International Securities

Part I: Theories of Securities Regulation

I. Domestic Markets: Justifications for Governmental Regulation

A. General Theories
1. In theory, securities regulation is optimal where at any given moment a proper
balance is struck between the private interest, which stresses freedom and
efficiency, and the public interest, which allows for limitations and proscriptions.
2. One of the major objectives of most forms of securities regulation is investor
protection. This principle informs the idea of mandatory disclosure which
underlies much of securities law in many countries of the world.
3. Risks: the probability that the actual return on an investment will differ from its
expected return. The general character of investment securities makes some of
them inherently riskier than others.
4. Private controls work most effectively in primary and secondary securities
markets where the investors are very sophisticated and the transactions are
privately negotiated. In these situations, most—but not all—risks can be evaluated
prior to investment.

B. Regulatory Goals and the Means to Achieving Them

1. Theoretically, both public and private interests can be served where regulation
is designed to achieve, simultaneously, three important goals:
a. Market efficiency: securities markets are efficient where market forces
and competition are the predominant limitations. All resources are used to
their potential.
b. Investor protection: this is all about defining unfair advantages in
investment decision making.
c. Reduction of systemic risk: reduce the financial failure of market
intermediaries, and, where such failure occurs, to reduce the impact of that
failure on the market and its participants.
2. Free market folks argue that in an efficient market, market forces and
competition—not governmental regulation—must remain the predominant
limitations. This is a challenge.
3. At a minimum, a highly sophisticated scheme for protecting investors should
address all of the critical aspects of investment, including the following:
a. Material information: of course, implicit in this is the need for uniform
and rigorous standards for determining what information in “material” and
when it should be disclosed.
b. Intermediaries: controls over the business activities of the major
market intermediaries, such as stock exchanges, broker-dealers, transfer
agents, and clearance and settlement firms, can be justified because of
their importance in the capital markets.
c. Availability of credit: for folks that borrow on margin.

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 d. Sanctions and remedies: as markets grow, the need for deterrence
against fraud and the like increases.

C. Policies Underlying Regulatory Practices

1. Three main reasons forwarded for the public interest in securities markets:
national property resource; availability of capital (safety, soundness and
efficiency of trading markets has a direct bearing on the flow of new capital into
private enterprises); general economic health.
2. Policies Underlying US Federal Regulation: two basic concepts predominate
—mandatory disclosure, and broad definitions of fraud.
a. These define the two predominant roles of securities law:
1) The bargaining role: it is in substance informational. Although
bargaining disadvantages are not redressed structurally, the system
is designed to fill the needs of investors for information in order to
make intelligent investment choices.
a) Originally based predominately on the “protective
model” that saw investors as unsophisticated persons who
were likely to make irrational decisions, who needed
protection from their ignorance. Related to disclosure
predominately about issuers.
b) Now the “informational model” serves ordinary
investors and institutional investors by defining what
information is “material.”
2) The inhibiting role—deterrence, et al.

D. Arguments For and Against the Modification of US Securities Laws in the Face
of Increased Cross Border Activities by Foreign Parties in US Capital Markets
1. Pro free trade:
a. It offers investors more choice at a lower cost—as opposed to investing
in foreign issuers abroad.
b. It supplies more competition in the primary market, increasing investor
returns, i.e., more issuers seeking capital.
c. It deepens secondary markets, adding liquidity.
d. It eliminates retaliation by regulators in other countries. Unless access is
allowed, other countries will deny access to US issuers, intermediaries,
and investors.
2. Protectionism:
a. By reducing regulatory costs for foreign persons, US policy makers
create an inequity for domestic persons—higher costs—the effect of
which may be to drive more US capital market participants abroad.
b. If modification means less information for domestic investors
concerning foreign issuers, domestic investors not only face greater risks
with foreign investments but they may also have problems comparing
domestic with foreign investments.

E. Movement Toward Effective Int’l Regulation

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 1. Most ambitious effort at creating a single regulatory body for the world capital
markets is found in the work of the International Organization of Securities
Commissions (IOSCO) founded in 1983. See pg. 4-19 for their goals.

Part II: Impact of Securities Act of 1933 and Investment Company Act of 1940 on
the Offer and Sale of Securities

I. Primary and Secondary Offerings: Securities of Domestic Issuers in Domestic

Transactions

A. Overview
1. The SEC states that “only through the steady flow of timely, comprehensive
and accurate information can people make sound investment decisions.”
2. Congress’ main objectives were to deal with disclosure in primary and
secondary markets.
3. The benefits of mandatory disclosure effect:
a. Intended offerees and purchasers,
b. Investors and intermediaries in primary and secondary markets—could
impact their decisions.
c. Gov’t agencies and private regulators.
4. 1933 Act background info: only concerned with offerings of securities.
a. Its purpose:
1) Provide investors with material info concerning new issues or
securities offered for sale to the public,
2) To prohibit fraudulent sales of securities, and make sure that
disclosure works.
b. Investor protection measures: §5 protects purchasers of securities by
providing them full and fair disclosure of the character of securities to be
sold; and contemplates that a copy of the prospectus be given to each
investor prior to sale, or at time of delivery of security after sale.
1) Registration and prospectus delivery requirements,
2) Prevention of registration violations,
3) Prevention of fraud by three anti-fraud provisions:
a) §8(A) provides for cease and desist proceedings for
fraud to be brought by the government. §20 also provides
that the SEC can bring civil actions for injunctions and
money penalties.
a) §17 prohibits fraudulent interstate transactions. Provides
basis for criminal sanctions by USDJ, and enforcement by
SEC in administrative proceedings or in court.
b) §11 gives private remedy to persons who buy in a
registered offering where misrepresentations or omissions
of material fact are in the registration statement when it
became effective.
c) §12(a)(2) protects defrauded buyers in either registered
or unregistered public offerings of securities. P can recover

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 damages against any person who fraudulently sells a
security. A defense is “I didn’t know, and with reasonable
care, couldn’t have known.”
d) §15 allows secondary liability to attach to a controlling
shareholder of a corporation that is liable for fraudulent
selling of securities. A defense is “I had no knowledge or
reasonable grounds to believe in existence of facts that
make me liable.”

5. The SEC:
a. Established by the Securities and Exchange Act of 1934.
b. Among its many services is its role in interpreting and explaining the
mandatory disclosure system.
c. Oversees other essential participants in the primary and secondary
markets, including stock exchanges, broker-dealers, investment advisors,
mutual funds, and public utility holding companies.
d. Engages in rulemaking to maintain fair and orderly markets and to
protect investors by altering regulations or creating new ones.

B. Definitions
1) “Security”--§2(a)(1) defines securities as and note, bond, stock, as well as
many specialized investment interests. The perimeters have been left to the courts
to determine.
a. SEC v. Howey (S. Ct 1946)—held that a security is a particular kind of
investment contract—“a contract, transaction, or scheme whereby a person
invests his money in a common enterprise and is led to expect profits
solely from the efforts of the promoter or a third party.”
2) The terms “offer” and “sale”--§2(a)(3) provides a very broad definition that
includes “every contract of sale or disposition of a security or interest in a
security, for value.” It also provides that the term “offer” shall include “every
attempt or offer to dispose of, or solicitation of an offer to buy, a security or
interest in a security, for value.”
a. Note that a communication that qualifies as an “offer” under §2(a)(3)
might only constitute a part of the preliminary negotiations leading up to
an “offer” under the common law K principles.
3) “Interstate commerce”--§2(a)(7) provides that interstate commerce includes
“trade or commerce in securities or any transportation or communications relating
thereto” among the states or between any state and any foreign country.
a. Note that judicial interpretations of procedural requirements that
conduct or communication involve the mails or interstate commerce have
been very liberal.

