March 8, 2004



I. INTRODUCTION TO MARKETS AND REGULATION

Terminology:

1. Difference between debt and equity: status of the person

a. Debt instrument has a maturity date – whether its 20 years down the road or more

b. At the end of a period of time as agreed, you are bought out of whatever investment you made w/out giving any ownership to any of the profits

i. Risks: Debt w/ fixed amount being repaid

c. Equity instrument has a little more risk that money will not be returned at all

i. Ownership is given under an equity instrument – high risk b/c of no income but also leads to greater value if it is a good investment

ii. Risk: no debt being repaid

2. Who has claims against the assets?

a. Creditor (secured/perfected, secured, unsecured)

b. Owners/shareholders

3. Difference between Direct and Portfolio Investments

a. Portfolio – equity investments that represent secure investments

i. Non-controlling equity investments of a company

§2.01: Financial Markets: Investment Interests

1. Money Markets

a. Refers to those markets w/ short-term debt instruments

2. Capital markets

a. Covers long-term debt instruments:

i. Government securities (“tax exempt securities)

ii. Corporate debt (bonds)

iii. Mortgaged backed securities

iv. Equity securities

3. Capital Markets: Debt

a. Corporate Debt

i. Bonds: corporate debt obligations secured by land, buildings or other property

ii. Debentures: long term unsecured debt obligations

b. Government Securities

i. Consist of all long-term debt instruments used by the US Tresury to finance the national debt

ii. Includes all securities issued by government-sponsored enterprises

c. Municipal Securities

i. Bonds sold by states and their political subdivisions to:

1. Finance cash needs between tax collection times

2. To provide funding for projects

ii. Interest paid on these bonds is tax-exempt

iii. Types:

1. General obligation bonds

a. Secured by the full faith and credit and general taxing power of the issuer

b. Investors receive repayment from all sources of revenue that the municipality is entitled to receive

2. Revenue Bonds

a. Usually issued to support a particular project

b. Holders are paid out of revenues from that project

c. Not backed by the full faith & credit of the issuer

3. Conduit Bonds

a. i.e., industrial revenue bonds

b. Issued to finance a project that is to be used in the trade or business of a private corporation

c. Payment of the interest and principal comes from the private entity

d. Mortgage-Backed Securities

i. Investment representing an interests in a pool of loans that is secured by mortgages or trust deeds

ii. Securitization: the process by which they are created

1. Financial institutions make loans w/ similar characteristics to consumers ( these are then sold to an intermediary who pools the comparable mortgages and creates an interest by selling them as debt securities

iii. Principal and interests payments on the underlying mortgages are paid by the original borrowers to the original issuer

1. who pays the intermediary who pays the investors

iv. Takes a previous illiquid asset and makes it liquid ( which then increases the amount of money available for lending

v. Special purpose entities

1. state-sponsored organizations

vi. Most are issued in “swap” transactions

1. An arrangement where the special purpose entity issues a mortgage-backed security to an eligible lender in exchange for a package of its mortgage loans

vii. Also issued in underwritten offerings to sophisticated investors (usually institutions)

viii. Some financial institutions sell their mortgage loans in exchange for cash (debentures)

4. Capital Markets: Equity

a. Includes either direct and indirect investments

b. Includes shares of common stock and preferred stock, mutual fund stock and limited partnership interests

§2.01: Domestic Capital Flows

1. Introduction

a. Primary market

i. Involves transactions between the original issuer (person raising capital) and investors

ii. AKA: distribution market

b. Secondary market

i. Transactions between investors

ii. AKA: Trading market

c. Difference between Primary and Secondary market:

i. Secondary Markets gives another investor a chance to coming into the market

Primary Markets

1. Government Securities

2. Municipal Securities

3. Mortgage-Backed Securities

4. Direct Investment

a. Purchase of assets does not require a transfer of an equity instrument by purchaser

b. Mergers and Acquisitions

i. Purchase price for the assets can take the form of cash

c. Includes the purchase of controlling equity interests in a company

5. Portfolio Equities and Corporate Debt

a. Direct Offerings: Those made in the primary market don’t have 3rd party assistance

i. Direct Public Offerings

1. Where an issuer relies solely on employees or other in-house agents to market securities to the public

ii. Rights Offering

1. Provision that requires a corporation to offer new shares of its stocks to existing stockholders before it can offer them to the public

2. Sometimes take the form of warrants

iii. Dutch Auction

1. Issuer invites bids for its securities at a state minimum price and pursuant other specified condition

2. Issue fixes the final offering price at the maximum price which all the securities can be sold pursuant to the bids

iv. Private Placement

1. Issuer sells a debt or equity security to a select group of experienced and sophisticate person

2. Often structured to comply w/ Rule 144A of the 33 Act

a. Referred to as Rule 144A offerings

v. “All or None” Offerings

1. Where the issuer offers a set amount of securities to be sold in a set amount of time

2. If the securities are not sold w/in the allotted time, the offering is terminated ( returns all proceeds from the slaes

b. Indirect Offerings

i. Where the issuer engages the assistance of an investment banker

1. Referred to as underwriters

a. Entities that exist to help issuers raise capital: invest for cash and not ownership

1. Way for the company to turn to firms for identifying investors

ii. Can involve a private placement, public offerings, rights offering or an “all or none” offering

iii. 2 methods for underwriting:

1. Firm Commitment Underwriting

a. Underwriter purchases the securities from the issuer and the resells them immediately to the public at a higher price

b. Spread:

i. Difference btwn amount paid by underwriters & public investors

2. Best Efforts Underwriting

a. Underwriter sells the securities to the public w/o ever purchasing the security

b. Compensation is based on the number of securities sold to the public

Secondary Markets

1. Overview

a. Can be thin or well developed

b. Not all secondary markets are open to all investors

2. Structure

a. Consist of Stock exchanges and over-the-counter markets and other private markets

b. Hierarchical

i. Top = the major stock exchanges

ii. Regional stock exchanges

iii. Securities sold through market-makers

1. OTCBB

2. “Pink Sheets”

3. Stock Exchanges

a. Transactions occur in a particular place

b. 2 Primary stock exchanges in the US

i. NYSE and the AMEX (American Stock Exchange)

c. 4 regional stock exchanges in the US

i. 2: Boston; 1: Philadelphia; 2: Chicago

d. Listing Requirements

i. The greater the prestige = the more demanding the listing conditions

ii. NYSE:

gives particular attention to

1. the degree of national interest in the company

2. Its relative position and stability in the industry

3. Whether it is engaged in an expanding industry, w/ prospects of at least maintaining its relative position

iii. Need a set amount of shares

iv. Need public float

v. Guarantees certain amount of shares for public trading

vi. Need an intermediary

e. Trading

i. Member firms of a stock exchange

1. Represent customers of their firms that want to buy/sell

a. Behaving as an agent

2. Trade on behalf of their own accounts

a. Behaving like an ordinary investor

ii. Member Firms act as “specialist”

1. Each listed security as assigned to a member firm who then acts as that security’s specialist

2. Functions like a wholesaler

a. maintain an inventory that increases/decreases in size

b. trades for its own account to ameliorate temporary disparities in supply and demand for the assigned stock

3. Four basic roles

a. Conduit for information

b. Act as agents

i. executing orders

c. buy/sell from own accounts when there is a shortage

i. Catalysts

ii. bringing buyers and sellers

iii. ORDER-DRIVEN

1. Buy and sell orders are matched

2. The direct interaction of buyers’ and sellers’ orders determines the price of an NYSE-listed stock

iv. Customer orders can be handled in one of 2 ways

1. Floor executive executes the trade

2. Electronically processed through SuperDot

f. The Nasdaq Stock Market (part of the OTC market)

i. Listing Requirements

1. Separates issuers into 2 tiers (each w/ their own requirements)

a. NASDAQ National Market system

i. Companies w/ high capitalization

b. NASDAQ stock market

i. NASDAQ small Cap securities

2. Imposes quantitative and qualitative standards for listing on either

ii. Delisting

1. Occurs when a company fails to satisfy the standards

2. Company generally first receives a warning and a grace period

iii. Trading

1. 2 distinguishing features from the stock exchanges

a. market is not a place

i. occurs through computer screen-based, floorless trading environment

b. Methods of trading

iv. QUOTE DRIVEN

1. investors deal w/ market-makers who quote bid and ask prices at which they guarantee to trade up to a certain quantity

i. Spread: difference btwn the bid and ask prices

2. Process

a. Investor places an order to buy or sell

b. Broker routes the order to the firm’s trading room

c. Firm either

i. Executes order internally

1. at a price equal to or better than that quoted by other market makers

ii. if it doesn’t have it ( will buy or sell to a market maker at a different firm

g. Other Markets in the OTC

i. Traditional Non-Nasdaq OTC Markets

1. Not eligible for initial listing on the stock exchange or NASDAQ

2. Dealer-driven

3. 2 primary

a. OTCBB

b. Pink sheet

i. Bottom rung

ii. Has no listing requirements

iii. Dealers, not companies insert quotations

ii. trading occurs through broker-dealers who manually contact dealers that function as market-makers

iii. Alternative Trading Systems (ATSs)

1. includes ECNs (electronic communication networks)

a. computerized trading network or market

b. used to display and execute limit orders

i. which causes some orders to not ever be filled

2. allow institutions and other market participant to electronically execute trades in a variety of ways

3. Organized and operated by professional intermediaries

4. Many broker-dealers operate these internally for their own traders or for their customers

§2.03: Principal Participants in the Capital Markets

1. Issuers (can be company, collective body, or individual)

a. Governments

b. Public Enterprises

c. State-sponsored Organizations

d. Private business entities

e. International Organizations

f. Investment Entities

g. Individuals

2. Intermediaries

a. Purpose: To bring together buyers and sellers

b. Types

i. Investment bankers

ii. Broker-dealers

1. where it is an agent ( broker

2. where it is buying/selling from own account ( dealer

3. introducing broker

a. a firm that cannot clear securities transaction ( can only carry

b. can solicit securities, but doesn’t have the capital to function as a full fledge firm

4. clearing broker

a. the firm that goes into business w/ the introducing broker to complete the transaction

iii. Investment advisers

1. advise other as to the value of securities and the advisability of investing

iv. Trading markets

v. Accountants and lawyers

vi. Securities Information Processors “SIPs”

1. organizations which distribute or public information w/ respect to trading transaction in or quotations for a security

vii. Clearance and Settlement Firms

1. make trade comparisons in the process of confirming and matching the terms of a securities transaction

2. perform multilateral netting of securities transactions between investors

viii. Depositories

1. company where stock certificates and other evidences of investment ownership are held in trust for the banks and broker-dealers that participate in the system

2. work in tandem w/ clearance and settlement firms by combing a book-entry securities transfer system w/ a money transfer system to archive delivery against payment

ix. Transfer agents

1. serve as ages for issuers

2. responsible for transferring record ownership of securities that are the subject of transfer

x. Securities rating Organizations (NRSROs)

1. rate bond issuers’ credit worthiness

2. 6 such organizations

a. Fitch investors service

b. Standard & Poor’s Corporation

c. Moody’s Investor Service, Inc.

d. Duff & Phelps, Inc

e. Thomson Bank Watch

f. IBCA Limited

xi. Investor Relations Firms

1. assist issuers in providing information to their owner

xii. Financial News Service

1. Rewrite and release information about companies into the marketplace

xiii. Financial printers

1. corporations retain a financial printer when they seek to raise capital and need to provide investors w/ disclosure materials

2. used in connection w/ the preparation of documents that must be filed w/ the SEC and disseminated to investors

xiv. Financial Portals

1. provide company fund research

2. i.e., Yahoo finance

3. Investors

a. Overview

b. Individual Investors

i. 4 primary means by which individuals may own stock

1. 27 million own shares in equity mutual funds outside of retirement saving plans and pension accounts

2. 34 million own equity through self-directed retirement plans

3. 48 million own equity through defined contribution pension plans

4. owning stock individually

c. Institutional Investors

4. Regulators

a. Represents a collaborative effort by persons inside and outside of the government

b. Federal securities laws are the cornerstone of this regulations

c. “federal securities law”

i. Securities Act of 1933

ii. Securities Exchange Act of 1934

d. SEC ( Securities Exchange Commission

i. Maintains the authority to administer and interpret the federal securities laws

e. DOJ

i. Exclusive authority to bring criminal prosecutions for securities law violations

f. US Postal Authorities

i. Investigate mail fraud in connection w/ securities offerings

g. Department of Treasury

i. Regulates offerings of its securities

h. Various U.S. Banking authorities

i. Responsible for offerings of bank securities

i. SROs ( Self-Regulatory Organizations

i. Subject to SEC oversight

ii. Regulate market professionals, banks and other participants in their system

iii. Consist of organizations w/ marketplace jurisdiction

iv. Consist of organizations that perform clearing agency

j. ALJ’s & federal Court judges

i. Construe legislative and administrative pronouncements

k. Members of the legal and accounting profession

i. Acting in the capacity of scholars, practitioners and advisers to government and SRO’s

ii. Financial Accounting Standards Board (FASB)

1. group of professionals w/ authority to establish standards of financial accounting and reporting

2. employs a multi-step process that resembles the rule-making procedures used by the SEC

iii. American Institute of Certified Public Accountant (AICPA)

iv. § of Business Law of the ABA

l. State securities statutes

i. Provide a separate layer of regulation

ii. Intended to supplement federal regulation

iii. State attorneys have authority to prosecute willful violations of state securities laws

m. North American Securities Administrators Association (NASAA)

i. working w/ the SEC to develop uniform regulations for both state and federal law

Chapter 3: INTERNATIONAL CAPITAL MARKETS

§3.01: Introduction

1. Capital Markets: includes direct investments and portfolio investments

2. International Capital Markets

a. Defined more broadly to include debt obligations

i. Which would be classified as short-term notes in the US

3. Bonds and Notes

a. Both are debt instruments

b. The Difference rest in the time it has to run before maturity

c. Which notes are part of the capital markets is not clear in the international financial market

4. Medium-term Notes

a. Unsecured notes w/ a maturity of about 3-6 years

b. In the international market: notes sold at 6 years remains a “note” (rather than bond)

5. Commercial Paper

a. Technically consist of notes maturing in less than one year

b. There are notes w/ 7 year maturity sold in cross-border transaction

6. International

a. In the context of international capital markets refers to securities transactions which take place wholly or in part outside the country where the issuer is organized

§3.02: International Bond Markets

1. Types of Bonds

(both are offered by an issuer that is foreign to the country or countries in which the bonds are being offered)

a. Foreign Bonds: i.e., “Samurai Bonds”

i. Obligations denominated in currency of the country in which they are sold

ii. The issuer is of another country

b. Euro Bonds

i. Currency of the bond as the same as the currency of the country where the security is sold

ii. i.e., Euroyen: bonds from a Japanese company that are sold in a different country but still in the currency of the yen

2. Currencies

a. Bonds can be denominated by the issuer’s currency, currency of country sold, or artificially created monetary unit

3. Types of Instruments

a. International bonds can carry a:

i. Fixed rate; or

ii. Floating rate notes

b. Borrowers can issue international bonds in either:

i. Bearer

ii. Registered Form

4. Bearer bonds: the customary investment instruments in the Eurobond market and many European countries

5. Bearer of the bond

a. Person in possession of the bond certificate/evidence of indebtness

b. Assumed to be the legal owner

c. Sends in coupons attached to the bond to receive interest payments

d. Identity is not known to the issuer

6. Registered bonds

a. Some countries require registering the owners

b. Makes it easier/safer to transfer securities/payments/communication

7. Issuance and Trading

a. Issuers usually sell international bonds into the primary market w/ the assistance of an international banking or investment banking firm

b. Managers are responsible for all of the preparations associate w/ the offering

c. Underwriters participate in a bond issue: influence and reputation in certain areas

d. Selling group

i. Consist of managers, underwriters, and additional banks/investment firms

e. Foreign bonds and Eurobonds trade in the secondary market

f. Association of International Bond Dealers (AIBD)

i. Private self-regulated organization based in Zurich

ii. Trade around the clock among themselves

g. Eurobonds: centers around market-makers & other financial institutions (not AIBD)

h. Japan & US: bonds are traded in OTC and Securities exchanges

i. NYSE: operates the largest centralized bond markets of any exchange

8. Challenges for Investors

a. Investors must evaluate information about the issuer and the market

b. These decisions must be made at the time of purchase and afterwards to know what steps to take next

§3.03: International Equity Markets

1. Primary Markets

a. International equity represents transfers of capital across political boundaries to the issuer’s country of origin

b. Primary offers of bonds raise more capital than primary offerings of international portfolio investments

c. There is an increase in the volume of offerings of equities into the primary markets

d. Privatization

i. Process involves the offering of ownership interest to thepublic by companies wholly or partially owned by the government

ii. Governments use the process to divest themselves of state-owned enterprises and to transfer ownership to the private sector

iii. Privatization volume is the heaviest in Western Europe

iv. Typically involves telecommunications, public utilities and energy industries

2. Secondary Markets

a. Equity trading markets have traditionally been national

b. Equity produce high shares of trading volume

c. Technology and high-speed communication systems w/ the acceptance of depositary receipts have removed many of the impediments to the international market

d. The major equity trading markets in the world are going directly to the public w/ their own web sites to provide information and indexes on individual stocks

§3.04: International Securities Markets and the United States

1. Introduction

a. 2 polar ends reflect no international elements

i. Securities offerings by US issuers or secondary trading of US issued securities solely w/in US and w/ only US citizens

ii. Offers by foreign issuers on markets outside US w/ no sales/offers by citizens or residents of the US

b. The major question is what makes a security or securities market “global” or “international”

c. The global equity markets intersect w/ the U.S. capital markets in many ways:

some variables that contribute to the global character of the US equity markets:

i. The residence of the issuer

ii. The residence of the investor in the primary or secondary markets

iii. The location where an investor makes an investment decision

2. Domestic Issuers of Equity Securities

a. Sales Occurring w/in the US: Foreign Investors

i. Figure 3-9 (page 3-22=

ii. The net capital inflow beginning in 1993 has been positive

1. more capital from foreign investors was spent on purchasing U.S. equity securities in U.S. equity markets than was received by foreign investors upon their sales of U.S. equity securities to U.S. purchasers

b. Sales occurring Outside the US: Foreign or US investors

i. The exact amount of foreign sales: US issuers selling equity securities to offshore investors is unknown

ii. Regulation S Offers:

1. transaction where many sales are made to institutional investors

iii. Overseas trading in U.S. equities is possible b/c issuers arrange convenient trading markets for their securities outside the US (i.e., London Stock exchange)

3. Foreign Issuers of Equity Securities

Sales occurring in the U.S.: Foreign or U.S. Investors

a. Primary Markets:

i. Private offerings by foreign companies to investors in the U.S.

ii. Participation by foreign companies in the U.S. primary capital market

b. Secondary Markets

i. Foreign companies list on the stock exchanges, otc, etc

ii. Problems for investors

1. Need to value the securities in the currency of the trading market, which is usually different than the currency of the foreign issuer’s home market

2. Difficult to make valuations w/ accuracy when the rates float

3. Difficult to make valuations w/ the necessary speed

iii. Some foreign issuers doing business in the US allow their shares to trade in the US secondary markets in US dollars

iv. Foreign issuers trading in US markets generally deal w/ the problems by allowing their securities to trade in the form of depositary receipts

1. A negotiable certificate evidencing ownership of shares in a business entity which is organized in a country outside the market where the receipts are traded

2. Quoted and traded in currency of the country where they trade

3. Governed by the trading and settlement procedures of the market where they are traded

c. Secondary Markets: Volume of Trading

i. Except for 1998 and 1999, foreigners have sold more foreign equity securities to U.S. investors that they purchase from them

ii. The volume of trading of foreign stocks on US secondary markets shows no signs of decreasing

iii. Activity in trading of NASDAQ-listed stock in the US also indicates continued growth

