Goals of regulation

Solve information asymmetry + agency problems ● Protect integrity of capital markets/increase accuracy Overcome collective action problem ● Cure potential for greedy behavior/manipulation

Is it material?

Yes, if substantial likelihood that disclosure would have been viewed by the reasonable investor as having significantly altered the cumulative total mix of info affecting the investment decision (TSC) Probability x magnitude (Basic) should affect >5% of earnings (SAB 99) unless qualitative trumps Prove with event studies after the fact (since fraud caused inflation, so after truth price should drop)

Is it a security?

Because §5 prohibits

offer or sale of

unregistered, non-exempt securities

Keeping substance over form and the policies of regulation in mind, yes if:1. Instrument commonly known as a security

a. Stock (usually w/ dividends, transferability, voting rights, appreciation)b. Note (presumed considering motivation, distribution, public expectation, & risk reducing alt (Reves))

2. Specified by §2(a)(1) as a “security” or3. Covered by catchall “investment contract” (Howey)

a. Investment of specific considerationb. In a common enterprise (horizontal or vertical [broad/narrow] commonality)c. With expectation of profitsd. “Solely” from managerial efforts of others

Is it a public/ reporting company?

Yes if:1. Completed IPO via Securities Act (see below)2. §12(a) listed on an exchange 3. §12(g) >500 SHs of record + $10m in assets or4. §15(d) effective registration statement for a public offering under the Securities Act

Exchange Act obligations for public companies

Reporting obligations §13(a) or §15(d) (integrated via Reg S-K)o Form 8-K = current report triggered by certain eventso Form 10-Q = quarterly report (non-audited financials)o Form 10-K = audited financials

Accuracy of books/records §13(b) (strict liability; need internal controls, no bribery, etc.) No voluntary selective disclosures to covered persons (= expected to trade) Reg FD

o If unintentional, then 8-K disclosure to public within 24 hours. If intentional, simultaneousPublic offering process (aka gun jumping rules in ISC)

Reg M limits market manipulation after distribution by participants

Pre-filing “quiet” period = after “in registration” (= talk w/ bank) and before filingo No offers §5(c) as defined in §2(a)(3) (about conditioning the market)

Safe harbors = issuer-underwriter communications and Rules 163A (30 days), 163 (WKSI), 168-69 (FBI for non-reporters, FBI+ for reporters), and 135 (tombstone ads)

o No sales §5(a) Waiting “cooling off” period = after filing and before declared effective

o Oral offers ok; written offers ok if w/ a §10(b) preliminary prospectus §5(b)(1) FWP Rule 164 ok if meets Rule 433 (= accompanied/preceded by & consistent w/ §10(b), legend, filed) Safe harbors:

From before = Rules 168-69 and 134 (expands 135 so can include underwriter’s name w/ legend) For analysts’ research reports in regular course of business Rules 137-139 (also in pre-filing per.)

o No sales §5(a) Post-effective period = after declared effective and before finish selling

o Sales ok if w/ a §10(a) final prospectus §5(b)(2) (access = delivery Rule 172) Updating

o Must keep §10(a) prospectus relatively fresho Registration only needs to be accurate on effective date, but amend if substance change

Issuer offerings exempted from §5

1. Specific securities §3(a) and others as SEC sees fit §3(b)2. Private placements §4(2) = offerees can “fend for themselves” (access/actual disclosure + sophistication)3. Reg D safe harbors (providing clarity to §3(b) w/ Rule 504 and §4(2) with Rules 505-506)

o See chart in outlineSecondary market transactions (aka resales) exempted from §5

§4(1) ordinary trading exemption (if not an issuer, underwriter, or dealer) Underwriter if §2(a)(11):

o Purchases from issuer w/ view to distribution (can argue personal changed circumstances) oro Direct/indirect participation in or underwriting of distribution

Control person liability = even if not underwriter, liable if person you sell to is acting as his underwritero Avoid with §4(1 ½) exemption = if buyer can “fend for himself” then no distribution so not underwriter (or

now use Rule 144) Rule 144 safe harbor from classification as an underwriter

o = allows non-affiliates to resell restricted securities, and affiliates to resell any (otherwise they couldn’t)o See chart in outline, but essentially:

Non-affiliates ok after 1 year

Affiliates ok after 1 year if info is available, limit amount sold, and only certain manner of sale

Rule 10b-5 (implements §10(b)) in EA §11 in SA §12(a)(1) in SA §12(a)(2) in SAScope (jx and transaction nexus)

Fraudulent devices, material misstatements/omissions, or fraudulent acts in connection w/ purchase/sale of any (= registered or exempt) security in ISC remember PSLRA heightened standards

Material misstatement/omission in registration statement (including prospectus) as of effective date used in ISCeffectively only applies to public offerings

Violation of §5 gun-jumping rules

not about fraud (liable merely if it was a security offered/sold without being registered or exempt)

Material misstatement/omission in prospectus or oral offering related to public offering in ISC not secondary market transactions (Gustafson)

Standing SEC enforcement or Implied private COA for purchasers

(Blue Chip) and sellers

Private COA for purchaser Private COA for purchasers Private COA for purchaser

Ds Primary violation (speak via Stoneridge)o Buyers/sellerso IPOs/secondary market

Aider/abettor for SEC only (Central Bank)

Control person §20(a) o Split as to whether potential

control or culpable participationo Has good faith defense

Signee Directors Underwriters Experts who prepared/certified Controlling person = one who

controls someone liable §15 (absent good faith defense)

Statutory sellero Owner passes title oro Person who solicits

purchase motivated partly by his/issuer’s $ interests (Pinter)

Controlling person §15 (absent good faith defense)

Same as §12(a)(1)

Causation Loss causation No, but see loss causation defense No No, but see loss causation defenseReliance Transaction causation for private COA

If omission or duty, no requirement If misstatement:

o Individual reliance if face-to-faceo Presumption via fraud on the

market if not (Basic)

Tracing is enough No No

Scienter Need actual motive, knowledge, or recklessness (so > negligence, unlike §11)

No, but see due diligence defense No No, but see reasonable care defense

Damages Yes Yes No No

SOL 2 years of discovery5 years of fraud

1 year of discovery3 years of offering §13

1 year of discovery3 years of violation §13

1 year of discovery3 years of prospectus/oral offer §13

Defenses None?

Note: Insider Trading

P’s actual knowledge (or §21E) Loss causation Due diligence (not for issuer; it

has strict liability)o Expert = reasonable

investigation for expertised o Non-expert = reasonable

invest. for non-expertised; red flags for expertised

None P’s actual knowledge Loss causation D’s lack of knowledge and

reasonable care

Remedy Unlimited Damages Rescission or damages Same as §12(a)(1)

-----------------------------------------------------INTRODUCTION-------------------------------------------------------

I. Capital Markets a. = ways to facilitate trading of capital represented by securities

i. = socio-economic contractual relationship between entrepreneur and inputs (workers, investors, customers, suppliers) he needs to produce output he can sell for profit and/or

ii. = fictitious representation of value (both nominal and dynamic since no business exists in a vacuum)

b. Kinds (privilege to be on these, not a right)i. Specialist markets (e.g. NYSE)

1. Accepted companies have a specialist firm (aka continuous auctioneer) that sets the trading price each morning via a quote to buy and sell and has an obligation to buy or sell to maintain liquidity and an orderly market and to break price falls (gets commissions)

2. Public since 2006, so no longer operated by underwriters and fewer regsii. Dealer markets (e.g. NASDAQ and bond markets; no central exchange like NYSE)

1. Brokered deals where market makers set quotes, but have no obligation to enter market to support price (paid purely from spread)

2. Takes more high risk stocks than NYSE, so spread is higheriii. Electronic Communications Networks (aka ECNs)

1. Alternative system w/ automated, anonymous matching and public prices2. Gives people speed they want to reduce the risk of big price changes 3. Allowed by Reg NMS

iv. Dark Pools 1. A type of ECN within one firm where someone like Goldman buys securities to

match with clients (and sell at a profit)c. Efficient market hypothesis = securities market price of an actively traded security incorporates

info related to it b/c intermediaries are informed, so individuals obtain info indirectly via priceHypothesis: Weak Semi-Strong (most likely) StrongDefinition: All info concerning

historical prices is fully reflected in current price

Current prices incorporate all historical and current public info (just noise?)

