SECURITIES REGULATION

I. OVERVIEW A. Policy reasons to regulate securities markets: 1. Investor Protection/Increase investor confidence a) KEYSTONE/MAIN GOAL of Securities Laws to investor Protectionhelping investors know what theyre getting into (disclosure if tell the truth you allow others to decide if they want to invest b) People will invest more and companies will invest more (capital formation; part with more money freely which will encourage more wealth) B. Securities Regulation focuses on 2 markets (Primary and Secondary 1. Primarytransaction where issuers sell securities in public offerings a) Issuer receives net proceeds from the offering, raising capital for issuer (i.e. IPO) b) Can you sell debt securities as an IPOYes? Viewed as anathema because IPO is where the price is bid up and founders get rich c) Primary Market TransactionDutch Auction (i.e. Google sold for $180.00/sh; 2nd offering14.2 million shares raised $4 billion of capital. New shares offered at a discount from old shares 2. Secondarysell more securities to the public (common stock or any security sold after the IPO a) Trading transaction between investorsinvestors receive proceeds b) Securities Exchange Act 1934 (1) Levels playing field amongst buyers and sellers in the secondary market (2) Disclosure obligations of issuers detailing financial standing (reporting companies) consistently (3) FraudSection 10(b) and 10(b)(5) (4) Insider Trading (5) Takeovers (Tender Offers) C. 33 Act 1. addresses primary market 2. addresses participants and the roles they play a) Underwriter counsel drafts RS b) Company counsel fills in the blanks

c) Auditors prepare the financial statements d) UnderwritersSection 2(a)(11)any person who has purchased a security from an issuer that intends (with a view)to distribute it to the public (1) Paid commission and expenses for placing securities with the public (2) Specialize in marketing new issuers of securities or secondary offerings of securities by selling shareholders (3) Real estate brokers for issuers (people bet the jockey, not the horse) (4) Firm Commitment Underwritingunderwriters commit to buy all securities at discount price and flip them to clients at the public offering price (a) Until the Underwriters gauge the demand; they wont sign an underwriting agreement (i) At times difficult to sell debt securities (5) Gatekeepers of informational veracity (i.e. double-check all the information in the prospectus (a) Underwriters counsel conducts due diligence to protect it from Section 11 liability (i) Due Diligence defensereasonable investigation of fact so long as nothing jumps outthen ok (a) Go to the company and ask probing questions (b) Go through the corporate documents (c) Minutes of shareholder meetings (d) Material contracts (e) HAAS: look for savory nuggets (6) Section 11 Liabilitymain tool for investor protection (a) Section 11(a)illegal to make material misstatement or omission in a RS (b) Strict liability for the company (c) BUT FOR the lies and omissionsyou wouldnt have bought the security (i) Section 11EWHAT YOU GET IF YOU WIN

(a) Difference of what you paid and what they are now worth or the price you sold them at if you sold them 3. 2005adopted rules that made it easier for Well-known seasoned companies (WIKSEAS) to raise capital 4. Not registered Securities a) Exempt Securities(US Government Securities) (1) safe backed by the full faith and credit of the US Government (2) HAASgovernment would actually have to spill the beans about the true deficit b) Exempt Transaction (1) Private Placement (Section 4(2)34 Act) c) Illegal Transaction 5. Registered Securities (RS) a) REGISTRATION STATEMENT (RS) (1) Document that is filed to register the offering; once the securities are registered, they may be sold to the public (2) Submitted on Form S-1 (IPO) (a) S-1mandates the most disclosure because the market doesnt know the company (b) S-3--seasoned company issues new securities incorporates by reference most information from periodic reports (3) 2 Parts to RS (a) Prospectussent to prospective investors; used to sell the securities (liability prevention documents) (b) Information required in a Prospectus (i) Statement re: individuals (ii) Signature pages (iii) Exhibits that are part of prospectus (iv) corporation documents (v) material contracts (vi) employment agreements (vii) if debt securitycopy of indenture (4) What goes into RS

(a) Describe business, competitors businesses, and legal proceedings (b) Detailed description of securities being offered (c) Financial statements and financial conditions; managements discussion and analysis (MD&Aview of business from the inside) (d) Accounting procedures followed (e) Discussion of management: compensation; transactions and relationships; disclosure of ethics code; corporate governance (f) How proceeds to be used; if equity issued, how diluted; (g) Incorporation by referenceonce info is disclosed, dont have to continue to reference the information; just refer back to a filed document (i) UWs worried about this because dont want to be held liable for a previously filed document II. PUBLIC OFFERING A. Section 5heart and soul of the 1933 Act 1. 2 Purposes a) Contains the registration requirements (1) New issues offered in interstate commerce must be registered with SEC (a) SEC entitled to comment and respond to the RS and prospectus and then declares it effective (i) SEC cannot opine on the merits of an offer (ii) Some states may comment on the merits of an offer (iii) SEC primary mandate is disclosure; if disclose everything; then you may offer the security no matter how weird (a) However, SEC engages in stealth merit review b) Prospectusdelivery requirementsmust be delivered to prospective investors prior to or simultaneous with the purchase of a security 2. Section 5applicable to everyone? a) Nobecause of Section 4(1) transactional exemptions (1) Only applies to: Issuer; U/W; or broker/dealer

