Securities Regulation Outline

Introduction to Securities Law

Why have Securities?
Starting with East Indian Company, companies became too large for one person to finance, so
people bought share certificates to own a piece of the company.
Now there are no certificates because DTC holds all of them. Brokers call DTC to make trades.
The SEC is there to protect unsophisticated investors from being taken advantage of in the stock
marketplace by big investment banks and sophisticated investors.
If there was no protection, ordinary investors would lose confidence in the marketplace being
a level playing field and a big source of capital markets dries up which hurts the economy.
The marketplace lowers transaction costs, so without the public it will lead to much higher
transaction costs for every attempt to sell the securities.
SECmission: protect investors, maintain fair, orderly, and efficient markets, and facilitate capital
formation.
Organization: 5 presidentially appointed commissioners, 4 Divisions
Division of Corporation Financereviews filings of publicly held corporations
Division of Trading and Marketsday-to-day oversight
Division of Investment Managementreviews disclosure of investment funds
Division of Enforcementrecommends investigations, actions, and prosecutes cases
Division of Risk Strategy and Financial Innovationdeveloped after 2008 crash; analyzes
new market trends for risks to the market.
Responsibilities: Interpret fed securities laws; issue new rules and amend existing rules; oversee
inspection of securities firms, brokers, investment advisers, and ratings agencies; oversee private
regulatory orgs in securities, accounting, and auditing fields; and coordinate with foreign law
3 Types of Securities Offerings
Registered (Securities Act)
Exempt
Private Placements
Rule 4(a)(2)
Rule 506
Rule 144A
Intrastate Companies
Limited Offerings and quasi-private placements
Reg A
Reg D (Rules 504-506)
Offshore (Reg S.)
Resales (144, 144A, 4(a)(1))
Illegal
Recent Trends in Security Litigation and Transactions
Sarbanes-Oxley made it very expensive to be a small public company
This means that there are fewer deals, but more, larger deals.
More lawsuits today over mergers.
Many of these are aiding and abetting suits against officers and other companies involved
because the actual company may be bankrupt if it is in this kind of trouble.
Going Public can happen in two ways
1. Public Sale of Securities (IPO)this requires Registration under the Securities Act
2. Gain Public Company Statusthis requires registration under the Exchange Act
Widely Held: 2000 shareholders of record or 500 unaccredited SH of record
Done a public offering

 Elect to be public.
Benefits of going public: capital is easier than getting private investors, liquidity increases if
shares can be sold on market, risk shifting/cashing out, prestige, reputation, credibility.
Costs of going public: offering cost (7% underwriter commission, legal, printing), time of
management, liability possibility, diminishes control unless you make separate classes of stock,
efficiency issues (usually sell for less than it is really worth).
Factors for whether you should go public:
Companys Size$20MM in annual sales and $1MM net income in current year
Financial Ratios and Historic Performancedebt-equity ratio, liquidity, debt coverage
should all be in line with industry average; need 12 to 15% growth per year.
Current Managementhigh-quality executives with broad experience.
Public Appeal of Businessgrowing industry, be an industry leader or have a niche.
Market Conditions
Steps of an IPO on page 32 of the book.
What is a Security?
Anything can be a security if its an investment where you expect to earn profits on labor of others.
SEV v. W.J. Howey Co. shows how oranges can be a security.
Investors bought land on orange farm.
With the land investors purchased service contract in which Howey would take care of
the land and distribute profits to the investorsdeemed to be security in orange field.

 Securities Act of 1933truth in securities law

Objectives
Require investors receive info concerning securities being offered for public sale (disclosure)
Prohibit deceit, misrepresentations, and other fraud in the sale of securities (anti-fraud)

Definitions

Securities (2(a)(1))provides a long list of instruments and such + investment contracts

4 part Test

What is the item in question?

Name of item is not dispositive

If a stock entitles you to an apartment in a housing project, it is not likely a stock
unless it is traded like a stock.

Look to Section 2(a)(1) list

If it is not listed, is it an investment contract?

No meaning of investment contract, so courts have created a test.

Basic question is if mandatory disclosure rules would be useful in court.
Howey Test:
Investment of Money
Noncontributory, compulsory pension plan is not an investment
Laborer is selling his labor as a way to make a living, not an investment.
With Expectation of Profit
Profits = capital appreciation resulting from the development of the initial
investment or a participation in earnings resulting from the use of
investors funds.
If instead, purchaser is motivated to occupy the land purchased or use the
item for some sort of consumption, it is not for profit. United Housing.
Fixed return does not preclude it from being for profit. Edwards
$7k to buy payphone and immediately lease it back for $7k+14%
Looks the exact same as a debt agreement, so it is a security.
In Common Enterprise
Horizontal Commonalityother investors are similarly situated so there is
some privity between you.
If there is only one investor, he will do his due diligence and gather as
much info as possible on the company
If there are many similar investors, company doesnt want each one
coming through its doors and going through its files.
If investors are the public, not sophisticated enough to coordinate.
Instead the company does the diligence and reports it for them.
Vertical Commonalityinvestors fortunes align with company
Somehow must be in privity with issuer.
A little redundant based on 4th criterion.
Issuer has info that investor needs, makes sense to force disclosure.
Two formulations by courts
1. Strict Vertical Commonalityfortunes of investor linked to
fortunes of promoter or third party.
2. Broad Vertical Commonalityfortunes of investor linked to efforts
of promoter or third party.
Koscot says even if it is your own efforts creating it, if your efforts
are based on higher organizational efficacy, then that is enough.
(fraud cases make bad results)

