Securities Regulation Outline- PK

8/12/2019 Securities Regulation Outline- PK

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SECURITIES REGULATION

INTRODUCTION

I. Securities Transactions

a. Securities are bought and sold in two principal settings:

i. Issuer Transactions: those involving the sales of securities by the issuer to

investors.

ii. Trading Transactions: the purchasing and selling of outstanding securities among

investors.

II. Reasons for Regulation

a. Regulation for the public interest

i. Will cure market failures and provide efficiencies by increasing information.

b. Interest Group apture

i. Rules made to help!s"uelch another group

c. Regulators #enefit

i. ertain rules help the S$% itself

III. &arious 'pproaches to Securities Regulation

a. 'ntifraudi. (itigation over defrauding someone

ii. 'fter)the)fact regulation

iii. $*ists on a federal and state level +,b)-

b. Registration and isclosure

i. /sed prior to selling securities

ii. Incentive to have more disclosure to have more people to trust you

iii. Included in the 011 'ct. opied from what was done by seasoned issuers ofsecurities prior to the implementation of the 211 'ct.

c. 3erit Regulation

i. Regulation that a company may not be able to sell securities in a particular state%

unless that company is a good one and has merit and is deemed worthy and in the

public interest by the state

ii. Re"uired in some states 4+56 still% but mostly preempted by federal law


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d. S$: Securities and $*change ommission

i. Regulatory body to control securities

ii. 3ost commissioners come from industry and return to the industry after.

IV. 1933 Securities Act

a. State laws were allowed to run concurrently% unless the

i. Stock was traded on the big stock e*changes 47'S'8% '3$9% 7S$6

ii. If you sell stock to sophisticated people: states are not able to regulate

iii. 7ame certain e*emptions that states can0t regulate

b. #asic Structure

i. iscussion of registration and new issues

ii. &arious e*emptions

iii. 'ntifraud: makes state

c. #asic ;hilosophy: ations 4i.e. the

7S$6

b. 'ntifraud Rules

i. ? +, and a rule that has been adopted pursuant @ Rule +,b)-

c. ontinuing isclosure Re"uirements

i. 'fter issuance% there are continued disclosure re"uirements

+. 'nnual report 4+,k6

5. 8uarterly Report 4+,"6

ii. isclosure only re"uired for companies:

+. Traded on a national e*change

5. If company is big% i.e.


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a. 3ore than A+, million dollar in assets '7

b. 3ore than -,, shareholders

c. Br if you filed the 011 act registration statement

d. ;hilosophy:

i. 'llows the govt to delegate to private% SRBs

&I. Sources of all Rules of Securities Regulation

a. onstitution

b. Statutes: 011 and 01= 'ct

c. Bfficial S$ rules and pronouncements

d. S$ interpretations

i. S$ can interpret the laws and regulations

ii. Sort)of have the force of law

e. Bfficial S$ formsCin practice very important

i.


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a. $ven if the type used isn0t e*actly mentioned% if it smells like a

security and looks like a security% and has risks like a security% it

likely is a security.

b. ;olicy Reasons at times determine what should be regulated by the securities acts

i. $conomists ask:

+. oes it make sense to be regulatedE

5. oes it solve a market inefficiency for these disclosuresE

a. ompany should do the disclosure if there are too many buyers

who will not do the disclosure% otherwise% let the one buyer do the

disclosure.

ii. ;sychological

+. ;eople tend to be overly optimistic

5. 'nd don0t recogni>e the amount of fluctuation there actually is.

c. Implications of the efinition

i. If defined to be a security% a host of re"uirements are triggered.

+. Registration and isclosures for public offerings

5. isclosures for e*emptions

1. (iabilities for selling unregistered securities and misrepresentations

=. 'ntifraud provisions

-. (imits on insider trading

F. 'dministrative and udicial liability for insider trading law

II. Investment ontracts: Howey Test

a. Test for determining whether an investment fits into the definition of a security by being

an investment contract

i. I!&est '!e(

ii. I! $ c))! e!ter*rise

iii. E+*ect$ti!s , -r,itsiv. Fr) te e,,rts , Oters

b. ase (aw

i. "#$ v. (.&. )owey $o.

+. Two orchard companies sold parcels of land. (and is not a security% but

here they are also offering service contracts to harvest the fruit from the

land. +- hired someone else% J- took the service contract.


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a. $conomically structured this way to allow people to Dust see the

land as an investment

b. Holding: definitely a security because it met the = part test. This

was an investment in a common enterprise that e*pected profits

solely from the efforts from others.

c. ust selling the land would not have been an issueK it was the factthat it was coupled w! a service contract 4or i.e a rental agreement

on a condo6

c. 'lternative to the Howey Test: Ris/ C$*it$0 Test

i. ' security will not e*ist under the risk capital test unless capital provided by

investors is at substantial risk.

ii. State ourt view that information must be disclosed because the investment is at a

substantial risk

+. 3uch easier test to satisfy

5. #ut Howe reDects it.

iii.


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information that would have suggested that the issuer was the low cost

provider of relevant information.

III. Howey Test 'pplied @ efinitions of the $lements

a. Two applications:

i. ;romoter will attempt to evade the securities laws

ii. Someone else will something and will be advised by not good lawyers and will

call it a stock or something else to fall under the definition when its not really a

stock

+. rofits *efined

i. United )ousin oundation, nc. v. orman

+. 7 built co)op housing and low)income individuals were able to live

there as long as they also paid a bit to buy LstockM in the ownership rights.There was a lawsuit because 7 increased the price to how much the

monthly rental rate increased because of problems budgeting. They

claimed that these LstockM were securities and they should have complied

w! all the registration!securities laws.

i. )oldin: 7ot a security. There was no e*pectation of

profits. B7S/3;TIB7 H$R$. When a purchaser is

motivated by a desire to use or consume the item purchase%

the securities laws do not apply.

+. $ven if it was called a stock% did not meet there"uirements of being a security.

a. 7B dividends

b. 7o profits e*pected

ii. 'lso% look to see whether this is Dust a game% or an actual investment for profit.

+. In determining this% look at the reasonable investor0s point of view on

whether this was done for profit or in a game.

iii. "#$ v. #dwards /"ale-'easeback inancin0

+. ;ayphone sales and lease back. Initially contract provided a += of

returns via a pyramid scheme 4;on>i scheme6. The defendants said this

was not a security b!c there was a fi*ed return.

a. ourt holds that e*pectation of profits does not re"uire variable

returns.


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reason people are attracted is because of the profits themselves

i. 7othing the)oweytest re"uired that profits be variable.

'nd that a fle*ible interpretation furthered the purpose of

the securities laws to snag unscrupulous marketers who

promise low)risk investments 4i.e. guaranteed fi*ed returns6

from the elederly!unsophisticatedc. ifferent 3eanings of ommon $nterprise

i. Horizontal Commonality: There are several people all investing in the same

enterprise

+. /sually applicable in every Durisdictions

5. 5 Ways to Get Hori>ontal ommonality

a. Whether investors are investing in the same way

b. Whether investors are all investing in the same enterprise and are

investing in the same manner.

ii. Vertical Commonality:5 forms

+. Broad vertical commonality:the most broad form% only a connection

between the efforts of the promoter and re"uire only a connection between

the efforts of the promoter and the collective success or losses of the

investors

5. Strict vertical commonality: re"uires a direct relationship between the

success 4as opposed to the efforts6 of the promoter and that of the

investorsK

a. Re"uires the promoters and investors to share the risks of a venture

. $fforts of Bthers

i. S$ v. (ife ;artners

+. 'IS patients life policies were sold to others% but everyone lost money

because the 'IS drugs were released and the patients were living longer.

5. Holding: This was a securityCfrom the efforts of others factors. The

promoters in this situation worked very hard prior and thus% satisfied the

a. $very other case looks only to the future actions of the promoter to

see whether the meet they efforts of others.

ii. In the case of figuring out whether efforts of others may not come into play

because profits are based on the world market prices 4i.e. fluctuations in the price

of gold6 look ne*t to whether the efforts of the promoter are the cause of the

profits or the world market price is the cause of the price fluctuations.

iii. $fforts of others should be analy>ed by how much control a person retains in their


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investment.

IV. Assci$ti!$0 Fr)$0ities: I!terests i! Cr*r$ti!s -$rt!ersi*s $!2 LLCs $s

Securities

'. Cr*r$ti!s: Stock as Security

i. 7on)investment stock

+.


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a. ' partnership is the pooled efforts of the partners.

