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Securities Regulations. Federal Law State Law. Federal Securities Laws and Regulations. 1933 Act Regulates the first issue of any security in interstate commerce 1934 Act Regulates the sales after the first issue (secondary trading) of any security in interstate commerce

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Securities Regulations


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    1. Securities Regulations • Federal Law • State Law (c) 2004 West Legal Studies in Business A Division of Thomson Learning

    2. Federal Securities Laws and Regulations • 1933 Act • Regulates the first issue of any security in interstate commerce • 1934 Act • Regulates the sales after the first issue (secondary trading) of any security in interstate commerce • Created the Securities and Exchange Commission (SEC) • Regulates the stock exchanges, brokers, and dealers • Many more federal laws regulating investment banks, companies, etc. See text p. 225 (c) 2004 West Legal Studies in Business A Division of Thomson Learning

    3. Securities and Exchange Commission (SEC) • Agency created in the 1934 Securities Act to administer the federal securities laws: • Legislate rules and regulations to implement broad law: Commission in Wash., D.C. • These are published first in the Fed. Register and then finally in the Code of Federal Regulations (CFR) • Investigate: investigators in SEC branch offices around the U.S. • Adjudicate the violations of these laws: administrative law judges in SEC branch offices around the U.S. (c) 2004 West Legal Studies in Business A Division of Thomson Learning

    4. State Securities Laws • Called “Blue Sky laws” • Modeled after the federal laws • Both federal and state laws must be followed, not one or the other • Unless either law says an issuer is exempt (c) 2004 West Legal Studies in Business A Division of Thomson Learning

    5. What is a security? • U.S. Supreme Court: Securities & Exchange Commission v. W.J. Howey Co. 1946 • Any time person, A, gives his money to person, B, in the hopes of making a profit mostly from the management efforts of person B • See broad definition in text = courts interpret the definition very broadly (c) 2004 West Legal Studies in Business A Division of Thomson Learning

    6. New definition • Reves v. Ernst & Young 1990 • Even uncollateralized and uninsured promissory notes were securities • Used a new test: the family resemblance test • Presume that they are securities • Can rebut this presumption by showing they more closely resemble the family of instruments found not to be securities (c) 2004 West Legal Studies in Business A Division of Thomson Learning

    7. Factors Court Will Consider Since Reves • Motivation of buyer and seller • Plan of distribution of the note • The reasonable expectations of the buyer/investor • Whether there were other laws regulating the transaction, rendering application of the Securities Act unnecessary (c) 2004 West Legal Studies in Business A Division of Thomson Learning

    8. Examples of Securities • Stock in Exxon, IBM, etc • Bonds • Limited Partnerships • Limited Liability Memberships (c) 2004 West Legal Studies in Business A Division of Thomson Learning

    9. Securities and Exchange Commission v. SG Ltd. (1st Circuit 2001) • Stockgeneration Web site: opportunity to purchase shares in eleven different “virtual companies” • Pushed “privileged” companies in which they had an interest • SEC said transaction in securities, SG said transaction was a game, fantasy, not security (c) 2004 West Legal Studies in Business A Division of Thomson Learning

    10. Securities Act of 1933 • Regulates the first issue of all securities for the first time • Only if sold in interstate commerce • Calls for the issuer to disclose: reveal all the important information about itself to the public • By filing a registration statement containing “everything about the issuer” with the SEC • By supplying a prospectus of “everything about the issuer in simplified form” to every purchaser (c) 2004 West Legal Studies in Business A Division of Thomson Learning

    11. SEC v. Abacus International Holding Corp. and Arthur Agustin • SEC alleged that Agustin had sold non-existent securities, violating the 1933 Act (c) 2004 West Legal Studies in Business A Division of Thomson Learning

    12. SEC Act of 1934 • Regulates secondary trading • National Security Exchanges have to register • Proxy solicitations • Insider Trading • Manipulating Price of Security • Aiding and Abetting • Private Securities Litigation Reform Act of 1995 • Securities Litigation Uniform Standards Act of 1998 • Williams Act = Tender Offers Act • Commodity Exchange Act • Foreign Corrupt Practices Act • Electronic Records and Signatures Under Federal Securities Law (c) 2004 West Legal Studies in Business A Division of Thomson Learning

