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SECURITIES OUTLINE FALLONE FALL 2013

KINDS OF TRANSACTIONS

- 1. Issuer Transactions: o Company sells stock to first buyer as a way to make money. o IPO, regulated by 1933

- 2. Trader transactions: o transaction from person to person (not for first time) secondary market

1.0 THE DEFINITION OF A SECURITY:

- § 2(a)(1) of the 33 Act and §3(a)(10) of the 34 Act, defines a “security” as a: stock, bond, debenture, note, evidences of indebtedness, certificates of interest in profit sharing agreements or transferable share, and the catchall term investment contract.

- Investment Contract: Howey test: o 1. Investment of money due to an expectation of profits

§ Something is not an investment if for consumption purposes. o 2. A common enterprise

§ Investors pooling their funds together towards a common goal. (ie purchasing a orange farm) Need money from several people to pool to make a larger profit.

o 3. Which depends solely on the efforts of a promoter or third party § The S. Ct has defined that “solely” does not really mean solely, it is more defined

as the predominant/key management activities are done by others than the investors.

§ o 1. Expectation of profits

§ Investment can be of cash or no cash, consideration, and is expected to produce income or profits; investor is looking for financial returns, not a consumable commodity or service.

§ Expected return must be the principal motivation for the investment. o 2. Common enterprise: Two types of common enterprise:

§ Vertical Commonality: Commonality arises between the investor and the promoter. Promoter has risk, ex. Broker who says give me your money and I’ll invest it and your fee will be 1% of what we make.

• Different from horizontal in that there the commonality is between the investors.

• No pooling of funds is necessary. § Horizontal commonality (minority): requires 1) a pooling of investors’ funds, 2)

profit sharing, and 3) loss sharing. (Profits/losses determined pro rata) • Occurs when multiple investors have interrelated interests in a common

scheme. - Characteristics of Stock as a security: (Forman)

o 1. Right to receive dividends contingent upon profits. o 2. Negotiability

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o 3. The ability to be used as collateral o 4. Confers voting rights in proportion to shares owned. o 5. Capacity to appreciate in value.

§ Forman: A cooperative housing corp. required residents to buy “shares” to secure housing. Upon moving residents were required to sell back shares at same price they purchased them for. Ct held that no 10b(5) action could be brought forth. Intent for sale and purchase was simply to supply a place to live.

- Business entities as securities:

o General Partnership: § Generally, not a security because each partner has equal management power.

• Williamson Test: (General partnership as security) A general partnership or joint venture Will be designated a security if: 1) No legal control, 2) no capacity to control, 3) no practical control.

o Limited Partnership: § Again, if there is a managing partner that controls the business while others simply

provide money and no expertise then it is a security. § Passive partners/investors are in need of protections of securities laws.

• Must pass 3rd prong of Howey Test, somewhat rare.

- Real Estate as a Security o Generally, not a security. However, sale of real estate coupled with real estate

management agreement raises a material issue as to whether it is a security and should pass summary judgment.

§ Similarity to Howey: Just like Howey, 1) investors purchased real estate at the same time they relinquished much of their right to use the property, 2) investors were not obligated to purchase the service Ks, 3) investors were usually nonresidents who lacked knowledge and equipment necessary to manage the investment.

- Notes as Stock: A note is credit w/ promise to repay.

o Familial resemblance test: Test Presumes that Notes that are longer than 9 months of maturity are securities UNLESS the notes at issue resemble the kind of notes that are not securities. 4 elements:

§ 1. Motivation of seller and buyer • If issuer of note uses proceeds towards business purposes it is likely a

security. If used to buy consumer goods then not. o (Investment of money)

§ 2. Plan of distribution • If generally distributed then likely a not. If face-to-face then not!

o (Horizontal commonality) § 3. Reasonable expectations of investing public

• Investor’s expectations matter, if they view them as an investment then likely a security.

o (Expatiation of profit) § 4. Is note governed by other laws?

• Such as by banking authorities, then more likely not a security.

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EFFICIENT MARKET HYPOTHESIS

- Idea that stock price is not dependent on past prices but rather on all the present information that is available about a company.

o 1. Weak form: Stock price reflects past price o 2. Semi-Strong: the stock reflects all publically available information. o 3. Strong form: all past and present publicly known info, as well as all privately known

info (inside knowledge) is reflected in the stock price § Noise: is the pricing influences not associated with a rational expectation about

stock values. It is used to describe irrational trading by investors. PUBLIC OFFERING

- Two Types of Laws o 1. Mandatory Disclosure

§ 1. Event based disclosure: (tied to the occurrence of an event) • 1. A public offering triggers disclosure under the 1933’ act.

o Registration Statement: A company must register an offering with the SEC, the registration statement then becomes public.

§ Reg SX: details about financial information that needs to be included in the registration statement.

§ Reg SK: Details what non-financial information must be included in the registration statement.

o Prospectus: Similar to a registration statement (sales statement) • 2. Hostile Takeover is an event that triggers disclosure. • 3. Soliciting proxies: asking shareholders to vote

o Sarbanes-Oxley adds add’l disclosure req’s, particularly that CEO & CFO must personally sign off on reports

§ Continued Reporting: (from the 34’ act)

• 10-Q, quarterly o Same info as 10-K

• 10-K, annual reporting includes o Business o Properties o Legal proceedings o Market for common stock o Mgmt. Discussion & Analysis of Financial Condition & Results of

Operations (aka M D & A) – basically, known risks and opportunities

o Directors & officers o Executive compensation

• 8-K, specific events occur within 3 days o Death of CEO o Bankruptcy o Acquisition/disposition of 10% of assets

• Additionally, Regulations SK and SX apply to continuous reporting.

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o Incorporation by reference: A company that has previously filed an annual or quarterly report can reference this report when filing a registration statement.

o Problem with selective disclosure is that voluntarily disclosed information can have the same effect on the market that mandatorily disclosed information has, therefore companies may use voluntarily disclosed info to sway the market.

§ Regulation FD meant to control this: • Differentiates between inadvertent disclosure and voluntary.

o 2. Anti-Fraud Rules: Seeks to punish lies and omissions

A. Who must disclose: there are three types of companies subject to this requirement under §12 of

the ’34 Act. a. 1) Listed on public exchange: those offering securities on a public market (e.g. NYSE)

§12(a), (b) b. 2) Over The Counter Market $10M/500 shareholders: those w/ assets more than $10M

and more than 500 equity shareholders. §12(g) Antimanipulation provision in § 12 to say you can’t manipulate record holder names to get below the 500+ shareholder level.

c. 3) Filed registration statement: those that have filed a registration statement under the ’33 Act.

