Securities Regulation Hypos

HYPO: Let’s say the facts are identical. You buy the piece of the orange field and get a service K. You get a crate of oranges on your doorstep—is that a security?

1-Invesment of money: YES2-Common enterprise: YES3-Profits: NO—oranges

-Similar to Forman case, getting use, not profits-But can make arguments regarding selling oranges and getting money-But, you do want the use of the oranges

4-From efforts of others: YES

HYPO: Let’s say that you get forged certificates. Can see the D arguing that this is NOT a security.-What makes it a security is WHAT IS OFFERED, not what is sold-If they offer you stock in what they claim is a company, that matters—not what they claim is a company

HYPO: What if you pay money to be a member of Sam’s Club?1-Investment of money: YES2-Common enterprise: YES3-Profits: NO

-You are expecting to get STUFF-You might get it at a discount-This reminds us of Forman: what you are expected to get from the Co-op is the USE of the Co-Op AT A DISCOUNT

4-From efforts of others: YES

Problem 2-1 (pg. 34):In 1989, Reuters carried a story describing Jaguar’s plans to develop the XJ220, a 200 mph sports car, to be sold for $587,000. The story continued:

Jaguar unveiled a prototype of the XJ220 last year, but execs feared it would never go on sale because flagging profits would prevent production. Customers are being asked to put down a deposit of $80,000 but will have to wait until 1992 before the first models roll off the production line. The wait could be worth it. The Times newspaper estimated that collectors would be prepared to pay $1.6 million for one of the cars.

Under U.S. law, was Jaguar selling investment contracts? Howey Test:

1) Investing money: YES2) Common enterprise: YES3) Expectation of profits: NO

a. Might expect to get a profit, but looks like car is for personal consumptionb. Are you trying to get money or use the car?

i. In the facts, it does say that they get you to buy in here is that you could sell 3 x as much once you get it: maybe this would be a security

1. Might be able to re-sell for a normal price because it depreciates the normal way: would mean you are buying for use

2. But, if the big goal is that you are offering this because you might be getting a huge discount: might be similar to a security

a. Kind of situation where securities laws are neededb. People who do not know about engineering of cars, etc—need protection of

securities laws 4) From efforts of others: YES

a. You are not making the car

Problem 2-2 on pg. 40:MPI is in the business of managing commercial real estate. It has sold $90 million in debt securities to 20 investors; the proceeds will be used by MPI to acquire eight suburban shopping centers that it will renovate and manage. To raise an

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additional $10 million needed to complete the acquisition, MPI has entered into an agreement with Handsome Trust. Under the agreement, Handsome will invest $10 million and will have the right to a substantial percentage of the net profits of the eight properties if and when a certain income threshold has been passed. Has Handsome purchased an investment contract? Does the answer depend upon which theory of common enterprise is employed? Is there any listed specific kind of security that fits this?

-Above a certain threshold, they share profits: profit-sharing agreements-Do we respect a label like this?

-From Forman, we do not respect automatically this label Howey test:

1) Invest money: YES2) Common enterprise: need to do tests

a. Horizontal commonality: Probably i. One way: there is not anyone investing in the same way that he is

ii. Other way: even though the details are different, all investing in the same enterprise and will all get profits

1. Professor: Court will likely come out this way b. Vertical commonality: Probably

i. Broad: Do the fortunes of the last investor depend on the fortunes of the promoter? YES ii. Strict: Sharing profits after a certain point—sharing the risks: YES

1. The entrepreneur will hope that the shopping centers are a big success 2. Both of their fortunes are tied to the success of the shopping centers

3) Expectation of profits: YES4) From the efforts of others: YES

Problem 2-3 on pg. 41:SG Trading Company maintains a website allowing individuals to play a game called ‘StockGeneration.” The

lure of this game is easy money, or as is stated on the website, “Would you like your money to double each month? Then welcome to the Virtual Stock Exchange SG.”

The game allows participants to purchase shares in eleven different virtual companies on the websites virtual stock exchange. Although the companies are fantasy companies that exist only in cyberspace, participants invest real money in this game. SG arbitrarily sets the purchase and sales price of each of the virtual companies (adjusted biweekly) and guarantees that investors can buy or sell any quantity of shares at the posted prices. Invested funds are pooled in a single account used to settle participants’ online transactions. SG believes that the system will work as long as the base of investors continues to grow. To ensure that condition, SG promises to pay StockGeneration participants who recruit new participants bonuses equal to 20 percent of the new recruits’ payments.

SG also promises that the share price for one “privileged company” will continuously rise and that investors in that company will enjoy a 10% per month return. To make sure that this happens, SG pledges that it will allocate a portion of its profits derived from its website operations to a special reserve fund designed to support the price of the privileged company’s shares.

Does this game involve an investment contract?--Promises return, 20% in recruiting new people (Panzi scheme : how Madoff was allowed to succeed, allowed new people to pay off the returns to the old)--Is this fake stock investment a security?

1) Investment of money: YES2) Common enterprise:

-Horizontal commonality: YES-Bunch of people providing money here

-Vertical commonality: -Broad: success of their company depends on if you do well too-Strict: the returns you get are based on how well the entrepreneurs run the business

3) Expectation of profits:-D could argue that this was just fun and games-Playing it to get a profit? Question of fact

-Certain gambling games you play just because they are fun-Ex: going to Las Vegas even though you know you are going to lose money

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-How would this issue be resolved?-Look at the reasonable expectations were-What would a reasonable person think?

-Promised a certain return, etc…-Just something to use?

4) From the efforts of others: YES-Certainly some participation from the investors of others-But, not enough to take us out -RULE IS MAINLY FROM THE EFFORTS OF OTHERS-Profitability for the investor is from the efforts of others

Problem 2-5 on pg. 45:McSushi, Inc. has been formed to develop Japanese fast food restaurants. Its initial capitalization is very small, and the plan is to raise funds to promote the concept and gain public recognition by selling franchises to operate specific restaurants. For an investment of $35,000 plus a percentage of gross receipts, McSushi will train franchisees in the preparation of Japanese food, provide equipment needed in the restaurants, engage in extensive advertising to promote the McSushi lable, and supervise the restaurants to ensure quality control and uniformity of operation. Both food and uniforms must be purchased from McSushi. The franchisees are expected to work as on-site managers. They may, however, establish menu prices and engage in local promotions. Are these franchises securities?HYPO: What about Franchises?

-Not mainly from the efforts of others, therefore NO-Securities laws do not protect franchisees

Problem 2-4 on pg. 45:Belmont Reid needs funds to develop its gold mines. It offers to sell gold, in the form of coins, directly to investors. The coins are sold in sets of 12. The price is at a substantial discount to the world market price of gold at the time of the offering. Delivery of the coins will be in the future, and purchasers are advised that the gold required to mint the coins has not yet been extracted. In the event the world market price of gold declines to a level below the prepayment price, Belmont Reid promises to refund the difference to purchasers. To secure both its guarantee and its performance, Belmont Reid puts the deed to one of its mines in a trust account. Is Belmont Reid selling a security? Does your answer depend upon whether the sales are made during a period in which the price of gold is rising? Howey Test:

1) Investment of money: YES2) Common enterprise: YES, lots investing3) Expectation of profits: YES4) Efforts of others: NO

a. Whether your profits exist or don’t exist depends on the market price—all the person is is a gold broker

b. BUT, there is a fact that they are selling the price at BELOW market price: do they have access to superior mining technology?

i. If that is what is going on, then their profits do depend on their ability to mineii. The fact that they are offering the price at below market price does not necessarily mean that

they have this technology right now Good chance that this will not be treated as a security

Does it matter that they do not have the gold right now? -Still have to pull the gold out of the ground-Professor: maybe

Problem 2-6 on pg. 48:Sam has agreed to purchase Hillary’s real estate brokerage business, Vistas, Inc. The parties are exploring alternative ways to structure the transaction. Hillary would like for Sam simply to purchase her stock in Vistas, but Sam would prefer to use a corporation he owns to purchase all of the assets and assume all of the liabilities of Vistas. In either case, Sam winds up owning Hillary’s business. How does the structure of the transaction affect the analysis of whether it involves a security?

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Can all the stock in the company and get money, or you can keep all the stock and trade all the assets (machines, etc) and require the buyer to assume all the liabilities

-You end up with MONEY versus a company-Which way should you set up this deal?

Sell the assets so you are not subject to the securities regulation-What motivated the seller was the fact he sold the stock

-Had to give money back-Had he kept the stock and sold the assets, no securities

Problem 2-7 on pg. 48:CART organizes auto races, most notably the Indianapolis 500. A share of stock in CART makes the holder a member of CART, which is a condition to participating in the races. No owner may enter a car in a race without the membership that is liked to CART stock ownership. Transfer of any CART shares requires approval of CART’s board, which may be had only if CART determines that the buyer is fit to race. Failure of a CART shareholder to participate in races may lead to a redemption of the shareholder’s stock. CART shareholders elect the board. They also are entitled to dividends, although historically, CART’s profit distributions have been minimal and the stock’s major attraction is the opportunity it provides to generate income from racing and consequent endorsements. Is stock in CART a security? Do you need additional information? Car racers buy stock in organization in order to race their cars. Is this a security? Let’s suppose that someone buys this stock and they don’t get the benefits they expected and want to get their money back. Should they be able to argue that the stock complied with the security laws?

-Similar to Forman case-Expectation of profits?

-May not wind up getting money-May just like to race cars-Seems to be a factual issue

-From others-Also depends on you and others-“Mainly” from the efforts of others

Will see in partnerships that if you participate at all substantially, then the “efforts of others” will not be satisfied

Interests in Limited Partnerships

Problem 2-8 on pg. 56Hibbert and Hubbert is a law firm headquartered in NY. The firm has more than 400 partners and branch offices in eight cities. Because of the departure of a probate lawyer in the LA office, Hibbert made an offer of partnership last year to Slickperson, a senior associate at another firm. Under the terms of the offer, Slickperson will make a modest capital contribution of $35,000. Slickperson’s income from the partnership pwill be set by a compensation committee on the basis of Slickperson’s productivity (measured by billable hours collected and clients brought to the firm). Slickperson was given only abbreviated financial statements on the firm and was led to believe it would be unseemly to push for more information. No disclosures were made that the partners in the Miami, Dc, and SF offices were about to leave and establish their own firms. Now, the partners have left, leaving the firm in dire financial straits. Is Slickperson’s partnership interest a security? Would it make any difference if the firm was a professional corporation, rather than a partnership? Not contributing as much; others are more responsible—mainly from the efforts of others that efforts of others evolves The hypothetical talks about guy being inexperienced—would have to look and see if the people who manage the firm have unique skills as well

Let’s suppose you are at a firm where “you eat what you kill.” Would your efforts based on your own or efforts or others?

-Still would come from efforts or others (question of fact)-Reason you are part of the firm is that you think you’d do better in a firm

Interest in LLCs

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Problem 2-9: Would likely find it to be a security

Real Estate as Security

HYPO: What if I just sell you land and convince you that it will appreciate a lot? Your land is right next to Disneyland and it is worth a lot of money. Is this a security?

1) Investing money2) Common enterprise: NO

a. Once the seller sells, not doing anything3) Expectation of profits: depends on what you use the land for4) Efforts of others

Problems2-11: Karla is a broker with an addiction to gambling known only to her family. To pay some overdue debts, she borrows money from 10 of her clients, issuing each a promissory notes bearing 8 percent interest and payable on demand. The clients, who are not terribly sophisticated in financial matters, are happy with this arrangement because the return it offers is much higher than they had been receiving in their money market accounts. Are Karla’s notes securities? Would your analysis change if each of the clients was highly sophisticated in financial matters? Starts with the presumption that it is a security Look to list to see if it is not a security: doesn’t fall on list Now, look to see if additional exception ought to be added with list:

1) Motivation: Buyer’s motivation was to generate investment income2) Trading to a broad distribution: not that broad

-Sophistication level: not that sophisticated 3) Reasonable expectations of investors

-Raising money-Investing in a stock

4) Risk-reducing factors: NO, no collateral, issue5) 9-month issue: these were demand notes

-In practice, when do people redeem these notes?-If every one redeemed them 3 weeks later, then that would be the important factor-One circuit has held that this only deals with commercial paper

2-12: Bradford Custom Homes intends to finance its homebuilding activities by borrowing money from qualified individuals. Each transaction is specific to a particular property and the lender’s funds are earmarked for an identified home. Bradford plans to have as many as 25 lenders for each parcel. This mode of financing departs from the industry practice of creating pools of funds available for financing multiple homes. Under the Bradford plan, each lender will receive a note with a maturity date 9 months from the closing of the loan with 1 renewal option. The note will be secured by a deed of trust on the property for the benefit of the lenders. The letters will not participate in Bradford’s profits and are motivated solely by the desire to earn interest on reasonably short-term loans. IS Bradford selling a security? Do you need additional information? Starts with a presumption that it is a security Look to list to see if it is not a security: doesn’t fall on list Look to the factors:

1) Motivation: generate money2) Trading to a broad distribution

-Sophisticated? Yes, security-Unsophisticated? NO

3) Reasonable expectations of investors-Did they view this as stock, short-term loan? -Hard to tell here

4) Risk-reducing factors? Secured-Fact that it is secured would go to reducing the risk-This would take away from the risk-reducing mechanism-There is collateral there for the loan—make it safer than unsecured loan

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--This is difficult to tell—SEC thought this was a security, but can make arguments either way

2-13: Same company as above. To finance its expansion into new regions, B would like to issue $10 million in 10-year, 11 percent bonds. The bonds will be collaterized by zero coupon US Treasury securities (i.e. government debt instruments that do not pay interest and are issued at deep discounts). Under this arrangement, B will take 20 cents of evey dollar raised in the bond offering and purchase the zero coupon securities. The maturity of the securities will coincide with that of the B bonds. As their maturity shortens, the discount on the government securities lessens and is eventually eliminated at maturity. Accordingly, purchasers of B bonds are assured sufficient funds will be available to pay principal on the bonds when they mature in 10 years. Is B selling a security? Zero-coupon bond: doesn’t have any interest payments—provides no interest

-Why would anyone buy a bond with no interest?-Seller of the bond right off the bat sells it at a huge discount

-Know that the value of the bond will go up --Collateral on the principal of the loan, but not with respect to the interest--There is a sale to unsophisticated investors and collateral--This is sort of in the middle

-Do the analysis, have an opinion-Can’t predict what the Court would do

a. Just because the promoter lied to you, doesn’t mean that is a securityi. Really the fact that someone defrauds you, doesn’t mean that is a security unless that person does

somethingii. Sue under state law fraud

Efficient Market Hypothesis

Problems on pg. 110:3-1: To illustrate some of the mechanisms that contribute to market efficiency, assume Alpha common shares and Beta common shares are each currently trading at $15 per share. Christine just discovered some “bad” news regarding Alpha and some “good” news regarding Beta. Have to know how she learned the information

-If inside information, then she could make money (strong hypo is fault)-What if she learns info on TV, could not make money from buying stock (price would have reacted a long time ago)

Let’s suppose an insider purchases the stock based on inside information, will that affect the price of the stock?-This is complicated—just because someone buys on inside information does not mean that it will affect the market -If some random person randomly purchases the stock of GM, that won’t affect the stock—doesn’t convey the underlying value of what is happening in GM-If the CEO buys 20 shares of GM, that may cause the stock to increase—people will think that an insider is purchasing stock and that will indicate that something good is going on in the company

If an analyst purchases stock, will that cause the price of stock to change?-Sometimes analysis have inside information, so that may cause price movements to

3-2: Bob believes his day has started out on a good note. Over his morning coffee, he is intrigued by a story in his local newspaper, the San Jose Mercury, reporting on local rumors that Omega Company, a large pharmaceutical company, is expected to file that day a patent application for a chemical compound that reduces significantly the adverse affects of asthma. Wasting little time, Bob called his cousin, Carol, who works in Omega’s research department. Carol confirmed the rumor. Bob could hardly contain himself. He called his broker, leaving a message on the broker’s voice mail to purchase 1000 Omega shares. The order was executed later in the day, approximately 6 hours after the Omega patent application was filed in Washington, DC. In an insider trading prosecution against Bob, how likely is it that the SEC will be able to establish that Bob benefited substantially by purchasing Omega shares? He purchased after markets had already adjusted—for a claim for inside information, you have to have PROFITED

-There is no profit here, although he traded on inside information he was slow in doing so and by the time he traded it was public information-6 hours is an eternity for markets

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-Based on semi-strong hypothesis, markets have already adjusted No financial advantage after trading 6 hours later

Omega Gun Jumping ProblemsFor the following problems, Omega is a Cupertino, CA company. Needs to raise money to expand. Wants to issue common stock via public offering. Assume it’s nonreporting co., unless otherwise indicated. Does it violate § 5 of Act?