    13. 1934 Act to Regulate • Regulates Secondary Trading (after the first issue) • Registration and reporting by big companies • Insider Trading Regulations: 16B and 10B • Proxy Regulations • Take-over Regulations • Stock Exchanges must register and follow certain rules and regs. • Brokers, Dealers must get licensed and follow certain rules and regs. (c) 2004 West Legal Studies in Business A Division of Thomson Learning

    14. How Does it Regulate Secondary Trading? • A domestic company must continue to disclose info about itself to the SEC and the public • register itself with the SEC if it: • Has $10 million in assets, 500 or more shareholders and • Lists its securities on a national stock exchange • File annual reports, quarterly reports, and maybe monthly reports with the SEC • Give its shareholders annual reports • Follow certain accounting and record-keeping procedures (Foreign Corrupt Practices Act) (c) 2004 West Legal Studies in Business A Division of Thomson Learning

    15. Haack v. Max Internet Communications, Inc. • Company sued for fraud in the selling of securities (c) 2004 West Legal Studies in Business A Division of Thomson Learning

    16. Investment Company Act • Regulates companies ( mutual fund companies) that • Invest, reinvest, trade in securities, whose own securities are publicly offered • Attempts to minimize conflicts of interest (c) 2004 West Legal Studies in Business A Division of Thomson Learning

    17. 1933 Act Exemptions From Registration • Certain types of issuers • Certain types of transactions (c) 2004 West Legal Studies in Business A Division of Thomson Learning

    18. Certain Types of Issuers are Exempt • If issuer is regulated by another federal law • Banks and Investment Companies • Railroads • Insurance Companies • If issuer is a nonprofit • Charities • Religious groups (c) 2004 West Legal Studies in Business A Division of Thomson Learning

    19. Certain types of transactions are exempt • Small • Private (only sell to “sophisticated” investors who can get info elsewhere and don’t need registration statement to get info) • Casual Sales (you and I selling & buying) • Brokers and Dealers after the “first allotment of that security” is sold (c) 2004 West Legal Studies in Business A Division of Thomson Learning

    20. Small Offering Exemptions • “Capital Chasm” $250,000 to $5 million • 1980 Small Business Investment Incentive Act • Congress told SEC to develop some exemptions for small business • Small businesses must still comply with the state securities laws • Intrastate exemption • Regulation A exemption • Regulation D: Rules 504 and 505 exemptions • SCOR exemption • California Limited Offerings exemption (c) 2004 West Legal Studies in Business A Division of Thomson Learning

    21. Intrastate Exemption • Issuer incorporated in the state where securities are being offered • Issuer does a significant amount of business in this state (80%) • Issuer will keep the money from sales(80%) in the state • Issuer makes offers and sales only to residents of the state • Red ink: cannot resell outside of state for 9 months • No limit on amount • Must register according to state securities rules (c) 2004 West Legal Studies in Business A Division of Thomson Learning

    22. Regulation A Exemption • Sell up to $5 million in a 12 month period • No solicitation or advertising • A lesser registration form with 2 years financial statements, but not audited • A prospectus, but a simpler format called an offering circular must be given to purchasers • Available to all investors • No limitation on number of investors • No minimum share price requirement • Bad boy disqualification (even is not convicted) • Resale not restricted • Must register with state and state requires audited financial statements • “Test the Waters” feature (c) 2004 West Legal Studies in Business A Division of Thomson Learning

    23. Reg. A “Test the Waters” Feature • To determine if there is sufficient interest and demand for their security offering prior to the time of the offer • Allowed to use general solicitations and advertising prior to the offer and sale, but no money may be accepted until SEC says so • File solicitation with SEC, then distribute • When finish solicitation, wait 20 days before offer for sale (c) 2004 West Legal Studies in Business A Division of Thomson Learning

    24. Small Offerings Exemptions Under Regulation D • No registration or prospectus required • Rule 504 • Rule 505 (c) 2004 West Legal Studies in Business A Division of Thomson Learning

    25. Regulation D Rule 504 • $1million in a 12 month period • No limitation on solicitation or advertising to public investors • Available to all investors • No limitation on number of investors • No specific disclosure requirements • No audited financial statements (still have to register with state) • No restrictions on resales (c) 2004 West Legal Studies in Business A Division of Thomson Learning

