain offerings to provide several documents taken together to = the statutory /final prospectus ii. Eligible Offerings 1. Final Prospectus = Red Herring /Preliminarily + Abbreviated Term Sheet d. Electronic Prospectus Delivery i. Safe Harbor For Issuers Using Electronic Delivery When: 1. Notice, 2. Access, 3. Paper Back Up, 4. Assurance of Delivery a. Consent to Electronic Delivery b. Evidence of Receipt c. Use of a Fax Machine d. Accessing Linked Documents e. Use of forms e. Length of Time Prospectus Must be Used – Throughout the Distribution Period i. Mandatory Updating – extend beyond 9 months cannot be older that 16 months ii. Updating to Avoid Liability – anytime new material facts develop • 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 Page 5 of 19 Property Interests Covered by the 1933 Act Act Applies Only To “Securities” Securities Subject to Registration 1. Interests or Instruments Specifically Mentioned in the Act a. Stock – if possesses the characteristics normally associated with stock i. Voting, Dividend, Liquidation, Negotiable, Pledged (i.e. don’t need all of them) b. Promissory Notes i. Presumed a Security (REBUTABLE PRESUMPTION) ii. EXCEPTIONS 1. Consumer Financing (I.E. Auto Loans) 2. Home Mortgages 3. Short Term Loans Secured by assets of small business 4. Character Loans (YOU HAVE A HISTORY OF BEING TRUSTED /INVESTMENT IN THE INDIVIDUAL) 5. Short Term secured financing of accounts Receivable 6. Short Term open account debts incurred in the ordinary course of business 7. Commercial Bank Loans c. Other interests or instruments i. Pre organization Subscriptions ii. Fractional undivided interest in oil, gas, other mineral rights iii. Collateral trust certificates iv. Certain types of receipts for securities 2. Investment Contracts a. Howey Test i. Investment of Money (i.e. $$$) ii. Common Enterprise (3 VIEWS) 1. Broad Vertical Commonality a. Likely to Hold Commonality Exists is when: Broadest View -> Resulting in finding an investment contract i. The efforts of the promoter are linked to the fortunes of the investor or investors. ii. (i.e. the promoter is going to make money regardless even if the investor does not) = broad Vertical Commonality 1. EXAMPLE -> promoter and investors do not share in the net profits overall iii. + the investors do not need to be pooled with other investors (i.e. broad vertical: 1 investor and 1 promoter 2. Strict Vertical Commonality a. 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 3. Horizontal Commonality a. Must be a pooling of investors profits (must have more than 1 investor & have them pooled together)-> resulting in finding an investment contract iii. Expectation of Profit iv. From the Efforts of the Promoter 3. Any Interest or Instrument Commonly Known as a Security a. The catch all provision EXAMPLES 1. Land with Service Contracts = Security 2. General Partnerships = Not a Security a. EXCEPTION – GP = Security When i. Agreement leaves so little power in the hands of the partner that the arrangement in facts distributes power as would a limited partnership (OR) ii. Partner is so inexperienced and unknowledgeable in business affairs that he is incapable of intelligently exercising partnership powers (OR) iii. Partner is so dependent on some unique entrepreneurial or managerial ability of the promoter or manager that he cannot replace the manger of the enterprise or otherwise exercise meaningful partnership power 3. Limited Partnership Interests = Security a. EXCEPTION – LP = Not a Security i. When LP retains Significant Control 4. LLC = Not a Security by Statute 5. Franchises = Not a Security if the Management is Active 6. Pyramid Schemes /Multi Level Marketing Schemes = Security b/c efforts from the promoter 7. Condominiums -generally not a security a. EXCEPTION -held to be a security when management will rent them out when the owner is not using them + units share rents and expenses CASES 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 – Security = Investment Contract =: • investment of money • in common enterprise • Expectation of profits • with profits to come solely form the efforts of others 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 Page 6 of 19 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. 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) 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 • 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. GREAT LAKES CHEMICAL CORPORATION v. MONSANTO COMPANY FACT: 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 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. • 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” • EXCEPT – WHEN THE STOCK IS REAL ESTATE • ALSO TO GET AROUND THIS YOU SELL ALL THE ASSETS 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 • Notes payable on demand offered by an organization to support its general operations are securities. • Alleged Material Misstatements and Material Omissions o 10b5 Liabilities whether or not registered with the SEC under the 33’ act • To reach its decision, the Court adopted the four-point "family resemblance" test created by the Second Circuit. o 1. (MOTIVATION OF BUYER AND SELLER)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. (MODE OF DISTRIBUTION)Second, the "plan of distribution" of the instrument must be examined to see whether there is "common trading for speculation or investment." o 3. (EXPECTATION OF THE PUBLIC)Third, the court should examine the reasonable expectation of the parties. (DOES THE BUYER VIEW THIS A SECURITY UNDER THE SEC LAW) o 4. (IS THERE OTHER REGULATORY SCHEME)Fourth, the existence of any other regulatory scheme should be explored to see whether application of the Securities Acts is rendered unnecessary. (IF Page 7 of 19 DISCLOSURE UNDER THE 1933 ACT-REGISTRATION STATEMENT 1. FINANCIAL INFORMATION a. Balance sheet, generally less than 90 days old b. Profit and loss statements covering last three years 2. OTHER MATERIAL FACTS a. Facts affecting price (e.g., difference between book value and sale price) b. Facts making security a high risk (e.g., absence of operating history) c. Facts regarding issuer's status (e.g., threatened or pending litigation) d. Facts regarding conflicts of interests (e.g., transaction between the issuer and a director or officer of the issuer) e. Facts regarding certain legal proceedings against directors and officers (e.g., criminal convictions or proeedings, securities or commodities laws violations) f. Facts regarding environmental litigation to which the government is a party unless issuer reasonably believes any resulting sanction will not exceed $100,000 3. "SOFT" INFORMATION (NOT REQUIRED) a. Financial projections (e.g., projections of future earnings and revenues i. (Permission) Forward looking statements (Rule 175) – (under safe harbor provision) ii. Need reasonable basis and good faith -> not fraudulent statement b/c of safe harbor iii. Fraudulent statement = material misstatement or material omission 4. MANAGEMENT DISCUSSION AND ANALYSIS (Required) a. Short-and long-term analysis of the company's business, addressing key variables and other factors needed for an understanding and evaluation of the