Solely from the efforts of others

Efforts cannot arise before the time of the sale. Must be post-purchase
efforts.
Life Partners involved a company picking life insurance policies before
selling pieces of the pie. Investors could research who is in the pie.
Ministerial Functions (collecting policy, distributing money, etc.) is not
important for security definition. Efforts must be entrepreneurial and pospurchase.
Ministerial versus Managerial Efforts
If it is not listeddoes context otherwise require it not to be a security?
Bank accounts are an example. Although they fit the other aspects of this
(especially because fixed returns arent an issue), insured by the FDIC, regulated by
federal government in other waysdisclosure isnt as necessary.
Sale of Business Doctrinewhen a corporate business is sold by means of a sale of
the corporations stock, the stock is not a security as the term is used in the Act
Landreth Timber rejected this rule. Stock is stock.
Would require all sales of businesses by stock sale to meet registration
requirementsvery illogical.
Reeves 4 factor test for whether a promissory note is a Security
Purpose of the Transaction
Seller: raising money for capital; Buyer: make profitsecurity
Facilitating a transaction (purchasing inventory on credit, buying a car on
financing)not a security
Plan of Distributionspeculation or investment?
Determines how widely a note will be traded
If it is held for speculation, more likely to be traded and 3rd party needs
source of information, so more disclosure is good.
If it is held for investment, it will stay a one-one transaction and buyer can
get his own information.
Reasonable Expectations of Investing Publicwould the public think that
the purchase they are making is regulated by federal securities law?
Other Regulatory SchemeFDIC, Banking Regulations, etc. reduce need
for disclosure because they are already being handled by other scheme.
Evidence of Indebtedness is another mushy term used in definition
Refundable airline ticket not an evidence of indebtedness. Not a primary obligation to
pay a sum of money. U.S. v. Jones.
CD is not a security because banks are insured and heavily regulated. Marine Bank.
Sale of a Franchise is a security because you could cash it in and get your deposit back.
In re Tucker Corp.
Swap agreements two creditors exchange interest rates so one gets a fixed rate for
more stable interest and the other takes a floating rate with more risk.
Proctor and Gamble says not a security because evidence of indebtedness requires
payment of principle.
2A of the 33 Act specifically excludes individually negotiated swap
transactions from definition of security. However, left open for courts by excluding
any note, bond, or evidence of indebtedness that is a security from the definition
Credit Default Swapsbuyer pays basically insurance premium to seller. Seller
insures buyer in case of bond failure. If the financial outlook of the bond turns sour
(because company isnt doing well), CDS worth more and can be resold on market.
Neither party needs to hold the underlying debt when transaction entered.

Debt vs. Equity

Debt (e.g. loans, notes, debentures, indentures): company is a borrower, creditor gives
the borrower cash.
Company sells a $1MM IOU to a company for $800k.
Equity has right to the residual, so it is given to an investor, not a creditor.
Equity-holder has interest in how company actually does, because they only get
share of residual profits. NO GUARANTEED AMOUNT.
Creditors get paid first, then equity holders get what is left over.
Unlimited upside, but nothing until creditors are paid in full.
BOTH ARE SECURITIESonly need some profit-seeking interest.
Asset-Backed Securities
Securitization solves the problems that arise when trying to sell a collection of assets.
Too expensive to buy all of them.
Too risky to buy any individual one.
Create Special Purpose Vehicle (SPV) that owns all of the assets.
SPV gives a note for value to the owner, and the owner transfers the assets.
SPV then issues bonds and bondholders give the SPV the money to pay off the note
Decreases the risk because bonds are guaranteed debt rather than risky asset
As income from the asset comes in (royalties, mortgage payments, etc.), use
income to service bondholders.
Purpose of the SPV is to limit liability on the true owner.
Prospectus (2(a)(10), Rule 430) any written offer, offer by radio or television, or confirmation
of sale.
10(a) prospectus is complete with no blanks. It includes the info on the registration
statement.
10(b)/Rule 430 preliminary prospectus allows some blanks in the waiting period for things
like price and other things that arent decided. Rule 401 directs a company to the correct
form.
Free Writing Prospectus (Rule 164/433)Allows updates and fixes for mistakes and omissions
in prospectus, but it must have a legend and be filed.
If you follow 433 you have a 10(b) prospectus.
If you are a WKSIonce filed 430 prospectus, the issuer can freely use FWP
Non-reporting and unseasoned issuers it depends on if issuer prepared or paid for the FWP
If yesthey must accompany or precede it with a 430 prospectus
If nodont need to accompany or precede by a 430 prospectus
433(f) gives an exception for FWP prepared by bona-fide media.
433(c) governs content.
Offers (2(a)(3))every attempt or offer to dispose of, or solicitation of an offer to buy, a security
or interest in a security, for value.
Any statement, written or oral, that conditions market for the issuers securities is an offer.
Securities Act Release No. 3844 introduced conditioning concept and gave examples.
Loeb, Rhoades makes press releases about issuer a public offer. As a result, Release 5180
provides issuers with guidelines for press releases in pre-filing period that advise against
forecasts, projections, or predictions relating but not limited to revenues, income, or earnigns
per share and publishing opinions concerning values.
Exception for Offers and Sales if it is preliminary negotiation with underwriter for purposes
of 5(c). However, this doesnt apply to dealers who hold onto the security for their own
portfolio, so underwriter must purchase with a view to distribute the security.
Sales (2(a)(3))every contract of sale or disposition of a security or interest in security, for
value.

Disposition can be broader than a final contract of sale.

