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SECURITIES REGULATION
Professor William C. Tyson, Fall 2005
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TOPIC 1—INTRODUCTION
A. History of Securities Regulation: “Of Bubbles and Giants”
 The Securities Act of 1933 did not spring full grown from the brow of any New Deal Zeus… It followed a generation of state
legislation and several centuries of legislation in England.”
a. Britain’s South Sea Bubble: bursting of the bubbles led to Bubble Act of 1720
b. U.S. stock market crash of 1929, followed by the Great Depression led to federal securities laws.
i. Point: financial cycles
B. Economic and Policy Rationales for Securities Regulation
1. From an economic standpoint, why do we have Sec. Reg.?
a. Wealth maximization entails economic efficiency which requires correcting market imperfections
i. Asymmetry of information: one party to a transaction (the seller) has all the information about the item
(e.g., stock, car), but the putative buyer has a lack of information, and thus the transaction, which may be
advantageous transaction, may not occur. Therefore, if we can eliminate this market imperfection, we can
improve wealth maximization. One way to do this is through regulation, forcing the party w/ knowledge to
disclose the information he has to the other party.
C. Federal Securities Law: 7 organic federal securities laws (this course concerns the first two)
1. Securities Act of 1933 (hereinafter “SA 33”) requires episodic disclosure.
a. Regulates the distribution of securities (2 types of securities to raise capital)
i. Debt security: bonds (loans→bonds→interest)
ii. Equity security : stocks (investment→stock→dividends)
b. Two-fold purpose:
i. Disclose ALL relevant information concerning the value of the securities sold so that investors can make
an informed decision
ii. To prevent fraud in the offer & sale of securities.
2. Securities Exchange of 1934 (hereinafter EA 34) requires continuous disclosure (through periodic disclosures  annual,
quarterly reports)
a. Regulates post-distribution trading (Tender offers, insider trading, proxy solicitations
3. Public Utility Holding Company Act of 1935
a. Registration and regulation of public utility holding companies
b. Designed to correct abuses in the financing of public utility companies
c. Requires SEC approval before issuance of securities or changing their financial structure
d. Some feel the Act should be repealed, since it is no longer needed: we previously needed it when we had elaboratelytiered holding companies w/ much abuse.
i. e.g., PECO is a holding company for PECO Electric.
4. Trust Indenture Act of 1939
a. Regulates public offering of DEBT (not equity) securities in tandem with SA 33.
b. If the transaction is for < $5M, you don’t have to comply
c. Trust indenture: A document stating the terms under which a bond is issued; a contract b/w a selling company and
the trustee (who plays the role of safeguarding rights and interest of purchasers of debt securities being sold to the
public). There can’t be any conflict of interest b/w trustee and the issuer.
5. Investment Company Act of 1940
a. Regulation requirements and regulations for publicly-owned companies that invest in securities
i. Investment company: e.g., mutual fund
1. Caveat!: each mutual fund is a separate company and must be registered accordingly
ii. Industrial company: generally provides services or makes goods
b. Open-end investment company: redeemable securities (most common)
i. If you own a security, you can redeem it at any time.
ii. Typically, the company will continuously offer new funds to the public to cover the cost of redeeming
securities.
iii. An investor usually purchases shares in the open market from mutual fund. May occasionally offer new
securities to the public.
iv. Each mutual fund is separate and must register w/ SEC
c. Closed-end investment company: non-redeemable securities (must sell securities to market place to get you money
back; cannot sell back to company)
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d.
6.
7.
Hedge funds: exempt from the ICA for two reasons
i. Fewer than 100 members
ii. Made up of sophisticated investors
Investment Advisers Act of 1940
a. Investment advisor: not a broker dealer
i. Sole function: to provide financial advice. They do not involve transaction of securities.
ii. Sets up and sponsors mutual funds and gives advice to investment companies
iii. Regulated by SEC and must register w/ SEC
b. Now SEC requires regulation and registration of hedge fund investment advisor even though the hedge fund itself is
exempt; this opens up to scrutiny the entire operation of the hedge fund.
Securities Investor Protection Act of 1970
a. Set non-profit organization: Securities Investor Protection Corporation (SIPC)
i. Receives funding from:
1. Assessments on the members (most securities firms must belong to the SIPC)
2. $1B line of credit from the gov’t
ii. SIPC helps customers when a securities firm fails, providing up to:
1. $500K per account coverage but
2. $100K per account max for cash.
iii. Customers deposit money w/ a broker dealer firm:
1. Covered up to $500K (up to $100K in cash and additional $400K in securities) unless you put up
no cash in which case you are covered for $500K in securities.
2. The analog in banking is FDIC.
D. Related Statutes
1. Bankruptcy Reform Act of 1978 (most recent iteration)
a. Authorizes the SEC to serve as an advisor when there is a substantial public interest to the U.S. Bankruptcy courts.
2. Sarbanes-Oxley Act of 2002: Bill won’t call it as one of the organic federal securities statutes.
a. Addresses the systemic issues in securities market.
i. Sets out the broker-dealer responsibility.
ii. Audit independence provisions (cannot do both audit and consulting)
iii. Independent accounting oversight board.
iv. Corporate governance and responsibility measures
v. Mandatory disclosure requirement: conflict of interest (underwriters are also analysts)
1. Regulation A-C
vi. Deals w/ securities fraud
3. Jurisdictional base: Congress’ interstate commerce and postal clause powers
a. SA 33 and EA 34 only regulate securities transaction that use interstate commerce and mails: after Lopez, they were
cautious
i. Art. I. Sec. 8: Commerce Clause—securities transactions usually involve interstate commerce
ii. Postal power: securities usually involve mail
b. CAVEAT: intra state communication or use of mail is covered.
c. Loophole: activity is only regulated if the jurisdictional means are used.
i. i.e., if you sell securities personally, no federal securities laws apply.
4. Federal Securities Code: ALI, ABA, and SEC tried to put all organic securities laws together.
a. Never adopted.
E. Securities Exchange Commission (SEC) (independent nonpartisan agency)
 History: In 1933, FTC did the work. In 1934, SEC was created by EA 34 under §4
a. EA 34 §4: shall consist of 5 members appointed by president and confirmed by senate, each to serve for 5 years (1
appointed each year)—not more than 3 may be a member of the same party—chairman designated by the president.
b. Composition: 5 commissioners. In addition, there is a staff (2/3 in DC, and regional offices – NY, Chicago, Denver,
Miami)
 Concerns of SEC
a. Disclosure: centerpiece of the federal securities laws.
b. Enforcement
c. Regulation
 Divisions of SEC
a. Corporation Finance (concerned with disclosure)
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b.
c.
d.



Enforcement: (investigates violation of federal securities laws & institutes enforcement suits).
Market Regulation: oversees national (securities) exchanges and OTC (broker / dealer) market
Investment Management: primarily jurisdiction over the Investment Company Act / Investment Advisors and the Public
Utility Holding Company Act
Sources of Laws
a. Statutes
b. Rules
i. Definitional
ii. Substantive: Congress delegates the rule-making power to SEC
c. Releases
d. Bulletins
e. No-action letters
f. Amicus curiae briefs
g. Telephone
h. Oversight over rules governing exchanges
Functions (normally not collection agency)
a. Quasi-legislative: Rule-making power.
i. Definitional rules: define terms used in the statutes (e.g., 135, 137-39).
1. Substantive rules w/ force of law: e.g., Rule 10b-5
ii. Adopts forms and instructions to forms
iii. General policy releases: interpretation of law
iv. No action letter: individual or a company who is going to engage in a transaction and consults an attorney to
ensure that they comply w/ sec. reg., submits to the SEC. SEC writes a letter that they “agree” to take no
action if the company proceeds w/ the transaction.
1. Publicly available: similar to private letter rulings by IRS. The difference is that the SEC discloses
everything (prices / parties / etc) whereas the IRS camouflages information.
v. Amicus curiae briefs (friend of the court): SEC often submits its opinion; it is not a party but has an interest
in the court ruling in a certain manner.
b. Executive: SEC is a part of the Executive branch.
i. Investigates possible violations of the laws and rules
ii. Enforces the laws against violators by going to federal courts seeking a federal injunction against violators.
1. Can seek civil penalty up to $500K (for securities professionals) paid into the federal treasury
2. Disgorgement of illegal profits
3. Injunction to prohibit part from engaging in certain course of action: must show likelihood of future
violation (can be held in contempt)
iii. When violation is willful, SEC, in conjunction w/ DOJ, can seek criminal sanctions
c. Quasi-judicial
i. SEC can serve as a court (in-house): SEC hearings are held before an ALJ appointed by the SEC, and the
decision is reviewed by the SEC. You can appeal to the federal circuit court and then to the Supreme
Court.
ii. SEC in-house: private party will enter into a consent letter, agreeing to settle.
1. Anyone: ALJ can issue cease-and-desist orders (basically in-house injunction but easier to obtain
than an injunction because do not have to show likelihood of future violation; just must show
wrongful conduct but cease and desist order is not court order so that if you fail to comply SEC
must obtain injunction from court and then if violator does not obey an injunction, then you’re held
in contempt)
2. Securities professionals: i.e., broker dealers, lawyers, and investment bankers & securities and
investment firms
a. Disciplinary sanctions imposed: trading license suspended, censure, etc.
b. SEC can impose civil penalties up to $500K but only against securities professionals.
iii. Wells notice: SEC investigating (may be criminal / civil / in-house), named after John Wells
Evaluation
a. Flexibility and informality of procedures
b. Good reputation: highly intelligent / integrity / avoidance of political identities
F. Securities Industry
1. Securities markets: system through which securities are bought and sold. 4 main markets. (national securities exchanges,
OTC, third and fourth market)
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a.
2.
3.
4.
5.
Securities Exchanges: total 8 national SEs (action market)
i. Tangible market w/ floor
ii. Each exchange is called Self-regulatory Organizations (SRO): each has its own rules
iii. Must be registered and are subject to SEC oversight
b. Over-the-counter (OTC) market:: Securities Association (only 1), aka second market (dealer market)
i. Non-tangible market: just telephones and computers matching buyers & sellers, no auctioneers
ii. Use of intermediary or a broker dealer
iii. NASDAQ (National Association of Securities Dealers, Inc.): only 1 Securities Association that is in charge of
all OTC market transaction
1. Subject to SEC oversight
2. SRO: Rules of NASD.
iv. SuperMontage: developed by NASDAQ to compete w/ ECN
v. OTC bulletin Board
c. Securities that are enlisted in NYSE but traded on OTC market (third market transactions)
i. Securities that are listed and can trade on exchange but instead trade on OTC
d. Individual persons or firms, trading w/o assistance of an underwriter
i. Private sales
Glass Steagall Act of 1933: Regulated commercial banks
a. IB business was focused on securities transactions (IB underwriting)
b. Underwriting could only be done by securities firms: Banks could not do both commercial and investment banking b/c
of the conflict of interest, unless through a subsidiary that accounted for only up to 25% of gross revenue and w/ the
ad hoc approval of the Federal Reserve Board.
i. Congress passed a statute prohibiting commercial bank from dealing in securities except gov’t bonds
ii. Policy concern that you don’t want losses in one area (IB) to bring down another (CB)
iii. Federal Reserve Board, which oversees enforcement of Glass Steagall Act allows some banks on ad hoc
basis to expand into underwriting and trading (e.g., Bankers’ Trust, Nations’ Bank, and Union Bank but the
broker-dealer must be a subsidiary; separately capitalized; w/ not more than 25% of the gross revenues
coming from investment banking)
Gramm-Leach-Bililey Act of 1999: Significantly dismantled major portion of Glass-Steagall Act.
a. Dismantled the distinction b/w CB and IB: allows one-stop shopping
b. However, there must be a subsidiary so that the liability does not affect the other
c. IBs still can’t deal w/ pension funds.
Functional v. consolidated regulation: securities, insurance, and banking.
a. In the U.S., the industry is consolidated, but the regulation is still functional.
i. Banks: regulated by Federal Reserve and the state bank commission
ii. Insurance industry: regulated by certain state insurance commission
iii. Securities: regulated by the feds.
Activities of Securities Firms (Merrill Lynch, Goldman Sachs)
a. Investment banking:
i. Underwriting: helps companies to sell their securities publicly
ii. Private placements: private equity (private sale)
iii. M&A
iv. Financial advice
b. Sales & Trading: Sales (customers buy and sell, also for outside investors, function as intermediary) v. Trading (take
proprietary transactions)
i. Market-making: traders make a market as middlemen. They buy and sell securities of certain company on a
regular basis.
ii. Commodities: fund management
iii. Real estate
c. Merchant Banking (private equity)
i. I.e., Carlyle Group
ii. Glass Steagall permitted securities firms to do merchant banking.
iii. Co. that identifies, structures, and manages private equity and venture capital investment opportunities.
iv. How far along business opportunity has been developed determines whether it will be private equity or
venture capital.
v. Done by investment banks as subsidiaries. After Gramm-Leech, merchant banking can now be conducted
in subsidiaries of commercial banks.
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G. State Securities Laws
1. Blue Sky Laws: Federal securities laws preserved the states’ power to regulate securities transactions on their level
a. The blue sky law originally enacted in Kansas in 1911 was aimed at promoters (solicitors from Wall Street) selling
securities to farmers worth nothing more than the blue sky.
b. Stock market crash in 1929 or the Great Depression did not cause sec. reg., but followed a generation of state
legislation—Blue Sky Laws—and tradition of sec. reg. in England.
c. All states now have blue sky laws.
2. Uniform Securities Act of 1956: attempt to create uniformity among state regulations of securities
a. Only 40 states have adopted some or most of the Act
b. NY, CA, IL, and TX have not adopted the Act
c. States have come up w/ different interpretation of the same law.
3. Consolidation vs. Functional Regulation: Uk consolidated regulation into new government agency and other EU countries
have considered adopting same model. After the passage of Gramm-Leech, US has adopted functional regulation instead. In
US, if you’re a commercial bank, regulated by Federal Reserve Board; if investment bank, regulated by SEC; if insurance, then
state insurance commissions. Now that we have entities able to do everything after Gramm-Leech, it is not that clear why we
still have functional regulation.
H. Transnational Transactions
1. §30(b): EA 34 does not apply outside the jurisdiction of the United States
a. The conundrum is what jurisdiction means
i. If it involves U.S. investors, we probably have jurisdiction
b. Guidance:
i. The securities laws are to protect the U.S. industries. If foreign companies come here to list their shares,
they need to apply to U.S laws, while U.S. companies going out to list shares in a foreign country do not
need the regulation of the securities laws.
ii. Rule 905-06: As long as there is no sale, offers, and buyers in the U.S., the securities exchange law does
not concern.
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TOPIC 2—DISTRIBUTION OF SECURITIES UNDER SECURITIES ACT OF 1933
A. Capital Raising Process (by selling securities to the public or private; through IPO or subsequent / repeat offering)
a. Two types of securities:
Debt: bonds
OR
Equity: stock
B. Categories of Issuers:
1.
2.
Reporting Company / Public Company. Must report under 1934 Act. Must use Form S-3 or Form S-1 (Form S-2 has been
eliminated). Form S-3 is abbreviated form, simple to fill out, and less expensive; does not require much information because
already a reporting company, public information on them available. Reporting companies are divided into 3 categories:
a. Well-Known Seasoned Issuer (Form S-3). Dark blue chip (most expensive chips when gambling).
i. Rule 405. Public float (value of shares in market place; shares held by public not counting shares held by
control person) of $700 million or 3 year historical issuance of at least $1B of non-convertible senior
securities (senior security could be preferred stock and that its nonconvertible means that it can’t be
exchanged for common shares) in registered cash offerings (price of bonds sold to public, at time sold, must
add to at least $3 billion). Can be dark blue chip by selling stocks or bonds.
b. Seasoned Issuer (Form S-3). Blue chip. Can still register under abbreviated S-3 Form.
i. Public float of 75 million or more OR offering debt securities of investment grade (rated investment grade by
at least one nationally recognized statistical organization like S&P).
c. Unseasoned Issuer (Form S-1). Small reporting companies are not seasoned.
Nonreporting Company (Form S-1). Private companies which do not have to file reports must file Form S-1 (most complicated
and expensive form to prepare) when issuing securities.
C. Underwriting: A form of insurance.
1.
Negotiated process: by securities firms (broker-dealer). All members of underwriting syndicate have privity of contract w/
issuer (direct relationship). Managing underwriters perform underwriting syndicate & dealers will prepare dealer selling group.
Issuer 
Every entity who issues or
proposes to issue any security
§2(a)(4)
Manufacturer
2.
Underwriter ( sometimes Subundewriter also) 
Dealer 
Entity selling for a control person or the issuer in Entity engaging as agent,
distribution of security
broker, or principal.
§2(a)(11)
§2(a)(12)
Wholesaler
Retailer
Public
Public
Three Types of Underwriting
Standby, strict, old-fashioned
Solicit subscriptions from dealers.
To extent that the securities are
not sold, underwriters will buy.
Flat Fee regardless of whether
underwriters buy shares or not.
Used in preemptive rights offering
where securities are sold only to
existing shareholders but not
generally used in US.
Firm Commitment (popular in US)
Underwriters buy the shares from issuers and
then sell them to the dealers who will then
further sell them to the public.
Price goes up along process; both SG dealer
and underwriter get paid by spread.
Issuer sells to underwriter for $23.
Underwriter sells to dealer for $23.80. Dealer
sells to public for $25. Underwriter gets $.80
& dealer gets $1.20 per share. Usually
dealer gets ~ 60% & underwriter ~ 40%.
Best Efforts
Firm will promise to make its best efforts to
sell the shares to the public and then will draw
commission out of the help.
Underwriters get commission for the number
of shares they sell.
Done when there is some concern over IPO;
not really insurance. Underwriters act as
agents. Cheapest way to issue for issuer
because if underwriters don’t sell everything,
issuers get their money back.
D. Competitive Bidding
Sealed Bids
Underwriter puts bid in envelope and gives it to
issuer. Highest bid becomes underwriter.
Typical for securities sold by municipalities
(public municipal bonds) or under Public
Holding Company Act.
Dutch Auction
Assuming there is only one object; the first to bid, gets it. Reverse of typical
progressive bid that we associate at common art auction.
Used for US treasury bonds / governmental securities. Ex: Google; underwriters
did not serve wholesaler purpose; you would contact underwriter & make bid.
Clearing price (based on bids) was highest price at which all shares would be sold
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so some people were paying less than they bid.
E. Types of Distribution
1.
Primary distribution. Company conducts initial public offering of securities (IPO).
a. Repeat/subsequent offering: When the company later offers securities after the IPO.
b. Issuer, §2(a)(4)
2.
Secondary distribution: When a large number of shares are offered by a control person to the public. Control person is not
issuer, but often function like issuers. Control person must register securities only if public distribution is done by underwriters
since 4(1) requires transactions involving issues, underwriters, or dealers to be registered.
Control Person (one of three types of people)  Inspected by SEC and SA 33
Controlling Person
Controlled Person
Person under common
control
An insider (director / officer) is always controlling person Some controlled by the issuer Brother sister corporations
regardless of stock they own. Other shareholders are (subsidiary of the parent)
which are under the same
rendered to control the issuer based on the following:
control of parent.
□ The more public the co, the smaller % of shares that E.g., A sub selling parent’s If Brother sells the Sister’s
controlling person must own.
securities while owning parent’s stock, the Brother is a control
□ If you have enough control to get issuer to prepare a securities. Parent is still the issuer, person of the Sister issuer 
registration statement for you to sign, you are control and the Sub is control person. control
relationship
that
person.
Simultaneously, subsidiary could requires registration
□ 10 to 15% ownership
also own shares of parent.
F. Registration and Prospectus Provisions
1. Registration = 1) Prospectus + 2) Other information
a. Prospectus: red herring
i. SEC simply evaluates the registration statement to ensure that it is truthful, and things are in the proper
form, not to see whether it is a good buy.
ii. Disclosure oriented: if you decide to buy the stock, it is up to you.
b. Prospectus (Part I of registration) sometimes viewed as “schizophrenic” because it is trying to 1) sell but at the same
time 2) make sure that it is following all rules (§5 mandates certain disclosures and prevents others)
2.
Time Sequence for Registration  “in registration”
Filing Date
Effective Date
Prefiling Period
Waiting Period
Posteffective Period
§5(a)(1)
§5(a)(2)
§5(b)(1)
§5(b)(2)
Major
activities
that
occur
during
public
offering
sorted
by
period
§5(c)
 Letter of intent signed (btw issuer
& mgming underwriters b/c 2(a)(3);
not binding)
 Registration statement prepared
(Sched A incl. items 1-32 on
statement; 1 – 27 in prospectus)
(Reg S-K incl files under both 33 and
34 Act)
Registration statement filed (may be
done online through EDGAR)
 Must contain
o audited balance sheets as
Registration statement filed




Rule 473. Delaying Amendments
Underwriters commence offering
to dealers
o Road show; inviting
securities firms &
institutional investors
o Roadshow DOES come
under jurisdictional base
Dealers commence offering to
public
Amendments to registration
statement filed / preeffective




Dealer agreement signed and
underwriters commence selling to
dealers
Dealers commence selling to
public
o Once NSG dealers start
functioning in aftermarket,
they are not governed
around public offering
price; not bound by original
dealer seller agreements.
Company and underwriters
exchange securities and cash
If applicable:
o Nine month prospectus
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o
of the end of the two most
recent fiscal years
audited income statements
/ audited changes in fiscal
positions as of the last
three 3 fiscal years
amendments
o
o
Posteffective amendments
Posteffective supplement /
prospectus sticker
Agreement among underwriters
signed
 Underwriting agreement signed
Price amendment filed

a.
b.
c.
3.
§5
a.
b.
c.
d.
Agreement among underwriters signed
i. Agreement among underwriters: establishes the obligations of each member of the group (up to 120
members) grants broad discretionary authority authorizing managers to enter into the underwriting
agreement.
Underwriting agreement signed
i. Underwriting agreement: shows privity of contract b/w issuer and all of the underwriters and the number of
securities that all the syndicate members are committed to buy. Contractual relationship w/ the issuer.
Really a sales contract. It is a letter of intent. The managing underwriter on behalf of the underwriting
syndicate executes this document w/ the issuer.
1. Letter of Intent is binding and is attached as an exhibit to the registration statement
SEC reviews registration statement during WP; if there appears to be misleading / untrue statement, SEC will conduct
hearing which can be appealed. Hearing can grant 8(b) refusal order or 8(d) stop order.
i. Normally, SEC will send letters or telephone call rather than issue stop order; may require you to amend
registration statement by way of a preeffective amendment.
Purpose
i. §5 mandates full and fair disclosure to correct market imperfection of asymmetry of info, mandating
disclosure of prospectus prior to delivery of securities and protecting customers and dealers from buying
w/o full knowledge. No sales until you file statement and that investor / purchaser must obtain prospectus
before or at the time of the delivery of the security. Registration statement that you file with SEC has two
parts (Schedule A [list of 32 items that must go on registration statement], Items 1-27 are part I of the
registration statement (prospectus), part II of the registration statement is 27 – 32). Predicated on notion
that investors should get Items 1-27 and should NOT get other things; some rules now are changing that
though due to free flow of information.
§5 read in conjunction with §4(1) tells us that §5 applies to:
i. Issuers
1. Control persons: when they use an underwriter to sell a large number of their securities.
2. §2(a)(4) defines “issuer” as every person who issues or proposes to issue any security.
ii. Underwriters
1. §2(a)(11) makes an underwriter out of anyone who has purchased a security “with view to its
distribution,” either from the “issuer” or from anybody who is in a “control” relationship with the
issuer.
2. §4(a) and its interaction with the definition of “underwriter” in 2(a)(11) brings underwritten
secondary distribution in control situations within 5.
iii. Dealers
1. §2(a)(12) defines dealer as “any person who engages either for all or part of his time, directly or
indirectly, as agent, broker, or principal, in the business of offering, buying, selling, or otherwise
dealing or trading in securities issued by another person.”
§4(1), Exemption: “The provisions of §5 shall not apply to transaction by any person other than an issuer,
underwriter, or dealer.”
i. Exempts transactions, not people.
ii. Thus, if a control person sells shares w/o use of an underwriter, he does not have to register under SA 33.
Control person engages in a secondary distribution of securities, so it would not be covered by the SA 33
unless it involves an underwriter.
Jurisdictional base only if using jurisdictional means: use of interstate commerce or the mails (fedex and emails
are included as well)
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0
i.
ii.
iii.
iv.
v.
Note that each of the five prongs for §5 contains its own jurisdictional base.
If a dealer does not use jurisdictional means for the sale or offer, he does not violate §5.
Intrastate mail or intrastate phone calls are also covered (both within or without the state)
Use of payment by the customer by mail is tantamount to having used mails in the sale.
A dealer would not violate §5 if he:
1. Offered to sell securities w/o the use of the jurisdictional means in the PFP
2. Sold the securities w/o the use of the jurisdictional means in the WP; and
3. Delivered the securities w/ a final prospectus using the mails in the PEP.
G. Prefiling period: begins at the point someone gets the idea that the company is going to raise capital, and certainly when you
enter into the Letter of Intent. Period ends when registration statement is filed.
1. Mechanics (choose which one of 3 underwriter techniques you will use)
a. Put together the underwriting syndicate w/ a managing underwriter
i. Underwriting syndicate: participating dealer or SG dealer. The dealers may act as agents of the underwriter,
and ultimately of the issuer.
b. Enter a Letter of Intent (gentlemen’s agreement) under 2(a)(3): the issuer and managers enter a non-binding
statement (not a formal contract because underwriter could back out though his name would be mud if he did; gives
issuer enough assurance) of intent to do a syndicate under a firm-commitment underwriting. 2(a)(3) allows preliminary
negotiation between issuer / control person and underwriter.
i. Typically, the managing underwriter gets to take half of the spread (which is paid once the securities are
sold by the other underwriters, rather than the issuer for liability purposes). Managing underwriters (usually
2) will form underwriting syndicate; managers along with underwriting syndicate members will form dealer /
seller groups. In any given offering, you may play different roles. Morgan Stanley may be chosen as one of
the managers and then underwriting syndicate of Goldman, Bear Sterns, etc.
ii. Then form dealer selling group with other securities firms. In another deal, someone that was a subdealer
may be a managing underwriter. And you can also be left out; which will be embarrassing for a large
securities firm. During the waiting period, dealer selling group not really formed, because cannot have
contact with dealer during waiting period and thus called prospective sellers.
c. Once there is a binding contract, each member of the syndicate purchases a number of securities.
i. The higher up you are the more you get to buy
ii. The underwriter and the issuer (or control person) must be in privity of contract during the prefiling period.
2.
A fortiori 5(a)(1) no sales and 5(a)(2), delivery. If you can’t offer to sell, you can’t sell or deliver. Under §5(c), offers to sell are
prohibited unless the offer falls under §2(a)(3) exemption.
a. §5(c), Prohibition of Offer to Sell or Offer to Buy during PFP: “It shall be unlawful for any person, directly or
indirectly, to make use of any means or instruments of transportation or communication in interstate commerce or of
the mails to offer to sell or offer to buy through the use or medium of any prospectus or otherwise any security,
unless a registration statement has been filed as to such security or while the registration statement is the subject
of a refusal order or stop order or (prior to the effective date of the registration statement) any public proceeding or
examination under §8.” (applies to both oral over the phone and written; oral face to face would not be included since
it does not use jurisdictional means)
b. §2(a)(3) permits the letter of intent: preliminary negotiations or agreements
i. “Preliminary” modifies negotiations and not agreements which are or are to be in privity of contract.
Negotiations refer to letters of intent, and agreements refer to contracts. Therefore, the letter of intent could
be binding.
1. Permits formation of underwriting group before effectiveness / filing of registration statement.
2. Underwriter could make offer to buy under 5(c) under this section; contracts of sale between
issuer and underwriter is allowed
ii. §2(a)(3) exemption does not apply to dealers.
c. The actual agreement occurs on the effective date b/w the issuer and the underwriter.
i. Underwriting Agreement: made right before the effective date
ii. Agreement among underwriters: signed on the same day as the underwriting agreement
iii. §2(a)(3), Offer to sell: every attempt to dispose of, or solicitation of an offer to buy, a security or interest in
a security, for value (not gift), anything that whets the appetite is an offer for securities purposes.
1. Solicitation of an offer to buy: Would you like to make an offer to buy? It is an invitation for offer.
2. Therefore, the definition of “offer to sell” goes well beyond the common law offer. Anything that
whets appetite is considered offer.
3.
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3. You don’t want underwriters or issuers whetting the appetite of potential investors BUT why does
it prevent offers to buy? Customers are exempt under 4(1)?
iv. §2(a)(3), Offer to buy: §5(c) protects the dealers. The only person really prohibited is the dealer. The dealer
cannot buy from the underwriter, otherwise underwriter would pressure dealers into lining up early.
v. Statutory definition of offer goes beyond the common law definition of offer.  Emily isn’t this a nice bag;
Emily do you want to buy for $5? Statutory offer; common law.
Conditioning the market: anything that whets the appetite is offer in SA 33.
a. Gun jumping/beating the gun: illegal conditioning of the market, usually during the prefiling period
i. Issuers face conflicts: some SROs require the issuers to disclose some information, but at the same time,
the disclosure may violate §5.
1. Sec. Release 5009 and 5180
a. Allows disclosure of purely factual information: no forecast, predictions, opinions, or
projections.
b. Can advertise, send out periodic reports & proxy materials, and answer unsolicited
questions of analysts and shareholders
b. Solicitation of offer to buy: permitted in the waiting period only if done w/ prospectus
c. Factual biz info incl settlement of strike, dividend notices, advertising company’s products; can be released
according to following rules as long as its regularly released. Forward looking info incl projections of revenue,
earnings forecast, statement regarding future performance, etc.
Rule 168
Factual biz & forward-looking
info regularly released by
reporting issuer (must be
released or disseminated by or
on behalf of issuer)
All 3 time periods
May not incl info re: registered
offering & may not be released
or disseminated as part of
offering activities in registered
offering
Rule 169
Factual biz info regularly
released by nonreporting
issuer (must be released or
disseminated by or on behalf
of issuer) (note that this does
not allow forward looking
information)
All 3 time periods
Must
be
released
disseminated to persons such
as customers / suppliers, other
than in their capacities as
investors
Info deemed not to be offer to
sell for 5(c) or 2(a)(10)
prospectus
Info deemed not to be offer to
sell for 5(c) or 2(a)(10)
prospectus
4.
Rule 163A
Communication by reporting /
nonreporting issuer > 30 days
prior to registration; can
release non-factual info so
allows for whetting appetite
(must be made by or on behalf
of issuer)
PFP
May not reference securities
offering; issuer must take
reasonable steps to prevent
further dissemination during
30 days preceding date of
filing registration statement
Info deemed not to be offer to
sell for 5(c)
Rule 163
Communication by well-known
seasoned issuer w/in 30 days
of filing registration statement
(must be made by or on behalf
of issuer)
PFP
Unlike 168 & 169, this is an
offer to sell but it is exempt;
liability provision will apply
here
Info is offer to sell as defined
in 2(a)(3) and 2(a)(10)
prospectus but is exempt from
prohibition on prefiling offers in
5(c)
If written rather than oral, will
be considered Rule 405 freewriting prospectus: would
have to incl legend & be filed
with SEC upon filing
registration statement & would
be subject to Rule 164 & Rule
433 cure / record retention
provisions
Rule 135, Notice of Proposed Registered Offerings: A customer may find out about the company and make an offer to buy.
Note, however, that a dealer cannot accept such an offer until the effective date. (Bill believes that it can be used in WP and
PEP but you could use tombstone ad instead. Soderquist (p.53-54) believes that it can only be used in PFP.
a. Doesn’t have to be filed w/ SEC: can be just published in a newspaper. However, communications under this rule
relating to business combination transactions must be filed as required by Rule 425(b).
b. Application: primarily during the prefiling period.
i. Underwriter, issuer, control person, and dealer fall under Rule 135.
c. Mandatory item: must state that notice does not constitute an offer to sell.
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d.
e.
f.
g.
h.
5.
Permissive items
i. Name of issuer / company
ii. Title, amount, and basic terms of securities
iii. Amount of the securities being sold simultaneously by a control person (i.e., typically through a secondary
offering)
iv. Anticipated time of offering
v. Manner and purposes of the offering: i.e., whether the issuer is directing the offering only to a particular
class of purchases
Cannot name underwriters or state price or price range.
Must be made by or on behalf of the issuer or a control person
Special rules for rights offerings, offerings to employees, exchange offers, and certain other business combinations
Can put additional information if:
i. (Preemptive) Rights offering: offering to existing shareholders
1. Stand-by, strict, old-fashioned underwriting
2. Can state subscription ratio and subscription price
ii. Offering to employees
1. Can state the offering price.
iii. Exchange offer: the communication has to be filed w/ SEC
iv. Rule 145 (a) offering: M&A offering
Rule 137-39, Market letters & Research reports (see definition in Rule 405): can be viewed as written offer to sell. Safe
harbor rule.
a. Application: The rules cover all three time frames. Under new regime, if you do not meet requirements, you can
argue that it is a free-writing prospectus that is on its way to being filed.
i. Issue: By the terms of the law, every securities firm in the country is regulated by §5 during the prefiling
period, b/c no one knows who is going to be SG dealers until the end of the waiting period.
1. Some firms may not know that the issuer is in the registration process.
a. The information is not known until Rule 135 Notice is given (which is not even required)
or until the registration statement has been filed (which is required).
2. Dealers and underwriters may not know whether they are participating.
b. Limits: Must be purely factual.
i. No forecast, prediction, opinions, or projections.
ii. You can:
1. Advertise
2. Send out periodic reports and proxy materials; and
3. Answer unsolicited questions.
c. Regular course of business v. regularly distributed in normal course of business: regularly distributed in normal
course of business (research reports) is more regular than regular course of business (market letters).
Rule 137
Publications by Persons Independent
of Participants in a Distribution
Company qualified to use Rule 137 can
use 138 & 139 but probably would not
want to because 137 is more lenient.
Can recommend / publish opinions about
any security of the issuer.

Broker / dealer who is not and does
not propose to be participant in
distribution of security. Considered
participating if broker or dealer is
member of underwriting syndicate of
part of SG dealers defined in
2(a)(11)
Rule 138
Publications or Distributions of
Research Reports by Brokers / Dealers
About Securities Other Than Those
They Are Distributing
narrow rule
Rule 139
Publications or Distributions of
Research Reports by Brokers or
Dealers Distributing Securities
Report must relate to common stock or a
convertible senior security of the issuer if
the offering is of a nonconvertible senior
security of the issuer or vice versa.
 Securities firm may be participating
in the registered offering (underwriter
or SG dealers).
 Report deemed not to be an offer to
sell for purposes of 5(c) or a
prospectus for purposes of 2(a)(10).
 Regular course of biz
Report may relate to the issuer or any
class of its securities.
higher standard



Securities firm may be participating in
the registered offering (underwriter or
SG dealer).
Report deemed not to be an offer to
sell for purposes of 5(c) or a
prospectus for purposes of 2(a)(10)
Seasoned issuer



2(a)(11) definition of offers,
participates, or participation will not
apply to research report
Regular course of biz
Reporting co or has effective
registration statement under 33 Act.
Rationale that even if report whets
the appetite too much, there still is
other information available to
balance off any unduly positive info

