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In General
General Rule
If a financial instrument is a security, then securities laws apply.
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DEFINITION OF A SECURITY
Statutory Definitions
Securities Act 2 Exchange Act 3
(a) Unless the context otherwise requires (a) Unless the context otherwise requires
(1) The term security means any note, stock, . . . bond, (10) The term security means any note, stock, . . . bond,
debenture, . . . investment contract, . . . or any interest or debenture, investment contract, . . . or any instrument
instrument commonly known as a security . . . commonly known as a security . . .
But shall NOT include currency or any note, . . . which has a
maturity date at the time of issuance not exceeding 9 months.
Investment Contracts
Investment Contract Defined
SEC v. W.J. Howey Co.
o An investment contract for purposes of the Securities Act 2(a)(1) means a contract, transaction, or
scheme whereby a person (1) invests money, (2) in a common enterprise, (3) with a expectation of profit,
(4) to come solely from the efforts of the promoter or a 3d party. All four prongs must be met.
Howey Applied
Forman
Expectation The expectation of profits prong requires either (1) capital appreciation or (2) participation in profits
of Profit Edwards
No distinction between flat and variable rates of return
Howey Investment contract will exist only if profits are derived solely from the efforts of others.
Issue -- Promoters may circumvent securities laws by merely requiring investors to nominally participate.
Solution -- Subsequent cases have replaced solely with significant managerial or entrepreneurial efforts.
Efforts of
Others Pre-Investment Efforts
Open question as to whether pre-investment efforts count.
o Whether a promoters pre-investment efforts count toward the efforts of others depends on whether the
promoter commits to perform meaningful post-purchase functions. SEC v. Life Partners, Inc.
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Investment Contracts Case Law
SEC v. W.J. Howey Co. Investment Contract Defined
Investor buys a land sales contract (row of fruit trees and service contract).
Facts In return, investor receives a share in the profits after harvest.
Whether, under the circumstances, the land sales contract, warranty deed, and service contract together constitute an
Issue investment contract within the meaning of 2(a)(1) of the Securities Act.
Investment Contract
Rule (1) Investment of money, (2) in a common enterprise, (3) with an expectation of profits, (4) to come solely from
the efforts of others.
District Court:
Treated the warranty deed and service contract as separate transactions
o The first transaction was merely an ordinary real estate sale and the second transaction was an agreement by
the seller to manage the property for the buyer.
Therefore, not a security.
SCOTUS
The seller is offering something more than fee simple interest in land and something different than a farm
coupled with management services.
Analysis o Investment of Money
Yes - Opportunity to contribute money in exchange for land
o In a Common Enterprise
Yes - Although there is no common ownership in the purchased plot, profits are shared among all
investors who purchased a plot
o With an Expectation of Profits
Yes Purchaser is buying not for consumption of oranges, but rather for a return on their investment
o To Come Solely from the Efforts of Others
Yes The purchasers live far away and are not contributing any expertise.
Profits are derived solely from the service contract.
The Howey test determines whether an instrument is an investment contract and therefore a security as defined in
Takeaway 2(a)(1) of the Securities Act.
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UHF v. Forman Investment vs. Consumption
Purchasers buy shares of stock to live and vote in an apartment cooperative (18 shares/room; $25/share)
Purchasers must still pay future rents.
Facts
Purchasers sue because future rent prices increased.
Allege the Co-op City Bulletin falsely represented that their future rents would not increase.
Issue Whether shares of stock entitling a purchaser to lease an apartment are securities
2(a)(1) Unless the context otherwise requires, the term security includes stocks . . . investment contracts . . .
Rule
Howey Test Defines Investment Contract
District Court
(1) Since the shares purchased were called stock and the Securities Act explicitly includes stock in its
definition of security, the Act applies to the transaction
(2) The transaction was an investment contract within the meaning of the Act as defined by Howey.
o Investment of Money
Purchaser gives money in exchange for a place to live
o In a Common Enterprise
Broad vertical commonality
o With an Expectation of Profits
Purchaser expects capital appreciation due to new commercial developments in surrounding area
Purchaser profits in the form of saving money because they do not have to live elsewhere
o To Come from the Efforts of Others
The expected profits depend entirely on the efforts of others
Analysis SCOTUS
(1) A transaction is not necessarily considered a security just because the instrument is labeled stock
o To be a security within 2(a)(1), an instrument labeled stock must bear the common characteristics of stock:
Rights to receive dividends Here, no dividend rights
Negotiable Here, non-negotiable
Voting Rights in proportion to the number of shares owned Here, voting rights are not proportional
Transferable, and Here, non-transferable
Capacity to appreciate in value Possibly satisfied (highly speculative)
(2) The transaction was not an investment contract as defined by Howey b/c there was no investment of money
o When a purchaser is motivated by a desire to use or consume the item purchased, securities laws dont apply
Here, purchasers were attracted solely by the prospect of acquiring a living space and not by a financial
return on their investment.
The potential for profits in the form of rent reduction from new commercial developments in the area is
too speculative.
Takeaway When a purchaser is motivated by a desire to use or consume the item purchased, securities laws do not apply.
Whether a moneymaking scheme is excluded from the term investment contract simply because the scheme offered a
Issue
fixed, rather than a variable return.
Argument #1:
Forman says that the expectation of profits prong requires either capital appreciation or a participation in the
earnings of the enterprise.
o Here, there is no capital appreciation because the underlying asset pays a fixed amount and the purchasers do
not participate in the earnings of the enterprise. Therefore, the expectation of profits prong is unsatisfied.
Counter-Argument #1:
Howey was referring to the profits the investor receives in the expectation of profits prong, not the profitability in
the investment scheme.
o There is no difference between a fixed or variable amount of profit paid to the investor.
Either way it is a return on their investment.
This is good policy because promoters shouldnt be able to skirt the law by giving a fixed amount
Analysis Forman did not intent capital appreciation or participation in the earnings to be an exhaustive list of
criteria that satisfies the expectations of profits prong.
Argument #2:
Howey requires profits to be derived solely from the efforts of others.
o Here, this prong is lacking because investors had a contractual entitlement on the return and therefore were not
relying on the efforts of others to derive a profit.
Counter-Argument #2:
Whether an investor has a contractual entitlement to payment is irrelevant in analyzing the efforts of others prong
o As a practical matter, the fixed amount being paid is dependent on the promoters efforts.
If the promoters fail to perform, they will default on the payments due to investors despite the contract.
o
Takeaway No distinction between variable and flat rate payments paid to investors.
Forman
This instrument bears all the ordinary characteristics of stock
If an instrument is labeled stock and contains the ordinary characteristics of stock, then the Howey investment contract
Takeaway analysis does not apply.
Stock in a corporation is the paradigm of a security.
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o Whether interests in various unincorporated associations (i.e., Pships & LLCs) are securities because
such interests are not listed in the 2(a)(1) definition of security.
Investment Contract?
o 3 out of 4 prongs are easy to meet:
Investment of money Partners invest money.
Common Enterprise Pooling of money. Need at least 2 partners by definition.
Expectation of Profits Partners invest for profit, not consumptions
Core Issue = Efforts of Others Prong
o Requires factual inquiry into the degree of control investors have in the management of their investment
Williamson v. Tucker General Partnership Interest as a Security
Limited Partnership v. General Partnership
In General Facts & Circumstances Inquiry
o General Partners Typically participate in management and thus fail to satisfy the efforts of others prong
o Limited Partners Typically do not participate in management and thus satisfy the efforts of others prong
A general partnership or joint venture can be designated a security, if the investor can establish that:
1. An agreement among the parties leaves so little power in the hands of the partner that the agreement in fact
distributes power as would a limited partnership,
Rule 2. The partner is so inexperienced and unknowledgeable in business affairs that he is incapable of intelligently
exercising his partnership powers, OR
3. The partner is so dependent upon some unique entrepreneurial or managerial ability of the promoter or
manager that he cannot replace the manager of the enterprise or otherwise exercise meaningful partnership
powers.
1. An agreement eliminates the partners management power,
Elements 2. Partner is inexperienced or unknowledgeable, OR
3. Partner is dependent upon some unique entrepreneurial or managerial ability
United States v. Leonard LLC Interests as a Security
Defendants operated independent sales offices selling interests in member managed LLCs formed to finance movies
Facts Defendants mailed potential investors offering materials (i.e., operating agreement, subscription agreement, etc.)
Defendants received a commission for each interest sold. However, this was not disclosed to investors.
Issue Whether the LLC member interests are investment contracts; Whether the efforts of others prong is satisfied
Rule Howey Test Defines Investment Contract
Held Notwithstanding the organizational documents drafted to suggest active member participation, the defendants sought
and expected passive investors. Therefore, the interests that they marketed constituted securities.
Despite the fact that the LLC operating agreement provided for a member managed LLC, in actuality the investors play
a very passive role in the company.
The investors managerial rights did not vest until the LLCs were fully organized.
o Until then, the LLC was temporarily manager managed, so by the time the members rights vest all the
Analysis important decisions have already been made.
Passive Investors
Investors did not negotiation any terms of the LLC agreements,
Investors had no experience in film, and
Investors were particularly dependent on centralized management due to their geographical dispersion
Takeaway The court did not look to the legal entitlements investors were granted in the operating agreement, but the practical
aspects of whether investors with little knowledge, expertise, and ability actually participated in management.
The Policy Question: Should Investment Contract Status be Elective?
Issue:
o If corporate stock, LP interests, and manager-managed LLC interests are generally securities, then
promoters may control whether the Securities Act applies by choosing one form over another.
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But, anti-waiver provisions . . .
Anti-Waiver Provisions:
o 14 Securities Act; 29(a) Exchange Act
Any condition or provision binding any person acquiring a security to waive compliance with any
provision of this Act or the rules and regulations of the Commission shall be void.
Why Have the Anti-Waiver Provisions?
o To protect those investors who are least able to protect themselves against schemes of clever promoters.
Notes as Securities
In General
33 Act and 34 Act differ slightly in their treatment of Notes:
o 33 Act 2(a)(1) includes in the statutory definition of a security any note,
But, 3(a)(3) then exempts from the registration requirements a note that arises out of a current
transaction or the proceeds of which have been or are to be used for current transactions and will
mature within 9 months.
17(c) makes it clear that this exemption doesnt extend to 33 Acts antifraud provisions
o In contrast, 34 Acts relevant inclusion & exclusion occur within the same definitional section
3(a)(10) describes a security as any note, but then proceeds to exclude notes with maturities
of less than 9 months.
Takeaway:
o In theory, the differing treatment means that short-term notes are exempt all together from the 34 Act, but
is still subject to the 33 Act other than those provisions dealing with registration.
If note maturity >9 months, then security.
However, most courts are unwilling to conclude that transactions such as home
mortgages, consumer installment purchases, and ordinary commercial financing involve
securities on grounds that the securities laws were not intended to cover these types of
transactions.
Notes as Securities Case Law
Reves v. Ernst Young
o A note is presumed to a security. The presumption may be rebutted if it is on the list of non-securities:
Note delivered in consumer financing,
Note secured by a mortgage on a home,
Short term (less than 9 months) note secured by a lien on a small business or some of its assets,
Note evidencing a character loan to a bank customer,
Short term notes secured by an assignment of A/R,
Note which formalizes an open-account debt incurred in ordinary course of business (bar tab), or
Notes evidencing loans by commercial banks for current operations.
o If an instrument is not on the list, then apply the Family Resemblance Test using the following factors
to determine whether the instrument bears sufficient resemblance to one of the enumerated non-securities:
Motivations of buyer and seller,
Plan of distribution,
Reasonable expectations of investors,
Risk reducing factors
Reves v. Ernst & Young Notes as Securities
Facts
In order to raise money to support its general business operations, an agricultural co-op sold promissory notes payable on
demand by the holder.
Although the notes were unsecured and uninsured, they paid a variable rate of interest that was adjusted monthly to
keep it higher than the rate paid by local financial institutions.
The co-op offered the notes to both members and non-members, marketing the scheme as an investment program
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The co-op filed bankruptcy at a time when over 1,600 people held notes worth $10MM.
Issue Whether the demand notes issued by the co-op is a security within the meaning of the 34 Act
Rule See Page 8 Above
Seller Motivations of Seller:
Security, if the purpose is to: Co-op sold notes to raise capital for general
o Raise money for the general use of a business business operations. (Security)
enterprise, OR
o To finance substantial investments Motivations of Buyer:
No security, if: Bought notes in order to earn a profit in the
Motivations o Note is exchanged to facilitate the purchase
form of interest. (Security)
of Buyer & and sale of a minor asset or consumer good,
Seller o Correct cash flow difficulties, OR
o Advance some other commercial or
consumer purpose.
Buyer
Security, if:
o Interested primarily in the profits the note is
expected to generate.
Considers whether the instrument is one in which Offered & sold to a broad segment of the public?
Analysis there is common trading for speculation or Co-op offered these notes over an extended
Plan of
investment period to its 23,000 members and also to
Distribution
Security, if: non-members. (Security)
o Offered & sold to broad segment of public.
Whether some factor such as the existence of another Risk Reducing Factors
regulatory scheme significantly reduces the risk of Notes were uncollateralized and uninsured.
Risk the instrument, thereby rendering the application of (Security)
Reducing the Act unnecessary. The notes here would escape federal
Factors Other federal law (FDIC Insurance), regulation entirely if the Acts were held not
Other state law (adequate??), to apply. (Security)
Collateral (more collateral = less risk)
Held The demand notes fall under the note category of instruments that are securities under 3(a)(10) and do not fall
within the exclusion for short-term notes despite being payable on demand.
The note falls within the short-term note exception b/c the notes are payable on demand and therefore could be paid
Dissent before the 9 months cutoff. In dictum, majority said result might be different if transaction suggested that both parties
contemplated that demand would be made within the statutory period.
Commercial Paper
What is Commercial Paper?
Unsecured notes with fixed maturity dates issued by large banks and corporations to raise money for short-term
debt obligations (i.e., payroll).
Commercial Paper Debate
Securities Act 3(a)(3)
Exempts any security that is a note, the proceeds of which are to be used for current transactions and
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the maturity of which does not exceed 9 months from the registration requirement.
The term security means any note . . . but shall not include . . . any note which has a maturity at the
Exchange Act 3(a)(10) time of issuance not exceeding 9 months.
Thus, the instrument is not a security if it fits in this definition.
Current Transaction
The consideration paid for the note must be used to finance current operations, not long-term
investments.
Prime Quality Requirement
The notes must be graded prime quality by one of the organizations that rate commercial paper.
Manner of Offering
The general public must not ordinarily purchase the notes.
