Securities Regulation

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Securities Regulation
Relevant texts Image of Securities Regulation: Cases and Materials (Aspen Casebook)
Securities Regulation: Cases and Materials (Aspen Casebook)


Image of Securities Regulation (University Casebook Series)
Securities Regulation (University Casebook Series)
Image of Securities Regulation in a Nutshell (Nutshells)
Securities Regulation in a Nutshell (Nutshells)

Related course(s)


  1. Contents

    Materiality

    1. Definition of Material 

      1. Test: The Substantial Likelihood Test

        1. Information is material if there would be a substantial likelihood that a reasonable investor would consider the information important in deciding whether to buy or sell the security, because the information significantly alters the total mix of information available that is relevant to that decision. Basic v. Levinson (1988).
      2. The Reasonable Investor

        1. Rule: The standard is objective. The reasonable investor in a market in which many individual investors trade will be deemed less schooled and sophisticated than a market containing only experienced traders and institutions using complex computer algorithms. United States v. Litvak (2d Cir. 2018).
          1. Litvak (holding that the standard applies to the reasonable investor in a particular market, not all markets; therefore, testimony that purchaser’s representative believe Litvak was acting as purchaser’s agent was not objectively reasonable in the residential-mortgage backed securities market)
    2. Analyzing the Materiality Test

      1. Courts use a variety of analyses and tests to analyze Basic’s rule for materiality:

      2. The Probability/Magnitude Test: Speculative Information

        1. Exclusive for M&As
        2. Under the probability/magnitude test, materiality depends “upon a balancing of both the indicated probability that the event will occur and the anticipated magnitude of the even in light of the totality of the company activity.” Basic v. Levinson
          1. Basic’s Facts:
            1. Basic made a series of statements about a merger. The merger info leaked. Basic said to the news that no negotiations were ongoing several times. A few weeks later, Basic announced that a takeover was imminent. Plaintiff sued under 10b-5. Court held that using the probability/magnitude test, such actions were material and basic committed a misstatement even though securities law prevented them from disclosing the acquisition.
          2. Probability in the M&A context depends on an “indicia of interest in the transaction at the highest corporate levels.”
            1. Board Resolutions
            2. High-level participation in negotiations
            3. Retention of investment bankers
            4. Specificity of deal—e.g., form of transaction, price, identity of surviving company, distribution of officer positions
            5. Possible regulatory roadblocks—e.g., antitrust, banking regs.
          3. Magnitude depends on whether we are considered the acquiror or target.
            1. Always high for the target
            2. Size of acquirer can make a deal a small magnitude for acquirer, but this can be important if the small target produces a product that the acquiring company needs to complete its product line or enter a new market
            3. Premium over market is also relevant
      3. Quantitative Analysis

        1. Note: Must be comparing apples to apples (revenue to revenue), not revenue to profit.
        2. Step 1: If the error of omission is less than 5% than the error or omission is likely not material. 
        3. Step 2: Using the SAB 99 Factors, determine whether the error or omission is material?
          1. SAB 99 Factors include:
          2. Whether the misstatement arises from an item capable of precise measurement or whether it arises from an estimate and, if so, the degree of imprecision inherent in the estimate.
          3. Whether the misstatement masks a change in earnings or other trends.
          4. Whether the misstatement hides a failure to meet analysts’ consensus expectations for the enterprise.
          5. Whether the misstatement changes a loss into income or vice versa.
          6. Whether the misstatement concerns a segment or other portion of the registrant’s business that has been identified as playing a significant role in the registrant’s operations or profitability.
          7. Whether the misstatement affects the registrant’s compliance with regulatory requirements.
          8. Whether the misstatement affects the registrant’s compliance with loan covenants or other contractual requirements.
          9. Whether the misstatement has the effect of increasing management’s compensation—for example, by satisfying requirements for the award of bonuses or other forms of incentive compensation.
          10. Whether the misstatement involves concealment of an unlawful transaction.
      4. Stock Price Movement: Historical Data

        1. Rule: When the stock of an issuer is traded in an efficient market, “the materiality of disclosed information may be measured post hoc by looking to the movement, in the period immediately following disclosure, of the price of the firm’s stock.” In re Merck & Co. (3rd Cir. 2005)
        2. Note: 
          1. A fact may be material if disclosure causes the price of the relevant stock to move up or down in a statistically significant way. This test is objective and persuasive at trial; however, stock prices move for many reasons.
          2. When analyzing whether the information changed the stock price, analyze whether nonpublic information changed the stock price or some other information or event affected that price. 
          3. Stock price must be immediate—within one day—after the release of nonpublic information.
      5. Qualitative Analysis: Historical Information & Management Integrity (Non-Financial Numbers)

        1. Covers: 
          1. Wrongdoings by directors and top management
          2. Managerial and business ability of directors and top management
          3. Wrongdoing
            1. Lying by mgmt. about matters other than the operation of the issuer may or may not be important
            2. Wrongdoing is presumptively material if its consists of actions by top management to benefit themselves at the expense of the company or shareholders
            3. May implicate quantitative analysis—e.g., where wrongdoing is a violation of the law which, if discovered, threatens business; removes a competitive advantage; or runs the risk of a fine or civil liability.
          4. Management ability and control of the company
            1. Management wrongdoing may cast doubt on ability to manage. 
              1. Franchard, where unauthorized withdrawals from business were prompted by the decline of Glickman’s other enterprises, which in turn suggested that he might not have the magic touch that the Glickman Corporation touted as the reason for buying that company’s stock
            2. Facts about directors or top management may be material in a particular case even if SEC rules do not require disclosure of the particular experience
          5. Puffing—general optimistic statements by an issuer, or general self-congratulatory statements, that market participants would not use in valuing the company—is not material
        2. Franchard’s Importance:
          1. Facts showing 
            1. misuse of corporate assets for personal benefit of top officers or directors or 
            2. self-dealing by top officers or directors at the corporation’s expense 
            3. are very likely to be material
    3. The Context: “Total Mix” Defenses

      1. Rule/Test: Under Basic, the information is only material if it affects the “total mix” of information available 
      2. Multiple Variations of the “Total Mix” Test
        1. “Truth on the Market” Defense: The truth on the market defense asserts that a misrepresentation is immaterial if the information is already known to the market because the misrepresentation cannot then defraud the market. Longman v. Food Lion, Inc.
          1. If information is already in the market, repeating it does not change the total mix, so the information, when repeated, is not material.
          2. Longman (holding that Defendants did not have a securities cause of action for Defendant’s unsafe and illegal employment and labor practices because it was known to the market during the time in question and when the information was disclosed during DoL settlement discussions, the stock price was relatively unchanged. Further, D’s sanitation issues were mere puffery and Ps evidence of quantiatively small samples was unavailing as to the business as a whole (quantitative analysis)) 
        2. Bespeaks Caution: Under this defense, forward-looking statements are rendered immaterial as a matter of law if they are accompanied by disclosure of risks—not boilerplate information--that may preclude the forward-looking projection from coming to fruition. Kaufman v. Trump’s Castle Funding (3rd Cir. 1993). The PLSRA codifies this at Securities Act § 27A; Exchange Act § 21E.
  2. Definition of a Security

    1. Opening Rule Statement

      1. In drafting securities laws, Congress enacted statutes to compel full and fair disclosure to the issuance of “many types of instruments that in our commercial world would fall within the ordinary concept of [the definition of] a security.” Landreth Timber Co. (1985). The definition of the word “security” includes, “unless the context otherwise requires,” any note, stock, and investment contract. Sec. Act. Section 2(a)(1); Exchange Act Section 3(a)(10). If the financial product or instrument falls within the scope of a financial product under the definition of the word security, then securities laws apply “unless the context otherwise requires” that it falls outside its scope. Id. In searching for the scope and meaning of any particular word under the definition of security, “form should be disregarded for substance and the emphasis should be on economic reality.” United Housing Fdn., Inc. v. Forman (1975). 
    2. Investment Contract 

      1. Opening

        1. The term “security” includes the words “investment contract.” Sec. Act. Section 2(a)(1); Exchange Act Section 3(a)(10). Investment contract is a catch-all provision and is broad. Under Howey, an investment contract means a “contract, transaction or scheme” that satisfies four elements. SEC v. W.J. Howey Co. (1946). 
      2. First, a person must invest. Howey. 

        1. To invest means to give specific consideration in return for a separable financial interest with the characteristics of a security. Int’l Brotherhood of Teamsters v. Daniel (1979). The investment must be voluntary by the investor and for investment purpose (i.e. a financial/monetary reteurn). The investment may be monetary or in-kind. Id. In Daniel, the Court found the involuntary donation to an employee’s pension fund as not a security because the employee was compelled to be in the plan and the employee was providing labor (thereby allowing them to obtain the contribution) for their livelihood—not investment purposes.
      3. Second, there must be a common enterprise. SEC v. SG Ltd. (1st Cir. 2001) 

        1. Circuit Split
        2. Horizontal Commonality involves the pooling of assets from multiple investors so that all share in the profits and risk of the enterprise. 
          1. Two elements: (1) Pooling of assets, and (2) share in profit and risks
        3. Broad Vertical Commonality requires that the well-being of all individual investors be dependent upon the promotor’s efforts and expertise (even if no pooling of funds or pro rata distribution of profits). Under this commonality, investors owning the same percentage of ownership may receive differing returns, and the promoter does not necessarily share the risk with investors.
        4. Narrow Vertical Commonality requires that the investors’ fortunes be interwoven with and dependent upon the efforts and success of the promoters. Essentially, this is broad vertical with the promoter assuming some risk along with the investors.
      4. Third, the investor is led to expect profits. United Housing Fdn. v. Forman (1975).

        1. Rule: Led to expect profits means that the investor is attracted to the investment solely by the prospect of a return on his investment. When a purchaser is motivated by a desire to use or consume the item, the securities laws do not apply. United Housing Fdn., Inc. v. Forman (1975)
          1. Forman (finding this element lacking when a purchaser-investor was motivated to invest by a desire to use or consume—“to occupy the land or to develop it”)
        2. Mixed Consumption and Return: An expectation of profits under Howey may exists even if the investor intends the profits to go towards charity or person consumption. Warfield v. Alaniz (9th Cir. 2009) (finding annuities were investment contracts and the fact that proceeds went to charity did not diminish this expectation).
        3. Finding: To determine whether the investor expects profit, the court may look to the promotion materials or oral presentations to see whether they pitched return as a reason for buying.
      5. Fourth, profits must be derived solely from the efforts of the promoter or a third party. Howey.