C. Primary offerings by domestic operating companies

1. Registration requirements: basis distinctions
a. Public offerings and non-public offerings:

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 1) Public offerings is used synonymously with the term
“distribution.”
2) The primary focus of §5 is the regulation of public offerings of
securities.
3) Registration and prospectus delivery requirements apply to all
offers and sales, and the full scale process applies only where
offers and sales of securities do not qualify for an exemption.
4) Generally, no transaction exemptions are available where the
offering is made generally to the public and where it possesses the
characteristics of traditional registered public offering (i.e., general
advertising, delivery of freely tradeable securities).
b. Affiliates (owners of control shares) and non-affiliates (owners of
non-control shares).
1) The application of the transaction exemption for ordinary
trading—not distributions.
2) A “distribution” is contemplated as covering both primary and
secondary distributions.
3) Special obligations are imposed on shareholders who are
controlling persons.
a) Rule 405 defines “control” as “the possession, direct or
indirect, of the power to direct or cause the direction of the
management and policies of a person, whether through the
ownership of voting securities, by contract, or otherwise.”
4) SEC presumption for identifying an affiliate: any person who
is a director or officer of the issuer or a person who owns 10% or
more of the issuer’s voting securities.
c. Restricted securities v. unrestricted securities:
1) Securities that are not freely tradeable by the owner are
restricted securities—i.e., issuer may impose resale limitations.
2) “Restricted securities” include any securities acquired directly
or indirectly from the issuer or an affiliate of that issuer in a
transaction not involving a public offering.
3) SEC requires the owner of such securities to hold them for an
appropriate period of time (see Rule 144, infra), otherwise such a
person will be considered an “underwriter” under §2(a)(11).
a) Therefore the selling shareholder is unable to claim an
exemption under §4(1), and has violated §5.
b) Note that non-affiliates who resell unrestricted securities
are not at risk of becoming an underwriter with respect to
those securities.
c) §2(a)(11) provides that an “underwriter” means any
person who has purchased securities “from an issuer with a
view to . . . the distribution” of any security. “Issuer”
includes, in addition to the issuer, any person directly or
indirectly controlling or controlled by the issuer.

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D. Registration and Prospectus Delivery Requirements: Registered Primary
Distributions and Section 5
Note: Resales are a different matter altogether. Whether purchasers of securities
in a registered public offering may resell without filing a registration statement
will depend on the status of the seller and whether the proposed resales will
involve a distribution (i.e., a secondary public offering) or simply a trading
transaction.

1. The registration process:

a. Pre-filing period:
1) §5(c) prohibits any person from making an offer to sell
securities prior to the time that the issuer files a registrations
statement with the SEC.
2) Policy: to prevent conditioning the market in a way that would
encourage investors to form premature opinions of value without
the benefit of the full set of facts contained in the prospectus.
3) In order to minimize the risk that its pre-filing activity is
actually improper selling, an issuer is encouraged to avoid using
forecasts or projections and publishing opinions concerning values.
b. Waiting period:
1) §5(a) prohibits sales during the period after filing a registrations
statement and effective date of registration statement, but §5(b)
permits oral offers, and some limited offers (limited to preliminary
prospectus included in registration statement filed with SEC).
2) Policy: to encourage the issuer and intermediaries to solicit
indications of interest by means of preliminary prospectus, but also
encouraging issuers to continue to disclose factual information to
shareholders.
c. Post-effective period:
1) Sales may take place. However, §5 requires the issuers,
underwriters and dealers to deliver a copy of the final prospectus to
each purchaser in connection with the sale of the registered
securities.
2) Post-effective developments that make the prospectus inaccurate
with respect to material facts must be reflected in changes to the
prospectus.
2. Compliance with registration forms: all issuers which offer and sell securities
to the public are subject to the registration and prospectus requirements of §5.
a. Disclosure requirements:
1) §7 is entitled “Information Required in the Registration
Statement,” and it refers, in part, to Schedule A (which specifies
32 items).
a) Other information: §7(a) states that any registration
statement filed under the 1933 Act “shall contain such
other information, and be accompanied by such other
documents, as the SEC may by rules or regulations require

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 as necessary or appropriate in the public interest or for the
protection of investors.”
2) §10 of the Act is entitled “Information Required for the
Prospectus,” and also contains specific disclosure requirements,
and a requirement that information in the prospectus be up to date.
3) Regulation C, which is a collection of rules (Rules 400 through
498) was adopted to govern every registration statement of
securities under the act.
a) Pursuant to Rule 401, the SEC has adopted forms to be
used—including the Form S-1, which must be used for the
registration of securities of all registrants unless another
form is authorized or prescribed.
b) Rule 408 provides that “there shall be added such further
material information, if any, as may be necessary to make
the required statements, in the light of the circumstances
under which they are made, not misleading.”
4) As a result of §§7 and 10, an operating company using Form S-1
would provide the following info:
a) Description of the company’s properties and business;
b) Description of security to be offered;
c) Information about company management;
d) Statement about intended use of proceeds from sale of
offered securities;
e) Financial statements certified by independent
accountants.

E. Transaction Exemptions
1. Statutory relief for the issuer--§4(2): not involving public offerings.
a. §4(2) of the 1933 Act provides that the registration and prospectus
delivery requirements of §5 shall not apply to “transactions by an issuer
not involving any public offering.”

Note: §4(2) and Rule 506, infra, require an issuer to take

reasonable steps to ensure that purchasers of its privately placed
securities do not become underwriters with respect to those
securities. A court faced with a §12 claim against the issuer by
other purchasers in the offering might conclude that the entire
transaction included the offers and sales by the purchaser who
resold too quickly and, therefore, find that the issuer’s offering was
public.

1) SEC v. Ralston Purina (S. Ct. 1953)—held that §4(2) ought to

be read in light of the purpose of the statute, as applying to
offerings made to those who can “fend for themselves.” But for
about 30 years after this case, what this actually meant was up in
the air.

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 2) Rule 506 was adopted in 1982. It is a non-exclusive safe harbor
interpretation of §4(2), and a part of Regulation D, which is
designed to assist companies in raising capital in limited offerings.
It provides a list of conditions that must be met in order to benefit
from its safe harbor. It is concerned with purchasers only.

Note: It is non-exclusive in that an issuer’s failure to satisfy

all of the terms and conditions of Rule 506 does not
foreclose an opportunity to take an exemption provided by
§4(2) if available.

a) It allows any issuer to sell an unlimited amount of its

securities to an unlimited number of “accredited
investors” and to 35 non-accredited investors.
(1) Rule 501(a) provides that an “accredited
investor” includes certain institutions, directors and
executive officers of a corporate issuer, natural
persons who have a net worth of $1 million, and
natural persons who have individual income in
excess of $200,000.
b) General advertising by issuer or affiliates is prohibited.
c) Specified info must be available to non-accredited
investors prior to sale.
d). Issuer must file with the SEC a notice of sales on Form
D.
e)Issuer must take reasonable care to make sure that
purchasers of Rule 506 securities are not underwriters.
(1) Issuer must get letter from purchaser saying that
they are buying for investment and not with a view
towards distribution.
(2) Issuer must clearly indicate on certificate that it
is not freely transferable w/o opinion of consul that
resale is not premature.
(3) Issuer must give instructions to transferee that
they are not to be transferred w/o opinion of consul.
f)As a result, such securities are “restricted securities”
within the meaning of Rule 144(a)(3).
2. Resales by owners of Securities of domestic operating companies--§4(1):
the trading exemption
a. §4(1) of the 1933 Act provides that the provisions of §5 shall not apply
to “transactions by any person other than an issuer, underwriter, or
dealer.” It is available for trading, and does not exempt sales that would
constitute a distribution.

Note: The potential problem areas regarding secondary sales are

(1) any person who resells restricted securities in the public trading

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 market runs the risk of becoming an underwriter; and (2) that an
affiliate’s resale will constitute a distribution of unregistered
securities, and thus not eligible for a §4(1) exemption.

1) Threshold questions: the issue—can the seller claim an

exemption under §4(1)?
a) What is the status at the time of the proposed resale of
the person reselling the securities?
(1) Is the person an affiliate?
(2) A non-affiliate?
b) What is the status of the securities to be resold?
(1) Unrestricted?
(2) Restricted?
2) Three case scenarios that illustrate the relevant issues:
a) Easiest case scenario: non-affiliate sells un-restricted
securities into the secondary market. No problem. §4(1)
applies.
b) Scenario #2: affiliate sells restricted or unrestricted
securities. The issue is how much can he/she sell before
considered making a distribution?
(1) Is this a distribution?
(2) How long must the affiliate hold the securities?
(3) Rule 144 will answer these questions.
c) Scenario #3: restricted securities sold by affiliate of
non-affiliate. The issue is whether they are being sold too
quickly, and thus the seller becomes an underwriter “with a
view toward distribution.” Seller may violate §5.
(1) Rule 144 will provide an objective test.

b. Rules 144 and 144A: safe-harbor interpretations of 4(1).

Note: SEC essentially provides that any person who meets all of
the terms and conditions in Rule 144 or Rule 144A is entitled to
claim the protection of §4(1).

