Survey of Securities Regulation

Professor Slain
Spring 2000
ASSIGNMENT NO. 1 - OVERVIEW
Historically, business failed bec of inability to find capital
State Blue Sky laws very simple licensing statutes now every state !as"# issuer of securities
planning to sell securities in t!at state !ad to obtain license from state official
Sec Act of 1933
P!ilosop!y of t!e statute# pure disclosure concept$ %!e admin agency !as no aut!ority to
re&ect proposal t!at security be registered be it disapproved$ The only reqnt: tht I f!lly"
cc!rtely" #eq!tely #e$cr%&e 'ht the #el %$" %ncl!#%n( #r'&c)$ *e+en %f %lle(l
#el , cn re(%$ter $ec!r%t%e$" only cc!rtely #%$clo$e- n# cn $ell to .eo.le.
%!e 'ct gives an effective remedy to people w!o boug!t securities in initial public offering
under Blue Sky laws private rig!t of action only if boug!t Blue Sky security in t!at state(
but not if no disclosure"
%ypically in )*+2, we boug!t t!e security !ow will it be marketed
,ssuer manufacturer"# sold security to might be disclosure docnt; no privity
-nderwriter.investment banker w!ole seller"# sold security to might be disclosure
docnt; no privity
/ealers.retail securities dealers retailer" privity, but no negligence
, buy security from t!e dealer( t!ings don0t work out( , look at disclosure doc0nt
inaccurate or misleading
-nder Blue Sky law no remedy
2 possibilities# 1 and tort
,f 1# , !ave to say t!at smb warranted t!e 2uality of info, but won0t find warranty so,
no 13tual remedy
,f tort#
Tort of #ece%t or /%$re.re$entt%on elements
)$ 4isrepresentation
2$ 4ateriality
+$ Reliance
5$ Scienter knowingly" conscious purpose to defraud
6$ Pro7imate causation !as to be a loss w!ic! is attributable to misrep0n
8!o !as t!e burden of proof9 P on eac! issue and element of t!is cause of action
,n t!is case, P can0t prove scienter very !ard to prove# t!ere isn0t any scienter# people issuer
and underwriter" simply got t!is wrong t!ey didn0t do it to me deliberately so, tort of deceit
will fail
So, fraud remedy provides little incentive for actors to disclose all material info$
Tort of ne(l%(ent /%$re.re$entt%on t!ere is a cause of action, but still not a good lawsuit
-ltramares case#
:actor commercial lender makes loans on securities inventories, accounts receivable"(
!ig! risk loans c!arge !ig! interest$
Here, borrower was looking for a factor( factor wanted audited financial st0nt( auditors
delivered copies to borrower for borrower to deliver to lenders( -ltramares.lender got it
2 problems# accounts receivable greatly overstated and accounts payable greatly understated(
borrower went broke
Palsgraf # anybody w!o0s w.n t!e ;one of risk created by neg conduct !as a cause of action$
-ltramares people say# t!is covers our sit0n auditors are liable to us, we0re w.n t!e ;one of
risk created by neg audit$
<t of 'pp <ardo;o"# no, no liability for indeterminate period, amount, indeterminate class$
Act%on for ne( /%$re.n req!%re# .r%+%ty: #%rect #el%n( &et 0 n# ne( /%$re.re$entor.
Here, auditors never dealt w.-ltramares no neg misrep0n$
,n our case#
,f try neg misrep0n sue t!e dealer w.w!om we dealt$ /ealer !as a defense no negligence$
He !as no more info t!an issuer( no way in w!ic! !e failed to perform$
,ssuer and underwriter must !ave misrepresented smt!, but problem no privity# we never
dealt w.issuer or underwriter$
So, under -ltramares we !ave no cause of action for neg misrep0n$ ,n )*+2 no remedy$
/ownsides# )" in&ury to ind0l investor and 2" systemic problem# does !arm to people0s
willingness to buy securities if t!ey !ave no remedy w!en t!ey are deceived$
1933 Act very narrowly drafted statute# deals wit! single topic
t!e issuer or persons controlling t!e issuer marketing securities to t!e public !as to go
t!roug! administrative process registration
in t!e end of t!e day product of registration disclosure doc0nt called prospectus
re2uired to be used in connection wit! sale of securities
w!en security is sold, prospectus !as to be delivered wit! it every buyer s!ould !ave it"
1 re/e#%e$
)$ Sec 11 provides a remedy w!en smb !as boug!t a security, and t!ere is info defect in
disclosure doc0nt damage remedy against series of /s ot!er t!an t!e dealer
2$ Sec 11*1- rig!t of rescission ag t!e party w!ic! investor is in privity wit! t!e
dealer" you can put a security back
Sec 12 of 33 Act virtually all lawsuits are federal# fed courts !ave e7clusive &0n over cases
arising under +5 'ct
Sec 11 of 33 Act state and fed courts !ave concurrent &0n ma&ority of cases is broug!t in fed
courts"
Sec 11 of 33 Act
'llows for private rig!t of action without privity$
8!o !as t!e burden of proof# P0s knowledge t!at info is bad is an affirmative defense( / !as
burden of proof burden of non3persuasion on t!at issue
8!o may be sued9 Sec 11*-*1-$
,n case any part of t!e registration st0nt, 'hen $!ch .rt &ec/e effect%+e, contained an
!nt!re $tnt of /ter%l fct or o/%tte# to $tte /ter%l fct re2uired to be stated t!erein
or necessary to make t!e st0nts t!erein not misleading, ny .er$on cq!%r%n( $!ch $ec!r%ty
unless it is proved t!at at t!e time of suc! ac2uisition !e knew of suc! untrut! or omission" /y
$!e
)" every person w!o signed registration st0nt( look at Sec 4*- w!o s!ould sign registration
st0nt issuer, its principal e7ecutive officers, its principal financial officer, its comptroller or
principal accounting officer, and t!e ma&ority of its board of directors or persons performing
similar functions"
2
2" every person w!o was a director or partner in, t!e issuer at t!e time of t!e filing of t!e part of
t!e registration st0nt w.r.t w!ic! !is liability is asserted
+" every person w!o, w.!is consent, is named in t!e registration st0nt as being or about to
become a director or partner
5" every accountant, engineer, or appraiser, w!o !as w.!is consent been named as !aving
prepared or certified any part of t!e registration st0nt, or report or valuation iin connection
w.t!e registration st0nt# liable only over t!e e7pertised portion
6" every underwriter w.r.t suc! security
5%&%l%ty ttche$ 'hen ny *rele+nt- .rt of re(%$trt%on $tnt &ec/e effect%+e
Sec 4*- reg st0nt is to be signed by t!e issuer = its principal officers = ma&ority of t!e board
of directors$ >nly issuer can register sec0s$
/irector t!at doesn0t sign reg st0nt is not better off t!an director w!o signed reg st0nt# under
Sec 11*-*1- every signer is liable( under Sec 11*-*1- every director is liable$
8!at all t!ese people !ave in common9 no privity bet t!em and buyer$ Sec )) !as
breac!ed t!e wall of privity$
06&!yer /!$t .ro+e:
he &o!(ht $ec!r%ty '6n l%/%tt%on$ .er%o#" 'h%ch '$ re(%$tere#
there '$ /ter%lly &# %nfo %n re( $tnt. 4ateriality is #eter/%ne# $ of
effect%+e #te of misleading part of registration st0nt.prospectus under Sec ))a" t!at
at t!e time w!en registration st0nt bec effective info was material"$
/s, one by one, now !ave burden to prove t!at t!ey were not negligent$
067!yer #oe$ not h+e to .ro+e:
privity
reliance ?7ception# Sec 11*&- 3 if buyer boug!t security later t!an ) year after
registration became effective buyer !as to prove reliance( ot!erwise not"
loss causation# P lost money 3 presumed
but loss causation is an affirmative defense# / may use Sec ))e" to reduce P0s @
recovery by s!owing t!at loss was caused by factors ot!er t!an reg st0nt
Only the %$$!er cn re(%$ter $ec!r%t%e$ e7ception securities of foreign gov0nt can be
registered by t!e underwriter"
'ffirmative.due diligence defenses are not available to issuer
,ssuer0s liability strict liability liability of insurer"# doesn0t matter !ow info got to be bad,
by neg or not issuer is liable for any matierial misrepresentations and omissions
Aff%r/t%+e6#!e #%l%(ence #efen$e$
11*&-*1- and 11*&-*1- disclaimers of responsibility , !ave not!ing to do w.t!is"
11*&-*3-*A- due diligence defense( it0s a negligence standard( burden is on /, rat!er t!an P, to
prove non3negligence different from common3law negligence"
Sec 11*&- provides
Ano person, ot!er t!an t!e issuer, s!all be liable w!o s!all sustain t!e burden of proof
*3- t!at *A- as regards any part of t!e registration st0nt not purporting to be made on t!e aut!ority
of an e7pert !e !ad, after reasonable investigation, reasonable ground to believe and did believe,
at t!e time suc! part of t!e registration st0nt became effective, t!at t!e st0nts t!erein were true and
t!at t!ere was no omission to state a material fact re2uired to be state t!erein or necessary to
make t!e st0nts t!erin not misleading(
So, for non3e7pertised portions, non3issues !ave affirmative defense of non3negligence#
Reasonable investigation
+
Reasonable belief in trut! of disclosure
*7- as regards any part of t!e registration st0nt purporting to be made upon !is aut!ority as an
e7pertB i" !e !ad, after reasonable investigation, reasonable ground to believe and did believe,
at t!e time suc! part of t!e registration st0tn became effective, t!at t!e st0nts t!erein were true and
t!at t!ere was no omission to state a material fact re2uired to be stated t!erein or necessary to
make t!e st0nt t!erein not misleading
?7perts !ave affirmative defenses of#
Con3negligence reas investigation = reas belief in trut!"
4isstatement of e7pert0s original version
*8- as regards any part of t!e registration st0nt purporting to be made on t!e aut!ority of an
e7pert ot!er t!an !imself" !e !ad no reasonable ground to believe and did not believe, at t!e time
suc! part of t!e registration st0nt became effective, t!at t!e st0nts t!erein were untrue or t!at t!ere
was an omission to state a material fact re2uired to be state t!erein or necessary to make t!e st0nts
t!erein not misleading$
Con3e7perts sued on e7pertised portions or reporoductions of public official documents,
!ave affirmative defenses of proving#
Co reas ground to believe poriton was materially misleading
Co reas ground to believe portion was not correct statement of e7pert0s original
opinion or public document
Sec 11*c- defines reasonable investigation and reasonable ground for belief
t!e standard of reasonableness s!all be t!at re2uired of a prudent man in t!e management
of !is own property
it0s a very !ig! standard
Sec 11*#- ,f any person becomes an underwriter w.r.t security after part of t!e registration st0nt
w.r.t w!ic! !is liability is asserted !as become effective, t!en for t!e purposes of ))b"+" suc!
part of registration st0nt s!all be considered as !aving become effective w.r.t suc! person as of
t!e time w!en !e became an underwriter e$g$ public offerings of utilities securities bidding by
underwriters bet t!ey become underwriters after reg st0nt bec effective"
Sec 11*e-
Hypo# ,P>P initial public offering price" @26( , boug!t at @50
Dalue at t!e time , sued is @2
How muc! are my damages9 3 @2+
Adamages as s!all represent t!e difference bet t!e amount paid for t!e security not
e7ceeding t!e price at w!ic! t!e security was offered to t!e public" and *1- t!e value t!ereof as of
t!e time suc! suit was broug!t"
@26 @2 E @2+
!ere @50, but not greater t!an @26"
Pretty narrow damage remedy( discontinuity
Hypo# P continues to !old t!e security( time of suit value of security is @2( time lawsuit is over
value is @0 ;ero"
How muc! are my damages9 same @2+
*e-*1- t!e price at w!ic! suc! security s!all !ave been disposed of in t!e market before
suit
Hypo# value of security at t!e time of &udgment is @)F
5
How muc! is my recovery9 same @2+
*e-*3- t!e price at w!ic! suc! security s!all !ave been disposed of after suit but before
&udgment if suc! damages s!all be less t!an t!e damages representing t!e difference bet t!e
amount paid for t!e security not e7ceeding t!e price at w!ic! t!e security was offered to t!e
public" and t!e value t!ereof as of t!e time suc! suit was broug!t
, still own t!is security at t!e time of &udgment$ ,s t!ere reduction in damages9 Co$
/amages are fi7ed at t!e time of suit$ ,f , continue to !old t!e security price at t!e time of suit"
my damages are not reduced unless , sell security prior to &0nt for @)F damages are now
reduced to @G @263@)F" price at t!e time of &udgment
AProvided, that if t!e / proves t!at any portion or all of suc! damages represents ot!er
t!an t!e depreciation in value of suc! security resulting from suc! part of t!e reg st0nt, w.r.t
w!ic! liability is asserted, not being true or omitting to state a material fact re2uired to be stated
to make t!e st0nts t!erein not misleading, suc! portion of or all suc! damages s!all not be
recoverableH
concept of loss causation
,n common law P !as burden of proof of loss causation
Here absence of loss causation is an affirmative defense
'merican rule on e7penses of litigation# eac! party pays !is own costs
Sec 11*e- court may re2uire t!e payment of all costs, including reasonable attorney0s fees, from
t!e loser potential for reversing t!e 'merican rule
'nalogy in corp law# CI if you want to maintain a derivative suit, you need to post a security
Sec 11*f-*1- 9o%nt n# $e+erl l%&%l%ty of :$ P can sue any / can c!oose <, but not ' or B",
and can enforce &0nt ag any /"
&!t Sec 11*e- l%&%l%ty of !n#er'r%ter$ %$ $e+erl because t!e cap on t!eir liability is public
offering price of securities t!ey !ave sold"
&!t
Sec 11*f-*1- reference to Sec 11:*f-*3- of 33 Act .ro.ort%onl l%&%l%ty of o!t$%#e #%rector$
comparative fault standard"
Sec 11*f-*1-*7- <ommission is aut!ori;ed to define outside director but never done"
-su court makes its own &0nt as to w!o is outside director
,n sum
,t0s a negligence statute
4isrepresentation concept is broader t!an common3law negligent misrepresentation
4ateriality re2uirement of t!e cause of action
's to issuer not negligence3based action, but insurer# absolute duty to make info rig!t
doesn0t matter if neg liability is t!e same"
>t!er /s negligence action, e7cept t!at non3negligence is an affirmative defense( /s, one
by one, !ave burden of proof on t!at issue
Reliance not part of P0s claim
<ongress breac!ed t!e law of privity, but tradeoffs#
)$ narrow damage remedy
2$ possibility of being stuck w.all costs of lawsuit if P0s claim is frivolous same for /"
+$ very s!ort st of lim Sec 13 action s!ould be broug!t w.n ) year of discovery of t!e
untrue st0nt or t!e omission t!roug! due diligence"
%!e statute is overinclusive
6
Sec 11*-*1-
Hypo# , boug!t security from t!e dealer , can0t sue dealer under Sec )) !e is not a director,
e7pert, or underwriter"$ , can sue !im under Sec )2a"$ 8!at0s t!e nature of remedy ag t!e
dealer9 rescission remedy$ /ealer0s defense# t!at !e did not know and in t!e e7ercise of
reas care could not !ave known$
?stablis!es liability for persons in privity w.P# broker3dealers, w!o offer or sell security by
use of &0nal means and by means of prospectus or oral communication
'ffirmative defense of non3negligence# didn0t know and in e7ercise of reas care could not
!ave known no reas investigation re2uirement"
Remedy is rescission( if P no longer owns t!e security 3 damages
?scott v$ Bar <!ris Sect%on 11 of 33 Act
S/CI )*JF"
%!e core Sec )) case( provides a norm for w!at constitutes due diligence
'ction by purc!asers of 6$).2K convertible subordinated fifteen year debentures of Bar<!ris
under Sec )) of ++ 'ct# t!at registration statement w.r.t t!ese debentures filed wit! t!e S?<,
w!ic! became effective on 4ay )J, )*J), contained material false st0nts and material
omissions$ Registration st0nt contained a prospectus Ps c!allenge t!e accuracy of figures
contained in t!e prospectus and also c!arge t!at t!e te7t of t!e prospectus, apart from t!e
figures, was false and t!at material info was omitted$
+ category of /s#
)$ t!e persons w!o signed t!e registration st0nt
2$ t!e underwriters F investment banking firms"
+$ Bar<!ris auditors Peat, 4arwick"
/s deny t!at t!e registration st0nt was false and plead defenses under Sec )) plus add0l
defenses, including st of lim"
4ain issue of liability#
)$ did t!e registration st0nt contain false st0nts of fact, or did it omit to state facts w!ic!
s!ould !ave been stated in order to prevent it from being misleading
2$ if so, were t!e facts w!ic! were falsely stated or omitted AmaterialH w.n t!e meaning
of t!e 'ct
+$ if so, !ave /s establis!ed t!eir affirmative defenses
Mter%l%ty
4aterial info info re2uired to t!ose matters as to w!ic! an average prudent investor oug!t
reasonably to be informed before purc!asing t!e security registered, i$e$ matters w!ic! suc!
an investor needs to know before !e can make an intelligent, informed decision w!et!er or
not to buy a security$
4aterial fact a fact w!ic! if it !ad been correctly stated or disclosed would !ave deterred or
tended to deter t!e average prudent investor from purc!asing t!e securities in 2uestion$ %!e
average prudent investor is not concerned w.minor inaccuracies or w.errors as to matters
w!ic! are of no interest to !im$ %!e facts w!ic! tend to deter !im from purc!asing a security
are facts w!ic! !ave an important bearing upon t!e nature or condition of t!e issuing corp or
its business$
%!e test# would it !ave deterred t!e average prudent investor from purc!asing t!ese
debentures if !e !ad been informed t!atB ,t0s a 20n of &0nt, to be e7ercised by t!e trier of t!e
fact as best !e can in t!e lig!t of all t!e cir0ces$
J
Here, many of t!e misstatements and omissions in t!is prospectus were material# all of t!em
w!ic! relate to t!e state of affairs in )*J) and many misstatements and omissions pertaining
to Bar<!ris0s status as of /ecember +), )*J0$
Aff%r/t%+e #efen$e$6:!e :%l%(ence :efen$e$
available to every /, e7cept Bar<!ris itself t!e issuer" Sec ))b"+"'", B", <"
?ac! /, e7cept Peat, 4arwick, claims t!at )" as to t!e part of t!e registration st0nt
purporting to be made on t!e aut!ority of an e7pert, !e !ad no reas ground to believe and did
not believe t!at t!ere were a!ny untrue st0nts or material omissions, and 2" as to t!e ot!er
parts of t!e registration st0nt, !e made a reas investigation, as a result of w!ic! !e !ad reas
ground to believe and did believe t!at t!e registration st0nt was true and t!at no material fact
was omitted
L0n as to eac! /# w!et!er !e !as sustained t!e burden of proving t!ese defenses
8!o is t!e e7pert !ere# only t!ose portions of t!e registration st0nt purporting to be made on
Peat, 4arwick0s aut!ority were e7pertised portions$ Ceit!er t!e lawyer for t!e co nor t!e
lawyer for t!e underwriters is an e7pert w.n t!e meaning of Sec ))$ %!e only e7pert was
Peat, 4arwick narrow view"
8!at are e7pertised portions# only t!e audited )*J0 figures narrow view"
%!e liability of a director w!o signs a registration st0nt does not depend upon w!et!er or not
!e read it or, if !e did, w!et!er or not !e understood w!at !e was reading
<?>, President, DP, treasurer.<:>, controller !ave not proved t!eir due diligence defenses
Mawyer Birnbaum"# signed later am0nts of registration st0nt, t!ereby becoming responsible
for t!e accuracy of t!e prospectus in its final form( entitled to rely on auditors for )*J0
figures, but not entitled to rely on treasurer.<:> and 2 ot!er lawyers for t!e ot!er portions of
t!e prospectus( !e was re2uired to make a reas investigaiton of t!e trut! of all t!e st0tns in t!e
une7pertised portion of t!e doc0nt t!at !e signed$ Having failed to make a reas investigation,
!e did not !ave reas ground to believe t!at all t!ese st0nts were true !as not establis!ed due
diligence defenses e7cept as to audited )*J0 figures$
Cew outside directors no due diligence defenses e7cept as to audited )*J0 figures$ Sec 11
%/.o$e$ l%&%l%ty %n the f%r$t %n$tnce !.on #%rector" no /tter ho' ne' he %$.
Mawyer.director t!at drafter reg st0nt no due diligence defenses e7cept as to audited )*J0
figures$ %o re2uire an audit would be unreasonable, but to re2uire a c!eck of matters easily
verifiable is not unreasonable$ ?ven !onest clients can make mistakes$ The $tt!te %/.o$e$
l%&%l%ty for !ntr!e $tnt$ re(r#le$$ of 'hether they re %ntent%onlly !ntr!e. %!e way
to prevent mistakes is to test oral info by e7amining t!e original written record$
%!e underwriters are &ust as responsible as t!e co if t!e prospectus is false$ 'nd prospective
investors rely upon t!e reputation of t!e underwriters in deciding w!et!er to purc!ase t!e
securities$
%!e positions of t!e underwriter and t!e co0s officers are adverse# st0nts made by co officers
to an underwriter to induce !im to underwrite may be self3serving unduly ent!usiastic,
deliberately false$
%!e purpose of Sec )) is to protect investors$ -nderwriters must make some reas attempt to
verify t!e data submitted to t!em( t!ey may not rely solely on t!e co0s officers or on t!e co0s
counsel$ Here, underwriter0s counsel did not make a reas investigation of trut! of
une7pertised portions( underwriter is bound by t!eir failure counsel is agent of underwriter",
and so t!e ot!er underwriters w!o relied on first underwriter, are also bound by it so liable
e7cept as to audited )*J0 figures"
'uditors Peat, 4arwick" e7pert Sec ))b"+"B""$ Part of registration st0nt made upon
t!eir aut!ority )*J0 figures( but t!e statute re2uires t!e court to determine t!eir belief and
G
t!e grounds t!ereof at t!e time suc! part of t!e registration st0nt became effective( so matter
must be viewed as of 4ay )J, )*J)
'ccountants s!ould not be !eld to a standard !ig!er t!an t!at recogni;ed in t!eir profession$
N''P re2uired furt!er investigation t!an t!at conducted !ere$ ,t is not always sufficient
merely to ask 20ns$ Here accountant was too easily satisfied w.glib answers to !is in2uiries$
%!e burden of proof is on Peat, 4arwick( it !as not been satisfied !as not establis!ed its
due diligence defense$
8!at went wrong wit! t!e business9 bowling alleys industry got overbuilt$
Bar<!ris is in construction business$ ,s construction business mobile9 no, e7tremely local
business$
Neograp!ical dispersion early alleys CI<( ot!er alleys fat!er and fat!er away"$
,s t!ere any claim t!at discussion of macroeconomic elements of business was inaccurate9
Co, bec no info in t!e prospectus relating to suc! matters at t!at time, t!ese people would
not !ave been permitted to tell t!is info"$
Business met!od )# <ustomer wants a bowling alley( gives small downpayment to B<( t!en
B< constructs t!e alley( t!en customer pays in installment notes$ B< discounts.sells notes to
t!e factor %alcott"$ :actor doesn0t pay B< t!e full amount only a fraction# t!e difference
being t!e interest rate t!at t!e factor c!arges for lending money$ %!e factor gets paid from
customers collects t!e notes$ ,f customer didn0t pay t!e note, B< !as to repurc!ase t!e
notes full recourse financing$
8!o is being financed !ere9 B<$ %alcott is financing t!e purc!ase of alley by t!e
customer$ >n w!ose credit is %alcott relying on making t!e loans9 on B<$ 'll financing
goes forward almost on B<0s credit$ So, customers don0t !ave a lot of money$
<!eaper way to borrow money t!e bank, but t!ey are being financed by a factor, bec t!ey
!ave no alternatives to t!at loans !ere e7pensive( cover almost entire purc!ase price"$
So, customers are totally dependent on t!e success of t!e business to be able to pay %alcott(
and if it doesn0t work out, B< will end up w.t!e alleys$
B< not in t!e situation of ordinary builder$ B< is never out of t!e picture unless and until
%alcott is paid off$ So, 78 %$ e;tre/ely +!lner&le to ny #o'nt!rn %n the $!cce$$ of
&o'l%n( lley$ %t h$ &!%lt. Cotes were supposed to be paid off out of operation of t!e
alleys$ ,f alleys fail as business, B< will get t!em back$
're accounts receivable a serious matter in operation of t!e business9 Ies$ 'ccounts
receivable accounts reflecting a balance owed by a debtor$
/istinguis! bet inside and outside /s# inside /s knew w!at was going on s!ortage of cas!$
%!ey t!oug!t t!ey !ad a good business, &ust a little s!ortage of cas! t!ey are trying to mask
problems$
>utside /s# Nrant.lawyer( <oleman.underwriter partner in /re7el lead underwriter"(
Ballard.atty lead underwriter cousel$
Sec ))6" imposes a due diligence obligation on underwriters
>t!er underwriters0 due diligence obligation is in!erently derivative t!ey are relying on t!e
lead underwriter /re7el$ %!en, due diligence was usu done by lead underwriter0s counsel$
So, t!ere is not ot!er way ot!er underwriters could !ave done due diligence t!eir
obligations !ave to be met under t!e statute$
>utside /s didn0t know about problems# inside /s were leading t!em$ 8!at misled outside
/s# t!ey t!oug!t t!ey knew t!ese people$ Nrant.outside counsel !ad done a registration st0nt
for inside people t!e same year$
F
' warrant an option to buy a security a certificate giving t!e !older t!e rig!t to purc!ase
add0l securities at a stipulated.bargain price w.n a specified time limit( sometimes a warrant is
offered w.securities as an inducement to buy"$ ' warrant itself is a security# !as to be
registered if offered publicly( it0s also an offer to sell underlying common stock$ ' warrant
an offer to buy( !ere not immediately e7ercisable$ Sec 2+" definition of offer to sell"$
Nrant was doing t!e new registration on t!e warrant !e !ad every reason to believe t!at !e
knew t!ese people$
,nside directors were trut!ful# t!ey believed t!at if t!ey lie a little to get money it0s ok$
Oudge assigned tremendous importance to officers0 loans t!e co was e7tremely tig!t for
cas!$ ,s it t!e central problem of t!e business9
8entrl .ro&le/: tht c!$to/er$ #%#nt .y 78
)$ t!e co0s li2uidity position was muc! worse t!an t!ey were telling
2$ t!eir customers weren0t doing well so, B< !ad to repurc!ase alleys to pay off
%alcott = decline in new business
,f purc!asers of securities knew t!at, t!ey would !ave never boug!t t!e securities$ Cone of
t!e outside /s !ad an7iety about t!is pos0ty t!ey trusted inside /s$
>rdinarily, you can do smt! to verify t!e accounts receivable routing audit steps were not
done !ere w!y not9 because accounts receivable appeared on %alcott0s books t!is
deceived everybody"$
Relations bet B< and %alcott# %alcott is better off if B< raises several million @( %alcott was
working w.B< to mask t!e facts$ :rom moral point of view, et!ically, does %alcott !ave any
responsibility to deceived investors9 8!y isn0t %alcott a / !ere9 bec0s it0s not covered by
Sec ))$ Sec 11*- l%$t$ ll .o$$%&le :$< Tlcott %$ not one of the/. There %$ no $!ch
conce.t %n Sec 11 $ %#er n# &etter l%&%l%ty , the only .eo.le 'ho cn &e $!e# !n#er
Sec 11 re tho$e /ent%one# %n Sec 11.
'lternative met!od of financing # a sale and leaseback agreement$ B< sells t!e interior to
%alcott not to customer"( %alcott leases it to customer$
2 kinds of leases
)$ operating leases tenants.landlord"
2$ financing lease, w!ere t!e lessee is functionally t!e owner of property, and makes
lease payments for t!e alley$ Better for %alcott because
)" you may be able to present your fin sit0n more favorably
2" t!ere may be a better position in being a lessor t!an a mortgagee
-nder t!is arrangement, B<0s e7posure is 26 K$
8e started B< !ad )00K e7posure$ ,n )*J0 reduced by 1 to 60K$ ,n t!e end of )*J0
switc!ed to alternative met!od of financing 26K 3 alternative '$
'lternative B# %alcott leases alley to B<( B< leases it to customer$ %!us, B< directly owes
to %alcott, rat!er t!an customer owes to %alcott t!is was seriously misdescribed in t!e
prospectus$ %!e B deal was never described in t!e prospectus$
Oudge !olds t!at t!is misdescription is not material$ 8!at would Slain t!ink about prospectus
w.o description of B deal# big problem potentially w.accounts receivable( %alcott !ad doubts
about t!at in t!e beginning, t!en grew confident( so, %alcott probably t!oug!t t!ere wasn0t
muc! problem w.accounts receivable so w!y s!ould , worry about t!at$ , would !ave been
misled$ So, t!ese facts were e7tremely material Oudge is wrong$
%!e )*J0 financials overstate t!e sales and net income figure by appro7imately GK( t!us,
earnings per s!are figure is overstated by )5K$ Oudge says it0s not material )5K of t!at
income but t!is is big error$ Slain# it0s material &udge is wrong.
=> r!le of th!/&: %f /ore thn => error , !$!. /ter%l.
*
8!at0s Peat, 4arwick0s responsibility for bad fin st0nt in )*J) &ust + mont!s"$ -nder Sec
))a"5", t!ey don0t !ave any$ ,f )*J0 figures not material error, t!en t!ey don0t !ave any
liability$
8!at &udge found material )*J0 b.s!eet figures is not material$ Ratio of )$J to ) current
assets and current liabilities" is unusually good for a construction co$
O!t$%#e #%rector$ 'uslander and Rose" liable bot! as signers and directors doesn0t matter
under w!ic! category"$ ?n#er Sec 11*&-*3-" the%r +%l&le #efen$e , no reqnt of re$
%n+e$t%(t%on" only re$ (ro!n# to &el%e+e $ to e;.ert%$e# .ort%on< reqnt of re$
%n+e$t%(t%on $ to non-e;.ert%$e# .ort%on. Reg st0nt prospectus w.cover s!eet( signature
page separately printed no necessity t!at t!ese people saw prospectus( one of t!ese people
didn0t know w!at !e signed$ <ourt it0s not reas investigation$
8!at would !ave been reas investigation for outside directors9 court doesn0t say$ Peat,
4arwick !ad more c!ance to find out and didn0t no reas c!ance t!at t!ese 2 directors could
do it$ Slain doesn0t know w!at kind of reas investigation t!ey could do to get alerted t!at
smt! was wrong$ %!ey did e7actly w!at Slain would !ave done find people w!o knew
about t!e co, like Peat, 4arwick$ 'fter t!is case t!is is not enoug! won0t work$ <ourt#
t!ey !ave to make some specific in2uires about registration, but t!eir c!ances of making reas
investigation are very slim$
Some say# !ire independent counsel for outside /s to do t!eir own due diligence, but )" cost
factor and 2" too many people
Cow# due diligence mtg of t!e Board a mtg at w!ic! directors w!o !ad prospectus for some
time read it" 2uestion mgmt, auditors and issuer0s lawyers about t!e prospectus for outside
directors t!is constitutes due diligence$
Standard of liability for outside directors !as c!anged since )**6 added Sec ))f"2", w!ic!
refers you to Sec 11:*f-*3- provides for .ro.ort%onl l%&%l%ty liability among /s acc to
t!eir own fault
Nood advice to 'uslander and Rose# don0t become directors &ust before registration $
/escription of business in t!e prospectus is not rig!t# only described as construction business,
but s!ould also be operating bowling alleys$ >t!er t!ings /s are masking generally relating
to cas! position to make it muc! better t!an it appeared$ 8!y mask it9 it0s ok for co w.
!uge rate of growt! stupid lie w!y compromise your integrity by lying about t!is
>fficers0 loans# some were repaid described in prospectus, but immediately after b.s!eet
date, new and larger loans were made$ Nrant actually asked insiders about t!e loans$ Slain
would do t!e same take t!eir word for it, w!en mgmt and accountants say t!at loans were
repaid$
<as! t!ey borrow appro7imately @)5G,000 before b.s!eet date it0s not a s!ocking t!ing$
,n an audit, t!e auditor doesn0t take every number and trace it back to underlying transaction(
auditor does a test c!eck bec of money.cost and time"$ 8e s!ouldn0t t!ink t!at Peat,
4arwick s!ould !ave discovered everyt!ing t!at was wrong$
Berardi didn0t discover t!at <apitol Manes !as not been sold, but it looked like it was sold
toug! error$
Wht 'o!l# h+e h..ene# %f they #%$co+ere# c$h $%tn@ , they# h+e #e$cr%&e# %t
/ore cc!rtely A they# &e le# to #%$co+er tht they# &een l%e# to *once #ont tr!$t
%n$%#er$ , e+ery $.ect 'o!l# h+e &een %n#e.en#ently re+%e'e# n# #%$clo$e# to other
.eo.le-
)0
S3) review Peat, 4arwick undertook"# auditors s!ould give a comfort letter( &ust c!eck if
anyt!ing c!anged in strange or remarkable ways( if not not!ing to talk about$ Slain doesn0t
see any fault in t!at not!ing !as c!anged$
'ccuracy of numbers very important$
Backlog unfilled orders on co0s books" court says t!at nobody knows !ow t!e number for
backlog was derived$
/o you ask auditor for info over t!e p!one or ask for memo9 8!ere t!e c!ances of getting
rig!t info are better9 ask for memo$ Sloppiness of info is !uge !ere$ ,t0s normative now to
$) the !#%tor$ for co/fort w!at backlog is, but it0s not part of e7pertised portion$
Megal problem in connection w.backlog# t!e number is off by appro7imately 60K 3 most
relates to %3Bowl 1s, t!at t!ey are not legally enforceable as a matter of form$ <ourt says
t!ey s!ould not !ave been included in t!e backlog$ But t!is is not t!e cause of business going
insolvent, bec$ all of %3Bowl deals, e7cept ), closed alleys were built and sold$ ,s t!at
material9 /ter%l%ty %$ #eter/%ne# $ of effect%+e #te of re( $tnt$ 'not!er defect it0s
not t!e cause of t!e loss$ ?n#er 11*e-" lo$$ c!$t%on %$ n ff%r/t%+e #efen$e.
ASSIGNMENT NO.1 , 8o+er(e of the 1933 n# 1933 Act$
1. 8o+er(e of the 1933 Act
A. The &$%c req!%re/ent. Sect%on = of 1933 Act
++ 'ct starts by re2uiring universal registration of all securities, but t!en e7empts **$*K of t!em
from t!is re2uirement
Sec =*- of 33 Act t!e starting point# 9nl /en$
-nless a reg st0nt is in effect as to a security, it s!all be unlawful for any person, directly
or indirectly
)" to make use of any means or instruments of transportation or communication in interstate
commerce or of t!e mails to sell suc! security t!roug! t!e use or medium of any
prospectus or ot!erwise( or
2" to carry or cause to be carried t!roug! t!e mails or in interstate commerce, by any means
or instruments of transportation, any suc! security for t!e purpose of sale or for delivery
after sale$
Have to means of transportation or communication in interstate commerce or t!e mails
narrow &0nal re20nt$ It$ !nl'f!l to !$e 9nl /en$ to $ell $ec!r%ty.
Preliminary qn: have the jnal means been used? If not no fed jn!
,t is not true t!at t!ere are 2 kinds of sec0s reg0d and unreg0d$ E+ery t%/e $ec!r%t%e$ re
$ol#" they /!$t &e re(%$tere#" or there /!$t &e e;e/.t%on fro/ re(%$trt%on.
"ecurities can be registered several times, and often are$
,f , want to sell my )000 s!ares of 4icrosoft t!roug! broker" t!ey are not registered$ ,
could not register t!em, bec only t!e issuer can register securities under Sec Ja"$ But , can
sell my s!ares
Sec 3# %!e provisions of Sec 6 s!all not apply to
)" transactions by any person ot!er t!an an issuer, underwriter, or dealer$
7. Wht %$ B$ec!r%tyC@
Sec 1*-*1- of 33 Act and Sec 3*-*1D- of 33 Act define B$ec!r%tyC
))
%!ese definitions differ, esp w.r.t treatment of notes# notes are securities under bot! 'cts, but
a lot of securities under Sec 2 are e7empt from registration under Sec +a")0" t!ey are not
securities at all under Sec +a")0"$
Sec 3*-*1D- of 33 Act#
A%!e term Psecurity0B s!all not include currency or any note, draft, bill of
e7c!ange, or banker0s acceptance 'h%ch h$ /t!r%ty t the t%/e of %$$!nce of not
e;cee#%n( n%ne /onth$, e7clusive of days of grace, or any renewal t!ereof t!e maturity
of w!ic! is likewise limited$H
<ourts cite definition of security interc!angeably, ignoring t!e difference
S?< v$ 8$O$ Howey :ef%n%t%on of %n+e$t/ent E
S$<t )*5J" Ser+%ce E , %n+e$t/ent E , $ec!r%ty *h# to &e re(%$tere#-
:lorida corp0s offered land sales 1 and service 1 to customers lots of customers from out
of state"$ Ser+%ce E a long3term lease of property to t!e seller so t!at seller takes care of
t!e citrus trees, and t!en mails profits to customer$ <ustomer does not !ave to buy a service
1, can &ust by a land sales 1 and can !ire anot!er provider of services$
S?< says# it0s investment 1 w.n t!e meaning of Sec 2a")", and s!ould !ave been registered
under Sec 6 of ++ 'ct$ %!us, violation of Sec 6a"$
State courts construed t!e term Ainvestment 1H to afford t!e investing public a full measure
of protection$ :orm was disregarded for substance and emp!asis was placed upon economic
reality$
:ef%n%t%on of %n+e$t/ent E# an investment 1 is a 1, transaction, or sc!eme w!ereby
.er$on %n+e$t$ /oney %n co//on enter.r%$e
n# %$ le# to e;.ect .rof%t$
$olely fro/ the effort$ of the .ro/oter or th%r# .rty"
%t &e%n( %//ter%l 'hether the $hre$ %n the enter.r%$e re e+%#ence# &y for/l
cert%f%cte$ or &y no/%nl %ntere$t$ %n the .hy$%cl $$et$ e/.loye# %n the enter.r%$e$
S.8t hol#$# it0s an investment 1 s!ould !ave been registered 3 ag$ Howey$ %!e deal only
makes sense t!is way$
%!e Sec 'ct pro!ibits t!e offer as well as t!e sale of unregistered, non3e7empt securities$
Hence it is enoug! t!at /s /erely offer t!e essential ingredients of an investment 1$ So, it is
irrelevant t!at few investors didn0t enter into service 1 w.affiliate$
8!at would !appen if Howey unbundled service 1 from land sales 1 w!at if Howey &ust
sold land and did not offer service 1 for cause of action, !as to offer or sell"9 no security$
8!at if Howey gave anot!er provider of services0 p!one number$
Ooiner case pre3Howey"
Selling mineral leases w.o service 1s were deemed securities bec individuals weren0t drilling
on t!eir own$
/efinition of sec0s in Sec 2a")" includes fractional undivided interest in oil, gas, or ot!er
mineral rig!ts$ ,f , sell full )00K of my mineral rig!ts related to a parcel of land is t!is
fractional9 A:ractionalH fraction of t!e mineral interest$ So !ere not fractional interest$
S$<t !eld t!at it was security bec t!e only way it makes sense if , own t!e land, w!ile smb
else drills oil for everybody$
8!at0s ApromoterH9 Person w!o drilled oil is not necessarily t!e person w!o sold you t!e
deal
)2
The &e$t for/!lt%on *F. :o!(l$-: 'hether yo!+e (ot $ec!r%ty
Are yo! &e%n( $ol# the &!$%ne$$ tht yo! co!l# r!n" or re yo! &e%n( $)e# to .!t
/oney %nto &!$%ne$$ tht $/& el$e %$ (o%n( to r!n@
Say, we take out service 1$ , sell orange trees only to people w!o live around >rlando,
:lorida$ ,f it0s possible for t!em to do smt! w.trees t!emselves not securities$
Say, we market.advertise trees to people far away in 4aine far away offerees" and to people
in >rlando local offerees"$ ,s it a security as to one class of offerees and a non3security to
anot!er class of offerees9 %!ere is a case t!at separates t!ese two transactions$ But Slain#
it0s very awkward and unreasonable arrangement bad$
-nited Housing :oundation v$ :orman Shre$ of $toc) ent%tl%n( .!rch$er to le$e
S$<t )*G6" n .t %n $tte $!&$%#%Ge# n# $!.er+%$e#
non.rof%t ho!$%n( coo.ert%+e re not
B$ec!r%t%e$C
8!et!er s!ares of stock entitling a purc!aser to lease an apt in a state subsidi;ed and
supervised nonprofit !ousing cooperative are AsecuritiesH w.n ++ and +5 'cts$
Business corp was organi;ed &ust to do t!e building$ <orp will only lease apts to people w!o
boug!t stock in t!e corp completely routine arrangement$
Ps say# in t!e selling doc0nt on w!ic! we relied on w!en buying stock, developer promised
t!at our cost of renting won0t go up bec of inflation$ <orp couldn0t make good on t!at
promise rents went up$ Ps allege fraud in violation of Sec )Ga" of ++ 'ct and Sec )0b"
and Rule )0b36of +5 'ct$ /s say# t!ese are not securities$
Sec )Ga" protects only purc!asers ag offer or sale$ 't t!at time, t!ere was 2
nd
<ircuit case
saying t!at t!ere is a private rig!t of action$ ,n 2000 no possibility t!at 2
nd
<ir would !old
t!at t!ere is a private rig!t of action under Sec )Ga"$
Ps# we boug!t securities in a CI business corp under CIB<M$
S.8t hol#$: %t$ not $ec!r%t%e$ you didn0t buy sec0s, you boug!t an apt". 8!y t!ese are not
securities9
Trn$ct%on $ho!l# not &e con$%#ere# $ec!r%ty trn$ct%on $%/.ly &ec!$e the
$tt!tory #ef%n%t%on of $ec!r%ty %ncl!#e$ the 'or#$ Bny $toc)C
Tennt$6$6h$ h+e .er c.%t!/ +ot%n(: 1 +ote for e+ery $6h" %n$te# of +ote$ %n
.ro.ort%on of the%r $hre$ , &!t %t$ $t%ll +ot%n(
When $toc): e;.ectt%on of %nco/e flo' , #%+%#en#$< here , th%$ $toc) #oe$nt .y
#%+%#en#$. S6h l$o ho.e$ to (et c.%tl ..rec%t%on , non here.
Tennt cn le+e the le$e only to $!r+%+%n( $.o!$e" not tennt$ .ro(eny.
Tennt 'ho 'nt$ to /o+e o!t h$ to $ell h%$ $toc) &c) to cor. t .!rch$e .r%ce.
7!t there %$ .ro$.ect of .rof%t: lo' rent. 's long as t!ey are leasing it t!ey get
!ousing at below3t!e3market rent it0s income in economic sense( it would meet t!e
Haig3Simons definition of income AbetteroffednessH$ %!is issue is undiscussed !ere$
%!e builder usu first constructs t!e building finances it out of loans from t!e bank", and
people buy stock after t!e building is already t!ere$ 7!t here" .eo.le &!y $toc) before the
&!%l#%n( %$ con$tr!cte#" $o they re f%nnc%n( the con$tr!ct%on , fctor %n f+or of
f%n#%n( $ec!r%ty.
S$<t# no #%$t%nct%on &et %n+e$t/ent E n# $ec!r%ty , they re coter/%no!$$
A8e perceive no distinction bet an Ainvestment 1H and an Ainstrument commonly known
as a Psecurity0$ ,n eit!er case, t!e basic test for distinguis!ing t!e transaction for ot!er
commercial dealings is Pw!et!er t!e sc!eme involves an investment of money in a
common enterprise wit! profits to come solely from t!e efforts of ot!ers$H Howey$H
)+
4ost circuits !eld t!at sale of business doctrine did put a limitation on definition of a security
w!ere t!ere is a )00K sale of stock of a closely !eld corp, suc! a sale does not constitute sale of
a AsecurityH under sec0s acts# w!ere t!ere is a sale of )00K stock of close corp, t!ere is no
e7pectation of profit from t!e efforts of ot!ers, so t!ere is no Ainvestment 1H, so it0s not a
security under :orman, definition of AsecurityH and investment 1H are coterminousH", so sec0s
laws are inapplicable"$
Mandret! %imber <o v$ Mandret! Sle of $toc) , $ec!r%t%e$ trn$ct%on
S$<t )*F6" Stn#r# of $tt!tory l%terl%$/
Re9ect$ $le of &!$%ne$$ #octr%ne
Sle of 1DD> of clo$e cor. , $le of $ec$
8!et!er t!e sale of all of t!e stock of a co is a securities transaction sub&ect to t!e antifraud
provisions of t!e fed securities laws.t!e 'cts$
P says# t!ese people owned all t!e stock( t!ey made representations to me, w!ic! turned out
to be untrue violation of Rule )0b36$
/ist ct = *
t!
<ircuit# sale of business doctrine applies !ere if you boug!t )00K of business,
go fig!t in a local court# fed securities laws do not apply to t!e sale of )00K of t!e stock of a
closely !eld corp$
S.8t re+er$e## under Sec 2a")" of ++ 'ct, stock is a security$ :orman court said t!at
investment 1 and security are coterminous$ S$<t doesn0t say t!at :orman case is overruled$
So now, investment 1 and security are coterminous e7cept w!en t!ey are not$ 8!atever
ot!er standards may be applied to ot!er transactions, $toc) %$ $toc)" n# $toc) %$ $ec!r%ty$
S.8t re9ect$ $le of &!$%ne$$ #octr%ne. The $tn#r# of $tt!tory l%terl%$/# look at
statute stock is a security t!at0s dispositive$
6 c!aracteristics usu associated w.common stock#
1. the r%(ht to rece%+e #%+%#en#$ cont%n(ent !.on n ..ort%on/ent of .rof%t$<
1. ne(ot%&%l%ty<
3. the &%l%ty to &e .le#(e# or hy.othecte#<
3. the conferr%n( of +ot%n( r%(ht$ %n .ro.ort%on to the n!/&er of $hre$ o'ne#<
n#
=. the c.c%ty to ..rec%te %n +l!e.
Problem# definition of security under eac! 'ct includes Bny noteC
, !ave an old car, w!ic! ,0m trying to sell( , tell you t!at car only been used a couple of times, and ,
sell it to you$ Iou don0t give me cas!, but a note payable in ) year$ Iou t!en find problems wit!
w.t!e car# turns out, it was used as a ta7i, been to flood$ , used &0nal means to lie to you$ ,s t!ere a fed
securities lawsuit t!at you could bring9 It$ .r%+te offer , not +%olt%on of Sec = of 33 Act. If
note %$ $ec!r%ty" yo! cn &r%n( $!%t !n#er R!le 1D&-= of 33 Act , I / .!rch$er of $ec!r%ty"
n# I #efr!#e# yo!.