Chapter 4: THEORIES OF SECURITIES REGULATION

§4.01: Domestic Markets: Justifications for Governmental Regulation

Offerings, Trades and Other Investment Decisions:

Areas of Possible Regulation

1. By identifying the public interest in the aspect of securities markets, the theoretical underpinning of laws will be recognizable

Then available either for

a. defense and support or

b. for challenge and reformulation

2. Private Interests

a. Flows naturally from the basic tenets of a capitalistic society

b. Reflects the fundamental belief that individuals or groups of individuals are entitled to maximum freedom in the ownership and use of their private property in an economy where market forces and competition are the predominant limitations

c. Entitles issuers, intermediaries and investors to a regulatory climate where all unnecessary impediments to efficient markets are eliminated

3. To impose restraints on the private interests

i. The public interests in regulations must be strong

4. Balancing private and public interests

a. Theoretically, Regulation is optimal where at any given moment a proper balance is struck between the private interests and efficiency

b. Private interests stresses freedom

c. Efficiency is the public’s interest

d. The perfect balance allows for limitations and proscriptions

Investment Risk

1. Introduction

a. Investor protection

i. Helps explain the principle of mandatory disclosure of important information for investors

ii. Understanding the risk helps illustrate the objective of investor protection w/in securities regulation

b. Risk

i. Probability that the actual return on an investment will differ from its expected return

ii. The major constraint on investment

iii. The larger the risk: the larger the potential return (and vice versa)

1. Risk aversion: must be compensated for the risk

2. Categories of Risk

(no consensus on the number or relative quality of investment risks)

a. Very General Risk

i. Market Risks

1. The variability in returns resulting from fluctuations in the market

ii. Inflation Risk

1. Refers to a loss in purchasing power due to the changes in the general purchasing power of the currency involved in the investment

iii. Interest Rate Risk

1. Results from changes in the level of interests rates

2. Prices of securities move inversely to interest rates

3. Associated primarily w/ bonds

4. Consumer spending moves inversely to interest rates

b. Less General Risks

These are more limited b/c of the nature of the issuer or the business sector

i. Liquidity Risk

1. Associated w/ securities that cannot be purchased or sold quickly and w/o major price concessions

a. i.e., owning shares in a privately held company = high risk

2. Circumstances can reduce or eliminate the liquidity of publicly traded securities

3. The possibility of computer problems at a stock exchange or w/ an intermediary represents a liquidity risk for all companies

a. Aka: operational risk

ii. Credit risk

1. Concerned w/ the possibility that the issuer of a debt will not be able to make interest or principle payments

iii. Financial Risk

1. The risk related to the use of debt financing by companies

2. Companies that use debt rather than equity to finance their assets assume a higher financial risk than those who do not finance through borrowing

a. The more debt that a company raises through debt ( the higher its payment obligations are ( the higher the likelihood that it will not be able to pay all of its debts

iv. Foreign Exchange Risk

1. Changing international currency effects the value when an investment is denominated in a currency other than the domestic currency

v. Government and Political Risk ( aka: “Country Risk”

1. The possibility that as a result of war, revolution, or other political, economic or social events, investment expectations related tot hat country will be negatively effected

2. Quantified by economists and political analysts

vi. Fraud Risk

1. The possibility that deception or manipulation by someone other than the investor will eliminate or reduce the investment value

c. Security Specific risks

i. Issuer or Business Risk

1. The risk of investing in a particular issuer or industry

ii. Off-balance sheet risk

1. The possibility of a loss in investment value that is not reflected on the issuer’s balance sheet

a. Either hasn’t occurred or it is not recognized as an asset or liability

3. Risk in Context

a. Nature of investment

i. General character of investment securities makes some more inherently riskier than others

ii. Equities vs. Debt instruments

1. Debt securities rank above equities in repayment priority when there is bankruptcy or involuntary/voluntary dissolution

iii. Hybrid Securities (i.e., preferred stock)

1. Fall somewhere between debt and equities

iv. Distinctions can be made w/in each of the general categories:

1. secured debt is less risky than unsecured debt

v. Degree of control that holders exercise, or have contractual rights to exercise

1. Holders w/ no or limited control over management decisions affecting the issuer have a higher risk

vi. Conditions on investments

1. Original purchases may have conditioned their investment on certain contractual protections that limit the freedom of choice by the issuer’s management

2. Contractual rights are likely to redound to the benefit of subsequent holders of the debt

3. Where debt instruments are widely held by the public, the holders may encounter practical problems trying to exercise contractual rights against the issuer

vii. Some categories of equity offer voting rights

b. Nature of the Issuer

i. When some or all of the owners are liable for obligations

1. Investors have recourse against persons other than the issuer

2. There is less risk of loss incurred in the event that the financial issuer is unsuccessful

ii. Corporations provide their owners w/ limited liability

1. Recourse w/ the issuer for honoring contractual obligations

2. Make it a higher risk

iii. Start-up or unseasoned business in infancy = higher risk

iv. Government corporations = lower risk

v. Not-for-profits

1. Carry less risk b/c they don’t pay dividends or distribute profits

vi. The size and financial success of a business entity are usually viewed as relevant considerations in evaluating investment risk

c. Nature of the Investor

i. Institutions

1. Thought to posses experience, sophistication and bargaining power to protect selves in assessing risk associated w/ particular risks

ii. Individuals

1. Some are more experienced than other

d. Nature of Regulation

i. Degree of risk is influenced by the extent to which regulators supervise the issuer and transaction where the investments are issued or traded

ii. Relevant is the nature of the regulators enforcing

1. Private person?

2. Sanctions or remedies?

a. Are they enforced?

Private Control of Risk

1. The private sector mechanisms often work in many non-securities investments (i.e., art)

2. works best where the investors are very sophisticated and the transactions are privately negotiated

a. Investment risk can be evaluated prior to investment

3. The question is:

a. Should – as a matter of policy – we allow private mechanisms to work in the area of equities and securities?

b. Should investment decision-making w/ respect to securities be subject to invasive governmental regulation

4. The answer depends on the limits of private control

Limits of Private control

1. Domestic Primary Markets: Unsophisticated Investors

a. Public offerings open the pool of potential buyers to many persons who are unsophisticated

2. Domestic Public Secondary Markets

a. Trading markets present challenges to investors regardless of their experience and sophistication

b. Policy questions

i. How can investors be confident that after a trade an investor will experience proper and timely clearance and settlement of the transaction and that an accurate transfer or computer book entry will be made?

ii. How can they be sure that all of the financial information which an issuer generates for disclosure to the secondary markets will satisfy GAAP and auditing standards? (and they will be reported?)

iii. On what basis can the investing public believe that ordinary investors will be treated fairly by insiders and controlling shareholders of an issuer in connection w/ their securities transactions?

3. Foreign Primary and Secondary Markets

a. Policy questions

i. Does it matter if the issuer is domestic but that all off of the investment decision-making occurs in a foreign country

ii. Does it matter if the issuer is foreign and its securities have no active trading market where the investors are domiciled

5. Public interest in the securities markets

a. Even if private controls are sufficient for dealing w/ certain securities transactions ( when they do break down, there is a large cost to the public

b. A minimum is to prescribe standards and conditions for the types of transaction for which regulation will otherwise not apply

Investment Decision-Making: Regulatory Goals

both private and public interest can be served where regulation is designed to achieve, simultaneously, 3 goals:

1. Efficiency

a. Securities markets are efficient where market forces and competition are the predominant limitations

i. Public and private resources are not wasted

b. Persons w/ disposable assets are more likely to invest where the markets for investment securities are efficient

2. Investor Protection

a. This is about defining unfair advantage in investment decision-making

i. Some investor difference will create “unfair” investment decisions b/c of an ability to be prepared

ii. Public policy should permit investors to use and maximize certain advantages

iii. Public policy should also proscribe or limit certain advantages

3. Reduction of Systemic Risk

a. All participants are dependent on the continued operation of important market intermediaries

b. Financial or technological failure is an essential intermediary representing risk to everyone

c. Policy need

i. Established procedures and regulations that reduce the risk of financial failure of market intermediaries

ii. Establish procedures and regulations that reduce the impact on the market and its participants when failure does occur

Methods of Achieving Regulatory Goals

In order for markets to remain efficient, market forces and competition – no government regulation – must remain the predominant limitations

Included among the aspects of investment decision-making are the:

1. Material information

a. Access to critical info to assess risk and returns:

i. Prior to investment

ii. After an investment

iii. Prior to sale

b. The “critical information” that an investor needs relates to the issuer, to persons associated w/ the issuer, the primary and secondary markets where the security is traded and intermediaries

c. There is a need for uniform and rigorous standards for determining what information is “material” and when it should be disclosed

2. Intermediaries

a. Controls safeguard cash and securities that are held for customers

b. Controls deal w/ systemic risk

c. Control help guarantee a high level of transparency in the trading market

d. Transparency and information places investors in a better position to assess the market and assists regulator in controlling trading abuses

3. Availability of Credit

a. Margin calls on lots securities and lots of investors are dangerous to the market

i. Margin: Investors borrowing money to purchase securities

ii. Margin Call: Market price on securities drops and then you must pay

b. The problem is compounded by the market being inundated by investors attempting to sell margin securities

c. These potential problems justify the controls on credit requirements

4. Sanctions and Remedies

a. Needed to ensure that the controls are effective

b. An optimal enforcement program might be multi-dimensional

i. Shared by regulatory organizations, a quasi-independent government agency, the criminal divisions of DOJ and private litigants and their attorney.

§4.02: Domestic Markets: U.S. Regulatory Policies

1. Public Interest in the Securities Markets

3 reasons have been advanced in US for giving the public an interest in the securities market: these reasons support some form of regulation

a. National Property Resource

i. The public has a legitimate interest in the long-term financial security of its important resources

1. B/c of the integrated nature of the resources w/in a large country

b. Availability of Capital

i. The safety, soundness, and efficiency of the trading markets have a direct bearing on the flow of new capital into private enterprise

ii. This relationship has a bearing on the country’s economic growth

c. Economic Health

i. Securities markets can affect the nation’s general economy and well-being

ii. Imperfections and fraud in the capital markets inflict harm on person other than the investors

iii. Congress in the securities regulation law expressed itself belief that the public has an interest in the domestic securities market, stating that “national emergencies, which produce widespread unemployment and dislocation of trade, transportation, and industry, and which burden interstate commerce and adversely affect the general welfare, are precipitated, intensified, and prolonged by manipulation and sudden and unreasonable fluctuations of security prices and by excessive speculation on such exchanges and markets”

2. Policies Underlying U.S. Federal Regulation

a. 2 basic concepts in US federal securities law

i. Mandatory Disclosure

ii. Broad definitions of Fraud that apply to all of the participants

b. These concepts perform 2 functions

i. Serve as a bargaining and informational role

1. Grows out of perceptions about the nature of the commodity being purchased and sold

2. Grows out of the difficulties that investors have in obtaining access to relevant and accurate information about the sale of securities

ii. Serve as an inhibiting function

1. A by-produce of the disclosure system’s bargaining function

2. Idea that disclosure will deter unlawful activity

c. Broad definition of fraud is coupled w/ enforcement mechanisms that together benefit investors in 2 respects

i. The anti-fraud provisions operate ex ante to impede some persons who might otherwise engage in illegal securities activities

ii. The anti-fraud provisions operate ex post in cases where fraud actually occurs in securities transactions

§4.03: Global Markets: Challenges for Regulators

1. U.S. Regulatory Authorities

a. There are 2 situations that are easy for domestic regulators and policy makers to address:

i. Domestic companies w/ domestic owners and creditors, w/ domestic markets for their securities and w/ capital raising that is also exclusively domestic; and

ii. Foreign companies w/ the same characteristics that are exclusively foreign

1. domestic companies w/ domestic owners and creditors, w/ domestic markets for their securities and w/ capital raising that is also exclusively domestic; and

2. foreign companies w/ the same characteristics that are exclusively foreign

b. Challenge to regulators

i. Decide how to apply law and policy, which is used to regulate exclusively domestic conduct and persons, to the conduct of persons that are part of the global markets

c. 2 distinct policy problems w/ adapting domestic law to global markets

i. U.S. Market participants and Transactions abroad

ii. Foreign Transaction in US markets

2. Challenge: US Market Participants and Transactions Abroad

a. U.S. issuers are increasingly crossing political and geographic borders to raise capital

b. Competition is driving US intermediaries into foreign markets for profitable business opportunities

c. More US investors away from their home country initiating securities trades that occur on US secondary markets, trading US securityes listed on foreign stock and investing abroad in foreign securities

3. Challenge: Foreign Persons and Foreign Transactions in U.S. Markets

In the US: challenge is how much of US securities law should be modified or abandoned to accommodate foreign persons and foreign transactions:

a. Arguments for and against modification of US securities law in the face of increasing cross border activity by foreign participants in the capital global markets

i. Free Trade

1. Modification of US securities law increases domestic investor welfare:

ii. Protectionism

1. Modification of US securities law threatens domestic capital market participants

4. International Regulatory Authorities

a. Traditional Regulation

i. Several countries ( especially in OECD countries) the regulations resemble the regulatory scheme of that in the US

ii. Some countries give more control to the SROs and others more to the government regulators

iii. In many non-OECD countries, regulation is only from private sectors

b. Movement Towards Effective International Regulation

i. There are new and expanding forms of international corporation in the world of international regulations

II. IMPACT OF SECURITIES ACT OF 1933 ON THE OFFER AND SALE OF SECURITIES

Chapter 5: PRIMARY AND SECONDARY OFFERINGS: SECURITIES OF DOMESTIC ISSUERS IN DOMESTIC TRANSACTIONS

§5.01: Overview:

1. Importance of Disclosure in Primary and Secondary Markets

a. “only through the steady flow of timely, comprehensive and accurate information can people make sound investment decision.” ~ SEC

b. Assists offerees and purchasers in delineating between choices

c. Public disclosures provide issuers w/ important information that assist in making investment and business decisions

d. Intermediaries can use information to analyze securities and make recommendations

e. Investors can use information to purchase, retain or sell

f. Information helps regulators discharge their obligations

2. Securities Regulation

a. “Federal Securities Laws” ~ Collective term for the Securities Act of 1933 and the Securities Exchange Act of 1934

b. Federal Securities law is derived from 6 statutes

i. Securities Act of 1933

ii. Securities Exchange Act of 1934

iii. Public Utility Holding Company Act of 1935

iv. Trust indenture Act of 1939

v. Investment Company Act of 1940

vi. Investment Advisers Act of 1940

c. Scope of the federal securities law:

i. substantive law is not applicable until a person ‘offers” or “sell” a security

3. The Securities and Exchange Commission

a. Headed by 5 Commissioners

b. 4 Divisions

i. Division of Corporation Finance

ii. Division of Market Regulation

iii. Division of Investment Management

iv. Division of Enforcement

4. Governmental Sanctions

i.e.,

a. §8A: Administrative cease-and-desist proceedings

b. §20: SEC proceeding in civil actions for injunctions and money penalties

c. §24: Allows referral to the DOJ for any violation of the registration or anti-fraud provisions

i. Sanctions may be brought against any person who has violated or is about to violate any provision of the 1933 Act

5. Rule-making

Involves 3 steps

a. Concept Release

i. The Commission describes the area of interest and its concerns

ii. Identifies different approaches to the problem

iii. Ends w/ a series of questions that seek the views of the public

b. Rule Proposal

i. Generally begins w/ the rule proposal, but can ask for input first

ii. Drafts a formal rule proposal and presents it to the full Commission

iii. It is specific in its objective and methods for achieving its goals

iv. If the Commission likes the rule: it publishes it for public comment (usually 30 – 60 days)

c. Rule Adoption

i. The rule becomes part of the official rules governing the securities industry if the majority of the Commissioners accept it

6. The Significance of Definitions

a. The Term “Security”

i. Formal Definitions

1. §2(a)(1) of the 1933 Act & §3(a)(10) of the 1934 Act

a. Define the term “security” for the purpose of the 2 statutes

2. Congress intended the legislation to encompass many traditional investment instruments

a. “note” “bond” “stock”

3. Congress intended to include many specialized investment interests

a. i.e., Interest in “oil, gas or other mineral”

4. Congress wanted the term to broad enough to cover certain business arrangements that Congress could not or would not specify in the formal definition

a. i.e., any “investment contract” and any “participation in any profit-sharing agreement”

b. defining the actual net casts by these broad terms is left to the courts

ii. Judicial Interpretations

1. Defined to include investment arrangements that are not mentioned specifically in the federal securities statutes

2. Construed the term in a manner that narrows the scope of some of the instruments that Congress included in the statutory definition

a. i.e., “note”

3. most decisions have expanded coverage of the federal securities laws

4. The scope of the securities regulations has been expanded by judicial construction of the phrase “Investment contract”

a. Found w/in the definition of a “security”

b. Securities & Exchange Commission v. W.J. Howey Co.

i. Leading case ( Howey Test

ii. Test for determining whether a person’s investment interest constitutes a “security” for purposes of the federal securities laws

iii. An investment contract for the purposes of federal securities laws is “a contract, transaction or scheme whereby a person invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or a 3rd party”

c. Subsequent interpretations have clarified the elements that must be satisfied to constitute a K, transaction or scheme w/in the phrase ( and consequently to be a security

b. “Offer” and “Sale”

i. Conduct or communication triggering disclosure & anti-fraud provisions

ii. Definition for conduct or communication which triggers disclosure and anti-fraud provisions

iii. §2(a)(3) of the 1933 Act

1. “sale” or “Sell” include

a. “every contract of sale or disposition of a security or interest in a security, for value.”