Reporting co

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Regular course of biz & must be
publishing / distributing research
reports about the issuer or its
securities
H. Waiting period: must be at least 20 calendar days. You may include delaying amendment (Rule 473) in red herring which kicks
in anytime 20 day period elapses. When ready to file price amendment & go effective, would then have to accelerate under Rule 461
(a privilege, not a right) which will let you go effective within ½ day. 5(c) is no longer in effect unless an 8(d) stop order is entered
where you go back to PFP. BUT §5(a)(1) prohibits use of interstate facilities or mails to sell such a security or transmit any
“prospectus” unless it meets the requirements of 10, which prescribes the contexts of the statutory prospectus. Lawyers for the
underwriter and issuer prepare the registration statement. Before this, they must take on due diligence meetings. Due diligence
means that lawyers for the underwriters can prove they were duly diligent, then they can escape liability.
1. Mechanics: You may have offers to sell.
a. Continue to form the underwriting syndicate
i. Sub-underwriters for local geographic areas: no privity of contract w/ the issuer.
b. SG Dealer: underwriters can get prospective and only prospective SG dealers. Sale to a dealer is not permitted
until the effective date. It is only in post-effective period that we know definitely whether the SG dealers have
accepted. Underwriting syndicate has long list of dealers they would like to bring in – assign shares to dealers based
on their retailing capacity. Then potential dealers call customers and make potential offers (customers can accept
because they are not bound by Section 5 but dealers are bound). Therefore dealers solicit an offer to buy (Section 5
allows this) so that customer can only make first half.
2.
Sale
3.
Preliminary prospectus (red herring): red legend.
a. Part I of the registration statement. See Schedule A on p.38  The only prospectus you can send during the waiting
period must meet the requirements of Schedule A.
b. Red herring can be sent to SG dealer. However, they are still prospective dealers. During WP, they can solicit offers
to buy from customers. However, dealers cannot accept the offer to buy until the effective date.
4.
Solicitation of offer to buy
a. Underwriters cannot offer to sell to dealers. However, subunderwriters buy from underwriters so there is no privity of
contract, so that they may sell to dealers.
b. You can only make a half contract to sell, which is allowed under §5. The offering can be rescinded by the customer.
i. Conditional offers (nonviolation): are permitted in the waiting period
1. Offer to sell, but the other party cannot accept until the PEP.
2. “I offer to sell you, but you cannot accept it until the PEP.”
ii. Conditional contracts (violation): are not permitted in the waiting period.
1. “I offer to sell and you can accept it now, but this contract is conditional on the subsequent that
the registration becomes effective. You know if the deal falls through, our duty will never ripen.”
2. Here, we have a binding contract and have a violation of §5.
5.
§5(b)(1): You can offer to sell or offer to buy, but it has to be done over the phone (oral offer). If you use written materials, it is
deemed to be a prospectus w/I the meaning of §2(a)(10), and thus it must meet the requirement of §10 (must be red hearing).
a. Prospectus can be sent through mail only if such prospectus meets the requirements of §10(a) or §10(b).
Tombstone ad does not meet the requirements of 10(a) or 10(b).
i. The first prospectus means §2(a)(10), i.e., any written confirmation.
a.
b.
c.
d.
Subunderwriters: buy from the underwriters so no privity of contract. Thus, they may sell to dealers.
Someone buys a certain number of shares from the issuer: it is a direct purchase from the issuer.
The prospective dealers can offer to buy, and the underwriters can accept only after the effective date.
As soon as the registration statement is effective, broker dealer firms have everything recorded b/c it is now okay to
agree to buy at whatever the public offering price is b/c neither party has control over what the price will be.
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1. Note that almost all writing is prospectus under §2(a)(10) – radio, prospectus, TV
ii. The second prospectus refers to §10.
6.
Rule 134 Tombstone ad: can be published in a newspaper. All types of tombstone ads may be used in PEP, and when they
are used, the purpose is usually to advertise the underwriters. Do not have to be preceded or accompanied by a preliminary
prospectus in the waiting period and they do not have to be filed with the SEC.
a. Rule 134 has more clout than Rules 135, 137-39 b/c Congress gave SEC the rule-making power.
b. Mechanics:
i. Non-reporting companies may state price range in tombstone ad.
ii. Managing underwriter is listed.
iii. Three tiers alphabetically listed company: bulge bracket.
c. Application: Only in WP & PEP
i. Not in prefiling period: §5(c) prohibits tombstone ads. Can’t offer to sell “by prospectus or otherwise.”
ii. Rule 135 notice becomes a tombstone ad in the waiting period, and it allows you to name price and list
underwriters.
iii. Can also be a letter, provided that it is preceded by or accompanied w/ a §10 prospectus (i.e., red herring).
d. Why is this allowed? It still whets the appetite.
i. §2(a)(10)(b), Old-fashioned statutory version: Tombstone ad is not considered prospectus.
1. Must state from whom a §10 prospectus (other than a free-writing prospectus) can be obtained.
2. Permissive items:
a. Identify the security
b. State the price (of course you don’t know the price in the waiting period)
c. State by whom orders can be executed: can list all the underwriters
ii. Rule 134, Expanded version: SEC has the power to play w/ tombstone ad under §2(a)(10)(b).
1. 22 permissive items (price and names of managing underwriters, name of company / title of
securities and the amt)
2. Rule 134 (b), 3 mandatory items:
a. Rule 134(b)(1), tombstone legend: if registration statement not yet effective: “A
registration statement has not yet become effective…”
b. Rule 134(b)(2): Primary or secondary distribution; new financing or refunding (when a
company issues bonds to pay off existing loans)
c. Rule 134(b)(3):States from whom a §10 prospectus can be obtained (unless
accompanied or preceded by a 10 prospectus)
3. Need not include mandatory items if:
a. ad is a §2(a)(10)(b) tombstone; or
b. ad is prepared or accompanied by a §10 prospectus or summary prospectus
iii. Rule 134(d): If ad (both old-fashioned and expanded version) is preceded or accompanied by a §10
prospectus and contains the specified legend, any tombstone ad may solicit offers to buy or request
indications of interest.
1. Cannot have a written offer to sell even if it is preceded or accompanied by a §10 prospectus or
red herring, b/c you can form a contract if the customer accepts after receiving a letter or seeing
the letter.
iv. Hypo: Roadshow—give them a sweatshirt w/ the issuer’s name (tombstone ad b/c name of the issuer is
permitted under Rule 134(c)(2)), but shove a prospectus in the shirt. Mug and t-shirt can be considered
tombstone ad according to 134
7.
Rule 430, Preliminary prospectus (red herring) Statute does not mention anything re: red herring.
a. Prospectus for use prior to effective date: can be used only during the waiting period.
i. Price can’t be decided until the effective date: Thus, anything that is dependent on price (underwriting and
dealer discounts or commissions, the amount of the proceeds, and other matters dependent on the offering
price) cannot be stated in the preliminary prospectus b/c it’s used only during the waiting period.
ii. Under §5(b)(1), any prospectus that whets the appetite must meet the requirement of §10.
iii. Under §5(b)(2), must comply with §10(a)
b. Permitted under §10(a)(4): allows to omit things from the prospectus; using 10(a)(4) SEC wrote rule 430 which
permits red herring for purposes of 5(b)(1) only in waiting period.
c. Red herring: Must contain legend
8.
9.
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i. Regulation S-K: repository regulation. Deals w/ both SA 33 and EA 34 and attempts to integrate information
that must be filed under SA 33(S) and EA 34 (K). Allows incorporation by reference (i.e., See the filing under
EA 34).
1. Regulation S-K, Item 501 (b)(10): must state “subject to completion” in red: “The information in
this prospectus is not complete and may be changed. We may not sell these securities until the
registration statement filed with the Securities and Exchange Commission is effective. This
prospectus is not an offer to sell these securities and it is not soliciting an offer to buy these
securities in any state where the offer or sale is not permitted.”
Rule 431, Summary prospectus: can only be used by three-year reporting company
a. Permitted under §10(b) for purposes of 5(b)(1): allows to summarize prospectus
b. Summary prospectus: posteffective period only (not used often)
i. Must have red herring legend
c. Rule 431:
i. Buff card prepared by statistical organization
ii. Newspaper prospectus
iii. Filed as part of registration statement, or as an amendment thereto, and must be filed five business days
before use
iv. Permitted in PEP period but called a summary prospectus
v. May be sent in PEP without a final prospectus as long as a final prospectus precedes or accompanies
delivery of the securities
vi. Must contain information specified in instructions as to summary prospectuses in the registration form used
and may contain information in registration statement and information specified in Rule 134(a) for a
tombstone ad
vii. When used in waiting period, must contain caption “Preliminary Summary Prospectus” and must comply
with requirements pertaining to preliminary prospectuses (e.g., must contain “Subject to Completion”
legend)
d. Eight copies of every proposed summary prospectus shall be filed as part of the registration statement (or amendment
thereto) at least 5 days (exclusive of Sat & Sun) prior to the use thereof, or prior to the release for publication by a
newspaper, magazine or other person, which is earlier.
Rule 164 and Rule 433: free-writing prospectus (WP & PFP)
a. Defined in Rule 405 as any written communication that constitutes an offer to sell securities that are or will be the
subject of a registration statement but that is not a Rule 430 preliminary prospectus or a Rule 431 summary
prospectus. Falls within the exception from the definition of prospectus in clause (a) of section 2(a)(10).
i. A dealer may send a free writing prospectus (as defined in Rule 405) to one customer in the waiting period
without filing it with the SEC because it does not constitute broad unrestricted dissemination. Nonetheless,
when an issuer is a nonreporting co, the free writing prospectus must be preceded or accompanied by a
preliminary prospectus that has been filed with the SEC. See Rule 164 & 433. Without access to and
delivery of a preliminary prospectus, the free writing prospectus does not meet the requirements of 10(b).
ii. Part I of the registration statement is the preliminary prospectus, which satisfies 10(a) during the waiting
period.
iii. Part II of the registration would be considered a free writing prospectus that is permitted, in the case of a
nonreporting issuer, if it is preceded or accompanied, by a preliminary prospectus that has been filed with
the SEC. See Rule 164 and Rule 433. Note that Part II of the registration statement does not have to be
filed with the SEC to satisfy Rule 433 if the mailing does not constitute a broad unrestricted dissemination.
iv. An electronic road show that does not originate live, in real-time to a live audience, is a free-writing
prospectus and is permitted if the conditions of Rule 433 are satisfied. A nonreporting co must put in the
electronic road show a hyperlink to its most recently filed preliminary prospectus and, as a nonreporting
company issuing equity securities, must file the SEC or make at least one version of a bona fide electronic
road show available electronically to all potential investors at the same time as the electronic road show.
Failure to comply with the hyperlink component or the “availability to investors) requirement of 433 results in
5(b)(1) violation.
b. Rule 164 provides that, after the filing of a registration statement, a free-writing prospectus that satisfies the
conditions of Rule 433 is a permitted prospectus under 10(b) for purposes of 5(b)(1) which requires that anything that
is in writing (during WP & PFP) meet requirements of 10.
i. If non-reporting company must send red herring. If well-seasoned company, you don’t have to send.
ii. Must file with the SEC (don’t confuse this with the possible requirement of having to precede this with red
herring requirement)
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c.
d.
e.
Free writing
prospectus
prepared/broadly
disseminated by
issuer,
underwriter,
dealer in WP.
… now only
disseminated
to selective
clients.
…to media
(gave
interview and
magazine
prepared it)
Rule 433 (c)(2)(i). A free writing prospectus used in reliance on this section shall contain substantially the following
legend: “The issuer has filed a registration statement (including a prospectus) with the SEC for the offering to which
this communication relates. Before you invest, you should read the prospectus in that registration statement and other
documents the issuer has filed with the SEC for more complete information about the issuer and this offering. You
may get these documents for free by visiting EDGAR on the SEC Web site at www.sec.gov. Alternatively, the
issuer, any underwriter or any dealer participating in the offering will arrange to send you the prospectus if you request
it…”
Rule 433 (g). Must not retain unless falls in one of the exemptions where does not have to be filed with SEC. Two
situations where one does not have to file it (retention only required when filing is not required)
i. Rule 164 tells us that free writing prospectus can be used by all 3 offering participants (issuer, underwriter,
dealer). If underwriter or dealer, disseminates it broadly, it has to be filed. However, when sent out
selectively to customers, it does not have to be filed.
ii. Also, does not have to be filed with the electronic road show though it has to be preceded / accompanied
by prospectus except as provided in Rule 433 (d)(8) where company is a nonreporting company and
offering is equity securities or convertible securities (and even then no requirement if you make at least one
version of a bona fide electronic road show available without restriction by means of graphic communication
to any person, including potential investor in the securities).
iii. Example of roadshow that is not a written communication is the traditional live roadshow. Live roadshow
does not require filing powerpoint slides used during presentation.
Who paid for news publication / interview plays key? Rule 433 (f). If issuer pays for interview, it is as if they had
written it themselves. If unseasoned company, would have to release copy of prospectus to all. If nonseasoned
company, you can’t pay magazine to do interview re: you because there is no way that you can send prospectus to
everyone in the world. If unaffiliated media distributes info on issuer & issuer did not pay, issuer will have to file
written communication w/in 4 business days after becomes aware.
Nonreporting or
unseasoned
reporting issuers
Seasoned
or
well-known
seasoned issuers
Nonreporting or
unseasoned
reporting issuers
Seasoned
or
well-known
seasoned issuers
Nonreporting or
unseasoned
reporting issuers
Seasoned
or
well-known
seasoned issuers
Must a preliminary prospectus
be available?
Must a preliminary prospectus
be delivered?
Must free-writing prospectus
be filed?
Yes
Yes
Yes
No (access = delivery)
Yes
Yes
Must a preliminary prospectus
be available?
Must a preliminary prospectus
be delivered?
Must free-writing prospectus
be filed?
Yes
Yes
No
No
No
Yes
Must a preliminary prospectus
be available?
Must a preliminary prospectus
be delivered?
Yes
No
Yes, issuer has 4 business
days.
No
Yes
Yes
Not possible to precede
with red herring to everyone!
Must free-writing prospectus
be filed?
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I. Posteffective period: starts on the effective date (price amendment is filed; SEC declares the registration statement effective),
and ends when the last SG dealer sells his last share in the case of a firm-commitment underwriting. §5(b)(1); §5(b)(2). Sales may
be made freely BUT offers are limited by 5(b) as in the waiting period, except that the term prospectus is defined in 2(a)(10) to allow
supplementary selling literature only after the effective date.
1. §5(a)(1) and 5(c) are no longer in effect BUT 5(b)(1) is still in effect. Note that 5(b)(2), which applies only in the posteffective period, refers to a 10(a) prospectus, whereas 5(b)(1), which applies in both the WP and PEP, contemplates a 10(a) or
a 10(b) prospectus.
2. §10(a) Final prospectus
a. Although red herring is a §10(a) prospectus, it cannot be used during the posteffective period. Rule 430 only allows
use of red herring during WP (nonreporting companies must state price range).
b. Summary prospectus still permitted and satisfies §10(b)
c. What is added to the final prospectus?
i. The price of the security / spread
ii. Names of the underwriting syndicate
iii. Any changes must be reflected in the final prospectus
d. Tombstone ad often used in PEP to celebrate the deal; however, tombstone ad cannot be used in PFP.
3.
§2(a)(10), Confirmation: prospectus = any writing confirms the sale of any security; confirmation only sent after effective date.
Written memo sent by broker / dealer to customer stating whether intermediary is acting as broker dealer, time, state prices,
number of shares.
a. §2(a)(10)(a): such confirmation is allowed as long as prospectus meeting the requirement of §10(a) precedes or
accompanies.
b. UCC, Art 8 eliminated securities requirement under UCC Statue of Frauds.
i. Confirmation is signed by the dealer.
ii. If the customer tries to back off, he has to object the confirmation w/I 10 days in writing, saying that he never
agreed to buy the securities.
iii. Under §12(a)(1), the customer can rescind the deal if there was a violation of §5.
c. Rule 172 provides that a confirmation is exempt from 5(b)(1) if the prospectus has been filed with the SEC. Thus, the
delivery of a confirmation is not linked to the delivery of the final prospectus. Rule 172 further provides that the
obligation to have a final prospectus precede or accompany the delivery of the securities is also eliminated if the final
prospectus has been filed with the SEC. Accordingly, under this provision of Rule 172, access = delivery.
i. In addition to providing access to information, the delivery of a final prospectus often serves the
function of informing investors that they purchased securities in a registered transaction. To
preserve this function, the SEC adopted Rule 173, which provides that whenever a final prospectus would
have been required to be delivered in the absence of Rule 172, purchasers must receive a final prospectus,
or in lieu of such prospectus, a notice to the effect that a sale was made pursuant to a registration
statement. This notice must be provided to the purchaser not later than two business days following the
completion of the sale. Under Rule 172, the purchaser may request a final prospectus, and it would not
have to be provided before settlement.
1. Compliance with Rule 173 is not a condition of compliance with Rule 172, and a failure to comply
with Rule 172 does not constitute a violation of §5.
4.
§2(a)(10)(a), Supplemental selling literature: as long as such literature is preceded or accompanied by prospectus that meets
the requirement of §10(a). In this sense, it would be better for seasoned or well seasoned company to call it free writing
prospectus so that you don’t have to send prospectus.
a. Supplementary selling literature is not a 10(b) prospectus and it does not have to be filed with the SEC. In this sense,
it would be better for seasoned or well seasoned company to call it supplemental selling literature so that you don’t
have to file.
b. Hypo: What if the research report upgrades a company in registration? Send a prospectus along w/ the research
report not to violate §5. It can be viewed as a supplemental selling literature, which is permitted during the
posteffective period.
c. Rule 172. When receiving supplemental selling literature, must be accompanied with physical delivery of prospectus.
Law firm representing selling group dealer in a registered offering. They called law firm up and informed that they send research
reports every month. We are in PEP period and they have box of research reports that they want to send. Research report has
recommendation for company for whom they are selling group dealer. Research report does not comply with 139 and violating
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section 5 by disseminating research report in 139. There is a way though? Call it supplementary selling literature and all you will
have to do is send final prospectus along with research report.
Today under free writing prospectus, would that also work? If it is a well known seasoned company or seasoned company that
solution would be better because you would not have to send a prospectus along. You would only have to file the free writing
prospectus with SEC. If non reporting company and nonseasoned issuer, then you would have to send prospectus.
5.
§5(b)(1), Requirements
a. If you send anything in the mail or use interstate commerce, it’d better be a prospectus that meets the requirement of
§10(a) or (b). See §2(a)(10).
i. Confirmation
ii. Supplemental selling literature
b. Thus, if you don’t follow the requirement of §2(a)(10)(a) for confirmation, supplemental selling literatures, you violate
§5(b)(1).
6.
Notice of Registration. In the Original distribution. An offering participant who sells must send a notice of a registration to the
purchaser within two business days of the completion of sale according to Rule 173
7.
§5(b)(2), Delivery of security: must be preceded / accompanied by a delivery of a prospectus.
a. Note that the statute only states that a final prospectus, which is contemplated in §10(a), must be delivered prior or
at the time the security is delivered.
i. §5(b)(2) is satisfied even if sent by someone else other than the dealer.
ii. It is required that the prospectus is delivered to the customer somehow.
iii. Confirmation. Rule 172(A) basically eliminates the confirmation requirements as long as the final
prospectus is filed with the SEC. Since final prospectus will always be filed with the SEC, then confirmation
is eliminated.
b. §5(a)(2)  “Delivery of security for purposes of sale or delivery after sale” Rule 172(b) satisfied if the final prospectus
filed with SEC (therefore, ACCESS = DELIVERY)
i. Unilateral contract: “delivery of security for purposes of sale”
1. Offer to buy  Delivery (acceptance)  Confirmation
2. Before the delivery, the prospectus must be delivered, or it must be accompanied at the time of
delivery.
ii. Bilateral contract: “delivery of security for purposes of delivery after sale”
1. Offer to buy  Offer to sell (acceptance)  Confirmation  Delivery
2. Was that offer to sell over the phone or in writing?
(i) In writing, the letter must be preceded or accompanied by a prospectus.
(ii) Over the phone, confirmation must be preceded or accompanied by a prospectus.
c. Loophole in the statutes: A prospectus doesn’t always have to be delivered to the customer before or at the
time of sale.
i. The statute still works b/c of the modern finance theory.
1. ECMH (Efficient Market Hypothesis): Once you file a registration statement, it becomes public,
and all the information will be reflected in the market price.
2. Bill thinks that it should be changed anyways.
ii. Rule 15c2-8(b), Delivery of Prospectus: Regulates only non-reporting company.
1. In light of the new rules, you should ask yourself “does access equal delivery”? While access =
delivery for freewriting prospectus and summary prospectus in reporting company, access does
not = delivery for non-reporting company.
2. If you are a proposed member of the selling group (dealer) and if you hook up w/ a customer
during the waiting period (no sale, but just an offer to buy from a customer, and the dealer intends
to accept the offer), you have to send a red herring to the customer during the waiting period so
that the customer can be informed. A dealer has to send a red herring 48 hours before she/he
sends the confirmation.
3. Why doesn’t SEC require the final prospectus sent 48 hours before confirmation during the posteffective period?
(i) The contract can be formed before the confirmation is sent.
(ii) §5(b)(1) requires that the prospectus must precede or accompany a confirmation. Thus,
the statute doesn’t give SEC the power to change the rule.
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d.
§4(3), Exemption for Dealers: Transactions by the dealers are not regulated by §5 except:
i. 4(1) says that 5 shall not apply to any other person than an issuer, underwriter, or dealer BUT 4(3) says that
provisions of (5) shall not apply to transactions by a dealer? 4(3)(B) says except “transactions in a security
as of which a registration statement has been filed taking place prior to the expiration of 40 days after the
effective date of such registration statement or prior to the expiration of 40 days after the first date upon
which the security was bona fide offered to the public by the issuer or by or through an underwriter after
such effective date, whichever is later”…This 40 – 90 day timeframe is called “quiet period.”
ii. 4(1) is right because (5) applies in some situations.
iii. 4(3) tells us when (5) applies and when it doesn’t. 4(3) tells us that it applies to all dealers (every securities
firm in the country) in the prefiling period, in the waiting period, and for part of the post effective period.
Afterwards (5) does not apply to dealers. The question is when does exemption end and begin? (whichever
is later, 40 days after the first date upon which security was bona fide offered or 40 days after the effective
date of the registration statement; sometimes the offering date is later than the effective date). Today,
usually 40 days into the post effective period. But if an IPO, the 40 days change to 90 days (see 4(3)(C)).
iv. Why are we concerned about nonselling group dealers? Why would a nonselling group dealer be involved
in a distribution? This is so because of secondary market transactions. However, Customer 1 wants to sell
– calls broker and broker buys and sells to another customer – broker was not part of selling group but will
sell to customer 2. If transaction occurs during quiet period during PEP then they have to comply with
section 5 and deliver a prospectus.
e.
Rule 174, Quiet period (1964; amended 1988): only applies to a non-reporting company; only applies in posteffective
period.
i. §4(3)(c): Does not change the duty of SG dealers to deliver the prospectus.
1. SG dealers are never exempt from the delivery of a prospectus requirement.
2. Hypo: If non-SG dealer produces a research report, which contains information about a nonreporting company that had just gone public, and if it was during the posteffective period, how
does he send it out?
(i) Send a prospectus w/ it.
(ii) Since it is treated as a supplemental selling literature under §2(a)(10)(a), it is okay to
do so during the posteffective period.
(iii) Note that under Rule 137, generally a research report cannot be sent out even by a
non-participating dealer unless it is about a reporting company at the time of filing.
ii. Aftermarket or secondary market transactions
1. Only SG dealers sell at the offering price.
2. IUSG dealersCustomer 1Non-SG dealersCustomer 2
(i) The last transaction can be done during the 40-90 day period (quiet period) and then
according to the statute the Non-SG would not be exempt from §5 until after the 90 day
period.
(ii) Non-SG dealer has prospectus requirement.
iii. W/o Rule 174, the non-SG dealer is required to deliver prospectus. (middle category created during 1988
amendments). In some cases, when you do IPO you are usually nonreporting company. Normally will not
be listed on major exchange but if company is hot NASDAQ or others may decide to list you on their
exchange. On Mircrosoft’s case, NASDAQ reported it (this represents the middle box that was created
resulting from the 1988 amendments).
Reporting Company at the
time when the registration
statement filed
SG dealer
Non-SG dealer
(aftermarket, not
in
original
distribution)
Must deliver according to
4(3)(c) until you sold all of
your original allotment
Exemption (Rule 174(b))
Non-reporting Company
whose stock will be listed on
an exchange or quoted on
NASDAQ on the offering
date
Non-reporting company
whose stock will not be listed
on an exchange or quoted on
NASDAQ on the offering
date
Must deliver (for same
reason)
Must deliver (for same
reason)
Exempt after 25 calendar
days after the offering date
(174(d)(2))
Non-IPO: 40 days
IPO: 90 days However,
usually 90 days because
nonreporting company will
be doing IPO. 174(f)
Co did IPO, bought back shares b/c 
like publicity of going public, would not
be reporting; but decide to 2nd-public
offering. Not IPO so that 40 day limit
would apply.
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iv. There is no exemption period for SG dealer until she sells the last issue of her allotment. Rule 174 (f)
1. When she sells last issue, she becomes Non-SG dealer.
2. What is the purpose of §4(3)(A)?
(i) Contemplates a situation where the issuer incorrectly assumed that it was exempt from
registration.
(ii) Non-SG dealer is not responsible for transactions done after the quiet period although it
might have been an illegal offering.
(iii) Dealer’s exemption may also apply to an underwriter after they have already sold all of
their shares.
f.
8.
§4(4) Broker /dealer exemption
i. A broker is a subset of a dealer, §2(a)(12): Every securities firm is a dealer.
1. Broker: Agent. Securities firm acts as an agent.
2. Dealer: Principal; however, in SA 33, dealer is defined to mean both an agent and a principal.
(i) Dealers hold the securities before they sell it to someone else
ii. IUSG dealerC 1 (through seller’s broker)  C 2 (through buyer’s broker)
1. When a seller’s broker has a requirement of delivering the prospectus, it is satisfied by delivering
it to the buyer’s broker.
(i) Note §2(a)(12): dealer includes broker. Thus, §5 also applies to brokers.
(ii) Sometimes, seller’s broker is also buyer’s broker. In that case, the broker must deliver
the prospectus to the buyer even if he did not solicit the offer to buy from the buyer.
2. When does the buyer’s broker have to deliver the prospectus to C 2?
(i) If the buyer’s broker did not solicit the buy order, the buyer’s broker does not have to
deliver the prospectus. Here, it’s hard to say that the broker is selling. If the customer
called buyer’s broker, then not considered a sale and irrelevant.
(ii) If the buyer’s broker solicited the buyer:
i. The buyer’s broker is considered a seller. Thus, must meet the prospectus
delivery requirement.
§10(a)(3), Nine-month prospectus (use for updating for currency)
a.
Mechanics
i. As long as your B/S is current from your filing date, it is deemed current.
ii. If you use the prospectus after nine months from the effective date, it’s very likely that the market has
changed.
1. Can’t be too stale: no more than 16 months
2. If it’s too old, a dealer can make the I and managing UW prepare a new prospectus.
3. In the below example, the old prospectus cannot be used b/c it’s older than 17 months.
Balance Sheet
3 months
b.
c.
d.
Filing Date
5 months
Effective Date
9 months
Buy
§10(a)(3), Nine-month Prospectus: Notwithstanding the provisions of paragraph (1) and (2) of this subsection, (1)
when a prospectus is used more than 9 months after the effective date of the registration statement, the
information contained therein shall be as of a date not more than 16 months prior to such use, so far as such
information is known to the user of such prospectus or can be furnished by such user w/o reasonable effort or
expense.
If a company registers and distributes additional securities of an outstanding class, must a dealer trading in the
securities comply w/ §5?
i. Dealers must be very careful in selling old certificates of a company which is in the process of the
registration.
1. You may be thinking that you’re selling old certificates, but you may end up delivering the new
certificates, in which case you’re in violation of §5(b). Thus, play it safe and comply w/ §5(b).
2. The problem is you may not know whether you’re selling an old certificate or not until you deliver
during the posteffective period b/c during the prefiling or waiting period the new certificates do not
exist yet.
10(a)(3) prospectus for self registration purposes, because 9 month period will come.
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9.
Rules 430A, 415, Delayed/Continuous offering: alternative registration technique. Securities may be registered for an offering
to be made on a continuous or delayed basis in the future. Rule intended for those who want to sell promptly.
a. Definition
i. Delayed offering: 2 months after the effective date, you can decide to take some shares and sell.
1. Each time when the batch is taken off, they are called tranche.
ii. Continued offering: The issuer continuously sells the shares.
1. Can be used to issue outstanding securities.
b. Rule 430A (1987): Contemplates an issuer who intends to sell promptly.
i. Only available for offering in cash.
ii. Gives the issuer an option to deviate from the traditional method (file price amendment and go effective)
1. The issuer can go ahead w/o the price amendment and make contracts of sale during 5
business days before the final prospectus is used.
(i) The key to remember is that once the registration statement goes effective, oral
contracts are allowed and the red herring can be used for 5 business days.
(ii) Issuers relying on Rule 430A believe it minimizes the risk of disruption of their marketing
schedule caused by the need of having to file a price amendment.
iii. Transaction-specific information: included in the registration statement (red herring).
1. Price information: Not included in the registration statement.
(i) Must be provided before the delivery, confirmation, or supplemental selling literature.
§5(b) still applies. In the end, §10(a)(3) still applies.
iv. Here, everybody is locked in w/o knowing the price. After the sale, you can come up w/ the price
information. The sale is pretty much done w/I two days.
v. Can use the red herring after the posteffective date for a short period of time.
1. Red herring: includes generic information about the issuer and transaction-specific information. All
you need to add after the 5 days from the effective date is the price information.
2. CAVEAT!: However, can’t use it after the 5-day period. However, you can’t send confirmation
or supplemental selling literature, or make delivery w/o sending the final prospectus first.
c. Rule 415, Shelf Registration (1983): Contemplates an issuer who intends to sell on a delayed or continuous basis.
Cheaper for companies to do shelf registration.
i. Mechanics
1. When you take securities off the shelf, you are always in the posteffective period. Therefore,
contracts for sale can be made immediately.
2. There is one quiet period of 40 or 90 days after the effective date.
ii. Generic information: For shelf registration, the registration statement is only based on the generic
information; thus, Rule 415 goes much further than Rule 430A.
1. W/o transaction-specific information (e.g., plan of distribution, no description of the securities, or
statement of the amount), the registration statement can go effective.
2. Must add transaction-specific information and price information for final 10(a) prospectus purpose.
iii. Register nunc pro tunc (now for thendelayed scheme): The issuer wants the securities registered
today, so that it can be distributed in 9 months.
1. Advantageous/flexible to the issuer b/c it allows to structure deals depending on the market
conditions (such as lower interest rates). Generally, for delayed offering, the tranche is smaller,
generating more competition among buyers.
2. 11 permitted securities distribution under Rule 415(a)(1)
(i) Offering by control person (i.e., Bill Gates)
(ii) Employee benefit plans: Form S-8, continuous offering
(iii) Securities issued upon the exercise of outstanding options, warrants, or rights:
underlying common stock ordinarily cannot be purchased immediately
(iv) Securities issued upon conversion of other outstanding (convertible) securities
(v) Securities which are pledged as collateral: when there is a default on the loan, the
securities can be sold.
(vi) Securities which are registered on Form F-6: American Depository Receipts/Shares
(ADRs) are used to get shares in exchange of the foreign securities which are not
registered in the United States. You can buy ADRs in U.S. dollars, and it is registered in
your name. Typically, foreign securities are bearer documents.
i. Form F relates to foreign securities. Foreign issuers must restate or reconcile
the financial statement according to US accounting principles.
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3.
4.
ii. Can deposit securities with US bank which will sell ADRs to the public. Can
also have securities firms interested in getting involved and they will set
depositary arrangement with commercial bank. Dividends of ADRs can be
purchased in US dollars. Usually they do not have voting rights.
(vii) Mortgage-backed securities: Mortgage loan is held by trust which sell interests to
investors, and the mortgage-back securities relate to the interests for mortgage loan. It
is useful to have shelf registration b/c as mortgages come in you can sell mortgagebacked securities. Banks lend money and make mortgage loans and transfer large
number of mortgage loans to a trustee who then sells interest in the trust – these
interests are debt securities that are constantly being sold.
(viii) Securities issued in connection w/ business combination transactions: Acquisitions are
often consummated w/ securities of the acquiring company.
(ix) Securities the offering of which will be commenced promptly, will be made on a
continuous basis and may continue for a period in excess of 30 days from the date of
initial effective: generally used for limited partnerships and condominium rental pools.
(x) Form S-3 companies: Radical innovation for dark blue chip companies. If the issuer is
a reporting company under Form S-3, the issuer can use shelf registration for any
securities, debt or equity.
i. Even if the issuer does not satisfy Rule 415(a)(1)(i)-(ix), it is okay.
(xi) Closed-end mutual fund distribution
CAVEAT!: Distribution of securities in Rule 415(a)(1)(viii)-(x) must be contemplated to be offered
and sold w/I two years.
In roman numerals 1-9 and 11, you do not have to be blue chip company, must only be involved in
any of the mentioned offerings; if not must qualify as blue chip for section x.
J. Summary
1. Oral v. Written Conduct
a. Written conduct is not allowed even during WP. Whereas a written brochure or letter can be disseminated, a
telephone call b/w two people cannot be disseminated.
b. Letter during WP: prohibited unless the letter has legend, accompanied by a prospectus. Can never be a offer to sell.
Transactions
Oral offers to sell
(Includes solicitation of offer
to buy)
Oral offers to buy
Written offers to sell
Written offers to buy
Sale
Deliveries
Confirmation
Preliminary Negotiations and
Agreements
Notice of proposed offering
Market letters and research
reports
Tombstone ads
(Must say where a §10
prospectus can be obtained)
Prefiling Period
No
§5(c)
Waiting Period
Yes
Conditional offers
Posteffective Period
Yes
No
§5(c)
No
§5(c)
No
§5(c)
No
§5(a)(1)
No
§5(a)(2)
No
§5(a)(1); §5(c)
Yes
§2(a)(3)
Yes
Rule 135
Yes
Rule 137-39
(reporting company)
No, 5(c).
Yes
Yes
Yes
Conditional offers
Yes
Yes
No
§5(b)(1).
No
§5(a)(1)
No
§5(b)(1)
Yes
Yes
-
-
Yes
Rule 137-39
(reporting company)
Yes
Rule 134
Yes
Rule 137-39
(reporting company)
Yes
Rule 134
No
Yes
Rule 430
No
Yes
No. Rule 430 creates it only
prior to effective date but
can be used in PEP.
No, only for waiting period.
Preliminary Prospectus
Preliminary Summary
Yes
Yes
Yes
Yes
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Prospectus
Free writing prospectus
Summary Prospectus
Final Prospectus
Supplementary selling
literature
Rule 431
(only in waiting period)
Yes. For well known
seasoned issuers. Will not
be 10(b) prospectus but
allowed as long as
including legend.
No
No
No
No
No
No
Yes
Rule 431
Yes
Yes
§2(a)(10)(a)
Hypo: Suppose you file registration statement on Dec 31, 2001. Your fiscal year ended on June 30 th 2001. You would have audited
balance sheets for fiscal year ending on June 30th 2000 and 2001. What about fiscal info from June 30th up to Dec 31st? You are
required to be current as of 90 days so you only have July, August, and September that you have to worry about (can do unaudited
interm balance sheets; accountants will do S-1 review to make sure there is no financial change in your structure, etc). If foreign
company wants to do public offering in US, it has to comply with US SEC rules. The problem comes with GAAP (generally accepted
accounting principles) that are very specialized.
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TOPIC 3—CIVIL LIABILITY
Hypo: During WP, if you have something wrong, SEC will make you file preeffective amendment. What happens if SEC discovers
something wrong in PEP. Well there are two types of errors:
Type I. Registration statement and prospectus describes fact that company owns 500 acres of timberland. But in PEP,
SEC discovers that the company only owns 250 acres due to mistaken survey. Will normally prepare PEP amendment which must
be filed with SEC (basically like doing registration all over again). Now this new prospectus must be used for any new purchasers.
As to what you do with those who previously bought under mistake, there are civil liability problems.
Type II. Events occur after the effective date. You don’t have to prepare post effective amendment. Say that 250 acres
burn down so that now you only own 250. You must file a prospectus supplement which is statement with correction (sticker on old
prospectus indicating new facts). This is cheaper but makes your prospectus accurate.
Use to be that prospectus supplements were better because they were not declared effective (the way post effective
amendments are). Rules this summer state that prospectus supplements are treated just as PEP amendments for purposes of
section 11 liability.
A. Criminal v. Civil liability
 §24, Criminal liability: Any person who willfully (intentional conduct) violates any of the provisions of this Act.
a. See also §32(a) of the EA 34: willful, intentional, egregious conduct
 Civil liability: rescission, injunctions, and damages
a. Rescission & injunctions: equitable remedies (can’t have jury trial in equity cases)
b. Damages: legal remedies
 Primary v. secondary liability
a. Primary liability: liability of the principal (actor)
b. Secondary liability: respondeat superior; vicarious liability for actions of agents.
c. §15, liability of controlling persons: Every person who [by or through stock ownership, agency, or otherwise,
or who pursuant to or in connection w/ an agreement or understanding w/ one or more other persons by or
through stock ownership, agency, or otherwise,] controls any person liable under §11 or 12 shall also be liable
jointly and severally w/ and to the same extent as such controlled person to any person to whom such
controlled person is liable…
i. Hypo: If a broker-dealer fails to comply w/ §12(a)(1) and is liable under §5, the firm would be the secondary
violator and would be held jointly and severally liable.
B. §12(a)(1), provides remedy for violation of §5 (strict liability provisions)
1. CAVEAT: Failure to register is NOT a misleading statement. Can’t use §12(a)(2).
a. Examples
i. “Illegal offer”, JM not used; Legal sale, JM used: no grounds for suit (each prong stands on its own feet)
ii. Illegal offer, JM used; legal sale, JM used: grounds for suit
2. Application: Applies to issuer, underwriter, or dealer
a. If a dealer is in violation of §12(a)(1), the purchaser can also sue the dealer’s firm under §15.
3. Drafting bug in §12(a)(1): “in the offer, sale, or delivery” is omitted.
C. §§12(a)(2), 11, 17, Antifraud provisions.
1. Elements of common law deceit
a. Scienter: Intentional/ knowingly
i. Culpability Standards
1. Intentional, willful: scienter
2. Knowing: scienter
3. Reckless: S(Ct) has not decided whether reckless conduct satisfies scienter
4. Negligent
5. Strict liability (liable even when innocent)
b. Materiality: Misrepresentation of a material fact
c. Privity: Parties are in privity of contract
d. Transaction causation: Inducing reliance
e. Loss causation: Causing damages
f. Statute of limitations has not expired.
g. The burden of proof is on the Π (who must plead, produce evidence, and persuade trier of fact)
2.
3.
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§§12(a)(2), 11, and 17 are similar in that they are based on fraud and fall under common law. Section 11 is just for final
prospectuses that are defective. Unclear whether private parties can sue under 17. If the SEC believes fraud, then will sue
under 17. Misleading prospectus is not necessarily tantamount to not receiving a prospectus. Classic violation of (5) is failure
to register; do not pretend this is tantamount to a misleading statement. Which one is worse? If you are plaintiff suing, you
would try to do 12(a)(1) because it is strict liability. Overlap between 11 and 12(a)(2) when it is a registered public offering and
final prospectus is fraudulent.
a. Increases the likelihood of a plaintiff to prevail under the statutes than under the common law
i. Use of federal court
ii. Half-truth (misleading statement) is actionable
iii. Privity often not required
iv. Scienter is usually not required: standard of culpability is usually negligence. Under §11, strict liability
applies to the issuer.
v. Materiality is assumed in the case of requirement statement in the registration statement.
vi. Burden of proof w/r/t culpability is on Δ.
vii. Reliance is usually not required
viii. Loss causation is not required
1. Burden of proof w/r/t loss causation is on Δ.
ix. Rescission is usually permitted.
b. Use supplemental/pendent jurisdiction to sue under common law fraud as well when suing under the statutes. Even
w/o diversity of the citizens, you can still bring out the state law claim in the federal court when there is already a
federal question.
c. Advantages of common law
i. Π does not have to show jurisdictional base.
ii. The statute of limitation may be longer.
iii. Controlling persons have no §15-like defense when Πs rely on the vicarious liability rule of respondeat
superior
Burden of Proof
a. In §12(a)(2) suit
Π
Jurisdictional means
Materiality
Π did not know that it was misleading
Statute of Limitation
b.
Δ
Culpability (Negligence)
Loss Causation: Comparative causation w/
reverse twist
In §11 suit
Π
Materiality
Reliance (when required)
Statute of Limitation
Δ
Culpability (Negligence)
Π knew
Loss Causation: Comparative causation w/
reverse twist
D. §12(a)(2), Offer or sale by means of untrue or misleading prospectus or oral communication
1. Drafting bug in §12(a)(2)
a. No mention of supplemental selling literature or tombstone ad.
i. Bill says that they are intended to be included.
b. There is a conflict b/w §3 and §12(a)(2) b/c §3 exempts from the entire statute, whereas §4 only exempts from §5.
2. Mechanics: If you lie by means of a prospectus or oral communication, you can get sued under §12(a)(2).
a. Jurisdictional means must be used w/r/t the particular Π.
b. CAVEAT!: A misleading prospectus is NOT a non-prospectus. Can’t use §12(a)(1).
c. Example
i. Through oral misrepresentation, offer, JM not used; through written acceptance, JM used: grounds for
suit as long as mails were used in some part of the transaction
3. Elements
a. Who is Π?
1. Gustafson v. Alloyd Co., Inc. (U.S. 1995: Kennedy)
a. §12(a)(2) applies to regular registered public offerings.
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b.
c.
d.
e.
b.
i. Even after market transactions that are covered by §5 is regulated by
§12(a)(2).
§12(a)(2) applies to §3 exempt public offering except:
i. §3(a)(2): government and banks
§(14): security futures product
§12(a)(2) does not apply to §4(2) exempt private offering.
§12(a)(2) does not apply to §§4(1), (3), and (4) ordinary trading transactions.
What does “prospectus” mean under §12(a)(2)?
i. §12(a)(2): “by means of a prospectus or oral communication”?
ii. The Court looked at §10, not §2(a)(10): Thus, the Court held that the
prospectus in §12(a)(2) meant the final prospectus under §10.
1. Bill thinks that they made a wrong decision. He thinks that §2(a)(10)
should be used.
Who is Δ?
i. Seller (i.e., dealer, issuer, underwriter, control person)
1. Who has primary liability as a “seller” for purposes of §12(a)(1) and §12(a)(2)?
a. Pinter v. Dahl (U.S. 1988) (All Δ did was to solicit the buyer. IUSG DealerC1 (Seller’s
broker) (Buyer’s broker) C2. Does a seller have to pass a title? Or is anybody who solicits a
seller?)
c.
d.
e.
f.
g.
i. If the buyer’s broker solicits the offer to buy for value, U, SG dealer, C1,
Seller’s broker and Buyer’s broker are all sellers.
1. For value: desire to benefit his/her own financial interest
(commission) or those of securities owner
2. Offer to sell includes a solicitation of an offer to buy.
ii. In Pinter, Δ argued that he was merely trying to share the information w/ a
friend.
b. §12 contemplates only an action by a buyer against his or her immediate seller.
i. Issuer is not covered: in best efforts underwriting, the issuer doesn’t sell the
securities to the underwriters. Their contract is merely preliminary negotiation
under §2(a)(3), and underwriters are merely agents.
1. In firm-commitment underwriting, the ultimate investor can recover
only from the dealer who sold to him. But the dealer in turn can
recover over against the underwriter, and the underwriter against
the issuer (CAVEAT!: preliminary negotiations under §2(a)(3). Each
Δ can bring in a predecessor in the chain of distribution as a thirdparty Δ). 159A recognizes discrepancy in result and says that issuer
will be treated as seller in firm commitment underwriting despite the
default that only the purchaser passing title can be sued.
ii. Controlling person under §15: not “control person”
iii. Brokers in §12(a)(2): Even if it is an after-market transaction, it is still regulated by §5. If it is still a part of
§5 regulated activity, it is still a part of public offering, and a broker may be involved in a public offering.
Culpability Standard: Δ has the burden of proof.
i. Primary liability: negligence under §12(a)(2)—“did not know or could not have known that it was untrue”
1. Scienter not required: Π does not have to show that Δ acted intentionally.
2. Reasonable care defense: §12(a)(2) provides affirmative defenses to the Δ.
a. Δ has the burden of proving the lack of negligence.
b. Dealers generally get off the hook, b/c they don’t prepare the prospectus.
ii. Secondary liability: negligence under §15—“unless the controlling person had no knowledge of or
reasonable grounds to believe in the existence of the facts”
Materiality: Π has to show the materiality.
i. Objective test: what would a reasonable investor think is important, and becomes a market-driving force
Reliance (transaction causation): Π does not have to show that he relied on the information.
i. CAVEAT!: Π still has to show that he did not know that the statement was misleading.
Loss causation: Π does not have to prove loss causation.
i. Comparative causation w/ reverse twist: Π does not need to prove the causation, but the Δ has the
burden of proving that some other factors had caused the price to go down.
1. Δ can reduce the damages if he can show that Π’s damages did not result from his misconduct.
2. Congress got this concept from §11(e).
Remedies: “may sue at law or in equity”
2
7
i. Damages: if Π sold securities before he sued.
1. Damages = Purchase price – Resale price + Interest on purchase price until resale + Interest on
damages from resale until judgment – Income and interest earned
ii. Rescission: if Π still owns securities, Π can give them back to the seller.
1. Rescission = Π tenders securities + Π receive purchase price + Interest on purchase price until
judgment – Income and interest earned (i.e., dividends or bonds)
2. Rescission is allowed even though the broker, technically, did not pass the title.
E. §11, Civil Liabilities on Account of False Registration Statement
1. Drafting bug in §11—no mention of jurisdictional base.
a. But the SEC requires the use of mail or EDGAR for registration.
2. Mechanics
a. The security must be registered to have a C/A under §11.
b. Only final prospectus or posteffective amendments
i. Red herring or supplemental selling literatures are not covered by §11.
ii. Note that if the error in supplemental selling literature is corrected by posteffective amendments, it is
covered by §11.
iii. §11(d), Posteffective underwriters: §11(d) contemplates a situation where the underwriter comes into the
play long after the effective date.
1. Generally, underwriters come to the game during the waiting period, and the due diligence is
assumed to be completed on the effective date when they had a final prospectus.
2. For posteffective underwriters, the statute will assume that the due diligence is completed at
the time when it became an underwriter.
c. Overlap b/w §11 and §12(a)(2) if:
i. when the issuer or an underwriter is the seller;
ii. the security is registered; and
iii. the wrongful conduct is use of a misleading prospectus
3. Elements
a. Who is Π?
i. Any person who acquired a registered security, whether in the process of distribution or in the open market.
ii. Open market buyers: Must be able to trace their particular securities to the registration statement when it
covers additional securities of an outstanding class.
b. Who is Δ?: Whoever signed registration statement (purchasers allowed to sue people they didn’t directly deal with)
i. Therefore, cannot sue a dealer under §11  Dealers must be sued under §12(a)(2).
ii. Underwriter: §11 creates an adversarial relationship b/w underwriters and the issuer, b/c the underwriters
are jointly and severally liable.
iii. Issuer: Often, suing the issuer isn’t a good idea b/c chances are that the issuers don’t have a lot of money if
they used a misleading statement.
iv. Directors/officers
v. Experts: accountant, lawyer, appraiser, and engineer
1. CAVEAT!: The fact that lawyers wrote the entire registration statement does not mean that the
lawyers can be Δs. To sue lawyers as Δs, the expert portion must be false.
vi. Control person: Securities must be registered when the control person uses an underwriter. Under §15, Π
can sue a control person b/c the control person directly controls the underwriter.
vii. Controlling person under §15
c. Culpability standard
i. Control person: Negligence under §15—“unless the controlling person had no knowledge of or reasonable
grounds to believe in the existence of the facts . . . .”
ii. Other primary liability: Negligence under §11—“after reasonable investigation, reasonable grounds to
believe and did believe at the time such part of the registration statement became effective . . . .”
1. What is “reasonable”? What would a prudent person in the management of his or her property do.
iii. Issuer: Strict liability under §11(b)—“no person, other than the issuer, shall be liable as provided therein
who shall sustain the burden of proof . . . .”
iv. §11(b), Due diligence defense: available for every Δ except the issuer
Whistleblower defenses
(1) Before effective date, resignation and notification of resignation to SEC and issuer;
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8
(2) After effective date (w/o knowledge of effectiveness), resignation and notification of resignation to
SEC and public notice that registration statement became effective w/o knowledge;
(3)(A) As to nonexpert portion of registration statement, experts have no liability, and nonexperts
have due diligence defense—they had, after reasonable investigation, reasonable ground to believe (at
time of effectiveness) that the statements were true;
(3)(B) As to expert portion, experts have due diligence defense—they had, after reasonable
investigation, reasonable ground to believe (at time of effectiveness) that the statements in their
expert portion were untrue;
(3)(C) As to expert portion, nonexperts have due diligence defense—they had no reasonable ground
to believe (at the time of effectiveness) that the statements were untrue.
1.
Standard of due diligence
a. High: After reasonable investigation, reasonable ground to believe that the statements
were true.
b. Low: No reasonable ground to believe that the statements were untrue.
Non expert portion
Expert portion
High
Low
Not liable
High
Non experts
(underwriter, officer, director)
Experts
(lawyer,
accountant,
appraiser)
d.
e.
f.
Materiality: What a reasonable investor consider when he decides to buy or not.
i. Required statement for registration statement is deemed material.
Reliance (transaction causation)
i. Required only after the issuer makes available an earnings statement covering a 12-month period after
effectiveness.
1. Note that reliance may in this situation be established w/o proof of having read the registration.
a. Rationale: Fraud-on-the-market theory. Π doesn’t have to show that he in fact read the
registration statement.
ii. Burden of proof for reliance: Δ has the burden of proof.
1. Δ has to show that Π knew that the statement was untrue or misleading. Different from §12(a)(2).
Remedies: Suits in law and equity are allowed under §11. Lien is when they refer to equitable remedy.
i. Difference w/ §12:
1. §11 makes no mention of interest although §11 purports to provide rescission.
2. §11 mentions attorney’s fees (but Bill says courts require attorney’s fees in §12 suits).
ii. Mechanics
1. No resale prior to judgment (modified tort measure):
a. Amount paid – value at time of filing suit
2. Resale before filing suit
a. Amount paid – resale price
3. Resale pending suit: lesser of 1. or 2.
a. If you want to being made whole, sell immediately after filing suit so that the resale
price would be the value at the time of filing suit.
4. The amount paid, §11(e) and the amount recoverable, §11(g) cannot exceed the public
offering price.
a. In a class action suit, Πs cannot recover, in aggregate, the public offering price * shares.
Public offering price = §10
#1
Amount Paid
- Resale price
Damages
b.
#2
10
8
2
#3
8
7
1
#4
7
9
0
#5
9
3
6
3
0
3
Therefore, when the investor purchased the security in the secondary market (not
during the IPO), his amount paid is limited to the public offering price.
g.
h.
i.
2
9
c. Minuend never exceeded ten so 11(e) is satisfied but 11(g) is not satisfied because
public offering price (10) < damages (12) which cannot happened according to 11(g).
§11(e), Limits for Underwriter liability
i. If the underwriter does not receive preferential treatment from the issuer (managers may receive preferential
treatment), the liability of the underwriter is limited to the total price at which the securities
underwritten by him and distributed to the public were offered to the public.
1. However, it’s easy to get around this provision b/c you can get preferential treatment from the
dealers, not from the issuer.
2. For example, managing underwriters get 50% of the spread, while other underwriters share the
rest.
ii. Joint v. Several underwriter
1. All of the underwriters are jointly underwriting the issues. They will be treated as underwriting for
the entire $500K.
2. When an underwriter underwrites severally, he underwrites to the extent of $200K.
a. Based on the limitation of the damages, several underwriting is better.
iii. Hypo: 50K shares sold in a registered public offering price/ share =$5
1. Managing underwriter gets 20K shares
a. Underwriter #1 gets 10K shares
b. Underwriter #2 gets 10K shares
c. Underwriter #3 gets 10K shares
2. Managing underwriter gets preferential treatment: joint underwriting
a. Liable for full $250K
3. Managing underwriter gets preferential treatment: several underwriting
a. Managing underwriter: $250K
i. §11(g): Amount recoverable is limited to the total offering price. Since the
managing underwriter got a preferential treatment, §11(e)’s several liability
provision doesn’t apply.
b. Underwriter #1-3: $50K each
4. Managing underwriter does not get preferential treatment: joint underwriting
a. All underwriters: $250K
5. Managing underwriter does not get preferential treatment: several underwriting (this is ideal
method)
a. Managing underwriter: $100K
b. Underwriter #1-3: $50K each
§11(f), Joint & Several Liability and Contribution
i. “As in case of contract from any person”: If only one guy is sued and he pays, he can get half the
damages he paid. If he can find two others who were not sued but would have been liable, he can get 1/3
from those two.
1. In tort, your contribution is determined by your proportionate liability. However, under §11, the
determination of proportionate liability is not required for contribution.
2. CAVEAT!: However, the liability of outside directors gets different treatment, though. It should be
proportionate liability. See §21D(f) of EA 34.
a. The outside directors must not act knowingly to get the benefit of proportionate
liability. Therefore, they must be simply negligent.
3. If one person is guilty of fraudulent misrepresentation (meaning intentional) and the other is not,
the other doesn’t have to make contribution.
a. X, a §11 Δ is sued. Can X seek contribution from Y, another §11 Δ?
i. X: Intentional; Y: Negligent, innocent: X does not get the contribution from Y
b/c Y did not act intentionally.
1. CAVEAT!: Only the issuer can be held liable for innocent conduct
under §11.
ii. X: Intentional; Y: Intentional: X can get contribution from Y.
iii. X: Negligent; Y: Intentional, Negligent, Innocent: X can get contribution from
Y.
iv. X: Innocent; Y: Intentional, Negligent: X can get contribution.
§15, Liability and contribution control person
i. Can get contribution from those who had primary liability
ii. No contribution among control persons
3
0
j.
k.
Indemnification for directors, officers, and control person
i. Indemnification: can arise outside of litigation in which parties agree to indemnify other parties in the event
that another party has to pay. Usually, based on written contractual agreement.
ii. SEC doesn’t like indemnification b/c it defeats the purpose of the statute.
iii. Regulation S-K, Item 512(h)(3), Johnson & Johnson Formula
1. In the opinion of SEC, indemnification for officers, directors, and control person is not enforceable
and against the public policy, and the issuer cannot enforce the indemnification agreement unless
it files a report.
2. The SEC won’t accelerate the registration statement unless the statement includes a clause
stating:
a. “In opinion of the SEC, indemnification agreements are not enforceable and against
public policy, and will not be enforced unless court determines that it is not against
public policy.”
iv. Rule 461(c), Insurance
1. The issuer can pay for the insurance. Bill thinks that it’s an anomaly, but probably SEC likes
another deep pocket—the insurance company.
v. Cross-indemnification agreement: B/w underwriter and the issuer, usually the issuer indemnifies the
underwriter’s officers and directors b/c underwriters provide very little for the registration statement if any.
Underwriters also agree to indemnify issuer for information provided by the underwriter.
vi. Control person can indemnify issuers, directors, etc.
Statutes of Limitation: Does §804 of Sarbanes-Oxley trump §13 for fraudulent statement, which is covered by §11
and §12(a)(12)?
i. §804: two years after discovery and five years the violation. §804 only covers fraud.
ii. Bill thinks that §13 governs for §11 and §12(a)(2) b/c there is no violation for §11 and §12(a)(2).
However, Bill thinks that §804 governs Rule 10b-5.
F. §17, Fraudulent interstate transaction
1. When SEC finds out the issuer is offering securities through fraud.
a. §5: When SEC finds out the issuer is offering securities while violating §5
b. Very similar to Rule 10b-5, but Rule 10b-5 applies much more broadly b/c it applies to sale, trading, etc whereas §17
applies only to offer of securities.
2. Private parties’ C/A is implied: however, some courts don’t allow private C/A.
a. Loss thinks that private parties should not be able to sue under §17(a). Bill agrees. He believes section is to be used
by SEC, not private parties. If private parties can sue, there is redundancy under 12(a)(2) and 17(a).
3. Elements
a. Materiality: Yes.
i. Common law materiality requirement
1. §17(a)(1): “device, scheme, or artifice to defraud”
2. §17(a)(3): “fraud or deceit”
ii. §17(a)(2): “material fact or omission”
b. The SEC cannot sue under §11 or §12(a)(2), b/c they are not violation clause.
c. Statute of limitation: unclear what S/L to use b/c Bill says private C/A wasn’t contemplated by the Congress. There
are debates as to which S/L applies to SEC.
i. Double barrel statute of limitation: cumulative
1. 1 year from discovery of untrue statement or omission
2. 3 years after the sale
ii. §804 of the Sarbanes-Oxley Act
1. two years after the discovery
2. 5 years after the violation
3
§12(a)(1)
Express/implied
Registered?
Jurisdictional base (P has burden)
Court
Π
Δ
Privity
Culpability
Express
No.
Exemption
§3(a)(2)-gov’t, banks
§3(a)(14)- security futures
Mail; Interstate commerce
Concurrent jur., §22
/
Δ cannot remove
Purchaser (jurisdictional means w/r/t/ Gustafson held § only applies to
particular P)
purchasers from public offerings &
not to private offerings or ordinary
trading transactions.
Applies to
registered & §3 public offerings except
for those exempt;  apply to 4(1), 4(2),
4(3), 4(4).
Any doc or oral communication in
12(a)(2) is covered.

A seller (Issuer, Underwriter, Dealer)

Controlling person (not control person)

Pinter (p.1217) (brokers can be sellers so accepts suit for aftermarket
purchases)
Yes, needs to violate §5.
No
Primary Liability: Strict liability,  Primary liability: negligence,
§5, no scienter req.
“reasonable
care
defense,”
§12(a)(2)
 Secondary Liability: Negligence
so off the hook if innocent (if  Secondary liability (through use
controlling person, negligence
of controlling person): negligence,
standard under 15 applies)
§15
(D may defend that the securities were
exempt from registration.)
NOTE: Δ has burden of proof for both! (in common law, normally P would have to
establish)