1) Rule 144
a) Provides benefits to at least 3 groups of persons:
(1) Benefits both affiliates and non-affiliates who
wish to resell restricted securities. It sets forth
objective criteria for determining the holding period
before resale, and the amounts that can be resold.
§144(e).
(2) Benefits affiliates who plan to resell their
control shares (whether restricted or not) by giving
volume limitations to protect against possibility of
“distribution.” §144(e).

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 (3) Not available to issuers, but helpful for holders
to use in connection with potentially troublesome
secondary sales.
b) Rule 144 terms and conditions:
(1) “Restricted Securities” under Rule 144(a)
includes any securities acquired from an issuer or
affiliate thereof in a transaction not involving a
public offering.
(2) Current public info under Rule 144(c):
adequate public info about issuer must be available
before the Rule can be used for resales.
(3) One year holding period for restricted
securities under Rule 144(d): one year holding
period commences when the recipient purchases
securities.
(4) Sales of restricted securities under Rule
144(e): person can sell, during any three month
period, an amount equal to the greater of (a) 1% of
the outstanding securities of that class, or (b) the
average weekly trading volume on organized
markets during the four calendar weeks preceding
the proposed resale.
(a) Policy: to prevent disruptions in trading
markets.
(5) Necessity of “brokers” transactions under
Rule 144(f): a person relying on Rule 144 must
resell in brokers’ transactions—which include those
in which a broker does no more than execute a sell
order as agent and receives no more than the usual
customary commission.
(6) Filing of Form 144 in certain circumstance
under Rule 144(h): filing Form 144 is required
where the number of securities to be sold exceeds
500 and the aggregate selling price will be greater
than $10,000.
(7) Non-affiliate 2-year rule under Rule 144(k):
any non-affiliate who has been a non-affiliate for at
least three months and who has owned restricted
securities for at least two years can sell an unlimited
amount of securities, regardless of the availability
of current information available about issuer, and
regardless of such sales being through brokers’
transactions. No Form 144 need be files either.
(a) This essentially exempts such persons
from the requirements of paragraphs (c),(e),
(f) and (h) of Rule 144.

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2) Rule 144A
a) Rule 144A provides a non-exclusive safe harbor from
the registration requirements of the Act for resales or
restricted securities and control shares to any “qualified
institutional buyer” as that term is defined.
(1) Eligible purchasers: “Qualified institutional
buyer” is an entity which owns and invests on a
discretionary basis at least $100 million of
securities not affiliated with it (it is assumed that
these entities can “fend for themselves”). It also
covers most corporate and partnership purchasers.
(a) Broker-dealer registered under the
Exchange-Act is deemed a QIB if it owns
and invests at least $10 million of
unaffiliated securities.
(b) Banks and S&Ls must satisfy the $100
million requirement, and have a net worth of
at least $25 million.
(2) Eligible securities: the rule is not available for
securities that, when issued, were of the same class
as or fungible with securities listed on a national
securities exchange or quoted on Nasdaq.
(a) This relegates the Rules application to
non-convertible debt and preferred stock.
(b) To prevent side-by-side public and
private markets of the same class of
securities of issuer.
(3) Information requirements: if issuer is a
reporting company, a holder wishing to resell under
Rule 144A has no duty to provide information on
issuer.
(a) But if securities are issued by a company
not subject to reporting requirements, or
exempt under 12g3-2(b), or foreign
government, then seller must be able to
obtain info concerning the business of the
issuer and financial statements if buyer
requests.
(b) Information required is the same as that
required in Rule 15c2-11(a)(5).
(4) Other requirements: Rule 144A does not
impose resale restrictions even though securities
acquired in such a transaction are “restricted
securities.” However, seller must take reasonable
steps to ensure that buyer is aware that seller may

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 rely on the rule as an exemption from registration
and prospectus delivery requirements of the Act.

II. Primary Offerings by Domestic Investment Companies: The Investment

Company Act of 1940

A. Introduction to Investment Funds

1. Open-end and closed-end funds:
a. Open-end funds are the most common—issues unlimited numbers of
shares to the public directly. They are redeemable at the option of the
holders.
1) Often the only secondary market for owners of such shares is
is the fund itself.
b. Closed-end funds have a fixed number of shares issued and
outstanding, which are traded as any other corporate stock might be traded
—i.e., on the NYSE.
2. Diversified and non-diversified:
a. A non-diversified fund is organized to invest only in voting securities
of one company.
b. A diversified fund has a more varied choice of investments.
3. Determination of price: the price of an investment fund’s shares is based on the
net asset value per share. It is the value of all investment owned by the fund
divided by its number of shares.
a. Investors in a closed-end fund, who do not buy directly from the issuer,
may pay a premium or a discount, depending on the popularity of the
fund.
4. Investment Company Act of 1940--Introduction
a. §7 of the 1940 Act prohibits an investment company from any form of
interstate commerce, unless exempted, where there has been a failure to
register with the SEC.
b. Registered investment funds must file such information and reports as
are required by other federal securities laws, like the 1933 and 1934 Act.
1) §30 of 1940 Act subjects all investment companies to periodic
reporting.
c. Diversified fund: under §5(b)(1) of the 1940 Act, in investment
company is diversified if meets each of the following conditions with
respect to 75% of the value of the fund’s total assets:
1) Of the securities so included, the fund may not have more than
10% of the outstanding voting securities of any one company, and
2) Not more than 5% of the fund’s assets may be in the securities
of any one company. See 5-35 for example.
3) If a fund is not diversified it qualifies as “non-diversified.”
5. US Regulations of Offerings by Domestic Investment Companies
a. Assuming that a domestic fund has registered under the 1940 Act and
wishes to make a public offering, the registration requirements of the
1933 Act apply.

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 1) Closed-end funds in need of more capital to invest are similar to
operating businesses that go to the primary markets on a periodic
basis—and must comply with registration and prospectus delivery
requirements of 1933 Act.
a) Each time a closed-end fund makes a new public
offering, it files a new registration statement for the shares
it plans to sell.
2) Open-end funds, by contrast, are continuously offering their
shares for sale to the public. As a result, an open-ed fund’s
prospectus must be revised and updated annually to reflect changes
in the business.
6. Private offerings: 2 exemptions for hedge funds
a. §3(c)(1)of the1940 Act provides that the following person is not an
investment company within the meaning of the Act: an issuer whose
securities are
1) Beneficially owned by not more than 100 persons, and
2) Which is not making and does not presently propose to make a
public offering of those securities.

Note: a fund relying on §3(1) must be careful if it is

affiliated with any other §3(1) funds. Where such funds are
so related, the SEC may determine that the funds should be
integrated and treated as a single issuer.

b. §3(c)(7) of the 1940 Act excludes from the definition of an investment

company any private investment company that consists solely of highly
sophisticated qualified purchasers.
1) Any natural person owning $5 million in investments;
2) A family owned company with at least $5 million in
investments;
3) A sophisticated trust;
4) Any person who invests at least $25 million from his and other
qualified purchasers’ accounts.
7. Resales by Owners of Securities of Domestic Investment Companies
a. Resales of securities issued by a closed-end fund are regulated in the
same way as securities of operating companies.
b. An open-end fund is both the issuer and purchaser of its shares. No
secondary market exists for holders, nor is it necessary. These
shareholders can cause issuer to redeem their shares at any time.
1) Holders of these shares are not subject to the registration
requirements of §5 of the 1933 Act.

III. Primary and Secondary Offerings: Securities of Foreign Issuers in Domestic

Transactions

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A. Practical problems for domestic investors
1. Stock quotations in foreign country.
2. Difficulty to find a broker to execute the transaction.
3. Trading, clearing and settling a transaction under foreign standards and in
foreign currency.
4. Foreign investment restrictions which control the amount of foreign money that
can be invested in local companies.
5. Possible need for foreign global custodian of the foreign securities and the
difficulty in locating and costs in using it.
6. Dividends and interest paid out in foreign currency.
7. Possibility of foreign tax withholding.
8. Difficulty acquiring information about the foreign issuer and about related
topics that would permit comparisons with other foreign investments.
9. Difficulty in transferring title at death under foreign law.

