SECURITIES REGULATION

I. Common Law Remedies

a. Tort of Deceit (Fraud)
i. false representation
ii. of a material fact
iii. known to be untrue
iv. made for purpose of deceivng plaintiff
v. upon which plaintiff justifiably relied
vi. from which plaintiff suffered damages as a consequence
b. quitable remedy of !ecission
i. misrepresentation of a material fact
ii. on which buyer relied
iii. in a transaction buyer never ratified
II. Mandatory Disclosure
a. "ro#mandatory disclosure argument$ provides more information to the markets%
omissions wont be covered otherwise% instills more confidence in capital markets
b. &nti$ disclosure is costly' market should demand the optimal amount of disclosure
anyway
c. vent studies look at amendments to (( &ct disclosure obligations
i. "roblems$ when do you begin measuring impact$ passage) nforcement)
ii. !esulted in abnormal e*cess returns mandatory disclosure is good+)
,. but could be for other reasons
iii. international study (schleifer)$ increased disclosure led to increased si-e of
financial markets% more liquidity etc
,. these markets might demand more disclosure . causality could be
reversed+
III. IO Allocation and ricin!
a. Standard IO rocess
i. /ead 0nderwriter 1 2elling 3roup (allotment)
,. 3ets firms together to sell
4. &llocates securities to members in group
(. stablishes offering price shortly before sale through 5bookbuilding6
(v. bought deals% which are done quickly)
7. "erforms price maintenance after sale
8. "urchases by underwriter
9. &nti#flipping clauses
:. ;nsider lock#ups
ii. Underwritin! " #asic Structure
,. <ethods
a. 5firm commitment6 # firm purchases securities from issuer to
sell to public at agreed upon offering price
b. underwriting syndicate (firm) # including agreement with issuer
and between underwriters.
c. 5gross spread6 = difference between issuer price and public
offering price (( parts) # usually :>
d. ?ompetitive process because underwriters risk in firm
commitment (slow sale and inability to sell tie up capital% affect
reputations)
4. 5best efforts6 # broker#dealers agree for fee to use best efforts to sell
securities at agreed price
a. 5straight6 = any securities sold closes deal
b. 5mini@ma*i6 = minimum amount must be sold for deal to close
(proceeds in escrow)
c. 5all or none6 = all must be sold for close
d. & !ule ,8c4#7$ not allowed to close out an offering before
satisfying stated conditions
iii. Agreement among the Underwriters $
,. Notice to underwriters$
a. Aumber of shares%
b. Time at which attorney power can be revoked% ?ompensation
c. Allotment of shares to each underwriter. ;mportant for (,)
compensation% (4) liability limitation (by B of shares)
d. The shoe = Cverallotments. ;mportant because of (,)
2ometimes there are more shares than anticipated% the option to
purchase more shares is 5green shoe6 option% (4) stabili-ing =
manager buys back some shares in aftermarket (this number is
limited by A&2D)
e. Anti-flipping Clause. "enalty for members whose shares flip.
iv. Agreement between Underwriters and Issuer
,. "rice to be paid
4. ;dentification of syndicate members
(. ?lause mandating disclosure to security holders
v. To protect underwriters$
,. Insider oc!-ups. <anagers cannot sell shares for ,DE days after ;"C
4. "ar!et #ut Change. ?lause permitting underwriters out if (,)
restrictions on trading of securities% (4) war% (() material adverse
change in markets% (7) material adverse affect to issuer. ACT good
form to e*ercise this clause
(. Indemnification Clause. 0nderwriters are not liable for error in
registration@prospectus.
7. Contribution Clause. /iability F fault.
8. Comfort etter. From issuer to underwriter certifying truthfulness of
information = way for underwriters to get out of liability (fraud% etc.)
$. IO issues
i. Ghy are ;"Cs underpriced in the short term ) # avg. price increase of ,D.D>
during ,
st
day.
,. Firms are risk#averse
4. &dvantages in aftermarket (post#initial)
(. A%oidance o& lia$ility for overpricing
7. 52pinning6 # selling to other companies about to go public to flip in
order to build relationship
ii. 2hould ;"Cs be sold at one fi*ed price )
,. 2? requires price in prospectus
4. A&2D has anti#discounting rule
iii. Gays to circumvent$
,. Designated Crder Technique # offering free research% etc. for overall
discount
4. Cvertrade@2wap # e*change of securities buyer already owns that are
worth less
(. !ecapture # institution forms a broker#dealer subsidiary and buys stock
at a discount% then turns the stock over to parent institution (= overall
discount).
iv. Do December 4EE7 "roposed ;"C !ules (AH2% A&2D% 2?) make sense)
,. <ajor concerns$ ;"C underpricing allows underwriters and managers
to benefit at e*pense of issuers
4. "rohibits allocation of ;"C stock to$
(. ?ustomers (mutual funds) as quid pro quo for e*cessive commissions
7. ?ustomers (future issuers) as quid pro quo for future business
8. ?ustomers (brokerage clients) as quid pro quo for buying future 5cold6
issues
9. Cfficers@directors of e*isting or prospective ibanking clients #
5spinning6
:. "articular individuals selected by underwriters
D. Ao commissions on flipped shares unless anti#flipping penalties
uniformly assessed@enforced
I. !equires e*tensive disclosure to issuers about allocations of issue
,E. !estrictions on 5laddering6 # requiring purchasers to support price in
aftermarket
c. IO Alternati%es
i. Dutch &uctions% eg. 3oogle
,. &ll bids above clearing price (price at which all offered shares can be
sold) accepted at clearing price (might be lower than bid)% typically use
pro#rata allocation (of all accepted bids) instead of the highest bidder
receiving all requested shares.
4. Did not prevent money being left on the table (but this may be
e*plainable by investor hesitation to enter into this type of ;"C).
(. Did remove incentive@possibility of ;"C allocations to favored
customers% but did it increase underwriting fees) (0nderwriters didnJt
get any soft compensation b@c shares were automatically allocated% so
they may have charged moreK)
7. *ample$ ;ssuer offers to sell ,EE shares
a. & bids for 8E shares at L,E
b. M bids for 7E shares at LD
c. ? bids for 4E shares at L9 ?learing "rice = L9 (,,E shares)
ii. 5Ghen ;ssued6 <arket # ;llegal at the momentK
,. 2tock can be traded before itJs issued (as in Treasury bill market
securities)% which would allow issuer to price offering at 5market.6
4. 5short#selling6 = selling when you donJt have anything # what
happens) There are many outstanding securities to fulfill N (even if
not the issued ones).
(. 2? effectively prohibits through restrictions on (a) short sales
(cannot cover shorts with ;"C issued securities)% !ule ,E8% and (b)
trading unregistered securities
I'. T(e Re!istration rocess
a. Types of ;ssuers$
i. )ell"*nown Seasoned Issuer (!ule 7E8) = L:EEm in public equity float%
eligible to use Form 2#( (if has issued L,bO in registered debt% GN2; for
purposes of issuing non#convertible debt% unless it also has L:8O million
public equity float% in which case it is GN2; for equity also) = (E> of issuers%
I8> of 02 market capitali-ation
ii. Seasoned Issuer% /arge !eporting ?ompanies # uses Form 2#(
,. !eporting and 2easoned $ ,4 mo. timely *change &ct reporting (must
report if over 8EE shareholders% whether or not listed)
4. /arge $ L:8mO in public common equity float (preferred stock not
included)
iii. Unseasoned Issuer$ ;"C or does not qualify for 2#(
iv. Ineli!i$le Issuers$ shell or penny companies% or bad actors (violators of 2?%
etc.).
b. 2ection 8 of the J(( &ct$
i. 5(a): No Sales before Registration Statement Effective
,. (a) 0nless a registration statement is in effect as to a security% it shall
be unlawful for any person% directly or indirectly
a. (,) to . . . sell PaQ security through the use or medium of any
prospectus or otherwise' or
b. (4) to carry . . . in interstate commerce . . . any . . . security for
the purpose of sale or for delivery after sale.
ii. 5(b): After filing, no written offers without prospectus conforming to S.!
,. (b) ;t shall be unlawful for any person
a. (,) to . . . transmit any prospectus relating to any security wit(
res+ect to w(ic( a re!istration statement (as $een &iled
under this title% unless such prospectus meets the requirements
of section ,E' or
b. (4) to carry . . . any such security for the purpose of sale or for
delivery after sale% unless accompanied or preceded by a
prospectus that meets the requirements of subsection (a) of
section ,E.
iii. 5(c): No offers to bu" or sell #uring pre$filing perio#
,. (c) ;t shall be unlawful for any person . . . to offer to sell or offer to
buy through the use or medium of any prospectus or otherwise any
security% unless a registration statement has been filed as to such
security% or while the registration statement is the subject of a refusal
order or stop order or (prior to the effective date of the registration
statement) any public proceeding or e*amination under section D.
c. ;mportant definitions useful to R8
i. ISSUER, -./01 " 2&n issuer is any person who issues or proposes to issue
any securityK6
ii. UNDER)RITER, -./a1/331 " 2&n un#erwriter is any person who has
purchased from an issuer with a view to% or offers or sells for an issuer Psee
belowQ in connection with% the distribution of any security. . . ' but such term
shall not include a person whose interest is limited to a commission. . . . not in
e*cess of the usual and customary distributorsJ or sellersJ commission6. Note$
&s used in this paragraph the term issuer shall include any person directly or
indirectly controlling or controlled by the issuer or under common control
with the issuer $istribution$ not defined in statutory% defined by case law%
basically the same definition of 5public offering6
iii. DEALER, -./a1/3.1 " 2& #ealer is any person who engages either for all or
part of his time% directly or indirectly% as agent% broker% or principal% in the
business of offering% buying% selling% or otherwise dealing or trading in
securities issued by another personK6
iv. ROSECTUS, -./341, P& prospectus meansQ 5&ny prospectus% notice%
circular% advertisement% letter or communication% written or by radio or
television% which offers a security for sale or confirms the sale of any
securityK6
d. Transactional *emptions # -0/31 5 /.1
i. - 0. "rovisions of R8 shall not apply to$
,. transactions by any person other than an issuer% underwriter% or dealer
4. transactions by an issuer not involving any public offering
e. Lia$ility 6or 'iolation o& Section 7,
i. 3./a1/31 , &ny person who sells security in violation of R8 is liable to the
person purchasing such security.
&. )(en is a re!istration statement 2in e&&ect89
i. &utomatic # -: of ,I(( # 4E days after filing
ii. stablished
,. Rule 0;< # dela%ing amendment filed w@!2 postpones effectiveness
until after 2? review (This is A&A'( used.)
4. !ule 79, # request for acceleration of effectiveness filed with
registration statement = immediate offering upon completion of 2?
review (otherwise 4E days)
(. Rule 0=3/$1 # 2? can den% request these grounds$
a. Ao effort to make prospectus in plain nglish
b. "reliminary prospectus is inaccurate or inadequate
c. 2? is currently investigating issuer
d. Cne of the underwriter does not meet financial responsibility
requirements
e. &n interested party has taken part in transactions artificially
affecting market price
f. ?ompensation hasnJt been cleared by A&2D
!. re"6ilin! eriod /Gun">um+in!1
i. Ghen does the period begin) Ghen you reach informal agreement with
underwriterK
ii. %asic &rohibitions:
,. No sales, 8(a)
4. No o&&ers to $uy or sell, 8(c)
a. ssentially any communication can be considered an offer to
sell unless there is an e*ception
b. !elease (D77$ &ny communication that conditions the market
or arouses public interest is considered a solicitation of an offer
to buy
iii. E?ce+tions to ro(i$itions on O&&ers to Sell Durin! re"6ilin!,
,. "erson releasing information
a. R 7(,) # &nyone other than issuers% underwriters% dealers
b. R 4(() # "reliminary negotiations between issuer and
underwriters
.. Researc( Re+orts $y #@Ds,
a. Rule 3;< /NON"ARTICIATING A ANBTCING1
i. Mroker#dealer ACT participating in the distribution can
publish research reports on all issuers at all times if not
receiving any compensation from anyone in the
offering and publishes report in ordinary course.
b. Rule 3;: . (ARTICIATING A DI66 SECURITIES)
i. broker#dealer can publish research reports on usual
business information on securities of a RE&'R()N*
issuer that are a different type than those being
distributed.
c. Rule 3;D . /artici+atin! $roEer"dealer A ANBTCING1
i. /a1/31 /Issuer Re+orts1 can publish information he@she
would have done anyway on specific issuer if has done
so in the past% not a re#initiation of reporting ;F ;ssuer is
a seasoned issuer )(-*+ and not bad actor
ii. /a1/.1 /Industry Re+ort1 can publish information
he@she would have done anyway on industry if (i)
includes similar info on substantial number of issuerJs
industry@sub#industry% or contains comprehensive list of
securities currently recommended by issuer% (ii)
analysis of issuer given no particular prominence% and
(iii) issuer is reporting,listed company and not bad
actor
(. Rule 3=; $ GN2; FG"
a. 3=;, )S*I 6ree )ritin! ros+ectus E?em+t &rom 7/c1 at
all times as long as$
b. There is an appropriate legend directing potential buyers to
look at prospectus% and one will be sent (or an email
address@website listed to find this info)(,9((b)(,)) &AD
c. The free#writing prospectus is filed with 2? when !2 is filed
(,9((b)(4)).
d. Oral and written o&&ers ONLB $y issuer
e. Note$ basically% violations of the above are N#T violations of R
8(c) as long as issuer makes good#faith effort to conform to the
rules.
7. Type of information released #B ISSUER
a. Rule 3;7 , NOTICE /any$odyF1
i. . "ermits basic notice ;A &AH <D;0< of a public
offering by the issuer
ii. /egend stating it is not an offer
iii. "ermissible info$ issuer name% description of securities%
amount of offering% anticipate time% brief statement of
manner and purpose (may NOT name u@w)
b. Rule 3=: (reporting issuers)
i. # &actual $usiness in&ormation G &orward"looEin!
in&ormation (for big boys only) (in ordinary course)
+,N-ER.R)(ERS -' N'( /,A0)123
c. Rule 3=D (anybody)
i. # actual business information (in ordinary course)
+,N-ER.R)(ERS -' N'( /,A0)123
8. Timing of information release #B ISSUER
a. Rule 3=;A , ;4 DABS
i. " communications ;4 days or more $e&ore &ilin!
e?em+t &rom 7/c1
ii. so long as do not reference the offering (must take
reasonable steps to prevent further distribution within
(E days)
iii. ros+ecti%e UNDER)RITERS NOT ROTECTED
(. )aitin! eriod
i. -asic .rohibition$
,. do not want communications to be deemed improper prospectus under
8(b)
4. prospectus defined broadly as any written communication including
TS or radio
ii. ros+ectus Deli%ery O$li!ation (Rule 37/c1.": of J(7 &ct)$
,. requires participating b@ds to deliver preliminary prospectus to those
who make written requests for one
iii. ermitted Sellin! Acti%ities Under 7/$1/31 @ #asic E?em+tions
,. "ermits C!&/ selling efforts (for bookbuilding)
4. allows tombstone ads 2../a1/341/$1
(. "reliminary "rospectus (Rule 0;41
a. "rior to the effective date of an !2% R8(b)(,) is satisfied by the
use of a prospectus that includes$
i. substantially the same info that will ultimately appear in
the final prospectus under R,E(a)% e?ce+t
ii. prelim. prospectus ma% e/clude offering price 0 other
info dependent on offering price
b. Mears a legend like the old red herring and the caption
5"reliminary "rospectus.6
7. 6ree )ritin! ros+ectuses may be R,E(b) prospectus
a. Ghat is a FG")
i. &ny written communication that constitutes offer to sell
securities subject to offering and that is N#T a
statutor% prospectus or other written communication
permitted or e/empted under other provisions of the
securities laws
ii. &nything on issuerJs website or linked from website
that could be deemed an offer
iii. <edia$ if give them information beyond registration
statement% must be filed (for ;"Cs again this would
require accompanied w@most recent " with price range
which is practically impossible)
iv. !esearch !eports$ can be deemed FG" if donJt fall
undre !esearch !eports safe harbors (;"C ?onte*t
mainly) M0T subjects you to liability under ,4(a)(4)
prospectus liabiliy% which is more stringent than ,Eb#8
disclosure liability that you would have gotten under
the 2T.
b. 1ligibilit%,
i. )*SIs, ?an be used by GN2; at &AH T;< (Rule
3=;)
ii. Seasonsed Issuers, Rule 0;; allows FG" by
2easoned issuers after filing !2 (no prospectus delivery
requirement% just need to notify via legend of filing of
!2 and 0!/ for sec website where receipient can
access prospectus)
iii. Non"re+ortin! @unseasonsed issuers$ allowed to use
FG" if accompanied or preceded by most recent
prospectus with price range (if material change since
last) (if e#FG"% hyperlink to most recent prospectus
qualifies)
c. 6ilin! ReHuirement,
i. & free writing prospectus generally must be filed with
the 2? if$
,. prepared or used by the issuer% if it includes
material non#public information provided by the
issuer' or
4. if it will be posted on a public web site or
otherwise made available by offering
participants in a broad% unrestricted distribution.
(. AC F;/;A3 !U0;!<AT if FG" from
0G to customers through restricted access
website or direct emails
d. ;nformation in FG"$
i. ?annot be inconsistent with "rospectus
ii. "rominent legend advising reader to read prospectus
and how to get it or request it
8. #asic in&ormation +ermitted a&ter re!istration (Rule 3;0)
a. ;nformation allowable$
i. Title of security and amounts being offered
ii. Mrief indication of type of business
iii. "rice of security
iv. Mrief descript of intended used of offer
v. Aame of underwriter
vi. <arketing plans (including place and times of road
shows)
b. ,(7 info NEED NOT #E 6ILED )ITC SEC
c. LEGEND REIUIRED (!2 filed but not yet effective' where
prospectus may be obtained)
9. Rule 3;0/d1 ermits )RITTEN Solicitation o& Interest
a. Ghen ,(7 information accompanied or preceded by prospectus
b. &nd accompanied by legend saying that sale cant be completed
until after effective date
:. Road S(ows
a. "resentations attended by underwriters% officers of issuer%
analysts% sec professionals% institutional investors
i. ACT attended by !T&;/ investors
b. CN if only C!&/ and only prelim prospectus delivered
c. 2? has approved use of electronic media
i. CN$
,. &udio video tapes distributed to specified
individuals
4. Sideo ?onferencing
(. "assword protected access to website to view
7. 2ubject to caveat that cannot be downloaded
and distributed to unqualified persons
d. ?harles 2chwab Ao &ction . allowing access to individuals
with 5significant6 trading e*perience (47 trades annually or
equity position V L8EEN) . high water mark
e. /ive% real#time road shows to a live audience that are
simultaneously transmitted graphically will not be a graphic
communication% and therefore not a written communication% or
a FG". 2o okay. (&?! ,49#,4D)
f. !oad shows that do not originate live% in real#time to a live
audience and are graphically transmitted are electronic road
shows that will be considered written communications and%
therefore% FG"s. 2o may be okay under FG" !ules ,97 and
7((. (&?! ,49#,4D)
D. 6actual #usiness In&ormation (Rules 3=:J 3=D) $y issuers
D. Researc( Re+orts /Rules 3;<J 3;:J 3;D1 $y $roEer dealers
i. ost"E&&ecti%e eriod
i. Masic "rohibitions$
,. 7/$1/.1 $ no sale before delivery (&??22) of a F;A&/ prospectus
that meets the ,E(a) requirements
a. Pthis does ACT apply to unsolicited brokerJs market
transactionsQ
b. ?onfirmations of sale can be sent electronically% but require
consent.
ii. 6ree )ritin!, once prospectus delivery% no restrictions on communications++
iii. IssuerKs O$li!ation to Deli%er ros+ectus, Access EHuals Deli%ery (Rule
3<.)
,. ;. &ccess = Delivery$
a. & final prospectus will be deemed to precede or accompany a
security for sale for purposes of R8(b)(4) as long as$
i. the final prospectus meeting the reqmJts of R,E(a) is filed%
or
ii. the issuer will make a 3F 1 reasonable effort to file it
w@2? as part of the !2 w@in the reqJd !ule 747
prospectus filing timeframe
b. 2eems that thereJs no consent reqmJt
4. ;;. R8(b)(,) says$ if !2 is filed% canJt use a prospectus that d@n meet R,E.
Mut under the wide R4(a)(,E) language% confirmations are prob
prospectusesK hence under Rule 3<.K
a. &fter ffective Date% the following are e*empt from 8(b)(,)$
i. Gritten confirmations of sales% and
ii. Aotices of allocation of securities sold or to be sold
i%. UnderwriterKs ros+ectus Deli%ery O$li!ation,
,. ;"C$ uws must deliver prelim prospectus at least 7D hrs to before
sending confirmation of sale
4. but no final prospectus delivery requirement (acces = delivery) as a
condition of mailing confirmation of sale
(. notice of sale must occur within 4 business days of sale
v. Cffering "articipantJs obligation to deliver ,E(a) prospectus pursuant to 7(()$
Rule 3<;, Notice o& Re!istration$ (no R8 liability for violating)
,. ;n a transaction involving a sale by an issuer or 0G to a purchaser' or
a sale in which the final prospectus delivery requirements apply$
a. not later that 4 days after sale%
b. each 0G or D will give a final prospectus to each purchaser%
or
c. will give notice that such is not reqJd due to !ule ,:4
4. ;nvestor can request a final prospectus.
%i. 6or Cow Lon! A&ter t(e EDJ Must ros+ectuses $e Deli%ered9
,. ;ssuer $ ;ndefinitely% R7(,)
4. 0G or M@D Tolding Criginal &llotment $ ;ndefinitely% for sales from
original allotment% R7(()(?)
(. !esales by Dealers (ie. 2ecurities Firms R4(a)(,4))$ Depends on info
avail on issuer% R7(()(M)
a. IE days after D or ,
st
date of bona fide offering to the public%
if itJs the issuerJs first registered offering% R7(() final sentence
b. 7E days after D or ,
st
date of bona fide offering to the public%
if the issuer has made other registered offerings% R7(()(M)
c. 48 days % if the securities are listed on a stock e*change or
A&2D&U% !ule ,:7(d)
d. E days % if the issuer was a reporting company when it filed its
!2% !ule ,:7(b)
e. E days % if the !2 relates to offerings from a shelf and the
relevant R7(() period has already e*pired for the first time
f. E days % if dealer does not solicit clientJs interest% R7(7)
vii. Rule 3<0 , Deli%ery o& ros+ectus $y Dealers
,. "rovides B of days for which dealers must continue to deliver
prospectuses after D
4. 2ee immediately above for key provisions
(. &ny of the provisions of !ule ,:7% can be satisfied by !ule ,:4
0. 3<0/$1, no +ros+ectus deli%ery reHuirement i& issuer is a re+ortin!
com+any
L. U+datin!@Correctin! t(e Re!istration Statement
i. "C2T#FF?T;S &<AD<AT2 TC !3;2T&T;CA 2T&T<AT
,. "ost effective amendments halt distribution efforts while 2? is
approving
4. /ogical "rogression to determine whether chg to "rospectus reqs
&mendment to !2$
a. /iability stems from R,4(a)(4)% which prohibits sales via
materially deficient prospectuses% which are deficient anytime
(ie. can become deficient over time)
b. ;f changes arise that make the prospectus misleading% or that
add info that now should be reqJd in the prospectus% the
prospectus can be amended.
c. Mut% does the !2 then need to be amended via post#effective
amendment) 2pecifically% R,, liability only judges the !2 at
the time it becomes effectiveK
i. 234)a+ sa%s the prospectus should contain the info
contained in the 5(.
ii. (o6 if language in the prospectus is being changed6 a
post effective amendment to the 5( is re78d so that the
prospectus will still contain the same info as the 5(
iii. -ut6 if new info is added to the prospectus6 it still
contains the same info as the 5(6 so no post effective
Amendment to the 5( is re78d
;. Materiality M
a. ven given this logical progression% the 2? says a material
change merits a post#effective amendment (!elease Ao. 94:9).
b. !ule 747(a)$ substantive changes from or additions to a
prospectus previously filed w@the 2? as part of a registration
need be filed as an amendment to the !2.
c. 2o <ateriality and 2ubstantive are treated as same here
0. SticEerin!,
a. a non#material change allows for a sticker containing the new
information to be placed on the prospectus according to the
procedure in !ule 747(b)(()#(8)
b. STALE ROSECTUS REIUIREMENT, NOT AN
AMENDMENT /NOT NE) LIA#ILITB1 whenever a
prospectus is used VI mo after the registration statement
became effective% the info must not date from more than ,9 mo
prior to use. R,E(a)(() demands that more recent info be
substituted in such cases. This more recent info doesnJt need
to be filed as a post#effective amendment though% can use
stickers' however ten copies of the new prospectus need to
filed w@ the 2? under !ule 74:.
c. GTH "!F! 2T;?N!;A3)
i. 4ust await SE5 Approval of &ost$Effective
Amen#ments6 so distribution must stop until
commission ma!es effective with its power under
(ection 9)c+
ii. 6 0iabilit" cloc7 is reset as of the date of
amendment6 29)c+ : new 1$. .roblem; #nce post-
effective amendment is approved6 it reaffirms all that
then appears in the 5(. (o6 an%thing in the original 5(
that8s no longer true can come bac! to bite %ou. &hole
5( has to be rechec!ed : timel%6 costl%6 and ma% miss
something.
