SECURITIES REGULATION

Spring 2003
Professor Quinn



PRELIMINARY MATTERS

I. Introduction
Main Concerns of Sec. Reg.
o Regulate how companies get $ through investment
o Maintain trading markets
Honest and fair w/out too much regulation
Too much de-regulation = fraud
Too much regulation = not enough risk so companies not get enough $
Statutes
o Security Act of 1933 = regulate newly issued securities
Deals w/ (1) investment banking (2) IPOs
How to file a registration statement w/ SEC
Exemption to registration
Liability provisions
o Securities Exchange Act of 1934 = Regs. for trading securities already issued
Establish oversight through the SEC
Has reporting requirements
Sect. 10b-5 = fraud
Market manipulation = scheme to drive up prices
Two Topics w/ 33 & 34
o Security:
Common stock or Corporate Bonds = definitely securities
not all stock or debt is security
Some PRIVATE investment can be security too
(ie/ if you borrow $10 from a friend, it could be a security)
Fraud = look to sec laws
SAME DEFINITION for 33 and 34 acts
o Materiality:
Material Information
Info that a reasonable investor would think is important

II. Historical Background
a. Prior to 1933
i. Very little regulation, no federal except for the RRs
ii. State regulation (blue sky laws -1
st
in KS in 1911), but these were weak
1. could be avoided if the offer was made interstate (offer made in one
state, accepted in another)
2. states not adequately fund regulators
b. Stock Market Crash
i. Congressional hearing uncovered many problems in the industry.
1. market manipulation
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2. borrowing on the margin
3. failure to disclose financial information
4. fraud
ii. Congress believed that dishonest practices of the securities industry caused the crash
and the Great Depression, BUT it was the effect of the poor global economy
c. 1933 and 1934 Securities Exchange Acts passed to provide federal regulation


III.
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Key Provisions of the 1933 and 1934 Acts

a. Securities Act of 1933:
i. 3 & 4
1. exemptions to registration
2. registration NOT required for transactions by
a. a person other than an
i. issuer,
ii. underwriter,
iii. dealer,
b. stock that does NOT require an IPO.
ii. 5 new issues of securities have to be registered with the SEC prospectus too!
iii. 6 & 8 procedures for filing a registration statement
iv. 7 & 10 information required in a registration statement and prospectus
v. 11 & 12 private remedies rights of action for false registration statements and
prospectuses.
vi. 13 statute of limitations = one year after discovery
vii. 15 controlling person is jointly and severally liable for people they control, when
they violate 11 or 12.
viii. 17 general anit-fraud = prohibits fraud by any person who offers or sells
securities

b. Securities Exchange Act of 1934: (much longer act)
i. Registration
1. 7 & 8 margin requirements and borrowing and lending
2. 15 Registration of brokers and dealers.
a. SEC can bring administrative actions against any person associated
with a securities firm.
ii. Regulating Disclosures
1. 12 registration required before transactions on a national securities
exchange
2. 13 reporting requirements
3. 14 disclosure requirements for proxies and tender offers
iii. Regulating trade of securities
1. 10(b) (Rule 10b-5)
a. general anti-fraud provision
b. deals w/ buying or selling of ANY secuity
2. 14 prohibits fraud with proxy and tender offers
3. 16(b)
a. trading by corporate officers (officers, directors, SH w/ 10%)
regulated b/c these people have material non-public
information
b. cannot make a profit w/in 6 month period

c. Sarbanes-Oxley
i. Biggest change in securities laws since 1930s
ii. Overrides much of state law
1. normally it would be controversial
2. w/ Enron = much easier to do

d. Other Securities statutes
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i. Public Utility Holding Act: to prevent abuse of power in the public utility market.
ii. Investment Company Act of 1940: regulates companies that hold and manage large
portfolios of securities for investors (mutual funds)
iii. Investment Advisors Act of 1947: regulates people who give investment advice for $

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STATUTORY DEFINITION OF SECURITY

5: unless a registration statement has been filed, it shall be unlawful for any person, directly or
indirectlyto sell a security.

I. Why is this important?
Arduous to register, and you must to sell securities (unless exempt)
o Expensive
o Must follow regulation
o Right of recision = if not register, buyer can revoke sale

II. Statutory definition courts have held the definition is the SAME for both acts!!
a. 2(a)(1) 1933 Act: any note, stock, treasury stockinvestment contract, put, call,
option entered into on a national securities exchange, any interest or instrument
commonly known as a security
b. 3(a)(10) 1934 Act: same definition, construed in same way
key term is INVESTMENT CONTRACT!!

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III. Investment Contracts
a. SEC v. Joiner: Joyner Co. owns land and sold portions of it, saying they were going to drill for oil.
He sent letters to people, claiming all they had to do was buy the land and they would get the
benefits (passive investment). SEC alleges securities fraud, claiming the oil interest was a security
and an investment contract. Joiner claimed he was just selling land.
i. SC held that it is an investment contract. (Test = (1) terms of offer, (2) plan of
distribution, (3) economic inducements held out) = VAGUE
ii. Joiners promise to drill and the oil made the land valuable (these were his efforts).
Without the oil, the land was worthless. There was a possibility that the landowner and
Joiner would lose out (common enterprise), so it is an investment contract.
iii. He promoted the land, through an advertisement, as an investment, specifically for
passive investors. Court said that you cannot advertise something as an investment and
then later claim it is not an investment.
iv. Interests in oil and gas are securities
b. SEC v. Howey: Howey was selling orange groves to the public. They also offered Howey in the
Hills to do the cultivating of the citrus groves. Possible investors were offered a land sales
contract and a service contract, saying that it was not feasible to invest in the grove unless there
was a service arrangement. Mails were used and there was no registration statement filed.
Purchasers were nonresidents of Florida, who lack knowledge and skill necessary to care for and
cultivate citrus trees. They expected profits. SEC alleged this was an unregistered security.
i. Howey Test: An investment contract means a contract, transaction, scheme whereby a
person invests his money in a common enterprise and is led to expect profits solely
from the efforts of the promoter or third party.
ii. SEC looked at state blue sky laws for the definition of security.
iii. SC held that this is an investment contract. They offered an opportunity to contribute
money and to share in profits of a large citrus fruit enterprise managed and partly owned
by respondents.
iv. NOTE: The Securities Act prohibits the offer as well as the sale of unregistered,
nonexempt securities. Hence it is enough that the respondents merely offer the essential
ingredients of an investment contract.
1. These investors were passive and should be protected by securities laws (they
lived far away and had no knowledge of the business).

Howey Test

1) investment of money
2) in a common enterprise
3) w/ expectation of profits
4) solely from the efforts of others


c. SEC Fraud vs. Common Law Fraud
i. Reliance
1. Common Law fraud = must show RELIANCE
2. SEC fraud = NOT need reliance
ii. Material Omission
1. CL = can leave out information, as long as not lie
2. SEC = duty to not have a material omission

d. Investment of Money
i. Elements
1. Must intend to invest for investing and making money
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2. Specific consideration = small portion of compensation that its not real
exchange
3. Concerned less w/ livelihood than investment
ii. International Brotherhood of Teamsters v. Daniel: Daniel was a truckdriver who was laid
off, went back to work and then left the company and was denied his pension. To get the
pension, the K required he work 20 continuous years, which he had not done. The
pension plan was compulsory and noncontributory. The employer put the funds in. Is the
pension plan an investment contract and therefore a security?
iii. SC held this is not an investment contract because the employee makes no payment to the
plan, the employer does. Therefore, a non-contributory, compulsory pension is
NOT an investment of money.
1. he did not give up specific consideration in return for a separable interest with
the characteristic of a security.
2. he was selling his labor to obtain a livelihood, not to make an investment in the
future.
iv. through the efforts of other is likewise not met because it depended on how long he
worked, not on the management of the company.
1. Majority of income generated came from the employers contributions and so
did not depend on the efforts of the fund managers.
v. Also, ERISA was enacted, which regulates pension plans, so there is no need for the
protection by the securities laws.

e. Common Enterprise
i. Horizontal Commonality
1. investors in a profit generating enterprise are linked to each other.
Money is pooled to fund the business and all investors share equally in
the profits.
1) Three circuits agree this satisfies common enterprise.
2) Ex: everyone in a condo resort agrees to participate in the rental
pool. Each person gets 20% of the rental.
ii. Vertical Commonality
Dfn = where an investors profit or loss is linked to the promoter or
manager. Each profit is independent, but tied to the promoter.
Ex: Each person pays a manager to rent your condo. There is
no pool and no link between participants. There is only
a link between manager and each owner.
1. Strict vertical commonality: each investors profit or loss is linked to the
promoters profit or loss.
2. Broad vertical: manager gets a flat fee whether an apartment is sold or
not.
courts disagree on which to accept!!
iii. Brodt v. Bache: Bache solicited appellants to open commodities trading accounts. They
sold their portfolios and invested in the accounts with Bache. Bache said they would reap
profits. They lost money and the company was insolvent. Bache gets a commission from
trading individual accounts.
1. There is an investment of money and an expectation of profit.
2. SC held that there is NOT an investment contract because there is no vertical
commonality. The broker gets a commission whether the client gets a profit or a
loss. There is no vertical commonality because Baches success did not depend
clients.

f. w/ expectation of profit
i. want profit!!
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g. solely from the efforts of others

i. If you do SOME of the work, is it still efforts of others? YES (see below)

Counterarguments
1) This raises costs for businesses to raise $ b/c have to look for who you
are selling to
i. To public = either
1. MORE regulation b/c public at large
2. LESS regulation b/c seeking neutral investors
who might be experts
ii. Have to discover if expert or not
2) Do you want bright line or flexible tests
i. Bright line = more regulation for legit business but its
easy to engage in more questionable activities b/c you go
right up to it w/out going over
ii. Flexible = easier for regulators but harder for businesses


ii. SEC v. Glenn Turner Enterprises: Glenn Turner formed an organization called Dare to be
Great, which ran seminars on how to get rich. It was a pyramid scheme, in which you
could recruit others and get a percentage of their membership fee. (Doomed to collapse
and a big fraud because you have to keep recruiting more people in order to make a
profit).
1. Turner argued that it is not an investment contract because the investor has to
recruit to get money, therefore it is not from the efforts of others. Also, you
are not a passive investor, they have to do something, so the investors are
different from those in Howey.
2. 9th Circuit held that the plans were securities. The court is not going to read
solely from the efforts of others literally.
1) TEST:
whether the efforts made by those other than the
investor are undeniable significant ones, those
essential managerial efforts which affect the failure
or success of the enterprise.
2) The investor has to exert some effort, but the significant
decisions come from others.
iii. SEC v. Aqua Sonic Products
1. AS would sell licensees the right to sell Steri Products. Ultrasonic Corp. was
responsible for all sales of Steri for the benefit of the licensee. Licensee could
cancel. Ultrasonic performed all significant marketing functions. The licensees
were told that if they entered the agreement, they would derive substantial tax
benefits. 50 licensees entered the agreements and had no experience selling
AquaSonic. It collapsed.
2. 2d Circuit held that it was an investment contract
1) makes same argument as Glenn Turner.
2) The decision to enter the agreement was optional. But the fact that it is
an option is not inconsistent with the scheme being an investment
contract. Court finds that it is not really an option because there is
doubt that the investor would have made money if they did not enter
the agreement.
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3) Solely should NOT be taken literally. Significant decisions
were made from the efforts of others.
iv. SEC v. SG, Ltd.
1. D had a virtual stock market game. D set the price of the stocks and people
bought it. SG said one company was great and raised the price by 215% per
year. D stopped people from pulling out their money, but kept letting others in.
D said not investment K, its just a game.
2. Court Held = it WAS a security
1) It was a Ponzi Scheme (people invest $, and get return from the new
investors the schemer recruits).
2) NOT game b/c (1) no term (2) no chance on which companies go up or
down.
3) Fantasy football = you pick the players, they perform by chance!
h. Schemes
i. Pyramid = Glenn Turner
ii. Ponzi = SEC v. SG Ltd.



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IV. Which Business Ventures Are Securities:

a. General Partnerships

i. Usually not an investment contract/security because
1. EACH GP has extensive rights to manage the business and have equal
rights to the profits.
2. So, the profits are not solely from the efforts of others.

what if some gps have no say in the GP

ii. TESTS: Its an INVESTMENT if
1. partner is so inexperienced and unknowledgeable in business affairs
that he is incapable of intelligently exercising his partnership or venture
powers. (Koch)


2. If investors have no voice in management because
1) Specific provisions in the partnership agreement that leaves so
little power in the hands of the investor, that power is
distributed as it would be in a limited partnership
2) The investors inexperience in business matters, makes the
business have to be from the efforts of others
3) The investors dependence on the unique skills of the
promoter

3. Other courts say
1) Investment = if you are experienced in oil, but invest in real
estate, the GP might be an investment contract because you dont
know anything about real estate.
2) Not Investment = you have the power and ability to research, so
you should not invest unless you know about it.

b. Franchises: not an investment contract because not form the efforts of others.

c. Limited Partnerships: generally held to be securities because LPs cant participate in
management and are relying on the efforts of others. (Goodman v. Epstein).


i. Koch v. Hankins: GPs set up to sell jojoba. The investors (partners) had a vote. They
could not show that they were left with so little power as to place them in the same
position as a limited partner. They had no experience in jojoba, but they had
experience selling pistachios. They were not relying on others, but had to figure out
how to make their plan work, so it is not an investment contract.
1. Held = In a GP investment contract, you should know what you are doing, so
you dont need to rely on others. So, it is not an investment contract,
usually.

ii. Williamson v. Tucker: Joint ventures each of which owned an undivided interest in real
estate. Each participant retained control over the prospect, pursuant to the joint venture
agreement.
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1. Here, there is no security, but the court discusses when a GP could be a
security.

d. Stocks
i. United Housing Foundation v. Forman: sale of stock in a nonprofit cooperative
housing corporation. When you bought stock, you were allowed to live there. When
you left, you had to sell your stock, but only at the price you bought it for (no profit).
1. SC held that it was not a security. They rejected the literal approach that
anything called stock was automatically a security.
2. This stock did not conform to the characteristics of stock.
1) They were not investing for a profit, but to acquire a place to live.
2) the stock did not confer the rights that normally accompany stock. It
was not transferable, could not be pledged, no voting rights, and had to
be offered back to the co-op at their initial selling price.
3. It was not an investment contract either because there was no expectation of
profit.
4. SC says you have to focus on the economic reality ONLY in
unusual circumstances (see below) of what was going on.
1) Not characteristics of stock
2) No expectation of profit

ii. Landreth Timber Co. v. Landreth: Landreth family owned all stock in their company.
They offered it for sale, but then a sawmill caught on fire. Dennis bought the stock and
tried to rebuild it. Rebuilding cost more than anticipated and they sold it at a loss.
Petitioner claimed that the stock was sold, but unregistered. If it is a security, it is subject
to the antifraud provisions and they claim fraud.
1. District Court held that this was a sale of 100% of the stock, so it was a
commercial venture and not an investment, for the purposes of the 33 Act.
2. Held = it was security.

1) Supreme Court rejects sale of business doctrine:
i. the idea that the incidental transfer of stock to manifest a
sale of a closely held business is NOT a security to those
who are entrepreneurs and not passive investors.
ii. Basically, since Landreth sold all stock, it was a sale and
they did not have to register the stock.
iii. Not accept at 100%, but what about if its at 90%? NO,
its rejected in ALL contexts.

2) this stock, unlike Forman, possessed all the characteristics
identified in Forman as traditionally associated with
common stock.
3) Respondents want court to look at the economic
substance/reality of what was going on.
i. They were not purchasing stock to earn profits, but to
buy a company that it could manage and control. They
were not passive investors, but active entrepreneurs, so
the Acts do not apply to them.

ii. The Court held that the economic reality of the
transaction will only be looked at when the
instruments involved are unusualnot easily
characterized as investments
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4) Forman does not eliminate the Courts ability to hold that an
instrument is covered when its characteristics bear out the label.
5) People trading in stock have a high expectation that their
activities are governed by the Act, so if we were to say
something that looked like stock was not actually stock, people
that thought they were protected would not be, which would not
make sense.
3. The Landreth Stock had all the characteristics traditionally associated
with common stock:
1) the right to receive dividends contingent on profits
2) negotiability
3) ability to be pledged or hypothecated
4) confers voting rights
5) capacity to appreciate in value

V. Notes
a. The statutory definition says any note is a security.
i. A note is a written promise to pay back in the future, which is very broad.
ii. commercial investment test
1. Lower courts held that it cannot be read literally, Congress could not
have intended security laws to cover every single note.
2. Dfn = look at notes on a case by case basis. If it is used as a commercial
instrument, then not a security, but if used as an investment, then it is a
security.

iii. Supreme Court adopts FAMILY RESEMBLANCE TEST (Reves v. Ernst &
Young)
1. A note is presumed to be a security, and the presumption can be
rebutted only by a showing that the note bears a strong resemblance to
one of the enumerated categories of instruments
(not securities).
1) Notes delivered for consumer financing
2) The note secured by a mortgage on a home
3) The short term note secured by a lien on a small business
4) Note evidencing the character of a loan
5) Notes evidencing loans by commercial banks
6) Note that formalizes an open account debt incurred in the
ordinary course of business

2. FACTORS to consider in determining whether it resembles or not:
1) motivations that would prompt a reasonable seller and buyer to
enter into the transaction
i. if to raise money for the general use of a business
enterprise security
ii. if purchased to buy an asset not a security
2) plan of distribution of the of the instrument
i. Is there common trading for speculation or investment?
ii. Were the notes offered to the public?
3) what are the reasonable expectations of the investing public?
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i. Are the notes advertised to the public or marketed as an
investment?
4) Is there another regulatory scheme that reduces the risk of the
instruments (making application of the SEC Act unnecessary).

b. Reves v. Ernst & Young: Facts: Agricultural cooperative with 23,000 members. To raise money,
the Co-op offered notes under a scheme called an Investment Program. Co-op filed for
bankruptcy. Noteholders sued auditor Arthur Young, claiming they did not value one of the assets
high enough. If not a security, then the fraud provisions do not apply.
i. Notes must be looked at in terms of what Congress expected the Act to do.
ii. Family resemblance Test (2d Cir): presume it is a security, but it can be rebutted if
issuer can show that it bears a resemblance to the exceptions.
iii. Howey test (8th Cir): Applied Howey to notes.
1. Court rejects the Howey test because it would make the enumeration of the
types of instruments in the definition of security, meaningless. The Howey test
was designed for investment contracts, not notes. To apply it to notes would
eliminate the distinction between notes and investment contracts.
2. Court also rejects the Landreth test, that if the note had the characteristics of a
note, it is a security. Notes are used in a broader variety of settings, some
commercial and some involving investments.

c. Great Rivers v. Farmland Industries
i. Class action against Farmland that the capital credits were securities. Are the capital
credits notes?
ii. Court does not apply the Reves Test because capital credits are not listed in the
statutory definition.
iii. Court applies the Howey Test
1. they did not expect profits, but to reap the benefits of the relationship. They
became members of a group
2. The credits were not issued to raise money for general business use.
3. No dividends and no liquidity
4. Similar to Forman, where they just invested to get an apt.
5. The court was blurry on what test they were using, Reves or Howey.
iv. They do not share any characteristics with a security, so NOT A SECURITY

d. Marine Bank v. Weaver: COD was issued by a federal bank. SC said that the note was not a
security because the Fed. Banking regulation and FDIC prevents loss. There is no investment risk,
and so no need for Fed. Securities laws.
i. CDs in FDIC banks do NOT apply b/c banking laws do!!
ii. Securities are usually instruments that can be publicly traded and a unique profit sharing
agreement, negotiated one on one is not a security.
iii. Congress did not intend to provide a broad federal remedy for all fraud

VI. Options and Futures

a. Derivative Instruments
i. Financial instrument whose value depends on something else (e.g. currency
swaps)
ii. Not necessarily a security
1. SEC regulates securities,
2. CFTC regulates commodities and futures
b. Options
i. Its a SECURITY
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ii. If company is trading at 20$, you think the price will go up. You buy an option
contract (an option to buy 100 shares of Z at any time before the expiration date
in the K). If stock price goes up, you make money and if it goes down, you lose
your premium.
iii. Used by people who want to hedge, have a speculation. If you have a hunch and
you want to gamble, you make a lot more money in options than in stock.
iv. Used by inside traders. If you know the price is going to go up because you have
nonpublic information, you buy an option and can make a lot of money.
v. a call option- the holder is hoping that the price will rise. It is a contract in
which the holder of the call option has the right to call the underlying stock
away from the option writer at the exercise price at any time prior to the
expiration date.
vi. a put option- the holder is hoping that the price of the security will fall. It is a
contract under which the option holder has the right to sell the underlying stock
to the option writer at the designated exercise price any time prior the expiration
date.
c. Futures
i. Contract for future delivery at a specified price on a definite date. Obligated to
buy.
ii. Not securities = regulated by CFTC
iii. Soy beans, orange juice
iv. Chicago Mercantile v. SEC:
1. Commodity Futures Trading Commission (CFTC) has authority to regulate
trading of futures contracts and options on futures contracts.
2. SEC has authority to regulate trading of securities and options on securities.
3. If security and futures contract, the CFTC regulates.
4. If future and an option on a security, then SEC regulates.