        1. More Control 🡪 Not a security; Less control🡪 Investment contract
        2. Rule: The test is whether the investors, considering actual and the practical exercise of their powers, had a sufficient influence over factors that would determine the success or failure of the business. 
        3. LLP/LLC: There is a rebuttable presumption that limited interests are securities and general partnership interests are not securities because limited partners do not exercise significant participation in the business while general partners do; however, if the Williamson factors are all present, either interest is a security.
          1. Regardless of management powers in the organizing documents, the question is whether the investors practically exercised management functions. Williamson Factors: 
            1. (1) Limited Power: “An agreement among the parties leaves so little power in the hands of the partner or venture that the arrangement in fact distributes power as would a limited partnership”
            2. (2) Inexperience and Unknowledgable: “The partner or venture is so inexperienced and unknowledgeable in business affairs that he is incapable of intelligently exercising his partnership or venture powers,”; or 
            3. (3) Dependency: The partner or venture is so dependent on some unique entrepreneurial or managerial ability of the promoter or manager that he cannot replace the manager of the enterprise or otherwise exercise meaningful partnership or venture power.”
        4. LLC/LPs: Generally, there is a rebuttable presumption that member-managed LLCs are not securities and manager-managed may be a security because in a member-managed the members exercise significant control and in a manger-managed, they do not.
          1. In Avenue Capital Mgmt v. Schaden, the 10th Cir (2016) asserted that the court considers several factors including: “contribution of time and effort to the success of the enterprise, their contractual powers, their access to information, the adequacy of financing, the level of speculation, and the nature of the business risks.”
    3. Stock

      1. Rule: If an economic interest is called a “stock” and bears the characteristics generally associated with stock, the court will find that it a stock under the definition of “security” and subject to securities laws. Landreth Timber Co. v. Landreth (1985). 
      2. Characteristics of (Common) Stock:
        1. Right to receive dividends upon an apportionment of profits;
        2. Negotiability;
        3. Ability to pledge or hypothecate;
        4. Voting rights in proportion to shares owned; and
        5. Capacity to appreciate in value.
      3. Note: Same test for passive and active investors and an economic interest may not be a security if the economic reality shows that the interest was not sold for the purpose of raising capital for a profit-making enterprise (Forman).
    4. Notes

      1. There is a rebuttable presumption that notes are securities subject to securities law and that presumption may be rebutted by application of the Reves Test.
      2. First, under securities laws, if the economic interest falls within the nine-month-or-less commercial paper (an unsecured obligation issued by a corporation or bank, with a high credit rating, to finance short-term credit needs) exception, then it is not a note within the definition of the word “security.” Securities Act sec. 3(a)(3); Exchange Act sec. 3(a)(10).
      3. Second, if the economic interest bears a strong resemblance to one of the enumerated categories of instruments exempted from securities laws then it is not a security:
        1. Securities laws do not apply to certain notes including:
          1. Notes delivered in consumer financing;
          2. Notes secured by a mortgage; 
          3. Short-term notes secured by a lien on a small business or some of its assets;
          4. Notes evidencing a character loan to a bank customer;
          5. Short-term notes secured by an assignment of accounts receivable;
          6. Notes formalizing an open-account debt incurred in the ordinary course of business; and 
          7. Notes evidencing loans by commercial banks for current operations. 
      4. Finally, if the economic interest is not one of the enumerated financial instruments exempted from securities law, the court must determine whether the instrument should be added to the list of notes by a showing of four factors:
        1. Motivation: If the seller’s purpose is to raise capital for general use, and the buyer is interested in profit, then the instrument is likely a security; however, if the note is exchanged to facilitate minor purchases, correct cash-flow difficulties, or advance some other commercial or consumer purposes, then this factor weighs against being a security.
        2. Plan of Distribution: The larger number of offerees and lower their sophistication, the more likely it is a security; however, the fewer offerees and greater the sophistication, the less likely it is a security.
        3. Public Expectations: If the public expects the interest to be sold as an “investment” then the factor weighs in favor of being a security.
        4. Presence or Absence of Risk Reducing Factors: If another regulatory scheme significantly reduces the risk of the instrument, application of the securities laws may be unnecessary. These risk-reducing factors include alternate regulatory regimes or the presence of collateral.
      5. REMEMBER THE PRESUMPTION OF A SECURITY.
  3. Public Company Disclosure

    1. Public Company Status

      1. Summary Table


<tbody></tbody>

SECTION

TRIGGER

REQUIREMENTS

TERMINATION (Going Dark)

§12 (a), (b)

Rule 12d2-2

Exchange Listing under the Exchange Act by filing a registration statement


  • Periodic Filings
  • Proxy rules + annual report
  • Tender offer rules
  • Insider stock transactions (§16)

Rule 12d2-2

  • Delisting (including filing Form 25 w/ SEC) and either:
  • (a) Less than 300 shareholders or
  • (b)less than 500 shareholders and $10 m in assets for 3 years

§12(g)


12g-4



Threshold under the JOBS Act: Total assets greater than $10 million on the last day of the company’s fiscal year; and either 2,000 shareholders of record of a class of equity (other than exempted securities) or 500 shareholders of record of such a security who are not accredited investors


  • Periodic Filings
  • Proxy rules + annual report
  • Tender offer rules
  • Insider stock transactions (§16)

Rule 12h-3

Either

  • (a) Less than 300 shareholders or
  • (b)less than 500 shareholders of record and $10 m in assets for 3 years

When either condition is satisfied, the company files a Form 15 so certifying, and the issuer’s duty to file reports required by Section 13(a) “shall be suspended immediately. Rule 12g-4(b).

§15(d)


Rule 12h-3



Filing of a registration statement under the 33 Act, which has become effective.

  • Periodic Filings
    • 10K
    • 10Q
    • 8K
    • NOT Proxy Statements

(Rule 12h-3)


Either 

  • Less than 300 shareholders and no earlier than next fiscal year after offering or
  • Less than 500 shareholders of record and less than $10 m in assets for 3 years 

The duty to file disclosure reports is only suspended for that fiscal year in which one is met and begins again in any fiscal year for which, on the first day of that year, the conditions are not met. Rule 12h-3



  1. Terminating Status (Going Dark)
    1. The company must delist;
    2. The company must ensure it is not a public company under § 12(g);
    3. If the company has filed a prior effective registration statement with the SEC, the company must meet the requirements to suspend public company status. 
  2. “Held of Record” – Rule 12g5-1
    1. Applicable to 12(g) and 15(d). 
    2. Securities held in a custodial capacity for a single trust or estate are counted by each trust, estate, or account as a distinct holder of record. Rule 12g5-1(a)(3).
    3. Institutional custodians are not single holders of record for purposes of the Exchange Act's registration and periodic reporting provisions. Instead, each of the depository's accounts for which the securities are held is a single record holder. 
    4. Securities held in street name by a broker-dealer are held of record under the rule only by the broker-dealer. 
    5. The JOBS Act, signed in 2012, provides that holders of record will not include “persons who received the securities pursuant to an employee compensation plan in transactions exempted from the registration requirements of section 5 of the Securities Act of 1933.”  15 U.S.C. § 78l(g)(5).  And persons who acquire securities in exempt crowdfunding offerings will not be counted as holders of record.  15 U.S.C. § 78l(g)(6). 
  3. Emerging Growth Companies
    1. “Emerging growth company” is an issuer with total annual gross revenues of less than $1 billion during it most recent fiscal year. 
    2. A company loses EGC status at the earliest of: [Sec. Act Sec. 2(a)(19)]
      1. Revenue exceeds $1 billion on the last day of the fiscal year;
      2. The last day of the fiscal year following the fifth anniversary of the date of the first sale of common equity in a registered public offering;
      3. The date on which the company has issued more than $1 billion in non-convertible debt aggregated over the previous three-year period; or
      4. The date on which the company is deemed to be a “large accelerated filer” (Rule 12b-2) 
        1. Rule 12b-2 defines large accelerate file as companies with over $700 million of worldwide equity float in the hands of non-affiliates among other requirements
    3. Benefits: Exempt from the following:
      1. “Say on Pay” requirement that shareholders have the ability to vote on executive compensation. Ex. Act. Sec. 14A.
      2. CEO pay disparity disclosures
      3. Certain disclosures under Items 301 (selected financial data) and Item 303 (management’s discussion and analysis) of S-K
      4. Requirement of an external auditor attesting to the internal controls under §404 of Sarbanes Oxley
      5. Rule promulgated by the PCAOB requiring mandatory audit firm rotation
  1. Periodic Disclosure

    1. Generally – Securities Act Sec. 13(a). 

      1. Under Sec. 13(a), the SEC requires three principal disclosure documents from public companies:
        1. Annual Report: Form 10-K
          1. Rule 13a-1
        2. Quarterly Report: Form 10-Q
          1. Rule 13a-13
        3. Special Reports: Form 8-K
          1. Rule 13a-11
      2. Certification of Periodic Reports: Under SEC rules, the CEO and CFO must each certify, using the form set out in Reg S-K Item 601(b)(31), the periodic reports, based on their knowledge, that (1) it does not contain material statements that are false or misleading, and (2) that it fairly presents the financial condition and results of operation of the company. Exchange Act Rule 13a-14, 15d-14. 
    2. Form 10-K, 10-Q: Periodic Reports

      1. Filing: Reporting companies must file within 90 days of the close of the fiscal year, an annual report containing certain information. Under Item 7 of Form 10-K, the company must disclosure information according to Item 303(a) of Reg S-K. 
      2. Item 303(a)(3)(ii) of Reg S-K requires disclosure of “any known trend or uncertainties that have had or that the registrant reasonably expects will have a material favorable or unfavorable impact on net sales or revenues or income from continuing operations.” 
        1. Accordingly, a “trend” occurs when something happens over time and continues. An “uncertainty” is an event in the future that is not the result of some continual development. 
        2. According to an SEC Release in 1989, companies must take two steps in determining whether a trend or uncertainty requires disclosure:
          1. First, the company must determine whether it is reasonably likely that the trend of uncertainty will continue as to affect net sales, revenue, or income. If it will not continue as to affect the company’s financials, then no disclosure is required.
          2. Second, if management cannot make that determination, management must objectively evaluate the consequences of the trend or uncertainty on the assumption that it will continue. Then, disclosure is required unless management determines that the impact is not reasonably likely to be material.
        3. Note: The trend or uncertainty must be known. 
    3. Form 8-K: Current or Special Reports

      1. Must be filed within four business days of triggering event.
      2. Events requiring disclosure:
        1. Section 1: Operational events:
          1. Entry into (or termination of) definitive material agreements outside the ordinary course;
          2. Bankruptcy or receivership
          3. Loss of significant customer
        2. Section 2: Financial events:
          1. Acquisition or disposition of assets constituting more than 10% of total assets
          2. Results of operations and financial condition 
          3. Costs associated with exit or disposal activities, including termination benefits for employees, contract termination costs, and other associated costs
          4. Material impairments to assets such as goodwill
        3. Section 3: Securities-Related events:
          1. Delisting 
          2. Unregistered sales of equity securities
          3. Changes in debt rating
          4. Material modifications to rights of securities holders
        4. Section 4: Financial Integrity events:
          1. Item 4.01. Changes in certifying accountant
          2. Item 4.02. Notice that previously issued financial statement or audit reports should no longer be relied upon. 
        5. Section 5: Governance events
          1. Changes in corporate control
          2. Item 5.02. Changes in directors and principal officers
            1. In Re Hewlett-Packard Co. (2007)
              1. Item 5.02 requires that if a director resigns because of a disagreement with the registrant on a matter of registrant’s operations, the registrant must disclose a brief description of the circumstances representing the disagreement that the registrant believes caused, in whole or in part, the director’s resignation
              2. Additionally, registrant must provide resigning director with a company of the disclosure, give the resigning director an opportunity to respond stating whether they agree with the 8-K, and if they receive a response, the letter must be filed by registrant as an amendment to the 8-K within 2 business days
          3. Amendments to corporate documents
          4. Amendment or waiver of company’s code of ethics
          5. Matters submitted to a vote of the company’s shareholders
        6. Section 6: Asset-Backed Securities
        7. Section 7: Regulation FD: Any disclosure the issuer elects to disclosure through Form 8-K to comply with Reg FD
        8. Section 8: Other Events: anything the issuer, at its options, think would be important to its security holders
      3. Penalties: Failure to file a form 8-K or a deficient 8-K is a violation of Section 13(a) and related rule (Rule 13a-11). SEC does not need to show scienter.
  2. Books and Records Disclosure