(a) Dont have to register the securities or prepare the prospectus (b) Exempts almost all secondary market transactions (2) Section 5 not applicable to Section 4(2)Private Placement (transaction investment) (a) Only for people who may fend for themselves (big boys who may demand as much info as they want/need) (3) Section 4(4)brokers who are affecting your orders are exempt b) Registration is transaction specific; every time shares trade hands they must be either registered or exempted c) Registration by issuer to an underwriter or public only pertains to the initial issuesubsequent transactions may require the securities to be registered again 3. Section 5(a)Pre-filing Period a) Unless the RS is filed, cant offer to sell/buy through the use the medium of a prospectus (otherwise could be hyping stock without full disclosure) b) HAAS: no movie previewpreconditioning the marketplacegun jumping; cant hype the security; cant have the public form an opinion prior to prospectus (1) Supp Class MaterialsWired Ventures (a) Internal email to Wired employees provided optimistic views of stock; email leaked and they abandoned IPO (i) Could be that they intended to leak the emails (ii) Employees likely to buy stock should have benefit of Section 5 protections (2) Supp Class MaterialsWEBVAN (a) Info not included in preliminary prospectus was leaked to Businessweek, Forbescame from execs (3) Supp Class MaterialsGoogle Playboy Interview (a) Google had to include interview as an appendix to the prospectus or couldnt do the IPO; lawyers didnt vet the interview so lawyers were fearful over the interview (b) SEC mandated cooling off period (delay the offering) so will hope public will forget about movie trailer c) Ends with the filing of an RS d) Begins with discussions of issuing securities

e) Rule 163(A)non-offering related communications made 30 days prior to the filing of an RS (backdoor way of stating when the pre-filing period begins) (1) Bright Line Testany communications made by an issuer 30+ days prior to filing the RS so long as they dont mention the security that will be part of an RS (a) Only applies to issuers and its agents; company can talk; U/W not part of exemption f) Underwriters(UW)(2(a)(11) definition)doesnt include anyone whose interest is based on commission (1) ProvisoSGM not considered an UW because no privity of contract with the issuer (a) Happens during waiting period (b) May be post-effective period (c) SGM cant speak with anyone g) Rule 135Not Popularif want to discuss offering before RS filed (1) 135(a)Noticeonly issuer or existing security holder (a) If the UW puts out the notice, then you know the identity of the UW (b) Rule 135(a)Requirements (i) Legend at the top that this isnt an offer for securities (ii) Name Issuer, title, amount, basic info about security (iii) Who is selling securities (iv) Anticipated timing (v) Manner and purpose of offering cant list any U/W because the reputational capital of the UW could prejudice the marketplace h) Reporting Companypublicly traded and subject to periodic reporting requirements (1) Back door reporting companyprivate company that has 500 shareholders and $10 million in assets; then must follow reporting rules (critical mass of people who want the information) (2) Annual Statement10K; Quarterly Statement10Q; Special Event8K; holders of 10% or more and senior officers (subject to reporting requirements) i) 2005Well Known Seasoned Issuer

(1) Must have market capitalization of $700 mill within 60 days of registration (2) Must have registered for equity or debt or preferred stock within the last 3 years (a) Issued $1 billion in debt securities or Preferred Stock (3) Cant be ineligible issuer (i.e. selling asset back securitizations or Mutual Funds) (200430% of all reporting companies qualified) (4) Rule 163may engage in unrestricted oral/written activity before RS filed (a) Completely carved out from gun jumping (b) If written selling activity, then must file with SEC (dont know what penalty is) (c) World knows everything about company, substantial number of analysts cover them (best surprise is no surprise) j) Non-Well Known Seasoned Issuer (1) Reporting and non-reporting (a) ReportingRule 168permitted to publish regularly released factual information and put out forward looking statements so long as done on a regular basis (b) Non-ReportingRule 169may do same as Reporting but information cant be furnished to individuals who are or will be future investors (cant target certain markets); cant publish forward looking information (c) Cant mention offering during any period of time prior to offering unless Rule 135 Notice k) Broker/Dealers(B/D)Section 5 prohibitions apply to anyone so could capture B/D putting out research report when contemplating offering (1) Concern is greater when B/D affiliate could be part of UW offering syndicate (2) Rules when Reports may be issued (a) 137No connectionif B/D no relationship to offering, then may publish so long as part of normal course of business and doesnt receive any compensation (b) 138Applies even if B/D affiliate is part of syndicate, if common stock offering, then may issue report re: debt

securities; must have previously published reports re: same type of securities (c) 139Seasoned company ruleif UW, then B/D may come out with report so long as issues an S-3 and info distributed at least previous report about issuer (d) Industry reports may be issued and talk about company so long as had done so before but cant spotlight company about to issue 4. Waiting Period a) Hard for company and UWs because everything in the hands of the SEC b) Policy behind Waiting Periodgives market cooling off period and so investors may make thoughtful decisions c) Begins with filing RS (1) Preliminary Prospectus (red herring) (PP) (a) Preliminary because no final pricing or pricing related information (b) This is so because dont know what the demand is (c) SEC hasnt commented on it so its preliminary (d) Legend on the front and binding that says Preliminary (red ink) (e) 501(b)(10)Reg S-Ksays what PP must state and where it goes and it must be written in plain English (f) 420(b)doesnt have to be in red ink d) Becomes Final Prospectus upon declaring effective (1) Sales campaign begins for UW (2) Offers to sell are permitted upon filing (a) HistoricallyWritten Offers (i) Use of 10(b) prospectus (ii) Tombstone Ad (2(a)(10) or Rule 134 indentify statement (a) Google used one (essentiallycontact UW for more info) (iii) If debt securities, then may put anticipated debt rating of security (iv) Post-effective period done by UW as chest beating exercise

