Securities Regulation

I. Introduction
A. Securities Act of 1933 (Distribution Process)
1. To require that investors are provided with material info concerning
securities offered for public sale; and
2. To Prevent misrepresentation deceit, and other fraud in the same of
securities
3. Accomplished via disclosure primarily in registration statement
• Registration  intended to provide adequate and accurate
disclosure of material facts concerning the company and the
securities it proposes to sell

B. Securities Exchange Act of 1934 (Order and Disclosure in After-Market)

1. Effect
• Extended the disclosure doctrine of investor protection to
securities listed and registered for public trading on national
securities exchanges
• Also applies to over the counter market if company has more
than $10M in assets and more than 500 investors
2. Corporate Reporting
• Must file a registration statement with the exchange and the
SEC
3. Proxy Solicitations
• Governs soliciting proxies
• Solicitations whether by management or shareholder groups
must disclose all material facts concerning matters on which
holders are asked to vote
• Holders must be given an opportunity to vote “yes” or “no” on
each item
4. Tender Offer Solicitations
• Reporting and disclosure provisions extended to situations
where control of a company is sought through a tender offer or
other planned stock acquisition of over 5% of a company’s equity
security
5. Insider Trading
• Prohibitions are designed to curb misuse of material
confidential information not available to the general public
6. Regulation of brokers and dealers

C. State Blue Sky Laws

1. Analogous to the ’33 and ’34 Act
2. Preempted by federal legislation (sometimes)

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D. Sources of Federal Securities Law
1. Statutes at Large (more legit than USC) but most people rely on BNA,
CCH etc.
2. SEC rules and other pronouncements
3. Policy and interpretative releases
4. Staff Legal Bulletins
5. Interpretive and No-Action Letters

E. How Securities Are Marketed and Sold

1. Private/Small Entities
a. Form  sole proprietorship, partnerships (general, limited, limited
liability), limited liability corporation
b. Unique contractual relationships
c. Methods by which securities get to public and trade in aftermarket
(1) Distribution  process in which capital is raised by issuer
through placement of security
(2) Aftermarket  secondary market where not capital is raised
for the corporation
2. Public/Large Entities
a. Form  some are limited partnerships, but most are corporations
b. Standard contractual relationships
c. Methods to get securities to public and trade in after-market
(1) Distribution
• Issuers approached by a “lead” underwriter (like
banks) who would act as an agent for an underwriting
group, typically a lead underwriter will approach issuer
and then assemble the group
• Lead underwriter interfaces between issuer and
underwriting group
• All members of underwriter group are responsible
for contacting dealers
• Underwriters sell to dealers who in turn sell to the
public
(2) After-Market  public trading securities among itself (price
does not directly effect company but effects price at which
they can later sell to public)

F. Context of 1933 Act Registration

1. Underwriters
a. General Definition  function of helping a company or one or more
of its major shareholders, sell securities to the public through an
offering registered under the Securities Act
b. Firm Commitment Underwriting  underwriter purchases
securities from a company at an agreed price and then attempts to
sell to public for a profit (risk on underwriter)

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 c. Best Efforts Underwriting  underwriter agrees to use its best
efforts to sell an agreed amount of securities to the public, risk
remains with issuer, done primarily with small underwriters
d. Standby Underwriting  used in “rights offerings”, company
directly offers its existing security holders the right to purchase
additional securities at a given price and the uw agrees to
purchase from the company any securities that are offered to the
security holders but not purchased by them
2. Dealers
• Refers to a firm when it buys and sells securities for its own
account (takes and gives title)
3. Brokers
• Refers to a firm when it buys or sells as an intermediary for a
customer rather than taking or giving title itself
4. Investment Banking
• Usually handles the underwriting business
• Comparison with commercial bankers who make loans and hold
depositor’s funds  because Glass-Stegall Act revoked,
commercial banks can not have affiliates who underwrite (but are
not suppose to use depositors funds)
• Functions:
a. assisting companies in the sale of securities, almost always in
large amounts to private purchasers such as insurance
companies
b. finding acquisition partners for companies that wish to acquire
or be acquired by others
c. giving financial advice of various sorts
5. Secondary Market
a. Process for getting securities on exchanges
(1) List  will contact desired exchanges and sell them on the
exchange
• Need to satisfy certain requirements – disclosure
• Very stringent/rigorous requirements, the more
prestigious the exchange is
(2) Once list privileges are granted, can contact members of the
exchange
(3) Function  if willing buyer and seller, can contact members of
the exchange
6. Exchange Vocabulary
a. Specialist Post – if want to sale a security that is specialists;
subject to certain exchanges’ regulations, subject to SEC approval,
need to maintain an orderly market
• Function  matching unless an unorderly market – then
specialist may be required to purchase/sell
7. Over the Counter Vocabulary
a. Market Maker  dealer than functions in the trading market by
maintaining an inventory of a particular company’s securities and

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 holding itself open, on a continuing basis, as willing to buy and sell
those securities
b. Broker  agent who acts on their client’s account
c. Self Regulated Organization
• Both market makers and brokers are regulated under the
1934 Act and are required to be members of an SRO
• Has rules and regulations regarding conduct of brokers
and deals that are subject to SEC approval
• Self-funded
• NASD is an SRO
8. Exchange
a. Form  physical location
b. Regulation  subject to rigorous regulation by SEC pursuant to
1934 Act
c. Process
• Buyer goes to brokerage – brokerage will communicate
that desire to a floor trader – member or floor trader will go
to a specialist post
• Seller will contact her broker about purchasing – seller’s
broker will communicate to a floor trader – they will go to
specialist post and hopefully transaction takes place
• Specialists perform matching function
9. Over-The-Counter
a. Form  everything except selling/buying of securities not listed on
an exchange
• Pink Sheets  advertisements; now we have electronic
bulletin boards
• Market Maker  regularly advertised self as willing to buy
or sell x security and usually lots of mm’s per security
b. Process
• Buyer goes to broker and broker goes to mm
• Seller goes to broker and broker goes to mm
• Mm lacks the matching function, do the transaction with
them??????
10. State Blue Sky Regulation
a. Types of Regulations
(1) Merit-Based  requires state officials to read info and
determine its suitability of securities
• Not used much anymore except for in “problem
markets”
(2) Disclosure-Based  will require filing of basic business
information (federal securities laws)
(3) Notice-Based  just need to send notice that will sell or trade
b. Preemption Law of 1988  forced state regulation into a notice
based system for most areas

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 c. Typically done by a specialist in a law firm in a large financial
center
11. Reasons for Going Public
a. Advantages
• New capital
• Obtain negotiability – acquisition of companies, employee
incentives, liquidity for present S/H, shares may have greater
value
• Future capital on more favorable terms
• Prestige
b. Disadvantages
• Expense of going public (underwriter’s fees – 7-10% of
public offering price, legal fees, accounting fees, printing
costs, registration and Blue Sky fees, registrar fees,
indemnity insurance)
• Additional obligations of public companies
• Market expectations
• Loss of control
• Higher estate tax valuation
12. Timing of Going Public and selection of underwriter
a. When
• Company’s earning and financial performance
• Size of company
b. Selection factors for agent underwriter
• Reputation and ability to distribute
• Ability to advise
• Ability to provide financial services following the offering
• After market performance of the security
• Experience in the company’s industry

13. Situation 2
a. Scenario
• Product  specialized computers with specialized
software
• Corporation has two shareholders
• Want to raise capital
b. Interests
• Size of company - $10 million + ultimate sales price
• How much do you want to raise - $10M
• Only want to sell 25% of the company
• Logical price is 2.5M b/c not is likely to pay $10M for
25% control of something that is worth $10M
• Decide they are willing to sell $3.3M
• $10M is value of corp.
• giving up 33% of company
c. Size of Deal for Underwriters
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 • Big Underwriters-$5M+ deals only
• Regional underwriters will take smaller dals

I. 1933 Act Registration

A. General Vocabulary and Applicable Statutes
1. Pre-Filing Period (Basic Rule  no offers, no sales)
a. Definition
• Period before registration statement is filed
b. Relevant Provisions
• §§5(a),(c)
2. Waiting Period
a. Definition
• Period after registration statement has been filed but has
not become effective
b. Relevant Provisions
• §§5(a),(b)(1)
3. Post Effective Period
a. Definition
• Period after registration statement becomes effective
b. Relevant Provisions
• §5(b)

B. Pre-Filing Period Prohibitions

1. §5(a)  no sales
a. Statutory Language
• Unless a registration statement is in effect as to a
security, it shall be unlawful for any person, directly or
indirectly –
• To sell such security through the use or medium of
any prospectus or otherwise; or
• To carry any such security for the purpose of sale or
for delivery after sale
b. Basic Meaning
• Prohibits the sale of securities unless a registration
statement has become effective (at the end of the waiting
period) and no sale or delivery for purposes of sale before
the effective date
c. Related Issues
• What is a sale  §2(a)(3)

2. §5(c)  no offers
a. Statutory Language
• It shall be unlawful for any person . . . to offer to sell or
offer to buy through the use or medium of any prospectus or
otherwise any security, unless a registration statement has
been filed as to such security . . .

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 c. Basic Meaning
• Cannot offer before filing a registration statement
d. Related Issues
• What is an offer  §2(a)(3)
• Rule 135  safe harbor from definition of “offer
• SEC releases 3844 and 5180

3. What is an Offer?
a. Section 2(a)(3)
a (1) Statutory Language
• The term “offer to sell”, “offer for sale”, or “offer” shall
include every attempt or offer to dispose of, or
solicitation of an offer to buy, a security or interest in
security, for value
• Not a complete definition b/c says “shall include”
b. Offer to buy
• The solicitation of an offer to buy is considered an offer to
sell. As a result, it is not possible to avoid the “no offer to
sell” prohibition of §5© by phrasing an offer in terms of a
solicitation of an offer to buy
c. General Interpretation
• Definition read broadly and includes things that may not
have been considered an offer at common law including
conditioning the market for the securities to be sold
d. Conditioning the Market
(1)Generally
• In the pre-filing period, it is not legally possible to
begin a public offering or initiate a public sales
campaign

(2)Securities Act Release No. 3844

• A public sales campaign is only unlawful when it
involves an offer as defined in the Act
• General attempts to stir up market interest
can be an offer even if do not mention actual
offer before filing
• “priming the pump”
• “gun jumping”
• Example 1  underwriter sent brochure describing
in glowing possibilities of market; no reference to
issuer, security or particular financing; contained name
of underwriter
• Intent was to stimulate interest, clearly was
the first step in a sales campaign to effect a
public sale of a security  violation

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 • Example 4  underwriter distributed to NASD
members company info, issuer and prospects, but info
was misleading  violation
• Example 6  President at co. was asked a year in
advance to give a speech about company and
industry; decided to give into to interested customers
etc; then the company began filing out a registration
statement
• Scheduling of speech had not been arranged
in contemplation of a public offering
• No violation but printed copies should not be
received by a wider audience or given out at
speech

(3) In Re Carl M Loeb, Rhoades & Co. (1959)

(a) Background
• Underwriters put out press release before reg. stmt.
filed
• Described the property involved, related the
company’s development plans in general, outlined the
proposed securities offering, and mentioned the names
of the two managing underwriters
• Did not directly offer to sell any securities
(b) Holding
• Publicity of this type and in this situation must be
presumed to set in motion or to be a part of the
distribution process and therefore involved an offer to
sell or a solicitation of a n offer to buy
• Such release and publicity was of a character
calculated, by arousing and stimulating investor and
dealer interest in the securities . . ., to set in motion
the process of distribution

(4)Securities Act Release No. 5180 (1971)

(a) Publicity
• While a publicly held company may not legally
initiate publicity that is for the purpose of facilitating
the sale of securities a business as usual general
publicity effort probably does not run afoul of
§5(c)
(b) When information is requested by
shareholders
• Factual information should be provided
• Responses involving predictions, forecasts,
projections, and opinions, concerning value are not
acceptable
(c) Generally

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 • New advertising campaign might raise questions
especially when it is presented in media that seem
calculated to reach investors rather than merely
customers
• Lawyer needs to focus on the real reason for a
particular action

(5)Interpretive Letter Request and Response

(a) Companies Activities
• Initiate and maintain periodic meetings with
securities analysts, brokers, etc.
• Want to know if should stop this when start
registration stmt.
(b) SEC Response
• During the period that an issuer is in registration,
issuer need not stop activities
• Activities desirable b/c have eventual effect of
conveying useful information to investing public
• Type of information should still conform with No.
5180
• Activities may give rise to “priming the market”
argument especially when issuer starts them right
before registration process begins (these issuers
should stop), but issuers who have a history of doing
this would generally seem to have a sound basis for
refuting a “gun-jumping” inference

e. Exceptions to Definition of “Offer”

(1)§2(a)(3)
(a) Statutory Language
• Offer shall not include preliminary negotiations
or agreements between and issuer (or agent)
and any underwriter or among underwriters who are
or are to be in privity of contract with an issuer
(b) Effect
• Exception is limited to underwriters – does not
cover dealers
• Company can find an underwriter in pre-filing period
• Managing underwriter can talk to other securities
firms to gauge their interest in joining underwriting
syndicate
• Managing underwriter cannot begin to assemble the
dealer group at all

(2) Rule 135  Notice of Certain Proposed Offerings

(a) Statutory Language

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 • For purposes of §5, a notice given by an issuer that
is proposes to make a public offering of securities to be
registered under the Act shall not be deemed to offer
any securities for sale if:
(1)notice says that offering will be made only by
means of a prospectus; and
(2)Contains no more than the following additional
language:
• Name of issuer
• Title, amount, and basic terms of the
securities, amount of offering, anticipated
time of offering, brief statement of the
manner and purpose of the offering
without naming the underwriters

f. Special Situations
(1) §2(a)(3)
• Any security given or delivered with, or as a bonus on
account of, any purchase of securities or any other thing,
shall be conclusively presumed to constitute a part of the
subject of such purchase and to have been offered and sold
for value
(2) Options
• Options/convertible securities/warrants shall not be
deemed to be an offer or sale; but the issue or transfer upon
the exercise of such right shall be deemed a sale of the
security
• The underlying security does not have to be registered
originally when the conversion or exercise cannot occur
immediately, but rather can only tae place at some point in
the future
• At the time the conversion or exercise can occur, an offer
exists, and the filing of a registration statement or the
availability of a registration exemption is required

g. Jurisdictional Means
• Language in §5(a) and §5(c)
• “means or instruments of transportation or
communication in interstate commerce or of the mails”
• Interpretation
• Very broad
• Any use of the telephone satisfies the requirement
• If offer at the country club, probably not satisfied, but if
friend then telephones for more info probably have the
jurisdictional means b/c offeror reasonably could have
foreseen the use of the telephone by the offeree

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C. Waiting Period
1. §5(a)  no sales or deliveries
a. Prohibits  no sales and no deliveries
b. Defining a Sale
(1) Statutory Definition (§2(a)(3)) (not complete definition)
• “the term ‘sale’ or ‘sell’ shall include every
contract of sale or disposition of a security or
interest in a security for value”
• read liberally
(2) Significance of Including “contract of sale”
• In the waiting period, certain offers may be made.
When an offer is accepted a contracts is created and
§5(b)(1) is violated b/c a sale has occurred
• Cure  offerors should condition their offers in such
a way that they cannot be accepted until the
registration statement is effective
(3) In Re Franklin, Meyer & Barnett
(a) Background
• Salesmen accepted checks sent by customers in
payment for offered shares
• Sales sold other securities for customers and held
the proceeds for application against the purchase price
of the offered shares
(b) Holding
• Salesmen accepted orders for stock during the
waiting period
• Although they initially invited indications of interest
in the form of checks and the proceeds of the sale of
other securities, they went beyond the permissible
scope of the Act.
• If take money in anticipation for subsequent
sale, this is a sale within definition and will be a
violation  should return money promptly or say do
not intend to apply to sale of stock until some even
and they don’t get any priority then possibly okay
2. §5(b)(1)  no prospectus unless a §10 prospectus
a. statutory language
• Unlawful for any person . . . to carry or transmit any
prospectus relating to any security with respect to which a
registration statement has been filed under this title, unless
such prospectus meets the requirements of section
10.
b. Prospectus Definition (§2(a)(10))
(1) Statutory Language
• “Any prospectus, notice, circular, advertisement,
letter, or communication, written or by radio or

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 television, which offers any security for sale or
confirms the sale of any security”
• Basically a written offer or a confirmation of
sale (but because §5(a) prohibits sales during the
waiting period, not concerned with affirmations of
sales)
(2) Offers
• If something is not an offer (use analysis from
above) then it is not a prospectus and will not violate
§5(b)(1)
• Remember Rule 135 which deems something to not
be an offer
(3) “Written or By Radio or Television”
(a) Definition of Write (§2(a)(9))
• Printed, lithographed, or any means of graphic
communication
(b)Oral Announcement by President that if in writing would be a
Prospectus
• When a reporter incorporates the announcement in
an article, the president has made an offer that is
written
• President caused the writing and that is enough to
make the offer one that is by means of a prospectus
(c) Answers to Press Inquiries
(d)Calling Customer with Offer
(e) SEC “no action” responses
• SEC has taken “no action” positions with respect to
certain transmissions by various broadcast
mechanisms (including satellite, telephone or cable
when the request was justified in terms of the
restricted character of the recipients and the
limitations on their ability to record and retransmit the
information received
(f) Email
• Constitutes a writing
• Notion is that if it is a graphic thing it could be
broadly disseminated to those who do not directly
communicate with offeror (therefore cannot tell his
credibility)
• If cannot be saved or printed, SEC regards as an
oral communication
(g)Voicemail
• There is a danger that it will be written down and
disseminated, but same danger when talking live that
someone will transcribe
• If transcription instigated by offeror  writing
• If instigated by oferee  not writing

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(4) Exceptions (§2(a)(10)(b))
• Things above will not be a prospectus if it states (1)
from whom a written prospectus meeting the
requirements of section 10 may be obtained; and does
not more than (2) identify the security (3) state the
price thereof (4) state by whom orders will be
executed (5) contain other info as SEC deemed
necessary in the public interest and for the protection
of investors
(5) Rule 134  Communications deemed not a prospectus
(1) Basic Idea
• If communication complies with this rule then it will
not be a prospectus
(2) Basic Structure
• (a) can be done if (b) is done, but (b) does not have
to be done if either (c)(I) or (c)(ii) is done, and if its
terms are followed, (d) can be done
• (a) may include and will not be a prospectus
• (b) is stuff included in (a) must put the stuff in (b)
• Must include disclosures in (b) unless have (c)(i) or
(c)(ii)
(6) Rule 134a
• Highly specialized rule providing that certain written
material relating to standardized option are not
deemed a prospectus

(7) Rule 135 (detailed in pre-filing period)

(a) Statutory Language
• Certain notices “by an issuer that it proposes to
make a public offering of securities to be registered
under the Act shall not be deemed to offer any
securities for sale”
(b) Possible Application
• Thrust of rule is toward the pre-filing period
• “proposes to make a public offering”  once file a
registration statement you really are no longer
proposing a public offering
• “to be registered” technically securities are still to
be registered during the waiting period but term may
be used in a somewhat loser sense
• Usually it does not matter because can use Rule
134
(8) Possible Impact of Gustafson v. Alloyd (See chapter 8)
• Defines a prospectus as a document used in a
public offering to sell a security by an issuer or
controlling shareholder

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c. Section 10 Prospectus
(1)Section 10(a) Prospectus
(a) prospectus “shall contain the information contained in
the registration statement,” with some exceptions
(b) a prospectus does not comply with this when it contains
blanks where required information is to be added by
amendment
(c) it may be possible for the prospectus as originally filed to
comply with Section 10(a), but usually certain information is
unknown (so usually Section 10(a) prospectus is not
available in the waiting period)
(2)Section 10(b) Prospectus
(a) Gives SEC authority to permit the use of a prospectus that
omits or summarizes information required by Section 10(a).
(b)Done through Rules 430 and 431
(c) Rule 430  Preliminary Prospectus
(i) Basic Idea
• Allows the use during the waiting period of a
preliminary prospectus
(ii) Requirements
• Will meet the requirements of §10 for
purposes only of §5(b)(1) if contains
substantially the information required by §10(a)
except does not have to include information on
offering price, underwriting
discounts/commissions, dealer
discounts/commissions, amount of proceeds,
conversion rates, call prices, or other matters
dependent upon the offering price
(d) Rule 431  Summary Prospectus
(1)Basic Idea
• Allows the use of “summary prospectuses” in
waiting period
• If prepared and filed with registration
statement it is deemed to be a prospectus
permitted under section 10(b)
(2)Requirements
• Page 126 of Supplement

d. Preliminary Prospectus Delivery Requirements  Rule 460 and

Acceleration
(1) Needed in order to “accelerate”  Sec. Act. Rel. No. 4968
• Why acceleration needed  Act provides that a
registration statement becomes effective twenty days
after filing, or after the filing of any amendment, but
SEC will accelerate.