VII. Exempt Securities -- 3(a)
a. Exempt from registration under the 1933 Act.
i. Not subject to registration and disclosure requirements, but
ii. still subject to antifraud provisions and civil liability provisions.

b. Listed in 3(a)
i. (2): securities issued by the state or federal government
ii. (4): securities issued for religious or charitable purposes
iii. (8): insurance or endowment policy or annuity contract

iv. SEC v. Life Partners: LPI is a promoter facilitating the sale of life insurance policies from
AIDS victims to investors. The viatical settlements permit AIDS patients to receive
funds for medical bills while the investor received the benefits of the policy when the
victim died.
1. District Court held that the promotion and repackaging of insurance into these
viatical settlements constitutes an investment contract and was not exempt from
registration as an insurance product under 3(a)(8).
2. D.C. Circuit REVERSED. It is not a security because LP does not do anything
significant after they bought interest in the policy. Therefore, the profits are not
from the efforts of others.

VIII. Securities that Do NOT EXIST
a. Investment schemes that dont exist SEC brings case
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b. ie = Prime Bank Notes = fake $1M notes where person tries to get people to invest in
Dont exist
SEC has power to enforce against the selling party

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MATERIALITY


I. Applicable Statutes and Regulations
i. Sect. 11 of 33
ii. 34 Act
iii. Regulation FD = can NOT selectively disclose material information
(ie/ not tell some investors material information and not others)

II. You can LIE, but NOT about MATERIAL information!!

III. Test: material if:
a. a reasonable shareholder would consider it important in making an investment
decision
OR
b. if there is a substantial likelihood that the disclosure of the omitted fact would have
been viewed by the reasonable investor as having significantly altered the total mix
of information made available.
c. An objective test standard of a reasonable investor
i. Not whether a particular investor would consider it important, but whether a
reasonable person would.
ii. Depends on context and circumstances/overall picture

IV. Qualitative Information =
Rule 408 = just b/c law not specifically mention an action you have to disclose, there
is still info you MUST disclose too
You can lie = just not about MATERIAL information

o Fair Price Rule (Basic)
Proxy solicitations = cant make false or misleading statements
Rule 14(a)(9)
If you quote a price that you belief is wrong, but it turns out to be
fair no liability

o Speculative Features not plainly evident to reasonable investor (Uni Camera)
o Minor Material Information = no matter how big, as long as its material
(Schlitz)
o Illegal Activity (even its a small amount) (SEC v. Schlitz)
SEC v. Schilitz = D bribed Spanish company violating Spanish law, but it
was a relatively small number.
Court held = MUST disclose.
o Integrity of management = Franchard Corp.
Highly Material
Evaluation of management
Essential ingredient of informed investment decision
Guide to future basic performance
o Past business experience
o Past performance
What is typically disclosed?
o Benefits paid or proposed to be paid to management
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o Material transactions btwn
corp AND
officers/directors/10% SHs
Information important b/c
Showed strained financial position
Integrity of management
Motive for corp to pursue policies which allow
o High distribution rates
o High price for shares
Show warnings of changes in management

a. CASES
b. Universal Camera Corp.: Universal was manufacturing cameras, but switched to
binoculars. They offered a new class of stock and filed a registration statement.
i. The shares were offered as a speculation.
1. Where there is speculation, the registrant is under a duty to
describe the speculative features of the offering in the
registration statement and the prospectus so clearly that they
will be plainly evident to the ordinary investor.
2. Explain the speculation in plain, ordinary terms. Plain English
Rule.
ii. Universal omitted:
1. difference between the book value and the offering price.
This meant that it would take an experienced analysts to
figure out that it would take many years to make an
earning.
2. product development
3. nature of the market
4. did not disclose that the products were not patented.
c. Franchard Corp
i. Glickman established control of registrant by acquiring 450,000 of its
600,000 shares. He was a dominant role in the management of registrants
affairs as president and chairman. Two days after filing, Glickman began
transferring funds from registrant to Venada. Neither the prospectuses nor
the filing reflected these transactions.
ii. Omissions
1. The 1960 prospectus failed to reveal that Glickman intended to use
Franchards funds for the benefit of Venada.
2. Also failed to show that he was using his stock to make personal
loans.
iii. These things reflect in the business ability, integrity and motivaiton of the
management.
iv. These were highly material disclosures to an evaluation of the competence
and reliability of registrants management.
v. Quality of management is of cardinal importance in any business.
Disclosures relevant to the quality of management are particularly important
when the securities are sold on the reputation of the controlling person.
INTEGRITY IS A MATERIAL FACTOR. So personal issues of the
director/pres. will be material.
1. Disclosures would have showed that the company was in a strained
financial position. The diversion of funds would have shown the
integrity of the management. The investor needs to be able to
evaluate the management of the company.
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vi. Glickman argued that these disclosures would invade his privacy. But, a
corporation asking for public funds must relinquish part of its privacy with
respect to his financial affairs which impinge on the affairs of the company.
d. In re Caterpillar
i. Caterpillar did not report a greater than usual profit of Caterpillar Brazil because
the profit contribution of each subsidiary had not been used for big decisions
(personnel, product etc.). The previous losses were due to economic policies in
Brazil. Since Brazil was not a separately reported business segment,
Caterpillars financial statement did not disclose the disproportionate impact that
Brazils profits had on the parent companys profits and financial condition.
ii. Caterpillar should have described the unusual events or transactions (that
Brazils economy was unstable) in the 10K/MD&A/Form S-K.
1. The 10K requires a registrant to discuss the liquidity, capital resources
and results of operations of the registrant and to provide other
information about changes in the financial condition.
iii. They had left investors with an incomplete picture of the investment.
e. Virginia Bank Shares v. Sandberg
i. Freezeout merger. The investment bankers say 42$/share is a good price. Most
minority shareholders took the offer. Sandberg did not and claims the proxy was
misleading.
ii. Is the statement, that the price is fair, a material fact?
iii. An opinion can be material. To avoid liability, need to back up your opinion
with facts.
iv. Mere disbelief is not enough for liability under 14(a) (misleading proxy
statement). Without a factual demonstration that the proxy statement was
false or misleading.


18
V. Uncertain Events
a. depends on the facts.
i. BALANCING TEST (Basic) (not a bright line rule) = depends on the
a. PROBABILITY
i. Possibility of the likelihood of the event
b. MAGNITUDE =
i. size of the event and how much it would effect the
company

ii. Basic v. Levinson
1. Combustion Engineering wants to acquire Basic and included the plan in their
strategic plan. They had meetings with Basic to discuss the possibility of
merger. Basic made three public statements denying that it was engaged in
merger talks. Eventually, Basic took the offer. Basic shareholder sues, claiming
that three public statements were misleading and a violation of 10(b).
2. Court adopts TSC test for materiality, but when the event is contingent or
speculative, it is difficult to ascertain whether the reasonable investor would
have considered the omitted information important at the time.
a. 3d Cir: agreement in principle test. The merger does not need to
be disclosed until an agreement in principle as to the terms of the
merger has been reached.
b. 2d Cir: materiality will depend at any given time on the balancing of
both the indicated probability that the event will occur and the
anticipated magnitude of the event in light of the totality of the
company activity.
3. Sup Ct = BALANCING TEST (probability/magnitude)Whether merger
discussions are material depends on the facts. To assess the probability that the
event will occur, a factfinder will need to look to indicia of interest in the
transaction at the highest corporate levels.
a. board resolutions, instructions to ibankers, negotiations
b. magnitude: size of the entities, size of premiums over market value


19
VI. Projections

a. bespeaks caution doctrine
i. common law doctrine
ii. if there is a meaningful cautionary statement included, then it is not material
iii. tell what could possibly go wrong = youre clear
iv. allows for forecasting.
b. What a reasonable person should know (need license for nuclear reactor) = NOT
material
c. Sales Puff (saying an auction is going well) = NOT material

i. Wielgos v. Comm. Edison
1. Comm. Edison owns nuclear reactors. Wielgos buys 500 shares. Byron 1 is a
reactor, but cannot operate without a license. The ASLB denies the license,
stock price drops. P claims that the Comm Ed. Underestimated the cost of
reactors and the company failed to disclose the application for the license.
2. Court held:
a. Cost: it is reasonable to look to past experience to calculate cost.
Company based on past experience, but it turned out to be too low.
They were made in good faith.
b. License: everyone knows that the license denial could happen. The
reasonable investor would know the denial was a possibility.
c. NOT MATERIAL
3. High burden on investors.
ii. Rule 175: forward looking statements made in SEC filings cannot be bases for liability as
long as they have a reasonable basis.
1. It is reasonable for a corp. to rely on the past
2. Projections that were accurate, even if not accurate at time it becomes effective,
are okay.
iii. Eisenstadt
1. Corp. makes announcement that they are going to sell. They go into private
negotiations and offerees offer a lower than expected price. Despite this, they
announce that the auction is going well.
2. Court held this is just SALES PUFF, and NOT MATERIAL
a. everyone knows that the sellers will say the auction is going well
because if you dont the auction would really do poorly.
3. Corps do not have to disclose the obvious, but what is obvious to the public?
Possibility of making the wrong assumptions.

20
SECURITIES ACT OF 1933

*** Absent an exemption, all offers or sales of securities must be registered pursuant to Section 5 of the
1933 Act
Quick Outline
1. Registration
a. The Process of Going Forward
b. Dissemination of Info during Regis.
c. Specific Disclosure Requirements Regis. Stmnt.
d. SEC Review
2. Exemptions From Registration
a. Non-public Offerings
b. Reg A &
c. Reg D
d. Secondary Transactions
3. Civil Liabilities
a. Sect. 11 standing; damages
b. Sect 11 due diligence
c. Sects 12(a)(1) & 12(a)(2)




21
Registration Public Offerings

5 of the 33 Act


22
PROCESS


I. The Process of Going Public

a. Going Public: all public offerings have to be registered unless an exemption applies.
i. This includes
1. initial public offerings and
2. offerings of securities by existing companies.

ii. Advantages:
1. raise capital, cheaper than borrowing from a bank
2. makes the stock liquid:
a. can use it to acquire other companies and
b. can compensate employees (stock options)
3. people can cash in and make millions
4. ego/status/prestige
iii. Disadvantages
1. cost of initially registering ($1M) and maintaining reporting
requirements
2. give up privacy of financial data (the price of disclosure)
3. excessive focus on
current performance, dictated by the market > instead of long term
business strategy


b. Process: Firm Commitment
i. underwriter gives a letter of intent to issuer so issuer can proceed with organizing
etc.
ii. Issuer (the Corp.) sells an issue of securities to ibankers
1. Usually at a discount
2. Ibankers bear all the risk
3. Prefiling, only negotitations between issuer and underwriter are allowed.
iii. issuer and ibanker negotiate and agree that it will not be binding.
iv. They price the stock
v. usually there is one managing underwriter and additional syndicates.
1. Managing underwriter determines how much the syndicate can sell.
2. agreement among underwriters is signed by syndicate, which says that
managing underwriter has authority over the offering process.
3. All in syndicate will offer at same time and price
vi. sign an underwriter certificate with the issuer
vii. Issuer and managing underwriter draft a registration statement. Issuer has
independent accountant to provide financial statements.
1. Issuer wants the highest price.
2. Underwriter wants high price too, but also wants to get rid of the stock,
so they tend to have a lower price.
3. If issuer goes broke, the shareholders will go after the underwriter
because they have deep pockets. The issuer barely has any money.
viii. SEC reviews registration statement, gives comments, amendments
ix. File registration statement with preliminary prospectus
1. Prelim. Prospectus: includes company history etc. minimal information.
23
x. Underwriters send out a preliminary prospectus
xi. Underwriter pitches deal, holds roadshows.
xii. Underwriter can get out of the deal once it is signed if there are exceptional
circumstances. (market out clauses in agreement)
1. National security, war, suspension of market, material adverse change
2. Walken Medical Services: decline in stock price is not an adverse market
condition that will allow underwriter out of deal.
xiii. ISSUER UNDERWRITER DEALER PUBLIC
1. Underwriter: 2(11) any person who has purchased from an issuer with
a view to, or offers or sells for an issuer
2. Dealer: 2(12) any person who engages as agent, broker or principal in
the business of offering, buying, selling or otherwise trading or dealing
in securities issued by another person.
c. Best efforts: companies that are not well established are not apt to find an underwriter
that will give a firm commitment and assume the risk. So, they use firms that pledge
their best efforts.
i. The securities house does not buy from the company and resell, but they act as
agents and get a commission.
ii. Issuer still bears the risk





24
II. Dissemination of Information During Registration
a. The securities must be registered before sale to assure availability of adequate reliable
information about securities that are offered to the public.
b. Three time periods:
i. Prefiling [5(c) (no offers); and 5(a) (no sales)]
1. time before registration statement made
2. starts when registrant thinks about selling securities
ii. Waiting Period [can offer; 5(a) (no sales); and 5(b)(1) (no prospectus
unless meets 10, can use R 430 (prelim prospectus))]
1. Filing registration statement UNTIL
2. RS becomes effective
iii. Post-Effective
1. time registration is effective UNTIL
2. sell the initial offering

25
c. Prefiling Period
i. 5(a) applies: NO SALES, unless a registration statement is in effect.

ii. 5(c) 1933 Act: it shall be unlawful to offer to sell or offer to buy through
the use of a prospectus, unless a registration statement has been filed as to
such security.
1. Sale: defined in 2(a)(3) shall include every contract of sale or
disposition of a security or interest in a security for value.
2. Offer: defined in 2(a)(3) as every attempt to offer to dispose of, or
solicitation of an offer to buy a securityfor value.
a. Very Broad = cant offer till file RS!!
b. NEGOTIATIONS BETWEEN ISSUER AND UNDERWRITER
ARE EXEMPT (not an offer)
c. issue: when do draw line between giving people information and
offering? Cant offer unless registered.
d. Gun Jumping: making an offer when prohibited, before Regis.
Stmnt. filed.
3. Prospectus: 2(10): notice, advertisement, letter, communication which
offers any security for sale, except that a) a communication after the
effective date shall not be deemed a prospectus if it is proved that prior to
the communication, a written prospectus was sent and b) a notice shall
not be deemed to be a prospectus if it states from whom a written
prospectus may be obtained and does not more than identify the security,
state the price etc.

iii. NO OFFERS TO DEALERS IN PREFILING (by underwriters)

iv. SEC takes a broad view as to what constitutes an offer.
1. formal offers; and
2. unusual publicity by the issuer may be an offer
3. Carl M. Loeb, Rhoades & Co.
a. Arvida published a news release with the plans of holding a public
offering to fund a new development. Response to the press release was
positive. After the press release, they registered the security. SEC
claimed a violation of 5(c).
b. Held: publicity prior to the filing of the registration statement via
public media, is presumed to set in motion or be a part of the
distribution process and therefore involves an offer to sell.
c. The Commission has a test to determine if something is an offer:
statements by means of publicity efforts which condition the public
mind or arouse public interest in the particular securities even if not
couched in terms of an express offer.
d. Here, they were furnished with price data, named the underwriter etc.,
so it is a selling effort and a violation of 5(c). (gun jumping)

v. Exceptions:
1. Rule 135: Safe Harbor Rule
a. A notice that there will be an offer is not an offer if the notice
contains only certain information.
i. Name, number of shares, type of security, purpose of
offering
b. Cannot disclose
26
a. the underwriter (if it is a big firm, it might hype up the
offer) or
b. the price.
2. Rules 137, 138, 139:
a. provide exceptions for broker dealers.
b. Firms that are just publishing research & not know about
offering

vi. What about selling stock for free?
1. Need exchange for value
2. Even if there is no $exchange, you are creating a potential market and
that makes it for value offer
American Space Corp: web site offers stock for free. SEC held it
was an offer. .