2. “Offer to Sell,” “Offer” include

a. “every attempt or offer to dispose of, or solicitation of an offer to buy, a security or interest in a security, for value.”

c. “Interstate Commerce”

i. In order to regulate ( Congress must act pursuant to its powers

ii. To regulate under the Commerce Clause, Congress usually identifies a national interest that would be served by federal regulation

1. an interest that is distinct from those interests which state government might address

2. One way that Congress justifies this regulation is by insisting that specified conduct or communications be effected through the use of the “mails”

a. An area of communication and transportation that the federal government traditionally regulates

3. Another way is for Congress to condition its regulation on the use of any means or instruments of transportation or communication in “interstate commerce” or through the facilities of “interstate commerce”

iii. §2(a)(7) of the 1933 Act defines the term “interstate commerce”

1. includes “trade or commerce in securities or any transportation or communications relating thereto”

2. Communications falls w/in this statutory definition

iv. Judicial interpretation of procedural requirement that conduct or communication involve the mails or interstate commerce are liberal

d. “Underwriter”

i. §2(a)(11)

ii. “any person who has purchased from an issuer (both the issuer or an affiliate) w/ a view to . . . the distribution of any security”

§5.02: Securities Act of 1933

History and Purposes

1. Investor Protection:

Registration and Prospectus Delivery Requirements

a. §5 of the 1933 Act

i. Implements one of the 2 major purposes of the statute

1. Protects purchasers of securities

2. Provides “full and fair disclosure of the character of the securities” to be sold

ii. Registration process under §5

1. Calls for the filing of a registration statement w/ the SEC

a. Including the Prospectus ( disclosure document

2. Requires that the SEC review all filed materials

iii. Delivery of the prospectus

1. A copy of the prospectus must be given to each investor prior to the sale or in some cases at the tie of delivery of the security

2. Public Offerings: duty to disseminate rest w/ the issuer

3. Underwritten Offerings: Duty to disseminate rests w/ the dealers

b. §4(3) of the 33 Act

i. Provides dealers w/ an exemption from the prospectus delivery obligation

ii. The exemption is inapplicable in the case of a public offering

1. §5 will extend to all dealers (defined in §2(a)(12))

2. Investor Protection:

Prevention of Registration Violations and Fraud

a. The 1933 Act authorizes governmental sanctions

b. 3 provisions give injured purchasers a private cause of action for rescission or damages

i. Helps investors act as private attorney generals

ii. Protects the public’s interest by encouraging compliance

Registration Requirements: Basic Distinctions

1. Public Offerings and Non-Public Offerings

a. Public offering can be made by the

i. issuer in the primary markets or

ii. by a controlling shareholder of the issuer

1. Offers to sell a substantial amount of securities into the secondary market

b. “Public offering” is used synonymously w/ the term “distribution” in the 1933 Act

c. §5: Registration and prospectus delivery requirement of the Act applies to all offers

i. Only some securities offerings undergo the entire registration process

1. Those that do not qualify for an exemption under §3 or §4 of the Act

d. Registration Process

i. Includes the preparation of disclosure materials in accordance w/ SEC forms,

ii. The filing of the registration statement w/ the SEC

iii. The review of that filing by the SEC staff

iv. the dissemination of the preliminary and final prospectuses

v.

e. Exemptions:

i. §3(a)(2) through §3(a)(8)

1. Exempted Securities

2. Most offerings will not qualify for one of these

ii. §4

1. Exempted transactions

2. Lays out exemptions for the person rather than the security

3. Generally: none of these transaction exemptions is available where the offering:

a. Is made generally to the public; and

b. Where it possess certain characteristics, such as general advertising and the delivery of freely tradeable securities

2. Affiliates (Owners of Control Shares) and Non-Affiliates (Owners of Non-Control Shares)

a. Determining who is an affiliate under this definition depends on the facts and circumstances

i. Affiliate is any person who is a director or officer of the issuer; or

ii. a person who owns 10% or more of the issuer’s voting securities

b. Voting securities of an affiliate are sometimes referred to as control shares

c. The application of the transaction exemption is limited to ordinary trading

i. In order to prevent secondary distributions from occurring w/out the protection of the registration process

d. §4(1)

i. Limits the scope of the exemptions to trading and not distributions

ii. Exemption is not available to a controlling person who sells significant amount of securities to the public in a relatively short period of time

e. Controlling person wanting to sell a significant amount of securities to the public in a relatively short period of time must:

i. Cause the issuer to file a registration statement; or

ii. Find another exemption for the resale

f. “Distribution”

i. is not defined in the Act

1. SEC opinion is that it connotes a quantitative threshold

ii. Threshold must be passed before a public offering can be said to exist

iii. Has a temporal aspect

1. Transcends the offer and sales ( A distribution comprises ‘the entire process by which a bloc of securities is dispersed and ultimately comes to rest in the hands of the investing public’

g. Rule 405

i. Determines the scope of “control”

1. Concerned w/ actual and potential control

ii. Control: “the possession, direct or indirect, of the power to direct or cause the direction of the management and policies of a person, whether through the ownership of voting securities, by contract, or otherwise”

3. Restricted Securities and Unrestricted Securities

a. Restricted Securities

i. Those that are not freely tradeable by the owner

ii. Generally have a legend placed on the stock certificate to inform the individuals of the restrictions

iii. Includes any security acquired directly or indirectly from the issuer or an affiliate of that issuer in a transaction not involving a public offering

iv. Technical meaning is a term of art

1. Growing out of the distinction between a trade and a distribution

b. §2(a)(11)

i. Defines an underwriter to held prevent circumvention of the distribution of unregistered securities

ii. Helps regulate the resale of restricted securities

c. Rule 144(a)(3)

i. Requires that the owner of restricted securities to hold them for an appropriate time and then to resell them in such limited quantities and in such a manner as not to disrupt the trading markets

d. Any non-affiliate who resells unrestricted securities is not at risk of becoming an underwriter w/ respect to those securities

Filing of Registration Statement, SEC Review of Disclosure

Materials and delivery of Prospectus to Investors: Limits on Selling Activity:

1. The Registration Process (§5)

aka: “Registration and prospectus delivery requirements of §5”

a. “in registration”

i. Has a technical meaning as used w/ §5 of the 33 Act

ii. The time period commencing immediately prior to the filing of a registration statement but after the issuer has reached a tentative agreement w/ an investment banker to underwrite the securities offering

iii. Continues until the completion of the offering and the period of 40 or 90 days which dealers must deliver a prospectus

b. Entire process includes

i. Preparation of a registration statement on an appropriate disclosure form

ii. The filing of the registration statement w/ the SEC (and the prospectus)

iii. SEC reviews the material

iv. Dissemination of the prospectus to investors

2. The Critical Time Periods in the Registration Process

a. Pre-Filing Period: §5(c):

i. Prohibits any person from making an offer to sell securities prior to filing a registration statement w/ the SEC

ii. Policy of §5(c)

1. Prevents a company that is planning to make a registered public offering from disseminating favorable information in the form of press releases or otherwise which would encourage investors to form a premature opinion of value w/o the benefit of the prospectus

iii. Legal Problem for the Issuer

1. Determining when the release of information is legitimate or an attempt to condition the market

a. Depends on the purpose of the issuer’s communication

iv. Only traditional corporate communication is allowed

1. Issuer should avoid issuing forecasts or projections and publishing opinions concerning values

b. Waiting Period ( §5(b)

i. Time after the filing of the registration statement and before the effective date of the registration period

ii. No sales are allowed during this time

iii. Policy

1. To encourage the issuer and intermediaries to solicit indications of interest in buying securities by means of the preliminary prospectus

iv. May continue to disclose factual information to shareholders

c. Post-Effective Period

i. Sales may occur

ii. Issuers, underwriters and dealers must deliver a copy of the final prospectus

iii. Issuer must ensure that the prospectus remains accurate during the distribution process

Exemptions from Registration and Prospectus and Delivery Requirements

1. §3: “Exempted Securities”

a. 3(a)(2) – 3(a)(8)

i. Provide an exemption from the registration requirements of the 33 Act for offers and sales of certain types of securities

ii. These are always available regardless of the nature of the transaction

2. §4: “Transaction Exemptions”

a. §4(1): concerned w/ offers and sales of securities into the secondary markets

b. §4(2): provides issuer w/ an exemption for transaction “not involving any public offering”

3. Exemptions from type of offerings: ( Found in §4 & the remaining sections of §3

Enforcement: Remedies and Sanctions

1. 1933 Act provides purchasers of securities w/ remedies against certain persons who violate the Act

2. §12(a)(1)

a. gives purchasers a private right of action for rescission; or damages against any person who offers or sells a security in violation of §5

b. Strict liability provision

c. (policy) Purpose

i. protect innocent investors

ii. encourages compliance w/ the requirements of §5

d. Provides few affirmative defenses

i. Proof of the absence of scienter or negligence, or evidence of good faith will not absolve the Δ

ii. Proof that the seller has an exemption under §3 or §4 is the strongest defense against noncompliance w/ §5

3. 3 anti-fraud provisions of 1933 Act serve as useful deterrents against fraudulent securities offerings

a. §17

i. Prohibits fraudulent interstate transaction

ii. Basis for gov’t actions against persons suspected of offering or selling securities by means of fraud

b. §11

i. Private remedy to person who buys in a registered securities offering where the misrepresentation or omission of material fact is contained in the registration statement at the time it became effective

1. Even if the misstatements were not intentional

ii. Permits the recovery of damages against specified person

iii. Eliminates the requirements of privity and reliance

c. §12(a)(2)

i. Broad in scope than §11

ii. Protects defrauded buyers in registered/unregistered public offerings

iii. Π recovers damages for misrepresentation or ommission of material fact

iv. Seller’s principle defense

1. requires Δ to show that he or she “did no know, and in the exercise of reasonable care could not have known, of such untruth or omission”

4. 1933 Act extends liability for violations of either §5 or the anti-fraud provisions to any person who is control of the person who is primarily liable ( §15 (as an example)

a. Secondary liability might attach to a controlling shareholder of a corporation which was primarily liable for having sold unregistered securities w/out an exemption

b. Affirmative defense for the controlling person

i. “had no knowledge of or reasonable grounds to believe in the existence of the facts by reason of which the liability of the controlled person is alleged to exist”

[pic]

§5.03: Primary Offerings by Domestic Operating Companies

Compliance w/ Registration Forms

1. The nature of the registrant’s disclosure obligations depends upon the nature of the issuer

2. §7: “Information Require in Registration Statement”

a. Refers to Schedule A

i. Specifies 32 items of information about the issuer and its business operations

b. Some information provided is intended only for SEC and not the public prospectus

i. Part I ( information that must be included

ii. Part II ( information that can be left out

3. §10: “Information required in the Prospectus”

a. Contains specific disclosure requirements

b. §10(a)(3): sets date guidelines for the prospectus

4. Regulation C

a. Rules (400 – 498) that govern every registration statement of securities under the Act

5. Rule 401

a. Under this rule, the SEC adopted forms to be used by registrants in preparing their registration statement:

i. Form S-1 (i.e.,) Must be used for the registration of securities of all registrants “for which no other form is authorized or prescribed.”

6. Regulation S-K:

a. Contains specific disclosure instructions for each of the SEC’s registration forms

7. General information called for on the registration forms

a. A description of the company’s properties and business

b. A description of the security to be offered for sale

c. Information about the management of the company

d. A statement about the intended use of proceeds from the sale of the securities to be offered; and

e. Financial statement certified by independent accountants

8. Form S-2 and S-3

a. They are less demanding than Form S-1

b. Permit eligible issuers to incorporate by reference certain information which those issuers have already disclosed to the public markets

c. Form S-3: is more beneficial to issuers b/c more information may be incorporated by reference

d. Generally, for an issuer to be eligible for the less demanding form (S2 and S3)

meet 2 conditions

i. The registrant has been a reporting company for 3 years (the preceding 36 months);

1. or: has been a reporting company for one year (the preceding 12 calendar months) and has a public float (the market value of securities held by non-affiliates) of $75 million (form S-3 issuers)

ii. The registrant has filed all reports timely during the past 12 calendar months and the portion of the month in which the registration is filed

9. Rule 408

a. A registrant is informed that in addition to the information expressly required to be included in a registration statement, “there shall be added such further material information, if any, as m ay be necessary to make the required statements, in the light of the circumstances under which they are made, not misleading.”

10. Some registration forms are designed for specific types of transactions

a. These differ from the standard disclosure form; i.e., Form S-8

i. provides special and simplified registration for employee benefit plans and certain consultation arrangements and the issuer’s securities that can be purchased pursuant to the plans or arrangements

ii. it may not be used to raise capital

iii. registers the issuer’s offers and sales to employees or consultants

iv. Typically does not register the resale of securities

v. It is not filed w/ the SEC

Transaction Exemptions

[A few of the possible transaction exemptions for issuers]

{( each exemption is generally specific in its focus}

1. Statutory Relief for the Issuer: §4(2)

a. Registration and Prospectus delivery requirements of §5 don’t apply to:

i. “Transactions by an issuer not involving any public offering”

b. SEC v. Ralston Purina Co. ( leading judicial interpretation

i. Applicability of the non-public offering exemption “should turn on whether the particular class of persons affected need the protection of the Act

ii. Can make the offering to those that can “fend for themselves”

c. Extends to all oferees in the transaction

d. Issuer has the burden of proving that they have met all of the conditions

2. Rule 506

a. Passed to reduce the ambiguity in the Purina Court: assist issuers

Private Placements under Rule 506 of Regulation D

1. Regulation D

a. Series of rules that include definitions and conditions in Rules 501 through 503 that are applicable to Rule 506

2. It is concerned w/ purchasers only

3. Sets forth the objective criteria for understanding and using the exemption §4(2)

4. Non-exclusive safe harbor interpretation of §4(2)

a. Issuer must meet all the conditions of the rule to enjoy the benefits of the safe harbor

5. Allows any issuer to sell an unlimited amount of its securities

a. to an unlimited number of accredited investors and

i. Defined in Rule 501(a)

b. to 35 non-accredited investors

6. Requirements of the issuer

a. Provide specified information in written form to non-accredited investors at a reasonable time prior to sale

i. Non-accredited investor must understand the merits of the risk of purchase

b. File a notice of sales on Form D w/ the SEC

c. Exercise reasonable care to assure that the purchasers are not underwriters

7. Effect on the securities

a. The have the status of securities sold in a §4(2) transaction

b. They are “Restricted securities” w/in the meaning of Rule 144(a)(3)

Relevance to Seller of Secondary Sales by Purchaser

1. Resale by a securities purchaser may have no legal effect on that person’s seller

a. Purchase securities in a registered public offering ( can resell immediately

b. Sellers of restricted securities who meet all of the conditions of Rule 144 may resell in broker’s transactions

2. Resales by a security holder can impact that person’s seller

a. Purchases made under the exemption of §(2) and Rule 506 can’t resell immediately

i. Must hold them for applicable time: ensures that the original purchaser does not become an underwriter

ii. If they are sold prematurely, then the exemption may be void and sanctions applicable under §12(a)(1)

b. Affiliates of an issuer

3. Persons who purchase securities in a registered primary offering can resell immediately w/out creating any legal problems for the issuer under the 1933 Act

i. Persons who purchased securities in the trading markets from sellers who relied upon Rule 144 in their broker’s transactions can resell

1. sellers of restricted securities who meet all of the conditions of Rule 144 may resell in brokers’ transactions

b. Resales by a security holder can impact that person’s seller

i. Purchases made under the exemption of §4(2) and Rule 506 can not resell prematurely

ii. Affiliates of an issuer

1. Not permitted to rely upon §4(1) for resales constituting a distribution

2. Persons acquiring securities from an affiliate can become underwriters (w/ respect to those securities)

3. Where an affiliate’s resale transaction includes an underwriter, the affiliate is prevented from claiming the ordinary trading exemption for his/her secondary sales

[pic]

§5.04: Resales by Owners of Securities of Domestic Operating Companies

§4(1): The Trading Exemption

1. Trading vs. Distribution

a. Exemption for non-issuer wanting to resell in the secondary market

b. Does not exempt sales that constitute a distribution

c. Anyone who resells restricted securities into the public markets runs the risk of becoming an underwriter

2. Threshold Questions

a. 2 questions for persons wanting to resell unregistered securities in reliance on §4(1)

i. What is the status of the person reselling the securities ( at the time of the proposed sell

1. Affiliate

a. Risk that the transaction will be deemed a distribution

b. Can’t make a public offering

c. Risk is not diminished by the status of the securities

2. Non-Affiliate

ii. What is the status of the securities to be sold

1. Unrestricted

2. Restricted

a. Risk that the seller is actually functioning as an underwriter

b. If there is doubt, a selling security holder might avoid the difficulties by arranging w/ the issuer for his/her securities to be included in a registration statement

c. Non-affiliate and unrestricted securities is the easiest case for applying §4(1)

d. 2 rules that assist affiliates and non-affiliates planning to resell securities in unregistered transactions

1. Rules 144 and 144A ( Safe-harbor interpretations of §4(1)

[pic]

Rules 144

1. Overview

a. Contains 2 trading exemptions

i. Regular One

ii. Special one for non-affiliates ( Rule 144(k)

b. Provides benefits to at least 3 groups of persons:

i. Persons who wish to resell restricted securities

1. 144(d): Sets objective criteria for determining the length of time the securities must be held prior to resale

2. 144(e): Amount of securities that can be resold w/in a limited time period w/ the resale being a distribution

ii. Person who plan to resell their control shares

1. 144(e): Sets volume limitations, that prevent it a distribution

iii. Guidance to the issuer

1. Assist issuers concerned about the legality of resales and their acquiescence in them

2. 144(d): guidance in deciding whether to permit holders of its restricted securities to resell into the public trading markets

2. Conditions of Rule

Seller should be concerned w/ the following terms and conditions:

a. the term “restricted securities:” ( Rule 144(a)(3)

i. Defined to include securities acquired from an issuer or an affiliate of an issuer in a transaction not involving a public offering

ii. Securities sold by an issuer pursuant to §4(2), w/ or w/out Rule 506, are restricted securities

b. the need for current public information about the issuer ( Rule 144(c)

i. Provides that adequate public information about the issuer must be available before the Rule can be used for resales

c. the one-year holding period required for restricted securities ( Rule 144(d)

i. Provides the provisions to sell Restricted Securities

ii. 144(d)(1) ( If restricted securities are to be resold:

1. A minimum of one year must elapse between the later of 2 events;

a. Either the date of acquisition of the securities from the issuer, or The date of acquisition of the securities from an affiliate of the issuer; and

b. Any resale of those securities in reliance on the rule

iii. Rule 144(d)(2) defines when the one-year holding period commences

1. When the recipient of restricted securities purchases the securities

d. the limitation on the volume of sales in any 3 month period ( Rule 144(e)

i. Focuses on the meaning of the term “distribution”

ii. Applies to all sales of restricted securities by a non-affiliate during any 3 month period

iii. Applies to all sales of restricted and non-restricted securities by an affiliate during any 3-month period

1. Provides that that a person can sell (during any 3-month period) an amount equal to the greater of

a. 1% of the outstanding securities of that class; or

b. the average weekly trading volume on organized markets during the 4 calendar weeks preceding the proposed resale

iv. Policy of limitations: “so as not to disrupt the trading markets”

e. the need for resales in brokers’ transactions ( rule 144(f)

i. Limits the manner of resales

ii. Prohibits private sales or public resales prearranged w/ a buyer

iii. A person relying upon Rule 144 must resell in “brokers transactions”

f. Rule 144(g): defines “brokers transactions”

g. the need for filing a Form 144 w/ the SEC ( Rule 144(h)

i. An obligation imposed on sellers where

1. the number of securities to be sold exceeds 500; and

2. the aggregate selling price will be greater than $10,000

3. Rule 144(k)

a. Provides relief to person who don’t meet the requirements of Rule 144 and to other non-affiliates who wish resell restricted securities

b. non-affiliates are excluded from reselling under Rule 144 if;

i. a trading market for the issuer’s securities does not exist and brokers’ transactions can not occur, or

ii. if the issuer does not comply w/ Rule 144(c) by providing adequate current information to the public

c. Exempts any sales of restricted securities by non-affiliates from the requirements of Paragraphs (c), (e), (f) and h of Rule 144

d. Requirements for this special exemption

i. Any non-affiliate who has been a non-affiliate for at least 3 months; and

ii. who has owned restricted securities for at least 2 years

e. Effects

i. Allows unlimited amount of the securities to be sold

ii. Sales do not have to be made in brokers’ transactions

iii. Privately negotiated, or public sales to pre-arranged buyers are permitted

iv. Seller doe not need to file a Form 144 w/ the SEC0

Rule 144A

1. Overview

a. Addresses 2 situations

i. Exempts certain resales of restricted securities from the registration

ii. Exempts certain resales by affiliates from those registration requirement

b. These situations were clearly meant to be exempted

i. Party was able to “fend for itself” in the marketplace; and

ii. B/c the resale is in a private transaction the worries associated w/ a public offering are not present offering are not present

c. Many R. 144A transactions follow a private placement in reliance on §4(2)

i. Called “bought deals”

ii. 144(a)(3): These are still “restricted securities”

d. Provides a non-exclusive safe harbor from §5 registration

i. For Resales of restricted securities; and

ii. Control shares to any QIB (qualified institutional buyer)

e. Operation of 144A turns on 3 factors

i. Eligible Purchasers

ii. Eligible Securities

iii. Information Requirements

2. Eligible Purchasers

a. Primarily for QIB

b. Any entity (except registered broker/dealers) may purchase under 144A as a QIB if in the aggregate it owns and invests on a discretionary basis at least $100 million in securities of issuers that are not affiliated w/ the entity

c. Registered Broker-dealers are deemed a QIB where

i. The aggregate it owns and invests on a discretionary basis is at least $10 million in securities of issuers that are not affiliated w/ it

ii. A broker-dealer acting as a riskless principal for an identified QIB

1. There must be a commitment from the QIB at the time of purchase

d. Banks and Saving & Loan Associations

i. Banks: ( defined in §3(a)(2)

ii. S & L ( defined in §3(5)

iii. Must own and invest in a discretionary basis at least $100 million in securities

iv. Domestic Banks and S&Ls must also have

1. Audited net worth of at least $25 million

a. Demonstrated in it latest published annual financial statements

b. At a date not more than 16 months preceding the date of sale

v. Foreign Banks and S&Ls

1. Audited net worth of at least $25 million

a. At a date not more than 18 months preceding the date of sale

3. Non-Eligible Securities

a. Identified in 144A(d)(3)

b. Not available for securities that – when issued – were of the same class as securities listed on a national securities exchange or quoted on NASDAQ

c. Purpose/Policy

i. Ensure that side-by-side public and private markets don’t develop for the same class of securities of the issuer

ii. Excludes common stock from the Rule’s protection

iii. Relegates the use to non-convertible debt and non-convertible preferred stock