Iou buy a !ouse, get a mortgage( give note to developer w!o sells it to financial institution$ %!en you
claim t!ere0s smt! wrong$ <an you sue developer9
Iou borrow money from a friend, give !im a note, but lie to !im w.r.t use of t!e money$ ,t0s a )0b36
case, if ,>- is a note$
Problem# it is understood by everybody, t!at yo! cnt ..ly the .r%nc%.le of $tt!tory
l%terl%$/ to chrcter%Gt%on of note$, bec ot!erwise you0ll bring every little dispute as to
borrowing money to fed sec law.fed courts$
)5
Reves v$ ?rnst Q Ioung :e/n# note$ cn &e $ec!r%t%e$ '6n Sec 3*-*1D- of 33 Act
S$<t )**0"
8!et!er certain demand notes are securities w.n t!e meaning of Sec +a")0" of +5 'ct$
<o3op agricultural cooperative" finances itself by offering commercial paper demand notes
to bot! members and nonmembers$ P is suing claiming t!at w!en t!is co sold !im notes, it
provided !im w.financial info, all of w!ic! was wrong$ :in st0nts were audited by 'ut!ur
Ioung, so Ps file suit ag 'ut!ur Ioung alleging violation of Rule )0b36$ /ist ct never got to
t!is issue, bec it ruled t!at demand notes are not securities$
S.8t hol#$: the$e #e/n# note$ re $ec!r%t%e$. /emand notes do not necessarily !ave s!ort
terms not covered w.n t!e +a")0" e7ception$
Sec +a")0" of +5 'ct *3mont!s provision $ So, /s say# you don0t !ave a )0b36 case, bec
t!ese instruments are precisely defined out of definition of security and you don0t !ave ++
'ct case"$
How do you tell w!et!er note is a security9 <ts of 'pp many different tests$
1. R%$) c.%tl te$t6Ho'ey te$t , S.8t re9ect$
' note is a security only if it evidences
)" an investment(
2" in a common enterprise(
+" wit! a reasonable e7pectation of profits(
5" to be derived from t!e enterpreneurial or managerial efforts of ot!ers
1. In+e$t/ent +er$!$ co//erc%l te$t
Cotes issued in an investment conte7t w!ic! are securities" v$ notes issued in a
commercial or consumer conte7t w!ic! are not"
3. I/%ly re$e/&lnce te$t , S.8t #o.t$
A note %$ .re$!/e# to &e $ec!r%ty" n# tht .re$!/.t%on /y &e re&!tte#
only &y $ho'%n( tht the note &er$ $tron( re$e/&lnce *%n ter/$ of 3
fctor$- to one of the en!/erte# cte(or%e$ of %n$tr!/ent tht re not
$ec!r%t%e$ *e+en tho!(h %t$ clle# BnoteC-
3 fctor$
)" the /ot%+t%on$ tht 'o!l# .ro/.t re$on&le $eller n# &!yer to enter %nto
the trn$ct%on# if t!e seller0s purpose is to raise money for t!e general use of a
business enterprise or to finance substantial investments and t!e buyer is interested
primarily in t!e profit t!e note is e7pected to generate, t!e instrument is likely to be a
security( if t!e note is e7c!anged to facilitate t!e purc!ase and sale of a minor asset
or consumer good, to correct for t!e seller0s cas!3flow difficulties, or to advance
some ot!er commercial or consumer purpose, on t!e ot!er !and, t!e note is less
sensibly described as a security$
2" the .ln of #%$tr%&!t%on of the %n$tr!/ent# to determine w!et!er it is an instrument
in w!ic! t!ere is common trading for speculation or investment
*3- the re$on&le e;.ectt%on$ of the %n+e$t%n( .!&l%c
5" the e;%$tence of nother re(!ltory $che/e significantly reduces t!e risk of t!e
instrument, t!ereby rendering application of t!e Securities 'cts unnecessary
>dd# t!is test still mirrors t!e Howey test$ S$<t disapproves Howey w.r.t notes, but t!ese
factors are t!e Howey factors$ >perationally, it may not be t!at toug! to apply, but you don0t
!ave any self3e7ecuting formulation w!at would permit you to c!aracteri;e ot!er gray areas$
%!e presence.absence of anot!er compre!ensive regulatory sc!eme important it was !eld
t!at e0ee pensions are covered by ?R,S' complete regulatory system, so don0t need fed sec
)6
laws( 4arine bank !eld t!at certificates of deposit </s" are not securities, bec t!eir issuance
is regulated by :ed Reserve Board and ot!er regulatory sc!emes"$
S?< v$ 1oscot 0yr/%# .ro/ot%on enter.r%$e , ye$" %n+e$t/ent E , $le of $ec!r%ty
6
t!
<ir )*G5"
Pyramid promotion enterprise 3 franc!ise, w!ic! sold cosmetics$
S?< sued for in&unction# t!at t!is enterprise was w0n t!e term security, t!at as suc! it !ad to
be registered w.S?< pursuant to ++ 'ct and t!at it violated t!e anti3fraud provisions of +5
'ct$
Buying a franc!ise depend on financial condition of franc!isor( very dependent on ot!er
franc!isees$ :ranc!ises are not treated as securities, bec buyer of franc!ise usu !as effective
control over franc!ise$
Here, franc!ise was !eld to be an investment 1 security, bec it0s so different from ordinary
franc!ise$ %!e money was made not from selling cosmetics, but from selling franc!ises$
4otivation# if you sell more franc!ises, you move up t!e ladder$
<ourt uses t!e Howley test# for investment 1
)" t!ere is an investment of money
2" t!e sc!eme in w!ic! an investment is made functions as a common enterprise
+" under t!e sc!eme, profits are derived solely from t!e efforts of ind0ls ot!er t!an
investors
2
nd
re20nt# co//onl%ty of the enter.r%$e
<ourt says t!at t!e fact t!at an investor0s return is independent of t!at of ot!er
investors in t!e sc!eme is not decisive$ Rat!er, t!e re2uisite commonality is
evidenced by t!e fact t!at t!e fortunes of all investors are ine7tricably tied to t!e
efficacy of t!e 1oscot meetings and guidelines on recruiting prospects and
consummating a sale t!is is broad vertical commonality
<ir <ourts of 'ppeals are divided as to w!et!er vertical commonality is sufficient for
finding investment 1s# !alf accepts vertical commonality, !alf re2uires !ori;ontal
commonality
Hor%Gontl co//onl%ty# pooling of investor funds classical investment 1 involves
!ori;ontal commonality" = usu a pro rata distribution of profits among t!e investors
Vert%cl co//onl%ty bet investors and promoters# a common enterprise may be found
w!en t!e activities of t!e promoter are t!e dominant factor in t!e investment0s success even
t!oug! t!ere is no pooling of funds or interests by multiple investors" if buyer is successful
1oscot and buyer divide t!e take"
Str%ct +ert%cl co//onl%ty# !as to be a direct relations!ip bet t!e promoters0
financial success and t!at of its investors re2uires t!at t!e fortunes of investors be
tied to t!e fortune of t!e promoter one profit pool being s!ared by buyer and seller"
7ro# +ert%cl co//onl%ty# investors0 fortunes !ave to be linked only to t!e
efforts of t!e promoter , won0t s!are profit w.you, but take a commission on selling
property to you( we0re not s!aring profits toget!er, but ,0m getting paid for managing
property for you"
8. Wht %$ B$leC@
Sec 1*- 8!en used in t!is subc!apter, unless conte7t ot!erwise re2uiresB
)J
Sec 1*3-# The ter/ B$leC or B$ellC $hll %ncl!#e e+ery E of $le or #%$.o$%t%on of $ec!r%ty
or %ntere$t %n $ec!r%ty" for +l!e.
S?< v$ /atronics S.%n-off , ye$" $le of $ec!r%ty !n#er Sec 1*3-
5
t!
<ir )*G+"
Stoc) #%+%#en# a dividend paid in t!e form of stock rat!er t!an cas!$ ' stock dividend is
usu e7pressed as a percentage of t!e number of s!ares already !eld by t!e s.!$ ' corp
normally elects to issue a stock dividend in order to conserve cas!$ %!e ta7 advantage of a
stock dividend to a s.! is t!at a stock dividend is ta7able at t!e time of sale, w!ile a cas!
dividend is ta7able w!en received$ ,t0s a distribution of add0l s!ares to people w!o already
own s!ares$
,s t!e recipient giving up anyt!ing by getting a stock dividend no$ He owns t!e same
percentage of t!e business, &ust represented by more s!ares$ Before, it was never regarded as
sale of securities$ Spin3off was never regarded to involve a sale of securities t!at would
re2uire registration under ++ 'ct$
S?< sued for violation of Sec 6 of ++ 'ct and Sec )0b" = Rule )0b36 of +5 'ct, saying t!at
spin3off was a sale of unregistered securities = false representations in t!eir sale$ But s.!s of
/atronics paid not!ing for s!ares t!at t!ey received$
S.%n-off a corp divestiture in w!ic! a division of corp becomes an ind0nt co and stock of
new co is distributed to original corp0s s.!s$ Here, w.o any business purpose of its own,
/atronics would enter into an agr0nt w.private corp$ %!e agr0nt provided for t!e organi;ation
by /atronics of a new corp, or t!e utili;ation of one of /atronics0 subsidiaries, and t!e
merger of t!e private corp into t!e new or subsidiary corp$ %!e private co was to receive t!e
ma&ority interest in t!e merger3corp$ %!e remainder of t!e stock of t!e corp would be
delivered to, or retained by, /atronics for a nominal sum per s!are$ Part of it would be
applied to t!e payment of t!e services of /atronics in t!e organi;ation and administration of
t!e proposed spin3off, and to /atronics0 counsel for legal services in t!e transaction$
/atronics was bound by eac! agr0nt to distribute among its own s.!s t!e rest of t!e stock as
dividends$ Before suc! distribution, /atronics reserved for itself about one3t!ird of t!e
s!ares$ Cone of t!e newly ac2uired stock was ever registered$
So, /atronics creates a new co or uses its own subsidiary$ Private corp merges into
subsidiary, /atronics takes stock of t!is merged corp and distributes it to its own s.!s as
dividends #see p!p! $%&$' of notes($
/atronics publicly !eld co !as significant number of public s.!s" registered
8!at !appened !ere# /atronics, a publicly traded co, would enter into agreement wit!
private co, w!ereby /atronics would create a w!olloy owned subsidiary t!at t!e private
co could merge into$ %!en /atronics would spin3off subsidiary0s s!ares as a stock
dividend to its own s.!s, but allowed /atronics to keep a poriton of t!e s!ares as payment
for its services$ %!is allowed public distribution of subsidiary0s s!ares w.o registration,
and t!ere was t!erefore no publicly available info about subsidiary$
>ne way for private corp to do it# register add0l number of s!ares and sell t!em to t!e public(
but !ave to prepare a registration st0nt w.audited financial st0nt, w!ereas most closely !eld
co0s don0t !ave audited fin st0nts = it takes time to !ave audit over several years"( !ave to
find an underwriter( it costs money to prepare a registration st0nt, and underwriter will take
significant portion of it( no way to do t!is 2uickly$
/atronics suggests to turn t!eir private corp into public co overnig!t$ Private corp now owns
F6K of sub0s stock( /atronics distributes stock to its own s.!s as dividend$
)G
,s it a sale9 ,s t!ere a c!ange in economic sit0n of s.!s of /atronics before and after
transaction9 Co( s.!s of /atronics now own )6K of anot!er business it cost t!em not!ing
free lunc!$ /atronics gave its s.!s )6K of operating business at ;ero cost$ 'dvantage of
spin3off# fast and spend not a lot of money$
S.!s of /atronics paid not!ing for t!ose s!ares$ Who$ the .er$on $o!(ht here to &e
.rotecte#@ , .eo.le %n tr#%n( /r)et 'ho &!y tho$e $hre$ fro/ :tron%c$ $6h$.
Held# for S?< spin3off !ere sale of securities for value under Sec 2+"
'fter t!is case, nobody would proceed to do a ta73free spin3off w.o getting a no-ct%on letter
*NA5- from S?<( but it commits S?< to not!ing in contrast to Revenue Ruling from ,RS
more reliable"$
C'M Nrasso avail$ F.20.*+"$ Nrasso involved a classic spin3off( S?< re2uired
)" spin3off !ad a business purpose
2" before transaction, subsidiary registers stock being distributed under Sec )2 of +5 'ct
t!is turns a subsidiary.public co into a reporting co
+" time of transaction, info st0nt analogous to Sec )5c" st0nt is distributed under Sec
)5c", mgmt doesn0t need to solicit pro7ies, c!ooses not to solicit t!em( but still it !as
to distribute an info st0nt w!ic! !as same info as would be re2uired if it did solicit
pro7ies"$
1. The 1933 Act co+er(e of %$$!er$
1933 Act
++ 'ct# issuer sells stock to t!e public# ,P> initial public offering" tiny fraction of t!e
market$ +5 'ct intended to deal wit! after3market trading market" in securities$
++ 'ct very seldom amended !ave to flip pages"$ +5 'ct !as been amended a lot$
Sec 3 establis!es S?<.administrative agency to administer Securities 'cts
Sec 4 provides for registration.licensing of Cational Securities ?7c!anges Sec J defines t!e
term"$ ?7c!anges are given aut!ority to set fort! rules to regulate conduct of t!eir own
members t!ey are SRO$ self3regulatory organi;ations" rules adopted by t!e ?7c!anges
are functionally t!e law of -S$
Sec 2 gives :ederal Reserve Board t!e aut!ority to regulate margin transactions( S?<
enforces t!em$
Sec 1= re2uires registration, i$e$ licensing, of Brokers and /ealers$ Broker acts as agent in
transaction( dealer acts as principal in transaction sells smt!" same person
Sec 1=A$ %!e vast ma&ority of broker dealers are not members of t!e ?7c!anges$ Sec 1=A
provides t!at an association of brokers and dealers may be registered as a national securities
association NAS: Cational 'ssociation of Securities /ealers" t!e only one t!at !as been
registered( it0s a voluntary organi;ation$
NAS:AJ automated 2uotations" C'S/ adopted a system t!at functionally became
and e7c!ange
'ny registered broker dealer can belong( every broker dealer &oins it w!y9
Sec 1=A*e-*1- %!e rules of a registered securities association may provide t!at no
member t!ereof s!all deal w.any nonmember professional e7cept at t!e same prices, for t!e same
commissions or fees, and on t!e same terms and conditions as are by suc! member accorded to
t!e general public$
%!us, a member of C'S/ can only deal wit! non3members as retail customers in >%<,
dealers regularly buy from ot!er dealers so t!ey are coerced to &oin"
)F
C'S/'L computeri;ed >%< market( more and more takes on functions of ?7c!ange( to
permit >%< dealers to post t!eir bids and offers on a system of automated 2uotations( t!en
added re20nt t!at you report transactions on C'S/'L
Re(!lt%on of %$$!er$ of $ec!r%t%e$
Sections )2, )+, )5, )J
Sec )2 re2uires registration of securities$ Sec 6 of ++ 'ct also re2uires registration of securities
but totally separate re2uirements
-nder ++ 'ct, you register !n%t$ of $ec!r%t%e$ &e%n( $ol# for the .!r.o$e of .rt%c!lr
trn$ct%on sell )00,000 s!ares of common register )00,000 of common"$
-nder Sec )2, you register the cl$$ of $ec!r%t%e$ *co//on" .referre#" etc-$ ?mp!asis
of +5 'ct disclosure is on financial status of t!e issuer and not t!at of t!e transaction at
issue$
,f you want to sell common, you !ave to register it under Sec 6 of ++ 'ct and under Sec
)2 of +5 'ct$ ,f you want to sell additional common, you !ave to register it under Sec 6, but you
don0t !ave register it under Sec )2, because t!at class is already registered$
If the %$$!er #oe$nt h+e cl$$ of $ec!r%t%e$ re(%$tere# !n#er Sec 11 , Sect%on$ 13" 13"
14 re %n..l%c&le
Sect%on 11*- ,f co0s securities are listed and traded on ?7c!ange, co !as to register suc! class of
securities
,t s!all be unlawful for any member, broker, or dealer to effect any transaction in any
security on a national securities e7c!ange unless a registration is effective as to suc! security for
suc! e7c!ange
Sect%on 11*&- ' security may be registered on a national securities e7c!ange &y the %$$!er filing
an application wit! t!e e7c!angeB
,n )*+5, t!is system applied only to securities listed on t!e e7c!anges, but most securities are
traded on t!e >%< market
,n )*J5 <ongress added Sect%on 11*(- to bring >%< w.n continuous disclosure system"
11*(-*1- ?very issuer w!ic! is engaged in interstate commerce, or in a business affecting
interstate commerce, or w!ose securities are traded by use of t!e mails or any means or
instrumentality of interstate commerce s!all
'" register security wit! t!e <ommission by filing registration statement w.n )20 days from
)*J5 if
)$ issuer !as total assets e7ceeding @)0 million and
2$ a class of e2uity security !eld of record by G60 or more persons
B" register security after 2 years from )*J5 if
)$ issuer !as total assets e7ceeding @)0 million and
2$ a class of e2uity security !eld of record by 600 or more but less t!an G60 persons
smaller co0s get additional year to register"
%!en issuer becomes sub&ect to Sections )+ continuous disclosure rule", )5 pro7ies", )J
one aspect of insider trading" of +5 'ct
Ain interstate commerce or affecting interstate commerceH very broad covers everyt!ing"
Cow, if you meet t!e 2uantum of assets and number of s.!s tests, you !ave to register
)*
Sect%on 13 8ont%n!o!$ :%$clo$!re Sy$te/
<onse2uences from !aving security registered under Sec )2 3 Sec )+a" becomes applicable
Sec )+a" re2uires annual reports wit! audited fin st0nt ind0nt opinion of certified public
accountants !eart of t!is Rule )+a3)# :orm )031", periodic.2uarterly reports Rule )+a3)+#
:orm )03L", and w!en some ma&or event.c!ange occurs bankruptcy, etc" mont!ly.current
reports Rule )+a3))# :orm F31"
Sect%on 11*h- gives <ommission blanket power to provide add0l e7emptions from Section
)2g" = )+, )5, )6d" or )J", but not )2a""
Sec 11*h- grant of aut!ority pursuant to w!ic! in Sec )2g")", S?< raised asset barrier to
@)0 million
Sect%on 1=*#-# if stock is registered under ++ 'ct you become sub&ect to continuous
disclosure system under Sec )6d" of +5 'ct you become sub&ect to entire Sec )+ as if you
!ave a class of e2uity securities registered under Sec )2 in )*J5, Sec )6d" was amended to
codify and legitimate S?<0s practice before t!at day"
Sect%on 3*-*11- of 33 Act e7empts intrastate offerings of securities
%!e statute trumps t!e rule
Registration st0nt# cover page, prospsectus, signature page
Sect%on 13 0ro;%e$
Plenary aut!ority of S?< to regulate pro7ies :or all securities registered under Section )2, it is
illegal to solicit pro7ies in contravention of S?< rules
If $ec!r%t%e$ re not re(%$tere# !n#er Sect%on 11" .ro;y r!le$ h+e noth%n( to #o '%th
yo!
%!ere is no re2uirement in fed law t!at pro7ies be solicited, but once one does, t!ey are
governed by Section )5 and t!e rules promulgated t!ereunder
,f mgmt owns 6)K of s!ares doesn0t need votes, but still !as to provide info to s.!
under Sec 13*c- , $/e %nfo $ %n .ro;%e$
Sect%on 14 deals wit! insider trading
Sec )J t!e only section t!at e7pressly deals w.,nsider %rading
Sec 14*- 3 cl$$e$ of .eo.le
1. &enef%c%l o'ner of /ore thn 1D> of ny cl$$ of ny eq!%ty $ec!r%ty re(%$tere#
!n#er K11
1. #%rector
3. off%cer
Cote# but if you are w.n reporting class director, officer", you !ave to report your owners!ip of
all e2uity securities w!et!er or not registered under R)2
:ile :orm + w.t!e <ommission
't t!e end of any mont!, you !ave to report any c!ange in your owners!ip( you !ave to report
any gift or purc!ase
Say, co !as a class of e2uity sec registered under Sec )2$ ,0m a director.officer, own
preferred stock not registered"$ /o , !ave to report it9 Ies = all c!anges in my owners!ip
position on a mont!ly basis, bec of my owners!ip of all e2uity securities of t!at issuer issuer
!as class of e2uity securities registered"
20
Sec 14*&- any e2uity security matc!es )Ja"0s reporting t!ing" s!ort term J mont!s"
insider trading#
,f any class of persons re2uired to report w.n )Ja" !as profit from purc!ase and sale w.n
less t!an J mont!s, issuer can recapture t!is profit
)$ %!e only people covered are people covered in Sec )Ja"
2$ Statute operates automatically t!e actual use of inside info is irrelevant"
+$ 're t!ese transactions illegal9 Co all it says it says is t!at profit is to be recaptured by t!e
issuer
5$ Iou can !ave a recapturable profit w.n a loss
6$ <ontemporaneous owners!ip rule in order to bring a derivative suit, you !ave to be a s.! at
t!e time of events does not apply to Sec )Jb"
How to compute profit# take transaction and go J mont!s back or forward and matc! it w.any
sale.purc!ase at !ig!er price *$ee .. 1D1 of note$ of cor.-$
)Jb" cases small number of Ps( 'ttys fees motivation for litigation lawsuits w.o clients"(
t!ese cases always get settled( )Jb" system effective, self3administering, efficient, doesn0t
cost any money to ta7payers it0s practice w.o clients
)Jb" aims at s!ort3term trading# to prevent mgmt from profiting on s!ort3term fluctuations(
t!is is not a broad statutory pro!ibition on insider trading
Pro!ibition on insider trading is not implicit in law
Sec 14*c- applies to any e2uity security need not be registered under Sec )2"( forbids a s!ort
sale by t!ese insiders
t!ey could be utili;ing inside info to t!e disadvantage of people buying
plus, once you sold s!ort, you can affect stock going down people in a position to affect
stock s!ouldn0t make use of it
%ransactions under )Jc" are illegal you get criminally prosecuted for t!is
%!en in )*JF, <ongress added t!e 8illiams 'ct regulation of tender offers 3 )+d")",
)5d", e", f" of +5 'ct
<ould a Sout! /akota corp, w!ose public offering of common stock solely to residents of
Sout! /akota and so e7empt from registration under ++ act by reason of Sec +a"))" and
t!us, e7empt from registration under +5 'ct under Rule )2g")" and Sec )2!", trade its
securities on C'S/'L9 C'S/'L would not want t!at unknown, non3reporting co$
8!ere do you get info about t!is co9 on t!e pink s!eets$ Before C'S/'L, t!e only source
of info about co were pink s!eets e2uity" and greet s!eets debt"
Misted dealers t!ose w!o deal w.ot!er dealers were prepared to buy.sell" on >%< market(
but t!e only t!ing you can find out about from pink s!eets w!at dealers !old t!emselves out
as being able to buy, for !ow muc!, and price as to ot!er dealers$
Problems Sec )2, )5 and )6d" of +5 'ct see !andout"
2)
<o0s listed on pink s!eets e2uity"# small domestic co0s and large world class co0s$ How
come9
Iore%(n I$$!er$
:oreign corps !istorically !ave been reluctant to become involved in -S securities market#
)" paranoid about S?<
2" muc! greater reason# to avoid being involved in 'merican litigation
+" accounting# ,n order to !ave your securities listed on stock e7c!ange statute says so"
and 2uoted on C'S/'L C'S/'L will not 2uote unless you register", you !ave to
file :orm )031 w!ic! !as audited financial st0nts, w!ic! !ave to be prepared in acc
wit! -S N''P$ :or foreign co0s#
2uestion of cost
'mericans are comfortable w.idea t!at fin st0nts for accounting
purposes balance s!eets" and for ta7 purposes are very different in
-S, acc books can be very different from ta7"$
,f foreign co0s would !ave to recompute t!eir income in acc
w.N''P, t!eir income will be !ig!er t!an income computed under
!ome3country N''P
%!us, very few co0s are traded on stock e7c!ange and C'S/'L most
t!at are traded are <anadian"
Mot0s of foreign co0s are traded on Mondon stock e7c!ange
4ost problems about +5 'ct registration are w.r.t foreign issuers
A:R$ 'merican /epository Receipts securities issued by a -S bank in place of t!e
foreign s!ares !eld in trust by t!at bank, t!ereby facilitating t!e trading of foreign s!ares in
-S markets$ -S banks sell negotiable instruments representing same securities t!at t!ey
!old abroad , buy '/R for stock of /eutsc!e bank$"
're co0s w!ose '/R , buy re2uired to register under Sec )29
Sec 11*(- says t!at co0s engaged in.affecting interstate commerce wit! number of re20nts
!ave to register$
Sec 3*-*12- of 33 Act definition of interstate commerce# defines interstate commerce
to include foreign commerce so, foreign co !as to file registration st0nt under Sec )2
even if it !as no -S s.!s and !as no assets in -S"
R!le 11(-3 involves '/Rs
%!ere are + levels of '/R programs# w!at set of obligations are imposed on corp w!ose
sec0s are traded locally t!roug! '/Rs
)" if foreign issuer wants to !ave public offering in -S, to arrange for '/Rs to be
offers will re2uire registration under ++ 'ct, t!en sub&ect to Sec )6d" of +5 'ct and
so, will !ave to register under Sec )2 of +5 'ct( if 2uoted on C'S/'L !ave to
register under Sec )2, ot!erwise C'S/'L won0t 2uote t!em
2" if want to apply for listing of '/Rs, !ave to register underlying stock under Sec )2
no problem"
+" problem# w!at about issuer w!ose securities are traded on >%< market and never !ad
a public offering and never soug!t to !ave sec0s listed on t!e e7c!ange or 2uoted on
C'S/'L w!at is t!eir obligation, and w!at can S?< do to enforce it9
22
R!le 11(3-1 of 33 Act applies to )
st
level of '/R programs
R!le 11(3-1*- Sec0s of any class issued by any foreign private issuer s!all be e7empt from Sec
)2g" of t!e 'ct if t!e class !as fewer t!an +00 !olders resident in t!e -S
R!le 11(3-1*&- broadly e7empts t!e foreign private issuers of )
st
level '/R programs from Sec
)2g", but under condition t!at t!ey furnis! not file" to S?< !ome3country info t!at a" t!ey
provide to t!eir own gov0nt, or b" stock e7c!anges, or c" are re2uired to distribute to t!eir
security !olders$
2 kinds of '/R level ) programs
)" sponsored foreign issuer is paying administrative costs of -S '/R programs
2" unsponsored foreign issuer doesn0t do anyt!ing( bank is paying e7penses and t!en
c!arges purc!asers of '/Rs
Rule )2g+32 doesn0t distinguis! bet sponsored and unsponsored programs$
Dery large number of issuers !ave never complied$
%!is rule applies to Aforeign private issuersH$ R!le 3D= of 33 Act Supp p$ )05"defines t!e
term Aforeign private issuerH# it doesn0t include every corp incorporated outside -S$ ,nternal
affairs doctrine# w!at state0s law applies( court may decide if it0s a corp or pseudo3corp
incorporated outside, but everyt!ing else.business is in -S" Rule 506 incorporates t!is
doctrine$
3. The %nte(rte# #%$clo$!re $y$te/
Prior sit0n# eac! form !ad its own instructions
,n )*F+, S?< adopted Re(!lt%on S-E great breakt!roug!# common source of instructions
as to disclosure, w!atever disclosure is for tremendous efficiency
'doption of the three t%er $y$te/ for 33 Act re(%$trt%on see !andout"
2+
People buy sec0s on t!e basis of advice from broker broker is getting t!is info from
securities analysts$ Securities analysts are t!e only people w!o read info provided by S?<0s
disclosures$ %!us, disclosure system !ad to )" e7clude !uge amount of info t!at sec0s
analyst already knows( 2" include info t!at sec0s analyst regards as !ig!ly important, but
w!ic! S?< did not re2uire to be disclosed# $oft6for'r#-loo)%n( %nfo
)*F0s S?< re2uired t!at co0s limit disclosure to only !istorical info about t!is co$ ,ssuer
insurer of accuracy of info incentive for issuers to limit disclosure to !istorical facts
But people want to know forward3looking info# not w!at !appened in t!e past, but w!at will
!appen in t!e future$
S?< re2uired disclosure of# offering price( underlying arrangements( w!at are you planning
to do w.t!e money$
,f :orm S3+# t!at0s all t!at0s re2uired to be disclosed$ 'ssumption# all ot!er info is easily
available$
%!is was a great reform# reduced t!e amount of useless paper$
/ownside # ,n Bar<!ris, underwriters were liable bec t!ey couldn0t meet Sec ))b"+" due
diligence defenses$ Ior/ S-3# info is incorporated by reference from ot!er public places$
How does underwriter meet due diligence obligations w.r.t documents prepared before !e
came to t!e scene and !ad no opportunity to investigate it can0t be done$
R!le 124 of 33 Act Supp p$ FF"# <ir0ces affecting t!e determination of w!at constitutes
reasonable investigation and reasonable grounds for belief under Sec )) of t!e Securities 'ct
compare Oudge 4aclean0s opinion in Bar<!ris and t!e statute"$ R!le 124 re#!ce$ #!e
#%l%(ence o&l%(t%on$ for !n#er'r%ter$ 'here %nfo %$ %ncor.orte# &y reference.
Sec 19*- of 33 Act# if good faith reliance on rule of ")* no liability, even if ultimately the
rule is determined to be invalid #or amended, or rescinded(; +ule is complete safe harbor!
-su$ no suc! t!ing gov0nt agents !ave no apparent aut!ority"$
-nderlying t!is + tier system is $e/%-$tron( for/ of eff%c%ent /r)et hy.othe$%$# info is
t!ere and available, everybody0s got it$ Slain 2uarrels w.its application$ :orm S3+# w.r.t
large co0s it0s true, but w.r.t small co0s wit! @G6,000,000 of stock not true$ ,n t!e )**0s,
S?< makes :orm S3+ more and more available( Slain S?< s!ould make it less and less
available bec :orm S3+ says you s!ould get info from ot!er sources"$
,n )**+, S?< adopted separate disclosure regiment w.r.t small businesses Ior/ S7 muc!
less rigorous$ ,t appears t!at S?< concluded t!at its disclosure re2uirements were too strict
w.r.t vast ma&ority of co0s overregulation( but it0s good t!at S?< recogni;ed t!e problem
and acted on it$
+ tier system for info disclosures pursuant to ++ 'ct registration# allows for reduced dislosure
by co0s in good standing and allows for incorporation of +5 'ct disclosures by reference$
ASSIGNMENT NO. 3 , 1933 A8T ELEM0TIONS
1. E;e/.t Trn$ct%on$
Sec 5 %!e provisions of Sec 6 s!all not apply to
Sec 3*1- Btrn$ct%on$ &y n %$$!er not %n+ol+%n( ny .!&l%c offer%n(C
Sec 1*3- #ef%ne$ B%$$!erC
S?< v$ Ralston Purina Sec 3*1- e;e/.t%on: B.!&l%c offer%n(C to )ey eee$
S$<t )*6+" E;e/.t%on 'hen there %$ cce$$ to $/e )%n# of %nfo $
re(%$trt%on 'o!l# #%$clo$e
7!r#en of .roof on the .er$on cl%/%n( e;e/.t%on
25
7!yer$ n# Offeree$
<o sold unregistered stock to its e0ees$ S?< sues to en&oin co0s unregistered offerings as
violative of Sec 6$ ,ssue# w!et!er co0s offerings of stock to its Akey employeesH is w.n Sec
52" e7emption$ Held# ag co./ stock is not w.n e7emption$
8as t!is co trying to raise capital9 no$ 're t!ey selling stock at discoung to e0ees no, at
market price no bargain purc!ase" so not as compensation$ %!is co was trying to
encourage owners!ip of e0es in t!e co# e0ee0s interest in t!e co is !ig!er w!en !is money is in
t!e co$
/ claimed t!at it sold stock only to Akey e0eesH, but in reality t!ey gave stock to any e0ee w!o
s!owed up and asked$ / says# t!ere was no Apublic offeringH$
8o!rt: n offer%n( to ll of co$ eee$ 'o!l# &e .!&l%c. To &e .!&l%c" n offer nee# not
&e o.en to the 'hole 'orl#.
%!e applicability of e7emption s!ould turn on w!et!er t!e particular class of persons affected
need t!e protection of t!e 'ct$
8o!rt e;.re$$ly re9ect$ n!/er%cl te$t. 8once.t!lly o.en$ .o$$%&%l%ty of .!&l%c
offer%n( to 1 .er$on.
The te$t: The foc!$ of %nq!%ry $ho!l# &e on the nee# of the offeree$ for the .rotect%on$
ffor#e# &y re(%$trt%on. The eee$ here 'ere not $ho'n to h+e A88ESS to the )%n# of
%nfo 'h%ch re(%$trt%on 'o!l# #%$clo$e# t!ere !as to be access to same kind of info as
registration would disclose
,ssuer !as t!e burden of proof on e7emption$ The &!r#en of .roof %$ l'y$ on the .er$on
cl%/%n( the e;e/.t%on.
)*+6 release# presumption offering to more t!an 26 people was public became t!umbnail
test for public offering t!ereafter( but S?< was never willing to take t!at position$
<an t!ere be offering to !undreds w!ic! would be non3public9 yes, %n$t%t!t%onl %n+e$tor$$
Offer%n( to ny n!/&er of %n$t%t!t%onl %n+e$tor$ %$ Sec 3*1- e;e/.t trn$ct%on even
if !undreds of inst0l investors"$
Sec 11*-*1- of 33 Act 'ny person w!o offers or sells a security in violation of Sec 6 s!all be
liable to t!e person purc!asing suc! security from t!e !im, w!o may be sue to recover t!e
consideration paid for suc! security w.interest t!ereon to rescind" or for damages if !e no longer
owns t!e security$
,ssuer sells sec0s to '
B
<
/ sells it to /23/2J
?
'BS/? not members of t!e public( sop!isticated$ Cobody knows t!at / !as a subgroup of
investors( issuer doesn0t know about it$ -nder Sec )2)", buyer /23/2J" can sue /$
' wants out$ ,ssuer didn0t sell sec0s to ' in violation of Sec 6$ But t!ere was a public offering
/ made one$ 'B<? are entitled to rescind against issuer$ ,ssuer cannot rescind$
%o establis! availability of Sec 52" e7emption, does issuer !ave to establis! t!at all people
w!o boug!t were not members of t!e public9 vice of Ralston Purina decision
8!en t!e sec0s Aco/e to re$tH# in w!ose !and !ave t!ey remained for some protracted
period of time$ Here, sec0s came to rest after /23/2J boug!t in
26
We #o h+e .!&l%c offer%n( *: re$ell$-. ,t0s not a public offering t!at issuer
contemplated.wanted( issuer tried to prevent it, but it doesn0t matter
Then Sec 3*1- #oe$nt ..ly , trn$ct%on %$ !ne;e/.t &ec of .!&l%c offer%n( tht :
/#e
/23/2J !ave rig!t of rescission ag /$ Mo! only h+e re$c%$$%on r%(ht$ ( %//e#%te
$eller$
8n : re$c%n#@ , no" : %$ e$to..e# &y h%$ o'n +%olt%+e con#!ct
' wants out of t!e deal bec deal is not going well
<an ' get out9 %t$ ll one trn$ct%on$ Sec 52" e7emption doesn0t apply so transaction
violates Sec 6 'B<? !ave rig!t to rescind
Say, / didn0t resell any sec0s( t!e only people w!o boug!t are 'B</? not members of t!e
public
So, it !as to be not public offering under Sec 52"
Ralston Purina said t!at 'ere concerne# '%th not only .eo.le 'ho &o!(ht $ec$" &!t l$o
'%th .eo.le to 'ho/ $ec$ h+e &een offere# - offeree$
1 law# offer is communications w!ic! ripen into 1 w!en smb says A, acceptH( in t!is conte7t,
offer %$ co//!n%ct%on$ to .eo.le tht there$ $/th here they co!l# &!y
Say, issuer goes broke bankruptcy$ ' wants out of t!e deal sec0s are not registered '
!as rig!t to rescind unless e7emption$ ?7emption depends on transaction not involving
public offering. I$$!er h$ &!r#en of .roof. 8!o is representing t!e issuer at t!is point
trustee in bankruptcy, w!o !as to prove t!at t!ese people are t!e only offerees$ :ormer mgmt
will know w!o offerees are, but mgmt won0t come to court to testify on trustee0s be!alf$ So,
' can rescind bec of trustee0s inability to prove t!at offerees are not members of t!e public
and so, inability to prove means no availability of e7emption
'fter Ralston Purina, w!at !appened w.Sec 52" e7emption# most sop!isticated buyers sued
to rescind after t!e deal didn0t turn out well, bec not only &!yer$" &!t offeree$ co!l# $!e ,
hr# to .ro+e 'ho offeree$ re$
<ontinental %obacco# issuer made an offering doc0nt put all info as to offerees( deal failed( one
of buyers sued for rescission$ %rustee says# we !ave proof on w!o offerees are$ <ourt# no Sec
52" e7emption Rl$ton 0!r%n $y$ tht offeree$ $ho!l# h+e %nfo n# cce$$ to %nfo: Not
only #%# yo! h+e %nfo" &!t l$o tht yo! co!l# h+e %nfo 'hether or not %$$!er 'nte# to
(%+e %t to yo! , yo! /!$t h+e h# cce$$ to ##%t%onl %nfo
So, Sec 52" e7emption !as always been limited
But generally, limit offers and sales" of securities to institutional investors sop!isticated"
*1- Who %$ n !n#er'r%ter@
Sec 5)" e7empts from Sec 6 registration re20nt Atransactions by any person ot!er t!an issuer,
underwriter, or dealerH
Sec 1*11- #ef%ne$ B!n#er'r%terC#
)$ any person w!o purc!ases from an issuer '%th +%e' to #%$tr%&!t%on of security
2$ any perso w!o offers or sells for an issuer in connection wit! distribution
+$ any person w!o participates or !as direct or indirect participatioon in t!e activities
covered by ) or 2 above
5$ any persoon w!o participates or !as participation in direct or indirect underwriting of
suc! undertaking
2J
%!e term AunderwriterH #oe$ not %ncl!#e persons w!ose interest is limited to a commission from
an underwriter or dealer not in e7cess of t!e usual and customary distributor0s commission
%!is language is intended to distinguis! selling group of dealers involved in t!e
initial distribution from sub3underwriters$
So, for person to be an underwriter, purc!ase, sale, or underwriting activity at issue must be
in connection wit! :ISTRI7?TION$
/istribution is not defined in t!e 'cts probably coterminous wit! public offering"$
S?< v$ <!inese <onsolidated Sec 3*1- e;e/.t%on< 8ont%n!l $ol%c%tt%on$
2d <ir )*5)"
/.CI corp sold bonds of <!inese gov0nt$ Bonds were never registered$ / didn0t !ave 13
tual relations!ip w.Bank of <!ina to w!ic! money was to be delivered" or gov0nt of <!ina$
<!inise gov0nt didn0t !ave agr0nt w./$ / volunteer got not!ing out of t!is patriotism$
/ was sued for violation of Sec 6$ Sec0s are not registered, so t!ere is violation, unless
e7emption under Sec 5)"$
Sec 2))" definition of underwriter# ABoffers or sells for an issuer in connection wit!, t!e
distribution of any securityH$ %o be underwriter, you !ave to be someone w!o gets sec0s wit!
a view of distribution$ %!e words Asell for an issuer in connection wit! t!e distribution of
any securityH oug!t to be read as covering cont%n!l $ol%c%tt%on$" 'h%ch nor/lly 'o!l#
re$!lt %n #%$tr%&!t%on of %$$!e$ of !nre(%$tere# $ec!r%t%e$ '6n the ?S$
How do you get sec0s sold9 Sec 6a" 3 you register sec0s
Sec 4*- Ho' $ec$ re re(%$tere#. Only the %$$!er cn re(%$ter $ec$ '%th one e;ce.t%on:
!n#er'r%ter cn re(%$ter $ec$ of fore%(n (o+nt.
Held# / is an underwriter !e sold sec0s distribution$
S?< v$ Nuild :ilms Sec 3*1- e;e/.t%on< Sec$ $ collterl for lon$ fro/ &n)$
2d <ir )*J0"
%!is case !ad tremendous conse2uences w.r.t private small co0s being sold to large co0s$
Oacobs
Stranton sub"
Hal Roac! sub"
8Rsub" and Rabco sub"
Hal Roac! borrowed @)20,000 from 2 <alifornia banks$ Roac! posted collateral for loans s!ares of
Oacobs listed on CIS?$ CIS? suspended trading on Oacobs0 stock$ Banks got suspicious, but
e7tended loan for add0l collateral$ Nuild :ilms made a deal to buy a ma&or asset of Hal Roac! in
e7c!ange for 500,000 s!ares of Nuild :ilm stock$ Buyer.8R and Rabco gave an investment
representation# t!at t!ey boug!t sec0s w.o any view of distribution$ Restriction was stamped on stock
certificates, t!at stock was issued for investment only, and cannot be transferred in t!e absence of
effective registration statement$ S?< suspended all trading on Oacobs0 stock$ Banks said t!at t!ey0ll
call stock rig!t now want to sell it$ Banks asked Nuild :ilms for clean certificate, but Nuild :ilms
wouldn0t do t!at$ Banks sued Nuild :ilms in CI state court, and court orders Nuild :ilms to issue
clean certificates to t!e banks$ S?< now sues Nuild :ilms to restrain t!e delivery of s!ares and sale of
stock$
8!y not &oin S?< as a party in t!e )
st
suit9 Iou cannot sue or &oin S?< under :octr%ne of So+ere%(n
I//!n%ty# you can0t sue sovereign in its own courts w.o its consent$
S?< position# t!ese transactions would be in violation of Sec 6$ Bank# we !ave e7emptions
under Sec 5)"$ 8e are not issuers, not dealers underwriters9
Prior position# w!en sec0s as collateral you can sell sec0s if deal doesn0t work it0s a
permissible transaction doesn0t re2uire registration, bec you contemplate t!at borrower will
pay you back position t!at banks are stating !ere$
2G
%!is is a loan w!ic! is already in default# t!e assets were not pledged until loans were already
in default$
So, t!e pledgor, a controlling s.!, pledged as collaeral for loan from bank a substantial
block of sec0s t!at bore a restrictive legend on t!e face of securities$ 'fter s.! defaulted
on t!e loan, bank, knowing of t!e restrictive legend, sold some of t!e securities w.o
registration statement being filed$ 1# 8%r hel# tht &n) '$ n !n#er'r%ter$
,s Rabco an underwriter9 yes( Roac! underwriter( banks underwriters$ Result is
incontestible$ But 2d <ir responds inappropriately to banks0 claim t!at t!ey purc!ased w.o
view of distribution t!at t!ey were bona fide pledgees$ <ourt# statute doesn0t impose suc! a
good fait! criterion# regardless of good fait!, banks engaged in steps necessary to t!is public
sale, and cannot be e7empted$
S8!ere a non3control person purc!ases unregistered security for t!e purpose of long3term
investment, court will not find t!at security was purc!ased w.view toward distribution !old
for + years"
?ven w!en t!ere is no investment intent, resale of unregistered securitly by non3control
person only constitues distribution if resale violates criteria of issuer0s original e7emptionT
Hypo
U corp# !as public s.!s t!ere0s public market", but most of stock is owned by U$ U comes to
banks wants to borrow money will pledge stock of U corp$ Banks says# look at Nuild
:ilms %f &n) t)e$ $ec$ $ .le#(ee" %t .!rch$e$ %ntere$t %n $ec$ &ec of .o$$%&%l%ty
tht yo! h+e to $ell $ec$ to (et /oney &c)" n# then &n)$ %$ cq!%r%n( $ec '%th
+%e' of #%$tr%&!t%on$
1 #ef%n%t%on$ of %$$!er
I$ L n %$$!er for .!r.o$e$ of Sec 1*3- , no
I$ L n %$$!er for .!r.o$e$ of Sec 1*11- - ye$
2d <ir# if you take sec0s as collateral you0re an underwriter no Sec 5)" e7emption
available w!en you sell so, you don0t realistically do t!e deal
'merican law is un!ospitable to efforts of !aving family business from generation to
generation t!is will ruin us"$
Iou can only register sec in contemplation of immediate sale = S?< will let you register
sec0s for t!e purposes of bank loan at corp0s s.!s0 cost"$ 8!en register sec0s prospectus,
w!ic! is delivered w.sec w!en sell sec$ Iou !ave to amend.rewrite prospectus every several
mont!s to keep it current add0l cost Aever3green prospectusH$
%!e only t!ing to do sell your co$
*1- Who %$ Sec 1*11- %$$!er
Sec 1*3-# At!e term issuer means every person w!o issues or proposes to issue any securityBH
corp itself"
Sec 1*11-# t!e term AunderwriterH means any person w!o !as purc!ased from an issuer 3
ABt!e term %$$!er s!all include, in addition to an issuer, any person directly or indirectly
controlling or controlled by t!e issuer, or any person under direct or indirect common control
wit! t!e issuerH
So, for purposes of determining w!o is an underwriter, a 2))" issuer is
)$ any issuer as normally defined under 25"
2F
2$ any person directly or indirectly controlling t!e issuer
+$ any person directly or indirectly controlled by issuer
5$ any person under direct or indirect common control wit! t!e issuer
,n re ,ra Haupt Sec 3*3- &ro)er(e e;e/.t%on
S?< )*5J" ?n#er'r%ter chrcter%Gt%on tr!/.$ &ro)er(e e;e/.t%on
,ra Haupt used to be a ma&or brokerage firm$
%!is is disciplinary proceeding ag ,ra for violation of Sec 6
Park Q %ilford !as FK of public stock traded on CIS? and *2K of stock owned by Sc!ulte
family$ P Q % announced t!at it will issue a dividend in kind to its s.!s of record, consisting
of w!iskey$ 4gmt of P Q % wants ,ra to act as broker to sell about 200 s!ares every 2uarter
point up stock goes up sell about 200 s!ares more"$ Price of stock went up, so ,ra sold
about 200 s!ares w!en stock went 2uarter point up distributed a big part of stock$ S?<
starts suit$ ,ra claims Sec 55" brokerage e7emption$
Sec 3*3- Sec 6 s!all not apply to &ro)er$ trn$ct%on$ e;ec!te# !.on c!$to/er$ or#er$ on
ny e;chn(e or %n the o+er-the-co!nter /r)et &!t not the $ol%c%tt%on of $!ch or#er$$
But not solicitation of buyer orders to w!ic! you0re selling# broker can only sell into open
market w!en smb else prepared buyers permissible transaction$
,ra# we did not!ing to find buyers t!ey were already t!ere( we only sold into t!at market(
w!at statute says is an e7empt transaction$
SE8: &ro)er(e e;e/.t%on %$ co/.le/ent to Sec 3*1- e;e/.t%on. Here" yo!r
&ro)er(e ct%+%ty %$ effect%+ely !n#er'r%t%n(: yo!re $ell%n( on &ehlf of %$$!er.
SE8: !n#er'r%ter chrcter%Gt%on tr!/.$ &ro)er(e e;e/.t%on.
:%$tr%&!t%on h$ &een hel# to co/.r%$e the ent%re .roce$$ &y 'h%ch %n the co!r$e of
.!&l%c offer%n( the &loc) of $ec$ %$ #%$.er$e# n# !lt%/tely co/e$ to re$t %n the hn#$
of the %n+e$t%n( .!&l%c.
