Law School Outlines - Securities_Regulation

1I. Definition of a Security A. §2A of the ‟33 Act enumerates: 1. Stocks, bonds, voting trusts, certificates of deposits, investment contracts, and anything commonly known as a security B. Is it specifically set forth in the statute? 1. Stocks a. Word doesn‟t necessarily mean it is a stock, look at the characteristics: i. Does it pay dividends? ii. Is it negotiable? iii. Does it confer voting rights? b. It is the quintessential security. i. It is a rebuttable presumption that a stock is a security 2. Notes a. Family Resemblance Test i. 4 Factor Test, presume it is a securities, but look at: A. Motivation of the Issuer – was the note sold in an effort to raise money/profits B. Plan/Type of distribution – common trading? C. Was there a reasonable expectation of profit? D. Are there any risk restrictions – are they risky on the face (ie, no collateral); are they risky b/c there‟s no gov‟t regulation? ii. Nine Month Maturity test no longer applies C. Non-Enumerated 1. Is it an Investment Contract? a. Investment contracts are securities and are therefore subject to securities laws and require disclosure b. If it is an investment contract, and none of the „33/‟34 Act requirements were met, purchasers may rescind the contract 2. Howie Test a. Look at the economic reality of the situation to decide if something is/isn‟t a security b. “Context clause”  the definition of security allows for flexibility 3. Four Factors of Howie Test [TOTALITY OF CIRCUMSTANCES] a. Is it a scheme w/ an underlying investment purpose? i. Is the purchase primarily for an investment or is it for consumption? b. Is there a common enterprise? [cts are outcome determinative] i. Horizontal Commonality: A. Is there a pooling of investors funds, issuing (usually) a pro rata distribution of money? ii. Vertical Commonality (broad test) [both rely on promoter‟s expertise] A. Is there a Connection b/w the efforts of the promoter and the collective investors‟ successes? iii. Vertical Commonality (strict test) A. Is there a DIRECT relationship b/w promoter‟s success and investors‟ success? iv. It is possible to have an investment contract w/ only one investor, if the promoter is doing all the work, and all other factors are met, it just depends on the jurisdiction you‟re in c. Is there a legitimate expectation of profits? i. Basically a question of intent. ii. Either by way of additional $ or by a reduction of expenses. d. Are the profits expected based solely on the efforts of others? i. Solely = Primarily ii. Is the investor a passive investor? 2 iii. Investor‟s conduct is key – The promoter must retain control over the essential managerial conduct of the enterprise 4. Typical Investment Contracts, must meet req‟ts of Howie Test a. Real Property i. Ex: condo-swapping b. Pyramid/Ponsie schemes c. Pension Plans d. General Partnership arrangements – have problems fulfilling the fourth prong, so you need to apply the Williamson Test i. Old school thinking: GP is not a security; LP is a security 5. Williamson Test tests to see if General Partnership is an investment contract, EITHER/OR TEST: a. Does the partner lack legal control? b. Does the partner lack specific knowledge of the subject or lack expertise? (Does partner have to rely on knowledge of an expert?) c. Does partner lack practical control over the situation (is he just a silent partner? Does he depend on the promoter totally?) i. Remember  apply first three prongs of Howie, first 6. Hybrids a. Mortgages i. Not securities b. Co-Op Notes i. See Reves v. Ernst & Young ii. Could be, see Family Resemblance Test c. LLCs i. The line is getting blurrier w/ partnerships, so depending on the structure, an LLC may be an investment contract II. Other Definitions A. Federal Securities Laws 1. ‟33 Act (Securities Act) 3 a. Regulates offers/sales of securities 2. ‟34 Act (Exchange Act) a. Includes Anti-fraud provisions, margin trading, etc b. Creates the SEC 3. The „40s Acts a. Investment Company Act of 1940 b. Investment Advisor Act of 1940 B. Speculation 1. Buying something w/ little money now, in hope that it will return lots of money later a. Ponsie schemes 2. Not necessarily a bad thing C. Margin Trading 1. Put down some money on stock, while a bank loans the rest of it, hoping that the price will go up, so that you can pay off the loan and still make a profit. Problem occurs when banks start issuing margin calls, if the market goes down, and a lot of investors lose their shirts 2. Also not necessarily a bad thing D. Pump and Dump Schemes 1. You start a corporation and issue stock to your self, then start getting people you know to buy at an inflated price so that others will see the price rising and buy in E. Issuer Transactions 1. Primary transactions a. Corporation is selling stocks to investors F. Secondary Transactions 1. Sales of stocks among investors 2. Traded on Exchanges and OTC markets a. OTC  NASDAQ G. Blue Sky Laws 1. State Securities Laws 4 a. Older than SEC b. Most are based on a merit system? III. Disclosure Requirements (See Flow Chart) A. When is there a duty to disclose? [remember, materiality does not always necessarily demand disclosure] 1. Specific Set requirements (e.g.: line item disclosures) a. Disclosure documents for the SEC i. E.g.: Form S1, or a 10k ii. Reg SK defines what forms, when, and to whom are required to be filed 2. Any further information necessary to make sure the information given is not materially misleading a. Very subjective, can include cautionary language. 