1
Securities Regulation
Professor Bradford
Spring 2012
Exam Answer Outline
The following answer outlines are not intended to be model answers, nor are
they intended to include every issue students discussed. They merely
attempt to identify the major issues in each question and some of the
problems or questions arising under each issue. They should provide a
pretty good idea of the kinds of things I was looking for. In some cases, the
result is unclear; the position taken by the answer is not necessarily the only
justifiable conclusion.
I graded each question separately. Those grades appear on your printed
exam. To determine your overall average, each question was then weighted
in accordance with the time allocated to that question. The following
distribution will give you some idea how you did in comparison to the rest
of the class:
Question
Question
Question
Question
Question
Question
1:
2:
3:
4:
5:
6:
Range
Range
Range
Range
Range
Range
2-8;
3-8;
2-9;
3-8;
0-7;
0-7;
Average
Average
Average
Average
Average
Average
=
=
=
=
=
=
4.78
5.33
4.94
4.83
3.33
4.83
Total (of unadjusted exam scores, not final grades): Range 2.42-7.05;
Average = 4.65
All of these grades are on the usual law school scale, with 9 being an A+ and 0 being
an F.
If you have any questions about the exam or your performance on the exam,
feel free to contact me to talk about it.
2
Question One
Flack’s Liability
Flack has no primary liability under Rule 10b-5 or the Exchange Act. One
does not make a false statement for purposes of 10b -5 merely by drafting it.
Janus Capital. The person who makes a false statement is the person with the
authority to release it and control over its contents. Id. Here, that would be
Zappa. The press release was approved and released by Prez, Zappa ’s
President, and was not even attributed to Flack.
Flack could be liable for aiding and abetting, if Zappa violated Rule 10b -5,
but only in an action brought by the SEC. There is no private cause of
action against someone who aids or abets a Rule 10b -5 violation. Central
Bank. In an SEC action, Flack would be under section 20(e) of the
Exchange Act if (1) Zappa violated the Act; (2) Flack acted knowingly or
recklessly; and (3) Flack substantially assisted the violation. The latter two
requirements are clearly met. Flack knew the press release was false. Flack’s
drafting of the press release substantially assisted the violation , if there was
one. Thus, Flack’s liability as an aider and abettor turns on Zappa ’s primary
liability, discussed below.
Zappa’s Liability
Zappa made a false statement—the press release was clearly false and, under
Janus Capital, Zappa clearly made this statement. It was released in Zappa’s
name and authorized by Prez, who had authority to act on Zappa’s behalf.
The press release must have been made “in connection with the purchase or
sale of any security,” but that requirement appears to be met. The question
is whether the fraud touches on a securities transaction or is reasonably
calculated to influence the investing public. Here, Prez knew that the r elease
would affect investors and, in fact, that was the whole point —to influence
the market price.
Reliance does not appear to be a major issue. Zappa is traded on NASDAQ
and is a reporting company. The market for its stock is probably an efficient
one. If the information in the release was material, it was undoubtedl y
reflected in the market price, and the fraud-on-the-market theory would
apply. Basic.
Zappa would be liable only if it acted with scienter—an intent to deceive.
Hochfelder. Most lower courts have held that recklessness is scienter. Veep
knew that Zappa did not have a new contract, but Veep was not involved in
any way with making the statement. It is usually not enough to establish
3
corporate scienter that someone in the organization knew the truth. The
person who actually makes or authorizes the statement for the company
must have knowledge of the fraud or act recklessly.
Prez does not appear to have had actual knowledge of the fraud. But he may
have acted recklessly. He relied solely on Flack, an outsider, for information
about his own company. A simple phone call by either Prez or his secretary
would have revealed the fraud. Prez appears to have been willfully blind; he
just didn’t care if it was true or not. His lack of care arguably is extreme
enough to constitute recklessness rather than mere negligence. If so, scienter
has been shown.
The false statement must also be material. A misstatement is material if
there is a substantial likelihood that a reasonable investor would consider it
important. TSC Industries. The fake contract only involves a one percent
increase in sales, and release of the information appears to have a negligible
effect on Zappa’s stock price. But what may make such a minor claim
material is its ability to push the stock price over $45, which in turn would
prevent an undoubtedly material stock option from being triggered. Given
the importance of the $45 threshold, information that might not otherwise
be material could be.
