INTRODUCTION

In General

General Rule
If a financial instrument is a security, then securities laws apply.

Where We Go From Here:

Definition of a Security (Ch. 2)
Securities Act Registration
o Registration/Restrictions on Offerings (Ch. 4)
o Exemptions (Ch. 5)
o Applications to Resales (Ch. 6)
o Additional Topics (Ch. 7)
o Securities Act Liability Issues (Ch. 9)
Materiality (Ch. 12)
Exchange Act Liability (Ch. 13, 14, 20)

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 DEFINITION OF A SECURITY
Statutory Definitions
Securities Act 2 Exchange Act 3
(a) Unless the context otherwise requires (a) Unless the context otherwise requires
(1) The term security means any note, stock, . . . bond, (10) The term security means any note, stock, . . . bond,
debenture, . . . investment contract, . . . or any interest or debenture, investment contract, . . . or any instrument
instrument commonly known as a security . . . commonly known as a security . . .
But shall NOT include currency or any note, . . . which has a
maturity date at the time of issuance not exceeding 9 months.

Investment Contracts
Investment Contract Defined
SEC v. W.J. Howey Co.
o An investment contract for purposes of the Securities Act 2(a)(1) means a contract, transaction, or
scheme whereby a person (1) invests money, (2) in a common enterprise, (3) with a expectation of profit,
(4) to come solely from the efforts of the promoter or a 3d party. All four prongs must be met.
Howey Applied

Howey requires an investment of money for an instrument to be an investment contract.

Investment v.
Therefore, if a purchaser is motivated by a desire to use or consume the item purchased, then the item is not an
Consumption investment contract. UHF v. Forman.

Horizontal Common Enterprise Vertical Common Enterprise

All courts agree this is sufficient to find a common Who is in common? Promoter & Investor
enterprise
Who is in common? Broad Vertical Commonality
o Investors Investor return dependent on promoter effort
What must be shown? o Efforts of Others Prong v. Common Enterprise
Common o Pooling of investors funds Efforts of Others =
Enterprise Pro Rata Distribution? Predominate effort of 3d party
o Profits must be shared Common Enterprise =
o Variable or fixed returns are acceptable. Some connection between promoter effort
Edwards and investor return

Strict Vertical Commonality

Promoters return tied to investor returns

Forman
Expectation The expectation of profits prong requires either (1) capital appreciation or (2) participation in profits
of Profit Edwards
No distinction between flat and variable rates of return

Howey Investment contract will exist only if profits are derived solely from the efforts of others.
Issue -- Promoters may circumvent securities laws by merely requiring investors to nominally participate.
Solution -- Subsequent cases have replaced solely with significant managerial or entrepreneurial efforts.
Efforts of
Others Pre-Investment Efforts
Open question as to whether pre-investment efforts count.
o Whether a promoters pre-investment efforts count toward the efforts of others depends on whether the
promoter commits to perform meaningful post-purchase functions. SEC v. Life Partners, Inc.

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Investment Contracts Case Law
SEC v. W.J. Howey Co. Investment Contract Defined
Investor buys a land sales contract (row of fruit trees and service contract).
Facts In return, investor receives a share in the profits after harvest.

Whether, under the circumstances, the land sales contract, warranty deed, and service contract together constitute an
Issue investment contract within the meaning of 2(a)(1) of the Securities Act.

Investment Contract
Rule (1) Investment of money, (2) in a common enterprise, (3) with an expectation of profits, (4) to come solely from
the efforts of others.

District Court:
Treated the warranty deed and service contract as separate transactions
o The first transaction was merely an ordinary real estate sale and the second transaction was an agreement by
the seller to manage the property for the buyer.
Therefore, not a security.
SCOTUS
The seller is offering something more than fee simple interest in land and something different than a farm
coupled with management services.
Analysis o Investment of Money
Yes - Opportunity to contribute money in exchange for land
o In a Common Enterprise
Yes - Although there is no common ownership in the purchased plot, profits are shared among all
investors who purchased a plot
o With an Expectation of Profits
Yes Purchaser is buying not for consumption of oranges, but rather for a return on their investment
o To Come Solely from the Efforts of Others
Yes The purchasers live far away and are not contributing any expertise.
Profits are derived solely from the service contract.

The Howey test determines whether an instrument is an investment contract and therefore a security as defined in
Takeaway 2(a)(1) of the Securities Act.

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 UHF v. Forman Investment vs. Consumption
Purchasers buy shares of stock to live and vote in an apartment cooperative (18 shares/room; $25/share)
Purchasers must still pay future rents.
Facts
Purchasers sue because future rent prices increased.
Allege the Co-op City Bulletin falsely represented that their future rents would not increase.

Issue Whether shares of stock entitling a purchaser to lease an apartment are securities

2(a)(1) Unless the context otherwise requires, the term security includes stocks . . . investment contracts . . .
Rule
Howey Test Defines Investment Contract

District Court
(1) Since the shares purchased were called stock and the Securities Act explicitly includes stock in its
definition of security, the Act applies to the transaction
(2) The transaction was an investment contract within the meaning of the Act as defined by Howey.
o Investment of Money
Purchaser gives money in exchange for a place to live
o In a Common Enterprise
Broad vertical commonality
o With an Expectation of Profits
Purchaser expects capital appreciation due to new commercial developments in surrounding area
Purchaser profits in the form of saving money because they do not have to live elsewhere
o To Come from the Efforts of Others
The expected profits depend entirely on the efforts of others
Analysis SCOTUS
(1) A transaction is not necessarily considered a security just because the instrument is labeled stock
o To be a security within 2(a)(1), an instrument labeled stock must bear the common characteristics of stock:
Rights to receive dividends Here, no dividend rights
Negotiable Here, non-negotiable
Voting Rights in proportion to the number of shares owned Here, voting rights are not proportional
Transferable, and Here, non-transferable
Capacity to appreciate in value Possibly satisfied (highly speculative)
(2) The transaction was not an investment contract as defined by Howey b/c there was no investment of money
o When a purchaser is motivated by a desire to use or consume the item purchased, securities laws dont apply
Here, purchasers were attracted solely by the prospect of acquiring a living space and not by a financial
return on their investment.
The potential for profits in the form of rent reduction from new commercial developments in the area is
too speculative.

Takeaway When a purchaser is motivated by a desire to use or consume the item purchased, securities laws do not apply.

SEC v. Edwards Profits from the Efforts of Others

Facts
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 Promoter is selling pay phones to investors and immediately leases them back under a management agreement
Promoters maintain the pay phones and buy them back at the end of the lease agreement.
Investors receive a fixed amount each month (rather than a % of the profit from the scheme)
o Thus, the promoters are not technically sharing profits with the investors; they are just paying a flat fee.
Promoters go bankrupt and stop paying the fixed amount. Investors sue.

Whether a moneymaking scheme is excluded from the term investment contract simply because the scheme offered a
Issue
fixed, rather than a variable return.

Rule Howey Test Defines Investment Contract

Argument #1:
Forman says that the expectation of profits prong requires either capital appreciation or a participation in the
earnings of the enterprise.
o Here, there is no capital appreciation because the underlying asset pays a fixed amount and the purchasers do
not participate in the earnings of the enterprise. Therefore, the expectation of profits prong is unsatisfied.
Counter-Argument #1:
Howey was referring to the profits the investor receives in the expectation of profits prong, not the profitability in
the investment scheme.
o There is no difference between a fixed or variable amount of profit paid to the investor.
Either way it is a return on their investment.
This is good policy because promoters shouldnt be able to skirt the law by giving a fixed amount
Analysis Forman did not intent capital appreciation or participation in the earnings to be an exhaustive list of
criteria that satisfies the expectations of profits prong.

Argument #2:
Howey requires profits to be derived solely from the efforts of others.
o Here, this prong is lacking because investors had a contractual entitlement on the return and therefore were not
relying on the efforts of others to derive a profit.
Counter-Argument #2:
Whether an investor has a contractual entitlement to payment is irrelevant in analyzing the efforts of others prong
o As a practical matter, the fixed amount being paid is dependent on the promoters efforts.
If the promoters fail to perform, they will default on the payments due to investors despite the contract.
o

Takeaway No distinction between variable and flat rate payments paid to investors.

Associational Formalities: Interests in Corporations, Partnerships, and LLCs as Securities

Stock as a Security
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 2(a)(1) Securities Act
o The term security means any note, stock . . .investment contract . . .
Howey & Forman
o Howey -- The Howey Test was designed to determine whether a particular instrument is an investment
contract, not whether it fits within any of the examples listed in the statutory definition of security
o Forman -- In Forman, the fact that instruments bear the label stock is not itself sufficient to be
considered a security within the 2(a)(1) definition.
Issue with Howey-Type Analysis:
o Howey-Type analysis might remove transactions in conventional stock from regulation
I.e., Seller is selling 100% stock in corporation to Buyer. This transaction would fail the efforts
of others and common enterprise prongs under the Howey Test and thus escapes regulation.
This gave rise in a number of circuits to the sale of business doctrine, which exempts
transactions of all or substantially all of the stock in closely held corporations.
Landreth Timber Co. v. Landreth Stock as a Security
Involved the sale of all the stock in a family owned lumber business
Facts
Dissatisfied with their investment, purchasers sought rescission of the sale

Issue Whether the stock is a security

2(a)(1) Defines security to include stock . . . investment contracts . . .

Forman Labeling an instrument stock is insufficient;
o The instrument must also have ordinary stock characteristics:
Right to receive dividends,
Negotiability,
Rule Ability to be pledged or hypothecated (i.e., collateral),
Voting rights in proportion to number of shares owned, and
Capacity to appreciate in value
Howey Test Defines Investment Contract
o Investment of money, in a common enterprise, w/ expectation of profit, predominantly from efforts of others

Fails Howey Test

No Common Enterprise
o No pooling of investors funds
No Efforts of Others
Analysis
o Buyer sought to earn profits by managing the business them self

Forman
This instrument bears all the ordinary characteristics of stock

This stock is a security.

Held
Instruments that bear both the name and all the usual characteristics of stock are clearly a security.

If an instrument is labeled stock and contains the ordinary characteristics of stock, then the Howey investment contract
Takeaway analysis does not apply.
Stock in a corporation is the paradigm of a security.

Partnership and LLC Interests as Securities

Issue:

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 o Whether interests in various unincorporated associations (i.e., Pships & LLCs) are securities because
such interests are not listed in the 2(a)(1) definition of security.
Investment Contract?
o 3 out of 4 prongs are easy to meet:
Investment of money Partners invest money.
Common Enterprise Pooling of money. Need at least 2 partners by definition.
Expectation of Profits Partners invest for profit, not consumptions
Core Issue = Efforts of Others Prong
o Requires factual inquiry into the degree of control investors have in the management of their investment
Williamson v. Tucker General Partnership Interest as a Security
Limited Partnership v. General Partnership
In General Facts & Circumstances Inquiry
o General Partners Typically participate in management and thus fail to satisfy the efforts of others prong
o Limited Partners Typically do not participate in management and thus satisfy the efforts of others prong
A general partnership or joint venture can be designated a security, if the investor can establish that:
1. An agreement among the parties leaves so little power in the hands of the partner that the agreement in fact
distributes power as would a limited partnership,
Rule 2. The partner is so inexperienced and unknowledgeable in business affairs that he is incapable of intelligently
exercising his partnership powers, OR
3. The partner is so dependent upon some unique entrepreneurial or managerial ability of the promoter or
manager that he cannot replace the manager of the enterprise or otherwise exercise meaningful partnership
powers.
1. An agreement eliminates the partners management power,
Elements 2. Partner is inexperienced or unknowledgeable, OR
3. Partner is dependent upon some unique entrepreneurial or managerial ability
United States v. Leonard LLC Interests as a Security
Defendants operated independent sales offices selling interests in member managed LLCs formed to finance movies
Facts Defendants mailed potential investors offering materials (i.e., operating agreement, subscription agreement, etc.)
Defendants received a commission for each interest sold. However, this was not disclosed to investors.
Issue Whether the LLC member interests are investment contracts; Whether the efforts of others prong is satisfied
Rule Howey Test Defines Investment Contract

Held Notwithstanding the organizational documents drafted to suggest active member participation, the defendants sought
and expected passive investors. Therefore, the interests that they marketed constituted securities.
Despite the fact that the LLC operating agreement provided for a member managed LLC, in actuality the investors play
a very passive role in the company.
The investors managerial rights did not vest until the LLCs were fully organized.
o Until then, the LLC was temporarily manager managed, so by the time the members rights vest all the
Analysis important decisions have already been made.
Passive Investors
Investors did not negotiation any terms of the LLC agreements,
Investors had no experience in film, and
Investors were particularly dependent on centralized management due to their geographical dispersion

Takeaway The court did not look to the legal entitlements investors were granted in the operating agreement, but the practical
aspects of whether investors with little knowledge, expertise, and ability actually participated in management.
The Policy Question: Should Investment Contract Status be Elective?
Issue:
o If corporate stock, LP interests, and manager-managed LLC interests are generally securities, then
promoters may control whether the Securities Act applies by choosing one form over another.
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 But, anti-waiver provisions . . .
Anti-Waiver Provisions:
o 14 Securities Act; 29(a) Exchange Act
Any condition or provision binding any person acquiring a security to waive compliance with any
provision of this Act or the rules and regulations of the Commission shall be void.
Why Have the Anti-Waiver Provisions?
o To protect those investors who are least able to protect themselves against schemes of clever promoters.

Notes as Securities
In General
33 Act and 34 Act differ slightly in their treatment of Notes:
o 33 Act 2(a)(1) includes in the statutory definition of a security any note,
But, 3(a)(3) then exempts from the registration requirements a note that arises out of a current
transaction or the proceeds of which have been or are to be used for current transactions and will
mature within 9 months.
17(c) makes it clear that this exemption doesnt extend to 33 Acts antifraud provisions
o In contrast, 34 Acts relevant inclusion & exclusion occur within the same definitional section
3(a)(10) describes a security as any note, but then proceeds to exclude notes with maturities
of less than 9 months.
Takeaway:
o In theory, the differing treatment means that short-term notes are exempt all together from the 34 Act, but
is still subject to the 33 Act other than those provisions dealing with registration.
If note maturity >9 months, then security.
However, most courts are unwilling to conclude that transactions such as home
mortgages, consumer installment purchases, and ordinary commercial financing involve
securities on grounds that the securities laws were not intended to cover these types of
transactions.
Notes as Securities Case Law
Reves v. Ernst Young
o A note is presumed to a security. The presumption may be rebutted if it is on the list of non-securities:
Note delivered in consumer financing,
Note secured by a mortgage on a home,
Short term (less than 9 months) note secured by a lien on a small business or some of its assets,
Note evidencing a character loan to a bank customer,
Short term notes secured by an assignment of A/R,
Note which formalizes an open-account debt incurred in ordinary course of business (bar tab), or
Notes evidencing loans by commercial banks for current operations.
o If an instrument is not on the list, then apply the Family Resemblance Test using the following factors
to determine whether the instrument bears sufficient resemblance to one of the enumerated non-securities:
Motivations of buyer and seller,
Plan of distribution,
Reasonable expectations of investors,
Risk reducing factors
Reves v. Ernst & Young Notes as Securities
Facts
In order to raise money to support its general business operations, an agricultural co-op sold promissory notes payable on
demand by the holder.
Although the notes were unsecured and uninsured, they paid a variable rate of interest that was adjusted monthly to
keep it higher than the rate paid by local financial institutions.
The co-op offered the notes to both members and non-members, marketing the scheme as an investment program
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 The co-op filed bankruptcy at a time when over 1,600 people held notes worth $10MM.

Issue Whether the demand notes issued by the co-op is a security within the meaning of the 34 Act
Rule See Page 8 Above
Seller Motivations of Seller:
Security, if the purpose is to: Co-op sold notes to raise capital for general
o Raise money for the general use of a business business operations. (Security)
enterprise, OR
o To finance substantial investments Motivations of Buyer:
No security, if: Bought notes in order to earn a profit in the
Motivations o Note is exchanged to facilitate the purchase
form of interest. (Security)
of Buyer & and sale of a minor asset or consumer good,
Seller o Correct cash flow difficulties, OR
o Advance some other commercial or
consumer purpose.
Buyer
Security, if:
o Interested primarily in the profits the note is
expected to generate.

Considers whether the instrument is one in which Offered & sold to a broad segment of the public?
Analysis there is common trading for speculation or Co-op offered these notes over an extended
Plan of
investment period to its 23,000 members and also to
Distribution
Security, if: non-members. (Security)
o Offered & sold to broad segment of public.

An instrument may be a security on the basis of Reasonable Expectations

Reasonable public expectations, even where an economic Notes were advertised as investments,
Expectations analysis of the circumstances of the particular and there is no countervailing factors that
of Investors transaction might suggest the instrument is not a would have led a reasonable person to
security. question this characterization. (Security)

Whether some factor such as the existence of another
regulatory scheme significantly reduces the risk of
Risk the instrument, thereby rendering the application of
Reducing the Act unnecessary.
Factors Other federal law (FDIC Insurance),
Other state law (adequate??),
Collateral (more collateral = less risk)
Risk Reducing Factors
Notes were uncollateralized and uninsured.
(Security)
The notes here would escape federal
regulation entirely if the Acts were held not
to apply. (Security)

Held The demand notes fall under the note category of instruments that are securities under 3(a)(10) and do not fall
within the exclusion for short-term notes despite being payable on demand.
The note falls within the short-term note exception b/c the notes are payable on demand and therefore could be paid
Dissent before the 9 months cutoff. In dictum, majority said result might be different if transaction suggested that both parties
contemplated that demand would be made within the statutory period.
Commercial Paper
What is Commercial Paper?
Unsecured notes with fixed maturity dates issued by large banks and corporations to raise money for short-term
debt obligations (i.e., payroll).
Commercial Paper Debate
Securities Act 3(a)(3)
Exempts any security that is a note, the proceeds of which are to be used for current transactions and
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 the maturity of which does not exceed 9 months from the registration requirement.

The term security means any note . . . but shall not include . . . any note which has a maturity at the
Exchange Act 3(a)(10) time of issuance not exceeding 9 months.
Thus, the instrument is not a security if it fits in this definition.

Whether both exemptions apply to commercial paper, or

The Debate If only the 3(a)(3) exemption applies to commercial paper because it includes the current
transaction language.

Both exemptions apply to commercial paper.

Therefore, 3(a)(3) has additional requirements (see below) in addition to the requirement for the
commercial paper having a maturity of less than 9 months.
SECs Position However, some SC justices questioned this position in Reves
Dissenting opinion wants to look just at the written language of the Acts
Concurring opinion agrees with SEC
Majority opinion ignores the issue because Reves was brought exclusively under the 34 Act

Current Transaction
The consideration paid for the note must be used to finance current operations, not long-term
investments.
Prime Quality Requirement
The notes must be graded prime quality by one of the organizations that rate commercial paper.

Manner of Offering
The general public must not ordinarily purchase the notes.
This requirement is enforced by:
o Requiring notes be issued only in large denominations (i.e., $100,000)
3(a)(3) Additional o Prohibiting general advertising and solicitations, and
o Requiring that any non-institutional investor be sophisticated
Requirements
9 Month Exception
Both Acts provide any note with a maturity of less than 9 months is not a security
Demand Notes
o Do not fall within the 9-month exception because they may be redeemed after 9 months.
Roll-Overs and Renewals
o While the 9 months exception in both Acts allow notes to be renewable, the SEC takes the
position that automatic renewal does not fall within the exemption. Thus, the note holder must
take some action to renew the note upon maturity.
Prime Quality Requirement and Renewal
The note must satisfy the prime quality requirement at renewal in order to
continue to be within the 9-month exception.

Separate Securities & Pass-Throughs

In General
Not all income-producing instruments are securities.
o I.e., Bank CD, note issued in a consumer transaction, etc.
However, the activities of an intermediary in packaging financial instruments may create a security out of
something that is not.
o I.e., Gary Plastic Packing Corp. v. Merrill Lynch

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Pass-Through Arrangements:
Promoter buys an instrument, adds value, and then resells the instrument to an investor.
Gary Plastic Packaging Corp. v. Merrill Lynch
Merrill Lynch offered its customers bank CDs.
The brokerage firm claimed to offer a number of services in this program, including:
o Screening banks to determine which offered the best yields,
Facts
o Negotiating with the banks,
o Monitoring the credit worthiness of the banks, and
o Maintaining a secondary market to promote the liquidity of these investments

Issue Whether the bank CDs are securities

Rule Howey Test Defines Investment Contract

Analysis Applying Howey, the court concluded Merrill Lynch was selling securities

The investors were not just buying CDs, but were buying the entire program that the investor was selling including their
Held
expertise in picking the CDs, monitoring the quality of the CDs, and marketing the investments

Takeaway Just because the CD, mortgage, etc., isnt a security, the packaged deal might be!

THE PUBLIC OFFERING

Underwriters & Underwriting

Underwriters
Investment banking firms
o Paid to help businesses raise money
Why use underwriters?
o Customer base,

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 o Expertise and knowledge of the market for securities offerings
o Reputational effects (Underwriters may be liable for fraudulent offerings)

Underwriting
In General
o If a corporation decides to raise money by offering securities, it may engage the services of broker-dealers
to sell the securities to the public in either firm commitment or best efforts underwritings
Methods of Underwriting
o Firm Commitment
One or more investment bankers agree to purchase the securities from the issuer for resale to the
public at a specified public offering price.
Underwriters buy from issuer, then resell
Used for the more established companies where there is already a known market
Signals to investors that the offering is a quality deal
o Best Efforts
Broker-dealers do not purchase the securities from the issuer. Instead, the broker-dealer agrees,
for a fee, to use their best efforts to sell the securities on behalf of the issuer at the offering price
Underwriter acts only as a salesperson
All risk is still on the issuer
The Spread
o Buyer ($100/share) Underwriters & Dealers ($5/share) Issuer ($95/share)
$100 $95 = $5 Spread

The Registration Statement

In General

Securities Act Applies if:

Registration Offering a security (Ch. 2)
Requirement No exemption is available (Ch. 5)

Securities Act
Registration Statement
Registration Filed with the SEC
Prospectus
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 Made available to investors

7(a): 7(a) says that the registration statement . . . shall

The registration statement, . . . shall contain the
information and be accompanied by the
documents specified in Schedule A . . . except
Registration that the SEC may by rules and regulations
Statement provide that any such information or document
need not be included . . . Any such registration
statement shall contain such other information,
and be accompanied by such other documents, as
the SEC may by rules and regulations require . . .
contain the info and be accompanied by the
documents specified in Schedule A.
But then goes on to sale the SEC may modify
Schedule A.
o Accordingly, the SEC has come up
with its own rules and forms and
therefore Schedule A is no longer
relevant.