Sec 3*3- %$ only %nten#e# to e;e/.t or#%nry tr#%n(" not $ell%n( for n %$$!er '%th
+%e' of #%$tr%&!t%on. So, broker w!o sold large blocks of s!ares was acting as an
underwriter and couldn0t get an e7emption$ Here distribution$
Problem# suppose U wants to get not a lot of money( wants broker to sell 200 s!ares$ But if
distribution you don0t !ave broker0s e7emption$
S?< adopted Rule )65 long gone" )K rule intended to give some comfort to t!e broker
Cew problem for U# !e can sell some modest amount of s!ares !ow many9 = sell every J
mont!s will be deemed distribution$
Co suggestion t!at any proceedings be broug!t ag$ Sc!ulte# view was t!at you could do
not!ing to Sc!ultes bec t!ey !ave Sec 5)" e7emption oversig!t in drafting"$
-S v$ 8olfson No e;e/.t%on for control .er$on$
2d <ir )*JF" 8ontrol
I$$!er$6control .er$on$ +%olte# Sec = &ec they $ol# !nre(%$tere# $hre$ thro!(h
&ro)er(e ho!$e$. %!ey claimed t!at t!ey didn0t know about registration re2uirements$
%!ey argued t!at t!ey come w.n Sec 5)" e7emption$
Hel#: &ro)er$ 'ere !n#er'r%ter$< TRANSA8TIONS &y !n#er'r%ter$ , no Sec 3*1-
e;e/.t%on. Sec 5)" e7empts transactions, not persons$ So, court c!aracteri;es brokers in
t!is case as underwriters, even t!oug! t!e brokers !ad no knowledge t!at a distribution was
taking place$
2*
Slain# it makes no sense repeals Sec 5)" e7emption 2uestion is not w!et!er transaction
involves an issuer, inderwriter, or dealer, but w!et!er it is by one of t!em"$ %!is analysis !as
never been applied to anyt!ing else limited to its facts$
Sec 3*3- '$ #e$%(ne# only to e;e/.t the &ro)er$ .rt %n $ec!r%ty trn$ct%on$. 8ontrol
.er$on$ /!$t f%n# the%r o'n e;e/.t%on$$
Broker can claim t!e e7emption of Sec 55" if !e was unaware t!at !is customer0s part in t!e
transaction is not e7empt$
Cot S?< proceeding$ ,t0s criminal prosecution$ Co reference to any rule t!at /s violated
no suc! rule$ Co announcement of S?<0s position$ Here real uncertainty in t!e law$ S?<
wants to find a test case w!ic! it !opes to win, find very unpopular figure./, indicting !im
for crime and prosecuting !im and sending !im to prison like <!iarella"$ People are entitled
to reas notice as to w!at t!e law is$
'not!er problem w.t!is case# 8olfson is largest s.!( Nerbert is anot!er s.! and director of
corp$ 8!y is person selling on !is be!alf !ere brokers" an underwriter9 bec Nerbert is an
issuer under Sec 2))"( !e is not an issuer under Sec 25"# t!e issuer of sec0s is corp itself$
-nder Sec 2))" is Nerbert #%rectly controll%n( t!e issuer9 yes, bec !e is 8olfson0s
associate, works w.8olfson on many t!ings( !e is part of controlling person$
8ontrol
8!at do you mean by control9 Mo! h+e control 'hen yo! re $o/e&o#y 'ho cn (et
the cor. to re(%$ter $ec$ %f yo! 'nt %t #one
Here, 8olfson is controlling s.!$ %!is definition doesn0t necessarily describe any one
director$ Status of officer or director !as never been s2uarely !eld to constitute controlling
person$ But all directors toget!er yes, control$ ,t0s a very amorp!ous concept$
' ma&or creditor, customer, e0ee can be controlling person$
'rticle A8!o0s P,n <ontrol09H
S?< Rule 506# At!e term control means t!e possession, direct or indirect, of t!e power to
direct or cause t!e direction of t!e management and policies of a person corp", w!et!er
t!roug! t!e owners!ip of voting sec0s, by 1, or ot!erwiseH
%!e power to control, even if une7ercised, may constitute a person a controlling person
?it!er t!e power to control or t!e actual e7ercise of control is sufficient to make a person a
controlling person
How little stock may a person own or !ave t!e power to vote and still be considered a
controlling person9 record or beneficial owners!ip or rig!t to vote" )0K or more of t!e
voting stock of a corp( can be less t!an )0K$
8!ile unencumbered owners!ip of more t!an 60K of t!e outstanding voting power of corp
will usu constitute control even t!oug! une7ercised simply bec t!e power to control is t!ere,
owners!ip of substantially less t!an 60K of stock may be indicative of control only if t!e
power in!erent in t!e voting power !as in some fas!ion been manifested t!roug! t!e e7ercise
of control, usu t!roug! t!e election of a favorably inclined ma&ority of t!e board of directors$
%!e searc! for controlling group commences w!en t!e searc! for controlling person fails
w!en a single person doesn0t appear to !ave actual operating control or t!e power to
control"$
%!e test # taking into account !istory, family, business affiliations, s!are!oldings, position and
all t!e ot!er cir0ces, w!at person or group calls t!e day3to3day s!ots9 %!e s!ots in ma&or
matters9 8!o could, if it wis!ed, call t!ose s!ots9
1. E;e/.t Sec!r%t%e$
+0
Sec 3 of 33 Act
)0 categories, several of t!em involve e7empt transactions
Sec 3*-*1--3*-*N- , .er/nent e;e/.t%on$
Sec +a"2"# any sec issued or guaranteed by any fed, state or territorial gov0l entity or by a nat0l
or state bank
Sec +a"+"# s!ort term notes or bills of e7c!ange w!ic! arise out of a current trans0n
Sec +a"5"# sec0s of nonprofit, religious, educational, fraternal or c!aritable institutions
Sec +a"6"# sec0s of certain savings and loan associations and farmers0 cooperatives
Sec +a"J"# interests in railroad e2uipment trusts
Sec +a"G"# certificates of a receiver, or trustee or debtor in possession in a bankruptcy
proceeding, w!en issued wit! court approval
Sec +a"F"# insurance policies or annuity 1s, issued sub& to supervision of a domestic gov0tal
aut!ority
%!ese are e7emptions from Sec 6
%!ese sec0s are still sub&ect to sec )22" and Sec )G anti3fraud provisions$ /iff rules apply#
t!ese two sections treat e7empt sec0s differently and differently from eac! ot!er$
/iscontinuity bet e7empt sec0s in Sec + and sec0s t!at are e7empt under Sec )2g" of +5 'ct$
:or e7ample#
Sec +a"2" any sec issued or guaranteed by a bank e7empt sec$ Co corresponding
e7emption under Sec )2g" bank wit! number 2ualifications" !as to register under Sec
)2$
Sec +a"F" e7empts insurance 1s from ++ 'ct reg0n re20nts# typical insurance 1s meet
t!e definition of investment 1s, but it doesn0t e7empt stock and debt of insurance co
stock and debt !ave to be registered$ But Sec )2g"2"N" of +5 'ct stock of insurance
co0s is e7empt from Sec )2$
Savings and loan ass0ns are e7empt from bot! +a"6" of ++ 'ct and )2g"2"<" of +5
'ct$$
Sec 3*-*9--3*-*11- , te/.orry e;e/.t%on$
Sec0s are e7empt only for purposes of particular tras0n described in t!is section# ##%t%onl
trn$ct%on e;e/.t%on$
Sec 3*-*9-
Sec e;chn(e$ &y the %$$!er '%th %t$ e;%$t%n( $6h$ e;cl!$%+ely 'here no co//%$$%on or
re/!nert%on %$ .%# for $ol%c%t%n( $!ch e;chn(e" e;ce.t $ec$ e;chn(e# !n#er T%tle 11
%itle )) of -S <ode# bankruptcy$
,t doesn0t mean t!at sec once e7empt is e7empt in t!e !ands of purc!asers# e7emption covers
only particular trans0n# mostly covers conversion of convertible sec0s# underlying common
delivered to you as a result of conversion doesn0t !ave to be registered e7empt trans0n$
S!..o$e %$$!er h$ to tl) .eo.le %nto con+ert%n( , $t%ll e;e/.t trn$n@ , h$ to &e no
re/!nert%on .%#$ <onvertible sec0s get converted bec issuer calls sec0s everybody
converts so, issuer doesn0t !ave to do anyt!ing to convert but call sec0s$
S!..o$e $ec %$ con+ert%&le &!t not re#ee/&le , then %$$!er h$ to tl) .eo.le %nto
con+ert%n( , no e;e/.t%on %f yo! .y .eo.le to %n#!ce the/ to con+ert$
S?<0s position# w!en corp uses its own e0ees ok( but if it !ires outside pro7y solicitors no
e7emption$
+)
Sec 3*-*1D-
E;ce.t $ec$ e;chn(e# !n#er T%tle 11" e;chn(e of $ec$ 'h%ch %$ ..ro+e# fter
her%n( !.on the f%rne$$: 'here co %$$!e$ $ec$ to $t%$fy cl$$ ct%on $ettle/ent
settlement of class action ag a corp re2uires approval after a !earing"
Prior to )*GJ t!is applied to bankruptcy reorgani;ation, but in )*GJ, <ongress put t!is
clause in Bankruptcy <ode itself and made t!is section inapplicable in t!e Sec 'ct
Sec 3*-*11-
5ocl6%ntr$tte offer%n( e;e/.t%on : ny $ec 'h%ch %$ .rt of n %$$!e offere# n# $ol#
only to re$%#ent$ of $%n(le $tte or terr%tory" 'here the %$$!er of $!ch $ec %$ .er$on
re$%#ent n# #o%n( &!$%ne$$ '6n" or" %f cor." %ncor.orte# &y n# #o%n( &!$%ne$$ '6n"
$!ch $tte or terr%tory.
0ro&le/ of %nte(rt%on of offer%n( , /r%tl #%$&%l%ty .ro&le/
,ssuer wants to make an offering, finds 6 buyers !as to be Sec 3*1- e;e/.t%on
*non-.!&l%c offer%n(-
,t0s a R, corp$ 5 buyers live in R,, ) buyer lives in CI still Sec 52" e7emption
%!en corp decides to sell sec0s in R, as a public offering$ Sec 3*-*11- permits issuer
to make a .!&l%c offer%n( %n one $tte $
Problem# is t!is ) or 2 offerings9 ,f it0s ) integrated offering we !ave no
e7emption under 52" bec offering is now public, and we !ave no e7emption under
+a"))" because ) buyer lives outside R, /r%tl #%$&%l%ty .ro&le/# you can0t
put t!ese 2 e7emptions toget!er everyone in bot! offers may be able to rescind
under Sec )2"
+a"))" sec0s are only e7empt for purposes of %n%t%l offer%n( &y %$$!er$ ,ssuer sells t!em in
R, it doesn0t mean t!at t!ey !ave to stay in R,$ But if purc!asers are underwriters w!o
distribute t!em outside R, How long do t!ese sec0s !ave to stay in R,9 When #o $ec$
co/e to re$t@
8!at do you mean by resident of t!e state9 S?<# re$%#ent your presence in t!e state"
/en$ #o/%c%l%ry intent to stay"$ But salesman won0t be able to ask every purc!aser t!at$
8!at do you mean by #o%n( &!$%ne$$ '6n the $tte9
)$ most business in t!e state
2$ you plan to use proceeds from offering w.n t!e state w!at do you mean by t!at"
S?<# very narrow reading of +a"))"
Problems
*1-
,ssuer wants 52" e7emption$ Selling to any number of institutional investors institutions"
ok, non3public offering$ However, issuer !as to establis! t!at t!ere are no .!&l%c offeree$
not only buyers"# concept of offering is broader t!an 1 concept of offering$
Iou !ave to establis! t!at none of the/ re !n#er'r%ter$ , h+ent cq!%re# $ec$ '%th
+%e' of #%$tr%&!t%on you !ave to !ave ac2uired sec0s wit! a view of !olding sec0s as an
investment"
8hn(e of c%rc!/$tnce$ doctrine# if cir0ces c!anged ok, can sell sec0s, but !as to be
!nfore$ee&le c!ange of .er$onl cir0ces not cir0ces of t!e world around"$ S?<# almost
anyt!ing is foreseeable$ But t!is !as not!ing to do w.investor protection$
8once.t of cce$$ to %nfo separate from !aving info, so really t!e only people you can sell
sec0s to is t!e mgmt bec mgmt !as access to info"
+2
*1- 5oc)e#-%n hol#er$
a" Sec 3*1- &!yer w!o boug!t wit! view ot!er t!an to distribution"$
S?<# t!e longer you !ave !eld t!e sec t!e better, but no t%/e %$ #%$.o$%t%+e
I!n(&%l%ty #octr%ne
Say, ,0m a 52" buyer of sec0s, , !eld t!em for 55 years is it fair to say t!at , boug!t t!em wit!
view ot!er t!an to distribution9 yes, ,0m not an underwriter, can sell t!ese sec0s$ But , also
boug!t sec0s last year as to t!ese sec0s, it0s not clear if ,0m an underwriter so , can0t sell t!ese
sec0s bec , mig!t be an underwriter$ S?<# , always was deemed to be selling t!e ones t!at , could
not sell ,0m an underwriter w.r.t older stock all stock if fungible, so if person makes two purc!ases
of stock in )*)) and in )*65, and t!en sells stock in )*66, !e is an underwriter w.r.t )*)) stock"
*&- 8ontroll%n( .er$on
'll problems of locked3in buyer, but also problem w.r.t sec0s w!ic! person ac2uired in t!e open
market, &ec .er$on #el%n( '6h%/ cn &e !n#er'r%ter '6n 1*11-$ Ho' #o 'e tell tht he %$
controll%n( .er$on@ t!e 8olfson problem any broker w!o sells securities for you carries t!e
risk of being deemed an AunderwriterH"$
System was so complicated, non3functional, nobody could understand it so it was about to
collapse bec of massive public disobedience$ S?< perceived t!at and in )*J5, formed a
study group result was the Whet Re.ort# said t!at t!ere0ll be massive public disobedience
bec people couldn0t understand it", unadministrability( system !ad to be simplified(
availability of e7emption !ad to be ob&ectively ascertainable( S?< could do it by rules
doesn0t need <ongress"$
R!le$ 133" 13=" 134" 132" 13N
)55 deals w.problems of locked3in s.!( !uge success almost no litigation"
)56 solution to problem t!at never really e7isted special problem of mergers( Slain# it will be
rescinded or greatly amended soon
)5J deals w.private placement problem( disaster no longer e7ists( was abandoned in favor of
Regulation / Rules 60)360F"
)5G deals w.intrastate offering +a"))"
)5F bankruptcy reorg sales, bec moot w!en <ongress in )*GJ put e7emption out of Sec 'ct into
Bankruptcy <ode no longer e7ists
?7treme difficulty w.financing new business in t!e )*G0s# no possibility t!at a startup co
could register and publicly sell stock# could find underwriter( nobody would buy t!e sec$ So,
to go publicly, co !ad to !ave a successful private placement$ ,n order to !ave successful
private placement co !ad to !ave sit0n of stability# confidence t!at s.!s wouldn0t suddenly
decide t!at t!ey want t!eir money back$ Cew co0s couldn0t get financing$
<ongress enacted Sec 5J" and Sec 2)6" to fi7 private placement sit0n
Sec 3*4- %!e provisions of Sec 6 s!all not apply to trans0ns involving offers or sales by
an issuer solely to one or more ccre#%te# %n+e$tor$, if t!e aggregate offering .r%ce of an
issue of sec0s #oe$ not e;cee# O= /%ll%on, if t!ere is no #+ert%$%n( or .!&l%c
$ol%c%tt%on in conn w.t!e trans0n by t!e issuer or anyone acting on t!e issuer0s be!alf,
and if t!e issuer files notice w.t!e <ommission dead letter"
++
Sec 1*1=- defines Aaccredited investorH certain institutional investors 3 bank, insurance
co, investment co, etc = any person w.certain level of fin sop!istication to be defined by
S?<"
Nrant of aut!ority to S?<# under grant of aut!ority in Sec 3*&-, S?< can grant e7emptions %f
the ((re(te /o!nt t 'h%ch %$$!e of $ec$ %$ offere# to the .!&l%c %$ le$$ thn
O=/%ll%on.
%!ese are le(%$lt%+e r!le$# e7empt any trans0n up to @ amount$ ,f leg rule agency !as
to go t!roug! administrative procedure$
Inter.ret%+e r!le$# like S?<0s interpretation of Sec 52" represent agency0s view of t!e
statute$ S?< !as aut!ority to administer statute( but not to amend it$ Co re20nt of going
t!roug! administrative procedure w.r.t interpretive rules, but normal practice of S?< and
,RS is to publis! t!em in t!e :ederal Register so diff0ce doesn0t !ave practical
cons0ces$ ,nternal Revenue <ode mostly interpretive rules$
<!estman # difference bet Rule )0b36 and Rule )5e3+ leg rule$ <ourt0s $tn#r# of re+%e'
w!ere c!ange is made to leg rule v$ interpretive rule#
,nterpretive rule # court will defer to agency0s view of statute until it concludes t!at
agency is wrong more stringent$ %!ere are ot!er possibilities of interpreting t!e statute,
ot!er t!an t!e one t!at S?< argues for$
Meg rule # t!e only in2uiry is w!et!er t!is is w.n t!e scope of aut!ority granted to S?< by
<ongress$ Practically no c!ance t!at court will conclude t!at leg rule is invalid$
Say, , act in reliance on one of rules of Regulation /$ Some rules are adopted pursuant to
grant of aut!ority in Sec +b" leg rules( ot!er rules are adopted pursuant to grant of
aut!ority in Sec )*a" to adopt rules and regulations as may be necessary to carry out t!e
provisions of t!is title$ , sell sec0s in reliance on one of t!ese rules w!at is t!e risk t!at Sec
will go after me bec it determines t!at t!e rule is invalid9 no risk$
?n#er Sec 19*-, %f co/.ly '%th r!le %n (oo# f%th" n# r!le %$ lter #eter/%ne# to &e
%n+l%# , no l%&%l%ty *$fe hr&or-. ?nt%l S.8t $y$ tht r!le %$ %n+l%# , cn rely on
%t.
Sec 19*- of 33 Act gives S?< plenary aut!ority over accounting in conn wit! registration
S?< responded wit! Regulation /
ASSIGNMENT NO. 3 , THE 1933 A8T ELEM0TIVE R?5ES
Re(!lt%on :" R!le =D1-=DN
'n effort to remove t!e impediments to capital formation by small businesses( result of
S?<0s evaluation of t!e impact of its rules and regs on t!e ability of small business to raise
capital
Relies on bot! Sec +b" and Sec 5J"
Rules 60)360+ definitions, terms, and conditions
Rules 605 and 606 provide e7emptions from registration under Sec +b" leg rules"
Rule 60J transactions t!at are deemed to be e7empt from registration under Sec 52"
interpretive rules"
+5
0rel%/%nry note$
)$ Reg / offerings are e7empt from Sec 6 registration re20nts, but are not e7empt from anti3
fraud, civil liability, or ot!er provisions of t!e fed securities laws
2$ Cot!ing in t!ese rules obviates t!e need to comply w.any applicable state law relating to t!e
offer and sale of sec0s
+$ 'ttempted compliance w.any rule in Reg / does not act as an e7clusive election( t!e issuer
can also claim t!e availability of any ot!er applicable e7emption
5$ %!ese rules are available only to t!e issuer, not to any affiliate of t!at issuer or to any ot!er
person for resales of t!e issuer0s sec0s
6$ <onfirms availability of Reg / for business combinations
J$ Cote J appears in all S?<0s rules# Reg / is not available if you structure trans0n so t!at it will
look like tec!nical compliance w.rules, but it is instead part of a plan or sc!eme to evade t!e
registration provisions of t!e 'ct registration is re2uired
G$ Sec0s offered and sold outside t!e -S in conformity w.Reg S may be conducted
simultaneously w.offers and sales w.n t!e -S in acc w.Reg / w.o causing t!e two
transactions to be integrated
R!le =D1 :ef%n%t%on$
=D1*- defines F categories of accredited investors
)" institutional investors
2" private business development co0s
+" ta7 e7empt organi;ations
5" directors, e7ecutive officers and general partners of t!e issuer of sec0s
6" @),000,000 net wort! test# any natural person w!ose individual net wort!, or &oint net
wort! wit! t!at person0s spouse, at t!e time of !is purc!ase e7ceeds @)million
J" @200,000 income test# any natural person w.ind0l income in e7cess of @200,000, or if
&oint income, in e7cess of @+00,000
G" trusts w.assets e7ceeding @6,000,000
F" any entity in w!ic! all of t!e e2uity owners are accredited investors
60)a" concept of accredited investor is broader t!an definition of accredited investor in Sec
2)6"
<oncept of Ralston Purina t!at if people don0t need protection of t!e 'ct, t!e issuer doesn0t
!ave to register, t!at people can t!en Afend for t!emselvesH
,n a"6", is issuer sop!isticated9 no$ ,t0s not t!at t!ese people are in!erently sop!isticated
t!ey !ave money to !ire sop!isticated people if t!ey don0t !ave sop!istication t!emselves$
Cet wort! t!e aggregate market value of assets less obligations$ But it0s diff in diff parts of
t!is country bec of diff costs of !ousing$ ,n CI, you can !ave @)million &ust by reason of
!aving @)million !ouse( but t!at0s not true in 4aine$ So, a"6" is defective in not e7cluding
t!e value of personal residence
=D1*&- 'ffiliate
=D1*c- 'ggregate >ffering Price
=D1*#- Business <ombination
=D1*e- <alculation of Cumber of Purc!asers# !ow to calculate t!e number of purc!asers under
Rules 606 and 60J$
:amily members t!at live in one residence are considered to be one purc!aser
60)e")"iv" %!e following purc!asers s!all be e7cluded# 'ny accredited investor
=D1*f- ?7ecutive officer
+6
=D1*(- ,ssuer
=D1*h- Purc!aser Representative# buyers t!emselves don0t !ave to be sop!isticated( buyer !as to
!ave purc!aser representative, w!o is sop!isticated$
R!le =D1 Generl 8on#%t%on$ to 7e Met
=D1*- Inte(rt%on# all sales t!at are part of t!e same Reg / offering must be integrated$ %!e
rule provides a safe !arbor for all offers and sales t!at take place at least J mont!s before t!e start
of or J mont!s after t!e termination of t!e Reg / offering, as long as t!ere are no offers and
sales, e7cluding t!ose to e0ee benefit plans, of t!e same sec0s w.n eit!er of t!ese J3mont! periods
= factors to determine w!et!er t!ere s!ould be integration"$
So, offers made J mont!s apart will not be integrated as a single offer
Solves problem of marital disability of offerings
Nives good description as to t!e body of law and safe !arbor
:actors indicating t!at offers will be integrated#
a" 're t!e sales part of a single plan of financing
b" /o t!e sales involve issuance of t!e same class of securities
c" Have t!e sales been made at or abou t!e same time
d" Has t!e same type of consideration been received
e" 8ere t!e sales made for t!e same general purpose
=D1*&- Infor/t%on Req!%re/ent$#
8!en issuer sells sec0s under Rules 606 or 60J differential standard w!en issuer is reporting or
non3reporting co#
,f issuer is non3reporting co same info as in Reg ' offering Rule 602b"2"i""
,f issuer is reporting co info t!at continuous disclosure system generates Rule 602b"
2"ii""
'dditional importation difference#
,f issuer sells only to accredited investors or under Rule 605 limited offerings less t!an
@)million" no info re2uirements
,f issuer sells to bot! accredited and non3accredited investors Rule 60)b")" re2uires
delivery of info specified in Rule 602b"2" to all purc!asers$
602b"v" %!e issuer !as to make available to eac! purc!aser due diligence opportunity
%!e rule focuses on info t!at must be furnis!ed to purc!asers, not offerees
Co info need be disclosed to accredited investors
=D1*c- 5%/%tt%on on Mnner of Offer%n(# ?7cept as provided in Rule 605b")", issuer cannot
use general solicitation or general advertising in conn wit! Reg / offerings
S?<# if issuer !as no prior relations!ip w.purc!asers general solicitation$ Pree7isting
relations!ip is an important factor in s!owing t!at t!ere is no public solicitation it enables t!e
issuer to be aware of t!e financial cir0ces or sop!istication of t!e persons w.w!om t!e
relations!ip e7ists"
P=D1*#- 5%/%tt%on$ on Re$le , +ery %/.ortnt# %!e issuer s!all e7ercise reas care to assure
t!at purc!asers of sec0s are not underwriters, w!ic! reas care will include certain in2uiry as to
investment purpose, disclosure of resale limitations and placement of legend on t!e certificate$
,f issuer sells sec0s purc!asers can resell people to w!om t!ey resell are part of t!e
universe of people to w!ic! issuer sold sec0s it0s critical t!at it doesn0t !appen$ Sec0s
+J
ac2uired under Reg / !ave t!e status of sec0s ac2uired in a 52" private placement, and can0t
be resold w.o eit!er registraiton or an e7emption$"
How to avoid it
)$ get investment letter agr0nt from purc!asers t!at t!ey won0t resell t!at t!ey are
buying for investment purposes only
2$ Slain# include an agr0nt to idemnify and !old !armless if investment representation
turns out to be wrong = you0ll !ave smb to sue"
=D1*#-*1- Reas in2uiry to determine if t!e purc!aser is ac2uiring t!e securities for !imself or for
ot!er persons
=D1*#-*1- 8ritten disclosure
P=D1*#-*3- , +ery %/.ortnt# Placement of legend on t!e certificate or ot!er document t!at
evidences t!e sec0s stating t!at t!e sec0s !ave not been registered under t!e 'ct and setting fort!
restrictions on transferability and sale of t!e sec0s
Sec is a negotiable instrument $ Person w!o takes negotiable instrument w.o notice is free and
clear of any obligations$ 5e(en# on the $ec!r%ty , con$tr!ct%+e not%ce to the 'orl# of the
fct tht there %$ re$tr%ct%on on the trn$fer( it doesn0t !ave to be actual notice$ So, it is
imperative safety device can0t be omitted$
?ssence of negotiable instrument integration$ Iou transfer all owners!ip in underlying
rig!ts in transferring a piece of paper$ 8!en stock certificate is issued, all rig!ts of s.!
become integrated in t!e certificate( w!en you transfer certificate you transfer all your
rig!ts$ Publicly !eld sec0s are certificated$
Con3certificated sec0s# you transfer rig!ts, but not in a piece of paper you transfer by 13tual
arrangements of t!e issuer$ 4ost debt sec0s are non3certificated$
R!le =D3 I%l%n( of Not%ce of Sle$
,ssuer offering or selling sec0s in reliance on Rules 605, 606 or 60J s!all file notice w.t!e
<ommission on :orm /
+ substantive e7emptive rules# 605, 606, 60J contrast w.Sec 5J"
Sec 3*4-
,ssuer 4anner of
Sale
>fferee
Lualifications
Purc!asers
Lualifications
Re2uired
/isclosures
Resale
Restrictions
any no advertising
no public
solicitation
ye$ *offere#
n# $ol# to
ccre#%te#
%n+e$tor$-
yes offered
and sold to
accredited
investors"
no yes Sec 52"
sec0s not
involving any
public
offering"
Sec 5J" statutory e7emption by <ongress"$ <an be used by any issuer( amount limitation
under Sec +b" of 6million$ Sec0s are restricted only for investment( can be sold only to
accredited investors
Sec 5J" is dead letter bec of offeree q!l%f%ct%on$ 4ost people using Rules 606 and 60J try
to limit t!eir sales to accreditors$ Sec 5J" !ad t!e same difficulty as Rule )5J in t!at it
governs not only sales, but offers# w!o offerees are( !ow many( w!et!er every offeree
satisfies statutory standard$ ,t made 5J" useless$ Statutory term is Apublic offeringH public
distribution of sec0s# no reason w!y t!is w!ole body of law s!ould depend on c!aracteristics
of offerees( !ow are offerees any worse off by reason t!at t!ey didn0t buy sec0s t!ey are no
worse off$ Problem wit! Sec 5J"# internal logic of Ralston Purina caused focus on offerees
now not used$
+G
Re( : big break in t!at yo! re only concerne# '%th ct!l &!yer$" not offeree$$
R!le =D3 E;e/.t%on for 5%/%te# Offer%n($ n# Sle$ of Sec!r%t%e$ Not E;cee#%n( O1"DDD"DDD
w.n )2 mont!s"
provides e7emption from registration under Sec 3*&- of ++ 'ct
cn only &e !$e# &y non-re.ort%n( %$$!er
a" E;e/.t%on# >ffers and sales of sec0s t!at satisfy t!e conditions in par b" of t!is Rule 605
s!all be e7empt from Sec 6 registration under Sec +b" e7emption, if t!e issuer is not
)" sub&ect to t!e reporting re20nts of Sec )+ or )6d" of +5 'ct ny non-re.ort%n(
%$$!er, but not
2" an investment co
+" a development stage co t!at !as no specific business plan or its business plan is to
engage in a merger or ac2uisition w.unidentified co blank c!eck offering
4anner of sale# no l%/%tt%on$ %f $tte re(%$trt%on ..l%e$ added so t!at state blue sky
laws could regulate really small offerings$ Plus, $ec$ re not re$tr%cte# %f $tte re(%$trt%on
..l%e$ buyer can turn around and sell it completely public kind of offering$ Slain# it0s a
great reform$ S?< regulatory system is on paper$ Small offerings very !ig! risk of fraud
not t!e kind of fraud t!at federal regulation is likely to catc! for e7ample, to c!eck of corp
sells oil, not water nat0l gov0nt can0t do it"$
Cow Sec 1N of 33 Act outlaws state regulation if sec0s are Acovered sec0sH#
Co state regulation s!all directly apply to a covered sec0ty( directly or indirectly
pro!ibit, limit, or impose any conditions upon t!e use of any offering doc0nt or pro7y
st0nt w.r.t covered sec0ty( directly or indirectly pro!ibit, limit, or impose conditions,
based on t!e merits of suc! offering or issuer, upon t!e offer or sale of any suc!
sec0ty$
Sec )F b" <overed securities#
)" nationally traded sec0s
2" investment 1s
+" sales to 2ualified purc!asers
,t eliminates capacity of state to license broker dealers w.r.t national sales$ Slain# t!is
is wrong !as to be bot! federal and state policing of broker dealers t!e more
policing t!e better"
R!le =D= E;e/.t%on for 5%/%te# Offer$ n# Sle$ of Sec!r%t%e$ Not E;cee#%n( O="DDD"DDD
w.n )2 mont!s"
provides e7emption from registration under Sec 3*&- of ++ 'ct for any issuer sub&ect to B&#
&oyC e;ce.t%on
a" >ffers and sales of sec0s t!at satisfy conditions in par b" by an issuer t!at is not an
investment co s!all be e7empt from Sec 6 registration under Sec +b" e7emption
,f you or your underwriter" !ave been marketed lousy you can0t use Regulation '$ Same
in Rule 606 Rule 606b")" %o 2ualify for e7emption under t!is Rule 606, offers and sales
must satisfy t!e terms and conditions of Rules 60) and 602"
@6million amount limitation of +b" up to @6million"
+6 purc!asers ot!er t!an unlimited accredited investors
+F
602b" info disclosure re20nts apply only if you0re selling to non3accredited investors( if you
sell only to accredited investors no disclosure re20nts
Co limitation on number of offerees w!o didn0t buy"
%!ese are restricted sec0s in t!e !ands of t!e buyer sub&ect to 602d" Mimitations on Resale
R!le =D4 E;e/.t%on for 5%/%te# Offer$ n# Sle$ W%tho!t Re(r# to :ollr A/o!nt of
Offer%n(
relates to transactions t!at are deemed to be e7empt from registration under Sec 3*1- of ++
'ct
60J offering is a covered security w.n t!e meaning of Sec )F
=D4*&-*1-*%%- Nt!re of .!rch$er$. ?ac! purc!aser w!o is not an accredited investor eit!er
alone or w.!is purc!aser representatives" !as suc! knowledge and e7perience in financial and
business matters t!at !e is capable of evaluating t!e merits and risks of t!e prospective
investment, or t!e issuer reasonably believes immediately prior to making any sale t!at suc!
purc!aser comes w.n t!is description $o.h%$t%ct%on reqnt
But not personal sop!istication is re2uired R!le =D1 .!rch$er re.re$entt%+e
Cow, purc!aser representative can be paid by issuer, if t!ere0s ade2uate disclosure
Rule 606 Rule 60J
Abad boyH e7ception
but not sop!istication re20nt
no Abad boyH e7ception
but t!ere is sop!istication re20nt, if ot!er t!an
accredited
Co policy !ere t!at differentiates bet t!e two rules$ 606 was adopted pursuant to S?<0s grant
of aut!ority in Sec +b" @6million limitation"$ Historically, t!is e7emption !ad a Abad boyH
e7ception part of Sec +b" &urisprudence$ So, S?< simply carried Abad boyH e7ception into
Rule 606
Rule 60J Ralston Purina case# t!is is part of Sec 52" written by decision in Ralston Purina
R!le =D2 :%$q!l%fy%n( 0ro+%$%on Relt%n( to E;e/.t%on$ ?n#er R!le$ =D3" =D= n# =D4
,f you don0t file :orm / under Rule 60+ bad t!ings will !appen$ Co e7emption under
Rules 605, 606 of 60J s!all be available for an issuer if !e0s been sub&ect to any order
en&oining !im for failure to comply w.Rule 60+$
R!le =DN In$%(n%f%cnt :e+%t%on$ Iro/ Ter/" 8on#%t%on or Req!%re/ent of Re(!lt%on :
I Q I #efen$e# creates a B%n#+ertent Q %//ter%l #efen$eC# buyer cannot rely on
defective compliance of Regulation / unless !e was pre&udiced by t!e defective compliance
,f issuer failed to comply w.Reg /, purc!aser boug!t t!e sec, wants to rescind says
e7emption under Rules 605, 606 or 60J is not applicable sec s!ould !ave been registered$
Rule 60F says# if error was inadvertent Q immaterial, purc!aser can0t rescind if no s!owing
t!at purc!aser is !imself pre&udiced by t!e defective compliance
)" failure to comply did not pertain to a re0nt directly inteded to protect t!e particular
individual w!o relied on Sec 6 e7emption
2" failure to comply was insignificant w.r.t offering as a w!ole see 60Fb"2" list"
+" issuer made good fait! and reas attempt to comply w.all of Reg /0s re20nts
But S?< may still sue for failure to comply w.Reg / under Sec 20
+*
R!le 2D1 E;e/.t%on for Offer$ n# Sle$ of Sec!r%t%e$ 0!r$!nt to 8ert%n 8o/.en$tory
7enef%t 0ln$ n# 8ontrct$ Relt%n( to 8o/.en$t%on
5" Only +%l&le to non-re.ort%n( %$$!er$. 'ffiliates of t!e issuer may not use t!is section to
offer or sell sec0s$ %!is section also does not cover resales of sec0s by any person$ %!is section
provides an e7emption only for t!e trn$ct%on$ in w!ic! t!e sec0s are offered or sold by t!e
issuer, not t!e sec0s t!emselves$
6" %!e purpose of t!is section is to .ro+%#e n e;e/.t%on fro/ the re(%$trt%on reqnt$ of t!e
'ct for $ec$ %$$!e# %n co/.en$tory c%rce$
aggreagate offering price of securities# up to @6 million during )2 mont!s"
:orm S3'# special form t!at issuer uses to register e0ee offers
Rule G0) covers 2 almost impossible sit0ns# )" !ig!3tec! start3up co0s and 2" Aguest
owners!ipH in close corps usu co0s sell stock to e0ees at book value( t!ere0s a 1 t!at e0ee
leaves t!e emloy, !e0s obligated to sell stock back to corp and corp is obligated to buy stock
back at book value t!at0s guest owners!ip# co doesn0t contemplate e0ees to be permanent
s.!s"
Con3reporting issuer can also use Rule 605
R!le 2D1 R!le =D3
)" Restricted.non3restricted sec0s purc!ased are restricted sec0s are not restricted if state
registration re20nts apply
2" ,ntegration of offerings
problem
Sales are not integrated wit!
ot!er offerings
if co sells sec0s to e0ees under
605 limited @ amount under
Rules 605 and 606
PR!le 133 0er$on$ :ee/e# Not to 7e En((e# %n :%$tr%&!t%on n# Therefore Not
?n#er'r%ter$
Purpose# provides a safe !arbor to persons !olding restricted sec0s of an issuer people w!o
boug!t sec0s in 52" trans0ns" and to affiliates of an issuer w!o seek to resell eit!er restricted
or unrestricted sec0s addresses t!e problem of t!e Alocked inH s.!"$
Provides a safe !arbor under 5)" e7emption for all s.!s w!o are selling t!eir restricted sec0s
and for affiliates w!o are selling t!eir unrestricted sec0s w.o registration, and a safe !arbor for
brokers under 55" e7emption w!o e7ecute suc! transactions$ ,f s.!s or brokers make a sale
in compliance w.Rule )55, t!ey will not be deemed to be underwriters or involved in a
distribution$
133*- :ef%n%t%on$
)" ff%l%te of the %$$!er is a person t!at directly, or indirectly t!roug! one or more
intermediaries, controls, or is controlled by, or is under common control wit! suc! issuer#
affiliate of t!e issuer is controll%n( .er$on
AaffiliateH Acontrolled by t!e issuerH contemplates a subsidiary or agent, w!o sells
for t!e issuer0s account( it !as never been applied to e0ee selling !is own sec0s even
t!oug! you can argue t!at every e0ee is controlled by !is e0er"
2" .er$on for w!ose account securiteis are to be sold in reliance upon t!is rule includes, in
addition to suc! person#
50
i" any relative or spouse of suc! person, or any relative of suc! spouse, any one of
w!om !as t!e same !ome as suc! person
ii" any trust or estate in w!ic! suc! person or any of t!e persons collectively own
)0K or more of t!e total beneficial interest or of w!ic! any of suc! persons serve
as trustee, e7ecutor or in any similar capacity
iii" any corp or ot!er organi;ation ot!er t!an t!e issuer" in w!ic! suc! persons" are
t!e beneficial owners collectively of )0K or more of any class of e2uity sec0s or
)0K or more of t!e e2uity interest
3- re$tr%cte# $ec$#
i" Sec0s ac2uired directly or indirectly from t!e issuer, or from an affiliate of t!e
issuer, in a transaction or c!ain of transactions not involving any public offering
ii" Sec0s ac2uired from t!e issuer t!at are sub&ect to t!e resale limitations of Rule
602d" under Regulation / or Rule G0)c"
133*&- 8on#%t%on$ to 7e Met substantive e7emptions
133*c- 8!rrent 0!&l%c Infor/t%on
,f t!e issuer is a re.ort%n( co sub&ect to Sec )+ or Sec )6d" of +5 'ct", it must be
up to date w.its filings
,f t!e issuer is a non-re.ort%n( co, t!e info contemplated by Rule )6c23)) must be
publicly available
133*#- Hol#%n( 0er%o# for Re$tr%cte# Sec$ covers restricted sec0s only ) year must elapse
between t!e later of t!e date of t!e ac2uisition of t!e sec0s from t!e issuer or from an affiliate of
t!e issuer, and any resale of suc! sec0s in reliance on t!is section for t!e account of eit!er t!e
ac2uiror or any subse2uent !older of t!ose sec0s( !as to be full purc!ase price or ot!er
consideration paid by t!e person ac2uiring sec0s from t!e issuer or affiliate of t!e issuer
133*e- 5%/%tt%on on A/o!nt of Sec$ Sol# in all )55 trans0ns, e7cept )55k" t!ere0s
volume limitation
*e-*1- Sle$ &y Aff%l%te$
,f RESTRI8TE: OR OTHER SE8S are sold for t!e account of affiliate of t!e issuer, t!e
amount of sec0s sold, toget!er wit! all sales of t!e same class for t!e account of suc! person w.n
t!e preceding + mont!s, s!all not e7ceed the greater of
)K of t!e s!ares or ot!er units of t!e class outstanding as s!own by t!e most recent
report or st0nt publis!ed by t!e issuer, or
t!e average weekly reported volume of trading in suc! sec0s on all national securities
e7c!anges and.or reported t!roug! t!e automated 2uotation system of a registered sec0s
association C'S/'L" during t!e 5 calendar weeks preceding t!e filing of notice re2uired by
)55!", or, if no suc! notice is re2uired t!e date of receipt of t!e order to e7ecute t!e trans0n by
t!e broker or t!e date of e7ecution of t!e trans0n directly wit! a market maker, orB
*e-*1- Sle$ &y Non-ff%l%te$
%!e amount of RESTRI8TE: SE8?RITIES for t!e account of any person ot!er t!an an
affiliate of t!e issuer, toget!er wit! all ot!er sales of restricted securities of t!e same class for t!e
account of suc! person w.n t!e preceding + mont!s, s!all not e7ceed
%!e greater of t!e number t!at would be calculated as above
7?T th%$ r!le #oe$ not ..ly %f R!le 133*)- %$ $t%$f%e#
133*f- Mnner of Sle
5)
:or all sales under t!is rule, t!e sale can only be done t!roug! eit!er#
)$ 55" brokers0 transaction or
2$ transaction directly wit! a market maker i$e$ >%< broker3dealer"
So, seller cannot#
)$ solicit orders to buy
2$ make any payment in connection wit! offer or sale of sec0sto any person ot!er t!an t!e
broker w!o e7ecutes t!e order to sell t!e securities broker0s commision"
133*(- 7ro)er$ Trn$ct%on$
Broker can only
)$ e7ecute a sell order as agent
2$ receive no more t!an t!e usual and customary commision
Broker cannot solicit customers0 orders to buy, but can talk to ot!er brokers or dealers w!o
!ave indicated an interest in t!e securities during t!e previous J0 days
Brokers are re2uired to make a reasonable in2uiry to determine if seller is engaged in a
distribution$ So, t!ey must ask about
a$ Mengt! of time seller !as !eld securities
b$ Cature of transaction in w!ic! securities were ac2uired by suc! person
c$ 'mount of securities of t!e same class sold during t!e past + mont!s by all persons
w!ose sales are re2uired to be taken into consideration under e"
d$ 8!et!er suc! person intends to sell additional sec0s of t!e same class t!roug! any
ot!er means
e$ 8!et!er suc! perosn !as solicited to buy orders in conn w.proposed sale of sec0s
f$ 8!et!er suc! person !as made any payment to any ot!er person in conn w.proposed
sale of sec0s
g$ Cumber of s!ares or ot!er units of class outstanding, or t!e relevant trading volume
133*h- Not%ce of .ro.o$e# $le
Iou must file :orm )55 w.S?< if you sell, during any +3mont! period, more t!an 600 s!ares
or ot!er units w.aggregatre price of more t!an @)0,000
B-% t!is notice re2uirement does not apply if Rule )55k" is satisfied
133*%- 7on I%#e Intent%on to Sell you can only fill :orm )55 if you intend to sell rig!t now
w.n reas time after filing t!e notice analogous to Sec Ja" register if sell rig!t now" can0t file
notice of offering Afor t!e s!elfH"
133*9- Non-e;cl!$%+e r!le Suppose , don0t comply w.Rule )55, can , argue ot!er e7emption9
yes$ Rule is not e7clusive you can argue t!at for some ot!er reason trans0n is e7empt
$
133*)- Ter/%nt%on of 8ert%n Re$tr%ct%on$ on Sle$ of Re$tr%cte# Sec$ &y 0er$on$ Other
Thn Aff%l%te$ 3safety valve
%!e re20nts of paragrap!s
c" current public info,
e" limitation on amount of sec0s sold,
f" manner of sale, and
!" notice of proposed sale
s!all not apply to restricted sec0s
sold for t!e account of a person w!o is not an affiliate of t!e issuer at t!e time of t!e sale
and !as not been an affiliate during t!e preceding + mont!s,
52
provided a period of at least 2 years !as elapsed since t!e later of t!e date t!e sec0s were
ac2uired from t!e issuer or from an affiliate of t!e issuer
So, non3affiliates can sell all t!e non3restricted securities t!ey want, even if t!ey !ave !eld
restricted securities for less t!an 2 years
Sec 2F of ++ 'ct grant of aut!ority to S?< to amend t!e statute essentially to rewrite t!e
statute$ Cote Sec )*a" of ++ 'ct# even if grant of e7emption is ultimately determined to be
invalid, until t!en it0s reliable$
0ro&le/$ ?n#er R!le 133
Basic is a CI corp, w!ose common stock t!e only class outstanding" is listed and traded on t!e
'merican Stock ?7c!ange$ >f t!e ),600,000 s!ares outstanding, G00,000 are !eld by persons
w!o purc!ased t!em in a public offering in )**2 or in t!e after market$ %!e remaining s!ares are
!eld by persons w!ose s!ares were sold by t!e issuer in Sec 52" transactions eit!er w!en t!e co
was organi;ed in )*G6 or later$ %!e common stock is registered under Sec )2 of +5 'ct, and
Basic is current on all filings re2uired under Sec )+ of +5 'ct$ ,n t!e prior 5 weeks t!e reported
trading volume of Basic0s common stock on t!e 'merican Stock ?7c!ange was# fourt! prior
week, 22,000( t!ird prior week 03( second prior week, +J,000( first prior week, )0,000$
Vol!/e l%/%tt%on# t!e greater of )K of sec0s issued outstanding, or average trading volume
during 53week period
)K of w!at9 3 of ),600,000 all s!ares outstanding, or of G00,000 publicly traded float"9
1> of the totl n!/&er of $hre$ of the cl$$ o!t$tn#%n( , 1"=DD"DDD
Here# )K of ),600,000 is )6,000
the +er(e tr#%n( +ol!/e is 22,000 = 0 = +J,000 = )0,000 E )G,000
At!e greater ofH# )G,000 V )6,000, so we take 12"DDD $ +ol!/e l%/%tt%on
)$ :red :ounder, c!airman of t!e board and t!e largest s.! of Basic 260,000" wis!es to sell
26,000 s!ares purc!ased from t!e issuer in )*G6
:red affiliate
-nder )55a"+", t!ese are restricted sec0s ac2uired from t!e issuer in a transaction not
involving a public offering
<urrent info condition we0re >1, bec it0s a reporting co not in default
Holding period re20nt under )55d")" 3 ) year from ac2uisition of sec0s from issuer ok !ere
!e purc!ased from issuer in )*G6"
Dolume limitation# )55e")" applies, bec !e is an affiliate
+3mont!s prior limitation ok !e didn0t sell
He cn $ell 12"DDD of 1="DDD no'
He cn $ell the other N"DDD 3 /onth$ lter *yo! cn !$e %t %n $!cce$$%+e 3-/onth
.er%o#$"
2$ Same facts as problem ), e7cept t!at :ounder boug!t J,000 additional s!ares from Basic in a
Sec 52" transaction F mont!s ago
Re2uired !olding period is not satisfied !as to be ) year so !e can0t sell J,000, but !e can
sell )G,000 of s!ares t!at !e boug!t in )*G6
5+
+$ Same facts as problem ), e7cept t!at Basic is in default in filing bot! :orm )01 and :orm
)0L$ However, t!e information contemplated by Rule )6c23))a"J" is publicly available
He can0t sell$ Bec Basic is a reporting co, it !as to !ave all t!e re2uired filings under +5 'ct
Rule )6c23)) Publication or Submission of Luotations 8it!out <urrent ,nformation
>bligations of market maker w!en co is not a reporting co# market maker can0t market
unless it !as certain info about t!e co but only non3reporting co"
Re.ort%n( %$$!er h$ to &e c!rrent on h%$ Sec 13 f%l%n($
5$ ,rving ,nvestor boug!t 26,000 s!ares from Basic in a Sec 52" transaction in )**J$ ,nvestor
!as no relations!ip to Basic e7cept as !older of t!ese s!ares w!ic! !e wis!es to sell$
He can sell t!em all$ -nder )55k", t!ese are restricted sec0s, !e is not an affiliate$ Here, +$6
years passed satisfies 23year re20nt$ -nder )55k", volume limitation of )55e" doesn0t
apply$
6$ Same facts, e7cept t!at Basic is in default on re2uired filings under sec )+ of +5 'ct$
Ies, !e can sell$ -nder )55k", )55c" <urrent Public ,nfo re20nt doesn0t apply to t!is man$
,f you0re non3affiliate, !eld sec0s for 2 years you0re now in Sec 5)" can do anyt!ing you
want wit! t!ese sec0s$
J$ Paul Pre7y, w!o is president of Basic and its c!ief operating officer, boug!t J0,000 s!ares in
a market transaction w!en !e became an e7ecutive in 4ay, )***$ He also boug!t )0,000
s!ares from Basic in a Sec 52" transaction in Oune, )***$ He wis!es to sell +0,000 of t!e
4ay, )*** s!ares$
He is an affiliate control over corp" !e wouldn0t be able to prove t!at !e is not an affiliate
Ies, !e can sell 4ay, )*** s!ares# t!ese are not restricted sec0s, bec !e boug!t t!em in a
market transaction
Dolume limitation of )55e")" applies to Arestricted or ot!er sec0sH bot! restricted and
unrestricted, so !e can only sell @)G,000$
He is not precluded from selling @)G,000, even if Oune, )*** sec0s are restricted$
%!is is 8olfson problem
,f !e wasn0t an affiliate, w!o owns unrestricted sec0s !e could sell all J0,000 t!ere is no
f!n(%&%l%ty #octr%ne$
G$ 'ssume Pre7y, president and c!ief operating officer, !ad owned on /ecember +), )***,
60,000 s!ares# 26,000 ac2uired in )**J from t!e issuer in a 52" transaction and 26,000
ac2uired in a market transaction in 4ay, )***$ >n Oanuary 6, 2000, Pre7y and 4rs$ Pre7y
were divorced, and !alf of eac! bloc was transferred to 4rs$ Pre7y as part of t!e divorce
settlement$ 4rs$ Pre7y wis!es to sell all of !er s!ares$
Pre7y is an affiliate
)**J s!ares 3 restricted
4ay )*** s!ares unrestricted
S!e !as t!e aggregate of 26,000 s!ares#
)2,600 w!ic! !er !usband got from t!e issuer in a 52" transaction in )**J restricted in
!er !ands
)2,600 w!ic! !er !usband got in a market transaction in 4ay )*** restricted in !er
!ands
)**J s!ares are restricted, bec ac2uired in a 52" trans0n( but $hre$ cq!%re# %n /r)et
trn$n re not re$tr%cte# %n ff%l%te$ o'n hn#$< &!t %f he trn$fer$ the/ %n non-
.!&l%c offer%n(" they &eco/e re$tr%cte# %n trn$feree$ hn#$$
55
133*-*3- Arestricted securitiesH# Sec$ &eco/e re$tr%cte# %n her hn#$" &ec 0re;y %$ n
ff%l%te" $he cq!%re# $ec$ fro/ n ff%l%te %n trn$ct%on not %n+ol+%n( ny .!&l%c
offer%n(
%!is is all assuming t!ey live in non3community property state in a common law state
stock initially is !is property"
%!is is analogous to 8olfson case# person w!o takes s!ares from an affiliate is an
underwriter$
8hrcter%Gt%on$ %!ere are 2 ways to c!aracteri;e t!is transaction#
)$ t!ese s!ares are a (%ft
2$ s!e .!rch$e# t!ese s!ares
)$ ,f it0s a gift, t!en s!e is a #onee
Then" !n#er 133*#-*3-*+-" $he cn tc) hol#%n( .er%o#$: her h!$&n#$ hol#%n( .er%o# A
her o'n hol#%n( .er%o#:
133*#-*3-*+- G%ft$ of Sec!r%t%e$
Securities ac2uired from an affiliate of t!e issuer, by gift s!all be deemed to !ave been
ac2uired by t!e donee w!en t!ey were ac2uired by t!e donor$
's to )**J s!ares, s!e meets )55d" !olding period re20nt more t!an ) year !ere"
's to 4ay )*** s!ares ) year !olding period re20nt s!e will meet in 4ay 2000
,f s!e is a donee, then (ro$$ !. .ro+%$%on of 133*e-*3-*%%%- ..l%e$:
133*e-*3-*%%%- %!e amount of sec0s sold for t!e account of a donee t!ereof during any period of +
mont!s wit!in ) year after t!e donation, and t!e amount of sec0s sold during t!e same +3mont!