    26. Accredited investors: • Insurance, Investment companies, employee benefit plans, Bus. Devl. Company, charity or educational institution with assets of $5 million, any director, executive officer or general partner of issuer, person who bought at least $150,000 of the securities offered, if purchase did not exceed 20% of the person’s net worth, any person with a net worth of over $1 million; and any person with an annual income of more that $200,000. (c) 2004 West Legal Studies in Business A Division of Thomson Learning

    27. Regulation D Rule 505 • $5 million in a 12 month period • No solicitation or advertising • Unlimited number of accredited investors and up to 35 non-accredited investors • Bad-boy disqualification • Audited financial information • Resale restriction (c) 2004 West Legal Studies in Business A Division of Thomson Learning

    28. SCOR Small Corporate Offering Registration 1992 • Uniform Limited Offering registration or the “seed capital exemption “ • $1million in 12 month • No resales • Use Regis. Form U-7 (simplified) • Not available to all investors • No testing the waters • Minimum share price • Audited financial statements are required (c) 2004 West Legal Studies in Business A Division of Thomson Learning

    29. California Limited Offering Exemption • SEC said that other states could do this also • No state registration for up to $5 million • General solicitation is allowed • Available to qualified investors (accredited) (c) 2004 West Legal Studies in Business A Division of Thomson Learning

    30. Other exemptions • Regulation S • Exempts certain international offerings • Regulation E • Exempts securities of small business investment companies • SEC Rule 701 • Exempts sales of securities through employee benefit plans of nonpublic companies (c) 2004 West Legal Studies in Business A Division of Thomson Learning

    31. Private Offerings Exemptions • Regulation D Rule 506 • Section 4(6) (c) 2004 West Legal Studies in Business A Division of Thomson Learning

    32. Regulation D Rule 506 • Any amount • Any time period • No solicitation or advertising • Unlimited number of accredited and up to 35 non-accredited investors, BUT • The non-accredited investors must be sophisticated • “In the know” or • Rich • No bad-boy disqualification • Audited financial information is required • Resale restrictions • National securities Markets Improvement Act of 1996: Some relief from state registration (c) 2004 West Legal Studies in Business A Division of Thomson Learning

    33. The Process of Conducting a Securities Offering • Prefiling period • Waiting period • Post filing period (c) 2004 West Legal Studies in Business A Division of Thomson Learning

    34. What is Required in Registration Statement and Prospectus? • Regis. Statement details in text on p. 155 • Prospectus (preliminary prospectus called a “red herring”) with red ink warnings that it has not been registered (c) 2004 West Legal Studies in Business A Division of Thomson Learning

    35. File registration statement (S-1) • 15 day waiting period, if SEC does not issue “stop letter”, then issuer may sell • Before file – no offering or sale • During 15 days – only face to face offering in writing (red herring and tombstone ad) ROAD SHOWS • After 15 days – offer and sell to public • There are modified, simpler registration statements for certain circumstances (S-2, S-3, etc.) (c) 2004 West Legal Studies in Business A Division of Thomson Learning

    36. Civil and Criminal Penalties for • Not filing when should • Filing with material misstatements or omissions • Material misstatement or omission does not have to be intentional • Material misstatement or omission does not have to be relied upon by purchaser (c) 2004 West Legal Studies in Business A Division of Thomson Learning

    37. Presumption of Liability (Burden on Defendant) • Against all who worked on or signed the registration statement • Issuer and Underwriter • Professionals: appraisers, geologists, CPAs lawyers • Directors & Officers • Anyone else who signed (c) 2004 West Legal Studies in Business A Division of Thomson Learning

    38. Internet Securities Offerings (ISOs) or Direct Public Offerings (DPOs) • Traditional Marketing and Sales of Securities was through Investment banking: screened the security before the public could get to it • Now Direct Solicitation, Advertising and Sales has opened up the securities world to the public without the middleman • Information now available to the public has leveled the playing field • EDGAR: electronic database of corporate information • InsiderScores.com market-influencing transactions previously only available to large institutions (c) 2004 West Legal Studies in Business A Division of Thomson Learning

    39. DPOs are Good and Bad • Greater access to new offerings at a cheaper cost • Greater risk because no layers of sellers and no secondary market (c) 2004 West Legal Studies in Business A Division of Thomson Learning