But that leads to another question. To recover for a violation of 10b -5, a
plaintiff must show loss causation—that the fraud caused the loss. What
really caused the stock price to fall was not the revelatio n that contract was
false, but the trigger of the stock purchase and the resulting dilution. Absent
the fraudulent press release, the purchase option would have been triggered
anyway, with the same negative effect on the stock price. Thus, the fraud
does not seem to have caused the loss. But for the fraud, the same loss
would have occurred.
If Flack had committed a violation, Zappa might be liable as a controlling
person under section 20(a) of the Exchange Act. Prez arguably induced the
violation by telling Flack to think of ways to get the stock price up, and
Prez’s recklessness could constitute a lack of good faith. Although Hearst
was an independent contractor, Zappa arguably had control over it with
respect to the press release. But a controlling person is liable only if the
person controlled violated the Act, and, as discussed earlier, Flack is not
liable.
4
Question Two
Instruction I.D of Form S-3 establishes the requirements for an automatic
shelf registration. Acme’s offering is eligible to be an automatic shelf
registration only if:
(1) The offering is eligible for shelf registration under Rule 415.
(2) Acme meets the requirements to use Form S-3.
(3) Acme is a well-known seasoned issuer (WKSI).
Rule 415 Requirements
To be eligible for a shelf registration, the offering must fall within one of
the categories in Rule 415(a). Since an automatic shelf registration must be
registered on Form S-3 anyway, the most obvious possibility is subsection
(a)(1)(x). If Acme’s offering is eligible for registration on Form S -3,
subsection (x) clearly applies. The shares are to be sold on “an immediate,
continuous, or delayed basis” and the sales will be by the registrant, Acme.
Rule 415 has other requirements, but those won’t be a problem.




Subsection (a)(2) doesn’t apply to securities in paragraph (a)(1)(x).
Under (a)(3), Acme must furnish the undertakings required by Item
512(a) of Regulation S-K—essentially undertakings to update the
information in the registration statement.
This is an at-the-market offering of equity securities, as defined in
Rule 415(a)(4). Acme is selling its common stock into an existing
trading market, the New York Stock Exchange, at the market price.
But all that subsection (a)(4) requires is that the offering come within
(a)(1)(x), and that’s the subsection Acme will be using.
Finally, subsection (a)(5) says the registration statement will only be
effective for three years, but that’s the period during which Acme
intends to sell.
Eligibility to Use Form S-3
Acme must be eligible to use Form S-3. To be eligible, Acme must meet the
registrant requirements of Instruction I.A of Form S-3 and the offering must
meet the offering requirements of Instruction I.B.
Registrant Requirements
Acme is organized under U.S. law (Del.) and its principal place of business
is in the United States (N.D.), meeting the requirements of A .1. It is an
Exchange Act reporting company, as required by A .2. We would need to
5
know if it has been reporting for at least 12 months and has filed all of its
reports in a timely fashion, as required by A.3. We also need to know
whether Acme has, since the filing of its last year-end financial statements,
materially defaulted on any preferred stock dividends, debt, or long term
leases. If so, it would be ineligible under A .5.
Transaction Requirements
Acme’s offering must also fall within one of the transact ion requirements in
Instruction I.B. This transaction probably fits within B.1. It is an offering
for cash and the aggregate market value of Acme’s voting and non-voting
common equity is $630 million, well above the $75 million level. As long as
at least $75 million of that is held by non-affiliates, Acme is eligible to use
Form S-3. None of the other possibilities fits. Paragraph B.6 wouldn’t work
because the amount to be sold, $300 million, is more than 1/3 of the
aggregate market value of common equity without even excluding any
shares held by affiliates.
Whether Acme is a WKSI
For a shelf registration to be automatically effective, the issuer must be (1) a
well-known seasoned issuer under Rule 405(1)(i)(A) or (2) a WKSI under
405(a)(i)(B), if the offering meets the transaction requirements of
Instruction I.B.1. Acme’s offering will be within I.B.1, so the offering would
be eligible for shelf registration if Acme falls within either category of
WKSI.