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 • Under Rule 460 will not accelerate the effective
date of a registration statement unless distributed to
underwriters and dealers who it is reasonably
anticipated will be invited to participate in the
distribution
• If issuer is not s.t. reporting requirements of §13 or
§15(d) of ’34 Act SEC will consider whether they have
taken reasonable steps to furnish them to those
persons who may reasonably be expected to be
purchasers of securities
• If it is inaccurate or inadequate acceleration will be
deferred until SEC assured correcting material has
been distributed
(2) Rule 15c2-8
• If do not do these things it constitutes a deceptive
act or practice under Exchange Act Section 15(c)(2)
• When offerings made by issuers that are not
subject to the reporting requirements of Exchange
Act, requires underwriters and dealers to deliver
copy to any person who is expected to receive a
confirmation of sale at least 48 hours prior to the
mailing of such confirmation
• Required underwriters and dealers to take
reasonable steps to furnish copies of the
preliminary to any person who makes a written
request for a copy. Underwriter must furnish
enough copies to dealers to get them to customers.
• Requires underwriters and dealers to furnish
copies to salesmen
(3) Posting on website
• While this provides access, the rules require an
affirmative act on part of issuer to get it in the hands
of underwriters, dealers etc.
• Can do if customer agrees to this in advance and it
will count as sending preliminary prospectus

D. Post-Effective Period
1. Section 5(b)(1)  no prospectus unless §10 prospectus
a. Statutory Language
• Cannot use a prospectus unless it is a Section 10
prospectus
• Usually only a final prospectus called for by Section 10
will satisfy
b. What is a prospectus?
• See Waiting Period analysis
• If something is considered a prospectus it must also meet
the requirements of Section 10.

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 c. What prospectus must be used?
(1) In the post effective period the only prospectus that satisfies
the requirements of Section 10 is the final prospectus call for by
Section 10(a).
(2) When can you use Summary Prospectus?  Rule 431
• Can never be used as a §10(a) prospectus for purposes of
§5(b)(2)
d. Exception  When a communication is not a prospectus
• A communication is not deemed a prospectus when
it is accompanied or preceded by a Section 10(a)
prospectus
• “Free Writing”  term used to describe
communications allowed by this exception

2. Section 5(b)(2)  no sales unless accompanied or preceded by §10(a)

prospectus
a. Statutory Language
• It is unlawful for any person . . . to carry . . .such
security for the purpose of sale or for delivery after sale,
unless accompanied or preceded by a Section 10(a)
(final) prospectus.
• Summary prospectus can never fulfill this requirement
b. What is a delivery?
(1) What is meant by security?
• Security vs. certificate representing security
• In security definition, referring to actual
security and not evidence of interest in a
security
(2) So even though cannot actually deliver a security must still
send prospectus when send certificate representing security
(pg. 75)

3. What can now be done?

a. Oral offers can be made (§5(c) does not apply anymore) except in
the case of a registration statement that is the subject of a stop
order or of a public proceeding instituted before the effective date
b. Written offers may be made by means of the final prospectus
c. Written offers can be made by free writing, when accompanied or
preceded by a final prospectus
d. Offers may continue to be made under exception (b) to section
2(a)(10) and under Rules 134 and 134a.
e. Sales may be made (5(a)(1) no longer applies)
f. Securities and confirmations of sale can be delivered if
accompanied or preceded by a final prospectus.

4. Section 5(b) and Defective Prospectuses

a. General Information

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 • Section 5(b)(1) allows the use of a prospectus that meets
the requirements of Section 10
• Section 5(b)(2) requires that a Section 10(a) prospectus
accompany or precede the delivery of a security
b. SEC v. Manor Nursing Centers (1972) (also applies in waiting
period)
• A prospectus does not meet the requirements of
§10(a) if the information required to be disclosed is
materially false or misleading.
• Therefore, because the prospectus was not a §10(a)
prospectus they violated §5(b)(2) b/c delivered securities for
sale accompanied by a prospectus, which did not meet the
requirements.

5. Final Prospectus Delivery Requirements

a. §5(b)(2)  requires prospectus be delivered with a security
(1)What is meant by security?
• Security vs. certificate representing security
• In security definition, referring to actual
security and not evidence of interest in a
security
(2)So even though cannot actually deliver a security must still
send prospectus when send certificate representing security
(pg. 75)

b. Confirmations of Sale
(1)underwriters and dealers usually deliver to customer written
confirmations of sale when agree to buy
(2)§2(a)(10) defines a written confirmation as a prospectus
(3)Because this is a prospectus it must meet the requirements of
§10

c. Rule 15c2-8
(1) final prospectus’ are to be furnished to sales personnel and to
other persons on written request, and if not they are
considered a fraudulent etc.

d. Dealers  Section 4(3)

(1)General Rule
• Must deliver final prospectus when they sell securities
that have been registered within the previous forty or ninety
days regardless of how may time the securities have
changed hands in the trading markets
(2)Specific Times
• 40 days  applies when the issuer of security has
previously registers other securities under the Securities Act
(baseline rule)

17
 • 25 days (Rule 174)  if security will be authorized to
trade on NASDAQ immediately upon issuance (automated
quotation system)
• 90 days  if securities of the issuer have not previously
been sold pursuant to an earlier effective registration
statement (1st public offering)
• No delivery requirement  if security issued by co. s.t.
reporting requirements of Exchange Act prior to the filing of
the registration statement to which the prospectus relates
• When must always deliver  If dealer decides to hold
onto some shares and sells a few months later at market
price, still has to deliver prospectus (Rule 174)

6. When Prospectus Defective or False or Misleading  2 Ways to

Correct
a. issuer may file a post-effective amendment (amended prospectus
or supplement to prospectus
b. under Rule 424(b) send or file ten copies of the new form of
prospectus with SEC before it is used (when small corrections)

7. SEC General Exemptive Authority (§28)

• SEC may conditionally or unconditionally exempt any
person, security, or transaction . . . from any provision . . . to
the extent that such exemption is necessary or appropriate
in the public interest, and is consistent with the
protection of investors

E. Registration Process
1. How to Register (Section 6)
a. Security may be registered by filing a registration statement (in
triplicate) with the SEC
b. Signers of Registration Statement
• Each issuer, the principal executive officer, principal
financial officer, comptroller or principal accounting officer,
majority of board of directors or persons performing similar
function
• Everyone who signs is subject to liability under §11 for
any material misstatement or omission
c. Effectiveness
• Registration statement is only effective for those
securities proposed to be offered in the statement
d. When Effective - §6(c)
• Filing takes place when it is received
• But, won’t take place unless sent with certified bank
check or cash for fee
e. Made Public - §6(d)

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 • Information in statement is made public (very hard to
keep it confidential)

2. Information required in registration statement - §7

a. Schedule A
• Must contain info requested in this form and
accompanying documents
b. Changes
• SEC has authority to add or subtract information
requirements
c. Forms

3. SEC Powers in Registration Process

a. Power to Investigate - §8(e)
(1)SEC has power to examine it order to determine whether a
stop order should be issued
(2) Effect  Under §5(c) makes it unlawful to offer to sell
securities while the statement is under examination under
this section (also unlawful when subject to a stop or refusal
order)
(3)If SEC begins the examination after effectiveness, can still
make offers (unless effectiveness is suspended)

b. Power to Issue Stop Order - §8(d)

(1) SEC has power to issue a stop order suspending the
effectiveness of the registration statement
• Can be issued before or after the effectiveness and
may even be issued long after all securities covered by
statement have been sold
(2) Standard
• If statement includes any untrue statements of a
material fact or omits to state any material fact
required to be stated or necessary to make the
statements already in it not misleading

c. Power to Issue Refusal Order - §8(b)

(1) SEC can issue an order prior to the effective date of
registration refusing to permit the statement to become
effective until it is amended
(2) Standard
• Can issue when on its face incomplete or inaccurate
in any material respect

d. Stop Order v. Refusal Order

• Refusals are rarely used b/c requirements are tougher
than stop order and stop orders may be used in the place of
refusal orders

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 e. Las Vegas Hawaiian v. SEC (1979)
(1)Background
• SEC initiates a §8(e) investigation prior to effectiveness
and just sits on it
• Registration statement becomes effective, but cannot
make any offers
• During this period LV cannot make any offers
• Issue  whether §8(e) can be utilized by SEC to delay
indefinitely the sale of securities under an effective
registration statement.
(2)Holding
• A court may compel the SEC to make a
determination within a reasonable time whether
to notice a hearing on the issuance of a stop
order under section 8(d) where the SEC has ordered
an examination under section 8(e) prior to the
effective date of a registration and the determination
whether a stop order should issue has unreasonably
delayed
• If unreasonable time Court can order SEC to hold
hearing and decide whether the issue a stop order

4. Delaying Language and Acceleration Process

a. Section 8(a)  When Reg. Stmt. Becomes Effective
• Registration statements are effective twenty days after
filed or earlier if SEC allows
• If issuer files an amendment, the twenty day waiting
period starts over again
b. Why Acceleration is Needed
• Usually registration statement needs to have added to in
information that cannot be determined twenty days in
advance (when amend start 20 days all over again)
• In addition, issuers and underwriters want to control date
of effectiveness to get most beneficial date
• Therefore, getting around automatic effectiveness and 20
day waiting period after amendment is a necessity
c. Avoiding Automatic Effectiveness
(1)Must amend registration statement before twenty day period
runs
(2)Rule 473
• Issuer may include a paragraph on cover of
registration statement that effects its continuing
amendment
• Keeps 20 days constantly starting over again until it
is removed (after removed acceleration is requested)
d. Acceleration

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 (1) General SEC Power
• Because issuer wants to accelerate and SEC has
power to do or not to grant it, is uses the threat of
denial to force actions not required by the statute
(2) Rule 461  Undertakings
(a) General Effect
• Contains a list of factors SEC will consider in
deciding acceleration requests
• Some are required generally while others are price
of registration
(b) Considerations
• Whether a preliminary prospectus was delivered
during the waiting period
• Indemnification  SEC disfavors officers, directors
and other controlling the issuer being indemnified by
the issuer for liability (says against public policy and
therefore unenforceable)
• Whether the SEC is making an investigation of the
issuer etc pursuant to and Acts administered by SEC
(3) Phoenix Steel
• Undertakings are only required if want acceleration
• If willing to wait twenty days, only have to comply
with the statute and SEC cannot force you to do
undertakings

5. Registration Statement Forms

a. Form S-1
• General, catch all form that is used when no other form
authorized or prescribed
• Most extensive disclosure
b. Form S-2
• To use must meet certain tests (issuer must have filed
Exchange Act reports for a specified number of months
(have some ’34 Act reporting history), and its most recent
history must be free of defaults on indebtedness and missed
preferred stock dividends)
• Registration statement will be a combo of spelled out
disclosures and incorporation by reference of information
from Exchange Act sources
c. Form S-3
• Need ’34 Act history and public float of certain amount
(certain amount of equity security in non-affiliates - $75M)
d. Form SB-1 and SB-2
• Easier forms for smaller issuers
• Requirements of financial statements are more easily met

21
 • SB-2 available for offering of securities for cash by a
“small buiness issuer” which is a co. other than an
investment co. that has annual revenues of less than $25M
• SB-1 available for small business issuers for offerings up
to $10M for cash within 12 months

6. Shelf Registration
a. General Rule
• Securities may generally not be registered unless there is
an intention to offer them in the proximate future (§6(a))
b. Rule 415  Shelf Registration
• Allows the registration of securities that are to be offered
on a continuous or delayed basis
• Companies that meet the requirements for use of Form S-
3 are essentially allowed to use this as they please
• ’34 Act company can do and others can also do in specific
transactions
7. Integrated Disclosure
a. Meaning
• If can use S-2 or S-3 can incorporate by reference
information contained in their ’34 Act disclosure
b. Effect
• Make registration statements more simplistic and less
time consuming
• Shelf Registration  allows issuer to incorporate ’34 Act
disclosure by those already filed but also those that they will
file in the future (SR would be almost impossible without it)
8. Rules, Regulations, and Industry Guides
a. Regulation S-K
• General repository of disclosure requirements (S-B for
small businesses)
b. Regulation C – Rule 408
• “in addition in info expressly required . . there shall be
added such further material information as necessary to
make required statements not misleading”
• basically anything material must be disclosed
9. Plain English Requirement – Rule 421(d)
• Issuers must prepare the front and back cover pages of
prospectuses, as well as the summary and risk factors
sections, in plain english
• Must comply with six basic plain english principles (short
sentences, definite concrete everyday words, active voice,
bullet lists for complex material, no legal jargon etc., no
multiple negatives

F. Disclosure Requirements (Chapter 4B and 4C)

1. In Re Universal Camera Corp. (1945)

22
 a. Background
• Omitted facts regarding the financial structure of deal
(transfer of money from old investors to new investors)
• Touched only lightly on competitive conditions
b. Holding
• Must be able to provide support for every assertion
• Avoid vagueness and too much optimism
• Disclosure should be plainly understandable to the
ordinary investor (even if enough information there for
expert to figure something out, this is not enough)
• Must spell out full implications of offering including
dilution (dilution may not be a deal killer b/c future earnings
may justify paying more)
2. In Re Texas Glass Manufacturing Corp. (1958)
a. Issue
• Determine whether a stop order should issue  material
fact?
b. Holding
• Standard of Materiality  SEC does list some things
but does not talk about crimes previously committed. If not
listed follow generic materiality standard (would a
reasonable investor find it important in deciding whether to
buy)
• Management Integrity and honesty  generally
courts say investors don’t care and therefore not material
• When dealing with risk factor disclosure, consider what
public wants to know and possible impact of dilution when
list too much.

3. Why have disclosure requirement v. merit regulation

a. Issues of Paternalism
b. Existence of other ways to regulate merits (state blue sky laws)
c. Special Interest Legislation (lobbying effects Congress)
d. Enforcement Costs  very time consuming and maybe less
effective
e. Government competence  someone is SEC rather than Congress
may prevent an industry from getting started b/c feel too risky

4. Why require disclosure?

a. More efficient way of providing information
b. If do not require it, those who want it will have to get it with
separate negotiation and bargaining  if make mandatory it is
available with extra costs and bargaining
c. Who then uses it?
• For the small investor, hard to understand. Even if can
understand, by the time they do everyone else has read it

23
 and market already reflects actual worth. Small investor
cannot beat the market.
• Institutional investors use it but do not solely rely on it,
also call co. Prospectus is superficial and does not give info
on future plans that will effect future value.
• Hard to produce something that is useful by big investors
but good also for small investors.
d. Why have it at all then?
• Hard to get rid of
• Investor confidence  people think SEC is encouraging
truthful and complete disclosure

5. Efficient Capital Market Hypothesis

a. Weak Form
• “random walk theory”  the price of a security yesterday
does not say anything about the price of the security today
or tomorrow (market will react to new information)
b. Semi-Strong Form
• Market immediately reacts and incorporates all publicly
available information
• Market price of a security at any time has been affected
by all of the publicly available information
• Small investors, therefore, cannot beat the market
c. Strong Form
• Market immediately reacts to all information, public or
private
• Price of security affected by public and inside information
so that even insiders cannot make money with their inside
information
• Even insider trading effects market price putting security
in right direction

II. Definition of a Security

A. Statutory Definition (Section 2(a))  Is it specifically listed?
• Unless the context otherwise requires:
• The term security means any note, stock, treasury stock, bond,
debenture, evidence of indebtedness, certificate of interest . . .
investment contract, voting-trust certificate . . . or in general any
interest or instrument commonly known as a security or any
certificate of interest or participation in . . . any of the foregoing.

2. Investment Contract
1. SEC v. W.J. Howey Co. (1946)
a. Background
• Orange groves were divided and sold in rows of trees –
sold land and service contract

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 • Company set up trees and harvested etc.
• When buy land, 85% enter into service contract with a
sibling company (relationship between land and service co. is
irrelevant)
• When buy land, could not use as you please, had to grow
trees
b. Holding
• This is an investment contract  therefore, a security
• Investment Contract Test  whether the scheme
involves an investment of money in a common enterprise
with profits to come solely from the efforts of others
• Four Elements
(1) investment of money
(2) common enterprise
(3) expectation of profit
(4) solely from the efforts of others
• Quoted Rationale
• They are offering an opportunity to contribute
money and to share in the profits of a large citrus fruit
enterprise managed and partly owned by respondent. . . .
The offered tracts gain utility as citrus groves only when
cultivated and developed as component parts of a larger
area. A common enterprise managed by respondents or
third parties with adequate personnel and equipment is
therefore essential if the investors are to achieve their
paramount aim of return on their investments
• Ct held that the Ks sold by Howey were securities
b/c it was part of common scheme b/c each tract had no
individual purpose, purchased w/ expectation of profit
(not in anticipation of moving to FL), primarily from efforts
of others b/c out of state purchasers could not water
themselves.
c. Distinguished from selling entire farm coupled with management
services
• Power of investor may be a distinguishing factor
• When buy entire farm more control (can fire manager or
build on land)
• Page 130
d. Diamond Seller Hypothetical
(1) Background
• Buy diamond and diamond dealer keeps them
• Dealer says diamonds will go up in value
(2) Analysis
• Not an investment contract

25
 • Even though investing money with expectation of profit,
the dealer is not putting in effort. The rise in price is due to
purely market forces.

2. Expectation of Profit (Forman)

a. Background
• People in need of housing were offered shares of stock
entitling them to state subsidized nonprofit housing
• Stock nontransferable and when sold back bought at
original offer price
• Project leased commercial space to third parties with any
income derived to be used to reduce the rent on the housing
units
b. Court’s Decision  Not a security
• Use of name “stock” was not determinative 
“form should be disregarded for substance and the
emphasis should be on economic reality”
• Does is have the characteristics congress intended
for a security?
• If the item is specifically listed, as is it what its
name implies?
• Characteristics of a security/stock
• Dividends contingent upon an apportionment of
profits
• Negotiable
• Can be pledged or hypothecated
• Confer voting rights in proportion to the number
owned
• Can appreciate in value
• Expectation of Profit
• Means either capital appreciation resulting
from the development of the initial investment
or a participation in earnings resulting from the
use of investor’s funds (investor attracted solely by
the prospects of a return on his investment)
• When purchaser is motivated by desire to use or
consume, not a security
• This does not mean you can get around
securities laws by paying out in things in kind (if
pay in oranges may still be in it for a profit and
will still be a security)
• Two additional arguments by plaintiff
(1) Deductibility for tax purposes
• Rejected b/c “no basis in law for the view that
the payment of interest with deduction
constitutes income or profits”

26
 • Any homeowner can do this
• Deductions from tax shelters may be
considered profit in lower courts
(2) Discounted Rental Charge
• Benefit cannot be liquidated into cash
• Does not result from managerial efforts of
others but rather state subsidies that could not
be liquidated into cash  profits and efforts of
others are to be linked
• Dissent argued that economists say reduction
in expenditure is not any different from payment
(3) Rent Reduction From Leasing Space
• If there is any income derived from this, it is
far too speculative and insubstantial to bring the
entire transaction within the Securities Laws
• Not primary motivation for entering co-op

3. Expectation of Profit (Daniel)

a. Background
• Truck driver thought he had pension plan but did not b/c
did not have 20 years of continuous service
• Employer contributed into the fund, not employee
b. Court’s Decision  Not a security
• Investment of Money
• Requires some volition on part of person making the
investment
• To constitute a security must give up some tangible
and definable consideration in return for an interest
that had substantially the characteristics of a security
• Pension plan was an insignificant part of his
compensation package and could not be
segregated from non-investment interests
• Economic reality dictated he was working for
his livelihood and not to make an investment
• Court rejected argument that employer
contributions constituted his investment
• No relationship between contributions to the
fund and employee’s potential benefits
• Those who work 20 years get same as those
who work 40
• Does not have to be actual money, but does have to
be valuable consideration

• Expectation of Profit from Common Enterprise

• Expectation of profit must stem from use of
investor’s funds

27
 • Profit must be substantial and non-
speculative  if highly speculative or insubstantial
then not profit
• Primary source of pension payments was from
employer’s contribution rather than someone’s
managerial efforts
• Vesting of pension depended on how long he
worked not on financial health of the plan
c. Three Incidental Points
(1) Nature of Plan
• Here, plan was involuntary noncontributory plan
• If characteristics change may be a security
• If plan were contributory there may be the specific
allocation necessary for investment of money
• If higher percentage of fund came from the good
management of the pool of funds rather than employer
than may be a security
(2) Alternative Regulatory Scheme
• If one exists may resolve doubts against coverage
by federal securities laws
(3) Ask about third point from class

4. Common Enterprise (Koscot)

a. Background
• Classic pyramid scheme that emphasizes attracting
additional advisors and supervisors while existing participants
take commissions on what new members pay to move up the
pyramid.
• Fist tier sells cosmetics, second tier invests money, gets
higher discount to sell to tier one or public, third tier has a
higher investment/distributorship
b. Court’s Decision
(1)Koscot satisfies common enterprise prong b/c the investors
fortunes are linked to promoter’s efforts and fortunes in the
common scheme
(2)Investment of Money
• While first tier does not invest money they have the
potential to move up and 2/3 in scheme do invest
money
(3)Common Enterprise
• Definition  one in which the fortunes of the
investor are interwoven with and dependent upon the
efforts and success of those seeking the investment or
of third parties
• Critical Factor  not the similtude or coincidence of
investor input, but rather the uniformity of impact of
the promoter’s efforts