8. REASONS TO AMEND
a. Re!istration Statement Inaccurate )(en 6iled $ if it is later
discovered that the !2 was materially misleading at the time
that it was filed% it must be amended immediately to avoid R ,,
liability.
b. Re!istration Statement #ecomes Misleadin! $ if a post#
effective event makes the !2 materially misleading% the
+ros+ectus % which is part of the !2 PR,E(a)Q% must be updated
to avoid R,4(a)(4) liability' whether this requires a post#
effective amendment to the !2 depends on whether one can
say that the amended +ros+ectus still 5containPsQ the info
contained in the !26 as per R,E(a).
ii. Sec. :, SEC O)ERS TO COMEL AMENDMENT
3. -:/a1, Automatic E&&ecti%eness
a. !2 is effective win 4E days of filing
b. but !ule 7:4 allows for permanent delaying amendment
4. -:/$1, RE6USAL ORDER$
a. 5if it appears to 2? that registration is incomplete or
inaccurate in any material respect 2? may issue an order
+rior to ED of registration refusing to permit such a statement
to become effective6
b. Aot so powerful b@c rror has to be pretty glaring # does not
apply where misleading feature of !2 is not apparent on its
face (ie. where misleading character can only be discerned
from conditions or facts not appearing in the !2)
c. 2? has to be on the ball since refusal order must be ordered
before !2 becomes effective (which can come on fast via 4E
day automatic period)
d. 0nder 8(c)% no offers to buy or sell can be made when refusal
order has been issued
(. -:/d1 STO ORDER /more +o+ular1$
a. ;f appears !2 includes an untrue statement of a material fact or
omits to state a material fact% 2? may issue an sto+ order
suspending the effectiveness of the !2.
b. ;ndicates that 2? has found !2 disclosures materially
misleading.
c. Cnly applies to errors present when !2 became effective
d. D@n apply where post#effective development renders a
previously accurate !2 misleading (similar to R,,)
e. Ghen proper amendment is made% RD(d) stop order is lifted
f. 0nder 8(c)% no offers to buy or sell can be made when stop
order has been issued
7. -:/c1 SEC ARO'AL O6 AMENDMENT,
a. an amendment filed after the D of the !2 shall become
effective on such date as the 2? may determine% having due
regard to the public interest and protection of investors
7. -:/e1 M IN'ESTIGATION
a. Aot public
b. Mut% triggers 8(c) bar if !2 is not yet effective
9. 2ec. D&, 2? can obtain a cease and desist order
:. !efusal or stop order triggers Wbad boyJ disqualifier
iii. )ITCDRA)AL o& t(e Re!istration Statement
,. 2? &cquiescence !equired $ ;f issuer wants to abandon the effort%
may w@draw !2 or amendments thereto if 2? does not object within
,8 days of the withdrawal notice' if 2? finds the w@drawal consistent
w@the public interest and protection of investors theyJll not object
(!ule 7::)' however even if G@D% ?ommission often publishes
opinion setting forth deficiencies to inform investors
i%. RI'ATE ACTIONS, RIGCT O6 RESCISION
,. Sec. 3./a1/31, if sell or offer in violation of 2ec. 8(b) (5unlawfulK.to
sell security unless accompanied by prospectus that meets 2ec. ,E(a)6)
Kliable for consideration paid w@ interest less income received C!
damages
4. Sec. 3./a1/.1, any offer by means of prospectus or oral
communication which contains an untrue statement or material fact
(donJt need to have violation of 2ec. 8) and cant sustain MC" that
didnJt know of untruth shall be liable to purchaser
'. Inde+endent Researc( Analysts
a. .44;@.440 Settlement on In%estment #anEin!@Researc( $
i. &pril 4EE( 2ettlement (,E firms) plus &ugust 4EE7 (4 firms)
ii. Total cost = L,.8M
iii. 2? and 2tate Fines$ L848<
iv. 2? Sictims Fund$ L7,:<
v. ;nvestor d$ L,E8<
vi. Funding 5independent6 securities research$ L79E<
vii. 2tructural ?hanges
,. 2eparate !esearch and ;M
4. &nalyst comp cannot be based on ;M revenues and cannot be
determined by ;#Mankers
(. &nalysts cannot market securities being underwritten (eg. no road
shows)
7. !esearch reports must disclose that company may seek to do bi-
w@covered firms
viii. ?omments$
,. 2o this settlement creates a regulatory regime through the process of
settlement b@c the firms in the settlement reflect some huge > of the
total market
4. Ao hearing% no legislative action% etc. ;s this the right approach)
b. Re!ulation AC . analyst certification mandated by section 8E, of 2arbanes#C*ley
i. ?ertifications in research reports$
,. Siews are those of the analyst
4. !elation between research and compensation
ii. ?ertifications in connection with public appearance
,. Siews are those of the analyst
4. Ao part of compensation depends on views
(. Neep records of public appearances
S;. fficient ?apital <arkets Typothesis
a. ?<T$
i. Geak$ The market incorporates all information based on past prices
,. 2tudies show prior prices are independent of each other% ie. canJt
e*trapolate future price from past price changes only
ii. 2emi#strong$ the market incorporates all publicly available information
,. ?onsider$ 2ince the theory assumes info is incorporated quickly% it
may be that the actual presence of this version fluctuates with factors
like amount of analyst coverage% number of sophisticated institutional
investors holding securities.
4. Cpen U$ This version suggests investors canJt generally beat the
market. ;f thatJs true% why even try% ie. why study the info thatJs
released) &nd if so% doesnJt that undermine the idea underlying this
version% ie. that people study the info released and act on it)
iii. 2trong$ <arket incorporates &// information
,. Ao empirical info to support e*istence of this form
b. Aoise # "ricing influences not assocJd w@rational e*pectations about asset values
i. Fads% fashions% seasonal effects% behavioral finance critique% see below
ii. mpirical evidence% and trading strategies of major market participants
suggests markets are quite noisy
iii. Mehavioral Finance critique of the !ational ;nvestor Typothesis
,. Sarious psychological elements cut against ?<T$ /oss &version'
?ognitive ?onservatism' Cver#reaction to new info' Terd influence'
Cverconfidence
c. ?onsequences of Disproof% i.e.% irrational investor base)
i. Ao regulation of securities% b@c disclosure wouldnJt make a difference anyway
ii. Mut not all people are irrational all the time% so it can be useful.
'II. S(el& Re!istration
a. ;ntegrated Disclosure
i. <ove to eliminate duplication due to disparate J(( and J(7 &ct reqmJts
ii. Two main features$
,. 2tandard disclosure reqmJts for docs filed under both the J(( and J(7
&cts
a. !eg 2#X for financial items
b. !eg 2#N for non financial items
4. &llow large companies to satisfy J(( &ct registration stmt reqmJts for
company (but not transaction) specific info% by incorporating info
from J(7 &ct filings (eg. ,EN% ,EU% DN)
iii. Forms$
,. 2#,
a. ?ertain reporting issuers may incorporate by reference into
their 2#, info from their previously filed J(7 &ct reports@docs
b. ligible issuers have filed at least one annual report and that
are current in their reporting obligation under the W(7 &ct
c. ?onditions
i. <ust update for material changes not yet reported in a
J(7 &ct report of some kind (,EN% ,EU% DN% etc.)
ii. <ust make the incorporated reports eligible% either via
an issuer web#site containing them% or hyperlinks to
dgar
iii. Ao 5forward incorporation by reference6 of docs filed
post ffective Date
iv. <ust include a list of the incorporated reports and
materials
d. ;f the issuer is not eligible for these new 2#, options%
presumably% theyJre relegated to the old 2#, conditions% as
below
i. !equires complete disclosure in prospectus
ii. Ao incorporation by reference
iii. "robably typically used in ;"C situations
4. 2#(
a. Used b%$ !egistrant who has been in the J(7 &ct reporting
system for ,O yrs' and% if offering new equity securities has a
min public float of L:8<% or if offering investment grade debt
no float re7m8t
b. ;nfo on registrant is fully incorporated by reference to J(7 &ct
reports
c. Aot reqJd to include info on registrant in prospectus unless
thereJs a material change
d. Aote$ !elies on ?<T
$. S(el& Re!istration /Rule 0371
i. 2ummary$
,. <ust qualify for 2helf !egistration% !ule 7,8(a)(,)
4. &llows continuous or delayed sale of securities covered by 2helf
!egistration statement
(. <ust file 2helf !egistration statement with 2?
7. /imitations% !ule 7,8(a)(4)#(8)
8. "ost#ffective &mendments to !egistration 2tatement$
a. &ll issuers must amend !2 for material changes in plan
b. of distribution
c. Aon 2#( issuers must amend for 5fundamental6 changes in
material facts% 2#(Js for non#incorporated (by prior reports)
material changes
ii. Rule 037,
,. /a1/;1 ReHuirement to U+date t(e RS% under 8,4(a)(,) of !eg 2#N$
a. 2#( filers donJt need to constantly update the 2helf !2 for
developments% unless those developments are <&T!;&/ (no
need for post#eff. &mendment if changes already in periodic
reports)
b. Non"S"; &ilers must u+date &or c(an!es t(at constitute
6UNDAMENTAL c(an!es &rom w(at was &iled in OST"
E66ECTI'E AMENDMENT. This std is higher than the
standard for 2#( filers
4. (a)(7) PAC5; If an issuer is registering a primar% e7uit% shelf offering
under <3=)a+)3+)/+6 the offering ma% be at the mar!et. There are no
limitations on the si>e of such an offering.Q
(. Duration, /a1/71 S(el& re!istrations &or S"; &ilers are %alid &or ;
years. ;f a new !2 is filed before ( yrs elapse$
i. ;n case of an &utomatic 2helf !2% it will be effective
immediately
ii. ;n cases other than an &uto 2helf !2% the issuer can
keep issuing under the old !2 for up to ,DE days or
until the new !2 goes effective% whichever is sooner
iii. under (a)(9)$ there are opportunities to continue issuing
off an old% e*pired shelf if a new shelf registration
statement has been filed
7. Amount o& securities$ shelf registrations for non#2#( filers limited to
securities reasonably e*pected to be sold within two years from the
initial effective date of the registration.
iii. &utomatic 2helf !egistration$
,. Defined (!ule 7E8) $ !egistration 2tatement filed on 2#( @ F#( by a
GN2; (as of date of filing most recent shelf registration
statement@amendment (later of))
4. ;mmediate ffectiveness $ &uto 2helf !2 and post#effective
amendments become effective immediately on filing% pursuant to !ule
794(e) and (f)
(. Fle*ibility $ &lso% allows eligible issuers to add addJl classes of
securities 1 to add eligible majority#owned subs as addJl registrants
after an automatic shelf !2 is effective
7. ;nfo !eqmJts $ Aew !ule 7(EM allows omission of more info from the
base prospectus in an automatic shelf !2 than in a regular shelf
offering !2
8. Duration $ ;ssuers must file new automatic shelf !2s every ( years that
will% in effect% restate their then#current !2 and amend it% as they deem
appropriate. ;ssuers will be prohibited from issuing securities off an
automatic shelf !2 that is more than ( years old. Mut can just file a
new one and so be seamless.
9. !ationales $
a. facilitate immediate mkt access 1 promote efficient capital
formation% w@o at same time diminishing investor protection
b. fle*ibility to take advantage of mkt windows% to structure
securities on a real#time basis to accommodate issuer needs or
investor demand% and to determine or change the plan of distro
of securities as issuers elect in response to changing mkt
conditions
i%. Rule 0;4# M In&o Omitta$le &rom S(el& RS ros+ectusJ U+datin! t(e
ros+ectus
,. !ule 7(EM is a shelf offering corollary to e*isting !ule 7(E&% in that it
describes the type of information that primary shelf eligible and
automatic shelf issuers may omit from a $ase +ros+ectus in a !ule
7,8 offering and include instead elsewhere
4. "araphrased
a. a) A $ase +ros+ectus filed as part of an !2 for shelf
registrations under 7,8(a)(,)(*)% auto shelf registrations under
R7,8(a)% (and others) may omit in&o not Enown or Enowa$le%
per !ule 7EI.
b. )f the &rospectus is part of an Auto Shelf RS, it can
a##itionall" omit$
i. whether the offering is a primary offering or an offering
on behalf of persons other than the issuer% or a
combination thereof%
ii. the plan of distribution for the securities%
iii. a description of the securities registered other than an
identification of the name or class of such securities%
and
iv. the identification of other issuers.
c. d) In&o omitted &rom a +ros+ectus t(atKs +art o& an e&&ecti%e
RSJ in reliance on t(e a$o%eJ can $e added to t(e
+ros+ectus $y$
i. (,) & post#effective amendment to the !2'
ii. (4) & prospectus filed pursuant to !ule 747(b)' or
iii. (() ;f the applicable form permits% including the info in
the issuerJs periodic or current reports filed under RR ,(
or ,8(d) of (7 &ct that are incorporated or incorporated
by reference into the prospectus that is part of the !2.
,. Mut this action must meet the reqmJts of
7(EM(h)% which essentially reqJs the issuer to
file a !ule 747 notice w@the 2? and a
supplement to the prospectus identifying the
reports that incorporate the omitted info
d. (f)(4)$ &or +ur+oses o& Section 33 lia$ilityJ e&&ecti%e date is
now t(e date o& t(e new amendment.
v. !ule 747(b)
,. & prospectus used in connection with a !ule 7,8(a)(,)(*) shelf
offering (amongst other shelf offerings)% that includes info previously
omitted from the prospectus filed as part of an effective !2 (omitted in
reliance on 7(EM)% shall be filed with the 2? w@in 4 bi- days
vi. Menefits
,. File !2 once% then just update
4. Timing fle*ibility to get ideal pricing
vii. !isk
,. <ay damp current trading% b@c people e*pect some new dilutive issue
to come on market at any time
4. 0Gs complain this denies them the time reqJd for due diligence under
R,, of the J(( &ct
(. 0Gs also complain that shelf offerings sharply reduce their role% since
issuers can go to market more easily
7. 2hort time between amendments and issuance may not give the market
enough time to digest the new information.
'III. Section 33 Lia$ility
a. - 33/a1 ?ivil /iability under R,,(a)
i. R,,(a)$
3. If an% part of an 5(6
?. when such part became effective6
8. contained an untrue statement of a material fact or
9. omitted to state a material fact re7uired to be stated therein )""#+
or necessar% to ma!e the statement therein not misleading
8. an% person ac7uiring such securit% can sue
@. unless he !new of the ""# at the time of ac7uisition
b. "laintiffs
i. "rivate parties
ii. R,,(a) does not require privity between the issuer and the purchaser in a
transaction
,. liable to anybody who acquires the securities pursuant to false !2% not
just those who purchase in the initial offering
.. CertN$er! %. Di!nity artners J D
t(
Cir. 3DDDJ C# 0<;
a. R,4$ seller is liable 5to the person purchasing such security
from him6 ;mplies privity reqmJt
b. R,, only says 5any person purchasing such security.6
i. ;mplies " can sue issuer% even if purchased in
aftermarket
c. M0T " must still be able to show that the securities were
associated w@the particular defective !2
iii. Tracin! ro$lem
,. ;f shares canJt be traced to that specific !2% then no R,, standing.
4. Mig companies have many !2s% so any purchase made in the
aftermarket cannot be traced to the specific !2
iv. Ao !eliance
,. Aeed not show reliance unless bought ,O yrs after !2 D and ,4
months financials were issued
c. Defendants
i. ;ssuer$ no diligence defenses
,. Draconian 2/ on issuers # R,,(a)
a. Nnowledge% reliance% causation not reqJd
i. ?f. Tort of Deceit% requiring reliance and scienter
b. <isstatement is all that matters% regardless of what the issuer
knew
c. Deterrence% not compensation
4. R,,(b) defenses . ;ssuer e*plicitly e*cluded
ii. /iable parties who have diligence defenses
,. very !2 signer'
4. Directors of issuer at time of !2 filing
(. every person named in the !2 as about to become a director
7. every accountant% engineer% or any person (generally% e*perts) named
as preparing or certifying any part of the !2
8. every 0G
iii. Form of /iability
3. Generally >oint and Se%eral />SL1
?. 1/ceptions
a. Aon#managing 0GsJ liability limited to amt of their
participation in the offering (R,,(e))
b. Cutside directorJs liability ltd to damage he caused% unless he
knowingly violated securities laws
(. Y2/ on ?ontrolling persons of 2ection ,, Defs . 2& R,8
a. if you control a liable party% you can be liable unless no
knowledge of or no reasonable ground to believe the party was
liable
b. e.g.% holding company that owns the 0Gs
d. 2C/ # R,(
i. suit must be brought w@in , yr after <<C was or s@h@b discovered' absolute
bar ( yrs after public offering
e. -33/$1 De&enses
i. R,,(b)(,) . Ghistle#blowing
,. insider can avoid liability if he resigns and notifies 2? (to alert them
that something is amiss) before !2 becomes effective
ii. Due Dili!ence De&enses M &or NON"issuers
3. R,,(b)(()(&) . #ue #iligence #efense for non#e*pertised portions of
the !2
a. &fter reasonable investigation% has reasonable ground to
believe (and did believe) at time of !2 effectiveness all
statements were true and no reqJd material fact was omitted or
necessary to make statements not misleading
4. R,,(b)(()(M) . allows e/perts to rel% on their own due diligence
defense
a. &fter reasonable investigation% has reasonable ground to
believe (and did believe) at time of !2 effectiveness all
statements were true and no reqJd material fact was omitted or
necessary to make statements not misleading
;. R,,(b)(()(?) . reliance #efense for e*pertised portions of the !2
a. Aon e*pert reviewing e*pertised portion.
b. Tad AC reasonable ground to believe and D;D ACT
M/;S6 that there was any inaccuracy or omission.
7. Define reasonable)
a. !easonable belief or investigation is that 5required of a
reasonable person in the mgt of his own property.6 R,,(b)(()
(&)
b. ?ircular
c. Rule 3<= elaborates this into a sliding scale% considering
relevant circs% incl$
i. !easonable reliance on officers% employees and others
ii. Type of underwriting arrangement and availability of
info
iii. w(et(er &or docs incor+orated $y re&erence D (ad
res+onsi$ility &or t(e &act or doc at t(e time o& &ilin!
&rom w(ic( it was incor+Kd $y re&erence
iv. 2uggests that 2helf !egistrations merit special
consideration that takes into acct factors such as actorJs
identity% role% the type of security% etc.
f. 1scott v. -arChris
i. 4 misstatement groups
,. B,) <isstated financials. *pertise section
4. B4) <isstated plans for use of proceeds. Aon#e*pertise section.
ii. $efendants
,. !usso (?C% D% !2 signer)
a. /iable for non#e*pertised portion <<C about use of proceeds
b. /iable for e*pertised financials because he knew they were
false
4. Mirnbaum . (Cutside D% !2 signer)
a. /iable for not investigating non#e*pertised portions' reliance
defense CN
(. &uslander . (Aew D (who is also an attorney though not for the issuer)
a. /iable for non#e*pertised$ must prevent !2 effectiveness if you
donJt have enough time to conduct a reasonable investigation
(his questions were not probing enough+)
7. ?oleman . (0G@D) .e*pertise defense' but failed due diligence duty
8. Dre*el . (0G) . failed both e*pertised and non#e*pertised duties
9. Drinker% Middle . (outside lawyers)
a. /awyers are not liable under R,,
i. ?onsidered agents of the 0G
ii. 2till subject to state law (malpractice) and R,E(b)(8)
b. ?an be liable for e*pertised legal opinions in !2
:. "eat% <arwick (auditors) . liable for the e*pertised portions
g. valuating the Due Diligence !egime
i. ?ost ineffective$ incredibly e*pensive undertaking
,. investors may bear substantial cost of diligence
4. 0Gs may under#price offerings to compensate for liability risk
(. ?ompetitive bidding by 0Gs for offerings gives them disincentives to
engage in costly diligence% especially in the shelf.
ii. Does strict liability for issuers make sense)
,. penalty levied on shareholders (shJs) for investigation and settlement
costs% robbing "eter to pay "aul
4. ;ncreases cost of capital
iii. &lternatives$ *panding or limiting liable parties
,. leave investigation to market forces @ reputation
4. limit liability to reckless and intentional violations
(. limit to issuers and e*perts who have best access to info@data
a. ;ssuer might be bankrupt by time of suit
i. Tolding other deep pocket parties liable serves
compensation and deterrence
7. &ttorney liability could create a more accurate and reliable regime
a. /awyers are already doing general due diligence
b. R,, inconsistent w@2C* notion of lawyers as gatekeepers
(. Due Dili!ence in a S(el& O&&erin!
i. <ore difficult than regular public offerings because less time to investigate
ii. &orldcom (civil liability% but there is always the specter of criminal liability
for willful security violations)
,. Facts$ 4 bond offerings on shelf' misstatements in 4EEE and 4EE,
!2Js
a. blatant fraud to maintain line e*penses over revenues (@!) by
capitali-ing e*penditures that should be deducted from income
4. &udited Financials
a. Aolding$ 0GJs should have recogni-ed @! anomalies
b. Counterarguments
i. this info was public and nobody else noticed or reacted
ii. liability obviates efficiency advantages of the shelf
(. 0naudited Financials
a. Aolding
i. 0naudited$ covered by higher due diligence defense%
not reliance
,. 0G reliance on comfort letter insufficient
ii. 0nreasonable due diligence beyond the comfort letter
,. ?ursory investigation' limited contact w@issuer
4. Tad knowledge of financial difficulties
b. Counterarguments
i. Tuge Z in 0G e*penses . they must audit interim
financials to avoid liability
7. !ule ,:9 did not protect 0Gs because judge held that the level of due
diligence in shelf offering is the same as any other offering
8. 2cott$ this is debatable. Yudge might be wrong.