5. 7ot a security% unless treated as a security

ii. $*ception: (illiamson case

+. General partnership is not a security% unless:

a. 7o legal control: ;artnership agreement eliminates investor controlBR

b. 7o capacity to control: Ine*perienced investor BR

i. Securities laws are supposed to protect the ine*perienced%

and thus securities laws should apply.

c. 7o practical control: ;romoter has uni"ue skills that can0t be

replaced

iii. (imited partnerships is generally more likely a security

+. $*ception: limited partner that gains more control and becomes liable for

his actions.

a. State statues and R/(;'Crules that allows a limited partner to do

certain things w!o gaining liability

5. "teinhardt 1roup v. $iticorp: (imited partnership created to sell of its

nonperforming assets. #ut there was only one limited partner @ Steinhardt.

The investment was not successful and he sued under the securities laws

for rescission. Was he Dust a passive investorE

a. The ourt held that because Steinhardt had significant powersunder the (;' and he directly profited from his efforts% this could

not be considered from the efforts of others.

i. He retained pervasive control of the partnership

b. 7ot an investment contract and thus not a security.

c. 'lso% at play is that Steinhardt was a sophisticated investor and

didn0t need the protection of the securities laws.

i. #ut other courts don0t agree with this.

. LLCs as Securities

i. 5 types

+. 3ember managed @ structured like a partnership

a. 7ot a securityCe"ual rights to management

b. If there is a very large member managed firm with +%,,, members%

have to look to the structure to make sure it doesn0t act more like


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manager managed

i. 7ot hard and fast rules

5. 3anager)3anaged @ structured like a corporation

a. 3ost likely a security

V. REAL ESTATE AS A SECURITY

a. /sually% buying real estate% you are not a security.

i. 7o hori>ontal or vertical commonality

ii. $*pect use of the land!real estate

b. If there is an attached management rental agreement% may be a security

i. ust looking for someone else to handle the rental and for you to profit out of it.

ii. ommonality is satisfied if there is some sort of rental pool @ Rental ;ool'greement 4R;'6

$. )ockin v. *ubois

i. Hocking a resident of (as &egas wants to buy an investment condominium in

Hawaii. He gets into contact w! ubois a real estate agent licensed in Hawaii% but

tells him he wants to be a Lfirst person buyerM from the developer. $nds up buying

in the secondary market. He signs a rental management agreement with H;% but

says it was a passive investment that ubois selected and managed. He however

defaults on the payments of the condominium% but says that it was caused by the

failure to receive the e*pected rental income and other misrepresentations byubois.

ii. Issue : Is it still a security when the rental agreement is not directly w! the land

developer under the Howey testE

+. 7ot purchased from the developer so not e*actly like the Howey case.

iii. Holding : ourt looks to the Howey test but under the e*pectation of the profits%

they applied the Williamson test. 416 the investor here was so dependent on the

services of the manager that he could not replace the manager of the enterprise or

e*ercise meaningful partnership or venture powers. The owner of the condo hadno control of the administration of the condominium. This is a security.

+. Williamson test is for partnerships. They analogi>ed to the partnership.

iv. #rokers now afraid they can0t recommend a service contract.

VI. NOTES AS SECURITIES


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a. 7otes are defined in both the 011 and 01= act

i. Securities laws define a security to include Lany noteM

+. Securities 'ct 40116 ? 54+6 and

5. $*change 'ct 401=6 ? 14a64+,6

ii. However% under the Securities 'ct a note that Larises out of a current transactionMand matures within nine months is e*empt from registration under the 'ct.

+. Intended for commercial paperCunsecured promissory notes issued by

large% financially sound companies to finance current operations and sold

to institutional investors in large denominations.

b. When is a LnoteM a securityE

i. Reves v. Ernst !oun" #use the $%& 'ct(

+. o)Bp is an agricultural cooperative that had 51k members. They sold

promissory notes payable on $3'7 by the holder% and paid a variablerate of interest that was adDusted monthly to keep above the rate paid by

local financial institutions. The note was offered as an investment. The

o)Bp filed for bankruptcy in +NJ=% but the holders filed suit under Rule

+,b)- against the accounting firm that handled the financial statements

citing a failure to disclose insolvency.

5. Issue: Is the note issued by the o)Bp a security within the meaning of the

+N1= act to "ualify as a +,b)-E

1. Holding: es.


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business

d. haracter loan to a bank customer

e. 7ote secured by a business0 accounts

receivable

5. 3ainly consumer loans and normal day)to)day

business loans especially short term loans don0t

have to comply w! securities laws.

ii. Second% if it doesn0t fit the list% should the list be e*pandedE

See if there is a family resemblance using the = part test.

1. 'ti&$ti! ,r Tr$!s$cti!:

a. If solely for profit or investment% then it is a

security% but if it is used to buy consumer

goods or for some commercial purpose% not

a security.

5. -0$! , Distriuti!: Is there common tradingE

a. If the notes are widely offered and traded% it

is more likely a security. If the note is given

in a face)to)face negotiation to a limited

group of sophisticated investors% it is more

likely not a security.

3. I!&estrs Re$s!$0e E+*ect$ti!s:

a. id the investors believe this investmentwould be protected by securities lawsE

i. Then more likely a security

4. Ris/Re2uci!5 F$ctrs , te I!&est)e!t

a. 're there other factors that reduce the risk of

this securityE

i. i.e. collateral

b. Br are there nonsecurities governmental

regulations to protect investorsE

c. If there are neither% it is more likely a

security.

d. annot meet the nine)months e*ception. These notes are on

demand and the maturity is indefiniteCanytime from a short term

to a very long term.

i. issent disagrees and calls these securities for less than


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nine months because it can be called upon at anytime.

ii. 2eevesapplied

3. Securities and E)chan"e Commission v. *allenbroc+

a. Wallenbrook sold promissory notes secured by the accounts

receivable of 3alaysian late* glove manufacturers. The buyers

future payment 4ninety days later6 was assigned to Wallenbrock%

who would then buy the account receivable for O-)J, of its

value. The individual investor and Wallenbrock would split the

cost of the receivable% with each party owning a -, undivided

security interest in the account receivable. 7otes had a 1)month

maturity. Turns out to be a pyramid scheme.

i. ourt holds that it does not fall into any of the members of

the family% and it also does not meet the family

resemblance test.

+. 3otiveCsold for profit 45, return6

5. ;lan of distributionC(arge: sold to +%,,, investors

over 5- states

1. Reasonable e*pectations of publicCthought of as

an investment

=. Risk)reducing


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I. The Bverview of the /.S. Securities 3arkets

a. Structure of the Trading 3arkets

i. /.S. $"uity Securities 3arkets could be described as having three distinct

sections

+. $*changes

a. 7S$ and '3$9 and - regional e*changes

b. Pnown as auction markets because the orders are e*ecuted at a

central location.

i. Try to match up the person who wants to sell for the lowest

amount and the buyer that will offer the lowest price.

ii. Want anti)competitive practices% i.e. minimum price levels.

c. Specialists are involved to make sure that the market runs

efficiently and functions properly.

i. ' specialist holds a bunch of securities and buys!sells when

no one else wants to.

ii. The specialist engages in limit ordersCbuy if the price falls

to a certain level. The specialist takes the order and

e*ecutes when the price falls or vice versa.

d. 3arket Restraints on ommission

i. 7S$ had minimum that commissions couldn0t go below%

but in +NO- got rid of these restrictions. 7ow very cheap.5. 7'S'8

a. omputer)based system for over)the)counter stocks.

i. 3atch buyer)seller through computer systems

ii. 7ow% other e*changes use the computer systems 4i.e.

(ondon Stock $*change6

b. 7'S'8 is a competition for other e*changes now.

1. Bver)the)ounter 3arket 4BT6

a. 7on)listed stocks

b. #roker)dealers buy and sell the stocks% if the broker!dealer doesn0t

have the stock then he buys it from a market maker.

ii. Technology% the increasing role of institutions in trading markets% and

globali>ation not only have blurred many of the distinctions% but have also

introduced new trading mediums.


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+. Regional e*changes:

a. 'bout 5, of the orders for 7S$ stocks are e*ecuted on a

regional e*change

5. ;roprietary Trading Systems: operated by broker)dealers

a. Some systems focus on the most active 7S$ stocks and match

buy and sale orders for small investors without the order ever

being routed to the 7S$.

1. $lectronic ommunication 7etworks

a. omputer)based market that automatically matches consumer limit

orders

=. #lock)Trading:

a. Involves trading of shares directly between institutional investors

without the use of a broker)dealer

b. Trading of blocks of +,%,,, or more shares.

-. $lectronic #ulletin #oards:

a. ;rice "uotes are available electronically for non)7asda" over)the)

counter stocks.

F. #ond 3arkets

a. 'lmost totally dealer markets

b. Globali>ation of 3arkets

i. Internationali>ation of 3arkets

+. Briginally% international markets were all separate when the 011 and 01=

acts were passed.

5. In the 2F,s% $uropean 3arkets opened up to /.S. companies for debt

financing.

a. 3any /.S. ompanies sold bonds abroad because the regulations

were much easier to comply with and less stringent and less forms

to fill out. 'ble to initiate the securities faster and raise money

faster.

b. /.S. investment bankers were losing money and so it lead to a

modest reduction in the amount of forms for /.S. regulations.

i. i.e. Shelf)registration.