In re Franklin, Meyer & Barnett: putting yourself in the position to cash someones check is
enough to be a sale.
Acquisitions
Commission formerly used form over substance analysis saying stock-for-stock mergers
were sales, but stock-for-assets were not sales of securities.
Release 5316 changed course and paved the way for rule 145.
Now if securities are exchanged for assets and provides for dissolution of asset-selling
companysale of securities.
Rule 145
Submission to vote to SH of a merger = offer to sell/sale.
Release 5463acquirer can elect to use private placement exemption instead of
registering the securities if he is acquiring a private company, but not a public company.
Spin OffsCompany sells bad asset to a wholly owned subsidiary, then distributes shares in
the subsidiary to its SH. Result is publicly traded company that has no disclosure and a bad
asset.
1997 Staff Legal bulletin provides a 5 factor test for whether this is deemed to be a sale.
If you meet all 5 factors, then this is not a sale:
Pro-rata distribution to SH
No Consideration from recipients
If you are paying consideration, you are giving something up and making an
investment decision
If you are making an investment decision, securities law would help you
Adequate information provided about spin-off and spin-off company to its SH
and to the public.
SH might go sell to someone else who is making an investment decision
Must have some disclosure if trading securities.
Valid Business Purpose
Main VBP is to get an asset off of your books
Datatronics was merely facilitating private companies going public without
registering under the act.
2 Years no sales on Restricted Securities (now 1 year under rule 144)
Issuer (2(a)(4))every person who issues or proposes to issue any security.
Many exceptions apply.
Types of issuers
Non-reporting issuer (company doing an IPO)
Unseasoned Issuerrequired to file reports under Exchange Act/voluntarily doing so,
but they are not seasoned issuers
Seasoned Issuer (Rule 433(b))filed reports under Exchange Act for at least 12 months
and either have $75MM equity or offering investment grade non-convertible debt.
Well-known Seasoned Issuer (Rule 405): Google, MS, IBM, etc.
$700MM common equity held by non-affiliates or issued for cash >$1B of
registered non-convertible securities other than common equity in last three years
Emerging Growth Company (JOBS Act 2(a)(19)))
Underwriter (2(a)(11))Purchase securities from issuer with a view to distribution of such
securities.
Types of Underwriting
Firm CommitmentUnderwriter (and its syndicate) purchase securities from the firm at
an agreed price and distributes it amongst the syndicate at agreed percentage allocations.

The syndicate then sells the securities to the public and makes a profit or loss based on
its percentage of the block. The head underwriter gets a fee from the proceeds.
Best EffortsUW sells the most that it can (less risk to UW)
Standbycorp. offers securities to existing SH, those that arent purchased are bought
by UW. Variation of firm commitment.
Broad use of issuer in the definition to include control persons
Dealer (2(a)(12))
Distinction between dealer and broker: in the industry, despite what Securities Act says, a
dealer trades for his own account and takes title before selling while a broker serves as an
intermediary and never takes title to the stock.
Emerging Growth Company (2(a)(19))Company with revenue of less than $1B
Allowed to file confidential registration statements so no one will know if you change
something or withdraw.

Registration for Public Offerings of Securities

Must make all material information available to the public when you are making a public
offering of securities.
33 Act has mandatory disclosure requirements, forms of disclosure, and prohibitions on
other disclosures.
First a company must file a registration statement, and then once it is made effective by the
SEC, they can sell securities.
General information required by registration statement
Description of properties and business
Description of security to be offered for sale
Info about management of company
Financial statements certified by independent accountants.
3 PeriodsSecurities Act 5 (CHART ON PG 79)
Pre-filing Period 5(a),(c)no offers or sales of securities before registration statement
filed.
Non-reporting Issuer
Allowed
Preliminary negotiations and agreements with underwriters
Exception put in 2(a)(3) to offers and sales for the purposes of 5(c)
Rule 135 Communications
Allows purely informational statements explaining an offer is taking place.
Only allows for when and where it is happening, manner and purpose.
No substantive information is allowed, not even name of UW.
Legend: statement that it does not constitute an offer of securities for sale
Rule 163A Communications
Communications that dont mention the offering, but might condition the
market in some waycan wait 30 days and fit in this safe harbor.
If your statement mentions the offering, there is no bright-line rule and
you dont know how long you have to wait. May never be able to make
the offering.
Still must take reasonable steps to stop further dissemination of
statements.
Doesnt apply to certain communications under 163A(b)
Rule 169 Communications
Regularly released factual information in the ordinary course of business
will not violate 5(c)
Major question here is if youve released similar statements in the past.

Level of subjectivity on the part of an SEC investigationif you intended

this to condition the market, they will likely find it did.
Can post company updates to websites, but just prior to an offering it
looks bad.
Unseasoned and Seasoned Issuers
May do all the same things as a non-reporting issuer PLUS
Regularly-released forward-looking information under Rule 168
Special privilege for public companies allowing them to make a statement
about the future of the company
Formerly prohibited, but this is information investors want to value the
company with b/c past information doesnt help much with how the company
will fare next year.
Seasoned Issuers can file on form S-3 which is also known as a shelf offering and
allows them to have registration statements ready in advance
Well-Known Seasoned Issuers (defined in Rule 405)
May do all the same things as unseasoned/seasoned issuers PLUS
May make oral offers at any time (Rule 163)
May give free writing prospectuses at any time without accompanying or preceding
them by any other prospectus (Rule 163).
Legend
Retained for 3 years
Be filed with Commission
Although they can make oral and written offers at any time, WKSI still liable for
fraudulent statements.
Emerging Growth Companies
Test the waters with QIBs and AIAs (5(d))
Research Reports by broker/dealers are ok (2(a)(3))
Waiting PeriodSEC reviews your registration statement.
Only 5(a) and (b) apply here. 5(c) is done.
Oral offers are now allowed. Written offers are not unless they are 10 prospectus.
Giving presentations is ok, but you couldnt give out copies afterwards. Any
recorded medium is not okay unless it is a 10 prospectus. (5(b)(1))
Allowable activities
Non Reporting
Oral Offers are now allowed.
Preliminary negotiations and agreements with underwriters
Rule 134 Communication
Section 10 Prospectus
Preliminary (Section 10(b) and Rule 430)
Summary (Rule 431)
Free Writing (Section 10(b) and Rules 164/433); must be accompanied or
preceded by preliminary prospectus.
Issuer must distribute prospectus to UW to have RS accelerated. Release 4968.
Brokers and UW must distribute preliminary prospectus according to R. 15c2-8
Unseasoned Issuers do not have to deliver a prospectus with offers according to
15c2-8 because they are already a reporting company, so they have public
information.
Seasoned Issuers dont have to send a prospectus with or before a FWP under
433(b)(2)

