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					Securities Regulation
Ruder, Fall 2001


INTRO TO SECURITIES MARKETS                                                       6
1.    CAPITAL MARKETS OVERVIEW                                                    6
      A. Why Regulate the Capital Markets?                                        6
      B. Overview of Financial Markets                                            6
2.    REGULATORY FRAMEWORK                                                        7
      A. Regulatory Bodies                                                        7
      B. SEC                                                                      7
      C. Statutes Comprising Federal Securities Laws                              7


SECURITIES ACT 1933 REGISTRATION PROCESS                                          9
1.    REGISTRATION REPORTING REQUIREMENTS                                         9
3.    PROXY REGULATION                                                            9
4.    INTEGRATED DISCLOSURE UNDER BOTH ACTS                                      10
5.    UNDERWRITING PROCESS                                                       11
      A. Underwriting Defined                                                    11
      B. Types of Underwriting                                                   11
      C. Underwriting Syndicate                                                  12
          1. Compensation Structure                                              12
6.    STATUTORY FRAMEWORK OF THE SECURITIES ACT OF 1933                          12
      A. Section 5                                                               12
7.    PREPARATION OF THE REGISTRATION STATEMENT                                  13
      A. Advantages of going public                                              13
      B. Disadvantages of going public                                           14
      C. Consultation with prospective underwriters is an important first step   14
      D. Preliminary Preparation – ―clean-up work‖                               14
8.    REQUIREMENTS OF REGISTRATION STATEMENT                                     14
      A. Quality/integrity of the management (Franchard Corp.)                   15
      B. MD&A Disclosure                                                         15
      C. MD&A Disclosure Calculation                                             16
9.    PENNY STOCK & BLANK CHECK OFFERINGS                                        16
10.   EFFICIENT MARKET THEORY DEBATE                                             16


SECURITIES ACT(1933) §5                                                          18
11.   ’33 ACT DEFINITIONS                                                        19


PRE-FILING PERIOD (―GUN JUMPING‖)                                                20
1.    GUN JUMPING DOCTRINE                                                       20
      A. §5 Liability                                                            20
      B. Exemptions from gun-jumping liability:                                  20


THE WAITING PERIOD                                                               22
1.    WHAT’S NOT PERMITTED                                                       22
2.    WHAT IS PERMITTED                                                          22
      A. Refusal or Stop Orders                                                  23
      B. Acceleration                                                            23
     C. Amendments                                                                                      24
     D. Withdrawal                                                                                      24
     E. Regulation M (the ―trading rule‖): allows mkt. stabilization purchases during public offering   25
3.   REGULATION OF UNDERWRITERS                                                                         26


THE POST-EFFECTIVE PERIOD                                                                               27
1.   WHAT’S ALLOWED                                                                                     27
2.   DURATION OF DELIVERY REQUIREMENT:                                                                  27
     A. Exceptions to the 40-day requirement:                                                           28
     B. Electronic delivery:                                                                            28
     C. Corrections of Incorrect Disclosure                                                             28
     D. How long can a prospectus be used in a Public Offering?                                         29
3.   SHELF REGISTRATION AND BEYOND                                                                      29


EXEMPTIONS FROM §5                                                                                      30
1.   EXEMPT SECURITIES                                                                                  30
     A. Exempt Securities                                                                               30
     B. Exempt Transactions                                                                             30
2.   INTRASTATE OFFERINGS                                                                               31
     A. §3(a)(11) – Intrastate Exemption                                                                31
     B. Rule 147                                                                                        31
     C. §3(a)(11) and Rule 147 chart                                                                    32
3.   PRIVATE PLACEMENT EXEMPTION                                                                        33
     A. Rationales                                                                                      33
     B. Before Ralston Purina – what used to constitute a Non-Public Offering                           33
     C. SEC v. Ralston-Purina (1953)                                                                    33
     D. Judicial Interpretation of Ralston Purina—strict                                                34
4.   SMALL OFFERING EXEMPTIONS                                                                          35
     A. §3(b) – Public Offering Exemption:                                                              35
     B. §4(6):                                                                                          35
     C. §28                                                                                             36
     D. Rule 215:                                                                                       36
     E. REGULATION D (Rules 501-506) – the key non-public offering SAFE HARBOR                          36
          1.   Rule 501: accredited investors                                                           36
          2.   Rule 502: 4 General conditions to be met:                                                36
          3.   Rule 503 Notice:                                                                         37
          4.   Rule 504                                                                                 37
          5.   Rule 505                                                                                 37
          6.   Rule 506                                                                                 37
          7.   Rule 507: ―Bad Boy‖ provision                                                            37
          8.   Rule 508                                                                                 37
          9.   Regulation D chart                                                                       38
     F.   Regulation E                                                                                  39
          1. Rule 701 – compensatory benefit plans                                                      39
          2. ULOE                                                                                       39
     G. REGULATION A – Rules 251-263 – ―SHORT REGISTRATION‖                                             39


EXEMPTIONS FOR RESALES OF SECURITIES                                                                    40
1.   CONTROL AND RESTRICTED SECURITIES                                                                  40
2.   §4(1) EXEMPTION: TRANSACTIONS BY ISSUERS, UNDERWRITERS AND DEALERS                                 40
     A. §2(11) – Statutory Underwriter                                                                  40
     B. Whether or not exemptions apply to resales of securities?                                       41
     C. SEC v. Chinese Benevolent Assn. – agent of issuer                                              41
     D. SEC v. Guild Films – purchase with a view to distribution                                      41
     E. Ira Haupt – underwriter for control person                                                     41
          1. Control (def)                                                                             41
     F.   §4(4): Broker‘s exemption                                                                    42
          1. U.S. v. Wolfson -                                                                         42
3.   EXEMPTIONS FOR RESALE OF RESTRICTED AND CONTROL SECURITIES                                        43
     A. RULE 144 – Safe Harbor for Secondary Distributions in Public Markets                           43
          1. Rule 144 RESTRICTIONS                                                                     43
     B. Secondary Private Placements (§4 (1 ½) and Rule 144 A)                                         44
          1. §4 (1 ½)                                                                                  44
          2. Rule 144A                                                                                 44
4.   EXTRA TERRITORIAL SALES                                                                           45
     A. Reg. S (def)                                                                                   45
     B. REG S –                                                                                        45
5.   REORGANIZATIONS AND RECAPITALIZATIONS – DOCTRINE OF ―SALE‖                                        47
     A. Exemptions for Corporate Reorganizations                                                       47
     B. Issuer Exchanges §3(a)(9)                                                                      48
     C. Court-Approved Exchanges §3(a)(10)                                                             48
     D. Fundamental Corporate Transactions (a, b &c Reorgs) – Rule 145                                 48
     E. Going Public by the Back Door                                                                  49
          1. SEC v. Datronics - ―shell corporation‖                                                    49
          2. Spin-offs                                                                                 49
     F.   Warrants, Options & Conversions                                                              50
     G.   Stock dividends                                                                              50
     H.   Gifts of securities                                                                          50
     I.   Rule 133 (now abolished by Rule 145, which requires registration) – the ―no sale‖ doctrine   50


DEFINITION OF SECURITIES                                                                               51
1.   CODE DEFINITIONS                                                                                  51
2.   INVESTMENT CONTRACTS                                                                              52
     A. The Howey Test – investment contracts                                                          52
     B. Koscot Interplanetary – investors ―mostly‖ passive                                             52
3.   THE ECONOMIC REALITIES TEST (DOWNSIZING THE DEFINITION OF SECURITIES)                             52
     A. STOCK (United Housing Found. v. Forman) – expanding Howey                                      52
     B. Landreth Timber – Rejecting ―Sale of Business‖ Doctrine                                        53
     C. Promissory Notes as Securities (Reeves v. Ernst & Young)                                       53
     D. Certificates of Deposit (CD‘s)                                                                 53
     E. Loan Participations                                                                            53
     F. Swaps                                                                                          53
     G. Condominiums                                                                                   53
     H. General Comments – [Schneider]                                                                 54


TENDER OFFERS, MANAGEMENT BUYOUTS, AND TAKEOVER CONTESTS                                               55
1.   INTRODUCTION                                                                                      55
     A. Disclosure of 5% stock accumulations (§13(d))                                                  55
     B. Disclosure by Tender Offeror (§14(d))                                                          55
     C. .Regulation of Substantive Terms of Tender Offer                                               55
2.   RECENT RULE CHANGES BY THE SEC                                                                    55
     A. Epstein v. MCA – equal price to all s/h                                                        56
3.   DEFINTIONAL ISSUES UNDER THE WILLIAMS ACT                                                         56
     A. Milstein (2d. 1971) – definition of ―group‖                                                    56
     B. SEC v. First City Financial Corp. – ―beneficial ownership‖                                     56
      C. SEC v. Carter hawley hale stores – Definition of ―tender offer‖              56
      D. Hanson Trust – the ―need for protection‖ test                                57
      E. Mai basic four, inc. v. Prime computer - who is ―bidder‖?                    57
4.    DEFENSIVE TACTICS                                                               58
      A. Hilton Hotels v. ITT - preclusive measures                                   58
      B. Defensive Tactics in Practice                                                58


LIABILITIES UNDER ’33 ACT                                                             60
1.    SECTION 11 – MISREPRESENTATION IN A REGISTRATION STMT                           61
      A. §11(A) - express private right of action                                     62
          1.   Plaintiff                                                              62
          2.   Possible Defendants                                                    62
          3.   Material Misinformation in RS                                          62
          4.   Culpability – Due Diligence Defenses and Proportional Liability        62
          5.   Escott v. Barchris Construction – Due Diligence Standards              62
          6.   Proportionate Liability                                                63
2.    SECTION 12 – VIOLATIONS OF §5                                                   63
      A. §12(a) - (express private right of action – Rescission)                      63
          1. Liability under §12(a)(2):                                               63
          2. Strict Liability under §12(a)(1)                                         63
      B. Definition of ―Seller‖ for purposes of §12 (Pinter v. Dahl)                  63
      C. Limits on §12(a) Liability (Gustafson v. Alloyd Co.)                         63
      D. §17(a) – Fraudulent Interstate Transactions:                                 64
3.    IMPLIED PRIVATE RIGHTS OF ACTION                                                65
      A. Rule 10b-5 Analysis (Private Right Of Action)                                65
      B. Implied Private Rights of Action:                                            66
4.    MATERIALITY AND THE DUTY TO DISCLOSE                                            67
      A. Substantial Likelihood Test (TSC Industries v. Northway) –Probability Test   67
      B. Probability Magnitude Test (Basic v. Levinson)                               67
      C. Relationship of Materiality and Duty to Disclose                             67
      D. Types of Information                                                         67
          1. Speculative Information – use probability-magnitude test                 67
          2. Soft Information – projections                                           67
          3. MD&A – required disclosure                                               67
      E. Contextual Disclosure: Total Mix Test                                        67
5.    BESPEAKS CAUTION DOCTRINE                                                       67
6.    DUTY TO UPDATE                                                                  68
      A. Time Warner – Duty to Update                                                 68
      B. STRANSKY v. CUMMINS ENGINE – contradicts Warner:                             68
      C. Virginia Bankshares:                                                         68
7.    CULPABILITY UNDER RULE 10B-5                                                    68
      A. Ernst & ernst v. Hochfelder – scienter requirement                           68
      B. Aaron v. SEC (1980) – applying Hochfelder to 1933 Act:                       69
8.    THE DECEPTION REQUIREMENT                                                       69
      A. Santa Fe Industries – breach of fiduciary duty not enough:                   69
9.    CAUSATION, MATERIALITY, AND RELIANCE                                            69
      A. Mills v. Electric Auto-Lite                                                  69
      B. Basic INC. V. Levinson - ―fraud on the market‖:                              69
      C. Mirkin v. Wasserman (California)                                             70
      D. Summary:                                                                     70
10.   INSIDER TRADING                                                                 71
      A. Texas Gulf Sulphur (―Disclose or Abstain‖ Rule)                              71
      B. Chiarella                                                                    71
      C. Dirks v. SEC (1983) – ―constructive insiders‖/fiduciary duty of tippees:   71
      D. U.S. v. O‘Hagan (1997)                                                     72
11.   SELECTIVE DISCLOSURE & REG. FD                                                72
12.   REMEDIES UNDER RULE 10B-5:                                                    72
                 INTRO TO SECURITIES MARKETS
1. CAPITAL MARKETS OVERVIEW

    A. WHY REGULATE THE CAPITAL MARKETS?
       1) Consumer Protection: Transactions in securities are affected with a national public interest which
          makes it necessary to provide for their regulation and control. Investors are vulnerable in a
          manipulated market and the economy suffer when investors disinvest in the market.
       2) Informational needs of investors: Self-help is not an option when purchasing securities; you
          cannot test drive a stock. Investors need standardized and uniform information to help them weigh
          the merits of an investment. For the securities markets to function, disclosure is essential.
          Government coordination may be the best way to specify a mutually desired common standard.
       3) Allocative Efficiency: The securities laws aim to ensure the accuracy of securities prices, which
          means prices that conform to the fundamental values of the companies traded. The capital markets
          promote efficiency by providing market discipline
       4) Corporate Governance and Agency costs: The securities laws address ―agency cost‖ problems
          between stock promoters and investors, and between shareholders and officers. The laws reduce the
          shareholders‘ (principals‘) costs of monitoring these agents.
       5) Economic Growth, Innovation, Access to Capital: It is a plausible hypothesis that a legal system
          that facilitates and encourages an active equity securities market may also promote a more
          decentralized economy and a more rapid pace of technological innovation.

    B. OVERVIEW OF FINANCIAL MARKETS
       The securities markets are a subset of broader financial markets. The federal securities laws
       apply unevenly to these financial markets.
       Once a financial product is deemed a security, three conclusions usually follow:
       1) a mandatory disclosure system becomes applicable to the sale and trading of the instrument (unless
           the security falls within one of several specified exemptions);
        2) stiff federal anti-fraud rules apply that are more favorable to the  than common law fraud; and
        3) the financial intermediaries that deal in the product become subject to strict regulation by the SEC.
        Financial markets perform 3 basic functions:
        1) match lenders with businesses seeking financing;
        2) permit investors to minimize risk through strategies such as diversification and hedging; and
        3) provide liquidity, which means essentially that a decision to buy or sell the security will not affect
            the market price.
        Types of Financial Markets
        1) Money Market: consists of a group of short-term credit market instruments (negotiable CDs,
           bankers‘ acceptances, treasury bills, and commercial paper
        2) Government Securities: includes both securities issued by the U.S. Treasury to finance the national
           debt and all securities issued by government-sponsored enterprises, (Fannie Mae). It is the world‘s
           largest securities market, and largely beyond jurisdiction of SEC.
        3) Municipal Securities: In 1975 a series of amendments were passed to the Exchange Act of 1934,
           establishing the Municipal Securities Rulemaking Board. It is authorized to adopt rules applying to
           dealers and brokers in municipal securities, but not to regulate the disclosure of municipal issuers,
           themselves.
        4) Corporate Debt: The bond market represents a greater source of capital for corporations than the
           equity markets.
        5) Derivative Products: Derivative instruments involve side bets on interest rates, currency rates,
           stock index levels, commodities prices, or similar market prices.




                                                                                                                    6
        6) Traded Options: An option gives the buyer the right (but not the obligation) to buy or sell shares of
           stock (or other financial assets) in the future at a fixed price (known as the ―strike price‖) that is
           agreed upon today. An organized secondary market in options was inaugurated by the Chicago
           Board Options Exchange in 1973.
        7) Futures: A futures contract is simply a contract to buy or sell a financial asset or commodity at a
           fixed price on a future date. Futures are regulated by the Commodity Futures Trading Commission.
        8) Swaps: a mechanism by which you pay a fee to transfer a risk to a better risk-bearer. At present,
           swaps are not considered securities.

2. REGULATORY FRAMEWORK

    A. REGULATORY BODIES
       Authority for the regulation and oversight of the securities markets is shared among three levels of
       regulators:
       1) Securities and Exchange Commission – SEC
       2) self-regulatory organizations (stock exchanges, NASD, MSRB)
       3) state securities commissioners (Blue Sky Laws)

    B. SEC
       1) An independent non-partisan agency that administers and enforces the federal securities laws.
       2) §19(a) gives SEC general rule-making power.
       3) Consists of five members: a Chairman and five commissioners.
              - The president with the advice and consent of the Senate appoints commission members for
                   five-year terms. They cannot be removed.
              - The Chairman is designated by the President.
              - Terms are staggered: one expires on June 5 of every year.
              - No more than three members can be of the same political party.
       4) SEC is organized into several principal divisions and offices:
              - Division of Corporate Finance: has overall responsibility for ensuring that disclosure
                   requirements are met by issuers registered with the SEC (reviews the RS!)
              - Division of Market Regulation: oversees the secondary trading markets, including the
                   registration and performance of stock exchanges, broker-dealers, and other participants in
                   these markets.
              - Division of Investment Management: has special responsibility for mutual funds and
                   investment advisors.
              - Division of Enforcement: the SEC‘s enforcement arm, charged with investigations of the
                   federal securities laws. When authorized by the Commission, it may undertake
                   enforcement actions, either by way of administrative proceedings or by seeking injunctions
                   and/or civil penalties in federal court. The SEC has subpoena power. Administrative law
                   judges hear cases; commissioners hear appeals.
              - Office of General Counsel: helps draft and respond to legislation; files amicus curiae
                   briefs.
    C. STATUTES COMPRISING FEDERAL SECURITIES LAWS
       1) Securities Act of 1933:
       prohibits the offer or sale of a security (except in certain exempt transactions) unless the security has
       been registered with the SEC. It also requires the delivery of a prospectus to a purchaser and to other
       persons to whom a written offer is made. (The 1933 Act was hastily drafted by three Harvard professors
       over the course of a three day weekend.) Regulates original offerings of securities.




                                                                                                                7
2) Securities Exchange Act of 1934:
Publicly held companies must enter its continuous disclosure system and file annual and quarterly
reports with the SEC, and also must preclear proxy statements with the SEC before soliciting
shareholder proxies for a vote.
Regulates:
         - registration and periodic reporting
         - proxy solicitation
         - insider trading
         - regulation of trading markets
         - tender offer solicitations
         - anti-fraud provisions
3) Public Utility Holding Company Act of 1935: public utility holding companies (as defined) to
    secure approval from the SEC before issuing securities or otherwise changing their financial
    structure, but this Act is largely insignificant now that Congress has greatly deregulated the
    industry.
4) Trust Indenture Act: It applies to public offerings of debt securities in excess of $1 million and
    essentially specifies the form of indenture that must be used, including many of the substantive
    terms that must be set forth in the indenture. (An indenture is a written agreement under which a
    bond or debenture is issued.)
5) Investment Company Act of 1940: Specifies substantive corporate governance standards for
    investment companies, such as ―open end‖ and ―closed end‖ mutual funds and money market funds.
6) Investment Advisors Act of 1940: Requires investment advisors to register with the SEC, prohibits
    fraud and deceptive practices, regulates aspects of their compensation, and specifies related
    requirements intended to ensure fair dealing.




                                                                                                    8
       SECURITIES ACT 1933 REGISTRATION PROCESS
1. REGISTRATION REPORTING REQUIREMENTS
        §12(a)      Prohibits trade w/o registration
                    It shall be unlawful for any member, broker, or dealer to effect any
                    transaction in any security (other than an exempted security) on a national
                    securities exchange unless a registration is effective as to such security for
                    such exchange in accordance with the provisions of this title and the rules
                    and regulations thereunder.
        §12(b)      Permits to register
                    A security may be registered on a national securities exchange by filing an
                    application with the SEC.
        Rule 12(b) Listed companies must register securities. §12(b) companies = listed on
                    nat’l sec. exchange.
        Rule 12(g) An issuer must register a security if the issuer on the last day of its most
                    recent fiscal year had total assets exceeding $10 million and the class of
                    security has 500 or more shareholders. §12(g) companies = unlisted, but
                    by size.
        §12(b) and §12(g) companies = ―registered companies‖, to which other disclosure
                    requirements of SEA apply (proxy rules, annual reports, reports of ―short-
                    swing profits, etc.)
        Form 10: General form for registration of securities pursuant to §12(b) or §12(g) of the
                    1934 Act.
        Form 10K: Annual report; needs to be certified in accordance with the SEC standards
                    (Reg S-X). This form is a comprehensive financial statement and must be
                    filed 90 days after the fiscal year. It includes MDA. – Key disclosure
                    document!
        Form 10Q: Quarterly report; doesn‘t need to be certified.
        Form 8-K: Event-oriented disclosure form.
        §13:        requires periodic disclosure to keep other information required under §12
                    current.

  3. PROXY REGULATION
    A proxy is the instrument through which the shareholder (principal) transfers the right to vote to a third party
    (transfer of power of attorney).
        §14(a)      makes it unlawful for anybody to use the mails or other means of interstate
                    commerce to solicit a proxy in respect of a security registered under §12, if
                    the solicitation is in violation of the SEC‘s rules.
        §14(c)      even if management of an issuer does not send a proxy, prior to the annual
                    meeting it must furnish the required information as if it were sending a
                    proxy.
        Rule 14a-1(f): proxy is defined to include ―any proxy, consent or authorization
                    within the meaning of §14(a).
        Rule 14a-1(l): solicitation is defined as any request for a proxy.