3. Anti-fraud provisions a. SEC requires complete honesty if you speak in connection w/ certain securities transactions (best bet – keep your mouth shut, or say “no comment”) b. No material misstatements/omissions regarding security transactions 4. To the extent you have no duty to disclose (as triggered by the preceding three duties), there is no action for staying silent a. If you do disclose, it must be FULL and FAIR 5. Who is a reasonable investor? a. Typical investor of average sophistication and wealth i. TSC Industry standard B. Burial Fact Doctrine 1. You can‟t bury information in a ton of junk a. Materiality can depend on the context of the disclosure C. “Bespeaks Caution Doctrine” 5 1. A possibly material misstatement, when placed in context of legitimate specific cautionary warnings, is not actionable (esp. in regards to forward looking statements) 2. Kaufman v. Trump‟s Castle a. Cautionary statements must be specific – can‟t be plain boilerplate warning D. “Truth on the Market” Defense 1. If a misstatement is in the context of widely known public facts, then the courts are reluctant to find liability a. Wielgos v. Commonwealth Edison Co. i. It was publicly known that there is great risk in the nuclear business, so the fact that the corporation didn‟t disclose it didn‟t trigger liability ii. This encourages investors to be a little more sophisticated w/ their monetary decisions iii. Also it supports the idea that courts find different degrees of lying. A. Soft Lies  forward looking information 1. More subjective B. Hard Lies  historical information 1. Bright line test (truth or not) E. Contingent Factors and Materiality 1. Basic Inc. v. Levinson a. At what point during merger discussions does the merger become material? 2. Probability and Magnitude Test [Very fact specific] a. Look to the factors of probability that the contingent event actually will/will not occur b. Look at the “anticipated magnitude” of the event in light of the total corporate activity. 6 3. When a corporation is questioned by the media regarding contingent events, the SEC expects “No Comment” from the corporation a. There isn‟t a duty to disclose, but if they deny the accusation, then they are lying b. Problem: No comment is equivalent to affirmation F. Forward Looking Information 1. A type of opinion that should be verifiable by underlying fact a. Future Projections based on facts and assumptions b. If you can‟t determine the outcome or verify the statement then it is a forward looking statement (Harris v. Ivax Corp.) 2. Rule 175: Limited Safe Harbor Provisions a. Forward looking statements are not actionable, so long as they are made based on facts, good faith and reasonable belief b. Is it verifiable and did the speaker believe it to be true? 3. The SEC currently requires certain forward looking projections a. Ex: Item 303, Reg. S-K, MD&As 4. Other than those required by the SEC, why do corporations make these statements at all? a. They are still trying to sell a product, and want to show their potential G. Safe Harbor Provisions of the 1995 Act [Either/Or:] 1. Identify the statement as forward looking and accompany it w/ cautionary statements 2. P must prove that the company made the statement knowing it was false 3. The Defendant must prove it is immaterial. a. This SH does not cover IPOs, Tender Offers REMEMBER, ALWAYS ASK IF IT IS MATERIAL! Yes Actionable Omission? Duty to Disclose? No Not actionable 7 Flow Chart for Material Misstatements “Actual” Opinion “Verifiable and Willful?” Not actionable Not actionable Historical Look at Context of Disclosure: Cautionary Language Truth on the Market Buried in Facts Boiler Plate Not Actionable Actionable Contingent Facts Probability and Magnitude Test Is it probable that the contingent event will occur? What is the anticipated Magnitude of the event in light of the corp‟s total activity? Forward Looking Statements Safe Harbor Provisions (doesn‟t apply to IPOs, or tender offers Cautionary Language? Not actionable P. proved D knew it was false D Proves it was Not Material Actionable 8 Not Actionable IV. Underwriters A. What is an Underwriter? 1. Financial intermediaries, who purchase stock from issuer to sell to the public B. Two methods of selling: 1. Best Efforts a. Brokers who don‟t purchase the stocks in advance, just use their best efforts to obtain buyers for the stocks b. Chinese Consolidated Case c. Actions of agent were necessary to the distribution of the securities and that is required to establish classification of an underwriter 2. Firm Commitment a. Brokers buy certain amount of stocks in advance, which they must sell C. Liability for Underwriters 1. Can be curbed by different provisions a. Generally, indemnification, market-out clauses, comfort letters, or contribution clauses i. Underwriters have same 10b5 liability as issuers D. Pricing 1. Spreads a. Corporation sells stock to an underwriter for a discount, underwriter sells at a