A. Generally: with certain exceptions, there is no affirmative duty for an issuer to disclose material

nonpublic information. Despite the unwillingness of the courts and SEC to recognize such a general mandate, there exist issuer affirmative disclosure requirements in a number of specific circumstances:

1. When SEC rules and regulations require disclosure of specified information;��� 2. When mandatory disclosure of forward looking statements is called for by Item 303 of

Regulation S-K which pertains to MD&A;��� 3. When the issuer is purchasing or selling its securities in the markets; 4. ���When the information revealed by the issuer contains a material disclosure deficiency at

the time that the statement was made; under such circumstances, there exists a duty to correct;���

5. When the issuer previously has made a public statement that, although accurate when made, continues to be “alive” in the market place and ahs become materially false or misleading as a result of subsequent events; under such circumstances, a duty to update may exist; and���

6. When material information has been leaked by, or rumors in the marketplace are attributable to the issuer.

UNDERWRITERS

A. Methods of Underwriting: a corporation may acquire funds by 1) borrowing from a bank, 2) selling securities in a public offering, or 3) a private offering.

• Underwriter Compensation i. Best efforts

• Underwriters don’t purchase the security but instead agree to use their best efforts to sell security. Usually, commission is given.

ii. Firm Commitment:

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• Investment banking company agrees to purchase agrees to purchase securities form issuer to resell to public as specified offering price

• Dutch Auction: under this technique, the issuer solicits bids from institutions and broker-dealers for any amount of securities each bidder wishes to acquire; the bidder states the amount of securities it wishes to purchase and the amount it will pay for those securities.

- Reducing Risk • Flipping: occurs when shares in an IPO are quickly resold in the market at a profit. • Spinning: Underwriting allocates some of the scarce IPO shares with preferred customer

as a means of retaining their business ; the executive then flips the shares. • Letter of Intent: usually the only document purporting to set forth a relationship b/w

issuer and underwriter until shortly b/f the registration statement becomes effective, at which point they sign the underwriting agreement.

• Underwriter Risk: Underwriters have various risks (below) that they hedge.

i. Underwriter withdrawal: a common feature of the firm commitment underwriters’ agreements with the issuer is a clause that permits the underwriters to withdraw any time prior to the public offering and/or the settlement date if one of the following occurs:

• Government restrictions: the gov’t has imposed restrictions on the trading of securities in general

• War: there is a war or other national calamity. • Adverse event: there is a material, adverse event affecting the issuer.

ii. Omission or misstatement: underwriters face the risk of liability if the registration statement contains misstatements of material facts. There is typically a standard clause requiring the issuer to indemnify the underwriters of this liability.

• Peculiar knowledge: this clause makes an exception for misstatements of matters the underwriters had peculiar knowledge of.

TYPES OF ISSUERS UNDER 33’ ACT

- 1. Non-reporting Company: Use S-1, No disclosure statement with SEC - 2. Unseasoned Reporting Company

o 1. Stock is listed on National exchange o 2. Company has filed an effective Registration statement o 3. Co. has more than 10 M in assets and more than 500 unaccredited shareholders

- 3. Seasoned Reporting Company: Reporting company that can use a FORM S-3 o 1. Must have been a reporting company for at least 1 year o 2. Have greater than 75 M of publically available stock

- 4. Well Known Seasoned Issuer (WKSI) o Have either

§ 1. Over 700 million of common stock § 2. Or if issuing debt or non-convertible stock then must have issued 1 billion in

debt in prior three years. • Also WKSI’s get benefit of Rule 163 whereas they can, at anytime, solicit

offers for sales. • Very limited SEC regulation, exempt from disclosure

- 5. Emerging Growth Company o Company that has less than 1 Billion in revenue. o Jobs Act 2(a)19

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o Can remain EGC for 5 years o EGC’s can file their registration statements in private.

§ Integrated Disclosure (Seasoned Companies): For reporting companies that are current in their exchange act filings for the past year, the prospectus may incorporate company related info by reference to other SEC filings.

Overview of Form S-1 and Form S-3

o A form S-1 is used by a Reporting Company o A form S-3 is used by Seasoned Issuers and WKSI’s

§ In order to qualify to use a Form S-3, become a Seasoned Issuer: • (1) Must be a reporting company for more than 1 year and one of the

following: • (2) Have greater than $75 Mil public float; or • (3)(a) If less than 75M in a cash offering, Must

o 1. Have their stock listed on Exchange for 12 months; and o 2. They DO NOT issue more than 1/3 of their public float in a 12

month period. • (4) in a sale of debt securities, issuer must meet one of the following

requirements: o (a) issued greater than 1 billion in non-convertible debt in prior 3

years o (b) issuer has outstanding greater than 75 mil in non-converted

securities (already owe that much); o Issuer is a subsidiary of a WKSI or issuer is a Real Estate Interest

Trust aka REIT. o

SECTION 5 REGISTRATION

- Central goal of 1933 act was the preparation of a registration statement for publically offered securities

- Process for filing: The first registration statement can take months to compile. o Preparing for Filing: lots of preliminary work that can take months. o Letter of comment: after filing w/ the SEC, the registration statement is reviewed. It is

typically amended based on recommendations given by the SEC in a Letter of Comment. o Underwriters signing: typically, underwriters won’t sign their K to purchase shares until

they have reviewed the registration statement. Overview of 1933’ Act

- § 5 prohibits the sale of securities before a registration statement is filed with the SEC and forbids certain kinds of marketing of the sale. Also, it forbids a final sale to the purchaser without the delivery of a prospectus.

- § 3 & 4 provide exemptions: the types of securities and transactions that are not regulated by § 5.

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- § 7 & 10 provide the content that must be included in the necessary disclosure documents (these are very bare bone but do point to reg. SX and SK)

- § 11 prohibits material misstatements or omissions in the Registration Statement - § 12 prohibits material misstatements or omissions in the Prospectus - § 17 prohibits fraud

The Registration Process is divided into three sections: (1) Pre-filing period (before registration is filed; (2) Waiting period (after the registration is filed but before it becomes effective); and (3) Post-effective period (after registration becomes effective).

1. PRE-FILING PERIOD (GUN JUMPING) - Generally the marketing and sale of any security is prohibited. - Definition: Under Section 5(c), it is unlawful “to offer to sell or buy” any security unless a

registration statement has been filed. - 5(a) Prohibits sales of unregistered securities or deliveries for purposes of sale.

o 2(a)(3): Defines “offer to sell” and offers to buy as every attempt or offer to dispose of, or solicitation of an offer to buy a security or interest in a security”

- UNSEASONED ISSUERS: SAFE HARBORS -- PRE-FILING PERIOD

o 1. Rule 163(a): Anything issuer releases before 30 days prior to filing of registration statement as long as it doesn’t mention upcoming public offering is not considered an offer for sale.

§ 1. The communication Cannot reference the public offering. § 2. To invoke rule 163 a written version of an offer made 30 days prior to the users

filling a registration statement must be filed promptly with the commission when the registration statement is ultimately filed.

o 2. Rule 135: allows notice of public offering (exempted from definition of security) § Limited information: Issuer, security, amount offered, timing, manner, purpose,

CANNOT name underwriter

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§ Must include a legend explaining that it is not an offer, that there will be a registration statement filed, and that there will be a prospectus forthcoming

§ Cannot make estimates about future capacity, If to institutional companies or sophisticated buyers then can talk about future.

o 3. Rule 169: Non-reporting companies may continue to release factual information that is regularly released.