Problem 4.1: On February 10th, Bob, Omega’s VP of marketing, places an ad to appear in 9 upcoming issues of Business Week. The ad previously had run for several months in Byte, a computer trade magazine, and in addition to listing the full range of products manufactured by Omega, it carried a quote from a trade magazine that ‘Omega is the emerging leader in the development and design of fiber optic switches.” If you are not relying on the safe-harbor and this is outside the 30-day period and want to be extra careful, this does not mean you automatically lose

-Is this kind of ad the normal thing you have done before?-The ad is the same thing you have done before, but you have placed it in Business Week—aiming this at people who might invest rather than people who do computers -Would have been safer to keep it at Byte

VIOLATION

Problem 4.2: Underwriting DiscussionsOn February 14th, Alice, Omega’s VP of finance, invites 5 representatives of SF investment banking firms to meet with her to explore each firm’s possible interest in underwriting Omega’s forthcoming offering. Asks one of the firms to serve as Omega’s underwriter. On February 15th, they execute a draft agreement calling for the firm to head a firm commitment underwriting syndicate of $4 million. Omega shares are to be sold for approximately $15 per share. All discussions were conducted in SF solely with the firm’s CA based staff. Omega meets with investment banking firms. One firm agrees to underwrite and executes draft agreement. All discussions were in CA. Answer: NO VIOLATION OF THE ACT

(1) Discussions with underwriter are allowed: Section 2(a)(3) excludes from the definitions of sale, offer to sell, and offer to buy both the negotiations and agreements that the issuer has with its underwriter

(2) Interstate Commerce : Section 5 does not apply if all the activities are on a face-to-face basis with no use of the mail, phone, or other commercial medium to arrange or carry out the sale—here, all the conversations were in CA (no interstate commerce)

a. Maybe here, even if it was prohibited, all discussions in CAb. Professor: loser of an argument because something happened over the phone surely

Problem 4.3: Agreement is faxedBob, the head of Hedley, Hadley’s SF’ office, on February 16th, faxes the underwriting agreement to his supervisors in NYC, where the agreement is signed on behalf of Hedley, Hadley. ANSWER: NO VIOLATION OF THE ACT--Falls under Section 5 now with interstate commerce --Exempt however, because discussions between underwriter and issuer are private and don’t violate 5(c)—same as above

-Specific exclusion for discussions with underwriter

Problem 4.4: Nonreporting issuer prepares brochureFrom its SF office, Hedley, Hadley circulates a letter inviting 80 national and regional brokerage houses to participate as underwriters in the upcoming Omega offering. This is OK—normal communications are OK

-Nexus is here but underwriters are excluded

Problem 4.5: Underwriter writes letter

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A few of the smaller firms invited by Hedley, Hadley to join in the underwriting have stated that they are not in the position to underwrite any part of the Omega offering. Hedley, Hadley responded with an offer to pay them their usual commission rate for any shares they sold in the Omega offering.ANSWER: THIS IS PROHIBITED Section 2(A)(3): are the people who are not going to help sell but will provide capital—are they underwriters?

-Section 2(A)(11): these people are not underwriters-Definition of underwriter in Sect. 2A11 which excludes such people that are talked about in problem (excludes people who will participate only as commission broker dealers); then flip to definition of offer to sell under 2A3 which excludes discussions among underwriters, but this isn’t b/c people who receive only commission are excluded from definition of underwritersmeans can’t make this kind of conversation.

Problem 4.6: Issuer prepares brochureOn March 15th, Omega’s public relations team prepared a brochure highlighting the company’s rapid development and innovative products for distribution to the financial media. Copies will also be distributed to lawyers, accountants, investment advisers, and other localities where Omega’s name is likely to be recognized. The brochure indicates that Omega intends to make a public offering in the near future and includes estimates of its future production capacity as a result of the forthcoming offer. Various possibilities:

-163A: this mentions the offer-163: just for reporting companies—can’t use -168: just for reporting companies—can’t use -169: giving a forward-looking projection—can’t use -135: bare-bones, but they are going beyond that

VIOLATION

Problem 4.7: Reporting Issuer Prepares BrochureSame as 4.6, but Omega is a reporting company recently filed Form 10K. If this were a WKSI, would be OK under Rule 163: permits such issuers to engage in unrestricted oral and written offers before a registration statement is filed

-You can do whatever you want when you are WKSI with respect to the pre-filing period If not WKSI, cannot give information under 168—wouldn’t work

Problem 4.8: Underwriter prepares brochure on issuerSame as 4.7, but underwriter prepares and distributes brochure under caption, “Companies to Watch.” Answer: Violation

-These exemptions are designed to let the ISSUER keep doing the normal financial statements it has done—an underwriter doing this is not the same -Research exemptions?

-138: only for reporting issuers (here, non-reporting)

Problem 4.9: Journalists print stories about issuerOmega invites journalists to tour production facilities and newspapers print stories about its products on April 5th. The business section of a number of newspapers around the country print stories about a particularly intriguing product that Omega highlighted. Does resolving this problem depend on what kind of journalists Omega invited to join on its tour? May get 163A:

-Prior to 30-day limit:-Not by underwriter/dealer-Doesn’t mention issue-However, can reasonably expect that reporters will take a few days to write it up and stories may appear during the 30-day period too close to the issue (even if appears outside limit, it may have impact in period)

-Best if the company invites the non-financial press Therefore, may LOSE 163A safe-harbor 169 may work (argue prototype as FLI, is this regularly introduced information, and intended audience non-financial press)

-However, depends if WKSI

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Problem 4-10: Broker circulates report on nonreporting issuer to its clients in investment letterLangman, Hillvort & Company, a regional brokerage form, on April 15th, circulates a glowing report of Omega in its monthly investment letter to its 11,000 clients THIS IS OK under Rule 137: permits non-participating brokers and dealers to publish or distribute information regarding securities of an issuer in a registration

-Will get it as long as it is not compensated -Nothing in the problem that indicates they are going to participate in the offering

Problem 4-11: Broker who circulated report then participates in offeringSame as 4.10, but broker then participates in underwriting. Can it do so? NO This is not permitted under Rule 137—permits only non-participating brokers and dealers to publish

-Issued the report BEFORE and impact of report is still effecting the market-If they were still reporting and were talking about company at same time seeking to participate—so this would be prohibited

This is not permitted under Rule 139: broker or dealer may publish opinions or recommendations focused solely on the issuer—but must be a reporting company and no the case here!

Problem 4-12: Broker circulated report on reporting issuerSame as 4.11, but Omega is reporting co. NO VIOLATION (reporting company) Rule 139 will allow this—we have lots of information so do not have as many concerns because of ECMH and not as much danger of people being misled

Problem 4-13: Underwriter issues on its letterhead an announcement and issuer posts it on its websiteIn late April, underwriter issues on its letterhead an announcement that is carried over the various financial wire services disclosing that Omega will soon undertake a public offering through a syndicate of underwriters of about 4 million common shares. The announcement further discloses that the proceeds of the offering will be used to expand Omega’s production capabilities as well as to broaden its research base. Omega obtains a copy of the announcement and posts it to its website. RULE 163A does not apply because it is outside 30-day limit—rule can only be used by the issuer and underwriters cannot exploit that Rule 135: can provide bare-boned notice of proposed offering—will not help that because you cannot name underwriters (using its own letterhead)

-Omega posting the letter would be viewed as conditioning the market-This is viewed as adopting the statement of the underwriter -Cannot use statement of the underwriter

Problem 4-14: Issuer mails annual report. It contains opinions and is glossyOn April 27th, Omega mails its annual report to its shareholders. In the report, Omega’s CEO states some really good things—glossier rendering of prior reports: The current report is filled with high-quality color photos of the company’s products, and regal graphics are used to portray the company’s earnings and sales progress since its formation. Safe-harbors:

-163A would not apply: not 30 days before-135: have too much information to qualify under this provision -Background rule: still permitted to distribute normal info that you always distributed even when you are not issuing securities

Here, mailing would be OK if it is done in the same manner as it has always been done in the past (in the normal course of business)

-Since this is not in the traditional form, and seems to be a selling document, it is likely that SEC would not be OK with this

Could have gotten this by ALWAYS sending out glossy reports and making that the norm—using Rule 169

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Problem 4-15: Digital recording of presentation on website. Makes a prediction about earnings and then responds to a question about earnings w/ forecast predictionOn April 28th, Omega paced on its website a digital recording of Alice’s recent presentation to a gathering of investment analysts. The analysts’ invitation to Alice was made before Omega had begun its discussions with Hedley, Hadley. At the meeting, Alice volunteers that management fully expects that the proceeds of the new offering will make a substantial contribution to earnings within a year or two. In response to a financial columnist’s question asking for Alice’s reaction to rumors that the new offering is likely to boost earnings by 25 cents/share, Alice observed that “25/cents was certainly in the ballpark.” Rule 163A (when outside the 30 days) doesn’t cover communications that talk about the offering—only for information that would have normally been revealed before—this is within 30 days so 163A does not apply

-Here, there were lots of questions about the securities offer A pre-existing invitation to speak is acceptable, and it is OK to go forward with the speech—but she made forecasts and predictions and this is over the line (pg. 170)

-Answering an unsolicited question about factual info is OK, but here the analysis is responding to a question with a prediction rather than factual information -May win on this

The placing of the speech on the website: is this normal for the company, or is this the first time the company has ever done something like this? If a safe harbor doesn’t work, go back to traditional analysis: in registration + conditioning the market

-Example 6: Securities Act Release No. 3844

Problem 4.16: Digital recording of presentation on website, but a reporting issuerSame as 4.15, but Omega is reporting company. Doesn’t change anything—however, if WKSI can do whatever you want!

-Does 168 work? NO-Cannot provide information about the offering

-163A won’t work—too close to filing of registration statement-If WKSI, can do whatever they want

No safe harbor applies, but go to analysis on background rules and might still be OK

Problem 4.17: Broker offers to purchase shares for his personal accountIn late April, Carl, a broker in St. Louis, heard of the Omega offering and wrote to Hedley, Hadley offering to purchase 1000 shares for his personal account Violated the act; expected to know the securities laws

-Underwriter cannot be expected to respond to his inquiry-Should respond that he cannot answer the question and will get back in a couple of weeks

SUMMARY:--There are various safe-harbors, but they PROTECT THE ISSUER

-The issuer can protect normal information --Also, analysts who are not connected with the offering (financial professionals) can continue providing their normal background information--The underwriters and dealers who are actually going to be helping with the securities should not do anything

Waiting Period

PROBLEMSRecall the earlier background information regarding Omega’s pending public offering that was discussed at the end of the materials focused on the pre-filing period. On May 1st, after several weeks of intense work by Omega, its lawyers and the staff from Hedley, Hadley, Omega files a registration statement with the SEC converting 4 million of its common shares. Each of the following activities occurs during the waiting period. For each of the following problems, resolve whether Section 5 of the Securities Act has been violated. Unless directed otherwise, you are to assume that Omega is not a reporting company and has not previously offered its securities to the public.

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4-18. Ethan, a broker with HT Gaines, one of the underwriters for the Omega offering, telephones Gail and strongly recommends that she purchase some of the upcoming Omega offering. Gail says she is mildly interested, and Ethan sends her a preliminary prospectus for review. Answer: this is OK Oral solicitations are OK—the written prospectus that is distributed and that is OK (that is the one document that is traditionally been permitted to be distributed) --Rule 430

4-19. Because Ethan has not heard from Gail for several days and his phone messages are not being returned, Ethan mails Gail a form that asks her to indicate how many shares of the offering she would like to purchase. Ethan attaches his business card to the form, with a note, “This is still a good buy.” Woman doesn’t respond to calls: solicitations of interest are ok under 134(d) if the requirements are fulfilled—here would have to have a disclaimer which indicates what section 5 requires (can have expression of interest but no actual contract until the registration statement becomes effective) Note on business card saying “this is still a good buy” This is not a full preliminary prospectus, but this is a free writing (forbidden unless 433 exception)

-Rule 433: Since this is an unseasoned, non-reporting issuer, would have first distribute a preliminary prospectus, free writing needs to have a legend that refers you to SEC website, and filing requirements

-Doesn’t appear there was a legend here-Probably wouldn’t be allowed

4-20. Gail responds to Ethan’s communication by sending him a check in the amount of $1500, penning a note, “put me down for 100 shares. Thanks for your thoughtfulness, Gail.” This is not allowed because we are in the waiting period—cannot be any sale until the registration statement becomes effective

-The broker would file away the card-Once the statement became effective, would get check then-Until then, return the check

--Could be a post-dated check in drawer--> but unsure of date, so return the share

4-21. Florence is a new broker with Hedley, Hadley and has yet to develop a solid clientele. As a step toward developing some rapport with prospective clients, she e-mails a preliminary prospectus to the entire membership of her health club, a total of 438 addressees. A few days later, she follows up with a phone call to each person to whom she earlier mailed the prospectus. Oral phone calls: Section 5 does not cover oral efforts—contacting customers by the phone is OK because it is oral communication E-mails to 438 people:

-Can send prelim prospectus under 5b1; can send to 438 addresses b/c a public offering-What about follow up telephone calls? ok b/c this is exactly what is supposed to happen with oral sales

4-22. Hedley, Hadley publishes an advertisement in all of the leading financial newspapers announcing that it is the lead underwriter for a public offering of 4 million Omega common shares. The advertisement also IDs the other underwriters and states that a prospectus can be acquired for any of the underwriters listed in the advertisement. This is a tombstone ad, so it is allowed under Rule 134 and 2(A)(10) as to what the definition of a prospectus is

-This is OK

4-23. Various underwriters associated with the offering prepare and distribute their own sales brochure to brokers and potential customers. These are not shared with other underwriters in the offering and are not filed with the SEC. This would normally be prohibited free writing because it is not the regular prospectus and not a tombstone Go to Rule 433: this is an unseasoned issuer because they are not a reporting company—would be OK as long as there is a legend with a link to SEC requirements and comply with filing requirements

-There is a filing problem here—failed to file! This would apply to underwriters and issuers as well—Rule 433 is not a filing scam

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4-24. What result in Problem 4-23 if Omega is a reporting company? Do not need to issue a preliminary prospectus in advance have filing requirement, legend required or email saying other information available on SEC website and free writing email are all filed with SEC NO REQ for reporting company to have actually distributed the preliminary prospectus in advance

Problems on Pg. 191-192

4-25: Wickersham & Dibble, a broker-dealer that does not intend to participate in the Omega offering, places on its website a glowing report of Omega common stock. Wickersham & Dibble periodically reviews the reports on its web site, removing some, amending others, and adding new ones. Its report mentions that Omega is about to make a public offering through a syndicate headed by Hedley, Hadley.--Can do it—goal of securities law is not to stop others--If later called to be part of a syndicate, would that be problematic?

-Can’t be issuing reports if they are going to be participating-Might say they are issuing the report and issuing afterwords—would still be making that report and would not be able to participate

--Rule 139: even if the broker is participating, can still issue reports, but that is for reporting issuers and this is not deemed to be a reporting issuer

4-26: Omega’s registration statement lists its web site address and states “Our SEC filings are also available to the public from our web site.” Among the items on its web site it’s a hyperlink to the Wickersham & Dibble web site report regarding Omega. --Issuer has a reference on its website to a report by an outsider --Traditional rule: this is a prospectus—look at envelope rule

-If hyperlink, would be e-mailing same stuff and would be a prohibited free writing prospectus--BUT, the rules have changed:

-Rule 433: must have a legend, have a prospectus on file with SEC-This would be OK if these requirements were complied with-Looks like they have not, therefore this is not OK

Rule 433: can generally use free writings during the waiting period as long as you jump through some minor hoops -The waiting period has been substantially opened up for previously forbidden free writings

4-27: Just after the registration statement is filed, the materials on Omega’s web site that are described in 4-15 are relocated on Omega’s web site under a newly created heading, “Historical Developments.” The recording is not a conversation once you record/link so this is a document—can be deemed a prospectus

-Not just an oral communication that wouldn’t be covered at all-When you have a recording and stick it in your website, loses oral nature

Look to Rule 433 for free-writing-Would have to comply and have legend requirements-If non-reporting, need to file preliminary prospectus

Under Rule 134: can have barebones information about the offering -But this is a much more expansive offering, so wouldn’t work

Under Rule 167-169: information by the issuer allowing the issuer to continue information if it had indicated information beforehand (before registration)

-This would not satisfy these rules because this dealt with previous information and not the issue itself—this deals with the issue and is aimed at investors

--Thus, it is ok to make forward looking statements in a free writing as long as you jump through the hoops!

4-28: What result in the above problem if Omega is a reporting company? Do not need to deliver the preliminary prospectus—do not need to think if S3 company

-Not that much different-Still have to use the legend on the free writing

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4-29: Alice, Omega’s VP of finance, undergoes a 1-hour interview with some of the underwriters for the forthcoming offering. The interview is digitally recorded and placed on the underwriter’s website where it is password protected. The password is then discretely distributed among the underwriters, members of the selling group, and select investors who are told that the recorded interview can be accessed through the underwriter’s web site and that the password can also provide access to a special e-mail address to Alice who is available to answer e-mail submitted questions. Describing a road show—doesn’t fit with specific statutory safe-harbors--Probably ok without 433, but even with 433 would be OK --Doesn’t fit within 433 but is not a problem because under prior SEC rulings, roadshows can be recorded and provided to a limited number of sophisticated investors

-If anyone could look at the website, violation of Section 5 Live e-mail: This would probably NOT be ok---chat session as an oral communication?

-E-mails themselves are like writing letters-CEO should have picked up the phone

-E-mails would be free writing and may be exception under 433, but need legends, etc.

