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1 Securities Regulation Professor Bradford May 3, 2005 9:00 a.m. 3 Hours and 15 Minutes INSTRUCTIONS 1. This is a partially open book exam. You may use the Cox, Hillman, Langevoort casebook, the statutory supplement required for this course, any handouts provided by the professor, and any materials, such as notes or outlines, prepared exclusively by you. You may not use any other materials, written, digital, or recorded. You may not consult with or communicate with any other person during this exam. 2. This exam has six (6) pages, including the instructions. The page numbers appear on the top right-hand corner of each page. Please check to be sure that this copy has all the pages. 3. You have three hours and fifteen minutes (3:15) to complete the exam. You must turn in your answers in this room, even if you are taking the exam somewhere else in the building. If you finish more than five minutes early, you may turn in your answers in the Dean’s Office. 4. The exam consists of three (3) questions. The recommended time for each question is as follows: Question 1…………..……..1 Hour and 5 Minutes Question 2………………..1 Hour and 20 Minutes Question 3…………………..………..45 Minutes An additional five minutes is not allocated to any particular question. Each question will be weighted in accordance with its recommended time. 5. Do not spend all of your time writing. Think about the issues and organize your answers before writing. Be concise. Be organized. Long, disorganized, rambling answers will be penalized, as will merely “dumping” portions of your notes or outline into your answers rather than answering the question posed. 2 6. This exam will require you to interpret and apply many of the statutory provisions and regulations we have examined. YOU SHOULD NOT JUST STATE GENERAL PRINCIPLES, BUT SHOULD CITE THE RELEVANT SECTIONS AND SUBSECTIONS OF THE STATUTES AND REGULATIONS AND EXPLAIN HOW THE LANGUAGE OF THOSE RULES APPLIES TO THE FACTS OF THE QUESTION. 7. If you believe that additional facts are needed to answer a question, state exactly what those facts are and how they would affect your answer. If you believe that a question is ambiguous or unclear, note the ambiguity or lack of clarity and indicate how it affects your answer. 8. You may take the exam in this room, in a typing room if you are typing, or in the computer lab if you previously reserved a spot. 9. If you are taking the exam on a computer, your answers must be formatted either for WordPerfect or Microsoft Word, and turned in on a disk. Your exam number must be on both the disk and the top of your answers. The file name should be your exam number. For example, if your exam number were 666, the file name would be 666.doc or 666.wpd. Double space. Do not put your name on the disk or anywhere on the answers. 10. Be sure to save a copy of your answers on your computer or on another disk, just in case it is needed. Do not delete it until the beginning of next semester. 11. If you are typing the exam, your exam number should appear on the top of each page of typing paper. Double space. Do not put your name anywhere on the answers. 12. If you have any technical problems during the exam, please report them immediately to the Dean’s Office; we will assume you had no technical problems until when you reported them. Be prepared to finish your exam by writing it. (Regular notebook paper is O.K.) 13. Save your answers often, and set your computer to back up every five minutes. No allowances will be made for problems you could have avoided by saving your answers regularly. 14. The Honor Code is in effect. 15. Good luck and have a pleasant summer. DO NOT TURN THIS PAGE UNTIL YOU ARE GIVEN THE SIGNAL TO BEGIN. 3 Question 1 (1 Hour and 5 Minutes) In the summer of 2003, Alpha, Inc. sold $5 million of its common stock pursuant to Rule 505 of Regulation D. The offering, which began on July 1, 2003 and was completed by August 1, 2003, fully complied with all the requirements of Rule 505. Until his retirement on April 10, 2004, Bob Barker was Alpha’s beloved Vice President for Public Relations. At Bob’s retirement party on his last day of work, Alpha gave Bob 1,000 shares of Alpha common stock “in recognition of his 25 years of meritorious service.” The market value of the stock at the time was approximately $25,000. Bob had no contractual right to this stock and this was the first time Alpha had ever done this for a retiring employee. The stock Alpha presented to Bob was not registered, nor did Alpha file anything with the SEC concerning the shares. Bob was touched. His net worth was only $500,000 at the time and his income at the time of retirement was only $150,000 a year, so the stock was a substantial addition to his wealth. Except for an investment in a mutual fund, Bob had never even owned corporate stock before. Bob was so proud of his new stock that he folded the stock certificate and carried it in his wallet from then on. On May 1, 2005, Bob was in the Oolala Bar in Hawaii with his friend Daphne Deal, a stock broker. After a significant amount of time in the bar, Bob discovered he didn’t have enough money to pay his bill. He asked Daphne if she would pay it. “No,” she replied, “but I think I can help you. You still have that stock certificate, don’t you? Give it to me and I’ll get you some money for it.” Daphne went around the bar and finally found a bar employee, Candi Cane, who was willing to buy the stock for $10,000. Bob sold the stock to Candi in return for her payment of the bar bill and two checks: one to Daphne for her usual 5% sales commission and one to Bob for the rest of the price, less the bar bill. Discuss whether Bob or Alpha have violated the Securities Act. NOTE: Assume: 1. Securities Act Rule 701 does not apply to anything in this question. 