company Page 8 of 19 Sarbanes Oxley • NOTE -Sarbanes only applies to companies that are registered under the 1934 act and from the time they file a registration statements under the 1933 act Auditor Independence Auditors Can not Perform other (9) functions for the company (b/c of the conflict of interest) • 1) bookkeeping and other services related to the company's accounting records or financial statements, • (2) financial information system design and implementation, • (3) appraisal and valuation services, • (4) actuarial services, • (5) internal audit outsourcing services, • (6) management functions (e.g., director, officer, employee of the company or performing any decision-making, supervisory, or monitoring function for the company), • (7) human resources functions (e.g., executive or management search or reference checks, psychological or other testing or evaluation, negotiating compensation or employee benefits), • (8) broker-dealer, investment adviser or investment banking services, • (9) legal or other nonaudit expert services, and • (10) any other service prohibited by the Board. Lawyers Liability /Responsibility • General Rule of Confidentiality – absent client consent to disclose that information, that rule is without exception (no permitted disclosure even with fraud or harm) • (NOW – permit disclosure to non party third parties in the case of harm or fraud) o Attorney may reveal confidential information (d)(2)(1) & (3) – to prevent future injury (report to the SEC) and to rectify past injury o CA lawyer should not make that disclosure until upheld by an appellate court Act Section 301 – INDEPENDENCE OF AUDIT COMMITTEE • Each member of the audit committee must be an "independent" board member. • For this purpose, appropriate independence is evidenced by o the member's not being an "affiliate" of the company, that is, not being an executive officer or director or o greater than 10% shareholder of the company and by the member's o receiving no consulting, advisory, or other compensatory fee, other than a director's fee, from the Company. Act Section 407, AT LEAST ONE INDEPENDENT AUDIT COMMITTEE MEMBER IS A “FINANCIAL EXPERT” • The audit committee's "financial expert" is a person who through education or experience as a public accountant or principal financial or accounting officer for a comparable company or through other relevant experience has an o (1) understanding of generally accepted accounting principles and financial statements, o (2) experience in financial statement preparation and application of accounting standards to estimates, accruals, and reserves, o (3) experience with internal accounting controls, and o (4) an understanding of the proper functioning of the audit committee. • a significant degree of technical financial and accounting knowledge, as well as experience is required. • It may be that relatively few present-day public company audit committee members would meet this definition CEO and CFO -> Certification of the statements • This is a direct response to the CEO’s saying that I did not know (that my time is spent doing other things) • The corporate establishment supported Congresses assumption that CEO”s should know the business o No one is suggesting that the certification provisions are to be amended /relaxed /or gotten rid of • 7 items that must be certified o Eyes have run across the report o No omission or misstatement o That the report fairly presents the condition of the company (“Fair Presentment”) broader than GAAP -> you need to give investors a fair picture o Certifying officers are responsible for (I have established and maintained appropriate disclosures processes and procedures) SECTION 404 (Widely despised section) (to show that internal controls are adequate) • Requires internal control report o (1) states management's responsibilities for maintaining adequate internal controls and procedures for financial reporting, and o (2) expresses management's conclusions on the effectiveness of the controls and procedures. Further, the company's auditor must attest to and report on management's evaluation of the controls and procedures. The auditor's report is to be included in the Form 10-K as well. Under proposed SEC rules, "internal controls and procedures" are those relating to the preparation of financial statements for external purposes in accordance with GAAP. • This have proved to be very costly for the companies to do • THE BIG PROBLEM IS THE SMALLER COMPANIES PAYING VERY MUCH IN ORDER TO COMPLY • There is a move to relax the requirements of section 404 for smaller companies (currently these requirements have been deferred for 1 year for smaller companies) o Currently if you have 10M in assets + 500 share holders o If you get under 300 shareholders you do not have to apply for any of these requirements (but must take an affirmative action to de register) SECTION 906 -creates a new criminal statute with certification requirements completely independent of those of Section 302 • Knowing violation – 1M and /or prison for 10 years (I know the # are not right /but I did not know I was violating) • Willful Violation – 5M and /or prison for 20 years (I know the #’s are not right /and I did know I was violating) Page 9 of 19 LIABILITY Liabilities Under the 1933 Act Purpose 1. full disclosure of material information to potential investors in newly issued securities and 2. generally preventing fraud and /or misrepresentation in the interstate sale of securities a. Conduct Resulting in Liability i. Improper Disclosure or Violation of § 5 Registration Provisions ii. Liability for Fraud or Misrepresentation in General b. Remedies for Violations i. Private Lawsuits Resulting in 1. Damages -equal to the amount lost by P (not to exceed amount initially paid) 2. Rescission – ii. SEC Lawsuits 1. Cease and Desist Orders (temporary or permanent) 2. Injunctions 3. Criminal Sanctions Persons Liable For Misstatements or Omissions in Registration Statement or Prospectus 1. Every Person who Signs the Registration Statement a. Issuer b. Principal Executive Officers (CEO) c. Principal Financial Officer (CFO) d. Principal Accounting Officer e. A Majority of the Members of the Boar of Directors 2. Every Director – even if did not sign the registration statement 3. Every Person Named “about to become” a director (with their consent) 4. Every “expert” who certifies preparation of registration statement 5. Every UW involved in the distribution 6. Control Persons Elements of P’s Cause of Action 1. Material Misstatements or Omissions – a. matters to which there is a substantial likelihood that a Rx investor would attach importance in deciding whether to purchase the registered security 2. No Reliance Necessary 3. No Causation Necessary Defenses 1. General Affirmative Defense a. Alleged False Statement were actually true b. Misstatements or Omissions were not of material facts c. Plaintiff /Purchaser know of the misleading statements or omissions and invested in the securities anyway d. Statute of Limitations has Run – 1 year after discovery /3 years total after first sold 2. DUE DILIGENCE DEFENSE (STANDARDS OF DUE DILIGENCE) a. EXPERTS i. Actual and reasonable belief that statement was true ii. Requires reasonable investigation into facts, generally performed up to the standards of the profession. b. NONEXPERTS REVIEWING STATEMENTS OF OTHER NONEXPERTS i. Actual and reasonable belief that statement was true ii. General standard: What a prudent person would do in the management of her own affairs. 