Prices incorporate all info (public & not, so might as well legalize insider trading)

Implication: Prices change only in response to new info, so don’t waste time looking at history

Investors can’t expect to profit from studying available info b/c market has already incorporated it

No identifiable group can earn systematic positive abnormal returns (i.e. can’t beat the market)

i. Basis of fraud on the market theory (i.e. that investors rely on info b/c rely on price)ii. Price efficiency = adjustment to news happens super rapidly, so hard to beat it. And even

if price doesn’t reflect true value, relative changes are. iii. Criticism = This is all noise. Investor behavior isn’t rational and both over and under

react, and market fragmentation (i.e. trading on both NYSE and ECN) affects the price 1. But markets for non-start ups are usually efficient

d. Types of transactionsi. Primary = when company offers and sells its own securities to investors

ii. Secondary = when one investor resells securities of the issuer to another investor

e. Playersi. Issuer = company that is offering its shares (via private offerings primary public

offering, or secondary/seasoned offerings) ii. Investment bank = intermediary between investors w/ capital and entrepreneurs without

1. Underwriter side = help issuers set price and sell in offerings (profit in spread)2. Analyst side = research opinions about potential investments to get ppl to buy3. Dealers = proprietary buyer and seller for an investment bank (builds its account)4. Brokers = facilitates secondary transactions making internal matches or routing

a. Can place limit order (= broker will buy when that price happens) or market order (= buy at whatever price it is now)

b. They are your nominee and own your stock in street name (= company has you down as them), but you’re beneficial owner

iii. Attorneys = draft disclosures to SECiv. Accounting firms = audit financial statementsv. Institutional investors (ex. mutual funds, index funds, pensions, insurance companies)

II. Securities Valuationa. = way to take future risks into account when valuing something today

b. Present Value (PV )= C(1+R)T

i. Cash flow (C) = annual return (ex. $10m of Treasury notes that mature in 2 years and pay 10%

annually and returns principal:PV= $ 1m(1+.05)1 +

$ 11m(1+.05)2 )

ii. Discount rate (R) = interest rate of return (= compensation for deferring consumption, risk of inflation, and uncertainty)

1. Use 5% if nothing given (ex. $10m in a safe for 2 years: PV = $ 10 m(1+ .05 )2

)

iii. Time period (T)

c. For common stock and perpetuities, just use PV =CR (while dividends aren’t guaranteed

there’s an imputed rate of return b/c fiduciary duties make stock ↑)d. CAP-M to determine R precisely (based on notion that markets are efficient—see below)

i. R stock+rf +betas(rm−rf )1. rf = risk free rate (i.e., US Treasury bonds, ~3%) 2. betas = how stock is affected by systematic risk (= affects everyone, but not in

same magnitude. High beta = more risk, and 1 = same as market)a. Unsystematic risk affects companies differently, so lower by diversifying

3. rm = market rate (i.e., S&P 500, ~11%)III. Regulatory Apparatus (enacted during Great Depression)

a. = single federal, mandatory disclosure regime run by the SEC (different divisions & offices which make rules and bring enforcement actions)

i. Goal = protect investors from abuses by insiders and market professionals w/ more info, discourage speculative frenzies, and change incentives to reduce agency costs and fraud

ii. If shareholders don’t like what they learn they have remedies:

1. Sell2. Sue derivatively3. Vote to oust board

4. Use publicity to pressure board5. Encourage collective action

b. Why we need it Deals with lemon problem (aka “used car” problem)

1. = information asymmetry between buyers and sellers means buyers can’t tell the difference between good and bad used cars so they apply a discount to all or are hesitant to even enter the market

Fixes collective action problem (firms have competitive risks and won’t disclose everything on their own unless everyone else has to)

Reduces coordination (don’t have to comply w/ 50 different laws) Avoids some manipulation (ex. ban on some insider trading) Reduces duplicative research Increases accuracy of prices (but could also help competitors?) Regulators are human and SEC is a monopoly

c. Statutes that make up federal regimei. Securities Act of 1933 = re: primary transactions by issuers

1. Gun jumping, registration, prospectus and integrated disclosure rules for public offerings (with some exemptions)

2. Antifraud liability for public offering documentsii. Exchange Act of 1934 = re: secondary transactions between investors (created SEC)

1. Mandatory periodic disclosure for reporting companies (10-K, 10-Q, and 8-K)2. Antifraud liability (10b-5)3. Anti-manipulation provisions

iii. Williams Act of 1968 (codified in Exchange Act) = disclosure re: tender offersiv. Sarbanes-Oxley of 2002 (post Enron)

1. Regulates auditors, requires audit committees, up the ladder reporting CEO/CFO certification of 10-K and 10-Q filings

v. Dodd-Frank (post 2008 blow up of systematic risk in securitization of housing market)1. SH proxy access; disclosure of pay vs. performance, employee hedging, and CEO

pay disparity; whistleblower provisions, advisory “say on pay” vote, etc.d. Other regimes

i. Blue Sky (aka state) laws largely preempted, but still apply if you’re doing a limited offering only in that state

1. And those require you to justify the price you’re asking for on its meritsii. And self-regulatory organizations (SROs) have had rulemaking delegated to them by

SEC (ex. NYSE and NASDAQ are regulated by private FINRA)

Remember: SEC thinks about everything functionally to obtain its policy goal of protecting ordinary investors from losing their money w/ full and fair disclosure. They’re flexible and stress substance/form.

------------------------------------------------------MATERIALITY---------------------------------------------------------

Disclosure must be materially accurate/complete, so absent duty, silence is golden (or “no comment” if normal)

I. Basisa. Statutory

i. §10(b) & Rule 10b-5 antifraud liability based on misstatement/omission of material fact (Food Lion = not puffery about clean stores, b/c reasonable investors wouldn’t rely on that)

ii. Rules 408 and 12b-20 requirement for additional material info to be disclosed to avoid creating a misleading omission

iii. Reg S-K (ex. Item 101 Business Description: info >5yrs must be disclosed if material) b. Common law

i. If substantial likelihood that the disclosure would have been viewed by the reasonable investor (objective standard) as having significantly altered the total mix of info (TSC)

1. Total mix of public info about company = cumulative (Food Lion = claims about overtime were in mix b/c of union warnings, so market had already incorporated that into price)

2. And can’t just bury facts and defend by saying “it was there somewhere”c. Applies to: registration statements (IPOs and stock acquisitions), periodic reports, and insiders

II. Tests (Franchard = omission of controlling person’s (whose reputation the co. is based on) personal use of co. funds for and encumbrances on his stock material b/c reflects poorly, and now must be disclosed per Item 400s of Reg S-K. But board’s compliance w/ fiduciary duties need not be since securities laws don’t seek to define everyday responsibilities)a. Basic = materiality will depend at any given time upon a balance of (Basic = lied about merger neg.):

i. The indicated probability the event will occur (risk of hindsight bias) and1. Ex. m/a is “probable” enough for disclosure once you sign a letter of intent/merger

agreement (i.e. late in the process, since telling too early will lead to valuation free riders and discourage potential bidders in the first place)

ii. Anticipated magnitude of the event in light of the totality of the company’s activity (Matrixx = drug co.’s failure to disclose plausible (although not statistically significant) medical reports that allergy medicine caused loss of smell is material omission b/c FDA cared about them and fixing allergies isn’t worth any chance of losing smell. Behavioralism > science)

b. SAB 99 = probability x magnitude should be >5% of earnings, but qualitative can be more important than quantitative, examples:

Affects compliance w/ regulatory or K requirements Hiding failure to meet analysts’ expectations Effect of increasing management’s compensation Masking a change in earnings or other trends

Concealment of an unlawful transaction Info on part w/ significant role in operations/profits

(Litwin = PE’s investment in co. is <5%, but that co. is part of flagship segment of PE’s portfolio and was expected to trigger clawback provision of executive comp., so material)

c. Event studies (alternative to rules of thumb by using external events) = fraud causes stock to inflate, so once the truth comes out the stock should fall (In re Merck = omission not material when all of info needed to make it clear was already public and price ok, even if price dropped after explicit public disclosure)

i. But need to be sure this wasn’t random and other variables didn’t cause it (experts!)ii. Method = ID event date and window, see if return is abnormal compared to CAP-M

Note effect of forward-looking info rules, “bespeaks caution” CL, and PSRLA “cautionary language”

iii. Courts usually accept this if statistically significant for companies with publicly traded stock that trades in liquid and efficient secondary markets

---------------------------------------------“SECURITY” UNDER 2(a)(1)----------------------------------------------

Securities laws apply only to offers and sales of instruments that are or purport to be securities (since interest in protecting investors from forged or nonexistent securities if represented as such)

I. Introductiona. Broad interpretation of the definition of “security” under 2(a)(1) to help SEC meet its goals

i. Substance over form b. So always keep in mind genuine “securities” transaction characteristics:

i. Information asymmetryii. Collective action problem

iii. “Closeness” to capital markets (goal is to protect their integrity)iv. Potential for greedy behavior (so sophistication of parties doesn’t matter)v. Lack of another comparable regulatory regime (IBT = noncontributory, compulsory pension plan w/

defined benefit isn’t b/c covered by ERISA) (Marine Bank = CDs aren’t b/c subject to banking regulations)1. Scams are covered by state consumer protection laws, but that’s not enough b/c

threatens integrity of financial markets (SG Ltd = pyramid scheme)