1. /.S. companies list in $uropean $*changes.

a. (ondon had become a wealthy e*change and attracted financial


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services markets as the gateway of money into the $uropean

/nion.

=. $uropean ompanies listing in the /.S.

a. (ess fre"uent because the /.S. has additional regulations

i. /.S. accounting rules may change $uropean profits into

losses

-. e all predictable trends of increased

returns out until the returns are e"uali>ed with other stocks.

i. Btherwise% arbitrage opportunities would e*ist.

b. ;rices are a Lrandom walkM with an upward drift to stay


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competitive with other prices.

ii. Semi)strong)


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the companies.

1. 3arkets can0t be allocatively efficient because:

a. The stock prices above intrinsic value stay there because it was too

e*pensive to correct the information.

b. 'nomaliesCyou can0t make money off them because it0s too hard

and too e*pensive to find them.

=. 3easures whether the market allocates capital to its highest and best use

e. Synopsis:

i. Weak hypothesis is true

ii. Semi)strong market hypothesis is true

iii. Strong hypothesis is wrong because you can still make money from insider

trading.

f. (essons of 3arket $fficiency

i. 3arkets have no memory

+. 'll prices are a random walk and will not necessarily bounce up or down

based on past occurrences.

ii. Trust market prices

+. Shouldn0t purchase shares because its LundervaluedMCnot undervalued

because the market has taken the information into account.

iii. 3arket prices tell a lot about performance

+. (ook to bond prices to see whether a company is going bankrupt

a. If the prices are low% then the sophisticated professionals are

betting that the company will go bankrupt.

b. #ut if it0s a high price% then they have confidence in the company.

iv. 7o financial illusions

+. Stock splits happen when management has good information

5. ;rices tend to go up when people think management has secret good

information.

v. ou can0t do better than the market.

g. Implications of $fficient 3arket Hypothesis

i. Greatly influenced the amount of disclosure from other companies

ii. The market0s best guess of a price of the security or worth of the security is the

market price.


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T7E -U8LIC OFFERING

I. Introduction

a. ifferent Type of Bfferings

i. -ri&$te O,,eri!5:

+. Bffering to a small number of investors who are sophisticated. an be

done by the issuer directly to avoid the high costs of registration and a

public offering.

a. ? =456 $*emption to the registration laws% much cheaper

5. /sed with offerings to officers of the company and to the board or &

firms. Sophisticated persons who don0t need the protection of the

securities laws.

ii. Ri5ts O,,eri!5

+. Sell stock only to e*isting shareholders. This is a common method for

those firms that are not public firms yet% and cheaper than public offerings.

a. /nderwriters still involved

5. Tricky to correctly price the security% but a low price benefits shareholders

and% thus% indirectly benefits the firm.

1. Typically% issuer will enter into a standby agreement with the investment

banker under which the banker agrees to purchase any of the offering0s

shares that are not subscribed for by the e*isting shareholders e*ercising

their rights.

iii. -u0ic O,,eri!5s: offerings to the general public

+. I;Bs: issued by a company for the first time

b. ifferent Risks that are associated with the offerings.

i. How is the risk of the offering distributedE

+. ;rice Risk: who bears the risk if the price of the securities falls during the

period of the offering.

5. Risk that the stock won0t be sold

1. (iability Risk

II. ;ublic /nderwriting Bfferings

a. History: G0$ssSte5$00 Act


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i. Separated commercial banking and investment banking

ii. /sed to eliminate the conflicts of interest when the same financial institution sells

securities to customers while lending them money to buy the securities on credit.

iii. Repealed in +NNN% each section of the bank is regulated by a different agency but

they are all allowed to co)e*ist under the same roof.

+. SecuritiesCS$% bankingCfederal!state bank regulators% insurance by

state insurance agencies.

b. Issuing Securities through the help of /nderwriters

i. Fir) U!2er6riti!5

+. The underwriter purchases the security from the issuer at an agreed price

and then resells the securities to brokerage firms or to the public at a

profit.

5. The participants in the underwriting receive a spread between the purchase

price and the public offering price.

a. 3anagement fee% underwriting compensation% and the selling

concession received for any sales to the public by broker!dealers.

i. Selling concession is for those that do the most work can be

anywhere form F,)F-

ii. ' broker!dealer is also called a market maker.

+. ' dealer% however% sells from his own inventory but

a broker only acts as your agent and puts you in

touch w! the other half of the trade you want to

make.

b. Handsome pay: 5,)-, of the amount to be raised in a public

offering.

i.


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stated amount of its securities to the public and the underwriter agrees to

use its best efforts to find investors.

5. The issuer pays the underwriter a fee for helping place the issue.

1. ifferent clauses in the agreement to show what types of best efforts:

a. 'll or 7one lause: The sales will not go through unless all of the

securities are sold

b. 3inimum percentage: Br can specify some intermediate number

=. /sually used with smaller underwriters unwilling to risk buying the

offered securities

-. isadvantages: bad signal to the market% the issuer couldn0t get an

underwriter to buy the capital.

iii. Re5u0$r U!2er6riti!5:

+. Issuer directly offers securities to the public% and the underwriter agrees topurchase from the issuer any securities not purchased by the public. The

standby underwriter is paid a fee for assuming the insurance risk.

5. /sually used in rights offerings.

c. Structure:

i. Letter , i!te!tis signed first

+. 'greement between the issuer and the lead underwriter laying out what

the underwriter gets even if the issuance is not successfulCworded so as

not to be bindinga. Bnly binding on the compensation so that bank0s reputations are

upheld

b. oesn0t provide any price for the offering.

5. This starts the Lin registrationM period. S$ has never really defined what

is Lin registrationM

ii. Get an u!2er6riter s(!2ic$teto distribute the risk and harms of the issuance

+. /nderwriter Syndicate is a group of underwriters that acts together under

the leadership of the managing underwriter

". A5ree)e!t A)!5 U!2er6riters:

a. Bnce% the underwriting syndicate is assembled: the underwriters

enter into an agreement among themselves.

b. The agreement% finali>ed Dust before the registration statement

becomes effective% authori>es the managing underwriter to act on

behalf of the syndicate in negotiations with the issuer.


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c. The agreement specifies the managing underwriter0s compensation

and imposes Doint liability on the underwriters for selling e*penses

iii. The registration documents are being produced with the help of the underwriter

and the issuer

+. ;rospectus and registration statement of the S$ filings

a. -rs*ectus: information pamphlet that is distributed to potential

investors% other underwriters.

b. Re5istr$ti! St$te)e!t:describes the offering and the issuer. The

RS is filed with the S$% and the prospectus becomes the principal

selling document for the offering.

i. /sually prepared by the counsel for the issuer% with careful

review by counsel for the managing underwriter.

i&. U!2er6riti!5 A5ree)e!t:

+. Issuer enters into an agreement with each of the underwriters% signed on

their behalf by the managing underwriter.

5. The agreement specifies the price and amount of securities to be offered

and specifies each participating underwriter0s allotment

a. 'greements may also include an over)allotment optionC

sometimes called a Green Shoe option

b. Bver)allotment allows underwriters to buy additional shares from

the issuer if demand outstrips the original number of shares

offered.

i. Helps stabili>e the post)offering price by first over selling

by +- and then buying back to buttress the post)market

price to prevent it from falling below the offering price

1. Signed Dust before the registration statement becomes effective and the

offering begins.

a. 3arkets change so they want the least amount of risk% but the S$

wants the price specified in advance.

v. Se00i!5 De$0er A5ree)e!ts!Selling)Group 'greements

+. The underwriters often enter into agreements with securities firms that will

act as retail dealers in the offering.

5. ed Dust before the offering begins% re"uire that all sales be at the

offering price.

a. 7ot allowed during the pre)filing period% but is allowed during the

waiting.


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2. I!e,,icie!t -rici!5 , I-Os

i. /nderwriters usually underprice I;Bs to ensure that the issue clears and to create

profit opportunities for the first I;B purchasers% typically institutional investors

and other favored customers of the underwriters.

+. 7ot beneficial to the company because even if the price sky rockets% the

company doesn0t get the money% the people who purchased it and sold itafter the day0s increase make the money.

a. emand for hot I;B stocks where investors can sell them "uickly

and make a "uick and si>eable trading profit 4a practice known as

LflippingM6

5. (ess risk to the underwriter if they do this because the risk is to sell it off.