                     Relief for large/institutional investors:
                      - Rule 14a-1(l)(2)(4): solicitation does not include a communication by a security holder
                          who states how he intends to vote by means of a speech or press release, or broadcast or
                          print advertisement.



                                                                                                                       9
                    -   Rule 14a-2(b)(1): allows large investors to communicate with each other about corporate
                        governance w/o being deemed to ―solicit proxies‖.

      Rule 14a-3 no solicitation of a proxy can be made unless a proxy statement containing
                 the information required in Schedule 14A accompanies the solicitation.
                    -   Rule 14a-3(b): requires an annual report (14a-3 proxy annual report differs from Form
                        10K; it is spartan). Can use 10-K report + the event information.
                    -   Rule 14a-3(b)(10): proxy statement must contain an undertaking to provide Form 10K at
                        the written request of anybody
           Two types of annual reports:
                  1) Form 10-K: comprehensive and certified; filed with the SEC; provided electronically on
                       EDGAR
                  2) §14a-3 proxy report: must be delivered to s/h; ―glossy and nice‖; must have all the basic
                       10-K information and include additional event information (Schedule A, Items 7 and on);
                       must also disclose info on executive compensation (Reg S-K, Item 402 on).

4. INTEGRATED DISCLOSURE UNDER BOTH ACTS
  In 1982, the SEC created a unified approach of disclosure under both Acts.
      1) Integrated disclosure simplifies corporate reporting in three ways:
           
               disclosure requirements are made uniform under the 1933 Act and 1934 Act
           
               Exchange Act periodic reporting is used to satisfy much of the disclosure necessary in the Exchange
               Act; and
           
               Use of informal shareholder communications is encouraged to satisfy normal statutory
               requirements of both acts.
      2) Regulation S-K was adopted to implement a single standard set of instructions for filing forms under
           both Acts.
      3) Sweeping revisions were made to Form 10-K (annual reports)
      4) The SEC made efforts to streamline the disclosure requirements under the 1933 Act. Forms S-1, S-2,
           and S-3 establish a new three-tier system for the registration of securities under the Securities Act.
           These allow varying degrees of incorporation by reference.
           
               Form S-3: seasoned issuers - allows maximum use of incorporation by reference. There is no
               delivery requirement. Can be used by companies widely followed in the market (by securities
               analysts!) with a float of $75 million (must be owned by non-controlling persons).
           
               Form S-2: co. has been a reporting company under Exchange Act (’34) for 3+ years, but not
               widely followed. Combines reliance on incorporation by reference of Exchange Act reports and
               presentation of streamlined information in the prospectus or in an annual report to shareholders
               delivered with the prospectus. Item 12 permits incorporation by reference and Item 11 contains the
               delivery requirement.
           
               Form S-1: unseasoned issuers - requires complete disclosure in the prospectus and permits no
               incorporation by reference. Companies which have been in the Exchange Act reporting system for
               less than three years, and any others who choose to do so, use Form S-1. Items 1 to 10 deal
               specifically with the contemplated transaction, while Item 11 calls for a detailed description of the
               registrant. All financial information must be certified in accordance with the SEC‘s standards (Reg S-
               X).
      NB! In the integrated disclosure system, a Securities Act registrant looks:
      -    to the available Form for a determination of the type and amount of disclosure that
           must be delivered to investors;
      -    to Regulation S-K for substantive disclosure requirements; and
      -    to Regulation C for procedural regulations.




                                                                                                                  10
      5) Streamlined registration for ―small business issuers‖ - The SEC also significantly relaxed the 1993
         Act‘s requirements when it introduced streamlined registration for ―small business issuers‖, defined
         as an issuer with revenues of less than $25 million during its last fiscal year and with a float of less than
         $25 million. (Regulation S-B). A subsidiary will qualify only if the parent company also qualifies!
                   - Form SB-1: to be used for sale up to $10 million in securities within a 12-month period.
                       The simpler form (could be Q-A). Available to most small business issuers.
                   - Form SB-2: no dollar limit for securities offered for cash; but a limit on revenues and
                       float (see above).
                   - A modified Form 10-Q (10Q-SB) and a modified Form 10-K (Form 10KSB) relax the
                       requirements of the 1934 Act‘s continuous reporting requirements. Financial information
                       must be certified in accordance with GAAP.
      6) Enhanced Disclosure of Management Discussion & Analysis (MD&A) - Not all of the SEC‘s
         revisions to the disclosure requirements have been deregulatory. The SEC now requires disclosure
         requirements under MD&A, which is forward-looking information. . Management must report trends
         and uncertainties that are ―reasonably likely‖ to affect company‘s financial position. The idea is to give
         a picture of company‘s prospects through the eyes of management, especially when historic data is not a
         good indicator of future results. (Item 303 of Regulation S-K)

5. UNDERWRITING PROCESS
  Types of Direct Offerings w/o underwriters
          
             Direct Public Offering: the issuer of a new security gambles upon its ability to sell the entire issue
             without the intervention of an underwriter or marketing syndicate. The issuer thus assumes the entire
             risk of failure to acquire the needed capital.
          
             Rights Offering: existing shareholders are offered warrants or rights to subscribe to a new class of
             securities of the same issuer. Rights are allocated in proportion to the size of existing holdings of the
             issuer‘s securities.
          
             Dutch Auction: securities are offered at a stated minimum price, subject to specified conditions. One
             condition is that each buyer has the option of bidding for any number of shares. The final offering
             price is the maximum price at which all shares can be sold pursuant to the bids.
          
             All or None Offerings: unless a designated number of shares are sold and paid for in full within a
             specified period, the offering will be terminated and all funds returned with interest to the
             subscribers.
          
             Private Placements: allows an issuer to sell securities to a legally restricted number of institutional
             and other sophisticated investors.

      A. UNDERWRITING DEFINED
         firm that specializes in the marketing of new issues of securities or secondary offerings of securities by
         selling to end consumer (investor). (By contrast, strict underwriting is when a party insures the issuer
         against loss in the case of when the public does not subscribe fully to a new offering.)
      §2(11)       underwriter (def)
                   broadly defines underwriter to mean any person who has
                   (1) purchased from the issuer (or controlling person)
                   (2) with a view to, or
                   (3) offers or sells for an issuer in connection with the distribution of any
                   security, or
                   (4) participates in any such undertaking.

      B. TYPES OF UNDERWRITING
                - Firm Commitment Underwriting: the underwriter (or syndicate) agrees to purchase (and
                    to later resell) all or specific amount of the offering for cash, subject to market-outs.
                - Stand-by Underwriting: underwriters agree to purchase shares not purchased by existing
                    shareholders, at the expiration of a specified period.




                                                                                                                    11
                    -   Best Efforts Underwriting: Underwriter agrees merely to act as an agent for the issuer in
                        marketing the issue to investors. 2 types: ―strict best efforts‖ and ―all-or-none‖.
      C. UNDERWRITING SYNDICATE
         In a registered offering, during the waiting period, the preliminary prospectus will be available and the
         lead underwriter will ask other underwriters to join the syndicate. At the same time as the signing of the
         underwriting agreement, the syndicate will enter into an ―agreement among underwriters‖ (signed
         on the morning of effectiveness!) During the waiting period underwriters will survey the market for
         interest in an issue. Based on this survey, the allocation of each the amount of securities to be purchased
         by each member of the syndicate will be made, thereby separating members into groups based on the
         size of their purchase commitment – major bracket underwriters, mezzanine group, etc. After the
         registration statement is filed, the syndicate manager as well as the syndicate members will test the
         market for the offering by making oral offers and by means of the preliminary prospectus and tombstone
         ad. If the offer is in demand, other broker-dealers may become members of the syndicate or become
         members of the ―selling group.‖ Members of the selling group serve as retailers of the securities.
         Underwriters try to sign the underwriting agreement as close to the effective date as possible. The
         Selected Dealer Agreement is not signed until after effective date.
         The typical underwriting agreement requires all underwriters and selling group members to adhere to the
         public offering price. The practical problem under the Securities Act is that the offering price must be
         stated in the Prospectus, and any sales by underwriters below that price makes the prospectus misleading
         and subjects the underwriter to liability under §11.
      NB! Incidentally, first time offers might have to price below the market price because
                 investors won‘t buy offerings in the future if the price goes down.

               1.   Compensation Structure
                    Assume the public ultimately pays $10 per share (list price).
                    Issuer will give underwriter a discount (the stronger the issuer, the lesser the discount).
                    Issuer will get $9 per share.
                    Managing underwriter is compensated for packaging the issue and management activities.
                    ($0.20 cents)
                    The underwriting group as a whole then receives $0.30 cents for expenses and assuming the
                    risk of underwriting.
                    Dealers are compensated $0.50 cents for their service.

6. STATUTORY FRAMEWORK OF THE SECURITIES ACT OF 1933
  A) The Securities Act of 1933 has 2 basic objectives:
          
             provide investors with material financial and other information concerning new issues of securities
             offered for sale to the public; and
          
             prohibit fraudulent sales of securities.
  B) In a nutshell, the 1933 Act is designed to prohibit the public distribution of securities without disclosure
     of relevant information to the investor. In this context, distribution refers to a public offering by the
     company itself – a primary offering. The 1933 Act also covers certain offerings by existing security holders –
     secondary offerings.
  C) Basic prohibitions found in:
          
             §5 which prescribes the rules compelling full disclosure; and
          
             §§17 and 12(2) which relate to fraud or misrepresentation in interstate sales of securities

      A. SECTION 5
         Its overall purpose is to require that new issues of securities offered by the use of the mails or other
         instrumentalities of interstate commerce shall be registered with the Commission, and that a prospectus
         (filed as part of the registration statement) shall be furnished to the purchaser prior to the sale or, in some
         cases, at the time of the delivery of the security after the sale.




                                                                                                                     12
              It states the ground rules for making offers and sales of securities during three distinct periods: (1) the
              pre-filing period; (2) waiting period; and (3) the post-effective period.
         §5(a)      concerns sales of securities
         §5(b)      states the prospectus requirements
         §5(c)      concerns activities in the pre-filing period
         §2         defines the technical terms used in §5
         §3         exempts certain securities from registration requirements
         §4         exempts certain transactions from §5 requirements
         §11        imposes liability for misrepresentation in the RS
         §12        imposes liability for fraud in inter-state offerings
         §18        partially preempts state laws regulating the issuance and sale of securities
         §19(a)     gives the SEC rulemaking powers, including power to define terms used in
                    the Act
         §§19(b) and 20(a) give the SEC investigative powers
         §9         provides that a person aggrieved by an SEC order can appeal in U.S. Court
                    of Appeals, which has jurisdiction by virtue of §22(a)


DISTRIBUTION
BEGINS (as early as letter of intent)


                                                        { PRE-FILING PERIOD
                                                            (2 to 3 monts)
FILING DATE
(when issuer files registration
with the SEC)

                                                        { WAITING PERIOD
                                                          (15 to 45 days, ranging from
                                                          seasoned issuer to IPO)
EFFECTIVE DATE
(can‘t sell before this date)


                                                        { POST EFFECTIVE PERIOD
                                                          (sale of securities)
END
(money distributed and
syndicate closes)



7. PREPARATION OF THE REGISTRATION STATEMENT

         A. ADVANTAGES OF GOING PUBLIC
            
              raise funds for corporate purposes
            
              company may gain prestige and become better known
            
              a company with publicly traded stock is in a better position to acquire other businesses through the
              issuance of stock, instead of cash
            
              an existing public market for securities enables ee compensation plans



                                                                                                                            13
          
              improve a company‘s net worth, enabling it to raise funds on more favorable terms, either in equity
              markets, or privately from institutional investors
          
              give owners a sense of financial success and self-fulfillment

      B. DISADVANTAGES OF GOING PUBLIC
         
            high expense of maintaining a public company (disclosure requirements)
         
            disclosure obligation make information available to competitors
         
            pressures from analysts and investors could make management focus on short term, foregoing long-
         
            company may become a candidate for a takeover bid

      C. CONSULTATION WITH PROSPECTIVE UNDERWRITERS IS AN IMPORTANT FIRST STEP
         
           Price: Some underwriters will advise the company to set the initial offering price slightly under
           projected after-market price simply to ensure a good reception for the stock. For companies with a
           good history and earnings record, the proper pricing of the issue often must be determined by the
           market conditions prevailing on the offering date.
         
           Number of Shares: It is generally felt that a minimum of 300,000 to 350,000 shares, and preferably
           400,000 shares or more, is desirable in the public float to support an active trading market.
         
           Underwriting Agreement: A ―letter of intent‖ is signed, outlining the proposed terms of the offering
           and underwriting compensation. It expressly states that it is not binding on either party, except with
           respect to specific matters.

      D. PRELIMINARY PREPARATION – ―CLEAN-UP WORK‖
         
           usually takes 2-3 months before registration statement can be filed
         
           To have a vehicle for the offering, the business going public must be conducted by a single
           corporation or a parent corporation with subsidiaries. Most often this arrangement must be obtained
           through mergers and liquidations.
         
           BoD takes internal steps and makes changes to corporate documents (ie. authorizing more shares to
           be issued)

8. REQUIREMENTS OF REGISTRATION STATEMENT
  A registration statement has 2 parts:
      1) prospectus
      2) technical/supplemental information (avail. for inspection at SEC)


      §§6, 7, 8 – set forth the basic rules for registration (who must sign RS; where the content
                   requirements are to be found; how RS becomes effective)
      Reg. C Rule 421: Plain English Rule. Information in a prospectus must be presented in a
                   clear, concise and understandable manner. Plain English principles include:
                   short sentences; definite, concrete, everyday words; tabular presentation or
                   bullet lists for complex information; no legal jargon or highly technical
                   business terms.
      S-K Item 503(a): Provides for a summary of the prospectus. The summary must give a
                   balanced presentation to favorable and unfavorable elements of the issue.
      S-K Item 503(c): Calls for a discussion of the principal risk factors that make an offering
                   speculative or one of high risk. The risk factors do not need to be prioritized,
                   but they should be stated fairly and not obscured. This section usually
                   contains language to the effect of ―there can be no assurance that…‖
      S-K Item 504: Requires the registrant to describe how it plans to use the proceeds from
                   the offering.




                                                                                                                    14
S-K Item 303: requires MD&A that gives an investor an opportunity to look at the issuer
           through the eyes of management by providing both short-term and long-term
           analyses of the business of the issuer and to examine the financial
           information of the issuer.
S-K Item 103: requires disclosure of ―material pending legal proceedings, other than
           routine litigation incidental to the business.‖


A. QUALITY/INTEGRITY OF THE MANAGEMENT (FRANCHARD CORP.)
   this information is critical to investor and therefore material (must be disclosed)  compensation,
   integrity, incentives
   Particularly relevant where securities are largely sold on the reputation of the company‘s controlling
   person. The SEC‘S concern in Franchard was that investors be provided with qualitative information
   enabling them to appraise the character, integrity and ability of their management has been today
   codified in a series of provisions in subpart 400 of Regulation S-K.


S-K Item 402: disclosure of disclosing executive compensation
           (does not apply to foreign issuers!)
S-K Item 404: disclosure of self-serving transactions between the issuer, its affiliates,
           and their family members when the transaction exceeds a specified dollar
           amount (currently $60,000), during the last fiscal year.
S-K Item 505: description of the plan of distribution of securities to the public and the
           terms on which the distribution is to be made.
S-K Item 506: disclosure of dilution of current shs outstanding.
           (example) If 100,000 shares are outstanding at $1 per share, and new
           shareholders are asked to pay $9 per share in the offering of an additional
           100,000 shares, then essentially they are asked to pay $9 for shares worth
           only $5.
S-K Item 305      disclosures about market risk (qualitative and quantitative)
S-K Item 402      disclosure of executive compensation
S-K Item 702: disclosure of indemnification agreements.
Rule 175          provides safe harbor for certain types of ―forward-looking‖
           information - such information shall not be deemed to be fraudulent unless
           it is shown that such statement was made or reaffirmed without a reasonable
           basis or was disclosed other than in good faith.

B. MD&A DISCLOSURE
   The SEC‘s most significant step to enhance disclosure standards was to strengthen MD&A, now
   required to be included in registration statements, the registrants Annual Report on Form 10-K, and its
   Quarterly Report on Form 10-Q.
    SEC can enforce MD&A requirements through administrative enforcement proceedings.

S-K Item 303(a)(1): disclosure of trends or uncertainties that will result in or are
           reasonably likely to result in a material change issuer‘s financial position
S-K Item 303(2): description of any known trends in the registrant‘s capital resources any
           expected changes in the mix and costs of such resources.
S-K Item 303(3): requires disclosure of known trends or uncertainties that are reasonably
           expected to have a material impact on net sales, revenues, or income from
           continuing operations.




                                                                                                         15
      C. MD&A DISCLOSURE CALCULATION
         Where a trend, demand, commitment, event or uncertainty is known, management must make two
         assessments:
             1) Is the known trend, demand, commitment, event or uncertainty likely to come to fruition? If
                  management determines it is not likely to occur, no disclosure is required.
             2) If management cannot make that determination, it must evaluate objectively the consequences
                  of the known trend, demand, commitment, event or uncertainty, on the assumption that it will
                  come to fruition. Disclosure is then required unless management determines that a material
                  effect on the registrant‘s financial condition or results of operations is not reasonably likely to
                  occur.
         Each final determination resulting from the assessments made by management must be objectively
         reasonable, viewed as of the time the determination is made.

9. PENNY STOCK & BLANK CHECK OFFERINGS
  Blank check offerings involve newly formed companies without a preexisting history or assets. Investors are
  asked to trust the promoter to use the offering‘s proceeds to acquire virtually any kind of assets that the
  promoter considers attractive.
  Penny stocks are not registered on an exchange.
      §7(b)       rules for blank-check offerings: SEC may require such issuers to:
                  (1) provide additional disclosures, both before and after the registration
                  statement is declared effective;
                  (2) place limitations on the use of the proceeds obtained in such an offering
                  and on the distribution of the securities sold; and
                  (3) provide a right of rescission to shareholders.
      §7(b)(3): blank check co (def) any development stage company that
                  (1) is issuing a penny stock, and
                  (2) has no business plan or purpose, or
                  (3) has indicated that its business plan is to merge with an unidentified
                  company or companies.
                  penny stock (def) includes any equity security other than a security
                  registered on a national securities exchange or authorized for quotation on
                  the NASDAQ.
      Rule 419: requires funds be placed in escrow - funds received and securities issued in
                  an offering of penny stock by a blank check company to be placed in an
                  escrow account until specified conditions have been met.
  Different from ―blind pool‖ offerings, where a company (issuer) is trying to raise funds to purchase unidentified
  assets, but it has a business purpose.

10. EFFICIENT MARKET THEORY DEBATE
  1) The central and least disputed claim of the Efficient Capital Market Hypothesis [ECMH] is that available
     information about securities traded in the principal securities markets is impounded into stock prices with
     sufficient speed that even sophisticated investors cannot systematically profit by trading on newly available
     information. Thus, the most common definition of an efficient market is that the prices in such a market
     ―fully reflect‖ all ―available information.‖ A clearer definition is that a market is efficient with respect to
     specific information, prices act as if everyone knows the information.
  2) Three strains of the ECMH:
      a) weak: only history of securities prices; provides no useful information to the investor
      b) semi-strong: publicly released information provides no useful information to the investor
      c) strong: even non-public information is reflected in price
  3) The ―random walk‖ implication: if stock prices incorporate all available information, then they will move
     only when truly new (i.e. unforeseen) information becomes available.



                                                                                                                       16
4) Many read ECMH to imply that markets are allocatively efficient, which means that there is no divergence
   between investment and market value of securities. In theory, allocative efficiency can be realized only if:
    a) all investors are equally rational;
    b) investors have relatively costless access to the available information; and
    c) arbitrage opportunities will be exploited until any evident disparity between investment value and
         market value is eliminated.
5) Some argue that the cost of information critically determines market efficiency because it dictates not only
   the amount of information attending to a particular security but also the distribution of that information
   among traders, which in turn determines the operative market mechanism. In this context, underwriters
   reduce the cost of acquiring information because their reputation is essentially rented to issuers in an effort
   to give a new issue greater credibility.
6) Criticism of ECMH: argue that not all investors are rational (as in the case of noise traders) and that
   investor sentiment plays a large, fickle role in stock prices. This theory supposes that arbitrageurs do not
   fully counter changes in investor sentiment and so changes in investor sentiment affect stock prices.
7) The SEC’s mandatory disclosure system can be viewed as a means of economizing on information
   costs. By collectivizing the acquisition of securities information, the securities laws reduce potentially
   duplicative and socially wasteful investments by private parties. In short, mandatory disclosure represents
   the lowest cost means of correcting the market‘s failure to provide adequate securities research and
   verification. After all, information is a public good, and public goods tend to be under-provided. This under-
   production stems from the fact that because of the excludability of information as a public good, analysts
   cannot capture the full economic value of their discovery, and thus do not have an incentive to invest in the
   production of such information. To the extent that mandated disclosure reduces the market professional‘s
   marginal cost of acquiring and verifying information, it increases the aggregate amount of securities research
   and verification provided.
8) Ruder: we need to be cautious in assuming that every investor is a rational economic agent. Moreover, we
   are the only major market with mandatory disclosure, so we need to be careful about attributing efficient
   market qualities to international markets.