§ Reporting companies: Can continue to release factual information as well as forward looking information.

o 4. Section 2(a)(3) 33’ Act: provides in the definition of “sale, sell, offer” that there is an exception for arrangements with and among underwriters and issuers.

- Rule 168: Reporting Companies (applies throughout the life of the IPO): includes the regular release of factual business information or forward looking information; however, it does not protect communications issued by the underwriter or other distribution participants.

o Also condition on the information being the type the issue has previously released in the ordinary course of its business and that the manner of its dissemination should correspond to past released to that type of info.

- Emerging Growth Company exceptions: o Section 5(d): Creates a safe harbor for emerging growth companies to communicate

about themselves even before the registration statement is filed as long as it is directed to qualified institutional buyer (Mutual funds, banks, considered to be sophisticated can protect themselves) and accredited investors (also considered sophisticated investors who can cut thru flowery language.

- RESEARCH REPORTS (RULES 137, 138, 139) (p. 189-90

o (1) Rule 137:Permits nonparticipating brokers and dealers to publish or distribute, in the regular course of business, information, opinions, and recommendations regarding an issuer in registration’s securities. (The dealer and/or broker must not receive compensation from the issuer for the report made or else they are considered an underwriter).

o (2) RULE 138 FOR REPORTING ISSUERS: A broker or dealer, even if a participant in the distribution of bonds offering but not stock offering, can publish opinions or recommendations for the registrants common stock. AND VICE VERSA. This exemption is conditioned on the broker or dealer having previously published or distributed in the regular course of its business research reports for similar types of securities.

o (3) RULE 139 Participant research Report: Broker or dealer that is even participating in the distribution of common stock can release reports, opinions, etc. that are solely about the issuer (as long as the issuer is a reporting company). The broker or dealer must have previously issued similar kind of report when relying on this rule.

2. WAITING PERIOD_________________ - Oral solicitations are allowed, written solicitations are allowed IF, it is accompanied or preceded

by a preliminary prospectus: Sales barred: while sales are still barred after registration is filed until it becomes effective, selling efforts can commence.

o Written offers: written offers made during the waiting period using a prospectus known as a red herring are permitted.

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o 1. § 2(a)(10) provides that any written communication, or communication on the radio or tv is a prospectus that must meet req. of section 10.

o 2. Rule 15(c)(2)-(8) provides that a non-reporting company and its underwriters must deliver a preliminary prospectus to any purchaser at least 48 hours prior to the closing of a sale.

o 5(b)(1): prohibition relates only to written offers. Oral selling efforts are only subject to anti fraud rules.

- SAFEHARBORS o 1. Rule 134 Identifying Statement: Permits identifying information about issuer

(exempted from definition of prospectus) § (a) permitted: issuer info, info about security, issuers business, price of security,

use of proceeds, identity of sender, schedule, nature of offering. § (b) During waiting period must include Legend explaining that the offer is not

binding and you can back out of it, and that no payment can be received until the reg. Statement becomes effective.

§ (c) Can seek investor interest if accompanied by prospectus. • Must include legend detailing that offer is not binding!

o 2. Rule 135: offering announcement still allowed o 3. Rule 168: Reporting issuers, and 169 New issuers Regular communications

§ Still allowed o 4. Rule 433 Free Writing: (For Non-reporting or Unseasoned issuers)

§ Written communications will be allowed as “free writing prospectuses” that qualifies as a prospectus under section 10 if certain conditions are satisfied: the free writing must be preceded by, or accompanied with a prospectus that satisfies Section 10 (preliminary prospectus) and includes the securities price range.

• Also, a legend must be included on the free writing explaining where a prospectus is available.

• Note that some free writings must be filed with the SEC. • Also, information included in the free writing cannot be contradictory to

information presented in the registration statement. • Can send email information as long as a hyperlink to the prospectus is

included in compliance with S 10. • Also, if you provide info that is considered a free writing on your website

you better include a legend and a hyperlink to your prospectus § Seasoned issuers & WKSI’s need not include preliminary prospectus

o Rule 433: Press interviews: § Media disseminated Free writing prospectus originating from issuer such as press

interview. File w/in 4 days by providing transcript of what was said. • No legend or prospectus necessary

o Rule 405: Road Shows § Live or real time web casts and road shows are treated as oral communications. § Powerpoint considered graphic, subject to 433 legending req.

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o 5. Tombstone Ad as excluded in definition of Prospectus in § 2(a)(10): can identify the security, the price, and underwriter if it provides where and from whom a written prospectus can be obtained

Basically, during the Waiting Period:

o Increased available means of communicating offers not gen’ly available during Pre-Filing Period

§ Oral Communications § Statutory Prospectus under Sec. 10 § Tombstone stmts § Free Writing Prospectuses

3. Post-effective Period

- No sale can close before the effective date; however, sales can occur and securities can be received so long as they are accompanied with or preceded by a final prospectus.

- Section 2(a)(10): exempts from the definition of prospectus any written sales literature if it is accompanied or preceded by a final § 10a prospective.

- 5(b)(2) requires that every security delivered be accompanied or preceded by a prospectus that meets the requirements of § 10(a) aka a final prospectus

- However, now the main rule is Rule 172(b), requiring that a final prospectus need not be delivered as long as access to the final prospectus is provided.

- Rule 433 Free Writing: made during the post-effective period is fine as long as it is accompanied with a legend and satisfies the necessary SEC filing requirements and it must be accompanied or preceded by a final prospectus --Access is probably sufficient

WKSI OVERVIEW

• To qualify as a WKSI: o In a Stock Offering: have to be S-3 Eligible w/ greater than $700 mil in public float aka

value of shares held by the public is greater than $700 mil o For a Debt Offering: S-3 Eligible w/ greater than $1 billion worth of non-convertible debt

sold over the last 3 years o Stock Offering: have greater than $75 mil in public float and greater than $1 billion in debt

over last 3 year • Benefits of Being a WKSI

o No rule 163: a WKSI can make almost any statement before the registration statement is filed (there is no 30 day rule or no cooling off period/quiet period)

§ The communications must be made by or on behalf of the WKSI, cannot be made by the underwriter.

§ all communications must be accompanied with a legend and filed with the SEC o Rule 433 Free Writing: there is no requirement that a WKSI deliver a prospectus with a

free writing… the free writing must just be accompanied by a legend and satisfy SEC filing requirement

o Rule 415 Shelf Registration: Automatic for WKSI’s, no registration statement necessary prior to offering securities.

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EXEMPTIONS FROM REGISTRATION UNDER § 5

Two kinds of exemptions: (1) issuer exemptions and (2) resale exemptions

o (1) Issuer Exemptions § 1) Intrastate, 2) private placement,

o 1. INTRATSTATE OFFERING—3(a)(11):

§ Scope of offering (Integration): • All securities offered as “part of an issue are integrated.

§ In-State issuer: • Resident and doing business within the state

§ In-State offerees: • Offerees must be domiciled within the state.

§ Restrictions on Sales • Securities must “come to rest” prior to being resold.

o Rule 147: If 147 is followed SEC guarantees that issue of stock will comply § Scope of offering (Integration):

• Sets of sales separated by six months are not integrated. § In-State issuer:

• Principal office within state, and doing business w/in state: 80% of gross revenues, assets and proceeds used are within the state.