(v) Most important place in prospectus is top left hand column (vi) Summary Prospectus used by mutual funds (vii) No other writing could be used (if you do sogun jumping) (b) Oral Offers (i) Meet face to face, phone, roadshow (ii) UWs will take members of senior management and go and invite investors and give oral presentation (Q&A) (c) EmailRule 405 makes Email communication; if sent in place of letter e) Rule Changes (1) WKSIS (a) No gun jumping, essentially (b) Rule 163May engage in oral or written communications before RS file, including free-writing prospectus (any writing that isnt statute compliant (c) If comply with Rule 433then it covers anything that isnt covered by 10(b) or 10(a) prospectus (d) Eliminates 5(b)(1) problem (e) Info must not conflict with RS, including periodic reports, if includes information not in prospectus (Rule 408doesnt constitute an admission of a deficient prospectus (i) Must include legend that RS filed and where to obtain one (2) All Other Companies (a) Non-reporting issuers and non-public companies (i) Entitled to free writing so long as RS filed (ii) Must proceed non-compliant written materials (hyperlinks ok) (iii) Prior to filing cant do any of this (iv) Tv/Radiobroad definition of offer (3) Non-WIKSISmay include legend that RS filed (a) Offers to sell may they be acceptedNO (b) U/Wdrumming up interestindicators of interest a written

(c) Distribute red-herrings (d) Go on a roadshow (institutional investors are invited to invest) (i) Rules 433 and 408 apply so long as give out red herrings (ii) Broadcastinglive allowed in webcast, not graphic communication so not free-writing but is an offer and subjects you to 12(a)(2) liability (a) Section 12false misleading, materially false prospectus (iii) Broadcastingrecorded is written communication so isnt required to be filed unless non-reporting company issuing common stock 5. Post-Effective a) SEC effectiveness of RS beginning of period (1) All about market conditions about when to issue (a) Acceleration of effectiveness, then SEC gives when you want b) Once clear SECprice talk and begin selling c) Declared effective even without pricing information (1) Rule 430(a)must publish additional prospectuses with pricing no later than 2nd business day after issuing final prospectus (a) Other people dont necessarily need to know (424(b)supplemental materials re: 430(a) d) Received stock without receiving preliminary prospectus and final prospectusis this legal? YES (1) It was available and they chose not to get the info (2) Investor gets prospectus as memento and not vehicle of info (3) Greatest utility that informs the after market (a) 15(c)2-8(b)only applies to IPOs (i) applies to B/D and UWlikely to participate in initial offering (ii) likely to buy security is to receive prospectus 48 hours before receiving confirmation (a) prepare written confirmation that rules have been complied with

(b) confirmation technically prospectus under the 1933 Act; either prior to confirmation or confirmation with 5(b)(1) e) filed electronically with SECresisted but SEC has oked (1) investors presumed to have access to internet (2) intermediaries may meet (5(b)(1) and (2) by posting on web (3) Rule 172cant deliver securities without prospectuses (if file final prospectus then ok) (4) Issuers, UW, B/D may rely on access = delivery (dont have to physically deliver prospectuses (5) Rule 174if already requirements public no prospectus delivery

f) SEC v. Manor Nursing Centers, Inc. (1) Shares sold on an all or nothing basis (2) Funds supposed to be held in escrow and returned plus interest if not all sold (a) Didnt return money and didnt hold in escrow (3) 4 material developments (a) violated 10(a) because prospectus is misleading (b) certain parties received additional compensation for participating and shares issued for consideration other than cash (c) if material event happens, then sticker the prospectus and send it out again (i.e. quarterly report) (d) if dont sticker and recirculate, then deficient in terms of 10(a) (i) 424(c)file stickered prospectus g) If positive event occurs before effective date, and before all securities are sold do you have to change prospectus? (1) Price probably wont change, but still want to sticker and recirculate so may change price (go up) (2) Secondary marketpeople who sell not knowing positive development (a) No statutory duty required to update in post-effective (i) May have to file form 8-K re: material development B. Pros and Cons of Going Public

1. Pros a) Access to large amounts of capital b) Easier to raise capital c) Capital improves net worth of company so improves balance sheet d) Cost of capital is cheaper in public arena vs. private (1) More liquidity in public market (2) May sell small percentage of company for higher per share price (a) Private more equity for higher price per share e) Offer stock options to employees (1) If company performs well and price increases then you get it at a low price (2) Privateyou need to assess value and then determine if went up (a) Dont have a market to determine price of company f) Could be easier to acquire other companies because can offer stock that is redeemable in secondary market g) Become rich h) Great publicity; exposure increases i) Perpetuates management in power because of the large number of shareholders 2. Cons a) Retain control over board (1) If public, existing board may retain more control over management b) Living in a glass house; competitors know whats up c) IPO may not go up (typically goes up initially (1) Only so many shares in the market (supply and demand; under priced so can get shares out the door d) Speculationpressure on public company to focus on short-term growth at expense of long-term growth e) Cost of Compliance increases (1) Cost of going public (RS300k-800k) (huge amount of senior management time, away from companys businesss) (2) Takes 3-6 months (3) UW commissions6-8% of proceeds