Materiality (Objective)
No.
“Reasonable investor”
Reliance (Subjective)
Transaction causation
No.
Causation
Loss causation (economic harm)
No.
§11
1
§17(a)
Implied; circuits split
No.
§17(c): exemptions in §3 does not apply
to §17.
Registration involves mail or EDGAR.
Any Ct of competent juris
Purchaser.. Most Cts permit any person
who acquitted a registered security,
whether in process of distribution or in
open market, to sue. Open-market
buyers, however, must be able to trace
particular securities to registration
statement.
Mail; interstate commerce
Concurrent jur., §22.
Purchaser from public/private offering,
and ordinary transactions.
U.S. v. Naftalin; proves that Gustafson is
wrong.
Anyone who signs registration
statement.
Issuer,
Underwriter,
Officer/director
Experts, Control person §15
Not dealers b/c they do not sign
registration statement.
No.
 Primary liability: negligence
 Issuer: strict liability (only defense
is that P knew of fraud)
 Control person: negligence
Defenses for D contained in 11(b):
1. resign b/f PEP (notify SEC/ issuer)
2. after PEP, = above but public
notice that registration statement
became effective w/o knowledge
3. Due diligence.
Yes.
Required statement is deemed material
Anyone who sells
Only if issuer makes earnings statement
covering a 12-month period after
effective date.
Even then, may be satisfied w/o proof of
reading the statement.
No.
Comparative causation w/ reverse twist
Yes.
No if SEC sues.
§12(a)(2)
Yes.
Π must show materiality
Rule 159 reqs that materiality involves
looking at all info before sale.
No.
However, Π has to show that he did not
know statement was untrue or
misleading.
No, §12(b)
BUT Comparative causation w/ reverse
twist:
Δ can reduce damages if show Π’s
damages did not result from misconduct
Express
Yes.
No.
§17(a)(1): scienter
§17(a)(2): negligence
§17(a)(3): negligence
Aron v. SEC
Cf. Scienter is required for all three
prongs of Rule 10b-5 b/c §10(b) requires
scienter.
Burden of proof on P.
Yes.
Rule 159.
Yes.
No if SEC sues.
3
2
Remedies (if remedy is rescission, the
P must tender securities purchased and
will receive the purchase price + interest
on the purchase price until judgment –
income / interest earned; if remedy is
damages, P will receive difference
between purchase price and resale
price + interest (on purchase price until
resale, then on damages until judgment)
– income / interest earned)
Statute of Limitations (not affirmative
defense; P must prove he is w/in SOL)
Is SA 13 the law or SOX 804? Has not
been resolved yet. Bill believes that you
cannot violate 12(a)(2) or 11 so that 804
would not apply. 12(a)(2) and 11 just
provide private right of action.
(Congress got this concept from §11(e))
Damages: if Π sold
Rescission: if Π still has
§13, double barrel S/L
w/in 1 yr: after the violation of §5 upon
which suit is based (at time of sale);
no more than 3 yr: after the security was
bona fide offered to the public. Public
offering date usually in WP, however,
courts have interpreted 3 years after
delivery of securities.
§13, double barrel S/L
1 yr: after the discovery of untrue
statement or omission
3 yr: after the sale
If Gustafson is right, why not just after
public offering? They didn’t use it
because they knew that there might be
ordinary transaction after sale.
Gustafson is wrong!
Only damages; in general in 12(a)(1)
and 12(a)(2) you are suing person you
bought from but in 11, you are not
necessarily suing person you bought
from / parties you did not have privity of
contract and therefore does not make
too much sense to have rescission
measure with person you did not buy
from
No mention of remedies in §17.
Generally, damages and rescission.
Even punitive damages are allowed.
§13, double barrel S/L
1yr: after discovery, §12(a)(2) + §11
No more than 3yr: after offering to
public, §12(a)(1) + §11
Remember offering can start before
effective date
Problematic b/c Congress didn’t
contemplate private C/A.
§12(a)(2)’s S/L was used, but §804 of
Sarbanes-Oxley is now used (2 years
after discovery and 5 years the violation)
Debate as to which S/L applies to SEC.
33
G. §27A, Forward-looking Statement.
1. Safe harbor for forward-looking statements (cf. §21E of the EA 34)
a. Only applies to reporting companies; Does not apply to IPOs (this is possible if co. grew through exempt offerings,
etc)
i. Reporting company can do an IPO, so both provisions are necessary
b. Who has the safe harbor?: Not dealers. Person acting on behalf of the issuer.
i. Issuer
ii. Directors, officers
iii. Outside reviewers: experts
iv. Underwriters
2. Covers both written and oral forward-looking statement in §12(a)(2), but §27A primarily applies to §11 suits.
3. §27A(c)(1), Operative test
a. Must have adequate cautionary language and must be identified as a forward-looking statement; or
b. The statement is immaterial; or
c. Π fails to prove that the forward-looking statement
i. If made by natural person, was made w/ actual knowledge by that person that the statement was false or
misleading
ii. If made by a business entity
1. Made by or w/ the approval of an executive officer of the entity; and
2. Made or approved by such officer w/ actual knowledge by that officer that the statement was false
or misleading.
d. Rationale: judicially developed bespeaks caution doctrine and Rule 175.
i. Bill says this provision amounts to a license to lie b/c basically, as long as you put the cautionary language,
you’re fine.
H. Civil Liability Summary
 §12
a. §12(a)(1) imposes liability for rescission or damages upon an issuer, underwriter, or dealer who violates §5, and the
suit must be brought by the purchaser of the security against the seller.
b. §12(a)(2) imposes liability for rescission or damages upon anyone who offers or sells publicly any security (whether or
not the security is exempt from registration) by means of an untrue or misleading prospectus or oral communication,
and the suit must be brought by the purchaser of the security against the seller.
c. Be careful not to transfer a 12(a)(2) action into a 12(a)(1) action and vice versa.
i. Use of a misleading prospectus is an adequate basis for a 12(a)(2) suit, but the theory that a misleading
prospectus is equivalent to no prospectus at all is not an adequate basis for a 12(a)(1) suit.
ii. Failure to register is an adequate basis for a 12(a)(1) suit, but the theory that it is a material omission (and
hence misleading) not to disclose that the securities have not been registered (when they should have
been) is not an adequate basis for a 12(a)(2) suit.
iii. Prof Loss points out on p. 1198 that when (1) the issuer or an underwriter is the seller, (2) the security is
registered, and (3) the wrongful conduct is use of a misleading final prospectus, there is some overlap
between 12(a)(2) and 11.
 §11 imposes liability for damages upon the issuer of a registered offering, certain of its officers, its directors, its
underwriters, and certain other persons (experts) when the registration statement (at the time it becomes effective) is untrue or
misleading, and the suit must be brought by the purchaser of the security.
 §17(a) prohibits fraud and untrue or misleading statements by anyone in connection with the offer or sale of any security
(whether or not the security is exempt from registration) and any security-based swap agreement. Therefore, §17(a) is the
general antifraud provision of the Securities Act, and it supplements §5 and the express fraud liability provisions contained in
§12(a)(2) and §11.
34
TOPIC 4—DEFINITIONS
1.
Security
a. §2(a)(1) of SA
i. “Context” refers to the context of the sections not of the cases.
ii. Security means any: (3 most important in bold)
1. note
2. stock
3. treasury stock
4. bond
5. debenture
6. evidence of indebtedness
7. certificate of interest
8. participation in any:
a. Profit-sharing agreement
b. Collateral-trust certificate
c. Pre-organization certificate or subscription
d. Transferable share
e. Investment contract
f. Voting-trust certificate
g. Certificate of deposit for a security
h. Fractional undivided interest in oil, gas, or mineral rights
i. Put
j. Call
k. Straddle
l. Option
m. Privilege on any security
n. Certificate of deposit
o. Group or index of securities, including any interest therein or based on the value thereof
9. Or any put, call, straddle, or option privilege entered into a national securities exchange relating to
foreign currency
10. Any interest or instrument commonly known as a security or any certificate of interest or
participation in, temporary or interim certificate for, receipt for, guarantee of, or warrant or right to
subscribe to or purchase any of the foregoing.
b. §3(a)(10) of EA, Definition of Security: Same as defined in §2(a)(1)
c. Notes: Reves v. Ernst & Young (U.S. 1990)
i. Family resemblance test: A note is a security unless a strong family resemblance to something else.
Basically, you have to have a feel for it.
1. e.g., consumer finance note (not security), home mortgage note (not security)
2. Categories of instrument being notes that are not securities are the following: note delivered in
consumer financing, not secured by a mortgage on a home, short-term note secured by a lien on
a small biz or some of its assets, not evidencing a “character” loan to a bank customer, short-term
notes secured by an assignment of accounts receivable, or a note which simply formalizes a
open-account debt incurred in the ordinary course of business.
ii. §3(a)(3), Exemption: Any note, draft, bill of exchange, or banker’s acceptance which arise out of a current
transaction or the proceeds of which have been or are to be used for current transactions, and which
has a maturity at the time of issuance of not exceeding 9 months, exclusive of days of grace or any
renewal thereof the maturity of which is likewise limited.
1. §3(a)(10) of EA: Excludes short-term paper from the definition so that one would expect even the
fraud provisions of the 1934 Act to be inapplicable.
2. CAVEAT!: In pari materia. In the same matter. The Supreme Court held that short-term notes
are treated the same in the sense that the antifraud provision applies to them, but they are
exempt from registration. Landreth (U.S. 1985); Tcherepnin v. Knight (U.S. 1967)
a. Under SA, short-term papers are securities but they are exempt under §3(a)(3).
Therefore, they are still subject to antifraud provisions. The Supreme Court has treated
EA the same way, so short-term papers are subject to antifraud provision under EA, but
they are not securities.
35
d.
Investment contracts: SEC v. W.J.Howey Co. (U.S. 946) (Purchased strips of land in conjunction w/ citrus farming.
SEC brought an injunctive action to stop Δ.) Sale of service package + real estate, resembled investment contract.
Selligman says there is no horizontal commonality; Bill thinks he is wrong, he thinks this was case of horizontal
commonality.
i. Economic reality test: a scheme involving an investment of money in a common enterprise w/ the
expectation of profits coming solely from the efforts of others.
1. Common enterprise
a. Horizontal commonality: will suffice alone w/o vertical commonality.
i. Pooling of investments. 3d, 6th, and 7th Cir.
Investor – Investor—Investor
b. Vertical commonality: There is a split when there is only vertical
Seller
commonality.
|
i.
Strict vertical commonality: 9th Cir. and the SEC think that
Investor
vertical commonality may be sufficient by itself, but it says that the fortunes of
investors must be linked to the fortunes of the promoter.
1. Requires more than “merely furnishing counsel to another for a
commission.”
2. Bill and Loss think this is a good approach.
ii. 5th and 11th Cir. seem to believe vertical commonality may be enough. Under
5 & 11, getting commissions would suffice; in 9th, would have to get % of
profits. SEC agrees with 9th Circuit’s definition of vertical.
2. Solely: obiter dictum. Not necessary in decision (not binding to subsequent decisions)
a. The Court did not have to say “solely.” Lower courts have said that “substantially or
primarily” from the efforts of others. So the dictum is written out of the definition.
i. e.g., franchise
ii. Partnership Interest The partnership is treated as a corporation for the purpose of the statute.
1. Subject to antifraud provisions of §17(a) of SA and Rule 10b-5 of EA
2. Limited Partnership: Has both general and limited partners. LP is more likely to have securities
b/c it is an investment contract since limited partners have no control as to the partnership.
a. A de jure LP may be a de facto GP. A limited partner can act as if he was a general
partner.
3. General partnership: Has only general partners
a. A de jure GP may be a de facto LP when a general partner doesn’t have a control. In
that case, the general partner can sue under the securities law.
4. Limited liability company: For tax purposes, it is treated like a partnership. Normally, investors of a
corporation don’t exercise control, but the shareholders of a LLC may exercise some control. So
whether it is considered as an investor contract, you have to look at the specifics.
iii. Resort condominiums: Fractional undivided interests in a building.
1. The economic inducement: The profits that the purchaser is led to expect may consist of revenues
received from rental of the unit.
2. Sec. Act Release 5347 (1975): The offering of condominium units in conjunction w/ any one of
the following will cause the offering to be viewed as an offering of securities in the form of
investment contracts:
a. Vertical commonality: The condominiums, w/ any rental arrangement or other similar
service, are offered and sold with emphasis on the economic benefits to the
purchaser to be derived from the managerial efforts of the promoter or a third party
designated or arranged by the promoter, from rental of the units.
b. Horizontal commonality: Sharing of expenses and revenues offerings of
participation in a rental pool arrangement; and
c. ~Rule 415(a)(1), Shelf registration: The offering of a rental or similar arrangement
whereby the purchaser (a) must hold his unit available for rental for any part of the
year; and (b) must use an exclusive rental agent or is otherwise materially restricted in
his occupancy or rental of his unit.
iv. Franchise
1. Right / license granted to individual / group to market company’s goods or services.
2. Test: Are profits driven by the significant effort of the franchisors? If yes, it is securities.
a. Generally, franchisee does most of the work, so it is not security.
36
3.
e.
f.
Pyramid (Ponzi) scheme: A fraudulent investment scheme where the issuer draws money from
subsequent investors to repay the original investors in order to attract more money.
a. SEC v. Glenn Turner Enterprises (9th Cir. 1973)
i. The court held that it was an investment contract, and therefore, the
franchisee can sue for fraud in the sale.
Stock
i. Essential characteristics test: stocks must have dividends, voting rights, etc. Doesn’t look to the economic
reality; rather, focus on the legal features of stocks (Ability to appreciate in value, right to dividends, voting
rights, transferability…)
1. United Housing Foundation v. Forman (U.S. 1975) (To be a tenant of the co-op city, people
had to buy stocks. §17(a) and Rule 10b-5 class action suit)
a. Were the shares stock?  Apply essential Characteristics Test. Under essential
characteristic test, the stocks did not have the rights of normal share.
b. Were the Shares Investment Contracts?  Economic Reality Test. It wasn’t investment
contract either b/c the nature of the project was non-profit. Moreover, the motive to buy
the stocks were to have a place to live, not to make an investment
ii. Sale of business doctrine: Over time, the lower courts have developed the doctrine that the federal
securities laws do not protect entrepreneurs who actively purchase businesses, although the sale may
involve 100% of the stock or the controlling block. It cannot be a common enterprise, b/c they buy to operate
the business themselves. Federal securities laws were passed to protect passive investors, not active
entrepreneurs.
1. Landreth Timber Co. v. Landreth; Gould v. Ruefenacht (U.S. 1985)(private action arguing
there was fraud in connection with security)
a. The Court rejected sale of business doctrine.
i. If you have a stock, apply the essential characteristics test!.
1. If yes, it is security, full stop.
2. If no, then go on to the economic reality test.
b. CAVEAT!: If you sell your entire company to another through the securities, you don’t
have to register the sale.
i. Why is it exempt? §4(1). The person selling is the control person, and if he
doesn’t use underwriters, the sale is exempt.
c. If you sell your asset, it is definitely not covered by the federal securities laws. But see
Rule 145.
Derivatives
i. An instrument that derives value from an underlying asset, rate, or index.
1. Underlying assets: corporate stock, commodities, currency, weather
2. Underlying rates: currency exchange rates, interest rates
3. Underlying index: Dow Jones Industrial Index (avg. of dark blue chip corporate stocks prices), the
S&P 500 Index
ii. Risk shifting devices
1. Options: one party is bound, and the other party is not bound. You have to put money down to
exercise the right to buy at a certain price (“strike price”).
a. Call: right to buy. You’re hedging against price increase. Long
b. Put: right to sell. You’re hedging against price decrease. Short
c. Straddles: double privilege of put and call on the same underlying asset.
2. Forwards: both parties are bound. It’s a fancy word for a contract; no money down.
a. Futures: generally marked to market (promise to buy x barrels in x months); margin
account has securities and cash; assurance to broker / dealer that if you’ve been given
credit, there is sufficient cash to cover the transaction; all futures are marked to market
b. Swaps: not marked to market;
i. Interest-rate swaps: A and B exchange interest rates. Betting. One party holds
10,000 home equity loan that has fixed interest rate, Party B holds another
10,000 home equity loan that has a floating rate. If parties exchange rates,
then this is an interest rate swap.
1. LIBOR (London Inter-bank Offering Rate)
ii. Cross-currency rate swaps: A and B exchange currencies. Betting. US
company sells goods in Mexico and contract for being paid in pesos;
concerned that current exchange rate is right for payment now but exchange
37
iii.
iv.
v.
vi.
vii.
rate may move in future; because of that concern they may enter into
derivative contract with financier that will be willing to pay them the difference
in exchange rate when the amount is due.
§2(a)(1) of SA 33 and §3(a)(10) of EA 34, Securities
1. A security includes (1) a security future, (2) an option on any security or on any group or index of
securities, and (3) an option entered into on a national securities exchange relating to foreign
currency.
a. A put option on crude oil: Although it is a derivative, it is not a security b/c crude oil is
not a security. It is a commodity future.
b. If the underlying asset, rate, or index is security, then it is a security.
i. CAVEAT!: Option on foreign currency is security under §2(a)(1) although
foreign currency is not security.
§3(a)(55)(A) of EA 34, Security Future.
1. A contract of sale for future delivery of a single security or of a narrow-based security index
a. Narrow-based index: Has 9 or less component securities. It is riskier than a broadbased index; component security comprises more than 30 percent of the index’s
weighting
b. The CFTC (Commodity Futures Trading Commission), not the SEC has the jurisdiction
over the broad-based index. Future on a single stock is regulated by CFTC and SEC.
2. §3(a)(12) of EA 34, exempted security (not subject to anti-fraud provisions)
a. Government securities: futures on treasury securities are not security future.
b. Municipal securities indexes
c. Option on future: Option to enter into a buy 18 barrels of crude oil in the future
§2A, Swap Agreement: Not security
1. The definition of security in §2(a)(1) of this Act does not include any non-security-based swap
agreement.
2. §2A(b)(1): the definition of security in §2(a)(1) of this Act does not include any security-based
swap agreement.
a. Security-based swap agreement: a swap agreement that relates to interest rate on the
yields of a security. Thus, cross-currency rate swaps are never security-based swap
agreement, but interest-rate swaps can be security-based swaps.
3. Subject to antifraud provisions
a. Subject to §17(a) of SA 33 and §10(b) of EA 34
b. However, swap agreements are not subject to §12(a)(2)
Markets for derivatives
1. Futures (Commodity) Exchanges: Standardized derivatives [CBOT, CME, NYME, NYCE]
2. 9 national securities exchanges: standardized derivatives [NYSE]
3. Over-the-counter market: customized derivatives [NASDAQ]
4. Hybrid exchange: futures on corporate stocks [Chicago One (CBOT, CME, and CBOE) and
NASDAQ-LIFFE (London International Financial Futures Exchange)], subject to joint SEC and
CFTC jurisdiction.
5. Interests in broad-based market baskets of stock are traded on national securities exchanges, and
they are subject to exclusive SEC jurisdiction. It is more like a mutual fund. Thus, it is really a
derivative on underlying asset (i.e., S&P 500 stocks for SPIDER). Does the antifraud provision
apply to the stock baskets securities? It is not security, but still subject to the antifraud provisions.
Derivatives and Payment
1. Cf. Options Clearing Co.: Registered Clearing Agency guarantees the exercise of the options.
2. Options on securities: Standardized (delivery); customized (delivery or cash-settled)
a. Puts, calls, straddles.
3. Options on indexes: cash-settled
a. Can be puts and calls; subject to SEC.
4. Futures on securities: marked-to-market (margin account that is marked daily), delivery or cashsettled.
a. Banned for 18 years, but now are allowed. These have joint jurisdiction.
5. Futures on indexes: marked-to-market or cash-settled.
6. Futures are always marked-to-market and everything can be cash-settled.
7. Option on the future on treasury bills are allowed to be traded
a. Still considered risky. Currently, not authorized. Contemplated that it will be.
38
Summary: Derivatives that are securities
Derivatives on Assets
Options on securities:
Derivatives on Indexes
Options on stock indexes:
traded on NSE, subject to exclusive SEC jurisdiction
trade on NSE; subject to exclusive SEC jurisdiction
Futures on corporate stocks:
authorized to trade on NSE, NASDAQ, and futures
exchanges, subject to joint SEC and CFTC jurisdictions
Options on futures on corporate stocks:
trading on NSE, NASDAQ, and futures exchanges may
be authorized in the future; if authorized will be subject
to joint SEC and CFTC jurisdiction
Options entered into on a national securities
exchange relating to a foreign currency:
Futures and options on futures, on narrowbased corporate stock indexes:
authorized to trade on NSE, NASDAQ, and futures
exchanges, subject to joint SEC and CFTC jurisdiction
trade on NSE, subject to exclusive SEC jurisdiction
2.
§2(a)(3), Offer & Sale
a. If we have offer or sale, registration or antifraud provision is applied.
i. To trigger the Securities Act, you have to have an offer or a sale, not just a security.
b. Definitions are broader than common law
i. §2(a)(3), Offer: Every attempt or to dispose of, or solicitation of an offer to buy, a security or interest in a
security for value
1. Anything that whets the appetite is an offer under §2(a)(3).
ii. §2(a)(3), Sale: Every contract of sale or disposition of a security or interest in a security, for value.
1. For example, pledge is a sale under securities law, but not a sale under common law. A pledge is
putting collateral for a loan.
c. Exchange: Exchange of one security for another is a sale.
i. Exchange of security may be exempt from registration. See infra §§3(a)(9), (10), at p.38-39.
1. Even if the exemption applies, it is still subject to antifraud provisions.
ii. Alteration Test:
1. Whether the rights of security holders have been so substantially affected by the particular
change in the terms of the outstanding security that it becomes a new security.
a. e.g., a change in interest or dividend rate or liquidation preference or underlying
security, or a change in the identity of the issuer = a new security
b. e.g., a mere change in the name of the security (perhaps from common to Class B
stock), or a change in the name of the issuer w/o a change of identity, or certain types of
charter amendment affecting the powers of the directors = not a new security
2. Rule 145: change in par value is not a sale (according to Tyson)
d. Gift: Bona-fide gift is generally not sale, although a stock bonus to employees as rewards is not a gift.
i. i.e., If a control person donates stocks to a university for a building, the university gets the stocks “with a
view to distribution,” and it is deemed as an underwriter.
ii. Warrant: Only the issuer of the stock can issue the warrant.
1. If the warrant can be immediately exercised, it is a sale of interest in the underlying security, and
the sale must meet the requirements of the securities laws.
2. If the warrant cannot be exercised until some time, there should be a shelf registration, just to be
safe.
e. Pledges
i. Rubin v. U.S. (U.S. 1981) (SEC instigated a criminal suit against Δ, who pledged stocks to a bank as a
collateral, but he lied.)
1. The Court held that it is sale, b/c there was a disposition of interest in a security for value.
2. Although it is a §17(a) suit, Bill thinks that it also applies to other sections in securities law.
f. Stock dividend
i. A stock dividend does not distribute property but simply dilutes the shares as they existed before. It just cuts
the same pie into smaller slices. If the dividend is declared in cash or stock, and shareholder elects stock
then that is not a sale. Your proportion of ownership in co has not changed with a stock dividend.
1. Therefore, there is no value given in stock dividend.
ii. Stock splits: When a company tries to reduce the price per share; thus, dividing a pie into smaller pieces.
39
g.
3.
iii. Reverse stock splits: When a company tries to increase the price per share; sometimes, it requires
amendment for the articles of incorporation. Shareholders must vote to amend & increase authorized
shares.
1. Authorized v. outstanding shares
Spin-offs
i. Stock dividends of portfolio securities: Property dividend, it should not be an offer or sale. It is more like
a partial liquidation.
1. Sec. Act release 9310 (1971): There must be a bona fide purpose for the spin-offs. A
conventional spin-off has a business purpose.
a. Dropping the assets down: Example of conventional spin-off with biz purpose. Spin-off
as a parent and a sub, the shareholders of W+G hold only W (parent), but W then holds
all the securities of G. W can offer G’s securities to shareholders as dividends payable
in portfolio securities (even though the only portfolio is G’s stocks).
ii. Corporate shell game: Spin-offs can be used to gain advantage of a public market by the back door without
public registration.
1. Issuer—Private Shell company (doesn’t have a lot of asset)—would go to a large well-known
Public company and sell most shares to the public company for a nominal consideration. Then
they make a spin-off to the shareholders of the public company. After spin-off, the price of the
shares goes up, although they are not worth anything. Eventually, the market finds out, and
someone gets ripped off.
2. Creates a problem for the SEC. However, there is not value, so how does the SEC have the
jurisdiction?
a. The public company in a shell game acts like an underwriter. They are selling for the
shell company. If the public company registers and makes a prospectus, the
shareholders are not going to read the prospectus.
b. SEC said that the value doesn’t have to come from a specific party. The value is
gained through the process. As long as someone gets value, not necessarily in the
original distribution, they need to be registered.
i. By requiring the prospectus, the buyers in the secondary market are
protected.
ii. WP for non-registered Co.: A preliminary prospectus must be accompanied
under Rule 15c2-8.
iii. Quiet period for a non-registered Co.: 25, 40, or 90 days. During the quiet
period, the broker-dealers must deliver the prospectus, even for a
secondary market transaction.
3. Rule 15c2-11 prohibits broker-dealers from publishing over-the-counter quotations unless
specified information is available w/ respect to the security and its issuer.
4. Sec. Act. Release 4982 (1969): Unconventional spin-off has no business purposes.
a. Any spin-off requires registration unless the issuer of the dividend security:
i. is a reporting company under the EA 34; or
ii. undertakes to register under the EA 34 promptly and some sort of statement
that as to the effect of the transaction accompanies the dividend.
b. SEC v. Dartronics Eng’rs., Inc. (4th Cir. 1973): There is an offer and sale because
the value does not have to come from the people that receive the stock, the value has to
inure to someone in the process. Must be registered. The shareholders of the public
company must deliver the prospectus of the private shell company to sell the shares.
Non selling group dealers in after market will have prospectus delivery requirement for
90 days but today since access equals delivery, it is the fact that must publicly disclose
that helps because then shareholders will know value of shares.
§2(a)(11), Underwriter
a. Purchases from issuer or control person w/ a view to distribution (synonymous w/ IPO): Firm commitment
i. Presumptive underwriter doctrine: If you buy 10% of the issue, you’re presumed to a statutory
underwriter if you sell the shares.
1. The SEC began to consider percentage as simply one factor together w/ other circumstances
such as the total amount of the issuer’s securities outstanding, the size of the “float,” and whether
the issuer was a reporting company under the 1934 Act.
40
a.
b.
c.
d.
e.
f.
g.
4.
No-action letters: greater of: (i) 1% of the amount outstanding; or (ii) the average weekly
reported volume of trading during the last four weeks.
2. Officers, directors can be underwriters: No distinction is made b/w I-bankers and amateurs.
a. If their selling activity is only an incidental function of their regular duties for no
additional compensation, they are not regarded as underwriters.
ii. Hypo: The issuer sells to underwriters and a pension fund. If the pension fund decides to sell the securities,
it is a statutory underwriter.
1. The pension fund cannot use a final prospectus used by the other underwriters b/c §10 requires
that all the underwriters must be named in the prospectus. There should be a new registration.
Offers or sells for issuer or control person in connection w/ a distribution: Best efforts
i. Rule 405, principal underwriter: Underwriter who has a privity of contract w/ the issuer. It is not the
same as the managing underwriter. Principal underwriters are distinguishable from sub-underwriters.
ii. SEC v. Chinese Consolidated Benevolent Ass’n (2d Cir. 1941) (Neither the association nor any of its
members had ever received any compensation.)
1. A person may be an underwriter even if it has no contractual relationship or understanding w/ the
issuer. BUT they were selling for an issuer in connection with a distribution.
Directly or indirectly participates in an underwriting or in an underwriting of an underwriting: Standby
(participates in an underwriting) underwriter or sub-underwriters for geographic areas; BUT
i. CAVEAT!: Sub-underwriters do not qualify as underwriters under §2(a)(3) b/c they do not have privity
of contract. They cannot form preliminary negotiations and agreements and cannot buy stocks from the
issuer before the effective date.
Such term shall not include a person whose interest is limited to a commission from an underwriter or dealer not
in excess of the usual and customary distributors’ or sellers’ commission.
i. Rule 141, Usual and customary commission clause [Dealer exemption]: underwriters are subject to
§11 liability. Dealers are not underwriters under Rule 141.
1. Under §11, subunderwriters and dealers cannot be sued, but for §2(a)(3) purposes, you want to
be an underwriter.
As used in this paragraph, the term issuer shall include, in addition to an issuer, any person directly or indirectly
controlling or controlled by the issuer, or any person under direct or indirect common control w/ the issuer.
i. Control person: Must be in a position to prepare the registration statement obtain the required signatures
of the issuer and its officers and directors.
ii. A control person is an issuer only w/I the definition of §2(a)(11).
1. See also §2(a)(3): for preliminary negotiations or agreements, control persons are treated like the
issuers.
2. The larger the public co, the smaller the share needed to become control person.
Examples
i. One who furnishes money to a statutory underwriter: usually not a underwriter
ii. An exclusive selling agent: an underwriter
iii. A subunderwriter for a specific geographical area: an underwriter under §2(a)(11)
iv. A finder: A person that brings the underwriter and the issuer together. Not an underwriter.
Gifts of control stock: CP can avoid paying tax for capital gain, if he donates.
i. CP  Charitable donee  Public
1. A charitable donee may be an underwriter. Was there a condition made w/ the donation? i.e.,
requirement to cash out the stocks and put the name of the donor on the building
a. Offers or sells for an issuer or a CP w/ the distribution of a security
b. Directly or indirectly participates in the underwriting or subunderwriting
ii. CP  Daughter  Public
1. Offers or sells for an issuer or a CP w/ the distribution of a security; can make argument that
daughter is selling for father as an underwriter.
Pledges: The case for finding an underwriter is stronger when securities are given w/ a prior pledge. The difference between (a)
and (b) below is that in one scenario the issuer is involved and in the other one it is not.
a. CP (Pledge)  Bank  Public
i. Is the bank an underwriter?
1. Yes b/c it “purchases” from a control person w/ a view to the distribution of a security under
Rubin. Aren’t banks banking on repayment than on foreclosure in case of default? If it’s a sale for
17(a), most likely a sale for purposes of 2(a)(3) as well.
2. Yes b/c it sells for the CP in connection w/ the distribution of a security.
41
3.
b.
5.
If the Bank sells for a CP, the distribution must be registered again even if there was registration
statement 6 months ago. Each distribution is different, the registration statement has transaction
specific. Once you have a different underwriter, you have to have a new registration statement.
Each distribution should be registered.
Issuer (GF)  NCP (Pledge) (Roach)  Bank (Santa Monica Bank)  Public
i. SEC v. Guild Films Co. (2d Cir. 1960) (Roach got stocks by private placement. The stock was called
restricted stock, and had legend on it—it could not be sold or pledged w/o registration or an opinion of
counsel that registration was not required. The issuer argued that it was exempt under §4(2), and both
Roach and Santa Monica Bank claimed that §4(1) applies.)
1. §4(2), Private offering exemption: transaction by an issuer not involving any public offering.
2. B/c Roach did not hold the stock for investment, §4(2) doesn’t apply, and thus §4(1) doesn’t
apply.
3. When you’re a NCP, where you got the stock matters.
a. If NCP get it from CP or the issuer, NCP is an underwriter. Bank becomes a
subunderwriter.
i. “Participates in the underwriting of the underwriting of a security”
ii. The private placement b/w Guild Films and Roach was exempt under
§2(a)(3) b/c Roach is an underwriter: preliminary negotiation or agreement.
iii. B/w Roach and the Bank, the pledge, which can be considered
preliminary negotiation or agreement, is not permitted even if the
agreement was among underwriters b/c the Bank is not in privity of
contract w/ Guild Films under §2(a)(3). But 2(a)(3) does not cover
subunderwriters or dealers so they cannot buy until the effective date so
cannot sale until they are registered.
b. If you bought in the open market, NCP not an underwriter.
4. Bank should have registered when the securities were pledged.
5. Guild Films is strictly liable under 12(a)(1).
a. Loss thinks the issuer should not be liable. B/c at the time of default, the Bank has to
foreclose, and the Bank is a bona fide pledgee.
b. The court opined that good faith of the pledgee does not matter. “It’s small solace to the
investing public that the bank is a bona fide pledge.” Bill agrees with the court.
ii. What can a bank do in a pledge situation?
1. By obtaining shelf registration, Rule 415(a)(1)(v) or a registration covenant
2. By utilizing a private sale under the UCC (take-out letter from a third party)
a. Find a private party who is willing to buy. As long as you can find a person who would
hold it for investment, it’s okay.
3. By foreclosing on noncontrol stock first before you foreclose on the control stock
4. By selling pursuant to the leakage provisions of Rule 144; or
5. By selling pursuant to the intrastate exemption, §3(a)(11)
§2(a)(12), Dealer v. Broker
a. Dealer: any person who engages either for all or part of his time, directly or indirectly, as agent, broker, or principal, in
the business of offering, buying, selling, or otherwise dealing or trading in securities issued by another person.
i. The definition of dealer concerns the ordinary business of the person, whereas the underwriter is defined to
focus on the transaction. Anyone can be an underwriter because it depends on your role in given
transaction but on the other hand a dealer involves with what you do on daily basis.
ii. A broker is an agent whereas a dealer is a principal. A broker is someone who never takes the title of
the securities. §2(a)(12) says that a broker is a type of a dealer. All brokers are dealers, but not every
dealer is a broker under §2(a)(12).
1. If you’re a non-SG dealer, you get some exemptions for delivery of prospectus.
2. All dealers must comply w/ §5 and are governed by §4(3) but only brokers are entitled to
the §4(4) exemption.
EA
Dealer-Principal
EA
Dealer-Principal & Agent
42
TOPIC 5—EXEMPTIONS
1.
In General
a. §3, Exempted Securities (carries gloss wherever it goes, security is always exempt)
i. True exempted securities: §§3(a)(2)-(8) and §3(a)(13)
1. If we have §3(a)(2) security, §12 doesn’t apply at all.
2. Rationale: They are already subject to other regulations.
ii. §§3(a)(9)-(11) and §3(b) are really exempted securities (transaction exemptions)
b. §4, Exempted Transaction (when securities subject to a transactional exemption are resold, a new exemption must
be found)
i. §§4(1)-(3) are true exempted transactions.
ii. Gustafson says that if the transaction exempt under §4, it is not a public offering. Therefore, if you’re
exempt §4, §12(a)(12) does not apply.
iii. CAVEAT!: Naftalin says that §17 applies even if the transaction is exempt under §4.
1. §17 always applies.
Is suit possible?
Exempt §3
§§3(a)(2)/3(a)(14)
Exempt §4
§12(a)(2)
Yes
No
No
§17(a)
Yes, 3(c)
Yes
Yes
2.
Integration: Intended to prevent an issuer from avoiding registration by structuring a transaction in two or more apparently
exempt offering when they actually should be considered a single nonexempt transaction.
a. Integration can occur b/w two exempt offerings or b/w registered and exempt offerings.
b. Five factors, Preliminary Notes to Rule 147 (most important are underlined)
i. Are the offerings part of a single plan of financing? Although Commission staff’s no-action letters are not
entirely consistent, a plan of financing tends to refer to factors such as the method of offering the security,
the timing of plans for raising capital, and whether the offerings are financially interdependent.
ii. Do the offerings involve issuance of the same class of securities? When different classes of securities,
such as common stock and preferred stock are offered, the courts and the Commission generally have not
integrated.
iii. Are the offerings made at or about the same time? The adoption by the Commission of integration safe
harbor rules for intrastate and Regulation D offerings separated by six months or more from other ostensibly
exempt offers suggests that a six month period before and after an offering will be necessary to
demonstrate that it was not made “at or about the same time.” The mere fact, however, that two or more
offerings are separated by six months or more will alone not necessarily lead to nonintegration. S
iv. Is the same type of consideration to be received? When different types of consideration are given for two
or more offerings, this has been cited as a factor justifying nonintegration.
v. Are the offerings made for the same general purposes? Normally refers to the use of the proceeds.
c. Rule 155, Integration of Abandoned Offerings
i. If you start doing private offering under 4(2), you abandon it, and then do registered offering – there is
concern that SEC would integrate both offerings. As long as there were no sales made during the private
offering and if you wait at least 30 calendar days, you don’t have integrations.
3.
§3(a)(9), Exchange Offers, Reclassifications, Recapitalizations, Reorganizations
a. If shareholders have Class A common stocks. If you want, turn them in, and we’ll give Class B common stocks.
i. Different voting rights, dividend payments, liquidation preferences.
ii. Voluntary exchanges?
1. When there is a vote, it can be involuntary. The majority decides.
2. Loss is wrong in calling §3(a)(9) a voluntary exchange.
a. Prior to 1972, it was a voluntary exchange. Before Rule 145, involuntary exchange for
sale was not even an offer or a sale.
b. Generally, exchanges are “sale,” but §3(a)(9) exempts “any security exchanged by the issuer w/ its existing
security holders exclusively where no commission or remuneration is paid or given directly or indirectly for
soliciting such exchange.”
i. Rationale: The companies do not try to raise new capital. Shareholders do not give up cash.
43
1.
c.
d.
e.
f.
Loss thinks it is a political horsetrade compromise: Shareholders are making a new investment
decisions, and therefore, information should be furnished. Gives no investor protection!
Requirements
i. “by the issuer”: Identity of the issuer
ii. “exclusively”: Double-duty
1. Shareholders may not give up cash except pursuant to Rule 149 (if the cash payments are
made by some security holders to effect an equitable adjustment)
a. Rule 149, Equitable adjustment:
i. e.g., A and B buy stock in X Co. for $25 each before the dividend record date.
B sells his stock to C after the dividend record date but before the dividend
payment date for $20. The dividend will be $5. X Co. plans to do a §3(a)(9)
exchange after B’s sale to C but before the dividend payment date. X Co. tells
A that if she wants to participate in the exchange, she must waive her right to
the dividend. X Co. tells C that if he wants to participate in the exchange, he
must pay X Co. $5.
1. Why doesn’t X Co. tell C that if he wants to participate in the
exchange, he must waive his right to dividend? He doesn’t have a
right to dividend.
2. If C pays X Co. $5 so that he can participate in the exchange, what
will X Co. do w/ C’s payment? Use it to pay B.
3. Will X Co.’s exchange qualify under §3(a)(9)? Yes. A is out of
pocket $5 for participating in the exchange.
2. Offering made only to existing shareholders
a. Does not have to be offered to all existing shareholders.
b. CAVEAT!: If the company is a reporting company, and if the exchange involves turning
in equity, then it has to be offered to all existing shareholders. This is untrue if co is
reporting co and securities being turned in are equity securities.
iii. No remuneration for soliciting the exchange
1. However, shareholder may receive cash. See Rule 150. Although anything of value (other than
the old securities) coming from the security holders will destroy the exemption, the payment of
cash by the issuer will not.
2. Fees: only allowed for ministerial acts; fees paid to lawyers or accountants or printers do not
destroy the exemption.
iv. May not be used in Title 11 Bankruptcy proceedings
Non-examples of §3(a)(9)
i. Voting trust certificates: A voting trust is set up, and if you participate, you deposit your stock and get
voting trust certificates. The issuer of the voting trust is not the issuer of the stock.
ii. Certificates of Deposit for a Security
iii. ADR (American Deposit Receipts): form F-6
Hypo: §3(a)(9) offering of Class B common stock in exchange for Class A common stock. Two weeks later, §4(3)
private offering of Class B common stock to institutional investors. Will these two offerings be integrated?
i. Bill thinks it should be integrated.
1. If it is integrated, then there must be an exemption covering the entire offering. Both offerings are
invalid since the aggregate should have been registered, even if they were individually exempted.
ii. If so, what happens to the exemptions under §3(a)(9) and §4(2)?
1. Loss says §3(a)(9) does not work well w/ other offerings. Combined, the exchange is not just
offered to the existing shareholders.
2. §4(2) won’t work, b/c it is a private offering where the investors must be very sophisticated.
§2(a)(3), Convertible stock
i. Preferred stock w/ a delayed privilege to convert into common stock: not a present offer of the common
stock
1. Classic §3(a)(9) reclassification: The common stock does not have to be registered.
ii. Preferred stock w/ an immediate privilege to convert into common stock: a present offer of the common
stock
1. Shelf registration should solve the problem.
2. The offer has to be registered, but the exchange doesn’t have to be.
44
a.
g.
4.
Rationale: §5 applies during the waiting period for the offering. §5(b)(1) and §5(b)(2)
compliance not required during posteffective period b/c §3(a)(9) exempts the
exchange (posteffective period is free of 3(a)(9)).
i. Bill doesn’t like this idea b/c he thinks that offering and exchange should be
one.
Warrants: Call options issued by the company.
i. The warrants are securities, and therefore should be registered. You exercise the warrant in the future, can
the company use §3(a)(9)?
1. No. When you exercise the warrant, you pay cash. §3(a)(9) does not apply.
a. “No commission or other remuneration is paid or given directly or indirectly for soliciting
such exchange”
§3(a)(10), Judicially or administratively approved exchanges
a. §3(a)(10) provides exemption from registration for securities issued in exchange (in part for cash) for legal claims,
securities, or property interest, when there is approval of the transaction after an adversarial hearing on the
fairness of the transaction; implicit requirement of adequate notice to all persons to whom it is proposed to issue
securities.
i. Rationale
1. To accomplish reorganization of solvent or insolvent company outside of bankruptcy.
2. B/w two solvent companies in merger
3. Settlement of private lawsuits: class action suit against the company or a CP
ii. Security exchanged for:
1. legal claims
2. securities
3. property interests
iii. Approval
1. State government authority: must be expressly authorized to approve it by the state legislators
(i.e., state bank commission).
2. State, federal, or even foreign court
3. Federal agency, official (do not have to have specific authorization)
iv. Fees are allowed
v. Does not rely on disclosure of regulation, but instead of merit regulation (many developing countries use
this) through fairness hearing.
Identity of Issuer?
Used for secondary offerings?
May recipients of securities give up
cash?
May recipients of securities receive
cash?
May remuneration be paid for
soliciting the exchange?
Used in title 11 Bankruptcy
proceedings?
5.
§3(a)(9) [only 1 co.]
Yes
No
No unless Rule 149
Yes Rule 150
No except ministerial
act
No
§3(a)(10)
No
Yes
Yes but can’t be all
cash otherwise it
won’t be exchange
Yes
Yes
No
Rule 145, Reclassification, Mergers and Consolidations, Transfers (Sales) of Assets (Business Combinations).
a. Lynchpin of Rule 145: Shareholders must vote. Rule 145(a) defines an “offer,” “offer to sell,” “offer for sale,” or “sale”
as coming within the scope of 2(a)(3) when there is submitted for the vote or consent of security holders a plan or
agreement for certain (1) reclassifications, (2) mergers or consolidations, (3) transfers of assets. This is a new
investment decision.
i. Involuntary transaction that is an offer or a sale.
ii. Merger: Acquisition of asset. Shareholders of both companies must vote for the merger. All state corporate
law requires shareholder vote.
1. In DE, more than 50% of the outstanding shares; in NY, more than 2/3 of the outstanding shares.
45
2.
b.
Directors approve the merger and decide the exchange ratio for the shares. Then, the
shareholders and directors of both companies must vote for approval. After approval, it is really a
sale of assets.
a. In reality, it is a purchase of assets b/c after the approval, by operation of law, all assets
and liabilities get transferred to the acquiring company. No deed of transfer is
necessary.
3. CAVEAT!: Even if the transaction is qualified for the exemption, it may be registered b/c
there is less restriction on resale.
iii. Reclassification: Shareholders exchange stock for another class (only one co involved)
1. Does not involve stock splits or reverse stock splits. Remember that stock splits or reverse
stock splits are not even sale under SA 33.
2. I.e., if a corp exchanged 8 shares of common stock for each share of preferred stock, it normally
could claim exemption under 3(a)(9). If however, the corporation hired a proxy solicitor to solicit
proxies for approval of the plan, a payment of remuneration would make 3(a)(9) unavailable, and
the common-for-preferred stock exchange would be defined by Rule 145(a)(1) to be a statutory
sale.
iv. Consolidation: When neither company wants to be called as a target, they create a new shell company C,
and both companies sell their assets to the new company.
v. Sale of asset (all or substantially all): pay w/ securities and maybe boot in cash
1. In sale of asset, the acquiring company does not take liabilities—which includes hidden liabilities
and tort claims— of the target company.
2. The target company generally dissolves. Generally before the acquisition the target company
pays off the debt. Sometimes, it pays off the debt after the sale.
a. Distributes shares of the acquiring company to the target shareholders.
b. If the target company does not dissolve and simply distribute the acquiring company’s
shares to the target shareholders pro rata.
c. If the target company dissolves after a year or distributes the shares to the shareholders
after a year, it has to be registered.
3. Not all state law requires shareholder vote for sale of assets.
4. To be within scope of Rule 145(a)(3) normally requires (1) a vote of the security shareholders of
the relevant corporation, (2) a transfer of assets of that corporation or other person to another
person in exchange for securities, (3) unavailability of a statutory exemption.
Must be registered: Prior to 1972, you didn’t have to register these transaction b/c they were involuntary.
i. Form S-4, Wraparound prospectus (p.218): In consolidation, it only has double-duty. In merger, it has
triple duty. In a merger, it serves as a joint proxy statement and the final prospectus.
1. Proxy statement for the target company’s shareholders
a. However, the acquiring company doesn’t like to be liable to the target company’s
shareholders for any misrepresentation in case the transaction does not go through. In
that case, they won’t use the wraparound.
2. Prospectus for the acquiring company: The acquiring company is offering securities for sale to
the target company’s shareholders. This is the public distribution of acquiring company’s
shares to the target company’s shareholders. Registration will allow target holders to decide
whether they should buy shares.
a. When you discuss the merger, for example, it whets the appetite, and b/c there is
offering, it must be registered.
3. Proxy statement for the acquiring company’s shareholders
ii. Waiting period for Form S-4: They do not dovetail.
1. 10 day waiting period for proxy statement
2. 20 day waiting period for prospectus
3. Example of time frame
a. March 29, 1999. Record date for meeting & registration statement filing)
b. April 5, 1999. Waiting period ended / registration statement declared effective because
of acceleration
c. April 9, 1999. Mailed to shareholders (joint proxy / prospectus)
d. April 27, 1999. Shareholder meeting.
iii. Form S-4 may also be used for:
46
1.
2.
3.
4.
c.
Short-form mergers: Merger of parent and sub w/o of the shareholder vote of either company
when parent owns more than certain percentage of the sub. Governed by state law; not 145
transaction.
i. Must be registered b/c it is a sale. It is involuntary even if there is no voting.
b. Why do we need registration when it’s not voluntary?
i. Bill says minority shareholders must be told if they are ripped off.
1. Breach of fiduciary duty
2. Seek an appraisal remedy
Exchange offers not qualifying for the §3(a)(9) exemption: It is easy to screw up b/c of
requirement of no remuneration or commission or only to the existing shareholders.
Exchange tender offers
a. If X Co. purchases Y Co.’s outstanding securities directly from the Y Co.’s shareholders
using X Co. securities as consideration, the transaction is not covered by Rule 145.
i. No vote is required. However, transaction can be registered on Form S-4.
Reoffering by CP of the target (in mergers and transfers of assets) and of the issuer (in
reclassification)
a. If the acquiring company gives shares to the CP of the target after the merger and if CP
decides to sell publicly after the merger, he or she is considered as underwriters even if
at that point he or she is not a CP of the acquiring company.
i. Rule 145(c), the CP simply discloses in the initial registration statement for the
merger that he or she intends to sell publicly after the merger.
Rule 153(a): Final prospectus must be delivered before vote to shareholders of record entitled to vote on the
transaction.
i. Shareholders on the record date gets to vote although he or she may sell the share right after the vote. The
new shareholder will receive the new share w/o ever receiving the final prospectus. In effect, the
shareholder on the record date makes the decision for the purchaser.
Voluntary (no vote)
Involuntary (vote)
Qualifies under §3(a)(9)
Exempt
Exempt
Does not qualify under §3(a)(9)
Register & use form S-4
Register & use form S-4 (Rule 145 transaction)
Exchange offer can be voluntary or involuntary. If no cash is involved, then exempt under 3(a)(9) whether voluntary or involuntary.
d.
Corporate tax: IRC §368(a)(1)
i. Merger & consolidation: A Reorg.
ii. Exchange tender offer: B Reorg.
iii. Sale of assets: C Reorg.
iv. Spin-off: D Reorg.
v. Reclassification: E Reorg.
Prefiling Period
Rule
166
Communication
e.
Rule 135 Notice:
First
public
announcement
Waiting Period
Preliminary Wraparound
(20 days)
Rule
165(a)
Communication
Posteffective Period
Final Wraparound
(40 days)
Rule
165(b)
Communication
Rule
Communication
165(a)
Rules
i. Rule 166, Business Combination Communication Exemption: Allows communication of the Rule 145
transaction, even before the prefiling period. The oral or written communication is not deemed to be an
offer to sell, as long as it does not involve any more dissemination of the information.
1. Allows communication before the first public announcement
2. It cannot be done more than once.
ii. Rule 135, Notice: Oral or written communication by the participants (issuer and underwriters) as to the
business combination under Rule 145.
1. The notice must state that the notice does not constitute an offer.
47
2.
If the notice relates to the business combination, it must be filed w/ the SEC on the date of the
first public announcement.
3. Rule 135(d): Allows mentioning of name of the target; assets to be sold; the name of any other
party to the transaction; brief description of their business; brief description of the transaction if the
transaction involves Rule 145 business combination.
iii. Rule 165, Communication: Allows free communication during the prefiling period. Allows whetting the
appetite during the prefiling period and waiting period.
1. Must have a legend to urge investors to read the registration statement filed w/ the SEC which is
available free of charge.
2. Any written communication notwithstanding §5(b)(1) will satisfy §10 as long as it is filed w/ the
SEC, and it has a legend.
a. Rule 165(a), Communication During Prefiling Period: Allows any oral or written
communication, reasonably designed to inform the public about the business
combination.
b. Rule 165(b), Communication After the Registration statement Is Filed
iv. Rule 425, Filing provision for Business Combination Transaction
1. Rule 425(a), Rule 165 filing: They are prospectuses and must be filed w/ the SEC.
2. Rule 425(b), Rule 135 filing: In general, Rule 135 notice doesn’t have to be filed except when it
is used in connection w/ business combination transactions.
6.
Intrastate Issues
a. §3(a)(11): the judicial and administrative interpretation of the statute
i. Sec. Act release 4434 (1961)
ii. Provides an exemption from registration for transaction in any security which is part of an issue offered and
sold only to persons residing in a single state, when the issuer is a person residing and doing
business w/I such state or when the issuer is a corporation that is incorporated and doing business w/I
such state.
1. §3(a)(11) is not based on Congress’ lack of power to regulate such transaction.
a. If a transaction involves the use of mail or interstate commerce, it can be regulated by
Congress.
2. Rationale: Investors would be protected by the state regulation and blue sky laws. The benefit of
federal regulation in this setting is remote. It promotes local financing of local business w/ local
viewpoint.
a. Bill thinks the exemption stinks. He says the proximity w/ the issuer has nothing to do w/
more protection.
iii. Requirements
1. An offer or sale to a nonresident, whether or not the jurisdictional means were used, destroys
the exemption.
2. If the exemption is destroyed, both resident and nonresident purchasers can sue their sellers
under §12(a)(1).
a. However, it matters whether the jurisdictional means were used w/r/t the particular
purchaser who wants to sue under §12(a)(1). Note that §12(a)(1) suit requires
jurisdictional base.
b. Hypo: If dealer X sells to A who is a nonresident, B, a resident, can institute a suit
against §12(a)(1) against dealer Y who sold to B assuming that dealer Y used the
jurisdictional means in selling to B and that dealer Y sold only to residents.
iv. Hypo:
1. If a dealer accepts payment from a nonresident customer who was a resident at the time of sale,
the exemption is not destroyed.
a. However, temporary residence insufficient for purposes of the exemption.
2. If the issuer sells parts of an issue pursuant to §3(a)(11) and then registered the balance, the
exemption is destroyed.
a. Integration
3. If any underwriter or SG dealer is not a resident, the exemption is not destroyed.
a. Therefore, the issuer sells to a out-of-state resident who buys w/ a view to distribution in
the state, it is allowed.
48
b.
Rule 147 (1974): Nonexclusive safe harbor. If you follow the rule, you’re sure to have the intrastate offering
exemption. Congress is the boss! Even if you don’t follow Rule 147, you still may get the exemption.
i. Requirements
1. 147(c), Issuer must be resident of state
a. Corp: incorporate in state
b. LP: certificate must be filed in state
c. GP: principal office in state
d. Individual: principal residence in state
i. If GP or an individual sells securities in its own interest, it is not security.
However, if GP or an individual offers debt security or starts a ponzi
scheme, it is a security and must be registered.
2. 147(c), Issuer must be doing business in state
a. Triple 80% test
i. Gross revenues
ii. Assets in the last fiscal year.
iii. Net proceeds must be used in the state.
b. Principal office in state: its where corporate HQ is.
3. 147(d), Offerees and purchasers must be resident of state on the date of sale
a. Corporations and partnerships must have principal office in state
b. Individuals must have principal residence in state
c. If a corporation and partnership is formed to buy security in a state, all beneficial
owners must have principal residence in state.
ii. Rule 147(b), Integration safe harbor
1. All securities of the issuer offered or sold pursuant to a registration statement or pursuant to
the exemptions contained in §3 or §4(2) prior to the 6-month period immediately preceding the
first offer of the intrastate issue or subsequent to the 6-month period immediately following the last
sale of the intrastate issue will not be integrated with the intrastate issue, as long as during these
two 6-month periods there are no offers or sales of securities of the same or similar class as
those offered and sold in the intrastate issue.
2. One-way safe harbor, p.323: Offering D or E may lose its exemption if the conditions for the
integration under the SEC’s five factor test so indicates. However, the Rule 147 offering would not
be affected.
a. Similar one-way safe harbor rule for Regulation D, see supra p. 47.
b. Rule basically says not to do anything in B and C and you will be okay.
D
Registered Exempt
B
6 months
A
Intrastate issue
Rule 147
§3
§4(2)
No offer or
sale
First offer
C
6 months
No offer of
sale
Last sale
E
Registered Exempt
§3
§4(2)
iii. 147(e), Resale: Gestation period is 9 months
1. Resale may not be made to nonresidents for 9 months after last sale by issuer.
a. It is difficult to control the first purchasers.
iv. Hypo: On Jan.1, intrastate issue of preferred stock convertible into common stock—the gestation period for
the preferred stock is from Jan. 1 to Sept. 30 under Rule 147(e). In the first scenario, the preferred stock is
convertible into common stock on Apr. 1 (delayed conversion privilege). If the public distribution of the
common stock upon conversion is registered or exempt under §3(a)(9)—the gestation period for the
common stock is from Apr. 1 to Sept. 30.
a. Do the holders of the common have a gestation period? It is considered somewhat
fungible with preferred. It still has the gestation period. It is b/w Apr. 1 and Sept. 30.
2. If the public distribution of the common stock upon conversion is exempt under Rule 147—the
gestation period for the common stock is from Apr. 1 to Dec. 31
a. Rationale: Now you’re have two separate applications of Rule 147.
49
c.
v. Hypo2: The preferred stock is convertible into common stock on Jan. 1 (immediate conversion privilege).
If the public distribution of the common stock upon conversion is registered for the PFP and WP and then
exempt under §3(a)(9) for the PEP or exempt from the outset under Rule 147—the gestation period
for the common is from Jan. 1 to Sept. 30.
1. Warrants?: The warrant is security, and therefore, it should be registered or exempt. When the
warrant is exercised, §3(a)(9) cannot be used.
a. No cash payment to the issuer is allowed under §3(a)(9).
2. If the warrant can be exercised on Apr. 1:
a. If the underlying common is registered, the gestation period for underlying common
is from Apr. 1 to Sept. 31.
b. If the underlying common is not registered, the gestation period for the underlying
common is from Apr. 1 to Dec. 31.
vi. Rule 147(f), Precautions to be taken by the issuer against interstate offers and sales
1. Place a legend on the certificate that the securities are not registered and that resale is restricted
2. Issue stop transfer instructions to the issuer’s transfer agent
3. Obtain a written representation from each purchaser as to his residence
4. Must disclose, in writing, the limitations on resale
Rule 147 v. Sec. Act Release 4434
i. Reoffer: Can first purchasers “offer” to out-of-state residents?
ii. Residence: domicile v. where you live
1. Rule: where you live
2. Release: domicile
May be used for secondary offerings?
Are resales to nonresident permitted?
Are reoffers to nonresident permitted?
What does doing business in state mean?
7.
Rule
No
No
Yes
-Triple 80%
-Principal
office
Release
Yes
No
No
No test in
Release
Small Issues, §3(b): Delegation of rulemaking power to SEC to adopt small issue exemptions not to exceed $5M. In 1938, it
was $100K. SEC has used this power (i.e. Rule 505)
a. Rationale: If small amounts are involved, less protection is necessary. Facilitates small business to raise capital.
Small business is Congress’ darling!
i. §3(c) authorizes the SEC to exempt, by rule, securities issued by small business investment companies,
which the SEC has done in Regulation E.
ii. §4(6) exempts offerings made to “accredited investors” (as defined in §2(a)(15)) where the aggregate
offering price does not exceed $5M (the dollar limit of §3(b)).
1. §4(6) is of limited use b/c §4(2) provides safe harbor for private offering w/ no dollar limit.
b. Regulation A (Rule 251-263): Short form exemption
i. $5M in any 12 month period
1. Note: NCP who is selling restricted securities must register under Guild Film. Regulation A may
be used by these people if they wish not to register.
ii. Only for non-reporting companies: half of the cost for registration
1. Form-1A, Offering Statement
a. Offering circular (=prospectus)
iii. No limit on investor qualification: no limit on the number of investors
1. The investors can be dumb and poor
iv. Rule 254, Solicitation of Interest Document for use prior to an offering statement
1. Requirements
a. A statement that no money is being solicited or will be accepted and that any indication
of interest by a prospective investor involves no obligation or commitment of any kind;
b. A brief general identification of the company’s business, products, and chief executive
officer.
2. The issuer may deliver the “test the waters” document to prospective investors or publish it in a
newspaper. Subject to antifraud provisions.
a. The document must be filed with the SEC.
50
3.
v.
vi.
vii.
viii.
ix.
x.
xi.
xii.
xiii.
Oral communication b/w the issuer and prospective investors are permitted but only after a “test
the waters” document has been submitted to the SEC.
4. What if the issuer changes mind and want to do registered offering?
a. Rule 254 (d): Bona fide change of intention
i. Must wait 30 calendar days to avoid integration.
Rule 251(d)(2), Preliminary offering circular delivery requirement
1. If you hook up w/ a customer during the waiting period, you must send him the preliminary offering
circular 48 hours prior to the delivery of confirmation. During the posteffective period, the final
offering circular must be sent at the time the confirmation is sent.
a. Compare: final circular offering must be sent 48 hours prior to the confirmation.
b. See also Rule 15c2-8, Delivery of Prospectus, supra, at p.14.
Rule 253(e)(2), 12 month Period Offering Circular: The offering circular for continuous offering must be
updated after 12 months after the offering statement was qualified.
Rule 251(b), Aggregation Offering Price Limit: Aggregation occurs only with other Regulation A offerings.
1. Hypo: Reg. A ($2.5M) – Reg. A ($4M): w/I 7 month period
a. The first offering is valid, but the second one is not.
2. Hypo 2: Reg. A ($2.5M) – Intrastate offering, Rule 147 ($1.2M): w/I 5 month period
a. Intrastate offering should use the offering circular to be qualified under Regulation A.
i. Tip: Bill says to aggregate first and then integrate.
Rule 251(c), Regulation A Integration Safe Harbor:
1. Regulation A offering will not be integrated w/:
a. Prior offerings;
b. Subsequent offerings that are registered; or
c. Subsequent offerings that are made more than 6 months after the completion of the
Regulation A offering
2. The only time you really have to worry about the integration is during the 6 month period from the
completion of the Regulation A offering.
a. But if the offering is registered, it is not integrated.
b. If the offering occurs w/I 6 month period, apply 5 factors under Rule 147.
Rule 251(d)(2), Delivery of Offering Circular & Sale: Offering circular must precede sale, but typically,
Sale  Offering Circular  Confirmation. Thus, the rule is written oddly.
1. Note: Non SG dealer has to deliver offering circular to customers only w/I 90 days after the
qualification of Regulation A offering statement. See Rule 251(d)(ii), p. 100.
Rule 255, After Form 1-A has been filed, oral offers may be made as may written offers, printed ad, tv ad if
they state from whom a preliminary of final offering circular may be obtained and are limited to “(1) the name
of the issuer of the security; (2) the title of the security, the amount being offered and the per unit offering
price to the public; (3) the general type of the issuer’s business; and (4) a brief statement as to the general
character and location of its property.” Once Form 1-A has been qualified, other written offers may be made,
but only if accompanied or preceded by a final offering circular.
Rule 260, Insignificant deviations
Rule 257, Notice of Sales to the SEC (Form 2-A). Every six months after the qualification of Reg A offering
statement or any amendment until substantially all the proceeds have been applied and within 30 days after
the termination of sale or the application of the offering’s proceeds, which is later, the issuer must file seven
copies of a report on sales and use of proceeds on Form 2-A.
Rule 256, Filing of sales material
Prefiling Period
Waiting Period (20 calendar days)
Rule 254
Solicitation of interest (test the waters)
documents (submitted to the SEC)
Oral communication
No sale may be made until qualification of
offering statement.
Rule 251(d)
After Reg A offering statement is filed with
the Commission, the issuer must
discontinue use of the written “testing the
waters” solicitation materials
Oral offers to sell
Written offers to sell (Preliminary Offering
Circular only): must be sent 48 hours prior
to confirmation
Tombstone ads
Post-qualification period (90-day quiet
period)
Rule 251(d)
Oral offers to sell
Written offers to sell (FOC)
Tombstone ads
Supplementary selling literature
Sales
Confirmations
Deliveries
51
No sales of Reg A securities may be made until the Form 1-A offering statement has been qualified [252(g)]; a preliminary or final
offering circular is furnished to the prospective purchaser at least 48 hours before the mailing of a confirmation of sale; and a final
offering circular is delivered with the confirmation if it has not been delivered earlier [251(d)(2)(i).
c.
Regulation D
i. Preliminary notes: The following rules relates to transactions exempted from the registration requirements of
§5 of the SA 33. Such transactions are not exempt from the antifraud, civil liability, or other provisions of the
federal securities laws.
1. The statement above is not correct any more.
2. Civil liability for fraudulent Regulation D offering: Under Gustafson, §12(a)(2) is not available for
private placement.
a. Bill thinks that Rule 504 at least should be subject to §12(a)(2). It seems more like
public.
ii. Structure
1. Rule 501: Definitions
2. Rule 502: Conditions
3. Rule 503: Filing of Notice of Sales (Form D)
4. Rule 504: §3(b)
5. Rule 505: §3(b)
6. Rule 507: Disqualifying provision
7. Rule 508: Insignificant deviations
iii. Rule 504: $1M in any 12 month period.
1. High risk for securities fraud: No limit on the number of purchasers.
2. Requirements
a. Only for non-reporting companies
b. Rule 504(b)(1), general advertisement and resale may be permitted if:
i. Registered under state blue sky laws
ii. No registration requirement under state blue sky laws in some states, but
registered under state blue sky laws in at least one state
iii. Exempted registration when offered only to accredited investors: Similar to
§4(2) private placement, but general advertising is permitted under the state
law.
3. ULOE (Uniform Limited Offering Exemption): Attempts to coordinate federal and state securities
law. If the offering is exempt under Rule 505, it is exempt under the state law too. But for Rule 504
offerings, the state law does not offer exemption under ULOE.
4. Rule 504, No general solicitation or general advertisement and securities are restricted
unless:
a. Offering is registered under state law; or
b. Offering is exempt under state law pursuant to a provision that permits general
solicitation and general advertisement so long as sales are made only to accredited
investors
iv. Rule 505: $5M in any 12 month period
1. Rule 505 has private placement flavor:
a. Number of offerees are limited (35 dumb and poor, and unlimited number of rich ( even
if they are dumb))
b. Investor qualifications
c. Manner of offering: no general solicitation or general advertisement.
i. Cf. Regulation A allows free writing.
d. Can only be used by the issuer
e. Restrictions on resale
2. For both reporting and non-reporting companies.
3. Compared to Regulation A, Rule 505 offering is much cheaper.
v. Rule 506, Safe harbor for §4(2) private offering exemption: Not small issue exemption.
vi. Aggregate Offering Price Limitation for Regulation D (Rules 504 and 505)
1. Rule 504(b)(2) and Rule 505(b)(2)(i): In general, aggregation occurs only with other exempt §3(b)
offerings and illegal unregistered offerings.
52
a.
Rule 506 offering is not aggregated w/ other Regulation D offerings.
2.
Rule 504
$1M (6/1/02)
Regulation A
$5M (6/1/02)
Regulation A
$5M (12/1/02)
Rule 504
$1M (12/1/02)
Regulation A is aggregated only with any other Regulation A offerings.
3.
Rule 504
$1M (1/1/02)
Rule 504
$0.5M (7/1/02)
The first Rule 504 offering is valid, the second one is not.
4.
5.
6.
Rule 504
$0.9M (6/1/02)
Rule 505
$4.1M (12/1/02)
When is the first date issuer can sell any securities under Rule 504 and how much?
a. 12/1/03, $1M
When is the first date issuer can sell any securities under Rule 505 and how much?
a. 6/1/03, $0.9M
Rule 505
$2M (6/1/02)
Rule 505
$1M (9/1/02)
The issuer wants to sell $4M at one time under Rule 505. When is the fist date it can do so?
a. 6/1/03
Rule 506
$3M (6/1/02)
Rule 505
$3M (12/1/02)
7. Both of the above offerings are okay.
a. Rule 505 is only aggregated with other §3(b) offerings (including Rules 504 and 505),
illegal offerings.
vii. Rule 502(a), Integration Safe harbor: One-way safe harbor
1. If there were no offers or sales during six month prior to the first offer or during six month
following the last sale, all offers and sales are not brought in to destroy the Regulation D offering.
a. Cf. Rule 147 safe harbor is similar, but Regulation D offering is more advantageous to
the issuer b/c Regulation D offering is broader in terms of price limit.
b. CAVEAT!: Rule 502(a) offering also integrates illegal offerings.
viii. Rule 501(e), Qualification of Purchasers
1. Rule 505 and 506 offerings must be made 35 unaccredited purchaser (can be dumb and poor)
a. “There are no more than or the issuer reasonably believes that there are no more than
35 purchasers . . . .”
i. Even if the issuer does not have reasonable ground, as long as there are no
more than 35 purchasers, the issuer is fine.
2. Rule 506(b)(2)(ii), Requirement of sophistication: The unaccredited purchasers cannot be
dumb. They must be sophisticated.
a. Knowledge and experience in financial and business matter to evaluate the merits and
risks
3. CAVEAT!: However, any accredited investors are not included in the calculation of number of
purchasers.
a. Any relative, spouse or relative of the spouse of a purchaser who has the same principal
residence as the purchaser is not included.
4. Rule 501(h), Purchaser Representative
a. Requirements
i. Must be acknowledged by the purchaser in writing, during the course of the
transaction, to be his purchaser representative in connection w/ evaluating
merits and risks of the prospective investment
ii. The purchaser representative must discloses to the purchaser in writing any
material relationship b/w himself and the issuer or its affiliates
b. If X is the purchaser, may Y, who is a director of the issuer, be X’s purchaser
representative? Not unless other requirements are met.
i. What if Y is also X’s sister?
1. Yes, Y can be X’s purchaser representative.
53
c.
ix.
x.
xi.
xii.
A director can act as a purchaser representative of a corporation or other organization if
he owns more than 50% of the equity securities or equity interest.
Rule 501(a), Accredited Investors.
1. Rule 501(a)(1): Broker
2. Rule 501(a)(3): Corporation total asset over $5M
3. Rule 501(a)(3): Partnership total asset over $5M
4. Rule 501(a)(4): Any director or officer
a. Doesn’t have to be rich b/c they have access to information.
5. Rule 501(a)(5): Wealthy individual total asset over $1M
6. Rule 501(a)(6): Wealthy individual income in excess of $200K ($300K joint income if married) in
each of the most recent years and has a reasonable expectation of reaching the same income
level in the current year.
7. Rule 501(a)(7): Trust total asset over $5M and whose purchase is directed by a sophisticated
person
Rule 502(b), Information Requirement
1. If the issuer sells securities under Rule 505 or 506 to any purchaser that is not an accredited
investor, the issuer must furnish the information to such purchaser a reasonable time prior to sale.
2. Information furnished to the purchasers must be the type of information disclosed by the
registration statement.
Rule 503, Notice of Sales to the SEC: no later than 15 days after the first sale of securities.
Rule 502(d), Limitation on resales
1. Rule 504 offering: If offering is registered under the state law; or offering is exempt under state
law pursuant to a provision that permits general solicitation and general advertisement so long as
sales are made only to accredited investors, no limitation on resales.
2. The issuer shall exercise reasonable care to assure that the purchasers of the securities are not
underwriters within the meaning of §2(a)(11), which reasonable care may be demonstrated.
Regulation A
Regulation D
Rule 505
Rule 504
Issuer qualification
May exemption be used
for
secondary
offerings?
Price limitation
Integration safe harbor
# of purchasers
Qualification
purchasers
Non-reporting Co.
U.S. or Canadian issuer
Rule 262, Bad Boy
Disqualification: convicted
of a felony in connection
w/ purchase or sale of
security or problem w/ the
SEC in general
Rule 251(b): no more
than $1.5 M by CP ($5M
total still stands)
NCP who is selling
restricted
stocks:
Regulation A can be
used.
$5M ($1.5M by all selling
security holders)
Prior offerings
Subsequent offerings that
are registered
Subsequent
offerings
made more than 6
months
after
the
completion
No limit
of
No qualification: can be
dumb and poor
Rule 506
Non-reporting
(blank
check or investment
neither)
Reporting and nonreporting
Bad boy disqualification
(except
upon
Commission
determination)
Reporting
reporting
No
No
No
$1M for 12 month period
$5M for 12 month period
No limit
All sales or offers won’t
be brought in to destroy
Reg D offering if there
was no sale or offer
during the six month
period prior to the first
offer and following the
last sale
No limit
All sales or offers won’t
be brought in to destroy
Reg D offering if there
was no sale or offer
during the six month
period prior to the first
offer and following the
last sale
35
unaccredited
+
unlimited
accredited
purchaser
Unaccredited purchasers
can be dumb and poor
All sales or offers won’t
be brought in to destroy
Reg D offering if there
was no sale or offer
during the six month
period prior to the first
offer and following the last
sale
35
unaccredited
+
unlimited
accredited
purchaser
Unaccredited purchasers
must be sophisticated
No limit
and
non-
54
Is general solicitation or
general
advertising
permitted?
Info Reqs
Solicitation
interest
document: PFP
Tombstone ads: WP
Offering circular
Notices of sales to SEC
Rule 257: Every 6 months
after qualification, you
have to let the SEC know
30 days after the
completion, you have to
let the SEC know. Form
2-A
In general, there is no
limitation on resale.
Limitation on resales
8.
Yes
if
it
requirement.
Includes seminar
No
meets
No.
No.
Must contact people Must contact people
directly
directly
1. If purchased solely by accredited investors, no
information specified
2. If purchased by nonaccredited investors,
a. Nonreporting companies under the EA must
furnish the same kind of information as in a
registered offering, or a reg A offering if eligible,
but with modified financial statement reqs
b. Reporting companies must furnish (1) specified
EA docs or (ii) info contained in the most recent
specified EA report or SA registration statement
on specified forms, and (iii) updating information
and limited additional info about the offering
c. Issuers must make available prior to sale: (1)
exchibits, (2) written info given to accredited
investors, (3) opportunity to ask questions and
receive answers
d. Issuers must advise purchasers of the limitations
on resale.
Yes. 5 copies of form D to be filed with Commission within 15 days after first sale
(called for by regulation D, but not absolutely required for exemption), every 6
months after first sale, and 30 days after last sale.
It depends
Yes
Yes
Limited Offerings
a. §4(2), Private offering exemption: The provisions of §5 shall not apply to transaction by an issuer not involving any
public offering
i. CAVEAT!: Under §4(2), you should be concerned about the characteristics of offerees whereas under
Rule 506, you should only be concerned about those of purchasers.
ii. Types of private placement
1. Offering to employees: SEC v. Ralston Purina Co. (U.S. 1953) (Offering of treasury stocks to “key
employees,” which included various employees.)
a.
2.
The availability of the §4(2) exemption depends on whether the class of persons to
whom securities are offered need the protection of the Act: Whether the members of
the class can fend for themselves.
i. The Court stated that the exemption should not depend on the number of the
offerees or whether it is offered to “key employees.”
Promotional or venture capital offering: Doran v. Petroleum Mgmt Corp. (5th Cir. 1977) (8 were
offered, 5 bought. If one of the 13 was on the blind, no §4(2) exemption.)
a.
b.
The sophistication of the offerees was not enough to establish a §4(2) exemption.
It must be shown that the information that a registration statement would have
disclosed was disclosed to each offeree or that each offeree had access to that
information b/c of a relationship w/ the issuer (family or employment) or b/c of
economic bargaining power.
3. Mergers and acquisitions
4. Institutional placements
iii. General Characteristics of private placement
1. Number of offerees: Not just sale, but also offer.
2. Qualification of offerees: Relationship to issuer? Rich? Smart?
a. The more relationship, the better.
b. Rationale: They can fend themselves better. They have economic bargaining power
to gain access to information. They can better assume the risk involved with the
ownership.
c. Directors and officers: Relationship to issuer and have access. Do not have to disclose
55
d.
3.
4.
5.
Rich (accredited investors): Economic bargaining power. Can gain access. Do not have
to disclose
e. Poor: If smart (sophisticated), you can get the securities. However, information must be
disclosed.
The manner of offering: Direct communication; No general solicitation or general advertisement
Availability of information: Even though there is no registration requirement, information must be
available for the investors to inform themselves.
Investment intent: limitations on resale—restricted securities. Guild Film
a. If they purchase with a view to distribution, the original purchasers will be underwriters
under §2(a)(11).
b. They can resell if
i. they register the securities;
ii. they meet conditions under Rule 144
iii. they sell to other qualified private offerees.
56
2ND HALF – continuation of “EXEMPTIONS”
9.
Trading Exemptions (Note that 4(2) is not a trading exemption; only available to issuers)
a. §4(1), Professional exemption: Transactions by persons other than issuers, underwriters or dealers. Exempts
transactions, not people. DOES NOT exempt person who is not underwriter, issuer, or dealer. Exempts transaction
when none of 3 people are in the transaction.
i. Presumptive underwriter doctrine: If person does distribution > 10% of the outstanding stocks
ii. The universe – 4 ways of acquiring securities: open market, a registered public offering, an exempt
public offering, or private placement
iii. Must following transactions by CP be registered if CP acquired in:
Open Market
CP  Sec Firm  Public
Registered public offering,
exempt public offering, or
exempt private offering
REGISTER
b/c securities firm becomes underwriter according to 2(a)(11)
DEPENDS