§ In-State offerees: • Offerees must have principal residence within the state • Come to rest: Confirming that securities were only sold to residents of a

single state can only happen after the securities have come to rest. § Restrictions on Sales

• Since offering the sale to a nonresident destroys the exemption, rule 147(e) prohibits the resale of any exempt security to a nonresident within nine-months from the date of the last sale by issuer.

o If even one security is sold to a non-resident or later transferred within the integration period the entire exemption becomes void!

• Integration: basically holding 2 offerings at the same time (and really trying to apply an exemption to both when only 1 would qualify) rule 147 provides the 6 month 2 way integration rule: so long as there is 6 months between offerings they will not be integrated.

o 5 integration factors to apply if offerings w/in 6months of each other: § (1) are the offerings part of a single plan of financing; § (2) do the offerings involve issuance of the same class of security; § (3) are the offerings made at or about the same time; § (4) is the same type of consideration to be received; § (5) are the offerings made for the same general purpose.

o 2. PRIVATE PLACEMENTS: No public offering §4(2)

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§ Section 4(2) exempts from registration, any offering “by an issuer not involving any public offering”

§ Offeree in a private placement must be sophisticated and have access to the same kind of information that would appear in a registration stmt.

• Cannot qualify for exception if general solicitations are used. • Person claiming 4(2) exemption must show that each purchaser and each

offeree meets the sliding scale test for sophistication. § Additional Steps For A Private Placement:

• (1) The number of offerees and their relationship to each other and to the issuer: the more offerees the more likely the offer will be considered public. Relationship is important because if the offerees are members of class that has special knowledge than more likely private. (Fallone says there is no magic number but that less than 100 people is key)

• (2) The number of units offered: large number of cheap securities equal more public. small number of expensive securities equal more private

• (3) The size of the offering: small offerings were intended to be exempt. • (4) The manner of the offering: direct contact is key as opposed to

informal advertising (no advertisements, no public distributions, No mass communications).

o Accredited investor Offerings 4(6):

§ Self-operating exemption for offerings up to 5M made exclusively to accredited investors provided there is no advertising or public solicitation and the issuer files with the SEC.

o What is an accredited investor? For the purpose of Regulation D, an accredited investor includes 1) financial institutions, 2) pension plans, 3) venture capital firms, 4) corporations larger than 5M in assets, 5) people with wealth >$1M or annual income > $200,000 or over $300,000 w/ spouse 6) high level employees of the issuer.

LIMITED OFFERINGS: REGULATION D

A. Basics: Aimed at easing the burdens the registration requirements placed on small businesses, Regulation D provides three exemptions to the general requirements spelled out in Rules 504, 505, and 506.

a. §4(2) states that registration requirements of §5 do not apply to transactions by an issuer not involving any public offering.”

REGULATION D: 504 505 506 Aggregate offer limit $1 M (aggregate against

505) 12 months $5M in 12 Mo. Deducting any amounts raised under 504 (12 months)

$Unlimited (doesn't count against 504, 505 amount)

Number of investors Unlimited 35 non-accredited & unlimited accredited investors

35 sophisticated purchasers & unlimited accredited investors

Issuer Qualifications Only non-reporting Any type of issuer Any type of issuer

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companies Limits on Manner of offering

Need a pre-existing relationship between issuer and offeree. (not allowed to do mass solicitations to the public) Exception: Don’t need a pre-existing relationship if the offer is made solely in a state that doesn’t require it and registration is done in the state Or if in a state that allows accredited investors to purchase w/o pre-existing relations.

General solicitation or advertising to sell the securities is not allowed.

Widespread offerings : ie television, internet, will be allowed as long as all actual purchasers are accredited and verified by reasonable steps. Reasonable steps include the collection of tax forms. Or If broker has client as a client and pre-clears them.

Limits on resale Restricted, person who buys securities is told that they have not been registered so they may have to register them, themselves our use a resale exemption.

Restrictions on resale’s for all 3!

Issuer has to take reasonable care that the there sales are not falling into the hands of those who are looking to quickly flip the security.

Provide written notice to purchaser

Also has a ledger on security that states that it is a restricted security.

Restricted

Limits on disclosure No disclosure to accredited Disclosure to non-accredited

No disclosure to accredited Disclosure to non-accredited (if disclosure to Unaccredited, then must disclose to AI.

No disclosure to accredited Disclosure to non-accredited Over 7.5 million need audited financial statements.

Exempt under state law NO state law preemption state can still require additional filing

NO state law preemption state can still require additional filing

Federal law preempts state law, no further disclosure just filing fee.

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Incomplete Compliance with Regulation D:

- Even if an issuer fails to comply with Reg D, the exemption is not lost if the issuer shows the failures were insignificant:

o 1. The noncompliance didn’t undermine purchaser protections. o 2. Noncompliance didn’t involve the ban on general solicitations, $ limits, or limits on # of

accredited investors.

Rule 504 provides an exemption for the offer and sale of up to $1,000,000 of securities in a 12-month period. Rule 505 provides an exemption for offers and sales of securities totaling up to $5 million in any 12-month period. Rule 506: Must satisfy:

• Can raise an unlimited amount of capital; • Seller must be available to answer questions by prospective purchasers; • Financial statement requirements as for Rule 505; and • Purchasers receive restricted securities, which may not be freely traded in the secondary market after

the offering. • Reliance on any of the Reg D exemptions requires that notice be filed with the SEC within 15 days

after the first sale Rule 503(a). • Safe harbor: Rule 506 acts as a safe harbor for the private offerings exemption meaning that a

party that conforms to Rule 506 will always comply with § 4(a)(2) Private placement that is why they have to be sophisticated.

What is an accredited investor? For the purpose of Regulation D, an accredited investor includes 1) financial institutions, 2) pension plans, 3) venture capital firms, 4) corporations larger than 5M in assets, 5) people with wealth >$1M or annual income > $200,000 or over $300,000 w/ spouse 6) high level employees of the issuer. Reg A: Rules 252-264 Insiders can sell up to 1.5M.

- Offering Circular: simplified disclosure document, doesn’t have to be audited. - Sales may commence 20 days after the filing. Prior to the circular being qualified investors can

use a preliminary offering circular. - Rule 255: allows issuers to test the waters

Regulation A Regulation

A+ Crowd funding 4(a)(6) Regulation 701

Amount raised $5 Million $50 Million $1 Million $1M or 15% Number of investors

No limit No limit Unlimited but w/ caps on the amount they can invest based on their income

Any employee

Issuer Qualifications

Non-reporting companies only

Non-reporting

Non-reporting Non-reporting

Limits on Manner of solicitation

Offering circular: simplified reg. Statement.

Offering circular

Done through a broker or internet portal.

Part of plan

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Allowed to test the waters prior to filing offering circular allows small companies to see if there is interest in the securities.

Limits on resale Anytime, Anytime 1-year basic holding period. Can sell to family member or back to issuer.

Restricted > $5M

Limits on disclosure

Offering circular: An abbreviated prospectus for a new security listing.