Acme could be a WKSI within the meaning of Rule 405(a)(1)(i)(A),
assuming it meets the registrant requirements of instruction I .A of Form S3, discussed earlier. The market value of its common equity, including non voting common equity, is $725 million, more than the $700 million cutoff.
However, if Acme’s affiliates own more than $25 million of its outstanding
equity, Acme would not be a WKSI because the $700 figure excludes
securities owned by affiliates.
If Acme does not fall within 405(a)(1)(i)(A), Acme would not be a WKSI.
Subsection (a)(1)(i)(B) clearly does not apply to Acme. The question
indicates that Acme has no outstanding securities other than its common
stock, so Acme has not issued any securities other than common equity.
Certain companies are disqualified from being WKSIs, but the problem
indicates that Acme is not an ineligible issuer, (iii), an asset -backed issuer
(iv), or an investment company or business development company, (v).
6
Therefore, assuming it has been a reporting company for more than a year,
is timely in its reports, and the common equity held by its affiliates is less
than $25 million, Acme is eligible to do an automatic shelf registration.
7
Question Three
The relevance of these factors depends on whether the particular investment
involves stock, a note, or some other type of investment.
Corporate Stock—All Factors Irrelevant
If the investor is buying ordinary corporate stock, none of the factors makes
any difference. Ordinary common stock is a security, regardless of any of
these facts. Landreth Timber.
Factor No. 1
If the investor is receiving a note for his investment, the first factor could be
relevant under the third factor of the Reves family resemblance test, which
looks at the reasonable expectations of the investing public. The language in
the brochure could be used to show that the investors did not reasonably
believe this to be an investment. However, not every part of the family
resemblance test needs to be met for a note to be a security, and this is
probably the least important factor, so it could still be a security.
If the investment is some other kind of instrument, the Howey investment
contract test would apply. Under that test, what the brochure says appears
irrelevant. An investment contract must involve an investment of money
with an expectation of profits, but the language in the brochure doesn’t
matter, only the actual characteristics of the investment.
Factor No. 2
If the investor is receiving a note, this could be relevant under the second
part of the family resemblance test—the plan of distribution. Obviously,
with one investor, there could be no common trading for speculation or
investment, and the note is not offered to a broad segment of the public.
But, again, the Reves test does not depend on any single factor, so it could
still be a security.
If the Howey investment contract test applies, this would be relevant under
the common enterprise requirement. There would be no horizontal common
enterprise if there’s only one investor, assuming there aren’t additional
investors resulting from other, prior offerings. However, if the promoter
offered to multiple investors and only one accepted, the promoter could still
be offering a security. If the horizontal common enterprise test is not met,
the investment could be an investment contract, and thus a s ecurity, only in
jurisdictions which hold that a vertical common enterprise—a common
enterprise between the investor and the promoter—satisfies Howey.
8
Factor No. 3
This factor doesn’t matter under either Reves or Howey. The Edwards case
makes it clear that a fixed rate of return is sufficient expectation of profits
for purposes of the Howey test. And a note by definition often involves a
fixed rate of return. A fixed rate of return would still be a profit motivation
for purposes of the first prong of the family resemblance test under Reves.
If there is a fixed rate of return, Landreth is less likely to apply, even if the
investment is “stock.” One of the ordinary characteristics of stock is
dividends contingent on an apportionment of profits.
9
Question Four
Section 5 of the Securities Act
Section 5(b)(1) of the Securities Act makes it unlawful to transmit a
“prospectus” for a security with respect to which a registration statement
has been filed, unless that prospectus meets the requirements of section 10.
Seller’s registration statement has been filed, so § 5(b)(1) applies. And the
June 1 report could be a prospectus. A prospectus is, among other things, a
written offer to sell. Sec. 2(a)(10). The report is written. Rule 405 defines
“written communication” to include “graphic communication” and it
defines “graphic communication” to include electronic web sites.
An offer to sell is any attempt to dispose of or solicitation of an offer to buy
a security, § 2(a)(3), and the SEC has indicated that anything that
conditions the market to buy the security can be an offer to sell. Broker’s
distribution of information about Issuer and its offering could generate
interest in buying the Issuer stock. And Broker, as a participant in the
offering, clearly has a motivation to generate such interest.
