-- Federal Securities Act of 1933 regulates the public offering
and sale of securities in interstate commerce.
-- $3 exempts numerous categories of securities from the Act's
registration requirements, the most significant being those issued
by governmental bodies, banks, and insurance companies.
-- $4 exempts securities sold in certain types of transactions.
-- $5 addresses the problem of uninformed investment in public
offerings. It prohibits offer or sale of a security not
registered with the SEC and requires the delivery of a prospectus
to the security's purchaser as well as those to whom written
-- $6 and $8 set out procedures for registration
-- $11 provides a private rights of action for materially false
statements in the registration statement.
-- $12 imposes civil liability upon those who sell securities in
violation of $5's registration requirement as well as on anyone
who sells any security by means of a materially misleading
-- $17 contains a general prohibition against fraudelent and
deceptive acts and practices in the sale of securities.
-- $19 gives SEC broad powers to adopt rules implementing and
defining any of the Acts' provisions.
-- $20 empowers SEC to prosecute violations of the ACt or its
rules in the federal district court.
-- State securities laws are generally referred to as blue sky
-- Blue sky laws include provisions for the registration of
broker-dealers, their agents, and investment advisers, antifraud
prohibitions with accompanying civil and criminal sanctions, and
the registration of securities.
-- SRO's (Self Regulatory Organizations)
-- national securities exchanges
-- national securities association
-- registered clearing agencies
-- Municipal Securities Rulemaking Board
-- Three categories of companies are subject to '34 Act's
continuous disclosure requirements:
1) companies with a class of its securities listed on a
national securities exchange ($12(b))
2) companies whose assets exceed $5 million and that have a
class of its equity securities held by at least 500 persons
($12(g) and Rule 12g-1)
3) companies that have filed a '33 Act registration statement
that has become effective ($15d)).
-- Firms eligible to use Form S-3 may also register equity
securities "for the shelf" under Rule 415(a)(1)(x). Shelf
registration allows the firm to hold stock for deferred sale.
-- $18 of the '33 Act expressly saves blue sky laws from
preemption so that generally an issuer's offering of securities
must be registered in each state where it is offered for sale or
qualify for an exemption from registration in that state.
MATERIALITY OF INFORMATION
-- Rule 408 requires that in addition to the information compelled
to be disclosed under the Commission's line-item requirements,
registrants must include in their '33 Act registration statement
material information as may be necessary to make the required
statement, in light of the
circumstances not misleading."
-- A similar requirement applies to all '34 Act filings through
-- While the fraud provisions of the federal securities laws do
not impose a duty to disclose information simply because it is
material, they do require affirmative disclosure of material
information in certain circumstances. And they bar both material
misstatements and half-truths whenever information is given to
-- TSC Industries v. Northway (page 62, Supreme Court)
An omitted fact is material if there is a substantial likelihood
that a reasonable shareholder would consider it important in
deciding how to vote. It does not require proof of a substantial
likelihood that disclosure of the omitted fact would have caused
the reasonable investor to change his vote. The standard requires
a showing of a substantial likelihood that, under all the
circumstances, the omitted fact would have assumed actual
significance in the deliberations of the reasonable shareholder.
In other words, there must be 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.
-- Some courts have held that in dealings between a single
shareholder and single buyer, the test for materiality is a
subjective test (see page 64.) Otherwise, the test is objective.
-- The element of fairness involves the format in which the
disclosure occurred. In Kennedy v. Tallant, the court held that
the prospectus did not fairly disclose who controlled the
corporation. The relevant material was fragmented throughout the
prospectus so that the average investor would fail to understand
its importance. This is the "buried facts" doctrine, which
applies to render misleading a document in which all the
substantive information has been set forth, but in such manner
that the mosaic can only be assembled with great difficulty and
only with advance knowledge that the whole picture requires a
great deal of assembly.
-- Basic, Inc. v. Levinson (page 66, Supreme Court) $10b and
Where an event may occur, materiality "will depend upon a
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." In the case of merger and
acquisition discussions, the buy-out of the target company is the
most significant event in that company's existence. Therefore,
the possibility of that event becomes "material" at an earlier
stage than where the event is a less important one (i.e. rise in
quarterly profits.) But it is a case-by-case factual
determination, including such facts as whether the board has
passed a resolution authorizing the company to conduct the
discussions, whether investment bankers have been brought in,
whether the principals have directly held negotiations, etc.
Materiality depends on the significance the reasonable investor
would place on the withheld or misrepresented information.
-- Basic makes it difficult for D to win on a motion for Summary
-- You don't have to disclose merger negotiations, but you cannot
lie about something very significant. You can simply say: "We
never comment on something like that."
-- Soft information refers to statements of subjective analysis
and extrapolations, such as opinions, motives, and intentions, or
forward-looking statements. There is no duty to disclose soft
information, even though under a straight application of
materiality standards investors would consider the information
important in arriving at either their investment decisions in or
deciding how to vote on a transaction requiring stockholder
approval. The information must not only be material, there must
be an independent duty requiring its disclosure.
-- Item 303 of Regulation S-K, the Management Discussion and
Analysis of Financial Condition and Results of Operations (MD&A)
requires each registrant to disclose future "trends, demands,
commitments or events" that it knows are "reasonably likely" to
occur and to have a material impact on its financial condition or
results. The SEC stated in a release that it expects registrants
in complying with the MD&A requirements to discuss long and short
term liquidity, capital resources, and the performance of
different segments of the registrant's business. Any changes in
particular items of its financial statements, such as revenues or
net income, must be discused. However, no disclosure of merger
negotiations need be made in the MD&A if the company believes the
disclosure could jeopardize completion of the acquisition.
RULE 175 SAFE HARBOR
-- Rule 175 under the '33 Act and Rule 3b-6 under the '34 Act
provide a limited safe harbor for projections made or reiterated
in a document filed with the SEC by a reporting company or in a
'33 Act registration statement. The substantive provisions of the
safe harbor relieve the issuer of liability under the antifraud
provisions for the projections, provided the projection was made
with a reasonable basis and in good faith. The rule also reaches
projections that were not initially made in an SEC filing provided
that projection is repeated "within a reasonable time" in an SEC
-- You are not required to make forward looking statements in
general, but SEC requires you to identify any known trends. You
can simply claim that you cannot identify any known trends.
-- Virginia Bankshares v. Sandberg
ISSUE: Whether a statement couched in conclusory or qualitative
terms purporting to explain directors' reasons for recommending
certain corporate action can be materially misleading within the
meaning of Rule 14a-9, and whether causation of damages
compensable under $14(a) can be shown by a member of a class of
minority shareholders whose votes are not required by law or
corporate bylaw to authorize the corporate action subject to the
HELD: No private recovery for proxy misstatements was available
to "a member of a class of minority shareholders whose votes are
not required by law or corporate bylaw to authorize the
transaction giving rise to the claim." Allowing members of a
minority shareholder class to recover for misstatements when
their vote of approval was not even necessary would give rise to
"speculative claims and procedural intractability" --the
litigation would get lost in a welter of speculation about why and
how badly the board wanted the legally-unnecessary minority-
shareholder approval, an issue on which "reliable evidence would
seldom exist". Congress could not have intended such a result.
-- The court says that if you have a sttatement of belief, then
you loose. But if you can tie that statement to something, you
might be able to win. In other words, knowingly false statements
of reasons may be actionable even though conclusory in form.
-- Dissent (four Justices) would have allowed recovery as long as
the solicitation ofproxies was an "essential link" in the
transaction (here, the freezeout merger.) SinceBank's board
decided that minority shareholder approval should be sought, this
was by itself enough to make the solicitation an essential link.
Also, there were facts here strongly suggesting that the majority
shareholders would not have voted its shares in favor of the
merger if the minority had failed to approve -- for example, board
minutes contained references to the need to avoid injuring the
majority shareholder by unfavorable public reaction to a low
-- Mendell v. Greenberg
The motivation of a controlling shareholder for favoring a course
proposed in a proxy statement must be disclosed when there is a
substantial likelihood that its disclosure will have a significant
bearing on a reasonable shareholder's assessment of the
recommended course of action. Here, there was enough evidence
for a rational jury to reach the conclusion that the omitted
information "might have induced shareholders to vote against the
-- Wielgos v. Commonwealth Edison Company
Forward looking statements need not be correct. It is enough that
they have a reasonable basis. Inevitable inaccuracy of a
projection does not eliminate the safe harbor. Firms need not
disclose tentative internal estimates, even though they conflict
with published estimates, unless the internal estimates are so
certain that they reveal the published figures as materially
-- The SEC does not require firms to reveal data, assumptions, and
methods. Rule 175(c)(4) allows the firm to reveal them, but their
disclosure is not a condition of the safe harbor. "Key
assumptions underlying a forward looking statement are of such
significance that their disclosure may be necessary in order for
such statements to meet the reasonable basis and good faith
standards embodied in the rule."
-- In the Matter of Franchard Corporation (page 97, SEC) $8(c)
and $8(d) of '33 Act
Director's withdrawals to another corporation were material
transactions between registrant and its management, and the
registration forms on which registrant's filings were made called
for their disclosure. The value of stock in registrant company
was based on the Director's reputation. The disclosures sought
here by the staff would require evaluation of the entire conduct
of a board of directors in the context of the whole business
operations of a company in the light of diverse and uncertain
standards. This is a function which the disclosure requirements
of the Act cannot effectively discharge. It would either result
in self-serving generalities of little value to investors or grave
uncertainties both on the part of those who must enforce and those
who must comply with that Act. Here, several factors give
adequate notice of the deficiencies in the registrant's effective
filings. Among those factors are the Director's departure, the
transfer of hs controlling B shares to management which has made a
substantial financial commitment in registrant's securities, and
registrant's voluntary disclosures to our staff prior to the
initiation of these proceedings.
-- Item 403 of Regulation S-K requires disclosure of who owns the
company. What do you have to reveal?
1) Identify Directors
-- positions held
-- arrangements with respect to election
2) Identify Executive Officers
-- positions held
-- arrangements with respect to elections
3) For new companies, if have other important people (i.e.
scientists), must reveal them also.
4) Describe business experiences
-- detail principal occupations for last 5 years
-- indicate what other directorships they hold
-- indicate their involvement in legal proceedings in last five
-- criminal proceeding, etc.
-- Item 402 Requires information on executive compensation. This
part changes almost annually, since the SEC constantly updates
what type of disclosure they require.
-- Item 405 says that it is illegal for certain insiders to make
short term profits by trading on company's stock. Basically, if
you buy and then sell within 6 months, your profits revert back to
the company IF you are sued.
-- Materiality of bribes might depend on the size of the bribe.
Might also depend on the potential consequences if the bribe is
-- Foreign Corrupt Practices Act was passed to deal with bribery
-- Subpart 400 of Regulation S-K requires disclosure of
information that bears on the incentives, integrity, and
commitment of the registrant's management. IN addition to
extensive background info for each director, executive officer,
and others expected to make a significant contribution to the
firm, registrants must disclose certain types of adjudications
that have occurred during the past five years that involve any
director, person nominated to become a director, executive
officer, control person, or promoter of the registrant. The
registrant may disclose any mitigating circumstances in connection
with its disclosure of one of the above events.
-- Regulation S-K requires elaborate and detailed disclosure of
executive officers' compensation, including that awarded through
stock options, pension, and other compensation devices. This info
must be presented in the aggregate for all executive officers as
well as for the five most highly compensated
executive officers whose cash compensation exceeds $60,000. The
registrant must also disclose the compensation arrangement for
directors, including any additional sums received for committee
-- Registrant must disclose in tubular form the total number of
shares owned by officers and directors as well as the shares they
hold under options or otherwise.
-- Item 403(c) of Regulation S-K requires disclosure of "any
arrangements, known to the registrant, including any pledge the
operation of which may at a subsequent date result in a change in
control of the registrant."
-- Certain conflict of interest transactions are required to be
disclosed under Item 404. Disclosure is required if the
transaction exceeds $60,000 and is between the registrant (or any
of its subsidiaries) and its director, executive officer of the
registrant, director nominee, an owner of more than 5 percent of
any class of the registrant's stock, or immediate family member
of any of the above. Special disclosures are also required of any
transactions between the registrant and its promoters that have
occurred or will occur. Details of any loans by the registrant
must be disclosed when made to its executive officers, directors,
and nominee directors, as well as members of their immediate
family or firms in which such persons have specified interests.
This requirement applies specifically to dealings between the
registrant and a law firm or investment banking firm in which a
director or nominee director of the registrant is a member.
-- SEC's position is that the five-year standard is simply a guide
to disclosure, and events occurring outside this period may be
material and should be disclosed.
-- Under Item 401(f) of Regulation S-K, the civil and
administrative actions of the type therein specified that involve
certain of the registrant's personnel must be disclosed only if
the claims have been adjudicated. With the exception of a pending
criminal proceeding, Item 401(f) does not expressly require
pending claims to be disclosed.
-- Disclosure is generally adequate if the "basic facts"
surrounding the suit are disclosed. Moreover, there is no need
for the registrant to characterize its conduct as illegal,
criminal, fraudelent, omproper, and so forth. It si not
appropriate to offer assertions that suit is without merit, etc.
Statements that unduly minimize the likelihood of the suit's
success or magnitude can themselves be materially misleading.
-- Courts have held that since self-dealing presents opportunities
for abuse of a corporate position of trust, the circumstances
surrounding corporate transactions in which directors have a
personal interest are directly relevant to a determination of
whether they are qualified to exercise stewardship of the company.
THE MATERIALITY OF VIOLATIONS OF STATE OR FEDERAL LAW
-- SEC v. Jos. Schlitz Brewing Co.
The test for materiality is whether there is a substantial
likelihood that a reasonable person would attach importance to
these matters in making investment decisions regarding Shlitz
securities. Info here was material because: it had a direct
bearing on the integrity of management, was material from an
economic standpoint (although amount was relatively small--3% of
annual earnings), and even if a criminal prosecution for certain
of the transactions is now barred, this does not establish the
immateriality of these activities insofar as a civil action to
laws is concerned.
-- Foreign Corrupt Practices Act. In 1977, $30A was added to the
'34 Act prohibiting reporting companies from bribing any "foreign
official" and adding as well $13(b)(2), which requires reporting
companies to maintain records that failry reflect transactions
and to "devise and maintain a system of internal accounting
controls sufficient to provide reasonable assurance that"
transactions are executed in compliance with management's
authorization as well as assuring that both access to and
accounting for assets is adequately controlled.
-- The Second Circuit in Matthews stated that the securities laws
do not require generally that individuals accuse themselves of
antisocial or illegal activities, but there is an exception when
dealing with self- dealing, fraud, or securities violations.
