Goals of
regulation
Is it
material?
Is it a
security?
Because §5
prohibits
offer or sale
of
unregistered,
non-exempt
securities
Is it a public/
reporting
company?
Exchange
Act
obligations
for public
companies
Public
offering
process (aka
gun jumping
rules in ISC)
 Reg M
limits market
manipulation
after
distribution
by
participants
Issuer
offerings
exempted
from §5
Secondary
market
transactions
(aka resales)
exempted
from §5
 Solve information asymmetry + agency problems
●
Protect integrity of capital markets/increase accuracy
 Overcome collective action problem
● Cure potential for greedy behavior/manipulation
Yes, if substantial likelihood that disclosure would have been viewed by the reasonable investor as having
significantly altered the cumulative total mix of info affecting the investment decision (TSC)
 Probability x magnitude (Basic) should affect >5% of earnings (SAB 99) unless qualitative trumps
 Prove with event studies after the fact (since fraud caused inflation, so after truth price should drop)
Keeping substance over form and the policies of regulation in mind, yes if:
1. Instrument commonly known as a security
a. Stock (usually w/ dividends, transferability, voting rights, appreciation)
b. Note (presumed considering motivation, distribution, public expectation, & risk reducing alt (Reves))
2. Specified by §2(a)(1) as a “security” or
3. Covered by catchall “investment contract” (Howey)
a. Investment of specific consideration
b. In a common enterprise (horizontal or vertical [broad/narrow] commonality)
c. With expectation of profits
d. “Solely” from managerial efforts of others
Yes if:
1. Completed IPO via Securities Act (see below)
2. §12(a) listed on an exchange
3. §12(g) >500 SHs of record + $10m in assets or
4. §15(d) effective registration statement for a public offering under the Securities Act
 Reporting obligations §13(a) or §15(d) (integrated via Reg S-K)
o Form 8-K = current report triggered by certain events
o Form 10-Q = quarterly report (non-audited financials)
o Form 10-K = audited financials
 Accuracy of books/records §13(b) (strict liability; need internal controls, no bribery, etc.)
 No voluntary selective disclosures to covered persons (= expected to trade) Reg FD
o If unintentional, then 8-K disclosure to public within 24 hours. If intentional, simultaneous
 Pre-filing “quiet” period = after “in registration” (= talk w/ bank) and before filing
o No offers §5(c) as defined in §2(a)(3) (about conditioning the market)
 Safe harbors = issuer-underwriter communications and Rules 163A (30 days), 163 (WKSI), 168-69 (FBI
for non-reporters, FBI+ for reporters), and 135 (tombstone ads)
o No sales §5(a)
 Waiting “cooling off” period = after filing and before declared effective
o Oral offers ok; written offers ok if w/ a §10(b) preliminary prospectus §5(b)(1)
 FWP Rule 164 ok if meets Rule 433 (= accompanied/preceded by & consistent w/ §10(b), legend, filed)
 Safe harbors:
 From before = Rules 168-69 and 134 (expands 135 so can include underwriter’s name w/ legend)
 For analysts’ research reports in regular course of business Rules 137-139 (also in pre-filing per.)
o No sales §5(a)
 Post-effective period = after declared effective and before finish selling
o Sales ok if w/ a §10(a) final prospectus §5(b)(2) (access = delivery Rule 172)
 Updating
o Must keep §10(a) prospectus relatively fresh
o Registration only needs to be accurate on effective date, but amend if substance change
1. Specific securities §3(a) and others as SEC sees fit §3(b)
2. Private placements §4(2) = offerees can “fend for themselves” (access/actual disclosure + sophistication)
3. Reg D safe harbors (providing clarity to §3(b) w/ Rule 504 and §4(2) with Rules 505-506)
o See chart in outline
§4(1) ordinary trading exemption (if not an issuer, underwriter, or dealer)
 Underwriter if §2(a)(11):
o Purchases from issuer w/ view to distribution (can argue personal changed circumstances) or
o Direct/indirect participation in or underwriting of distribution
 Control person liability = even if not underwriter, liable if person you sell to is acting as his underwriter
o Avoid with §4(1 ½) exemption = if buyer can “fend for himself” then no distribution so not underwriter (or
now use Rule 144)
 Rule 144 safe harbor from classification as an underwriter
o = allows non-affiliates to resell restricted securities, and affiliates to resell any (otherwise they couldn’t)
o See chart in outline, but essentially:
 Non-affiliates ok after 1 year
 Affiliates ok after 1 year if info is available, limit amount sold, and only certain manner of sale
Scope
(jx and
transaction
nexus)
Standing
Ds
Causation
Reliance
Scienter
Damages
Rule 10b-5 (implements §10(b)) in EA
Fraudulent devices, material
misstatements/omissions, or fraudulent
acts in connection w/ purchase/sale of any
(= registered or exempt) security in ISC
 remember PSLRA heightened standards


SEC enforcement or
Implied private COA for purchasers
(Blue Chip) and sellers
 Primary violation (speak via
Stoneridge)
o Buyers/sellers
o IPOs/secondary market
 Aider/abettor for SEC only
(Central Bank)
 Control person §20(a)
o Split as to whether potential
control or culpable participation
o Has good faith defense
Loss causation
Transaction causation for private COA
 If omission or duty, no requirement
 If misstatement:
o Individual reliance if face-to-face
o Presumption via fraud on the
market if not (Basic)
Need actual motive, knowledge, or
recklessness (so > negligence, unlike §11)
Yes
§11 in SA
Material misstatement/omission in
registration statement (including
prospectus) as of effective date used
in ISC
effectively only applies to public
offerings
Private COA for purchaser
§12(a)(1) in SA
Violation of §5 gun-jumping rules





Signee
Directors
Underwriters
Experts who prepared/certified
Controlling person = one who
controls someone liable §15
(absent good faith defense)
not about fraud (liable merely if it
was a security offered/sold without
being registered or exempt)
§12(a)(2) in SA
Material misstatement/omission in
prospectus or oral offering related to
public offering in ISC
 not secondary market transactions
(Gustafson)
Private COA for purchasers
Private COA for purchaser

Same as §12(a)(1)

Statutory seller
o Owner passes title or
o Person who solicits
purchase motivated partly
by his/issuer’s $ interests
(Pinter)
Controlling person §15
(absent good faith defense)
No, but see loss causation defense
Tracing is enough
No
No
No, but see loss causation defense
No
No, but see due diligence defense
No
No, but see reasonable care defense
Yes
No
No
SOL
2 years of discovery
5 years of fraud
1 year of discovery
3 years of offering §13
1 year of discovery
3 years of violation §13
1 year of discovery
3 years of prospectus/oral offer §13
Defenses
None?
None
Note: Insider Trading






Unlimited
Damages
Rescission or damages
Same as §12(a)(1)
Remedy
P’s actual knowledge (or §21E)
Loss causation
Due diligence (not for issuer; it
has strict liability)
o Expert = reasonable
investigation for expertised
o Non-expert = reasonable
invest. for non-expertised;
red flags for expertised
P’s actual knowledge
Loss causation
D’s lack of knowledge and
reasonable care
-----------------------------------------------------INTRODUCTION-------------------------------------------------------
I.
Capital Markets
a. = ways to facilitate trading of capital represented by securities
i. = socio-economic contractual relationship between entrepreneur and inputs (workers,
investors, customers, suppliers) he needs to produce output he can sell for profit and/or
ii. = fictitious representation of value (both nominal and dynamic since no business exists in
a vacuum)
b. Kinds (privilege to be on these, not a right)
i. Specialist markets (e.g. NYSE)
1. Accepted companies have a specialist firm (aka continuous auctioneer) that sets
the trading price each morning via a quote to buy and sell and has an obligation to
buy or sell to maintain liquidity and an orderly market and to break price falls
(gets commissions)
2. Public since 2006, so no longer operated by underwriters and fewer regs
ii. Dealer markets (e.g. NASDAQ and bond markets; no central exchange like NYSE)
1. Brokered deals where market makers set quotes, but have no obligation to enter
market to support price (paid purely from spread)
2. Takes more high risk stocks than NYSE, so spread is higher
iii. Electronic Communications Networks (aka ECNs)
1. Alternative system w/ automated, anonymous matching and public prices
2. Gives people speed they want to reduce the risk of big price changes
3. Allowed by Reg NMS
iv. Dark Pools
1. A type of ECN within one firm where someone like Goldman buys securities to
match with clients (and sell at a profit)
c. Efficient market hypothesis = securities market price of an actively traded security incorporates
info related to it b/c intermediaries are informed, so individuals obtain info indirectly via price
Hypothesis:
Definition:
Implication:
Weak
All info concerning
historical prices is fully
reflected in current price
Prices change only in
response to new info, so
don’t waste time looking at
history
Semi-Strong (most likely)
Current prices incorporate
all historical and current
public info (just noise?)