period for t!e account of t!e donor, s!all not e7ceed, in t!e aggregate, t!e amount specified in
paragrap! e")" or 2" of t!is section, w!ic!ever is applicable$
#onor n# #onee re req!%re# to (ro$$ !. 1> +ol!/e l%/%tt%on %n ny 3-/onth
.er%o# for 1 yer fter the #te of the (%ft
2$ S!e is a .!rch$er s!e paid for t!ese s!ares by surrendering !er rig!ts"
'll t!ese s!ares are restricted eit!er way"$ )55d")" applies ) year !olding period
8!en does !olding period begin on Oanuary 6, 2000 $he cnt tc)
But t!ere is no (ro$$ !. .ro+%$%on &et &!yer n# $eller
S?< issued C'M, w!ic! said t!at# e73wife can tack !olding periods and e73wife doesn0t !ave
to gross up# logical discontinuity s!e gets t!e better of bot! worlds
Iou c!aracteri;e it by nature of trans0n in w!ic! s!e ac2uired a security
F$ <!arles <apitalist boug!t 50,000 s!ares from Basic in a 52" trans0n in )**J, and purc!ased
)6,000 s!ares in a market trans0n in Covember, )***$ <apitalist !as no relation to Basic
e7cept as owner of t!ese s!ares$ >n Oanuary )0,2000, <apitalist made t!e following gifts#
a" )6,000 s!ares from t!e Covember )*** bloc to !is son, w!o does live in !is !ome(
b" )6,000 s!ares from t!e )**J bloc to !is older daug!ter w!o does not live in !is !ome( and
c" G,600 s!ares from eac! bloc to !is younger daug!ter w!o !as resided in !is !ome at all
relevant times
%!e son and bot! daug!ters wis! to sell
<!arles is not an affiliate
56
a" Covember )*** s!ares are not restricted sec0s bec !e ac2uired t!em in a market trans0n"$
His son can sell all s!ares not under )55, but under Sec 5)" !e can do anyt!ing we wants
wit! t!em$
b" )**J sec0s are restricted$ <!arles is not an affiliate, so )55k" applies 2 year !olding period
!as elapsed so, s!e can sell$ ,t doesn0t matter t!at s!e does not live in !is !ome$
c" Covember )*** s!ares market transaction s!ares are not restricted can sell
)**J s!ares )55k" applies can sell see above"
So, s!e can sell s!ares from eac! bloc$ ,t doesn0t matter t!at s!e !as resided in !is !ome at
all relevant times$
*$ ,n early )**G Basic became involved in product liability litigation to w!ic! t!e market
responded by a s!arp decline in t!e price of Basic0s common$ %o support t!e market :ounder
boug!t 60,000 s!ares in a market trans0n in 'pril, )**G$ ,n 4ay )**F, :ounder sold t!ese
s!ares at a significant discount to Bob Buyer, a business ac2uaintance$ Buyer financed t!e
purc!ase by borrowing t!e entire purc!ase price from !is sister, to w!om !e pledged t!e
s!ares on a non3recourse basis$ ,n Oanuary 2000 Buyer paid !is sister and recovered t!e
s!ares$ He now wis!es to sell$
'pril )**G s!ares are not restricted in :ounder0s !ands$ But :ounder is an affiliate c!airman
of t!e board, largest s.! of Basic"$ So, 4ay )**F s!ares are restricted in Bob0s !ands bec !e
boug!t from :ounder.affiliate"$
<lassic Sec 5)W" trans0n$
:ull recourse # note ,>-" creates legal obligation to pay note wit! full recourse
Con3recourse note# w!en collateral of some kind !as been pledged like !ouse mortgage",
and obligation is only enforceable against t!e collateral$ ,f Bob doesn0t pay !is sister, sister
can take collateral and sell it, but s!e can0t do anyt!ing else$ Here, non3recourse note$
/oes non3recourse financing interrupt Bob0s !olding period9 Co
133*#-*1- 0ro/%$$ory Note$" Other O&l%(t%on$ or In$tll/ent E$
Niving t!e seller from w!om t!e sec0s were purc!ased a promissory note or ot!er
obligation to pay t!e purc!ase price$$$ s!all not be deemed full payment of t!e purc!ase price
unless t!e promissory note, obligation or 1B
Here, Bob didn0t give note to :ounder.seller, but !e gave non3recourse note to !is sister
someone is at risk ot!er t!an t!e seller$ So, it doesn0t interrupt !is !olding period$
<an !e sell9 He is not affiliate( t!ese are restricted s!ares, !e ac2uired t!em in 4ay )**F$
-nder )55k", 2 year !olding period$ He can sell )G,000 now and t!e rest in 4ay 2000 !e is
selling @)G,000 now under d" ) year !olding period t!en e" volume limitation applies( in
4ay 2000 !e can sell under )55k" t!en no volume limitation"
)0$ Same facts as problem *, e7cept t!at Buyer0s note to !is sister was a demand note providing
for full recourse$ Buyer0s sister demanded payment in Oanuary, 2000, and Buyer failed to
pay$ Buyer0s sister wis!es to sell t!e sec0s$
-nder )55d"+"iv", bec it0s a f!ll reco!r$e note, her hol#%n( .er%o# cn &e tc)e# to
7!yer$ hol#%n( .er%o#
,f non-reco!r$e, .le#(ee one wit! w!om pledge is deposited" hol#%n( .er%o# $trt$ 'hen
the .le#(e $trt$
133*#-*3-*%+- 0le#(e# Sec!r%t%e$
Sec0s w!ic! are bona fide pledged by an affiliate of t!e issuer w!en sold by t!e pledgee,
or by a purc!aser, after a default in t!e obligation secured by t!e pledge, s!all be deemed to !ave
been ac2uired w!en t!ey were ac2uired by t!e pledgor, e7cept t!at if t!e sec0s were pledged w.o
5J
recourse, t!ey s!all be deemed to !ave been ac2uired by t!e pledgee at t!e time of t!e pledge or
by t!e purc!aser at t!e time of purc!ase$
So under )55k", s!e can sell )G,000 now, and t!e rest in 4ay 2000$
))$ 4ike 4anager is a sales e7ecutive of Basic, w!o boug!t 6,000 s!ares in a market trans0n
w!en !e was !ired in )**G$ He also purc!ased 6,000 s!ares from Basic in a 52" trans0n in
Covember, )***$ He now wis!es to sell all !is s!ares$
He is not an affiliate$ )**G s!ares non3restricted sec0s$ So, !e can sell t!em under 5)"$
)*** s!ares restricted sec0s$ /oes it keep !im from selling !is )**G s!ares9 Co t!ere is
no fungibility doctrine$
So, )*** s!ares are restricted sec0s, !e is not an affiliate$ -nder )55d")", ) year !olding
period for restricted sec0s$ He !as to wait a year and t!en sell !is 6,000 s!ares under )55e"
2" !is volume of sec0s is ok @6,000 X @)G,000" for )55k", !as to be 2 years !e doesn0t
need t!at, bec !e can sell a year earlier under )55d")""$
)2$ Same facts, e7cept t!at 4anager !as &ust been fired and needs money$
He can sell )**G s!ares$ 8.r.t )*** s!ares, !e !as to wait a year for )55e"2" and 2 years
for )55k"$
<an !e use c!ange of cir0ces doctrine9
S?<0s view# w.adoption of Rule )55, it disapproves of w!ole concept of c!ange of cir0ces
doctrine t!is doctrine is not applicable to any trans0n
)+$ Oones boug!t )0,000 s!ares from Basic in a 52" trans0n in 'ugust, )**+$ ,n September,
)**+, !e sold )0,000 s!ares s!ort$ Oones did not cover t!e s!ort sale until Covember, )***$
He now wis!es to sell t!e )0,000 s!ares$
Short $le occurs w!ere a person sells borrowed stock and repays t!e lender wit!
substantially identical property eit!er !eld on t!e date of t!e s!ort sale or purc!ased after t!e
sale e7pecting to be able to buy t!e stocks later at a lower price"$ , t!ink t!at stock of U corp
will go down, , borrow stock from t!e broker, , sell stock today at @)0, , will later buy it back
for 60 cents, , make profit less t!e amount t!at broker c!arges me for doing t!e deal$ , make
t!e assumption t!at stock will go down, , will come in later to buy it at c!eaper price$
Cot!ing in Rule )55 t!at says s!ort sale !as any significance from t!e point of view of
!olding period$ <an s!ort sale interrupt !olding period9 Co$
,dea of !olding period# ,0m not underwriter , !eld t!ese sec0s at my own risk for some time,
, boug!t t!em w.investment intent, ,0m an investor
, buy sec and simultaneously sell it s!ort$ 'm , at economic risk9 , !ave to buy stock back$
8orst possible case price goes up$ 8!en )55 was originally drafted, s!ort sale interrupted
!olding period$
No' !n#er R!le 133" /y hol#%n( .er%o# %$ not %nterr!.te# &y $hort $le. %!eory# if , sell
s!ort, , got my money out of t!e deal$
)5$ ,n late )***, :ounder in immediate need of money found an investment advisor w!o sold
)00,000 of :ounder0s Basic s!ares to a total of 50 persons w!om t!e advisor found by cold
calling$ Pauline Purc!aser, one of t!e persons located by t!e investment advisor, boug!t 200
s!ares$ S!e now wis!es to sell$
%!ese are illegal trans0ns $ ,nvestment advisor broker" is an underwriter t!is trans0n
violates Sec 6 of ++ 'ct$ So, :ounder is also in violation of Sec 6# !n#er Wolf$on" %f (ent
+%olte#" then %$$!er +%olte#.
5G
<an Pauline sell9 Ies, under Sec 5)"# s!e0s not issuer, not underwriter, not dealer$ S!e
boug!t t!em in a public offering even t!oug! illegal"$
,f s!e boug!t t!em in a private offering t!ey would be restricted sec0s, but s!e boug!t t!em
in a public offering$
)6$ Pre7y President and <?>" boug!t 20,000 s!ares in a market transaction in 'ugust, )***$
He now wis!es to sell$
%!ese are unrestricted sec0s so no !olding period re20nt$ He is an affiliate so e")"
volume limitation applies for sales of bot! restricted and unrestricted sec0s( volume limitation
is satisfied under e")", !e can sell @)G,000 today$
Megal problem# under Sec 14*&- of 33 Act" %f he /)e$ .rof%t" th%$ .rof%t %$ rec.t!r&le ,
&ec he cq!%re# $ec$ '6n the l$t 4 /onth$.
2 factors of c!ange# )" globali;ation of sec0s markets( 2" no good way to integrate
electronic offerings t!is !as to c!ange
Rules came from t!e 8!eat Report$
>ld Rule )5J turned into Reg /
Rule )5G# Sec +a"))" intrastate offerings rule
Rule )5F went into bankruptcy code
Neneral rules#
,n caluculating amount of s!ares outstanding for )55e" purposes, you count both t!e public
float and s!ares!eld by affiliates
:ungability doctrine doesn0t apply to Rule )55 sales
'ffiliate0s non3restricted sec0s become restricted w!en
t!ey are transferred to t!e !ands of donee, pledgee, trust, or estate
t!ey are ot!erwise ac2uired from affiliate t!roug! smt! ot!er t!an market transaction
e$g$ marital settlement( private placement t!roug! 5)" e7emption"
Dice presidents and ot!er e0ees are generally not affiliates$ %!e only persons w!o are
generally affiliates are
<ontrolling s.!s
Subsidiaries
/irectors
Presidents
%!ere is no Ac!ange of cir0ceH doctrine under Rule )55( so if you lose your &ob, get sick, etc
you are not relieved from Rule )55 compliance( but you may be able to sell t!roug! 5)"$
8!ere broker violates )55g" by soliciting buy orders, cusomer w!o purc!ases security does
not !old restricted sec, bec !e got it t!roug! public offering albeit illegal"$ So,
<ustomer can sell security under 5)"
<ustomer can rescind under )2)"
' person purc!asing from customer cannot rescind under )2)", bec )2)" re2uires
privity, and it is not t!e original customer0s act t!at was wrongful$
R!le 13= Recl$$%f%ct%on$ of Sec!r%t%e$" Mer(er$" 8on$ol%#t%on$
n# Acq!%$%t%on$ of A$$et$
5F
-nless an e7emption from registration is available, Rule )56 re2uires t!at securities issued in
connection wit! mergers, consolidations, and certain ot!er recapitali;ations must be
registered under ++ 'ct$ %!e rule also addresses issuer communications in t!e pre3filing
period and applicable restrictions on resales by persons ot!er t!an t!e issuer :orm S35"
Solution to a circular problem$ %!ere was a point w!en it was a serious problem# lot0s of co0s
were becoming public for t!e )
st
time, but not registered on ?7c!ange$ Sec )2g" was enacted
only in )*J5, so t!ese co0s were not sub&ect to Sec )2 and Sec )5 pro7y rules"$
8!at were re20nts for providing info to s.!s# t!ose imposed by state law notice of mtg,
some states summary of info w.appraisal rig!ts$ So, state law was not!ing$
Say, ' corp merges into B corp$ Stock of ' will be converted into stock of B$ ,s it possible
to argue t!at stock of B isn0t being offered to s.!s of '9 no, stock of B is being offered to
s.!s of '$
%!ere was a no-$le r!le + classes of cases
)$ reclassification of sec0s by c!arter am0nt
2$ statutory mergers and consolidations
+$ c3type reorgani;ations# transfer of co0s all assets in e7c!ange of stock of anot!er co,
w!ic! is t!en distributed to selling co0s s.!s Apractical mergerH
,f t!ese + classes t!en t!ere was no AsaleH under ++ 'ct$ But S?< took t!e opposite position
w.r.t )0b36# t!is is a sale w.n )0b36
' corp B corp merger$ Bot! trade >%< sec0s( bot! !old s.! mtg( eac! co sends to its s.!s
notice of mtg$ Suppose, mgmt !as enoug! s!ares to get t!e trans0n approved no motivation
to provide info to s.!s info won0t be provided$ S.! of ' becomes s.! of B !e knows
not!ing about B corp$ %!us, public demand to correct t!at sit0n by t!e time of t!e 8!eat
Report$ ,n )*JJ, 8!eat Report$
But in )*J5 <ongress enacted Sec )2g", w!ic! applies to >%< market = some re20nts as to
assets and number of s.!s so, suc! co0s became sub&ect to pro7y rules$
Pro7y st0nt re2uired same info as you would get from registration st0nt description of
transaction, audited financial st0nt, etc"
,s t!ere crying need for ++ 'ct registration9 ,nfo is being provided by pro7y st0nt of B corp
to ' s.!s
8!eat Report proposed R!le 13=: $ec$ of $!r+%+%n( co h+e to &e re(%$tere# !nle$$ other
e;e/.t%on in reclassification cases often e7emption"
Say, ' and B bot! reporting co0s( want to merge( !ave to provide pro7y solicitation$ M(/t
h$ eno!(h $toc) , #oe$ %t h+e to .ro+%#e %nfo %f %t #oe$nt $ol%c%t .ro;%e$@ , ye$" !n#er
Sec 13*c-" %t h$ to .ro+%#e $/e %nfo $ %n .ro;y $tnt
++ 'ct registration re2uires prospectus covering sec0s of B offered to s.!s of ' = pro7y st0nt
of bot! ' and B essentially duplicate disclosure re20nts
Rule)56 considers reclassifications, mergers or consolidations, and transfers of assets as 2+"
sales of securities, so now#
Sec0s issued as a result of t!ese transactions must be registered
S.!s entitled to vote on t!e transaction must be presented wit! a prospectus of new
securities to be issued prior to t!e vote taking place
/isclosures re2uried under pro7y ruled and prospectus are virtually identical, so S?< came
up wit! :orm S35, w!ic! essentially serves as bot!$
5*
Ior/ S-3
Wr.-Aro!n# re(%$trt%on $tnt , 9o%nt .ro;y $tnt6re(%$trt%on $t6nt# ' and B normally
publis! a &oint pro7y st0nt addressed to s.!s of eac! corp, t!at is also registration st0nt, w!ic!
consists of pro7y st0nt Q cover s!eet t!at says it0s also registration st0nt( and reg st0nt !as a
cover s!eet t!at says it0s also a pro7y st0nt
/ownside# very bad writing
Rule )56b" <ommunications Cot /eemed to be a AProspectusH or A>ffer to SellH amends
all provisions relating to offers prior to registration$ ,n t!is transaction you !ave to solicit
pro7ies reconciles re2uirements of pro7y rules wit! Sec 6 of ++ 'ct
Rule )56c" Persons and Parties /eemed to Be -nderwriters$ Say, in a merger,
#%$..er%n( cor. n# %t$ ff%l%te$ re !n#er'r%ter$ of $ec$ of $!r+%+%n( cor., w!ic! are
being issued$ W6r6t ff%l%te$ of $!r+%+%n( cor. , ho' cn they $ell the%r $ec$@
t!ey can register for immediate sale, but t!ey may not want to sell immediately
t!ey can register for sale form time to time, but t!en sec0s will remain registered(
prospectus ages w!en sec0s are sold, t!ey would !ave to provide current
prospectus, so t!ey0ll !ave to create Aever3green prospectusH, w!ic! would cost a
fortune
piggyback rig!ts# give t!em rig!ts to piggyback any furt!er registration by t!e co
w!en co registers stock affiliates too"
Rule )56d" Resale Provisions for Persons and Parties /eemed -nderwriters le) o!t
.ro+%$%on AunderwriterH is not affiliate of t!e issuer and !as not been for + mont!s$ But if
)56d" doesn0t work, t!ese people are stuck, bec Rule )55 doesn0t apply# t!ese are not
restricted sec0s, t!is is a public offering
Slain# S?< will rescind t!is feature w.r.t affiliates c!aracteri;ing t!em as underwriters
Sect%on 3*1R- e;e/.t%on
' !ybrid e7emption from registration, not enumerated in ++ 'ct, but w.n its intent$ ,t seeks
to feel t!e gap in t!e statutory e7emptive sc!eme concerning sales of sec0s by affiliates, and
sales of restricted sec0s by nonaffiliates, w!o desire to sell suc! sec0s in a routine private
transaction$ <ertain establis!ed criteria of 5)" and 52" e7emptions must be met for party to
successfully invoke t!is e7emption$
Some say, t!ere is a 5;ero" e7emption# a good deal if it0s a good deal, nobody cares if you
violated anyt!ing
5)W" since early )*60s or before t!at
?n#er Sec 3*1-" %$$!er cn $ell &loc) of $ec$ to ny n!/&er of %n$t%t!t%onl %n+e$tor$ ,
%t$ .r%+te offer%n( e;e/.t !n#er 3*1-. Wht %f %n$t%t!t%onl %n+e$tor #ec%#e$ to $ell
the$e $ec$ to nother %n$t%t!t%onl %n+e$tor@ , ye$ 3*1R- e;e/.t%on. 0er$on 'ho &!y$
the$e $ec$ (et$ re$tr%cte# $ec$.
,t is not 5)" e7emption, bec inst0l investor in t!is case sounds like underwriter, and it is not
52" e7emption, bec 52" applies only to non3public offerings by issuers, w!ereas !ere it is
non-.!&l%c offer%n( &y non-%$$!er$ So, 5)W" e7emption
Ho' #oe$ 3*1R- &!yer (et o!t of %n+e$t/ent@
He can !ave anot!er 5)W" trans0n by making anot!er private sale$ Sec0s remain
restricted in t!e !ands of successive 5)W" buyer
60
He can get t!e issuer of sec0s to register t!em for !im, usu 1 rig!t to compel issuer to do
t!at
R!le 133 !e is non3affiliate, !e !olds restricted sec0s
Problem# ,ssuer sells to ,nst ,nv ), w!o J mont!s later sells to ,nst ,nv 2, w!o 6 mont!s later
sells to ,nst ,nv + t!ese are restricted sec0s$ Rule )55 !olding period re20nt w.r.t restricted
sec0s ) year$ 4easured from w!en9
R!le 133*#-*1- /e$!re# fro/ 'hen $ec$ 'ere cq!%re# fro/ the %$$!er w!en
issuer sold sec0s"
S!cce$$%+e 3*1R- &!yer$ cn tc) the%r hol#%n( .er%o#$
So, ,nst ,nv + only !as to wait ) mont! to sell sec0s
,f ,ssuer ,nst ,nv 2 ,nst ,nv + ,nst ,nv 5# no !olding period re20nt w.r.t ,nst ,nv 5
,f s.!s of disappearing corp vote in favor of merger, t!eir stock is converted into surviving
corp0s stock$ S?< said# t!ese s.!s don0t !ave investment decision to make$ But not true#
t!ey !ave to make a decision to vote for or against merger
appraisal decision
decision to !old sec0s or sell t!em
%!ese are all investment decisions
R!le 133A 0r%+te Re$le$ of Sec!r%t%e$ to In$t%t!t%on$
Provides a none7clusive safe !arbor e7emption from ++ 'ct0s registration re20nts for resales
to eligible institutions L,Bs" of certain restricted sec0s
'ntifraud provisions of t!e 'cts still apply
+ cases
)$ 8e !ave a foreign issuer w!o wants to sell a large bloc of sec0s in -S in a private placement,
probably w.inst0l investor doesn0t !ave to register$ ,nst0l investors are willing to buy
2$ Hig!3tec! start3up# co finds inst0l investors w!o are willing to provide start3up money for t!e
co
+$ -S issuer maybe a reporting co it doesn0t matter" wants to make a private debt offering
w.inst0l investor
,n all + cases, price t!at issuer will get, will be discounted bec of t!e .ro&le/ of %ll%q!%#%ty
,n t!e )
st
case, inst0l investors can sell sec0s in a 5)W" trans0n, if t!ey find a person to w!om
t!e issuer could !ave sold under 52"$ But it0s not t!e same as selling &ust t!roug! broker =
large bloc of sec0s$ Person buying from is getting a restricted sec same illi2uidity problem
so !e is willing to pay less for sec
R!le 133A crete$ tr#%n( /r)et %n re$tr%cte# $ec$ %n the hn#$ of JI7$ *J!l%f%e#
In$t%t!t%onl 7!yer$-( brings into e7istence L,B market
Rule )55'a" defines L,Bs
'ny of t!e following entities, action for its own account or t!e accounts of ot!er
L,Bs, t!at in t!e aggregate owns and invests on a discretionary basis at least @)00 million
in securities of issuers t!at are not affiliated wit! t!e entity
,nsurance co
,nvestment co
Small business investment co
Plan maintained by state on be!alf of its e0ees
?0ee benefit plan
6)
%rust fund
,nvestment advisor
/ealer w.investing @)0 million
/ealer on be!alf of L,B, etc$
Sec0s boug!t in 52" trans0n can be resold in 5)W" trans0n$ 133A crete$ tr#%n( /r)et
'6n 3*1R-
no !olding period
no restrictions on t!e manner of sale
only reqnt: &!yer l$o h$ to &e JI7
only l%/%tt%on on $ec$: t the %nce.t%on of JI7 tr#%n( %n th%$ $ec" th%$ $ec cnt
&e one tht %$ tr#e# on E;chn(e or NAS:AJ
,t permits inst0l buyer to !ave a li2uid sec, bec t!ere is now a trading market in t!ese sec0s
s!arply reduced illi2uidity discount in t!e original sale
!uge issue
Ho' #o 'e (et o!t of JI7 tr#%n(@ Say, foreign issuer sells large block of stock to inst0l
investors in -S( inst0l investors initiate L,B trading$ %!en public market in -S comes into
e7istence in t!e same sec$ How can you sell into t!at public market9 're you locked in L,B
market9 8!at is t!e Be;%t trn$ct%onC9
,0m a L,B$ ,0m not an affiliate( , !old restricted sec0s , can get out under R!le 133
E;%t trn$n$ %nto tr#%n( /r)et !n#er R!le 133 assuming t!at public trading
market !as come into e7istence e7ample# !ig!3tec! offering to inst0l investors in >%<
market, and t!en public offering of same sec0s"
,ssuer sells to L,B ) L,B 2 L,B +$ Holding period is ) year$ 8!en does it start to run9
'hen $ec$ 'ere cq!%re# fro/ the %$$!er !n#er 133*#-: tc)%n( of $!cce$$%+e JI7
&!yer$
133A*#-*3- if sec0s of issuer not sub&ect to Sec )+ or )6d" of +5 'ct, nor e7empt from
reporting, t!e !older and prospective purc!aser !ave t!e rig!t to obtain reasonably current
info about t!e co$ :oreign issuers find t!is very ob&ectionable = people don0t make t!e
demand$
<onsensus outside offices of S?<" t!at )55' !ad enormous success$ 'ircraft <arrier
Release proposes to abolis! )55' not a practical program$ %!is market is too big, too
important, produces no problems, no litigation, no dispute of any kind w!at0s not to like$
0ro&le/ for R!le 133*e- n# *)-
)55d")" ' minimum of ) year must elapse bet t!e later of t!e date of t!e ac2uisition of
t!e sec0s from t!e issuer or from an affiliate of t!e issuer, and any resale of suc! sec0s in
reliance on t!is section for t!e account of eit!er t!e ac2uiror or any subse2uent !older of
t!ose sec0s
Say, ,ssuer L,B ) L,B 2( L,B 2 is affiliate of t!e issuer$ Th%$ &re)$ hol#%n( .er%o#: $trt$
hol#%n( .er%o# r!nn%n( (%n.
%!ese are freely traded sec0s, so you don0t know in w!ose !ands t!ey !ave been w!en you got
t!em problem# L,B + doesn0t know w!o is selling$ Slain doesn0t know w!at to do w.t!is but
maybe t!ere can0t be t!at many inst0l investors w!o are affiliates of issuer"
133A , the$e re 3*1R- trn$n$. Iou can do t!em w.o t!e Rule, but in t!e absence of t!e
rule dealers will start making market
62
Re(!lt%on S
R!le$ (o+ern%n( offer$ n# $le$ /#e o!t$%#e the ?S '6o re(%$trt%on
!n#er the Sec!r%t%e$ Act of 1933
S?< would regard offer and sale of sec0s by -S issuers outside -S as being outside t!e reac!
of ++ 'ct
bec of t!e balance of payments =
if you sell sec0s abroad, all t!ese c0s !ave t!eir own sec0s laws
<oncern# if t!ese sec0s were sold abroad in contemplation of selling t!em back to -S to avoid
registration
Mock up provision# w!en you sold sec0s, for some time buyer of sec0s didn0t get certificates,
&ust letter from !older of global certificate saying t!at you !ave interest in w!at we own( t!en
global certificate was broken down, and buyer got t!eir own certificates
's initially adopted, Reg S was a disaster# sec0s sold abroad could be resold in -S w.n 50
days w.o registering opportunities for sec0s fraud
?arly )**0s, t!en )**J amended
>ffs!ore transaction buyer and transaction must be abroad
+ categories of sec0s
)" foreign issuers w.o substantial -S market interest for t!eir sec0s Rule *0+b")""
2" foreign or -S issuers t!at are reporting co0s under +5 'ct and foreign issuers of debt
sec0s Rule *0+b"2""
+" all ot!er issuers Rule *0+b"+""
3
r#
cte(ory /o$t %/.ortnt , ?S %$$!er$
Sec$ $ol# o!t$%#e ?S &y ?S %$$!er re re$tr%cte# $ec$" $o yo! cn only $ell the/
!n#er R!le 133
Slain# it !asn0t solved all t!e problems w.Reg S$
ASSIGNEMENT NO. = , 1933 A8T REGISTRATION 0RO8ESS
<o wants to go public s!ould weig! advantages and disadvantages
A#+nt(e$
Public trading markets in -S great way to raise capital#
)$ you increase your net wort!, so
2$ you increase your ability to borrow
<o gets better known easier to get customers
<o0s t!at manufacture t!ings, !ave inventories leaving aside !ig!3tec! co0s# one of
t!e biggest problems is finding good people good management for closely !eld
co0s$
Reason# it0s not your family( Naller v$ Naller classic !orror story of family corp
you don0t want to work for t!ese people$ Plus, people prefer to work for t!emselves,
not for closely !eld co$
,t c!anges totally w!en co is publicly !eld$ Iou !ave a lot of mobility if you
work for publicly !eld co easier to move on easier to !ire people
?ntrepreneurs0 own sense of accomplis!ment
Mi2uidity# entrepreneurs desire to get AunlockedH
:%$#+nt(e$
<ost# N Q ' general and administrative" costs go up
Real discontinuity bet accounting of public co0s and closely !eld co0s$ 8!en closely
!eld co0s don0t keep t!eir books in acc w.N''P, but w.ta7 accounting standards$
6+
8!en public co0s books !ave to be maintained in acc w.N''P so, accounting
costs will go up significantly = will !ave to !ave annual audits
8!at can be left unclear about t!e deal in closely !eld co, !as to be clear in public
co$ ,n closely !eld co0s, business deal is not spelled out contemplate t!at t!ey will
work it out$ 8!en public co you are reporting auditors !ave to be able to report
complete significance of 1s
Significance of lawyers rises
<ost of administration of public co is muc! !ig!er
Problem of disclosures# once co is public, your sales, cost, salaries to senior mgmt,
conflicts of interest transactions become known to your s.!s and also to your
competitors
Re(%$trt%on $tte/ent
)$<over page
2$ Prospectus
*6K of registration statement
'udited financial st0nts most important part
+$ ,nfo not re2luired in t!e prospectus
5$ Signature page
>nly an issuer can registere sec0s Sec Ja""( unless foreign issuer t!en underwriter can
register sec0s$
Sec =*- cnnot $ell !nt%l re(%$trt%on $tnt %$ effect%+e
-nless a re(%$trt%on $tnt %$ %n effect as to a security, it s!all by unlawful for any
person, directly or indirectly, t!roug! &0nal means, to $ell suc! security t!roug! t!e use of any
prospectus or ot!erwise
Sec =*c- cnnot /)e offer to $ell or offer to &!y !nt%l re(%$trt%on $tnt h$ &een f%le#
,t s!all be unlawful for any person by using means of interstate commerce or of t!e mails
to offer to $ell or offer to &!y t!roug! t!e use or medium of any prospectus or ot!erwise
any security, unless a re(%$trt%on $tnt h$ &een f%le# as to suc! security
8e !ave decided to go public
Ce7t step# f%n# n !n#er'r%ter don0t buy stock of co t!at0s going public w.o underwriter
if stock is not underwritten t!en co could not get an underwriter, t!en it0s not a good deal"
Sec =*c- speaks to period before filing registration st0nt$ Problem# !ow do we find an
underwriter9
,f we use telep!one even an intrastate call is a means of interstate commerce
Sec 1*3- broad definition of AsaleH, but
t!e term AsaleH and t!e term Aoffer to buyH as used in Sec 6c" s!all not include
preliminary negotiations or agreements bet an issuer and any underwriter or among
underwriters w!o are or are to be in privity of 1 wit! an issuer
So, Sec =*c- #oe$ not %ncl!#e offer &y %$$!er to !n#er'r%ter
<an we sign underwriter agreement at t!is point9 yes, it0s deemed to be preliminary
negotiation or agreement
<an t!e lead underwriter go to some ot!er underwriters9 yes Aor among underwritersH"
65
<an an ordinary person, w!o over!eard talks about co going public, make an offer to buy by
telep!one9 yes, !e can, under Sec 3*1- if not by telep!one, no &0nal means, !e can, but even
if by telep!one !e can"
So, underwriter can offer to buy 6c" doesn0t apply( ordinary person can offer to buy under
5)" e7emption$ 8!o is forbidden to do smt!9 dealer. :eler$ re for&%##en to /)e
offer to &!y !n#er =*c-.
,dea of 6c" to in!ibit t!e early formation of selling groups$ /ealers are retailers, w!o don0t
really know anyt!ing about t!e product$ ,f dealer, before !e !as seen any doc0nt about t!is
co, makes an offer to buy it will be !ard for dealer to back out of t!e deal after !e !as seen
doc0nts w.o compromising !is relations w.underwriters moral pressure to stay in$ So, t!ey
!ave to see prospectus w.financial st0nts before t!ey make suc! commitment
'fter we file registration st0nt
Sec 6a", we cannot sell until registration st0nt is effective$
Sec N*- The effect%+e #te of re(%$trt%on $tnt %$ 1D #y$ fter the f%l%n( of re(%$trt%on
$tnt. S?< !as power of acceleration$ S?< doesn0t !ave to do anyt!ing re(%$trt%on $tnt
%$ effect%+e !to/t%clly '6.$$(e of t%/e
How do we keep defective registration st0nt from being effective9 file amendment$ -nder
Sec Fa", filing of amendment starts 203day period running again$
R!le 323 :ely%n( /en#/ent$ , !to/t%clly #ely%n( /nt 'h%ch )ee.$ %t fro/
&eco/%n( effect%+e !nt%l yo! $) for %t
'n amendment filed wit! registration st0nt w!ic! !as not become effective s!all be
deemed, for t!e purpose of Sec Fa", to be filed on suc! date as may be necessary to delay t!e
effective date of suc! registrationB
,f it0s ,P> initial public offering", document will get full review$ %!e end product is a letter
of co//ent *B#ef%c%encyC- w!at S?< is interested in# typically furt!er disclosures, maybe
add0l accounting info
Iou s!ould provide to staff w!at it wants$ S?< !as no aut!ority to demand t!is info but go
along
%!en file substantive am0nt, wait for letter t!at says Ano commentH
,n t!e meantime, it0s '%t%n( .er%o#
Sec =*&-*1-
,t s!all be unlawful for any person, directly or indirectly, to make use of &0nal means to
carry or transmit any prospectus relating to any security w.r.t w!ic! a registration st0nt
!as been filed, !nle$$ $!ch .ro$.ect!$ /eet$ the req!%re/ent$ of Sec 1D
Registration st0nt !as been filed$ <an underwriter call dealers and offer sec0s to dealers9
no, unless underwriters also send prospectus t!at meets re2uirements of Sec )0
:!r%n( '%t%n( .er%o# " yo! cn /)e ll offer$ *$y BI $ellC-" &!t not !ncon#%t%onl
offer$ *#eler $y$ BI &!yC- , yo! cnnot $ell $ec
8n yo! /)e offer to .eo.le@ , ye$
8n #eler$ cll .eo.le to offer $ec$@ , ye$ */r)et%n( .roce$$ (oe$ on-
Sec 1D*- describes final prospectus
Sec 1D*&- .rel%/%nry .ro$.ect!$ can be filed it0s not final doc0nt for purposes of Sec ))"
66
,n addition to prospectus permitted or re2uired in )0a", S?< s!all permit t!e use of a
prospectus for the .!r.o$e$ of Sec =*&-*1- w!ic! omits in part or summari;es info in t!e
prospectus specified in )0a"
)0b" was adopted to legitimate t!e Ared !erringH practice
)$ it is undesired t!at people be committed to buying sec until complete, full, final
prospectus
2$ but get as muc! info as possible in t!e !ands of prospective buyers before t!ey make
t!is decision
?ven t!oug! t!is doc0nt is read like an offer, it is not an offer# it0s a selling doc0nt during waiting
period
,n )*65, t!is practice was legitimated by staff am0nt Sec )0b" preliminary prospectus
R!le 33D 0ro$.ect!$ for !$e .r%or to effect%+e #te t!is doc0nt can be used as a selling
doc0nt during waiting period
<ase# releasing info before effective registration st0nt is pre3conditioning t!e market
constitutes offer
Problem# co is about to !ave offering to finance build3up of inventories for new product line(
it0s a couple of mont!s away from filing$ <o learns t!at competitor is about to enter t!e
market$ <an t!ey begin massive advertising campaign of new product no, will be perceived
by S?< as B(!n 9!/.%n(C con#%t%on%n( the /r)et"$ 's a remedy, S?< will put t!e
w!ole offering on !old for J3* mont!s$ %!ere are no good solutions for t!is problem$
W%t%n( .er%o#
Sec 6b")" controls w!at you can do during t!e waiting period$ Sec 6c" is now out of case,
bec reg st0nt !as been filed
Iou don0t !ave final prospectus yet final prospectus would !ave price info
6b")" legitimates Ared !erringH practice# S?< is directed to adopt rules .er/%tt%n( the !$e
of .rel%/%nry .ro$.ect!$ #!r%n( the '%t%n( .er%o# , R!le 33D$
0rel%/%nry .ro$.ect!$ %$ $ell%n( #ocnt" 'h%ch yo! re req!%re# to !$e. ?ventually,
you0ll want acceleration of effective date of registration issuer and underwriter would want
to !ave control$
R!le 34D*- :%$tr%&!t%on of 0rel%/%nry 0ro$.ect!$
R!le 34D*&-*1-
Co acceleration unless you !ave efficiently used preliminary prospectus
R!le 1=c1-N of 33 Act :el%+ery of .ro$.ect!$
'pplies also to underwriters and dealers# !ave to !onor re2uests for preliminary
prospectus$ 4anaging underwriter !as to provide ot!er underwriters and dealers
w.enoug! copies so t!at t!ey can meet t!eir respective obligations
,f %$$!er %$ non-re.ort%n( co, #eler h$ to #el%+er .rel%/%nry .ro$.ect!$ to
e+ery .ro$.ect%+e &!yer 3N ho!r$ &efore conf%r/t%on of $le
/iskin v$ Momasney Ille(l offer of $ec$ , +%olt%on of =*&-*1-
/.underwriter( made 2 offers
<ontinental in t!e waiting period
Ski Park reg st0nt was effective
/ sent letter to customer# !ere0s final prospectus of Ski Park, and if you buy ),000 s!ares of Ski
Park, we0ll save for you 6,000 s!ares of <ontinental, w!en <ontinental0s reg st0nt becomes
effective$ ,n :ebruary, reg st0nt becomes effective( telep!one conversation bet / and P( P says !e
6J
wants it( / sends to P confirmation of sale$ %!en / sent to P certificate representing sec along
w.final prospectus for <ontinental$
)53)6 mont!s after t!e receipt of )
st
letter, P sues to rescind under )2a" of ++ 'ct# says
transaction was a violation of Sec 6b")"$ P isn0t claiming t!at !e was misled, pre&udiced by
t!e letter, or t!at letter !ad bad info$ He says# / offered me sec under conditions w!ic!
violated Sec 6, so , !ave rig!t to rescind accurate state of t!e law
2d <ir# ye$" +%olt%on of Sec =$ 2 violations !ere# eit!er one triggers t!e rig!t to rescind and
cannot be cured$
)
st
violation
/uring waiting period, / sends to P certificate w.final prospectus for Ski Park w.letter of
transmittal$ <an !e do t!at9 for Ski Park, yes
,s t!is letter a prospectus w.n 1*1D- #ef%n%t%on of .ro$.ect!$9 3 yes
The ter/ B.ro$.ect!$C /en$ ny .ro$.ect!$" not%ce" c%rc!lr" #+ert%$e/ent" letter
or co//!n%ct%on" 'r%tten or &y r#%o or tele+%$%on" 'h%ch offer$ ny $ec for $le or
conf%r/$ the $le of ny $ec
e7cept t!at a" co//!n%ct%on $ent or (%+en fter the effect%+e #te of the re(%$trt%on $tnt
$hll not &e #ee/e# .ro$.ect!$ %f %t %$ .ro+e# tht .r%or to or t the $/e t%/e '%th $!ch
co//!n%ct%on 'r%tten .ro$.ect!$ /eet%n( the reqnt$ of 1D*- t the t%/e of $!ch
co//!n%ct%on '$ $ent or (%+en to the .er$on to 'ho/ the co//!n%ct%on '$ /#e
-nder 6b")", it is unlawful to send a prospectus unless it meets re20nts of Sec )0$ %!is
letter doesn0t meet t!ese re20nts not permissible
/ send letter of transmittal saying t!at t!is prospectus is an offer
How to break out of t!e circle9
1*1D- Bfree 'r%t%n(C: ny co//!n%ct%on 'h%ch cco/.n%e$ or follo'$ #el%+ery of
.ro$.ect!$ %$ #ef%ne# o!t of =*&-*1-
Say, , send you final prospectus of Ski Park and letter of transmittal = offer you ),000 s!ares
of Ski Park$ Reg st0nt is filed and even effective$ /oes 6b")" reac! t!roug! post3effective
period9 yes$ Metter offer of sec$ ,s letter a prospectus9 no, permissible by 2)0"0s
e7ception a"$ Once yo! rece%+e f%nl .ro$.ect!$" other co//!n%ct%on$ re not #ee/e#
to &e .ro$.ect!$ !n#er 1*1D- e;ce.t%on *-$ So, letter is not prospectus$
How about offer w.r.t stock of <ontinental9 <ontinental is in waiting period$ Reg st0nt !as
been filed$ 6b")" applies$ ,s t!e letter offering <ontinental s!ares a prospectus9 yes, w.n
2)0"$ %!is prospectus doesn0t meet re20nts of )0a" or b", so violation of 6b")"$
2
nd
violation
'fter effectiveness of <ontinental, telep!one conversation( customer says , want sec0s(
broker sends confirmation of sale violation of 6b")"$
1*1- .ro$.ect!$ %ncl!#e$ conf%r/t%on of $le. To $en# conf%r/t%on of $le '6o f%nl
.ro$.ect!$ %$ +%olt%on =*&-*1-.
'fter t!ese 2 violations, / sent final prospectus w.certificate, as re2uired by 6b"2"$ 8.n )
year from t!at, beyond ) year after )
st
violation, P sues for rescission
)$ Iou !ave legal sale under 6a"# sec0s were registered before sold( sec0s were delivered
w.final prospectus as re2uired by 6b"2"$ But it doesn0t take t!e curse of %lle(l offer
not!ing you can do about it$ Once th%$ +%olt%on occ!r$ , no 'y to c!re %t
6G
2$ "tatute of limitations$ -nder Sec )+, st of limitations for actions under Sec )) and Sec )2a"
)" is ) year$ 8!en does st of lim start to run9 court# at t!e time of sale not time of
violation"
%oday, you can send preliminary prospectus and oral offer
So, reg st0nt !as been filed( preliminary prospectus can0t use it as a selling doc0nt yet# wait
till we get S?<0s deficiency letter and see !ow muc! work we !ave to do
S?< may re2uire significant revision of preliminary prospectus and t!at we recirculate t!e
one we already sent
8!en we !ave preliminary prospectus w.o price" use it as a selling doc0nt
%!en agr0nt among underwriters will be signed, t!at includes power off attorney aut!ori;ing
lead underwriter to e7ecute underwriting agr0nts on be!alf eac! underwriter bet underwriters
and issuer
%!en !ave a Bro#$ho'C# mgmt of co going out of town and meeting underwirters t!is is
!ow underwriters fulfill t!eir due diligence obligation( it0s mostly inst0nal investors
-ntil recently, not!ing was ever !anded out t!ere, e7cept for preliminary prospectus$
Practice was to e7clude presence of lawyers from roads!ows
Cow, moving toward electronic roads!ows( now t!oug!t desirable to make electronic
roads!ows not only to inst0nal investors, but to t!e general public$ Slain# bad idea$
'dvantage of roads!ow was t!at inst0l investors asked mgmt0s &0nt about t!ings not permitted
in prospectus$ ,n t!e !ands of t!e general public, it0s dangerous stuff
)$ eit!er will be less info to professionals
2$ or info provided to professionals will be provided to general market buyers
%!en we are waiting for letter saying Awe !ave material commentsH
Mead underwriter and issuer get toget!er and set final price of sec, final terms of underwriter
arrangement.commission
,n order for S?< to grant acceleration re2uest, C'S/ !as to approve issuer0s underwriting
arrangement$ C'S/ !as rules of fair practice# one relates to underwriting compensation
commission( maybe underwriter can get c!eap stock from issuer( is issuer paying
underwriter0s e7penses"
,f sec is registered on :orm S3+, you don0t need t!at large, more mature inv co0s"$ C'S/ is
concerned t!at underwriter is overreac!ing t!e issuer$
Price am0nt final is filed
Re2uest for acceleration is granted you !ave effectiveness underwriters start calling
dealers and inst0l investors dealers call customers and sell sec0s
Problem# Ski Park problem yo! cnt $en# conf%r/t%on '6o f%nl .ro$.ect!$$ 8e now
!ave truly national sec0s market not like +0 years ago" !ow do you confirm t!e deal until
final prospectus you need price info
R!le 33DA 0ro$.ect!$ %n Re(%$trt%on Stte/ent t the T%/e of Effect%+ene$$
How do you get info out to people w!o need to use it$ If yo! offer $ec for c$h" yo! cn
(o effect%+e '6o .r%ce %nfo. 0r%ce %nfo cn &e ##e# on the $e.rte ter/ $heet" 'h%ch $ho!l#
&e f%le# '6SE8 '6n 1 #y$ fter yo! $trt !$%n( %t
0ro$.ect!$ $!&9ect to co/.let%on *'6o .r%ce %nfo- A ter/ $heet S f%nl .ro$.ect!$
R!le 1=c4-1 Settle/ent 8ycle
% = +# you !ave to settle in + days
Problem of fails# c!ain effect if ma&or inst0l buyer.investor fails$ %!is applies to public
offering
6F
So, during waiting period
/ealer can make offer to buy
6c" is inapplicable once reg st0nt is filed
2)0" definition of prospectus includes only offers to sell
/ealer cn orally offer to sell a security, bec 2)0" definition of prospectus does not include
oral offers
But dealer cannot actually buy until registration st0nt is effective
Before t!e effective date, t!e only t!ings you can send regarding t!e security is
Preliminary propspectus
,dentifying statement
So, reg st0nt is in effect
8n 'e $ell the $ec$ , ye$" !n#er =*-
8n 'e #el%+er $ec$ fter $le , ye$" !n#er =*-*1-
We h+e to $en# .ro$.ect!$ '6$ec$ !n#er =*&-*1-
After #el%+ery of f%nl .ro$.ect!$" yo! cn $en# lon( ny $ell%n( /ter%l$ tht yo! l%)e"
&ec 'e h+e free 'r%t%n( , the$e /ter%l$ re #ef%ne# o!t of .ro$.ect!$ !n#er 1*1D-
e;ce.t%on *-. The only l%/%tt%on , nt%-fr!# .ro+%$%on$
>nce registration is effective, preliminary prospectus may no longer be used$ %!e only
prospectus t!at will satisfy 6b"2" is )0a" final prospectus
8!en broker sells you security in post3effective period#
,f !e sends you a confirmation of sale before delivering t!e security, t!e confirmation
must be accompanied by final prospectus /iskin"
>t!erwise, !e is re2uired to send you a final prospectus eit!er before or at t!e same time
!e delivers t!e security to you 6b"2""
Broker is not e7empted by 55" from t!is re2uirement because !ere !e is acting as a
dealer
8!at if registration st0nt is accurate w!en it becomes effective, but later becomes inaccurate9
%!ere is no cause of action under Sec )) bec it only creates liability for statements t!at
were untrue at t!e time registration st0nt becomes effective ))a""
' person w!o sells security using false registration st0nt would violate#
)$ )22"
2$ Rule )0b36
+$ )Ga"
S?< v$ 4anor Cursing Incc!rte .ro$.ect!$ %$ not .ro$.ect!$ tht /eet$ reqnt$ of
1D*- , $o" +%olt%on of =*&-*1-
Th%$ %$ SE8 %n9!nct%on .rocee#%n(
-nderwriter agreed to sell issuer0s sec0s as &e$t effort$ ll-or-none offer%n(# underwriter !as
to use best efforts = sec0s s!ould be sold w.n specific period of time, and t!e money s!ould
be put in escrow, and if entire block of offered sec0s is not sold, s!ould give t!e money back
to investors
R!le 1D&-9 0roh%&%te# Re.re$entt%on$ %n 8onnect%on W%th 8ert%n Offer%n($
R!le 1=c1-3 Trn$/%$$%on or M%ntennce of 0y/ent$ Rece%+e# %n 8onnect%on W%th
?n#er'r%t%n($
req!%re n e$cro' for c!$to/er$ /oney
6*
Here, no escrow account is ever set up
Plus, prospectus says it0s all or none
/ couldn0t sell all sec0s t!ey ware!oused t!em sold sec0s under t!e deal t!at buyers could
get money back t!at all sec0s were sold w!en in fact t!ey !aven0t
Diolation of
)Ga" of ++ 'ct
Rule )0b36
Rule )0b3*
Rule )6c235
But S?< doesn0t sue to en&oin /s( SE8 $!e$ lle(%n( +%olt%on of =*&-*1-
/s did deliver final prospectus$ But S?<# %ncc!rte .ro$.ect!$ %$ not .ro$.ect!$ tht
/eet$ reqnt$ of 1D*- , $o" +%olt%on of =*&-*1-. S?< again found / w!o0s anyway clearly
liable, and wanted to e7pand some provision of t!e statute$
2d <ir# yes, it0s not a )0a" prospectus$ Post3effective developments w!ic! materially alter
t!e picture presented in t!e registration st0nt must be broug!t to t!e attention of public
investors$ Ant%fr!# .ro+%$%on$ of 33 n# 33 ct$ req!%re tht the .ro$.ect!$ reflect
.o$t-effect%+e #e+elo./ent$ 'h%ch /)e the .ro$.ect!$ /%$le#%n( %n ny /ter%l
re$.ect.
Problem# does it apply beyond S?<0s in&unction proceeding9 ,f yes, would you ever sue
under Sec ))9 no, bec you also !ad case under 6b"2" you can always rescind$ ?ffect is
to read Sec )) and )2a"2" out of t!e 'ct
2 cases
)$ 0ro$.ect!$ %$ 'ron( */ter%l %ncc!rcy- &efore re(%$trt%on $tnt %$ effect%+e# under Sec
)), if materially inaccurate info at effective date of registration many people are liable$
S?< will insist t!at you correct it by filing post3effective amendment Sec Fa" post3
effective am0nt doesn0t become effective until S?< declares it effective( but S?< will make
you wait a year or two before t!ey declare t!at post3effective am0nt is effective$
Iou still !ave effective registration st0nt can you go on selling9 ,n t!eory, you can
correct it and go selling before post3effective am0nt is effective$ ,n reality, once you file
post3effective am0nt, you0re dead until S?< declares it effective$
2$ 0ro$.ect!$ %$ r%(ht 'hen re(%$trt%on $tnt %$ effect%+e" &!t %t &eco/e$ 'ron( lter# say,
plants are burned down$ How to correct#
,f c!anges are small stickering you print a sticker and put it on cover on c!anged
info$
,f c!anges are big you !ave to rewrite w!ole prospectus it doesn0t re2uire filing
of post3effective am0nt$ Iou can correct prospectus and t!en furnis! corrected
prospectus to S?<$ R!le 313" 312 conte/.lte tht .ro$.ect!$ tht yo! ct!lly
#el%+er to .eo.le %$ #%fferent fro/ the one f%le# '6SE8< &!t yo! h+e to f%le %t
lter.
