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Securities Regulation

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Securities Regulation

Course Info

Professor: Coffee Semester: Unknown Source: Securities Regulation - Coffee.txt

Topics Covered

Detailed Outline

I. Basic Structure of the Securities Act of 1933

Two Main Federal Securities Statutes:

  • Securities Act of 1933: Regulates the primary market (initial issuance). Focus on offer and sale of securities; registration statement (RS) and prospectus disclosure.
  • Securities Exchange Act of 1934: Regulates the secondary market. Focus on registering companies and continued disclosure by reporting companies.

Reporting Company Thresholds (Exchange Act):

  • §12(g): 2,000 shareholders of record or 500 non-accredited investors (JOBS Act standard)
  • §15(d): Companies listed on national exchange

Key Prohibitions — §5:

  • §5(a): Prohibits delivery or sale of unregistered securities unless RS is effective
  • §5(b): Makes it unlawful to carry in interstate commerce any prospectus after RS filed unless prospectus meets §10 requirements
  • §5(c): Offers to sell/buy using any means of interstate commerce prohibited until RS is filed

Who is an Underwriter? §2(a)(11):

  1. Persons who purchased from issuer with a view to distribution
  2. Persons who offer or sell in connection with a distribution
  3. Persons who participate in a distribution

§5 Does Not Apply to:

  • Transactions by persons other than issuers, underwriters, and dealers [§4(1)]
  • Transactions by issuer not involving any public offering [§4(2)]

II. Registration Timeline: Three Periods

A. Pre-Filing (Quiet) Period

Begins when issuer prepares for offering (at least when issuer signs letter of intent with underwriter).

§5(c) prohibits: all offers to sell/buy using IC means.

Rule — No conditioning the market: speeches, press releases, advertising could violate §5(c).

Allowed in Pre-Filing Period:

  • Preliminary negotiations between issuer and underwriter [§2(a)(3)]
  • Communications made prior to 30 days before filing RS [Rule 163A]
  • Communications containing only issuer/security info under Rule 135 (cannot name underwriter or price)
  • Factual business info/forward-looking info by reporting issuers [Rule 168] — must not reference offering
  • Factual business info by non-reporting issuers [Rule 169] — must not reference offering; must be intended for non-investor audience
  • WKSI oral and written offers at any time [Rule 163]

WKSI (Well-Known Seasoned Issuer) [Rule 405]:

  • Meets S-3 registration requirements (reporting co. for 12 months, timely filer)
  • AND has public float ≥ 1B in non-convertible debt in last 3 years

B. Waiting Period

Begins when RS (preliminary prospectus) is filed with SEC. §5(c) no longer applies; §5(b) governs.

§5(b)(1): illegal to carry any prospectus unless it meets §10. §5(b)(2): illegal to carry any security for sale unless accompanied/preceded by §10(a) final prospectus.

Two Types of Prospectus:

  • §10(a) prospectus: Full final prospectus (all information required under ‘33 Act)
  • §10(b) / Rule 430 prospectus: Preliminary prospectus — satisfies §10 during waiting period

Free Writing Prospectus (FWP) [Rules 163, 164, 433]:

  • Any written communication after RS filed constituting an offer
  • Requirements [Rule 433]: legend; filed on or before first use; accompanied/preceded by preliminary prospectus (not needed for WKSIs or seasoned issuers on S-3); cannot conflict with RS
  • WKSI can use FWP at any time [Rule 163]

Allowed in Waiting Period:

  • Oral selling activities (but no binding sales yet)
  • Tombstone advertisements [Rule 134] — can name underwriter and price; include legend
  • FWPs if Rule 433 conditions met [Rule 164]
  • Preliminary prospectus [Rule 430]
  • Rules 168 and 169 communications (same as pre-filing period)

Road Shows [Rule 433(d)(8)]:

  • Live/real-time webcast = oral communication (need not be filed)
  • Written road show = FWP (reporting issuer need not file; non-reporting must make bona fide electronic road show available)

C. Post-Effective Period

RS is effective; sales now allowed; written offers allowed; FWPs allowed.

§5(b)(2): Securities can be carried in IC if accompanied or preceded by §10(a) final prospectus.

Access = Delivery [Rule 172]: after effectiveness, need not physically deliver final prospectus if RS effective, filed with SEC, and not subject to SEC investigation.

Rule 173: Must notify purchaser of registration within 2 business days of sale.