II. Is it an instrument commonly known as a security?a. Stock (if it purports to be stock [common or preferred] and has normal characteristics, then ok)

i. Bu can’t just call it stock if it doesn’t have these characteristics (Forman = “stock” to let you lease an apartment in a co-op is not a security b/c no rights of stock and not likely someone thought it was):

1. Dividends or buybacks2. Transferability (and negotiability/ability to be pledged?)3. Voting rights in proportion to number of shares owned4. Capacity to appreciate in value (tied to liquidity)

ii. OLD: sale of a business doctrine = not a security if you’re buying the whole business b/c then you’re buying control (so like an asset purchase) and don’t need protection

1. NO LONGER GOOD LAW (Landreth = sale of all stock of a company is a security transaction b/c complies with Congress’ purpose of protecting investors w/ full and fair disclosure)

b. “Any Note” considering the Reves factors and whether it resembles risks of equity investment (balancing test, so don’t need all) (Reves = note payable on demand by a co-op is a security b/c purpose to raise capital and make profits, offered to public, characterized as such in investments, and would otherwise not be regulated):

i. Buyer and seller motivations (investment or consumer purchase?)ii. Plan of distribution (public trading & collective action problems?)

iii. Expectation of the public andiv. Risk reducing alternatives (other regulatory scheme?)

Cash Flow Rights Liquidation Rights

Voting Rights Misc.

Common stock

Dividend (residual & discretionary)

Residual Yes, but limited Board may also repurchase stock, otherwise earnings are retained

Preferred stock

Dividend (fixed & discretionary)

Medium Negotiated via K (often contingent)

Were more like bonds (fewer preferences; issued to up equity for debt ratio, but now VCs get conversion)

Debt (senior Fixed interest Highest None Ex. notes, bonds, indentures (longest-term). Interest

Notes are presumed to be securities, but P can rebut by using Reves

Even if you’re the sole SH so no agency costs, corp. form dictates result

& junior) payment deduction, whereas dividends are taxed twiceIII. Is it specified by §2(a)(1) as a “security”? or

a. E.g., fractional undivided interest in oil, gas, or other mineral rightsIV. Is it covered by the catchall “investment contract”? See Howey 4-prong test (Howey =

opportunity to share in profits of a citrus grove by selling strips of land managed by third parties as sole incentive since individual development would not be economically feasible is an investment contract so it’s a security and must register):a. An investment of money = giving up specific consideration in return for (aka this is the real intent)

a separable financial interest (IBT = not w/ noncontributory pension plan since didn’t give up specific consideration in return for a separable financial interest b/c decision to work was to make a living, so this is just incident to employment like employee profit-sharing plans. But yes w/ voluntary contributory plans, but exempt under §3(a)(2))

b. In a common enterprise (Circuits are split on form of commonality required so go through all):i. Horizontal commonality = (majority view) focus on relationship between investors where

funds are pooled and profits/losses distributed pro rata so collective action problem + agency costs (SG Ltd = pyramid scheme b/c funds in 1 account & everyone shared in profits since guaranteed return)

ii. Vertical commonality = focus on relationship btwn investors and promoter—his activities must be controlling factor in success/failure of investment (same scheme but varying returns), so clear and significant agency costs even if no collective action problem

1. Broad = promoter must exert effort (so there’s a tie), but doesn’t take on risk2. Narrow/strict = promoter actually takes on risk, too

c. W/ expectation of profits (objective standard: capital appreciation or participation in earnings) andi. NOT for personal consumption (Forman = “stock” to lease an apartment is for personal use, not profits)

ii. Fixed or variable returns ok b/c still attracted by representation of investment income (Edwards = sale leaseback for payphones with contractual return of 14% ok b/c still default risk)

d. Solely from managerial efforts of others (“solely” = primarily/substantially) (Mutual Benefits = buying fractions of life insurance from terminally ill is an investment K even though effort came in pre-purchase life-expectancy analysis to choose what to pool together. No basis to exclude activities taken to insure success of investment)

i. Consider:1. Offered/sold with emphasis on economic benefits derived from another’s efforts?2. Offering of participation in a rental pool arrangement?3. Is purchaser materially restricted in his occupancy/rental of the unit?

ii. But modicum of effort by investor won’t exclude the scheme iii. So LPs are securities b/c limited partner is passive player depending on acts of general

partner with full discretion, like a SH (but GPs are not)1. If an LLC or other entity, analogize to LP and GP considering legal structures and

economic realities (Williamson) (Merchant Capital = interests in RLLPs count b/c illusory powers, inexperienced in this industry, and no realistic alternative to the seller/manager):

a. Legal power distribution (if member-managed then not a security b/c like a GP, but if manger-managed then security b/c like an LP)

b. Experience/knowledge (can they exercise legally sufficient control rights?) ori. General biz expertise doesn’t have to = expertise in this area

c. Ability to replace managing partner (unique experience or impossible voting structure), making plaintiffs dependent

iv. But buying land in fee simple isn’t, since profits would come from your effortsV. What about securitization? (See appendix)

Investor does nothing

Investor picks 1 orange

Investor relies on managers without control

Investor relies on managers with control

Investor does it all

If offer meets these then ok (need not be sale) b/c §5 prohibits offer or sale of unregistered, non-exempt securities

Success must depend on entrusting control to another (so high agency costs and collective action problems), not just supply/demand of a commodity. Ownership must be meaningfully separated from control!

a. These are securities! But their transactions are often exempted b/c sophisticated playersb. Use Howey if = issuance of interests directly in return from pool | Reves if issuance of debt backed by assets of pool

--------------------------------------PUBLIC COMPANY DISCLOSURES-----------------------------------------

All public companies are subject to mandatory disclosures and accuracy provisions under the Exchange Act

I. Types of Companiesa. Private company = shares closely held by managers and small circle of friends/family

i. Investment based on trust in character of mangers, with outside investment coming from VCs who vet and make contracts giving them substantial control

b. Public companies = more broadly dispersed so harder to get this info, which is why we need mandatory disclosures and accuracy to form this trust…

c. How to become a public (aka Exchange Act reporting) company:i. Connection with interstate commerce (ISC) and either:

1. IPO via Securities Act, triggering §15(d) reporting obligations (see next section) or2. Registration via Exchange Act, triggered by:

Triggering Event Obligations "Going Dark"

§12(a) 

Exchange listing  Can just list for liquidity, i.e. w/out raising money, but rare

Register §12(b) Reports & accuracy §13 Proxy/tender offer rules §14 Insider stock transaction

disclosures §16

Registration terminated if delisted 

§12(g) > 500 shareholders of record + >$10m assets  Beneficial (not legal) owners if form is used for circumvention 12g5-1(b)(3) 

W/in 120 days of close of fiscal year when you meet this: Register §12(b) Reports & accuracy §13 Proxy/tender offer rules §14 Insider stock transaction

disclosures §16

Registration terminated if certify under Form 15: < 300 holders or < 500 holders and < $10m in total assets on the last day of

each of its prior three fiscal years

§15(d) Effective reg. statement for public offering under Securities Act   Rare to get here w/out reaching 12(g)

Periodic reports per §15(d) (same requirements as §13)

Obligation suspended if certify on Form 15 < 300 holders For foreign private issues, Rule 12h-6 = registration

terminated if certify under Form 15F:o Reported for past 12 montho Listing on foreign jxo <5% trading volume in US or < 300 US holders

II. §13(a) or §15(d) Reporting Obligationsa. Introduction

i. Integrated disclosure informed by Reg S-K (for lawyers) & Reg S-X (for accountants)ii. CEO and CFO must certify reports filed with SEC are materially accurate per SOX §302

1. Must return bonus if results restated b/c misconduct SOX §304 (aka clawback)iii. Note: foreign private issuers use Form 20-F instead of Form 10-K

b. Form 8-K = current report (must be filed w/in 4 days) triggered by events in these categories:i. Business and operations

1. Material definitive agreements outside ordinary course of businessii. Financial info

1. Acquisition/sale of assets >10%, bankruptcy, off-balance sheet arrangements…

iii. Securities and trading markets (since affect liquidity and may lead to dilution)1. Delisting or transfer, material modification to holders’ rights, unregistered sales…

iv. Accountants/auditors (since could hurt credibility and price)v. Corporate governance and management

