SEC REG: Prof. Horwich, Spring 2011

Securities law – all about disclosure First: cover what is a security? Most of class: disclosure

o What is disclosure?o When must it be provided?o What meets the required standard / is correct?

If done incorrectly:o Civil liabilityo SEC enforcemento Etc.

Securities Law – overview Statute and rule based Until 2002, fundamentally securities law about disclosure Since 2002, SOx passed - in response to scandals at Enron, Worldcom, etc.

o Brought securities law into corporate governance for first timeo Dodd-Frank has added further: federal law into corporate governance

Deals with voting, proxy statements, etc. IPO – cornerstone of what securities act is about Any sale of securities – must either be registered or exempt (essence of § 5) Under what circumstances can securities be sold without registration

o Usually about institutional investors Hedge funds PE funds Pension plans Insurers

I [primary] Public [IPO] X [secondary]o Must comply with §5

Materiality:o Defined by SCOTUS – for when “disclosure of material info” is requiredo Varies depends on nature of info; and may have party protections from liability for certain

situations Reporting regime

o 10-K, 10-Q – annually, quarterly reporting requiredo Specific events that trigger filing: within 4 days after event: 8-Ko S-K: SEC picks and chooses from items for various disclosure requirements for filings

S-1: for IPO filings S-3: for already public companies 10-K, 10-Q, 8-K, etc

Securities Acts Securities Act of 1933 – covers basics

o Describes what must be given in a public offer – mandatory disclosures / requirementso §11 – very limited right of action for false or misleading info in registration statement

Securities Exchange Act of 1934 – deals with markets for trading mostlyo Periodic reporting regime: not real-time, but through forms o Deals with public companieso §10b-5

Acts have 2 different numbering schemes – can tell where rule is fromo 3 digits: Securities Act of 1933o #letter-#: Securities Exchange Act of 1934

Now: SEC has integrated disclosure o Can incorporate elements needed from S-K into S-3 registration doc

SEC 5 members, appointed by the Pres No more than 3 from any one party 1 chairman Formerly had to be unanimous, but no longer – often division of 3-2

o Courts have occasionally invalidated SEC rules SEC – generally thought of as good agency until Madoff debacle

o Has tarnished reputation very badly, with Congress reluctant to give them $$$ for enforcement under Dodd-Frank (100+ new complicated rules and additional responsibilities)

o Tension over budgetary process (ongoing political issue) 5 divisions

o Division of corporation finance – deals with most issues from this classo Other divisions:

Trading and markets Investment management (mutual funds, investment advisors, etc) Civil enforcement (SEC doesn’t prosecute crimes) Risk, strategy and financial innovation (new division)

Regional offices – deal primarily with enforcement matters Criticism of SEC – from flaws in enforcement and

SRO – self-regulatory organization NYSE, NASDAQ, etc. – registered exchanges Have obligation to enforce securities law SEC disciplines exchanges that fail to enforce the law

FINRA – Financial Industry Regulatory Authority Enforcement arm – to fulfill responsibility under securities law

CFTC – Commodities Future Trading Commission Look a lot like securities now Congress has allocated lots of these to SEC and CFTC

o Both now in effort to adopt regulations under Dodd-Frank for responsibility for enforcement

What is a security? §2(a)(1) of 1933 Act: §3a-10 of 1934 Act: Both begin by saying “unless the context otherwise requires”

***Class #2 – 1/4/11

SEC v. W.J. Howey Co. (1946, pg. 21): Supreme Court grappled with definition of an “investment contract” where SEC asserted that marketing of land contracts to a citrus grove was an attempt to sell securities without registering, in violation of Section 5.

Whether or not this is an investment contract

1. Invests money2. Common enterprise – pooling of funds

Opportunity to “contribute money and share in profits of large citrus fruit enterprise managed and partly owned by Howey”

3. Expect profits4. Solely based on efforts of others

Investment contract (one of statutory criteria from both acts) No consumption in Howey

§5(c) – bottom of p9 – “unlawful for any person to sell [or offer] any security…unless registration has been filed” Violation even if no one bought, only if offered is violation

CASE: Marine Bank v. Weaver, 1982, p24 – bank certificate of deposit to secure a bank loan to Columbus Packing; in return, Weavers share in Columbus’ net profits

Columbus goes bankrupt – court said Weavers didn’t purchase a securityo SCOTUS said securities law covered those instruments “ordinarily and commonly considered to be

security” These are not those commonly thought covered by securities law Often private offerings are not considered securities – doesn’t mean it’s not covered –

court more focusing on the one-on-one nature of this transaction Securities are usually tradable, and these certainly are NOT No disclosure document

o Perhaps main motivation was for consumption Veto right is not characteristic of security

Do we need to extend securities law to cover this, or is this already regulatory ways to cover this?o Factors in Marine Bank – demonstrate variety of factors to tick off

Federal Law vs. State Law Tunnel vision in this course because only looking at federal law, even though state law may apply in many

of these transaction One distinction – to extent money is at risk doesn’t seem to be a factor federal courts take into account in

interpreting federal laws o Versus state laws, which state courts may take into account when interpreting whether security

or not at state level

CASE: US Housing Foundation, Inc. v. Forman, 1975, p28 Issue that use of the word “stock” literally automatically qualifies the element as a stock

o SCOTUS held use of the word not dispositive Facts of “stock”

o Not used in profit-making effort, but instead intended for consumptiono Issued by Riverbay, a non-profit cooperative housing corporation – under UHFo Purchased by tenants of Co-op City – can only acquire if tenant, and if tenant no choice to acquire

stock (it’s required) Stock amount – 18 shares per room, at price of $25 per share Ownership of shares entitled owner to tenancy (vs in Howey, ownership of stock didn’t

entitle owner to right to occupy land) Plaintiffs complaining about anti-fraud

o Alleged deception – likely claim under §10(b)-5, p384 – “unlawful to make any untruthful statement in connection with the purchase or sale of any security” (applies to all sections)

If no security involved, then no claim Issue: is this stock in question actually a security? If not, then doesn’t apply under §10(b) - 5

o Stock – no ordinary characteristics traditionally associated with stock: (p31 top) Most common feature – no “dividends contingent upon an apportionment of profits” Not negotiable Cannot be pledged or hypothecated – non-transferrable No voting rights in proportion to the number of shares owned Cannot appreciate in value

o Investment Contract – did put money in with common enterprise, but no motivation to get profits

Different from Howey – intended for consumption, not for profits “when a purchaser is motivated by a desire to use or consume the item

purchased – “to occupy the land or to develop it themselves” – the securities law doesn’t apply”

o One sticky point: rent reduction possible when net income from commercial facilities applied Kind-of like profit, but didn’t weigh heavily in court’s view because purpose was to live in

space and not to generate profit

CASE: SEC v. Edwards, 2004, p33 – rare 9-0 securities-related decision, prof doesn’t quite know why SCOTUS took it

Issue: If fixed return, then can it be an investment contract?o Court held doesn’t matter, still a profit, whether fixed or variable return

Common Enterprise Easy to understand under Howey case But in general, raises more questions for lower courts to deal with Common interest – what is this?

o Lower courts have generated 3 different tests of commonality Will depend on which Appellate court you get for what the test will be

***3 Tests for Common Interest:1. Broad, vertical commonality

Whether generates profits is dependent on promoter; but promoter’s success and success of investment is unrelated

2. Strict, vertical commonality Whether generates profits is dependent on promoter; but here promoter’s compensation

is variable with success of investment enterprise3. Horizontal commonality

Pool assets of all parties, with multiple investors, and then share profits based on results of pooled investments in totality

Still dependent on promoter Why?

o Because securities law deals with more than just public transactions – applies to private too Can’t single out one factor from Weaver as dispositive

o Can have vertical commonality in almost all situationso One other factor – Howey discussed solely on efforts of others; court later watered down this 4th

standard – changed to “primarily” profits driven by efforts of others

Problem 2-1, p33 Jaguar is going to develop a new car; prototype but no production until enough people willing to buy

o Request deposit, with car delivery in 3 yearso Anticipated when cars are delivered, will be worth 3 times price of down payment

Issue: are those who put down down-payment, are they buying a security?

o What will Jaguar do with money? Pool assets to build cars Promoter is given money People will have something valuable to re-sell

o Perhaps common enterprise?o Is this an investment contract?

BUT: Is there any real profit for Jaguar?

o Potentially like broad vertical commonality Is this for consumption or profit?

o After-market – is where profit will come, not created by Jaguar Take-away: what defines a security isn’t so clear – profit-making schemes dependent in large measure by

promoter, then securities laws may supply (even if not conventional security)o Driven by nature of arrangement

Class #3: 1.5.11

Problem 2-2, p40 – property sold $90M in debt securities to 20 investors; needs an additional $10M – entered agreement with Handsome Trust – investing $10M for right to % of net profits of properties

Issue: is this an investment contract? 4 factors: on balance, looks like investment contract

o investing $o in common enterprise?

Vertical works Promoter, MPI, is using assets from first 20 investors

Horizontal? All $ is necessary to make deal, so perhaps necessary

o Profits – yeso Handsome dependent on efforts of promoter

Security? Looks like oneo NOTE: Promoters like to have investors “do something” that addresses 4th criteria, to say success

of deal required efforts to person who fronted money to financial outcome of enterprise, and thus not a security

Problem 2-5, p45 – Japanese fast food restaurants – investment of $35K plus percentage of gross – then train franchisee, provide equipment, ads, supervise restaurants

Issue: is this investment contract?o NO

Investing $, common enterprise, for profits Violates 4th factor: need both efforts – franchisor can’t get $$$ without work by franchisee

What if franchisee didn’t have to be on-site managers…does this change situation?o Can become continuum as facts change and move away from franchisee involvemento NOTE: what agreement provides versus actuality changes whether or not looks like investment

contract

Sale of Business Doctrine – if you transferred entire business, even if through stock, then wouldn’t function as transferring a security

SCOTUS disagreed in Landreth case (1985, p45) – if it has what we qualify as stock from Forman case, then it’s stock!

o Howey test was not relevant

Doesn’t have to satisfy investment contract test if it’s stock Fact that transaction was private doesn’t tell whether it’s a security in the first place

Problem 2-6, p48 – Sam buying Hillary’s real estate brokerage firm Vistas; ways to structure the transaction – Hillary wants him to purchase all her stock, but Sam wants to assume all assets and liabilities

Issue: how does transaction structure affect whether this involves security or not?

Problem 2-7, p48 – have to buy shares of stock in CART to race car; transfer of shares requires approval of Board, with failure to race may result in stock revocation; S/H are entitled to dividends, although rare

Issue: is this a security?o Under Forman, not security just because called it “stock” – title isn’t despositiveo Also under Forman, stock’s main purpose was consumption; like here, stock’s main purpose was

to allow opportunity to race Conclusion: NOT securities

o Gives dividends, voting rightso BUT Not transferrable without approval

2(a)(1) (1933) or 3a-10 (1934) – Defining Security ’33 Act: “Note” – is security a note?

o §2(a)(1) – blanket statement, “any note”o §3(a)(3) – exempted securities (p5)

Entire ’33 Act doesn’t apply to “any of following securities” “Maturity of which is not to exceed 9 months” – short-term notes are NOT

covered ’33 Act §17, p21 – unlawful to sell any security where misrepresentation is made

o But doesn’t apply to short-term notes?o But no! says exemptions to §3 do NOT apply

’34 Act: §3a-10, p282: “any note…but shall not include any short term-note, 9 months or less”o Not an exemption, just excluded all together

Both intended to mean commercial paper of high qualityo Notes sold by business entities to finance their ongoing operationso Courts rely on introductory language in statute…”unless context otherwise requires”

Have free reign about whether or not to apply that language

10b-5 – who can be sued?

CASE: Reves v. E&Y, 1990, p66 Issue: are the demand notes issued by the Farmer’s Coop “securities?”

o Court held YES Reasoning:

o Family resemblance test – longer term note (more than 9 months) presumed to be covered by statute, unless you can show it resembles family of notes that aren’t covered

List (p69) – consumer finance note, mortgage note, personal loan from bank note, etc. – not covered

o 4 factors:1. Assess motivations of reasonable seller and buyer2. Plan of distribution– whether there’s a market for the notes3. Public’s reasonable perceptions4. Risk-reducing factor

Justice Marshall: said it could be longer than 9 months, thus not necessarily long term

Justice Stevens joined in judgment – held only intended for commercial paper, not investment securities

Problem 2-11 – broker addicted to gambling; to pay off debts went to clients for loans, and gave promissory notes with 8% interest, payable on demand

Issue: are these securities?o Motivations?o No broad distribution / marketing of noteso Does sophistication make a difference?

Court held that b/c investors weren’t sophisticated, court didn’t put much weight on this factor

o Risk-reducing factor?