8!at is liability e7posure if you deliver prospectus w!ic! was accurate at t!e time reg0n st0nt
became effective, but w!ic! is now inaccurate
Sec ))a" applies to reg0n st0nts at t!e moment of effectiveness( if after t!at point reg
st0nt become inaccurate, Sec )) doesn0t apply gap in t!e statue( issuer will keep
info as it is
%!ere can be a stop order under Sec Fb" to stop effectiveness of prospectus B'/
Sec )Ga"
)" maybe applies, maybe we0re doing t!at
2" our case e7actly
J0
So, duty to correct prospectus is imposed by Sec )Ga"2"
Problem# Sec )Ga" does not give rise to private rig!t of action$ ,t implicates Sec )2a"2",
but it only implicates sale to immediate buyer t!e dealer
Rule )0b36 covers t!is# yes, liability e7posure for use of inaccurate prospectus
But Sec )) does not re2uire scienter or fault of any kind( w!ereas Rule )0b36
re2uires purposeful conduct
Suppose, amended prospectus is inaccurate but original prospectus was accurate"$
Iou can use Sec )2a"2" as applied to dealer( as to ot!er parties apply Rule )0b36$
,n sum
0re-f%l%n( .er%o#
%ime period before reg st0nt !as been filed w.S?<$ Sub&ect to certain e7ceptions, offers
to sell as well as offers to buy are pro!ibited( sales are pro!ibited( negotiations and agreements
w.underwriters w!o are or will be in privity w.issuer are permitted( Rule )+6 announcements are
permitted( ertain broker3dealer publis!ed info is permitted pursuant to Rules )+G3)+*$
W%t%n( .er%o#
%ime period after reg st0nt !as been filed w.S?< but before it becomes effective$ >ral
offers and written offers by means of Sec )0 prospectus are permitted$ However, only in t!e
post3effective period may securities be sold and offers to buy be accepted$ <ertain broker3dealer
publis!ed info is permitted$ Sec 2)0" tombstone ad and Rule )+5 Aidentifying statementH may
be used$
-se )0b" preliminary prospectus under 6b")"# subst0ly same info as in final prospectus(
legend in red ink t!at reg st0nt !as yet to become effective red !erring prospectus"
%ombstone ad# advertisement of an offering, not deemed to be a prospectus under 2)0",
t!at may be publis!ed during waiting period and post3effective period"$ ,t provides basic info
about t!e offering and identifies memebers of t!e underwriting syndicate$$ 4ention of price of
sec0s is permitted$
0o$t-effect%+e .er%o#
Sales can be made only by means of statutory )0a" prospectus( free3writing is permitted
if accompanied or preceded by )0a" prospectus( certain broker3dealer info is permitted
tombstone ad and identifying st0nt may be used( prospectus delivery re20nt for dealers generally
applies( unsolicited brokers0 transactions w.o prospectus delivery re20nts are generally permitted
if on e7c!ange or >%< market$
Shelf re(%$trt%on
Sec Ja" last sentence
' registration statement s!all be deemed effective only as to t!e sec0s specified t!erein as
proposed to be offered
Iou can only register sec0s in contemplation of immediate offering, not Afor t!e s!elfH
But S?< recogni;ed sit0ns w!ere sec0s were registered Afor t!e s!elfH
)$ 8e sold warrants t!ey !ave significant life, may be perpetual it0s in!erently an
offer to buy underlying sec( but you don0t know w!en warrant will be e7ercised( so,
you can register t!e underlying sec and !ave to maintain t!e Ae+er (reen
.ro$.ect!$H
2$ ?0ee options# e0ee will work for e0er for some years and t!en can e7ercise t!e option(
underlying sec !as to be registered, but in contemplation of sale down t!e line not in
contemplation of immediate sale"
J)
+$ ,ra Haupt situation# controlling s.!s w!o want to sell t!eir stock in a market trans0n
from time to time( again register Afor t!e s!elfH and maintain t!e Aever green
prospectusH$ But Rule )55 eliminated t!e need for suc! transactions
R!le 31= :elye# or 8ont%n!o!$ Offer%n( n# Sle of Sec!r%t%e$ 3 deals w.s!elf
registration broke some new ground
<ategories i" t!roug! i7" traditional
<ategory 7" broke new ground
a" Sec0s may be registered for an offering to be made on a continuous or delayed basis in
t!e future, provided t!at )" t!e registration st0nt pertains only toB
7" Sec0s registered or 2ualified to be registered" on :orm S3+ or :orm :3+ e2uivalent to S3+
w.r.t foreign private issuers" w!ic! are to be offered and sold on a continuous or delayed basis by
or on be!alf of t!e registrantB
Has potential to wipe out traditional investment banking relations!ips won0t survive$
But S?< did adopt Rule 5)6 w.long dissent# t!is s!elf reg0n process s!ould not be applied to
e2uity sec0s, bec underwriters s!ould do due diligence before sec0s are sold, and it will disappear,
so Rule 5)6 s!ould be made inapplicable to e2uity sec0s
R!le 31=*-*1- $ec$ h+e to &e $ol# '6n 1 yer$
Any %$$!er el%(%&le to !$e Ior/ S-3 cn no' re(%$ter ny ty.e of $ec!r%ty for the h$elf
!n#er R!le 31=
/ilution of t!e earnings, bec t!ere will be more s!ares outstanding lowering market prices
of se0cs problem of market over!ang co0s stopped using s!elf reg0n for e2uity offerings
<lear about Rule 5)6# any notion of underwriter due diligence is gone
Say, issuer registered sec0s last Covember for t!e s!elf on :orm S3+, w!ic! re2uires
prospectus as a term s!eet( ll other %nfo %$ %ncor.orte# %nto re( $tnt &y reference fro/
.r%or f%l%n($$ -nderwriters !ave never seen any of t!ose$ %!is morning %reasurer says today
we0ll sell @200 million wort! of debentures( t!ere will be bidding by underwriters from * to
2#+0 no c!ance of due diligence
So, S?< adopted R!le 124 8%rc!/$tnce$ Affect%n( the :eter/%nt%on of 'ht
8on$t%t!te$ Re$on&le In+e$t%(t%on n# Re$on&le Gro!n#$ for 7el%ef ?n#er Sec 11
-nderwriter would never !ave responsibility
/oes Rule )GJ amend Sec )) by wiping out underwriter0s due diligence obligation w.r.t
S3+ s!elf offerings9
<ons0ces
)" t!is was t!e end of relations!ip investment banking# investment banking became a
commodity w!et!er issuer sold sec0s to underwriter only depends on t!e price
2" transaction costs involved in t!ese offerings were dramatically reduced
+" 'rg0nt# t!ere0s great disproportion bet amount of professional time and energy spent
on ++ act issues and time and energy spent on continuous disclosure system of +5 act
++VV+5"$ 8!y9 >nce you0re past initial public offering, w!y do we care about
additional offerings9 'rg0nt# we s!ould stop registering sec0s and start registering
co0s( focus on continuous disclosure system
Say, we register sec0s in Covember, incorporate info by reference( J mont!s later we !ave
offering, produce prospectus also lots of info by reference, but muc! of it is filed after
effective date of reg st0nt underlying s!elf offering$
,tem )G of :orm S3+ refers to ,tem 6)2b" of Reg S31 solve t!at problem( under ,tem
6)2b" :ilings ,ncorporating Subse2uent ?7c!ange 'ct /ocuments by Reference ech
f%l%n( of nn!l re.ort tht %$ %ncor.orte# &y reference %n the re( $tnt $hll &e
J2
#ee/e# ne' re( $tnt" n# the offer%n( $hll &e #ee/e# to &e the %n%t%l &on f%#e
offer%n($
Ior/ S-3 A $helf re(n '%.e# o!t #!e #%l%(ence$ But not a big problem$ -ntil recently, t!e
only sec0s t!at t!ese co0s offered were debt sec0s not a big problem$
Mast few years developed Auniversal s!elfH bonds, debentures, notes, preferred stock,
common stock, warrants, etc$ 4arket stopped treating suc! stock as t!oug! it was currently
issued$ Iou now get more offerings of common stock$
7ln) 8hec) n# 0enny Stoc) offer%n($
Penny stock
Sec 2*&- deals w.stock w!ic! is not traded on t!e ?7c!ange and C'S/'L$
,f stock is selling for more t!an @6 a s!are it0s not penny stock
Penny stock low3priced stock issues often !ig!ly speculative selling at less t!an @) a
s!are"
Blank c!eck co0s
Blank c!eck c!eck w!ic! is signed by drawer but left blank as to payee and.or amount
R!le 319 S?< can re2uire t!at proceeds of sale be escrowed, t!at sec0s t!emselves be
escrowed until co figures out w!at to do w.t!e money( t!en register a rescission offer to
people w!o boug!t sec, to see if t!ey still want it w!ole blank c!eck t!ing died
Re(!lt%on A
?7emption under Sec +b" for small offerings, w!ic! you can perfect by registering by
filing >ffering <ircular
Sec )) is n.a, bec sec0s are not registered$ /isclosures are re2uired$
/ifference bet Reg ' and registration# you can register under Reg ' w.o audited fin st0nt$
but :orm SB simplified reg process for small offerings don0t need Reg '"
The #eler$ e;e/.t%on
Sec 3*3- %!e provisions of Sec 6 s!all not apply to transactions by a dealer including an
underwriter no longer acting as an underwriter wit! respect of t!e security involved in suc!
transaction", e7cept
*A- transactions taking place prior to t!e e7piration of 50 days after t!e first date upon
w!ic! t!e sec was bona fide offered actually offered" to t!e public by t!e issuer or by or t!roug!
an underwriter
<ontemplates illegal public offering sec0s don0t !ave to be registered"(
dealer0s delivery of prospectus re2uirement ends 50 days after suc! illegal
public offering started
dealer doesn0t know t!at offering is illegal
dealer doesn0t !ave t!e prospectus
but dealer !as obligation to deliver prospectus for 50 days
Purpose# so t!at purc!aser of suc! sec0s from t!e dealer can rescind under
Sec )2)" doesn0t depend on dealer0s knowledge or fault" gives buyer
absolute rig!t to rescind against any person w!o sold sec0s in violation of Sec
6 sold unregistered sec0s"
J+
,f you sell sec in violation of Sec 6 no defenses e7cept st of lim"$ ,f P
knows t!at /.dealer violated it doesn0t bar t!e action$
'nyone w!o buys from a dealer during t!e )
st
50 days of an illegal offering
can rescind under )2)"
*7- transactions in a sec as to w!ic! a registration st0nt !as been filed taking place prior
to t!e e7piration of 50 days after t!e effective date of suc! reg st0nt or prior to t!e e7piration of
50 days after t!e first date upon w!ic! t!e sec was bona fide offered to t!e public by t!e issuer or
by or t!roug! an underwriter after suc! effective date, w!ic!ever is later
8.r.t transactions referred to in clause B", if sec0s of t!e issuer !ave not previously been
sold pursuant to an earlier effective registration st0nt non3reporting co" t!e applicable period,
instead of 50 days, s!all be *0 days
So, if t!e issuer !as not previously sold its sec0s pursuant to an earlier effective reg st0nt, a
dealer must provide a statutory prospectus up to *0 days after t!e effectiveness of reg st0nt or
after sec0s !ave been bona fide offered to t!e public, w!ic!ever is later$
R!le 123
)$ %f re.ort%n( co duty to deliver prospectus is eliminated# all dealers0 transactions are
e7empt e7cept as to original unsold" allotment
2$ %f I0O, and sec !as been approved for listing on t!e E;chn(e or NAS:AJ Rule )G5
reduces prospectus delivery period to 26 days
,nstructions to :orm S3, w.r.t ,P>" re2uire t!e issuer to make undertakings re2uired by Ite/
=D1 of Re(!lt%on S-E# ,tem 602b" outside back cover page of prospectus s!ould !ave
date after w!ic! delivery of prospectus is no longer re2uired
*8- transactions as to sec0s constituting in w!ole or a part of an unsold allotment to or
subscription by suc! dealer as a participant in t!e distribution of suc! sec0s by t!e issuer or by or
t!roug! an underwriter
%o t!e e7tent t!at sec0s in t!e !ands of a dealer are part of !is allotment in sec0s
t!at are unsold no e7emption# until sec0s are sold, dealer !as to deliver a prospectus w!en !e
sells t!e sec
So, if dealer is an underwriter most common sit0n", !e trades sec0s, t!en gets t!em back and
resells t!em no delivery obligation after 50 or 26 days
8!at if t!e issuer stops t!e offering for a period of time and t!en starts it up again9 %!en t!e
dealer !as no way of knowing if !is !sares are part of initial 50 days of t!e offering or part of
t!e post 503day market$ ,n t!is case, dealer s!ould give everyone t!e prospectus$
ASSIGNMENT NO. 4 , 1933 A8T REME:IES
Sec 11*-
Sec 12*-*1-
R!le 1D&-=
R!le 13-9
l%&%l%ty #e.en#$ !.on /ter%l%ty of %nfo
1. Mter%l%ty
Basic v$ Mevinson 1D*&- A R!le 1D&-=
J5
S$<t )*FF" Mter%l%ty #e.en#$ !.on a &lnc%n( of &oth the %n#%cte#
.ro&&%l%ty tht the e+ent '%ll occ!r and the nt%c%.te# /(n%t!#e of the e+ent in l%(ht of
the totl%ty of the co ct%+%ty
0re$!/.t%on of Rel%nce llo'$ for 8l$$ 8ert%f%ct%on:
Ir!#-on-the-/r)et theory
S%lence %$ not ct%on&le" 'hen no #!ty to #%$clo$e
Mter%l%ty %n the conte;t of .rel%/%nry /er(er ne(ot%t%on$
Basic was involved w.merger discussions w.<ombustion ?ngineering for + years, yet made +
public st0nts denying t!at it was engaged in merger negotiations$
Ps.class former Basic s.!s w!o sold t!eir stock after Basic0s )
st
public st0nt and before t!e
final announcement.t!e suspension of trading t!e day before public announcement of its
approval of <ombustion0s tender offer"$
P0s !ave standing, bec t!ey are sellers$
/ist ct certified t!e class, but dismissed suit negotiations are not material until main
negotiation.agr0nt was reac!ed until t!ere was a deal
J <ir reversed on t!at issue# any st0nt you make t!at is untrue is by definition material =
certified class on fraud3on3t!e3market t!eory# reliance need not be s!own independently by
Ps, bec presumption of reliance info was public affected market price semi3strong form
of efficient market !ypot!esis"
4'%?R,'M,%I
S$<t adopts standard of materiality set fort! in %S< ,ndustries v$ Cort!way for 1D*&- n#
R!le 1D&-= cases# there /!$t &e $!&$tnt%l l%)el%hoo# tht the #%$clo$!re of the
o/%tte# fct 'o!l# h+e &een +%e'e# &y the re$on&le %n+e$tor $ h+%n( $%(n%f%cntly
ltere# the totl /%; of %nfo /#e +%l&le
S$<t adopts 2d <ir test of materiality in S?< v$ %e7as Nulf Sulp!ur#
Mter%l%ty #e.en#$ !.on a &lnc%n( of bot! the %n#%cte# .ro&&%l%ty tht the
e+ent '%ll occ!r and the nt%c%.te# /(n%t!#e of the e+ent in lig!t of t!e totality of
t!e co activity
depends on t!e facts fact3specific in2uiry
no brig!t line it0s a &0nt call
probability t!at t!e activity will occur indicia of interest at t!e !ig!est corp
levels# board resolutions, instructions to investment bankers, actual
negotiations
magnitude of trans0n to t!e issuer of securities allegedly manipulated si;e
of 2 corp entities and potential premiums over market value but merger is
obviously of great magnitude to t!e co"
/s argue for 3 8%r te$t# preliminary merger discussions do not become material until
(ree/ent-%n-.r%nc%.le as to t!e price and structure of t!e transaction !as been reac!ed bet
t!e would3be merger partners S$<t re&ects
+ rationales S$<t re&ects eac! one"
)$ noise concern t!at investor not be overw!elmed w.trivial info = risk t!at prelim
merger discussions may collapse( S$<t t!is arg0nt assumes simplemindedness of
investors not &ustified
2$ t!is test will preserve confidentiality of negotiations( serious business re2uires
privacy( S$<t true, but so w!at S$<t s!ould be addressed to <ongress"
J6
+$ provides brig!t line for w!en disclosure must be made S$<t nice, but not w!at
<ongress provided for"
Slain# 2
nd
and +
rd
rationales make sense
S$<t also re&ects 4 8%r te$t t!at %nfo %$ l'y$ /ter%l %f 'ht yo! $y &o!t %t %$ !ntr!e(
S$<t you !ave to make preliminary in2uiry w!et!er info is material in R$)0b36 claim P
must s!ow t!at st0nts were misleading as to material fact, not enoug! t!at st0nt is false or
incomplete, if misrep0d fact is ot!erwise insignificant
S$<t# it doesn0t matter t!at info is untrue, if it0s not material !as to be material first"
But w!en does it become material9 no guidance !ere
PR!le 1D&-= #oe$ not %/.o$e .o$%t%+e o&l%(t%on to #%$clo$e %nfo. Mo! 9!$t cnt /%$le#
.eo.le n# yo! cnt (%+e %nfo tht %$ $o %nco/.lete $ to &e /%$le#%n(
Iootnote 12: To &e ct%on&le" $tnt /!$t l$o &e /%$le#%n(. S%lence" &$ent #!ty to
#%$clo$e" %$ not /%$le#%n( !n#er R!le 1D&-=. BNo co//entC $tnt$ re the f!nct%onl
eq!%+lent of $%lence. %!us, Rule )0b36 does not impose an obligation to speak$ %!e only
time w!en it imposes duty to speak is w!en you said smt!, and your st0nt is not completely
true, or w!en you intended your st0nt to make people rely on it, t!en cir0ces c!anged you
!ave duty to correct your st0nt$ So you can &ust say Ano commentH$
So, t!ey mean to keep negotiations secret, but some info leaks out$ Say Ano commentH$
But if in t!e past you !ave denied t!e e7istence of any negotiations, and t!en said Ano
commentH you &ust told people t!at it0s true
So, !ave broad policy of Ano commentH
But# purpose of statute is to increase flow of info to investors, and !ere we in!ibit t!at flow of
info$
'lways a problem of Aputting co in playH by telling people you0re negotiating an ac2uisition$
're you ac2uiring or being ac2uired# if t!e only possibility is t!at you0re being ac2uired
risk arbitrageurs come into play, and so co comes in play tender offers"
Marger 20n# w!et!er all transactions by corp are permissible only to t!e e7tent t!at t!ey
ma7imi;e t!e immediate return to s.!s some people argue t!at"
So" %f yo! 'nt .r%+cy , n# yo! #o 'nt .r%+cy , yo! h+e to h+e &ln)et r!le of
Bno co//entC
0re$!/.t%on of RE5IAN8E llo'$ for 8l$$ 8ert%f%ct%on
Reliance element of Rule )0b36 case
Suppose ct adopts /0s position t!at Ps in a class action !ave to prove ind0l reliance to
many ind0l issues, Ps wouldn0t sue$ 4odern securities markets are not face3to3face
transactions unlike common3law fraud cases"$ Presumptions are useful = allocate burden of
proof# difficult to !ave direct proof, fairness, public policy, probability = common sense,
&udicial economy
S$<t adopts fr!#-on-the-/r)et theory#
,n t!e market, t!e price of t!e co0s stock is determined by t!e available material info re#
co and its business( misleading st0nts defraud purc!asers of stock, even if t!ey do not
directly rely on t!e misst0nts$
%!us, reliance of ind0l Ps on t!e integrity of t!e market price may be presumed$ 4ost publicly
available info is reflected in market price impersonal efficient market$
/ may rebut presumption as to ind0l Ps if / can s!ow t!at misrep0n did not affect t!e market
price, or t!at ind0l P did not rely on integrity of t!e market price"$ Slain impossible to do$
Slain# O$ 8!ite0s dissent better case
JJ
<ourt decided to take on semi3strong form of efficient market !ypot!esis( you don0t !ave
to prove w!at is universally known and incontrovertible, but is t!is !ypot!esis universally known
and incontrovertible9 Co$ <an you &ustify presumption of reliance w.o fraud3on3t!e3market
t!eory9 Securities law is replete w.derivative reliance# , buy security not bec t!e price is rig!t,
but bec t!at0s !ow , was advised by broker or ot!er securities analyst( t!ey are getting info from
publicly disclosed info, t!ey rely on it, so , rely on t!is info so, my reliance is derivative and
unprovable$ ,t0s a far easier arg0nt to make t!an t!at efficient market !ypot!esis operates in some
way to produce reliance$
8!y is reliance an element of R$)0b36 case9 R$)0b36 itself imposes no disclosure
obligations( t!ey come from somew!ere else$ In non-#%$clo$!re c$e" rel%nce '%ll &e
$$!/e#. <ourt continues to insist t!at reliance is an element of R$)0b36 case, bec reliance is an
element in common law of deceit$
,s t!ere a 2uantified standard for materiality9 ,f so, is t!at t!e ultimate standard for
materiality9
'ccounting Series Release Co$ **
A q!nt%tt%+e $tn#r# of /ter%l%ty %$ e;.re$$ly #%$..ro+e#
,n Bar<!ris, t!ere was a !uge margin of error 3 )5K$ Oudge 4acMean !eld t!at t!is was not a
material error$ Slain no, material$
6K rule of t!umb# anyt!ing larger t!an 6K is material t!at0s accounting rule of t!umb, but
t!at0s not S?<0s view and not :'SB0s view"
SE8: %nfo %$ /ter%l" ho'e+er $/ll the /o!nt" %f there %$ $!&$tnt%l l%)el%hoo# tht
%nfo 'o!l# h+e &een +%e'e# &y the re$ %n+e$tor $ h+%n( $%(n%f%cntly ltere# the totl
/%; of %nfo /#e +%l&le.
Sec 13*&-*1- of 33 'ct books and records
<reates a federal standard for reporting co0s as to t!eir books and records# books and
records s!ould be in good enoug! s!ape
)$ to permit mgmt to police accountability of co0s assets
2$ to permit accounting in acc w.N''P
So, even if not material misstatement, it may violate Sec )+b"2"# you may !ave to report
t!ings even if t!ey are not material
4anaging.HmassagingH earnings
<o t!inks# let0s !ide earnings, bec if we report all earnings, people will e7pect still better
ne7t year$ %!ey understate closing inventory by, say, +K below 6K" it overstates t!e
cost of goods sold net income will go down, and ne7t year t!ey0ll report correct amount
,n -S, managing earnings is regarded as true misbe!avior
:ranc!ard SE8: $tn#r# of /ter%l%ty %$ not q!nt%tt%+e" &!t q!l%tt%+e.
S?< )*J5" Anyth%n( &o!t /(/t %nte(r%ty %$ /ter%l , re.ort&le.
<o was registering sec0s under ++ 'ct, and prospectus contained misleading info didn0t
disclose some info
23part proceeding
)$ S?< issued stop order on registration st0nt, but co registered sec0s in )*J0, w!ereas stop
order in )*J+ no effect of stop order after prospectus delivery dates !ave gone by$ %!e
only cons0ce# you0re marked lousy in a public way
JG
2$ S?< re2uired post3effective amendment, but sec0s long since sold$ Post3effective am0nt
becomes effective w!en S?< declares it effective
,nfo not disclosed in a prospectus#
)$ Nlickman leading s.!" borrowed @2$+ million from t!is co to anot!er co
2$ 'll of !is stock was pledged as collateral for loans
%!ere were no disclosure re20nts concerning t!ese precise points$ /efense !ad to !ave been
t!is info is not material$
/# @2$+ million )K of assets not material
SE8: $t%ll /ter%l , /n(e/ent %nte(r%ty %$ l'y$ /ter%l
8!at about pledged stock# if !e doesn0t pay t!e loan, t!e creditor e7ecutes t!e pledge and
sells sec0s to !imself creditor becomes controlling s.! important for investors to know#
you s!ould disclose t!e possibility t!at Nlickman may not be t!ere
Here, really mgmt !as arranged loans to itself# investors oug!t to know !ow mgmt is dealing
w.co0s assets, !owever small amount$ Suc! transactions are re2uired to be reported
>b&ections to disclosure# @ amount doesn0t rise to t!e level of materiality
SE8: $tn#r# of /ter%l%ty %$ not q!nt%tt%+e" &!t q!l%tt%+e. Anyth%n( &o!t /(/t
%nte(r%ty %$ /ter%l , re.ort&le.
2
nd
issue post3effective am0nt# Staff of S?< wanted it to be public confession t!at Board of
/irectors did a poor &ob policing t!e co reportable event$ S?< <!airman" no$
Staff tried to establis! a federal standard for managing co by directors$ SE8: no" %t$
/tter of $tte l' , #!t%e$ of #%rector$ re $tte e$t&l%$he# *not fe#erlly e$t&l%$he#-.
Slain# but t!ere is no state law on t!is sub&ect eit!er$"
-S v$ 4att!ews There %$ no #!ty to re.ort cr%/%nl con#!ct tht yo!re not chr(e#
2d <ir )*FJ" '%th
If there %$ no $.ec%f%c r!le req!%r%n( #%$clo$!re , yo! #ont h+e to
#%$clo$e
Suspicion t!at officers were going to bribe a ta7 official
4att!ews involved outside counsel, and t!ey did some investigation, found no bribe$
Prepared report to Board of /irectors$ %!ey decided t!at t!ey s!ould not report t!is
2uestionable payment to Bo/ = danger of disclosure of t!is info# e7tremely !ig! risk of
defamation accusing public official of being bribed w.o any evidence$ So, 4att!ews
doesn0t report t!is
>t!er people at Sout!land are indicted for income ta7 violation# t!ey misdescribed payment
as deductible, w!ere it wasn0t bec it0s a bribe$ %rial one# all /s e7cept for ) guy are not
liable$ %!is guy is reindicted, and 4att!ews is indicted w.!im$
Nov0nt claims sec0s laws violation# claim t!at 4att!ews0 election to Bo/ was accomplis!ed
by means of a pro7y st0nt w!ic! failed to disclose t!at !e was engaged in a conspiracy to
bribe ta7 officials$ He is ac2uitted on )
st
c!arge and convicted on 2
nd
c!arge logical
discontinuity$
2d <ir# no, !e is not liable on 2
nd
c!arge !e did not !ave to disclose t!at !e was engaged in a
conspiracy$ :urt!ermore, !eld# there %$ no $.ec%f%c r!le req!%r%n( #%$clo$!re , $o" there %$
no #!ty to re.ort cr%/%nl con#!ct tht yo!re not chr(e# '%th
't least so long as unc!arged criminal conduct is not re2uired to be disclosed by any rule
lawfully promulgated by t!e S?<, nondisclosure of suc! conduct cannot be t!e basis of a
criminal prosecution$
:ranc!ard says# anyt!ing t!at implicates integrity of mgmt is material and s!ould be
disclosed$ So !ere, s!ould be disclosure, bec conspiracy s!ould be material
JF
Say, new pro7y st0nt or reg st0nt( <?> of t!is co !as &ust been diagnosed w.incurable cancer$
Reg S31 says not!ing about disclosing !ealt! of t!ese people( but arg0nt investor would
like to know t!at9
Ite/ 3D1 of Re( S-E $y$ #%rector h$ to #%$clo$e cr%/%nl con+%ct%on '6n l$t = yer$.
Sy" 1D yer (o he '$ con+%cte# of e/&eGGle/ent. 8n $y: nyth%n( tht $ho'$
chrcter of the$e .eo.le %$ re.ort&le
People do not c!ange# if !e embe;;led )0 years ago, !e0ll do it now$
Slain# 4att!ews !orror, s!ocking case
Slain# !ave to be diff cons0ces bet civil and criminal proceedings$ Here criminal$
1. Soft Infor/t%on
Policy of S?< in ++ 'ct = +5 'ct pro7y rules and continuous disclosure system" to
e7clude from prospectus any info w!ic! was not !istorical( reported info s!ould be only
!istorical info = solely about t!is co$ Result would be# all info would be from !istory( no
st0nts about t!e future or ot!er co0s"$
,ssuers !ad no motivation to c!ange S?<0s attitude w.r.t disclosure of estimated info$ 8!y9
bec of Sec )) nature of issuer0s liability insurance liability absolute liability as to any
misleading st0nts$
%!en academic criticism# to introduce some level of fle7ibility into disclosure system
%!en lawsuits, esp$ w.r.t pro7y st0nts
S?< Release of )*G+# S?< announced t!at forward3looking and predictive info mig!t be
included in a prospectus w.n very narrow limits but of course, none of issuers included suc!
info bec of Sec )) liability
)*F+ concept of Mn(e/ent :%$c!$$%on n# Anly$%$# soft info is re2uired to be
disclosed
5ot$ of #%$clo$!re #ocnt$ req!%re M:QA $ect%on
Ior/ S-1" Ite/ 11*h-
Ior/ 1D-E" Ite/ 2
Ior/ 1D-J 0rt I" Ite/ 1
*Ann!l re.ort to $ec!r%ty hol#er$- R!le 13-3*&-*=-*%%-
Re(!lt%on S-E" Ite/ 3D3
Re(!lt%on S-E" Ite/ 3D3
2 parts
a" :ull :iscal Iears
b" ,nterim periods s!ort"
*-*1- 5%q!%#%ty
,dentify any known trends or any known demands, commitments, events or uncertainties
t!at will result in or t!at are reasonably likely to result in t!e registrant0s li2uidity increasing or
decreasing in any material way
,t0s not w!at !as !appened, but w!at you can see is going on now t!at is likely to !ave
material effect on li2uidity = identify areas of uncertainty
Problem# self3fulfilling prop!ecy# if you publicly announce t!at you0re maybe going broke
you0ll go broke it0s an absolute certainty$ ,f you tell people t!at you !ave severe li2uidity
problem it0s unsolvable
)$ nobody will give you money
J*
2$ creditors will try to collect from you
*-*1- 8.%tl Re$o!rce$
i" /escribe t!e registrant0s material commitments for capital e7penditures
ii" /escribe any known material trends, favorable or unfavorable, in t!e registrant0s
capital resources
*-*3- Re$!lt$ of O.ert%on$
i" /escribe any unusual or infre2uent events or transactions or any significant econ
c!anges t!at materially affected t!e amount of reported income from continuing
operations
ii" /escribe any known trends or uncertainties t!at !ave !ad or t!at t!e registrant
reasonably e7pects will !ave a material favorable or unfavorable impact on net
sales or revenues or income from continuing operations
?ssentially predicting info
,n re <aterpillar M:QA $ect%on< M:QA $tn#r# of /ter%l%ty<
S?< )**2" Te$t , 'hen #%$clo$!re %$ req!%re#
<aterpillar0f failure in its :orm )031 for )*F* and its :orm )03L for t!e first 2uarter of )**0
to comply wit! ,tem +0+ of Reg S31 4/Q' section$ 4/Q' rules re2uired <aterpillar to
disclose info about t!e )*F* earnings of <aterpillar Bra;il, its w!olly owned Bra;ilian
subsidiary, and uncertainties about Bra;ilian sub0s )**0 earnings$ Hel#: ye$" +%olt%on of
Sec 13*- n# R!le$ 13-1" 13-13 of 33 Act.
Bra;ilian sub was not a !uge part of consolidated sale value of <aterpillar, but profit
attributed to it was muc! greater 2+K
%!ere was not place in t!e doc0s w!ere separate result from Bra;ilian sub was reported
8!at <aterpillar was reporting was consistent w.N''P# no re20nt to publis! subsidiary info
separately
,nternally, <aterpillar didn0t focus on t!is p!enomenon of Bra;ilian sub it was a function of
Bra;ilian e7c!ange rates currency"$
Beg of )**0 )
st
time mgmt observed t!at tremendous amount of F* profits is because of
Bra;ilian.-S currency conversion$ :eb0*0 )
st
report to board of directors t!is fact was
told$ )031 was still a couple of weeks away$ 4/Q' in )031 doesn0t refer to t!is$
?vents in Bra;il Bra;ilian business was dropping$ 'pril0*0 2
nd
report to board of
directors tells t!at Bra;il is volatile, !ard to predict$ 't t!at point )031 was filed, but )03L
!asn0t been filed
4ay0*0 t!ey !ad t!e financial results of Oanuary troug! 4ay3beginning of Oune 6 mont!s#
Bra;ilian operations go down bec of inflation and currency conversion t!ere will be loss
rat!er t!an big income from last year, and loss won0t be offset by income from ot!er
<aterpillar places overall income loss$ %!ey issue press release announcing t!ese facts$
%!eir defense# we couldn0t say it earlier, until we !ad operating numbers for 6 mont!s
But it0s not a legal standard( the le(l $tn#r# %$ tht they h+e to #%$clo$e %nfo e+en
tho!(h they cnt q!nt%fy %t
M:QA $ect%on h$ %t$ o'n #%$t%nct%+e $tn#r# of /ter%l%ty, diff from ot!er sections
Te$t , 'hen #%$clo$!re %$ req!%re#:
8!ere a trend, demand, commitment, event or uncertainty is known, mgmt must make 2
assessments#
G0
)$ ,s t!e known trend, demand, commitment, event or uncertainty likely to come to fruition9 If
/(/t #eter/%ne$ tht %t %$ not re$on&ly l%)ely to occ!r" no #%$clo$!re %$ req!%re#
2$ ,f mgmt cannot make t!at determination, it must evaluate ob&ectively t!e conse2uences of t!e
known trend, demand, commitment, event or uncertainty, on t!e assumption t!at it will come
to fruition$
:%$clo$!re %$ then req!%re#" !nle$$ /(/t #eter/%ne$ tht /ter%l effect on the
re(%$trnt$ f%nnc%l con#%t%on or re$!lt$ of o.ert%on$ %$ not re$on&ly l%)ely to
occ!r.
,t0s a +ery lo' /ter%l%ty $tn#r#
<ourt# By t!e time of t!e :eb0*0 board mtg 2 weeks before <aterpillar0s :orm )031 for
)*F* was filed
mgmt could not conclude t!at lower earnings from Bra;ilian sub were not reasonably
likely to occur,
nor could mgmt conclude t!at a material effect on <aterpillar0s results of operations was
not reasonably likely to occur due to Bra;ilian sub0s lower earnings
8as 4/Q' section in :orm )031 certified by auditors# t!e auditor !ad reviewed t!e
disclosure set fort! in t!e 4/Q' for inconsistencies w.t!e fin st0nts$ Slain# you s!ouldn0t
re2uire of auditors more t!an t!at$
8ielgos v$ <ommonwealt! ?dison R!le 12= - $fe hr&or for for'r#-loo)%n( $tnt$
G
t!
<ir )*F*"
,nvestors broug!t action ag utility co w!ic! operates nuclear reactors" for violation of Sec ))
of ++ 'ct$ Held# for /$
S!elf registration was done for common stock offering$ Registration st0nt on :orm S3+
incorporated by reference info from ot!er filings$ /oc0nts incorporated by reference into reg
st0nt filed on :orm )031 estimated t!e total costs of building reactors and t!e years t!ese
reactors would begin making power 3was filed mont!s before$ ?stimates incorporated into
September0F+ prospectus were calculated in /ec0F2$ Sec0s were sold in /ec0F+$
%!ere was a licensing application pending before nuclear regulatory agency to license t!e
)
st
of nuclear plants$ 'lmost immediately after offering of sec0s in /ec0F+, agency denied t!e
application smt! t!at !as never !appened before reversed later"$ ,f t!at were agency0s
final disposition !uge costs( no c!ance of recovering t!ese costs( plus cost of tearing down
t!e plant$ 4arket dropped about @J a s!are about 26K$
<lass action Ps sue under Sec )) of ++ 'ct$ I$$!er n# !n#er'r%ter$ +%olte# Sec 11
1. &y !n#ere$t%/t%n( the co/.let%on co$t$ of the rector$ n#
1. &y f%l%n( to re+el tht the ..l%ct%on for 1
$t
.lnt$ l%cen$e '$ &efore the
(ency
Ps didn0t read t!e doc0nts w!ere t!is underestimation was$ ,t0s not important to t!is lawsuit$
All 0$ h+e to .ro+e %$ tht %nfo '$ 'ron(. 0$ #ont h+e to .ro+e rel%nce , tht 0$
'ere /%$le# &y th%$ %nfo.
/ist ct dismissed on grounds of materiality
G
t!
<ir
)
st
element of P0s case# underestimation of completion costs of t!e reactors
4argin of error was 6K of J$6 billion about @+00 million
P0s say# under standard of liability of Sec )), / is liable$ / incorporated by reference info
about completion of reactors t!at was off by about @+00 million$ Reas investor would want
to know t!at t!ere is @+00 million increase in costs$
G)
/efense to t!at# Rule )G6 safe !arbor
R!le 12= 5%&%l%ty for cert%n $tnt$ &y %$$!er$
*- ' st0nt w.n t!e coverage of paragrap! b" of t!is rule w!ic! is made by or on be!alf of an
issuer or by an outside reviewer retained by t!e issuer s!all be deemed not to be a fraudulent
st0nt, unless it is s!own t!at suc! st0nt was made or reaffirmed w.o a reasonable basis or was
disclosed ot!er t!an in good fait!
*&- %!is rule applies to t!e following st0nts#
)" ' forward3looking st0nt made %n #oc!/ent f%le# '6the 8o//%$$%on
*c- Ior'r#-loo)%n( $tnt s!all mean and s!all be limited to
)" ' st0nt containing a pro&ection of revenues, income loss", earnings loss" per s!are,
capital e7penditures, dividends, capital structure or ot!er financial items
2" ' st0nt of mgmt0s plans and ob&ectives for future operations
+" ' st0nt of future econ perf0ce contained in 4/Q' section
5" /isclosed st0nts of t!e assumptions underlying )", 2", +" above
*#- Ir!#!lent $tnt s!all mean a st0nt w!ic! is an untrue st0nt of a material fact, a st0nt false or
misleading w.r.t any material fact, an omission to state a material fact necessary to make a st0nt
not misleading, or w!ic! constitutes t!e employment of a manipulative, deceptive, or fraudulent
device, contrivance, sc!eme, transaction, act, practice, course of business, or an artifice to
defraud$
P would say# , do not claim t!at t!is is a fraudulent st0nt$ :raud is not an element of my Sec
)) case$ %!e only re20nt is material misinformation in reg st0nt at t!e time reg st0nt became
effective$ ,f info is wrong, it doesn0t matter !ow it got to be wrong issuer !as absolute duty
to provide t!e rig!t info$ Rule )G6 would be a complete defense to )0b36 case w!ere fraud
is an element", but ,0m not suing under )0b36$
2
th
8%r: PR!le 12= %$ $fe hr&or for Sec 11 cl%/
Ir!#!lent $tnt %n R!le 12=*- t!rn$ o!t to &e $horthn# for ll of the &$e$ of
l%&%l%ty %n the 33 Act n# %t$ %/.le/ent%n( r!le$.
P# t!ese people disclosed in Spring0F+ t!eir F2 estimates, and t!ey !ad more info before filing
reg st0nt and even more before selling sec0s$ %!ey didn0t disclose reas basis for estimates$
I$ th%$ #%$clo$!re of n e$t%/te ftlly fl'e# &y f%l!re to #%$clo$e %nfo !n#erly%n( the
e$t%/te@ , no. It$ .er/%$$%&le o.t%on to #%$clo$e $!ch %nfo" %t$ not reqnt.
Problem w.disclosing t!is info# once you start, w!ere do you stop$ %!e more detail you
provide you0re deemed to !ave impliedly negated ot!er t!ings$
)031 !ad cautionary language$ 8!at weig!t does &udge give t!at9 none( no importance( !e
says it0s boilerplate$ Slain# rig!t boilerplate cautionary disclosures are meaningless
8!at about t!e fact t!at co knew it was off by @+00 million$ Oudge#
)no'le#(e&le6$o.h%$t%cte# re#er$ )ne' tht n!/&er$ 'ere !n#ere$t%/te#$
P would say# so w!at, , didn0t know about t!is, and , s!ould be protected, , s!ould be able to
recover$ Response# t!ese assumptions about estimates were built in t!e price of t!e stock
t!e market price of stock reflected all info 3 the .!&l%c &!yer$ of $ec$ re rely%n( on
/r)et .rofe$$%onl$< %f /r)et .rofe$$%onl$ re not /%$le# , .!&l%c %n+e$tor$ 'ont
&e /%$le#$ Slain# t!at0s true$ Oudge is relying on $e/%-$tron( for/ of eff%c%ent /r)et
hy.othe$%$$
Oudge# w!at motivates an issuer to make disclosures of forward3looking info9 not!ing# ;ero
c!ance t!at you0ll be rig!t depending on t!e direction t!at you0re wrong, people eit!er
buyers or sellers of sec0s" will always be mad$
G2
M:QA req!%re$ #%$clo$!re of for'r#-loo)%n( %nfo. Here" e+eryth%n( tht$ nee#e# to
&e #%$clo$e# '$ #%$clo$e#.
2
nd
element of P0s case# failure to disclose licensing proceeding is underway
Oudge# you don0t !ave to disclose smt! t!at somebody else wants to know$ / revealed all
t!at is re2uired only firm3specific info must be revealed"$ Plus, t!e market !ad in its
possession all significant info about /$
)**6 <ongress adopted Sec 12A of 33Act
A..l%ct%on of Sfe Hr&or for Ior'r#-5oo)%n( Stte/ent$
Sec 2G' v$ Rule )G6
)$ safe !arbor in 2G' is not limited to filings w.S?< applies to oral or any kind of
communication
2$ standard of liability is diff from standard t!roug!out ++ 'ct 2G' !as scienter
liability re20nt
,n re 8orlds of 8onder the B&e$.e)$ c!t%onC #octr%ne
*
t!
<ir )**5"
Predictive st0nt t!at co !as enoug! li2uid assets$ <ourt finds no liability w.r.t t!is st0nt under
Abespeaks cautionH doctrine
%!is doctrine eit!er undercuts pos0ty of reliance but reliance is not part of P0s case under Sec
))", or undercuts materiality
Slain# bot!ersome about t!is doctrine# #octr%ne ele+te$ the )%n# of ro!t%ne &o%ler.lte
*l%)e %n W%el(o$- to .o$%t%on of (ret %/.ortnce
%o date, no court !as applied t!is doctrine ot!er t!an to $oft %nfo , for'r#-loo)%n( %nfo"
!$! %n M:QA" h$nt ..l%e# %t to h%$tor%cl fct$$ 8!at if t!ere0s a !istorical fact w.all
disclaimers, and t!en it turns out to be wrong$ Slain# doctrine probably wouldn0t apply$
8orlds of 8onder, a toy co, sold @F0 million of &unk bonds *K convertible subordinated debentures"
to t!e investing public$ <o defaulted on its very first interest payment and filed for bankruptcy,
rendering sec0s wort!less$ ' class of disappointed investors filed securities3fraud action !n#er Sec 11,
naming as /s co0s officers, directors, auditors, underwriters, and ma&or s.!s$
?vents#
)*F6 co formed( ) toy was a success in F6 <!ristmas season( t!en 2
nd
product was a success in
)*FJ <!ristmas season
%!en public offering of debentures on Oune 5, )*FG to fund fut!er e7pansion"
Ouly )*FG corp reported losses for )
st
2uarter of fiscal )*FG, fire e0ees
Cov0FG reported losses again, announced price reductions on 2 toys
'fter FG <!ristmas sales fell far below pro&ections, co defaulted on )
st
interest payment and filed
for bankruptcy on /ec0FG, rendering sec0s wort!less
0$ $!e !n#er Sec 11 , .r%+te r%(ht of ct%on %n f+or of $ec$ .!rch$er$ 'ho rely !.on
/ter%lly fl$e or /%$le#%n( .ro$.ect!$.
/ist ct# sum &0nt in favor of all /s# )" e7cept for possible errors in t!e certifies )*FG fin st0nts,
prospectus wasn0t false or misleading and 2" even assuming t!at )*FG fin st0nts were false or
misleading, eac! / !ad establis!ed an affirmative defense to Sec )) liability
/ist ct applied the B&e$.e)$ c!t%onC #octr%ne: econ .ro9ect%on$" e$t%/te$ of f!t!re
.erfor/nce" n# $%/%lr o.t%/%$t%c $tnt$ %n .ro$.ect!$ re not ct%on&le 'hen
.rec%$e c!t%onry ln(!(e el$e'here %n the #ocnt #eq!tely #%$clo$e$ the r%$)$
%n+ol+e#. ,t doesn0t matter if t!e optimistic st0nts are later found to !ave been inaccurate or
based on erroneous assumptions w!en made, provided t!at t!e risk disclosure was specific
G+
and ade2uately disclosed assumptions upon w!ic! t!e optimistic language was based$ In the
conte;t of $!/ 9nt /ot%on: 'here .ro$.ect!$ cont%n$ #eq!te c!t%onry ln(!(e
#%$clo$%n( $.ec%f%c r%$)$" no re$ %nference cn &e #r'n tht $tnt re: tho$e r%$)$ '$
/%$le#%n(.
0l!$" %nfo &o!t co '$ )no'n to the /r)et t the t%/e of the offer%n(.
*
t!
<ir# affirm in part and reverse in part adopts dist ct0s formulation of t!e doctrine
/octrine merely represents t!e application of concepts of materiality and reliance$ Predictions are
necessarily contingent$ :octr%ne: 'hen o.t%/%$t%c .ro9ect%on$ re co!.le# '6c!t%onry
ln(!(e$
Here, dist ct applied t!e doctrine narrowly# applies only to precise cautionary language w!ic! directly
addresses itself to future pro&ections, estimates or forecasts in a prospectus$
/octrine !elps to minimi;e t!e c!ance t!at P w.groundless claim will bring suit and conduct e7tensive
discovery in t!e !opes of obtaining an increased settlement
Ps claim t!e te7tual disclosures in debenture prospectus were false or misleading in 5 areas#
)$ li2uidity
2$ internal controls
+$ revenue recognition
5$ sales performance
1. 5%q!%#%ty
t!at prospectus was false and misleading bec it stated t!at co e7pected to !ave sufficient cas! to
operate t!roug! 4arc! +), )*FF
But prospectus made disclosures w.r.t li2uidity
/ist ct# prospectus clearly bespoke caution on serious risks 8>80s li2uidity crisis posed to investors$
P0s are not entitled to an inference t!at t!ey were mislead in t!e face of suc! disclosures$
*
t!
<ir agrees$ Prospectus refers to 8>80s continuing cas! s!ortfall and borrowing re20nts$
1. Internl control$
t!at 8>80s internal controls at t!e time of t!e offering !ad crippling deficiencies and t!at no reas
investor reading prospectus would !ave concluded t!at te!re were any e7isting problems w.controls
/ist ct# prospectus included e7press disclaimer t!at t!ere can be no assurances t!at 8>80s e7isting
internal controls would continue to be ade2uate given t!e rapid pace at w!ic! co was growing
prospectus ade2uately bespoke caution
*
t!