1. Change in control, amendments to charter, etc.2. Departure of directors (+ reason if resigned b/c of operational disagreement) (HP)3. Whether or not they have a code of ethics (i.e. shaming them into it)

vi. Asset-backed securities (ABS)vii. Reg FD compliance

viii. Other events “deemed of importance” by registrant (no time limit)ix. Current financial statements

c. Form 10-Q = quarterly reporti. Financials don’t need to be audited (but still must be GAAP per Reg G)

d. Form 10-K = annual report (often paired with proxy via Rule 14a-3), that must include info on:

i. Business (audited financials)ii. Properties

iii. Material legal proceedingsiv. MD&A of $ (forward-looking)v. Executive comp. (salary, perquisites

>$10k, in the money options, CD&A)

vi. Directors and officers (bios, misconduct if adjudicated or re: self-dealing/integrity [no 5th Am.])

vii. Security ownership of managementviii. Certain relationships and related transactions

ix. Principal accounting fees and servicesx. Outcome of SH votes

III. §13(b) Accuracy of Books/Records (from Foreign Corrupt Practices Act)a. Must keep books/ records in reasonable detail that accurately reflect transactions §13(b)(2)(A)

i. Strict liability and no materiality requirement b. Must devise and maintain a system of internal controls so §13(b)(2)(B):

i. Transactions and access to assets are authorized (generally or specifically)1. Must police consultant compliance, too (Oil States)

ii. Records generate useful info so financial statements can reflect GAAPiii. Records maintain accountability iv. Double check of recorded asses with existing assets at reasonable intervals

c. If knowingly circumvent , falsify records, or fail to implement, then criminal penalties §13(b)(4)d. And no bribes!e. Applies to stock options, so can’t backdate without telling (Brocade = can’t falsify date options are issued as

before you were hired to make then in the money [= stock price higher than exercise price])f. Need to report on these controls & have auditors attest to them if market cap >$75m SOX §404

IV. Reg FD Prohibition on Voluntary Selective Disclosures a. If employee of domestic Exchange Act reporting co. discloses non-public material info to a covered

person (= one reasonably expected to trade on the info, like a broker-dealer, investor, or investment advisor) (Siebel Systems = CEO’s private comments didn’t materially contrast with public comments b/c substance was equivalent, implications the same, and don’t need to parse every word, so no need for additional reporting per Reg FD)

i. But NOT journalists or temporary insiders, i.e. people owing/agreeing to a duty of trust (like attorney or family member)

b. Then company must ALSO disclose that info to the public via an 8-K or wide press releasei. If disclosure was intentional/reckless this must be simultaneous (if not then have 24 hrs)

c. BAD? Chilling effect, and prevents smoothing effect on prices if info is leaked over timed. Exclude oral communications of reporting companies in relation to offerings

-------------------------------------PUBLIC OFFERINGS AND SECTION 5--------------------------------------

I. Introductiona. Capital-intensive co. will eventually generate revenue but need to make expenditures now. Options:

i. Internally generated funds (like last year’s profits) or investments from foundersii. Banks (but they demand regular interest payments and numerous covenants)

iii. Private placement like Venture Capitalists (see below)iv. IPOs! (but then subject to expensive disclosure obligations and pesky SHs…see above)

b. Types of issuers:i. Non-reporting = not required to file reports under Exchange Act §13 or §15(d)

ii. Unseasoned = reporting, but doesn’t satisfy requirements for Form S-3 (see below)iii. Seasoned = can use Form S-3 (see below)iv. WKSI = can use Form S-3, not behind on filings in last 12 months, and has $700m of non-

affiliate common equity w/in 60 days of last shelf reg. or Form 10-K (with $1b in principal of non-convertible securities during past 3 yrs if issuing the same) per Rule 405

II. IPO Processa. Engage in discussions with an investment bank b. Decide on an offering type:

i. Firm commitment (majority) = underwriter guarantees sale of the offering by buying all shares at a discount then selling them itself (risk is accounted for via spread)

a. Green shoe = option to sell moreii. Best efforts = underwriter uses “best efforts” to sell as many as it can (can be conditioned

so rescind all sales if offering isn’t sold out) (usually for less established underwriters)iii. Direct public offering = to SHs or public directly (but investors want banks to screen)iv. Dutch auction = take bids, then choose the highest price that will result in a sellout (seen

as a way to avoid underpricing and help retail investors)c. Sign non-binding letter of intent w/ managing underwriter (= in charge of allocation, registration

statement, pricing [via road show], and due diligence)a. It then finds a syndicate of underwriters to help share risk (sign Ks among themselves)b. FINRA requires underwriting fees be reasonable, and SEC won’t declare registration

effective until FINRA agrees Rule 461d. File primary offering registration statement, which is either a:

a. Form S-1 (Part 1 = §10 prospectus, Part II = technical filings) orb. Form S-3/F-3 (easier b/c inc. by reference to prior filings, but then liable for them per §11)

i. = for issuers that have been an Exchange Act reporting company for 1 year, are current in SEC filings, and have >$75m of common equity in hands of non-affiliates (= public float requirement)

ii. If don’t meet last requirement, can still use if sales limited to 1/3 of public floate. Registration statement is effective after informal process and selective review

Pre-Filing/ “Quiet Period”

Waiting/ “Cooling Off” Period

a. 20 days after filing if no amendments, but everyone chooses to add a Rule 437 delaying amendment to automatically amend it until the SEC declares it effective

b. SEC stop order can prevent §8(b) or suspend effectiveness §8(d) if incomplete/inaccuratef. Then you sign underwriting agreement and sell

III. §5 Gun Jumping Rules = regulate transactions in ISC (not securities or participants)

a. Policiesi. Want ppl to slow down so they don’t make rash decisions and cause a speculative frenzy

ii. Keep issuers from conditioning the market with rosy disclosure b/c by the time there’s full mandated disclosure it may be too hard to change investors’ minds

iii. Balance gun jumping concerns with need for disclosure to keep people informedb. Pre-filing period = after “in registration” (= discussions w/ investment bank) and before filing

i. No sales until registration statement is effective §5(a)ii. No offers prior to filing of registration statement §5(c)

1. Offer §2(a)(3) = attempt to dispose of/solicitation of offer to buy, security in ISC a. It’s an offer if it conditions the market or arouses public interest b. So no oral offers or prospectuses (aka written offers per §2(a)(10))

i. Includes all non-real time electronic communications Rule 405c. Consider:

Motivation (arranged months ago = not offer) Type of info (soft/-looking = offer), Breadth of distribution (broad = offer)

Form of comm. (easily reproduced = offer) Mentioning facts about offering, like underwriter’s

name = offer

2. So don’t initiate any new ad campaigns and stick to factual business info (FBI) instead of soft info (projections/predictions) when answering questions

3. Safe harbors (i.e. don’t count as offers) for issuers and those working for them (issuer has obligation to police them to make sure they comply once clock starts):

a. Preliminary neg. btwn issuer & underwriter (b/c will be in privity) §2(a)(3)b. Rule 163A = communications not referring to the offering made >30 days

before filing of registration statement (note: Reg FD still applies)c. Rule 168 for Reporting Issuers = can release FBI and forward-looking info

if previously released same type of info in ordinary course of business, but can’t mention the offering

d. Rule 169 for Non-Reporters = same, but only FBI (and only for issuers)

= when you finish selling

Purpose is to allow issuers to continue normal business during this cool down

period

Before “in registration” ok

e. Rule 163 for WKSIs = oral ok, and written ok b/c treated like FWP (below)i. Policy= lots of info out there, so allow them to test the waters

f. Rule 135 Tombstone Advertisements = issuer can have short, factual notices of proposed offering with legend (but can NOT ID underwriter by name)

c. Waiting period = after filing registration statement but before it is declared effective by SECi. No sales until registration statement is effective §5(a) (so don’t bind or collect any $)

ii. Oral offers ok (ex. road show by management) b/c not a prospectus under §2(a)(10)iii. Non-real time written offers only if §10 prospectus §5(b)(1)

1. No final prospectus yet §10(a), so must be preliminary prospectus §10(b)a. = contains same info as §10(a) minus price, so balanced pros/cons (but not K)b. So all other written offers are forbidden

i. Safe harbors (i.e. don’t count as offers):1. Rules 168-69 (see above)2. Rule 134 (expands on 135 Tombstone Ads)

a. Can now include underwriter’s nameb. But must have legend indicating registration statement

is filed and where one can get §10(b) prospectus2. Rule 164 post-filing free writing prospectus (FWP)

a. = any written communication by anyone that offers to sell & doesn’t meet §10b. Meets Rule 433 (permitted post-filing FWPs) so counts as §10(b) for

purposes of §5(b)(1) if:i. Accompanied/preceded by recent §10 prospectus (hyperlink ok)