vii. Suppose you are an established company and therefore, you are required to
disclose under the securities act. Is there a violation of 5(c)?
What if you are asked by the commission to release information, but you know
that you plan on doing an offer in a week?
This is troubling. Where do you draw the line? At what point are you
arousing interest?
a. You CAN
i. Continue to advertise products and services
ii. Send out customary periodic reports
iii. Publish proxy statements
iv. Announcements to the press about factual business and
financial developments
v. Answer unsolicited telephone inquiries from SH,
analysts, and press about factual info
vi. Open door policy on answering unsolicited inquiries
concerning factual maters
vii. Hold scheduled SH meetings

viii. 5(c) deals with offers. What about sales? 5(a) says you cannot sell a security
until a registration statement becomes effective.
1. sale is broadly defined in 2(a)(3)
shall include every contract of sale or disposition of a security or
interest in a security for value.


d. Waiting Period (between date filed and date it becomes effective)
i. While SEC is reviewing it for 60 days

ii. Permits offers, but no sales. But offers have to be a prospectus and the definition
of prospectus limits what info can be disseminated.

iii. 5(c) no longer applies (offers allowed)

iv. 5(a) still applies (no sales)

27
v. 5(b)(1) applies: it is unlawful to transmit any prospectus, relating to any security
with respect to which a registration statement has been filed unless such
prospectus meets the requirements of 10.
1. Prospectus ( 2(10)): any communication that is written or by radio or
tv that offers a security for sale
2. not a prospectus ( 2(a)(10)): a notice, circular, advertisement, letter
in respect to a security that does no more than identify the security, state
the price, and state who will execute orders.
a. Rule 134: Tombstone ads are okay.
i. Written communication is not a prospectus if it states
where you can get a prospectus and only limited
information.
ii. Names underwriter (where they can get a prospectus), #
of shares, price.
b. Does not prohibit oral offers. ( 5(b)(10))
i. Can have Road Shows
ii. Can call people over the phone
iii. Can NOT close the deal
c. Should not initiate publicity, but can respond to inquiries.
3. Should receive preliminary prospectus 48 hours before the effective date.

vi. 10 of the 1933 Act: Information Required in a Prospectus
1. 10(a): what goes into the prospectus (info required)
2. 10(b): Commission can make rules that omit or summarize what is
otherwise required by 10.
a. Rule 430:
i. Allows you to send preliminary prospectus in waiting
period (aka Red Herring)
ii. preliminary prospectus has to contain substantially the
same info as final prospectus, but certain info can be
omitted if it is not available yet.
a. i.e. price can be omitted.
b. Underwriter can be named.
c.
b. Rule 15c2-8
i. Requires broker/dealers to deliver Prelim. Prospectus to
their investors.
ii. SEC has no control over issuers
iii. Prelim Prospectus is available at www.sec.gov for FREE

3. Free Writing Forbidden
a. free writing = ads, brochures, etc
b. NOT send during waiting period b/c free for investors and get
info

4. BOTTOM LINE: in waiting period, you can distribute a preliminary
prospectus (red herring) or tombstone ad.




28
e. Post-effective Period (after registration statement is declared effective)
i. After effective, underwriters and dealers can make sales to anyone. BUT, a final
(statutory) prospectus must be sent too

ii. 5(a) no longer applies because registration statement has been filed.

iii. 5(b) still applies.
1. 5(b)(2): shall be unlawful to carry or transmit any security for sale
unless accompanied or preceded by a prospectus that meets requirements
of 10(a).
2. 4(1): exempts sales by anyone not an issuer, underwriter or dealer.
3. 4(3): exempts dealers.

iv. Under 10(a), prospectus means a registration statement (final prospectus).
1. Rule 434: if a preliminary prospectus was already sent, you can just
send a term sheet with the price and whatever was omitted in the
preliminary prospectus.
2. Rule 174: if dealing w/ and ESTABLISHED COMPANY, dont have to
deliver final prospectus b/c there are already periodic reports that have
all the info.

v. free writing: sending an advertisement/written materials IS allowed. But,
you need to be sure they have a prospectus FIRST.
1. Sometimes it is viewed as a prospectus and you would not be registered
and then be held liable.

29
III. Disclosure Requirements
a. Three Types of Forms: S-1, S-2, S-3
b. Form S-1
i. All IPOs must file.
ii. No incorporation by reference
iii. Any companies that do not qualify for S-2 or S-3 must file an S-1
c. Form S-2 = skip it b/c no one uses it!
d. Form S-3 (most desirable)
i. Abbreviated form
ii. Issuers do not have to repeat information that is in the registration statement
iii. Incorporation by reference to 10K can be used.
iv. Two requirements (restricts who can use it)
1. Issuer requirement: must be a US company and filed with the SEC in
the last year (so no IPO)
2. Transaction requirement: if cash offering then persons not affiliated
with the issuer must hold stock with issuer worth 75,000,000.

e. Registration Statement
i. 7(a) 1933 Act: the registration statement shall contain information required by
Schedule A. (describes what must be included in the RS)
7 says that SEC can require more or less info if it wants

ii. 2 Parts of the RS

iii. Part I = Form S-1 info required in the prospectus. Part I is the prospectus.
Refers to Reg. S-K.
1. Reg S-K:
a. Item 10(b): allows use of predictions and forecasts if there is a
reasonable basis
i. Materiality
ii. Rule 175 = safe harbor for projections
b. Item 10b3: you must disclose material pending proceedings
against the company
c. Item 303: Management Discussion & Analysis (MD&A)
i. MUST include known trends and uncertainties that
could affect future operations
ii. This is supposed to give investors an opportunity to look
at the company through the eyes of the management by
providing for a short term and long term analysis of the
companys business.
iii. Should include material changes in advertising, purchase
or sale of major assets.
iv. Cant be too optimistic or pessimistic (no bright line)
d. Item 304: if change accountants, must notify
e. Item 501(b)(7): must put on the cover SEC has not approved or
disapproved of this security
i. The govt has no opinion about the security/investment.
They are just looking at the disclosure, not the merits of
the security.
f. Item 503:
i. Prospectus summary
30
ii. risk factors as to the securities being offered

2. Other Disclosure Requirements
a. Rule 408:
i. registration statement must include such MATERIAL
information as necessary to make the required
information not misleading.
ii. Injects English-style principles into American law
b. Rule 421: Plain English Rule. Prospectus should be intelligible
to people that are not professionals.

3. Small Business forms =
a. Regulation S-B (equivalent of Reg S-K)
i. Reg S-B 1 and
ii. Reg S-B2:
b. Disclosure rules for small businesses (simpler and less expensive
than Reg S-K)
c. Requirements
i. US and Canadian Companies
ii. $25M year in revenue
iii. $10M in offering

4. Misc. Forms
a. F-1, F-2, F-3 = foreign issuers
b. S-4 = Mergers and Acquisitions
c. S-8 = Employee Benefit Plans
d. S-11 = Real Estate Companies

iv. Part II Form S-1: items not required in prospectus but are available for public
inspection in the SEC files.


f. Who has to sign the registration statement?
i. 6 of 1933 Act: issuer, officers, financial officer, accounting officer and
majority of its Board.
1. important because under 11, whoever signs is liable.

g. Shelf Registration: Corp. can register securities now to be issued in the future (up to 2
years) so they can wait for more favorable market conditions.
i. Rule 415: list of who can use shelf registration. Any company that can use an S-3
can use shelf registration.
ii. Must comply with 512(a) of Reg S-K.
1. you have to file a post effective amendment that discloses facts that
happened after the registration statement that represent a fundamental
change.
2. But, if S-3, you do not need to do this because you would already have to
file the amendment under the S-3 rules.
h. Rule 512(a)
i. When selling securities, have to file post-effective statement
include facts that have had a fundamental change since registration
ii. Fundamental Change NOT Material Change
31
1. which is higher?
2. No one knows!

i. 1998 Proposed Reforms
i. aircraft carrier = 1000 Westlaw pages
ii. Release 706(a) = NOT ADOPTED
1. allow offers in pre-filing of IPO
a. up to 30 days before filing (30 days to cool off before IPO)
b. allows company to determine interest in stock
2. Waiting period would allow for free writing (just send it to SEC)
3. Prospectus Delivery
a. Require preliminary prospectus 3 days BEFORE pricing the
stock
iii. Industry like #1 and #2, but HATED #3


32
IV. Process of SEC Review
a. 8 of the 1933 Act: gives the SEC authority to review.
i. 8(a): once registration is filed, it becomes effective 20 days later. Every time it
is amended, the 20 day period starts again.
1. BUT, 20 days after filing is too short and 20 days after amendment is too
long.
a. Rule 473 delaying amendment solves the too short problem
b. Rule 461 acceleration rule solves the too long problem by
providing acceleration. Must be filed in GOOD-FAITH!

ii. 8(b): if registration statement is incomplete, they can issue a refusal order,
only 10 days after the filing
iii. 8(d): if untrue statement, SEC can issue a stop order. = order anytime
iv. 8(e): SEC can investigate = order anytime

b. SEC Review:
i. Not review all public offerings
ii. Review ALL IPOs
iii. Sarbanes-Oxley = requires SEC to review public offerings every 3 years

c. Doman Helicopters:
i. Corp. said they had an existing operational prototype helicopter, which was an untrue
statement. SEC issued a stop order. The corp did not make a good faith effort to comply
with registration requirements. The conduct must be really egregious for the SEC to
issue a stop order.
d. Las Vegas Hawaiian Development Corp v. SEC:
i. LVH files an S-11 with a delaying amendment. The SEC returned the registration
statement because of deficiencies. LVH filed another RS, without a delaying amendment.
So, technically, it would be effective in 20 days. SEC ordered an examination under 8(e).
ii. LVH claims the SEC has prevented registrant from having a hearing. SEC argued that the
RS became effective, so the SEC is not harming LVH.
iii. The SEC issued its investigation order before the effective date of the RS, so the
plaintiffs do feel the action in a concrete way.
iv. Congress did not put a time limit on the duration of an 8(e) investigation, so the plaintiff
has to use the remedies provided for by the APA.
v. But, a district court can compel the SEC to make a determination within a
reasonable time whether to notice a hearing on the issuance of the stop order
when the SEC has ordered the examination prior to the effective date.

33
Exemptions from Registration

I. Introduction

a. Party invoking the exemption has the burden of proving they satisfy the exemption.
b. Exempt Securities vs. Exempt Transactions
vi. 5 says you must register securities for interstate commerce.

vii. 3(a)(2)-3(a)(8): Exempt Securities = if you resell them = still exempt!!
a. insurance, endowment, annuity, security issued by a savings and
loan, issued by the US

viii. 4 Exempt Transactions = if resell = need ANOTHER exemption
1. Section 3 Exempt Transactions
a. 3(a)9
b. 3(a)10
c. 3(a)11 =
i. Intrastate Exemptions
ii. Rule 147 = safe harbor for this rule
2. Section 4 Exempt Transactions
a. 4(a)(1): transactions by any person other than issuer,
underwriter, or dealer
b. 4(a)(2): transactions not involving a public offering-therefore, it
is a private offering
i. NOTE: the antifraud provisions still apply even though
it is a private offering
ii. Regulation D = Safe Harbor
c. 4(a)(3): transactions by a dealer

ix. Entire offering needs to fit in one exemption.
1. Cant be 80% intrastate and 20% private
2. If one offering does not comply, the entire offering will be
invalidated.

34
II. Non-Public Offerings 4(2)
x. Section 5 (registration) shall not apply to transactions by an issuer not
involving any public offering
(PRIVATE OFFERING must be an offer from the issuer). safe harbor

1. Can be used by
a. private companies
i. want to raise $ w/out going public
ii. start-up raise capital w/out expense of regulation
b. public companies.
i. public companies use private offerings to sell debt
ii. BONDS
2. Two ways to structure exemption from 5 for private offerings:
a. comply with 4(2)
b. Comply with terms of safe harbor provision of Reg. D.
3. Issuer cannot engage in solicitation or advertising
4. certain limits on number of offers apply
5. Rule 155 = safe harbor provision for PUB PRIV
a. If you have a public offering & not doing well, and want to
change to a private offering
a. w/ public, all info is on SEC b/c filed
registration statement
b. info to whole world already
b. If meet conditions of Rule not worry about abandoned offering
being combined w/ new offerings
c. Wait 30 days

xi. SEC v. Ralston Purina:
1. Ralston made private offerings to key employees, without registering it and
used the mail. They claimed the private offering exemption and claimed that all
employees were key employees.
2. Are offerings of treasury stock to key employees covered by the exemption in
4(2)?
3. Public does not mean that it is open to the whole world.
4. Exempt transactions are those as to which there is no practical need for the Acts
application, so whether it is exempt under 4(2) depends on whether the class of
persons affected need the protection of the Act.
5. These investors are considered part of the investing public and need the
protection of the Act.
a. Some employee offerings will be exempt under 4(2) (i.e. an offering to
the executive employees that have access to registration statements).
This burden is on the issuer.
6. Absent these special circumstances, employees are just as much members of the
investing public as any of their neighbors in the community.
7. If all offerees have access to the same kind of information that the act would
make available if registration were required.

xii. Rules after Ralston:
1. Availability of information:
a. people need access to the same information that would have been
disclosed in a registration statement
35
b. company gives the info to people INSTEAD of worrying about
them getting it on their own.
c. Relationship between Issuer and Offerees for Information:
i. is there a relationship that affords the investors access to
or disclosure of the information about the issuer that
registration would reveal?
ii. Here, Murphy refused to give information.
2. Investor sophistication:
a. Do they have knowledge, experience, on financial matter to
accurately assess the risks?
b. Wealth of the investor
c. can have representatives who are sophisticated when you are not
d.
3. Number of investors & size of investment:
a. No bright line rule
b. Fewer looks private = More looks public
c. Money = if small and direct offering, then probably private.
d. Technically, the rule applies to any size, but smaller is more
likely to be exempt.

4. Private offering: SOPHISTICATION AND ACCESS (from Doran)
a. sophistication of one offeree is not enough.
b. All need to be sophisticated.
c. Sophistication is not necessarily a substitute for access to info a
registration would disclose
d. Each offeree must have access to information.
i. Rule 146: disclosure of information or effective access
to information is sufficient.
e. Knowledge and wealth cannot substitute for access.

NOTE: A person may NOT separate parts of a series of related transactions,
the sum total of which is really one offering, and claim that a particular part
is a non-public transaction.

5. Integration Factors (Murphy)
a. relevant to determining whether the offering is part of a larger
offering made or to be made:
b. When a person organizes or sponsors the organization of limited
partnerships and is primarily responsible for the success and
failure of the venture for which the partnership is formed, he will
be considered an issuer for purposes of determining the
availability of the private offering exemption.
c. Issuers BURDEN to prove it is NOT
d. Number of Offerees: Integration Doctrine: consider each
offering of partnership interests in the aggregate, as one
integrated offering.
Should offers be integrated??
FACTORS
1. whether the offerings are part of a single plan of financing (here, all to
finance Intertie)
2. whether the offerings involve issuance of the same class of securities
36
3. whether the offerings are made at about the same time
4. whether the offerings are made for the same general purposes.
6. whether the same type of consideration is to be received

xiii. Cases
xiv. SEC v. Murphy
1. Murphy formed Intertie and was Chairman of the Board. Intertie promoted 30
limited partnerships. Murphy would buy a cable tv company, finance it and then
sell to one of the partnerships. Intertie engaged a securities brokerage firm to
find investors who wanted to buy interests in the cable companies. These
securities were not registered, and Murphy claimed they were exempt under
4(2). Murphy did not assure that the securities were offered to only a small
number of sophisticated investors. He was heavily involved in the offerings.
2. Court focuses on the relationship between the issuer and the offerees.
a. Not clear who the issuer was. There is no company issuing securities,
but a group of individuals.
b. Intertie was so involved that investors needed information about
Intertie in making their investment decisions.
3. When a person organizes or sponsors the organization of limited partnerships
and is primarily responsible for the success and failure of the venture for
which the partnership is formed, he will be considered an issuer for purposes
of determining the availability of the private offering exemption.
4. Since he is an issuer, does 4(2) apply between him and the offerees? Burden on
Issuer to fit the exemption. Was it a private offering???
i.
5. Held: it is one integrated offering and the investors were not sophisticated, so
Murphy is not exempt under 4(2) and must register.
xv. Doran v. Petroleum Management
1. Interests in LP that managed oil wells were offered to eight people and four
accepted. They were not registered. P was sophisticated. He signed a note for
113,000 to a supplier which was to be paid by Ps production royalties. The
royalties were unable to pay for the note and noteholder sued P. P sued for
damages to rescind his purchase of the interest, claiming D did not register.
2. Private offering: SOPHISTICATION AND ACCESS
a. sophistication of one offeree is not enough. All need to be
sophisticated. Here, they were all sophisticated.
b. Sophistication is not necessarily a substitute for access to info a
registration would disclose
c. Each offeree must have access to information.
i. Rule 146: disclosure of information or effective access to
information is sufficient.
d. Knowledge and wealth cannot substitute for access.
xvi. Hill York v. American International Franchise
1. Investors all got information about the offering and were all sophisticated, small
number of offerees.
2. Court held that they are not exempt because the information was misleading.