The Rule 139 Safe Harbor
The SEC has promulgated a couple of safe harbors that allow brokers to
distribute reports without running afoul of section 5. Rule 137, one of
those safe harbors, does not help Broker because it only applies to non participants in the offering. Rule 137(a). Rule 138 only applies when the
report relates to common stock and the offering is of non-convertible
preferred stock or debt, or vice versa, and that isn’t the case here. Thus,
Broker’s only option is Rule 139.
Rule 139 authorizes two types of reports: (1) issuer -specific research reports
and (2) industry reports. Rule 139(a)(1), dealing with issuer-specific reports
is not available. The issuer must meet the registrant requirements of Form
S-3, 139(a)(1)(i)(A)(1), and Issuer is not eligible to use Form S-3.
For Broker to use Rule 139(a)(2), Issuer must be a reporting company, Rule
139(a)(2)(i) and it may not be a blank check company, a shell company, or
an issuer of penny stock. Rule 139(a)(2)(ii). It is unclear whether Issuer
meets these requirements; if not, the Rule 139(a)(2) safe harbor is
unavailable to Broker.
Broker must distribute the report in the regular course of its business,
(a)(2)(v), but that appears to be the case. The distribution is irregular and
sporadic, but it is done as part of Broker’s regular course of business.
10
Broker must also include in the reports similar information about a
substantial number of issuers in the industry or sub-industry. Rule
139(a)(2)(iii). This requirement is probably not met. Each of the two
reports only includes information about three companies out of twelve.
That doesn’t seem to be a “substantial number” of issuers.
Broker must also be including similar information about the issuer and its
securities in similar reports. Rule 139(a)(2)(v). Issuer also appeared in the
January report, but information about the offering was not included,
because it had not begun at the time. Broker does include information
about offerings when they occur, but is that enough to meet (a)(2)(v)?
Finally, the information about Issuer in the report must be given no more
space or prominence than information about the other companies, Gamma
and Delta. Rule 139(a)(2)(iv). We don’t know if that requirement is met.
In short, Rule 139 looks problematic, and therefore, Broker may violate
section 5(b)(1) if it distributes the June report.
Other Possible Safe Harbors
Rule 433, the free-writing prospectus rule, would not help. Issuer is not
eligible to use Form S-3, so it would not be a seasoned issuer. See Rule
433(b)(1). Therefore, to use Rule 433, the report would have to be
accompanied by Issuer’s preliminary prospectus and include a cautionary
legend. See Rule 433(b)(2)(i), (c)(2). There is no indication that Broker did
that.
Rule 134 would not be available because the information included in
Broker’s report (for example, financial statements) is beyond what Rule
134(a) allows.
Other possible safe harbors, such as Rule 169, are available only to the
issuer, and would not help Broker. See Rule 169(a) (“by or on behalf of the
issuer”).
11
Question Five
Section 5 and the registration requirements of the Securities Act apply to
resales as well as offerings by an issuer. The usual statutory exemption for
resales is section 4(1), bolstered by two safe harbors, Rule 144 and 144A.
Rule 144A clearly is not available here. It applies only to resales to qualified
institutional buyers, and the buyer, Daughter, is clearly not an institution.
See Rule 144A(a)(i).
RULE 144
Is Seller an Affiliate?
The requirements of Rule 144 depend on whether Seller is an affiliate of
Beta, as defined in 144(a)(1)—in particular, whether he controls Beta.
Control is defined as the power “to direct or cause the direction of the
management and policies of a person” and can include control through
contract. Rule 405. Here, Beta cannot engage in any extraordinary
transactions without Seller’s approval—either actions outside the ordinary
course of business or involving more than $100,000 in assets. But Seller
does not have any power over smaller transactions, is not involved in day -today management, and has no authority over the policies of Beta. He also
does not have the power to force Beta to file a registration statement. It is
unclear if he has enough control to make him an affiliate.
If Seller is Not an Affiliate
If Seller is not an affiliate, Rule 144(b)(1)(ii) applies because Beta has not
been subject to the reporting requirements of the Exchange Act for 90 days
prior to the sale. The Rule 144(b)(1)(ii) safe harbor is available to Seller only
if he is selling “restricted securities” and only if he meets the condition in
paragraph (d).