4-30: Omega’s key executives meet with journalists and other members of the media on May 17. They talk up the company and indicate how pleased they are with how the offering is going. Stories to that effect appear in a number of newspapers and on some financial web sites. Omega provides hyperlinks to some of those stories on its own web site. Oral communications are ok, but if reporters then write down what you say, would have to file within 4 days

-Rule 433(f)(1): this is OK as long as you file the story with the SEC-Do not need to file preliminary prospectus -Rule 433(f) would say that stories eventually printed in the media are free writing and need to satisfy the requirements—company cannot meet those requirements (legend, filing, etc)

--Would have to file news story with SEC and include legend

4-31: In the wake of news reports critical of Omega’s recent performance, Alice, Omega’s VP of finance, sent an e-mail to pep up the company’s 334 employees. The memo spoke optimistically about Omega’s future. Somehow a copy of the e-mail message was posted on a popular online chat room. Rule 401: exemption from securities for everyone but the underwriters, issuers, and the dealers Are communications to employees covered by the securities laws?

-There is nothing in the securities laws that excludes employees-Securities are sold to employees (potential investors) -All of the dangers that the securities laws are designed to prevent are the same ones marketed and entitled to employees

-So, this is not OK -Doesn’t fit with exceptions in 433, not filed, no legend, etc. -Nothing that exempts communications to employees or makes it more onerous

If this communication was sent to someone outside the company? -This is a forbidden free writing

4-32: Hedley, Hadley e-mails copies of an article from the Wall Street Journal to many of its customers. The article paints a very positive picture of Omega’s performance and discusses the likely effects of its forthcoming public offering, including several bits of information about Omega that are not in the documents filed with the SEC (e.g., a quote from its CFO forecasting a 15% jump in earnings in the next fiscal year). The e-mail contains a hyperlink to Hedley, Hadley’s web site where a preliminary prospectus for Omega can be obtained. Rule 433: would still have to meet filing with SEC in four days

-If someone just publishes an article about the issuance, the issuer doesn’t have to do anything-If the issuer then writes an email and has a link to it, then like them distributing the article—becomes like they had written the article -The potential violation of the securities laws is the e-mail referring to the issue

Would have to satisfy the requirements of 433--433(b)(2)(i): in this situation, no filing requirement—need legend on e-mail providing required language

SUMMARY: IMPORTANT POINTS

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Before Rule 433, really had to be quiet during the waiting period Now, 433 has opened it up a lot—as long as you jump through some hoops: if unseasoned, have to file a

prospectus (requirement can be satisfied by having a link to preliminary prospectus), legend, and filing requirements—then free writings are permitted during the waiting period!

Post-Effective Period

Problems on Pg. 195

4-33: Reprise of Problem 4-32. Hedley, Hadley e-mails copies of an article from the Wall Street Journal to many of its customers. The article paints a very positive picture of Omega’s performance and discusses the likely effects of its forthcoming public offering, including several bits of information about Omega that are not in the documents filed with the SEC (e.g., a quote from its CFO forecasting a 15% jump in earnings for the next fiscal year). The e-mail contains a hyperlink to Hedley, Hadley’s web site where a final prospectus for Omega can be obtained. OLD WAY: Traditionally, would have to include a final prospectus since this is a free-writing

-Section 5(b)(1): cannot distribute any prospectus unless it meets the requirements of Section 10-2(a)(10): something is not a prospectus if before you sent that other thing (or at the same time) you sent a full 10(a) final prospectus—traditionally, have to include a final prospectus to satisfy 5-b-1

NEW WAY: Under 433, have to provide a legend and if a non-seasoned issuer and would have to provide a full final prospectus but could be satisfied through a link to final

-Would get you off the hook in this situation

4-34: Hedley, Hadley e-mails confirmations for sales to all its customers who made efforts to purchase during the waiting period. Each customer had earlier been given a preliminary prospectus and most have consented to the electronic delivery of information via e-mail. The confirmation informs the customer that by accessing Hedley, Hadley’s web site the customer can obtain a “term sheet” that sets forth information about the offering’s price, amount, and underwriter commissions that was omitted from the preliminary prospectus. 15-c-2-8 is satisfied—2 days before, customers have to be given preliminary prospectus Under Rule 172, do not have to send the full, final prospectus along with the confirmation as long as you provide a notice that you are NOT sending the full, final prospectus and it has been filed with SEC

4-35: CT Gaines, one of the underwriters in the Omega offering, sold its entire allotment by July 5th. On July 10th, Nida, one of the brokers with CT Gaines, recommended that Oscar purchase a block of Omega common stock on Nasdaq. Must CT Gaines forward a final prospectus to Oscar when it confirms the sale and delivers the shares to Oscar? Section 4(4): broker’s exception—does this fit?

-There is an exception for certain kinds of broker transactions-Order has to have been unsolicited, but this is solicited

-If the customer had called, then 4(4) would apply Traditionally, under 4(3) , would have required a 40-day requirement that the broker, even when involved in sales on the secondary market, the delivery requirements would have still applied—doesn’t apply anymore because of 172 Rule 172(b): obligation to forward a final prospectus when delivering securities is satisfied if the issuer has filed with the Commission as prospectus meeting the requirements of 10(a)—provided that the registration statement is not then subject to an administrative enforcement action

-Do not have to deliver confirmation along with securities!

4-36: Polly, a broker with Hedley, Hadley in June sent to Ralph a preliminary prospectus for the Omega offering. Ralph, after studying the prospectus and talking with his bowling buddies on July 18th, phones Polly and purchases 100 Omega common shares at the offering price. What further information must Hedley, Hadley provide Ralph?No final prospectus needs to be delivered because of 172, but still need preliminary prospectus

4-37: Tom, a longtime customer of Polly’s and a very independent sort, instructs Polly to purchase 300 Omega shares on the market. Polly purchases the shares through the Nasdaq system, even though Hedley, Hadley still has not sold its allotment for the Omega public offering. Hedley, Hadley does not include a prospectus with the confirmation it mails to Tom.

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Polly is not a dealer because she did not solicit the interest in the security and is a dealer-She would be exempt under 4(4)

4-38: Hedley, Hadley learns that not all the brokers with CT Gaines have been provided with copies of the term sheet for the Omega Offering. IT posts a copy of the term sheet on its web site and gives notice of the posting to CT Gaines. Has Hedley, Hadley fulfilled its obligations with respect to this member of the syndicate?--Term sheet: piece of paper that supplements a preliminary prospectus to turn it into a final prospectus

-2 documents together satisfy the final prospectus--Rule 172: doesn’t require the dealers to even pass it on to the clients

-The only question is whether the preliminary prospectus has been delivered--This probably wouldn’t be a violation but the only requirement for the underwriter is that they have to have delivered the preliminary prospectus in sufficient time so the dealer can deliver it within the 2-day advance period to the actual customers

-Do not know if this has been done

Shelf RegistrationProblems on pg. 204:4-39: Thorprods, Inc. common stock is listed on the NYSE and satisfies the listing requirements in Form S-3, but it is not a well-known seasoned issuer. Thorprods common shares currently trade at $15/share. Thorprods proposes to register $100 million of bonds to be issued in $1000 denominations bearing a face rate of interest in 11 percent, payable each quarter. Each bond is convertible at any time into 50 Thorprods common shares. Bonds of the same risk classification as Thorprods currently carry an effective rate of interest of about 12%. Throprods is not desperate for the cash from the offering and hopes to be able to place the bonds when there is a deadline in interest rates, which it hopes will be in the near future. Can the securities Thorprods proposes to offer be registered for the shelf? The way the laws look at this is that there are 2 sales of securities to be accounted for—sale of bonds and information to which they can be converted (common shares)--The sale of the bonds: use 415(a)(x)--For the conversion to the stock: use 414(a)(4)—talks about securities to be issued upon conversion of other outstanding securities

4-40: Assume Beta Chem, Inc. is considering raising capital. It is uncertain whether it will do via issuing 1 or 2 million additional shares or via a senior security, such as preferred stock or even bonds. It would prefer not to issue common shares but is concerned that rising interest rates may make bonds or even preferred shares carry too high an interest or dividend, respectively. BetaChem believes it needs to move forward in satisfying its regulatory requirements so that it can be in a position to move quickly to take advantage of any positive developments in capital markets. What regulatory flexibility is available for it to register the offering without identifying the amount and type of security it proposes to offer assuming it must register the security on Form S-1? What flexibility does it enjoy if its eligible to use Form S-3, but is not a WKSI? How does your answer change if BetaChem is a WKSI? What if not a S3 company but a S1 company?

-Wouldn’t have any flexibility because not a S3 company--Cannot use 415(a)(1)(x)—but try 415(a)(1)(i)-(ix)

-Can’t do a shelf registration and have to do normal registration-Specify in your registration materials what kind you want to issue and go through SEC process -Have to specify the type and amount

IF you are an S3 but not a WKSI?-Talked of universal registration-Would be able to not even specify what kind of securities you are going to issue

IF you are WKSI?-Can pretty much do anything—do not need to specify-Can file an amendment later when actually going to issue the securities

4-41: Tavist Company, a small company whose shares are traded in the over-the-counter market, has been a reporting company for less than one year. Its controlling shareholder, Alice, wishes to sell a significant amount of her stock. Because Tavist stock is quite volatile, Alice is contemplating registering 100,00 shares for the shelf and selling as many shares as she can whenever the stock price is above $15 or $16 per share. Can Alice’s shares be registered for the self?

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This is not an S-3 company (need to have reported for 12 months), so 415(a)(1)(x) does not apply—look to exceptions in 415(a)(1)(i) –(ix)

-Issuer cannot do shelf registration --415(a)(1)(i): this would apply—can do this

-If not connected with the company at all, do not have to worry about this provision -BUT, if you are a controlling person in a company, then you do have to worry—deemed to have to comply with the securities laws just as if you were the company -Idea there is that the insiders of the company have just the same informational advantage as the company itself

4-42: Ralston Purina Co. is a large and highly successful corporation and a well-known seasoned issuer. To foster strong relations with its employees, the firm’s management embarked on a concentrated effort to encourage “key employees’ at all levels to become owners of the company’s shares. This could occur by the employees devoting some of their personal retirement accounts to the purchase of Ralston shares or using a payroll deduction plan. As an incentive, Ralston offers to match (up to 5% of the employee’s annual gross salary) the individual employee’s purchase with an incremental increase in the employee’s salary. Shares will be sold to the employees at the closing market price on the day the employee’s order is received. An elaborate process was established to ID key employees who would become the beneficiaries of this program. What information must Ralston make available to the key employees singled out pursuant to this program and how should it proceed with registering the securities? The company made a HUGE mistake

-If you sell securities to someone else, the company would have to register the securities in the normal way or it would have to do shelf registration-Is it any different when it sells stock to employees?

-NO, just the same -The company goofed it up: should have registered the securities

They are wanting to do a shelf registration—telling employees that they can buy the securities whenever they want -There would need to be some kind of shelf registration here-BUT, they didn’t do anything—securities laws do apply here

--This is probably a WKSI company, would only have to file S3 and would have been an automatic shelf registration

--415(a)(1)(ii): allows shelf registration of employees sold in an employee benefit plan -So, they could have done this but had to do the requirements

--So if the stock does poorly, the employees can get their money back!

Post-Effective AmendmentsProblem on pg. 2084-43: Alpha Company’s registration statement became effective on July 12th, and reported that Alpha owned 900,000 acres of un-cut Oregon timberland and that the company would soon obtain permits to log the timberland. On July 18th, with les than ½ of the Alpha offering sold, 350,000 acres of Alpha’s Oregon timberland was lost to forest fires then ravaging the Pacific Northwest. On the basis of the readings that follow, consider the source of Alpha’s duty to amend its registration statement as well as the SEC’s power to compel such an amendment. Consider how your response is altered if the registration statement’s initial figure was inflated by an error made by the company’s surveyor and the actual amount of timberland is 350,000. Was this material true at the beginning or has something happened to make it untrue?

-This is an example of adding information -This would be viewed as adding information, rather than changing information that may be false

-Do not have to amend the registration statement-BUT, would want to amend the prospectus

-The prospectus is a selling document-Provisions create liability for fraud if they are wrong -Would need to comply with the Manor Nursing requirements too

What if the registration statement had a typo (said 9 million acres when there are really only 900,000 acres)—do you need to amend the registration statement in this instance?

-YES, need to change the original information rather than adding something to it

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-Have a duty if the information is false and you find out

Trading Practice Rules

Manipulating the Market HYPO: Suppose that there is lots of a company’s stock that has been issued and the company wants to issue some more. Suppose the registration statement has become effective and price has been set. Then, something horrible happens in the world and ALL stocks are worthless. The underwriters are stressed: the price has been set already! What is the incentive for the underwriter and issuer to do?

-Incentive is for them to prop up price of the security-Would do this by PURCHASING the old shares of the stock

-What determines the price that the new shares will sell at is the existing market price -Incentive for market manipulation

--The rules, however, prohibit this!-Rule 102 of Regulation M (pg. 775)

Problems on pg. 218:4-44: First Bank recently announced it would acquire Watchoveru Bank by issuing shares it to the W shareholders. First Bank has filed a registration statement covering the shares to be issued in the merger. Soon after First’s announcement, Sun Bank announced it would soon formally announce an offer to acquire all the outstanding shares of the W by offering its shares to the W stockholders. After Sun’s announcement, but well before it filed a registration statement covering the shares it will offer for the W shares, the Federal Reserve Bank increased substantially the net capital requirements that apply to national banks such as First and Sun. Fearing that Fed’s actions will depress their stock’s value by engaging in substantial market purchases of their company’s shares. Can they do this?

First Bank who has registered securities: -Suppose the bank is a medium or small bank-Really cannot do this

-This is after the registration date has become effective-First Bank should withdraw the registration statement to see what W Bank is going to do

W Bank: has not registered-Would be permitted to trade its own securities-No registration statement filed, no price set-Is this unfair?

-One of the potential competitors is hobbled by rules, and one isn’t

--Problem doesn’t indicate whether the RS has become effective, but the PRICE has been set—this is what implicates the periods for restriction

-When a cash issuance, normally just starts when effective --For the trading practice restrictions, what matters is when the price was SET (price has been set as indicated by the problem)

4-45: Tempco, a large multi-national corporation, earlier filed a registration statement for the shelf for a $150 million offering of its 10 percent, 20-year debentures that became effective January 10th; it sold $30 million of the registered debentures at that time. The debentures are not rated as investment grade by any rating agency. Tempco soon began to plan another $ 40 million of the registered debentures to be sold through competitive bidding on or about March 15th, if market conditions were favorable. On March 10th, Tempo’s VP of finance called the leading underwriting firms…

--706: Definition of “distribution participant” includes prospective underwriters: includes those that have submitted a bid and are substantially certain of winning

-The issue: when they made this bid, did they fully expect that they would be participating? -Permitted to keep transacting in the company’s stock in the secondary market-If they fully expected the bid to be expected, then they are not

--Even if they did reasonably expect to be participating, what are possible outs?

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1) 101(b)(7): de minimum exception-Can make tiny purchases if small compared to AATV (less than 2%)-Would be ignored for purposes of restrictions

-What percent is purchase of $600K of AATV?-Total float is $30 million

-This is not the AATV-Would NOT fit within the de minimus exception unless they trade a certain amount each day—which almost never happens

2) Huge float and huge AATV company-Not here

3) Investment grade securities -Not here

--IS this during the restricted period? -More than a day before, so this is OK-Another way of getting out of this

-Prohibits manipulative purchases during a restrictive period for issuers-Rule 101

-Prohibits manipulative purchases during a restrict period for underwriters

--Does this mean it is ALWAYS forbidden?-There is a restricted period where you can’t do this

HYPO: Let’s suppose you price on a certain day the securities at $30/share. At the time that you priced those securities, the market price of these securities in the after-market was $25/share.

-What’s the highest price you are able to bid for if affiliated with this offering?-$25

-Cannot do $30—that would be a scam-This is a danger when you have a company with SMALL FLOAT-No one knows about the securities being traded

-Possibility of real manipulation

Problems on pg. 2204-46: Hedley, Hadley is the lead underwriter of Tecto Company common stock. Tecto common shares are currently quoted on Nasdaq, and Hedley, Hadley has maintained a bid to purchase Tecto common at $9 for several days prior to Tecto’s registration statement becoming effective. The last quoted price before Hedley, Hadley entered its $9 bid was $9.25. Just before it filed the pricing amendment, the last sale price of Tecto common stock was $9.50. Tecto filed its pricing amendment, setting an offering price of $9.50, and the Commission’s staff permitted acceleration of that amendment, so that the registration statement became effective at 10 AM that day. Hedley, Hadley then increased its bid to $9.50. Do Hedley, Hadley’s actions constitute lawful stabilization?--This is OK because the last market price is the same as the price in which they priced the security--Forbidden from going above either of those 2 numbers—but they are not, so this is OK! Since the issuance price was $9.50, and the last price on the market was $9.50, this is a lawful stabilization

-The bid cannot exceed the offering price

International Offerings

PROBLEMS ON PG 2384-47: Textron, Ltd., a British textile company, plans to raise $20 million by selling common stock in London and Toronto. Textron’s common stock is traded on the LSE and also on the Amex (approximately ½ of its weekly trading volume occurs on each exchange). The offering circular has been prepared essentially by its NY counsel in close cooperation with its Canadian and British underwriters. Textron expects that all arrangements for the offering will be such that sales can commence on January 15th. Can the Textron common shares be sold to Americans working or traveling in Canada or GB? What steps must the underwriters take to assure that the offering does not flow back to the US? Is it likely that these steps will cause the offering price to be less than the price quoted on Amex?