This requirement is enforced by:
o Requiring notes be issued only in large denominations (i.e., $100,000)
3(a)(3) Additional o Prohibiting general advertising and solicitations, and
o Requiring that any non-institutional investor be sophisticated
Requirements
9 Month Exception
Both Acts provide any note with a maturity of less than 9 months is not a security
Demand Notes
o Do not fall within the 9-month exception because they may be redeemed after 9 months.
Roll-Overs and Renewals
o While the 9 months exception in both Acts allow notes to be renewable, the SEC takes the
position that automatic renewal does not fall within the exemption. Thus, the note holder must
take some action to renew the note upon maturity.
Prime Quality Requirement and Renewal
The note must satisfy the prime quality requirement at renewal in order to
continue to be within the 9-month exception.
In General
Not all income-producing instruments are securities.
o I.e., Bank CD, note issued in a consumer transaction, etc.
However, the activities of an intermediary in packaging financial instruments may create a security out of
something that is not.
o I.e., Gary Plastic Packing Corp. v. Merrill Lynch
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Pass-Through Arrangements:
Promoter buys an instrument, adds value, and then resells the instrument to an investor.
Gary Plastic Packaging Corp. v. Merrill Lynch
Merrill Lynch offered its customers bank CDs.
The brokerage firm claimed to offer a number of services in this program, including:
o Screening banks to determine which offered the best yields,
Facts
o Negotiating with the banks,
o Monitoring the credit worthiness of the banks, and
o Maintaining a secondary market to promote the liquidity of these investments
Analysis Applying Howey, the court concluded Merrill Lynch was selling securities
The investors were not just buying CDs, but were buying the entire program that the investor was selling including their
Held
expertise in picking the CDs, monitoring the quality of the CDs, and marketing the investments
Takeaway Just because the CD, mortgage, etc., isnt a security, the packaged deal might be!
Underwriters
Investment banking firms
o Paid to help businesses raise money
Why use underwriters?
o Customer base,
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o Expertise and knowledge of the market for securities offerings
o Reputational effects (Underwriters may be liable for fraudulent offerings)
Underwriting
In General
o If a corporation decides to raise money by offering securities, it may engage the services of broker-dealers
to sell the securities to the public in either firm commitment or best efforts underwritings
Methods of Underwriting
o Firm Commitment
One or more investment bankers agree to purchase the securities from the issuer for resale to the
public at a specified public offering price.
Underwriters buy from issuer, then resell
Used for the more established companies where there is already a known market
Signals to investors that the offering is a quality deal
o Best Efforts
Broker-dealers do not purchase the securities from the issuer. Instead, the broker-dealer agrees,
for a fee, to use their best efforts to sell the securities on behalf of the issuer at the offering price
Underwriter acts only as a salesperson
All risk is still on the issuer
The Spread
o Buyer ($100/share) Underwriters & Dealers ($5/share) Issuer ($95/share)
$100 $95 = $5 Spread
Securities Act
Registration Statement
Registration Filed with the SEC
Prospectus
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Made available to investors
Contents of Prospectus:
Includes information provided in Form S-1
less the exhibits/undertakings
Reg. S-X
Accounting and financial statements
Reg. S-K
Disclosure All other disclosure
Requirements Rule 408(a) Catch-all disclosure requirement
o In addition to the information expressly required to be included in a registration statement
(i.e., Reg. S-K), there shall be added such further material information, if any, as may be
necessary to make the required statements, in light of the circumstances, not misleading.
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statement is on its face incomplete or registration statement when an issue
inaccurate, then appears on the face of the registration
o Within 10 days of filing the registration statement without looking to any outside
statement, the SEC must give notice of source.
the refusal order and hold a hearing SEC must discover the problem and
within 10 days after such notice. provide notice within 10 days and then
hold a hearing 10 days later. Not a
practical timeframe.
Issuers Perspective:
Issuers do not want to risk a stop order proceeding
o Issuers would rather just know about potential problems so they can fix it and save face with potential
investors.
Issuers do not want to set their offering price 20 days in advance.
o Issuers recognize that the market is volatile and cannot risk price fluctuations over a 20-day period.
In General:
The SEC and Issuers have worked out informal procedures to avoid the problems associated with the 8 statutory
review processes without violating the statutes.
Actual Practice:
1. File Registration Statement Issuer may file their registration statement without the offerings price information to avoid
(w/o Pricing Information) changes in market conditions between the time of filing and the effective date.
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Notes:
Rule 473(a): Basically, when the registrant files they
The registrant hereby amends this attach a delaying amendment that says
registration statement on such date the registrant will be amending the
2. Delaying Amendments necessary to delay its effective date until registration statement on every 20th day
(Rule 473(a)) the registrant files a further amendment as necessary.
which specifically states the registration
statement shall become effective in
accordance with 8(a).
This is a back and forth process between the Registrant and SEC whereby ambiguities or
3. SEC Comment Letter(s) potential issues in the registration statement are discussed. Allows the SEC to avoid having to
issue stop orders and stop order examinations.
8(a): Notes:
The effective date of a registration After the SEC has completed their
5. Acceleration ( 8(a)) statement shall be the 20 day after filing review of the registration statement, the
or such earlier date as the SEC may Registrant may request the SEC to
determine . . . accelerate the effective date.
Section 5
Section 5 Statute Notes
5(a)
(a) Unless a registration statement is in effect as to a security, Scope:
it shall be unlawful for any person, directly or indirectly Pre-Filing Period and Waiting Period
(1) To make use of any means or instruments of Prohibitions:
transportation or communication in interstate commerce of or (a)(1): Cant sell.
the mails to sell such security through the use or medium of o Sell = contract of sale ( 2(a)(3))
any prospectus or otherwise; or (a)(2): Cant deliver.
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(2) To carry or cause to be carried through the mails or in
interstate commerce, by any means or instruments of
transportation, any such security for the purpose of sale or for
delivery after sale.
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Pre-Filing Period Prohibitions
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5(c): 2(a)(3):
Prohibits any offer to sell or offer to buy The term offer to sell, offer for sale, or offer shall
until the registration statement has been filed, or include every attempt or offer to dispose of, or solicitation of
o While the registration statement is subject to an offer to buy a security.
a 8 refusal order, stop order, or
examination. Arrangement With and Among Underwriters:
2(a)(3) excludes from the definition of sale, offer to
sell, and offer to buy:
o Negotiations and agreements the issuer has with its
underwriter, and
o Negotiations and agreements among underwriters.
2(a)(11) defines underwriter and excludes from the term:
o Anyone whose interest is limited to a commission
from the underwriter not in excess of the usual and
customary distributors or sellers commission.
5(c)
Thus, dealers (those who just get commission for
sales) are not underwriters included in the
2(a)(3) exclusion.
Issuer can put together the underwriter
group, but cannot go down to the dealer
level because that is to close to selling.
135(a): In General:
An issuer or person acting on their behalf may publish a A notice of a proposed registered offering shall
notice of a proposed offering without being deemed an not constitute an offer, if:
offer, if: o Legend, and
o Strictly limited to the information in 135(a)
135(a)(1): Legend (2).
The notice includes a statement to the effect that it does Cant describe issuers business, or
not constitute an offer to sell, and Identify underwriters
135(a)(2): Permissible Info
Rule 135: The notice is strictly limited to the following info:
Issuers Only!
Bare Bones Dealer and underwriters cannot use Rule 135.
(i) Name of the issuer,
Notice o An issuer and person acting on behalf of an
(ii) Title, amount, and basic terms of the security,
issuer
(iii) Amount of the offering,
Excludes underwriters and dealers
(iv) Anticipated timing of the offering,
because their only motive is to sell
(v) Brief statement of manner & purpose of offering
securities.
w/o naming the underwriters,
(vi) Whether the issuer is directing the offering to a
particular class of purchasers,
(vii) Any statements or legends required by any state
or foreign law, and
(viii) (Info for special offering types)
Rule 169:
Factual See Next Page
Information
Safe
Rule Notes
Harbor
Rule 163A:
See Previous Page See Previous Page
30 Days
Rule 135:
Bare Bones See Previous Page See Previous Page
Notice
Rule 169:
Factual Rule 169(a): In General In General:
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For purposes of 2(a)(10) and 5(c), the regular Not an offer, if:
release or dissemination by or on behalf of an issuer of o Factual Business Information,
communications containing factual business o Satisfies the 169(d) conditions, and
information shall not be deemed an offer, if the o Does not mention the offering
conditions of this rule are met:
Factual Business Information
Rule 169(d): Conditions Cannot be forward-looking!
(1) The issuer has previously released or disseminated Rule 168(b)(2)
information of this type before, o Defines forward-looking information
(2) The timing, manner, and form in which the Projections, future plans, etc.
information is disseminated is consistent with
similar past releases, Issuers Only!
(3) The information is directed towards customers and 169(b)(2)
Information suppliers (not investors or potential investors) o Underwriters and dealers cannot act by or
on behalf of an issuer
Rule 169(c): Exclusions
If the communication containing information about the
registered offering, then such communication is
excluded from Rule 169.
5(c) 5(c)s broad prohibitions against offers to sell and offers to buy disappear when the registration statement is filed.
However, 5(b)(1) restricts such selling efforts.
5(b)
5(b)(1): Prospectus
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It is unlawful . . . to make use of any 2(a)(10): The term prospectus means any written, radio, or
means of communication in interstate television communication, which offers any security for sale or
commerce to transmit any prospectus confirms the sale of any security
relating to any security with respect to o 2(a)(3): Broadly defines offer for sale to include
which a registration statement has been conditioning the market.
filed, unless such prospectus meets the o 2(a)(9): Written includes graphic communication
requirements of 10. Rule 405: defines graphic communication to include
electronic communications
Is the communication a prospectus? Oral Communication = Not a Prospectus
2(a)(10) defines prospectus
o 2(a)(3) defines offer Rule 134 Communication Not Deemed a Prospectus
Not an offer 134(a) Communications may include . . .
Rule 135 o i.e., Not prospectuses
Rule 169 134(b) Conditions
Rule 168 Reporting Cos. o If registration statement is not yet effective, then every
Rule 134 Not a prospectus communication shall contain the legend in (b)(1), and
If yes, does it meet the requirements of 10? o The name and address of a person(s) from whom a written
Rule 430, prospectus for the offering meeting the requirements of 10
Rule 431, may be obtained.
Rule 164/433 134(c) If one of these are satisfied, then 134(b) does not apply:
o If the communication does no more than:
If yes, then not a violation of 5(b).
State from whom, and include the URL, where a written
prospectus meeting 10 requirements may be obtained,
ID the security,
State the price, and
State by whom orders will be executed, OR
o Is accompanied or preceded by a prospectus or summary
prospectus (other than a free writing prospectus), which meets
the 10 requirements, at the date of such preliminary
communication.
134(d) Solicitations
o A communication may solicit an offer to buy, if:
The conditions in (b) or (c) are satisfied,
It contains the legend required in (d), and
Is accompanied or preceded by prospectus meeting 10
Rule 430:
Rule 430(a): If, during the waiting period:
Preliminary A prospectus shall be deemed to meet the requirements A person transmits a prospectus ( 2(a)(10)), and
Prospectus of 10 for the purpose of 5(b)(1) so long as it Such prospectus contains the info in Rule 430(a),
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contains: Then, such person does not violate 5(b)(1).
o Substantially the same information required in
a 10(a) final prospectus, except for:
Offering price,
Underwriter/dealer commissions,
Amount of proceeds, or
Any other matter dealing with price
Rule 431:
Rule 431:
A summary prospectus filed with the SEC shall be deemed to meet the requirements of 10 purposes of 5(b)(1).
Summary
o The registrant must have been a reporting company for 36 months prior to filing the registration statement
Prospectus Rarely used.
433(d)(8)(i):
A written (including graphic) communication that is a road show need not be filed, EXCEPT . . .
433(d)(8): o Note: if broadcast is live in real time, then not a graphic communication, and thus not a prospectus.
Road Show 433(d)(8)(ii):
Exception for If the issuer is a Non-Reporting company and offering common equity or convertible equity securities, then
(d) Filing must file. BUT
If at least one version of a bona fide electronic road show is made publicly available w/o restriction by means
Requirement
of a graphic communication, then do not have to file.
o If Reporting Company, then never have to file
o If Non-Reporting Company, then must file unless made publicly available without restriction.
433(g):
Issuers and offering participants shall retain all free writing prospectuses that they have used, but have not filed,
Record for a period of 3 years.
Retention
433(e)(1): Anything the Issuer hyperlinks to is considered a communication by the issuer.
433(e):
433(e)(2): Historical issuer info that is identified as such and located in a separate section of the issuers website
Hyperlinks
will not be deemed a current offer of the issuers securities and thus not a free writing prospectus
If issuer or offering participant gives info to the media 433(f)(1): If the following conditions are met, then
and it is published, then it is deemed a free writing need not comply with the (b)(2), (c), or (d)
433(f):
prospectus by whomever provided the information. requirements:
Media Reports (f)(1)(i): No payment, and (f)(1)(ii) issuer files the
stories, or (f)(2)(iii) issuer files a transcript.
5(a): No longer applies and therefore issuer and other participants can now sell.
Introduction 5(b): Still applies
However, SEC rules have modified its statutory requirements and to whom it applies.
Delivery of
Exchange Act Rule 10b-10(a): Rule 172(a): Easier Way To Send Confirmations
Confirmation Requires brokers and dealers to send confirmations to If the conditions in 172(c) are met, then
their customers. confirmations are exempt from 5(b)(1).
o Confirmation is deemed to be a 2(a)(10) o 172(c) Conditions:
Prospectus. Reg. Stmt. is effective,
Not subject to 8 stop order, and
5(b)(1): Makes it unlawful to transmit a prospectus (i.e. Final prospectus has been filed.
23
confirmation), unless it satisfies 10.
SEC has not approved confirmations under 10(b); Under Rule 172, a dealer can send their customer
so sending them appears to violate 5(b)(1), even confirmations whether or not a copy of the final
though they are required. prospectus is sent.
The statutory way out of this contradiction is through But, see Rule 173.
a 2(a)(10)(a) Free-Writing Exception to the
definition of prospectus, which says no
communication is a prospectus once you send the
person a final prospectus.
o Therefore, once the customer has received a
final prospectus, youre free to send them the
confirmation required by Rule 10b-10.
In General:
As a result of Rule 172, a seller usually doesnt have to deliver a final prospectus.
o However, when the SEC added Rule 172, it also added Rule 173
Rule 173 delivery obligation applies to 3 categories of people:
o Issuer of the security,
o Underwriter in the offering, and
Rule 173 o Anyone else who isnt exempted by 4(a)(3) or Rule 174.