<ir agrees# )" prospectus didn0t say t!at internal controls problems were in t!e past and not
ongoing, it warned t!at it mig!t prove to be inade2uate and 2" Ps presented no evidence t!at internal
controls at t!e time of t!e offering were materially deficient and +" 8>8 probably would not !ave
needed to disclose even serious internal3control deficiencies
3. Re+en!e reco(n%t%on
t!at prospectus failed to disclose t!at 8>8 engaged in various tactics to Apump upH revenue figures
w.o completing actual sales omitted 8>80s observance of price protection, stock balancing, and
guaranteed sales
)" P0s introduced no evidence t!at at t!e time of t!e offering mgmt could !ave foreseen t!at it would
!ave to reduce prices$ %!e speculative impact of future e7c!anges and price reductions was not
material$ 2" Price protection is a common practice in t!e toy industry 8>8 !ad no duty to disclose
it
Ps didn0t !ave to disclose t!e practice of guaranteed sales rig!t to return non3defective products"$
/eloitte analy;ed 8>80s sales practices &ust bec some customers were allowed a refund does not
mean t!at co !ad a practice of offering guaranteed sales to all its customers
So, normal business practice not material omission
3. Sle$ .erfor/nce
G5
t!at prospectus misstated co0s performance in t!e )
st
2uarter of fiscal )*FF and !id t!e fact t!at at t!e
time of t!e offering sales and demand for co0s products declined
but Seasonality of Luarterly Results sales of toys are !ig!ly seasonal co e7pects sales to be lower
in t!e )
st
!alf of t!e calendar year
Ps arg0nt contends t!at co s!ould !ave predicted collapse in sales t!at occurred in late )*FG, long after
offering t!at future prospects were not as brig!t as past perf0ce
/ist ct rig!t# not material facts
4arket c!aracteri;ed debentures as &unk bonds !ig! risk"
8!en co fails, it doesn0t automatically mean t!at violation of sec0s laws !as occurred$ %!ere are
always risks involved
Here, investors took a gamble, as do all investors
,t was obvious to any reas investor t!at if eit!er of co0s 2 products were to lose favor w.consumers, co
would be devastated
Sum &0nt for /s
3. 1933 Act $tn#%n(
Barnes v$ >sofsky Sec 11 e;ten#$ only to .!rch$e$ of the ne'ly re(%$tere#
2d <ir )*JG" $hre$
8!o !as standing to sue under Sec ))
,f t!is !as been ,P>, could t!is case !ave arisen9 no$ Here, co already !ad sec0s in t!e
market$ Cow new offering$ Ps boug!t sec0s following new offering, but can0t trace t!eir
sec0s to t!is offering$ /oes Sec )) liability apply to t!em
,nitial public offering t!e )
st
public offering of securities t!at an issuer makes$ By so doing,
t!e issuer goes public and becomes sub&ect to +5 'ct0s reporting obligations$
Sec )) Aany person ac2uiring suc! securityH
particular units of t!is class now registered 2d <ir !olds"
or sec0s of t!is class now registered or previously outstanding
P# if prospectus is materially wrong, ,0m affected in t!e same way w!et!er , buy in ,P> or
sec0s previously outstanding t!at0s true
2d <ir# narrow reading$
Sy" I $' .ro$.ect!$" re# %t" n# I '$ /%$le#" &!t I cnt trce $ec , $o" no Sec 11
cl%/. Any other $ect%on !n#er 'h%ch to &r%n( cl%/@ , 1D&-=
:%fference &et Sec 11 n# 1D&-=: %n 1D&-=" $c%enter %$ n ele/ent of 0$ c$e
Sy" th%$ %$ n I0O *no .re+%o!$ly o!t$tn#%n( $toc)-< !n#er'r%ter$ $ell $ec$ to #eler$ ,
#eler$ $ell to .!&l%c: %t$ tr#%n( %n the $econ#ry /r)et. I &!y $ec %n the tr#%n(
/r)et. 8n I h+e cl%/ !n#er Sec 11 - ye$
1. yo! &!y $ec n# trce %t to offer%n(
1. yo! #o %t '6n $tt of l%/
+ class actions by purc!asers of sec0s ag 'ileen, ,nc were consolidated"# claim under Sec )) of ++ 'ct
t!at registration st0nt and prospectus contained material misstatements and omissions, primarily in
failing to disclose danger signals of w!ic! t!e mgmt was aware prior to t!e date w!en registration st0nt
took effect$
/ist ct approved settlement deposit of a fund of @GG6,000, 60K of w!ic! was contributed by corp
and t!e remainder by t!e two selling s.!s in e2ual amounts$ %!e fund was distributed among persons
w!o beneficially ac2uired any part of 200,000 s!ares, w!ic! was t!e sub&ect of t!e public offering of
Sept )0, )*J+ bet Sept )00J+ and 'ugust )G0J5$
G6
%!e sole ob&ectors to settlement appellants# ob&ection to t!e provision limiting t!e benefits of t!e
settlement to persons w!o could establis! t!at t!ey purc!ased sec0s issued under )*J+ reg st0nt, w!ic!
t!us eliminated t!ose w!o purc!ased after t!e issuance of t!e allegedly incomplete prospectus but
could not so trace t!eir purc!ases
'ppellants can0t trace t!e s!ares purc!ased on t!e market( e2uity
,ssue# w!et!er dist ct was rig!t in ruling t!at Sec 11 e;ten#$ only to .!rch$e$ of the ne'ly
re(%$tere# $hre$
Reading of Aany person ac2uiring suc! securityH in Sec ))
broad reading ac2uiring a sec of t!e same nature as t!at issued pursuant to reg st0nt" appellants
claim for wrong
nrro' re#%n( ac2uiring a sec issued pursuant to reg st0nt" 3 rig!t
Sec )) provides remedy only for particular s!ares registered
Sec )22" and )G antifraud sections of ++ 'ct re2uire scienter and are not limited to t!e newly
registered sec0s( Sec )) doesn0t re2uire scienter
))g" and ))e" point in t!e direction of limiting Sec )) to purc!asers of registered s!ares
'n action under Sec )) may be maintained only by one w!o comes w.n a narrow class of persons, i$e$
t!ose w!o purc!ase sec0s t!at are t!e direct sub&ect of t!e prospectus and reg st0nt
3. Sect%on 11*-*1-" *1-
11*1- 'ny person w!o offers or sells a security in violation of Sec 6
11*1- 'ny person w!o offers or sells a security w!et!er or not e7empted by Sec +", by t!e use of
&0nal means, by means of a prospectus or oral communication, w!ic! includes an untrue st0nt of
material fact or omitsB, and w!o s!all not sustain t!e burden of proof t!at !e did not know, and
in t!e e7ercise of reas care could not !ave known, of suc! untrut! or omission,
s!all be liable to t!e person purc!asing suc! security from !im, w!o may sue for
rescission, or for damages if !e no longer owns t!e security$
Sec )22" does not apply to gov0nt and municipal sec0s e7empt under +a"2", but does apply
to all ot!er e7empt securities and transactions
Pinter v$ /a!l 11*1-: $tt!tory $eller: &!yer-$eller 0RIVITM A $ol%c%tt%on h$ to &e
S$<t )*FF" for +l!e
%n .r% #el%cto #efen$e
Pinter sells fractional undivided s!ares in oil well$ /a!l invests !is own money, and gets !is
friends to invest as well$
>ffering to /a!l0s friends.relatives is under Rule )5J w.o reg0n st0nt
Pinter0s defense# sec0s don0t !ave to be registered, bec under Sec 52" it0s not a public
offering
%!en Pinter is suing /a!l for contribution
it is undecided w!et!er t!ere is rig!t to contribution under Sec )2
'not!er issue# Pinter says t!at /a!l is also in violation of Sec )2)", bec t!ey bot! sold sec0s
/a!l0s t!res!old defense# #octr%ne of in pari delicto positiv defendentis potrir est# bet
persons w.e2ual fault, t!e position of / is stronger$ /a!l says# if , violated Sec )2, so did
Pinter , can0t be sued$ /ist ct said t!at doctrine doesn0t apply
<t of 'pp reversed on t!at issue# it applies, but only to persons w.appro7imately e2ual fault
-nder Sec )2)", if you still own t!e sec, you can rescind
8!o transferred owners!ip of leases title" to Ps Pinter$ /a!l0s defense# you can0t rescind
trans0n ag person w.w!om you didn0t deal$ <ourt# disapproves t!is transfer of title test
GJ
)2)" includes solicitation under )2)", any person w!o offers or sells in violation of Sec 6
is liable
>t!er cts of app# liability ran ag smb w!o was a subst0l factor in a sale$ <ourt disapproves
subst0l factor test$
S.8t #o.t$ te$t: .er$on %$ l%&le !n#er 11*1- %f he %$
1. Stt!tory $eller !n#er 11*1-: only .er$on$ '6'ho/ 0 #%rectly #elt
.r%+%ty %#e# smb w.w!om P is in contact 3 not in t!e sense of smb w!o
transferred title, but smb w!o sold P t!e deal
Say, issuer sells in a 52" trans0n( , resell to smb else not in a 52" trans0n$
<an buyer rescind as ag me9 Ies Sec 6 applies$ <an buyer rescind ag my
seller9 3 Co
Iootnote 11: 11*1- %/.o$e$ l%&%l%ty on only the &!yer$ %//e#%te
$eller< re/ote .!rch$er$ re .recl!#e# fro/ &r%n(%n( ct%on$ ( re/ote
$eller$. Th!$" &!yer cnnot reco+er ( h%$ $eller$ $eller.
1. After 'e+e #ec%#e# tht :hl %$ $tt!tory $eller" %$ he l%&le !n#er 11*1-@ , only
%f h%$ /ot%+t%on %$ to (et .er$onl f%nnc%l &enef%t or benefit t!e securities owner"( if !e only
wants to lead ot!er investors to t!e deal for t!eir benefit !e is not liable
S$<t remands t!e case to determine w!et!er /a!l was trying to get money or was &ust being a
nice guy
Sec 1*3-
ASleH every 1 of sale or disposition of a security or interest in a security, for value$
AOffer to $ellH every attempt or offer to dispose of, or solicitation of an offer to buy, a security
or interest in a security, for value$
,ssue# w!et!er one must intend to confer a benefit on !imself or on +
rd
party in order to 2ualify as a
AsellerH w.n t!e meaning of Sec )2a" $ol%c%tt%on h$ to &e for +l!e for financial gain"
Sale of unregistered sec0s fractional undivided interests in oil and gas leases"
Pinter sold t!ose sec0s to /a!l real estate broker and investor" and !is friends and family# /a!l
invested, t!en recommended investment to ot!ers$ ?ac! investor completed t!e subscription3
agreement form t!at participating interests were being sold w.o t!e benefit of reg st0nt under Rule
)5J of ++'ct$
Denture failed( investors broug!t suit ag Pinter, seeking rescission under Sec )2)" of ++ 'ct for
unlawful sale of unregistered sec0s
Pinter argued t!at /a!l fraudulently induced Pinter to sell sec0s, t!at !e assured Pinter t!at !e would
provide sop!isticated investors
:%$t ct# for investors Pinter !ad not proved t!at oil and gas interests were entitled to private3offering
e7emption from reg0n so rescission under Sec )2)"
8t of A..# w!et!er /a!l was !imself a AsellerH w.n meaning of Sec )2)"$ ,f !e was, !e could be !eld
liable in contribution for ot!er Ps0 claims ag Pinter$ Seller is
)" one w!o parts w.title to sec0s in e7c!ange for consideration or
2" one w!ose participation in t!e buy3sell trans0n is a subst0l factor in causing t!e trans0n to take
place
!ere, /a!l conduct yes, subst0l factor
but still /a!l not seller w.n )2)"
<ourt refined t!e test to include a t!res!old re20nt t!at one w!o acts as a promoter be motivated by a desire
to confer a direct or indirect benefit on someone ot!er t!an t!e person !e !as advised to purc!ase
GG
Here, /a!l didn0t seek or receive any fin benefit in return for !is advice so, not seller no
liability
8ert#
't t!e very least, )2)" contemplates a buyer3seller relations!ip not unlike trad0l 13tual
privity it imposes liability on owner w!o passed title, or ot!er interest in t!e security, to t!e
buyer for value
/a!l not a seller in t!is sense not liable
Sec 2+" defines AsaleH as A1 of sale of sec for valueH# range of persons potentially liable
under )2)" is not limited to persons w!o pass title
also person w!o engages in solicitation not only actual owner"
Plus, P !as to purc!ase sec0s from /.seller purc!ase re20nt confines Sec )2 liability to t!ose
sit0ns in w!ic! sale !as taken place( but it doesn0t e7clude solicitation from t!e category of
activities t!at may render a person liable w!en a sale !as taken place
statutory seller includes at least some persons w!o urged t!e buyer to purc!ase
broker can be suc! seller
Solicitation of a buyer is per!aps t!e most critical stage of t!e selling trans0n it0s t!e stage at
w!ic! investor is most likely to be in&ured by being persuaded to purc!ase sec0s w.o full
and fair info
But <ongress did not intend to impose rescission based on strict liability on a person w!o
urges t!e purc!ase but w!ose motivation is solely to benefit t!e buyer
Miability e7tends only to person w!o successfully solicits t!e purc!ase, motivated at least in part
by a desire to serve !is own fin interests or t!ose of t!e sec0s owner
Pinter argues for subst0l factor test too broad wrong$ Plus# it mig!t e7pose professionals to
liability$ Plus, it reac!es participants in sales trans0n w!o don0t fit w.n definitions in Sec 2+"$ %!is
test not sufficient to render / liable under )2)"$
S$<t# unable to determine w!et!er /a!l may be !eld liable as a statutory seller under )2)"$
Nustafson v$ 'lloyd Sec 11*1- cl%/$ cn only r%$e o!t of the %n%t%l $toc) offer%n($
S$<t )**6" Stoc) .!rch$e (rnt here %$ not .ro$.ect!$ '6n 33 Act
Seriously flawed concept of materiality$ Here, deal was seriously negotiated$ ,n 1, parties
e7pressly contemplated pos0ty t!at estimates were wrong and provided for li2uidated
damages in case t!ey were$
%!is case involves t!e sale of all or subst0ly all of stock of closed corp$
?verybody agrees t!at if deal doesn0t turn out rig!t it0s material you0d want to know
about t!is$ But is t!is smt! t!at would c!ange t!e investment decision in t!is case no t!ey
negotiated t!at suc! case would be covered w.li2uidated damages so, it was not material to
t!em$ ,t0s outrageous t!at P seeks rescission w!ile it e7pressly negotiated for damages$ %!is
is unreasonable materiality standard( t!is case s!ouldn0t !ave gone forward$
Sl%n #oe$nt #%$(ree '6the re$!lt %n th%$ c$e" &!t for #%fferent re$on$. E %n th%$ c$e
%$ .ro$.ect!$" n# %f there %$ /%$re.re$entt%on , 0$ $ho!l# reco+er. 7!t here .rt%e$
e;.re$$ly ne(ot%te# tht #el /%(ht not t!rn o!t to &e r%(ht n# .ro+%#e# for l%q!%#te#
#/(e$. So" for the/ %t .l%nly #%#nt /)e #%fference , not /ter%l. Here , fr too
lo' $tn#r# of /ter%l%ty.
,n )*++, no one 2uestioned t!at )22" covers any sec0s trans0n$ %!en ) case !eld t!at )22"
only covers public offerings obviously wrongly decided$ S$<t granted <ert in t!is case$
4assive error from t!e outset of t!e opinion# <ourt first looks at arc!itecture of t!e statute
w.o reference to definition unort!odo7" = doesn0t get it rig!t
<ourt says# ASec )) provides for liability on account of false registration st0nts( Sec )22"
for liability based on misstatements in prospectuses$H
GF
But Sec )) applies to defective info in a prospectus complete misunderstanding
of structure of t!e 'ct
S.8t: Sec 11*1- only ..l%e$ to .!&l%c offer%n($< .!&l%c offer%n($ tht re e;e/.t re l$o
co+ere# &y Sec 11*1- prospectus is not provided w!en e7empt sec0s but still covered"
S$<t# t!e only oral communication covered by )22" is oral communication t!at relates to
prospectus$ Slain# t!ere is no basis for t!at$
F. Tho/$$ #%$$ent %$ r%(ht( 4a&ority opinion is wrong$
O$ Ninsburg0s dissent# !eavy reliance on leg !istory, so Slain is less supportive of it$
Bot! %!omas and Ninsburg say# start w.definition to figure out w!at smt! in t!e statute
means$ Slain# rig!t$ Here, definition is clear and plainly covers t!is trans0n$
>t!er issues#
Basis for saying t!at t!ere is no implied rig!t of action under )Ga" !as always been t!at
conduct w!ic! is made illegal under )Ga" is made actionable under )22" t!at died w.t!is
case, bec it narrowly reads )22"$
/efinition of prospectus e7pressly covers confirmation$ Iou can0t send confirmation w.o
final prospectus$ /oes t!is survive t!is opinion9 S$<t w.o selling doc0nt, you don0t !ave a
prospectus reads confirmation out of prospectus can send confirmation w.o final
prospectus, bec confirmation is not a selling document$
8!at if make a false Aoral communicationH not related to prospectus9 Salin# you s!ould be
able to bring action under )22"$ But S$<t seems to restrict it as oral communication relating
to a prospectus$
O$ %!omas is rig!t in saying t!at court started w.bias in favor of narrow reading, and t!en
&ustified it
,n sum#
S.8t l%/%te# 11*1-$ ..l%ct%on to .!&l%c offer%n($ &y %$$!er$ or the%r controll%n( $6h$.
%!us, )22" may be invoked only by purc!asers in registered offerings under ++ 'ct and
per!aps by purc!asers in Sec + e7empt offerings provided t!at suc! e7empt offerings take on
a public nature$
)22" does not e7tend to t!e secondary market ot!er t!an public offerings by controlling s.!s$
Orl co//!n%ct%on /!$t relte to .ro$.ect!$.
By interpreting t!e term AprospectusH as Aa term of art referring to a document t!at describes
a public offering of sec0s by an issuer or controlling s.!H, S$<t significantly limited t!e scope
of )22"$
11*1- ..l%e$ only to .!&l%c offer%n($.
,ssue# w!et!er rig!t of rescission under )22" e7tends to a private, secondary trans0n, on t!e t!eory t!at
recitations in t!e purc!ase agr0nt are part of a prospectus Co$
Nustafson and ot!er were t!e sole s.!s of 'lloyd, ,nc$ 8ind Point Partners agreed to buy subst0ly all
stock t!roug! 'lloyd Holdings new corp formed to effect t!e sale of 'lloyd0s stock$ 1 of sale was
e7ecuted$ %!en t!e year3end audit of 'lloyd revealed t!at 'lloyd0s actual earnings for )*F* were
lower t!an estimates$ -nder 1, buyer !ad t!e rig!t to recover t!e ad&ustment amount from sellers$ But
buyers broug!t suit, seeking outrig!t rescission of 1 under )22" of ++ 'ct$
Buyers said t!at 1 of sale was a prospectus, so any misstatements t!ere gave rise to liability under
)22"$
:%$t ct# sum &0nt for sellers: Sec 11*1- cl%/$ cn only r%$e o!t of the %n%t%l $toc) offer%n($$
Private sale agr0nt cannot be compared to initial offering bec purc!asers !ad direct access to fin and
ot!er co doc0s, and !ad t!e opp0ty to inspect seller0s property$
G*
2
th
8%r# decision in Pacific /unlop# t!e term AcommunicationH in definition of AprospectusH includes
all written communications t!at offered sale of sec$ Held# )22" rig!t of action for rescission applies to
any communication w!ic! offers any sec for sale, including stock purc!ase agr0nt in t!e present case$
S.8t# Reverse for /s$
'ssuming stock purc!ase agr0nt contained material miss0nts of fact made by sellers and t!at / would
not sustain its burden of proving due care, P would !ave rig!t to obtain rescission if t!ose misst0nts
were made by means of prospectus or oral communication$ ,ssue# w!et!er 1 !ere is prospectus w.n ++
'ct 3 Co$
Sec 1D sets fort! info t!at must be contained in a prospectus
1 !ere was not re2uired to contain info contained in reg st0nt( no stat e7emption was re2uired 1
is not a prospectus
Prospectus under Sec )0 is confined to doc0s related to public offerings by issuer or its controlling
s.!s
Sec 11 imposes liability based on misst0nts in a prospectus
%erm AprospectusH must !ave t!e same meaning under Sec )0 and Sec )2 ter/ B.ro$.ect!$C
relte$ only to #ocnt$ tht offer $ec$ $ol# to the .!&l%c &y n %$$!er
Miability imposed by )22" cannot attac! unless t!ere is an obligation to distribute prospectus in
t!e first place or unless t!ere is an e7emption"
But Sec )2 refers to a broader set of communications t!at t!e same term in Sec )0
%!e 'ct uses one term Aprospectus0 t!roug!out
Sec 1*1D- defines prospectus
8ord AcommunicationH is one word in a list( !as to be read in conte7t$ So, the ter/ .ro$.ect!$
refer$ to #ocnt $ol%c%t%n( the .!&l%c to cq!%re $ec$
)Ga" does not contain t!e word AprospectusH broad construction$ ,n contrast, )22" contains limiting
language Aby means of prospectus or oral communication" t!at limits )22" to public offerings
narrow construction
Hel#: the 'or) B.ro$.ect!$C %$ ter/ of rt referr%n( to #ocnt tht #e$cr%&e$ .!&l%c offer%n(
of $ec$ &y n %$$!er or controll%n( $6h. The E of $le" n# %t$ rec%tt%on$" 'ere not hel# o!t to the
.!&l%c n# 'ere not .ro$.ect!$ $ the ter/ %$ !$e# %n 33 Act.
%!omas dissent#
Begin wit! )22", and t!en turn to 2)0", before consulting structure of t!e 'ct as a w!ole$ )22"
s!ould apply to secondary or private sales of sec as well as to initial public offerings$
4a&ority is motivated by policy references t!at <ongress could never !ave intended to impose
liability on sellers engaged in secondary trans0ns$ But <ongress did so w.r.t )Ga" of ++ 'ct and )0b"
of +5 'ct$
Ies, can be increase in sec0s litigation, but t!at0s for <ongress to resolve$
Ninsburg dissent#
/rafting !istory# )22", like )Ga", is not limited to public offerings$
/rafters borrowed from Britis! <ompanies 'ct of )*2*, but didn0t include Aoffering to t!e publicH w.n
definition of AprospectusH
Primary offering an offering of newly issued securities
"econdary offering an offering of previously issued securities
F0
ASSIGNMENT NO. 2 , THE WI55IAMS A8T
TEN:ER OIIERS
Sect%on 13*#-" *e-
Sect%on 13*#-" *e-" *f- of 33 Act
)*J0s tender offers start, as alternative to pro7y contest$
But !istorically, 'merican s.!s wouldn0t vote ag mgmt t!ey sell t!eir s!ares$ So, pro7y
contests to oust mgmt" failed$
Wht W%ll%/$ Act %$ %nten#e# to re/e#y
Stock of U co is wort! a lot more t!an its market price$ -ndisclosed principal gets a bank,
acting as agent of non3disclosed principal, to run ad in newspaper inviting tenders of U
corp$ Person tendering s!ares of U corp is making t!e offer$ %erms# undisclosed principal
would buy 60K = ) s!are at a premium over market price$ %!ere was no period for w!ic!
tender offer was open usu$ s!ort period of time$ By tendering !is s!ares, s.! makes an
irrevocable offer$ Principal can buy as many s!ares as !e wants for any period of time$ <o
buys s!ares on )
st
come )
st
served basis$ S.!s don0t know anyt!ing about t!is co, including
its identity$
4arket price will go up to tender offer price discounted for uncertainty deal may never
close" 3indY0 s.!s tender instantly mgmt of target co loses very soon
Pro7y conte7t never worked t!is always worked = no transaction costs you were buying
underpriced stock$ 4gmt couldn0t do anyt!ing about it$
194N W%ll%/$ Act
)*JF 8illiams 'ct to deal w.problem of panic generated by tender offer s.!s panicked if
tender early ok, tender( if not dealing w.unknown people"
Sect%on 13*#-
A .er$on 'ho h$ cq!%re# &enef%c%l o'ner$h%. of /ore thn => of ny cl$$ of eq!%ty
$ec!r%t%e$ re(%$tere# !n#er Sect%on 11 /!$t f%le '6SE8 Sche#!le 13:-1 '6n 1D #y$ of the
cq!%$%t%on '6co.y to %$$!er of $ec!r%t%e$ *'ho %$ he" 'ho$ f%nnc%n( th%$" #oe$ he h+e ny
$%#e #el$ relt%n( to th%$ co" 'hy #oe$ he &!y-
Gro!.$ of .er$on$ cn con$t%t!te .er$on w.n )+/3)
Ior/t%on of (ro!. 'ho$e /e/&er$ %n the ((re(te for/ => %$ re.ort&le
t!is tends to in!ibit getting institutional investors to cooperate w.one anot!er to take stands ag
mgmt, w!ereas S?< favors t!is"
)+d" early warning system# anybody ac2uiring e2uity sec registered under Sec )2, w!o
reac!es 6K, must file w.<ommission and t!e issuer w.n )0 days t!e st0nt of t!e owners!ip
w.doc0nt disclosing info as to#
)$ w!o are you
2$ w!o0s financing you w!ere is t!e money coming from
+$ w!at side deals you !ave relating to t!is co
5$ w!at plans you !ave for t!is co
Mike Sec )Ja"$ /ifference bet )+d" and )Ja" at t!at time# )Ja" filing re2uired w.n )0 days
after t!e end of t!e mont!s w!en you did it( )+d" w.n )0 days after you did it
Substantive regulations )5d" and implementing Rules
13*e- 4akes it unlawful for an issuer w!ic! !as a class of e2uity security registered under Sec
)2" to purc!ase its own s!ares in contravention of S?< rules
F)
R!le 13e-3 Noverns issuer tender offers for a company0s own securities$ Pro!ibits fraudulent,
deceptive, and manipulative acts and establis!es filing, disclosure, and dissemination re20nts$
Sect%on 13*#- n# *e- !eart of tender offer regulation
)5d" v$ )5e"# 13*e- , nt%-fr!# r!le$ - %$ not re$tr%cte# to eq!%ty $ec$ re(%$tere# !n#er
Sec 11< ..ly to ny ten#er offer of ny $ec!r%ty
13*#- applies only to eq!%ty $ec!r%t%e$ re(%$tere# !n#er Sect%on 11
,t s!all be unlawful for any person to make a tender offer for, or a re2uest or invitation
for tenders of, any class of any e2uity security w!ic! is registered pursuant to section )2 if, after
consummation t!ereof, suc! person would, directly or indirectly, be t!e beneficial owner of more
t!an 6K of suc! class, unless at t!e time copies of t!e offer or re2uest or invitation are first
publis!ed or sent or given to security !olders suc! person !as filed w.t!e <ommission a statement
containing info specified in Sec )+d"
'bsent from t!e statute no definition of tender offer
%!ere is no substantive regulation of t!ese deals t!is is all procedure$ 8illiams 'ct doesn0t
regulate w!at kind of deals you make only procedure$
1ey event of tender offer is co//ence/ent# day on w!ic!, in any manner, bidder disclosed
identity of target co and sec0s to be ac2uired and some kind of price range
>n t!e day of commencement, bidder is re2uired to deliver tender offer st0nt and to !and
deliver to t!e issuer same info as in Sc!edule )+/ if filed$
13*e- Ant%-fr!# .ro+%$%on# not so limited &ust refers to tender offers #el$ '6ny )%n# of
ten#er offer
,t s!all be unlawful for any person to make any untrue statement of material fact or omit
to state any material fact necessary in order to make t!e statements made, in t!e lig!t of t!e
circumstances under w!ic! t!ey are made, not misleading, or to engage in any fraudulent,
deceptive, or manipulative acts or practices, in connection wit! any tender offer or re2uest or
invitation for tenders, or any solicitation of security !olders in opposition to or in favor of any
suc! offer, re2uest, or invitation$
%!e <ommission s!all by rules and regulations define, and prescribe means reasonably
designed to prevent, suc! practices as are fraudulent, deceptive, or manipulative
R!le 13#-1 /ate of <ommencement of a %ender >ffer t!e key event in tender offers is
commencement"( 8o//ence/ent occ!r$ 'hen ny )%n# of co//!n%ct%on: .!&l%c"
tr(et" &%##er" /o!nt of $hre$" .r%ce of $ec!r%t%e$
>n t!e day of commencement bidder !as to file w.S?< tender offer statement and !and
deliver it to t!e issuer$ %ender offeror !as to provide s.!s w.tender offer st0nt w.same info$
R!le 13#-3" =" 4 !ow t!is info is disseminated out to s.!s
Bidder is to be provided w.opportunity to make direct solicitation of s.!s it can demand on
t!e day of commencement of t!e issuer#
)$ to provide complete s.! list to bidder, or
2$ target co can itself disseminate tender offer st0nt 3 mail materials to s.!s on be!alf of
tender offeror
target cp does t!e 2
nd
option
%arget !as until day + to decide w!at it wants to do target will prefer to mail materials to
s.!s itself
Rule )5d"J" info to be provided to s.!s
F2
How long can t!is tender offer go on9
R!le 13e-1*- %ender offer must remain open for 20 days( t!at period is sub&ect to
automatic e7tensions of 20 days, say, if you amend tender offer by upping price
4a7imum period of time of undeciding w!et!er to buy is J0 days if you !aven0t
boug!t, you !ave to give back stock
Sec )5d"6" and J" provides for '%th#r'l r%(ht$$ Pre38illiams 'ct irrevocable offer(
but now, under 8illiams 'ct, yo! cn '%th#r' $hre$ t ny t%/e .r%or to t%/e 'hen
$hre$ re &o!(ht
= 0rort%on# if more s!ares are tendered t!an tender offeror plans to buy before 8illiams
'ct )
st
come )
st
served pressure on s.!s to tender fast$ No'" !n#er W%ll%/$ Act" %f
/ore ten#ere# $hre$ thn co 'nt$ to &!y" co /!$t &!y rt&ly fro/ e+ery&o#y 'ho
ten#ere# , #oe$nt /tter 'hen to ten#er *erly or lte-
R!le 13#-2 wit!drawal" and 13#-N e7emption from statutory pro rata re20nts" supercede
Section )5d"6" and J" Statute gives very limited wit!drawal and pro3rata rig!ts, but grants
S?< aut!ority to do t!at
R!le 13#-2 %!e s.! !as a rig!t to wit!draw t!e stock during t!e period of tender offer 20
days" prior to t!e moment of purc!ase, so it becomes practical for new bidder to make a
tender offer
8!at if bidder wants 60K of t!e stock, but gets G6K
Rule )5d3F Bidder !as to take stock ratably as nearly as pro rata" from everybody w!o
tendered doesn0t matter w!et!er you tender early or late
Sect%on 13*#-*2- 7e$t .r%ce" ll hol#er A R!le 13#-1D Eq!l Tret/ent of Sec!r%ty
Hol#er$ tender offer must be open to all !olders of class of stock you want to buy
Rule )5d3)0a")" 'll !older rule
Rule )5d3)0a"2" Best price rule
R!le 1D&-13 Pro!ibiting ot!er purc!ases during tender offer or e7c!ange offer you can0t
buy alongside t!e offer# if you0re making tender offer you can0t buy sec0s in any manner,
e7cept t!roug! tender offer# you can0t buy in market or t!roug! private deals you can buy
only t!roug! tender offer$
M(/t re$.on#$ to ten#er offer:
8!ite knig!t # w!en mgmt of target co reali;es t!at it will be taken over, but prefers a
takeover by someone ot!er t!an t!e original bidder( mgmt t!erefore solicits competing tender
offers from friendly corps smb makes competing tender offer t!en bidding will begin"
8!ite s2uire # somebody buys enoug! stock to give us a blocking position and not tender it
4gmt announces t!at t!is is a dreadful deal
Mock3up # device t!at is designed to protect friendly bidder ag competition by ot!er less
friendly bidders$ %!e favored bidder is given an option to ac2uire selected assets or s!ares in
t!e target at favorable price under designated conditions like defeat of t!e favored bidder0s
attempt to ac2uire corp, or occurrence of events t!at would make t!at defeat likely"
<rown3&ewel # to defeat or discourage a takeover bid by a disfavored bidder, t!e target0s mgmt
may sell or give to a w!ite knig!t a lock3up option t!at covers t!e target0s most desirable
business, or at least t!e business most wanted by t!e disfavored bidder
<rown &ewel lock up # cut a side deal w.competing tender offeror and give !im valuable part
of business at bargain price
F+
Poison pill # device adopted by target to make its stock less attractive to bidder like w!en
target issues a new series of pref stock, or ot!er rig!ts, t!at gives e7isting s.!s t!e rig!t to
redeem t!e stock at a premium price after certain events, like takeover, or buy add0l s!ares at
bargain price"
Only $tte f%#!c%ry #!ty l'$ re(!lte /(/t" not fe#erl l'
%!en w!at !appens is t!at tr(et co %$ %n .ly
,nstitutions sell into market( investors dumb t!eir s!ares into market risk arbitrageurs buy
t!ose s!ares
'rbitrage process of trading a commodity bet 2 markets( t!ey buy in ) place and sell in
anot!er t!is brings prices to one level
Risk arbitrageurs buy s!ares at tender offer price and take t!e risk t!at tender offer deal
doesn0t close$ %!ey are not long3term investors$ %!y pay for s!ares w.borrowed money$ ,f
deal doesn0t close, price of sec drops back from discounted tender offer price to point below
w!ere it started potential loss = t!ey can0t afford to !old t!ese s!ares$ So, w!en co is in
play, c!ances of co remaining independent are slim to none$
8!en tender offer price is, say, 60K over t!e market price, s.! will usu sell !is stock at,
say, 5GK$ 8!o is buying risk arbitrageurs arbitraging t!e risk# w!en s.! sells at 5GK, risk
arbitrageur tenders t!e stock and takes t!e risk( no possibility t!at risk arbitrageur will not tender
t!e stock co is now at play a lot of stock in t!e !ands of risk arbitrageurs" once co is at play,
it0s inevitable t!at it will be sold"
'fter 8illiams 'ct was enacted, idea to take over a good, respected, well3run co, bec t!e
stock was so c!eap
%obin L Ratio# w!y people in t!e )*G0s started to make tender offers for good, successful
co0s stock was very c!eap"#
market capitali;ation value of s!ares 7 number of s!ares outstanding"
asset replacement value cost of replacing t!e assets"
>nly 2 points w!en market cap e2ualed replacement value of assets )*J5 momentarily( )**0
and going up ever since
)*G03mid )*F0s# tender offers took on a different c!aracter it became normal manner of
doing ac2uisition in friendly environment, w!ic! !istorically would !ave been done by
statutory merger tender offer bec a common alternative to statutory merger in a friendly
negotiated deal"$ 8!y# '0s stock looks like a !uge bargain good reason for buying$
>rdinary statutory merger is a stock for stock deal$ But bot! '0s and your own stock is
undervalued so, you0d sell your stock for fraction of its value you prefer to do t!e deal as
a cas! deal$ So, ordinary statutory merger almost disappeared all ac2uisitions became
tender offers = tender offer faster transaction t!an negotiated stat merger"
Cow ac2uisitions tend to be statutory mergers stock for stock bec stock is overvalued$
)**0 market capitali;ation became more t!an cost of replacement of asset tender offer is
not as common a transaction$
4id3)*J0s leveraged buyout# mgmt of co borrows money to buy out almost all of its stock,
e7cept for s!ares t!ey own and is replacing e2uity in business w.&unk bonds$ By t!e time of
retiring debt, mgmt owns valuable property$ %a7 dynamic# !istorically, 'm s.!s are not
interested in getting dividend income bec of duplicative ta7ation at s.! and corp level
)*FJ ta7 reform )" lowered rates for ind0ls and 2" eliminated separate long3term capital
rate for ind0ls no ta7 advantage in leaving your money in corp s.!s prefer money today$
4ore efficient way to provide current income debt interest is ded0n to corp$ %a7 is ;ero at
corp level( only ta7 at s.! level turning your stock for &unk bonds$ ,t died off in late )*F0s
w!en ta7 reform died off we again !ave separate capital rate"$
F5
Rule )5a32b"2" pro7y rule# e7ception to concept of pro7y solicitation# intended to free up
institutions to communicate wit! one anot!er
<ompare it wit! Rule )+d36b")" ac2uisition of sec0s by group# if group owns more t!an
6K of class of e2uity security !as to file Sc!edule )+/ takes a lot of &oy out of Rule )5a3
2b"2"
%ender offers# mi7ed reputation good t!ing or bad t!ing9
,t0s !ard to figure out w!o comes out well$
<lear t!at s.!s of target co come out well t!ey !ave real gains$
'rg0nt# costs are borne by e0ees$
Bond!olders of target co0s, esp$ in leveraged buyouts !ave done e7tremely badly !ave been
!urt by t!is$
Bidders# w!en tender offer is announced market price of target0s stock moves up to tender
offer price( bidder0s stock goes down
Study# )0 best tender offers w!en same.similar business( )0 worst tender offers unrelated
businesses$ Slain0s t!eory# people regularly underestimate difficulty of running business t!ey
are not already in$
Sect%on 13*#-
N': <orp v$ 4ilstein Me$" 3 M%l$te%n$ con$t%t!te# B(ro!.C n# th!$" $ .er$on"
2d <ir )*G)" 'ere $!&9ect to the .ro+%$%on$ of 13*#-.
I$$!er h$ $tn#%n( to $!e !n#er 13*#- , %/.l%e# .r%+te r%(ht
of ct%on.
5 4ilsteins ac2uired more t!an )0K of preferred stock t!en )+d" measured number" of
N': class of sec0s registered under Sec )2$ ,t !appened before enactment of 8illiams 'ct$
%!en 4ilsteins became !ostile( started pro7y conte7t( t!en lost on t!e voting$
,ntervening step# N': took position t!at after 8illiams 'ct, 4ilsteins agreed to act in
concert to take control over co$ Cew entity t!e group (ro!. cq!%re# $hre$ of ech of
%t$ /e/&er$ ac2uired more t!an )0K 3 (ro!. h# to f%le Sche#!le 13:$ -nder )+d", if
!older !as ac2uired more t!an )0K of s!ares 3 duty to file$
/s say# group didn0t ac2uire any s!ares t!ere were no purc!ases by members of t!e group$
1# 8%r: for/t%on of the (ro!. re.re$ente# cq!%$%t%on &y (ro!. , (ro!. %$ req!%re# to
f%le !n#er 13*#-.
Re/e#%e$: %n9!nct%on ( +ot%n( $toc)" &!y%n( /ore $toc).
)+d" doesn0t provide for private rig!t of action$ But court# %/.l%e# .r%+te r%(ht of ct%on.
:oe$ %$$!er h+e $tn#%n( to $!e !n#er 13*#- , Me$ but not under all of t!ese provisions"$
P.N': <orp argues t!at /.4ilstein, !is 2 sons and daug!ter, violated Sec )+d" of +5 'ct first by
failing to file t!e re2uired st0nts and t!en by filing false ones$
)+d" re2uires any person, after ac2uiring more t!an )0K now 6K" of a class of registered e2uity
security, to send to t!e issuer and t!e e7c!anges on w!ic! t!e security is traded and file w.t!e
<ommission t!e st0nt re2uired by t!e 'ct$
4ilsteins moved for dismissal or for sum &0nt$
/ist ct
I$$!e: 'hether *1- or(n%G%n( (ro!. of $6h$ o'n%n( /ore thn 1D> '%th +%e' to $ee)%n(
control %$" '6o /ore" re.ort&le e+ent !n#er 13*#- n# *1- 'hether %n the &$ence of
F6
connecte# .!rch$e or $le of $ec$" the tr(et cor. cl%/%n( +%olt%on of Sec 1D n# R!le 1D&-="
h$ $tn#%n( to $ee) n %n9!nct%on ( control conte$tnt for fl$%ty %n Sche#!le 13: f%l%n(.
%!e 5 4ilsteins received )0$26K of preferred s!ares outstanding, w!en t!e Ruberoid <o, in w!ic! t!ey
!ad subst0l !oldings, was merged into N':$
0$: M%l$te%n$ for/e# con$.%rcy to ct $ $yn#%cte or (ro!. to cq!%re control of GAI< they
!n#ertoo) $o/e ct$ for tht .!r.o$e.
8!en N': contended t!at 4ilsteins were in violation of )+d", 4ilsteins filed Sc!edule )+/ said
t!at at some future time t!ey mig!t determine to attempt to ac2uire control of N':, but no present
intention to ac2uire add0l s!ares$ But t!ey did purc!ase more s!ares and filed amended Sc!edule )+/$
%!en +
rd
Sc!edule )+/ intention to wage a pro7y contest at )*G) annual mtg$ But N': mgmt
prevailed$
N': complaint# t!at 4ilsteins be preliminary and permanently en&oined from )" ac2uiring or
attempting to ac2uire add0l N': stock( 2" soliciting any pro7y from a N': s.! to vote N': stock( +"
voting any s!ares of N': stock !eld or ac2uired during t!e conspiracy( and +" ot!erwise acting in
furt!erance of t!e conspiracy$
13*#-*4-*7- e7empts from its filing re20nts any ac2uisition w!ic!, toget!er w.all ot!er ac2uisitions by
t!e same person of sec0s of t!e same class during t!e preceding )2 mont!s, does not e7ceed 2K of t!at
class$ 13*#-*3- provides t!at Aw!en 2 or more persons act as a group for t!e purpose of ac2uiring,
!olding, or disposing of se0cs of an issue, suc! group s!all be deemed a Pperson0H$
Hel#: Me$" 3 M%l$te%n$ con$t%t!te# B(ro!.C n# th!$" $ .er$on" 'ere $!&9ect to the .ro+%$%on$
of 13*#-.
,ssue# w!et!er t!e complaint alleges as a matter of law t!at t!e 4ilstein (ro!. ac2uired t!e +25,)JJ
s!ares of preferred stock owned by members after Ouly 2*, )*JF after )23mont! period w!en 2K
e7emption from filing"$ Hel#: ye$" co/.l%nt $tte$ cl%/ !n#er 13*#-.
<oncept of beneficial owners!ip
/ist &udge wrong w!en !e says t!at language of statute compels t!e conclusion t!at ind0l members
must ac2uire s!ares before t!e group can be re2uired to file
Purpose of )+d" is to re2uire disclosure of info by persons w!o !ave ac2uired a subst0l interest w.n
s!ort period of time$
Here, alleged conspiracy on t!e part of 4ilsteins is w.n t!e reac! of )+d"# 5 s.!s w!o toget!er own
)0$26K of outstanding class of sec0s and allegedly agreed to pool t!eir !oldings to take over N':$
2 policy cons0ns ag court0s interpretation
)$ difficulty of ascertaining w!en group was formed but t!is difficulty is not disspated even
under /0s view t!at ind0l members must ac2uire more t!an 2K after Ouly 2*, )*JF, before t!e
group can be compelled to file( burden of proof is on N':
2$ overinclusive families and ot!er mgmt groups w!ic! control co0s and w!ose members own
more t!an 6K of stock but mgmt groups per se are not customarily formed for t!e purpose
of ac2uiring control of t!e issuer and would not be re2uired to file unless t!e members
conspired to pool t!eir sec0s interests for suc! purpose
/ agrees 3 Ies, private rig!t of action under )+d"$ Ies, N': !as standing as an issuer$ I$$!e:
'hether GAI h$ $tn#%n( !n#er 13*#- to $ee) n %n9!nct%on ( lle(e#ly fl$e n# /%$le#%n(
f%l%n($. Hel#: o&l%(t%on to f%le tr!thf!l $tnt$ %$ %/.l%c%t %n the o&l%(t%onto f%le '%th the %$$!er"
n# $o" %$$!er h$ $tn#%n( !n#er 13*#- to $ee) rel%ef %n the e+ent of fl$e f%l%n(.
:alse disclosure subverts t!e purpose of t!e 'ct$
S?< v$ :irst <ity :inancial <orp BGreen/%lC
/ist of <olumbia <ir )*F*" .!t n# cll (rnt
#%$(or(e/ent !n#er 13*#-
ANreenmailH# you try to make people believe t!at you0re rut!less( you make tender offer( co
will buy you out at a premium$
Bel;berg started many tender offers, but never completed a tender offer$
FJ
Bel;berg started greenmail w.'s!land >il, but didn0t want to file Sc!edule )+/$ So !e called
Bear Stearns, broker, to buy 's!land stock( but Bear Stearns buys it assuming t!at it buys it
for :irst <ity$ )0 days critical$ 'fter t!e point Sc!edule )+/ would !ave been re2uired to
be filed, :irst <ity calls broker and makes put and call arrangements broker makes a call on
customer and puts stock on customer s!ifts risk to customer"$ Beneficial owner of stock is
broker0s client Sc!edule )+/ is involved$ Bel;berg didn0t become beneficial owner of
stock until about )6 days after t!at and t!en filed )+/$
S?<# t!ey s!ould !ave filed )+/ w.n )0 days after t!e w!ole program started$
Remedy t!at S?< seeks disgorgement of all profits made by Bel;berg more t!an )0 days
after Sc!edule )+/ s!ould !ave been filed$
/0s most serious c!allenge met!od of computation$ <ourt# application of rule of e2uity# if
can0t ascertain uncertainty falls on /$ Hel#: 7elG&er( h$ &!r#en of .roof of
e$t&l%$h%n( 'ht .rt of .rof%t '$ le(lly #er%+e# , %t$ %/.o$$%&le to $cert%n , $o"
rec.t!re ent%re .rof%t
/ifferent from )Jb"# under )Jb" co gets it( !ere gov0nt gets it$
S?<# :irst <ity and 4arc Bel;berg DP" deliberately evaded )+d" in t!eir attempted !ostile takeover
of 's!land >il <o by filing t!e re2uired disclosure st0nt after t!e )0 day period$
/ist# yes, /s violated )+d"( en&oined t!em from furt!er violations of )+d" and ordered t!em to
disgorge all profits derived from t!e violation$
Bel;berg telep!oned Nreenberg in brokerage firm# w!et!er Bel;berg asked Nreenberg to buy subst0l
s!ares of 's!land for :irst <ity account or, as /s say, Nreenberg misunderstood Bel;berg# Bel;berg
intended only to recommend t!at broker buy 's!land for its own account$
S?<# on 4arc! 5, Bel;berg telep!oned Nreenberg asked Nreenberg for .!t n# cll (rnt# broker
would purc!ase stock sub&ect to agr0nt and place it in its own account( t!e investor can call or purc!ase
s!ares from broker for an agreed upon period at an agreed upon price$ /ist$ ct# on 4arc! 5, Bel;berg
entered into an informal put and call agr0nt and t!en deliberately violated t!e )0 day filing re20nt of
)+d", bec t!ey filed Sc!edule )+/ on 4arc! 2J, rat!er t!an on 4arc! )5$ %!ey !ad to file on 4arc!
)5, bec if Nreenberg purc!ased s!ares for :irst <ity, :irst <ity would !ave 6K of 's!land s!ares$ /s
!ad *K of 's!land0s s!ares on 4arc! 26$
/# Bel;berg only recommended t!at Nreenberg buy stock for !imself
4arc! )G# written put and call agr0nt strike price below market price
%!en :irst <ity proposed friendly takeover 's!land re&ected t!e offer
8t of A.. , ff%r/ #%$t ct
,ssue before dist ct# w!et!er put and call agr0nt bet :irst <ity and Bear Stearns broker" was entered
into on 4arc! 5, as S?< claims, or on 4arc! )G, as / argues$ /ist ct0s answer may not be overturned
on appeal unless clearly erroneous$
/ist ct ordered #%$(or(e/ent of .rof%t$ of @2$G million, representing /0s profits on t!e F*0,000
s!ares of 's!land stock ac2uired bet 4arc! )5 and 26$
/s# fed courts don0t !ave aut!ority to employ t!at remedy w.r.t )+d" violations( it0s not appropriate in
t!is sort of case = amount is e7cessive$ <t of 'pp# dist ct rig!t$
/isgorgement is an e2uitable remedy designed to deprive a wrongdoer of !is un&ust enric!ment and to
deter ot!ers from violating t!e sec0s laws yes, w.n dist ct0s aut!ority$
Ies, violations of )+d" cause in&ury to s.!s, w!o sold t!eir stock w.o knowledge of :irst <ity0s
!oldings ot!erwise market price would go up bec of likely takeover"
How to measure illegal profits$ /isgorgements may not be used punitively so S?< !as to distinguis!
bet legally and illegally obtained profits$
/0s e7pert witness testified t!at 5 ind0nt factors combined to increase t!e stock price to t!e level it
reac!ed on 4arc! 26 and t!at t!ese factors were not present on 4arc! )5, w!en /s s!ould !ave
disclosed see p$ GJF"$
/isgorgement need only be a reas appro7imation of profits causally connected to t!e violation$
FG
S?< bears t!e ultimate burden of persuasion t!at its disgorgement figure reas appro7imates t!e amount
of un&ust enric!ment !ere g0nt at least presumptively satisfied t!at burden$ %!en burden s!ifts to /s
to clearly demonstrate t!at disgorgement figure was not a reas appro7imation$ /s may make suc! a
s!owing, for instance, by pointing to intervening events from t!e time of t!e violation$ Here, / used
e7pert witness for answer to !is 5 factors see p$ GJ*"
Putting burden on /s to rebut S?< may result in actual profits becoming t!e typical disgorgement
measure as in insider trading conte7t", but t!e risk of uncertainty s!ould fall on t!e wrongdoer w!ose
illegal conduct created t!at uncertainty$
Sect%on 13*#-: Wht %$ ten#er offer@
S?< v$ <arter Hawley Hale 13*e- n# R!le 13e-3 of the W%ll%/$ Act
*
t!
<ir )*F6" N-fctor Well/n te$t: 'hen %$$!er re.!rch$e
.ro(r/ #!r%n( 3
r#
.rty ten#er offer %$ ten#er offer
I$$!e: 'hether 8HH$ re.!rch$e of $hre$ #!r%n( 3
r#
-.rty ten#er offer %t$elf
con$t%t!te# ten#er offer.