Form S-1 Contents of Form S-1:

IPO/Unseasoned Issuers Registrant & Business
o Financial Statements, directors and
Form S-3
officers, property, risk factors, etc.
Reporting Companies/Seasoned Issuers Distribution & use of proceeds
F Series o Terms of the underwriting agreement,
Registration Foreign Issuers use of proceeds, why raising money
Attributes of securities sold
Forms
Specialized Forms o Shareholder rights (i.e., voting, etc.)
i.e., S-4 for mergers Exhibits/undertakings
o AoI, bylaws, legal opinions

Contents of Prospectus:
Includes information provided in Form S-1
less the exhibits/undertakings

Reg. S-X
Accounting and financial statements

Reg. S-K
Disclosure All other disclosure
Requirements Rule 408(a) Catch-all disclosure requirement
o In addition to the information expressly required to be included in a registration statement
(i.e., Reg. S-K), there shall be added such further material information, if any, as may be
necessary to make the required statements, in light of the circumstances, not misleading.

Preparation of the company,

Registration: Drafting the registration statement,
Legal Work Filing and revising the registration statement,
Compliance with offering restrictions
Registration Procedure / 8 Statutory Review System

Effective Date: Amendments:

Registration statement will become effective
automatically 20 days after it has been filed
Effective Date - 8(a)
with the SEC
If an amendment is filed, the registration
statement is deemed filed when such
amendment is filed.
o Thus, filing an amendment restarts
the 20-day clock.

Refusal Order - 8(b)

Refusal Order: Problems:
If it appears to the SEC that a registration SEC must discover the problem with the

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 statement is on its face incomplete or
inaccurate, then
o Within 10 days of filing the registration
statement, the SEC must give notice of
the refusal order and hold a hearing
within 10 days after such notice.
registration statement when an issue
appears on the face of the registration
statement without looking to any outside
source.
SEC must discover the problem and
provide notice within 10 days and then
hold a hearing 10 days later. Not a
practical timeframe.

Stop Order: Notes:

If it appears to the SEC at any time that the
registration statement includes any untrue
statement of a material fact or omits to state
Stop Order - 8(d)
a material fact, the SEC may, after
notice . . . issue a stop order suspending the
effectiveness of a registration statement . . .
No Timing Issues.
o SEC can use 8(d) at any time,
even after the effective date.
No Limitations.
o SEC can discover any untrue
statement of a material fact from
any source.

Stop Order Examinations:

SEC has the power to make an examination in any case to determine whether a 8(d) stop
Stop Order Exams - 8(e) order should be issued.
If the issuer or underwriter fails to cooperate in the examination, then such conduct is proper
grounds to issue a 8(d) stop order.

Problems with the 8 Statutory Review System

SECs Perspective:
The SEC lacks the resources necessary to complete a proper review within 20 days

Issuers Perspective:
Issuers do not want to risk a stop order proceeding
o Issuers would rather just know about potential problems so they can fix it and save face with potential
investors.
Issuers do not want to set their offering price 20 days in advance.
o Issuers recognize that the market is volatile and cannot risk price fluctuations over a 20-day period.

Registration Procedure in Actual Practice

In General:
The SEC and Issuers have worked out informal procedures to avoid the problems associated with the 8 statutory
review processes without violating the statutes.

Actual Practice:
1. File Registration Statement Issuer may file their registration statement without the offerings price information to avoid
(w/o Pricing Information) changes in market conditions between the time of filing and the effective date.

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 Notes:
Rule 473(a): Basically, when the registrant files they
The registrant hereby amends this attach a delaying amendment that says
registration statement on such date the registrant will be amending the
2. Delaying Amendments necessary to delay its effective date until registration statement on every 20th day
(Rule 473(a)) the registrant files a further amendment as necessary.
which specifically states the registration
statement shall become effective in
accordance with 8(a).

This is a back and forth process between the Registrant and SEC whereby ambiguities or
3. SEC Comment Letter(s) potential issues in the registration statement are discussed. Allows the SEC to avoid having to
issue stop orders and stop order examinations.

Amendment with Pricing Information: Rule 430A:

4. Final Registration Statement
Amendment with pricing
information, or
Use Rule 430A
Registrant files an amendment to
terminate the Rule 473(a) delaying
amendment, and
Files an amendment that includes the
offerings pricing information.
The registrant may omit pricing
information provided that the securities
are offered for cash and other certain
conditions are satisfied.

8(a):
The effective date of a registration
5. Acceleration ( 8(a)) statement shall be the 20 day after filing
or such earlier date as the SEC may
determine . . .
Notes:
After the SEC has completed their
review of the registration statement, the
Registrant may request the SEC to
accelerate the effective date.

Section 5
Section 5 Statute Notes
5(a)
(a) Unless a registration statement is in effect as to a security, Scope:
it shall be unlawful for any person, directly or indirectly Pre-Filing Period and Waiting Period
(1) To make use of any means or instruments of Prohibitions:
transportation or communication in interstate commerce of or (a)(1): Cant sell.
the mails to sell such security through the use or medium of o Sell = contract of sale ( 2(a)(3))
any prospectus or otherwise; or (a)(2): Cant deliver.

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 (2) To carry or cause to be carried through the mails or in
interstate commerce, by any means or instruments of
transportation, any such security for the purpose of sale or for
delivery after sale.

(b) It shall be unlawful for any person, directly or indirectly Scope:

Waiting Period and Post-Effective Period
(1) To make use of any means or instruments of
transportation or communication in interstate commerce or of Prohibitions:
the mails to carry or transmit any prospectus relating to any (b)(1): Cant transmit prospectus,
security with respect to which a registration statement has o Unless it meets the requirements of 10.
been filed, unless such prospectus meet the requirements of (b)(2): Cant deliver security,
10; or o Unless accompanied or preceded by a
prospectus that meets the requirements of
(2) To carry or cause to be carried through the mails or in
10(a).
5(b) interstate commerce any such security for the purpose of sale
or delivery after sale, unless accompanied or preceded by a 2(a)(10): Prospectus
prospectus that meets the requirements of 10(a). Any written, radio, or television communication
that offers a security for sale or confirms the sale
of any security.
o 2(a)(9): Written
Printed or graphic communication
Rule 405 defines graphic
communication to include electronic
communications.

It shall be unlawful for any person, directly or indirectly, to Scope:

make use of any means of communication in interstate Pre-Filing Period, and
commerce to offer to sell or offer to buy though the use of any o Stop orders, refusal orders, examinations
5(c)
prospectus or otherwise, unless a registration statement has
Prohibitions:
been filed, or while the registration statement is subject to a
Cant offer to sell or offer to buy
refusal order, stop order, or examination under 8.

Limitation. Notwithstanding any other provision of this Scope:

section, an emerging growth company or any person Pre-Filing, Waiting, & Post-Effective Periods
authorized to act on behalf of an emerging growth company Emerging Growth Company
may engage in oral or written communications with
Application:
potential investors that are qualified institutional buyers (Rule
5(d) Emerging growth company ( 2(a)(19)) may
144A) or institutions that are accredited investors (Rule
501(a)), to determine whether such investors might have solicit qualified institutional buyers or institutions
an interest in a contemplated securities offering, either that are accredited investors.
prior to or following the date of filing a registration statement,
subject to the requirements of 5(b)(2).

16
Pre-Filing Period Prohibitions

Statute Prohibitions Notes

5(a)(1): 2(a)(3):
Prohibits the sale of any security until the The term sale or sell shall include every contract of sale
registration statement becomes effective. or disposition of a security for value.
5(a)
5(a)(2):
Prohibits the delivery of any security until the
registration statement becomes effective.

17
 5(c):
Prohibits any offer to sell or offer to buy The term offer to sell, offer for sale, or offer shall
until the registration statement has been filed, or
o While the registration statement is subject to
a 8 refusal order, stop order, or
examination.
5(c)
2(a)(3):
include every attempt or offer to dispose of, or solicitation of
an offer to buy a security.
Arrangement With and Among Underwriters:
2(a)(3) excludes from the definition of sale, offer to
sell, and offer to buy:
o Negotiations and agreements the issuer has with its
underwriter, and
o Negotiations and agreements among underwriters.
2(a)(11) defines underwriter and excludes from the term:
o Anyone whose interest is limited to a commission
from the underwriter not in excess of the usual and
customary distributors or sellers commission.
Thus, dealers (those who just get commission for
sales) are not underwriters included in the
2(a)(3) exclusion.
Issuer can put together the underwriter
group, but cannot go down to the dealer
level because that is to close to selling.

Conditioning the Market:

The SEC broadly construes the term offer to include any
publicity that attempts to arouse public interest in the
offering.
o Safe Harbors:
Rule 135: Bare bones notice about offerings,
Rule 163A: 30 day rule,
Rule 169: Factual information

Pre-Filing Period Safe Harbors

Safe
Rule Notes
Harbor
Rule 163A:
30 Days 163A(a): In General:
Except as excluded in (b), any communication made by 30 days prior to filing a registration statement
or on behalf of an issuer more than 30 days before the o Any communication made
filing of a registration statement that does not reference o By or on behalf of an issuer
a securities offering that is or will be the subject of a o Shall not violate 5(c)
registration statement shall not constitute an offer to sell Provided that
for purposes of 5(c), provided that the issuer takes o The communication does not reference the
18
 reasonable steps within its control to prevent further
distribution or publication of such communication
during the 30 days immediately preceding the date of
filing the registration statement.
163A(b):
The exemption in (a) shall not apply to the following
communications:
offering, and
o The issuer takes reasonable steps within its
control to prevent further distribution or
publication of such communication during
the 30 days immediately before filing.
Issuers Only!
Rule 163A(c)
o By or on behalf of the issuer means any
agent or representative of the issuer, other
than a participant who is an underwriter or
dealer.

135(a): In General:
An issuer or person acting on their behalf may publish a A notice of a proposed registered offering shall
notice of a proposed offering without being deemed an not constitute an offer, if:
offer, if: o Legend, and
o Strictly limited to the information in 135(a)
135(a)(1): Legend (2).
The notice includes a statement to the effect that it does Cant describe issuers business, or
not constitute an offer to sell, and Identify underwriters
135(a)(2): Permissible Info
Rule 135: The notice is strictly limited to the following info:
Issuers Only!
Bare Bones Dealer and underwriters cannot use Rule 135.
(i) Name of the issuer,
Notice o An issuer and person acting on behalf of an
(ii) Title, amount, and basic terms of the security,
issuer
(iii) Amount of the offering,
Excludes underwriters and dealers
(iv) Anticipated timing of the offering,
because their only motive is to sell
(v) Brief statement of manner & purpose of offering
securities.
w/o naming the underwriters,
(vi) Whether the issuer is directing the offering to a
particular class of purchasers,
(vii) Any statements or legends required by any state
or foreign law, and
(viii) (Info for special offering types)

Rule 169:
Factual See Next Page
Information

Safe
Rule Notes
Harbor
Rule 163A:
See Previous Page See Previous Page
30 Days

Rule 135:
Bare Bones See Previous Page See Previous Page
Notice
Rule 169:
Factual Rule 169(a): In General In General:
19
 For purposes of 2(a)(10) and 5(c), the regular Not an offer, if:
release or dissemination by or on behalf of an issuer of o Factual Business Information,
communications containing factual business o Satisfies the 169(d) conditions, and
information shall not be deemed an offer, if the o Does not mention the offering
conditions of this rule are met:
Factual Business Information
Rule 169(d): Conditions Cannot be forward-looking!
(1) The issuer has previously released or disseminated Rule 168(b)(2)
information of this type before, o Defines forward-looking information
(2) The timing, manner, and form in which the Projections, future plans, etc.
information is disseminated is consistent with
similar past releases, Issuers Only!
(3) The information is directed towards customers and 169(b)(2)
Information suppliers (not investors or potential investors) o Underwriters and dealers cannot act by or
on behalf of an issuer
Rule 169(c): Exclusions
If the communication containing information about the
registered offering, then such communication is
excluded from Rule 169.

169(b): Defines Factual Business Information

(1)(i) Factual information about the issuer, its business
or financial developments (past developments),
or other aspects or its business, and
(1)(ii) Advertisements of, or other information about,
the issuers products or services.

Waiting Period Prohibitions

Statute Prohibitions Notes
5(a)(1), (2): 2(a)(3):
5(a) Cant sell or deliver until registration The term sale or sell shall include every contract of sale or
statement is effective. disposition of a security for value.

5(c) 5(c)s broad prohibitions against offers to sell and offers to buy disappear when the registration statement is filed.
However, 5(b)(1) restricts such selling efforts.
5(b)
5(b)(1): Prospectus

20
 It is unlawful . . . to make use of any
means of communication in interstate
commerce to transmit any prospectus
relating to any security with respect to
which a registration statement has been
filed, unless such prospectus meets the
requirements of 10.
Is the communication a prospectus?
2(a)(10) defines prospectus
o 2(a)(3) defines offer
Not an offer
Rule 135
Rule 169
Rule 168 Reporting Cos.
Rule 134 Not a prospectus
If yes, does it meet the requirements of 10?
Rule 430,
Rule 431,
Rule 164/433
If yes, then not a violation of 5(b).
2(a)(10): The term prospectus means any written, radio, or
television communication, which offers any security for sale or
confirms the sale of any security
o 2(a)(3): Broadly defines offer for sale to include
conditioning the market.
o 2(a)(9): Written includes graphic communication
Rule 405: defines graphic communication to include
electronic communications
Oral Communication = Not a Prospectus
Rule 134 Communication Not Deemed a Prospectus
134(a) Communications may include . . .
o i.e., Not prospectuses
134(b) Conditions
o If registration statement is not yet effective, then every
communication shall contain the legend in (b)(1), and
o The name and address of a person(s) from whom a written
prospectus for the offering meeting the requirements of 10
may be obtained.
134(c) If one of these are satisfied, then 134(b) does not apply:
o If the communication does no more than:
State from whom, and include the URL, where a written
prospectus meeting 10 requirements may be obtained,
ID the security,
State the price, and
State by whom orders will be executed, OR
o Is accompanied or preceded by a prospectus or summary
prospectus (other than a free writing prospectus), which meets
the 10 requirements, at the date of such preliminary
communication.
134(d) Solicitations
o A communication may solicit an offer to buy, if:
The conditions in (b) or (c) are satisfied,
It contains the legend required in (d), and
Is accompanied or preceded by prospectus meeting 10

10 Information Required in Prospectus

(a): Info required in final prospectus (when reg. stmt. effective)
(b): Other communications approved by SEC
o Rule 430: Preliminary Prospectus,
o Rule 431: Summary Prospectus,
o Rule 164/433: Free Writing Prospectus
Waiting Period Safe Harbors
Safe Harbor Rule Notes
Rules 135, 169
Pre-Filing If a communication falls into one of these safe harbors, then it is not an offer to sell and therefore does not violate
Period Safe 5(c).
Harbors These safe harbors also apply for purposes of 5(b)(1) because if a communication does not constitute an offer to
sell, then it is not a prospectus as defined in 2(a)(10) and therefore does not violate 5(b)(1)

Rule 430:
Rule 430(a): If, during the waiting period:
Preliminary A prospectus shall be deemed to meet the requirements A person transmits a prospectus ( 2(a)(10)), and
Prospectus of 10 for the purpose of 5(b)(1) so long as it Such prospectus contains the info in Rule 430(a),
21
 contains: Then, such person does not violate 5(b)(1).
o Substantially the same information required in
a 10(a) final prospectus, except for:
Offering price,
Underwriter/dealer commissions,
Amount of proceeds, or
Any other matter dealing with price

Rule 431:
Rule 431:
A summary prospectus filed with the SEC shall be deemed to meet the requirements of 10 purposes of 5(b)(1).
Summary
o The registrant must have been a reporting company for 36 months prior to filing the registration statement
Prospectus Rarely used.

Rule 164: Free Writing Prospectus Rule 164:

Rule Must satisfy the conditions of Rule 433 If, during the waiting period, a person transmits a
164/433: prospectus ( 2(a)(10) that satisfies the
Free Writing Rule 433: Free Writing Prospectus Conditions conditions of Rule 433, then such prospectus will
Prospectus See Next Page for Conditions . . . meet the requirements of 10(b) and therefore not
violate 5(b)(1).

Rule 433 Conditions to Permissible Post-Filing Free Writing Prospectus

433(a): A free writing prospectus that satisfies the conditions of this rule will be a prospectus permitted under 10(b) for
Scope purposes of 2(a)(10), 5(b)(1)-(2).
433(b):
433(b)(1): Seasoned Issuers & WKSI 433(b)(2): Non-Reporting & Unseasoned Issuers
Accompanied No requirement for free writing prospectus to be (i) If free writing prospectus is prepared by or on
or Preceded by preceded or accompanied with a 10 prospectus behalf of an issuer or any other offering participant
Prospectus (or if paid by an offering participant), then free
(Separates Issuer writing prospectus must be accompanied or
Type) preceded by a preliminary prospectus.
o Note 1: If the communication is electronic,
then can satisfy the accompanied or
preceded by a preliminary prospectus
22
 requirement w/ hyperlink.

(ii) Everybody else

o Dont have to accompany or precede with a
preliminary prospectus.
433(c): 433(c)(1): Content 433(c)(2): Legend Requirement
Content & Content cannot conflict with information contained Free writing prospectus shall contain substantially
Legend in registration statement or prospectuses. the same legend in (c)(2)(i).

433(d)(1)(i): Issuer shall file . . . 433(d)(1)(2): Offering Participant shall file . . .

(A) Any issuer free writing prospectus
433(d): (B) Any issuer info that is contained in a free
Filing writing prospectus prepared by or on behalf of or
Conditions used by any other offering participant, and
(C) A description of the final terms of the issuers
securities (i.e., pricing info)
When a free writing prospectus is used in a
manner reasonably designed to lead to its broad
unrestricted dissemination.
o i.e., Underwriter sends free writing
prospectus to all its customers.

433(d)(8)(i):
A written (including graphic) communication that is a road show need not be filed, EXCEPT . . .
433(d)(8): o Note: if broadcast is live in real time, then not a graphic communication, and thus not a prospectus.
Road Show 433(d)(8)(ii):
Exception for If the issuer is a Non-Reporting company and offering common equity or convertible equity securities, then
(d) Filing must file. BUT
If at least one version of a bona fide electronic road show is made publicly available w/o restriction by means
Requirement
of a graphic communication, then do not have to file.
o If Reporting Company, then never have to file
o If Non-Reporting Company, then must file unless made publicly available without restriction.
433(g):
Issuers and offering participants shall retain all free writing prospectuses that they have used, but have not filed,
Record for a period of 3 years.
Retention
433(e)(1): Anything the Issuer hyperlinks to is considered a communication by the issuer.
433(e):
433(e)(2): Historical issuer info that is identified as such and located in a separate section of the issuers website
Hyperlinks
will not be deemed a current offer of the issuers securities and thus not a free writing prospectus
If issuer or offering participant gives info to the media 433(f)(1): If the following conditions are met, then
and it is published, then it is deemed a free writing need not comply with the (b)(2), (c), or (d)
433(f):
prospectus by whomever provided the information. requirements:
Media Reports (f)(1)(i): No payment, and (f)(1)(ii) issuer files the
stories, or (f)(2)(iii) issuer files a transcript.

Obligations in the Post-Effective Period

5(a): No longer applies and therefore issuer and other participants can now sell.
Introduction 5(b): Still applies
However, SEC rules have modified its statutory requirements and to whom it applies.

Delivery of
Exchange Act Rule 10b-10(a): Rule 172(a): Easier Way To Send Confirmations
Confirmation Requires brokers and dealers to send confirmations to If the conditions in 172(c) are met, then
their customers. confirmations are exempt from 5(b)(1).
o Confirmation is deemed to be a 2(a)(10) o 172(c) Conditions:
Prospectus. Reg. Stmt. is effective,
Not subject to 8 stop order, and
5(b)(1): Makes it unlawful to transmit a prospectus (i.e. Final prospectus has been filed.

23
 confirmation), unless it satisfies 10.
SEC has not approved confirmations under 10(b); Under Rule 172, a dealer can send their customer
so sending them appears to violate 5(b)(1), even confirmations whether or not a copy of the final
though they are required. prospectus is sent.
The statutory way out of this contradiction is through But, see Rule 173.
a 2(a)(10)(a) Free-Writing Exception to the
definition of prospectus, which says no
communication is a prospectus once you send the
person a final prospectus.
o Therefore, once the customer has received a
final prospectus, youre free to send them the
confirmation required by Rule 10b-10.

5(b)(2): Rule 172(b):

Delivery of Unlawful to deliver a security unless it is Says the prospectus delivery obligation in 5(b)(2)
Security accompanied or preceded by a 10(a) final is met as long as the conditions in 172(c) are met.
Itself prospectus. o Thus, seller can deliver the security without
worrying about prospectus delivery.

In General:
As a result of Rule 172, a seller usually doesnt have to deliver a final prospectus.
o However, when the SEC added Rule 172, it also added Rule 173
Rule 173 delivery obligation applies to 3 categories of people:
o Issuer of the security,
o Underwriter in the offering, and
Rule 173 o Anyone else who isnt exempted by 4(a)(3) or Rule 174.

Rule 173(a):
Requires some sellers to deliver their purchasers one of the following within 2 days of a sale:
o A copy of the final prospectus, or
o A notice that the sale was made pursuant to a registration statement
173(d): Purchaser may still request a copy of the final prospectus.

Obligations in the Post-Effective Period Contd . . .

Other
Rule 172:
Communications Only applies to the delivery of confirmations
with the Customer Does not affect 5(b)(1), which still makes it unlawful to carry or transmit any prospectus unless such
prospectus meets the requirements of 10.

Oral Communications:
The 2(a)(10) definition of prospectus does not include oral communications, so oral
communications are unrestricted by 5(b)(1).

Other Communications:
To what extent can a prospectus be sent during the post-effective period?
o 2(a)(10)(a) Free Writing Exception
24
 Says no communication is a prospectus if it is accompanied or preceded by a final
prospectus.
Therefore, once a final prospectus is sent to the customer, no other communication will
be a prospectus so theres no problem under 5(b)(1).
o Rule 433 Free Writing Prospectus
(b)(2)(i): Non-Reporting Companies & Unseasoned Issuers
After the effective date, the final prospectus must precede or accompany any free
writing prospectus.
o Thus, the 2(a)(10)(a) free writing exception allows free communication after
sending the final prospectus w/o all the other requirements in Rule 433.
If (b)(2)(i) does not apply:
Rule 433(b)(1) allows communications during the effective period without delivering a
copy of the final prospectus, but subject to the other conditions of Rule 433.

People who are NOT Issuers, Underwriters, or Dealers

4(a)(1): Exempts any person other than an issuer, underwriter, or dealer from 5

Issuers, Underwriters, and Dealers

Two Exemptions:
o Unsolicited Brokers Transactions
4(a)(4) exempts unsolicited orders
o Other Transactions by Dealers
4(a)(3) exempts all transactions by dealers, EXCEPT:
Participants with an Unsold Allotment
Who is Subject to
o i.e., underwriters or dealers who hasnt yet sold their allotment
these Requirements? Time Period for Compliance
o Dealers are excused from 5, 40 days (If IPO, 90 days) after either the
effective date or the date securities were first offered to the public, whichever is
later.
o In some cases, Rule 174(f) shortens that time period, but again not for
participants with an unsold allotment.
174(b) If issuer is a reporting company, all prospectus delivery
requirements are eliminated
174(d) if issuer is non-reporting company, time period is shortened to
25 days when the security is listed on a national exchange.