-- When a trend, demand, commitment, event or uncertainty is
known, management must make two assesments:
1) Is the known trend, demand, commitment, event or uncertainty
likely to come to fruition? If management determines that it is
not reasonably likely to occur, no disclosure is required.
2) If management cannot make that determination, it must
evaluate objectively the consequences of the known trend, demand,
commitment, event or uncertainty, on the assumption that it will
come to fruition. Disclosure is then required unless management
determines that a material effect on the registrant;s financial
condition or results of operations is not reasonably likely to
-- Each final determination resulting from the assessments made by
management must be objectively reasonable, viewed as of the time
the determination is made.
DEFINITION OF A SECURITY
-- If something is a security, then selling it requires a
registration or exemption from certain procedures.
-- '33 Act defines security in $2-1.
-- The '33 Act and '34 Act have substantially similar definitions
of a security.
-- SEC v. W.J. Howey Company (page 126, Supreme Court)
D owned a large Florida citrus grove, and sold purchasers small
parcels of orchard land along with a service contract under which
D would harvest and market the fruit, and distribute to the
purchasers part of the profits. Court held that since a buyer
would be relying solely on D's efforts, not his own, to make money
from the parcel, the land sale contract was an "investment
contract" and thus a "security." Court defined investment
contract as being a "contract, transaction or 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 a third
-Court says that if you invest money and expect profits solely
from the efforts of others and it is a common enterprize, it is an
-- SEC v. Koscot Interplanetary, Inc.
Here, there is commonality because the fortunes of all investors
are inextricably tied to the efficacy of the Koscot meetings and
guidelines on recruiting prospects and consummating a sale. The
test for "efforts of others" is whether the efforts made by those
other than the investor are the undeniably significant ones, those
essential managerial efforts which affec the failure or success of
-- Koscot looked to vertical commonality in evaluating the
presence of a common enterprise. Under this approach, which
emphasizes the relationship between the investors and the
promoter, the principal inquiry is whether the activities of the
promoter are the controlling factor in the success or failure of
the investment, and a common enterprise may exist even though
there is no pooling of investors' funds or interest.
-- A more restrictive approach looks to the presence of horizontal
commonality, which requires a pooling of investors' funds and,
usually, a pro rata distribution of profits or sharing of losses
among investors. This approach emphasizes the common enterprise
among investors rather than the common enterprise between a
promoter and investors.
-- An investment contract may exist even though there is some
investor participation in a venture. In these cases, the problem
is one of determining how active investors may be without
undermining the character of her investments as investment
REAL ESTATE AS SECURITIES
-- The standard real estate transaction in the form of a sale or
lease of property does not involve the offer of a security. When
the seller or its affiliates offer collateral arrangements
promising postacquisition income to the buyer, however, an
investment contract may be present.
-- Hocking v. Dubois
Here the combination of several factors, including promotion of
the condomionium with emphasis on economic benefits derived from
the managerial efforts of third parties designated by agent and by
including with condo an offer for a rental arrangement or rental
pool arrangement, the agent offered to plaintiff a security and
jury should decide the issue.
-- Williamson v. Tucker, the leading case on the control issue,
states that where the investor is a general partner or joint
venturer, he must establish that:
1) an agreement among the parties leaves so little power in the
hands of the partner or venturer that the arrangement in fact
distributes power as would a limited partnership; or
2) the partner or venturer is so inexperienced and unknowledgeable
in business affairs that he is incapable of intelligently
exercising his partnership or venture powers; or
3) the partner or venturer is so dependent on some unique
entrepreneurial or managerial ability of the promoter or manager
that he cannot replace the manager of the enterprise or otherwise
exercise meaningful partnership or venture powers.
-- Koch v. Hankins (page 26 supplement)
Jojoba case. Follows the Williamson test, and suggests that
partnership interests can be classified as a security.
-- Some states have adopted the risk capital test. A security
will not exist under the risk capital test unless capital provided
by investors is at substantial risk. The existence of
collateralization or other security may negate the possibility
that a transaction involves a security.
-- Differences between risk capital test and Howey:
-- Risk capital test does not necessarily require a common
enterprise among investors.
-- Risk capital test avoids the requirement that profits be
derived "solely" from the effrots of others, although circuit
court interpretations of this element of Howey have softened its
-- The risk capital test accommodates an analysis based upon the
degree of risk assumed by the investor. If that risk is minimal
because of the issuer's strong balance sheet or adequate
collateralization, the likelihood that an investment contract will
be found is lessened.
-- United Housing Foundation v. Forman
"Stock" does not always mean its literal interpretation (name not
relevant). Here, the securities lacked the characteristics of
stock (dividends, not negotiable, cannot be pledged or
hypothecated, confer no voting rights in proportion to the number
of shares owned, cannot appreciate in value.) Here, investors
were attracted solely by the prospect of acquiring a place to
live, and not by financial returns on their investments. What
distinguishes a security transaction -- and what is absent here --
is an investment where one parts with his money in the hope of
receiving profits from the efforts of others, and not where he
purchases a commodity for personal consumption or living quarters
for personal use.
-- International Brotherhood v. Daniel
An employee's participation in a noncontributory, compulsory
pension plan such as the Teamster's does not comport with the
commonly held understanding of an investment contract. When
viewed in light of the total compensation package an employee must
receive in order to be eligible for
pension benefits, it becomes clear that the possibility of
participating in a plan's asset earnings is far too speculative
and insubstantial to bring the entire transaction within the
-- Marine Bank v. Weaver
There are important differences between a certificate of deposit
purchased from a federally regulated bank and other long-term debt
obligations It is unnecessary to subject issuers of bank
certificates of deposit to liability under the antifraud
provisions of the federal securities laws since the holders of
bank certificates of deposit are abundantly protected under the
federal banking laws. So, the CD here is not a security. The
agreement negotiated between Weavers and the other party was not a
security because it was a one-on-one agreement, and although
anticipated profits, is not sufficient to be labeled a security.
STOCK AS A SECURITY
-- Landreth Timber Co. v. Landreth
Here, it is a traditional stock, within the statutory definition.
The '34 Act contains several provisions specifically governing
tender offers, disclosure of transactions by corporate officers
and principal stockholders, and the recovery of short-swing
profits gained by such persons Eliminating from the definition
of "security" instruments involved in transactions where control
passed to the purchaser would contravene the purposes of these
provisions. So, stock here is a security and the sale of business
doctrine does not apply.
-- Williamson v. Tucker
A general partnership or joint venture interest can be designated
a security if the investor can establish, for example, that (1) an
agreement among the parties leaves so little power in the hands of
the partner or venturer that the arrangement in fact distributes
power as would a limited partnership; or (2) the partner or
venturer is so inexperienced and unknowledgeable in business
affairs that he is incapable of intelligently exercising his
partnership or venture powers; or (3) the partner or venturer is
so dependent on some unique entrepreneurial or managerial ability
of the promoter or manager that he cannot replace the manager of
the enterprise or otherwise exercise meaningful partnership or
venture powers. None of these factors are present here.
-- Courts have held that limited partners are the types of passive
investors in need of the protection of the federal securities
-- Reves v. Ernst & Young
Ct adopts the family resemblance test. The test begins with the
language of the statute; because the Securities Acts define
"security" to include "any note," one must begin with a
presumption that every note is a security. Ct. lists types of
notes which are not securities: note delivered in consumer
financing, note secured by a mortgage on a home, the short term
note secured by a lien on a small business or some of its assets,
the note evidencing a 'character' loan to a bank customer, short
term notes secured by an assignment of accounts receivable, or a
note which simply formalizes an open account debt incurred in the
ordinary course of business (particularly if, as in the case of
the customer of a broker, it is collateralized). Here, notes were
sold to raise capital for general business operations, so this is
an investment in a business enterprise rather than a purely
commercial or consumer transaction. Second, notes were offered
and sold to a broad segment of the public, and that is sufficient
to establish the requisite "common trading" in an instrument.
Third, the advertisements for the notes characterized them as
"investments," and there were no countervailing factors that would
have led a reasonable person to question this characterization.
Finally, there was no risk-reducing factor here to suggest that
these instruments were not in fact securities. Notes were
uncollateralized and uninsured.
-- Banco Espanol de Credito v. Security Pacific National Bank
Here, loan participations are analogous to a category of loans
issued for commercial purposes and thus do not come under the
rubric of "notes", which are securities.
-- Gary Plastic Packaging Corporation v. Merrill Lynch
Court applied the Marine Bank v. Weaver test. It held that in
Marine Bank, the reason for exempting CD's from the securities
acts was to eliminate double coverage when the Glass-Steagall Act
and the securities acts overlap. If the court were to find the
CD's sold through this CD Program not to be covered by the federal
securities laws, a gap would exist in the regulatory scheme that
would strip the investor of needed federal protection. So, the
CD's here are "securities" for purposes of the antifraud
provisions of both Acts .
-- The presense of a repurchase obligation may in and of itself
be sufficient to create a separate security offered by the
-- Section 3 exempts from registration requirements securities
issued or guaranteed by a domestic governmental entity or a bank.
Many pass-throughs have such guarantees and therefore need not be
registered notwithstanding the fact that they may constitute
separate securities. Similarly, the packaging of corporate
accounts receivable is often accompanied by a bank guarantee of
THE PUBLIC OFFERING
-- Section 5 bars any offers to sell and sales of a security until
a registration statement covering the security has become
-- The registration statement contains information about the
security's issuer, the security, contemplated uses of the
offering's proceeds, and the manager of the sale (i.e.
underwriters and their compensation), all with the intended
purpose of facilitating informed investment decisions and
discouraging the fraudelent promotion of worthless securities. A
prospectus must also accompany the security's delivery to its
-- Section 11 of the Securities Act imposes liability upon the
issuer, its principal officers, its directors, and its
underwriters for any material ommissions or misstatements in the
registration statement when it became effective. The issuer's
outside accountants are also liable if they have certified
materially misleading financial statements that are included in
the registration statement.
UNDERWRITING AND UNDERWRITERS
METHODS OF UNDERWRITING
-- In the Matter of the National Association of Securities
Broker-dealers can sell securities to the public in either "firm
committment" or "best efforts" underwritings. In a firm
committment underwriting, one or more investment banking firms
agree to purchase the securities from the issuer for resale to the
public at a specified public offering price. In a best efforts
underwriting, broker-dealers do not purchase the securities from
the issuer but instead agree for a fee to use their best efforts
to sell the securities on behalf of the issuer at the offering
-- The underwriters and the selected dealers agree to sell the
securities to the public at a fixed public offering price. The
difference between that price and the amount received by the
issuer is known as the "gross spread."
-- The "spread" is normally composed of three parts: 1) the
management fee for the managing underwriter, 2) the underwriting
compensation received by the underwriters, and 3) the "selling
concession" received for any securities sold to the public by any
broker-dealer participating in the distribution.
-- Section 11(e) of the Securities Act limits the liability of
each underwriter to the "total price at which the securities
underwritten by him and distributed to the public were offered to
-- The agreement between the issuer and the underwriters has
several features designed to reduce the underwriter's risks:
-- Market Out Clause. This permits the underwriters to withdraw
any time prior to the public offering and/or settlement date (i.e.
when the syndicate must pay for the securities purchased) if one
of several exigent circumstances develops: (1) the government or
an SRO has imposed restrictions on the trading of securities in
general, (2) there is awar or other national calamity, (3) there
has been a material adverse change in markets (either generally or
for the distributed security), or (4) there has been a material
adverse event affecting the issuer.
-- Indemnification Clause. Underwriters can avoid liability of
they can demonstrate they "had, after reasonable investigation,
reasonable ground to believe and did believe" that the
registration statement was not materially misleading. See
$11(a)(5) and 11(b)(3). This clause can shift responsibility to
away from the underwriter.
-- Comfort Letters. Underwriters like to get these from issuer
and accountants, stating that disclosure info is ok. Obviously,
issuer and accountants, etc. are hesitant about providing such
letters (since they may be liable if there is a problem.)
-- Contribution Clause. If the underwriters cannot shift their
liability by indemnification or comfort letters, their fallback
position is their provision for contribution among those liable
under the registration statement.
REGISTRATION UNDER THE '33 ACT
-- The SEC enjoys broad rulemaking authority under $19(a), wherein
it has the power to adopt, amend, and rescind "such rules and
regulations as may be necessary to carry out the provisions of"
the Act including the contents of registration statements and
prospectuses, as well as "defining accounting, technical and trade
terms" used in the Act.
-- The information that must be included in a registration
statement can roughly be divided into four categories: information
bearing on the registrant, information about the distribution and
use of its proceeds, a description of the securities of the
registrant, and various exhibits and undertakings that must be
filed as part of the registration statement. Only information
within the first three categories must be reproduced in the
-- Information with Respect to the Registrant. Description of
registrant's business, property, and management. Registrant must
disclose legal proceedings involving the issuer or certain
individuals affiliated with the registrant. Regulation S-X is the
core of the info requirement. See, particularly, items 301, 302
-- The Distribution and Its Proceeds. Underwriters in privity
with the registrant must disclose the general terms of their
agreement and their compensation (both in the aggregate and on a
per share basis). The net expected proceeds of the offering must
be disclosed, and if the registrant has plans for the proceeds
those plans must be dicslosed. More detailed disclosure about the
proceeds' use is required when they are to be used in connection
with other funds to accomplish a specified purpose. For example,
a more detailed disclosure of the proceeds' use is required if the
proceeds will be used to discharge indebtedness or to acquire
assets other than in the ordinary course of business or to engage
in acquisitions of other businesses.
-- Exhibits and Undertakings. Numerous exhibits must be filed as
part of the registration statement, including registrant's
articles of incorporation, bylaws, attorney's opinion as to the
legality of the securities registered, and any 10-K or 10-Q
reports incorporated by reference into the registration statement.
The registrant must also include in its registration statement
information regarding all unregistered securities sold during the
past three years.
-- The above categories of info describe the content of the
registration statement embodied in Form S-1. Because Form S-1 is
resorted to only when the registrant cannot avail itself to one of
the other forms of registration, Form S-1 should be viewed as the
residual registration form. The registration and prospectus
requirements for many registrants are gratly simplified through
the integrated disclosure system embodied in Forms S-2 and S-3.
-- Requires complete disclosure to be set forth in the prospectus
and permits no incorporation by reference. To be used by
registrants in the Exchange Act reporting system for less than
three years and also may be used by any registrants who choose to
do so or for whom no other form is available.
-- Registrants in the Exhange Act reporting system for three years
may use this Form, which allows them to choose to either: (1)
deliver a copy of their annual report to security holders along
with the prospectus describing the offering or (2) present
registrant-oriented information comparable to that of the annual
report in the prospectus along with the descriptions of the
offering. In either case, the more complete information of the
Form 10-K is incorporated by reference into the prospectus.