Investors can’t expect to
profit from studying
available info b/c market
has already incorporated it
Strong
Prices incorporate all info
(public & not, so might as
well legalize insider trading)
No identifiable group can
earn systematic positive
abnormal returns (i.e. can’t
beat the market)
i. Basis of fraud on the market theory (i.e. that investors rely on info b/c rely on price)
ii. Price efficiency = adjustment to news happens super rapidly, so hard to beat it. And even
if price doesn’t reflect true value, relative changes are.
iii. Criticism = This is all noise. Investor behavior isn’t rational and both over and under
react, and market fragmentation (i.e. trading on both NYSE and ECN) affects the price
1. But markets for non-start ups are usually efficient
d. Types of transactions
i. Primary = when company offers and sells its own securities to investors
ii. Secondary = when one investor resells securities of the issuer to another investor
e. Players
i. Issuer = company that is offering its shares (via private offerings primary public offering,
or secondary/seasoned offerings)
ii. Investment bank = intermediary between investors w/ capital and entrepreneurs without
1. Underwriter side = help issuers set price and sell in offerings (profit in spread)
2. Analyst side = research opinions about potential investments to get ppl to buy
3. Dealers = proprietary buyer and seller for an investment bank (builds its account)
4. Brokers = facilitates secondary transactions making internal matches or routing
a. Can place limit order (= broker will buy when that price happens) or
market order (= buy at whatever price it is now)
b. They are your nominee and own your stock in street name (= company has
you down as them), but you’re beneficial owner
iii. Attorneys = draft disclosures to SEC
iv. Accounting firms = audit financial statements
v. Institutional investors (ex. mutual funds, index funds, pensions, insurance companies)
II.
Securities Valuation
a.
= way to take future risks into account when valuing something today
𝐶
b. 𝑃𝑟𝑒𝑠𝑒𝑛𝑡 𝑉𝑎𝑙𝑢𝑒 (𝑃𝑉) = (1+𝑅)𝑇
i. Cash flow (C) = annual return (ex. $10m of Treasury notes that mature in 2 years and pay 10%
annually and returns principal:𝑃𝑉 =
$1𝑚
(1+.05)1
+
$11𝑚
(1+.05)2
)
ii. Discount rate (R) = interest rate of return (= compensation for deferring consumption,
risk of inflation, and uncertainty)
$10𝑚
1. Use 5% if nothing given (ex. $10m in a safe for 2 years: 𝑃𝑉 = (1+
)
.05)2
iii. Time period (T)
c. For common stock and perpetuities, just use 𝑷𝑽 =
III.
𝑪
𝑹
(while dividends aren’t guaranteed
there’s an imputed rate of return b/c fiduciary duties make stock ↑)
d. CAP-M to determine R precisely (based on notion that markets are efficient—see below)
i. 𝑅𝑠𝑡𝑜𝑐𝑘 + 𝑟𝑓 + 𝑏𝑒𝑡𝑎𝑠 (𝑟𝑚 − 𝑟𝑓 )
1. rf = risk free rate (i.e., US Treasury bonds, ~3%)
2. betas = how stock is affected by systematic risk (= affects everyone, but not in
same magnitude. High beta = more risk, and 1 = same as market)
a. Unsystematic risk affects companies differently, so lower by diversifying
3. rm = market rate (i.e., S&P 500, ~11%)
Regulatory Apparatus (enacted during Great Depression)
a. = single federal, mandatory disclosure regime run by the SEC (different divisions & offices
which make rules and bring enforcement actions)
i. Goal = protect investors from abuses by insiders and market professionals w/ more info,
discourage speculative frenzies, and change incentives to reduce agency costs and fraud
ii. If shareholders don’t like what they learn they have remedies:
1. Sell
4. Use publicity to pressure board
2. Sue derivatively
5. Encourage collective action
3. Vote to oust board
b. Why we need it
 Deals with lemon problem (aka “used car” problem)
1. = information asymmetry between buyers and sellers means buyers can’t tell the
difference between good and bad used cars so they apply a discount to all or are
hesitant to even enter the market
 Fixes collective action problem (firms have competitive risks and won’t disclose
everything on their own unless everyone else has to)
 Reduces coordination (don’t have to comply w/ 50 different laws)
 Avoids some manipulation (ex. ban on some insider trading)
 Reduces duplicative research
 Increases accuracy of prices (but could also help competitors?)
 Regulators are human and SEC is a monopoly
c. Statutes that make up federal regime
i. Securities Act of 1933 = re: primary transactions by issuers
1. Gun jumping, registration, prospectus and integrated disclosure rules for public
offerings (with some exemptions)
2. Antifraud liability for public offering documents
ii. Exchange Act of 1934 = re: secondary transactions between investors (created SEC)
1. Mandatory periodic disclosure for reporting companies (10-K, 10-Q, and 8-K)
2. Antifraud liability (10b-5)
3. Anti-manipulation provisions
iii. Williams Act of 1968 (codified in Exchange Act) = disclosure re: tender offers
iv. Sarbanes-Oxley of 2002 (post Enron)
1. Regulates auditors, requires audit committees, up the ladder reporting CEO/CFO
certification of 10-K and 10-Q filings
v. Dodd-Frank (post 2008 blow up of systematic risk in securitization of housing market)
1. SH proxy access; disclosure of pay vs. performance, employee hedging, and CEO
pay disparity; whistleblower provisions, advisory “say on pay” vote, etc.
d. Other regimes
i. Blue Sky (aka state) laws largely preempted, but still apply if you’re doing a limited
offering only in that state
1. And those require you to justify the price you’re asking for on its merits
ii. And self-regulatory organizations (SROs) have had rulemaking delegated to them by
SEC (ex. NYSE and NASDAQ are regulated by private FINRA)
Remember: SEC thinks about everything functionally to obtain its policy goal of protecting ordinary
investors from losing their money w/ full and fair disclosure. They’re flexible and stress substance/form.
------------------------------------------------------MATERIALITY--------------------------------------------------------Disclosure must be materially accurate/complete, so absent duty, silence is golden (or “no comment” if normal)
I.
Basis
Note effect of forward-looking info rules, “bespeaks caution” CL, and PSRLA “cautionary language”
a. Statutory
i. §10(b) & Rule 10b-5 antifraud liability based on misstatement/omission of material fact
(Food Lion = not puffery about clean stores, b/c reasonable investors wouldn’t rely on that)
ii. Rules 408 and 12b-20 requirement for additional material info to be disclosed to avoid
creating a misleading omission
iii. Reg S-K (ex. Item 101 Business Description: info >5yrs must be disclosed if material)
b. Common law
i. If substantial likelihood that the disclosure would have been viewed by the reasonable
investor (objective standard) as having significantly altered the total mix of info (TSC)
1. Total mix of public info about company = cumulative (Food Lion = claims about overtime
were in mix b/c of union warnings, so market had already incorporated that into price)
2. And can’t just bury facts and defend by saying “it was there somewhere”
c. Applies to: registration statements (IPOs and stock acquisitions), periodic reports, and insiders
II.
Tests (Franchard = omission of controlling person’s (whose reputation the co. is based on) personal use of co. funds for
and encumbrances on his stock material b/c reflects poorly, and now must be disclosed per Item 400s of Reg S-K. But
board’s compliance w/ fiduciary duties need not be since securities laws don’t seek to define everyday responsibilities)
a. Basic = materiality will depend at any given time upon a balance of (Basic = lied about merger neg.):
i. The indicated probability the event will occur (risk of hindsight bias) and
1. Ex. m/a is “probable” enough for disclosure once you sign a letter of intent/merger
agreement (i.e. late in the process, since telling too early will lead to valuation free
riders and discourage potential bidders in the first place)
ii. Anticipated magnitude of the event in light of the totality of the company’s activity (Matrixx =
drug co.’s failure to disclose plausible (although not statistically significant) medical reports that allergy
medicine caused loss of smell is material omission b/c FDA cared about them and fixing allergies isn’t worth
any chance of losing smell. Behavioralism > science)
b. SAB 99 = probability x magnitude should be >5% of earnings, but qualitative can be more
important than quantitative, examples:
 Affects compliance w/ regulatory or K requirements  Concealment of an unlawful transaction
 Hiding failure to meet analysts’ expectations
 Info on part w/ significant role in operations/profits
(Litwin = PE’s investment in co. is <5%, but that co. is part of
 Effect of increasing management’s compensation
flagship segment of PE’s portfolio and was expected to trigger
 Masking a change in earnings or other trends
clawback provision of executive comp., so material)
c. Event studies (alternative to rules of thumb by using external events) = fraud causes stock to inflate,
so once the truth comes out the stock should fall (In re Merck = omission not material when all of info needed
to make it clear was already public and price ok, even if price dropped after explicit public disclosure)
i. But need to be sure this wasn’t random and other variables didn’t cause it (experts!)
ii. Method = ID event date and window, see if return is abnormal compared to CAP-M
iii. Courts usually accept this if statistically significant for companies with publicly traded stock
that trades in liquid and efficient secondary markets
---------------------------------------------“SECURITY” UNDER 2(a)(1)---------------------------------------------Securities laws apply only to offers and sales of instruments that are or purport to be securities (since interest in
protecting investors from forged or nonexistent securities if represented as such)
I.