Issuer  CP  Sec Firm 
Public
Open Market
CP  Public (hard to do)
Registered public offering,
exempt public offering, or
exempt private offering
NO
registration
DEPENDS
Private offering. REGISTER. CP that acquires securities directly from issuer
in private placement takes RS which cannot be sold public. CP becomes
underwriter, securities firm becomes subunderwriter.
 Registered public offering / exempt public offering.
o If part of 1 offering, registration statement covers entire offering.
Securities have never come to rest so CP need not register.
o BUT if CP buys for investment & distributes through securities firm,
REGISTER AGAIN b/c it’s a different distribution.
b/c no underwriter


Issuer  CP  public
Private offering. Must be registered.
Registered public offering / exempt public offering.
o One distribution? Then registration statement or exemption applies.
However, if CP doing different distribution, then must do new
registration statement or exemption. Fact intensive issue re:
whether securities have come to rest.
iv. For NCP, it does not matter whether NCP used a securities firm or not. Did he purchase with a view to
distribution?
Open Market
NCP  Sec Firm  Public
Registered public offering,
exempt public offering, or
exempt private offering
Issuer  NCP  Sec Firm 
Public
Open Market
NCP  Public
Registered public offering,
exempt public offering, or
exempt private offering
Issuer  NCP  public
b.
c.
NO
registration
DEPENDS
NO
registration
DEPENDS
securities firm not underwriter – someone who purchases from NCP who bought in
open market is not an underwriter.
 Private offering. REGISTER. NCP deemed underwriter. Guild Films.
 Registered public offering / exempt public offering.
o If part of 1 offering, registration statement covers entire offering.
Did registration statement disclose role of NCP and securities firm
in this? If not, then NCP and securities firm doing new distribution
that must be registered.
b/c no underwriter