B. American Depository receipts (ADRs)

1. Capital markets have developed a convenient method for domestic investors to
purchase and sell securities of foreign issuers on their own, i.e., to make direct
investments. ADRs is the answer.
a. ADRs can be publicly offered or privately placed.
b. Privately placed securities are sold to Qualified Institutional Buyers
(QIBs), which are institutions that own or invest at least $100 million in
securities and registered broker dealers that own or invest on a
discretionary basis $10 million in securities of non-affiliates.
2. Depositary receipts defined:
a. A negotiable certificate evidencing ownership of shares in a foreign
corporation from a country outside the market where the DRs are traded.
b. Each DR denotes depositary shares which represent a specific number
of the underlying shares remaining on deposit in the issuer’s home market.
c. A depository is a bank that provides all stock transfer and agency
services in connection with a DR program. The bank is usually in the US.
d. The custodian, in connection with ADRs, might be an overseas branch,
affiliate or correspondent of the depositary bank, and is responsible for
holding the shares underlying the ADRs.
3. Theory behind ADRs:
a. Based on the notion of “beneficial ownership” where legal owner hold
an asset in a fiduciary capacity for 3rd parties (the beneficial owners).
1) For example, Depositary Trust Companies hold physical
evidence of securities, maintain book entry ownership of securities,
settle transactions between clearing companies, etc.
2) In the case of ADRs, the depositary is the “legal entity” for
registration purposes—must file a Form F-6 with the SEC.
4. Sponsored depositary v. un-sponsored depositary facilities:
a. Un-sponsored facilities are rare.
b. Sponsored depositary facilities are the norm—where the facility is
established jointly by the foreign issuer and the depositary.

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 1) The issuer of the deposited securities enters into a deposit
agreement with the depositary and signs the Form F-6 registration
statement that the SEC requires to be filed under the 1933 Act.
2) The benefits to a foreign issuer:
a) To enlarge the market for its shares through a broadened
and more diversified exposure which may increase or
stabilize the share price.
b) To enhance the image of the company’s products,
services or financial instruments in a marketplace outside
its home country.
c) To provide a mechanism for raising capital or as a
vehicle for an acquisition.
d) To enable employees to invest easily in the parent
company.
3) Three categories of sponsored facilities:
a) Level 1: Involve arrangements between a depositary and
outstanding securities of a foreign issuer which trade or
will trade in the OTC but not on Nasdaq or OTC Bulletin
Board. Relate to securities which a foreign issuer has
already sold and which are in the hands of investors.
b) Level 2: Involve sponsored facilities for outstanding
securities of a foreign issuer which trade or will trade on a
national stock exchange, on Nasdaq or on the OTC Bulletin
Board. Also relate to securities already sold.
c) Level 3: Are used by foreign issuers in connection with
efforts to raise capital. Level 3 sponsored facilities assist a
foreign issuer to sell its securities in the primary market.
4) Disclosure in connection with a Level 3 ADR program:
a) Foreign issuer must file a registration statement with the
SEC in connection with the offering and in connection with
a Level 3 ADR program.
(1) Registration statement contains a prospectus
which will provide investors with material
information about the foreign issuer and the
offering.
b) SEC also requires a registration statement to be filed by
the depositary as part of the creation of any depositary
receipt program.
(1) This registration statement is on Form F-6.
(2) Foreign issuer must co-sign with the depositary.
(3) §5 of 1933 Act requires the depositary to deliver
the F-6 prospectus to purchasers of depositary
receipts. This also happens with Level 3 offerings.

C. Primary Offerings by Foreign Operating Companies

1. 1933 and 1934 Acts contemplate three categories of issuers:

15
 a. Issuers that are organized under US federal and state laws;
b. Issuers that are organized under the laws of a foreign jurisdiction but
that are “essentially” domestic in character;
c. Issuers that are organized under the laws of a foreign jurisdiction and
that are essentially foreign in character.
2. Definition of “foreign private issuer”—
a. Rule 405 provides that the term “foreign private issuer” means any
foreign issuer other than a foreign government except an issuer meeting
the following conditions:
1) More than 50% of the outstanding voting securities of such
issuer are held of record either directly or through voting trust
certificates or DRs by residents of the US.
2) Any one of the following:
a) The majority of executive officers or directors are US
citizens or residents;
b) More than 50% of the assets of the issuer are located in
the US; or
c) The business o the issuer is administered principally in
the US.
Note: “resident” means the address of any person that
appears on the records of the issuer, etc. as being located in
the US.
3. Foreign issuers: disclosure obligations under the 1933 Act
a. A foreign issuer that does not qualify as a foreign private issuer under
the SEC’s definition of that term does not enjoy the regulatory benefits
that obtain for foreign private issuers.
b. Unless the foreign issuer is a government or political entity, it will be
regulated as if it were a domestic issuer.
4. Foreign private issuers: obligations under the 1933 Act
a. Where the foreign issuer meets the definition of a foreign private issuer
in SEC Rule 405 or SEC Rule 3b-4, it is eligible for less stringent
regulation under the 1933 and 1934 Acts.
b. Under 1933 Act, the SEC has developed special forms of disclosure for
foreign private issuers that are planning to make a registered public
offering of their securities in the US:
1) Forms F-1, F-2, and F-3. They are comparable to the
registration forms S-1, S-2, and S-3, only not as demanding—e.g.,
SEC modified the accounting requirements under US GAAP.
c. There are no exemptions designed especially for a foreign private
issuer. Thus, for example, such an issuer might claim the same protections
as a domestic issuer in making a private placement under §4(2) or Rule
506 of Regulation D.
d. Resales of securities of a foreign private issuer in domestic
transactions are subject to the same limitations as resales of securities of
domestic issuers in US secondary markets.

16
D. Primary Offerings by Foreign Investment Companies
1. §7(d) of the 1940 Act says that the only foreign investment companies that can
make public offerings are those created under the laws of the U.S.
2. The SEC has interpreted this to allow only Canadian investment companies to
register under the 1940 Act.
3. Policies behind the protectionism: 5 reasons investment companies are in the
public interest--§1(a)—and the eight ways public interest can be adversely
effected--§1(b). So if an investment company is organized outside the country,
the SEC cannot easily monitor it.

IV. Primary and Secondary Offerings: Securities of Domestic or Foreign Issuers in

Offshore Transactions

A. Possible US interests in such “foreign” transactions:

1. Protecting US investors in primary offerings regardless of where those
investors are located at the time of an investment.
2. Regulating US companies in primary offerings regardless of where they sell
their securities;
3. Regulating US trading markets that receive securities that are issued in primary
offerings outside the US, especially where those securities carry unusual risks for
individuals who are unsophisticated investors.

B. Regulation S
1.Generally
a. Adopted by SEC in 1990 as party of its goal of “achieving a truly global
market system,” by clarifying the registration requirements of the 1933
Act to offshore transactions.
b. Regulation S provides both an issuer safe harbor and a resale safe
harbor from the registration requirements of §5 for certain offshore
transactions.
1) If a sale satisfies either safe harbor it will be deemed “outside
the US” for purposes of Rule 901, infra.
c. Policies:
1) Guard against possibility that unregistered securities sold abroad
would flow back into the US, or into its citizens hands, leaving the
US investors unprotected.
d. The Regulation is available for offers and sales of securities of any
investment company that is not registered or required to register under the
1940 Act. (?)
2. Rule 901—the general rule:
a. For the purposes only of §5 of the Act, the terms “offer,” “offer to sell,”
“sell,” “sale,” and “offer to buy,” shall be deemed to include offers and
sales that occur within the US and shall be deemed not to include offers
and sales that occur outside the US.
b. This codifies the territorial approach to §5 of the Act.

17
3. Two general conditions that apply to all offers, sales and resales made in
reliance on the safe harbors of Rules 903 and 904, infra.
a. The offer or sale must be made in an “offshore transaction.” (Rule
902(h)) An offshore transaction requirement has two prongs, both of
which must be satisfied:
1) No offer is to be made to a person in the United States.
2) And at time of sale,
a) The buyer must be outside the US when the buy order
is originated, or seller must believe that buyer is outside the
US, and
b) The sale must not be specifically targeted to any US
citizens abroad—like members of US armed forces, etc.
b. No “directed selling efforts” may be made in the US in connection
with an offer or sale of securities in reliance of Rule 903 or 904.
1) Rule 902(c) defines directed selling efforts as those activities
undertaken for the purpose of or could reasonably be expected to
have the effect of conditioning the market—i.e., big advertisement
in a publication with general circulation.
2) No directed selling efforts may be made in the US by the issuer,
distributor, any of their respective affiliates, or any person acting
on the behalf of any of the foregoing.
4. Rule 903--the issuer safe harbor:
a. Three categories. Note that the procedural safeguards become more
onerous as one progresses from Category 1 to Category 3.
1) Issuer Category 1:
a) Types of securities falling in this category are:
(1) Securities of a “foreign issuer” with “no
substantial US market interest;” (SUSMI)
(a) Definition of SUSMI permits an issuer to
rely upon its reasonable belief as to the
existence of a SUSMI.
(b) Rule 902(j) provides objective criteria—
the single largest market test, or the 20%
test.
(2) Securities offered and sold in an “overseas
directed offering;” (ODO)
(a) In the definition of an ODO, the
requirement that the offering be “directed”
at a single country is key.
(3) Securities backed by the full faith and credit of a
“foreign government;”
(4) Securities offered and sold pursuant to certain
employee benefit plan.
b) This first category imposes no additional conditions on
the offering—only the two general conditions discussed
above are applicable.