 Well-Known Seasoned Issuers have no waiting period. Sales are available

immediately after filing the registration statement.
Post-Effective Period
5(a) no longer applies so issuer can sell securities now.
Permissible Communications
5(b)(1) says any prospectus must be 10 compliant.
R. 430 doesnt apply nowpreliminary prospectuses arent 10 compliant
Manor Nursing says if too much incorrect infoit isnt 10(a) compliant.
1st circuit adopted this, but the 5th circuit did not
Could argue if its misleading, fraud claim is better than SEC enforcement
action.
If you make fraud a Sec. 5 violation, Sec. 11 is redundant.
Generally updates to the prospectus will be made with a 424(b) prospectus
Free Writings are still allowed under Rule 433, but if you are a non-reporting
company you must still accompany or precede FWP with a 10(a) prospectus.
2(a)(10)(a) says this is not a prospectus if accompanied or preceded.
Rule 134 Tombstone Ads
Ads for sale of security in a newspaper
Can only describe general nature of the markets and strategies.
Need disclosures: risks, no past or projected performance figures, no
recommendation to purchase or sell is made, dont reference specific stocks.
Delivery and Confirmation
5(b)(2) requires delivery of security to be accompanied or preceded by 10(a)
prospectus
R. 172(a) exempts confirmations from being prospectuses if the
confirmation is limited to the information in R. 10b-10.
R. 172(b) says that access is the same as delivery. Hyperlink works.
That doesnt apply to FWP or offers though. Those still need to be
A/P by 10(a) prospectus.
R. 173 requires delivery of a prospectus or notice within 2 business days
of confirmation for UW and dealers.
Confirmation of sale is a prospectus. Required under 34 Act R. 10b-10, but dont
need to be accompanied or preceded b/c of notice under R. 172. (R. 173).
Weird thingno need to see prospectus, just receive it (even after purchase).
Release 7856 says customers can consent to e-delivery in which case posting a
hyperlink to the prospectus can be enough. Rule 433 says the same for FWP.
Disclosure RequirementAll Material Information must be disclosed
How to make disclosures depends on the type of offering
Initial Public Offering (IPO)first time issuing securities
7 says what must be included in the registration statement
Look at forms instead of Schedule A (Rules 130, 401)
If it is not a shelf offering, must use Form S-1. If shelfS-3.
8 deals with when registration statement becomes effective (sort of)
Although it says it takes affect after 20 days, Rule 473 allows SEC to delay
effectiveness automatically.
SEC makes issuer add language that says if this is to become effective, it is
amended to not become effective yet. ResultMust ask SEC to become effective.
SEC can accelerate effectiveness under 8(a) and R. 461.
Completely at their discretion
Dont want to challenge SEC on this.

Shelf Offeringallows company to have a registration statement waiting for when they want
to offer again. Faster alternative.
Rule 415 controls shelf offerings
Limited to certain offerings. 415(a)(1).
If not an S-3 issuer (non-registered issuer) then there is a 2 year limit.
S-3 Filer must be:
Public Reporting Company
Have been one for at least 12 months
More or less a seasoned issuer.
Rule 430B allows a base prospectus to leave out info and include it in a later
supplement when you are ready for a shelf takedown
Process
File S-3 with SEC as a base prospectus
May go through notice and comment in SEC
Declared Effective
Wait until market looks good for selling the securities
File a 424(b) pricing amendment then you sell.
Automatic Shelf Offeringno need to wait for the registration statement to be effective. As
soon as the company files the base statement it is effective.
Defined in Rule 405
462 says it is effective upon filingno waiting period
Unless SEC notifies of an objection, RS will be deemed on the right form.
430B(a) says you only need to specify a class of securities, not amount/price
What must be Disclosed? Reg C (400s) gives mechanics.
Rule 408 requires all material information necessary to make the statement not misleading.
Materiality and Valuation must be disclosed
Materiality is determined by Efficient Capital Market Hypothesis (ECMH)
The price of a stock is the public valuation of all information
That means if price changes, the information was important to investors.
Materiality means anything that a reasonably prudent investor would care about, so
a change in price means the information was material.
Supreme Court adopts ECMH in Basic v. Levinson
Valuation is determined by discounted cash flows
(amount in year one)/(1+discount rate)^years from now
Also called Fundamental Analysis.
There are many explicit prescriptions
Forms (S-1 and S-3)
S-1 is for non-reporting issuers because they just cant use anything else.
S-3 is for seasoned issuers. Allows more reference to other forms that they have
disclosed on.
Public Companies for at least one year and timely filed your reports.
F-1 is an S-1 for foreign companies
S-4 is used for M&A transactions
Reg S-K incorporates corporate information.
Reg S-X incorporates a lot of accounting materials. GAAP standards.
SEC can determine more disclosure is necessary after review and comments.
There can be liability for material omissions in disclosure.
Forward Looking Disclosures
Formerly frowned upon by SEC, but now they are being more encouraged because it is
what investors want.

Management Discussions & Analysis (MD&A) required.