i. Rule 3<= M Limits on Due Dili!ence
i. &ttempt to create some safe harbor for due diligence obligations
,. /ook at relevant circumstances% including
a. !easonable reliance on officers% employees and others
b. Type of underwriting arrangement and availability of info
c. whether documents incorporated by reference the defendant
had responsibility for the fact or document at the time of filing
from which it was incorporated by reference
4. 2uggests that 2helf !egistrations do merit special consideration
ii. ?odifies a sliding scale approach to liability
,. .g.% in -arChris$ insiders had greater duty than outsiders and insiders
with special e*pertise had even higher duty
j. R,D of the ,I(7 &ct . /iability for <isstatements in J(7 &ct Filings
i. &ny person who makes false or misleading statement in (7& filing (at time of
filing) is liable to any person who% in reliance on such statement% purchased
the security% if he did not know the statement was false or misleading
ii. focuses on those who actually prepare the financials
,. might be better approach than (( &ct R,,
E. Dama!es Under Section 33/e1
i. Aegative ?ausation
3. R,,(e) . I& D +ro%es t(at +art or all o& t(e claimed dama!es
re+resents somet(in! ot(er t(an de+reciation in %alue due to
errors in t(e RS &or w(ic( (eKs lia$leJ t(at &raction o& t(e dama!es
is not reco%era$le
4. Tempers harshness of R,, liability substantially
(. Damages from factors unrelated to the misstatement@s create the
qualification to usual rescissory recovery
7. Turns into something closer to 5out of pocket6 damages% similar to
fraud
8. DJs victory in &kerman is unusual. Aegative causation is a difficult
defense to prove
9. AEerman %. Ory? Communications (4d ?ir ,ID:)
a. Disclose misstatement in Yune (E registration to 2? on Cct
,8
th
' tell public Aov ,E
th
. 2ued on Aov 48
th
. 2tock rises .48 b@w
the disclosure and suit.
b. D does a study which claims that the stock movement before
disclosure (decline) was consistent with its cohort of fellow
;"Cs.
c. "laintiff shows an opposing study
d. ?t finds that D met R,,(e) burden by est. that the
misstatements were barely material and that public failed to
react adversely to disclosure
ii. Measure o& Dama!es
,. &s indicated in &kerman% R,, creates presumption of recissionary
damages based on$
a. Difference between amt paid ( so long as [ offering price) and
i. ;ts value at time of suit%
ii. ?onsideration received on resale if sold before suit% or
iii. ?onsideration received if sold after suit% but before
judgment% ;F less than a) would produce
$. Use o& 2%alue8 lets ar!ue marEet +rice at time o& suit was
im+ro+erly in&latedJ to !ain lar!er reco%ery
c. Mut an individualJs recovery is therefore capped at offering
price
d. A!!re!ate Ca+J -33/!1 . amt recoverable under R,, will
never e*ceed price at which security was offered to the public
4. Dura (armeceuticals %. #roudo (2?CT02 4EE8% cbs (7)
a. &ddresses pleading requirement for loss causation
b. I
th
?ircuit
i. 2T complaint% alleging only that 2TJs paid 5artificially
high6 price in 5reliance on integrity of the market6
ii. M@c of false claims that Dura e*pected to profit from its
new product% ct held that "s adequately pleaded that
price was overstated and sufficiently ;DJd cause
c. SCOTUS re%erses D
t(
Cir %iew o& loss causationJ !oes wit(
t(e ot(er circuits
i. )n 1'(4 cases, inflate# purchase price is not itself a
loss an# cannot be the onl" pro:imate cause of one
,. /ogic$ you can sell at whatever the price is% so
whether you win or lose depends on what you
do and what happens ne*t. &nd the longer the
stock is held% the more factors can influence the
price
ii. <ust show an economic loss% once truth becomes
known and price shakes out
iii. &lso argues policy$ protections are to maintain public
confidence by deterring fraud% not to act as general
market insurance against price declines
iv. &nd rather% "2/!& requires securities that fraud
complaints$
,. 2pecify each misleading statement
4. 2et forth facts on which belief that statement is
misleading was formed
(. State w; particularit" facts giving rise to strong
inference that D acted w@ required state of mind
<. And finall%6 .laintiffs must prove
misrepresentations caused loss
iii. ?ompare R ,, to !ule ,Eb#8$
,. Difference between measure of damages in ,Eb#8 and ,,$
a. 2ection ,,$ diff between purchase price and the price at which
the person sells
b. Ao damage cap in ,Eb#8
4. Murden of proof$
a. Cn defendant in 2ection ,, and on plaintiff in ,Eb#8
(. Ghy these differences between ,, and ,Eb#8)
a. 2ection ,, covers the registration statement
b. ,, is more strict liability b@c congress cares more about
integrity of reg statement
c. ?onfers more confidence in public offerings
d. ;tJs a balancing test$ to get more damages% have to prove more
(,Eb#8)
l. A++ortionment o& Lia$ility under Section 33
i. Yoint and 2everal /iability (Y2/) for most R ,, Defendants
,. <odified rules for 0Gs and outside directors
a. 0Gs$ E?cludin! mana!in! U)J no U) is lia$le in e?cess o&
total +rice o& (is underwritin! o&&ered to +u$lic
b. Outside Directors$
i. ;f the outside director was a knowing violator% Y2/
ii. "2/!& added R,,(f)(4)(&) to switch to proportionate
liability% in absence of knowing misconduct
iii. &dditional 5uncollecti$le s(are6 liability based on
wealth of "
,. ;f AG [ 4EEk and damages V,E> of AG%
outside directors Y2/
4. else% proportionately liable for uncollectible
share but this liability cannnot e*ceed 8E> of
directorsJ total proportionate liability
ii. ;ndemnfication
,. 2? views issuer indemnification for liability of directors and officers
found in violation of 2ection ,, to be against public policy and hence
unenforceable
4. !eg 2#N% ;tem 8,4(h)(() requires issuer facing such indemnification
claim to present matter to court to judge enforceability
;. #UT, directors t(en Lust &orce com+anies to !et D5O insuranceJ
w(ic( t(e SEC does NOT +roscri$eF /irrational +olicy stance1
iii. ?ontribution
,. 33/&1, ?ontribution clauses valid and enforceable because shares the
burden among equal wrongdoers.
4. Cutside directors can seek contribution from others% while others can
only seek proportionate contribution from outside directors
(. Cutside directors who settle private actions prior to final verdicts
discharged from all claims for contribution brought by other parties
i%. SLRA, Settlement Disc(ar!eJK;0 Act .3D/&1/<1
,. &) ;n 3eneral$
a. & covered person Pincludes outside director% (f)(,E)(c)Q who
settles any private action at any timeKshall be discharged from
all claims for contribution brought by other persons. PThe court
shall enter a bar order precludingQKall future claims for
contribution arising out of the action\
i. (i) by any person against the settling covered person'
and
ii. (ii) by the settling covered person against any person%
other than a person whose liability has been
e*tinguished by the settlement of the settling covered
person.
4. M) !eduction.\
a. ;f a covered person enters into a settlement w@" prior to final
verdict or judgment% the verdict or judgment shall be reduced
by the greater of\
i. (i) an amt that corresponds to the percentage of
responsibility of that covered person' or
ii. (ii) the amount paid to the plaintiff by that covered
person.
b. Gorld?om 2ettlement$
i. bar order thrown out b@c P)Q (non#settling parties
objected b@c they felt the judgment amt should have
been reduced by the proportionate liability of the
settlers (L(M) rather than by their proportionate ability
to pay (L,EE<))
ii. Mrought in all parties to settle so nobody could object
v. "ersonal /iability for Directors$
,. "olitically motivated prosecutor could force personal e*posure through
Cammer Clause$ allows insurance company to require settlement if
in their judgment its acceptable% allowing them to pay less and forcing
director to pay more out of pocket
4. but today% &;3 at least has eliminated hammer clause.
IO. Lia$ility under Section 3./a1/31J 3./a1/.1J and 3</a1
a. 2ummary of /iability !ules under J(( &ct$ (see Class Slides 3.J +.3 &or c(art)
i. Gide range of remedies (,Eb#8 applies to everything)
ii. 2trictest rules are under 2ections ,, and ,4(a)(,) with respect to the
registration and offering process
iii. *empt securities covered by ,4(a)((4)
iv. 2econdary private offerings are only covered by ,Eb#8% Bustafson
v. Does it make sense to have different liability standards for different types of
securities violations) "robably% since cost#benefit trade#offs are different in
different situations
b. ,:(a)$ 3eneral &nti#Fraud provision of J(( &ct
i. Cnly covers fraud in offer or sale supplanted by ,Eb#8% created by 2? to
cover &// securities fraud
ii. Ao private right of action
c. 3./a1/31, Lia$ility &or o&&er or sale in %iolation o& Section 7
i. -3./a1/31, &ny person who offers or sells a security in violation of 2ection 8
shall be liable to the person purchasing the security from himK
ii. ur+ose$ To enforce the registration and gun#jumping reqmJts of R8
(!enerally a++lies to im+ro+erly unre!istered securities)
iii. &vailable !emedies$
,. !escind transaction and get money back O interest% or
4. !ecover recissionary damages if stock has been sold
iv. !equirements
,. D@n require proof of any misrepresentation
4. ReHuires +ri%ity$ issuer usually would not be liable then in a major
securities offering% it would be the underwriter
v. 2/ 2tandard
,. 2/ against sellers of unregistered securities when no e*emption
applies
4. Cnce thereJs a violation of R8% later compliance does not cure
a. g. Defective 5offer6 during waiting period% is not cured by
subsequent compliant sale
vi. 2C/ (2& R,() .
,. 2uit must be brought w@in , yr after the violation.
4. ;n no event% more than ( years after security was bona fide offered to
the public
vii. "ossible Defendants
3. A +erson is not a seller under -3./a1/31 unless (e is moti%ated to
ser%e (is own &inancial interestsJ or t(ose o& t(e PrealK seller /i.e.
&inter1.
4. 0nclear$ 5&ny person who offers or sells6 to 5the person purchasing
such security from him6
(. &inter v. -ahl (?M 8E4)
a. 6acts$ Dahl% a ?& real estate broker and occasional oil
investor% invests L(,E%EEE in oil properties with "inter% a TX
C13 producer. Dahl later told friends and family about the
venture% and wit(out recei%in! commissions% helped them
complete subscription forms% prepared by "inter% for
unregistered securities in the oil properties. The venture failed%
leading Dahl and his friends to sue "inter under R,4(a)(,)
(recession from sellers for failing to comply w@ R8). "inter
sued Dahl for contribution.
b. Issue$ Gas Dahl a 5seller6 of securities for purposes of R,4(a)
(,))
c. Coldin!@Rationale$
i. A +erson is not a seller under -3./a1/31 unless (e is
moti%ated to ser%e (is own &inancial interestsJ or
t(ose o& t(e PrealK seller /i.e. inter1.
ii. ?ourt observes that while R,4(a)(,) was intended to
cover those who solicit sales (that is the stage of the
transaction where investors need protection)% R4(()
defines 5sale@sell@offer6 to include F5every contract of
sale or offer for disposition of a securityKfor value.6
&ccordingly% such a solicitor is not a seller under R,4(a)
(,) if his efforts are 5gratuitous6. !ather% must be
motivated to serve his own financial interests% or those
of the WrealJ seller.
iii. Note$ This definition of 5seller6 applies to R,4(a)(4)
too. (?M 8,9).
d. ro?imate Cause @ Collateral artici+ants, ?t rejected the
idea that collateral participants who helped but did not solicit
sales are reached by R,4(a)(,)Js 2/
%iii. INNACURATE ROSECTUSES SU#>ECT ISSUERS TO STRICT
LIA#ILITB UNDER SECTION 3./a1/31,
,. misinformation has the effect of voi#ing the prospectus' the court
implied that info must be true and correct and if it is not% the
requirements of ,E(a) . that a prospectus contain material info and all
info in registration statement # and 8(b)(4) are not met' this leads to
private actions under 2ec ,4(a)(,) allowing for rescission' creates 2@/
w@o defenses for mistakes in prospectuses' (2? v. <anor Aursing
?enters)
4. Pthe key difference is that R,, liability stems from the registration
statement at effectivity date% rather than prospectus anytime as under
R,4(a)(4)Q
(. SEC %. Manor Nursin! % 78D F.4d ,ED4 (4d ?ir. ,I:4) Inaccurate
ros+ectuses 6lunE - 7/$1 on Strict Lia$ility. <anor Aursing
decides to violate all sorts of conditions and commitments it sets forth
in its prospectus (after registration statement became effective)% and
clearly falls afoul of the antifraud provisions of the J(( &ct. The
question is whether it also violates the prospectus delivery
requirements of R 8(b). <E0-$ implicit in the statutory ,E(a)
provision that the prospectus contain certain info is the requirement
that such information be true and correct' a prospectus that is not
amended to remain true and correct stands in violation of R 8(b). So
+ros+ectuses must $e amended to re&lect +ost"e&&ecti%e
de%elo+ments w(ic( maEe +ros+ectus misleadin! in any material
res+ect.
7. CritiHue. the securities laws are intended to serve to goals . full
disclosure and deterrence of fraud # but <anor intertwines them% by
making R,,% which sets up a negligence std for liability for
misstatements and omissions in the !2% superfluous. 0nder <anor% R
,, is replaced with a regime of 2/ allowing rescission under R,4(a)(,)
for misstatements and omissions in the !2.
d. -3./a1/.1 Lia$ility
i. &pplies to$ e*empt securities% registered securities sold by means of false
prospectus% FG"
ii. a) &ny person who##
,. 4) offers or sells a security (whether or not e*empted by R(% other than
R((a)(4) and R((a)(,7))%
4. by the use of any means or instruments of transportation or
communication in interstate commerce or of the mails%
(. by means of a prospectus or oral communication (oral communication
must relate to the prospectus)%
a. which includes an untrue statement of a material fact% or
b. omits to state a material fact necessary to make the statements
not misleading in the light of the circumstances under which
they were made%
c. (the purchaser not knowing of such untruth or omission)% and
7. who shall not sustain the burden of proof that he did not know% and in
the e*ercise of reasonable care could not have known% of such untruth
or omission%
8. shall be liable% subject to subsection (b)% to the person purchasing such
security from him% who may sue K
a. to recover the consideration paid for such security with interest
thereon% less the amount of any income received thereon% upon
the tender of such security% or
b. for damages if he no longer owns the security.
iii. Loss causation
,. ;n an action described in R,4(a)(4)% if the offeror or seller proves that
part or all of the amt recoverable under R,4(a)(4) represents something
other than depreciation in value of the subject security due to errors or
omissions in that part of the prospectus or oral communication for
which heJs supposedly liable% then such portion or amount% shall not be
recoverable.
iv. Dama!es under ,4(a)(4)
,. !ecovery of LL paid O interest (#) income earned on the security% or
4. Damages if security is already sold
(. Aote$ "2/!& added R,4(b)% which allows D in R,4(a)(4) actions to
show that loss was due to other factors not related to the misstatement.
v. lements (similar to those in quitable !ecission)
,. <isrepresentation of a material fact
4. ?ulpability of seller
a. 2eller can defend if can show he did not know or by e*ercising
reasonable care could not have known
b. Reasona$le Care .:
th
?ir. has held that 0G must have
actually performed investigations to use the 5reasonable care6
defense. Mut% 2? has stated this is not necessary' the
5reasonable care6 defense s@n@b as difficult to meet as the R,,
5due diligence6 defense
(. !eliance of purchaser
a. "urchaser need not show he relied% just that he did not know
the defect
b. 2ome courts place a transaction causation reqmJt% such that the
defect had to have been instrumental in making the sale happen
7. /oss causation
a. "2/!& adds R,4(b) 5loss causation6 defense similar to R,,
5negative causation6 defense
vi. "ossible Defendants
,. 2eller O ?ollateral "articipants &cting for Salue
a. R,4(a)(4) has same language as R,4(a)(,) . 5&ny person who
offers or sells a security6
b. 2o% under "inter% it covers ,) seller who passes title% 4)
collateral participants who solicit purchasers for their own or
the issuerJs benefit
4. ;ssuer $ Issuer Lia$ility under -3./a1/.1 M Rule 37DA
a. For purposes of R,4(a)(4)% an issuer is a seller% regardless of the
method of underwriting% if the securities are sold to the
purchaser by means of a statutory prospectus
b. &s for sales made by FG"% issuer only liable for
communication prepared by or on behalf of issuer or used or
referred to by issuer.6
c. 2o% issuer canJt argue wasnJt a seller just b@c the 0Gs who
technically sold the securities
vii. 2C/ (2& R,()
,. 2uit must be brought w@in , yr after discovery of the defect% or after
discovery s@h@b made
4. ;n no event% more than ( years after security was bona fide offered to
the public
viii. In&ormation +ost"contract o& sale not considered &or +ur+oses o& 3./a1/.1
lia$ility, information received by the investor after the contract of sale
established% ie. final prospectus supplement in a takedown received post
investment decision% does not count as disclosure to investor at point of sale
for ,4(a)(4) liability.
i?. 3./a1/.1 only a++lies to +u$lic o&&erin!s /Gusta&son1
,. *ustafson v. Allo"# 5o. (?M 8E:)
a. 6acts$ 3ustafson was selling &lloyd% ;nc. to Gind "oint
"artners. &t closing time% &lloydJs actual earnings were lower
than had been projected in the contract% so buyers sought
recession% claiming that the contract was a prospectus under
R,4(a)(4).
b. Issue$ Gas sales agreement a prospectus) Does ,4(a)(4) apply
at all) Does R,4(a)(4)Js rescissory right reach private%
secondary *#actions% on the theory that recitations in the
purchase agreement are part of a prospectus)
c. Coldin!@Rationale$ Ao% because the N was not a prospectus.
?ourt begins with R,E% which states that a prospectus must
include the information in a !2. 2ince no one contends that a
N must contain all info of the !2% the N canJt be a prospectus.
]]T(usJ i& K;; Act is to $e consistently inter+retedJ -3./a1
/.1 lia$ility &or a misleadin! +ros+ectus canKt attac( unless
t(e alle!ed 2+ros+ectus8 was reHKd to $e distri$uted in t(e
3st +lace /or unless t(ereKs an e?em+tion1
d. <oreover% R4(a)(,E)Js definition of 5prospectus6 includes docs
of 5wide dissemination%6 which this N was not. ;n sum%
5prospectus6 is a doc that describes a public offering of
securities by an issuer or a controlling shareholder% which this
N was not.
4. #ottom Line " R,4(a)(4) only applies to public offerings% and
offerings that would be a public offering but for an e*emption.
(. E?em+t Transactions . Ghile these arenJt true 5public offerings6
Bustafson says R,4(a)(4) liability still applies% because it would have
been a public offering were it not for the e*emption.
7. Oral Communications . Bustafson dicta suggests that R,4(a)(4)
liability attaches to oral communications onl% if they pertain to the
prospectus.
O. Sar$anes"O?ley and NBSE Listin! Standards, #oard and Auditor Inde+endence
a. T(e Sar$anes"O?ley Act
i. Yuly 4EE4. &ct is implemented in 2? !egs
ii. /argely applicable to foreign issuers% with some e*ceptions
iii. Created u$lic Co Acct! O%ersi!(t #oard /CAO#1 under 2?
supervision% responsible for estJg auditing% U?% attestation 1 ethics stds for
public co auditors. 2C* R:4,,% ?2 ,I(8
iv. Audit ReHuirementsJ J(7 &ct% R,E& (?2 9,8).
,. &udits must cover$ ,) controls in place to detect illegal acts% 4) to
detect related party *#actions 1 () evaluation of going concern status%
,E&(a)
4. "rohibiting various types of non#audit services (R,E&(g)% ?2 9,:)
(. !equires &udit ?omm. approval and disclosure for other non#audit
services% ,E&(h)
7. &udit partner rotation every 8 yrs 1 a , yr cool#off period before
certain members of the audit team may accept certain jobs w@the issuer
(R,E&(g)% ?2 9,:)
8. &udit firm shall report particular data to &udit ?ommittee% ,E&(k)
9. &udit firm is selected and employed by the audit committee
:. Aon#compliance delisting
D. &udit committee has LL to pay audit firm or other advisers% ,E&(m)
I. Aeed to establish ombuds process for complaints and whistleblowers
,E. !esponse to &udit Discoveries$ ;f auditor finds info that suggests an
illegal act has or may have occurred% the auditor should determine
whether itJs likely to have occurred% and inform management and@or
the audit committee. ;f no acceptable remedial action is taken% auditor
should report to MCD. MCD must then file a notice with the 2?. ;f
MCD does not% &uditor should resign% or notify the 2? directly.
(R,E&(b)% ?2 9,8)
v. Loans to e?ecuti%e o&&icers and directors prohibited
vi. Dis!or!ement o& of ?C and ?FC compensation following restatement of
financial statements
vii. Rules &or Attorneys% 2C* R:478%
,. !equires 2? to establish rules for professional conduct for attorneys
4. nacted by 2? in ,: ?F! 4E8.*%
viii. CEO and C6O certi&ications o& &inancial statements. (7E7)
,. For each periodic report% must certify$
a. That theyJve reviewed the report%
b. That to their knowledge% the report contains no untrue stmt of
material fact%
c. That to their knowledge% the report fairly presents the financial
condition and results of operations
d. That the officer is responsible for maintaining the firmJs
internal controls and% amongst other things% has evaluated their
effectiveness in the last IE days% and notified the &udit
?ommittee of$
i. 5significant deficiencies6 and 5material weaknesses6 in
the internal controls% and
ii. any fraud% material or not% involving employees
involved in controls
i*. Inde+endence o& t(e Audit Comm.% 2#C* R(E, (R,E&(m) of J(7 &ct% ?2
9,D)% R7E:
,. Inde+endent directors only' may not be an 5affiliated6 person of the
issuer or accept any consulting% advisory% or other compensatory fee
from the issuer
a. &ffiliate is 5a person that directly% or indirectly through one or
more intermediaries% controls or is controlled by% or is under
common control with% the person specified%6 !ule ,E&#((e)(,)
(i)% ?2 D7I
b. The following will be deemed to be affiliates$ an e*ecutive
officer of an affiliate' a director who is also an employee of an
affiliate' a general partner of an affiliate' 1 a managing
member of an affiliate% !ule ,E&#((e)(,)(iii)% ?2 D7I
4. Aut(ority o%er Auditor$ MCD has authority to control selection% fees%
1 performance of outside auditor R,E&(i)(,)(&)% ?2 9,:
(. Outside Ad%isers$ "ower to retain% eg. law firm% 1 compel funding%
R,E&(m)(8)#(9)m
7. 6inance E?+ert$ <ust disclose whether any member of the &udit
?omm is a finance e*pert (defined at !eg 2#N ;tem 7E,(h)) 1 if not%
why not. 2C* R:498% ?2 ,I8I
a. Financial e*pert attributes$ hasK(,) an understanding of
generally accepted accounting principles and financial
statements' (4) e*perience in (&) the preparation or auditing of
financial statements of generally comparable issuers' and (M)
the application of such principles in connection with the
accounting for estimates% accruals and reserves' (() e*perience
with internal accounting controls' and (7) an understanding of
audit committee functions.
b. 2afe Tarbor$ &udit committeeJs fin. e*pert is not an e*pert for
any purpose% incl. R,, liability under the J(( &ct. 2uch
designation imposes no obligations or liabilities beyond those
of a normal director. (!eg 2#N ;tem 7E,(h))
?. ro"6orma 6inancials
,. !eg 3$ Ghenever pro#forma financials are issued% issuer must provide
a comparison@reconciliation to the 3&&" financial statements
4. ;tem ,E(e) of !eg 2N adopts similar reqmJts when issuer is filing
periodic reports w@2?
$. NBSE Rule C(!,
i. Amend certain +ro%isions o& -;4;A o& t(e NBSE Listed Com+any
Manual /SS 34D"3;.1
ii. Scott thin7s this is a ba# wa" of ma7ing law$ 2? essentially bullying 2!Cs
into 5independently6 promulgating rules for independence% etc.
iii. ;ndependence$ 2eries of bright line tests that directors must satisfy in order to
be eligible to be deemed independent
,. 3eneral . MCD must determine director has no 5material6 relationship
w@the company% 1 disclose the basis of this determination.