    1. Keep Records: Companies are required to “make and keep books, records, and account, which, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the issuer.” Section 13(b)(2)(A). 
      1. Notes: 
        1. No scienter—strict liability
        2. No materiality requirement
        3. No private right of action to enforce §13(b)(2)—only SEC and, in extreme cases, the Department of Justice
    2. Internal Controls: Companies are also required to devise and maintain a system of internal account controls sufficient to provide reasonable assurances that—(i) transactions are executed in accordance with mangement’s authorization; (ii) transactions are recorded as necessary; (iii) access to assets is permitted only with management’s authorization; and (iv) the recorded accountability for assets is compared with existing assets at reasonable intervals and appropriate action is taken for the differences. Section 13(b)(2)(B).
    3. In Sum: 
      1. Subpart (A) requires good records.
      2. Subpart (B) requires systems to produce good records
    4. Qualifiers: 
      1. “Reasonable detail” and “reasonable assurances” means “such level of detail and degree of assurance as would satisfy prudent officials in the conduct of their own affairs.” Section 13(b)(7). 
    5. Actors:
      1. Company is primary violator
      2. Officials in the company can be aiders and abettors or control person
        1. Aiding and abetting violation requires 
          1. (1) an independent primary violation, 
          2. (2) actual knowledge by the alleged aider and abettor of the primary violation, or reckless ignorance of that violation, and actual knowledge by the alleged aider and abettor of his or her own role in furthering it, or reckless ignorance of that role, and 
          3. (3) substantial assistance by the aider and abettor in the commission of the primary violation
        2. Individuals within a company can be pursued as control persons under section 20(a)3
      3. In re BHP Billington Ltd. (2015)
    6. Rules relating to 13(b):
      1. Rule 13b2-1: Prohibits directly or indirectly falsifying books and records subject to 13(b)(2)(A).
        1. No materiality qualifier.
        2. No scienter
  3. Executive Compensation

    1. Dodd-Frank requires companies to disclose the compensation of their CEO, CFO, and the next three highest paid executive officers.
    2. Amount includes bonuses, stocks, options, and retirement benefits. Equity must be disclosed at FMV.
  4. Regulation FD: Selective Disclosure

    1. Prevent selective disclosure by mandating disclosure through Form 8-K.
    2. Applies when an issuer, or someone acting on its behalf, discloses material nonpublic information to:
      1. “a broker or dealer, or a person associated with a broker or dealer,” FD 100(b)(1)(i)
      2. “an investment adviser . . . an institutional investment manager” FD 100(b)(1)(ii)
      3. “an investment company” or “affiliated person” of an investment company” FD 100(b)(1)(iii); or
      4. “a holder of the issuer’s securities, under circumstances in which it is reasonably foreseeable that the person will purchase or sell the issuer’s securities on the basis of the information.” FD 100(b)(1)(iv).
    3. Reg FD does not apply to disclosure to:
      1. a person who owes a duty of trust or confidence to the issuer; FD 100(b)(2)(i)
      2. a person who expressly agrees to maintain the disclosed information in confidence; FD 100(b)(2)(ii)
      3. disclosures in connection with certain securities offerings. FD 100(b)(2)(iii)
    4. If the regulation does apply, the company must:
      1. Disclose the information simultaneously to the public if disclosure was intentional; FD 100(a)(1)
      2. Disclose the information “promptly” to the public if disclosure was not intentional; FD 100(a)(2)
        1. Promptly means “as soon as reasonably practicable” but in no event after the later of 24 hours or the commencement of the next day’s trading on the NYSE after a senior official of the issuer learns that there has been a non-intentional disclosure or is reckless in not knowing.
    5. SEC identified seven cateogries of information that are material and subject to disclosure under Reg FD, note that these are still subject to the materiality qualifier and are not dispositive as material:
      1. Earnings information;
      2. M&As, joint ventures, or changes in assets;
      3. New products or discoveries, or developments regarding customers or supplies 
      4. Changes in control or in management;
      5. Changes in auditors or auditor notification that the issuer may no longer rely on an auditor’s audit report;
      6. Events regarding the issuer’s securities—e.g. defaults on strict securities, calls of securities for redemption, repurchase plans, stock splits or changes in dividends, changes to rights of security holders, public or private sales of additional securities, and
      7. Bankruptcy or receivership.
      8. SEC v. Seibel Systems., Inc. (SDNY 2005).
    6. Public disclosure may be made by:
      1. Filing an 8-K; FD 101(e)(1)
      2. “another method (or combination of methods) of disclosure that is reasonably designed to provide broad, non-exclusionary distribution of the information to the public” FD 101(e)(2)
        1. E.g. Press release
        2. May also do both.
    7. Actionability: No Private Right of Action; SEC only
  1. Rule 10b-5 Antifraud

    1. The Statute/Regulation

      1. Exchange Act Section 10(b) declares it is “unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce or of the mails, or of any facility of any national securities exchange—
        1. (b) To use or employ, in connection with the purchase or sale of any security . . . any manipulative or deceptive device or contrivance in contravention of such rules and regulations . . . .”
      2. Rule 10b-5 also declares that 
        1. “It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce or of the mails, or of any facility of any national securities exchange:
          1. (a) To employ any device, scheme, or artifice to defraud; 
          2. (b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading, or 
          3. (c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person,
        2. In connection with the purchase or sale of any security. 
    2. Generally

      1. Cause of Action
        1. Private cause implied; the statute does not create an express private cause of action. See Kardon v. Nat’l Gympsum Co. (E.D. Pa. 1946)
        2. SEC can bring 
          1. A suit in federal court based upon a 10b-5 violation
          2. An administrative enforcement action before an ALJ
        3. DOJ may bring criminal prosecution for violation of Rule 10b-5
      2. PSLRA 
        1. Imposes a rebuttable presumption that the lead plaintiff in a class action is the shareholder with the largest financial interest in the class;
        2. Requires plaintiffs plead with particulatity facts leading to a strong inference of scienter;
        3. Imposes a stay on discovery until after the MtD is decided;
        4. Provides a safe harbor for forward looking statements;
        5. Limits the liability of defendants not engaged in intentional fraud to their proportionate share of the harm.
      3. Time Limits: 28 U.S.C. §1658(b).
        1. Statute of Limitations: 2 years. Does not begin to run until plaintiffs discovers the facts constituting the violation or when a reasonably diligent plaintiff should have become aware of the violation—whichever is first.
        2. Statute of Repose: 5 years. Cut off without exception.
    3. Jurisdictional Hook

      1. Requires “the use of any means or instrumentality of interstate commerce or of the mails, or of any facility of any national securities exchange.” Rule 10b-5. The jurisdictional hook, however, is usually easily satisfied as an intrastate telephone call, intrastate mailing, internet use, or otherwise will satisfy this element.
    4. Proper Defendants

      1. Generally

        1. In a private Rule 10b-5 action, all defendants must either be 
          1. Primary Violators of the rule; or
          2. Control person defendant
        2. In an SEC action, defendants may be either:
          1. Primary violators of the rule;
          2. Control person defendants; or
          3. Aiders and Abettors
            1. Limited to SEC actions. Central Bank v. First Interstate Bank of Denver
      2. Primary and Secondary Violators

        1. A natural person who 
          1. “makes” a misstatement in the sense that they have control over the misstatement’s content and dissemination or to whom the misstatement is attributed. Janus Capital Grp. V. First Derivative Traders (2011)—proper under 10b-5(b).
          2. Fails to disclose a material fact when under a duty to disclose.
          3. Acting with scienter, disseminates a misstatement, even though they did not “make” the statement and the act is proximately related to the misstatement. Lorenzo (proper under 10b-5(a),(c))
        2. Note:
          1. Stonebridge controls Rule 10b-5(a), (c) 
          2. Janus controls Rule 10b-5(b): Requirement of “to make” the statement
            1. Rule: “[T]he maker of a statement is the entity with authority over the content of the statement and whether and how to communicate it. Without such authority, it is not ‘necessary or inevitable’ that any falsehood will be contained in the statement.” Janus. 
        3. If a natural person spoke or wrote on behalf of a company, then the company is also a proper defendant—through agency principles—and the company is a proper defendant if they issued a statement. 
        4. Other defendants are proper if plaintiff can prove reliance because:
          1. They had a duty to disclose a material fact and they did not; or
          2. Their deceptive act—under Rule 10b-5(a), (c)—had a proximate or immediate relationship to a false or misleading statement by a defendant listed above
            1. Not a proper defendant if their deceptive act and the statement were remote. Stoneridge.
            2. Are proper if their deceptive acts made the statement “necessary or inevitable” Stoneridge.
      3. Control Person Liability: “Potential” Control Test (8th Cir)

        1. Exchange Act Sec. 20(a) states that “Every person who, directly or indirectly, controls any person liable . . . shall also be liable jointly and severally with and to the same extent as such controlled person . . . unless the controlling person acted in good faith and did not directly or indirectly induce the act.”
        2. Control person means “the possession, direct or indirect, of the power to direct or cause the direction of the management and policies of a person, whether through the ownership of voting securities, by contract, or otherwise.” Rule 12b-2. 
        3. The Test: The 8th Circuit requires:
          1. (1) The primary violator to violate federal securities laws.
            1. Note: FRCP 9 heightens the pleading requirements.
          2. (2) The defendant exercised actual general control over the controlled person or entity and
            1. No heightened pleading requirement.
            2. IE: He had the power to exercise control in general
          3. (3) The defendant “possessed the power to control the specific transaction or activity upon which the primary violation is predicated, but he need not prove that this latter power was [actually] exercised.”
            1. IE: He had the potential to control the particular transaction, it does not matter that they did or did not.
          4. Lustgraaf v. Behrens (8th Cir. 2010) 
        4. Defense: Defendant bears the burden to show they acted in good faith and did not directly or indirectly induce the act or acts constituting the violation or cause.
      4. Aider or Abettor Liability – Exchange Act 20(e)

        1. Not applicable in private causes of action; only SEC enforcement.
        2. PLSRA expressly grants the SEC the power to bring an action against aider and abettors of a 10b-5 violation by knowingly giving substantial assistance to the primary violation. Exchange Act 20(e).
        3. The SEC must show:
          1. An independent primary violator;
          2. Actual knowledge, or reckless ignorance, by the alleged aider and abettor of the primary violation, and actual knowledge, or reckless ignorance, of their role in furthering the primary violation, and
          3. Substantial assistance by the aider and abettor in the commission of the primary violation.
    5. Elements- All