1. UNDERWRITERS a. Lead underwriter must conduct a reasonable investigation; other underwriters must be satisfied that the lead underwriter made such an investigation. 2. INSIDE DIRECTORS\ MANAGERS a. Virtual guarantors of the accuracy of the registration statement; probably liable no matter how diligent. 3. OUTSIDE DIRECTORS a. Must attend directors' meetings during registration process; read minutes of meeting, registration drafts, etc. c. NONEXPERTS REVIEWING STATEMENTS OF EXPERTS i. No actual belief that statement was false and no reason to believe it was false ii. Generally, nonexperts are entitled to rely on statements of experts, so no investigation is required unless facts show a potential problem. EXAM TIP If an exam question involves a person criminally charged under section 24 of the 1933 Act, remember that it is not a defense that the person did not know that the thing fraudulently sold was a security or that the sale violated the 1933 Act. The defendant need only have intentionally defrauded a victim or made representations without knowing whether they were truthful. Remember also that a willful violation of section 5 (e.g., failure to register offers of securities) can also be a criminal violation. EXAM TIP • Don't let professional pride sway you on your exam. Remember that an accountant is considered an "expert" under rule 11—and so is held to the expert's standard of due diligence. • An attorney who drafts the registration statement is not considered an expert. The difference lies in their jobs: • The accountant certifies that financial statements were prepared in a certain way while the drafting attorney makes no such certification. Express Civil Liabilities • Section 11—liability for misstatements or omissions in registration statement or prospectus Page 10 of 19 • Section 11 imposes liability on designated persons for materially false or misleading statements or omissions in an effective registration statement or prospectus, Persons subject to liability • Every person who signs the registration statement (issuer, principal executive officers, principal financial officer, controller or principal accounting officer, and a majority of the board of directors must sign the statement); • Every director of the issuer; • Every person about to become a director, who consents to being named in the registration statement; • Every "expert" who consents to being named as having prepared or certified part of the registration statement; • Every underwriter involved in the distribution; and • Control persons of the issuer, unless they are without knowledge of the facts on which liability is based. Elements of plaintiff's cause of action • Material misstatements or omissions o Material facts are those to which there is a substantial likelihood that a reasonable investor would attach importance in deciding whether to purchase the security. • Limited reliance requirement o There is no reliance requirement unless the issuer sends out an earnings statement covering the period of one year after the effective date of the registration statement (a person thereafter acquiring some of the registered securities must prove reliance on the misrepresentation or omission to recover). Defenses • General affirmative defenses o 1) The alleged misstatements were true; o 2) The facts misstated or omitted were not material; o 3) Plaintiff knew of the misrepresentations and invested anyway; and o 4) The statute of limitations has run. • Due diligence defenses (SEE ABOVE SECTION) (BAR CHRIS CASE) Section 12(a)(l)— liability for offers or sales in violation of section 5 • Section 12(a)(l) provides that any person who offers or sells a security in violation of any of the provisions of section 5 of the 1933 Act shall be liable to the purchaser for: o (i) the consideration paid (with interest) less the amount of any income received on the securities (i.e., a suit for rescission); or o (ii) for damages if the purchaser no longer owns the security. • Liability for any violation of section 5 o Liability under section 12(a)(l) is absolute for any violation of any provision of section 5. o Such violations include a sale of unregistered securities, failure to deliver the required prospectus, making an illegal offer in the pre-filing period, etc. • (a) Control persons o Persons who "control" any person liable under section 12(a)(l) may be held jointly and severally liable with the controlled person, unless the controlling person had no knowledge of or reasonable grounds to believe in, the existence of the facts on which the liability of the controlled person is alleged to rest. • (b) Participant liability o Section 12(a)(l) imposes liability on those who offer or sell a security in violation of section 5. • Defenses to a section 12(a)(l) cause of action o privity requirement has not been met; (i.e., direct privity of contract between plaintiff-purchaser and the seller-defendant is necessary) o Lack of any violation and o running of the statute of limitations are also defenses. Section 12(a)(2)—general civil liability under the Act It provides that any person • (i) who offers for sale a security by the use of any means of interstate commerce, • (ii) by means of a prospectus or oral communication that contains an untrue statement or omission of material fact, and • (iii) who cannot sustain the burden of proof that he did not know and in the exercise of reasonable care could not have known of such untruth, is liable to the purchaser of such security. o Plaintiff's cause of action (Plaintiff may sue for rescission or damages but in any case must show the following) (i) Sale of a security; (ii) Use of some means of interstate commerce; (iii) Sale by means of an oral communication or prospectus (section 12(a)(2) is applicable only to primary offerings) (iv) An untrue statement or omission of material fact; and\ (v) Plaintiff must plead that defendant knew or, in the exercise of reasonable care, should have known of the untrue statement or omission of material fact. • However, defendant carries the burden of proof on this issue. • Note that plaintiff need not prove reliance on the misrepresentation. • Defenses o (a) Lack of knowledge. Defendant may show that she did not know, and was not negligent in not knowing, of the untrue statement or omission. o (b) Waiver or estoppel (i.e., plaintiff has shown acceptance of defendant's conduct). o (c) Plaintiff knew of the untrue statement. Page 11 of 19 o (d) No privity of contract. o (e) No participation. Most lower courts require the defendant to have been a "participant," o (f) Statute of limitations. o (g) Loss causation (i.e., defendant is not liable for losses caused by something other than defendant's misstatements and/or omissions). Liabilities Under the 1934 Act Civil Liability Under Rule 10b-5 of the 1934 Act Rule 10b-5 • makes it unlawful, in