No Action letter: lawyer uncertain what rule would be under securities law Can write letter to staff giving facts and ask if use exactly what is said, then SEC will not take action Letters are public to function almost as “precedent” – but not binding, and essentially only Yes or No

Problem 2-12 – based on SEC no-action letter; to finance homebuilding, borrows money specific to property – gives note with mature date 9 months from closing of loan with 1 renewal option; secured by deed of trust on property; lenders not partaking in profits

Issue: is this a security?o Motivation? For short-term loanso Broad distribution? Problem doesn’t suggest so – 25 sold per parcelo Etc.o SEC staff refused to give no-action response

Perhaps too broad? Is 25 too many? We don’t know

Derivatives Regulation of derivatives – big part of Dodd-Frank Act Derivative – instrument or interest that derives its value from something else

o Ex: stock optiono Ex: credit default swap (like those AIG sold)

Agreements on part of AIG that said debt of particular company (e.g., bonds of Lehman), if defaulted, then AIG would pay holder of swap a certain amount of $

Value of swap would change based on credit-worthiness of underlying bond Value of swaps went up when Lehman more risky

o Markets were unregulated – believed by those behind Dodd-Frank that these were behind financial crisis; therefore Dodd-Frank reversed switch and now requires that derivatives be regulated, but goal is to make them a standard fungible instrument

Formerly were unique – now want them to be more like a stock, which is the same for all Ex: no one knew how many swaps were out there for Lehman – because unregulated, and

didn’t require ownership of underlying stock $63T in existence at time of Lehman crash – mostly netted out, but didn’t know it!

o Law not yet adopted because rules required to be created by SEC and FCTC

Class #4 – 1/10/11

Secondary trading – take place after company issues shares If publicly traded – on registered exchange as exchange-traded or OTC

o Registered under the exchange act, and to regulate broker-dealers who trade on the exchange Ex: NYSE, Nasdaq

Formerly membership-owned exchanges Now, for-profit stock corporations, almost all publicly owned

Trading – formerly done on the flooro Now, mostly electronic

OTC – one broker puts in bid price, and seller asks a specific price System puts the two sides together

Derivatives – trading in indices based on large group of stocks (like S&P 500), or trading in futures or options Commodity markets relating to securities

Foreign private issuers – have disclosure requirements, which are more lenient than domestic companies, in order to be listed on exchange

Still have to comply with same fundamental disclosure needs Regulation S – mechanism by which US and foreign companies can raise capital overseas without

registering in US

Efficient Capital Markets Hypothesis Weak form

o Semi-strong form

o All public information is reflected in the trading price Strong form

o All information, public or private, is reflected in the trading price

If you can’t beat the market, why pay for research? Regulation FD – fair disclosure – prohibits senior management from disclosing info on a selective basis

o Has to be given to public simultaneously

Issue with EMH: How does momentum factor in to EMH? Emotional factors aren’t built in, but still can play into stock price EMH is a hypothesis, but it’s the only SEC uses in imposing disclosure requirements Debate in academia about whether we should even have mandatory regime of disclosure

Why disclose? Managers want to minimize risk – have incentive to disclose more about company because investors may

be willing to pay more for less risko Managers may also own securities in their company, and therefore want benefits of stock priceo If bad news, then 2 options:

Don’t give out the bad news – but then increases risk Absorb cost anyway and relay all info

Company absorbs costs of disclosureo Use good rep i-bankers to bring info to marketo May voluntarily list on exchange

Counterarguments for disclosure (per Easterbrook and Vischal), p253:1. May conceal bad news, lie, etc. 2. Also, dredging up information is wasteful – mandatory disclosure is standardized and simplifies /

eliminates waste; but investors always want more – counter is that who says Congress or SEC are best to say what info is needed, and when is enough

Disclosure can be heavy, expensive burden, particularly after SOx

o Thus, many companies re-privatized! TO do so, must make additional, quite intrusive disclosures before doing so

Class #5: 1.11.11How to Raise Capital & Comply with Law

Section 5 – requirements re: registration §12(a)(1) – allows for nullification of sale, can get $ back if fail to register per Sec. Act

o Very little burden on plaintiff – only have to say no registration statement on file when purchased security; defendant has to prove exception

Historical Background / Framework Issuer, §2(a)(4) – entity that issues securities Underwriter, §2(a)(11) – buy securities from issuer to sell to buyers (institutional investors, retailers, etc)

o Aka: Broker-dealero Structural process that fits into Sec. Acto Role: gets involved in sale of securities, provides advice

Ex: will the market buy them, what needs to be done to make the securities attractive to the market, etc.

Primary or Secondary offeringo Primary – initial registered offering from company

Common stock, preferred stock or bondso Secondary – secondary marketo Can have both – primary, with sales revenue to company, and secondary, with sales revenue to

those cashing out

Underwriting 2 types:

o Firm commitment Eve of offering: underwriter buys securities from company, and then undertakes risk of

selling to public (capital at risk)o Best efforts

Takes fee in exchange for “best efforts” to sell securities to market 3 types:

o Straighto Mini-maxio All or none

Don’t have to have an underwritero Can have an auction instead; ex: Google

Broker Structure Managing Underwriters – lead underwriters – get larger commission, more shares, determine who else to

include Syndicate – other key underwriters to support the offering Selling Group – take some of shares and resell to public via retail – for broader market availability

§2(a)(3) – defines terms “offer” and “sell” – p2 Negotiations between issuer and underwriter – terms shall not include preliminary negotiations or those

in privity (excluded from the definition)

Over-allotment – limited by industry to 15% of offering Ex: 90M by company, 10M internal – 100M total

o But if company kept 20M shares, you may want to know if those will end up on market Leads to lock-up agreements

Underwriter Impact Reputation – has strong impact on offering and public view of risk in purchasing securities

o Also concerned about its own reputation – want good company to underwrite, makes underwriters more selective

Liability o §11 – liability for anyone that’s part of the offering if there’s “fraud or misleading” information in

disclosure – statute lays out who, but almost everyone can be sued

Integrated Disclosure Statement Allows companies to register using past filings, such as 10-K, 10-Q, 8-K

o How do underwriters protect themselves?

Underwriting Industry: very concentrated Ex: P124, Tombstone ad

o Top: managing underwriters Underwriting agreement – executed with the issuer

o Middle: syndicate Selected dealer agreement – establishes obligations of each member

o Bottom: major bracket – more retail firms Agreement among underwriters – additional broker-dealers to assist the syndicate

o Look at how things have changed in 6 years! Lehman = gone JP Morgan = now JP Morgan Chase Goldman, Morgan Stanley = now bank holding companies

Cyclical nature of business

Timeframe Pre-filing period Filing time Waiting period – underwriters talking to clients: gauge interest, but can’t actually “offer” sale – obtain

commitmento Select price range for IPO; ex: $20 - $23

Effective upon saleo Ex: if strong interest, then maybe IPO price will go up…$28o Eventually market dictates price – limited ability in underwriting group to participate in market

§5: core of 33 Act If ever going to sell security, must register transaction with SEC or have exemption

o Registered offering = registers transaction Statute works from “bottom-up” §5(c) – cannot offer in any way to buy or sell until registration statement filed with SEC

o Policy: why? No offers until there’s disclosure out there! Can’t condition or influence market for securities until disclosure is on file and available to

anyone who wants it

§5(a) – unless registration statement in effect, then…o Can sell now that disclosure is FINAL

§5(b) – purpose for having a prospectuso Prospectus defined, §2(a)(10) – prospectus, notice, circular, advertisement, letter, or

communication, written or by radio or television, which offers any security for sale or confirms the sale of any security

Rule 405 – deals with VM and other electronic communications Any writing about sale – must comply with SEC requirements re: what contents must be

o §5(b)(2) – deals with prospectus that must be delivered with actual sale

§7 – provides registration statement shall contain whatever SEC says it shall contain Used to be listed in detail but now is just in forms – S-1 (p192, p195), S-3, S-4 (used to combine

registration statement and proxy statement), etco Lists each item that must be included in registration statement, and prospectus is 98% of what

must be included

Lawyers & iBankers – roles to dig into company to find everything necessary for SEC registration statement Rule 408 – in addition to info required to be included in registration statement, must also add information

to demonstrate the required statements are not misleadingo Requires very intensive factual investigation

Registration statement typically requires 3 years of audited financial statements Give opinion at end of day that statement is factually issued In-house counsel may not be of help if haven’t dealt with disclosure Lawyers draft disclosure statement, and have sr. leadership review it / gather whatever additional

information neededo Need to conduct due diligence to avoid liability and sanction under §11

Likely not lawyers liable, but client will be! Important lesson: verify everything

SEC in action If SEC suspects anything, they go out and review!

o Criminal offense to represent SEC has approved issuance of securities or contents of documents o Provide comment letter

§8 – taking effect of registration statementso §8(a) - once registration filed, then becomes effective 20 days after filing dateo SEC typically takes longer than 20 days for review; if SEC believes something deficient – can bring

stop order proceeding (under §8(b)) – to refuse to allow registration statement becomes effective

o §8(d) – can issue stop suspension order after effective date also to require statement be amended

Note: Didn’t have rules for pre-filing period really until 2005

Amendments Rule 473 – can delay an amendment to prevent 20 days effectiveness period and await SEC comments

o Note 24, p153 – put something on front of registration statement to say “this will be deemed amended from time to time until…” – this is a delay amendment

Rule 461 – can request acceleration from SEC to move up from 20 days of last amendmento 461(b)(2) – SEC wants “satisfactory assurance” that correct material is publico Note: 48 hours desired to have prospectus in hand for prospective buyers, before registration

statement is effective

Preliminary prospectus – has red legend on it saying it’s prelim, subject to change (called “red herring”)o Changes every time registration is amended

Notes Very expensive process, lawyers and ibankers to pay

Class #6: 1.12.11

Registration Statement Review: §8 – provision don’t apply here; principal exemptions under §4

o Otherwise, §5 always applies Exemption ex: §4(2) – transactions of issue not involving any public offering

o “Public offering” not defined in statute – so courts have told us what it is Reminder: §5(c) – prohibits any offers or sales until registration statement filed §2(a)(3) – brief overview of offer to buy or offer to sell, with carve-out for issuer and those in

underwriting group

§5(c) limitations Prohibition kicked off by company going “in registration” What defines this “in registration” point?

o Not defined legally, so most parties are cautiouso If you overstep, SEC can stop you – issue stop order but also claim you violated securities laws and

either injoin your offering or at least delay it Can be very costly in terms of timing your offering right

Before 2005, what you could do in pre-filing period was unclear; in 2005, new 160-series of rules that say “if you do X and don’t do Y, you won’t have violated §5(c)”

o Safe harbor provisions – follow the rule roadmap so you don’t violate the lawo During waiting period: deemed to be complaint if you follow §10

Rule 163.A, p90 – “Exemption” – attempted compliance is not exclusive Available to all issuers, for disclosures more than 30 days prior to the filing date No protection for underwriter, only issuer Cannot refer to offering Prevent redistribution of document in 30 day window

WKSI – well-known seasoned issuers: greater flexibility still More info out on company under ’34 Act, so SEC gives them more flexibility

Rule 135, p50 – allows issuer to announce intention to make offering prior to filing date; strictly limits what can be disclosed

No anticipated price No telling underwriters Legend on doc that says it doesn’t constitute offer (common in words of rule) Only way can disclose impending offering before registration has been filed

o Exception now for WKSI companies

Rule 169, p96 – mostly for non-reporting issuers; for company not reporting under ’34 Act can, in pre-filing period, release regularly timed releases in same manner and timing

Not targeted to investors because SEC says that’s just raising company’s profile proceeding the filing – that’s an offer and is NOT allowed

Problem 4-1, p166; Omega Needs $50 – 70M through IPO; registration statement planned for 5/1 Issue: on 2/10, VP of marketing runs ads in Business Week; is this an offer?

o Under 163(a), have to prevent re-circulation within 30 days of filingo Under 169, there may be a problem – now that it’s in Business Week, looks like it’s targeted to

investors – not allowed to allow qualification as exemption under 169(d)(3) Also potential issue under 169(d)(2) – has timing, manner or form changed?

o Change the scenario – under §5(a)(2), if same ad running for years, is this an offer? No, doesn’t require business to suspend business ops

Problem 4-2, p167 2/14, VP Finance invites 5 ibanking firms to discuss firms’ interest in underwriting 2/15, execute draft agreement Issue: is this an offer?

o Under §5, not an offero §5(c) – doesn’t apply; no interstate commerce

Issue: is Hedley an underwriter?o Under §2(a)(11) – must participate in distribution for issuer; Hedley signed up to do just this – fits

the statutory definition

Problem 4-3, p167 Head of Hedley faxes underwriting agreement to NY offices Issue: is this covered?

o Under 2(a)(3) – no, still within underwriting firm

Problem 4-4, p167 Letter circulate to 80 brokerage houses to participate as co-underwriters Issue: how do statutes apply?

o §2(a)(3) – “privity of contract with an issuer” – this communication is allowed

Problem 4-5, p167 Communication with smaller firms not underwriting being offered commission to sell Issue: how do statutes apply?

o §2(a)(11) – not excluded from Soliciting others for selling, not underwriting, is NOT covered in this provision; because