Public Offers by Seasoned and Well-Known Seasoned Issuers (WKSI)

Categories of Issuers

25
 Well-Known Seasoned Issuers (Rule 405)
Meets all the Registrant Requirements to use Form S-3, AND
WKSI
o Public Equity Float of $700 Million, OR
o Issued $1 Billion of specified securities in last 3 years

Seasoned Issuer
Eligible to use Form S-3 (pg. 240-241 code book)
o Registrant Requirement
34 Act Reporting Company for at least 12 months
Seasoned Issuer
o Transaction Requirement
Must be cash offering,
Company has at least $75 Million equity outstanding,
Aggregate market value of securities sold now or in last 12 mos. < 1/3 total float

Unseasoned Issuer
Unseasoned Issuer Reporting Company, but not eligible to use Form S-3
o Fails to satisfy the Form S-3 Transaction Requirement

Non-Reporting Issuer
Non-Reporting Issuer Not a 34 Act Reporting Company for at least 12 months
o Fails to satisfy the Form S-3 Registrant Requirement

Ineligible Issuer (Rule 405)

Bad Actor (i.e., failed to file reports, violated securities laws, filed BK, etc.)
Ineligible Issuer
o Most integrated disclosure forms do not extend to Ineligible Issuers
o Note: Any of the above categories could become an Ineligible Issuer
Form S-3

Requirements to
Any registrant which meets the requirements of Registrant Requirement
Use Form S-3
I.A. (Registrant Requirements) may use this US Company, AND
26
 Form for the registration of securities under the 34 Act Reporting Company for at least 12
33 Act which are offered in any transaction months (and reporting on time).
specified in I.B. (Transaction Requirement)
Transaction Requirement
Cash offering,
Note:
Company has at least $75 Million equity
Must satisfy both the
outstanding, OR
o Registrant Requirement, and
Aggregate market value of securities sold
o Transaction Requirement
now or in last 12 months is not more than 1/3
of total float.

Form S-1 Registration Statement: Form S-3 Registration Statement:

Registrant & Business info. 34 Act Filings by Reference
Required Distribution & Use of Proceeds info. o Update Material Changes
Contents in Attributes of Securities Sold Distribution & Use of Proceeds info.
Form S-3 Exhibits & Undertakings Attributes of Securities Sold
Exhibits & Undertakings
o Some by Reference

IPOs: Issuers who are already public: WKSI:

Selective Full Review Selective Review Automatic Effectiveness
Review of o See pg. 14-15 o Some = Full Review,
Registration o Some = Partial Review,
Statements o Some = Superficial
Review

Gun Jumping Concerns for the Seasoned Issuer

In General
Public companies have stockholders who have ongoing needs for current information about the issuer.
o Releasing such information may constitute an offer and therefore violate 5(c).

27
 SEC has adopted a series of safe harbors to better balance the regulatory objectives of 5 with
the ongoing information needs of investors.
Issuer Safe Harbors
Well-Known Seasoned Issuers (WKSI)
o Rule 163
Exemption from 5(c) for certain communications by or on behalf of WKSI.
Reporting Issuers (i.e., Seasoned & Unseasoned Issuers)
o Rule 168
Exemption from 2(a)(10) and 5(c) for certain communications of regularly released factual
business information and forward-looking information.
Free Writing Prospectus
o Rule 433

Rule 163 WKSI Exemption from 5(c)

Rule 163 provides WKSIs an exemption from 5(c) and therefore allows unrestricted oral and written offers during
In General
the pre-filing period, provided that the Rules conditions are satisfied.

WKSIs Rule 163 applies only to communications by or on behalf of the issuer.

Only! Thus, it does not shield communications by other distribution participants (brokers, dealers, & underwriters)

Rule 163(b)(1):
The communication must contain substantially the same legend set forth in 163(b)(1)(i).
Legend
Requiremen Rule 163(b)(1)(iii):
t Excuses immaterial or unintentional failure to include the legend so long as a good faith and reasonable effort
was made to comply.

Rule 163(b)(2):
A written version of the communication made during the pre-filing period must be filed promptly with the SEC
when the registration statement is ultimately filed.
Filing o If the issuer has filed a registration statement (waiting-period), then the offer is treated as a free writing
Requiremen prospectus and must be filed with the SEC.
t
Rule 163(b)(2)(iii):
Excuses immaterial or unintentional failure to file a communication with the SEC so long as a good faith and
reasonable effort was made to comply.

Rule 168 Exemption from 2(a)(10) and 5(c) for Communications of Regularly Released Factual Business
Information and Forward-Looking Information

28
 Rule 168(a):
When Does Rule 168
Applies to a registration statement that the issuer proposes to file, has filed, or is effective.
Apply?
o Therefore, Rule 168 applies during the Pre-Filing, Waiting, and Post-Effective Periods.

Rule 168(a):
By or on behalf of an issuer
Who Can Use Rule o Excludes offering participant who is an underwriter or dealer. 168(b)(3).
168?
Reporting Rule 168(a)(1):
Companies! As a condition to use Rule 168, an issuer is required to file reports pursuant to section 13 or
15 of the 34 Act.
o Therefore, the issuer must be a Reporting Company.

Rule 168(a):
Announcements by Reporting Issuers that have engaged in the regular release of factual
General Rule
business information or forward-looking information will not be treated as offers to sell a
security for purposes of 2(a)(10) and 5(c).

Rule 168(d):
The following conditions must be satisfied:
o (1) Information must be of the type the issuer has previously released in the ordinary
Conditions
course of its business, and
o (2) The timing, manner, and form in which the information is released must be
consistent in material respects with similar past releases.

Rule 168(c):
Exclusions
A communication that contains information about the offering is excluded from Rule 168.

Rule 168(b)(1):
Factual Business Information
o (i) Factual info about the issuer, its business or financial developments, or other aspects
of its business,
o (ii) Advertisements of, or other info about, the issuers products or services, and
o (iii) Dividend notices.
Definitions
Rule 168(b)(2):
Forward-Looking Information
o (i) Projections of the issuers revenue, income, expenditures, or other financial aspects,
o (ii) Statements about the issuers management plans and future objectives,
o (iii) Statements about the issuers future economic performance

Rule 164/433 Free Writing Prospectus Prospectuses Deemed to Satisfy 10(b)

Scope
WKSI Seasoned Issuers + Distribution Participants
29
 Rule 163 Free Writing Prospectus Rule 433 Free Writing Prospectus
o Applies to WKSI during Pre-Filing Period o Applies to Seasoned Issuers + Distribution
Participants during Waiting (pg. 23) and Post-
WKSI + Distribution Participants Effective Period (pg. 25).
Rule 433 Free Writing Prospectus
o Applies to WKSI + Distribution Participants
during Waiting (pg. 23) and Post-Effective
Period (pg. 25)

Waiting Period: Post-Effective Period:

Permits a free writing prospectus to be used after
registration statement has been filed, and
Conditions Such free writing prospectus is not conditioned on
it being preceded or accompanied with a
prospectus.
o Pg. 23
2(a)(10) permits free writing prospectus so long
as the material is accompanied or preceded by a
10(a) Final Prospectus.
o Pg. 25

Rule 433(d)(8) and (f)

Same guidelines apply to seasoned and unseasoned issuers with respect to road shows and issues that arise
Note
when the issuers representatives speak to the press.
o Pg. 23

Research Reports
In General
Scope:

30
 Brokers, Dealers, Underwriters, and Investment Professionals
o Not Issuers
Purpose:
Investment professionals, such as those that publish research reports and investment newsletters, and broker-
dealers who regularly circulate investment recommendations among their clientele, may violate 5.
o Rules 137, 138, and 139 were created to protect individuals who create and distribute information about
companies as part of their ongoing business.
Tension:
Distributing Information v. Conditioning the Market

Rule 137 Non-Participating Brokers or Dealers

Rule 137 allows non-participating brokers and dealers to publish or distribute, in the regular course of their business,
In General
information, opinions, and recommendations regarding securities of an issuer in registration.

Reporting Any issuer

Status of the Not limited to just Reporting Companies
Issuer
137(a): Non-Participant
The broker-dealer that published or distributed the report:
o Must not have participated,
o Is not participating, and
o Will not be participating

137(b): No Compensation
The broker-dealer that published or distributed the report can not directly or indirectly receive compensation, or
Conditions o Acting under any direct or indirect arrangement or understanding with:
(1) The issuer of the securities,
(2) A selling security holder,
(3) Any participant in the distribution, or
(4) Any other person interested in the security

137(c): Regular Course of Business

The report is published in the ordinary course of business

Rule 138 Participating Brokers or Dealers (Limited Rule)

Rule 138 allows participating broker-dealers to publish research reports on debt or debt convertible securities
In General during offerings of equity or equity convertible securities, and vice versa.
Basically, the research report must mention something different than the actual offering.

Reporting Status 138(a)(2):

of the Issuer Reporting Issuer that is current on all 34 Act filings.

Conditions Available to Participating or Non-Participating Brokers or Dealers

Rule 139(a)(1) Issuer Specific Reports

In General
Rule 139(a)(1) allows brokers or dealers, whether or not participating in the issuers distribution, to publish or
distribute opinions and recommendations focused solely on the issuer, provided that the conditions of the rule are
satisfied.
31
 Rule 139(a)(1)(i)(A)(1): Issuer eligible to use Form S-3 or F-3, AND
Reporting Status Registrant Requirement 34 Act Reporting Company for at least 12 months, and
of the Issuer Transaction Requirement See pg. 27

Rule 139(a)(1)(i)(A)(2): Filed all periodic Reports for last 12 months

Rule 139(a)(1)(iii):
The broker or dealer must publish or distribute the report the regular course of business. AND
o The report must not be the
Initiation, or
Requirements Re-initiation after discontinuance of a report about the issuer
Note:
Worried that if you havent reported on this company before or it has been a long time and all of the sudden
you start reporting on it again, then it looks less like a report and more like conditioning the market

Rule 139(a)(2) Industry Reports

Rule 139(a)(2) allows brokers or dealers, whether or not participating in the issuers distribution, to publish or
In General distribute industry reports so long as the issuer is given no greater prominence than other issuers and the other
conditions of the rule are satisfied.

Reporting Status Rule 139(a)(2)(i): Reporting Companies

of the Issuer Issuer is a 34 Act Reporting Company current on its filing

Rule 139(a)(2)(iii): Report Contains Multiple Issuers

Report must contain similar info with respect to a substantial number of other issuers in the issuers
industry, OR contain a comprehensive list of securities current recommended by that broker/dealer

Rule 139(a)(2)(iv): No Greater Prominence Given to the Issuer

Requirements Analysis of the issuer must not be given any greater prominence in the publication than other issuers

Rule 139(a)(2)(v): Regular Course of Business

The broker/dealers must distribute these reports in the regular course of their business, AND
o At the time of the publication or distribution of the report, the broker/dealer is including similar info
about the issuer or its securities in similar reports.

Shelf Registration
In General
Non-Shelf
File Registration Statement
Registration Waiting Period,
32
 Review Process,
Registration Statement becomes Effective
Sell Securities Immediately!

File Registration Statement Rule 415

Waiting Period, (a)(1): Offerings eligible to use this rule
Review Process, o Except exclusions in (b)
Shelf Registration Registration Statement becomes Effective (a)(2)-(6): Conditions
Securities Placed On the Shelf o Not all conditions apply to all offerings
Securities sold on an immediate, continuous, or
delayed basis.

Instruction I.D., Form S-3

Says WKSI may use Form S-3 for Rule 415 offerings

Automatic Shelf Rule 462(e)

Registration for If a WKSI uses Form S-3 for a Rule 415 offering, then the offering is effective upon filing
WKSI
Rule 415(a)(5)
Effective for 3 years
o Rule 415(a)(6): May re-file

Issuer doesnt know when the sale will occur

i.e., stock options; employees have the right to purchase whenever they want

Market Timing
Reasons to use
Issuer may want to delay the sale in order to obtain a better price
Shelf Registration
Raise Capital Quickly
Issuer may need to raise capital quickly and therefore wants to avoid the registration process
o i.e., Issuer may see an opportunity to acquire another company and must act quickly

Rule 415 Shelf Registration

415(a)(1): Offerings Eligible to use Rule 415
Other than the
Registrant (a)(1)(i):

33
 Securities which are to be offered or sold solely by or on behalf of a person other than the
registrant

Employee (a)(1)(ii):
Benefit Plan Securities which are to be offered and sold pursuant to a dividend or interest reinvestment
plan or an employee benefit plan of the registrant

Issued upon the (a)(1)(iii):

exercise of rights Securities which are to be issued upon the exercise of outstanding options, warrants, or rights

Issued upon (a)(1)(iv):

conversion of Securities which are to be issued upon conversion of other outstanding securities
other securities o Example:
Issue bonds that are convertible into common stock

Pledged as (a)(1)(v):
Collateral Securities pledged as collateral

Form F-6 (a)(1)(vi):

Securities which are registered on Form F-6

(a)(1)(vii):
Mortgage Related
Mortgage related securities, including such securities as mortgage backed debt and mortgage
Securities
participation or pass through certificates
Business
(a)(1)(viii):
Combination
Securities which are to be issued in connection with business combination transactions
Transactions
(a)(1)(ix):
Commenced Securities, the offering of which will be commenced promptly, will be made on a continuous
Promptly basis, and may continue for a period in excess of 30 days from the date of initial
effectiveness

(a)(1)(x):
Securities registered (or qualified to be registered) on Form S-3 or Form F-3, which are to be
Form S-3
offered and sold on an immediate, continuous, or delayed basis by or on behalf of the
registrant

415(a)(2) (6): Conditions

Conditio Application Rule

34
 n
(a)(1)(viii) and (ix)
(a)(2)
(a)(3) Everyone must comply w/ (a)(3)
If Registration Stmt pertains to:
At the Market Offering,
Of an equity security,
By or on behalf of the
Registrant,
(a)(4) Then must be (a)(1)(x) offering
Note:
by or on behalf of language
make it so (a)(1)(i) need not
comply w/ the (a)(4) condition
Automatic Shelf Registration
WKSI (462(e))
(a)(1)(vii), (ix), or (x)
(a)(5)
Within 3 years of registering
securities described in (a)(5)
(a)(6)
Automatic Shelf Registration,
(a)(1)(vii), (ix), or (x)
2(a)(3): Special Rule for Convertible Stock
General Rule:
If the issuer is offering a security that grants the purchaser an option to immediately convert it into another type of
security, then the issuer is actually offering two types of securities.
o Therefore, both securities must fit under Rule 415(a)(1) to be eligible for shelf registration.
See Problem 4-34
Information Omitted from Prospectus
In General
An issuer making an offering under Rule 415 is not going to be selling their securities
If it applies, may only register an amount of securities, which, at the time the
registration statement becomes effective, is reasonably expected to be offered
or sold within 2 years from the initial effective date
Requires the Registrant to update changes in their filings
If Registration Statement pertains to:
At the Market Offering,
Of an equity security,
By or on behalf of the Registrant,
Then must be (a)(1)(x) offering
Note: At the Market Offering
Offering of equity securities into an existing trading market for
outstanding shares of the same class at other than a fixed price.
o NYSE, NASDAQ, etc.
If it applies, then the offering must be sold within 3 years of effective date.
But, if Registrant files a new registration statement pursuant to (a)(6), then
o If new reg. stmt. is automatic shelf reg., then immediately effective,
OR
o If new reg. stmt. is not automatic
(A) Securities covered by the prior registration statement may
still be offered and sold until the earlier of
The effective date of the new registration statement, or
180 days after the 3 years has expired for the old reg. stmt.
(B) A continuous offering of securities covered by the prior
registration statement that commenced within 3 years of the
initial effective date may continue until the new registration
statement becomes effective, if the offering is permitted under the
new registration statement.
Issuer may file a new registration statement.
If it is an automatic shelf registration statement, then effective upon filing
35
 until a later date and therefore may not have all the information that they would
normally have in a traditional offering.

Rule 430(a): Prior to the registration statements effective date, the issuer may omit price-related
Preliminary Prospectus information in its preliminary prospectus.
Rule 430A(a):
In the post-effective period, the issuer may omit price-related information
Final Prospectus

Rule 430B(a): Automatic Shelf Registration

If automatic shelf registration (WKSI only), then minimal info is required:
o Omit plan of distribution, and
o Omit description of securities (except name or class),
We are selling common stock, preferred stock, or bonds

Rule 430B:
Rule 430B(a): (a)(1)(vii) or (x)
Prospectus in Shelf Registration
If offering fits within Rule 415(a)(1)(vii) or (x), then prospectus may omit
information required by the form that is not reasonably known

Rule 430B(b): Form S-3 AND (a)(1)(i)

If the issuer is eligible to use Form S-3 and the offering fits within Rule 415(a)(1)
(i), then the prospectus may omit certain other stuff

International Public Offering Issues

International Issues
Foreign Issuers Sale Securities U.S. Markets
36
 Covered by the Securities Act
o Different Forms (F-1 and F-3)
Looser accounting and disclosure requirements
SEC allows compliance with international accounting standards

U.S. Issuers Sale Securities Foreign Markets

Must comply with other countries laws
o Securities Act concern = U.S. Investors
Offers in U.S. to U.S. Investors
Resale in U.S. to U.S. Investors
Regulation S
o Restrictions designed to ensure securities sold outside the U.S. dont circumvent
U.S. securities law by being immediately re-sold back into the U.S.
Registration under Blue Sky
Blue Sky Laws: State Regulation
Federal Regulation
Registration Requirement
o Exemptions

State Regulation
Registration by Coordination
o Exemptions, or Registration by Qualification

Federal Philosophy v. State Philosophy

Federal = Disclosure based regulation
State = Merit based regulation
o Interested in full disclosure and whether the offering is substantively a good offering
Nebraska: Unfair, unjust, inequitable, or oppressive

Section 18 of the Securities Act

Section 18(a)
Preempts any state registration, qualifications, or merit review requirements for Covered Securities

Section 18(b)
Covered Securities
o (1)(A): Securities on NYSE, American Stock Exchange, or NASDAQ
o (1)(B): Allows SEC to add other exchanges to this list
o (1)(C): Rule 506 exemption

Remaining State Authority

Securities that arent Covered Securities
Covered Securities:
o (c)(1): Fraud/wrongful conduct,
o (c)(2)(A): Notice filings,
o (c)(2)(B): Fees in some cases
EXEMPTIONS FROM THE REGISTRATION REQUIREMENT

Introduction

37
Two Classes of Exemptions

Transaction Exemption Exempt Securities

Provides an exemption from the registration provisions of 5 No registration requirement
Still subject to 33 and 34 Act May be re-sold without registration
Cannot be re-sold unless registered or another exemption is Still generally subject to anti-fraud provisions
available

Exemptions from Registration, Not Anti-Fraud Provisions

Section 4(a):
Exempt Transactions
The provisions of section 5 shall not apply to . . .

Section 3(a):
Exempt Securities Except as hereinafter expressly provided, the provisions of this Act shall not apply
to any of the following classes of securities: . . .

Section 12(a)(2):
Any person who offers or sells a security (whether or not exempted by the
provisions of section 3, other than paragraphs (2) and (14) of subsection (a)), . . .
Section 17(c):
Anti-Fraud Provisions The exemptions provided in section 3 of this Act shall not apply to the provisions
of this section.

Section 11:
Doesnt apply to exempt securities because 11 talks about fraud in registration

Policy behind the Registration Requirement and its Exemptions

Registration Requirement:
Benefits > Costs
Benefits Costs
38
 Informed Investors Preparation of disclosure documents
Less fraud Legal/Accounting costs
More efficient allocation of capital Delay
Competitive costs
SEC enforcement costs

Transaction Exemptions:
Benefits < Costs
1. Small Offerings
If want to raise $100K, then max amount of benefit from registration is
$100K, but cost of registration is significantly higher.
2. Sophisticated Offerees
Idea that sophisticated people can protect themselves even in the absence of
registration and disclosures, so the benefits of registration shrink but the
costs stay the same.
3. Deference to Another Regulator
If, for example, an issuer is re-organizing in bankruptcy, the bankruptcy
court will be overseeing any exchange of securities and evaluating the
fairness of it. Thus, benefits of registration in these situations are small but
the cost is high.

Transaction Exemptions, In General

Intrastate Offerings
o 3(a)(11), Rule 147
Private Offerings
o 4(a)(2), Rule 506
Regulation D
o Rules 504, 505, 506
Crowdfunding
o 4(a)(6), Rules 100-300
Employee Benefit Plans
o Rule 701
Regulation A
o Rules 251-263

Exempt Securities

Section 3, In General

Exempt Transactions v. Exempt Securities

Unlike exempt transactions, exempt securities are permanently exempt from the
registration requirements of 5.
Issuers = No Registration Requirement
39
 Security Owners = No exemption needed to re-sell

A few reasons for 3 securities being exempt:

Character of the issuer (i.e., U.S. Government)
Why Exempt?
Regulatory regime protects investors (i.e., Securities issued by FDIC Bank)
Instrument are not securities (i.e., securities for non-profit issuers)

Exempt securities are not entirely exempt from 33 and 34 Act

Anti-fraud provisions may still apply
Anti-Fraud Provisions still apply o 17 33 Act
o 10(b) 34 Act
o 12(a)(2) 33 Act

Some 3 exemptions apply to the transaction, not the security.

3 Applies to Some Transactions Thus, exemption does not apply to re-sale
o i.e., 3(a)(11) Intrastate Offerings

3(a)(2):
Governmental securities (i.e., municipal securities), Bank Securities

3(a)(3):
Short term notes

3(a)(4):
Exempt Securities Non-profit issuers

3(a)(5):
Securities issued by Savings and Loans, Cooperative Banks, and similar
institutions
3(a)(8):
Insurance Policies and Annuities

Intrastate Offering Exemption: 3(a)(11); Rule 147

3(a)(11) Intrastate Offering

Any security which is part of an issue offered and sold only to persons resident within a single State,
3(a)(11) where the issuer of such security is a person resident and doing business within, or, if a corporation,
incorporated by and doing business within such State.

Part of an Issue
The entire issue of securities must be:
40
 Offered, Sold, and Come to Rest exclusively intrastate.
o So, issuer cant split the offering up.
i.e., Issuer cant use 3(a)(11) for half of the offering and another exemption for other half.

Issuer must only offer and sell to residents of the same state as the Issuer.
Cant Offer or Sell to
Mere presence in the State is not sufficient to constitute residence
Non-Residents o Look to where they live, not where they work.