      1. Deception or manipulation by primary violator.

        1. Deception 

          1. The rule does not provide relief where plaintiff simply alleges a breach of fiduciary duty and no deception occurs. Santa Fe (1977) (asserting that minority’s 10b-5 claim failed simply because they did not follow proper protocol to dispute value of their shares—the officers did not deceive them)
          2. Note: The rule does apply where such breach entails a misstatement of a material fact or an omission of a material fact when the defendant had a duty to disclose as this amounts to deception. Santa Fe.
        2. Misstatement of Material Fact

          1. Materiality 🡪 Material Portion of Outline
          2. If an issuer misstates a material fact, the misstatement may be actionable; however, context can play a role in determining whether the statement is materially false and “true statements may discredit the [misleading] one[s] so obviously that the risk of real deception drops to nil.” Va. Bankshares. 
        3. Opinions: Generally

          1. Facts v. Opinion (Omnicare)
            1. A fact is “a thing done or existing” or “an actual happening.”
            2. “An opinion is ‘a belief, a view’ or a ‘sentiment which the mind forms of persons or things.’’” 
          2. To show falsity of an opinion, a plaintiff must show:
            1. Speaker or writer did not believe the opinion at the time it was spoken or written; 
            2. Opinion contained a non-opinion embedded fact that was false; or
            3. The speaker did not disclosure “particular (and material) facts going to the basis for the issuers opinion” including
              1. “Facts about the inquiry the issuer did or did not conduct or [Facts underlying the opinion]
              2. The knowledge it did or did not have—whose omission makes the opinion . . . misleading to a reasonable person reading the statement fairly and in context.” [Facts throwing the opinion into doubt if revealed to a reasonable investor]
          3. Omnicare: 
            1. Words such as “we believe” and “we think” do not nullify a whole statement, and even these words make the statements capable of misleading investors. 
        4. Opinions: Forward Looking Statements

          1. Rule: Forward-looking statements—including statements of business plans, projections of earnings, and historical facts regarding issuer’s earning for a quarter on which the company’s books are closed—is analyzed in a manner similar to falsity of other opinions (above). Omnicare; Ind. Pub. Retirement Sys. v. SAIC, Inc. (2d Cir. 2016) 
          2. Protections under the PLSRA 
            1. APPLIES ONLY IN PRIVATE ACTIONS. Section 21E(c)(1). 
            2. Available only to: 
              1. Issuers (public companies); Section 21E(a)(1);
              2. “a person acting on behalf of such issuer” Section 21E(a)(2)
              3. An underwriter, with respect to information derived from an issuer. Section 21E(a)(3)
              4. An outside reviewer retained by such issuer making a statement on behalf of such issuer. Section 21E(a)(4).
            3. Not available for:
              1. Statements made “in connection with an initial public offering.” Exchange Act 21E(b)(2)(D).
              2. Statements “included in a financial statement prepared in accordance with [GAAP].” Exchange Act 21E(b)(2)(A).
              3. Statement made with respect to an issuer that—in the three years prior to the statement being made—“has been made the subject of a judicial or administrative decree or order arising out of a government action that—
                1. Prohibits future violations of the antifraud provisions of the securities laws;
                2. Requires that the issuer cease and desist from violating the antifraud provisions of the securities laws; or
                3. Determines that the issuer violated the antifraud provisions of the securities laws.”
                4. Exchange Act 21E(b)(1)(A).
            4. Protection 1: Exchange Act 21E(c)(1)(A)(ii)
              1. Immateriality. Statements must be material to be actionable. 
            5. Protection 2: Exchange Act 21E(c)(1)(A)(i)
              1. Forward looking statements are protected if the statement, when made, is accompanied by meaningful cautionary language that identifies important risk factors that could alter the results. Sec. 21E(c)(1)(A)(i). “Meaningful cautionary statement” cannot be boilerplate and should include language tying risks to the issuer’s business. As risks change, the language should change.
            6. Protection 3: Exchange Act 21E(c)(1)(B)
              1. The plaintiff must prove that when the statement was made, the maker of the statement, or its officers or directors, had actual knowledge that the forward-looking statement was false or misleading. Sec. 21E(c)(1)(B).
          3. Bespeaks Caution Doctrine (Judicially-Created)
            1. Forward-looking statements are protected if when made, the forward-looking statements were coupled with cautionary language that identified the risks that eventually matured and frustrated the realization of the statement.
              1. NO Boilerplate
              2. Add information from PLSRA protection 2
          4. Other Notes:
            1. Asher v. Baxter Intern. Inc., (7th Cir. 2004) (“As long as the firm reveals the principal risks, the fact that some other event caused problems cannot be dispositive.”)
        5. Omissions 

          1. No liability for omissions unless under a duty to disclose.
          2. Such duties arise if:
            1. The defendant has a positive legal duty to disclose imposed by statute or regulation—e.g. Items in 8-K or 303(a)(3) disclosures.
            2. Defendant makes a statement that misleads absent disclosure of the omitted fact
            3. Defendant is trading under conditions that impose a duty to disclose or abstain (e.g. issuer is buying or selling its own stock)
        6. Duty to Correct/Update

          1. Rule: Duty to correct arises when the maker of a statement discovers, after making the statement, that the statement was false when they made it. This duty continues so long as the maker “knows or should know that potential investors are relying on” the false statement. The duty does not extend to statements made by third parties. Gallagher v. Abbott Labs.
          2. Rule: Duty to update arises when the make of a statement—which was true when made but later became untrue—has a duty to disclose the effect of the later events on the subject of the statement. Gallagher v. Abbott Labs.
            1. Outside of explicit, specified events under Regulation S-K, a company does not need to provide continuous disclosure of all events. 
          3. Gallagher v. Abbott Labs. (holding that Defendant did not need to continuously update/correct their prior statements on litigation since they were not incorrect when made and the 8-K was proper when they filed it to account for the event). 
      2. Scienter

        1. Rule: To succeed in a 10b-5 action, the plaintiff must adequately prove that the defendant had the requisite scienter or “a mental state embracing an intent to deceive, manipulate, or defraud.” Ernst & Ernst v. Hochfelder (1976) (finding that the statute of 10b imposes a scienter requirement from the words “manipulative,” “deceptive,” and “contrivance” meaning “intention or willful conduct”).
          1. Extreme recklessness, such as “a highly unreasonable omission” beyond simple or even inexcusable negligence, which “presents a danger of misleading buyers or sellers that is either known to the defendant or is so obvious that the actor must have been aware of it” satisfies the scienter requirement of 10b-5 actions.
        2. Scienter is imputed to a company when the corporate official who makes or issues the statement has scienter. Southland. 
          1. Scienter is imputed by the executive official to the entity if:
            1. The executive wrote or reviewed the statement;
            2. The statement was attributed to the executive with the executive’s permission
            3. The executive signed the document containing the statement
        3. Special Rules for Pleading Scienter in PRIVATE SUITS: PLSRA
          1. The complaint must, with respect to each act or omission, state “with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind. Section 21D(b)(2)(A); FRCP 9.
            1. Forward-looking statements protected by 21E must be pled with facts raising a strong inference that the statement was made with actual knowledge that it was false or misleading. Section 21 E(c)(1)(B).
          2. Tellabs test for “strong inference”:
            1. First, when faced with a 12b6 motion under a 10(b) action, courts must accept all factual allegations in the complaint as true.
            2. Second, courts must consider the complaint in its entirety, as well as other sources such as documents incorporated by reference and matters taken on judicial notice.
            3. Third, the reviewing court must determine whether the alleged facts raise such a “strong inference” and the court, in doing so, “must consider plausible nonculpable explanations for the defendant’s conduct, as well as inference favoring the plaintiff.”
            4. In sum, the reviewing court conducts a comparative analysis and must ask: when the allegations are accepted as true and taken collectively, would a reasonable person deem the inference of scienter at least as strong as any opposing inference. Section 21D(b)(2)(A); FRCP 9; Tellabs, Inc. v. Makor Issues & Rights, Ltd. (2007).
      3. “in connection with” requirement

        1. Rule: The “in connection with” requirement of 10b is satisfied when deception occurs within one of Rule 10b-5’s three subparts and occurs with the purchase or sale of a security. Zanford. 
        2. An SEC filing or a press release by the company—or even an advertisement—can satisfy this element if causes the investor to purchase or sale securities in the capital markets. Zanford.
        3. In private actions to satisfy the requirement:
          1. In a misrepresentation case, the plaintiff must have bought or sold the security after the defendant misrepresented the material fact (and, in order to rely on that fact and to prove loss, before the truth was disclosed)
          2. In an omissions case, the plaintiff must have bought or sold the security after the defendant was under a duty to disclose the omitted fact but failed to do so (and, in order to rely on the omission and to prove loss, before the omitted fact was disclosed)
    6. Elements– Private Only

      1. Standing

        1. Rule: Only actual purchasers or sellers (and the SEC) may recover damages under Rule 10b-5. Blue Chip Stamps v. Maynard Drug Stores (1975). The rule does not cover offers to sell, but only actual sales and purchases. Id. 
        2. Birnbaum bars three classes of potential plaintiffs:
          1. Potential purchasers of shares who allege that they decided not to purchase because of representations or omissions by issuer
          2. Actual shareholders in the issue who allege that they decided not to sell their shares because of representations of omissions
          3. Shareholders, creditors, and others who suffered loss in the value of their investment due to insider activities in connection with the the purchase or sale of securities.
        3. In a misrepresentation case, the plaintiff must have bought or sold the security after the defendant misrepresented the material fact (and, in order to rely on that fact and to prove loss, before the truth was disclosed)
        4. In an omissions case, the plaintiff must have bought or sold the security after the defendant was under a duty to disclose the omitted fact but failed to do so (and, in order to rely on the omission and to prove loss, before the omitted fact was disclosed)
      2. Reliance

        1. In a private action, the plaintiff must prove reliance, which can be satisfied by:
          1. Actual reliance whereby the plaintiff relies on a misstatement of the defendant and, as a result, buys or sells the security;
            1. Applies only to missrepresentations.
          2. Fraud-on-the-market reliance whereby the plaintiff is granted a presumption that they relied on a material misstatement to purchase or sell the security in an efficient market because the misstatement distorted stock prices—inducing the plaintiff to buy or sell. Basic v. Levinson.
            1. Defense: The defendant may rebut this presumption by showing (1) the challenged misrepresentation in fact did not change the stock price, or (2)the particular plaintiff would have traded regardless of the misrepresentation. Basic v. Levinson. 
            2. Note: To invoke the presumption: 
              1. The misstatement must be publicly known;
              2. The misstatement must be material;
              3. The stock must be traded in an efficient market; and
              4. The plaintiff must have traded the stock between the time when the misstatement was made and when the truth was revealed.
              5. Halliburton Co. 
          3. In Omission Cases, the plaintiff presumptively relies on an omission of a material fact if the defendant had a duty to disclose; however, this presumption may be defeated by showing the disclosure of material information would not have affected plaintiff’s trading decision. Affiliated Ute (1972) (holding omissions of material fact are granted presumptive reliance).
            1. Notes: 
              1. Plaintiff presumptively relies on omissions of material information.
              2. For half-truths, courts are split with some courts requiring reliance the half-truth (5th Cir.) and other granting presumptive reliance (2d Cir).
              3. Presumption does not apply in markets that lack information efficiency—excludes small companies in thinly traded markets.
      3. Loss Causation