Public Securities Lit. Reform Act (PSLRA)safe harbor for meaningful cautionary
language (actual risks), but not for IPOs.
Upbeat Drafting
Universal Camera shows that SEC hated upbeat prospectuses
Now SEC is less negative, but still dont like it.
Must still disclose material risksneed to be specific: risky or speculative doesnt
cut it.
Other Rules
Make front and back cover pages, summary, and risk factors in plain EnglishR. 421
Forward-looking disclosure must be based on reasonable dataR. 175 (hard for courts)

Registration Exemptions

Private Placement4(a)(2)
4(a)(2) exempts transactions by an issuer, not involving any public offerings
What is a public offering?
Ralston Purina says that there isnt a limit on the number of people, they just have to be
informed.
Public does not mean open to the whole world.
Limiting the offer to key employees is not a good enough limitation because
employees are just as uninformed as general public.
More sophistication in the limited classless disclosure required.
Release 4552
Who the offerees are matters, not just who the purchasers are.
Securities must come to rest with the purchaser. If purchaser acquires the
securities with a view to public distribution, seller assumes risk of possible violation
of the registration requirements.
Not strict liability for the issuer here.
Look to see what issuer did/could have done to stop this.
Maybe put a legend on the contract so any buyer might see it.
UW status is deemed if purchased from an issuer with a view to distribution.
Integration
Single plan of financingtrying to finance one item with both sales
Same class of securityone class of stock makes them all fungible. But if PP
and S-1 sale are of different classes, they cant be exchangednot integrated.
Easier to make non-fungible debt than non-fungible securities
Debt, just make different interest rates and different terms.
At or about the same time
Same type of consideration received
Offerings made for same general purpose
ABA Position Paper found decisions to rest on 5 factors (based on Purina and 4552)
Sophistication
Limitation on offerees needs to be based on some level of sophistication
Can give the class of offerees a representative to make them sophisticated
Informationmake people sophisticated by educating them in the company through
disclosure
Manner
Cant condition the market to make non-sophisticated people want them by
sending out a mass advertisement saying only available to sophisticated buyers

Integrationif you do a private placement contemporaneously with a public

sale of securities, the two transactions are integrated and your private sale
becomes an illegal pre-filing public sale.
Redistribution
Number of Offerees
Accredited Investor Offerings4(a)(5), Reg. D & Rule 506
4(a)(5) exempts sales that are only to accredited investors when aggregate offering price is
less than $50MM (maybe $5MM?)
Accredited Investor = $1MM of net worth or $200k of income ($300k w/ spouse)
REG D
Rule 506 operates as a Safe Harbor for private placements
CHART ON PG. 215
Rules 504 and 505 are exemptions, but not safe harbors.
Structure
Rule 501 provides definitions including Accredited Investor
501(e)accredited investors dont count for the 35 person limit in 505 and 506
Rule 502 provides certain requirements to qualify for Reg D exemptions
502(a)Sixth-month safe harbor of six months
502(b)must furnish registration-type information to non-accredited investors
If accredited, no need to send any information
More of a reason to limit to only accredited.
502(c)No general solicitations are allowed.
502(d)Need to take reasonable care to prevent purchaser-resale
Disclosure of non-registration and restriction
Legend
Rule 503 requires filing notices of sale on Form D.
Rule 504Chart on 215
Rule 505Chart on 215
Rule 506
No aggregate dollar limitation for sales.
506(b)Can sell to non-accredited investors, but they must be knowledgeable
and experienced and fewer than 35 of them.
506(c) General Solicitation allowed if:
All purchasers are accredited
Reasonable steps are taken to verify accredited status if:
IRS form from last two years & representation of expectations in
contract
Wealth: bank/brokerage statementconsumer report of liabilities
Representation of prior reasonable steps by registered broker/dealer,
investment adviser, attorney, CPA
For offerees prior to effective date, offeree certification.
Stated in Form D if using 506(c) or not
Not a bad actor
506(d) says what a bad actor is
Exchanges3(a)(9)
Security Holder 1 trades a 5% 1 year note for a 9% 3 year note.
Security holders are the same as before and arent paying someone to solicit for them, so no
disclosure required.
Intrastate Offerings3(a)(11)
Release 4434

an issue is subject to integration with an issue that is interstate.

Doing business within a state requires substantial operations
Residence is not established by presence or representation and the securities must come
to rest in the state. Need to do a lot to ensure that.
Safe Harbor in Rule 147
Six month Integration safe harbor for 4a2 and Sec. 3 exempt deals
Doing business if:
80% revenues/assets/net proceeds derived from that state
Incorporated in that state AND
Principle office is in that state
Person resident if: principle office/residence is in that state
9 month in-state resale rule: legend on certificate, stop transfer instruction, and written
representation of residence.
Offshore ExemptionReg S (Rule 901-905)
Release 4708Registration requirements dont apply to offerings reasonably designed to
come to rest outside of the United States
Safe Harbor if security is sold in foreign exchange, seller believes buyer is outside of the
US, or resale is made in offshore market.
Type of issuer matters
Small Brazilian Firm trading on Brazilian marketeasy offshore case
Large Brazilian Firm trading on NYSE with some American investorsharder
US company can take advantage by selling in Brazil, but will receive higher scrutiny on
methods used to avoid resale in the US.
Publicity
Old Rule: US reporters could not participate in foreign press conferences.
Now 135e has a safe harbor for offshore press releases open to foreign and US press
Offering must be at least partially offshore
Written materials distributed offshore only with a legend
Safe Harbor applies to both registered and non-registered offerings.
Release 33-7516 deals with websites
Non-US issuer doesnt make offer if:
Prominent disclaimer not for offer in the US and
Procedures designed to guard against US sales
US Issuer has stricter requirements
Password protection on website
Disclaimers
Avoid likelihood of reentry.
Limited OfferingsJOBS Act
Reg Ashort form registration governed by Rules 241-263 and 3(b)
Testing the waters permitted prior to filing under Rule 254 and 251(d)(1)
Offering amount in 3(b) has been increased from $5MM to $50MM so this is used more
often.
Crowdfunding comes out of 4(a)(6)
Aggregate of $1MM in 12 months
Any investor is ok, but limited to:
$2k/5% income if income/worth < $100k
$100k/10% of income/net worth if income/worth > $100k
Registered funding portal required
Info to be provided/filed
1 year restrictions on resale.