37
e. Regulation A = (exemption for 11)
i. If exempt under Reg A, no civil liability under 11, but
ii. still subject to antifraud provisions of 10(b) 1934 Act.
iii. 3(b) Regulation A

iv. Rules 251-263 (focus on Rule 251 and Rule 254)
1. 251(a): Requirements, who is eligible: must be a US or Canadian
Company
2. 251(b): Can only use Reg A if you sell less than 5 million in 6 months
(good for small companies)
3. 251(c): Safe Harbor from integration. Reg A offerings will not be
integrated if you wait 6 months.
4. 251(d): conditions and process.
a. Must file a Form 1-A (similar to RS in Sect. 5, but much
simpler)
b. Must be approved by the Commission.
c. NO audited financial statements, process is shorter and less
expensive.
5. 254: Issuer can solicit interest in the offering before it goes out. Test the
Waters with oral and written communications
a. This varies from 5(c) which prevents gun-jumping.
b. But you have to wait 20 days.
c. The idea is to let a company go out and see if there is anyone
interested.
d. NOTE: You are NOT allowed to do this under Reg D or 5.
e. Although Reg A provides a cheaper and faster registration,
there are those that argue that it is still too expensive and a pain
to even have to do the mini registration. For this reason, Reg. D
is more popular.
f. However, the internet is changing this. You are allowed to do
solicitation via the internet which is cheap and efficient.
v. NOT use if
1. register on 34 Act
2. assets of $10M AND 500 or more people hold stock
3. IPO
4. history of past violations

38
f. Regulation D = (exemption from 4(2))
i. Safe Harbor for 4(2) exemptions
ii. Rule 501-508 (most important are 504, 505, 506).
iii. 3(b) Additional Exemptions: allows the SEC to issue rules to add exempted
securities, 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 million.
a. Rule 504 and 505 fit under this provision

iv. Rule 504: (for small start ups fewest conditions)
1. offerings not exceeding 1 million dollars in a 12 month period.
2. not available to companies that have to register under the 1934 Act
3. no limit on the number of ivestors
4. comply with 502(a), (c), and (d).
a. 502(a): Integration provision: Offerings that are separated by
more than six months are not deemed part of the same offering.
Whether offerings within six months of each other will be
considered part of the same offering depends on application of
the five factors.
i. Are they part of a single plan of financing?
ii. Involve the same class of securities
iii. Are made at the same time
iv. Involve the same consideration
v. Are they made for the same general purpose
b. 502(c): Manner of Offering: cannot be advertised or general
solicitation
c. 502(d): Limitation on resale: cannot be resold by purchaser,
unless another exemption applies or you register.
i. Issuer shall exercise reasonable care to assure that the
purchasers are not underwriters.
a. Underwriters (2(11)) are those who
buy with a view towards distribution,
not investment.
b. How?
i. Buyer signs letter swearing its
for investment, not re-sale
ii. Restriction on stock = not allow
it to be sold
ii. Is the buyer a conduit for the securities to reach the
public?
v. Rule 505:
1. offerings of up to 5 million in any 12 month period.
2. 502(a) (no integration), (c) (no general solicitation) and (d) (restriction
on re-sale) apply
3. Limit on number of purchasers (35)
a. 35 purchasers and unlimited accredited investors.
i. purchaser defined in 501(e): excludes accredited
investors.
ii. Accredited Investor: 501(a) bank, person with net worth
of 1 million or more, income of 200,000. Presumed they
39
have access to information about the issuer. Accredited
Investor: defined to include:
a. any bank, savings and loan association,
credit union, insurance company,
investment company, or employee
benefit plan,
b. any business development company,
c. any charitable or educational institution
with assets of more than $5 million, as
well as corporations, partnerships, and
business trust with more than $5 million
in assets,
d. any director, executive officer or general
partner of the issuer,
e. any person with a net work of more than
$1 million, and
f. any person with an annual income of
more than $200,000 (or annual joint
spousal income of $300,000)
iii. If there are any unaccredited investors, the information
prescribed by Rule 502 must be furnished to them.
4. 502(b) applies: information to be disclosed:
a. type of information depends on size of the offering.
b. Disclosures required only for purchasers.
c. No information required to disclose to an AI.
vi. Rule 506:
1. no limit on dollar amount of the offering.
2. can sell to 35 purchasers and unlimited accredited investors.
a. BUT, purchasers must have knowledge and experience in
financial and business matters that enables them to evaluate the
risks.
b. No limit on number of offerees, but there is a limit to purchasers.
3. 505(d) has a disclosure requirement to those who are not accredited
investors. Rule 502(b) applies. Disclosure requirements apply.
4. Form D must be filed.
5. No advertising or solicitation, offers to large numbers of offerees may be
viewed as advertising, resulting in loss of exemption.
vii. Rule 508:
1. failure to comply with 504-506 requirements will not result in the loss of
the exemption if the person relying on the exemption shows a good faith
and reasonable attempt to comply.
viii. No Action Letter
1. To know how these Regs are interpreted, send the SEC a no action letter.
2. Explain in the letter what you want to do and then the SEC will respond
with what you need to do to avoid prosecution.
3. They are not binding, no precedential value, but they support your case.

g. Intrastate Offerings
i. Less important now b/c of National Securities Improvement Act of 1996
1. Congress pre-empted most state registration
2. 18
40
a. if covered security, than exempt from state registration
b. Covered Security = on a national exchange
3. NOT pre-empt state anti-fraud provisions
4. States CAN still charge fees

ii. 3(a)(11): Any security which is part of an issue offered and sold only to
persons resident in a single state or territory, where the issuer is a person
resident and doing business within such state or territory.
1. Early Release 4434: the entire issue of stock must be offered and sold to
residents of the state. If any buyer is a nonresident, no exemption.
Therefore, just one sale outside the state screws up everything.
2. Rationale:
a. The investor is in the same state as the issuer
b. State regulator has power over business in their state
3. Steinberg book: rationale for the exemption is based on the probability
that investors in local enterprise will have adequate familiarity with
enterprises and an acknowledgment that local issuers will be relatively
small and less able to bear the burden of federal registration.

4. SEC v. McDonald Investment Corp.
a. Minnesota corp. sells securities to residents in Minnesota. But, the
proceeds from the sales go to make loans to land developers outside
Minn. Can they be exempt from registration? (no)
b. P claims the income producing operations of D are located outside the
state.
c. Was doing business in state?
d. Held: securities are not exempt. The strength of the notes depends on
activities outside of Minnesota. Court looks to the Dunn case, which
held that substantial business must be done in the state too.
5. Busch v. Carpenter
a. First sale to nonresident occurred seven months after the offering.
b. bears the burden of showing they are exempt.
c. For the intrastate exception, the securities must have come to rest in
the hands of resident investors and not with a view to further
distribution or for the purposes of resale.
i. has the burden of proving the stock had not come to rest in
a state, but was sold only to people who intended to resell it
outside the state.
ii. Here, there was nothing questionable about the offering, the
securities came to rest.
d. Doing business: means more than just having an office in the state.
iii. Rule 147 safe harbor
1. Provides rules for intrastate offerings, to know when it applies.
2. Integration applies:
a. Five Factors
3. Issuer qualifications:
a. incorporated or organized in the offering state
b. Must be doing business in the state
4. Defines residence: state where business has principal office and where
person has principle residence
5. Defines doing business: 80% TEST
a. 80% of revenue is earned from property or services in state
and-
41
b. 80% of corps assets are in state and-
c. 80% of proceeds from the offering are used in state for operation
of the business
6. Applies not only to issuer, but also shareholders who want to resell
a. Resales:
i. 9 month test, if held for nine months, it has come to rest.
ii. Resell to resident has no restrictions, but resale to
nonresident only after it has come to rest in the state.
7. Advantages of intrastate
a. there is no dollar amount limit like there is in Reg. A.
b. there is no disclosure requirement like in 505 and 506.
8. Disadvantages
a. there is a very strict view that even one offer to an out of state
person disqualifies you.

h. Foreign Offerings in US Securities- Offerings that are made outside the U.S. that arent
going to immediately find its way back into the U.S.
i. Reg. S
1. provides a safe harbor
2. Rules 901-905
a. 5 registration requirements will not apply if offerings are made
in an offshore transaction and there are NO directed selling
efforts in the U.S.
i. an offshore transaction means that
a. there is no offer made to a person in the
U.S. (it doesnt matter if that person is a
U.S. citizen, that person simply cannot
be physically within the U.S.)
b. the buyer is either outside the U.S. or
the transaction takes place on a foreign
securities exchange.
ii. a directed selling effort - to anything in the U.S. (cannot
generate interest in the U.S.)
b. cannot be a RUSE to outside the US and bring them BACK to
the US
3. If you look at Reg. S, you will see that it is an attempt to stop companies
from selling securities abroad with the intention of having them come
back to the U.S.
4. Anti-fraud provisions are BROADER
a. Fraudulent conduct IN the US
b. Fraudulent conduct outside the US w/ EFFECTS reaching the
US



42
i. Secondary Transactions (Re-sales by Non-Issuers)

i. Main Point: When individual investors want to resell their securities, they can do
so without registration, as long as they are not an underwriter.
1. Prior to this discussion, we have discussed exemptions from 5 for the
issuers.
2. We are now moving onto secondary transactions (re-sales by persons
who are not issuers, i.e., someone who buys securities and decides that
he wants to sell them).
3. Governed by 4(1), 4(3), and 4(4)

ii. 4(1): exempts from registration any transactions by any person other
than an issuer, underwriter or dealer.

1. Issuer: issuers and those who control the issuer.
a. Also applies to those who
i. Sell on behalf of the issuer
ii. sell on behalf of the control person
b. Rule 405: control = the possession, direct or indirect, of the
power to direct or cause the direction of the management and
policies of a person, whether through the ownership of voting
securities, by contract, or otherwise

2. Dealer (( 2(a)(12)):
a. Anyone engaged in business of selling for another

3. Underwriter ( 2(a)(11)):
a. Typical Underwriter = 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.
b. Statutory underwriter: if you are not technically an
underwriter, but you have a view to distribute securities,
indirectly distribute.
i. You dont want to be a statutory underwriter, because
then you are not exempt from registration.
c. Three ways to become a statutory underwriter
i. Direct or indirect participation in a selling effort
Chinese Benevolent Association
(no intent needed!!)
ii. Purchasing securities from an issuer or control person
with a view to distribute
Sherwood
(how long do you have it for?
Sherwood said 2 YEARS)
Change of Circumstances Doct.
o If your situation changes,
CAN sell the stock
o Hard to prove
iii. Sell securities for issuer or control person in
connection w/ distribution
43
1. control person: anyone who has power to direct management and
policies of the issuer
(a) directors, officers and owners of 10% are presumed to be
control person. (
(b) look to intent of the buyer
iv. Selling for an issuer or control person with a view to
distribute

CASES
4. SEC v. Chinese Consolidated Benevolent Assoc.
a. Chinese govt issues bonds to sell in US. is a nonprofit organization
that advertised the offering of the bond, collect money from people and
transmit it to CCB. receives no compensation for the service.
b. Ct finds they are an underwriter and must register, 4(1) exemption
does not apply to them.
i. was an essential cog in the offering
ii. participation in an indirect offering
iii. no intent required
5. United States v. Sherwood
a. Sherwood purchased shares from the issuer. He owned 8% of the
outstanding stock and held it for two years.
b. Is he a statutory underwriter? NO.
i. He is not a control person. He bought from a control person,
but he is not a control person. He owned 8%, but he could not
get a place on the Board and he had a falling out with Doyle,
who controlled the management decisions.
ii. He held onto the stock for two years, so there is no intent to
distribute.
6. SEC v. Guild Films: Guild issued to WR Corp 400,000 shares of stock. They
did not register, under the 4(2) exemption. The CEO used the shares as
collateral for bank loans. When he defaulted, the bank tried to sell the shares.
Guild refused to sell shares, claiming it would violate the 33 Act. Court agreed
that selling the stock would violate the 33 Act.


iii. 4(3) Exemptions
1. 5 applies to DEALER
2. Unless
a. Less than 1 year holding
b. By/through underwriter
c. Part of a larger deal

iv. 4(4) Exemptions
1. Brokers transactions, executed on customers orders, in an over-the-
counter market
2. NOT on solicitation of orders
a. you can call a broker who is NOT controlled by an issuer and
want to buy stock, its OK
can NOT have a broker ask YOU

v. CASES
1. Ira Haupt & Co.
44
a. Shulte was in control of Park & Tilford. He told Haupt to sell some of
his stock. Haupt sold and was charged with violating section 5 because
the stock was not registered. claims he is exempt from registration.
b. claims he is exempt under 4(3) and 4(4) which exempts transactions
by a dealer
i. Broker transactions executed on customers orders
c. Is he an underwriter?
i. Sells for an issuer (includes control person).
ii. Yes, he sold for a control person, but claims that he was not
intending to sell in connection with a distribution, which the
definition of underwriter requires.
a. Distribution: the entire process by which
in the course of a public offering the block
of securities is dispersed and ultimately
comes to rest in the hands of the investing
public.
b. Court found there was a plan of distribution.
So, he is not exempt and must register.
c. 4(3) and (4) do not exempt brokers from
section 5 when they act as underwriters in a
distribution plan.
2. United States v. Wolfson
a. Wolfson is control person of Continental Enterprises. sold 55% of
their holdings without registration. US brought criminal charges.
i. Wolfson is an underwriter because he is a control person.
So, he is not exempt under 4(1).
ii. Court rejects this. is an underwriter
b. claims that they are exempt because of 4(4) which exempts brokers
from transactions made on customers orders.
i. 4(4) is unavailable because it is designed only to exempt the
brokers part in securities transactions, not a control
persons.

vi. Rule 144: Persons Deemed Not to be Engaged in the Distribution and therefore
Not Underwriters.

1. Restricted Security = security acquired by a 3
rd
Person from the issuer
that has no registration statement b/c no public offering
2. safe harbor,
a. provides clear guidelines of who is and who is not
i. an underwriter.
b. Must comply too
i. An affiliate (control person) of the issuer, or
ii. a sale of restricted securities (private)
3. Steinberg book: those who are NOT underwriters are: distributors and
dealers who receive a commission from an underwriter not in excess of
usual and customary commission.

4. Requirements:
a. There must be adequate information about the issuer.
can use 34 Act reports
b. Holding Period: the person can resell restricted securities if you
hold them for one year.
45
i. If less than 2 years, there is a limit on the volume you
can sell.
ii. If more than 2 years, resell w/out limits except cannot be
CP 3 months prior to sale
c. Volume Restriction = Cant sell more than
i. 1% of issuers securities.
ii. Average weekly trading volume
d. Notice of sale must be filed with SEC
e. Issuer must be subject to requirements of 34 Act.

vii. Section 4(1 )
1. Deals with affiliates and nonaffiliates who want to sell securities in a
routine private transaction after a short holding period. Allows affiliates
to sell if some of 4(1) and 4(2) requirements are met.
2. If you fail 4(1): you are an issuer, underwriter or dealer, but you dont
want to register your securities for resale.
3. Look at 4(2):
a. Would it be a private offering?
Do the investors have access to info?
Is it a small offering?
Is there investor sophistication?
b. Basically, you are failing under 4(1), but winning under 4(2) and
Regulation D caselaw (Ralston).
4. If you participate in a distribution, you become a statutory underwriter.
5. Distribution is the equivalent of a public offering, so if no public
offering, no distribution. So, make it a private offering (sophisticated,
small number, access to info, only sell to those who do not need
protection of the acts). Then, you are not distributing and do not need to
register it.
6. Elements
a. Buyer needs access to information through Registration
Statement
b. Buyer meets 4(2) caselaw
c. If too many 4(1) Exemptions = possible distribution

46
Civil Liabilities

The Securities Act of 1933
11
12(a)(1)
12(a)(2)


V. Introduction
a. Overview:
i. Purpose: to create incentives for the people who have control over the
registration statement to make it accurate; so investors can make informed
investment decisions based on disclosure of information about the issuer.
ii. For a material misstatement or omission
1. Under common law, had to show
a. reliance and scienter, which was very hard to do.
b. You had to show D had an intent to file a false or incorrect
registration statement.
c. Also, had to show a reliance on the misrepresentations.
iii. Provisions
1. Section 11: persons liable, reasonableness for material misstatements or
omissions
2. Section 12(a)(1): any person who sells in violation of 5 (offer/sale) is
liable to the purchaser.
3. Section 12(a)(2): person who offers or sells a security w/ a material
misstatements or omissions in a registration statement is liable to the
purchaser
4. Section 17 ~ 10b-5: general anti-fraud provision in offer or sale of
security. No private right of action (for priv right, use 10b-5).

47
VI. Section 11

(I) Standing
a. If any part of the registration statement contained an untrue statement of material
fact or omitted a material fact required to make statements not misleading, any person
acquiring such security may sue.
i. Requirements 11:
1. privity, scienter and reliance are NOT necessary.
These are basically strict liability provisions.
2. NO showing of causation
3. Statute of limitations: 1 3 years
4. must show materiality

b. No reliance required by buyer, unless there has been an earning statement filed in the last
12 months
i. in that case, the has to prove that they relied on the untrue statement or did not
know of the omission
ii. For reliance, the does not need to prove they read the registration statement.

c. Who can bring the suit?
i. 11(a): anyone purchasing the security, unless it can be shown that at the time
of the purchase, the purchaser knew of the misstatement or omission.
ii. aftermarket purchaser
1. has standing to pursue a claim under section 11 so long as he can prove
the securities he bought were those sold in an offering covered by the
false registration statement.
2. Joseph v. Wiles: The purchaser didnt purchase at the initial offering, instead, he
purchased on the secondary market.
a. The issue is aftermarket purchasers have standing to sue under 11.
b. The court holds that an aftermarket purchaser has standing to pursue
a claim under section 11 so long as he can prove the securities he
bought were those sold in an offering covered by the false registration
statement.
c. The ambiguity of any person and such security is resolved by the
court as meaning that the buyer must have purchased a security issued
under the registration statement at issue, rather than some other
registration statement.
d. NOTE: If A gets from the initial offering and then trades to B, B trades
to C, and C trades to D, arguably, they might all have standing.

d. Who is liable?
i. 11(a)(1): anyone who signed the registration statement, anyone who was
director or partner at the time of the filing.
1. 6 says that people who must sign are issuer, officers, financial
officer, accounting officer, majority of Board
ii. 15: Control Persons: any person who controls any person liable under section 11
is also liable to the same extent as that person.
iii. 11(a)(4): every accountant, engineer, appraiser, or any person whose
profession gives authority to a statement made by him in the RS
iv. 11(a)(5): every underwriter
v. anyone who is about to become a control person

48
e. Statutory Provisions
i. 11(a): purchaser cant recover if he knew of the misstatement or omission.
ii. 11(b): provides defenses for everyone EXCEPT THE ISSUER
iii. 11(g): caps total damages; shall not exceed the offering price.

f. Case Law
i. Section 11 is only available to those who can trace their shares back to the
falsely registered shares (Barnes)
applies only to after-market purchasers
ii. After-market purchasers CAN sue under Sect. 11 IF they can prove purchased
securities were sold in an offering covered by false RS (Joseph v. Wiles)
1. How do you trace back?
a. Show you dealt w/ either UW (if wealthy) or broker retailer (if
normal)
b. UW or broker shows you RS and asks if you want to buy
i. You say yes after looking at it
ii. You keep records of this conversation and transaction
2. NOT need privity for Sect. 11
a. 12(2) (Gustafson) = needs privity no tracing there!

iii. Barnes v. Osofsky:
1. sued underwriters under 11 for failing to disclose the misstatements in the
registration statement. There was a settlement and appellants objected to it
because it limited benefits of the settlement to persons who could establish that
they purchased securities issued under the 1963 registration statement. (Limited
recovery to those who could trace their shares back to the registered shares).
This eliminated those who purchased after the issuance but could not trace their
purchases.
2. They were bought on the market and could not be traced to the original issuance.
3. Issue: Does 11 only apply to purchases of newly registered shares?
a. Any person acquiring, or any person acquiring pursuant to a
registration statement
b. Appellants argue that an overly optimistic prospectus will affect
securities that are already issued. Also, it is difficult to determine which
securities are old and new (tracing), when most trading is done through
brokers.
4. Court held that a broad reading (any person acquiring a security) is
inconsistent with the statutory scheme. If they did not require tracing, the
amount of plaintiffs would be huge.
a. Only those that can trace back to the RS can recover.
5. Section 11 is only available to those who can trace their shares back to the
registered shares.
a. technically, 11 is available for purchasers in the initial offering and
the aftermarket. But, in the aftermarket, the shareholders have to trace
their shares to the deficient RS, arguing that they purchased shares
pursuant to the deficient statement.
i. This is difficult to do, so the tracing requirement has nullified
many 11 aftermarket claims.
iv. Joseph v. Wiles
1. facts = P bought debentures in a secondary market with a false RS.
2. Hold = after-market purchasers CAN sue under Sect. 11 IF prove bought
securities in an offering covered by false RS
a. Other fed circuits agree
b. Text = any person acquiring SUCH security
49
c. Leg History = Sctn. 11 amended to say must prove reliance, and
price offered to the public not necessary unless secondary market b/c
use purchase price.
d. Tracing theory
e. Gustafson

g. Elements of the Claim:
i. Misrepresented facts must be MATERIAL
What an average, prudent investor ought reasonably to be
informed about before he can make an intelligent, informed
decision whether to buy the security or not.