Issuer = Issuer must be a resident in the same state in which the securities are being offered and sold.
Resident in the Same If Issuer is a Corporation, then must be incorporated by that same state.
State

SEC Position
Issuer = Substantial operational activities in the state of incorporation
Doing Business in the o Must be more than just bookkeeping and similar administrative tasks
Same State Some Courts
Say must be Predominate amount of business in that State

Resales:
Any offers or sales to a non-resident in connection with the distribution would destroy the exemption
o However, securities that have come to rest in the hands of resident investors may, in due
course, resell to non-residents.
The purpose for the come to rest concept is to prevent people from circumventing the
registration requirement by allowing an exempt intrastate offering to be re-sold the very
Come to Rest / next day to an out of State purchaser.
Resales Come to Rest
If an intrastate offering exempt security is re-sold out of State before it has come to rest, then the
entire offering will fail the exemption.
o Look for Investment Intent
Look at amount of time held
Generally, a 1-year holding period will establish investment intent.
However, the holding period may be longer or shorter depending on circumstances

Residency
Uncertainty in whether a purchaser is a resident in the same State as the Issuer
Come to Rest
The Investment Intent test for determining whether a security has come to rest creates uncertainty
3(a)(11) Doing Business
Uncertainties Difficult to determine whether the Issuer is doing business in the State.
o SEC Position = Substantial operational activities
o Some Courts = Predominate amount of business
Rule 147
Safe Harbor designed to address the uncertainties.

Rule 147 Safe Harbor

Rule 147(a):
If an Issuer complies with Rule 147, then their offering is certainly exempt under 3(a)(11).
In General o Preliminary Note 1:
If, however, the Issuer fails to comply with Rule 147, the Issuer may still rely on 3(a)(11)
but risks the associated uncertainties.

Part of an Issue
Rule 147(b)(1):

41
 For purposes of this rule, all securities, which are part of the same issue, must comply w/ this rule.
o i.e., The entire issue must be exclusively intrastate.

Rule 147(b)(2):
Securities offered pursuant to the exemptions provided by section 3 (i.e., Rule 504/505) or section
4(a)(2) (i.e., Rule 506) or pursuant to a registration statement
o That take place 6 months immediately before or immediately after a Rule 147 offering are NOT
deemed to be part of the same issue.
Provided that, during either 6 month period there are no offers or sales of securities by or
for the Issuer of the same or similar class as those offered pursuant to Rule 147.

Rule 147(c)(1): Issuer shall be deemed to be a resident of the State in which:

Residence of the (i) If corporation, the State where it is incorporated
Issuer (ii) If other form of business, where its principal place of business is located
(iii) If an individual, where his principal place of business is located

Rule 147(c)(2): Issuer shall be deemed to be doing business within a State, if:
(i) Issuer derived 80% of its gross revenues
o (B) From the operation of a business or real property located in or from the rendering of
Doing Business
services within such State.
Requirement (ii) Issuer has at least 80% of its assets located within such State
(iii) Issuer intends to use at least 80% of the net proceeds from the offering within the State, AND
(iv) Issuers principal office is located within such State.

Rule 147(d): Offers and sales shall be made only to residents within the same State as the Issuer
Residence of the (d)(1): Corporation or other form of business organization = Principal office within State
Offerees (d)(2): Individual = Principal residence within State
(d)(3): If organized for specific purpose of acquiring security look to all beneficial owners

Rule 147(e):
All re-sales shall be intrastate during the initial offering AND for a period of 9 months after the last
Limitation of Resales
sale (not 9 months from time purchaser originally buys).
o Basically, SEC says securities have come to rest 9 months after final sale.

Rule 147(f):
Issuer must take the these precautions to ensure re-sale doesnt occur before securities come to rest
Issuer Must Take o (1)(i) Place a legend stating that the securities are not registered and set forth the re-sale
Certain Precautions restrictions contained in 147(e).
o (1)(ii) Issuer must notify its transfer agent not to transfer the securities, AND
o (1)(iii) Obtain a written representation from each purchaser as to his residence.

Private Offering Exemption: 4(a)(2); Rule 506

In General
4(a)(2): The provisions of section 5 shall not apply to . . .
Transactions by an issuer not involving any public offering
o Thus, 4(a)(2) exempts Private Offerings

Notes:
Only talking about transactions by the Issuer
o So 4(a)(2) does not exempt secondary/resale transactions
Issue: What is not involving any public offering?
42
 o Offerees, not just purchasers
o Burden of proof on the Issuer

SEC v. Ralston Purina

Private Offerings
o Offerings to individuals who can fend for themselves
Sophisticated Investors, and
What is a Access to Information
Private Offering? 4(a)(2) Private Offering?
Uncertainty in terms of level of sophistication and access to information
o Factors:
Access to information, Disclosure, Relationship to Issuer, Sophistication, Number of
Offerees, Resales; Come to Rest?

4(a)(2) = Transactional in Nature

The private offering cannot be used as a pretense for a public offering by making a private placement
Resale of Securities to a small group of individuals who then proceed to sell the securities to the public.
Acquired in a Issuers often take 3 steps to protect themselves:
Private Offering 1. Require purchasers to sign statements of investment intent
2. Include legend that securities are unregistered and transfers are restricted until certain conditions are met
3. Instruct transfer agents not to process any transfers of restricted securities

Rule 506:
Rule 506
Represents a non-exclusive safe harbor for the private offering exemption of 4(a)(2)

SEC v. Ralston Purina What is a Public Offering?

Unregistered offering of stock to key employees. Key employees included all employees, not just executives.
Facts
Ralston Purina argued that the offering was not a public offering because it was limited only to employees.

Issue Whether Ralston Purinas offering to its key employees are within the 4(a)(2) private offering exemption

To be a public offering, an offer need not be open to the whole world.

An offering is a public offering when the particular class of persons affected need the protections of the 33 Act
Analysis
o Thus, an offering to those able to fend for themselves is a transaction not involving any public offering
Here, the employees were not shown to have access to information that registration would disclose

The focus of the inquiry should be on the need of the offerees for the protections afforded by registration.
Held Sophistication, and
Access to Information

Regulation D
Rule 504 -- 3(b)(2) Exemption from the provisions of the 5 registration requirement
In General Rule 504 Conditions Definitions
$1 Million
Rule 504(b)(2): Aggregate Offering Price shall not exceed Rule 501(c):
Maximum $1 Million, LESS: Aggregate Offering Price
Aggregate o The aggregate offering price for all securities sold within 12 months
Offering before the start of and during
Price The offering of securities under this rule,
In reliance on any 3(b) exemption, or
43
 In violation of 5(a)

Eligible Rule 504(a):

Issuers Non-Reporting Companies

No Limitations
Eligible No sophistication requirement
Investors No number of purchaser requirement

Rule 502(b)(1):
Issuer to Issuer is not required to
Provide No Disclosure Requirements furnish information to
Information? purchasers when it sells
securities under Rule 504

Rule 504(b)(1): Rule 502(c):

Prohibition No restrictions on the manner of offering Limitations on manner of
o Provided that the offering is limited to: offering
on General States that provide for registration and a disclosure document, or
Solicitation? States that permit general solicitation and advertising but limit
sales to accredited investors.

Rule 503:
Requires Form D filing with SEC within 15 days of the first sale
o Rule 507:
Form D
Makes Reg. D unavailable to Issuers that previously have been enjoined for failure to comply w/ the
Filing? Rule 503 filing requirement
However, may possibly still be able to use 4(a)(2)

Rule 502(a):
Offers and sales made
Integration o 6 months before the start of a Reg. D offering, and
o 6 months after the completion of a Reg. D offering
Will not be considered part of that Reg. D offering

Limitation on Rule 502(d): Rule 502(d):

Resales? Except as provided in Rule 504(b)(1), resales are restricted Limitations on Resales

Rule 505 -- 3(b)(2) Exemption from the provisions of the 5 registration requirement
In General Rule 505 Conditions Definitions
Rule 505(b)(2)(i): Aggregate Offering Price shall not exceed Rule 501(c):
$5 Million $5 Million, LESS: Aggregate Offering Price
o The aggregate offering price for all securities sold within 12 months
Maximum
before and during
Aggregate The offering of securities under this rule,
Offering Price In reliance on any 3(b) exemption, or
In violation of 5(a)

Eligible Issuer
Rule 505(a):

44
 Reporting Company or Non-Reporting Company

Rule 505(b)(2)(ii): Rule 501(a):

Eligible 35 Purchasers Accredited Investors
o Accredited Investors dont count!
Investors Rule 501(e):
o Issuer reasonably believes there are no more than 35 purchasers
How to Count

Rule 502(b)(1): Rule 501(a):

Issuer to Affirmative disclosure obligations to any Non-Accredited purchaser Accredited Investors
Provide
Rule 502(b)(2):
Information?
Info to be furnished

Prohibition on Rule 502(c): General Solicitations

General No General Solicitations See infra.
Solicitation? o If pre-existing relationship, then not a general solicitation

Rule 503:
Requires Form D filing with SEC within 15 days of the first sale
o Rule 507:
Form D Filing? Makes Reg. D unavailable to Issuers that previously have been enjoined for failure to comply w/ the
Rule 503 filing requirement
However, may possibly still be able to use 4(a)(2)

Rule 502(a):
Offers and sales made
Integration o 6 months before the start of a Reg. D offering, and
o 6 months after the completion of a Reg. D offering
Will not be considered part of that Reg. D offering

Rule 503(d):
Limitation on Resales Restricted
Resales? o Securities purchased under Reg. D shall have the status of securities acquired in a transaction under
4(a)(2) and therefore cannot be resold without registration or an exemption.

Bad Actor Rule 505(b)(2)(iii):

Disqualificatio The Rule 505 exemption is unavailable for any issuer that has violated any federal security law described in
n Rule 262 of Reg. A. (pg. 130)

Rule 506 If the conditions in (b) or (c) are satisfied, then offers and sales by an issuer shall be deemed to be
transactions not involving any public offering within the meaning of 4(a)(2)
Rule 506(b) Rule 506(b) Conditions Definitions
No Maximum
Rule 501(c):
Aggregate No Maximum Aggregate Offering Price
Aggregate Offering Price
Offering Price

Eligible Issuers Any Issuer

Eligible
Rule 506(b)(2)(i): Rule 501(a):
Investors 35 Purchasers Accredited Investors
o Non-accredited purchasers dont count (Rule 501(e)(1)(iv)
Rule 501(e):
45
 Rule 506(b)(2)(ii): How to Count
Sophistication Requirement for Non-Accredited Purchasers
o Non-Accredited Purchasers or their Purchaser Representative Rule 501(i):
must have sufficient knowledge and experience to be capable of Purchaser Representative
evaluating the merits and risks of the prospective investment, OR
Issuer reasonably believes purchaser is Sophisticated.

Rule 502(b)(1): Rule 501(a):

Issuer to Provide Affirmative disclosure obligations to any Non-Accredited purchaser Accredited Investors
Information? Rule 502(b)(2):
Info to be furnished

Prohibition on Rule 502(c): General Solicitations

General No General Solicitations See infra.
o If pre-existing relationship, then not a general solicitation
Solicitation?

Rule 503:
Requires Form D filing with SEC within 15 days of the first sale
o Rule 507:
Form D Filing? Makes Reg. D unavailable to Issuers that previously have been enjoined for failure to comply w/
the Rule 503 filing requirement
However, may possibly still be able to use 4(a)(2)

Rule 502(a):
Offers and sales made
Integration o 6 months before the start of a Reg. D offering, and
o 6 months after the completion of a Reg. D offering
Will not be considered part of that Reg. D offering

Rule 503(d):
Limitation of Resales Restricted
Resales? o Securities purchased under Reg. D shall have the status of securities acquired in a transaction under
4(a)(2) and therefore cannot be resold without registration or an exemption.

Rule 506(d): Bad Actor Disqualification

Bad Actor
506(e): Protects Issuer from losing the exemption if it could not have reasonably known of the
Disqualification
disqualification

Rule 506(c) Rule 506(c) Conditions Definitions

No Maximum
Rule 501(c):
Aggregate No Maximum Aggregate Offering Price
Aggregate Offering Price
Offering Price

Eligible Issuers Any Issuer

Eligible
Rule 506(c)(2)(i): Rule 501(a):
Investors Accredited Investors Only! Accredited Investors
o Rule 506(c)(2)(ii): Verification
Issuer shall take reasonable steps to verify that all
purchasers are accredited
Reasonable, If:
(A) Basis of Income = Review tax statements

46
 (B) Basis of Net Worth = bank stmts., credit report, OR
(C) Obtain written confirmation

Issuer to Provide No Affirmative Disclosure Requirements

Information?
Prohibition on No limitations on the manner of offering.
General
Solicitation?

Rule 503:
Requires Form D filing with SEC within 15 days of the first sale
o Rule 507:
Form D Filing? Makes Reg. D unavailable to Issuers that previously have been enjoined for failure to comply w/
the Rule 503 filing requirement
However, may possibly still be able to use 4(a)(2)

Rule 502(a):
Offers and sales made
Integration o 6 months before the start of a Reg. D offering, and
o 6 months after the completion of a Reg. D offering
Will not be considered part of that Reg. D offering

Rule 503(d):
Limitation of Resales Restricted
Resales? o Securities purchased under Reg. D shall have the status of securities acquired in a transaction under
4(a)(2) and therefore cannot be resold without registration or an exemption.

Rule 506(d): Bad Actor Disqualification

Bad Actor
506(e): Protects Issuer from losing the exemption if it could not have reasonably known of the
Disqualification
disqualification

General Solicitations -- Limitations on the Manner and Scope of a Reg. D Offering

Rule 504
Restrictions on General Solicitations apply except as provided in Rule 504(b)(1)
Rule 505
No General Solicitations
Reg. D Rule 506(b)
No General Solicitations
Rule 506(c)
General Solicitations allowed,
o Provided that Issuer takes reasonable steps to verify all investors are accredited

Rule 502(c)
Rule 502(c):
Except as provided in Rule 504(b)(1) or 506(c),
o Neither the Issuer nor any person acting on its behalf shall offer or sell securities by any form of
47
 General Solicitation or General Advertising, including, but not limited to, the following:

Easy Cases:
Mass mailings, cold calls, marketing of interests through seminars

Tough Cases:
Targeted Communications
o In the Matter of Kenman Corp.,
What is a General Materials sent from these sources were found to be a General Solicitation
Solicitation? List of persons who participated in prior offerings by them,
List of executive officers from annual reports,
List of names who previously invested $10k+ in real estate offerings,
List of doctors in California
o Black Diamond Fund
Invitations to seminar addressed anonymously to Dear Valued Client

If Pre-existing Relationship exists between the Issuer (or person acting on its behalf) and the Offeree,
What is Not a
then the communication is NOT a General Solicitation.
General
The pre-existing relationship requirement is a way to ensure that issuers will have an opportunity to
Solicitation? evaluate whether the offeree is an accredited investor (i.e., sophistication and financial condition)

Brokers provide assistance to Issuers without the necessary relationship in reaching prospective investors
Issuers in Reg. D offerings often solicit the marketing assistance of Broker-Dealers
o Pre-Existing Relationship between Broker & Offeree OK under 502(c)

Activities by Broker- Broker-Dealers and Rule 502(c):

Dealers Not a General Solicitation to potential clients, if:
o The initial solicitation is generic in nature and would not identify specific investments the
firm was offering or would be offering, AND
o The firm implements procedures to ensure no persons solicited would be offered securities the
firm was offering or contemplating offering at the time of the solicitation

Not a General Solicitation, if:

The Internet and The questionnaire is generic in nature and does not reference specific offerings,
General Solicitations The password protected page cannot be accessed before the investor is pre-qualified, AND
Investors can only participate in offerings posted subsequent to the investors qualification

Determining the Aggregate Offering Price in Offerings under Rules 504 and 505

Rules 504(b)(2); 505(b)(2)(i):

The aggregate offering price for an offering of securities under this rule, as defined in Rule 501(c), shall not
exceed {$1 Million (Rule 504) or $5 Million (Rule 505)}, LESS:
o The aggregate offering price for all securities sold
Within 12 months before the start of and during the offering of securities under this rule
In reliance on any exemption under 3(b) or in violation of 5(a).
In General
Preliminary Note 3 to Reg. D:
Attempted compliance with any rule in Reg. D does not act as an exclusive election; the Issuer can also
claim the availability of any other applicable exemption.
o Issuer can go back and say that a prior offering was e.g. not a 504, but rather a 505, etc.

Note: Possible integration issues

Aggregate
Rule 501(c): Defines Aggregate Offering Price
48
Offering Price The sum of all cash, services, property, notes, cancellation of debt, and other consideration the issuer
Defined receives for the securities

If Offering is for Mixed Cash and Non-Cash Consideration:

Rule 501(c): The aggregate offering price is determined on the basis of the price at which the securities
are offered for cash
o Example:
If 1,000 securities are being offered for $100/share and 1,000 are being offered for non-cash
consideration (i.e., real estate), then the non-cash consideration also equals $100/share.
Issuer does not need to place an independent value on the real estate.
If, however, Issuer is offering 1 security for $100/share and 1,000 securities for non-cash
consideration, then the Issuer may be denied the exemption.
Preliminary Note 6 to Reg. D:
How to Value o Reg. D is not available to those whose, although are in technical compliance with
Non-Cash the rules, are trying to evade the registration provisions.
Consideration
If Offering is for Non-Cash Consideration:

Issuer needs to come up with a valuation for the non-cash consideration:

o Rule 501(c):
Aggregate offering price shall be based on:
The consideration received from a bona fide sale, OR
In the absence of a bona fide sale, the fair value as determined by an accepted standard
o I.e., Appraisal, County Assessor, etc.
Valuation must be reasonable at the time made.
Thus, if valuation turns out to be wrong, Issuer will not lose exemption so long as the
appraisal was reasonable.

The maximum aggregate offering price is lowered by the amount of any other securities sold within specified
time periods in reliance upon any 3(b) exemptions.
Relevant Two relevant time periods for either Rule 504 or 505:
Amount and 1. 12 month period preceding a Rule 504 or 505 offering, and
2. The period of time during a Rule 504 or 505 offering.
Time Period
Needed to prevent an Issuer with no offerings during a preceding 12-month period from commencing a Rule 504
and Rule 505 offering simultaneously with a second offering purportedly exempt under 3(b).

Disclosure Obligations in Offerings under Rules 505 and 506(b)

Rule 502(b)(1):
If the issuer sells securities under Rule 505 or 506(b) to any non-accredited purchaser, then the Issuer
shall furnish the information specified in Rule 502(b)(2) to such purchaser a reasonable time prior to
In General
sale.
o The Issuer is NOT required to furnish the specified information to purchasers when it sells securities
under Rule 504, or to any accredited investor.

If Non-Reporting
Rule 502(b)(2)(i):
Company
(A) Non-Financial Statement Information
o If Issuer is eligible to use Reg. A, then need to disclose the same info as required under Reg. A
o If NOT eligible to use Reg. A, then need to info required in Part I of a Registration Statement

(B) Financial Statement Information

o (1) Offerings up to $2 Million --
Audited balance sheet dated within 120 days of the start of the offering
o (2) Offerings between $2 - $7.5 Million --

49
 Generally need to provide the financial statement information required in Form S-1
o (3) Offerings over $7.5 Million
Generally need to provide the financial statement as would be required in a registration
statement filed under the Act of the form that the Issuer would be entitled to use (S-1 or S-3)

Rule 502(b)(2)(ii):
If Reporting Company, then must, at a reasonable time prior to sale furnish the information set forth in
If Reporting (b)(2)(ii)(A) OR (b)(2)(ii)(B) AND (b)(2)(ii)(C).
Company o (A) Annual Report and Proxy Statement, or
o (B) Form 10-K, and
o (C) Updates to the above information and a brief description of the securities being offered

Rule 502(b)(2)(iv):
If purchasers are non-accredited:
To Non-Accredited
o Brief description of any material written information furnished to accredited investors, and
Investors Purpose: We assume that accredited investors will ask for the necessary info
o Full disclosure of any information prior to sale, upon written request.

Rule 502(b)(2)(v):
Issuer shall provide all purchasers:
To All Purchasers o An opportunity to ask questions regarding the terms and conditions of the offering, and
o An opportunity to obtain additional information that the Issuer possess or can acquire without
unreasonable effort or expense that is necessary to verify the accuracy of info furnished to them.

Accredited Investors Rule 501(a)

Application: Advantages of Selling to Accredited Investors:

Rule 504 -- Investor status is irrelevant No disclosure documents 502(b)(1)
In General Rule 505 -- Accredited Investors dont count No sophistication requirement 506(b)(2)(ii)
Rule 506(b) -- Accredited Inv. dont count Dont count toward the 35 purchaser
Rule 506(c) -- Accredited Investors only limitations in 505 and 506(b) - 501(e)(1)(iv)

Rule 501(a):
501(a):
The term accredited investor shall mean, at the time of sale:
Accredited Investors
o Any person who comes within any of the categories listed in (a)(1) (8), OR
Defined o Who the Issuer reasonably believes comes within (a)(1) (8).

Rule 501(a)(1):
(a)(1):
Any bank, registered broker-dealer, insurance company, venture capital firm, some employee
Large Institutions
benefit plans, etc

(a)(4):
Rule 501(a)(4):
Director, Executive
50
 Any Director, Executive Officer, or General Partner of the Issuer

o Rule 501(f): Defines Executive Officer

President,
Officer, or General
Any VP in charge of a principal business unit, division or function (i.e., sales,
Partner of the Issuer
administration, finance, etc.), OR
Any other officer who performs a policy making function, or any other person who
performs a similar policy making function for the issuer.

Rule 501(a)(5):
Any person whose individual net worth, or joint net worth with that persons spouse, exceeds $1
Million
Rule 501(a)(5)(i) -- Calculating Net Worth
(a)(5): (A) The persons primary residence shall not count as an asset.
(B) Indebtedness secured by the persons primary residence up to the estimated FMV of the
Individuals Net Worth
persons primary residence shall not count as a liability, UNLESS
Exceeds $1 Million o Such indebtedness was incurred within 60 days of purchasing the security.

Reasonable Belief Standard

If investor is not in fact accredited, the Issuer must reasonably believe they are.
o Establishing such belief requires some due diligence by the Issuer.
Blind reliance on a written piece of paper is not sufficient.

Rule 501(a)(6):
(a)(6):
If an Individual has income exceeding $200,000 in each of the previous 2 years and a reasonable
Individuals Income
expectation of reaching the same income in the current year, then such individual is an accredited
Exceeds $200,000 or
investor.
$300,000 o If married, joint income must exceed $300,000.

Rule 501(a)(8):
(a)(8): Any entity is which all of the equity owners are accredited investors is an accredited investor
Any Entity Owned by
Accredited Investors

Sophistication Requirement in Rule 506(b)(2)(ii) and Purchaser Representatives

Rule 506(b)(2)(ii):
Each Non-Accredited Investor either alone or with his Purchaser Representative, either:
Rule 506(b)(2)(ii): o Has such knowledge and experience in financial and business matters that he is capable
Sophistication Requirement of evaluating the merits and risks of the prospective investment, OR
o The Issuer reasonably believes immediately prior to sale that such that such purchaser
comes within this description.

Rule 501(i):
Rule 501(i): Purchaser Representative
Purchaser Representative Any person who satisfies ALL of the following conditions, OR
o The Issuer reasonably believes satisfies all of the following conditions.