1. WKSIs need not follow this delivery requirementii. Doesn’t contain info inconsistent with filed §10 prospectus or

periodic/current report incorporated in registration statementiii. Includes legend andiv. Filed with SEC if new info same day if by issuer, or within 4 days of

becoming aware of it (if immaterial or unintentional can cure)1. Non-issuers don’t have to file unless broad unrestricted dissemination

3. Safe harbors for analysts’ research reports (i.e. don’t count as offers)a. Must be in regular course of business (not new coverage!)b. Rule 137 for unaffiliated broker-dealers

i. Dealers §2(a)(12), but not underwriters so §4(3) exemption from §5ii. No direct or indirect compensation

c. For broker-dealers participating in the distributioni. Rule 138 = if offering is for convertible securities then can only do

research reports on non-convertible since not offer per §2(a)(10)ii. Rule 139 = ok to issue reports on S-3 eligible companies and the

“wider industry” (so long as your co. doesn’t get more space)iii. Timing FINRA 2711(f):

1. Managing underwriters can’t until 40 days after IPO2. Others have 25 days3. Only 10 for secondary offering

d. Post-effective period = after registration statement is effective until issuer is done selling

BONAFIDE ROADSHOW If “graphic communication”

in Rule 405 (= downloadable)then it’s “written” and mustmeet Rules 164 + 433 (so must be filed or unrestrictedly available)

But if it’s live/real-time transmission or slides/handouts investors can’t take with them, then “oral” so not prospectus and need not be filed

Also in the pre-filing

period

i. Can only offer or sell in ISC if accompanied /preceded by a §10(a) final prospectus§5(b)(2) 1. §10(a) final prospectus is §10(b) + price (just file a supplement w/ Rule 430)2. Traditional FWP = all written offers not complying with §10(a) are ok only if

preceded or accompanied by at §10(a) per §2(a)(10)(a), otherwise no per §5(b)(1)a. Except confirmations of sale Rule 172

3. Access = delivery per Rule 172, so if §10(a) is filed w/ SEC then oka. But underwriters/brokers/dealers must also send info telling investors sale

took place & they have rights under §11, §12(a)(2) in 2 days per Rule 1734. Exemptions to delivery requirement (since §5(b) provides no limit):

a. §4(1) ordinary trading for non-issuers, underwriters or dealers (see below)b. §4(3) dealers not acting as underwriters selling unsold allotment unless:

i. < 90 days after IPO (only 25 days if now on national exchange)ii. Or 0 days if issuer was already a reporting company Rule 174

c. §5(4) for independent brokers executing non-solicited customer ordersIV. Updating IPO Filings

a. §10(a) prospectusi. If grossly misleading may violate §5(b)(2) delivery req. (Manor Nursing = rescission per §12(a)(1))

ii. So when do you have to update it?1. If used >9 months after effective date then info must be <16 months old §10(a)(3)2. If Rule 415 shelf registration then only if “fundamental” changes

b. Registration statementi. Must be accurate as of the effective date to escape liability

ii. Don’t have to update previously accurate info1. But must update Rule 415 shelf registration is “fundamental” changes

iii. Have to refile if “substantive change from or addition to,” but that resets date for liability1. But if non-substantive change/addition then just sticker

V. Reg M and Secondary Market Manipulation to Drive Up Pricea. = limits trading during restricted period of covered securities by distribution participants

i. Covered securities: those subject to distribution or any reference security (= one that a distributed security may be converted into)

ii. Distribution participants: issuer, underwriters, participating brokers/dealers, & affiliatesiii. Restricted period: ends when participation in distribution is over and starts when:

1. If ADTV for last 2 mos. is $100k and public float is $25m, then 1 day before price set2. If not, then 5 business days before price is set3. If m/a, then day when proxy solicitation materials are disseminated

b. Distribution participants can’t bid for or induce another to bid for covered securities during restricted period per Rule 101 except:

i. Offers to sell or solicitations of offers to buy, and underwriters can buy from issuer and sell ii. Research reports under Rules 138-39 safe harbors

iii. Stabilization = to maintain price of security (= only to prevent drop in secondary market below offering, and must give way to independent bid of same price) Rule 104

1. Only applies to underwriters and affiliated purchasers, not issuers Rule 102iv. De minimis transaction (= <2% of ADTV) or actively traded securities (= if ADTV is <$1m

w/ common equity <$150m))

c. And no short selling by purchasers in the offering Rule 105

--------------------------------------------------CAUSES OF ACTION----------------------------------------------------I. §11 of Securities Act (easier than CL fraud)

a. Covers: fraud in registration statements (determined as of effective date; reset for amendments)b. Plaintiff standing = private COA

i. Must be a purchaser (but need not show privity of contract with issuer)ii. Tracing requirement, so must show shares purchased were sold as part of public offering

under the reg. statement containing the alleged fraud (so essentially limited to IPOs) (Krim = even if highly likely stock was from offering, if pool you bought from was comingled w/ a few outside shares then can’t prove ALL stock for which you claim damages was actually issued pursuant to a defective statement)

c. Defendants (listed in statute):

i. Those who signed reg. statementii. Directors/partners

iii. Underwriters

iv. Experts who prepared/certified part (i.e. auditors)v. Controlling person §15 (i.e., anyone who controls

one liable under §11, unless good faith defense)

a. Elements:i. Material misstatement or omission in effective registration statement used in ISC & damages

ii. NO causation or reliance (tracing is enough) neededb. SOL = 1 year of discovering fraud, and no more than 3 years after offering §13c. Defenses

i. If you resign and tell the SEC §11(b)(1)ii. If plaintiff has actual knowledge (shown by public info) of fraud at time of purchase §11(a)

iii. Loss causation = D can reduce liability if it shows value declined due to other factors §11(e)iv. Due diligence (NOT FOR ISSUER) (about behaving as if it’s your money) §11(b):

Non-Expertised Portion Expertised Portion (audited financials)Expert D(auditors)

No liability §11(a)(4) No liability if §11(b)(3)(B): Reasonable investigation and Reasonable and actual belief in statements

Non-Expert D (officers, underwriters, and outside directors)

No liability if §11(b)(3)(A): Reasonable investigation and Reasonable and actual belief in statements

No duty to investigate if no red flags! Just can’t have a reason to believe untrue §11(b)(3)(C) (reliance defense)

The more you know/have leverage, the greater your responsibility to see red flags (Escott = “reasonable investigation” means more than taking ppl at their word w/o checking available corporate records, but young Birnbuam was new so could rely on expertised portion b/c no knowledge and wasn’t around long enough to see red flags) (WorldCom = underwriters can’t blindly rely on audited financial statements when there’s a weird ratio compared to competitors since that’s a red flag)

d. Remedyi. = difference between what P paid (≤ offering price) and:

1. If sold before suit then price at time sold §11(e)(2)2. If still owns shares at end of the suit then “value” at filing §11(e)(1) (Beecher = “value”

can be something other than market price if public was mis/uninformed. Here, subtract some to account for financial crisis but add to account for what it would have been w/out panic selling)

3. If sold after filing but before judgment, then greater of price at time sold of “value” at filing §11(e)(3), so incentive to sell ASAP after learning of fraud

ii. Presumption that all Ds are jointly and severally liable except:1. Underwriters only up to amount distributed to the public §11(e)2. Outside directors are proportionally liable with other Ds §11(f)(2)(A)3. Can adjust liability by K, but probably won’t be enforced unless insurance (Brennan =

underwriters have express right to seek contribution, but not indemnification b/c counter to policy)

II. §12(a)(1) of Securities Acta. Covers: violations of §5 gun-jumping rules (NOT an antifraud provision)b. Plaintiff standing = private COA

i. Anyone who bought a security that meets elements c. Defendants:

i. Statutory seller or1. Owner who passes title of the security to a buyer for value (issuer) or2. Person who successfully solicits purchase of the security, motivated at least in part by

desire to serve her own financial interest or those of the owner (underwriters/brokers) (Pinter = don’t have to pass title, just need to have solicitation motivated at least in part by financial gain. This goes with the policy b/c solicitation is the most critical stage of the transaction)

ii. Controlling person §15d. Elements:

i. Offer or sale of security involving the use of ISCii. §5 violation (so no exemption)

iii. NO scienter, causation, reliance, or damages needed (so it’s strict liability)e. SOL = 1 year of discovering fraud, and no more than 3 years after offering §13f. NO defenses (b/c it’s strict liability)g. Remedy = rescission (= money back if not been sold) or damages if already sold (= difference

between purchase price and sales price)III. §12(a)(2) of Securities Act

a. Covers: fraud in a prospectus or oral offer related to a public offering (NOT secondary market or privately negotiated transactions post Gustafson)

b. Plaintiff standing = private COA i. One who was bought security by means of prospectus/oral offer meeting elements

c. Defendants = statutory seller (like §12(a)(1)) or controlling person §15d. Elements:

i. Offer/sale of security involving ISC by means of prospectus (= doc describing a public offering by issuer or controlling SH [Gustafson]) or oral communication relating to prospectus

