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I.

Introduction
A. Overview of key concepts
1. Issuer vs. trading transactions
a. Issuer transactions: sale of securities by issuer to public
i. E.g. private placements, primary distributions (including
IPOs)
b. Trading transactions: resale of securities
i. Includes secondary distributions (sale of stock by control
persons)
2. Stock exchanges vs. Over the counter markets
a. Stock exchanges (e.g. NYSE) are auction markets
b. OTC markets (e.g. NASDAQ): linkages between different
securities firms allow them to match buyers and sellers
3. Brokers and dealers
a. Brokers buy and sell securities on behalf of their clients (for
commission)
b. Dealers buy securities on their own behalf and resell them to
customers
c. Lots of overlap, so most firms are broker-dealers
4. Self-regulatory organizations (SROs)
a. Include national securities exchanges
b. Have authority (under the 1934 Act) to regulate the activities and
business practices of their members; SEC gives them considerable
autonomy
5. Blue sky laws
a. State laws regulating securities
b. Registration regulations are largely preempted, save for relatively
small offerings of stock not listed on the big exchanges and that are
made to unsophisticated investors
6. SEC
a. Functions include rulemaking, interpretation (including no-action
letters), investigating, initiating formal proceedings
7. 1933 Act vs. 1934 Act
a. Purpose
i. 33 Act: regulate the original issuance of securities and
prevent fraud in offerings
ii. 34 Act: regulate trading of previously issued securities
b. Method
i. 33 Act: Full disclosure
ii. 34 Act: Registration and regular reporting of financial
information; regulate trading
B. Efficient market hypothesis
1. Weak form: price of security reflects information embodied in past prices
of security
a. Future stock prices are independent of stock prices; generally
accepted as true
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2. Semi-strong form: security prices reflect all publicly available info, and
the prices move very quickly
a. Large companies all have efficient markets; smaller companies
may not
b. Implication: you cant beat the market!
c. Irony: to have efficient markets, you must have people who dont
believe in EMH and invest in research
d. Noise theory: lots of volatility is due to investor behavior entirely
unrelated to underlying asset value
i. Behavioral economics is relevantpeople very confident
in their ability to pick stocks
e. Arbitrage is probably a very small factor
3. Strong form: securities prices reflect all info, regardless of its availability
a. Nobody thinks this is the case
4. IPOs do not operate in an efficient market; not enough info is available
a. Underwriters create the market
b. IPOs see an average gain of 20% on the first day
c. Haft: this isnt that big a deal; no way of knowing what true
price is
C. Underwriters
1. Pattern of distribution
a. Issuer Underwriter(s) Dealers Retail purchasers
b. K between issuer and MU
c. MU organizes syndicate, enters ks with all other Us
i. Other Us typically enter into k with issuer, too
d. MU says who can sell directly to public, who must go through
dealers
2. Types of underwriter agreements
a. Firm-commitment underwriting: issuer sells its securities to
underwriters; most common
b. Best-efforts underwriting: underwriters make no guarantee that
they will sell all, but get paid commission
c. Stand-by underwriting: issuer plans to issue securities directly, but
secures an underwriter as insurance in case issuer cant
3. Spread consists of three parts
a. Managing underwriter fee
b. Underwriting compensation for underwriter
c. Selling concession of broker-dealer
4. Allotments
a. Determines how much risk each underwriter bears
b. Also determines how much compensation each underwriter
receives for commission
II. Registration statements
A. Overview
1. Types of info required
a. Info about registrant
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c. 5-year guide for saying whether event is material
i. This is in Regulation S-K
ii. Courts do not need to strictly adhere; see Rule 408
d. S-K item 401(f): some pending litigation against registrants
personnel must be disclosed
i. Do not need to disclose that one is guilty of an uncharged
matterUS v. Mathews (2d Cir 1986):
e. Conflict of interest transactions
i. In the Matter of W.R. Grace & Co (SEC 1997): directors
should have sought advice of counsel as to what needed to
be disclosed in 10-K regarding executive compensation and
a pending transaction between the company and the CEO
f. Violating law to try to help the company
i. MaterialSEC v. Jos. Schlitz (ED WI 1978): omitting info
about illegal schemes was material because it goes to
integrity of management, illegal payments were large in
themselves, and potential for future sanctions
ii. Courts have generally denied monetary relief to Ps where
illegal act does not threaten to put company out of
businesssee Roeder v. Alpha Industries (1st Cir 1987)
(no duty to disclose bribes, although they were material;
did not address any specific 33 or 34 Act filings)
(A). See also Gaines v. Haughton (9th Cir 1981):
failure to disclose large foreign bribes alleged