                                                                                                               17
                                                  SECURITIES ACT(1933) §5

               Pre-Filing Period                                Waiting Period                                        Post-Effective Period

               5(a) prohibits the sale of any                   5(a) prohibits the sale of any                        5(b)(1) prohibits the use of any
               security before the effective                    security before the effective date                    prospectus with respect to any
               date                                                                                                   security for which a registration
                                                                5(b)(1) prohibits the use of any                      has been filed, unless such
               5(c) prohibits offers to sell or                 prospects with respect to any                         prospectus meets the
               buy securities through the use                   security for which a registration                     requirements of §10
               of any prospectus or otherwise                   has been filed, unless such                           5(b)(2) prohibits sale or delivery
               (including oral offers) unless a                 prospectus meets the                                  of security unless preceded or




                                                                                                     Effective Date
               registration statement has been                  requirements of §10 - i.e. §10(b)                     accompanied by a prospectus
Prohibitions




                                                  Filing Date




               filed                                            prospectus.                                           meeting the requirements of
                §2(a)(3) exempts negotiations                                                                         §10(a) – final statutory
                     between issuers and                         No sales                                             prospectus.
                     underwriters                                Oral offers are allowed
                §4(1) exempts transactions by                                                                         ―Free writing‖ privilege, but
                                                                 No ―free writing‖; written offers
                     any person other than an                        only in 4 forms:                                 sales and delivery only with a
                     issuer, underwriter, or                                                                               final prospectus (some
                                                                1) Rule 430 – preliminary
                     dealer                                                                                                flexibility for large issuers);
                                                                    prospectus.
                                                                2) Rule 431 – summary                                 -no sale confirmations w/o a final
               - No sales                                           prospectus                                             prospectus
               - No offers                                      3) §2(a)(10)(b) – tombstone ad
               - No sales negotiations with                     4) Rule 134 – identifying
               dealers or the public                                statement




                                                                                                                                                             18
11. ’33 ACT DEFINITIONS

                                    1933 ACT DEFINITIONS

     §2(a)(10) PROSPECTUS: any prospectus, notice, circular, advertisement, letter, or
                communication, written or by radio or television, which offers any security
                for sale or confirms the sale of any security – all written offers.

                 Exception: a statement is not a prospectus if it states where a §10 prospectus
                 may be obtained and does no more than identify the security, state the price,
                 and follows other SEC rules)

     §2(a)(11) UNDERWRITER: any person who has purchased from an issuer with a view
                to, or offers or sells for an issuer in connection with, the distribution of any
                security, or participates or has a direct or indirect participation in any such
                undertaking, or has a participation in the direct or indirect underwriting of
                any such undertaking

     §2(a)(12) DEALER: any person who engages either for all or part of his time, directly or
                indirectly, as agent, broker or principal, in the business of offering, buying,
                selling, or otherwise dealing or trading in securities issued by another person.
                (Contrast this definition with the 1934 Act definitions, which defines a
                broker as an agent for others and a dealer as a principal for oneself. The
                1933 Act lumps the two functions together.)

     §2(a)(2) PERSON: individual, corporation, partnership, association, joint stock co., any
                unincorporated organization, or government or political subdivision thereof.

     §2(a)(3) SALE: includes every contract of sale or disposition of a security or interest in a
                security, for value.
                Does NOT include preliminary negotiations between an issuer and an
                underwriter or between underwriters.

     §2(a)(4) ISSUER: any person who issues or proposes to issue any security




                                                                                                    19
               PRE-FILING PERIOD (“GUN JUMPING”)
1. GUN JUMPING DOCTRINE
  §5(c) prohibits any activity that has the effect of conditioning the market, arousing/stimulating public interest;
  SEC concerned about publicity b/c market may be forming impressions about issuer and its securities
  prematurely, since registration has not yet been filed (no public info available yet).

      A. §5 LIABILITY
         Disclosure during public offering is regulated by §5:
                   a) No security may be offered, unless registration statement filed - §5(c)
                   b) No prospectus may be disseminated, unless it contains certain info - §5(b)(1)
                   c) No security may be sold or deliverd, unless registration statement becomes effective, and
                       unless investors receive a formal prospectus - §5(a) and §5(b)(2).
         divides registration and regulates disclosure in 3 periods: (1) prefiling, (2) waiting, and (3) post-
         effective
         Gun Jumping: no offers (sell or buy) during pre-filing.
         Any announcement that tends to arouse interest in the offering may be deemed gun jumping.
         Meaning of ―offer:
                   a) no publicity by underwriters and dealers to arouse interest in the offering
                   b) Dealers are not permitted to offer to buy securities from the underwriters during the pre-
                       filing period.

      B. EXEMPTIONS FROM GUN-JUMPING LIABILITY:
         1) preliminary negotiations between issuer and underwriter, or among underwriters (does not cover
            the selling group of dealers!)
         2) securities firm recommendations (see Rules 137-139)
         3) ordinary course of business activities/publicity of issuer: In the normal conduct of its business a
            corporation may continue to advertise its products and services without interruption, it may send out
            its customers annual, quarterly, and other periodic reports to security holders, and may publish its
            proxy statements, send out its dividend notices and make routine announcements to the press.

              Neither a company in registration nor its representatives should instigate publicity for the purpose of
              facilitating the sale of securities in a proposed offering. Further, any publication information by a
              company in registration other than by means of a statutory prospectus should be limited to factual
              information and should not include such things as predictions, projections, or opinions with respect
              to value.
           4) A broker-dealer becomes subject to §5 restrictions at any time when he commences to participate
              in the preparation of a registration statement (after preliminary negotiations)




                                                                                                                       20
Rule 134: communications that are NOT a prospectus:
          identifying statement; tombstone ad

Rule 135    allows issuer to publish a notice announcing issuer plans to make
            registered offering. In order for it NOT to be considered an offer to sell, it
            must:
            1) include only basic info (type, amount, timing, purpose)
            2) must recite offering will be made only by means of prospectus
Rule 135(c) testing the water provision - allows issuer to publish a notice announcing
            plans to make unregistered offering;
            reporting companies only, must state issuer will not make an offer unless
            there is registration or exemption thereof
Rule 135(e) off shore news conferences are not offers

Rules 137-138 - BROKER/DEALER (analyst firms)
           SAFE HARBORS (reporting companies only)
Rule 137: non-participant recommendations OK if: (1) publish information and
           opinions in the regular course of business and (2) dealer is not being
           compensated by the issuer (exempts from §2(11) underwriter)
Rule 138: recommendation of issuer’s other securities
           (participating in offering of preferred or non-convertible debt registered on
           Form S-2 or Form S-3 (available only to reporting companies, well
           established in securities mkt.)
Rule 139 participant’s recommendations
           if it appears (i) in a regular publication of the securities analyst firm, (ii) co is
           seasoned reporting company (Form S-3), and (iii) recommendation is not too
           prominent.

§19(a):      safe harbor from §5; liability will not be imposed to any act done or
             omitted in good faith in conformity with any rule or regulation of the SEC
§23          while a registration statement is being considered, the SEC makes no
             determination that it is true or accurate and it shall be unlawful to make, or
             cause to be made, to any prospective purchaser any representation contrary
             to the foregoing provisions of this section.
§12(a)(1)    imposes strict liability for violations of §5




                                                                                                   21
                                THE WAITING PERIOD
1. WHAT’S NOT PERMITTED
  2 prohibitions during waiting period:
           1) prohibition against sales or deliveries continues - §5(a)
           2) no prospectus that does not comply with §10 - §5(b)(1)
  No Sales or Deliveries
  Since a sale is a finalized contract, offers cannot be accepted during waiting period. To avoid creating a binding
  contract, solicitations of interest must be phrased as to not constitute an offer capable of acceptance – participants
  in the offering will collect indications of interest, but will not accept checks of orders.
  No prospectuses
  §2(10) defines a prospectus as any communication ―written, radio, or TV, which offers a security for sale (any
  selling efforts in writing).

2. WHAT IS PERMITTED
  Oral Offers (§5(b)(1))
  §5(b)(1) prohibition relates only to written offers. Oral offers still subject to antifraud provisions of both Acts.
  Preliminary Prospectus (Rule 430)
  typically, the prospectus filed as part of registration statement is incomplete, so §10(b) authorizes use of
  incomplete prospectus. Rule 430 allows red herring/preliminary prospectus (vs. §10(a) final/statutory prospectus
  used in post-effective period to confirm sales)
  Tombstone Ads (§2(10))
  §2(10) exempts from definition of ―prospectus‖ tombstone ads (states from whom a §10 prospectus may be
  obtained, only identifies the security, price and name underwriters)
  Identifying Statements (Rule 134)
  Rule 134 expands allowed written communication of identifying statements; if:
  a) more detailed info about issuer and business
  b) who is selling securities, and where to get §10 prospectus
  c) ask for indications of interest
  Prospectus Dissemination
  §5(b)(1) scheme leaves a gaping hole where investor gets an oral offer during waiting period, places an order
  contingent on effective registration, but never receives §10 prospectus. So SEC, as a condition to acceleration of
  effective date, makes sure red herrings are made available to all participating underwriters and dealers. Rule
  15c2-8 then mandates these participants send the red herring to anyone who is expected to receive confirmation
  of sale upon effectiveness.


      §5(a):      jurisdictional aspect - makes it unlawful to make use of any means of
                  instrumentality of interstate commerce or the mails to sell a security, unless a
                  registration statement for the security is in effect
      §5(b):      makes it unlawful to make use of any means of instrumentality of interstate
                  commerce or the mails to carry or to transmit any prospectus relating to any
                  security with respect to which a registration statement has been filed, unless
                  such prospectus meets the requirements of §10. It does not prohibit oral
                  offers to sell.
      §10(a): specifies the content of the final or statutory prospectus, which can only be
                  available after the effective date.




                                                                                                                         22
§10(b): authorizes the SEC to issue rules allowing the use for §5(b)(1) purposes of a
            prospectus which summarizes or omits a part of the information in the
            statutory prospectus.
            Rule 430: provides that form of prospectus filed as a part of the registration
            statement shall be deemed to meet the requirements of §10 for the purpose of
            §5(b)(1) prior to the effective date of the registration, if it includes
            substantially all of the information in the statutory prospectus, with the
            exception of price, underwriting discounts or commissions, discounts or
            commission to dealers, amounts of proceeds, conversion rates, call prices,
            other matters dependent upon the offering price. The red-herring prospectus
            must include in red a caption ―subject to completion.‖ (S-K 501(10)).
            Rule 430A: permits the registration statement to become effective prior to
            the final pricing negotiation between the issuer and underwriter.
            Rule 431: provides for a summary prospectus to be filed with the
            registration statement. In general, a summary prospectus may be used by (1)
            domestic issuers that have their principal operations in the U.S.; (2) are
            registered pursuant to §12(b) or §12(g) or are required to file reports
            pursuant to §15(d); and (3) have filed in a timely manner all reports under
            §§13, 14, or 15(d) for three years prior to the filing of the registration
            statement. Such a prospectus is not considered part of the registration for the
            purpose of §11 liability.
            Tombstone Ad: §2(a)(10) permits the use of a tombstone ad during the
            waiting period and the post-effective period. A tombstone ad may include the
            name of the issuer, title of the security, its price, a statement of the source of
            the §10 prospectus, and the identity of persons by whom orders will be
            executed. It is not customary to publish a tombstone ad during the waiting
            period.
            Identifying Statement: Rule 134 authorizes an expanded tombstone ad. In
            addition to the items permitted in the tombstone ad, an identifying statement
            may include a brief description of the general type of business, and specific
            information generally relating to senior securities, that is, debt securities,
            convertible securities, and preferred stock.

    FREE WRITING is illegal during the waiting period. Free writing can be defined as any writing
    not meeting the requirements of a 10(b) prospectus.

A. REFUSAL OR STOP ORDERS
Rule 8(b): if a registration statement is ―incomplete on its face,‖ then the SEC can issue a
            refusal order after giving adequate notice to the issuer (must be w/n 10 days
            after filing – impractical and rare!)
Rule 8(d): if a registration statement appears to include an untrue statement of a material
            fact or appears to omit a material fact, then the SEC can issue a stop order
            after providing the issuer with adequate notice. This power is much broader
            then Rule 8(b) because there is no ―on its face‖ requirement.

B. ACCELERATION
   Acceleration is a mutually beneficial instrument for issuers and the SEC. Essentially, in exchange for
   more time to review the registration statement (thanks to amendments to the registration), the SEC will
   use its acceleration power to select an effective date/time that is designated by the issuer.
§8: the effective date of a registration statement shall be the 20th day after the filing
             thereof or such earlier date as the Commission may determine. If an
             amendment has been made to the registration statement before the effective
             date, the registration statement shall be deemed to have been filed when such
             amendment was filed.



                                                                                                             23
Rule 459: in calculating the effective date, the 20th day includes Saturdays, Sundays, and
            holidays
Rule 461: provides instructions for requesting acceleration – to be made w/n 48 hours
            before the desired date; also lists conditions under which the statutory
            standard for acceleration under §8 will not have been satisfied, such as in
            certain situations when the registrant bears the cost of insurance against
            liabilities of directors and officers.
Rule 460: provides that as a condition to acceleration of the waiting period, the SEC
            will consider whether the issuer has taken reasonable steps make the
            information contained in the registration statement available to dealers
            who may participate in the distribution = Forcing distribution of
            preliminary prospectus!!!
C. AMENDMENTS
Rule 472: sets out the rules for filing amendments
Rule 473: permits what is in effect a permanent delaying amendment to be filed along
            with the original statement, and an amendment to make a RS effective.


D. WITHDRAWAL
Rule 477: a registration statement or any amendment or exhibit thereto may be
            withdrawn upon application of the registrant only if the SEC finds such
            withdrawal consistent with the public interest and the protection of investors.
            This rule is designed to avoid cases in which a registrant allows
            misrepresentations to disseminate in the market, so that it can later withdraw
            the registration and sell privately by exploiting the misinformation.




                                                                                              24
E. REGULATION M (THE ―TRADING RULE‖): ALLOWS MKT. STABILIZATION PURCHASES DURING PUBLIC
OFFERING
    SEC uses its broad authority under §10(b) to promulgate ―trading practices rules‖ (Reg. M) prohibiting
    market manipulation during a public distribution, but permitting market stabilization purchases if issuer
    is a large public company and securities are actively traded ($150 float and $1 million ADTV).
    Regulation M is not a safe harbor. If intent to manipulate can be shown, a dealer, underwriter, or any
    other person would presumably violate Rule 10b-5, even if it complied with the applicable rules under
    Regulation M.
    Affiliates of underwriters, selling shareholders, or issuers are excluded so long as the underwriter
    or issuer maintains information barriers (Chinese Walls).


Rule 101: prohibits distribution participants (underwriters, prospective underwriters,
            broker/dealers, or other persons who have agreed to participate in the
            distribution) from bidding or purchasing the covered securities during the
            applicable restricted period.
            Securities with an Averaged Daily Trading Volume (―ADTV‖) of at least
            $1 million and are issued by an issuer with a float of $150 million are
            exempted.
            The prohibition remains for these actively traded securities, however, during
            distribution.
Rule 102: prohibits the issuer (or selling shareholder) from bidding or purchasing the
            covered security during the restricted period. Securities with an ADTV of at
            least $1 million that are issued by an issuer whose common equity securities
            have a float of at least $150 million are exempted. The prohibition remains
            for these actively traded securities, however, during distribution.
Rule 103: permits an underwriter or dealer to continue to make a market on Nasdaq in a
            security during distribution. However, the market maker must remain
            ―passive;‖ that means that its bid or purchases cannot exceed the highest
            independent bid for, or purchase of, a covered security at the time of the
            transaction. It also places limitations on the aggregate amount that can be
            purchased in a day. These prohibitions are limited to Nasdaq and do not
            apply to other over-the-counter securities.
Rule 104: continues the prior practices with regard to stabilization, which (1) require
            any person entering a stabilizing bid to grant priority to independent bids; (2)
            permit only one stabilizing bid to be made at a time in any market; and (3)
            requires disclosure to the market of any stabilizing bid.
Rule 105: prohibits short selling
Rule 100: when a security has an ADTV of $100,000 or more and its issuer has a public
            float of $25 million or more, the restricted period begins one business day
            prior to the determination of the offering price (or such later time when the
            person becomes a distributive partner.) Otherwise, the restricted period
            begins 5 business days prior to the determination of the offering price or
            when the person becomes a distributive partner.




                                                                                                           25
3. REGULATION OF UNDERWRITERS
  1) Underwriters are scrutinized during the distribution process by the SEC and the NASD
  2) NASD reviews and limits the amount of compensation that underwriters may receive in connection with a
     public offering. An underwriter may not (1) purchase securities of the issuer at a price significantly below
     the offering price within a 12-month period before the offering; (2) receive warrants to purchase issuer
     securities in excess of ten percent of the securities to be offered or warrants having an exercise price below
     the offering price or a maturity in excess of five years; (3) obtain an over-allotment option exceeding 15
     percent of the offering; or (4) sell warrants or stock received from the issuer as compensation until one year
     after the offering is completed.
  3) An underwriter is forbidden from siphoning off securities intended for the public to itself, its affiliates,
     or other allies, based on knowledge that the offering is oversubscribed.
  4) Three techniques are used by the institutional investor to outflank the fixed price offering scheme:
     a) institutional investor may be given free research by the underwriter;
     b) institution may engage in a ―swap‖ or ―overtrade‖ by which it exchanges securities in its portfolio for
          securities in the offering at a ratio that amounts to a discount; and
     c) institution can ―recapture‖ some of the underwriting discount by forming its own broker-dealer
          subsidiary to participate in the syndicate.




                                                                                                                 26
                       THE POST-EFFECTIVE PERIOD
1. WHAT’S ALLOWED
  2 prohibitions:
      1) prohibits any prospectus unless it complies with §10 - §5(b)(1), and
      2) prohibits any delivery of securities unless accompanied (or preceded) by a §10(a) STATUTORY
           prospectus
  1) Final Prospectus Requirement (§5(b)(1))
         After the registration statement has become effective, a §10(a) prospectus may be used for §5(b)(1)
         purposes, but a §10(b) summary prospectus may also be used pursuant to Rule 431 for
         informational and screening purposes.
  2) Prospectus Delivery Requirement (§5(b)(2))
         a) §2(a)(10) defines prospectus to include confirmations. In the post-effective period it is thus an
             illegal prospectus because it is not a 10(a) or 10(b) prospectus. However, §5(b)(2) essentially says
             that a confirmation is not an illegal prospectus if accompanied by a 10(a) prospectus.
         b) Once the RS has become effective, the seller may not mail a written ―confirmation‖ without
             accompanying it or preceding it with a statutory prospectus. Indeed, if the negotiations are face
             to face, and no written confirmation is transmitted by the use of the mails or other instrumentality of
             interstate commerce, then the security may not be mailed unless accompanied or preceded by a
             statutory prospectus.
         c) Incidentally, because the confirmation with which the 10(a) prospectus is sent comes after the sale,
             the Act does not require the buyer to have the prospectus at the time the actual investment decision
             is made.
  3) Free Writing - §2(a)(10): excepts from definition of prospectus any written sales literature if
     accompanied by (or preceded) by a final §10(a) prospectus.
  4) Rule 434 - allows information traditionally required to be included in the statutory prospectus to be
     delivered instead to investors in piecemeal fashion in multiple documents.
  5) Confirmation - §2(10) defines prospectus to include a written sales confirmation. To comply with UCC
     sales writing requirements, under §2(10)(a) a confirmation is not a prospectus if it accompanied or preceded
     by a statutory prospectus. Effect – to compel dissemination of statutory prospectus to every purchaser in
     post-effective period. (Otherwise a confirmation by an issuer, underwriter or dealer would be a prohibited
     prospectus).
  6) Delivery of Securities – despite prospectus delivery requirements, Rule 153 allows compliance with the rule
     by delivery of prospectus to the stock exchange instead of the purchaser.

2. DURATION OF DELIVERY REQUIREMENT:
  Length of Prospectus Delivery Obligation – see §4 – continues to apply:
                  - indefinitely for sales by an issuer (§4(1))
                  - indefinitely for sales by an underwriter for issuer‘s original allotment ((§4(3)(C)).
                  - sales by dealers (subsequent trading)
                      - 90 days if it‘s the issuers first registered offering (§4(3))
                      - 40 days if issuer has other reg. offerings (§4(3)(B))
                      - 25 days if securities are listed on exchange or NASDAQ (Rule 174(d))
                      - 0 days if issuer was a reporting company when it registered(Rule 147(b))
                  - dealers acting as brokers for a customer – no prospectus delivery requirement.