        1. Rule: Plaintiffs in private actions bear the burden of proving that the act or omission of the defendant caused the loss for which the plaintiff seeks to recover. Exchange Act 21D(b)(4). To prove loss causation, the plaintiff must show that the defendant’s omission or misstatement caused, when controlling for outside factors, a change in the price of the stock after the truth or disclosure of omitted facts was revealed. Dura Pharms. 
      4. Damages—Exchange Act 21D(e)

        1. Out-of-Pocket Damages: (Presumptive Measure of Damages). The plaintiff  may recover the difference between the purchase price and value of the security at the time of sale (or vice versa for purchases).
          1. Must control to remove other factors contributing to price fluctuations
          2. Compensation equals the plaintiff’s losses.
        2. Punitive Damages: Not allowed.
          1. PLSRA Section 21D(f) limits damages to actual damages.
        3. Rescissory Damages: Arises when the fraud consists of inducing the purchase of securities that were fairly priced at the time of purchase but were riskier than represented. This measure restores the plaintiff to their original position had the event not happened.
          1. If plaintiff sold, he gets his stock back; if he purchased, he returns the stock and the seller refunds the purchase price.
          2. Only suited to face-to-face transaction
        4. Disgorgement: Arises when the defrauder received more from than the fraud than the defendant loses
          1. Only available when there is no break in the casual chain between the fraud and the defrauder’s profits. 
          2. Measure is the defrauder’s profit. 
        5. Cover Damages: Difference between the price at which the plaintiff transacted and the price at which the plaintiff could have transacted once the fraud was revealed. Section 21D(f)
        6. Proportionate Liability
          1. All defendants who knowingly violate securities laws are jointly and severally liable for the entire judgment. 
          2. Defendants found merely to be reckless are required to pay only their proportionate share of the damages caused. PLSRA 21D(f). The jury will determine their responsibility and the defendant will only pay their proportionate share unless other defendant’s are unable to pay.
  2. Insider Trading under Rule 10b-5

    1. Classical Insider Trading: Chiarella

      1. Insider or Temporary Insider
        1. Chiarella v. United States (1980) (finding no violation of insider trading because the prohibition does not arise from mere possession of nonpublic information but an affirmative duty to the corporation)
      2. Acquires (i.e. has actual knowledge) material, nonpublic information 
      3. As a result of being an insider
      4. Intended to be available only for corporate purposes and not for personal gain
      5. Has scienter because he or she knows or is reckless in not knowing that
        1. The information is nonpublic
        2. The information is material
        3. He or she has a duty not to use it for personal benefit by trading on it
      6. Trades on the basis of that information in the common or preferred stock of the insider’s company
        1. “on the basis of” means anyone who is aware of material nonpublic information at the time that he or she purchases or sells a security
      7. Without disclosing the information to opposite side trader 
        1. In an open market, this is the world.
    2. Classical Tipper Liability - Dirks

      1. Insider or temporary insider
      2. Acquires (i.e., has actual knowledge) material nonpublic info 
      3. As a result of being an insider
      4. Intended to be available only for corporate purposes and not for personal gain
      5. Deliberately passes the information to another in violation of that duty
      6. For personal benefit, and
        1. Under Dirks, a personal benefit includes:
          1. A pecuniary gain or reputational benefit that will translate to future earnings;
          2. A relationship between the insider and the recipients that suggests a quid pro quo
          3. A gift of confidential information to a trading relative or friend because the tip follows a gift of profit
          4. Salman v. U.S. (finding 10b-5 “personal gain” through gratification of helping a sibling through a nonmonetary way).
        2. Question of fact
      7. Has scienter because he or she knows or is reckless in not knowing that
        1. The information is nonpublic
        2. The information is material
        3. He or she has a duty not to use it for personal benefit by obtaining a personal benefit by passing it to others
      8. While knowing or reckless in not knowing that the passing the information on is reasonably likely to result in trading on the information
    3. Classical Tippee Liability: Dirks

      1. Insider or temporary insider 
        1. Acquires (i.e., has actual knowledge) material nonpublic info 
        2. as a result of being an insider
        3. Intended to be available only for corporate purposes and not for personal gain
          1. Salman v. U.S. (finding 10b-5 “personal gain” through gratification of helping a sibling through a nonmonetary way).
        4. Deliberately passes the information to another in violation of that duty
        5. For personal benefit
      2. Tippee 
        1. knows or should know that the insider tipper has violated his or her duty by providing the information, which includes knowing or negligent ignorance that the tipper received a personal benefit from the tip
        2. has scienter because he or she knows or is reckless in not knowing that
          1. The information is nonpublic
          2. The information is material
          3. trades on the basis of that information in the common or preferred stock of the insider’s company
        3. Without disclosing the information to opposite side traders
    4. Misappropriation Theory: O’Hagan

      1. Misappropriation Insider Trading
        1. Anyone, regardless of whether he or she is an insider at any company or not
        2. Acquires (i.e., has actual knowledge) material nonpublic info from a source to which the defendant owes a duty of trust or confidence under Rule 10b5-2, or otherwise owes a traditional fiduciary duty
        3. Has scienter because he or she knows or is reckless in not knowing that
          1. The information is nonpublic
          2. The information is material
          3. He or she has a duty not to use it for personal benefit by trading on it
        4. Trades on the basis of that information in any security issued by any company 
        5. Without disclosing to the source of the information—before trading—that he or she is going to trade
      2. Misappropriation Tipper Liability 
        1. Anyone, regardless of whether he or she is an insider at any company or not
        2. Acquires (i.e., has actual knowledge) material nonpublic info 
        3. from a source to which the defendant owes a duty of trust or confidence under Rule 10b5-2 or otherwise owes a traditional fiduciary duty
        4. Deliberately passes the information to another in violation of that duty
        5. For personal benefit
        6. Without disclosing to the source of the information—before passing on the information—that he or she is going to pass on that information
        7. While knowing or reckless in not knowing that the passing the information on is reasonably likely to result in trading on the information
        8. Has scienter because he or she knows or is reckless in not knowing that
          1. The information is nonpublic
          2. The information is material
          3. He or she has a duty not to violate the duty of trust or confidence by passing on the information
      3. Misappropriation Tippee Liability
        1. Anyone, regardless of whether he or she is an insider at any company or not
          1. Acquires (i.e., has actual knowledge) material nonpublic info 
          2. From a source to which the defendant owes a duty of trust or confidence under Rule 10b5-2 or otherwise owes a traditional fiduciary duty
          3. Deliberately passes the information to another in violation of that duty
          4. For personal benefit
        2. Tippee 
          1. Knows or should know that the tipper has violated his or her duty by providing the information
            1. Note that this is a negligence rather than a recklessness standard 
          2. Which includes knowing or negligent ignorance that the tipper received a personal benefit from the tip
          3. Has scienter because he or she knows or is reckless in not knowing that 
            1. the information is nonpublic
            2. the information is material
          4. Trades on the basis of that information in any security issued by any company
          5. Without disclosing to the source of the information—before trading—that he or she is going to trade
      4. O’Hagan: Misappropriation Theory
        1. The theory arises from the fiduciary’s duty and prohibits corporate “outsiders” from using information in breach of a duty, not owed to a trading party, but to the source of the information.
        2. It is a defense that the person receiving or obtaining the information has no duty of trust or confidence with respect to the information by establishing that he or she neither knew nor reasonably should have known that the person whom they received it from had a fiduciary relationship with the corporation or such person know or should have known that the person would not keep the information secret based on the person’s history, pattern, or past practices. O’Hagan.
          1. There is a presumptive duty of trust or confidence among family members.

    5. Notes on Insider Trading

      1. Insiders include
        1. Directors and officers;
        2. Controlling shareholders (10%+)
        3. Employees;
        4. The Corporation itself;
        5. Temporary insiders if “they have entered into a special confidential relationship in the conduct of the business of the enterprise and are given access to information for corporate purposes.” The corporation must “expect the outsider to keep the disclosed nonpublic information confidential, and the relationship at least must imply such a duty.” Chiarella.
        6. Chiarella
      2. The liability of the tipper and tippee are not interrelated; one may be convicted. 
        1. There is no requirement that the insider know or be reckless in not knowing that he or she has violated there duty under tippee liability. Hence, it is possible for a tippee to violate Rule 10b-5 even though the tipper does not. U.S. v. Evans.


  1. Public Offerings

    1. Forms

      1. Form S-1

        1. Available to all issuers
        2. Used for IPOs
        3. Items in Form S-1 are keyed to the items in Regulation S-K and Regulation S-X
        4. Prospectus under S-1 contains both company information and transaction-related information
        5. Form S-1 issuers that are Exchange Act reporting issuers and current in their filings for the past 12 months may incorporate company-related info by reference to their prior SEC filings
      2. Form S-3

        1. Issuer Requirements
          1. Organized under US law 
          2. Principal Place of Business in the US
          3. Public Company under 12(g) or 15(d) of the Exchange Act
          4. Had been the subject to 34 Act filing requirements for at least 12 months before registration statement and has been timely on those filings.
          5. Disqualification for certain financial events occur since end of last fiscal year, like
            1. Failure to pay dividend on preferred stock or
            2. Default on indebtedness in a material amount
        2. Transaction Requirements
          1. Where the issuer is selling securities for cash, the “aggregate value of the voting and non-voting common equity held by non-affiliates . . . is $75 million or more” or
            1. An affiliate under Rule 405 is a person or entity that controls the issuer, is controlled by the issuer, is under common control as the issuer, 
          2. Where the issuer is selling securities for cash and “the aggregate market value of the securities sold by or on behalf of the [issuer] . . . during the period of 12 calendar months immediately prior to, and including, the sale is no more than one-third of the aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant” and 
            1. Issuer is not a shell company and
            2. Issuer has at least one class of common equity securities listed and registered on a national securities exchange
      3. The Prospectus

        1. SEC mandates that the prospectus contain language drafted in a “clear, concise and understandable manner.” In other words, in “plain English.” The prospectus must use “short sentences,” “active voice,” and avoid “legal and highly technical business terminology.” Rule 421. 
    2. Key Terms (Types of Issuers)