simple breach of fiduciary duty/waste of corp
assets; not recoverable under 34 Act
(B). May allow reelection of directors
iii. If company states that they are clean when they are not, that
is generally a material misstatement
C. Soft and forward-looking information
1. Refers to activities that will occur, if at all, at some future date
2. Bespeaks caution doctrine
a. Optimistic forward-looking statements may be rendered harmless
if surrounded by meaningful cautionary statements warning of
circumstances that might change the analysis
i. Mere boilerplate is not enough
b. Kaufman v. Trumps Castle Funding (3d Cir 1993): lots of
cautionary language surrounded projection that company could pay
its debts; so not misleading
i. Courts less likely to protect sophisticated investors when
cautionary language is present
c. Consistent with TSC: cautionary language is part of the total mix
of info available
3. Statutory safe harbors
a. PSLRA (33 Act 27A)
i. Who may use
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(A). Thus no more anti-fraud provisions for private
placements, which are the biggest form of capital
raising
(1). See Yung v. Lee (2d Cir 2006) (even when
prospectus relied on in private placement
was prepared for a public offering)
(2). 17 provides some protection, but its a
criminal provision that must be brought by a
prosecutor
iv. 2005 reforms by SEC now state that free writing
prospectuses are considered public and thus within reach of
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c. Defenses
i. Lack of knowledge
(A). D did not know and could not have known with
exercise of reasonable care
(B). Sanders v. John Nuveen & Co (7th Cir 1980):
underwriters must make reasonable investigation of
issuer
(1). Same standard as 11 due diligence
(C). No different standards for experts vs. non-experts
ii. P knew or approved of conduct
iii. 12(b): Loss causation
(A). D can reduce liability by showing that the loss
otherwise recoverable under 12(a)(2) was caused by
something else
iv. Statute of limitations
(A). Again, 1-3 years
IV. Section 5
A. In general
1. 5 bars any offers to sell and sales of a security until a registration
statement covering the security has become effective
2. Most important parts of registration statement are also set forth in the
prospectus
3. Parties
a. 4(1): 5 applies only to issuers, underwriters, and dealers
B. Pre-filing period
1. 5(c): it shall be unlawful to offer to sell or offer to buy through the use
or medium of any prospectus or otherwise any security, unless a
registration statement has been filed
a. Ceases to apply once registration statement is filed
2. Rationale: allowing offers prior to registration statement being filed would
circumvent the purpose of the 33 Act (to provide disclosure)
3. 2(a)(3): offer to sell does NOT include negotiations between issuer and
underwriter
4. Generally, broad definition
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(A). Only after registration statement is filed
iv. Unseasoned and non-reporting issuers
(A). Only after registration statement is filed
(B). Must be accompanied by preliminary prospectus
contained in registration statement
v. Required content
(A). legend saying where preliminary prospectus is
available from underwriter
(B). cannot conflict with info in registration statement
(1). But it may include info not in registration
statement
vi. Website
(A). Rule 433(e) Offer of securities on issuers website
is a written offer; must comply with requirements
(B). Hyperlink to preliminary prospectus is sufficient
(1). Absent a hyperlink, must determine if the
websites content is an offer to sell and
whether prospectus is in close proximity
vii. Road shows
(A). Attempts by issuer to stir up interest in an offering
among underwriters and dealers
(B). Not regulated
(1). People together in a room
(2). Real-time presentation to a live audience,
even if transmitted
(C). Regulated under Rule 433(d)(8) as a graphic
communication and thus a free writing prospectus
(1). Broadcast not in real time
viii. Issuer communications with the media
(A). Free writing prospectus subject to Rule 433
(B). If media initiates/is not paid for the story, Rulee
433(f) does not require delivery of a preliminary
prospectus
D. Post-effective period
1. Sales are now allowed
2. 5(b)(2)
a. Written offers must be accompanied by final 10(a) prospectus
3. Post-effective free writing
a. Excluded from definition of prospectus
b. Must be accompanied or preceded by 10(a) prospectus
c. Differs from free-writing prospectus
i. But 433 allows free-writing prospectuses to still be used in
this period
4. Rule 172access to final prospectus equivalent to delivery
a. Confirmation of sale may be sent without prospectus if conditions
are met
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evaluating the merits and risks of the prospective
investment
(A). Or the issuer must reasonably believe that the
purchaser meets that description
e. Resale of securities is generally restricted
8. Disclosure requirements under 505 and 506
a. Pursuant to 502(b)(2), when securities are sold to anyone other
than accredited investors
b. Non-reporting issuers
i. Must provide disclosure based on Reg A for offerings up to