If they price too high% won0t sell.

a. 'lso% underwriters used I;Bs to arrange L"uid pro "uoM

arrangements where I;B shares are allocated to customers whoagreed to pay e*cessive commissions on unrelated trades.

b. 'lso% underwriters face a larger chance of lawsuits when the price

dips from an overpriced stock.

c. Wanting to rip off their own company for their own personal gain%

i.e. trying to help sell a different I;B.

e. Restrictions on Securities Bfferings

i. A!tiF0i**i!5 C0$uses

+. on0t want individuals to unload the stock "uickly Dust to get a "uickbuck. 7ow there is a tendency to make it harder to flip.

a. If flips are prevented among one class% they must be prevented

from every class. 4i.e. institutional flippers have to be prevented if

individual flippers are prevented6

5. reates incentives to the uw to place the shares w! investors who are likely

to hold the stock for longer.

3. I!si2er Lc/U*s

a. Insiders aren0t able to flip the shares because this signals to themarket that the insiders think the stock is overpriced and will cause

the markets to move and depreciate.

ii. (imiting!iluting lauses: (imiting the 'mount of Shares to be Sold

+. It is commonplace to have a limit on the amounts that can be sold because

of the possibility of dilution

a. Stock prices are high because individuals are willing to pay a


24/119

certain amount b!c its uni"ue and not common% but if you issue

more it will decrease the stock price.

b. Rare ;icasso $*ampleCif there is only +!-,% value higher than

+!5%,,,

iii. I!2e)!i,ic$ti! C0$uses

+. If the price of the security drops% there will be many more lawsuits. ? ++4a6

4-6 makes all underwriters severally liable for any false statements for the

chunk of securities that they sold.

5. Indemnification clauses between the issuer and the underwriter provides

that the issuer will provide insurance for any false statements

a. S$ doesn0t like this because the underwriters then aren0t as

careful in making sure the registration statement is correct if they

don0t face liability.

i. Have to have boiler plate in the RS if they receiveindemnification

b. Want the underwriter to do due diligence: investigate in a careful

way that is defined by the case law.

i&. C),rt Letters

+. /nderwriters typically demand that the issuer0s counsel write a letter to

the underwriters assuring them the issuer0s legal house is in order: i.e. duly

incorporated% the securities are authori>ed% etc.

5. 'lso demand a comfort letter from the issuer0s accounting firm regardingthe accuracy of the financial disclosure in the prospectus.

a. In effect% Dust like an indemnification clauseCcertification from an

accountant and get contribution in any lawsuit.

1. 'ccountant and (awyer will be compensated for this additional risk

f. ;roblems of ing the small buyers.

ii. 1 ircumventions around the fi*ed selling prices


25/119

+. esignated Brder Techni"uesCdistributing uw helps to give institutions

free goods or discount on research services to be a discount on the price.

5. Bvertrader Swap: institutional buyer swap securities in their portfolio for

the new one in the I;B% which is an indirect discount

1. Recapture: broker)dealer form a subsidiary that purchases the security and

then sells it off and reaps the benefit of the purchasing spread

III. Re5istr$ti! -rcess

a. Registration Statement

i. Registration Statement under ? O4a6 is re"uired to include:

+. ;rospectus))? +,4a6 specifies which of the Schedule ' information must

be included in the prospectus

a. Information about the registrant and the registration

b. Information about the securities being offered

c. Information about the issuer and its business

d. The issuer0s financial history

e. Information about the distribution and its proceeds

5. $*hibits and /ndertakings:

a. /nderwriting agreement

b. #ylaws and incorporation of the corporation

c. (awyers have to provide an opinion paper that it will sell thatmany shares

d. &arious financial statements 4Regulation S)96

e. 7on)financial re"uirements 4Regulation S)P6

i. #oth regulation S)P and S)9 are now integrated to the

periodic disclosure statements.

ii. (essens the e*pense of issuing new securities because most

of the information is already in the periodic forms.

iii. 3anagement iscussion and 'nalysis

iv. 01= 'ct Re"uirements in S)P and S)9

+. 'nnual Report

5.


26/119

a company 4maDor events6

-. 'll of this is contained in the company0s #asic

Information ;ackage 4L#I;M6

f. 'll material information that may lead to a showing of conflict of

interest between key management 4board of directors and officers6

and issuers

g. Issuers have to use plain $nglish in writing the prospectus

ii. What is re"uired in the registration statement is the best practices of what was

provided in +N5N 4re"uiring everyone to do what others had always done.6

+. ifferent forms that re"uire different amounts of detail% as well as the

latitude they give registrants to incorporate by reference information in

other S$ filings

a. Fr) S1: This contains the most detailed set of "uestions and

must be used by companies that do not "ualify to use


27/119

J. Item N: escription of securities

N. Item +,: Interests of named e*perts and counsel

+,. Item ++: Information with respect to the registrant

iii. Includes more than the S)1 re"uirements because it is much

more risky when there is no established market price

. Fr) S"

i. $liminated by the 5,,- ;ublic Bffering Reforms

ii. Had permitted smaller% reporting companies to use a

prospectus that incorporated by reference information from

the company0s annual report and other periodic S$

filings.

c. Fr) S3: this form is available to companies that have reported

for more than one year 4a.k.a. a seasoned reporting issuer6 '7

one of the following re"uirements:i. 3ore than AO- million in Lpublic floatM 4i.e. of non)

affiliates% can0t be $B holding most of the stock6 BR

ii. Their common stock is traded on a national stock e*change

BR

iii. Issue +!1 of their public float in a +5 month period BR

iv. Rated as Linvestment)grade securitiesM from the rating

agencies 4SQ; and 3oodies6

+. The investment)grade rating independentlyguarantees that there isn0t fraud going on

d. Bther more speciali>ed forms

i. S)= forms for securities issued in a merger or ac"uisition

ii. S)J: ac"uisition as part of an employee stock purchase

plans

iii. S)++: real estate companies

iv. S#+ and S#5: small businesses

iii. Who has to sign the registration statementE

+. ? F4a6:

a. $B on behalf of officers% comptroller% chief accounting officer%

and the board.

b. 'ny signer is on the hook if there are defects in the statement

5. ? ++ creates liability for the underwriters.


28/119

b. ? J4a6: $*plains when registration statement becomes effective

c. ? -: annot make any sales until the registration statement has become effective 4when

approved by the S$6

i. ;artial Selling $fforts are allowed by distributing the prospectus% and getting

individuals to agree that when the stock has become available% they will be

bought.

+. In essence% these agreements are binding.

d. Timing

i. 8uiet ;eriod: time between when the issuer decides to sell and when they are

filing the registration statement.

ii. Waiting period: filing until effective registration statement

+. If the company sells or talks during this period% investors can compel

rescission.

I&. Registration Statement ;rocess

a. ? -: the heart of the Securities 'ct and registration process

b. ISS/$R 'T$GBRI$S: The activities permitted durin the reistration period vary

reatly dependin on which cateory the issuer falls into5on the theory that investors

will learn about new issuers with an established market presence.

i. 7on)reporting Issuers

+. ompanies that are not re"uired to file under the $*change 'ct 4i.e.

issuers going public in an I;B6ii. /nseasoned Issuers:

+. ompanies that are re"uired to file $*change 'ct reports% but are not

eligible for


29/119

+. Issuers must satisfy the re"uirements of S)1 but must be larger:

a. AO,, million in e"uity float or A+ billion in debt float issued in the

last three years

b. 'nd cannot be an ineligible issuer 4can0t have violated any rules

from the S$6

5. (east amount of informationCmarket already knows about this company

because of the established market price and the information that goes into

that price.

a. 3erit the greatest amount of fle*ibility

c. O&er&ie6 on the Three ;eriods during the Registration ;rocess

i. -reFi0i!5 -eri2:

+. #egins when the issuer prepares for the offering and thus is Lin

registrationM

5. The marketing and sale of any security is prohibited% and written

marketing efforts are strictly regulated. 7othing public is supposed to be

provided.

a. 'ny violations of the "uiet period instituted when a company is in

registration is known as a gun Dumping.

ii. $iti!5 -eri2

+. 'fter a registration statement is filed with the S$% but before it becomes

effective

5. ? -: Sales are still prohibited% and written marketing efforts are strictly

regulated.

1. /nder ? J4a6% the S$ has a 5, day waiting period 4unless S$ allows for

"uicker6% but usually that0s not long enough so use different tools to delay

the waiting period.

a. $ffectiveness: the registration statement becomes effective

automatically 5, days after its filing 4or 5, days from any

amendment unless the S$ determines an earlier effective date. ?

J4a6

b. S$ Review: +, days to review the registration for incomplete or

misleading disclosure and give notice of its intention to issue a

refusal order that keeps the registration statement from becoming

effective

i. Refusal Brder under ? J4b6

+. S$ says on the face of the registration materials%


30/119

the RS can0t be effective because there are defects

in it.

c. S$ Bversight: #efore or after effectiveness% the S$ can begin a

nonpublic administrative investigation. 'fter the registration

statement becomes effective% the S$ can issue a stop order if it

notices a defect in disclosure. 7o offering activities are permittedwhen a refusal or stop order is outstanding or the S$ is

investigating a registration statement.

i. Stop Brder: ? J4d6:

+. uring the waiting period or even during the post)

effective period% issuer must stop any activity in

selling the securities.

a. Stop order is available at any time

d. ;roceed for an 'ccountingi. If during the post)effective period% the S$ can re"uire the

company to cough up all the money if something was

wrong.

e. ease and esist Brders

i. S$ telling the company to stop the offering or stop doing

what they are doing. S$ can specify.

f. /sually% none of these = is the methods to stop registration.