connection with the purchase or sale of any security, for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails, or of any facility of any national securities exchange: o To employ any device, scheme, or artifice to defraud; o To make any untrue statement of a material fact, or to omit to state a material fact necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading; or o To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person. • a "security" must be involved before the rule will apply. Elements of Cause of Action [§906] • Actions by the government o (1) Fraud or deception; o (2) With respect to a material fact; o (3) In connection with the purchase or sale of a security; and o (4) Scienter (i.e., fraudulent intent). • Actions by private plaintiffs [§908] o (1) Fraud or deception; o (2) With respect to a material fact; o (3) In connection with the purchase or sale of a security; and o (4) Scienter (i.e., fraudulent intent). (5) Reliance (i.e., transaction causation); and (6) Loss causation (i.e., deception was a substantial factor in causing theloss). EXAM TIP • Chances are great that rule 10b-5 will be tested on your exam. Be sure to remember the basic cause of action. • The plaintiff must prove: o (i) fraud or deception; o (ii) with respect to a material fact; o (iii) in connection with the purchase or sale of a security; and o (iv) scienter (an intent to defraud). • If the plaintiff is not the goverment, the plaintiff must also prove: o (v) reliance; and o (vi) loss causation. Page 12 of 19 EXEMPTIONS FROM REGISTRATION REQUIREMENTS Exempted Securities [§385] (Note: Such securities may be subject to the general antifraud and civil liability provisions of the Act; see infra.) • Bank and government securities [§386] o Section 3(a)(2) of the 1933 Act exempts from the registration requirements: (i) securities issued or guaranteed by the United States, its territories, or the states themselves; (ii) securities issued or guaranteed by banks; (iii) certain kinds of tax-free industrial revenue bonds; (iv) equity interests in certain trust funds maintained by banks in a fiduciary capacity; and (v) interests in insurance company "separate accounts" that fund pension or profit-sharing plans qualified under the Internal Revenue Code. • Short-term notes and other debt instruments o Notes or drafts arising out of current transactions are exempt if their maturity date does not exceed nine months. • Charitable organizations o Securities issued by religious, educational, or charitable organizations are also exempt from registration. • Savings and loan associations o Securities issued by savings and loan or related institutions are exempt if the issuer is supervised by state and/or federal authorities. • Railroad equipment trusts o Securities issued by common carriers to finance the acquisition of rolling stock are exempt. • Bankruptcy o Likewise, securities issued by a receiver or trustee in bankruptcy with the approval of the court are exempt. • Insurance policies o Finally, insurance, endowment, or annuity policies issued by companies supervised by state agencies are exempt. Exempt Transactions • The exempt securities above can be sold and resold without ever being subject to the section 5 registration requirements. • There are also transaction exemptions that cover only one sale; resales of the same securities might be subject to registration unless the resale is also exempt. o Integration Issuers will attempt to qualify for transaction exemptions to avoid the costs of registration. When an issuer makes several offerings fairly close together and claims that one or more are exempt, the S.E.C. might decide that the several offerings are integrated (i.e., part of a single offering), which often results in a violation of section 5. There are two ways to avoid having several offerings integrated—qualify under the S.E.C.'s general five-factor test, discussed below, or qualify for the specific "safe harbor" provision particular to the transaction ex¬emption being used. o Five-factor test -The S.E.C. will consider the following in determining whether several offerings are integrated: Whether the offerings are part of a single plan of financing; Whether the offerings involve issuance of the same class of security; Whether the offerings are made at about the same time; Whether the same type of consideration is to be received; and Whether the offerings are made for the same general purpose. o Mortgage transactions Certain mortgages initiated by regulated financial institutions and participating interests in the mortgages sold to investors are exempt. Private offering exemption • Whether an offering is exempt under the general language of section 4(2) is a question of fact, considering: o Whether under the circumstances potential purchasers need the protection of the registration provisions (which depends on whether the potential investors are sophisticated and knowledgeable enough to ask the right questions, demand information, and make an intelligent investment decision); o Whether the investor has access to all material investment information; Whether the issuer actually distributed information to the offerees; Whether the offerees are few in number; and Whether the offering looks like a public offering. Small issue exemptions Regulation D • Accredited investor o Regulation D defines several key terms. An "accredited investor" includes entities such as institutional investors, corporations, and partnerships having more than $5 million in assets; natural persons with at least $1 million in net worth or $200,000 annual income, etc. Charity, For Profit Corp, LLC, Partnership (cannot be formed for the purpose of buying the securities in question) (if it has been formed for the purpose -> all members must be accredited investors) • Purchasers o Under regulation D, the term "purchaser" does not include accredited investors. • General conditions to be met o Integration Regulation D provides a safe harbor for all offers and sales that take place at least six months before the start of, or six months after the termination of, the regulation D offering, as long as there are no offers and sales of securities of the same or similar class within either of these six-month periods. o Information requirements Regulation D requires delivery of financial information when securities are sold under rules 505 or 506 (infra) to anyone not an accredited investor. When securities are sold under rule 504 (infra) or only to accredited investors, there is no mandatory disclosure under regulation D. o Manner of the offering General solicitation and general advertising are prohibited in connection with an offering under rule 505 or 506, and also in rule 504 transactions unless compliance with certain state law registration procedures has occurred. • Mass Broadcasting (NOT OK) Page 13 of 19 • Personal Oral /Targeted Mailing (OK) o Limitations on resale Resales of securities issued under most transaction exemptions are restricted. Issuers must exercise reasonable care in determining that purchasers are not underwriters. • Asking Purchases (what there plans are) • Legend (placing a legend on the securities) o Filing