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Category 1 does not apply because there is a substantial US market interest (sold on Amex) -If main location of trading is in US, then that it deemed to be substantial market interest-Also, could also not qualify for Category one based on 20% and not 55% in any other country—here, more than 20% in US, and less than 55% in another country—doesn’t qualify here either -Have to direct to only 1 non-US country (sold in both London and Toronto)-This is equity stock:

-Not backed by FFC or backed by US issuer Category 2: Would FIT -Equity by reporting foreign issuer that is traded on American Exchange

-What are the restrictions?-Can it sell to US citizens working or traveling in London or Toronto?

-Depends on how you define US citizen—what if they are residents and non-US person -If a resident of the foreign country, then NOT a US person-If just a tourist, then could not sell to them

What steps do the underwriters have to take? -Can’t have re-sales-Offering restrictions-Each distributor has to agree to no-resales or violations-Disclaimers on materials-Distributor has to send notices who will ultimately purchase indicating restrictions

Will the price be lower here than in the US? -YES-Take a substantial amount of buyers out of play

4-48: Is Regulation S still available in Problem 4-47 if some of the Textron shares are sold to Ira Blue, a US citizen who heads up the London office of a major NY law firm? Depends if he is an actual London resident

-Although US citizen, his residence is in the other country and is not a US person-OK to sell to him

4-49: Assume in Problem 4-47 that Textron was incorporated in Delaware. What steps then must its underwriters take to assure the offering does NOT flow back to the US? Not a foreign issuer under Category 1 or 2, so falls under Category 3: all other issuers

-No longer equity reporting foreign issuer-Therefore, must be in Category 3

-All equity offerings by domestic offerings by foreign and domestic issuers-Have to comply with requirements

--Subject to offshore and no directed selling efforts-One year primary and resale restrictions

--HOW YOU TELL FOREIGN/DOMESTIC ISSUER: based on place of incorporation

4-50: Assume Textron’s management in the problem above wishes to inform its US stockholders that the company is raising capital by issuing additional shares at a discount from their quoted market price and that the offering’s proceeds will be used to modernize Textron’s facilities. Will this announcement jeopardize the Regulation S safe harbor? Is this conditioning the US Market?

-Rule 135(c): can describe briefly in a tombstone-like way, what you are doing

4-51: MoneyConnections.com operates a European-based financial bulletin board service through its web site. Approximately 20% of the bulletin board’s subscribers are residents of the US. In return for a modest compensation paid by the underwriter representing Textron in Problem 4-47, MoneyConnections has placed on the bulletin board offering materials for the Textron offering. MonneyConnections’ web site and the offering materials placed on the bulletin board

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clearly warn that the offering is not available to US residents. Does this render Regulation S unavailable for the Textron offering? Is this a directed selling effort?

-Look to 20% rule-If the problem said 10%, then we’d be oK-But the problem says 20%, so it may or may not still be a directed selling effort

--Need to be careful because it appears the material contains not just the barebones things—contains offering materials that are forbidden by 902(c)--If not there, then Regulation S would not apply

-What do you have to do-Look to Release 7516: under Regulation S, and says you would need prominent disclaimers and website would have to implement special mechanisms to make sure this wasn’t designed to promote sales to people

Materiality

Problem p. 583Bloomsters is raising $5m by selling c/s to 30 investors; detailed information about steady growth of business, its history as a company and shifting products- using proceeds of offering to fund expansion; investor Carl called Bloomster's president who failed to mention that company was ceasing old operations but answered Carl's questions about new products; were material misrepresentations made to Carl who purchased c/s?

It is a reasonable investor standard and this is probably immaterial because a reasonable investor would care about what the profits were going to be and not how they were derived; it is an objective standard

It is material if say profits are $10m but are actually $5m If reveal a prediction that profits will be $10m but turn out to be $5m- likely covered by safe harbor if sufficient

cautionary language and reasonable belief for basis

Problem p. 592Alice is completing a 10-K for her client and discovers that company's main land encroaches on neighbor/main competitors land and would be extremely expensive to buy the land and without the purchase, Company's plant would be inoperative; the 20 year adverse possession period ends in 3 months; is the information "material" for purposes of the 10-K?--What is the issue is whether the company will have to tear down their factory in the future--When apply the probability/material test (Shepherd- "this is a weird problem"), hard to determine because in the "maybe" box--However, Regulation S-K says that this is material so no need to apply the test\

Problem p. 600Kiwi, traded on NYSE, reported on 10-K highly competitive market engaged in; Bill rec'd report and purchased 1000 shares; a week before the report a class action was filed against Kiwi alleging price fixing and share prices declined slightly on the say the suit was filed; a year later Kiwi settled the suit and announced lower profit projections; Bill filed suit alleging fraud on 10-K; does Kiwi have a "truth on the market" defense?

Does the filing of the lawsuit inform the market that this statement is false (there is no competitive market and Kiwi was engaged in price fixing)- courts would probably say no- lots of time anti-trust lawsuits lose - this is something a reasonable investor would want to know about and a mere filing of a lawsuit is insufficient to overcome the CEO's statements

Once the plaintiffs win and the CEO makes the statement, the truth on the market defense would applyo Markets had already adjusted—may or may not be true: depends on how the market responds to the

conduct

Problem p. 621Vencor operates hospitals/nursing homes and potential legislation, if passed, would decrease profits and share prices; after the legislation was passed but before the president signed it into law Vencor filed its 10Q and stated its business would not be adversely affected by the legislation with additional legislation that not all possible adverse effects could be predicted;

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Vencor's share price subsequently plummeted as a result of the legislation; is Vencor covered by the forward looking statement safe harbor?

PSRLA and Bespeaks Caution

Problem 11-4: Company says new legislation will not hurt its earnings (says this before President signs the legislation, but after Congress passes it). It also contains cautionary language that it says it doesn’t know if it will pass, but it does look certain that it will. The company also knows that if the legislation passes, it will reduce the company’s earnings. No liability for a forward looking statements if:

Accompanied by meaningful, cautionary statements Even if it’s not, if the P can’t prove that the defendant knew the statement was false

PSLRA:-Would the PSLRA apply?

-YES-Does it protect the statement?

-Is it forward-looking statement? -YES: prediction of future earnings: guessing the earnings will not be affected because legislation will not affect -Also looks like a misrepresentation of historical fact

-Says it could not predict the impact of the bill and it actually could—also knew that the passage of bill was much more certain than represented

--P would probably lose here because it was a prediction about earnings—future economic performance, so would be a forward-looking statement--If forward-looking, is it within the safe harbor?

-It’s false and a knowing misstatement: does not eliminate application of PSLRA-Even if lie, still protected as long as there is specific cautionary language-This sounds kind of boilerplate, rather than a specific kind of statement that is required

--As things develop, have to make sure the cautionary statements develop too—to be safe, lawyer should have insisted the cautionary statements were updated to reflect the state of the world

Duty to Disclose Forward Looking Statements

Problems on Pg. 62511-5: Spandy Enterprises is traded on the American Stock Exchange and on September 23 became the target of a hostile takeover by Alliance Company. Spandy is a conglomerate whose products include paint, air conditioners, cosmetics, and high-fashion apparel. Soon after Alliance’s bid was announced, Spandy’s management launched an aggression search for a “white knight,” which on October 9 culminated in enticing Bethel Industries to make a higher bid for Spandy than Alliance had. Spandy shared with Bethel certain confidential forecasts and appraisals of Spandy’s operations and assets. The internal projections forecast a 43% increase in cosmetic sales, Spandy’s key product line, and the asset appraisals revealed that no less than $200 million in profit could be garnered by selling to some third party the paint and air conditionings product lines. The forecasts and appraisals shared with Bethel were prepared using highly conservative assumptions, information, and procedures. Must these forecasts and appraisals be disclosed in a joint proxy statement prepared by Spandy and Bethel that seeks stockholder approval of their merger?Spandy Co was a target of a hostile acquisition. They tried to find a white knight (some other company that might be willing to merge with the target instead of the original acquiring company) and in doing so shared some confidential internal projects that showed great earnings (so they would bid higher than the hostile acquierer). Do they need to share these with the SH in the proxy statements?

-Is this material information? -YES, something the shareholder would want to know

-There is no over-arching duty for anyone to reveal if material—question is there a duty to disclose? -Court in the actual case found there to be a duty-Fiduciary duty owed to the shareholders

-Court said that in this special situation there was a duty -Danger of conflict of interest (trying to not get fired)

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--NOTE: MOST OF THE TIME NO DUTY TO DICLOSE FINANCIAL PROJECTIONS-Only time to disclose is when you don’t want to make the information misleading (have already disclosed)—but courts will usually side with the corporation in not disclosing the rest of the information

11-6: Assume in Problem 11-5 that the lawyer representing Spandy in its negotiations with Bethel purchased Bethel stock after Bethel announcement its bid for Spandy. The record documents that the lawyer’s purchase was guided by his belief that Bethel was purchasing Spandy at a bargain and would soon reap a great windfall as a result. Has the lawyer traded on material non-public information?

Insider lawyer involved in transaction trades on info. He believes valuations have not been revealed to shareholders will show that acquirer is getting a huge bargain—should he be liable for insider trading?

o Is it material? YES

o Is there a duty to disclose? YES: have a duty to disclose in advance of trading—or could have abstained for trading

--In the insider trading context, the trading itself creates the duty to disclose or abstain from trading-You create the duty to disclose based on trading the insider information

Corporate Governance

11-7: An interesting report in the press raise an intriguing disclosure question. Stephen L. Lane, chief executive of Emerson Radio Corporation, a large publicly traded corporation, sued his wife for mismanaging his account while she was a broker with Drexel Burnham Lambert. Mr. Lane complained that unsuitable stocks and options were purchased for his account at the suggestion of his broker-wife over at three-year period during Mr. Lane alleged he was unable to monitor his personal finances due to his having undergone surgery twice for brain tumors and once for a spinal tumor. During that same period, no public disclosure of Mr. Lane’s medical problems was made by Emerson or anyone else. Mr. Lane did manage to participate in several meetings with investment analysts in that three-year period. Assuming that Mr. Lane was indeed unable to monitor his own affairs and assuming further that during the period of Mr. Lane’s illness Emerson sold securities pursuant to a registration statement that did not disclosure Mr. Lane’s problems, did the registration statement omit a material fact?Director of company sues his wife for making bad trades while he was unable to monitor his personal finances because of his repeated brain surgery. The question is if the company he worked for should have been disclosing his medical condition all along (this was a three year period). Is this information material?

-Could maybe argue that he wasn’t competent-Would a reasonable investor want to know if the CEO is helpless?

-Is there a duty to disclose?-Probably a court would say there is a background duty to disclose

--Under Rule 408: general duty to provide any additional information that is required to make earlier information that you have already provided not misleading

-Similar to Franchard case: presenting to the world image of the CEO being normal but instead, he is completely incompetent here-Probably, the conclusion would be DUTY TO DISCLOSE and without duty this is a violation

--What important company has a situation like this? -APPLE: Steve Jobs

-Investors saying that he has indicated that he is totally healthy-Turns out that he did have a health issue

Problems on pg. 63611-8: Actonomics, Inc. is listed on the NYSE and has a code of conduct that among other features requires that “any transaction must be approved by the company’s Audit Committee if the transaction involves an amount in excess of $10,000 between the company and a senior officer, or between the company an entity in which its senior officer has a financial interest, is a director, or is an officer. “ Willis is Actonomic’s CEO, a devoted alumnus of prestigious Ivy University, and a member of that institution’s board of trustees. To make it more likely that he will be selected to be the next chair of Ivy’s board of trustees, he persuaded Actonomics’ board of directors approve a $5 million donation to

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establish the Willis Student Center at Ivy University. Are there reasonable arguments for concluding this transaction is not material? CEO talks the board into making a sizable donation to his alumni so he can be on the board of trustees for the school. Sounds like he’s using the company funds for personal gains, that should be disclosed.

-This is similar to Glickman—he’s funneling money to himself and he is acting dishonest (violating the spirit of the company’s internal codes) -If the board is not acting properly, it’s material to how the shares are traded-Fact that other corporations do not it is not a good defense to rely upon

--If we called any time a CEO got a corporate benefit, if we called that illegal—almost every corporate gift would be illegal; however, this does seem more extreme

Problems on pg. 64311-9: Wherehouse, Inc. issued $15 million of bonds through a registered public offering. An important feature of the bonds was that, if more than 80% of Wherehouse’s common stock was acquired by anyone, the bonds could be tendered for cash equal to their face value unless the acquisition was approved by Wherehouse’s independent outside directors. 6 months after the bonds were sold, Wherehouse announced all the common stock would be acquired in a management buyout that had been approved by all of Wherehouse’s directors. This announcement piqued the interest of a group of institutions that then held 34% of the Wherehouse bonds, in part because as a result of the leveraged buy-out the value of the outstanding bonds declined 50%. After a brief investigation, they report to you that it appears that 3 individuals have served as outside directors for Wherehouse during the past 4 years and were serving when the buyout was approved by Wherehouse’s BOD. The institutions’ investigation has turned up several facts not revealed in any public filings by Wherehouse, including that the 3 outside directors have never voted against a position advocated by management and have always justified their decisions as being in the stockholders’ best interest. Did Wherehouse commit a material omission in failing to disclose these facts in the bond registration statement? For 3 years, the outside members of the board were just rubber-stamping anything presented to the board. The company had promised that there would be independent directors. The bond-holders say that the votes are always in the interests of the shareholders, not the bond holders. Is it enough that since they always vote with management, they are not independent?

--When we say a director is independent, does that mean they are supposed to vote in the interest of the bond-holders? NO-In general, the bond holders, are not represented by the managers -The directors are not required to look out for the interest of the bond holders—whatever rights they have are created in the documents (no over-arching duty to them)

-There are no fiduciary duties to bond holders; only contractual duties--What about the fact that they do tend to vote with management—does this mean they are not independent in some way?

-Cannot just necessarily assume they were not independent—could have been disciplining the managers so they voted with the directors-The fact you have them voting the same way does not indicate much about them not being independent

NO RECOURSE FOR BOND HOLDERS: Bond holders are given title only to what they are given in the bond contract; stuck with the bad deal!

11-10: Ruth has filed suit challenging the disclosures in the proxy statement for the reelection of Curly, Moe, and Larry to the BOD of Go Go Value Fund, a mutual fund managed by Silver Sleaves Associates. Ruth faults the proxy statement not only for its express representation that the 3 individuals are independent outside directors, but also for failing to disclose that they serve on between 22 and 38 other boards of mutual funds managed by Silver Sleaves and receive from all such board service aggregate director fees of $65,000 and $81,000. Is the proxy statement materially misleading? Three directors that claim to be independent, but on the boards of a lot of other companies. Can these directors be deemed independent? First, there are lots of directors who are directors of lots of companies—just because they serve on other boards does not mean they are not independent

-Another argument that they might make is: how can you possibly be able to do your job as a director if you are always a director of other companies (have a duty to be informed, oversight, etc)—cannot do that if you do not have time (violation of duty of care)

-Had to vote along with management because you didn’t have time to research

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11-11: The CEO of a publicly owned national bank had over some period of time caused an excessive amount of bank money to be funneled to a series of related real estate development projects being promoted by an old college friend. Ultimately, these projects failed, and the bank is now in serious trouble. Among other things, such loans violated a provision of federal banking laws that precludes committing too much of the bank’s assets to a single borrower. The federal banking authorities are now seeing the CEO’s removal from office on the grounds that he willfully endangered the safety and soundness of the bank. That matter is currently in litigation. Was the non-disclosure of such malfeasance at the time material? To whom? Under what circumstances? Must the ongoing action by the federal banking authorities be disclosed?--This is self-dealing and a violation of fiduciary duty—certainly material

-Pending litigation: Item 401(f)-When there is litigation against the company itself, does that have to be resolved if not resolved? YES, if above a financial level-In contrast, when talking about litigation against officers/directors:

-Criminal: disclosed, even if pending and not resolved-Civil: does not have to be disclosed until judgment

-If we look at this as just litigation, this would not have to be revealed—would indicate something about the integrity independently

--The conduct that is adjudged here does reflect on management integrity—would be safe to reveal (Shepherd: could see someone seeing this as reflecting on management integrity)

-Note: 401 does not say anything about settlements

--Here, we have a government agency seeking what looks like a civil cause, but what may have risen to the level of criminal—probably needs to be disclosed

-Would have to disclose the litigation per 401, but also the underlying action per Glickman (since it’s integrity of management)

If the loans in the Glickman case reflected integrity of management and Glickman had been sued—would that eliminate the duty to report if the case is not resolved? NO--There are lots of reasons to report:

1) Litigation reduced to judgment2) Underlying causes of action (integrity of management)

--Something that is subject to litigation should not be withheld from being revealed—wise general counsel would deem it appropriate to reveal

What if you are a CEO and go and bunch someone at your child’s baseball game? Would this reflect on the integrity of the management—not necessarily—just because there is a misdeed does not mean it has to be revealed

Problems on pg. 508-5099-1:

Beta Corporation, a small software firm, recently made its IPO. At the time the RS was being prepared, the company’s sales staff had been hearing rumors from a variety of customers regarding the plans of one of the major software companies to launch a new product that would be comparable to Beta’s most innovative and profitable offering. One had written a memo to the VP for marketing, passing this information along. The VP took no action other than to ask that he be kept posted in the event that any hard information came along. No other Beta officials were informed.