                                                                                                                  27
A. EXCEPTIONS TO THE 40-DAY REQUIREMENT:

Rule 153: is stock traded on exchange, prospectus can be delivered to the exchange
           instead of to the purchaser (does not apply to NASDAQ)
Rule 174(b): if issuer is a reporting company when he filed for registration, dealer is
           not obligated to deliver a prospectus
           (the reporting requirements of §13 or §15(d) of the 1934 Act – i.e. a §12(b)
           or §12(g) company (important exception!)
Rule 174(d): delivery requirement for dealers = 25 days after the offering date, if the
           security is listed on a national securities exchange or authorized to trade on
           NASDAQ.
Rule 15c2-8: Rules for Delivery of a Prospectus (to avoid liability for deceptive acts!)
           (a) Broker dealer must take reasonable steps to mail final prospectus to
           those who ask
           (b) Broker dealer must take reasonable steps to deliver final prospectus to
           associated persons who will be soliciting
           (c) Managing underwriter must make copies of final prospectus available to
           participating broker dealers to enable them to comply with (d) and (e) of the
           Rule.
           (d) Managing underwriter ―shall take reasonable steps to see that any broker
           or dealer participating in the distribution or trading in the registered security‖
           is furnished adequate copies of the prospectus.
§4(3) – Dealer exemption: exempts from the delivery requirement of §5 dealers
           (including underwriters who are no longer acting as such in respect of the
           security involved in such transaction) with three exceptions:
           (1) illegal transactions
           (2) transactions taking place prior to the expiration of 40 days after the first
           date upon which the security was bona fide offered to the public by the issuer
           or by or through an underwriter
           (3) transactions as to securities constituting the whole or a part of an unsold
           allotment to or subscription by such dealers as a participant in the
           distribution of such securities by the issuer or by or through an underwriter.


B. ELECTRONIC DELIVERY:
   The SEC would view information distributed through electronic means as satisfying the delivery of
   transmission requirements of the federal securities laws if such distribution results in the delivery to the
   intended recipients of substantially equivalent information as these recipients would have had if the
   information were delivered to them in paper form. As in the case with paper delivery, there should be an
   opportunity to retain a permanent record of the information. Recipients must have access to the chosen
   electronic medium. The issuers should get the recipient’s consent to use the electronic medium. (see
   examples page 156)


C. CORRECTIONS OF INCORRECT DISCLOSURE
   departure of CEO, adverse court judgment now makes the prospectus misleading.
  1) Rule 424: rules for filing the prospectus with the SEC
      Rule 424(b) - post-effective revisions to the prospectus filed with a RS :
      if the prospectus omitted price-related information (in reliance on Rule 430A or Rule 415 – shelf
      registration), 10 copies of a new prospectus containing such information shall be filed with the SEC
      w/n 2 business days after the determination of the price or the first sale;

        all prospectuses sent out must have a sticker on cover page supplying missing information (to avoid
        liability under §12);



                                                                                                            28
               The language of Rule 424(b) implies that the new prospectus does not have to be a part of the RS.
               However, Reg S-K, Item 512(i) requires a revised prospectus filed under this Rule (supplying price
               information pursuant to Rule 430A) to be included as part of the RS as of the effective date.
               Under Rule 430A, if such new prospectus filed later than 15 business days after the effective date, it
               has to filed as a post-effective amendment to the RS, not as a Supplement!
               Reg S-K, Item 512(i): any post-effective amendment containing a form of prospectus shall be
               deemed a new RS, and the offering of covered securities at that time shall be deemed to be the first
               bona fide offering thereof.

         2) Rule 418: where appropriate, the SEC may request supplemental information. This information,
            however, will not be deemed part of the registration statement, so not subject to liability
            provisions of §11. However, if information is added by amendment, it is subject to §11 liability
            provisions.
         3) Rule 463 (anti-fraud): requires first-time issuers to file a Form S-R = report on the use of the
            proceeds from the issue (w/n 3 months + 10 days after the effective date, and at 6-month intervals
            until the termination of the offering).
         4) SEC v. Maynard Nursing Centers
            prospectus turns out to be wrong (perhaps on purpose); has the effect of voiding the registration
            case not widely followed – held purchasers could rescind b/c a fundamentally deficient prospectus
            cannot comply with §10, and therefore violates §5.


      NB! If information is now misleading, but was accurate at the time of delivery, the
                  information is still okay for the purpose of the 10(a) prospectus requirement,
                  but it not okay with respect to the anti-fraud provisions. So, the info in the
                  prospectus needs to be corrected to reflect post-effective changes.


      D. HOW LONG CAN A PROSPECTUS BE USED IN A PUBLIC OFFERING?
         9 month cutoff – info cannot be older than 16 months
         §10(a)(3): puts a time limit on the validity of a 10(a) prospectus; when a prospectus is used more than
         9 months after the effective date, the information cannot be more than 16 months old at the time of use,
         so long as the information is known to the user of such prospectus


3. SHELF REGISTRATION AND BEYOND
  For issuers that are constantly issueing new securities, they can prepare ONE SINGLE registration statement,
  thereby registering all securities they may offer at any time in the future.
  Problem – inadequate disclosure.
      §6(a):    shelf registration - Any security may be registered… by filing a registration
                statement in triplicate and signed by specified officers. A registration
                statement shall be deemed effective only as to the securities specified therein
                as proposed to be offered.
      Rule 415: permits registrant to register securities for future sale
                Applies to traditional shelf offerings (in which registrant undertakes to
                update the material changes in the prospectus through post-effective
                amendments) listed in the Rule and to registrants eligible to use the short
                form registration statement (Form S-3).
          
               In a universal shelf registration, the registrant does not have to describe the securities – only for
               large issuers using Form S-3; they just have to deliver the ―term sheet‖ (omitted price-related info)
               and an S-3 prospectus at the time of the offering,
          
               ―Offerings at the market‖ are permitted if the registrant uses an underwriter.



                                                                                                                       29
                                 EXEMPTIONS FROM §5
Rationales for exemptions – given high cost of registration, SEC provides exemptions where it may be unduly
expensive given investor sophistication, state securities regulation, or issuer‘s small capital needs.
Caveat – exempt offerings (1) remain subject to antifraud provisions of securities laws (SEC can proceed against any
seller under §17 of ‘33 Act); (2) Purchasers still may have a private right of rescission under §12 for misrepresentation
in an offering, and (3) rule 10b-5 still applies
1. EXEMPT SECURITIES
    §3(a) – enumerates securities that can be sold without compliance with §5.

         A. EXEMPT SECURITIES
            exempt securities are always exempt from registration, when issued and later when traded
            
               government securities (§3(a)(2))
            
               commercial paper (§(3(a)(3))
            
               securities subject to other regulation (banks, S&L‘s, insurance companies, ee pension plans – all
               regulated by state laws)
            
               securities of non-profit issuers (§3(a)(4))

         B. EXEMPT TRANSACTIONS
            do not become exempt themselves; each time they are resold, they must find a transaction exemption
            
               intrastate offerings, private placements, and exchanges by the issuer
            
               Any security exchanged by the issuer with its existing securities holders where no commission or
               other remuneration is paid
            
               Any security issued in exchange for outstanding securities, where the terms and conditions of the
               exchange are approved, after a hearing on the fairness of the exchange
            
               Any security in intrastate offering (see below)
            
               Integration requirement: an issuer cannot slice and dice an offering so different parts fit separate
               exemptions if the whole offering fits none. 5 factor test: whether multiple offers and sales constitute
               an integrated offering:
                     1) part of a single plan of financing
                     2) involve same class of security
                     3) took place at about the same time
                     4) involved the same consideration
                     5) made for the same general purpose
                     Safe harbors: sets of sales separated by 6 months are not subject to integration (Rule 502(a) –
                     Reg. D, Rule 147(b)(2) – intrastate offerings, Rule 152 - §4(2) exemption)




                                                                                                                      30
2. INTRASTATE OFFERINGS
    §3(a)(11)    exempts issues sold only within one state, where issuer is doing business in
                 the state
    Rule 147     safe harbor for intrastate offerings
                 defines requirements for purposes of §3(a)(11)

    A. §3(A)(11) – INTRASTATE EXEMPTION
       exempts purely local offerings – by in-state issuers to in-state residents. No numerical limitations, but
       very narrowly interpreted, so issuers rely on it at their peril.
       a) The entire issue must be:
                - offered and sold exclusively to residents of the state in question;
                - come to rest in the hands of the residents within the state. Any sale to a non-resident voids
                    the exemption.
       b) ―Doing business within the state‖ =
                - Substantial amount of activities undertaken in state of incorporation
                - Proceeds of the offering to be used for purposes primarily in the state
       c) Residence within the state =
                - Issuers, offerees, and purchasers must be resident of the state (principal residence; principal
                    place of business)
                - Mere presence in the state is not sufficient for residence (domicile).
       d) Exemption will be defeated, if during the course of distribution, any underwriter, dealer, or other
           person were to offer or sell the securities to a non-resident.

    B. RULE 147
    a) Rule is available only for transactions by an issuer and not for secondary transactions. By its terms, it
       does not protect controlling persons, but by §3(a)(11) issuer and affiliates are protected.
    b) Intrastate offering exemption may be available for secondary offers and sales by controlling persons of
       the issuer, if the exemption would have been available to the issuer.
    c) Rule 147(a): offers and sales by an issuer to persons resident within a single state or doing business
       within a single state.
    d) Rule 147(b) - integration ―safe harbor‖ rule: no integration with §3 or §4(2) exempt offerings w/n 6
       months before and 6 months after the Rule 147 issue, as long as no sales or offers to sell securities of the
       same or similar class by or for the issuer.
       If safe harbor is not available, look at the 5 factors for integration:
            1) Are the offerings parts of a single financing plan?
            2) Do the offerings involve issuance of the same class of securities?
            3) Are the offerings made at or about the same time?
            4) Is the same type of consideration to be received?
            5) Are the offerings made for the same general purpose?
    e)   Rule 147(c): Doing business within the state if:
              1) Issuer derived at least 80% of its gross revenues and those of its subsidiaries from operation in
                 the state;
              2) At the end of its most recent semiannual fiscal period, had at least 80% of its assets located
                 within the state;
              3) Issuer intends to use at least 80% of the net proceeds from the issue in connection with
                 operations in the state; and
              4) The principal office of the issuer is in the state.
    f)   Rule 147(d): sales only to residents in the state; a person is a resident if their principal residence is in the
         state


                                                                                                                      31
g) Rule 147(e) – resale restrictions: For a period of nine months from the last sale by the issuer, any
   resales of any part of the issue must be made only to person resident within the state.
h) Rule 147(f): Issuer should take precautions against interstate offers: use a legend, stop transfer orders,
   obtain written representation of each purchaser‘s residence

C. §3(A)(11) AND RULE 147 CHART

                                               §3(a)(11)                              Rule 147
        Scope of offering       all securities offered as ―part of an    sets of sales separated by 6
          (integration)               issue‖ are integrated                    months are not integrated
          In-state issuer       ―resident and doing business‖ within     principal office within state and
                                      the state                               80% of gross revenues,
                                                                              assets, and intended use of
                                                                              proceeds are within the
                                                                              state
         In-state offerees      offerees must be domiciled within        offerees must have principal
                                      the state                                residence within the state
         Restrictions on        securities must ―come to rest‖ piror     9 month safe harbor holding
             resales                 to being resold                         period




                                                                                                                32
3. PRIVATE PLACEMENT EXEMPTION

                            1933 ACT EXEMPTION PROVISIONS

    §4: The provisions of §5 shall not apply to –
    1) transactions by any person other than an issuer, underwriter, or dealer.
    2) transactions by an issuer not involving any public offering
    3) transactions by a dealer (including an underwriter no longer acting as an underwriter
        in respect of the security involved in such transaction), except
        if such transaction takes place prior to 40 after the first date upon which the security
        was bona fide offered to the public by the issuer
    4) brokers‘ transactions executed upon customers‘ orders on any exchange or in the
        over-the-counter market but not the solicitation of such orders.

    §2(a)(4) ISSUER: any person who issues or proposes to issue any security


    A. RATIONALES
       Embodies a Congressional judgment that registration is unnecessary when investors on their own have
       adequate sophistication and information to protect themselves. Important because more than 2/3 of all
       debt issued is privately placed; to not exempt it would pose a huge burden on capital formation in this
       country.
       
          §4(2): exempts transactions by an issuer not involving any public offering.
       
          Rule 152: The phrase ―transactions by an issuer not involving any public offering‖ in §4(2) shall be
          deemed to apply to transactions not involving any public offering at the time of said transactions
          although subsequent thereto the issuer decides to make a public offering and/or files a registration
          statement.
          Effect – the issuer can change his mind and not have to integrate the 2.

    B. BEFORE RALSTON PURINA – WHAT USED TO CONSTITUTE A NON-PUBLIC OFFERING
       
         Number of Offerees: offering to < 25 people, sometimes up to 100 people if they were institutional
         investors (the SEC was concerned with offerees, not buyers)
       
         Availability and Access of Information: key factor to be considered (some argue should be only
         factor). Either the issuer furnishes the information or the investor has access to the information by
         virtue of position or power
       
         Nature of the Offerees: financial sophistication of buyer and his ability to bear risk
       
         Manner of Offering: concept of private offering precluded general advertising
       
         Limitation of Resales: if resales occur, then statutory underwriter status may be triggered, which is
         tantamount to a public offering

    C. SEC V. RALSTON-PURINA (1953)
       gave operative framework for §4(2) exemption. Company offering stock to ee’s without registration –ct
       rejected argument that selling to a limited class of people it is not a public ofering (ee’s are not
       sophisticated, dockworkers and clercks, not executives)
       
           The private placement exemption should apply only to those buyers who do not need the protections
           of the 1933 Act – investors who already have access to information which would be disclosed in
           registration. Inquiry: need for protection of ’33 Act.
       
           2components to the access to information requirement:
            1) sophistication– the offeree is knowledgeable enough to understand financial information, and
            2) access to information–he has sufficient leverage to demand information.



                                                                                                             33
    
        Burden of showing that the offerees were ―able to fend for themselves‖ is on the party seeking an
        exemption (issuer).
Ralston Purina Private Placement Test:
1) offeree has information or access to it, AND
2) is financially sophisticated
no numerical limitations on # offerees
burden on party claiming exemption to show these factors are met

D. JUDICIAL INTERPRETATION OF RALSTON PURINA—STRICT
   Courts interpret Ralston Purina test very strictly; every OFFEREE (not purchaser) must meet the
   requirements of private placement test.
   
      Sophistication without information – denied §4(2) exemption where sophisticated investors in a
      franchise received no disclosure or access to information (Hill York)
   
      Information without sophistication – denied §4(2) exemption when investors received information
      comparable to registration disclosure, but lacked investment sophistication. Requires personal
      contact with corporate officers (Continental Tobacco)
   
      Information access, but no actual disclosure – investors must either receive or have access to
      information comparable to registration statement. Access can be shown by investor‘s insider status,
      family, or privileged relationship with issuer, or economic bargaining power (Doran v. Petroleum
      Mgmt Co.). A person claiming a §4(2) exemption must show that EACH purchaser and EACH
      offeree (even one who does not purchase) meets the sliding scale test. Absent this showing, the
      exemption is lost for the entire offering.
   
      all these cases hold that the private offering exemption is lost unless:
                 a) the offer was made to a very limited number of offerees;
                 b) who must be sophisticated purchasers having a relation to each other and to the issuer
                     with access to all the information a registration would disclose
                 c) with an actual opportunity to inspect the company‘s records or otherwise verify the
                     statements made to them.
Expanded Private Placement Test:
1) each offeree and each purchaser
2) is financially sophisticated, AND
3) has an actual opportunity to inspect books
- has a relation to each other and with corporate officers
- actual opportunity to verify info (ie. inspect books)
- small # offerees
4) no general solicitation
5) no resale to unqualified investors
   (turns whole offering into public distribution and turns them into statutory
   underwriters §2(11))



NB! A knowledgeable securities lawyer should take certain steps to ensure that the
          offerees qualify as sophisticated investors, such that the §4(2) exemption is
          not forfeited: 1) a private placement master schedule, setting forth all
          significant events that must occur throughout the offering period to meet the
          conditions of the rule; 2) a private placement memoranda distribution record;
          3) potential offeree identification form; 4) offeree questionnaire; 5) potential
          offeree evaluation form; 6) offeree representative documents; and 7) final
          evaluation form.



                                                                                                            34
4. SMALL OFFERING EXEMPTIONS
  Offerings up to $5 million - §3(b)
      §3(b)       Public Offering exemption
                  if issue is very small or not necessary in the public interest.
                  Regulations A and D adopted pursuant to this authority.
          pursuant to §3(b)…
          Regulation A – ―short registration‖ for offerings during 12-month period having aggregate price up to
          $5 million (Rules 251-264). Exempts offerings that use an ―offering circular‖ and comply with filing
          and circular delivery requirements that mimic §5. Only available to non-reporting companies that are
          not subject to ―bad boy‖ provisions (ie. under SEC review, enjoined in the last 5 years, etc.). Recently,
          Regulation D much more used.
          Rules 504 and 505 of Reg. D – SEC uses §3(b) authority to exempt small offerings up to $1 million
          (Rule 504) and nonpublic offerings up to $5 million as long as there‘s no more than 35 ―non-accredited
          investors‖ (Rule 505). Along with §4(2) exemptions, these make up Regulation D.
  ―Accredited Investor‖ Offerings - §4(6). Up to $5 million made solely to accredited investors (def.) §2(15),
  Rule 215. Requirements: no advertising or public solicitation, notice to SEC.


      §4(6)       Small Private Issue exemption (<$5million)
                  exempts offerings solely to accredited investors, no advertising or public
                  solicitation
      Rule 215    accredited investor (def)-
      §28         General Exemptive Authority of SEC
                  may exempt any person, security or transaction from any requirement if it‘s
                  in the public interest and consistent with protection of investors.
      Reg. D      key non-public offering exemption – private placement safe harbor
                  (Rules 501-506)
      Rule 501    accredited investor (def)
      Rule 502    General Conditions to be Met (under Reg. D)
                  integration, information, limitation on manner of offering and resales
      Rule 503    filing of notice of sale
      Rule 504    Exemption for Issues <$1 million
      Rule 505    Exemption for issues <$5 million
      Rule 506    Unlimited $ issues
                  35 purchasers max, those who are non-accredited have financial knowledge
                  (or their investment advisers)
      Rule 507    ―bad boy‖ provision- no exemption for companies that have been subject to
                  injunction
      Rule 508    ―insubstantial and insignificant‖ provision – Reg. D exemption is not lost
                  if made a mistake in good faith


      A. §3(B) – PUBLIC OFFERING EXEMPTION:
         gives the SEC power to exempt securities from §5 registration requirements, if it is not necessary in the
         public interest b/c of a small amount or limited offering (no need for special protection). Current
         amount limitation = $5 million.
         (Reg. A, Reg. D were adopted pursuant to that authority.)

      B. §4(6):
         exempts offerings made solely to accredited investors; amount limitation - $ 5 million



                                                                                                                 35
C. §28
   gave SEC broad exemptive power: it can exempt any person, security, or transaction from any
   requirement of the Act, if it is in the public interest and consistent with the rest of the Act.

D. RULE 215:
   definition of accredited investor:
            - bank, investment company, broker or dealer, trust with assets over $5 mil., etc.
            - director or executive of the issuer
            - natural person with net worth over $1 mil.
            - natural person with annual income over $200,000 for the preceding 2 years ($300,000 of
                 joint income with a spouse)
            - same definition (slightly expanded list of entities) – in Rule 501 of Reg. D.
E. REGULATION D (RULES 501-506) – THE KEY NON-PUBLIC OFFERING SAFE HARBOR
   
     In 1982, SEC adopted Regulation D to deal with private placements. This is a safe harbor if you
     comply with the rules. It is predicated on the private placement exemption of §4(2) and the
     exemptive powers of §3(b).
   
     Applies only to issuers (not control persons!)
   
     securities issues are restricted
   
     alternative to Reg. A (see below)
   
     3 exemption rules:
      1) Rule 506: private offering exemption under §4(2) – ―safe harbor‖ for §4(2) exemption
      2) Rule 505: small issue exemption under §3(b)
      3) Rule 504: small issue exemption under §3(b)
        1.   Rule 501: accredited investors
             Definition of ―accredited investor‖ includes an extensive list (institutional investors, private
             development companies, tax-exempt charities etc. – see above)
        2.   Rule 502: 4 General conditions to be met:
             (i) 502(a) Integration:
             All sales that are part of the same Reg. D offerings must meet all the terms and conditions.
             Sales 6 months before and 6 months after Reg. D offering will be considered part of that
             offering.
             Factors to consider when determining whether offers or sales (w/n the 6-month period) should
             be integrated:
             - whether the sales are part of a single plan of financing;
             - whether the sale involved issuance of the same class of securities
             - whether the sales have been made at or about the same time
             - whether the same type of consideration has been received
             - whether the sales are made for the same general purpose
             (ii) 502(b) Information requirements:
             - if the issuer (which cannot be a reporting company under ’34 Act) sells securities under
                   Rules 505 or 506, it is required to furnish the specified information (non-financial and
                   financial statement information) to any purchaser that is not an accredited investor (but
                   encouraged to supply info even to accredited investors, to avoid anti-fraud liability!);
             - if the issuer is selling securities under Rule 504, or to any accredited investor, info is not
                   required (but must comply with any state disclosure requirements!)
             (iii) 502(c) Limitation on the manner of offering: no public solicitation under Rule 505 and
             506
             ―General solicitation‖ - SEC interpreted that the key for distinguishing ―limited‖ from ―general‖
             is the substance of prior relationship between the issuer (its agents) and the offerees.