28
 • Vertical  intermingling of investor and promoter
interests; the single investor’s funds must be related to
the funds or efforts of the promoter
• Strict  requires that fortunes of the investor
be linked to the fortunes of some other party
(like profit sharing)
• Broad  requires only that the fortunes of
the investor be liked to the efforts of another
wsdparty (promoters effort must have an effect
on investor’s fortune)
• Horizontal  intermingling of fortunes of multiple
investors (interests must be similarly effected by
scheme)
• Individual Discretionary Account  investor puts
money on account and allows broker discretion in
trading
• Horizontal  No multiple investors, fortune
not related to other investors
• Vertical Broad  giving broker discretion on
trading so his efforts will effect the investor’s
fortune (whether he picks good stocks)
• Criticism  merely reiterates solely
from efforts of others requirement b/c
compensation of broker not tied to how
investor is doing???
• Vertical Strict  depends on the
compensation scheme, if paid a flat fee not met
b/c fortunes of investor and promoter are not
intermingled, but if % of profit met
(4)Which Definition of Common Enterprise is accepted by courts?
(a) all take horizontal
(b) if take broad vertical  will accept all
(c) if take strict  will also take horizontal but not broad vertical
(5) Solely From Efforts of Others
• Functional rather than literal approach
• “whether the efforts made by those other than the
investor are the undeniably significant ones, those
essential managerial efforts which affect the failure
or success of the enterprise”  test goes from solely
from the efforts of other to “from the essential
managerial or entrepreneurial efforts of others”
• Test satisfied b/c role of investors at these meetings
were little more than a perfunctory one
• Act of consummating sale is ministerial, not
managerial

29
 • Policy rationale was to avoid promoters avoidance
of securities laws by requiring menial efforts on part of
investor
• Holding limited to those schemes in which promoters
retain immediate control over the essential managerial
conduct of an enterprise and where the investor’s realization
of profits is inextricably tied to the success of the
promotional scheme

c. Distinguishing a Franchise
• A franchisee is a person who invests in a restaurant and
pays for the right to use the name
• If the franchisee (investor) has a lot of control not a
security
• But some arrangements are so restrictive that investor
has no managerial control and these would be a security
• Must look to individual contracts  discretion over
operations

d. Limited Partners in a Limited Partnership

• A limited partner has limited liability because he refrains
from managerial control
• It will pass as a security as a matter of law b/c no
managing on part of investor and relies on efforts of general
partner to make money
• Passes on investment of money b/c have to buy into
partnership

e. General Partner in a General Partnership

• Typically not a security b/c partners as investors will put
in a lot of effort
• But if agreement says you have no control and this is
reality, may be a security
• Circuit Split  some say not a security (but did not
consider when agreement restricts control) and some look at
reasonable expectation of parties with respect to realistic
participation (protecting those who have a legal right to
participate but chose not to)

f. General partners interest in a limited liability partnership

• Still will turn on ability to participate and control
• Will probably have control and therefore not a security

g. Member is a limited liability company

• Have characteristics of both partnership and corporation
h. Other examples in notes

30
5. Life Partners
a. Background
• LP in viatical settlement industry
• Markets fractional interests in insurance policies on the
lives of the terminally ill
• Responsible for screening the insureds and for collecting
and disbursing insurance proceeds
b. Court’s Decision
• Not a security  does not meet solely from efforts of
others prong
• Efforts have to at least occur after purchase of
investment
• Efforts before investment are not irrelevant but by
themselves will not suffice
• Possible different outcome if get money from
investors and then find terminally ill people to do
screening
• Absent one entrpreneurial post purchase service, there
simply is not on-going common enterprise involved when profit
depends entirely upon the death of insured, which requires no
effort on part of promoter

3. Evidence of Indebedness
1. United States v. Jones (1971)
a. Background
• D is forging airline tickets
• Got tickets belonging to someone else, and validated
tickets to be used by third parties
b. Court’s Decision
• Not a security
• Evidence of indebtedness does not encompass all writings
which represent an obligation on part of the writer to do
something for the holder
• It embraces only such documents as promissory
notes which on their fact establish a primary obligation
to pay the holders thereof a sum of money
2. In Re Tucker Corp. (1947)
a. Background
• Tucker sold car franchises requiring $25 deposit per car
b. Court’s Decision
• Since agreements provided for the repayment of
deposits received they were securities
c. Consistency b/w Jones and Tucker: can be established by looking
at protecting investors. Buyers of airline tickets wouldn’t be
worried about repayment b/c they expect to use their ticket
whereas franchise buyers may be more aware of repayment

31
 obligations. Tucker did not require primary obligation to repay on
face.

3. Procter & Gamble v. Bankers Trust (1996)

a. Background
• Interest rate swap
b. Court’s Decision
• Test whether an instrument is an evidence of
indebtedness is essentially the same as whether an
instrument is a promissory note

4. Unless the Context Otherwise Required

1. Additional Federal Regulatory Scheme (Marine Bank)
a. Background
• Whether a certificate of deposit issued by a national bank
was a security
b. Holding  Not a security
• COD of a national bank is issued by an institution that is
well regulated and is federally insured
• Not a security b/c of contextual factors
• B/c it is regulated elsewhere, do not need
protection of securities laws also
• If foreign regulatory scheme, not a security
• If state regulatory scheme, will still be a security

2. Sale of a Business (Landreth)

a. Background
• Whether the sale of all of the stock of a company is a sale
of securities.
b. Holding  rejects sale of business doctrine (is a security)
• If something is called stock and possesses all of the
characteristics, it will be deemed a security
• Not need to look beyond the characteristics of the
instrument to the economic reality of Howey test
• Cases following economic reality involved
instruments difficult to characterize as a security
• Here have stock, plainly within the statutory
definition
• Howey test is used to determine if something is an
investment contract not whether it fits within any examples in
statute
• Stock is a specific category of a security provable by its
characteristics, not economic reality
• Holding does not extend to other categories
specifically named (i.e. notes)

32
 • Policy  opposite rule would make it very difficult to
figure out if something is a security (parties will not know
ahead of time whether the register)

c. Stock issued pursuant to alternative regulatory scheme (ERISA)

• This is a clear case of a security
• People expect security laws to apply
• Fact that it is governed also by ERISA will not change its
classification as a security
• Argument concerning alternative regulatory
schemes more applies to catch all phrases (investment
K, evidence of indebtedness)

3. Promissory Notes (Reves)

a. Background
• Issued promissory notes payable on demand that were
uncollateralzed and uninsured but paid a variable rate
• Marketed as a investment program
• When went bankrupt, holder sued auditors
b. Holding
• Not bound by legal formality, can take into account the
economies of the transaction
• Lamberth does not apply to notes b/c note is a
broad term
• General Test 
• Note is presumed to be a security
• Presumption may be rebutted only be a showing
that a note bears a strong resemblance (in terms of
four identified factors) to one of the enumerated
categories on list (things on list are not securities)
• If not sufficiently similar to an item on the list, the
decision whether another category should be added is
to be made by examining the same four factors
• Categories Listed as not being securities
• Commercial type things
• Note delivered in consumer financing
• Note secured by a mortgage on a home
• Note evidencing a character loan to a bank
customer
• Factors
(1)Assess motivations that would prompt a reasonable seller
and buyer to enter into the transaction
• If seller’s purpose is to raise money for general
business use or finance substantial project and buyer
interested in note primarily for profit  security

33
 • If note exchanged to facilitate purchase and sale of
minor asset or consumer good, to correct cash flow
difficulties, or advance commercial or consumer
purpose  not a security
(2)Examine “plan of distribution” to determine if there is a
common trading for speculation or investment
• If traded, more likely you need protection and more
likely a security
(3)Examine Reasonable expectations of the investing public
• May be considered a security if investing public
believes that it is even if not a security under the
analytical framework
(4)Examine whether some factor significantly reduces the risk
of the instrument making Securities Acts unnecessary
• Another regulatory scheme

c. Application of Test to Demand Note  Is a security

(1)Called a note so it is presumed to be one
(2)This presumption not rebutted
• Does not closely resemble any of the family
resemblance examples
(3)Applying four factors, not a security
• Motivation is an investment in a business enterprise
rather than a purely commercial or consumer
transaction
• While not traded on an exchange, they are offered
and sold to broad segment of public (all that is needed
to establish “common trading”)
• Security fundamental essence is being an
investment and notes here were advertised as a great
investment opportunity (public expectations)
• No risk reducing factor – would escape federal
regulation if act does not apply
• Court rejected argument that instant liquidity
makes them not a security
• Stock on exchange just as liquid
• Liquidity does not eliminate risk altogether

What is a security? FLOW CHART

Is it specifically named? Yes is it the investment security

security
the name suggests? yes

NO NO

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 Is it an investment contract? HOWEY
1. invest $ (specific allocation for
valuable consid) - Daniel
2. common enterprise (horiz or
NO
strict/broad vert commonality and
Life Partners – entrepreneurial
operation)
3. expectation of profit – Forman
4. solely from efforts of others (solely
means primarily – Koscot and Life
Partners ltd – must be post-sale
effort)
is it an evidence of indebtedness?
1. SEC literal interp
2. Judicial – at minimum, a primary obligation to repay
3. See also NOTES

NO

Not a security
IF DEEMED A SECURITY, MAKE SURE THE CONTEXT DOES NOT NEGATE
III. Definition of a Sale
A. General
1. Statutory Language
• Sale shall include every contract of sale or disposition of a
security for value
2. Value Aspect
• Gift is not a sale (not kind of value contemplated by
definition
• Pledges are typically a sale (pledges to secure a loan)

B. Acquisitions
1. General
• Acquisition by means of a stock for stock tender offer is a sale
• Sale occurs when parties become bound by the contract
2. Applicable Rules and Statutes
a. Rule 145 (a)
• The submission to a vote of security holders of a proposal
for certain reclassification of securities, merger,
consolidations, or transfers of assets is deemed to involve a
sale of purposes of transaction
• Effect is to require registration of the securities to be
issued unless exemption

35
 b. Rule 153a  Definition of “precede by a prospectus”
• Have to deliver a prospectus before shareholders vote on
the combination (before used in context that have to deliver
before a sale)
c. Rule 145(b)  Communications not deemed to be a prospectus
• Rule 145(b)(1) lists those things that can be in a written
communication without it being a prospectus and therefore
not an offer for sale involved in §5

3. Tender Offers
a. Cash for Stock
• Company A goes directly to Company B’s shareholders
and offers them cash for their shares
• When A offers cash for stock A is not selling a security b/c
they are offering cash (not a security)
• Do not have to register
b. Stock for Stock
• Company A offers own shares in exchange for shares from
B’s shareholders
• Now A is selling a security and will have to register
• Nothing in Rule 145 tells you this b/c SEC never held the
position that it was not a sale

4. Consolidations
a. Voting by Shareholders  When two companies consolidate, need
a vote by both sets of shareholders resulting in merged company
b. Rule 145(a)(2)  Sale occurs when there is submitted for the vote
or consent of such security holders a plan or agreement for
• Mergers or Consolidations  securities of one corporation
will become or be exchanged for securities of any other
person (unless done to change issuers domicile)
• Because both vote, sale
5. Merger
a. Mechanics
• After a vote on merger, Company B is out of existence
and their shareholders now hold shares in Company A
b. Holding
• Company A’s shareholders do not vote so there is not sale
as to them (per “such shareholder” language in rule)
• But there is a sale as to shareholders of Company B

6. Sale of Substantially All Assets

a. Rule 145(a)(3)(A)
• Mechanics
• Company B transfers all assets to Company A and A
issues shares to Company B

36
 • Company A is now partly owned by Company B
• Company B then liquidates and only Company A
exists with shareholders of itself and Company B
• Holding
• Result is same as when merger
• This is a sale  Rule 145(a)(3)(A)  sale when
transfer of assets of such corporation in consideration of
the issuance of securities of such other person if “such
plan or agreement provides for dissolution of the
corporation whose security holders are voting or
consenting
b. Rule 145(a)(3)(B)
• Mechanics
• Company B transfers all assets to Company A and A
issues shares to Company B
• Company A is now partly owned by Company B
• Company B does not dissolve but distributes A’s
shares as dividends
• Holding
• This is a sale
c. Rule 145(a)(3)(c)
• Transfer of assets is still a sale even if shareholders can’t
vote on plan with results above, but within one year board
votes to do it anyway
d. Rule 145(a)(3)(D)
• Transfer of assets is a sale if transfer is part of a pre-
existing plan for distribution that is not disclosed to
shareholders (even if done years later still a sale if part of
pre-existing plan)
C. Spin-Offs
1. General
• In a spin-off a corporation takes stock that it owns in
another corporation and distributes this stock to its
shareholders as a dividend
• When the corporation engaging in a spin-off is publicly
held, the spun-off corporation becomes publicly held also
• Some shareholders will want to sell their shares,
and a trading market will develop
• Those who purchase will not have benefit of
registration disclosure
2. Securities Act Release No. 4982 (1969)
a. Permutation of a spin-off
• Publicly help co. acquires partial ownership of private co.
for minimal consideration and then distributes some of those
shares to its own shareholders
• Those shareholders will begin to sell in open market

37
 • No business purpose except for benefit of spin-off
b. Benefits
• Private co. takes company public with little cash outlay
and retains ownership
• Public co. will keep shares and later sell for profit
• Public co. gets something for nothing
c. Costs
• Losers are those who buy share w/o benefit of disclosure
d. SEC Position
• This type of spin-off cannot be done without registration
• Spin-off is a sale
• “When the shares are issued to the publicly owned or
acquiring co. a sale takes place and if shares are then
distributed to shareholders of acquiring co. that co. may be
an underwriter as a person “who purchased from an issuer
with a view to distribution of a security”
• Because involves an underwriter must be registered

3. SEC v. Datronics Engineers (1973)  “For Value” Requirement

a. Definition of sale
• Disposition of a security for value
b. Where is value in a spin-off?
• Market for the stock is created by its transfer from
shareholders of acquiring co. to general public
• Because of creation in market, value goes up and
acquiring company can then sell the shares it retains for a
higher value

4. Staff Bulletin
a. Not all spin-offs are sales
b. Registration not necessary if all of the following are met:
• Spin-off is pro rata to the parent company’s shareholders
• The recipients of the spun-off securities provide no
consideration
• The parent provides to its shareholders and the public
adequate information about the spin-off and about the
company being spun-off
• The parent has a valid business purpose for the spin-off
• If the parent spins off “restricted securities” it has held
the securities for at least two years

5. Free Stock Offers

a. Is a sale
b. Form of value in agreement

38
IV. ’33 Act Exemptions
A. Statutory Scheme
1. Section 4  Exempted Transactions
a. Meaning
• Specific types of transactions are exempted
• When purchaser of security here wants to resell have to
find own exemption
b. Exempted from what
• Registration requirements of section 5 do not apply to the
transactions covered
• All other sections of the Securities Act do apply

2. Section 3  Exempted Securities

a. Meaning
• The provisions of “this title” do not apply to certain kinds
of securities
• Regardless of whose hands they fall into and the
frequency of sale, never have to be registered
b. Exempted From What
• Provision of the Securities Act do not apply to the
securities enumerated “except as expressly provided”
• Section 17 and Section 12(a)(2) still apply
c. Securities Exempted
• Government securities
• Securities issued by religious, educational or charitable
organization
• Interests in a railroad equipment trust
d. Three Important exempt transactions:
(1)Securities exchanged with existing security holders
(2)Securities issued under a plan of exchange approved by a court
or other governmental authority
(3)Securities issued in an intrastate transaction
e. Section 3(b)
(1) Language
• SEC may add any other securities to those exempted by
Section 3 when it finds that registration is not necessary in
the public interest and for the protection of investors by
reason of the small amount involved or the limited character
of the public offering
• These will be transaction exemptions only
(2) Dollar Limit  $5M
(3) Mandatory Considerations
• Whenever SEC has to determine whether an action is
necessary or appropriate in the public interest, it must also
consider in addition to the protection of investors, whether

39
 the action will promote efficiency competition, and capital
formation
(4) Rules and Regulations Promulgated Under
• Regulation A
• Rule 504
• Rule 505
• Rule 701 (employee benefit plans)
• Rule CE (issuers in California)

3. Exempted Securities v. Exempted Transactions

a. Exempted Securities
• It does not matter how often they are traded, or by whom,
they never have to be registered
b. Exempted Transactions
• They are only exempt from registering for that specific
transaction
• If a buyer in an exempted transaction wishes to resell, he
must find another transaction exemption or the securities have
to be registered

4. Section 28  General Exemptive Authority

a. Language
• SEC has power to “exempt any person, security, or
transaction, or any class or classes of person from any provision
of the Act so long as the exemptions necessary or appropriate
in the public interest and is consistent with the protection of
investors”
• Remember additional §2(b) considerations
b. Other powers
• Allows the SEC to raise the dollar limit of exemptive rules
previously adopted under Section 3(b)

B. Private Placement Exemption  §4(2) (Only the initial transaction

exempted)
1. Language
• The provisions of Section 5 shall not apply to transactions by an
issuer not involving any public offering
• Only available to issuers
2. Defining a Private Placement  Ralston Purina Co.
a. Background
• Sold stock to employees without registering
• Employees had to initiate sale
• Wide variety of people in varying positions bought stock
• Claimed only sold to key employees for sale to all would
definitely be public
b. Issue

40
 • Whether the sale to employees is a public offering or
private placement.
c. Holding  Public Offering
• Burden of Proof
• Burden of proof is on the person who wants the
protection of an exemption
• There is no bright line numbers test
• “the statute would seem to apply to a public
offering whether to a few or many”
• Numbers still relevant b/c have to show test is met
to each offered  the more there are the harder it is to
show
• The Test
• Applicability of the exemption should turn on
whether the particular class of persons affected
needs the protection of the Act
• Can the offerees fend for themselves?
• Do they know the questions to ask and smart
enough to know what to do with the information
• Did the offerees have access to the kind of
information which registration would disclose?
• Do not have to have access to “the”
information that would be available in a
registered offering
• An offering to only executive officers would be entitled to
the exemption

3. Defining a Private Placement  Securities Release 4552

a. Focus on Offerees as well as purchasers
• Focus is on the offerees of securities rather than
purchaser
b. One Bad Apple Doctrine
• Inclusion of one offeree that does not meet the test (fend
for themselves and access to kind of info) ruins the existence
of the exemption
• Not available even if caught early and does not buy
• Example  sell to four executives and one janitor
c. Public Advertising
• Inconsistent with private placement
• Do not know who offerees are and whether they have
information and can fend for themselves
d. Number of offerees is not conclusive
• Number of offerees is relevant only to the question
whether they have the requisite association with and
knowledge of the issuer which make the exemption available
e. “Coming to Rest”

41
 • SEC considers the offering to continue until the offered
securities have come to rest in the hands of persons who are
not “merely conduits for a wider distribution”
• If the purchasers do in fact acquire the securities with a
view to public distribution, the seller assumes the risk of
possible violation of registration requirements
• Mere acceptance of them telling you won’t sell it is not
enough
• Put legend on security and issue stop-transfer orders may
work
• If sell to someone known to buy and sell quickly rather
than for investment, likely violation
d. Integration of Offerings
(1) Issue  whether what purports to be a single offering
should be combined with one of more other purportedly
separate offerings
(2) Effect  when offerings are integrated in that way, the
larger offering, viewed as a whole, must meet the requirements
of an exemption or all the securities must be registered
(3) Factors
(a) different offerings are part of a single plan of financing
(b)the offerings involve issuance of the same class of
security
(c) offerings are made at or about the same time
(d)same type of consideration is to be received
(e) offerings are made for the same general purpose
4. Defining a Private Placement  Circuit Courts (page 181)
5. Defining a Private Placement  ABA Position Paper
a. Offeree Qualification  Can be qualified in several ways:
(1) Ability to understand the risk  sophistication
(2) Ability to assume the investment risk  wealth
• But if completely no knowledge about business
matters, should have a representative
(3)Personal relationship to issuer or promotion
• Family ties, friendship, employment relationship,
pre-existing business relationship
(4)Manner of Disclosure
• The more careful, painstaking and detailed the
disclosure is, the more readily one may find that a
particular offeree is able to understand the risk
(5)Economic Bargaining Power
• Concept that is essentially shorthand for describing
institutional and some other types of professional
investors
(6)Offeree representative principle

42
 • Idea is that sophistication may be imputed to an
offeree
b. Availability of information
• Adequate to give basic information concerning the
issuers financial condition, results of operations,
business, property and management
c. Manner of offering How to locate the qualified people:
• Offering should be made through direct communications
with qualified offerees or their representatives
• All forms of general advertising and mass media
circulation should be avoided
d. Absence of redistribution
• 1st tier purchasers should not immediately redistribute the
shares or it would turn it inot a public offering
• A legend is not required although it would be helpful. The
absence of one does not make the exemption unavailable
e. One Bad Apple  What happens when one offeree is not qualified:
• ABA says in some situations one bad apple will not ruin
the availability of the exemption
• Courts reject this and say will always ruin exemption
f. Advertising
• All forms of general advertising and mass media
circulation should be avoided
g. Significance of Factors
• These are only minimum standards used to help predict a
court decision
• When planning should set standards higher
h. Number of Offerees
• Always has been some relationship between the number
of offerees considered acceptable and the level of the
offerees sophistication
• But they feel counsel should feel comfortable if selling to
all institutional investors even if 100 of them

6. Safe Harbor  Rule 506

• Safe harbor under §4(2)
• But still can go naked under the statute and statute remains
important
• Fallback when other exemptions tried and failed
• Sometimes no doubt about private nature and don’t need
the safe harbor
• Requirements more easily satisfied by chance