4. Information Requirements

a. Seller – wanting to sell under 144A – has no duty to provide buyer w/ info where:

i. The issuer is a reporting company under the Exchange act (

1. Publicly available information is sufficient for protection

ii. Where the issuer is a foreign private issuer under Rule 12g3-2(b)

1. Rule elicits certain information

iii. Issuer is a foreign government eligible to register securities on schedule B

b. Information required under 144A

i. Statement of the nature of the issuer’s business and of its products and service offered

ii. Balance sheet and Profit & loss and retained earnings statement

5. Resale

a. Although these are “restricted securities” there are no resale limitations

b. Seller must only ensure that the buyer is aware that the seller may rely on Rule 144A as an exemption from the registration and prospectus delivery requirement of §5

Primary Markets

[pic]

§5.05: Primary Offerings by Domestic Investment Companies

Introduction to Investment Funds

1. Investment company is essentially an investment fund that pools money contributed to it by persons who purchase ownership interests

2. Purpose: Only to make Money

3. 2 forms:

a. open-end fund

i. Issue unlimited numbers of shares to the public directly

ii. These securities are redeemable at the option of the holders

iii. Generally the only secondary market is the fund itself

iv. securities are either:

1. a new issue or

2. already-issued redeemable securities

b. closed –end

i. has a fixed number of shares issued and outstanding

ii. traded as any other corporate stock might be traded

4. Types of investments:

a. Can be diversified or non-diversified

b. Mutual Fund

i. Organized like a corporation

ii. Investment decisions are made in line w/ the fund’s stated objective

iii. Investment decisions are made by:

1. the owners (if few in number)

2. by a management group

3. by an investment adviser

c. UIT: Unit Investment Trust

i. Unmanaged investment vehicle that invests in a fixed portfolio of securities and sells redeemable interests (units) in itself

5. Price

a. Based on the Net Asset Value (NAV) per share

i. Value of all investments owned by fund divided by the number of shares

b. Open-ended fund

i. Investors pay the NAV for each share plus commission

c. Closed-end

i. Pay either a premium or a discount depending on the popularity of the fund

1. Premium ( price higher than the NAV

2. Discount ( price lower than the NAV

Investment Company Act of 1940

1. Background

a. A highly regulatory regime b/c of the unique nature of an investment company

i. Not operated by investment company employees ( generally reliance is on external service providers

ii. Officers of funds are usually affiliated w/ the fund’s adviser

iii. The interest of the officers and the shareholders usually diverge

2. Overview

a. §7: Must register w/ the SEC to engage in interstate commerce

i. Unless it has an exemption

ii. Violation = criminal sanctions & Un-enforced contract

b. §30: all investment companies are subject to periodic reporting

c. Investment Advisory: Act regulates their relationship w/ the investment company

d. Net worth: Can’t make a public offering w/o a net worth of at least $100,000

e. Advertising: Must file all literature w/ SEC w/ 10 days of use/publication

f. Limits on Interlocking Ownership: §12(d)(1)

i. Prohibits control of one investment company by another investment company

g. Nature of Securities Issued: §18(i)

i. All stock be voting stock w/ equal voting rights (few exceptions)

ii. Can’t issue warrants or rights

h. Offering price

i. Majority of stockholders must agree to sell shares below NAV

i. Board of Directors: must be comprised of at least 40% disinterested persons

3. Categories: Diversified or Non-Diversified

a. Diversified Fund §5(b)(1): Company is diversified if 75% of the value of assets:

i. of the securities so included the fund may not have more than 10% of the outstanding voting securities of any one company; and

ii. Not more than %5 of the fund’s assets may be in the securities of any one company

b. Non-Diversified: 5(b)(2)

i. Must still have sufficient diversification among its total assets to receive favorable tax treatment

ii. At the close of each quarter of the taxable year:

1. not more than 25% of the market value of the Fund’s total assets are invested in the securities of a single issuer; and

2. The same 5% and 10% tests (w/ diversified) are satisfied w/ 50% of te fund’s total assets

U.S. Regulation of Offerings by Domestic Investment Companies

1. Public Offerings

a. Overview

i. Must file a registration statement under the 33Act

ii. Requires a prospectus

iii. Open End: prospectus must be revised and dated annually

iv. Closed End: must file new registration w/ each public offering

b. Sample Mutual Fund Disclosures

2. Private Offerings

a. §3(c)(1) Private Funds

i. To rely on this exception must meet:

1. No more than 100 beneficial owners

2. Not make a public offering

ii. When 2 or more funds are so related the SEC may determine that they are integrated ( which may defeat the exemption

b. §3(c)(7) Private Funds

i. Excludes from the definition of an investment company any private investment company that consists solely of highly sophisticated qualified purchasers

ii. Creates 4 categories of persons eligible to invest in qualified purchaser pools

1. Any natural person owning $5 million in investment

2. a family-owned company w/ at least $5 million in investment

3. a trust that was established and funded by a qualified purchaser for which investment decisions are made by a qualified purchaser where the trust was not formed for the specific purpose of acquiring the securities offered;

4. any person who in the aggregate owns and invests on a discretionary basis for its own account or for the accounts of other qualified purchasers not less than $25million in investments

iii. Don’t make a public offering

c. Relationship Between §3(c) of the 1940 Act and §4(2) of the 1933 Act

i. In order to avoid §5 ( §3 (c) must claim an exemption under §4(2)

ii. Judicial and administrative interpretations of §4(2) - & 506 – have stated that any offering of securities which meets the conditions required for an exemption under §4(2) will qualify as an offering which is non-public for purposes of §3(c)(1) and 3(c)(7)

§5.06: Resales by Owners of Securities of Domestic Investment Companies

1. Closed-End Funds

a. Resales of securities issued by a close-end fund are regulated in the same way as securities of operating companies

b. Must address the seller’s and the securities’ status

2. Open-End Funds

Chapter 6: Primary and Secondary Offerings: Securities of Foreign Issuers in Domestic Transactions

o 3 major topic

▪ trading w/ international securities

• 6-2 very helpful w/ the adr process

▪ Impact of §5 of the 33 act on the creation and selling of the adrs

• Why might an issuer have to file an f-1

▪ Difference between the creation

§6.01: Introduction

Challenges for Domestic Investors:

Acquisition of Securities of Foreign Issuer as Issued in Home Market

1. Nature of Securities Acquired

a. The law of the jurisdiction where a foreign issuer is organized determines the nature of the securities to be issued, sold and traded

b. There are numerous factors that will effect the nature of the securities

2. Practical problems for Domestic investors

(non-exhaustive list)

a. Stock quotations in foreign country

b. Difficulty in locating a broker to execute the transaction

c. Trading, clearing and settling a transaction under foreign standards in foreign currency

d. Foreign investment restrictions

e. Possible need for foreign global custodian and the costs associated w/ it

f. Dividends and interest paid in foreign currency

g. Foreign tax w/holding

h. Difficulty acquiring information about the foreign issuer

i. Difficulty in transferring title at death under foreign laws

3. Domestic Investors as Beneficial Owners

a. 2 Forms of Securities ownership

i. Legal and

1. Relates to the rights of the person who is listed on the books and records of the issuer, or its agents

2. Record owner whom corporate law provides protection on various matter

ii. Beneficial

1. Relates to the rights of employment of some or all of the rights associated w/ legal ownership

iii. Sometimes the legal owner is also the beneficial owner

b. Problem for domestic investors in foreign issuers

i. Physical evidence of investment is retained by the legal owner – foreign custodian

ii. The legal owner’s place of business might make it more difficult to transfer ownership benefits

§6.02: Method for Investing in Securities of Foreign Issuers: Depositary Receipts

Depositary Receipts Defined

1. Introduction

a. DR = negotiable certificate evidencing ownership of shares in a foreign corporation from a country outside the market in which the DRs are traded

i. Each DR represents a specific number of the underlying shares remaining on deposit in the issuer’s home market

ii. Defined by Markets that they are available in

b. Depositary = bank that provides all stock transfer and agency services in connection w/ the DR program

c. Custodian = Responsible for holding the shares underlying the ADRs

i. Can be an overseas branch, affiliate or correspondent of depositary

ii. Acts on instructions given by the depositary to collect and remit dividents

d. Selling and trading

i. DRs can be publicly offered or privately placed

ii. In US: publicly traded securities are sold from the OTC to NYSE

iii. Privately placed securities are sold to QIB

2. Types of Depositary Receipts

a. See chart: page 6-6

b. Rule 144A ADRs (RADRs): DRs that are privately placed under Rule 144A in US markets

c. Global depositary Receipts (GDRs) DRs that are offered to investors in two or more markets out the issuer’s home country

d. American Depositary Receipts (ADR): DRs that are publicly available to US investors

Mechanics of Depositary Receipts

1. Issuance and Trading

The mechanics depends on the type of receipt program employed

a. New Drs are created once the underlying shares are deposited w/ the depositary’s custodian in the issuer’s home market

b. Then depositary issues Drs to investors

2. Cancellation

a. Investor contacts broker

b. Broker either sells them to another investor or sells the underlying shares back into the home market

Depositary Receipt Programs

1. 3 different distinction

a. Where the depositary receipts are sold

i. Public Trading market

ii. Private placement

iii. Enters primary markets where foreign issuers make public offering outside their home country

b. Nature of the depositary facilities

i. Sponsored

ii. Un-sponsored

c. Different categories of sponsored Depositary Facilities

i. Level 1

1. Involve arrangements between a depositary and outstanding securities of a foreign issuer which trade or will trade in the OTC, but not on NASDAQ or the OTCBB

ii. Level 2

1. Involve sponsored facilities for outstanding securities of a foreign issuer which trade or will trade on a national stock exchange, on NASDAQ or OTCBB

iii. Level 3

1. Used by foreign issuers in connection w/ efforts to raise capital

2. Assist a foreign issuer to sell securities in the primary markets of a foreign country

2. Sponsored Depositary

a. Is established jointly by a foreign issuer and a depositary

b. Created generally in the same manner as unsponsored facilities

i. Except that the issuer enters into a deposit agreement w/ the depositary and signs the Form F-6 (for the 33Act)

c. Benefits to a foreign issuer: (non exhaustive list)

i. Enlarges the market: diversified exposure ( increase and stabilizes the price

ii. Enhance the image of the company’s products, service, financial instruments

iii. Provides a mechanism for raising capital

iv. Vehicle for acquisition

v. Enable employees to invest easily in the parent company

d. Basic Steps

i. Issuer appoints a depositary bank

ii. Issuer of underlying securities complies w/ registration of 33 and 34 Act

iii. Issuer and depositary execute a deposit Agreement

iv. Issuer and depositary sign the Form F-6

v. Issuer’s agents launch the program (i.e., road shows)

Impact of §5 of the 1933 Act on Depositary Receipt Programs

1. Legal Problems Associated w/ the Creation of Beneficial Ownership Interests

a. Overview:

i. ADRs don’t always represent one security ( they often represent a fractional amount

b. Identifying the “Security” and the “issuer”

i. §2(a)(1): Security

1. is not limited to “stock” but included any “participation in . . . [or] receipt for . . . any of the foregoing.”

2. The definition is broad enough to include the “participation rights” associated w/ fractional ownership

ii. Rule 405 of Regulation C: “depositary share”

1. “a security, evidenced by an ADR, that represents a foreign security or multiple of or fraction thereof deposited w/ a depositary”

iii. §2(a)(4): “Issuer”

1. “every person who issues or proposes to issue any security

2. Will include a partnership – even though it is not a formal legal entity ( can be a fictional entity composed of numerous parties

iv. Form F-6

1. Suggests that the foreign issuer is the “issuer”

2. The “legal entity created by the agreement for the issuance of ADRs” is also an “issuer”

a. Includes the depositary

2. Regulation of Offers and Sales of Depositary Shares

a. Compliance w/ Form F-6

i. Form F-6 is a registration statement covering the offers and sales of the ADRs

ii. A depositary’s decision to create a depositary receipt program entails a public offering of ADRs

iii. Form F-6

1. Must be filed by depositary as part of creation of the DR program

2. Can be used for the registration of ADRs only if the Issuer of the deposited securities either is a reporting issuer under the 34 Act or is exempt from reporting by Rule 12g3-2(b)

iv. Prospectus contained in the Form F-6

1. Can take the form of the ADR certificate

2. Only has to disclose information regarding the depositary shares and the depositary

v. §5 requires depositary to deliver the F-6 prospectus to purchasers of DRs

vi. Requires that the depositary sign the registration statement

1. The issuer must also sign when it is a sponsored DR program

vii. Liability: “no person or entity has the liability of an issuer under §11”

3. Offers and Sales of Deposited Shares: A separate Legal issue

a. When there is a public offering of securities in ADR form the offers and sales of both the ADRs and the underlying deposited securities must be registered

b. Form F-6 covers the offer and sale of the ADRs

c. Another form , i.e., Form F-1, must be filed to cover the offers and sales of the deposited shares

§6.03: Primary Offerings by Foreign Operating Companies

Nature of Foreign Issuer

1. 33 and 34 Act contemplates 3 categories of issuers

a. Issuers that are organized under US federal or state laws

b. Issuers that are organized under the laws of a foreign jurisdiction but that are “essentially” domestic in character

c. Issuers that are organized under the laws of a foreign jurisdiction and that are essentially foreign in character

2. SEC adopted rules that provide guidelines for making distinction between foreign issues which are or are not essentially foreign

3. Rule 405 ( 33 Act & Rule 3b-4 ( 34 Act

“The term ‘foreign private issuer’ means any foreign issuer other than a foreign government except an issuer meeting the following conditions:

(1) more than 50% of the outstanding voting securities of such issuer are directly or indirectly owned of record by residents of the US; and

(2) Any of the following:

(i) the majority of the executive officers or directors are US citizens; or

(ii) More than 50% of the assets of the issuer are located in the US, or

(iii) The business of the issuer is administered principally in the US

4. Guidelines for determining the percentage of a foreign issuer’s outstanding securities that “are directly or indirectly owned of record by residents of the US:

“Instruction to paragraph (1) of this definition: To determine the percentage of outstanding voting securities held by US residents:

a. Use the method of calculating record ownership in Rule 12g3-2(a) except that your inquiry as to the amount of shares represented by accounts of customers resident in the US may be limited to brokers, dealers, banks and other nominees located in:

i. The US

ii. Your jurisdiction of incorporation; and

iii. The jurisdiction that is the primary trading market for you voting securities

5. Rule 405 & 3b-4 vs. Rule 12g3-2(a)

a. 405 and 3b-4 is narrow than 12g3-2(a)

b. 405 and 3b-4 limits the scope of the inquiry to registered nominees

6. “Foreign Government” Rule 405 ( “the government of any foreign country or of any political subdivision of a foreign country

7. “Foreign issuer” Rule 405 ( “any issuer which is a foreign government, a national of any foreign country or a corporation or other organization incorporated or organized under the laws of any foreign country

Foreign Issuers: Registered Offerings and Disclosure Obligations Under the 1933 Act

1. Introduction

a. Foreign issuer that does not qualify as a foreign private issuer does not enjoy the regulatory benefits

b. Non-foreign private issuers are regulated as if they were a domestic issuer

c. Foreign private issuers are eligible for less stringent regulation under 33 and 34 Act

2. Foreign Private Issuer: Obligations under the 1933 Act

a. Forms:

i. F-1 ( comparable to S-1

ii. F-2 ( comparable to S-2

iii. F-3 ( comparable to S-3

b. SEC has modified the accounting requirement of US GAAP to reduce unreasonable expenses

c. Foreign Private issue must co-sign the Form F-6 registration statement

3. Disclosure Standards

a. SEC has adopted the IOSCO disclosure requirements for foreign issuers ( creates a framework for the “international passport”

b. Standards consist of 10 core disclosure items

Exemptions from the Registration and Prospectus Delivery Requirements

1. Capital Raising Transactions

a. Unregistered securities offerings in domestic transaction by foreign private issuers must be made pursuant to an exemption from §5

b. There are no exemptions designed especially for a private issuer

i. Follow §4(2) or Rule 506 of Regulation D

2. Special Transactions

a. 3 Rules under §3(b) to exempt certain offers and sale of securities by foreign private issuers in 3 special transaction from §5

i. Rule 800

Defines the terms found in 801 and 802

ii. Rule 801

Exempt equity securities issued in rights offerings by foreign private issuers from registration requirement

1. if US security holders own 10% or less of the issuer’s securities that are subject of the rights offering

iii. Rule 802

Exempt securities issued in exchange offers for foreign private issuer’s securities and securities issued in business combinations involving foreign private issuers

1. If US security holders hold 10% or less the subject class of securities

b. Policy

i. To encourage issuers and bidders to extend tender and exchange offers, rights offerings and business combinations to US Security holders of foreign private issuers

ii. All US holders to participate on an equal basis w/ foreign security holders

iii. To eliminate the need for disadvantageous treatment of US investors

§6.04: Resales by Security Holders of Foreign Operating Companies

1. Introduction

a. Depositary Arrangements

b. All resales of foreign securities that are effected w/ jurisdictional means must be tested against the limitations of §5

c. Resales of securities of a foreign private issuer in domestic transactions are subject to the same limitations as resales of securities of domestic issuers in US secondary markets

2. Registration and Prospectus Delivery Requirements

a. Overview

b. Case Study: Daimler-Benz Shares Offering, January 1994

i. Overview

ii. Implications of U.S. Disclosure Obligations

§6.05: Primary Offerings By Foreign Investment Companies

1. SEC Interpretations of §7(d)

a. Only Canadian companies or “investment funds” can register under the 1940 Act

b. Rule 7d-1

i. Canadian investment company may obtain an order pursuant to §7(d)

c. No Canadian foreign company has succeeded in convincing the SEC that it should be permitted to register in light of its “special circumstances and local laws”

2. Offerings by Private Foreign Investment Company

a. 2 problems for Foreign investment company planning to sell shares in US

i. Foreign fund must comply w/ 1940 Act ( serious problem w/ §7d

ii. Registration requirements of the 33 Act

b. The 1940 Act Requirements

i. Foreign investment fund avoids the regulation of §7(d) if it meets the conditions of the subsections of §3(c) of the 1940 Act

ii. §3(c)(1) and §3(c)(7) are the best possible exemption

iii. Problems:

1. Integration ( same as for domestic

2. Exceeding 100 ( Is this domestic or total?

iv. Touche Remnant no action ( can’t have more than 100 beneficial owners in the US

v. Public Offering in §7(d): construed to include an offer by jurisdictional means that results in the shares of a foreign investment company being beneficially owned by more than 100 U.S. residents