(a) Google negotiated 2.8% (4) On-going expenseslawyers, accountants disclosures, including audited financial statements preparing

(a) Low market cap to have to comply (less than $100 mill) (b) Costs 700-1 mill/year to comply f) Hostile takeover g) Lack of flexibilitycant talk to stockholders re: options must communicate through proxy statements h) Cost to file RS C. Registration Process 1. Qualitative Disclosurenot number oriented, goes to the quality of person/thing being discussed 2. In the Matter of Franchard Corp. (Glickman Case) a) Glickman controlled the board and began to finance things by pledging his stock b) SEC ruled (1) Shouldve disclosed pledging of shares because could lose control of company if default (2) Evaluation of the integrity of Glickman is always material (3) Company argued that it didnt see a lot of the disclosure stuff it was calling forthe SEC responded by referring to Section 408 (4) SEC Remedypublicly disclose to all past and present shareholders a copy of the SEC opinion which would lead to possible class action suits 3. Registration S-K a) Section 400 items to be disclosed: (1) Criminal convictions and pending proceedings, prior SEC infractions, bankruptcy proceedings, compensation, including options, conflict of interest transactions (2) Section 16(a)reporting persons, officers, directors and holders of 10%+ of stock, code of ethics for officers and directors (3) Should you disclose present/past health problems? (a) What if you had AIDS? (b) Religion not allowed to seek medical help (c) Steve Jobs?

(d) Superstar CEO (Public Figure); Other Guys? standard or multiple standards) (e) What if a large shareholder?

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(f) If CEOs dont matter why do we disclose who they are (g) Shareholders will determine if theyve been deceived so if didnt disclose but should have beenRule 10(b)(5) suite could be brought 4. Projections (Soft InformationPredictions of how might do in the future) a) Trends in a particular industry (1) SEC hated projections because they will always be wrong (2) UKprojections are what investors want (3) Companies dont want to be liable each time they didnt come true (4) 33 Act Section 27A; 34 Act Section 21Emay provide forward looking statements in prospectus or report so long as followed up with meaningful cautionary language 5. Shelf Registration a) Must Qualify as an S-3 company b) Register more securities than you need so they may be used and sold when needed c) Rule 415 (33 Act)used to be outside limit (must be sold within 2 years) (1) Still true for some business combination securities (2) 2 year limit ended and its the earlier of sold all securities or 3 years (a) if shares registered but not sold; then submit new registration statement and get a credit for the fees paid previously (rollover minutes) (b) may be issued same daydebt securities because sensitive to interest rates d) Two parts to a registration statement (1) Basegeneric information that is applicable to any offering with respect to anything that could be issued, doesnt specify type of security to be issued (2) Supplementsecurity specific, usually done day of issuance, typically when put on shelf company may have an offering in mind e) common stock reluctant to be put on the shelf

(1) dilution issuesexisting shareholders are concerned (2) if money not put to good use, then earnings per share decreases (3) Now less concern with putting common stock on the shelf (a) Universal self-registrationpre-register debt securities and equity securities so anything is available to issue (i) This created more acceptance of putting common stock on the shelf 6. Google Prospectus a) Regulation 501Rule 421(d)cover must be written in plain English What is a Security? 1) 33 Act-Section 2(a)(1); 34 Act 3(a)(10) 2) Defined specifically and generically a) Specific i) Notes ii) Stock iii) Bonds iv) Debentures b) General i) Evidence of indebtedness ii) Investment contract iii) Any interest or interst commonly known as a security 3) Look at the lead in to Section 2 unless the context otherwise requires a) Gives the court wiggle room to determine if it is a security 4) SEC v. WJ Howey Co. a) WJH owns land with citrus trees; service company cultivates trees and gets them out into the public i) Offered land sales contract and service contracts ii) Once contract signed they get warranty deed b) Must also enter into service contract and profits pooled and disbursed pro rata (10 yrs. No way out) i) Prospective purchasers typically non-FL residents, vacationersgreed element drives idea to pursue c) how does citrus grove and service contract become a security i) considered an investment contract ii) Court looked to states blue sky laws iii) Investment Contract definition (p257) (1) 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 third party, it being immaterial whether the shares in the enterprise are evidenced by formal certificates or by nominal interests in the physical assets employed in the enterprise

5) 6) 7)

8)