-- Allows maximum use of incorporation by reference of Exchange
Act reports and requires the least disclosure to be presented in
the prospectus and delivered to investors. Generally, the Form S-
3 prospectus will present the same transaction-specific
information as will be presented in a Form S-1 or S-2 prospectus.
Information concenring the registrant will be incorporated by
reference from Exchange Act reports. The prospectus will not be
required to present any information concerning the registrant
unless there has been a material change in the registrant's
affairs which has not been reported in an Exchange Act filing or
the Exchange Act reports incorporated by reference do not reflect
certain restated financial statements or other financial
-- In 1992, the SEC lowered the requirements for use of Form S-3.
First, an issuer generally must have an Exchange Act reporting
history of twelve months rather than the former thirty-six months.
Second, once in the reporting system for twelve months, an issuer
would qualify for Form S-3 by having a public float of $75 million
(representing the aggregate market value of the company's voting
stock held by non-affiliates.) The former three million share
annual trading volume test has been eliminated.
-- Under FORM S-3, investor receives in prospectus information
bearing on the plan of distribution, the use of the proceeds, and
the like. FORM S-2 includes the same info, but the difference is
that FORM S-2 registrant's prospectus must be accompanied by
either (1) its most recent annual report and its most recent
quarterly report or (2) an annual report and other financial
information prepared pursuant to the form's specific requirements.
-- Form S-4 is used in certain merger transactions where stock
will be issued. S-8 is used in connection with employee benefits
plans where stock is to be issued.
REGULATION S-B (Small Business Initiatives)
-- A small business issuer is defined as a company with revenues
of less than $25 million. However, if the aggregate market value
of the issuer's voting stock held by non-affiliates (referred to
as the "public float") equals or exceeds $25 million, the issuer
does not qualify as a small business issuer. (this definition
includes Canadian issuers). Further, if the small business issuer
is a majority owned subsidiary of another company, its parent must
also meet the definition of small business issuer.
-- Form SB-2 is the designated Securities Act registration form
for small business issuers. There is no dollar limit for
offerings on Form SB-2 and the Form may be used for both initial
and repeat offerings, and for both primary and secondary
offerings. Small business issuers may file initial public
offerings on Form SB-2 with the regional office closest to the
issuer's principal place of business or at the Commission's
headquarters. All subsequent filings will be made at the
-- Once reporting, a company may continue to report under the
small business integrated disclosure system until it exceeds the
$25 million revenues for two consecutive years or public float
test for two consecutive years, based on its annual report on Form
-- Small business issuers are permitted to register securities on
Forms S-2, S-3, and S-8 if they otherwise meet the eligibility
requirements for use of those forms.
-- The '33 Act imposes strict liability on issuers in shareholder
suits based on misrepresentations in a registration statement and
requires certain others associated with the distribution (i.e.
underwriters) to exercise due diligence to assure the accuracy of
the registration statement to avoid sharing that liability.
-- '34 Act liability is only from intentional or reckless conduct,
and 10-K's and annual reports no doubt reflect some lesser
diligence in their preparation. As a result, one cannot assume
that "off the rack" use of '34 Act disclosure forms necessarily
results in the same quality of disclosure as that produced in a
'33 Act setting.
-- Feit v. Leasco Data Processing Equipment Corp.
The objectives of full disclosure can be fully achieved only by
complete revelation of facts which would be material to the
sophisticated investor or the securities professional not just the
average common shareholder. But, the less experienced are
entitled to have within the four corners of the prospectus an
intelligible description of the transaction.
-- After the registration statement is filed with the SEC, the SEC
reviews it and finally issues its letter of comments. The time
period calls for the issuance of an initial letter of comments
within thirty days of the filing of a registration statement (but
this is often longer).
-- Filing fees are due upon filing and under $8(a) the
registration statement can, barring any other actions, become
effective 20 days after filing.
-- Under $8 of the '33 Act, the Commission has authority to set
the effective date of a registration statement earlier than the
twentieth day after filing of a registration statement or any pre-
effective amendment. SEC Rules 460 and 461 set out the standards
which must be considered in determining whether $8 standards have
SHELF REGISTRATION UNDER RULE 415
-- Under Item 512(a)(1)(i) the registrant must file a
posteffective amendment covering any prospectus required by
$10(a)(3). This in effect means that the registrant must update
its financial statements annually. Any acts or events arising
after the effective date of the registration statement that
individually or in the aggregate represent a fundamental change in
the information set of the registration statement is required by
Item 512(a)(1)(ii) to be disclosed in a posteffective amendment to
the registration statement. Item 512(a)(1)(iii) requires a
registrant to file a posteffective amendment for any material
change with respect to the distribution.
-- By far the most significant dimensiton of Rule 415 is its
authorization in paragraph (a)(1)(x) that expands the availability
of shelf registration for certain issuers beyond the traditional
uses of shelf registration, so that issuers qualified to use Form
S-3 can register for the shelf primary offerings of debt or equity
securities to be made on a continuous or delayed basis. The
amount of securities that can be so registered is lijmited to the
securities the registrant reasonably expects to sell on a
continuous or delayed basis within two years of the registration
statement's effective date. The two-year limit also appliees to
shelf registrations by issuers of securities to be issued in
business combinations and on a continuous basis for a period in
excess of 30 days.
-- Paragraph (a)(4) of Rule 415 imposes an important qualification
on the use of the shelf registration rule for an issuer's offering
of an equity security into a trading market that already exists
for securities of the same class as those being registered for the
shelf. Such an offering can be registered for the shelf only if
the issuer is qualified to use Form S-3 and the offering must be
made only through an underwriter to be named in the registrants
statement. If the equity stock being offered is also voting,
there is a further limitation that the amount registered for the
shelf cannot exceed 10 percent of the market value of the
issuer's voting stock held by nonaffiliates.
-- The limitations in paragraph (a)(4) do not apply to shelf
registrations on behalf of control persons (so-called secondary
distributions) nor to the issuer's offering of debt securities,
even though those sales are proposed to be made into an existing
market for such security. Furthermore, the limitations in
paragraph (a)(4) do not apply to fixed price offerings, even
though the sales will be made through a national securities
exchange or market-maker, and do not apply to offerings made
outside an existing market, which is the casse for so many of the
traditional shelf offering.
ISSUES IN PRE-FILING PERIOD
-- What can company say? Rule 135 governs announcement of intent
to make an offering. Companies should stick to facts while they
are "in registration."
-- What can investment bankers say? Rule 137, 138, 139 governs
-- Rule 137 permits nonparticipating brokers and dealers to
publish or distribute, in the regular course of their business,
information, opinions, and recommendations regarding securities of
an issuer in registration. Rule 137 is limited to the
distribution of information about issuers required to file reports
under $13 or 15(d) of the Exchange Act and the protection of the
rule is lost if the broker or dealer receives compensation or has
a special arrangement with the issuer, a selling security holder,
or any participant in the distribution.
-- Rule 138. This rule applies only if the registrant meets all
the requirements of Form S-2 or F-2. A broker or dealer, whther
or not a participant in such a registrant's distribution of
nonconvertible preferred stock or nonconvertible debt security,
may publish opinions or recommendations for that registrant's
common stock; correlatively, the broker-dealer, whether or not a
participant in the distribution of the registrant's common stock,
can publish opinions or recommendations for that registrant's
nonconvertible preferred stock or nonconvertible debt security.
-- Rule 139. This rule permits a broker or dealer, whether or not
participating in issuer's distribution, to publish opinions and
recommendations concerning an issuer that is in registration and
is required to file reports pursuant to $13 or 15(d), if certain
conditions are met. If the issuer meets the requirements of Form
S-3 or F-3, the only condition that must be satisfied is that the
opinion or recommendation appear in a publication that appears
with reasonable regularity. For other issuers, the opinion or
recommendation must not be given special prominence and must not
be more favorable than the last previous recommendation
distributed prior to the broker or dealer becoming a participant.
-- $5(c) prohibits any offer to sell or offer to buy prior to the
filing of a registration statement. Even after a registration
statement is filed, the constraints of $5(c) reappear if that
registration statement is "the subject of a refusal order or stop
order (prior to the effective date of the registration statement)
or any public proceeding or examination under $8."
-- There are no limitations on oral offers. Under 5(b)(1), oral
offers are ok.
-- Under $5(a), no sales or delivery of sold securities can occur
until the registration statement is effective. After the
registration statement is filed and even after it is effective,
$5(b)(1) requires that all written offers to sell must be in
connection with a prospectus that complies with $10 of the Act.
This provision is designed to assure a wide distribution of the
most salient portions of the registration statement so that
investors have reliable information on which to consider their
purchase of the registered security. A final prospectus is
required to accompany any transportation of the securities to
-- The jurisdictional reach of each of the provisions in $5 is the
same, namely the use of any means or instruments of transportation
or communication in interstate commerce or the mails. None of the
provisions of $5 applies if all activities are on a fact to face
basis with no use of the mails, phone, or other commercial medium
to arrange or carry out the sale. At the same time, if the money
for the purchase or the security is mailed by the seller to the
buyer after all negotiations occurred on a face to face basis, the
jurisdictional requirements of the statute are met. This is the
import of the "directly or indirectly" language of each provision.
-- The most important exemption appears in $4(1), which exempts
from $5 everyone, other than "an issuer, underwriter, or dealer."
Each of these nonexempt parties is defined in $2: Issuers are
defined in $2(4), the term underwriter is broadly defined in
$2(11), and dealers are defined in $2(12) to include brokers. The
effect of $4(1) is to subject to $5 those actively involved in the
issuer's distribution -- the issuer itself as well as its
underwriters and certain dealers.
-- The publication of information and statements, and publicity
efforts, generally, made in advance of a proposed financing,
although not couched in terms of an express offer, may in fact
contribute to conditioning the public mind or arousing public
interest in the issuer or in the securities of an issuer in a
manner which raises serious question whether the publicity is not
in fact part of the selling effort.
-- Rule 135 permits issuers in registration to release certain
information about their operations and activities without that
release being considered an offer to sell a security.
-- Ordinarily, a broker-dealer becomes subject to restrictions at
any time when he commences to participate in the preparation of a
registration statement or otherwise reaches an understanding with
the person on whose behalf a distribution is to be made that the
firm will become a managing underwriter, whether or not the terms
and conditions of the underwriting have been agreed upon. Other
brokers become subject to restrictions at such time as they are
invited by a managing underwriter or a person on whose behalf a
distribution is to be made, to participate or seeks to
participate. Persons who choose to forego such underwriting in
order to be free to distribute such publications should not
thereafter participate in the distribution as a dealer or
-- If a broker-dealer is a participant in a proposed underwriting
and material events occur during the "pre- filing" period, the
broker should be able to make a brief, strictly factual report of
these events to his customers.
-- A company cannot refuse to disclose factual information simply
because it is "in registration"
-- See page 287 for a list of items that issuers should and should
not do with respect to disclosure of information.
-- $2(3) excludes from the definition of sale, offer to sell, and
offer to buy both the negotiations and agreements that the issuer
has with its underwriter as well as the negotiations and
agreements among the underwriters, provided they are or will
become parties to the underwriting agreement with the issuer. The
parties excluded are members of the selling group who absorb none
of the offering's risk.
-- Even though a registration statement has been filed $5(a)
continues to bar sales until the registration statement becomes
effective; but with the filing of the registration statement
selling efforts can commence. $5(b)(1) shapes the form of all
such selling efforts. (in combination with $2(10)).
-- $10(b) confines the use of the prospectus so authorized to one
satisfying the prospectus requirements of $5(b)(1). Hence, a
$10(b)-authorized prospectus cannot be used to fulfill $5(b)(2)'s
requirement that a prospectus meeting the requirements of $10(a),
a final prospectus, must accompany or precede the delivery of
-- Rule 430 provides that prior to the effective date of a
registration statement $5(b)(1) is satisfied by the use of a
prospectus that includes substantially the same information that
will ultimately appear in the final prospectus under $10(a),
except the preliminary prospectus may exclude the offering price,
underwriter and dealer compensation, the amount of the proceeds,
and conversion raters, call prices, and other matters dependent
upon the offering price. This is the preliminary prospectus.
-- Rule 431 authorizes the summary prospectus for use in meeting
the requirements of $5(b)(1). To do so, you needed to have been a
public company for 3 years and not in default.
-- If a preliminary prospectus or summary prospectus is used, a
copy must be filed as an exhibit to the registration statement.
Even though filed with the Commission, neither the preliminary nor
summary prospectus is considered part of that registration
statement for the purposes of $11 liability.
-- Rule 134 lists the info that can be included in a "tombstone
ad", which is the publicity about registration.
-- Rule 134(d) does permit, subject to a few formal conditions, a
written communication to be sent during the waiting period to
anyone asking the investor to express his interest in a security
by, for example, completing a card or form. This device is
conditioned on the communication's being accompanied or preceded
by a prospectus satisfying $10 and that it also contain a
statement that, among other things, warns the investor that no
offer to buy can be accepted and that no payment toward the
purchase price can be received until the registration statement is
effective and that further informs the customer that her offer can
be withdrawn anytime before acceptance is given after the
-- Rule 460 says that the Commission will not accelerate the
effective date of a registration statement unless the preliminary
prospectus contained in the registration statement is distributed
to underwriters and dealers who it is reasonably anticipated will
be invited to participate in the distribution of the security to
be offered or sold.
-- Whenever the security is delivered to the customer, $5(b)(2)
requires that it must be "accompanied or preceded by a prospectus
that meets the requirements of $10(a)." This means that only a
final prospectus mmay be used when a security is transported for
sale or delivered after sale.
-- Rule 430A permits for cash offerings of securities the
registration statement to become effective even though the
offered security's price, the participants in the underwriting
syndicate, the underwriters' comensation, and other information
dependent on the offering price have not been filed. Rule 430A
requires that if such information is omitted from the registration
statement when it became effective it must be disclosed in the
final prospectus, and Rule 432(b) further requires that the final
prospectus including such information must be filed with the
Commission as a posteffective amendment to the registration
statement. The overall intent of Rule 430A is to allow
registration statements for cash offerings to become effective
earlier and thus allow somewhat earlier use of written materials
in the promotional efforts. Under Rule 430A the risk of delay in
the offering's going to market on the target day is reduced by any
last-minute problems associated with setting the price or forming
the offering syndicate.
-- Written offers to sell can be made either through a final
prospectus covered by 10(a) or a summary prospectus covered by
10(b). However, pursuant to Rule 430, the preliminary prospectus
cannot be used after the registration statement becomes effective.