4. mployees . & director who is an employee% or whose immediate
family member is an e*ecutive officer of the issuer would not be
independent until three years after such employment relationship
(. Direct ?ompensation . & director who receives% or whose immediate
family member has received% more than L,EE%EEE per year in direct
compensation from the listed company Pe*cept for director and
committee fees% compensation by an immediate family member as a
non#e*ecutive employeeQ during any twelve month period within the
last three years would not be independent
7. &uditors . & director who is affiliated with or employed by% or whose
immediate family member is affiliated or employed in a professional
capacity by a present or formal internal or e*ternal auditor is not
independent until three years after the end of the affiliation or
employment
8. ;nterlocks . & director who is employed or whose immediate family
member is employed as an e*ecutive officer of another company
where any of the listed companyJs present e*ecutives serve on that
compensation committee would not be independent until three years
after the end of such service or the employment
9. Musiness !elationship . & director who is an e*ecutive officer or an
employee% or whose immediate family member is an e*ecutive officer
of a company that makes payments to% or receives payments from% the
listed company which% in a fiscal year% e*ceed the greater of L,<% or
4> of such other companyJs gross revenues would not be independent
until three years after falling below such threshold Pcharities are not
companies% but contributions of this scale must be disclosedQ
iv. Aon#management directors must meet in regular e*ecutive sessions without
management
v. Aominating% audit and compensation committees must all have only
vi. independent directors
vii. &udit ?ommittee$ min (#person% all independent directors
,. each member s@b financially literate
4. <in , reqJd to have acctg or related financial mgt e*pertise
viii. very company must have an e*ternal audit function
i*. ach company must have disclosed corporate governance guidelines and a
code of business conduct and ethics
*. !equire ?C of each listed company to certify to AH2 each year that he is
not aware of any violation of AH2^s corporate governance listing stds
*i. Controlled Com+anies$ *empts any listed company where V8E> of the
voting power is held by an individual% a group or another company from the
reqmJts that its board have a majority of independent directors% and that the
company have nominating@corporate governance and compensation
committees composed entirely of independent directors.
*ii. 6orei!n ri%ate Issuers$ "ermit AH2#listed F";s% to follow home country
practice in lieu of the new requirements% with some e*ceptions
c. Auditor Inde+endence
i. &uditor ;ndependence% 2? !egulation 2#X% !ule 4#E, (+rinci+les"$ased
a++roac()
,. &ccountant is not independent if the accountant is not% or a reasonable
investor with all of the facts would conclude he@she was not% capable
of e*ercising objective and impartial judgment. ;n considering whether
an accountant is independent% the ?ommission will consider all
relevant circumstances% including all relationships between the
accountant and the audit client
4. "rohibited financial relationships (of auditor or immediate family
member)% no look back$
a. investments in an audit client or a material investment in a
company in which the audit
b. company has an investment or which has a material investment
in the audit client
c. investments in a company which can significantly influence or
be significantly influenced by the audit company
d. loans to or from the audit client% financial relations with the
audit client% e.g. deposits in a bank% insurance form the audit
client (unless obtained prior to engagement)
(. Mroad prohibited employment and business relationships
7. ?annot provide non#audit services (does not include ta*)
8. ?annot charge contingent fee
9. "artner rotations every five years (e*empts small audit firms)
:. /ack of knowledge of violation of independence requirements a
defense to liability if prompt correction of violation% and has a quality
control system based on si-e and nature of practice
d. conomic 2tudies *amining fficacy of 2arbanes#C*ley
i. Q(an! (4EE8)$ e*amines market judgment as to whether 2CX was net benefit
to s@hs% concludes that market did not like 2CX because of abnormally high
negative volatility in periods surrounding 2CX legislation and enactment
,. severe problems with this event#driven study$
a. which events do you choose)
b. 2tocks could have gone down b@c they thought Mush would
G&NA 2CX% which they actually valued
c. i.e.% so hard to actually pinpoint what the stock reaction means
d. also looks at overall volatility of market and not particular
companies
ii. Go%ernance Inde? Studies /G"scores1,
,. #(a!at and #lacE /.44.1$ no significant correlation between board
independence and stock returns
4. Ney study$ Gom+ersJ Is(ii and MetricE /.44;1 find firms with strong
shareholder rights% as measured by a 47 item 3#inde*% have stock
returns that are D.8> higher than other firms
(. Aot really relevant to 2CX because 3#inde*es (see Mrown and ?aylor
(4EE8)% Table ;)% include many items that were unrelated to 2CX% e.g.
lack of anti#takeover protection
7. G"inde? &actors wit( e?+lanatory +ower, #e$c(uEJ Co(en and
6arrell /.4401Rsta!!ered $oardsJ limits to s(are(older $ylaw
amendmentsJ su+ermaLority reHuirements &or mer!ers and
c(arter amendmentsJ +oison +ills and !olden +arac(utes
(management entrenchment)'
8. Mrown and ?aylor$ staggered boards% poison pills% directors attend
:8> of meetings or have valid e*cuse (measures interest% not
independence)% nominating committee composed solely of outside
directors (AH2)% board guidelines in pro*y statement% no option re#
pricing within last three years% average options granted in last three
years did not e*ceed (> of shares outstanding
9. Association o& !o%ernance &actors wit( $etter returns does not
necessarily s(ow causality, ?ore% 3uay and !usticus (4EE8)% (22
,E()\firms with poor corporate governance% based on 3#47 inde*%
have worse operating results% but this does not surprise the market.
&nalyst forecast errors no different for good@bad firms (analysts Enow
a$out !o%ernance)% nor does market react to earnings announcements
differently for good@bad firms\so better returns must be due to
something else.
OI. Sar$anes"O?ley, Internal Controls and Duties o& a Securities Lawyer
a. ;nternal ?ontrols (2CX 7E7)
i. (a) each annual report is to contain an internal control report% which shall$
,. state managementJs responsibility for establishing and maintaining
adequate internal control over financial reporting of the company%
&AD
4. include a management assessment of the effectiveness of such controls
ii. (c) each registered public accounting firm that prepares the audit report for the
issuer shall attest to and report on the management assessment (i.e.% the
auditor must verify the statements made by management)
b. De&inition o& Internal Controls /37d"37/&1)$
i. The term internal control over financial reporting is defined as a process .
ii. . .to provide reasonable assurance regarding the reliability of financial
reporting and the preparation of financial statements for e*ternal purposes in
accordance with generally accepted accounting principles and includes those
policies and procedures that$
,. (,) "ertain to the maintenance of records that in reasonable detail
accurately and fairly reflect the transactions and dispositions of the
assets of the issuer'
4. (4) "rovide reasonable assurance that transactions are recorded as
necessary to Ppermit proper accountingQ and that receipts and
e*penditures are being made only in accordance with the
authori-ations of management and the directors of the issuer'
(. (() "rovide reasonable assurance regarding prevention or timely
detection of unauthori-ed PtransactionsQ . . .that could have a material
effect on the financial statements.
c. ?C @ ?FC ?ertification$
i. <ust certify they have fulfilled the obligations of 7E7% (R(E4 @ R:47,(7)#(9)%
?2 ,I8()
,. g. That the officer is responsible for maintaining the firmJs internal
controls and% amongst other things% has evaluated their effectiveness in
the last IE days% and notified the &udit ?ommittee of$
a. 5significant deficiencies6 and 5material weaknesses6 in the
internal controls% and
b. any fraud% material or not% involving employees involved in
controls
4. Material )eaEness is 5a significant deficiency% or combination
significant deficiencies% that results in more than a remote li7elihoo#
that a material misstatement of the annual or interim financial
statements will not be prevented or detected.6 ("?&CM &uditing
2tandard Ao. 4% <arch I% 4EE7)
(. 2si!ni&icant de&iciency8 is 5a control deficiency% or combination of
control deficiencies% that adversely affects the company^s ability to
initiate% authori-e% record% process% or report e*ternal financial data
reliably in accordance with generally accepted accounting principles
such that there is more than a remote li7elihoo# that a misstatement of
the company^s annual or interim financial statements that is more than
inconsequential will not be prevented or detected.6 ("?&CM &uditing
2tandard Ao. 4% <arch I% 4EE7)
ii. ?riminal liability for knowing (up to ,E yrs) or willful (up to 4E yrs)
violations of certification requirements% 2C* RIE9
iii. !eg 2N% ;tems (E:% (ED implement these certifications
d. Costs o& SOO 040,
i. Total direct costs (4EE7)$ total L,8#4E billion% L( # L8 million per large
company
ii. 3reater "2 (earnings per share) impact on smaller companies (same controls
and less revenue)
iii. *pected to decrease by (E> . 7E> in succeeding years% but still very
significant
iv. ;ndirect costs may be far more significant
,. <anagement opportunity cost
4. ?hange business decisions to reduce need for controls
(. ?ompetitive impact on 0.2. capital markets$ foreign and
7. private
e. #ene&its o& SOO 040, Di&&icult to Iuanti&y
i. "revention of Frauds through better controls$
,. Mryan and /ilien study$ its the small firms that have 5material
weaknesses6\represent only ,.4D> of market value of 21" 8EE
4. Use restatement im+acts as $enc(marE$ (4EE7) restatement
frequency of 8> of companies% with negative market impact of #4>%
means impact of ,E basis points (.EE,) of total market capitali-ation of
L,: trillion% or L,: billion\but most restatements not due to failure of
internal controls% e.g. accounting changes% ta* miscalculations% so true
figure is probably (E> of this
ii. !estore ;nvestor ?onfidence$
,. Aicolaisen% former ?hief 2? accountant$ 5!epresenting to the world
that a company has in place an appropriate control system% free of
material weaknesses% that gathers% consolidates% and presents financial
information strengthens public confidence in our markets and
encourages investment in our nationJs industries. ;f thatJs the case then
its worth it% and it is absolutely critical that we get the internal control
requirements right.6
&. CAO# olicy Recommendations to Decrease Costs o& SOO 040
i. &uditors should$
,. ;ntegrate audits of internal controls with audits of financial statements
4. Tailor audits to risks facing individual clients (small v. large)
(. 0se a top#down approach to e*amine company level controls and drill
down where there are problems
7. 0se the work of others (internal auditors@consultants)
8. ngage in direct and timely communication with audit clients
ii. 2? continues to defer application of 7E7 to small companies (and also new
listings and foreign companies)
iii. #ut t(ese recommendations are incredi$ly %a!ue /al$eitJ +rinci+les
$ased1 and donKt s(ield auditors &rom lia$ility
,. ?ould make these guidelines more specific
4. ?ould offer safe#harbors to certain reliances as above
a. ]]Tave them monitor the internal auditors
(. Ghy are auditors beign so e*cessive)
a. They canJt get indemnified . theyJre afraid of liability
b. They want to get paid+++
c. &lso concentration of 7 acct firms gives them leverage on price
iv. !educing liability of auditors under 2CX 7E7
,. /iability under ,Eb#8 or some other general fraud statute
4. Ghat can be done) ?ap damages.
a. Mut go back to basic M"/ formula$ burden of loss as compared
to probability of loss times times the magnitude of loss
b. Damages arent the only deterrent$ reputational damages
c. &/2C$ te*as juries donJt use M"/ to calculate damages
d. 2o by capping damages% weJre trying to calibrate more
appropriate damges
(. Mut what is the ?&"))
a. 2ome absolute figure)
b. "ercentage of net worth) (hard to do with audit firms)
c. 2hould it vary based on type of behavior) i.e. low cap for
negligence to high cap for willful fraud
7. &nother solution$ do an audit every three years
8. Cr% do random audits (like drug testing)
a. <ight cause market problems in terms of information$ b@c
market may have trouble comparing companies
!. Duties o& a Securities Lawyer /SOO ;4<1
i. ?ommission must promulgate rules$
,. requiring an attorney to report evidence of a material violation of
securities law% breach of fiduciary duty% or similar violation by the
company or any agent thereof% to the chief legal counsel or ?C' AND
4. if the counsel or officer does not appropriately respond to the evidence
(adopting% as necessary% appropriate remedial measures or sanctions
with respect to the violation)% requiring the attorney to report the
evidence to the audit committee of the issuer% or to another committee
of the board comprised solely of outside directors% or to the entire
board of directors
ii. AC "!;S&T !;3TT CF &?T;CA
iii. Duty to report evidence of material violation by all attorne"s practicing
before the 5ommission
,. Transactin! any $usiness wit( t(e CommissionK
4. Re+resentin! an issuer in a ?ommission administrative proceeding or
in connection with any ?ommission investigationK
(. ro%idin! ad%ice in respect of the 02 securities laws or the 2?Js
rules or regulations there#under re!ardin! any document that the
attorney has notice will $e &iledKwith the ?ommissionK
7. Ad%isin! an issuer as to w(et(er in&ormation or a statementJ
o+inionJ or ot(er writin! is required under the 02 securities laws or
the 2?Js rules or regulations thereunder to be filed with% or submitted
to% or incorporated into any document that will be filed with or
submitted to the ?ommissionK
8. *cludes attys who$
a. ?onduct the above activities in a conte*t other than atty#client
provision of legal svcs% or
b. &re non#appearing foreign attorneys
9. ACT$ when representing an issuer% represent only the issuer and not
individuals (4E8.((a)).
:. #UT do not want to $e a$le to allow issuers to circum%ent +rocess
$y (a%in! only directors (ire +ersonal lawyers to +ro%ide
securities ad%ice . 4E8.4(g)$ you represent issuer if you advise
relating to legal services of issuer regardless of employment by
another
i%. E%idence o& a Material 'iolation,
,. credible evidence based upon which it would be unreasonable% under
the circumstances% for a prudent or competent attorney not to conclude
that it is reasonabl% li!el% that a material violation has occurred% is
ongoing% or is about to occurK
4. (1C comment; this formulation adopts an objective standard% yet also
recogni-es that there is a range of conduct in which an attorney may
engage without being unreasonable
(. 5reasonably likely6$ lower standard than actual knowledge of material
violation' 5must be more than a mere possibility% but need not be
Wmore likely than notJ6
v. Material %iolation isnJt restricted to securities laws
,. <ust report material violation of any 02 federal or state law
4. <akes sense b@c even if not securities related% if its material% it will
have a material impact on the company if not disclosed etc.
vi. &M& <odel !ule ,.,((b)
,. (b) ;f a lawyer for an organi-ation 7nows that an officer% employee or
other person associated with the organi-ation is engaged in action%
intends to act or refuses to act in a matter related to the representation
that is a violation of a legal obligation to the organi-ationKthen the
lawyer shall proceed as is reasonabl% necessar% in the interest of the
organi>ationK
4. 0nless the lawyer reasonably believes that it is not necessary in the
best interests of the organi-ation to do so% the lawyer shall refer the
matter to higher authority in the organi-ation including% if warranted
by the circumstances% to the highest authority that can act on behalf of
the organi-ation
(. (c) PGhen the highest authorityQKfails to address in a timely and
appropriate manner an action or refusal to act that is clearly a violation
of law andKthe lawyer reasonably believes that the violation is
reasonably certain to result in substantial injury to the organi-ation%
then the lawyer ma" reveal information relating to the representation
Kbut only to the e*tent that the lawyer reasonably believes necessary
to prevent substantial injury to the organi-ation.
vii. Aoisy Githdrawal 2? "roposal still not accepted$
,. modified proposal would require disclosure of withdrawal by attorney
by issuer which would then disclose that to 2?
4. 2till problematic$ private advice of lawyer to company now becomes
public% which may violate codes of professional responsibility
OII. De&inition o& a Security
a. Definitions$
i. J(( &ct (R4(a)(,))$ Sunless t(e conte?t ot(erwise reHuiresJT security means
any note% stock% treasury stock% security future% bond% debenture% evidence of
indebtedness% profit#sharing agreementsKor% in general% any interest or
instrument commonly known as a 5security6K
ii. J(7 &ct (R((a)(,E)$ Sunless t(e conte?t ot(erwise reHuiresJT security means
any note% stock% K.$ut s(all not include currency or any noteJ dra&tJ $ill o&
e?c(an!e or $anEerKs acce+tance w(ic( (as a maturity at t(e time o&
issuance o& not e?ceedin! nine mont(sK
b. Novel or irregular #evices reached by act if widely offered or dealt in under terms or
courses of dealing which established their character in commerce as 5investment
contracts6 or as 5any interest or instrument commonly known as a security6. Yoiner
/easing (,I7() (holding offering and sale of an assignment of oil leases as security)
c. <owe" Test &or In%estment Contracts,
i. %riefl" state#$ &n investment contract for purposes of the (( &ct means a N%
transaction or scheme whereby$
,. a person invests his money%
4. in a common enterprise% and
(. is led to e*pect profits%
7. solely from the efforts of the promoter or a third party
ii. 1acts$ ;nvolved the offering of units of a citrus grove development coupled
with a contract for cultivating% marketing and remitting the net proceeds to the
investors
iii. Towey Test$
3. In%estment o& Money /cas( or non"cas(1
.. Common Enter+rise amon! in%estors
a. 'ertical Commonality, In%estor/s1 (as/(a%e1 a common
interest w@t(e m!r o& (is in%estment
i. emphasi-es the relationship between the investors and
the promoter
ii. Turns on w(et(er +romoterKs acti%ities are t(e
critical &actor in t(e in%estment success@&ailure
iii. <ay e*ist even tho thereJs no pooling of investorsJ
funds or interests
iv. <ay arguably e*ist even if there is only a single
investor
v. -road vertical commonality# requires only a connection
between the efforts of the promoter and the collective
successes or losses of the investors
vi. strict vertical commonality# requires a direct
relationship between the success (as opposed to the
efforts) of the promoter and that of the investors
,. this requires them to share the risks of the
venture
$. CoriNontal Commonality, Multi+le in%estors (a%e a
common enter+rise amon!st t(em
i. more restrictive approach. ?overs fewer transactions.
ii. requires a pooling of investorsJ funds
iii. can have fi*ed or variable returns% but usually involves
a pro rata distribution
;. is led to e?+ect +ro&its
a. Ghich come from earnings of the enterprise% not just inflow of
addJl investor LL
0. deri%ed solely &rom t(e e&&orts o& ot(ers
a. not really 5solely%6 some investor participation is allowed
i. 5fforts of others6 just have to be undeniably
significant@predominate% or be the essential managerial
efforts that affect the enterpriseJs failure@success
(Turner and Noscot% ?M (D)
ii. literal approach of Towey test would frustrate the
remedial aspects of the securities acts. 2eller could
condition the deal on a minimal mgt by the investor%
and thus avoid Towey
b. 6ranc(ise or distri$utors(i+ arran!ements generally require
a level of activity by investors to defeat classification as
investment contracts
i. but% if the optional nature of a sales agency agreement
is illusory because the franchisees% as a practical matter%
are not in a position to sell the product themselves% it
can be an investment contract% 2? v. &cqua#2onic
"roducts ?orp.% ?M 7E
c. Timing of efforts of others is relevant to the investment N
analysis% 2? v. /ife "artners% ?M 7E
i. the value of the promoterJs efforts was already in the
purchase price of the investment% b@c promoter was not
e*pected to make further efforts to affect the investment
outcome
ii. so% the need for federal securities regulation was greatly
diminished
iii. the administrative functions (making sure insurance
premiums were paid% overseeing the disbursement of
funds) that /ife "artners would still have to perform
received less weight than if they still had to perform
entrepreneurial functions
iv. the viatical settlements marketed by /ife "artners were
not securities b@c the profits did not depend
predominately on the efforts of /ife "artners
d. RisE"Ca+ital Test # alternative test employed by some state courts
i. risk# a security will not e*ist unless capital provided by investors is at
substantial risk
,. if the risk is minimal b@c of the issuerJs strong balance sheet or
adequate collaterali-ation% the likelihood that an investment contract
will be found is lessened
ii. capital# not used in a narrow sense% but rather the economic capital which is
placed subject to the risk of loss through operation of the scheme in question
iii. differences from Aowe%
,. does not necessarily require common enterprise
4. avoids requirement that profits be derived 5solely6 from the efforts of
others
e. ri%ate commercial transactions not classi&ied as securities if$
i. "ersonally and uniquely negotiated
ii. Aot widely promoted
iii. "arine -an!$ ?CD not a security (otherwise protected by banking laws)
f. Consum+tion %. In%estment
i. "urchase of 5shares6 in subsidi-ed housing co#op not securities because the
purchase was made not with an investment intent but instead an intent to reap
a gain from the efforts of others. Corman.
g. In%estments wit( &i?ed returns Huali&y as securities' indeed investments pitched as
low risk may be most enticing to unsophisticated investors most prone to securities
fraud. 1dwards. (note that sale#leasebacks here might not have been securities had
they been lent out by a commercial bank)
h. Sales o& all or su$stantially all o& t(e stocE in closely (eld cor+orations not
e?em+t &rom t(e &ederal securities laws. andreth Timber (stock here possessed all
the usual characteristics of a stock in acquisition of a company)
i. Towey test only applies to investment contracts% not other enumerated items
in definition of security
ii. Gould have F&;/D howey test here . not an investment but a full purchase+
iii. )mplication$ securities laws protect acquisition of ,EE> of a company or
asset . M0T do we really need to protect in those situations))
i. "artnerships as 2ecurities
i. not addressed directly in the statute% so issue is usually presence of an
investment contract and whether investors are dependent for their profits on
the efforts of others.
ii. Few cases actually do treat "#ship interests as securities.
,. "laintiffs have a better chance if theyJre /"s than if theyJre 3"s
4. ?ts tend to see passive /"s as parties deserving 2ecurities /aws
protections. &nd thereJs latitude that actually allows /"s a relatively
broad range of participation before they lose these protections
iii. "artnership interest is a security if party can establish$ (Tuc!er)
,. no legal control'
4. no capacity to control' C!
(. no practical control
iv. (teinhardt$ /" had meaningful control$ veto power% removal of 3"% material
actions required its appoval not a security
L. De$t Securities /Notes1
i. 5eves Family !esemblance Test$
,. Megin with presumption that any note is a security% unless falls into an
e*ception
4. Then look at list of notes that are obviously not securities
a. ;ssuer can rebut presumption that a note is a security if it can
show that the note bears a strong family resemblance to an item
on the list of e*ceptions
b. g. Aotes in a consumer financing% notes secured by a
mortgage on a home% 2T note secured by a lien on a small bi-
or some of its assets% 2T notes secured by assigned &!s
(. ;f note isnJt sufficiently similar to an item on the list% or for new
transactions% the decision rests on the factors that helped create the list$
a. <otivation of parties$ investment v. consumption
b. "lan of distribution
c. "ublic e*pectations
d. !isk reducing factors% eg. ?ollateral or alternative regulation
ii. Facts of 5eves$
,. Demand notes issued by a farmerJs co#op to members and non#
members alike% at variable rates of interest% payable on demand
4. Aotes are unsecured but touted as 5safe and secure6
(. ?o#op files for bankruptcy% defaults on notes
7. Aoteholders sue auditor
iii. Ghy were the notes in 5eves securities)
,. Term could be more than I months
4. The demand note doesnJt resemble items on list
(. Factors suggest this
a. <otivation$ conceived as an investment in a bi- enterprise
rather than as a purely commJl *#action
b. "lan of distribution$ notes were offered 1 sold to broad
segment of the public
c. "ublic perception$ advertisement for notes characteri-ed them
as 5investments6
d. !isk#reducing factors$ none
iv. S(ort"term e?em+tion o& K;0 Act only a++lies to (i!( Huality commercial
+a+er. &allenbroc!
,. 2? wants to protect investors here% so will only e*empt short#term
notes that are high quality
4. here it was a pyramid scheme marketed to retail investors
(. qualifies as a security under the !eves test
k. !eason for 2eparate Tests for quity and Debt 2ecurities$
i. quity requires the efforts of others% whilst debt is purely financial
l. Conclusions a$out w(at is a security
i. Root o& t(is is in%estor +rotection$ language of statutes is often manipulated
to achieve this result
ii. Tard to justify two tests$ howey v reves
iii. *emptions treated differently under J(( and J(7 acts
3. E?em+t securities entirely outside t(e co%era!e o& ;0 actJ anti"
&raud +ro%isions as well as on!oin! re+ortin!