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 c) Offers and sales of such securities that are made to US
investors who are overseas at such time will not preclude
reliance on this safe harbor category.
2) Issuer Category 2:
a) Types of securities encompassed in this category are
(1) Debt securities of a domestic reporting issuer;
(2) Equity securities of a foreign reporting issuer
with a substantial US market interest;
(3) Debt securities of a non-reporting foreign issuer;
(4) Convertible debt of foreign reporting issuer.
b) Offerings of securities in this category are subject to the
two general conditions discussed above, as well as subject
to specified selling restrictions:

Note: The policy behind these restrictions is that

there is a greater likelihood that the securities will
flow back into the US.

(1) Transaction restrictions:

(a) 40-day distribution compliance period
before being sold to or for benefit of US
person. Note that residency, not citizenship,
drives the definition of US person—Rule
902(k).
(b) Seller must ensure that no non-
distributor to whom securities are sold is a
US person.
(c) If distributors sell to professionals, must
advise them that he is subject to same
restrictions.
(2) Offering restrictions:
(a) Each distributor must agree in writing
that all its offers and sales will be made in
compliance with the safe harbor or with
registration or an exemption under the 1933
Act.
(b) Must disclose that securities have not
been registered and may not be offered or
sold in the US or to a US person (other than
a distributor) unless registered or exempt
from registration.
3) Issuer Category 3:
a. Types of securities included in this category are
(1) Equity securities of a reporting domestic issuer;
(2) Equity securities of a non-reporting domestic
issuer;

19
 (3) Equity securities of a non-reporting foreign
issuer with a SUSMI in its equity securities;
(4) Convertible debt securities of domestic issuers,
and convertible debt of a non-reporting foreign
issuer with SUSMI in its convertible debt.
b. Securities in this category are subject to the two general
conditions above, as well as being subject to the offering
restrictions applicable to Category 2.
c. Increased transaction restrictions: these vary
according to the characteristics of the securities. For equity
securities the following apply:
(1) Distribution compliance period of 1 year.
(2) Purchaser certification—“not purchasing
securities for the account or benefit of any US
person.”
(3) Purchase agreements—agree to resell in
accordance with Regulation S, the registration
requirements of the Act, or an exemption.
(4) Legends are to be placed on securities sold
offshore advising that transfer is prohibited other
than in accordance with Regulation S, etc.
(5) Stop transfer instructions—where an issuer
must bind itself by contract, or through another
means, to refuse to register any transfer not made in
accordance with Regulation S, etc.

Note: what this means is that

(a) US citizens traveling abroad, they cannot be offered
category 2 or 3 securities (w/ compliance periods), but no
problem with category 1.
(b) Non-US citizens resident in the US are treated the same
as US persons, and if they go abroad, they cannot buy
category 2 or 3 securities prior to expiration of compliance
period.

5. Rule 904—The resale safe harbor

a. Rule 904 provides an outlet to certain persons who acquire securities
from Category 2 or Category 3 issuers who wish to resell those securities
during the applicable distribution compliance period.
b. It applies only to resales by persons other than the issuer, a
distributor, their respective affiliates and persons acting on behalf of
any of the foregoing parties.
1) Officers and directors of issuers and distributors can use the
Rule 904 safe harbor if they are affiliates solely by virtue of their
position as an officer or director, and receive no remuneration in

20
 connection with the offer or sale other than customary broker’s
commission.
c. Resales must comply with the two general conditions above, as well
as the following:
1) If Category 1: no more resale requirements;
2) If Category 2 or 3: Purchasers can resell to other non-US
persons in offshore transactions during the compliance period.

Note: This resale safe harbor is available whether or not the

securities were acquired in an offshore transaction, therefore
permitting use of Rule 904 for resales of restricted securities
originally acquired in a private placement under Regulation D or
§4(2) or for securities acquired in a Rule 144A transaction. The
availability of this safe harbor is unaffected by the activities o the
issuer or affiliates.

7. Potential abuses under Regulation S:

a. Introduction:
1) Rule 903 imposes transactions restrictions in connection with
offer and sale of securities under Regulation S.
2) Rule 904 provides a resale safe harbor to certain persons during
the distribution compliance periods that apply to securities in
Category 2 and Category 3 of Rule 903.
a) The resales must be made in an offshore transaction and
cannot involve directed selling efforts in the US.
3) But Rule 904 is not the only way holders of securities acquired
in a Regulation S transaction can resell during the distribution
compliance periods imposed by Rule 903.
a) Rule 144A is available for such persons, whether or
not they are “qualified institutional buyers,” to resell
Regulation S securities during the distribution
compliance period.
b) Such resales must be made into the US private resale
market in accordance with the requirements of Rule 144A.

c) Because of resale abuses, the SEC added Rule 905 in

1998.
4) Rule 905: important limitations on resales--
a) Equity securities of domestic issuers that are acquired
from the issuer, a distributor, or any of their respective
affiliates in a transaction subject to Regulation S are
“restricted securities” as defined in Rule 144(a)(3).
b) Any resales of domestic equity securities must be made
in accordance with Regulation S, registration under the
1933 Act, or pursuant to an exemption.

21
 c) Equity securities will remain “restricted securities” even
if acquired in a transaction pursuant to Regulation S—they
cannot be freely sold.
5) Hypo: Domestic issuer sells securities offshore pursuant to Rule
903. Purchaser can resell immediately into the US to a QIB
pursuant to Rule 144A—but the QIB holds restricted securities and
must honor the requirements of Rule 144.
a) If, instead, a foreign purchaser resells during the
distribution compliance period, pursuant to Rule 904, his
purchaser continues to hold restricted securities.
b) After the 1-year compliance has expired, which is also
the holding period for Rule 144(a)(1), a holder of any
domestic equity securities sold initially pursuant to Rule
903 may now resell in the US pursuant to Rule 144.
c) After the expiration of 2 years, a non-affiliate may make
unlimited resales of those securities pursuant to Rule
144(k).

Part III: Impact of Securities Exchange Act of 1934 on Disclosures to Trading

Markets by Certain Issuers and Key Persons

I. Mandatory Disclosure: Securities of Domestic Issuers

A. Securities Exchange Act of 1934—General stuff

1. The 1934 Act requires that certain securities be registered with the SEC. Once a
company has registered its securities, it is subject to continued reporting under the
Act, and to regulation of many of its other activities.
2. The purpose of the Act is to protect interstate commerce and to ensure the
maintenance of fair and honest securities trading markets.
3. What is the consequence of registering for a company with outstanding
“restricted securities” according to the 1933 Act?
a. The short answer is that there is no effect. The securities are still
restricted, but presumably, there will be a better market for holders of such
securities after the holding period if another class of securities is
registered.

B. Registration under §12 of the Act; triggering events:

1. The issuer decides to list a class of equity securities on a national securities
exchange. §§12(a), (b).
a. Register on Form 10.
2. The issuer, at the end of the fiscal year, has total assets greater than $10
million, has 500 or more record owners of a class of equity securities and is
doing business in interstate commerce. §12(g)(1).
a. Note that this doesn’t apply if the securities of the company are listed on
a national exchange.
b. Register on Form 10.

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 3. The issuer voluntarily decides to register. §12(g)(1).
a. Note that now Nasdaq and the OTC Bulletin Board require registration
under the 1934 Act.
b. Register on Form 10.

C. The consequences of registration for domestic companies:

1. §13(a) requires periodic disclosure and filings with the SEC.
a. Form 10-Q: quarterly reports every three months of fiscal year. Most
information is unaudited.
b. Form 10-K: annual and transition reports. Information is audited.
c. Form 8-K: Current reports, to provide the market with updated and ad
hoc info when important events occur—i.e., changes in control,
bankruptcy, changing auditors, etc.
2. The Act governs the manner in which voting proxies are solicited from
shareholders. §14(a) provides that it is unlawful for a §12 company to solicit any
proxy.
3. The Act also governs the practices used in making a tender offer. §14(d)(1)
provides that it is unlawful for a §12 company to attempt to make tender offers of
securities registered under §12.
4. The Act also provides for continuous scrutiny by the SEC, SROs and Market
Professionals.
a. §18 imposes liability for making misleading statements on filed
documents.
b. SROs and Market professionals demand constant diligence.
c. §10(b) is a powerful anti-fraud provision.
d. Rule 10b-5 gives private parties a cause of action for use of deceptive
devices.