                                                                                                                36
     (iv) 502(d) Limitation on resale: resales restricted for securities issued under
     Rules 505 and 506 (if sold to accredited investors w/o disclosure, and then the accredited
     investor sold it to the public – there is a violation!)
3.   Rule 503 Notice:
     w/n 15 days after the first sale of sec. under Reg.D, the issuer must file a notice with SEC
     (Form D). Requirement has been relaxed with adoption of Rules 507-508.
4.   Rule 504
     - buyers- unlimited
     - eligible issuers - only non-reporting companies (under ‘34 Act)
     - amount – cannot exceed $1 million
     - Must comply with §502(c) and (d)
     - No information distribution requirements
5.   Rule 505
     - Buyers: number of purchasers limited to 35+ accredited investors
     - Eligible Issuers: Available to reporting and non-reporting companies (as long as not
         investment companies)
     - Aggregate Offering Price: shall not exceed $5 million
     - If sold to non-accredited investors, then must meet info requirements of §502(b).
6.   Rule 506
     - Buyers: 35 purchasers + accredited investors (sophisticated purchasers or have
         representatives)
     - Eligible Issuers: any issuers
     - Aggregate Offering Price: unlimited
     - If sold to any non-accredited investors, then must meet info requirements of §502(b).
7.   Rule 507: “Bad Boy” provision
     denies exemption to issuers that have been subject of an injunction for failure to file notice
     under Rule 503
8.   Rule 508
     Issuer won‘t lose the Reg. D exemption if he made a minor mistake while attempting in good
     faith to comply with the regulation (―Insignificant and Insubstantial‖ provision).




                                                                                                      37
         9.    Regulation D chart

Comparison
                         Rule 504                  Rule 505                  Rule 506
  Item
                  $1 million
                  (w/n 12 months)           $5 million (12 months)
                  Aggregation with:         Aggregation with: other
                                                                      Unlimited (emphasis
                  other Rule 504            Rule 505 offerings;
Dollar Ceiling                                                        on non-public nature,
                  offerings; other          other §3(b) exempt
                                                                      not small issue!)
                  exempt §3(b)              offerings; offerings in
                  offerings; offerings in   violation of §5.
                  violation of §5.
 Number of                                  35 plus unlimited         35 plus those
                  Unlimited
 Investors                                  accredited investors      purchasing $150,000
                                                                      Non-accredited
                                                                      purchasers (not
                                            Accredited                offerees) must be
                  None required (no         (presumed qualified)      sophisticated (alone or
 Investor
                  sophistication            plus 35 non-accredited    with representative) –
Qualification
                  requirement)              (no sophistication        must understand risks
                                            requirement)              & merits of investment.
                                                                      Accredited presumed to
                                                                      be qualified
                  General solicitation
 Manner of                                  No general solicitation   No general solicitation
                  permitted
 Offering                                   (Rule 502)                (Rule 502)
                  (“test the waters”)
 Limitations
                  No restrictions           Restricted                Restricted
  on Resale
                  NO:                       No investment
                  reporting companies       companies; no issuers
                  investment companies;     disqualified under Reg.
   Issuer                                                               None (except for Rule
                  or ―blank check‖          A (Rule 262 ―Bad
Qualifications                                                          507 ―unworthy issuer‖)
                  companies;                Boy‖);
                  no Rule 507               no Rule 507 ―unworthy
                  ―unworthy issuer‖         issuer‖
                                            If purchased solely by accredited, no information
                                            specified; for non-accredited – Rule 502 info
                                            required:
                                            a) nonreporting companies must furnish the
                                                 same kind of info as in a registered offering
 Information      No information
                                                 or Reg. A offering, but with modified
Requirements      specified
                                                 financial statement requirements;
                                            b) reporting companies must furnish specified
                                                 SEA documents, or info in the latest SEA
                                                 reports or SA registration statement, plus
                                                 limited additional info about the offering.




                                                                                                 38
F. REGULATION E
      1. Rule 701 – compensatory benefit plans
         a) Exempts from §5 requirements certain offers and sales of securities pursuant to certified
             compensatory benefit plans and contracts relating to compensation by non-reporting
             issuers.
         b) Amount of securities that may be issued in reliance on the rule in any 12 month period is
             $500,000 or the amounts determined under two formulas: 15% of the issuer‘s total assets at
             the end of its last fiscal year or 15% of the amount of outstanding securities in the class
         c) Rule 701 offerings are discrete and not subject to integration with other offerings
        2.   ULOE
             Uniform Limited Offering Exemption.
             Promulgated by NASAA (North American Securities Administrators Assn), to facilitate the use
             of Reg. D, creates a uniform state exemption for Rule 505 and 506 offerings, but it‘s more
             demanding b/c of certain investor ―sophistication-suitability‖ requirements and bad boy
             disqualifications.

G. REGULATION A – RULES 251-263 – ―SHORT REGISTRATION‖
   Conditional Small Issues Exemption.
           - alternative to Reg. D
           - only non-reporting issuers.
           - Aggregate offering price ceiling $5 million
           - Securities issued are not restricted securities, and thus can be freely resold (this is an
                advantage over Reg. D)
           - Reg. A can be used for secondary offerings by existing securities holders, up to a
                maximum of $1.5 million in any 12-month period (counts toward the $5 million limit)
           - Not available to reporting companies and ―blank check‖ companies
   a) Rule 252: requires a scaled-down disclosure document (offering statement – Form 1-A, which
      contains an offering circular); there is a 48-hour delivery requirement for an offering circular.
   b) No sales before the offering is qualified.
   c) Rule 262 – “Bad Boy” disqualification provision - if the issuer (or any predecessor, affiliate, or
      director) has violated federal securities laws, it is banned from using Reg. A exemption for 5 years.
      Applies also to Rule 505 of Reg. D (most common alternative to Reg. A).
   d) Rule 254: ―test the waters” provision – issuer may deliver written documents (offers) to determine
      whether there is sufficient interest in a contemplated securities offering; such written documents
      must be registered with SEC (but failure to register does not destroy the exemption!). They must
      state that no sales are to be made before the offering statement is qualified.
   e) Integration
           1) The doctrine of integration entails the process of combining multiple offerings into a single
                offering, and the effect of such combination may be to destroy one or more of the
                exemptions.
           2) Reg. A offerings cannot be integrated with prior registered or exempt offering; can be
                integrated with subsequent Reg. A offerings.
           3) Rule 152: The phrase ―transactions by an issuer not involving any public offering‖ in §4(2)
                shall be deemed to apply to transactions not involving any public offering at the time of
                said transactions although subsequent thereto the issuer decides to make a public offering
                and/or files a registration statement. (No integration if the issuer changed its plan after
                testing the waters – no retrospective invalidation of exemption).




                                                                                                         39
         EXEMPTIONS FOR RESALES OF SECURITIES

1. CONTROL AND RESTRICTED SECURITIES
  Control securities – owned by a control person who is an affiliate of the issuer. SEC defines ―affiliate‖ of the
  issuer as anyone who directly or indirectly ―controls‖ the management and policies of the issuer, by virtue of
  ownership of voting securities. (Rule 405). SEC is concerned that when a control person sells his securities to
  the public, he might exploit his superior informational position. For this reason, the act controls sales by control
  persons as much as sales by issuers.
  Restricted Securities – securities originally bought in a nonpublic offering (from issuer or control person) cannot
  be resold to the public trading market without causing the purchaser-reseller to be treated as a conduit for the
  issuer or control person. Restricted securities may be acquired in a variety of ways:
       a) in a §4(2) private placement
       b) in a Rule 505 or 506 offering subject to the reselling limitations of Reg. D
       c) in a transaction meeting conditions of Rule 144A (resales to QIBs OK)
       Securities acquired in a restricted transaction retain their restricted character.

2. §4(1) EXEMPTION: TRANSACTIONS BY ISSUERS, UNDERWRITERS AND
   DEALERS



      §4(1): exemption for transactions by any person other than an issuer, underwriter, or
                 dealer. (Allows resale by shareholders without registration)

      §2(11): The term ―underwriter‖ means any person who has purchased from an issuer
                  with a view to, or offers or sells for an issuer in connection with, the
                  distribution of any security, or participates or has direct or indirect
                  participation in any such undertaking, or participates or has a participation in
                  the direct or indirect underwriting of any such undertaking; but such term
                  shall not include a person whose interest is limited to a commission from an
                  underwriter or dealer not in excess of the usual and customary distributors‘
                  or sellers‘ commission.
                   As used in this paragraph, the term ―issuer‖ shall include, in addition to an
                  issuer, any person directly or indirectly controlling or controlled by the
                  issuer, or any person under direct or indirect control with the issuer.

      Rule 405: The term ―control‖ means the possession, direct or indirect, of the power to
                 direct or cause the direction of management and policies of a person, whether
                 through the ownership of voting securities, by contract, or otherwise.


      A. §2(11) – STATUTORY UNDERWRITER
        1) purchases from an issuer/controlling person (prohibited source)
        2) with a view to the distribution of a security (subjective element of intent)
        3) offers or sells for an issuer in connection with the distribution of a security (prohibited activity)
        4) has a direct or indirect connection with a distribution
        5) participates in the underwriting of the distribution




                                                                                                                   40
      any person performing 1-3 for a control person becomes a statutory underwriter. 3 categories of
      underwritters:
      1) agent ―for issuer‖
      2) purchaser from issuer ―with a view to‖ distribute
      3) underwriter for control person

    B. WHETHER OR NOT EXEMPTIONS APPLY TO RESALES OF SECURITIES?
       §2(a)(11) focuses on distribution (as opposed to ordinary trading):
               1) The first question is was there a distribution?
               2) If yes, was the distribution by a prohibited source (issuer or controlling person)?
               3) If yes, then there is statutory underwriter status = no exemption. If no, then exemption
                    applies, even if there was a distribution (no underwriter status!)

         Rule 142 - exception: a person is not a statutory underwriter/ ―distribution participant‖
                 - if not affiliated with the issuer or principal underwriter, and
                 - if agrees to purchase from an underwriter the undistributed portion of the issue for
                      investment, not for further distribution
NB! As a practical matter, Rule 142 allows institutional investors (insurance, investment co., pension funds) to
make advance commitments to purchase blocks of securities to be offered at a discount from the public offering
price, w/o incurring liability of an underwriter.

    C. SEC V. CHINESE BENEVOLENT ASSN. – AGENT OF ISSUER
       even though  received no compensation for soliciting offers to buy bonds, they became statutory
       underwriters under §2(11) – agent for issuer
       Compensation from issuer is not a condition to being an underwriter.
       §4(1) exempts transactions by any person other than an issuer, underwriter, or dealer. §2(11) defines an
       underwriter as any person who purchased from the issuer with a view to, or sells in connection with, the
       distribution of any security, or participates or has a direct or indirect participation in any such
       undertaking.
       When the defendant endeavored to buy the securities for value, it engaged in selling unregistered
       securities. The solicitation of offers to buy the bonds, either with our without compensation, brought
       ‘s activities literally within the prohibition of §4(1).

    D. SEC V. GUILD FILMS – PURCHASE WITH A VIEW TO DISTRIBUTION
       pledged stock sold when loan defaults = distribution- purchase with a view to distribution
       Bank that sold debtor‘s stock in a foreclosure acquired statutory underwriter status under §2(11).
           1) banks cannot be exempted on the ground that they did not ―purchase‖ within the meaning of
               §2(11), because there is a disposition of a security for value
           2) Inquiry – did bank acquire the securities expecting the borrower would default? yes
           3) scienter is irrelevant; a necessary participant is subject to registration reqs.

    E. IRA HAUPT – UNDERWRITER FOR CONTROL PERSON
       BD acted as statutory underwriter in a distribution when assisted controlling shareholder sell 38%
       interest in the company over 6 months
             1.   Control (def)
                  Rule 405      The term ―control‖ means the possession, direct or indirect, of the power to direct
                  or cause the direction of management and policies of a person, whether through the ownership
                  of voting securities, by contract, or otherwise.
                  - ownership of 10% or more of voting stock raises a red flag
                  - SEC never issues ―no-action‖ letters on control issues – heavily factual!




                                                                                                                   41
                   -    Controlling persons and issuers have info that the public wants /needs to know – that is
                        why they have to register.
                   The §4(4) broker/dealer exemption also does not apply because these are control securities
                   4(4) permits individuals to sell their securities through a broker in an ordinary transaction,
                   during the period of distribution or while a stop order is in effect, without regard to §5
                   requirements. But the process of distribution itself, however carried out, is subject to §5
                   registration. §4(4) cannot exempt transactions by an underwriter executed over the Exchange in
                   connection with a distribution for a controlling person.
―Coming to rest in the hands of the public‖: when members of the public resell securities, it is not a
distribution; they are not underwriters. Even if it‘s a large institutional investor selling large blocks, the key
inquiry:
who is the source? If the securities are sold on behalf of the issuer or control person, the seller = statutory
underwriter. If not, exemptions apply.

                   Controlling person = issuer only for purposes of §2(11), to determine who is a statutory
                   underwriter
                   (otherwise, s/h would not be able to sell their securities w/o registration). Controlling
                   person is not an issuer for purposes of §5 registration - §4(1) exemption still applies to CP.
    F. §4(4): BROKER’S EXEMPTION
        executed upon customers’ orders on any exchange or in the over-the-counter market but not the
        solicitation of such orders
      1) During a distribution of securities, an ordinary investor can sell his securities through a §4(1)
          exemption. However, most of these transactions are conducted through brokers. §4(4) is aimed to
          protect the brokers who execute the transactions for the ordinary investor. The brokers need a
          transaction because they are defined as ―dealers‖ in §2(a)(12), which means the §4(1) exemption is not
          applicable to them.
      2) The customer must have his own exemption. A broker cannot use the §4(4) exemption if the
          customer is an issuer (which includes controlling person) because the broker will acquire §2(11)
          statutory underwriter status as in Ira Haupt.
          In other words, no §4(4) exemption for a broker-dealer assisting a controlling person in the sale
          of securities (= statutory underwriter)
              1.   U.S. v. Wolfson -
                   control persons claimed §4(1) protection because they were not issuers, underwriters or dealers
                   ans sold shs through a broker. Broker sold the stock for the controlling parties, which made the
                   broker an underwriter. Thus, the §4(1) exemption does not apply because the exemption applies
                   to certain transactions, not to certain classes of people.
                   When a broker = underwriter:
                        - no §4(1) exemption, and
                        - no §4(4) exemption




                                                                                                                     42
3. EXEMPTIONS FOR RESALE OF RESTRICTED AND CONTROL SECURITIES

      A. RULE 144 – SAFE HARBOR FOR SECONDARY DISTRIBUTIONS IN PUBLIC MARKETS
         defines when a person is an underwriter and clarifies when control persons/holders of restricted stock
         may sell to public trading mkts. Rule 144 clarifies §4(4) broker‘s exemption by giving objective set of
         criteria establishing an investment intent to avoid underwriter status.
         control – securities owned by control person (affiliate) of issuer
         restricted - Rule 144(a)(3) (def)
         
             Purchased in a private placement - under §4(2) or §4(6).
         
             Purchased in a Reg. D Rules 504 or 505 distribution where there are restrictions on resale, or in Rule
             701 offerings (sales to employees)
         
             §1001 transactions
         
             Reg. S transactions
         Rule 144 safe harbor: the following activities are NOT distributions provided Rule 144 conditions are
         met:
         
             sales by non-control persons of restricted stock
         
             sales by control persons of restricted stock (and by their brokers)
         
             sales of control person‘s unrestricted stock
             No distribution  no statutory underwriter status  exemptions apply
      Rule 144(b)Safe Harbor:
                 Any affiliate or other person who sells restricted securities of an issuer for
                 his own account (dealer), or any person who sells restricted or any other
                 securities for the account of an affiliate of the issuer of such securities
                 (broker), shall be deemed not to be engaged in a distribution of such
                 securities and therefore not to be an underwriter thereof within the meaning
                 of §2(11), if all the conditions of Rule 144 are met:
                 (1) current public information about issuer
                 (2) holding period
                 (3) limitations on amount sold
                 (4) manner of sale
                 (5) notice of sale

                 1.   Rule 144 RESTRICTIONS

                                               Restricted                                   Control
   year 1                                         no sales
                                must comply with Rule 144 restrictions           rule 144 restrictions always apply
   year 2
                                                  (below)
   year 3                                     no restrictions
                                                 Restricted                                      Control
   holding period                                  1 year                                       not appl.
                                 (all restrictions disappear after 2 yrs)                (it‘s always control)
   amt. sold cannot exceed                                             greater of:
                                                            1% outstanding securities, or
                                                     average weekly trading in 3-month period
   sale method                                              ordinary broker‘s transactions
                                            (no solicitations of buyers or large commissions allowed)
   information                                  adequate current public info available about issuer
   notice to SEC                                                   filing Form 144
                                                       (if sell more than 500 shs or $10,000)



                                                                                                                      43
        1) Current Public Information: This requirement is satisfied if the issuer has (1) securities registered
           under the 1933 Act or the 1934 Act; and (2) has been subject to the reporting requirements for a
           period of at least 90 days prior to the sale; and (3) filed all 1934 Act reports required to be filed
           during the 12 months preceding the sale.
        2) Holding Period (important to show an investment intent, not ―view to distribution‖): The one-
           year holding period runs continuously from the later of the date of the acquisition of the restricted
           securities from the issuer or from an affiliate until their subsequent resale by either the initial
           acquiror or subsequent holder. Thus, a subsequent holder may tack the holding periods of all
           previous owners, other than affiliates. If a non-affiliate acquires restricted securities from an issuer
           or an affiliate of an issuer and an affiliate thereafter acquires any of these securities in a chain of
           transactions within one year of the non-affiliate‘s initial acquisition, a resale of the securities by the
           affiliate will trigger the beginning of a new holding period.
        3) Limitation on Amount of Sale: Both restricted and unrestricted securities are aggregated for
           determining the volume limitation for sales by affiliates. Only restricted securities are considered in
           determining the limitation on sales by non-affiliates. Where both a convertible and the underlying
           security are being sold, the amount of the underlying security for which the convertible being sold
           may be converted is aggregated with the sales of the underlying security in determining the
           aggregate amount of both securities allowed to be sold.
        4) Manner of Sale: Sales under the rule can be made either in brokers‘ transactions within the
           meaning of §4(4) or transactions with a market maker. The seller cannot solicit or arrange for the
           solicitation of buy orders or may any payment in connection with the sale other than usual
           commissions to the broker who executes the order.
        5) §3(a)(38): market maker is (1) specialist who is permitted to act as a dealer; (2) a dealer who acts as
           a block positioner; (3) a dealer who holds himself out as willing to buy and sell a particular security
           for his own account on a regular or continuous basis.

    B. SECONDARY PRIVATE PLACEMENTS (§4 (1 ½) AND RULE 144 A)
          1. §4 (1 ½)
             where offers and sales are to nonpublic investors =
             no public offering  no distribution  no u/w status under §4(2)  §4(1) exemption applies
             A person may resell restricted securities in a private placement, only if that person meets some
             of the established criteria for both §4(1) exemptions and §4(2) exemptions.
             The holder of the control/restricted securities must avoid statutory underwriter status to be
             eligible for §4(1) exemption. To do that:
                   a) the holder must not have purchased the shares with a view to distribution (holding for
                        a long period) and
                   b) must not offer to sell the shares for the issuer in connection with a distribution by
                        offering only to sophisticated investors (Ralston Purina)
             2.   Rule 144A
                  codified the §4(1 ½) exemption to facilitate trading in securities privately placed with
                  institutional. There is no distribution, and therefore no underwriter status for any securities firm
                  if resales are only to qualified institutional investors (―Q.I.B.‖), defined in Rule 144A(a)(i)
                  generally as any institutional investor with at least $100 million in a securities portfolio (or
                  banks with net worth of at least $25 million), and the securites cannot be traded on Exchange or
                  NASDAQ.
                  Notice to the buyer: the seller must take reasonable steps to make the buyer aware that the
                  seller can rely on Rule 144A‘s registration requirement (written disclosure).


NB! In the case of securities sold under Reg. D (with danger that resales might destroy the exemption), a person
that purchases securities from an issuer and immediately offers to sell the securities in accordance with Rule
144A does not become an underwriter within the meaning of Rule 502(d) or Reg. D.



                                                                                                                   44
4. EXTRA TERRITORIAL SALES

    A. REG. S (DEF)


    Rule 902(k): U.S. person means (i) a natural person resident in the U.S.; (ii) any
               partnership or corporation organized or incorporated under the laws of the
               U.S….

    Rule 902(h): An offer or sale of securities is made in an ―offshore transaction‖ if:
               (1) the offer is not made to a person in the United States; and
               (2) Either (a) at the time the buy order is originated, the buyer is outside the
               U.S., or the seller believes the U.S. is outside the U.S.; or (b) the transaction
               is executed through a physical trading floor or an establish foreign exchange

    Rule 902(c): Directed selling efforts means any securities activity undertaken for the
               purpose of, or that could reasonably be expected to have the effect of,
               conditioning the market in the United States for any of the securities being
               offered in reliance on Reg. S. The following are not directed selling efforts:
               tombstone ads, bona fide visits to real estate plants or other facilities in the
               U.S., providing journalists access to press conferences outside the U.S.