1. Escott v. BarChris:
a. bring suit against BarChris under 11 for material misrepresentations
in the registration statement. BarChris was inadequately financed and
defaulted on the payment of the interest on the debentures. claim
inadequacies and omissions in the prospectus.
b. For a 11 suit, the facts allegedly misrepresented must be material.
c. 1961 statements: Court finds that the misstatements about the condition
of the company were material.
d. 1960 statements: debentures were characterized as speculative and
probably would not have deterred an investor and they were not
material.




h. Damages/Causation Defense:
i. How are damages calculated?
1. 11(e): damages shall represent the difference between the
(A) amount paid for the security AND
(B)
1) the value at the time the suit was brought, OR
2) the price at which such security shall have been disposed of
before suit OR
3) the price at which security shall have been disposed of but
before judgment was brought if less than #1.

ii. Negative Causation Defense:

show the drop in value was due to something else.
(Was the stock price fall the same for all in the industry?)

1. If the defendant can show that there were reasons other than materially
false statement that caused the loss, this will offset the damages that the
plaintiff can receive.
a. 11(e) says: . . . if the defendant proves that any portion or all of
such damages represents other than the depreciation in value of
such security resulting form such part of the registration
statement, with respect to which his liability is asserted, not
being true or omitting to state a material fact required to be
stated therein or necessary to make the statements therein not
50
misleading, such portion of or all such damages shall not be
recoverable.
b. has the burden of proving that any portion of the damages
claimed by represents damage other than the depreciation in
value of such security resulting from the misstatement.

2. Beecher v. Able: Court found had issued securities under a materially false
prospectus. How are damages calculated?
a. 11(e): damages shall represent the difference between the amount paid
for the security and 1) the value at the time the suit was brought, or 2)
the price at which such security shall have been disposed of before suit
or 3) the price at which security shall have been disposed of but before
judgment was brought if less than 1.
b. Dispute over time suit is filed, value of stock at time of suit, cause of
market drop.
c. Time Suit is Filed: the date the first claim was filed.
d. Value at time of suit:
i. says take market value on the day of suit because that is
what people thought the price was. They did not know that
the security was in crisis, or they would have paid less for it.
ii. says the price was due to panic selling, so the value should
be less than the market value.
iii. Court held that the knowledge probably would not have led
investors to pay less. They would view it as a temporary crisis.
So, the court agreed that there was panic selling(evidence
showed this) and added value to the stock. Fair value = $85.
e. Negative Causation Defense: show the drop in value was due to
something else. Was the stock price fall the same for all in the
industry? If the defendant can show that there were reasons other that
materially false statement that caused the loss, this will offset the
damages that the plaintiff can receive.
i. 11(e) says: . . . if the defendant proves that any portion or all
of such damages represents other than the depreciation in
value of such security resulting form such part of the
registration statement, with respect to which his liability is
asserted, not being true or omitting to state a material fact
required to be stated therein or necessary to make the
statements therein not misleading, such portion of or all such
damages shall not be recoverable.
ii. has the burden of proving that any portion of the damages
claimed by represents damage other than the depreciation in
value of such security resulting from the misstatement.
1. claimed that other events caused the drop in value.
2. claimed it was due to the third quarter loss which was foreseeable.
3. claims that general economic phenomena (interest rates) affected the price pre
Sept. 26. so that bought pre Sept. 26 cannot recover. The decline was not due
to the misstatement because the misstatement was not published yet. What
would they be reacting to?
iii. After Sept. 26, failed to carry the burden of proving
depreciation was due to something else. It was clearly related
to the falsities in the prospectus.
3. Ackerman v. Oryx:
a. Prospectus overstated earnings. The price declined. Then Oryx
disclosed the mistake and the stock price rose.
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b. sue under 11 for untrue statements in the registration statement and
claims they are not material.
c. The prospectus stated that the stock price may decline AND the
misstatement was an innocent bookkeeping error.
d. Considering the stock was likely to decline anyway, the small error was
not likely to cause a decline in stock price.
e. met their burden of proving the Negative Causation Defense because
the misstatement was not material and the public did not react
adversely to the disclosure (stock price went up after disclosure).


Defenses for the non-issuer
(Secondary Person)
1. purchasers knowledge of the misstatement
(11(a))
2. lack of causation (tracing)
3. expiration of the statute of limitations
4. due diligence defense ( 11(b))
5. he resigns before RS becomes effective
6. after effective, advises SEC

ISSUER:

Can only use 1-3 as a defense. No due diligence




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VII. Section 11 Due Diligence Defense

a. 11(b): provides an affirmative defense for any party EXCEPT THE ISSUER if
they can meet the prescribed standard of diligence.

b. 11(c): Reasonableness Standard
i. ISSUER STRICTLY LIABLE

ii. Others not liable if..
Three Key Provisions (11(b)(3)(A)-(C)):
1. (A) for any part of the registration statement not made on the
authority of an expert, at the time of the filing of the
registration statement you have to make a reasonable
investigation and have a reasonable grounds to believe that
statements were true and there was no omission of material fact.

2. (B) part of registration made by an expert,
after reasonable investigation, expert he had reasonable
ground to believe it was true.

3. (C) if you are not an expert, as to the parts prepared by the expert,
there is no requirement that you do an investigation, you just
have to have a reasonable ground to believe that the statements
are not false.
a. therefore, if you are not an expert, you will be held liable if you
know that there are false statements
4. Divide the registration up to the expertised parts and the non expert parts.
a. Expert parts
i. experts: reasonable investigation and reasonable belief
ii. everyone else: no investigation requirement, they just
have to show that they had a reasonable belief that the
statements werent false or misleading
b. Non expert parts
i. experts: no responsibility
ii. everyone else: reasonable investigation and reasonable
belief
iii. Reasonableness: 11(c) What constitutes reasonable investigation and
reasonable ground for belief, the standard for reasonableness shall be that
required of a prudent man in the management of his own property.

1. Inside vs. Outside Directors
a. Inside Directors held to a strict standard of due diligence.
i. Inside Directors are liable for a failure to investigate.
Reasonable investigation and reasonable
ground to believe will vary with the degree of
involvement of the individual, his access to
information and his expertise.
b. Outside directors must make some independent verification of
the information

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2. Escott v. BarChris Construction Corp. cant rely on others to investigate for
you.
a. Every pleaded the 11(c) Due Diligence defense.
b. Russo (CEO): He knew all the relevant facts. He could not have
believed that there were no untrue statements. No Due Diligence
defense.
c. Vitolo and Pugliese (Inside Directors): does not matter if they read the
RS or not. They were members of the executive committee and knew
large advances had gone unpaid. They could not have believed it was
true. No Due Diligence. Inside Directors held to a strict standard of
due diligence.
d. Kircher (Treasurer and CFO): thoroughly familiar with BarChris
financial matters. He prepared the RS and read it. He had reason to
believe that the expertised portion was incorrect. No Due Diligence.
e. Birnbaum (young lawyer): he was named as a director, but court noted
that he was not an executive officer in any real sense. He took minutes,
which necessarily informed him about the companys affairs. He made
no investigation and relied on others. He should have known his
obligations under the statute; that all he needed to do was to make a
reasonable investigation of the unexpertised portion. No Due
Diligence defense.
i. he was found liable under 11 because he was technically a
director. His status as attorney was considered in determining
the reasonable investigation he made.
f. Auslander (Outside Director): Elected Director after the RS was filed.
He had no reason to believe that the expertised part was untrue. If he
had read the RS, he would have seen that the nonexpertised portion was
incorrect. It does not matter how new a Director you are, you are
presumed to know your responsibilities. He can only escape liability if
he uses reasonable investigation. Here, he relied on representations of
strangers. No Due Diligence defense. Even outside directors must
make some independent verification of the information.
g. Grant (Outside Director, Counsel): He signed and drafted the RS. No
due diligence.
h. Underwriters: no investigation. They are in a unique position to
position to verify the accuracy of the of the RS. No Due Diligence.
i. Peat Marwick: Accountants. They are EXPERTS and are responsible
for investigating the part of the RS that they made. They did not make a
proper investigation.
3. Feit v. Leasco Data Processing Equipment Corp.
a. claimed failure to disclose exchange offer was an omission of
material fact in registration statement.
b. Inside Directors
i. Steinberg & Schwartz (Inside Directors) & Hodes (Partner in
law firm representing Leasco): sometimes a lawyer can be so
involved that he becomes an insider. He was a director and
lawyer and was intimately involved in the affairs of the corp.
So, hes an insider.
ii. Inside Directors are liable for a failure to investigate.
iii. Reasonable investigation and reasonable ground to believe
will vary with the degree of involvement of the individual, his
access to information and his expertise.

iv. Inside directors will be expected to make a more complete
investigation and have more extensive knowledge of facts
than outside directors.
54
v. Held: they had no grounds for believing that omitting the
exchange offer was not materially misleading.
1. They also failed to investigate the accuracy of the prospectus. They never got a
second computation of the exchange offer.

c. Underwriters
i. They have the same burden of proving reasonable investigation and reasonable
ground to believe the accuracy of the registration statement.
1. Underwriters do have an obligation to do SOME investigation.
2. They should pay attention to what is being reported, whats in the press.
3. They cant just rely on information that is coming from the issuer.
ii. BUT, they have limited access to information.

d. Rule 176
i. Guidance about Due Diligence
ii. Useless rule b/c too broad
iii. Factors
1. type of issuer
2. type of security
3. type of person
4. office held when one is officer
5. presence/absence of relationship to issuer when one is director
6. reasonable reliance on officers, employees, & others whose duties gave
them knowledge of particular facts
7. UW = type of UWing arrangement, role of person as UW, and
availability of info
8. whether person had responsibility for fact or document at time of filing






55
SECTION 12


12 of the 33 Act = civil liability for
1. security sold in violation of 5 of the Act
2. security sold by means of an oral or written communication which has material misstatement or
omission


VIII. Section 12(a)(1): (Civil Liability for violation of 5 = OFFERS and SALES)

a. Any person who offers or sells a security in violation of section 5 is civilly liable to the
person purchasing from him.
i. Different defendant than 11. Here it is the seller.
ii. Private right of action
iii. No reliance
iv. Strict liability
v. No due diligence defense allowed
vi. Remedies:
1. rescission (get purchase price, if not yet sold security)
2. damages: if you have already sold
what you paid what you sold = damages
i.
b. Who is the Seller = PINTER TEST
i. Not limited to just one who passes title
can be the promoter too
ii. P must actually BUY security from D or Promoter
iii. Promoter (solicitor) MUST intend to make money for himself OR the owner of
the security, NOT the buyer

iv. Supreme Court = overruled Substantial-Factor Test w/ Pinter Test
statutory seller
1. one who exchanges security for consideration
2. one who participates in buy-sell transaction is substantial-factor in
causing transaction to occur
Reject b/c
a. use proximate cause form tort law uncertainty
b. no Congressional intent to incorporate tort law of
i. reliance
ii. causation
c. not in Sect. 12
d. focuses attention on Ds involvement in transaction
extends sect. 12 to participants only remotely related to
relevant aspects of the sale


v. Pinter v. Dahl
1. Pinter sells unregistered securities (oil and gas interests) to Dahl. Other people
invested when Dahl did. Dahl helped them, but got no commission from Pinter.
The venture proved to be worthless. The buyer sought rescission under 12(1),
for unregistered securities.
2. 12(a)(1) says those who offer and sell in violation of 5 can be liable.
56
a. the language of 12(a)(1) contemplates a buyer seller relationship, like
the one in contract law.
b. 12(a)(1) imposes liability on the owner who passed title or other
interest to the buyer, for value.
3. Issue: Did Dahl sell??
a. He is not a seller in the normal sense, he did not pass title, but does
12(a)(1) liability extend that far?
4. Rule liability extends to only those who successfully solicits the purchase,
motivated at least in part by a desire to serve his own financial interests or
those of a security owner.
a. Being a substantial factor in the sale is not enough.

c. in pari delecto defense: (Bateman Eichler Test)
i. was equally at fault as , therefore P cannot recover.
ii. Available only in really narrow circumstances:
1. Security Sale
2. P must be equally at fault and
3. P must be active, voluntary participant in unlawful subject of suit
a. ie/ even if you know its illegal sale, it is NOT enough
you must actively promote it too!
4. Factors
a. Extent of Ps involvement in relation to others 3
rd
Parties
b. Incidental nature of Ps promotional activities
c. Benefits to P by promotional activities
d. Extent of Ps involvement in planning strategy
overlaps w/ Pinter Test
IX. Section 12(a)(2) (communication w/ MATERIAL MISSTATEMENT or OMISSION)

a. Any person who offers or sells a security in interstate commerce by means of a
prospectus or oral communication, which includes an untrue statement of material
fact or omits to state a material factshall be liable

i. Remedies
1. rescission or
2. damages
what you paid what you sold = damages
ii. Applies whether or not the securities are exempt.
iii. Creates a private right of action against sellers
iv. Who is seller? = Pinter Test


b. Defenses available:
i. Seller Knew Def = If knew of the untrue statement and bought anyway
ii. Reasonable Care Defense = has burden to show that did not know and
could not have known about the untruth or omission
iii. Negative causation Defense applies: did something else, besides the material
untruth or omission, cause the stock price to fall?

X. 12(a)(2) v. 11
a. Defendants are different.
i. In 11 anyone who signed RS
1. Broker is not liable under 11 because they did not sign the RS.
57
2. Reasonable investigation is DEF
ii. In 12(a)(2) sellers only (narrower class of defendants).
1. Underwriters are not necessarily in the reach of seller
2. Reasonable care standard (lower than standard for 11).

3. Gustafson v. Alloyd
a. bought almost all stock in . claims that the written sale
agreement was a prospectus and it contained a material
misrepresentation. wanted rescission.
b. Issue: does the right of rescission under 12(a)(2) extend to a private
secondary transaction (is the sale agreement = to the prospectus)?
i. Held: no. A prospectus is confined to documents related to
public offerings by an issuer.
ii. Supreme Court holds that a prospectus refers to a document
that describes a public offering of securities by an issuer or
controlling shareholder.

b. Sales CAN be different
i. So, 12(a)(2) is limited to sales from a public offering.
ii. 11 = can get after-market seller

c. Duites
i. Sect 12 = reasonable care
ii. Sect 11 = reasonable investigation (higher standard)



58
SECTION 13

XI. Section 13 = Statute of Limitations

a. Deals with BOTH Sect. 11 & Sect. 12
b. 1 year or 3 years Rule

11 & 12(a)(2)
i. One Year
1. P must bring suit 1 year after discovery of misstatement or omission
2. OR 1 year after discovery SHOULDVE been made through reasonable
care
ii. Three Years
1. no matter what you do to discover or when you shouldve discovered,
not suit can be brought after 3 years
12(a)(1)
iii. One Year
1. 1 year after violation
iv. Three Years
1. 3 years no matter what

c. Sarbanes-Oxley 804 = change!!
i. Statute of limitations was extended to 2 years & 5 years
o ONLY for
Fraud
Deceit OR
Manipulation
ii. Applies to 10b-5
1. not necessarily to 11 or 12 b/c of Strict Liability





59
SECTION 14

XII. Section 14
a. Counterpart of 29 of 34 Act
b. Buyer of securities cant waive any provisions of Act
c. Don so people are not going to be tricked to waive
i. ex/ sell unregulated securities at 50% discount if waive right to sue, still can sue
b/c K is VOID


60
THE SECURITIES EXCHANGE ACT OF 1934


***Main Point = regulate securities already issued on secondary markets
(20 to 40 times more than 33 Act issues)

Quick Outline
I. Introduction
II. Securities Fraud Litigation Under Rule 10b-5
a. Elements of the Violation
b. Statute of Limitations; standing to sue
c. Persons Liable; Corporate Misstatements; Litigation Reform Act
d. Insider Trading
1. Part I
2. Part II
III. Section 16(b) = Short-Swing Profits by Insiders
IV. Market Manipulation
V. Takeovers and Tender Offers
VI. Proxy Regulation
VII. Responsibilities of Attorneys





61
INTRODUCTION

I. Introduction
a. Purpose: assure public availability of adequate information about companies with publicly
traded stocks. The 1934 Act regulates trading in the secondary market, securities that have
already been issued.


i. 9: manipulation
ii. 10: general anti-fraud provision
iii. 12: file an application in order to effect a transaction on a national securities
exchange
iv. 13: requires companies to file annual and quarterly reports (MD & A)
v. 14: reporting with regard to proxy solicitation.
vi. 15: no one can engage in business as a broker or a dealer unless he is registered
with the Commission
vii. 16: Short-Swing profits = companies officers/directors 10% of stock, not sell for 6
months.

b. Markets:
i. NYSE: auction market.
1. All orders go to the trading floor.
2. Every security that trades has a specialist on the floor that conducts the
auction.
a. The specialist maintain a fair and orderly market and take steps
reasonably necessary to maintain an orderly market.
b. If there is an imbalance, then they should take the other side.
ii. NASDAQ: screen based trading.
1. Quotations are entered into the computer and firms get access to the
computer.
2. Market makers enter quotes and are willing to buy and sell.
a. Make money from difference between buy and sell price.
3. Most securities have more than one market maker, so that sets the price as
they compete.
iii. Electronic Communications Networks: alternative trading system.
1. The ATS matches buy and sell orders between members, so you can limit
transaction costs.
2. It is automatically executed when the buyer puts their request to buy in the
system.