higher price – difference is the spread b. Distributed b/w manager, underwriters and sell group E. Market Out Clause 1. Underwriting Agreements: a. Issuer and Underwriter enter into underwriting agreement which isn‟t signed until just before selling occurs, therefore the underwriters aren‟t technically legally bound by anything except for their letter of intent 9 2. Allows Underwriter s to get our of deals even after it begins depending on: a. Nat‟l calamities; material changes in issuer; material changes in Underwriters; gov‟t restrictions 3. It is considered very poor form to exercise this right. F. Stabilization 1. Ability of Underwriter to step in and try to stabilize the price of a stock a. Usually done when stock price starts dropping right after an offering – the underwriter will start purchasing the stock at the initial price to try and keep the market up. G. Over-allotment provisions 1. Underwriter has the ability to issue more shares than originally contracted – “green shoes” H. Valuation 1. Underwriter sells low then buys so they can resell at a much higher price 2. Sometimes done for greater profits, other times it‟s done to prevent stabilization problems and to keep the sale from going bad. V. Registration Processes A. Prospectus 1. Goes out to all investors a. Should be in laymen‟s terms 2. Needs to contain information regarding the corporation‟s status and history (see 10k, 10q) and information regarding specific transactions (such as IPOs)(see ‟33 Act) B. Integrated Disclosure 1. If you have ‟34 Act information already on file, you just need to refer to it w/in your ‟33 Act documents 2. Allows different corporations to file more easily/efficiently according to their status. 3. Types of Integrated Disclosure Forms 10 a. S1 Form i. Corporations who have never had an IPO, but who have filed 10k (under ‟34 Act) for 3 years or less ii. Must include ALL information, including that information already in ‟34 Act documents b. S2 Form i. Corporations who have been filing under ‟34 Act for three years of more ii. Can either include a condensed version of the ‟34 Act information or attach a copy of the ‟34 Act registration c. S3 Form i. Corporation must have at least $75million worth of stocks that are outstanding, and must have filed an S form before ii. May refer to all information in ‟34 Act d. S4 Form i. Business mergers/acquisitions e. S8 Form i. Stock issued to employees f. F Form i. Foreign companies 4. All information must be filed in a timely manner C. Shelf Registration (under the ‟33 Act) 1. Only corporations eligible for S3 forms are eligible for shelf registration 2. Allows issuer to register stocks way in advance of when they plan on selling them a. Either b/c it‟s waiting for a profitable time or b/c it just wants to have stocks ready for sale, just in case it needs the money 3. Issuer must make certain to amend the forms regarding any fundamental changes to the corporation 4. Used more for debt offerings than equity 11 D. Pre-Filing Period 1. There are restrictions on sales, offers, and purchases 2. No conditioning of the market 3. No solicitations a. There are safe harbors for press releases E. Waiting Period (post filing, before prospectus is effective) 1. Oral Selling is permitted 2. No written offers, unless in the form of the prospectus 3. No acceptances F. Post-Effective Period 1. Prospectus Delivery is Required a. Issuers/underwriters/some broker/dealers  must deliver G. Violations of Process – Civil Liability and the 33 Act 1. §12(a)(1) Seller‟s Liability, Defect in Registration (Pre-filing) a. Civil Remedy for violations i. Recissionary damages ii. Later cures don‟t prohibit suits b. Must have PRIVITY b/w buyer and (statutory) seller i. Or with someone who solicited on behalf of seller for financial gain c. Strict Liability – NO DEFENSES 2. §11 Registration is Effective a. No reliance or scienter necessary to prove a violation. i. All that‟s needed is a material misrepresentation b. Plaintiff  any purchaser (no privity req‟d) c. Defendant  Can Include Experts d. Defenses: i. For Experts, Due diligence A. They‟re only liable for their portion of expertise. 12 B. Liable unless they prove they had reasonable grounds, that after reasonable investigation, everything was true. ii. Non-Experts, Ignorance can be a defense A. For Expert Portions: no duty to investigate B. Non-Expert Portions: Due Diligence duty iii. Truth is always a defense: A. Proving that Plaintiff knew the truth is always a defense iv. Negative Causation is always a defense/ 3. §12(a)(2) Post Effective – Violation in Solicitations a. Prospectus defects (including oral communications relating to the prospectus) – no need to prove P even saw the prospectus i. Need privity b/w Plaintiff and Defendant ii. Good faith is a defense, but there is a duty to investigate iii. Defesenes: A. Truth, Negative Causation, Immateriality, Good Faith b. Private Placements are NOT covered by §12(a)(2) VI. Transactions Exempt from Registration A. Two types of exemptions 1. Exempt Securities a. Always exempt, by their own nature (includes issuer and purchaser) b. Govt. (also exempt from ‟33 Act anti-fraud requirements); Banks (exempt due to the existence of an adequate regulatory scheme already