Private offering. Must be registered b/c NCP deemed as underwriter.
Registered public offering / exempt public offering.
o One distribution? Then registration statement or exemption applies.
Fact intensive issue re: whether securities have come to rest.
§4(3), Dealer’s exemption: The exemption does not kick in until after the quiet period is over.
1. Reporting Co.: No quiet period
2. NYSE/NASDAQ: 25 days
3. No trading: 40 days/ 90 days (IPO)
§4(4), Broker’s transactions: exempt from §5 if executed upon customers’ order but not solicitation of orders
i. For the purpose of EA, a broker is a type of dealer.
1. 4(3) better than 4(4) because can solicit under 4(3)!
2. Since all brokers are dealers, §4(4) only helps brokers when §4(3) and rule 174 does not apply:
a. Non-reporting Co. during 40 or 90 day quiet period
57
b.
c.
ii.
iii.
iv.
v.
vi.
vii.
viii.
Non-reporting Co. during 25 day quiet period under Rule 174.
During time period, NSG have delivery req (or access = delivery). Broker is type of
NSG because not part of selling group. Broker is exempt in quiet period if satisfy 4(4).
After quiet period, 4(3) kicks in & no delivery req for NSG which also exempts brokers.
If co is reporting co, 4(4) is irrelevant because of 174(b)!
Only a solicited buy order will destroy the exemption; not if broker solicits customer’s sell order 
Purpose of 33 Act is to protect buyers!
A buyer’s broker who has not solicited the buy order from the customers is not covered by §5 b/c the
broker does not sell to the customer but buys for the customer.
1. What is the need for the §4(4) exemption?
a. During the quiet period, a broker can use §4(4); and
i. The broker is not subject to prospectus delivery req w/ the confirmation of sale
or w/ the delivery of securities, whichever first occurs.
b. §4(4) exemption permits a broker to execute unsolicited transaction at any time.
i. §4(4) helps brokers when stop order or offering of additional securities of an
outstanding class. Thus technically, sale can occur in PFP.
I  U  SGD  (SB) C1 (BB) C2
1. SB (sellers’ broker) always offers and sell to C2.
a. SB qualifies for the §4(4) exemption if:
i. SB(SB≠BB) does not solicit the buy order from BB; or
ii. SB(SB=BB) does not solicit the buy order from C2
2. BB does not offer and sell to C2 if BB does not solicit the buy order from C2 (this is scenario
where C2 approaches BB) – BB does not sell even if he solicits the buy order unless the
solicitation of offer to buy was for value. Not covered by §5. See Pinter, supra p. 22.
3. CAVEAT!: Exemption  apply when broker’s principal is the issuer, underwriter, or dealer
a. i.e., I U  (SB) SGD  (BB) C1
When one broker represents the seller and another broker represents the buyer, and if the SB has a
prospectus delivery requirement, it is satisfied by delivery to the BB.
If the BB has a prospectus delivery requirement, it is satisfied by delivery to the buyer.
When one broker represents both the seller and the buyer, and if the broker has a prospectus delivery
requirement, it is satisfied by delivery to the buyer.
Basically this is important for supplemental selling literature because it is the only thing that requires
physical delivery (in presence of new rules). And if you are sending supplemental selling literature, you will
not be covered by 4(4) because you are soliciting!
SB≠BB
SB does not solicit the buy order from BB
BB does not solicit the buy order from C
SB does not solicit the buy order from BB
BB solicits the buy order from C
SB solicits the buy order from BB
BB does not solicit the buy order from C
SB solicits the buy order from BB
BB solicits the buy order from C
SB=BB
Broker does not solicit the buy order from C
Broker solicits the buy order from C
Must Broker Deliver a Prospectus?
SB≠ Agent of I, U, D
SB= Agent of I, U, D
SB: No, §4(4)
SB: Yes
BB: No, not a sale by BB (Loss, p. 120)
SB: No, §4(4)
SB: Yes
BB: Yes (access = delivery now). If you
use supplemental selling lit where need
physical delivery, tough luck! BB needs to
find one, and can’t necessary rely on SB!
SB: Yes
BB: No, not a sale by BB. But should read
prospectus even if no delivery req – think
liability!
SB: Yes
BB: Yes
Must Broker Deliver a Prospectus?
SB≠ Agent of I, U, D
SB= Agent of I, U, D
No, §4(4)
Yes
Yes
58
TOPIC 6—RESALES OF CONTROL AND RESTRICTED SECURITIES
§4(1 ½): Derived from §4(1). Do all the things that the issuer does, and sell only to the rich and smart (way more than accredited
investor). Why not from §4(2)? §4(2) can only be used by the issuer.
A. Two areas of uncertainty prior to the adoption of Rule 144
1.
Selling too much?: CP-NRS
a. IRA Haupt & Co. (SEC, 1946). Broker loses 4(4) or 4(3) exemption when they sell too much; broker becomes an
underwriter and CP loses 4(1) exemption.
b. Amount is significant b/c 4(1) intended to exempt only routine exemptions; not large lumps of distributions which
cause greater need for investor protection. If CP sells privately, must insure that person stands in your shoes and
stands for investment. If securities come to rest in hands of that person, then there has been no public distribution. **
CP pretending he is an issuer and doing a private placement** But CP cannot do a private placement because 4(2) is
only for issuers so sale from CP to 2nd tier purchasers can never be exempt under 4(2). But because CP is following
same procedures that issuer would do, its called 4(1 ½) but it is really 4(1). It was clear that you could have sold
privately as long as you sold to someone that was not going to be an underwriter (left hand side of ea. chart).
I.e., CP had to ‘pretend’ they were issuer – sell to just rich and smart, no general ad or solicitation, &
purchaser had to hold for investment. Securities purchased in 4(1 ½ ) become RS by slight of hand (legerdemain).
Usually only issuer creates restricted stock but here CP can do it.
c. Non restricted securities: Open market, registered public offering, or exempt public offering.
CP
RS
§4(1 ½)
RS
d.
2.
§4(1 ½)
§4(1)
CP/NCP
Broker
CP/NCP
PRIVATE
§4(3) or
§4(4)
PUBLIC
NRS
Register
§3(a)(10) (unlikely)
§3(a)(11)
Reg. A ($1.5M)
Rule 144
When a broker sells a substantial block of securities for CP, the broker is a statutory underwriter w/I the meaning of
§2(a)(11), as a person who sold for CP in connection w/ a distribution.
i. Since a broker is an underwriter, §4(3) is not available. Also, §4(1) exemption is not available b/c it is a
transaction involving an underwriter  both CP and the broker is in violation of §5.
1. CP and first-tier purchasers (statutory underwriter w/view to distribution) are in violation of §5.
2. CPs lost their §4(1½) exemption: CP becomes a part of a transaction involving an underwriter.
Selling too soon?: CP-RS and NCP-RS
a. Issuers make sales of securities to CP and NCP (first-tier purchasers) in a private offering exempt under §4(2), and at
some point the first-tier purchasers would resell their securities either:
i. Publicly, claiming that the resales were exempt under §4(1); or
ii. Privately to second-tier purchasers, claiming that the resales were exempt under §4(1½) exemption.
1. Bill says that it really is §4(1) exemption, b/c §4(2) is only available to offerings by the issuer.
2. The trick is to use §4(1) exemption and the §4(2) private placement nature would give assurance
that the second-tier purchasers would not be characterized as statutory underwriters.
3. However, at some point the second-tier purchasers would resell to public claiming §4(1)
exemption.
b. When the public resales by the first-tier purchasers or by the second-tier purchasers occurred too soon after the
issuer’s private offering, the issuers offering was not private but public.
i. They are all statutory underwriters.
1. First-tier purchasers: persons who purchased from an issuer w/ a view to distribution
2. Second-tier purchasers: Persons who:
59
3.
a. purchased from a CP w/ a view to distribution; or
b. who participated in the underwriting of such undertaking (subunderwriter).
Thus, all of them violate §5.
a. The issuer lost §4(2) exemption.
b. First-tier purchasers resell publicly: Lost §4(1) exemption.
c. First-tier purchasers and second tier purchasers: Lost §4(1) and §4(1½) exemptions.
Issuer
RS
§4(2)
CP/NCP
(underwriter)
§4(1½)
CP/NCP
§4(1½)
RS
CP/NCP
PRIVATE
Broker
Here, you don’t need a broker to be called the
underwriter because the underwriter is the CP
or NCP; whether or not the broker is used is
irrelevant.
PUBLIC
NRS
Choices:
Register
§3(a)(10)
§3(a)(11) – for CP only under release / not Rule 147
Reg. A: only if issuer is non-reporting co
144(j) – nonexclusive safe harbor
R144A: only if securities not listed when registered
3.
Hypo: Issuer sells to X and Y in a §4(2) offering. X and Y both state that they have an investment intent. X is lying, and Y is
telling the truth. X then sells publicly w/o registration?  no longer a private placement  §12(a)(1) suit:
i. Y v. Issuer: Y wins
ii. X v. Issuer (innocent): issuer wins (in pari delicto)(equal fault is a valid default for the defendant)
iii. X v. Issuer (not innocent): X wins
4.
Safeguards for the uncertainty (many of these still required for Rule 506)
a. Every first-tier and second tier purchaser was asked to sign an investment letter indicating that he or she was not
purchasing w/ a view to distribution.
i. Private resales by a purchaser would be permitted as long as next purchaser was not purchasing w/
intention of reselling publicly THUS **Better way to couch letter was that you did not intend to sell publicly**
b. Legend on each certificate indicating transfer of securities was restricted  “restricted securities”
c. Stop transfer instructions were delivered to the issuer’s transfer agent.
d. A statement of the purchaser’s financial condition.
e. First-tier purchasers requested a registration covenant (CP could likely get this; issuer will register securities if need
be) or a piggyback registration arrangement (issuer would insert the selling shareholders as underwriters in next
public registered offering).
B. Rule 144 (1972): Definitional rule as to who is not deemed as an underwriter.
1. In General
a. Problems
i. How much can a broker sell before he is deemed to be an underwriter?: CP-NRS
ii. How soon can you sell before CP or NRS is deemed to be an underwriter?: CP-RS; NCP-RS
b. Prior rules
i. Change of circumstances doctrine: abandoned
ii. Fungibility doctrine: abandoned
1. If you purchased NRS on 1/1/02 and RS on 6/1/02 (same issuer), stock purchased on 1/1/02
would be treated as RS b/c securities are fungible. If you wanted to sell, you had to wait until
6/1/03. (Now if you can trace serial #s & prove NRS, you can be okay under different rules for RS
and NRS)
c. Mechanics
60
i. Whenever CP or a NCP selling RS violates §5, the issuer of the securities (or in a §4(1½) transaction, the
CP from who the securities were directly or indirectly acquired) also violates §5.
ii. When Rule 144 applies, all sales can be made publicly w/o registration.
Rule 144(d), Holding period
Rule 144(e), Amount
Can sell dribble every three months; so
can do 4 per year. Can’t carry over.
Rule 144(c), Current public info
Rule 144(f), Manner of sale
Rule 144(h), Notice of proposed sale
Rule 144(i), Bona Fide Intention to sell
NRS by a CP
None (no prob about how
soon they can sell)
Dribble until he loses the
CP status
Yes
Yes
Yes
Yes
RS by a CP
1 year
RS by a NCP
1 yr
2yr144 (k)
Dribble until he loses the
CP status (If become NCP,
then 144(k) may apply)
Yes
Yes
Yes
Yes
Dribble
Unlimited
Yes
Yes
Yes
Yes
No
No
No
No
2.
Rule 144(b), Operative Provision: Any CP or NCP who sells RS of an issuer for his own account, or any broker who sells
(RS or) NRS for CP of the issuer, shall be deemed not engaged in a distribution of such securities and not an underwriter
w/I §2(a)(11) if all conditions of rule are met.
a. CP or NCP selling RS
i. I  CP-RS
ii. I  NCP-RS
b. Not mentioned: Broker selling RS for NCP
i. NCP  Broker-RS
c. Not needed: NCP selling NRS; Broker selling NRS for NCP
3.
Rule 144(d)(1), Holding Period for RS: 1 year min must elapse b/w the later of the date of the acquisition of the securities
from issuer or from affiliate of issuer, and any resale in reliance on Rule 144. HP for RS  start to run until full purchase
price is paid by the person acquiring the RS from the issuer of a CP.
a. Rule 144(d)(2), Promissory Notes
i. If the purchaser has paid for the RS w/ a note, the HP will start to run on the date of sale if the note is a fully
collateralized (not w/ the RS purchased) recourse note (collateral is not the only asset you have), and if
the note is fully paid off before the sale of the RS pursuant to Rule 144.
b. Rule 144(k), Termination of Restrictions on NCP-RS
i. §144(c), (e), (f), and (h) shall not apply to RS sold for account of NCP at time of sale if has not been a CP
during the preceding 3 months, provided at least 2 years has elapsed since the later of the date of the
securities were acquired from the issuer or from a CP of an issuer.
4.
Rule 144(d), Tacking of HPs for RS
a. Sale of NRS: in sale is made pursuant to §4(1½) or Rule 144A, CP / NCP may tack HP of its seller if the seller was
NCP at time of sale.
i. Only prohibits tacking of HP when there is a sale by the issuer or a CP b/c NCP deemed as underwriter.
1. CAVEAT!: The intervention of a CP starts a new HP for subsequent purchasers.
ii. Hypo: OM  CP (9 mos.; NRS)  NCP (3 mos.; RS)  NCP
1. Anything that is sold under §4(1½) becomes RS.
iii. Hypo2: I  NCP1 (3 mos.)  NCP2 (3 mos.)  CP (3 mos.)  NCP3
1. How can NCP1 resell only after 3 months?  4(2) Private placement; Rule 144 only prohibits
public sale.
2. CP can tack the HP, and CP is deemed to be holding for 6 months.
3. NCP3 has 0 HP. Must wait 1 year to resell.
b.
Stock dividend, stock split, a conversion, or recapitalization: Tacking permitted for RS acquired as a stock
dividend or pursuant to a stock split, a conversion, or recapitalization.
i. Except conversion and recapitalization, tacking of HPs is not permitted in transactions specified in
Rule 145(a).
1. Merger, sale of asset, consolidation cannot be tacked, regardless of whether it was registered
under Rule 145 or exempt from registration.
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c.
Gifts: Donee may tack HP of donor, whether donor is a CP or NCP. (Rule says only CP, but you can tack from a NCP
anyway so they don’t need to say it) This is because you can always tack to NCP  144(d)(1)
d.
Pledge w/ Recourse: Pledgor Pledgee  Purchaser on default
i. Pledgee may tack HP of the pledgor, whether pledgor is a CP or NCP.
ii. Purchaser on default may tack HP of pledgee and pledgor, whether pledgor or pledgee are CPs or NCPs.
e.
Trust: Grantor/Settlor  Trust  Beneficiary
i. Trust may tack HP of grantor, whether grantor is a CP or NCP.
ii. Beneficiary may tack HP of trust and grantor, whether grantor and trusts are CPs or NCPs.
f.
Estate: Decedent  Estate  Beneficiary
Decedent
Selling Estate
CP/NCP
CP
CP/NCP
NCP
Decedent
CP/NCP
CP/NCP
Estate
CP/NCP
CP/NCP
Beneficiary
CP
NCP
Tacking permitted from decedent
Immediate sale of unlimited amount permitted
No manner of sale requirement
Tacking permitted from decedent for purposes of Rule
144(k)
Tacking permitted from decedent and estate
Immediate sale of unlimited amount permitted
No manner of sale requirement
Tacking permitted from decedent and the estate for
purposes of Rule 144(k)
i. How can the selling estate be a CP when the decedent was a NCP?
1. The estate might have bought more, or the issuer might have bought back stocks.
5.
Rule 144(e), Limitation on Amount of Securities Sold: A CP or NCP can dribble (leakage, volume, or quantity)
a. Dribble amount: Greater of 1% of shares of outstanding or avg weekly trading volume of 4-wk period.
i. If security is not listed on NSE or quoted in NASDAQ (just traded in OTC), dribble amt is 1% of class
outstanding.
ii. Moving target: Dribble amt always changing, so you may not dribble b/c you have already exceeded limit on
dribble for the 3 month period.
b. Numbers counting
i. NSE/NASDAQ: C1 (SB) (BB) C2.
1. Counted as 100 shares.
ii. NASDAQ
1. C1  Dealer  C2.
a. Dealer takes title, and thus, it counts as 200.
2. C1  Dealer  Dealer  C2
a. Dealer takes title, and thus, it counts as 300.
3. Bill says that double and triple count is not fair.
6.
Rule 144(a)(2) and Rule 144(e)(3), Aggregation (6 AGGREGATION CONCEPTS)
a. Sales by CP: CP must aggregate sales of RS (held 1 year) w/ sales of NRS (sold immediately)
i. Hypo: If CP has both NRS & RS, & held for a year, cannot double dribble b/c sales of NRS & RS by CP is
aggregated.
ii. NCP does not have to aggregate sales of RS (held 1 year) w/ sales of RS (held 2 years) or w/ sales of NRS.
b. Group person: Relatives or spouse who share = household deemed to be a person (incl relatives of spouse (i.e.
mother in law), & they are all treated as one person)
i. 2-way aggregation: Each individual in group must aggregate sales w/ sales by every other group member
1. However, only individuals who make sales can violate §5.
ii. X is Y’s father. X & Y share = household. X is CP, & Y is NCP. Dribble amt is 100. All shares owned by X &
Y were purchased by them.
1. X sells 150 shares of NRS, and Y sells no shares. X has violated §5, but Y has not.
2. X sells no shares, and Y sells 150 shares of NRS. Neither X nor Y has violated §5.
3. X sells 100 shares of NRS, and Y sells 50 shares of NRS. X violated §5, but Y has not.
62
4.
c.
d.
e.
X sells 100 shares of NRS, and Y sells 50 shares of RS (held 2 years). X has violated §5, but Y
has not.
Individual & relatives w/= household owning 10%+ beneficial interest of trust or estate (come from 144(a)(2))
i. . . . must aggregate their sales w/ sales by the trust or estate.
1. 1-way aggregation: Trust or estate need not aggregate its sales w/ sales by such individuals.
e.g., trustee, executor, or relatives who share the same household.
ii. However, only individuals who make sales can violate §5.
iii. X, an individual, is the trustee of Y, a trust. X is a CP, and Y is a CP. The dribble amount is 100. All shares
owned by X and Y were purchased by them.
1. X sells 150 shares of RS (held 1 year), and Y sells no shares. X has violated §5, but Y has not.
2. X sells no shares, and Y sells 150 shares of RS (held 1 year). Y has violated §5, but X has not.
3. X sells 100 shares of RS (held 1 year), and Y sells 50 shares of RS (held 1 year). X has violated
§5, but Y has not.
4. X sells no shares, and Y sells 150 shares of NRS. Y has violated §5, but X has not.
Individual & relatives w/= household owning 10% of a corp: . . . must aggregate their sales w/ sales by corp.
i. 1-way aggregation: Corp need not aggregate its sales w/ sales by such individuals.
1. CAVEAT!: The sales by the individuals and the corporation are sales of another corporation’s
securities.
ii. However, only individuals who make sales can violate §5.
iii. X, an individual, owns 10% of a class of equity securities of Y, a corporation. X is a CP, and Y is a CP.
Dribble amount = 100. All shares owned by X & Y were purchased by them.
1. X sells 150 shares of NRS, and Y sells no shares. X violated §5, but Y has not.
2. X sells no shares, and Y sells 150 shares of RS (held 2 years). Y has violated, §5, but X has not.
3. X sells 100 shares of NRS, and Y sells 50 shares of RS (held 2 years). X has violated §5, but Y
has not.
4. X sells 100 shares of RS (held 1 year), and Y sells 50 shares of RS (held 1 year). X has violated
§5, but Y has not.
Gifts, pledges, or trusts
i. In gift, pledge, or trust context, the following sales must be aggregated:
1. Sales by the donor and donee
2. Sales by pledgor, pledgee, and purchaser on default
3. Sales by grantor and trust (not by the beneficiary). NOTE: in tacking, the beneficiary is included,
but they are not included for aggregation.
ii. Duration:
1. NCP-RS: Aggregation terminates 1 year after the gift, 1 year after a default on the obligation
secured by the pledge, and 1 year after the transfer to the trust or upon completion of Rule 144(k)
2-year HP (after tacking), whichever occurs first. (not in rule, but SEC release)
2. Aggregation only applies to securities that are gifted, pledged, or trusted. If you own other stock
in Co that isn’t gifted, pledged, or trusted, they can be sold independent of these rules.
iii. During the aggregation period, sales by the donee, pledgee, and trust are deemed to be made on behalf
of the donor, pledgor, and grantor, respectively. Sales by the purchaser on default are deemed to be made
on behalf of the pledgor and the pledgee.
1. Effect: NCP selling on behalf of the a CP stands in the shoes of the CP, assumes the status of
a CP, and is subject to = Rule 144 limitation as a CP.
a. CAVEAT!: During aggregation period, a donor, pledgor, pledgee, and grantor can
violate §5 even when they make no sales, if sales made on their behalf violate §5.
i. Cf. Guild Film: Δ & issuer violated §5 even though it was bank making sale.
2. In practice, if you run out of cash, you can pledge the RS and borrow money, but pledgee cannot
sell the RS. If purchaser on default sells RS, he is in the shoes of the worst of pledgee or pledgor
(CP). If purchaser violates §5 in doing so, both pledgee and pledgor violate §5.
iv. X is donor, & Y is donee. X is a CP, and Y is a NCP  household relative of X. Dribble amount is 100.
1. X sells 150 shares of NRS, and Y sells nothing. X has violated §5, but Y has not.
2. X sells no shares, 6 months after the gift, Y sells 150 shares of the shares gifted by X, which is
NRS. Both X and Y have violated §5.
3. 6 months after the gift, X sells 100 shares of NRS, and Y sells 50 shares of the shares gifted by X,
which is NRS. Both X and Y have violated §5.
4. 6 months after the gift, X sells 100 shares of NRS, and Y sells 150 shares of NRS that he
purchased in the open market. Neither X nor Y has violated §5.
63
5.
f.
6 months after the gift, X sells 100 shares of NRS, and Y sells 150 shares of the gifted stock,
which is RS, held 1 year and 6 months by X before the gift. Neither X nor Y has violated §5.
v. Donor (CP-NRS)  Donee (NCP)
1. Donee can sell immediately for dribble amount. NCP donee steps in shoe of CP Donor. Donee
sell dribble amt for 1 yr. Donor & donee aggregate during the 1 year period. Can sell unlimited
amount after year after gift
vi. Donor (CP-RS)  Donee (NCP): Donor held the securities for 6 months at the time of the gift.
1. During the 6 months period after the gift: NCP donee cannot sell. NCP donee stands in the shoe
of the CP donor for 1 year after the gift.
2. During the next 6 months period: NCP donee can dribble but NCP donee still stands in the shoe
of the CP. Aggregation still applies.
3. During the next 6 months period: NCP donee can sell dribble amount w/o aggregation (1 yr has
passed). Since 2 years haven’t passed yet, NCP donee can only sell dribble amount.
4. During the next 6 months period: NCP donee can sell unlimited amount. No restrictions (i.e.,
notice of proposed sale; current public information; manner of sale; bona fide intention to sell)
apply even though Donee only held the securities for a year and a half b/c of tacking.
vii. Donor (CP-RS)  Donee (NCP): Donor held for 18 months before gift.
1. During the 6 months after the gift: NCP donee can sell dribble, but the donee still has to aggregate
b/c Donee stands in the shoe of the CP donor. Tacking allowed
2. After next 6 months: Rule 144(k) occurs before the 1 year after the gift period. NCP can sell
unlimited amount w/o restrictions.
viii. CAVEAT!: 10%+ trust beneficiary must aggregate sales of all securities w/ sales of ALL securities by
the trust under the third concept, not just sales of the securities put in trust.
ix. Note: Under this rule, there is no aggregation b/w:
1. sales by grantor of a trust and a trust beneficiary;
2. sales by trust and a trust beneficiary.
Estates: Sales by the decedent, the decedent’s estate if the estate is a CP, and an estate beneficiary if the
beneficiary is a CP must be aggregated.
i. Limitation: Only sales of the securities that were bequeathed are subject to aggregation.
1. Aggregation is required only during any 3-month period surrounding the date of death.
2. If the last sale was 1 month before decedent’s death, period ends after 2 month from his death.
ii. Effect: During such 3-month period, sales by a CP estate are deemed to be made on behalf of decedent,
and sales by a CP estate beneficiary are deemed to be made on behalf of decedent and a CP estate.
1. CAVEAT!: During such period, a decedent and a CP estate can violate §5 even when they make
no sales, if sales made on their behalf are in violation of §5.
iii. NCP: During such period and any time thereafter, there is no limitation on amt of securities sold by an
estate or an estate beneficiary that is a NCP, if securities sold were the securities bequeathed by decedent.
iv. X is a decedent, Y is her estate, and Z is a 5% beneficiary of the estate. X is a NCP, Y is a NCP, and Z is a
CP who is not a household relative of X or an executor Y. The dribble amount is 100.
1. 1 month before her death, X sells 150 share of RS (held 1 year), and during the 2-month period
after X’s death, Y and Z sell no shares bequeathed by X. X has violated §5, but Y and Z have not.
2. In the 3-month period before X’s death, X sells no shares, and during the 3-month period after the
X’s death, Y sells 150 shares of RS bequeathed by X (held by X and Y a total 1 year), and Z sells
no shares bequeathed by X. Neither X nor Y nor Z has violated §5.
3. In the 3-month period after X’s death, Y sells no shares bequeathed by X, and Z sells 150 shares
of RS bequeathed by X (held by X, Y, and Z a total of 1 year). X and Z have violated §5, but Y has
not.
a. Z is a CP, and Z is selling on X’s behalf. Y did not violate b/c he is a NCP, and NCP
estates or beneficiaries are allowed to sell unlimited shares immediately in this 6 th
concept.
v. CAVEAT!: 10%+ estate beneficiary must aggregate sales of all securities w/ sales of ALL securities by
the estate under third concept, not just sales of the securities put in trust.
7.
Whenever a CP or NCP selling RS violates § 5, issuer of securities violates § 5 as well.
8.
Rule 144(c), Current Public Information: Information about the issuer must be publicly available.
a. (1) reporting company  reports under EA is enough.
b. (2) non-reporting company  similar info must be publicly available (Rule 15c2-11).
64
9.
Rule 144(f), Manner of Sale:
a. Broker’s transaction or transaction directly w/ a market maker
i. Rule 144(g), Broker’s transaction: As long as SB does not solicit a buy order from BB or C2, we have a
broker’s transaction. See §4(4), supra, p. 51.
1. . . . receive no more than the usual & customary broker’s commission;
2. Broker should neither solicit nor arrange for the solicitation of a buy order.
a. However, the broker is allowed to ask other brokers and dealers who have indicated an
interest in the securities w/I preceding 60 days and ask a customer who has indicated
unsolicited bona fide interest in securities w/I preceding 10 business days.
ii. §3(a)(38), Market maker: Any (floor) specialist permitted to act as a dealer, any dealer acting in the
capacity of block positioner, and any dealer who, w/r/t security, holds himself out (by entering quotations in
an inter-dealer communications system or otherwise) as being willing to buy and sell such security for his
own account on a regular or continuous basis. Market maker cannot solicit buy order.
1. Specialist: You can have a market maker in NSE, called one-floor specialist for each company.
He is a true dealer, as a principal.
b. Requirements: The person selling cannot
i. Solicit or arrange for solicitation of buy order; and
ii. Make any payments in connection w/ the offer or sale of the securities to any person other than the broker
who executes the order to sell the securities.
c. Exception:
i. Sale by the estate or the beneficiary of the estate if the estate or the beneficiary is not a CP.
ii. Sale by a NCP after 2-year holding period. See Rule 144(k), supra p.55.
10. Rule 144(h), Notice of proposed Sale: If the amount sold during any period of 3 months exceeds 500 shares or has an
aggregate sale price in excess of $10,000, the person selling must file Form 144 w/ SEC and w/ principal exchange. Thus,
there exists a de minimus exemption  under 500 shares OR 10K.
a. Filing concurrently w/ either the placing w/ a broker of an order to execute a sale of securities in reliance upon the rule
or the execution directly w/ a market maker of such a sale.
11. Rule 144(i), Bona Fide Intention to Sell: Form 144 filer must have bona fide intention to sell w/I a reasonable time after filing.
a.  insider placing order to sell at very high price may be viewed as trying to promote / manipulate market price
(depressing or increasing it).
b. Reasonable time? Probably 90 days. If you don’t sell w/I 90 days, you violate §5.
12. Definitions
a. Rule 144(a)(1), CP: CP or affiliate of an issuer = CP of the issuer, a person controlled by the issuer, or a person under
common control w/ an issuer.
i. Control may be established indirectly through an intermediary.
b. Rule 144(a)(3), RS: Securities acquired from issuer under §4(2), Rule 505, Rule 506, or from a non-issuer under
§4(1½) or Rule 144A.
i. NRS: All other securities (i.e., securities acquired in the open market, in a registered public offering, or in an
exempt public offering other than Rule 505 offering).
ii. CAVEAT!: Securities acquired from the issuer under Rule 504 may be RS or NRS. See Rule 504(b)(1),
supra, p. 46.  DEPENDS on state law.
c. Rule 144(a)(2), Person:
i. Generally, term “person,” when used w/ reference to a person for whose account securities are to be sold
pursuant to Rule 144, incl seller &
1. any relative or spouse of seller, or any relative of such spouse, any one of whom has = household
as seller (associate household relatives/ group person);
2. any trust or estate in which seller &/or household relatives collectively own 10%+ beneficial
interest in the trust or estate or of which the seller or any household relative serves as trustee or
executor (associate trust or estate); and
3. any corp (other than issuer) in which the seller and/or household relatives collectively own 10%+
of any class of equity of the corp (associate corporation).
ii. CAVEAT!: The determination of who is deemed a CP under Rule 144(a)(1) is distinct from the resolution of
who qualifies as the same person under Rule 144(a)(2).
65
1.
Assume X is CP of A Co., and Y is his son. Y would be a CP of A Co. if indirectly controlled A Co.
through X, whether or not he lived in the same household as X. Y would be the same person as X
if he lived in the same household as X, whether or not he indirectly controlled A Co. through X.
C. Rule 144A (1990): Nonexclusive safe harbor for private sale (Safe harbor for 4(1½)) . . . defines who is not an underwriter.
1. In General
a. Purpose: A more liquid and efficient institutional market for unregistered securities.
i. Rule 144A (private resales)—Rule 144 (public resale)
ii. Rule 506 (§4(2))—Rule 144 (§4(1))—Rule 144A (§4(1½))
b. Application: Rule 144A does not apply to the issuer.
c. §4(1½) applies to:
i. Private resale of RS; or
1. Issuer [§4(2)]  CP/NCP (RS) [§4(1½)]  CP/NCP (RS) [§4(1½)]  CP/NCP (RS)
ii. Private resale of NRS by CP/NCP (legerdemain situation / slight of hand) (Stock becomes restricted when
an issuer sells stock at a private placement or a CP/NCP acts like an issuer doing a private placement)
1. OM  CP (NRS) [§4(1½)]  CP/NCP (RS) [§4(1½)]  CP/NCP (RS)
2.
Rule 144A(a)(1), Qualified Institutional Buyers (QIBs): Must sell to an institution if you want to qualify for the safe harbor.
Offers AND sales can only be made to QIBs.
a. In aggregate, institutions that own and invest at least $100M on a discretionary basis & not affiliated w/ issuer.
i. i.e., Bank, investment co, insurance co, pension funds, charitable orgs, corps, partnerships.
ii. “Own” means proprietary.
iii. “Invest” means discretionary (you don’t own them, but you have discretionary authority) (exercise of
investment discretion). QIBs do not have to own the $100M. Only has to have the authority. So it’s not
really own AND invest, but rather OR in that sense. However, you can have 50M own and 50M invest and
that is ok.
iv. Dealers acting as an agent in a non-discretionary basis: mutual fund which is part of a family of mutual
funds which owns 100M in securities
v. Banks and Savings & Loan association: own and invest $100M in securities or $25M net worth.
1. Banks are insured by FDIC.
b. Exceptions:
i. Dealers only, in aggregate, own and invest at least $10M on a discretionary basis and not affiliated w/
the issuer.
ii. Dealers acting in a riskless principal transaction on behalf of QIBs: The dealer himself can be a QIB then
even w/o $10M.
1. Rule 144A(a)(vi)(5), Riskless principal transaction: A transaction in which dealer buys security
from any person and makes a simultaneous offsetting sale of such security to a QIB, including
another dealer acting as riskless principal for a QIB. Person who sells to dealer doesn’t have to
be a QIB. Dealer is a principle that buys BUT at time of purchase broker-dealer has commitment
from QIB that it will simultaneously purchase the securities.
iii. Dealers acting as an agent on a non-discretionary basis in a transaction w/ a QIB (never take title but
can facilitate intermediation)
iv. Mutual fund which is part of a family of mutual funds which owns $100M in Securities (like JANUS).
v. Banks and Savings & Loan Associations—Own and invest 100M in securities, AND 25M net worth
(these unlike rest are backed by federal insurance funds and therefore they are able to purchase without the
same risk).
vi. NOTE: these monetary determinations are done as follows:
1. The aggregate value of securities owned and invested on a discretionary basis by an entity shall
be the cost of such securities, except where the entity reports its securities holdings in its financial
statements on the basis of their market value, and no current information with respect to the cost
of those securities has been published. In the latter event, the securities may be valued at market
for purposes of this section.
3.
Rule 144A(d), Operative provision
a. Mechanics: All offers & sale must be made only to QIBs or to people who seller reasonably believes to be QIBs.
i. Reasonable belief can be ascertained by relying on most recent publicly available financial statement w/I 16
months preceding date of sale; most recent publicly available info appearing on doc filed w/ SEC w/I 16
months preceding date of sale; most recent publicly available info appearing in a recognized securities
66
4.
manual w/I 16 months preceding date of sale; a certification by the CFO specifying the amount of securities
owned and invested on a discretionary basis.
b. Requirements
i. The seller must let the QIBs aware that the seller may rely on the exemption. 144A(d)(2). It is possible that
seller is just accredited investor and not a QIB. Subsequent sales may be between two QIBs.
ii. 144A(d)(4)(i). Purchasers’ right to ask for basic info if issuer is non-reporting co & no otherwise publicly
available info.
1. Why doesn’t Reg. D rationale apply? Doesn’t QIBs have enough economic bargaining power?
Unlike Reg. D, Rule 144A cannot be used by the issuer. In 506, u buy from issuer, you are
accredited, so you have economic bargaining power vs issuer. Here, you aren’t buying from
issuer, so the fact that you have economic bargaining power wont matter to the issuer b/c they
could care less if u buy the stocks.
c. Limitation
i. If the securities offered or sold were, when issued, listed on NSE or quoted in NASDAQ, the seller cannot
use Rule 144A. This may be hard to know if you acquired the securities in the open market. But in some
scenarios, this is determinable, and Rule 144A can be used as long as the securities weren’t listed.
ii. By its own terms it does not apply to the issuer since §4(1) does not apply to a transaction involving the
issuer.
1. However, in practice, it can be used by the issuer indirectly. For example, if the issuer sells to the
securities firm (accredited investor), and securities firm sells to QIBs.
Rule 144A(d)(3)(i)
a. 2 Q’s
i. On what date did the issuer sell the securities? Problem is that how does he know the date that the issuer
sold securities? CP that bought in open market is not going to know.
ii. On that date, was the same class of securities traded on a national securities exchange or NASDAQ?
1. If answer is yes to Q2, then seller cannot use 144A. You can still do 4(1 ½), but cant get safe
harbor.
b. SEC doesn’t want side-by-side markets. They will let you sell under 144A and start up this private market, so long as
there isn’t a public market running alongside.
c. SEC considers this rule to be a first step in achieving a more liquid market for unregistered securities. The safeharbor incentivizes people to comply and helps create a more liquid market.
Exchangeable preferred is convertible into debt; convertible preferred is convertible into preferred stock.
Co’s often do 144A and then register securities when in hands of QIB and then publicly distributed because it allows issuer to unload
the securities right away.
This rule presents an issue for convertible stock. Since securities sold under this rule cannot be traded on Nasdaq, then if the
convertible stock is traded on the exchange, this is a problem because would violate the rule. 144(d)(3)(i) may provide an answer 
it does not cost much to convert; to convert is cheap so it is very fungible.
D. Public Sales by NCP-NRS (not covered by Rule 144)
1. Open market (NCP acquired in OM)
a. No restrictions. Sell unlimited amounts immediately.
2.
Registered offering
a. Generally no restriction.
b. If NCP is a presumptive underwriter (purchased 10% or more in the registered offering and then distribute you are
deemed to be an underwriter), use Rule 144 by analogy.
i. By analogy?: In case of CP-NRS, CP can dribble immediately w/o 1 year HP. In case of NCP-NRS,
similarly, NCP must be able to dribble for the 1st year and then sell unlimited after 1 year.
ii. Presumptive underwriter doctrine: If NCP purchase minimum 10% of an offering, he is deemed to be an
underwriter.
3.
§3(a)(9), §3(a)(10), Reg. A
a. Use presumptive underwriter doctrine by analogy and then Rule 144 by analogy.
b. Dribble for 1 year then unlimited amounts
67
c.
Loss says that if it’s a merger and one of these three types of transactions and it’s exempt, you use Rule 145(d) by
analogy, not presumptive underwriter/144.
4.
§3(a)(11), Intrastate offering
a. Unlimited amounts after 9 months. See Rule 147(e), Gestation period, supra, p. 44. Once securities have “come to
rest” they can sell.
5.
Rule 504 (if NRS)
a. Unlimited amounts immediately.
i. Recall that Rule 504 offering could be RS. See supra, p. 46.
b. CAVEAT!: Rule 505 and Rule 506 offerings are RS. Thus, it is governed by Rule 144.
6.
Registered Rule 145 offering
a. Rule 145(c), Resales by CPs in Rule 145 Transactions: CPs of Target Co. (in a merger or sale of assets) and CPs
of the issuer (in a reclassification) must register such resales unless registration statement for Rule 145 transaction
discloses that such resales will be made.
i. They are presumptive underwriters of the registered Rule 145 transaction unless their resales are made
pursuant to Rule 145(d).
ii. If resales are not registered or not disclosed initially, they must be made pursuant to Rule 145(d) which
borrows from Rule 144.
iii. If a Rule 145 transaction was not registered b/c it qualified for an exemption under §3(a)(9), §3(a)(10), or
Reg. A, CP of Target Co. can use Rule 145(d) by analogy for resales of securities received in Rule 145
transaction.
b. Rule 145(d), Resales: Resales can be made in accordance w/ Rule 144.
i. Sale by NCP of Target Co. who becomes CP of Acquiring Co.
1. He must resell under Rule 144. Thus, he can dribble immediately. However, all the requirements
of Rule 144 must be met.
ii. Sale by CP of Target Co. who becomes CP of Acquiring Co.
1. He can dribble immediately under Rule 144 as long as current public info of issuer is available and
manner of the sale requirements are met.
a. CAVEAT!: Notice of proposed sale and bona fide intention to sell is not required.
i. Bill says it has an odd result b/c NCP of Target Co. who becomes CP of
Acquiring Co. has more restrictions on resale than CP of Target Co. who
becomes CP of Acquiring Co.
iii. Sale by CP of Target Co. who becomes NCP of Acquiring Co.
1. He can dribble immediately under Rule 144 as long as current public info of the issuer is available
and the manner of sale requirements are met.
2. After 1 year, can sell unlimited amounts, but current public info of the issuer must be available.
3. She can sell unlimited amount w/o restrictions after 2 years.
a. She must be a NCP of Acquiring Co. for at least 3 months.
c. Rule 144(d)(3)(viii), No tacking of HP for Securities Acquired in Rule 145 Transactions
i. In case of recapitalization, and reclassification, tacking is allowed. So they only mean you cant tack with
mergers and sales of assets.
ii. For exempt exchange, tacking is allowed
Before Exempt exchange After
Tacking?
RS
§4(2)
RS
Yes
RS
§3(a)(9)
RS
Yes
NRS
§4(2)
RS
Yes
NRS
§3(a)(9) & §4(2)
RS
Yes
NOTE: qualifying under 3a9 doesn’t get you out of the change over to RS b/c u still used 4(2)
d. If a Rule 145 transaction is not registered b/c it qualifies for an exemption under §4(2) or Reg. D, Rule 144 will
govern the public resales of the securities received in the transaction unless securities are nonrestricted Rule 504
securities.
i. NCPCP under the analogy of Rule 144 has more restrictions in resales than CPCP.
ii. Even if the Rule 145 transaction can be qualified for exemption under §4(2) or Reg. D, generally the target
company would prefer registration b/c less stringent restrictions on resale.
68
Public resales of securities received in a registered Rule 145 transaction w/ public resales of securities received in a Rule
145 transaction exempt under §4(2) or Reg. D
CP of Acquiring Co. at time of resale
Not governed by Rule 145 (governed
by 144)
NCP of Target at time of vote
* Dribble Immediately
Current public Information
Manner of sale requirement
Notice of proposed sale? (the reason
for the ? is b/c this is an NCP situation,
whereas for CP resale, you don’t have
these requirements, so it is weird that
this is more restrictive)
Bona fide intention to sell?
Rule 145(d)
CP of Target at time of vote
* Dribble immediately
Current public information
Manner of sale requirement
§4(2) or Reg. D: Rule 144 (restricted
securities)
NCP/CP of Target at time of vote
* Dribble after 1 year
Current public information
Manner of sale requirement
Notice of proposed sale
Bona fide intention to sell
NCP of Acquiring Co. at time of resale
Not governed by Rule 145 (governed
by nothing)
NCP of Target at time of vote
* No restrictions or conditions
Rule 145(d)
CP of Target at time of vote
* Dribble immediately
Current public information
Manner of sale requirement
* Unlimited amounts after 1 year
Current public information
* Unlimited amounts after 2 years
§4(2) or Reg. D: Rule 144
(non-restricted securities)
NCP/CP of Target at time of vote
* Dribble after 1 year
Current public information
Manner of sale requirement
Notice of proposed sale
Bona fide intention to sell
* Unlimited amounts after 2 years
69
Topic 7 – Registration Provisions of the Securities Exchange Act
A. In General
1. SA & EA
a. SA: episodic disclosure (transaction based) on Form S1
b. EA: continuous disclosure obligation (quarterly and annual reports) on Form 10
c. Hypo: Public utility holding company issues publicly debt securities that will be listed on a national securities exchange
must comply with SA, EA, Public Utility Holding Company Act, and Trust Indenture Act.
2. For 30 years after enactment of the Exchange Act, there was a double standard of investor protection—a standard that resulted,
more by accident than by design, from the piecemeal adoption of the SEC statutes but that nevertheless glowed with an
incandescent illogic.
a. Inconsistent disclosure requirement for listed companies and OTC market (there were no disclosure requirements for
OTC companies, and it made no sense)  in 1964, added § 12(g) to make it consistent between NSEs and OTCs.
3. The ordinary human does not willingly put his or her head in the lion’s mouth. . . . The privilege of voluntary registration will also
take care of the company with almost 500 stockholders that prefers the lion’s mouth to the cliff’s edge.
a. §12(g)
i. If more than $10M total assets AND 500 shareholders, you have to register under 12(g). This test is done
on the last day of the fiscal year. Voluntary registration is still permitted even if you don’t meet the test.
B. Reporting Companies [§12(b), §12(g), and §15(d)]
1. §12(a): it is unlawful for any broker-dealer to trade any security (other than an exempted security) on NSE unless security has
been registered on such exchange under EA.
a. Broker-dealers must be registered under §15(a).
2. §13(a), Periodic Reports.
a. Form 10-K: Annual report.
i. Must be filed in 90 days from the end of the fiscal year (seasoned companies have 60 days)
1. Financial information audited
ii. See Rule 13a-1, Rule 15d-1
iii. The proxy rules have gradually been tightened so that today a proxy solicitation on behalf of the issuer with
respect to an annual meeting for the election of directors must be accompanied or preceded by an annual
report to security holders. Copies of the report to security holders must also be mailed to the Commission
“solely for its information,” which is to say, the report is not considered to be filed for purposes of civil liability
under 18. Includes
1. balance sheets for 2 yrs & Inc Statement for 3, all audited & prepared on a consolidated basis in
accordance w/ Reg S-X;
2. selected financial data
3. info concerning changes in and disagreements with accountants
4. mgmt’s discussion & analysis of financial condition & results of operations
5. quantitative & qualitative disclosures about market risk req’d since 1997 by Reg S-K Item 305
6. a brief description of the biz and its subs during the most recent fiscal yr & industry segment data
7. info concerning ea of registrant’s directors & executive officers
8. market price of & dividends on registrant’s common equity, together w/ related security holder
matters
b. Form 10-Q: Quarterly report
i. Must be filed in 45 days from the end of each of first 3 quarters of fiscal year (the last quarter is covered by
annual report) (accelerated filers have 35 days)
1. Financial information does not have to be audited, but must follow GAAP (this part of the report is
not considered to be “filed” for purposes of civil liability under 18).
ii. See Rule 13a-13, Rule 15d-13
c. Form 8-K: current report
i. Filed in 15 days after extraordinary current events (sometimes it is 5 biz days—depends on the event)
1. Change of control; major sale of assets or acquisition; resignation of director over policy dispute
d. Sarbanes-Oxley Act: Requires accelerated filing date for dark-blue chip companies
3.
Section 302 SOX. Requires each quarterly and annual report filed under 13(a) or 15(d) of the 1934 Act to be certified by the
principal executive officer or officers and the principal financial officer or officers.
70
§12(b), Registration of Listed on NSE
Any class of debt or equity security traded on NSE
1.
2.
3.
4.
In general: Triggers proxy rules, tender offer rules, and §16 insider trading provisions.
Registration
a. Use Form 10: Double-duty for §12(b) as a listing application and the registration document.
i. Registration of debt securities: Form 8-A
b. Registration is satisfied by filing Form 10 w/ the exchange. (similar to SA 33)
i. However, duplicate originals must be filed w/ SEC.
c. Application to the whole class: Registration, once effective, automatically extends, w/o further application or
exchange certification or SEC order, to unauthorized or unissued additional securities of the same class upon
issuance.
i. However, the exchange may require, as part of their own listing standards, the issuer to notify them of how
many securities have been issued or to file documents with the exchange. See Rule 12d1-1.
d. §12(d), Effective date: 30 days after the certification by the Exchange.
i. On the effective date, the issuer is subject to proxy rules, tender offer rules, and insider trading rules.
ii. Rule 12d1-2, Acceleration: Written requests shall be made to SEC either by the exchange or registrant, or
both.
e. §3(a)(12), Exempted security:
i. Governmental security
ii. Municipal security
iii. Securities issued by any interest or participation in any common trust fund
iv. §3(a)(12)(A)(vii), SEC exemption: Other securities as SEC may, by such rules & regulations, exempt.
1. Rule 3a12-11: Debt security registered pursuant to §12(b) shall be exempt from proxy rules
(§14(a)-(c)).
a. Debt security: Anything that is not an equity security as defined in §3(a)(11).
b. §3(a)(11), Equity security: Any stock or similar security, or any security convertible, w/
or w/o consideration, into such a security.
f. §12(h), Exempt by the SEC
i. By rule or order, the SEC can grant exemption for any class of security
Jurisdictional base: securities traded on Exchanges and interstate commerce
Delisting: deregulation from §12(b) may be voluntary or involuntary. Generally, harder to get out than to get in.
a. §12(d), voluntary delisting: A security may be withdrawn or stricken from listing and registration in accordance w/
the rules of the Exchange or such rules that the SEC establishes. See Rule 12d2-2.
i. Upon application to the SEC by the Exchange: Form 25  SEC may hold hearing.
ii. Upon application by the issuer: Form 25
1. SEC publishes application in Federal Registry and requires:
a. Vote by a majority of shareholders; AND
b. Vote by a majority of per capita vote (per head)
2. Rationale: Necessary to protect innocent security holders
iii. Effect of voluntary withdrawal: Duty to file is immediately suspended.
1. However, the issuer may become §12(g) or §15(d) reporting company.
b. §12(j), Involuntary Termination/ Suspension (up to 12 months)
i. Applies under 12(b) or 12(g).
ii. After a notice and hearing to either:
1. Deny or to suspend for a period not exceeding 12 months; or
2. Revoke the registration.
iii. If revoked, the issuer has to reregister. In the mean time, there could be no trading of the securities.
1. Loss says that the remedy is draconian because it punishes innocent security holders.
Termination results in inability to trade securities altogether. (NOTE: quotable quote #1, 11/5/04)
2. Broker-dealers cannot trade the security. Thus, the effect is as if the shareholders hold RS.
iv. §15(c)(4), Compliance order: May be used against any person subject to §§12-14 and §15(d), but not §16
(directors, officers, and principal shareholders)
1. After notice and hearing, the SEC can enforce compliance regarding past violations
2. The sanction of delisting for failure to comply with the provisions of the act has been imposed only
infrequently by the Commission because delisting would have the effect of relieving the issuer of
71
5.
6.
the duty of complying with the disclosure provisions of the act and would deprive investors of an
exchange market for the trading of their securities.
v. §21C, Cease and desist order: Pertains to potential future violations. (In 33 Act, this is covered in § 8A)
1. After notice and hearing, the order can be used against any person subject to §§12-14 and
§15(d). If you disobey, can get an injunction.
c. Rule 12g-2, Effect of Delisting: If a class of equity security is delisted from the exchange, it is deemed to be
registered under §12(g) if securities of the class are not exempt from registration under §12(g) and all securities of
such class are held of record by 300 or more persons. Only way out is if you aren’t regulated under § 12 or you have
less than 300 shareholders.
Suspension of trading for §12(b)
a. Rule 12d2-1, Trading Halts by Exchange: Exchange can temporarily suspend trading any security.
i. Exchange must promptly notify SEC of effective date of suspension & of restoration of trading, & reasons for
suspension.
ii. Such suspensions may continue until such point it appears to the SEC that the Exchange is using this
temporary suspension to evade more demanding §12(d) authorized suspension.
iii. During the suspension, Exchange shall notify SEC promptly in any change in reasons for suspension.
1. No termination is possible through this mechanism.
2. Most Exchanges have several trading halts / day (lasts 30 mins). Issuer may also req trading halts
b. §12(j), Suspension of registration by SEC: SEC can suspend registration for period not exceeding 12 months.
During the registration suspension, the trading is also suspended.
i. Notice and hearing required.
c. §12(k), Suspension of trading by SEC (Quotable quote #2 of the day, 11/5/04) (emergency suspension power)
i. §12(k)(1)(A), Summary suspension of trading: SEC can summarily suspend trading in any security (other
than exempt security) for period not exceeding 10 biz days.
1. Notice or hearing not req’d.
2. Consecutive suspension order by the SEC for the same company for the same reason
a. Pendente lite power: During litigation w/r/t §12(j), the SEC used §12(k).
b. SEC v. Sloan (U.S. 1978)—The Court held that it was illegal.
3. Under 12(J), you get a notice and hearing, but in 12(k), they don’t have to give you a hearing or
notice, but the benefit is that you can only be suspended for 10 days. The problem came when
the SEC kept tacking on 10 days after another. SEC didn’t get away with that. SEC v. Sloan.
(The company that got the horrible treatment was Canadian Javelin). SEC said if you want to do
consecutive suspensions, you need a new reason each time.
ii. §12(k)(1)(B), Summary suspending of all trading: In case of a national emergency, SEC can summarily
suspend trading of every security (other than exempt security) for period not exceeding 90 calendar
days.
1. Must notify President, but the President cannot disapprove.
9 National Securities Exchanges: American (this is now a sub of NASDAQ), Boston, Chicago, Chicago Board Options,
Cincinnati (recently changed name to National Stock Exchange), International Securities, New York, Pacific, and
Philadelphia(oldest--1790)
a. NSEs must be registered under §6: Self Regulatory Organization (SROs)
i. SROs: They have their own rules. Subject to SEC oversight. Their rules must be approved by the SEC.
ii. Listing criteria depending the Exchanges
1. Number of public security
2. Demonstration of earning power
3. Aggregate market value
4. Float
iii. NSE: auction markets
1. Brokers—place orders for sellers & buyers w/specialist, who matches orders. Sometimes, floor
specialist acts a sub-broker– title passes between seller and buyer. But sometimes will act as
dealer and buy / sell as principal. Bid price is buy price and ask price. Under Rule 144, a
specialist is referred to as a market maker. The reason we need this economic lubricant is that in
all markets buyers / sellers do not arrive at = time – timing differences. Each co has several
market markers – publish bid and ask quotes (price at which they are willing to buy and price at
which they are willing to sell). Transaction with market makers qualify as manner of sale req. In
OTC, you go to dealer to buy security, if he is not market maker then has to find market maker to
acquire security.
72
2.
7.
Floor specialist (act as broker, dealer, and auctioneer—monitors the auction). Floor specialist
companies are monopolists b/c they are the only ones serving the function for that particular listed
company. (i.e. Ernst is a floor specialist for Exxon).
a. As an auctioneer, specialist establishes bid and ask prices.
3. Two types of orders:
a. Limit orders: I’ll sell/buy only when the price reaches a certain level.
b. Market orders: I’ll sell/buy at market price
b. Exempted stock exchange: Arizona
c. Securities can be traded on multiple exchanges so long as the rules permit. A question arises in whether you can be
traded on NSEs and OTCs. It has flip-flopped over the years, but now you can do it.
Exemptions
a. Under 12(b), the only exemption is § 3(a)(12)
§12(g), Registration of Big Companies traded in OTC
Class of equity (DEBT need not be registered) held of record by 500 shareholders (for just that class of stock) and issuer has total
assets exceeding $10M (originally asset test = $1M but rule 12g-1 raised volume to $10M)
Of all registered companies, about 2/3 are 12(g) and 1/3 are 12(b).
Some companies want to “try for the cliff’s edge” by buying back securities from shareholders to avoid hitting 500.
OTC market is regulated by NASD (located in DC). NASD and other NSEs are all SROs. Each SRO must register under 15(a).
§12(g)(1)(A), Phasing-in provision: Held of record by 750 shareholders and issuer has total assets exceeding $1M
a. Phasing in the statute for the first two years. So they did the big companies first (i.e. more than 750 shareholders),
and 2 years later, they did the companies with 500-750 shareholders.
5. §12(g)(1)(B), Voluntary Registration: Allows voluntary registration if the issuer is at cliff’s edge
a. In case of proxy battles and tender offers, nonmanagement would be subject to proxy rules and tender offer rules if a
class of security is registered under §12(g).
6. §12(g)(2)(A): Any security listed in Exchange and registered under §12(b) is exempt from §12(g).
a. If a co w/ requisite size w/ common stock listed, unauthorized or unissued another class of stock unlisted by co held of
record by 500 or more shareholders must be registered under §12(g).
7. Registration: Use Form 10.
a. Filing: w/I 120 days after end of the fiscal year. Even if the security is held by fewer than 500 shareholders during the
120 days, the company must still register.
b. Application to the whole class: Registration, once effective, automatically extends, w/o further application or
exchange certification or SEC order, to additional securities of the same class upon issuance.
c. Effective date: 60 days after filing w/ SEC.
i. Until the effective date, it shall not be deemed filed for the purpose of §18.
d. Convertible debenture: May have to be registered under §12(g).
i. Considered an equity security under §3(a)(11). Thus, it must be registered under §12(g) as long as it is held
of record by 500 or more persons and the issuer has total assets > $10M.
1. Exchange preferred: Preferred stock that can be exchanged into debt.
e. §3(a)(12), Exempted security, see supra, p. 64.
f. §12(h), Exempt by the SEC, see supra, p. 64.
i. Rule12g3-2: ADRs are exempt from §12(g).
8. Interplay b/w §12(b) and §12(g): If an issuer (having more than $10M in total assets) that wants to list its common stock on an
exchange and that must register its preferred stock because it has 500 holders, it may use one Form 10 for both the §12(b)
registration of the common stock and the §12(g) registration of the preferred stock.
a. Although there is no timing concern w/r/t §12(b), the timing must be right w/r/t §12(g).
i. §12(g): Must register w/I 120 days after the end of the fiscal year that meets the requirement
9. Jurisdictional base: A company that is engaged in interstate commerce broader than SA.
10. Suspension/Termination  going private (but harder to get out than to get in)
a. §12(g), voluntary withdrawal filed any time during fiscal yr
i. §12(g)(4), Statutory Test:: Registration shall be terminated 90 days after issuer files certification w/ SEC on
Form 15 certifying:
1. # of shareholders of record for such class of securities is < 300
a. As long as # does not go back up to 500 on last day of fiscal yr, the termination is ok.
ii. Rule 12g-4, Regulatory Test: Issuer must file certification w/ SEC on Form 15 certifying:
1. # of shareholders of record for such class of securities is < 300; OR
1.
2.
3.
4.
73
2.
b.
c.
Such class of security is held by < 500 shareholders of record any day during the year, and total
assets of the issuer > $10M on last day of each of last 3 fiscal yrs (can’t use it for the two
succeeding years after the registration became effective).
a. In Oct. 2003, must go back to years 2000, 2001, and 2002.
b. May be filed at any time during the fiscal year.
iii. Rule 12g5-1, Holders of Record for purposes of §12(g) and §15(d)
1. Securities shall be deemed to be “held of record” by each person who is identified as the owner of
such security on records of security holders maintained by issuer.
a. Securities identified as held of record by a corporation, a partnership, a trust, or
other organization, is included as one person.
i. Stock held in street name by brokerage firm for 50 customers is deemed to
held of record by 1 person.
b. Securities held by 2+ persons, as co-owners, is included as held by one person
c. Each outstanding unregistered or bearer certificate is deemed as held by a
separate individual, except to extent that issuer can establish otherwise.
i. Under §15(d), certification reqs showing # of bondholders. When you are
trying to get out of 15(d), you need to be able to count holders incl
debtholders. So it doesn’t matter to get in to 15d, but it matters when you are
trying to get out.
ii. NOTE: “unregistered” has a different meaning here, meaning not registered
in someone’s name.
iii. Ex. 50 bearer bonds are treated as held by 50 shareholders, but NOTE:
Stock held in street name by a brokerage firm for 50 customers is
treated as held of record by ONE person.
iv. Rule 12g5-2, Total Assets defined as total assets as shown on the issuer’s B/S or the B/S of the issuer
and its subsidiaries consolidated, whichever is larger.
1. In case of a parent-sub situation, if Parent has $100K total asset, Sub is wholly owned by the
Parent, and the Sub’s total asset is $1K has no liability, and Sub lends all its assets to the parent,
a. P’s corporate B/S: $101K (100K + Loan of 1K)
b. Consolidated B/S: $100K
i. Parent B/S: $101K (Plus sub)
ii. Sub B/S: $ 1K (still has 1K b/c it is a receivable)
iii. Deduct: 1K (P’s investment in Sub)
1K (Payable/Receivable)
1. Total: $100K
v. Rule 12g-4(b), Effect: Issuer’s duty to file any reports req’d under §13(a) shall be suspended immediately
upon filing a certification on Form 15, provided:
1. If certification is withdrawn or denied, issuer shall, w/I 60 days, file w/ SEC all reports that would
have been req’d.
§12(j), Involuntary withdrawal by the SEC. See supra §12(j), p. 64-65.
1. §15(c)(4), Compliance order: See supra §15(c)(4), p. 65.
2. §21C, Cease and desist order: See supra §21C, p. 65.
If the issuer’s only class of securities outstanding is common stock, which year the company deregister from §12(g)?
Co can be public without
doing IPO due to use of
exempt offerings.
Year
1
Year
2
Year
3
Year
4
Year
5
$10M+ total assets
500 shareholders
$8M total assets
400 shareholders
$8M total assets
400 shareholders
$8M total assets
400 shareholders
$8M total assets
400 shareholders
Register §12(g) (at
close of fiscal year
1)
IPO (Register §5)
Deregister
12(g) (i.e.
didn’t work)
from
IPO
74
Year
6
Year
7
$8M total assets
400 shareholders
$8M total assets
400 shareholders
i. The company can deregister from §12(g) starting only from Year 5 under the regulatory test. (less than 500
shareholders any time in year and less than 10M assets over past 3 fiscal years)
ii. However, the company still has a reporting duty under §15(d) lying dormant from year 4.
1. Significance of getting out of 12(g): don’t have to comply with all the proxy, reporting, etc… rules.
2. NOTE: if you do an IPO, you automatically have a 15(d) requirement even if you are already
reporting under 12g and 12j. the 15d lies dormant and it pops up when you get out of 12g, so you
need to find a way out of 15(d).
3. To get out of the 15(d), it is basically the same test as getting out of 12(g), so even though 15d
crops up and haunts us, it looks like we would get out of it. But that is not the case b/c of Rule
12h-3(c), which limits the ability to get out of certification. Under the limits, we couldn’t avoid 15(d)
during the year of the IPO (year 4), and we couldn’t get out during the succeeding two years
(since we relied on part 2 of the test), which are Years 5 and 6. So the first year we could get out
is year 7, and that would work since the three prior years are less than 10M.
4. Even if the company deregister from §12(g), the company must report.
a. Rule 12h-3: Can’t get out the fiscal year of registration under SA and if the second test
applies not for two succeeding fiscal years. In this case, can get out in year 7.
b. If in year 8, there are 500 shareholders but only $8M, the company must report again.
i. §15(d) may come back and haunt you. Must do test every single year, no way
to get out permanently, must always do analysis!!!!!!!!!!!!
11. Suspension of Trading
a. Trading halts by NASD.
b. §12(k), Trading halts by the SEC. See supra §12(k), p. 65.
12. National Securities Association: NASD (only equity) registered under §15A
a. NASD is also a SRO and in charge of all OTC markets.
i. NASDAQ stock market: Dealer markets. Not an auction market. No floor.
1. Brokers; dealers; market-makers (similar to a floor specialist)
2. Some securities are traded in both NYSE and NASDAQ.
ii. Pink sheets/ OTC bulletin board
13. OTCs: Dealer Markets
a. Brokers
b. Dealers
i. Market Makers (a firm that holds itself out as being willing to buy and sell a certain company’s security on its
own account on a semi-continual basis). They serve the function of the floor specialist.
§15(d), Reporting of Companies Registered under SA
Class of debt or equity traded OTC (but not §12(g)—not big enough) if the class was registered under SA(33 Act). No requirement
to register under 34 Act, but still have to file periodic reports. Unlike 12(b) and 12(g), these co’s do not register with SEC but they
have the same disclosure requirements. If co has 12(b) or 12(g) equity, proxy rules, the tender offer provisions, and 16 insider
trading provisions apply. National Securities Exchanges must register under 6. There could be more than one national
securities association but only one as of now with monopoly. Exchanges are called auction markets and over the counter
called dealer market. On an exchange securities firm trade as brokers – most transactions are accomplished using brokers
but the floor specialist (one per co) is a dealer / principal. IN OTC market, this is market maker (economic lubricant).
1.
Why do we need §15(d)?: Most companies that do a public offering under the SA will become a §12(b) or §12(g) company, but
a. §15(d) covers companies that is not covered by §12(g) or §12(b) b/c of a time lag b/w registration under SA and the
time the reporting requirement arises under §12(g) or §12(b).
b. §15(d) also covers companies that are getting out of §12(g) or §12(b): If the company becomes deregistered, it would
still need to file reports under §15(d).
i. CAVEAT!: §15(d) lies dormant. Once the company is subject to §15(d) requirement, in every year after
such requirement, the company must check whether it qualifies so that it does not have to file reports under
§15(d).
b. Tyson calls the movement from 15(d) to 12(g) to 12(b) the American Dream. You start off small, then become bigger
to be a 15(d), then even bigger to become 12(g), etc… 15(d) is needed to cover the time between 15(d) and 12(g).
75
2.
3.
4.
5.
6.
No Registration required
a. Effective date: Reporting required on the effective date of SA registration
b. Exemption
i. Exemption under SA: If the issuer is exempt under SA, the issuer is also exempt from §15(d) reporting
requirement.
ii. Registration under §12(b) or §12(g): The duty to file shall be automatically suspended if and so long as any
issue of securities of each issuer is registered pursuant to §12 of the Act.
1. §15(d) reporting requirement, unlike §12(b) or §12(g), is a company requirement rather than a
security requirement. So long as one security of the company is registered under the EA, the
company does not have a §15(d) duty.
2. CAVEAT!: §15(d) lies dormant, and it can come back and haunt the issuer at any moment.
a. Even if a company gets deregistered under §12(b) or §12(g), the company may still
have a reporting duty under §15(d).
b. Once a company is subject to §15(d) duty, it always lies dormant.
i. Each year, the company must check whether it is suspended from the
reporting requirement unless the requirement is terminated.
iii. §12(h), Exemption by the SEC, see supra, p. 64.
1. Rule 12h-4: An issuer shall be exempt from §15(d) duty to file reports requirement by §13(a) w/r/t/
securities registered under SA on Form F-7, F-8, or F-80, provided that the issuer is exempt from
§12(g) obligation.
Jurisdictional base: Piggybacks SA’s jurisdictional base.
Suspension/Termination of reporting requirement
a. §15(d), Automatic suspension: Automatic suspension occurs in any fiscal year except the fiscal year that the
registration statement was declared effective.
i. If at the beginning of the fiscal year, the securities of each class to which the registration statement relates
are held of record by fewer than 300 shareholders.
1. Rule 15d-6, Notification to the SEC: If suspension is applicable, the issuer must w/I 30 days of
the first day of the fiscal year file a notice on Form 15 informing the SEC.
2. Therefore, every company that has a registered offering under SA must spend 1 year as a
reporting company.
3. Rule, not statute, requires notification.
b. Rule 12h-3, By certification: An issuer may obtain suspension by certification at any time during a fiscal year if:
i. The securities are held of record by fewer than 300 persons at any time during year; OR
ii. The securities are held of record by fewer than 500 persons at any time during year AND the total assets of
the issuer’s total assets have not exceeded $10M on the last day of each of 3 most recent fiscal years.
1. Rule 12h-3(c), Limitation
a. Suspension by certification is not available for the fiscal year during which the
registration statement became effective.
b. Under the second test of Rule 12h-3, suspension by certification is not available for the
next two fiscal years after the registration statement became effective.
2. CAVEAT!: If the issuer fails to meet the test in any year in the future, it becomes subject to the
reporting requirement under §15(d). Thus, the issuer must recheck availability of the suspension
every year. Tyson refers to this as the dormant clause.
c. No involuntary suspension or termination. §12(j) does not apply.
i. §15(c)(4), Compliance order, see supra p. 65.
ii. §21C, Cease and desist order, see supra p. 65.
Suspension of Trading, see supra p. 65.
Summary Table
Critieria used by national securities exchange for permitting a security to be listed and registered for trading:
 Publicly held shares
 Earnings power
 Market value
Securities Covered
12(b)
Debt or equity listed on an
exchange
12(g)
Equity. Large companies
(500 shareholders + 10M
Assets)
15(d)
Debt or equity registered
under 33 Act.
76
Jurisdictional Base
Registration
Effective Date
(Important because triggers
proxy and insider trading
rules.)
Exemptions
Periodic Reports (§ 13(a))
Suspensions/Terminations
Suspensions of Trading
Securities traded on
exchange or interstate
commerce
One document filed with
exchange and SEC (double
duty): Form 10. NOTE: no
prospectus portion, not sent
out to shareholders. Can
also use Form 8-A for debt
securities or for companies
that were 15(d) companies
that become 12(b) or 12(g).
12(d). Since Proxy rules,
tender rules, and insider
trading rules apply, this date
is important. Effective date is
30 days after certification by
exchange
§ 3(a)(12) defines “exempted
security” as including govt
securities, or sec’s that SEC
exempts by rule pursuant to
rulemaking power—i.e. See
Rule 3(a)(12)(vii), See Rule
3a12-11
Form 10-K (Annual
Report…different from
Annual Report to
Shareholders), Form 10-Q
(Quarterly Report), Form 8-K
(Current Report)
Voluntary: Form 25—§
12(d), Rule 12d2-2. (Per
Exchange Rules, Upon
Application to SEC by
Exchange, OR Upon
application to SEC by
Issuer(but this is hard-usually
requires per capita or majority
vote)). Involuntary
Termination or Suspension
(up to 12 months): 12(j)
Trading halt by Exchange:
12d2-1; 12(j); 12(k): SEC v.
Sloan
Note that the shareholder and
asset tests are done on the
last day of the fiscal year.
Company must be engaged
in interstate commerce or
securities traded by mails or
IC (broader than the 33 Act)
Form 10 used again. Form
10 must be filed within 120
days after the end of the
fiscal year in which
shareholder/asset test is met.
Piggybacks the jurisdictional
base used in filing the
registration statement under
the 33 Act.
No registration (or effective
date of registration) under
15(d).
12(g)(1). 60 days after filing
N/A. Effective date is same
as E.D. of 33 Act registration;
no real effective date because
there is no registration
§ 3(a)(12); 12(g)(2)
(securities issued by
insurance companies,
investment companies, etc…
are exempt); 12(b) securities;
12(h) gives exemptive power
by rule or order;
Form 10-K (Annual
Report…different from
Annual Report to
Shareholders), Form 10-Q
(Quarterly Report), Form 8-K
(Current Report)
Voluntary: Form 15—§
12(g)(4), Rule 12g-4.
(Statutory test—you can get
out if at any point, you have
fewer than 300 shareholders;
Regulatory test—see study
guide (h)). Involuntary
Termination or Suspension
(up to 12 months): 12(j)
§ 12(h)
Trading Halts by NASD; 12(j);
12(k)
Form 10-K (Annual
Report…different from Annual
Report to Shareholders),
Form 10-Q (Quarterly
Report), Form 8-K (Current
Report)
Suspension of Duty to File
Reports. Voluntary: Form
15 (statutory test: § 15(d)—
automatic suspension; Rule
15d-6…regulatory: 12h-3
Trading Halts by NASD; 12(k)
C. Civil Liability for Misleading Statement
1. §18, Civil Liability for Misleading Statement: Any false or misleading report that is filed is subject to §18 civil liability. If an
issuer files a misleading Form 10 or Form 10-K, an investor who purchased or sold securities of the issuer after the filing of the
report can sue the issuer. Bill says that it is poorly drafted and that nobody knows what it really means.
a. This is an attenuated version of § 11 of the 33 Act (not as severe as Section 11; not plaintiff friendly)
b. Express liability, not implied.
77
c.
d.
e.
f.
g.
h.
i.
j.
k.
l.
General scope: Any statement made in any application, report or document report filed under EA which was false or
misleading w/r/t a material fact at the time and in the light of the circumstances under which it was made. Doesn’t
only apply to § 12 and § 13 documents, but rather all documents filed.
i. If the document is only submitted but not filed w/ the SEC, it is not subject to §18.
Courts: Only in federal jurisdiction. Exclusive jurisdiction (you don’t have a choice)
Π: A person who has either bought or sold the security w/ reliance.
Δ: Any person who shall make or cause to be made such false or misleading statement that has to have been filed
under proxy, tender offer, insider trading rules. Accountants can be sued. Key word is filed; that is why throughout the
rest of course we will pay attention to documents that are filed or not filed.
i. Privity of contract not required
Culpability: Δ has the burden of proof to show that he had no knowledge and acted in good faith
i. Negligence not sufficient: Scienter is required, but the burden is on Δ.
ii. Δ must show that he did not know that such statement was false or misleading
Materiality: Must be material
Reliance: Π must show reliance AND show that he did not know that it was misleading. (different from §11) (similar to
12(a)(2)) Must show actual reliance unlike section 11.
Loss Causation: Π must show that the price was affected by such misleading document filed. (this is what makes it
so difficult to win under § 18) No comparative causation with reverse twist (P must show loss causation unlike 11)
Remedies: Damages
i. Contribution: Every person who becomes liable to make a payment may recover contribution as in cases
of contract from any person, who if joined in the original suit, would have been liable to make the same
payment.
18(c). Statute of Limitation: Double barrel S/L. §804 of Sarbanes-Oxley Act may trump (Tyson does not believe so)
i. 1 years after the discovery of the facts constituting the violation; or
ii. 3 years after such violation.
78
TOPIC 7—PROXY RULES
A. Proxies
1. The costs of proxy solicitation
a. Rosenfeld v. Fairchild Engine & Airplane Corp. (NY 1954)
i. Incumbent BOD can use corporate funds as long as proxy solicitation is related to policy disputes BUT not
for self-entrenchment / self-perpetuation.
ii. Successful insurgents can also get reimbursement from the corporation (law is not clear on this but
tends to suggest yes). If you pay for professional solicitors, answer is unclear, but in real life co pays for it.
iii. Company can also pay for costs of proxy solicitors
2. Rule 14a-2, Exemptions
a. Rule 3a12-11, Debt security: Debt equity registered pursuant to §12(b) is exempt from §14(a) w/ a few exceptions
(traded on exchange, OTC are not registered)
i. Still subject to antifraud rules under Rule 14a-9.
3. Jurisdictional base: Use of mail, interstate commerce, any facility of NSE, or otherwise.
a. “Otherwise”: probably broad enough to cover ordinary face-to-face, word-of-mouth solicitation. These rules only
apply to securities under 12(b) & 12(g), so the jurisdictional base comes from that.
4. Waiting period for proxy rules: 10 calendar days.
a. Recall Form S-4 (wraparound prospectus) had problems w/ different waiting period for proxy and prospectus.
5. Proxy statement delivery requirement: Proxy statement must precede or accompany solicitation of proxy.
B. Mechanics of Proxy Rules
1. §14(a), Proxy: Unlawful to solicit proxies, consents, or authorizations w/r/t registered securities in contravention of SEC rules.
a. Rationale: State laws do not provide enough protection. Fraud occurred frequently in connection w/ proxy solicitation.
Mainly disclosure oriented.
b. Statutory trilogy of “proxy”: refers to the three items below
i. Proxy: vote (you vote when you are a shareholder of stock)
ii. Consent: written consent in lieu of meeting under DE law
1. i.e., debt holders consent to amendment (debtholders don’t vote, but when they do have a voice, it
is consenting or authorizing)
iii. Authorization: i.e., reclassification authorized.
c. Note: the distinctions between proxies, consents, and authorizations is no longer as important b/c the SEC exempted
debt securities solicited on an exchange from the proxy rules in Rule 3a12-11.
d. Rule 14a-1(f), Proxy: Every proxy, consent or authorization w/I the meaning of §14(a) of EA. The consent or
authorization may take the form of failure to object or to dissent.
e. Congress copped out here and gave all the rulemaking power to the SEC. Similar to 3(b) cop out in 33 Act.
2.
Rule 14a-1(l), Solicitation: (defined broadly)
a. Any request for a proxy whether or not accompanied by or included in a form of proxy;
b. Any request to execute or not to execute, or to revoke, a proxy; or
c. The furnishing of a form of proxy or other communication to security holders under circumstances reasonably
calculated to result in the procurement, withholding, or revocation of a proxy.
i. Very broad: A newspaper editorial constitutes the solicitation of a proxy as a continuous plan calculated to
result in the procurement of a proxy. Now the SEC added exceptions.
d. Exceptions
i. Furnishing of a form of proxy to a security holder upon the unsolicited request of such security holder;
1. i.e., Securities firm that is the record holder (b/c it holds securities in street name for a customer
who is the beneficial owner) transmitting proxy materials to the customer w/ a request for
instructions how to vote. Certainly if the publisher had some sort of biz relationship or interest in
co, yes could definitely be considered solicitation.
ii. The performance by the registrant of acts required by Rule 14a-7
iii. The performance by any person of ministerial acts on behalf of a person soliciting a proxy
iv. Rule 14a-1(l)(2)(iv). A communication by a security holder who does not otherwise engage in a proxy
solicitation (other than solicitation exempt under Rule 14a-2) stating how the security holder intends to
vote and the reasons therefore, provided that the communication:
79
1.
2.
3.
3.
Is made by means of speeches in public forums, press releases, published or broadcast opinions,
statements, or advertisements appearing in a broadcast media, or newspaper, magazine or other
bona fide publication disseminated on a regular basis;
a. The security holder can even be an officer or director of the registrant as long as it does
not otherwise engage in solicitation
Is directed to persons to whom the security holder owes a fiduciary duty in connection w/ the
voting of a registrant held by the security holder; OR
Is made in response to unsolicited requests for additional information w/r/t a prior
communication by the security holder made pursuant to this paragraph.
Rule 14a-2, Exempted Solicitations
a. Rule 14a-2(a)(1)-(6) Full Exemptions: Rules 14a-3 to 14a-15 do not apply
i. Solicitation by the record holder (other than a voting trustee) to the beneficial holder
1. If the record holder is the beneficial holder, the registrant may not vote the proxy unless the proxy
is signed and sent.
2. If the record holder is not the beneficial holder, the record holder can vote and sign if no response
was given by the beneficial holder.
ii. Solicitation by the beneficial holder
1. Customer (the beneficial owner) requests a proxy from securities firm that is the record holder b/c
it holds the securities in street name for the customer.
2. A buyer after the record date asks the record holder (seller) to send the proxy materials.
a. CAVEAT!: The record holder cannot vote once the buyer gets the proxy materials
since it is irrevocable proxy b/c it is coupled w/ interest
iii. Solicitation involved in the offer or sale of securities registered under the SA other than a Rule 145
transaction: Only applies to voting trust.
1. Voting trust: voting device to pool security holders’ voting rights. Unlike a polling arrangement, the
trustees of the voting trust, not individual security holders, decide how to vote.
a. The voting trust shares (not the underlying share) must be registered under SA for
distribution. If the underlying share is registered under §12, normally the voting trust
would be required to comply w/ §14, but under this provision, it is exempt.
iv. Solicitation w/r/t a plan of reorganization under Chapter 11
1. Rationale: Chapter 11 provides adequate protection for investors.
v. Solicitation which is subject to Rule 62 under the Public Utility Holding Co. Act of 1935
1. Rationale: PUHA provides adequate protection for investors.
vi. Solicitation by way of a tombstone ad through the medium of a newspaper advertisement
1. A solicitation that does no more than state:
a. Where to obtain proxy materials
b. Who is the registrant
c. The reasons for the advertisement
d. Identify the proposal to act on
e. The notice of a meeting when there is a merger or Rule 145 transactions
2. i.e., a newspaper ad by the insurgent group stating where they can get the proxy statement.
b. Rule 14a-2(b)(1)-(4) Partial Exemptions: Rules 14a-6(g) & (n), 14a-7, and 14a-9 do apply. Applies only when the
exemptions under Rule 14a-2(a) are not applicable.
i. 14a-2(b)(1): Solicitation by certain eligible persons who are not seeking proxy authority, do not
furnish or request a form of revocation, abstention, consent, or authorization, and do not have a
substantial interest in the subject matter of the solicitation (other than shareholder or employee)
1. Rule 14a-2(b), Eligible person: The eligible person cannot be (i.e. these people are presumed
to have a substantial interest)—
a. The registrant or an affiliate of the registrant
b. An officer or director of the registrant, if financed by registrant
c. Nominees
d. Any person soliciting in opposition to a merger, or other extraordinary transaction
e. Any person required to report beneficial ownership of the registrant’s equity securities
on a Schedule 13D who seeks control
f. Any person who is acting on behalf of one of the above
2. i.e., an employee of the registrant solicits large shareholders
80
3.
ii.
iii.
iv.
v.
4.
CAVEAT!: If you use Rule 14a-2(b)(1) exemption, you must maintain your exempt status
throughout the proxy period.
4. Rule 14a-6(g), Notice of exempt solicitation: Shareholder owning more than $5M of the
securities subject to the solicitation must, w/I 3 days after the written solicitation was first sent,
furnish the SEC the notice of exempt solicitation to which shall be attached all written soliciting
material and furnish the notice to each NSE in which any security of the registrant is listed and
registered.
a. However, oral solicitation and public solicitation are exempt. So it only applies to
regular written solicitations.
b. Rationale: When such a (probably institutional) shareholder uses a written solicitation,
the management can have notice of such solicitation and defend itself. It’s a sort of
compromise
c. So even though you are exempted from proxy rules, must file notice of exempt
solicitation with SEC and the exchange.
Nonmanagement solicitation to not more than 10 persons
1. If you solicited 10 persons under this exemption, you can solicit the same 10 persons again during
the proxy period under this exemption.
2. Each nonmanagement group may use this exemption: not cumulative.
a. Bill says this is similar to the preliminary negotiations under §2(a)(3) of SA.
The furnishing of proxy voting advice by a financial advisor to a client
1. Even if the financial advisor has a substantial interest in the subject matter of the solicitation, the
exemption can apply as long as it is disclosed and the advice is not given on behalf of any person
soliciting proxies or a participant in an election.
Preliminary roll-up communication by security holder
1. A holder of security that is subject to a proposed roll-up transaction who engage in preliminary
discussions w/ other shareholders that are subject to the same roll-up, for purposes of
determining whether to solicit proxies in opposition can use this exemption provided:
a. The security holder may not be an affiliate of the registrant or the general partner
b. The exception does not apply to holders of 5% or more, who is in the business of buying
and selling limited partnership interest in the secondary market unless disclosure is
made to other security holders.
2. Roll-up transaction, see infra p. 74.
3. Rationale: Bill says this exemption prevents the general partner from taking unfair advantage of
the limited partners in the roll-up transactions.
4. Rule 14a-6(n), Notice of Exempt Preliminary Roll-up Communication: Shareholder-dealer
owning 5% of the securities subject to the proposed roll-up and engaging in the business of
buying and selling limited partnership interest in the secondary market must file the notice w/ the
SEC.
a. Allows all (regardless of the ownership amount) limited partners to discuss the
contemplated roll-up.
New! Publication or distribution by a broker or a dealer of a research report in accordance with Rule 138 or
Rule 139 during a transaction in which the broker or dealer or its affiliate participates or acts in an advisory
role.
Regulation 14A: Rules 14a-1 to 14a-15.
a. Rule 14a-3(a), Publicly-filed preliminary or definitive written proxy statement: No solicitation subject to this
regulation shall be made unless each person solicited is concurrently furnished or has previously been
furnished w/ a publicly-filed preliminary or definitive written proxy statement containing the information specified
in Schedule 14A or w/ a preliminary or definitive written proxy statement in a registration statement on Form S-4.
i. Centerpiece of proxy rules. (§ 5 : 33 Act :: 14a-3: 14A)
1. This centerpiece concept has been fundamentally changed with Rule 14a-12
ii. Rule 14a-3(f), Exemption (this IS a solicitation, but there are no proxy delivery requirements)
1. If communication is made by means of speeches in public forums, press releases, published or
broadcast opinions, statements, or advertisements appearing in a broadcast media, newspaper,
magazine or other bona fide publication disseminated on a regular basis, the requirements of Rule
14a-3(a) do not apply if:
a. No form of proxy, consent, or authorization or means to execute such is provided to
security holders; and
81
b.
b.
c.
At the time of such communication, a definitive proxy statement is prepared and filed w/
the SEC pursuant to Rule 14a-6(b). (doesn’t say whose proxy statement must be filed,
but it must be YOURS, not the other side)
2. Prior to 1992, if you gave a speech in the park or went on tv, etc…, that was a solicitation to every
shareholder meaning a written proxy statement had to be sent to each shareholder before doing
that. Since this chilled communications, SEC adopted 14a-3(f), allowing you to do the speech,
broadcast, etc.. as long as you meet the above conditions.
3. This is different from 14a-12, b/c here, you prepared the proxy statement and filed it, but you cant
afford to send it to everyone but you want to communicate with all shareholders. In 14a-12, it is
usually very early on, and you likely haven’t prepared proxy statement yet. They both deal with
situations where you might have insurgent shareholders.
iii. Rule 14a-4(f), Delivery of Definite Proxy Statement prior to a delivery of proxy form
1. No person conducting solicitation subject to this regulation shall deliver a form of proxy,
consent, or authorization to any security holder unless the security holder concurrently
receives or has previously received a definitive written proxy statement that has been filed
w/, or mailed for filing to, the SEC.
iv. Rule 14a-3(b), Delivery of annual report
1. If the solicitation is made on behalf of the registrant … and relates to an annual meeting of
security holders or written in consent in lieu of such meeting at which directors are to be elected
… each proxy statement furnished pursuant to §14a-3(a) shall be accompanied or preceded
by an “annual report to shareholders.”
a. If Co uses picture report, it is not subject to §18 liability. Not filed w/ SEC (only
submitted). If shareholder later requests, Co must also furnish full annual report (10K).
i. Generally, Form 10K does not have to be sent to shareholders, but it is filed
with SEC (it’s a dull document, not the picture book (called annual report to
shareholders) that companies send to shareholders)
Rule 14a-12(a), Solicitation prior to filing or furnishing required proxy statement: Trumps Rule 14a-3 as long as
you meet reqs. (Tyson believes that after 14a-3, this is the most important provision; complements 14a-3) (you can
orally solicit and get around 14a-3) (similar to Rule 165)
i. Permits oral or written solicitations prior to filing or furnishing the required proxy statement. This allows
either side to move quickly.
ii. Requires
1. Identity of the participants in the solicitation; AND For participants, see below p. 88.
2. Description of their direct or indirect interests (i.e. number of shares); or
3. Prominent legend in clear, plain language advising security holders where they can obtain
that information; and
4. NOTE: Participants: people participating in the solicitation
5. Prominent legend in clear, plain language advising security holders to read the proxy statement
when it is available b/c it contains important information. The legend also must explain to investors
that they can get the proxy statement, and any other relevant documents, for free at the SEC’s
website and describe which documents are available free from the participants; AND
6. NOTE: Similar to Rule 165(b): Communication for business combination transactions.
7. A definitive proxy statement meeting the requirements of Rule 14a-3(a) is sent or given to
security holders solicited in reliance of this rule before or at the time as the forms of proxy,
consent or authorization are furnished to or requested from security holders. Tyson reads this
as saying that if you do use 14a-12, you need to do a full solicitation and send the proxy
statement eventually.
iii. Rule 14a-12(b), filing requirement: Any soliciting material published, sent or given to security holders
pursuant to Rule 14a-12(a) must be filed w/ the SEC no later than date the material is first published, sent or
given to security holders.
1. Copies must at the same time be filed w/ or mailed for filing to each NSE upon which any class of
securities of the registrant is listed and registered.
2. NOTE: significance of “filing” things under the 34 Act is that it exposes you to § 18 liability.
iv. 14a-12(c): relates to solicitations involving director contests. If management is opposing solicitation that
was started quickly under 14a-12, if you comment in your annual report about it, the annual report would
have to be filed with SEC (normally they don’t have to be filed)
Rule 14a-4, Form of proxy (notice that you have a preliminary and definitive forms of proxy)
i. Rule 14a-4(a), Requirements
82
1.
ii.
iii.
iv.
v.
Must indicate on whose behalf proxy is solicited
a. If the proxy is given by a majority of the board, it is management solicitation.
2. No bundled proxies: two different proposals must be separately indicated in the proxy form.
3. Blank for dating proxy.
a. Rule 14a-10, No undated or post-dated proxies: Proxies can be revoked by
completing another proxy at a later date.
4. Identify all matters to be acted on, indicating whether proposed by management or shareholders
a. Rule 14a-8, Shareholder proposal
i. CAVEAT!: The shareholder proposal cannot relate to the election of the
directors. If this was allowed, the management’s proxy statement would
provide information for all nominees, whether nominated by the management
or non-management.
5. Separate identification of each matter
Rule 14a-4(b)(1), Proposals
1. Boxes: Specify approval, disapproval, or abstention
a. Abstention may be required to form quorum.
2. Proxy may confer discretionary authority on proxy recipient if a choice is not specified and
proxy states how recipient intends to vote: If the proxy is signed and sent by the shareholder
w/o specifying a choice, the recipient may use the proxy.
a. If you return it signed and dated without checking anything, you give authority to
management (discretionary authority) i.e. “If no direction is made, this proxy will be
voted for Proposals 1, 2, and 3.” (see proxy handout)
b. SEC release: Management’s form of proxy may contain a statement that management
favors or opposes a proposal.
Rule 14a-4(b)(2), Election of directors
1. Names of nominees
2. May provide means to grant authority to vote as a group as long as you provide (MUST) the
means to withhold authority to vote for each nominees: Use boxes, striking out name, or blank
spaces to enter name (i.e. see 3 different sample forms)
a. Effect of withholding authority for one nominee: In general, if you are one of the highest
9 votes, you would be elected assuming that there are 9 seats. However, if there is a
proxy contest, withholding authority can generate mixed board.
i. You cannot sign proxies from the both sides.
Rule 14a-4(c), Discretionary authority
1. Proxy may confer discretionary authority on registrant (annual meeting) regarding a non-Rule
14a-8 shareholder proposal if:
a. For annual meeting, the registrant does not get prior notice (45 days)
b. The registrant receives a timely notice and includes the proposal in the registrant’s
proxy statement
i. CAVEAT!: Management cannot exercise discretionary voting authority if the
proponent of the proposal or the insurgent provides a separate proxy
statement w/ timely notice.
c. In the election of any person to any office for which a bona fide nominee is named in the
proxy statement and such nominee is unable to serve or for good cause will not
serve, can vote for a new nominee.
d. Approval of minutes of the prior meeting if it does not amount to ratification of action
e. Any proposal omitted pursuant to Rules 14a-8 and 14a-9
f. Matters incident to the meeting
Rule 14a-4(d), Limitation on Discretionary Authority
1. Proxy may not confer authority on proxy recipient to vote for election of any person to any office
for which a bona fide nominee is not named in the proxy statement.
a. A person shall not be deemed to be a bona fide nominee unless he has consented
to being named in that proxy statement and to serve if elected.
2. If the nonmanagement group wants to nominate directors, it cannot name any of the management
nominees as their nominees b/c consent is required by the nominees.
a. Nonmanagement Committee intends to use this form of proxy to vote for persons
nominated by management to serve as directors other than A, B, C. You may withhold
authority to vote for one or more additional management nominees by writing names
83
d.
e.
below. Refer to proxy statement distributed by management for names / qualifications of
management nominees. There is no assurance that management nominees will serve
as directors if any of non-management nominees are elected to the Board.
i. Bill supports a universal ballot. However, the issue raises the question of
federalism.
vi. Rule 14a-4(e), Voting Instructions: Proxy statement or form of proxy must provide that properly executed
proxies will be voted as directed.
1. Management can express opinions as to whether shareholders should vote for or against.
Rule 14a-3(f), General broadcast or publication of soliciting materials: Communication made by means of
speeches in public forums, press releases, published or broadcast opinions, statements, or advertisements
appearing in a broadcast media, newspaper, magazine or other bona fide publication disseminated on a
regular basis does not have to be preceded or accompanied by the proxy statement as long as:
i. No form of proxy, consent or authorization or means to execute the same is provided to a security holder
in connection w/ the communication; and
1. Note that press release under Rule 14a-3(f) does not have to have legend unlike press release
under Rule 14a-12(a). 14a-12 assumes you have not done proxy statement yet….14a-3(f)
assumes you have proxy statement but you cannot afford to send to everyone.
ii. At the time the communication is made, a definitive proxy statement is on file w/ the SEC under Rule
14a-6(b).
iii. Prior to implementation of this rule, had to proceed with proxy statement, everyone who heard general
broadcast, etc.
Rule 14a-6(a), Filing Preliminary Proxy Statement and Form of Proxy: Must be filed w/ the SEC 10 days prior to
date definitive copies will be used. Soliciting materials must also be filed.
i. Preliminary Proxy Statement: During the waiting period, it may be sent out w/ annual report or other
soliciting materials.
1. Revised preliminary proxy statement: Filing revised materials do not recommence the 10
day period unless revised material contain material revisions or materially new proposals
that constitute fundamental changes.
2. Wraparound prospectus Form S-4: 20 days waiting period for prospectus, but 10 days waiting
period for proxy.
a. Although under the proxy rules you can solicit proxies using the preliminary proxy
statement, when you use Form S-4, you cannot solicit at all during the 20 day waiting
period.
ii. Preliminary form of proxy: Cannot be sent out. Period. Full stop.
iii. Supplemental soliciting material: Can be used during the waiting period as long as a preliminary or
definitive proxy statement precedes or accompanies the materials. Supplementary and follow up are really
the same; all of these documents are filed so Section 18 liability attaches.
1. Contra Supplemental selling literature: Doesn’t have to be filed w/ the SEC.
2. Glossy annual report must be sent to the SEC, but it is not deemed to be filed w/ SEC for
purpose of civil liability unless it is supplemental soliciting material or comments on
opposition proposal.
iv. Rule 14a-6(e), Publicly available information
1. Generally, all copies of preliminary proxy statements and forms filed w/ SEC shall be deemed
immediately available for public inspection unless confidential treatment is obtained.
v. Rule 14a-6(b)(2), Confidential Treatment: Item 14 transaction (merger & acquisition) will be considered
confidential until the definitive proxy statement is filed w/ the SEC except when there is a going private or
a roll-up transaction.
1. Rule 13e-3 & Rule 145, Going private: Mouse acquiring an elephant. Can be used for squeezeout of minority shareholders or limited partners. Must be registered for §5 of SA.
2. Regulation S-K, Item 901(c), Roll-up: Going public by partnerships (generally LP). Must be
registered for §5 of SA b/c it is a Rule 145 transaction.
a. CAVEAT!: Generally, roll-ups are not covered by §12. However, if resulting company
(the corporate General Partner) is a §12 company, the proxy rules apply as if the
partnership itself was a §12 company b/c the resulting company will be covered by §12.
i. Bill thinks that the SEC does not have authority to do this.
b. i.e., a public corporate general partner purchases the assets of the LP in return of the
public corporation’s securities, subject to the vote of the limited partners.
84
3.
f.
g.
h.
Rationale: These mergers are not arm’s length transactions. The purchasers are the affiliates of
the corporation or the partnership. The transaction can be abused, so the minority shareholders
and limited partners are given junk bonds or debt securities.
Rule 14a-6(a), Exemption for plain vanilla proxy statement and form of proxy
i. If proxy statement by the registrant is sent out before the annual meeting (or special meeting instead of
the annual) and only addressing standard issues, preliminary proxy statement, preliminary form of
proxy, or other soliciting materials do not have to be filed w/ the SEC.
ii. Standard issues
1. Election of directors
2. Approval of accountant
3. Any shareholder proposals under 14a-8
iii. However, if the registrant comments upon or refers to a solicitation in opposition in connection w/ the
meeting in its proxy material, plain vanilla exemption does not apply.
Rule 14a-6(b), Filing of Definitive Proxy Statement and Form of Proxy: Must be filed w/ the SEC and Exchanges
at the time of first use. These documents must be sent to any NSE upon which ANY class of securities of the
registrant is listed. Other soliciting materials must also be filed.
i. Follow-up soliciting materials
1. Must be filed w/ SEC at the time of first use.
ii. Rule 14a-6(c), Personal solicitation materials
1. If the solicitation is to be made in whole or part by personal solicitation, the instructions material
given to the solicitor shall be filed w/ the SEC not later than the date any such material is first
given to such individuals.
a. If the material is not given or sent out to shareholders, Rule 14a-6(b) is not triggered by
such material. Thus, there is no need to send copies of the instructions to the NSE.
2. Can be sent out before the shareholders get the preliminary proxy statement.
Rule 14a-7, Obligations of Registrant in either mailing soliciting materials or providing the list
i. Requirements
1. The registrant must have solicited or intend to make a proxy solicitation; and
2. The person making the request must be record or beneficial holder of securities of the class
entitled to vote at the meeting. (NOTE: record holder: held in your name, like street name --beneficial owner: true shareholder)
ii. The registrant must decide w/I 5 days either mail the group’s proxy materials or provide a security
holder list of a category of shareholders designated by the group if the election is to be made by the
registrant under Rule 14a-7(b).
1. Partial solicitation is allowed, and the security holder can ask for a partial list of the security
holders. (Don’t have to send it to everyone—NOTE: management can also do a partial
solicitation to whomever they want)
2. The insurgent group bears the cost.
a. Management prefers mailing the proxy materials b/c it can see what the solicitation is
going to be about.
b. The insurgent prefer getting the shareholder lists.
3. If the registrant sends a shareholder list to the proponent, the proponent can use it only for
solicitation for the same meeting.
a. After the solicitation, the shareholder must return the list to the registrant.
4. If the registrant decides to send the shareholder list, it must also provide NOBO/COBO list (NonObjecting Beneficial Owner / Consenting Beneficial owner) list, which enables the solicitor to
personally solicit shareholders.
a. NOBO: Shareholders must object to revealing their identity.
b. Prior to 1985, it was called COBO (Consenting Beneficial Owners) list.
iii. Rule 14a-7(b)(1), Federal Access to the Shareholder List: If the transaction is either going private or
roll-up, the requesting security holder, not the registrant, has the option b/w mailing and getting the list.
(Quotable Quote, 11/16/04)
1. Generally, under the state law, the shareholders must show proper motive to obtain the
shareholder list.
2. If a shareholder wants to communicate with other shareholders, they can go to mgmt and tell
them, and then mgmt can either do it all for them or give them a list. More often, mgmt just does it
for them, b/c they don’t want to give away the list and then they can look at what is being sent out.
85
i.
Shareholders prefer to get the list so they can do some individual personal solicitation. You also
have to return the list when done.
3. Going private transactions: getting out once you are in. No longer going to be subject to § 12/15
reporting requirements. Merging the elephant into the mouse (big company merged into small
private company and old shareholders will get cash and debt instead of stock).
4. Roll-up transactions (Rule 145 transaction; sale of assets): Going public, but usually just involves
limited partnerships. Can be hostile or friendly. GP says “I want to roll up the partnership,”
meaning they will buy all assets of LP with corporate/GP stock and the LP dissolves into the
corporation/GP. The corporate GP is often the corporate GP of many LPs and they roll them all
up. These roll-ups present potential abuse problems. (NOTE: exemption under 14a-2(b)(4) for
preliminary roll-up communications: must be filed with SEC but not with exchange).
Rule 14a-8, Proposals of Security Holders: Q&A format.
i. Allows shareholders to put proposals on proxy statements (NOT for director elections)
ii. Eligibility of Shareholder Proponent: Shareholder must
1. Be a beneficial or record holder of securities entitled to vote on the matter at the meeting;
2. Hold at least 1% or $2,000 in market value of such voting securities of the registrant;
3. Have held them for at least 1 year at the time of the submission;
4. Continue to hold them, constituting the requirement % or the value, through the time of the
meeting.
iii. Requirement
1. The registrant must do proxy solicitation.
a. If the registrant does not do proxy solicitation and if it is a §12(b) or §12(g) company, the
registrant must include the proposal in the information statement under Schedule 14C.