Rule 173(a):
Requires some sellers to deliver their purchasers one of the following within 2 days of a sale:
o A copy of the final prospectus, or
o A notice that the sale was made pursuant to a registration statement
173(d): Purchaser may still request a copy of the final prospectus.
Oral Communications:
The 2(a)(10) definition of prospectus does not include oral communications, so oral
communications are unrestricted by 5(b)(1).
Other Communications:
To what extent can a prospectus be sent during the post-effective period?
o 2(a)(10)(a) Free Writing Exception
24
Says no communication is a prospectus if it is accompanied or preceded by a final
prospectus.
Therefore, once a final prospectus is sent to the customer, no other communication will
be a prospectus so theres no problem under 5(b)(1).
o Rule 433 Free Writing Prospectus
(b)(2)(i): Non-Reporting Companies & Unseasoned Issuers
After the effective date, the final prospectus must precede or accompany any free
writing prospectus.
o Thus, the 2(a)(10)(a) free writing exception allows free communication after
sending the final prospectus w/o all the other requirements in Rule 433.
If (b)(2)(i) does not apply:
Rule 433(b)(1) allows communications during the effective period without delivering a
copy of the final prospectus, but subject to the other conditions of Rule 433.
25
Well-Known Seasoned Issuers (Rule 405)
Meets all the Registrant Requirements to use Form S-3, AND
WKSI
o Public Equity Float of $700 Million, OR
o Issued $1 Billion of specified securities in last 3 years
Seasoned Issuer
Eligible to use Form S-3 (pg. 240-241 code book)
o Registrant Requirement
34 Act Reporting Company for at least 12 months
Seasoned Issuer
o Transaction Requirement
Must be cash offering,
Company has at least $75 Million equity outstanding,
Aggregate market value of securities sold now or in last 12 mos. < 1/3 total float
Unseasoned Issuer
Unseasoned Issuer Reporting Company, but not eligible to use Form S-3
o Fails to satisfy the Form S-3 Transaction Requirement
Non-Reporting Issuer
Non-Reporting Issuer Not a 34 Act Reporting Company for at least 12 months
o Fails to satisfy the Form S-3 Registrant Requirement
Requirements to
Any registrant which meets the requirements of Registrant Requirement
Use Form S-3
I.A. (Registrant Requirements) may use this US Company, AND
26
Form for the registration of securities under the 34 Act Reporting Company for at least 12
33 Act which are offered in any transaction months (and reporting on time).
specified in I.B. (Transaction Requirement)
Transaction Requirement
Cash offering,
Note:
Company has at least $75 Million equity
Must satisfy both the
outstanding, OR
o Registrant Requirement, and
Aggregate market value of securities sold
o Transaction Requirement
now or in last 12 months is not more than 1/3
of total float.
27
SEC has adopted a series of safe harbors to better balance the regulatory objectives of 5 with
the ongoing information needs of investors.
Issuer Safe Harbors
Well-Known Seasoned Issuers (WKSI)
o Rule 163
Exemption from 5(c) for certain communications by or on behalf of WKSI.
Reporting Issuers (i.e., Seasoned & Unseasoned Issuers)
o Rule 168
Exemption from 2(a)(10) and 5(c) for certain communications of regularly released factual
business information and forward-looking information.
Free Writing Prospectus
o Rule 433
Rule 163 provides WKSIs an exemption from 5(c) and therefore allows unrestricted oral and written offers during
In General
the pre-filing period, provided that the Rules conditions are satisfied.
Rule 163(b)(1):
The communication must contain substantially the same legend set forth in 163(b)(1)(i).
Legend
Requiremen Rule 163(b)(1)(iii):
t Excuses immaterial or unintentional failure to include the legend so long as a good faith and reasonable effort
was made to comply.
Rule 163(b)(2):
A written version of the communication made during the pre-filing period must be filed promptly with the SEC
when the registration statement is ultimately filed.
Filing o If the issuer has filed a registration statement (waiting-period), then the offer is treated as a free writing
Requiremen prospectus and must be filed with the SEC.
t
Rule 163(b)(2)(iii):
Excuses immaterial or unintentional failure to file a communication with the SEC so long as a good faith and
reasonable effort was made to comply.
Rule 168 Exemption from 2(a)(10) and 5(c) for Communications of Regularly Released Factual Business
Information and Forward-Looking Information
28
Rule 168(a):
When Does Rule 168
Applies to a registration statement that the issuer proposes to file, has filed, or is effective.
Apply?
o Therefore, Rule 168 applies during the Pre-Filing, Waiting, and Post-Effective Periods.
Rule 168(a):
By or on behalf of an issuer
Who Can Use Rule o Excludes offering participant who is an underwriter or dealer. 168(b)(3).
168?
Reporting Rule 168(a)(1):
Companies! As a condition to use Rule 168, an issuer is required to file reports pursuant to section 13 or
15 of the 34 Act.
o Therefore, the issuer must be a Reporting Company.
Rule 168(a):
Announcements by Reporting Issuers that have engaged in the regular release of factual
General Rule
business information or forward-looking information will not be treated as offers to sell a
security for purposes of 2(a)(10) and 5(c).
Rule 168(d):
The following conditions must be satisfied:
o (1) Information must be of the type the issuer has previously released in the ordinary
Conditions
course of its business, and
o (2) The timing, manner, and form in which the information is released must be
consistent in material respects with similar past releases.
Rule 168(c):
Exclusions
A communication that contains information about the offering is excluded from Rule 168.
Rule 168(b)(1):
Factual Business Information
o (i) Factual info about the issuer, its business or financial developments, or other aspects
of its business,
o (ii) Advertisements of, or other info about, the issuers products or services, and
o (iii) Dividend notices.
Definitions
Rule 168(b)(2):
Forward-Looking Information
o (i) Projections of the issuers revenue, income, expenditures, or other financial aspects,
o (ii) Statements about the issuers management plans and future objectives,
o (iii) Statements about the issuers future economic performance
Research Reports
In General
Scope:
30
Brokers, Dealers, Underwriters, and Investment Professionals
o Not Issuers
Purpose:
Investment professionals, such as those that publish research reports and investment newsletters, and broker-
dealers who regularly circulate investment recommendations among their clientele, may violate 5.
o Rules 137, 138, and 139 were created to protect individuals who create and distribute information about
companies as part of their ongoing business.
Tension:
Distributing Information v. Conditioning the Market
137(b): No Compensation
The broker-dealer that published or distributed the report can not directly or indirectly receive compensation, or
Conditions o Acting under any direct or indirect arrangement or understanding with:
(1) The issuer of the securities,
(2) A selling security holder,
(3) Any participant in the distribution, or
(4) Any other person interested in the security
Rule 139(a)(1)(iii):
The broker or dealer must publish or distribute the report the regular course of business. AND
o The report must not be the
Initiation, or
Requirements Re-initiation after discontinuance of a report about the issuer
Note:
Worried that if you havent reported on this company before or it has been a long time and all of the sudden
you start reporting on it again, then it looks less like a report and more like conditioning the market
Rule 139(a)(2) allows brokers or dealers, whether or not participating in the issuers distribution, to publish or
In General distribute industry reports so long as the issuer is given no greater prominence than other issuers and the other
conditions of the rule are satisfied.
Shelf Registration
In General
Non-Shelf
File Registration Statement
Registration Waiting Period,
32
Review Process,
Registration Statement becomes Effective
Sell Securities Immediately!
Market Timing
Reasons to use
Issuer may want to delay the sale in order to obtain a better price
Shelf Registration
Raise Capital Quickly
Issuer may need to raise capital quickly and therefore wants to avoid the registration process
o i.e., Issuer may see an opportunity to acquire another company and must act quickly
33
Securities which are to be offered or sold solely by or on behalf of a person other than the
registrant
Employee (a)(1)(ii):
Benefit Plan Securities which are to be offered and sold pursuant to a dividend or interest reinvestment
plan or an employee benefit plan of the registrant
Pledged as (a)(1)(v):
Collateral Securities pledged as collateral
(a)(1)(vii):
Mortgage Related
Mortgage related securities, including such securities as mortgage backed debt and mortgage
Securities
participation or pass through certificates
Business
(a)(1)(viii):
Combination
Securities which are to be issued in connection with business combination transactions
Transactions
(a)(1)(ix):
Commenced Securities, the offering of which will be commenced promptly, will be made on a continuous
Promptly basis, and may continue for a period in excess of 30 days from the date of initial
effectiveness
(a)(1)(x):
Securities registered (or qualified to be registered) on Form S-3 or Form F-3, which are to be
Form S-3
offered and sold on an immediate, continuous, or delayed basis by or on behalf of the
registrant
34
n
(a)(1)(viii) and (ix) If it applies, may only register an amount of securities, which, at the time the
(a)(2) registration statement becomes effective, is reasonably expected to be offered
or sold within 2 years from the initial effective date
(a)(3) Everyone must comply w/ (a)(3) Requires the Registrant to update changes in their filings
Automatic Shelf Registration If it applies, then the offering must be sold within 3 years of effective date.
WKSI (462(e)) But, if Registrant files a new registration statement pursuant to (a)(6), then
o If new reg. stmt. is automatic shelf reg., then immediately effective,
(a)(1)(vii), (ix), or (x)
OR
o If new reg. stmt. is not automatic
(A) Securities covered by the prior registration statement may
still be offered and sold until the earlier of
(a)(5) The effective date of the new registration statement, or
180 days after the 3 years has expired for the old reg. stmt.
(B) A continuous offering of securities covered by the prior
registration statement that commenced within 3 years of the
initial effective date may continue until the new registration
statement becomes effective, if the offering is permitted under the
new registration statement.
35
until a later date and therefore may not have all the information that they would
normally have in a traditional offering.
Rule 430(a): Prior to the registration statements effective date, the issuer may omit price-related
Preliminary Prospectus information in its preliminary prospectus.
Rule 430A(a):
In the post-effective period, the issuer may omit price-related information
Final Prospectus
Rule 430B:
Rule 430B(a): (a)(1)(vii) or (x)
Prospectus in Shelf Registration
If offering fits within Rule 415(a)(1)(vii) or (x), then prospectus may omit
information required by the form that is not reasonably known
State Regulation
Registration by Coordination
o Exemptions, or Registration by Qualification
Section 18(b)
Covered Securities
o (1)(A): Securities on NYSE, American Stock Exchange, or NASDAQ
o (1)(B): Allows SEC to add other exchanges to this list
o (1)(C): Rule 506 exemption
Introduction
37
Two Classes of Exemptions
Section 4(a):
Exempt Transactions
The provisions of section 5 shall not apply to . . .
Section 3(a):
Exempt Securities Except as hereinafter expressly provided, the provisions of this Act shall not apply
to any of the following classes of securities: . . .
Section 12(a)(2):
Any person who offers or sells a security (whether or not exempted by the
provisions of section 3, other than paragraphs (2) and (14) of subsection (a)), . . .
Section 17(c):
Anti-Fraud Provisions The exemptions provided in section 3 of this Act shall not apply to the provisions
of this section.
Section 11:
Doesnt apply to exempt securities because 11 talks about fraud in registration
Transaction Exemptions:
Benefits < Costs
1. Small Offerings
If want to raise $100K, then max amount of benefit from registration is
$100K, but cost of registration is significantly higher.
2. Sophisticated Offerees
Idea that sophisticated people can protect themselves even in the absence of
registration and disclosures, so the benefits of registration shrink but the
costs stay the same.
3. Deference to Another Regulator
If, for example, an issuer is re-organizing in bankruptcy, the bankruptcy
court will be overseeing any exchange of securities and evaluating the
fairness of it. Thus, benefits of registration in these situations are small but
the cost is high.
Exempt Securities
Section 3, In General
3(a)(2):
Governmental securities (i.e., municipal securities), Bank Securities
3(a)(3):
Short term notes
3(a)(4):
Exempt Securities Non-profit issuers
3(a)(5):
Securities issued by Savings and Loans, Cooperative Banks, and similar
institutions
3(a)(8):
Insurance Policies and Annuities
Any security which is part of an issue offered and sold only to persons resident within a single State,
3(a)(11) where the issuer of such security is a person resident and doing business within, or, if a corporation,
incorporated by and doing business within such State.
Part of an Issue
The entire issue of securities must be:
40
Offered, Sold, and Come to Rest exclusively intrastate.
o So, issuer cant split the offering up.
i.e., Issuer cant use 3(a)(11) for half of the offering and another exemption for other half.
Issuer must only offer and sell to residents of the same state as the Issuer.
Cant Offer or Sell to
Mere presence in the State is not sufficient to constitute residence
Non-Residents o Look to where they live, not where they work.
Issuer = Issuer must be a resident in the same state in which the securities are being offered and sold.
Resident in the Same If Issuer is a Corporation, then must be incorporated by that same state.
State
SEC Position
Issuer = Substantial operational activities in the state of incorporation
Doing Business in the o Must be more than just bookkeeping and similar administrative tasks
Same State Some Courts
Say must be Predominate amount of business in that State
Resales:
Any offers or sales to a non-resident in connection with the distribution would destroy the exemption
o However, securities that have come to rest in the hands of resident investors may, in due
course, resell to non-residents.
The purpose for the come to rest concept is to prevent people from circumventing the
registration requirement by allowing an exempt intrastate offering to be re-sold the very
Come to Rest / next day to an out of State purchaser.
Resales Come to Rest
If an intrastate offering exempt security is re-sold out of State before it has come to rest, then the
entire offering will fail the exemption.
o Look for Investment Intent
Look at amount of time held
Generally, a 1-year holding period will establish investment intent.
However, the holding period may be longer or shorter depending on circumstances
Residency
Uncertainty in whether a purchaser is a resident in the same State as the Issuer
Come to Rest
The Investment Intent test for determining whether a security has come to rest creates uncertainty
3(a)(11) Doing Business
Uncertainties Difficult to determine whether the Issuer is doing business in the State.
o SEC Position = Substantial operational activities
o Some Courts = Predominate amount of business
Rule 147
Safe Harbor designed to address the uncertainties.
Rule 147(a):
If an Issuer complies with Rule 147, then their offering is certainly exempt under 3(a)(11).
In General o Preliminary Note 1:
If, however, the Issuer fails to comply with Rule 147, the Issuer may still rely on 3(a)(11)
but risks the associated uncertainties.
Part of an Issue
Rule 147(b)(1):
41
For purposes of this rule, all securities, which are part of the same issue, must comply w/ this rule.
o i.e., The entire issue must be exclusively intrastate.