Conditions . . .
501(i)(1):
Any person who is NOT an affiliate, director, officer, or other employee of the Issuer, or
beneficial owner of 10% or more of any class of the equity securities or 10% or more of the
equity interest in the Issuer, EXCEPT where the purchaser is:
o (i) A relative of the purchaser representative by blood, marriage, or adoption and
51
 not more remote than a first cousin;
o (ii) A trust or estate in which the purchaser representative and any persons related to
him collectively have more than 50% beneficial interest or of which the purchaser
representative serves as trustee; OR
o (iii) A corporation or other organization of which the purchaser representative and any
persons related to him collectively are the beneficial owners of more than 50% of
the equity securities or equity interests.
501(i)(2):
Has such knowledge and experience in financial and business matters that he is capable of
evaluating, alone, or together with other purchaser representatives of the purchaser, or
together with the purchaser, the merits and risks of the prospective investment; AND
501(i)(3):
Is acknowledged by the purchaser in writing, during the course of the transaction, to be his
purchaser representative, AND
501(i)(4):
Discloses to the purchaser in writing a reasonable time before the sale any material
relationship between himself and the issuer, that is mutually understood to be contemplated,
or that has existed at any time during the previous 2 years, and any compensation received or
to be received as a result of such relationship.

Policy for 501(i)(1) Requirement:

SEC concerned that the purchaser representative would be acting in the Issuers best interest
rather than the purchasers if the purchaser representative is related to the Issuer
Policy o Policy for 501(i)(1)(i)-(iii) Exceptions:
If the purchaser representative was one of these relationships with the purchaser,
then the SEC is less worried that the purchaser representative will be acting in the
Issuers best interest rather than the purchasers best interest.

Rule 501(e) Limitations on the Number of Purchasers in Rules 505 and 506(b)

Rules 505(b)(2)(ii) and 506(b)(2)(1):

35 Purchaser Limit, or
Application o Issuer reasonably believes there are no more than 35 purchasers.
This might come up when Issuer e.g. sells to A thinking they are buying for themselves, but in
fact they are buying for themselves, B, and C.

501(e):
Rule 501(e) Calculation of Number of Purchasers
How to Count
(1) The following purchasers shall be Excluded:

o (i) Any relative, spouse, or relative of the spouse of a purchaser who has the same principal
residence as the purchaser
o (ii) Any trusts of estates in which a purchaser owns more than 50%

o (iii) Any corporation or other organization in which a purchaser owns more than 50%

o (iv) Any Accredited Investor (Rule 501(a))

(2) A Corporation, Partnership, or other entity shall be counted a 1 purchaser, UNLESS

52
 o The entity was organized for the sole purpose of acquiring the securities offered.
In such case, each owner of the entity shall count as a separate purchaser.
Note: Must analyze each owner individually because they still may be excluded as an
accredited investor or any other reason in 501(e)(1).

Other Features of Regulation D

Rule 502(d):
Except as provided in Rule 504(b)(1), Issuer must exercise reasonable care to avoid re-sales.

Safe Harbor:
If the Issuer does these 3 things, then they will be deemed to have exercised reasonable care:
502(d): o (1) Reasonable inquiry to determine if purchaser is acquiring the securities for himself or others
Resales Restricted
o (2) Written disclosure to each purchaser prior to sale that the securities have not been registered
under the Act and therefore cannot be re-sold unless they are registered or an exemption
from registration is available
o (3) Placement of a legend on the security certificate stating that the securities have not been
registered under the Act and setting forth or referring to the restrictions on transferability

503:
Rule 503:
Form D Filing Requires Form D filing with SEC within 15 days of the first sale
Requirement o Rule 507:
Makes Reg. D unavailable to Issuers that previously have been enjoined for failure to comply
w/ the Rule 503 filing requirement
53
 However, may possibly still be able to use 4(a)(2)

Rule 508(a):
A failure to comply with a term, condition or requirement of Reg. D will not result in the loss of the
exemption, if the person relying on the exemption shows:
o (1) The failed condition was not intended to protect the person suing,

o (2) Failure to comply was insignificant, AND

The Following Rules are deemed Significant
Rule 502(c) General Solicitations
508: Rule 504(b)(2) $1 MM Aggregate Offering Price
Substantial Rule 505(b)(2)(i) $5 MM Aggregate Offering Price
Compliance Rule 505(b)(2)(ii) 35 Purchaser Limit
Rule 506(b)(2)(i) 35 Purchaser Limit

o (3) Issuer must show a good faith attempt to with all conditions in Reg. D

Reasonable Belief Language:

Accredited Investors,
Number of Purchasers,
Rule 506(b) Sophistication

Crowdfunding Exemption: 4(a)(6); Regulation Crowdfunding

In General

What is Crowdfunding?
Crowdfunding is the collective effort of a large number of individuals who pool their resources to support a third
partys effort to achieve a stated goal or engage in a defined activity

Section 4(a)(6) and Regulation Crowdfunding

4(a)(6)(A): Offering Amount [Rule 100(a)(1)]
o $1 million in 12 months
Not affected by other offerings
4(a)(6)(B): Individual Investment Limits [Rule 100(a)(2)]
o Depends on Net Worth and Annual Income
Applies to all crowdfunding rules
4(a)(6)(C): Through Broker or Funding Portal [Rule 300(a)]
o Complies with 4A(a)
4(a)(6)(D): Issuer complies with 4A(b) [Rules 201-205]
o Extensive disclosure requirements
54
Investment Limits
4(a)(6)(B)
o Lower Limit
If either the annual income or net worth is less than $100k, then the investment limit is the greater
of $2,000 or 5% of annual income or net worth
o Higher Limit
If either the annual income or net worth is equal to or more than $100k, them the investment limit
is 10% of annual income or net worth (not to exceed $100k)
o Statutory Ambiguity
Both limits apply, if:
One of those figures is less than $100k, and
The other is equal to or greater than $100k
Ambiguity is cleared up in the rules
Rule 100(a)(2)
o Lower Limit
Lower limit applies unless both annual income and net worth exceed $100k
o Higher Limit
If both annual income and net worth are equal to or more than $100k, then 10% of the lesser of
annual income or net worth.

Section 4(a)(6) & Regulation Crowdfunding

In General 4(a)(6) Regulation Crowdfunding
4(a)(6)(A): Rule 100(a)(1):
Offering Issuers aggregate amount sold pursuant to a 4(a) Issuers aggregate offering amount sold pursuant to
Amount: (6) exemption shall NOT exceed: a 4(a)(6) exemption shall NOT exceed:
o $1 million during any 12-month period o $1 million during any 12-month period
($1 MM in Notes: Notes:
12 months) $1 million limit is not affected by securities sold $1 million limit is not affected by securities sold
pursuant to other exemptions. pursuant to other exemptions.

Individual
4(a)(6)(B): Rule 100(a)(2):
Investment The amount sold to any investor, including any The amount sold to any investor, including any
Limits: amount sold in reliance on 4(a)(6), shall not amount sold in reliance on 4(a)(6), shall not
exceed: exceed:
(Annual
4(a)(6)(B)(i): Lower Limit Rule 100(a)(2)(i): Lower Limit
Income &
If purchasers Annual Income or Net Worth is LESS If either the purchasers Annual Income or Net
Net Worth)
than $100k, then the maximum amount that Worth is LESS than $100k, then the maximum
purchaser can buy during the 12-month period amount that purchaser can buy during the 12-
preceding the transaction shall be the greater of: month period preceding the transaction shall be the

55
 o $2,000 or
o 5% of annual income or net worth
4(a)(6)(B)(ii): Higher Limit
If purchasers Annual Income or Net Worth is
MORE than $100k, then the maximum amount that
purchaser can buy during the 12-month period
preceding the transaction shall be:
o 10% of annual income or net worth
But, cant exceed $100,000
greater of:
o $2,000 or
o 5% of annual income or net worth
Rule 100(a)(2)(ii): Higher Limit
If BOTH Annual Income and Net Worth are equal
to or more than $100k, then the maximum amount
that purchaser can buy during the 12-month period
preceding the transaction shall be the lesser of:
o 10% of annual income or net worth

Notes: Notes:
Investment limits apply to all crowdfunding Investment limits apply to all crowdfunding
offerings. offerings.
o This is not just a limit for each offering, but a o This is not just a limit for each offering, but a
limit on the total amount that the investor may limit on the total amount that the investor
invest in all 4(a)(6) offerings. may invest in all 4(a)(6) offerings.
Statutory Ambiguity:
o Both limits apply, if:
One of those figures is <$100k, and
The other is equal to or >$100k
o Ambiguity is cleared up in the Rules

Through
4(a)(6)(C): Rule 300(a):
Broker or The transaction must be conducted through a broker Offering must be conducted through a web portal
Funding or funding portal that complies with 4A(a) operated by a securities broker or SEC
Portal
4(a)(6)(D): Rule 201 205:
Issuer
Issuer must comply w/ disclosure req. in 4A(b) Issuer must comply w/ disclosure requirements
Complies
with 4A(b)

Crowdfunding Rules

Rules 100(b)(1), (2): Issuer must be a Non-Reporting Company organized under U.S. law
Eligible Issuers
Rules 100(b)(4), 503: Bad actor disqualifications similar to Reg. A and Reg. D

Offering Rule 100(a)(1): The aggregate offering amount sold pursuant to 4(a)(6) is $1 million in any 12-month period.
Amount Securities sold pursuant to other exemptions do not affect this limit.

Rule 300(a): The offering must be conducted through a web portal operated by a registered securities broker or a
registered funding portal.
Offers & Sales The Issuer may not offer or sell the securities directly to the public w/o using an intermediary.
through The Issuer may not even advertise the offering off-platform, except for a bare-bones notice
Registered directing investors to the intermediarys platform. (See Rule 204)
Intermediaries
Rule 303(c): The intermediarys platform must include communication channels that allow potential investors to
communication with the issuer, and with each other, about the offering.

Disclosure
Rule 201: Issuer must file with the SEC, and make available to potential investors on the crowd
funding platform, detailed disclosure about the company, its business, and offering.

$100,000 or less; Rule 201(t)(1)

o If no audited financial statements . . .
Total income, taxable income, and total tax reported on most recent tax return.
56
 CEO must certify the accuracy of these figures.
o If audited financial statements, provide those instead.
$100,000 - $500,000; Rule 201(t)(2)
o Issuer must furnish financial statements reviewed by an independent public account.
o If audited financial statements are available, then Issuer must provide those instead.
Over $500,000; Rule 201(t)(3)
o Issuer must furnish audited financial statements, unless this is its first 4(a)(6) offering.
In that case, financial statements independently reviewed by an independent public
accountant are sufficient (unless audited financial statements are available).

Target Amount:
Rule 201(g): Issuer must specify target amount to be raised in offering and deadline for raising that amount
Target Amount o Rule 303(a)(2): Offer must remain open for at least 21 days
o Rule 201(g): If offering does not reach target amount by deadline, all investment commitments must
& Withdrawal
be cancelled and any money already submitted must be returned to investors.
Rights
Withdrawal Rights:
Rule 304(a): Investors may cancel their investment commitments any time up to 48 hours before deadline

4(a)(6)(B): Investors may not invest more than a specified amount in 4(a)(6) offerings within any 12-months
Note: This is not just a limit for each offering, but a limit on the total amount that the investor may invest in
all 4(a)(6) offerings.
Rule 100(a)(2): Lower Limit
Investment
Unless both annual income and net worth exceed $100k, maximum investment shall be the greater of:
Limits o $2,000 or 5% of annual income or net worth

Rule 100(a)(2)(ii): Higher Limit

If both annual income and net worth exceed $100k, maximum investment shall be the lesser of:
o 10% of annual income or 10% of net worth

4(a)(6)(B) provides for two limits. The applicable limit depends on the investors annual income and net worth.
The lower set of limits, in 4(a)(6)(B)(i), applies if either the annual income or the net worth of the
investor in less than $100,000.
The higher set of limits, in 4(a)(6)(B)(ii), applies if either the annual income or the net worth of the
investor is equal to or more than $100,000.
Investment o If one of those two figures is less than $100,000 and the other is equal to or greater than $100,000,
Limits Statutory then the statute literally says both apply.
Ambiguity Rule 100(a)(2) clarifies the ambiguity. The lower limit applies unless both annual income and net
worth exceed $100,000.
o Rule 100(a)(2)(ii) also clarify an ambiguity as to the higher limit.
Under 4(a)(6)(B)(ii), the higher limit is 10% of annual income or net worth, but doesnt say
whether the limit is the great or the lesser of those two figures.
Rule 100(a)(2)(ii) makes clear that the limit is the lesser of the two figures.

Rule 301(b): When an investor opens an account with a crowdfunding intermediary, the intermediary must
provide educational materials that inform investors about the crowdfunding exemption.
Rule 303(b)(2)(i): Before investment, the intermediary must obtain a representation that the investor has
Investor reviewed the educational materials and understands that the entire amount of their
Education investment may be lost and that they are in a financial condition to bear such loss.
Rule 303(b)(2)(ii): Intermediary must also require the investor to complete a questionnaire demonstrating the
investors understanding of certain risks specified in the regulation.

Annual Reports
57
 Rule 202(a): Issuers that have sold pursuant to 4(a)(6) must file, and post on their web sites, annual reports
that include financial statements.

Rule 202(b): This annual reporting obligation continues until:

o The Issuer becomes an Exchange Act reporting company,
o The Issuer has fewer than 300 security holders,
o At least 3 years have passed and the Issuers total assets do not exceed $10 million,
o The Issuer or someone else purchases all of the 4(a)(6) securities, OR
o The Issuer liquidates or dissolves.

The crowdfunding intermediary has an enforcement role under the exemption:

Investment Limits: The intermediary must have a reasonable basis for believing each investor satisfies the
investment limits. The investors representation is sufficient unless the intermediary has reason not to
believe it. (Rule 303(b)(1))

Issuers Compliance: The intermediary must have a reasonable basis for believing that the Issuer is in
compliance with the requirements of the exemption. The Issuers representations to that effect are sufficient
The
unless the intermediary has reason not to believe it. (Rule 301(a))
Intermediarys
Enforcement Issuers Record Keeping: Intermediary must have reasonable basis for believing the Issuer has established
Role a means to keep accurate records. Issuers representations to that effect are sufficient. (Rule 301(b))

Background Checks: Intermediary must conduct a reasonable investigation and deny any Issuer access to
its platform that has been disqualified under a bad actor exception. (Rule 301(c)(1))

Potential for Fraud: Intermediary must deny access to its platform if it has reasonable basis (due diligence
not required, but unclear) for believing that the Issuer or the offering presents potential for fraud or
otherwise raises concerns about investor protection. (Rule 301(c)(2))

Rule 501: Securities purchased pursuant to 4(a)(6) may not be resold for 1 year, with some exceptions:
(1) Securities are transferred to the issuer of the securities,
(2) Securities are transferred to an accredited investor,
Resales (3) Securities are transferred as part of a registered offering, or
(4) Securities are transferred to a member of the family of the purchaser

Substantial Rule 502: There is a substantial compliance requirement similar to that in Regulation D
Compliance i.e., failure to comply with a term will not result in a loss of the exemption (see pg. 54)

Integration with
The crowdfunding rule itself says nothing about the integration of 4(a)(6) offerings with other offerings.
Other Offerings However, the release has the following to say on the subject:
An offering made in reliance on 4(a)(6) should not be integrated w/ another exempt offering made by the
Issuer, provided that each offering complies with the requirements of the applicable exemption being relied
upon.

Example 1:
o An Issuer conducting a concurrent exempt offering for which general solicitation is not permitted (i.e.,
Rules 505, 506(b)) will need to be satisfied that purchasers in that offering were not solicited by means
of the offering made in reliance on 4(a)(6).

Example 2:
o An Issuer conducting a concurrent exempt offering for which general solicitation is permitted (i.e.,
Rule 506(c)), could not include any such general solicitation in an advertisement of the terms of an
offering made in reliance on 4(a)(6), unless that advertisement otherwise complied with 4(a)(6) and

58
 the final rules.
As such, a concurrent offering would be bound by the more restrictive solicitation requirements
of Regulation Crowdfunding, unless the Issuer can conclude that the purchasers in the
Regulation Crowdfunding offering were not solicited by means of the offering made in reliance
on Rule 506(c).

Employee Benefit Plans; Rule 701

Rule 701 provides an exemption from 5 for private (non-reporting companies) companies that sell securities to
In General employees for compensatory purposes.

Rule 701(b)(1): Non-Reporting Companies

If Issuer becomes an Exchange Act reporting company after it has already made a Rule 701 offer, the Issuer
Eligible
may still rely on Rule 701 to sell the securities previously offered. Rule 701(b)(2).
Issuers
Reporting Company Issuer may rely on Rule 701 if it is merely guaranteeing the payment of a subsidiarys
securities that are sold under Rule 701. Rule 701(b)(3).

Rule 701(c):
Eligible Exempts securities under a compensatory benefit plan established by the Issuer (or its subsidiaries) for the
participation of their:
Transactions o Employees, directors, general partners, officers, or consultants & advisors, and their family
/ Investors members who acquire such securities through gifts or domestic relations orders.
See Definitions on page 61

Amount that Rule 701(d)(2):

may be Sold The amount of securities in reliance on this Rule during any 12-month period shall not exceed the greater of:
o (i) $1,000,000;
o (ii) 15% of Issuers total assets; OR
o (iii) 15% of the outstanding securities of the same class
Outstanding securities with convertible options are to be counted. Rule 701(d)(3)(iii).
59
 Rule 701(d)(3)(i): Aggregate Sales Price
The value of services exchanged for services issued is measured by the value of the securities issued.
Rules for Options are valued based on the exercise price of the option.
Non-cash consideration is valued based on a sale or, if no sale, a reasonable method.
Calculating
the Amounts Rule 701(d)(3)(ii): Time of the Calculation
Options to purchase Sales price determined when option grant is made (not when option is exercised)
Other securities Sales price determined when sale is made

Rule 701(e):
Issuer must deliver to investors a copy of the compensatory benefit plan or contract, and
Disclosure If the amount of securities sold during a 12-month period exceeds $5 million, then Issuer must also deliver
the disclosure listed in (e)(1) (6) to investors a reasonable time before sale.

Rule 701(d)(3)(iv):
Securities sold under this rule do not affect the aggregate offering price in other exemptions, AND
Aggregation Amounts of securities sold in reliance on other exemptions do not affect the amount that may be sold in
reliance on Rule 701.

Rule 701(f):
Integration Rule 701 securities do not integrate with other offerings (whether exempt or registered).

Rule 701(g):
Resales (1) Rule 701 securities are restricted securities and therefore must still comply with State security law
(2) Resales must comply with the 5 registration requirements or an exemption

Employee
Rule 701(c): The term employee shall include insurance agents who are exclusive agents who are
exclusive agents of the Issuer (or subsidiaries) or derive more than 50% of their annual income from those
entities.
o In a SEC no action letter, the SEC has taken the position that insurance agents include any other sales
agent as a de facto employee.

Special Conditions for Consultants & Advisors

Rule 701(c)(1): Rule 701 is available to consultants and advisors only if:
Definitions o (i) They are natural persons,
o (ii) They provide bona fide services to the Issuer (or its subsidiaries), and
o (iii) The services are not related to a capital raising transaction

Family Member
Rule 701(c)(3): Family member includes any:
o Child, stepchild, grandparent, parent, stepparent, grandparent, spouse, former spouse, sibling, niece,
nephew, mother-in-law, father-in-law, son-in-law, daughter-in-law, brother-in-law, or sister-in-law,
Including adoptive relationships,
Any person sharing the employees household, and
Any other entity in which these persons (or employee) own more than 50% interest

60
Regulation A; 3(b); Rules 251-264
In General Reg. A is a 3(b) exemption

Rule 251(b)(1), (2):

Non-Reporting Companies
Eligible o U.S. or Canadian Issuers
Issuers
Rule 262: Bad Actor Disqualification
Reg. A is unavailable if Issuer or other specified persons have engaged in certain types of past misconduct.

Rule 251(a)(1): Tier 1 Offering Rule 251(a)(2): Tier 2 Offering

Offering $20 million, LESS: $50 million, LESS:
Amounts o Reg. A securities sold within 12 months before o Reg. A securities sold within 12 months before
the start of and during the current offering. the start of and during the current offering.

Mini-
Reg. A is sometimes called mini-registration b/c some of its requirements resemble registered offerings ( 5).
Registration
Rule 252: The Issuer must file an Offering Statement (Form 1-A)

Before Filing -
o Rule 251(d)(1)(i): Except for the Rule 255 testing the waters provision, no offers may be made

After Filing, But Before Qualified

o Rule 251(d)(1)(ii):
(A) Oral offers may be made;
(B) Written offers pursuant to a Rule 254 Preliminary Offering Circular may be made; and
(C) Solicitations of interests and other communications pursuant to Rule 255 may be made.
61
 After Qualification
o Rule 251(d)(1)(iii): Offers
Offers may be made after the offering statement has been qualified, but
Any written offers must be accompanied or preceded by the most recent Rule 253 Offering
Circular filed with the SEC.
o Rule 251(d)(2)(i): Sales
(A) No sales of the security may be made until the offering statement has been qualified.
(B) Tier 1 Offering: Preliminary Offering Circular must be delivered 2 days before sale
(C) Tier 2 Offering: See Purchase Limits in Certain Tier 2 Offerings below

No resale restrictions.
Resales
Regulation A securities may be resold immediately.

Substantial
Rule 260: Substantial compliance rule similar to Rule 508 in Regulation D (see page 54)
Compliance
Tier 1 Offering:
Subject to State securities law registration and offering requirements
o Thus, a Tier 1 offering, even though exempted from federal registration, may have to be registered at
the State level.
State
Regulation Tier 2 Offering:
Regulation A preempts State registration requirements for Tier 2 offerings.
o How?
Rule 256 defines offerees and purchasers in Tier 2 offerings as qualified purchasers.
That makes Tier 2 securities covered securities for purposes of preemption under 18.

Purchase Limits in Certain Tier 2 Offerings

If a Regulation A Tier 2 Offering is offering securities that will NOT be listed on a national securities
In General
exchange, then special investment limits apply. Rule 251(d)(2)(i)(C)

Rule 251(d)(2)(i)(C)(1):
Total price paid by a natural person who is not an accredited investor shall not exceed the greater of:
Non-Accredited
o 10% of the persons annual income, OR
Natural Person o 10% of the persons net worth
Issuer may rely on Investors representations. Rule 251(d)(2)(i)(D)

Rule 251(d)(2)(i)(C)(2):
Total price paid for non-accredited investors who are not natural persons shall not exceed the greater of:
Non-Accredited;
o 10% of the persons revenue, OR
Not Natural Person o 10% of the persons net assets
Issuer may rely on Investors representations. Rule 251(d)(2)(i)(D)

Rule 251(d)(2)(i)(C):
Accredited Investor
Accredited investors are NOT subject to the purchase limits

Integration with Other Offerings

Rule 251(c) is an integration safe harbor.