i. The registrant does not have to include the supporting statement for the
proposal in the information statement. Item 4 makes it clear that mgmt must
include s/h proposals in statement..
ii. If mgmt solicits proxies from just women, for example, the women will get the
proxy statement, but the men must get an information statement. However,
some exchanges such as NYSE require full solicitation.
2. Must submit 120 days before to management
iv. Mechanics
1. A proponent can submit 1 proposal per meeting.
a. If you violate Rule 14a-8 as a shareholder, you cannot have a proposal using Rule 14a8 for the next two years.
b. CAVEAT!: If a proponent contact other shareholders to support his proposal, he doesn’t
have to file the proxy statement under Rule 14a-2(b)(1).
i. However, he cannot solicit proxies or provide proxy form. He can just say,
“Vote for the proposal on the registrant’s proxy form.”
2. The supporting statement can be submitted up to 500 words: “A,” “The,” or “And” is not counted
toward 500 words.
a. The registrant may include an opposition statement w/ NO word limit.
3. The proponent must disclose her name, but the registrant does not have to include the name of
the proponent.
a. However, the registrant must disclose the name upon written or oral request by
shareholders.
4. The registrant must bear the cost of printing
v. Exclusion
1. If the registrant excludes a proposal, it must notify the SEC, and if the exclusion is based on a
matter of law, they must include a letter of opinion from a lawyer.
a. CAVEAT!: Even if the registrant excludes a proposal, it must include the proposal itself
in the proxy statement if the shareholder informs the registrant that he intends to show
up at the meeting and propose. However, it does not have to show in the proxy form,
and the registrant does not have to include the supporting statement.
vi. The registrant may exclude a shareholder proposal if the proposal: (must notify SEC and proponent of your
reasons, and should get opinion of counsel if law is involved)
1. Improper under state law: is not a proper subject for shareholder action under the applicable
state law;
86
a.
DGCL §141(a) “The business and affairs of every corporation organized under this
chapter shall be managed by or under the direction of a board of directors.”
b. Rephrasing proposal from demand for action to request or recommendation for action
would make proposal proper.
c. i.e., Pay dividend this year! Under state corporate law, declaring dividend is in the
province of board of directors. Note the difference with item 13, which is about paying a
specific amount of dividends
2. Violation of law: would require the issuer to violate the law (state, federal, or foreign);
3. Violation of proxy rules: including Rule 14a-9, the antifraud provision;
4. Personal grievance: or is designed to further a personal interest of the proponent;
5. Relevance: if relates to operations that are less than 5% of the business and is not otherwise
significantly related to the registrant’s business (assets, earnings, and sales);
a. Must include if it relates to significant social, economic, cultural impact even if it
relates to less than 5% of the registrant’s business.
6. Absence of power/authority: is beyond the registrant’s power to effectuate (ultra vires);
a. i.e., asking the registrant to open a fast-food franchise when the articles of incorporation
says the registrant’s business limited to sales of clothing.
7. Management functions: relates to the conduct of ordinary business operation;
8. Relates to election: relates to an election for membership on the registrant’s board of directors;
a. i.e., asking a U.S. oil company to prohibit an Arab to sit on the board. This is a specific
request to prohibit a particular person to be nominated for the board, and can be
excluded.
9. Conflicts w/ company’s proposal: conflicts w/ a proposal to be submitted by the registrant at the
same meeting;
10. Substantially implemented by the registrant;3
11. Duplication: is substantially duplicative of another proposal previously submitted by another
proponent that will be included in the registrant’s proxy materials for the same meeting;
12. Resubmission: deals w/ substantially the same subject matter as a proposal included in the
registrant’s proxy materials w/I the preceding 5 calendar years for any meeting held w/I 3
calendar years of the last time it was included if the proposal received;
a. Less than 3% of the vote if proposed once w/I the preceding 5 calendar years;
b. Less than 6% of the vote on its last submission to shareholders if proposed twice
previously w/I the preceding 5 calendar years; or
c. Less than 10% of the vote on its last submission to shareholders if proposed three
times or more previously w/I the preceding 5 calendar year
2001
2002
2003
2004
2005
2006
2007
2%
3%
3%
3%
3%
3%
j.
6%
6%
3%
5%
5%
6%
9%
10%
2008
Include
Include
Notes.
Brought
up once
in 20032007, got
less than
3%, must
wait 3
years
Got 3%
Include
Include
Include
Include
Include
13. Specific amount of cash or stock dividends
a. i.e., Pay $5 dividend this quarter! However, “I recommend that the company pay
dividend this quarter!” should not be excluded, but you cant say I recommend you pay
$5 dividend.”
Rule 14a-9, Antifraud Provision
87
i. No solicitation subject to this provision shall be made by means of proxy statement, form of proxy, notice
of meeting or other communication, written or oral, containing any statement which, at the time and in light
of circumstances under which it is made:
1. is false or misleading w/r/t any material fact (NOTE: the word “false” isn’t used in 12a2 or 17a,
but rather those sections use “untrue”)
2. omits to state any material fact necessary in order to make the statements therein not false or
misleading
3. is necessary to correct any statement in any earlier communication w/r/t the solicitation of a proxy
for the same meeting or subject matter which has become false or misleading.
a. A duty to correct an earlier statement: This concept was never discussed in other
antifraud provisions in securities law.
ii. Implied C/A: J.I. Case Co. v. Borak (U.S. 1964)
iii. Application: Solicitation of registered company under §12(b) or §12(g).
1. CAVEAT!: Rule 3a12-11 exemption for debt securities registered under §12(b) does not apply not
to Rule 14a-9. So 14a-9 applies to debt securities traded on an exchange
iv. Jurisdictional base: §12(b) or §12(g) registration
v. Jurisdiction: Exclusive jurisdiction by federal courts
vi. Who is Π?: Direct or derivative suit by solicitee (someone who has been solicited; even if did not send
proxy)
1. “Either side who is crying foul” may sue:
a. The registrant (direct) and shareholders of registrant (derivative—on behalf of the
corporation) can sue the opposition
b. Shareholders of acquiring company can sue the management (direct or derivative)
c. Nonmanagement group can sue the registrant
d. Nonmanagement groups can sue each other
2. Standing to sue
a. Π does not have to be solicited
b. Π does not have to have given proxy
vii. Who is Δ?: Anyone who solicited or assists in the solicitation (i.e., accountant, lawyer)
1. Thus, privity is not required: Δ does not have to be a solicitor.
a. CAVEAT!: This is not privity of contract.
viii. Standard of culpability: not quite clear (judicially developed)
1. The registrant: Negligence or maybe even strict liability (but usually negligence it seems)
2. Inside directors: Negligence
3. Outside directors: Negligence or maybe even scienter (usually negligence)
4. Nonmanagement group: Negligence
5. Outside counsel: Scienter
ix. Materiality: TSC Industries v. Northway, Inc. (U.S. 1976)
1. Π must show that there is a substantial likelihood that a reasonable shareholder would have
considered the false or misleading statement important in deciding how to vote
a. “Would,” not “might.”
b. Does not require a substantial likelihood that disclosure of omitted fact would have
caused investor to change her vote.
2. Statements of reasons, opinions or beliefs can be material. Virginia Bankshares, Inc. infra.
3. Mixed question of law and fact: In general, summary judgment is not appropriate for the question
of materiality. In unusual cases, though, it can be granted. Sometimes it is appropriate if
reasonable minds cannot differ on interpretation of the facts
4. §21E, Bespeaks caution doctrine: If cautionary language is used, the safe harbor applies, and
Rule 14a-9 does not apply.
a. Contra §27A of SA, supra, p 29.
x. Reliance: Π must satisfy reliance requirement, but it is watered down.
1. Mills v. Electric Auto-Lite Co. (U.S. 1970)
a. If Π shows the materiality, Π has satisfied reliance 95%.
b. “Where there has been a finding of materiality, a shareholder has made a sufficient
showing of causal relationship b/w the violation and the injury for which he seeks
redress if, as here, he proves that the proxy solicitation itself, rather than the
particular defect in the solicitation materials, was an essential link in the
accomplishment of the transaction.”
88
i. Π simply needs to prove that the proxy solicitation was necessary in the
transaction, rather than the defective statement was necessary in the
transaction.
2. Virginia Bankshares, Inc. v. Sandberg (U.S. 1991)
a. Nonvoting causation: If proxy solicitation was not necessary in the transaction, and
thus shareholder votes were not necessary, Π cannot show the transaction causation.
b. In this case, they didn’t have to have a vote b/c mgmt had enough shares to direct the
result, but they did a vote anyway to prevent ill-will. So even if the proxy was
misleading, reliance cant be shown.
c. Appraisal rights?
i. Almost all states require that shareholder must abstain or vote against the
transaction to have an appraisal rights. Loss and Bill think that the Court
decided in the wrong way.
xi. §21D(b)(4), Loss causation required: Π must show that the Δ’s wrongful conduct caused the Π’s loss.
1. Δ may rebut the loss causation by showing that something else caused Π’s loss.
xii. Remedies: Generally, damages, rescission, and an injunction.
1. In a merger solicitation, an injunction:
a. against further solicitation
i. After this point, Loss says the court has crossed the Rubicon. §14(a) gives the
SEC a rulemaking power in connection w/ solicitation only;
b. against use of proxies
c. against consummation
d. to unwind
xiii. Statute of Limitation: Bill think §804 of the Sarbanes Oxley probably doesn’t apply.
1. Use §18 or §9(e)’s double barrel statute of limitation.
a. W/I 1 year after discovery of the facts constituting the C/A; or
b. W/I 3 years after such C/A accrued.
5.
Schedule 14A, The written proxy statement: 23 items (similar to Schedule A in the 33 Act for what goes into registration
statement)
a. Item 1, Date, time, and place of shareholder meeting
b. Item 2, Revocability of proxy: Must state whether or not the person giving the proxy has the power to revoke it. If
they are limited in some way, must explain the procedures to follow. You revoke a proxy by issuing new proxy and
dating it with current timeframe OR by showing up at the meeting.
i. Proxies are generally revocable by completing another proxy or giving your proxy to someone else at a
later date or showing up at the shareholder meeting and voting except when it is coupled w/ interest.
1. Coupled w/ interest: Proxy could have been given for consideration. However, you cannot just
sell your proxy. Interest is less than consideration.
2. i.e., If a shareholder A sells the security after the record date, the buyer gets the proxy and its
irrevocable. If a shareholder A pledges the security, the bank gets the proxy and they get to vote
the shares (also irrevocable)
c. Item 3, Dissenters’ rights of appraisal: Must outline the right of appraisal or similar rights of dissenters.
i. Right of appraisal: Arises from fundamental corporate changes (i.e., merger, change of control, sale of
assets). Right to drop out if you do not vote in favor of the proposed transaction. You get cash if you decide
to drop out, and if you don’t like the cash you get, you can go to court and get an appraisal remedy.
Shareholders of the acquiring company can also get appraisal.
ii. NOTE: Doesn’t have to be in every proxy statement (would be in M&A transaction)
d. Item 4, Persons making the solicitation: Must also state who is bearing the cost of solicitation.
i. Participants (Item 4, Instructions, Page 1492)
1. the registrants;
2. any director of the registrant and any nominee;
3. Any committee or group which solicits proxies, any member of such committee or group, and any
person whether or not named as a member who, acting alone or w/ one or more other persons,
directly or indirectly takes the initiative, or engages, in organizing, directing, or arranging for the
financing of any such committee or group;
4. Any person who finances or joins w/ another to finance the solicitation of proxies, except persons
who contribute not more than $500 and who are not otherwise participants;
89
5.
e.
f.
g.
h.
i.
j.
k.
l.
6.
Any person who lends money or furnishes credit or enters into any other arrangements, pursuant
to any contract or understanding w/ a participant, for the purpose of financing or otherwise
inducing the purchase, sale, holding or voting of securities of the registrant by any participant or
other persons, in support of or in opposition to a participant; except that such terms do not include
a bank, broker, or dealer who, in the ordinary course of business, lends money or executes orders
for the purchase or sale of securities and who is not otherwise a participant; and
6. Any person who solicits proxies.
ii. Non-participants
1. Any person or organization retained or employed by a participant to solicit security holders and
whose activities are limited to the duties required to be performed in the course of such
employment;
2. Any person who merely transmits proxy soliciting material or performs other ministerial or clerical
duties;
3. Any person employed by a participant in the capacity of attorney, accountant, or advertising,
public relations or financial advisor, and whose activities are limited to the duties required to be
performed in the course of such employment;
4. Any person regularly employed as an officer or employee of the registrant or any of its
subsidiaries who is not otherwise participant; or
5. Any officer or director of, or any person regularly employed by, any other participant, if such
officer, director or employee is not otherwise a participant.
Item 5, Interest of certain persons in matters to be acted upon
i. Nominees for directors
ii. Numbers of shares held by the officers,
Item 6, Voting securities and principal holders: Must specify the number of votes outstanding for each class that
can vote; state the record date, if any; state holders of more than 5% (i.e. principal holders); and state whether it is
cumulative or straight if there is an election of directors.
i. Straight voting: 1 vote for 1 share for each director
ii. Cumulative voting: 1 vote for 1 share multiplied by the number of directors you can vote for
1. A has 55 shares. B has 45 shares.
a. Under the straight voting, A can always control the corporation (i.e. A puts 55 votes to
each of the four candidates they want, and B puts 45 to each that they want)
b. Under the cumulative voting, B has 180 votes, and A has 220 votes. B can elect 2
directors. (A and B would split their total votes amongst their 2 favorite candidates—i.e.
110, 110, 90, 90)
2. Number of shares needed to elect: 1 + (Shares voting * Number of shares needed to elect
R)/(Number of directors that will be elected + 1)
a. If you own 45 shares and there are 100 shares voting for 4 directors
i. 1+ (100R/(4+1)) = 45 20R = 44
ii. Thus, R= 2.2 So you can elect 2 directors.
iii. Proxy statement must state whether its straight voting or cumulative voting
Item 7, Directors, executive officers, and nominees for election as a director
Item 8, Compensation of directors and executive officers
Item 9, Election, approval, or ratification of accountant
Item 14, Special Items w/r/t Merger, Consolidation, and Acquisition: Done in a special meeting
i. Rule 14a-6(b)(2), Confidential Treatment: Item 14 transaction (merger & acquisition) except when the
company is going private or there is a roll-up transaction.
ii. NOTE: doesn’t have to be included in all proxies (just for mergers)
Item 20, Other proposed action
Item 21, Voting Required for Approval: Regarding each matter which is to be voted on:
i. State the vote required for approval; and
ii. Disclose the method the votes will be counted by.
iii. Must have a quorum and a majority vote of the votes cast, but for mergers, it must be majority of all
outstanding shares. For director elections, must be plurality (highest vote getters—i.e. if 9 directors are
being elected, you can get elected with 1 vote even if others got 1M votes, as long as u were in the top 9)
§14(b), Transmission of proxy materials to beneficial owners by broker-dealers and banks: Gives the SEC power to
adopt rules assuring that securities firms (broker-dealers) and banks holding securities in street name or nominee name
90
(broader concept than street name, but includes “street name”) forward proxy soliciting materials to the beneficial owners of
securities registered pursuant to §12(b) or §12(g).
a. Application: Rule 3a11-12 exemption for debt security registered pursuant to §12(b) does not apply to Rules 14a13, 14b-1, and 14b-2.
b. Rules 14a-13, 14b-1, and 14b-2: A registrant must send its proxy soliciting materials (except the annual report in
some situations) to broker-dealers and banks holding securities in street or nominee name b/c they are the record
holders.
i. The record holders must execute (sign) the form of proxy.
1. Beneficial owners are entitled to give such broker-dealers & banks instructions on how to vote.
ii. Rule 14a-13: Registrant must supply broker-dealers & banks w/ sufficient copies of soliciting materials for
forwarding to beneficial owners.
iii. Rules 14b-1 and 14b-2: The broker-dealers (b-1) and banks (b-2) must forward the proxy soliciting
materials to the shareholders/beneficial owners.
1. The registrant bears all the cost.
2. Instructions on How to Vote: Shareholders  B/Ds and Banks
3. The Vote: B/Ds and Banks  Registrant
4. Delivery of NOBO/COBO list: Broker-dealers and banks must supply registrant, upon request, w/
a list of names and addresses of beneficial owners who have not objected to revealing their
identity to the registrant.
a. Registrant may use list to send its annual report directly to beneficial owners (in lieu of
sending the annual report to the record holders for forwarding to the beneficial owners.
b. List may also be used by registrant to disseminate other proxy solicitation materials, as
long as these proxy soliciting materials have been disseminated to record holders &
adequate disclosure is made concerning the need for the record holder to execute the
form of proxy.
c. Clearing agencies
i. Depository trust company: e.g., Cede & Co (this is the nominee name for Depository Trust Company)
7.
§14(c), Distribution of information statement by Registrant when the registrant is not soliciting proxies: Gives the SEC
power to adopt rules requiring a registrant, which has securities registered pursuant to §12(b) or §12(g) but does not solicit
proxies w/r/t these securities in connection w/ a shareholder meeting, to file w/ the SEC and provide shareholders w/
information substantially equivalent to the information that would have been transmitted if a solicitation had been made.
a. Regulation 14C (Rules 14c-1 to 14c-7): Applies only to the registrant.
i. Application: Rule 3a11-12 exemption for debt security registered pursuant to §12(b) does not apply to
Rules 14c-1, 14c-6, and 14c-7.
ii. Regulation 14C parallels Regulation 14A, but there is no comparable provision of Rule 14a-7, Rule 14a-8,
or Rule 14a-12.
1. If a shareholder submits a proposal (not pursuant to Rule 14a-8), the registrant must include the
proposal in the information statement.
2. No form of proxy is required to be sent to the shareholders w/ the information sheet.
iii. Rule 14c-3. Even if management is not soliciting proxies, the same annual report (with all of the
same required disclosures) must still be given to shareholders before the annual meeting, as if
proxies where being solicited.
iv. Rule 14c-6, Antifraud provision: Has a little bite, if any after Virginia Bankshares, Inc.
v. Partial solicitation: If the registrant does partial solicitation and sends proxies to some shareholder, all
other shareholders must receive information sheet (information statement and the annual report).
1. Some thinks that it is unfair, but you should be able to solicit whomever you want.
2. NYSE does not allow partial solicitation.
b. Schedule 14C
Rules 14a-10. Prohibition of Certain Solicitations.
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TOPIC 8—TENDER OFFERS
A. Williams Act Amendments (1968)
1. Background
a. Proxy battle (hostile)
b. Merger
c. Exchange tender offer: SA also applies.
d. Cash tender offer: Hostile tender offer
2. Purpose
a. No more Saturday night special: Williams Act enables unhurried, informed decision-making by target shareholders.
Williams Act closes regulatory gap that existed when these first became popular. Initially, the bill was very promanagement and tried to thwart hostile tender offers. Today, the Williams Act regulates cash tender offers and
exchange tender offers (which both can be friendly or hostile)
i. Regulates method of capturing corporate control that had become popular in the 1960s (cash tender offers)
b. One main purpose: disclosure of information to shareholders
c. Neutrality: Tender offers can play a useful role in displacing inefficient entrenched management. Therefore, the tender
offer rules keep the balance.
d. To regulate a practice that often precedes tender offers (open market or privately negotiated purchases of substantial
blocks of securities)
e. Hypo: In a proposed merger, the registrant sends a letter to shareholders during the waiting period. The letter includes
an investment banker’s statement that the transaction is fair.
i. Under Rule 165(c), even during the waiting period, the registrant may send the letter w/o violating §5.
ii. Under Rule 14a-12, the letter is also a soliciting material that is allowed.
1. However, Rule 14a-12 requires a legend stating who the participants are.
a. CAVEAT!: If the registrant is a non-reporting company, it does not have to follow
the proxy rules.
iii. Rule 165(c)(2) requires that in business combination transactions in connection with an exchange offer, the
offer must follow tender offer rules. If the transaction involves the vote of security holders, the offer must be
made in accordance w/ the proxy rules.
f. NOTE: exchange tender offers always existed, but they were always friendly. Now, they are sometimes hostile.
They were regulated under the 33 Act as a public offering of securities.
3. In general
a. §14(d), Disclosure obligation for third-party tender offers/substantive rights to target shareholders in third-party
tender offers. Substantive rights don’t include appraisal rights (b/c u only get those rights when there is a
vote)…rather, the substantive rights are noted below in C3
i. Centerpiece of the tender offer rules
b. §14(e), Tender offer antifraud provision
c. §13(d), Disclosure obligation for open market and privately negotiated purchases
d. §13(e), Regulation of self-tender by the issuer. Delegation of Rulemaking Power to SEC to Regulate Repurchases
and Tender Offers by Issuer.
e. §14(f), Disclosure obligations for private agreements for transfer of control
i. Seriatim Resignation of Directors: Change of control by means of private agreement w/o shareholder vote
(i.e. ABCDE are directors, A resigns, BCDE replaces him with someone, then B resigns, and CDE replace
him, etc…)
B. Tender Offer and Application
1. What is tender offer?: Not defined in the statutes or rules. (has been delegated to the courts on a case by case basis)
a. Tender offer is not a merger: When completed, there is only one company after a merger, b/c all assets and liability
of the acquired company belongs to the acquiring company. When tender is completed, there are two companies, and
the acquiring company is the parent of the target company.
b. No vote by shareholders: In a tender offer, shareholders decide whether they want to tender their shares to the
bidder. Otherwise, shareholders can sell in the open market although the market price slightly lower than the tender
offer price.
i. If a shareholder sells in the open market, all the shares will be sold unlike in a partial tender offer. A tender
offer can be called off.
ii. Why Premium?: The whole is greater than in part. The bidder thinks that there can be a synergy.
c. Conventional v. Unconventional tender offer: In unconventional tender offer, the bidder denies that it is engaged in
tender offer so they don’t have to comply with Williams Act, but Court might say it is a tender offer and there is a
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d.
e.
2.
violation since they didn’t comply. Conventional tender offer is when everyone agrees that what is going on is called a
tender offer.
SEC’s 8-factor test for defining a tender offer, Wellman v. Dickinson (S.D.N.Y. 1979): None of the factors are
dispositive or exclusive.
i. Active and widespread solicitation of public shareholders of target
ii. Solicitation made for a substantial percentage of the issuer’s stock (partial offer)
iii. Offer to purchase made at a premium over the prevailing market price
iv. Terms of the offer are firm rather than negotiable
v. Offer contingent on the tender of a fixed number of shares, often subject to fixed maximum numbers to be
purchased
vi. Offer open for a limited period of time only
vii. Offeree subjected to pressure to sell his or her stock
viii. Public announcement of a purchasing program precedes or accompanies rapid accumulation of the target
securities.
Hanson Trust v. SCM Corp. (2d Cir. 1985). Bill does not agree with case.
i. HT was a British company that made a hostile bid for SCM at 60 bucks a share. SCM didn’t want to be
taken over, so they found a white knight (Merrill Lynch) to try and outbid, and they had a bidding war. ML
tried 70, HT went to 72, etc… HT then decided to withdraw their bid via an out clause instead of continuing
in the bidding war, and they went out in the market and purchased 25% of the SCM stock in private
transactions.
ii. When a tender offer is announced, shareholders have 3 options: (1) hold on to it, (2) tender the shares, (3)
sell in open market to arbitrageurs (or to someone else) (Tyson says this is the best option b/c it’s
riskless…the market price gets close to the tender price, and the tender offer may get called off, so better to
take guaranteed 72 instead of risky 74)
iii. Market (street) sweep: During the tender offer, risk arbitrageurs buy up the shares from the regular
shareholders. When the tender offer is called off, there are just a few large shareholders. Any person who
purchases from these shareholders can get control.
1. The district court held that it was a de facto tender offer, and it was in violation of the Williams Act
(§ 14(d)). Was then appealed immediately and the Second Circuit said it was not a tender offer
by using the needs test instead of the 8-factor test.
iv. The needs test: The applicability should turn on whether the particular class affected need the protection of
the Act. Cf. Ralston Purina Co., supra, p. 49.
1. The court did not use the 8-factor test.
2. SEC still thinks its 8-factor test is viable.
Equity securities: Most of provisions of the Williams Act and the rules thereunder are only applicable when a class of equity
securities registered pursuant to §12 is involved.
a. Jurisdictional base?
i. §14(d), §13(d), and §14(f) apply only to class of equity securities. The registration of the equity securities
under § 12 is what creates the jurisdictional base
ii. §14(e) applies to any tender offers of all securities as long as mails or IC is used: Πs must plead the use
of mail and interstate commerce by the Δ for the tender offer though there is no such language in the statute
b/c of a drafting bug. This applies to debt as well as equity
iii. §13(e) applies to equity securities, but Rule 13e-4 applies to self tender offer by reporting companies
the SEC relies on the authority under §10(b). Jurisdictional base comes from either § 12 registration or
15(d).
1. Bill thinks that it pushes the envelope.
C. Regulation 14D, Third-party Tender Offer
1. §14(d)(1), Regulation of third-party tender offer: The offeror, upon making a tender offer to the target shareholders, must file
w/ the SEC and furnish the target company, detailed information about itself and the offer.
a. Underwriter : Public Offering :: Dealer manager : Tender Offer
b. 14(d) requires filing at the time of commencement of the tender offer, whereas §13(d) requires filing w/I 10 calendar
days of the acquisition.
c. Exemption:
i. §14(d)(1): If the bidder wants to acquire less than 5% and would have less than 5% after the completion of
the tender offer. (i.e. bidder owns 1% and makes a tender offer for 3%, it isn’t regulated by 14(d) b/c after
the bid, they wont own 5%--still might be subject to 14(e))
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2.
ii. §14(d)(8)(A): if the bidder already owns 10%, in a 12 month period, the bidder does not engage in tender
offer when it buys 2% shares in the open market. (i.e. bidder owns 10%, and within a certain 12 month
period, he makes open market purchases for ½% and a mini tender offer 1%, in that 12 month period he
hasn’t acquired 2%, so the tender offer isn’t regulated by 14(d))
iii. §14(d)(8)(B): Self-tender
1. Rule 14d-1, Bidder: Whether the person in question is playing a central participatory role in the
tender offer.
a. CAVEAT!: Explicitly excludes a person that makes a self-tender covered under
separate regulation.
Regulation 14D (just third party tenders) and 14E (all tender offers)
a. Rule 14d-2, Commencement of a tender offer: When bidder first publishes, sends or gives shareholders a
transmittal letter or a statement how transmittal letter may be obtained. Must have transmittal letter in order to tender.
i. On the date of commencement, bidder must comply w/:
1. the filing requirement of Rule 14d-3;
2. the dissemination requirements of Rule 14d-4; and
3. the disclosure requirements of Rule 14d-6.
ii. Transmittal letter: Securities of the target can be transmitted to the bidder or its depository by this letter.
Must be specified in the long-form or summary publication. Must specify depositary
1. Must be filed w/ the SEC as part of tender offer materials.
iii. Pre-commencement communication by bidder (Oral or Written)
1. First public announcement (NOTE: public announcement defined in 14d-2 (instructions)) can be
oral or written.
a. If written it must contain legend (instruction 3—similar to Rule 165 and 14a-12) and be
filed Under the cover of Schedule TO (tender offer statement) w/ the SEC and
transmitted to the target company and competing bidders.
2. Rule 14e-8 Prohibited conduct in connection w/ pre-commencement communication ~144(i)
a. Tender offerors are prohibited from announcing an offer:
i. w/o an intent to commence offer w/I reasonable time and complete the offer;
ii. w/ intent to manipulate price of securities of tender offeror or target Co; or
iii. w/o reasonable belief that the means exist to purchase the securities sought.
b. CAVEAT!: Applies to all tender offers, not just tender offers for a class of equity
securities registered pursuant to §12.
iv. Post-announcement communication: Can be oral or written.
1. If written, it must contain legend and be filed under cover of Schedule TO w/ SEC. If first public
announcement is oral, then this next announcement must be transmitted to target company and
competing bidders.
b. Rule 14d-3, Filing and Transmission of tender offer statement
i. Tender offer statement and the tender offer materials: The information must be filed w/ the SEC and
transmitted to target company, competing bidders, exchanges and NASD if security is quoted in NASDAQ.
1. Tender offer statement is not sent to target shareholders.
2. Schedule TO: Tender offer statement
a. Regulation M-A (Subpart 1000 of Regulation S-K)
b. Doesn’t go to shareholder. Gets filed with SEC and transmit to target, competing
bidders, exchanges, and NASD. The name of the document that goes to shareholders
is called the “tender offer materials” which includes the transmittal letter. This is an
exhibit to the tender offer statement (TO).
3. Rule 14d-1(g)(9), Tender offer material (exhibit to schedule TO): Bidder’s formal offer, including
all material terms & conditions of tender offer and all amendments; related transmittal letter & all
amendment; and press releases, advertisements, letters and other documents published by
bidder or sent or given by bidder to security holders which, directly or indirectly, solicit, invite or
request tenders of securities being sought in tender offer.
ii. Filing v. Transmitting: Difference is that if something is filed with an exchange or SEC, it gives rise to § 18
liability, whereas if it is transmitted, there isn’t liability.
c. Rule 14d-4, Dissemination of tender offers to security holders: Tender offeror may inform target shareholders of
tender offer by publication in a newspaper.
i. Long-form publication: multiple pages. Usually summary is put in the paper and that is good enough. Can
contain transmittal letter.
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d.
e.
3.
ii. Summary publication: The bidder must mail the tender offer materials to any shareholder who requests
them, and tender offer materials must include info required to be disclosed in long-form publication. Cannot
contain the transmittal letter, but rather can just tell you where to get the materials.
1. If bidder uses the summary publication, the target company can request the long-form publication.
Rule 14d-5, Dissemination of certain tender offers by use of stockholder lists and security position listings
i. Must use the long-form or summary publication to get the stockholder list.
1. Shareholder lists are rarely used: During tender offer, there are a lot of open market transactions
so the list becomes somewhat obsolete.
ii. The target company decides whether to mail or provide the shareholder list (compare w/14a-7)
Rule 14d-6, Disclosure requirements w/r/t tender offers: Sets forth disclosure requirements for long-form or
summary publications and the information sent to the target holders pursuant to Rules 14d-4 and 14d-5.
i. In general, required disclosures includes major portions of tender offer statement & certain other info.
1. Out clause: if the lock-up option is present and target company finds a white knight
2. Underwriter: Public offering—Dealer-manager : Tender offer
Substantive rights of shareholders in connection with a tender offer under Regulation 14D and 14E
a. §14(d)(5), Withdrawal rights: Target shareholders who tendered their shares are allowed to withdraw during the first
7 days (modified by 14d-7). S(Ct) has interpreted 60 days being max period for which offer can be open.
i. Rule 14d-7, Additional withdrawal rights: Withdrawal rights extended to life of offer.
b. §14(d)(6), Pro rata req: If tender offer is for < all of outstanding shares and > requested number of shares is
tendered, offeror must purchase tendered shares pro rata during first 10 days (changed by 14d-8)
i. Rationale: Facilitates disclosure by bidder b/c target shareholders do not have to hurry.
ii. Application: In any-and-all offer, the rata requirement does not apply. Req only applies to partial offers
which are oversubscribed.
1. Not first come first served, as it was prior to the Williams Act.
iii. Rule 14d-8, Pro rata acceptance rights: Pro rata reqs are extended to life of offer by the SEC although
there was no rulemaking power granted by §14(d)(6).
iv. Hypo: X Co. makes a partial tender offer for Y Co. Y Co. has 1,000 shares outstanding. X Co. seeks 400
shares, and 600 shares are deposited. You deposit 30 shares. X Co. must purchase 20 shares from you.
400/600=2/3*30=20.
c. §14(d)(7), Increased price provision: If the offering price is increased, the offeror must pay the increased price to all
tendering shareholders.
i. When tender offer price is increased from $50 to $60, everyone gets $60.
d. Rule 14d-10, Equal treatment of shareholders: Bill wonders where the SEC derives the authority to make this rule,
although he thinks that the rule is fair to investors.
i. All-holders provision: Offer must be made to all target shareholders of the class (unlike proxy solicitation)
1. Rationale: Facilitates disclosure by the bidder b/c target shareholder do not have to hurry.
ii. Best-price provision: Each shareholder must be paid highest consideration paid to any other shareholder.
1. Bill thinks that this provision trumps §14(d)(7), increased price provision. It covers increased
price situation contemplated in §14(d)(7). It goes further by covering decreased price situation.
a. If price goes down from $60 to $50, everyone gets $50. However, tendered shareholder
can withdraw (so this is effectively a way for the bidder to get out of the offer at any time
by just lowering the price to 1 cent since all shareholders would withdraw)
i. If the target’s value goes down b/c of a changed situation, the bidder may
decrease the price. For example, the white knight may obtain a lock-up
agreement w/ the target (sale of crown jewel at a bargain basement price)
2. Can use different types of consideration: Allows partial cash tender offer and exchange tender
offer as long as the shareholders have a choice.
a. However, the bidder must pay the highest consideration for each part (i.e. everyone who
wants cash has to get same amount of cash, and everyone who wants securities gets
same amount of securities)
3. Front-end-loaded or two-tier offer: A tender offer followed by a merger. A bidder makes initial
tender offer for control (i.e. 51%). After tender offer is completed, bidder does a merger where
minority target shareholders would be offered small amount of cash and junk bond w/o a choice.
a. Freeze-out: Two-tier offers are coercive and present a prisoner’s dilemma to the target
shareholders. Everyone is going to want to tender b/c if they don’t do so, they are
gonna get junk down the road, so even though they don’t want to tender, they feel
compelled to.
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e.
f.
4.
b. Best price provision does not prohibit this b/c the second step is not a tender offer.
Rule 14e-1, Unlawful tender offer practices: Bill wonders how this rule is designed to prevent fraud (second
power), but it purports to be an exercise of the prophylactic power.
i. A tender offer must be held open for at least 20 business days.
1. Min offering period: 20 business days
2. Max offering period: 60 calendar days under §14(d)(5). Roll-ups req heightened investor
protection.
ii. If the % of securities sought in tender offer or price is increased / decreased, tender offer must be kept
open for at least 10 more business days.
1. However, if there is de minimus increase in % of securities sought (2% or less), it will not be
deemed to be an increase for purpose of this rule.
iii. CAVEAT!: Applies to all tender offers, not just tender offers for a class of equity securities registered
pursuant to §12.
Rule 14d-11, Subsequent offering period: Can always extend offer after initial tender offer.
i. 3rd pty tender offeror can provide subsequent offering period of 3 to 20 business days during which
shareholders can tender securities into the offer w/o withdrawal rights.
1. Requirements
a. Must be an any-and-all bid: All outstanding securities of class must be sought (cannot
be a partial offer).
b. Same form and amount of consideration: Bidder cannot increase / decrease the price
c. Must start immediately upon expiration of first offering.
2. SEC Release requirement
a. Subsequent offering period must begin on day after expiration of initial offering
period.
b. Tender offeror’s determination to include a subsequent offering period must be
disclosed sufficiently in advance of the expiration date of the initial offering period.
Rule 14d-9, Recommendation or solicitation by target company and others: Provides some neutrality for bidder, although
Bill thinks that the tender offer rules are still lopsided.
a. Others?
i. Directors and officers of the target: regulated by Rule 14d-3
ii. Employees of the target
iii. Shareholders of target and bidder
iv. Doesn’t cover directors, officers, and employees of the bidder b/c their communications are included in the
Schedule TO, so they are just covered under those rules.
b. Pre-commencement communication (oral or written)
i. If written, it must contain legend and be filed under cover of Schedule 14D-9 w/ the SEC.
c. Rule 14d-9(b), Post-Commencement communication (oral or written)
i. Solicitation/recommendation statement (Schedule 14D-9) and solicitation/recommendation
1. Target: file w/ SEC, transmit to bidder, exchanges, and NASD if security is quoted in NASDAQ.
2. Others: file w/ the SEC, transmit to the bidder, and target.
ii. Exception: Rule 14d-9(f), Stop-look-and-listen communication
1. The target company may request target shareholders to wait up to 10 business days from the
date of commencement of the tender offer for the target company’s views.
2. Such communication can only:
a. Identify the tender offer by the bidder;
b. State that such tender offer is under consideration by the target company;
c. State that on or before a specified date, the target company will advice such security
holders of
i. Whether the target company recommends acceptance or rejection of the
tender offer, or expresses no opinion and remains neutral; or is unable to take
position w/r/t the tender offer; and
ii. The reasons for the position taken by the target company; and
d. Request security holders to defer making a determination whether to accept or reject
such tender offer until they have been advised of the target company’s position.
d. Rule 14e-2, Position of subject company w/r/t a tender offer: Designed to prevent fraud, though Tyson doesn’t
see how, but SEC says that it has to do with silence of the target company (see below); prophylactic power
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e.
i. W/I 10 day period, target company must publish or give target shareholders its position on the tender
offer (i.e., recommends acceptance or rejection of tender offer, is remaining neutral, or is unable to take
position).
1. CAVEAT!: Applies to all tender offers, not just tender offers for a class of equity securities
registered pursuant to §12.
2. Rationale: Silence by target company can be unfair, and this rule makes the target company to
make a statement.
ii. If the tender offer is also subject to §14(d) b/c the tender offer is for over 5% of equity securities, the position
statement by the target must also comply with Rule 14d-9 as well as Rule 14e-2 and file Schedule 14D-9.
iii. If the tender offer is not for a class of equity registered under § 12, then you wouldn’t have to comply with
14D at all.
§14(f), Disclosure obligation for private agreements for transfer of control
i. Seriatim resignation of directors: Allowed under state law. When one by one directors resign, and the
remaining directors elect a replacement w/o shareholder meeting.
1. Disclosure to the SEC and shareholders are required as if there were a shareholder meeting.
5.
Rule 14e-4, Prohibited transactions in connection w/ partial tender offers: Designed to prevent fraud; Bill thinks this is
valid; based on definition power.
a. Short tendering disallowed: If person does not own securities, he cannot tender securities. Provision only works for
partial tender offer.
b. Hedged tendering disallowed: If person tenders all of his shares, he cannot sell tendered shares in the open market
w/o first withdrawing the shares.
i. However, multiple tender is allowed as long as shareholder withdraws from one offer before the expiration
of another tender offer (i.e, you must be net long)
c. CAVEAT!: Applies to all tender offers, not just tender offers for a class of equity securities registered pursuant to §12.
6.
Rule 14e-5, Prohibiting purchases outside a tender offer: Designed to prevent manipulation; prophylactic power
a. Tender offeror that has made an offer for equity securities is prohibited from buying ANY of these securities of
the target company alongside the tender offer.
i. Prohibition applies from time of public announcement of tender offer until expiration of tender offer.
b. CAVEAT!: Applies only to tender offers for equity securities.
c. Bill believes most of the 14e rules are invalid
Rule 14e-8, Prohibiting conduct in Connection with Precommencement communications; definition power
a. Rule prohibits tender offerors from announcing an offer
i. w/o an intent to commence the offer w/I reasonable time & complete the offer
ii. w/intent to manipulate the price of the securities of the tender offer or the target co
iii. w/o reasonable belief that the means exist to purchase the securities sought.
7.
D. Fraud and Manipulation in Connection with a Tender Offer—Applies to ALL tender offers, unlike 14(d)
1. §14(e), Antifraud provision:
a. Unlawful, in connection w/ any tender offer:
i. To make untrue or misleading statements; or
ii. To engage in fraudulent, deceptive, or manipulative acts or practices
b. Delegation of rulemaking power to the SEC
i. To define fraudulent, deceptive, or manipulative acts or practices; and
ii. To prescribe means reasonably designed to prevent them (prophylactic power)
c. § 14(e) thunderbolt: when each side sues the other side for a violation of § 14(e).
d. Requirements
i. Implied C/A
ii. Application: Applies to ALL tender offers!.
1. Securities subject to tender offer rules does not have to be registered pursuant to §12. See
Equity Securities, supra p. 82.
2. Even if tender offer was for debt security, §14(e) applies.
iii. Jurisdictional base: Drafting bug (not referenced in statute). However, Π must plead that the tender offer
used mail or interstate commerce.
iv. Jurisdiction: Exclusive federal court jurisdiction (27).
v. Who is Π?:
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1.
2.
Damages: Piper v. Chris-Craft Industries (U.S. 1977) (defeated offeror was Piper and hostile
bidder was Chris Craft; fraud all over the place)
a. The intended beneficiary of the Williams Act are target shareholders who did not
tender shares, not a defeated bidder (i.e. Piper) b/c nontendering shareholders cannot
sue under 10b-5.
i. If target shareholders tenders their shares, they can sue under Rule 10b-5.
(though they are allowed to sue under 14e, but they just don’t need it)
b. Bidders and target company cannot sue for damages.
i. Rationale: neutrality
Injunction
a. Bidder and target shareholders can sue for injunction
b. The target company can sue for an injunction even before the tender offer if there is
problems.
Bidder
Target
Target Shareholders
Damages
No
No
Yes
Injunction
Yes
Yes
Yes
vi. Who is Δ?: Anyone who violated §14(e)
1. Target company, target management, bidder, bidder’s officer and directors, competing bidders,
solicitors, shareholders of bidder or target, etc…
vii. No privity required
viii. Culpability: Scienter and negligence
1. First prong, §14(e): Negligence
2. Second prong, §14(e): Scienter
3. Compare Aaron v. SEC (U.S. 1980)
a. §17(a)(1) of the SA: Scienter
b. §17(a)(2) & (3) of the SA: Negligence
ix. Manipulation: §14(e) is just about fraud, nothing else. Manipulation is a form of fraud.
1. Schreiber v. Burlington Northern, Inc. (U.S. 1985) (The bidder terminated the initial tender offer
and entered a new friendly tender offer w/ the target. Π was upset b/c her shares were purchased
less by the bidder at the closing of the offer since more shares were tendered by the target
shareholders, the pro rata purchase was less for each shareholder; she was not successful but
case is significant because case was deathnell for challenging defensive measures of target as
manipulative; S(Ct) said that manipulation was term of art for fraud so that it requires showing of
misrepresentation or acts complained of.)
a. A cause of action on manipulation require a showing of misrepresentation or
nondisclosure of the acts complained of.
i. Manipulation is a type of deceit or fraud. §14(e) prohibits conduct designed
to deceive or defraud investors by controlling or artificially affecting the price
of securities.
ii. Fraud or deceit is a misrepresentation or nondisclosure when there is a
duty to speak. (this is the only way that manipulation works)
b. Here, Δ did not misrepresent or make nondisclosure.
c. Cf. Defensive measures: Are fully disclosed to everyone. Thus, it is not manipulation.
Generally, defensive measures are dealt by state corporate law.
2. Market or price manipulation at common law: To lie (misrepresentation) or not to disclose when
there is a duty to disclose.
a. Dissemination of fictitious reports about a company’s earnings: Misrepresentation
b. Wash sales and rigged prices: Nondisclosure usually essential to their success.
i. Wash sales: A manipulator buys and sells shares simultaneously in the
market. It appears that there is a lot of market activity for the securities, and it
pushes the price up. It is a secretive trading. If the purpose of the trading is
disclosed, the trading would not increase
x. Reliance: Π probably has to show that the untrue or misleading statement (or the fraud, deception, or
manipulation) caused Π to tender or not to tender.
xi. §21D(b)(4), Loss causation: Π has to show that Δ’s wrongful conduct caused the Π’ loss.
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1.
Gold, silver, or tin parachute: An agreement to pay the management, mid-level officers, or
employees if they get kicked out b/c of a successful tender offer. Doesn’t cause Π’s loss.
xii. Statute of Limitation: Not clear since adoption of SOX. Tyson says that second prong most definitely uses
§ 804, but the first prong could be § 18, § 9(e), or § 804 (but I would go with 18 or 9e for exam purposes)
1. First prong of §14(e)’s S/L would be based on §18 or §9(e).
a. W/I 1 year after discovery of the facts constituting the C/A; or
b. W/I 3 years after such C/A accrued.
2. Second prong of §14(e)’s S/L would be based on the Sarbanes-Oxley Act, §804.
a. 2 years after the discovery of the facts constituting the violation; or
b. 5 years after such violation.
E. Third-party Exchange Tender Offers (Paper or Stock Tender Offers)  Overlap of Williams Act & 33 Act
1. Generally
a. After exchange tender offer (rather than cash tender), target co becomes sub of acquiring co  no vote by
shareholders  not Rule 145 transaction (can still use Form S-4).
b. Non-early commencement: Tender offer is commenced when registration statement is declared effective.
c. Early commencement: Tender offer is commenced when bidder declares after registration statement filed. (i.e.
during WP)
2.
Timeline
Pre-PFP
PFP
WP (Filing of S-4)
Pre-commencement
Commencement
(135 Notice = First public announcement)
(Transmittal letter)
166 prior to/during PFP
165(b) during WP
165(a) during PFP
3.
PEP (Effective Registration Statement)
Effective date
Expiration
165(b) during PEP
Tendered shares can be
purchased
Mechanics (Note Rule 163, 163A, 164, 433, 172, and 173 do not apply to register exchange tender offers).
a. Rule 166, Biz Combo Communication Exemption: Allows communication of exchange tender offers, even before
PFP. Oral / written communication not deemed to be offer to sell, as long as  involve more dissemination of info.
i. Allows communication before 1st pub announcement but it cannot be done > 1x.
ii. Biz combo: All Rule 145 transactions and exchange tender offers.
b. Rule 135, Notice: Oral or written communication by participants (issuer & underwriters) as to exchange tender
offers.
i. Notice must state that notice  constitute an offer.
ii. If notice relates to biz combo, must be filed w/ SEC on or before date of 1st use.
1. Generally, Rule 135 notice is 1st public announcement.
iii. NOTE: if this is regarding a class of equity registered under § 12, 14D rules will apply & communication will
have to contain a legend which says to read the statement when you get it.
iv. Rule 135(a)(2)(viii)(C), Exchange offer: Allows to state basic terms of exchange offer; name of target, and
subject class of securities sought in the exchange offer.
v. Rule 425(b), Rule 135 filing: doesn’t have to be filed except when used in connection w/ biz combo.
c. Rule 165, Communication: Allows free communication during PFP. Allows whetting appetite during PFP & WP.
i. If it’s a 14d tender offer, must have legend to urge investors to read registration statement & prospectus
filed w/ SEC.
ii. Any written communication notwithstanding §5(b)(1) will satisfy §10 as long as it is filed w/ SEC, & has
legend.
iii. Rule 165(a), Communication During PFP: Allows any oral or written communication, reasonably designed
to inform public about biz combo.
iv. Rule 165(b), Communication After Filing of Registration Statement
v. Rule 425(a), Rule 165 filing: They are prospectuses and must be filed w/ the SEC.
d. Rule 14d-4(b), Registration Statement (Form S-4) & Prospectus Delivery Req: For tender offers in which
consideration consists solely or partially of securities registered under SA, registration statement containing all
of req’d info, incl pricing info, has been filed & §10(a) preliminary prospectus or §10(a) prospectus, incl letter of
transmittal, is delivered to security holders.
i. Preliminary prospectus or tender offer material w/ transmittal letter disseminated to target
shareholders: Schedule TO must be filed w/ the SEC on same day.
99
b.
c.
d.
e.
f.
g.
ii. Going-private & roll-up transactions: Registration statement registering the securities to be offered
must have become effective and only a §10(a) prospectus may be delivered to security holders on the
date of commencement.
i. Rule 432, Additional Information on Prospectus: Any prospectus relating to exchange tender offer must
contain information required by Rule 13e-4(d)(1) or Rule 14d-6(d)(1), as applicable in all tender offers,
requests, or invitations that are published, sent or given to security holders. (long form publication)
Rule 14d-6(d)(1), Summary advertisement: Unlike in cash tender offers, the summary advertisement can not have
transmittal information.
Rule 14d-5, Shareholder list: See supra, p. 83.
i. In a friendly deal, the shareholder list is not necessary, b/c the target will provide one.
ii. In a hostile deal, the bidder must ask for a shareholder list. During WP, bidder may only send out
preliminary prospectus to those who the bidder knows to be target shareholders.
Rule 14d-4(d)(2), Extension of tender offer: If bidder disseminates preliminary prospectus, offer must remain
open from the date that material change to the tender offer materials are disseminated to security holders:
i. 5 biz days for a prospectus supplement containing a material change other than price or share levels;
ii. 10 biz days for a prospectus supplement containing a change in price, amt of securities sought, the
dealer’s soliciting fee, or other similarly significant change;
iii. 10 biz days for a prospectus supplement included as part of post-effective amendment; and
iv. 20 biz days for a revised prospectus when the initial prospectus was materially deficient.
Rule 162, Submission of Tenders in Registered Exchange Offers
i. Notwithstanding §5(a), offerors may solicit tenders of securities in an exchange offer subject to Rule 13e4(e) or Rule 14d-4(b) before a registration statement is effective as to the security offered, so long as
no securities are purchased until the registration statement is effective and the tender offer has expired
in accordance w/ the tender offer rules.
1. Tenders can be made and can be withdrawn during the life of tender offer even if the registration
statement is not yet declared effective.
2. Rule 162 implies that tender of their shares by the target shareholders in cash or exchange tender
offers constitute a sale, which is any disposition of security or interest in a security for value.
a. The sale, thus, has a very broad meaning, compared to contracts law.
3. However, purchase means payment for the sale.
ii. Notwithstanding §5(b)(2), a §10(a) prospectus need not be delivered to security holders in an exchange
offer subject to Rule 13e-4(e) or Rule 14d-4(b), so long as a preliminary prospectus, prospectus
supplements and revised prospectuses are delivered to security holders in accordance w/ Rule 13e4(e)(2) or Rule 14d-4(b), as applicable.
Rule 14d-3, Filing of Schedule TO: Schedule TO must be filed on the date of commencement. See supra p. 83. The
date of commencement should be after the filing of the registration statement in case of early commencement
exchange tender offers.
i. Item 1016 of Regulation M-A, Disclosure Requirement of Schedule TO, Disclosure requirements
Purchase of tender offers: Bidder purchases securities once the tender offer is expired and the registration
statement is declared effective.
i. No final prospectus delivery requirement but final prospectus must be filed w/ the SEC.
F. Substantial Acquisition of Securities
1. Generally
a. §13(d), Disclosure obligation for open market and privately negotiated acquisition: Any person, after acquiring
more than 5% beneficial ownership of a corporation’s equity securities that is registered pursuant to §12, must file
Schedule 13D w/ the SEC and furnish the target and any exchange on which the security is traded w/I 10
calendar days of the acquisition.
i. Exempt Investors: Must file Schedule 13G (short form) in lieu of Schedule 13D.
1. §13(d)(6)(A), Acquisition made by means of a registration statement under SA: Any
acquisition or offer to acquire securities made or proposed to be made by means of a
registration statement under SA;
a. Very rarely used. If you own 4.1% and you acquire 3.5% . . . co wants to acquire 3.5%
percent with their own securities (privately negotiated transaction) buying from selected
shareholders (not exempt under 4(2) because dumb and poor) . . .  Must file
Sche13G
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0
2.
b.
c.
d.
e.
2.
§13(d)(6)(B), De minimus acquisition: Any acquisition of the beneficial ownership of a security
which, together w/ all other acquisitions by the same person of securities of the same class
during the preceding 12 months, does not exceed 2% of that class;
a. You have 4.1% of registered equity securities of a corporation. You during the last 12
months purchased 1.9% more. You have to file Schedule 13G w/I 45 days at the closing
of the calendar year, not Schedule 13D.
b. But 13(g) gives SEC power to close up the gap  gave birth to short form 13G.
3. §13(d)(6)(C), Issuer purchases: Any acquisition of an equity security by the issuer of such
security.
Rationale: To provide the same information that is required when a tender offer is made. Open market and privately
negotiated purchases is generally a harbinger of a tender offer.
Application: Applies to any type of acquisitions of registered equity security, including gifts.
Rule 13d-3, Determination of Beneficial Ownership: Recording holders cannot have beneficial ownership.
i. Beneficial owner has:
1. voting power which includes the power to vote, or to direct the voting of, such security; AND/OR
2. investment power which includes the power to dispose, or to direct the disposition of, such
security.
ii. Rule 13d-1(i), Non-voting security: Equity security does not include non-voting security. So don’t have to
report ownership
iii. Rule 13d-3(d)(1), Stock options, warrant, right, or conversion
1. When the person does not have a control intent: stock options, warrant, right, or conversion
counts toward the beneficial ownership if the underlying security can be acquired w/I 60 days.
2. When the person has a control intent: Stock options, warrant, right, or conversion count toward
the beneficial ownership regardless of when securities can be acquired.
iv. Rule 13d-3(d)(3), Pledges: A pledgee is not deemed to be a beneficial owner until the default.
1. Requirements
a. The pledgee is an institutional investor
b. The pledge was based on a bona fide agreement (in ordinary course of business)
c. There has not been a default on the loan
d. The pledgee has no voting power or investment power before the default.
Rule 13d-5, Acquisition of Securities
i. Rule 13d-5(b)(1), Group person: If they agree to act in concert for acquiring, holding, voting, or disposing.
1. Joint filing is allowed by the group persons, or it can be individual
2. Don’t confuse this with a scenario where 2 people have beneficial ownership in the same stock.
(i.e. a trustee of a trust and a beneficiary, any stock in the trust is treated as owned individually by
each person and they must count it in determining their individual 5%)
Regulation 13D
a. Rule 13d-1(a), Filing requirement: Any person acquiring (means of acquisition are irrelevant) more than 5% of a
registered equity security shall, w/I 10 days after the acquisition, file Schedule 13D w/ the SEC and transmit
Schedule 13D to the issuer and exchanges.
i. Schedule 13D
1. Identity of person who made the acquisition
2. Source of the funds used for the acquisition
3. The number of such securities which are beneficially owned
4. Purpose of the transaction: (Item 4) This is the key. Under Schedule 13G, you don’t have to state
the purpose.
5. Information as to any contracts, arrangements, or understandings w/ any person w/r/t such
securities.
b. Rule 13d-2(a), Amendment requirement: Upon the occurrence of any material change, including a change in
investment purpose, such beneficial owner must file promptly to reflect such change.
i. Promptly?: Two or three days. The point here is that the amendment must be filed sooner than the initial
filing.
ii. Material change
1. Change in investment purpose.
2. Acquisition or disposition of beneficial ownership of securities equal to 1% or more of the
class shall be deemed material.
3.
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1
Acquisition or disposition of less than 1% may be material depending upon the facts and
circumstances.
3.
Rule 13d-1(e), Switching from Schedule 13G to Schedule 13D
a. Qualified Institutional Investors
i. A qualified institutional investor who previously filed Schedule 13G loses that status and must file Schedule
13D w/I 10 days if the person:
1. Determines that it no longer holds the securities in the ordinary course of business;
2. Determines that it no longer holds the securities w/o the purpose or effect of changing or
influencing control of the issuer; OR
3. Ceases to be an eligible institution.
ii. Hypo: If you are a qualified institutional investor who used to file Schedule 13G b/c you no longer hold the
securities in the ordinary course of business or b/c you lost your eligibility as a qualified institution, you
may still able to argue that you are still qualified to file Schedule 13G as long as you do not have 20% or
more. (i.e. become a passive investor)
iii. Hypo2: But if you had change of intent in holding those securities, you have to file Schedule 13D w/I 10
days after such change.
iv. Rule 13d-1(e), Cooling-off period upon a change in investment
1. From the time the person no longer holds the securities w/o the purpose or effect of changing or
influencing control of the issuer until the expiration of the 10th day after the date Schedule
13D is filed.
a. During the cooling-off period, the person may not vote the securities or acquire any
additional equity securities of the issuer.
b. Exempt Investors
i. An exempt investor who previously filed Schedule 13G must file w/I 10 days upon making an acquisition
subject to, or not exempt from §13(d).
1. i.e., If you had 5.1% beneficial ownership, during the last 12 months, you acquire 2.1%. You no
longer has the exempt status and must file Schedule 13D. 2% threshold is the key.
c. Passive Investors
i. A passive investor who previously filed Schedule 13G must file Schedule 13D w/I 10 days if:
1. The person acquires or holds the securities w/ the purpose or effect of changing or influencing
control of the issuer or in a transaction having issuer or in a transaction having that effect; OR
2. The person’s beneficial ownership equals or exceeds 20% of a class of equity securities.
d. Rule 13d-1(e), Cooling-off period upon a change in investment
i. From the time the person no longer holds the securities w/o the purpose or effect of changing or
influencing control of the issuer until the expiration of the 10th day after the date Schedule 13D is filed.
1. During the cooling-off period, the person may not vote the securities or acquire any additional
equity securities of the issuer.
e. Rule 13d-1(f), Cooling-off period upon acquiring 20% or more of a class
i. From the time the person’s beneficial ownership equals or exceeds 20% of a class until the expiration of
the 10th day after the date Schedule 13D is filed.
1. During the cooling-off period, the person may not vote the securities or acquire any additional
equity securities of the issuer.
4.
Regulation 13G
a. Rule 13d-1(b), Filing of Schedule 13G: A person who would otherwise be obligated to file Schedule 13D may, in lieu
thereof, file Schedule 13G w/ the SEC and transmit Schedule 13G to the issuer.
i. Doesn’t have to be transmitted to exchanges.
ii. Schedule 13G: Does not have Item 4, Purpose of the Transaction.
b. Rule 13d-2(b), Amendment requirement: Must file an amendment w/I 45 days after the end of the calendar year
to report any change in information.
i. An amendment doesn’t have to be filed if such change results solely from a change in the aggregate
number of securities outstanding.
ii. Once an amendment is filed to reflect beneficial ownership of 5% or less, no additional filing is required
unless the person later becomes a beneficial owner of 5% or more who is required to file Schedule 13D.
iii. i.e., If you are a qualified institutional investor who had more than 5% during the year but went under the 5%
mark at the end of the year, you don’t have to file the amendment.
c. Rule 13d-1(b)(1), Qualified Institutional Investors
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2
d.
e.
f.
5.
i. Eligible institutions acquiring more than 5% of a registered equity security.
ii. Rule 13d-1(b)(2), Initial filing
1. W/I 45 days after the end of a calendar year in which the person holds more than 5% as of the
year end; or
2. W/I 10 days after the end of the first month in which the person’s beneficial ownership
exceeds 10% of a class of registered equity securities computed as of the end of the month.
iii. Rule 13d-2(c), Additional amendment requirement
1. W/I 10 days after the end of the first month in which the person’s beneficial ownership
exceeds 10% of a class computed as of the end of the month; and
2. Thereafter w/I 10 days of the end of any month in which the person’s beneficial ownership
increases or decreases more than 5% computed as of the end of the month.
iv. Rule 13d-1(b) & Item 10(a), Schedule 13G Certification requirement
1. Requires certification that the securities were:
a. Acquired in the ordinary course of business;
b. Not acquired for the purpose of changing or influencing control of the issuer; and
c. Not acquired in a transaction having such an effect.
Rule 13d-1(d), Exempt Investors (exempt from 13(d))
i. Persons holding or acquiring more than 5% of a registered equity security who are not subject to, or
whose acquisitions are exempt from §13(d).
ii. Rule 13d-1(d), Initial filing
1. W/I 45 days after the end of a calendar year in which the person becomes obligated to file.
iii. NOTE: when a company buys back securities (i.e. 500 shares out of 1000 outstanding, you own 40
shares), but doesn’t buy any from you, your % goes from 4% to 8%. You have become a more than 5%
holder with no action on your own. You would be exempt from 13(d), but you do have to file Schedule 13G.
Rule 13d-1(c), Passive Investors
i. Any person acquiring more than 5% but less than 20% of a registered equity security and who did not
acquire such securities w/ a purpose or effect of changing or influencing control of the issuer or in a
transaction having that effect. Once you reach 20%, you are no longer a passive investor.
ii. Rule 13d-1(c), Initial filing
1. W/I 10 days after the acquisition.
iii. Rule 13d-2(d), Additional amendment requirement
1. An amendment must be filed promptly upon the person’s beneficial ownership exceeding 10%
of a class and thereafter promptly upon the person’s beneficial ownership increases or
decreases more than 5%.
iv. Rule 13d-1(c) & Item 10(b), Schedule 13G Certification requirement
1. Requires certification stating that:
a. Not acquired for the purpose of changing or influencing control of the issuer; and
b. Not acquired in a transaction having such an effect.
Rule 13d-1(h), Refiling Schedule 13G after disqualification: The filing person may refile on Schedule 13G once the
disqualification has ended.
Violation of §13(d) or §13(g)
a. Remedies: Rondeau v. Mosinee Paper Corp. (U.S. 1975). Did not grant injunction b/c there supposedly was no
irreparable harm. Standard for permanent injunction is irreparable harm and winning on the merits.
i. Rondeau was 2 months late in filing his 13D, but he defended that the rule used to be 10% and he didn’t
know it was changed to 5%.
ii. Suit for a permanent injunction: Requires irreparable harm and actual success on merits
iii. Suit for a preliminary injunction: Requires irreparable harm and substantial likelihood of success on merits
b. Standard of culpability: Scienter is not required.
c. Parking of stock: Typically, a sham transaction when a broker-dealer (or other person) transfers stock to a
customer’s account or to another broker-dealer and subsequently repurchases the stock w/o a loss to the person w/
whom the stock was parked.
i. A bona fide transaction by one party who intends to transfer the stock to another is called warehousing.
d. The company itself is the one who gets really mad if 13D is not filed!
G. Self-Tenders by the Issuer
1. §13(e), Delegation of rulemaking power to the SEC: The SEC can regulate an issuer’s repurchases of its securities in the
open market, in privately-negotiated transactions, or by way of tender offer.
a.
Application: An issuer is subject to §13(e) if it has a class of §12 registered equity security
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3
2.
Rule 13e-1, Repurchases of its securities by issuer during a third-party tender offer
a. If a third party has commenced a tender offer for a class of equity securities pursuant to §12, the issuer of these
securities may not purchase during the pendency of the tender offer ANY of its equity securities in the open
market, in privately negotiated transactions, or by way of a tender offer unless:
i. The issuer files w/ the SEC a statement disclosing certain information regarding the purchases.
1. The statement is not named.
b. The equity securities does not have to subject to the tender offer.
c. Does not apply to a preexisting issuer repurchase program.
d. Rationale: Bill believes that seeks to balance the regulatory balance and achieve neutrality. The purpose this
transaction is to make the target company less desirable. If the issuer repurchases its shares, it depletes the cash of
the target company by using the cash, or it may give out junk bonds to its shareholders in return of its shares, thereby
leveraging the company. 14d-9 is another example of neutrality.
3.
Rule 13e-2 does not exist.
4.
Rule 13e-3, Going-private transaction (i.e. mouse acquires elephant): Schedule 13E-3
a. In general: Whenever an issuer purchases its own equity securities, makes a tender offer for its own equity securities,
and the effect of the transaction is:
i. to cause any class of equity securities of the issuer which is subject to §12(g) or §15(d) to be held of record
by less than 300 persons; or
ii. to cause any class of equity securities of the issuer to be delisted from a NSE or dequoted from NASDAQ,
then the issuer must file a transaction statement on Schedule 13E-3 w/ the SEC.
b. Repurchases through private negotiations:
c. Self-tender offer:
d. Merger or similar transaction:
i. When a mouse acquires an elephant. A private shell company acquires the target which is a public reporting
company. This is usually done by management buyout or leveraged buyout.
1. After the transaction, the shareholders get stock and/or junk bond
a. Junk bond: High yield and unrated or low rated bond.
ii. Reverse stock splits: Shareholders are required to vote to amend the articles of incorporation to approve
reduce the amount of the outstanding shares.
e. Schedule 13E-3, Transaction statement
i. Item 8, Fairness Statement: Only applies to a going-private transaction
1. If the management thinks that the transaction is not fair, it should state that it is not fair.
Otherwise, the management will be liable for misrepresentation.
2. Management has to state that its fair…this helps ensure that the transactions will be fair, b/c if
they say its fair when it’s not, they are liable for fraud. They cant otherwise require that it be fair,
so this is how they do it.
f. Rule 13e-3(g), Exceptions:
i. This rule shall not apply under Rule 13e-3(g)(1), to any Rule 13e-3 going-private transaction that is the
second step of a merger, which:
1. Occurs w/I 1 year of the termination date of the tender offer, in which such person was the bidder
and became an affiliate; and
2. The consideration offered to the minority shareholders in the second stop going-private
transaction is at least equal to the highest offer during the tender offer.
ii. The rule shall not apply under Rule 13e-3(g)(2), where the security holders receive only an equity security
in exchange for their shares of the issuer, provided that:
1. Such equity securities is itself registered under §12 or the issuer is required to report under
§15(d).
g. Rule 13e-3(b) and (c), Antifraud provisions:
i. Equity securities registered under §12
ii. Debt and equity securities required to report under §15(d)
5.
Rule 13e-4, Issuer Tender Offers: Modeled after the third-party tender offer rules in Regulation 14D and 14E.
a. Application
i. Rule 13e-4 applies when:
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4
1.
b.
c.
d.
e.
the issuer has a class of registered equity securities pursuant to §12 or unregistered equity or
debt securities subject to reporting requirements under §15(d); AND
2. the issuer or the affiliate of the issuer engages in a tender offer for ANY class of its equity
securities.
ii. CAVEAT!: If an issuer does a self-tender for unregistered equity securities but if the issuer has debt
securities that is required to report under §15(d), the self-tender is covered by Rule 13e-4.
Rule 13e-4(a), Commencement of Self-Tender: First day on which issuer tender offer is first published, sent, or
given to security holders.
Rule 13e-4(c), Filing requirement
i. All written communication, from and including the first public announcement: Must be filed as soon as
practicable on the date of commencement.
1. Each pre-commencement written communication must contain legend.
ii. Schedule TO, Issuer Tender Offer Statement: Must be filed as soon as practicable on date of
commencement.
1. Amendment and final amendment of Schedule TO: Must be filed promptly.
iii. Issuer Exchange Tender Offer
1. Any communications made for registered exchange tender offer must be filed pursuant to Rule
425.
a. See Rule 135, 165, and 166 for pre-commencement communications.
2. If the issuer does an exchange tender offer but there is remuneration paid for soliciting the
exchange, the securities must be registered pursuant to §5 of SA and it must comply with Rule
13e-4.
3. It could be exempt under §3(a)(9) of SA, supra, p. 38 as long as it is voluntary (no vote).
a. However, if there is a solicitation by I-Bankers the issuer loses the exemption b/c under
§3(a)(9), no remuneration can be paid for solicitation.
Rule 13e-4(d), Disclosure requirement
i. Summary publication: The summary advertisement must not include transmittal letter and must
disclose required information.
Rule 13e-4(e), Dissemination of tender offer to security holders
i. Solely cash or exempt exchange offers
1. Long-form publication: By publication in a newspaper on the date of commencement.
2. By use of stockholder and other lists
a. By mailing/furnishing promptly the statement to each security holder who appears on
the most recent stockholder list;
b. By contacting each participant on the most recent security position listing w/I the
possession or access of the issuer or affiliate and making inquiry of each participant as
to the approximate number of beneficial owners;
c. By furnishing to each participant a sufficient number of copies of the statement; and
d. By agreeing to reimburse each participant promptly for reasonable expenses.
3. Summary publication
a. If the tender offer is not going-private, by summary publication in a newspaper on the
date of the commencement; and
b. By mailing/furnishing the statement and the transmittal letter to a requesting security
holder.
ii. Solely or partially registered exchange tender offers: By delivering to the security holders—
1. A registration statement that has been filed; and
a. Must include pricing information
2. A preliminary prospectus that meets the requirement of §10(a).
a. Must include the transmittal letter
3. Exception: In going-private or roll-up transactions, the registration statement must be declared
effective and only a prospectus that meets the requirement of §10(a) can be delivered to security
holders.
iii. Material changes: Must be informed promptly.
1. Registered exchange tender offer: If the preliminary prospectus was used, the tender offer must
remain open:
a. For 5 business days if the prospectus supplement contains material change other than
price or share levels;
b.
c.
d.
e.
f.
g.
h.
2.
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5
b. For 10 business days if the prospectus supplement contains significant change such as
price, amount of securities sought, the dealer’s soliciting fee;
c. For 10 business days for post-effective amendment; and
d. For 20 business days for a revised prospectus where the initial prospectus was
materially deficient.
Rule 13e-4(f)(6), Cooling-off period: Until at least 10 business days after the termination of the tender offer, neither
the issuer nor any affiliate can make any purchase of any security that was sought in the tender offer and any security
that was being offered pursuant to the exchange tender offer.
i. Anti-manipulation provision.
Rule 13e-4(f)(2), Withdrawal rights: Tendered shares can be withdrawn:
i. At any time during the period the tender offer is open; and
ii. If not accepted for payment, after the expiration of 40 business days after the commencement.
Rule 13e-4(f)(3), Pro rata acceptance rights: If tender offer is for less than all of the outstanding shares and more
than the requested number of shares is tendered, the issuer or the affiliate must accept the tendered shares pro rata
during the life of the tender offer.
Rule 13e-4(f)(3), Acceptance by lot: Shareholders are allowed to condition their tender, requiring the issuer to
purchase all or minimum number of shares held by the shareholders. If the issuer does not meet the requirement, the
shareholder can require that the issuer cannot purchase the shares of the shareholders at all.
i. The issuer must first purchase the shareholders who do not elect to have this condition based on the pro
rata. After that, the issuer can purchase the shares held by shareholders who conditioned their tender.
1. CAVEAT!: This is not allowed in a third-party tender offer.
Rule 13e-4(f)(4), Increased price provision: If the offering price is increased, the offeror must pay the increased
price to all tendering shareholders.
i. When tender offer price is increased from $50 to $60, everyone gets $60.
Rule 13e-4(f)(8), Equal treatment of shareholders:
i. All-holders provision: The offer must be made to all target shareholders of the class.
ii. Best-price provision: Each shareholder must be paid the highest consideration paid to any other
shareholder.
1. If the price goes down from $60 to $50, everyone gets $50. However, the tendered shareholder
can withdraw.
2. Can use different types of consideration: Allows partial cash tender offer and exchange tender
offer as long as the shareholders have a choice.
a. However, the bidder must pay the highest consideration for each part.
Rule 13e-3(f)(1), Length of Tender Offer
i. A tender offer must be held open for at least 20 business days.
1. Minimum offering period: 20 business days
2. Maximum offering period: 40 business days.
ii. If the percentage of securities sought in the tender offer, the price, or the dealer’s soliciting fee is
increased or decreased, the tender offer must be kept open for at least 10 more business days.
1. However, if there is de minimus increase in the percentage of securities sought (2% or less), it will
not be deemed to be an increase for the purpose of this rule.
Application of all the rules  Triggers 13e-1, 13e-3, 13e-4: If a third-party tender offer is pending and the issuer is making a
self-tender that makes the issuer to go private, all the three rules apply. Would have to file Schedule 13E-3 and TO along with
13e-1 information.
H. State Takeover Statutes and Corporate Law
1. State takeover statutes
a. First generation: Enacted Unconstitutional
i. Pre-commencement waiting period
ii. Substantive fairness requirement
iii. Hearing provision: Imposed delay in the process
iv. Edgar v. MITE Corp. (U.S. 1982) (The IL statute applied to a corporation, if 10% of its shares were owned by IL
residents. The Court held the statute unconstitutional under the Commerce Clause by the plurality.)
1.
Dormant Commerce Clause scrutiny: Congress has the power to regulate the interstate
commerce under the Commerce Clause. By implication, Congress has the dormant power to
make state regulation invalid if the state law burdens the interstate commerce. The Court held that
the state law was over-inclusive.
10
6
2.
b.
Supremacy Clause: If there is a conflict b/w state and federal law, the federal law trumps. 3 out
of 5 Justices held that the state law upset the neutrality objective set by the Williams Act.
Second generation: Enacted as a part of corporation law, not blue sky law  jurisdictional base was narrowed;
constitutional. Deals w/ corporate governance, and so only deals w/ the internal management of a corporation.
Designed to deal w/ coercive two-tier merger. – CA and TX only states without such laws
i. Constituency statutes: The Board can consider the interest of employees, creditors suppliers, and the
community.
1. CA is the only state that has not enacted a state takeover statute. Bill thinks it’s clever.
2. Generally, the target management can opt out of state takeover statutes. Bill thinks that it is better
for the corporation to opt out although it may not be good for the management.
ii. Fair price statutes: For the second step merger of a two-tier merger, the Board must vote, supermajority of
disinterested shareholders must vote for, or the price should be fair. (9 states have)
iii. Redemption statutes (cash out statutes): If the bidder acquires controlling interest of 30% (subsidiary),
whether or not the bidder does 2nd step merger, if the disinterested shareholders demand the bidder
purchase the shares. (PA & ME)
iv. Moratorium statutes: For a few years, the bidder is prohibited from a second step merger unless the
management votes for the merger or the supermajority of disinterested shareholders vote for the merger.
Fair price statute with moratorium in front of it. (28 states have it – De 3; NY 5)
1. Short-form merger: If the bidder has more than 85% shares in DE, it can go ahead with the
merger without complying with moratorium statutes.
v. Control Share Acquisition Statutes -- CTS Corp. v. Dynamics Corp. (U.S. 1987) (Dynamics was bidder; CTS
was target. The Board w/o shareholder vote could opt in to the takeover statutes in question. The Court held that the
statute was constitutional.)
1.
2.
c.
2.
3 required paying procedure.
The shares acquired by the bidder were sterilized but disinterested shareholders could vote to
restore the voting rights of the shares in a special meeting. A bidder can condition the tender offer
that the offer can be accepted only if the shareholders restore the voting rights of the bidder.
a. This is not as lethal as it sounds b/c the disinterested shareholders may want to get
cash. Solves the coercive two-tier merger problem (prisoner’s dilemma) by a collective
action by the shareholders.
3. There was no inconsistent regulation w/Williams Act b/c statute applied to Indiana corporations
only. Moreover, there was no discrimination against out-of-state bidder.
4. Court stated that statute furthers objective of the Williams Act. Although Indiana statute can delay
tender offer by 50 calendar days, but it is w/I maximum 60 days allowed under the Williams Act.
Third generation: PS takeover act in 1990
i. Disgorgement statute: Bill says this is lethal.
1. Defines controlling person as any person acquired, public intention to acquire 20% of PA corp, or
any person who has disclosed it may seek power to control. Considered as control person even
before you own any shares.
2. The bidder must disgorge any profit made by the tender offer to the target company.
3. Greenmail is prohibited.
ii. Greenmail: The bidder approaches the target management, and solicit an offer to buy the shares acquired
by the bidder. The bidder can repeat the greenmailing.
1. Standstill agreement: The bidder promise contractually that the bidder will not acquire the target
shares for a while.
iii. Player
1. Announces a tender offer with no intention of doing it.
State corporations law: Defensive tactics of target companies by the Board. The Schreiber Court held that defensive tactics
are not illegal under the federal law. See supra. p. 87.
a. Lock-up options to sell crown jewels at bargain basement price (or unissued or treasury shares) to a white knight 
solely by directors, shareholders have no input
i. The target may entice a friendly party by a lock-up provision.
ii. Gray knight: another hostile bidder when there is a hostile bidder.
iii. Black knight: A hostile bidder when there is a friendly bidder.
b. Shark repellents/porcupine provision
i. Amendments to articles or by-laws to create a staggered board or require supermajority vote by the
shareholders.
ii. In Del, cannot remove directors without cause.
c.
d.
e.
f.
3.
10
7
Sales to friendly shareholders (white squires)
i. ESOP. The shareholder will not vote for a merger or tender.
Defensive acquisitions
i. Anti-trust Problems with Clayton Act
ii.
Litigation defense
i. 14e “thunder bolts” charges that each side is manipulating, etc. More possibilities under state corporation
law.
Poison pills: Occasionally, the bidder survives even after swallowing the poison pills.
i. Flip-in: Entitles non-bidder shareholders to purchase shares at ½ of the market price at the triggering
event such as acquisition of x% of the target or a tender offer for the target company. (does not flip in for 10
days)  increases # of shares the bidder must acquire
1. Requires the takeover to be friendly.
ii. Flip-over: If the flip-in is not strong enough, you can opt to flip-over.
1. If the second step merger is done, the minority shareholders have the right to buy securities of
the acquiring company at ½ of the market price.
2. The theory is that such right is part of the target company’s liabilities.
Fiduciary duties of directors and officers (duty of care, duty of loyalty)
a. Common law business judgment rule: Courts will not second guess the directors’ business judgment based on the
benefit of hindsight as long as they did not breach the duty of care or loyalty. Presumption can be overcome by
showing of negligence.
i. Traditional: Applies to ordinary business matters.
ii. Modified: Unocal v. Mesa Petroleun Co. (Del. 1985) in takeover situations only. No initial presumption;
directors must satisfy burden that:
1. Was there a threat? There must be a threat or danger to the company. (corporate policy or
effectiveness)
2. Was the defense proportionate to the threat? (reasonable in relation to threat)
10
8
TOPIC 9—INSIDER TRADING
A. § 16(a), Disclosure by Directors, Officers, and Principal Stockholders
1. §16(a)(1), Reporting Requirement: Every person who is directly or indirectly the beneficial owner of more than 10% of any
class of any equity security (other than an exempted security) which is registered pursuant to §12, or who is a director or an
officer of the issuer of such security, shall file statements w/ SEC (&, if security is registered on a NSE, also w/ exchange).
a. Purpose: To facilitate the enforcement of §16(b) and to require disclosure.
b. Application: Once you are in b/c you hold §12 registered equity security, you have to report ALL equity securities
owned by you and are liable for any short-swing transactions for ANY equity securities, incl unregistered preferred.
c. Rule 16b-5, Gifts: Must be reported under §16(a) & counted to determine 10+% beneficial ownership, but exempt
under §16(b).
d. No right of private action: SEC can sue §16(a) in a criminal proceeding or for a cease and desist order.
i. Private parties may use §18.
e. §16(a) reports are publicly available
D or O
#1
2.
Initial (holding) report: Must be filed on Form 3.
a. At time of registration of such security on NSE or by effective date of a registration statement pursuant to §12(g);
i. must incl amt of all equity securities of such issuer of which filing person is beneficial owner
b. W/I 10 days after he or she becomes such beneficial owner, director, or officer;
i. must incl amt of all equity securities of such issuer of which the filing person is the beneficial owner.
3.
Periodic (transactions) report: Must be filed on Form 4.
a. If there has been a change in such ownership involving such equity security, before the end of 2d business day
following the day on which the subject transaction has been executed.
i. Statement must indicate ownership by the filing person at date of filing, any such changes in ownership.
ii. §403 of SOX moved deadline from 10 days after the end of the month to 2 business days.
iii. Conversions & exercises of options are exempt from 16(b) BUT must be filed on Form 4.
4.
Annual report, Rule 16a-3: Must be filed on Form 5.
a. W/I 45 calendar days of end of the issuer’s fiscal year, an annual report must be filed, indicating:
i. Certain transactions during fiscal year that were exempt from §16(b) (and not previously reported on Form
4); and
ii. All holdings and transactions that should have been reported during the fiscal year but were not.
5.
Getting in & out for Officer & Directors
a. §12 registration: On the effective date of registration, directors and officers must file Form 3 indicating all equity
securities owned by them.
i. If there is any change, the director or officer must file Form 4 w/I 2 business days.
ii. Rule 16a-2(a), Additional reporting requirement for directors and officers
1. If an officer or director subject to §16 files a Form 4 to reflect a change in beneficial ownership
occurring any time w/I 6 months after filing Form 3, the Form 4
must reflect all change in beneficial ownership of equity securities
of the issuer occurring w/I the 6 month period prior to the date
1 mo
5 mo
of the change that triggered the filing of the Form 4.
iii. Hypo: On Jan. 2, a director of X Co. buys 100 shares. On Feb. 1, the
company registers under §12. On June 30, he sells 100 shares.
1. On Feb. 1, he has to file Form 3.
§12 Reg
#2
2. For June transaction, he has to file Form 4, reporting both June
Form 3
Form 4
and Jan transactions b/c even though he was not subject to §16(a)
in Jan., he might have had insider information.
Report # 1 & 2
b.
1 mo
#1
Becoming a director or officer: When you become a director or officer, you have to file Form 3.
i. Any changes must be filed on Form 4, but you do not have a similar Rule 16a-2(a).
ii. Hypo: On Jan. 2, an average Joe buys 100 shares. On Feb. 1, Joe becomes a
director of X Co. On June 30, Joe sells 100 shares.
5 mo
1. W/I 10 days from Feb. 1, he has to file Form 3.
Become
D or O
Form 3
#2
Form 4
Report # 2 only
2.
10
9
For June transaction, he has to file Form 4 w/I 2 business days. Form 4 does not have to include
Jan transaction b/c the assumption is that he did not have inside information back then.
c.
Rule 16-2(b), Duration of Periodic Report
i. If an individual ceases being a director or an officer or the issuer no longer has a class of equity securities
registered pursuant to §12 (deregistration), a transaction (sale in case of later purchase; purchase in case of
later sale) of the opposite transaction (that occurred w/I a period of less than 6 months) must be reported on
Form 4 that occurred after the director or officer is ceased to be one or after the deregistration of the issuer.
ii. Hypo: On Jan. 2, a director of X Co, buys 100 shares. On Feb. 1, he gets fired
or the company deregisters from §12. On June, 30, he sells 200 shares.
1. For the Jan. transaction, he has to file Form 4 w/I 2 business days.
1 mo
5 mo
2. For the June transaction, he has to file Form 4 w/I 2 business days
b/c it occurred w/I 6 months from the Jan. matching transaction.
iii.
Hypo2:
On
Jan. 2, a director buys 10 shares. On Mar. 1, the company registers
D or O
under §12. On May 1, he gets fired. On June 30, he sells 20 shares.
#1
Dereg. Or
#2
1. On Mar. 1., he must file Form 3.
Cease Being Form 4
Form 4
2. For the June transaction, he has to file a Form 4, reporting
Report #1 D or O
transactions on Jan. and June.
Report # 2 if
opposite transaction
6.
Getting in & out for 10+% Beneficial Owners
a. Initial purchase must be reported pursuant to §16(a), but is not counted toward computation of profits.
b. Must file Form 4 reporting a transaction that gets you out of 10% ownership, or the company deregisters.
i. Unlike Rule 16a-2(a) or Rule 16a-2(b), 10% beneficial owners do not have to report transactions that
occurred while they were not 10+% beneficial owners.
1. Rationale: They are not likely to have insider information unless they hold shares exceeding the
threshold.
B. §16(b), Express liability
1. §16(b), Profits from purchase and sale of security w/I 6 months: For the purpose of preventing the unfair use of information
which may have been obtained by such beneficial owner, director, or officer by reason of his relationship to the issuer, any
profit realized by him from any purchase and sale, or any sale and purchase, of any equity security of such issuer (other
than an exempted security) w/I any period of less than 6 months, unless such security was acquired in good faith in
connection with a debt previously contracted (bona fide pledge), shall inure to and be recoverable by the issuer,
irrespective of any intention on the part of such beneficial owner, director, or officer in entering into such transaction of
holding the security purchased or of not repurchasing the security sold for a period exceeding (more than) 6 months.
a. Crude rule of thumb: §16(b) is objective whereas §10(b) and Rule 10b-5 is subjective and considers fairness.
b. Pmbl., §16(b), Purpose: The purpose of the section is to prevent unfair use of information that may have been
obtained by directors, officers, and 10+% holders. However, §16(b) Π does not have to show that the Δ-insider made
unfair use of corporate information in order to prevail. Remember, it is an objective test.
c. Referential inaccuracy: Must have read “more than 6 months.”
d. Less than 6 month: Must be a day less than 6-months period
i. A purchase on January 1 cannot be matched against a sale on June 30.
ii. A sale on April 8 cannot be matched against a purchase on October 7.
2.
Suits for Disgorgement: Suit to recover such profit may be instituted at law or in equity in any court of competent
jurisdiction by the issuer, or by the owner of any security of the issuer in the name and in behalf of the issuer if the issuer
shall fail or refuse to bring such suit within sixty days after request or shall fail diligently to prosecute the same thereafter; but no
such suit shall be brought more than 2 years after the date such profit was realized.
a. Quasi-derivative suits: No contemporaneous ownership requirement. However, shareholders do not get the profits;
the profits should be returned to the company. Attorneys for the plaintiffs, however, can be recovered (champerty).
b. Statute of Limitation: 2 years
3.
Exemption: §16(b) shall not be construed to cover any transaction where such beneficial owner was not such both at the
time of the purchase and sale, or the sale and purchase, of the security or any transaction or transactions which the SEC by
rules and regulations may exempt as not comprehended within the purpose of this subsection.
a. The first sentence of §16(b) exempts bona fide pledges for the purpose of §16(b).
11
0
4.
b.
c.
d.
§12(h), Exemption by the SEC: supra, p. 64. Gives power to exempt by rule / order by 16(b).
Rule 16b-5, Gifts, conversion, devise: Exempt from §16(b), but need to report for §16(a) purposes.
If you have an exempt from §16(b), you still have to report under §16(a).
i. Rule 16a-10, §16(a) exemption: If you are exempt from §16(a), you are not liable for §16(a).
Calculation of the Profits
a. Status of the insiders: A director, officer, or a 10+% beneficial owner must have that status at both the time of the
purchase and the sale.
i. Exception: A transaction that has occurred after a director or officer ceases to be one or after the
deregistration may be covered by §16(b). Similarly, transaction occurred before the company was
registered may be covered by §16(b).
b. Matching (opposite) transactions: There must be sale-purchase or purchase-sale.
c. Short-term capital gain from such transactions should be recovered by the issuer.
i. Brokerage commission and transfer taxes are deducted in computing §16(b) profits realized.
ii. W/r/t dividends earned by the Δ during the 6 months period and the interest earned on the profit, there is no
fixed rule.
d. Smolowe v. Delendo Corp. (2d Cir. 1943)
i. If there were more than one pair of transactions, place all purchases in one column and sales in another.
Then, take the shares purchased at the lowest price and match them w/ the shares sold at the highest
before or after the sale w/I the 6 months period.
ii. Hypo: Director of X Co enters a series of transactions for the X Co. stock registered under §12(b).
Lowest Purchase
Aug. 18, 2000: 300 shares @ $2
Jan. 7, 2001: 200 shares @ $6
Jan 5, 2001: 200 shares @ $8
Apr. 8, 2001: 1,000 shares @ $11
e.
Highest Sale w/I 6 months
No match
Mar. 5, 2001: 200 shares @ $19
Mar. 5, 2001: 100 shares @ $19
Mar. 3, 2001: 100 shares @ $14
Mar. 3, 2001: 300 shares @ $14
Profit
$
0
$13 * 200 = $2,600
$11 * 100 = $1,100
$ 6 * 100 = $ 600
$ 3 * 300 = $ 900
Total
$5,200
Foremost-McKesson, Inc. v. Provident securities Co. (U.S. 1976)
i. Rule 16a-2(c), Initial Purchase Exemption: The purchase which makes a person 10+% holder is excluded
from the computation of the profit realized under §16(b).
1. CAVEAT!: The reasoning should not be applied to a transaction that is not an initial purchase but
in reality is repurchase.
ii. Hypo: Profit realized = $75
Purchase 12% (12 shares @ $10)
Purchase 15% (15 shares @ $10)
Sale 27% ( 27 shares @ $15)
The first shares purchased
iii. Hypo2: Profit realized = $135
Sale 27% ( 27 shares @ $15)
Purchase 12% (12 shares @ $10)
Purchase 15% (15 shares @ $10)
f.
The only shares owned
Kern County Land Co. v. Occidental Petroleum Corp. (U.S. 1973) (Pre-Williams Act tender offer. New Kern instituted
suit against Occidental under §16(b) to recover short-swing profits from Occidental’s dealings in Old Kern stock.)
i. Facts:
1.
2.
3.
4.
May 8: Occidental announced a cash tender offer for 500,000 shares of Old Kern at $85 a share.
May 10: Occidental acquired 10+% in the tender offer and extended the offer for an additional
500,000 shares.
May 19: Old Kern’s board approved a defensive merger of Old Kern into New Kern (a subsidiary
of Tenneco, a white knight).
June 2: Occidental granted an option to Tenneco to purchase the Tenneco preferred stock that it
would receive when Old Kern merged into New Kern. Tenneco paid a premium for the option by
giving Tenneco preferred.
5.
6.
7.
8.
9.
11
1
June 8: Occidental’s tender offer expired.
July 17: Old Kern’s shareholders approved the Old Kern-New Kern merger.
Aug. 30: Old Kern was merged into New Kern.
Dec. 9: Occidental option to Tenneco could not be exercise until this date.
Dec. 11: Tenneco exercised the June 2 option for $105 a share. (Occidental waited until this date
to receive the Tenneco preferred shares to which it was entitled pursuant to the merger).
ii. Which purchases and sales did New Kern try to match?
1. Tender offer for Old Kern (purchase)—Grant of option to Tenneco preferred (sale)
a. Can you match transactions involving different companies’ stocks?
i. Presumably yes b/c Tenneco preferred is functionally equivalent to Old Kern
stocks.
b. However, the Court held that a grant of option is not a sale. The exercise of the option is
a sale. The exercise occurred beyond 6 months period.
2. Tender offer for Old Kern (purchase)—Exchange of Old Kern stocks to Tenneco preferred by
merger (deemed as sale of Old Kern and purchase of Tenneco)
a. The Court held that the sale in the merger was not voluntary. The Court stated that
subjective standard should be used for unorthodox transactions.
b. Bill thinks that it is ridiculous b/c §16(b) is a crude rule of thumb.
iii. This case predates Foremost-McKesson, supra, p.100: If Foremost applied to Kern, the tender offer of
Old Kern stocks does not count for the purpose of §16(b) because purchase of Kern was purchase that took
them over the 10% amt.
iv. Rule 16b-6, Derivative Securities: A grant of option is a sale, whereas the exercise of the option is not a
sale.
1. This in effect overrules Kern, where the Court held that a grant of option is not a sale, whereas
the exercise of the option is a sale.
2. Authority: §16(b) gives the SEC the power to exempt the exercise of option. However, the
exemptive power does not give the SEC the power to undo an exemption established by the
Court.
3. Bill thinks that there is a problem b/c the Court’s decision is not overruled in holding the grant of
option is a sale. However, Bill thinks that the SEC rule is conceptually correct.
C. Definitions
 Rule 16a-1(f), Officer: Anyone who has a title of policy making functions. However, a title is not really important.
Officers of the general partner will be deemed as officers of the limited partnership.
 §3(a)(7), Director: A director of a corporation or who performs similar functions.
a. Partnership/ voting trust
b. One who deputizes another to be a director is a director for purposes of §16(b).
i. Feder v. Martin Marietta Corp. (2d Cir. 1969): The deputizer-corporation
ii. An individual or partners can be deputized (a partnership / individual can also deputize someone else)
1. Loss never liked this rule.
 Beneficial Ownership
a. Rule 16a-1(a)(1), 10+% Beneficial Ownership: Solely for purposes of determining whether a person is a beneficial
owner of more than 10% of any class of equity securities registered pursuant to §12, §13(d) test must be used.
i. Rule 13d-3, Beneficial Ownership: Voting and/or investment power. Supra, p. 90. However, §13(d) is
concerned w/ control, whereas §16 is concerned w/ people making short-swing profits.
1. Control v. Economic interest: Bill thinks this dual approach, albeit complicated, is sound given that
§16(b) is about liability for realized profit whereas §16(a) is about reporting of control.
b. Rule 16a-1(a)(2), Direct or indirect Pecuniary Interest: For all other purposes (i.e., for purposes of the §16(a)
reporting obligations and §16(b) short-swing profit liability), beneficial ownership means a direct or indirect
pecuniary (economic) interest in the securities.
i. The reporting and short-swing profit provisions of §16 apply only to those securities in which an insider
(officer, director, or §13(d) 10+% beneficial owners) has a pecuniary interest.
ii. Hypos: X Co. has 1,000 shares of §12 equity securities. Ms. Y, the trustee of Z trust, purchases 110 shares
for the trust. Neither ms. Y nor any of her family members is a beneficiary of Z trust. On the same day, Ms.
Y purchases 40 shares individually.
1. Ms. Y must disclose 150 shares of beneficial ownership (15%) in Schedule 13D b/c as a trustee
she has control over 150 shares.
11
2
c.
d.
e.
f.
g.
h.
2. Ms. Y has to file Form 3, reporting only 40 shares b/c she does not have an pecuniary interest in
110 shares. Ms. Y will be liable for any short-swing profits she earned for 40 shares.
Non-voting securities: You do not have a §13(d) beneficial ownership, but you have §16 beneficial ownership b/c of
your pecuniary interest.
Derivatives that cannot be exercised for 60 days: Unless it can be exercised for 60 days, you do not have a §13(d)
beneficial ownership, but you have §16 beneficial ownership b/c of your pecuniary interest.
i. Rule 13d-3(d)(1), Stock options, warrant, right, or conversion, supra, p. 90.
1. Stock options, warrant, right, or conversion counts toward the beneficial ownership if the
underlying security can be acquired w/I 60 days.
ii. Thus, if you have derivatives that cannot be exercised for 60 days, it does not count in determining whether
you are a 10+% beneficial owner for §16(a) reporting requirement purposes. However, once you are a
10+% beneficial owner, the derivatives, whether they can be exercised for 60 days or not, count for §16(b)
short-swing profit purposes b/c you certainly have pecuniary interest in the derivatives.
Rule16a-1(a)(2)(ii)(A), Family ownership
i. Indirect pecuniary interest in any class of equity securities shall include securities held by members of a
person’s immediate family sharing the same household.
1. However, the presumption of such beneficial ownership can be rebutted.
a. i.e., hostile mother-in-law
Rule 16a-1(a)(2)(ii)(B), Partnerships
i. A general partner has an indirect pecuniary interest in portfolio securities held by the general or limited
partnership in proportion to his interest in the partnership. This percentage shall be greater than his
percentage of profits or percentage of capital account.
Rule 16a-1(a)(2)(iii), Corporations
i. A shareholder shall not be deemed to have a pecuniary interest in the portfolio securities held by the
corporation or a similar entity in which the person owns securities, if the shareholder is not a controlling
shareholder.
Rule 16a-1(a)(2)(ii)(E) & Rule 16a-8, Trust
i. A typical trust where the trustee has voting and investment power but no pecuniary interest in the securities
held by the trust.
Trust
Trustee
Beneficiary
Settlor (grantor)
Remainder interest
Subject to §16(a)—§13(d) BO
Yes
Yes
No
No
No
§16(a) /§16(b)—§16 BO
Yes
No
No
No
No