Introduction
a. Broad interpretation of the definition of “security” under 2(a)(1) to help SEC meet its goals
i. Substance over form
b. So always keep in mind genuine “securities” transaction characteristics:
i. Information asymmetry
ii. Collective action problem
iii. “Closeness” to capital markets (goal is to protect their integrity)
iv. Potential for greedy behavior (so sophistication of parties doesn’t matter)
v. Lack of another comparable regulatory regime (IBT = noncontributory, compulsory pension plan w/
defined benefit isn’t b/c covered by ERISA) (Marine Bank = CDs aren’t b/c subject to banking regulations)
1. Scams are covered by state consumer protection laws, but that’s not enough b/c
threatens integrity of financial markets (SG Ltd = pyramid scheme)
II.
Is it an instrument commonly known as a security?
a. Stock (if it purports to be stock [common or preferred] and has normal characteristics, then ok)
i. Bu can’t just call it stock if it doesn’t have these characteristics (Forman = “stock” to let you lease
an apartment in a co-op is not a security b/c no rights of stock and not likely someone thought it was):
1. Dividends or buybacks
Even if you’re the
sole SH so no
2. Transferability (and negotiability/ability to be pledged?)
agency costs, corp.
3. Voting rights in proportion to number of shares owned
form dictates result
4. Capacity to appreciate in value (tied to liquidity)
ii. OLD: sale of a business doctrine = not a security if you’re buying the whole business b/c
then you’re buying control (so like an asset purchase) and don’t need protection
1. NO LONGER GOOD LAW (Landreth = sale of all stock of a company is a security transaction
b/c complies with Congress’ purpose of protecting investors w/ full and fair disclosure)
b.
“Any Note” considering the Reves factors and whether it resembles risks of equity investment
(balancing test, so don’t need all) (Reves = note payable on demand by a co-op is a security b/c purpose to raise
capital and make profits, offered to public, characterized as such in investments, and would otherwise not be regulated):
i.
ii.
iii.
iv.
Buyer and seller motivations (investment or consumer purchase?)
Plan of distribution (public trading & collective action problems?)
Expectation of the public and
Risk reducing alternatives (other regulatory scheme?)
Cash Flow Rights
Common
stock
Preferred
stock
Debt (senior
& junior)
III.
Dividend (residual
& discretionary)
Dividend (fixed &
discretionary)
Fixed interest
payment
Liquidation
Rights
Residual
Medium
Highest
Voting Rights
Yes, but limited
Negotiated via K
(often contingent)
None
Notes are presumed to
be securities, but P can
rebut by using Reves
Misc.
Board may also repurchase stock, otherwise earnings
are retained
Were more like bonds (fewer preferences; issued to up
equity for debt ratio, but now VCs get conversion)
Ex. notes, bonds, indentures (longest-term). Interest
deduction, whereas dividends are taxed twice
Is it specified by §2(a)(1) as a “security”? or
a. E.g., fractional undivided interest in oil, gas, or other mineral rights
IV.
Is it covered by the catchall “investment contract”? See Howey 4-prong test (Howey =
opportunity to share in profits of a citrus grove by selling strips of land managed by third parties as sole incentive since
individual development would not be economically feasible is an investment contract so it’s a security and must register):
a. An investment of money = giving up specific consideration in return for (aka this is the real intent)
a separable financial interest (IBT = not w/ noncontributory pension plan since didn’t give up specific
consideration in return for a separable financial interest b/c decision to work was to make a living, so this is just incident
to employment like employee profit-sharing plans. But yes w/ voluntary contributory plans, but exempt under §3(a)(2))
b. In a common enterprise (Circuits are split on form of commonality required so go through all):
i. Horizontal commonality = (majority view) focus on relationship between investors where
If offer meets
funds are pooled and profits/losses distributed pro rata so collective action problem + agency
these then ok
costs (SG Ltd = pyramid scheme b/c funds in 1 account & everyone shared in profits since guaranteed return)
(need not be sale)
b/c §5 prohibits ii. Vertical commonality = focus on relationship btwn investors and promoter—his activities
offer or sale of
must be controlling factor in success/failure of investment (same scheme but varying
unregistered, nonreturns), so clear and significant agency costs even if no collective action problem
exempt securities
1. Broad = promoter must exert effort (so there’s a tie), but doesn’t take on risk
2. Narrow/strict = promoter actually takes on risk, too
c. W/ expectation of profits (objective standard: capital appreciation or participation in earnings) and
i. NOT for personal consumption (Forman = “stock” to lease an apartment is for personal use, not profits)
ii. Fixed or variable returns ok b/c still attracted by representation of investment income
(Edwards = sale leaseback for payphones with contractual return of 14% ok b/c still default risk)
d. Solely from managerial efforts of others (“solely” = primarily/substantially) (Mutual Benefits = buying
fractions of life insurance from terminally ill is an investment K even though effort came in pre-purchase lifeexpectancy analysis to choose what to pool together. No basis to exclude activities taken to insure success of investment)
Investor does
nothing
Investor picks 1
orange
Investor relies on managers
without control
Investor relies on
managers with control
Investor does it
all
i. Consider:
1. Offered/sold with emphasis on economic benefits derived from another’s efforts?
2. Offering of participation in a rental pool arrangement?
3. Is purchaser materially restricted in his occupancy/rental of the unit?
ii. But modicum of effort by investor won’t exclude the scheme
iii. So LPs are securities b/c limited partner is passive player depending on acts of general
partner with full discretion, like a SH (but GPs are not)
1. If an LLC or other entity, analogize to LP and GP considering legal structures and
economic realities (Williamson) (Merchant Capital = interests in RLLPs count b/c illusory powers,
inexperienced in this industry, and no realistic alternative to the seller/manager):
Success must depend on
entrusting control to another
(so high agency costs and
collective action problems),
not just supply/demand of a
commodity. Ownership must
be meaningfully separated
from control!
a. Legal power distribution (if member-managed then not a security b/c like a
GP, but if manger-managed then security b/c like an LP)
b. Experience/knowledge (can they exercise legally sufficient control rights?) or
i. General biz expertise doesn’t have to = expertise in this area
c. Ability to replace managing partner (unique experience or impossible voting
structure), making plaintiffs dependent
iv. But buying land in fee simple isn’t, since profits would come from your efforts
V.
What about securitization? (See appendix)
a. These are securities! But their transactions are often exempted b/c sophisticated players
b. Use Howey if = issuance of interests directly in return from pool | Reves if issuance of debt backed by assets of pool
--------------------------------------PUBLIC COMPANY DISCLOSURES----------------------------------------All public companies are subject to mandatory disclosures and accuracy provisions under the Exchange Act
I.
Types of Companies
a. Private company = shares closely held by managers and small circle of friends/family
i. Investment based on trust in character of mangers, with outside investment coming from VCs
who vet and make contracts giving them substantial control
b. Public companies = more broadly dispersed so harder to get this info, which is why we need
mandatory disclosures and accuracy to form this trust…
c. How to become a public (aka Exchange Act reporting) company:
i. Connection with interstate commerce (ISC) and either:
1. IPO via Securities Act, triggering §15(d) reporting obligations (see next section) or
2. Registration via Exchange Act, triggered by:
§12(a)
Triggering Event
Obligations
Exchange listing




 Can just list for
liquidity, i.e. w/out
raising money, but rare
Registration terminated if delisted
Register §12(b)
Reports & accuracy §13
Proxy/tender offer rules §14
Insider stock transaction
disclosures §16
§12(g)
> 500 shareholders of
record + >$10m assets
§15(d)
Effective reg. statement Periodic reports per §15(d)
for public offering
(same requirements as §13)
under Securities Act
W/in 120 days of close of fiscal Registration terminated if certify under Form 15:
year when you meet this:
 < 300 holders or
 Register §12(b)
 < 500 holders and < $10m in total assets on the last day of
 Beneficial (not
each of its prior three fiscal years
 Reports & accuracy §13
legal) owners if form is  Proxy/tender offer rules §14
used for circumvention  Insider stock transaction
12g5-1(b)(3)
disclosures §16
 Rare to get here
w/out reaching 12(g)
II.