C. Intrastate Offerings  §3(a)(11)

1. Statutory Language

43
 • Any security which is a part of an issue offered and sold only
to persons resident within a single State or Territory, where
the issuer of such security is a person resident and doing
business within, or if a corporation is incorporated by and doing
business within such State or Territory
2. General Considerations
• Only exempt purely local offerings  those by in-state
issuers to in-state residents from registration requirements
• Good for local business
• No concern with the recipients ability to understand
anything and fend for himself
• Interpreted narrowly and strictly
• Must look to both offerees and purchasers  can’t
even offer to one non-resident
• No $ limit on amount that may be raised
3. Interpretation  Securities Release 4434
a. “Issue” Concept
• Entire issue of securities must be offered and sold
exclusively to residents of the state in question
• One Bad Apple  an offer to a single non-resident
which is considered part of the intrastate issue will
render the exemption unavailable to the entire offering
• Integration
• Whether an offering is “part of an issue” is
determined by integration principles trying to
determine if issue in question is part of an offering
previously made or proposed to be made
• What constitutes an issue  Question of integration
• Are the offerings part of a single plan of financing
• Do the offerings involve issuance of the same class
of security
• Are the offerings made at or about the same time
• Is the same type of consideration to be received
• Are the offerings made for the same general
purpose

b. Coming to Rest
• The shares must come to rest with residents for the
exemption to be available
• Issuer, underwriters and dealers must help ensure there
are no resales to non-residents
• How long must residents hold them until they have been
deemed to come to rest with them?
• Ask to determine the purchasers intentions of the
shares to make sure they are being bought for
investment purposes

44
 • Place limits on transfer of shares subject to an
attorney saying that they can sell and exemption will
remain intact

c. Doing Business Within the State

• Issuer must have substantial operational activities in the
state of incorporation
• Not met by having only bookkeeping, records etc. in state
• Substantial amount of the proceeds from the offering
must be used in state
• Exemption should not be used for series of corporations
organized in different states where there is in fact and
purpose a single business enterprise or financial venture

d. Residence
• Mere presence is not sufficient
• SEC at one time construed it to mean domicile in the
conflict of laws sense (Louis Loss article)

e. Re-sales
• Any offers or sales to a nonresident in connection with the
distribution of the issue would destroy the exemption as to
all securities which are part of that issue (including those
sold to residents and regardless of whether sales are made
directly to nonresidents or sold to them by residents)
• Securities may be sold to nonresidents when the
securities had in fact come to rest in the hands of resident
investors

f. Use of Facilities of Interstate Commerce

• Exemption is not dependent upon the absence of use of
these

g. Effect of Exemption Being Lost

• SEC threatens injunction if offering continued without
registration
• Registration statement disclose a contingent liability
under §12(1) of shares already sold
• Insists issuer offer rescission to persons who already
bought

4. Busch v. Carpenter (1987)

a. Background
• After an offer and sale to the public (all residents) a
majority of the proceeds were shifted to a different state
because of the merger
b. Holding

45
 (1) Coming to Rest (she says this confuses the issue)
• “if an issuer makes a prima facie showing that securities
initially were sold only to state residents, if can get summary
judgment on the coming to rest issue, regardless of the
purchasers’ holding period, unless the other party produces
some evidence to the contrary”
• The initial seller of the securities has the burden of
showing that the sales were made to residents only
• The plaintiff then has the burden of producing some
contrary evidence
• General Standard for Coming to Rest
• Person must be purchasing for investment and not
with a view to further distribution or for purposes of
resale
(2) Doing Business
• Refers to income producing activity
• Issuer must conduct a predominant amount of that
activity within his home state
• Means more than maintaining an office, books, and
records in one state
• When a corporation is being set up and it intends
to use proceeds in one state, but then intentions are
genuinely changed and proceeds go elsewhere, may
still qualify for exemption
• If company is being set up, the intent to invest proceeds
elsewhere may suffice to defeat a claim of exemption

5. Doing Business Interpretation  Securities Release 5450

• Principal or predominant business must be conducted in
the state
• Substantially all of the proceeds must be used in the local
area

C. Rule 147  Safe Harbor for Intrastate Offerings

1. Integration
• Issue does not include offers or sales made more than six
months before or more than six months after any offers or
sales made under the rule
• Two offerings will not be considered one if they are six
months apart
2. Doing Business
• 80% of the revenues and assets of the company are
located within the state
• 80% of the proceeds from the offering are to be used in
the state
3. Residence

46
 • Principal residence (can be a resident of more than one
state, but principal residence is where you spend more time)
• If a corporation, residence is where its principal office is
4. Coming to Rest
• Shares have come to rest when they have been held by
initial purchaser for nine months
• After this the resident can sell to a nonresident
5. Technical Compliance May Not Be Enough
• If in technical compliance with rule but offering is part of a
plan or scheme by such person to make interstate offers or
sales of securities then exemption not available
• Any plan or scheme that involves a series of offerings by
affiliated organizations in various states, even if in technical
compliance, may be outside the parameters of the rule and
of §3(a)(11) if what is being financed is in effect a single
business enterprise

D. Regulation D
1. Rule 504 (Under §3(b) power)
a. Aggregate Offering Price
• Limited to $1M in a twelve month period
• All §3(b) exempt offerings within the prior 12 months are
aggregated together
b. Number of Investors/Purchasers
• Unlimited
c. Investor Qualifications
• None required
d. Sales Commissions
• Permitted
e. Limitations on Manner of Offering
• None
f. Limitations on Resale
• No restrictions
• Rule 144 is not applicable here
g. Issuer Qualifications
• No Exchange Act reporting companies
• No blank-check or investment companies
h. Notice of Sales
• Five copies of Form D must be filed with SEC within 15
days after the first sale
• Failure to file will not cause the issuer to lose the
exemption but may jeopardize the chance of using a future
Regulation D exemption
i. Information Requirements
• None
j. Integration Safe Harbor

47
 • If offer is more than 6 months before or after, SEC won’t
integrate

2. Rule 505 (Under §3(b) power)

a. Aggregate Offering Price
• Limited to $5M in a twelve month period
• All §3(b) exempt offerings within the prior 12 months are
aggregated together
b. Number of Investors/Purchasers
• Can sell to 35 purchasers plus an unlimited number of
accredited investors
• Focus on purchasers, not offerees
• Accredited Investor  any bank, savings and loan,
Investment Company, director executive officer or general
partner of the issuer, natural person with net worth of $1M,
natural person with net income of $200,000 or joint income
of $300,000 in two most recent years, trust with assets of
more than $5M
c. Investor Qualifications
• None required
d. Sales Commissions
• Permitted
e. Limitations on Manner of Offering
• No General Solicitations Permitted
f. Limitations on Resale
• Restrictions on resale under Rule 144
• Rule 144 is not applicable here
g. Issuer Qualifications
• Exchange Act reporting companies may use it
• No investment companies or issuers disqualified under
Regulation A
h. Notice of Sales
• Five copies of Form D must be filed with SEC within 15
days after the first sale
• Failure to file will not cause the issuer to lose the
exemption but may jeopardize the chance of using a future
Regulation D exemption
i. Information Requirements
• If purchased solely by accredited investors, no
information required
• If purchased by non-accredited investors  See Chart
j. Integration Safe Harbor
• If offer is more than 6 months before or after, SEC won’t
integrate

3. Rule 506 (Under §4(2))

48
 a. Aggregate Offering Price
• Unlimited b/c under §4(2)
b. Number of Investors/Purchasers
• Can sell to 35 purchasers plus an unlimited number of
accredited investors
• Focus on purchasers, not offerees
• Accredited Investor  any bank, savings and loan,
Investment Company, director executive officer or general
partner of the issuer, natural person with net worth of $1M,
natural person with net income of $200,000 or joint income
of $300,000 in two most recent years, trust with assets of
more than $5M
c. Investor Qualifications
• Purchaser must be sophisticated (alone or with
representative)
• Accredited investors are presumed to be sophisticated
d. Sales Commissions
• Permitted
e. Limitations on Manner of Offering
• No General Solicitations Permitted
f. Limitations on Resale
• Restrictions on resale under Rule 144
• Rule 144 is not applicable here
g. Issuer Qualifications
• None
h. Notice of Sales
• Five copies of Form D must be filed with SEC within 15
days after the first sale
• Failure to file will not cause the issuer to lose the
exemption but may jeopardize the chance of using a future
Regulation D exemption
i. Information Requirements
• If purchased solely by accredited investors, no
information required
• If purchased by non-accredited investors  See Chart
j. Integration Safe Harbor
• If offer is more than 6 months before or after, SEC won’t
integrate

4. Rule 508
• In certain circumstances, an insignificant deviation
from requirements will not result in the loss of
exemption if there is a good faith and reasonable
attempt by the issuer to comply with the Rule

5. Interpretation  Securities Release 6455

49
 a. Accredited Investors  Rule 501(a)
• An investor is accredited if he falls into one of the
enumerated categories at the time of the sale of securities to
that person
• For a company to be an accredited investor, all of the
equity owners must also be an accredited investor
• Executive officer  the executive officer of a parent of
the Regulation D issuer that performs a policy making
function for the subsidiary is an executive officer of the
subsidiary

b. Disclosure to potential investors

• An issuer may provide a summary of information followed
up by a complete disclosure document if does not obscure
material information
• When relying on Rule 505 if initially plan to only sell to
accredited investors, make sales to them, and then decide to
sell to non-accredited investors issuer must deliver a
complete disclosure document to all investors and agree to
return the funds of those who have already bought  if do
this will not lose exemption

c. Counting Purchasers  Rule 501(e)

• If an accredited purchaser lives with his cousin and both
are buying  both are excluded
• Partnership shall count as one purchaser and issuer does
not have to consider the sophistication of each individual
partner

6. Aggregation and Integration Problems

a. General Rules
• Offerings under §3(b) (Rules 504 and 505) have to be
aggregated if within a twelve month period to make sure fall
within dollar limitation
• Integration safe harbor is six months before and after
b. 7 months since public offering and Rule 506 safe harbor is used to
make a private offering
• aggregation is not a problem
• Integration  these are six months apart so deemed to
not be integrated
c. 3 months since public offering and Rule 506 safe harbor is used to
make a private offering
• Problem with integration. SEC might find that the public
and private offering are part of the same offering and require
that the 2nd be registered also
• Have to look at factors to determine if they will be
integrated

50
 d. 7 months since public offering and Rule 505 is used to make the
2nd offering
• Rule 505 has a $5M aggregate limit.
• But, only other §3(b) exemptions get aggregated
(so do not have to aggregate public and private offerings)
e. Use 505 to make 2nd offering and 7 months later use Rule 504 to
make another offer
• Aggregation is a problem
• For Rule 504 only get $1M less any other §3(b)
exemptions within prior 12 months

E. Regulation A (Section 3(b) exemption so $ amount can change)

1. Effect
• Exemption from registration requirements of the
securities act
• Mini registration with offering statement that must be
filed
• Used less frequently now due to simplified registration
forms
2. Dollar Limit
• Only $5M of securities may be sold in a 12 month period,
and $1.5M of that may be sold by security holders
3. Who Cannot Use
• ’34 Act reporting companies cannot use
• when exempt securities from registration do so to
help small businesses
• ’34 act companies are not intended beneficiaries
• must be a US or Canadian company
• cann have run afoul of specified laws in the past
4. Testing the Waters Allowed
• Issuer may test the waters before filing of an offering
statement, by oral and written communications to potential
buyers that are designed to gauge interest in the offering

F. Section 4(6)
1. Statutory Language
• The provisions of section 5 shall not apply to
transactions involving offers or sales by an issuer
solely to one or more accredited investors
2. Limitations
• Money raised is limited to amount specified in §3(b) ($5M)
• Issuer must file the required notice with the SEC
3. Accredited Investor
• Includes certain institutions, such as banks and insurance
companies and any person who on the basis of such factors
as financial sophistication, net worth, knowledge, and

51
 experience in financial matters or amount of assets under
management qualifies under rules
• Rule 215  for natural persons if net worth with one’s
spouse of more than $1M or net income of more than
$200,000 in each of the two most recent years (or $300,000
jointly with ones spouse)

G. Regulation CE
1. California Exemption
2. $5M Ceiling on amount raised
3. Limited to California Issuers
• Limited to CA issuers and non-CA issuers that have more
than 50% of their property, payroll, and sales in that state,
so long as more than 50% of the non-CA issuer’s voting
securities are hold of record by persons having addresses in
California
4. Must satisfy requirement of 25102 of CA code

H. Rule 701
1. Not available to Exchange Act reporting companies or investment
companies
2. For companies who wish to sell stock to their employees
3. Dollar limit (that can be changed by SEC)
• Enacted under power of §3(b) so dollar limit can be
adjusted by SEC

V. Regulation of Resales of Securities

A. Introduction
1. Violation of Section 5
• Applicable in the context of re-sales
• Unless a registration statement is in effect or there is an
exception for the security, any resales or delivery after re-
sale of such security would be a violation of §5
2. Only Issuer May Register
• Security holders can, however, bargain for registration
rights (right to compel the issuer to register for purpose of
resale) or Piggy Back Rights (if issuer registers some
securities they will also register their securities for resale)
3. When Shares Never Registered
• Purchaser must find an exemption to re-sell their shares
• §3(a)(11) is available for use for re-sales (intrastate
offering)
• Rule 147 is only available for use by the issuer
4. Section 4(1)
a. Statutory Language

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 • The provisions of section 5 shall not apply to transactions
by any person other than an issuer, underwriter, or dealer
b. Issuer
• Every person who issues or proposes to issue any security
c. Dealer
• Any person who engages either for all or part of his time,
directly or indirectly as an agent, broker, or principal, in the
business of offering, buying, selling, or otherwise dealing or
trading in securities issued by another person
d. Underwriter
(1)Generally
• Any person who purchased from an issuer with a
view to distribution
• Any person who offers or sells for an issuer in
connection with a distribution
(2)Definition of Issuer
• Includes control persons
• So someone who buys from a control person with a
view to distribution is an underwriter

B. Control and Restricted Securities

1. Control
a. Control Securities
• Securities owned by a person who is an affiliate of the
issuer
• Affiliate
• Person that directly or indirectly through one or
more intermediaries controls or is controlled by or is
under common control with the person specified
b. Control Person
• Term control means the possession, direct or indirect, of
the power to direct or cause the direction of management
and policies of a person whether through the ownership of
securities
c. Amount of Securities Needed
• 10% equity is a good rule of thumb
• will be considered an affiliate
d. What Control Can Be
• Unexercised ability to control is control
• Control Group  you are a control person if you are a
member of a group that controls

2. Restricted Securities
a. Securities acquired directly or indirectly from the issuer or from an
affiliate of an issuer, in a transaction or chain of transactions not
involving any public offering

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 • Covers a security that at one point were sold by the issuer
under a §4(2) non public offering exemption
• Covers a security sold under §4(6) (sale to only accredited
investors)
b. Securities acquired from an issuer that are subject to the resale
limitations of Rule 502(d) under Reg. D or rule 701(c)
• Includes securities purchased directly from an issuer in a
ny transaction under rule 505 and 506
c. Fungibility
• If a person owns both restricted and non-restricted
securities of the same class and from the same issuer, the
non-restricted securities take on the taint of the restricted
status

C. Sales of Control Securities

1. Definition of Underwriter
• Any person who has purchased from an issuer or an
affiliate of the issuer with a view to distribution
• Any person who offers or sells for an issuer or an affiliate
of the issuer in connection with a distribution
• Issuer includes control persons
2. Effect
• If you buy from a control person with a view to
distribution  you are an underwriter and cannot
claim the §4(1) exemption
• If you sell shares of a control person in connection
with a distribution you are an underwriter and cannot
claim the §4(1) exemption
• If a securities firm handles the sale as a dealer (buys the
securities themselves with the idea of reselling them) may
be considered to have “purchased from an issuer with a view
to distribution”  makes them an underwriter
3. Meaning of Distribution
• Synonymous with public offering
4. Exemptions
• Underwriter  No exemptions
• Dealer  The provisions of Section 5 do not apply to
transactions by a dealer who is not longer acting as an
underwriter with some exception
• Ordinary investor can sell their shares through a
dealer
• Broker  The provisions of Section 5 do not apply to
brokers’ transactions executed upon customers’ orders on
any exchange or in the over-the-counter market but not the
solicitations of such orders and not if brokers is also acting
as an underwriter

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5. In Re Ira Haupt & Co. (1946)
a. Background
• A broker sold on behalf of a major shareholder (control
person) a substantial number of shares over the course of a
few months
b. Holding
(1) Was the Broker an Underwriter? Yes
• Underwriter Any person who offers or sells for an issuer
or an affiliate of the issuer in connection with a distribution
• Here the broker sold for an issuer (control persons are
issuers) in connection with a distribution
• Distribution? Yes
• SEC is willing to allow control securities to trickle
into the market, but it will not allow a flood
• A distribution comprises the entire process by which
in the course of a public offering the block of securities
is dispersed and ultimately comes to rest
(2) Can the Broker avail himself the §4(4) Broker’s exemption? No
• Exemption allows a person brokering that does not
actually solicit from the other side to get an exemption
• Because he is also an underwriter, §4(1) is not available
and cannot rely on §4(4) when also an underwriter
• Not available here because public distributions by
controlling persons, through underwriters, are intended to be
subject to registration
• Cannot get around this when going through a broker

6. United States v. Wolfson (1968)

a. Background
• Control persons sold large amounts of stock through
brokers without telling brokers what they were doing
b. Holding
• The brokers provided outlets for the stock of
issuers (control persons) with a view to distribution
(large amounts of stock) and thus were underwriters
and §4(1) not available
• Controlling persons tried to argue that they fall into the
§4(1) exemption b/c they are not issuers, underwriters or
dealers and if brokers can do this that they should be able to do
it also
• One, the brokers did not know they were doing this
• Two, even though control persons not in plain
language of statute can still be liable
• §4(1) is available for transactions not
distributions

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 • The brokers were underwriters. Therefore,
the control persons were engaging in a
transaction by an underwriter and were also
captured by the rule.
• Control persons who sell or offer to sell through
underwriters can’t get §4(1) exemption
• Brokers allowed to have §4(4) exemption b/c there were
unaware that their customer’s part of the transaction is not
exempt
• Those who offer or sell for control persons are
underwriters unless they do so unknowingly
• If what is going on is not a distribution, then you will be
okay b/c no one is an underwriter and then control persons are
not selling through an underwriter

c. Summary
• Control persons can cause problems for brokers
• Control persons can cause problems for themselves by
selling through underwriters

D. Sale of Restricted Securities

1. General
• Restricted securities should be sold under Rule 144
• But they do not have to be and may be re-sold outside the rule
by going naked under §4(1)
• When doing this SEC interpretations are important
• Small unrelated purchaser of 1% of the stock  Can they turn
around the next day after buying and resell in a private offering
security?
• Problem  view towards distribution
• A person who purchases securities in a private
placement and then resells in a public trading market
is an underwriter if she purchased with a view to
distribution (as an underwriter they cannot use §4(1))
• Issuers often place resale restrictions on privately places
securities to avoid having the issuance converted into a
public distribution subject to registration
• Main Issue  What is meant by purchasing with a view to
distribution?
• How long a holding period is required to avoid the
problem?
• No holding period removes the taint of an underwriter
status from someone who has purchased with a distribution
in mind.