The RS spoke of the market niche Beta had found as a result of its innovative efforts, with the usual disclaimer that there was no guarantee that competitive conditions would permit this niche to continue indefinitely. No mention was made of any more concrete market risks. A few months after the offering, Microsoft indeed came out with the competitive product, and a short time later, Beta was on the verge of insolvency.

A Section 11 suit has been brought for failure to disclose the information in question, naming Beta and all the usual defendants. In discovery, the memo to the VP was obtained. In deposition, the VP testified that he had withheld the information from others because he did not want to throw a monkey wrench into the financing effort, especially since the information was “only in the form of rumors.” Investigation and discovery by the plaintiffs have also established that when the registration statement was prepared, there was no publicly available information about the bigger company’s plans, and the few investment analysts who followed Beta were recommending purchases at the time of the offering. On

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the other hand, there is some indication that a few analysis who specialize in technology stocks were aware of the new product, and information about the plans had indeed spread to its sales staff, who in a major number of instances, had asked retailers and others to hold off making major purchases of Beta’s product.

How likely is it that, among the defendants, the following would be held liable: (a) the VP; (b) Beta’s CEO; (c) the managing underwriter; or (d) a software industry magazine publisher who sits on Beta’s board? Beta Company, a small software developer, is registering for their IPO. The VP of marketing is told a rumor that Microsoft may come out with a competing product. They do not disclose this in the RS and go public—then Microsoft comes out with a product and the stock plummets. Is there a violation?

1) MATERIAL and Duty to Disclosea. Material: Seems to be speculative since it was rumors so would undergo the Basic v. Levinson test

(Magnitude v. probability) i. Probability is low since only possibility, but if it does come out with a competing product that

is bad for the company—then large magnitude MATERIALb. Duty: Had they said nothing, no duty—problem was that they said they had found a “niche market”

where no one else was competing i. Maybe this was like the internal financial reports, no duty to disclose because so speculative,

not a hard factii. No duty to disclose internal projections

c. Forward-looking? Bespeaks caution? i. Forward: Yes, we’d have to wait and see if there was competition? Or no, since they were

stating fact? ii. Disclaimers here are rather generic regardless

2) Other defenses: a. Truth in the market (if others knew of the rumors)b. No statutory help (it’s an IPO)—but market test (the price dropped)

3) IF ASSUME MATERIALITY and DUTY:a. Who is liable?

i. Company/Issuer: YES (only defense is if the purchaser knew the truth and there are no facts to that regard here)

1. If there are materially incorrect aspects of the registration, then the issuer is LIABLE ii. VP of Marketing:

1. Not on list under § 11—unless they are on the boarda. He is not a principal officer so probably not liable

2. If so, should have done more than sit back—duty for due diligence iii. CEO: YES—on the § 11 list

1. Had a duty to investigate non-expert information—cannot just rely on information that came across his desk—needs to do reasonable investigation

2. Also has a duty to set up internal structures for reporting3. Like BarChris, CEO is deemed to know everything—all others are agents

a. Sliding scale: higher level on the scale you are, the more you are expected to know (not strict liability, but approaching that)

iv. Managing Underwriter: YES—only a due diligence defense, but they didn’t do any investigation

1. Should have been aware of rumors about Microsoft entering their market2. Have a profound duty to investigate

v. Outside Board Member: YES 1. Have a due diligence defense—courts are more lenient on outside directors 2. Should they have known about Microsoft’s plans? 3. Although the outside director was a software industry magazine publisher, he may

have been viewed as having a greater due diligence responsibility because of his expertise

a. What is expected of you is what kind of person you are: if you are a financial whiz, then you have more duties in regards to that

--Great potential for liability for the higher-ups in the company, but not for the VP of Marketing

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-The underling who had the information may not end up being liable, but will not make bosses happy--Due diligence requires that overlings do the due diligence to figure out what is going on with the underlings D can still try to show that any price drop or losses of Ps were not due to false statements (D can try to rebut the presumption that they are due to false statements)

9-2: Assume the facts above, but the rumors about Microsoft’s competitive product begin to spread shortly before the date of the public offering. To squelch rumors, Beta and the managing UW prepare and disseminate a statement in the form of a free writing prospectus indicating that the rumors are unfounded and are sourced in competitors who did not wish Beta to have a successful stock offering. Assuming it is false, what are the Section 11 liability implications of the statement? Does your answer depend on whether the statement is filed with the SEC? --Section 11 only applies to registration statements so go to section 12(a)(2) for false statements

-There it talks about statements other than those in the registration statement --Reforms adopted by the SEC in 2005 permit the use of a free writing prospectus that includes information beyond that which is constrained in the prospectus that forms the part of the RS—unless the issuer elects to the contrary, a free writing prospectus will not be part of the RS and therefore will be beyond the reach of Section 11--There is liability for a false or misleading prospectus as well as liability under the anti-fraud provisions of the securities laws will apply to the free writing

Intrastate Exemption

Problems on pg. 2685-1: Two physicians plan to form a MA insurance company that will write medical malpractice insurance policies from MA physicians. They would like to make an offering of common stock in the company to all MA physicians. They propose to advertise the offering in the Boston Globe and include information on the offering on their website. Are there any problems with the breadth of this offering? They also propose a direct mailing to all physicians on a Blue Shield mailing list of MA doctors (providing the officer addresses of Blue Shield doctors). Any problems? What about if you have lots of doctors—is that a problem? NO

-As long as all comply, doesn’t matter the number -Even one flaw eliminates the exemption for everyone

No integration problem because they are issuing it at one time Requirement: issuer incorporated in the state and must do business there (assume corporation)

-Would have to be incorporated there and be doing business there—satisfies that-Doing predominant amount of business there: looks like they will just be selling to MA doctors

Ad in Boston Globe is OK so long as there is a disclaimer on it NOTE: problem is whether the physicians are really MA residents—can only be for people that are from the state

-What does resident from the state mean? DOMICILE (resident with intent to remain)-So, if you are a student from Boston, but born and raised in Maine, then your domicile is Maine

-Is it possible that some doctors who practice in MA might not be from there? -Someone who lives in NH, for example—would not fit-Have to be careful that making offers to ALL doctors would be a mistake—have to say DOMICILED in MA

With large offerings like this, have to be careful: what if someone flips? Lies?

If this is offered in the heart of TX somewhere, then there wouldn’t be so much danger that there would be out-of-state residents—problems with small states (showcases why people don’t use this exemption very much)

5-2: Promoters intend to form a WA limited partnership for the purpose of investigating in oil and gas drilling ventures. All of the general and limited partners will be WA residents, all of the books and records of the partnership (including securities and similar evidences of ownership in the ventures) will be maintained in WA, and the sole office of the partnership will be in WA. Moreover, investments in the oil and gas ventures will be executed through WA brokers. Almost all of the ventures in which the partnership will invest, however, will be outside of WA. Will this partnership be doing business in WA for purposes of the intrastate offering exception? All the partners will be WA residents and everything is in WA—however, everything they invest in will be outside of WA. Are they doing business inside WA for the purposes of the exemption?

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--Mainly what they are doing is doing business OUTSIDE the state—business would not fit exemption here--Issuer is incorporated in the state but predominant amount of business is not necessarily there--Have to see if the offering came to rest with people outside WA (have to see if it is flipped)--Have to make sure that only offered to people within the state

Problems with the Exemption--People recognized the failures of this exemption: people found that it was safe to use only in situations where you offered securities only to a small amount of people

-There are other exemptions that work for issuances to small amount of people-So people used those

-Moreover, this exemption offers STRICT LIABILITY -Even if someone lies and tells you their a resident, then the exemption still fails

Problems on Pg. 2725-3: Minnesota Cablesystems is planning an intrastate offering of limited partnership interests. One of the potential investors recently accepted a job offer with a Chicago-based company. He has listed his Minneapolis home for sale, but it is likely to take several months to complete the sale. In the meantime, he will stay in a Chicago hotel during the week and return home on the weekends. May this investor participate in the MN offering? Safe harbor: principal residence: still Minnesota because he comes back home there Statutory exemption: domicile: Probably has moved to Chicago and intends to remain there, so arguably domicile has changed to IL (because he will work there)

-Wouldn’t qualify for statutory exemption and would eliminate—everyone would get their money back if they sold to him under the statutory exemption

--How can the SEC create a safe harbor that doesn’t seem to comply with the statute it is interpreting? SEC CAN DO WHATEVER IT WORKS!

5-4: Valdosta will merge into a subsidiary of Omega Corporation, a GA corporation. Most of the Valdosta shareholders not electing to receive cash will be giving common stock, for which a registration statement will be filed. Shareholders who are residents of GA, however, may elect instead to receive promissory notes issued by Omega. Omega would like to rely on the intrastate offering exemption and avoid regulation of the notes. How does the common stock issuance affect the availability of this exemption for the notes? What if the notes are convertible into common stock? Safe harbor: Since the offerings are within 6 months of each other, it is one issue and therefore cannot get intrastate exemption

-Safe harbor only applies if you are doing them at different times Statutory exemption: need to look at 5-favor test (unclear)

-Single plan: YES-Same class: NO-Made at the same time: YES-Same type of consideration: NO-Same general purpose: ?

-If the court views the different classes as different, then might not be integrated -Would have been smarter to separate the transactions within 6 months

5-5: The Money Café, Inc. is a CA company in the business of making consumer loans. It has about 300 employees who work in a LA office were all work relating to loan approvals and collections are done. About 30 percent of its gross revenues is in the form of interest from loans made to out-of-state borrowers. The company has operated for the past several years under financing provided by a TX bank. IT would like to refinance this debt by issuing debt securities to CA residents and using the proceeds to pay down the bank debt. Is Rule 147 available even though (1) the company has substantial income from interest paid by out-of-state customers, and (2) the company will be sending the proceeds out of the state to the TX bank? Safe harbor: The SEC ruled that this was all intra-state activity—that everything they were doing and using the money for was for in-state reasons

-Even though it’s a TX loan, they were using the proceeds to promote an in-state business

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-The fact that the proceeds are FROM another state doesn’t mean that the proceeds are going to be USED in the other state

--30% of revenues seem to come from out-of-state need 80% in-state, not 70%--but the revenues could be from in-state because the bank makes loans in CA even though the loans are to people who will use the money out-of-state--It is operating in CA and the original loan for TX bank was for loans in CA and the proceeds for the operation go to CA SEC recognizes that these are strict requirements and interpret them in ways to help the issuer and promote the business

5-6: X Corp. commences a Rule 147 offering on January 1. A purchases shares on January 15. The final sale to D occurs on March 1. When may A re-sell the shares to a non-resident? Looks at safe-harbor for re-sales 9 months from when the issue is complete—so 9 months from March 1, or December 1

5-7: A CT corporation plans to offer stock to CT residents. In lieu of paying cash, investors may elect to purchase their stock on an installment plan calling for 36 easy monthly payments. At what point will Rule 147’s holding period expire? What if before this point one of the purchasers moves to another state? What can be done to ensure the holding period expires at the earliest possible date? 9 months from the last payment this is because the security is not really sold until the last payment is made

-Out-of-state resident at the end of the 36-month payment: can’t move for 36 months and then 9 months after SEC: what counts is the last payment being made and the security being delivered

5-8: Preparation of a balance sheet in accordance with GAAP may result in an understatement of the value of certain assets, particularly real estate. Assume an issuer cannot satisfy Rule 147’s in-state asset standards unless a method of valuation not sanctioned by GAAP is used. Further assume an independent appraisal using such a method shows the 80% test is easily satisfied. Any problems? What if the balance sheet prepared in accordance with GAAP shows 79% of the assets are in the state? Can the issuer round this up to 80%? Have to look at the accounting statements and cannot look at true economic value

-May understate the true value of your statements Idea is that the book value is a clear-cut rule and appraisals can be monkeyed with: so GAAP must be used

-The rule is that you have to reflect the assets as they are reflected on your accounting statements What if you almost make 80% but you are at 79%?

-Can round up between percents-If you are at 79%, should round up to 80%

Private Offering Exemption

Problem on pg. 278:5-9: Ralston decides to reestablish its stock plan in conformity with the SC’s opinion. It limits participation in the plan to officers at the level of VP or higher, directors, and plant managers. Does the access to information these individuals may have raise questions regarding improper insider trading because of the use of the information? Moreover, does a VP of personnel necessarily have the kind of access to information the Court in Ralston had in mind? Does a plant manager? Looking at the access requirement under Ralston:

-VP and plant managers: would have to look—in some companies, every employee is not the custodian of the VP -Maybe the plant manager doesn’t have information on the company as a whole

Insider trading issue: if you are only selling stock to those with inside information, may have issues with insider trading

-What do companies do in this situation to avoid this?-Require systematic purchases of the stock: agree to buy 100 shares every quarter, or something-Cannot be any kind of insider trading claim if you are agreeing to a stock purchase plan before you acquire the stock

5-10: Nolotek is an oil and gas operation that would like to make a private placement of unsecured debentures to Herb, a high school dropout who recently won $5 million in the state lottery. There are no other offerees, and resale of the securities will be restricted to prevent the possibility of a public distribution. Because it feels an offering limited to one

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person, is, by definition, a private offering, Nolotek does not intend to incur the expense of preparing a disclosure document for Herb; it is willing, however, to answer any of his questions. Under Ralston, is Nolotek safe? Even though he may have access to the information, he is not sophisticated (unless one views all rich people as sophisticated)—can see that even with full registration, there is a danger that unsophisticated people will get ripped off always

-Under Ralston, argument that this person is not sophisticated --What about access to information?

-This person does not have direct access as an insider, but can you just give him the same info that would go in a registration statement? YES

--Here, not sophisticated and not an insider but could potentially have access—so questionable under Ralston --Look to statutory factors: SEC release factors: should satisfy

-Only 1 offeree-Only 1 unit offered-Do not know the exact size-Manner of the offering: No public advertising: only face-to-face

What about basing analysis on how sophisticated someone is based on how rich they are? -Doctors may not know a lot about finance, for example-Rich people may not always know the finance

Problems on pg. 288:5-11: Two physicians recently sold their interests in a medical center for a sizable profit. Flush with cash and in urgent need of a tax shelter, they commence negotiations with a promoter experienced in developing and operating oil and gas limited partnerships. The physicians have no experience with oil and gas ventures, but they have made a number of past investments in real estate ventures. Over the next 3 months, the physicians and the promoter work on developing a LP custom tailored to meet the physicians’ needs. In the view of the physicians, this is an educational process and by the time the agreement is struck and they make an investment of $700,000, they are quite confident about their own level of expertise on the oil and gas business. How sophisticated are these investors? How easy will it be for them in a subsequent suit to establish their lack of sophistication? What level of disclosures is required in order for the promoter to protect itself? 2 doctors have no experience and investi in oil and gas venture—work with a promoter to develop a limited partnership and invest $700K Will they fit within the exemption? NO

-Are they sophisticated? NO-They looked into this for 3 months: but this is not what courts will look into-Even sophisticated business people, not enough to be sophisticated -Need sophistication in investments-If they had hired an investment professional to help them, then sophistication is imputed to the investors to help them

-Expert: this would have to be a sophisticated business people, like CPA or an investment professional, a basic lawyer would not be enough (would need specific expertise in this area)

How much access to information is necessary?-To be safe, the promoter would give the doctors some disclosure that looks like a registration statement

Do you have to be a specialized expert? Do you have to be an expert in oil and gas?-Usual minimum is that the person has to have experience in investment/financing-Courts come out in different ways

Problems on pg. 2915-13: Assume a pool of 60 offerees, half of whom qualify as accredited investors. Each offeree is wiling to invest $100,000 in Regulation D offering. The issuer would like to structure the offering in a way that minimizes the expense of preparing a disclosure document. It also has reason to believe some of the offerees are not terribly sophisticated and

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wants to assume no risk in this regard. Advise the issuer on its options and the trade-offers of each of the Regulation D exemptions. 60 potential offerees, and each is willing to invest $100K but only ½ are accredited. The issuer doesn’t want to use a disclosure statement and doesn’t want to have to worry about anyone being sophisticated or not. How should is use 504, 505, and 506 to get the largest amount of money possible? 505 or 506:

-Could only raise $3 million with just accredited investors-Could raise $6 million in going into the pool of non-accredited

IF he sticks to the accredited investors, is there a sophistication requirement? NO-Being accredited is different than being sophisticated-Just need to have a certain amount of income/assets

-So can be “unsophisticated but accredited” -Would not have to worry about disclosures if all investors are accredited

SO: $ 3 million with just accredited

Can he got $ 4 million? Use 504 and 505 -Could have 30 accredited investors under 505-Have 10 non-accredited investors under 504 ($1 million)

-Timing issues-There is no requirement under 504 for accredited-Look to aggregation and integration rules: tells us how long to wait before “flipping”

Problems on pg. 294-295:5-14: Sybil is the VP in charge of governmental relations for Interg. Her principal functions are to coordinate the company’s legislative lobbying and to disseminate information on important regulatory developments. Will she qualify as an accredited investor by virtue of her position as an officer in the company? She is not really the person involved in policy-making--Would she be privy to lots of information about the issuer? Maybe not

-Distributing info about the policies not setting the policy --Would not qualify as an accredited investor

5-15: Person with lists of assets—is this person accredited? YES; under 501(a)(5)—net assets are more than the threshold--Is this a good idea?