$2 million
ii. For offerings of over $2 million, disclosure is based on 33
Act registration forms
iii. For offerings over $7.5 million, even more is required
c. Reporting issuers
i. Can use info they already filed with SEC
d. All issuers
i. Must give investors opportunity to ask questions and obtain
additional info
ii. Must advise non-accredited investors of limits on resale
9. Limitations on resale
a. 502(d)
i. At a minimum, issuer must
(A). Make reasonable inquiry that purchasers are
acquiring the security for their own accounts and
not with intent to resell
(B). Provide written disclosures to each purchaser that
securities are unregistered and cannot be sold unless
registered or under an exemption
(C). Place a legend on securities identifying their status
as restricted shares
10. Rule 135C notices
a. Publicly held corps can use 505 and 506 as well
i. But there is potential conflict with reporting obligations and
ban on general solicitations
b. Notices complying with 135C will not be deemed general
solicitations
c. Content
i. Can announce companys plans to make unregistered
offerings of securities
ii. May not condition the market
iii. May not contain info other than the limited info specified in
rule (e.g. name of issuer, class of securities to be offered)
C. Regulation A
1. Intended to help small businesses
2. NOT an exemption
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b. So non-control person must not sell to the public and prevent his
purchaser from reselling to the public without an exemption
i. Not a public offering if it meets requirements of 4(2)
(A). Especially sophistication; see Ralston Purina
ii. Restricting resales can be done through contract or placing
a legend on the security
3. Sales by control persons
a. Restricted securities
i. Same as for non-control personsdo not sell to public and
prevent resales
b. Non-restricted securities
i. Avoid selling to an underwriter (i.e. avoid resales)
(A). The control person isnt an underwriter because the
securities arent restricted (i.e. did not come from
issuer or affiliate)
(B). But if purchaser then sells to the public in a
nonexempt transaction, purchaser will have
acquired the securities from an affiliate, and they
will then be restricted
VIII. Reorganizations and acquisitions
A. For value
1. 2(a)(3): sale and offer to sale mean every attempt to dispose of a
security for value
2. Free stock
a. SEC goes far too find considerationIn re Capital General Corp
(SEC 1993) (value found when promoters gave away as gifts some
of the shares of companies they owned all of; value was in creating
a public market for the securities)
3. Stock dividend
a. Typical stock dividend is not a salethere is no consideration
b. Still not a sale if corporation gives option of accepting a cash or
stock dividend
c. Dividend reinvestment programs are subject to registration,
however
i. SHs by prior agreement have their dividends applied
toward the purchase of additional shares at current market
prices
4. Warrants and convertible securities
a. Specifically mentioned in 2(a)(1) as securities and must be
registered or exempted
b. Does underlying security have to be exempted?
i. If the security is immediately convertible, both the option
and the underlying security must be registered/exempted
ii. If it becomes convertible in the future, then it has not been
offered for sale and underlying security need not be
registered yet
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a. Under such general language, no
duty to update when talks dont go
well
(2). Second statement: failed to disclose that
another method of raising capital was being
considered
a. More specific statement meant that it
must be updated to remain accurate
ii. Gallagher v. Abbott Labs (7th Cir 2001): no duty to update
(A). Projections are just guesses anyways
b. Middle ground
i. No duty to update things that arise in the ordinary course of
business
ii. Duty to update for major policy changes
c. Not much case law to justify any strong conclusions in this area
3. No duty to correct or update statements by third parties
a. Unless issuer is the source of the inaccuracy
F. Reliance and Causation
1. Reliance
a. P must be able to show that his belief in the misrepresentation was
a substantial factor in entering the transaction
b. Face to face transactions
i. Affirmative misrepresentations
(A). Usually require P to show that he actually relied on
the misrepresentation
ii. Omission
(A). Reliance is generally presumedAffiliated Ute
Citizens v. US (1972)
c. Fraud on the market
i. Based on idea that investors rely on market prices as valid
and that no unsuspected manipulation has artificially
inflated the price
(A). Rests on efficient market hypothesis
ii. Rebuttable presumption of reliance
(A). See Basic v. Levinson (1988)
d. Scheme liability
i. Could show that Ds participated in a scheme that was relied
upon
ii. No longer valid because of Stoneridge
(A). Fraud in Stoneridge also occurred in ordinary
business sphere, not in the investment sphere
2. Loss causation
a. P must show that Ds misrepresentation or omission caused the loss
suffered
b. Dura Pharm v. Broudo (2005)
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