      1. Non-Reporting Issuer:  Issuer not required to file reports under the Exchange Act.
      2. Unseasoned Issuer—issuer required to file reports under the Exchange Act, but is not eligible to use Form S-3 for a primary offering of its securities
      3. Seasoned Issuer: a public company that is filing reports under the Exchange Act and is eligible to use Form S-3 to register primary offerings of securities 
      4. Well Known Seasoned Issuer (WKSI): Rule 405. A public company that 
        1. Meets the issuer qualifications to use Form S-3 and
        2. As of a date within 60 days of the determination date, has either:
          1. A minimum $700 million of common equity worldwide market value held by non-affiliates; or
          2. Has issued in the last three years at least $1 billion aggregate principal amount of non-convertible securities and is offering “only non-convertible securities, other than common equity,” or will register a common equity issuance under Form S-3 and has outstanding voting and non-voting common equity held by non-affiliates of $75 million or more; and
        3. Is not an “ineligible issuer”
      5. Ineligible Issuer: Rule 405. Includes, but is not limited to, an issuer that
        1. Not current in their Exchange Act filings or late in satisfying those obligations for the preceding twelve months
        2. Is a shell company
        3. Within the past three years, the issuer or a subsidiary was the subject of a judicial or administrative decree arising from action that: prohibitions certain conduct or activities regarding the anti-fraud provisions of the securities laws, requiring the person to cease and desist from violating the anti-fraud provisions, or determines that the person violated the anti-fraud provisions.
      6. Emerging Growth Companies: an issuer with total annual gross revenues of less than $1 billion during it most recent fiscal year. 
        1. A company loses EGC status at the earliest of: [Sec. Act Sec. 2(a)(19)]
          1. Revenue exceeds $1 billion on the last day of the fiscal year;
          2. The last day of the fiscal year following the fifth anniversary of the date of the first sale of common equity in a registered public offering;
          3. The date on which the company has issued more than $1 billion in non-convertible debt aggregated over the previous three-year period; or
          4. The date on which the company is deemed to be a “large accelerated filer” (Rule 12b-2) 
            1. Rule 12b-2 defines large accelerate file as companies with over $700 million of worldwide equity float in the hands of non-affiliates among other requirements
    3. Gun-Jumping (Generally)

      1. Penalties for gun-jumping. Section 12(a)(1)
        1. Rescission or Rescission damages
        2. SEC will delay the offering causing:
          1. Disruption of the issuer’s schedule on using the funds in the future;
        3. Section 12(a)(1)

    4. Prefiling Period

      1. Generally

        1. The prefiling period begins “once a company decides to take concrete steps toward a public offering” and continues until the issuer files a registration statement.
      2. No Offers: Section 5(c)

        1. Rule: Securities Act Section 5(c) makes it unlawful for an issuer to make an offer before the filing of a registration statement. Sec. Act. Section 5(c). The definition of “offer” is broad meaning “every attempt or offer to dispose of, or solicitation of an offer to buy, a security or interest in a security, for value,” Securities Act 2(a)(3), and includes written and oral offers as well as prospectuses. Section 2(a)(10). Any communication or publicity that may “contribute to conditioning the public mind or arousing public interest” is an offer. Securities Act Release No. 3844 (1957).
        2. In Securities Act Release no. 5180 (1971), the SEC identified four factors that contribute to a communication constituting an offer including: (1) whether the issuer or underwriter instigated publicity, (2) whether the statement was for the purpose of selling the security in a public offering, (3) whether the statement was distributed to investors, and (4) whether the statement includes projections and estimates of future performance or opinions concerning value. 
        3. The following are not offers:
          1. Preliminary negotiations or agreements between an issuer and underwriter or among underwriters who are in privity of contract with an issuer. Securities Act 2(a)(3).
          2. Securities Act Release No. 5180 (1971):
            1. Continuing to advertise products or services;
            2. Continuing to release periodic reports to existing shareholders;
            3. Continuing to make press announcements concerning business facts;
            4. Answering unsolicited inquires from shareholders or analyst;
            5. Holding stockholder meetings and answering questions 
      3. No Sales: Section 5(a)(1)

        1. Rule: Until a registration statement becomes effective, the issuer may not sell securities. Sec. Act. 5(a)(1). 
      4. No Deliveries: Section 5(a)(2)

        1. Rule: Until a registration statement becomes effective, the issuer may not deliver securities. Sec. Act. 5(a)(1). 
      5. (Offer) Safe Harbor Rules During the Pre-Filing Period

        1. Preliminary Negotiations: 33 Act §2(a)(3) 

          1. Excludes preliminary negotiation and agreements between the issuer and the underwriters and among the underwriters who will be in privity with the issuer from the definition of “offer”
        2. Rule 163: Free Writing Prospectuses (only for WKSI)

          1. Availability: Only to WKSI. Rule 163(a).
          2. Exempts offers from 5(c) prohibitions
          3. Communication must be “by or on behalf of an issuer” which means that “the issuer or an agent or representative of the issuer, other than an offering participant who is an underwriter or dealer, authorizes or approves . . . release or dissemination before it is made.”
          4. Oral offers permitted
          5. Written offers are free writing prospectuses, subject to legend and failing requirements of Rule 163(b).
            1. Legend Rule 163(b)(1).
              1. Must include specific words as stated in the rule.
              2. Immaterial or unintentional failure to provide a legend not a violation if: 
                1. Good faith and reasonable attempt was made to comply with legend requirement and
                2. Written offers that are free writing prospectuses are 
                  1. retransmitted, with legend, “as soon as practicable after discovery of the omitted or incorrect legend”
                  2. “by substantially the same means as, and directed to substantially the same prospective purchasers to whom, the free writing prospectus was originally transmitted.”
            2. Filing Rule 163(b)(2)
              1. If offer made before filing of registration statement or filing of amendment covering the securities as to which the offer was made, then the free writing prospectus must be filed “promptly upon” the filing of the registration statement or the amendment
              2. Exceptions to filing
                1. “any communication that has previously been filed with, or furnished to, the Commission” or
                2. any communication “that the issuer would not be required to file with the Commission pursuant to the conditions of Rule 433 if the communication was a free writing prospectus used after the filing of the registration statement.”
              3. Immaterial or unintentional failure to timely file not a violation of 5(c) if
                1. Good faith and reasonable attempt was made to comply with filing requirement and
                2. Free writing prospectus filed “as soon as practicable after discovery of the failure to file”
        3. Rule 163A: Preregistration Communications

          1. Available to any issuer not underwriters or other participants
          2. Protects communications made “more than 30 days before” filing registration statement
          3. Does not cover a communication that “reference[s] a securities offering”
          4. Effect is that communication is not an offer under 5(c)
        4. Rule 168: Regular Communications by reporting issuers

          1. Available to issuers who are domestic reporting issuers, but not underwriters or other participants
          2. Communication is limited to the “regular release or dissemination” of “factual business communication or forward-looking information”   
            1. Factual information about the issuer, its business or financial developments, or other aspects of its business
            2. Advertisements of, or other information about, the issuer’s products or services; and
            3. Projections of the issuer’s revenues, income (loss), earnings (loss) per share, capital expenditures, dividends, capital structure, or other financial items
            4. Statements about the issuer management's plans and objectives for future operations, including plans or objectives relating to the products or services of the issuer;
            5. Statements about the issuer's future economic performance, including statements of the type contemplated by the management's discussion and analysis of financial condition and results of operation described in Item 303 of Regulation . . . S-K . . ; and
            6. Assumptions underlying or relating to any of the information described in 4–6 above
          3. Does not cover “a communication containing information about the registered offering.”
          4. “The timing, manner, and form in which the information is released or disseminated is consistent in material respects with similar past releases or disseminations”
          5. Effect is that for purposes of 2(a)(10) and 5(c) covered communication is not an offer
        5. Rule 169: Regular Communications by new issuers

          1. Available to any issuer (most importantly, to issuers that are not, before registration being considered, 34 Act public companies). Not available to underwriters.
          2. Communication is limited to “factual business information”
            1. Factual information about the issuer, its business or financial developments, or other aspects of its business
            2. Advertisements of, or other information about, the issuer’s products or services; and
            3. Unlike 168, no projections as these are not factual business information.
          3. Does not cover “a communication containing information about the registered offering.”
          4. “The timing, manner, and form in which the information is released or disseminated is consistent in material respects with similar past releases or disseminations”
          5. Effect is that for purposes of 2(a)(10) and 5(c) covered communication is not an offer
          6. NOTE: The information must be “for intended use by persons, such as customers and supplies . . . by the issuer’s employees or agents who historically have provided such information” not by potential investors. 
        6. Rule 135: Offering Notice

          1. Available to any issuer or “any person acting on behalf of either of them” whom “publishes through any medium a notice of a proposed offering to be registered.”
            1. Not available to underwriters because it cannot name underwriters.
          2. Notice is limited to:
            1. Name of issuer
            2. Title, amount and basic terms of securities offered;
            3. The amount of the offering, if any, to be made by selling security holders;
            4. The anticipated time of the offering;
            5. A brief statement of the manner and the purpose of the offering, without naming the underwriters;
            6. Whether the issuer is directing its offering to only a particular class of purchasers
          3. Effect is that notice “will not be deemed to offer . . . securities for sale”
          4. Must include a legend state that notice “does not constitute an offer of any securities for sale.”
        7. Sec. Act §5(d): Emerging Growth Companies

          1. EGC may make offers during the pre-filing period to “qualified institutional buyers” under Rule 144A and “accredited investors” under Rule 501(a)
            1. Does not apply to offers made to individuals.
          2. PC 2.1 🡪 Defines “qualified institutional buyers” and “accredited investors”
          3. Test Issue: Careful of Reg FD and selective disclosures—Unclear whether they conflict. 



  1. The Waiting Period 

    1. Generally

      1. The Waiting Period begins upon the filing of the registration statement and runs until the registration statement becomes effective. During this period, section 5(a)’s prohibition on sale and deliveries remain in effect; however, section 5(c)’s prohibition on offers is lifted. Section 5(b)(1)’s restriction are now imposed prohibiting the issuer from distributing a prospectus unless it complies with Section 10 of the Securities Act.
    2. Permitted Offers: §5(c) Prohibition Lifted

      1. Oral offers
        1. Including road shows
        2. Graphics presented real time at road shows but not distributed in hard copy 
      2. Offers by a prospectus that complies with Section 10
        1. Preliminary Propspectus 
        2. Free Writing Prospectuses under rule 164 and 433


  1. Written Offers: Permissible, but Prospectus must comply with 10(b): §5(b)(1)

    1. While §5(c) prohibition on offers is lifted, the issuer may not distribute a prospectus unless it complies with Section 10. Section 5(b)(1). A prospectus is any communication “written or by radio or television, which offers any security for sale;” therefore, a written offer is usually a prospectus, but an oral offer is not. Sec. Act. Section 2(a)(10). 
      1. NOTE: FIRST CHECK TO SEE IF IT IS AN OFFER. NOT AN OFFER🡪NOT A PROSPECTUS
    2. Section 10(b) prospectuses that may be used include: the preliminary statutory prospectus under Rule 430 and free writing prospectuses under Rule 164/433. 
  2. No Sales: Section 5(a)(1)

    1. Rule: Until a registration statement becomes effective, the issuer may not sell securities. Sec. Act. 5(a)(1). 
  3. No Deliveries: Section 5(a)(2)

    1. Rule: Until a registration statement becomes effective, the issuer may not deliver securities. Sec. Act. 5(a)(1). 
  4. Safe Harbor Rules During the Waiting Period

    1. Rule 134: Identifying Statements

      1. Available to issuer, UW and other participants
      2. Requires
        1. Communication to be limited to certain information about the issuer and security, Rule 134(a)
        2. A legend, Rule 134(b)(1), 
        3. Can avoid legend if accompanied by or preceding the statement with the preliminary prospectus, Rule 134(c)(2) or limiting the communication to a tombstone, or basic advertisement, Rule 134(c)
      3. Solicitation of Interest
        1. If a preliminary prospectus accompanies or precedes a rule 134 communication, the communication may solicit an offer to buy or a less formal indication of interest so long as a mandatory boilerplate legend advising the investor of his or her right to revoke the offer to buy prior to acceptance and that indications of interest involve no legal obligation are included. Rule 134(d).
    2. Rule 135: Offering Notice