Rule 147(b)(2):
Securities offered pursuant to the exemptions provided by section 3 (i.e., Rule 504/505) or section
4(a)(2) (i.e., Rule 506) or pursuant to a registration statement
o That take place 6 months immediately before or immediately after a Rule 147 offering are NOT
deemed to be part of the same issue.
Provided that, during either 6 month period there are no offers or sales of securities by or
for the Issuer of the same or similar class as those offered pursuant to Rule 147.
Rule 147(c)(2): Issuer shall be deemed to be doing business within a State, if:
(i) Issuer derived 80% of its gross revenues
o (B) From the operation of a business or real property located in or from the rendering of
Doing Business
services within such State.
Requirement (ii) Issuer has at least 80% of its assets located within such State
(iii) Issuer intends to use at least 80% of the net proceeds from the offering within the State, AND
(iv) Issuers principal office is located within such State.
Rule 147(d): Offers and sales shall be made only to residents within the same State as the Issuer
Residence of the (d)(1): Corporation or other form of business organization = Principal office within State
Offerees (d)(2): Individual = Principal residence within State
(d)(3): If organized for specific purpose of acquiring security look to all beneficial owners
Rule 147(e):
All re-sales shall be intrastate during the initial offering AND for a period of 9 months after the last
Limitation of Resales
sale (not 9 months from time purchaser originally buys).
o Basically, SEC says securities have come to rest 9 months after final sale.
Rule 147(f):
Issuer must take the these precautions to ensure re-sale doesnt occur before securities come to rest
Issuer Must Take o (1)(i) Place a legend stating that the securities are not registered and set forth the re-sale
Certain Precautions restrictions contained in 147(e).
o (1)(ii) Issuer must notify its transfer agent not to transfer the securities, AND
o (1)(iii) Obtain a written representation from each purchaser as to his residence.
Notes:
Only talking about transactions by the Issuer
o So 4(a)(2) does not exempt secondary/resale transactions
Issue: What is not involving any public offering?
42
o Offerees, not just purchasers
o Burden of proof on the Issuer
Rule 506:
Rule 506
Represents a non-exclusive safe harbor for the private offering exemption of 4(a)(2)
Unregistered offering of stock to key employees. Key employees included all employees, not just executives.
Facts
Ralston Purina argued that the offering was not a public offering because it was limited only to employees.
Issue Whether Ralston Purinas offering to its key employees are within the 4(a)(2) private offering exemption
The focus of the inquiry should be on the need of the offerees for the protections afforded by registration.
Held Sophistication, and
Access to Information
Regulation D
Rule 504 -- 3(b)(2) Exemption from the provisions of the 5 registration requirement
In General Rule 504 Conditions Definitions
$1 Million
Rule 504(b)(2): Aggregate Offering Price shall not exceed Rule 501(c):
Maximum $1 Million, LESS: Aggregate Offering Price
Aggregate o The aggregate offering price for all securities sold within 12 months
Offering before the start of and during
Price The offering of securities under this rule,
In reliance on any 3(b) exemption, or
43
In violation of 5(a)
No Limitations
Eligible No sophistication requirement
Investors No number of purchaser requirement
Rule 502(b)(1):
Issuer to Issuer is not required to
Provide No Disclosure Requirements furnish information to
Information? purchasers when it sells
securities under Rule 504
Rule 503:
Requires Form D filing with SEC within 15 days of the first sale
o Rule 507:
Form D
Makes Reg. D unavailable to Issuers that previously have been enjoined for failure to comply w/ the
Filing? Rule 503 filing requirement
However, may possibly still be able to use 4(a)(2)
Rule 502(a):
Offers and sales made
Integration o 6 months before the start of a Reg. D offering, and
o 6 months after the completion of a Reg. D offering
Will not be considered part of that Reg. D offering
Rule 505 -- 3(b)(2) Exemption from the provisions of the 5 registration requirement
In General Rule 505 Conditions Definitions
Rule 505(b)(2)(i): Aggregate Offering Price shall not exceed Rule 501(c):
$5 Million $5 Million, LESS: Aggregate Offering Price
o The aggregate offering price for all securities sold within 12 months
Maximum
before and during
Aggregate The offering of securities under this rule,
Offering Price In reliance on any 3(b) exemption, or
In violation of 5(a)
Eligible Issuer
Rule 505(a):
44
Reporting Company or Non-Reporting Company
Rule 503:
Requires Form D filing with SEC within 15 days of the first sale
o Rule 507:
Form D Filing? Makes Reg. D unavailable to Issuers that previously have been enjoined for failure to comply w/ the
Rule 503 filing requirement
However, may possibly still be able to use 4(a)(2)
Rule 502(a):
Offers and sales made
Integration o 6 months before the start of a Reg. D offering, and
o 6 months after the completion of a Reg. D offering
Will not be considered part of that Reg. D offering
Rule 503(d):
Limitation on Resales Restricted
Resales? o Securities purchased under Reg. D shall have the status of securities acquired in a transaction under
4(a)(2) and therefore cannot be resold without registration or an exemption.
Rule 506 If the conditions in (b) or (c) are satisfied, then offers and sales by an issuer shall be deemed to be
transactions not involving any public offering within the meaning of 4(a)(2)
Rule 506(b) Rule 506(b) Conditions Definitions
No Maximum
Rule 501(c):
Aggregate No Maximum Aggregate Offering Price
Aggregate Offering Price
Offering Price
Rule 503:
Requires Form D filing with SEC within 15 days of the first sale
o Rule 507:
Form D Filing? Makes Reg. D unavailable to Issuers that previously have been enjoined for failure to comply w/
the Rule 503 filing requirement
However, may possibly still be able to use 4(a)(2)
Rule 502(a):
Offers and sales made
Integration o 6 months before the start of a Reg. D offering, and
o 6 months after the completion of a Reg. D offering
Will not be considered part of that Reg. D offering
Rule 503(d):
Limitation of Resales Restricted
Resales? o Securities purchased under Reg. D shall have the status of securities acquired in a transaction under
4(a)(2) and therefore cannot be resold without registration or an exemption.
46
(B) Basis of Net Worth = bank stmts., credit report, OR
(C) Obtain written confirmation
Rule 503:
Requires Form D filing with SEC within 15 days of the first sale
o Rule 507:
Form D Filing? Makes Reg. D unavailable to Issuers that previously have been enjoined for failure to comply w/
the Rule 503 filing requirement
However, may possibly still be able to use 4(a)(2)
Rule 502(a):
Offers and sales made
Integration o 6 months before the start of a Reg. D offering, and
o 6 months after the completion of a Reg. D offering
Will not be considered part of that Reg. D offering
Rule 503(d):
Limitation of Resales Restricted
Resales? o Securities purchased under Reg. D shall have the status of securities acquired in a transaction under
4(a)(2) and therefore cannot be resold without registration or an exemption.
Rule 504
Restrictions on General Solicitations apply except as provided in Rule 504(b)(1)
Rule 505
No General Solicitations
Reg. D Rule 506(b)
No General Solicitations
Rule 506(c)
General Solicitations allowed,
o Provided that Issuer takes reasonable steps to verify all investors are accredited
Rule 502(c)
Rule 502(c):
Except as provided in Rule 504(b)(1) or 506(c),
o Neither the Issuer nor any person acting on its behalf shall offer or sell securities by any form of
47
General Solicitation or General Advertising, including, but not limited to, the following:
Easy Cases:
Mass mailings, cold calls, marketing of interests through seminars
Tough Cases:
Targeted Communications
o In the Matter of Kenman Corp.,
What is a General Materials sent from these sources were found to be a General Solicitation
Solicitation? List of persons who participated in prior offerings by them,
List of executive officers from annual reports,
List of names who previously invested $10k+ in real estate offerings,
List of doctors in California
o Black Diamond Fund
Invitations to seminar addressed anonymously to Dear Valued Client
If Pre-existing Relationship exists between the Issuer (or person acting on its behalf) and the Offeree,
What is Not a
then the communication is NOT a General Solicitation.
General
The pre-existing relationship requirement is a way to ensure that issuers will have an opportunity to
Solicitation? evaluate whether the offeree is an accredited investor (i.e., sophistication and financial condition)
Brokers provide assistance to Issuers without the necessary relationship in reaching prospective investors
Issuers in Reg. D offerings often solicit the marketing assistance of Broker-Dealers
o Pre-Existing Relationship between Broker & Offeree OK under 502(c)
Determining the Aggregate Offering Price in Offerings under Rules 504 and 505
Aggregate
Rule 501(c): Defines Aggregate Offering Price
48
Offering Price The sum of all cash, services, property, notes, cancellation of debt, and other consideration the issuer
Defined receives for the securities
Rule 501(c): The aggregate offering price is determined on the basis of the price at which the securities
are offered for cash
o Example:
If 1,000 securities are being offered for $100/share and 1,000 are being offered for non-cash
consideration (i.e., real estate), then the non-cash consideration also equals $100/share.
Issuer does not need to place an independent value on the real estate.
If, however, Issuer is offering 1 security for $100/share and 1,000 securities for non-cash
consideration, then the Issuer may be denied the exemption.
Preliminary Note 6 to Reg. D:
How to Value o Reg. D is not available to those whose, although are in technical compliance with
Non-Cash the rules, are trying to evade the registration provisions.
Consideration
If Offering is for Non-Cash Consideration:
The maximum aggregate offering price is lowered by the amount of any other securities sold within specified
time periods in reliance upon any 3(b) exemptions.
Relevant Two relevant time periods for either Rule 504 or 505:
Amount and 1. 12 month period preceding a Rule 504 or 505 offering, and
2. The period of time during a Rule 504 or 505 offering.
Time Period
Needed to prevent an Issuer with no offerings during a preceding 12-month period from commencing a Rule 504
and Rule 505 offering simultaneously with a second offering purportedly exempt under 3(b).
Rule 502(b)(1):
If the issuer sells securities under Rule 505 or 506(b) to any non-accredited purchaser, then the Issuer
shall furnish the information specified in Rule 502(b)(2) to such purchaser a reasonable time prior to
In General
sale.
o The Issuer is NOT required to furnish the specified information to purchasers when it sells securities
under Rule 504, or to any accredited investor.
If Non-Reporting
Rule 502(b)(2)(i):
Company
(A) Non-Financial Statement Information
o If Issuer is eligible to use Reg. A, then need to disclose the same info as required under Reg. A
o If NOT eligible to use Reg. A, then need to info required in Part I of a Registration Statement
49
Generally need to provide the financial statement information required in Form S-1
o (3) Offerings over $7.5 Million
Generally need to provide the financial statement as would be required in a registration
statement filed under the Act of the form that the Issuer would be entitled to use (S-1 or S-3)
Rule 502(b)(2)(ii):
If Reporting Company, then must, at a reasonable time prior to sale furnish the information set forth in
If Reporting (b)(2)(ii)(A) OR (b)(2)(ii)(B) AND (b)(2)(ii)(C).
Company o (A) Annual Report and Proxy Statement, or
o (B) Form 10-K, and
o (C) Updates to the above information and a brief description of the securities being offered
Rule 502(b)(2)(iv):
If purchasers are non-accredited:
To Non-Accredited
o Brief description of any material written information furnished to accredited investors, and
Investors Purpose: We assume that accredited investors will ask for the necessary info
o Full disclosure of any information prior to sale, upon written request.
Rule 502(b)(2)(v):
Issuer shall provide all purchasers:
To All Purchasers o An opportunity to ask questions regarding the terms and conditions of the offering, and
o An opportunity to obtain additional information that the Issuer possess or can acquire without
unreasonable effort or expense that is necessary to verify the accuracy of info furnished to them.
Rule 501(a):
501(a):
The term accredited investor shall mean, at the time of sale:
Accredited Investors
o Any person who comes within any of the categories listed in (a)(1) (8), OR
Defined o Who the Issuer reasonably believes comes within (a)(1) (8).
Rule 501(a)(1):
(a)(1):
Any bank, registered broker-dealer, insurance company, venture capital firm, some employee
Large Institutions
benefit plans, etc
(a)(4):
Rule 501(a)(4):
Director, Executive
50
Any Director, Executive Officer, or General Partner of the Issuer
Rule 501(a)(5):
Any person whose individual net worth, or joint net worth with that persons spouse, exceeds $1
Million
Rule 501(a)(5)(i) -- Calculating Net Worth
(a)(5): (A) The persons primary residence shall not count as an asset.
(B) Indebtedness secured by the persons primary residence up to the estimated FMV of the
Individuals Net Worth
persons primary residence shall not count as a liability, UNLESS
Exceeds $1 Million o Such indebtedness was incurred within 60 days of purchasing the security.
Rule 501(a)(6):
(a)(6):
If an Individual has income exceeding $200,000 in each of the previous 2 years and a reasonable
Individuals Income
expectation of reaching the same income in the current year, then such individual is an accredited
Exceeds $200,000 or
investor.
$300,000 o If married, joint income must exceed $300,000.
Rule 501(a)(8):
(a)(8): Any entity is which all of the equity owners are accredited investors is an accredited investor
Any Entity Owned by
Accredited Investors
Rule 506(b)(2)(ii):
Each Non-Accredited Investor either alone or with his Purchaser Representative, either:
Rule 506(b)(2)(ii): o Has such knowledge and experience in financial and business matters that he is capable
Sophistication Requirement of evaluating the merits and risks of the prospective investment, OR
o The Issuer reasonably believes immediately prior to sale that such that such purchaser
comes within this description.
Rule 501(i):
Rule 501(i): Purchaser Representative
Purchaser Representative Any person who satisfies ALL of the following conditions, OR
o The Issuer reasonably believes satisfies all of the following conditions.
Conditions . . .
501(i)(1):
Any person who is NOT an affiliate, director, officer, or other employee of the Issuer, or
beneficial owner of 10% or more of any class of the equity securities or 10% or more of the
equity interest in the Issuer, EXCEPT where the purchaser is:
o (i) A relative of the purchaser representative by blood, marriage, or adoption and
51
not more remote than a first cousin;
o (ii) A trust or estate in which the purchaser representative and any persons related to
him collectively have more than 50% beneficial interest or of which the purchaser
representative serves as trustee; OR
o (iii) A corporation or other organization of which the purchaser representative and any
persons related to him collectively are the beneficial owners of more than 50% of
the equity securities or equity interests.
501(i)(2):
Has such knowledge and experience in financial and business matters that he is capable of
evaluating, alone, or together with other purchaser representatives of the purchaser, or
together with the purchaser, the merits and risks of the prospective investment; AND
501(i)(3):
Is acknowledged by the purchaser in writing, during the course of the transaction, to be his
purchaser representative, AND
501(i)(4):
Discloses to the purchaser in writing a reasonable time before the sale any material
relationship between himself and the issuer, that is mutually understood to be contemplated,
or that has existed at any time during the previous 2 years, and any compensation received or
to be received as a result of such relationship.