NOT in privity Technically underwriters under this statute, but NOT in privity (from §2(a)(3)) –

thus not protected re: sale Policy: shielding early stages of process to allow for effective raising of capital, but if not in privity then not

protected – not allowed to move into “sale” concerns

Problem 4-6, p167 3/15, PR team prepares brochure highlighting company’s new developments – also indicates intent to

make IPO and estimates of future production capacity Issue: is this a violation of §5(c)?

o Rule 135 – No legendo Rule 163.A – cannot refer to offering

Also, how going to prevent redistribution within 30 day periodo Rule 169 - Only facts and not forward looking info

Conclusion: clearly an offer, not protected by any of the 3 rules above

Problem 4-7, p167 4/5, journalists and others invited to tour and see “expansion plans” – runs in newspapers Issue: is there violation?

o Rule 163.A – within 30 day window, so doesn’t applyo Rule 135 – ok, because no mention of proposed offering; therefore, not 135 statemento Rule 168, p94 – issuer required to file reports under exchange act – not available to non-reporting

companyo Rule 169 – this one applies! Can’t be directed at investors, so depends on which types of mags /

journalists are invited, and to whom they write

Problem 4-8, p167 4/8, Hadley issues on letterhead announcement to financial wire services re: upcoming IPO through

syndicate with 4M shares; Omega posts to website Issue: is Hadley’s action permissible under securities act?

o Under §5(c), No! This looks like an offer and thus is a violation None of these rules give underwriter exemptions

Policy: why don’t rules give underwriter exemptions, nor under Rule 135 do the rules allow the issuer to even tell who the underwriter is!

o Might cause interested investors to approach underwriters – violates the rules

Problem 4-9, p168 4/27 – annual report; mentions expected IPO Issue: is Hadley’s action permissible under §5(c)?

o Safe harbor possible? Rule 163.A – only applies within 30 days, this doesn’t qualifyo Rule 135 – discloses info not allowed under 135, doesn’t applyo No – also violation under 169 – like advertising offer, b/c aimed at investors; also, forward-looking

statements Time, manner and form = upgraded the annual report – manner of presentation / profile

is raised; not really presented in the “same” way Tension between need to communicate and ensuring communication is not

incomplete but doesn’t cross the line addressing the offering – difficult to balance

***Class #7: 1.18.11

Problem 4-10, p168 - 4/28 – Omega places Alice’s (VP of finance) presentation on website and she remarks on expected future

earnings Issue: is Alice’s action permissible under §5(c)?

o No – also violation under 169 –advertising offer, aimed at investorso Invitation excepted before company in pre-registration, so this helpso Talk about expansion but not about offering? “no comment” – or perhaps should withdraw

acceptance of invitation – like quiet period Rules more flexible now than they once were; risky thing to do, before anything is filed, to

talk about the company, and any future plans, publiclyo Info goes well beyond a Rule 135 statement – p121, bottom – “written communication is any…

written, printed, radio or TV, or graphic comm. (includes anything online)”

Problem 4-11, p168 -

Late April – broker writes to Hedley offering to purchase shares Issue: is this permissible?

o No – violation under §2(a)(3) and §5(c) §5(3) prohibits offers to buy as well as offers to sell

Waiting Period Period after pre-filing period, now we’ve filed – rules change significantly §5(c) no longer applies §5(b) – now in charge

o §5(a) continues to bar sales after registration statement is filed o BUT §5(b)(1) governs the start of sales efforts after registration but before IPO date

Bars any prospectus – but defined broadly under §2(a)(10) – no written, radio or TV transmissions

Oral offers ARE allowed Does communication constitute a prospectus?

o §5(c) prohibited any offer to buy or sell, nothing in §5(b) that prohibits oral solicitations, nor does it require conformity to any requirements

o §12(a)(2) – ’33 rule on truth / material factso SEC enforcement provision Rule 17(a) – can make offer, not flatly prohibited – but focused on

written communication Start sending customers prospectus – may wait until after SEC notes

o Important because: Marketing shares to get people to buy Determine supply and demand point

SEC sets own rules for what content must be, pursuant to §10 and …o Rule 430 – requirements for preliminary prospectus (doesn’t require all deal related info to be

included) – part I of registration statement Part II are materials included in registration statement, but doesn’t have to be in

prospectus

§2(a)(10) – bottom, p3 – ad shall “not be deemed a prospectus if it states from whom a written prospectus meeting the requirements of section 10 may be obtained and, in addition, does no more than identify the security, state the price thereof, state by whom orders will be executed, and contain such other information as the Commission, by rules or regulations deemed necessary or appropriate in the public interest and for the protection of investors, and subject to such terms and conditions as may be prescribed therein, may permit.”

§2(a)(10)(b) – tombstone, NOT a prospectus

Rule 134, p47 – another thing NOT deemed a prospectus Used primarily by underwriter – for use with investors Can send something to customer to allow them to express if they have any interest Does require a legend, per §16, p134 Rule 134(d) – “may solicit from the recipient of the communication an offer to buy the security or request

the recipient to indicate whether he or she might be interested in the security, if the communication contains substantially the following statement: No offer to buy the securities can be accepted and no part of the purchase price can be received until the registration statement has become effective, and any such offer may be withdrawn or revoked, without obligation or commitment of any kind, at any time prior to notice of its acceptance given after the effective date.”

o Separate permitted communication during waiting period

Rule 405 – defines “free writing prospectus” If it isn’t under Rule 134, and isn’t a preliminary prospectus, then it’s a free writing prospectus

***Prospectus Options: Rule 430 – complies with §5(b)(1) and §10 §2(a)(10)(b) – carves out of §10

o Rule 134 Rule 433

Rule 164 and 433 – must satisfy free writing prospectus, p144 Can say more than or cover things that aren’t in preliminary prospectus

o But must be consistent with preliminary prospectus Not part of registration statement (unless you choose to file it as part of reg statement – don’t do this!) Must contain a legend informing reader that registration statement is filed, and how they can get copy of

preliminary prospectus – EDGAR website, SEC, or call toll-free # from underwriter Can also provide hyperlink to website of issuer or underwriter (this is something you can add), but still

have to give URL for registration statement Issues:

o Can create more risk for issuer o If hyperlink other things to free writing prospectus, may be deemed to be part of it – want to keep

anything else on website separate to not allow courts to see it as “one” Filing with SEC:

o Free writing: must be filed on same day as first useo Journalistic report – will be deemed free writing prospectus once it appears; doesn’t have to have

legend, but has to be filed with SEC within 4 days of issuer or underwriter becoming aware of it Purpose: can have additional disclosures as long as not inconsistent with preliminary prospective, have a

legend, and filed same day as first useo NOTE: If WKSI, can use free writing prospectus prior to filing of registration statement, as long as

filed on date registration is filed also

Rule 15c2-8: Free writing prospectus can only be used with people who have received preliminary prospectus before or concurrent with free writing prospectus, if not reporting company yet

If electronic, then can accomplish delivery requirement of prelim prospectus by having link in free writing prospectus

If seasoned issuer, can deliver free writing without prelim prospectus, BUT must provide that registration statement is filed in legend (required)

P147, d(1) – “any offering participant other than issue shall file…”

Rule 164(a) – “In connection with a registered offering of an issuer meeting the requirements of this section, a free writing prospectus, as defined in Rule 405, of the issuer or any other offering participant, including any underwriter or dealer, after the filing of the registration statement will be a section 10(b) prospectus for purposes of section 5(b)(1) of the Act provided that the conditions set forth in Rule 433 are satisfied.”

SEC complies with 5(b)(1) as complaint with 10(b) as long as you satisfy Rule 433 Rule 164 gives some leeway – if miss something (no legend, forget to file, etc), as long as in good faith and

quickly rectify, then won’t lose protection of Rule 433o Broad concept because encompasses anything that’ll be linked to preliminary prospectus

Anything linked is free writing prospectus

Road Show, p150, Rule 433(h) - definitions When management of company and underwriters travel around to major investment centers and put on

presentations to prospective (usually only institutional) investorso Formerly invitation only, closed

o Oral presentations are fine – BUT if start handing something out, ppt slides, etc…have to comply with §10

o If record / graphic road show – possible and popular, but still must follow rules Generally need not be filed; BUT if road show is for common stock by non-reporting

company, and graphically recorded, then must be filed unless issuer makes it available for anyone to see

Road show = an offer that contains a presentation regarding an offering by one or more members of the issuer’s management and includes discussion of one or more of the issuer, such management, and the securities being offered

Brokers go out, drum up interest, etc.

Rule 15c2-8: SEC will not grant acceleration until confirm everyone on interested list – rules require most recent prelim prospectus (red herring) must be distributed at least 48 hours before any confirmed sales

Allows seller enough time to review if they want to change / sell / cancel order

Problem 4-12, p176 Broker telephones client and strongly recommends stock – he sends prelim prospectus Issue: does this violate any securities law?

o NO – allowed because done orally; doesn’t have to have prospectus first

Problem 4-13, p177 Broker follows-up – sends letter saying still good buy Issue: does this violate any securities law?

o YES! Should comply with securities law Rule 433 – has to be filed – too extreme for this case, where the note itself has to be filed

with SEC Rule 134 – ok, could consider as “not a prospectus”…but can’t put in personal opinion – if

included, must have legend (from 134(d)) If really wants to use this document as described in problem, then need to file it with SEC

– probably extreme; more likely to just rely on telephone More grey area: voicemails – just leave name, call back re:

Class #8: 1.19.11

INSERT MISSING NOTES:

Problem 4-14, p177 – Sum: Issue:

Problem 4-15, p177 – Sum: Issue:

Problem 4-16, p177 – Sum: Issue:

o Covered by 2(a)(10)(b)?

Problem 4-17, p177

Multiple underwriters prepare and distribute own sales brochures to broker and potential customers; not shared with other underwriters in offering and not filed with SEC

Issue:o Free writing prospectus – needs legend and to be filedo Any writing that’s not prelim prospectus that’s used during waiting period has to find a “lawful

home” somewhere Not tombstone – beyond 2a10b Beyond Rule 134 Only remaining lawful alternative is Rule 433 to comply with all requirements – is

“offering participant” – used in Rule and refers to underwriters Have to know price range has been disclosed (pre-condition for free writing

prospectus in connection with non-public company)

Problem 4-18, p177 Omega’s registration statement lists its web site address – there has hyperlink to trade pub touting

Omega’s more recent product Issue:

o Ok re: prospectus; don’t have to worry about fulfilling requirements for free writing prospectuso What about trade pub article being reproduced?

Ok to advertise current products during waiting period – Rule 169 expressly includes under 169(b)(1)-2

BUT If on website for first time after filing, then not same “time, manner or form” (169(d)(2)) – becomes free writing prospectus – now under Rule 433

Under Rule 433, has to be filed with SEC, includes legend, click through prospectus to get to ad, etc. – because has to show delivered concurrently or previously

These are the risks for companies going public Any info that will color investor’s perspective on what’s being offered, then need

the “stop, look and listen” warningo Ex: Goldman Sachs’ revamped efforts over weekend to only sell to

offshore clients re: Facebook shares – to avoid being non-compliant

Problem 4-19, p177 Alice, VP Finance, undergoes interview with underwriters – digitally recorded and placed on Hadley’s

website and available to public Issue:

o This is a free writing prospectus But – open interview with journalist – covered under Rule 433(f) File within 4 days and not paid for interview with public – then ok

o What if considered a road show? Doesn’t have to be filed as long as it’s posted online / graphic communication made

available and openly to public Slightly ambiguous as to how it’s available…just issuer’s website? Underwriter’s

website?o Issuer’s website doesn’t have to be filed – conventionally it’ll be hereo Underwriter’s website seems to need it to be filed

Must include issuer and not just underwriters

Problem 4-20, p177 Alice sends email to all employees – speaks optimistically about Omega’s future – then posted on popular

online chat room Issue:

o Should attach prospectus with emailo Should file with SEC same day as emailo Include legend

What if VM?o Not oral communication – lots of VM these days distributed as attachments to emails!