in place); trust funds; short term notes (that mature w/in 9 months); issuances from Non-profits 2. Exempt transactions a. Party seeking exemption bears burden of proving exemption 13 C. Intra-State Offer Exemption 1. Statutory Exemption -- §3(A)(11) a. All offerings must be within the same state i. Any transaction completely w/in the jurisdiction of one state is exempt from Federal Law ii. Very strict, one out-of-state will break ALL exemptions iii. State‟s securities law apply b. Integration i. All sales must be within the same offering A. Was it part of a single plan? B. Was issuance of the same class of securities? C. Were offerings made at same time (up to 6 month separation permitted)? D. What type of consideration is being given? E. Were offerings made for same general purpose? c. Corporation must be “resident” of the state in which the offer was made and have substantial in-state operations d. Resale i. Stock must come to rest w/in the state A. Was it purchased w/ an intent to invest or sell? ii. Strict Liability iii. Fact intensive inquiry iv. Once corp. proves that it sold to resident, burden shifts to plaintiffs to prove purchasers bought w/ intent to resell v. One invalid resale destroys exemption 2. Safe Harbor – Rule 147 (not completely exclusive) [using safe harbor is preferable over statute] a. Issuance  any security offered in one issuance must be sold to individuals of the same state i. Sales separated by six months won‟t be considered part of the same issuance 14 b. Doing Business in the state (corporation‟s residence) i. Substantial Operational activities w/in the state A. At least 80% of gross revenue must come from the state B. The company‟s principle assets must be in the state ii. Proceeds of offering should generally be used w/in the state A. Look to both intent and actual use of proceeds B. This is the McDonald test C. To the extent that the corporation uses proceeds outside of the state, the exemption doesn‟t stand iii. Incorporated in the state, and residing in the state (PPB) iv. Ask: Can the state‟s securities law regulate that company? A. This is the Chapman test v. Busch/Carpenter Test: To the extent the issuer intends on doing interstate activities, they are NOT exempt c. Purchaser must be a state resident i. Corp. must find out if they are residents, their word isn‟t enough A. Corp. can rely on written representation of purchaser for Safe Harbor ii. Place of domicile, at the time of issuance A. Principle residence must be in state d. Stock must come to rest before resale in the hands of an instate purchaser i. 9 month holding period before resale is permitted ii. Not strict liability under the safe harbor; so long as corporation had a reasonable belief that it wouldn‟t be resold 15 3. Can you engage an underwriter who has an out-of-state office? a. So long as the underwriting is conducted w/in the state. B. Regulation A (mini Registration) 1. Exempts issuances w/ an aggregate offering price not exceeding $5million 2. Must be a Non-reporting company 3. Requires an offering statement and an offering circular a. Allows solicitation of interest before filing the offering statement (in other words, allows corporation to test the waters before issuing stock) 4. If issuer or executive officer or underwriter is convicted of a security law crime or sanctioned under securities laws, no regulation A allowed. a. “Bad Boy Disqualifier” 5. Secondary Offerings (Resales) a. Reg A is available for offerings up to $1.5million C. Private Placement Exemption 1. Statute (4(2)) a. Turns on the type of investor i. Sophisticated  has access to information or is an insider A. With a certain level of sophistication comes the assumption that the investor has a certain amount of bargaining power as well ii. Doran v. Petroleum Mgmt. Sophistication Tests A. Access Test: Person has a position of access. Special relationship w/ issuers allows them to access; expected that they could use the information B. Disclosure Test: Actually provided information to the investor and investor must be able to understand the risks b. Requires a lot of disclosure 16 i. Ralston Purina Case: The availability of 4(2) turns on whether a particular class of persons needs the protection of the act ii. All persons to whom offers are made must be provided w/ or have access to the type of information that would be contained in a registration statement. c. Exemption is lost if an offer/sale is made to any person who lacked the requisite knowledge d. Four factors to determine if it is a public or private offering i. Offeree‟s Relationship to the Issuer A. Knowledge, pre-existing relationship, insiders ii. Size and number of the Units A. A distinction b/w a small number of units in a large chunk (private) v. a large number of units in small chunks (public) iii. Size of the offering A. Small number of offerees and purchasers are req‟d for private placements iv. Manner of offering A. Face to face (private) v. Broad (public) 1. No broad solicitations or distributions 2. Safe Harbor (Regulation D) a. (R. 504) If it‟s a placement for less than $1million, it‟s exempt i. Not allowed for reporting or investing companies ii. No resale limitations b. (Rule 505) Placements for less than $5million i. Restrictions on resale (can‟t sell to underwriters) ii. Prohibitions advertising/soliciting iii. 35 or less non-accredited investors 17 A. Accredited investors: include certain institutional investors as well as financially sophisticated and/or wealthy investors iv. Bad Boy Disqualifier c. (Rule 506) Placements with no Monetary Limitations i. As many accredited investors as you want, after that you must prove sophistication ii. Mark v. FSC Securities A. Written representations re: sophistication of investors satisfies req‟t d. Same integration rules apply as in R. 147 i. Six months to satisfy safe harbor VI. Broker/Dealers A. Who can be a broker/dealer? 