The common stock is clearly a restricted security. Where securities are
acquired in an exchange, they acquire the characteristic of th e securities
that were exchanged. The original preferred shares were acquired in a
private offering, so the common would be restricted securities within the
meaning of subsection (a)(3)(i).
Seller must also comply with paragraph (d). Since Beta has not been a
reporting company for 90 days, (d)(1)(ii) applies. A minimum of one year
must have elapsed since Seller acquired the securities from the issuer.
However, if the securities were acquired from the issuer in exchange for
other securities, the holding period runs from the date the original securities
were acquired. Rule 144(a)(3)(ii). Thus, the holding period runs from June
12
1, 2010, when he acquired the preferred stock, which he exchanged to get
the common. He sold on April 30, 2012, obviously more than a year later,
so he has met the required holding period. If he is not an affiliate, the sale
is exempt and he did not violate the Securities Act.
If Seller Is an Affiliate
If Seller is an affiliate, Rule 144(b)(2) applies. He must meet all of the
conditions of 144. Since Beta has not been a reporting company for 90 days,
the public information requirement of 144(c)(2) applies. Beta probably
meets this requirement because of the information filed and publicly
available in its initial Exchange Act report. As previously indicated, Seller
meets the holding period requirement of (d). He is also within the limit on
the amount of sales in subsection (e). The limit is the greater of the weekly
reported trading volume (essentially, zero here) or 1% of the amount
outstanding. That limit would be 1% of 500,000, or 5,000 shares, and S eller
is within that limit. But subsection (f) requires that the securities be sold in
brokers’ transactions. The problem says nothing about a broker, so this
condition is probably not met
If Seller is an Affiliate—Outside the Safe Harbor
Even if he doesn’t qualify for the Rule 144 safe harbor, Seller might still
have an argument under section 4(1) itself. Section 4(1) covers transactions
not involving an issuer, underwriter or dealer. Ne ither Seller nor his
daughter is an issuer or a dealer. The question is whether there is an
underwriter involved.
Seller is not selling for the issuer, so he would be an underwriter only if he
purchased from the issuer with a view to distribution.


Investment Intent. Again, the common stock acquires the
characteristics of the preferred stock for which it was exchanged. The
question is whether Seller intended to resell or to hold the stock. The
bend point in the case law for establishing investment intent is
typically two years, and Seller held the stock, from the original issue
of the preferred, for only 18 months. However, the two-year
presumption was established when Rule 144 itself had a two -year
holding period. Now that the Rule 144 period is shorter, perhaps a
court could be convinced that the holding period under 2(a)(11) ought
to be correspondingly shorter.
Distribution. Even if he can’t establish investment intent, Seller is an
underwriter only if his resale is a distribution. Distribution has two
different meanings, but they’re equivalent here. Before securities have
come to rest, resales inconsistent with the issuer’s exemption, in this
13
case section 4(2), constitute a distribution. For resales by affiliates,
even after the securities have come to rest, “distribution” is usually
equated with “public offering” under section 4(2), and that depends
on whether the buyer can fend for herself. Daughter is
unsophisticated and unaccredited and has no relationship to Beta, so
she doesn’t have the sophistication and access to information that
would be required under section 4(2). However, there is not an exact
equation between public offering under section 4(2) and distribution
under section 2(a)(11), and Seller’s sale is limited to one person, so
this still might not be a distribution.
If this part of the definition of underwriter doesn’t apply, the second part
clearly doesn’t apply. No one here is selling for the issuer or for a control
person. Even if Seller is a control person, no one is selling on his beha lf.
Selling for oneself does not make one an underwriter.
14
Question Six
Rule 147
Rule 147 would not be available. Lone Star is a resident of Texas under
subsection (c)(1)(i), but it does not meet all of the doing business
requirements. All of its gross revenues are derived from operations in Texas.
Rule 147(c)(2)(i). And at least 80% of its assets are located in Texas. Rule
147(c)(2)(ii). It has total assets worth $50 million and it has only spent $3
million on the Oklahoma plant. Its principal office is in Texas. Rule 147
(c)(2)(iv).The problem is Rule 147(c)(2)(iii). Lone Star does not intend to
use at least 80% of the net proceeds “in connection with the operation of a
business or of real property, the purchaser of real property located in, or the
rendering of services within” Texas. It will use the money to continue
construction of the plant in Oklahoma, and to support the eventual
operation of that business in Oklahoma.