(a) 3 Key elements (i) Investment of moneymay be any form of valid consideration (doesnt have to be cash); NY and DE property and services are valid considerations for stock (ii) Common Enterpisecrops pooled together; investors fortunes all woven together (iii) Led to expect profits solely from the efforts of a promoter or third party d) Purpose of issuing deed and service contractway to get around this being the sale of a securityconvenient way to determine allocable profits and losses e) If only sold land and made service contract optional; then may not be investment contractwierd because may not be offering securities to all f) Economic reality testlook at the economics of the transaction HYPOcondo purchase in resort areasame offer made to everyone; developer will provide certain servicesrent it out for you, generic furniture a) SEC releasemay constitute an offering of securitiesdepends on the details HYPOco-op buy stock in co-op corporation, shares come with lease; sale of stock in co-op a security? United Housing Foundation, Inc. v. Formanco-op stock is not a security a) Buyers in a co-op b) Juxtapose with Landreth casetraditional attributes of stock i) Right to receive dividends(if declared) dont get any in co-ops ii) Negotiablecan sell it subject to board approval iii) Can be pledged/hypothecatedyes iv) Voting rightsyes v) Capacity to appreciate in valueyes (1) Based on this Forman seems wrongly decided c) NYSMartin Act regulates co-op offerings; must provide prospectus; heavily regulated SEC v. Koscot a) Pyramid schemefocus on details i) Sell cosmeticsmake the spread ii) Recruiting more people (1) Beauty advisor45% discount, make the spread (2) Supervisorpay $1,000.00 and 55% discount and $600.00 for each supervisor you bring in (3) 65% discount and $600.00/supervisor and $3,000.00/distributor iii) Opportunity meetings; friends and family, curiosity approach (1) Scripts for meetings b) SECs position i) Sale of cosmetics is cool ii) Recruitment aspects fall with 2(a)(1) definition of security c) District Courtnot sale of security because 3rd element of Howey was lacking because had to expend effort (find people and bring them in, pitch, if lose got to pursue others) i) Not solely through the efforts of other people (youre not just sitting back watching tv) th CircuitSOLELY on the efforts of othersliterally or functionally? d) 5 i) Apply Howey (investment of money1,000 to 3,000)

ii) Commonalityinterwoven, dependent on Koscots efficacy (Prof says differentiated among investor efforts, not focused on by the courts) (Court says without the scheme; no money would be made iii) Why would literal approach have been badslippery slopecould have investors do something nominal so that it wouldnt be solely on efforts of other people (Prof but for bringing asses in, no one could make money) iv) Court adopts gloss from 9th Circuit (1) Focus on the promoter, not the investor (undeniably significant)essential managerial efforts that affect the success/failure (MANAGERIAL TYPE TEST) (a) Koscot planned meetingsmost essential managerial efforts were putting the scripts together (Court wrongly characterized investor efforts as nominal) (i) Could you argue that the investors were Koscot employees? 1. Like employees working on commission? (Small changes change the analysis completely) 9) SCM 16Albania Ponzi Scheme a) The burned blamed it on the government 10) Franchises a) Sale of franchisesno despite managerial help, supportbut you are the one at the store doing lots of work (argument) 11) SEC v. Edwards (FIXED RETURNSHOWEY and KOSCOT VARIABLE RETURNS) a) Payphone sale/lease back arrangement; guaranteed 14% returns b) 11th Circuitsays not a security i) Investment contracts, based on precedent, didnt encompass schemes with fixed returns ii) Contract entitles you to returnsyou shall receive Xnot based solely on efforts of others c) Supreme Court i) Just because scheme is based on a contract, it doesnt mean it is an investment contract ii) Why distinguish between fixed and variable returnsno reason toin fact, guaranteed returns are more dangerous because they appear conservative (particularly insidious 12) Teamsters v. Daniel a) Daniel was denied a pension because of a technicalityhis LDapproach it was a security so we can sue under the 33 Act b) Pension non-contributory, compulsory pension plan (participate whether you want to or not, you cant pull out, stuck with it (Daniel didnt personally contribute, the employer did (Court said Daniel couldve contributed himself) c) Plaintiff arguesteamsters misrepresented/omitted; violated 10(b)(5) and 17(a) of 33 Act (1. Security; 2. Securities Fraud) d) Lower Courtyes investment contractsecurity under 2(a)(1) and a sale under 2(a)(3) because he voted for this pension arrangement e) Supreme CourtApply Howey i) Noemployers are investing money, not the employees (1) Profisnt the employee foregoing something good for this pension contribution (supreme court disparages Daniels argumentthat its abstract

(2) Considerationcash, services, or goods (this guy worked for 20 years but didnt give anything of value ii) Commonalitylike social security system; majority of money to retirees flows from current employees, no expectation of profits iii) Not addresseddidnt meet the first 2 elements STOCK 13) Landreth Timber Company v. Landreth a) How to sell your business i) Buyer buys all of your assets ii) Buyer buys all of your stock (tax issues) b) Buyer seeks rescission and damages claiming he bought stock in an illegal offering under 33 Act and 34 misrepresentations and fraud c) Not an IPOwe are selling our businesscash for stock i) Not to raise capital, the device we chose was a stock deal (could have gone for an asset deal (Sale of Business Doctrinebuyer purchased the business not a security; just passing control d) Lower courtembraces the sale of business doctrine100% sale of stock in a closely held corporationbuyer was heavily involved, partially to blame for collapse e) BUT IT IS STOCKspecifically listed in 2(a)(1)lower court just because its called stock isnt enoughlead in to Section 2unless otherwise what the lead in is there for f) Supreme CourtgoofCampbell chicken soup would work i) Chides the lower court re HT application---dont apply it here its stock (1) Specifically listed (2) Some characteristics of it (application of attributes is a little off) (a) Negotiability yes it was sold4(1)it cant be stock if it wasnt registered??? HUH??? (Prof. says clerk is a goofus) (what about non-voting stock???) (b) Does the Landreth stock have the right (not a right) to receive dividends yes (c) Could be pledged? (d) Voting2 different classes here (e) Appreciation capacityyes ii) Passage of Controlessential element of the SOB doctrine (slippery slopewhere do you draw the linehere it was 100%, but could open a can of worms) (1) Non legal distinction made re: the control concept iii) Stockplain definition and attributesthats it, doesnt matter if its being sold as an IPO or the sale of a businessstock is special paradigm of a securitydont apply this analysis to anything else (PROF calls the analysis NAVE) iv) What if it was an asset dealassets of a timber company arent securitiesbuyer wouldnt have a federal securities law claim NOTE 1) REVES v. ERNST & YOUNG a) Small farmers pool resources i) Co-op acts as marketing arm ii) Provides financing to farmers