1. Only extends (if at all—depends on the court) to secondary market transactions if subject to §10 prospectus delivery requirement in §5(b)(2) (Feiner = only extends to aftermarket trading if occurs by via a prospectus. If no delivery required by seller, then no standing)

ii. Material misstatement or omission in the prospectus or oral offeriii. Casual connection btwn prospectus and decision to buy, but focus on market as whole (easy)iv. NO reliance or damages needed

e. SOL = 1 year of discovering fraud, and no more than 3 years after offering §13

f. Defenses:i. If plaintiff has actual knowledge (shown by public info) of fraud at time of purchase

ii. D did not, and in exercise of reasonable care could not have known, of the fraud2. Easier for D to show than §11’s due diligence (no distinction btwn portions)

iii. Loss causation = D can reduce liability if it shows value declined due to other factors (Miller = when price doesn’t decline until weeks after disclosure of correct info, then no loss causation. Here, none b/c it was obvious the stock was trading on the OTCBB instead of the NMS, so can’t link to misstatement)

g. Remedy = same as §12(a)(1)IV. §10(b) and Rule 10b-5 of Exchange Act (most action, but usually settles; easier than CL fraud)

a. Introductioni. Overlap with §9 of Exchange Act (forbids knowing manipulation on national exchanges)

and state COAs which are not preempted per §28(a) savings clause, i.e. class actions)ii. The rule:

1. Unlawful to directly/ indirectly, by use of ISC (jurisdictional nexus):a. Employ any fraudulent device, scheme, or artifice 10b-5(a)b. Make any untrue statement of a material fact or to omit to state a material

fact necessary in order to make the statements it made, in the light of the circumstances under which they were made, not misleading 10b-5(b) or

c. Engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person 10b-5(c)

2. In connection with the purchase or sale of any security (transactional nexus) (Blue Chips = can’t sue b/c they didn’t buy based on fraudulently pessimistic prospectus, have to actual buy or sell) (Zandford = when a sale is necessary to carry out a fraud, then connected. Here, broker sold customer’s securities and used the proceeds for himself without telling, but wouldn’t have violated §10(b) if he decided to do that after a lawful transaction)

a. Covers both issuer transactions and the secondary market, unlike§12(a)(2))iii. Goal = prevent lemons problem, have price reflect value, and encourage market participationiv. But concern about strike suits (= force unjustified settlement) so Congress passed PSLRA:

1. Increased pleading standard to particularity 2. No discovery until after survive motion to dismiss

a. Pleading standard for motion to dismiss = fraud must be at least as compelling as story that it’s normal (Tellabs = consider allegations collectively)

3. Lead plaintiff presumption for class actions §21D(a)(3)(B) (Cendant = lead P retaining a substantial investment in D corp. is not enough to rebut b/c rebuttal is not a relative inquiry)

b. Most adequate P is the person/group that (this is a relative inquiry):i. Has filed the complaint or made a motion,

ii. Has the largest financial interest in the relief andiii. Satisfies FRCP 23:

1. Claims/defenses are typical of the class2. Will fairly/adequately protect class’ interests

c. Limited to 5 of these in 3 yrs, and can’t recover more per share than others4. Court review for reasonable attorney’s fees (usually “lodestar” for hourly rate x

hours x risk/complexity/outcome multiplier with % cap on recovery)d. Presumption of reasonableness (Cendant = power to select and retain counsel is lead

P’s, but court can approve it [not a relative inquiry] and can only rebut fees is clear excess)

Prohibits fraud, but doesn’t compel disclosure unless

otherwise a duty to disclose

5. Forward looking information safe harbor §21E(c)(1) (codified “bespeaks caution”)e. = not liable if accompanied by meaningful cautionary statement identifying

important factors that could cause actual results to differ materially, even if knowingly false (Asher = not boilerplate to say statements are forward looking and mention risks and product lines, so these were meaningful and market must’ve reflected them. If 10-K says “we will earn $100m unless X” and subsequent PR says “we will earn $100m” the reasonable investors [analysts in efficient markets] didn’t forget about X…)

6. Proportionate liability if not intentionalb. Scope = applies whether or not the security is registered or exempt

a. Typical cases:i. Securities trading, where a party to the transaction gives false or misleading info to

induce the other, or remains silent when there’s a duty to discloseii. Corp. trading, where manager induces corp. to enter into bad transaction so it sues

iii. Corporate disclosures (without trading), where it issues false or misleading info tp the public or remains silent when it has a duty to disclose.

1. Then contemporaneous buyers or sellers can suec. Plaintiff standing

i. SEC enforcement action orii. Implied private COA

1. Can be a seller or a purchaser (whereas only purchaser in §§11 and 12(a)(1)-(2))d. Defendants = any person whose fraud is in connection with purchase or sale of a security by P

(buyer, seller or other, and secondary market resales count so no Gustafson problem) i. Aider and abettor liability for non-primary violators?

1. SEC = yes, if knowingly or recklessly provide substantial assistance §20(e)2. Private COA = no (Central Bank) (Stroneridge = you have to “speak.” So no scheme liability.

Here, cos. agreed to overpay D to help it cook the books did not make it necessary for D to record the transactions in fraudulent way it did, so they didn’t speak and investors didn’t rely on them) (Janus = liability is w/ the person who has ultimate authority over the statement. Only D’s sub has the statutory obligation to file the prospectus, so its parent and advisor who actually did all the work aren’t liable)

a. Not about general insurance against any commercial fraudii. Control person liability §20(a) for SEC or private COAs

1. Purpose = prevent ppl from using straw men acting on their behalf to accomplish ends that would be forbidden directly

2. Can allege both Rule 10b-5 and §20(a) liability (ex. inside director)3. Circuits vary. All must show primary violator.

a. Majority use potential control test, where must exercise control over primary violator and possessed power to control the transaction (Lustgraaf = broker-dealer can be liable for its registered representative’s fraud b/c it provided him with access to the markets and had a duty to oversee him, but broker-dealer’s parent is off the hook b/c no proof that it could control anything beyond the general operations)

b. Minority require control plus culpable participation4. GOOD FAITH DEFENSE §20(a)

e. Elements:i. ISC (purchase/sale involved instrumentality of ISC or a facility of a national stock exchange)

ii. Material fraud (device, misstatement/omission, or act) in connection w/ purchase/sale

1. Deception (Santa Fe = can’t sue for this instead of appraisal rights when no deception in merger, i.e. when shareholders have a choice and are fully informed)

2. Verifiable facts (no liability for opinions) (Bankshares = When directors said in proxy solicitation that SHs should approve merger b/c they thought it was “high value and fair price,” SHs will believe it b/c no efficient market for proxies to rely on. While couched in conclusory terms, it was based on verifiable facts, so misleading. But only actionable if the deal is in fact not good)

3. Duty to correct info that was incorrect when disclosed (even if believed true then)4. Duty to update info that was correct at the time but turns out to be misleading (like

w/ reg. & prospectuses) (Gallagher = only continuous duty to update when selling. FDA’s letter was dated after 10-K, so 10-K wasn’t false at the time and no duty to update b/c not selling)

5. Not for forward looking statements if you follow PSLRA (see above)iii. Scienter = need actual motive, knowledge, or recklessness (Ernst = auditor that just didn’t catch red

flags of issuer can’t be held liable b/c you need scienter)1. Not negligence or SL like §11 (we wanted to terrorize ppl into not violating §11)2. Keep post-PSLRA heightened pleading in mind

iv. Loss causation = act/omission you relied on caused the loss you suffered §21D(b)(4) (Dura Pharm = can’t satisfy this by merely showing the price on the date of purchase was inflated b/c of the misrepresentation b/c that doesn’t mean you lost money, although would likely be a factor in losing money when you sold later after a price drop, which is what you really need to prove)

1. Use experts and event studies (see materiality, above)2. Split as to whether must plead with particularity FRCP 9(b) or plausibility 8(a)(2)3. Different from reliance (EPJ Fund = loss causation is not a prerequisite to establishing Basic

presumption or certifying a class)v. Reliance (aka transaction causation)

1. SEC need not prove this2. Private Ps do, but EASY (based on efficient market hypothesis, see above)

Face-to-Face Open MarketOmission w/ duty to disclose (Affiliated Ute = don’t need proof of reliance if just failure to disclose and facts are material)

No reliance requirement No reliance requirement

Affirmative misrepresentation Investor must show individual reliance

Rebuttable presumption of reliance via fraud-on-the-market (Basic)