2. Holding Period  United States v. Sherwood

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 a. In determining whether someone purchased with a view to
distribution the purchaser will want to show bought for
investment which can be indicated by the holding period
before resale
b. When purchase directly from the issuer if hold for two
years then bought with no view to distribution unless other
evidence to the contrary
• Two years became the standard minimum safe holding
period
c. SEC seems to indicate in no-action letters that a three year holding
period would be better
• Staff freely granted no-action letters when restricted
securities were held for three years, but not as likely to do so
when only held for two

3. Change in Circumstances Doctrine

a. Argument  planned to hold for investment but due to a change in
circumstances had to sell b/c needed the money
b. SEC looks very dimly on this and won’t accept, but some courts
endorse and allow it to save someone who did not register
• Courts will allow it to shorten the acceptable holding
period

4. Putting Legends On Stock

a. when purchase from issuer the issuer wants to establish not
involved in a distribution so it will restrict the sale of the stock
b. also for purchasers benefit b/c if they take the security with legend
it should they planned on holding them for investment
• this means no view to distribution and therefore not an
underwriter when eventually resell

E. Rule 144  Persons Deemed Not to Be Engaged in a Distribution

and Therefore Not Underwriters
1. General
• Way for holders of restricted securities or control persons to sell
their shares  compliance with the Rule secures a §4(a)
exemption
• The rule defines what is not a distribution and therefore when a
person is not an underwriter
• All sales must follow the amount, manner and notice
requirements below

2. Categories of Requirements
a. Current Public Information
• Must be publicly available specified current information
concerning the issuer

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 • ’34 Act company has sufficient information available to
satisfy
• many companies will therefore register voluntarily so can
use this rule
• may also increase price due to liquidity b/c there
will be enough information to use this rule
b. Holding Period for Restricted Securities
• One year
• For a non-affiliate a two year holding period means you
are home free
c. Limitation on amount of securities sold
• Greater of
• 1% of the class of securities outstanding; or
• average weekly trading volume of the class of
securities during the preceding four weeks
d. Manner of Sale
• Must be sold in a broker’s transaction or directly to a
market maker
• Not face to face transactions
e. Notice of sale
• Seller must file a notice of sale with the SEC unless sales
during a three month period do not exceed 500 shares or a
total sales price of $10,00

3. Make Flow Chart

F. Private Re-sales  Rule 144A

1. Requirements for safe harbor (144A)
a. Available only for re-sale (not for issuers)
b. Purchaser must be a “Qualified Institutional Buyer”
• Means certain entities (insurance company, investment
company, employee benefit plan, trust fund) owning and
investing on a discretionary basis at least $100 Million in
securities of issuers that are not affiliated with the entity
c. Security must be non-fungible with a publicly traded market
(whatever that means????)
d. Modest information required to be delivered to purchasers
• Issuer may have to provide information through contract
with purchaser
• Creation of after market for security that will not get back
to the public
f. Not available for the resale of securities
• That at the time of their issuance, were of the same class
of securities listed on a national securities or NASDAQ

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 • That were issued by one of the enumerated types of
companies that are or are required to be registered under
the Investment Company Act
G. Going naked under Section 4 ½  Private Re-sales
1. Generally
• If you are not an underwriter and you resell a security you will
be exempt under §4(1); one way to not be an underwriter is to buy
w/o a view to distribution; since distribution is same as public
offering, when you sell in a private resale there is not distribution,
you are not an underwriter and you get exempted under §4(1)
• The exemption has the character of a §4(2) exemption but is a
§4(1) exemption b/c by definition it involves no transaction by an
underwriter
• Offers and sales are not made in a public offering – No
distribution – No underwriter – no registration
• Must be sure that seller did not originally purchase with a view
to a distribution and is not acting for an issuer (b/c then will be an
underwriter)
2. If satisfy rules you are deemed not to be engaged in a distribution the
therefore will not be underwriters
3. Trying to make the sale not a public offering, so it will not be a
distribution, so no one will be an underwriter (and get §4(1)
exemption)
4. Structure to ensure
• Seller is not an underwriter; and
• Cannot be made an underwriter by actions of the
purchaser
• This means selling only to those who can meet the
requirements for purchasing in a private placement
• Make sure purchasers can’t resell in a non-exempt
transaction b/c that would destroy exemption that
supported earlier sales
• Purchaser must agree to contractual restriction
restricting the sale
5. Staff Letter (page 237)

H. Deemed Underwriter under Rule 145 (ASK)

a. Rule 145(c)  Persons and Parties Deemed to be Underwriters
b. Rule 145(d)  Resale Provisions for Persons and Parties Deemed
Underwriters
I. Rework Situation 7

VI. ’33 Act Liability

A. Introduction
1. Criminal Liability

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 • §5  “Unless a registration statement is in effect as to a
security, it shall be unlawful”
• §17  broad anti-fraud provision
• §24  willful violation of the act is punishable by imprisonment
and $10,000 fine

2. Civil Actions Brought by Government

a. Section 8A issue cease and desist orders
b. Section 20(d)  ask a district court to imposed a penalty
c. SEC no authority to bring aiding and abetting actions under the
Securities act or its rules
• Under the Exchange Act can bring aiding and abetting
actions for violations of those rules (Section 20)
3. Civil Liability to private parties
• §11  private right of action for damages based on a material
misrepresentation in a registration statement
• §12(a)(1)  private right of action to rescind deal that had
violation of §5
• §12(a)(2)  private right of action to rescind for material
misrepresentation from prospectus (§17)

B. Criminal and Other Governmental Actions

1. Meaning of Willful under §24
a. SEC Administrative Action
• Does not require a finding of intention to violate the law
• Sufficient that registrants be shown to have known
what they were doing

b. United States v. Brown (9th Cir. 1978)

• Government is required to prove specific intent
only as it relates to the action constitution the
fraudulent, misleading, or deceitful conduct, but not as
to the knowledge that the instrument used is a security
• Do not have to show D knew of §17, or what he was doing
is legally “fraud” or knew they were selling a security
• Just have to that he was aware that what he was saying
was untrue or fraudulent in the general sense

2. Effect of Jurisdictional Means

• Each separate use of these means is a separate violation

3. SEC Power over Criminal and Civil Violations

a. SEC does not have the power to bring criminal actions
• §20  SEC can formally investigate
• §20(a)  can bring action seeking injunctive relief

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 • §20(b)  transmit evidence to attorney general who may
then institute the necessary criminal proceedings

b. Civil Actions
• §8A  can bring actions seeking civil penalties and to
issue cease and desist orders
• §20(d)  power to seek civil penalties
• penalty varies with culpability and risk to public of
violations
• $5,500-$110,000 for individual
• $55,000-$550,000 for others
• but penalty can be as high as gain to violator as a
result of the violation
• Rule 9  can reduce amount for small entities
• SEC can bring aiding and abetting action under Exchange
Act for violation of its rules, but not under the Securities Act
c. Court’s Power
• §20(e)  prohibit a person who has violated §17(a)(1)
from acting as an officer or director of a company that has
securities registered under §12

C. Civil Liability  Section 11

1. Statutory Language
• If part of the registration statement when it became
effective contained an untrue statement of a material fact or
omits to state a material fact required to be stated therein or
necessary to make the statements no therein misleading . . . may
sue.
2. General Issues
a. Plaintiff’s Case
• Proper plaintiff
• Proper defendant
• Material Misrepresentation of omission
• May have to show reliance (12 month earning statement
available)
b. Defenses Available
• Culpability - Due diligence defense
• Resign and squeal
• Lack of loss causation to reduce damages - §11(e)
• Bespeaks caution doctrine
• Statute of limitations  §13
• P knew about omission or misstatement
• Rebut part of P’s case
• §27A and Rule 175  safe harbor for forward looking
statements
b. Damages

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 • Calculated under §11(e)
• Joint and several liability §11(f)
• Proportionate liability for outside directors - §21D(f)

3. Common Law of Misrepresentation

a. Material Misrepresentation
b. Culpability
• Varies by jurisdiction
c. Causation
• Transaction  general causation (reliance)
• Loss causation  prove that but for the D’s wrong P
would not have incurred the injury
d. Damages

4. Proper Plaintiff
a. purchaser of a registered security may sue under §11
irrespective of whether he or she purchased the security in
the registered offering or later in the trading markets
b. Section 13  must bring suit before statute of limitations run
• One year after discovery of untrue statement or one year
after discovery should have been made by the exercise of
reasonable diligence

5. Proper Defendant  Section 11(a)

a. Every Person who Signed the Registration statement
• Includes the issuer, CEO, CFO, UW
b. Every director at the time of filing
c. Every underwriter with respect to such security
d. Accountants and people whose profession allow them to put their
name on the registration statement as having prepared it or
certified part of it
• If prepare, but name does not appear in it as having
written a portion, then no liability
• If named and part attributed to you, may be liable (but
only responsible for part you prepared and certified)
• If law firm named, firm liable but not specifically an
individual attorney

6. Material Misrepresentation
a. Material
• Substantial likelihood that a reasonable investor would
attach importance in determining whether the purchase the
security registered
b. Objective Standard
• For number figures 10% is a good ball park figure (if
assets misstated by 10%)

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 7. Bespeaks Caution Doctrine (Taj Mahal Litigation)
a. General Doctrine
• Inclusion of sufficient cautionary statements in a
prospectus renders misrepresentations and omissions
contained therein immaterial
• If D’s make the risk adequately clear, and hedge the
statement with cautionary language, then something that would
ordinarily be material is immaterial
• Need to be abundant and meaningful
b. Effect
• Because the statement is not material, there is no liability
c. Vague and Blanket Disclaimers do not suffice
d. Limitations on Use
• Due diligence is required for historical facts (can’t make
an assertion and then say might be wrong
• Some courts have limited doctrine to forward looking
statements
e. Safe Harbor  §27A
• Safe harbor for certain forward looking statements that
are accompanied by cautionary statements meeting the
section’s requirements

8. Due Diligence Defense (BarChris)

a. Generally
• P does not have to prove culpability
• But D can show lack of culpability as a defense to liability
• Not available to the issuer

Expert
“Expertised” • D after reasonable
Portion investigation had
reasonable grounds to
believe, and in fact did
believe that statement was
true
Non Expertiesd • D had no reason to believe
Portion they were not true
Non-Expert
• Least Required
• Ignorance is sufficient
• No reasonable ground to
believe, and did not
believe that statement
untrue
• D after reasonable
investigation had
reasonable grounds to
believe and in fact did
believe that statement was
true

b. What is a reasonable investigation

(1) D’s position is a factor in determining what is a reasonable
investigation
(2) CEO

63
 • Because aware of all relevant facts cannot believe there
were no untrue statements or material omissions
• No due diligence defense
(3) Outside Directors
• Not a reasonable investigation to not read the registration
statement and not know what they were signing
(4) Underwriters
• Should have verified any claims made by managers
(5) Auditors
• No liability for the non-expertized portions
• For the expertized part they prepared, have to do a
reasonable investigation and make sure that the numbers
they are using are correct
(6) Audited Portion
• Non-experts can rely on experts
• Experts must show they reasonably investigated where
numbers came from
(7) Non-Expertized Portion
• Everyone (but the auditors) should have verified claims
by the managers
• Cannot rely on management’s statements of how things
are
c. Weinberger v. Jackson
• Court permitted outside director to rely on reasonable
representations of management provided his own conduct
was reasonable under the circumstances
• Director was familiar with operations, attended meetings,
reviewed financials, involved in decision, review six drafts of
registration statement and saw nothing suspicious with the
knowledge he had
• No duty to make specific inquiries of company’s
management as long as prospectus consistent with his
knowledge which he had reasonable acquired as a director.
Also given comfort b/c info was reviewed by underwriters,
counsel, and accountants
• Due Diligence established

d. Things Issuer’s Counsel and Underwriter’s Counsel Should Do

• Information is the registration statement should be
verified
• Issuer and affairs must be examined to try and uncover
what must be added to the statement to prevent it from
containing a material omission
• If question arises as to the adequacy of disclosure, an
independent check of the facts is required

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 e. §11(b)(1)  Resign and Squeal Defense
• Once D finds out about the misrepresentation, he resigns
and tells the SEC all before the registration statement becomes
effective

9. Damages
a. Section 11 (e)
• Damages are calculated by the difference between the
offering price in the registered offering and the value of the
securities at the time of the suit (or the price at which the P
disposed of them earlier)
b. Underwriter
• No underwriter can be held responsible for damages in
excess of the aggregate public offering price of the securities
underwritten by it
c. Section 11(f)
• Proper Defendants are jointly and severally liable
• If a D is held liable he can get contribution from any
person who would have been held liable if sued
• Outside Directors
• Liability determined by §21D(f)
• Can only hold outside directors jointly and severally
liable if prove they knowingly committed a violation of
the securities laws
• If cannot show this strict liability still applies but
they will only have proportionate liability  liable
solely for the portion of the judgment that corresponds
to the percentage of responsibility of that covered
person
• Show how much he contributed to the
damage
10. Causation
a. Loss Causation
• P does not have to prove loss causation (just purchased
the stock under untrue registration statement)
• After time P may have to show reliance on untrue
statement
• If purchase after issuer publishes an earnings
statement covering 12 after registration statement
effective, must show reliance on untrue statement
• Defense  D is entitled to show lack of loss causation as
a defense
• Show loss in value due to something other than the
material misrepresentation

D. Civil Liability  §12(a)(1)

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1. Statutory Language
• “Any person who offers or sells a security in violation of §5 shall
be liable to the person purchasing such security from him [and get
recission of the sale]”
• liability flows when unregistered securities are offered or sold
without an available exemption
2. Plaintiffs Case
a. Plaintiff must be an ACTUAL purchaser
b. Proper Defendant
(1) purchaser may not recover from an issuer or any other seller
unless there is a direct link between the purchaser and the
seller
• if buy from an intermediate seller, must sue that
seller and not the issuer
• the intermediate seller can then turn around and
sue the seller that they bought from
(2) Pinter v. Dahl (1988)
• Definite liability for person who passes title (privity)
• “seller” also extends to person who successfully solicits
the purchase, motivated at least in part by a desire to serve
his own financial interest or those of the securities owner”
• important to protect investors at solicitation stage
• willing to put liability on agent of real seller b/c they
usually do the bad act
• construed the same for purposes of §12(a)(2)

3. D has offered or sold in violation of §5

a. Effect
• P does not have to show cause, damages, or culpability
• Strict liability provision to discourage violations of
registration provisions
b. Unclean Hands Defense (Fuller)
• If can show person trying to rescind is just as guilty as D
court will have sympathy
• So even though a technical violation there is a possible
unclean hands defense
c. Statute of Limitations is a Defense

d. Curing occurrence of bad act (Diskin)

• D sent an illegal written offer (sent offer without
prospectus) and later sent a proper final prospectus after
registration statement became effective
• Strict Liability Provision with no opportunity to cure by
sending prospectus later
• Once D messes up under §5, purchaser can get out of the
deal

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 • Advice  once mess up stop the deal, allow for a
cooling off period and start all over again
• Also, one bad apple will ruin all offers in the entire
offering so will have to stop all offers

E. Civil Liability  §12(a)(2)

1. Statutory Language
• Any person who offers or sells a security by means of a
prospectus or oral communication which includes a untrue
statement of a material fact or omits to state a fact (the purchaser
not knowing of such untruth or omission) . . . and who shall not
sustain the burden of proof that he did not know, and in the
exercise of reasonable care could not have known is liable”
2. Government Securities are Exempt
3. Proper Plaintiff
• Someone who purchased the securities (can’t be a mere
offeree)
4. Proper Defendant
• Same as in §12(a)(1)
• Either transferor of title or solicitor with a financial interest
(Pinter)
5. Definition of the Bad Act (Gustafson)
a. Generally
• Material misrepresentation in a prospectus or in an oral
communication relating to a prospectus
b. Defining Prospectus
(1) Issue
• Whether the right to rescission extends to a private,
secondary transaction on the theory that recitations in the
purchase agreement are part of a prospectus.
(2) Facts
• Sole shareholders or Alloyd sold their stock to an investor
group
• Group claimed that in the contract for sale, there was a
misrepresentation of companies financial position and want
rescission
(3) Holding
• Word “prospectus” is a term of art referring to a
document that describes a public offering of securities by an
issuer or controlling shareholder.
• The contract of sale, and its recitations were not
held out to the public and were not a prospectus as the
term is used in the ’33 Act
• Because the communication (contract for sale) was not a
prospectus, §12(a)(2) is not activated
• Intent of Congress and design of statute require that
§12(a)(2) liability be limited to public offerings

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 • Contract for sale is not a prospectus b/c was not the
prospectus described in §10 and filed in a registered public
offering
(4) Dissent
• Looked at definition of prospectus in §2(a)(10) and
determined that a contract for sale fit
(5) Effect of Narrow Construction
• Restricts the scope of §5 and allows more activity in the
waiting period which prohibits prospectus unless it is a §10
prospectus
c. §5 Prospectus Post-Gustafson
• seems that only formal offers associated with public
offerings come under the definition
• that would mean that those offering letters and circulars
that were previously held to be prospectuses are not
prospectuses

6. P can’t win if knew of misstatement of omission?

• P bears the burden of pleading and proving that they did
not know about the misrepresentation or omission (not sure
about this)
• P can’t win if he knew about them

7. Statute of Limitations  §13

• One year of discovery of misstatement or omission or after its
discovery should have been made by the exercise of reasonable
diligence – OR
• Three years after sale

8. Defenses for Defendant

a. Knowledge
(1)But D can defeat a claim by showing that he did not know, and
in the exercise of reasonable care could not have known of the
material misstatement or omission
(2) Similarity with Due Diligence Defense (Nuveen)
• Exercise of reasonable care equated with due diligence
and reasonable investigation under §11
• There should be no liability under §12(a)(2) when a D
could escape liability under §11
• Someone who falls under the specifically tailored liability
provisions of §11 should not be subjected to different rules
under more general liability provision
b. Loss Causation
• D can reduce damages if can show the loss in value is due
to something other than his material misstatement or
omission
• This only applies to §12(a)(2) and not §12(a)(1)
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 c. Statute of limitations - §13
d. Unclean Hands
e. D can rebut P’s case
f. Bespeaks caution
g. §27A  safe harbor for forward looking statements

9. Back to Manor Nursing

a. Holding of Manor Nursing  If prospectus has a mistake or
misstatement then it cannot be a §10 prospectus
• Because it is not a §10 prospectus they violate §5
b. If you violate §5, you are liable to those you purchase from you
under §12(a)(1)
c. But under §12(a)(2) a misrepresentation is subject to some
defenses
• Defense of reasonable care
• Congress intended this to be a defense to a misstatement
in the prospectus, but the bootstrapping logic of Manor
Nursing makes someone liable for a misstatement under
§12(a)(1) with no defense

F. Section 15
1. Statutory Language
• Anyone who controls a person liable under §11 or 12 is jointly
and severally liable to the same extent as the controlled person
(express private right of action)
• Exception  controlling person had not knowledge of or
reasonable grounds to believe in the existence of fact by reason of
which the liability of the controlled person is alleged to exist
2. Requirements for D to fall under exception
• If knew or reasonable should have known you are liable
• Some courts say if don’t try to monitor, will charge you with
knowledge you would have had if they had done reasonable
investigation
3. Who is a control person?
a. “every person who, by or through stock ownership, agency, or
otherwise, or in connection with an agreement has these things
controls any person liable under §11 or §12
b. Easily includes major shareholders, directors, and officers
c. Stadia Oil v. Whellis (10th Cir. 1957)
• Term given a broad definition
• Control  organizer of company, V.P., one of three
directors, signed stock certificates, presided over board
meetings where sale discussed
• Control will be determined by looking at characteristics
from other cases that found control
• Cautionary tale  do not have to own 90% of stock to be
a control person

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 4. Role of Culpability
a. Some courts require a showing of culpability by the P
b. Others require a lack of culpability to be raised by the defendant
as an affirmative defense

G. Section 17(a) and Implied Private Rights of Action

1. Statutory Language  Unlawful in the offer or sale of any securities
a. to employ any device, scheme, or artifice to defraud, or
b. to obtain money or property by means of untrue statement of a
material fact or any omission
c. to engage in any transaction, practice, or course of business which
operates or would operate as a fraud or deceit upon the purchaser
2. Cort Factors (implied right of action)
a. Is the plaintiff of the class for whose especial benefit the statute
was enacted?
b. Is there any indication of legislative intent to give a private right of
action?
c. Is it consistent with the underlying purpose of the legislative
scheme to imply a remedy for the P?
d. Is this subject matter traditionally relegated to state law, in an
area basically the concern of the states?
3. Washington Public Power Supply System (1987)
a. Background
• Company defaulted on bonds bought by the P’s
• Could not sue under §11 b/c were not required to be
register and can’t sue under §12(a)(2) b/c does not apply to
government securities
b. Issue
• Is there a private right of action under §17(a)? 
NO
c. Holding
• Court applied the Cort factors
• P must establish that Congress intended to imply a
private right or at least that it is consistent with the
legislative scheme
• Failure to satisfy these two factors is determinative
even if show you were in class meant to be benefited
• Court will not find a private right of action if Congress did
not intend one even if P is the intended beneficiary and not
state law implication
• Congress did not intend a private right of action under
§17(a)
d. Arguments to be made
(1) When Congress wanted a private damages remedy, it knew
how to do it and it did so expressly (§11 and §12)
• If it knew how to do it and did not do it here, must
not have wanted one

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 (2) Prevailing Legal Context
• If provision is construed consistently in one way and
Congress amends statute and leaves it alone  seen
as an affirmation that they intended that interpretation
• Cannot infer this when the views among the courts
is split
(3) Who was intended to benefit from the statute?
• Enacted to protect investors or issuers or who?
(4) Remedy at State Law
• If there is a remedy at state law, this cuts against a
finding of a private remedy in federal law
(5) Legislative Intent
• Look to legislative history and committee reports
(6) Consistent with Legislative Scheme
• The presence of express civil remedies within the
same statute militates against a finding of
Congressional intent to imply further remedies
• Express private rights have bells and whistles that
would not be present in implied private right (get out
of procedural limitations like statute of limitations
(§13)
• Would implying a private right be superfluous?
• Presumption that a remedy was deliberately
omitted from a statute is strongest wen Congress has
enacted a comprehensive legislative scheme including
an integrated system of procedures for enforcement
4. Context
a. Most courts have concluded that there is not a private right of
action under §17
b. But, ripe for review after Gustafson
• Case cut back drastically on coverage of §12(a)(2), §11
(only apply in public offerings)
• So not as much overlap as court may have thought b/c
§17 only applies in private offerings

H. Indemnification and Contribution

1. Difference
a. Contribution  when one person is held liable and others who are
guilty are not initially sued, the person who is sued and required to
pay under joint and several liability will go to other wrongdoers
and get money for their part in violation
b. Indemnification  one party agrees to hold the other party
harmless and pay any damages they must pay

2. Contribution  §11(f)
a. Statutory Language

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 • Grants right of contribution to any person liable under the
section if the person they are seeking contribution from
would have been liable to make the same payment
• Cannot seek contribution under this section from person
who is not guilty of fraudulent misrepresentation
b. Liability of Outside Directors
• Proportionate liability of section 21D(g) apply
c. Also available under §17(a) and §12 and Exchange Act Rule 10b-5

3. Indemnification
a. SEC Position
• Indemnification is against public policy
• Any provision granting indemnification is unenforceable

b. Globus v. Law Research Services (7th Cir. 1969)

(1) Issue
• Whether an underwriter may be indemnified by an issuer
for liabilities arising out of misstatements in an offering
circular of which the underwriter had actual knowledge.