/sually% the S$ will Dust ask the company to fi* certain sectionsthrough various letters of comment.

i. Bnce the registrant amends the statement% the 5, day period

starts all over again or the S$ can set it up so that upon

amendment the RS becomes immediately effective%

shortening the 5, day period.

+. $ssential to the ;ricing 'mendment that is done

right before the issuance to avoid the risk of the

securities not being able to be sold. S$ has to

accelerate the RS and then upon pricing% say that theRS is effective.

5. However% under ; 43e of the


31/119

offering can vary by 5,.

b. esigned to increase fle*ibility for the

issuer.

c. /sed with 80$!/ Cec/ C)*$!ies:

i. ompanies without any specific

business plan or purpose or whose

plan is to engage in Lac"uisitionsM of

an unidentified company.

ii. Ru0e 419: investments go into an

escrow account until the promoter

gets a business plan. 't that point%

investors have a right to opt in. If

they do not get a right to opt in% the

money is automatically refunded to

the investors.

iii. -ste,,ecti&e -eri2

+. 'fter the registration statement becomes effective% until the offering ends

and the issuer is no longer Lin registrationM

5. Sales are permitted% but written marketing continues to be regulatedK

purchasers must receive a prospectus that complies with statutory and S$

specifications.

V. -REFILLING -ERIOD

a. ;rohibited 'ctivities

i. 7o Sales or eliveries

+. ? -4a6 prohibits sales of unregistered securities or deliveries for purposes

of sale.

a. The prohibition is straightforward: ? 54a6416 defines sale as

including every contract of sale or disposition of a security for

value

ii. 7o Bffers+. ? -4c6 prohibits any person to Loffer to sellM or Loffer to buyM any security%

unless a registration statement has been filed.

a. efinition of an Bffer to Sell

i. ? 54a6416: Levery attempt or offer to dispose of% or

solicitation of an offer to buy% a security or interest in a

security for value.M


32/119

3. *oesn6t apply to underwriter and underwritin

syndicate and issuer preliminary neotiations.

a. (ook for a Durisdictional ne*us.

7. !ny bindin contract between the issuer and uw5a

final sale5remains prohibited by 8 9/a0/30

a. 4therwise, an underwriter would assume

the full financial risk of an offerin before

effectiveness with nobody to sell to, a

temptation too danerous for the "#$.

ii. &ery #road efinitionCany attempt that may contribute to

conditioning the public mind or arousing public interestM in

the offering can be seen as part of a selling effort and thus

constitute a prohibited LofferM

iii. S$ wants to prevent early% incomplete% and misleadinginformation to poison the disclosure.

5. ;rospectus materials cannot be used for an offer to sell

a. ? 54a64+,6: prospectus is defined broadly% anything written

i. ? -4c6 also makes sure that no oral sales are made either.

'ny communication thru interstate commerce is prohibited

4i.e. email or phone6.

+. /nderwriter!issuer negotiations are e*cluded from

interstate commerceii. ? =4a64+6: provisions of section - shall not apply to anyone

other than uw% issuer% or dealer and thus% secondary markets

are not regulated by these rules

1. Interpreted by the S$ very strictlyCmust remain 8/I$T

a. oes not apply to setting up deals with the underwriters

b. ;ermitted 'ctivities

i. Traditional Rule is that you can continue to distribute information that you would

normally would distribute in the absence of the intention to sell securities.

+. 7ow% S$ provides issuers with certain Safe Harbors

5. If however the safe harbor does not apply% must look to traditional rules

ii. S$,e 7$rrs

+. Revealing $*istence of the /pcoming Issue: RULE 13=

a. Rule +1- permits the issuer to announce its intention to make a


33/119

public offering by stating:

i. the amount and type of security to be offered and

ii. the timing% manner% and purpose of the offering.

b. The statement must say that the Loffering will be by prospectusM

but cannot identify prospective underwriters or the e*pected

offering price.

i. $nsures that people aren0t contacting the underwriters.

c. an be issued by issuers or a selling security holder or anyone

acting on behalf of them.

5. ;reregistration ommunications: RULE 1>3#$%

a. ommunications by issuers and those acting on their behalf 4other

than prospective underwriters or dealers6 are permitted when made

more than 1, days before the registration statement is filed.

b. (imits:

i. St$te)e!ts c$! !0( e )$2e ( te issuer% not

underwriters or dealers.

+. Issuers must issue statements in the r2i!$r(

curse , usi!ess

a. ' glossy report seems to be the first step in

the sales of the securities% and would not be

in the ordinary course. #ut a president0s

long)standing speaking engagement is in the

normal ordinary course.

5. General Rule: things that would have been

announced before in normal course of business can

be continued% but no other information can be

provided.

ii. The statement cannot refer to Dust the issuance of securities.

The statement must have general information about the

company.+. n re $arl %. 'oeb and 2hoades : $o. /3;9;0:

disciplinary proceeding against two underwriters

that issued press releases concerning a land

development company that proposed a public

offering before the company had filed a registration

statement.

a. The S$ sanctioned the two firms for


34/119

violating ?- and arousing investor!dealer

interest before a registration statement was

filed. The statements provided an

incomplete and misleading picture of the

details of the offering.

b. Issued safe harbors because of the problemsin this case.

iii. The issuer must take reasonable steps to ensure these

preregistration communications are not further distributed

or published within the 1, days before filing

+. i.e. stop Dournalists from reprinting statements later.

1. WPSI ommunications: RULE 1>3

a. WPSI0s are able to make any Loral offersM during registration.

b. WPSI0s can make Lwritten offersM that bear a legend that stateswhere to get a prospectus% along with a warning to read the

prospectus.

i. 'll written offers must be filed with the S$

+. 3ust have a legend

ii. Bnly the issuer can make statements

iii. In effect% the S$ has decided that WPSIs are unable to

condition the market with pre)filing disclosures

+. #asically a Ldo whatever they wantM mentality.

=. Regularly Released Information: RULE 1>? @ 1>9

a. Ru0e 1>?: Issuers that are reporting companies do not need to

remain completely silent% they can still continue to release not only

factual business information% but also forward)looking information

about the company0s operations and finances)))including to

investors.

i. Li)its:

+. Bnly issuer can make statements

5. Same information as was provided before

a. an issue forward)looking proDections only

if they had done so in the past.

1. 7o information about the offering.

b. Ru0e 1>9: 7on)Reporting% 7ew Issuers


35/119

i. 'll issuers can continue to release factual business

information to their customers% suppliers% and other non)

investors.

ii. (imits:

+. an0t include forward looking statements

a. Br e*plain how they e*pect their business to

succeed

5. annot reference the offering

1. 3ust be intended only for non)investors.

=. Bnly issuer can make statements

iii. $*ample 7o. F in the S$ release: the president0s speech

would be at the time of the registration and it was deemed

okay before there was any intent to file a registration.

+. #/T B 7BT ;RB&I$ '7 WRITT$7

I7


36/119

i. Ru0e 13?: $ven if you are a participant in an offering% you

can continue to publish reports about the kinds of securities

not being offered 4i.e. fi*ed income securities if the

offering is for common stock6

+. The market for other securities 4i.e. fi*ed income6 is

largely institutional% and it assumes investor interestin the market for common stock will not be

affected.

5. The securities firm must have previously issued

reports on similar securities in the regular course of

business.

a. 'lso% must be over domestic re*rti!5

companies and some foreign issuers.

ii. -$rtici*$!t Rese$rc Re*rts: Ru0e 139

+. ;articipants can offer information about the

securities being sold% i.e. company)specific research

report about the issuer:

a. If the report appears in a regular publication

and

b. The issuer is a large% seasoned reporting

company that meets the re"uirements of S )1

5. (imits:

a. ;articipant must have already issued regular

reports about this issuer 4even if they

weren0t a participant before6

b. 7ot as worried

F. Bnly underwriters and dealers are not able to provide information.

a. #ut can negotiate with the issuer.

c. If you do not meet the safe harbors% look back to the traditional analysis. 'sk:

i. Issue2 ( s)e!e ter t$! $! issuer u!2er6riter r 2e$0erB $!2

ii. I! re5istr$ti!B

+. S$ hasn0t defined this but

5. In registration...means the entire process of registration% at least from the

time the issuer reaches an understanding with the broker)dealer% which is

to act as a managing underwriter until the completion of the offering and

the period of =, or N, days during which dealers must deliver a


37/119

prospectus.

iii. C!2iti!e2 te )$r/etB

VI. AITING -ERIOD

a. The period after the filing the registration statement.

b. ;rohibited 'ctivities

i. 7o Sales or eliveries

+. ? -4a6 prohibition during sales re"uires that no binding contracts be

created. To avoid creating a binding contract% any solicitation of interest

must be phrased not to constitute a common)law offer capable of

acceptance.

a. /sual practice is for participants in an offering to collect

indications of interest from investors, but not to take checks or

otherwise accept orders.

ii. 7o ;rospectuses:

+. ? -4b64+,6: prohibition to use any prospectus unless it complies with ? +,

a. ? 54a64+,6 defines prospectus to be: Lany communication written

or by radio or television, which offers any security for sale.

i. +asically anythin written or broadcast.

c. ;ermitted 'ctivities

i. Bral Bffers:

+. ? -4b64+6: no prohibition against oral selling efforts.