b) Co-op raises money by selling notespayable on demand by holder (no set maturity date c) EY argues notes not securities d) 3 Approaches to determine if a Note is a Security i) Investment v. Commercial Approach (1) Capital raising by issuer and purchasers looking for returnsecurity (2) Issuer looking to sell you something so issued in a commercial or consumer context ii) Family Resemblance Approach (1) Note presumed to be security and then decide if should be backed out (a) If it shows strong family resemblance to an item on a judicially crafted list of exceptions or persuades should be added to list iii) HoweyEconomic Reality Test (1) Court rejects this and says Howey all about investment contracts only and nothing else e) Court adopts Family Resemblance Approach i) Rebuttable presumption that a note is a security (1) If a note resembles something on a the list or should be added, then rebuttal is met (a) Note re: consumer transaction (financing); note secured by mortgage; short term note secured by lien on small business assets; character loanpersonal loan; note secured by accounts receivable (i) 1-off notes issued by people who need to issue 1 at a time (ii) Banks accepting notes because it is there business (banks take money as deposits, give interest and then lend at a higher rate and make the spread) (iii) FACTORS TO BE ANALYZED 1. Motivation behind the transaction a. (raise money for general use of a business enterprise or to finance substantial investments and the buyer is interested primarily in the profit note is expected to generate, then security b. If not is exchanged to facilitate purchase and sale of a minor asset or consume good, to correct for sellers cash-flow problem or to advance some other commercial purposenot typically not a security 2. Plan of distribution of instrument a. Consumer no plancommon trading for speculation or investment) 3. Reasonable expectation of public a. Would the public view this as a security; public must be able to purchase 4. Is there another regulatory scheme if not then may be securities laws a. FDIC then may not mandate use of securities laws f) Application i) Co-op issued notes to raise capital for its general business operations and buyers expected a return (profit)

ii) Offered to public and own members (sold to public can mean common trading isnt an instrument (Prof disagrees doesnt believe in the common trading notion but says regulatory scheme is needed iii) Notes advertised as investements so security iv) No risk reducing factornotes uncollateralized and uninsured and would escape regulation so court applied securities laws g) Defendant focused on demand feature of the notesargument unpersuasive Other Types of Interests 1) General Partnership Interest a) Not security; all general partnerships have the same control; general partnerships not passive investors, have equal right in management i) Williamson v. Tuckermust argue that you are a de facto limited partnership (1) Partnership agreement that leaves so little power in your hands then become limited partner (2) Partnership so inexperienced and unknowledgable so is incapable of intelligently exercising partnership powers (3) [DONALD TRUMP]partner dependent on entrepreneurial or managerial ability of promoter/manager that cant replace manager of enterprise or exercise meaningful partnerships 2) Limited Partnership a) general presumption that interests are securities because limited partnerships are designed to be passive investors, relied on others to make money i) if go too far then may become general partnership because overstep control line and if do so then argument of being limited partnership may be ignored (1) Steinhardtlimited partner retained pervasive control over investment so cant be deemed a passive investor under Howey 3) Limited Liability Company Interests a) Great Lakes Chemical Corp. v. Monsanto i) 2 companies form NSC and sold 100% interests to GLCC and GLCC sued NSC for failing to include material information ii) 3 precedential cases applied to Howey iii) GLCC says LLC interest should be treated as stock because interests are functional equivalent of stock (1) Court doesnt believe should be treated as stock (a) Answer is weak says Prof (b) Highlight similarities but says not traditional stock iv) Court Applies Howey and considers whether interest could be seen as a security (1) 1st elementinvestment of money, purchased LLC interests for cash (2) 2nd elementdefendants argue because bought 100% so no interests pooled (a) When LLC created defendants pooled money so common enterprise (b) Court sides with defendants and says look at time of sale not @ LLC formation (i) Court says no common enterprise in either horizontal or vertical concept (ii) This case no because bought 100% of interest 1. HorizontalHowey test (pool money and receive distribution of profit and loss