1. is not triggered b/c of leakage

2. triggered by activities undertaken by or on behalf of a foreign investment company

c. The 1933 Act Registration Requirements

i. If either type of private investment fund offers its shares in the US it will have to structure the private offering to comply w/ a non-public exemption under the 33 Act

Chapter 7: Primary and Secondary Offerings:

Securities of Domestic or Foreign Issuers in Offshore Transactions

§7.01 Introduction

1. Review: Registration under the 1933 Act

a. 2 assumptions in Chapter 5

i. The 1933 Act applied; and

ii. The SEC and US Courts had subject matter jurisdiction

b. The focus of the Acts

i. 1933 Act ( focused on the transaction

ii. 1934 and 1940 Acts ( on the person’s status

c. 2 basic distinction are reflected in the registration requirements of the 1933 Act

i. Primary vs. Secondary Markets

ii. Public Offerings/Distributions vs. Trading

d. An issuer has 2 choices for complying w/ the registration requirements

i. File a registration w/ the SEC and make a public offering

ii. Structure its securities offering to conform to the requirements of a transaction exemption ( so that it does not resemble a public offering

i.e., §4(2) & Regulation D

e. Secondary Transactions that are distributions:

i. Seller must arrange w/ the issuer for the issuer to file a registration statement for the proposed transaction; or

ii. The seller must structure the resale transaction to qualify under an exemption of §5 by §4(1) ( i.e., Rule 144 and Rule 144A

2. Framework for Discussion

a. This chapter is concerned primarily w/ the extraterritorial aspects of the registration and prospectus-delivery requirements of the 1933 Act

b. Rule 144A

i. Is not necessary if the securities transaction occurs outside the United States

ii. Is important in connection w/ Regulation S and other offshore sales

1. b/c of its practical value to institutional investors in reselling unregistered securities that issuers have privately placed

iii. many securities offering outside the US involve securities which are resold immediately under Rule 144A to institutional buyers located in the US

§7.02 Identifying U.S. Interests in “Foreign” Transactions

1. Policy issues regarding the applicability of §5 arise when issuers offer securities into the primary markets outside the US

2. Whether the issuer has to register its securities or prove an exemption depends on whether the US can demonstrate an interest in what appears to be a foreign transaction

3. Possible US interests in such “foreign” transactions

a. Protecting US investors in primary offerings regardless of the investor’s location

b. Regulating US companies in primary offering regardless of where they sell securities

c. Regulating US trading markets that receive securities that are issued in primary offerings outside the US

i. Especially where those securities carry unusual risks for individuals who are unsophisticated investors

§7.03: Introduction to Regulation S

1. Overview of Regulation S

a. Regulation S clarifies applicability of the registration requirements of 33 Act to offshore transaction

b. B/c of the broad definitional boundaries of “interstate commerce”, the registration requirements could be construed to apply to securities transaction only having a superficial and fleeting nexus w/ the US

c. Regulation S provides both an issuer safe harbor and a resale safe harbor

2. Regulatory Structure Prior to Regulation S

§7.04: Regulation S: Preliminary Notes and General Statement (Rule 901)

1. Application of Regulation S

a. Applies only to the registration requirements of the Securities Act

b. Available for offers and sales of securities issed by a closed-end investment company that is registered under the 1940 Act

2. Policy

a. Regulation S is based on a territorial approach to §5

b. To effectuate this policy, Rule 901 of Regulation S:

i. “For the purpose only of §5 of the Act, the term “offer,” “offer to sell,” “sell,” “sale,” and “offer to buy” shall be deemed not to include offers and sales that occur outside the US”

3. Makeup: Consist of 8 preliminary notes and 4 additional rules

a. Rule 902: Definition section

b. Rule 903: provides and issuer safe harbor

c. Rule 904: provides a resale safe harbor

d. Rule 905: imposes resale limitations w/ respect to equity securities of domestic issuers

4. Limitations

a. Not to anti-fraud, or to state laws, nor to other provisions of the federal securities law

b. Is not available when there is a plan or scheme to evade the registration provisions

c. Not available for offers and sales of securities issued by open-end investment companies or unit investment trust registered or required to be registered

d. No available to non-registered closed-end investment companies required to be registered under the Investment Company Act of 1940

§7.05: Regulation S: General Conditions

Overview

1. Rules 903-04 set forth non-exclusive safe harbors for extraterritorial offers, sales, and resale

a. If a sale satisfies either safe harbor ( it is “outside the US” for 901s

b. Both include conditions designed to protect against indirect, unregistered, non-exempt offerings flowing into the US capital markets

2. 2 general conditions apply to all offers, sales and resales made in reliance of 902/3

a. Requires that the offer or sale must be made in an “offshore transaction”

b. No “directed selling efforts” may be made in the US in connection w/ an offer or sale of securities in reliance on R. 903/4

Offshore transactions

Offshore Transaction requirement has 2 prongs ( both must be satisfied

1. Concerned w/ the Offer

a. No offer can be made to a person in the US

2. Concerned w/ the Sale

a. The buyer be outside of the US at the time the buy order is originated; or

b. Alternative 2:

i. For the issuer safe harbor:

Certain transactions executed in, on, or through a physical trading floor of an established foreign securities exchange

ii. For the resale safe harbor

Certain transaction executed in, on, or through the facilities of a designated offshore securities market

Directed Selling Efforts 902(c)

1. Those activities that could reasonably be expected, or are intended, to condition the market w/ respect to the securities being offered in reliance upon Regulation S

2. Issuer Safe Harbor

a. No directed selling efforts may be made in the US by the issuer, a distributor, any of their respective affiliates, or any person acting on their behalf

3. Resale Safe Harbor

a. This prohibition is limited to directed selling efforts in the US by the seller, its affiliates or any person acting on their behalf

4. 902(c)(3): enumerates specific types of activities that are not directed selling efforts

a. Contacts w/ person (or persons holding accounts) excluded from the definition of “U.S. person”

b. Certain advertisements required to be published under United States or foreign law

c. Certain tombstone advertisements

d. Bona fide visits to real estate, plants, or other facilities located in the US

5. Rule 902(c)(1-2) defines Directed selling efforts

6. Legitimate selling activities carried out in the US w/ a registered/exempted offering won’t constitute selling efforts for offers/sale under Reg. S.

§7.06: Rule 903 of Regulation S: The Issuer Safe Harbor

Introduction

1. Applies to offers and sales by issuers, distributors and their respective affiliates and person acting on any of their behalf

2. Includes 3 distinct categories

w/ criteria such as:

a. Nationality and reporting status of the issuer

b. Type of security to be sold

c. Degree of US market interest in the issuer’s securities

3. Each category is matched w/ varying procedural safeguards

a. Amount of procedural safeguards depends on the risk of “flowback” into the US

b. The safeguards become more onerous as from Category 1 to 2 to 3

Issuer Category I

1. Overview

a. Imposes no additional conditions on the offering

b. Types of securities

i. Securities of a “foreign issuer” w/ no “substantial U.S. market interest

ii. Securities offered and sold in an “overseas directed offering”

iii. Securities backed by the full faith and credit of a “foreign government”

and

iv. Securities offered and sold pursuant to certain employee benefit plan

c. Can sell to US investors who are overseas at the time

i. Must be sure to not target them

ii. If the SEC determines that there is a scheme ( where these US persons essentially become underwriters ( won’t be able to rely on this

2. Important Terms:

a. “Substantial U.S. market interest” ( Rule 902(j)

i. aka: SUSMI

ii. Measurements can be difficult ( permits an issuer to rely upon its reasonable belief as to their existence

iii. May depend on whether the securities are debt or equity securities

c. Debt securities: Rule 902(a)

d. Warrants (where issued) are measured by the level of market interest in the securities to be purchased upon exercise of the warrants

e. Convertible securities are generally treated as the security into which they are convertible

f. “overseas directed offering” ( defined in 903(b)(1)(ii)

i. includes 2 classes of securities offerings

1. “offerings of securities of foreign issuers directed to residents of a single country other than the US, made in accordance w/ local laws, and customary practices and documentation of that country; and

2. offerings of non-convertible debt securities, asset-backed securities and non-participating preferred stock of domestic issuers directed to residents of a single foreign country, provided the principal and interest of the securities are denominated in a currency other than the US dollars

ii. directed at a single country is key

1. cannot know or believe that a substantial portion will be sold or resold outside of that country ( loses the safe harbor

Issuer Category II

1. Overview

a. Securities encompassed here are:

i. debt securities of a domestic reporting issuer

ii. equity securities of a foreign reporting issuer w/ a substantial U.S. market interest

iii. debt securities of a non-reporting foreign issuer;

and

iv. convertible debt of a foreign reporting issuer

b. 1998 amendments moved domestic equity securities of reporting issuers from Category 2 to Category 3

c. Must still meet the conditions found in category one and specified selling restrictions: “transaction restrictions” and “offering restrictions”

2. Transaction Restrictions

a. Limitations applicable during the “distribution compliance period”

i. Restrictions applied to the issuer, distributors, affiliates and their agents

ii. Securities (sold under Category 2) cannot be offered or sold to or for the benefit or account of a U.S. person

iii. must advise the purchaser that he is subject to the same limitations

3. “distribution compliance period” ( defined in 902(f)

a. 40 day period

4. “U.S. persons” as defined in 902(k) is critical

a. Residency rather than citizenship drives the definition

b. Place of incorporation/organizations determines whether business organizations are US persons

c. Entity organized under foreign laws by a U.S. person for the principal purpose of investing in unregistered securities is US person

i. Unless it is owned and organized by accredited persons who are not natural persons, estates or trust

d. Trusts and Estates are generally US persons if any trustee, executor or administrator is US person

i. Unless

1. Non-U.S. person executor or administrator has sole or shared investment discretion w/ respect to the estate assets and

2. The estate is governed by foreign law

e. Branches and agencies of a foreign entity located in the US are deemed US person

f. Branches and agencies of US banks and insurance companies are not US persons if:

i. They are located outside the US; and

ii. They operate for valid business reasons under substantive local banking or insurance regulation

5. Offering Restrictions

a. Procedures that ensure compliance w/ the transaction restrictions and must be adopted w/ regard to the entire offering by the issuer

b. Safe harbor can be destroyed for all parties if offering restrictions aren’t complied w/

c. Restrictions

i. Each distributor must agree in writing that:

1. all of its offers & sales will be made in accordance w/ safe harbor

2. or pursuant to registration or an exemption under Securities Act

ii. Certain material connected w/ the offering must disclose

1. That the securities have not been registered and

2. May not be offered or sold in the US or to a US person (other than a distributor)

a. Unless registered or exempt from registration

Issuer Category III

1. Introduction:

a. Contemplates that little information is available to the market about the issuer and its securities

b. Includes

i. equity securities of a reporting domestic issuer

ii. equity securities of a non-reporting domestic issuer

iii. debt securities of a non-reporting domestic issuer

iv. equity securities of a non-reporting foreign issuer w/ a substantial U.S. market interests (SUSMI) in its equity securities

v. convertible debt securities of a domestic issuers

vi. convertible debt of a non-reporting foreign issuer w/ SUSMI in it convertible debt

d. Most restrictive category ( includes all of the previous restrictions w/ additions

i. Additions vary depending on the characteristics of the securities to be offered in a particular offshore transaction

e. Has a one-year distribution compliance period

i. not applicable to the straight debt securities

ii. Includes convertible debt securities of a domestic issuer and convertible debt of a non-reporting foreign issuer, where SUSMI is present

2. Transaction Restrictions

a. Equity Securities ( Rule 902

i. Rule 405 of Regulation C controls here

1. Includes stock, securities convertible or exchangeable into stock, warrants, options, rights to purchase stock and other types of equity-related securities

ii. 2 traditional types of equity securities are subject to a distribution compliance of 40 days ( treated as debt

1. Certain non-convertible non-participating preferred stock

2. Asset-backed securities

iii. Rule 903(b)(3)(iii) imposes 4 restrictions on equity securities in Category 3 that are not imposed on debt securities

(Safe harbor is conditioned on compliance w/ each of these)

1. Purchaser Certification (not referring to a distributor)

a. Purchaser must certify that it is not a US person

b. Purchaser must certify that it is not acquiring the securities for the “count or benefit of any US person”

i. Other than person who purchased securities in transaction exempt from the registration of 33 Act

2. Purchaser Agreements

a. Each purchaser is required to agree to resell the securities in accordance w/ Regulation S, the registration requirements or pursuant an exemption

b. Agree to not “engage in hedging transactions”

3. Legends

a. Applies only to Category 3 equity securities of domestic issuers

b. The legend on the security must advise

i. The transfer of such securities is prohibited other than in accordance w/ Regulation S . . .

ii. Hedging transactions must be conducted in compliance w/ the 33 Act

4. Stop Transfer Instructions

a. An issuer of Category 3 equity securities must bind itself by k or through its articles of incorporation/bylaws/charter to refuse to register any transfer of equity securities not made in accordance w/ the registration or exemption provision of the 33 Ac or regulation S

b. Debt Securities ( Defined in 902(a)

i. 903(b) imposes 2 transaction restrictions limited to debt securities

1. Those not included in Category 3 must be represented by a temporary global security that is not exchangeable for definitive securities until the 40 day compliance expires

a. For persons other than the distributor the global security must remain in place until certification of beneficial ownership by a non-US person or by a US person who purchased securities in a transaction that did not require registration under the act

2. Relates to guaranteed debt: Rule 903(b)(4)

a. When the guarantees and the guaranteed securities fall into different issuer safe harbor categories

c. Equity or Debt Securities

i. Rule 903(b) provides 2 transaction restrictions

(applicable to any type of security included in category 3)

1. Relates to the resale of category 3 securities that are made prior to the expiration of the applicable distribution compliance period

2. Any offer or sale of a debt or equity security included in category 3 must not be made to a US person or the account or benefit of a US person during the 40 day compliance period

ii. Pertains to distributors ( defined in 902(b)

1. During compliance period, distributor must notify all purchasers that they are subject to the same restrictions during the compliance period

d. Offering Restrictions

i. All securities in category 3 are subject to offering restrictions (902(g))Issuer must implement the restrictions to enjoy the Rule 903 safe harbor

1. identical to those that apply to securities in category 2

The Presence “Offshore” Transactions of Persons

1. Introduction

a. Issuer Safe Harbor is designed to ensure that offers/sales of unregistered securities take place outside the US

b. R. 903 doesn’t sever all transaction-related activities w/ persons w/ US

i. Domestic companies making offers outside the US

ii. Participation of US bankers, lawyers, etc

c. To understand when the rule is applicable despite a US presence ( need to understand the 3 concepts embodied w/ R. 903

i. Person in US ( R. 903(a)(1)

ii. US Citizen ( R. 902(h)(2)

iii. US Person ( R. 902(k)

1. Has significance when the issuer falls w/in category 2 or 3

2. Practical problems

a. Offers and sales to made to persons who are US citizens who are residents of a country other than the US where the issuer is offering its securities

i. These persons fall outside the definition of US person w/in 902(k)(1)(i)

1. Not a resident of the US at the time of the offer and sale

ii. There is still a problem if the issuer targets these groups of US citizens

b. Offers/sales made to persons who are US citizens but who are away from their domestic home traveling offshore in the country where issuer is offering its securities

i. These are persons w/ in US person as defined in Rule 902(k)(1)(i)

ii. 2 potential problems

1. the issuer may not target offers and sales to groups of these persons

2. offers/sales of securities included in category 2 or 3 are subject to limitations during the applicable distribution compliance period

iii. Only Category 1 issuers can offer and sell securities to these person

1. Still can not target them

c. Offers and sales to persons who are not US citizens but who are residents of the US and who might be present here at the time of the transaction

i. 2 problems

1. This is not an offshore transaction

a. Unless it is specifically exempted in 902(h)(3)

b. Offers/sales can’t be made to a person in the US, regardless of that person’s status ( Rule 902(h)(1)

2. These persons are residents of the US and fall w/in the definition of US person in Rule 902(k)(1)(i)

a. Even if they are traveling outside the US at that time

d. Offers and sales to persons who are neither US citizens nor residents of this country but who are traveling in the US at the time of the transactions

i. Neither the purchasers nor the offerees are “US person”

ii. Problem:

1. These persons are in the US at the time offers and sales are made

2. Not offshore ( can’t use Regulation S

§7.07: Rule 904 of Regulation S: Resale Safe Harbor

Overview

1. Provides an outlet for certain person wanting to resell securities obtained from a Category 2 or 3 issuer

2. Provides a safe harbor to eligible persons for resales of securities acquired in other types of transactions

3. 2 conditions

a. Offshore Transaction

b. No directed selling efforts can be made in the US

4. Applies to resales by persons other than the issuer, a distributor, their respective affiliates and persons acting on behalf of any foreign persons

5. Available to certain officers and directors of issuers and distributors

a. May rely on Rule 904 if they are affiliates solely by virtue of holding a position as an officer or director and no selling concession, fee to other remuneration is paid in connection w/ the offer or sale other than a usual customary broker’s commission

6. Securities offered in a distribution by the issuer could not be resold under Rule 904 by an officer or director during the distribution or during any applicable distribution period

7. Securities professionals

a. must satisfy requirements in addition the 2 general conditions

i. when the offer or sale is made prior to the expiration of an applicable distribution compliance period and

ii. the securities are not in Category 1

b. Additional requirements for securities professionals

i. The seller nor any person acting on its behalf knows that the offeree or buyer of the securities is a US person

ii. Where the seller or any person acting on its behalf knows that the purchaser is a securities professional , a confirmation containing appropriate restrictive language must be sent to the purchaser

8. Resale safe harbor is available whether or not the securities were acquired in an offshore transaction

a. Permiting its use for the resale of restricted securities originally acquired in a private placement under Regulation D or §4(2) or for securities acquired in a Rule 144A transaction

9. Resales pursuant to rule 904 of securities that were originally privately placed will not destroy an otherwise valid private placement exemption relied upon by the issuer

10. Commission protects the safe harbor seller from other’s actions

a. It is unaffected by the actions of the issuer, distributor, their respective affiliates or persons acting on behalf of any of the foregoing

b. The seller doesn’t have to worry if the distributor violates the prohibition on the directed selling efforts, etc

c. This protection is voided if the Commission finds that there is an ongoing scheme to circumvent the regulations

Potential Abuses Under Regulation S

1. Introduction ( review

a. Rule 903

b. imposes transaction restrictions in connection w/ the offer and sale of certain securities under Regulation S

i. Places limitations on these securities

c. Rule 904

i. provides a resale safe harbor to certain persons during the distribution compliance periods

1. Apply to securities in Category 2 and Category 3 of Rule 903

ii. Not the sole exemption for resell of Regulation S acquired securities wanting to be resold during the compliance period

1. Rule 144A is also available

a. Such resales must be made into the US private resale market in accordance w/ the requirements of Rule 144A

2. Rule 903 Abuses

a. Flagrant cases of abuse involve preconceived 2-step distributions of unregistered securities into the US secondary markets

b. Usually involve the publication of materially misleading information that is designed to pump-up

i. the market price of the issuer’s stock and

ii. the willing participation of many persons not directly associated w/ the issuer

c. 1st group of necessary assistants ( the foreign “purchasers” of unregistered securities in offshore transactions

i. these person quickly resell the securities into the US and remit a sizeable percentage of the proceeds to the issuer or an affiliate

d. 2nd group of players ( US brokerage firms that cooperate w/ the issuer

i. they promote the stock and

ii. assist the foreign purchasers in liquidating the unregistered stock in the US

iii. they are compensated directly or indirectly

e. Problems arise b/c Rule 903 permits an issuer to offer and sell unregistered securities to foreign investors w/out any notice to the SEC or the public

i. when these securities are the same class as equities trading in the US securities market there is a devaluation of domestic investors’ shares