Class #9: 1.24.11

§5 – path to registration Potential exempt via §4 Pre-filing period Waiting period

o Prospectuso Free writing prospectus (if any)

(Acceleration to) Effective Date Post-filing period

o Final prospectus Later: secondary Market

o ’34 Act – reporting requirements

§5 – after Effective Date §5(a) - prohibits sales until effective Can now make sales, send bills in form of confirmation

o Now at effective point, §5(a) is goneo §8 is also not application

Only §5 requirement left is prospectus delivery requirement from §5(b)o Now will also distribute “final prospectus”

What happens in post-effective period if… Something wrong in prospectus OR Facts change from what was recorded in prospectus on effective date

Rule 430(a), p138 Caption – prospectus for use prior to effective date

o But suggested final prospectus needs offering price and other details that are allowed to be omitted from prelim prospectus

o Rules proscribe final prospectus can be created from prospectus that’s missing info, but then filed as addendum to prospectus within 15 days of effective date, and is then deemed part of the prospectus once filed

o Final prospectus becomes selling doc

Rule 433: If use free writing prospectus after effective date: Legend Filing requirement Note: these 2 requirements not eliminated after effective date

Rule 2(a)(10)(a), p3 “except that (a) a communication sent or given after the effective date of the registration statement

(other than a prospectus permitted under subsection (b) of section 10) shall not be deemed a prospectus if it is proved …”

Can continue to use free writing prospectus but note, if going to use 433 prospectus, should probably deliver final first or concurrently

o Seems silly (to Prof) to file free writing prospectus after already effective

Prospectus Requirements post-effective dateFormer: Can’t solicit without delivering final prospectusCurrent: SEC has relaxed these rules

Ex: Rule 172 – can send a confirmation without it being a prospectuso Also if deliver a certificate for security doesn’t have to give prospectus first

§4 Exemptions §4(1) – exempts transactions NOT by issuer, underwriter, or dealer §4(2) exempts transactions by issuer NOT involved in IPO §4(3) gives complex rules for dealer acting as an underwriter §4(4) when customer comes to broker unsolicited and asks to buy – exempt from §5 and from prospectus

delivery requirements

Rule 173 Underwriter must deliver a final prospectus within 2 days of effective date; BUT sufficient to satisfy simply

by giving people a notice that registration made pursuant to prospectuso Giving notice under 172(a)(1) – NOT a prospectus; satisfies requirement from Rule 153

Big exception: §4(4)

Rule 153 – for already public organizations Relaxes rules re: delivery requirements from §5(b)(2) Have to be already listed on exchange before effective date

o Delivery requirement then only 25 days (not 40 or 90 days as seen in §4(3)

Problem 4-21, p181 Omega’s registration with 2M shares with IPO price of $15 pps effective on July 1 – after, shares will trade

on NASDAQ Hadley emails copies of WSJ to customers, including info not filed with SEC – email contains hyperlink to

final prospectus online Issue:

o Covered because had hyperlink right to final prospectus – satisfies deliver requirement, concurrent is OK

“Writing” now evolved to encompass electronic communications

Problem 4-22, p181 Hadley emails confirmations of sales to all customers who made offers to purchase; earlier given prelim

prospectus and most consented to ecopy; informs customers to where to find term sheet online Issues:

o Is confirmation a prospectus? Under §2(a)(10) – if this is a prospectus which must be accompanied by final prospectus Exempt from delivery requirements under §5(b)(1), not a prospectus

Filing under Rule , p147 When not part of filing requirement, under d(1)(i) –

Problem 4-23, p181

One of underwriters sold entire allotment by 7/5; on 7/10 one of brokers suggests a customer purchase a block on NASDAQ, and he agrees; must the underwriter forward a final prospectus to client?

Issue:

Problem 4-24, p181

Problem 4-25, p182 Unsolicited transaction – exempt under §4(4) from §5, and also thus exempt from delivery requirements

Problem 4-26, p182 Hadley makes term sheet available §15(c)(2)(8) – by Hadley providing term sheet, it’s requirements are fulfilled

o Brokers must have all necessary documents – prelim prospectus, term sheet, etc.

Analysis Order §4(4) to see if any exemptions from delivery If delivery requirement, analyze under Rules 172, 173, and 174 If already traded, Rule 153

Class #10: 1.25.11

Decision Tree – requirement for registration: §5 – applies equally to any seller Exemptions – that exclude compliance with §5

o Some under §4o Use S-1

Route #1: non-public company (from yesterday) Route #2: already public company

o Still has to comply with §5 unless transaction is exempto Different route following cap markets hypothesiso Use S-3 : other alternative for fundamental sales by issuer to public

Integrated disclosure system – mostly S-3 If already filing 10-K, 10-Q, and 8-K forms – then can be incorporated by reference in S-3

o Means that all items that you have to respond to in S-3 can be satisfied using existing forms and their data

o Standards in S-3 as to who can use it Qualifications for issuer to see if they satisfy standards to qualify Which transactions can it be used for

Can rarely use integrated disclosure for S-1, under §7 Missing from 3 forms that must be added in S-3:

o Elements of specifics regarding issue: Use of proceeds Distribution method Price Underwriters

Levels of Issuers WKSI – Well Known Seasoned Issuer

o Can use S-3; doesn’t take a lot to be a WKSI: $700M of market cap (# common shares outstanding * pps)

Seasoned Issuero Filing under for at least 12 months, but doesn’t meet WKSIo Can use S-3

Unseasoned Issuero ’34 Act company, BUT doesn’t meet requirements of seasoned issuer

Unregistered Issuero Fall under Rule 433(b)

Rule 163, p88 – only for WKSI ISSUER Allows WKSI to make offer prior to registration statement (overrules §5(c) for WKSI) 163(a) – “any written communication that is an offer made in reliance on this exemption will be a free

writing prospectus as defined in Rule 405 and a prospectus under section 2(a)(10) … to be covered by the registration statement to be filed; and (b) exemption from section 5(c)”

o Issuer-only rule o Treated as free writing prospectus – i.e., must be filed with SEC and have legend

Note: if legend omitted and good-faith attempt to comply, then not violation …if…filed asap after discovery that need to file

Rule 168, p – ONLY FOR ISSUER Allows issuer to include forward-looking material, but still limited by “time, manner, and form”

o Also cannot refer to offering Still have Rule 135 available Brokers could also use Rule 134, at least during waiting period Parallel that allows company to continue to disclose info as it has done in the past, even as it’s embarking

on new offering

Rule 137, 138, 139 – FOR BROKERS Acknowledge appropriateness for brokerage community to continue doing what it’s been doing, so long

as it doesn’t attempt to “condition” the market Idea: if already public and trading, why do we care anyway?

o Answer: if brokers could hype market in any way, want to be sure those buyers have info they need before committing themselves to buy

o What’s in S-3 (or S-1 for unseasoned issuer) – will tell what company’s going to do with money SEC wants this info in registration statement and disclosed

Apply throughout all periods NOTE: doesn’t include 135(a) – that ONLY applies to mutual funds 137 – allows broker-dealers who aren’t part of offering to continue in what they’ve been doing (aka

nothing to gain by hyping interest in offering) 138 – only available when it is reporting company and CURRENT in ’34 Act reporting

o Available whether or not participating in offering, but limited exception = can only comment on securities that are NOT economic equivalent of offering

Ex: if stock offering, then can comment on debt, but NOT on stock price 139 – allows broker, whether or not participant in underwriting, to continue what it’s been doing – if

company qualifies for S-3 AND current in ’34 Reporting AND already been commenting on company in the same way

o Alternative: can issue a report about industry in which company is involved, as long as issuer is reporting company and report has info on substantial # of similar companies

Substantial – vague word, may be factor based on industry or court

Problem 4-27, p191 Omega now a reporting company eligible to use S-3 but not a WKSI 4/15 – just before filing, PR prepared a brochure highlighting company’s development - indicates intent

for offering and estimates future production capacity Issue:

o Not a WKSI, so can’t use free writing prospectus prior to filingo Rule 135 not availableo Rule 168 available – but 168(c) – exclusion exists around any communication containing info

related to offering; therefore, the brochure as is stands is INVALID

Problem 4-28, p191 Now issuer is WKSI Issue:

o Can use more flexible Rule 163 WKSI can publish info before registration is filed Can function as free writing prospectus: but still need to file and have legend (combine

Rule 163 with Rule 430)

Problem 4-29, p191 Issuer is WKSI and brochure prepared by broker; circulated it on 5/2 to institutional clients Issue:

o Rule 168 is ONLY for issuer, and this is an underwriter – not availableo Rule 137 is ONLY for non-participating brokers – not availableo Rule 138 is ONLY for not same security as issue – not availableo Rule 139 – issuer-specific report; could use if the below are true:

Issuer must be eligible for S-3: yes Current in ’34 Reporting: yes Already commenting in same way: yes

o Rule 433 – allows underwriter to participate in something like this after registration if free writing prospectus requirements are met:

Legend Filed Etc. NOTE: in reality, managing underwriter would KILL if this actually happened!

Problem 4-30, p191 If issuer can’t use S-3, does Problem 4-29 change? Issue:

o Rules 137 – 139 not available because 1) participating broker; 2) same as issuing security; and 3) can’t use S-3

o Rule 433 – follow free writing post-registration rules and then can use this!

Problem 4-31, p191 5/1 after filing registration statement, issuer placed on web site a section labeled “Historical

Developments” with a report on Omega prepared by non-participating in offering Issue:

o Rule 137 – protected for brokero What about Omega / rule for issuer?

Rule 168 – for reporting companies with forward-looking info, BUT has to be same time, manner and form

Violation! Rule 433(e)(1) – re: items on issuer’s website

433(e)(2) – allows separate section of company’s website to contain historical info that’s not linked to any offering materials

Problem 4-32, p191 C-suite execs meeting with journalists just minutes before statement is effective; Omega provides

hyperlinks to some of these stories that arise Issue:

o Rule 168 – prohibited to talk about offeringo Rule 433(f)(1)(ii) – treat as free-writing prospectus

Issuer has to file within 4 days re: journalist articles NOTE: really quit talking to press to avoid these scenarios

Don’t do this – not good form

Problem 4-33, p192 Broker made plans to send to several institutional clients as email day after filing confirming its purchase

of Omega shares Issue:

o Must satisfy what requirements to deliver prospectus: Rule 174(b) – reporting company, doesn’t need to send prospectus Rule 172 – don’t have to send prospectus with confirmation

NOTE: Free writing prospectus under Rule 433(b)(1) – for WKSI and seasoned issuer – don’t have to deliver prospectus as long as it’s filed

Class #11: 1.26.11

Rule 415 – shelf registration rule Historical idea: Takedown – take securities “off the shelf” and sell them Lots of sub-categories under this rule If shelf is S-3, constantly kept up-to-date by filing forms as required – doesn’t become stale because of

integrated disclosure system – auto updates every time you file something under ’34 Exchange Act Note: Every quarter – want registration statement out there getting updated every quarter by new filings Delayed basis:

o When looking for market to be right Ex: want to sell bonds, but only want to sell when market is right

List class but not price – then can list them immediately when market is better Have effective registration statement, then take down bonds when ready to

market with price Condition:

o Will have shelf continually updated by quarterly filings, so have to commit that if fundamental change to any info, then will amend registration statement

Telling SEC: let us go effective, and then if anything fundamental we’ll be sure to update it S-3 filers: will be incorporated likely by reference If not, have to file post-effective amendment, which won’t become effective for

48 hours

Hiccup: what is “fundamental” – vague; more than material, but what we don’t know

Becoming standard for most companies

Rule 415.1.b / Rule 462(b) - Automatic shelf For WKSI’s only - As part of increased flexibility with ’33 Act Goes effective IMMEDIATELY Have to file a new one every 3 years (or they expire) Poised to raise money on a moment’s notice; effective with flexibility – id classes of stock without pricing

or listing volume

Rule 430.B – how much can leave out of shelf registration When know if doing takedown, then can file remaining docs / fill in blanks and go ahead with offering Sets forth contents required for “base prospectus” that’s part of registration statement – not a final

prospectus, but becomes final when supply missing infoo Registration is active, but prospectus not finalo Does become part of registration statement when final – deals with §11

§11 – civil liability options for truth / completeness in registration statement

Rule 424 Provides mechanism and sets for how to supply missing info: pricing info, # shares, method of distribution

Problem 4-34, p199 S-3 eligible company; common stock already trading, wants to register convertible bonds – to 50 shares at

option of bond holder Company wants to sell bonds at 11% but market is 12% - doesn’t want to sell yet, wants to wait until

interest rates drop and be ready; files self registration statement Issue:

o §2(a)(3) – when a sale occurs, has a carve-out for ____ But really an offer of underlying security – offering both bond and stock, unless terms of

conversion right are that it can’t take place until some date in future after sale of bondso Will shelf registration be allowed for both securities?

415(a)(1)(10) – “securities registered on Form S-3 which are to be offered and sold on an immediate, continuous or delayed basis by or on behalf of the registrant, a majority owned subsidiary of the registrant or a person of which the registrant is a majority-owned subsidiary”

Shelf registration statement to encompass 2 classes of securities (stock and bond) combined under this rule as under 1 registration statement

Problem 4-35, p199 Company considering raising capital, but don’t know what kind of security want to issue Issue:

o If S-1 company, can it use shelf reg to register multiple classes of securities without committing to what securities it will sell?