Rule 251(c) Regulation A offerings will not be integrated with any prior offerings, or
Subsequent offerings that fall into on of the categories in Rule 251(c)(2)(i)-(vi)

Prior Offerings
Rule 251(c)(1):
62
 Regulation A offerings will NOT be integrated with
o Prior offers or sales of securities

Rule 251(c)(2):
Regulation A offerings will NOT be integration with subsequent offers or sales of securities that are:
o (i) Registered under the Securities Act, except as provided in Rule 255(e),
o (ii) Exempt from registration under Rule 701,
Subsequent Offerings o (iii) Made pursuant to an employee benefit plan,
o (iv) Exempt from registration under Regulation S
o (v) Made for than 6 months after the completion of a Regulation A offering, OR
o (vi) Exempt from registration under 4(a)(6) of the Act (i.e., crowdfunding)

Rule 255(e): Abandoned Offerings

If an Issuer decides to make a registered offering after soliciting interest in a contemplated, but
abandoned Reg. A offering, then the abandoned Reg. A offering is NOT INTEGRATED with the
registered offering, if:
Rule 255(e):
o Solicitations were made only to qualified institutional buyers & qualified institutional investors
Abandoned Offerings
If solicitations of interest were made to other persons, an abandoned Reg. A offering is NOT
INTEGRATED, if:
o Issuer waits at least 30 days between the last solicitation of interest in the Reg. A offering and
the filing of registration with the SEC

Mini-Registration and Permissible Communications

Rule 251(d)(1)(i):
Before Offering
Except as allowed by Rule 255 (Testing the Waters),
Statement is Filed o No offers may be made unless an offering statement has been filed with the SEC

Rule 251(d)(1)(ii):
After the offering statement has been filed, but before it is qualified:
After Filing, But o (A) Oral offers may be made,
o (B) Written offers pursuant to Rule 254 (Preliminary Offering Circular) may be made, and
Before Qualification
o (C) Solicitations of interest and other communications pursuant to Rule 255 (Testing the
Waters) may be made.

Rule 251(d)(1)(iii):
After Qualification After the offering statement has been qualified, offers may be made, BUT
o Written offers must be accompanied with or preceded by the Offering Circular filed with the SEC

Rule 255:
Rule 255: Solicitations of Interest and Other Communications
Testing the Waters
(a) Solicitations of Interest
o An Issuer may communicate orally or in writing to determine whether there is any
interest in a contemplated securities offering before filing the offering statement
Solicitation may continue even after the offering statement is filed.

(b) Conditions. The communication must:

o State that no consideration is being solicited or accepted,
o State that no offer to buy may be accepted and any such offer may be revoked,
o State that the persons indication of interest is not binding, and
o After the offering statement has been filed:

63
 State from whom a copy of the Preliminary Offering Circular may be obtained,
Provide a URL where the Preliminary Offering Circular may be obtained, or
Include a copy of the Preliminary Offering Circular

Rule 254:
After filing an offering statement, but before qualification, written offers may be made if they meet the
following requirements:

(a) Outside Front Cover Page

Rule 254: o Must bear the caption, Preliminary Offering Circular and state the legend set forth in 254(a).
Preliminary
Offering Circular (b) Other Contents
o Must contain substantially the same information required to be in the Offering Circular as
required by Form 1-A, except may omit certain pricing and other distribution related info.

(c) Filing
o The Preliminary Offering Circular is filed as part of the offering statement.

Sales and Final Offering Circular Delivery Requirements

Rule 251(d)(2)(i):
In General
No sale of securities may be made . . .

Rule 251(d)(2)(i)(A), (B):

In a Tier 1 offering, no sale of securities may be made

Tier 1 Offering o Until the offering statement has been filed, AND

o Until a Preliminary Offering Circular is delivered at least 2 days before the sale to any person
that before qualification had indicated an interest in purchasing securities in the offering.

Rule 251(d)(2)(i)(A), (C):

In a Tier 2 offering of securities NOT listed on a national exchange, no sale of securities may be made

Tier 2 Offering o Until the offering statement has been qualified, UNLESS
The purchaser is an accredited investor, OR
The aggregate purchase price to be paid by the purchaser does not exceed a given limit (See
page 63 for purchase limits)

Rule 251(d)(2)(ii):
Delivery of Final If a sale is made by the Issuer, Underwriter, or Dealer within 90 days after qualification,
Offering Circular o Then the seller must deliver a copy of the Final Offering Circular within 2 days after the sale,
Subject to the provisions in 251(d)(2)(ii)(A)-(E).

Differences between Tier 1 and Tier 2 Offering

Tier 2 Offering
Investment Limits
Rule 251(d)(2)(C)

64
 Audited Financial Statements
Periodic Reporting Requirements
Rule 257

State Regulation is Preempted

Rule 256; Only thing that cuts in favor of Tier 2

Regulation A vs. Regulation D

No Limitation on Re-Sales
Advantages of Fewer Restrictions on Solicitations
Reg. A Rule 255 Testing the Waters
No pre-existing relationship required

Filing and Disclosure Requirements

Disadvantages of Rule 252
Reg. A Limited to Non-Reporting Companies
Rule 251(b)(1), (2)

The Integration Doctrine

In General
Exemptions:
All exemptions require that the entire offering or issue must comply with the exemption
o Integration of two offerings by an Issuer may destroy the availability of an exemption for either or both
offerings.
Question:
What is a single offering or issue?
o Are there really separate offerings or should they be treated as a single offering?

Two Kinds of Integration Issues:

One Issuer trying to separate a single offering into two offering in an effort to escape the registration requirement
Two related Issuers making separate offerings
o Are the Issuers sufficiently related so that they should be treated as a single Issuer?

Integration:
5 Factor Test
o SEC approach
Single plan of financing,
Same class of security,
At or about the same time,
Same consideration, and
Same general purpose
Integration Safe Harbors
o If safe harbor applies, dont use 5 factor test
Rule 147

65
 One-sided protection for 3(a)(11) intrastate offerings
Rule 502(a)
One-sided protection for Reg. D offerings
Rule 251(c)
Reg. A offerings not integrated with any prior offerings and certain subsequent offerings
Rule 155
Abandoned offerings

5 Factor Test

No single factor is determinative.

In General Even if only one factor is present, it is possible for the SEC to find integration.
o This fact intensive analysis creates uncertainty and therefore relying on the test is risky.

Whether the offerings are part of a single plan of financing; What is a single plan of financing?

Different Approaches:

o (1) Make reference to the presence or absence of the other factors.

1: The fact that two offerings had the same timing, general purpose, class of security, and
Single Plan of consideration indicates that they were a single plan of financing.
Financing
o (2) Intent of the Issuer
If the Issuer can show that a later offering was not contemplated at the time of the initial
offering, then there is no single plan of financing.
May be difficult to show intent

2:
Whether the offerings involve the issuance of the same class of security;
Same Class of
Security Debt + Equity Offering
o If the offerings include both equity and debt securities, then that one factor alone may be enough to
prevent integration even when the other 4 factors point towards integration.
However, the SEC has not always recognized this general rule (Kunz)
Note:
o If debt security is immediately convertible into equity, then the Issuer is said to be
offering both classes of securities at the same time.
o If debt security is convertible at some future date, then under 2(a)(3), the offering
will be said to be offering only equity securities.

Multiple Offerings in the Same General Class

o Sometimes not integrated because of distinctions within the class
i.e., differences in maturities, interest rates, transferability, etc.
66
 Whether the offerings are made at or about the same time;

If offerings are separated by a substantial period of time, then presumption against integration
3: o Rebuttable presumption = 6 months
Same Time o Irrefutable presumption = 1 year

If both offerings are within 6 months, then presumption towards integration

Whether the consideration to be received is the same;

Cash Consideration
4: o Since cash is the most common form of consideration, it does not militate either way.
Same Cash + Non Cash Consideration
Consideration o Suggests the offerings should NOT be integrated.

Non Cash Consideration

o Non cash consideration of a similar type increases the chance that multiple offerings will be integrated.

5:
Whether the offerings are made for the same general purpose.
Same General For what purpose is the Issuer raising capital for in the offerings? If similar, then cuts towards integration.
Purpose
Integration Safe Harbors

Rule 502(a):
Offers and sales made
o 6 months before the start of a Reg. D offering, and
o 6 months after the completion of a Reg. D offering
Will not be considered part of that Reg. D offering
o So long as there are no offers or sales of securities by or for the Issuer that are the same or a similar
Rule 502(a): class as those offered or sold under Reg. D during either of those 6 month periods.
Reg. D Offerings
One-Sided Protection:
Rule 502(a) says will not be considered part of that Reg. D offering
o Therefore, Rule 502(a) offers one-sided protection for the Reg. D offering.
Only protects the Reg. D offering from integration with another offering
Does NOT protect another offering from being integrated with the Reg. D offering and therefore
may cause another offering to violate the exemption it is relying on.

Rule 147(b)(2):
Offers and sales made pursuant to the exemptions provided by 3, 4(a)(2), or a Registration Statement
o 6 months before the start of a Rule 147 offering, or
Rule 147: o 6 months after the completion of a Rule 147 offering
3(a)(11) Will not be considered part of that Rule 147 offering
Intrastate o So long as there are no offers or sales of securities by or for the Issuer that are the same or a similar
Offerings class as those offered or sold under Rule 147 during either of those 6 month periods.
One-Sided Protection:
Rule 147(b)(2) says, an issue shall be deemed not to include. Thus, offers one-sided protection.

Rule 251(c):
Rule 251(c)(1), (2):
Reg. A Offerings Regulation A offerings will NOT be integrated with
o Prior offers or sales of securities, or
o Subsequent offers or sales of securities that are:
(i) Registered under the Securities Act, except as provided in Rule 255(e),

67
 (ii) Exempt from registration under Rule 701,
(iii) Made pursuant to an employee benefit plan,
(iv) Exempt from registration under Regulation S
(v) Made for than 6 months after the completion of a Regulation A offering, OR
(vi) Exempt from registration under 4(a)(6) of the Act (i.e., crowdfunding)
Two-Sided Protection:
Rule 251(c) says, will not be integrated with. This broad term provided two-sided protection.

Rule 155:
Abandoned See Below (pg. 69)
Offerings

Rule 155(a): Private Offering Defined

Any unregistered offering exempt from registration pursuant to 4(a)(2) or Rule 506

Rule 155(c): Abandoned Registered Offering Private Offering

The abandoned registered offering will not be considered part of a subsequent private offering, if:
o No securities were sold in the registered offering,
o The Issuer withdrawals the registration statement under Rule 477,
o The Issuer must wait 30 days after withdrawal before commencing the private offering,
o The Issuer notify each offeree in the private offering that
The offering is not registered,
Re-sale limitations,
No protections under 11, and
That a registration statement for the abandoned offering was filed and withdrawn
Rule 155:
Abandoned
Offerings Rule 155(b): Abandoned Private Offering Registered Offering
The abandoned private offering will not be considered part of a subsequent registered offering, if:
o No securities were sold in the private offering,
o The Issuer terminates all offering activity in the private offering before filing registration statement,
o The 10(a) Final Prospectus and 10(b) Preliminary Prospectus disclose:
The size and nature of the private offering,
The date on which the private offering was abandoned,
Any offers to buy in the private offering were rejected, and
That the prospectus delivered in the registration statement supersedes other offering material
o The Issuer does not file the registration statement until at least 30 days after abandoning the private
offering, unless
Offers were limited to accredited investors, or
Persons with knowledge and experience

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 SECONDARY DISTRIBUTIONS (RE-SALES)

The Underwriter
4(a)(1): Exempted Transactions
4(a)(1) --
Exempts transactions by any person other than an Issuer, Underwriter, or Dealer.
o 2(a)(4): Issuer Any person who issues or proposes to issue a security
o 2(a)(12): Dealer Any person in the business of dealing in securities issued by another person
o 2(a)(11): Underwriter Big battleground in re-sales

Who is an Underwriter?

The term underwriter means any person who --

Has purchased from an issuer with a view to . . . the distribution of any security; or
2(a)(11):
Offers or sells for an issuer in connection with the distribution of any security; or
1st Sentence
Participates or has a direct or indirect participation in the undertaking; or
Participates or has a participation in the direct or indirect underwriting of any such undertaking

Control Person Relationships:

As used in this paragraph, the term Issuer shall
Control Person Issuer
include, in addition to an Issuer, Issuer Control Person
Any person directly or indirectly controlling the Person X control both the Issuer & Control Person
Issuer, or
Rule 405:
2(a)(11): Any person directly or indirectly controlled by Defines Affiliate same way 2(a)(11) defines
2nd the Issuer, or Control Person.
Sentence o Thus, Affiliate and Control Person are
Any person under direct or indirect common
interchangeable.
control with the Issuer.
Defines Control
o Management power or policy power,
o SH control,
o Contractual control,
o or otherwise (i.e., directors & officers)

69
 The term Underwriter means

2(a)(11): Any person who has purchased from an Issuer [or Control Person] with a view to . . . distribution,
Net Result OR
Any person who offers or sells for an Issuer [or Control Person] in connection with the
distribution of any security.

Definition #1: Purchased from an Issuer [or Control Person] with a view to the distribution

2(a)(11): Among those included in the definition of underwriter is any person who has
Purchased from an Issuer [Control Person] with a view to the distribution of any security.

o Obviously, this includes the firm commitment underwriter.

o Also includes any purchaser of unregistered securities from an issuer who acquires the securities
In General with intent to resell them to the public.
Issues:
What is a Purchase
The purchasers investment intent (with a view to), and
The meaning of distribution

What is a 2(a)(3) says the disposition of a security must be for value.

Purchase? Thus, excludes gifts.

Investment Intent
With respect to the purchased securities, did the investor intend to hold for investment or re-sell?
o Since intent is difficult to prove, look for objective evidence (i.e., Holding Period).

Holding Period (Measured from the time of the original issue) --

o SEC and Courts Position:
3 years is determinative of investment intent
2 years is presumed investment intent
With a View To o Rule 144 Safe Harbor:
Holding period ranges from 6 months to 1 year, provided that certain requirements are met.
Thus, may argue that because the SEC has shortened the holding period in Rule 144, it
should impact the common law 3 year and 2 year rules.
Change in Circumstances
If a set of events take place that can support the conclusion that the investor sold the unregistered shares
earlier than contemplated, then such change in circumstances may prove the investor did not purchase
with intent to re-sell.

Distribution
Distribution
If re-sale occurs before securities come to rest, then distribution is defined w/ respect to Issuers original
exemption
o i.e., continuation of the Issuers distribution
o Come to rest = same analysis as with a view to

70
 If re-sale by an affiliate is inconsistent with the Issuers exemption, then distribution.
o Examples:
3(a)(11) intrastate offering re-sold to purchaser out of state
4(a)(2) private offering re-sold to purchaser lacking access to information

Definition #2: Offers or sells for an Issuer [Control Person] in connection with a distribution

SEC v. Chinese Consolidated Benevolent Association

The Association was found to have made an offer for an Issuer and therefore deemed to be an
Offers or Sells underwriter within 2(a)(11) when it solicited offers to buy unregistered securities without
compensation or authorization from the Issuer.

For an Issuer
United States v. Wolfson
[Control Person]
in Connection Facts:
with a Wolfson and his family own 40% of Continentals outstanding stock.
Wolfson is a Control Person
Distribution
o Largest shareholder and had final say on all corporate policy and business decisions
Wolfson sold 400,000 shares (25% of outstanding shares)
o 6 brokers assisted in the OTC transactions

Issue:
Whether the transaction is exempt from section 5 under 4(a)(1) or 4(a)(4)
o Wolfson argues that he is not an Issuer, Underwriter, or Dealer and therefore transaction is exempt.

Rule:
4(a)(1) exempts transactions not involving an Issuer, Underwriter, or Dealer

Analysis:
Is Wolfson an Issuer?
o Wolfson does not fit within the 2(a)(4) definition of Issuer and therefore is not an Issuer for
purposes of 4(a)(1).
o However, Wolfson is a Control Person and therefore is an Issuer for purposes of 2(a)(11) and
therefore may be an Underwriter for 4(a)(1) depending on his involvement in the transaction.

Is Wolfson a Dealer?
o No, because 2(a)(12) defines dealers as those engaged in the business of trading securities.

Is Wolfson an Underwriter?
o Under 2(a)(11), Wolfson will be deemed an underwriter if he (1) purchased securities from an
issuer with a view to distribution, or (2) offers or sells for an issuer in connection with a distribution.
Wolfson is not purchasing with a view to distribution
Wolfson purchased and held the securities for many years and therefore did not purchase
with a view to distribution, but rather purchased with investment intent.
Wolfson is not offering or selling for an Issuer
Wolfson is offering on his own behalf.

71
 Wolfson is not an Issuer, Dealer, or Underwriter.
o Therefore, it would appear that the transaction is exempt under 4(a)(1). HOWEVER,
The brokers who assisted in the OTC transactions are underwriters because Wolfson is a
2(a)(11) Issuer and therefore the brokers offered or sold for an Issuer [Control Person] in
connection with a distribution.
Therefore, the 4(a)(1) exemption fails because the transaction involved an underwriter.

4(a)(4): Brokers Exemption

o Exempts the brokers transactions in the OTC sales.
However, 4(a)(4) is only designed to exempt the brokers part in the transaction. Wolfson must
find his own exemption.

The 4(1 ) Exemption

Section 4(1 ) Exemption:

Term used to express the statutory relationship between 4(a)(1) and 4(a)(2).

o 4(a)(1) Section 5 only applies to issuers, underwriters, and dealers.

2(a)(11) definition of underwriter depends on the existence of a distribution
In General
Distribution = Public Offering
o 4(a)(2) Private offering exemption
Ralston Purina Sophistication and Information

Therefore, whether a party is an underwriter for purposes of 4(a)(1) requires an inquiry into whether the
transaction involves a public offering.

Ackerberg
Facts:
v.
Vertimag, Inc. sold shares to Johnson in an unregistered private offering.
Johnson
o Johnson is Vertimag chairman of the board and largest SH. Thus, Johnson is a Control Person
Johnson engages PJH (broker) to sell some of his shares. PJH sells 12,500 shares to Ackerberg.

Issue:
Whether 4(a)(1) exempts Johnson from section 5 registration.
o Clearly, Johnson is not an issuer or dealer, but is he an underwriter?

Rule:
4(a)(1) exempts any person other than an issuer, underwriter, or dealer from registration.

Analysis:
Is Johnson an underwriter?
o Under 2(a)(11), the term underwriter includes any person who
Purchases from the issuer [or control person] with a view to distribution, or
Offers or sales for an issuer [or control person] in connection with a distribution.

Did Johnson purchase from an issuer with a view to distribution?

o Johnson held the shares for 4 years so they came to rest in his hands and therefore did not
purchase with a view to distribution.
Did PJH offer or sell for an issuer in connection with a distribution?
o Johnson is an issuer within the meaning of 2(a)(11) because he is a control person.
o However, the transaction was not in connection with a distribution.

72
 Distribution requires a public offering.
Whether the resell is considered a public offering is determined by the Ralston Purina
criterion (i.e., Sophistication and Access to Information).
o Ackerman is sophisticated and had access to information.

Held:
Johnson is entitled to the 4(a)(1) exemption because the transaction did not involve an issuer,
dealer, or underwriter.
Note:
Although PJH is neither an issuer nor underwriter, they are a dealer.
o Therefore, the transaction involved a dealer. However, this does not destroy the 4(a)(1)
exemption because PJH is entitled to a broker exemption under 4(a)(3).
Resale Safe Harbors; Rules 144, 144A, 4(a)(7)
Rule 144 Safe Harbor for Resales of Control and Restricted Securities

General Rule:
If the conditions in Rule 144 are satisfied, then a person re-selling securities shall not be deemed to
be engaged in a distribution and therefore not underwriters
In General
Purpose:
The purpose of Rule 144 is to provide objective criteria for determining that the person selling
securities to the public has not acquired the securities for distribution.

Rule 144(b) Conditions to be met (Roadmap)

Subject to paragraph (i) of this section, the following conditions must be met:
o (1) Non-Affiliates . . .
o (2) Affiliates or persons selling on behalf of affiliates . . .

Roadmap Rule 144(a)(1) Defines Affiliate

The term affiliate means any person that directly, or indirectly through one or more intermediaries, controls,
or is controlled by, or is under common control with the issuer.
o Note ---
The same language is used to define control person in Rule 405.
Affiliate = Control Person

Non-Affiliates
Rule 144(b)(1)(i):
If non-affiliate is selling Restricted Securities of
a Reporting Company, then must satisfy the
following conditions:
o Rule 144(d) Holding Period, AND
Rule 144(b)(1)(ii):
If non-affiliate is selling Restricted Securities of
a Non-Reporting Company, then must satisfy
the following conditions:
o Rule 144(d) Holding Period

o Rule 144(c)(1) Current Public Info.

Notes:
(c)(1) no longer applies after 1 year has
Non-Reporting Company is any company that has
elapsed from the time of issuance.
not been a Reporting Company for at least 90
days
Notes:
Must have been a Reporting Co. for 90 days

For purposes (c)(1), 1 year must have passed

between a purchase from the issuer or from an
73
 affiliate of the issuer.
o Doesnt matter how long re-seller held it.

Affiliates
Rule 144(b)(2):
or If an affiliate or any persons selling on behalf of an affiliate sells Restricted Securities or any other security,
Persons Selling then all the conditions in Rule 144 must be satisfied.
on Behalf of
Affiliates

Rule 144 Restricted Securities

Rule 144(a)(3): The term Restricted Securities means

144(a)(3)(i) -- Private Offerings

Securities acquired directly or indirectly from the issuer or from an affiliate of the issuer, in
a transaction or chain of transactions not involving any public offering.
o Must not be a public offering (Ralston Purina)

144(a)(3)(ii) Regulation D
Securities acquired from the issuer that are subject to the resale limitation of Rule 502(d)
under Regulation D or Rule 701(c).
o The language subject to makes this safe harbor available even if the original issuer
Rule 144(a)(3): violated Reg. D, as long as the securities were subject to the resale limitation (i.e.,
Restricted Securities contractually).

144(a)(3)(iii) Rule 144A

Securities acquired in a transaction or chain of transactions meeting the requirements of
Rule 144A.

144(a)(3)(v) Foreign Offerings

Equity securities of domestic issuers acquired in a transaction or chain of transactions
subject to the conditions of 901 or 903 under Reg. S

144(a)(3)(viii) -- 4(a)(6) Crowdfunding

Securities acquired from the issuer in a transaction subject to an exemption under 4(a)(6)

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Rule 144 Conditions

Rule 144(c):
Adequate current public information about the issuer must be available.
o Such information will be deemed available if:

Rule 144(c)(1): Reporting Issuers

144(c): The issuer must have been a Reporting Company for at least 90 days before the sale, and
Current o (i) Filed all required reports during the 12 months preceding the sale
Public Info Rule 144(c)(2): Non-Reporting Issuers
There must be information about the issuer publicly available (i.e., Annual Report)
o Make sure the information is truly publicly available!
For instance, the issuers Annual Report may have been sent exclusively to shareholders. To be
publicly available, the Annual Report must be on the issuers website.

Rule 144(d)(1)(i): Reporting Issuers

If the issuer is a Reporting Company (for at least 90 days before the sale),
o Then 6 months must have elapsed since any purchase from the issuer or an affiliate of the issuer before
144(d): the securities can be re-sold.
Holding Period Rule 144(d)(1)(ii): Non-Reporting Issuers
If the issuer is a Non-Reporting Company (or has not been a Reporting Company for 90 days before sale),
o Then, 12 months must have elapsed since any purchase from the issuer or an affiliate of the issuer
before the securities can be re-sold.