(2) Holding  underwriter cannot be indemnified

• Court emphasizes that this is a situation when underwriter
has committed a sin graver than ordinary negligence
• But must remember that SEC always thinks it is
against PP and court cites to SEC as one of its reasons
for not allowing it here
• To tolerate indemnity would encourage flouting the policy
of act – well established that one cannot insure himself
against his own reckless, willful, or criminal misconduct
• SEC views indemnification as against public policy
• Liabilities are there to promote enforcement and deter
negligence  indemnification cuts against this policy
(3) Some courts refuse to enforce indemnification irrespective of
culpability
• Lawyers are cautious to include them
• Some courts also hold that there is no private right of
action for indemnification under either Act

VII. Registration under ’34 Act and Reporting Requirements

A. Commission’s General Exemptive Authority - §36
1. Statutory Language
• SEC may conditionally or unconditionally exempt any
person, security, or transaction from any provision or
provisions of this title or of any rule or regulations
thereunder
2. Caveats

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 • Any exemption must be necessary and appropriate in the
public interest, and consistent with the protection of
investors
• Authority of the SEC does not extend to Exchange Act
§15C which relates to government securities brokers and
dealers
3. §3(f) – relevant factors in rulemaking and regulations
• when the SEC must consider whether the action will
promote efficiency, competition, and capital formation at any
time it is required to consider or determine whether an
action is necessary or appropriate in the public interest

B. Registration and Periodic Reporting

1. Who must register - §12 (Registration Requirements for Securities)
a. An issuer must register when the securities are to be
traded on a stock exchange
• §12(a)  It is unlawful for any broker etc. to effect any
transaction on a national securities exchange unless the a
registration is effective
b. Must register is meet certain tests  §12(g)
(1)Equity securities are held by at least 500-750 people; and
(2)Issuer has total assets exceeding $10M
• Rule 12g-1 raised amount using authority under
§12(h)
(3) Issuer must make filing required within 120 days after end of
first fiscal year on the last day of which it meets these
requirements  but remember §15(d)
c. Nasdaq
• NASD requires securities traded on Nasdaq to be
registered under Section 12 (SEC considers this voluntary
registration)
2. Voluntary Registration - §12(g)
• Act contemplates voluntary registration
• Why voluntarily register?
• Interlinks with ’33 and ’34
• Make dealer prospectus delivery requirements
easier
• Take advantage of abbreviated filing form (start ’34
history)

3. Terminating Registration
a. §12(g)(4)
• to de-register have to have fewer than 300 record holders
(even if you voluntarily registered)
b. Rule 12g-4 (liberalized standard)

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 • To de-register need less than 300 holders or have less
than 500 AND total assets have not exceeded $10M on last
day of three most recent years

4. Determining How Many Shareholders You Have

a. §12(g)(4)
• Have requisite assets and “a class of equity security held
of record by five hundred . . . “
b. Definition of “class” - §12(g)(5)
• Class shall include all securities of an issuer which are of
substantially similar character and holders of which enjoy
substantially similar rights and privileges
c. Hypothetical #1
• Issuer has requisite assets and 400 common S/H and 200
preferred S/H – do they have to register? NO
• Common and preferred stock have different
characteristics and will not be considered to be in the same
class.
• Do not have to add 400 and 200 together so do not have
a equity class of more than 500 holders
d. Hypothetical #2
• $10M is assets with 600 common S/H and 300 preferred
• Now have to register
• But, only have to register the class that fits the test (i.e.
register the common but not the preferred)
• What difference does it make?
• Reporting of shareholders is tied to certain classes
and only shareholders of certain classes have to report
• Some shareholders do not want to have to register
(and will force co. to sell them stock that does not
have to be registered – why see multiple classes of
preferred stock)

C. Forms to Register
1. Form 10
• Different from ’33 Act forms so registration under ’34 Act
does not also constitute registration under the ’33 Act
2. Form 10-SB
• For small business issuers
• Easier financial statements
3. Regulation S-K
• Adopted under both acts (so form 10 will say “provide the
information called for in line x of Reg. S-K)

D. Reporting
1. §13(a)  two types of filings required

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 a. filings of such information and documents as the SEC requires to
keep current the information provided at the time of registration
b. filings of such annual and quarterly reports as the SEC requires
irrespective of the updating requirement
2. Form 10-K (annual report)
• Same information as S-1 in ’33 Act for most part
• Incorporated by reference in S-2 and S-3
3. Form 10-Q (quarterly report)
• Contains non-audited financial statements
4. Form 8-K
• Events that are important, if happen, may require filing
this form immediately and not waiting until next quarterly
report
• Changes in who controls company, changes in auditors,
resignation of a director over certain types of agreements

E. Timing of Filings and §15(d)

1. Explanation from class
• If file registration statement under the ’33 Act have to file
Form 10-K, 10-Q, and 8-K
• While most people who file under ’33 Act will fall under
§12(g) of ’34 Act and have to file them anyway, §15(d) was
enacted as a timing issue
• §15(d) will require earlier compliance with filings
than normal under the ’34 Act
• periodic reporting must begin immediately upon the
effectiveness of a ’33 Act registration statement
2. Other Explanation
a. Registering is not the only way to become subject to Exchange Act
reporting requirements
b. §15(d) requires that a company that has registered securities
under the ’33 Act is subject to §13 reporting
• these are the companies that typically meet §12(g)’s
requirement to register but they then have 120 days to
register and start reporting
• this forces then to star registering immediately upon the
effectiveness of the registration statement (even if have not
registered under §12 of Exchange Act yet)
• if a company is reporting only because of §15(d) (i.e. it
does not meet the requirements of §12(g)) and has fewer
than 300 shareholders it may discontinue reporting after 1
year)

F. Record-Keeping  §13(b)(2)-(3)
1. Requirements  §13(b)(2)
a. maintain financial records in “reasonable detail” to reflect
accurately company transactions, and

75
 b. put into place internal accounting controls sufficient to provide
“reasonable assurances” of internal accountability and proper
accounting
2. Exemptions  §13(b)(3)
• Exempted from these requirements when act in cooperation
with certain federal officials in connection with matters concerning
national security – provide cover for clandestine operations
3. Problems under §13(b)(2)
a. Enacted under the Foreign Corrupt Practices Act in response to
“corporate Watergate  corporations making questionable
payments
b. Open ended nature made provisions very controversial and
brought fears of administrative overreaching
c. SEC said that inadvertent record keeping mistakes will not give
rise to enforcement proceedings and to be subject to enforcement
the company has to be aware or reasonably have known about the
mistakes
d. Act now reads  “reasonable assurances” and “reasonable detail”
mean such level of detail and degree of assurance as would satisfy
prudent officials in the conduct of their own affairs

G. Section 32 (Penalties)
1. Statutory language
• Any person who willfully and knowingly makes a
statement . . . [in a filed document] . . . which was false
or misleading with respect to any material fact . . . but
no person shall be subject to imprisonment under this
section for the violation if he proves that he had no
knowledge of such rule or regulation
2. Willful  did it on purpose
3. Knowing  knew there was a rule that made it illegal to do that they
did

H. Private Right of Actions under §12 and §13

1. Cramer v. General Telephone (1977)
a. Background
• Is there an implied right of action under §12 for
misrepresentation and omissions of material facts?
b. Holding
• No implied private right of action under §12, but
there is an express private right of action under §18
• There is a case that holds private right of action under
§12 when issuer does not register at all
2. In Re Penn Central Securities Litigation (1974)
a. Issue
• If there an implied private right of action under §13?
b. Holding

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 • No private right of action under §13
• P’s are avoiding §18 b/c not attractive
(1) no one succeeds in court under it
(2) purchaser/seller requirement (cannot argue would
have purchased)
(3) reliance requirement
• “eyeball reliance”  had to have actually
read report yourself rather than just relying on
information or advice
(4) loss causation
• misrepresentation cause the diminution in
value to the investor
(5) D has a good faith and no knowledge defense
• So if negligent, not liable as long as in good
faith
(6) Costs and attorneys fees can be assessed against
either party

VIII. Proxy Regulation

A. Regulatory Scheme
1. Who Covered
• Securities that are registered under §12(b),(g)
• Does not cover purely §15(d) filers
2. Proxy statements and cards
• Proxy statement  what is voted on
• Proxy card  instrument employed to vote on statement
3. Section 14 (a)
• Gives the SEC the power to pass rules
• Gives rules passed the force of law
4. Section 14(b)
a. Statutory Language
• Unlawful for securities firms, banks and other exercising
fiduciary powers to violate the SEC’s proxy rules in respect of
registered and certain other securities that are carried for the
account of a customer
b. Effect
• Makes sure beneficial owners get proxies and decide what
action to take
5. Section 14(c)
a. Language
• If management does not solicit proxies, consents or other
authorizations in connection with a meeting, the Company
still must file equivalent materials with the SEC and send
them to the shareholders to keep the shareholders informed
b. Effect
• Companies that do not need to solicit proxies must still
provide shareholders with adequate disclosure
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6. Regulation 14A
• Instructions for the preparation, filing and provision to
security holders of proxy materials
• Schedule 14A details information that must be included

7. Distribution of Proxy Statement  Rule 14a-6

a. Requirements
(1)When company is having mundane annual meeting
• Proxy statement and form of proxy must be filed
with or mailed for filing to SEC not later than the date
they are first used
(2)If not a mundane meeting
• Proxy statement and proxy card must be filed with
SEC ten days before they are used
b. If proxy statement sent by management in connection with an
annual meeting, must be preceded or accompanied by an annual
report

8. What Communications are governed by Proxy Rules  Any

Solicitation
a. Proxy Statement
b. Proxy Forms
c. Any other communications to security holders under
circumstances reasonable calculated to result in procurement,
withholding or revocation of a proxy
• Very broad definition

9. What Communications are Excluded by the Proxy Rules  Not a

Solicitation:
a. Public communications by shareholders as to how they intend to
vote and their reasons for their decision
• Allows shareholders to discuss corporate matters among
themselves
• Especially helpful for institutional investors
b. Activities that would constitute solicitations, so long as the
shareholders or other people involved:
• Are not affiliated with management
• Do not have an individual interest in the proposal to which
the solicitation relates
• Do not seek proxy authority
• Do not provide anyone proxy or other forms, such as
consents, relating to voting
c. De Minimis Exception
• A shareholder can solicit less than ten shareholders and
not be subject to proxy rules

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 10. Who is subject to proxy rules
a. Everyone who seeks proxy authority
b. Solicitation conducted by management
• If in connection with an annual meeting, proxy must be
accompanied or preceded by an annual report
• Also must follow filing requirements from above
c. Solicitations of shareholders by shareholders  Rule 14a-8
• Too expensive for the security holder to do alone unless
big institutional investor
• Rule 14a-8
• Requires management to include in its proxy
statement proposals made by security holders, along
with supporting statements (up to 500 words) when
certain conditions are met
• Requirements for shareholder  timeliness, amount
of securities held, subject of proposal (can’t violate
law, can’t be about ordinary business operations of the
issuer, can’t relate to an election of an office)
• If management wants to exclude, it must make a
filing with SEC stating its reasons for not including it
(no-action letter)

B. False or Misleading Statements

1. Statutory Language  Rule 14a-9
• No solicitation . . . shall be made by means of any proxy
statement . . . that is false or misleading with respect to any
material fact, or which omits to state any material fact.
• §14 gives the SEC power to make rules dealing with proxies and
gives those rules the power of law (but the statute itself does not
prohibit fraud)

2. Potential Problems
a. Criminal Liability  §32
(1) Statutory Language
• Any person who willfully violates any provision of this title
or any rule or regulation thereunder . . . or any person who
willfully and knowingly makes any statement in any
application or document required to be filed . . . which
statement was false or misleading with respect to any
material fact . . . can get prison or fine
• But no person shall be subject to imprisonment for the
violation of any rule or regulation if he proves that he had no
knowledge of such rule or regulation
(2) Standard of Fault
• Misrepresentations in filings  willful and knowing

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 • Knowing  must know of statute or rule accused of
violating
• All other sections  only have to show willful
• No imprisonment if can show lack of knowledge
b. SEC enforcement
c. Express Private Rights of action under §18 for filed documents
d. Implied Private rights of action
• Available for solicited shareholders
• Usually not available for proxy contestants
• All others  apply Cort

3. Proper Plaintiff
a. Shareholder whose vote was solicited
• Will be a proper plaintiff (Borak)
• Mean to be protected by statute and rule
b. Possible Competitor (3rd party) claiming merging cos. Are being
misleading
• Not a proper plaintiff
• “When a plaintiff’s claim arises from its role as a proxy
contestant, it does not have standing to sue” (Royal Business
Group)
c. Other potential plaintiffs
• Probably none  must determine if they were the
intended beneficiary of statute

4. General Issues
a. P must prove
• Proper P
• Proper D
• Material misrepresentation
• Causation (essential link doctrine)
• Degree of fault (varies depending on circuit)
• Loss causation
b. Defenses Available
• Rebut P’s case
• Safe harbor for forward looking statements §21E
• Bespeaks caution
c. Damages
• Limitations - §21D(e)
• Proportionate Liability - §21D(f)
• P must prove them

5. Proper Defendant
a. Anyone who does the bad act
• “one who send a proxy solicitation that contains a
material misrepresentation or omission of a material fact”

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 b. Anyone engaging in solicitation subject to §14(a) rule, but
remember some are exempted
c. If they do no solicit, did not do Bad Act, and not a proper D

6. The Bad Act  Material Misrepresentation or Omission

a. General Background
• Statement must be material
• There is an explicit duty to correct statements which may
become misleading
b. Definition of Materiality (TSC Industries)
• Material  substantial likelihood that a reasonable
shareholder would consider it important in deciding how
to vote
• Showing that fact would have assumed actual
significance in the deliberations of the reasonable
shareholder, not that it would have changed their vote
• Fact significantly altered the total mix of
information available
• Rationale for Standard  purpose of the rule is to ensure
disclosures by corporate manage in order to enable
shareholders to make an informed choice
c. Statements of Belief (Virginia Bankshares)
• Opinions of directors are material where they
suggest something about the underlying subject matter
• “we do not substantially narrow the cause of action
by requiring a plaintiff to demonstrate something false
or misleading in what the statement expressly or
impliedly declared about its subject”
• If they do not mislead as to underlying subject matter 
not actionable
• Disbelief or undisclosed motivation standing alone is
insufficient to satisfy the element of fact that must be
established under §14(a)
• A misstatement of opinion is hardd to prove

d. Additional Considerations
• Bespeaks Caution Doctrine Applies
• Can render statement immaterial if in document
with sufficient cautionary language
• Safe Harbor §21E
• Forward looking proxy statements in proxy
materials are covered by this if follow requirements
and not excluded

7. Causation Required (Mills v. Electric Auto-Lite)

a. Establishing Causation

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 • Where there has been a finding of materiality a
shareholder has made a sufficient showing of causal
relationship between the violation and the injury for which he
seeks to redress if he proves that the proxy solicitation
itself, rather than the particular defect in the
solicitation materials, was an essential link in the
accomplishment of the transaction
b. Rationale for Standard
• If D could defend by showing the merger was fair, a
judicial appraisal for the merger’s merits could be substituted
for the actual and informed vote of the stockholders
• This test will avoid the impracticalities of determining of
how may votes were affected
• P does not have to show reliance
c. Causation When Management Has Enough Shares Without
Shareholders (Cole)
• Issue  Whether causation could be shown where the
management controls a sufficient number of shares to approve
the transaction without any votes from the minority
• Holding
• Solicitation of proxies was not required by any law
(ASK ABOUT THIS AND DISTINCTIN W/VA)
• Plaintiffs had three options  seek appraisal rights,
threaten to seek them to force D to improve its offer,
seek to enjoin the merger
• “in view of these three alternatives to
accepting the offer, proxy solicitation was an
essential link”
• By lulling shareholders into thinking this was a good
merger, D avoided have to deal with shareholders
exercising one of those options
• These alternatives are not available for all P’s in this
situation
d. Causation When Management Has Enough Shares (Virginia
Bankshares)
(1) Issue
• Whether causation can be demonstrated by a member of
a class of minority shareholders whose votes are not
required by law or corporate bylaw to authorize the
transaction giving rise to the claim
(2) Holding
• P argues link existed and was essential b/c vote need for
public relations and good will
• Court rejects  majority had enough votes to push
merger through (this was not an essential reason to
solicit proxies)

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 • Theory would expand the class of plaintiffs who can
bring suit (Congress did not intend this)
• Under Blue Chips, did not want to turn statute into
questions of hypothetical causes of action  issues
would be hazy, reliable evidence would seldom exist
• P argues shareholder vote resulted in loss of self dealing
cause of action
• Court does not decide question b/c no indication
that proxy solicitation resulted in any such loss
• If information not adequately disclosed favorable
minority vote induced by the solicitation would not
suffice to render the merger invulnerable to later
attack on the ground of conflict (must have informed
voting to protect merger from later attack)
(3) Remains of Cole
• Cole not overridden b/c there vote was required by law
(not sure)
• Here not bylaw or law required the vote of shareholders
and proxy solicitation involved
• Gabaldon speculates that if Cole had to deal with loss of
state right, Supreme Court would not endorse state
right?????

e. Type of Causation Involved in These Cases  Transaction

Causation
• If show statement material and an essential link, do
not have to show reliance on the misstatements

8. Loss Causation (not much case law b/c cases come up at injunction
stage)
a. Typically required under Rule 14a-9
b. What is it?
• Forms the link between the wrong complained of
and the fact that the plaintiff has been damaged by
the wrong
• Plaintiff must show that he suffered a loss because of the
proxy solicitation
c. §21D(b)(4)
• “In any private action arising under the Exchange
Act the plaintiff shall have the burden of proving that
the act or omission of the defendant alleged to
violate the Act caused the loss for which the plaintiff
seeks to recover”

9. Limitations on Damages  §21D(e)

a. Applies To:

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 • Private actions where the plaintiff seeks to establish
damages by reference to the market price of a security
b. Limit
• Damages cannot exceed the difference between
the plaintiff’s purchase or sale price and the mean
trading price
• Mean Trading Price  price during the 90 day period
beginning on the day on which the information correcting the
misstatement or omission that is the basis for the action is
disseminated to the market

C. Degree of Fault Required

1. General Background
• Never decided by the Supreme Court
• Courts have gone both ways  some say negligence is
enough while others require scienter (strict liability has not
been decided
• Rule is very plaintiff friendly  people who do this should
be liable, but Gabaldon says if apply strict Cort factors may
come out a different way
• Courts are inclined to be more permissive with outsiders
(directors and accountants) then with insiders (issuer and
directors)
2. Two Possible Degrees of Fault
• Negligence  P is not required to establish any evil
motive or reckless disregard of the facts by D (very broad
standard of fault)
• Scienter  P must show a knowing misrepresentation of
reckless disregard of the truth (very hard standard of fault to
prove)
3. Gerstle v. Gamble Skogmo (Negligence is sufficient)
(1) Background
• Minority shareholders are bringing suit
• Proxy sent to them contained an inadequate disclosure of
profits from sale of advertising plants and plans to sell the
plants
(2) Holding
• Where the plaintiffs represent the very class who were
asked to approve a merger on the basis of a misleading
proxy statement and are seeking compensation from the
beneficiary who is responsible for the preparation of the
statement, they are not required to establish any evil motive
or even reckless disregard of the facts  negligence
sufficient
• Rationale 
• Rule 14a-9 is distinguishable from Rule 10b-5

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 • 10b-5 requires scienter but legislative mandate is to
regulate manipulative and deceptive devices
• here more concerned with protection of outsider
whose proxy is being solicited (consistent with
legislative scheme)
• Rule 10b-5 tries to encourage companies to release
information  if can be liable on lower negligence
standard may not do it
• Here, the disclosures are mandatory
• Under tort liability, negligence is sufficient for
person who supplies false information to another with
intent to influence transaction
• Court did not have to decide if strict liability should be
imposed
• Here the D was at least negligent so court does not
have to decide if liable without any culpability

4. Adams v. Standard Knitting Mills (Must show scienter)

(1) Background
• Outside accounting firm made a negligent error in failing
to point out in proxy statement sent to shareholders that
restrictions on dividends applied to preferred as well as
common stock
(2) Holding
• Standard is scienter  have to know of misstatement was
false/misleading or have a reckless indifference to the truth
• Rationale for higher standard
• Accountant will not benefit form the
misrepresentation (lack of motive)
• Accountants prepare financial statements daily and
the potential liability for relatively minor mistakes
would be huge under a negligence standard

D. Damages
1. P can get damages or an injunction
• P typically seeks an injunction  courts often inquire into
the fairness of a completed transaction on which
shareholders voted and impose damages the effectively
reformulate the terms of the transaction
• When seeking damages  P must prove damages  have
to show both transaction and loss causation (discussed
above)
2. §21D(g)  Private Actions Under the Exchange Act
• D generally is liable solely for the portion of a
judgment that corresponds to the percentage of
responsibility of that D, as determined under §21D

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 • D is liable for damages jointly and severally only when the
trier of fact specifically determines that the D knowingly
committed a violation of the securities laws (can only be
liable for everything if knew committing violation)
• D has a right of contribution based on proportionate
liability

IX. Tender Offer Regulation

A. Context  Two Types of Tender Offers
1. Stock Tender Offers
• Acquiring company offers its securities in exchange for shares
in the target
• Williams Act applies
• Always been subject to registration requirements of ’33 Act b/c
offering stock
• Do not have to worry about Rule 145 (only applies to collective
decision making)
2. Cash Tender Offers
• Target’s shareholders are offered cash in exchange for their
shares
• Williams Act applies
• ’33 Act does not apply b/c not offering stock
• Rule 145 of ’33 Act does not apply

B. Williams Act
1. Purpose of Act
• Intended to level the playing field for the target and the
acquirer
• Prevent shareholders from giving up their shares without
adequate disclosure
2. Section 13(d)
a. Requirement
• A person who owns beneficially more than five percent
of a class of equity security registered under the
Exchange Act to provide certain information to the
issuer, SEC, and each exchange on which the security is
traded within 10 days after the acquisition of securities
that trigger reporting requirement
b. Scope
• Not limited to tender offers  anyone who gets 5% must
file
• Only applies to equity securities, not debt
c. Reporting Requirements
• §13(d) contains a list of what must be disclosed
• But SEC has added to the list