§3(a)(11), Equity Security, supra, p. 64.
a. Voting trust certificate is also an equity security as long as it relates to the underlying equity security of the issuer.
b. Treasury stock and warrant for treasury stock are also equity securities.

Class, Derivative Securities (Convertible Securities & Options)
a. Whether a person is a §13(d) 10+% beneficial owner of a class of registered equity securities
i. Chemical Fund, Inc. v. Xerox Corp. (2d cir. 1967) (Δ owned more than 10% of an outstanding issue of
convertible debentures of Xerox and 2.36% of common stocks. The debentures were a registered security and an equity
security as defined in §3(a)(11). They were presently convertible into approximately 2.72% of the Xerox common stock,
which was also a registered equity security. Δ then purchased convertible debentures and sold common stock w/I less
than 6 months.)
1.
The convertible debentures do not constitute a separate class of equity securities.
a. Δ was not a 10+% beneficial owner of a class of registered equity securities at the time
of the purchase and the sale. Therefore, Δ was not subject to §16(a).
b. CAVEAT!: Recall that if it can be converted w/I 60 days, it is deemed presently
convertible. See Rule 13d-3(d)(1), supra, p. 90.
i. Determining the percentage of a class of equity securities
Common owned by Δ + Common that would be received on conversion of the debentures owned by Δ
All outstanding common + Common that would be received on conversion of the debentures owned by Δ
11
3
i. Rule 16a-4, Class of Derivative Securities: For purposes of §16, both derivative securities and the
underlying securities to which they relate shall be deemed to be the same class of equity securities,
except that the acquisition or disposition of any derivative security shall be separately reported.
1. Codifies Chemical Fund, supra.
i. Rule 13d-3(d)(1)(ii), Class of equity security: For the purpose of §13(d), convertible, warrant, option,
and right constitute separate class of equity security.
1. Therefore, for §16(a) purposes, insiders must report equity security and derivative securities
separately.
b.