of notices of sales The seller must give the S.E.C. notice of the sale within 15 days after the first sale of securities under regulation D. Specific conditions of rules 504, 505, and 506 • Rule 504 o Rule 504 provides an exemption for offers not exceeding $1 million over a 12-month period for companies not registered under the 1934 Act. o 6 months prior /6 months after • Rule 505 o Rule 505 provides an exemption for offers and sales to an unlimited number of accredited investors and to no more than 35 non-accredited purchasers where the aggregate purchase price does not exceed $5 million during any 12-month period. o 6 months prior /6 months after • Rule 506 o Rule 506 provides an exemption for offers and sales to an unlimited number of accredited investors and to no more than 35 non-accredited investors in any dollar amount, but the non-accredited investors must be sohphisticated in financial or business matters or employ a representative who is sophisticated. CLASS NOTES • If you are going to have unaccredited investors then you have to give them information (full disclosure) then you should give your accredited investors the same information to shield yourself from future liability (Accredited Investors v. Corp -> Fraud COA) o What Kind of Information do you have to give Non Financial Information -The same kind of information that is required in a publicly filed registration statement The financial information – the larger the offering the more complete the financial information • Solicitation and Advertising – limitation on the manner of offering o No broadcasting advertising (what they want is oral solicitation, and targeting mailings) • The Shares must come to rest – they must not be purchased with the intent of re-sale o Limitation on re-sale o Future sales must be registered or exempt Intrastate offering exemption Securities offered and sold only to persons residing within a single state, by an issuer that is also a resident of and doing business in that state, are exempt from registration under section 5. • Requirements for statutory intrastate offering exemption—section 3(a)(ll) o Under section 3(a)(ll), the entire issue must be intrastate, and resales to nonresidents can destroy the exemption unless the offering has "come to rest" (the point at which the securities are purchased with the intention of keeping them for investment). o Note that the issuer, offerees, and purchasers must all reside in the same state. • Rule 147 criteria for intrastate offering exemption -Rule 147 provides the following, objective criteria for determining what is exempt under section 3(a)(ll). o Integration of offerings Rule 147 provides that transactions covered by section 3 exemptions or by the section 4(2) exemption, and which occur either six months or more before or at least six months after the rule 147 transaction will not be integrated with the intrastate offering as long as there are no offers or sales of the same or similar class of securities during either of these six-month periods. o Requirement of coming to rest Rule 147 provides an objective standard for the "coming to rest" test. • No sales can be made to persons residing outside the state of issue during the time the securities are being offered and sold by the issuer and for an additional nine months following the last sale by the issuer. • Moreover, the issuer must o (i) place a legend on each securities certificate that the securities are not registered and are subject to rule 147's "coming to rest" provisions, o (ii) issue instructions to its transfer agent prohibiting the transfer of the securities until they have "come to rest," and o (iii) obtain a written representation from each purchaser as to the purchaser's residence. o Requirement of residence Issuers • Issuers must both reside in and be doing business in a state. To be doing business in a state, the issuer must derive 80% of its gross revenues from business within the state, have at least 80% of its assets within the state, use at least 80% of the proceeds from the securities transaction in question in the state, and have its principal office within the state. o Offerees and purchasers Corporations and business organizations are deemed to be residents of the state in which their principal business office is located. "Restricted securities" • Rule 144 defines "restricted securities" to include o (i) privately offered securities acquired from an issuer or control person; o (ii) securities issued pursuant to rules 505 or 506, or to rule 701(c) (employee benefit plans); o (iii) securities sold under rule 144A (infra); and o (iv) other securities not previously offered to the public. • Sales by control persons o Rule 144 states when and how many securities a control person may sell without making those who purchase and resell "underwriters." o The rule applies to both restricted and nonrestricted securities held by control persons. Page 14 of 19 Requirements of rule 144 • The limitations of rule 144 do not apply to sales by persons who are not affiliates of the issuer and have not been so for the last three months, and who have held the securities for at least two years. • For all other sales of restricted securities, or sales by affiliates of the issuer, the following requirements must be met: o Adequate public information about the issuer Such information must be available to the public at the time of sale. o One-year holding period for restricted securities The restricted securities cannot be resold until one year after they were acquired, and this period is tolled until the initial buyer has fully paid for the securities. o Limitation on amount of securities sold (AKA ORDINARY TRADING TRANSACTIONS) During any three-month period, the volume of restricted securities, and securities held by control persons, that can be sold may not exceed the greater of: • (i) 1% of the shares of the outstanding class, • (ii) if the security is traded on an exchange, the average weekly reported volume of the security on all exchanges and/or automated securities quotations systems for the four weeks prior to the filing of a notice of sale, and • (iii) the average weekly reported volume of trading in the securities reported through the consolidated transaction reporting system during the four weeks prior to filing the notice of sale. • Limitation on manner of sale o Sales made under rule 144 must be made directly with a "market-maker" (infra) or in "broker's transactions." • Notice of intent to sell o A seller who intends to sell more than 500 shares or any number of shares for more than $10,000 must file a notice of intention with the S.E.C. • Nonexclusive rule o Rule 144 is not exclusive; sales may be made pursuant to a registration statement, another exemption, or regulation A. • IF YOU MEET THE REQUIREMENTS OF 144 THEN IT IS A SAFE HARBOR AND THE BROKER IS NOT CONSIDERED AN UW AND THE SALE OF SHARES WILL NOT VIOLATE THE REGISTRATION REQUIREMENT Restrictions on resale of securities issued in transaction exemptions • A distribution is complete only when the securities finally come to rest in the hands of those investors who intend to hold them for a substantial period of time. • A