2. VerticalKoscotinvestor and promoter in common enterprise; how well you interfere with promoter and how promoter does job rd elementdo LLC membership interests satisfy this element? (3) 3 (a) depends on LLC agreement (i) is LLC run like GPmember managed (wont be security) (ii) Manager managed LLC; agreement concedes power to 1 or more people/entitiesinterests like LP so may be security 1. GLCC argues that this element is met because members no authority to manage/control operations of company so rely on others efforts a. Court says no because GLCC may change whenever, may dissolve LLC, and may remove managers whenever because own 100% (Respondeat Superior) EXEMPTED SECURITIES 1) Section 3Exempted SEcurities a) So long as maintain exempt attributes then 33 Act doesnt apply except when 33 Act expressly applies i) 17(c)Section 3 doesnt apply to Section 17 (SEC only enforce anti-fraud provisions 2) Section 4Transaction Exemptionsonly applies to exempt securities from Section 5 (registration provision) a) All transactions expire upon completion of qualifying transaction i) If Exempt SecurityA to B to C to D (may sell freely) ii) If Exempt TransactionA to B to C to D (1) Each transaction must be registered or another transaction exemption (a) B to C to DSection 4(1) exempts almost all secondary market trades (i) Underwriter and B/D definitions are broad and capture more people 3) Section 3not all securities listed are exempt a) 3(a)(2)-3(a)(8)true exempt securities i) 3(a)(2)securities issued or guaranteed by any Federal and State government (virtually no risk) ii) 3(a)(3)notes that have maturities not to exceed 9 months for current operations (1) Commercial paper, high credit worthiness used to fund current operations iii) 3(a)(4)charitable organizations iv) 3(a)(5)savings and loan and building societies (farmers co-op exemption) v) 3(a)(7)trustee or debtor in possession (DIP) in bankruptcy b) 3(a)(9), 3(a)(10), 3(a)(11)really exempt transactions c) 3(b)exempt same transaction if money amount is so small that no one cares ($5 mill); small issue offering exemption i) Regulation A ii) Regulation D Sections 504 and 505 d) 3(c)SEC may exempt securities from unregistered mutual funds that invests in small business and givers managerial advice EXEMPT TRANSACTIONS 1) Section 4(2)Private Placement i) Section 5 doesnt apply to transactions by issuer not involving public offering (1) If not issuer cant engage in this transaction (2) Purpose of Sectionpolicy to help small business that couldnt pay for registration and wont be much help

(3) Private offeringoffered to sophisticated investor and provide disclosure so long as people may read/understand information dont need to register (a) Friends and family investment really investment for guilt and registration wont do much (b) Institutional investors may demand information and documents and hold all the cards so may get all information need to decide to invest ii) FACTORS (1) Small number of investors (number isnt dispositive) (larger numbers then argument engaged in public ads) (2) KEYACCESS To information (existence of information)if structured like a registration statement but didnt filed with SEC then may be good (3) Sophistication of investorsif not given information and give access to due diligence fishing expedition need to have knowledge to request the right information (4) Relationship between offeree and issuer (5) Manner of offering 2) SEC v. Ralston Purina a) Transaction exemption didnt exist b) Emphasis is on the investors. They didnt have access to information that would be in a prospectus (without information couldnt protect themselves so needed 33 Act protection i) People who can fend for themselves are those who may be part of an exempt transaction (fend for themselves = economic sophistication; and access to similar information that would be in a registration statement) ii) May sell securities to select employees with access to information (senior management, directors, etc.) iii) If only access to information then level of sophistication of investor is important because need to know what information to ask for iv) If access and available information, then in better position v) Not about numbers but sophistication and access to information (what about limiting the number of investors?) (1) Problemgreater number of purchasers and the no nexus to people so had to get to them through advertising vi) Issuer has burden of proof to establish that they are exempt 3) DORAN v. PETROLEUM MANAGEMENT CORP. a) District Court said private placement was available and Doran could fend for himself b) Appeals court said 4 factors are relevant (not dispositive) i) Number of offereesmust need to know how many, could shed light on manner of offering (1) Higher number of offerees more likely public (2) Once identified then may investigate relationship with issuer (3) Act is about disclosure of information to offerees not public sales (a) Safe harbor provisionhas carve out for purchasers (4) If cant come up with all the names then this is fatal (a) MUST KEEP CONTROL OVER THE PROCESS; MUST KEEP LIST OF ALL OFFEREES and INFORMATION DISTRIBUTED (b) More you pitch, more likely public

(c) Identity goes to sophistication (even if 1 sophisticated and 7 unsophisticated then deal dies) (5) Relationship to between offerees not important (6) Relationship between issuer and offerees (a) Sophistication of offerees (not substitute for access to information) (b) Ability to fend for themselves (i) Less sophisticated more likely need protection under 33 Act 1. not all offerees must be sophisticated but dependent upon how information given to offerees a. 506everyone must be sophisticatedeither alone or with purchaser representative (c) Access to information also (not just sophistication) (i) Do you receive or have access to information would get in public offering 1. effective accessinformation is there but not in an easily organized manner (offerees trace access to books, records, files of issuer, and may ask questions of management that would yield same information as a public offering a. must be real not imaginary (ii) to determine who has access must look at their leverage 1. when issuer relies on access then offerees must have privileged positiontransactional insider a. people who will write a huge check so management will bend over backwards to obtain investment (offerees who may demand and receive information) 2. if issuer who relies on access then all offerees must be sophisticated; need to know what to ask for; and what documents to request, know what to do with the information a. actual disclosureput together a document that contains same information as a prospectus and give people (private placement memorandum) i. when provided didnt need to be in privileged position ii. enforce accuracy of disclosure document10(b)(5) of the 34 Actany fraud with purchase of security then liable civilly and criminally ii) number of units offeredfunction of money per unit iii) size of offeringshouldnt matter because either needs protection or not (1) Rule 506 of Reg Dno limits on amount of money that may be raised iv) manner of offeringif engage in general solicitation or advertise then bad and could be illegal offering REGULATION D 1) Rule 504 i) Upper limit on amount may be offered (1 mill) ii) Designed for extremely small offerings (1) Limited in geographic scope and regulated by applicable state blue sky laws iii) certain issuers may not use (1) reporting company (2) investment company (mutual fund)