Offering circular

Basic information +, must annually file updated financial statements

Exempt under state law

Not covered YES, covered security

Yes, covered Depends

Regulation A: exemption for securities offerings under a certain dollar amount. a. Rules: only non-reporting co., ≤$5m/12mo(only “A,” also can sell $1.5m

secondary), unlimited purchasers, b. disclosure: Offering Stmt. & Offering Circular (analogous to basic RegStats &

StatProspecs) c. No Resale Restrictions! d. relaxed gun-jumping rules: firm may “test the waters” pre-filing, as long as company is

filed w/ SEC & it has disclaimer i. no free writing during waiting period, allowed post-qualification period

e. Liability - 10b-5 applies, §11 does NOT, §12(a)(2) “less clear) EMPLOYEE BENEFIT PLANS: Rule 701

A. Rule 701: allows private companies to sell securities to employees without filing a registration statement when those sales are part of an approved employee benefit plan or compensation contract. This is not allowed when the purpose of the sale is to raise capital.

B. Who qualifies: Rule 701 sales can be made to employees, officers, directors, partners, consultants and advisors.

C. Maximum: the max amount of securities that can be sold in one year under Rule 701 is 1) $1 million, 2) 15% of total assets, or 3) 15% of the outstanding securities of that class.

EXEMPTIONS FROM REGISTRATION UNDER § 5

The regulatory boundary between regulated “distributions” and unregulated “market trading” is drawn by §4(1)

- §4(A) MOTHER OF ALL EXEMPTIONS o §4 exempts from registration under section 5 any transaction not involving an issuer,

underwriter, or dealer. § Does not exempt from registration sales by control persons of the issuer. § Control Person: equivalent of underwriter/issuer; someone who can dictate policy

at issuing company, top official, officer. - 2(a)(11) Defining Underwriter

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o Defined broadly as to limit §4(1) exemption. § (1) any person who purchases from an issuer with a view to the distribution of a

security; § (2) any person who offers or sells for an issuer in connection with a distribution; § (3) any person who participates or has direct or indirect participation in the

activities covered by 1 or 2 above; § (4) any person who participates or has a participation in the direct or indirect

underwriting of any such undertaking (under 1 or 2). o Furthermore, someone engaged in the continual solicitation or active promotion of

unregistered securities may be an underwriter even thought they have no official connection to the underwriter.

• Essentially Three categories of underwriters exist: o 1. Agent for “issuer”:

§ Those who offer to sell for issuer in connection with a distribution.

o 2. Purchaser from issuer with intent to distribute: § Intent to distribute is key.

o 3. Underwriter for control person § Someone who performs either 1-2 in connection w/ a control

person. § For the definition of underwriter to apply there must be a distribution!

o DISTRIBUTION:

§ When does a purchaser have a “view” to distribute? • Two factors to determine intent: to determine whether the securities were

purchases “w/ a view to…distribution” look at 1) length of time b/w initial purchase and resale, and 2) any change in the purchaser’s circumstances following the purchase.

o General presumption: it is generally presumed that a party who has held securities for more than 3 years did not purchase with intent to distribute. Furthermore, when there has been a change in circumstances for the purchaser, it is presumed that holding for more than a year satisfies the rule.

§ If the securities CAME TO REST with Purchaser 1, then the issuer is off the hook for any rescinding of the initial sale (if the securities did not come to rest with P1 and P1 resells in a way that is contrary to the original exemption, then it voids the first exemption for the issuer)

• There is a 9-month holding period for purchaser of intrastate offering security; then you can sell to anyone.

§ If the security came to rest with purchaser 1, then the issuer is exempt from prosecution as the distribution is over.

§ Gilligan (came to rest): Test is whether they were bought with investment intent? If greater than 3 years then you have investment intent.

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• <1 year presumption that you don’t have investment intent.

o Ultimately, the question of whether an investor is an underwriter turns on whether the investor who resells is likely to be in a better informational position based on a relationship with the investor then the buyer.

- §4(1): Exemption: Transactions not involving an issuer, underwriter, or dealer o How can holders of restricted securities and control persons resell shares without

registration? § 1. Wait until security “comes to rest” § 2. Avoid a distribution and sell in nonpublic transaction. § 3. Comply with Rule 144.

• Control persons have 3 options: o 1. Claim that isolated sales are not a distribution. o 2. Avoid using an underwriter either by selling in a nonpublic

transaction or by selling directly without assistance. o 3. Comply with rule 144.

RULE 144 SAFEHARBOR FOR RESALE OF RESTRICTED SECURITIES

A. Rule 144: provides that any person, whether it be a control person or a non-control person, who in compliance with the rules on holding period, amount sold, informational availability, manner of sale, and SEC filing, sells restricted securities on behalf of himself or on behalf of a control person (such as a broker would do), will not be deemed to be engaged in the distribution of securities, and therefore will not be considered an underwriter as defined in § 2(11) of the Act.

B. RULE 144 1) Availability of current public information, 144(c)

i. Issuer must be current with filing requirements under the Exchange Act 2) Holding periods for restricted securities 144(d)

i. Control persons selling 3) Limitation on the amount of control securities that can be sold 144(e)

i. Amount of securities sold cannot exceed the greater of “one percent of the class outstanding, or if traded on the exchange…the average weekly volume on all such exchanges, during the four weeks preceding the sale, looking back 3 months.”

1. Greater of the two standards determines how much could be sold in a 3-month period.

a. Average weekly trading volume in a typical week for the 4 weeks preceding the sale. Then take a 3-month period and during that three-month period the most that you could sell is the greater of the two.

4) The manner of sale of control securities 144(f) i. Securities must be sold in a broker transaction.

5) Required filings with the SEC that give notice of the sale by a control person 144(h) C. SUMMARY OF 144

1) Resales of restricted securities of reporting company i. 6 month holding period for both control and noncontrol persons. After 6 months

noncontrol person can resell as long as issuer is reporting company and current with Exchange Act; after one-year noncontrol persons can sell without any restrictions. Control persons after 6 months can sell but are subject to trickle, sale method, information, and filing limitations of Rule 144.

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2) Resales or restricted securities of non-reporting company i. 1 year holding period for both control and noncontrol persons. After 1 year

noncontrol can sell w/out restriction. Control people still must comply with Rule 144 limitations.

D. 144A— Qualified Institutional Buyers: institutional investor w/ at least 100M portfolio. 1) Non-issuer sale of restricted securities, (can’t be used for registered securities)

i. Sales of unregistered privately placed securities to QIB’s does not require registration as there is not a distribution.

ii. There is a whole market place that only qualified institutional buyers have access to.

2) Cannot be same class traded on NYSE or NASDAQ i. Shares of stock in a foreign company are the most often traded in these.

EXCEPTION FOR SECONDARY PRIVATE PLACEMENTS:

- The resale of securities originally purchased in a private transaction (exempt under 4(2) and then resold in another private transaction is not a distribution and does not trigger underwriter status.