-- Under 5(b)(1), if the underwriter is aware that its offeree has
already been sent a final prospectus, there is no need to supply
him with another. More significantly, the exemption in 2(10)
allows participants in the offering to prepare and circulate their
own materials extolling the offered security. The use of
supplementary selling materials is known as "free writing" and is
only permitted in the posteffective period and only if those
materials are accompanied or preceded by a final prospectus.
-- Issuers must continue to deliver a prospectus under $5(b) so
long as they are offering the security to the public.
-- Under $4(3)(C), underwriters and dealers are subject to the
prospectus delivery requirements as long as their allotment or
subscription in the distribution is unsold. See $4 for more
-- Under Rule 174, a dealer that is not an underwriter or
otherwise selling an allotment or subscription is completely
relieved of an obligation to deliver a prospectus if the issuer,
prior to filing its registration statement, was a reporting
company undedr the '34 Act. Even if the issuer is not a reporting
company, the prospectus delivery requirement for dealers is
dispensed with 25 days after the offering date if the security is
either listed on a national exchange or authorized for inclusion
in an inter-dealer quotation system of a registered SRO (i.e.
-- Rule 174(c) provides relief from the prospectus delivery
requirements for a dealer trading in a security of an issuer not
subject to the '34 Act reporting provisions, if that security has
been registered for the shelf; for such a security, dealers need
not deliver a prospectus after 25 or 40, or 90 days have passed
after the shelf-registered securities were FIRST OFFERED to the
-- SEC v. Manor Nursing Center, Inc.
A prospectus must contain true and correct information. Here,
company failed to correct the prospectus via an amendment. and
information was materially false or misleading. Appellants
violated $5(b)(2) by delivering securities for sale accompanied by
a prospectus which did not meet the requirements of $10(a) in that
the prospectus contained materially false and misleading
statements with respect to information required by $10(a) to be
-- $5(b)(1) does not reach oral selling efforts, except in the
unlikely event they occur via radio or television.
-- Under $5(a)(1), any arrangement between customers and broker-
dealers cannot constitute the sale of a security prior to the
registration statement's becoming effective.
REFUSAL ORDERS AND STOP ORDERS
-- Under $8(b), the Commission can issue a refusal order barring a
filed registration statement from becoming effective. This
reaches only patent misstatements and omissions in a filed
registration statement. $8(b) does not apply where the
misleading feature of the registration statement is not apparent
on its face.
-- Under $8(d), the Commission can issue a stop order that broadly
empowers it to act "if it appears at any time that the
registration statement includes any untrue statement of material
fact " Under $8(e), the Commission can also issue a stop order
solely on the basis of the registrant's or underwriter's failure
to cooperate in the Commission's investigation or their
obstruction of the staff's investigation.
-- The stop order authority exists only if the registration
statement contained a material misrepresentation when it became
effective. It does not reach situations where posteffective
developments render a previously accurate registration statement
-- $8(d) provides that when the registration statement "has been
amended in accordance with such stop order the Commission shall so
declare and thereupon the stop order shall cease to be effective."
-- Under $5(c), no offers to buy or offers to sell can be made
when a refusal or stop order has been issued against a
registration statement, and if the registration statement has not
become effective, $5(c)'s bar applies if "any public proceeding or
examination under $8? has been initiated.
-- Under $8(c), a posteffective amendment becomes effective on a
date that the Commission determines.
-- In deciding whether to file a posteffective amendment, one
begins under Rule 424(a), which requires that to the extent that
information in a "prospectus contains substantive changes from
or additions to a prospectus previously filed with the Commission
as part of a registration statement" the prospectus must be filed
as a posteffective amendment to the registration statement. In
practice, this is interpreted to require a posteffective amendment
of the registration statement only when the posteffective
information is to be substituted but not added to information
appearing in the registration statement.
-- Information that does not portend the type of substantive
change or addition referred to in Rule 424(a) can occur without
filing an amendment to the registration statement. Usually such
an addition occurs by placing a sticker containing the new
information on the prospectus. The procedures for filing the
stickered prospectus with the Commission are set forth in Rule
424(b)(3)-(5) and such a filing does not constitute an amendment
to the registration statement.
-- See Rule 415 (shelf registration) and requirement under Item
512(a) that the registrant will file particular information as a
WITHDRAWAL OF REGISTRATION STATEMENT
-- Rule 477 provides that the registration statement, or any
amendment or exhibit thereto, may be withdrawn upon application if
the Commission finds that withdrawal is consistent with the public
interest and the protection of investors.
PURCHASES DURING A DISTRIBUTION
-- Rule 10b-6 is an antimanipulation rule that prohibits the key
participants in a distribution from bidding or purchasing
securities of the same class as those being distributed until they
have completed their participation in the distribution. The rule
is intended to prevent those involved in the distribution of
securities from artificially conditioning the market for
securities to facilitate the distribution.
-- Paragraphs (1)(1)-(4) of Rule 10b-6 proscribe bids or purchases
during a distribution by (1) the issuer or other person on whose
behalf the distribution is being made, (2) the distribution's
underwriter (and even prospective underwriters), and (3) a
broker, dealer, or other person who has agreed to participate or
is participating in the distribution. Rule 10b-6 also reaches
the purchases of so-called affiliated purchasers -- - those acting
in concert with any of the above named participants in the
distribution or who control or are under the control of the
-- There are 13 exemptions to the rule.
-- Jaffe & Co. v. SEC
Here, one of the participants in a secondary issue PURCHASED
shares. SEC need not show that participant actually intended to
defraud the marketplace through his purchases. Where the rule
applies, its prohibition is absolute. Finally, he intended to
commit the purchases, so there is sufficient evidence to show
-- A shelf shareholder is required to observe the appropriate
cooling-off period and other Rule 10b-6 restrictions only with
respect to her own offers and sales off the shelf; coordination is
required with respect to offers and sales by others with whom the
shelf shareholder is in a control relationship or is acting in
concert. A shelf shareholder's participation in her shelf
distribution continues for so long as any of her or any of her
affiliated purchasers' shares remain unsold or until all such
shares are withdrawn from registration.
-- Rule 10b-6 also prohibts the same regulated parties to solicit
others to purchase until the regulated party has completed his
participation in such distribution.
-- The meaning of distribution for 10b-6 purposes only is not
determined by whether the offering is registered or not, but
rather "by the magnitude of the offering and the presence of
special selling efforts and selling methods."
-- Under paragraph (b) of rule 10b-6, the distribution of a
security convertible into, or that can be exchanged for, the
underlying security is deemed a distribution of both securities,
so that the parties regulated by Rule 10b-6 can purchase neither
the convertible nor the underlying security. Thus, if the issuer
were engaged in distributing its bonds convertible into common
stock, Rule 10b-6 would bar any purchases of the bonds or common
shares. On the other hand, if the convertible security is already
outstanding (i.e. it is not currently being distributed),
paragraph (f) exempts from the rule's prohibitions purchases of
the underlying security.
STABILIZATION UNDER RULE 10b-7 and RULE 10b-8
-- Stabilization is the pegging or fixing of a security's market
price through purchases or bids for the limited purpose of
preventing or retarding a decline in the security's price during a
public offering of the security.
-- The dual effects of compliance with Rule 10b-7 are that the
purchases are not deemed to be manipulative or deceptive as that
term is used in $10(b) of the Exchange Act, and furthermore
purchases and bids that comply with Rule 10b-7 do not violate Rule
10b-6's bar to purchases during a distribution. See 10b-
6(a)(4)(viii). When stabilizing is likely to occur, Item 502(d)
of Regulation S-K requires appropriate disclosures to be made in
the bold type in the inside cover page of the prospectus. Under
paragraph (g) of Rule 10b-7 stabilization is not permitted for
offerings that are made "at market".
-- There can be only one stabilizing price at any one time in a
single market. The price at which stabilization can initially
begin is governed by paragraph (j) and generally is the security's
last independently established sale price. Even though Rule 10b-
7 provides that stabilization can begin even before the
distribution commences or even before the registration statement
becomes effective, in practice stabilizing usually does not
commence until the distribution begins. Rule 10b-7 has no limits
on lowering the stabilizing price -- there is complete freedom to
folow the market down. There are restraints, however, on
increasing the stabilizing price above that previously used by the
distribution participants. Paragraph (j)(3) permits the
stabilizing price to be raised if the initial stabilizing price
before the security's public offering price was established, and
paragraph (j)(4) permits the stabilizing price to be raised
provided stabilizing activities (purchases and bids) have been
discontinued for three business days. In each case, however, the
new stabilizing price is determined by the last independently
established sale price. Obviously, it is unlawful to stabilize at
a price greater than the security's offering price.
-- A rights offering occurs when the issuer offers the distributed
security to its existing security holders before they are sold to
others, and any purchases by those involved in such an offering
are regulated under Rule 10b-8 at a level of complexity equal to
that of Rules 10b-6 and 10b-7. Overall, Rule 10b-8 constrains
those selling a security pursuant to a rights offering to the
price established for the rights offering; the rule does,
however, contemplate that the price may be changed from time to
time as provided for in the terms of the offering. However, the
price for any calendar day can be increased only once. Purchases
are permitted in connection with rights offerings so long as they
constitute lawful stabilizing activity within the strictures of
Rule 10b-7. Other types of purchases may occur, but subject to
very serious limits set forth in Rule 10b-8 that guide the price
at which the rights may be purchased and the ability to increase
the price at which the rights are so purchased.
INTERNATIONAL PUBLIC OFFERING
-- Absent one of the exemptions in $3 and 4 of the Act, the
foreign issuer that offers its securities in the U.S. must
register its offering under $5.
-- Regulation S, which embodies Rule 901-904, provides safe
harbors for offshore disbributions and resales of unregistered
securities of U.S. and foreign issuers.
-- See page 330-345 for additional info on international
REGISTRATION UNDER STATE BLUE SKY LAWS
-- There are three procedures: notification, coordination, and
-- Notification is available for certain seasoned, quality
issuers. Under the Uniform Securities Act, notification can be
used by firms that have been in operation for at least five year,
have not defaulted within the current or preceding three years on
fixed interest or dividend payments, and have earned at least 5
percent on their capital during the preceding three fiscal years.
Notification entails filing a statement demonstrating the issuer
is eligible to register through notification, some basic
information about the offering, and a copy of the offering
-- Registration by coordination is only available for issuers that
have filed a registration statement with the SEC under the '33
Act. Coordination usually entails filing a copy of the federal
registration statement and any amendments to it with the state
administrator. Subject to certain conditions, the state
registration statement for an offering registered through
coordination becomes effective automatically when the federal
registration statement becomes effective. As under the federal
rules, offers to sell the security can occur priot to the
registration statement's becoming effective, but actual sales
within the state cannot occur until after the statement has become
-- Qualification entails filing a registration statement in each
state where the offering will be made. The disclosure elicited
through qualification is quite extensive. When the state
registration occurs through qualification, there is no automatic
effectiveness of the state registration statement. It becomes
effective when the state administrator so orders.
-- Transaction exemptions provide an exemption only from the
registration provisions of $5 of the '33 Act. Securities placed
under one of these exemptions remain subject to both the '33 and
'34 Acts and, importantly, cannot be resold unless either they
are registered or another exemption is available.
-- Exempt securities, on the other hand, not only need not be
registered but also may be resold free of registration burdens.
Determining that a security is exempt, however, does not negate
application of the securities acts in their entirety, for exempt
securities remain subject to the antifraud provisions of the '33
and '34 Acts.
THE INTRASTATE OFFERING EXEMPTION: $3(a)(11)
-- This section exempts "Any security which is a part of an issue
offered and sold only to persons resident within a single State or
Territory, where the issuer of such security is a person resident
and doing business within, or, if a corporation, incorporated by
and doing business within, such State or territory.
SCOPE OF THE EXEMPTION
-- A basic condition of the exemption is that the entire issue of
securities be offered and sold exclusibely to residents of the
state in question. Consequently, an offer to a nonresident which
is considered a part of the intrastate issue will render the
exemption unavailable to the entire offering.
-- If the proceeds of the offering are to be used primarily for
the purpose of a new business conducted outside of the State of
incorporation and unrelated to some incidental business locally
conducted, the exemption should not be relied upon.
-- Any offers or sales to a nonresident in connection with the
distribution of the issue would destroy the exemption as to all
securities which are a part of that issue, including those sold to
residents regardless of whether such sales are made directly to
nonresidents or indirectly through residents who as part of the
distribution thereafter sell to nonresidents.
-- It is possible to have re-sale to nonresidents, but this is a
factual determination. If re-sale occurs shortly after the
offering, maybe the resale was a way around the exemption. Thus,
it is important to try to figure out intent.
-- The intrastate exemption is not dependent upon nonuse of the
mails or instruments of interstate commerce in the distribution.
Securities isued in a transaction properly exempt under this
provision may be offered and sold without registration through the
mails or by use of any instruments of transportation or
communication in interstate commerce, may be made the subject of
general newspaper advertisement (provided the advertisement is
appropriately limited to indicate that offers to purchase are
solicited only from, and sales will be made only to, residents of
the particular state involved), and may even be delivered by means
of transportation and communication used in interstate commerce,
to the purchasers.
-- Chapman v. Dunn
In order to qualify for the exemption of $3(a)(11), the issuer
must offer and sell his securities only to persons resident within
a single State and the issuer must be a resident of that same
State. In addition to this, the issuer must conduct a predominant
amount of his business within this same State.
-- An underwriter acting only as an agent, as in a best efforts
underwriting, may participate in an intrastate offering even if
the underwriter is not a resident of the state. If an out-of-
state underwriter purchases the shares in a firm commitment
underwriting, it is a nonresident purchaser and the exemption is
unavailable. The SEC allows, however, a nonresident underwriter to
participate, on a firm commitment basis, in an intrastate offering
if offers and sales will take place only through the underwriter's
branch offices in the state where the offering occurs.
-- Rule 147 provides a safe harbor in the form of a nine-month
holding period before securities may be sold to nonresidents.
-- Busch v. Carpenter
In the face of defendants' undisputed showing that all of the
original buyers were Utah residents, plaintiffs were therefore
required to produce evidence that the stock had not come to rest
but had been sold to people who intended to resell it out of
state. A newly formed company may not claim the exemption while
planning covertly to invest the proceedws of a local offering in
RULE 147 SAFE HARBOR
-- Exchange Act Release No. 5450
-- Factors to consider when deciding what constitutes "part of an
-- are the offerings part of a single plan of financing;
-- do the offerings involve issuance of the same class of
-- are the offerings made at or about the same time;
-- is the same type of consideration to be received; and
-- are the offerings made for the same general purpose.