Rule 501(e) Limitations on the Number of Purchasers in Rules 505 and 506(b)
501(e):
Rule 501(e) Calculation of Number of Purchasers
How to Count
(1) The following purchasers shall be Excluded:
o (i) Any relative, spouse, or relative of the spouse of a purchaser who has the same principal
residence as the purchaser
o (ii) Any trusts of estates in which a purchaser owns more than 50%
o (iii) Any corporation or other organization in which a purchaser owns more than 50%
52
o The entity was organized for the sole purpose of acquiring the securities offered.
In such case, each owner of the entity shall count as a separate purchaser.
Note: Must analyze each owner individually because they still may be excluded as an
accredited investor or any other reason in 501(e)(1).
Rule 502(d):
Except as provided in Rule 504(b)(1), Issuer must exercise reasonable care to avoid re-sales.
Safe Harbor:
If the Issuer does these 3 things, then they will be deemed to have exercised reasonable care:
502(d): o (1) Reasonable inquiry to determine if purchaser is acquiring the securities for himself or others
Resales Restricted
o (2) Written disclosure to each purchaser prior to sale that the securities have not been registered
under the Act and therefore cannot be re-sold unless they are registered or an exemption
from registration is available
o (3) Placement of a legend on the security certificate stating that the securities have not been
registered under the Act and setting forth or referring to the restrictions on transferability
503:
Rule 503:
Form D Filing Requires Form D filing with SEC within 15 days of the first sale
Requirement o Rule 507:
Makes Reg. D unavailable to Issuers that previously have been enjoined for failure to comply
w/ the Rule 503 filing requirement
53
However, may possibly still be able to use 4(a)(2)
Rule 508(a):
A failure to comply with a term, condition or requirement of Reg. D will not result in the loss of the
exemption, if the person relying on the exemption shows:
o (1) The failed condition was not intended to protect the person suing,
o (3) Issuer must show a good faith attempt to with all conditions in Reg. D
In General
What is Crowdfunding?
Crowdfunding is the collective effort of a large number of individuals who pool their resources to support a third
partys effort to achieve a stated goal or engage in a defined activity
Individual
4(a)(6)(B): Rule 100(a)(2):
Investment The amount sold to any investor, including any The amount sold to any investor, including any
Limits: amount sold in reliance on 4(a)(6), shall not amount sold in reliance on 4(a)(6), shall not
exceed: exceed:
(Annual
4(a)(6)(B)(i): Lower Limit Rule 100(a)(2)(i): Lower Limit
Income &
If purchasers Annual Income or Net Worth is LESS If either the purchasers Annual Income or Net
Net Worth)
than $100k, then the maximum amount that Worth is LESS than $100k, then the maximum
purchaser can buy during the 12-month period amount that purchaser can buy during the 12-
preceding the transaction shall be the greater of: month period preceding the transaction shall be the
55
o $2,000 or greater of:
o 5% of annual income or net worth o $2,000 or
o 5% of annual income or net worth
4(a)(6)(B)(ii): Higher Limit
If purchasers Annual Income or Net Worth is Rule 100(a)(2)(ii): Higher Limit
MORE than $100k, then the maximum amount that If BOTH Annual Income and Net Worth are equal
purchaser can buy during the 12-month period to or more than $100k, then the maximum amount
preceding the transaction shall be: that purchaser can buy during the 12-month period
o 10% of annual income or net worth preceding the transaction shall be the lesser of:
But, cant exceed $100,000 o 10% of annual income or net worth
Notes: Notes:
Investment limits apply to all crowdfunding Investment limits apply to all crowdfunding
offerings. offerings.
o This is not just a limit for each offering, but a o This is not just a limit for each offering, but a
limit on the total amount that the investor may limit on the total amount that the investor
invest in all 4(a)(6) offerings. may invest in all 4(a)(6) offerings.
Statutory Ambiguity:
o Both limits apply, if:
One of those figures is <$100k, and
The other is equal to or >$100k
o Ambiguity is cleared up in the Rules
Through
4(a)(6)(C): Rule 300(a):
Broker or The transaction must be conducted through a broker Offering must be conducted through a web portal
Funding or funding portal that complies with 4A(a) operated by a securities broker or SEC
Portal
4(a)(6)(D): Rule 201 205:
Issuer
Issuer must comply w/ disclosure req. in 4A(b) Issuer must comply w/ disclosure requirements
Complies
with 4A(b)
Crowdfunding Rules
Rules 100(b)(1), (2): Issuer must be a Non-Reporting Company organized under U.S. law
Eligible Issuers
Rules 100(b)(4), 503: Bad actor disqualifications similar to Reg. A and Reg. D
Offering Rule 100(a)(1): The aggregate offering amount sold pursuant to 4(a)(6) is $1 million in any 12-month period.
Amount Securities sold pursuant to other exemptions do not affect this limit.
Rule 300(a): The offering must be conducted through a web portal operated by a registered securities broker or a
registered funding portal.
Offers & Sales The Issuer may not offer or sell the securities directly to the public w/o using an intermediary.
through The Issuer may not even advertise the offering off-platform, except for a bare-bones notice
Registered directing investors to the intermediarys platform. (See Rule 204)
Intermediaries
Rule 303(c): The intermediarys platform must include communication channels that allow potential investors to
communication with the issuer, and with each other, about the offering.
Disclosure
Rule 201: Issuer must file with the SEC, and make available to potential investors on the crowd
funding platform, detailed disclosure about the company, its business, and offering.
Target Amount:
Rule 201(g): Issuer must specify target amount to be raised in offering and deadline for raising that amount
Target Amount o Rule 303(a)(2): Offer must remain open for at least 21 days
o Rule 201(g): If offering does not reach target amount by deadline, all investment commitments must
& Withdrawal
be cancelled and any money already submitted must be returned to investors.
Rights
Withdrawal Rights:
Rule 304(a): Investors may cancel their investment commitments any time up to 48 hours before deadline
4(a)(6)(B): Investors may not invest more than a specified amount in 4(a)(6) offerings within any 12-months
Note: This is not just a limit for each offering, but a limit on the total amount that the investor may invest in
all 4(a)(6) offerings.
Rule 100(a)(2): Lower Limit
Investment
Unless both annual income and net worth exceed $100k, maximum investment shall be the greater of:
Limits o $2,000 or 5% of annual income or net worth
4(a)(6)(B) provides for two limits. The applicable limit depends on the investors annual income and net worth.
The lower set of limits, in 4(a)(6)(B)(i), applies if either the annual income or the net worth of the
investor in less than $100,000.
The higher set of limits, in 4(a)(6)(B)(ii), applies if either the annual income or the net worth of the
investor is equal to or more than $100,000.
Investment o If one of those two figures is less than $100,000 and the other is equal to or greater than $100,000,
Limits Statutory then the statute literally says both apply.
Ambiguity Rule 100(a)(2) clarifies the ambiguity. The lower limit applies unless both annual income and net
worth exceed $100,000.
o Rule 100(a)(2)(ii) also clarify an ambiguity as to the higher limit.
Under 4(a)(6)(B)(ii), the higher limit is 10% of annual income or net worth, but doesnt say
whether the limit is the great or the lesser of those two figures.
Rule 100(a)(2)(ii) makes clear that the limit is the lesser of the two figures.
Rule 301(b): When an investor opens an account with a crowdfunding intermediary, the intermediary must
provide educational materials that inform investors about the crowdfunding exemption.
Rule 303(b)(2)(i): Before investment, the intermediary must obtain a representation that the investor has
Investor reviewed the educational materials and understands that the entire amount of their
Education investment may be lost and that they are in a financial condition to bear such loss.
Rule 303(b)(2)(ii): Intermediary must also require the investor to complete a questionnaire demonstrating the
investors understanding of certain risks specified in the regulation.
Annual Reports
57
Rule 202(a): Issuers that have sold pursuant to 4(a)(6) must file, and post on their web sites, annual reports
that include financial statements.
Investment Limits: The intermediary must have a reasonable basis for believing each investor satisfies the
investment limits. The investors representation is sufficient unless the intermediary has reason not to
believe it. (Rule 303(b)(1))
Issuers Compliance: The intermediary must have a reasonable basis for believing that the Issuer is in
compliance with the requirements of the exemption. The Issuers representations to that effect are sufficient
The
unless the intermediary has reason not to believe it. (Rule 301(a))
Intermediarys
Enforcement Issuers Record Keeping: Intermediary must have reasonable basis for believing the Issuer has established
Role a means to keep accurate records. Issuers representations to that effect are sufficient. (Rule 301(b))
Background Checks: Intermediary must conduct a reasonable investigation and deny any Issuer access to
its platform that has been disqualified under a bad actor exception. (Rule 301(c)(1))
Potential for Fraud: Intermediary must deny access to its platform if it has reasonable basis (due diligence
not required, but unclear) for believing that the Issuer or the offering presents potential for fraud or
otherwise raises concerns about investor protection. (Rule 301(c)(2))
Rule 501: Securities purchased pursuant to 4(a)(6) may not be resold for 1 year, with some exceptions:
(1) Securities are transferred to the issuer of the securities,
(2) Securities are transferred to an accredited investor,
Resales (3) Securities are transferred as part of a registered offering, or
(4) Securities are transferred to a member of the family of the purchaser
Substantial Rule 502: There is a substantial compliance requirement similar to that in Regulation D
Compliance i.e., failure to comply with a term will not result in a loss of the exemption (see pg. 54)
Integration with
The crowdfunding rule itself says nothing about the integration of 4(a)(6) offerings with other offerings.
Other Offerings However, the release has the following to say on the subject:
An offering made in reliance on 4(a)(6) should not be integrated w/ another exempt offering made by the
Issuer, provided that each offering complies with the requirements of the applicable exemption being relied
upon.
Example 1:
o An Issuer conducting a concurrent exempt offering for which general solicitation is not permitted (i.e.,
Rules 505, 506(b)) will need to be satisfied that purchasers in that offering were not solicited by means
of the offering made in reliance on 4(a)(6).
Example 2:
o An Issuer conducting a concurrent exempt offering for which general solicitation is permitted (i.e.,
Rule 506(c)), could not include any such general solicitation in an advertisement of the terms of an
offering made in reliance on 4(a)(6), unless that advertisement otherwise complied with 4(a)(6) and
58
the final rules.
As such, a concurrent offering would be bound by the more restrictive solicitation requirements
of Regulation Crowdfunding, unless the Issuer can conclude that the purchasers in the
Regulation Crowdfunding offering were not solicited by means of the offering made in reliance
on Rule 506(c).
Rule 701 provides an exemption from 5 for private (non-reporting companies) companies that sell securities to
In General employees for compensatory purposes.
If Issuer becomes an Exchange Act reporting company after it has already made a Rule 701 offer, the Issuer
Eligible
may still rely on Rule 701 to sell the securities previously offered. Rule 701(b)(2).
Issuers
Reporting Company Issuer may rely on Rule 701 if it is merely guaranteeing the payment of a subsidiarys
securities that are sold under Rule 701. Rule 701(b)(3).
Rule 701(c):
Eligible Exempts securities under a compensatory benefit plan established by the Issuer (or its subsidiaries) for the
participation of their:
Transactions o Employees, directors, general partners, officers, or consultants & advisors, and their family
/ Investors members who acquire such securities through gifts or domestic relations orders.
See Definitions on page 61
Rule 701(e):
Issuer must deliver to investors a copy of the compensatory benefit plan or contract, and
Disclosure If the amount of securities sold during a 12-month period exceeds $5 million, then Issuer must also deliver
the disclosure listed in (e)(1) (6) to investors a reasonable time before sale.
Rule 701(d)(3)(iv):
Securities sold under this rule do not affect the aggregate offering price in other exemptions, AND
Aggregation Amounts of securities sold in reliance on other exemptions do not affect the amount that may be sold in
reliance on Rule 701.
Rule 701(f):
Integration Rule 701 securities do not integrate with other offerings (whether exempt or registered).
Rule 701(g):
Resales (1) Rule 701 securities are restricted securities and therefore must still comply with State security law
(2) Resales must comply with the 5 registration requirements or an exemption
Employee
Rule 701(c): The term employee shall include insurance agents who are exclusive agents who are
exclusive agents of the Issuer (or subsidiaries) or derive more than 50% of their annual income from those
entities.
o In a SEC no action letter, the SEC has taken the position that insurance agents include any other sales
agent as a de facto employee.
Family Member
Rule 701(c)(3): Family member includes any:
o Child, stepchild, grandparent, parent, stepparent, grandparent, spouse, former spouse, sibling, niece,
nephew, mother-in-law, father-in-law, son-in-law, daughter-in-law, brother-in-law, or sister-in-law,
Including adoptive relationships,
Any person sharing the employees household, and
Any other entity in which these persons (or employee) own more than 50% interest
60
Regulation A; 3(b); Rules 251-264
In General Reg. A is a 3(b) exemption
Mini-
Reg. A is sometimes called mini-registration b/c some of its requirements resemble registered offerings ( 5).
Registration
Rule 252: The Issuer must file an Offering Statement (Form 1-A)
Before Filing -
o Rule 251(d)(1)(i): Except for the Rule 255 testing the waters provision, no offers may be made
No resale restrictions.
Resales
Regulation A securities may be resold immediately.
Substantial
Rule 260: Substantial compliance rule similar to Rule 508 in Regulation D (see page 54)
Compliance
Tier 1 Offering:
Subject to State securities law registration and offering requirements
o Thus, a Tier 1 offering, even though exempted from federal registration, may have to be registered at
the State level.
State
Regulation Tier 2 Offering:
Regulation A preempts State registration requirements for Tier 2 offerings.
o How?
Rule 256 defines offerees and purchasers in Tier 2 offerings as qualified purchasers.
That makes Tier 2 securities covered securities for purposes of preemption under 18.