    40. 1933 and 1934 Securities Laws Still Apply • Some Cases • SEC has issued: advice, interpretive releases, enforcement actions, final rules, No-Action Letters (c) 2004 West Legal Studies in Business A Division of Thomson Learning

    41. 1995 SEC Gave Its OK to Electronic Delivery of Materials • 1995: SEC Release 33-7233: SEC encourages further technological research, development, and application of the use of electronic media to paper-based media • Brown & Wood on behalf of its clients Merrill Lynch and Goldman Sachs • Inquired whether prospectus delivery requirements were met by providing it via computer on a proprietary system for investors to download • SEC issued a No-Action Letter concluding that it was OK if certain conditions are met (c) 2004 West Legal Studies in Business A Division of Thomson Learning

    42. 2000 - SEC Updated this Information • Addressed three areas of concern • E-Deliver • Issuer’s liability for Web site content • Conduct of Issuers and Market Intermediaries (c) 2004 West Legal Studies in Business A Division of Thomson Learning

    43. 1996 Spring Street Brewing Company • Posted a “Regulation A” IPO prospectus on its web site with the approval of the SEC and raised $1.6 million • But, if e-mail, have to have purchaser’s consent in advance to receive it by email and then an acknowledgement back from the purchaser that he received the e-mail (c) 2004 West Legal Studies in Business A Division of Thomson Learning

    44. Delivery of Offering Materials –SEC’s three basic guidelines: • Notice: having it just “sit on the website” is not enough, but accompanied by an e-mail or posted mail to potential investors that it is on the site • Access: easy to use electronic communication system available for public to ask questions, get material • Evidence of delivery of the electronic prospectus • Receipt is presumed if sent by postal mail or facsimile • Must have receipt if delivered over Internet (c) 2004 West Legal Studies in Business A Division of Thomson Learning

    45. SEC Gave Examples of Notice Requirement • Hyperlink on page with sales pitch that brings up open prospectus is OK because it is the same as if the prospectus was in the same envelope • Sales pitch with letter that says prospectus is at a particular location on the Internet is not OK because not all investors would know how to get access to the prospectus (c) 2004 West Legal Studies in Business A Division of Thomson Learning

    46. Hyperlinks Can be a Source of Liability if: • The issuer does not keep them CURRENT • Linking prospectus with newspaper articles or other “good publicity” is not a good idea because these articles get outdated and it looks like you are still trying to say good things about your security when it is not true any longer – don’t link to these. (c) 2004 West Legal Studies in Business A Division of Thomson Learning

    47. 1996 SEC Issued “How to” Guide to Formatting Electronic Delivery • 1997 Great Plains Software, Inc.: first to post a Web site prospectus with audio and video components: streaming of audio, could not be copied • 1997 the first CD-ROM prospectus was delivered to investors in an offering by Ameritrade • SEC’s position: electronic prospecti must be fairly and accurately described on paper to be be filed with EDGAR: a graph, a transcript, an explanation of graphics or whatever. (c) 2004 West Legal Studies in Business A Division of Thomson Learning

    48. Private Placement Offering • If the offering is a private offering under Reg. D = no general solicitation is allowed and having offering on web is general solicitation • Is “password protected” enough online? (c) 2004 West Legal Studies in Business A Division of Thomson Learning

    49. In Re: Iponet • Query to SEC: • Will the posting of a Notice of a Private Offering in a Password-protected Page of IPONET accessible only to IPONET members who have previously qualified as Accredited Investors Involve any General Solicitation or General Advertising Within the Meaning Of Regulation D? (c) 2004 West Legal Studies in Business A Division of Thomson Learning

    50. In Re: Iponet cont…. • SEC: No Action Letter = means OK • OK for investors to show interest in an upcoming sale, announced by tombstone ad and red herring prospectus on the web, by sending in a coupon or card either by email, fax or posted mail. • When the offering is private (no general solicitation or advertising), it is OK to have the potential investors apply to qualify themselves as accredited or sophisticated by sending in information about themselves on a card, and then, upon showing the the proper qualifications, being issued a password to get to a certain part of the site where the private offering is shown. (c) 2004 West Legal Studies in Business A Division of Thomson Learning