Exception §4 ½ § Simply stated 4 ½ is just the concept that because under 4(1) no distribution is said

to occur if a transaction is private. § When offers and sales or to nonpublic investors: no distribution, no underwriter, no

registration… EXEMPT SECURITES & STATE BLUE SKY LAWS §3

- Exempt Securities: §3: o Government Securities, State Securities, Bank Securities, Insurance Policies and Annuities.

State Law - Securities Act § 18 Preempted state regulation of offerings to Qualified purchases, specified §3(b)

offerings and §4(2) offerings. - Still subject to states registration are resales of securities acquired in certain federally exempt

offerings. o 1. Offerings of charitable or religious orgs. o 2. Offering of municipal securities in issuers state. o 3. Intrastate offerings exempt under 3(a)(11) and o 4. Small offerings exempt pursuant to 3(b)—Rule 504, 505, Rule 701 and Regulation A.

§ In Wisconsin you are now allowed to “Test the Waters” using Reg A.

NSMIA: Covered Securities (If comply with Fed law, don’t have to comply w/ state law)

- 1. Covered security: All securities that are filed with a national exchange NYSE, DOW, NASDAQ - 2. Any security issued by a mutual fund. - 3. Any security sold to “qualified purchasers” - Qualified Purchasers: SEC has not defined. (Same as accredited investor) - 4. Securities sold under Rule 506 - 5. A 505 offering only to accredited investors

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- 6. Various re-sales (ie. re-sales exempt under 4(a)(1): transactions not involving issuer, underwriter, or dealer)

- 7. Regulation A+ - 8. Crowd funding

What is not a “covered security?”

1. Rule 504 2. Reg A

3. Intrastate offering 4. Private placement LIABILITY UNDER THE SECURITIES ACT §11

§11 Material Misrepresentations in Registration Statement: All purchasers of registered security have standing to sue. §11(a).

A. What Does P have to prove? P has to show a. 1) standing to bring suit, b. 2) that he is bringing it against an appropriate category of D, c. 3) misstatement or omission, d. 4) material, e. 5) damages.

B. What Doesn’t P have to prove? a. 1) Scienter – the state of mind of the individual Ds. Don’t have to have knowledge of

wrongdoing or recklessness or willful blindness; b. 2) Reliance –Don’t have to show that Ps suing actually read the registration statement.

Just that they purchased the securities; i. (BUT P Can’t know truth)

c. 3) Lost causation – P does not have to show their losses were even caused by the misstatement. That is left as an affirmative defense of the D.

i. SOL under section 11 is one year of discovery or should have discovered 1. Tracing: Plaintiffs must show that securities that they are suing for are

linked to a defective registration statement. C. Who can be sued:

(1) Every person who signed the registration statement (CEO, accountant, etc) (2) Every director of the issue, whether or not they signed reg stmt. (3) Incoming directors named in statement (4) Every Expert who consents to his opinion being used in Reg Stmt.

Liability is limited to only info prepared by expert. (5) Every underwriter (liability limited to amount of participation)

- Defenses:

o Issuer liability: Issuers are strictly liable for material misstatements and omissions in their registration statements. (no due diligence defense)

o Due diligence: due diligence is a possible defense for all other persons liable under § 11, including current and prospective directors, accountants, other experts, and underwriters.

§ Generally, the due diligence defense requires the person to have made a reasonable investigation and had no reason to doubt the statement’s accuracy.

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o Affirmative Causation 11(e): Defendant has the burden as a defense that there was an intervening cause that caused the misstatement.

§ (Ie. The US Gov defaulting on debt would be an intervening cause) - Forward looking statements

o Plaintiff must show that the person making the forward looking statement had actual knowledge that the statement was false or misleading.

- Experts: o Expert opinions: For expertised portions of the registration statement, experts are liable

for misstatements/omissions unless they actually and reasonably believed the statements were true, after reasonable investigation.

§ However, non-experts are not liable for these portions if they did not believe, and had no reasonable ground to suspect, that there was an inaccuracy/omission. § 11(b)

o Non-expert opinions: For nonexpertised portions, the responsible persons may escape liability only if “after reasonable investigation” they had “reasonable ground to believe and did believe” the statements were true and complete. § 11(b)

o Duty to Verify Issuers’ Statements: An issuer’s accountants, attorneys, and underwriters, in conducting due diligence of a registration statement, must verify the issuer’s officers’ statements against the original underlying documents. Lawyers have to review the major contracts.

12(A)(1) CIVIL LIABILITY FOR UNREGISTERED SECURITY

- Allow purchasers to sue statutory sellers for offering or selling a non-exempt security without registering it. As long as the purchaser can prove a direct link between the purchaser and the seller, and the suit is within the statute of limitations, the purchaser may obtain rescission with interest, or damages if the investor sold his securities for less than he purchased them.

How violations occur - 1. Failure to register properly - 2. Failure to fall into an exemption when you believe you did.

o Solicitations for purchase occurred prior to acceptable time, w/ no exemption Elements of Violation: No Injury or Intent required - No proof of injury or intent needed - 1. § 5 violation: there was an unlawful sale of unregistered security. - 2. Interstate commerce: the sale/offer of securities involved interstate commerce. - 3. SOL: the action is within the statute of limitations of § 13.

o 1 year from when they should have discovered and in no event after 3 years. - 4. Privity: must prove that you purchased the security from the seller

o (different from Section 11) (Language states someone “who offers or sells”) - 5. Affirmative defense of loss causation.

A. Persons liable: “SELLERS”: Pinter v. Dahl

a. Rule: § 12(a)(1) extends liability for selling unregistered securities to sellers, and brokers/solicitors, but not to gratuitous solicitors or people peripherally involved in the sale.

i. Need more than just solicitation to be considered a seller, need to be paid for solicitation or services or provided a commission.

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ii. Attorney’s who are paid at an hourly rate are usually not considered sellers (Because they don’t have a stake in whether the security sells or not. However, if they have a financial interests in the sale then a lawyer may be considered a seller)

B. For an action under 12(a)(1) it is strict liability, no reliance is required, no intent is needed, and no causation is needed. However, there is an affirmative defense of loss causation

C. Remedy: The remedy for violations is rescission of the security for the original consideration. If P sold the security, he may recover the original consideration minus the value received.

12(A)(2) MISREPRESENTATIONS IN PUBLIC OFFERINGS

A. Background: if a security is sold through a false or misleading prospectus or oral communication, through an instrumentality of interstate commerce, the purchaser is entitled to rescission.

a. Only applies to public offerings! (Gustafson) 1. Consequently, private placements and Rule 506 offerings are loopholes.

B. (1). G/R: Elements of a Cause of Action under §12(a)(2): to bring a cause of action for rescission under §12(a)(2):

a. 1. The prospectus or oral communication regarding prospectus must have contained a material misstatement of fact made by the sellers;

b. ���2. The sellers did not sustain the burden of proving due diligence; then c. 3. The buyers would have the right to obtain rescission if those misstatements were made

by means of prospectus or oral communication. C. Proof: Reliance is not required under §12(a)(2); indeed, a plaintiff need not prove that he ever

received the misleading prospectus. D. DEFENSES

a. Loss Causation: the defendant may avoid all or part of the damages that otherwise would be incurred by proving that all or part of the depreciation in the value of the securities in question resulted from factors unrelated to the material misstatements or omissions.

b. Due Diligence Defense: Nonculpability is a defense. The seller must show he did not know and “in the exercise of reasonable care” could not have known of the misinformation.

i. Since Pinter v. Dahl Courts have refused to apply 12(a)(2) liability to aiders and abettors.