1. §15(a)  No person can act as a broker (who buys stock on behalf of another person) or as a dealer (who buys for their own account) w/o registering w/ the SEC a. Most firms are both 2. Can‟t use “Boiler Room Operations” a. Cold selling, high pressure tactics to new customers of a highly speculative security B. Shingle Theory of Broker/Dealer Liability 1. By becoming a broker/dealer, there is a presumption of duty b/w the broker/dealer and the customer C. Recommendations – Know your Security 1. Hanley v. SEC: B/D “overpumped security to clients, and didn‟t bother to investigate the validity of his assertions 2. Can‟t sue for securities fraud  can‟t prove reliance or loss causation 3. B/D is responsible to observe DUE DILLIGENCE D. Suitability – Know your Customer 1. Brown v. E.F. Hutton Group 18 2. Factors of Unsuitability: a. Securities were unsuited to buyer‟s needs b. Defendant knew of unsuitability c. Defendant recommended/purchased security for buyer anyway d. There was a material omission/misrepresentation e. Buyer relied on all of the above 3. Suitability standard must be objective a. Can‟t put too much of a burden on B/D to know everything VIII. Sales on the Secondary Market A. Issuances by Underwriters (not issuers) §4 1. Exempts all transactions except those by an issuer, underwriter or dealer a. Dealer  person who engages in the business of dealing or trading securities i. Subject to §4(3) restrictions ii. Not a dealer if transaction occurs 40 days after offering or 90 days after IPO iii. If you aren‟t required to distribute a prospectus, then you aren‟t a dealer 2. UW‟s need either another exemption or to register securities before reselling a restricted stock, or else issuer‟s exemption is destroyed a. Any affiliate who sells restricted securities from an issuer for their OWN account will NOT be engaged in a distribution (and therefore are not underwriters, and are exempt) i. Restricted: Non-registered, sold through exemptions 3. It is up to the person claiming the exemption to prove it. 4. Impacts 3 types of transactions: a. Sales by non-control persons of restrictive stocks b. Sales by controlling persons (affiliates of issuer) of restrictive stocks c. Sales by controlling persons of non-restrictive stocks through a broker-dealer 19 B. Are you an underwriter (persons who purchase stocks from issuers w/ intent to distribute to the public)? 1. Public distribution – are you selling w/ a plan to distribute? a. Is it a private placement or a public offering (R. 4 ½) i. If it‟s private placement  doesn‟t matter if you are an underwriter or not (b/c it‟s a second exemption) ii. If it‟s for a public offering, then you will be deemed an underwriter b. Is the offer made on behalf of an issuer? i. Chinese Consolidated Case ii. Then you are deemed an underwriter 2. There is a two year holding period before an underwriter may distribute. a. If you sell in less than two years, then you have to rely on the changed circumstances doctrine: 3. What other types of Underwriters are there? a. Control Persons i. Someone who has the ability to direct and manage the policy of the corporation, whether or not they own stock in that corporation ii. Presumption that anyone who has 10% of stock is deemed to be an underwriter iii. U.S. v. Wolfson, Test to determine Control A. Person has ability to use their influence to direct control of the company B. Person has power to get signatures on registration statement iv. Brokers who assist control persons in selling of control person‟s private stock is deemed an underwriter v. Broker Exceptions are pursuant to §4(4) C. Sales on behalf of a Non-Control Person (SH R. 144 applies) 1. One year holding period required 20 2. Small sales test a. Can‟t exceed 1% of outstanding shares from last three months or weekly average of traded stocks in a 4 week period b. Same for affiliates as for non-affiliates 3. Must be done through a broker (No safe harbor w/o a broker) 4. Public information about the issuer must be widely available 5. If you hold for more than two years, then you don‟t have to worry about the other conditions D. Sales on behalf of a Control Person of Restricted Stocks (SH R. 144 applies) 1. One year holding period required 2. Small sales test applies 3. Must be done through a broker 4. Public information about the issuer must be widely available 5. If you hold for more than two years, then you don‟t have to worry about the other conditions E. Sale on behalf of a Control Person of Non-Restricted Stocks (SH R. 144 applies) 1. Must be done through a broker 2. Two year holding period doesn‟t remove the requirements F. Secondary Trading and Rule 144 1. 