 Resales4(a)(1) & Rule 144/145

Creates exemption for all sellers that arent issuers, underwriters, or dealers.
Main emphasis is on underwriters because dealers/brokers have their own exemption.
UWpurchases from the issuer with a view to distribution.
For purposes of who is an UW, issuer broadly defined to include control persons
Includes CEO, subsidiary, parent company, director, etc.
10% equity interest is a rule of thumb to make SH a control SH and affiliate of corp.
Control groupindividual is deemed to be a control person/affiliate if he is member of
group that has control (family, board of directors, firm with controlling share).
What is distribution?
Courts and SEC have defined distribution as a public offering.
Many things are public offerings but dont count
Two Types of Transactions we are concerned about
Control SecuritiesIssuer sells part of its shares to the public and some shares to officers
and subsidiaries to hold onto in a registered offering. Then a few years later, without
registering, it has its officers and subsidiaries sell to the public when it would not be able to.
Upon redistribution, the seller is an issuer and the buyer is an underwriter.
Ira Hauptbroker sells for account of controlling SH of a company. SH is an issuer as a
control person under 2(a)(11). Makes broker an underwriter b/c selling for an issuer in
connection with a distribution.
Restricted SecuritiesIssuer makes Private Placement to buyer, buyer sells it to the public.
Shares never come to rest, so PP buyer is an underwriter
Sherwoodbuyer buys stocks in a PP with intent to hold on indefinitely. Circumstances
change and he has to sell the securities2 year holding period considered acceptable
before Rule 144.
Change of Circumstances doctrine now defunct. Release 4552.
Public Resales
Rule 144 is a safe harbor for how to publicly resell these securities safely
Definitions
Affiliate = Control person
Restricted Securitiesfrom issuer/affiliate not involving public offering: Reg D, 144A,
CE, Reg S, 4(a)(5), 4(a)(2)
Safe Harbor creates four categories of transactions
Unrestricted Securities, Non-affiliatesno restriction
Restricted Securities, Non-affiliatemust meet (c)(1) and (d) if reporting
144(c)(1)current public information by reporting issuer. Issuer has been s/t
reporting requirements for 90 days before the sale.
144(d)Holding period
Reporting Company6 month
If held for a year, then no info requirement necessary.
Non-reporting Company1 year.
Non-reporting companies only have to meet (d)
Restricted Securities, Affiliatemust meet all requirements
(c) requires current public information for both reporting and non-reporting
(d) holding period
(e) limits the amount of the salenot more than 1% of outstanding shares in 3
month period.
(f) manner of salemust be anonymous broker transaction
(h) notice of salemust notify commission if >$50,000 or 5000 shares.
Unrestricted Securities, Affiliatedo not have to meet holding period requirement

Economic Reality Test: If buyer doesnt take on real risk of the stock (e.g. Issuer pledges to
indemnify buyer in case of any losses on resale), then this is really a public offering by the
issuer
If outside of Rule 144, you can argue you dont meet control person or that you held it for 2 years.
Private Resales4(a)(1.5)
Private Placements by their terms only apply to issuers, so cant be used on resale.
However, if you avoid underwriter status by avoiding a distribution (i.e. doing a private
placement rather than public offering)then you meet 4(a)(1)
Rule 506 doesnt completely apply, but you could do an equivalent transaction without
advertising it to the public.
Private resale safe harbor is Rule 144A
Allows resales to Qualified Institutional Buyers (QIBs) after an exempt placement.
QIB
Corp. that owns or invests more than $100MM in securities of non-affiliates
Banks and savings & loans
Registered dealers ith more than $10MM investments in non-affiliates
Sales by dealers are covered in (c) and are generally ok.
Sales by person who is not issuer or dealer are not deemed an UW if:
Offers are only to QIBs
What you can rely on
Most recent publicly available financial statement (of last 16 months)
Info in forms filed with SEC
Public info in Securities Manual
Certification by CFO or other executive stating amount of discretionary
investment company has.
Take reasonable steps to inform of restricted status of 144A exemption.
Not fungible
Non-fungibility requirementsecurities cant be listed nationally at time of
issuance because it cant be fungible with publicly traded securities.
Necessitates debt securities.
Reasonably current information on issuer upon request by purchaser.
144A(e) provides integration safe harborif someone sells to public, it doesnt destroy
the entire chain of transactions
How all of these alternatives work on private resale market
506 is what is most commonly used, but problem is if one person sells to the public, the
entire transaction loses its exempt status. One big integrated transaction.
144A would take care of the integration problem, but then it is limited to QIBs
144 may work if issuer sells to employees and they wait a year and start a market. No
restrictions then, but the problem is if the original seller is affiliated.