-- Not only should the business be located within the state, but
the principal or predominant business must be carried on there.
Also, substantially all of the proceeds of the offering must be
put to use within the local area. The principal office of the
issuer must be within the state.
THE PRIVATE OFFERING EXEMPTION: $4(a)(2)
-- This is the main exemption for registration under the
-- A private placement is a direct sale of securities to a limited
number -- sometimes only one -- of knowledgeable investors,
usually life insurance companies and pension funds. The offering's
terms are negotiated directly with the purchaser, thereby
eliminating the need for underwriting.
-- A 1935 SEC release listed four factors:
1) The number of offerees and their Relationship to Each other and
to the issuer. Since any attempt to dispose of a security is an
offer, preliminary negotiations or conversations with a
substantial number of offerees will cause the offering to be
public in nature. Also important is the relationship between the
offerees and the issuer; if the offerees are members of a class
having special knowledge of the issuer, the case for a private
offering is strengthened.
2) The number of units offered. The issuance of securities in a
large number of units of small denominations is an indication the
issuer anticipates subsequent public trading in the securities.
Conversely, an issuance of a small number of units in large
denominations is evidence of a private offering.
3) The size of the offering. The exemption was intended to apply
chiefly to small offerings.
4) The manner of offering. Transactions effectuated through
direct negotiations are more likely to be private offerings than
those effected through the use of the machinery of public
distribution (such as advertising.)
-- $4(2) exempts "transactions by an issuer not involving any
-- SEC v. Ralston Purina Co. (page 377, Supreme Court)
The focus of inquiry should be on the need of the offerees for the
protections afforded by registration. The employees here were not
shown to have access to the kind of information which registration
would disclose. Thus, this transaction would not be exempt.
-- Although Ralston has had the effect of negating any numerically
based guidelines for determining the scope of the statutory
exemption, it may be read only as rejecting a quantity limit above
which an offering is necessarily public in nature. That is, the
Ralston Court rejected the SEC argument that the large number of
individuals given the opportunity to participate in the stock
purchase plan was in and of itself conclusive proof the offering
was not private. The Court did not say, however, that the use of
a number below which an offering will be deemed private is not
-- A number of courts have held that sophistication of the
purchasers is no substitute for information.
-- The court in SEC v. Continental Tobacco held that supplying
information equivalent to that in a registration statement would
not have been enough, for not only must the offerees have been
provided with the opportunity to obtain additional information,
but also each offeree must have had personal contact with the
officers of the issuer.
-- Doran v. Petroleum Management Corp.
There must be sufficient basis of accurate information upon which
the sophisticated investor may exervise his skills. The
"availability" of information means either disclosure of or
effective access to the relevant information. The relationship
between the issuer and offeree is most critical when the issuer
relies on the latter route. When the issuer relies on "access"
absent actual disclosure, he must show that the offerees occupied
a privileged position relative to the issuer that afforded them an
opportunity for effective access to the information registration
would otherwise provide. When the issuer relies on actual
disclosure to come within the exemption, he need not demonstrate
that the offerees held such a privileged position. Although mere
disclosure is not a sufficient condition for establishing the
availability of the private offering exemption, and a court will
weigh other factors such as the manner of the offering and the
investment sophistication of the offerees, the "insider" status of
the offerees is not a necessary condition of obtaining the
exemption. Continental should not be read as limiting the $4(2)
exemption to insider transactions.
-- Court here outlined four basic tests:
1) focus on the number of offerees and relationship to issuer
2) number of units offerred
3) size of the offering
4) manner of the offering
Factors to consider in determining sophistication of investors:
-- the professional status and investment experience of the party
-- the age, intelligence, wealth and income of the party
-- the specific activities of the party such as regular
consultation with investment professionals, membership or
participation in investment groups or seminars, and personal
review of account statements and recommendations.
-- Rule 506 is a safe harbor, where an unsophisticated investor is
represented by a sophisticated and disinterested expert. The
sophistication of the expert may be imputed to the offeree.
-- The line of cases holding that sophistication is no substitute
for information does not embrace situations in which the offerees
are sophisticated institutional investors.
-- The private offering cannot be used as a subterfuge for a
public offering by making a private offering placement to a small
group of individuals who then proceed to sell the securities to
the public. The critical question is whether any of the
purchasers acquired the securities with a view to their
distribution rather than as investment (an intent to hold for the
-- Issuers normally take three steps to avoid the problem of
initial purchasers acting as conduits in the public distribution
1) First, they require purchasers to sign statements of investment
intent. Although these types of statements are somewhat self-
serving, they do serve to make sure the investors are aware that
they are receiving unregistered securities the transfer of which
2) Second, issuers normally inscribe securities placed in a
private offering to disclose that the securities are unregistered
and a transfer may take place only if specified conditions are
3) Finally, issuers customarily put into effect stop-transfer
orders instructing the transfer agent not to process any transfers
of restricted securities without the consent of the issuers.
REGULATION D AND THE LIMITED OFFERING EXEMPTIONS
-- This is a safer harbor for 4(2) exempt transactions.
-- Rules 504, 505 and 506 must be read in conjunction with the
Preliminary Notes to Regulation D and Rules 501-503 and 507-508,
which provide conditions appicable, for the most part, to all
three exemptions. The principal conditions of each of the
RULE 504: Maximum aggregate offering price of $1 million (provided
no more than $500,000 of which is attributable to securities not
registered under a state's securities laws); not available for
reporting companies or investment companies; no limitations on
tthe number of purchasers; no affirmative disclosure obligations;
resale of the shares is restricted unless an exceptttion
pertaining to state registration applies.
RULE 505: Maximum aggregate offering price of $5 million; no more
than 35 purchasers; certain classes of individuals, including
accredited investors, not counted in computing the number of
purchasers; affirmative disclosures required to nonaccredited
investors; resale of securities is restricted.
RULE 506: No limitation on the maximum aggregate offering price;
no more than 35 purchasers; certain classes of individuals,
including accredited investors, not counted in computing the
number of purchasers; affirmative disclosures are required to
nonaccredited investors; nonaccredited investors or their
representatives must meet sophistication standards; resale of
securities is restricted. This is a safe harbor for 4(2).
-- In addition, Rules 504, 505, and 506 aree subject to common
requirements concerning integration with other offerings of the
issuer, filing of notices of sales witth the SEC, and limitations
on the manner of offering.
-- Rule 501(e)(2) defines accredited investor. The following are
some classes of accredited investors:
-- Financial Institutions (banks, S&L's, registered brokers or
dealers, insurance companies, investment companies.
-- Pension Plans.
-- Venture Capital Firms.
-- Corporations and Other Organizations Exceeding a Certain Size
($5 million in assets).
-- Insiders of the Issuer
-- Natural Persons with Wealth or Income Exceeding Threshhold
Standards ($1 million net worth; annual income exceeding $200,000
-- or $300,000 when combined with spousal income -- for each of
the last two years.)
-- Entity Owned by Accredited Investors.
SOPHISTICATION STANDARD OF RULE 506
-- Mark v. FSC Securities Corp.
Must have answers from investors in order to make a determination
about their sophistication. Here, there were no answers available
and jury could not determine whether investors were sophisticated.
-- Rule 506 requires:
1) each purchaser who is not an accredited investor must alone or
with a representative have such knowledge and experience in
financial and business matters to be able to evaluate the merits
and risks of the prospective investment, or
2) the issuer reasonably believes this is the case.
CALCULATING THE NUMBER OF PURCHASERS
-- Rules 505 and 506 are available only if the number of
purchasers does not exceed 35 or, the issuer reasonably believes
the number of purchasers does not exceed 35. Rule 501(e) however,
provides that certain types of purchasers are excluded for
purposes of this calculation: accredited investors, trusts or
estates in which purchasers have beneficial interests exceeding 50
percent, spouses and certain relatives of purchasers, and
corporations or other organizations in which purchasers are at
least 50 percent beneficial owners.
-- A corporation, partnership, or other entity that is not
accredited is counted as a single purchaser unless it was formed
for the purpose of purchasing securities in the offering.
Relevant factors to determine this include: (1) the existence,
duration, and nature of prior activities of the entity; (2) the
structure of the entity; (3) the proposed activities of the
entity; (4) the size of the entity's capitalization in relation to
its investment in the Rule 505 or 506 offering; and (5) the extent
to which all equity owners will participate in all of the equity's
LIMITATIONS ON THE MANNER AND SCOPE OF AN OFFERING
-- 502(a) deals with integration
-- 502(b) deals with info that has to be provided. Not need to
provide info in 504 offering. Not need to provide info to
-- Rule 502(c) prohibits an issuer or any person acting on its
behalf from offering to sell securities by any form of general
solicitation or general advertising. [The only exception is
certain Rule 504 offerings that utilize disclosure documents and
are state registered.]
-- In the Matter of Kenman Corporation, et. al.
When offerror engaged in general solicitation, exemptions from
registrations under $4(2) and safe harbor of Rule 506 of
Regulation D not available.
-- Rule 506 relies on a pre-existing relationship between the
offeror and the investors solicited for an offer.
-- Even newsletters, describing companies intending to have exempt
offerings in the future may violate the rule.
ACTIVITIES BY BROKER-DEALERS
-- SEC has said that a broker-dealer can contact people based on
questionnaires filled out by prospective offerees, which provide
the broker-dealer with sufficient information to evaluate the
prospective offerees' sophistication and financial circumstances.
This relationship is considered pre-existing if there was
sufficient time between establishment of the relationship and an
offer, so that the offer is not considered made by general
solicitation or advertising. [so, this does not violate Rule
-- In one case, SEC said that solicitation was ok when: (1) the
initial solicitation would be generic in nature and would not
identify specific investments the firm was offering or would be
offering, and (2) the firm would implement procedures to insure no
persons solicited would be offered securities the firm was
offering or contemplating offering at the time of the
DETERMINING AGGREGATE OFFERING PRICE IN OFFERINGS UNDER RULES
504 and 505
-- Rules 504 and 505 limit the aggregate offering price on
offerings within any twelve-month period. In the case of Rule
504, the maximum aggregate offering price on securities that can
be sold in reliance on the Rule during any twelve-month period is
$1 million (provided that no more than $500,000 is attributable to
securities not registered in a state). Rule 505 sets a similar
limitattion (in this case, $5 million without regard to state
-- Aggregation rules of Rules 504(b)(2) and 505(b)(2) restrict the
ability of an issuer to avoid the monetary limitations on Section
3(b) exemptions by staggering the offering and selling securities
over a relatively short period of time.
CALCULATING THE AGGREGATE OFFERING PRICE
-- Rule 501(c) defines aggregate offering price as the sume of all
cash, services, property, notes, cancellation of indebtedness, or
other consideration the issuer receives for the securities.
-- If securities are offered for both cash and noncash
consideration, Rule 501(c) requires that the aggregate offering
price be determined on the basis of the price att which the
securities are offered for cash.
-- If the securities are not offered for cash, Rule 501(c) directs
the calculation of aggregate offering price on the basis of the
balue of the consideration as determined by bona fide sales made
within a reasonable time, or, if there are no sales, "fair value
as determined by an accepted standard."
RELEVANT AMOUNT AND TIME PERIOD
-- The maximum aggregate offering price is lowered by the amount
of any other securities sold within specified time periods in
reliance on any of the $3(b) exemptions. Two time periods are
relevant: (1) the twelve-month period preceeding the commencement
of the offering under Rule 504 or 505, as the case may be, and
(2) the period of time during the offering of the securities under
the applicable rule. The second of the two relevant time period
limitations is needed to prevent an issuer with no offerings
during a preceding twelve-month period from simultaneously
commencing a Rule 504 or 505 offering with a second offering
purportedly exempt under $3(b).
DISCLOSURE OBLIGATIONS IN OFFERINGS UNDER RULES 505 and 506
-- If only purchasers in Rule 505 or 506 offering are accredited
investors, no affirmative disclosure under Regulation D imposed.
-- If there are nonaccredited investors, disclosure obligations
remain in effect, although under the 1989 amendments, the
accredited investors do not have to get the same disclosure
material when unaccredited investors receive the material.
-- If the issuer is a reporting company, the obligation largely
can be satisfied by providing purchasers with filings previously
made with the SEC pursuant to the 1934 Act reporting requirements.
-- If the issuer is not a reporting company, Rule 502(b)(2)(i)
prescribes certain disclosures to the extent material to an
understanding of the issuer, itts business, and the securities
-- For offerings of up to $2 million, the issuer must supply the
equivalent of the Offering Circular required by Regulation A,
together with an audited balance sheer.
-- For offerings of up to $7.5 million the issuer must supply the
information called for in Part I of the S-18 registration form or,
if that form is not available, the information required by Part I
of the form the issuer is eligible to use.
-- For offerings over $7.5 million, the issuer must supply the
information required by Part I of the registration form it is
eligible to use.
-- The principal difference between the offerings under and over
$7.5 million is that the former require delivery of the last two
years of financial statements (audited for the last year), while
the latter requires delivery of audited income statements for the
last two years and audited balance sheets for the last two years.
-- If audited financial statements cannot be prepared "without
unreasonable effort or expense," then issuers that are not limited
partnerships need provide only an audited balance sheet; if the
issuer is a limited partnership, the financial statements
requirement is satisfied by providing purchasers with tax returns
prepared and reported in accordance with generally accepted
accounting principles. [Rule 502(b)(2)(i)]
-- The issuer must provide nonaccredited investors with a written
summary of any written materials provided accredited investors,
and upon request, must provide nonaccredited investors with copies
of this information. Moreover, each purchaser (whether or not
accredited) must be given the opportunity to ask questions and
obtain information needed to verify disclosures if the issuer can
provide such information without unreasonable effort or expense.
ADDITIONAL REGULATION D REQUIREMENTS AND FEATURES
LIMITATIONS ON RESALE
-- Resale of securities acquired in a Rule 504, 505, or 506
offering is restricted. Must assure that the issues do not fall
into the hands of underwriters.
RULE 505 and THE "BAD BOY" DISQUALIFIERS
-- Absent a waiver by the SEC, Rule 505 is unavailable fore the
securities of any issuer described in Rule 252 of Regulation A.
This limitation will arise if the issuer, a predecessor of the
issuer, an affiliated issuer, an underwriter, a director, officer,
or general parttner of the issuer, or a 10 percent or greater
shareholder has engaged in certain conduct violative of federal
securities laws. Since the disqualification provisions of Rule
505(b)(2)(ii) operate without regard to the issuer's reasonable
belief, considerable care must be excercised to investigate the
backgrounds of relevant parties to insure the exemption is not
lost by virtue of the bad boy disqualifiers.