"Going Dark"


Obligation suspended if certify on Form 15 < 300 holders
For foreign private issues, Rule 12h-6 = registration
terminated if certify under Form 15F:
o Reported for past 12 month
o Listing on foreign jx
o <5% trading volume in US or < 300 US holders
§13(a) or §15(d) Reporting Obligations
a. Introduction
i. Integrated disclosure informed by Reg S-K (for lawyers) & Reg S-X (for accountants)
ii. CEO and CFO must certify reports filed with SEC are materially accurate per SOX §302
1. Must return bonus if results restated b/c misconduct SOX §304 (aka clawback)
iii. Note: foreign private issuers use Form 20-F instead of Form 10-K
b. Form 8-K = current report (must be filed w/in 4 days) triggered by events in these categories:
i. Business and operations
1. Material definitive agreements outside ordinary course of business
ii. Financial info
1. Acquisition/sale of assets >10%, bankruptcy, off-balance sheet arrangements…
iii. Securities and trading markets (since affect liquidity and may lead to dilution)
1. Delisting or transfer, material modification to holders’ rights, unregistered sales…
iv. Accountants/auditors (since could hurt credibility and price)
III.
v. Corporate governance and management
1. Change in control, amendments to charter, etc.
2. Departure of directors (+ reason if resigned b/c of operational disagreement) (HP)
3. Whether or not they have a code of ethics (i.e. shaming them into it)
vi. Asset-backed securities (ABS)
vii. Reg FD compliance
viii. Other events “deemed of importance” by registrant (no time limit)
ix. Current financial statements
c. Form 10-Q = quarterly report
i. Financials don’t need to be audited (but still must be GAAP per Reg G)
d. Form 10-K = annual report (often paired with proxy via Rule 14a-3), that must include info on:
i. Business (audited financials)
vi. Directors and officers (bios, misconduct if adjudicated
or re: self-dealing/integrity [no 5th Am.])
ii. Properties
vii. Security ownership of management
iii. Material legal proceedings
viii. Certain relationships and related transactions
iv. MD&A of $ (forward-looking)
ix. Principal accounting fees and services
v. Executive comp. (salary, perquisites
x. Outcome of SH votes
>$10k, in the money options, CD&A)
§13(b) Accuracy of Books/Records (from Foreign Corrupt Practices Act)
a. Must keep books/ records in reasonable detail that accurately reflect transactions §13(b)(2)(A)
i. Strict liability and no materiality requirement
b. Must devise and maintain a system of internal controls so §13(b)(2)(B):
i. Transactions and access to assets are authorized (generally or specifically)
1. Must police consultant compliance, too (Oil States)
ii. Records generate useful info so financial statements can reflect GAAP
iii. Records maintain accountability
iv. Double check of recorded asses with existing assets at reasonable intervals
c. If knowingly circumvent , falsify records, or fail to implement, then criminal penalties §13(b)(4)
d. And no bribes!
e. Applies to stock options, so can’t backdate without telling (Brocade = can’t falsify date options are issued as
before you were hired to make then in the money [= stock price higher than exercise price])
f. Need to report on these controls & have auditors attest to them if market cap >$75m SOX §404
IV.
Reg FD Prohibition on Voluntary Selective Disclosures
a. If employee of domestic Exchange Act reporting co. discloses non-public material info to a covered
person (= one reasonably expected to trade on the info, like a broker-dealer, investor, or investment
advisor) (Siebel Systems = CEO’s private comments didn’t materially contrast with public comments b/c substance was
equivalent, implications the same, and don’t need to parse every word, so no need for additional reporting per Reg FD)
i. But NOT journalists or temporary insiders, i.e. people owing/agreeing to a duty of trust
(like attorney or family member)
b. Then company must ALSO disclose that info to the public via an 8-K or wide press release
i. If disclosure was intentional/reckless this must be simultaneous (if not then have 24 hrs)
c. BAD? Chilling effect, and prevents smoothing effect on prices if info is leaked over time
d. Exclude oral communications of reporting companies in relation to offerings
-------------------------------------PUBLIC OFFERINGS AND SECTION 5--------------------------------------
I.
Introduction
a. Capital-intensive co. will eventually generate revenue but need to make expenditures now. Options:
i. Internally generated funds (like last year’s profits) or investments from founders
ii. Banks (but they demand regular interest payments and numerous covenants)
iii. Private placement like Venture Capitalists (see below)
iv. IPOs! (but then subject to expensive disclosure obligations and pesky SHs…see above)
b. Types of issuers:
i. Non-reporting = not required to file reports under Exchange Act §13 or §15(d)
ii. Unseasoned = reporting, but doesn’t satisfy requirements for Form S-3 (see below)
iii. Seasoned = can use Form S-3 (see below)
iv. WKSI = can use Form S-3, not behind on filings in last 12 months, and has $700m of nonaffiliate common equity w/in 60 days of last shelf reg. or Form 10-K (with $1b in principal of
non-convertible securities during past 3 yrs if issuing the same) per Rule 405
II.
IPO Process
a. Engage in discussions with an investment bank
b. Decide on an offering type:
i.
Firm commitment (majority) = underwriter guarantees sale of the offering by buying all
shares at a discount then selling them itself (risk is accounted for via spread)
a. Green shoe = option to sell more
ii.
Best efforts = underwriter uses “best efforts” to sell as many as it can (can be conditioned
so rescind all sales if offering isn’t sold out) (usually for less established underwriters)
iii. Direct public offering = to SHs or public directly (but investors want banks to screen)
Pre-Filing/
Dutch auction = take bids, then choose the highest price that will result in a sellout (seen
“Quiet Period” iv.
as a way to avoid underpricing and help retail investors)
c. Sign non-binding letter of intent w/ managing underwriter (= in charge of allocation, registration
statement, pricing [via road show], and due diligence)
a. It then finds a syndicate of underwriters to help share risk (sign Ks among themselves)
b. FINRA requires underwriting fees be reasonable, and SEC won’t declare registration
effective until FINRA agrees Rule 461
d. File primary offering registration statement, which is either a:
a. Form S-1 (Part 1 = §10 prospectus, Part II = technical filings) or
b. Form S-3/F-3 (easier b/c inc. by reference to prior filings, but then liable for them per §11)
Waiting/
i. = for issuers that have been an Exchange Act reporting company for 1 year, are
“Cooling Off”
current in SEC filings, and have >$75m of common equity in hands of non-affiliates
Period
(= public float requirement)
ii. If don’t meet last requirement, can still use if sales limited to 1/3 of public float
e. Registration statement is effective after informal process and selective review
a. 20 days after filing if no amendments, but everyone chooses to add a Rule 437 delaying
amendment to automatically amend it until the SEC declares it effective
b. SEC stop order can prevent §8(b) or suspend effectiveness §8(d) if incomplete/inaccurate
f. Then you sign underwriting agreement and sell
III. §5 Gun Jumping Rules = regulate transactions in ISC (not securities or participants)
Before “in
registration” ok



= when you finish selling
a. Policies
i. Want ppl to slow down so they don’t make rash decisions and cause a speculative frenzy
ii. Keep issuers from conditioning the market with rosy disclosure b/c by the time there’s full
mandated disclosure it may be too hard to change investors’ minds
iii. Balance gun jumping concerns with need for disclosure to keep people informed
b. Pre-filing period = after “in registration” (= discussions w/ investment bank) and before filing
i. No sales until registration statement is effective §5(a)
ii. No offers prior to filing of registration statement §5(c)
1. Offer §2(a)(3) = attempt to dispose of/solicitation of offer to buy, security in ISC
a. It’s an offer if it conditions the market or arouses public interest
b. So no oral offers or prospectuses (aka written offers per §2(a)(10))
i. Includes all non-real time electronic communications Rule 405
c. Consider:
Motivation (arranged months ago = not offer)
 Form of comm. (easily reproduced = offer)
Type of info (soft/-looking = offer),
 Mentioning facts about offering, like underwriter’s
name = offer
Breadth of distribution (broad = offer)
2. So don’t initiate any new ad campaigns and stick to factual business info (FBI)
instead of soft info (projections/predictions) when answering questions
3. Safe harbors (i.e. don’t count as offers) for issuers and those working for them
(issuer has obligation to police them to make sure they comply once clock starts):
a. Preliminary neg. btwn issuer & underwriter (b/c will be in privity) §2(a)(3)
b. Rule 163A = communications not referring to the offering made >30 days
Purpose is to
before filing of registration statement (note: Reg FD still applies)
allow issuers to
c. Rule 168 for Reporting Issuers = can release FBI and forward-looking info
continue normal
if previously released same type of info in ordinary course of business, but
business during
can’t mention the offering
this cool down
d. Rule 169 for Non-Reporters = same, but only FBI (and only for issuers)
period
e. Rule 163 for WKSIs = oral ok, and written ok b/c treated like FWP (below)
i. Policy= lots of info out there, so allow them to test the waters
f. Rule 135 Tombstone Advertisements = issuer can have short, factual notices
of proposed offering with legend (but can NOT ID underwriter by name)
c. Waiting period = after filing registration statement but before it is declared effective by SEC
i. No sales until registration statement is effective §5(a) (so don’t bind or collect any $)
ii. Oral offers ok (ex. road show by management) b/c not a prospectus under §2(a)(10)
iii. Non-real time written offers only if §10 prospectus §5(b)(1)
1. No final prospectus yet §10(a), so must be preliminary prospectus §10(b)
a. = contains same info as §10(a) minus price, so balanced pros/cons (but not K)
b. So all other written offers are forbidden
i. Safe harbors (i.e. don’t count as offers):
1. Rules 168-69 (see above)
2. Rule 134 (expands on 135 Tombstone Ads)
a. Can now include underwriter’s name
b. But must have legend indicating registration statement
is filed and where one can get §10(b) prospectus
2. Rule 164 post-filing free writing prospectus (FWP)
BONAFIDE ROADSHOW a. = any written communication by anyone that offers to sell & doesn’t meet §10
b. Meets Rule 433 (permitted post-filing FWPs) so counts as §10(b) for
 If “graphic communication”
in Rule 405 (= downloadable)
purposes of §5(b)(1) if:
then it’s “written” and must
i. Accompanied/preceded by recent §10 prospectus (hyperlink ok)
meet Rules 164 + 433 (so must be
1. WKSIs need not follow this delivery requirement
filed or unrestrictedly available)
ii. Doesn’t contain info inconsistent with filed §10 prospectus or
 But if it’s live/real-time
periodic/current report incorporated in registration statement
transmission or slides/handouts
investors can’t take with them,
iii. Includes legend and
then “oral” so not prospectus
iv. Filed with SEC if new info same day if by issuer, or within 4 days of
and need not be filed
becoming aware of it (if immaterial or unintentional can cure)
1.