-We assume that someone who is accredited is sophisticated--If this investor came to you and wanted to invest—what would you do? Would you just accept what he said?

-Would have to VALIDATE: may be lying about how valuable all his stuff is-May have an incentive to lie in order to get you to sell him the securities

--What if he does totally lie and tries to get money back later?-He cannot repudiate: he is estopped from saying he wasn’t an accredited investor

--What about the other investors: there were already 35 non-accredited investors in the offering and now there are 36 as a result of the liar (failing the exemption)?

-Some flexibility built in—exemption would not fail -Have to “reasonably believe they are accredited” 506(b)(2) -If you are reasonably tricked, then the exemption does not fail—even if that changes the number to 36

Problem on pg. 2955-16: Three purchasers participate in the Rule 506 offering. The issuer was without legal counsel and made no attempt to assess whether the purchasers qualified as accredited investors or complied with the provisions of Regulation D applicable when purchasers are non-accredited. In fact, each of the purchasers satisfied the accreditation standards at the time of the offering. The investment has soured, and the purchasers would now like to rescind. What is the relevance of the issuer’s lack of reasonable belief that the investors were accredited? The issuer didn’t reasonably believe that the investors were accredited; but had good luck and they DID qualify—can the purchasers get their money back?

-To satisfy the requirements of the exemption, do you have to reasonably believe or do you just have to believe?

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-501(a): accredited investor is any person who comes within any of the categories or who the issuer reasonably believes to come within the categories if the person comes within the categories, then accredited

-If they don’t, but the issuer reasonably believes, then the issuer is deemed accredited Here, good to be lucky—doesn’t matter that the issuer knows that they are, just have to be

5-34: An issuer has completed a $ 7 million private placement under Rule 506. The purchasers consist of 9 pension trusts (each qualifying as an accredited investor) and 1 individual who purchased a relatively small amount of securities offered. The individual had no pre-existing relationship with the issuer or any of its agents, did not satisfy the standards of an accredited investor, is not sophisticated, and did not have a purchaser representative. Three of the pension trusts would now like to rescind the transaction, and the issuer claims substantial compliance under Rule 508. What result? --To aid investors who are properly accredited, there was 1 investor who was not properly accredited and NOT sophisticated—can the others get their money back? --Did the violation harm the other investors? NO--Is it insignificant?

-Talk of being a solicitation—if general solicitation, then automatically significant but the exemption would fail (need to know more about the nature of the solicitation)-Doesn’t say anything about amount being high-Doesn’t say anything about more than 35

--In addition, for 508 to apply, have to look at GOOD FAITH doesn’t look like there was, just didn’t do any of the things they were supposed to

Problems pg. 2985-17: Marvella is interested in purchasing securities in a Rule 506 offering by Synertech. Although Marvella lacks the requisite sophistication required by the exemption, she relies on her brother-in-law George for advice. Assuming George has the requisite experience to meet the sophistication standard, which of the following circumstances would disqualify George from acting as a purchaser representative?

a) Marvella divorces her husband (rep no longer related)--This is fine: there is no requirement that you are related to your representative—only arises when representative is also an insider (not assuming insider here)--Can hire a representative who is not a relative

b) George is an officer of Synertech--This is not OK: Related: blood, marriage, or adoption—would qualify because he fits within this --Once there is a divorce, then not related anymore and could not do it after that

c) George is an officer of Synertech and does not tell Marvella of his position--Violation for 2 reasons: he is an officer of the company and did not disclose it

d) George is planning to buy a substantial block of stock offered by Synertech—not an officer yet --In general, doesn’t automatically disqualify him: not an officer of the company yet--Allowed to have a representative as long as they have not already done that—the one potential barrier is that you are required to disclose any relationship with the company that is mutually contemplated

5-18: Assume Marvella decides not to rely upon George for advice. Instead, she consults Priscilla, her attorney, on the merits of the investment. Does the issuer need to take any steps to satisfy itself that Priscilla is sophisticated? What if Priscilla is a CPA, rather than attorney? What if Priscilla is a CPA, rather than an attorney? What is Priscilla is both a PCA and an attorney? Exemption in 506 applies only if non-accredited investor is sophisticated--Is an attorney automatically sophisticated?

-Have to look at what specialty the lawyer practices -An attorney is not automatically sophisticated

--Is a CPA automatically sophisticated? NO-Could have accountants that do not know about investing-Have to CHECK and do due diligence

5-19: As an attorney, what risk of liability will Priscilla incur if she acts as a purchaser representative for Marvella? Is it likely that this liability is covered by her malpractice insurance policy?

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Is it smart for the attorney to serve as the representative? -The standard of care: of a normal lawyer (normal legal things)-Here, you re being hired to be an investment expert (standard goes up)

-Have to satisfy standard of care as an investment expert -Have to be careful—probably not covered by malpractice insurance-Covers only legal mistakes

--Should decline to take this kind of representation

5-20: Suppose Marvella, who is thrifty and unwilling to pay high fees to anyone, refuses to hire a representative. May the issuer pay the fee of Marvella’s representative? Could see that it is smart for the issuer to sell to a sophisticated investor—if she doesn’t want to hire the representative herself, then the exemption would fail--Can see conflict of interest

-Disclosure of the relationship is deemed by 504(h)(4) to be sufficient: disclosure to the purchaser regarding any material relationship between the representative and the issuer—if you disclose the relationship than that is sufficient

Problems on pg. 299:5-21: Priscilla is a CA resident and a non-accredited investor in a Rule 505 offering. Her father, a NY resident, is a non-accredited investor in the same offering, as is a corporation in which Priscilla and her father each have 50% beneficial ownership interests. Assuming the corporation does not qualify as an accredited investor, will Priscilla, her father, and the corporation be counted as 1, 2 or 3 purchasers? The corporation is counted as a separate purchaser because the purchasers each have 50% beneficial owners Two relatives will be counted separately because they have separate residences

= 3 purchasers (dad, daughter, and corporation)

5-22: A partnership not qualifying as an accredited investor has 10 partners. If the partnership purchases securities, will the transaction be regarded as 1 by a single purchaser, 10 purchasers, or 11 purchasers? Must the individual partners satisfy the accreditation standards? What if the partnership was formed for the purpose of acquiring the securities being offered? The partnership will count as 1 purchaser unless the partnership was solely formed for this investment (then it is 10)

5-23: An individual who is a purchaser in a Rule 506 offering satisfies the net worth standards for accredited investor status. He lives in the same home with his wife and her brother, who is not an accredited investor, but who would like to purchase securities in the offering. Does the brother count for purposes of computing the number of purchasers? 501(e)(1)(i): doesn’t count relatives or spouses living in the same household

-HOWEVER, since the husband is accredited and never counted, then the brother does count = 1 non-accredited (even if brother, mother, etc wanted to buy)

--Accredited = not a purchaser relative does not count

Problem on pg. 3035-24: J.R. is a promoter of oil drilling ventures and a member of the Houston Petroleum Club. He has sent an offering circular to the Club’s members (approximately 200 individuals) describing the “deal” he is now putting together and soliciting their interest in participation as investors. JR is confident that all of the Club’s members are accredited investors for purposes of Regulation D, but to avoid any problems, he has stamped in red, on the first page of the offering circular: “FOR ACCREDITED INVESTORS ONLY.” Has JR engaged in a general solicitation? Does it make a difference if all of the offerees are in fact accredited investors? Sent an offering circular to all the members of the club. By circulating this solicitation to them, is this a general solicitation or not?

-Is this the kind of prior relationship that the SEC is contemplating? -NO!

--Have to have some kind of relationship in which they have either received securities before, or been customers before—just knowing someone socially is not enough

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Problem on pg. 3055-25: A broker-dealer uses suitability requirements to pre-qualify potential investors in Regulation D offerings. The questionnaire is of the type described in the Hutton no-action letter. Moreover, the firm follows the lesion of the Bateman Eichler no-action letter and imposes a 45-day waiting period between pre-qualification and any subsequent offer. Assume a client pre-qualifies (on the basis of new worth and annual income) on February 1. On July 1 of the following year, the firm would like to offer securities to the client. Need it be worried about the client’s continuing qualification? If so, what should it do? Once people send in their completed questionnaires, have to wait 45 days. What if directly after the 45 days there is a Regulation D offering and the broker was hired? Would these people who just signed up 45 days before be appropriate purchasers pursuant to Regulation D?

-This would be OK-This is what you are supposed to do: 45 days is enough of a wait

What if you wait 18 months—July 1st of the next year? What are the issues there?-Would still have a pre-existing relationship with the broker-Other problems that would have to be solved for the pre-qualified person:

-Investor would want to make sure the investor still meets the qualifications needed and to make sure that everything is OK with the purchaser-A lot of things can happen in 18 months: what happens if they have lost their job or assets?

-Is not a law to check up on the investor; but it is prudent—it will not be a reasonable belief to let the investor go unchecked if there is a later law suit-It is not reasonable to rely on 1-year old information without checking up

5-26: Murphy, a registered investment advisor, plans to publish a monthly newsletter that will be sold by subscription to tax attorneys and accountants in CA. The newsletter will provide information concerning Regulation D offerings that may be of interest to subscribers who have clients in need of suitable investment opportunities. Murphy will gather information on the offerings by collecting private placement documents and choosing for coverage the more interesting of the offerings. The newsletter will cover the selected offerings by summarizing information gleaned from the private placement documents, supplementing the information with additional data produced by interviews with the issuers, and providing an analysis of the tax and economic ramifications of the investments. Murphy will rate each covered investment on a scale of 3 (good, neutral, or negative).

Assuming Murphy has no relationship with any of the issuers covered and his compensation is derived solely from the subscription sales of the newsletter, do Murphy’s activities create problems under 502(c)? What if the newsletter is also sold to potential investors? But, what if an independent person publishes an article about a company’s offerings and securities?

-The only contact with the person has with the issuer is that it may go interview the CEO and ask him about upcoming Regulation D offerings-Does that constitute general solicitation such that it will destroy 504-506?

Can do it if he just gets the info from public sources—but if he interviews CEOs from the company, the SEC has held that these do not cause a problem

-Can interview CEOs without it destroying Reg D exemption

5-27: Murphy instead decides to publish a newsletter for attorneys and accountants containing only information derived from public sources. Is this permissible under Rule 502©? Seems to be OK since it is from public sources

5-28: DSM maintains a web site that includes a number of Regulation D offerings. To obtain information on any of the offerings, an investor must first register with DSM. The registration form includes a “full access” option for an “accredited individual investor.” This status can be achieved by checking 1 of the 2 boxes that provide:

I alone, or in combination with my spouse, have a net worth in excess of $ 1 million; or For each of the past 2 years, my annual income has been greater than $200Kor the combined annual income of my spouse and I has been greater than $300K.

Upon checking the box, the investor is registered and immediately has access to materials on the offerings. Is there a problem? One issue: they are taking the clients word for it and not double-checking if they client is telling the truth (how do we know if they are millionaires)?

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o One issue is that they are taking the clients word for it- they are not double checking whether the client is telling the truth. They may not be millionaires

Therefore, should require the website to have a follow-up process that before access is granted, they have to send in copies of tax returns or banking statements to provide some sufficient evidence that there is a reasonable basis for the broker/issuer to feel that they are an accredited investor. Another issue: sign up and can get immediate access you are supposed to wait for a substantial period so the website can argue for a pre-existing relationship

-It is not pre-existing if you sign up and then get an offering a few days later

Problems on pg. 314:5-29: On January 1, an issuer commences an offering under Rule 505. By April 1, $5 million in securities has been sold, and the offering is terminated. When may the issuer commence a new offering under any of the Section 3(b) exemptions? When may the issuer safely commence an offering of the same class of securities under Rule 506?

Under 504/505, the new offering should only be offered on April 1st of the next year (wait 12 months from April 1st)

May be able to issue another offering earlier depending on the date of the securities that were soldo Ex: IF 4 million was sold on January 1st, you could only sell 4 million more by the next January.

506 offering? o Since there is no aggregation or dollar limit for 506 (allows you to issue infinite amounts of securities),

there is an integration worry—would want to wait 6 months from April to issue. You could wait 12 months from April 1st. If 4 million was sold on January first, you could sell 4 million 12 months from January.

3(b): statute that enables the adoption of any kind of exemption having to do with a small offering (504 and 505, for example)

5-30: An issuer has not offered or sold securities in the preceding 12 months. On January 1, it begins a Rule 505 offering that remains open until June 1; it sells $4.5 million in securities in the offering. On May 1 of the same year, the issuer begins a Rule 504 offering; in this second offering, which is open for 2 months, the issuer sells $750,000 in securities. What is the effect of the aggregation rules on each of these offerings? Need to examine the actual timing of when the $750K was sold--If everything was sold AFTER June 1, then you are ok--If sold before June 1st, violating the $ 5 million limit under 505—so potentially have a problem with the 505 offering (look back within the last 12 months)

-Could have sold a max of $ 5 million-Have to look and see the timing of 505 sales

-If they sold the entire $750K before 505 offering, then problem --504 may also present problems:

-At the instant you start 504, over the $ 1 million-Aggregate pursuant sales that occurred within the last 12 months-Dead even before it starts

5-31: An issuer sells securities in a transaction structured to comply with Rule 504 and completes Form D claiming this exemption. It not determines that the earlier offering satisfied the conditions of Rule 506. In order to avoid aggregation with a new Rule 504 offering it would like to have, may the issuer now treat the earlier offering as a Rule 506 rather than a Rule 504 transaction? Yes, as long as you satisfy the requirements, it doesn’t matter what you called it before—so if it qualifies, then you are OK

-Possible that you qualify under 504 and 506, and pick the one you want to use --Advantage to have under 506—have unlimited amounts and do not have to worry about aggregation

5-32: A LP has been formed for the purpose of acquiring and developing real estate. A total of 40 units of the partnership will be sold to investors at a cash price of $10,000 per unit. An additional ten units will be sold for non-cash consideration in the form of real estate. Given the mix of cash and non-cash consideration, how will the aggregate offering price be determined? What if the offering is structured so that all investors contributed real estate and here is no cash consideration?

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Rules say that if it is part real estate and part cash, you assume the real estate is equal to the cash per unit (under 501©)—here, each unit of real estate will be valued at 10K

-Total aggregate value: $500,000 What if no cash being sold, all being sold as real estate?

-What is the possible scam here?-If trying to evade the dollar limits of 504/505, what is the incentive if you are selling real estate? -Play with the value of the real estate

-Ex: 501(c): if the securities are not offered for cash, look to other sales and in the absence of sales, then the fair value by an accepted standard (appraisal)

Problem on pg. 319:5-33: An issuer is subject to an injunction because of its failure to file Form D notices. Notwithstanding this disqualification, the issuer proceeds with a Rule 506 offering that is in complete conformity with the requirements of the Rule. To what extent can the disqualification deny the issuer the benefits of the private placement safe harbor? What if the second offering is under Rule 505? Can it enjoy the protections of 506?

-Look to 507(a): you cannot use 504/505/506 if subject to injunctions by SEC--Does this mean the offering would not enjoy an exemption? What are you left with in that situation?

-Can go to 4(2): the statutory exemption (private offering)-If you screw up Reg D, can still enjoy an exemption

Regulation A

Problem on Pg. 331:5-39: Brocon has prepared a brochure for potential investors in anticipation of a sale of common stock under Regulation A. The brochure includes a coupon (with a return postage pre-paid) that allows an investor to communicate to Brocon an interest in the offering. Is the coupon allowed in a “test the waters” document? What is the effect on the availability of Regulation A if Brocon forgets to submit a copy of the brochure to the SEC? And may Brocon use the brochure together with the offering statement after the latter is filed with the SEC? --This is an appropriate testing the waters document--Is a coupon ok?

-YES Rule 254(c): coupon returnable --Supposed to submit the brochure to the SEC: what if you forget? Does this eliminate the exemption?

-254(b): not a condition of the exemption (forgetting to mail)—so does not eliminate the exemption-But, if the SEC gets mad, can stop the offering (Rule 258(a)(1) failure to comply with the provision is grounds for SEC to prevent issue)

--Can you keep using the brochure after the offering statement is filed? -NO: Rule 254(b)(3) cannot test the waters after you file the offering statement-Why?