INTEGRATION OF OFFERINGS: THE SAFE HARBOR
-- Rule 502(a) of Regulation D provides a six month look-forward
and look-backward guideline for defining when another offering by
the issuer will not be regarded as part of the same issue in
measuring compliance with the conditions of the safe harbor.
Securities offered LESS than six months before the START or six
months after the COMPLETION of a Regulation D offering may be
integrated with the offering if it is part of the same issue.
-- To determine if part of same issue, consider: (1) whether the
sales are part of a single plan of financing; (2) whether the
offerings involve the same class of securities; (3) whether the
sales have been made at about the same time; (4) whether the same
type of consideration is received, and (5) whether the sales are
made for the same general purpose.
-- Offers and sales of securities pursuant to an employee benefit
plan are disregarded for pusposes of determining the six month
RELAXING THE RULES FOR STATE REGISTERED RULE 504 OFFERINGS
-- Rule 504(b)(1) relieves the issuer from compliance with
Regulation D's limitations on the manner of offering and
limitations on resale provisions. Specifically, the manner of
offering and limitations on resale restrictions are inapplicable
only if either (1) sales are made exclusively in one or more
states requiring the registration of securities and the delivery
of disclosure documents, or (2) sales are made in states that have
no provisions for the registration of securities and the delivery
of disclosure documents if the securities have been registered in
at least one state that provides for registration and delivery of
disclosure documents and the disclosure documents are delivered to
purchasers in the states lacking such procedures.
NOTIFYING THE SEC: FORM D
-- Rule 503 requires the filing of Form D with the SEC no later
than 15 days after the first sale of securities under Rule 504,
505 or 506.
-- One can substantially comply and not lose the exemption under
Regulation D. Must demonstrate that (1) the term, condition or
requirement violated was not directly intended to protect the
complaining party, (2) the failure to comply was insignificant to
the offering as a whole, and (3) a good faith and reasonable
attempt was made to comply with all of the regulation's terms,
conditions, and requirements. [SEC release 6825]
-- Conditions relating to dollar ceilings, numberical purchaser
limits and general solicitation would always be deemed significant
and therefore beyond the protection of the rule.
-- The question of whether or not particular activities constitute
a general solicitation must always be determined in the context of
the particular facts and circumstances of each case. Thus, for
example, if an offering is structured so that only persons with
whom the issuer and its agents have had a prior relationship are
solicited, the fact that one potential investor with whom there is
no such prior relationship is called may not necessarily result in
a general solicitation. [SEC release 6825]
FOREIGN OFFERINGS AND REGULATION D
-- Foreign purchasers are not counted in computing the number of
purchasers under Regulation D, and proceeds generated in the
foreign offerings are not included in the aggregate offering
THE SECTION 4(6) EXEMPTION: SALES TO ACCREDITED INVESTORS
-- Similar to Regualation D, so not of much use today.
REGULATION A: MINI-REGISTRATION
-- Regulation A (Rules 251-264) is an administrative exemption
promulgated under the authority of $3(b) of the '33 Act, which
authorizes the SEC to exempt from registration a class of
securities if the aggregate offering price of the issuance does
not exceed $5 million. Regulation A results in unrestricted
securities and may be used for primary or secondary offerings.
-- Aggregate Offering Limitations. In the case of an issuer
transaction, the aggregate offering price over a twelve-month
period cannot exceed $1.5 million. This amount is reduced by the
amount of securities offered and sold under any $3(b) exemption in
the one-year period prior to the commencement of the Regulation A
offering. Lower ceilings apply to offerings by affiliates
($100,000 each), nonaffiliates ($300,000 as a group and $100,000
each), and estates ($100,000).
-- Resales. Securities sold under Regulation A are not
restricted. However, resales may be integrated with the issuer's
offering for purposes of the limitation on aggregate offering
price until the securities ultimately come to rest in the hands of
the investing public.
-- Filing and Disclosure Requirements. Rule 255 requires the
filing of an Offering Statement with a Regional Office of the SEC
ten days prior to the date of the first offer or sale. Unlike the
financial statements used in a registration statement, the
financial statements in a Regulation A offering need not be
certified, and only statements for the last two years need be
included. $11 liability for defects in a prospectus does not
extend to Offering Circulars, although the more general antifraud
provisions of the securities laws remain applicable.
-- Disqualification. Rule 252(c)-(e) includes the so called bad
boy disqualifiers that deny the exemption when the issuer or those
closely associated with the issuer have engaged in certain types
-- Unseasoned Issuers. Rule 253 imposes special restrictions on
unseasoned issuers, which are issuers (1) organized or
incorporated within the previous year and without net income from
operations, or (2) organized or incorporated at an earlier date
but without net income from operations for at least one of the
last two years. In the case of such issuers, the computation of
the amount of securities offered includes securities previously
issued for assets or services and all securities issued to any
director, officer, promoter, underwriter, or dealer. Moreover,
Regulation A is available only for primary offerings by unseasoned
-- Regulation A compared to Regulation D (advantages and disads--
lok at page 435)
INTEGRATION OF OFFERINGS
-- Integration of two offerings by an issuer may destroy the
availability of an exemption for either or both of the offerings.
-- Single Plan Financing.
-- Same Class of Securities
-- Timing of the Offerings (six month separation creates a
rebuttable presumption against integration)
-- Type of Consideration
-- The Uniform Limited Offering Exemption (ULOE), incorporates
Rules 501-503 of Regulation D and establishes an exemption for
offerings made in compliance with Ruled 505. ULOE allows states
the option of also adopting Rule 506 as a basis for compliance
(most states adopting ULOE have excercised this option.)
-- ULOE includes a number of conditions that add to or expand the
requirements of Regulation D. The more important of these include
limitations on commissions to persons other than registered
broker-dealers or agents, expanded "bad boy" disqualifiers, and
suitability requirements applicable to all nonaccredited
-- Whether others are within the reach of $5 in most cases depends
on whether they are within $2(11)'s definition of an underwriter.
THE UNDERWRITER CONCEPT AND SALES FOR AN ISSUER
-- $4(1) is the central transaction exemption of the '33 Act. It
exempts everyone except issuers, underwriters, and dealers.
-- There are four roles which qualify someone as an underwriter:
1) any person who purchases from an issuer with a view to the
distribution of a security; or
2) any person who offers or sells for an issuer in connection with
a distribution; or
3) any person who participates or has a direct or indirect
participation in the activities covered by 1 or 2 above; or
4) any person who participattes or has a participation in the
direct or indirect underwriting of any such undertaking.
-- Members of a public offering's selling group are expressly
excluded from the underwriter's classification, provided tthe
commission received from an underwriter or dealer is "not in
excess of the usual and customary distributors' or sellers'
-- SEC v. Chinese Consolidated Benevolent Association
Although D did not take compensation, it sttill solicited offfers
to buy securities "for value" and thus violated $5(a), when read
in connection with $2(3).
PURCHASES FROM AN ISSUER
-- The length of time the purchaser has held the shares before
reselling them plays a pivottal role in determining whether the
purchaser acquired the shares with a view to their distribution.
-- If held three years or more, probably investment intent.
-- If held three years or less, consideration must then be given
to the circumstances surrounding the shares' purchase as well as
any change in the purchaser's circumstances after their purchase.
DISTRIBUTIONS AND TRADING TRANSACTIONS CONTRASTED
-- Ralston Purina said that a distribution exists if there are
sales to those who cannot "fend for themselves."
-- Not every resale of an unregistered security by one who took
without investtment intent constitutes a distribution (i.e. sales
only in New York eligible fro intrastate exemption of $3(a)(11),
and resale to a New York citizen). It is only when the resale
violates the criteria of the exemption under which the issuer
sought to avoid registration that the resale gives rise to a
CONTROL PERSON DISTRIBUTIONS
-- One who purchases from a control person, or sells for a control
person, or otherwise participates, directly or indirectly, in a
distribution of the control person's securities is an underwriter.
-- $2(11) provides that a control person is an issuer, but only
for the purpose of determining whether the person who purchases
from or sells for the control person is an underwriter. A control
person is not an issuer for other purposes of the Act because
ttthe control person is not included within $2(4)'s definition of
an issuer. The control person therefore is not able to use the
issuer-based exemptions esttablished in $4(2) or 4(6), Regulation
D, or Rule 147.
-- Three significant control relationships are implicated in
$2(11)'s broad sweep: first, any person controlling the issuer;
second, any person controlled by the issuer; third, any person
under common control with the issuer. The effect of this
provision is to subject the distributions by such control persons
to regulation similar to that applied to issuers.
-- U.S. v. Wolfson
W and his associate sold twenty-five percent of the issuer's
shares over stock exchanges without registration. Although not
active in management, the two defendants held forty percent of the
total stock and controlled the company "behind the scenes." They
were therefore held to be control persons (and so "issuers") who
had unlawfully sold their shares publicly through underwriters.
RULE 144: SAFE HARBOR FOR RESALES OF CONTROL AND RESTRICTED
-- Rule 144 provides that any affiliate or other person who sells
restricted securities of an issuer for his own account, or any
person who sells restricted securities for the account of an
affiliate of the issuer, is not deemed to be engaged in a
distribution of the securities, and therefore is not an
underwriter as defined in $2(11) of the Act, if the securities are
sold in accordance with all the terms and conditions of the rule.
The rule requires, among other things, that the restricted
securities must have been beneficially owned for a period of at
least two years by the person for whose account they are sold;
that the amount sould shall not exceed one percent of the class
outstanding, or if traded on an exchange, the greater of that
amount or the average weekly volume on all such exchanges dcuring
the four weeks preceding the sale; and that the securities must be
sold in brokers' transactions. In addition, there must be
adequate information available to the public in regard to the
issuer of the securities and notice of the sale (Form 144) must be
filed with the Commission concurrently with the sale.
-- Also, change in circumstances concept is no longer considered a
factor in determining whether a person is an underwriter.
-- Availability of public information requirement is satisfied if
the issuer has been subject to the reporting requirements of $13
or 15(d) of the '34 Act for a period of at least 90 days
immediately preceding the sale of the securities and has filed
[during the 12 months preceding the sale] all reports required
by that Act and the rules and regulations.
-- In case of companies not subject to the reporting requirement
of $13 or 15(d) of the '34 Act, the information requirement is
deemed to be met if there is publicly available with respect to
the issuer, the information required by clauses (i) to (xiv),
inclusive, and clause (xvi) of paragraph (a)(5) or Rule 15c2-11
under the '34 Act. This information includes among other things,
the exact name of the issuer, the address of its principal
executive offices, the exactt ttitle and class of the security,
the number of shares or total amount of the security outstanding,
the nature and extent of the issuer's facilities and the product
or service offered, and financial information concerning the
issuer including its most recent balance sheet and profitt and
loss statement, which shall be reasonably current.
-- Tacking of holding periods will be permitted for bona fide
pledgees, donees, and trusts since it is considered that such
persons when they sell the securities stand in the place of their
respective pledgors, donors or settlors.
THE INSTITUTIONAL TRADING MARKET FOR UNREGISTERED SECURITIES AND
-- -Rule 144A sets forth a non-exclusive safe harbor from the
registration requirements of $5 of the '33 Act for the resale of
restricted securities to specified institutions by persons other
than the issuer of such securities.
-- An institution mustt in the aggregate own and invest on a
discretionary basis at least $100 million in securities of issuers
thatt are not affiliated with the institution.
-- Banks, as defined in$3(a)(2) of the '33 Act, and S & L's as
referenced in $3(a)(5)(A) of the Act, must in addition to owning
and investing on a discretionary basis at least $100 million in
securities, have an audited net worth of at least $25 million, as
demonstrated in their latest published annual financial
-- A broker-dealer registered under the '34 Act which in the
aggregate owns and invests on a discretionary basis at least $10
million in securities of issuers that are not affiliated with the
broker-dealer is a qualified institutional buyer. Additionally,
the Rule provides that registered broker-dealers acting as
riskless principals for identified qualified institutional buyers
would themselves be deemed to be qualified institutional buyers.
The broker-dealer must at the time of the purchase have a
commitment from a qualified institutional buyer that it will
simultaneously purchase the securities from the broker-dealer to
qualify as a riskless principal for purposes of the Rule.
Riskless principal transactions are defined in the Rule as those
involving a simultaneous purchase from any person and sale to a
qualified institutional buyer, including another dealer acting as
riskless principal for a qualified institutional buyer.
-- Any corporation or partnership (except for the bank exception)
that meets the $100 million in securities threshold may purchase
under the Rule. Eligible purchasers under the Rule include
entities formed solely for the purpose of acquiring restricted
securities, if they satisfy the qualifying test.
THE SECTION "4(1 1/2)" EXEMPTION
-- If unable to bring sale within Rule 144, "$4(1 1/2)" may
provide an exemption.
-- Ackerberg v. Johnson
Here, Ackenberg was a sophisticated investtor and not in neeed of
protections afforded by registration under the 1933 Act. Johnson
held on to his shares for over four years, and thus the shares
came to rest. Thus, this case involves no public offering, and
thus no distribution. Absent a distribution, Johnson cannot be an
underwriter when he sold the shares to Ackenberg, within $4(1),
and is, therefore, entitled to the exemption.
RESALES UNDER THE BLUE SKY LAWS
-- The scheme of blue sky laws is that resales require the
security to be registered in the state unless the resale falls
within one of several possible exemptions.
ISOLATED NONISSUER RESALE
THE MANUAL EXEMPTION
-- Uniform Securities Act $402(b)(2) provides that: any nonissuer
distribution of an outstanding security if (A) recognized
securities manual contains the names of the issuer's officers and
directors, a balance sheet of the issuer as of a date within
eighteen months, and a profit and loss statement of either the
fiscal year preceding that date or the most recent year of
UNSOLICITED OFFER EXEMPTION
-- $402(b)(3) of the Uniform Securities Act provides an exemption
to: "any non-issuer transaction effected by or through a
registered broker-dealer pursuant to an unsolicited order or offer
to buy "
SMALL OFFERING EXEMPTION
-- $402(b)(9) provides an exemption that is available to both the
issuer and those who acquire securities from the issuer with
investment intent who later wish to sell their shares: "any
transaction pursuant to an offer directed by the offeror to not
more than ten persons [plus an unlimited number of certain types
of institutional investors] in this state during any twelve
consecutive months, whether or not the offeror or any of the
offerees is then present in this state, if (A) the seller
reasonably believes that all the buyers in this state are
purchasing for investment, and (B) no commission or other
enumeration is paid or given directly or indirectly for soliciting
any prospective buyer in this state .[is exempt].
-- Contrast this with ULOE (Uniform LImited Offering Exemption)
[above] which is available only for ISSUER transactions.