144(e): Rule 144(e)(1):

Limitation on The amount of any securities sold within the past 3 months shall not exceed the greatest of:
Amount of o (i) 1% of the outstanding shares as shown by the issuers most recent report, OR
Securities Sold o (ii) The average weekly trading volume in such securities on a national securities exchange.

144(f):
Rule 144(f)(1)(i):
Manner of Sale The securities must be sold through a Brokers Transaction within the meaning of 4(a)(4).
o Basically, a broker must facilitate the transaction, but cannot solicit orders.

Rule 144(g):
In a Brokers Transaction, the broker must:
o (1) Must do no more then execute the order as agent for the person for whose account securities are sold,
o (2) Receive no more than the usual brokers commission,
o (3) With certain exceptions (see statute), the broker cannot solicit the customers order, and
o (4) Perform a reasonable inquiry into whether the seller is an underwriter
i.e., whether the transaction is in connection with a distribution

75
 Reasonable inquiry includes asking the seller and having knowledge of the information provided in
the required 144(h) notice.

Rule 144(h):
144(h):
If the amount of securities sold in reliance of Rule 144 during the past 3 months exceeds
Notice of o 5,000 shares or $50,000
Proposed Sale Then copies of a notice on Form 144 shall be filed with the SEC.

Rule 144A Safe Harbor for Private Resales of Securities to Institutions

Rule 144A
If any person other than the issuer (i.e., dealer or underwriter) re-sells a security that satisfies the conditions of
In General Rule 144A, then such transaction is not a distribution.
o Therefore, under 4(a)(1) the transaction is exempt from registration because it does not involve an issuer,
underwriter, or dealer.

Rule 144A(b): Sales by Persons Other Than Issuers or Dealers

Any person, other than the issuer or a dealer, who offers or sells securities in compliance with this Rule shall not
be deemed to be engaged in a distribution.
o Therefore, such person is not an underwriter within the meaning of 2(a)(11) and 4(a)(1).

Eligible
Rule 144A(c): Sales by Dealers
Sellers
Any dealer who offers or sells securities in compliance with this Rule shall not be deemed to a participant in a
distribution of such securities within the meaning of 4(a)(3)(A) and not an underwriter within the meaning of
2(a)(11).
o Therefore, under 4(a)(1) the transaction is exempt from registration because it does not involve an issuer,
underwriter, or dealer.

Rule 144A(d) Conditions

Rule 144A(d)(1):
The securities must only be sold to a Qualified Institutional Buyer (QIB) or to a purchaser that the seller
reasonably believes is a QIB.
Sold only to
QIB Rule 144A(a)(1): QIB Defined
An entity that owns and invests on a discretionary basis at least $100 million in securities of issuers that are not
affiliated with the entity.

Rule 144A(d)(2):
Seller takes
The seller must take reasonable steps to ensure that the seller may rely on the exemption provided by this
Reasonable
section.
Steps o Easy condition to meet

Non- Rule 144A(d)(3):

Fungibility If the security is already trading on a stock exchange, then Rule 144A is NOT available.

Right to
Rule 144A(d)(4):
Obtain Info If issuer is a Non-Reporting Company, then buyer must have a right (i.e., contractual right) to obtain info about
76
 the issuer.
o If issuer is a Reporting Company, then 144A(d)(4) does not apply.

Rule 144A(e) Integration Safe Harbor

Rule 144A(e):
Offers and sales of securities pursuant to this Rule do not affect any exemption or safe harbor relating to:
Integration o Any previous or subsequent offer or sale of securities by the issuer or subsequent holder.
Safe Harbor Example:
o If the issuer sells to someone and that next day the buyer re-sells to a QIB, then the re-sell doesnt affect the
prior offerings exemption. No come to rest issues.

4(a)(7) Exemption for Resales to Accredited Investors

4(a)(7)(d)(4):
Eligible
Issuers and their subsidiaries are disqualified from the exemption.
Sellers o Therefore, the 4(a)(7) exemption is only available to sellers other than the issuer.

4(a)(7)(d)(1):
Eligible
Each purchaser must be an Accredited Investor as defined in Rule 501(a).
Purchasers o See page 51

4(a)(7)(d)(2):
No General
Seller is prohibited from offering or selling securities by any form of general solicitation or general advertising.
Solicitations o Pre-existing Relationship is required!

4(a)(7)(d)(3):
Seller to If the issuer is a Non-Reporting Company, then the seller shall provide the purchaser with the information listed
Provide Info in 4(a)(7)(d)(3)(A) (K).
o If the issuer is a Reporting Company, then this requirement does not apply.

Covered Securities sold pursuant to 4(a)(7) are covered securities under 18(a)(4) of the Securities Act.
Securities Therefore, State registration requirement are preempted for these resales.

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 RECAPITALIZATIONS, REORGANIZATIONS, & ACQUISITIONS

In General
Up To This Point . . .
The securities transactions studied have involved orthodox financing transactions.
o Issuer seeks fresh capital by issuing securities.

Here . . .
Securities are also issued in Recapitalizations, Reorganizations, Acquisitions, and Distributions of Dividends.
o Recapitalizations
Exchange of one type of security for another (i.e., security holder converts debt for equity)
o Reorganizations
Exchange of securities for outstanding claims (i.e., Company in BK)
o Acquisitions
Company issues its securities to an acquired companys stockholders
o Distribution of Stock Dividends
Company declares a stock dividend

Are these transactions subject to the provisions of 5?

o 2 Issues:
(1) What constitutes a Sale?
2(a)(3) Defines Sale
o Every attempt . . . to dispose of . . . a security . . . for value
(2) If Sale, then possible exemption for exchanges.
3(a)(9) Exemption for Exchanges
o Exchange = Sale
Any security exchanged by the issuer with its existing security holder
exclusively where no commission or other remuneration is paid or given
directly or indirectly for soliciting such exchange.

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 2(a)(3): For Value Requirement

5:
The expressions sale and offer to sell are very important in the operation of 5.

2(a)(3):
In General Defines Sale and Offer to Sale
o Every attempt . . . to dispose of . . . a security . . . for value
For Value
Requires an exchange of a security for something that has value.

If a security were given away for free, then such transaction would not appear to be a sale because the security is not
being exchanged for value.
HOWEVER, a gift of securities is said to be exchanged for value when it is given as part of a plan that will lead
to the distribution of securities.

Free Stock Examples

o If an individual fills out a questionnaire, then the issuer will give the individual free stock.
Security was issued in exchange for the information, which has value, and therefore a sale occurred.
o If an issuer gives away free stock for no reason, then a sale has occurred.
Security was issued in exchange for the creation of a market to boost subsequent sales, which has
value, and therefore a sale occurred.

If an issuer declares a stock dividend, then no sale has occurred.

The issuer is providing stockholders with a dividend but receiving nothing in return.
o Therefore, no sale has occurred because a security has not been disposed of in exchange for value.

Stock
If an issuer offers stockholders a choice between (1) cash dividend or (2) stock dividend, then no sale has occurred.
Dividends
It would appear that issuer is disposing a security in exchange for value because the stockholder is receiving one
type of dividend in exchange for giving up the other type of dividend.
o However, when the issuer offers these two types of dividends separately no sale occurs.
Therefore, the SEC has said that when a simultaneous choice is given no sale occurs either.

Material
If the issuer makes a material change to the rights of existing securities, then a sale has occurred.
Change to i.e., a security is disposed in exchange for the material change in rights and therefore a sale.
Rights of
Existing Material Change
Securities Any change in rights that has economic consequences for the holders
o Amendment to AoI
Change in voting rights, dividend rights, common stock convertible into preferred stock, etc.
Note: If convertible stock is immediately convertible, then must register both stocks
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 Non-Material Change
Material change in rights of existing security solely because the issuer reincorporated in a new State is NOT a
sale.

3(a)(9): Exemption for Exchanges

When an issuer disposes a security in exchange for another security, a 2(a)(3) sale occurs because a security
was disposed of in exchange for value.
If the conditions of 3(a)(9) are satisfied, such transaction may be exempt from 5.
In General
3(a)(9):
Any security exchanged by the issuer with its existing security holder exclusively where no commission or
other remuneration is paid or given directly or indirectly for soliciting such exchange.

By the Issuer The exchange transaction must involve the issuer of the securities

Exclusively modified 3 things:

1. The transaction must exclusively involve securities (i.e., no money involved)
Rule 149: Equitable Adjustment
o Allows for an equitable adjustment for dividends or interest between security holders of
the same class. (No equitable adjustment allowed between shareholder and issuer!)

2. The transaction must be exclusively limited to the issuer and existing security holders
Exclusively Integration issue?
o If issuer is making an exchange with existing shareholders and also making an offering to a
third party, then apply 5 Factor Test to determine whether it is part of the same transaction.

3. The transaction must be exclusively limited to the issuers securities

Acme Acme Stock Acme Bondholders Acme Bonds Acme
o Exempt under 3(a)(9)
Acme IBM Stock Acme Bondholders Acme Bonds Acme
o Not exempt under 3(a)(9) because transaction involves IBM securities

No Payment If any person solicits existing shareholders for the exchange, then such person cannot be compensated.
for Soliciting Example
the Exchange o Issuer cannot hire an attorney to tell existing shareholders the tax benefits of an exchange.

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 LIABILITY UNDER THE SECURITIES ACT

11: False or Misleading Registration Statement

Scope

Scope of 11
Notes:
Any part of the registration statement, Does not apply to exempt offerings
o Requires a Registration Statement
When such part became effective,
Only applies to final prospectus, not
11(a) Contained an untrue statement of a material fact, or
preliminary prospectuses.
Omitted to state a material fact required to be stated therein o When Effective
or necessary to make the statements therein not misleading Ask:
o Is the registration statement false or
misleading on the effective date?

11 Plaintiffs

11(a):
Any person acquiring such security
Who Can Sue? o Therefore, any person who purchases a security pursuant to a defective registration statement has
standing to sue under 11
Unless, the purchaser has aware of the untruth or omission at the time of purchase.

11(a):
Any person acquiring such security
Tracing
o Therefore, plaintiff must trace the securities purchased to the registration statement is question.
Requirement Easy to prove when there is only 1 registration statement (Hertzberg v. Dignity Partners, Inc.)
Almost impossible to prove when securities are traded on an exchange

No Reliance
Plaintiff need not show reliance on the defective registration statement.
Requirement

No Causation
Plaintiff need not show that the defective registration statement caused an injury.
or Injury
The principal objective of 11 is deterrence, not just compensation
Requirement
Statute of
Limitations 13: SoL

81
 No action may be brought 1 year after the untruth or omission was discovered or should have been discovered

11 Defendants

11(a)(1) (5):
Lists possible defendants in a 11 action
11(a)(1):
Every person who signed the registration statement.
o Form S-1 requires certain signatures:
Registrant (i.e., Issuer), Officers, and a majority of the BoD (if no BoD, the equivalent)

11(a)(2):
Every person who was a director of the issuer at the time of filing.
o If no director, then persons performing similar functions.
Who Can Get
Sued? 11(a)(3):
Every person who, with his consent, is named in the registration statement as being or about to
become a director (or person performing similar function).
11(a)(4):
Experts preparing reports in connection with the registration statement are only liable with respect
to the portions prepared by them.
o Accountants, auditor, appraiser, etc.

11(a)(5):
Every underwriter with respect to such security.

11 Defenses

11(a):
Purchaser
If the defendant can prove that the purchaser had knowledge of the fraud at the time the securities were
Knew
acquired, then no liability.

Issuer = 11(b):
Strictly Liable The 11(b) defenses are not available to the issuer and therefore the issuer is strictly liable for the fraud.

Due Diligence
11(b)(3)(A): Non-Expert Portions
Defenses
If, after a reasonable investigation, the defendant
had reasonable ground to believe and did believe
that the registration statement was free from fraud
at the time of effectiveness, then not liable.
11(b)(3)(B), (C): Expert Portions
(B) Expert Portion Relied on by Expert
If, after a reasonable investigation, the defendant
had reasonable ground to believe and did believe
that the registration statement was free from fraud

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Notes:
Reasonable Investigation Requirement
If defendant knew about the fraud, then they did
not believe the registration statement was free
from fraud and therefore liable.
at the time of effectiveness, then not liable.
(C) Expert Portion Relied on by Non-Expert
Non-expert defendants may rely on portions of
the registration statement prepared by experts
without incurring liability so long as they did not
know about the fraud at the time the registration
statement became effective.

What is Due Diligence? The 11 Reasonable Investigation Requirement

Escott v. BarChris Construction What is a Reasonable Investigation?

Audited financial statements in the registration statement were misleading.

Facts Two Parts:
o (1) Expert Portions (i.e., audited financial statements), & (2) Non-Expert Portions (i.e., everything else)

Issue Who is liable for the fraudulent registration statement?

11(a)(1) (5): Defendants

Lists possible defendants in a 11 action

11(b)(3)(A): Non-Expert Portions

If a defendant can establish that after a reasonable investigation they had no reasonable grounds to believe the
registration statement contained fraud, then they are not liable for portions of the registration statement
prepared by non-experts.
Rule
11(b)(3)(B): Expert Portion Relied on by Expert
If after a reasonable investigation, they had no reasonable grounds to believe the portion of the registration
statement prepared under their authority was free from fraud, then not liable.
11(b)(3)(C): Expert Portion Relied on by Non-Expert
Non-expert defendants may rely on portions prepared by experts without incurring liability, so long as they
did not know about the fraud.

Application
BarChris Construction
Proper Defendant? Yes, as a signatory of the registration statement. 11(a)(1)
Due Diligence Defense? No, the 11(b) due diligence defense are not available to the issuer. 11(b)

Russo (CEO) & Kircher (CFO)

Proper Defendant? Yes, as signatory of the registration statement. 11(a)(1)
Due Diligence Defense? No, because these people had actual knowledge of the fraud. 11(b)(3)(A)-(C)

Directors
Proper Defendant? Yes, every person who was a director at the time of filing. 11(a)(2)
Due Diligence Defense?
o Yes, Non-Expert Portions = Reasonable Investigation 11(b)(3)(A)
o Yes, Expert Portions = No Reasonable Investigation 11(b)(3)(C)

Auditors
Proper Defendant? Yes, experts preparing reports for the registration statement. 11(a)(4)
Due Diligence Defense?

83
 o Yes, Export Portions Prepared by the Expert = Reasonable Investigation. 11(b)(3)(C)
o Only liable for portions prepared under the authority of the expert. 11(a)(4)

Grant (Director)
Did an investigation of sorts Asked Russo and Kircher some questions
What is a
Not sufficient b/c Grant had access to info that could have allowed him to check on Russo/Kirchers answers
Reasonable o Must go beyond merely asking questions.
Investigation o Must look at the underlying documents
? How far must one go? Facts and circumstances!
o More was expected of Grant because he was a lawyer and spent a lot of time drafting the reg. stmt.
More is expected on general counsel and inside directors than outside directors.

WorldCom, Inc Underwriters due diligence defense in Shelf Registration

Shelf Registration significantly reduces the time and expense necessary to prepare for public offerings
At the same time, shelf registration also significantly reduces the amount of time underwriters have to perform
In General their due diligence of the issuer.
o As a result, SEC introduced Rule 176 to set forth standards of a reasonable investigation.
However, Rule 176 clearly does not eliminate the reasonable investigation requirement

Shelf Registration
Underwriters due diligence defense
o Still must conduct a reasonable investigation
Rule Due to the time constraints, this essentially makes underwriters strictly liable because they have no
time to conduct an investigation when the issuer decides to sell.
As a result, underwriters have increased their prices.

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Damages

11(e): The Measure of Damages

11 begins with a presumption that the measure of damages are based upon the difference between:

The amount paid for the security (not to exceed the offering price), and

o (1) Its value at the time of suit, OR

o (2) The consideration received on resale if the security was sold before the suit, OR
Calculating
Damages o (3) The consideration received if the security was sold after suit, but before judgment, if that would
produce a lesser measure than that stated in (1)
Note:
Note the use of the term value, not market price
o This allows a party to argue that the market price at the time the suit was filed was improperly inflated
or deflated in order to claim a larger recovery or mitigate damages.
However, it is very rare for the value to be different from market price
McMahan & Co. v. Warehouse Entertainment

11(e): Negative Causation Defense

The 11(e) calculation of damages may be reduced to the extent the defendant can prove that the drop in
price was caused by something other than the fraud.
11(e):
Ackerman v. Oryx Communications Inc.
Negative
The defendant may prove that the drop in price was due to a variable other than fraud with statistical studies
Causation
of market performance during the relevant time period.
Defense o However, a broad analysis of the defendants company performance against the entire market is not
sufficient.
o The statistical study must evaluate the performance of the defendants company in relation to the stock
of companies possessing common characteristics (i.e., industry, product, assets, revenue, etc.)

11(f)(1): In General

In general, 11 defendants are subject to jointly and severally liable for damages.
o Therefore, any one defendant is subject to the burden of the entire measure of damages.
Joint & Several 11(f)(2)(A): Outside Directors
Liability
The liability of an outside director is determined by 21D(f)(2) of the Exchange Act.
o (B)(i): If outside director had knowledge of the fraud, then liable.
o (B)(ii): If outside director did not have knowledge of the fraud, then liable according to the percentage
that they were responsible for the fraud.

Indemnificatio
11(f)(1): Indemnification & Contribution
85
 Two Approaches:
o Comparative Fault
Divides responsibility according to relative blameworthiness
n& o Per Capita
Contribution Divides responsibility equally

21D(f) Exchange Act

o Comparative fault applies to outside directors

12(a)(1): Liability for Any Offer or Sale in Violation of 5

In General

12(a)(1):
12(a)(1): Any person who offers or sells a security in violation of 5 . . .
Rule Shall be liable to the person purchasing (if sale 12(a)(1) does not apply!) such security from him . . .
For the consideration paid for such security.

Offers or Sells
Pinter v. Dahl says that within the definition of 12(a)(1), a person is deemed to make an offer or sale, if:
o The title owner of the securities passes title to the purchaser, or
o Makes a solicitation to buy . . . for value
To satisfy the for value requirement, the solicitation to buy must be
To advance the solicitors own financial interests, or
To advance the financial interests of the securities owner.

In Violation of 5
Requirements Must be a security subject to the registration requirement of 5
for Liability o i.e., non-exempt security, no transaction exemption available

Liable to the Purchaser

Liable to the person purchasing such security.
o Therefore, only liable to the person an offer or sale was made, not to those who purchased from
another underwriter.
NOTE:
If a person is merely performing ministerial acts or drafting materials in which such person has no control of
the content, then a solicitation has not been made and therefore 12(a)(1) liability will not attach.

Plaintiff Must Show:

There was a violation of 5,
An offer or sale had been made to the plaintiff,
Plaintiffs The plaintiff purchased the security, and
The action had been brought within the 1 yr. SoL of 13.
Burden
Plaintiff Need Not Show:
Intentional violation of 5 (this is strict liability), or
Injury

The Remedy
Rescission:
If purchaser still owns the security, then may recover consideration paid in the original transaction.
If purchaser has disposed of the security, then may recover the difference between the price paid and the

86
 amount received in the subsequent sale.

Pinter v. Dahl Defines Offer or Sells in 12(a)(1)

Pinter owns a company offering unregistered securities

Dahl purchases some of Pinters securities
Dahl goes around telling all his buddies how great this investment opportunity is
As a result, some of Dahls buddies also purchase the securities
Facts
Pinters company fails
Dahl and all of the investors sue Pinter under 12(a)(1) seeking to rescind their purchases
Pinter brings counterclaim against Dahl
Pinter alleges that Dahl should share in the liability because he offered or sold to his buddies

Issue Whether Dahl was a seller of securities

12(a)(1):
Rule Any person who . . . offers or sells a security in violation of 5 shall be liable to the person purchasing
securities from him.

12(a)(1): Imposes liability on the owner who passed title to the buyer for value.
Dahl was not the owner of the securities
o Therefore, Dahl is only liable if 12(a)(1) extends to persons other than the person passing title.

2(a)(3): Defines offer to include solicitation of an offer to buy . . . for value.

Therefore, it appears Congress intended 12(a)(1)s prohibitions against offers that violate 5 to include
solicitations to buy
o However, a mere solicitation to buy is not enough. The solicitation must be in exchange for value.
Thus, a person who gratuitously urges another to make an investment is not requesting value in
exchange for his suggestion.
Application
The language and purpose of 12(a)(1) suggest that liability only extends to the person who successfully solicits the
purchase, motivated in part by a desire to serve his own financial interests or the financial interests of the owner.
What were Dahls motivations?
o Pinter did not pay Dahl a commission
But this is not conclusive
o District Court concluded that Dahl was motivated by a gratuitous desire to share an attractive investment
opportunity with his friends.
SCOTUS remands this decision
District court needs to make a finding on whether Dahl urged the other purchasers in order to
further some financial interest of his own or of Pinter.

Takeaway
Within the definition of 12(a)(1), a person is deemed to make an offer or sale, if:
The title owner of the securities passes title to the purchaser, or
Makes a solicitation to buy . . . for value
o Value =
87
 To advance your own financial interest, or
To advance the financial interests of the securities owner.

12(a)(2): Offers or Sales of a Security by means of a Fraudulent Prospectus or Oral Communication

In General

12(a)(2):
Any person who offers or sales a security
12(a)(2):
By means of a materially false or misleading prospectus or oral communication
Rule Shall be liable to the person purchasing (if a sale occurs, 12(a)(2) does not apply!) from him
For the consideration paid for such security

Offers or Sales
Pinter v. Dahl --
o Person from whom title passes, or
o Person who solicits to serve
His own financial interest, or
Requirements Sellers financial interest
for Liability
Prospectus or Oral Communication
Gustafson
o 12(a)(2) is limited to Public Offerings by the issuer or controlling shareholder
o Prospectus = 10(b) Prospectus
i.e., Rule 433 Free Writing, Rule 430 Preliminary, or Rule 431 Summary

Rescission
If purchaser still owns the security, then may recover consideration paid in the original transaction.
The Remedy
If purchaser has disposed on the security, then may recover the difference between the price paid and the
amount received in the subsequent sale.

12(a)(2): Reasonable Care Defense

Any person who did not know, and in the exercise or reasonable care could not have known of such untruth or
omission.
o Is a reasonable investigation required?
The Defenses Depends on the circumstances

12(b): Negative Causation Defense

The 12(a)(2) calculation of damages may be reduced to the extent that the defendant can prove that the drop
of price was caused by something other than the fraudulent prospectus or oral communication.

Rule 159A
Rule 159A:
If the issuers communications are used to solicit, the issuer may be liable because they made an offer within
the meaning on Pinter as a person who solicits to serve his own interest.
o Must be in the primary offering of securities of the issuer.
Debate over whether this includes resales. Probably includes resales if resale occurs before the
security has come to rest because the resale may still be considered part of the issuers primary
88
 offering.

By Means of a Prospectus or Oral Communication When does 12(a)(2) apply?