S?<.P broug!t suit for in&unctive relief to en&oin t!e target co.<HH./ from repurc!asing its
own stock to defeat takeover attempt by Mimited w.o complying w.tender offer regulations
under )+e" and Rules )+e3) and )+e35$
<an a corp vote treasury stock in -S9 Co, it can0t# corp or subsidiary can0t vote s!ares of
its own stock$
?ffect of <HH0s buying t!eir own s!ares is to decrease t!e number of s!ares outstanding(
!elps create blocking position$
<HH !as driven up t!e price of every @ per s!are( every @ per s!are costs Mimited @)$60( t!e
premium is appro7imately 60K# Mimited will !ave to increase its offer and increase premium(
<HH is making it more e7pensive game for Mimited to play$ Mimited wit!drew its tender
offer$ So !ere, successive defensive tec!ni2ue by <HH$
)+e" contemplates t!e possibility t!at issuer can make tender offer# re2uired to do same
filings as e7ternal bidder is re2uired to do
So, was t!e buying program !ere a tender offer9 <HH is buying in t!e open market$
Co definition of tender offer in t!e statute and t!e Rules$
8!ite S2uire find somebody w!o is prepared to come in and give s!ares to give target co
blocking position to prevent tender offeror from completing !is plans w.r.t transaction
S?<# <HH0s repurc!ase program constituted a tender offer conduction in violation of )+e"$
<t applies N-fctor Well/n te$t# %$$!er re.!rch$e .ro(r/ #!r%n( 3
r#
.rty ten#er
offer is a ten#er offer 'hen
)$ 'ctive and widespread solicitation of public s.!s for t!e s!ares of an issuer no"(
2$ solicitation made for a substantial percentage of issuer0s stock unclear# t!ey didn0t
solicit subst0l percentage, but t!ey ac2uired subst0l percentage"(
+$ offer to purc!ase made at a premium over t!e prevailing market price no"(
Premium is determined not by reference to pre3tender offer price, but rat!er by
reference to market price
5$ terms of t!e offer are firm rat!er t!an negotiable no"(
6$ offer contingent on t!e tender of a fi7ed ma7imum number to be purc!ased no"(
J$ offer open only for a limited period of time no"(
G$ offeree sub&ected to pressure to sell !is stockno"(
F$ public announcements of a purc!asing program concerning t!e target co precede or
accompany rapid accumulation of a large amount of target co0s securities yes"
FF
Not ll fctor$ nee# &e .re$ent to f%n# ten#er offer$
Held# under F3factor 8ellman test, <HH0s repurc!ase program did not constitute a tender
offer$
<ourt re&ects S3N Securities test, advocated for by S?<
)" ' publicly announced intention by t!e purc!aser to ac2uire a block of t!e stock of t!e
target co for purposes of ac2uiring control t!ereof,
2" a subse2uent rapid ac2uisition by t!e purc!aser of large blocks of stock t!roug! open
market and privately negotiated purc!ases
<ourt says t!is test is ambiguous and difficult to apply$ Slain# it0s easier to apply$
0!r.o$e of ten#er offer r!le$: .ro+%#e %nfo to $6h$ of tr(et co
w!o0s buying
w!at0s t!e game plan
Iou0re s.! of <HH do you know w!at mgmt0s long3range goal is s!ort term goal getting
rid of Mimited"$ But co will sign0ly c!ange its capital structure bec it boug!t all t!e stock$
So, you0d like to know w!at mgmt is t!inking$
,f it was c!aracteri;ed as tender offer, s.!s would get t!is info $ Slain# case was incorrectly
decided$
Hanson v$ S<4 0r%+tely ne(ot%te# .!rch$e$ 'o!l# not" $tn#%n( lone" q!l%fy $
2d <ir )*F6" ten#er offer< here , not ten#er offer
,f tender offer violation of Rule )0b3)+# you can0t buy alongside t!e offer$ Luestion# is t!is
a tender offer9
<ourt# we do not adopt t!e 8ellman test( but t!en t!ey apply it to t!e facts of t!is case
8!y did t!ese people sold to Hanson, rat!er t!an tender t!eir stock9 s.!s prefer to sell now,
rat!er t!an tender later take t!e profit t!at0s immediately available
Hanson terminated its tender offer and made private purc!ases of 26K of S<40s outstanding
s!ares# 6 privately3negotiated cas! purc!ases and one open3market purc!ase$
S<4 successfully soug!t restraining order barring Hanson from ac2uiring more S<4 stock$
S<4# Hanson0s cas! purc!ases immediately following its termination of its @G2 per s!are
tender offer amounted to de facto continuation of Hanson0s tender offer, designed to avoid
)5d", and t!at unless preliminary in&unction issued, S<4 and its s.!s would be irreparably
in&ured bec Hanson would ac2uire enoug! s!ares to defeat t!e S<434errill offer$ /ist ct#
for P.S<4 issued in&unctive relief$
2d <ir
' preliminary in&unction will be overturned only w!en dist ct abuses its discretion$ ,ssue on
appeal# w!et!er dist ct erred as a matter of law in !olding t!at w!en Hanson terminated its
offer and immediately t!ereafter made private purc!ases of a subst0l s!are of t!e target co0s
outstanding stock, t!e purc!ases became a tender offer w.n )5d"$
,n t!e case of privately negotiated trans0ns many of t!e conditions leading to enactment of
)5d" do not e7ist, bec solicitees are sop!isticated$
<ourt considered t!e F3factor 8ellman test of w!at is a tender offer# it0s not mandatory$
<ourt applied t!e principle of $%/.ly loo)%n( to the $tt!tory .!r.o$e$
The te$t : $%nce the .!r.o$e of 13*#- %$ to .rotect the %ll-%nfor/e# $ol%c%tee" the qn of
'hether $ol%c%tt%on con$t%t!te$ Bten#er offer '6n the /en%n( of 13*#- t!rn$ on
'hether" +%e'%n( the trn$n %n the l%(ht of totl%ty of c%rce$" there ..er$ to &e
l%)el%hoo# tht !nle$$ the .re-cq!%$%t%on f%l%n( $tr%ct!re$ of tht $tt!te re follo'e#
F*
there '%ll &e $!&$tl r%$) tht $ol%c%tee$ '%ll lc) %nfo nee#e# to /)e cref!lly
con$%#ere# ..r%$l of the .ro.o$l .!t &efore the/.
Here# Hn$on$ Se.te/&er 11 ne(ot%t%on of = .r%+te .!rch$e$ n# 1 o.en-/r)et
.!rch$e of S8M $hre$" totll%n( 1=> of S8M$ o!t$tn#%n( $toc)" %$ not ten#er
offer '6n the /en%n( of the W%ll%/$ Act.
0r%+tely ne(ot%te# .!rch$e$ 'o!l# not" $tn#%n( lone" q!l%fy $ ten#er offer
for reasons see p$ GFJ G factors
Th!$" the totl%ty of c%rce$ tht e;%$te# on Se.t 11 #%# not e+%#ence ny l%)el%hoo# tht
!nle$$ Hn$on '$ req!%re# to co/.ly '613*#-*1-$ .re-cq!%$%t%on f%l%n( n# 't%n(-
.er%o# reqnt$ there 'o!l# &e $!&$tl r%$) of %ll-con$%#ere# $le$ of S8M $toc) &y %ll-
%nfor/e# $6h$.
Whether Hn$on$ .r%+te .!rch$e$ 'ere #e fcto cont%n!t%on of %t$ erl%er ten#er
offer , No dist ct wrong" see p$ GFF"
,ut the buying occurred the same afternoon! Hanson people testified t!at t!e idea to buy
after tender offer was an aftert!oug!t$
%!is trans0n is called Astreet sweepH# tender offer !as been going on( lots of stock in t!e
!ands of arbs( you buy from arbs$ 2d <ir# it0s not tender offer$ >t!er courts may decide
differently$
Held# dist ct abused its discretion to issue a preliminary in&unction reverse vacate
preliminary in&unciton$
<ase Burlington v$ Sc!riber# 0!r.o$e of ten#er offer r!le$ %$ #%$clo$!re. Trn$ct%on 'h%ch
%$ f!lly #%$clo$e# cnnot &e +%olt%+e.
R!le$ 13#-1 , 13#-1D: the $!&$tnt%+e r!le$
?pstein v$ 4<' K13*#-*2- n# R!le 13#-1D: ll-hol#er" &e$t-.r%ce r!le
*
t!
<ir )**6" req!%re$ ll &%##er$ to tret ll $6h$ on eq!l ter/$
There %$ .r%+te r%(ht of ct%on for +%olt%on of 13*#-*2- !n#er
3-fctor 8ort +. A$h te$t
/.4atsus!ita made tender offer to ac2uire 4<'$ Ps.class action.former 4<'0s s.!s w!o
tendered t!eir s!ares for @G) tender price$ Ps# 4atsus!ita violated Rule )5d3)0 by treating
8asserman and S!einberg differently from ot!er s.!s in t!e tender offer$ Ps want t!e
premium.difference same price as 8"
<t# there %$ .r%+te r%(ht of ct%on for +%olt%on of 13*#-*2-. <ourt ..l%e# 8ort +. A$h 3-
fctor te$t to decide w!et!er in enacting )5d"G", <ongress intended to create private cause
of action
1. 'hether 0 %$ one of the cl$$ for 'ho$e e$.ec%l &enef%t the $tt!te '$ encte#
1. 'hether there %$ ny %n#%ct%on of le( %ntent" e;.l%c%t or %/.l%c%t" e%ther to crete
$!ch re/e#y or to #eny one
3. 'hether %t %$ con$%$tent '6the !n#erly%n( .!r.o$e$ of the le( $che/e to %/.ly
$!ch re/e#y for 0
3. 'hether the c!$e of ct%on %$ one tr#%t%onlly rele(te# to $tte l'
,n cases after Borak )*J5", courts developed implied rig!t of action &urisprudence, so
<ongress didn0t t!ink it !ad to decide t!e private rig!t of action 20n itself w!en it enacted t!e
8illiams 'ct in )*JF$
*0
W$$er/n trn$ct%on# <apital <ontribution and Moan 'gr0nt 8 agreed to e7c!ange !is
4<' s!ares for preferred stock in a subsidiary 4atsus!ita would create$ Performance of t!is
'gr0nt was conditioned on t!e tender offer in several respects#
)$ neit!er 4atsus!ita nor 8 was obligated to perform 'gr0nt if any of t!e conditions of
t!e tender offer were not satisfied
2$ t!e timing of performance was tied to tender offer immediately after 4atsus!ita
accepted tendered payment for payment
+$ amount of cas! 4atsus!ita was re2uired to contribute to subsidiary was dependent
upon t!e tender price )0JK of tender offer price
5$ redemption value of 80s preferred stock was set as t!e tender price
Whether W trn$ct%on +%olte# R.13#-1D #e.en#$ !.on
1. 'hether W rece%+e# (reter cn thn other M8A $6h$ #!r%n( $!ch ten#er offer" or
1. 'hether W rece%+e# ty.e of cn not offere# to other M8A $6h$ %n ten#er offer
/ defense# timing 8 transaction closed after tender offer period e7pired( But <t# not rigid
period of time( the te$t %$
1. 'hether W trn$ct%on '$ n %nte(rl .rt of Mt$!$h%t$ ten#er offer Ies"
1. %f ye$" Mt$!$h%t +%olte# R.13#-1D &ec %t .%# h%/" .!r$!nt to the ten#er offer
#%ff n# /ore +l!&le cn thn %t offere# to other $6h$
/amages# Mt$!$h%t h$ to .y 4> o+er ten#er offer .r%ce to e+ery&o#y 'ho ten#ere#.
Green/%l
1amerman v$ Steinberg Green/%l
2d <ir )*F*"
,f you !ave greenmail in mind, you want to create impression t!at you0re smb t!at nobody
wants to deal wit!
S.!s of target co started derivative suit ag greenmailer alleging violation of Sec )+d"# t!at
Sc!edule )+/ didn0t disclose t!at purpose of trans0n was greenmail$ /isney.target wasn0t
mislead so, no claim$ %!e only cause of action for damages is under Sec )Fa"$
Sec * and Sec )F t!e only sections t!at provide for damages under +5 'ct$ Basically no
caselaw under eac! section very narrowly drafted cover not!ing now subsumed under
)0b36$
)*F* <ongress enacted R6FF) of ,nternal Revenue <ode# e7cise ta7 on greenmail( amount of
ta7# 60K of profit = it0s not a deductible item$
P.1amerman.e7ecutri7 of estate of original P, alleges t!at /.Steinberg, in concert w./
Reliance co0s in w!ic! Steinberg !olds a controlling interest", Agreenmailed /./isney, a co
of w!ic! 1amerman is a s.!, by purc!asing a large block of /isney stock and t!en, following
t!e t!reat of !ostile tender offer, selling t!at stock to /isney at a subst0l premium over market
7!y&c) A(ree/ent# )" payment to Reliance of @G0$F+ per s!are for its !oldings of /isney common
stock price substantially e7ceeded t!e market price of /isney common stock( 2" payment to
Reliance @2F million in reimbursement of e7penses incurred in conn w.its actual and contemplated
purc!ases of /isney common stock( +" termination of litigation previously initiated ag /isney by
Reliance( and 5" commitment by Reliance not to ac2uire /isney stock or ot!erwise seek to control or
influence /isney for )0 years$
1# 8%r , ff%r/ #%$t ct , ( 0
>ne complaining of a false or misleading st0nt in Sc!edule )+/ may seek damages only
under Sec 1N*- of t!e 'ct$
S%nce E/er/n $!e$ #er%+t%+ely on &ehlf of :%$ney" $he $tn#$ %n :%$ney$ $hoe$. So"
%n or#er to .re+%l on her Sec 1N*- cl%/" $he /!$t e$t&l%$h tht :%$ney$ .!rch$e of
%t$ $toc) fro/ Rel%nce '$ /#e %n rel%nce !.on fl$e or /%$le#%n( $tnt$ %n
*)
Rel%nce$ Sche#!le 13: f%l%n($. 7!t %n her &r%ef" $he #oe$ not cl%/ tht :%$ney '$
#ece%+e# &y the fl$e 13:$. Th!$" th%$ cl%/ '$ .ro.erly #%$/%$$e#.
Sect%on 13*e-
Piper v$ <!ris3<raft K13*e- *nt%-fr!# .ro+%$%on %n W%ll%/$ Act-
S$<t )*GG" E;chn(e ten#er offer
:efete# ten#er offeror h$ no %/.l%e# .r%+te c!$e of
ct%on for #/(e$ !n#er K13*e-
0!r.o$e of the W%ll%/$ Act %$ to .rotect $6h$ of tr(et co" not
&%##er$
In9!nct%on .rocee#%n( h$ to &e &ro!(ht &efore the
co/.let%on of ten#er offer
8!et!er t!ere is private rig!t of action under R)5e", and if t!ere is, w!o !as standing to sue
P.<!ris3<raft made unsuccessful tender offer to /.Piper( now seeks damages ag Piper for
alleged violation of )5e" t!at t!eir tender offer was frustrated by somebody else0s conduct
violating tender offer rules w!ic! was true"$ %!e Piper family opposed <!ris3<raft0s tender
offer
<ompeting tender offers# bidding by Bangor Punta and <!ris3<raft to ac2uire control of
Piper$ %!is is an e;chn(e ten#er offer# bidder is not offering cas!, but its own securities
%obin L Ratio# at t!at time, in t!e )*J0s, price of stock was !ig!"
So, tender offer coupled wit! ++ 'ct registration# !ave to comply w.++ 'ct registration
provisions = prospectus and +5 'ct tender offer rules
Bangor Punta !ad 2 defects#
)" it violated Rule )0b3)+ by buying alongside t!e offer and
2" disclosure defect in Bangor Punta prospectus of its own sec0s# w!y didn0t <!ris3<raft
sue on t!at basis, claiming t!at conduct is actionable under R)) of ++ 'ct9 bec
<!ris3<raft didn0t buy any stock of Bangor Punta$ -nder R)), only purc!asers !ave
standing to sue$
<!ris3<raft is suing for t!eir loss in trans0n loss profits$
Held# t!ere is no implied private cause of action for damages by bidders under )5e"
<ourt applies the 3-fctor 8ort +. A$h te$t#
)$ W$ 0 one of the cl$$ for 'ho$e e$.ec%l &enef%t the $tt!te '$ encte#@ Co,
on t!e contrary, bidder is a member of t!e class w!ose activities )5d" seeks to
regulate, not protect$
Held# primary purpose of 8illiams 'ct to protect target s.!s$
2$ I$ there le( %ntent to crete n %/.l%e# c!$e of ct%on *le( h%$tory-@ Co$ Plus,
lack of purc!aser.seller re20nt in )5e" does not give bidder standing rat!er, it could
be designed to give remedy to s.!s3offerees t!at did not tender t!eir s!ares due to
fraudulent misrepresentations# t!ese s.!s do not !ave standing under Blue <!ip
Stamps$
+$ I$ cret%n( n %/.l%e# c!$e of ct%on here con$%$tent '6the !n#erly%n( .!r.o$e
of the $tt!te *con(r!ence-@ Co$ The .!r.o$e of the W%ll%/$ Act %$ to .rotect
$6h$ of the tr(et co" not &%##er$. >t!erwise, if Piper is found liable, t!en t!e effect
of t!e lawsuit is to transfer loss to t!e precise class t!at t!e statute is designed to
protect people w!o used to be s.!s of Piper are now s.!s of Bangor Punta, t!e co
w!ic! won t!e contest"# t!is was an e7c!ange offer$ Piper s.!s became s.!s of
Bangor Punta$ P is trying to get &0nt ag Bangor Punta$ Cet effect of permitting P get
damages is to go ag t!e class of persons statute is trying to protect$ Plus, <!ris3<raft
*2
s!ould !ave sued for in&unction, rat!er t!an damages paid by ultimate beneficiaries of
t!e 'ct$
5$ I$ the c!$e of ct%on one .ro.erly #ele(te# to $tte l'@ Ies, common3law
principles of interference w.prospective commercial advantage$
,f t!is !ad been all3cas! tender offer possibly not t!e same result$ Primary beneficiaries of
8illiams 'ct !olders of securities soug!t to be boug!t$ ,f all3cas! tender offer no !arm
to Piper s.!s$
Rule# #efete# &%##er #oe$nt h+e c!$e of ct%on for #/(e$ !n#er K13*e-$ But it
doesn0t mean t!at nobody !as suc! standing$
'lso undisputed rule# $6h$ of tr(et co h+e $tn#%n( to $!e for +%olt%on of K13*e- n# for
#/(e$ but often t!ey don0t get damages"
Suit was not timely broug!t !ere# %n9!nct%on .rocee#%n( h$ to &e &ro!(ht &efore the
co/.let%on of ten#er offer$
Cote# S$<t e7pressly reserved its views on a" w!et!er t!e target or its s.!s !ad standing, and
b" w!et!er a tender offeror mig!t obtain in&unction relief as distinct from damages$
ASSIGNMENT NO. N , THE IM05IE: A8TIONS
1. In (enerl
4ost statutes no e7press private rig!t of action
Sec 1D*&-# any security is covered$ 8!at conduct is forbidden9 none$ ,t0s a blank c!eck to
S?< to adopt rules$ ,t0s not self3enforcive$
Sec 12*- of 33 Act# only covers people w!o are trying to sell sec0s
R!le 1D&-= applies to purc!ases or sales
R!le 1D&-= E/.loy/ent of /n%.!lt%+e n# #ece.t%+e #e+%ce$
It $hll &e !nl'f!l for ny .er$on, directly or indirectly, by t!e use of any means of
interestate commerce, or of t!e mails, or of any facility of any national securities e7c!ange,
)$ to employ any device, sc!eme, or artifice to defraud,
2$ to make any untrue statement of material fact or to omit to state a material
fact necessary in order to make t!e statements made, not misleading,
+$ to engage in any act, practice, or course of business w!ic! operates or would
operate as a fraud or deceit upon any person
in connection wit! t!e purc!ase or sale of any security
O$,$ <ase v$ Borak I/.l%e# .r%+te r%(ht of ct%on on &ehlf of $6h$ for +%olt%on of
S$<t )*J5" K13*- n# R!le 13-9
Re/e#y: &oth %n9!nct%on n# #/(e$
:or t!e )
st
time S$<t !eld t!at t!ere could be private rig!t of action under statutes and rules
w!ic! didn0t e7pressly provide for one
?stablis!ed n %/.l%e# .r%+te r%(ht of ct%on on &ehlf of $6h$ for +%olt%on of K13*- n#
R!le 13-9 anti3fraud w.r.t pro7ies for violation of federal statute w!ic! doesn0t provide
for private rig!t of action"$ S$<t# private enforcement is a necessary supplement to
enforcement by S?<$
Ps# merger was effected t!roug! circulation of false and misleading pro7y st0nt by t!ose
proposing t!e merger$
*+
Ps litigate t!e w!ole case after t!e event merger"$ /ist ct# no remedy bec t!ere can be only
prospective relief$ 'lso, dist ct dismissed state claim of breac! of fiduciary duty# Ps didn0t
post security to maintain state action outcome determinative$ %!ey !ad to post security for
t!e cost of derivative suit 8isconsin"$ CI also !as security for cost# RJ2G of CIB<M$ /el
doesn0t !ave it$
Re/e#y: &oth %n9!nct%on n# #/(e$ so, not only prospective relief"
Cot!ing in Sec )5a" says t!ere is private rig!t of action !ow come t!ere is one9 <ourt# for
protection of investors = S?< can0t inspect t!e facts in pro7y material$ <ourt doesn0t cite to
anyt!ing no precedent for Borak$
Slain0s t!eory# problem of state.federal conflicts of law$ Holding t!at t!ere was private rig!t
of action under 13*- *.ro;y r!le$- no conflict bet fed and state law, bec t!ere was no state
law$ But R!le 1D&-= action is a tort of deceit common3law fraud# t!ere is state law on t!at
so, conflict bet federal and state law$
4ills created R$)0b36, turned it into industry, alt!oug! it0s not a R$)0b36 case, it0s a Rule
)5a3* case !uge increase in R$)0b36 litigation after )*G0$
4ills v$ ?lectric 'uto3Mite I/.l%e# r%(ht of ct%on for +%olt%on of K13*- n#
S$<t )*G0" R!le 13-9 of 33 Act reco(n%Ge# %n 7or)
Mter%l%ty A .ro;y $ol%c%tt%on S trn$ct%on c!$t%on
Rule )5a3* pro!ibits solicitation of pro7ies by means of materially false or misleading st0nts$
Ps s.!s in 'uto3Mite$ 4ergent!aler owned more t!an 60K of 'uto3Mite and names all )) of
its directors$ 'uto3Mite sends pro7ies to its s.!s asking for approval of merger and board
recommendation, but pro7ies did not disclose t!at all board members of 'uto3Mite were
nominees and under direct control of 4ergent!aler$
Ps sue bot! derivatively on be!alf of 'uto3Mite and as representatives of t!e class of all its
minority s.!s$ Ps didn0t seek temporary restraining order or in&unction t!ey sued t!e day
before t!e vote( voting went a!ead as sc!eduled t!e following day merger went forward$
But after Borak, case still could go forward$
8!y did Ps wait so long to bring suit wanted to !ave a lawsuit not settlement"$ ,f Board
decided to correct !ow# addendum cross3reference# ) sentence ABoard recommends it,
but see p$ B for relations!ipBH" P wants lawsuit$ P owns )00 s!ares of 'uto3Mine
wouldn0t want to !ire council$ P0s atty t!e only person w.real econ interest in t!is
litigation$
Ps# violation of pro7y solicitation
'uto3Mite is a reporting co, ot!erwise pro7y rules would not be applicable to it$
'uto3Mite board recommended t!e merger$ CI and /el statute# &urisdictional before !ave
statutory merger, t!ere !as to be Board recommendation$ 8.o Board recommendation no
merger$ Here merger into 4ergent!aler, w!ic! owned more t!an !alf of stock of 'uto3
Mine influence in 'uto3Mite Board of /irectors if not dumb, s.!s understood it"$ But
4ergent!aler needed 2.+$
/ist ct# for P defect in t!e pro7y st0nt is a material omission$ G
t!
<ir reversed on issue of
causation# if fair deal no cause of action$
<ert# issue of causation$ :ootnote 5# issue of materiality wasn0t before S$<t before$
%ort# need causation S$<t granted <ert on transaction causation issue"
%ransaction causation !ere" v$ Moss causation
Ele/ent$ of tort of /%$re.re$entt%on6o/%$$%on:
1. /ter%l%ty
*5
1. rel%nce
3. $c%enter
S$<t#
)$ 4ateriality# M%$$tte/ent6o/%$$%on %n .ro;y $tnt %$ /ter%l %f %t /%(ht h+e &een
con$%#ere# %/.ortnt &y re$on&le $6h 'ho '$ %n the .roce$$ of #ec%#%n( ho' to +ote.
2$ Reliance# Where there h$ &een f%n#%n( of /ter%l%ty" $6h h$ /#e $!ff%c%ent
$ho'%n( of c!$l relt%on$h%. &et'een +%olt%on n# %n9!ry" %f he .ro+e$ tht the .ro;y
$ol%c%tt%on %t$elf '$ n e$$ent%l l%n) %n the cco/.l%$h/ent of trn$ct%on
S!owing of materiality satisfies t!e causation re20nt 3 need not!ing more to prove
causation t!an to prove materiality
Mter%l%ty A .ro;y $ol%c%tt%on S trn$ct%on c!$t%on. 0 #oe$nt h+e to
e$t&l%$h rel%nce impossible to s!ow t!at t!is defect in disclosure caused sufficient
votes"
+$ Sc%enter in a R$)5a3* case probably not an element
Here, 2.+ of 'uto3Mite s!ares were re2uired for approval of merger$ S$<t# :ootnote G# we
need not decide in t!is case w!et!er causation could be s!own w!ere t!e mgmt controls a
sufficient number of s!ares to approve transaction w.o any votes from t!e minority$
,ut see -irginia ,an.shares: Ps dont have standing if mgmt doesnt need their votes
Rel%ef:
R2* of +5 'ct merger doesn0t !ave to be set aside it0s already gone t!roug!"
t!us, no in&unction( t!ere may be a remedy, so S$<t remanded t!e case$ %!e most
convenient remedy monetary relief$
<ircular# yes, cause of action, t!en !old a fairness !earing on issue of relief w!et!er
deal is fair( if fair damages so, no cause of action"
Atty$ fee$ . S.8t hel# tht 0 %$ ent%tle# to tty$ fee$. So" fter th%$ c$e *1-
tr%+%l /%$$%n( $tnt , /ter%l #efect , &!t nyth%n( %$ /ter%l" n# *1- %f yo!
e$t&l%$h $ cl$$ tht there %$ +%olt%on , yo! (et tt$ fee$ nyho'" 'hether
or not yo! (et /onetry reco+ery , (ret for 0$ tt$. 0$ tty$ , rel .rt%e$ %n
%ntere$t here.
Here, / did need votes of outside s.!s to get t!e deal done$ Suppose t!ey !ave enoug! stock
2.+ or simple ma&ority, if /el corp" w!at result9 the .ro;y $ol%c%tt%on %t$elf" rther
thn the .rt%c!lr #efect %n the $ol%c%tt%on /ter%l$ h$ to &e n e$$ent%l l%n) %n the
cco/.l%$h/ent of the trn$ct%on so / !as to need t!e votes$ But most courts doesn0t
matter if you need t!e votes, if t!ere is defect in pro7y solicitation$
%!us, materiality !olding !as done !uge !arm but it0s not even a S$<t !olding, but came to
be understood as suc!"( very low materiality standard flood of litigation$ Plus, if violation
P is entitled to atty0s fees, w!et!er t!ere is any econ significance to corp or not$ 4ills turned
)0b36 into an industry$
R$)0b36 cases mostly publicly traded securities, but don0t !ave to be
%ouc!e Ross v$ Redington No .r%+te r%(ht of ct%on !n#er K12*- of 33 Act
S$<t" on &ehlf of &ro)er(e f%r/ c!$to/er$ for lo$$e$
r%$%n( fro/ /%$$tte/ent$ cont%ne# %n K12*-
re.ort$ *( cco!nt%n( f%r/-
R)Ga" of +5 'ct re2uires registered broker3dealers to file financial st0nts w.S?<
,ssue# w!et!er customers of securities brokerage firms t!at are re2uired to file certain
financial reports w.S?< by R)Ga" of +5 'ct, !ave an implied cause of action for damages
*6
under R)Ga" against accountants w!o audit suc! reports, based on misstatements contained in
t!e reports$
Ps# fin st0nts filed w.S?< were misleading$ /.firm of certified public accountants$
,s t!ere any claim t!at Ps relied on t!ese fin st0nts9 no, Ps never !eard of t!em$ Ps say# if
fin st0nts !ad been rig!t, S?< would !ave intervened and s!ut t!is place down would !ave
been no losses for so long$
Ps0 arg0nt# R)Ga" of +5 'ct creates an implied rig!t of action in favor of anybody w!o comes
out badly as a result of broker3dealer0s violation$
Hel#: %t #e.en#$ on 8on(re$$: 'hether %t crete# .r%+te r%(ht of ct%on. If %t #%#nt
.ro+%#e for one" #oe$ le(%$lt%+e h%$tory $!((e$t tht they %nten#e# one@ , %f no" %nq!%ry
en#$ , no %/.l%e# .r%+te r%(ht of ct%on. Th!$" en# of %/.l%e# .r%+te r%(ht of ct%on ,
en# of %/.l%ct%on #octr%ne.
,f try to find leg intent deat! of concept, bec w!at0s t!e point of implication doctrine )5a3*
and )0b36 e7ception"
>ne area w!ere court would continue to imply private rig!t of action rules under R)0
So, t!ere is no private rig!t of action on be!alf of brokerage firm customers under )Ga"
against accounting firm"
1. R!le 1D&-=< K12*- of 33 Act< K13*e- of 33 Act< R!le 13-9
Ele/ent$ of c!$e of ct%on
Tort of #ece%t
)" misrepresentation
2" materiality
+" scienter
5" reliance
6" pro7imate causation
Ele/ent$ of 1D&-= c!$e of ct%on
?rnst Q ?rnst v$ Hoc!felder K1D*&- A R!le 1D&-=
S$<t$ )*GJ" Nee# lle(t%on of $c%enter 'hen .r%+te c!$e of
ct%on for #/(e$
Sc%enter , con$c%o!$ %ntent to #efr!#
Sco.e of R!le cnnot e;cee# $co.e of $tt!te
/.?rnst Q ?rnst accounting firm, is auditing broker3dealer, failed to discover fraud by
President of corp.Cay$ Ps 3 3customers of corp, w!o invested in fraudulent securities sc!eme
non3e7istent escrow accounts"$
Ps# Cay0s escrow sc!eme violated )0b" and R$)0b36$ Cay used money of later investors to
pay off earlier investors$ But !e didn0t do it in connection w.purc!ase or sale of any security#
!e was telling people t!at t!ey were buying sec0s, but t!ere weren0t any sec0s still violation.
R!le: It$ $ettle# tht f%ct%t%o!$6none;%$tent $ec!r%ty %$ $ec!r%ty for .!r.o$e$ of the Act$
ot!erwise t!ese people would be w.o remedy"$
Ps# / aided and abetted Cay0s violations by its failure to conduct proper audits of corp
negligent nonfeasance# / failed to discover internal practices of t!e firm mail rule" said to
prevent any effective audit$
*J
Co allegation of fraud# allegation of negligence in audit$ Ps specifically disclaimed e7istence
of fraud or intentional misconduct on t!e part of /$ ,f t!ey noticed, t!ey could !ave refused
to issue clean opinion on financials as re2uired by S?< corp would soon go out of business$
Mike %ouc! Ross arg0nt# if t!ey discovered t!is, S?< would !ave intervened earlier
operation would !ave been s!ut down before loss to P$
Sc%enter %$ nece$$ry ele/ent of 1D&-= c!$e of ct%on
S$<t ag$ Ps# .r%+te c!$e of ct%on for #/(e$ '%ll not l%e !n#er 1D& n# R.1D&-= %n
the &$ence of ny lle(t%on of $c%enter , %ntent to #ece%+e" /n%.!lte" or #efr!#.
Cegligence is not enoug!$
Nrant of aut!ority to Sec under Sec )0b" to regulate deceptive purpose" or manipulative
conduct term of art# creating an illusory appearance of market trading can0t do it
inadvertently
R$)0b36 3 clauses
)" intent
2" can do inadvertently it is unlawful Ato make any untrue st0nt of material fact or to omit to
state a material fact necessary in order to make t!e st0nts madeB not misleadingH and Ato
engage in any act, practice, or course of business w!ic! operates or would operate as a fraud
or deceit upon any personH
+" arguable
But S$<t# :e$.%te the &ro# +%e' of the R!le #+nce# &y the 8o//%$$%on %n th%$ c$e" %t$
$co.e cnnot e;cee# the .o'er (rnte# the 8o//%$$%on &y 8on(re$$ !n#er 1D*&"$
Rule can0t be beyond grant of aut!ority to t!e agency rule is invalid$ Rules are interpreted
in suc! a way as to establis! t!eir validity$
:ootnote G# S$<t doesn0t reac! t!e 20n of w!ere t!ere is a cause of action for aiding and
abetting in violation of )0b36$ %o aid and abet, t!ere must e7ist an underlying securities law
violation committed by someone else$"
N7 :ootnote )2#
Wht #o yo! /en &y $c%enter@ <ts of 'pp# intent to defraud, reckless disregard for
t!e trut!, or knowing use of some practice to defraud$ Here, /s didn0t intend to defraud$
'not!er view# scienter means t!at t!is was conscious be!avior, doesn0t matter if / was intending
to defraud$ S$<t# in t!is opinion t!e term scienter refers to /entl $tte e/&rc%n( %ntent to
#ece%+e" /n%.!lte" or #efr!#
S$<t doesn0t address !ere t!e 20n w!et!er, in come cir0ces, reckless be!avior is
sufficient for civil liability under )0b" and R$)0b36$
So" 'ht #o yo! /en &y $c%enter: con$c%o!$ effort to #efr!# or 9!$t : #%# 'ht
he #%#@
S$<t also doesn0t consider t!e 20n w!et!er scienter is a necessary element in an
action by S?< for in&unctive relief under )0b and R$)0b36$
)0b36 essentially tort of deceit so, same elements result of t!is case is not controversial
'aron v S?< 06SE8 $ee)$ %n9!nct%on< SE8 h$ to e$t&l%$h:
S$<t )*F0" 1D*&- of 33 Act A R!le 1D&-= - $c%enter
12*- of 33 Act
12*-*1- - $c%enter
12*-*1- , no $c%enter
12*-*3- , no $c%enter
In9!nct%on $ho!l# %$$!e 'hen there %$ $o/e l%)el%hoo# of f!t!re
+%olt%on conc opinion"
*G
,ssue# 8!et!er S?< is re2uired to establis! scienter as an element of a civil enforcement
action to en&oin violations of )Ga" of ++ 'ct, )0b" of +5 'ct and Rule )0b36$ ,n&unctive
relief under 20b" of ++ 'ct for violation of )Ga" and in&unctive relief under 2)d" for
violation of )0b = Rule )0b36$"
P.S?< wants to en&oin /.'aron.corp from violating t!ese sections seeks preliminary and
final in&unction :ootnote )2 in ?rnst leaves open t!e 20n w!et!er scienter is re2uired w!en
S?< is suing for violation"
Slain# !ere obvious case of scienter clearly, purposive conduct by /s# /0s reps were
making false st0nts about co.client optimistic st0nts about common stock and fin condition"
Held# violation of
1D*&- A R!le 1D&-= req!%re$ $c%enter , %ntent to #ece%+e" /n%.!lte" or #efr!#
re(r#le$$ of %#ent%ty of 0 or nt!re of rel%ef $o!(ht
12*- of 33 Act
12*-*1- req!%re$ $c%enter
12*-*1- no $c%enter mere negligence is enoug!
12*-*3- no $c%enter mere negligence is enoug! but closer 2uestion"
R$)0b36 and )Ga"2" identical language( but Rule !as to be interpreted w.underlying grant
of aut!ority to S?< ?rnst Q ?rnst"( R$)0b36 w.n )0b" scienter$
,s t!ere a private rig!t of action under )Ga"9 ,f t!ere is, t!en it doesn0t re2uire scienter in
)Ga"2" and )Ga"+" actions$ S$<t never resolved it every <t of 'pp !eld t!at t!ere is no
private rig!t of action"$ Slain# S$<t will !old t!ere is no private rig!t of action under )Ga"
)Ga" applies only to sellers( so, because )Ga"2" and +" do not re2uire scienter, S?< can
now en&oin merely negligent sellers, but !as to s!ow scienter to en&oin buyers under )0b"
=R$)0b36$ So, if can0t make )0b36, can make )Ga"2" or +", e7cept it will only apply to
offers or sales$
<!ief Oustice Burger0s concurring opinion#
In9!nct%on $ho!l# %$$!e 'hen there %$ $o/e l%)el%hoo# of f!t!re +%olt%on$ %o make
suc! a s!owing, it will almost always be necessary for S?< to demonstrate t!at /0s past sins
!ave been t!e result of more t!an negligence, so /s w!ose past actions !ave been in good
fait! are not likely to be en&oined after t!is conc opinion, dist cts started to !old t!at t!ey
would not grant in&unctions w.o s!owing of likeli!ood of future violations$"
,f need in&unction, t!en /s intend to continue to do t!e wrong t!en obviously scienter$
Permanent in&unction perpetual$ Remedy for violating in&unction# criminal go to &ail(
civil contempt imprisonment$ <!ief Oustice# usual standards for issuing in&unction apply
!ere serious risk of furt!er violation$ ,f conduct wasn0t purposive, w!y would dist ct issue
in&unction$
Santa :e v$ Nreen 1D*&- n# R!le 1D&-=
S$<t )*GG" :el $hort-for/ /er(er $tt!te 1=3
7rech of f%#!c%ry #!ty &y /9or%ty $6$h" '6o ny #ece.t%on"
/%$re.re$entt%on" or non#%$clo$!re" #oe$ not +%olte 1D*&- n# R.1D&-=.
1D&-= %$ #%$clo$!re r!le. No +%olt%on %f %nfo %$ f!lly n#
cc!rtely #%$clo$e#.
0!r.o$e of $ec$ l'$ - f!ll #%$clo$!re
R.1D&-= c$e , $/e $ R.13-9 c$e: cnt &e +%olt%on of the R!le '6r6t trn$ct%on tht
%$ f!lly n# cc!rtely #%$clo$e#
*F
/.Santa :e owned *6K of 1irby Mumber stock, and wants to do a s!ort3form merger under
:el 1=3# parent to merge w.subsidiary upon approval by parent0s board and to make payment
in cas! for s!ares of minority s.!s( doesn0t re2uire consent or advance notice to minority s.!s(
re2uires notice w.n )0 days after merger$
4inority s.!s !ave appraisal rig!ts under :el 141, but didn0t seek t!em w!y# /elaware
didn0t permit class actions under appraisal rig!ts statute = under /el law, w!at are s.!s
entitled to in appraisal proceeding fair value( under /el block met!od, it would be close to
market price of sec0s, even w!en it was depressed, as !ere
Santa :e offered @)60 per s!are to min s.!s buyout price"( market value of stock was @)26,
constructive market price of stock" as valued by 4organ Stanley$ Daluation of underlying
assets was @J50$ ?7planation# %obin L Ratio compares market price of securities
w.replacement value of t!e assets"# time of events late )*J0s( %obin L Ratio was
appro7imately 0$+ stock was +0K of replacement value of assets stock value was !ugely
depressed$
Ps.min s.!s of 1irby to set aside merger or to recover fair market value of t!eir s!ares
didn0t seek appraisal rig!ts"# 1irby0s stock was wort! at least @GG2 per s!are based on fair
market value of 1irby0s p!ysical assets as it says in info st0nt sent to min s.!s$ Slain# s!ould
be @J50 = @)26 doesn0t know w!ere @GG2 comes from"$ %!us, Ps allege violation of Rule
)0b36$
<orp law 2uestion# in t!is appraisal proceeding, w!at are you entitled to value of your
s!ares or value of underlying business not t!e same"
1D&-= theory
Ps don0t argue t!at trans0n wasn0t fully disclosed to t!em( t!ey don0t argue t!at t!ey were
misled or deceived$ Basis of )0b36 claim# Santa :e !ad duty not to cause 1irby to enter into
trans0n for t!e benefit of t!e parent co as a controlling s.!, Santa :e !ad duty to run 1irby
in t!e interest of min s.!s
2d <ir# no arg0nt t!at Ps !ad been deceived, but no business purpose of merger$ Slain#
merger w.o business purpose contradiction in terms$
S.8t: no 1D&-= c$e
But / disclosed all t!is info to P$ <ause of action under )0b" only if conduct alleged is
Amanipulative or deceptiveH$ :und0l purpose of t!e 'ct is implementing a p!ilosop!y of full
disclosure, not fairness of trans0ns$ Plus, t!ere is a cause of action under state law in /el$
<ourt of <!ancery for appraisal$ <ongress by )0b" did not seek to regulate transactions
w!ic! constitute no more t!an internal corp mismanagement$
%!is is like ,n re :ranc!ard# S?< refused to set standard of 2ualities of Board of /irectors
20n of state law, not federal law
Hel#: Trn$ct%on '$ ne%ther #ece.t%+e nor /n%.!lt%+e n# $o" #%# not +%olte 1D*&-
n# R!le 1D&-= *e+en %f %n#eq!cy of .r%ce +%olte$ Snt Ie$ f%# #!t%e$-. 7rech of
f%#!c%ry #!ty &y /9or%ty $6$h" '6o ny #ece.t%on" /%$re.re$entt%on" or non#%$clo$!re"
#oe$ not +%olte 1D*&- n# R!le 1D&-=.
Cote# if corp !ad deceived min s.!s, t!en t!ere would !ave been a R$)0b36 action$
Say, ,0m a controlling s.!, own 60K = ) s!are, but in a state w!ere , can cause merger$
/isclosure doc0n# as a controlling s.!, ,0ll cause t!is trans0n, purpose of w!ic! is to benefit
me, not to benefit you s.!s", and ,0ll do bad t!ings to you$ Diolation of )0b36 Co$ 1D&-= %$
#%$clo$!re r!le. No +%olt%on %f %nfo %$ f!lly n# cc!rtely #%$clo$e#. ,f t!ere are any
problems decide under law of state of incorporation
Burlington
Same t!ing under R)5d" and Rule )5e3+$ R)5e" doesn0t create fid duty, it creates duty of
disclosure$ ,f full disclosure no violation$ Purpose of sec0s laws disclosure$
**
'pple <omputer case 'pple computer lost t!is litigation"
<o0s always make st0nts, but not necessarily file t!em w.S?<$ Problem of reliance on co0s
st0nts t!at are not formally filed w.S?<$
Ps# co made positive announcements about t!e product, but it didn0t tell t!at product was
losing t!e market
,t0s a )0b36 case# you can0t isolate st0nts t!at you make for sec0s markets from ot!er st0nts
'rg0nt# initially product looked great customer loved it so, initially, info was true$
'pple <omputer case# st0nts obviously affected trading market of sec0s, but t!ey weren0t
made for purpose of inducing people into buying stock$ 't t!e time st0nts were made, t!ey
co t!oug!t t!ey were rig!t$ /id t!ey !ave obligation to disclose to people buying.selling
sec0s t!at t!ere was deterioration of market for t!eir product9
%!ey repeated suc! st0nts$ Ps# t!is created %nference tht %nfo %$ $t%ll tr!e $
8!at if / &ust made t!is st0nt once didn0t repeat it"9
0ro&le/: ny co %$ $y%n( th%n($. It$ 'orr%$o/e %f yo! h# to con$tntly (o &c) o+er
e+eryth%n( yo! $%# %n .!&l%c to /)e $!re %t '$ $t%ll rel%&le , on(o%n( re+%e' #y &y
#y. If yo! h# tht o&l%(t%on , yo! 'o!l#nt $y nyth%n( to ny&o#y e;ce.t th%n($
yo!re force# to $y !n#er $ec$ l'$.
8einer v$ Luaker >ats 1D&-= ct%on< Ior'r#-loo)%n( $tnt$< Mter%l%ty $tn#r#
+
rd
<ir )**G" Re.ete# o.t%/%$t%c $tnt$ crete %nference , re$
!n#er$tn#%n( tht they re tr!e or '%ll &e correcte# %f
&eco/e !nrel%&le
Bo+er t%/eC , not /ter%l
A#+%ce: #ont /)e ny for'r#-loo)%n( $tnt$
I$$!e: 'hether n# %n 'ht c%rce$ cor. h$ n o&l%(t%on to %n+e$tor$ to !.#te" or t
le$t not to re.et" .rt%c!lr .ro9ect%on$ re(r#%n( cor.$ f%nnc%l $%tn.
Ps.purc!asers of stock in Luaker contend t!at /s disseminated false and misleading info to
t!e investment community violated Sec )0b" and Rule )0b36 by continuing to announce or
let stand certain pro&ected figures for earnings growt! and debt3to3e2uity ratio w!ic! /s
knew !ad become inaccurate in lig!t of Luaker0s planned ac2uisition of Snapple$
Luaker did not, at any time before announcement of ac2uisition of Snapple, make any public
st0nt or public filing t!at amended or 2ualified t!e )**+ 'nnual Report and :orm )03L$
So, /s said Ain t!e future, our debt3to3e2uity ratio will beBH for'r#-loo)%n( $tnt
typically not actionable if good fait! and reasonable basis$
<ourt# by including t!e total debt3to3total capitali;ation ratio guideline in t!e )**+ 'nnual
Report by setting it fort! in at least t!ree separate places in t!at document J!)er /y
'ell h+e crete# the re$on&le !n#er$tn#%n( /on( %n+e$tor$ tht the rt%o (!%#el%ne
'$ n!/&er to 'h%ch J!)er ttche# con$%#er&le $%(n%f%cnce. 'nd any suc!
understanding could well !ave been reinforced by t!e iteration of t!e ratio guideline in t!e
:orm )03L and t!e )**5 'nnual Report$ %aken toget!er, t!e st0nts could indeed !ave
induced a reas investor to e7pect eit!er t!at t!e ratio guideline would remain in t!e upper3
J0K range, or t!at if /s believed t!at Luaker0s total debt3to3total capitali;ation ratio would
soon c!ange significantly, t!e co would !ave said so in its )**5 'nnual Report$
Hel#: J!)er$ $tnt$ re(r#%n( %t$ totl #e&t-to-totl c.%tl%Gt%on rt%o (!%#el%ne
'o!l# h+e &een /ter%l to re$ %n+e$tor" n# hence J!)er h# #!ty to !.#te $!ch
$tnt$ 'hen they &ec/e !nrel%&le.
A#+%$%n( :: #ont /)e ny .ro9ect%on$" #ont /)e ny for'r#-loo)%n( $tnt$
)00
Al$o hel#: ern%n($ .ro9ect%on$ 'ere %//ter%l. Luaker0s )**5 'nnual Report contained
t!e st0nt t!at Awe are committed to ac!ieving a real earnings growt! of at least GK o+er
t%/eH3 t!e p!rase Aover timeH in t!is 2
nd
st0nt inoculates Luaker from any claims of fraud t!at
point to a decline in earnings growt! in t!e immediate aftermat! of Snapple ac2uisition$ Co
reas careful investor would find material a prediction of growt! followed by t!e 2ualifier
Aover time0$
A#+%$e: $y $ l%ttle $ .o$$%&le. E+en tho!(h $ec$ l'$ (ol$ , to /;%/%Ge #%$clo$!re.
'dams v$ Standard 1nitting 4ills 13-9 ct%on< Sc%enter reqnt
J
t!
<ir )*F0" O!t$%#e cco!ntnt$: $c%enter %$ req!%re# *for c!$e
of ct%on-
In$%#er$6%$$!er: no $c%enter req!%re#
I$$!e: 'hether 0et6f%r/ of o!t$%#e cco!ntnt$6 %$ l%&le for ne(l%(ent error , the
f%l!re to .o%nt o!t %n the .ro;y $tnt $ent to $6h$ of the cq!%re# cor. tht cert%n
re$tr%ct%on$ on the .y/ent of #%+%#en#$ &y the cq!%r%n( cor. ..l%e# to .referre# $
'ell $ co//on $toc). Hel#: 0et %$ not l%&le for $!ch con#!ct.
<!adbourn CIS? co" ac2uired Standard >%< co" statutory merger$ Standard issued
pro7y st0nt# describes bot! co0s and t!e deal$ Stock being issued to Standard s.!s is preferred
stock of <!adbourn$ <!adbourn !as long3term debt covenants t!at restrict payments of
dividends on all stock$ Pro7y st0nt describes it = footnote to Standard fin st0nts t!ese
covenants restrict payments of dividends of common stock error$
Peat, 4arwick learned about t!e error after pro7y st0nt was sent, but before s.! mtg t!at
t!ere was mistake in footnote"$ But partner decides t!at it0s immaterial mistake forget
about it$ /eals goes forward Standard is merged into <!adbourn$ %!en <!adbourn goes
down$
:ormer Standard s.!s are suing under )5a3* allegedly false pro7y solicitation$
8!y not sue under Sec )) of ++ 'ct9 events of t!is case pre3date Rule )56 doctrine t!at
no sale of stock was involved in t!e merger
/ist ct !olds# Peat0s be!avior involved sciener
J
t!