1. Fraud-on-the-market rebutted by showing:

a. Market not deceivedb. Market not efficient

c. Specific Ps would have sold anywayd. Corrective statements

vi. Damagesf. SOL = w/in 2 years of discovering fraud, and no more than 5 years after fraud (no tolling)g. Remedies: out-of-pocket damages, with proportionate liability for unknowing violators and

contribution availableV. Insider trading (based on §10(b) and Rule 10b-5)

a. = prohibits trading securities on material nonpublic info when you owe a fiduciary duty to disclose. Silence is then fraud so this is a deceptive device under §10(b)

i. Companies often have their own policies forbidding this, toob. Policies

i. Don’t want to ban all trading on material nonpublic info b/c want investors to have an incentive to research to make market more efficient (this is based on skill so fair)

1. But do want to prevent breaches of fiduciary duties, so we draw the line there But more info available, so prices are more accurate, which is good if you’re diversified…

Unfair (goal is equal access) ↑ costs via bigger bid-ask spread Harms liquidity

Investors discount $ willing to pay to reflect risk Undermines property rights in valuable info Encourages choice of more volatile investments

c. OLD RULE: special circumstances = insider may trade without disclosing material nonpublic info since no duty owed to prospective SHs unless special circumstances like active concealment in a face-to-face transaction (Strong = D had overwhelming influence as director and majority owner, so couldn’t actively conceal his identity when buying from P by using a broker and lying to get better price from SH)

d. CURRENT RULES:i. Classical theory: Rule 10b-5 imposes an

affirmative duty to abstain or disclose (or use a big boy letter with sophisticated institutional investors to waive reliance, thereby barring private COAs) if:

1. Insider (including corp. itself) trades on material nonpublic info learned in the course of his duties (b/c now believe insiders have fiduciary duties to prospective SHs) (Chiarella = silence can count as a deceptive device under §10(b) if duty to disclose. Here no duty b/c printer just deduced info from announcements of corporate takeovers. Had a duty to his employer, but that’s why he was fired) or

a. Can also be a temporary insider if access to material nonpublic info gives you a duty (ex. underwriters, accountants, and lawyers)

2. Tipper/tipper liability (Dirks = inside whistleblowers told him company earnings were overstated. He investigated and told the SEC [who ignored him] and some clients [who traded on it]. D had no pre-existing relationship with SHs and the insiders who gave him info didn’t receive a benefit, so no insider trading) if:

b. Insider discloses that info to another in breach of a fiduciary duty to SHsc. For some personal benefit (cash, reciprocity, or intention to make a gift)d. Recipient knows this (so assumes that duty) ande. Recipient subsequently trades

ii. Misappropriation theory = info that is subject to a fiduciary duty of confidentiality is used for trading in securities without disclosing to the owner of the info that it’s being used (O’Hagan = lawyer working on confidential tender offer for acquiror bought shares of target. Can be liable under §10(b) or Rule 14e-3 b/c misappropriated confidential info in breach of duty owed to the source, defrauding principal of the exclusive use of that info)

1. So the duty breached is owed to the owner of the info, not the opposite trading partya. This duty can be created under Rule 10b5-2 if:

i. Person agrees to maintain info in confidence orii. Person receives material nonpublic info from spouse/parent/child/

sibling, unless recipient demonstrates no duty of trust (Rocklage = insider told wife who at first said she wouldn’t tell but then said she would and did tell her brother who traded. But this brazenness doesn’t undo the deception b/c didn’t give him a chance to take remedial action, so she’s the tipper, not him)

b. But if you tell the owner that you’re going to trade on it with time for him to take remedial action, then brazen misappropriator = no deception so ok

So can be subject to “tippee liability” for using

“misappropriated” info

Insider trader Outsider traderInside info

Chiarella classical theory (perm. insider)Dirks temp. insider

Dirks tipper-tippee liability

Outside info

Misappropriation theory

2. Breaks elements of “deception” & “in connection with” apart so easier to meet policya. Misc. related rules

i. §16(b) = only explicit prohibition on insider trading, but only applies to D/O or >10%ii. Rule 14e-3 = restricts use of material non-public info relating to a reporting company’s

stock once a tender offer is initiated (don’t need deception or breach of fiduciary duty) iii. Reg FD = limits ability of issuers to convey informational advantage selectively to secondary

market participants (see above)iv. Rule 10b-18 = concern that share buyback programs manipulate the market by creating

exaggerated appearance of market interest, but safe harbor from §10(b) and §9(a)(2) if issuer buys back its own shares and:

1. Only uses one broker/dealer to solicit or makes bids on only one day (not the first transaction or within 30 minutes of closing) and

2. Can’t exceed current independently published bids and is ≤ 1 round lot or 25% trading volume

--------------------------------OFFERINGS EXEMPTED FROM SECTION 5-----------------------------------

§5(b) lasts forever, so without an exemption issuer would have to provide a registration statement or be liable under §12(a)(1) etc. every time (but can never be exempted from §10(b) and Rule 10b-5)

I. §3 Exemptions of Specific Securitiesa. Examples from§3(a):

i. Government issued securities §3(a)(2)ii. Commercial paper §3(a)(3) (= way for industries to make payroll before selling inventory)

1. Exempted if capable of being executed w/in one year, mature w/in 9 months, i.e. gestational period of an animal (Reves)

iii. Insurance §3(a)(8)b. §3(b) authorizes SEC to create additional exemptions

II. §4(2) private placement offerings (basic exemption for issuers)a. = exempts transaction by an issuer not involving a “public” offering

i. Offerees (# doesn’t matter) must be able to “fend for themselves,” (Ralston Purina = offering to employees who asked doesn’t cut it b/c can’t show they all had access to the info or could understand it):

1. Need to have access to info that would be in a registration statement or actual disclosure

a. Access if you’re an executive of have economic bargaining power2. And have the sophistication to understand it

a. Consider wealth/income, experience, education, present investment status, performance on test

b. Burden on issuer to reasonably believe offerees meet this, so use a suitability questionnaire to meet reasonable belief standard

ii. All offerees must meet this standard, not just buyers (Doran = sophisticated buyer gets rescission right b/c other offerees weren’t sophisticated)

b. Consider purposes of securities laws and:

i. Number of offerees

ii. Relationship of offerees to each other

iii. Number of units offered

iv. Size of the offeringv. Manner of the offering

c. Some offerings clearly count as “private,” like:i. Founders giving their corporation cash in exchange for initial capital stock

ii. First round investments from venture capitalists d. But others are less clear and §12(a)(1) liability is strict, so Reg D safe harbor Rule 506 offers clarity!

III. Reg D Safe Harbors to provide clarity to §3(b) and §4(2) offerings (must file Form D with SEC)Rule 504 safe harbor for §3(b) Rule 505 safe harbor for §3(b) Rule 506 (safe harbor for §4(2)

Excluded issuers Reporting companies Investment companies Blank check companies

Investment companies Disqualified1 companies per

(b)(2)(iii)

Disqualified1 companies per Dodd-Frank

Offering price ≤ $1m every 12 mos. (b)(2) Subject to aggregation2 w/

§3(b) sales and those that violate §5(a)

≤ $5m every 12 months (b)(2) Subject to aggregation2 w/

§3(b) sales and those that violate §5(a)

Unlimited

Purchasers No qualifications ≤ 35 non-accredited3

Unlimited accredited ≤ 35 sophisticated non-

accredited3 (b)(2) Unlimited accredited

General advertising or solicitations

Ok under state law exemption (if sold exclusively under state registration that provides substantive info pre sale (b)(1))

No4 502(c) No4 502(c)

Resale Only if follow state registration No, so must take reasonable care to discourage investors from reselling (ex. legend)

No, so must take reasonable care to discourage investors from reselling (ex. legend)

Specific disclosure requirements

No…so CHEAP Only for non-accredited investors5 502(b)(2)

Only for non-accredited investors5

502(b)(2)a. Integration (aka a way to prevent people from escaping these limitations by breaking up offerings)

i. = treats seemingly separate offerings as one considering:1. Whether sales are part of a single plan of financing2. Issuance of the same class of securities3. Made at or about the same time4. Same type of consideration received5. Made for the same general purpose

ii. Distinct from, but can influence, aggregation (see below)iii. Safe harbor from integration under 502(a), where separate if 6 months before or after:

b. Innocent/insignificant mistakes 508 (compare to “public” offerings where no forgiveness)a. Shields issuer from private COA for violating §5, not SEC enforcement