NO! Rule 430B allows for flexibility if you file an S-3 Doesn’t apply here

o If could use S-3 but is a WKSI, then use Rule 415.a.1.10o If WKSI, can list everything without specifying

NOTE: as you go up scale from S-1 to WKSI, greater flex possible Efficient market theory: larger market cap of company, more amount of info

available, more flexibility available

Problem 4-36, p200 Small unseasoned company has OTC market shares traded – reporting co for less than 1 year; stockholder

wishes to sell significant amount of stock Issue: can she register her shares for secondary offer sale?

o Rule 415.a.1.i – permits secondary offering o Any registration statement still has to be filed by issuer and signed – S/H could have contractual

right to force issuer to do so…but…

Problem 4-37, p200 WKSI that encourages employees to own stock in company; has program to buy as payroll deduction Issue: does this need registration statement?

o Continuous offering, so good candidate for shelf registrationo Rule 430A – can leave off lots of info and supply as sales are made by filing prospectus

supplement from time to time

NOTE: Shelf is important and flexible tool for corporate financing Offerings that facilitate capital raising and, in some cases, employee ownership participation

TIMELINE Carries as long as 3 years past filing date Post-effective period – 2 concerns:

1. Find out something wrong with registration statement on effective date: material inaccuracy Exposes issuer to liability under §11 Must file post-effective amendment to correct info – not effective until amendment is

effective – therefore if any further sales made pursuant to registration statement, tried to limit liability for sales coming after

Most sales are immediate and therefore shouldn’t make difference when amendment occurs in practice, but still important

2. Facts change after effective date: supplementing info Issue: secondary market or further sales after effective date

Remember: prelim prospectus can’t be circulated for offers; but final prospectus can be

o Thus can amend registration statement but can correct – sticker (p207)

Rule 424 – sticker to update prospectus Also amend registration statement, as common practice

§12(a)(2) – requirement of truthfulness Rule 10b-5 – ______

Problem 4-38, p201 Registration statement became effective 7/12, and reporting owning 900K acres; on 7/18, 350K acres lost

to forest fire Issue:

o No complaints because accurate on effective dateo What if surveyor error and had less than 900K acres?

Creates §11 liability because statement inaccurate on effective date §8 – stop order approach?

§8(b) – refusal order Bars filed registration statement from becoming effective Limited use – only for patent misstatements and omissions

o Notice of hearing required within 10 days of the statement’s filing - and then hearing occurs within 10 days of notice

o §8(a) – requires registration statement become effective within 20 days of its filing – small window for refusal order

o Rule 473 – procedure for a permanent delaying amendment – continuously tolls the commencement of the 20 day period (mitigates the 20 days under §8(a))

§8(d) – stop order More frequently used than §8(b) refusal orders Allows SEC to stop if appears registration statement contains untrue statement(s) of material fact; used

even when the offering has been completely sold Serves as a notice to investors – materially misleading disclosures from registration statement

o Can be used before and after effective date o §8(e) – can issue stop order solely on basis of issuer or underwriter’s failure to cooperate with SEC

investigation

Post-effective Period Changes to be Materially Misleading §8(d) Note: does NOT include changes that make truths at time of registration statement now misleading

during post-effective periodo Makes §8(d) consistent with §11 – liability exists when materially misleading at effective time

§12(a)(2) – available for those who purchase security which has registration statement become misleading after effective date

§8A – SEC can issue cease and desist order or invoke §20 to obtain federal court orders to prevent violation of SEC Acts (for ex: under §17(a) for antifraud)

§5(c) – no offers to buy or sell allowed when refusal or stop order issued If reg statement already effective, then §5(c) bars any public proceeding or exam under §8

§8(e) – investigations under §8 that are NOT public

§8A – gives SEC power on emergency basis to enter cease and desist order administratively Not common, but SEC doesn’t independently investigate facts; rely on company for facts

8-K – form used to correct registration Thus market has everything available that’s current 8.01 – allows 8-K to be used for reporting any material developments Nothing mandates disclosure of any material event, BUT protects company from §11 liability – so

companies use 8-K at their discretion

***Trading Rules

Covers what happens after effective date and offering as trading develops Trading market allows for possibility of manipulation – particularly if market goes down

Desire to have liquidity; but also restraints that prevent manipulating price in period after offering

Regulation M – out of ’34 Exchange Act – p801o Act deals with secondary market and tradingo Puts limits on purchases under certain circumstances – lots of definitions, but also lots of

exemptions Ex: Research reports (from Rules 138 / 139) – considered exceptions If actively traded, then exempt

“Actively traded” = >$1M traded per day, public float of $150M+ Reg M, Rule 102 – prohibits ___ by issuer during this period

o Designed to allow trading after IPO, but limiting to restrain manipulation

Class #12: 1.31.11

Problem 4-40, p210 Status as of March 12th – on day of purchase, not yet an underwriter Restricted Period, §2 – “For all other securities, the period beginning on the later of five business days

prior to the determination of the offering price or such time that a person becomes a distribution participant, and ending upon such person's completion of participation in the distribution”

o March 15 – 5 = March 10th; distribution participant = March 15th (winning bid awarded) – later of two, thus March 15th begins restricted period

o But Hedley didn’t know if they’d be accepted; don’t fit test of “prospective underwriter” – no reason to believe they knew they’d win

o If bought on March 12th, then ok – NO violation

Rule 100, p804 – Regulation M

Rule 104 – Stabilization What an underwriter can do during an offering – pre-offering and post-offering activities, that will be

permissible and not violate Rule 101 Rule 508(l) - Have to disclose in prospectus’ registration statement Allows underwriters to initiate and change stabilizing bids based on price in principal market

o So long as bid does NOT exceed offering price Only permissible to prevent or retard a decline in price – cannot be used to move it up

o If offering is made “at the market” – then can’t stabilizeo CANNOT stabilize at price higher than offering price – no higher than last independent price

If no market, then can stabilize no higher than offering price if stabilizing bid was made before market developed (rare)

o Can increase stabilizing price only if someone else has moved the price up – must follow market

Problem 4-41, p212 Maintained bid at $9 prior to effective date – to absorb selling interest at that price Last quoted price before offering - $9.25 Last sale was $9.50; Hedley then increases bid to $9.50

o Can initiate stabilization NO HIGHER than last independent bido Thus this is OK (can’t go above it)

International IPO’s Foreign-private issuer – non-governmental entity, organized in a foreign country, organized in the US

marketso Use forms F-1 or F-3, parallels (but not identical) S-1 and S-3; somewhat loosening of disclosure

standards to facilitate access to US capital markets

US companies selling overseas Implications re: interstate commerce Rule903(b) under Regulation S -in effect a safe harbor; if you fit within one of categories within

Regulation S; then won’t have to comply with §5

o Only outside of §5, not any other ruleso Registration exemption (NOT a fraud exemption)

Regulation S Little risk that securities will bounce back into US as “run around” §5 Category 1: Foreign Issuers with no substantial US market interest; overseas directed offerings; securities

back by full faith and credit of foreign government; employee benefit plans Category 2: Reporting US issuers’ debt securities; foreign issuers’ debt securities; reporting foreign issuers’

equity securities Category 3: all other issuers

o Greatest restrictions among 3 categories 2 basic requirements:

o Transaction is “offshore” as defined in rules Sales made in foreign exchange trading floor In offshore market and not pre-arranged to flow back to US

o No offers made to US persons NOTE: If a single offering, have to find a single exemption that covers all the sales

o If you have a valid Regulation S exemption, then there won’t be integration – dependent upon Regulation S exemption being fully complied with (???)

Regulation S issues – with internet If can access offering online from US portal, then it’s considered “offering to US”

o Therefore must assure that only qualified investors (those allowed to buy overseas) are the only with web access to site, or use password

Based on what local law requires Ex: if offered in Spain, must comply with Spanish laws

o Comply with US law if comply with Regulation S – then don’t need registration statement in US

Rule 135(c) – allows US journalists to attend press conferences overseas, as long as press conference held overseas and with no offering in US

Problem 4-42, p230 Textron – common stock on LSE and NYSE; ½ of trading volume on each Issues:

o Regulation S? Not Category 1 – because US market

P181 – “substantial US market interest” defined – 20%+ on NYSE, and less than 55% on single other country exchange

Rule 902(b)(1) (i) – no because no substantial US interest in securities being offered

Category 2 – YES! Foreign-private issuer offering securities overseas – registered and reporting

under ’34 Exchange Act Sale to US citizens overseas?

o NO – because US person; Rule 902(k) – any natural person resident in US If resident overseas, then offering ok?

Rule 902(g) – offering restrictions imposed on US person re: moving securities back to US

Can’t sell to US persons for 40 days

Problem 4-43, p230 US citizen based in London office

o If resident in London, then not barred – test isn’t citizenship, it’s residency

Problem 4-44, p230 If company incorporated in Delaware, what changes?

o Shifts to Category3 – greater burdens imposed Longer period for shares to be sold to US persons: 1 year, not 40 days

Problem 4-45, p230 Can this be done without violating §5?

o Simply informing the market vs. conditioning the market Rule 902(c)(3)(1) – Rule 135(c) –

*** CHAPTER 5Exempt Transactions

Any sale has to comply with §5 unless exempt Issuer exemptions:

o Useful because such a long and complicated timelineo Exemptions under §4

Ex: under §4(2) – sell to stockholder (exempt) – but if wants to resell, then has to register resale, or find exemption for resale

Resale also runs up against §5o If claiming exemption – sell securities without registering transaction – if question is raised, then

burden ALWAYS on party making sale to demonstrate ok under exemption If do this, buyer can rescind under §12(a)(1) – only has to show no effective reg statement

covering transaction (very easy to prove)

§3(a)(11) – Exemptions for Local Offerings From 1933 – made sense to exempt intrastate transactions Doesn’t apply for interstate – seems arbitrary (ex: Chicago to Kenosha, vs. downstate) Statute is pretty vague, from Release No. 4434 – SEC gives more info

o Means entire issue must be sold to residents of 1 state Ex: Sale to 1 person outside permitted category destroys exemption for all sales

Then everyone can sue under §12(a)(1) and get their $$ back o Also means only can be offered to residents of state; resale out of state would destroy exemption

unless securities had “come to rest” in original buyer Interpretation up to the courts

Problem 5-1, p261 Ad in local newspaper and on website, and direct mailing

o How to restrict only in state of Mass.? Include legend – offer only to those residing in Mass. For physicians licensed in Mass. – must check mailing addresses

Rule 147 – definitions for §3(a)(11) If follow to the letter the elements of this rule, then complying with elements of statute; if not, then are

not complying with statute

o To satisfy §3(a)(11); then entitled to exemption – one of many safe harbor exemptions

Problem 5-3, p261 Doing business = “performance of substantial operational activities in the state of incorporation”

o Not fulfilled by bookkeeping, stock record and similar activities or by offering securities in state

INSERT 2.7.11 NOTES

CLASS #13CLASS #14

CLASS #15: 2.8.11

Regulation D - Rules Governing the Limited Offer and Sale of Securities Without Registration Under the Securities Act of 1933 §3(a)(11) – “Any security which is a part of an issue offered and sold only to persons resident within a single State or Territory, 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 or Territory.”

§4(2) – “The provisions of section 5 shall not apply to: (2) transactions by an issuer not involving any public offering.”

§18: EXEMPTION FROM STATE REGULATION OF SECURITIES OFFERINGS. (a) SCOPE OF EXEMPTION.—Except as otherwise provided in this section, no law, rule, regulation, or order, or other administrative action of any State or any political subdivision thereof— (b) COVERED SECURITIES.—For purposes of this section, the following are covered securities:

(1) EXCLUSIVE FEDERAL REGISTRATION OF NATIONALLY TRADED SECURITIES.—A security is a covered security if such security is— (2) EXCLUSIVE FEDERAL REGISTRATION OF INVESTMENT COMPANIES.—A security is a covered security if such security is a security issued by an investment company that is registered, or that has filed a registration statement, under the Investment Company Act of 1940. (3) SALES TO QUALIFIED PURCHASERS.—A security is a covered security with respect to the offer or sale of the security to qualified purchasers, as defined by the Commission by rule. In prescribing such rule, the Commission may define the term ‘‘qualified purchaser’’ differently with respect to different categories of securities, consistent with the public interest and the protection of investors. (4) EXEMPTION IN CONNECTION WITH CERTAIN EXEMPT OFFERINGS.—A security is a covered security with respect to a transaction that is exempt from registration under this title pursuant to—

(c) PRESERVATION OF AUTHORITY.— (1) FRAUD AUTHORITY.(2) PRESERVATION OF FILING REQUIREMENTS.(3) ENFORCEMENT OF REQUIREMENTS.

(d) DEFINITIONS.

***Rule 135c - Notice of Certain Proposed Unregistered OfferingsRule 147 - "Part of an Issue," "Person Resident," and "Doing Business Within" for Purposes of Section 3(a)(11)Rule 152 - Definition of "Transactions by an Issuer Not Involving Any Public Offering" in Section 4(2), for Certain Transactions

The phrase "transactions by an issuer not involving any public offering" in Section 4(2) shall be deemed to apply to transactions not involving any public offering at the time of said transactions although subsequently thereto the issuer decides to make a public offering and/or files a registration statement.”

Rule 155 - Integration of Abandoned OfferingsRule 477 - Withdrawal of Registration Statement or AmendmentRule 701 - Exemption for Offers and Sales of Securities Pursuant to Certain Compensatory Benefit Plans and Contracts Relating to Compensation

***Securities Act Regulation D (Rules 501-508)i - Rules Governing the Limited Offer and Sale of Securities Without Registration Under the Securities Act of 1933

Securities Act Regulation A (Rules 251-63) and Form 1-A – Conditional Small Issues Exemption

***Problem 5-22 – Non-accredited partnership

Issue: how many purchasers?o Rule 501(e)(2) – only 1 purchaser

“A corporation, partnership or other entity shall be counted as one purchaser. If, however, that entity is organized for the specific purpose of acquiring the securities offered and is not an accredited investor under paragraph (a)8 of this section, then each beneficial owner of equity securities or equity interests in the entity shall count as a separate purchaser for all provisions of Regulation D, except to the extent provided in paragraph (e)1 of this section.”