<ir reverses no scienter
2 2uestions
1. I$ $c%enter req!%re# for 13-9 +%olt%on
1. Wht #o yo! /en &y $c%enter
:ootnote )2 of ?rnst# scienter 3 conscious intent to defraud
Peat didn0t intend to defraud anyone$ %!ey knew t!at info was wrong, but didn0t understand
t!at it was material
%!is court no scienter$ Cot every court would reac! t!is conclusion
/o you need to !ave fraud to !ave scienter9
Basic v$ Mevinson# Basic wasn0t trying to defraud anybody, &ust tried to keep it down to
prevent ot!er from destroying t!e deal$ However, S$<t !eld t!at Basic did !ave scienter
under )0b36$
4
th
8%r: no $c%enter here" &ec no %ntent to #efr!#
Ele/ent$ of 13-9 +%olt%on
>utside accountants# scienter is re2uired for cause of action"
,nsiders.issuer# no scienter re2uired
)0)
<ourt# Ain contrast to Sec )) of ++ 'ct w!ic! imposes liability for negligent misrep0n in
registration st0nts, Rule )5a3* does not re2uire proof of actual investor reliance on t!e
misrep0n wrong$ Sec 11 #oe$ not req!%re rel%nce
Rule )5a3* standard of liability# strict liability$ Same language as in Sec )) of ++ 'ct$ Sec
)) absolute liability absolute duty to get t!is info rig!t$
R!le 13-9
Co solicitation sub&ect to t!is regulation pro7y solicitation" s!all be made by means of
any pro7y st0nt, form of pro7y, notice of mtg or ot!er communication, written or oral,
containing any st0nt w!ic!, at t!e time and in t!e lig!t of t!e cir0ces under w!ic! it is
made, is false or misleading w.r.t any material fact, or w!ic! omits to state any material
fact necessary in order to make t!e st0nts t!erein not false or misleading or necessary to
correct any st0nt in any earlier communication w.r.t t!e solicitation of a pro7y for t!e
same mtg or sub&ect matter w!ic! !as become false or misleading$
Co case !eld strict liability under )5a3*$ <onsensus# )5a3* imposes a negligence standard$
Slain# not!ing in )5a3* t!at would suggest t!at$
/epends on w!o0s being sued
if mgmt negligence standard
if collateral participants.auditors scienter standard
But not!ing in t!e rule t!at would sugget t!at
3. Stn#%n(
Blue <!ip Stamps v$ 4anor /rugs R!le 1D&-=
S$<t )*G6" 0 h$ no $tn#%n( to /%nt%n .r%+te c!$e of ct%on
for #/(e$ !n#er R!le 1D&-= &ec!$e he %$ not $eller
or .!rch$er of $ec!r%t%e$
Blue <!ip was in a trading stamp business
'bout !alf retailers boug!t s!ares( about !alf didn0t buy( it turned out to be a good deal so,
t!ose w!o didn0t buy sue claiming t!at prospectus was unduly pessimistic$ ,f it wasn0t
unduly pessimistic, t!ey would !ave boug!t sec0s
Here, identified class of persons w!o under antitrust decree !ad rig!t to be offered sec0s at
bargain price$
8!y not sue under R)) of ++ 'ct9 bec t!e only person w!o !as standing under R)) is t!e
person w!o boug!t sec0s$ So, Ps sue under )0b36$
06non-$6h # prospectus distributed by Blue <!ip in connection w.t!e offering to retailers w!o
!ad used t!e stamp service in t!e past was materially misleading in its overly pessimistic
appraisal of Blue <!ip0s status and future prospects( P seeks damages representing t!e lost
opportunity to purc!ase s!ares allege violation of R$ )0b36 Slain# it0s not unusual t!at
prospectus is pessimistic in tone"$
Ps sue for profits t!at t!ey didn0t get = e7emplary.punitive damages$ But R2F of +5 'ct# t!e
only damages recoverable are actual damages( punitive damages are not affordable
S$<t adopts trad0l view of 2d <ir 3 up!olds 2
nd
part of 7%rn&!/ #octr%ne only someone
w!o actually boug!t or actually sold sec0s !as standing to sue under )0b36$ Here, P0s
complaint t!at t!ey didn0t buy$ %!us, P !as no standing neit!er purc!aser nor seller of
securities
+ classes of potential Ps are barred by Birnbaum rule#
)02
)$ potential purc!asers of s!ares w!o allege t!at t!ey decided not to purc!ase bec of
unduly gloomy representation or omission of favorable material fact w!ic! made t!e
issuer appear to be a less favorable investment ve!icle t!an it actually was !ere"
2$ actual s.!s in t!e issuer w!o allege t!at t!ey decided not to sell t!eir s!ares bec of an
unduly rosy representation or failure to disclose unfavorable material
+$ s.!s, creditors, and ot!ers related to an issuer w!o didn0t sell and suffered loss in t!e
value of t!eir investment due to corp or insider activities in connection w.purc!ase or
sale of securities w!ic! violate R$)0b36 t!ey were defrauded"
Re!n2uist# problems t!at would arise if Birnbaum was overturned( anyone could say ,
s!ould !ave sold.boug!t would ve7atious litigation e7tortionate" = problems of proof 3
availability only of oral testimony$ / would want to settle bec of !uge costs of discovery$
So, lawsuit w!ic! !as very little c!ance of success, !as very substantial settlement value$
De7atious litigation problem e7tortionate litigation$ <o stock does badly$ Smb starts class
action alleging violation f )0b36# mgmt failed to disclose t!at t!ings were going bad, s!ould
!ave disclosed earlier$ / would move to dismiss$ ,f no motion to dismiss discovery$ 8!o
gets t!e )
st
s!ot at discovery /( but / can0t do muc!$ Cow P gets a s!ot at discovery
interrogatories$ / wants to settle$ So, even t!oug! t!ere is not even a remote pos0ty of P to
win if no motion to dismiss real settlement value$ P0s lawyer comes out well out of it$
Settlement re2uires permission of &udge, but t!en P and / want to settle$ %!is is e7tortion$
Nood proposal# in every class action, for guardian to be appointed to represent P0s class$
Ho'e+er" here , %#ent%f%e# cl$$ of .er$on$ 'ho !n#er nt%tr!$t #ecree h# r%(ht to &e
offere# $ec$ t &r(%n .r%ce. They cl%/ tht they 'ere /%$le# , .ro$.ect!$ $%# th%$
'$nt &r(%n. If no 1D&-= cl%/ , they h+e no other cl%/. Sl%n: &etter to hol#
tht they h+e $tn#%n( !n#er 1D&-=.
>t!er case# , !ave options to buy sec0s( options are e7piring( co misleads me , let my
options e7pire( t!en co announces t!ey discovered cure for common cold$ Ies, t!ey misled
me$ But , don0t !ave standing to sue t!em under )0b36$
Suppose my security was supposed to be converted on certain date, but mgmt induces me not
to convert w!at result9 , don0t !ave standing to bring t!e suit neit!er purc!aser nor
seller =for derivative suit t!ere !as to be !arm to corp"
The techn%q!e to re#!ce +e;t%o!$ l%t%(t%on h$ &een to #eny $tn#%n( to cl$$e$ of 0$"
&!t then yo! (et r%# of &oth (oo#6/er%tor%o!$ n# &# c$e$. Sl%n: th%n($ tht 'o!l#
'or) &etter:
1. r%$e /ter%l%ty $tn#r#
1. re+%$%t q!e$t%on of tty$ fee$: %f 'e re+er$e the A/er%cn r!le n# #o.t Blo$er
.y$ llC r!le , no chnce$ of e;tort%o!$ l%t%(t%on , the .ro&le/ '%ll #%$..er
Dirginia Banks!ares v$ Sandberg K13 A R!le 13-9
S$<t )**)" 1 hol#%n($ - $!&9ect%+e &el%ef &y #%rector$ n#
$tn#%n( - &oth 'ron(
2 issues
)" /oes a simple st0nt of opinion w.r.t significance of fully disclosed facts constitue actionable
misrepresentation
2" /o t!ese s.!s, w!ose votes were not needed, !ave standing to complain of inaccurate pro7y
st0nt
Slain# S$<t got bot! issues wrong
:ree;e3out merger# parent co !ad enoug! stock F6K" to approve transaction w.o any pro7ies
from outside s.!s, but t!ey issued pro7y st0nt and solicitation to minority s.!s$ ,n case of
subse2uent litigation, considerable advantage to / is transaction was voted for by ma&ority of
minority s.!s entire burden of proof would s!ift to /$"
)0+
/ got most pro7ies, but not from t!is P$ P defect in t!e pro7y st0nt# Board recommends t!e
transaction = says t!at it recommends bec deal gives s.!s !ig!er price 3 @52 per s!are and
t!is is fair price$ P# directors didn0t believe t!at t!is was really a !ig! price( t!ere is info t!at
co can sustain !ig!er price t!an @52 P gets t!is info from pro7y st0nt$
S.8t hol#$ 1 th%n($:
1. Mere $!&9ect%+e #%$&el%ef &y #%rector$ %$ not ct%on&le. If #%$&el%ef &o!t
fct!l &$%$ 'h%ch %$ %ncc!rte , ct%on&le *%f /%$$tte the $.e)er$ re$on$
n# l$o /%$le# &o!t the $tte# $!&9ect /tter-
R$ )5a3* imposes liability only for misstatements of material facts$ :act is
material if t!ere is substantial likeli!ood t!at a reas s.! would consider it
important in deciding !ow to vote$ But a st0nt of belief by corp directors
about a recommended course of action, or an e7planation of t!eir reasons for
recommending it is normally material e7pertise, knowledge, perceived
superiority of directors"$ 4ere disbelief or undisclosed motivation is
insufficient to satisfy t!e element of fact t!at must be establis!ed under
R)5a"$
Here, pro7y st0nt says t!at Board believes t!at trans0n is fair( Board doesn0t
!ave t!at sub&ective belief, but trans0n is ob&ectively fair st0nt, alt!oug!
false, is not actionable
2$ 0$6/%nor%ty $6h$ #ont h+e $tn#%n( to $!e &ec the%r +ote$ 'ere not req!%re# to
ffect the trn$ct%on" e+en %f there %$ /ter%l #efect %n .ro;y $tnt t!is is w!at
S$<t didn0t decide in Blue <!ip Stamps"( parent owns or controls ma&ority of stock
Slain# +ot%n( %$ the le$t %/.ortnt .rt of .ro;y .roce$$ , .ro;y r!le$ re
nee#e# to .ro+%#e %nfo to $6h$. %!is court awful result# if you don0t need s.!
vote, it doesn0t matter !ow you lie to t!em$ <ourt is wrong# statute or rule don0t
re2uire t!at s.! votes affected trans0n$
II SE8?RITM IS NOT REGISTERE: ?N:ER K11 - 0ROLM R?5ES ARE
IRRE5EVANT.
3. V%cr%o!$ l%&%l%ty n# collterl .rt%c%.nt$
Sec0s laws t!eir own vicarious liability ruled drafted into t!em# K1= of 33 Act n# K1D*-
of 33 Act
R)6 is limited to actions arising under RR)) and )2
R20a" actions under +5 'ct and Rules under +5 'ct
usu one or t!e ot!er"
K1= Provides t!at a person w!o controls a person !eld liable under R)) or R)2 of ++ 'ct s!all be
&ointly and severally liable wit! suc! controlled person, unless suc! controlling person did not
!ave knowledge of t! efacts or reas grounds to believe in t!e e7istence of suc! facts upon w!ic!
t!e controlled person0s liability is predicted$
K1D*- ,mposes &oint and several liability on persons directly or indirectly controlling one !eld
liable under +5 'ct, unless suc! controlling person acted in good fait! and neit!er directly or
indirectly induced t!e violation$
)$ %!is is not common law of vicarious liability$ -nder common law# if tort committed by e0ee
in t!e scope of e0nt e0er is vicariously liable$ -nder sec0s laws defense of due diligence
and good fait!
)05
2$ Manguage of t!ese 2 provisions is different, but cases under R)6 and R20a" are cited and
relied upon interc!angeabley, as t!oug! t!e language were identical
Hollinger v$ %itan 8ontroll%n( .er$on l%&%l%ty !n#er 1D*-: not only ent
*
t!
<ir )**0" relt%on$h%." cn &e %n#nt E-tor
It$ the .er$on $o!(ht to &e hel# +%cr%o!$ly l%&le !n#er 1=
n# 1D*- tht h$ &!r#en of .roof *not 0-
Goo# f%th Q #!e #%l%(ence , ff #efen$e
Goo# f%th #efen$e for &ro)er-#eler
Broker working for registered broker3dealer registered rep( is licensed by C'S/$ >n !is
C'S/ application !e lied didn0t mention t!at !e committed forgery( but !is registration
wasn0t cancelled( and !e stole from clients
Problem of embe;;ling e0ee# !e did it once !e0ll do it again$
Here, client sues broker3dealer
Broker3dealer defends#
)$ 8e didn0t control t!e rep( t!is rep wasn0t an e0ee, but ind0nt 13tor out of reac! of
20a"
2$ 8e didn0t intend t!at !e do all of t!is
+$ ?ven if all of t!e above doesn0t work, we can only be liable if we are culpable
participant in !is wrondoing
/ist ct dismissed t!e case
*
t!
<ir# for P
8ontrol #oe$nt req!%re eer-eee relt%on$h%. Slain# t!is is rig!t"( control means control of
fact
Held to be controlling person vicariously liable#
e0er
partner
e0ee of t!e tortfeasor !e made decisions"
creditor
customer
/ist ct seems to !old t!at in order to be vicariously liable for t!e tort, t!e broker3dealer must
!ave an e0nt relations!ip confused w.common law of agency$ %!is is not true if business
tort# co is responsible for ind0nt 13tors
Luestion of c!l.&le .rt%c%.nt
%!ere is a defense of good fait! and due diligence$ 8!o !as burden of proof# *
t!
<ir it0s t!e
person soug!t to be !eld vicariously liable under )6 and 20a" t!at !as burden of proof of due
diligence and good fait!
So, good fait! and due diligence is affirmative defense
P is not re2uired to s!ow culpable participation to establis! t!at broker3dealer is a controlling
person under 20a"
/0s burden of proving good fait!
Broker3dealer cannot satisfy its burden of proving good fait! merely by saying t!at it !as
supervisory procedures in place, and t!erefore, it !as fulfilled its duty to supervise
A &ro)er-#eler cn e$t&l%$h the (oo# f%th #efen$e only &y .ro+%n( tht %t /%nt%ne#
n# enforce# re$on&le n# .ro.er $y$te/ of $!.er+%$%on n# %nternl control
So, it0s a complete defense# we !ad compliance w.supervisory procedures t!ey were in
place and efficiently administered
)06
Broker3dealers don0t usu succeed
0ro&le/$
1. 're t!ese vicarious liability rules in )6 and 20a" layered on top of common law vicarious
liability, or do t!ey operate as alternative to common law vicarious liability is statutory
vicarious liability e7clusive split in circuits"
Better arg0nt t!at t!ese rules are e7clusive
8!en does it make a difference# under common law, no suc! t!ing as good fait! and due
diligence defense( if w.n scope of employment e0er is vicariously liable
1. See Bateman in pari delicto
<entral Bank of /enver v$ :irst ,nterstate A%#%n( n# A&ett%n( !n#er 1D&-=
S$<t )**5" Hel#: no .r%+te %#%n( n# &ett%n( l%&%l%ty
!n#er 1D*&-< &!t See K1D*e- , ye$" SE8 cn #el '6%#or$ n# &ettor$
Slain prefers caveat emptor buyer beware, but Ps in t!is case !ave every reason to be
outraged
/ indenture trustee under municipal bonds$ Bonds re2urie t!at smb provide trustee
w.appraisal of property sub&ect to lien on bonds$ -nder 13tual arrangement, property !ad to
at all times be wort! )J0K of face amount of bonds$ Cew appraisal came in, but trustee &ust
filed it away$ Bank enters into negotiation w.issuer of bonds, agrees to wait )) mont!s
before it !ires outside appraisal$ ,mprovement district sells more bonds$ Ps0 bank boug!t
t!em( land went down$ Ps sue everybody alleging violation of )0b36$
Ps claim t!at indenture trustee aided and abetted )0b36 violation
Ele/ent$ of %#%n( n# &ett%n(:
1. .r%/ry +%olt%on
1. : )ne' or $ho!l# h+e )no'n
3. : $$%$te#
Here#
)$ yes
2$ / didn0t know, but !ad reason to be suspicious
+$ yes, / materially assisted by not e7ercising t!e rig!t to !ave outside appraisal
/ist ct = <ir ct# / was aidor and abettor of )0b36 violation
<ert
1ennedy distinguis!ed bet 2 kinds of issues implicated by )0b36
)$ 8!at would <ongress !ave decided in )*+5 if it drafted )0b" in contemplation of possibility
of private rig!t of action
2$ 8!at conduct is forbidden$ 1ennedy# only conduct of smb w!o directly or indirectly
engaged in forbidden acts, but aiding and abetting attac!es to someone w!o !asn0t done t!at
<ongress did it in ot!er statutes, so it could !ave done it !ere, but it didn0t
Hel## t!e te7t of )0b" does not pro!ibit aiding and abetting, $o .r%+te .l%nt%ff /y not
/%nt%n n %#%n( n# &ett%n( $!%t !n#er 1D*&-
'lso issue# federal aiding and abetting statute criminal liability# aidor and abettor is a co3
principal of t!e crime$ Possibility t!at if you aid and abet a criminal violation of sec0s laws
can be prosecuted
,n )**6 <ongress enacted K1D*e- of 33 Act# capacity of S?< to deal w.aidors and abettors
was restored
)0J
=. 0roce#!rl /tter$
Rodri2ue; v$ S!earson 'merican ?7press Ar&%trt%on cl!$e
S$<t )*F*" A(ree/ent$ to r&%trte entere# %nto t the
$/e t%/e $ the !n#erly%n( trn$ct%on re enforce&le
8ilko v$ Swan !eld t!at Sec )5 of ++ 'ct and Sec 2*a" of +5 'ct anti3waiver provisions
!ad t!e effect of making agreement to arbitrate sec0s laws dispute unenforceable
Here, S$<t reversed t!is
'rbitration 'ct wasn0t enacted at t!e time of Swan
,s arbitration a good or bad idea9 good# arbitration is faster and c!eaper t!an lawsuit$
,f you !ave tec!nically deficient legal case, but strong sympat!etic case better arbitration
and vice versa"
,ssue# can arbitrator give punitive damages9 Sec 2* of +5 act actual damages only$
Punitive damages are not available under sec0s laws$
Bateman, ?ic!ler v$ Berner In .r% #el%cto #efen$e
S$<t )*F6"
Salesman w!o finds some customers and sells t!em sec0s based on fictitious claim of inside
info$ <ustomers lose money and sue salesman and !is e0er alleging violation of )0b36$
?0er defends doctrine of in pari delicto# Ps engaged in sec0s law violation t!ey !oped to
trade on inside info$
're Ps barred9
S.8t: .r%+te ct%on for #/(e$ %$ &rre# &y %n .r% #el%cto only *1- 'here 0 h$ t
le$t $!&$tnt%lly eq!l re$.on$%&%l%ty for +%olt%on A *1- .recl!$%on of $!%t 'ont
%nterefere '6effect%+ene$$ of $ec$ l'$ n# .rotect%on of %n+e$tor$
' private action for damages may be barred on t!e grounds of P0s own culpability only
w!ere )" as a direct result of !is own actions, P bears at least substantially e2ual
responsibility for t!e violations !e seeks to redress, and 2" preclusion of suit would not
significantly interfere w.effective enforcment of t!e sec0s laws and protection of t!e
investing public
Here, salesman knew !e was engaged in fraud$ /id !is e0er know9 no$ -nder Sec 20 of +5
'ct !ig! duty of supervision of registered rep$
Luestion# co !as e0ee or ind0nt 13tor agent, w!o defrauds smb w.w!om co is dealing$
Dictim is a good man$ But !ere Ps know t!ere is fraud, &ust doesn0t know t!at t!e fraud is
on t!em$
Say, salesman driver delivers cases of milk to stores$ He regularly delivers )6 cases and
c!arges t!e store for 20$ How could e0er detect t!at9 no way, unless !ire a private
detective$ How could t!e customer prevent t!is9 easily spot c!eck at least once$ So,
completely innocent e0er is non3negligent, but vicariously liable( and AvictimH w!o knows
t!ere is fraud, &ust t!inks it0s not on !im or customer w!o0s e7tremely careless negligent$
8!ere do t!e laws fall9 Risk is being consistently placed on e0er$
Here, e0er did not!ing to cause t!is sit0n, w!ereas P knew t!ere was fraud, &ust didn0t t!ink it
was on !im$
Slain# law s!ould fall on P !ere( but no pos0ty of suc! result e0er winds up being liable$
/amages !ere tort damages P0s out of pocket loss"
)0G
?rnst Q ?rnst # none of people w!o dealt! w.Cay !ad an indication in confirmation letters
from auditors t!at co !eld t!eir sec0s, but nonet!eless confirmed t!eir accounts to t!e
auditors$ So Ps e7tremely negligent$
4usick, Peeler 8ontr%&!t%on: co-:$ %n 1D&-= ct%on h+e r%(ht to $ee)
S$<t )**+" contr%&!t%on
Hel#: r%(ht of contr%&!t%on %$ to &e %/.l%e# /on( co-:$ %n 1D&-= c$e
Slain, like Oustice %!omas, stunned by t!e result# S$<t earlier decided t!at t!ere was no
contribution among antitrust /s$ S$<t ignored t!is precedent in antitrust area
So" tho$e chr(e# '6l%&%l%ty %n 1D&-= ct%on h+e r%(ht to contr%&!t%on (%n$t other
.rt%e$ 'ho h+e 9o%nt re$.on$%&%l%ty for the +%olt%on
ASSIGNMENT NO. 9 , INSI:ER TRA:ING
K1DA" K11A< R!le 1D&-=" R!le 13e-3
Sect%on 1DA Private rig!t of action based on contemporaneous trading
Sect%on 11A <ivil penalties for insider trading
R!le 1D&-= E/.loy/ent of /n%.!lt%+e n# #ece.t%+e #e+%ce$
It $hll &e !nl'f!l for ny .er$on
)$ to employ any device, sc!eme, or artifice to defraud,
2$ to make any untrue statement of material fact or to omit to state a material fact
necessary in order to make t!e statements made, not misleading,
+$ to engage in any act, practice, or course of business w!ic! operates or would
operate as a fraud or deceit upon any person
in connection wit! t!e purc!ase or sale of any security
R!le 13e-3 Trn$ct%on$ %n Sec!r%t%e$ on the 7$%$ of Mter%l" Non.!&l%c Infor/t%on %n
the 8onte;t of Ten#er Offer$
a" ,f any person !as taken a substantial step or steps to commence, or !as commenced, a
tender offer, it s!all constitute a fraudulent, deceptive or manipulative act or practice w.n t!e
meaning of section )5e" for any ot!er person w!o is in possession of material info relating to
suc! tender offer w!ic! info !e knows or !as reason to know is nonpublic and w!ic! !e knows or
!as reason to know !as been ac2uired directly or indirectly from
)" t!e offering person,
2" t!e issuer of t!e securities soug!t by suc! tender offer, or
+" any officer, director, partner or employee or any ot!er person acting on be!alf of t!e
offering person or suc! issuer,
to purc!ase or sell or cause to be purc!ased or sold any of suc! securities, unless suc! info and its
source are publicly disclosed by press release or ot!erwise$
<ady, Roberts
Broker3dealer firm( partner sold !is s!ares based on inside info
S?<# violation of )0b36( <ourt# yes$
S?< v$ %e7as Nulf Sulp!ur R!le 1D&-= In$%#er Tr#%n(
2d <ir )*JF :!ty to #%$clo$e or &$t%n
Who re l%&le@ - ll .eo.le 'ho h+e %n$%#e %nfo:
eee$ n# %n#e.en#ent contrctor$ *not only #%rector$ n# off%cer$-
)0F
Inh%&%t%on on %n$%#er tr#%n( %$ ..l%c&le not only to &ro)er-#eler$" &!t +ery &ro#ly
Hel#: Anyone %n .o$$e$$%on of /ter%l %n$%#e %nfo must eit!er disclose %t to the %n+e$t%n(
.!&l%c" or" %f he %$ #%$&le# fro/ #%$clo$%n( %t %n or#er to .rotect cor. conf%#ence" or he
choo$e$ not to #o $o" must abstain fro/ tr#%n( %n or reco//en#%n( the $ec!r%t%e$
concerne# 'h%le $!ch %n$%#e %nfo re/%n$ !n#%$clo$e#.
No &$ol!te #!ty to #%$clo$e: #!ty to #%$clo$e or &$t%n - yo! only h+e #!ty to
#%$clo$e %f yo! tr#e %nfo
R!le: #%$clo$e to co!nter .rty or &$t%n fro/ tr#%n(< no' 'y to #%$clo$e to co!nter
.rty , $o" relly &$t%n
So, if , !ave business reason for keeping t!e news 2uiet , can abstain no duty to disclose
until t!ey drill up smt!"$
8!en insiders may trade# must wait until t!e material info !as been Aeffectively disclosedH in
a manner sufficient to ensure its availability to t!e investing public$ 't minimum wait until
it goes over /ow Oones broad tape .eo.le 'ho h# %nfo re not t l%&erty to !$e %t !nt%l %t
%$ #%$$e/%nte# on the /r)et# last person to use info is t!e first person w!o !as it$ Slain#
odd$
,f t!e info was material, its possessors s!ould !ave kept out of t!e market until disclosure was
accomplis!ed$
%est of materiality# w!et!er a reasonable man would attac! importance in determining !is
c!oice of action in t!e transaction in 2uestion$
Whether fct$ re /ter%l '6n R!le 1D&-= w!en t!e facts relate to a particular event and
are undisclosed by t!ose persons w!o are knowledgeable t!ereof depends upon a balancing
of bot! t!e indicated probability t!at t!e event will occur and t!e anticipated magnitude of
t!e event in lig!t of t!e totality of t!e company activity$
Here, knowledge of t!e results of t!e discovery would !ave been important to a
reasonable investor and mig!t !ave affected t!e price of t!e stock$
Slain# conception of securities market as a place of perfect info# person w!o is trading on
securities market !as t!e same info as anybody else but impossible to operationali;e$
%!is standard of materiality is absurd, bec speculator is interested in anyt!ing
1# 8%r $tn#r# of /ter%l%ty: nyth%n( tht 'o!l# %ntere$t Wll Street
$.ec!ltor , +ery lo' $tn#r#
%!e core of R )0b36 is t!e implementation of t!e <ongressional purpose t!at all investors
s!ould !ave e2ual access to t!e rewards of participation in securities transactions$ 'll
members of t!e investing public s!ould be sub&ect to identical market risks$ %!e insiders !ere
were not trading on e2ual footing w.outside investors ine2uities based upon une2ual access
to knowledge$
:acts
2 actions !ere# one for misleading press release and t!e second one for ag t!e officers for
insider trading"
%NS ac2uired drilling rig!ts to a mineral deposit discovered ma&or mineral fund$ Some
geologists, some directors boug!t stock and calls options" to by %NS stock$ %NS also issued
stock options to various e0ees including 6 t!at knew of drilling$ Mand ac2uisition goes
t!roug! t!ey boug!t all t!e land", t!ey start redrilling$ %!en %NS issued a press release
saying t!at not!ing definite was found$ %!en %NS announced ma&or mineral strike$ <ourt
!olds for S?<$
<all option to buy a security, usu at a price slig!tly above t!e current market$ 8riter
person w!o gives t!is option, usu institutional investor# + classes of people = >f t!ese +
classes, w!o is !urt by insider trading9 >f t!ese + classes, w!o is !urt by insider trading9
)0*
)$ people w!o write options for purc!ase by insiders yes, t!ey are !urt, bec t!ey0ll
lose muc! stock
2$ co, like %NS, itself writes options to its e0ees s.!s are not worse off by t!e fact t!at
insiders came into t!e market as a buyer, it could even !elp s.!s
+$ people w!o sold co0s stock in t!e open market and w!ose stock was boug!t by
insiders
So, you0re %e7as s.!, decided to sell your stock$ How worse off are you if smb w.info buys
t!is stock !ow is t!is unfair9 !e didn0t do anyt!ing to induce you to sell no in&ury to you
Cobody could e7plain w!y in an e7c!ange transaction t!ere is an in&ury to counterparty from
insiders( but counterparty w!o traded w.inside trader could !ave cause of action but almost no
lawsuits"
,f >%< security t!is would work differently$ ,f >%< w!o is t!e counter party t!e
market maker$ ,f you !adn0t sold, , wouldn0t !ave boug!t and vice versa rel %n9!ry to
/r)et /)er dealer" insider caused !im to buy.sell, w!en ot!erwise !e wouldn0t !ave
done so$
Here, S?< in&unction proceeding# S?< seeks remedy #%$(or(e/ent for / to turn over t!e
profit
4otivation for press release to 2uell t!e rumors$ DP :ogarty knew t!at assay was positive(
press release is not very optimistic, less optimistic t!an t!e state of !is knowledge$ ,f !e
issued a more factually accurate press release, price of stock would go up a lot$
Rule of t!umb# w!en in doubt make t!e news bad$ 8!ose interests were disserved by t!at9
people w!o sold t!eir stock = people w!o didn0t buy, but see Blue <!ip Stamps t!ey
don0t !ave standing
?rnst v$ ?rnst # elements of )0b36 violation, one of w!ic! is $c%enter conscious intent to
defraud( t!is press release is not conscious intent to defraud( t!ese people were trying to keep
situation from getting out of !and$
But <ourt# yes, violation( so w!at0s t!e meaning of scienter intent to defraud or &ust t!at /
did w!at !e did
5%&%l%ty of %n$%#er$# w!o are t!e people w!o can be !eld liable9 not limited to directors
and officers( ll .eo.le 'ho h+e %n$%#e %nfo: eee$ n# %n#e.en#ent contrctor$
<ongress amended +5 'ct by adding Sec 20' and Sec 2)'
Sec 1DA solves t!e problem t!at was t!oug! to in!ibit private suits provides for .r%+te
r%(ht of ct%on &$e# on conte/.orneo!$ tr#%n(( 20' itself does not add anyt!ing
substantive to insider trading &ust t!at insider trading is a violation of statute or rules
<ady = %e7as# c!aracteristic of inifo info came from t!e co itself Ainside infoH, but in
<!iarella info is not known to t!e co
<!iarella v$ -S S$<t )*F0" K1D*&- A R!le 1D&-=
V%olt%on of 1D&-= only 'hen #!ty to #%$clo$e &ec!$e
of .re-e;%$t%n( f%#!c%ry relt%on$h%. , yo! cnt &e 1D&-= +%olter !nle$$ yo! o'e f%# #!ty
to co!nter .rt%e$ %n the tr#e *to cor. , to %t$ $6h$-.
/.printer for a financial printer, figures out t!e real names of co0s sub&ect to tender offers,
makes @+0,000 in 5 years trading on t!is info a!ead of tender offer$ S?< brings )0b36 action$
<ourt !olds for /$
<!iarella0s defense# !e is not corp insider$
))0
,nside info coming from inside t!e co" v$ 4arket info info relating to t!e co coming from
somew!ere else"$ Here, info is not coming from inside t!e co in w!ose securities / is
trading$ / knows info even t!oug! !is co doesn0t know$ His info wasn0t known to t!e target
co not AinsideH info( it came from tender offeror$ Here <!iarella is a market insider$
But you can argue t!at e0ee owes fid duty to !is e0er t!roug! corp runs to corp s.!s$ Mower
court said t!at <!iarella is a market insider( market insider !as t!e same duty as corp insider,
based on academic t!eory, not law draft of bill not yet introduced in <ongress"$ S$<t
reversed <!iarella0s conviction$
A #!ty to #%$clo$e !n#er 1D&-= #oe$ not r%$e fro/ the /ere .o$$e$$%on of /ter%l
non.!&l%c %nfo.
Hel#: one 'ho f%l$ to #%$clo$e /ter%l %nfo .r%or to the con$!//t%on of trn$ct%on
co//%t$ fr!# only 'hen he %$ !n#er #!ty to #o $o< n# the #!ty to #%$clo$e r%$e$
'hen one .rty h$ %nfo tht the other .rty %$ ent%tle# to )no' &ec of f%#!c%ry or
other $%/%lr relt%on of tr!$t n# conf%#ence &et the/.
Silence in connection wit! t!e purc!ase or sale of securities may be fraud actionable under
)0b"( but suc! liability is premised upon a duty to disclose arising from a relations!ip of
trust and confidence bet parties to a transaction$
Basis of )0b36# breac! of fiduciary duty owed to t!e counter3party $ Iou0re e0ee of %e7as
Nulf get info want to sell$ ,0m a s.!# yes, you owe fiduciary duty to me$ ?0ee0s fiduciary
duty runs not only to e0er, but to e0er0s s.!s$ So, an e0ee or agent !as fiduciary duty to t!e co
!e works for, and t!is duty runes to s.!s of t!e co# e0ee w!o buys co stock from s.! w.o
disclosure breac!es fid duty to s.!s( e0ee w!o sells co s!ares to anot!er w.o disclosure also
violates fid duty to future s.!s"
8!en you buy on t!e market, you buy from a counter3party
'not!er t!eory !ere# tender offeror could be in&ured if price of target stock goes up$
'not!er risk# / will go to broker to buy stock( so t!e 2
nd
time !e0ll do it, broker will notice
t!at / knows smt! piggybacking p!enomenon$
4a&ority does not decide t!e issue of misappropriation$ <!ief Oustice Burger# conviction
s!ould be affirmed on misappropriation grounds !e would read )0b and )0b36 to
encompass t!e principle t!at a person w!o !as misappropriated nonpublic info !as an
absolute duty to disclose t!at info or to refrain from trading$ <!iarella misappropriated t!is
info from !is e0er0s client tender offeror$ ,nfo was supposed to be confidential so, t!eft,
duty to disclose to !is e0er$ ,f info was misappropriated, can0t trade bec of duty to disclosure
to t!e counter party$ /ifferent turn in >0Hagan"$
<ongress enacted t!e last sentence of Section )5e" of +5 act$ 's an aftert!oug!t, S?<
enacted R!le 13e-3$
:%r)$ +. SE8 *S.8t 19N3- T%..ee l%&%l%ty !n#er 1D*&- n# R!le 1D&-=: l%&le only 'hen
t%..er *%n$%#er- %$ l%&le< t%..er %$ l%&le 'hen .er$onl #+nt(e
/irks received material nonpublic info from insiders of a corp wit! w!ic! !e !ad no
connection$ He disclosed t!is info to investors w!o relied on it in trading in t!e s!ares of t!e
corp$ ,ssue# w!et!er /irks violated )Ga" of ++ 'ct and )0b" and Rule )0b36 of +5 'ct by
tipping !is customers t!at ?2uity :unding is not a good place to invest money because of
massive fraud w.n t!e co"
Hel#: for :%r)$ , he %$ t%..ee *rece%+e$ %n$%#e %nfo fro/ %n$%#er- *not t%..er-< t%..ee %$
1D&-= +%oltor only %f t%..er %$ 1D&-= +%oltor. When %$ t%..er l%&le for 1D&-=
+%olt%on@ , 'hen .ro+%#e %nfo for $o/e .er$onl #+nt(e: f%nnc%l #+nt(e"
)))
re.!tt%onl #+nt(e" (%ft. Here , noth%n( l%)e th%$< they t%..e# for .!&l%c .!r.o$e ,
(+e %nfo &o!t %lle(l ct%+%t.
/uty to disclose before trading on material nonpublic info does not arise from t!e mere
possession of nonpublic market info( suc! a duty arises from t!e e7istence of fiduciary
relations!ip$ Plus, t!ere must be manipulation or deception$ %!us, insider will be liable
under Rule )0b36 for inside trading only w!ere !e fails to disclose material nonpublic info
before trading on it and t!us makes secret profits$ Co duty to disclose w!en person w!o !as
traded on inside info was not t!e corp0s agent, not a fiduciary, or was not a person in w!om
t!e sellers of t!e securities !ad placed t!eir trust and confidence$
R!le: A t%..ee $$!/e$ f%#!c%ry #!ty to the $6h$ of cor. not to tr#e on /ter%l
non.!&l%c %nfo only 'hen the %n$%#er h$ &reche# h%$ f%# #!ty to the $6h$ &y #%$clo$%n(
the %nfo to the t%..ee n# the t%..ee )no'$ or $ho!l# )no' tht there h$ &een &rech.
8!et!er disclosure is a breac! of duty depends on purpose of disclosure$ The te$t: 'hether
the %n$%#er .er$onlly '%ll &enef%t" #%rectly or %n#%rectly" fro/ h%$ #%$clo$!re. A&$ent
$o/e .er$onl (%n" there h$ &een no &rech of #!ty to $6h$.
Slain is against O$ Blackmun0s dissent securities investment is a game of perfect info( /irks
clients profited at t!e public0s e7pense"$ S$<t direction of arg0nt t!at S?<0s policies are
seriously flawed$ Cobody buys securities after reading disclosure doc0s people buy from
advisors( people w!o advise advisors securities analysts like /irks" t!e only people w!o
read disclosure doc0s t!ey s!ould !ave info to advise everybody else"$ ,t0s /irks0s &ob to
advise !is customers$ ,f you give strong disincentive to /irks to pass info to !is customers,
you also give !im disincentive to discover fraud you impede securities analysts, and so
defeat t!e goals of securities system$
R!le 13e-3 Pro!ibits insider and tippee trading in t!e tender offer conte7t by applying t!e
disclose3or3abstain provision w!ere an individual is in possession of material info relating to a
tender offer w!en !e or s!e knows or !as reason to know t!at suc! info is nonpublic and was
obtained directly or indirectly from t!e offeror, t!e sub&ect corp, any of t!eir affiliated persons, or
any person acting on be!alf of eit!er co$
-S v$ <!estman 2d <ir )**)" R!le 13e-3< 1D& A R!le 1D&-= - /%$..ro.r%t%on theory<
f%#!c%ry #!t%e$ of f/%ly /e/&er$
<!estman stockbroker( got info from 1eit! Moeb about negotiated takeover of 8aldbaum
by 'QP t!roug! tender offer( President told !is sister !er daug!ter !er !usband Adon0t
tell anyoneH" /.<!estman( <!estman buyes stock for !is client portfolios, inluding 1eit!0s(
t!en 1eit! bec witness ag <!estman$ Purgery lying to S?< investigators( mail fraud$
4a&ority O$ >akes"# ,ssues
*1- Vl%#%ty of R!le 13e-3 n# 'hether : %$ l%&le !n#er R!le 13e-3 , ye$" +l%# n# ye$" :
l%&le
/# S?< e7ceeded its aut!ority w!en it enacted Rule )5e3+$ Held# S?< did not e7ceed its
statutory aut!ority in drafting Rule )5e3+a"( a rational trier of fact could infor t!at t!e info
originated, Adirectly or indirectly,H from a 8aldbaum insider ag$ /$
Rule )5e3+ speaks to tender offers not ot!erwise regulated, like debt it0s broader t!an t!e
rest of t!e 8illiams 'ct# not tr#e on %n$%#e %nfo %n connect%on '6ny ten#er offer t!at0s
w!at / did"$ ,t0s a disclosure provision$
8!at is t!e standard of review !ere# ,nterpretive rules v$ Megislative rules$ Here S?< is
enabled by <ongress to implement t!e 'ct t!is is Megislative rule$ %!e only 20n# is t!is w.n
t!e grant of aut!ority from <ongress# if yes valid, unless arbitrary or capricious w!ic! is
not !ere"( deference to Rule !ere valid$
))2
/# , lacked proper notice did not know w!et!er <ourt would ultimately find it valid
evidentiary arg0nt"$ <ourt re&ects$
*1- R!le 1D&-= , : not l%&le
/ is )" aider and abetter of 1eit!0s violation of Rule )0b36 and 2" !imself a violator of )0b36
as 1eig!0s tippee$ ,n any case, !is violation depends on 1eit!0s +%olt%on
:$ 1D&-= con+%ct%on$ 'ere &$e# on the /%$..ro.r%t%on theory: tht one 'ho
/%$..ro.r%te$ non.!&l%c %nfo %n &rech of f%#!c%ry #!ty n# tr#e$ on tht %nfo to
h%$ o'n #+nt(e +%olte$ Sect%on 1D*&- n# R!le 1D&-=.
8!y not find 1eit! liable on traditional insider trading standards as in %e7as Nulf Sulp!ur9
because after <!iarella, you can0t be a )0b36 violator unless you owe fiduciary duty to
counter parties in t!e trade to corp to its s.!s"$ :or <!estman to be a violator, 1eit! !as to
be a violator 1eit! !as to owe fiduciary duty to 8aldbaum corp to its s.!s$ 1eit! is not
an e0ee of 8aldbaum$ %!us, !e can0t be liable unless !e misappropriated from 8aldbaum
family$
-nder /%$..ro.r%t%on theory, a person violates Rule )0b36 w!en !e misappropriates
material nonpublic info in breac! of fiduciary duty or similar relations!ip of trust and
confidence and uses t!at info in a securities transaction$ S%!is t!eory e7tends liability to
persons possessing material nonpublic info w!o use t!e info in violation of a duty owed to
someone ot!er t!an s.!s of corp w!ose sec0s were traded$T
I%#!c%ry #!t%e$$
Nov0nt# alleged misappropriator is 1eit! !e breac!ed fiduciary duty to !is wife and t!e
8aldbaum family w!en !e disclosed to <!estman info concerning a pending tender offer for
8aldbaum stock$ 2 critical elements# 1eit! breac!ed fid duty and <!estman knew about it$
<ourt !olds#
)$ ' fiduciary duty cannot be imposed unilaterally by entrusting a person wit! confidential info
can0t impose fid duty on someone w!o doesn0t accept it, by saying Adon0t tellH"$
2$ 4arriage does not, wit!out more, create a fiduciary relations!ip# !usband and wife do not
owe eac! ot!er fiduciary duties( rat!er, t!e e7istence of a confidential relations!ip must be
determined independently of a pree7isting family relations!ip$
Sl%n# I%#!c%ry person w!o is in some relations!ip wit! ot!ers w!ere law to some e7tent
limits !is rig!t to look to !is own interests Slain t!inks marriage s!ould be grounds for fiduciary
duty bec no one deals w.t!eir spouse in an arms3lengt! bargaining posture"$
Oudge 8inter *conc!r %n .rt n# #%$$ent %n .rt-
'lternative t!eory# &!$%ne$$-.ro.erty rt%onle for &nn%n( %n$%#er tr#%n(# info belongs
to t!e co, bec co e7pended resources to create it t!en taking t!is info is a t!eft$ ,nsider
trading may reduce t!e return on info# creates incentives for insiders to disclose info t!at may
disregard t!e welfare of corp = creates a risk t!at info will be prematurely disclosed by suc!
trading, and corp will lose part or all of its property in t!at info$ Piggybacking$
8inter# <!estman can be liable under )0b36 under eit!er t!e /irks rule, or misappropriation
t!eory, bec t!ere is fid duty of family members# duty not to use info obtained from family
members for personal profit w!ere t!e use risks disclosure$ Susan0s saying A/on0t tellH is
enoug! for 8inter$ 'nybody w.inside info about anyt!ing can0t use it, but t!en nobody w!o
works for co can ever buy co0s stock not a good idea$
Slain# problem not possible to turn sec0s into game w.perfect info like c!ess"$
8inter# in t!e modern world, most valuable asset of business is info so insider trading
liability !as to protect party0s property rig!ts to info$
))+
,n tender offer area easy to find in&ury to source of t!e news# if start trading drives up t!e
price obvious in&ury to tender offeror legitimated )5e3+ pro!ibition$
W%nter #%$(ree$ '6r6t f/%ly: there h$ to &e f%#!c%ry #!ty of f/%ly /e/&er$ ,
B&!$%ne$$ f/%lyC #!ty. %!en by !is formulation, 1eit! is a violator$ Slain bad view
can0t be suc! a family relations!ip$
F!#(e M%ner concur"
:%$(ree$ '6F. W%nter$ f/%ly r!le: f/%ly #%$co!r$e 'o!l# &e %nh%&%te# '6W%nter$
r!le.
Says t!at rationale for 8inter0s rule is t!at family members would be encouraged to speak
freely on all matters pertaining to t!e family, knowing t!at t!e lips of t!ose w!o receive
confidential corp info in t!e course of ongoing family interc!anges would be sealed$ But
w!at family members would want to receive any info w!atsoever t!at mig!t bear on t!e
family business = not clear &ust w!o would be sub&ect to t!e duty of confidentiality$
F. Mhoney concur in part and dissent in part"
:%$$ent '6r6t R!le 13e-3*-: SE8 e;cee#e# %t$ r!le/)%n( !thor%ty 'hen %t
.ro/!l(te# R!le 13e-3*-.
S?< could only regulate like common law fraud$ Manguage of Section )5e" is t!e same as
language of Section )0b"$ Rule )5e3+ anybody w!o !as info issuer, bidder, someone
working on t!e deal engages in fraudulent act if t!ey are trading w.o disclosing to t!e
counter3party if ,0m buying to t!e seller"( but not real pos0ty of disclosure( so S?< really
says abstain from trading$
8h%rell : $%lence cn &e fr!# only %f there '$ #!ty to #%$clo$e< &!t R!le 13e-3*- (oe$
&eyon# 8h%rell" &ec!$e %t conte/.lte$ #%$clo$!re to the co!nter-.rty.
4a!oney0s view lonely" got picked up very 2uickly$
-S v$ >0Hagan S$<t )**G" 1D*&- A 1D&-= , /%$..ro.r%t%on theory<
13*e- A 13e-3*-
/.>0Hagan partner is law firm$ <onvicted of fraud in violation of )0b" and )0b36 and
fraudulent trading in connection wit! a tender offer in violation of )5e" and )5e3+a"$
2 issues
:irst# ,s a person w!o trades in securities for personal profit, using confidential info
misappropriated in breac! of fiduciary duty to t!e source of t!e info, guilty of violating )0b"
and )0b369 Ies ag /"
Second# did S?< e7ceed its rulemaking aut!ority by adopting Rule)5e3+a", w!ic! proscribes
trading on undisclosed info in t!e tender offer setting, even in t!e absence of a duty to
disclose9 Co ag /"
1D*&- n# 1D&-=
Hel#: cr%/%nl l%&%l%ty !n#er 1D*&- /y &e .re#%cte# on the /%$..ro.r%t%on theory ,
.er$on co//%t$ fr!# %n connect%on '%th $ec!r%t%e$ trn$ct%on" n# there&y +%olte$
1D*&- n# 1D&-=" 'hen he /%$..ro.r%te$ conf%#ent%l %nfo for $ec!r%t%e$ tr#%n(
.!r.o$e$" %n &rech of #!ty o'e# to the $o!rce of the %nfo.
%!e classical t!eory targets corp insider0s breac! of duty to s.!s wit! w!om t!e insider
transacts
The /%$..ro.r%t%on theory o!tl'$ tr#%n( on the &$%$ of non.!&l%c %nfo &y cor.
o!t$%#er %n &rech of #!ty o'e# not to tr#%n( .rty" &!t to the $o!rce of the %nfo.
))5
:ull disclosure forecloses liability under misappropriation t!eory# if fiduciary discloses to t!e
source t!at !e plans to trade on t!e nonpublic info, t!ere is no deceptive device and t!us no
)0b" violation$
Has to be deceptive conduct in connection wit! purc!ase or sale of security$
<riminal liability may be sustained under t!e misappropriation t!eory$ %o establis! a
criminal violation of rule )0b36, Nov0nt must prove t!at a person AwillfullyH violated t!e
provision$
%!e fraud is on /orsey and /orsey0s client$
M%$..ro.r%t%on theory , $t%ll &$t%n or #%$clo$e r!le. Ho' cn OH(n +o%#
+%olt%on of 1D&-= !n#er /%$..ro.r%t%on theory , #%$clo$e to h%$ e/.loyer" o'ner of
%nfo , :or$ey , tht hell tr#e on %n$%#e %nfo.
8!at is t!e utility of t!is to public investors9 How will it protect investors9
13*e- n# 13e-3*-
13e-3*- #oe$ not req!%re $.ec%f%c .roof of &rech of f%#!c%ry #!ty.
S?< may pro!ibit acts, not t!emselves fraudulent under t!e common law or )0b", if t!e
pro!ibition is reasonably designed to prevent acts and practices t!at are fraudulent$
F. Tho/$ *#%$$ent-
%!omas# we are criminali;ing amorp!ous situation in )0b36 t!e range of possible situations
is limitless$ ?verybody buys info for t!e purpose of trading rig!t$
%!omas sides w.4a!oney w.r.t )5e3+# )5e3+ calls use of inside info fraud or deception 3
wrong
Slain# %!omas is rig!t about )0b36( Ninsburg ma&ority" is rig!t about )5e3+
<!iarella# is t!ere pro!ibition on using inside info if you are not getting it from t!e issuer, and
so don0t owe fiduciary duty to t!e issuer and its s.!s
<ongress added last sentence of )5e" to 8illiams act after it was enacted so it wanted to
deal wit! t!is issue
Slain concedes t!at language of )5e" is bad, but <ongress must !ave contemplated t!at S?<
would deal wit! t!is
Nrro'ne$$ of $!&9ect /tter !n#er 13e-3*-
tender offer
sources# issuer
bidder
somebody working on t!e deal t!e only people w!o generate info
In contr$t" 1D&-= %$ co/.letely o.en-en#e## Aif you misappropriate info and t!en trade it
you violated, but misappropriation is not defined
Slain# no good reason for criminali;ing t!ese transactions we take state fid duty w.r.t e0ees
and criminali;e it" doesn0t serve investors$
))6