If a Regulation A Tier 2 Offering is offering securities that will NOT be listed on a national securities
In General
exchange, then special investment limits apply. Rule 251(d)(2)(i)(C)
Rule 251(d)(2)(i)(C)(1):
Total price paid by a natural person who is not an accredited investor shall not exceed the greater of:
Non-Accredited
o 10% of the persons annual income, OR
Natural Person o 10% of the persons net worth
Issuer may rely on Investors representations. Rule 251(d)(2)(i)(D)
Rule 251(d)(2)(i)(C)(2):
Total price paid for non-accredited investors who are not natural persons shall not exceed the greater of:
Non-Accredited;
o 10% of the persons revenue, OR
Not Natural Person o 10% of the persons net assets
Issuer may rely on Investors representations. Rule 251(d)(2)(i)(D)
Rule 251(d)(2)(i)(C):
Accredited Investor
Accredited investors are NOT subject to the purchase limits
Prior Offerings
Rule 251(c)(1):
62
Regulation A offerings will NOT be integrated with
o Prior offers or sales of securities
Rule 251(c)(2):
Regulation A offerings will NOT be integration with subsequent offers or sales of securities that are:
o (i) Registered under the Securities Act, except as provided in Rule 255(e),
o (ii) Exempt from registration under Rule 701,
Subsequent Offerings o (iii) Made pursuant to an employee benefit plan,
o (iv) Exempt from registration under Regulation S
o (v) Made for than 6 months after the completion of a Regulation A offering, OR
o (vi) Exempt from registration under 4(a)(6) of the Act (i.e., crowdfunding)
If an Issuer decides to make a registered offering after soliciting interest in a contemplated, but
abandoned Reg. A offering, then the abandoned Reg. A offering is NOT INTEGRATED with the
registered offering, if:
Rule 255(e):
o Solicitations were made only to qualified institutional buyers & qualified institutional investors
Abandoned Offerings
If solicitations of interest were made to other persons, an abandoned Reg. A offering is NOT
INTEGRATED, if:
o Issuer waits at least 30 days between the last solicitation of interest in the Reg. A offering and
the filing of registration with the SEC
Rule 251(d)(1)(i):
Before Offering
Except as allowed by Rule 255 (Testing the Waters),
Statement is Filed o No offers may be made unless an offering statement has been filed with the SEC
Rule 251(d)(1)(ii):
After the offering statement has been filed, but before it is qualified:
After Filing, But o (A) Oral offers may be made,
o (B) Written offers pursuant to Rule 254 (Preliminary Offering Circular) may be made, and
Before Qualification
o (C) Solicitations of interest and other communications pursuant to Rule 255 (Testing the
Waters) may be made.
Rule 251(d)(1)(iii):
After Qualification After the offering statement has been qualified, offers may be made, BUT
o Written offers must be accompanied with or preceded by the Offering Circular filed with the SEC
Rule 255:
Rule 255: Solicitations of Interest and Other Communications
Testing the Waters
(a) Solicitations of Interest
o An Issuer may communicate orally or in writing to determine whether there is any
interest in a contemplated securities offering before filing the offering statement
Solicitation may continue even after the offering statement is filed.
63
State from whom a copy of the Preliminary Offering Circular may be obtained,
Provide a URL where the Preliminary Offering Circular may be obtained, or
Include a copy of the Preliminary Offering Circular
Rule 254:
After filing an offering statement, but before qualification, written offers may be made if they meet the
following requirements:
(c) Filing
o The Preliminary Offering Circular is filed as part of the offering statement.
Rule 251(d)(2)(i):
In General
No sale of securities may be made . . .
Tier 1 Offering o Until the offering statement has been filed, AND
o Until a Preliminary Offering Circular is delivered at least 2 days before the sale to any person
that before qualification had indicated an interest in purchasing securities in the offering.
Tier 2 Offering o Until the offering statement has been qualified, UNLESS
The purchaser is an accredited investor, OR
The aggregate purchase price to be paid by the purchaser does not exceed a given limit (See
page 63 for purchase limits)
Rule 251(d)(2)(ii):
Delivery of Final If a sale is made by the Issuer, Underwriter, or Dealer within 90 days after qualification,
Offering Circular o Then the seller must deliver a copy of the Final Offering Circular within 2 days after the sale,
Subject to the provisions in 251(d)(2)(ii)(A)-(E).
64
Audited Financial Statements
Periodic Reporting Requirements
Rule 257
No Limitation on Re-Sales
Advantages of Fewer Restrictions on Solicitations
Reg. A Rule 255 Testing the Waters
No pre-existing relationship required
In General
Exemptions:
All exemptions require that the entire offering or issue must comply with the exemption
o Integration of two offerings by an Issuer may destroy the availability of an exemption for either or both
offerings.
Question:
What is a single offering or issue?
o Are there really separate offerings or should they be treated as a single offering?
Integration:
5 Factor Test
o SEC approach
Single plan of financing,
Same class of security,
At or about the same time,
Same consideration, and
Same general purpose
Integration Safe Harbors
o If safe harbor applies, dont use 5 factor test
Rule 147
65
One-sided protection for 3(a)(11) intrastate offerings
Rule 502(a)
One-sided protection for Reg. D offerings
Rule 251(c)
Reg. A offerings not integrated with any prior offerings and certain subsequent offerings
Rule 155
Abandoned offerings
5 Factor Test
Whether the offerings are part of a single plan of financing; What is a single plan of financing?
Different Approaches:
2:
Whether the offerings involve the issuance of the same class of security;
Same Class of
Security Debt + Equity Offering
o If the offerings include both equity and debt securities, then that one factor alone may be enough to
prevent integration even when the other 4 factors point towards integration.
However, the SEC has not always recognized this general rule (Kunz)
Note:
o If debt security is immediately convertible into equity, then the Issuer is said to be
offering both classes of securities at the same time.
o If debt security is convertible at some future date, then under 2(a)(3), the offering
will be said to be offering only equity securities.
If offerings are separated by a substantial period of time, then presumption against integration
3: o Rebuttable presumption = 6 months
Same Time o Irrefutable presumption = 1 year
Cash Consideration
4: o Since cash is the most common form of consideration, it does not militate either way.
Same Cash + Non Cash Consideration
Consideration o Suggests the offerings should NOT be integrated.
5:
Whether the offerings are made for the same general purpose.
Same General For what purpose is the Issuer raising capital for in the offerings? If similar, then cuts towards integration.
Purpose
Integration Safe Harbors
Rule 502(a):
Offers and sales made
o 6 months before the start of a Reg. D offering, and
o 6 months after the completion of a Reg. D offering
Will not be considered part of that Reg. D offering
o So long as there are no offers or sales of securities by or for the Issuer that are the same or a similar
Rule 502(a): class as those offered or sold under Reg. D during either of those 6 month periods.
Reg. D Offerings
One-Sided Protection:
Rule 502(a) says will not be considered part of that Reg. D offering
o Therefore, Rule 502(a) offers one-sided protection for the Reg. D offering.
Only protects the Reg. D offering from integration with another offering
Does NOT protect another offering from being integrated with the Reg. D offering and therefore
may cause another offering to violate the exemption it is relying on.
Rule 147(b)(2):
Offers and sales made pursuant to the exemptions provided by 3, 4(a)(2), or a Registration Statement
o 6 months before the start of a Rule 147 offering, or
Rule 147: o 6 months after the completion of a Rule 147 offering
3(a)(11) Will not be considered part of that Rule 147 offering
Intrastate o So long as there are no offers or sales of securities by or for the Issuer that are the same or a similar
Offerings class as those offered or sold under Rule 147 during either of those 6 month periods.
One-Sided Protection:
Rule 147(b)(2) says, an issue shall be deemed not to include. Thus, offers one-sided protection.
Rule 251(c):
Rule 251(c)(1), (2):
Reg. A Offerings Regulation A offerings will NOT be integrated with
o Prior offers or sales of securities, or
o Subsequent offers or sales of securities that are:
(i) Registered under the Securities Act, except as provided in Rule 255(e),
67
(ii) Exempt from registration under Rule 701,
(iii) Made pursuant to an employee benefit plan,
(iv) Exempt from registration under Regulation S
(v) Made for than 6 months after the completion of a Regulation A offering, OR
(vi) Exempt from registration under 4(a)(6) of the Act (i.e., crowdfunding)
Two-Sided Protection:
Rule 251(c) says, will not be integrated with. This broad term provided two-sided protection.
Rule 155:
Abandoned See Below (pg. 69)
Offerings
The abandoned registered offering will not be considered part of a subsequent private offering, if:
o No securities were sold in the registered offering,
o The Issuer withdrawals the registration statement under Rule 477,
o The Issuer must wait 30 days after withdrawal before commencing the private offering,
o The Issuer notify each offeree in the private offering that
The offering is not registered,
Re-sale limitations,
No protections under 11, and
That a registration statement for the abandoned offering was filed and withdrawn
Rule 155:
Abandoned
Offerings Rule 155(b): Abandoned Private Offering Registered Offering
The abandoned private offering will not be considered part of a subsequent registered offering, if:
o No securities were sold in the private offering,
o The Issuer terminates all offering activity in the private offering before filing registration statement,
o The 10(a) Final Prospectus and 10(b) Preliminary Prospectus disclose:
The size and nature of the private offering,
The date on which the private offering was abandoned,
Any offers to buy in the private offering were rejected, and
That the prospectus delivered in the registration statement supersedes other offering material
o The Issuer does not file the registration statement until at least 30 days after abandoning the private
offering, unless
Offers were limited to accredited investors, or
Persons with knowledge and experience
68
SECONDARY DISTRIBUTIONS (RE-SALES)
The Underwriter
4(a)(1): Exempted Transactions
4(a)(1) --
Exempts transactions by any person other than an Issuer, Underwriter, or Dealer.
o 2(a)(4): Issuer Any person who issues or proposes to issue a security
o 2(a)(12): Dealer Any person in the business of dealing in securities issued by another person
o 2(a)(11): Underwriter Big battleground in re-sales
Who is an Underwriter?
69
The term Underwriter means
2(a)(11): Any person who has purchased from an Issuer [or Control Person] with a view to . . . distribution,
Net Result OR
Any person who offers or sells for an Issuer [or Control Person] in connection with the
distribution of any security.
Definition #1: Purchased from an Issuer [or Control Person] with a view to the distribution
2(a)(11): Among those included in the definition of underwriter is any person who has
Purchased from an Issuer [Control Person] with a view to the distribution of any security.
Investment Intent
With respect to the purchased securities, did the investor intend to hold for investment or re-sell?
o Since intent is difficult to prove, look for objective evidence (i.e., Holding Period).
Distribution
Distribution
If re-sale occurs before securities come to rest, then distribution is defined w/ respect to Issuers original
exemption
o i.e., continuation of the Issuers distribution
o Come to rest = same analysis as with a view to
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If re-sale by an affiliate is inconsistent with the Issuers exemption, then distribution.
o Examples:
3(a)(11) intrastate offering re-sold to purchaser out of state
4(a)(2) private offering re-sold to purchaser lacking access to information
Definition #2: Offers or sells for an Issuer [Control Person] in connection with a distribution
For an Issuer
United States v. Wolfson
[Control Person]
in Connection Facts:
with a Wolfson and his family own 40% of Continentals outstanding stock.
Wolfson is a Control Person
Distribution
o Largest shareholder and had final say on all corporate policy and business decisions
Wolfson sold 400,000 shares (25% of outstanding shares)
o 6 brokers assisted in the OTC transactions
Issue:
Whether the transaction is exempt from section 5 under 4(a)(1) or 4(a)(4)
o Wolfson argues that he is not an Issuer, Underwriter, or Dealer and therefore transaction is exempt.
Rule:
4(a)(1) exempts transactions not involving an Issuer, Underwriter, or Dealer
Analysis:
Is Wolfson an Issuer?
o Wolfson does not fit within the 2(a)(4) definition of Issuer and therefore is not an Issuer for
purposes of 4(a)(1).
o However, Wolfson is a Control Person and therefore is an Issuer for purposes of 2(a)(11) and
therefore may be an Underwriter for 4(a)(1) depending on his involvement in the transaction.
Is Wolfson a Dealer?
o No, because 2(a)(12) defines dealers as those engaged in the business of trading securities.
Is Wolfson an Underwriter?
o Under 2(a)(11), Wolfson will be deemed an underwriter if he (1) purchased securities from an
issuer with a view to distribution, or (2) offers or sells for an issuer in connection with a distribution.
Wolfson is not purchasing with a view to distribution
Wolfson purchased and held the securities for many years and therefore did not purchase
with a view to distribution, but rather purchased with investment intent.
Wolfson is not offering or selling for an Issuer
Wolfson is offering on his own behalf.
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Wolfson is not an Issuer, Dealer, or Underwriter.
o Therefore, it would appear that the transaction is exempt under 4(a)(1). HOWEVER,
The brokers who assisted in the OTC transactions are underwriters because Wolfson is a
2(a)(11) Issuer and therefore the brokers offered or sold for an Issuer [Control Person] in
connection with a distribution.
Therefore, the 4(a)(1) exemption fails because the transaction involved an underwriter.
Term used to express the statutory relationship between 4(a)(1) and 4(a)(2).
Therefore, whether a party is an underwriter for purposes of 4(a)(1) requires an inquiry into whether the
transaction involves a public offering.
Ackerberg
Facts:
v.
Vertimag, Inc. sold shares to Johnson in an unregistered private offering.
Johnson
o Johnson is Vertimag chairman of the board and largest SH. Thus, Johnson is a Control Person
Johnson engages PJH (broker) to sell some of his shares. PJH sells 12,500 shares to Ackerberg.
Issue:
Whether 4(a)(1) exempts Johnson from section 5 registration.
o Clearly, Johnson is not an issuer or dealer, but is he an underwriter?
Rule:
4(a)(1) exempts any person other than an issuer, underwriter, or dealer from registration.
Analysis:
Is Johnson an underwriter?
o Under 2(a)(11), the term underwriter includes any person who
Purchases from the issuer [or control person] with a view to distribution, or
Offers or sales for an issuer [or control person] in connection with a distribution.
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Distribution requires a public offering.
Whether the resell is considered a public offering is determined by the Ralston Purina
criterion (i.e., Sophistication and Access to Information).
o Ackerman is sophisticated and had access to information.
Held:
Johnson is entitled to the 4(a)(1) exemption because the transaction did not involve an issuer,
dealer, or underwriter.
Note:
Although PJH is neither an issuer nor underwriter, they are a dealer.
o Therefore, the transaction involved a dealer. However, this does not destroy the 4(a)(1)
exemption because PJH is entitled to a broker exemption under 4(a)(3).
Resale Safe Harbors; Rules 144, 144A, 4(a)(7)
Rule 144 Safe Harbor for Resales of Control and Restricted Securities
General Rule:
If the conditions in Rule 144 are satisfied, then a person re-selling securities shall not be deemed to
be engaged in a distribution and therefore not underwriters
In General
Purpose:
The purpose of Rule 144 is to provide objective criteria for determining that the person selling
securities to the public has not acquired the securities for distribution.
Subject to paragraph (i) of this section, the following conditions must be met:
o (1) Non-Affiliates . . .
o (2) Affiliates or persons selling on behalf of affiliates . . .