6 Principles to Keep in Mind a. You are not deemed engaged in distribution by selling restricted stocks to a Qualified Institutional Buyer (QUIB) b. There are no holding requirements c. Applies to anyone but the issuer d. Can‟t be a security that is traded on a national exchange or NASDAQ e. QUIB must have over $100million in investments i. Banks must have a net worth of at least $25million ii. Brokers must meet a $10million threshold f. Information Must Be Available 21 i. Either the company needs to be a reporting company ii. OR the purchaser must be allowed the right to any requested information prior to the sale 2. Rule 4 ½ a. The exemption permits affiliates to make private sales of securities held by them so long as some of the established criteria for sales under both section 4(1) and 4(2) are satisfied b. Criteria: i. Determination of appropriate standard is §4(2) ii. No advertising or soliciting iii. Limit on number of offerees/purchasers A. See discussion on private v. public offerings iv. Holding period, information available, and level of purchaser‟s sophistication are all also factors G. Overview of Exemptions Who is Issuing the Stock? Issuer Presumed to require registration Exemptions: Intra-state; Private placement; Underwriter Presumed to require registration Need significant Time lapse b/w first sale and resale IX. The „34 Act A. How a corporation becomes subject to the 34 Act: 1. In order to trade securities on a National Exchange or NASDAQ 2. Registering under the 33 Act automatically triggers registration requirement under 34 Act 3. To the extent corporation meets asset/shareholder requirement: a. 500 shareholders or $10million in assets 4. Voluntary registration B. Once subject to Registration: 1. Must submit annual 10k and quarterly 10q reports 22 2. Proxy statements, tender offers, margin trading, etc. are all subject to regulation of 34 Act C. Proxy Fraud and Proxy Solicitation 1. §14A  It is unlawful (in violation of ‟34 Act) to solicit proxies w/o filing a proxy statement a. There is a ban on solicitation prior to filing b. Once a proxy statement is filed, the only ban is on fraud 2. Proxy Statement Requirements: a. For management i. Must give information regarding the corporation, regarding the information to be voted on, and regarding the management of the corporation. b. For Non-Management i. Must give information on the background of those soliciting proxies and on the issue to be voted on 3. What is a solicitation? a. Any act that is part of a continuous plan to gain proxies 4. 1992 Amendments to the Proxy Rules a. §14(a)(1) - §14(a)(16)  Exemptions i. Solicitations by people Not Seeking a proxy ii. Solicitations of LESS than 10 people iii. Solicitations regarding the manner of the vote, NOT asking for a proxy card b. Intent is important c. Those owning more than 10% of shares are NEVER exempt d. If an action is found NOT to be a solicitation, then NONE of the proxy rules apply (including fraud) e. In Exemption cases, since they are still solicitations (that are just exempt), the fraud provisions still apply. 5. Proxy Fraud a. Material Misrepresentation 23 b. You Do NOT Need to Show RELIANCE i. You still need to prove materiality, scienter, transactional causation, and loss causation c. Virginia Bankshares v. Sandberg i. Court held that a material misrepresentation was NOT fraud, b/c it was only to a minority of shareholders (whose votes wouldn‟t change the outcome)  No transactional causation or damages? D. Criminal Liability (excluding 10b5) 1. SEC‟s power: a. SEC can issue injunctions, cease and desist orders, disgorgement actions and civil penalties 2. RICO (Rackateer Influenced and Corrupt Organizations Act) a. Forfeiture Remedy  all property bought w/ improper assets could be seized b. No civil violations of RICO could be brought unless the individual was already convicted of a criminal violation of security fraud. 3. Mail and Wire Fraud Statute a. Must include an interstate transmission E. Secondary Liability 1. Control Persons Under the ‟33 Act a. §15 of ‟33 Act holds (jointly and severally) liable any person who controls a person liable under §11 or 12 “unless the controlling person had no knowledge of or reasonable grounds to believe in the existence of the facts by reason of which the liability of the controlled person is alleged to exist” b. Burden is on the accused (it is an affirmative defense) 2. Control Persons Under the ‟34 Act a. §20 of the ‟34 Act provides that “every person who . . . controls any person liable under any provision of this title shall also be 24 liable jointly and severally w/ and to the same extent as such controlled person to any person to whom such controlled person is liable, UNLESS the controlling person acted in good faith and did not directly or indirectly induce the act or acts constituting the violation” b. Burden of Proof to prove establish good faith is on the accused (it is an affirmative defense) c. State of mind required: More than negligence (at least recklessness – see Hochfelder v. Ernst & Ernst) d. Conspiracy is not a valid action under either act. 3. Who is a Controlling Person? a. Donahue v. COPCO  2 prong