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 • Regulation 13D-G details the disclosure
requirements
• Schedule 13D
• Duty to file amendments
• Must file upon the occurrence of material changes
in the disclosed information
• Information that must be disclosed 
• Designed to give mgt. basic information concerning
potential tender offerors
• Number of shares beneficially owned
• Source of funds used to purchase the shares
• If purpose of the purchase of shares is to acquire
control
• Any plans to liquidate the issuer, to sell its assets,
to engage in a merger, or to effect any other major
change in its structure

3. Section 13(e)
• SEC has power to regulate repurchases by issuers of their
own equity securities

4. Section 14(d)
a. Statutory Language
• It is unlawful for any person to make a tender offer for
and Exchange Act registered equity security if success in
the offer would result in ownership of more than five
percent of the class unless certain filings are made
b. Timing of Disclosure
• Main disclosure document must be filed with the SEC not
later than the time the tender offer is announced
• All other documents must be filed by the time they are
first used
• Copies of all filings must be sent to the issuer not later
than the time they are first published or sent to shareholders
c. Substantive Regulation  regulate terms of TO by disclosure
(1) Withdrawal Right
• Rule 14d-7  securities deposited in response to a tender
offer can be withdrawn at any time during the entire period
of the TO
• Easy rescission for security holders who change
their minds
• Protection against having securities tied up
indefinitely while a tender offeror waits to receive
desired number of shares

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 • Actual statute only provides for withdrawal within seven
days after original tender offer, and after sixty days have
elapsed following this date
(2) Pro Rata Purchasing
• Rule 14d-8  when a tender offer is for less than all the
securities of a class, a tender offeror must purchase
tendered securities pro rata according to the number of
securities tendered at any time during the period of the
tender offer
• Helps avoid pressure security holders may feel to
tender quickly and without adequate thought
• Protects small holders from being ignored
• Actual statute only requires pro rata purchasing from
those tendering during the first ten days the offer is open
(3) Best Price Rule
• When a tender offeror increases the tender offer price
after some holders have tendered, statute requires that all
tendering security holders must be paid the higher price

5. Section 14(e)  Anti-Fraud Provision

a. Statutory Language
• “It shall be unlawful for any person to make any untrue
statement of material fact or omit to state any
material fact . . . or to engage in any fraudulent, deceptive,
or manipulative acts or practices in connection with any
tender offer . . . .”
• “The SEC shall for purposes of this subsection, by rules
and regulations define, and prescribe means reasonably
designed to prevent, such acts and practices as are
fraudulent, deceptive or manipulative”
• This is how SEC had power to pass substantive
regulations above (withdrawal, pro rata and best price)
b. Application
• Applies to tender offers for any security (not just
registered equity securities)
6. Section 14(f)
a. Disclosures required when:
• Majority of directors are to be filled, otherwise
than at a meeting of security holders, following an
acquisition of securities that is subject to the
requirements of §13(d) or §14(d)
• Disclose to SEC and security holders
b. Trigger
• Filling of vacant directorships by sitting directors
• After an acquisition subject to regulation under Williams
Act

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C. What is a Tender Offer
1. Not defined by statute or SEC regulation or rule
• SEC wants to maintain flexibility
• Courts have own formulations  factors used overlap and
may not matter which approach you apply
2. Wellman v. Dickinson (S.D.N.Y. 1979)
a. Eight Factors suggested by SEC as characteristic of a Tender Offer
(1) active and widespread solicitation of public shareholders for
the shares of an issuer
(2) solicitation made for a substantial percentage of the issuer’s
stock
(3) offer to purchase made at a premium over the prevailing
market price
(4) terms of the offer are firm rather than negotiable
(5) offer contingent on the tender of a fixed number of share,
often subject ot a fixed maximum number to be purchased
(6) offer open only a limited period of time
(7) offeree subject to pressure to sell his stock
(8) public announcements of a purchasing program concerning
the target company precede or accompany rapid
accumulation of large amounts of the target company’s
securities

b. SEC v. Carter Hawley Hale Stores (9th Cir. 1985)

• All eight of the Wellman factors do not have to be present
in a particular situation before it is recognized as a tender
offer
• Rather, the provide some guidance as to the traditional
indicia of a tender offer

3. S-G Securities v. Fuqua Investment (D. Mass. 1978)

a. Tender offer exists when there is:
(1)a publicly announced intention by the purchaser to acquire a
substantial block of stock of the target company for purposes
of acquiring control thereof, AND
(2)a subsequent rapid acquisition by the purchaser of large
blocks of stock through open market and privately
negotiated purchases
b. Limitations on Test
• Only relates to specialized situations that do not fit the
mold of classic tender offers
c. Rejected by Ninth Circuit
• Test is vague and difficult to apply
• Offers little guidance to the issuer as to when his conduct
will come within the ambit of a SEC rule

4. Hanson Trust PLC v. SCM Corp. (2nd Cir. 1985)

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 a. Background
• Cash tender offer by HT – counter proposal by SCM – HT
then increased price – SCM increased price and added a crown
jewel
• HT then terminated tender offer and made private
purchases
b. Holding  Not a tender offer
(1) Rejected Wellman 8 factor test
• Although many of the factors are relevant, court does not
want to have a mandatory litmus test
• Court said that a solicitation may constitute a tender offer
even though some of the 8 factors are missing OR may not
be a TO even though many of the factors are present
(2) Test  Look to statutory purpose
• Tender Offer If  viewing the transaction in light of the
totality of circumstances, there appears to be a likelihood
that unless the pre-acquisition filing strictures of that
statute are followed there will be a substantial risk
that solicitees will lack information needed to make a
carefully considered appraisal of the proposal put
before them
• Looks at whether the purpose of the TO regulations would
be furthered if applied  would the offerees lack information
needed to make a careful appraisal of the proposal without
the pre-acquisition filings
(3) Application of Test  Not a tender offer
• Few number of sellers
• All buyers were sophisticated
• No pressure to sell except by forces of the market place
• No widespread advance publicity
• Not at a substantial premium
• Offers not made contingent on getting certain number of
shares
• No time limit within which he would only make the
purchases

D. Section 13(d)  Who May Bring Suit

1. SEC
a. Section 21
• Can bring an enforcement action in a district court
seeking an injunction
b. Section 21C
• Can issue a cease and desist order
2. Justice Department
• Can seek a criminal indictment when it believes
willfulness was involved in a breach

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 3. Private Plaintiff
a. Context
• Major issue is whether an issuer can sue a shareholder
who have violated disclosure requirements by failing to file
Schedule 13D or filed a defective one
b. Indiana National Corp. v. Rich (7th Cir. 1983)
(1) Issue
• Whether there is an implied private right of action for an
issuer corporation to seek injunctive relief under §13(d)
of ’34 Act
(2) Holding  implied right of action exists
• Cort Factors Analysis
• Congressional intent is particularly important
• When Congress does a significant amendment and
leaves intact provision where federal courts have
implied a private cause of action, evidence was that
Congress had affirmatively intended to preserve that
remedy
• Application  Congress intended a private right
•
• Statute on which this was modeled had a private
right of action
• Act has been amended twice and Congress did not
overturn precedent holding a private right of action
• SC had assumed one was available to issuer
corporations
• Only holding that can make disclosure requirements
effective  filing is only sent to SEC and issuer
c. Other Holdings
(1) Some district courts and one circuit court say no private right
(2) Liberty National Insurance v. Charter (11th Cir.)
• Plaintiff sought divestiture of its shares that were
owned by D
• Held Congress did not intend a private right of action
• 1st amendment to statute too soon after passage to
affirm precedent
• 2nd amendment did not permit an unambiguous
inference of legislative intent to preserve a judicially
recognized issuer right of action
(3) Florida Commercial Banks v. Culverhouse (11th Cir. 1985)
• Held a target company does have standing to sue
when seeking corrective disclosure rather than divestiture

E. Proper D under §13(d)

1. Anyone who violates §13(d)
2. The acquiring person or group who own more than 5% and don’t file
or make defective filings

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F. Substantive Section 13(d) Issues
1. Group Acquiring More Than 5%  GAF Corp. v. Milstein
a. Background
• The Milsteins’s owned more than 5% of GAF’s preferred
stock and some time after the effective date of the Williams Act
they agreed to act as a syndicate to seize control of GAF
• Filed a Schedule 13D and each time denied an intention
to accumulate additional shares but continued to acquire GAF’s
common stock
b. Holding
• Section 13(d)(3)  when two or more persons act
as a partnership or other group for the purpose of
acquiring, holding, or disposing or securities of an
issuer, such syndicate or group shall be deemed a
“person” for the purposes of §13(d)
• The Milsteins separately held more than 5% but the only
question is whether the syndicate acquired those shares after
the effective date of the Williams Act
• Voting control of stock is the only relevant element
of beneficial ownership
• The syndicate gained beneficial control of the stock
after its formation which was after the effective date of
the Act
• Individuals acquired stock before effective date of
Act  then groups formed representing more than 5%
of stock with an eye towards control after the effective
date  this constitutes acquiring stocks under §13(d)
• House and Senate reports support this  group is
deemed to have become the beneficial owners of more
than 5% at the time they agreed to work together
• Should have filed a Schedule 13D within 10 days of
forming the syndicate and “acquiring” the shares

c. Broad Reading of Statute

• If a group collectively owns more than 5% of stock and
talk about the future, the are a group
• Mere conversations are not enough
• Beyond that to forming a plan will place you under §13(d)
• If form group with not enough shares, do not have to file

2. Irreparable Harm  Rondeau v. Mosinee Paper Corp.

a. Background
• D bought more than 5% of stock and did not file 13D
because was unaware of requirement

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 • After getting a letter from company, consulted an
attorney and immediately filed one
• His bought stock b/c though it was a good investment and
may gain control and change management
b. Issue
• Whether a showing of irreparable harm is necessary for a
private litigant to obtain injunctive relief in a suit under §13(d).
c. Holding
• Court does not address issue of standing, but a target
almost always has standing (but may be dependent on remedy
sought)
• In order to get an injunction under §13(d) a
plaintiff must prove irreparable harm
• While issuer will have standing not every little
violation will give rise to an injunction
• Injunctive relief is a remedy based on having irreparable
harm and inadequacy of legal remedies
• An action for damages is better, but if damages not
adequate equity will try to make you whole
• Danger of recurrence?
• Not likely that he will do it again
• Persons who allegedly sold at an unfairly
depressed price have an adequate remedy by way of
action for damages, thus negating the basis for
equitable relief
• No irreparable harm found
• Has enough shares, but has not launched an assault
or any tender offer in the works

d. Scope of Holding
• Not necessarily binding under §14(e)  equitable
considerations may be different and have different purposes for
the statute

G. Section 14(e)  Who may sue? Proper P?

1. Generally
• Shareholders can sue
• Target corporations can sue tender offerors when they
seek an injunction
• Potential acquirer in suit for damages in NOT a proper P
• For all others  argue by analogy
2. Application
• §14(e) applies to tender offers for any security  not just
registered equity securities
3. Piper v. Chris-Craft Industries (SC 1977)
a. Issue

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 • Is an unsuccessful tender offeror a proper P to sue the
target company or a competing offeror for damages? No
b. Holding
(1)Tender offeror suing in its capacity as a takeover bidder
does not have standing to sue for damages under §14(e)
(2) Rationale
• Purpose of the Williams Act is to insure that public
shareholders who are confronted by a cash tender offer for
their stock will not be required to respond without adequate
information
• Nothing in legislative history suggests Congress
contemplated a private cause of action for damages by one
of several contending offerors against a successful bidder
• Application of Cort Factors
• Act was passed for benefit of shareholders
• Inconsistent with legislative scheme to allow
unsuccessful bidder to get damages
• No legislative intent
• State cause of action present
• Even though SEC has practical constraints recognized in
other cases, institutional limitations alone do not lead to the
conclusion that any interested party in a tender offer should
have a cause of action for damages against a competing
bidder

4. Liberty National Insurance v. Charter (11th Cir. 1984)

• Held target does not have right to bring an
injunction under §14(e)
• Analyzes Cort, but slips lightly over question of legislative
intent
• Limited precedential value
5. Florida Commercial Banks v. Culverhouse (11th Cir. 1985)
• Target company has standing to sue under §14(e)
when seeking corrective disclosures rather than
divestiture of stock in the plaintiff owned by the defendant
6. Electronic Specialty v. International Controls Corp. (2nd Cir. 1969)
• Target corporation can sue tender offerors when they
seek an injunction
• Shareholders of the target also have the right to sue
tender offerors when they seek an injunciton
• Williams Act was intended to protect shareholders
confronted with a tender offer
• Clearly they have standing

7. Lewis v. McGraw (2nd Cir. 1980)

a. Issue

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 • Whether shareholders may maintain a cause of action for
damaged under the Williams Act where they concede that no
tender offer has been made to them.
b. Holding  No Implied Right of Action
• P’s concede that no tender offer took place and no
shareholder was in a position to tender his shares at the stated
price
• Statements must be made “in connection with a
tender offer” as required by §14(e)
• Purpose of §14(e)
• Protect investors
• Ensure won’t be required to respond without
adequate information
• One element of a cause of action is a showing that there
was a misrepresentation upon which the target corporation’s
shareholders relied
• There cannot be any reliance here b/c no
opportunity to tender shares
• Shareholders have no cause of action b/c they could
not have relied on the statements made because they
were not made “in connection with a tender offer”
• No reliance was even possible so to presume
reliance (as do in other sections of the Act) would be
illogical
• Scope of Holding
• Statements made on eve of tender offer by target
or offeror may be covered
• If offer becomes effective and reliance
demonstrated or presumed, such statements may be
made “in connection with a tender offer” as required
by §14(e)

H. Conduct Proscribed by Section 14(e)

1. Statutory Language
• “It shall be unlawful for any person to make any untrue
statement of a material fact or omit to state any fact . . .
or to engage in any fraudulent, deceptive or
manipulative acts in connection with a tender offer”
• “The SEC shall by rules and regulations define and
prescribe means reasonably designed to prevent, such acts
and practices as are fraudulent, deceptive, or manipulative”
2. Early Case Law
• Sixth Circuit had found that a defendant could be held
liable for conduct that was manipulative even when the
conduct did not contain an element of misstatement or
nondisclosure

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 • Second, Third, and Eighth Circuits had issued opinions
with the opposite conclusions
3. Schreiber v. Burlington Inc. (1985)
a. Background
• P reads the phrase “fraudulent, deceptive, or
manipulative acts or practices” to include acts which, although
fully disclosed, artificially affect the price of the takeover
target’s stock
• P believes can have a violation of §14(e) without any
allegation of nondisclosure (i.e. no untrue statement or
omission)
• D made one tender offer and then withdrew
• Substituted with new tender offer at same price but
reduced number of shares and a golden parachute
• P claims this was manipulative b/c stirred up interest
through first tender offer and then withdrew

b. Holding
• “manipulative” acts under §14(e) require
misrepresentation or nondisclosure
• Manipulative connotes “conduct designed to
deceive or defraud investors by controlling or
artificially affecting the price of securities”
• Without misrepresentation of nondisclosure, §14(e)
has not been violated
• Congress relied primarily on disclosure to
implement the purpose of the Williams Act
• Court is not interested in fairness and substance 
this is a disclosure statute
• Must have a disclosure related effect
• Nowhere in the legislative history is there the
slightest suggestion that this serves any purpose other
than disclosure
• Lack of disclosure in 2nd tender offer regarding golden
parachute
• The nondisclosure must have a causal relationship
to plaintiff’s alleged injuries
• Plaintiff is complaining that she was injured by first
tender offer, and the nondisclosure took place during
the second tender offer
• Just because a technical violation may not lead to
recovery
• Must have misrepresentation/nondisclosure and just
because there is a violation does not mean you have a private
right  need cause and suing for the right remedy

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 I. Rule 14e-3
1. Rule’s Language
• “it shall constitute a fraudulent, deceptive, or
manipulative act or practice within the meaning of §14(e) for
any person who is in possession of material information
relating to such tender offer which information he knows or
has reason to know is non-public and which his knows or has
reason to know has been acquired directly or indirectly form
certain people . . . to purchase or sell or cause to be
purchased or sold any of such securities”
• also illegal for insiders to tip others with material
information about tender offers
2. How Violated
• Can be violated without the existence of a related
violation of a fiduciary or other such duty, as is required in a
Rule 10b-5 case
3. SEC’s Power to Enact  US v. O’Hagan
a. Background
• Straightforward misappropriation of information case
involving a lawyer who worked for a law firm that
represented a bidder
b. Holding
• Under §14(e), SEC may prohibit acts, not themselves
fraudulent under the common law or §10(b), if the prohibition
is reasonably designed to prevent acts and practices that are
fraudulent
• As applied to this type of case, this qualifies under §14(e)
as a means reasonably designed to prevent fraudulent
trading on material, nonpublic information in the tender offer
context

X. Fraud in the Purchase or Sale of Securities  §10(b) and Rule 10b-5

A. Overview
1. Rule 10b-5
a. Language
• It shall be unlawful for any person, directly or indirectly to

(a) to employ any device, scheme, or artifice to defraud
(b)to make any untrue statement of a material fact or to
omit to state a material fact necessary to make that
which was said not misleading
(c) to engage in any act, practice, or course of business
which operates to would operate as a fraud or deceit upon
any person in connection with the purchase or sale of any
security
b. Origin

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 • Drafted by combining numbered subdivision of Securities
Act §17(a) together with Exchange Act §10(b)

c. Why Needed?
• Section 10(b) only makes it unlawful to use any
manipulative or deceptive device in contravention of such rules
and regulations as the SEC may prescribe as necessary or
appropriate
• Statute does not make any acts unlawful, it just allows the
SEC to make rules that, if violated, will be unlawful

d. Classifications of Violations
(1) Misleading Statement (including statements which require a
speaker to say more to make it not misleading)
• Rule 10b-5(b)
(2) Insider Trading Including Tippers and Tipees
• Rule 10b-5(a) & (c)
(3) Market and Other Manipulation
• Rule 10b-5(a) & (c)
• Usually done by market professionals

e. Organization of Cases
Misleading Insider Trading
Basic Definition • Texas Gulf Sulfur • Cady
• Superintendent of • Texas Gulf Sulfur
Insurance • Chiarella
• Brown v. Ivie
• Ernst/Aaron
Private Plaintiff • Basic (in market • Affiliate Ute (face to
trans.) face)
• Blue Chips • Shapiro (presume
reliance in open
market)

2. In Re Cady Roberts & Co. (1961)

a. Issue
• What are the duties of a broker after receiving non-public
information as to a company’s dividend policy from a
director who is employed by the same brokerage firm?
b. Holding (Insider Trading  Tipper/Tipee)
(1) Obligation
• An insider with non-public material
information has (a) a duty to disclose the
information or (b) refrain from trading
(2) Who is under this obligation?