1. the dilutive effect occurs after the foreign purchasers resold back into the US secondary markets

ii. In 1996, SEC started requiring companies to report unregistered equity sales ( including those made in reliance of Regulation S

f. Another problem occurs when the issuer essentially makes a single public offering of unregistered securities to US purchasers but through foreign intermediaries

i. The initial offering appears to go the intermediaries, but these persons immediately resell the securities back into the US

ii. The addition of Rule 905 should help alleviate some of these abuses

3. Rule 904 Abuses

a. SEC found that the company could not claim rule 904

i. SEC indicated that the shares were bought for distribution purposes rather than for investing purposes ( violating the exemption

1. B/c large quantity bought and then all resold into the open market

2. The overall actions indicated the intent to distribute

b. Rule 904 cannot be used for the purpose of “washing off” resale restrictions

i. cannot use it to get around the holding period requirement for restricted securities in Rule 144(d)

ii. the restricted status of securities is not affected by a prearranged transaction by or on behalf of the sale conducted offshore

1. Restricted securities sold offshore ( the replacement securities are subject to the same restrictions as those replaced

Rule 905

1. Announces 3 important limitations on resales

a. Equity securities of domestic issuers that are acquired from the issuer, a distributor, or any of their respective affiliates in a transaction subject to Regulation S are “restricted securities” as defined in Rule 144(a)(3)

b. States that any resales of domestic equity securities, acquired in a transaction subject to the conditions of Rule 901 and 903, must be made in accordance w/ Regulation S, registration under the 1933 Act, or pursuant to an exemption

c. Provides that any equity securities of a domestic issuer that are deemed “restricted securities” w/in the meaning of Rule 144(a)(3), “will continue to be deemed to be restricted securities, notw/standing that they are acquired in a resale transaction made pursuant to Rule 901 or Rule 904

i. clarifies that the resale of restricted securities offshore under Rule 904 does not “wash off” the restricted status of those securities to allow them to be freely resold into the US by the purchaser

2. Has no application to equity securities of a domestic issuer which the prospective seller acquired under circumstances other than those referred to in the Rule

3. Is limited to equity securities of domestic issuers

a. Allows securities to be sold in US and then resold back to foreign issuer’s country w/out restrictions

The Limits of Rule 904: Categories of Resale Transactions

1. Resales Outside the US

a. 904 provides a safe harbor for eligible sellers w/out regard to where the securities were originally acquired

b. Types of offerings that eligible sellers can claim the safe harbor

i. a registered public offering

ii. an offering exempted from the registration requirements of §5

iii. an offering that complied w/ the requirements of Rule 903 or Rule 904

iv. an offshore offering that does not violate §5 but does not satisfy the requirements of Regulations S, or

v. an offering that violates §5

c. Permits resale of Cat. 2/3 securities during distribution period (to eligible sellers)

d. 904 imposes special obligations on 2 categories of persons who are eligible to claim the safe harbor

i. Consists of any officer or director of the issuer,, any officer or director of a distributor, who is an affiliate solely by virtue of holding such position

1. These persons who offer or sell securities must be sure that “no selling concession, fee or other remuneration is paid in connection w/ such offer or sale other than the usual and customary broker’s commission that would be received by a person executing such transaction as agent.” ( Found in 904(b)(2)

ii. Consists of dealers and other persons who make offers or sales of securities prior to the expiration of the distribution compliance period specified in Category 3 or 3; and who receive a selling commission, fee, or other remuneration w/ respect to the securities offered or sold ( 904(b)(1)(i)

1. necessary that neither the seller nor any person acting on its behalf know that the offeree or buyer of the securities is a US person

2. if f the seller, etc knows that the purchase is a dealer or is a person receiving a selling concession, fee or other remuneration, then the seller, etc must send a confirmation or notice

a. that states that the securities may be offered and sold during the distribution compliance period only in accordance w/ the provisions of Regulation S, pursuant to registration under the 1933 Act or pursuant to an exemption form the registration requirements of the 1933 Act

2. Resales w/in the US

• 904 doesn’t provide protection to resale in US

• What isn’t clear under Regulation S is the impact that Reg S has on persons who acquire securities in an offshore transaction and then wish to offer/sell the securities in the US

a. Resales of Securities Sold Offshore in Reliance upon Rule 903

i. Persons who acquire securities from the issuer, etc in a R. 903 transaction are able to resell those securities immediately w/in US

ii. Securities that are sold offshore pursuant to R. 902 or 903 might be subject to resale limitations during the distribution compliance period

1. When these are equity securities of a domestic issuer they are “restricted securities”

a. To resell, must find exemption or have them registered

iii. Person offshore who owns securities sold pursuant to R. 903 and who intends to resell them w/in the US w/o registration is likely to rely on R. 144 or 144A

1. If these were equity secuirites of a domestic issuer: must remember holding period requirement of 144(d)(1)

2. Also be leery of the commencement of the holding period

b. Resales of Securities Sold offshore in Reliance upon Rule 904

i. Sales made under 904 do not obliterate the legal status

ii. So, restricted secuirites of a domestic issuer still must be sold under registration or an exemption

c. Resales of Securities sold offshore not in compliance w/ Regulation S

i. Securities are always sold: Registered, Under an exemption, or Illegal

§7.08 Contemporaneous US Offerings and Regulation S Offerings – in general: No Integration

1. Overview

a. Territorial Policy approach

i. “Principles of comity and the reasonable expectations of participants in the global markets justify reliance on laws applicable in jurisdictions outside the US to define requirements for transactions effected offshore”

ii. “As investors choose their markets, they choose the laws and regulations applicable in such markets”

b. Offerings that Satisfy the conditions of Regulation S are independent of any offers/sales of securities w/in the US

i. The are not integrated w/ its contemporaneous domestic offers/sale

2. Special Problems: Offerings by Foreign Funds

a. §3(c)(1) and (&) of the 1940 Act exempt certain foreign funds from the definition of an investment company

i. both are dependent on the foreign funds not making a public offering in US

b. Regulation S is available to funds that are not required to register under the 1940 Act

c. Whether a public offering outside of the US by a foreign fund relying upon either 3(c)(1) or 3(c)(7) for an exemption under the 1940 Act will be integrated w/ a private placement inside the United States where the offshore offering is conducted in compliance w/ regulation S

i. Generally not integrated

ii. Qualification

1. shares sold to a US resident beneficial owner in a transaction outside the US count towards the 100 person limit

d. “10 Commandments” don’t implicate §7(d)

III. IMPACT OF SECURITIES EXCHANGE ACT OF 1934 ON DISCLOSURE TO TRADING MARKETS BY CERTAIN ISSUERS AND KEY PERSONS

CHAPTER 8: Mandatory Disclosure: Securities of Domestic Issuers

§8.02: Securities Exchange Act of 1934: Introduction to Company Disclosure

Overview and Purpose of Continuous Disclosure

1. Mandatory Disclosure

a. The philosophy is part of the theoretical underpinning for the regulation under the Securities Act of 1933

b. Practical definition of the philosophy

i. Prospective purchasers of securities in registered public offers are given disclosure material to enable them to make an intelligent investment decision about the issuer and the securities that are being offered for sale

2. Purpose of the 1934 Act

a. Remedy several problems in the domestic capital market

b. Remedy the lack of information that is available

i. Companies doing business in interstate commerce, achieving significant asset size and having a large number shareholder w/o having to file registration

Basic Distinctions

1. Categories of Issuers

a. Registered Companies

i. Required to register under §12 of the Exchange Act

ii. Make periodic filing w/ SEC pursuant to §13

iii. Subject to special regulation w/ solicitation of proxies ( §14(a)

iv. Certain persons face federal regulation under §13 and §16

b. Reporting Companies

i. May or may not be registered

ii. Subject to §15(d)

c. Registered and Unregistered companies

d. Reporting and Non-reporting companies

2. Categories of Securities and Security Holders

a. “Security”

i. §3(a)(10): covers both debt and equity security

1. Nearly same definition as in the 33 Act

ii. Part of the Act only refers to certain equities ( careful to apply the appropriate statutory or administrative definition

1. §14(a) ( “any security”

2. §13(d) ( “any equity security”

3. §12(g)(1) ( “a class of equity security”

4. §14(d) and 16 ( “any class of any equity security”

b. Beneficial and Legal owners

i. Distinction is important in interpreting the requirements of certain sections of the act

1. “held of record” (§12(g)(1) & §15(d) ( legal owner

2. “beneficial owner” ( §13(d)(1) & §16(a)

3.

3. Categories of Registration

a. “Registration”: has different meaning in each federal securities regulations and sometimes different meanings w/in the same statute

b. 34 Act imposes registration requirements on different persons for different reasons

i. Broker dealers ( §15

ii. National Securities Exchanges ( §6

iii. Securities Information Processors ( §11A

iv. Securities Associations ( 15A

v. Government Securities Brokers and Dealer ( §15C

vi. Clearing Agencies and Transfer Agents ( §17A

vii. For certain Issuers ( §12

a. Integrated Disclosure System

i. Integrated areas of the registration requirements of both the 33 and 34 Act

ii. Allows “registered companies” (§12) who intend to make a registered offering under the 33 Act to use simplified registration form

1. Permits these companies to incorporate by reference

iii. Part of the Efficient Capital Market Hypothesis

b. Registration under the 34 Act does not change the character of its previously issued shares as “restricted shares”

§8.02: Registration for Securities of Certain Issuers

Triggering Events

1. There are 3 reasons why a company might registered under the 1934 Act

a. 2 are mandatory

b. 1 is voluntary

2. Mandatory Registration

a. §12(b)

i. Listing on the national securities exchange triggers registration

ii. Relates to §12(a): “unlawful for any securities professional to effect purchases or sales of a company’s securities on a national securities exchange unless a registration is in effect as to that security on the exchange”

b. §12(g)(1)

i. The issuer’s size triggers registration

ii. Determination is made at the end of the issuer’s fiscal year

iii. Has to register if it meets 3 criteria

1. Issuer is “engaged in interstate business, or in a business affecting interstate commerce”

2. Issuer has total assets greater than $10 million

3. Issuer has 500 or more record owners of a class of equity securities

iv. Doesn’t apply to any security that has already been registered under §12(b)

c. Voluntary Registration

i. §12(g)(1): “may register any class of equity security not required to register”

ii. Companies often register in order to trade on NASDAQ or the OTCBB

Registration Statement

1. All registered – voluntary/involuntary – must file Form 10 registration statement w/ SEC

2. Technical differences exist between registration filings and effectiveness under §12(b) and 12(g)(1) ( substantially the same

a. §12(b)

i. issuer files and application w/ exchange and files duplicate copies w/ SEC

ii. If exchange certifies to SEC that the issuer’s security is approved ( registration is effective w/in 30 days or less

b. §12(g)(1)

i. registration is effective w/in 60 days or less

§8.03: Significance of §12 Registration: Domestic Companies

Consequences for Domestic Issuer

(some of the special obligations not found in the law of the incorporated state)

1. Domestic Issuers must be concerned w/

a. Periodic reporting under §13(a)

b. Compliance w/ the SEC proxy rules in connection w/ the solicitation of proxies from shareholders under §14(a); and

c. Reports for its issuers under §16(a)

1. Independent Public Auditor

a. Independent auditor is part of the fulfillment in following GAAP

b. Set forth in Regulation S-X

c. Policy Reasons

i. Efficient market and pricing

1. Encourage investors: info is martierally accurate, fair and complete

ii. “Gatekeeper” to the public securities ( SEC can’t phsycially view all docs

d. “Public Trust standard”

i. Ultimate allegiance belongs to the investing public & creditors/stockholders

e. Sarbanes-Oxley Act of 2002

i. Goal is to strengthen the auditor’s independence

f. Scope of the Auditor ( §202 of Sarbanes-Oxley

i. requires that the audit committee of a registered issuer approve in advance all audit and non-audit services to be provided to the issuer

g. Prohibited Non-Audit Services ( §2(a)(8) of Sarbanes-Oxley defines non-audit

i. “any professional services provided to an issuer by a registered public accounting firm, other than those provided to an issuer in connection with an audit or a review of the financial statements of an issuer”

ii. §201 of Sarbanes-Oxley prohibits accounting firms from providing a variety of “non-audit services”

iii. Specific Prohibitions:

1. Bookkeeping or other services related to accounting records or financial statements of the audit client

2. Financial information systems design and implementation

3. Appraisal or valuation services, fairness opinions, or contribution-in-kind reports

4. Actuarial services

5. Internal audit outsourcing services

6. Management functions or human resources

7. Broker-dealer, investment adviser, or investment banking services

8. Legal services and expert services that are unrelated to the audit

9. Public Company Accounting Oversight Board may prohibit other non-audit services ( Authorized in §201

iv. Those non-audit functions that are performed must be approved in advanced and disclosed to investors in a Form 10-Q or Form 10-K report

h. Mandatory Disqualification and Rotation

i. §206 ( attempt to close the “revolving door”

1. Prohibits an accounting firm from auditing any public company whose CEO, CFO, controller, Chief accounting officer (etc) who worked at the accounting firm within the past year

ii. §204

1. Auditors must rotate the partner with primary responsibility for conducting the audit at least every five years

2. Mandatory Periodic Disclosure in Filings with the SEC

a. Policy

i. The periodic disclosures of §13 are at the heart of a legislative effort to create a continuous disclosure system for issuers that have a national presence

1. §13(a)(1) and (2) (indicate generally the type of info required of §12 registrants

b. Periodic disclosures

consist of the following reports

i. quarterly reports on Form 10-Q

1. Required by Rule 13a-13

2. Item 2: Specifies that the issuer must include the MD&A disclosures required by Item 303 Regulation S-K

3. Items 3 and 4: Require quantitative and qualitative disclosures about market risk and about certain internal controls and procedures

4. Form must be filed with the SEC “within 45 days after the end of each of the first 3 fiscal quarters of each fiscal year

ii. annual report on Form 10-K

1. Rule 13a-1 requires a §12 company to file an annual report with the SEC on form 10-K

2. Annual reports on Form 10-K must be filed with the SEC by accelerated filers within 75 days after the end of the fiscal year covered by the report ( Rule 12-b2:

3. Contains detailed disclosures about the issuer’s business operations

iii. Current reports on Form 8-K ( Required by Rule 13a-11

1. this has changed: no current info

c. Regulation 13A ( Consists of Rule 13a-1 through Rule 13b2-2

i. Contains specialized disclosure forms that supplement the statutory provisions

d. §§12 company that has a security registered on a national securities exchange

i. must file duplicate originals of those reports with the exchange

ii. The report is intended to provide disclosure about important “current” information that should not wait to be disclosed publicly until the next quarterly or annual report

iii. Information that must be filed with the SEC within 15 calendar days after the occurrence of the event

e. Sarbanes Act of 2002

i. Provides for enhanced financial disclosure that impacts public companies

ii. Key aspects of these enhancements involve the following:

1. Enhanced disclosure of pro form financial measures ( §401

2. Enhanced disclosure of off-balance sheet arrangements and contractual obligations and contingent liabilities ( §401

3. Prohibition of loans to executive officers and directors, subject to limited exceptions ( §402

4. Accelerated reporting of insider transaction on Form 4 under §16 of the 1934 Act ( §403

5. Annual reports required to contain an internal control report ( §404

6. Required disclosures as to adoption of a code of ethics and whether the audit committee includes at least one “audit committee financial expert” ( §§406,407

7. Mandated SEC review of public filings once every 3 years ( §408

8. Required disclosure by issuers “on a rapid and current basis” of information concerning material changes in their financial conditions and operations ( §409

3. Regulation of Proxy Solicitation

a. The form and use of proxies by a record shareholder to vote at a shareholder’s meeting is a matter of state corporate law

b. public companies that are registered under §12 must comply with both state law and with the SEC’s proxy rules in order to solicit proxies in connection with regular or special meetings of the shareholders

i. §14(a) makes it unlawful for any person “in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of the investors, to solicit or to permit the use of his name to solicit any proxy or consent or authorization” in respect of any security registered under the 1934 Act

c. §14(a): was designed by congress to prevent management or others from “obtaining authorization for corporate action by means of deceptive or inadequate disclosure in proxy solicitation”

d. Sen.Rep. No 1455, 73d Cong., 2d Sess., 77 (1934)

i. States that “the rules and regulations promulgated by the Commission will protect investors from promiscuous solicitation of their proxies, on the one hand by irresponsible outsiders seeking to wrest control of a corporation away from honest and conscientious corporate officials; and on the other hand by unscrupulous corporate officials seeking to retain control of the management by concealing or distorting facts.”

e. Regulation 14A

i. consist of rules 14a-1 through 14b-2

ii. Regulates the solicitation of proxies with respect to securities registered under §12 of the 34 Act

f. Rule 14a-3

i. regulates the information to be furnished to security holders

ii. requires the issuer intending to solicit proxies for a shareholders meeting to provide the shareholders, prior to the meeting, with a written proxy statement containing all of the information specified in Schedule 14A

iii. states that if the solicitation is made on behalf of the issuer and relates to an annual meeting of security holders, each proxy statement must be accompanied by or preceded by an annual report to shareholders ( §14(b)

g. Rule 14a-4

i. Sets out the requirements for the form of proxy that is furnished to shareholders to use in expressing their choices

h. Rule 14a-8

i. Describes the circumstances where shareholders of a registered company may force the company to include shareholder proposals in the company’s proxy statement.

i. Rule 14a-9

i. Contains a special anti-fraud regulation

ii. Provides an important remedy to shareholders if issuers use false or materially misleading information in connection with the solicitation of their proxies

iii. Because the Supreme Courts decided the§14a gives shareholders an implied private cause of action against the company and , maybe other persons as well, for damages and other appropriate relief

1. J.I. Case Co. v. Borak, 377 U.S. 426 (1964)

4. Corporate Governance

a. Sarbanes-Oxley Act of 2002

i. Forced public companies to face new obligations under the rubric of “corporate governance” or “corporate responsibility”

b. Summary of the new obligations

i. Companies with securities listed on a national stock exchange must have fully independent audit committees to hire and supervise the company’s outside auditor ( Sarbanes-Oxley Act, §301

ii. CEO and CFO must certify financial reports filed with the SEC ( §302

iii. Directors and officers are prohibited from fraudulently influencing any audit ( §303

iv. CEO and CFO must disgorge compensation following a restatement of financial statements ( §304

v. A lower standard for SEC-sanctions barring offers and directors from public corporate positions ( §305

vi. Insiders are prohibited from engaging in certain securities transaction during blackout periods under pension funds ( §306

vii. Enhanced responsibilities for corporate attorneys requiring lawyers to report evidence of violations of law and breaches of fiduciary duty to the issuer ( §307

5. Regulation of Tender Offers for Issuer’s Securities

a. A person can gain control of an issuer in many ways

i.e.,

i. The person enters into an agreement with the issuer for a business acquisition, agreeing with management of the issuer for that person to purchase all of the issuer’s business assets and to assume all of its liabilities in return for cash or stock of the acquiring person

ii. Offer cash to shareholders who tender their shares of purchase to the person willing to pay paying a premium for their shares

1. This bypasses management all together

2. This arrangement is known as a cash tender offer

b. §14(d) of the 34 Act, together with §13(d) were added by the Williams Act amendments to the Exchange Act in 1968

i. These were meant to regulate cash tender offers for any class of equity security that is registered under §12 of the Act

c. §14(d), and the SEC’s tender offer rules that are adopted pursuant to §14(d) and (e), require the tender offeror, or bidder, to provide disclosure to the shareholders of the target company in connection with the tender offer

i. These disclosure obligations are included in Schedule 14D-1

ii. The tender offer rules regulate the timing and duration of a tender offer

1. §§149(d)(5) and 14(d)(6); Ruled 14d-8 and 14e-1

iii. The target company, whose class of equity security registered under §12 is the subject of the tender offer, is also subject to §14(d)

d. Rule 14-d

i. states that any person who solicits or makes a recommendation to shareholders in respect of a tender offer must file a Schedule 14D-9