D. Consequences for certain persons associated with the issuer

1. Regulation under §13:
a. §13(d)(1) provides that any person (or entity) that becomes the owner of
more than 5% of any class of securities registered under §12 must file with
the issuer of those securities and the SEC Schedule 13D.
2. Regulation under §16(a):
a. Reporting obligations for officers, directors, and >10% equity holders—
(Rules 16a-1 through 16a-13) on Forms 3, 4 and 5
b. Such a filing is for the purpose of fully disclosing their actions, and
must be reported within 6 months.

E. The protection and regulation of forward-looking statements

1. Rule 3b-6 protects companies when making forward-looking statements from
lawsuits when such statements do not come to fruition. Such statements are not
deemed fraudulent so long as they can be shown to have had a reasonable basis.
2. §21E of the Act provides a safe harbor for forward-looking statements. The
section applies to persons subject to the reporting requirements of §13(a) (>5%).
a. No liability if the statements are clear and cautionary.

23
 b. If such claims are adequately presented, the claims will be dismissed on
summary judgment (FRCP §12(b)(6)).
c. If the info is generally couched in language that a reasonable investor
would take with a grain of salt, then the “bespeaks caution doctrine”
suggests that courts will dismiss any claims.
3. §10A requires independent auditors to bring apparent fraud to the attention of
the board of directors. If nothing is done, they are to take it to the SEC. Auditors
cannot be liable.

F. Disclosure obligations of domestic companies not registered under §12

1. Limited periodic reporting after a 1933 Act registered offering:
a. §15(d) of the 1934 Act imposes periodic reporting obligations on any
company that has filed a registration statement under the 1933 Act.
1) Such issuers must make periodic reports that a company
registered under §12 would make under §13(a).
2) Such reports must be made on Forms 10-Q, 10-K, and 8-K, as
required by Rules 15d-13, 15d-1, and 15d-11, respectively.
b. Exception--if a company registers pursuant to §12, then they are
exempted from §15(d)—sort of a safe harbor. Obligations under §15(d)
are also suspended if <300 shareholders of record after the first fiscal year
after registration was recorded.

Note: All §12 companies are “reporting companies” under the

1934 Act, but some §15(d) companies can be reporting companies
while not registered.

2. Disclosure for dealers in issuer’s securities (fraudulent statements rules):

a. Broker-dealers are regulated under §15(c)(1)(A) and §15(c)(2)(A).
b. Rule 15c2-11 prohibits a broker dealer from making a market in any
security unless the issuer
1) Has recently made a public offering under the 1933 Act, or
2) The dealer has current reports on file under the 1934 Act, or
3) The dealer has specified current financial info on file and other
info about the issuer.
c. Under Rule 15c2-11, dealers must also review the info before making
any quotations for any security, and to have a reasonable basis to believe
that the information is true and accurate and obtained from reliable
sources.
d. The purpose, and effect, of this rule is to prevent the creation of public
trading markets in securities that have not been registered under either the
1933 or 1934 Act.
e. This means that if a company wants a market in one’s stock, even if
only in the pink sheets, broker-dealers must have up-to-date info about the
issuer for investors. This applies to “certain foreign issuers.”

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II. Mandatory Disclosure for Securities of Foreign Private Issuers

A. Registration Under §12

1. When a foreign private issuer decides to list a class of equity securities on a US
national securities exchange, it too must register under §12—this includes Nasdaq
or the OTC Bulletin Board. Of course, a foreign private issuer can also
voluntarily choose to register.
2. Without an exemption, a foreign private issuer that does some business in the
US, but does not have any assets or record holders in the US would be required to
register under §12.
a. This applies to any foreign issuer with assets > $10 million, regardless
of where the assets are located, and 500 or more record holders of a class
of equity securities, regardless of where those record holders reside, and
does business in interstate commerce.
b. But foreign private issuers have two special exemptions from the
requirements of §12(g)(1)—Rule 12g3-2(a) and Rule 12g3-2(b).
3. When foreign private issuers register under §12, they register on SEC Form
20-F.
4. Disclosure obligations for foreign companies registered under §12:
a. Where a foreign issuer meets the definition of a foreign private issuer in
Rule 3b-4 of the 1934 Act, it is eligible for less stringent regulation.
b. Reporting and proxy requirements under §13(a) and §14(a) are not as
onerous.
1) Under Rule 3a12-3, foreign private issuers and their insiders are
exempted from the proxy solicitation rules under §14(a) and filing
obligations under §16(a).
c. Periodic reporting by registered foreign private issuers, pursuant to
§13(a) is done on Form 20-F for the annual report, and on Form 6-K for
interim reports.
1) Form 20-F is the 10-K corollary for foreign private issuers. The
SEC doesn’t assume the incorporation of other rules into the
instructions (i.e., Regulation S-K is literally incorporated into the
instructions for Form 20-F).
2) Form 6-K is the 8-K corollary for foreign private issuers. It
defers to the disclosure obligations of the home country.
5. Disclosure for depositary receipts holders:
a. §5 of the 1933 Act requires the depositary to deliver the F-6 prospectus
to purchasers of depositary receipts.
b. The deposit agreement between the foreign issuer and the depositary, as
well as Form F-6, regulate dissemination of the foreign issuer’s periodic
disclosures to holders of its DRs after the depositary receipts program for
the foreign issuer has been established.

B. Disclosure Obligations of Foreign Companies Not Registered under §12.

25
 1. A foreign private issuer which is exempt from §12g(1) because of Rule 12g3-
2(b) must furnish information on a continuous basis to the SEC as a condition of
the exemption.
a. Rule 12g3-2(a) provides a total exemption from §12(g) if the company
has < 300 holders of record resident in the US. This is a fiscal year
exemption only—applicability evaluated each year.
1) Note that these folks must disclose something in order to have
an ADR distribution in the US (Form F-6).
2) They must also provide info to US broker-dealers pursuant to
Rule 15c2-11, supra.
b. Rule 12g3-2(b) provides that securities of a foreign private issuer shall
be exempt from §12(g) if the issuer provides home country disclosure.
This rule is deferent to home country disclosure requirements. This is
actually ongoing disclosure, and requires filing of Form 6-K whenever
necessary.
2. Foreign private issuers that make registered public offerings under the 1933
Act and which are not registered under §12 of the 1934 Act, are subject to limited
periodic reporting under §15(d) of the 1934 Act pursuant to Rule 15d-16 on form
20-F and 6-K.
a. Rule 12h-3(b)(2) provides for the suspension of filing obligations under
§15(d) if
1) Securities held by < 300 persons resident in the US, or
2) < 500 persons resident in the US where the total assets of issuer
have not exceeded $10 million on the last day of each of issuers
three most recent fiscal years.
b. To take advantage of this suspension of obligations under §15(d), the
issuer must file Form 15.
3. Rule 15c2-11, supra, prohibits broker-dealers from making a market in any
security without certain information about the issuer. This essentially means that
non-registered companies with a Rule 12g3-2(a) exemption must provide some
information for investors through the broker dealer.

C. Disclosure Obligations of Key Persons Associated with Foreign Companies

Registered under §12
1. §13(d) filing obligations for beneficial owners (>5% owner) pertain to the
filing of Schedule 13D. Rule 13d-1(c) permits certain persons, including passive
investors with <20% ownership to file a shorter form.
2. Rule 3a12-3 exempts certain officers, directors and 10% shareholders of
foreign private issuers from §16(a) filing obligations.

III. Policy Implications of SEC Regulation of Foreign Companies

A. Quality of Information Available to US Investors of Foreign Issuers

1. The quality of information disclosed by a foreign issuer to US investors
depends on the nature of the issuer and the type of securities offering it makes
into the primary market—and the relevant disclosure obligations.

26
 2. Disclosure in private offerings is controlled by the conditions of the
registrations exemption and the potential liability under anti-fraud provisions of
the domestic security laws. Note, that filing on Form F-6 is necessary of
depositary receipts are to be used.