Non-issuers don’t have to file unless broad unrestricted dissemination
3. Safe harbors for analysts’ research reports (i.e. don’t count as offers)
a. Must be in regular course of business (not new coverage!)
b. Rule 137 for unaffiliated broker-dealers
i. Dealers §2(a)(12), but not underwriters so §4(3) exemption from §5
ii. No direct or indirect compensation
c. For broker-dealers participating in the distribution
Also in the
i. Rule 138 = if offering is for convertible securities then can only do
pre-filing
research reports on non-convertible since not offer per §2(a)(10)
period
ii. Rule 139 = ok to issue reports on S-3 eligible companies and the
“wider industry” (so long as your co. doesn’t get more space)
iii. Timing FINRA 2711(f):
1. Managing underwriters can’t until 40 days after IPO
2. Others have 25 days
3. Only 10 for secondary offering
d. Post-effective period = after registration statement is effective until issuer is done selling
i. Can only offer or sell in ISC if accompanied /preceded by a §10(a) final prospectus§5(b)(2)
1. §10(a) final prospectus is §10(b) + price (just file a supplement w/ Rule 430)
2. Traditional FWP = all written offers not complying with §10(a) are ok only if
preceded or accompanied by at §10(a) per §2(a)(10)(a), otherwise no per §5(b)(1)
a. Except confirmations of sale Rule 172
3. Access = delivery per Rule 172, so if §10(a) is filed w/ SEC then ok
a. But underwriters/brokers/dealers must also send info telling investors sale
took place & they have rights under §11, §12(a)(2) in 2 days per Rule 173
4. Exemptions to delivery requirement (since §5(b) provides no limit):
a. §4(1) ordinary trading for non-issuers, underwriters or dealers (see below)
b. §4(3) dealers not acting as underwriters selling unsold allotment unless:
i. < 90 days after IPO (only 25 days if now on national exchange)
ii. Or 0 days if issuer was already a reporting company Rule 174
c. §5(4) for independent brokers executing non-solicited customer orders
IV.
Updating IPO Filings
a. §10(a) prospectus
i. If grossly misleading may violate §5(b)(2) delivery req. (Manor Nursing = rescission per §12(a)(1))
ii. So when do you have to update it?
1. If used >9 months after effective date then info must be <16 months old §10(a)(3)
2. If Rule 415 shelf registration then only if “fundamental” changes
b. Registration statement
i. Must be accurate as of the effective date to escape liability
ii. Don’t have to update previously accurate info
1. But must update Rule 415 shelf registration is “fundamental” changes
iii. Have to refile if “substantive change from or addition to,” but that resets date for liability
1. But if non-substantive change/addition then just sticker
V.
Reg M and Secondary Market Manipulation to Drive Up Price
a. = limits trading during restricted period of covered securities by distribution participants
i. Covered securities: those subject to distribution or any reference security (= one that a
distributed security may be converted into)
ii. Distribution participants: issuer, underwriters, participating brokers/dealers, & affiliates
iii. Restricted period: ends when participation in distribution is over and starts when:
1. If ADTV for last 2 mos. is $100k and public float is $25m, then 1 day before price set
2. If not, then 5 business days before price is set
3. If m/a, then day when proxy solicitation materials are disseminated
b. Distribution participants can’t bid for or induce another to bid for covered securities during restricted
period per Rule 101 except:
i. Offers to sell or solicitations of offers to buy, and underwriters can buy from issuer and sell
ii. Research reports under Rules 138-39 safe harbors
iii. Stabilization = to maintain price of security (= only to prevent drop in secondary market
below offering, and must give way to independent bid of same price) Rule 104
1. Only applies to underwriters and affiliated purchasers, not issuers Rule 102
iv. De minimis transaction (= <2% of ADTV) or actively traded securities (= if ADTV is <$1m
w/ common equity <$150m))
c. And no short selling by purchasers in the offering Rule 105
--------------------------------------------------CAUSES OF ACTION----------------------------------------------------
I.
§11 of Securities Act (easier than CL fraud)
a. Covers: fraud in registration statements (determined as of effective date; reset for amendments)
b. Plaintiff standing = private COA
i. Must be a purchaser (but need not show privity of contract with issuer)
ii. Tracing requirement, so must show shares purchased were sold as part of public offering
under the reg. statement containing the alleged fraud (so essentially limited to IPOs) (Krim =
even if highly likely stock was from offering, if pool you bought from was comingled w/ a few outside shares
then can’t prove ALL stock for which you claim damages was actually issued pursuant to a defective statement)
c. Defendants (listed in statute):
i. Those who signed reg. statement
iv. Experts who prepared/certified part (i.e. auditors)
ii. Directors/partners
v. Controlling person §15 (i.e., anyone who controls
iii. Underwriters
one liable under §11, unless good faith defense)
a. Elements:
i. Material misstatement or omission in effective registration statement used in ISC & damages
ii. NO causation or reliance (tracing is enough) needed
b. SOL = 1 year of discovering fraud, and no more than 3 years after offering §13
c. Defenses
i. If you resign and tell the SEC §11(b)(1)
ii. If plaintiff has actual knowledge (shown by public info) of fraud at time of purchase §11(a)
iii. Loss causation = D can reduce liability if it shows value declined due to other factors §11(e)
iv. Due diligence (NOT FOR ISSUER) (about behaving as if it’s your money) §11(b):
Non-Expertised Portion
No liability §11(a)(4)
Expert D
(auditors)
Non-Expert D
(officers, underwriters, and
outside directors)
No liability if §11(b)(3)(A):
 Reasonable investigation and
 Reasonable and actual belief in statements
Expertised Portion (audited financials)
No liability if §11(b)(3)(B):
 Reasonable investigation and
 Reasonable and actual belief in statements
No duty to investigate if no red flags! Just can’t
have a reason to believe untrue §11(b)(3)(C)
(reliance defense)
The more you know/have leverage, the greater your responsibility to see red flags (Escott = “reasonable
investigation” means more than taking ppl at their word w/o checking available corporate records, but young Birnbuam was new so
could rely on expertised portion b/c no knowledge and wasn’t around long enough to see red flags) (WorldCom = underwriters can’t
blindly rely on audited financial statements when there’s a weird ratio compared to competitors since that’s a red flag)
d. Remedy
i. = difference between what P paid (≤ offering price) and:
1. If sold before suit then price at time sold §11(e)(2)
2. If still owns shares at end of the suit then “value” at filing §11(e)(1) (Beecher = “value”
can be something other than market price if public was mis/uninformed. Here, subtract some to
account for financial crisis but add to account for what it would have been w/out panic selling)
3. If sold after filing but before judgment, then greater of price at time sold of “value” at
filing §11(e)(3), so incentive to sell ASAP after learning of fraud
ii. Presumption that all Ds are jointly and severally liable except:
1. Underwriters only up to amount distributed to the public §11(e)
2. Outside directors are proportionally liable with other Ds §11(f)(2)(A)
3. Can adjust liability by K, but probably won’t be enforced unless insurance (Brennan =
underwriters have express right to seek contribution, but not indemnification b/c counter to policy)
II.
§12(a)(1) of Securities Act
a. Covers: violations of §5 gun-jumping rules (NOT an antifraud provision)
b. Plaintiff standing = private COA
i. Anyone who bought a security that meets elements
c. Defendants:
i. Statutory seller or
1. Owner who passes title of the security to a buyer for value (issuer) or
2. Person who successfully solicits purchase of the security, motivated at least in part by
desire to serve her own financial interest or those of the owner (underwriters/brokers)
(Pinter = don’t have to pass title, just need to have solicitation motivated at least in part by financial
gain. This goes with the policy b/c solicitation is the most critical stage of the transaction)
d.
e.
f.
g.