Important to not be integrated with an IPO b/c then these would violate §5, but presumed not b/c of Rule 152

b. Only shield if failure to comply didn’t pertain to a requirement directly intended to protect that particular person (so can’t complain for faults that affect others)

c. Only available if failure to comply was insignificant with respect to offering as a whole (so not if about general solicitation, aggregate offering price, or limit on purchasers)

d. Must have good faith attempt to complyc. 1Disqualification under 505 (and probably 506, but those rules aren’t made yet)

e. SEC can waive if good causef. Disqualifies issuers if:

i. Subject to §8 SEC proceeding, stop/refusal order, crime for false filing, or injunction of purchase/sale in last 5 years

ii. Key individuals (D/O, beneficial owner of >10% of a class, private placement agent) are subject to punishments relating to false filings or bad business conduct

d. 2Offering price aggregation for 504 and 505i. Example: if you raise $1m/month over 5 months (starting in January) to 25 unsophisticated

purchasers, you’re ok under 505 but can’t sell any more under 504 or 505 until next January (and slate isn’t wiped clean until next May)

1. So if you offer $2m to non-sophisticated investors next January, even though you could offer $1m, since you offered too much the whole offering is disqualified from Reg D and without another exemption violates §5

ii. Counting §5(a) violations w/in last 12 months as part of cap is just extra punishmente. 3Purchasers

i. Accredited investors for 505 and 506 (don’t count as purchasers under 501(e)(1)(iv))1. Policy = sufficient ability to get access to info comparable to that in registration

statement2. Issuer/placement agent must reasonably believe they are one of the following:

a. Banks, broker-dealers, registered investment companies 501(a)(1)b. Trusts, partnerships, and corporations with > $5m in total assets 501(a)(3), (7)

i. But if organized specifically to acquire the securities, then each beneficial owner must be accredited (can’t cheat!) 501(e)(2)

c. Any entity in which all equity owners are accredited 501(a)(8)d. D/O (= someone who performs policy making) or GP of issuer 501(a)(4)e. Natural person with:

i. Net worth (= assets – liabilities) with spouse > $1m (- value of primary residence) 501(a)(5) and Dodd-Frank

ii. Income > $200k last 2 years or jointly >$300k, and reasonable expectation for this yr 501(a)(6)

ii. Sophistication requirement for 506 (see §4(2) above)1. Can meet by renting sophistication from their purchaser representative 506(b)(2)(ii)

f. 4General solicitation prohibition for 505 and 506 per 502(c)i. So only send out a limited number of ads/private placement memos to people you have a pre-

existing relationship with such that you can assess their sophistication! (Kenman)ii. Can buy these pre-existing relationships by hiring a brokerage firm with a list

g. 5Specific disclosure requirements for non-accredited investors in 505 or 506 offering per 502(b)(2)

g. If reporting company, then must provide most recent filings and update material info (plus a brief description of securities offered) (2)(ii)

h. If non-reporting company, then provide material from Reg A & some audited financials (2)(i)i. Non-accredited investors must receive notice of additional info given to accredited investors,

and if they provide written request must comply in reasonable time (iv)j. Must give each purchaser opportunity to ask questions and receive answers (v)

---------SECONDARY MARKET TRANSACTIONS EXEMPTED FROM SECTION 5------------

If you buy restricted securities (= those issued without a registration statement under an exemption/safe harbor) then can only resell them without a registration statement if you have your own exemption

I. §4(1) Trading Exemption for Persons not Issuers, Underwriters, or Dealersa. The definition of issuers and dealers are self-explanatoryb. But underwriter is defined in §2(a)(11) to be one who:

i. Purchases from an issuer w/ a view to the distribution (= public offering) of securities or1. Investor can argue changed circumstances, but they must be about him and not

the company (Gilligan = saying you only bought with a view to hold if the company is profitable is equivalent to purchasing it with a view to distribute, so you’re an underwriter)

ii. Direct/indirect participation in or underwriting of a distribution of securities (Chinese Consolidated = continuously soliciting Chinese, making a market, and arousing interest in bonds from China makes you an underwriter even though no contractual agreement with Chinese government)

II. Control person liability a. = either one who directs or how the power to direct the management/policies of the issuer

(through stock ownership, position, contract or otherwise) OR has the power to obtain the signatures of those required to sign a registration statement

i. Either way, this makes the SEC view the transaction with the same suspicions as an issuer transaction b/c likelihood of exploiting informational advantage is higher

b. RULE: if someone acts for a control person or purchases form a control person with a view to distribute, they’re an underwriter under §2(a)(11) so the control person can’t use §4(1)

c. Avoid this with the §4(1 ½) exemption (useful before Rule 144)i. = if control person sells to an investor able to “fend for himself” then no “distribution” so

not an underwriter under §2(a)(11) so §4(1) is availableii. Based on §4(1) and definition of underwriter, and informed by §4(2)’s distinction

between public and private offeringsIII. Rule 144 safe harbor from classification as an underwriter

a. = allows sale of restricted securities into public markets w/out becoming an underwriter, and allows participation in sale by affiliates (aka control persons) who otherwise pretty much can’t sell w/out registration (but are in the position to require registration so we don’t feel bad)

i. Non-affiliates can always freely sell unrestricted securities

b. Definitionsi. Affiliate = person that directly/indirectly controls or is controlled by/under common

control with the issuer (counts if you were in the past 3 months)ii. Restricted security = acquired directly/indirectly from issuer or affiliate in transaction

not involving public offering or in a Rule 505 or 506 offering (so no reg. statement)c. Must meet:

i. Holding period for restricted securities 144(d) (see below)1. Makes sense b/c longer you hold less info asymmetry

ii. Public info requirement 144(c) 1. For reporting issuers = public info current for 12 months2. For non-reporting issuers = info from Rule 15c2-11 (facts + balance sheet)

iii. IF AFFILIATE RESALE, then must file Form 144 with SEC and meet:1. Limitation on amount of securities sold over 3 months 144(2)

a. = greatest of 1% outstanding shares of the class or average weekly trading volume of same class during 4 weeks before filing notice of sale with SEC

b. Policy: don’t want a lot of shares entering at once to disrupt market2. Limitation on manner of sale 144(f), so only these are ok:

a. Unsolicited broker transaction §4(4)b. Directly with a market maker §3(a)(38) orc. Riskless principal transaction (= buy and sell at the same time)

< 6 months 6 months – 1 year ≥ 1 yearNon-affiliate and reporting issuer (≥ 90 days)

No resales Resales ok if public info is current for 12 months

No restrictions

Non-affiliate and non-reporting issuer

No resales No resales No restrictions

Affiliate and reporting issuer

No resales of restricted Resales of unrestricted ok if they

meet other 3 requirements above

Resales ok if they meet other 3 requirements above

← Same

Affiliate and non-reporting issuer

No resales of restricted Resales of unrestricted ok if they

meet other 3 requirements above

No resales of restricted Resales of unrestricted ok if they

meet other 3 requirements above

Resales ok if they meet other 3 requirements above

----------------------------------------------------------APPENDIX-----------------------------------------------------------

I. Private Equity (PE)a. = big pools of capital assembled to buy up companies (includes VCs)b. Based on model of corporate control

i. Plan = buy a target, fix it, go public or resell it in bits, pay back debt, and get profit!c. Structure

ii. LP, with GP being LLC composed of PE managers1. This way individuals don’t face any liability2. GP usually earns 2% management fee on capital committed from institutional

investors if it finds a worth target and does a capital calliii. LP has many different funds for each target

II. Securitization (= the process, derivatives = the contract specifying payment)a. = the pooling of non-liquid assets, sold to SPV, & the sale of interest in the returns from this pool

b. Pros/Cons While future payments on 1 loan are unpredictable, return from a lot is easier to quantify Makes previously non-liquid assets liquid and allows for diversification Shifts risk of collecting on receivables to special purpose vehicle (off balance sheet)

1. Receivables = legal claim to cash flow (interest) from borrower If risks affect a class as a whole, there’s systematic risk

1. Dodd-Frank seeks to fix this by:a. Making securitizers retain 5% of the interest created (so skin in the game) andb. Having SEC rulemaking to prohibit underwriters of asset-backed securities from

engaging in transactions that result in a material conflict of interest with any investor for the next year

c. Mortgage backed securities (MBS) = way to pool credit and sell pieces in the mortgage marketi. Ordinarily made when banks make loans to homebuyers and bank issues security based on

that underlying asset pool for institutional investors to buy so bank can collect nowii. Types:

1. Real (collateralized debt obligations or CDOs)a. Typically diversified so you’ll have $X in a portfolio of bonds and loans, then

liabilities of varying risk degrees (ex. AAA super senior tranche and BB mezzanine tranche)

2. Synthetic (credit default swaps or CDSs)a. Elements:

i. Credit = bond or loan as the reference instrumentii. Potential default event

iii. Swap = counter-party willing to assume the risk of defaultb. So like neighbors taking out insurance on your house in pieces, then they get

paid off if your house is destroyed (pyramid effect)