test for control i. Was there actual exercise of general control over the operations of the wrong doer? ii. Did the controlling person have the power or ability – even if not exercised – to control the specific transaction? A. Not as definitive as the first prong – in the above, it is the ability to prevent the fraud that is important 4. What is good faith? a. Taking reasonable measures to prevent the fraud i. Preventive measures (precautionary) ii. Were those measures strictly adhered to? 5. What is inducement (see ‟34 Act language) a. For good faith to be proved, you must show that you didn‟t directly/indirectly induce someone to engage in the fraudulent transaction 6. OVERVIEW OF CONTROL PERSON LIABILITY a. Is it a Security? b. If so, is there a Registration Exemption? c. If not, What liability under ‟33 Act? 25 d. Are any statements actionable as Securities Fraud? e. If so, are any criminal? f. Can Y be held liable as a controlling person? F. Aiding and Abetting 1. New aiding and abetting policy is from: Private Securities Litigation Reform Act of 1995, amending §20 of ‟34 Act a. Doesn‟t allow private suits for aiding and abetting 2. Authorizes Injunctive relief and civil monetary actions 3. Rule doesn‟t give specific elements of the violation, use old cases: a. Must have an actual Primary violation i. MAKE SURE YOU FIND A PRIMARY VIOLATION FIRST, BEFORE YOU CAN HAVE ANY SECONDARY VIOLATIONS! ii. Still must prove: Scienter, Material misrepresentation, intent to deceive, transactional causation, loss causation b. Aiding and Abetting must have been done KNOWINGLY c. Defendant must have actually/substantially assisted the violation i. Primary Violation – Awareness – Assistance X. Securities Fraud A. Insider Trading, Fraud, Material misrepresentations 1. Prohibitions against manipulative devices in connection w/ purchase/sale of securities 2. Implied right of private action 3. Touches anyone who uses the mail, even those not registered under the 34 Act B. Elements of 10b5 violations 1. Misrepresentation a. An affirmative misrepresentation i. Opinions, contingent information A. If based on verifiable contradictory facts that the speaker knew  actionable 26 ii. Forward Looking Information A. Now often it is a requirement B. Safe Harbor  If information is cloacked w/in cautionary language (See Disclosure discussion) b. A Material Omission i. Only if there was a duty to disclose 2. Materiality a. Is there a substantial likelihood that the information would have an impact on the decision of a reasonable investor? i. Would it alter the total mix of information? b. This can also be negated. i. By cautionary language or by pro-actively clarifying the mistake ii. By proving investor knew the truth of the issue c. Material Deception must occur in Connection w/ a sale/purchase of a security i. The material deception must “touch” the transaction A. Direct causal link b/w act and the stock price ii. Similar to causation or forseeability iii. Can‟t be after the fact 3. Scienter a. Was there an intent to deceive? i. Some jurisdictions allow recklessness – Negligence is not enough b. Intentional, Reckless 4. Reliance a. Affirmative misrepresentations in Public Offering Transactions i. Reliance is Presumed ii. Rebuttable A. Truth on the Market 27 iii. Presumption is allowed b/c of the fraud on the market theory – reliance on the integrity of the market b. Affirmative misrepresentations in Private Offering Transactions i. Reasonable Reliance must be proven c. Non-Disclosures i. Reliance is presumed, so long as the omission is material 5. Causation a. Loss Causation i. Must prove you actually caused the losses ii. Proximate causation b. Transactional Causation i. “But For” Causation – similar to reliance 6. Damages a. Must have actually monetary damages, can‟t be speculative C. Defenses 1. Good Faith a. It is almost always a defense for anything 2. Recklessness a. Most courts think recklessness is enough to prove intent, therefore it is not a defense 3. BJR a. Management‟s reasons not to disclose do not matter when it comes to their duty to disclose – NOT a defense XI. Off Shore Transactions: Reg S A. §5 of 33 Act doesn‟t place a limit on only sales w/in the US; US issuers selling outside the US could be subject to registration and Foreign issuers selling in the US may also be covered 1. R. 901  Acts were intended to protect US investors, and the courts will interpret the statutes accordingly 2. Safe Harbors apply to registration requirements, not anti-fraud 28 B. Rule 903  Safe Harbor for Those participating in Off Shore transactions (issuers) 1. Foreign Issuer w/ no US market interests [903(c)(1)] a. Those who direct transactions to a specific single foreign country (engaged in an overseas directed offering) b. Or a foreign government issuance c. Must also show: i. An Off Shore Transaction A. No offers are made on US territory B. The buyer is reasonably believed to be outside the US C. Or the transaction is taking place on the floor of a foreign exchange D. Can‟t make offers or sales to identifiable US citizens abroad (i.e. can‟t go to a US military base) ii. No directed selling efforts were made in the US A. There are exceptions for routine press releases, some tombstone ads, and