III.
ii. Controlling person §15
Elements:
i. Offer or sale of security involving the use of ISC
ii. §5 violation (so no exemption)
iii. NO scienter, causation, reliance, or damages needed (so it’s strict liability)
SOL = 1 year of discovering fraud, and no more than 3 years after offering §13
NO defenses (b/c it’s strict liability)
Remedy = rescission (= money back if not been sold) or damages if already sold (= difference
between purchase price and sales price)
§12(a)(2) of Securities Act
a. Covers: fraud in a prospectus or oral offer related to a public offering (NOT secondary market
or privately negotiated transactions post Gustafson)
b. Plaintiff standing = private COA
i. One who was bought security by means of prospectus/oral offer meeting elements
c. Defendants = statutory seller (like §12(a)(1)) or controlling person §15
d. Elements:
i. Offer/sale of security involving ISC by means of prospectus (= doc describing a public
offering by issuer or controlling SH [Gustafson]) or oral communication relating to prospectus
1. Only extends (if at all—depends on the court) to secondary market transactions if
subject to §10 prospectus delivery requirement in §5(b)(2) (Feiner = only extends to
aftermarket trading if occurs by via a prospectus. If no delivery required by seller, then no standing)
ii. Material misstatement or omission in the prospectus or oral offer
iii. Casual connection btwn prospectus and decision to buy, but focus on market as whole (easy)
iv. NO reliance or damages needed
e. SOL = 1 year of discovering fraud, and no more than 3 years after offering §13
f. Defenses:
i. If plaintiff has actual knowledge (shown by public info) of fraud at time of purchase
ii. D did not, and in exercise of reasonable care could not have known, of the fraud
2. Easier for D to show than §11’s due diligence (no distinction btwn portions)
iii. Loss causation = D can reduce liability if it shows value declined due to other factors (Miller
= when price doesn’t decline until weeks after disclosure of correct info, then no loss causation. Here, none b/c
it was obvious the stock was trading on the OTCBB instead of the NMS, so can’t link to misstatement)
g. Remedy = same as §12(a)(1)
IV.
§10(b) and Rule 10b-5 of Exchange Act (most action, but usually settles; easier than CL fraud)
a. Introduction
i. Overlap with §9 of Exchange Act (forbids knowing manipulation on national exchanges)
and state COAs which are not preempted per §28(a) savings clause, i.e. class actions)
ii. The rule:
1. Unlawful to directly/ indirectly, by use of ISC (jurisdictional nexus):
a. Employ any fraudulent device, scheme, or artifice 10b-5(a)
b. Make any untrue statement of a material fact or to omit to state a material
Prohibits fraud, but doesn’t
fact necessary in order to make the statements it made, in the light of the
compel disclosure unless
circumstances under which they were made, not misleading 10b-5(b) or
otherwise a duty to disclose
c. Engage in any act, practice, or course of business which operates or would
operate as a fraud or deceit upon any person 10b-5(c)
2. In connection with the purchase or sale of any security (transactional nexus) (Blue
Chips = can’t sue b/c they didn’t buy based on fraudulently pessimistic prospectus, have to actual buy
or sell) (Zandford = when a sale is necessary to carry out a fraud, then connected. Here, broker sold
customer’s securities and used the proceeds for himself without telling, but wouldn’t have violated
§10(b) if he decided to do that after a lawful transaction)
a. Covers both issuer transactions and the secondary market, unlike§12(a)(2))
iii. Goal = prevent lemons problem, have price reflect value, and encourage market participation
iv. But concern about strike suits (= force unjustified settlement) so Congress passed PSLRA:
1. Increased pleading standard to particularity
2. No discovery until after survive motion to dismiss
a. Pleading standard for motion to dismiss = fraud must be at least as compelling
as story that it’s normal (Tellabs = consider allegations collectively)
3. Lead plaintiff presumption for class actions §21D(a)(3)(B) (Cendant = lead P retaining
a substantial investment in D corp. is not enough to rebut b/c rebuttal is not a relative inquiry)
b. Most adequate P is the person/group that (this is a relative inquiry):
i. Has filed the complaint or made a motion,
ii. Has the largest financial interest in the relief and
iii. Satisfies FRCP 23:
1. Claims/defenses are typical of the class
2. Will fairly/adequately protect class’ interests
c. Limited to 5 of these in 3 yrs, and can’t recover more per share than others
4. Court review for reasonable attorney’s fees (usually “lodestar” for hourly rate x
hours x risk/complexity/outcome multiplier with % cap on recovery)
d. Presumption of reasonableness (Cendant = power to select and retain counsel is lead
P’s, but court can approve it [not a relative inquiry] and can only rebut fees is clear excess)
5. Forward looking information safe harbor §21E(c)(1) (codified “bespeaks caution”)
e. = not liable if accompanied by meaningful cautionary statement identifying
important factors that could cause actual results to differ materially, even if
knowingly false (Asher = not boilerplate to say statements are forward looking and
mention risks and product lines, so these were meaningful and market must’ve reflected them.
If 10-K says “we will earn $100m unless X” and subsequent PR says “we will earn $100m”
the reasonable investors [analysts in efficient markets] didn’t forget about X…)
6. Proportionate liability if not intentional
b. Scope = applies whether or not the security is registered or exempt
a. Typical cases:
i. Securities trading, where a party to the transaction gives false or misleading info to
induce the other, or remains silent when there’s a duty to disclose
ii. Corp. trading, where manager induces corp. to enter into bad transaction so it sues
iii. Corporate disclosures (without trading), where it issues false or misleading info tp
the public or remains silent when it has a duty to disclose.
1. Then contemporaneous buyers or sellers can sue
c. Plaintiff standing
i. SEC enforcement action or
ii. Implied private COA
1. Can be a seller or a purchaser (whereas only purchaser in §§11 and 12(a)(1)-(2))
d. Defendants = any person whose fraud is in connection with purchase or sale of a security by P
(buyer, seller or other, and secondary market resales count so no Gustafson problem)
i. Aider and abettor liability for non-primary violators?
1. SEC = yes, if knowingly or recklessly provide substantial assistance §20(e)
2. Private COA = no (Central Bank) (Stroneridge = you have to “speak.” So no scheme liability.
Here, cos. agreed to overpay D to help it cook the books did not make it necessary for D to record the
transactions in fraudulent way it did, so they didn’t speak and investors didn’t rely on them) (Janus =
liability is w/ the person who has ultimate authority over the statement. Only D’s sub has the statutory
obligation to file the prospectus, so its parent and advisor who actually did all the work aren’t liable)
a. Not about general insurance against any commercial fraud
ii. Control person liability §20(a) for SEC or private COAs
1. Purpose = prevent ppl from using straw men acting on their behalf to accomplish
ends that would be forbidden directly
2. Can allege both Rule 10b-5 and §20(a) liability (ex. inside director)
3. Circuits vary. All must show primary violator.
a. Majority use potential control test, where must exercise control over primary
violator and possessed power to control the transaction (Lustgraaf = broker-dealer
can be liable for its registered representative’s fraud b/c it provided him with access to the
markets and had a duty to oversee him, but broker-dealer’s parent is off the hook b/c no proof
that it could control anything beyond the general operations)
b. Minority require control plus culpable participation
4. GOOD FAITH DEFENSE §20(a)
e. Elements:
i. ISC (purchase/sale involved instrumentality of ISC or a facility of a national stock exchange)
ii. Material fraud (device, misstatement/omission, or act) in connection w/ purchase/sale
1. Deception (Santa Fe = can’t sue for this instead of appraisal rights when no deception in merger, i.e.
when shareholders have a choice and are fully informed)
2. Verifiable facts (no liability for opinions) (Bankshares = When directors said in proxy
solicitation that SHs should approve merger b/c they thought it was “high value and fair price,” SHs
will believe it b/c no efficient market for proxies to rely on. While couched in conclusory terms, it was
based on verifiable facts, so misleading. But only actionable if the deal is in fact not good)
3. Duty to correct info that was incorrect when disclosed (even if believed true then)
4. Duty to update info that was correct at the time but turns out to be misleading (like
w/ reg. & prospectuses) (Gallagher = only continuous duty to update when selling. FDA’s letter
was dated after 10-K, so 10-K wasn’t false at the time and no duty to update b/c not selling)
5. Not for forward looking statements if you follow PSLRA (see above)
iii. Scienter = need actual motive, knowledge, or recklessness (Ernst = auditor that just didn’t catch red
flags of issuer can’t be held liable b/c you need scienter)
1. Not negligence or SL like §11 (we wanted to terrorize ppl into not violating §11)
2. Keep post-PSLRA heightened pleading in mind
iv. Loss causation = act/omission you relied on caused the loss you suffered §21D(b)(4) (Dura
Pharm = can’t satisfy this by merely showing the price on the date of purchase was inflated b/c of the
misrepresentation b/c that doesn’t mean you lost money, although would likely be a factor in losing money
when you sold later after a price drop, which is what you really need to prove)
1. Use experts and event studies (see materiality, above)
2. Split as to whether must plead with particularity FRCP 9(b) or plausibility 8(a)(2)
3. Different from reliance (EPJ Fund = loss causation is not a prerequisite to establishing Basic
presumption or certifying a class)
v. Reliance (aka transaction causation)
1. SEC need not prove this
2. Private Ps do, but EASY (based on efficient market hypothesis, see above)
Omission w/ duty to disclose (Affiliated Ute = don’t need proof
of reliance if just failure to disclose and facts are material)
Affirmative misrepresentation
Face-to-Face
No reliance requirement
Open Market
No reliance requirement
Investor must show
individual reliance
Rebuttable presumption of reliance
via fraud-on-the-market (Basic)
1. Fraud-on-the-market rebutted by showing:
a. Market not deceived
c. Specific Ps would have sold anyway
b. Market not efficient
d. Corrective statements
vi. Damages
f. SOL = w/in 2 years of discovering fraud, and no more than 5 years after fraud (no tolling)
g. Remedies: out-of-pocket damages, with proportionate liability for unknowing violators and
contribution available
V.