If organized only for purpose to “get around” regulation, then won’t be considered only 1 purchaser

Problem 5-23: Rule 506 purchaser is accredited Issue: how do we count his brother-in-law from the same residence

o True answer: prof. is unsureo Key: look at NOTE, p___

Whether count or not, must be either accredited or sophisticated

Manner of Offering: To whom is offer made? Who can purchase? Rule 506 – says can’t offer to those accredited or sophisticated; but can only sell to those accredited or

sophisticatedo At offering stage, cannot make general solicitation

Problem 5-24, p296 Stamped “for AI only”; is this a general solicitation? Issue: is this permissible approach?

o Rule 506 – no; Does he know all of them? If not, then general Prolly general solicitation unless know everyone – no pre-existing relationship; thus,

although the # isn’t large, it also isn’t trivial

Problem 5-25, p296

Broker-dealer uses suitability questionnaire; follows no-action letter and imposes 45-day waiting period between prequalification and offer. Client pre-qualifies on 2/1; on 7/1, firm wants of offer securities to client…is this ok?

o Note: Using net worth test or income testo Issue: general solicitation or permissible offer?

Classic ex of broker approaching potential investors to determine if qualify No general solicitation bc already gathered group together – id’d as eligible to participate,

and has had some contact already with broker-dealer

Problem 5-26, p297 Gather offering info from private placement memos – publish monthly newsletter to sell by subscription

to tax attys and accountants; No relationship to issuers, compensation only from subscription sales Issue: Problems under 502(c)? General solicitation?

o Key – to extent issuers are voluntarily feeding him info, then puts issuers at risk – because then part of larger general solicitation

o If issuers cooperate with publisher Like Rule 433 – if journalists write with cooperation with issuer, then creates problem; if

independent, then not an issue

Problem 5-27, p297 If all info from public sources – then NOT a general solicitation; no issue for issuer

Internet Creates new problems – idea: password-protect, so only can be accessed by those pre-qualified for

offering

Problem 5-28, p300 Broker has website with Reg D offerings; if attest to being AI, then can get PW and access all info on site Issue: is there an issue under Reg D?

o Can’t pre-qualify via self-qualification – someone has to review it to ensure you’re actually ok

Rule 135(c) – SEC says comparable to public offerings: Like a safe harbor – if you follow road map, and stay within a(3), then not deemed an offer If do this, then issuer shall file any notice under section with form 8-K – then public for all to see

o Restricted as to resale o NOTE: Must disclose material fact if:

1. ____2. If said something only partially true (§10(b)(5))3. If some fiduciary obligation to speak

2. Thus rule is not upon any material fact must disclose

Aggregation Issue under Rule 504 and 505

o Have to address BOTH aggregation and integration Deals with how many securities you can sell in a defined period

o Reduced by those sold under 3(b) exemption or under §5 (not registered and not exempt) Have to count to determine how much is left to be sold – independent of integration

Problem 5-29 Sold $5M from 1/1 to 4/1 When can issuer commence another offering when using exemption under §3(b)?

o §3(b) exemptions: Rule 504 and Rule 505 (so far) “Commission may from time to time by its rules and regulations, and subject to such

terms and conditions as may be prescribed therein, add any class of securities to the securities exempted as provided in this section, if it finds that the enforcement of this title with respect to such securities is not necessary in the public interest and for the protection of investors by reason of the small amount involved or the limited character of the public offering; but no issue of securities shall be exempted under this subsection where the aggregate amount at which such issue is offered to the public exceeds $5,000,000.”

o Rule 502(a) – integrationo Aggregation?

Rule 505(b)(2)(i) –“aggregate offering price for an offering of securities under this Rule 505, as defined in Rule 501(c), shall not exceed $5,000,000, less the aggregate offering price for all securities sold within the twelve months before the start of and during the offering of securities under this Rule 505 in reliance on any exemption under section 3(b) of the Act or in violation of section 5(a)”

Thus must wait until APRIL 1 of next year – then have $5M available also NO! Can do a 1-year look-back with rolling amounts of availability

Ex: Jan: $500K; 70 investors, 30 AI April: $2M; 25 AI So these aren’t offerings protected by safe harbor under Rule 502 Can be aggregated because still have $2.5M left to sell However, what if integrated? Same issuance, same security, same price, etc?

o If integrated, then single offering, then need single exemptiono What exemption works???

Rule 505 – no, too many AI (with 55) §3(a)(11)? All Ill. residents? §4(2)? All independent Look for exemption that will fit integrated offer

Note: aggregation can be issue, even if integration is not – and vice versa

CLASS #16: 2.9.11Problem 5-30, p305

1/1 – Rule 505 offering open until 6/1 – sells $4.5M 5/1 – Rule 504 offering – open for 2 months – sells $750K Issue: aggregation?

o Overlap – yes, but how? $5M – 3(b) – 5(a) Key – look on a rolling basis – if already sold $4.5M under 505, no room left under 504 Aggregation Rule: look back 12 months and during offering – tack on; for all securities

(not just of like type – different than integration)

Ex: 8/1 – 10/1 offering: under Rule 505 5/1 – 6/1 offering: under 504 NO integration problem - because under safe harbor of 502(a) with >6 months apart

o Note: If potential integration problem, then look at 5 factors (under 502(a)(a-e)):a) Whether the sales are part of a single plan of financing;

b) Whether the sales involve issuance of the same class of securities;c) Whether the sales have been made at or about the same time;d) Whether the same type of consideration is being received; ande) Whether the sales are made for the same general purpose.

Possible aggregation problem – if SOLD amounts >$1M have to check timeline of sale

KEY: If integration, then need SINGLE exemption; If so, then ensure it doesn’t fail aggregation test!

Rule 504, Note 2 – “If a transaction under Rule 504 fails to meet the limitation on the aggregate offering price, it does not affect the availability of this Rule 504 for the other transactions considered in applying such limitation. For example, if an issuer sold $1,000,000 worth of its securities on January 1, 1988 under this Rule 504 and an additional $500,000 worth on July 1, 1988, this Rule 504 would not be available for the later sale, but would still be applicable to the January 1, 1988 sale”

Ex: can’t have $1.2M sold under exemption – all elements have to meet the exemption; thus Note 2 only applies with second offering that will push over the limit – that only destroys the 2nd offering

No Note 2 under Rule 505 – but SEC has interpreted it there – applies to both

Problem 5-31 Sells securities under Rule 504 and determines meets std. for Rule 506 Issue: is this ok?

o Preliminary notes: “Attempted compliance with any rule in Regulation D does not act as an exclusive election; the issuer can also claim the availability of any other applicable exemption.”

Thus it is OK to switch to Rule 506 If needed, amend Form D

Disclosure No disclosure necessary under Reg D

Problem 5-33, p310 Issuer doesn’t file Form D – gets an injunction; wants to pursue Rule 506 offering Issue: this ok?

o No – violates Rule 507 – failure to comply with Rule 503 – disclosure requiremento If haven’t gotten caught and proceed:

Not good under Rule 506, but §4(2) is possible Note: people are sloppy with Form D, but do NOT do it! Disastrous if you get enjoined, and Dodd-Frank

has included “bad boy provision”:o If do something wrong and get caught, then can be excluded from exclusions in future

Problem 5-34, p313 Issuer completes $7M placement under Rule 506 – purchasers are 9 pension trusts (each as AI) – and 1

individual (with no pre-existing relationship, not AI, not sophisticated, no purchase rep); Trusts want rescinded, issuer claims substantial compliance under Rule 508

Issue: can they rescind?

Employee Benefits Exemption S-8: register sales of securities Only under Rule 701 for non-reporting companies

o Old authority - §3(b) exemption; thus limited by statute (now $5M0o New authority – NSMIA –

No longer §3(b) exemption Allows for sale of greatest of:

$1M 15% of issuer’s total assets 15% of outstanding securities of that class

NOT used to raise capital – only to compensate employees Not integrated with anything (no aggregation / integration issues – no longer

§3(b))o Only exemption from §5 (registration requirement); NOT exempt from truthfulness / liability

Problem 5-35, p318 Issuer has 10K shares of common stock and 5K preferred stock (1-to-1 convertible); wants to establish

stock option plan under 701; nothing under 701 in past 12 months – what limits?o Can include 15% of 15K – 2,250 shares option

Note: would have an impact if convertible ratio were different

Problem 5-36, p319 INSERT

Regulation A Another §3(b) exemption

o Thus capped at $5M Called “mini-registration” rule Only to non-reporting / non-public companies (like Rule 504 and Rule 701) Includes “bad boy rule” of disqualification (Rule 262) Sell up to $5M every 12 months Have to aggregate Reg A, BUT doesn’t allow anything else to count against it (ex: Rule 504 or 505) Limited application to existing security-holders:

o Can use Reg A up to $1.5M in 12 months; counts against $5M total under Reg Not integrated with any other offering, and not with subsequent registered offering or any other offering

that takes place more than 6 months after Reg A issueo Includes disclosure requirements for everyone

Note: Reg D disclosures a lot more robust than Reg D Unlimited # of purchasers Not restricted for resale Can use internet to reach potential investors (not so with Reg D – no general solicitations)

Rule 254(b)(2) – if going to test the waters, can’t make sale before offering circular has been sent; can only briefly describe issuer’s business

Sales can’t be made until offering is qualified and occurs 20 days after registration statement / offering circular is filed

CLASS #17: 2.14.11

Regulation A – scaled down version of registration process For non-public companies

Problem 5-38, p324

Issue? Rule 254(c) – this is ok

Problem 5-39, p324 Test-the-waters effort, decides to switch to Rule 506

Why is Rule 506 better?o No limit on amount – not restricted to $5M like in Reg A

Rule 254(d) – 30 days wait for registered offeringo Does this apply and protect issuer from Reg A to Rule 506?

Rule 251(c)(2)(v) – no integration if they wait 6 months Last marketed on May 1 – so have to wait until Nov. 1 to market new Rule 506 offering –

full safe harbor Why wait 6 months?

o Because with registered offering, everyone gets all info o But under Rule 506, not everyone gets full disclosureo Reg A – non-public companies

Problem 5-40, p324 Treat differently if Reg A vs. Reg D offerings? Need integration?

o Reg A can be $5M – nothing integrated with it Per Rule 251(b)

o Reg D – do have to aggregate anything sold under §3(b) in prior 12 months Rule 504(b)(2) - thus have to subtract Reg A offering

Offerings more than 6 months apart – so no integration problem; covered under full safe harboro IF not, then have to use 5-factor test from Kuntz

Rule 152 – “phrase "transactions by an issuer not involving any public offering" in Section 4(2) shall be deemed to apply to transactions not involving any public offering at the time of said transactions although subsequently thereto the issuer decides to make a public offering and/or files a registration statement”

Doesn’t destroy earlier exempt transaction; Non-public offering under Section 4(2)is not undermined by a later public offering

Rule 155 – “private offering means an unregistered offering of securities that is exempt from registration under Section 4(2) or 4(6) of the Act or Rule 506 of Regulation D.”

If start with private offering and abandon for registered offering, private offering not included if:o No securities were sold in private offeringo All activities were terminated before registration statement filedo And registration statement was not filed until 30 days after termination (unless offers were too all

sophisticated/accredited investors)o Have to make some disclosures

If start with registered offering, and can raise money without registered offering – so abandon registered offering – if want to take advantage of this – then have to:

o FORMALLY withdraw under Rule 477o Can’t do private offering until 30 days after withdrawal is effectiveo Must notify private offerrees that don’t get benefit of liability provision to those under registered

offeringo Doesn’t work the other way – Rule 504 or 505

Problem 5-41, p333 2/1 formation of company; 2/14 intrastate §3(a)(11) offering – raised $4M 7/1 – want to pursue Rule 506 offering for $5M Issues?

o Rule 502(a) – 6 month safe harbor, not met hereo Thus have to use 5 factors:

Single plan of financing?

Both plans include some component for working capital Same class of securities?

Both involve common stock Timing?

Shorter than 6-months, not at the longer end of the safe time period Same consideration?

Cash Same general purpose?

Likely same reason as factor 1, but clearly problematic

Problem 5-42, p333 What about if offer in September? If 505?

o Aggregation problem? Can only sell $5M under Rule 505 Rule 505(b)(2)(1) – do these need to aggregate? What about integration? Need single exemption (won’t work under Rule 505?)

Problem 5-43, p333 Registered offering, but before filing registration statement, cancelled offer; 2 months later – revive

offering under Rule 506 Issue?

o Rule 155 – have to follow all steps Formally withdraw under Rule 477 Wait 30 days Make necessary disclosures

What about if “conditioned the market?”