Securities Act Liability

Public Offering Liability11

Section 11 gives liability for inaccurate content of registration statement
Applies to a lot of people
Anyone who signed
Directors or partners at time of filing
Everyone named in registration as about to become director or partner
Any expert who has prepared or certified part of the registration statement (wrt his
statement)
Every underwriter

Strict Liability for material misstatements and omissions on registration statement at time
it becomes effective.
No liability under Sec. 11 for preliminary prospectus.
Materiality defined by Rule 405
Not liable for systemic world events (War with Syria tomorrow!)
In re Adams Golf (2004) involved golf club company failing to disclose
graymarket had been started for its clubs which would decline future revenue.
Announcement in press release didnt cause price to drop of stock.
Helps prove immaterial under EMCH, but there could be other reasons.
Proving that info is immaterial saves you from liability.
Escot v. Barchris discusses materiality through the various lies told by Barchris
Earning Statementsdiscounted cash flow to show actual earnings and the value of
the difference. Percentage differential.
Backlogorders that cannot yet be filled. Lying would show increased coming
cash flow in the future.
Failure to disclose officers loans outstanding and unpaidconflict of interest
Failure to disclose use of proceedsreally paying bonuses instead of investing.
Defendant must show non-causation under 11(e), whereas in 10b-5 plaintiff must make
out causation.
Publicly available information does not normally have to be disclosed.
May have to disclose special risk to your business if something that is public
knowledge happens
Sufficient to say that the risk is dependent upon the price.
Bespeaks Caution Doctrinea court may determine that inclusion of sufficient
cautionary language in a prospectus renders misrepresentaions and omissions contained
therein non-actionable. In re Donald Trump Casino.
meaningful cautionary statements make forward-looking statements not create
basis for fraud claim if dont affect total mix of info provided to investors.
Cautionary statement must be specific, so you cant just include every risk .
Including too many makes it all meaningless. Vonage.
R. 175 and 1995 reform make forward looking statements more protected.
Due Diligence Defense
Issuer has no defense for misstatements.
Expert
Expertized Portion of the RS
Reasonable investigation that provides reasonable ground to believe the
statements were true
Ex. Audited financials, engineering reports, oil reserves
Non-Expertized Portion
Reasonable investigation that provides reasonable ground to believe it is true
Non-Expert
Expertized Portion of RS
Show you had no reasonable ground to believe it wasuntrue
Non-Expertized Portion of RS
Reasonable investigation that provides reasonable grounds to believe it is true.
Reasonable investigation is a sliding standard based on your involvement. Managers and
underwriters are very involved. They can delegate this task.
Only those who purchased in IPO or directly from issuer can sue under Sec. 11, not those
who purchased in the trading market.

Damages are in 11(e)Difference between amount paid for security (not to exceed IPO
price) and a number of variable things.
10b-5 requires fraud, but gives higher damages.
Choose both.
Illegal offers and Sales12(a)(1)
If you mess up the registration statement process, this is where your liability comes from.
Strict liability for not following the correct procedure.
Recission liabilitybuyer from illegal offer/sale can get their money back.
Basically a put option for the buying price.
2 types of options
Putright to sell at a certain price
If trading at lower than the put, you can make money by buying a stock
then selling it at the put price.
CallRight to buy at a certain price
If trading at a higher price, you can make money by buying at the call
price then reselling at market price.
Requires direct link between issuer and purchaser.
Cannot fix a 5 violation after the fact. Once violation happens, liability sticks. Diskin.
Who is the Seller?
Broad conception of who is a seller.
Dahlinvestor in oil wells (who doesnt own any of these oil wells) recruits friends to
come buy interests from Pinter.
Dahl (investor) is an expert, so he is carrying out the diligence for all of his friends
and says there are productive wells.
Wells end up not producing after Pinter sells to Dahls friends and friends suePinter
Pinter sues for contributionwins.
Nothing in definition of sell requires passing of title. Offers include
solicitation.
Seller must somehow benefit himself through the sale, but doesnt have to be
the former owner of the securities. Cant only be interested in benefit of buyer.
No commission is not a conclusive non-interest. Can be liable if advancing your
own or owners interest. Rejected Substantial Factor Test.
Seller Liability for Prospectus12(a)(2)
This provision has been somewhat gutted by Gustafson, which says this only provides
liability to original issuer and not subsequent sellers with individual prospectus misstatement.
Gustafson says that prospectus is only document of wide dissemination, so offer letter to
an individual doesnt count.
THIS IS WRONG. But we are stuck with it.
Makes it so 10b-5 is way more common.
Allows previous sellers to sue up the ladder. Purchaser 5 cant sue issuer because no privity.
However, he can sue purchaser 4 who can sue purchaser 3, etc.
If purchaser 3 made the material misstatement, liability stops there.
Coverage is broader than 11final prospectus, FWP, preliminary, oral communication, etc.
Also covers exempted communications and info from people who are not the issuer or
affiliates.
Same standard of care as 11Sanders says reasonableness requirement is same as
reasonable investigation.
Aiding and Abetting15
Provides liability for control persons if they did not have reasonable belief that statements
were not true.

Much harder to bring now

Anti-Fraud17
Almost the exact same as 10(b) of the Exchange Act.
No private right of action though.
Cort v. Ash test:
Is P of class meant to be protected by statute?
Is there evidence of legislative intent?
Would private right be consistent with underlying purpose of the overall scheme of
statute?
Is cause of action a matter of traditional state law, or a concern of the states?
Touche Ross v. Redington says legislative intent is most important factor.
Only applies to offers/sales while 10(b) also applies to purchases.
SEC can do anything under 10(b) that it can do under 17, plus 10(b) has private right of
action.
Willful Violations/Criminal Liability24
Generally use mail/wire fraud to put someone in jail because those only require deceptive act
with use of mails (not even materiality)
Securities Act is much harder, must prove willfulness
Willfulness only requires that the person know what they are doing, not that specific
instrument used is a security. U.S. v. Brown.
Need specific intent to commit the fraudulent act.
Note: SEC has no criminal prosecution power, but can seek civil penalties and transfer cases
to the Attorney General for prosecution.
Pre-Enron AG was reluctant to take Securities Cases
Post-Enron they are eager.
If you do a deceptive act, you know lying is wrong, even if you dont know its against the
lawconsidered willful and knowing.