5. SubDect to the antifraud provisions only.

1. 7o need to send a prospectus

ii. -re0i)i!$r( -rs*ectus:

+. ? +,4b6 authori>es the S$ to permit the use during the waiting period of

an incomplete prospectus.

5. RULE 43


38/119

iii. the dealer compensation

iv. amount of the proceeds

v. conversion rates

vi. call prices and other matters dealing w! price.

iii. T)st!e A2s: Ru0e 134

+. Section 54a64+,6 e*cepts from the definition of LprospectusM

advertisements 4typically made in the financial press using a tombstone)

like border6 that state from whom a ? +, prospectus may be obtained.

5. The Tombstone 'd lists the underwriter% the security% and the price only.

i&. I2e!ti,(i!5 St$te)e!ts

1. Ru0e 134

a. ou can give specified written information about the issuer% the

underwriter% and the offering 4more detailed than a tombstone ad6

I the fwd lookin statements.a. an0t be in the back in an appendi*.b. If the information is accompanied by meaningful caution% won0t

affect the total mi* of information% and thus% creates no liability forfalse)statements.

=. 8i0er*0$te c$uti!$r( 0$!5u$5e: doesn0t avail issuers of the protection.an0t be boilerplate information% must be tailored to be forward lookingstatements given at that moment.

-. The warnings must be s*eci,ic% and provide the reasons for the risk.

a. The rule is that issuers must include information on the )$i!

)e$!i!5,u0 $!2 s*eci,ic risks.

i. If you include the main risks and some other risk causes a

default% the issuer is protected from liability. This% however%

is not true if the issuer left out a key risk.

b. The bespeaks caution allows dismissal before trial and often beforediscovery. Bnly need to look at the prospectus and other offeringmaterials and that will have enough to understand whether therewas cautionary language.

i. This is main benefit as it decreases settlement leverage.

F. an0t be intentionally false statementsCthose will not be protected by thebespeaks caution doctrine.

O. oes not limit liability if the bad events have already occurred

a. an0t say might occur if the event has already occurred

ii. St$tutr( S$,e 7$rr: -ri&$te Securities Liti5$ti! Re,r) Act #-SLRA%

+. 33 Act: ;"#$%: 'pplies only to forward looking statements made by

R$;BRTI7G companies only


65/119

a. reated in +NN-

b. Still turn to #espeaks aution octrine for non)reporting

companies.

5. Requirements: 7o liability for a fwd)looking statement if:

a. C$uti!$r( St$te)e!ts: 'ccompanied by meaningful cautionary

statements BR

i. ismisses a lawsuit if the statements are accompanied by

identifying important factors that could cause actual results

to differ materially from those proDected in the future

looking statements.

b. N Actu$0 !60e25e: ;laintiff is unable to prove that the

defendant knew the statement was false

i. $ven though the statement is false% there is no liability as

long as the person creating the statements doesn0t know itto be false.

ii. Seems to cover statements that are intentionally untrue and

known to be so by the company.

+. 'cademically conDectured to be a license to lie.

c. I))$teri$0it(: if the statement was immaterial

i. The safe harbor focuses on whether the

forward-looking statements were too soft to be

material.

ii. ;uffery

3. C&er$5e:

a. PSLRA 27a!" does not a##l$ to"

i. %on-re#orting com#anies

ii. &ad-bo$ issuers

iii. &lank check issuers

i'. Penn$ Stock issuers

'. (P)s

'i. *oesn+t a##l$ for offerings from #artnershi#s

b. #espeaks aution applies generally.

=. 'sher v. Ba)ter:

a. #a*ter% a manufacturer% released its 5nd)"uarter financial results%


66/119

and sales and profits didn0t match analyst0s e*pectations. ;laintiffs

sued saying the prices set out were the result of materially

misleading proDections.

b. ourt ruled: #a*ter may be liable.

i. ;laintiff never e*plained what caused the proDections to go

wrong% and whether the cautionary statements would havesaved them from going wrong.

+. on0t have to nail the e*act risk but should e*plain

the main risks

5. 7eed more discovery

ii. ompetitive pressures changed% and the same risks were

left in. Seems more like boilerplate language that doesn0t

deserve the protection of the ;S(R'

iii.


67/119

a. ;S(R' 5O4a64i64+6: fwd)looking statement is a prediction that will

affect the future

b. Statements that are a mi* of past and fwd looking are deemed to be

fwd looking

i. $*amples:

+. Bur business plan and underlying business

strategies are sound.

a. 'ffects future economic performance.

5. /ni"ue challenges are behind the company.

d. uty to isclose


68/119

+. S$ has based materiality on whether a fact bears on a company0s

"uantitative assets.

ii. (awsuits:

+. Issuer: Regulation S)P 4Item +,16: issuer has a duty to disclose those

litigations that are at least +, of the issuer0s assets.

5. irectors: Bnly must reveal pending litigation if it0s a criminal case%

otherwise% only completed cases must be revealed.

a. on0t have to reveal everythingK too many cra>y lawsuits. Reveal

if the lawsuit has some weight to it.

1. Regulation S)P 4Item =,+6: have to disclose certain types of adDudications

w!in the past five years that are material to an evaluation but only w!in the

past - years% against the d!o or the company.

a. ;assed after Watergate.

iii. ishonesty among 3anagers

2. 0n re 1ranchard Cor3. #25&(

a. ompany0s $B was engaging in sketchy activities% including

using the money for personal uses and promising to pay it back at

lower interest rates than the banks. 'lso% borrowed money from

lenders and pledged the company0s securities as collateral.

irectors were not paying attention to any of this.

b. Issues: Should they have disclosed this information: either about

the $B or the directors not paying attentionE

c. Holding: 3ust disclose information about $B but not about the

directors not paying attention.

i. $B0s management: material information because they

thought he was a great manager and turns out that he

engaged in fraudulent activities. If you didn0t take back this

information% you would leave a false impression that he

was a good manager.

+. 'lso% the fact that he used the securities as collateralis material information because that could signal

change in the company.

a. 'ny default in the loan would shift

ownership to the bank

ii. irectors: ,ourt didn+t reuiredirectors to disclose

anything more than the re"uisite standard of diligence for

the registration statement


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+. How the board carried out its state)mandated

oversight duties was not a matter for federal

securities laws.

iii. o disclosure re8uirements to "enerally admit you are

horrible or "eneral laziness. 6nly have to disclose if

fraudulent activities.5. Rules have changed slightly since +NF= and the


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seeking the specific and fully informed advice of counsel and if not

reasonably satisfied% they should have insisted on disclosure.

c. The 1aterialit$ of #eing a L#adM iti>en: &iolations of State or


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+. If a RS% including the prospectus% contains a materially false or misleading

statement% purchasers in a registered offering can recover damages from

specified participants in the offering.

ii. ? +54a64+6: Rescission for failure to comply with violations of ? -

+. If a seller or offeror violates the registration or gun)Dumping re"uirements

of ? -% securities purchasers can rescind their investment.

iii. ? +54a6456: (iability for Bther


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a. Section ++ liability is broadly interpreted% but unless it is an I;B% it

is tough to determine pursuant to which RS this was bought.

b. If the plaintiff bought directly from an /W or a dealer selling its

allotment% tracing is possible. Btherwise% on the secondary market%

tracing becomes near impossible given the absence of any

numbering system or other identification of securities in the /.S.markets.

iii. Re0i$!ce:

+. In the usual ? ++ case% proof of reliance is unnecessary. The plaintiff need

not have read the registration statement or prospectus% much less have

known of the false or misleading information.