The term affiliate means any person that directly, or indirectly through one or more intermediaries, controls,
or is controlled by, or is under common control with the issuer.
o Note ---
The same language is used to define control person in Rule 405.
Affiliate = Control Person
Non-Affiliates
Rule 144(b)(1)(i): Rule 144(b)(1)(ii):
If non-affiliate is selling Restricted Securities of If non-affiliate is selling Restricted Securities of
a Reporting Company, then must satisfy the a Non-Reporting Company, then must satisfy
following conditions: the following conditions:
o Rule 144(d) Holding Period, AND o Rule 144(d) Holding Period
Affiliates
Rule 144(b)(2):
or If an affiliate or any persons selling on behalf of an affiliate sells Restricted Securities or any other security,
Persons Selling then all the conditions in Rule 144 must be satisfied.
on Behalf of
Affiliates
144(a)(3)(ii) Regulation D
Securities acquired from the issuer that are subject to the resale limitation of Rule 502(d)
under Regulation D or Rule 701(c).
o The language subject to makes this safe harbor available even if the original issuer
Rule 144(a)(3): violated Reg. D, as long as the securities were subject to the resale limitation (i.e.,
Restricted Securities contractually).
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Rule 144 Conditions
Rule 144(c):
Adequate current public information about the issuer must be available.
o Such information will be deemed available if:
144(f):
Rule 144(f)(1)(i):
Manner of Sale The securities must be sold through a Brokers Transaction within the meaning of 4(a)(4).
o Basically, a broker must facilitate the transaction, but cannot solicit orders.
Rule 144(g):
In a Brokers Transaction, the broker must:
o (1) Must do no more then execute the order as agent for the person for whose account securities are sold,
o (2) Receive no more than the usual brokers commission,
o (3) With certain exceptions (see statute), the broker cannot solicit the customers order, and
o (4) Perform a reasonable inquiry into whether the seller is an underwriter
i.e., whether the transaction is in connection with a distribution
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Reasonable inquiry includes asking the seller and having knowledge of the information provided in
the required 144(h) notice.
Rule 144(h):
144(h):
If the amount of securities sold in reliance of Rule 144 during the past 3 months exceeds
Notice of o 5,000 shares or $50,000
Proposed Sale Then copies of a notice on Form 144 shall be filed with the SEC.
Rule 144A
If any person other than the issuer (i.e., dealer or underwriter) re-sells a security that satisfies the conditions of
In General Rule 144A, then such transaction is not a distribution.
o Therefore, under 4(a)(1) the transaction is exempt from registration because it does not involve an issuer,
underwriter, or dealer.
Eligible
Rule 144A(c): Sales by Dealers
Sellers
Any dealer who offers or sells securities in compliance with this Rule shall not be deemed to a participant in a
distribution of such securities within the meaning of 4(a)(3)(A) and not an underwriter within the meaning of
2(a)(11).
o Therefore, under 4(a)(1) the transaction is exempt from registration because it does not involve an issuer,
underwriter, or dealer.
Rule 144A(d)(1):
The securities must only be sold to a Qualified Institutional Buyer (QIB) or to a purchaser that the seller
reasonably believes is a QIB.
Sold only to
QIB Rule 144A(a)(1): QIB Defined
An entity that owns and invests on a discretionary basis at least $100 million in securities of issuers that are not
affiliated with the entity.
Rule 144A(d)(2):
Seller takes
The seller must take reasonable steps to ensure that the seller may rely on the exemption provided by this
Reasonable
section.
Steps o Easy condition to meet
Right to
Rule 144A(d)(4):
Obtain Info If issuer is a Non-Reporting Company, then buyer must have a right (i.e., contractual right) to obtain info about
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the issuer.
o If issuer is a Reporting Company, then 144A(d)(4) does not apply.
Rule 144A(e):
Offers and sales of securities pursuant to this Rule do not affect any exemption or safe harbor relating to:
Integration o Any previous or subsequent offer or sale of securities by the issuer or subsequent holder.
Safe Harbor Example:
o If the issuer sells to someone and that next day the buyer re-sells to a QIB, then the re-sell doesnt affect the
prior offerings exemption. No come to rest issues.
4(a)(7)(d)(4):
Eligible
Issuers and their subsidiaries are disqualified from the exemption.
Sellers o Therefore, the 4(a)(7) exemption is only available to sellers other than the issuer.
4(a)(7)(d)(1):
Eligible
Each purchaser must be an Accredited Investor as defined in Rule 501(a).
Purchasers o See page 51
4(a)(7)(d)(2):
No General
Seller is prohibited from offering or selling securities by any form of general solicitation or general advertising.
Solicitations o Pre-existing Relationship is required!
4(a)(7)(d)(3):
Seller to If the issuer is a Non-Reporting Company, then the seller shall provide the purchaser with the information listed
Provide Info in 4(a)(7)(d)(3)(A) (K).
o If the issuer is a Reporting Company, then this requirement does not apply.
Covered Securities sold pursuant to 4(a)(7) are covered securities under 18(a)(4) of the Securities Act.
Securities Therefore, State registration requirement are preempted for these resales.
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RECAPITALIZATIONS, REORGANIZATIONS, & ACQUISITIONS
In General
Up To This Point . . .
The securities transactions studied have involved orthodox financing transactions.
o Issuer seeks fresh capital by issuing securities.
Here . . .
Securities are also issued in Recapitalizations, Reorganizations, Acquisitions, and Distributions of Dividends.
o Recapitalizations
Exchange of one type of security for another (i.e., security holder converts debt for equity)
o Reorganizations
Exchange of securities for outstanding claims (i.e., Company in BK)
o Acquisitions
Company issues its securities to an acquired companys stockholders
o Distribution of Stock Dividends
Company declares a stock dividend
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2(a)(3): For Value Requirement
5:
The expressions sale and offer to sell are very important in the operation of 5.
2(a)(3):
In General Defines Sale and Offer to Sale
o Every attempt . . . to dispose of . . . a security . . . for value
For Value
Requires an exchange of a security for something that has value.
If a security were given away for free, then such transaction would not appear to be a sale because the security is not
being exchanged for value.
HOWEVER, a gift of securities is said to be exchanged for value when it is given as part of a plan that will lead
to the distribution of securities.
Stock
If an issuer offers stockholders a choice between (1) cash dividend or (2) stock dividend, then no sale has occurred.
Dividends
It would appear that issuer is disposing a security in exchange for value because the stockholder is receiving one
type of dividend in exchange for giving up the other type of dividend.
o However, when the issuer offers these two types of dividends separately no sale occurs.
Therefore, the SEC has said that when a simultaneous choice is given no sale occurs either.
Material
If the issuer makes a material change to the rights of existing securities, then a sale has occurred.
Change to i.e., a security is disposed in exchange for the material change in rights and therefore a sale.
Rights of
Existing Material Change
Securities Any change in rights that has economic consequences for the holders
o Amendment to AoI
Change in voting rights, dividend rights, common stock convertible into preferred stock, etc.
Note: If convertible stock is immediately convertible, then must register both stocks
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Non-Material Change
Material change in rights of existing security solely because the issuer reincorporated in a new State is NOT a
sale.
When an issuer disposes a security in exchange for another security, a 2(a)(3) sale occurs because a security
was disposed of in exchange for value.
If the conditions of 3(a)(9) are satisfied, such transaction may be exempt from 5.
In General
3(a)(9):
Any security exchanged by the issuer with its existing security holder exclusively where no commission or
other remuneration is paid or given directly or indirectly for soliciting such exchange.
By the Issuer The exchange transaction must involve the issuer of the securities
2. The transaction must be exclusively limited to the issuer and existing security holders
Exclusively Integration issue?
o If issuer is making an exchange with existing shareholders and also making an offering to a
third party, then apply 5 Factor Test to determine whether it is part of the same transaction.
No Payment If any person solicits existing shareholders for the exchange, then such person cannot be compensated.
for Soliciting Example
the Exchange o Issuer cannot hire an attorney to tell existing shareholders the tax benefits of an exchange.
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LIABILITY UNDER THE SECURITIES ACT
Scope
Scope of 11
Notes:
Any part of the registration statement, Does not apply to exempt offerings
o Requires a Registration Statement
When such part became effective,
Only applies to final prospectus, not
11(a) Contained an untrue statement of a material fact, or
preliminary prospectuses.
Omitted to state a material fact required to be stated therein o When Effective
or necessary to make the statements therein not misleading Ask:
o Is the registration statement false or
misleading on the effective date?
11 Plaintiffs
11(a):
Any person acquiring such security
Who Can Sue? o Therefore, any person who purchases a security pursuant to a defective registration statement has
standing to sue under 11
Unless, the purchaser has aware of the untruth or omission at the time of purchase.
11(a):
Any person acquiring such security
Tracing
o Therefore, plaintiff must trace the securities purchased to the registration statement is question.
Requirement Easy to prove when there is only 1 registration statement (Hertzberg v. Dignity Partners, Inc.)
Almost impossible to prove when securities are traded on an exchange
No Reliance
Plaintiff need not show reliance on the defective registration statement.
Requirement
No Causation
Plaintiff need not show that the defective registration statement caused an injury.
or Injury
The principal objective of 11 is deterrence, not just compensation
Requirement
Statute of
Limitations 13: SoL
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No action may be brought 1 year after the untruth or omission was discovered or should have been discovered
11 Defendants
11(a)(1) (5):
Lists possible defendants in a 11 action
11(a)(1):
Every person who signed the registration statement.
o Form S-1 requires certain signatures:
Registrant (i.e., Issuer), Officers, and a majority of the BoD (if no BoD, the equivalent)
11(a)(2):
Every person who was a director of the issuer at the time of filing.
o If no director, then persons performing similar functions.
Who Can Get
Sued? 11(a)(3):
Every person who, with his consent, is named in the registration statement as being or about to
become a director (or person performing similar function).
11(a)(4):
Experts preparing reports in connection with the registration statement are only liable with respect
to the portions prepared by them.
o Accountants, auditor, appraiser, etc.
11(a)(5):
Every underwriter with respect to such security.
11 Defenses
11(a):
Purchaser
If the defendant can prove that the purchaser had knowledge of the fraud at the time the securities were
Knew
acquired, then no liability.
Issuer = 11(b):
Strictly Liable The 11(b) defenses are not available to the issuer and therefore the issuer is strictly liable for the fraud.
Due Diligence
11(b)(3)(A): Non-Expert Portions 11(b)(3)(B), (C): Expert Portions
Defenses
If, after a reasonable investigation, the defendant (B) Expert Portion Relied on by Expert
had reasonable ground to believe and did believe If, after a reasonable investigation, the defendant
that the registration statement was free from fraud had reasonable ground to believe and did believe
at the time of effectiveness, then not liable. that the registration statement was free from fraud
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at the time of effectiveness, then not liable.
Notes:
Reasonable Investigation Requirement (C) Expert Portion Relied on by Non-Expert
If defendant knew about the fraud, then they did Non-expert defendants may rely on portions of
not believe the registration statement was free the registration statement prepared by experts
from fraud and therefore liable. without incurring liability so long as they did not
know about the fraud at the time the registration
statement became effective.
Application
BarChris Construction
Proper Defendant? Yes, as a signatory of the registration statement. 11(a)(1)
Due Diligence Defense? No, the 11(b) due diligence defense are not available to the issuer. 11(b)
Directors
Proper Defendant? Yes, every person who was a director at the time of filing. 11(a)(2)
Due Diligence Defense?
o Yes, Non-Expert Portions = Reasonable Investigation 11(b)(3)(A)
o Yes, Expert Portions = No Reasonable Investigation 11(b)(3)(C)
Auditors
Proper Defendant? Yes, experts preparing reports for the registration statement. 11(a)(4)
Due Diligence Defense?
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o Yes, Export Portions Prepared by the Expert = Reasonable Investigation. 11(b)(3)(C)
o Only liable for portions prepared under the authority of the expert. 11(a)(4)
Grant (Director)
Did an investigation of sorts Asked Russo and Kircher some questions
What is a
Not sufficient b/c Grant had access to info that could have allowed him to check on Russo/Kirchers answers
Reasonable o Must go beyond merely asking questions.
Investigation o Must look at the underlying documents
? How far must one go? Facts and circumstances!
o More was expected of Grant because he was a lawyer and spent a lot of time drafting the reg. stmt.
More is expected on general counsel and inside directors than outside directors.
Shelf Registration significantly reduces the time and expense necessary to prepare for public offerings
At the same time, shelf registration also significantly reduces the amount of time underwriters have to perform
In General their due diligence of the issuer.
o As a result, SEC introduced Rule 176 to set forth standards of a reasonable investigation.
However, Rule 176 clearly does not eliminate the reasonable investigation requirement
Shelf Registration
Underwriters due diligence defense
o Still must conduct a reasonable investigation
Rule Due to the time constraints, this essentially makes underwriters strictly liable because they have no
time to conduct an investigation when the issuer decides to sell.
As a result, underwriters have increased their prices.
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Damages
The amount paid for the security (not to exceed the offering price), and
o (2) The consideration received on resale if the security was sold before the suit, OR
Calculating
Damages o (3) The consideration received if the security was sold after suit, but before judgment, if that would
produce a lesser measure than that stated in (1)
Note:
Note the use of the term value, not market price
o This allows a party to argue that the market price at the time the suit was filed was improperly inflated
or deflated in order to claim a larger recovery or mitigate damages.
However, it is very rare for the value to be different from market price
McMahan & Co. v. Warehouse Entertainment
The 11(e) calculation of damages may be reduced to the extent the defendant can prove that the drop in
price was caused by something other than the fraud.
11(e):
Ackerman v. Oryx Communications Inc.
Negative
The defendant may prove that the drop in price was due to a variable other than fraud with statistical studies
Causation
of market performance during the relevant time period.
Defense o However, a broad analysis of the defendants company performance against the entire market is not
sufficient.
o The statistical study must evaluate the performance of the defendants company in relation to the stock
of companies possessing common characteristics (i.e., industry, product, assets, revenue, etc.)
11(f)(1): In General
In general, 11 defendants are subject to jointly and severally liable for damages.
o Therefore, any one defendant is subject to the burden of the entire measure of damages.
Joint & Several 11(f)(2)(A): Outside Directors
Liability
The liability of an outside director is determined by 21D(f)(2) of the Exchange Act.
o (B)(i): If outside director had knowledge of the fraud, then liable.
o (B)(ii): If outside director did not have knowledge of the fraud, then liable according to the percentage
that they were responsible for the fraud.