Delivery Exemptions:

  • Rule 174: Dealers exempt from prospectus delivery if reporting company prior to offering, or if non-reporting and shares listed on national exchange

III. What is a Security?

Investment Contract — Howey Test

SEC v. W.J. Howey Co.: Investment contract = transaction where a person:

  1. Invests money (cash or non-cash consideration; for investment, not consumption)
  2. In a common enterprise
    • Horizontal commonality: multiple investors’ fortunes pooled together (majority view)
    • Strict vertical commonality: investor’s fortune rises and falls with promoter’s fortune (most courts)
    • Broad vertical commonality: investor relies on promoter’s efforts, even without pooling (11th Cir. only)
  3. With expectation of profits
    • Must be primary motivation; incidental profit = consumption (e.g., Forman — co-op apartments)
    • Fixed or variable returns do not matter (Edwards — payphone lease-back)
  4. Solely (principally) from the efforts of others
    • Investor must be passive
    • LP presumed to be security (Steinhardt — presumption rebutted when LP had actual control)
    • Pre-investment services insufficient (Life Partners — AIDS life insurance policies)

Key Cases:

  • Howey: Citrus grove lots with management contracts = investment contracts
  • Forman: Housing co-op “stock” not a security — economic realities control, not the label
  • Edwards: Fixed-return payphone lease = investment contract (fixed vs. variable irrelevant)
  • Koscott: Pyramid scheme = investment contract

Stock

  • Label “stock” is not determinative — look to economic realities (Forman)
  • Common characteristics: negotiability, voting rights, pledge rights, dividend rights
  • Sale of all shares in a company = securities transaction (Landreth — sale of business doctrine)
  • A sale of assets (not stock) is NOT a securities transaction

Notes

  • Presumption: Notes are securities
  • Family Resemblance Test (Reeves v. Ernst & Young): Presumption rebutted if note resembles a non-securities category:
    • Consumer lending; home mortgages; short-term secured notes; bank character loans; open account debt
  • Factors to determine if note is a security:
    1. Motivation of seller and buyer (profit motive → security; business purpose → not)
    2. Plan of distribution (widely offered → security; face-to-face → not)
    3. Reasonable expectations of investing public
    4. Other regulatory scheme (if sufficient, less likely to be a security)

IV. Exemptions from §5 Registration

A. Statutory Exempted Securities [§3]

B. §4(2) Private Placement Exemption

Ralston Purina Standard: §4(2) applies when offerees (regardless of number) are able to “fend for themselves” — meaning they have:

  1. Economic sophistication, AND
  2. Access to the same type of information that registration would disclose

Key Rules:

  • Person claiming exemption bears the burden (Hill York)
  • A single unsophisticated offeree destroys the exemption (Doran v. Petroleum)
  • Focus is on offerees, not just purchasers
  • Actual sophistication required (unlike Rule 506 which allows reasonable belief)
  • Securities are restricted — cannot be freely resold

Factors to evaluate §4(2):

  • Need for protection (sophistication of investors)
  • Access to information (close relationship to issuer?)
  • Number of offerees (too many = public offering)
  • Absence of resales
  • Absence of public advertising

C. Regulation D — Safe Harbor Rules

Reg D provides bright-line safe harbors under §3(b) (Rules 504, 505) and §4(2) (Rule 506).

Common Conditions [Rule 502]:

  • (a) Integration: Offers/sales 6+ months before or after a Reg D offering won’t be integrated
  • (b) Information: If non-reporting, must furnish financial/non-financial info to non-accredited investors (not needed for 504 or for accredited investors)
  • (c) No general solicitation: No advertisements or broad outreach (JOBS Act exception for 506 offerings to accredited investors by emerging growth companies)
  • (d) Restricted securities: Cannot resell without registration or exemption

Accredited Investor [Rule 501(a)]:

  • Institutional investors; corporations/partnerships/pensions with assets > $5M
  • Directors, officers, executive officers of the issuer
  • Natural persons with net worth > $1M (excluding primary residence)
  • Natural persons with individual income > 300K joint) for last 2 years

Rule 504 (Small Issue — up to $1M in 12 months):

  • Non-reporting companies only
  • Any number of purchasers, accredited or unaccredited
  • No information delivery requirements
  • No general solicitation (unless state blue sky law permits for accredited investors)
  • Restricted securities

Rule 505 (Up to $5M in 12 months):

  • Reporting or non-reporting companies
  • Up to 35 non-accredited purchasers + unlimited accredited investors
  • Must furnish information to non-accredited investors
  • No general solicitation
  • “Bad boy” disqualifiers apply [§262 of Reg A list]
  • Restricted securities

Rule 506 (Unlimited amount — based on §4(2)):

  • Up to 35 non-accredited purchasers + unlimited accredited investors
  • Non-accredited purchasers must be sophisticated (capable of evaluating merits and risks, or have sophisticated financial advisor)
  • No general solicitation (JOBS Act exception for emerging growth companies + only accredited investors)
  • Must furnish information to non-accredited investors
  • Restricted securities
  • Rule 508: Minor technical violations excused if good faith compliance attempt and violation is insignificant (but not: ban on general solicitation, dollar limits, or 35 non-accredited limit)