    B. REG S –
      1) Regulation S essentially reflects a shift from a ―national‖ approach focused on protecting U.S.
          nationals (wherever located) to a ―territorial‖ approach (which permits U.S. and foreign issuers to
          sell unregistered securities in foreign markets, even to U.S. nationals).
      2) With Reg. S, the Commission in its broadest sense said its okay to sell securities abroad to non-U.S.
          citizens and avoid flow back by prohibiting the conditioning of the market in the U.S.
      3) The safe harbors of Reg. S are not exclusive and are not intended to create a presumption that any
          transaction failing to meet their terms is subject to §5.
      4) Reg. S does not limit the scope or applicability of the antifraud or other provisions of the federal
          securities laws. (Reg. S offerings = subject to anti-fraud provisions)
        C) Rule 901: For the purposes of §5 the terms ―offer‖ and ―sell‖ shall be deemed to include offers and
        sales that occur within the United States and shall be deemed not to include offers and sales that occur
        outside the United States.
        D) Rule 903: provides a safe harbor for participants in a distribution, including issuer, underwriters,
        and selling group members

                 Category 1 (least dangerous): Foreign issuers without a U.S. market presence can use safe
                 harbor if:
                 1) securities are sold in offshore transactions and
                 2) no direct selling efforts are made in the U.S.; and
                 3) Trading of a substantial amount of such securities in the U.S. shortly after they had been
                     offered offshore may indicate a plan or scheme to evade the registration requirements;
                     where a transaction is part of such a plan or scheme, Reg. S is not available.

                 Category 2: Equity securities of a reporting foreign issuer with a substantial U.S. market
                 interest, or debt securities of a reporting foreign issuer, or of a non-reporting foreign
                 issuer with a substantial U.S. market interest can use the safe harbor if:
                 1) Securities are sold in offshore transaction; and



                                                                                                              45
                      2) No direct selling efforts are made in the U.S.; and
                      3) 1 year restricted period needs to be respected during which offers or sales may not be made
                         to U.S. persons; offering restrictions must be implemented, and a notice requirement
                         applies. The restricted period begins to run on the later of the date of the closing of the
                         offering or the date the first offer of the securities to persons other than distributors is
                         made.); and
                      4) Offering restrictions are implemented (contractual agreement that buyer will sell securities
                         in accord with the safe harbor); and
                      5) Must disclose that the securities are not registered.

                       Category 3 (most dangerous): For all other securities, such as equity securities of U.S.
                       reporting and non-reporting companies, and equity securities of non-reporting foreign
                       issuers with no significant U.S. market presence may use the safe harbor if:
                       1) Securities are sold in offshore transactions; and
                       2) No direct selling efforts are made in the U.S.; and
                       3) One year restricted period on sale of securities to U.S. persons; and
                       4) Buyers of equity securities must certify that buyer is not a U.S. person or buying for a U.S.
                            person;
                       5) Buyers of equities agree to resell only in accord with Reg. S; and
                       6) A legend must be placed on equity securities
             E) Rule 904: The resale safe harbor is available for offers and sales by all persons except an issuer, a
             distributor, an affiliate of either (other than specified officers and directors), and any person acting on
             behalf of the foregoing.
                  a) Securities are sold in offshore transactions; and
                  b) No direct selling efforts are made in the U.S.; and
                  c) The buyer is not a U.S. person.

NB! Generally, securities bought in a Reg. S offering are restricted securities, subject to Rule 144 (resale).
            Rule 12g3-2(b): exemptions from 12(g) for certain foreign issuers




                                                                                                                      46
5. REORGANIZATIONS AND RECAPITALIZATIONS – DOCTRINE OF ―SALE‖

     A. EXEMPTIONS FOR CORPORATE REORGANIZATIONS
                   - non-public offering §4(2) or Rule 506
                   - intrastate offering §3(a)(11) or Rule 147
                   - ―small issue‖ exemption under Reg. A
                   - limited offering under Reg. D
                   - Specific exemptions under §3(a)(9) or (10)
  General Provisions:
   §2(a)(3) - ―sale‖ shall include every contract for sale or disposition of a security or interest in a security, for
     value.
   §19(a) - Rule Making Authority: The Commission shall have authority form time to time to make, amend,
     and rescind such rules and regulations as may be necessary to carry out the provisions of this title.
  Under these provisions, corporate reorganizations and recapitalizations would be subject to registration


      A Reorg. – statutory merger
                 Merger: A (surviving corp.) + B (constituent corp.) = A
                 Consolidation: A + B = C
      B Reorg. – stock purchase
                 A purchases stock of B, which becomes a subsidiary of A
      C Reorg. – asset purchase
                 A purchases assets of B and assumes B‘s liabilities; B ends up with cash or
                 stock or whatever A paid for it and B dissolves.
  assume co. A is doing a reorg. for stock of B according to each type of reorg.

      Reorganization          Shareholder        Tax Consequences       Registration Required?
                              Vote
                A             A       yes                               §5 applies
                              B       yes              tax free
            (merger)

                                                                        §5 applies
                                                       tax free
                B             A        no
                                                  if 80% of stock is
                                                                        (Rule 145 does not
        (stock purchase)      B        no                               address b/c it is clearly
                                                       acquired
                                                                        ―sale‖)

                                                                        §5 applies only if:
                                                                        - dissolution of B, or
                                                                        plan provides for pro-rata
                                                                        distribution of A
                                                                        securities to
               C                                                        voting/consenting s/h of
           (stock for                                                   B, or
        assets/liabilities    A        no              tax free         - BoD of B ratifies
       AND liquidation of     B        yes                              measures above w/n 1
                B                                                       year after vote, or
                                                                        - subsequent dissolution
                                                                        or distribution is part of
                                                                        pre-existing plan for
                                                                        distribution of A
                                                                        securities




                                                                                                                      47
B. ISSUER EXCHANGES §3(A)(9)
§3(a)(9) - any security exchanged by the issuer with its existing security holders
             exclusively where no commission is paid or given directly or indirectly shall
             be exempt from registration requirements.
    1) Where issuer exchanges its own securities with current holders without paying a commission to
       anyone for soliciting the exchange (no pressure recapitalizations)
    2) issuer cannot offer securities for cash under §3(a)(9)!
    3) No solicitation (no proxy solicitation)! The issuer cannot hire an underwriter to solicit the class of
       security holders for the exchange.
    4) Subsequent resales of the securities that are exchanged are not exempted by §3(a)(9)
            - most investors will be able to resell using the §4(1) exemption
            - controlling persons remain controlling persons, and should they seek to resell their
                securities, the resulting transaction may involve a §2(11) underwriter. Remember that
                under Rule 147 there is a 9-month waiting period before securities issued in an exempt
                intrastate offering can be sold out of state, and an exchange under §3(a)(9) does not shorten
                the waiting period.
C. COURT-APPROVED EXCHANGES §3(A)(10)
§3(a)(10) exempts any security which is issued in exchange for one or more bonafide
          outstanding securities, claims or property interests, or partly in such
          exchange and partly in cash, where the terms and conditions of such
          issuance and exchange are approved, after a hearing, upon the fairness of
          such terms and conditions at which all persons to whom it is proposed to
          issue securities in such exchange shall have the right to appear, by any court
          or administrative agency.
  Difference from §3(a)(9)exemption:
    
       the securities need not be of the same issuer;
    
       the issuer can use a broker/dealer;
    
       securities can be offered for cash
    
       since these securities are not restricted, resales are not subject to Rule 144.

D. FUNDAMENTAL CORPORATE TRANSACTIONS (A, B &C REORGS) – RULE 145
   merger, sale of assets accomplished by vote of shs; replaced Rule 133 in 1972, abolished the ―no sale‖
   rule for certain corp. reorgs.
   1) Rule 145 subjects certain transactions involving business combinations to the registration
        requirements of the 1933 Act. It is intended to inhibit the creation of public markets in securities of
        issuers about which adequate current information is not available to the public. But it does not
        affect any available exemptions for corporate reorganizations!!!
   2) When registration required – reclassifications, transfer of assets, or statutory merger or
        consolidation
Rule 145(a): An ―offer‖, ―offer to sell‖, or ―sale‖ shall be deemed to be involved where,
           pursuant to statutory authority or provisions of the articles of incorporation
           or similar controlling instruments, or otherwise, there is submitted for the
           vote or consent of such security holders a plan of agreement for:

            (a) Reclassifications which involve the substitution of a security for another
            security (other than a stock split);




                                                                                                              48
             (b) Statutory merger or consolidation or similar plan or acquisition in
             which securities of such corporation or other person held by such security
             holders will become or are exchanged for securities of any other person,
             unless the sole purpose of the transaction is to effect a change in domicile.

             (c) Transfer of assets of such corporation or other person, to another person
             in consideration of the issuance of securities of such other person or any of
             its affiliates, if such plan involves dissolution of the corporation whose
             security holders are voting; or such plan or agreement provides for a pro-rata
             distribution of such securities to the security holders voting or consenting,
             etc. (see table).
             [A = issuer; B s/h = purchasers; B company = underwriter]
    3) Allowed communication
       Rule 145(b): since Rule 145(a) makes registration requirements applicable to certain transactions, a
       question arises whether notices of such transactions will constitute statutory prospectuses.
       Rule 145(b) provides that such ―bare-bone‖ notices will not be deemed a prospectus (as long as
       it‘s only a brief description of the transaction
    4) Form S-4: registration form to be used for transactions specified in Rule 145(a). In situation where
       shareholder approval of the transaction is required, Form S-4 may also serve as a proxy statement,
       thereby enabling the acquiring company and the company being acquired to combine registration
       statement/proxy statement and deliver to shareholders a single prospectus/proxy statement.
       (Delivery requirement – before the vote).
    5) Rule 145(c): Any person, other than the issuer, who acquires securities in a Rule 145 transaction
       and any affiliates of such person will be deemed underwriters if they resell the securities, except
       with respect to limited resales permitted in Rule 145(d).
    6) Rule 145(d) - exception: Persons specified in Rule 145(c) will not be deemed underwriters if they
       sell the securities under Rule 144 exemption:
             - in ordinary trading transactions
             - sell only limited quantities
             - the issuer is a reporting company (current info is publicly available)
             - seller is a non-affiliate of issuer and held securities for 1 year (if issuer is a reporting co.!),
                 or
             - seller has not been an affiliate for 3 months at the time of purchase of securities + 2-year
                 holding period (a non-affiliate who held securities for 3 years is free to sell w/o
                 restrictions)
             - Sales are permissible w/n successive 3-month periods.
             - Control persons must register or find another exemption (even though the securities
                 were registered in the Rule 145 transaction!)
E. GOING PUBLIC BY THE BACK DOOR
      1. SEC v. Datronics - “shell corporation”
          a) held Datronics received value through the dissemination of the stock in that a public market
             was created. Because the disposition of the security was for value, it was a sale of
             securities.
          b) This is an example of using a shell corporation to go public by the back door. The shell
             corporation has no asset other than its shareholder list, and distributes stock of a company
             wishing to go public to its shareholders as a dividend and keeps some of the stock as a fee.
        2.    Spin-offs
              Spin-off = a corporation takes stock it owns in another corporation and distributes it to its s/h as
              dividend. Problem: if the corporation engaging in a spin-off is public, the spun-off corporation
              also becomes public. When the spin-off creates a public market for unregistered securities, it



                                                                                                                49
                may receive benefit (―value‖) – may require registration as in a ―sale‖ of securities (see
                Datronics).
                A spin-off will NOT require registration if the following conditions are met:
                a) No consideration given by parent‘s shareholders for the spin-off shares (otherwise an
                     obvious sale).
                b) The spin-off must be pro-rata to the parent corporation‘s shareholders with no surrender of
                     rights or value by those who receive the spun-off shares.
                c) The parent corporation must provide adequate information to its shareholders and the
                     public.
                d) There must be a valid business purpose (!!!)
                If the parent company spins-off restricted securities, the parent corporation may be deemed an
                underwriter, unless the parent has held the subsidiary‘s stock for at least 2 years (Rule 144)

F. WARRANTS, OPTIONS & CONVERSIONS
   new rights to acquire additional securities in the future. Exempt from registration unless it is to be
   offered or disposed of for value, or is immediately exercisable
§2(a)(3):      the issue or transfer of a right of conversion or a warrant which cannot be
               exercised until some future date shall not be deemed to be an offer or sale of
               such other security, but the issue or transfer of such other security upon the
               exercise of such right shall be deemed an offer or sale.

G. STOCK DIVIDENDS
   exempt b/c not a sale for value.

H. GIFTS OF SECURITIES
   are not sales. (Unless a subsequent active public market?)

I. RULE 133 (NOW ABOLISHED BY RULE 145, WHICH REQUIRES REGISTRATION) – THE ―NO SALE‖
DOCTRINE
     a)   a voluntary exchange of securities – registration is required
     b)   statutory merger or consolidation – no registration is required
     c)   a sale of assets of the acquired corporation – no registration is required
     d)   Mergers and sales of assets require votes of shareholders, which are interpreted not to involve a ―sale‖
          or ―offer to sell.‖ (Rule 133 ―no sale rule‖)




                                                                                                                50
                         DEFINITION OF SECURITIES
                       IS OWNERSHIP SEPARATED FROM CONTROL?
        are investors suffering agency and collective action costs as if they were corporate shs
  Key Inquiry – IS OWNERSHIP SEPARATED FROM CONTROL?
  Definition important because concept is jurisdictional in nature; if instrument not a security instrument, ‘33 Act
  doesn‘t apply. Definition of security closely tied to investment.
      1) when does an unorthodox investment fall within catchall def. of investment contract?
      2) when are instruments that fall into enumerated categories (notes, bonds) not really securities?
  Any instrument not listed in definition or unusual, use:
      1) Howey (inv. contract)
      2) Reeves (notes – family resemblance)


1. CODE DEFINITIONS

      §2(a)(1):    Security (def)

                   specific list - note, stock, treasury stock, bond, debenture….investment
                   contract…., or any put, call, straddle, option, or privilege entered into on a
                   national stock exchange relating to foreign currency, or
                   catchall - any interest or instrument commonly known as a ―security,‖ or any
                   certificate of interest or participation in, temporary or interim certificate for,
                   receipt of, guarantee of, or warrant or right to subscribe to or purchase, any
                   of the foregoing.
                   unless the context otherwise requires - refers to the economic reality test.
                   Something might not be a stock just because it‘s called a stock. Still the
                   instruments specifically enumerated in the definition are presumed to be
                   securities until proven otherwise.

                   Congress intended to have a broad def. of what’s a security

      §3(a)(3) exception - Any note, draft, bill of exchange, or banker‘s acceptance which
                  arises out of a current transaction or the proceeds of which have been or are
                  to be used for current transactions, and which has a maturity at the time of
                  issuance not exceeding 9 months, exclusive of days of grace, or any renewal
                  thereof the maturity of which is likewise limited shall be exempted from the
                  registration requirement.

      §3(a)(10): def. in ‘34 Act same as above (‘33 Act)




                                                                                                                       51
2. INVESTMENT CONTRACTS

     A. THE HOWEY TEST – INVESTMENT CONTRACTS

                                         HOWEY TEST
     4 factors: is it an investment contract?:
     1) investment of $
     2) commonality
     3) expectation of profits
     4) from efforts of others


          Commonality  common enterprise.
                   - Horizontal – multiple investors with related interests in common scheme. Problem is when
                         there is only 1 investor; does not focus on economic substance of transaction.
                   - Vertical – one single investor
                         strict: profits depend on promoter‘s efforts, broad: profits tied to efforts
                   - Dismissed by most courts because it‘s simple agency for hire. S. Ct. has not resolved issue
                         re. whether vertical commonality is required.
          Risk Capital Test – other courts use this test, focusing on the extent to which investor‘s outlay is
          subject to risk over which he has no control; non-pecuniary benefits can be subject to risk. This test has
          obscured the notion of ―expectation of profit‖ in Howey.

     B. KOSCOT INTERPLANETARY – INVESTORS ―MOSTLY‖ PASSIVE
        pyramid schemes are securities based on ―vertical commonality‖ and ―significant managerial efforts‖
        1) ―profits must be derived solely from the efforts of individuals other than the investors.‖ The ct. held
            ―solely‖ from efforts of others does not have to be read literally; as long as investors are
            mostly passive, the test is satisfied.
        2) vertical commonality – court examined commonality between promoter and investor, but most
            courts now reject vertical commonality and require horizontal

3. THE ECONOMIC REALITIES TEST
   (DOWNSIZING THE DEFINITION OF SECURITIES)

     A. STOCK (UNITED HOUSING FOUND. V. FORMAN) – EXPANDING HOWEY
        Characteristics of stock were NOT present where coop housing corp. requires residents to buy ―shares‖,
        ct. held they were not shares based on the economic realities of transaction (Howey). That test should
        be used to examine ALL transactions:
                                CHARACTERISTICS OF STOCK
                                        (Landreth Timber)
     1)   right to receive dividends contingent on profitability
     2)   negotiability/transferability
     3)   ability to pledge/hypothecate
     4)   rights proportional to # shares owned
     5)   capacity for appreciation in value




                                                                                                                 52
B. LANDRETH TIMBER – REJECTING ―SALE OF BUSINESS‖ DOCTRINE
   stock is stock.
   If something has the significant elements of stock, it‘s not necessary to look further and examine other
   economic realities of the transaction:
   Howey test is relevant to the inquiry whether an investment contract is a security, not whether all
   instruments are securities. If something is a stock, there’s no reason to go further.
   The sale of business doctrine (which says that the sale of a business is not a security) should not apply
   because it is too difficult to determine in many cases whether control has been transferred.

C. PROMISSORY NOTES AS SECURITIES (REEVES V. ERNST & YOUNG)
   1) Current transaction exemption - notes that mature in less than 9 months are exempt under both ‘33
      and ‘34 Acts, exempt from definition of security.
   2) Reeves - Family Resemblance Test: a note is presumed to be a security unless it resembles a family
      of excused securities/notes. The presumption can be rebutted by 4 FACTORS (similar to Howey)
               a) motivation of buyer and seller
                   if seller‘s purpose to make money, buyer‘s purpose to make money
                   security; if seller facilitates buyer‘s purchase consumer goods →non-security
               b) plan of distribution
                   notes where there is common trading for speculation/investment →security
                   only available to sophisticated investors →non-security
                   key: manner of offer
               c) reasonable expectations of investing public
                   investors generally view the type of notes as investment, issuer markets or peddles
                   notes in a manner that suggests they are securities →security
               d) other factors reduce risk
                   separate regulatory scheme or collateralized note →security
                   secured or otherwise regulated (CDs) →non-security)
D. CERTIFICATES OF DEPOSIT (CD’S)
   Government-insured COD‘s are not like other long-term obligations and are not securities, largely
   because the they are issued by federally regulated banks that are subject to comprehensive regulation and
   federally insured (other protection for investors exists) – ―unless the context otherwise required‖
   exception applies (Marine Bank v. Weaver).

E. LOAN PARTICIPATIONS
   The Reves family resemblance test needs to be applied.
   Distribution is the key: if the loan participations are distributed through broad-based, unrestricted sales
   to the general public, then they are likely to be deemed securities.

F. SWAPS
   A swap is a type of derivative instrument; it is a contract between two parties under which they agree to
   exchange a series of cash flows over time usually to protect one side against interest rate or currency
   fluctuations. Under the Reves test, courts have found these not to be securities (motivation;
   distribution)

G. CONDOMINIUMS
   The offer and sale of condominium units, coupled with the offer or agreement to perform or arrange
   rental or other services for the purchaser, may involve the offering of a security in the form of an
   investment contract or participation in a profit sharing scheme. The offering of condo units in
   conjunction with any one of the following will cause the offering to be viewed as an offering of
   securities in the form of investment contracts:




                                                                                                             53
             1) condos offered and sold with the emphasis on the economic benefits to the purchaser to be
                derived from the managerial efforts of the promoter (or 3 rd party arranged for by promoter)
                from rental of the units.
             2) participation in rental pool arrangements; and
             3) arrangements where purchaser‘s right of occupancy is limited (i.e. timeshares)

H. GENERAL COMMENTS – [SCHNEIDER]
   An offering to the general public militates toward finding a security, while a directed two-party
   transaction is less likely to involve a security. If the targeted investors are likely to be passive and not
   inclination to become involved in the business, it weighs in favor of a finding of a security. Economic
   realities are important. A security will be found if the investor is forced to rely upon the management of
   the promoter as a matter of substance. Fraud also militates toward a finding of a security.
   1) An investment in most employee benefit plans is not a separate security – although the employer
        stock is a security, and may be an investment medium under the plan.
   2) A general partnership interest is generally not a security, even if the investor elects to be passive. A
        limited partnership interest, by contrast, generally is a security.
   3) A fractional undivided interest in mineral ventures has been found to be a security, but a joint
        venture in oil and gas drilling was not a security.
   4) Conventional franchise arrangements where the franchisee has an active role to play are generally
        held not to be securities.
   5) Discretionary security and commodity trading accounts are generally not securities, unless
        investors‘ funds are pooled.
   6) In investment programs involving the purchase, sale, or lease of personal property, there may well
        be a security if the promoter uses skill in selecting the item; manages the asset; renders service to
        maintain, operate, or insure the asset; determine when or how to buy the asset; or makes a market
        for the asset; or where the investor is dependent on the promoter as a practical matter.
   7) Certain insurance products such as annuities are securities, but insurance products in general are
        not.
   8) Stock or membership in a business coop may or may not be a security. If a nominal amount is paid
        for a non-transferable interest with no appreciation potential, and where earnings are distributed in
        accordance with patronage volume rather than shareholding, no security will be found.