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 • Traditional corporate insiders  officers,
directors, controlling stockholders
• “Any person” who (a) has access, directly or
indirectly, to information intended to be available only
for a corporate purpose and not for the personal
benefit of anyone, and (b) the inherent unfairness
involved where a party takes advantage of such
information knowing it is unavailable to those with
whom he is dealing
(3) Rationale for Rule
• Purpose of the law is to give equal access to info
• Violates notion of equal access and unfair if have
intended for corporate affairs to be used to gain an
advantage in the market
• This is why trading on insider information is fraud or
deceit

3. SEC v. Texas Gulf Sulphur Co. (1968)

a. Background
• D was mining for minerals and found stuff it knew was
good but downplayed importance of finding
• D did not want to increase the stock price and wanted to
figure out other land to buy (but court is interested in what they
were doing not motivation for doing it)
• Concern is not over silence but rather the downplaying of
the importance of the discovery (misleading)
b. Holding
(1) Introduction
• Rule 10b-5 is based in policy on the justifiable expectation
of the securities marketplace that all investors trading on
impersonal exchanges have relatively equal access to
material information
• Essence of Rule is that anyone who, trading for his own
account in the securities of a corporation has access, directly
or indirectly, to information intended to be available only for
a corporate purpose and not for the personal benefit of
anyone may not take advantage of such information
knowing it is unavailable to those with whom he is dealing
• People who come up with own theories on company can
trade on that information if developed for own purpose
(2)Material Inside Information
• Whether facts are material within Rule 10b-5 when the
facts relate to a particular even and are undisclosed by those
persons who are knowledgeable thereof will depend at
any given time upon a balancing of both the indicated
probability that the event will occur and the

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 anticipated magnitude of the event in light of the
totality of company activity
• Take both into account  so if don’t know if
something will happen will not always have to disclose
(3)When May Insiders Act?
• Before insiders may act upon material information,
such information must have been effectively
disclosed in a manner sufficient to insure its
availability to the investing public
• Must have effective dissemination
• Mere pres reliease does not mean have this
• Where a formal announcement to the entire financial
news media had been promised in a prior official release
known to the media, all insider activity must await
dissemination of the promised official announcement
(4) May Insiders Accept Stock Options Without Disclosing Material
Information to the Issuer?
• Because top managers were under a duty before
accepting stock options to disclose any material information
to the Board issuing the options
• Lower tier insiders assumed superiors had told board 
issue of their liability undecided (may or may not have to
disclose
• Rationale  Board did not have material information that
insiders had when issued options and therefore the insiders
were trading at information disadvantage
(5)In Connection With Requirement
• Argument  D relies on holding below that release
produced no unusual market action and in absence of intent
to affect the market it was not issued in connection with the
purchase or sale of any security
• General Rule  speaker of misrepresentation does
not have to purchase of sell  just reasonably
expected that it will be relied upon by a reasonable
investor to be “in connection with the purchase or
sale of a security”
• Phrase “in connection with the purchase or sale of any
security” intended only that the device employed be of a
sort that would cause reasonable investors to rely thereon
and in so relying cause them to purchase or sell a
corporation’s securities.
• Corporations or persons responsible for the issuance of
the misleading statement does not have to engage in related
securities transactions to violate the law
• Duty to Avoid Misleading Statements  applies to any
person whose statement may be relied upon by a reasonable

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 investor (person making the statement does not have to buy
and sell in connection with …)
• Do not have to be buying or selling a security to be
liable if a reasonable investor would rely on what you
said

B. “In Connection With” Requirement

1. Generally
• To be subject to Rule 10b-5, the conduct prohibited by the
rule must be “in connection with the purchase or sale of a
security”
2. Superintendent of Insurance v. Bankers Life & Casualty Co. (1971)
a. Type of Case
• Element of the bad act (not private P)
• Misleading case (not insider trading)
b. Background
• Insurance company sold the stock of one of its
subsidiaries to D
• Through a series of transactions D raised funds to pay for
the stock by causing the corporation they purchased to sell
bonds it owned and by misappropriating the proceeds from
the sale of the bonds
• The board of directors thought is was replacing Treasury
bonds with CD’s and still had that money
c. Holding
(1) Section 10(b) outlaws the use “in connection with the
purchase or sale” of any security of “any manipulative or
deceptive device or contrivance”
(2) Company was injured as an investor thought a deceptive
device which deprived it of any compensation for the sale of
it valuable block of securities.
(3) Congress by §10(b) did not seek to regulate transactions
which constitute no more than internal corporate
mismanagement
(4) Company suffered an injury as a result of deceptive
practices touching its sale of securities as an investor
(5) Touch Test  deceptive practices touched sale of
security, not necessarily caused sale of security

3. Brown v. Ivie (5th Cir. 1981)

a. Background
• Brown, Ivie and Lightsey were the only three shareholders
in a close corporation
• In ’76 entered into a buy-sell agreement that required
shareholders to sell stock back at book value
• This agreement was unenforceable

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 • Ivie and Lightsey wanted to get rid of Brown so they had
him sign another agreement telling him that it was necessary to
effectuate a change in insurance companies
• Seven days later they fired Brown
b. Rules
• A necessary element of Rule10b-5 offense is that the
fraud or deceit be in connection with the sale of a security
• Concept is flexibly applied but requires that there be a
nexus between the fraud and the securities sale
• Plaintiff need not establish a direct or close relationship
between the fraudulent transaction and the purchase or sale,
but only that the transaction involving the sale touch the
transaction involving the defendant’s fraud
c. Ketchum v. Green (3rd Cir. 1977)
(1) Background
• P alleged ousted from corporation due to D’s
misrepresentations
• P had to sell his stock back at less than fair value due to
stock retirement agreement
(2) Holding
• “In Connection With” requirement is not met  fraud too
remote to the sale of the security
• D did not as an integral part of their scheme induce P to
enter into the agreement
• Objective of D’s fraud was to expel P from corporation in
order to gain control  resulting sale of security was an
indirect consequence of P’s expulsion
• Agreement had been in place over seven years prior to
the alleged fraud
d. Holding
• “In Connection With” requirement was met more direct
causal connection between fraud and sale of security
• D’s could oust P at any time  but had to lie to him to get
him to sign the agreement to sell his stock back at
termination of employment
• D’s fraud caused P to sign agreement saying he would sell
stock back at termination  terminated seven days later 
sale of stock required due to agreement that was
fraudulently obtained

4. “In Connection With” and Corporate Mismanagement  Santa

Fe v. Green (1977)
a. Background
• Santa Fe controlled 95% of Kirby’s stock

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 • Wanted to merge with Kirby doing a short form merger
requiring vote of parent’s board and payment to minority
shareholders
• Minority stockholders do not have to approve but have
appraisal rights (did not exercise these rights)
• Appraisal by Santa Fe priced the stock at $125/share and
minority shareholders were given $150/share  minority says
worth $772/share and offering price was misleading
b. Holding  No Violation
• In order to have a violation of Rule 10b-5 must be
an allegation of fraud, deceit of manipulation that is
meant to mislead investors
• Manipulation is a term of art when used in
connection with securities markets  refers to
practices that are intended to mislead investors by
artificially affecting market activity
• §10(b) did not seek to regulate transactions which
constitute not more than internal corporate
mismanagement
• shareholders only alleged that they were treated unfairly
 not that they were mislead
• had all the relevant information
• also element of causation  misrepresentation did not
cause alleged injury b/c did not seek appraisal rights

C. Fault Required
1. Ernst & Ernst v. Hochfelder (1976)
a. Background
• Accounting firm prepared annual reports of First
Securities
• P invested with FS and their money directly transferred to
president of firm rather than to escrow accounts as he had
promised
b. Holding (private P case)
(1)Scienter is required to be liable under §10(b) and Rule
10b-5
• Mere negligence is insufficient
• Must show intentional conduct or lower courts also
say recklessness
• Applies to all sections of Rule 10b-5 even though it
seems some can be violated with negligence  must
be read in light of §10(b) and not §17 of ’33 Act
(2) Rationale
• Words “manipulative or deceptive” used in
conjunction with “device or contrivance” strongly

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 suggest that section was intended to proscribe
knowing or intentional misconduct
2. Aaron v. SEC (1980)
a. Is scienter required to be proved in an enforcement action
by the SEC?
• Yes
b. Is recklessness sufficient by itself to constitute scienter?
• Most courts have found that recklessness constitutes
scienter, but the story is a changing one
3. Possible Complication for Private Plaintiff  Section 21D
a. Statutory Language
• Congress changed the pleading requirements for private
P’s and it is unclear whether they meant to change the
degree of fault required
• “private P must state with particularity facts giving rise to
a strong inference that the defendant acted with the
required state of mind”
b. Court Interpretation
• Most courts say that just changing the pleading
requirement
• But perhaps Congress was trying to reject 2nd Circuits
reckless standard

D. Persons Subject to Trading Constraints

1. Chiarella v. US (1980)  Tipee Duty
a. Background
• Employee of a financial printing company that printed
documents relating to planned tender offers purchased
shares in target companies before the tender offers were
announced publicly
• Sold shares at a profit after announcements cause the
market price to rise
• Acquirer

Printer Shareholders
 
Chiarella. Target

b. Holding  not liable

• One who fails to disclose material information prior to the
consummation of a transaction commits fraud only when he
is under a duty to do so
• Duty arises only when one party has information
that the other party is entitled to know because of a
fiduciary or similar relation of trust and confidence
between them

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 •Not a corporate insider (for target)  got no confidential
info from target, no info on earning power
• Duty arises from access is rejected  now it is access
plus
• Chiarella would have a duty to the acquirer as a
temporary insider
c. Announced Misappropriation Theory
• D breached a duty to a acquiring corporation when he
acted upon information that he obtained by virtue of his
position as an employee of a printer employed by the
corporation
• The breach of this duty is said to support a conviction
under §10(b) for fraud perpetrated upon both the acquiring
corporation and the sellers
d. SEC response  Rule 14e-3
• It shall constitute a fraudulent, deceptive, or manipulative
act for any other person who is in possession of material
information relating to such tender offer which information
he knows or has reason to know is nonpublic which he knows
or has reason to know has been acquired directly or
indirectly from (1) offering person (2) issuer of securities
sought by such tender offer or (3) any officer, director,
partner or employee . . . to purchase of sell securities . .
unless information publicly disclosed
• Makes trading on non-public information from acquirer,
issuer or employees illegal
• Controversial because puts liability on people who
supreme court refused to hold responsible
• On facts of O’Hagan SEC had power to do this

2. United States v. O’Hagan (1997)  Fiduciary Duty to Acquirer

a. Background
• D is partner in a law firm representing Grand Met in a
tender offer for Pillsbury
• D bought shares and sold after tender offer announced
Acquirer (Grand Met) Shareholders
 
Law Firm Target (Pillsbury)

D Partner

b. Holding  D Liable
(1) Classical Theory
• Corporate insider who owes a fiduciary duty to the
shareholders trades with those shareholders with
confidential information by reason of their position with
corporation
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 • Applies to not only to officers etc. but also to attorneys,
accountants etc. and others who temporarily become
fiduciaries of a corporation
• Does not apply here b/c D does not owe the shareholders
of the target (people he bought shares from) any fiduciary
duty
(2) Misappropriation Theory
• Outlaws trading on the basis of nonpublic
information by a corporate “outsider” in breach of a
duty owned not to a trading party, but to the source
of the information
• Fiduciary’s undisclosed, self-serving use of a
principal’s information to purchase or sell securities in
breach of a duty of loyalty and confidentiality defrauds
the principal of the exclusive use of that information
• Effect of Disclosure to the Principal
• Full disclosure forecloses liability under this theory
• Because deception involve feigning fidelity to
the source of info, if he discloses to the source
that he plans to trade on the nonpublic info no
violation (may be duty of loyalty violation)
• “In connection with the purchase or sale of a security”
Requirement
• fraud takes place not when he gets information but
when he uses it to buy or sell securities
• theory does not apply when defraud bank into
giving you a loan and then use proceeds to buy a
security
• proceeds have value apart form their use in a
securities transaction
• fraud complete as soon as money obtained

c. Application to a Thief
• Sneak thieves are not covered under misappropriation
theory
• Only those who owe a fiduciary duty to target or acquirer
are covered

3. Dirks v. SEC (1983)  Tipee Liability

a. Background
• Insider gave D information trying to expose fraud
• D interviewed employees and tried to get Wall Street
Journal to expose fraud
• D talked with others about fraud and these people sold
their shares

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 b. Holding  How tippee acquires the duty to refrain from trading on
inside information
(1) D is only in breach of duty if info passed to him
was in breach of insider’s duty
(2) Whether a disclosure is a breach of duty  whether the
insider will personally benefit, directly or indirectly,
from the disclosure
(3) Overall test  absent some personal gain by the insider,
there has been no breach of duty to the stockholders,
and absent a breach by the insider there is no derivative
breach
(4)Determining whether someone benefits
• Focus on objective criteria
• Pecuniary gain or reputational gain that will
translate into future earnings
• Relationship between the insider and the recipient
that suggests a quid pro quo from the recipient or an
intention to benefit the particular recipient
• Insider makes a gift of confidential information to a
trading relative or friend  resembles trading by
insider himself followed by a gift of the profits to the
recipient

5. Issuer’s Duty to Disclose

1. General Background
• So long as a publicly held company is not trading in its own
securities there is not general duty that requires it to disclose
material inside information
• In the absence of an explicit mandate in a given situation, or
some special circumstance a company may disclose material
information or not as suits its purposes
• What circumstances trigger a disclosure requirement

2. Basic Inc. v. Levinson (1988)

a. Background
• Company was in pre-merger negotiations and over a
course of two years denied this three times
b. Holding
• Duty to disclose is not absolute and depends on
materiality
• Material  an omitted fact is material if there is a
substantial likelihood that a reasonable stockholder would
consider it important in deciding how to vote
• Under circumstances with respect to
contingent or speculative information or events,
materiality will depend at any given time upon a
balancing of both the indicated probability that

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 the even will occur and the anticipated
magnitude of the even in light of the totality of
company activity
• Probability  need to look to indicia of interest in
the transaction at the highest corporate levels
• Courts have found pre-merger negotiations material
before  but court will not hold as a matter of law they are
material
• Silence
• Whenever an issuer responds to an inquiry
concerning rumors, unusual market activity, possible
corporate developments, or any other matter, the
statement must be materially accurate and complete
• If an issue wishes to avoid disclosure it can do so by
responding “No Comment”
• Must be sure silence is what it is communicating 
if issuer always denies rumors that are false but says
“No Comment” when rumors are true then this is not
silence and company cannot be misleading
• Corporation can be silent even if something is
material

6. Aiding and Abetting

1. Section 20  Liabilities of Controlling Persons and Persons who Aid
and Abet
• Controlling persons are jointly and severally liable for any
violation of the Exchange Act or its rules committed by the
company or other person they control, unless the controlling
person acted in good faith and did not directly or indirectly induce
the act or acts constituting the violation or cause of action

2. No aiding and abetting liability in private actions (First Interstate Bank

of Denver)
• Not a bad act when private P involved under §10(b)
• Court’s reasoning was broad enough to cover SEC actions as
well
3. Section 20  Aiding and Abetting
• Any uncertainty as to whether SEC could bring aiding and
abetting action was cleared up when congress passed
• Said SEC and DOJ has authority to bring actions for aiding and
abetting the violation of any Exchange Act or any of its rules and
regulations

7. Private Plaintiffs Must Show

1. Generally
• Standing  purchaser/seller requirement

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 • Reliance and transaction causation
• Loss Causation
• Obligation to show damages
• Private right does exist
• Degree of fault required and Section 21D may change for
private P

2. Transaction Causation
a. Generally (from review)
• Non-disclosure cases
• Face to face transaction  Ute presumption
• Open market  Shapiro/Fredrich split
• Misleading cases
• Public arena  Basic presumption of fraud on the
market
• Face to Fact  no presumption and P must prove
reliance

b. Affiliated Ute v. US (1972)  nondisclosure

(1) Background
• Face to face dealings between officers of a bank who
engaged in stock transactions with members of the UTE tribe
• Allegations were about the failure of the bank officers to
disclose material information
(2) Holding
• Plaintiff has a rebuttable presumption of reliance if
allegation is of material nondisclosure in a face to
face transaction

c. Shapiro v. Merril Lynch (2nd Cir. 1974)  nondisclosure

(1) Background
• Allegations of insider trading by persons in the open
market
• Nondisclosure in the open market
• People who did not sell their shares bought suit alleging
that they would have sold at a higher price had they known
the information (that earnings were going down)
(2) Holding  D liable
• Extends Affiliated Ute presumption to
nondisclosure on the open market
• All the plaintiff has to show is D engaged in bad act of
nondisclosure, and court will presume reliance and causation
• D owned a duty not only to the purchasers of the actual
shares sold by D but to all person who during the same
period purchased stock in the open market without

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 knowledge of the material inside information which was in
the possession of defendants
• Requisite element of causation in fact has been
established by the admitted withholding by defendants of
material insider information which they were under an
obligation to disclose  reasonable investor might have
considered it important in making their decision to purchase
stock

d. Fridrich v. Bradford (6th Cir. 1976)  nondisclosure

(1) Background
• D bought shares on tip and sold for profit
• Case is about nondisclosure in the open market
• P did not buy or sell from D, but claimed D did the bad act
and they should be able to recover
• P did not even buy on same day or month
(2) Holding
• D’s conduct caused no injury to plaintiffs
• Disagree with Shapiro saying that it is the act of
trading without disclosing material inside information
which causes plaintiffs’ injury
• Bad act only occurs when trade is made  if D does not
disclose but he also does not trade then no bad act
• Must share their trade caused your harm or effected
the market
• Reliance does not necessarily mean causation 
you can rely on the fact that market reflects all public
information and those who are trading are not at an
informational advantage, but you must also show how
their acts caused your injury
(3) Created Circuit Split
• Shapiro presumes reliance and causation from D making
trades in the open market without disclosing material inside
information
• Fridrich says you must show that their trade caused your
harm or harm on the market
• ASK ABOUT THIS

e. Blackie v. Barrack (9th Cir. 1975)  misstatements

• Fraud on the market theory  presumption of
reliance arises in a misstatement case even in the
absence of any proof that a plaintiff relied
individually on a defendant’s misstatement
• Theory rationale  purchaser relies generally on the
supposition that the market is validly set and that no
unsuspected manipulation has artificially inflated the price,
and thus indirectly on the truth of the representations

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 underlying the stock price – whether he is aware of it or not,
the price he pays reflects material misrepresentations

f. Basic Inc. v. Levinson (1988)  misstatements

(1) Background
• Basic made three public statements over a two year
period denying that it was engaged in merger negotiations
• This was untrue
• Later it then said it had been approaches by another
company about a possible merger
• P is a former shareholder who sold their stock after
Basic’s first public statement and before trading was
stopped on account of the merger
• P does not claim that they read or heard the denials, but
rather that the denials effected the market price and they
sold at that lower market price
(2) Holding
• Adopts the fraud on the market theory  presume
that D relied on stock being properly priced in the
market on truthful information
• Accept presumption that people who trade shares
relied on the integrity of the price set by the market
and because D’s material misrepresentations that the
price had been fraudulently depressed
• Presumption can be rebutted  show that this reliance
did not cause the injury
• P would have sold stock anyway (i.e. to pay taxes)
• Market makers were privy to the truth about the
merger discussions (market price would not be
affected by D’s misrepresentations

3. Loss Causation §21D(b)(4)

• “in any private action arising under the Exchange Act, the
plaintiff shall have the burden of proving that the act or
omission of the defendant alleged to violate the Act caused
the loss for which the plaintiff seeks to recover damages”

4. Standing and “Purchaser-Seller” Requirement  Blue Chips (1975)

a. General Rule
• §10(b) and Rule 10b-5 on proscribe fraud “in connection
with the purchase or sale of securities”
• the plaintiffs class in a Rule 10b-5 action is limited
to actual purchasers and sellers
b. Potential Plaintiffs who are barred under this rule
(1) Potential purchasers and sellers

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 • These people will allege that they decided not to
purchase because of an unduly gloomy representation or the
omission of favorable material which made the issuer appear
to be a less favorable investment
• Burden on D would be too great if a P can sit on the
sidelines and waits to see what will happen and then decide
to sue if favorable to him  will just say if only I would have
known I would have purchased
(2) Actual shareholders who allege that they decided not to sell
because of an unduly rosy representation or a failure to
disclose unfavorable material
(3) Shareholders, creditors and perhaps others related to an issuer
who suffered loss in the value of their investment due to
corporate or insider activities in connection with purchase or
sale

c. Effect of this case

• Put breaks on Rule 10b-5 litigation
d. Application to the SEC
• SEC does not have to prove anyone bought or sold
• All they have to show is whether there is a
misrepresentation or the bad act

XI. Exchange Act Section 16

A. Statutory Language
1. Section 16(a)
• Requires beneficial owners of more than 10% of any class of
equity security that is registered under the Exchange Act, and
officers and directors of issuers of such securities, to file reports
with the SEC and relevant securities exchanges
• Owners of exactly ten percent are not subject to the section
• Have 10 days to file a report
• Not criminal provision
2. Section 16(b)
• (a) any profit (b) by any person subject to the reporting
requirements of §16(a); (c) realized on any purchase and sale, or
sale and purchase (d) within any period of less than six months; (e)
of any nonexempt security of an issuer that has an equity security
registered under the Exchange Act
• shall inure to and be recoverable by the issuer

3. Defining “within less than six months”

• Interpreted literally
• If purchase and then sell exactly 6 months later  not covered
by §16(b)
• 1/1/00 – 7/1/00  not covered

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 • If purchase and then sell within 6 months  not covered by
§16(b)
• 1/100 – 6/30/00  not covered
• If purchase and then sell within less than 6 months  covered
by §16(b)
• 1/1/00 – 6/29/00  covered and must disgorge

4. Exception
• When the security was purchased in good faith in connection
with a debt previously contracted (not covered)
5. Derivatives
• Grant of a derivative security is deemed to be a purchase of the
underlying equity security, thus triggering §16(b) short swing
trading liability if the purchase can be matched with an
appropriate sale within less than 6 months

B. Persons Liable
1. Titles
a. Definition of Director  §3(a)(7)
• Any director of a corporation or any person performing
similar functions with respect to any organization whether
incorporated or unincorporated
b. Definition of Officer  Rule 16a-1(f)
• Page 506 of book

2. Deputization
a. Defined
• Legal concept that can be used to bring within coverage
of §16(b) a person or firm who although not a director, officer or
greater than 10% holder has his interest in a corporation
represented by a person who sits on the board of directors

C. Timing of Purchases and Sales

1. Provision on Issue of Timing
• “This subsection shall not be construed to cover any
transaction where a 10% plus beneficial owner was not such
both at the time of the purchase and sale, or the sale and
purchase”
2. Issue in Provident Securities
• Whether a person purchasing securities that put his
holdings above the 10% level is a beneficial owner at the
time of the purchase so that he must account for profits
realized on a sale of those securities with six months
• Purchase that increase ownership above 10% do not
count for section 16(b) purposes
3. Issue in Reliance Electric Co.
a. Background

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 • Owner of 13.2% of stock sold all stock in two transactions,
each within six months of original purchase
• First sale reduced the owner’s interest to 9.96% and
second he sold out entirely
b. Holding
• Trade that takes you under 10% does count (so
must disgorge profit from first sale)
• However, when he sold the second batch he did not own
more than 10%  was not a beneficial owner of more than
10% at the time of purchase and the time of sale  he can
keep profits
• Look at ownership at time transaction initiated 
that is when you will have information others may not
have
4. Problems for Clarification
a. 1990 buy 1000 shares for $50/share
1/1/00 buy 1000 shares for $10/share
3/1/00 sell 1000 shares for $20/share
• even if you can prove the shares you sold in march of
2000 were the shares you purchased in 1990 you still have to
give company profits
• securities are fungible
• any buy and sell within six months must disgorge profits
 $10,000
b. 1990 buy 1000 shares for $50/share
1/1/00 sell 1000 shares for $10/share
3/1/00 buy 1000 shares for $20/share
• order in which you buy and sell is irrelevant
• because you bought and sold within six months must
disgorge profits  $10,000

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