E. Liability of Control persons: a. Persons who control any person liable under §11 and §12 are jointly and severally liable to

the same extent as the person who is controlled. b. Control persons have a defense “if they did not know, and had no reason to know, of the

facts on which liability is based.

MATERIALITY OF INFORMATION

A. Objective test: The general rule is whether there is a substantial likelihood a reasonable shareholder would consider the non-disclosed information important in voting, purchasing or selling then it is material.

a. Bespeaks Caution Doctrine: Statements of opinion and forward-looking statements of future projections are deemed immaterial as a matter of law, so long as they appear with sufficient cautionary language warning about the uncertainty of the statements.

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b. Buried facts doctrine: disclosure of material information in a way that it is obscured or difficult to ascertain or notice, is inadequate.

B. Truth On The Market: there will not be an material omission if info is not included but the info was available in the market (when everyone knows the info because it is already in public knowledge)

C. Absent a duty to disclose, the omission of a material fact is not actionable. D. Future Possibilities as Material:

a. Probability vs. Magnitude test1 i. Something that has only a limited probability of occurring but a huge magnitude

may be considered material, needing disclosure. E. Rule 303(c), Regulation S-K F. Information about Management Integrity

a. SEC line item disclosure rules require information about management incentives (compensation, conflict of interests,) Management integrity (lawsuits involving personal insolvency, convictions, stock fraud) and management commitment to the company (stock ownership, stock as security for loans)

G. Disclosing pending litigation a. Environmental suits involving damages >10% of current assets.

10(b)(5) SECURITIES ANTI-FRAUD RULE

10b(5) Elements:

- 1. In connection with o (Close enough to a security transaction that we can say it touched the transaction, close in

time, causally related, not a hard standard to meet) o Misrepresentation of financials when attempting to purchase another company is “close

enough” - 2. The purchase or sale of a security

o Must actually have a purchase or sale, can’t have fraud that deterred you from purchasing or caused you to not sell.

- 3. A material o Substantial likelihood that a reasonable investor would consider it as altering the “total

mix” of information in deciding whether to buy or sell. o Manipulation:

§ Activities that manipulate the price of securities by creating false appearances of market activity can have the same effects as false statements and can be actionable.

- 4. Misstatement or omission of fact was made o Must be material for both actual facts and projection for the future. o Silence does not equal fraud, unless there is a duty to disclose.

- 5. Upon which plaintiff relied o P must provide evidence that they acted or relied on misstatement. o Reliance: To state a 10b-5 claim, P must show reliance, but this requirement is loosely

interpreted. Sometimes reliance may be presumed (subject to rebuttal)

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o when there is: § 1) a face-to-face transaction, § 2) a material omission, and § 3) a fiduciary relationship b/w P and D. Affiliated Ute Citizens v. US.

• Reason for this switch is that fraud was set up under a historical account where fraud occurred face to face, so now sometimes it is presumed there was fraud and burden switches to D to disprove.

§ “Fraud on the Market” Theory • In cases of false or misleading statements on a public trading market “Fraud

on the Market Theory” applies finding that a misstatement affects the price of the security based on the efficient market hypothesis and this is the basis of decision-making.

o Defense to Fraud on Market theory: § 1) Misrepresentation did not affect the stock price § 2) Particular P would have bought anyway.

- 6. That was made w/ scienter (or was reckless for not knowing it)

o Not enough simply to say that the D must have knew must at least list a few facts to support assumption in complaint.

- 7. That caused a but for cause: and loss cause: o But-For: But for the D’s fraud, P would not have entered into the transaction. o Loss Causation: P must show the misrepresentation was the cause of the loss, not just a

link in the chain. § Fallone’s boat hypo: a company owns 1 single ship that it uses for exporting. It

states that the ship can hold 500 ft of cargo, when in fact it can only hold 300 ft of cargo. The ship is not insured and is sunk in a storm. The stock collapses. Is there loss causation? No, because the misstatement, that the boat could hold more than it actually could, was not related to the loss, the boat sinking in a storm.

- 8. Damages o The difference between what you paid for the security and what it was worth at the time of

the lawsuit, plus interest.

PRIMARY VIOLATORS: 10b(5) Defendants

- Any person who makes false or misleading statements and induces others to trade to their detriment (primary violator) can become liable.

- Control persons liability o Exchange act imposes joint and several liability on any person who controls a primary

violator o “Control persons” are liable for securities violations of controlled wrongdoers if

§ 1) actually exercised general control over the wrongdoer’s operations, and § 2) had the power to control the specific transaction creating the liability, unless

the D proves good faith or mere negligence. - Aiding and Abetting:

o the SC has held that there is no aiding and abetting liability under Exchange Act §10(b)/Rule 10b-5 for private suits. Central Bank of Denver v. First Int’l Bank of Denver.

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§ Case: Cent. Bk of Denv. v. First Int’l Bk of Denv. (No Aiding and Abetting liability under § 10(b)/Rule 10b-5 for private suits)

• Facts: When an indenture trustee allowed a bond issuer to violate its covenants, a bondholder sues the trustee for aiding and abetting securities fraud.

• Subsequently, SEC may pursue these actions thru enforcement actions. • Rule: There is no aiding and abetting liability under ’34 Act § 10(b) or Rule

10b-5 for private suits. - Secondary actors: Secondary actors primarily liable if they are substantial participants in the

fraud, considering their role in preparing and approving the misstatement. (Wright v. Ernst & Young – aiders cannot be primarily liable unless they made a misleading statement to investors.

o In order for an aider and abettor to be liable there must be: • 1. Existence of primary violation • 2. Knowledge of violation • 3. Substantial assistance

MATERIALITY AND DUTY TO DISCLOSE

- -1. Possession: o Corporations possessing material nonpublic information have no duty to disclose it, even

to counteract misimpressions/rumors, as long as the corporation itself did not cause the misimpressions.

- 2. Duty to correct: o If you said something that you thought was true when you said it but you later find out that

it is not true you have a duty to correct. o If the corporation supplies financial information to third parties, it acquires the duty to

correct those third parties’ mistaken statements. § However, if a third party independently writes a story about a future product

without influence the Co. has no obligation to correct. § Silence does not equal fraud absent a duty to disclose.

- 3. Duty to Update: o Abbot labs: 7th circuit said that there is no obligation to update. o Split in circuits: o 2nd Circuit: TimeWarner: If a corporation issues a press release saying it is pursuing a

business goal with a stated approach, it has a 10b-5 obligation to disclose when alternate approaches are under active consideration, if the original information has become misleading. In re Time Warner Securities Litigation.

§ Rule: If a corporation makes a press release about a stated goal and its approach to achieving it, it has a duty to disclose when alternative approaches are under active consideration.