Emerging Growth Company [§2(a)(19)]:

  • Total annual gross revenue < $1B in most recent fiscal year
  • Ceases to be EGC on earliest of: last day of fiscal year exceeding 1B in non-convertible debt; becoming large accelerated filer ($700M public float)

D. Other Exemptions

Reg A [§3(b)]:

  • Scaled-down offering statement and offering circular (“mini prospectus”)
  • Issuance ≤ 50M)
  • Non-reporting companies only
  • Can offer to anyone; no sophistication requirement
  • NOT restricted — investors can resell immediately
  • Requires annual disclosure filings with SEC; §12(a)(2) negligence liability applies
  • “Bad boy” disqualifiers apply

Rule 701 (Compensatory Benefit Plans):

  • Offers/sales pursuant to compensatory benefit plans for employees, directors, advisors
  • Not for capital raising; non-reporting issuers only
  • Dollar cap: greater of $1M, 15% of issuer’s assets, or 15% of outstanding securities in the class (per 12-month period)
  • If exceeds $5M, must provide summary plan description and material terms to investors
  • No integration with other exemptions
  • Restricted securities (but resale allowed after 90 days of becoming reporting company)

§4(6) Crowdfunding:

  • ≤ $1M in 12-month period
  • Per-investor limit based on net worth (≤ 2K or 5%; > 100K)
  • Must be sold through broker or funding portal (not directly by issuer)

V. Shelf Registration and Registration Process

Integrated Disclosure: Reg S-X prescribes a single set of instructions for filing under both the ‘33 and ‘34 Acts.

Form S-3 (Seasoned Issuers):

  • Reporting company for ≥ 12 months with timely filings
  • Transactions allowed: cash offerings if > $75M public float; certain investment-grade debt; etc.
  • Can incorporate future filings by reference (“evergreen”)

Form S-1: General form for unseasoned and non-reporting companies.

Shelf Registration (SR) [Rule 415]:

  • Permits registration of securities for later sale (within 3 years)
  • Available to seasoned reporting companies (qualified for S-3)
  • Minimal SEC review (but must be approved)
  • Must file post-effective amendment for any fundamental change

Automatic Shelf Registration (ASR):

  • Available to WKSIs only
  • No SEC review — effective automatically upon filing
  • WKSI can add new class of shares without new RS [Rule 413]

Rule 430B: Describes info required for shelf take-down prospectus (more info for SR than ASR)

10(a)(3) — 9 and 16 Months Rule:

  • Prospectus used more than 9 months after effectiveness must have info not more than 16 months old
  • Filing annual reports (10-K) restarts the clock; S-3 incorporators are perpetually current

VI. MD&A Disclosure

Reg S-K Item 303:

  • Requires forward-looking disclosure about events that are possible and will affect earnings
  • Trends, demands, events, uncertainties reasonably expected to affect liquidity, results, capital
  • SEC: uses two-part test (Release 6835): (1) likely to come to fruition? (2) if uncertain, evaluate consequences as if it occurred

Material Standard for MD&A: “Reasonably likely” (≈40% likely) — broader than materiality for §11/§12 liability.

  • Omission that violates MD&A may not be material enough to generate §11/§12 liability, though SEC may bring enforcement action.

Key Doctrines

Key Cases

Exam Approach

1. Is This a Security?

  • Investment contract? → Howey four-part test
  • Stock? → Landreth (economic characteristics, not label)
  • Note? → Reeves family resemblance test (rebuttable presumption of security)
  • Watch for: co-op housing (Forman = no), pyramid schemes (security), LPs (presumed security)

2. §5 Registration

  • Identify the period: pre-filing / waiting / post-effective
  • Pre-filing: no conditioning the market; narrow exceptions (WKSI, 163A, 135, 168, 169)
  • Waiting: FWPs if Rule 433 met; oral offers OK; tombstones (134) OK
  • Post-effective: sales allowed; must accompany/precede with §10(a) prospectus; access = delivery (Rule 172)

3. Private Placement / Reg D

  • §4(2) first: each offeree sophisticated? each has access to information?
  • Rule 506 safe harbor: any number of accredited + up to 35 sophisticated; no general solicitation (JOBS Act exception)
  • Rule 505: up to $5M; 35 non-accredited OK; bad boys disqualified
  • Rule 504: up to $1M; non-reporting only; any purchasers
  • Integration risk: offerings within 6 months aggregated

4. WKSI / Shelf

  • WKSI = S-3 eligible + 1B debt in 3 years → ASR, can use FWP anytime
  • Shelf (SR): seasoned S-3 filer; SEC review; 3-year shelf
  • MD&A: “reasonably likely” standard; broader than §11/§12 materiality

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