5. Reliance is relevant in 5 cases 4? ++4a66:

a. There can be no recovery if the defendant proves that the plaintiff

knew the alleged misinformation was falseb. Reliance is re"uired to be shown if the 3laintiff bou"ht the

security after the issuer had released an earnin"s statement for

the one=year 3eriod afterthe reistration statement6s effective

date.

i&. Lss C$us$ti!:

+. ? ++ plaintiff need not prove that the challenged misinformation caused

his loss.

a. $asy to show and be sued.5. 7egative ausation efense: efense for efendants

a. If the defendant can show how other factors besides the

misinformation e*plain 4or contributed to6 the depreciation in

value.

v. D$)$5es:

+. ? ++4e6: difference between the price of the securities 4not greater than the

offering price6 and the price you can get now.

a. This means that a ? ++ plaintiff0s recovery is capped by theoffering price% and defendants are not liable for the e*tra damages

if the plaintiff purchased registered securities in a trading market

above the offering price.

c. De,e!2$!ts $!2 Teir De,e!ses

i. ;otential efendants

+. ? ++4a64+6: Section ++ lists potential defendants


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a. 'll people who signed the registration statement

i. /nder ? F4a6 this includes:

+. The issuer

5. ;rincipal e*ecutive officer

1. ;rincipal financial officer

=. ;rincipal accounting officer

-. 3aDority of the board of directors 4entire board isn0t

re"uired to sign it6

b. 'll directors

c. ;rofessionals 4accountants% engineers% etc6

i. (iable when they certify some information of which they

are an e*pert

ii. (awyers only rarely

+. Tend to get sued indirectly and have some other

rule @ i.e. if they are also directors

5. 'lso% held liable later for malpractice% even tho not

held liable right now% held liable later.

d. 'll underwriters of the Bffering

i. efinition of underwriters is very e*pansive

+. 'nyone that helps w! the issuance

ii. efenses

+. Issuer: Strictly (iable. #ut everyone else is not absolutely liable

5. ? ++ provides other defenses))

a. Whistle #lower efense:

i. If you resign before the RS becomes effective you are not

liable for the false statements within the RS.

ii. one to encourage whistle blowing.b. Reasonable are iligence efense

i. ue iligence: The investigation by potential ? ++

defendants of information contained in the registration

statement and prospectus.

+. The due diligence task is often delegated to outside

law firms.


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5. If they can say they take reasonable care thru

investigations% they are off the hook.

ii. ? ++4b6416: The level of due diligence depends on whether

the defendant is an e*pert and whether the alleged

misinformation had been e*pertised.

+. 7on)$*pertised

a. 7o liability if after due diligence is done the

investigator didn0t actually know the

statement was false.

b. $B and main officers are basically

guarantors of the information in the RS% they

can rarely use this defense.

5. $*pertised:

a. ;arts of a RS where a statement is certifiedand prepared by an e*pert% i.e. an accounting

firm or legal opinions from lawyers.

b.


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1. N!e+*ert sue2 ,r !!e+*ertise2 )$teri$0s

". N! e+*ert $!2 e+*ertise2)$teri$0s:

3. E+*erts 6it res*ects t teire+*ertise2 2cu)e!ts:

$*pert is liable for misstatements oromissions unless:

he did re$s!$0e

i!&esti5$ti!%

re$s!$0e 5ru!2 t

e0ie&e% '7

Di2 e0ie&e that at the time

such part of the registrationstatement became effectivethat the statements werecomplete and accurate.

3ay raise the defense that they:

Had no reasonable ground

to believe% '7

id not believe that there

was any inaccuracy oromission.

N ur2e! , 2ue 2i0i5e!cei!&esti5$ti!. Have a "ualifiedright to rely on the e*perts efforts.

$*pert is liable for misstatementsor omissions unless:

he had after re$s!$0e

i!&esti5$ti!%

re$s!$0e 5ru!2 t

e0ie&e% '7

Di2 e0ie&e that at the time

such part of the registrationstatement became effectivethat the statements werecomplete and accurate.

>Same as bo) 2.?

Hiring lawyers may not be enoughunless they did a reasonableinvestigation. ou don0t have topersonally go through thedocuments% but you must sendsomeone to do that.

If you had reasonable ground tobelieve it was false% you are on thehook.

H;B: something is false that hasbeen certified by the accountants.

%. Escott v. BarChris Construction Co.

a. /pon the failure to collect payments due upon completion of the

construction of numerous bowling alleys% the company wants to

raise funds thru a bond issuance. #ut the RS is prepared by cutting

and pasting from older statements from the company successful

issuance of stock with very minor updates.

i. (iability of the various players:

+. $B: (iable for not doing due)diligence

5.


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a. $ven though he was made a director only 5

days before the RS was signed the first time%

the second RS afforded him opportunity to

conduct due diligence

-. (awyer but also a director

a. efense was that he did due diligence% butthe court doesn0t believe that he reasonably

didn0t know these statements to be false. He

relied on others to put it together.

b. 3ust check information yourself.

F. /nderwriters: liable for the non)e*perted part% off the hook for the e*perted partK must do own due)

diligence.

iii. ue iligence and Shelf)Registration

+. #ecause under shelf)registration the underwriters come in at the lastminute 4usually only 5 days before6% they have less time to do due

diligence.

a. ompetitive bidding process% which will reduce the underwriter0s

inventive to launch an e*tensive review of the issuer0s registration

statement. on0t want to delay the offering because the bid will

most likely not win then. on0t want to spend too much in due

diligence because need to spend less to place the winning bid.

5. Recogni>ing these problems% the S$ passed Ru0e 1>: 'n uw in a shelf)

registration has a little less re"uired diligence due than those regularly

re"uired

%. 0n re *orldCom

a. ourts say that investors are re"uiring the underwriters to do due

diligence and so they are still on the hook.

b. Hugely e*pensive systemCdue diligence re"uires a lot of time and

money.

EE'-T TRANSACTIONS

I. Introduction

a. Registering a security under the 011 'ct is e*pensive with all the costs of disclosure%

underwriting% and potential liability.

b. The Securities 'cts also e*empts specified kinds of securities from ?- registration


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re"uirements when other market or regulatory protections make S$ registration

superfluous.

c. 'll e*empt securities remain subDect to the antifraud provisions of the securities laws.

i. ? +54a6456: liability for offers for sale of a security whether or not e*empted by

section 1% unless the state or local government

ii. State regulation of many small and intrastate offerings e*empt from federal

registration is not preempted.

II. Types of $*emptions

a. $*empted Securities: doesn0t have to comply with securities laws regardless of how its

sold

b. $*empted Transactions: ? =

i. Bnly sales in a certain manner are e*empt.

ii. If sold in one way% its e*empt% but if you sell it in another way% its no longere*empt.

iii. ? =4+6: Re)sales e*empt by anyone that is not an issuer% underwriter% or dealer

iv. ? =4=6: brokerage transaction

+. Bnly the buys and sells based on solicited orders.

5. Transactions are e*empt% not the security

v. Transactions that should be under ? 1

+. ? 14a64++6: intrastate e*emption.5. ? 14a64N6)securities e*changed w! a company0s own stockholders)1. ? 14a64+,6% authori>ed govt. okays it.=. ? 14b6: rules that e*empt special small offerings% that0s a transaction

e*emption. Intrastate offeringsCe*empt

c. $*empt Securities: ? 1

i. Whether debt or stock% doesn0t have to comply with the securities laws. oesn0t

have to do with the nature of the transaction.

ii. ? 14a6456K Government Securities

+.


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+. not)for profit need not register their securities so long as none of the

issuer0s net earnings benefit any person% private stockholder% or individual.

v. ? 14a6456: ertificates Issued by #ankruptcy Trustees

vi. ? 14a64F6: ;articipation Interests in Railroad ars of a


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5. &ery vague% and never determinative.

1.


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2. INSTATE ISSUER

i. Issuer must be a person resident and doing business within the state of the

offering.

+. ' corporation resides in the state of incorporation. BR

5. 'n issuer is okay if it predominately does business in a state

a. If its revenues% assets% principal office% and use of the offerings

proceeds are principally in)state.

b. $*. (.(. #ean

ii. (ocation of the business is what matters% not the location of the underwriters and

dealers and brokers.

e. ;roblems with the statutory e*emptions

i. ;;l thought this was safe for only small numbers of people% but there is already

and e*emption for that.

ii. This e*emption re"uires strict liabilityCb!c +,, compliance re"uirement

,. RULE 14: SAFE 7AR8OR

i. Rule +=O is narrower than ? 14a64++6

+. eemed to be within ? 14a64++6 if within this rule.