The prior offering was probably not confined to Oklahoma, but integration
is not a problem. The Rule 147(b) six-month safe harbor would protect this
offering from integration and the Rule 502(a) safe harbor would protect the
Rule 505 offering from integration.
Carfix appears to be an acceptable purchaser under Rule 147(d)(1) because
its principal office is in Texas. However, the professors would not be, since
they teach across the country and would not all have their principal
residences in Texas. Rule 147(d)(2). The general partnership would be
acceptable. It’s formed for the purpose of the offering, but that’s not a
problem, because all of its beneficial owners are Texas residents. Rule
147(d)(3).
Regulation A
Regulation A would also not be available. It is also limited to non -reporting
companies. Rule 251(a)(2). Otherwise, it would be available. The of fering
amount limit is $5 million, less than the $3 million Lone Star intends to sell.
And only offerings pursuant to Regulation A in the last 12 months reduce
that limit, so the Rule 505 sales would not affect th e limit. Integration
would also not be a problem. Rule 251(c) says Regulation A offerings will
not be integrated with any prior offers or sales.
Rule 504
Rule 504 is not available. Issuers that are subject to the reporting
requirements of the Exchange Act may not use it. Rule 504(a)(1). In
addition, Lone Star is seeking to raise $3 million and the 504 limit is $1
15
million. Further, that amount must be reduced by amounts sold pursuant to
a 3(b) exemption in the last 12 months, and the Rule 505 offering is a § 3(b)
exemption, so the effective amount is now $0. The previous R. 505 offering
will not present an integration problem because of the Rule 502(a) safe
harbor.
General solicitation is generally prohibited in Regulation D offerings,
including some, but not all, Rule 504 offerings, but gene ral solicitation is
not a problem because Broker has a preexisting relationship with all of the
offerees.
Rule 505
Rule 505 is also not available. First, the offering amount is limited to $5
million, reduced by the amount of, among other things, § 3(b) offerings in
the last 12 months. Rule 505(b)(2)(i). Subtracting the $4 million sold seven
months ago in the 505 offering, that only leaves $1 million, less than the $3
million Lone Star needs to raise.
Rule 505 also limits the number of purchasers to 35, Rule 505(b)(2)(ii), and
this offering would exceed that limit. The 20 college professors would count
as 20 purchasers. Carfix would ordinarily count as one purchaser, since it
was not formed solely for purposes of investing in this offering. Rule
501(e)(1)(3). However, it is an accredited investor under Rule 501(a)(3), so it
is excluded from the count. Rule 501(3)(1)(iv). Magna was formed solely for
this offering, so it would not be counted as one purchaser. Rule 501(e)(2).
We have to count each partner as a separate purchaser. The twenty partners
with net worths in excess of $1 million are accredited investors. Rule
501(a)(5). As accredited investors, they aren’t counted. Rule 501(e)(1)(iv).
However, the other 20 don’t appear to be accredited, so they would count.
That results in a total of 40 purchasers, in excess of the limit.
Rule 506
Rule 506 also has a 35-purchaser limit. Rule 506(b)(2)(i). The rules for
counting are exactly the same, so this would also be violated. The Rule
506(b)(2)(ii) requirement would not be a problem. The 20 college professors
do not appear to be accredited, but their finance and investment background
probably gives them “such knowledge and experience in financial and
business matters that . . . [they] . . . are capable of evaluating the merits and
risks of the prospective investment. Carfix, with assets in excess of $20
million, would be an accredited investor under Rule 501(a)(3). However,
Magna would not be an accredited investor. I t doesn’t fall within Rule
501(a)(3) because it was formed for the specific purpose of acquiring the
securities offered. It doesn’t fall within Rule 501(a)(8) because not all of its
16
partners are accredited investors. Therefore, Magna would have to meet the
sophistication requirement. That shouldn’t be a problem, however, because
all of its investors are sophisticated, so whoever is making the investment
decisions on its behalf would undoubtedly meet the sophistication
requirement.
Rules 144 and 144A
Neither of these exemptions applies because they deal with resales, and this
is an original offering by the issuer, not a resale.