Indemnificatio
11(f)(1): Indemnification & Contribution
85
Two Approaches:
o Comparative Fault
Divides responsibility according to relative blameworthiness
n& o Per Capita
Contribution Divides responsibility equally
In General
12(a)(1):
12(a)(1): Any person who offers or sells a security in violation of 5 . . .
Rule Shall be liable to the person purchasing (if sale 12(a)(1) does not apply!) such security from him . . .
For the consideration paid for such security.
Offers or Sells
Pinter v. Dahl says that within the definition of 12(a)(1), a person is deemed to make an offer or sale, if:
o The title owner of the securities passes title to the purchaser, or
o Makes a solicitation to buy . . . for value
To satisfy the for value requirement, the solicitation to buy must be
To advance the solicitors own financial interests, or
To advance the financial interests of the securities owner.
In Violation of 5
Requirements Must be a security subject to the registration requirement of 5
for Liability o i.e., non-exempt security, no transaction exemption available
The Remedy
Rescission:
If purchaser still owns the security, then may recover consideration paid in the original transaction.
If purchaser has disposed of the security, then may recover the difference between the price paid and the
86
amount received in the subsequent sale.
12(a)(1):
Rule Any person who . . . offers or sells a security in violation of 5 shall be liable to the person purchasing
securities from him.
12(a)(1): Imposes liability on the owner who passed title to the buyer for value.
Dahl was not the owner of the securities
o Therefore, Dahl is only liable if 12(a)(1) extends to persons other than the person passing title.
Takeaway
Within the definition of 12(a)(1), a person is deemed to make an offer or sale, if:
The title owner of the securities passes title to the purchaser, or
Makes a solicitation to buy . . . for value
o Value =
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To advance your own financial interest, or
To advance the financial interests of the securities owner.
In General
12(a)(2):
Any person who offers or sales a security
12(a)(2):
By means of a materially false or misleading prospectus or oral communication
Rule Shall be liable to the person purchasing (if a sale occurs, 12(a)(2) does not apply!) from him
For the consideration paid for such security
Offers or Sales
Pinter v. Dahl --
o Person from whom title passes, or
o Person who solicits to serve
His own financial interest, or
Requirements Sellers financial interest
for Liability
Prospectus or Oral Communication
Gustafson
o 12(a)(2) is limited to Public Offerings by the issuer or controlling shareholder
o Prospectus = 10(b) Prospectus
i.e., Rule 433 Free Writing, Rule 430 Preliminary, or Rule 431 Summary
Rescission
If purchaser still owns the security, then may recover consideration paid in the original transaction.
The Remedy
If purchaser has disposed on the security, then may recover the difference between the price paid and the
amount received in the subsequent sale.
Rule 159A
Rule 159A:
If the issuers communications are used to solicit, the issuer may be liable because they made an offer within
the meaning on Pinter as a person who solicits to serve his own interest.
o Must be in the primary offering of securities of the issuer.
Debate over whether this includes resales. Probably includes resales if resale occurs before the
security has come to rest because the resale may still be considered part of the issuers primary
88
offering.
2(a)(10):
Defines Prospectus
10:
Rules
Sets forth the information required in a prospectus
12(a)(2):
Imposes liability based on misstatements or omissions in a prospectus
10:
There is no dispute that the contract in this case was not required to contain the information in a registration
statement because it was a private offering and therefore a registration statement did not exist.
o Only public offerings require a registration statement
Thus, a 10 prospectus is limited to the documents related to a public offering
Prospectus means the same thing in 12 as it does in 10.
2(a)(10):
The term prospectus means any prospectus, notice, circular, advertisement, letter, or communication, written or
Analysis
by radio or television, which offers any security for sale of confirms the sale of any security.
o Alloyd focuses on the word communication.
Any written communication that offers or security for sale is a prospectus and that this definition
should be inserted into 12.
o SCOTUS says that the word communication is but one word in a list.
From the terms prospectus, notice, circular, advertisement, or letter, it is apparent that the list refers to
documents of wide dissemination.
Including the term communication in that list suggests that it too refers to pubic
communication
Conclusio
The word prospectus refers to documents that describes a public offering
n
89
The contract of sale, and its recitations, were not held out to the public and therefore not a prospectus.
Note:
Gustafson leaves open an important question:
o What is a public offering for purposes of 12(a)(2)?
See Hyer v. Malouf
12(a)(2):
Provides a cause of action to a purchaser of a security against one who offers or sells a security by means of a
prospectus or oral communication that includes an untrue statement or omission of material fact.
Gustafson v. Alloyd
Held that the phrase by means of a prospectus limits the reach of 12(a)(2) to public offerings.
o Specifically, the court held that the term prospectus, as found in 10 and 12 is confined to a
Rule
document that must include the information contained in a registration statement.
Ralston Purina
Whether an offering is public or private turns on whether the particular class of persons affected needs protection
of the Act.
o An offering to those who can fend for themselves is not a public offering.
Sophistication and Access to Information
The public offering analysis is fact intensive and requires inquiry into each investor to determine whether they are
sophisticated and have access to information.
Held
Therefore, further discovery is necessary to determine whether each of these offerees has access to the type of
information in a registration statement.
90
17(a): SEC Enforcement against Fraudulent Offers or Sales
In General
17(a)(1):
Makes it unlawful to employ any device, scheme, or artifice to defraud.
o Scienter (intentional misconduct) required
91
INQUIRIES INTO THE MATERIALITY OF INFORMATION
In General
Securities Laws recognize that is it not practicable for Issuers to disclose everything to potential investors.
However, the Antifraud Rules ( 11, 12, 17) prohibit Issuers from withholding Material information.
Scope o Example: 12(a)(2) prospectus which includes an untrue statement of material fact . . .
Therefore, liability under the Antifraud Rules turns on whether information is material.
If info is deemed material, silence does not violate the Antifraud Rules unless there is a duty to disclose.
Example of an Affirmative Duty to Disclose:
o Regulation S-K Item 103 Describe any material pending legal proceedings.
Silence
Duty to Disclose? Disclosure Requirements Two Questions:
1. Is a fact material?
2. Is there a duty to disclose the fact?
Materiality Determination:
There are 2 points in time when a person must decide whether something is material
1. Time of Disclosure, and
2. Litigation
Time of Disclosure
Hindsight Bias It is often very difficult to determine whether something is material in the heat of the moment
Litigation
Court has hindsight.
o Hindsight Bias Easier to determine something is material after the market has already reacted.
Error on the side of caution and disclose unless there is an important business reason not to
What is Materiality?
TSC Industries, Inc. v. Northway
Objective Standard
In General:
Whether an omitted fact is material is determined based on an objective standard.
o Therefore, the relevant inquiry is whether a reasonable investor would consider the omitted fact
important in light of the total mix of information available.
Face-to-Face Omissions:
As a result, a face-to-face omission must not be deemed material based on the subjective value a single
person assigns to a piece of information.
92
o Rather, the omission must the judged against an objective standard that looks to whether a
reasonable investor would consider the omitted fact important in light of the total mix of
information available.
Important Important = Significantly altered the total mix of information made available.
Total Mix An omitted fact is material if there is a substantial likelihood that a reasonable shareholder would consider it
important in deciding how to [vote, buy, sell, etc.]
o Important = If the omission would significantly alter the total mix of information available.
If a statement is made that a reasonable investor, under the circumstances, would dismiss, then the statement is
immaterial as mere puffery.
Puffery o Example:
In Eisenstadt, corporation stated negotiations were going smoothly despite underlying problems.
Court held statement was mere puffery and therefore immaterial because a reasonable investor,
under these circumstances, would expect the corporation to make this statement.
Probability + Magnitude
Rule:
Test Under the Probability and Magnitude Test, materiality will depend upon a balancing of both the
indicated probability that the event will occur and the anticipated magnitude of the event.
Material?
High Probability + High Magnitude = Clearly Material
Low Probability + Low Magnitude = Clearly Immaterial
If one is high and the other is low = Unclear
o Two Options:
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Error on the side of disclosure (Hindsight Bias), or
Silence
To be actionable, a statement must be misleading and silence is not misleading
unless there is a duty to disclose.
Omnicare Prospectus:
Facts
We believe . . . [our contracts] . . . are in compliance with applicable federal and state laws.
Anti-Fraud Rules:
Rule . . . Contained an untrue statement of material fact or omitted to state a material fact required to be
stated therein or necessary to make the statements therein not misleading . . .
Issue #1: To be liable for a statement of opinion the plaintiff must show:
Liability for an Untrue The statement was subjectively false (i.e., person making the statement didnt believe it), and
Statement of Opinion The statement was objectively false (i.e., the statement turned out to be indeed false).
Issue #2:
To be liable for an omission relating to an opinion, the statement must be (1) misleading & (2) material
Liability for an (1) If the opinion is not grounded in any reasonable basis, then it is misleading.
Omission Relating to an (2) To be material, the omission, if disclosed, must change the total mix of information.
Opinion
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Forward-Looking Information Safe Harbors
(A) Projections of revenues, income earnings per share, capital expenditures, dividends, etc.
Forward-Looking (B) Plans and objectives for future operations
Statement (C) Future economic performance
Defined (D) Any statement of assumptions underlying any statement made in (A)-(C)
(E) Reports made by third parties (retained by issuer) making a statement of behalf of the issuer
(F) Projections or estimates of any other items as specified by rule or regulation of the SEC
27A(b)(1) This section does not apply to any forward-looking statements from an issuer
(A) If the issuer has been a bad actor during the past 3 years
(B) If the issuer makes the statement in connection w/ offering of securities by a blank check company
(C) If the issuer issues penny stock
When it Does (D) If the issuer makes the statement in connection with a rollup transaction
NOT Apply (E) If the issuer makes the statement in connection with a going private transaction
Safe Harbor
27A(c)(1) In General
Except as provided in subsection (b), in any private action arising under this Act, a person referred to in
subsection (a) shall not be liable with respect to any forward-looking statement to the extent that . . .
(c)(1)(A) -- Written Forward-Looking Statements
(i) The forward-looking statement is identified as such (need not be expressly identified, an opinion is
enough. Asher v. Baxter) AND accompanied by (efficient market. Id.) meaningful cautionary
statements, OR
(ii) Immaterial, OR
(c)(1)(B)(i)-(ii) The plaintiff fails to prove that the forward-looking statement was made with actual
knowledge that it was false or misleading.
(c)(2) Oral Forward-Looking Statements
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(A)(i)-(ii) The forward-looking statement is accompanied by a cautionary statement that identifies the
forward-looking information as such AND states that actual result may differ
(B) If the cautionary statement is not accompanied with the forward-looking statement, then there must
be a readily available written document (i.e., Form 10-K).
Half-Truths An affirmative duty to disclose arises when omitted information would render a statement misleading.
Circuit Split
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FRAUD IN CONNECTION WITH THE PURCHASE OR SALE OF A SECURITY
Rule 10b-5
Ask:
Was an untrue statement made?
o Was it material?
Fraud Was there an omission?
o Was it material?
o Was there a duty to disclose?
The Purchase
Plaintiff:
or Sale of Any Must be a purchaser or seller
Security
Defendant:
Need not be a purchaser or seller
o No direct connection to plaintiff required
HYPO:
Smith is about to sell his Acme Corp stock
o Market Price = $45/share
Before Smith sells, Acme Corp announces a huge new order that will significantly increase revenue
o This announcement is a LIE!
As a result of the announcement, Smith decides not to sell
o Market Price = $30/share
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Smith has no cause of action under Rule 10b-5
o Not a purchaser or seller
Must list every statement that plaintiff is alleging is The complaint shall state with particular facts
a violation, giving rise to a strong inference that the defendant
List why its a violation, (i.e., why its misleading?), acted with the required state of mind.
If allegation is not based on actual facts, then the
complaint must state with particularly all facts on Tellabs, Inc. v. Makor Strong Inference
Pleading which the belief is formed. If a reasonable person would deem the inference of
Scienter scienter cogent and at least as compelling as any
opposing inference one could draw from the facts
alleged.
o Example
Based on the facts alleged, could a
reasonable person infer that the defendant
acted without actual knowledge or
recklessness? If so, no scienter.
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Transaction Causation (Reliance)
Actual Reliance:
When an investor is induced to purchase or sale a security in actual reliance on a fraudulent
Actual Reliance
statement, then transaction causation has been established.
o But for the fraud, a transaction would not have occurred.
Basic v. Levinson
Fraud on the Market
To establish a presumption of fraud on the market, the plaintiff must show:
o (1) The alleged fraud is publicly known/distributed,
o (2) The alleged fraud is material, and
o (3) The security is traded in an efficient market.
The defendant may rebut the presumption of fraud on the market by showing:
o The market knew that the statements were false (and therefore adjusted), or
o That the plaintiff had knowledge of the fraud (and therefore did not rely on the market)
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Loss Causation
Loss Causation:
21D(b)(4) of the Exchange Act burdens the plaintiff with establishing a causal connection between the fraud
and the loss or damages.
o In other words, did the fraud cause the loss or was it something else?
In General
21D(b)(4) Exchange Act:
In any private action arising under this Act, the plaintiff shall have the burden of proving that the act or
omission of the defendant alleged to violate this Act caused the loss for which the plaintiff seeks to recover.
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Who is Liable?
Primary Liability
Rule 10b-5; The Maker of a Statement = Primary Liability
Under Rule 10b-5 it is unlawful for any person to MAKE an untrue statement of material fact in connection
with the purchase or sale of any security.
o Therefore, to be liable the defendant must have made the material misstatement.
Janus
Capital For purposes of Rule 10b-5, the maker of a statement is the person or entity with ultimate authority over the
statement, including its content and whether and how to communicate it.
o Therefore, a statement is only made by the person to whom it is attributed
One who prepares or publishes a statement on behalf of another is NOT its maker.
Secondary Liability
Who can bring an action against an Aider & Abettor?
No private right of action for aiding and abetting a violation of 10b-5. Central Bank
20(e) of the Exchange Act authorizes the SEC to bring an action against an aider and abettor
18 U.S.C. 2 imposes criminal liability for knowingly aiding and abetting someone elses crime.
SEC v. Apuzzo
In order for an aider and abettor to be liable, the SEC must bring an action pursuant to 20(e) of the Exchange
Aiding & Act and prove:
Abetting o The existence of a securities law violation by the primary party,
o That the aider and abettor had knowledge or acted recklessly with respect to the primary violation, and
o That the aider and abettor provided substantial assistance in the achievement of the primary violation.
Substantial Assistance requires proof that the aider and abettor was involved in the fraud and
sought by his action to make it succeed.
When the aider and abettor has a high degree of actual knowledge, it lessens the burden the
SEC has in proving substantial assistance.
A purely administrative/ministerial act is probably not substantial assistance.
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