2. Alpha has not engaged in any securities transactions, other than those mentioned, during the time period covered by this question 3. No securities fraud occurred. 4 Question 2 (1 Hour and 20 Minutes) Omega is a well-known public company whose common and preferred stock is traded on the New York Stock Exchange. Omega files reports pursuant to the Exchange Act. In late December 2004, Omega decided to sell additional preferred stock to help pay for a new manufacturing facility. On January 2, 2005, Omega published a half-page ad in the Wall Street Journal that stated, in large capital letters: “ANOTHER OMEGA PUBLIC OFFERING. FOR DETAILS, SEE www.omeganotice.com.” This was all the ad said, except for a small disclaimer at the bottom: “This ad is not an offer.” The following appeared at www.omeganotice.com: NOTICE OF UPCOMING PUBLIC OFFERING Omega will be selling 100,000 additional shares of preferred stock at a price of approximately $50/share. The preferred stock to be issued is convertible into common and has a dividend preference of $0.50/share. We expect to file a registration statement around Feb. 1, and to be able to sell the shares around April 15. The money raised will be used to pay part of the cost of a new manufacturing facility for Omega. This is not an offer to sell the preferred stock. Go to Omega’s Home Page The link at the bottom of the page took the reader back to Omega’s home page, which included all kinds of information about the company, its products, its officers and directors, and its history. Under a “News About Omega” heading, the home page also included links to media stories about Omega and its prospects. Except for adding recent news stories, Omega’s home page has looked exactly the same since the beginning of 2004. Larry Law, a wealthy attorney, saw the Wall Street Journal ad and went to the 5 specified web page for details about the offering. On February 3, 2005, the day after Omega filed its registration statement with the SEC, Larry called his broker, Barb Broker. Barb works for Investo Partners, the lead underwriter for Omega’s offering. Barb told Larry about the upcoming offering and asked if he was interested in buying. She gave him an honest review of what analysts were saying about Omega and its future prospects, and expressed her true belief, based on extensive research about Omega, that it was an attractive investment. Larry said, “As a drug company, Omega must be involved in a lot of medical research. They don’t do anything involving fetal tissue, do they? I am strongly opposed to the use of fetal tissue in medical research.” “No,” Barb replied. “They stay out of that mess.” In fact, as Barb knew from reading the preliminary prospectus, about 40 percent of Omega’s research involved fetal tissue and some of their best-selling drugs resulted from that research. “Then, I’m interested,” Larry told Barb. “Send me a preliminary prospectus.” Barb sent a preliminary prospectus to Larry the next day. He received it, but never got a chance to read it. Omega’s registration statement became effective on April 7. On April 8, Barb called Larry again and asked if he wanted to buy some of the preferred stock. Larry said he wanted to purchase 1,000 shares (at the offering price of $48 a share). On April 10, Barb mailed Larry a confirmation and a copy of the final prospectus. On May 1, some medical equipment that Omega was using for fetal tissue research caught fire and exploded. The explosion destroyed a good part of Omega’s factory and inventory. Omega was underinsured, so it will have to bear some of this loss itself. On May 2, when Omega announced this to the public, its preferred stock price fell from $46 a share to $39 a share. Discuss Larry’s claims, if any, under federal securities law. 6 Question 3 (45 Minutes) Cleanway, Inc. manufactures and sells an industrial-strength cleaning solution called Super Shine. It only sells the solution in 50-gallon drums. Until recently, all of its customers were big institutions, such as hotels, hospitals, and office buildings, which do large amounts of cleaning. After receiving inquiries from several individuals who were impressed by how well Super Shine cleaned, Cleanway began selling Super Shine to individuals, but still only in 50-gallon drums. When some individual purchasers asked if they could resell the cleaner to their friends, Cleanway set up what it calls its Dealer Program. Any individual buying a 50-gallon drum may pay a $200 annual fee to become a dealer. Once a person becomes a dealer, Cleanway will sell the dealer individually labeled small plastic bottles that can be filled from the large drums. Dealers must agree not to do any advertising, although they may go door to door. Cleanway has had a very good response to its Dealer Program. Many people, very few of whom have past experience with cleaners or the cleaning business, have signed up. Cleanway advertises in newspapers and magazines and on television and radio. Each ad says that Super Shine is not sold in stores and gives a phone number and Internet address for buyers to contact. If institutions contact Cleanway, it sells to them directly. If individuals contact Cleanway, it asks if they want to buy a 50-gallon drum or a smaller, consumer size. If they want to buy a smaller size, Cleanway gives them the name and phone number of the nearest dealer. If they want to buy a drum, Cleanway sells to them directly, explains the Dealer Program, and asks if they want to be dealers. Cleanway’s advertisements include a money-back guarantee; customers who are dissatisfied with Super Shine can get a refund. Cleanway requires dealers to honor the guarantee and pay for any refunds out of their own pockets. Discuss whether Cleanway is selling securities to the dealers.
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