-Can use the preliminary offering circular instead-There are other documents that are available

5-40: On Aprill 1, Limitbeat begins testing the waters for a $5 million Regulation A Internet offering. On May 1 (the date the last prospective purchaser was contacted), it concludes that he demand for its securities was so great that it can proceed with an offering in the $6 million to $7 million range. Accordingly, it decides to proceed with a Rule 506 offering, rather than a Regulation A offering. What is the earliest point at which it may safely begin the Rule 506 offering? What are the 2 options if it wishes to proceed more quickly? 3(b): allows SEC to come up with exemptions for up to $ 5 million. Let’s suppose you test the waters and can raise more than $5 million. Can you abandon the Regulation A offering and engage in a Regulation D offering?

-Have to see if there is an integration problem-Integration rules for a Regulation A offering: have to wait 6 months under 251(c): a regulation offering will not be integrated with subsequent offerings made 6 months after the completion of the offering-If you abandon the offering, that means it has been completed, and need to wait for 6 months

If you want to engage in a regulated, full-on offering, have to wait 30 days: 254(d)

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5-41: On March 1, Hightech completed a $1 million Rule 504 offering. On November 1, it commences a Regulation A offering. How large may the Regulation A offering be? Aggregation: What is the max amount you can issue?

-$5 million-You do not have to count other Regulation D offerings: aggregation rules for Regulation A offerings say you only look at Regulation A offerings, not other exempt offerings

For integration: Rule 251(c): Regulation A offerings will NOT be integrated with prior offerings of securities will not be integrated

-Not going to be integrated with any prior offering

Secondary Offerings

Problem 6-1: pg. 353Carl, as a favor to his cousin, Alice, assists her in drafting an offering brochure for securities of her new company, Birdseed.com. At the conclusion of the drafting process, Carl was so impressed with the venture that he provided Alice with e-mail addresses of 250 members of the local chapter of the National Audubon Society for which he is secretary. Alice forwarded the offering brochure of the e-mail addresses and thereby sold a significant portion of the offering to 40 of the chapter’s members. In gratitude to Carl, she gave him 500 shares of the offering stock. Is Carl an underwriter? Question is whether Carl is a “helper” under Category 1

-What was his level of help compared to the Chinese case?-He is helping a lot-So, he is an UW and 4(1) does not apply

-Does it matter if he is paid?-Does not matter if you are paid for your services, just matters if you are aiding the distribution

What if he had been helping out not the issuer, but A to sell her own shares?-C would still be considered an underwriter, if A is a control person -Category 1: helpers for the issuer or control person

What if instead of helping out, you purchase/resell -Category 2: purchase with an intent to re-sell-Not an UW, because instead of an intent to re-sell, you have investment intent

What if there is a private placement sale, and then flip them?-Do have to register if I am a purchaser with an intent to re-sell-When does someone have an intent to resell

-If you originally purchased with investment intent, you are not an UW because you did not have an intent to resell

--It is difficult to have this definition to apply since investment intent is SUBJECTIVE

Problems on pg. 6566-2: 16 months ago, B purchased 1000 unregistered Chromium Mines, Inc. common shares through a private placement. Much to her surprise, B had just been admitted to the prestigious and expensive P University graduate school. If B now sells her Chromium shares to pay the tuition deposit, will she violate Section 5? There is a change in circumstance: if she knew about it, then might not be a change

-Not really an unforeseen circumstance—foreseeable thing that she hoped would happen (as opposed to getting hit by a meteor)-If her circumstances hadn’t really changed, then she is an issuer

IF she waited 3 years, would not even have to show a change of circumstance-She waited 16 months, so the presumption of change in circumstance is lower

6-3: J, in desperate financial shape, exchanged worthless desert real estate for 125,000 shares of issuer unregistered common stock. Thereupon, J pledged all the shares to Bank as collateral for a loan. She obtained the loan through fraudulently prepared financial statements. J promptly left town. While J has demonstrated several important flaws in her character, can Bank nevertheless resell the shares to satisfy the outstanding loan? --She defrauds the bank and gives shares as collateral—can the bank re-sell the shares?

-No, would look at the purchaser’s investment intent here-Here, the purchaser is defrauding the bank and doesn’t intend to pay back the loan

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-Prohibits the bank from re-selling because not investment intent -Do not focus on the bank, but focus on what her intent was: lots of situations where you pledge securities for a loan—question is whether she expected to pay off the loan?

-Probably not if she defrauded-Therefore, investment intent would NOT exist

--Bank would not be able to resell the shares without even registering them or waiting for 3 years --Otherwise, this is a way for her to re-sell the share and get outside of private placement exemption

What can the bank do? --Could get a promise from the issuer

-Bank wants a letter from the issuer saying that if we need to re-sell them, the issuer promises to register them or promise to buy them back

--Bank would be able to sell the stock to sophisticated people with access: not deemed to be a distribution if you resell consistent with Ralston --Bank could hold on the stock for a long time so that it will be deemed to have investment intent?

Problems on pg. 358:6-4: 1 year ago, Burt acquired 1000 shares of SunTech, Inc. in a private placement. SunTech’s annual report, which has just been released, reflects that earnings have quadrupled in the past year. Burt is both ecstatic and in need of cash for a new addition to his house and has approached his neighbor Carol, a broker-dealer, about possibly re-selling the shares. Carol offers to contact several of her clients about their purchase of Burt’s shares. Burt agrees. Before Carol actually begins soliciting her clients, she asks for your advice. What would you tell Carol?--Let’s suppose B just want to sell on the market—can he do that right after he purchased it? NO

-The issuer is that he is deemed to be a UW, therefore not fit within 4(1) if he was a purchaser from the issuer (he purchased from the private placement) with an intent to re-sell (how long he held on to it)-A year is not a long enough wait to establish the investment intent

--What other way are you allowed to sell restricted securities earlier than 3 years?-Can argue change of circumstances: “stock price went down!”

-With that excuse will not succeed-The purchaser has to experience the change in circumstance: in order to win, have to show that the change in circumstance is not a result of the company (less profitable/more profitable), the only ones that succeed are the ones that happen to the purchaser (ex: cancer)

-Here, has not held long enough, has not satisfied change of circumstance--What he would have to do is ask the company to register the securities!--Unless some other exemption applies: way to convince the court that he fits 4(1) and not a UW--He would argue that he is going to sell to people in a way that is NOT a distribution: selling to other sophisticated people with access

--What if he purchased shares pursuant to registered shares pursuant to the offering?-Since he is a non-control person, this is a trading transaction so you can do that-Not the facts here (say it is a private placement)

GO THROUGH 4(1) ARGUMENT + DISTRIBUTION TO GET AROUND UW

6-5: Assume in Problem 6-4 that, when Burt acquired his SunTech shares, there already existed trading in SunTech shares in the over-the-counter market. Nevertheless, SunTech had issued shares to selected purchasers in a private placement to raise funds quickly and cheaply. One year after purchasing his shares, Burt approaches Carol about selling the shares into the OTC market. How would you advise Carol? Can he sell in the active OTC market?

-The answer doesn’t change at all: if you purchased pursuant to a private placement, doesn’t matter that there is a market -With the background law (not looking at 144), doesn’t matter if there is an active market or not—still have to sell ONLY to people who are sophisticated or have access (or change of circumstance or lacks investment intent)

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6-6: What results if the shares had been sold to Burt as part of a registered offering and shortly after Burt purchased those shares he resold them through Carol in the OTC market? Then could flip them immediately

-When you re-sell them, not deemed to be a distribution

Problems on pg. 365:6-7: Orange Company, Inc. is a highly successful software company, its shares are traded on NASDAQ, and it has a 6-member board of directors. Alice, who owns 18.3% of the outstanding Orange common shares and is Orange’s largest shareholder, has asked Bob, a broker with Fedder Investments, Inc., to sell him in the market approximately one-third of her Orange shares. Bob is aware that three of the six members of Orange’s board of directors are Alice’s nominees. Bob has also been asked by Carl, one of Alice’s nominees, to sell his Orange shares. Advise Alice, Bob, and Carl whether they have any section 5 concerns. Assume the shares held by Alice and Carl were issued 4 years ago pursuant to a registered public offering. Is Alice a control person?

-She has the power to elect 3 of the directors-She owns 18.3% of the stock

-Therefore, it looks like she would be a CP-If she wanted to sell her shares, she could force the company to register

Assuming Alice is a control person, then Bob would be deemed her “helper” -She would satisfy the 4(1) requirement -Does 4(1) apply if there is UW involved?

-4(1) applies if UW is involved, then look to 2(a)(11): if someone is helping out a CP, then same analysis as if they are helping out the issuer-Bob, helping out CP, has same legal impact as helping out issuer

How can they get off the hook?-They can show that purchasers satisfied Ralston requirements (sophisticated + access)

IF Alice was not a CP, could instantly flip them. But, she is—what is suggested here?1) Could get company to register them2) 4 1 ½ exemption: sell to Ralston people without registering them

Why 4 1 ½? -Suppose the issuer was trying to sell—could either register or sell pursuant to a private placement/intrastate

-Could a CP use a intrastate exemption?-What the CP can do is use this judicially created 4 ½ exemption to do the private placement the same as an issuer-If a CP has stock, how can they sell it?

-Either have to register or sell in a private placement: sell to sophisticated people with access

Rule 144

Problems on Pg. 3756-10: Jeff is the owner of 10,000 unregistered Apex common shares that he purchased in a private offering. He now wishes to sell some of these shares.--Has to wait 6 months since he is an affiliate

-Comply with holding period, once he has waited 6 months, would have to let them trickle out pursuant to volume limits, file forms with SEC, and comply with broker’s transaction

--If not an affiliate, he would have to wait 6 months and comply with informational requirements—if he waits for 1 year would not even have to do that.

6-11: Assume the shares Jeff owns in the above problem were initially issued to Jeff pursuant to the intra-state offering and Alice sold the shares to Jeff. As far as 144 goes, these are unrestricted securities--If not an affiliate, no 6-month requirement--147 for the intra-state exemption says 9 months in this situation

-There would be nothing required for a non-affiliate for 144, but other statutes do require things What is the rule when a non-affiliate can sell pursuant to a registered public offering?

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-Do not need a safe harbor: if non-affiliate can just re-sell immediately What if you are an affiliate and dealing with securities sold in registered public offering?

-Deemed to be the same as the issuer under 2(a)(11)-In the same shoes as the issuer—would have to have the company register the securities or find an exemption

-The main way 144 is used:-Look to whether purchased by affiliate under intra-state (non-restricted) or ones that satisfy normal restricted securities offering -If person owns both kinds, have to look to holding period and would have to comply with the requirements: volume limits, information, file forms, etc.

6-12: 1.5 years ago, Zeta issued 2 million common shares pursuant to an offering under Rule 505. However, Zeta’s attorney failed to keep track of the number of purchasers in that offer, so that there were about 47 non-accredited purchasers in that offer. Susan, one of those purchasers, now wishes to resell her shares. They wrote 144 specifically to deal with this situation--Just because there was a technical problem by the issuer, you should not be prevented from re-selling Just because the original exemption was messed up, this does not stop Susan from being able to re-sell Even though they sold to too many people, still subject to restrictions of Regulation D

-Since these are restricted securities, have to determine if affiliate or not to determine what has to be done -Doesn’t say that she is an affiliate or not

-What if she is NOT an affiliate? -She has to wait for 6 months with information requirement, then has to wait for a 1 year with no information requirement

-What if she IS an affiliate?-Still has to wait for 6 months with information requirements, and also volume limits (trickle them out, broker’s transactions, etc)

6-13: Bill, a control person of Omega Company, is negotiating to sell his control block to Alice. All discussions between Bill and Alice have been on a direct personal basis so far.--144 is not the exclusive way to re-sell securities

-In the absence of 144, how could you sell securities?-Sell on street corner-Negotiate deal yourself as the example suggests

--In general, SEC recognizes that if the statute says something, SEC cannot pass rules to contradict what the statute says—144 would respect the street corner approach--144(b)(2): Affiliates or persons selling on behalf of affiliates. Any affiliate of the issuer, or any person who was an affiliate at any time during the 90 days immediately before the sale, who sells restricted securities, or any person who sells restricted or any other securities for the account of an affiliate of the issuer of such securities, or any person who sells restricted or any other securities for the account of a person who was an affiliate at any time during the 90 days immediately before the sale, shall be deemed not to be an underwriter of those securities within the meaning of section 2(a)(11) of the Act if all of the conditions of this section are met.--> THUS STANDING ON STREET CORNER IS FINE

6-14: In the preceding problem, Bill has grown restless with his negotiations with Alice. He has hired Broker to sell a large amount of his shares through NYSE. Under 144, deemed an affiliate—here, falls under 144 and has to comply because someone is helping him (street corner approach doesn’t work anymore)--Here, would have to comply with 144(b)

-Here, a broker will be selling for the account of an affiliate (this is OK) but have to comply with 144: holding period, volume requirements, broker transaction requirements, etc.

NOTE: If CP gets someone to help them, that person is deemed as a UW because it’s like CP is issuer

6-15: Alpha Company is 5 months later in filing with the SEC the 10-Q report for its third quarter, which it is now required to file under Section 13 of the SEA. Carla, an owner of Alpha restricted stock for 7 months, wishes to resell her shares. Consider also the result if Carla owned her shares for 6 months but the shares had been issued by Alpha 14 months prior to the proposed sale. What result if Carla was Alpha’s CEO?

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The company has messed up in providing the information, Carla wants to re-sell her shares—what is the deal if she is an affiliate or not affiliate?

-If Carla is NOT an affiliate, for 1 year, the non-affiliate is subject to information requirements-If the company hasn’t complied with requirements, can still sell if she waits for 1 year and she can sell them all as an affiliate

-If Carla is an affiliate, the information requirements go away after 1 year—would have to get the company to provide the necessary disclosures

-If she is a CP/affiliate, has power to influence -Treated more harshly with respect to information, but only saddled with that requirement because she is a CP

6-16: Beta Inc. is a small publicly owned company with 150 stockholders, but is not subject to the Exchange Act’s reporting provisions. Beta recently mailed to its stockholders its most recent annual report, which includes 3 years of comparative audited financial statements. Dave had owned his restricted Beta common stock for 11 months and wishes to resell. Issue is whether information is the same as in annual report

-If he waited another month (1 year), then doesn’t have this-Wait 1 month because he may lose otherwise

--If he sells the stock, price goes down, then buyer wants the money back—so, the safe thing to do is wait another

6-17: Ellen, the CEO of Ocean Enterprises, 10 months ago purchased 10,000 Ocean Enterprises common share son the NYSE. She now wishes to sell those shares. Because the stock is registered, this is not a restricted security

-6 month holding period doesn’t apply, but all other requirements apply-Regardless of how she got them (NYSE or public offering or whatever), if she has them, then treated as having same information advantage of company itself, securities laws saddle her with same burden

--There would be no holding period, but only able to trickle them out—requirement that they’re sold only to broker’s transactions, etc.

IF you sell them in 5 months, would they be subject to 16(b) so you wouldn’t be able to make a profit?-16(b): causes an insider (executive, board member, or someone who owns more than 10% of the stock) then they have to disgorge profits to the customer

-Might have to disgorge the profits

6-18: 3 years ago, John acquired in a private offering Amalgamated Company common shares in exchange for his personal note in the amount of the shares’ purchase price. John is Amalgamated’s CEO. The note is full recourse note due on demand and bears interest at the rate of 9 % per annum. The shares are collateral for the note. John now plans to sell the shares, receiving enough after payment of the note to have earned a small profit. This deals with the issue of how stuff works when we buy things on credit. Have the CEO, and he purchases shares by borrowing money from the shares for the company. It is full recourse and the shares are collateral. What happens?

-If you borrow money from the company (different if you borrow from a bank) for the securities—the time starts running from when you actually pay for the securities unless full recourse loan and secured by collateral OTHER than shares itself and have to actually pay off shares before you sell them

-This is not the case here, doesn’t fit within rules of 144(d)(2)-Although full recourse loan, the only collateral is the shares themselves

-Has not paid off loan—hopes to sell the shares and use them to pay off the loan--Before the time starts running, has to pay off the loan—so this is OUTSIDE 144

-Thrown back to show investment intent, etc (background loan)--What should he do instead?

-Figure out some other way to pay off the loan-Once that has happened, then wait 6 months-Will not be able to sell immediately, has to comply with volume requirements (do not know how much he is selling)

If 144 doesn’t apply because he hasn’t not paid off the loan, what does pay?

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-4 (1 ½): When does it apply?-In a situation where an affiliate has securities that would be unrestricted but because he is an affiliate, there are problems. What this does is say that as long as he sells to sophisticated people with access, he is OK. BUT, have to come to rest—have they come to rest?

-Maybe (3 years)

6-19: Assume in the preceding problem that 17 months ago, John pledged his shares with National Bank, using the loan proceeds to pay Amalgamated. John is now hopelessly insolvent and has defaulted on the loan from the bank, so that National Bank wishes to sell the Amalgamated shares. What result if John was Amalgamated’s CEO? Pledged the shares to outside bank and used loan proceeds to pay off note to issuer—then, not going to be able to re-pay loan to bank. HE is the CEO. What can the bank do? -Can sell the collateral—when?