c. Reporting Requirements
i. Applies to:
1. companies with securities listed on a securities exchange
2. Companies with
a. more than $10 million in assets AND
b. held by 500 persons
3. If the company filed under the 1933 Act.

ii. What do you file an MD & A under 13?
1. 10K 10 days after the close of the fiscal year
62
a. description of company, audited financial statements, management
discussion & analysis (MD&A).
2. 10Q 45 days after the fiscal quarter.
3. 8-K if there are material developments or extraordinary events. Must file
within five days for some things, 15 days for others.
a. Change in control of company
b. Change of auditor
c. Resignation of director
d. Bankruptcy

iii. Regulation F-D:
1. companies cannot selectively disclose material nonpublic information.
2. If it makes a disclosure to some, it MUST file an 8-K to disclose to all.
a. If you intentionally disclose = immediate release to public
b. If you accidentally disclose, you have 24 hours
3. Exceptions:
a. It doesnt apply to any companys communications with the press.
b. Doesnt apply to ordinary business communications.
c. NOT apply to registered offering of 33 Act


d. 34 Act allows the securities businesses (exchanges) to regulate selves
i. 15(a)
1. requires exchanges to register with the commission
2. as a result, the commission has substantial authority
ii. 15 and 19
1. gives the commission the authority to bring administrative action against any
securities firm and individual and
2. has the authority to sanction the firm and the individual
iii. Commission also has authority over any rule change

e. Self Regulation
i. How it works
1. stock exchanges and NASD has own rules & enforcement staffs
2. can punish own members
3. lot of rules = market makers, qualifications, specialists, etc
ii. Actions for Procedural History
1. NASD brings charge & punishment
fines, suspension, ban
2. appeal to SCE
3. appeal to Circuit Courts
4. appeal to Supreme Court
iii. Sarbanes-Oxley setup self-regulation for accounting industry
iv. If exchanges not self-reg, then SEC grows 10x

f. Regulation of trading of securities
i. 10(b) deals with fraud
ii. 9 deals with market manipulation (this is also a type of fraud)
iii. 16 deals with trading by corporations, officers and directors that own 10% or more
of the company
1. they have to report their trades
63
2. this section is designed by Congress to be a bright-line prohibition against
insider trading


64
SECURITIES FRAUD LITIGATION UNDER RULE 10b-5


II. Elements of the Violation

a. 10(b) it shall be unlawful for any person to use or employ, in connection with the
purchase OR sale of any security registered on a national securities exchange or any security
not so registeredany manipulative or deceptive device or contrivance in contravention of
such rules and regulations as the Commission may prescribe
i. 17 of the 1933 Act prohibited fraud in the in the sale of securities, but NOT in the
purchase of securities.
ii. By itself, 10(b) would have no force.
1. 10(b) by its terms does not make anything unlawful unless the Commission
has adopted a rule prohibit it.
2. Rule 10(b)-5 was adopted because of a loophole that existed.
3. 17 of 33 Act prohibits fraud when it dealt with a sale.
a. Someone took advantage of this while buying.
b. 10(b)-5 was created to fix this.

b. Rule 10b-5 It shall be unlawful for any personto employ any device, scheme or artifice
to defraud, to make any untrue statement of material fact or to omit to state a material fact
necessary to make the statements not misleading, or to engage in any act, practice or course
of business which would operate as a fraud or deceit on any person in connection with the
purchase OR sale of any security.

c. Elements:
i. Plaintiff must be a seller or purchaser.
1. Unless cause of action is brought by the SEC
ii. Defendant is anyone who commits a fraud with a purchase or sale
iii. Deception or silence where there is a duty to disclose
iv. Defenses:
1. full disclosure
a. If there is complete disclosure, even if the transaction is unfair, there
is no deception and therefore, no liability under 10(b)-5
b. (this was the issue in Santa Fe Industries v. Green- the Court said
that all the facts of the transaction were disclosed and the securities
fraud provisions require some kind of deception)
2. remain silent if there is no duty to speak
a. If you dont have a duty to disclose and you remain silent (even if
there is important information to divulge), you are not liable.
v. in connection with the purchase or sale of securities
vi. Material fact
vii. Scienter required (intent to deceive)
viii. Reliance on misrepresentation
ix. Causation
x. ***10(b) does not expressly give a private right of action, but the cases have
interpreted it to have an implied private right of action
xi. ***also damages and
xii. ***within the statute of limitations
xiii. ***plead with particularity

65
d. Private plaintiff must show:
i. Reasonable reliance on misstatements or omissions
ii. Causation of damages

e. Court imposed requirements (Ct. gave a private right of action, but limited it)
i. Transaction causation: but for the s wrongful act, plaintiffs purchase would not
have happened
ii. Loss causation: defendants wrongful act caused loss to the plaintiff.

f. Mental State Culpability
i. Under 11 and 12, negligence was the standard used.
ii. Under 12a-1, strict liability was the standard.
iii. 1934: scienter, intent to deceive.
1. Ernst & Ernst v. Hochfelder
a. Ernst & Ernst was retained by First Securities. E&E prepared statements to
the SEC and Midwest stock exchange. Respondents gave money to First
Securities president who was supposed to invest them in escrow accounts.
There were no escrow accounts and he used them for his own personal
investment. There was no record of them on the firm financials.
b. President committed suicide and left a note saying the escrows were fake.
c. The President had a mail rule that he could only open the mail addressed
to him, to cover the fraud.
d. sued the accounting firm, claiming that if they had not been negligent in
their audit, they would have found the inconsistency in the firms financial
documents. Since they did not uncover the mail rule, they were negligent.
i. Is scienter required?
1. SC says YES.
2. If scienter were not required, people would be held liable
for wholly faultless conduct would be
3. It would change the meaning of the words in the statute.
Manipulative or deceptive used in conjunction with
device or contrivance strongly suggest that 10(b)
was intended to proscribe knowing or intentional
conduct.
4. It left open the question whether reckless conduct is
enough.
a. All of the lower courts that have addressed this
have held that reckless conduct is enough to
suffice under 10(b)-5.

g. in connection with (BROAD VIEW)
i. bar deceptive devices and contrivances in the purchase or sale of securities whether
conducted in the organized market or face to face.
ii. touching the sale of securities
iii. fraud and securities trade coincide (Zanford, 2002)
1. Superintendent of Insurance v. Bankers Like & Casualty
a. Bankers Life agreed to sell all of Manhattans stock to Begole for 5
million. Begole conspired with others to pay for the stock with Manhattans
assets. They arranged to obtain a check from Irving Trust for 5 million, but
they had no funds there. They purchased stock from Manhattan. Then
Manhattan sold treasury bonds and put cash in the Manhattan account at
Irving Trust. The check was charged against the assets deposited and so
Begole had effectively bought all of Manhattan using its own assets.
66
b. SC held that Manhattan was the seller of bonds and protected by 10b-5.
The seller (Manhattan) was duped into thinking it would receive the
proceeds from the sale. The Act protects corporations and individual
sellers of securities. It is irrelevant that the proceeds of the sale were
misappropriated.
c. Manhattan was deprived of its compensation
i. The securities laws were devised to bar deceptive devices and
contrivances in the purchase or sale of securities whether
conducted in the organized market or face to face.
ii. Manhattan suffered an injury as a result of deceptive practices
touching the sale of securities as an investor.

iv. Met where assertions are
1. connected to a sale/purchase of securities
2. made in manner reasonably calculated to influence the investing public.

a. Texas Gulf Sulphur: Corp. discovers minerals and wants to buy land. They
issue a pessimistic press release that is fraudulent. People sold stock and
the price increased.
i. If made false and reasonably connected to a sale/purchase of
securities, then it is in connection with.
ii. If the statement is reasonably calculated to deceive the
investing public, it is in connection with.
b. In Kechum v. Greene, all the employees of the company signed a stock
retirement agreement. If the employee retired, he has to sell back the stock.
He the employee was fired, the company doesnt have to pay you back the
full amount of the stock value. Defendants tricked plaintiffs into voting for
new directors who had their own schemes. The new directors are elected
and the plaintiffs were fired.
i. The court says assuming that fraud went on, this fraud was not in
connection with the purchase or sale of the stocks. The purpose
of this scheme was to get defendants to take over the company.
As a consequence of this, plaintiffs were fired and the plaintiffs
only got part value of their stock. This is simply a consequence
and does not relate to the sale of the stock.
c. In Brown v. Ivie, they each owned one third of the company. They signed
an agreement that said that if either of them left the company, he would
have to sell the stock back to the company at book value. Book value was
set up so that it would always be less than face value. Two of people that
want to force out the third, trick him the third into signing the new
agreement. The result is that the third person got less value for his stock if
then he would have received if he hadnt signed the agreement.
i. Here, the court finds behavior was in connection with, therefore
for the plaintiffs and distinguishes this from Kechum. The fraud
here was getting the person to sign the agreement which dealt
with the sale of the stock.







67
III. Statute of Limitations and Standing
a. Under the express liability provisions of 1933 and 34 Acts, the statute of limitations was
i. three years, or
ii. one year from the plaintiffs discovery or when it should have been discovered.
So, plaintiffs looked to state law or 10b-5 because it gave them a longer statute of
limitations.
Rule 10b-5 is an IMPLIED RIGHT OF ACTION = nothing in statute about
statute of limitations

***NOTE***- Sarbanes Oxley Act has extended this to
1. 2 years after the discovery of the fraud AND
2. before 5 years after the damage occurred

b. Statute of Limitations
i. 1/3 year statute of limitations (just like 33 Act)
1. usually look to local rules when federal law is silent
2. most local rules said 5 years = what SEC wanted
3. Court rejected 5 years (Lampf)
ii. 2/5 year w/ Sarbanes-Oxley

a. Lampf v. Gilbertson: Congress did not set a limitations period for actions
under 10(b).
i. Should we adopt a uniform statute of limitations for administrative
purposes? Predictability and judicial economy counsel for the
adoption of a uniform limitations period. Usually, when Congress
does not provide a statute of limitations, look to local time
limitations.
ii. Should we take it from state or federal law?
1. This is more difficult because the private right of action
has been implied. Congress did not create the cause of
action, it was implied, Congress did not think about the
limitations period, since there was no cause of action. So,
where there is an implied right of action and the statute
also has an express cause of action with its own time
period, then the statute of origin should be used.
iii. Each of the other provisions in the 1934 Act includes a 1 year
period after discovery and a three year period of repose. [NOTE
that is has changed.]
iv. Some conduct is actionable under 20A and 10(b), so we cannot
subject them to different statute of limitations.
v. Equitable tolling will not apply: It is inconsistent with the 1-3 time
limit.
vi. Held: 1/3 year statute of limitations, reject 5 year that SEC
wanted.
iii. What is Discovery?
1. a reasonable investor of ordinary intelligence on notice of the
unsuitability of the investments. (Dodds)
a. Dodds v. Cigna
i. Appellant filed more than one year after the date on which she
made the investment in which she suffered losses. She filed within
one year that her accountant told her that the investments were bad.
ii. alleges that the appellees induced her to invest in LPs that were
not suitable for her because of their risk and illiquidity. The time
limit should not start until her accountant told her.
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iii. argues that it was all disclosed in the prospectus.
1. These warnings in the prospectus were sufficient. The
statute of limitations will begin to run when a reasonable
investor of ordinary intelligence on notice of the
unsuitability of the investments.
2. She was on inquiry notice (constructive knowledge) when
she received the prospectus and made the investments, so
the one year period started then, not when her accountant
told her.
iv. Held: her claim is time barred.

iv. NOTE: Statutes of limitations do not apply to the government in general and the
SEC.
1. If the SEC wants to bring a fraud case, it can when it learns of it.
2. Even though, there is not an absolute bar, the court might say no can do
because it is too far removed.


c. Standing to Sue must be a purchaser or seller

i. Birnbaum Rule = need to be a purchaser or seller, NO EXCEPTIONS!!
1. case reversing trend
a. pre-1975 = Ps won
b. 1975-now = Ds win
2. Arguments Against =
a. Favors businesses
b. Precludes harmed people from compensation

3. The SEC is not prevented from bringing suit in this case.
a. Although the individuals cannot bring suit, the government can bring
suit to prevent the company from continuing to make false
statements.
4. This does not apply also in a criminal case.

a. Blue Chip Stamps v. Manor Drug Stores
i. Under a consent decree in an antitrust case, Blue Chip was
required to offer a substantial number of shares to retailers that
used its stamp service. They were registered and sold. Two years
later, 1 purchaser sued under 10b-5, alleging that the prospectus
was overly negative, so P did not purchase the shares. offered
the shares to the public at a higher price. Can P sue, even though
he did not purchase or sell the security?
1. Birnbaum: one needs to purchase or sell in order to have
standing.
ii. Held: there is ample evidence that congress did not intend to
extend a private cause of action for money damages to the non-
purchasing offeree of a stock offering registered under the 1933
Act for loss of the opportunity to purchase due to an overly
pessimistic prospectus.
1. It would increase the number of potential plaintiffs too
far.
b. The Wharf (Holdings Limited v. United International Holdings:
69
i. The court differentiates between the speculative question of how
many shares you would have bought if there wasnt a misstatement
(Blue Chips) and an oral agreement.
ii. Supreme Court holds that an oral agreement can be enforced. It
doesnt raise a the speculative concerns that were found in Blue
Chip.
ii. Duty to Update?
1. 3
rd
Circuit = you DO have to
a. company issues public statement & later it changes
b. company does have to make public announcement in addition to
required reports
2. 7
th
Circuit = NO DUTY to update = just as to be reasonable prediciton


70
IV. Persons liable

a. No liability for aiding and abetting in a civil case

i. Before Central Bank, courts allowed aiders and abettors to be sued in civil cases
ii. Who are typical Aiders and Abettors?
1. small purchasers
2. lawyer (general counsel or firm) who drafted the deal
3. outside Lawyer who changed the language
iii. What DID you have to show
1. primary violation
2. A/A knew of primary violation & gave substantial assistance to violatiors
iv. Changed w/ Central Bank
1. Central Bank v. First Interstate
a. Whether private civil liability under 10(b) extends as well to those who do
not engage in the manipulative or deceptive practice but who aid and abet
the violation?
b. Before the second offering, the real estate market declined and the bank
knew that the appraisal was wrong. They did not do a new appraisal until
after the second offering. argues that if the bank had done another
appraisal before the second offering, then the second offering would not
have occurred. They argue that the bank allowed the issuer to sell when
they knew it should not have, therefore they aided and abetted the violation
of 10(b).
c. Held: no liability for aiding and abetting in a civil case.
i. The plain language of the statute does not include liability for
aiding and abetting and so it will not be included.
ii. The statutory language directly or indirectly does not include
aiding and abetting.
iii. Aiding and abetting was applicable to federal criminal cases,
Congress has not enacted a general aiding and abetting statute for
suits by the government or private parties.
d. So, no aiding and abetting in a civil case, but the federal government can
have aiding and abetting in a criminal case.

b. Other issues:
i. Peripheral Ds
1. now = if 1% guilty, still 100%
2. Committee Conference = fair share system = 1% pays 1%
ii. Joint Several OR Proportional Liability
1. JS liable ONLY if trier of fact specifically determines that he/she knowingly
committed a violation of security laws
2. EXCEPT
a. All Ds JS liable to P whose net worth is less than $200K, and is
entitled to damages exceeding 10% of her net worth
b. If D is not able to pay fair share, other Ds pay up to 50% of $ owed
iii. Direct/Indirect Distinction
1. best argument of P
2. court said indirect NOT equal A/A
3. What is Indirect?
a. 3
rd
Party tells primary guy to do something he knows is illegal but
not sign it!
iv. Primary/Secondary Distinction
71
1. litigated in Enron
2. Lawyers & Accountants intentionally helped Enron misstatements &
misrepresented debt BUT not sign anything
a. 2
nd
/ 11
th
Circuits
i. no primary liability UNLESS rep is attributed to primary
actor through signature
ii. narrow view of primary liability
b. 9
th
Circuit
i. broad view
ii. primary liability is substantial participation in preparing
misleading documents
1. draft and not sign = liability
2. advice = NO liability
c. SEC
i. Primary violator if you create misrepresentation
ii. If one paragraph is false = created misrep.
d. Priv. Sec. Litigation Reform Act of 1995
i. A/A can be sued by SEC
ii. A/A can NOT be sued by private actor

c. Private Securities Litigation Reform Act of 1995 = for CLASS ACTIONS
i. Passed in response to perceived abuses in securities class actions
ii. Weakens class actions
1. 20(f): in any action brought by the Commission under 21(d), any person
that knowingly provides substantial assistance to another person in violation
of a provision of the Act shall be deemed to be in violation of such provision
to the same extent as the person to whom such assistance is provided
a. must prove that the defendant knowingly committed a violation, so
negligence is not sufficient, which limits the scope of defendants in a
class action.
2. Stay of discovery,
a. files a motion to dismiss to stay the discovery P cannot do
discovery until the dismissal issue is decided
b. Leads to less burden for D and less expense in litigation.
c. Also, so cannot depose top directors immediately
3. Lead Plaintiff:
a. lead plaintiff would be the one with the biggest stake in the claim,
who has the most to recover
b. To avoid claims by professional plaintiffs who have only a few
shares and buy them in order to bring suit when the price drops.
4. Plead with particularity: makes standard more strict
5. Forward looking statements (codified the bespeaks doctrine):
a. LRA states that predictions are not material if they are followed by
cautionary language.
b. Predictions are not actionable unless proves the person who
made the prediction had actual knowledge that the prediction is
false.