Insider trading (based on §10(b) and Rule 10b-5)
a. = prohibits trading securities on material nonpublic info when you owe a fiduciary duty to disclose.
Silence is then fraud so this is a deceptive device under §10(b)
i. Companies often have their own policies forbidding this, too
b. Policies
i. Don’t want to ban all trading on material nonpublic info b/c want investors to have an
incentive to research to make market more efficient (this is based on skill so fair)
1. But do want to prevent breaches of fiduciary duties, so we draw the line there
 But more info available, so prices are more accurate, which is good if you’re diversified…
 Unfair (goal is equal access)
 Investors discount $ willing to pay to reflect risk
 ↑ costs via bigger bid-ask spread
 Undermines property rights in valuable info
 Harms liquidity
 Encourages choice of more volatile investments
c. OLD RULE: special circumstances = insider may trade without disclosing material nonpublic info
since no duty owed to prospective SHs unless special circumstances like active concealment in a
face-to-face transaction (Strong = D had overwhelming influence as director and majority owner, so couldn’t
actively conceal his identity when buying from P by using a broker and lying to get better price from SH)
d. CURRENT RULES:
i. Classical theory: Rule 10b-5 imposes an
affirmative duty to abstain or disclose (or use a
big boy letter with sophisticated institutional investors
Inside
info
Insider trader
Chiarella classical
theory (perm. insider)
Dirks temp. insider
Outsider trader
Dirks tippertippee liability
Misappropriation
Outside
if:
theory
info
1. Insider (including corp. itself) trades
on material nonpublic info learned in the course of his duties (b/c now believe
insiders have fiduciary duties to prospective SHs) (Chiarella = silence can count as a
to waive reliance, thereby barring private COAs)
deceptive device under §10(b) if duty to disclose. Here no duty b/c printer just deduced info from
announcements of corporate takeovers. Had a duty to his employer, but that’s why he was fired) or
a. Can also be a temporary insider if access to material nonpublic info gives
you a duty (ex. underwriters, accountants, and lawyers)
2. Tipper/tipper liability (Dirks = inside whistleblowers told him company earnings were
overstated. He investigated and told the SEC [who ignored him] and some clients [who traded on it]. D
had no pre-existing relationship with SHs and the insiders who gave him info didn’t receive a benefit,
so no insider trading) if:
b. Insider discloses that info to another in breach of a fiduciary duty to SHs
c. For some personal benefit (cash, reciprocity, or intention to make a gift)
d. Recipient knows this (so assumes that duty) and
e. Recipient subsequently trades
ii. Misappropriation theory = info that is subject to a fiduciary duty of confidentiality is used
for trading in securities without disclosing to the owner of the info that it’s being used
(O’Hagan = lawyer working on confidential tender offer for acquiror bought shares of target. Can be liable
under §10(b) or Rule 14e-3 b/c misappropriated confidential info in breach of duty owed to the source,
defrauding principal of the exclusive use of that info)
1. So the duty breached is owed to the owner of the info, not the opposite trading party
a. This duty can be created under Rule 10b5-2 if:
i. Person agrees to maintain info in confidence or
ii. Person receives material nonpublic info from spouse/parent/child/
So can be subject to “tippee
sibling, unless recipient demonstrates no duty of trust (Rocklage =
liability” for using
“misappropriated” info
insider told wife who at first said she wouldn’t tell but then said she would and
did tell her brother who traded. But this brazenness doesn’t undo the deception
b/c didn’t give him a chance to take remedial action, so she’s the tipper, not him)
b. But if you tell the owner that you’re going to trade on it with time for him to
take remedial action, then brazen misappropriator = no deception so ok
2. Breaks elements of “deception” & “in connection with” apart so easier to meet policy
a. Misc. related rules
i. §16(b) = only explicit prohibition on insider trading, but only applies to D/O or >10%
ii. Rule 14e-3 = restricts use of material non-public info relating to a reporting company’s
stock once a tender offer is initiated (don’t need deception or breach of fiduciary duty)
iii. Reg FD = limits ability of issuers to convey informational advantage selectively to secondary
market participants (see above)
iv. Rule 10b-18 = concern that share buyback programs manipulate the market by creating
exaggerated appearance of market interest, but safe harbor from §10(b) and §9(a)(2) if issuer
buys back its own shares and:
1. Only uses one broker/dealer to solicit or makes bids on only one day (not the first
transaction or within 30 minutes of closing) and
2. Can’t exceed current independently published bids and is ≤ 1 round lot or 25%
trading volume
--------------------------------OFFERINGS EXEMPTED FROM SECTION 5----------------------------------§5(b) lasts forever, so without an exemption issuer would have to provide a registration statement or be liable
under §12(a)(1) etc. every time (but can never be exempted from §10(b) and Rule 10b-5)
I.
II.
§3 Exemptions of Specific Securities
a. Examples from§3(a):
i. Government issued securities §3(a)(2)
ii. Commercial paper §3(a)(3) (= way for industries to make payroll before selling inventory)
1. Exempted if capable of being executed w/in one year, mature w/in 9 months, i.e.
gestational period of an animal (Reves)
iii. Insurance §3(a)(8)
b. §3(b) authorizes SEC to create additional exemptions
§4(2) private placement offerings (basic exemption for issuers)
a. = exempts transaction by an issuer not involving a “public” offering
i. Offerees (# doesn’t matter) must be able to “fend for themselves,” (Ralston Purina = offering to
employees who asked doesn’t cut it b/c can’t show they all had access to the info or could understand it):
1. Need to have access to info that would be in a registration statement or actual
disclosure
a. Access if you’re an executive of have economic bargaining power
2. And have the sophistication to understand it
a. Consider wealth/income, experience, education, present investment status,
performance on test
b. Burden on issuer to reasonably believe offerees meet this, so use a suitability
questionnaire to meet reasonable belief standard
ii. All offerees must meet this standard, not just buyers (Doran = sophisticated buyer gets rescission
right b/c other offerees weren’t sophisticated)
b. Consider purposes of securities laws and:
i. Number of offerees
iii. Number of units offered
ii. Relationship of offerees to each
iv. Size of the offering
other
v. Manner of the offering
c. Some offerings clearly count as “private,” like:
i. Founders giving their corporation cash in exchange for initial capital stock
ii. First round investments from venture capitalists
d. But others are less clear and §12(a)(1) liability is strict, so Reg D safe harbor Rule 506 offers clarity!
III.
Reg D Safe Harbors to provide clarity to §3(b) and §4(2) offerings (must file Form D with SEC)
Excluded issuers
Offering price
Purchasers
General advertising
or solicitations
Resale
Specific disclosure
requirements
Rule 504 safe harbor for §3(b)
 Reporting companies
 Investment companies
 Blank check companies
 ≤ $1m every 12 mos. (b)(2)
 Subject to aggregation2 w/
§3(b) sales and those that
violate §5(a)
No qualifications
Rule 505 safe harbor for §3(b)
 Investment companies
 Disqualified1 companies per
(b)(2)(iii)
 ≤ $5m every 12 months (b)(2)
 Subject to aggregation2 w/
§3(b) sales and those that
violate §5(a)
 ≤ 35 non-accredited3
 Unlimited accredited
Ok under state law exemption (if
sold exclusively under state
registration that provides
substantive info pre sale (b)(1))
Only if follow state registration
No4 502(c)
≤ 35 sophisticated nonaccredited3 (b)(2)
 Unlimited accredited
No4 502(c)
No, so must take reasonable care to
discourage investors from reselling
(ex. legend)
Only for non-accredited investors5
502(b)(2)
No, so must take reasonable care
to discourage investors from
reselling (ex. legend)
Only for non-accredited investors5
502(b)(2)
No…so CHEAP
Rule 506 (safe harbor for §4(2)
Disqualified1 companies per
Dodd-Frank
Unlimited

a. Integration (aka a way to prevent people from escaping these limitations by breaking up offerings)
i. = treats seemingly separate offerings as one considering:
1. Whether sales are part of a single plan of financing
Important to not be
2. Issuance of the same class of securities
integrated with an IPO
b/c then these would
3. Made at or about the same time
violate §5, but presumed
4. Same type of consideration received
not b/c of Rule 152
5. Made for the same general purpose
ii. Distinct from, but can influence, aggregation (see below)
iii. Safe harbor from integration under 502(a), where separate if 6 months before or after:
b. Innocent/insignificant mistakes 508 (compare to “public” offerings where no forgiveness)
a. Shields issuer from private COA for violating §5, not SEC enforcement
b. Only shield if failure to comply didn’t pertain to a requirement directly intended to protect
that particular person (so can’t complain for faults that affect others)
c. Only available if failure to comply was insignificant with respect to offering as a whole (so
not if about general solicitation, aggregate offering price, or limit on purchasers)
d. Must have good faith attempt to comply
1
c. Disqualification under 505 (and probably 506, but those rules aren’t made yet)
e. SEC can waive if good cause
f. Disqualifies issuers if:
i. Subject to §8 SEC proceeding, stop/refusal order, crime for false filing, or injunction
of purchase/sale in last 5 years
d.