***CLASS #18: 2.14.11CHAPTER 6

Statutory Underwriter – under §2(a)(11) Broad – includes anyone who buys from issuer in intent to distribute securities

o “Any person who participates in offering, selling or underwriting process for issuer, and any person who purchases from or sells for a control person, …as part of control person’s distribution”

o Legislature: intended to cover anyone as conduit of getting securities into public hands §2(a)(11) – “term ‘‘underwriter’’ means any person who has purchased from an issuer with a view to, or

offers or sells for an issuer in connection with, the distribution of any security, or participates or has a direct or indirect participation in any such undertaking, or participates or has a participation in the direct or indirect underwriting of any such undertaking; but such term shall not include a person whose interest is limited to a commission from an underwriter or dealer not in excess of the usual and customary distributors’ or sellers’ commission. As used in this paragraph the term ‘‘issuer’’ shall include, in addition to an issuer, any person directly or indirectly controlling or controlled by the issuer, or any person under direct or indirect common control with the issuer”

CASE: SEC v. Chinese Consolidated Benevolent Assoc., 2nd Circuit, 1941 Facts: NY corporation selling $500M in 4% China gov’t bonds If the Chinese gov't had paid for an advertisement in the NYT, saying send us your money we will send you

a bond certificate, would the NYT would have been an underwriter?o Holding: YESo Not considered exempt transaction because as underwriter, no §4(1) exemption

SEC sought injunction because claimed unregistered offering

Problem 6-1, p344 Carl drafts brochure for offering, then provides emails to get offering distributed – gives him 500 shares of

offering stock; is he an underwriter?o §2(a)(11) – “direct or indirect” participation in sale – thus likely indirect participation in her

solicitation – makes him an underwriter

Problem 6-2, p348 Purchased 1K unregistered shares in private placement – wants to sell shares – does this violate §5?

o Change in circumstance after purchase within 2 years (“bendpoint”) as exception?

Problem 6-3, p348 Pledges worthless stock for loan, giving faulty financial statements – can bank now sell shares?

o NO! Shares have to be “for value” - §2(a)(3)o If not issuers, then exempt transaction?o Bank’s resale, because for Janice’s account, then no bona fide change of circumstances

Problem 6-4, p350 Burt acquired 1K shares – wants to resell; can Carol do this for him?

o NO change in circumstances – can’t meet investment intento Carol would be underwriter if sold for him

Problem 6-5, p350 OTC market – Burt wants shares sold in OTC market by Carol – does this work?

o NO – less than 2 years, no investment intent still

Distribution Not defined in Act, but key to §2(a)(11) – defined by SCOTUS in SEC v. Ralston

o Distribution = sales to those who cannot “fend for themselves”

Problem 6-6, p350 Burt becomes controlling person as “issuer” – but only for purposes for §2(a)(11)

o Carol becomes underwriter

PIPE Transactions Company will sell security in exempt transaction (ex: §4(2)) – agreement is shares sold will eventually be

registered for resale (either shares themselves or convertible shares)o Convertible preferred – converted into common – then registered for secondary offering

When buy convertible preferred, restricted (because bought in exempt transactions and sale is restricted – if sold, would be underwriter)

Shares thus sell at some discount because illiquido Hedge funds and others that buy PIPEs – once publicly announced that company has made sale in

exempt transaction (which it must do on form 8-K), then common stock market will dropo In anticipation of drop, hedge fund will borrow common shares from another, and sell with idea

that price will drop (i.e., sell short); buy back at lower price – make money Would deliver converted shares – SEC contended this was evasions of §5 – because really distributing

common shares that they indirectly requiredo Courts have ruled NO violation of §5, because shares provided were registered

Sold shares high before disclosure by using non-public info – THIS is an issue!o SEC sued Mark Cuban for insider trading on this issue

Control Person Distributions §2(a)(11) – “As used in this paragraph the term ‘‘issuer’’ shall include, in addition to an issuer, any person

directly or indirectly controlling or controlled by the issuer, or any person under direct or indirect common control with the issuer”

o One who purchases from, sells for, or otherwise participates, directly or indirectly, in a distribution of control person’s securities is an underwriter

CASE: US v. Wolfson, 2nd Circuit, 1969 Wolfson – controlling person, thus under §2(a)(11) considered issuer – any sellers on his behalf were

underwriterso Thus no exemptions available

§4(4) – only covers unsolicited sales We care because want public protected by disclosure

§4(4) – “brokers’ transactions executed upon customers’ orders on any exchange or in the over-the-counter market but not the solicitation of such orders”

Problem 6-9, p361 Alice wants Bob to sell 1/3 of her shares; issued 4 years ago in registered public offering Issues?

o Alice is control person – no exemption But acquired 4 years ago without view to distribution – but since CONTROL person,

functions like issuer for §2(a)(11) Thus broker is underwriter

Not entitled to §4(1) exemption because broker functions as underwriter

Problem 6-10, p361 Maybe new scenario makes Alice NOT control person – still sounds like need to comply with §4(1), thus

use Rule 144 o Maybe NOT control person now because no way to protect herself by causing shares to be

registered

***§2(a)(12) – “term ‘‘dealer’’ means any person who engages either for all or part of his time, directly or indirectly, as agent, broker, or principal, in the business of offering, buying, selling, or otherwise dealing or trading in securities issued by another person.”§4(1) – “provisions of section 5 shall not apply to . . . transactions by any person other than an issuer, underwriter, or dealer”§ 4(3) – “transactions by a dealer (including an underwriter no longer acting as an underwriter in respect of the security involved in such transaction), except—(A) transactions taking place prior to the expiration of forty days after the first date upon which the security was bona fide offered to the public by the issuer or by or through an underwriter,(B) transactions in a security as to which a registration statement has been filed taking place prior to the expiration of forty days after the effective date of such registration statement or prior to the expiration of forty days after the first date upon which the security was bona fide offered to the public by the issuer or by or through an underwriter after such effective date, whichever is later (excluding in the computation of such forty days any time during which a stop order issued under section 8 is in effect as to the security), or such shorter period as the Commission may specify by rules and regulations or order, and(C) transactions as to securities constituting the whole or a part of an unsold allotment to or subscription by such dealer as a participant in the distribution of such securities by the issuer or by or through an underwriter.

With respect to transactions referred to in clause (B), if securities of the issuer have not previously been sold pursuant to an earlier effective registration statement the applicable period, instead of forty days, shall be ninety days, or such shorter period as the Commission may specify by rules and regulations or order.

***Rule 141 - Definition of "Commission from an Underwriter or Dealer Not in Excess of the Usual and Customary Distributors' or Sellers' Commissions" in Section 2(a)(11), for Certain Transactions

***Rule 144 - Persons Deemed Not to Be Engaged in a Distribution and Therefore Not Underwriters

Not an exclusive safe harbor Purpose:

1. Provides adequate information to public2. Requires holding period – securities acquired in exempt transaction (restricted as to resale)

a. Relatively brief period, shortened over time (most recently in 2008)b. Buyer assumes economic risk, can’t immediately transfer to market

3. Limitation on # of shares to be sold within given time (no dumping) Pertains:

1. Affiliates selling restricted shares2. Affiliates selling non-restricted shares3. Affiliates selling through intermediary

Note: if no intermediary, and not restricted shares, then fit within §4(1)

Rule 144 Terms Affiliate = controlling person 144(a)(3) –

i. “ Securities acquired directly or indirectly from the issuer, or from an affiliate of the issuer, in a transaction or chain of transactions not involving any public offering;

ii. Securities acquired from the issuer that are subject to the resale limitations of Rule 502(d) under Regulation D or Rule 701(c);

iii. Securities acquired in a transaction or chain of transactions meeting the requirements of Rule 144A;iv. Securities acquired from the issuer in a transaction subject to the conditions of Regulation CE;v. Equity securities of domestic issuers acquired in a transaction or chain of transactions subject to the

conditions of Rule 901 or Rule 903 under Regulation S (Rules 901 through 905 and Preliminary Notes);vi. Securities acquired in a transaction made under Rule 230.801 to the same extent and proportion that the

securities held by the security holder of the class with respect to which the rights offering was made were, as of the record date for the rights offering, "restricted securities" within the meaning of this paragraph (a)(3);

vii. Securities acquired in a transaction made under Rule 230.802 to the same extent and proportion that the securities that were tendered or exchanged in the exchange offer or business combination were "restricted securities" within the meaning of this paragraph (a)(3); and

viii. Securities acquired from the issuer in a transaction subject to an exemption under section 4(6) of the Act.”

Rule 144 – Preliminary Notes Follow the rule – then NO distribution – no distribution, then NO underwriter

o “A person satisfying the applicable conditions of the Rule 144 safe harbor is deemed not to be engaged in a distribution of the securities and therefore not an underwriter of the securities for purposes of Section 2(a)(11). Therefore, such a person is deemed not to be an underwriter when determining whether a sale is eligible for the Section 4(1) exemption for "transactions by any person other than an issuer, underwriter, or dealer."

Rule 144 Application Chart, p365 – 366

o Issuer reporting company, for at least 90 days – sale by or on behalf of affiliate held for 6 months on day of purchase – can be sold if done in manner required by rule (key: sale by broker), and file Form 144 if sale above certain threshold in $ or # of shares

If not held for 90 days – then o Sale by non-affiliate of restricted shares

Held for at least 6 months, no info disclosed except required public info Can be made after 1 year with NO Rule 144 requirements

INSERT DATA FROM CHART

***CLASS #19: 2.15.11

Rule 144 Provides safe harbor for (i.e., no underwriter creation like in §2(a)(11)) §4(1), and thus can rely on §4(1)

exemption:o Resales on restricted securities (list from Rule 144(a)(3))o Sale by affiliate (“control securities” – restricted or non-restricted

Crucial rule – relied on by corporate execs who want to sell own company’s stocko Careful internal mgmt

Conditions of sale:o Adequate current public infoo If restricted, must hold for specified holding period before saleo Resale within volume limitso Resale complies with manner of sale requirementso Seller must file From 144 if amount exceeds specific thresholds

Problem 6-12, p372 Jeff owns 10K unregistered Apex common shares that purchased in private offering – wants to sell Issue?

o Rule 144(a)(3)(i) - Securities acquired in a transaction not involving any public offeringo If reporting company, must wait 6 months - 144(d)(1)(i)o If non-reporting, wait 1 year - 144(d)(1)(ii)o Not enough info to determine if sale could be made – array of questions

Problem 6-13, p372 If above was intrastate offering, then Rule 144 doesn’t apply

o Security not restricted (under Rule 144(a)(3))o Thus have to rely on §4(1) elsewhere

Problem 6-14, p372 18 months ago Zeta issued 2M common stock under Rule 505; attorney failed to track # of purchasers,

and had 47 non-accredited purchases in offer; Susan, unaccredited, now wants to sello Rule 144(a)(3)(ii) – includes Reg D offeringso Also not valid Rule 505 – 47 non-accredited, only allowed for 35 within rule

If valid 505, hold max 1 year (if non-reporting company) If not valid 505, should hold for 3 years (safe point) – irrebutable presumption that she

bought with investment intento Reasonable action: treat as if valid Rule 505, then sell in 6 months or 1 year (if reporting / non-

reporting)

Problem 6-15, p372 Bill, control person for Omega, negotiating to sell control block to Alice

o If no qualification as “restricted” under Rule 144(a)(3), then no holding periodo What are his other options?

Still under §4(1) Just a SALE, not a distribution – simply a sale by a controlling person to another; no

underwriter

Problem 6-16, p372 Bill hires broker through NYSE

o Rule 144(b)(2) – affiliates who sell restricted securities are not deemed underwriters within §2(a)(11)

Problem 6-17, p373 Alpha 5 months late in filing 10-Q; Carla owns Alpha restricted stock 7 months ago but wants to resell

o Rule 144(d)(1)(i) – 6 months for reporting company, but only if reporting in compliance within 90 days before sale!

o Thus must rely on Rule 144(d)(1)(ii) – 12 months for non-reporting company

Problem 6-18, p373 Beta – small public co with 150 stockholders but not subject to SEC reporting; just mailed holders most

recent financial statements; Dave has owned restricted Beta common stock for 11 months and wants to resell

o Wait 1 yearo If an affiliate, still have to wait 1 yearo Info requirements:

Problem 6-19 CEO wants to sell 10K shares from 5 months ago

o Affiliate (because CEO) – must deal under Rule 144(e) volume restriction and public info Non-restricted – so no holding period

o Limits on ability to sell using broker? Cannot use 4(1), but 144 says if you follow the roadmap then there is no distribution and

therefore 4(1) doesn't come into play

Problem 6-20, p373 John acquired stock in private offering – common stock in exchange for personal note – full recourse note

due on demand – 9% interest / year; options to sello Must meet Rule 144(d)(2) requirements

Must have to pledge collateral equal to the purchase price other than the securities Also did not fulfill third requirement which says that you must pay off the note first;

holding period does not begin until it is paid of Delivery of the promissory note here does not start the time period running

o Reason: Purchaser must assume the economic risk; he has assumed the risk to the extent that it is a full recourse note but not by actually paying the money

Problem 6-21, p373 17 months ago John pledged shares using loan proceeds to pay for shares – now defaulted – bank wants

to sell the shares

o Rule 144(d)(3)(iv) – pledged securities - deemed when acquired by pledgor

CLASS # 20: 2.16.11

Problem 6-22, p373 Mary is control person of Theta, acquiring shares in registered IPO; listed on NYSE – average weekly

trading volume is 150K, with 18M outstanding; during first 3 months of year, Mary sold 150K of her Theta shares, 50K each month. How many can she sell in April?

o Shares are not restricted, but Mary is a control person and therefore an affiliate, as a result her shares are going to be subject to the volume limits

o She was capped at 180,000 shares (1% of 18 million, which was the higher number), and she can sell that in any 3 month period which is a rolling 3-month period, so can sell 80,000 in April (50k in Feb, 50k in March, 80k in April)

Volume Notes Notes on volume test:

o Actually day by day for rolling 90 dayso Rule requires a bona fide intent to sell when you file form stating how many shares you’ll sell

Don’t have to file until first sale dayo If volume of stock goes up, can file an amended form and claim a larger amount

Hitch is that you can't use your own volume during that measuring period in order to calculate the average weekly volume

If number goes down as you move through the 3-month period covered on your form, that does not reduce your ability to sell (not adversely impacted if the market volume declines)

Problem 6-23, p373 Now before sale, Mary gives Cornell 120K shares – when can Cornell sell these?

o Quite common that when people donate shares, the recipient will sell them right away as a matter of course

o Rule 144(e)(3)(iii): Together, Cornell and Mary are subject to Mary's maximum; if Cornell is going to sell 120k shares in a 3-month period within 6-months of the donation then during that same 3-month period Mary can only sell 60k

This does not allow Mary to circumvent the volume limits that constrain volume sales by giving it to a donee and then having a donee sell the shares into the market

Problem 6-25, p374 Theta common shares are traded OTC; Mary has retained a broker to dispose of her shares over time.