- 4. Half Truths: o if a security issuer makes a voluntary statement that is only half of the truth, it acquires the

duty to speak completely and avoid half-truths. o Pg 727: Would it be a half truth that it was committed in strategic plan, however it doesn't

declare that the CEO opposed it? § Yes, this likely qualifies as a half-truth and would need correcting.

- 5. When the Company is in the Market for its own securities:

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o Must disclose what it knows, if company is selling in a public offering or a buyback then it must disclose what it knows because this creates a fiduciary responsibility with those on the other side of the transaction.

§ Case: Jordan v. Duff & Phelps, Inc (close corporations must disclose material information to shareholders)

• Facts: Closely-held company’s employee left and sold back his shares just before a merger would have increased their value. He sued, contending the corporation should have disclosed the merger plans.

• Rule: Closely-held corporations have a duty under 10b-5 to disclose material information about their securities to at-will employees and shareholders when the plan a share repurchase.

- 6. Listing Standards: o New York Stock Exchange, upon becoming a member you must “promptly” disclose

material information even if usually it wouldn’t have to be disclosed. o If you violate this standard, there is no private right (ie wont get sued for fraud) however,

the NYSE might kick you off. (big company probably doesn’t have to worry)

§ Reality of disclosure: • Regulation S-K must be filed ever 90 days, which requires managerial

disclosure where material information must be released, even if not required voluntarily.

o (Really just a question of how long you can keep it secret.) Manipulation

- Manipulation: manipulation is a term of art in the securities field and it refers to certain practices, such as matched orders, wash sales, or rigged prices, that are designed to mislead investors by artificially affecting market activity, including the price of the subject company’s securities.

- Generally, to find manipulation under §10(b) it has to be proven that the defendant engaged in the transactions in questions with the specific intent to solely affect the market price of the securities at issue.

(9)(a)(2): Prohibition Against Manipulation of Security Prices: generally, to prove manipulation under §9(a)(2) [which is more difficult than under §10(b)], the following elements must be shown:

1. that the defendant effect a series of transactions in a security registered on a national securities exchange;��� 2. creating actual or apparent active trading in such a security, or raising or depressing the price of such security;��� 3. for the purposes of inducing the purchase or sale of such security by others.

SECURITIES LAWYERS’ DUTIES A. Basic obligations: lawyers basic professional obligations are set by legal ethics codes. Additional

rules arise under the SEC’s dictates under Rule 102(e) and “aiding and abetting” caselaw. a. Case: In re Keating, Muething & Klekamp (SEC may sanction or suspend law firms

involed in securities violations) i. Facts: law firm negligently prepared misleading securities filings. The SEC sought

to require better supervision and a temporary suspension. ii. Rule: SEC may use Rule 102(e) to sanction law firms involved in securities

violations.

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B. Aiding and Abetting: lawyers are liable for aiding and abetting securities fraud if they participate in a securities transaction knowing it was based on materially misleading information.

a. Opinions: they are only liable for opinions if the opinion enables the transaction, but are not liable for failing to retract opinions after the transaction. SEC v. National Student Marketing Corp.

b. Attorneys are liable for aiding and abetting securities fraud if they participate in a transaction knowing it is based on materially misleading information

C. Duty to Act: lawyers who regularly handle securities disclosure, and who become aware their client is committing violations, must act promptly and reasonably to stop the violations. Rule 102(e).

INSIDER TRADING

A. Definition of Insider Trading: Insider trading is any unlawful trading by those in possession of material nonpublic information. The prohibition is justified on the ground that it fosters investor confidence by providing them with a reasonable assurance that they are not at an unfair and insurmountable informational disadvantage vis-à-vis a select group of insiders.

a. Duty to disclose: there is a duty to disclose nonpublic information held by certain insiders. Corporate insiders are barred from trading on inside information based on duties oweed to shareholders. These duties would require the disclosure of that information before trading on the market.

b. Possession is not enough: possession of material nonpublic information does not, alone, create a duty to disclose prior to trading on the market. Chiarella v. US.

i. Case: Chiarella v. US (Duty to disclose material nonpublic information must arise from a fiduciary relationship)

1. Facts: After finding the identity of several targets of a takeover bid, without ever disclosing that information the employee purchased shares in the target companies and sold the shares after the takeovers were publicly announced.

2. Rule: Abstain or disclose. 3. Assessment: The holding in Chiarella has been read to negatively imply

that the duty to disclose arises from the existence of a fiduciary relationship with marketplace traders.

A. Materiality: as in other areas of securities law, insider trading standard of materiality is the reasonable investor/total mix formulation. SEC v. Bausch & Lomb Inc.

OUTSIDER TRADING: - Where corporate information is revealed to underwriters, accountants, lawyers or consultants and

the corporation expects the information to remain confidential, these professionals become fiduciaries of the shareholders. Dirks v. SEC.

THE MISAPPROPRIATION THEORY

A. Misappropriating confidential information: a person commits fraud “in connection with” a securities transaction (violating § 10(b) and Rule 10b-5, when he misappropriates confidential information for security trading purposes. US v. O’Hagan. (extending the misappropriation theory to outsiders)

a. Case: US v. O’Hagan (non-traditional outsiders commit insider trading when he misappropriates confidential information in breach of a duty owed to the source of the information)

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i. Facts: SC upheld the conviction of an attorney who purchased and sold securities using confidential information about a tender offer his law firm was hired to work on.

ii. Rule: The use of confidential information obtained as a result of a fiduciary relationship served as the deception necessary under § 10(b) and was “in connection with” the subsequent trading.

b. Limits on Theory: There is no deception where 1) the misappropriator discloses his intent to trade on the information, prior to transacting in the marketplace, and 2) the misappropriator must have a duty to keep the source’s information confidential.

B. What type of relationship suffices for the misappropriation Theory? The SC has been silent on the issue of what kind of relationship is necessary for this theory to be applicable. However, the theory has been applied in cases involving partners, employees associated w/ acquiring companies, investment bankers, lawyers and printers. Familiar ties do not necessarily give rise to a duty to keep the information confidential.

C. Misappropriation is governed by state law! RULE 14e-3 – KNOWLEDGE OF IMPENDING TENDER OFFERS

A. Tender Offers: pursuant to the rule-making power granted in the Williams Act, the SEC has prohibited all people from trading based on knowledge of impending tender offers.

B. Rule 14e-3: prohibits all people from acquiring any securities of the target of a tender offer when that person possesses information he has reason to know is nonpublic and was acquired from the bidder, target or a person affiliated with either. This power was upheld in US v. O’Hagan.

TIPPERS AND TIPPEES

A. Tipper/Tippee Liability Defined: this liability deals with situation where a corporate insider passes along nonpublic information to a person who then trades using that information.

a. Corporate outsider: a corporate outsider who trades on nonpublic information obtained from a corporate insider may be liable for securities fraud if the corporate insider communicated the information in breach of his duty to the shareholders. Dirks v. SEC.

i. Case: Dirks v. SEC (Rule: corporate insider’s breach their duty to shareholders when they disclose information for personal gain)

b. Eaves Dropping: overhearing a conversation by a third party is not deemed a tip. SEC v. Switzer.