e.
f.
g.
ii. Key individuals (D/O, beneficial owner of >10% of a class, private placement agent)
are subject to punishments relating to false filings or bad business conduct
2Offering price aggregation for 504 and 505
i. Example: if you raise $1m/month over 5 months (starting in January) to 25 unsophisticated
purchasers, you’re ok under 505 but can’t sell any more under 504 or 505 until next January
(and slate isn’t wiped clean until next May)
1. So if you offer $2m to non-sophisticated investors next January, even though you
could offer $1m, since you offered too much the whole offering is disqualified from
Reg D and without another exemption violates §5
ii. Counting §5(a) violations w/in last 12 months as part of cap is just extra punishment
3Purchasers
i. Accredited investors for 505 and 506 (don’t count as purchasers under 501(e)(1)(iv))
1. Policy = sufficient ability to get access to info comparable to that in registration
statement
2. Issuer/placement agent must reasonably believe they are one of the following:
a. Banks, broker-dealers, registered investment companies 501(a)(1)
b. Trusts, partnerships, and corporations with > $5m in total assets 501(a)(3), (7)
i. But if organized specifically to acquire the securities, then each
beneficial owner must be accredited (can’t cheat!) 501(e)(2)
c. Any entity in which all equity owners are accredited 501(a)(8)
d. D/O (= someone who performs policy making) or GP of issuer 501(a)(4)
e. Natural person with:
i. Net worth (= assets – liabilities) with spouse > $1m (- value of primary
residence) 501(a)(5) and Dodd-Frank
ii. Income > $200k last 2 years or jointly >$300k, and reasonable
expectation for this yr 501(a)(6)
ii. Sophistication requirement for 506 (see §4(2) above)
1. Can meet by renting sophistication from their purchaser representative 506(b)(2)(ii)
4General solicitation prohibition for 505 and 506 per 502(c)
i. So only send out a limited number of ads/private placement memos to people you have a preexisting relationship with such that you can assess their sophistication! (Kenman)
ii. Can buy these pre-existing relationships by hiring a brokerage firm with a list
5Specific disclosure requirements for non-accredited investors in 505 or 506 offering per 502(b)(2)
g. If reporting company, then must provide most recent filings and update material info (plus a
brief description of securities offered) (2)(ii)
h. If non-reporting company, then provide material from Reg A & some audited financials (2)(i)
i. Non-accredited investors must receive notice of additional info given to accredited investors,
and if they provide written request must comply in reasonable time (iv)
j. Must give each purchaser opportunity to ask questions and receive answers (v)
---------SECONDARY MARKET TRANSACTIONS EXEMPTED FROM SECTION 5-----------If you buy restricted securities (= those issued without a registration statement under an exemption/safe
harbor) then can only resell them without a registration statement if you have your own exemption
I.
§4(1) Trading Exemption for Persons not Issuers, Underwriters, or Dealers
a. The definition of issuers and dealers are self-explanatory
b. But underwriter is defined in §2(a)(11) to be one who:
i. Purchases from an issuer w/ a view to the distribution (= public offering) of securities or
1. Investor can argue changed circumstances, but they must be about him and not
the company (Gilligan = saying you only bought with a view to hold if the company is
profitable is equivalent to purchasing it with a view to distribute, so you’re an underwriter)
ii. Direct/indirect participation in or underwriting of a distribution of securities (Chinese
Consolidated = continuously soliciting Chinese, making a market, and arousing interest in bonds from
China makes you an underwriter even though no contractual agreement with Chinese government)
II.
Control person liability
a. = either one who directs or how the power to direct the management/policies of the issuer
(through stock ownership, position, contract or otherwise) OR has the power to obtain the
signatures of those required to sign a registration statement
i. Either way, this makes the SEC view the transaction with the same suspicions as an
issuer transaction b/c likelihood of exploiting informational advantage is higher
b. RULE: if someone acts for a control person or purchases form a control person with a view to
distribute, they’re an underwriter under §2(a)(11) so the control person can’t use §4(1)
c. Avoid this with the §4(1 ½) exemption (useful before Rule 144)
i. = if control person sells to an investor able to “fend for himself” then no “distribution” so
not an underwriter under §2(a)(11) so §4(1) is available
ii. Based on §4(1) and definition of underwriter, and informed by §4(2)’s distinction
between public and private offerings
III.
Rule 144 safe harbor from classification as an underwriter
a. = allows sale of restricted securities into public markets w/out becoming an underwriter, and
allows participation in sale by affiliates (aka control persons) who otherwise pretty much can’t
sell w/out registration (but are in the position to require registration so we don’t feel bad)
i. Non-affiliates can always freely sell unrestricted securities
b. Definitions
i. Affiliate = person that directly/indirectly controls or is controlled by/under common
control with the issuer (counts if you were in the past 3 months)
ii. Restricted security = acquired directly/indirectly from issuer or affiliate in transaction
not involving public offering or in a Rule 505 or 506 offering (so no reg. statement)
c. Must meet:
i. Holding period for restricted securities 144(d) (see below)
1. Makes sense b/c longer you hold less info asymmetry
ii. Public info requirement 144(c)
1. For reporting issuers = public info current for 12 months
2. For non-reporting issuers = info from Rule 15c2-11 (facts + balance sheet)
iii. IF AFFILIATE RESALE, then must file Form 144 with SEC and meet:
1. Limitation on amount of securities sold over 3 months 144(2)
a. = greatest of 1% outstanding shares of the class or average weekly trading
volume of same class during 4 weeks before filing notice of sale with SEC
b. Policy: don’t want a lot of shares entering at once to disrupt market
2. Limitation on manner of sale 144(f), so only these are ok:
a. Unsolicited broker transaction §4(4)
b. Directly with a market maker §3(a)(38) or
c. Riskless principal transaction (= buy and sell at the same time)
≥ 1 year
No restrictions
No resales
6 months – 1 year
Resales ok if public info is current
for 12 months
No resales


Resales ok if they meet other 3
requirements above
← Same


Resales ok if they
meet other 3
requirements above
< 6 months
Non-affiliate and reporting
issuer (≥ 90 days)
Non-affiliate and nonreporting issuer
Affiliate and reporting
issuer
No resales
Affiliate and nonreporting issuer


No resales of restricted
Resales of unrestricted ok if they
meet other 3 requirements above
No resales of restricted
Resales of unrestricted ok if they
meet other 3 requirements above
No resales of restricted
Resales of unrestricted ok if they
meet other 3 requirements above
No restrictions
----------------------------------------------------------APPENDIX-----------------------------------------------------------
I.
Private Equity (PE)
II.
a. = big pools of capital assembled to buy up companies (includes VCs)
b. Based on model of corporate control
i. Plan = buy a target, fix it, go public or resell it in bits, pay back debt, and get profit!
c. Structure
ii. LP, with GP being LLC composed of PE managers
1. This way individuals don’t face any liability
2. GP usually earns 2% management fee on capital committed from institutional
investors if it finds a worth target and does a capital call
iii. LP has many different funds for each target
Securitization (= the process, derivatives = the contract specifying payment)
a. = the pooling of non-liquid assets, sold to SPV, & the sale of interest in the returns from this pool
b. Pros/Cons
 While future payments on 1 loan are unpredictable, return from a lot is easier to quantify
 Makes previously non-liquid assets liquid and allows for diversification
 Shifts risk of collecting on receivables to special purpose vehicle (off balance sheet)
1. Receivables = legal claim to cash flow (interest) from borrower
 If risks affect a class as a whole, there’s systematic risk
1. Dodd-Frank seeks to fix this by:
a. Making securitizers retain 5% of the interest created (so skin in the game) and
b. Having SEC rulemaking to prohibit underwriters of asset-backed securities from
engaging in transactions that result in a material conflict of interest with any investor
for the next year
c. Mortgage backed securities (MBS) = way to pool credit and sell pieces in the mortgage market
i. Ordinarily made when banks make loans to homebuyers and bank issues security based on
that underlying asset pool for institutional investors to buy so bank can collect now
ii. Types:
1. Real (collateralized debt obligations or CDOs)
a. Typically diversified so you’ll have $X in a portfolio of bonds and loans, then
liabilities of varying risk degrees (ex. AAA super senior tranche and BB
mezzanine tranche)
2. Synthetic (credit default swaps or CDSs)
a. Elements:
i. Credit = bond or loan as the reference instrument
ii. Potential default event
iii. Swap = counter-party willing to assume the risk of default
b. So like neighbors taking out insurance on your house in pieces, then they get
paid off if your house is destroyed (pyramid effect)