some isolated incidents 2. Domestic or Foreign Issuers of debt securities who are subject to reporting req‟ts: [903(c)(2)] a. Must show i. Off Shore transaction ii. No directed selling efforts iii. 40 day restricted period A. No sales to US persons (persons residing in US) B. Securities professionals must be informed of the restrictions on sale to US persons 3. All Other Issuers [903(c)(3)] a. Same Offering restrictions as 1 &2 b. Restricted period for selling to US persons is extended to a full year 29 c. Ex: Maryland start-up wishing to sell in UK  must comply w/ 903(c)(3) b/c since it is a start-up it hasn‟t yet registered C. Rule 904  Safe Harbor for Resale of Off Shore Transactions 1. Must be an Off Shore transaction (see CB 326) a. Can‟t make offers or sales to identifiable US citizens abroad (i.e. can‟t go to a US military base) 2. There can be no directed selling efforts or market conditioning in the US D. Failure to Comply 1. §12(a)(1) suits 2. Possibly §12(a)(2) suits, if there is an offering document that meets characteristics of a prospectus a. Still have to prove materiality E. Liability of Securities Fraud and Subject Matter Jurisdiction 1. Conducts Test a. Was there a substantial amount of activity conducted in the US b. Schoenbaum v. Firstbrook i. Corporations listed on American exchanges automatically are exposed to subject matter jurisdiction c. Preparatory conduct, if material, may be enough d. Bersch v. Drexel Firestone and Materially Important i. Was the activity conducted in the US an essential link to the transaction? A. Need direct causality ii. Zolsch v. Arthur Anderson  follows Bersch e. SEC v. Kasser (more liberal view than Bersch) and the Scope of Conduct Test i. Any conduct that is a part of and designed to further the fraudulent scheme, if done w/in the US, can trigger jurisdiction 30 A. Doesn‟t have to be an essential link, or be a direct cause 2. Effects Test a. Conduct may not always be enough, some courts require an impact on US investors/market XII. Corporate Takeovers A. Two-Tier Tender Offers (what used to happen and why the SEC reacted) 1. Announce purchase at a premium and only buy 60% of the shares offered; and 2. At the same time, announce what they were going to do w/ the remaining shares: a. Freeze out at a lower price b. Force people to tender early c. Usually on a first come first serve basis d. Coercive measure B. Congress protected shareholders and passed amendments to change the ‟34 Act 1. §§3d; 13(d); and 14 2. §13d a. Requires a filing by any person who becomes the beneficial owner of more than 5% of a class of equity securities registered pursuant to §12 or of certain other issuers b. The purpose is an early warning system c. Requirements i. Must file a disclosure statement w/in 10 days of passing the 5% threshold ii. Must file a schedule 13(d) d. Includes: i. Intentions related to the acquisition ii. Background/ID of acquirer e. Requirements: i. Make amendments reflecting material changes 31 ii. To the extent that the takeover is 1 of several possibilities, you should report that: A. Even if it is only a remote possibility, you should report it B. Once it becomes more definite, file an amendment f. Wellman v. Dickerson i. A group in furtherance of a common objective may qualify for a 13d if that group collectively owns >5% ii. Ownership plays a key role -- it must be beneficial ownership. A. Beneficial ownership  investment control over voting power 3. §14(d) a. Another disclosure statement in connection w/ a tender offer b. Must file at the time of announcement c. File w/ SEC and send to all shareholders d. In addition to information statement, must follow proceedings designed to alleviate pressure on shareholders e. Makes it unlawful to make a tender offer for the equity securities of any publicly held company if upon consummation the bidder would own more than 5% of the class in question, unless the bidder first files and transmits to the target company a schedule 14(d)(1) f. 14(d)(7) i. Any shareholders that give you shares are allowed to take back their shares prior to the offering of the tender offer g. 14(d)(10) i. Tender offer is open to all shareholders of a class that is offered a tender offer h. Time limits 32 i. Offer must be open for at least 20 business days ii. If increase or decrease in number of shares or amount paid, then must leave open for an additional ten days i. Same Fraud rules apply i. Liable if you have possession of material nonpublic information j. MAI Basic Four Inc. Case i. If you are a bidder, even if you aren‟t a person, you must register k. Epstein v. MCA Corp. i. Issue – Whether Wassermann received greater consideration than other shareholders during the tender offer or whether he received a different type of offer ii. When making a tender offer don‟t use favoritism iii. Timing plays an important role in this analysis iv. The fact that a provided purchase of stock and a public tender offer are both part of a single plan of acquisition does not, by itself, render the purchase a part of the tender offer for purposes of rule 14(d)(10). If the private purchase is conditional the tender offer than it will probably be seen as part of the offer???????????????????????????????????? 33