person who purchases securities from an issuer with a view toward reselling to the public is an underwriter, and if such a sale actually takes place without registration, there is a violation of the registration requirements. • Thus, the intent of the original purchaser is key to whether a violation has occurred. • Control persons are considered issuers. o Traditional factors showing investment intent Whether an original purchaser bought for investment or distribution is a question of fact. The following factors are usually considered: • Whether the original purchasers gave the issuer a letter indicating that it is buying for investment purposes rather than resale; • The length of time the original purchaser holds the securities; and • Whether the securities certificate includes a legend that the certificates cannot be transferred without the issuer's permission. o Proof of investment intent—rule 144 Rule 144 specifies objective criteria that establish investment intent. If these factors are met, purchasers may resell "restricted securities." Scope of rule 144 • “Restricted securities” o Rule 144 defines "restricted securities" to include (i) privately offered securities acquired from an issuer or control person; (ii) securities issued pursuant to rules 505 or 506, or to rule 701 (c) (employee benefit plans); (iii) securities sold under rule 144A (infra); and (iv) other securities not previously offered to the public. • Sales by control persons o Rule 144 states when and how many securities a control person may sell without making those who purchase and resell "underwriters." The rule applies to both restricted and non-restricted securities held by control persons. SECTION 4(2) PRIVATE OFFERING CONSIDERATIONS IN DETERMINING WHETHER THE PRIVATE OFFERING EXEMPTION APPLIES, CONSIDER THE FOLLOWING: • Need for protection of the 1933 Act o (if the offerees are sophisticated in investing, the exemption is more likely to apply). • Access to information o (if the offerees had a close relationship with the issuer, or the issuer gave the offerees the same type of information that would be contained in a registration statement, the exemption is more likely to apply). • Number of offerees o (if there are many offerees, the offering will likely be deemed public and not exempt regardless of any other factor). • Absence of resales o (if the securities are resold within a short time, the exemption can be destroyed). • Other factors that make the offering look "public" o (e.g., if the offering involves millions of dollars, o the securities are readily marketable, o the offerees are a diverse group, or o the offering is made through public advertising, the offering will likely be considered public and the exemption will not apply) Page 15 of 19 REGULATION D EXEMPTIONS—A SUMMARY RULE 504 RULE 505 RULE 506 When is Disclosure Required When required by state law When sales made to unaccredited investors When sales made to unaccredited investors Is General Solicitation Permitted Generally No, except in some circumstance where state law is followed NO NO Are Re sales Limited Yes, except in some circumstances where state law is followed YES YES Are there Price Limitations YES – 1M during any 12 month period YES – 5M during any 12 month period NO Are there limitations on the number of buyers NO YES – no more than 35 unaccredited buyers…unlimited accredited buyers YES – no more than 35 unaccredited buyers (who must be sophisticated in financial matters; any number of accredited buyers KEY POINTS OF RULE 147—A SUMMARY INTEGRATION SAFE HARBOR o Sales of other securities are ignored if they occur six months or more before or after the rule 147 offering. COMING TO REST o Securities will be deemed to have come to rest within a state if no sales are made to nonresidents during the time the securities are being issued or within nine months after the last sale by the issuer. TRIPLE 80% PLUS PRINCIPAL OFFICE TEST o An issuer will be considered to be doing business in a state if its principal office is in the state and: o At least 80% of its gross revenues are derived from business in the state; and o At least 80% of its assets are held in the state; and o At least 80% of the proceeds from issuance of the securities are used in the state. RESIDENCE o Under rule 147, an individual's residence is determined objectively, by the location of the individual's primary residence, rather than by the individual's domicile, which is determined by subjective intent. CHECKLIST OF RULE 144 REQUIREMENTS UNDER RULE 144 -PURCHASERS MAY RESELL THEIR SECURITIES WITHOUT VIOLATING THE 1933 ACT, IF THE FOLLOWING CRITERIA ARE SATISFIED: • NOT BEEN A CONTROL PERSON o Is the sale by a person who has not been a control person for the last three months, and o who has held the securities for at least two years? If so, the securities may be freely resold. If not, the remaining issues should be checked. • PUBLIC HAVE ADEQUATE INFORMATION o Does the public have adequate information about the issuer, either through reports filed under the 1934 Act or from voluntary disclosure? • SECURITIES ARE RESTRICTED o If the securities are restricted, have they been held for at least one year since they were acquired from the issuer and fully paid for? • VOLUME LIMITATIONS o Have sales subject to rule 144 by any one person exceeded the following volume limitations over any three-month period? 1% of the shares of the outstanding class of securities in question. The average weekly trading volume for the security, if traded on a national exchange or in NASDAQ, for the four weeks prior to filing a notice of sale. The average weekly trading volume for the security reported through the consolidated transaction reporting system contemplated by rule HAa3-l of the 1934 Act. • MANNER OF SALE o Is the manner of the sale (by broker or market maker) proper (the seller generally may not solicit orders or pay a commission to anyone other than the broker, or the broker may not do more than execute the sale for the customary commission or solicit orders to buy, and must make reasonable inquiry to ensure that the seller has the right to sell without registering)? • NOTICE OF INTENTION TO SELL o If the seller intends to sell more than 500 shares or any number of shares for more than $10,000, has a notice of intention to sell been filed with the S.E.C.? § 4(2) Exemption SEC v. Ralston Purina Co CASE • Action to enjoin the unregistered offerings of stock under the SEC act of 1933 FACTS • Ralston Purina (D) offered treasury stock to their key employees which the SEC attempted to enjoin RULE • The exemption in § 4(2) of the SEC act of 1933 which exempts transactions by an issuer not involving any public offering form the registration requirements, applies only when all the offerees have access to the same kind of information that the Act would make available if registration was required • Does this class of offerees need the “full disclosure” that one would get under the 33 Act. • Can these investors “fend for themselves” ISSUE Page 16 of 19 • Does an offer of stock by a company to a limited number of its employees automatically qualify for the exemption for transaction not involving any