 Exchange Act of 1934

Registration/Reporting Requirements of Public Companies
How to become a public company
Public Offering 15(d), Reg 15Dif youve gone through registration process of Securities
Act you must file periodic reports under Exchange Act (same effect as 34 Act registration)
Like 13(a), and 12 there is no private right of action here if company fails to file.
Sufficiently Large 12(g)(1)
Shareholders of record for a single class of security of more than 2000 or 500
unaccredited investors AND
Assets > $10MM
Elect to be soRegister with Form 8-A
Listed on an exchange 12 and 6
What is required of public companies?
Reporting
10k annual report that is available to public
10Q quarterly report
8k for certain material events
Substantive requirements for how the company must conduct itself
Formerly only disclosure, but now substantive requirements as well
Sarbanes Oxley introduces a lot of substantive corporate governance.
13(a) requires periodic reporting, by not doing reporting correctlyviolate 13(a)
No private right of action under 13(a). Any right of action must come from 18.
18(a) is exclusive remedy for violations of 13(a). In re Penn Central
If no material misstatement or omission, private litigants dont have remedy for
purely technical violation here. (Different than 12(a)(1)).
According to recent decision against JP Morgan, 13(a) can be violated by making inadvertent
wrong disclosure. A little overly aggressive.
13(b) requires certain record-keeping functions. Still probably no private right of action.
SEC said they wouldnt go after bookkeeping alone, but that is what just happened to JP
Morgan Chase.
13(l) is SOX real-time reporting requirement
Certain material events must be disclosed using Form 8-K.
13a-11 has safe harbor for failure to file for certain events.
18(a) is how all of these disclosure requirements would have to come by private suit.
Provides cause of action for false or misleading statements in 34 Act filings
What are the elements?
Purchase or sale in reliance on defective filing
Actual purchaser of seller, no someone who would have bought but for the
defective statements
Price must be affected by defective filings
Use ECMH?
Good Faith defenseacted in good faith and w/o knowledge that filing was defective
Securities Fraud (10(b) and Rule 10b-5)
Rule 10b-5 is most important liability in Securities Law
Prohibits fraud in connection with the purchase or sale of any security.
Insider Trading
ClassicCady, Roberts & Co.
Somebody that is an insider leaks information to an outsider than he isnt allowed to
know
Do not need a duty to the corporation.

Test
Relationship giving access
Inherent unfairness of unequal playing field.
Texas Gulf Sulpher involves geologists who know that they had a big find.
Bought a lot of securities when company made misleading statement that it didnt
have a big find because they knew that it did.
Duty to disclose or abstain from trading when information is likely to have
effect on price.
Duty applies to anyone in possession of material inside info
Economics of Insider Trading insider trading will depress market prices and keep outsiders
out of the market because it is a lose-lose for them.
Misappropriationget information from some relationship as vendor to the company
(financial printer or lawyer) and use it to insider trade.
ChiarellaFinancial printer cracks code on documents and trades on it
Court said this wasnt an insider, so it didnt count
However, now that is against the rules.
U.S. v. OHaganlawyer insider traded, but not an insider because he wasnt the lawyer
on the case. Saw it on a partners desk.
Misappropriation theory adopted.
OHagan had duty to law firm to not misappropriate information
When he misuses info he breaks his duty to law firm in connection with
sale/purchase of security.
U.S. v. CarpenterWSJ writer misuses power of article changing prices to trade before
publication. Same thing.
In Connection With Requirement
Materiality will satisfy in connection with as long as there is public dissemination
Semerenko expressly relies on the ECMH to say that if price moves we have materiality and
in connection with
If there is a price change in the market, someone is buying or selling based on a different
price than they would if information was correct.
Market integrity and broker integrity are suitable grounds for 10b-5 suit. Zandford.
Breach of fiduciary duty in trying to screw SH does not necessarily come under 10b-5,
especially if there is another law covering that specifically. Santa Fe (short-form merger
situation with false valuation).
Reliance and Causation
Reliance requirement doesnt come from statute, but common law fraud requirement.
Affiliated Ute Citizenin face to face transactions, if there is material misleading
information then there is no proof of reliance required.
Defendant can rebut the presumption of reliance
Has been extended beyond face-face transactions including fiduciary duty claims
Duty to disclose only applies to insiders sale, not all other peoples losses who are trading.
Too speculative to say other people wouldnt have traded if insider abstained or
disclosed.
Damages are limited to people he actually sold to or purchased from.
Basic v. Levinson adopted ECMH and Fraud on the Market Theory
FOTMTEven if purchaser didnt rely on actual statement made, but relied on public
price, reliance and causation are satisfied.
Rebut the presumption by showing P knew a statement was false or by saying statement
didnt change the price because no one believed it.

10b-5 Elements
Fraud
Scienter
Inferences are allowed. Motive is taken into account by courts (show incentive)
Recklessness generally counts
Corporate Knowledge
Agent making statement for company must know statement is false or be
recklessly negligent in not finding out it is true for liability to be imputed on
company
Minority says if one agent knew of falseness that suffices
Materialitywhat a reasonable investor deems important
Deductionuse net present value to find out what information is worth.
Inductionlook at how the market responds. ECMH
Reliance
Fraud on the Market Theory
Rebuttable
Becomes corollary of materiality
Who relies on fraudulent price?
People who purchase between fraudulent announcement and revelation of
fraud
Dura says P must show economic loss so that price inflation isnt enough, but
you need a drop (seems wrong because you paid too much if price is inflated)
Causation
Transaction causationfraud induced transaction
Loss causationfraud caused the actual loss complained of
Damages
Bastian is bad decision by Posner which makes it so lying is profitable.
no harm, no foul
However, expected value of lie makes it so they can lie and if it is just a bad market,
they win.
By any person
In connection withdiscussed above
The purchase or sale
Blue Chipmust actually purchase stock. Cant say you would have if the information
wasnt falsely negative.
Wharfgetting securities in return for services is still purchase
Of any security