-- The investment intent is not absolute; the person relying upon
the exemption does not lose the exemption if it turns out that one
of his purchasers quickly resold the securities soon after her
purchase. The exemption does not require clairvoyance, only a
reasonable belief that the purchaser takes with investment intent.
RECAPITALIZATIONS, REORGANIZATIONS, AND ACQUISITIONS
THE "FOR VALUE" REQUIREMENT
VALUE IS NOT ALWAYS WHAT IT SEEMS
-- Stock Dividends. A choice between cash or a stock dividend (as
a dividend) does not involve the sale or offer to sell a security.
On the other hand, dividend reinvestment programs, in which
stockholders may by prior agreement have their dividends applied
toward the purchase of additional shares from the corporation at
current market prices, are subject to registration under the '33
-- An important exception arises in the latter case when the
dividend reinvestment program is structured so that an entity
separate from the issuer purchases on behalf of participating
stockholders the issuer's shares on the market with the cash being
the amount that the issuer would otherwise have distributed to
those stockholders as a dividend. SEC says here, the issuer is
not involved in the sale of its securities.
-- Warrants and Convertible Securities. Bonds, warrants, and
options are each specifically identified as securities in $2(1)
and must be registered, unless an exemption is available. Whether
the underlying security -- the security tthat may be acquired
through conversion or the exercise of a warrant or option -- must
be registtered depends upon WHEN, by the instrument's terms, the
holder can acquire the underlying security through conversion or
exercise of the warrant or option. If the conversion feature's or
the warrant's or the option's terms provide that it can be
immediately exercised, two distinct securities are then being
offered so that each must be registered or qualify for an
exemption from registration. On the other hand, if the by therms
of the instrument the holder cannot convert or exercise the
warrant or option until some future date, the underlying security
is not "offered for sale" until that future date and the
underlying security's registration is not required when the
convertible security, warrant, or option is being offered.
-- Reincorporations and Amendments of Articles and Indentures.
-- Extension of the maturity date on a bond's indenture by one or
five years at the individual bondholder's option is a sale under
the Public Utility Holding Company Act of 1935's broad definition
of sale, which is nearly identical to that in $2(3) of the '33
-- For reincorporation, the SEC says it is only a change in form,
not substance, and registration is not required.
SHELLS AND SPIN-OFFS: CREATING "VALUE"
-- SEC v. Datronics Engineers, Inc.
D, a public company, bound itself contractually to a group of
promottters to distribute the stock of several private companies
to its shareholders as dividends. D retained a portion of the
stock in each transaction for itself, making a profit when the
stock subsequently went up as part of the promotional scheme. The
court found three violations of the '33 Act: (1) D could be held
as an "issuer" of the securities. (2) There was a "sale" of the
private companies' securities "for value" since D kept part of the
stock that was distributed to its shareholders, and, when
subsequent trading began, D profited. (3) And D could also be
held liable as an underwriter since it took the stock of the
private companies with the INTENT of distributing it to the
-- Rule 15c2-11 regulates the initiation or resumption of
quotations in a quotation medium by a broker or dealer for certain
over-tthe-counter securities. [see pages 511-513]
EXCHANGES UNDER $3(a)(9)
-- $3(a)(9) exempts "Any security exchanged by the issuer with its
existing security holders exclusively where no commission or other
renumeration is paid or given directly or indirectly for
solicitting such exchange." [traditional format is twap of new
security for the old security -- ie common stock for preferred
stock.] [pages 517-520].
REORGANIZATIONS UNDER $3(a)(10)
-- $3(a)(10) exempts the issuer's exchange of securities for
outstanding securities, claims, or property, provided the
transacttion's fairness has been approved, after a hearing, by a
court, agency, commission or other governmental authority. This
section can be used to exchange stock of one company for stock of
another, and it permits payment in connection with any
solicitation undertaken in connection with the exchange.
MERGERS, ACQUISITIONS, AND RECAPITALIZATIONS UNDER RULE 145
-- 145(a) provides that the submission to a vote of security
holders of a proposal for certain reclassifications of securities,
mergers, consolidations, or transfers of assets, is deemed to
involve an "offer", "offer to sell", or "sale" of the securities
to be issued in the transaction. The effect of the Rule is to
require registration of the securities to be issued in connection
with such transactions, unless an exemption from registration is
-- Rule 145(a)(3) says the rule applies only if: (1) the matter
voted upon provides for dissolution of the corporation receiving
the securities; (2) the mattter voted upon provides for a pro rata
distribution by the corporation receiving the securities; (3) the
directors of the corporation receiving the securities adopt
resolutions relative to (1) or (2) within one year after the vote;
or (4) a subsequent dissolution or distribution is part of a pre-
existing plan for distribution. However, if the securities
acquired in the transaction are distributed after one year,
notwithstanding the absence of a plan, such securities must be
registered unless a statutory exemption from registration is then
-- 145(b) says that any written communication which contains no
more than the information specified in paragraph (b) of the Rule
shall not be deemed a prospectus for purposes of $2(10) of the Act
and shall not be deemed an "offer for sale" of the security
involved for the purposes of $5 of the Act.
-- 145(c) provides that any party to any transaction specified in
Rule 145(a), other than the issuer, or any person who is an
affiliate of such party at the time any such transaction is
submitted for vote or consent, who offers or sells securities
acquired in such transaction, shall be deemed to be engaged in a
distribution and therefore an underwriter, except with respect to
the limited resales permitted pursuant to paragraph (d) of Rule
-- 145(d) provides that a person or party specified in paragraph
(c) shall not be deemed to be engaged in a distribution if certain
conditions are satisfied. The precise conditions are determined
according to the person's holding period. No restraints apply to
resales by a person or party who has for three years been the
beneficial owner of registered securities received in a Rule 145
transaction, provided such person or perty is not at the same time
of such resale an affiliate of the issuer and has not been such
for three months. A person or party who is not an affiliate of
the issuer and who for two years has been the beneficial owner of
registered shares received in a Rule 145 transaction may resell
the shares only in accordance with volume limitations of Rule
144(d), and the issuer must be one that satisfies the information
requirements of Rule 144(c). Finally, resales of registered
securities by any other party or person covered by paragraph (c)
must be in accordance with Rule 144 paragraphs (c) [Current Public
Information], (e) [Limitation on Amount of Securities Sold], (f)
[Manner of Sale], (g) [Brokers Transaction]. All holding periods
are determined according to paragraph (d) of Rule 144.
-- Rule 153A provides that the delivery of the final prospectus to
security holders entitled to vote on or consent to the transaction
shall be deemed to satisfy the prospectus delivery requirements of
$5(b)(2) of the Act.
RELATIONSHIP BETWEEN RULE 144 and $4(2) BUSINESS COMBINATIONS
-- Form S-4 is used to register securities issued not only in
mergers and purchases of assets, but other forms of business
combinations such as share exchanges (i.e. offers of securities in
connection with tender offers.) [page 541]
-- Exempt securities are permanently exempt from the registration
provisions of the '33 Act, which means that not only issuers are
free of the burdens of registration, but also owners of the
securitties need no exemption in order to resell their securities.
OVERVIEW OF $3
$3(a)(2): Government Securities, Bank Securities, and Collective,
Common, or Single Trust Funds.
-- Government Securities are exempted. Also exempted are
municipal securities, and industtrial develppment bonds (IBD's)
are exempt as well.
-- Bank Securities are exempted. A U.S. branch of a foreign bank
is a bank for purposes of this section provided that they are
subject to the same standards/rules as are U.S. banks.
-- Common, Collective, and Single Trust Funds are exempt.
$3(a)(3): Short-Term Notes
-- This section exempts any note, draft, bill of exchange, or
banker's acceptance arising out of a current transaction if the
maturity at time of issuance does not exceed nine months.
$3(a)(4): Nonprofit Issuers
-- This section exempts securities offered by issuers that are
organized and operated exclusively for religious, educational,
benevolent, fraternal, charitable, or reformatory purposes,
provided that no part of the earnings of the organization inure
to the "benefit" of any person.
-- The test for charitable organization is whether those charged
with its operation were conducting it for their private profit or
$3(a)(5): Securities Issued By S&L's, Cooperative Banks, and
-- These are exempt, provided the issuers are supervised and
examined by federal or state authorities having supervision over
their operations. Without regard to supervision by governmental
authorities, the exemption is also available for farmer
cooperatives and certain corporations that are exempt from federal
$3(a)(8): Insurance Policies and Annuities
-- These are exempt if issued by a corporation subject to
regulation by insurance regulators at the state or federal level.
-- Rule 151 is a safe harbor for annuitties. Under the safe
harbor, an annuity will be within the exemption of $3(a)(8) if it
is issued by a bank or insurance company regulated at the state or
federal level, it is not marketed primarily as an investment, and
tthe issuer "assumes the investment risk under the contract."
Investment risk is deemed assumed by the issuer if the value of
the contract does not vary according to the investment experience
of a separate account, the issuer guarantees principal and
interest, and the issuer credits a specified rate of interest (at
least equal to that required under the state's nonforfeiture law)
that will not be changed more often than once a year.
Additional Section 3(a) Exemptions
-- An interest in a "railroad equipment trust" is an exempt
security under $3(a)(6).
Sections 3(b) and 3(c)
-- $3(b) authorizes the SEC to exempt a class of securities (up to
an aggregate offering amount of $5 million) if it finds that
enforcement of the '33 Act with respect to the securities is not
necessary to protect the public interest because of either the
small amount involved or the limited character of the offering.
-- $3(c) authorizes the SEC to exempt securities issued by small
business investment companies if such registration of the
securities is in the public interest and not necessary for the
protection of investors.
-- Although disclosures in municipal offerings are voluntary
rather than mandatory in nature, market forces have operated to
penalize (in the form of higher interest costs) those issuers that
do not provide an acceptable level of information to underwriters
and prospective investors.
-- The Rule is directed to underwriters participating in a primary
offering of the municipal securities with an aggregate principal
amount of $1 million or more.
-- Paragraph (b)(2) of the Rule requires that, except in
competitively bid offerings, underwriters must provide any
potential customers who so request with a copy of the issuer's
most recent preliminary official statement. The rule does not
establish the content of a preliminary official statement or
require the preparation of such a document, but if one has been
prepared, it must be made available to interested investors.
-- (b)(1) of the Rule requires underwriters participating in a
primary offering "to obtain and review an official statement that
is deemed final by the issuer" prior to the earlier of the time it
executes a bond purchase agreement or the first sale of the
-- (b)(4) requires underwriters to make the official statement
available for a period of 90 days following the "end of the
underwriting period." This period is shortened, however, if the
official statement is available to any person from a nationally
recognized municipal securities information repository.
-- The rule includes three exemptions available if the securities
are sold in denominations of not less than $100,000. The
exemptions are available for limited placements (not more than 35
sophisticated investors), short-term securities (maturities of
less than nine months), and securities that investors may put to
the issuer at least as frequently as every nine months.
LIABILITY UNDER THE SECURITIES ACT
LIABILITY IN PUBLIC DISTRIBUTIONS
-- A material misrepresentation or omission in a registration
statement will subject the issuer and (subject to due dilligence
defense) a variety of persons associated with either the issuer or
the distribution to damages in a suit brought by any person who
bought securities issued pursuant to that registration statement.
PERSONS BRINGING SUIT
-- Anyone who buys stock issued pursuant to a defective
registration statement has standing to sue. [privity is not
Under $11, a Plaintiff:
-- must have purchased the security where a means or
instrumentality of interstate commerce was used in connection with
the offer or sale;
-- at the time of purchase, must not have known of the
misrepresentation or nondisclosure;
-- must show that the misrepresentation or nondisclosure was
"material," meaning thatreasonable investors would have considered
the pertinent information important inmaking their investment
-- need not establish privity;
-- can recover for aftermarket purchases, subject to the
-- normally need not show reliance upon the misrepresentation or
-- Pursuant to $11(a), however, where the plaintiff acquired the
securities more than twelve months after the effective date of
the registration statement and if the issuer has made generally
available an "earnings statement" covering this twelve- month
period, the plaintiff must prove reliance on the misstatement or
omission. Such reliance may be shown by means other than the
actual reading of the prospectus.
-- need not prove that the misrepresentation or nondisclosure
"caused" the loss (in other words, causation is presumed once a
material misstatement or nondisclosure has been shown to exist);
-- $11(e) permits the defendant to prove that the plaintiff's
loss was due to factors other than the material
misrepresentations or nondisclosures contained in the
-- must bring the action within the time period set forth by
$13's statute of limitations.
-- Must be brought within one year after the discovery of the
untrue statement or the omission, or after such discovery should
have been made by the exercise of reasonable diligence but in
no event shall any such action be brought more than three years
after the security was offered to the public.
-- Pursuant to the tracing requirement, plaintiffs must show not
that they "might" havepurchased shares by means of a deficient
registration statement in a particular offering,but that they in
fact did purchase such shares pursuant to that specific offering
DEFENDANTS AND DEFENSES
-- The issuer is strictly liable for material misstatements or
omissions in its registration statement.
-- $11(a) of the Securities Act specifies the classes of persons
who may be subject to liability for material misstatements or
omissions contained in the registration statement. Parties
subject to liability include:
(1) all persons who sign the registration statement, including,
pursuant to $6(a) of the Securities Act, the issuer, its principal
executive officer or officers, its principal financial officer,
its controller or principal accounting officer, and the majority
of its board of directors or persons performing similar functions,
(2) every director (or person performing similar functions) or
partner of the issuer,
(3) every person named with his/her consent in the registration
statement as being or about to become a person stated in (2)
(4) every expert "who has with his consent been named as having
prepared or certified any part of the registration statement, or
as having prepared or certified any report or valuation which is
used in connection with the registration statement, with respect
to the statement in such registration statement, report, or
valuation which purports to have been prepared or certified by
(5) every underwriter of the offering, and
(6) every control person of the issuer.
-- The courts have refused to impose "aiding and abetting"
liability pursuant to 11(a).
-- $11(b) provides a number of due dilligence defenses for persons
other than the issuer. Generally, the only defenses available to
the issuer, which otherwise is strictly liable, are the
purchaser's knowledge of the misstatement or omission, lack of
materiality, lack of causation, in pari delicto, and expiration of
the statute of limitations. Moreover, a non-issuer defendant, who
discovers a material misstatement or omission in the registration
statement, may avoid liability by taking the action specified in
$11(b)(1) or (2). That action is, if before the registration
statement becomes effective, takes the required steps to resign
the position witth the issuer, and the SEC is advised of such
action and that further responsibility for the accuracy of the
registration statement will not lie. (b)(1).