Mary entered into a similar arrangement with a dozen other brokers, unknown to themo Rule 144(g)(4)(ii): Lays out the reasonable inquiry requirements for brokers' transactions,

including to make reasonable inquiry whether she is intending to sell additional securities, or whether such person has solicited or made any arrangement for the solicitation of buy orders in connection with the proposed sale of securities

Problem 6-26, p374 Mary will sell shares through broker in OTC market; also tells broker she’s selling 60K shares privately to

Tom; Tom is not sophisticated, but he and Mary negotiated directlyo Rule 144(e)(3)(vii): Includes what types of securities need not be included in determining the

amount of securities to be sold in reliance upon this section

Rule 144(e)(3)(vii)(C): Should exempt this transaction from being included as it is exempt under §4(1) given that even if Mary is an issuer, only for purposes of §2(a)(11), due to her control person status, she is not using an intermediary and therefore no underwriter

Rule 144A - Private Resales of Securities to Institutions Facilitates transactions by issuers w/o registration, but where issuer may not have capacity to carry out

transaction on its own Issuers to iBank resale to QIB (qualified investment buyers)

o Initial sale to iBank has to be exempt: either §4(2) or Rule 506o Resale – yes, looks like distribution – but Rule 144A allows for this secondary exemption

Problem 6-27, p380 FMACo. Needs to raise $70M by issuing 5 year bonds w/8% interest; shares are traded on NASDAQ

o Options: 1. Marge, CFO, will solicit 200 institutions (each with $100M+ portfolio size) to buy

unregistered bonds 2. Place all bonds with iBank first, and have them sell them

o Issue? Rule 506 does NOT work – only exemption for issuer Need Rule 144A to use bank as intermediary

Class # 21: 2.21.11

Class #22: 2.22.11

Problem 7-9, p416

Problem 7-10, p416 Rule 165(a) – as long as file written communication, can then make oral offers

o Before registration statement is filed, so long as what is in writing gets filed on a timely basis

Problem 7-11, p416 Alex acquires 10K shares after March 1 proxy vote solicitation – acquired on March 15, and rule is must

hold for 30 days prioro Rule 153(a) – prospectus must be delivered to those who are entitled to vote only

As defined under §5(b)(2) for purposes for 145A

Problem 7-12, p416

§3(a)(9) – transactional exemption that exempts transactions only by issuer from registration requirements, even though there is a sale for value in exchange for other securities for the issuer

For issuer exchanging with existing securities holders ONLY, with no commission or other payments madeo Unsolicited exchange

May be exempt from §5 – thus no registrationo If solicited $, then wouldn’t apply – cannot have sale for value

Problem 7-14, p421 Charter business: Smith leaves ½ shares to Irene and ½ to Carl, all common stock; Jones is other s/h

o Irene and Carl prefer not to be involved in mgmt; want preferred stock with dividend instead; are NOT sophisticated

o Issue? Someone else is being paid to solicit the shareholders, which arguably crosses the line and

obliterates the 3(a)(9) exemption

Problem 7-15, p421 Venture’s charter provides quarterly dividends for preferred shares; exchange on 11/15, instead of 10/1

as planned; because preferred shares not owned for full quarter when next dividend paid, agree to pay $5K

Problem 7/16, p422 Albert wants to raise $3M by issuing $4 non-redeemable preferred stock – funds to expand ops, issued

about same time as exchange offero Issue?

Rule 506 perhaps? Look to be issuing the same security, for cash, at the same time they are seeking the

exchange Does it matter that for one group shares are being delivered to the company, while the

other group will be providing cash to the issuer (different consideration)? Still integrated

Problem 7/17, p422 Irene sold 100 preferred shares through exchange to Ray; Ray’s interest piqued by Irene’s stockbroker

Sara, who pushed for sale in return for commissiono Issue?

Defeats §3(a)(9)? If Irene were affiliate, then issuer for §2(a)(11), then Sara is underwriter – may not be

exempt

***Chapter 8: EXEMPT SECURITIES

§3(a)(11) and 3(a)(9) – types of transaction exemptions

’33 & ’34 Acts – relate to disclosure In 1933, Congress deemed that certain issuers are ones that we do not have to worry about in terms of

the '33 Act, i.e. the governmento Other provisions in the '34 Act and changes in Dodd-Frank which will change the regulatory

scheme in terms of municipal securities Some of the other exemptions are driven by the fact that the securities in question are covered by other

regulators (i.e. state insurance regulators) Need to just be aware that this bundle of exemptions exist Section 3 is not complete protection from the provisions of the '33 Act

Materiality SCOTUS has defined materiality under the ’34 Exchange Act

o TSC Indus. (most important case) An omitted fact is material if there is substantial likelihood that a reasonable s/h would

consider it relevant in deciding how to vote Same idea applies in deciding whether to buy or sell securities

o Definition not very precise

o Plaintiff does not have to show that had the truth been disclosed your judgment would have been different; does not have to show that the fact was outcome-determinative but merely that it would have been considered important in deciding how to vote or whether or not to buy the securities

Alternatives:o Fact would have had actual significance in the deliberations of the shareholdero Would have been viewed by the reasonable shareholder as having significantly altered the total

mix of the information available Assess it in the context of what was already known and publicly available Objective test (reasonable shareholder) and try to figure out what the likelihood is that

the reasonable shareholder would have found it important In foresight, when client approaches asking whether some facts are material under Section 12(b)(20)?

o Must inform yourself fully on the company and relevant facts in order to help make that judgmento The lore and learning in the area comes from what went wrong in the cases brought by the SEC

and private plaintiffs who claim they were misledo Sometimes facts are found to be material even if the market does not move, question as to

whether market movement is dispositive Materiality questions are questions of FACT

o Not disposable on a motion to dismiss so if the question is materiality it will go to the jury

Class #23: 2.23.11

Rule 10b-5 “It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of

interstate commerce, or of the mails or of any facility of any national securities exchange,1. To employ any device, scheme, or artifice to defraud, 2. To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or3. To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security.”

CASE: Basic Inc. v. Levinson, 485 US 224, 1988, p590 Facts:

o People sold shares in Basic because it had denied that it was involved in merger negotiations; Basic was in on-going merger negotiations; Denied 3 times that there was anything

additional that was material Shareholders complained that they were misled by denials

o Private claim for damages under Rule 10b-5 Issue: Materiality question and Rule 10b-5

o Silence: FN 17, Absent a duty to disclose, silence is not wrongful Important because a lot of people have the idea that if a material event occurs in the life

of a company that it is legally obligated to disclose thato If you've made some statements, but by leaving something out you've created a material "half-

truth" then you can be in troubleo Does not impose the obligation to affirmatively speak when you are otherwise silent and there

is no independent duty Rationale: How do we know when a misstatement or half-truth is material?

o Probability Magnitude Test: Magnitude of the event if it were to occur plus the probability of it occurring

This occurs over a time-line, at any given time the probability-magnitude might be changing

o Court rejects option to simply disclose once agreed in principal to terms of deal; ease of application alone is not enough to justify ignoring the purposes and rationale of the disclosure requirements

Agreement in principal ignores standard of materiality Problem arose here because Basic chose to substantively respond to inquiries when it did not necessarily

have too Can Basic use confidentiality to justify their deception?

Court: Has nothing to do with materiality; confidentiality may be valuable in this setting but Basic blew its right to confidentiality or its opportunity to maintain confidentiality once it chose to substantively respond to the inquiries

Policy: This is a paternalistic regime in some respects in that information in the mandatory disclosure scheme is dumped on investors, but do not protect investors from other information that might either overwhelm them or cause them to make foolish choices

What should Basic have done when they got these inquiries?o If have always responded with no comment and consistently adhered to that, then would likely

have been ok

Problem 11-2: Company has a 10-K annual report due in a week, usual practice is to take last year's report, prior disclosures had said that its one and only plant had been owned in fee simple, but now Alice, in charge of disclosures, has learned that some years back there was an error in the property survey and in fact the plant is on the adjacent land owner's property, who is a competitor, but adverse possession will kick in in 3 months; on the other hand if competitor were to raise an issue it would render their one and only plant unusable for a year while they knocked down the part that encroaches and refit the equipment on the interior. If Alice files the 10-K, due in a week, that says the property is owned in fee simple, is that a material misstatement?

Section S-K requires you to describe any major encumberance of some personal property Tough evaluation on probability-magnitude scale with extremely small probability but tremendous

magnitude

CASE: Weilgos v. Commonwealth Edison, 892 F2d 509, 1989, p600 ComEd was sued because it included estimates of its construction costs in its S-3 for a shelf-registration

for bonds they were selling, and turns out their projection was wrong Issue: Was their erroneous projection materially false?

o Court: No, a reasonable investor would have known that the estimates and projections were not reliable, and would not have relied on them

Projections were NOT material to their investment decision Court is dealing with the "total mix" argument: Did the projects alter the "total mix" of

information? Easterbrook: Part of the total mix is that everyone always knew that these

projections ALWAYS turned out to be wrong P.603 – 604, “truth on the market” doctrine mentioned by court

Voting: Different presumption, fraud on the market hypothesis does not hold because you are not operating in a

market When you are voting you are not influenced or impacted by anyone else's voting

o May be impacted by some other information that is not in the proxy statement, but not by other people's transactions (votes) so there the total mix theory works but concept of fraud on the market does not work in the same way

Puffery When the statement that is challenged as materially misleading by the plaintiff, if the statement is so

vague and general so as not to be the kind of thing that anyone would rely on, those are held not materialo One area where courts can and do grant summary judgment for defendants

Subjective Statement of Opinion “We believe…” Will not usually support a claim that it was material, even if it was falsely held, in part because courts

likely do not want to get into the area of judging good faith and beliefs Only to the extent that the subjective opinion conveys some objective fact underlying the opinion, then it

can be the basis for a claim

Staff Accounting Bulletin (SAB ’99) There is no absolute rule of thumb that tells you when something is material or not SEC: Lists reasons why small amounts of earnings, if misstated, could be material

o Can be material if it masks a change in a trend of earningso Effects the registrant's compliance with a regulatory requiremento Effects the registrant's compliance with some contractual requirement

NOTE 17: A known misstatement may result in a significant positive/negative market reaction and that expected market reaction should be taken into account in determining whether that known misstatement is material

o Converse is not true

Rule 12(b)(2) What else do we have to say so that what we do say isn’t a half-truth?

o Inside and outside lawyers spend a great deal of time wrestling with this problem

Projections Soft vs. Hard Info

o Most typically earnings projections and other matters relating to the future of the company Called "soft information" "Hard information" are the facts and historical information that are certain

Securities laws seem premised on the ECMH; if there is soft information out there, the market does reflect that

o Investors: Soft information (projections) is much more important than historical information Where soft information does not come true, companies often get sued

o In 1995 Congress raised the bar in maintaining the type of lawsuit in Basic because companies got sued so many times when their projections were wrong

Info Safe Harbors SEC first tried to deal with this liability issue by adopting two rules, which were intended to be safe

harbors with respect to statements related to the future Rule 175 of ’33 Act Rule 3b-6 of ’34 Exchange Act

o Statement within the coverage of paragraph (b) (forward-looking statement, term of art) shall be deemed not to be a fraudulent statement unless it is shown that the statement was made or reaffirmed without a reasonable basis or was disclosed other than in good faith

Problem in the real world is that if a company was sued for making such a statement, there would be no way on the fact of the complaint that was filed that the company could get a dismissal

When these allegations come up, often look to whether the forward-looking statement was misleading

More recently: statutory interpretation / safe harbors

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