B. Summary of Disclosure Requirements of Foreign Issuers:

1. Foreign Issuer—essentially a US Issuer:
a. If they make a public offering in the US domestic investors will receive
information required by §15(d) of the 1933 Act following the distribution.
b. If subject to §12 of the 1934 Act, then investors will receive periodic
reports as required by §13 of that statute.
c. If they have not made a registered public offering and if not subject to
§12 of the 1934 Act, investors will receive indirectly only that info
required by Rule 15c2-11 as disclosed to broker-dealers.
2. Foreign private issuer—not registered under the 1934 Act:
a. If relying on either 12g-1 or 12g3-2(a) as an exemption from
registration under §12 of the 1934 Act, then they are not required to
furnish any information to investors (see supra).
b. If claiming an exemption under 12g3-2(b) of the 1934 Act, the foreign
private issuer must provide US shareholders with the same information as
disclosed in the issuers home country.
3. Foreign private issuer—registered under the 1934 Act:
a. Domestic investors are entitled to information in an annual report on
Form 20-F, and to periodic reporting on SEC Form 6-K, which is the same
information disclosed in the issuers home country.

Part IV: Impact of US Securities Regulation on Broker-Dealers and Other

Intermediaries

I. Registration of Broker-Dealers

A. Introductory Remarks
1. To ensure that the public is not disappointed in their expectations of brokers
and dealers, Congress has imposed certain obligations on brokers and dealers as
conditions for participating in the national securities markets.
2. §3(a)(4) of the 1934 Act defines a “broker” as “any person engaged in the
business of effecting transactions in securities for the account of others, but does
not include a bank.”
3. §3(a)(5) defines a “dealer” as “any person engaged in the buying and selling
securities for his own account, through a broker or otherwise, but does not include
a bank, or any person who buys or sells securities for his own account, either
individually or in some fiduciary capacity, but not as part of a regular business.”
4. §15(a) of the 1934 Act requires anyone meeting the statutory definition of
brokers and dealers to register with the SEC. Registration carries with it
continuing obligations, including anti-fraud rules of §15(c) and regulations

27
 imposed by §15(c)(3) which focuses on the financial soundness of the broker-
dealer. Broker-dealers must also become a member of NASD.

B. The Rule 15a-6 exemption for certain foreign brokers and dealers:
1. Rule 15a-6, adopted in 1989, provides an exemption from §15 requirements for
certain foreign brokers and dealers.
2. Generally the SEC considers the use by a foreign broker-dealer of any
jurisdictional means, such as the mails or telephone lines, to contact a US person
located in the US, as a sufficient basis for regulating that person or firm.
3. Rule 15a-6 sets forth an exemption from registration for a foreign broker or
dealer to the extent that he or she:
a. Effects transactions in securities for persons that have not been
solicited by the foreign broker or dealer;
b. Furnishes research reports to major US institutional investors, and
effects transactions in securities mentioned in the reports with or for such
institutions with certain limitations;
c. Induces or attempts to induce the purchase or sale of any security by a
US institutional investor, with certain limitations;
d. Effects transactions in securities with or for, or induces the sale of any
security by certain professionals, government organizations, certain
foreign persons temporarily present in the US or certain US citizens
resident outside the US.
4. The main issue for the SEC is whether the issuer’s communication or other
activity attempt to “instigate publicity for the purpose of facilitating the sale or
securities in a proposed offering.”

C. Offshore Press Releases

1. Rule 135e provides that issuers or selling security holders will not be deemed
to offer any security for sale by virtue of providing any journalist with access to
its press conferences held outside the US, or meetings with issuer and the like, if

a. The present or proposed offering is not conducted solely in the US;

b. Access is provided to both US and foreign journalists; and
c. All press-related materials must
1) State that they are not an offer of securities in the US;
2) Include a statement of any intention to register any part of the
present or proposed offering in the US; and
3) Not include any purchase order or the like with the materials.

D. Broker-Dealer Involvement in Advertising and Sale of Securities During the

Registration Process:
1. Generally, broker-dealers can continue to advise the trading market for
securities of certain issuers in registration within reasonable limits.
a. No consideration for such information, etc.

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II. Registration of Investment Advisors

A. Investment Advisors Act of 1940

1. §202(a)(11) of the 1940 Act defines an investment advisor as “any person who,
for compensation, engages in the business of advising others, either directly or
indirectly or through publications or writings, as to the value of securities or as to
the advisability of investing in, purchasing, or selling securities, or who, for
compensation and as part of a regular business, issues or promulgates analysis or
reports concerning securities.”
a. The test for an investment advisor focuses on whether the person:
1) Is providing advice or issuing reports or analyses concerning
securities;
2) Is in the business of providing such services;
3) Is receiving compensation for such services.
b. The definition excludes banks, lawyers and accountants (professionals)
that give some advice incidental to the practice of his or her profession,
broker-dealers whose advice is likewise incidental, and publishers of
newspapers or magazines or general and regular circulation.
2. §203(a) of the Advisors Act prohibits any investment advisor from using any
US jurisdictional means in connection with its business unless registered with the
SEC, or exempted or excluded from the registration requirement.
a. Exemption: §203(b)(3) provides for an exemption for any advisor who
during the course of the preceding 12 months has had fewer than 15
clients and who neither holds itself out generally to the public as an
investment advisor nor acts as an advisor to a US registered investment
company or business development company.
1) Foreign advisors are required to count only their US clients for
purposes of determining their eligibility for this exemption.
b. Registered foreign investment advisors need not maintain an office or
staff in the US, but must furnish a consent to service of process with the
SEC and undertake to furnish books and records to the SEC upon request.
1) Note that foreign advising companies with separate US
registered subsidiaries may be subject themselves to the provisions
of the Act if they share personnel.

B. Hypos
1. Hypo #1: Foreign company w/out knowledge of or connections in the US
market get help from a US or foreign person with experience. Is this person a
broker dealer and thus must register? The determination hinges on the presence
of any of the following factors:
a. Participating in presentations and negotiations;
b. Making recommendations concerning securities—i.e., research and
advice in the decision making stage;
c. Receiving transaction-based compensation (it seems that charging a flat-
fee would be fine);
d. Making recommendations about the nature of securities to be offered;

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 e. Continuing involvement in the securities of the company.

Note: these factors determine whether one is considered a bona-fide finder

like Paul Anka. Because Lawyers are often involved in negotiations, they
may have problems passing the test.

2. Hypo #2: Hot-shot guy brought into a company to make connections like a
finder and consultant advisor. Is he a broker or dealer?
a. The SEC passed Rule 3a4-1, which provides that a person is not a
broker if
1) The person has a good reputation and no bad juju;
2) Paid a regular salary, not compensated by commissions;
3) Not affiliated with a broker-dealer;
4) Is not otherwise disqualified—i.e., must have other duties in the
company that persist, etc.
3. Hypo #3: Foreign issuer wants to use a lawyer in the US to find prospective
investors in the US, and the lawyer has not preexisting ties with the company.
a. The lawyer cannot make general solicitations or general advertising.
b. It could be problematic if the lawyer sends information willy-nilly to
prospective finders.
4. Hypo #4: US broker-dealer asks a US lawyer if he knows of some folks
interested in a particular foreign investment. The lawyer is to just find interested
parties, and has no K with the issuer.
a. Wirthland No-Action Letter: finders for broker-dealers are soliciting
investments. Any transaction based compensation would be problematic.
In this situation, the professional is functioning entirely as an
intermediary, and is not at all affiliated with the issuer (unlike Paul Anka).
5. Hypo #5: A pilot makes charts and wants to recommend stocks to folks on an
email list. He takes only a 10% totally voluntary donation. Is he an investment
advisor?
a. Yes: he is receiving compensation, regardless of whether it is voluntary;
he is in the business, even if he has another job; and he is providing
advice.

III. Internet issues

A. Generally:
1. SEC Policy Release No. 7516 said that passive posting of offering and
solicitation materials on a web page would not be considered activity taking place
in the US for purposes of registration requirements of securities laws.
a. The SEC has indicated that mass-emailing or “spamming” would be
considered comparable to the use of the mails.

B. Foreign broker-dealers on the internet: advertising on a web site will not be

considered an attempt to induce a transaction with US persons so long as the foreign
broker dealer

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 1. Posts a prominent disclaimer stating that services are not available to US
persons; and
2. Refuse to provide brokerage services to any potential customer the broker-
dealer has reason to believe is a US person.

Note: Rule 15a-6 of the 1934 Act, supra, exempts broker-dealer

registration for foreign broker-dealers that effect transactions in securities
with or for persons that they have not solicited.