                                                                                                             54
TENDER OFFERS, MANAGEMENT BUYOUTS, AND TAKEOVER
                   CONTESTS
 1. INTRODUCTION
   a) The federal government generally does not get involved with internal corporate governance. The federal
      securities laws regulate internal corporate affairs in these areas: 1) registration of securities and issuance;
      2) voting/proxy rights; 3) sales of securities; and 4) tender offers.
   b) Congress passed Williams Act to plug gaps in the regulation of corporate acquisitions; regulates the
      purchase of a control block of stock on the market and tender offers.
   c) Some people argue that shareholders do not need protection form acquirers. First, target shareholders profit
      significantly. Second, target shareholders have a very effective armory of self-help weapons against ―unfair‖
      hostile bids, which target management are more than ready to employ. The goal of federal regulation = to
      prevent coercion of s/h: dispersed shareholders are incapable of collective action in a takeover, and various
      offensive tactics, such as two-tier front end loaded coercive tender offers, may coerce them into selling at
      prices well below that at which a single owner of stock might negotiate.
   d) One of the dilemmas that exist is that the party most likely to seek to enforce Williams Act protections is

        A. DISCLOSURE OF 5% STOCK ACCUMULATIONS (§13(D))
           trip-wire provisions
           to signal to the market (and target‘s management) that the company may be in play, requires disclosure
           within 10 days by filing a document with SEC

        B. DISCLOSURE BY TENDER OFFEROR (§14(D))
           ensure shs make informed decisions in response to a bid for their shares, requires disclosure of tender
           offers that would result in >5% ownership.
           target management has 10 days to make formal response (oppose, support bid, take neutral or no
           position)

        C. .REGULATION OF SUBSTANTIVE TERMS OF TENDER OFFER
        Rules 14d-10(a)(1), 14e-(1)
                    all holder’s rule - tender offer must be offered to all shs for 20 days
        Rule 14d-7 shs can withdraw shares (revoke their tenders) at any time
        Rules 14d-10(c)(1), and 14d-10(a)(2)
                    shs must paid the best price paid to any other shs
        §14(d)(6), Rule 14d-8
                    when bidder seeks less than all shares and shs tender more shares than bidder
                    seeks, bidder must purchase shares on pro-rata basis and return unpurchased
                    shares.
        Rule 10b-13
                    while bid is pending, bidder cannot purchase outside the tender offer

 2. RECENT RULE CHANGES BY THE SEC
   a) Rule 14e-5 (―no purchases alongside‖): This rule revoked Rule 10b-13 (―no purchase alongside rule‖),
      which provided that if a person launches a tender offer, they cannot purchase the securities targeted by the
      tender offer through other means after the announcement of the tender offer. The new language is ― as part
      of the offering period.‖ An exception is made to purchases made during a subsequent offering period.
   b) When does a tender offer commence? This issue is still governed by Rule 14d-2 but the provisions have
      changed. It used to be that the tender offer began at public announcement, with a 5-day period for retraction.
      Now, the Commission has said that commencement begins when the acquiror gives shareholders the means
      to tender or advertises the specific means by which shareholders can tender.



                                                                                                                     55
   c) Rule 14e-8: an anti-fraud provision that prohibits announcing an intent to launch a tender offer if that intent
      is not sincere.
   d) Rule 14d-11: Permits an issuer to have a subsequent offering period between 3 to 20 days; during which
      no withdrawal rights are permitted. The tender must be at the same price and the same terms.
   e) SEC has a new takeover document – Form TO.
   f) Reg. MA: Compiles under one regulation the regulations regarding third-party tender offers, issuer tender
      offers, and issuer ―going private‖ transactions.

                      Privately Negotiated Purchases of Securities Targeted in Tender Offer
 Before Tender Offer Commences                 During Tender Offer                After Tender Offer Terminates
                                                                                $90 per share offer is prohibited
 $90 per share offer is permissible        $80 per share is tender price
                                                                                      for the first 20 days

        A. EPSTEIN V. MCA – EQUAL PRICE TO ALL S/H
           This case involves an interpretation of Rule 14d-10, which prohibits a bidder from making a tender offer
           that is not open to all shareholders or that is made to shareholders at varying prices. In this case, the
           arrangement worked out by Wasserman was part of the tender offer, so it violated the rule. Had
           Wasserman, in advance of the tender offer, become unconditionally obligated to exchange his shares, the
           transaction would not have violated the rule.

3. DEFINTIONAL ISSUES UNDER THE WILLIAMS ACT

        A. MILSTEIN (2D. 1971) – DEFINITION OF ―GROUP‖
           1) §13(d)(3) provides that when two or more persons act as a partnership, limited partnership,
              syndicate, or other group for the purposes of acquiring, holding, or disposing of securities of an
              issue, such syndicate or other group shall be deemed a person for purposes of §13(d).
           2) Once a group controlling more than 10% is formed, it must report on Schedule 13D. It is not
              necessary for a person in the group to purchase more shares in order to trigger the reporting
              requirement. All that is required is an agreement to act in concert = group (subject to
              registration).
   NB! Rule 13d-5 today goes beyond the statutory language in §13(d)(3). Rule 13d-5 state that a group arises
   ―when two or more persons agree to act together for the purpose of acquiring, holding, voting, or disposing of
   equity securities.‖ No mention of voting is made in §13(d)(3).
            Schedule 13D requires groups to disclose the purpose of the acquisition of securities. Courts have found
            it materially misleading for a group to say it was holding securities for an investment purpose, when it
            really wanted to try to influence corporate affairs. In this vein, it is sometimes required that groups
            disclose potential or contingent plans stemming from an acquisition of securities.

        B. SEC V. FIRST CITY FINANCIAL CORP. – ―BENEFICIAL OWNERSHIP‖
           A shareholder must comply with §13(d) if he beneficially owns 5% of registered equity security. Under
           Rule 13d-2(a), whenever a person possesses investment or voting power through any agreement or
           understanding, he enjoys beneficial ownership.
           Rule 14d-3 is crafted broadly enough to sweep within its purview informal, oral agreements to confer
           upon a person voting or investment power. [The arrangement in this case: a 3rd party purchased
           securities, and First City had a ―put and call‖ agreement on them, to disguise ownership. Illegal
           ―parking‖ arrangement, so First City violated the filing requirements of §13(d).]


        C. SEC V. CARTER HAWLEY HALE STORES – DEFINITION OF ―TENDER OFFER‖
           1) This case focuses on whether an issuer repurchase program during a third-party tender offer will
              itself constitute a tender offer. The court applies the factors from Wellman v. Dickinson (SDNY,
              1979). Such factors focus on the manner in which the offer is conducted and whether the offer has



                                                                                                                    56
       the overall effect of pressuring shareholders into selling their stock. Not all factors need to be
       present to find a tender offer, but they are traditional indicia of a tender offer. The Wellman test for
       t/o:
                 - Active an widespread solicitation of public shareholders for the shares of the issuer
                 - Solicitation made for a substantial percentage of the issuer‘s stock
                 - Offer to purchase made at a substantial premium over the prevailing market price
                 - Terms of the offer are firm rather than negotiable
                 - Offers are contingent on the tender of a fixed number of shares, often subject to a fixed
                      minimum number to be purchased
                 - Offer open only for a limited time
                 - Offeree subject to pressure to sell his stock
                 - Public announcements of a purchasing program concerning the target company
                      precede or accompany rapid accumulation of a large amount of a company‘s securities.
                 -
             th
    2) The 9 Cir. rejected the test in S-G Securities v. Fuqua investment Co. (D. Mass. 1978):
       A tender offer exists for purposes of §14(d), when there is
       a) a publicly announced intention by the purchaser to acquire a substantial block of the stock of
            the target for purposes of acquiring control thereof, and
       b) a subsequent rapid acquisition by the purchaser of large blocks through open market and
            privately negotiated purchases.
    3) ―Street sweep‖: one announces a tender offer; the shares are purchased by risk arbitrageurs, the
       tender offeror withdraws; shares have gone from widespread public ownership to concentration in
       the hands of only a few; the tender offeror tries to buy the shares from the risk arbitrageurs.

D. HANSON TRUST – THE ―NEED FOR PROTECTION‖ TEST
   The Court decided that while the Wellman factors are germane for determining whether a solicitation
   amounts to a tender offer, it should not be elevated to a mandatory litmus test. Instead, in the spirit of
   Ralston-Purina, the court should look to see if the purchasers need the protections of §14(d). In other
   words, viewing the transaction in the light of the totality of the circumstances, does there appear to be a
   likelihood that unless the pre-acquisition strictures of the statute are followed there will be a substantial
   risk that solicitees will lack information needed to make a careful appraisal of the proposal. In this case,
   there was no tender offer. The private transactions involved a small fraction of the shareholders, the
   sellers were mostly sophisticated investors, the sellers were not pressured, there was no active or
   widespread publicity, there was no real premium offered, and there was no time limit or contingency.
   Also, the private transactions were not a de facto continuation of the original tender offer. The original
   tender offer was ended legitimately and for a good reason – the poison pill enacted by SCM.

E. MAI BASIC FOUR, INC. V. PRIME COMPUTER - WHO IS ―BIDDER‖?
   The case involves a determination of whether Drexel, financing and acting as a consultant on a tender
   offer, is itself a bidder, such that it must fill out Schedule 14D-1. The court could not say, as a matter of
   law, that an active financier-participant who owns less than a majority interest in the surviving entity is
   not a bidder, where, as here, there has been a history of close association, equity sharing, board
   representation and involvement from the beginning in the present offer, and where there is the possibility
   of the advisor-broker being the key to the offer‘s success. Financial advisor ―central to the offer‖ =
   bidder subject to filing requirements.




                                                                                                             57
4. DEFENSIVE TACTICS
  a)   §14(e)(1) -anti-fraud provision: it is unlawful for any part to make any false or misleading statement, or
       engage in manipulative behavior, in connection with any tender offer.
                      - Nontendering shareholders other than the bidder can sue the target under this section where
                          they can allege that but for the fraudulent statement or omission they would have tendered.
                      - Manipulative conduct has been interpreted to mean conduct that violates fiduciary duties.
  b)   Schedule 14D-9: must be filed by any person who makes a solicitation or recommendation to target
       shareholders, which also applies to the target company and its management (Rule 14d-9). In case of
       ―material change‖ in a situation, Schedule 14D-9 must be updated.
  c)   Rule 14e-2 – mandatory target management recommendation: within 10 days after a tender offer is first
       published, the target management must provide shareholder with a statement articulating the company‘s
       posture toward the tender offer. Thus, target management must file Schedule 14D-9 and update it if
       changed its course (e.g., entered into negotiations with a ‗white knight‘).
  d)   Rule 13e-4: governs tenders offers by issuers
  e)   Rule 14e-3: governs ―going private‖ transactions by certain issuers or their affiliates
  f)   Rule 10b-18: governs purchases of certain equity securities by the issuer and others
  g)   §14(f): if, in connection with a tender offer, any persons are to be designated as directors of the target
       corporation, other than at a shareholder meeting, and will constitute a majority of control, the target must
       disclose this information to the shareholders as if they were going to have the right to vote on the
       designation. (Rule 14f-1)
  h)   Management’s Repertoire of Defensive Tactics -
                      - Under Unocal, the defensive measures must be reasonable with respect to the threat posed
                          by the tender offer. This standard falls between the business judgment rule and the intrinsic
                          fairness standard (fair process, fair price).
                      - Under Revlon, once the sale of a company becomes inevitable, the duty of management
                          switches to that of an auctioneer, focusing on maximizing shareholder value.
       A. HILTON HOTELS V. ITT - PRECLUSIVE MEASURES
          1) Offer: Hilton announced a $55 per share (later $70) tender offer for ITT stock and its intention for a
             proxy contest at ITT‘s annual meeting.
          2) Alleged Threat: inadequate price
          3) Defensive Measures: ITT split into three separate entities. The Board of ITT Destinations, the
             largest entity with the coveted assets, would be staggered. The plan also contained a tax poison pill,
             which would be triggered if Hilton acquired more than 50% of ITT Destinations. ITT delayed a
             shareholder meeting, so that the plan could be implemented before proxy vote.
          4) Rule: ―Unocal plus ―standard applies when the Board tries to thwart the shareholders‘ free exercise
             of franchise. Board has heavy burden of showing a compelling justification.
          5) Application: The Court codifies DE law. Under Unocal, the threat is mild or nonexistent. The claim
             that the price offered was inadequate is contradicted by ITT‘s own investment bankers. The
             implementation of the staggered board is clearly preclusive because it prevents shareholders from
             voting on membership of the ITT board. Under Unitrin, the court held that a board‘s unilateral
             decision to adopt a defensive measure touching on issues of control that purposefully
             disenfranchises shareholders is strongly suspect under Unocal and cannot be sustained without a
             compelling justification. (―Unocal plus‖ standard). Vague claims used to justify a defensive
             measure, such as they avoid market risks and other business problems, are not sufficient to show
             defensive measures are proportionate and to avoid suspicion that they are designed to entrench the
             incumbent board.

       B. DEFENSIVE TACTICS IN PRACTICE
          1) Prospectively, the company needs to ask whether it is a tender offer target? (Does it have a lot of
             liquid assets, etc.)



                                                                                                                    58
2) Board Structure: classified/staggered board with 3 year terms (1/3 elected each year), so even if
   tender offer is successful, new owners cannot obtain control of the board immediately
3) Poison Pill: rights plans – 1) if change in control happens, rights permit current shareholders to buy
   stock at a bargain price; 2) if a merger happens, rights permit shareholders to buy shares in
   acquiring corporation at a bargain price
4) Shareholder Restrictions: limit shareholder power to call special meetings (supermajority
   provisions); don‘t permit ―consent in writing provisions‖ but rather require meetings for shareholder
   initiatives. But be careful not to be overly preclusive!
5) Lock-up Device/ ―White Knight‖ defense: 1) shares – a third party has option to buy shares in the
   company if a tender offer is launched; 2) assets – a third party has option to purchase company
   property if a tender offer is launched (―crown jewel‖ defense). Be careful not to violate Revlon duty!
6) Golden Parachutes: attractive severance packages




                                                                                                      59
                          LIABILITIES UNDER ’33 ACT
Liability for non compliance with registration regime – if seller or offeror violates §5 requirements, securities
              purchasers can rescind investment §12(a)(1)
Liability for fraudulent registration statement – if RS (including prospectus) is materially false or misleading,
              purchasers can recover damages from offering participants §11
Liability for other fraud in registered offering – if sales or offers accomplished by means of materially false or
              misleading info, purchasers can rescind investment §12(a)(2)
Respondeat superior liability – investors can recover on joint & several basis from persons who control anyone
              liable under 11 or 12 §15
Government civil and criminal enforcement




                                                                                                                     60
1. SECTION 11 – MISREPRESENTATION IN A REGISTRATION STMT
       §11(a):       In case any part of the registration statement, when such part became
                     effective, contained an untrue statement of a material fact required to be
                     stated therein or necessary to make the statements therein not misleading,
                     any person acquiring such security (unless it is proved that at the time of
                     such acquisition he knew of such truth or omission) may, either at law or in
                     equity, in any court of competent jurisdiction, sue certain parties listed
                     herein.


         Common Law Deceit Elements                                          §11 Elements
  Misrepresentation
                                                      Lie, omission; half-truth
  (non-truth)
  Material fact (important)                           Materiality
  Relied on by the plaintiff                          No reliance necessary in the first 12 months; after –
  (change in position)                                reliance can be shown w/o proof of reading the RS
                                                      Causation Defense
                                                       If defendant can prove that damages are not related
  Causing damage
                                                           to the material misrepresentation, then that portion of
  (to ‘s detriment)
                                                           the damages shall not be awarded. §12(e)

                                                      No scienter for issuer; liability is absolute unless issuer
                                                      can show that the plaintiff knew of the untruth/omission

                                                      Due Diligence Defense for other defendants:
                                                       If plaintiff is not relying on experts, defendant not
                                                         liable if he can prove that he had, after reasonable
                                                         investigation, reasonable ground to believe and did
                                                         believe that the registrations statements was truthful
                                                       If plaintiff relies on a part of registration statement
  State of mind
                                                         made by an expert, and the defendant is not that
  (range of scienter from strict liability to
                                                         expert, than defendant not liable if he can prove that
  negligence)
                                                         he had no reasonable ground to believe and did not
                                                         believe the registration statement was untruthful;
                                                       If plaintiff relies on a part of a registration statement
                                                         prepared by an expert, and the defendant is the
                                                         expert, defendant is not liable if after reasonable
                                                         investigation, defendant had reasonable ground to
                                                         believe and did believe that the registration statement
                                                         was truthful

                                                      Issuer, officers, all directors, directors in waiting, experts,
                                                      underwriter (no privity necessary) + all who signed the
                                                      RS (§6)

                                                      Underwriter liability is limited to the extent of the total
  Identity of  (privity required)                    price at which the securities underwritten by him were
                                                      offered to the public. §12(e)

                                                      If either the suit brought by the plaintiff or the defense
                                                      put forward by the defendant are deemed frivolous, the
                                                      party losing the suit may be forced to incur expenses


                                                                                                                        61
A. §11(A) - EXPRESS PRIVATE RIGHT OF ACTION
   creates civil remedy for purchasers in a registered offering if there‘s material misrepresentation or
   omission in RS, imposes joint and several liability on the issuer and other specified potential defendants
   associated with the distribution, subject to due-diligence defenses
§11(a)        In case any part of the registration statement, when such part became
              effective, contained an untrue statement of a material fact required to be
              stated therein or necessary to make the statements therein not misleading,
              any person acquiring such security (unless it is proved that at the time of
              such acquisition he knew of such truth or omission) may, either at law or in
              equity, in any court of competent jurisdiction, sue certain parties listed
              herein.

         1.    Plaintiff
               all purchasers of registered securities have standing to sue, whether bought in offering or in
               trading market (have to prove it was part of that issue)
         2.    Possible Defendants
               - issuer/registrant (always)
               - directors
               - people who signed RS
               - underwriters
               - expert
               - anyone  can show controlled the people named above
         3.    Material Misinformation in RS
               - material untruths or omissions.
               - Forward-looking statements may also be actionable, but 1995 Reform Act created safe
                  harbor from §11 liability if no reasonable basis or disclaimer
         4.    Culpability – Due Diligence Defenses and Proportional Liability
               §11 abandons the common law requirement of scienter;  need not prove ‘s culpability, non-
               issuer s have burden of proving non-culpability, while the issuer is strictly liable
               Due diligence defense – investigation by the potential s.
                                  expert info                                non-expert info
              expert               reasonably believes, after reasonable    no liability
                                          investigation, information is
                                          true
                                          (ignorance no excuse)
              non-expert           no reason to believe information is      reasonably believes, after
                                          false                                    reasonable investigation,
                                          (ignorance is an excuse)                 information is true
                                                                                   (ignorance no excuse)


         5.    Escott v. Barchris Construction – Due Diligence Standards
               The court comes to the important conclusion that lawyers are not experts. It would be
               unreasonable to say that an entire registration statement is expertised because a lawyer prepared
               it. To what level can rely on others? Duty to read and verify info, or can rely on another’s
               opinion?
               - D&O – due diligence varies in relation to 2 factors: (1) director‘s access to inside company
                    info, and (2) director‘s position as an insider or as non-employee outsider (insider or
                    outside insiders)
               - underwriter - can rely on their counsel
               - expert – (accountant) same as inside outsider (high)



                                                                                                                62
              6.       Proportionate Liability
                       exception to joint and several liability of §11- only if the director ―knowingly‖ committed a
                       violation of securities laws; if not, he‘s only liable for portion of damages he actually caused.

2. SECTION 12 – VIOLATIONS OF §5

     A. §12(A) - (EXPRESS PRIVATE RIGHT OF ACTION – RESCISSION)
        any person who purchases a security may sue the seller, if
            1) the security was sold in violation of §5, or
            2) if a person offers or sells a security by means of a prospectus or oral communication, which
                 includes an untrue statement of a material fact or omits to state a material fact necessary in
                 order to make the statements, in light of the circumstances under which they were made, not
                 misleading.
                 - Requires privity (purchaser sues the seller).
                 - No reliance is required.
                 - Recovery = rescission of the sale (―recover consideration paid‖)
              1.    Liability under §12(a)(2):
                   -  Applies to exempted securities as well (!)
                   -  No liability for omission, only a misrepresentation or half-truth.
                   -  The purchaser of a security may have an action under both §12(a)(2) and §11.
                   -  In some important respects, a purchaser may have a cause of action only under §12(a)(2):
                              where false statements were made to purchaser orally or in written selling literature
                                  (not part of the RS) separate from the statutory prospectus;
                              where the seller is not one of the persons enumerated in §11 (e.g., a dealer in the
                                  selling group)
                   - Defenses to §12(a)(2): purchaser‘s actual knowledge of misstatement; a ―loss causation‖
                      defense; a ―reasonable investigation‖ defense (defendant can show that he conducted a
                      reasonable investigation and could not have known of and did not know of the
                      misrepresentation or half-truth); no privity; statute of limitations.
                   - Under §13, an action must be brought w/n 1 year after discovery of misstatement, no more
                      than w/n 3 years of the sale.
              2.       Strict Liability under §12(a)(1)
                            may arise whenever there is any violation of §5:
                                      the issuer or underwriter makes an improper offer to potential purchaser in pre-
                                           filing period;
                                      failed to register;
                                      did not qualify for an exemption (the bulk of §12(a)(1) litigation!!!), etc.
                            Defenses to §12(a)(1):
                                      no sale of a ―security‖
                                      no violation of §5 (prove exemption)
                                      no privity
                                      statute of limitations (3 years after bona fide offering)

     B. DEFINITION OF ―SELLER‖ FOR PURPOSES OF §12 (PINTER V. DAHL)
        collateral participants liable under an “aiding and abetting” theory
        §12(a)(1) statutory seller – includes also collateral participants who solicits purchasers for his or the
        issuer‘s benefit

     C. LIMITS ON §12(A) LIABILITY (GUSTAFSON V. ALLOYD CO.)
        limited §12(a)(2) liability to public offerings, not private placements



                                                                                                                           63
    the right of rescission to buyers under §12(a)(2) does not extend to private, secondary transactions.;
    recitations in the purchase agreement are not part of a prospectus.
    1) The Court should have looked at the definitions in §2(a), not in §10.