-Tacked to when he first purchased them-The normal rule would be the bank couldn’t sell them until the bank waited an additional 6 months -Here, the transaction with the bank (bank with affiliate—would think they would have to wait until 6 months after affiliate default)—but TACKING allows to add affiliate time (rule for helping banks)

-BUT, exception for this rule: has to be a full recourse loan-If not full recourse (like a pawn shop), then the time starts running from when he defaults-But, if a full recourse loan that he got from the bank, then tacking

Note: used to be a lot longer that banks had to wait (now 6 months)

If shares are from a non-reporting company, than have to be 1 year

6-20: Mary is a control person of Theta. She acquired her shares in a registered public offering. Theta shares are listed on Amex, where the average weekly trading volume for Theta common stock is 150,000 shares and there are 18 million outstanding Theta common shares. During the first 3 months of the current calendar year, Mary sold 150,000 of her Theta shares, 50,000 shares each month. How many Theta shares may she sell in April? CP gets shares in public offering. How quickly can she re-sell them?

-Does she have a holding period?-No, these are not restricted shares (so no holding period) but still restrictions

-What are the restrictions? -Volume restrictions for affiliate: within 3 months cannot sell the greater of either the weekly trading volume or 1% of the number of outstanding shares which is greater? 1% of the 18 million = 180,000 vs. 150,000 (weekly trading volume)

-She sold 50,000 each month in a 2-month period, and in the 3rd month, she can only sell 80,000 because she has already sold 100,000

--Volume limit says you cannot dump shares all at once—can only trickle them out. The most you can sell in any 3-month period is average weekly volume or 1% of total outstanding shares. Look to the GREATER of those 2 numbers and that is your MAXIMUM for a 3-month period.

6-21: Assume in the preceding problem that prior to her sale of the 150,000 shares Mary gave Cornell University 120,000 Theta shares. If Cornell sold all of those shares in the second quarter of the current year, how many shares can Mary sell during that same quarter? She gave shares to her college and the college then sold those shares during the period she wants to sell the shares. How many can she sell?

-Assuming she is still bound by 180,000 total, so only 60,000 more--Point is that 144(e)(3)(iii): the re-sale of a gift that you have given to someone, if the donee resells those shares in a given month, then that counts towards the period you sold (180,000 – 120,000 = 60,000)-Why? What other way could she give value to Cornell?

-Could sell the shares herself and give money to Cornell, but then have volume limits

6-22: Assume Theta common shares are traded in the OTC market. Mary retained Broker to dispose of some of her Theta shares. Broker wrote Margin & Co., which makes a market in Theta common shares, to inquire if it had any unfulfilled orders for Theta shares at or near the current market price.

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Mary (an affiliate) hires a broker to sell her shares. The broker then contacts someone else to find out if it has any orders for those shares so that the broker might be able to use unfilled orders. Does that count as a broker’s transactions?

-One of the requirements: if an affiliate, only certain ways to resell-A broker’s transaction: unsolicited transaction

--Does this count with this in mind?-Traditionally, broker’s transaction means broker without sales efforts just sells securities-But, 144(g) loosens that up: allows broker to go out and talk to other brokers who have indicated an interest in the securities in the last 60 days

-What is in this question is probably not include din 144(g)--Not asking the broker if they are interested, asking if they have other customers who are interested --NOTE: Shepherd doesn’t care if we know that much about broker’s transactions, but just about 144(g) and the requirements for broker’s transaction are complicated

6-23: Assume the Theta common shares in Problem 6-22 are traded over the counter and Mary has retained Broker to dispose of a sizable amount of her Theta shares over time. Unbeknownst to Broker, Mary has entered into a similar agreement with a dozen other brokers, all of whom are selling for Mary’s account sizable amounts of Theta shares. What happens if she hires this broker to trickle out the shares but she is also illegally hired a bunch of other brokers to do something else? Each broker thinks they are disposing the amount allowed in the volume requirements, but she is violating the volume restrictions by not telling them. What happens in this situation? (similar to Wolfson case)

-In Wolfson, the brokers were not liable -The same rule is indicated here: 144(g)(4)

-If the broker undertakes a reasonable inquiry and not aware of circumstances that they are part of a big distribution, then the broker is not liable-Does that mean the person actually selling shares can still use 144? NO

-Broker is protected there-Ultimate re-seller is NOT protected like in Wolfson

6-24: Assume Mary, in the preceding problem, will sell shares in the OTC market exclusively through Broker. Mary discloses to Broker that, at the same time Broker is selling Mary’s control shares to the public, Mary will privately sell 60,000 shares to Tom. Tom is not a sophisticated buyer, but he and Mary have negotiated directly with one another without the assistance of any intermediary. Must Broker take account of Mary’s sale to Tom when considering the number of shares Broker can sell? Have CP doing 2 things at the same time: she is using the broker to sell some shares pursuant to 144 and she is standing on a street corner and selling shares. Do you count the amount she is selling on the street corner with the volume requirements?

-Yes, but what is the issue? -The issue is about the max number of shares she can sell -Will the 2 transactions be integrated?

-Street corner outside 144, but if integrated, volume transactions violated--144(e)(3)(vii)--144(c)—don’t have to count 4 (1 ½) offering—4 (1 ½) transaction would have to be to a person who is sophisticated and has access

-Probably the best answer is that this WOULD COUNT and she would have blown 144 by doing the transaction at the same time-There is a great danger of that and she shouldn’t have done that

--She should have complied with 144 and 144(a) if available

Rule 144A

Problems on Pg. 383:6-25: FMAC needs to quickly raise $70 million by issuing 5-year bonds carrying an 8 percent interest rate. FMAC common shares are traded over NASDAQ. With time being of the essence, a registered public offering is not practicable. Marge, FMAC’s CFO, has excellent ties to numerous financial institutions. She seeks your advice on which of the following strategies FMAC should pursue. Under Option I, Marge, by mail and phone, will solicit approximately 200 large financial institutions to buy the unregistered bonds. Option II calls for FMAC first placing all the bonds with an

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investment banking firm with the understanding that the investment banking firm will dispose of the bonds by selling them to the same 200 large financial institutions targeted in Option I. You are told that each of the financial institutions has an investment portfolio in excess of $100 million. Which of these 2 options do you recommend?

1. Option I: CFO will contact 200 financial institutions by mail and phonea. By Rule 144A, they can issue the debt but not common shares as they are already sold on a national

exchangea. The issuer selling bonds to financial institution: not a re-sale under 144 or 144A (144 only pertains to

sale of stock to someone who has already purchased) b. Options:

a. 506: Have a problem of violating the Rule 506 safe harbor (has no limit) by contacting the financial institutions to fit within 506, would have to be all accredited and how are you going to ID these people?

i. Cannot just solicit them ii. Have to do background check: prior relationship, etc. Cannot just have a general solicitation

or violate 506 b. Private placement: 200 people might betoo much for this

c. If you were able to get the shares to the 200 financial institutions, they could use 144/144A to re-sell the shares would NOT come into play with an initial sale

2. Option II: issuer will place all the bonds with one financial institution who will then dispose of the bonds to the targeted financial institutions from Option I

a. It is the better option b. Would sell the shares to the investment bank

a. Under 506, can just make sure that 1 is accreditedb. No danger of relationshipc. Then, investment bank can then use 144A to get the bonds into the hands of the people you wanted to

sell directly i. Note: investment bank does not have to have shares over $100 million

ii. 144/144A are for re-sales, not initial shares1. Have to make sure bonds are not fungible for bonds that are already sold on public

markets2. Here, they are NOT selling stock on public market but they are only trying to sell

BONDS --144A is a really powerful tool—in order to use it, the issuer cannot use. There is no rule saying issuer can automatically sell to whoever it wants so long as buyers have more than $100 million. ONLY people who want to RESELL can use 144A.

-To exploit 144A, want the bonds in the hands of someone else who can re-sell-Arranged simple transaction to 1 investment bank who can re-sell them using 144A to all the other institutions

-Why investment bank is willing to pay a lot of money for the shares--What 144A does is that it is a wealth gift to investment banks: the issuer itself cannot use 144A, and have to PAY an investment bank to use 144A

6-26: Assume Bancorp purchased 20% of the FMAC bonds sold through the investment banker in 6-25. Three months after this purchase, Bancorp is in financial distress and simultaneously sells half the FMAC bonds to its own cross-town rival, Citizens’ Bank, and the remaining half to 7 wealthy, albeit unsophisticated, individual investors. Does FMAC or its investment banker have any exposure under Section 5 because of Bancorp’s re-sale? What are Bancorp’s problems under Section 5? If someone engages in a valid 144 transaction (sold to investment bank who re-sold), let’s assume Bancorp didn’t do things right does that cause problems for the initial seller? INITIAL SELLER: If the original seller sold pursuant to 144A and it was all part of a scam and knew the QIB would sell in a non-complying way—that would not work

-Normal rule: initial user of 144A doesn’t have to worry about re-sales to non-compliers-User of 144A doesn’t have to worry about resales later-Not going to eliminate the safe harbor later

BANCORP: -Are rich people QIBs? NO

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-What about 506? NO-Requirement for accredited investor is merely that you are rich-But, ONLY issuers can use 506

-What about 4(1 ½)? NO-Nature of the person who sold the securities: buyer has to be rich and sophisticated and have access to information—people here are not sophisticated

--The sales to Bacorp to other QIB would normally be thought to be ok—but they have sold part of them in a complying way and a part in a non-complying way

-Look to 144A(e)-No integration therefore do not lose 144A because of non-compliance

6-27: A partial reprise of Problem 6-11. 13 months ago, Alice acquired 10,000 Apex common shares in an intrastate offering. After holding the shares for 6 months, she sold them to State Bank, a QIB. After holding the shares for 7 months, State Bank sold the shares to Jeff. Can Jeff re-sell the shares in the OTC market? 144(a)(2)(iii): Restricted securities—ones to which the safe harbor might apply if you do what is required—transactions acquired --Every link in the chain has be a 144A—the other way to look at it is that there is just 1 link that is 144A

-Here, this is a situation in which only 1 link is 144A: sale of Alice (purchased from issuer) to QIB was 144A, but the sale to QIB to Jeff was not 144A because he is not a QIB

--Might 144 apply to Jeff’s sales because at least 1 link that he received the securities was 144A? -Most courts would say YES-That would work! -Therefore, these would be considered to be restricted securities to which 144 safe harbor would apply

--What would have to do for 144 to apply? -What are the requirements when a non-affiliate attempts to use 144?

-6 month holding period + information -If you wait 1 year, information requirements fall away

Problems on Pg. 390:6-28: Candice is a CP of Amalgamated Dry Goods. She resold 1000 shares of Amalgamated to Devin 2 months after she acquired her control shares from Amalgamated in a private offering. Devin is Amalgamated’s newly recruited CFO. Private offering and quick re-sale to someone with access: CP purchased shares in private offering (4(2) was used because she was a sophisticated person with access—she is the CP/CEO) and now wants to re-sell: can she do this?

-NO -Permitted to re-sell securities as long as you sell them consistently with the exemption here, there was a

sale for her pursuant to private placement and she is re-selling pursusant to same private placement-That is OK because the re-sale doesn’t conflict with the first exemption

Let’s say the first sale was intrastate, and resale was intrastate: that would be OK because the re-sale does not conflict with the original exemption (not 4 (1 ½) Let’s suppose there was a sale under intrastate and then a sale to a sophisticated person with access outside the state does 4 (1 ½) apply?

-Rule of consistency described above does not apply-Cannot use 4 (1 ½): 4 (1 ½) applies to situations in which we are talking about unrestricted securities but for the fact we have an affiliate—the securities sold pursuant to intrastate are restricted and to become unrestricted, would have to hold them for 5 years

-Have to hold them for 5 years and then can re-sale--If in the hands of non-affiliate, could they be freely sold? Yes, but can’t sell them any way you want and use 4 (1 ½): sell to sophisticated + access

**What is an unrestricted security?-Sold pursuant to any exemption that have come to rest

-Can be freely resold if owner is non-affiliate, if affiliate, cannot resale--All these exemptions: as long as come to rest, at some point, become unrestricted

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--At some point, someone who has purchased securities has to be able to just re-sell them: have to show investment intent and have to wait a while

-Not freely allowed to re-sell if you are an affiliate

RECOGNIZE THAT 4(1 ½) TO APPLY: SECURITIES MUST BE OTHERWISE UNRESTRICTED-Understand why 4 (1 ½) cannot apply—sold pursuant to same exemption that they were originally resold

6-29: Assume Amalgamated issued the shares to Candice, its controlling stockholder, and others pursuant to the intra-state offering exemption of Section 3(a)(11). 2 months later, Candice resold 1000 of those shares to her brother, Edward, a sophisticated and experienced investor who lives in a neighboring state. Intrastate offering—issuer sells to controlling people, CP later resells to sophisticated person with access who is outside the state

-As long as the re-sale is pursuant to the original exemption, then that is ok: is the re-sale pursuant to the original exemption? NO (not to another person within the state)-Would 4 (1 ½) work? NO—not “otherwise unrestricted”

6-30: Assume the same facts as Problem 6-29, except that Candice’s resale to Edward occurs 5 years after she acquired the shares from Amalgamated and that her attorney negotiated the terms of the sale to Edward. Here there is no problem because the shares came to rest. The resale would ok under §4(1 ½) and can sell to sophisticated with access

6-31: 5 years ago, Candice acquired her control shares as part of Amalgamated’s intra-state offering. There is no active market in Amalgamated common stock. Candice wishes to sell some of her shares and proposes to fly to NYC, where, on a street corner outside of NYSE, she will attempt to sell some of her shares to any and all pedestrian traffic. How would you advise her? An affiliate can hawk things themselves as long as no one helps them out--The exemption that applies here: 4(1)

-Do not have to apply securities laws unless issuer, underwriter, or dealer-Here, definition of UW does not include this affiliate-Only when you have someone helping the affiliate is the helper deemed to be in the same position as the issuer just have someone who is not helping

6-32: Assume the facts of Problem 6-31, except that Candice is too busy to make the trip to NY. For a standard commission fee, she retains her broker of many years to carry out this selling effort to her. Now that she has contracted a broker because she has an helper who is helping out an affiliate, so 4(1) does not apply so she needs an exemption--Could try using 144: but this is intra-state--4 (1 ½): cannot sell on street corner in this way once you get someone to help you (if you do it yourself, then you can)

-Need to sell to sophisticated people with access

6-33: Candice has been a controlling stockholder of Amalgamated for 8 years. Amalgamated commons tock is traded on the OTC market. She now wishes to diversify her investments and has retained Smith Baley and Co. to sell 30,000 of her 1 million shares in an orderly manner in the OTC market. Candice has herself privately negotiated to sell 50,000 of her shares to Harrold, an unsophisticated and inexperienced, albeit wealthy, investor. Soon after Harrold’s purchase, Amalgamated’s market price declines sharply. Advise Harrold of his rights. Let’s suppose she arranges a sale herself to Harrold. Would just this be OK?

-Doing it herself, then it is OK even if person is unsophisticated-Like the street corner example

What about sales in the market?-She is trying to sell in an orderly market in OTC—looks like she is using 144 (trickling them out when affiliates use 144)

Are her sales integrated with 144? WHO KNOWS-This doesn’t arise

Theory of the Sale

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Problems on pg. 4017-1: Ventures Corporation has 300,000 shares of preferred stock outstanding. The preferred shares carry a cumulative dividend of $2/share, with a possibility of receiving an additional $1 per share annually if the BOD so decides. Ventures’ board resolved that the preferred shares should be entitled to choose between 1) receiving their regular dividend of $2 per share, or 2) forgoing that dividend and receiving for each 10 preferred shares owned 1 share of common stock as a stock dividend. The common stock’s current market price is $24/share. Company says you could even have a $2 dividend or getting 10 more shares of stock—would that be “for value”?

-SEC has said that it is NOT-NO

7-2: Assume in the preceding problem that the regular $2 per year dividends on the Ventures preferred shares were 4 years in arrears. Assume that V BOD has resolved to permit 3 shares of preferred stock to be exchanged for 1 share of common stock—the common stock’s current market value is $24/share. --If you already have an entitlement to preferred shares (in arrears)—at that point can you exchange for shares instead?--NOT within the holding of SEC—this is different because you are being asked to give up something you already had for the shares instead

-Would be a share for value: $8 in dividend or $8 instead

As long as you are given the SAME CHOICE in money or stock, even if one is worth more or less, that is NOT a SALE FOR VALUE

-Needs to be at the same time to be not for value If you already have a entitlement for money, and the company says they will give you stock instead—that is a SALE FOR VALUE (giving up value)

7-3: Assume in Problem 7-1 that Ventures’ BOD, in order to deal with the preferred stock dividends that are in arrears, proposes that Ventures’ BOD, in order to deal with the preferred stock dividends that are in arrears, proposes that V’s article of incorporation be amended to make V’s preferred shares convertible into common shares at any time. If the preferred shareholders approve the amendment and many of the preferred shares are converted, has there been a sale? If this is a substantial change in the security, would have to re-register

-Change in the nature of the preferred shares would be enough to trigger the doctrine--Would have to register for the common shares since there are 2 securities here--Common shares into which the preferred shares being converted, as well as original shares7-4: What if they want to re-incorporate in a state with worse law for shareholders? --The rule is that you do not have to register that

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