72
V. RELIANCE
a. The reliance standard doesnt pertain to the SEC.
It does not have to show that it relied on a misstatement and it doesnt have to show that
someone else did.

b. Corporate Misstatements
i. Basic v. Levinson:
1. Whether a person who traded a corporations shares on a securities exchange
after the issuance of a materially misleading statement by the corporation
may invoke a rebuttable presumption that, in trading, he relied on the
integrity of the price set by the market?

ii. Fraud on the market Theory
1. the price of a companys stock is determined by the available material
information regarding the company and its business.
2. Misleading statements will defraud purchasers of stock even if the purchasers
do not directly rely on the misstatements.
3. This makes is much easier to form a class.
a. If each plaintiff had to prove that they relied on the misstatement
would preclude them from being able to form a class. So, can they
use the fraud on the market theory to prove reliance?
b. SC agrees that reliance is an element of a 10(b) violation, but also
recognizes that the securities markets differ from the face to face
transactions contemplated by early fraud cases and, our
understanding of 10b-5s reliance requirement must encompass
these differences
c. SC recognized that other courts have concluded that where
materially misleading statements have been disseminated into an
impersonal, well developed market for securities, the reliance of the
individual plaintiffs on the integrity of the market price may be
presumed
i. The investors reliance on public material misrepresentations
may be presumed.

iii. RELIANCE IS PRESUMED, BUT IT IS A REBUTTABLE PRESUMPTION.
Burden is on the defendant.
1. Any showing that severs the link between the alleged misrepresentations
and either the price received by the plaintiff or his decision to trade will be
sufficient to rebut the presumption of reliance.
2. Possible rebuttal arguments:
a. Market makers were privy to the truth, so the price would not reflect
the misstatement
b. Show that divested themselves of their Basic shares without
looking at the market.

iv. the s failure to disclose material information may be excused where that
information has been made credibly available to the market by OTHER sources.

1. In re Apple Computers
a. alleges that Apple Computers misled the market about capabilities and
prospects of a novel office computer and disk drive. They claim they
73
purchased in reliance on the artificially high stock price and they purchased,
then suffered damages.
b. SC: the s failure to disclose material information may be excused where
that information has been made credibly available to the market by other
sources.
c. There were press releases in the public the computer was risky, is not
liable. When deficiencies are corrected with lots of media coverage,
reliance using fraud on the market will be rebutted.
d. BUT, this is a limited holding
i. Must be transmitted to the public with a degree of intensity and
credibility sufficient to effectively counterbalance any misleading
impression created by the insiders one sided representations.

c. Fraud on the Market (Quinn) requirements:
i. Material Misrepresentation
ii. Plaintiff traded shares between the time the misrepresentations were made and the
time the truth was made public.
iii. Market on which the shares are traded is an efficient market
1. trading volume
2. market figures
3. number of analysts following the company
4. how the price responds to press releases
5. Need to make sure the market is reflecting all publicly available information.

74
VI. Insider Trading

a. 10b-5 does not explicitly address insider trading, but it has an important application to 10b-5.
b. Insider Trading:
i. Elements
1. The purchase or sale of securities
2. w/ a breach of duty
3. by people who have access to material, nonpublic information.

ii. Liability extends to people not traditionally thought of as corporate insiders.
1. this is different from aiding and abetting because aiding and abetting did not
have to do with insider trading, just making misstatements or helping
someone buy on misstatements.
c. Two main theories:
i. Classical: where a companys officers trade shares of their OWN company based on
material nonpublic information.
ii. Misappropriation theory: where a person uses information that was obtained by
breaching a duty to the source of the information.

d. Case Evolution
i. Cady = INSIDER cannot IT
ii. TX Gulf = INSIDER and anyone w/ a DUTY cannot IT

iii. Cases
e. Cady, Roberts Co.
i. Broker got information that the Board was going to cut a dividend, so he
placed an order to sell Curtis-Wright stock for his customers before the
news of the dividend was disseminated to the public.
ii. SEC: if you have nonpublic material information, you either have to
DISCLOSE TO ALL or ABSTAIN FROM TRADING.
1. if you use it before you disclose, you are liable.
iii. The rationale:
1. existence of a relationship giving access, directly or indirectly to
information intended to be available only for a corporate purpose
and not for personal benefit to anyone
2. the inherent unfairness involved where a party takes advantage of
such information knowing it is unavailable to those with whom he
is dealing.
3. need to figure out who has a special relationship with the company
and is privy to its internal affairs intimacy demands restraint
lest the uninformed be exploited
f. SEC v. Texas Gulf Sulphur Co.
i. claimed officers of TGS bought stock or calls using material nonpublic
information about a drilling site in Canada. Two of the officers had given
information to others for use and recommended purchase while the
information was undisclosed to others.
ii. Cites Cady: anyone who, trading for his own account in the securities of a
corporation has access, directly or indirectly, has access to information
intended to be available only for a corporate purpose and not for the
personal benefit for anyone may not take advantage of such information
knowing it is unavailable to those with whom he is dealing
iii. Court holds that ANYONE in possession of material inside information
must either DISCLOSE it to the investing public, or if he is disabled from
75
disclosing it in order to protect corporate confidence, must ABSTAIN from
trading in or RECOMMENDING the securities concerned while such
information remains undisclosed.
1. Tippers: tippers who pass along to relatives are also in violation.
iv. All were in violation. The drill results were material. The insiders were
not trading on an equal footing with the outside investors. They had access
to the information about the probability of the finding ore on the land, while
the public was unaware of the favorable probabilities or unproductive
exploration.

g. DISCLOSE OR ABSTAIN RULE
i. To remedy insider information, one must either
1. disclose the inside information to the public
2. abstain from trading using that information

76
h. SPECIAL RELATIONSHIP TEST (Classical Theory)
i. You need to BREACH a DUTY to be found guilty of IT
ii. Reasons
1. not EVERY unfair security transaction is wrong
2. no duty to target of take over from whom stock was bought
iii. CASE
1. Chiarella v. United States:
a. Printer uses information in printing documents and buys stock in companies
about to merge.
b. Court held that the duty to disclose only extends to those that have a special
relationship.
i. the duty to disclose arises when one party has information that the
other party is entitled to know because of a fiduciary or other
similar relationship of trust and confidence between them
c. Before, it had been the rule that anyone who had access to information was
subject to the disclose or abstain rule. Here, the Court is saying you only
have a duty to disclose when there is a special relationship.
i. Chiarella was a virtual stranger to the company, so he had no duty
to disclose. In the end, he was not liable.
d. a purchaser of stock who has no duty to a prospective seller because he is
neither an insider nor a fiduciary has been held to have no obligation to
reveal material facts.
i. under this theory, individuals, like accountants and attorneys enjoy
a special relationship with the corporation, so they would be
viewed as insiders and would have a duty to disclose.
e. Burger Dissent: introduces the misappropriation theory.
f. NOTE: If you break into a companies office and steal a memo, that is theft
and not fraud. Fraud, for example, is if you pretend to be someone else to
get information. These are treated differently by the court. 10b-5 works for
fraud but not for theft.

77
i. MISAPPROPRIATION THEORY
i. Did you breach a duty to the source of the information?
1. D owes duty to firm, firm owes duty to Predatory company = GUILTY
ii. In connection with a purchase or sale?
1. security fraud when you TRADE
2. NOT when you get information
3. Therefore, if you use fraud to get $, then use the $ to trade = NOT GUILTY
iii. Deception? (required by Bryan)
1. D owes duty to firm, firm owes duty to Predatory company
2. if D tells firm, and firm is OK with it = NOT GUILTY

iv. What types of relationships create a duty?
1. Attorney-Client (OHagen)
2. Family Relationships if show EITHER
a. Explicit Promise of Duty
i. dont tell anyone
b. Implicit Promise of Duty
i. Practice of spouses or family members telling each other of
confidential information
3. Doctor-Patient (US v. Willis)
4. Club Relationship = NO under US v. Kim, but 10b-5 codified it

_____________________________________________________________________________________

** RULE = Rule 10b-5(2) = fiduciary duty or similar relationship of trust & confidence for
Misappropriation Theory on IT

j. Rule 10b-5(2): Duty of Trust or Confidence in Misappropriation Insider Trading Cases
i. Definition of circumstances in which a person has a duty of trust and confidence for
purposes of the misappropriation theory.
1. Explains where there will be a duty, breach of which is misappropriation.
ii. When a person agrees to maintain information in confidence
iii. Where the parties have a history, pattern or practice of sharing confidences so that
the recipient knows or should know that the person communicating nonpublic
material information expects it to remain confidential


1. person agrees to maintain info in confidence (Chestman)
Factors:
1. reliance (K to be silent codifies Kim)
2. de facto
a. superiority
b. dominance
c. control
based on characteristics of(fiduciary-like dominance)
(1) disparate knowledge & expertise
(2) persuasive need to share confidential information
(3) legal duty to render aid
2. person communicating and getting communication have a history of sharing confidences
through
(a) history
78
(b) pattern
(c) practice
3. receives or obtains material, non-public information from
1. spouse
2. child
3. parent
4. sibling
this is a rebuttable presumption!!
_____________________________________________________________________________________

iv. Cases
k. US v. Newman
i. SEC brought case in which investment banking company was advising a
bidder. The ibankers traded with the information about a merger.
ii. 2d Cir: held that the ibanker had violated rule 10b-5, using the
misappropriation theory.
1. they breached a duty to the source of the information.
l. US v. Carpenter
i. Writer for WSJ knows what the column is going to say about a price of
stock. Trades on the stock before the column is published.
ii. 2d Cir: misappropriation theory. He had an agreement that he would
not sell, he sells and it breaches a duty.

m. US v. OHagan
i. OHagan is a crooked lawyer. He had embezzled money and used proceeds
from insider trading money to recoup clients that he had embezzled from.
ii. Court held:
1. there must be a fiduciary like duty between the
misappropriator of the information and the source of such
information.
iii. Nutshell: misappropriation constitutes a violation of 10(b) because it
involves deception.
n. US v. Chestman
i. Waldbaum is chair of Waldbaum stores. A&P decides to buy out
Waldbaum. Waldbaum tells sister, who tells daughter, who tells husband
(Loeb). Loeb trades.
ii. Ct. has to show that Loeb breached a duty to his wife (the source of the
information). Liability does not automatically exist between spouses.
1. duty can be implied or expressly agreed
iii. Held: no misappropriation. No duty to the source. The husband was not part
of the inner circle of the family.
o. Doctor/Patient- U.S. v. Willis
i. Patient tells doctor about stuff. Doctor tells his wife. Wife tells her
psychiatrist who goes off and trades.
ii. The court went after the doctor because he breached his duty to his patient.
It discusses the fact that doctors take the Hippocratic Oath.

79
p. Tippees: Dirks v. SEC

i. Test: will the insider receive a benefit?
1. A tippee assumes the fiduciary duty of the insider to the shareholders of the
corporation. The insider has a fiduciary duty to the shareholders not to trade
on material nonpublic information. Since the insider cannot trade on the
information without breaching a duty, a tippee cannot either.
a. Tippee responsibility is related back to insider. Tippee knows that
the information was given to him in breach of the duty the insider
had to the issuer.
2. Will the insider personally benefit, directly or indirectly, from his disclosure?
Absent some personal gain, there is no duty to the shareholder.
a. personal benefit could be pecuniary gain or a reputational benefit
that will translate into future earnings

ii. Rule:
1. tipper has fiduciary duty
2. tipper breaches by telling tippee
a. the breach that he is disclosing is for personal gain
3. tippee knew or should have known the breach was happening
4. tipper receives a financial benefit/pecuniary gain/reputation improve.
5. NOTE: If you have inside information and you are in a public place talking
about it, you are arguably being reckless and therefore, subject to liability
under 10b-5.
a. Think of the difference of negligence and recklessness as being
the difference between stupidity and recklessness.

b. Dirks v. SEC
i. Dirks gets information from a former officer of a corporation,
stating that the company was full of crooks and the stock would
plummet when fraud was uncovered. The officer wanted Dirks to
verify the fraud and disclose it. Dirks tried to inform SEC, WSJ,
but no one listened. Dirks trades. He was not an insider, had no
duty to shareholders.
ii. In Dirks, the tippers received no monetary or personal benefit for
revealing secrets. They were motivated to uncover the fraud.
Therefore, he was not held liable.

q. NOTE:
i. In theory, everything that can be brought under the classical theory can also be
brought under the misappropriation theory, but not vice versa.
ii. In theory, the misappropriation theory subsumes the classical theory, however, it is
easier to look at them as two separate tests.


Misappropriation theory- the cases that fall into this theory and
not the classical theory are those cases in which the source of
information is not one of the parties who has stock being
traded.



80



r. Rule 10b-5(2): Duty of Trust or Confidence in Misappropriation Insider Trading Cases
i. Definition of circumstances in which a person has a duty of trust and confidence for
purposes of the misappropriation theory.
1. Explains where there will be a duty, breach of which is misappropriation.
ii. When a person agrees to maintain information in confidence
iii. Where the parties have a history, pattern or practice of sharing confidences so that the
recipient knows or should know that the person communicating nonpublic material
information expects it to remain confidential
1. SEC v. Adler
a. There was a meeting and trading. Then there was a public statement.
Problem was, there was no scienter, no intent to deceive.
b. Ct held that there must be proof that the information is used. There is a
strong inference that it was used, but if there is good evidence of a pre-
existing plan to sell/trade/buy, then it is an affirmative defense.
c. Court goes with the use test as opposed to the suggested knowing
possession test.

s. Rule 10b-5-1: Defines trading on the basis of
i. Lists affirmative defenses that can be used:
1. before becoming aware of the information, the person had
a. entered into a binding contract to buy/sell
b. instructed another to purchase or sell
c. adopted a written plan for trading securities

81
VII. 16(b) - Short Swing Offers by Insiders

a. 16 Securities Exchange Act of 1934: only part of 34 Act that directly addresses insider
trading.
i. 16(a):
1. every person
a. who is directly or indirectly the beneficial owner of more than 10%
of any class of any equity security that is registered OR
b. who is a director or
c. who is an officer of the issuer of such security
2. must filea statement indicating
a. his ownership at the close of the calendar month and
Sarbanes-Oxley changed to 2 DAYS
b. changes that have occurred.


ii. 16(b): for the purpose of preventing the unfair use of information which may have
been obtained by such beneficial owner, director or officer by reason of his
relationship to the issuer, any profit realized by him from the purchase and sale of a
security of the issuershall inure to and be recoverable by the issuer, irrespective of
any intention on the part of the beneficial owner in a six moth period.
any profit by 10% SH, director, or officer from the sale of his stock in the
company w/in a 6 month period MUST give $ back to the company

1. Strict liability, no scienter is required.
2. No good faith defense available.
3. ONLY corporation or an individual shareholder can sue.
SEC has no power to enforce the liability imposed by this section.

a. Smolowe v. Delendo Corp.
i. owned 12 %. are shareholders. Corp was negotiating to sell its
assets to Schenley Distillers. Sale went through in 1940. s
purchased and sold there stock in the six month period before the
sale to Schenley. District court held that they were within 16 and
ordered s to pay the Corp.
ii. argues that the preamble of the statute means that they would
only be held liable for proved unfair use of inside information. 2d
Cir. does not agree.
iii. 16(b) was designed to protect outside stockholders against at least
short swing speculation by insiders with advance information.
iv. A subjective standard of proof, requiring a showing of an actual
unfair use of inside information, would render senseless the
provisions of the Act limiting liability period to six months.
1. If congress had intended only profits from actual misuse
of inside information be recoverable, it could have said
so.

b. NOTE: If you cant prove scienter, and therefore, cannot use 10(b) and Rule 10b-5, and the
trader fits within the category of people included in 16(a), then you should go after them
with 16(b).

c. Who is an officer?
82
i. It is the duties of an employee, especially his access to inside information, rather
than his corporate title which determine whether he is an officer subject to short
swing trading restrictions of 16(b).
ii. to be considered an officer under 16(a) and therefore subject to 16(b), you cant just
look at the title, you have to look at the persons responsibilities.

1. CRA Realty v. Crotty
a. District Court dismissed the charge that Crotty had enagaged in short swing
trading. District Court had held that Crotty was not an officer because he
was middle management.
b. Crotty was a VP of United Artists. He was head film buyer and then became
VP, but continued as head film buyer. He supervised distribution of films,
including signing agreements and settling contracts. Also, some supervision
of advertising. He purchased 7500 shares and sold 3500 shares within 6
months. He realized a profit and did not give to corp. Appellant seeks to
recover this profit on behalf of the corp.
c. Appellant claims that Crotty was an officer and 16(b) would apply,
prohibiting short swing trading by an officer.
d. Held: Crotty is not an officer. It is the duties of an employee, especially his
access to inside information, rather than his corporate title which
determine whether he is an officer subject to short swing trading
restrictions of 16(b).
i. to be considered an officer under 16(a) and therefore subject to
16(b), you cant just look at the title, you have to look at the
persons responsibilities.

d. You are an insider and trading within a six month period:
- You buy 100 shares at $30.
- You buy 100 shares at $50.
- You sell 100 shares at $60.
- You sell 100 shares at $10.
Under the Smolowe rule, you match the 100 shares bought at 30 with the 100 shares sold
at 60, so this insider has to pay back 3000 dollars. (But if you go through the numbers
you will see that the person actually lost 1000 dollars.)

e. Arguments to repeal 16(b):
i. Plaintiffs lawyers soliciting people generates a lot of litigation.
ii. Given development of insider trading law, if insiders misuse information, they can
use 10b-5.
iii. Its unfair
1. Cong not set out calculations
2. Courts formula can cost people $
iv. 6 Months is too long
1. things move faster in 2003 than in 1934
v. Insiders dont like paying back $
vi. Take away private right of action & only let SEC sue them

f. Penalties
i. Originally, it was just to pay back the $ you earned
ii. 1980s it changed to include
1. pay back as much as 3x as much as you earned
2. Bounty Provisions
83
a. Pay people who give info about IT
b. Only 2 bounties b/c most people who know of IT are in on it
NOT WORK

84
VIII. Market Manipulation

a. In the 1930s, Congress was concerned with trading pools which would run up the price of
a stock through well timed transactions and then unload holdings on the public just before the
price dropped.
i. Pre-arrangement of groups of people to drive up stock and get out when its high
ii. A B C A
1. Each time you sell, sell for a little higher price
2. As price goes up, more people buy, drives up higher, sells, & makes killing

b. 9 Manipulation of Security Prices
i. prohibits manipulative practices in connection with securities traded on an exchange.
1. Any conduct that violates section 9 also violates 10(b). Allege both.
a. 9 is harder for a plaintiff to prove.
b. It requires INTENT
2. Manipulation: conduct that is designed to deceive investors by controlling
or artificially affecting the price.

ii. 9(a)(1): it shall be unlawful
(1) for any person for the purpose of creating a false or misleading appearance of
active trading in any security or a false or misleading appearance with respect
to the market for any such security,
(A) to effect any transaction in such security which involves no change
in the beneficial ownership thereof, or
(B) to enter an order or orders for the purchase of such security with the
knowledge that an order or orders of substantially the same size
at the same price has been or will be entered by or for the same
parties or different parties
1. prohibits
a. batch sales
b. wash sales = stock traded between parties who are related and no
actual change in beneficial ownership as result of sales
i. illusion that stock is more heavily traded
c. any simultaneous transaction for the purpose of creating a false
appearance of active trading.