-- The "due dilligence" defenses are contained in $11(b)(3). As
regards the "unexpertised" portion of the registration statement,
a defendant must show that after a reasonable investigation she
had reason to believe and did believe at the time such part of the
registration statement became effective, there were no material
misstatements or omissions. As regards the "expertised" part, a
defendant (other than the responsible expert) need show only that
she had no reasonable ground to believe and did not believe that
the expertised portion of the registration statement was
defective. While a non-expert is not required to make an
investigation of expertised information, she must "have no
reasonable ground to believe" such information is inaccurate.
-- An expert, on the other hand, is required to show that after
reasonable investigation, she had reasonable ground to believe and
did believe her statement to be accurate. In other words, an
expert is required to exercise the same standard of care regarding
the part expertised by him/her as a non-expert is required to
exercise regarding the non-expertised portion of the registration
statement. Experts are not subject to liability for misstatements
or omissions in the unexpertised part of the registration
statement merely by reason of their involvement as experts.
-- $11)c provides that the standard of reasonableness by which the
concept of "reasonable investigation" is to be measured is that
required of "a prudent man in the management of his own property".
The "prudent man" standard applies not only to the reasonableness
of one's investigation but also to the reasonableness of one's
-- Rule 176 lists a number of factors to be taken into account as
"circumstances affecting the determination of what constitutes
reasonable investigation." These factors are:
-- the type of issuer
-- the type of security
-- the type of person
-- the office held when the person is an officer
-- the presence or absence of another relationship to the issuer
when the person is adirector or proposed director
-- reasonable reliance on officers, employees, and other whose
duties should have given them knowledge of the particular facts
(in the light of the functions and responsibilities of the
particular person with respect to the issuer and the filing);
-- when the person is an underwriter, the type of underwriting
arrangement, the role of the particular person as an underwriter
and the availability of information with respect to the
-- whether, with respect to a fact or document incorporated by
reference, the particularperson had any responsibility for the
fact or document at the time of the filing fromwhich it was
-- $11 imposes liability only for "material" misstatements or
omissions in the registration statement. Therefore, materiality
is a threshold determination. Similarly, the plaintiff must have
suffered damages compensable within the provisions of $11(e). The
defendant can reduce (either in part or totally) the plaintiff's
monetary damages by showing that the loss (or portion thereof) was
attributable to factors other than the pertinent
misrepresentations or nondisclosures.
Violators are subject to joint and several liabilty.
-- $11(f) clearly provides for a right to contribution. The
provision, however, leavesunsettled the extent to which losses are
to be shared among the parties. The traditionalview is that the
parties share the entire loss on a pro rata basis (i.e. equally
among thejoint tortfeasors irrespective of individual fault.) The
emerging view is that apportionment of damages should be premised
upon the relative culpability of thevarious parties.
-- Right to indemnification is far more uncertain (no provision
provides for such a right). The SEC's position, as contained in
Item 512(h) of Regulation S-K, is that indemnification of
officers, directors, and controlling persons of the registrant
forliabilities arising under the Securities Act is against public
policy, and hence, unenforceable.
-- Escott v. BarChris Construction Co.
Accountants must make an investigation of the facts that would
conform to the standards of their profession and must state the
issuer's financial results according to the generally accepted
accounting principles set forth by the S.E.C. The test is what
kind of investigation a prudent person in the defendant's
position, with the same responsibilities, skills, etc. would have
- How to prove due dilligence:
-- you have to look at company's chartter and by-laws
-- look at minutes of Board of Directors and various sub-
-- look at the major contracts of the issuer
-- loot at lawsuit this company is involved with (disclosure of
legal proceedings). Also look at pending lawsuits in which
company might have large exposure.
-- Attorneys are not listed as potential defendants, unless they
are also officers or directors or otherwise treated as experts.
-- $15 imposes joint and several liability on any person who
controls a primary violator, "unless the controlling person had no
knowledge of or reasonable ground tto believe in the existence of
the facts by reason of which the liability of the controlled
person is alleged to exist."
-- Akerman v. Oryx Communications, Inc.
The price decline here occurred independent of the misstatement
and may not be charged to the defendants.
-- Pinter v. Dahl
Here, court rejects a broad interpretation of seller under 12(1),
arguing that interpreting seller as one whose participation was a
substantial factor was clearly against congressional intent.
-- Plaintiff not need to show state of mind; this is a strict
liability section. Also not need to establish an injury. Need to
show only: (a) there was a violation of $5; (b) the facilities of
interstate commerce were involved in the offer or sale to the
plaintiff; (c) the plaintiff has made adquate tender of the
security if it is still owned; and (d) the action has been brought
within the time stated in the statute of limitations found in $13.
-- An illegal offer creates rights of rescission even though the
subsequent sale is lawful.
-- $12(2) affords an express right of action to a purchaser
against her seller for rescission, or damages if the securities
have been disposed of, where the purchaser acquired the securities
by means of a prospectus or oral communication which contained a
material misstatement or omission. Proof of reliance is not
required. Indeed, to recover under $12(2), "a plaintiff need not
prove that he ever received the misleading prospectus."
-- $12(2) also provides the seller with a "quasi due diligence"
defense. Once the purchaser has established a prima facie case,
the onus is shifted to the seller to establish that it did not
know, and in the exercise of reasonable care could not have known,
of the untruth or omission.
-- $12(2) action differs from $11 action in the following ways:
-- Under 11, tthe source of misstatement or omission is
registration statement. Under 12, can be either written or oral.
-- The action under $12(2) is afforder to purchasers of
securities in both registered and exempt offerings, whereas $11
only applies to registered offerings.
-- $12(2) extends liability only to those who "sold" the
securities to the allegedly aggrieved purchasers. $11
specifically enumerates those parties who are subject to liability
under that provision.
-- Some courts have held that $12(2) is available to purchasers
in the aftermarket because (unlike $11) the provision encompasses
"oral communications", whereas prospectuses generally are used
only in connection with primary offerings. That is not to say
that $11 is not available to purchasers in the aftermarket.
However, due to the "tracing" requirement, it may not be
-- It is generally accepted that under 11 and 12(2) you cannot
invoke aiding and abetting theories. Under 10b-5, you can.
-- Whereas $11 establishes an affirmative defense of "reasonable
investigation," $12(2) provides that the seller exercise
"reasonable care." This apparently lower standard of care is
consistent with the general notion that sellers of securities may
not be intimately involved with the offering and may not have the
same access to information as do potential $11 defendants.
WHO IS A "SELLER"?
-- Wilson v. Saintine Exploration & Drilling Corp.
Where someone does not solicit buyer to purchase the securities,
they cannot be deemed a seller under 12(2), regardless of whether
loss causation is proven. The definition of seller under 12(1) is
identical to the definition of seller under 12(2).
-- Sandes v. John Nuveen & Co
12(2) requires that the offer or sale of securities occur by means
of a "prospectus or oral communication" that includes the
misrepresentation or fails to disclose the material fact. Since
12(2) does not have a reliance requirement, individual plaintiffs
need not actually read the writing that contains the
misrepresentation. If a private cause of action is implied, the
plaintiff would have to prove that the defendant acted
intentionally or with actual knowledge.
-- Court also said that a showing of reliance on the falsity or
omission is not part of the plaintiff's case under 12(2).
-- Most courts require a minimal showing of causation--that the
prospectus or oral communication--as opposed to the misstatement
or omission itself--played a role in the purchase.
-- Tracks rule 10(b)(5) in all respects except that it applies
only to fraud in connection with sales. Does not apply to
-- This is not as clearly the subject of an implied private right
of action as is 10(b)(5).
-- For some aspects of $17(a), a negligence standard suffices.
Need not prove scienter.
-- Aaron v. SEC
The language of 17(a) require scienter under 17(a)(1), but not
under 17(a)(2) or 17(a)(3).
-- In Re Washington Public Power Supply Systtem Securities
Litigation (9th Cir. page 672)
There is no private remedy in section 17(a). Other alternatives
-- Most courts follow this decision from the 9th Circuit.
-- The Supreme Court adopted a four prong standard for implied
rights of action (Cort v. Ash):
1) Is the plaintiff "one of the class for whose special benefit
the statute was enacted." -- that is, does the statute create a
federal right in favor of the plaintiff?
2) Is there any indication of legislative intent, explicit or
implicit, either to create such a remedy or to deny one?
3) Is it consistent with the underlying purpose of the
legislative scheme to imply such a remedy for the plaintiff?
4) Is the cause of action one traditionally relegated to state
law, in an area basically the concern of the States, so that it
would be inappropriate to infer a cause of action based solely on
-- Much of the emphasis is now on the second prong of that test.
THE ENFORCEMENT OF SECURITIES LAWS
ENFORCEMENT ACTIONS BY THE SEC
-- 21(a) of the '34 Actt authorizes tthe Commission in connection
with its power to investigate violations "to publish information
concerning any such violation."
THE DUTIES OF THE SECURITIES LAWYER
-- SEC v. National Student Marketing Corp.
Lawyers should be held to a duty of reasonable care in
investigating the facts and in disclosing any material factts
discovered. Thus, a lawyer cannot take the word of the client for
how things are; she must make an independent investigation of the
facts. And if the lawyer discovers that a client has made
misrepresentations or material omissions and insists on going
forward with the registration statement anyway, then she must
disclose her discovery, possibly even to the S.E.C., or face
possible liability as an aider and abettor. Here, it was aiding
and abetting the fraud by the officers of Interstate for the
lawyers to remain silent and permit the merger transaction to
close when they had a duty to tthe client--including its
-- SEC feels that a lawyer engages in "unethical or improper
professional conduct" when a lawyer with significant
responsibilities in the effectuation of a company's compliance
with the disclosure requirements of the federal securities laws
becomes aware that his client is engaged in a substantial and
continuing failure to satisfy those disclosure requirements, his
continued participation violates professional standards unless he
takes promptt steps to end the client's noncompliance.
TRANSNATIONAL SECURITIES FRAUD
THE EXTRATERRITORIAL APPLICATION OF U.S. SECURITIES LAWS
JURISDICTION BASED ON EFFECTS
-- Schoenbaum v. Firstbrook
The district court has subject matter jurisdiction over violations
of the '34 Act although the transactions which are alleged to
violate the Act take place outside the U.S., at least when
transactions involve stock registered and listed on a national
securities exchange, and are detrimental to the interests of
JURISDICTION BASED IN WHOLE, OR IN PART, ON CONDUCT
-- In Leasco Data Processing Equp. v. Maxwell, the 2nd Circuit
found that even if the critical misrepresentations occurred
abroad, if the earlier misrepresentations in the U.S.
"significantly whetted" Leasco's interest in acquiring Pergamon
shares, they constituted an "essential link: in the fraud and
would be sufficient to establish subject matter jurisdiction.
-- Bersch v. Drexel Firestone, Inc.
Anti-fraud provisions of tthe federal securities laws: (1) apply
to losses from sales of securities to Americans resident in the
U.S. whether or not acts (or culpable failures to act) of material
importance occurred in this country; and (2) apply to losses from
sales of securities to Americans resident abroad if, but only if,
acts (or culpable failures to act) of material importance in the
U.S. have significantly contributed thereto; but (3) do not apply
to losses from sales of securities to foreigners outside the
United States unless acts (or culpable failures to act) within the
U.S. directly caused such losses.
-- SEC v. Kasser
ISSUE: Whether the SEC may invoke the jurisdiction of the federal
courts over defendants who have allegedly engaged in fraudulent
conduct within the U.S., when the sole victim is a foreign
corporation and when the purported fraud had little, if any,
impact within this country.
HELD: Yes, since some activities took place in the U.S.
Activities included: (1) various negotiations; (2) executtion of
one of the investment contracts in New York; (3) utilization of
the instrumentalities of interstate commerce (i.e. telephones and
mails) to further the scheme; (4) incorporation of defendant
companies in the U.S., or at least the establishment of corporate
offices; and (5) the use of New York office of a Swiss bank as a
conduit for moneys received from the Fund.
-- In Continental Grain (Australia) Pty. v. Pacific Oilseeds, Inc,
the 8tth Circuit held that where defendants' conduct in the U.S.
was in furtherance of a fraudulent scheme and was significant with
respect to its accomplishment, and moreover necessarily involved
the use of the mails and other instrumentalities of interstate
commerce, the district court has subject matter jurisdiction.
-- Zoelsch v. Arthur Andersen & Co.
Jurisdiction is appropriate when the fraudulent statements or
misrepresentations originate in the U.S., are made with scienter
and in connection with the purchase or sale of securities, and
"directly cause" the harm to those who claim to be defrauded, even
if reliance and damages occur elsewhere.
RESTATEMENT THIRD OF FOREIGN RELATIONS LAW OF THE U.S.
-- 401 of the Restatement defines three categories of
jurisdiction: jurisdiction to prescribe permits a state to make
its law applicable to the activities, relations, or status of
persons or the interests of persons in things; jurisdiction to
adjudicate permits a state to subject persons or other things to
the process of its courts or administrative tribunals; and
jurisdiction to enforce permits a state to induce or compel
compliance with its laws or punish noncompliance.
FRAUD ON THE MARKET THEORY
-- The fraud on the market theory is based on the hypothesis that,
in an open and developed securities market, the price of a
company's stock is determined by the available material
information regarding the company and its business Misleading
statements will therefore defraud purchasers of stock even if the
purchasers do not directly rely on the misstatements..The causal
connection between the defendants' fraud and the plaintiffs'
purchase of stock in such a case is no less significant than in a
case of direct reliance on misrepresentations. Thus, FOMT
pressumes reliance in cases where D relied on accuracy of market
price of security. So, we impose liability in cases where
misrepresenation causes the market tto inacurrately value a
-- What does plaintiff need to prove?
-- that the market is efficient (get expert testimony). NYSE,
AMEX, and NASDAQ are generally regarded as efficient.
-- that they traded in a market affected (by what?)
-- misrepresentation (and that it was PUBLIC)
-- misrepresentation was material
-- Once FOTM is invoked, D can argue that the sale of securities
was going to be made anyway and did not result because of the
statements of misrepresentation.
-- The express remedies under the '33 Act generally do not require
a showing of reliance or causation.
-- Basic v. Levinson
Because most publicly available information is reflected in market
price, an investor's reliance on any public material
misrepresentations, therefore, may be presumed for purposes of a
Rule 10(b)-5 action. Any showing that severs the link between the
alleged misrepresentation and either the price received (or paid)
by the plaintiff, or his decision to trade at a fair market price,
will be sufficient to rebut the presumption of reliance.
-- It is very difficult for D to rebut the presumption, especially
when the class is too big. So, by shifting presumption to P, we
make it much more likely that the class would be certified. The
result is greater deterrence, since the settlement value of
securities cases would increase.
by: Ross E. Kimbarovsky
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