4. *empt securiites under J(( act may only be e*cluded from
registration (really a transaction e*emption) and not the ,4(a)(4)
antifraud provisions$ does this remainig coverage make sense)))
OIII. Intrastate O&&erin! E?em+tion
a. R((a)(,,) e*empts$
i. 5&ny security which is$
,. a part of an issue
4. offered and sold only to persons resident within a single 2tate or
Territory%
(. where the issuer of such security is$
a. a person resident and doing business within% or
b. if a corporation% incorporated by and doing business within%
7. such 2tate or Territory
b. Despite placement in 2ection ( (*empt 2ecurities)% ((a)(,,) considered a
T!&A2&?T;CA X<"T;CA
c. 2cope of *emption
i. ?oncept
,. <ust sell e*clusively to residents of single state# usually for local
financing of local business via local investment
4. 5"art of an issue6# looks to facts on whether part of plan or program'
so no e*emption is combined with different parts of single issue where
some sold to nonresidents' voids all of intrastate e*emption
ii. Doing Musiness in 2tate
,. 2ubstantial operational activities (not just bookkeeping% etc.)
4. ?anJt rely on e*emption if used for new business outside of state and
unrelated to business locally conducted
(. Aot valid for series of corporations in different states where they
constitute single venture
iii. !esidence within 2tate
,. !esidence is more than presence
4. Formal representations of residence and agreements not to resell to
nonresidents are not enough w@o more
(. ;f offering large enough from start% questions if it will be successful as
local offering
7. 2econdary offering by controlling person in state may be made in
reliance on e*emption if would be available to issuer in primary
offering' if corporation is in state% individual seller need not be resident
iv. !esales
,. Cnly get e*emption if entire issue is to residents' if sell to nonresidents
or resales to nonresidents% lose e*emption
4. Needs to 2come to rest8 in state $e&ore resale# time between sale
and resale a primary factor' needs to not be part of primary distribution
a. 2tatutory Test$ depends on whether purchaser bought with
intent to invest% e.g.% hold for substantial time
i. !esale within ,#4 years suspect% burden of proof on
seller
ii. investor change of circumstances may shift burden
b. ;nference even stronger if short time if party is a broker
(although broker can be out of state but must sell to residents)
v. 0se of mails and facilities of intrastate commerce# can use intrastate modes of
communication
d. NotesJ Iuestions and olicy
i. "remise# Uuestion whether state regulation is really adequate and whether
investors are more familiar with company just because itJs in#state (esp. with
large states and comple* and national businesses)
ii. Nonresident sales" e%en i& $y accident or to small num$erJ %oids
e?em+tion
iii. <easuring Musiness &ctivity in state# 5substantial operational activities test6'
?hapman says must be 5predominant6' difference)
iv. 2econdary offerings# !elease says control person can do as part of secondary
offering' 2? v. Tuchinsky says rule does not e*empt secondary sales% and
some 2? interpretations say primary must also have been qualifying under
e*emption
v. Comin! to rest# 2? issues <innesota !elease because of epidemic reselling
of intrastate offerings to nonresidents in <A# warned e*emption is not
available to issuers if as a result of a chain of transactions% process of
distribution is not completed prior to time securities are acquired by
nonresidents
,. !elease 77(7 issued shortly thereafter softened this and said that
securities that have actually come to rest in hands of residents who
purchase without a view to resales to nonresidents may be resold
without voiding e*emption
vi. Resales# uncertain when securities 5come to rest6' !ule ,7:% infra% provides I
month holding period' previous rule of thumb was one year# but still
ambiguous (ACT$ b@c itJs a transaction e*emption% unregistered resales
SC;D the e*emption)
e. Rule 30< Sa&e Car$or
i. !ule ,7:$ offers and sales made in accordance with ,7: provisions qualify for
((a)(,,) e*emption
,. ;ntroductory notes
a. !efers to ((a)(,,)
b. !ule so integration as above
4. "art a# Transactions ?overed# transactions within ((a)(,,)
(. "art b# "art of an ;ssue (Inte!ration Sa&e Car$or)
a. ?anJt combine with e*emptions from 2ection ( or 7(4) C!
"ursuant to registration statement wit(in = mont(s of ,7:
e*emption
b. Factors for integration (!elease 77(7)$ are@do the offerings
i. "art of a single plan of financing
ii. ;nvolve issuance of same class of security
iii. <ade at same time
iv. For the same type of consideration
v. <ade for same general purpose
c. ;ntegrated if same class of securities made by issuer at or about
the same time
7. "art c# Aature of ;ssuer
a. !esident of state if
i. ;ncorporated or organi-ed under that state if itJs
corporation
ii. ;tJs principal office is located in state but a non#
corporation organi-ation
iii. ;tJs principal resident is there if individual
b. Doing Musiness in state if$ (Triple DE Test)
i. DE> of gross revenues derived from that state (for
appro*imately last fiscal year)
ii. DE> of assets in state
iii. DE> of issue proceeds to run operations% provide
services% or purchase assets in that state
iv. &AD principal office in state
8. "art d# Cfferees and "urchasers' "erson !esident# is a resident for
offeree or purchaser if$
a. ?orporation% partnership% organi-ation has principal office in
state
b. ;ndividual has principal residence
c. Musiness organi-ation organi-ed specifically to acquire part of
an issue must have all of its beneficial owners in a state
9. "art e# Limitation o& resales
a. I month period from last sale by issuer before can sell out of
state
b. ?an always sell in state
c. Ghy can you resell as unrestricted) b@c those securities are
e*empt securites (b@c they fall under 2ection ()
:. "art f# "recaution against interstate offers and sales
a. ;ssuer shall
i. place on certificate noting securities are unregistered
and subject to intrastate limitations from e
ii. issue stop transfer instructions to transfer agent
iii. obtain written representation as to residentJs in#state
residence
b. <aintain the above for new certificates and will disclose the
above restrictions on resale regarding any offers to sell
ii. Notes and Iuestions
,. !arely will get no#action letter if going intrastate outside of !ule ,7:
4. Aothing in ,7: about disclosure to investors
(. GhoJs allowed the e*emption) Aote to ,7: indicates onl% for issuer%
but !elease 878E says it may be available to affiliates as well
a. Mut loose requirements for underwriters who can sell on a best
efforts or firm commitment basis
7. <ay lose ,7: safe harbor even if through an 5innocent and
immaterial6 deviation (unlike !egs D and &)
7. De&ense o& !ood &ait( com+liance /3D/a11 K;; act, rotected &rom
lia$ility i& you com+ly wit( a rule t(at is c(an!e or is &ound in%alid
=. Ideas &or re&orm in 3DD= Re+ort on t(e TasE 6orce on Disclosure
Sim+li&ication /none ado+ted1
a. Development of 5substantial compliance6 provision so canJt
inadvertently fall outside ,7:
b. Focus of e*emption should be on purchasers% not offerees
c. allow sales to investors who spend substantial amounts of time
in more than one state
d. rela* I month resale period to 9 or ( months
e. 5doing business6 test to be reduce to 8E> or eliminated in
favor of predominance or substantial operation test% and get rid
of 5use of proceeds6 test entirely
f. &llow new 2ection ((b) that allows 5local6 transactions across
state lines in major metropolitan areas (eg Tristate area) or
within prescribed distance of issuerJs principal place of
business
OI'. ri%ate lacement E?em+tion and Re!ulation D
a. ri%ate O&&erin! E?em+tion, - 0/.1$ "rovisions of 2ection 8 shall not apply to
transactions by issuer not involving a public offering
i. ;ncreasing ;mportance of "rivate <arkets Today
,. "ublic equity issues are more important than private equity% ,DT v 7T
4. Mut if you combine everything% debt and equity% more is raised private
than public% private are 9I> of the whole.
(. "rivate issuance of securities is S!H important in the 02 these
daysKits probably accelerated dramtically since then.
7. "rivate equity cpaital commitments stlil remains a small portion of
total pubilc market cap% weJre talking about around 4#8>
8. 3oing private transactions as > of public takeovers$ has risen from
4.4> in I8 to about 48> today
ii. Ghat is a private offering)
,. ?onsiderations$
a. 2ophistication (8
th
and D
th
?ircuits de#emphasi-e this)
b. B of offerees(as this number increases% higher burden of proof
on issuer to show all offerees had requisite access)
c. &ccess to info
d. Disclosure of info (safest to make those required by 2chedule
& of the ,I(( &ct)
e. ;nsider status @ relationship to issuer
f. 2i-e and manner of offering
4. 5alston$ *emption applies when offerees are able to fen# for
themselves
(. Doran Test (today)$ So+(istication +lus access or disclosure
a. sophistication of offeree% plus$
i. registration statement quality D;2?/C20!' or
ii. effective &??22 to such information
iii. !esale
,. ?ritical question# whether any of the purchasers acquired the securities
with a view to their distribution% rather than as an investment
a. & determination that supposed investors were actually acting as
conduits in a public offering will retroactively negate the
validity of the original transaction as a private placement
4. ;ssuers commonly take three steps to avoid this
a. ,) !equire purchasers to sign statements of investment intent
b. 4) ;nscribe securities to disclose that they are unregistered and
a transfer may take place only if specified conditions are
satisfied
c. () "ut into effect stop#transfer orders instructing the transfer
agent not to process any transfers of restricted securities
without the consent of the issuer
$. Re!ulation D
i. 3eneral$
,. !ules 8E7 and 8E8 were promulgated on the basis of R ((b) of the ,I((
&ct% which authori-es the 2? to develop e*emptions covering
offerings up to L8 million in amount when registration is not necessary
to protect the public interest or investors.
4. !ule 8E9 represents a none*clusive safe harbor for the private offering
e*emption of R 7(4).
ii. !ules$
,. Rule 74=
a. Ao /imitation on &mount
b. <ay sell to unlimited &;s and [ (8 non#&;s
c. Disclosure an# sophistication requirements for non#&;s
.. Rule 747
a. 0p to L8<
b. <ay sell to unlimited &;s% [ (8 non#&;s
c. Cnly disclosure (not sophistication) requirement for non#&;s.
d. Mad boy disqualifier
(. Rule 740
a. 0p to L,<
b. <ay sell to anyone
c. Ao disclosure or sophistication requirements
d. 2olicitation and resale depend on state law.
iii. conomic analysis of the structure of !egulation D
,. sliding#scale structure is sound in theory% but
4. are the dollar thresholds properly set)
(. they should be inde*ed for inflation
7. cost of regulating small business offerings through 8E7 may e*ceed the
benefits and justify an unconditional small offering e*emption
iv. Accredited In%estors #
,. Aot included when calculating total number of investors
4. ;mportant in determining the disclosure obligation of 8E8% 8E9
(. !ule 8E,(a) . definition
a. Financial institutions
b. "ension plans
c. Senture capital firms
d. ?orporations and other organi-ations e*ceeding a certain si-e
e. 1/ecutive Insiders of the issuer
f. Aatural persons with wealth or income e*ceeding
i. Aet worth V L, million' C!
ii. &nnual income V L4EE%EEE (of L(EE%EEE incl. spouse)
for each of the last 4 yrs if the current yearJs income is
likely to be above this level
7. ACT$ issuer needs only to reasonabl" believe investors falls under
above categories
8. Ghy consider wealth
a. Focus is the a$ility to $ear t(e risE of loss with this set#up
b. small issuers who are unable to attract the interest of &;s have
to deal with
i. increased disclosure burdens
ii. if under 8E9% sophistication requirements
9. ?oncerns$
a. /iquidity . Aon#liquid assets (eg. home) factor in to net wealth
b. Tonesty . ;s the supposed &; providing accurate info) &bsent
red flags% issuer not reqJd to audit &;Js supposed assets.
%. So+(istication Standard o& Rule 74=
,. To enLoy Rule 74= sa&e (ar$orJ issuer must o&&er e%idence o& t(eir
reasona$le $elie& as to t(e nature o& each +urc(aser. "ar! v. C(C
(ecurities Corp. (9
th
?ircuit% ,IDI) (/" interests in horse investments
sold)
a. ;ssue $ Did offering fall w@in private placement safe harbor of
!ule 8E9)
4. (ophistication 5e7uirement$ !ule 8E9 requires either$
a. ach non#&;% alone or w@a rep% have such knowledge and
e*perience in financial and business matter to be able to
evaluate the merits and risk of the prospective investment% or
b. The issuer reasonably believes this is the case
c. P8E8 and 8E7 do not impose this reqmJtQ
(. F2? didnJt offer any completed questionnaires prove this was the case%
so didnJt get the e*emption
0. urc(aser Re+resentati%es
a. Definition of "urchaser !epresentative% 8E,(h)$ (h) _"urchaser
representative_ shall mean any person who satisfies all of the
following conditions or who the issuer reasonably believes
satisfies all of the following conditions$
i. (,) ;s not an affiliate% director% officer or other
employee of the issuer . . . e*cept where the purchaser
is . . .PaQ relative of the purchaser representative by
blood% marriage or adoption and not more remote than a
first cousin'
ii. (4) Tas such knowledge and e*perience in financial and
business matters that he is capable of evaluating . . .the
merits and risks of the prospective investment'
iii. (() ;s acknowledged by the purchaser in writing . . . to
be his purchaser representative in connection with
evaluating the merits and risks of the prospective
investment' and
iv. (7) Discloses to the purchaser . . . any material
relationship between himself or his affiliates and the
issuer or its affiliates.
%i. Solicitation
,. !ule 74./c1 must be satisfied for !eg D e*emptions to apply
a. !ule Te*t$ 5*cept as provided in !ule 8E7( b)( ,)% neither
the issuer nor an" person acting on its behalf shall offer or
sell the securities b" an" form of general solicitation or
general a#vertising =>
b. Rule 740/$1/31 $ 2tates that the prohibitions on general
solicitation and advertising (!ule 8E4(c)) and the limitations on
resale (!ule 8E4(d)) do not apply to 8E7 offers and sales if
theyJre made$
i. *clusively in states w@robust blue sky disclosure laws
and the offers@sales are made in accordance w@those
laws
ii. ;n a state w@robust blue sky disclosure laws and the
offers@sales are made in accordance with those laws and
disclosure docs are delivered to all purchasers% or
iii. /imited to &;s% in accordance with state laws that then
allow general solicitations
4. *amples$ advertisements% articles% notices% seminars@meetings whose
attendees have been invited by any general solicitation or general
advertising G;// S;C/&T 8E4(c)
(. 2afe harbor$ publication by an issuer of a notice in accordance with
!ule ,(8c
vii. ?ase comparisons
,. asy cases$ Mass mailin!s are !eneral solicitations
a. In the "atter of .riorit% Access6 Inc )5elease No. **-DE4<+ . 4
million spam emails attempting to attract investors =
solicitation
b. Fohnston v. -umba (AD ;ll. ,II,) . 4%8EE mailings re$ offering
= general solicitation or advertising
4. Tougher case$ Iuasi"tar!eted mailin! still a !eneral solicitation
a. In the "atter of Genman Corp. (2?% ,ID8) . information
about offerings sent to si* groups of people$ prior purchasers%
e*ecutives of Fortune 8EE firms% people who had invested
L,E%EEE before with other issuers% physicians in ?alifornia% and
selected individuals from an industrial directory' T/D$
general solicitation% no e*emption
(. Dispositive Factor$ re"e?istin! relations(i+ $@w issuer and o&&eree
a. Definition$ must be sufficient to make issuer aware of offereeJs
financial circumstances and sophistication' looks at
substance@duration
b. "olicy$ want issuers@reps to be able to evaluate suitability of
offerees as purchasers
i. ?oncern for offerees is rooted in R7(4)% which is
foundational here% at least for 8E9
0. #@D can +ro%ide t(e +re"e?istin! relation $@w issuer and o&&eree
8. 1.C. Autton No Action etter (,ID8) . Iuestionnaire can satis&y +re"
e?istin! relations(i+ test when prequalification is based on$
investment objectives% net worth% income% sophistication% and history
of investments' no need for prior investment with broker
a. #UT relations(i+ must $e est. RIOR TO time #@D $e!an
worE on t(e Re! D o&&erin!
b. ?annot offer securities that the firm was offering or
contemplating offering at time of the questionnaire
9. ;nternet solicitations@pre#qualifications
a. !elease Ao. ((#:4(( (,II8) . generally placing private
offering materials on web sites 5would not be consistent with
the prohibition against general solicitation or advertising.6
b. I.#Net No Action etter (,II9) . online information can be
distributed re$ offerings if$
i. online questionnaire allows broker to determine
whether the investor is accredited Punder 8E,aQ or
sophisticated Pfor 8E9Q
ii. the broker verifies the information provided by the
investor% and
iii. the investor is given password access to page where
offerings posted subse7uent to the investorJs
registration are listed
:. !elease Ao. ((#:D89 (4EEE) . reinforced ;"CAet practices% but
e*pressed concerns over self#certification by investors by merely
checking a bo*% and non#broker#dealer websites that pre#qualify
investors and then pass them off b@c both donJt connect well with
policy of pre#e*isting relationship
viii. !ule ,(8c 2afe Tarbor
,. &dopted b@c issuers needed to be able to convey some information
about their offerings to inform e*isting shareholders of change in
business@direction
4. ?annot be used to 5condition the market6 for the offering
(. Cnly limited information allowed under ,(8c$
a. name of issuer%
b. basic terms of securities offered%
c. brief statement of the manner and purpose of the offering
d. without naming the underwriters or price
i*. ?alls for !eforms
,. "roblems$ (,) hardship on small issuers w@o pre#e*isting relationships'
(4) focus on offerees not purchasers' (() uncertainty in communication
4. &lthough the 2? has looked into it 1 the &M& Musiness /aw 2ection
has urged elimination of the prohibition on general solicitation% the
2? has not changed
?. A!!re!ation
,. !ule 8E7 and 8E8 limit the total offering prices within a ,4 month
period
a. !ule 8E7b4 = L, million
b. !ule 8E8b4 = L8 million
.. Calculatin! t(e ca+,
a. O&&erin! +rice o& all securities sold under Rule 740 or Rule
747 G
$. O&&erin! +rice o& all securities sold w@in t(e +re%ious 3.
mont(s in reliance on any -;/$1 e?em+tion M Rule 740J Rule
747J Re! AJ Rule <43 G
c. O&&erin! +rice o& all securities sold in +re%ious 3. mos. in
%iolation o& t(e -7 re!istration reHmKts
(. Te*t of !ule 8E8b4$ 5The aggregate offering price for an offering of
securities Kshall not e*ceed L8%EEE%EEE% less the aggregate offering
price for all securities sold within the twelve months before the start of
and during the offering of securities under this section in reliance on
any e*emption under section (( b) of the &ct P8E7 and 8E8Q or in
violation of section 8( a) of the &ct.6
7. ?alculating value$ cash is best
a. ;f 8E> cash 1 8E> other% take 4 ] ?ash = ,EE> value of
offering (!ule 8E,c)
b. ;f all non#cash% determine by bona fide sales of the
consideration or 5FS using accepted standard6
8. Timing$ ,4 months O offering period
a. &ggregate for ,4 months prior and for the period in which
offering is open (closes loophole of multiple offerings at the
same time after a year waiting)
?i. Disclosure
,. 3overned by !ule 8E4b
a. Depends on the si-e of the offering and nature of issuer
b. "olicy balance between providing investor protection (via
mandatory disclosure) and purpose of rules 8E8 and 8E9
(permitting small issuers to raise capital in a cost#effective
way)
4. !ule 8E7 Cfferings$ Ao disclosure reqJd
(. !ule 8E8% or !ule 8E9 Cfferings
a. ;f sell only to &;s% no disclosure reqJd
b. ;f sell to any non#&;% must disclose to all non#&;s and
preferably to &;s too
i. ;f a reporting company% must provide J(7 &ct filings
ii. ;f a non reporting company% must disclose
,. Aon#financial info = !2 if offering is L8<O% or
!eg & offering if [ L8<
4. Financial information
a. [ L4< . balance sheet audited and dated
within ,4E days
b. L4< [V L:.8< . audited financial
statements (but some breaks)
c. V L:.8< . e*tensive@full audited
financials
iii. Aon#&;s are entitled to any info given to &;s
c. &;s and Aon#&;s entitled to ask questions
?ii. Limitations on Resale
,. 3overned by !ule 8E4d
.. NO TIMING CURE LI*E )ITC INSTRATEF
(. Te*t of !ule$ 5*cept as provided in section 8E7( b)( ,)% securities
acquired in a transaction under !egulation D shall have the status of
securities acquired in a transaction under section 7( 4) of the &ct and
cannot be resold without registration H6 and further e*emption
7. !ule ?ontinued$ 5The issuer shall e/ercise reasonable care to assure
that the purchasers of the securities are not U&s w@in the meaning of
R4( ,,) of the &ct% which reasonable care may be demonstrated by the
following$
a. Reasona$le inHuiry to determine if the purchaser is acquiring
the securities for himself or for other persons'
b. )ritten disclosure to each purchaser prior to sale that the
securities have not been registered under the &ct and%
therefore% cannot be resold unless they are registered under the
&ct or unless an e*emption from registration is available' and
c. lacement o& a le!end on t(e certi&icate or other doc that
evidences the securities stating that the securities have not been
registered under the &ct and setting forth or referring to the
restrictions on transferability and sale of the securities.
8. ?loses loophole that would allow issuers to use private offering and
then resell immediately
?iii. Inte!ration /C#, ;.0";;.1
,. Cffering ;ntegration 3overned by !ule 8E4a
4. = Mo. #ri!(t Line$ 5K Cffers and sales that are made more than si/
mos before the start of a !eg D offering or are made more than si/
months after completion of the !egulation D offering will not be
considered part of that !egulation D offering% so long as during those
9 mo periods there are no offers or sales of securities K6
(. ;f there is another offering within si* months of the !eg. D offering%
the following factors will determine whether the offering will be
integrated (from !elease Ao. ((#7884)$
a. art o& a sin!le +lan o& &inancin!
i. <ay turn on intent of issuer since plan presupposes
intent (ivens v. &illiam $. &itter6 Inc.% D. <ass. ,I:7)
ii. <ay also just be combination of other 7 factors
(.ropert% Inv. No Action etter% ,I:4)
$. Issuance o& t(e same class o& securities
i. 3enerally debt not integrated with stock ((-T Corp. No
Action etter% ,IDE)
ii. <ore subtle differences like maturity and interest rate
for debt can be enough ((1C v. $unfee% G.D. <o.