      1. Available to any issuer or “any person acting on behalf of either of them” whom “publishes through any medium a notice of a proposed offering to be registered.”
        1. Not available to underwriters because it cannot name underwriters.
      2. Notice is limited to:
        1. Name of issuer
        2. Title, amount and basic terms of securities offered;
        3. The amount of the offering, if any, to be made by selling security holders;
        4. The anticipated time of the offering;
        5. A brief statement of the manner and the purpose of the offering, without naming the underwriters;
        6. Whether the issuer is directing its offering to only a particular class of purchasers
      3. Effect is that notice “will not be deemed to offer . . . securities for sale”
      4. Must include a legend state that notice “does not constitute an offer of any securities for sale.”
    3. Rule 164/433: Free Writing Prospectuses

      1. Available to issuer, underwriter or other participant
      2. A free writing prospectus is any written communication to offer a security that is or will be subject to a registration statement and that does not meet the requirements a Section 10 statutory final or preliminary prospectus and include written, printed, broadcast, and graphic communications. 
      3. For a issuer to seek 164/433 protection, the following conditions under rule 433 must be satisfied:
        1. FWP must include a legend
        2. FWP must be accompanied by (or linked to) the preliminary/final prospectus
          1. Does not apply to seasoned issuers/WKSIs
        3. Must file the FWP with the SEC on the date of first use
          1. Must retain FWP for three years, if not filed with the SEC
      4. Other Notes:
        1. Rule 433(c)(1) allows inclusion in the protected FWP of “information the substance of which is not included in the registration statement” provided that this information does not conflict with the registration statement or information incorporated into the registration by reference.
    4. Rule 168: Regular Communications by reporting issuers

      1. Available to issuers who are domestic reporting issuers, but not underwriters or other participants
      2. Communication is limited to the “regular release or dissemination” of “factual business communication or forward-looking information”   
        1. Factual information about the issuer, its business or financial developments, or other aspects of its business
        2. Advertisements of, or other information about, the issuer’s products or services; and
        3. Projections of the issuer’s revenues, income (loss), earnings (loss) per share, capital expenditures, dividends, capital structure, or other financial items
        4. Statements about the issuer management's plans and objectives for future operations, including plans or objectives relating to the products or services of the issuer;
        5. Statements about the issuer's future economic performance, including statements of the type contemplated by the management's discussion and analysis of financial condition and results of operation described in Item 303 of Regulation . . . S-K . . ; and
        6. Assumptions underlying or relating to any of the information described in 4–6 above
      3. Does not cover “a communication containing information about the registered offering.”
      4. “The timing, manner, and form in which the information is released or disseminated is consistent in material respects with similar past releases or disseminations”
      5. Effect is that for purposes of 2(a)(10) and 5(c) covered communication is not an offer
    5. Rule 169: Regular Communications by new issuers

      1. Available to any issuer (most importantly, to issuers that are not, before registration being considered, 34 Act public companies). Not available to underwriters.
      2. Communication is limited to “factual business information”
        1. Factual information about the issuer, its business or financial developments, or other aspects of its business
        2. Advertisements of, or other information about, the issuer’s products or services; and
        3. Unlike 168, no projections as these are not factual business information.
      3. Does not cover “a communication containing information about the registered offering.”
      4. “The timing, manner, and form in which the information is released or disseminated is consistent in material respects with similar past releases or disseminations”
      5. Effect is that for purposes of 2(a)(10) and 5(c) covered communication is not an offer
      6. NOTE: The information must be “for intended use by persons, such as customers and supplies . . . by the issuer’s employees or agents who historically have provided such information” not by potential investors. 
    6. Rule 405/433: Road Shows

    7. Rule 433: Press Interviews

      1. The company can turn the press interview into a free writing prospectus under rules 164/433. To do so the company must:
        1. File a copy of the transcript or
        2. File a copy of an article
      2. With the SEC within four days of the date the company became aware of the publication. Rule 433(f)(1)(ii), (2)(iii).
      3. Further, the filing should contain the Rule 433(c)(2)(i) legend, and the interviewer does not pay for the interview through direct payment or a promise of future advertising, rule 433(f)(1)(i),(ii), and
      4. The issuer, underwriter, and other participants are not affiliated with the media company, rule 433(f), the company will be excused from taking the following steps that would be needed to turn the public into a free writing prospectus:
        1. Accompany or precede each copy of the writing with the most recent preliminary prospectus, rule 433(c)(2)
        2. Place a legend on each copy of the interview, rule 433(c)(2)(i), and 
        3. File the article no later than the first date of its distribution (which is now impossible). Rule 433(f).
    8. Sec. Act §5(d): Emerging Growth Companies

      1. EGC may make offers during the pre-filing period to “qualified institutional buyers” under Rule 144A and “accredited investors” under Rule 501(a)
        1. Does not apply to offers made to individuals.
      2. PC 2.1 🡪 Defines “qualified institutional buyers” and “accredited investors”
      3. Test Issue: Careful of Reg FD and selective disclosures—Unclear whether they conflict. 
  1. Post-Effective Period

    1. No prospectus unless complies with §10: Section 5(b)(1) continues

    2. No deliveries unless accompanied by final prospectus. Section 5(b)(2)



  1. Exempt Offerings (Private Offerings)

    1. Penalties

      1. An offering must either be registered or meet the requirements for an exemption, otherwise the sale violates section 5(a). If offering is sold in violation of 5(a), then the SEC may bring an enforcement action seeking rescission under section 12(a)(1). The elements of a 12(a)(1) actions are simply: plaintiff is a purchaser, defendant is a seller, and the offering is sold without registration.
    2. Section 4(a)(2) Offerings

      1. Rule: Section 4(a)(2) states that Section 5 shall not apply transaction by an issuer not involving any public offering. 
        1. Issuer is defined by Section 2(a)(4).
      2. Under Section 4(a)(2), the issuer turns on whether an offering is public and such determination turns on “whether the particular class of persons affected need the protection of the Act.” SEC v. Ralston (1953) (finding that some employees need the protection of the Act and other may not). 
      3. In Securities Act Release no. 285 (1935), the SEC released several factors that determine whether an offering is “public” as the word is used in section 4(a)(2), including
        1. The number of offerees;
          1. THE INQUIRY IS NOT ON THE NUMBER OF PURCAHSERS. Doran.
          2. More offerees 🡪 leans public
          3. Less offerees, or few sophisticated 🡪 leans private
        2. The relationship of the offerees to each other and the issuer;
          1. Under this rule, for it to weigh in favor of the exemption, courts utilize the disclosure or access rule (Doran) to ensure the offerees have adequate information and protection. This rule requires that the
          2. Issuer must provide, as to all offerees, either 
            1. Disclosure, which requires that the issuer in fact provides information that a registration statement would have provided and offerees perhaps must have sophistication with which to evaluate the information, OR
            2. Access, which requires that offerees have access (by executive position at issuer, family ties, bargaining power, agreement, or otherwise) to the records of the company that contain relevant information (sufficiently similar to a registration statement in public offerings) and offerees are sufficiently sophisticated that they could obtain the necessary information and evaluate the risks and merits of the investment
              1. High standard of sophistication for access than disclosure.
        3. Number of units offered;
          1. More units 🡪 Leans public
          2. Less units 🡪 Leans private
        4. Size of offering (total dollar amount)
          1. Greater amount 🡪 leans public
          2. Less amount 🡪 leans private
        5. Manner of offering
          1. Cannot include a general solicitation
          2. General solicitation 🡪 Public
      4. Issuer must at lease show:
        1. Disclosure or Access (Factor 2)
        2. No general solicitation (Factor 5)
    3. Regulation D (When a company complies with 4(a)(2))

      1. Rule 504

        1. Aggregate Price: $5 Million. Rule 504(b)(2).
        2. Purchaser Limit: No limit
        3. General Solicitations: Maybe
          1. Generally, rule 502(c) bans “any form of general solicitations or general advertisements;” however, rule 504(b)(1) exempts the issuer from this ban if the issuer registers such and delivers a “substantive disclosure document” to purchasers in accordance with state law. 
        4. Disclosure: Not required to give disclosure to accredited or non-accredited. 
        5. Resales: Securities under regulation D cannot be resold , 502(d), unless the resale complies with state law restrictions under ruel 504(b)(1)
      2. Rule 506(b)

        1. Aggregate Price: No limit.
        2. Purchaser Limit: Accredited investors plus up to 35 non-accredited investors that meet rule 506(b)(2)(ii) sophistication requirements.
          1. Excludes from the 35 investor limit:
            1. Accredited investors under rule 501(a), see rule 501(e)(1)(iv),
            2. Any family member of the purchaser who has the same primary residence as the purchaser, rule 501(e)(1)(i).
          2. Sophistication Requirements for non-accredited investors
            1. Under rule 506(b), all non-accredited investors—either alone or with a purchaser representative
            2. —must have “such knowledge and experience in financial and business matters that he is capable of evaluating the merits and risks of the prospective investment.” Rule 506(b)(2)(ii).
            3. Issuer must reasonably believe, immediately prior or at the time of sale, that each purchaser meets the definition of accredited investor. A self-verification by purchaser (e.g. a statement that they have a net worth greater than $1 million) is sufficient to effect a reasonable belief, provided that the issuer does not facts that call the statement into question. 
        3. General Solicitations: Rule 502(c) bans “any form of general solicitations or general advertisements;” therefore, under Rule 506(b) offerings, general solicitations are banned.
        4. Disclosures:
          1. Accredited Investors: No disclosures required.
          2. Non-Accredited Investors: Disclosure Required. Rule 502(b).
            1. Prior to the sale, the issuer must furnisher to a non-accreditor investor “a brief description in writing of any material written information concernin the offering . . . upon [the investor’s] written request” in a easonable time. Rule 502(b)(2)(iv).
            2. Prior to sale, issuer must make available to each purchaser at a reasonable time prior to purchase, an opportunity to ask questions and receive answers concerning the terms and conditions of the offering.” Rule 502(b)(2)(v).
            3. Prior to sale, investor must advise the purchase of the limitations on resale. Rule 502(b)(2)(vii).
        5. Resales: Resales under rule 506 are prohibited by rule 502(d). Rule 502(d) imposes a requirement on the issuer to take reasonable care to discourage investors from reselling the securities including disclosing in writing the unregistered status of the securities and placing a legend on those securities. Rule 502(d). 
      3. Rule 506(c)

        1. Aggregate Price: No limit.
        2. Purchaser Limit: Only to accredited investors 
          1. Issuer must reasonably believe, immediately prior or at the time of sale, that each purchaser meets the definition of accredited investor. A self-verification by purchaser (e.g. a statement that they have a net worth greater than $1 million) is sufficient to effect a reasonable belief, provided that the issuer does not facts that call the statement into question. Rule 506(c)(2)(ii).
            1. Net worth requires verification through the individuals financial statements. Rule 502(c)(2)(ii)(B).
        3. General Solicitations: Generally, rule 502(c) bans “any form of general solicitations or general advertisements;” however, rule 506(c)(1) requires that offering companies under 506(c) comply with rule 502(a), (d), not (c) and therefore companies under rule 502(c) are not banned from general solicitations (though, they may only sale and offer securities to accredited investors under 506(c)(2)(i)). 
        4. Disclosure: Not required because 506(c) only has accredited investors.
        5. Resales: Resales under rule 506 are prohibited by rule 502(d). Rule 502(d) imposes a requirement on the issuer to take reasonable care to discourage investors from reselling the securities including disclosing in writing the unregistered status of the securities and placing a legend on those securities. Rule 502(d). 