1. Which must disclose

2. any conflicts of interest and

3. any recent or pending negotiations and

4. tractions relating to the takeover bid in which the target company is engaged

e. Rule 14e-2

i. Requires that the target is required, no later than 10 business days from the date of the tender offer is first sent or published, to give its security holders a statement disclosing management’s position of the tender offer

ii. Means that the target company cannot avoid filing a Schedule 14D-9

iii. Management of the target company must state whether it recommends acceptance, rejection or is unable to take a position and

iv. it must include a reason for that position

6. Scrutiny by SEC, SROs, Independent Auditory and Market Professionals

a. Most issuers with securities that are registered under §12 are companies with a public trading market for their shares.

b. Public companies are subject to constant scrutiny by a variety of person

i. regular contact between 34 Act reporting companies and the SEC increases the incidents of administrative oversight and examination

c. Once a company is registered under §12 of the 34 Act, it enters the continuous disclosure system that requires it to file information with the SEC on a regular basis

d. Where the SEC staff suspects that a registered company has violated or is likely to violate any provision of the 34 Act, it can take one or more steps to protect the investing public

i. §12(k): The SEC can temporarily suspend trading in the securities of a registered company

ii. §21: SEC can commence an investigation

iii. §21B: Allows administrative actions that can result in civil remedies

iv. §21A: Allows for civil penalties in a federal court in situations where the Commission suspects insider trading

e. Issuers with a security registered pursuant to §12(b)

i. face additional regulations by the self regulatory organization (SRO) on which their securities trade

ii. The listing agreement between the issuer and that stock exchange sets forth conditions of listing

f. NYSE Listed Company Manual

i. The comprehensive rulebook for listed companies

ii. Details original and continued listing requirements of the Exchangse and

iii. sets forth NYSE rules and policies on such matters as corporate governance, shareholder communications and shareholder approval

g. NASDR

i. SRO responsible for supervising issuers with securities trading on NASDAQ or the Bulletin Board

ii. imposes regulations on companies whose securities trade on these markets and may discipline companies that fail to meet their contractual obligations

h. Public companies also face scrutiny from their own outside auditors

i. §10A added by Congress in the Securities Litigation Reform Act of 1995

1. Introduces a requirement that auditors of public companies include procedures to

a. detect illegal acts and

b. report those acts that come to their attention to the registrant’s management and

2. The outside auditor must also:

a. ensure that the audit committee of the registrant’s board of directors is aware of the activity

b. If the auditors determines management has not taken appropriate remedial actions, then must make a report to the board of directors and the board is required to notify the SEC

3. If the independent auditor fails to comply w/ requirements of §10A

a. Can result in administrative or civil action by the SEC

ii. Play a role in the preparation of quarterly reports on Form 10-Q

1. Must review the companies’ financial information prior to the companies filing their quarterly reports on Forms 10-Q or form 10-QSB with the commission

2. In the proxy statements to shareholders, companies must disclose:

a. Certain information about the audit committee

b. Reports from their audit committee containing certain disclosures

3. Policy:

to improve disclosure related to the functioning of corporate audit committees and to enhance the reliability and credibility of the financial statements of public companies

i. Investors: using the disclosure system for registered issuers for investment decision-making

i. Disclosures impact the trading market price of their securities

ii. Disclosures can prompt inquires to the issuer’s investors relations personnel

iii. Provides investors enough information to pursue any possible remedies for alleged wrongdoing

j. Remedies to eligible shareholders of register companies

i. Civil actions for fraud: §10(b) and Rule 10b-5

ii. Claims of misrepresentations in connection with the filing of reports under the 34 Act ( §18

iii. Solicitation of proxies ( Rule 14a-9

iv. Tender offers ( §14(e) and its rules

v. Claims of insider trading ( §16(b) or §20A

k. Examination by market professionals

(i.e., investment analysts, money manager and financial journalists)

iv. Looking for important information about a particular company

v. Information can end up helping or hurting the trading price of securities

1. Now subject to Regulation FD

l. Regulation FD (Fair disclosure)

i. Adopted in August 2000

ii. An attempt to level the playing field for interested persons seeking access to important non-public information

iii. POLICY:

1. Full & Fair disclosure = cornerstone of the federal securities laws

2. Promote disclosure of ‘honest, complete and correct information’

3. to facilitate the operation of fair and efficient markets=

4. FD was a way to help level out the playing field

5. FD is intended to allow the information to come out all across without the previous discrimination

6. Selective disclosure has an adverse impact on market integrity

a. too close to insider trading

vi. Doesn’t require issuer to publicly disclose all material events as soon as they occur

1. Issuers sometimes choose to disclose information selectively

2. Bars registers and reporting companies from disclosing material non-public information selectively

a. Can’t disclose to a securities analysts and institutional investor without also disclosing to the public

vii. Divides the disclosures into non-intentional and intentional

1. Non-intentional disclosure

a. the issuer must make the public disclosure promptly

2. Intentional disclosure

a. must make the public disclosure simultaneously

[pic]

Consequences for Certain Persons Associated with Domestic Issuer

(§12 registered companies)

(remember: we are considered with the acquisition)

1. §§13(d) and 13(g)(1)

a. §13(d)

i. Requires that any person or group of persons who becomes the beneficial owner of more than 5% of a class of an equity secuirity of a publicly held company must file a disclosure document w/ the SEC

1. Schedule 13D; or

2. Schedule 13G

b. Schedule 13D (more typical)

i. Must occur w/in

1. 10 days after the purchase; or

2. the act that pushes the shareholder beyond the 5%

ii. Information mandated: comparable to disclosures in a contested proxy fight

1. Identity and background of the person filing

2. the source and amount funds

3. Plans to purchase additional securities

4. the purpose of the acquisition

5. aggregate number and percentage of the class of securities beneficially owned

6. any contracts, arrangements, understandings or relationships with respect to the securities of the issuer

c. Schedule 13G

i. Must file w/in 45 days after the end of the calendar year

ii. Shorter form allowed to be filed by certain institutional investors who

1. acquires “such securities in the ordinary course of its business and not with a purpose nor with the effect of changing or influencing the control over the issuer, and

2. who do not intend to change or influence control of the issuer; and who are not directly the beneficial owner of 20% or more of the class

3. §§16(a) and 16(b): Disclosure by officers/insiders

a. §16 was designed to prevent insider trading

b. §16(b)

i. Permits a corporation to recover any profit realized by certain insiders who purchase and sell, or sell & purchase, w/in a period of 6 months

ii. Even if the officer acted innocently

c. Policy for allowing recovery of short swing profits realized by insiders

i. Congressional hope to discourage such persons from trading on material non-public information that in reality is the property of the issuer

d. §16(a)

i. complements §16(b)

ii. Requires certain insiders to report their acquisitions and dispositions of equity securities

e. Those who must file:

i. Every officer or director of a company – with an equity security registered under §12,

ii. Every person ‘who is directly or indirectly the beneficial owner of more than 10% of any class of any equity security so registered with the SEC,

f. Where they must file

i. With the SEC, and

ii. And any exchange on which the security is listed

g. What they must file

i. Initial Report on Form 3 of his holdings of all the issuer’s equity securities

ii. Addition Report: Form 4

1. Required within 10 days after the close of each calendar month in which there has been any change in his or her holdings

iii. A year-end report: Form 5

1. mandated for all acquisitions or dispositions that were exempted from earlier filings

Statutory Issuers of Securities

Provision Registered under mandatory

the 34 Act Disclosure

Registered Co.

[pic]

§8.04: Disclosure Obligations of Domestic Companies not Registered under §12

Limited Periodic Reporting after 1933 Act Registered Offering

1. Periodic Reporting Obligations: §15(d)

a. imposes limited periodic reporting obligations on any company that has filed a registration statement under the 33 Act

b. Those subject to §15(d) would file the reports mandated by a company registered under §12

i. 10-Q; 10-K; 8-K

ii. Rules 15d-13, 15d-1 15d-11

2. Duration of Required Reporting: §15(d) ( exemptions

a. Duty to file under §15(d) is suspended as long as the issuer is registered under §12 (34 act)

b. Suspended if there are less than 300 hundred shareholders within the class

i. other than the year that the 33 Act registration state

3. Sarbanes-Oxley

a. All of the obligations that the Sarbanes-Oxley Act of 2002 imposes on a public company apply to an issuer that is subject to §15(d) of the 34 Act

4. Regulation FD

a. §15 issuers are subject to the anti-selective disclosure requirements of Regulation FD

Disclosure to Dealers in Issuer’s Securities

1. §15(c) and Rule 15c2-11

a. Relevant to those companies that are not subject to the requirements of §13 and §15(d) but wants to have some sort of trading market

b. These rules provide the information that must be disclosed to market intermediaries

c. Rule 15c2-11

i. Contains requirements that are intended to deter broker-dealers from initiating or resuming quotations for covered OTC securities that may facilitate a fraudulent or manipulative scheme

ii. prohibits a broker-dealer from publishing or submitting for publication a quotation for a covered security in a quotation medium

1. unless it has obtained and reviewed current information about the issuer

iii. Contains several exceptions to it prohibitions

i.e., 15c2-11(f)(3): “piggy back” exception

1. the Rule’s information gathering requirements are inapplicable when a security has been the subject of quotations in an interdealer quotation system for at least 12 business days during the previous 30 calendar day

2. W/ no more than 4 consecutive days elapsing w/o a quotation

3. Refers to the fact that only the first broker-dealer has to procure information and from then on it “piggy backs” on this to other broker dealers

4. Theory: Regular and frequent quotations for a security generally reflect market supply and demand and are based on independent informed pricing decisions

[pic]

CHAPTER 9: Mandatory Disclosure: Securities of Foreign Private Issuers

§9.01: Registration under §12

Application to Foreign Private Issuers

1. Overview

a. Registration for domestic issuers

i. the issuer lists securities on a national securities exchange

ii. the issuer attains a certain size

1. measured in terms of total assets, number of record owners of a class of equity securities and business in interstate commerce

iii. the issuer voluntarily chooses to register

b. There is the possibility that a foreign private issuer must also register

i. Have less stringent regulations

ii. Defined in Rule 3b-4 of the 34 Act

1. Identical to the definition in Rule 405 of the 33 Act

2. Those not qualified under this definition do not receive the regulatory benefits

3. Generally relates to a governmental or political entity

iii. those with securities listed on a national securities exchange must register under §12(b) ( there is no exemption

iv. Might chose to register under §12(g)(1)

1. Might want to list on the NASDAQ or be quoted on the OTCBB

vi. those with 500 or more record holders of a class of equity securities have to register

1. §12(g)(1) requirements

2. regardless of where these shareholders reside

3. There are exemptions from 12(g)(1)

3. Exemptions

a. Rule 12g-1

i. §12(g)(1) shall not apply “if on the last day of its most recent fiscal year the issuer had total assets not exceeding $10 million

1. this number is subject to change

ii. the exemption is not conditioned upon any disclosure or filing with the SEC

b. Rule 12g3-2(a)

i. Exempt if at the end of its fiscal year it has fewer than 300 holders of a class of its equity securities who are resident of the US

1. Requires an issuer to “Look through” all registered banks, broker-dealers or other nominee holders – regardless of their location – to determine the residence of the actual holders

ii. Broader than R. 3b-4 & 405 ( which limit the search

iii. Does not require the foreign private issuer to make any disclosures to the US markets or to the SEC

c. Rule 12g3-2(b)

i. More limited exemption

ii. Available to any foreign private issuer

1. the issuer furnishes the SEC w/ certain specified information that it has disclosed since the beginning of its last fiscal year; and

2. Thereafter continues to furnish home country disclosure to the SEC

iii. Unavailable for certain private issuers

1. Those that are subject to reporting obligations under §15(d)

2. Those w/ securities on the NASDAQ

iv. Rule 12g3-2(b)( list of general disclosure obligations

1. Requires that the Commission be furnished a list which identifies, in a general manner, the type of information which the issuer

a. (A) has made or is required to make public pursuant to the law of the country of its domicile or which it is incorporated/organized

b. (B) has filed or is required to file with a stock exchange on which its securities are traded and which was made public by such exchange; or

c. (C) has distributed or is required to distribute to its security holder

2. The list should include an

a. indication of which agency, exchange or other entity requires such information to be made public, filed with an exchange or distributed to shareholders and

b. an indication of the timing for publication, filing or distribution of the information

3. Must be updated after the end of any fiscal year in which there is a change in the company’s disclosure obligations

v. Rule 12g3-2(b)(1)(i)

1. An inventory of the actual disclosure that were made during the time period indicated pursuant to the general disclosure obligations identified in subsection (ii); and

2. Those that will be included in materials furnished to the Commission in connection w/ the initial claim of exemption

vi. Information posted on an Internet website is considered to be information that the issuer made public ( for subsections (i) and (ii)

Application to Depositary Shares

1. Question: are ADRs subject to §12

a. The shares underlying ADRs – the deposited securities – are clearly subject to §12

2. Rule 12a-8 and Rule 12g3-2(c)

a. Commission eliminated the registration requirement under §§12(b) and 12(g)(1)

i. Provided that they are registered on Form F-6 of the 33 Act

d. When securities being registered on Form 20-F are in the form of ADRs

i. a description of the ADRs will be included in the response to Item 12

ii. But the depositary is not required to sign the registration statement

Registration Procedure

1. Foreign private issuers registered under §12 essentially face the same immediate disclosures as a domestic issuer

2. They file Form 20-f

a. Rather the Form 10 (for domestic)

3. Canadians register on Form 40-F

§9.02: Disclosure Obligations: Foreign Companies Registered under §12 or reporting under §15(d)

[pic]

Introduction

1. The significance of mandatory disclosures by foreign private issuers can be evaluated by examining the extent to which interested persons have access to that information

2. 4 categories of persons that have access to information

a. Government

b. Self Regulatory Organizations

c. Market intermediaries

d. Members of the investing public

3. Disclosure obligations of foreign private issuers arise in different ways

4. One method for distinguishing these duties is to separate these issuers into 2 groups:

a. Foreign private issuers which are subject to §§ 12 or 15(d) of the 1934 Act; and

b. Foreign private issuers which are not subject to these statutory requirements

Disclosure Obligations under U.S. Securities Law

1. Duties of §12 Registrants

a. §13(a) Periodic reporting

i. Form 20-F for the annual report

ii. Form 6-K for the interim report

c. Rule 3a12-3 exempts foreign private issuers and their insiders from

i. the proxy solicitation rules under §14(a); and

ii. the filing obligations under §16(a)

d. Sarbanes-Oxley Act of 2002

i. does not distinguish between US and foreign private issuers

ii. applies equally to all public companies that are reporting under §13 or 15(d) of the Act

e. Regulation FD does not apply to foreign private issuers

f. Subject to applicable SRO rules and policies

g. Might be subject to the anti-fraud provisions of the 34 Act

2. Duties under §15(d)

a. Foreign private issuer who makes a registered public offering under the 33 Act and is not registered under §12 of the 34 Act is subject to limited periodic reporting under §15(d) of the 34 Act

b. Must make periodic reports pursuant to Rule 15d-16 on Form 20-F and Form 6-K

c. Subject to Sarbanes-Oxley

d. Exemption ( provided in Rule 12h-3(b)(2)

i. Those eligible to take advantage of this exemption must file Form 15

3. Disclosure by Dealers in Issuer’s Securities (Rule 15c2-11)

a. For dealers to submit quotations for the company’s shares in the pink sheets, the private issuer must first provide those dealers with specified, current information

b. POLICY

i. intended to deter broker-dealers from initiating or resuming quotations for covered OTC securities that may facilitate a fraudulent or manipulative scheme

c. Prohibits a broker-dealer from publishing, or submitting for publication, a quotation for a covered security in a quotation medium unless it has obtained and reviewed current information about the issuer.

d. Broker-dealer must also have a reasonable basis for believing that the issuer information, when considered along with any supplemental information, is accurate and is from a reliable source

e. Specifies the type of information about an issuer that a broker-dealer must review and determine, based on a reasonable belief, is accurate and current in all material respects.

f. Requires that the broker-dealer to have in its records the issuer information required by paragraph (a) of the Rule

g. Issuer of the ADR’s means the issuer of the deposited shares represented by the ADR (15c2-11(e)(4)

Disclosure Obligations under SRO Rules

1. Stock Exchange

a. Requires registration under §12

2. NASDAQ

a. Requires registration under §12

b. Issuer must sign a listing agreement with NASDAQ

i. subjects the company to the NASDAQ Marketplace Rules

c. Market Place Rule 4350

i. sets forth the qualification requirements for non-Canadian foreign securities and ADRs

1. 4320(e) (12),(13), and (14)

a.

d. Requires disclosure of certain shareholder information to beneficial owners as well as legal owners

i.e.,

i. “NASDAQ issuers which distribute interim reports to shareholders should distribute such reports to both registered and beneficial shareholders”

3. OTCBB

a. Requires that the issuer be registered under §12 or to be reporting under §15(d)

b. The supervising SRO does not impose listing standards and does not maintain relationships with quoted issuers

c. All dealers submitting quotations in the OTCBB are subject to Rule 15c2-11(a) of the 34 Act

i. Because the issuer must be registered under §12 or reporting under §15(d), the dealers are likely to have access to the necessary information and have a reasonable basis for believing that the information is accurate in all material respects

4. OTC: pink sheets

a. Most likely these companies are not registered under §12 or 15(d) since then they could be listed on the OTCBB

b. Companies that not current in their reporting duties under 15(d) might be listed here

c. There are no eligibility requirements for the companies quoted here

d. However there is an element of regulation because the dealers listing these securities are still subject to Rule 15c2-11

i. as a practical matter ( these dealers are going to have to communicate directly with the company itself in order to receive the necessary information

Disclosure in Connection with Depositary Receipt Programs

1. Must remember that the creation of any ADR program requires the issuer to file Form F-6

a. Contains critical information

2. Also, deposit agreement between the foreign issuer and depositary will regulate dissemination of the foreign issuer’s periodic disclosures

§9.03: Disclosure Obligations of Foreign Companies Not Registered under §12 and not Subject to §15(d)

Disclosure Obligations under U.S. Securities Law

1. §12: Exemptions and Disclosure:

a. Exemptions not Based on Disclosure: Rules 12g-1 and 12g3-2(a)

1. There is no exemption from the registration requirements of §12(b)

2. 3 Exemptions from §12g(1)

1. Rule 12g-1: applies to both domestic and foreign

2. Rule 12g3-2(a): limited to foreign private issuers

3. Neither of the above exemptions depends on disclosure of info to SEC or to investors

1. There is no duty to provide disclosure to investors under these

b. Disclosure-Based Exemption: Rule 12g3-2(b)

1. Rule 12g3-2(b) requires continuous basis to the SEC as a condition of exemption

2. The amount/quality of disclosure will based on home country requirements

2. Disclosure by Dealers I issuer’s Securities (Rule 15c2-11)

a. Overview

1. Purpose of §15(c)(2): deter broker-dealers from initiating or resuming quotations for covered OTC securities that may facilitate a fraudulent or manipulative scheme

2. Rule 15c2-11(a) specifies the type of information about an issuer that a broker-dealer must review and determine, based on a reasonable belief