Gustafson v. Alloyd Co. -- 12(a)(2) Applies to Public Offerings
12(a)(2):
Gives buyers the right of rescission when sellers make material misstatements or omissions by means of a
prospectus
o The issue is whether 12(a)(2) extends to a private, secondary transaction, on the theory that the recitations
in the purchase agreement are part of a prospectus

In General Is the contract between Alloyd and Gustafson a prospectus?

Alloyd:
o Argues that prospectus is defined broadly enough to cover the contract
i.e., prospectus means any written communication
Gustafson:
o Argues that prospectus means a communication soliciting the public
i.e., prospectus means the information contained in the registration statement

2(a)(10):
Defines Prospectus

10:
Rules
Sets forth the information required in a prospectus

12(a)(2):
Imposes liability based on misstatements or omissions in a prospectus

10:
There is no dispute that the contract in this case was not required to contain the information in a registration
statement because it was a private offering and therefore a registration statement did not exist.
o Only public offerings require a registration statement
Thus, a 10 prospectus is limited to the documents related to a public offering
Prospectus means the same thing in 12 as it does in 10.

2(a)(10):
The term prospectus means any prospectus, notice, circular, advertisement, letter, or communication, written or
Analysis
by radio or television, which offers any security for sale of confirms the sale of any security.
o Alloyd focuses on the word communication.
Any written communication that offers or security for sale is a prospectus and that this definition
should be inserted into 12.
o SCOTUS says that the word communication is but one word in a list.
From the terms prospectus, notice, circular, advertisement, or letter, it is apparent that the list refers to
documents of wide dissemination.
Including the term communication in that list suggests that it too refers to pubic
communication

Conclusio
The word prospectus refers to documents that describes a public offering
n
89
 The contract of sale, and its recitations, were not held out to the public and therefore not a prospectus.

Note:
Gustafson leaves open an important question:
o What is a public offering for purposes of 12(a)(2)?
See Hyer v. Malouf

Hyer v. Malouf What is a Public Offering?

Plaintiff alleges defendant solicited funds from plaintiff for real estate investment
Such solicitations consisted of oral and written communications
o Written communications included project offerings that outlined the merits of the investment

Real estate project was never constructed

Facts Plaintiff sues under 12(a)(2), alleging:
o Defendant made false statements and material omissions of fact in prospectuses and in oral
communications in connection with the plaintiffs purchase.
Defendant argues:
o Complaint fails to state a claim for relief under 12(a)(2) because it does not allege a public offering.

Issue Whether the offering was a public offering

12(a)(2):
Provides a cause of action to a purchaser of a security against one who offers or sells a security by means of a
prospectus or oral communication that includes an untrue statement or omission of material fact.

Gustafson v. Alloyd
Held that the phrase by means of a prospectus limits the reach of 12(a)(2) to public offerings.
o Specifically, the court held that the term prospectus, as found in 10 and 12 is confined to a
Rule
document that must include the information contained in a registration statement.

Ralston Purina
Whether an offering is public or private turns on whether the particular class of persons affected needs protection
of the Act.
o An offering to those who can fend for themselves is not a public offering.
Sophistication and Access to Information

The public offering analysis is fact intensive and requires inquiry into each investor to determine whether they are
sophisticated and have access to information.
Held
Therefore, further discovery is necessary to determine whether each of these offerees has access to the type of
information in a registration statement.

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 17(a): SEC Enforcement against Fraudulent Offers or Sales

In General

17(a)(1):
Makes it unlawful to employ any device, scheme, or artifice to defraud.
o Scienter (intentional misconduct) required

Aaron v. SEC: 17(a)(2):

Prohibits any person from obtaining money or property by means of any untrue statement of a
General Rule material fact or any omission to state a material fact.
& o No scienter (intentional misconduct) required
Intent Requirements
17(a)(3):
It is unlawful for any person to engage in any transaction, practice, or course or business which
operates or would operate as a fraud or deceit.
o No scienter (intentional misconduct) required

In re Washington Public Power Supply System Securities Litigation

No Private Right of
No private right of action under 17(a)
Action o SEC enforcement tool only

United States v. Naftalin

17(a) is not limited to fraud in distributions. It covers all offers and sales, including fraud in ordinary
Focuses on the
trading transactions (unlike 10b-5).
Selling Side o Only covers fraud by the offeror or seller, not the buyer.
Thus, if a purchaser defrauds the sellers, then 17(a) does not apply.

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 INQUIRIES INTO THE MATERIALITY OF INFORMATION
In General

Securities Laws recognize that is it not practicable for Issuers to disclose everything to potential investors.
However, the Antifraud Rules ( 11, 12, 17) prohibit Issuers from withholding Material information.
Scope o Example: 12(a)(2) prospectus which includes an untrue statement of material fact . . .
Therefore, liability under the Antifraud Rules turns on whether information is material.

If info is deemed material, silence does not violate the Antifraud Rules unless there is a duty to disclose.
Example of an Affirmative Duty to Disclose:
o Regulation S-K Item 103 Describe any material pending legal proceedings.
Silence
Duty to Disclose? Disclosure Requirements Two Questions:
1. Is a fact material?
2. Is there a duty to disclose the fact?

Materiality Determination:
There are 2 points in time when a person must decide whether something is material
1. Time of Disclosure, and
2. Litigation
Time of Disclosure
Hindsight Bias It is often very difficult to determine whether something is material in the heat of the moment

Litigation
Court has hindsight.
o Hindsight Bias Easier to determine something is material after the market has already reacted.
Error on the side of caution and disclose unless there is an important business reason not to

What is Materiality?
TSC Industries, Inc. v. Northway

TSC Industries, Inc. v. Northway Materiality Standard

Rule: A false statement or omission is material, if
What is Material? o There is a substantial likelihood that a reasonable shareholder would consider it important in
deciding how to [vote, buy, sell, hold, etc.].

Objective Standard
In General:
Whether an omitted fact is material is determined based on an objective standard.
o Therefore, the relevant inquiry is whether a reasonable investor would consider the omitted fact
important in light of the total mix of information available.
Face-to-Face Omissions:
As a result, a face-to-face omission must not be deemed material based on the subjective value a single
person assigns to a piece of information.

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 o Rather, the omission must the judged against an objective standard that looks to whether a
reasonable investor would consider the omitted fact important in light of the total mix of
information available.

Important Important = Significantly altered the total mix of information made available.

The Total Mix of Information and Market Efficiency

TSC Industries v. Northway Materiality Standard

Total Mix An omitted fact is material if there is a substantial likelihood that a reasonable shareholder would consider it
important in deciding how to [vote, buy, sell, etc.]
o Important = If the omission would significantly alter the total mix of information available.

Wielgos v. Commonwealth Edison Co. Truth on the Market

Truth on the
If information is public, then the market has already accounted for the information and therefore considered to
Market
be in the total mix of information because markets are assumed efficient.
Doctrine o As a result, any false statement or omission cannot be deemed material when the underlying facts of the
statement are public information.

Eisenstadt v. Centel Corp. Puffery is immaterial

If a statement is made that a reasonable investor, under the circumstances, would dismiss, then the statement is
immaterial as mere puffery.
Puffery o Example:
In Eisenstadt, corporation stated negotiations were going smoothly despite underlying problems.
Court held statement was mere puffery and therefore immaterial because a reasonable investor,
under these circumstances, would expect the corporation to make this statement.

Omitting Speculative Information & Materiality

Basic Inc. v. Levinson

Basic Inc. v. Levinson Materiality of Speculative Information

Applying the materiality standard in TSC Industries to speculative information, Basic Inc. says that
Predicting the Future: o An omitted statement regarding speculative information is material if there is a substantial
Is Speculative likelihood that a reasonable investor would consider it important in deciding how to [vote,
Information Material? buy, sell, etc.].
The Probability and Magnitude Test is applied to determine whether the information is
important. (i.e., substantially alters the total mix of information available)

Probability + Magnitude
Rule:
Test Under the Probability and Magnitude Test, materiality will depend upon a balancing of both the
indicated probability that the event will occur and the anticipated magnitude of the event.

Material?
High Probability + High Magnitude = Clearly Material
Low Probability + Low Magnitude = Clearly Immaterial
If one is high and the other is low = Unclear
o Two Options:

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 Error on the side of disclosure (Hindsight Bias), or
Silence
To be actionable, a statement must be misleading and silence is not misleading
unless there is a duty to disclose.

Opinion Statements, Omissions Relating to an Opinion, & Materiality

Omnicare, Inc. v. Laborers

Omnicare Prospectus:
Facts
We believe . . . [our contracts] . . . are in compliance with applicable federal and state laws.

Anti-Fraud Rules:
Rule . . . Contained an untrue statement of material fact or omitted to state a material fact required to be
stated therein or necessary to make the statements therein not misleading . . .

Issue #1: To be liable for a statement of opinion the plaintiff must show:
Liability for an Untrue The statement was subjectively false (i.e., person making the statement didnt believe it), and
Statement of Opinion The statement was objectively false (i.e., the statement turned out to be indeed false).

Issue #2:
To be liable for an omission relating to an opinion, the statement must be (1) misleading & (2) material
Liability for an (1) If the opinion is not grounded in any reasonable basis, then it is misleading.
Omission Relating to an (2) To be material, the omission, if disclosed, must change the total mix of information.
Opinion

Forward-Looking Statements & Materiality

Kaufman v. Trumps Castle Funding

Predictions or Forecasts of the Future -- Forward-Looking Information

Example:
o Income will be 10% higher next year
Issue:
o What if the prediction turns out wrong? Liable?
In General Liable, if:
o Prediction is subjectively false, OR
o There is a material omission relating to the statement
Material?
The Bespeaks Caution Doctrine is applied to determine whether an omission relating to a
prediction is a material omission.

The Bespeaks Caution Doctrine

If meaningful cautionary language accompanies a forward-looking statement, then an omission related to such
Bespeaks statement is deemed immaterial because the cautionary language is included in the total mix of information.
Caution
Doctrine What is Meaningful Cautionary Language?
Cautionary language is sufficient when it is tailored precisely to address the forward-looking statement.
o A vague or blanket (boilerplate) disclaimer that merely warns of generalized risks is not sufficient.

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Forward-Looking Information Safe Harbors

Securities Act 27A and Exchange Act 21E

Provide a statutory safe harbor for certain forward-looking statements made by companies subject to the
Exchange Acts reporting requirements.
In General
o Purpose
Fear that private suits were too often brought against innocent corporations for forward-
looking statements regarding their performance or their products.

27A(i)(1) Forward-Looking Statement Defined

(A) Projections of revenues, income earnings per share, capital expenditures, dividends, etc.
Forward-Looking (B) Plans and objectives for future operations
Statement (C) Future economic performance
Defined (D) Any statement of assumptions underlying any statement made in (A)-(C)
(E) Reports made by third parties (retained by issuer) making a statement of behalf of the issuer
(F) Projections or estimates of any other items as specified by rule or regulation of the SEC

27A(a) This section only applies to forward-looking statements made by:

(1) An issuer that is a Reporting Company

When it Applies (2) A person acting on behalf of such issuer
(3) An outside reviewer (retained by the issuer) making a statement on behalf of the issuer
(4) An underwriter, with respect to info provided by or derived from the issuer

27A(b)(1) This section does not apply to any forward-looking statements from an issuer

(A) If the issuer has been a bad actor during the past 3 years
(B) If the issuer makes the statement in connection w/ offering of securities by a blank check company
(C) If the issuer issues penny stock
When it Does (D) If the issuer makes the statement in connection with a rollup transaction
NOT Apply (E) If the issuer makes the statement in connection with a going private transaction

27A(b)(2) This section does not apply to a forward-looking statement that is

(A) Included in a financial statement prepared in accordance with GAAP (i.e. balance sheet/income stmt)
(D) Made in connection with a initial public offering (IPO)

Safe Harbor
27A(c)(1) In General
Except as provided in subsection (b), in any private action arising under this Act, a person referred to in
subsection (a) shall not be liable with respect to any forward-looking statement to the extent that . . .
(c)(1)(A) -- Written Forward-Looking Statements
(i) The forward-looking statement is identified as such (need not be expressly identified, an opinion is
enough. Asher v. Baxter) AND accompanied by (efficient market. Id.) meaningful cautionary
statements, OR
(ii) Immaterial, OR
(c)(1)(B)(i)-(ii) The plaintiff fails to prove that the forward-looking statement was made with actual
knowledge that it was false or misleading.
(c)(2) Oral Forward-Looking Statements
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 (A)(i)-(ii) The forward-looking statement is accompanied by a cautionary statement that identifies the
forward-looking information as such AND states that actual result may differ
(B) If the cautionary statement is not accompanied with the forward-looking statement, then there must
be a readily available written document (i.e., Form 10-K).

Duty to Disclose Material Non-Public Information?

Material Omissions of Non-Public Information:

To be actionable under Rule 10b-5, a statement must be misleading
o Silence, absent a duty to disclose, is not misleading.

When is there a duty to disclose?

In General Half-Truths
Duty to Correct v. Duty to Update
Disclose or abstain from trading
Periodic disclosures required by the 34 Act
Fiduciary duty may give rise to a duty to disclose

Half-Truths An affirmative duty to disclose arises when omitted information would render a statement misleading.

There is an affirmative duty to correct mistakes.

Duty to Correct If a statement is false, but it wasnt known to be false at the time it was made, then there is a duty to correct
the false statement when it is discovered to be false.

Circuit Split

In re Time-Warner Securities Litigation (2nd Circuit)

o When there is a change in circumstances that would render a statement misleading, then there is a duty
to disclose the update as long as the market is relying on the original statement.
Duty to Update
Gallagher v. Abbott Laboratories, Inc. (7th Circuit)
o So long as the statement was true at the time it was made there is no duty to update the original
statement.
Duty to disclose will arise with under the 34 Act periodic disclosure requirements
Be careful of half-truths when making future statements

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 FRAUD IN CONNECTION WITH THE PURCHASE OR SALE OF A SECURITY

Rule 10b-5

Rule 10b-5 Elements: Rule 10b-5:

Fraud Prohibits the use of an instrumentality of interstate commerce:
In Connection With o To employ a device, scheme, or artifice to defraud
The Purchase or Sale of Any Security o To make any untrue statement of a material fact or omit to
In General
state a material fact
o To engage in any act, practice, or business, which operates
as a fraud upon any person
In connection with the purchase or sale of any security

Ask:
Was an untrue statement made?
o Was it material?
Fraud Was there an omission?
o Was it material?
o Was there a duty to disclose?

3 Ways In Connection With has been interpreted:

1. Reasonably calculated (i.e., foreseeable) to influence the investing public
2. Fraud must touch the purchase or sale
3. Fraud must be an essential part of the securities transaction, not just incidental
Note:
In Connection The person making the fraudulent statement does not have to be on the other side of the transaction as the
With person purchasing or selling the security.
o Examples
CEO stands up and makes a false statement
May be liable b/c statement is reasonably calculated to influence investing public
Advertisements
Not directed towards investors but if it could be reasonably foreseeable that investors would
rely on it that may be enough.

The Purchase
Plaintiff:
or Sale of Any Must be a purchaser or seller
Security
Defendant:
Need not be a purchaser or seller
o No direct connection to plaintiff required

HYPO:
Smith is about to sell his Acme Corp stock
o Market Price = $45/share
Before Smith sells, Acme Corp announces a huge new order that will significantly increase revenue
o This announcement is a LIE!
As a result of the announcement, Smith decides not to sell
o Market Price = $30/share

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 Smith has no cause of action under Rule 10b-5
o Not a purchaser or seller

Scienter Requirement & Pleading Scienter

Ernst & Ernst v. Hochfelder

To be liable under Rule 10b-5, the defendant must have acted with scienter.
In General
o Actual Knowledge of the fraud, or
o Acted with recklessness and therefore should have known of the fraud

Scienter = Actual Knowledge of the Fraud or Intent to defraud

A mental state embracing intent to deceive, manipulate, or defraud. (i.e., Actual Knowledge or Intent)
o Negligence is not enough!
Actual Entity Scienter
Knowledge If an employee has actual knowledge (which some employee always will), does the entity have knowledge?
o If yes, then the entity is essentially strictly liable. Is that bad policy?
An entity has scienter if the people who have primary responsibility for preparing and authorizing the
statement (i.e., CEO, CFO, etc.) have actual knowledge.

Scienter = Recklessness or a Lack of Good Faith

An extreme lack of care constitutes scienter
Recklessness o Example
False statement made without any reasonable basis
I believe we are in compliance with all laws with no verification whatsoever

Exchange Act 21D(b)(1) Complaint Exchange Act 21D(b)(2) Scienter

Must list every statement that plaintiff is alleging is The complaint shall state with particular facts
a violation, giving rise to a strong inference that the defendant
List why its a violation, (i.e., why its misleading?), acted with the required state of mind.
If allegation is not based on actual facts, then the
complaint must state with particularly all facts on Tellabs, Inc. v. Makor Strong Inference
Pleading which the belief is formed. If a reasonable person would deem the inference of
Scienter scienter cogent and at least as compelling as any
opposing inference one could draw from the facts
alleged.
o Example
Based on the facts alleged, could a
reasonable person infer that the defendant
acted without actual knowledge or
recklessness? If so, no scienter.

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Transaction Causation (Reliance)

Transaction Causation (Reliance):

To be liable under Rule 10b-5, the plaintiff must show transaction causation.
o In other words, the plaintiff has the burden of establishing a causal connection between the
fraud and the purchase or sale.
But for the fraud, the purchase or sale would not have occurred.

In General Three Possible Ways to Show Transaction Causation:

Actual Reliance
o But for the fraud, a transaction would not have occurred.
Pure Omission Cases
o Reliance is not required in a pure omission case
Fraud on the Market
o Reliance is presumed when the fraud affects the market price

Actual Reliance:
When an investor is induced to purchase or sale a security in actual reliance on a fraudulent
Actual Reliance
statement, then transaction causation has been established.
o But for the fraud, a transaction would not have occurred.

Affiliated Ute Citizens v. United States

Transaction causation (reliance) is assumed when:
o The defendant owes the plaintiff a duty to disclose (i.e., fiduciary) material information, and
o Fails to disclose (remains completely silent).
Pure Omission Cases
Stoneridge Partners
The rule in Affiliate Ute Citizens is limited to pure omission cases.
o Therefore, a showing of reliance/transaction causation is still required when an affirmative
fraudulent statement or half-truth statement is made.

Fraud on the Market Theory:

The price of a companys stock is determined by the available material information.
o As a result, any public material misrepresentation affects the market price, which in turn affects
investors even if they do not directly rely on the fraud.
Therefore, an investors reliance on any fraud may be presumed because publicly available
information is reflected in market price.

Basic v. Levinson
Fraud on the Market
To establish a presumption of fraud on the market, the plaintiff must show:
o (1) The alleged fraud is publicly known/distributed,
o (2) The alleged fraud is material, and
o (3) The security is traded in an efficient market.

The defendant may rebut the presumption of fraud on the market by showing:
o The market knew that the statements were false (and therefore adjusted), or
o That the plaintiff had knowledge of the fraud (and therefore did not rely on the market)

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Loss Causation

Loss Causation:
21D(b)(4) of the Exchange Act burdens the plaintiff with establishing a causal connection between the fraud
and the loss or damages.
o In other words, did the fraud cause the loss or was it something else?
In General
21D(b)(4) Exchange Act:
In any private action arising under this Act, the plaintiff shall have the burden of proving that the act or
omission of the defendant alleged to violate this Act caused the loss for which the plaintiff seeks to recover.

AUSA Life Insurance Co. v. Ernst & Young

Loss causation requires that the loss be one of the foreseeable consequences of the misrepresentation
o Was it the fraud that caused the loss?
In this case, the fraud certainly induced investors to invest in the company (transaction
Face-to-Face
causation). However, it is unclear whether the fraud caused the bankruptcy (loss).
Transactions On one hand, the fraud allowed the company to acquire sufficient funds to make a poor
purchase that ultimately drove the company into bankruptcy.
On the other hand, it was not the fraud that caused the bankruptcy, but rather it was a poor
purchase that caused the bankruptcy.

Dura Pharmaceuticals Inc. v. Broudo

To establish loss causation, the plaintiff must show:
o The market price was artificially inflated due to a fraud (i.e., the market did not know),
o The fraud was disclosed/exposed, and
Open Market o The fraud caused the market price to drop
Transactions
Metzler Investment GMBH v. Corinthian Colleges, Inc. --- Application of Dura
Dura requires a disclosure of the fraud.
o The two public disclosures did not expose the alleged fraud. Therefore, the price drop was not related to
the fraud.

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Who is Liable?
Primary Liability
Rule 10b-5; The Maker of a Statement = Primary Liability

Under Rule 10b-5 it is unlawful for any person to MAKE an untrue statement of material fact in connection
with the purchase or sale of any security.
o Therefore, to be liable the defendant must have made the material misstatement.
Janus
Capital For purposes of Rule 10b-5, the maker of a statement is the person or entity with ultimate authority over the
statement, including its content and whether and how to communicate it.
o Therefore, a statement is only made by the person to whom it is attributed

One who prepares or publishes a statement on behalf of another is NOT its maker.

Secondary Liability
Who can bring an action against an Aider & Abettor?

No private right of action for aiding and abetting a violation of 10b-5. Central Bank
20(e) of the Exchange Act authorizes the SEC to bring an action against an aider and abettor
18 U.S.C. 2 imposes criminal liability for knowingly aiding and abetting someone elses crime.

SEC v. Apuzzo
In order for an aider and abettor to be liable, the SEC must bring an action pursuant to 20(e) of the Exchange
Aiding & Act and prove:
Abetting o The existence of a securities law violation by the primary party,
o That the aider and abettor had knowledge or acted recklessly with respect to the primary violation, and
o That the aider and abettor provided substantial assistance in the achievement of the primary violation.
Substantial Assistance requires proof that the aider and abettor was involved in the fraud and
sought by his action to make it succeed.
When the aider and abettor has a high degree of actual knowledge, it lessens the burden the
SEC has in proving substantial assistance.
A purely administrative/ministerial act is probably not substantial assistance.

Statutory Authority for Control Person Liability

15 Securities Act:
o Every person who . . . controls any person liable under section 11 or 12, shall also be liable.
20(a) Exchange Act:
o Every person who, directly or indirectly, controls any person liable, shall also be liable.

Issues: Donohoe v. Consolidated Operating & Production Corp.

Step 1 -- Is the defendant in control of the primary violator? (Plaintiffs burden)
o Control =
Control (1) Actual Control over the defendants actions generally, and
Person (2) Potential Control (Power to Control) over the specific transaction
Step 2 -- If yes, is there an affirmative defense? (Defendants burden)
o 15 The control person can avoid liability if it can be established that the control person had no
knowledge of or reasonable grounds to believe that the primary violator committed a fraud.
o 20(a) The control person can avoid liability if it can be established that they acted in good faith and
did not directly or indirectly induce the primary violator to commit a fraud.
Respondeat Superior (Employer/Employee) Liability
Employer may be vicariously liable for a violation committed within the scope of employment.
Good Faith = Affirmative Defense

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