,I99)
c. Sales made at or a$out t(e same time
i. 9 month lapse creates rebuttable presumption against
integration
ii. , year lapse may make the presumption irrebuttable
d. Same ty+e o& consideration !i%en
i. 2ince most offerings involve cash consideration% the
fact that two offerings both give cash consideration is
not a factor for integration (aserCa/ No Action etter%
,ID8)
ii. Aon#cash consideration of the same type increases
likelihood of integration
e. Made &or t(e same !eneral +ur+ose
i. <ay be same as the first factor (single plan)
ii. $onohoe v. Consolidated #perating 0 .rod. Corp. (:
th

?ir. ,II4) = best case
,. 5suggests a level of generality to the integration
analysis6 . that each partnership in the case was
to drill for oil was enough
4. M0T$ 5each project was designed to stand or fall
on its own merits6 and 5turnkey price was
fi*ed6 so 5savings were not passed on to the
partnership6 1 court did not integrate
*iv. ?ritics$
,. Mradford% ,II9 mory /Y article$
a. Doctrine is ill#defined (factors listed% but no
e*planation@clarification)
b. 0ncertainty of 8 factor test in application
c. ?ostly both to administer by 2? and to comply with via
private legal costs
d. ?hilling effect on issuers b@c of risk of integration
4. ?ampbell% Ny /Y article$ call for complete elimination of integration
doctrine
(. ?ommittee !ecommendation$ e*tend concept of 2helf offering to !eg
D . allow GN2;s% once registered to do as many of these as they want
*v. Issuer Inte!ration under (1C v. "urph% (I
th
?ir. 4EE,)
,. Definition$ offerings by ostensibly distinct issuers are integrated as one
issuer
4. &pplied in "urph% to get to company (;ntertie) that sponsored limited
partnerships even though the individual partnerships nominally
conducted the offerings
(. ?ritical issue is investorsJ need for information concerning issuing
entity
?%i. Rule 37. M ri%ate O&&erin!s 6ollowed $y u$lic O&&erin!s
,. ;magine$ "rivate placement under a R7(4) e*ception% quickly following
by a public offering
4. !ule ,84 says that even if the factors suggest integration% the two *#
actions are not integrated
(. Mut when does the first end and the second begin)
a. Mest answer right now% is when the buyers are all unalterably
committed to the first% it ends
?%ii. Rule 377 M A$andonment o& O&&erin!s
,. &llows issuer to abandon private offering in favor of public offering or
vice#versa (without triggering integration problems) if abandoned
before any securities are sold and conditioned upon a (E day cooling
off period b@w !2 withdrawal and the private offering
?%iii. Rule 30</$1/.1, Inte!ration Sa&e Car$or
,. . 5for this rule K an issue shall K not include offers K pursuant to
the e*emption provided by R( or R7(4) of the &ct or pursuant to an !2
filed under the &ct6 outside of 9 months before@after other offers
O'. Secondary O&&erin!s and Resales
a. Underwriter Conce+t
i. 2ales of securities by non#issuers are within scope of R8 b@c it requires that
every sale be either registered or e*empt and R7(,) does not e*empt
transactions by 5issuer% underwriter% or dealer6
ii. 0G defined by R4(a)(,,)$
,. The term _underwriter_ means any person who has purchased from an
issuer with a view to6 or offers or sells for an issuer in connection
with6 the distribution of an% securit%. . . ' but such term shall not
include a person whose interest is limited to a commission . . . not in
e*cess of the usual and customary distributors^ or sellers^ commission
iii. Functionally 7 roles qualify a person as an undertaker$
3. any +erson w(o +urc(ases &rom an issuer wit( a %iew to
distri$ution o& a security /'IE) TO DISTRI#UTE1
.. any +erson w(o o&&ers or sells &or an issuer in connection wit( a
distri$ution /AGENT1
(. any person who has direct or indirect participation in , or 4
7. any person who directly or indirectly participates in the underwriting
of such an undertaking
a. ?onnection to the distri$ution is key. Yust buying@selling is
not enough
b. &nother *emption$ &verage members of the selling group%
are not 0Gs if they donJt receive commissions beyond the
normal dealer commission
iv. 7 &ddJl ?ategories$
3. Any +erson w(o (as +urc(ased &rom a Scontrol +ersonT w@a %iew
toU t(e distro o& a security SU) 6OR CONTROL ERSONT
.. Any +erson w(o 2o&&ers or sells &or Sa control +ersonT in
connection w@t(e distro o& any security
(. &ny person who 5participates or has a direct or indirect participation
in any such undertaking6% ie. ,#4
7. &ny person who 5participates or has a participation in the direct or
indirect 0G of any such undertaking6% ie. ,#4
v. !esults in ( major categories$
3. A!ent &or issuer
.. urc(aser &rom issuer w@a %iew to distri$ute
;. U) &or control +erson
$. A!ent &or Issuer
i. (1C v. Chinese Consolidated -enevolent Ass8n (4d ?ir. ,I7,)
,. Facts$ unregistered ?hinese gvt bonds% ??M& of its own initiative
facilitated sales in 02
4. T/D$ ??M& was a 0G and violated 2& R8(a)
(. T&N&G&H$ Tuge reach of 0G definition
a. ;mmaterial whether ?hinese gvt (issuer) solicited or merely
availed itself of the ??M&Js acts' still 5for the benefit of6
issuer in connection with distribution of bonds
b. &im of the 2& is to make info avail to investors and protect the
public. These goals not served by focusing on issuerJs
solicitation or contracting for 0G svcs. !ather furnishing of
a#e?uate info is the 7e" in?uir"
c. ?ourt also noted even if ??M& was not 0G% it still was
5participating in a transaction with an issuer6 by funneling the
money (steps necessary for distribution)
7. D;22AT$ concern statute too broad' worried newspaper editorial
urging purchase of bonds based on patriotism would make the paper
an underwriter
ii. *pansive interpretations of 5participates6
,. (1C v. Allison (AD ?al. ,ID4)$ &nyone who has arranged for public
trading of an unregistered security or who has stimulated investor
interest though advertising% research reports or other promotional
efforts can be considered to have 5participated6 in the issuerJs
distribution
4. Aarden v. 5affensperger (:
th
?ir. ,II8)$ conducting due diligence on
offering was enough to 5participate in an underwriting6 since it was a
step necessary for the distribution
c. urc(ase &rom an Issuer @a 'iew to Distri$ute,
i. 2ecurities &ct R4(a)(,,)$
ii. <eaning of 5"urchase6$
,. Aot defined in the &ct% but a sale requires the disposition of a security
5for value6 (R4(a)(())
a. 2o% donee isnJt a 0G unless gift is conditioned on doneeJs
performance of an undertaking that would constitute the giving
of 5value6 (e.g.% a chair position to be named in the donorJs
honor)
b. "ledge of stock as collateral for a loan is an 5offer or sale6 of a
security within the meaning of R,:(a) (5ubin v. U()
problem for bank taking shares as collateral
iii. <eaning of 5Gith a view to K the distribution6 of the security$
,. 2eller must have purchased with investment intent or else resale
violates R8
4. ?ourts use an Cbjective test for investment intent . 4 factors$
a. ength of Time$
i. [4 years$ presumption against investment intent% but
may show by change of circs (below)
ii. 4#( years$ investment intent is presumed (M0T
rebuttable)
iii. V( years$ investment intent is established (irrebuttable)
b. Change of Circumstances$ PAC /CA3! S&/;D "C2T#,77Q
i. ?hange in "urchaserJs (ACT issuerJs) circs may be
considered to show investment intent
,. "olicy$ donJt consider change in issuerJs circs
since otherwise would permit a dealer to make
speculative purchases in unregistered securities%
and then unload the shares on the 5unadvised
public6 without required disclosures. Billigan%
4d ?ir% ,I8I% ?M (78
ii. The change must be something 5basic and
unforeseeable6 (e.g.% sale made to satisfy une*pected
call by bank of demand note)
(. Ao violation unless there is a #istribution
a. For resales of registered securities by non#controllers% thereJs
no resale U b@c the !2 applies
b. For resales by non#controllers% thereJs no distribution U% if
there is investment intent
c. ;f a non#controller canJt show investment intent% we enter the
distribution inquiry
i. Distribution$ includes an offering of a security thatJs
reqJd to be registered b@c the issuerJs offering d@n come
to rest only w@ investors who satisfy the criteria of a
single e*emption from registration
ii. 5a distribution e*ists if there are sales to those who
cannot fend for themselves6
iii. The analysis is whether the resale destroys the
e*emption the issuer used in the first place% i.e.% non"
control +ersons can resell to +ersons w(o meet t(e
criteria o& o& t(e e?em+tion relied u+on $y t(e Issuer
and (ence (er resale is NOT a distri$utionF
iv. VVVSummary, !esale by a non#control person$ first look to investment intent
(i.e. holding period of some sort) then if not present look to whether itJs a
distribution i.e. whether resale destroys the e*emption under which issuer
initially sold offering.
d. Control erson Distri$utions,
i. 0nlike normal purchasers% a control +erson is not +rotected $y (er
in%estment intent (i.e.% even if the issuerJs offering has come to rest%
investment intent does not protect resale of a control personJs shares)$
,. Control +ersons may rely on 0/.1 transaction e?em+tion &or
IMMEDIATE resale to !alston "urina (i.e. fend for themselves)
qualified purchaser who would not destroy the issuerJs e*emption.
4. &nyone who purchases from a control person% or sells for a control
person% or otherwise participates% directly or indirectly% in a
distribution of the control personJs securities is an underwriter (R4(a)
(,,)).
ii. Two Definitions of ?ontrol
,. ,) &bility to direct management and policies of the issuer% !ule 7E8
a. !ule 7E8$ 5control6 K means the possession% direct or indirect%
of the power to direct or cause the direction of the mgt and
policies of a person% whether through the ownership of voting
securities% by contract% or otherwise ... common control with
the issuer.
4. 4) "ower to obtain signatures reqJd to file an !2
iii. US %. )ol&sonJ .d CirJ 3D=:J C# ;7. " Lia$ility o& Control ersons
,. G was companyJs largest 2T (7E> interest). 2old V8E> of his shares
through various different brokers.
4. GJs liability ## ( steps$
a. G is a controller is a R4(a)(,,) statutory issuer.
b. ;f G is R4(a)(,,) issuer% brokers are R4(a)(,,) 0Gs
c. ;f brokers are R4(a)(,,) 0Gs% then the stock was sold in 5*#
actions by 0Gs6
d. X#&ctions by 0Gs d@n enjoy the e*emption of R7(,)
e. G@out the R7(,) e*emption% the transaction violated R8.
(. MrokerJs *emption
a. The brokers% however% are shielded by R7(7) broker e*emption
b. Mut% G c@n rely on R7(7) brokerJs e*emption% since the brokerJs
e*emption applies only to brokers.
7. Gould G have violated the &ct if he had sold his shares without a
broker) Hes% since he would be acting as his own underwriter (i.e.%
someone 5selling for a control person6)
8. ?ould G have sold his shares as part of a shelf registration or under
!egulation D) Ao' since a control person is not a 4(7) issuer% they
cannot take advantage of such issuer#based e*emptions
iv. Ghy such a harsh rule for control personJs)
,. ?oncerned that ?" will take advantage of investors ## information
advantage
4. Cther ways for ?"s to make public offerings
(. 2cott suggested ?" rules may reach too far wrt public companies
(M0T there is !ule ,77 alternative)
e. T(e #roEerKs E?em+tion
i. 2ecurities &ct R7(7)$
,. *empts from R8 5brokersJ transactions e*ecuted upon customersJ
orders on any e*change or in the over#the#counter market M0T ACT
the solicitation of such orders6
4. Distinguish 5Mrokers6 from 5Dealers6$ a dealer buys@sells shares
for@from his own inventory% whereas a broker acts solely as the agent
in carrying out his customerJs purchase or sale.
ii. Towever% since all brokers are included in 4(a)(,4)Js definition of dealer%
brokers need never resort to 7(7) if for a specific transaction the brokerJs
conduct is already e*empt under 7(() or !ule ,:7.
iii. *ample$ a broker who sells to his customer registered securities of a
reporting company is already e*empt under !ule ,:7.
iv. Mrokers who wish to rely on 7(7) must make a 5searching inquiry6 as to the
character of the securities being offered for sale whenever a customer wishes
to sell a substantial number of shares of a little#known company.
v. 7(7) e*emption protects CA/H the broker' the brokerJs client must seek his
own e*emption for a resale.
&. T(e 20/3W1 E?em+tion8 /is resale $y a control +erson a distri$ution91
i. Ghen control person canJt resell based on ,77 (volume limit% issuer not
current in reporting% or sale not via broker)
ii. - 0. "rovisions of R8 shall not apply to$
,. transactions by any person other than an issuer% underwriter% or dealer
4. transactions by an issuer not involving any public offering
iii. ;s a R7(,) e*emption in which there is no distribution% under the criteria for an
issuer making a private offering under R7(4)
iv. ;e. a R7(,) e*emption when offers and sales are to non#public investors$
,. Ao distribution Ao 0G Ao registration reqJd. DCA.
v. The 7(,`) e*emption is like a 7(4) e*emption for transactions by individuals
(who are not issuers and thus cannot technically rely on 7(4))
vi. Tave to meet (somewhat rela*ed) requirements of 7(4) for the resale to be
e*empt under 7(,)
,. 0ncertain if sophistication is a requirement
4. &lthough court in Ac!erberg thought buyer sophistication was
important% casebook suggests that focus of 7 (,`) is . like focus of
7(,) . more on whether or not there is a 5distribution6' by contrast%
focus of 7(4) is more on whether the buyer can fend for himself.
(. Mroad solicitations are inconsistent with 7 (, `)
7. Aumber of purchasers must be small
8. ;nformation disclosure requirement
9. 2ecurities sold under 7 (, `) are considered restricted (i.e.% purchaser
cannot resell without an e*emption)
!. Rule 300
i. .urpose of 3<<
,. To let an a&&iliate get rid of its restricted shares
a. &ffiliate defined in ,77(a)(,)
i. 5control6 defined by !ule 7E8
b. designed to let them resell into "0M/;? market
4. To let an initial +urc(aser o& a +ri%ate +lacement to do the same
(. 3enerally viewed as on of 2?Js most successful projects
a. 2? says that 5distribution6 is the key concept in defining
5underwriter6
b. &ctJs purpose and policy require focus on
i. Disclosure
ii. Tolding period to make sure people buying under 7(4)
e*emption assume economic risks
iii. <arket impact of transaction
,. 7(,) applies only to routine trades% not
distributions
ii. 1lements of 3<<
,. A++lies to (,77(b))$
a. securities bought through non#public offerings or subject to
!eg D (restricted securities)
b. 2ecurities held by control persons (restricted and
unrestricted)
4. O+erati%e ro%ision,
a. any affiliate or other person as specified above shall be deemed
not to $e en!a!ed in a distri$ution o& suc( securities and
therefore not to be an underwriter thereof within the meaning
of section 4(,,) of the &ct if all of the conditions of this
section are met 0/31 E?em+tion
(. Tolding "eriods (,77(d)%(k))
a. NO COLDING ERIOD 6OR UNRESTRICTED
SECURITIES sold $y control +erson
$. NO COLDING ERIOD 6OR securities acHuired under
740 /$@c t(eyKre not restricted securities1/su$Lect to certain
restrictions1
c. d$ one year for conditional sales (cJeJ&J() of restricted
securities
d. E$ two years for unconditional sales of restricted securities\
but control persons always subject to conditions
e. A.M. Ao holding period for non#restricted securities
7. In&ormation ReHuirements and 'olume Rules /c and e1
a. ;n the one year period for restricted securities
b. &lways for securities sold by control persons
c. (c) requires current public information w@r@t issuer
7. Limitations on Manner o& Sale /&1
a. <ust be through brokers during one year holding period for
restricted securities (brokersJ 7(7) e*emption codified in (g))
b. &lways for securities sold by control persons
=. Notice to SEC ReHuirements /(1
a. ;n the one year period for restricted securities
b. &lways for securities sold by control persons
:. Limitation on Amount o& Sale, during previous three months amount
of sale shall not e*ceed greater of$
i. ,> of class outstanding% or
ii. if traded on an e*change% avg. weekly volume on all
such e*changes within the preceding four weeks
b. ,77(e) sometimes requires aggregation of two or more sellers
in determining volume
i. when securities are sold by pledgees% trustees% estates'
or when selling a convertible security and the security
itJs convertible into
ii. DCAJT count$ (see ,77(e)(()(vii))
,. securities sold pursuant to registration
statement% a !eg & e*emption% a R7 transaction
e*emption and not involving any public
offering% or offshore sales pursuant to !eg 2
D. Rule not e?clusi%e% but if you sell outside it youJre on notice that you
have a heavy burden of proof and cannot ask for a no#action letter
I. ?hange in ?ircumstances AC /CA3! !/S&AT
iii. Important $efinitions
,. 5!estricted 2ecurity6 . ,77.a.(
a. 2ecurities acquired in non"+u$lic o&&erin!
b. subject to Re!. D resale restrictions (even if !eg. D offering
is 5illegal6)
c. securities in Rule 300A transaction
d. securities obtained in Re!. CE transaction
e. !eg 2
f. ACT$ -;.a.33 are ACT 5!estricted6 and thus not subject to
!ule ,77
4. 5&ffiliate6 M 300.a.3
a. 5a person that directly% or indirectly through one or more
intermediaries% controls% or is controlled by% or is under
common control with% such issuer6
(. Two different definitions of distribution$
a. ,\5alston .urina where a distribution occurs when the
investors are unsophisticated
b. 4\Solume definition utili-ed in !. ,77 where the key concern
is flooding the market.
iv. Re!istered s(ares sold $y control +erson REIUIRE re"re!istration$
,. Loss and Seli!man$ itJs an altogether different offering from the
original distribution now that the control person is in control% so
requires a new !2
4. Scott$ informational advantage of ?"s
v. 2elling 2hort to ?ircumvent Tolding "eriods
,. non#?" subject to ,77 holding period for restricted stock% but
unrestricted stock of same series trading on public market
4. then can sell public stock short to lock in profit and repay broker with
the restricted stock at end of holding period
(. "olicy$
a. Ge donJt really care about holding periods when there is
already unrestricted public stock also trading
b. Full compliance with rules and separate policies
(. Rule 300A, Sales o& restricted securities to II#s $y non"issuers
i. O+erational ro%ision 300A/$1,
,. 2ales by dealers or persons other than issuers% when compliant with
,77&% are not distributions
4. therefore the parties are not 0Gs
(. therefore the e*emption of R7(,) applies
7. therefore R8 is not violated.
ii. Ghat does ,77& do$
,. For securities originally sold under !egulation D of (( &ct% you can
+urc(ase &rom an issuer and t(en immediately resell without
becoming an underwriter (under !ule 8E4(d) of !eg D) if you follow
,77&
4. DoesnJt matter if you purchase intended to resell
(. M0T$
a. DC2AJT e*tend to publicly traded securities
b. $#1(N8T cleanse shares of restrictions li!e 3<<
iii. Ge% 1lements
3. Eli!i$le +urc(aser M Iuali&ied Institutional $uyers
a. #anEs and S5Ls .
i. <ust invest in and own min. L,EE< in securities of
institutions other than the bank@21/ in question
ii. <ust have audited net worth of min. L48<
b. Re!istered #roEer Dealers # <ust invest in and own min.
L,E< in securities of institutions other than the dealer in
question
c. Ot(ers # <ust invest in and own L,EE<O in securities of
institutions other than entity in U
d. 'eri&yin! Iuali&ications, 2eller can rely on public info or info
given by buyer to see heJs a U;M. <ost of the info must be ,9
months old% ma*.
.. Eli!i$le Securities
a. ;f similar securities are listed@registered% no e*emption for the
new securities issued% ,77&(d)(()
b. This also includes &D!s and convertibles if the underlying
security is traded publicly (unless conversion premium V,E>)
;. De&ecti%e rior or Su$seHuent Sales Do Not Destroy 300A
E?em+tionJ Rule 300A/e1,
a. *emption under ,77& will not be affected by prior or
subsequent *#actions by other sellers
7. Coldin! eriod, Aone
8. In&o $ basic financial info when issuer doesnJt file under W(7 &ct or
furnish home country info under !ule ,4(g)((#4)(b)
a. must be able to obtain\and be provided on request\
i. brief statement of business% and products and services
offered
ii. most recent balance sheet
iii. profit and loss and retained earnings statements
iv. similar statements for previous two fiscal years
b. "olicy$ does it make sense to have this requirement)
i. <arket seems to impose its own demand
ii. Typical ,77& placemJt begins w@offer memo incl.
e*tensive disclosures 1 warranties
iii. Mroker#dealerJs counsel usually provides a 5,Eb#8
opinion6
,. 2tates that no fact is known to counsel
suggesting any of the memoJs or disclosuresJ
statements are untrue
c. ;f all these disclosures are being made anyway% why is ,77& so
popular)
=. Seller must ensure $uyer is aware seller may rely on 300A to a%oid
-7
<. Must $e a ri%ate sale
:. Lia$ility,
a. "rovides e*emption only from R8 of the J(( &ct
i. Therefore% no liability under R,,% R,4(a)(,)% R,4(a)(4)
b. /iability remaining$
i. ,Eb#8
ii. &nti#fraud or other provisions of the 2ecurities /aws
(eg. J(7 &ct registration)
iii. 2tate laws
I. Non"inte!ration (,77&(e))$
a. Cffers and sales of securities pursuant to this rule shall be
deemed not to affect the availability of any e*emption or safe
harbor relating to any previous or subsequent offer or sale of
such securities by the issuer or any prior or subsequent holder
thereof.
iv. &hat could be done to ma!e 3<<A more attractiveI
,. /ess restrictive U;M definitions
4. Ao info requirements
(. !educe liability (,Eb#8% "armalat)
a. DonJt violate 2ec. ,, b@c not faulty underwriter and not ,4(a)
(,) and ,4(a)(4)
b. Mut still liability under ,Eb8
c. ;f wanted to e*pand market% reduce liability in situations like
"armalat
7. "armalat $ "" to U;Ms which trade in ,77& market
a. /itigation against banks for facilitating the fraud
v. A,- 1/change #ffers
,. Ghen restricted securities are e*changed for registered ones%
e*changing security holders are named in registration statement as
selling shareholders and thus have underwriterJs investigation burden
4. 2? Ao#&ction /etters$ e*changing shareholder avoids underwriter
status if not otherwise a broker engaged in the distribution of a security
(&@M e*changes)
(. 2? limits its position to nonconvertible debt% certain preferred stock%
and foreign issuersJ initial 0.2. offerings
7. Aot available to 0.2. issuers of common shares whereby restricted
security is e*changed for a registered one
8. Cccur increasingly around ,77&% w@ institutional buyers obtaining
agreement from issuer to e*change at a later date the registered for the
unregistered securities
O'I. On!oin! Disclosure O$li!ations
a. 2ummary of ?ontinuous Disclosure Cbligations 0nder J(7 &ct
i. eriodic Re+ortin! ReHuirements (disclosure with respect to specified
items)
,. &nnual 2tatements% ,EN
a. 9Eday delay% post December 4EE8% for 5large accelerated filers6
(public float of L:EE million or more% 2? !elease Ao. ((#
D9,:% 2eptember 44% 4EE8)
b. :8day delay for 5accelerated filers%6 companies with public
float of L:8 million to L:EE million% IE days for rest% !elease
((#D9,:
4. Uuarterly 2tatements% ,EU (2? !elease ((#D9,:)$ 7E day delay% post
December 4EE8% for filers over L:8 million of public float% 78 days for
rest
(. 2ignificant vents% DN (7 business day delay% no ,Eb#8 liability for
failure to file with respect to several events% !ule ,(a#,,(c)% ?2 I4E)
7. Item ;4;/a1/;1 of !egulation 2#N$ ,ENs and ,EUs must include new
material information (?2 (4:) (<D1&)
ii. Rule 3.$".4 (J(7) (counterpart of !ule 7ED for registration statements% ?2
,(D)$ must add further material informatin to prior re7uired reports or
registration statement (see those above) to make sure they are not misleading
iii. Common Law o& 34$"7$ cannot make material misrepresentations and must
correct inaccurate prior disclosures (not in reports) that have become
misleading$ -asic6 &ielgos6 In re Time &arner
b. Duty to 0pdate Metween !equired !eports (pros and cons)
i. ro,
,. vents happen% and valuable to get it out
4. <akes for more efficient markets
(. "rice accuracy needed for allocation of resources
7. "revent volatility
8. Metter managerial discipline
ii. Con,
,. ?osts of disclosure' administrative costs and management
4. Difficult to define materiality
(. Disrupts business activity
7. Hou get pricing accuracy every quarter' this increases volatility and
short#termism
8. ?an hurt e*isting shareholders% e.g. disclosure of merger negotiations
could kill the merger
c. DN !equired Disclosure
i. #ld$
,. ?hange in control
4. &cquisition or disposition of significant amount of assets
(. (e*panded)
7. Mankruptcy (e*panded)
8. ?hange in certifying accountant
9. !esignation of a director% principal officer or election of director and
appointment of principal officer (e*panded)
:. ?hange in fiscal year
D. Financial information in connection with an acquisition
I. !esults of Cperations
,E. Cptional$ events of importance to shareholders
,,. 0se to satisfy !egulation FD disclosure (prohibits selective disclosure)
ii. Aew$
,. nter into or terminate material agreements% not in ordinary course
(;tems ,.E, and ,.E4)
4. ?reation of material financial obligation on or off#balance sheet
(nron) (;tem 4.E()
(. Triggering events that accelerate or increase material financial
obligations (;tem 4.E7)
7. ?osts associated with e*it or disposal activities (;tem 4.E8)
8. <aterial impairment of assets (;tem 4.E9)
9. Delisting or failure to satisfy a listing rule' transfer of listing (;tem
(.E,)
:. 2ales of unregistered securities (;tem (.E4)
D. <aterial modifications to rights of security holders (;tem (.E()
I. Aon#reliance on previously issued financial statements or a related
audit report or completed interim review (;tem 7.E4)
,E. &mendment to &rticles or My#/aws (;tem 8.E()
d. !equirements of Financial !eporting
i. 2tatements prepared in accordance w@3&&"
ii. !eports are accurate and honest
iii. <aintenance of reliable and trustworthy acctg records
iv. !eport must 5fairly present6 its financial position and operations
v. 3&&"
,. ?oncern over manipulation
4. ,st line of defense$ &ccounting metrics that are objective principles
and rules
(. 4nd line of defense$ Cutside@independent auditor (?"&).