      4. Defined: Accredited Investors. Rule 501(a).

        1. “Any director, executive officer, or general partner of the issuer.” Rule 501(a)(4).
        2. Any natural person with a net worth of $1 million exclusive of their primary residence. Rule 501(a)(5).
        3. Any natural person who received $200,000 in come (or $300,000 with a spouse) during each of the last two years and have a reasonable expectation of receiving that much in the current year. Rule 501(a)(6).
        4. Any partnership or corporation with more than $5 million in assets, provided that it was not formed for the specific purpose of acquiring the securities in the offering. Rule 501(a)(3).
      5. Defined: Purchaser Representative. Rule 501(i). [For 506(b) usage]

        1. Under 501(i), to qualify as a purchaser representative:
          1. The representative cannot be an officer, director, employee, or major shareholder of the issuer except where the representative is a close relative of the purchaser, rule 501(i)(1),
          2. The representative must have such knowledge and experience in financial and business matters that hey are capable of evaluating the merits and riks of the prospective investment, rule 501(i)(2),
          3. The purchaser must acknowledge in writing that the representative is their representative for evaluating the particular offer, rule 501(i)(3),
          4. The representative must disclose to the purchase any material relationship between them and any affiliates or the issuer, rule 501(i)(4).
      6. General Solicitations – 502(c) Prohibition

        1. Rule 502(c) bans general solicitaitons
        2. Under each offering:
          1. 504: Allowed if meeting certain requirements
          2. 506(b): Banned
          3. 506(c): Allowed only to accredited investors.
        3. Whether a solicitation is a general solicitation is fact specific and depends on the whether the issuer and offeree have a preexisting relationship of the sort that allows the offeror to assess sophistication. SEC Release No. 6825 (1989).
        4. Targeted solicitation of very sophisticated purchasers may not constitute general solicitation even if the issuer does not have a pre-existing relationship. SEC Release No. 6825 (1989).
      7. Resales – 502(d) Prohibition

        1. Resales are prohibited under Rule 502(d).
        2. Rule 504: Prohibit unless complies with 504(b)(1).
        3. Rule 506: Resales under rule 506 are prohibited by rule 502(d), which imposes a requirement on the issuer to take reasonable care to discourage investors from reselling the securities including disclosing in writing the unregistered status of the securities and placing a legend on those securities. Rule 502(d). 
      8. Integration – Rule 502(a)

        1. Integration prevents an issuer from dividing an offering into pieces claiming exemption from registration for each piece when the offering, considered as a whole, would not satisfy the criteria for any exemption.
        2. Five Factor Test for Integration
          1. Whether the sales are part of a single plan of financing—look to timing of financing plan and manner of sale (also planned use of proceeds; same facts here may also be useful for factor five)
          2. Whether the sales involve issuance of the same class of securities
          3. Whether the sales are made at or about the same time from Registration
          4. Whether the issuer receives the same type of consideration—not too important if consideration is cash, as the great majority of securities sales are for cash
          5. Whether the sales are made for the same general purpose—look to plan for and actual use of proceeds
            1. Factors 1, 5 are most important but no factor is dispositive.
        3. Integration Safe Harbors under 502(a).
          1. An offering that ends more than 6 months before the Reg D offering begins will not be integrated into that Reg D offering;
          2. An offering that begins more than 6 months after a Reg D offering ends will not be integrated into that Reg D offering
          3. Protects a Reg D offering from having another offering integrated into the Reg D offering where the other offering is separated from the Reg D offering by more than 6 months
          4. Safe harbor conditioned on no sales of same or similar class of security during either of the 6-month periods on either side of the Reg D offering
        4. Effect of Integration: 
          1. All offers and sales, in each offering into which another offering is integrated, must be considered when determining whether the offering, after integration, is exempt from registration.
            1. So, integration may prevent satisfaction of the requirements of Reg because, after integration, an integrated offering exceeds applicable aggregate offering price or purchaser limits.
      9. Innocent and Insignificant Mistakes – Rule 508

        1. Under rule 508, insignificant deviations from conditions in a Regulation D exemption will not cause the loss of the exemption for the purposes of a 12(a)(1) rescission action by purchasers in the offering so long as the issuer made a “good faith and reasonable attempt . . . to comply with all applicable terms, conditions and requirements.” Rule 508(a)(3).
        2. The following failures cannot be excused by rule 508(a) because they are “significant to the offering as a whole:”
          1. Violation of the $5 million aggregate price limit under 504 offerings;
          2. Violations of the prohibition on general solicitations in 504 or 506(b);
          3. Violations of the 35 Purchaser limitations in a 506(b) offering
        3. Does not block an enforcement action by the SEC.
    4. Intrastate Exemptions

      1. Section 3(a)(11) Statutory Exemption

        1. For section 3(a)(11) exemption to apply all offers and sales must only be to residents of the state of the issuer and an issuer must also be a resident “doing business in” the same state; accordingly, and any offer or sale to a non-resident will render the exemption unavailable. Securities Act 3(a)(11).
        2. Residence (Purchaser/Issuer)
          1. The residence of a natural person means the natural person’s domicile: the place where the natural person has (1) presence through a true, fixed home and (2) an intent to return or remain indefinitely.
          2. Residence of a corporation or other entity organized under state law is the place of incorporation or organization.
          3. The residence of an unorganized entity such as a general partnership or sole proprietorship is the state with its principal place of business. 
          4. A single offer to an out-of-stater loses the exemption.
        3. “Doing Business In” Requirement (Only Issuer)
          1. Under section 3(a)(11), the issuer must also be doing business in the state which it is offering the securities. The requirement of doing business in refers to revenue-generating activity in the issuer’s home state and non-revenue generating activity such as merely setting up an office or conducting substantially all income-producing operations elsewhere does not satisfy this requirement. Busch v. Carpenter (10th Cir. 1987).
          2. Accordingly, the issuer must also intend to use any income derived from the offering for business activity within the state—they cannot intend to use the majority of funds for foreign state activities. 
        4. Restrictions on Resales: Coming to Rest
          1. Securities must “come to rest” in the hands of a resident of issuer’s state. SEC Release 4434 (1961). 
          2. An offering may be so large that it is impracticable that it will come to rest in one state. SEC Release 4434 (1961).
          3. The securities must come to rest in a resident of the state. A quick resale by purchaser suggests that the stock did not come to rest in the hands of a resident-puchaser; however, this alone may or may not void the exemption. SEC Release 4434 (1961).
      2. Rule 147

        1. Issuer:
          1. Under rule 147, all offers and sales are limited to resident of the same state in which the issuer is a resident and doing business in the same. Rule 147(c). 
          2. An issuer is deemed a resident if
            1. A corporation or entity organized under state law, it is incorporated and organized in that state and it has its principal place of business—where the executives primarily direct, control, and coordinate the company’s activities—in the same. Rule 147(c)(1)(i).
            2. An unorganized entity has its residence at its principal place of business—where the executives primarily direct, control, and coordinate the company’s activities. Rule 147(c)(1)(ii).
            3. A natural person is a residence where its principal residence is located. Rule 1479c)(1)(iii). 
          3. Further, a issuer must be doing business in the same state which means that it satisfies at least one of the following under rule 147(c)(2)(i)–(iv):
            1. It derives more than 80% of its gross revenues from in-state operations;
            2. It has more than 80% of its assets within the state; 
            3. It intends to use more than 80% of the proceeds from the offering for its business in the state; or
            4. A majority of the issuer’s employees are located in the state. 
        2. Offerees: Rule 147(d)
          1. An issuer may only make offers and sale to residers in which the issuer is a resident and who the issuer “reasonably believes” to be residents at the time of the offer or sale; therefore, a single offer to an out-of-state resident causes the issuer to lose the exemption unless the issuer reasonably believes that the offeree was an in-stater. Rule 147(d).
          2. Residence for offerees is determined by: 
            1. For a corporation or other business entity—organized or unorganized—the state of its principal place of business (i.e. where the executives primarily direct, control, and coordinate the company’s activities), rule 147(d)(1).
            2. For an individual, the state in which they maintain their principal residence, rule 147(d)(2)
            3. For businesses organized for the specific purpose of acquiring securities offered under rule 147, the business is only a resident if all beneficial owners are residents of the state, rule 147(d)(3). 
        3. Limitations on Resale: Rule 147(e).
          1. For a period of six-months from the date of sale, any resale may only be made to residents within the state. Rule 147(e). Accordingly, the issuer must take steps to prevent resale before this time including by placing a legend on the certificate, issuing a stop transfer instruction to the issuer’s transfer agent, or obtaining a written representation from each purchaser. Rule 147(f).
            1. If they sell before the six-month period, the securities have not “come to rest.”
            2. NO INSIGNIFCANT MISTAKES PROVISIONS
        4. Anti-Integration Safe Harbor
          1. A 147 offering will not be integrated with offers or sales made prior to the commencement of the current 147 offering or made thereafter if they are made more than six months after the 147 offering ends. Rule 147(g).
      3. Rule 147A (Use 147) except:

        1. Issuers:
          1. Issuer need not be incorporated or organized in the state (if a corporation) or organized in the state (if an entity other than a corporation); but must have its principal place of business in the state and must meet the same “doing business” test as under 147
        2. Offerees:
          1. Offers (but not sales) not limited to residents of the issuer’s state; so offers by internet are permitted. ALL SALES MUST STILL BE TO RESIDENTS. Rule 147A(d).
        3. Essentially: No general solicitation under 147 but may have general solicitation under 147A.
  2. 12(a)(1) Rescission Actions

    1. 12(a)(1) is a rescission action by the a purchaser or the SEC for violation of section 5. The defendant cannot rely on an exemption unless
      1. The defendant cam provide proof that the offering met the terms, conditions, and requirements of the exemption or
      2. Any failure to comply with a term, requirement, or condition for a regulation D offering is excused by rule 508 (insignificant mistakes)
    2. Proper defendant in a 12(a)(1) action must “sell” the security to the plaintiff—i.e. must be a statutory seller under section 12.
      1. Statutory sellers include, and proper defendant must fit into, one of the following categories:
        1. Owner that passes title to the security to the defendant for value;
        2. Someone who solicits the purchaser to buy the security, motivated at least in part by a desire to serve their financial interest
          1. Majority View: Solicitation more than simply preparing offering disclosure documents is required; playing a professional role (accountant, lawyer etc) is not enough)
            1. Thus, sellers include (i) the issuer, (ii) officers or employees of the issuer who sell the securities by personally urging offerees to buy, (iii) and placement agents and broker/dealers who sell by personally urging offerees to buy
    3. Recovery in 12(a)(1) Action
      1. If purchaser has not resold the security:
        1. Return security to issuer
        2. Receive: Amount paid plus interest less any income received from holding the security
      2. If purchaser has resold the security
        1. Receive: amount paid plus interest less any income received from holding less price received on resale