3. Broker-dealer must have in its records the issuer information required by paragraph (a)(5) of the Rule

4. Rule 15c2-11 uses home country disclosures from Rule 12g3-2(b) as the basis

5. Rule 12c2-11(a)(4): must look at the information furnished since the beginning of the issuer’s last fiscal year

b. Relationship to Rule 144(c)

1. The Information required in R. 144(c) is the information specified in Rule 15c2-11(a)(5)

2. 15c2-11(a)(5):

1. Information must be “reasonably current” ( same as 144(c)

3. Compliance w/ 15c2-11(a)(5) satisfies info requirement of Rule 144(c)

Disclosure Required by NASD

1. Has its own rules to ensure that dealers acquire the information required by rule 15c2-11(a)(5)

2. Dealer quotations are only allowed w/ rule 15c2-11(a)(5) disclosures

3. Can trade in pink-sheets w/o dealer quotations

Disclosure Obligations in Connection with Depositary Receipt Programs

1. Only foreign issuers that are exempted by §12g3-2(b) may establish a sponsored depositary receipt program

2. Foreign private issuer in a Level 1 ADR program aggress to provide the depositary w/ copies of the issuer’s periodic disclosure under Rule 12g3-2(b)

3. If the foreign private issuer is not relying upon Rule 123-2(b) and is not providing disclosures to the SEC the foreign issuer must agree w the depositary to provide the information on request

a. Generally seen in the RADR: sold only to QIB

§9.04: Disclosure Obligations of Key Persons Associated with Foreign companies Registered Under §12

1. 13 Disclosure

a. Imposes filing obligations on certain persons who are beneficial owners of a class of securities that is registered w/ the SEC under §12

b. Applies equally to such persons who are investors in a registered foreign private issuer

c. Disclosure obligations are not applicable to beneficial owners of issuers which are subject to the reporting requirements of §15(d)

d. Forms: must be filed 10 days after a described acquisitiion

i. Schedule 13D

ii. Schedule 13G

1. only available for certain person who meet the requirements of Rule 13d-1(c)

2. Allows filing a shorter form if the don’t own more than 20% of the outstanding securities

3. Generally applicable to §12 companies

2. §16(a) Filings

a. Requires periodic reports to be filed w/ the SEC by officers, directors and 10% shareholders

b. Rule 3a12-3 exempts officers, directors and 10% holders in foreign private issuers from §16 requirements

§9.05: Policy Implications of SEC Regulation of Foreign Companies

1. Quality of Information Available to U.S. Investors in Foreign Issuers

a. Information at Time of Issuance by Foreign Issuer

i. Quality depends on the nature of the issuer and the type of securities

b. Information after Issuance by Foreign Issuer

c. Availability of Information to U.S. Investors

2. Policy Implications of U.S. Securities Law as Applicable to Foreign Issuers

a. Introduction

b. Negative Policy Implications of U.S. Disclosure Law

c. Benefits of Current regulatory Policies

IV. IMPACT OF U.S. SECURITIES REGULATION ON BROKER-DEALERS AND OTHER INTERMEDIARIES

§10.01: Regulation of Broker-Dealers

Theoretical Support for regulation

1. Based on the roles played by these persons as market intermediaries and on the public’s perception of their qualifications and interests

2.

Registration of Domestic Broker-Dealers under the 1934 Act

1. Domestic Broker-Dealers

a. Overview

i. §15(c) of 34 Act: imposes regulations

ii. broker: any person engaged in the business of effecting transaction in securities for the account of other but does not include a bank ( §3(a)(4)

iii. Dealer: “any person engaged in the business of buying sand selling securities for his own account, through a broker or otherwise,

1. not a bak, or

2. any person insofar as he buys or sell securities for his own account – individually or fiduciary – but not as a regular business

iv. “Engaged in the business”: “effecting transaction in securities for the account of other” or “buying and selling securities” for a person’s own account

b. Identifying Persons as Broker-Dealers

i. Finder

1. Can be a company or individual who may receive a fee in connection w/ the solicitation for potential investors

2. not required to register as a broker-dealer if the finder’s activies are limited

ii. Is the finder a broker-dealer

1. Becoming involved in presentations or negotiations

2. Discussing details concerning securities or making a recommendation about the securities

3. being compensated on the basis of the success of the transaction

4. Having previous involvements in the sale of securities

iii. Foreign issuers of securities are not brokers/dealers und 34 Act where their selling activities are limited to their own securities

1. Rule 3a4-1: safe harbor

a. Must be incident to their duties

2. Scope of Regulation

a. §15(a): must be registered or exempt

b. SEC can deny registration

i. §15(b)(4): public interests

c. §15(c): anti-fraud

d. §15 (c)(3): financial soundness

e. §15(b)(1)(B): member of NASD

Registration of Foreign Broker-Dealers under the 1934 Act

1. Statutory Requirements

a. §3(a)(4) & (5): defined

b. §15(a)(1): registration

c. §30(b)

i. Defined in Rule 15a-6

2. SEC Pragmatic Interpretations

a. Introduction

i. §30(b): “any use of jurisdictional means is enough to regulate the person

ii. §15(a)(2): SEC can exempt broker/dealer from requirements

1. SEC is taking a more pragmatic view

b. Rule 15a-6: Foreign Broker-Dealer Activity

i. Provides an exemption from registration under §15(a)

ii. Policy: Interpretation is based on a territorial approach

iii. Scope

1. Contains exemptions for non-direct contacts w/ US residents through unsolicited transaction & distributing research reports to such person

2. Allows for direct contacts w/ certain US institutional investors through intermediaries

iv. Requirements that the broker dealer do no more than:

1. Rule 15a-6(a)(1) ( effects transaction in securities w/ or for persons that have not been solicited by the foreign broker/dealer ; or

2. Rule 15a-6(a)(2) ( furnishes research reports to major US institutional investors and effects transaction in the securities discussed in the research reports w/ or for such institutions/ win certain limitations; or

3. Rule 15a-6(a)(3) ( Induces or attempts to induce the purchase or sale of any security by a US institutional investor or a major US institutional investor, w/ certain limitations; or

4. Rule 15a-6(a)(4) ( effects transaction in securities w/ or for, or induces or attempts to induce the purchase or sale of any security by certain professional, government organizations, certain foreign persons temporarily present in the US or certain US citizens residents outside the US

v. Methods of Solicitation: ( see page 10-6

1. any affirmative effort by a broker/dealer intended to induce transaction business for the broker/dealer or its affiliates

c. Rule 15a-6: International Broker-Dealer: Branch or Affiliate

i. Branch:

1. if the domestic broker-dealer operation is a “branch” of the larger firm then §15(a), et al, is applicable to the entire global operation

ii. Affiliate

1. Only the affiliate is subject

iii. SEC has not provided clear regulation for distinguishing

has suggested that it relies in part on:

1. whether important business decisions affecting the US operations are made by personnel in the US office or in the home office of the foreign broker-dealer firm; and

2. whether the regulatory authorities of the foreign broker-dealer’s home country asserted responsibility for the US operation’s activities and actively examined that US operation for compliance w/ home country regulatory requirements

Impact of Regulation AC on Foreign Research

1. Overview of Regulation AC (Analyst Certification)

a. Contains 6 Rules

b. Basically must certify that they certify the reports and to reveal any compensation

2. Certifications in Connection with Research Reports ( page 10-10

a. Research report: Rule 500

i. “a written communication (including electronic) that includes an analysis of a security or an issuer and provides info reasonably sufficient upon which to base an investment decision

ii. Determination is fact based – circumstantial

b. Rule 501

i. Applies to brokers, dealers, and their associated persons that are “covered persons” ( defined in rule 500

ii. Applicable when any of such persons public, circulate, or provide research reports and requires the person to include: see page 10-11

c. research analyst: “any natural person who is primarily responsible for the preparation of the content of a research report

3. Certifications in Connection with Public Appearances

a. In cases where the broker-dealer doesn’t obtain a statement by the research analyst in connection w/ public appearances, the broker/dealer must promptly notify its examining authority

i. Designated pursuant to §17(d) and Rule 17d-2

§10.02: Investment Advisors: Registration Requirement

1. Investment Advisors Act of 1940

a. Overview

i. SEC has regulatory authority over all investment advisers who

1. are subject to the 1940 Act and that either manage funds w/ assets of $30 million or more

2. or provide advice to a registered investment company

ii. All other regulation is subject to the states

b. Definition of Investment Adviser

i. Statutory Regulation

1. §202(a)(11) of 1940 Act defines investment advisor (page 10-18)

2. Definition is broad

3. 3 part test by SEC

whether the person is

a. providing advice or issuing reports or analyses concerning securities

b. is in the business of providing such services; and

c. is receiving compensation for such service

whether the person is

4. Excluded:

a. Banks which are not investment companies

b. Certain professionals, including any lawyer or accountant that gives advice incident to profession

c. Broker/dealers whose advice is incidental to business

i. Provided no special compensation for advice

d. Persons who limit their advice to bona fide newspaper, news magazine or business or financial publication or general and regular circulation

ii. Judicial Interpretation: Lowe v. SEC

1. Bona fide: Genuine Publication ( would contain disinterest commentary and analysis as opposed to promotional materials

2. 1940 Act: designed to apply to those persons engaged in the investment-advisory profession

3. those who provided personalized advice attuned to a client’s concern the way that the staff reads the decision can be illustrated in the Smith No-Action letter on page 10-19, fn 34

a. any benefit = compensation

4. Critical fact: wasn’t advice tailored to specific recommendation ( to receive the exclusion had to be general

5. Tout:

a. What makes it not a bona fide news publisher

b. See page 23 in supplement

c. Age old term

d. Person is receiving a kickback for its “general advice”

e. See Jerome wanger 292 F.Supp 2d 1296

iii. Impact of the Lowe Decision

1. gives us an idea of how the SEC goes about addressing those that are called investment advisors

iv.

c. Exemptions from Registration under §203(a)

i. Exemptions under 203(b)

1. 6 categories of exemptions

a. preceeding 12 months has had fewer than 15 clients and who neither holds self out generally to the public as as an investment advisor nor asct as an adviser to a US registerd company

2. Client:

ii. Exemptions under §203A

1. Discretion of SEC: used in internet advisors b/c of burden

2. Foreign Investment Advisers

a. Only have to count their US clients

b. “look through” requriement

§10.03: Impact of the Internet on Registration Requirements of Broker-Dealers and Investment Advisers

1. Regulating Internet Advisers

2. Introduction to SEC Policy Release No. 7516

3. Foreign Broker-Dealers

4. Foreign Investment Advisers

Internet and its place

• the SEC is trying to feel its way through this new world to see how much regulation that it can impose

• Securities Act Release No. 7516

o SEC is worried about persons “targeting” persons within the US with the website.

▪ This is about as far as they have gone so far.

o How do you conclude the “targeting”

▪ Is the issuer taken steps to ensure that the sales are not being deliberately sought through the internet

▪ No spamming ( same as using the mails

▪ Wants it to be a passive message with an affirmative step to ensure that it is not targeting

• The sign ( not intending

o Then the SEC will infer that it is not targeting

• Foreign Broker dealers

o Wants it to take the step to make sure that the broker-dealer is not targeting the US

o Gives some examples on page 32

▪ Post a disclaimer ( stating where its services are available

▪ Refusing some clients where it believes would cause it to be in violation

• Foreign Investment Advisers

o Harder because the law is not that clear

o Also, because there are clear exemptions

o SEC states that the adviser cannot have more than 15 US persons and is making reasonable safe guards ( then not holding self out as investment adviser

o The foreign adviser providing advisory serves over the Internet generally would be holding itself out as an investment adviser

▪ Can also take measures that reasonably guard against this

V. ENFORCEMENT: SANCTIONS & REMEDIES

CHAPTER 12: Violations of Registration Requirements and Prohibitions against Fraud

§12.01: Legal Issues

Introduction

1. Registration, Reporting and Anti-Fraud Provisions under Federal Securities Law

a. Fraud prevention is an important goal in regulation

i. §10b of the 34 Act

ii. §35 of the Investment Company Act of 1940

iii. §207 of the Investment Advisors Act of 1940

b. 1933 Act contains two statutory sections that provide purchasers of securities with a private cause of action for damages

i. §11 and 12(a)(2)

c. §10b of the 34 Act

i. Broader than the 33 Act because it involves both the purchases and sells of securities

ii. Does not provide an express cause of action

iii. Does not state specifically what conduct is proscribed

2. Governmental and Private Enforcement

a. Enforcement of securities law and policy can take at least 5 different forms

i. private litigation in court or in arbitration where injured persons seek damages, rescission of contracts and/or equitable relief

ii. SEC enforcement actions against registered companies or registered market intermediaries

iii. SeC actions in judicial proceedings against any person involved in improper activities

iv. criminal actions by the US DOJ in a US federal court

v. SRO actions to sanction members for violations of SRO rules which have been approved by the SEC

b. Private litigation

i. Generally in the federal forum this is compensatory and not punitive

ii. But, some state law does allow the punitive damages

iii. Certain violations allow individuals to act as private attorney generals

1. §12(a)(1) of the 33 Act: violation of the registration requirements

2. §11 and 12(a)(2) of the 33 Act for violations of the anti-fraud provisions

3. §10b and Rule 10b-5 and §14(a) and Rule 14a-9 under the 34 Act for violations of anti-fraud provisions

c. Criminal Cases

i. States often assist in interstate actions that constitute fraud

d. Self Regulatory actions

i. the SRO’s will often sanction there own liability

e. Foreign investors sometimes prefer to litigate in the US (rather than their home country)

lists some reasons

i. the potential of a large jury verdict

ii. the generous discovery rules

iii. contingent fee arrangements with US lawyers

iv. Absence of a loser-pays rule for attorney fees which exists in other countries

v. the possibility that their claim can be brought in the form of a class action lawsuit

1. also allows the Πs to spread the costs

Personal Jurisdiction

1. Remember that the Court must have personal jurisdiction over a person before it can take its property

2. Each jurisdiction has a different position on this: must remember to view the jurisdiction

3. Pinker v. Roche Holdings Ltd.

a. Roche had consciously and deliberately took actions to have its stocks traded on the stock exchange ( affirmative steps

b. was enough to satisfy the Minimum Contacts

c. “Although the Π’s complaint does not allege that the fraudulent media releases and annual reports were specifically directed to American investors, a foreign corporation that has created an American market for its securities can fairly expect that that market will rely on reports and media releases issued by the corporation”

Subject Matter Jurisdictions

1. This is where the real controversy lies

2. States have no subject matter jurisdiction under 34 Act violations

a. Statutorily created subject matter jurisdiction limits this to the federal courts

3. Concerned with the substance of the regulation

4. Jurisdiction

a. Can agree to have dispute settled in forum

b. Registration: §12(b) or (g) and §15 of the 1345 Act

c. §22 of the 33 Act: both state and federal courts have have “jurisdiction of offenses and violations under this title and under the rules and regulations promulgated thereto

d. §27 of the 34 Act: contains the same language but confers jurisdiction only to federal courts

§12.02: Subject Matter Jurisdiction: Background

1. Review of Anti-Fraud Provisions Under the 1933 and 1934 Acts

a. The 1933 Act ( consist of 3 statutory sections

i. §11 and §12(a)(2)

1. provide purchasers of securities with a private cause of action for damages

ii. §17: “Fraudulent Interstate Transactions”

1. SEC has authority to seek equitable relief against persons who offer to sell or sell securities by means of misleading statements

2. Applies only to sales

iii. §25

1. DOJ can bring criminal charges against violations of §17

b. The 1934 Act

i. §10(b): page 557

1. Prohibits fraudulent misstatements in connection with the purchase or sale of securities which are in contravention of any rules or regulations that the SEC adopts pursuant to that provision

ii. Rule 10b-5 ( page 769

1. Looked to §17 of the 33 Act

2. Has developed to be the most powerful anti-fraud provision that the government and individual investors have

3. applicable to both purchases and sales of all issuers

a. don’t have to be registered ( can apply to private companies

4. The S.Ct. has recognized an implied private cause of action

2. Private and Governmental Enforcement

§12.03: Subject Matter Jurisdiction: SRO and SEC actions

1. Fraud Cases

a. There are persons that have agreed to be subject to the SEC jurisdiction

b.

2. Non-Fraud Cases

a. Nomura, Japanese securities firm

i. Agrees to jurisdiction when it became a member of the NYSE

b. In the matter of lai sum pan, (page 1 of cases in vol i)

i. There is activity taking place within the US

§12.04: Subject Matter Jurisdiction: Judicial Approaches to Foreign Transactionsu

1. Introduction

a. The case for Extraterritorial Application

b. The Case against Extraterritorial application

c. Current Judicial Approaches

2. Judicial Tests

a. Introduction

b. Application and Effects and Conduct Tests: Fraud cases

i. Effects Test

ii. Conduct Test

1. See the 2 extremes

a. Most rigorous ( District Columbia

b. Least rigorous ( 8th and 9th Circ

2. See those in between (page 23)

iii. Combination of Effects and Conduct Tests

iv. Citizenship or Residence of Π as a Relevant Factor

c. Application of Effects and Conduct Tests: Non-Fraud Cases

§12.05: Subject Matter Jurisdiction: Judicial and Private Controls

1. Comity and Forum Non-Conveniens

2. Pre-Dispute Contract Provisions

§12.06: Multinational Enforcement

1. Practical Problems

2. Agreements Among Regulators

-----------------------

Purchasers of Securities

DOJ

SEC

Sellers of securities and other persons who violate §5 or engage in fraudulent sales

(5v

¤

·

¸

ÿb“¦Üêhx1H°¿lyUf 7àáht…-¡-_x ! ?"Ž"f$k$Ò'Ó'Ý(Þ(**?+ž+l,m,ý.1/õçõÜõçõÉõ»õ»õçõ­õ­õ¡õ•õ­õ­õ­õ­õ­õ»õ­õ­õ­õ¡õÉõ­õÉõÉõ­õ»õÉõçh„} hO DCJH*[pic]aJh„} hO D>*[pic]CJaJh„} hO D6?>*[pic]CJaJWillful Violations of Registration & Anti-Fraud Provision:

§24

Registration Violations:

• §12(a)(1)

• §15

Fraud

• §11

• §12(a)(2)

• §15

•

Registration Violations:

• §8A

• §20

Fraud

• §8A

• §17

• §20

ISSUERS

PRIMARY MARKETS

Non-public offerings [e.g., Private Placements or Limited Offerings]:

§5 and Transaction exemptions

Public Offerings [Distributions]:

§5 and Registration

Unrestricted Shares

Restricted shares

NON-ISSUERS

(owners of issuer’s securities)

• Affiliates

• Non-Affiliates

SECONDARY MARKETS

Non-public offerings [Trading]

§5 and §4(1)

Public Offerings [Distributions]:

§5 and Registration

Control Shares

Non-control & unrestricted shares

Unrestricted control shares

• Sophisticated

• Very Wealthy

• Accredited

• QIB

Issuer

Shareholders

SECONDARY MARKETS

§12(b) or 12(g)(1)

§13(a)

§10(b)

§14(a)

Issuer of Securities Registered under the 1934 Act: Registered Company

SEC Form 10

Periodic Reports

All Material Facts

Proxy Statement and Annual Report

Reistered Company’s Security Holders

§13(d) or 13 (g)

§16(a)

§10(b)

Holders of more than 5% of registered securities

Officers, Directors, and 10% Shareholders

Reports

All Material Facts

Reports

SECONDARY MARKETS

§15(d)

§15(c)

& Rule 15c2-11

§10(b)

Issuer of Equity Securities, No class of which is registered under the 1934 Act: Unregistered Company

Periodic Reports

All Material Facts

Basic Information About Issuer

SECONDARY MARKETS

Registered Broker-Dealer

................
................

In order to avoid copyright disputes, this page is only a partial summary.

Google Online Preview   Download