7. Aon#accounting info is also important to investors and shareholders.
Disclosures mandated by 2? in !egulation 2#N are a blend of
accounting#based info and non#accounting info
e. Material Disclosures ReHuired Under Common Law o& 34$"7
i. 2peculative information and materiality$
,. Omitted &act is material i&$ )-asic v. evinson)
a. 2ubstantial likelihood that reasonable shareholder would
consider it important in deciding how to vote
b. <ust be subst likelihood reasonable investor would consider
disclosure as alterin! t(e total mi? of available information
c. <ateriality defined based on +ro$a$ility@ma!nitude test
4. Facts$ Masic (publicly traded) in talks to merge% but makes ( public
denials. <erger happens. 2Ts bring ?& alleging injury b@c sold
shares at artificially depressed prices in a market affected by
misleading statements and in reliance thereon.
(. ?ourt rejects (
rd
?. &greement in "rinciple Test
7. No a&&irmati%e duty to disclose (ereJ but must be truthful when
voluntarily disclosing
ii. Total <i* of ;nformation$ fficiency and Truth on the <arket
,. (ruth on the 4ar7et: optimistic estimates not materially misleading
because market surely understood the overstatements and discounted
the consistently optimistic forecasts (&ielgos) (asterbrook)
4. 6acts$ Facts$ 2Ts sue issuer 1 0G. ?laims violation of R,, b@c shelf
!2 contained defective estimates of cost 1 time for nuclear plants
(incorporated by reference b@c 2# filer)
(. Duty to disclose$ (not discussed in case)$ but arguably not% b@c e*pense
2T;<&T2 made at time may not have been inaccurate% and e*pense
estimates change% so no duty to correct
7. olicy$ ;s TCT< fair to rely on in discharging a duty to update)
a. O@# of ?<T
b. (#) 0ndermines the disclosure policy)
c. (#) T2$ Does the mkt know the si-e of the error)
d. (#) T2$ Tow can the mkt price in the error when itJs a shelf)
<aybe into bookbuilding)
iii. Total <i* of ;nformation$ u&&ery
,. Mere sales +u&&ery not actiona$le under 34$"7 (1isenstadt) ("osner)
4. Facts$ ?& filed for those who bought ?entel stock in reliance on
optimistic press announcements% where company said auction process
was 5going smoothly.6
(. A#missions Recommen#ation 0ogic$ "uffing is so common that literal
truth could be misleading% 1 c@b taken to mean prospects for auction
were much grimmer than they actually were.
7. "olicy$ T. 2cott$ 2eems to contradict Masic% where 2?CT02 said 5shut
up% or tell the truth.6 ACT 5shut up% or lie and rely on TCT<.6
8. @irginia %an7shares v. San#berg (02 ,II,)%
a. Cbjective falseness can be the basis for liability% when
statements of opinion relate to material facts% and therefore fall
within the standard rules of antifraud provisions.
i. There was objective evidence presented to MCD that
was inconsistent w@their professed opinions% so " pled
more than mere subjective disbelief or undisclosed
motive.
b. <oreover% here% the ct thought the info took material
significance to the 2Ts% who rely on and look up to the MCD.
CTCT% in ?entel% puffery was the 5order of the day6 .
everyone did it% and everyone knew everyone did it.
i%. 6raud in Connection w@urc(ase or Sale o& a Security, A&&irmati%e Duty
to Disclose
,. Ghen a corp is pursuing a specific bi- goal and announces that goal as
well as an intended approach for reaching it% it ma% come under an
obligation to disclose other approaches when those approaches are
under active and serious consideration. In 5e Time &arner.
4. 6acts$ Time announces search for 5strategic partners6 to infuse new
capital. /ots of publicity% but search fails. Then propose 4 new rights
offerings to e*isting 2Ts. "rice falls in response.
a. Duty to disclose arises whenever secret information renders
prior public statements materially misleading% not merely when
that info completely negates the public statements.
b. Taving publicly hyped strategic alliances% Time Garner may
have come under a duty to disclose facts that would place the
statements concerning alliances in a materially different light.
O'II. 6orward LooEin! Statements
a. MD5A, Duty to Disclose Forward /ooking ;nformation
i. "rovided for in ;tem (E( of !egulation 2#N
,. "urpose $ ?alls on management to provide narrative e*planations of the
financial statements for the purpose of increasing the transparency of a
companyJs financial performance and of providing overall better
disclosure to investors
4. Ghat <ust Me Disclosed$
a. Trends and risks that have shaped the past and are reasonabl%
li!el% to have an impact on net sales K if registrant knows of
events that will cause a material change in the relationship
between costs and revenues K the change in the relationship
shall be disclosed (;tem (E((a)(())
b. ;n the <atter of ?aterpillar . 2? found that ?at should have
disclosed the e*tent that its volatile Mra-ilian contingent
contributed to its overall earnings
i. Towever $ No 34$"7 +ri%ate COA &or Item ;4; duty
to disclose a +essimistic internal &orecast (Serifone
2ecurities /itigation)
(. Ghat Aeed Aot Me Disclosed $ <erger negotiations if the company
believes the disclosure could jeopardi-e the completion of the
acquisition
7. nronJs ?ontribution $
a. Detailed presentation of 5off balance sheet arrangements6
i. Data about off M@2 entities that either have or are
reasonably likely to have a current or future effect on
financial condition% revenues% e*penses% or liquidity that
is material to investors. ;tem (E((a)(7)
b. *panded list of things to be disclosed on D#N$
i. The making or terminating of a material agreement that
is not part of the ordinary course of business
ii. The creation of% or default upon% a material financial
obligation
iii. ?redit rating changes
iv. &sset impairment that leads to a material charge
$. Duty to Disclose 6orward"LooEin! In&ormation
i. (oft information$ events or activities that will occur% if at all% at some future
date.
,. very reason to believe its materiality should be assessed by the
probability@magnitude standard applied in Masic.
4. 2upreme ?ourt e*pressed no opinion whether "@< test should be
applied across the board in assessing the materiality of all uncertain
events
ii. )tem 8!8$ Directly requires management to assess the past performance of the
bi- and% importantly% to provide its view of what operations% trends% and forces
will affect future operations. <ust disclose trends that are likely to affect the
firmJs financial performance% liquidity% or capital resources as well as the
effects of inflation on operations.
iii. T(e duty to disclose so&t in&ormation e?ists w(en t(e in&ormation is
material and t(ere is an inde+endent duty reHuirin! its disclosure
/Mur+(y1
,. There is an independent duty to disclose soft information that arises
from the overall rule that no half#truths should appear in filings with
the 2? and public announcements 2ince the line#item disclosures
mandated by 2#N do not independently require disclosure of soft
information and since many financial announcements are not the
subject of 2? filings% the duty to disclose so&t in&ormation
!enerally arises &rom t(e o%erall o$li!ation t(at announcements
not $e materially misleadin!
a. Aote $
i. Courts are e?tremely reluctant to deem a disclosed
statement misleadin! $ecause it isnKt Huali&ied or
ot(erwise accom+anied $y an a++raisalJ a
+redictionJ or an estimate t(at is materially
inconsistent wit( t(e disclosed statement ("anter# :
th

?ir. Teld it was not a material omission for the
management of a target company to report in a letter to
stockholders higher I month earnings and not also to
disclose an internal projection for year#end decline in
earnings. The court reasoned that disclosure of
projections would not be allowable unless they were
5reasonably certain6)
ii. DonKt (a%e to disclose i& nondisclosure wouldnKt
c(an!e t(e 2total mi? o& in&ormation a%aila$le8
*ademian %. Ladis( Co .# ;n which the :
th
?ircuit held
that internal estimates of the intrinsic value of the
issuerJs stock didnJt have to be disclosed in a pro*y
statement in which management sought stockholder
approval of the firmJs merger at a price lower than the
internal valuations)
iii. Towever $ &n intent to liHuidate must $e disclosed as
must estimates about a hostile target companyJs facts to
the target companyJs 2Ts (Feit v. /easco Data
"rocessing quipment ?orp.)
c. Lia$ility &or 6orward LooEin! Statements
i. Common Law and Rule 3<7 Sa&e Car$or
,. !ule ,:8$
a. )a+ A Jforward loo!ingK statement H which is made b% or on
behalf of an issuer H
b. shall be deemed not to be a fraudulent statement )as defined in
paragraph )d+ of this section+6 unless it is shown that such
statement was made or reaffirmed
c. without a reasonable basis or
d. was disclosed other than in good faith
i. This applies to a F/2 made in a document filed with the
2? (b)(,)
ii. F/2 = a statement containing a projection of revenues%
income (loss)% earnings (loss) per share% capital
e*penditures% dividends% capital structure or other
financial items (c)
e. 5Aot to be a fraudulent statement6 protects against all bases of
liability in the J(( &ct% including R,, liability (Gielgos)
f. 0nder !ule ,:8% Forward looking stmts need not be correct% it
is enough that they have a reasonable basis.
g. 5!easonable basis6 $ ?ost estimates incorporated into that
prospectus that have become stale and do not e*plain that these
estimates are based on nothing going wrong in the market have
a reasonable basis once they are understood as projecting
forward from past e*periences rather than trying to predict
what new things can go wrong% provided that there are no other
estimates (e*cluding tentative internal estimates). (Gielgos)
h. Firms need not reveal all projections. They make projections
all the time and this would mean de facto continuous reporting.
!ather they can choose which one they reveal so long as it has
a reasonable basis. <oreover% they need not% under !ule ,:8%
though they may% reveal underlying assumptions
i. "olicy rationales$
i. &ant to encourage enterprises to disclose information$
enterprise will not be inclined to do so if there is a good
chance they will be liable for them or if disclosure
requires revealing all the data% assumptions and
methodology behind its projections (competitors could
use this to the detriment of the enterprise)
ii. In&ormation t(at t(e cost estimates are inaccurate is
already on t(e marEet and t(ere&ore will liEely
moderate@eliminate t(e +otential o& a dated
+roLection to mislead
ii. #es+eaEs Caution Doctrine
,. Ghen an offering docJs soft info is accompanied by meaningful
cautionary stmts% the forward looking stmts will not for the basis of a
securities fraud claim if the stmts did not affect the 5total mi*6 of info
the doc provided to investors.
4. ;CG$ Cautionary lan!ua!eJ i& su&&icientJ renders t(e alle!ed
omissions or misre+resentations immaterial as an MOL
a. Naufman v. TrumpJs ?astle Funding # There was a misleading
statement re$ ability to pay back principal and interest on
bonds% but the court found that it was overwhelmed by
cautionary language and thus the statement was harmless.
(. CTCT$ vague or boilerplate cautions that merely warn of the general
risk of investment% will not be enough.
7. !ather$ the warnings must be substantive and tailored to the specific
forward looking stmts included in the document
8. & forward#looking statement is material if it rises to the level of a
guarantee (Tillson "artners /td. "artnership v. &dage% ;nc.) Sague%
generally#worded statements of optimism can be deemed immaterial
because they are mere puffery
iii. Statutory Sa&e Car$or 6or 6orward LooEin! Statements
,. "2/!& adds R4:& to J(( &ct and R4, to J(7 &ct which provide
statutory safe harbors for certain forward#looking statements
()RITTEN OR ORAL) made by companies that are subject to the
*change &ctJs continuous reporting requirements
a. 6orward"looEin! statements includes financial projections%
plans and objectives of mgt% statements of future economic
performance% assumptions underlying the previous statements%
reports issued by issuerJs outside reviewer assessing forward#
looking statement% and projections or estimates of other items
specified by ?ommission (R4,)
4. ,) 6irst Sa&e (ar$or applies to$
a. a) ;mmaterial forward looking stmts% and
b. b) & fwd looking stmt that 5is accompanied by meaningful
cautionary stmts identifying the impt factors that could cause
actual results to differ materially from those in the fwd looking
stmt
(. 4) Second Sa&e Car$or applies where$
a. " fails to show that the fwd looking stmt was made w@ actual
knowledge it was misleading
7. "ossible !esult$ Ao liability for stmts the issuer knows are misleading%
but accompanies with cautionary language.
=. Impt factors
a. ,) !elevant to the projection
b. 4) ?ould actually affect whether the fwd looking stmt is
reali-ed
c. M0T the impt factors provided need not be all inclusive. This
is not carte blanche for " to seek discovery of other factors that
m@h@b known% see R4,(f)
9. Sa&e (ar$or co%ers oral stmts% if they say where the cautionary info
can be found
a. #ut see Easter$rooE in #a?ter
b. &sher v. Ma*ter ;nternational% ;nc. The market for Ma*terJs
stock is efficient% therefore its cautionary language must be
treated as if attached to every one of its oral and written
statement. Therefore% if suing on the fraud on the market
theory% it doesnJt appear that the oral statement actually has to
identify where the meaningful caution can be found. Then the
only question left was whether statements satisfied statutory
requirements.
i. The "2/!& doesnJt require the most helpful caution' it
is enough to identify important factors that could cause
actual results to differ materially from those in the
forward#looking statement
:. 2tay pending motion on Forward /ooking 2tatements (4,(f))
a. ;n any private action arising under this chapter% the court shall
stay discovery during the pendency of any motion by a D for
summary judgment that is based on the grounds that$
i. the statement or omission is a forward#looking
statement% and
ii. the e*emption provided for thin this section precludes a
claim for relief
D. Sa&e (ar$or not a%aila$le &or$
a. ;nitial public offerings
b. Tender offers
c. 3oing#private transactions
d. Mut these *#actions can still rely on 2? !ule ,:8 and the
5Mespeaks ?aution6 doctrine
I. &ssumption
a. Disclosure of assumptions underlying a forward#looking
statement can prevent the statement from being misleading
b. Towever $ assumptions generally donJt rise to the level of
themselves being meaningful cautionary language
c. & leading pre#"2/!& case held that failure to disclose key
assumptions was itself materially misleading (Meecher v. &ble)
O'III. Rule 34$"7
a. Rule 34$"7$
i. ;t shall be unlawful for any person% directly or indirectly% by the use of any
means or instrumentality of interstate commerce% or of the mails% or of any
facility of any national e*change%
,. (a) to employ any device% scheme or artifice to defraud% P2?;AT!Q
4. (b) to make any untrue statement of a material fact or to omit to state a
material fact necessary in order to make the statements made% in the
light of the circumstances under which they were made% not
misleading% or
(. (c) to engage in any act% practice% or course of business which operates
or would operate as a fraud or deceit upon any person%
ii. in connection with the purchase or sale of any security.
$. Scienter ReHuirement,
i. "er 1rnst 0 1rnst v. Aochfelder% private ,Eb#8 actions must show D acted
w@scienter ;CT succeed
ii. &las% scienter is vaguely defined
iii. Dominant view is that itJs enough if the #efen#ant 7new true state of affairs
an# appreciate# the propensit" of the misstatement or omission to mislea#
(even if no desire to mislead)
iv. &uthority suggests that rec7lessness constitutes scienter for liability purposes
under ,Eb#8
v. 4artha Stewart$ court dismisses criminal ,Eb#8 claim on ground that no jury
could reasonably believe her purpose was to influence the price of <2/C
instead was to e*press her innocence+
vi. &lea#ing Re?uirement$ 4,D(b) requires " plead with particularity facts
giving rise to 2T!CA3 ;AF!A? that D acted with required state of mind
. -iscover" sta"e# until pen#anc" of motion to #ismiss (A-(b))
c. Reliance
i. General Test, did the misrepresentation cause the plaintiff to buy or sell)
(AU(A)
ii. No reliance reHuired $y SCOTUS in 6raud on t(e MarEet cases$ ;n
market transactions% 5the market is interposed between seller and buyer and%
ideally% transmits information to the investor in the processed form of a
market price6% hence $uyer relies on t(e inte!rity o& t(e marEet )-asic+
iii. &resumption of reliance when there is a misprepresentation
,. ;n -asic% the 2upreme ?ourt claims that empirical studies support the
?<T% which suggests that any misinformation in the market will
impact the price
4. ven if this is wrong (ie. people donJt rely on integrity of market
prices)% imposing a higher burden would effectively eliminate ?&Js
under ,Eb#8
iv. resum+tion o& reliance w(en t(ere is omission (Ute)
v. *treme% problematic e*ample$ woman purchases stock relying on G2Y
article about new product line% company makes fraudulenet misrep@omission
w@r@t something else% but she still gets recovery (.an>irer)
,. possible e*planations$ G2Y article might have had diff tone' broker
would have warned her
d. Loss Causation
i. SLRA .3D/$1/01, ;n any private action . . .the plaintiff shall have the burden
of proving that the act or omission of the defendant alleged to violate Pthis
sectionQ . . . caused the loss for which the plaintiff seeks to recover damages.
ii. -ura (4EE8% 2?CT02)$ " must demonstrate price drop caused by DJs alleged
misreps or omissions
,. Facts$ Two different misreps$ earnings lower than e*pected and then
no FD& spray approved% both resulted in price drops% but then ,4
trading days later% recovers a little
4. Ao liability for inflated purchase price b@c of misrep . " could always
have sold at that price+
iii. Cther Tests (&02&% 4
nd
?)
,. Cakes$ base loss causation on foreseeability$
a. Ghy focus on scienter rather than causation)
4. Yacobs$ was it foreseeable that H would know that inaccurate
financials could lead to an acquisition of a bad business)
(. Ginters$ looks mistakenly at reliance$ question is whether investors
would have invested in the notes if they had known they were dealing
with management that had misstated financial information
e. Dama!es
i. only !ets dama!es &or amount o& loss t(e D actually caused
(?&02&T;CA /<AT)
ii. 5owe v. "aremont (:
th
?.% ,IDI)$ family sells stock to buyer% who promises
not to do tender offer but later does% loses% but then sells familyJs stock for
L7< profit' court only awards family L:78k b@c thatJs the amount he believed
they would have bargained up for had they known he was going to do a tender
offer (essentially he knew they were going to sell regardless and soon)
,. 5Meing a rescissionary measure of damages% disgorgement is meant to
place a defrauded seller in the same position as he would have
occupied had the buyerJs fraud not incuded him to enter the
transaction.6
OIO. Re!ulation 6D
a. 2ummary of !egulation FD$ NO SELECTI'E DISCLOSURE
i. Ghen an issuer% or person acting on its behalf (senior official)% discloses
material nonpublic information to certain enumerated persons% e.g. securities
market professionals and security holders who may trade on the basis of that
information% it must make public disclosure of that information.
ii. For intentional disclosure% public disclosure must be simultaneous% for non#
intentional disclosure it must be made 5promptly6 (the later of 47 hours or the
commencement of the ne*t dayJs trading on the AH2).
b. 2? reasons for !eg FD
i. 2elective disclosure to analysts is similar to insider tipping
,. 5"rivileged few6 benefit from nonpublic information
4. adversely affects the market
ii. ?orporate managers use inside info to 5bribe6 analysts
,. analysts feel pressured to report favorably
iii. Technology makes it easier to make the information public quickly
,. internet webcasting
4. teleconferencing
c. Narrowed sco+e o& Re! 6D /sa&e!uards a!ainst +otential 2c(illin! e&&ect81
i. FD only applies to the following people
,. securities market professionals
4. security holders who are likely to trade on the basis of the information
ii. FD only applies to disclosures from
,. senior corporate officials
4. those people who regularly communicate with securities market
professionals (analysts) or securities holders
iii. 6D !i%es NO +ri%ate or SEC cause o& action under -34$"7
iv. Cnly applies when issuerJs personnel 5know or is reckless in not knowing6
that info is material and non"+u$lic
v. does not affect eligibility for short#form registration or resale under !ule ,77
d. Cther limitations to !eg FD
i. Does not apply to most registered securities offerings (road shows% etcK)
ii. Does not apply to foreign governments or foreign private issuers
e. Tippee /iability "re#FD ($ir!s)
i. SEC osition$ 5Ghere WtippeesJ\regardless of their motivation or
occupation\come into possession of material information that they know is
confidential and know or should know came from a corporate insider% they
must either publicly disclose that information or refrain from trading.6
ii. SCOTUS in -ir7s,
,. no duty to disclose if thereJs not fi#uciar" ne:us between tippee an#
corporation
A. #ut" to abstain from tra#ing onl" when
a. tippee !new the tip was a breach of insiderJs duty
b. insider tips in or#er to gain personal benefit
i. pecuniary gain
ii. reputational benefit
iii. curry favor with analysts
(. Facts$ during investigation receives information from insiders
confirming fraud% discloses to third parties
iii. FD doesnJt focus on tippee% but instead requires full disclosure by insiders to
prevent this situation from happening
&. Im+act o& Re! 6D on 6low o& In&ormation to t(e MarEet /Analyst Calls1
i. 2ummary of 2tudies$
,. Fewer analyst calls (but not sure of impact)
4. ?onflicting conclusions about impact on continuous flow of quality
info (3omes v. Mushee@Teflin)
(. &ppears there is no more insider trading (although difficult to say)
7. 2C if anything% !eg FD might have worked% but data is not clear
ii. Mushee 2tudy$ minimal evidence of sign. Aegative impact of FD
,. ?ompanies that had formally closed calls had fewer calls post FD
4. ?ompanies that had open calls before continued with changing timing
(. 0ltimately% less information coming out in conference calls
7. Mut same amount of absolute information$ so many diff channels%
press releases% etcKdoesnJt have to just be thru conf calls$ can always
use press releases% which reach wider audiences (query how efffective
they are in comparison though)
iii. Teflin$ 5egulation C$ and the Cinancial Information 1nvironment
,. <ethodology\e*amine trading volatility% price changes% and number
of voluntary disclosures post and pre !eg FD
a. Trading Solatility$ lower volatility overall after earnings
announcements (suggests more efficient dissemination of
previously selectively disclosed info)
b. "rice ?hanges$ price converges more quickly to post earnings
announcement level (suggest more efficient dissemination of
info)
c. Soluntary Disclosures$ overall more voluntary forward looking
disclosures
d. Cther aspects of analysis (accuracy% bias% dispersion)$ no
reliable data suggesting change
iv. 3omes$ (1C 5egulation Cair $isclosure6 Information6 and the Cost of
Capital
,. <ethodology\e*amines cross section of firms of different si-es pre
and post !eg FD
4. ?onclusion$
a. small firms may be affected more by !eg FD since big firms
are likely to already have efficient information dissemination
systems in place
b. small firms unable to adopt other means of disclosure as easily
as big firms
(. "roblem$ study took place near analyst settlement% so could be other
major reason for drop in analyst coverage
v. Recent stu#" (4( contemp acc research 7I, 4EE9)$ +ost"6DJ analysts
co%erin! SMALLER &irms rat(er t(an #IGGER &irms
,. finds fall off of analyst coverage (attempting to control for settlement)
4. however% the falloff is in the big firms and not the small firms
(. the hypothesis$ analysts think theyJll get a bigger payoff on doing
research on smaller firms
vi. Tas FD led to more insider trading)
,. Ghat would be the story) ;t increases the payoff to insider tradingKno
longer the opporutnity for quid pro quo with analyst% so instead might
just trade on the informationb @c presumably people
4. ;f we obvsered /22 or the 2&< volatility near the announcement%
that would be evidence of insider trading
OO. Aidin! and A$ettin! Lia$ility
a. No private !b$5 ai#ing an# abetting liabilit" B must fin# the part" itself was a
primar" participant in the frau#. 5entral %an7.
b. .4/e1 confirms that 2? may bring aiding and abetting liability claim under ,Eb#8
c. lements of &iding &betting /iability pre Central -an! of $enver
i. *istence of an independent disclosure violation
ii. &ctual knowledge (maybe recklessness) by the aidor@abettor of the
misrepresentation and of his role in furthering it
iii. &idor@abettor provided substantial assistance in the transaction giving rise to
the investor injury
d. Cenral -an! of $enver v. Cirst Interstate -an! of $enver 8,, 02 ,97 (,II7)
i. Facts
,. D was the indenture trustee of bonds% failed to ensure that land value
for mortgage was at least ,9E> of bond value.