iii. 9(a)(2): to effect a series of transactions in any registered security creating
1. actual or apparent active trading in such security or
2. raising or depressing the price of such security, for the purpose of inducing
the purchase or sale of such security by others.

iv. 9(e): Persons liable
1. any person who willfully participates in any transaction in violation of a,
shall be liable to any person who shall purchase or sell any security at a price
that was affected by the conduct.
2. INTENT IS REQUIRED (willfully).a
3. MUST BE TRADED ON AN EXCHANGE
therefore, few cases ever brought!!

v. Cases
1. SEC v. Lorin
85
a. had an unwritten contractual agreement to manipulate the prices of
publicly traded securities (Haas stocks). They tried to artificially increase
prices. They also participated in wash sales (where stock is traded between
the parties who are related and no actual change in beneficial ownership
occurs, but the price rises).
b. The law permits the factfinder to infer market manipulation where stock is
being transferred between a few parties in a manner that took place here.
c. 10(b) does not require a showing of manipulative purpose, the purpose
may be presumed upon a showing of a course of conduct that has the effect
of manipulating the securities market for certain stocks. It is sufficient for
the person to engage in a course of business which operates as a fraud or
deceit as to the nature of the market for security.
d. Here, there was ample evidence to infer that he was manipulating the stock.
2. United States v. Mulheren
a. Mulheren was chief trader at and general partner of Jamie Securities, a
registered broker dealer. U.S. claimed that M purchased 75,000 shares of
G&W common stock with the intent to drive the price to $45/share, as a
favor to Boesky. He was convicted of market manipulation and appeals his
conviction.
b. He claims that the govt failed to prove beyond a reasonable doubt, that he
purchased the shares for the sole purpose to drive the price up. Even so, he
claims that he did not misrepresent anything or act with a purpose of
deceiving others.
c. Facts: Boesky wanted to gain control of G&W and met with Davis. Davis
was not interested. Boesky offered to sell his shares back to the company at
45$/share. Davis said he would only buy back if it were the last sale.
Boesky called Mulheren. Mulheren asked if Boesky liked the stock. He said
yes, and it would be great if it traded at $45. Mulheren gets Ihasz to buy
shares. These purchases led the stock price to go up to 45.
d. Did he do this with the intent to raise the price of the stock or with an intent
to invest? The Court held that there was not enough information for a
reasonable doubt standard that the phone call indicated an intent to raise
prices.
3. Recent kinds of manipulation cases - Involving the internet:
a. Lebed- in this case, he was the youngest person charged by the SEC (15).
He was buying shares of thinly traded companies. He then posted hundreds
of messages under false names in chat rooms saying that the prices of the
stock were gonna go up.
b. SEC v. Hoke- Hoke put a message in a chat room. He either had a link or
webpage for the company. The webpage looked exactly like a Bloomberg
page. He made false claims. The price of the stock jumped.
c. Emulex- Mark Jacob worked at Internet Wire. He sent an email with a
phony press release attached to it to people who were working the night
shift at Internet Wire. It was about Emulex, which was a real company.
The press release said that Emulexs ceo was resigning and that the SEC
had started an investigation. The story circulated and was picked up by
other new companies. The stock price dropped 60% in 20 minutes. People
who sold, lost a lot of money and the people who happened to buy while the
stock was plummeting, made a lot of money.

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IX. Takeovers and Tender Offers

a. Most states have anti-takeover laws
i. SH of target company = win
ii. Local employees and workers = lose jobs
iii. 1982 = SC said laws unconstitutional
iv. 1988 = SC upheld such a law in Indiana

b. Williams Act: 1968 added provisions to sections 13 and 14.

c. 13(d): (general disclosure)
i. any person, after acquiring beneficial ownership of any equity security is the owner
of 5% of the class of stock,
ii. shall within 10 days, sent to the issuer a statement containing the
1. background,
2. identity,
3. residence and
4. citizenship
iii. of the
1. owner,
2. the source of the funds,
3. the purpose of the purchases,
4. number of shares.
iv. This applies regardless of whether or not there is a tender offer.

d. 14(d): (disclosure & substantive regulation of TO)
i. unlawful to make a tender offer if afterwards, the person would be the beneficial
owner of 5% of the class, UNLESS a 13(d) statement has been filed.
ii. Includes specific rules that must be followed for TOs.
1. Must be open for 20 days
2. Target can withdraw at any time
3. Purchaser has to purchase the shares pro rata.
a. If buyer makes a TO for 75% of shares, each shareholder will only
sell 75% of their shares.
b. this means that if a bidder needs 75% and 90% of the shareholders
say that they will sell their shares, then all of those shareholders are
entitled to sell some shares
i. it is not first come first served
ii. you cant consume until you get to 75% and then stop
iii. you must wait the twenty days and then, after that break
down the 75% that you need among the 90% of shareholders
that are willing to sell
4. if bidder increases the offer, everyone gets the higher price


e. 14(e): Untrue statements with respect to tender offer.

(general anti-fraud)
i. This is an antifraud provision. It shall be unlawful to make any untrue statement of a
material factin connection with any tender offer.
ii. Rule 14e-3 under 14(e)
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1. if anyone has taken a substantial step to commence a tender offer then it is
unlawful to trade in the target companys securities if you know or have
reason to know that you are in possession of material non public information
obtained directly or indirectly from the bidder or from the target

2. NO requirement to show a breach of duty
a. this makes it easier to persecute under 14e-3 then 10b-5
b. but remember that 14e-3 only comes into play when there is a tender
offer
c. upheld in OHagan!!

f. What is a tender offer?
i. Not clearly defined for flexibility purposes.
ii. But you dont want it to be a tender offer because if its not a tender offer, then you
dont have to meet all the requirements under 13 and 14.

iii. The theory
1. is that a tender offer puts pressure on the shareholders and for this
reason, tender offers need to be regulated.

iv. it would have the following features:
1. a bidder makes a public appeal to the target shareholders
2. it is contingent on the bidder receiving a certain percent of shares
3. there is usually a substantial premium over market price
4. usually the offer is open for a limited number of time


v. Definition of tender offer not clear, but the characteristics are:
1. a bid by an individual or group to buy shares of a company
2. usually at a price above market.
3. Those accepting the offer are said to tender their stock for purchase.
4. The person making the offer obligates himself to purchase all or a portion of
the tendered shares if certain conditions are met.


vi. Courts differ
1. 9
th
Circuit = Wellman Eight Factor test to determine it is not a TO.
a. active or widespread solicitation of public shareholders for the shares of the
issuer
b. solicitation made for a substantial percentage of the issuers stock
c. offer to purchase made at a premium over the prevailing price
d. terms of the offer are firm, rather than negotiable
e. offer contingent on the tender of a fixed number of shares, often subject to a
fixed maximum number to be repurchased
f. offer only open for a limited period of time
g. offeree subjected to pressure to sell his stock
h. public announcements of a purchasing program concerning the target
company precede or accompany rapid accumulation of a large amount of
target companys securities.
2. 2d Cir. = Rejected Wellman Test = Developed Their Own Test
a. purpose = examine Leg intent to protect investors
b. factors
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i. small # of investors compared w/ total public solicitations
ii. # of sophisticated investors
iii. sellers were pressured or not
iv. advance publicity
v. whether there is a premium
vi. whether fixed minimum of shares
vii. time limit


vii. Cases
1. Kennecott v. Curtiss-Wright: CW decided to acquire an interest in Kennecott. CW
filed its Schedule 13-D within 10 days of acquiring 5% of the stock. Kennecott
claims that it was a tender offer and more was needed to satisfy 14(d).
2. Court held that it was not a tender offer.
a. It was purchased on a national exchange, only solicited 50 stockholders, off
market purchasers were sophisticated.

viii. SEC v. Carter Hawley Hale: (9
th
Circuit)
1. Limited wanted to take over Carter. When Limited made the offer, Carters
management did not think it would be in the shareholders best interest, so
they instituted a repurchase plan. They bought back stocks.
2. SEC claimed the repurchase was a tender offer.
3. Court used the Wellman Eight Factor test to determine it is not a TO.
a. active or widespread solicitation of public shareholders for the shares
of the issuer
b. solicitation made for a substantial percentage of the issuers stock
c. offer to purchase made at a premium over the prevailing price
d. terms of the offer are firm, rather than negotiable
e. offer contingent on the tender of a fixed number of shares, often
subject to a fixed maximum number to be repurchased
f. offer only open for a limited period of time
g. offeree subjected to pressure to sell his stock
h. public announcements of a purchasing program concerning the target
company precede or accompany rapid accumulation of a large
amount of target companys securities.
ix. Hanson Trust v. SCM: (2
nd
Circuit)
1. Hanson announced he was going to make a tender offer of 60$/share. He filed
the necessary documents under 14(d). SCM tells shareholders not to buy.
SCM and Merrill form a new entity. New entity would buy SCM shares at
70/share. Hanson increased his offer to 72/share. The Merrill offers 74/share.
2. Hanson decides to make cash purchases of a substantial percentage of SCM
stock in the open market and through privately negotiated transactions.
3. In 2 hours, he got 25% of the outstanding stock through his financial advisor,
Pirie. Then Pirie phoned more people who sold their stock.
4. SCM argued for a preliminary injunction stopping Hanson because if he
continued his series of private transactions, he could defeat the SCM/Merrill
offer and damage the shareholders.
5. 2d Cir. held that it was not a tender offer because it was a small number of
people, they were highly sophisticated, and did not need to be protected.
6. Since the purpose of the 14(d) is to protect the ill informed solicitee, the
question of whether a solicitation constitutes tender offer within the meaning
of 14(d) turns on whether, viewing the transaction in the light of the totality
of the circumstances, there appears to be a likelihood that unless the
preacquisition filing strictures of that state are followed there will be a
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substantial risk that solicitees will lack information needed to make a carefully
considered appraisal of the proposal put before them.

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X. Proxy Regulation

a. 14(a): any person soliciting proxies with respect to any security registered under the
exchange act MUST comply with rules and regulations adopted by the SEC.

b. Interplay between federal and state law
i. State Law
1. Who can vote
2. when shareholder approval is required
ii. Federal Law
1. Congress felt federal law was necessary
2. 14(a)

c. 14(a)
i. Rule 14a-3: sets out disclosure requirements.
1. Sets forth the type of information that has to be given to shareholders in
connection with a proxy solicitation.
2. Annual reports must accompany proxies.

ii. Rule 14a-6: companies have to file preliminary copies of materials with the SEC.

iii. Rule 14a-7:
1. corporation must comply with a request for a shareholder list.
2. If a shareholder wants to fight a proxy, they need a list.

iv. Rule 14a-8: deals with shareholder proposals.
1. Most controversial
2. Shareholder proposals
a. These include political, social, environmental issues and other issues.
b. If shareholder meets requirements in rule, shareholder can have
their proposal, along with a brief statement explaining it,
included in the proxy materials.
3. Rule sets when company can omit shareholder proposal.
a. proposals that relate to ordinary business operations of the issuer.
b. No bright line rule as to what falls under ordinary business
operations.

v. Rule 14a-9: antifraud provision.
1. Unlawful to make a material misstatement or omission in connection with a
proxy solicitation.
2. this could be negligence no scienter requirement.
a. Unlike 10b-5, most lower courts say scienter is not required.
b. Negligence is enough to establish a violation under Rule 14a-9.
c. Section 14(a), unlike Section 10, does not contain words like
manipulative or deceptive device that Supreme Court said
required sceinter for violation of Rule 10b-5.
d. But, NOTE that Supreme Court has not addressed this issue under
Rule 14a-9.
d. Case Law
i. Causation Test: (Mills)
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1. upon a finding of materiality, a shareholder made a sufficient showing of
causal relationship between the violation and the injury if he proves that the
proxy itself was an essential link to the accomplishment of the transaction.
2. if minority SH votes are needed for a company action, that is enough of a
LINK
3. e.g.if votes needed, that is sufficient.

ii. Minority SH votes are NOT needed = State Remedies
1. If minority SH votes NOT needed AND have state remedy
NO causation (VA Bankshares)
2. If minority SH votes NOT needed AND have NO state remedy
causation (Wilson)



e. CASES
i. J.I. Case v. Borak: implied right of action exists under 14(a) and 14a-9. Like implied action
under 10b-5, courts have said that plaintiff must show causation.
ii. Mills v. Electric Auto-Lite
1. Causation Test: upon a finding of materiality, a shareholder made a sufficient
showing of causal relationship between the violation and the injury if he proves that
the proxy itself was an essential link to the accomplishment of the transaction.
a. e.g.if votes needed, that is sufficient.
iii. Virginia Bankshares v. Sandberg
1. Freeze-out merger in which they did not need the minority shares votes. They
solicited proxies anyway.
2. Plaintiff alleged that minority was an essential link because public relations and
minority approval would satisfy state law regarding potential conflict of interest of
one director.
3. Court held that the votes were not necessary, so the requisite causation was not
shown.
a. public relations is too speculative and state remedy is available whether or
not minority approved
iv. Wilson v. Great American
1. Addressed issue left open by Virginia Bankshares: even if minority votes not needed,
what if misleading proxy statement and shareholder votes yes and shareholder loses
possible remedy under state law.
2. Court says that this establishes causation.


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Responsibilities of Attorneys:



1. Two Types of cases
a. Lawyer assists people who violate securities laws
b. Lawyer represents a company and has a strong suspicion that the client is violating the
securities laws

2. Lawyer assisting those who violate the law
3. Rule 102(e) [was Rule 2(e)], codified by Sarbanes-Oxley
a. any lawyer or accountant who appears before the SEC is subject to this
rule.
b. SEC can bar you from practicing before it, if you engage in unethical or
unprofessional conduct.
c. Most 102(e) cases against accountants
1. Keating Case
1. Firm repd business for filings w/ SEC. One L in firm on Board of
bank, another L on subsidiary Board. Both companies lied or
omitted facts about transactions. 50-80% of annual revenues come
from business. Transactions not in filing was loans to L to buy
parent company.
2. SEC theory
a. law firm is so connected to business, hold EVERYONE
in firm responsible.
3. Case settled

4. Central Bank = Aiding and Abetting
a. Central Bank = no private right of action for A/A
b. 9
th
Cir = substantial involvement in drafting (L can just give advice)
c. 2
nd
Cir = need misleading statement to be attributed to person (L have to draft
but not sign)
d. SEC = work on it and try to hide your involvement

5. Ziemba v. Cascade
a. Facts = SH of companies sued as SEC said they had misleading reports. Company
threatened suit against analysts. Company issued millions of unauthorized stock.
Company said law firm made knew of the errors. Ls never made them publicly.
b. Before Central Bank, easy aiding and abetting.
c. Court held = NOT liable
1. no A/C relationship between P (SH) and firm = NO duty to disclose
2. A/C relationship between Company and firm = firm was FORBIDDEN
from discussing it in public.
3. firm not give statements to P = NO reliance
4. Company not prepare documents = NO duty, NO reliance


6. Lawyer reping a company and suspects client is making misleading statements

a. Sarbanes-Oxley =

1. Sarbanes-Oxley = 307 (not adopted look at it this summer)
1. noisy w/drawl
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2. MUST
a. w/draw if C about to do illegal
b. tell SEC you are w/drawing

2. SEC has set forth rules for minimum conduct of L representing issuers
1. Attorneys MUST report
a. violations of securities laws OR
b. report it to the head of your department
2. if head not respond, go up the ladder
a. to general counsel
b. to Board

3. SEC Rules want go beyond this to answer
1. when do you have to w/draw?
2. when do you have to notify SEC?
3. what about A/C privilege?

4. ABA Rule 1.16 = w/drawl
1. may w/draw if believe C involved in criminal act or fraud
2. may ONLY reveal criminal act that causes bodily harm or death
5. Most states = allow or require L to report if C is ABOUT to break the law


6. SEC Proposed Rule = Noisy Withdrawal or Reporting Out
1. can reveal confidential info, w/out consent, if violation likely to cause significant
financial hardship to company or investors
2. If company not do anything
a. w/draw
b. tell SEC you are w/drawing, just not why


7. SEC HAS adopted
1. rule to talk if financial hardship = give up C
2. rule to go to Gen Counsel then Board then w/draw
8. NOT adopted
1. Noisy Withdrawal


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7. NOT ON EXAM --




REGULATION OF INVESTEMENT ADVISERS



1. Investment Adviser Act of 1940
2. Investment Advisers are highly regulated.
3. Potential conflict between investment advisor registration and the first amendment and other
issues.
4. Lowe v. SEC: Lowe was president and principal shareholder of Law Management Corporation.
He was convicted of misappropriating funds of an investment client, engaging in business as an
investment adviser without filing registration application, tampering with evidence to cover up
fraud of an investment client, and of stealing from a bank. His registration was revoked and he
was ordered not to associate with any investment adviser. Thereafter, Lowe was involved in
publishing investment newsletters and soliciting subscriptions for a stock-chart service.
a. An investment adviser is defined as any person who, for compensation, engages in the
business of advising others, either directly or through publications or writings, as to the
value of securities or as to the advisability of investing in, purchasing, or selling
securities, or who, for compensation and as part of a regular business, issues or
promulgates analyses or reports concerning securities.
b. The court notes that the Act excludes several categories of persons from its definition of
an investment adviser, lists certain investment advisers who need not be registered, and
also authorizes the Commission to exclude such other person as it may designate by rule
or order.
i. One of the statutory exclusions is for the publisher of any bona fide newspaper,
news magazine or business or financial publication of general and regular
circulation.
ii. The court notes that Congress, sensitive to First Amendment concerns, wanted to
make clear that it did not seek to regulate the press through the licensing of
nonpersonalized publishing activities.
c. Court holds that these publications fall within the exception because they are both (1)
bona fide and (2) of regular and general circulation.
d. Court notes that the words bona fide describe the publication and not the character of
the publisher. Hence, his negative history is inconsequential.
e. Because the content of the newsletters was completely disinterested, and because they
were offered to the general public on a regular schedule, they were described by the plain
language of the exclusion.
5. SEC v. Park- Park was the sole owner of a company. He starts a website named after the
company. He puts stock picks on the site. He charges a membership fee for giving advice. What
he doesnt disclose is that he owns the stock that he is recommending and he was selling them at
the same time that he was telling people on his website to buy them.
a. His defense was straight First Amendment.
b. It turned on whether this was a bona fide publication of regular circulation.
c. Court held that this did not meet the standard of the exclusion. It was not bona fide
because it was not disinterested advice and because it was not regularly circulated.

95