D. §17(A) – FRAUDULENT INTERSTATE TRANSACTIONS:
   It is unlawful for a person in the offer or sale of any securities
         1) to employ any device, scheme or artifice to defraud, or
         2) to obtain money or property by means of any material untruth or half-truth or omission; or
         3) to engage in any transaction, practice or course of business which operates or would operate as
             fraud or deceit upon the purchaser.

    A criminal provision (implied private right of action is not likely to be recognized)
    Rule 10b-5 was drafted after §17(a); the only difference: §17(a) covers only ―offers or sales‖ of
    securities, whereas Rule 10b-5 covers ―purchases and sales‖.




                                                                                                             64
               LIABILITY UNDER EXCHANGE ACT (’34)
3. IMPLIED PRIVATE RIGHTS OF ACTION
  a) §9 – Price manipulation: It is unlawful to effect a series of transactions that involve no change in the
     beneficial ownership of the securities or that create an actual or apparent active market for the securities or
     manipulate the price for the purpose of inducing a sale of such securities. Any person who ―willfully
     participates‖ in any such act is liable to any person who purchased the security at a price affected by such
     manipulation. (Limited to listed securities. The requirement of ―willfulness‖ restricts practical application –
     easier to bring an action under Rule 10b-5). Statute of limitations = 3 years after violation.
  b) §14(a) – Proxy solicitation: It is unlawful to solicit a proxy in contravention of the rule imposed by the
     Commission.
  c) §14(e): It is unlawful for any person to make an untrue statement of a material fact or omit to state a material
     fact necessary in order to make the statement not misleading in connection with any tender offer.
  d) Rule 14a-9: Prohibits solicitation made by a proxy, which at the time and in the light of the circumstances in
     which it was made, that is false or misleading with respect to a material fact, or which omits to state any
     material fact that is necessary not to make the proxy false or misleading.
  e) §18(a): Express liability to buyers of securities for any person making false statements or half-truths in
     reports or documents filed with the Commission. There is no privity requirement. But reliance required; and
     the defendant has a good faith defense. Statute of limitations = 3 years after violation.
  f) RULE 10B-5

4. RULE 10B-5 – FRAUD



      A. RULE 10B-5 ANALYSIS (PRIVATE RIGHT OF ACTION)
      §10(b): It shall be unlawful for any person to use or employ, in connection with the
                   purchase or sale of any security registered on a national securities exchange
                   or any security not so registered, any manipulative, device, or contrivance in
                   contravention of such rules and regulations as the Commission may prescribe
                   as necessary or appropriate in the public interest or for the protection of
                   investors. [Not self-operative – requires SEC rules!]

      Rule 10b-5: It shall be unlawful for any person:
                 (1) to employ any device, scheme or artifice to defraud,
                 (2) to make any untrue misstatement 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
                 (3) to engage in any act, practice, or course of business which operated or
                 would operate as fraud or deceit upon any person,
                 (4) in connection with the purchase or sale of any security.

           
               There is no privity requirement.
           
               Also applies to securities that are not traded in organized markets.
           
               Misrepresentation/deception must be ―in connection with‖ purchase or sale of security: reliance,
               causation establish the required ―nexus‖.
           
               Today Rule 10b-5 is the most frequently used remedy in the federal securities laws. It has
               primarily been applied to three types of fraud:
                1) misrepresentations or omissions in corporate statements
                2) insider trading


                                                                                                                  65
         3) manipulation

B. IMPLIED PRIVATE RIGHTS OF ACTION:
   1) Kardon v. Nat‘l Gypsum (1946): there is a private right of action under Rule 10b-5 based on the
       principle in the Restatement of Torts that violating act makes a person liable to those who are
       injured as a result of the violation.
   2) Borak (1964) – rationale for implied private rights of action: §27 gives parties a right to bring
       suit for violations of §14(a). While §14(a) makes no specific mention of a private right of action,
       among its chief purposes is the protection of investors, which certainly implies the availability of
       judicial relief to achieve that result. In this case, a private right of action is a necessary supplement
       to SEC enforcement.
   3) Banker‘s Life (1971): S.Ct. affirms that a private right of action is implied under Rule 10b-5.
   4) Blue Chip Stamps (1975): Rehnquist is critical, but admits that it an implied private right of action
       under Rule 10b-5 is universally accepted.
   5) Cort v. Ash (1975) – restricting Borak: Supreme Court enumerates four factors that need to be
       considered when determining whether an implied private right of action exists:
            a) is the plaintiff one of the class of people for whose special benefit the statute was created
            b) is there any indication of legislative intent, explicit or implicit, to create or deny such a
                 remedy
            c) is it consistent with the overall legislative scheme to imply such a remedy (Borak‘s focus)
            d) is the cause of action one traditionally relegated to state law
   6) Piper (1975): Court left open the question of whether an implied right of action exists under §14(e).
   7) Touche, Ross v. Redington (1979) – refining the 4-factor analysis:
            - Not all 4 factors carry equal weight in determining existence of the implied private right of
                 action. The key is legislative intent.
            - The Supreme Court said that there was no private right of action under §17(a). The
                 Court noted that to the extent its analysis is more stringent than Borak, it is sufficed to say
                 that the Court now adheres to a stricter standard. The source of the plaintiff‘s right must be
                 found in the substantive provisions of the 1934 Act that they seek to enforce, not the
                 jurisdictional provision (§27).
   8) Curran (1982) – focus on legislative intent: Held an investor could maintain an action against his
       broker in violation of the antifraud provision of the SEA. The key to the inquiry into the existence of
       a private right of action is legislative intent.
   9) Herman & McLean v. Huddleston (1983): Court does not look at legislative intent; does not adopt
       Curran approach; held the availability of an express remedy under §11 does not preclude defrauded
       purchasers from maintaining an action under Rule 10b-5.
   10) Central Bank of Denver (1994): Court took a very literal approach to statutory interpretation and
       held that there was no aiding and abetting cause of action under Rule 10b-5.




                                                                                                             66
5. MATERIALITY AND THE DUTY TO DISCLOSE
  TO avert information overload, only material information must be disclosed.

      A. SUBSTANTIAL LIKELIHOOD TEST (TSC INDUSTRIES V. NORTHWAY) –PROBABILITY TEST

  A fact is material if there is a substantial likelihood a reasonable investor would consider it important in making a
  securities-related decision.
           1) Put another way, there must be a substantial likelihood that disclosure of the omitted fact would
              have been viewed by the reasonable investor as altering the ―total mix‖ of information made
              available.
           2) Information PROBABLY (not MIGHT) have affected investor‘s decision, but no need to show it
              acutally caused reasonable investors to change their vote (it‘s not a but for test)
           3) The question of materiality is primarily a question of fact that should not be taken away from the
              jury unless the court can rule as a matter of law that the misrepresentation or nondisclosure could
              not reasonably be found by a jury to have been material.

      B. PROBABILITY MAGNITUDE TEST (BASIC V. LEVINSON)

  for contingent or speculative events, materiality depends upon balancing the probability the event will occur with
  the anticipated magnitude in light of the total mix of information.
           1) If probability is very low but magnitude is extremely high, balance in favor of disclosure.
           2) This case involved disclosure of negotiation proposals; the Court says that it is not addressing any
              other kinds of speculative information, such as earnings forecasts or projections.)

      C. RELATIONSHIP OF MATERIALITY AND DUTY TO DISCLOSE
         Just because information is false or misleading doesn‘t mean it‘s material, and just because information
         is material doesn‘t mean it must be disclosed.
         Duty – whether and when info must be disclosed
         Materiality – what info must be disclosed

      D. TYPES OF INFORMATION
            1. Speculative Information – use probability-magnitude test
            2. Soft Information – projections
                Safe Harbor – Rule 175 permits soft information as long as it has reasonable basis
               3.   MD&A – required disclosure
                    under Item 303 of Reg. S-K


      E. CONTEXTUAL DISCLOSURE: TOTAL MIX TEST

  there must be a substantial likelihood that the disclosure of the omitted fact would have been viewed by the
  reasonable investor (subjective b/c judge-made) as having significantly altered the total mix of information
  available.

6. BESPEAKS CAUTION DOCTRINE
  caveats and warnings are often part of the total mix of information received by investors. The bespeaks caution
  (warnings beyond boilerplate disclaimers) can negate the materiality, or reliance on, unduly optimistic
  representation or omission


                                                                                                                     67
  Buried Facts Doctrine – conversely, if facts are buried in a mountain of information, it may be unfairly
  misleading.

7. DUTY TO UPDATE

      A. TIME WARNER – DUTY TO UPDATE
         1) A duty to update opinions and projections may arise if the original opinions or projections have
            become misleading as a result of intervening events.
         2) An omission is actionable under the securities laws only when the corporation is subject to a duty to
            disclose the omitted fact. The questions of duty and materiality are separate. Where the disclosure
            duty arises from the combination of a prior statement and a subsequent event, which, if not
            disclosed, renders the prior statement false and misleading, the inquiries as to duty and materiality
            coalesce. A duty to disclose arises whenever secret information renders prior public statements
            materially misleading, not merely when the information completely negates the public statements.

      B.   STRANSKY V. CUMMINS ENGINE – CONTRADICTS WARNER:
           1) There is a duty to correct, but there is a not duty to update. (Ruder: duty to update should turn on
              whether there is a continuing statement.) The duty to correct exists only so long as the prior
              statements remain alive.
           2)   Attribution: In limited circumstances an issuer may be responsible for correcting or updating
              third party statements when the issuer is the source of the inaccuracies or is responsible for their
              dissemination. Normally, however, the mere presence of rumors or of publicly circulating
              inaccuracies concerning the issuer does not requires a response from the issuer.
           3) While adhering to a policy not to comment on earnings forecasts, a company assumes no duty to
              disclose its own internal forecasts or to warn analysts that the company does not share their
              optimistic views. Under the entanglement doctrine, however, if the company signs off on an
              analyst‘s report, there is a form of attribution to the company.

      C. VIRGINIA BANKSHARES
         Opinions are normally not treated as facts, but when the speaker knowingly iterates a false opinion, it
         should be treated as a fact and is actionable.



      Questions arising in Rule 10b-5 context:
      1) No duty of timely disclosure
      2) Duty to correct (statements that were erroneous when made)
      3) No duty to comment on rumors (right ―to remain silent‖)
      4) Entanglement/attribution: duty to correct only statements attributable to the company




8. CULPABILITY UNDER RULE 10B-5

      A. ERNST & ERNST V. HOCHFELDER – SCIENTER REQUIREMENT
         1) The Court held that an action under §10(b) will not succed without the requisite scienter.
            Negligence is not enough. The words ―manipulative and deceptive‖ strongly suggest that §10(b)
            was intended to proscribe knowing or intentional misconduct. Use of the word manipulative
            connotes intentional or willful conduct designed to deceive or defraud investors by controlling or
            artificially affecting the prices of securities.
         2) After Hochfelder, 11 out of the 12 circuits have held that recklessness is a sufficient basis for
            liability. Reckless conduct may be defined as highly unreasonable conduct, involving not merely



                                                                                                                     68
             simple, or even inexcusable negligence, but an extreme departure from the standards of ordinary
             care, and which presents a danger of misleading buyers or sellers that is either known to the
             defendant or is so obvious that the actor must have been aware of it

     B. AARON V. SEC (1980) – APPLYING HOCHFELDER TO 1933 ACT:
        1) Congress intended a scienter requirement under §17(a)(1), but not under §17(a)(2) or (3) –
           negligence is enough.
        2) Proper scienter for §17(a)(1) = knowing or intentional misconduct (―defraud‖).

9. THE DECEPTION REQUIREMENT
     §9:         price manipulation
                 It is unlawful to effect a series of transactions that involve no change in the
                 beneficial ownership of the securities or that create an actual or apparent
                 active market for the securities or manipulate the price for the purpose of
                 inducing a sale of such securities. [Applies to listed securities only!]

     A. SANTA FE INDUSTRIES – BREACH OF FIDUCIARY DUTY NOT ENOUGH:
        A fraud under Rule 10b-5 does not arise when the majority executes a short form merger without any
        business purposes. §10b was intended to prohibit conduct that is deceptive or manipulative – something
        beyond internal corporate management. Congress meant to prohibit the full range of ingenious devices
        that might be used to manipulate securities prices; however, nondisclosure is usually essential to the
        success of a manipulative scheme. There is a lack of case law to support the proposition that a breach of
        fiduciary duty by majority stockholders, without any deception, misrepresentation, or nondisclosure,
        violates §10(b) or Rule 10b-5.
        In footnote 14 the Court said that failure to give notice of the merger was not a material nondisclosure
        because they could not have enjoined the merger; appraisal is the only remedy in Delaware for alleged
        unfairness in terms of the merger.

10. CAUSATION, MATERIALITY, AND RELIANCE

     A. MILLS V. ELECTRIC AUTO-LITE
        1) To support an action for violation of §14(a) in the context of a merger, the plaintiff must show that
           the proxy statement was materially misleading. Beyond materiality, the plaintiff must show that the
           statement itself was an essential link to the accomplishment of the transaction. The plaintiff must
           show that the defect in the proxy statement has a significant propensity to affect the voting process.
           Where the misstatement or omission in a proxy statement has been shown to be material, that
           determination itself indubitably embodies a conclusion that the defect was of such a character that it
           might have been considered important by a reasonable investor weighing how to vote.
        2) The Court did not address the issue of causality in Mills. In Virginia Bankshares the Court reasoned
           that where management possessed enough votes to approve a merger and plaintiffs could identify no
           remedy that was lost because of defendants alleged material misrepresentations or omissions,
           plaintiff would fail to demonstrate causation.

     B. BASIC INC. V. LEVINSON - ―FRAUD ON THE MARKET‖:
        1) With respect to a Rule 10b-5 action, it is appropriate for courts to apply a rebuttable presumption of
           reliance, supported in part by the fraud on the market theory. Requiring a plaintiff to show a
           speculative state of facts, i.e., how he would have acted if omitted material information had been
           disclosed, would place an unrealistic evidentiary burden on Rule 10b-5 plaintiffs who trade on an
           impersonal market. (Affiliated Ute Citizens analysis)
        2) The decision was only 4-3. The most liberal judges were in the majority and the most conservative
           did not take part in the decision.
        3) Fraud on the Market Theory—don’t need reliance: Based on the hypothesis that, in an open and
           developed securities market, the price of a company‘s stock is determined by the available




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         information regarding the company and its business. Misleading statements therefore defraud
         purchasers of stock even if the purchasers do not directly rely on the misstatements.

C. MIRKIN V. WASSERMAN (CALIFORNIA)
   Plaintiffs, who purchased securities at a price allegedly impacted by misrepresentations, cannot plead a
   cause of action for deceit without alleging that they actually relied on the misrepresentations. While
   fraud on the market theory is sufficient to plead reliance in §10(b) cases, common law deceit and
   misrepresentation claims are distinct. In short, California does not permit plaintiffs to state a cause of
   action for deceit without pleading actual reliance.

    1) Reliance is a necessary factor in a Rule 10b-5 violation.
    2) Knowledge of a misrepresentation = affirmative defense
    3) Affiliated Ute Citizens: No reliance is required to be established in pure omission cases. There is a
       rebuttable presumption of reliance.


D. SUMMARY:
   Materiality is an objective standard; it is the same as reliance but in the
   universe of reasonable people,
   Reliance is a subjective standard: did the misstatement cause the
   defendant to change his position? Reliance is sometimes called transaction
   causation.
       Two exceptions to subjectivity (reliance is presumed)
       a) complete non-disclosure cases (Affiliated Ute) – presumption of
          reliance;
       b) information transmission to the market (Basic v. Levinson) – ―fraud
          on the market‖ theory; no need to show individual reliance;
          reliance is presumed
   Causation asks whether the defendant was harmed because of his change
   in position? This is called loss causation.




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11. INSIDER TRADING
  1) §20A: Provides an express private cause of action against insider traders for those who contemporaneously
     sold or purchased securities of the same class.
          
             Recovery: profits gained or losses avoided by insider.
          
             SOL = 5 years after the date of last transaction.
  2) §21A: Discusses civil penalties (action brought by SEC) for insider trading violations.
          
             Penalty = tripled profit gained or losses avoided.
          
             Persons controlling violators can also be liable.
          
             SoL = 5 years after sale/purchase.
          
             Profits gained‖ or ―losses avoided‖ = difference between the price and the value of securities
             (trading price a reasonable time after public dissemination of non-public information).
  3) Rule 14e-3: One violates Rule 14e-3 if he trades on the basis of material nonpublic information concerning a
     pending tender offer that he knows or has reason to know has been acquired directly or indirectly from an
     insider of the tender offeror or the issuer. It creates a duty in those traders who fall within its ambit to abstain
     or disclose, without regard to whether the trader owes a fiduciary duty to respect the confidentiality of
     the information.
  4) Insiders who trade on confidential, non-public information are liable to those with whom they trade.
  5) Tippers are liable, even if they themselves do not trade, to contemporaneous buyers from tippees.

      A. TEXAS GULF SULPHUR (―DISCLOSE OR ABSTAIN‖ RULE)
         Disclose or abstain rule – anyone trading for his own account, who has access (directly or
         indirectly) to information intended solely for corporate purposes may not take advantage of that
         information unavailable to those he’s dealing with. Must either disclose the information or abstain
         from trading or recommending the securities.

      B. CHIARELLA
         1) no violation of Rule 10b-5 unless there is a duty that is being violated (fiduciary)
         2) A duty to disclose under §10(b) does not arise from the mere possession of nonpublic information.
            Neither Congress nor the Commission ever has adopted a parity-of-information rule. A duty to
            disclose is required to make silence actionable. No duty could arise from petitioner‘s relationship
            with the sellers of the target company‘s securities, for petitioner had no prior dealings with them; he
            was not their agent; he was not a fiduciary; he was not a person in whom the sellers had placed their
            trust.
         3) It has long been recognized that officers and directors and majority or controlling shareholders are
            subject to §10b(5)‘s disclose or abstain rule.

      C. DIRKS V. SEC (1983) – ―CONSTRUCTIVE INSIDERS‖/FIDUCIARY DUTY OF TIPPEES:
         
            Duty to disclose under §10(b) does not arise from the mere possession of nonpublic market
            information. Such a duty arises rather from the existence of a fiduciary relationship.
         
            Not all breaches come within the ambit of Rule 10b-5; there must also be manipulation or
            deception.
         
            In an insider trading case this fraud derives from the inherent unfairness involved where one takes
            advantage of information intended to be available only for corporate purposes and not for the
            personal benefit or anyone.
         
            A tippee assumes a fiduciary duty to the shareholders of a corporation not to trade on material
            nonpublic information only when the insider has breached his fiduciary duty to the shareholders
            by disclosing the information to the tippee and the tippee knows or should know that there has
            been a breach. Whether a disclosure is a breach depends on whether the insider will benefit,
            directly or indirectly, from his disclosure.
                  - Footnote 14 transforms outsiders such as underwriter accountant, lawyer, or corporate
                       consultant into constructive insiders (―fiduciaries of the shareholder‖) when they enter



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                        into a special confidential relationship in the conduct of the business of the enterprise are
                        given access to the information solely for corporate purposes.
          
              Not only are insiders forbidden by their fiduciary relationship from personally using undisclosed
              information for their advantage, but they also may not give such information to an outsider for the
              same improper purpose of exploiting the information for their personal gain.

      D. U.S. V. O’HAGAN (1997)
         1) Held that the SEC did not exceed its rulemaking authority by adopting Rule 14e-3(a), which
             proscribes trading on undisclosed information in the tender offer setting, even in the absence of a
             duty to disclose.
         2) Rule 14e-3 is justified on the theory that, while it may be possible to prove circumstantially that a
             person traded on the basis of material nonpublic information, it may be impossible to prove that the
             trader obtained such information in breach of a fiduciary duty owed either by the trader or by the
             ultimate inside source of the information.
         3) Rule 14e-3 reaches non-insiders trading on the basis of inside information (Chiarella) in the specific
             context of tender offers.

12. SELECTIVE DISCLOSURE & REG. FD
      Regulation FD – Selective Disclosure
      whenever an issuer (or someone acting on issuer‘s behalf) discloses any material non-
                    public information, the issuer must make a public disclosure of that
                    information:
                    a) simultaneously (if intentional disclosure), or
                    b) promptly (if unintentional)
      applies to - issuer, broker, dealer, investment adviser, or holder of issuer‘s securities.
      Does not apply to:
                    a) a person who owes duty of confidence to issuer
                    b) a person who under contract signed non-disclosure


13. REMEDIES UNDER RULE 10B-5:
     rescission;
     damages (restitution, ―disgorgement of profits‖, or ―benefit of the bargain‖).




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