C. Foreign investment advisors on the internet:

1. In general, a foreign advisor offering services on the internet, may be able to
rely on the exemption from registration under §203(b)(3) of the Advisers Act if
they have < 15 US clients.
2. Also, generally, such an advisor is considered holding itself out to the US
public unless they take reasonable measures:
a. Posting a prominent disclaimer; and
b. Implementing procedures designed to guard against directing
information to US persons.

Part V: Subject Matter Jurisdiction/Enforcement Remedies and Sanctions

Note: Personal Jurisdiction pursuant to the 1933 and 1934 acts has been extended
“to the full reach permitted by the due process clause.” Note that the Asahi
“purposeful availment/minimum contacts” and “reasonableness” analysis applies.

I. Subject Matter Jurisdiction for Transnational Securities Fraud

A The Anti-fraud provisions of the 1933 and 1934 Acts and other enforcement
mechanisms:
1. 1933 Act: §§11 and 12(a)(2) provide purchasers with private causes of action
for damages. The SEC has jurisdiction under §17 to seek equitable relief against
persons who offer to sell or sell securities by fraudulent means (misleading
statements). The USDJ has authority under §24 to bring criminal charges against
anyone in violation of §17.
2. 1934 Act: §10(b) prohibits fraudulent misstatements in connection with the
purchase or sale of securities. Rule 10b-5 is applicable to purchases and sales of
securities of all issuers, whether or not they are registered under §12 of the 1934
Act. The Supreme Court has also implied a private cause of action under Rule
10b-5, and the SEC and the USDJ can use it as a basis for their claims also.
3. Enforcement of anti fraud policies can take at least 4 different forms:
a. Private litigation;
b. SEC enforcement;
c. USDJ criminal actions;
d. SRO actions to sanction violators of SRO rules.

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B. Extraterritorial Application of US Securities Laws
1. Generally:
a. Non-Fraud cases: most lawsuits involve unregistered offerings—the
remedy is to get $ back (private action). The government or private
persons can bring suit. The D must show that they had an exemption. The
P only has to show the following:
1) No registration;
2) Jurisdictional means was used;
3) The D sold the securities to the P;
4) Statute of limitations has not run.
b. Fraud cases: According to §11 of the 1933 Act, a person acquiring
securities can sue just about anyone who signed the registration statement
—directors, experts, underwriters, etc.—but they are only liable for their
contributions to the statement.
1) §11(b)(3)(A) provides for two “due diligence” defenses for
anyone but the issuer:
a. For the “non expert” portions of the statement:
(1) Reasonable investigation; and
(2) Reasonable grounds to believe in the accuracy
of statements.
b. For the “expert” portions of the statement:
(1) No reasonable grounds to believe, and
(2) Didn’t believe it was inaccurate.

2. Essentially domestic transactions—the easy cases:

a. In Matter of Lai Sum Pang (SEC 1995): Hung Foo effects transactions
with US persons for securities of Taiwan companies. Lost of connections
outside the US. All activities demonstrate actions of a “broker.”
b. State Bank of Pakistan (SEC 1992): Foreign issuer government is
subject of enforcement action by the SEC. They had unregistered bonds.
Clearly an offer and sale in the US. They should have filed.
c. Chinese Consol. Benev. Ass’n (2nd Cir. 1941): Association formed to
send $ to China ultimately for the Republic Government. No relationship
between the issuer and people being sued—SEC just wants an injunction.
On appeal, the court issues an injunction. SEC is paranoid about certain
“bad” governments raising $ in the US (like Japan and Germany).
Appellate court says that the Assn’ is acting as an “underwriter”—
essentially offering and selling for the issuer.
1) Acting for the benefit of a company is enough to be an
“underwriter.” The language “for an issuer” means “for the benefit
of an issuer.”
2) The fact that the Assn’ wasn’t getting any value doesn’t matter.
The “for value” criteria actually means “for value to the issuer.”
3) Majority says that “continual solicitation” means you are an
underwriter.

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 4) §4(1) exempts only trading “transactions.” The whole series of
event makes up the transaction, and the exemption was not
intended for such distributions by an issuer. The D was
participating in the transaction with the issuer.

3. Domestic and foreign transactions—the not-so-easy cases:

a. Lloyds of London (9th Cir. 1998): Int’l agreement where US investors
signed agreements where they would indemnify Lloyds in case of
problems with underwriting syndicates. Ps bring fraud suit. Closing for all
Ks took place in London, and all US investors signed choice of law and
choice of forum clauses. The clauses are enforceable.
1) Bremen holding applies to securities: S. Ct. upheld a choice of
forum provision, for reasons of clarity, and to eliminate
parochialism in US courts.
2) Scherk holding also applies: securities case with arbitration
clause calling for arbitration in France with US law as applicable
law. Court upheld both clauses.
3) The primary concern was over the availability of protection
under UK law.
4) Court assumes that context in which the securities were sold—
i.e., offerings in the US to sophisticated investors. This, of course,
cannot be assumed in all fact scenarios.
5) Court doesn’t accept the notion that the broad scope of US
securities law automatically renders another forum inferior.
b. Freitsch (7th Cir. 1995): US D invokes forum selection clause in K
signed by Ps (but not by Ds) to throw it out of US court. In other words,
the forum selection clause is used as a defense. Posner says no. Hold:
forum selection clauses are like any K clause, it has to be able to do what
it is supposed to do—and can be used against you.

4. Foreign transactions—the difficult cases:

a. The effects test:
1) Schoenbaum (2nd Cir. 1967): Banff Oil shareholder sues for
fraud under 10b-5. Aquitaine purchased shares of its subsidiary
corporation, Banff Oil, at an unfair price based on inside
information about an oil discovery. Both corporations are
Canadian and all events took place in Canada, but Banff was listed
and traded on an American Stock Exchange.
a) The court has subject matter jurisdiction. The effects of
the fraud are in this country and is “detrimental to the
interests of US investors.”
b) After this case, the question “how much effects?”
became a major issue, and cast doubt on the usefulness of
the test.
b. The conduct test:

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1) Leasco (2nd Cir. 1972): P contacted by UK company and led to
believe that they should buy some of the company’s stock.
Eventual fraud. P brings suit in the US, and D contests subject
matter jurisdiction.
a) Court said that Schoenbaum wasn’t applicable, and
neither was its “effects” analysis.
b) The proper test is the “conduct” test: whether there has
been enough conduct by D for the statute to apply.
c) Because of abundant misrepresentations in the US—the
D passes the “substantial conduct test.”
2) Bersch (2nd Cir. 1975): Class action suit where investors lost $
when company collapsed. All offerings for company were abroad.
Court rejects the claim that the effects test is enough.
a) District court found subject matter jurisdiction using
3 factors:
(1) Amount of activity in the US;
(2) Sales to Americans;
(3) Generally adverse effects upon the US securities
market from public collapse.
b) Conduct test focuses on conduct that takes place in the
US in relation to alleged fraud, and takes into account the
nature of the P.
c) Hold: We have thus concluded that the anti-fraud
provisions of the federal securities laws:
(1) Apply to losses from sales of securities to
Americans resident in the US whether or not acts of
material importance occurred in this country; and
(2) Apply to losses from sales of securities to
Americans resident abroad, but only if, acts of
material importance in the US have significantly
contributed thereto; but
(3) Do not apply to losses from sales o securities to
foreigners outside the US unless acts within the US
directly caused such losses.
3) Since Bersch, lots of controversy over what kind of conduct is
sufficient for foreign Ps to bring suit.
a) DC Circuit: Zelch case—all elements of 10b-5 occurred
in the US. This is one extreme.
b) 3rd, 8th, 9th Circuits: some activity designed to further
fraudulent scheme must happen in the US, but mere
preparatory activities is not enough. This actually goes
quite far to protect foreign persons.
c) 2nd, 5th, 7th Circuits: The middle route. When foreign
person brings suit, must show that conduct directly causing
the loss (completing the fraud) occurred in the US. See
Bersch.

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 (1) But in 1998 the 2nd Circuit “let the effects test
in the back door” when they ruled that jurisdiction
should not attach unless there is a national interest
for taking the case.
c. A combination of both tests:
1) Itoba (2nd Cir. 1995): Court said that the conduct test is not an
either/or proposition. If effects and some conduct in the US, then a
court may take jurisdiction. The court allowed the P to bring the
case because the D filed with the SEC, and continued to disclose
fraudulent materials.

Note: All 10b claims require a jurisdictional basis, so the analysis

for such claims is: (1) Do we have a basis as a court to take the
case—effects/conduct analysis, and (2) Do we have a jurisdictional
connection—i.e., use of the mails.

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