If a person is a §16 insider, how beneficial ownership of derivative securities is treated for §16(a) and §16(b)
i. Rule 16a-1(a)(2)(F), Beneficial Ownership of Derivative Securities: A person’s right to acquire equity
securities through the conversion or exercise of any derivative security, whether or not presently
convertible or exercisable, represents beneficial ownership of the equity securities for purposes of §16(a)
b/c the person has an indirect pecuniary interest in these securities.
1. Derivative securities: Beneficial ownership of derivative securities is functionally equivalent to
holding the underlying securities, since the value of the derivative securities is a function of or
related to the value of the underlying equity security. See Rule 16a-4 and Chemical Fund, supra.
ii. Rule 16a-3, Reporting Derivative Securities: All holdings of, and transactions in, derivative securities
beneficially owned are reportable under §16(a).
iii. Rule 16a-4, Transactions for Derivative Securities: Transactions in derivative securities include
acquisitions, dispositions, conversions, and exercises.
1. The exercise or conversion of a call equivalent position shall be reported on Form 4 and be
treated for reporting purposes as: a purchase of the underlying security; and a closing of the
derivative security position.
2. The exercise or conversion of a put equivalent position shall be reported on Form 4 and shall be
treated for reporting purposes as: a sale of the underlying security; and a closing of the derivative
security position.
3. The disposition or closing of a long derivative security position, as a result of cancellation or
expiration, shall be exempt from §16(a) if exempt from §16(b) pursuant to Rule .
iv. Rule 16b-6(a), Acquisition and Disposition: The acquisition or disposition of the derivative security is
treated as the significant event for purposes of §16(b), not the conversion or exercise.
1. SEC exemption power: exempts conversion or exercise.
2. Transactions in derivative securities are matchable against transactions in the underlying
securities and against each other, and short-swing profits obtained through use of derivative
securities are recoverable.
a. CAVEAT!: If the increase or decrease occurs as a result of the fixing of the exercise
price of a right initially issued w/o a fixed price, where the date the price is fixed is not
known in advance and is outside the control of the recipient, the increase or decrease
shall be exempt from §16(b) w/r/t any offsetting transaction w/I the 6 months prior to
the date the price is fixed.
3. Rule 16b-6(b), Exception: Out-of-money derivative securities (e.g., a long call option when the
exercise price is greater than the market price of the underlying security) do not follow the general
rule.
a. When you exercise such out-of-money options, it is deemed to be a critical event.
b. Rationale: No one in right mind would generally do it. They must know something that
other people do not know.
Profit Calculation Standard For Derivative Securities
a. Rule 16a-1(c), Derivative Securities: Any option, warrant, convertible security, stock appreciation right w/ an
exercise or conversion privilege at a price related to an equity security, or similar securities w/ a value derived
from the value of an equity security.
i. Stock appreciation right (SAR): Part of executive compensation, equal to the increase of the stock price
for a given period. A right to acquire an equity security.
ii. Convertible preferred: An preferred stock by itself w/ a right to get another equity security, common stock.
iii. Convertible debenture: A debt security w/ a right to convert it to an equity security.
iv. Derivatives do not include:
1. Rights of a pledgee of securities to sell the pledged securities;
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2. Rights of all holders of a class of securities of an issuer to receive securities pro rata, or
obligations to dispose of securities, as a result of a merger, exchange offer, or consolidation
involving the issuer of the securities;
3. Rights w/ an exercise or conversion privilege at a price that is not fixed.
b. Acquisition: Means “increase or establish.”
c. Disposition: Means “decrease or liquidate.”
Optionor
Writer of a call option
(short call option position)
Obligation to sell
Writer of a put option
(short put option position)
Obligation to purchases
PUT
CALL
CALL
PUT
Optionee
Holder of a call option
(long call option position)
Right to purchase
Holder of a put option
(long put option position)
Right to sell
d. Rule 16a-1(b), Call Equivalent Position: A derivative security position that increases in value as the value of
underlying equity increases and includes:
i. a long convertible security (the right to purchase an equity security upon conversion);
ii. a long call option (the right to purchase an equity security upon exercise); and
iii. a short put option (the obligation to purchase an equity security if the optionee exercises the option).
1. Call feature: Permits the owner to acquire securities upon conversion or exercise.
e. Rule 16a-1(h), Put Equivalent Position: A derivative security position that increases in value as the value of the
underlying equity security decreases and includes:
i. a long put option (the right to sell an equity security upon exercise); and
ii. a short call option (the obligation to sell an equity security if the optionee exercises the option).
1. Put feature: Permits the owner to dispose of securities upon exercise.
Matching Transactions for Purposes of §16(b)
Purchase
Acquisition of
a
call
equivalent
position
Disposition of
a
put
equivalent
position
Sale
Disposition of call equivalent position
Acquisition of a put equivalent position
Disposition of the underlying security
Acquisition of a put equivalent position
Disposition of the underlying security
Sale
Disposition
of a call
equivalent
position
Acquisition
of a put
equivalent
position
Purchase
Acquisition of a call equivalent position
Disposition of a put equivalent position
Acquisition of the underlying security
Disposition of a put equivalent position
Acquisition of the underlying security
f. Rule 16b-6(c), Calculation of Profit
i. If the same security is purchased or sold (i.e., a purchase and a sale of call options; a purchase and a sale
of convertible debentures), the profit recovery is the profit received.
ii. For transactions involving different types of equity securities (i.e., a purchase of a call option and a sale of
convertible debenture or the underlying security), the maximum profit recovery is the difference in market
value of the underlying security on the date of purchase and of the date of sale.
iii. The actual profit may be measured by calculating the profit that would have been realized had the
subject transactions involved purchases and sales solely for the derivative security that was purchased or
solely of the derivative security that was sold, valued as of the time of the matching purchase or sale
and calculated for the lesser number of underlying securities actually purchased or sold.
1. The actual profit can never exceed the maximum profit.
iv. Hypo: Assume that an X Co. convertible debenture is convertible into one share of X Co. Common stock
and that an X Co. standardized call option covers one share of X Co. common stock. Assume further that Y
is a director of X Co. whose common stock is registered pursuant to §12.
1. Y purchases 1 X Co. convertible debenture on Apr. 1, 2003 for $10 and sells 1 X Co. standardized
call option on May 1, 2003 for $20. The price of X Co. common stock on Apr. 1, 2003 is $50, and
the price of X Co. common stock on May 1, 2003 is $75.
a. Y’s maximum profit is $25 (the difference in price of X Co. common stock on the date of
purchase and sale).
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b. Y’s actual profit is measured by calculating the profit that would have been realized had
the transaction involved a purchase and sale of a standardized call option, i.e., had Y
purchased an X Co. standardized call option on Apr. 1, 2003 instead of an X Co.
convertible debenture. The price of an X Co. standardized call option on that date is
$15.
i. The profit would be $5.
c. Alternatively, Y’s actual profit is measured by calculating the profit that would have been
realized had the transaction involved a purchase and sale of convertible debenture, i.e.,
had Y sold an X Co. convertible debenture on May 1, 2003 instead of an X Co.
standardized call option. The price of X Co. convertible debenture on that date is $25.
i. The profit would be $15.
d. Since neither $5 nor $15 exceeds the maximum profit $25, Y’s actual profit would be
either $5 or $15. Rule 16b-6(c)(2) does not indicate which profit should be chosen.
2. Y purchases 20 X Co. standardized call options on Apr. 1, 2003 for $300 and sells 5 shares of X
Co. common stock on May 1, 2003 for $375. The price of X Co. common stock on Apr. 1, 2003 is
$50.
a. Y’s maximum profit is $125 (the difference in price of 5 shares of X Co. common stock
on the date of purchase and sale).
b. Y’s actual profit is measured by calculating the profit that would have been realize had
the transactions involved a purchase and sale of 5 standardized call options, i.e., had X
Co. standardized call options on May 1, 2003. The price of X Co. standardized call
option on May 1, 2003 is $20.
i. The profit would be $25. Since $25 does not exceed the maximum profit of
$125, Y’s actual profit would be $25.
6.
Purchase & Sale
a. §3(a)(13), Purchase: any contract to buy, purchase, or otherwise acquire.
b. §3(a)(14), Sale: any contract to sell or otherwise dispose of.
c. §2(a)(3) of SA, Security as Bonus: Giving security as a bonus on account of a purchase of securities constitutes a
sale or purchase.
i. Rule 16b-3, Grant of Security: If conditions are met, grant of equity security by the issuer to directors and
officers is exempt from §16(b).
d. For the date that is determinative for fixing the date of a purchase or a sale for purposes of §16(b), is the broker’s
confirmation.
i. However, for purpose of §16(a)’s beneficial ownership, the date that a person is contractually bound and/or
committed is determinative.
e. Matching the purchase of one security against the sale of another
i. Am Standard, Inc. v. Crane Co. (2d Cir. 1974), n. 35: They are not matchable even if they are functionally
equivalent.
1. However, the Kern court was willing to do so if functionally equivalent.
2. The question remains open.
D. §16(c), Prohibition against Short Sales by §16 Insiders
1. §16(c), Illegal short sales of equity securities: It shall be unlawful for any such beneficial owner, director, or officer, directly or
indirectly, to sell any equity security of such issuer (other than an exempted security), if the person selling the security or his
principal
(1) does not own the security sold; or
(2) if owning the security, does not deliver it against such sale w/I 20 days thereafter, or does not w/I 5 days after such sale
deposit it in the mails or other usual channels of transportation; but no person shall be deemed to have violated this
subsection if he proves that notwithstanding the exercise of good faith he was unable to make such delivery or deposit w/I
such time, or that to do so would cause undue inconvenience or expense.
a. Rule 3b-3, Short-sales: Insiders bet against their companies by selling stocks that they do not own. Selling will
decrease the price of the stock.
i. Short-sale in the box: Insiders sell borrowed securities, and give their securities to the lender.
b. Rule 10a-1, Tick test: Regulates short-sales by non insiders to prevent the price of a security from being pushed
down due to short-sales.
i. Bill says SEC may change this rule next year.
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TOPIC 10—FRAUD & INSIDER TRADING: §10(b)
A. Basic Provisions
1. §10(b), Manipulative and Deceptive Device: It shall be unlawful for any person, directly or indirectly, by the use of any means
or instrumentality of interstate commerce or of the mails, or of any facility of any NSE to use or employ, in connection w/
purchase or sale of any security registered on NSE or any security not so registered, or any securities based on swap
agreement any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the
Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors.
a. Securities Act protects buyers and not sellers: §11, §12(a)(2), and §17.
i. §11 and §12(a)(2) provided defraud buyers w/ express private right of action.
ii. §17(a) outlawed fraud in the offer or sale of securities.
1. However, the private right of action is not express.
b. The Securities Exchange Act gives limited protection to buyers and sellers: §9(a)(4), §9(e), §15(c)(1), §15(c)(2), and
§10(b), but §10(b) is not self-operative.
i. §9(a)(4) outlawed false statements by any person selling or buying a listed security for the purpose of
inducing the purchase or sale of such security by others.
1. §9(e) provided an express private right of action for violation of §9(a)(4).
ii. §15(c)(1) and (2) outlawed fraud in the purchase or sale of a security by a broker-dealer over the counter.
1. Courts have implied private right of action.
c. The SEC adopted Rule 10b-5 in 1942 for an in-house proceeding to give protection to sellers when the buyer was
misrepresenting facts to the sellers.
i. Adopted for in-house proceeding, not contemplated for a private action for damages.
1. Bill says that the rule was not designed to prohibit insider trading: It was really designed to deal w/
manipulation. “Deceptive” was tacked on at the last minute.
ii. The gap closed by Rule 10b-5: Defraud sellers were not protected unless the fraud was effected: (i) by a
person buying a listed security for the purpose of inducing the sale of such security; or (ii) by a broker-dealer
over the counter.
2.
Rule 10b-5, Employment of Manipulative and Deceptive Devices: It shall be unlawful for any person, directly or indirectly, by
the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any NSE:
(a) To employ any device, scheme, or artifice to defraud,
(b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the
statements made, in the light of the circumstances under which they were made, not misleading, or [Misrepresentation]
(c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon
any person,
in connection w/ the purchase or sale of ANY security.
a.
b.
Early Cases
i. Implied private action for damages for fraudulent nondisclosure of material, nonpublic information. Insiders
purchased securities from shareholders at an artificially deflated price.
ii. Kardon v. Nat’l Gypsum Co. (E.D. Pa. 1947): The court held that all three prongs of Rule 10b-5 were
applicable since they are mutually supportive. The courts held that Rule 10b-5 prohibits insider trading b/c it
is fraudulent. When there is a duty to speak, failure to speak is fraud.
1. Bill says that Kardon is a fluke. But it had an impact on insider trading that was not contemplated
by the SEC when it adopted the Rule.
iii. Speed v. Transamerica Corp. (D. Del. 1947): The court held first and third prongs were applicable in
fraudulent nondisclosure cases.
Common law duty of disclosure: Officers or directors in purchasing the stock of the corporation may owe a duty of
disclosure.
i. Majority: Corporate insiders have a fiduciary obligation only to the corporation and its shareholders in their
dealings w/ or on behalf of the corporation. Therefore, when they trade in an individual capacity, they may
trade in the securities of the corporation w/o any affirmative obligation of disclosure, as long as there is
no misrepresentation, half-truth, or active concealment by word or deed.
ii. Minority: Corporate insiders are held to fiduciary standards in their dealings w/ the corporation’s
shareholders and therefore must make full disclosure of all material facts.
1. Kardon and Speed adopted the minority view.
c.
d.
e.
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iii. Special circumstances doctrine: A corporate insider has a duty to disclose special facts or circumstances
before purchasing from shareholders. Strong v. Repide (U.S. 1909)
1. Pre-Erie decision
Purchase by insiders: Initially, the common law only imposed a duty to disclose when the insider was purchasing.
Insiders have fiduciary duty to the shareholders who sold to the insiders.
Sale by insiders: An insider owes a duty to disclose when the insider is selling to an individual who is not a
shareholder. Diamond v. Oreamuno (N.Y. Ct. App. 1969)
Fraud: Fraud is misrepresentation and nondisclosure when there is a duty to speak.
B. Fraudulent Disclosure: Misrepresentation (Trading by Insiders Not Required)
1. Anyone—insider or outsider—including the issuer itself may be held liable under Rule 10b-5 for material misrepresentation in
connection w/ the purchase or sale of a security.
a. Must have used jurisdictional base.
2. SEC v. Texas Gulf Sulphur Co. (2d Cir. 1968) (The company issued an unfavorable press release regarding an ore strike that was
untrue or misleading and the press release affected the price of the company’s stock. However, neither the company nor any insiders traded.)
a.
b.
3.
Both the company and insiders who were responsible for the misleading press release was held liable for Rule 10b-5.
Materiality: Probability-magnitude test should be applied to contingent events.
i. The test required a balancing of the probability that the event will occur against the anticipated magnitude of
the event in light of the totality of the company’s activity.
Basic, Inc. v. Levinson (U.S. 1988) (Basic issued 3 misleading public statements denying that it was engaged in merger negotiations
when in fact it had already begun preliminary negotiations. The press release, however, were issued at a time when the price and structure of
the merger had not yet been arranged. A class action was brought by Πs, who had sold in the market from time to time of the first press
release up to the time of the formal announcement of the merger.)
a.
b.
Materiality: TSC Indus., supra, p. 78.
i. A fact is material if there is a substantial likelihood that a reasonable investor would consider it
important in deciding whether to buy or sell.
i. Application of this test, however, is difficult in preliminary merger negotiations b/c at the time of the
negotiations, the impact of the misleading information is not clear since the merger may never occur.
1. Δ argued that the press release was immaterial.
ii. The Court remanded the case, after holding that the test for materiality should be based on TSC Industries
and Texas Gulf Sulphur.
1. In this case, the probability is low, but the magnitude was high.
No affirmative duty to speak: Even if preliminary merger negotiations were material, the company would not have
violated Rule 10b-5 if it failed to disclose them as long as the company was not buying or selling its securities. i.e.,
“No comment.”
i. However, if the company decides to speak, the company has to duty to speak truthfully, accurately and w/
total candor as to the material fact.
1. The exchanges have addressed the problem by requiring listed companies to release publicly
information that might reasonably be expected to have a material effect on the market price of its
securities.
ii. An issuer has a duty under Rule 10b-5 to correct and earlier statement that is untrue or misleading in a
material respect.
iii. An issuer has a duty under Rule 10b-5 to update an earlier statement that has become untrue or misleading
in a material respect.
C. Fraudulent Nondisclosure: Traditional Theory (Trading by Insiders Required)
1. Possession, not use of the information: In order to establish a claim under Rule 10b-5 for insider trading, it is sufficient if the
Π shows that the insider was aware of the insider information when he traded.
a. The insiders does not have to use material, nonpublic information. Rather, possession of such information, coupled w/
the insider’s knowledge that the information was material and nonpublic would be sufficient.
2. In the matter of Cady, Roberts Co. (SEC 1961) (The company found that it was not doing well. The company decided to disclose it to
the public, but it was not disclosed quickly. Gintel was told by his partner, a director of the company that the company was not doing well.)
a.
Duty to disclose-or-abstain: The issuer and insiders have a duty to disclose material, nonpublic information or
abstain from trading.
i. Practically, it means that insiders cannot disclose at all b/c it’s not their function to disclose.
ii. If an insider discloses rather than abstains, the insider can trade a reasonable time period after public
dissemination of the nonpublic information.
1. Disclose  Place order  Execute order
2. In face-to-face transactions, you have to disclose to the other party.
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3.
3. In transactions in exchanges, you have to disclose publicly.
iii. Rationale: This rule solves asymmetrical information problem. Based on the common law minority view.
1. Bill doesn’t think that insider trading is fraud. It should be called something else.
b. §17(a) can be used when fraud is committed in connection w/ sale. It can be substituted for Rule 10b-5.
i. Bill says it was never articulated by the Supreme Court yet.
c. Gintel is not an insider, but really a tipee: Under Dirks, he would not be liable b/c he did not know that it was material,
nonpublic information. The case does not satisfy the scienter requirement. He was not tipped for personal gain.
i. The case was designed for protection of defrauded buyers.
ii. In this case, Cady and Gintel were sanctioned for violating Rule 10b-5. Gintel was held liable, but the tipper
(Cowdin) was not found liable.
Liability of Insiders
a. Chiarella v. U.S. (U.S. 1980) (Outsider, C, traded on information that he got while working as a printer of the bidder. C
guessed who the target was and traded on the information.)
4.
i. A company and its insiders violate Rule 10b-5 if they trade on material, nonpublic information.
ii. Bill says Chiarella was an outsider, so it really isn’t a insider trading case. However, the Court, in dictum,
discussed insider trading in connection w/ Rule 10b-5.
b. Insiders: For purposes of liability for insider trading under Rule 10b-5, insiders include directors, officers, control
persons, employees, and Dirks’s footnote 14 temporary insiders (e.g., I-bankers, accountants, lawyers, consultants).
i. Unlike in insider trading cases under §16, there is no requirement for equity securities or matching
transactions by insiders under Rule 10b-5.
Liability of Tippers and Tippees
a. Securities Firms: A securities firm that serves as an investment banker for a company and as a broker-dealer for the
company’s securities faces a problem when the investment bankers receive from the company adverse material,
nonpublic information about the company.
i. Slade v. Shearson, Hammill & Co. (2d Cir. 1974)
1. Securities firms have a duty of confidentiality to the client, the company. Therefore, it cannot
disclose the information. Moreover, it is not even clear whether broker-dealers have the
information.
ii. Chinese Wall: Involves procedures adopted at securities firms which are designed to prevent the brokerdealers from knowing what the investment bankers know and vice versa.
1. Bill is very skeptical of the effectiveness.
iii. Restricted list: Maintained by a securities firms is a current list of securities in which proprietary, employee
and certain solicited transactions are restricted and prohibited. The list is usually distributed among the
firm’s broker-dealers.
1. This could lead to a guessing game.
iv. Watch list: Maintained by a securities firm is a current list of securities whose trading is subject to close
supervision by the firm’s compliance and/or legal department. The dissemination of the list is limited.
b. Dirks v. SEC (U.S. 1983) (Secrist, former officer of the company, gave bearish information to Dirks. Dirks then investigated the
company by talking to company employees. During the investigation, Dirks gave the information to his clients, including institutional
investors. Therefore, Dirks was both a tipper and tippee.)
i. Derivative Duty: A tippee can only inherit a fiduciary duty to a company’s shareholders not to trade on,
or tip, insider information when the insider has breached his or her fiduciary duty to the company’s
shareholder by disclosing the information to the tippee.
1. Personal gain: An insider breaches his or her fiduciary duty when he or she tips for personal
gain, which can be gift, money, or reputation.
2. Knowledge of the tippee: Even if the insider breaches his or her fiduciary duty, the tippee only
inherits he fiduciary’s duty to disclose-or-abstain from trading if the tippee knows or should
know that there has been a breach by the insider.
a. Knows or should know: Implies scienter or negligence.
i. Bill says “should know” should not be there.
b. Bill says that the primary gainer by Dirks is the financial analyst b/c insiders generally
do not give out material, nonpublic information to financial analysts.
3. Therefore, Dirks did not endorse Cady, Roberts.
4. If an insider discloses material, nonpublic information to a tippee who does not trade on the
information, the insider is not liable for violation of Rule 10b-5 b/c violation requires “in connection
w/ purchase or sale.”
ii. Fn 14, Temporary Insiders: When corporate information is legitimately revealed to I-Bankers,
accountants, lawyers, or consultants working for the corporation, these outsiders may be temporary
insiders.
b.
c.
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1. For such a duty to be imposed, the corporation must expect the outsider to keep the disclosed
nonpublic information confidential, and the relationship at least must imply such a duty.
2. After O’Hagan, the footnote is superfluous b/c if temporary insiders trade on the information, they
are liable under the misappropriation theory.
iii. Tipper-Tippee Liability: Tippers and tippees are jointly and severally liable for insider trading under Rule
10b-5.
1. The tippee is a participant after the fact in the insider-tipper’s breach of the fiduciary duty.
2. Tippees who get the information from a tippee are subtippees.
Regulation FD, Fair Disclosure (2000): Whenever an issuer, or any person acting on its behalf, discloses material,
nonpublic information regarding the issuer or its securities to any person specified in the rule, the issuer must disclose
the information publicly: simultaneously, in the case of an intentional disclosure; and promptly, in the case of a nonintentional disclosure.
i. Specified persons
1. Broker-dealers
2. Investment advisor
3. Investment company
4. Holder of the issuer’s securities when it is reasonably foreseeable that the person will trade on the
information.
ii. Violation of Regulation FD is not criminal, and such violation is not as serious as violation of Rule 10b-5.
This is an issuer disclosure rule.
False Tips: In pari delicto
i. Bateman Eicher, Hill Richards, Inc. v. Berner (U.S. 1985) (A broker in the firm called a customer and told him
that a company just discovered a gold mine. This was a lie. The customer sued the broker and the firm for violation of
Rule 10b-5.)
1.
2.
The in pari delicto does not apply to tippees who complain of being dupe by false tips.
The Court held that the parties were not in equal fault and held the firm liable.
a. Bill thinks that the false tipper cannot even violate Rule 10b-5 b/c he did not own any
insider information.
D. Fraudulent Nondisclosure: Misappropriation Theory
1. Misappropriation Theory:
a. A person violates Rule 10b-5 if the person misappropriates material, nonpublic information and then secretly uses the
information to trade in securities, in breach of a fiduciary or similar duty (such as a duty arising from a relationship
of trust or confidence) owed to the source of information.
i. It complements the traditional theory.
b. Application: It is usually applied to outsiders who trade on market information (i.e., information about the supply of,
or demand for, a particular security) as distinguished from corporate information (i.e., information regarding the
company’s assets, operations, or earnings).
c. Rationale: The misappropriation theory is not predicated on the duty for the buyers or purchasers. Fraud committed
to the source of the information.
i. Buyers and purchasers from the Δ cannot sue Δ under the misappropriation theory. Only the SEC and DOJ
can use the theory.
d. Scope:: The misappropriation theory covers not only conduct that violates a duty arising from a fiduciary relationship
but also conduct that violates a duty arising from a relationship of trust or confidence.
i. Rule 10b5-2, Duty of Trust or Confidence: The duty of trust or confidence includes
1. If a person agrees to maintain information in confidence
2. When two people have a history, pattern, or practice of sharing confidences such that the
recipient of the information knows or reasonably should know that the person communicating the
material nonpublic information expects that the recipient will maintain its confidentiality.
a. Protects only reasonable expectation of confidence.
3. If a person receives or obtains material nonpublic information from certain enumerated close
family members: spouses, parents, children, and siblings.
a. An affirmative defense permits the person receiving or obtaining the information to
demonstrate that under the facts and circumstances of that family relationship, no duty
of trust or confidence existed.
ii. Moss v. Morgan Stanley (2d Cir. 1983)
1. The misappropriation theory also applies to tipping by a misappropriator and trading by the
misappropriator’s tippee.
2. Chiarella, supra, p. 108.
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3.
a.
b.
The Court refused to consider the misappropriation theory b/c it had not been submitted to the jury at trial.
The fact that you own a material, nonpublic information does not automatically impose a duty to disclose-or-abstain.
i. This is market information b/c it is outsider information.
Carpenter v. U.S. (U.S. 1987) (C was a famous columnist for WSJ. He told his lover about his forthcoming column She traded on the
information. This was scalping.)
a.
b.
4.
4-4 deadlock by the Court, but the lower court’s holding stood.
It was criminal violation of Rule 10b-5 and §10(b).
i. Once he decides to write a column, it is property of WSJ. He cannot give away the information or trade on
the information.
U.S. v. O’Hagan (U.S. 1997) (The bidder hired a law firm to acquire Pillsbury. O was not from M&A department, but found that a hostile bid
was going to be made for Pillsbury.)
a.
5.
When a person misappropriates information from the source of information to which he owes a fiduciary or similar
duty, the person has a duty to disclose his plan to trade on the information to the source of information.
i. Justice Ginsburg thinks that failure to disclose is fraud in connection w/ purchase or sale of the securities.
Thus, fraud is deceptive nondisclosure or misrepresentation to the source of the information.
1. Bill doesn’t think that fraud rubric works for the misappropriation theory. He think that it stinks.
Conceptually, it’s close to a case where the lawyer steals money from the firm and buys securities
w/ the money. Telling the firm about his plan to “misappropriate the information” does not undo
“fraud.” There is no fraud to undo. It is closer to embezzlement or theft.
2. It is not inside information; the employer already knows the information.
Insider trading context: The misappropriation theory can be used to impose Rule 10b-5 liability on an outsider who
misappropriates information from an insider.
a. U.S. v. Reed (S.D.N.Y. 1985) (R got the insider information from his father.)
i. The court held that there was no Rule 10b-5 violation b/c Father was not motivated by personal gain or an
intention to benefit the son.
ii. Bill is skeptical as to how there is a confidential or fiduciary relationship b/w a parent and a son.
b. SEC v. Willis (S.D.N.Y. 1991) (W, a psychiatrist, got insider information from a corporate executive. This was a breach of
fiduciary duty of patient-psychiatrist.)
6.
i. Although W got the information properly, W had to disclose his plan to the patient.
1. Again, Bill wonders, “How does telling the patient about the plan to trade on the information undo
the fraud?”
Executive Blabbermouth
a. SEC v. Switzer (W.D. Okla 1984) (S, a university football coach, overheard the conversation b/w a corporate director and the
wife regarding a potential merger.)
7.
i. Neither the tipper executive nor the trading tippee violates Rule 10b-5.
ii. Under the misappropriation theory, S is not liable b/c there was no fiduciary duty owed to the director.
iii. Under the traditional theory, the director did not even know that he was tipping, so there cannot be a
violation of Rule 10b-5. There is no tipping for personal gain.
Rule 14e-3, Insider Trading in Connection w/ Tender Offer:
a. Rule 14e-3(a), Trading on Material Nonpublic Tender Offer Information: If any person has taken a substantial
step or steps to commence or has commenced a tender offer, it is §14(e) fraud for any person, other than the
bidder, to purchase or sell the target’s securities while in possession of material, nonpublic tender offer
information that the person knows or should know has been obtained directly or indirectly from that bidder or the
target.
i. Rule 14e-3(a) is based on the SEC’s power to define §14(e) fraud.
1. Rationale: There is a general duty to disclose material, nonpublic tender offer information before
trading. A failure to disclose is considered fraud in connection w/ tender offer.
2. Bill thinks that this is the most extreme measure against “fraud.” The rationale sounds nice, but it
is just plain wrong.
ii. Scope: Rule 14e-3(d) prohibits conduct that does not violate rule 10b-5 under either the traditional theory or
the misappropriation theory.
1. An executive blabbermouth would be liable even if he did not act w/ scienter or tipped for personal
gain.
iii. Culpability: Scienter
b. Rule 14e-3(d), Anti-tipping Provision: It is §14(e) fraud to communicate material, nonpublic tender offer
information to any person under circumstances in which it is reasonably foreseeable that such communication is
likely to result in a violation of Rule 14e-3(a).
i. Rule 14e-3(d) is based on the SEC’s power to prevent §14(e) fraud.
ii. CAVEAT!: Even the bidder can violate Rule 14e-3(d).
c.
d.
iii. Culpability: Negligence
O’Hagan, supra, p. 110, held that Rule 14e-3 is valid.
There is an implied private C/A under Rule 14e-3.
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E. Additional Regulation of Insider Trading
1. Civil Enforcement: Disgorgement; cease-and-desist order; criminal suit against for knowing violation in conjunction w/ DOJ.
2. §21A, Civil Penalties for Insider Trading (The Insider Trading Sanctions Act of 1984): A civil penalty may be assessed in a
suit brought by the SEC for violations of Rule 10b-5 and Rule 14e-3 of up to 3 times profit gained or loss avoided as a result of
such insider trading.
a. The penalty is paid into the Treasury.
b. Jurisdictional base: Applies to transactions on an exchange or through a broker-dealer
c. Application: Tippers and controlling persons can be held liable
i. Controlling person: Includes all employers, such as securities firms, whose lax supervision may allow
employees to commit insider trading violations.
1. Controlling persons liable only if the SEC establishes knowing or reckless behavior.
2. The SEC can impose a civil penalty to controlling person up to the greater of $1M or 3 times the
amount of the profit gained or loss avoided as a result of the controlled person’s violation.
d. Statute of Limitation: 5 years
i. CAVEAT!: The S/L is for insider trading cases only.
3.
§20A, Private Right of Action for Contemporaneous Traders (The Insider Trading and Securities Fraud Enforcement Act of
1988): The provision creates an express private action in favor of persons who “contemporaneously” sell or purchase securities
of the same class as persons who violate any provision of the Exchange Act or the rules thereunder while in possession of
material, nonpublic information (i.e., Rule 10b-5 and Rule 14e-3).
a. Contemporaneous: Not defined in §20A. It covers the period from the time the trading violation took place to the time
the material, nonpublic information used in the trading became public.
b. Application
i. Tipper can be liable to contemporaneous traders, but the liability is measured by the profit gained or loss
avoided by the tippee-trader.
ii. A controlling person can be liable to contemporaneous traders for violations of a controlled person (a trader
or tipper) by virtue of §20(a).
1. A controlling person is liable unless they can establish that they acted in good faith pursuant to
§20(a).
c. Limit on Damages: Damages are limited to the profit gained or loss avoided by the violator and will be offset by any
amount disgorged in connection w/ an SEC enforcement action pursuant to §21(d).
d. Misappropriation Theory: Bill says that §20A may allow a private action based on the misappropriation theory by
overruling Moss. Bill is not sure about this point, but he doesn’t like the idea.
i. When the misappropriation theory is used, private parties do not have a standing to sue the insiders b/c the
defrauded party is not the seller/purchaser but the source of the information. Moss, supra, p. 110.
e. Statute of Limitation: 5 years
i. CAVEAT!: The S/L is for insider trading cases only.
F. Elements of Rule 10b-5 Violation (Misrepresentation and Nondisclosure)
1. Jurisdictional base: Use of mails and interstate commerce.
a. The security purchased or sold by Π need not be registered equity security pursuant to §12.
i. The rule applies to debt securities, but conceptually fiduciary duty is not owed to debt holders.
2. Courts: Exclusive federal court jurisdiction.
3. In connection with the purchase or sale
a. Superintendent of Ins. of the State of N.Y. v. Bankers Life & Casulaty Co. (U.S. 1971)
i. The phrase “in connection with a purchase or sale” means “touching” a purchase or sale.
1. It is not a substitute for reliance: It does not mean that the fraud must have caused the purchase
or sale.
b. SEC v. Zandford (U.S. 2002)
i. The Court held that a broker’s alleged conduct of selling customers’ securities w/ undisclosed intent to
misappropriate the proceeds constituted fraud in connection w/ the purchase or sale of any security.
1. Bill wonders, “Where is the fraud?” Theft, yes, but fraud?
ii. The Court noted that the phrase should not be construed so broadly to convert every common law fraud that
happens to involve securities into a violation of Rule 10b-5.
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4.
Who is Π?: To have standing to sue under Rule 10b-5, a Π must be a purchaser or seller of a security.
a. Blue Chip Stamps v. Manor Drug Stores (U.S. 1973) (Fraud in connection w/ a registered public offering and a Π who did
not purchase the security in reliance of bearish information, which was misrepresentation by the Δ.)
b.
c.
d.
e.
f.
i. Π presumably did not sue under §11, §12(a)((2), or §17(a) of SA b/c these provisions also require that the Π
be a purchaser or seller of a security.
Derivative suit: Π does not have to be a purchaser or seller of securities, but the corporation must be.
Criminal suit or SEC action: Someone must be a purchaser or seller.
Private injunctive action: The 2d Cir. held that in private injunctive actions, Π does not have to be a purchaser or
seller.
A contract to buy or sell: A contract to buy or a contract to sell involve a purchase and sale under §3(a)(13) and
§3(a)(14).
Simple breach of Fiduciary Duty: Is not violation of Rule 10b-5 if there was a full disclosure of such breach.
i. Santa Fe Indus. v. Green (U.S. 1977) (In a short form merger, the sub was grossly undervalued. However, such
facts were disclosed to the minority shareholders.)
1.
g.
The Court held that mere breach of fiduciary duty is not a violation of Rule 10b-5 as long as there
was no misrepresentation or nondisclosure of such breach.
a. The fact that no business purpose existed for the short-form merger did not make the
merger a violation of Rule 10b-5.
2. The minority shareholders can resort to state law remedy such as appraisal rights.
Relationship b/w Rule 10b-5 and §16(b)
i. If a §16 insider purchases securities covered by §16 w/o disclosing material, nonpublic information to the
seller and then sells the securities in the market at profit w/I less than 6 months, the seller may sue under
Rule 10b-5, a purchaser may sue under Rule 10b-5, and the corporation may sue under §16(b).
1. However, treble liability is unlikely.
Purchase at 50
Nondisclosure of Bullish Info
Rule 10b-5 liability to seller?
h.
Purchase-sale within
less than 6 months
§16(b) liability to Corporation?
Sale at 60
Nondisclosure of Bearish Info
Rule 10b-5 liability to purchaser?
Action by purchasers
i. Purchasers may forego the express rights of action under §11 and §12(a)(2) and sue under Rule 10b-5.
See Herman & MacLean v. Huddleston (U.S. 1983)
1. The Court held that remedies in securities laws are cumulative.
ii. A Π might prefer Rule 10b-5 b/c:
1. he or she would not have to post security for costs and would not have to pay the opponent’s
counsel fees, which is possible under §11 and §12(a)(2)
2. the S/L may be longer for Rule 10b-5
a. When Herman & MacLean was decided, Rule 10b-5 used state S/L.
iii. If there is a private right of action under §17(a) of SA, §17(a) might be preferred in suits against fraudulent
sellers b/c:
1. scienter is not required under §17(a)(2) or (3);
a. Negligence will suffice for §17(a)(2) and (3).
2. punitive damages are permitted; and
3. the suit may be brought in state court.
5.
Who is Δ?: Anyone who violates Rule 10b-5 is a permissible Δ in a suit brought under Rule 10b-5. Δ does not have to be a
purchaser or seller of a security.
a. Privity: Not required.
b. Aiding and Abetting: Secondary liability
i. Private civil liability does not extend to those who aid and abet a violation of Rule 10b-5. See Central Bank
of Denver v. First Interstate Bank of Denver (U.S. 1994).
ii. However, the SEC may bring a civil enforcement action pursuant to §20(e) for aiding and abetting a
violation of Rule 10b-5 if the Δ knowingly provided substantial assistance to the primary violator.
6.
Scienter: Ernst & Ernst v. Hochfelder (U.S. 1976)
a.
b.
c.
d.
e.
f.
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Rule 10b-5 borrows the language from §17(a) of SA. Scienter is a necessary element of a private cause of action
for damages under Rule 10b-5.
i. The Court defined scienter as an intent to deceive, Manipulate, or defraud.
ii. The culpability standard is the same for all three prongs of Rule 10b-5.
1. Intentional and/or knowing violation satisfies the scienter.
iii. Under the Court’s decision, an allegation of recklessness could suffice to state a private cause of action for
damages under Rule 10b-5. The Court hasn’t spoken on this issue unequivocally.
Aron v. SEC (U.S. 1980)
i. Scienter is an essential element of an injunctive action brought by the SEC under Rule 10b-5 and §17(a)(1)
of the SA, but negligence will suffice under §17(a)(2) and (3).
§32(a), Violation of Rule 10b-5: A violation of EA is criminal if the person willfully violates.
Dirks, supra, p. 109: The issue is whether there was any deception or misrepresentation at all.
i. Therefore, the analysis for Rule 10b-5 goes:
1. Whether there was breach of fiduciary duty or not.
a. If no breach, full stop.
2. If there was a breach, then whether there was scienter or not.
Executive Blabbermouth: In Switzer, supra, p. 111, the court held that neither the tipper-executive nor the trading
tippee violates Rule 10b-5.
i. Rationale: The tipper did not breach a fiduciary duty to the corporation’s shareholders and the tipper did not
act w/ scienter.
Violation by Nonverbal Acts
i. When liability under Rule 10b-5 is based on insider trading, the violation is the nondisclosure of the
material, nonpublic information, not the trading in the absence of disclosure.
ii. Churning: Excessive trading by broker-dealers to collect commission.
1. Rule 15c1-7 prohibits churning.
2. Violation of Rule 10b-5
a. Bill doesn’t like the idea b/c he wonders where the fraud is.
7.
Materiality: A fact is material if there is a substantial likelihood that a reasonable investor would consider it important in
deciding whether to buy or not. See Basic, Inc., supra, 107.
8.
Reliance
a. A Π does not have a viable claim under Rule 10b-5 if the Π is aware of the true facts when he or she bought or sold.
b. Nondisclosure: Affiliated Ute Citizens of Utah v. U.S. (U.S. 1972) (Indians were defrauded by the securities firm b/c the
firm did not disclose the information to the seller-indians and made profit from the transaction.)
c.
i. Rebuttable presumption of reliance in face-to-face transactions
ii. A party in a position of trust has obligation to disclose material facts before trading and if material facts are
withheld, reliance is presumed.
1. In this case, however, the Court used a more difficult materiality standard (“might” rather than
“would”) b/c it predated TSC Indus., supra, p. 78 and Basic, Inc., supra, p. 107.
Misrepresentation: Basic, Inc., supra, p.107. (Firm misrepresented through press releases stating that there was no
corporate development.)
i. Rebuttable presumption of reliance in market transactions based on the fraud-on-the-market theory
1. Misleading statements about a company will defraud purchasers and sellers of the company’s
stock b/c the market transaction transmits the misleading information to investors through the
market price.
2. Based on ECMH: All available information is reflected in the market price.
Misrepresentation
Nondisclosure
9.
Face-to-face transactions
Prove reliance
Yes, Ute
Market transaction
Basic
Basic/Ute
§21D(b)(4), Loss Causation: If there are multiple causes of Π’s loss, Π has the burden of proof that Δ’s fraud was the
substantial factor in causing Π’s loss.
a. To the extent that Π’s loss is not due to Δ’s fraud, the damages are reduced.
10. Remedies
a. Injunction, Rescission, Actual damages:
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b.
c.
d.
Face-to-face transaction: damages or rescission at the election of Π
i. Tort (out-of-pocket) measure of damages = Π’s loss
ii. If the Π is a seller and the market price has fallen, it is best to seek damages.
iii. Once Π elects rescission, however, Π cannot seek damages.
Market transaction: Damages
i. Profit gained or loss avoided by the Δ
Right to Contribution
i. A Δ in Rule 10b-5 suit has the right to seek contribution. See Musick, Peeler & Garrett v. Employers Ins.
of Wausau (U.S. 1993).
ii. §21D(f)(1)-(3) & (8)-(10)
1. In suits brought under EA, Δs are jointly and severally liable if they acted knowingly.
a. If only A was sued where both A and B violated securities laws in EA knowingly, A
cannot seek contribution from B.
2. There is a proportionate liability if Δs did not act knowingly.
3. In all cases, contribution is based on proportionate fault.
11. Statute of Limitation
a. Lampf, Pleva, Lipkind, Prupis, & Petigrow v. Gilbertson (U.S. 1991)
i. The Court borrowed the 1-to-3 year period of §9(e) for fraudulent disclosure cases brought under Rule 10b5.
b. Misrepresentation cases : S/L is the 2-to-5 year period of §804 of the Sarbanes-Oxley Act.
c. Nondisclosure insider trading cases: S/L is the 5 year of §20A of EA.