5. Without the safe harbor% you are not automatically e*cluded% check under

? 14a64++6

1. Still an all)or)nothing ruleCthe offers and sales that are Lpart of an issueM

must satisfy all the conditions of the statutory e*emption.

ii. Integration: ;art of an Issuance: Rule +=O4b6456

+. Bffers and sales made si* months before the intrastate offering begins% as

well as offers and sales made si* months after it ends% are not integrated

with the intrastate offering.

a. 3ust be F months from any offers% not Dust actual sales

b. 't the end of the offer% stay out of the market for F months

i. If you can0t% make sure the sales don0t integrate through thefive)factor test.

iii. 7ature of the Issuer: Rule +=O4c64+6

+. ;artnership

a. State of the principal office is located @ deemed to be wherever

most of the partners live

5. orporations:


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a. Incorporated and doing business in the state

b. oing business is defined by R +=O as:

i. ;redominate business: at least -, of the business is in the

state

ii. 'lso% triple J, re"uirement

+. J, of gross revenues located within the state

5. J, of the assets located within the state

1. J, of the net proceeds must be used w!in the state

=. Round up only ON.- and up.

iii. 3ust be valued thru G'';

iv. Residents of ;urchasers: +=O4d64+6 and 456

+. 'll the purchasers must be residents

a.


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+. $*emption is securities come to rest in N monthsCin)state purchasers can

resell after a nine)month holding period.

a. #ut if even one out)of)state offer or resale voids the rule0s

e*emption if it occurs during the nine)month period after the issue

is completed.

b. Rule +=O is a transaction e*emption and doesn0t cover secondary

sales by the control person

; 3#$%#11% Ru0e 14

I!te5r$ti! 'll securities

offered as Lpart of

an issueM are

integrated. /se -factor test

Sets of sales

separated by si*

months are not

integrated

Issuer LResident and

doing businessM

within the state

;rincipal office

within state% and

J, of gross

revenues% assets% and

proceeds used are

within the state

4oncentrate on the

/S$6

I!St$te O,,erees Bfferees must be

domiciled within

the state

Bffeees must have

principal residence

within the state

Restricti! !

Res$0es

Securities must

Lcome to restM prior

to being resold

4around + yr.6

7ine)month safe

harbor holding

period from the final

sale


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IV. -RIVATE OFFERING EE'-TION: SECTION 4#"%

a. Introduction

i. Section =456 e*empts from ? - registration any offering Lby any issuer not

involving any public offeringM

+. Registration is unnecessary when investors on their own have ade"uate

sophistication and information to protect themselves.

5. 'lso% if only selling to a few people% shouldn0t have to register and go thru

the large e*pense.

ii. $conomic ustifications

+. /sually there is no incentive to do any personal investigation. When

selling to a large group of people% there is an incentive to free ride off of

other people to get information. If everybody free rides% than no one does

investigation.

5. #ut since there is only a small number of people who are being sold the

securities% each individual has an incentive to do the research and benefit

fully. Thus% no reason for the S$ to step in.

iii. ourts have interpreted ? =456 to not limit the AA amount of a private offering or

the number of investors. #ased restrictions on the investor "ualificationCi.e.

sophistication and access to information about the issuer.

b. #efore Ralston ;urina: 3apping the Scope of the $*emptionC


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5. onversely% an issuance of a small number of units in large denominations

is evidence of a private offering

iv. Si>e of the Bffering

+. The e*emption was intended to apply chiefly to small offerings

v. 3anner of the Bffering

+. Transactions effectuated through diret negotiations are more likely to be

private offerings than those effected through the use of the machinery of

public distribution 4such as advertising6

5. S$((


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the availability of the private offering e*emption is

asserted.

1. riti"ues:

a. S$ wanted a numerical limitCbut the court failed to give one.

=. #urden of ;roof is on the issuer to see that they have applied.

-. ases now proceed ? ++ and ? +5%

d. Sophistication of Investors:

i.


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+. Who the offerees were

5. That they had access to info

1. That they were sophisticated

=. Records must be kept of anyone that is approached by the issuer.

&. REGULATION Dand the (imited Bffering $*emption

a. Introduction

i. Response to easing burdens on ongressional demands that registration burdens

on small businesses% who want to issue securities.

ii. Regulation carries with it three e*emptions 4Rules -,=% -,-% and -,F6 that

taken together cover the vas maDority of offerings e*empt from registration.

+. Rule -,= and Rule -,- were based on ? 14b6 of the 011 'ct% which

authori>es the S$ to develop e*emptions covering offerings up to A-

million in amount

a. -,=: offerings less than + million

b. -,-: offerings up to - million

c. -,F: safe harbor for the private offering e*emption

5. Rule -,F is a none*clusive safe harbor for the private offering e*emption

of Section =456

b. haracteristics

i. Rule -,=: Small Bffering Registered or $*empt /nder #lue Sky (aw

+. 7on)reporting companies seeking to raise capital for specific purposes can

sell up to A+ million in securities in any +5)month period.

a. Statutory e*emption focuses on offerees

5. 'ny securities issued under this e*emption became LrestrictedM which

meant that there can be no resales

1. 7o general solicitations or general advertising% unless:

a. 4+6 Sales only to accredited investors BR

b. 456 State disclosure documents allow it.

ii. Rule -,-: 3edium)Si>ed offering SubDect to S$ onditions

+. ompanies can sell up to A- million in securities in a +5)month period.

a. The offering can be sold to an unlimited number of Laccredited

investorsM but only 1- non)accredited investors.


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b. If there are any non)accredited investors they must receive

specified written disclosure and have an opportunity to ask

"uestions of the issuer.

c. 3ust be companies that are neither investment companies nor Lbad

guysM under the criteria of Regulation '

i. i.e. be a worthy purchaser

d. Rule -,- securities become Lrestricted securitiesM and cannot be

resold 4minus compliance w! other rules6

i. 3ust be a legend on the certificates to show that there are

restrictions on resale

e. 7o general solicitation allowed and there is no e*ception.

i. ;romise from the buyer they will not be resold

iii. Rule -,F: ;rivate Bfferings SubDect to S$ Safe Harbor onditions

+. 'ny company can sell an unlimited amount of securities in a +)month

period to 1- non)accredited investors and an unlimited number of

accredited investors.

a. $ach non)accredited investor must be sophisticated.

i. 3ust have sufficient knowledge and e*perience in business

and financial matters so she can evaluate the merits and

risks of the investment.

ii. ' representative may be sophisticated for the purchaser.

b. 7o general solicitations with no e*ceptions.


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=e

of the offering:

a. /p to A5 million:

i. Relatively brief information

ii. Regulation ' offering circular with financials re"uired of

small business issuers


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b. #etween A5 million and AO.- million

i. 'dditional re"uirements but not the full RS

c. 'bove AO.- million

i. Have to provide all the information in the RS

ii. ;eople still choose not to register because there is no backand forth with the S$ even though the costs are mainly

the same.

+. 'lso% they are saved from section ++ liability

because even if they provided all the information in

a RS% they still didn0t provide a RS.

a. Still subDect to ? +54a6456: anyone who made

false statements.

d. 'ccredited Investors:

i. The status of purchasers as accredited investors is important for purposes of both

Rule -,- and Rule -,F.

+. $ach rule limits availability of the e*emption to offerings in which there

are no more than 1- purchasers% but accredited investors are not counted in

that total number.

ii. To avoid double counting:

+. -,+4e6: e*cludes accredited investors from the 1- count

a. Trusts or estates where beneficial interests e*ceeding -,b. When an investor purchases for himself% additional purchases by

his spouse or relatives who live w! him or purchases for a trust%

estate or other organi>ation in which he has significant interest are

not counted.

i. 'ny relative or spouse that has the same principal residence

as the purchaser will be e*cluded from the count.

ii. However% if the original purchaser is accredited% then his

relatives who purchase will not be double credited but they

will be counted as + non)accredited purchasers.

c. orporation if purchases as an accredited investor and then an

individual who owns more than -, of that company will be

counted as one purchase. 4-,+4e64+64iii6

i. If the individuals live in the same house and own

B3#I7$ over -, of the corporation% then the

corporation and the two% would only count as one investor.


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d. ;artnership!orporation is counted as one investment unless the

partnership is made solely for investment.

i. (ook to the e*istence!duration!nature of the prior activities

ii. Structure of the entity

iii. ;roposed activities of the entity

iv. Si>e of the entities capitali>ation in relation to its

investment in the -,- and -,F offering

v. $*tent to which all e"uity owners will participate in the

entity0s investment

iii. Rule -,+4a6 defines accredited investors and includes:

+. nstitutional investorsB #anks% saving institutions% brokerage firms%

insurance companies and investment companies

5. ension plansBemployee retirement plans that are managed by aninstitutional trustee or registered investment adviserCas long as company

with assets over A- million.

1. Eenture $apital irmsBa & firm provides capital and loans to business

that have significant growth potential% but are not yet large enough to have

a public offering of their own

@. $orporations exceedin assets of F9 million

9. nsiders of the ssuersB

a. irectorsb. $*ecutive Bfficers

i. ? -,+4a64=6: Who is an e*ecutive officerE

+. -,+4f6: efinition

a. ;resident% any &; in charge of a principal

business unit.

b. 'ny other officer that makes a policy

decision for the company 4performs similar

e*ecutive functions6

i. an0t implement the policy

=. !n entity owned wholly by accredited investors

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