4. Ao deception or misrepresntation
(. Mond issuer defaults
ii. &rguments
,. 2?\5directly or indirectly6 language in R,Eb#8 invites secondary
aiding@abetting liability
a. ?ourt says AC% would proscribe legal conduct
b. Gould also create unintended secondary liability for other
sections of the *change &ct
iii. Tolding
3. To allow aidin!@a$ettin! lia$ility &or secondary o&&enders would
circum%ent RELIANCE reHuirement o& 34$"7, in%estors must
(a%e relied on de&endantKs misstatements or omissions &or +ri%ate
lia$ility to attac(
.. EssentiallyJ i& secondary actors /lawyersJ accountants1 are to $e
lia$leJ t(ey must $e lia$le as +rimary actors
iv. Dissent
,. this is a new interpretation of a statute that allowed secondary
aiding@abetting liability for (E years.
4. undermines forms of liability long recogni-ed by 2?
e. &right v. 1rnst 0 'oung . (4
nd
?ircuit% ,III)
i. 5Mright line6 test$ NO lia$ility &or misre+resentations not attri$uted to t(e
de&endant at t(e time o& t(e o& t(e stmtKs dissemination /t(e time o& t(e
in%estment decision1
ii. Facts
,. @H 5ensured6 the accuracy of MTJs accounting results
4. MT then disseminates those results to investors
iii. Tolding
,. must meet $enver test of material misstatement upon which plaintiff
relied.
.. No reliance (ereJ since EB isnKt mentioned at all in #TKs re+ort
;. NO lia$ility &or misre+resentations not attri$uted to t(e de&endant
at t(e time o& t(e o& t(e stmtKs dissemination /t(e time o& t(e
in%estment decision1
7. AC substantial participation in the fraud by nH because nH werenJt
5controlling persons6 as in Cirst Ferse%
a. Cirst Ferse%$ director told employees to make false and
misleading statements
7. DECLINE to ado+t t(e 2su$stantial +artici+ation8 o& ot(er
Lurisdictions
&. Tests &or aidin!@a$ettin! lia$ility
i. 2ubstantial participation test (adopted by I
th
circuit)
,. attempts to define those who would previously have been
aidor@abettors as 5primary participants6
4. must participate substantially in the drafting and editing of documents
with the knowledge that they will be disseminated to investors
ii. Mright line test (proposed by 2?)
,. primary participant$ a person acting alone or with others PwhoQ creates
or makes a misrepresentation Pon which the investor#plaintiffs reliedQ
4. "erson who doesnJt make the misstatement not a primary participant
!. SEC ro+osed Statement on Com+le? Structure 6inance
i. !equires due diligence by financial institutions for elevated risk ?2FTs
ii. Ghy)
,. 2? ?oncerned with investor protection . wants financial institutions
to be gatekeepers
4. Fed and other banking agencies want to protect their regulatees from
risk
iii. levated !isk ?2FTs$
,. Transaction lacks substance or business purpose
4. Designed principally for questionable accounting% regulatory or ta*
objectives
(. !aises concern that client will disclose in misleading way
7. ;nvolves circular transfers of risk that lacks substance
8. ;nvolves side oral or undocumented understandings that if known
would have material impact on accounting% regulatory or ta* treatment
9. conomic terms inconsistent with market norms
:. "rovides compensation to the financial institution disproportionate to
the services rendered
iv. Due Diligence !equired
,. Tigh level approval with input from staff independent from business
unit
4. Documentation
(. Tone at the top$ ethics policy
7. <onitor compliance with procedures
8. Training
9. !egular audit
v. &ccounting and Disclosure (4EE7 Sersion)$ Ppart of making the F; the
3&TN"!Q
,. <ost controversial part which was dropped
4. Financial institution had to understand how the customer would
account for the transaction+
(. F; should have policies as to when third party should be engaged to
determine appropriate accounting
7. Ghere proposed transaction may result in materially misleading
statement% F; may decline to participate or condition participation on
customer making accurate disclosurs
8. F; should consider getting reps and warranites from customer state
purpose of transaction and that customer will use correct accounting
vi. Ghat were the F;Js concerns about this)
,. !aises the cost of doing these transactions
4. Tow do you find out how they &?T0&//H do the accounting)
(. Ghy put culpability on banks)
a. 3atekeeper liability
b. <akes it easier for 2? to enforce
OOI. En&orcement, 6ederal and State
a. 6ederal En&orcement
i. 2? has discretionary power to investigate past@current@future violations.
,. *change &ct% sec. 4,(a).
4. !ules of investigation\2? !ules% ,: ?F! RR4E,., et seq.
(. "olicy$
a. 2tructural bias toward bringing enforcement action once
investigation is underway)
b. Fairness)
c. 2? canJt use enforcement powers to establish regulatory
policy$ line of cases dismissing 2? actions b@c defendant
lacked adequate notice that 2? considered their activities
violations. Upton v. (1C% 4
nd
?ir. ,II9% p. ::(.
ii. ;nformal@preliminary investigation\non#public% relies on voluntary
cooperation.
iii. Formal investigation\
,. 2? staff need reason to believe violation occurred O formal order
from ?ommissioners.
4. Masically unrestricted power of 2? to investigate (if in good faith).
(. 2ubpoena power\enforced through federal district court.
7. Aotice to target of investigation not required when (rd party
subpoenaed.
8. 2? powers not restricted by contemporaneous criminal investigation%
absent showing of actual prejudice. (1C v. $resser Industries.% 02
,IDE% p. ::4.
iv. !ecommendations to ?ommission$ (non#public meeting% no right to notice% or
right to appear)
,. &ells submission$ 2? may grant target an opportunity to submit a
written statement. Tricky for lawyer b@c nature of charges unknown
and evidentiary privileged probably waived.
4. 2ettlements$ most recommendations include offers to settle (2?
limited resources).
a. <ost 2? enforcement actions are settled not
litigatedinjunction or other relief w@ no admission of guilt.
b. 2ettlements as !ulemaking$ the settlements create a body of
securities law principles that have not been tested through
formal rulemaking or litigation.
(. ?autionary letter to target (non#public##2? may forward to AH2%
A&2D% other 2!C).
7. 2ection 4,(a) !eport$ (published@public)
a. ?ontroversial use by 2? as determination of guilt w@o a
benefit of a hearing.
i. 2? can require 5any person6 to submit written
statement\often admission guilt.
ii. &nalogous to consent decree##2? uses to push reform
or change targetJs practices.
b. 2? also uses 4,(a) reports to comment on practices it sees as
inappropriate but not actual violations.
v. &dministrative "roceedings$
,. Types of &dministrative "roceedings (see list of typical proceedings%
p. ::D#:I).
a. !efusal and stop order proceedings\for defective registration
statements.
b. 2ection ,8(c)(7)\for defective periodic reports% TC% pro*y
(misleading or tardy).
4. 2? !ules of "racticeprocedural requirements. ;nitial "leading%
answer to be filed w@in 4E days% independent admin. law judge
presides over hearing% limited discovery% e* parte depositions allowed%
Federal !ules of vidence do not apply.
a. 2? must prove violation by 5preponderance of the evidence.6
(teadman v. (1C% 02 ,ID,.
b. !esulting sanction must be in the public interest.
vi. ?ease and Desist order\(powerful augmentation of 2? enforcement
powers).
,. Uuick% fle*ible% can tailor to offense% efficient for minor or isolated
offenses.
4. "ermanent cease and desist\bans future violations and may include
disgorgement or affirmative steps to prevent future violations.
(. Temporary order\target must refrain from violation pending a
hearing.
7. Siolation of cease and desist ordercourt imposed civil penalty
and@or mandatory injunction directing compliance w@ order.
vii. ?ivil "enalties and Disgorgement$
,. &uthori-ed by 2ection 4E(d)% (( &ct and 2ection 4,(d)(()% (7 act.
4. ?ivil "enalty ## L8N@violation for most minor up to L8EEN@violation
for fraudulent@deceitful.
(. Disgorgement . alternatively court can substitute 5gross amount
defendant gained through violation6
7. Fair Fund provision of 2CX R(ED% and disgorgement may be added to
fund for investors.
8. arnings !estatements% 2CX R(E7$ if earnings restatement is result of
earlier 5misconduct%6 ?C@?FC must disgorge to issuer any bonus or
other incentive during the year following the original release of the
restated financials.
viii. Cfficer and Directors bars$
,. &uthori-ed by 2ection 4E(e)% (( &ct and 2ection 4,(d)(4)% (7 act.
4. ?ourts in 2? enforcement may suspend or bar for fraud or unfitness
to serve.
(. 2tandard$ must find violation likely to recur. (1C v. .atel% 4
nd
?ir.
,II7% p. :DD.
i*. Trading 2uspensions$
,. 2? can suspend trading for up to ,E days to protect the public
interest. 2ec. ,4(k)% (7 &ct.
4. <ay tack multiple ,E day suspensions only if give notice and
opportunity for a hearing. (1C v. (loan% 02 ,I:D (2? issued
continuous series of ,E day suspensions over ,(#months).
(. <ay also indirectly prevent trading in a security by revoking
registration under the (7 &ct. 2ection ,4(j). (also requires
notice@hearing and finding necessary to protect investors).
*. Free-e &ssets$
,. ?aselaw$ <ust show ,) likelihood of success on merits% and 4)
legitimate concern the D will dissipate@move the assets. (1C v.
Unifund (A% 4
nd
cir. ,IIE% p. :ID.
4. 2CX R4,?(c)(()\authori-es initial 78#day free-e where 5lawful
investigation6 into a possible securities violation% w@ addition 78#days
available for good cause.
*i. ;njunctions$
,. <ust apply to federal court for this 2ection 4E(b)% (( &ct and 2ection
4,(d)% (7 act.
4. Aeed$ bare showing that a violation has been committed O show
realistic likelihood of recurrence. (1C v. Commonwealth Chemical
(ecurities% 4
nd
cir.% p. :I(.
(. &ncillary relief$ disgorgement% rescission% appointment of a receiver%
appointment of special counsel to investigate violations% appointment
of independent directors to targetJs board.
a. Determining amt. of disgorgement$ need only be a reasonable
appro*imation of profits casually connected to the violation.
Cirst Cit%% D? ?ir.% IDI.
7. ?ollateral consequences$ Mad Moy status
a. Disclosure of injunction in reg. statement under (( &ct and
periodic reports under (7 &ct.
b. "rofessionals who 5practice6 before 2? may be suspended for
up to , year. !ule ,E4(e). Mroker dealers can be suspended up
to , year% 2ec. ,8(b)(7)% and barred from advising@employee of
investment company% 2ection I of ;nvestment ?ompany &ct.
c. 0nworthy Cffering doctrine$ barred from using !egulation &
or !ule 8E8.
8. ?ollateral stoppel$
a. ?ourt issued injunction from 2? actionfinding of guilt.
<ay be used by private litigants in subsequent private action to
support summary judgment. .ar!lane Aosier%% 02 ,I:I.
b. &dministrative adjudications by the 2? may also be used by
private litigants for collateral estoppel if there was opportunity
to fully and fairly litigate the issue.
9. /ifting the ;njunction$ very difficult\circuit split on e*act standard.
a. Aeed 5showing of grievous wrong evoked by new and
unforeseen conditions%6 (?ardo-o)% U( v.(wift% 02 ,I(4. (I
th

cir. still requires this\must have unforeseen and significant
change in circumstances.)
b. 4
nd
?ir$ 5decree not properly adapted to accomplishing its
purposes.6 (p. :I:).
c. (
rd
?ir$ Aot dissolving will work 5an e*treme and unnecessary
hardship on Ds.6
*ii. ?riminal nforcement$
,. "olicy$ is this proper use of the criminal justice system)
a. "owerful deterrent
b. ?riminal and civil cases can proceed simultaneously.
c. Tighly technical statutes\regulatory crimes.
d. Sictimless crimes$ 5investor@public confidence%6 or 5corporate
suffrange.6
4. ?riminal provisions of the securities laws . 2ection 47% (( &ct and
2ection (4% (7 &ct.
a. ?rime to willfully violate statutory provisions% or promulgated
rule@regulation.
b. ?rime to 5willfully6 make a false statement in document
submitted to 2?% (( &ct.
i. (7 &ct requires 5willfully and knowingly.6
ii. Gillfulevil purpose (in criminal conte*t).
iii. Nnowinglyconsciousness of guilt
c. <a*imum penalties established.
i. Ao imprisonment if unaware your act@omission was
illegal. 2ec. (4% (7 &ct.
(. <ail and Gire fraud% ,D 02? RR,(7,% ,(7(.
a. lements$ ,) scheme to defraud% and 4) mailing a letter for
purpose of e*ecuting the fraud. .ereira v. U(% 02 ,I87% p.
D(I.
i. <ust prove !nowledge of a scheme to defraud and
purpose to defraud.
ii. Aegligence or innocent misstatement ACT enough.
iii. ?ircuit split on recklessness (,,
th
% (
rd
% I
th
yes' 8
th
and 4
nd
no)% p. D(I.
b. "enalties$ fines O 4E years ((E if victim is a financial inst.).
c. 0ses$ full range of fraudulent investment schemes% stock
manipulation% lie@omission in sale of securities.
7. !acketeer ;nfluence and ?orrupt Crgani-ations &ct (!;?C)% ,D 02?
RR,I9,#,I9D.
a. !;?C defines securities fraud as racketeering.
i. R,I94(a) bans using@investing L from racketeering to
acquire an interest in an enterprise engaged in
commerce.
ii. R,I94(b) bans using a pattern of racketeering activity to
acquire an interest in an enterprise engaged in
commerce.
iii. R,I94(c) bans using a pattern of racketeering activity to
conduct the affairs of an enterprise engaged in
commerce.
iv. R,I94(d) bans conspiring to do any of the above.
b. <ost 2? claims based on ,I94(c). R,I9,(8) defines 5pattern
of racketeering activity6 only vaguely. <ust commit two or
more 5acts of racketeering6 w@in ,E years.
i. 2ecurities fraud% as well as mail and wire fraud% defined
as racketeering.
ii. "/2!& amended R,I97(c) to no longer include fraud in
purchase@sale of securities under definition of 5pattern
of racketeering activity6
c. ?riminal "enalties$ fines% imprisonment% mandatory forfeiture
of property acquired in violation of !;?C. &sset free-ing
power while awaiting trial% upheld in U( v. "onsanto% 02
,IDI.
d. ?ivil "enalties$ divestiture orders% injunctions% dissolution of
the enterprise.
e. "rivate litigants$ private parties may recover treble damages O
costs and attys fees.
*iii. Cbstruction of Yustice% ,D 02? ,8,((b)(4)(&) and (M)$ Arthur Andersen v.
U(% 02 4EE8.
,. Gitness tampering% destruction of documents% evidence
tamperingfines O ,E years.
4. 5for use in an official proceeding$6 need ne*us b@t the obstruction and
an official proceeding.
(. 5knowingly K corrupt$6 requires mens rea\wrongful% immoral%
depraved% evil. <erely impeding govtJs factfinding ability not enough.
$. ri%ate En&orcement
i. "2/!&% ,II8. (2ection 4: of 2ecurities &ct% 2ection 4,D of *change &ct.)
,. Center+iece is a++ointment o& 2lead +lainti&&.8 R4:(a)(() and
R4,D(a)(()\re$utta$le +resum+tion t(at +lainti&& w@ (i!(est staEe
is 2most adeHuate +lainti&&.8 Intent is to (arness t(e
incenti%es@so+(istication o& t(e institutional in%estor.
4. Ao discovery until after the defendantJs motion to dismiss.
*. 5aised pleading standard to re7uire pleading with particularit% as to
raise a strong inference that $ committed violation.
ii. 5a>orfish% 2DAH 4EE,% p. :,I.
,. "2/!& says presumptive lead plaintiff is one with biggest stake in
litigation% who then selects counsel. ?ourt says 5single sophisticated
entity6 most effective. 0arge sta7e provi#es incentive for close
supervision of counsel, an# strong negotiation of att"s fees.
4. ?ourt can reject highest#stake plaintiff w@ attys fee proposal court finds
unreasonable.
(. ?ourt rejects &uction system (sealed bids for attys fees arrangements
submitted by competing law firms and lowest qualified bidder is
designated lead counsel).
iii. 5Fairness6 of class action settlements$
,. "2/!& added 2ec. &ct R4,(a)(9)% *ch. &ct R4,D(a)(9)\attys fees
and e*penses cant e*ceed reasonable percentage of any
damages@interest paid to the class.
a. 2ubsection (a)(:) of each of the above also require e*tensive
disclosure and notice.
4. "aying lead plaintiffs$ why is this bad)
c. State #lue SEy Laws
i. !egistration$ 0niform 2ecurities &ct ( procedures for registering securities
w@ 2tate.
,. Aotification$ available for seasoned% quality issuers (age 8O years% no
default past ( years on interest or dividend payments% 8> return on
capital past ( years).
a. <ust notify state of offering% give some basic info% copy of
prospectus.
4. ?oordination$ available if registration statement filed w@ 2? under
(( &ct.
a. <ust file copy of reg. statement and any amendments w@ state
administrator.
b. ffective automatically when 2? reg statement is effective.
c. Cffers to sell okay b@t filing and effective date% but actual sales
only after effective.
(. Uualification$ applies to offerings that are e*empt from registration
under the (( &ct.
a. <ust file a registration statement in each state where an
offering will be made.
b. *tensive disclosure required under 0niform 2ecurities &ct
(states vary widely\so itJs a big pain for the attys if many
states are involved).
c. <erit review$ 7E states authori-e administrator to review
substantive merits of the offering. 2ee 2? !eport D#I% p. 474.
A&2&&\model merit standards% p. 47(.
d. ffective only when state administrator says it is.
ii. Financial institutions e*empt$ Aational Mank &ct completely preempts state
law for banks.
,. &ppropriate model for securities regulation) Ghy the overlapping
regimes)
iii. 5?overed 2ecurities6 e*empt$
,. 2ection ,D% (( &ct states intention to preempt state law for 5covered
securities.6
4. ?overed 2ecurities
a. if listed or will be listed on AH2% Aasdaq or &merican 2tock
*change. R,D.
b. &lso if listed on "acific *change% "hiladelphia *change% and
?hicago Moard of Cptions *change.
c. "rivate offerings e*empt under 2ection 7(4).
d. Cfferings to Uualified "urchasers% e*empt under ))).
iv. 2ecurities /itigation 0niform 2tandards &ct (2/02&)% R4D(f)% (7 &ct.
,. &fter "2/!& passed in ,II8% many class actions diverted to state
court. 2/02& designed to stop this flow.
4. Gi%es &ederal courts e?clusi%e Lurisdiction o%er most securities
class actions. R4D(f)% (7 &ct. Ao state jurisdiction for 5covered
securities.6 R,D(b). see above.
;. Delaware car%e"out, DE can (ear &iduciary claims under DE state
law.
v. 2tate enforcement$
,. 5effectiveness of the capital markets6 will not be foremost in minds of
state officials#should the federal government be e*clusive)
4. Federal regulation preferable b@c 2?@Federal !eserve properly
insulated from political processes.
(. 2tate atty generals are not\elected officials may be partisan@self#
interested in enforcing the law.
7. Gorking group created to address conflict b@t state@federal regs##,4
2?@A&2&& officials.
d. Notes on En&orcement Re&orm /im+osin! &ines on issuers)$ SE5 #ecision to
impose a civil penalt" on an issuer turns on two primar" factors:
i. "resence or absence of a direct benefit to the corporation as a result of the
violation
ii. The degree to which the penalty will recompense or further harm the injured
shareholders
iii. Cther factors$
,. Aeed to deter certain types of offenses
4. *tend of injury to innocent parties
(. Ghether complicity in the violation is widespread throughout the
corporation
7. /evel of intent on part of perpetrators
8. Degree of difficulty in detecting particular type of offense
9. "resence or lack of remedial steps taken by the corporation
:. *tent of cooperation with 2? and other law enforcement
e. ?offee &rticle on 2ecurities !eform$
i. Deterrence has to be the only rationale that can justify securities class actions
ii. "unishing corporation and shareholders is much like punishing victims of
burglarly for having suffered a burglary' might lead to additional precautions%
but not the most efficinet or fair way to solve the problem
iii. 4,D(f) of "2/!& requires factfinder in securities class action to apportion
liability among the covered persons (all defendants)' no Yoint and 2everal
/iability Y2/ unless knowing violationKhow to apportion liability to issuer
tho)
iv. 2uggests that in settlements% independent directors must evaluate fairness of
settlement proposal to corporation and e*plain it publicly to shareholders
v. !equire this as mandatory D#N filing.
vi. ;ssues$
,. ?reates a liability potential for the directors issuing the statement
a. &nswer$ thatJs a good thing% will force them to be more
diligent in approving settlements
4. &dds to litigation risk of being an outside director fewer outside
directors
a. Cutside directors have virutally no anti#fraud liability%
negligence only actionable under 2ection ,,% and they could
easily be indemnified
vii. "erhaps require different insurers to cover directors as distinct from the issuer
viii. ?hange plaintiffs attorneys fee structure to give incentive to get more
recovery from directors than corporation through differential contingency fees
f. 2pit-er$ better to let federal govJt regulate rather than politically motivated state &3s.
i. <artin &ct in AH2 has no reliance requirement like the analagous federal
securities laws
XX;;. ?ommittee on ?apital <arkets !egulation
a. ?ompetitiveness$ ;s there a problem) ;s it important)
b. !egulatory "rocess
i. 2? cost#benefit
ii. "rinciples#based regulation
iii. 2? and DCY have last word on matters of national importance (legislation)
c. nforcement
i. !esolving ,Eb#8 uncertainty
ii. liminate duplicate recovery under 2? Fair Funds and private actions
iii. "rohibit pay#to#play for the securities bar (legislation)
iv. ?riminal prosecutions of companies as last resort (where rotten from top to
bottom)
v. ?ongress to consider caps@safe harbors for auditing firms (minimum capital
and federal investigation when triggered% with possibility of corporate
monitors) (legislation)
vi. Cutside directors protected against 2ection ,, liability (due diligence under
!ule ,:9) for good faith reliance on audited and unaudited financial
statements (see Gorld?om)
vii. 2? permits corporate indemnification of outside directors for acting in good
faith
d. 2hareholder !ights
i. shareholder votes on poison pills of companies with staggered boards
(legislation or listing requirements)
ii. endorse majority voting
iii. shareholders free to choose remedies% e.g. arbitration without class actions
e. 2CX 7E7
i. new materiality standard for 7E7 and financial statements\reasonable
possibility that poor controls or accounting treatment could have a 8> or more
impact on pre#ta* income (currently 5greater than remote possibility
effectively means E.EEE8> probability% according to 3rundfest)
ii. 2mall companies$ defer application until major changes% if still too
burdensome ?ongress to consider e*emption from auditor attestation and
lower level of management certification (possible legislation)