public offering (NO) Private Placement “Private Offering” Doran v. Petroleum Management Corp CASE • Appeal of dismissal of action to rescind the sale of securities SUMMARY • Doran (P) sole purchaser in a securities offering sought rescission for violation of registration requirements, despite his status as a sophisticated investors RULE • That the sole investor in an offering was a sophisticated investor will not in itself relieve the offeror of registration requirements ISSUE • Will the fact that the sole investor in an offering was a sophisticated investor in itself relieve the offeror of registration requirements (NO) ANALYSIS • § 4(2) “private offering” exception (Four Factors) o The number of offerees & the relationship to each other (most important element) their sophistication + their access to the relevant information Can these investors “fend for themselves” o The number of units offered o The size of the offer o Manner of the offering • Having just one offeree not be able to “fend for themselves” (sophistication + access to information) -> you have a public offerings Reg D • Reg D Rule 506 -> give objective criteria in order to allow business to have certainty in private placement offerings • Even if you fail upon Reg D Rule 506 • You can still fall back upon case law Limited Offerings Exemptions (Reg D) • 3 Exemption Rules under Reg D o 504 Limited in terms of $ amount Cannot exceed $1M 6 months prior and 6 months after o 505 Limited in terms of $ amount Limited to $5M NO Accredited Investors Required o 506 (we will focus on) Not limited in $ amount Limitations of Re-Sales (imposed by rule 144) • Stock acquired in 504, 505, 506, must be held for 1 year before it may be re-sold “publicly” • Issuers must advise purchaser of re-sale restrictions EXAM TIP • You are very likely to see an exam question involving exemptions from 1933 Act registration. Be familiar with the rather short list of securities that are exempt from registration. o (i) bank and government securities, o (ii) notes and drafts maturing in less than nine months, o (iii) securities of charitable organizations, o (iv) securities of savings and loans organizations regulated by state and/or federal authorities, o (v) securities issued by common carriers to finance the purchase of rolling stock, o (vi) securities issued by a receiver or trustee in bankruptcy with court approval, and o (vii) insurance, endowment, and annuity policies issued by state-supervised agencies. • Transactions in all other securities must be registered unless the transaction qualifies for an exemption (see below). § 3a(11) • Any security that is part of an issue • Offering and Selling to resident of a state where a corp is incorporate and doing business in (§ 3a(11) = intrastate exemption • POLICY • 4 CONCEPTS IN §3(a)(11) o TRANSACTION CONCEPT – Intrastate Exemption (transactional exemptions) (not a security exemption = not magic securities) (i.e. future sales of securities must be registered or exempt) o ISSUE CONCEPT – ALL transactions of that issue must be intrastate (i.e. any interstate transaction will destroy the exemption for all of the sales) o INTEGRATION ISSUE – private placement followed by a public offering o COMING TO REST – the purchasers state of mind must be that they plan to hold the securities for an indefinite amount of time o DOING BUSINESS CONCEPT -Page 17 of 19 HYPO • CA Corp -> 10M to CA residents (intrastate) • The day after • CA Corp -> 4(2) Rule 506 -> NV Residents (accredited investor) o They would both be exempt if they are considered to offerings • IF THEY ARE CONSIDERED ONE ISSUANCE IT SCREWS UP BOTH OFFERINGS SEC V. MCDONALD INVESTMENTS • FACTS o Incorporation in Minnesota o Office in Minnesota o Selling Debentures -> Yes securities b/c the residents are buying them for investment purposes o Then the Minnesota company loans the money out to out of state residents (i.e. 100% of the proceeds are used out of state • ISSUE o Does this transaction (the offer and sale of these notes) qualify for exemption under 3(a)(11) – the COURT HOLDS THAT IT DOES NOT • RULE • ANALYSIS o This company is not doing substantial business in the state of Minnosota o Local Companies, Local Activities, • RULE o In order to qualify for the intrastate exemption of § 3(a)(11), • the issuer must offer and sell securities to residents of one state, of which the issuer is also a resident, and • the issuer must conduct predominant amount of its income producing business in that state CHAPMAN V. DUNN • FACTS • RULE o Selling intrastate securities (only to intrastate residents) & o A predominate amount of business within that state (not all business) & o This business must be the one financed by the offering SEC v. Chinese Consolidated Benevolent • RULE o An association is an UW when it solicits funds for the purchase or unregistered securities (whether or not it is authorized to do so by the issuer) and no compensation is received for its activities • ANALYSIS o A Group or individual who used interstate commerce to solicit purchase of unregistered securities is violation the SEC Act of 1933 SEC v. Guild Films Co • RULE o A bank cannot sell unregistered stock pledged to secure a loan since it does not fall within the exception in § 4(1) of the securities Act of 1933 o A bank which accepts unregistered securities as collateral for a loan is an underwriter when it later attempts to sell these securities • CLOSING THE LOOPHOLE o This case stands in order to close the loophole in the Act that would be a way for issuers to avoid registration • NOTE – o Guild would not apply to non issuer transactions. If Roach hand not held a controlling interest in any of the companies involved the bank would probably have not been deemed an UW. It could have then sold the unregistered shares (the sale would have been between private parties which would be exempt IN RE IRA HAUPT & CO • CASE o Dividends in Whiskey….Sell shares and every quarter and half tick • RULE o Any transaction by an underwriter executed over the Exchange in connection with a distribution for a controlling stockholder is subject to the registration and prospectus requirements of the SEC Act • NOTE o Although this case literally satisfies § 4(2) which provides an exception to § 5 (a) the court still held that this was a distribution and therefore was not exempted and did violated § 5 (a) o Brokers Exemption Executed in accordance with a customer’s requires (not first solicited by the broker The purchasers are not first solicited by the broker o Mere Trading v. Distribution U.S. V. WOLFSON • RULE o Controlling shareholders who utilize brokers to effect the sale of unregistered shares are in violation of the Securities Act Page 18 of 19 REVIEW CLASS (REVIEW PLUS PROBLEM 2 OF THE FINAL EXAM) SECTION 5 RULES + PICKING UP THE NEW RULE PREFILING • NO OFFERS • NO SALES • EXCEPTIONS o NEGOTIATIONS BETWEEN I & UW PERMITTED (+ UW & UW) o BASIC COMMUNITATION (UW MAY NOT BE NAMED • NEW RULES o 163A – Any communication by issuer prior to 30 days will not be taken into account (30 day safe harbor) o Communicated (super seed 5180) that said you can do product advertising 168 – for reporting issuers (34’ act) • They can communicate Factual + Forward Looking • By the Issuer NOT the UW 169 – for non reporting companies (private) (IPO situation) • They can report factual business information + product advertising • By the Issuer NOT the UW NEITHER – can release information about the offer o RESEARCH REPORTS 137 – (applies to BOTH Reporting and Non Reporting Companies) Brokers research report is OK as long as not participating in the offer 138 – (ONLY to Reporting Comnpany)Brokers research report is OK even if participating in the offer but must relate to a class of security not being offered • (I.E. company has both C.S. and Pref. Stock – then if the report is about the Pref. Stock and the offering is for Commons Stock 139 – Broker reports on large reporting companies – Is OK (DON’T WORRY ABOUT THE DISTINCTION BETWEEN 138 /139 FOR EXAM WAITING PERIOD • CAN MAKE OFFERS (solicits for interest) • BUT CANNOT MAKE SALES (NO EXECUTORY CONTRACTS) (i.e. cannot have agreements to buy or sell) • 5 types before the new Rules o Oral offers o Preliminary Prospectuses (aka 10b Prospectuses) o Tombstone Ads (very basic information about the offer) o Identifying Statement – you can name the UW and list some information about the company (new rule 134) o Preliminary Summary Prospectus (is a preliminary prospectus filed by an already reporting company • Before DEC 1 – no free prospectus allowed • NEW RULES o 164 (a) – a free writing prospectus will be deemed as a preliminary prospectus (if it meets the requirements of (§433) 405 – Written communication (radio, TV, graphic communication) o WKSI – may use free writing prospectus NOT accompanied by anything o Other issuers – the free writing prospectus must be accompanied by the Preliminary Prospectus o Information in the FWP – cannot conflict with the registration statement & must have a ledgend (you cannot accept this offer and can only be purchased o FWP must be filed with the SEC no later than the date of first use o For IPO’s – cannot conflict with information, ledgend, filed with the SEC o Road Shows – live road shows are not FWP -> it is an oral offer (and the person making the pitch can have charts and graphs as long as there is no take away Recorded Road Shows – are FWP but do not need to be filed with the SEC on the first Date of use *UNLESS IT IS AN IPO (however even if an IPO if there is unrestricted access to the Road Show – do not need to be filed o Hyperlinked = FWP and must meet the filing requirements o Historical Information o Media IPOS – is when you give an interview to somebody and they publish it (before that was prohibited (GOOGLE), however now it is a FWP but does not need to be a filed with the SEC, however cannot be inconsited with the registration statement and does not need to be filed + prior or contemporaneous delivery of preliminary prospectus No payment for the interview Must file with the SEC upon 4 days after the publication POST EFFECTIVE PERIOD • OFFERS AND SALES MAY BE MADE • OLD Rules – Final Prospectus must be delivered prior /contemporaneous • NEW RULE o 172 Conformations no longer need to be preeced or accompanied by final prospecutes IF • Effective Registration Statement • Filed Final Prospecutus with the SEC o 173 Access = Delivery In a transaction where a final prospecuts needs to be delievered prior or contemporaneous • You need to delivery final prospecuts or • Notice that this sale was made pursuant to effective registration statement Purchaser may request a final prospectus if requested Page 19 of 19 o 174 90 /40 /25 /0 Days after to deliver Final Prospecuts Delivery o NOTE – if a purchaser demands a final prospectus (than it can be electronic (or) preliminary prospectus + term sheet Question 2 • 5 Scenarios – Issue • Is this a security • + tell me about the remedies available (if it is a security) -> section 5 will be violated and there will be remedies o Incorporated by Reference (2a , 2b, 2c) • You have an offer to sell in the WSJ – you know right there that is a public offering (thus no REG D right away) • There is an offer to sell these general partnership interest • Then a specific presentation made to a law firm • HOWEY o Investment of Money in a Common Enterprise You have both vertical and strict commonality Expectation of profits Issue = solely from the efforts of a 3rd party (Williamson v. Tuker) • General Partnership interests are not securities b/c all partners can bind the corporation • Latent Investor control = still equals the power to control • EXCEPTION – where GP can be securities o Irrevocable delegation of power o Incapable of exercising the power b/c lack of sohphsitication o If too old or too young o So dependant on the promoters expertise that no lay person could know (i.e. technology /black box) o Assuming it is a security is it exempt from registration PROBABLY NOT – B/C NO INFORMATION /B/C CANNOT BE EXPECTED TO BE SOPHISTICATED IN FINANCIAL MATTER (B/C PURINA) PLUS B/C PUBLIC OFFERING IN THE WSJ -> no Reg D exemption + they do not meet the Accredited Investor Threshold o 12a 1REMEDIES Recession Rights b/c not registered even if no fraud o You may in fact have right to recover damages b/c material omission and misstatements Power to run the Business Power of the LP can • B/c LP have no right to run the business -> viewed as a security • EXCEPTIONS o UNLESS THEY HAD THE RIGHT TO RUN THE BUSINESS (NO B/C ONLY VETO BUSINESS PLAN) o IF THEY HAD THE RIGHT TO FORCE HIM OUT (NOT HERE B/C THEY HAVE TO BUY HIM OUT AT A PREMIUM /BUT IF THEY COULD BUY HIM OUT AT A DISCOUNT -> THEN THEY SHOW CONTROL • It is doubtful that the LP have control over the promoter and most likely that they are securities o NOT REGISTERED UNDER SEC Interested in an LLC • Discuss the Common Enterprise Factor • Discuss the Solely from the Efforts of others – probably the same analysis as howey (property + service contact) D except Hooten ownes all the stock of the corporation • Sells all the stock • Then paid a consulting fee • DOES THE OFFER AND SALE OF STOCK CONSTITUTE A SECURITY – YES • IS IT EXEMPTED FROM § 5 (this is a non issuer transaction) I -> H -> S&L o If Hooton was buying the stock for resale then he will be an underwriter o If Hooten held the stock for 50 years -> he is neither an issuer dealer of UW for section o However you do not know how long you need to hold the stock o If the Sale is to S&L a distribution Q – would it be a distribution even if held for 50 years Q – what about the LLC Give a NOTE • REEVES V. ERNST YOUNG o A note is presumed to be a security may be rebutted if to the family of commercial notes (7 types) o If you can’t find it listed in the family of 7 then you use the 4 factors to see if it resembles a commercial note Commercial Note – is not an Security Investment Note – is a Security • Here this is an unsecured note – to be paid out of farm proceeds, and the note is a ST note o Motivation – raising money for business enterprise o S & L – is a good return (10%) o Plan of Distribution – WSJ for Stock, however this was for the note not the stock o Resonable Expectation of the Public (will the SEC come to our rescue) o Any other Regulatory Scheme • Here the presumption was probably not rebutted