(3) development stage, with no business plan iv) doesnt limit number of purchasers v) dont have to furnish any specific disclosure, must comply with state law vi) may engage in general ad and general solicitation if permitted by state law b) Rule 505 i) Upper limit $5 million within one year ii) Cap on number of purchasers (1) Up to 35 (2) 501(e)(1)may exclude every investor who qualifies as an accredited investor (relative, spouse, or relative of a spouse may be excluded) (i.e. husband and wife only = 1 person) (3) 501(a)(8)entities only count as 1 person unless created to only acquire security and dont otherwise count as acquired then all members of entity count as purchasers (4) Accredited investors (501(a) (a) Banks, broker/dealers, tax exempt organizations501(c)(3); any director, general partner, executive of issuer (b) Natural person (c) Pass either net worth test or income test (i) 501(a)(5)Net worth of 1+ mill (you or you and spouse) may include value of your home (ii) Income 200+ past 2 years; 300+ for husband and wife each 2 years and reasonable expectation of doing just as well this year (d) Any entity in which all investors of which individually qualify also qualifies (i) Issuers arent strictly liable if not really accredited only need reasonable belief accredited (e) Not required to have any certain level of sophistication (i) Up to 35 poor investors regardless of sophistications (35 dumb poor) c) Differences between 504 and 505 i) Information502(b) specific information must be provided to each unaccredited investor dont have to give to accredited investors ii) Reporting companies could use this (1) Difference in information to be provided for reporting and non-reporting iii) Ads and solicitationscant engage in general solicitation or ads (1) How to counteract this (show pre-existing business relationship) d) Rule 506 i) No cap on upper limit (unlimited amount to raise) because private placement ii) 35 purchasers (non-accredited); exclude accredited (unlimited accredited) (1) Knowledge and experience in investing (2) May move person into sophisticated by purchaser representative who understands (a) Outsource sophistication (b) 501(h) (i) Cant be affiliate, director, officer of issuer (only in limited circumstances) (ii) Such knowledge in business and investment that may weigh merits of investment (iii) Must acknowledge in writing that person is their rep

(iv) Purchaser rep must disclose any material relationship, including any money receiving 1. issuer may hire purchaser rep for people a. doesnt relieve purchaser rep of fiduciary duties to purchaser b. tell them you can lose all money and cant sell security iii) up to 35 smart poor investors e) why dont worry about rich dumb because they could hire someone to tell them if this is good f) maximum number of people to sell to unlimited g) more offerees (more likely engaged in public offering) h) potential to become backdoor reporting company i) 34 Act 12(g)(1)if 10 million in assets and securities, equity held by more than 500 investors then reporting i) Section 18 of 33 Act i) Downside to 504 and 505 vs. 506 (1) Securities issued are covered securities so issuers dont need to fully register with states (2) Notice filing with state and pay filing fee and states may not engage in merit review (3) 504 and 505 not covered securities so must fully register with state 2) Integration a) If multiple offerings in certain period that each small offering are exempt but put together then not exempt b) Policy i) Registration avoidance technique by fracturing large offering (i.e. raise 10 mill through Reg A offering and then Rule 505 offering ii) Prevent preconditioning of marketplace c) If integration occurs depends on facts and circumstances i) Single plan of financing ii) Same class of security iii) Made about same time iv) Same type of consideration received (not that important) v) Made for same general purpose d) Problem with private placementpublic offering, gun jumping e) Public offering then private placementprotections are different i) Cant advertise, generally solicit 3) Rule 155Integration of Abandoned Offerings a) Private Placement then public offering i) Rule 155(b) wont be integrated with public offering ii) Cant sell any securities in private placement iii) Registration statement must be filed 30+ days after termination of private placement unless only made to accredited investors and sophisticated investors iv) Full disclosure in preliminary prospectus and final prospectus b) Registered offering then Private Placement i) Cant sell any securities in public offering ii) Withdrawn registration statement re: Rule 477 iii) Private placement must commence 30+ days after registration statement been withdrawn

iv) Each offeree must be told not registred so lose certain protections v) Private placement memo must include most up-to-date information re: offering Other Exemptions 1) Regulation A (Rules 251-263) a) Mimics public offering; ability to publicize offering b) Reporting company may not use c) No investment company (Mutual Funds) d) No shell companies e) Rule 262(a)if abuse laws may not use safe harbors (convicted of violating securities laws last 5 years) f) Raise up to 5 mill g) Up to 1.5 million may consist of securities sold as an exit strategy h) Rule 251(a)Integration Bright Line Test i) Prior to Reg A offering wont be integrated at all (1) Nothing that occurred prior to Reg A may be integrated into Reg A (2) Could be an issue going backwards (i.e. raise 3 mill with Reg A and 5 mill with 505 then may blow up 505 (3) Wont be integrated if 6+ months after (4) What if make offers but no takersdirty 6 month period doesnt impact Reg A offering i) Offering Conditions (Rule 251(d)) i) File docs with the SEC to be reviewed ii) May make offers orally or preliminary offering document iii) Place ad that states limited information of issuer and where to obtain issue materials iv) May sell pursuant to final offering v) DO IT YOURSELF Offering j) Rule 254Test the Waters Rule i) Allows potential issuers to solicit offers (gauge interest) ii) Quintessential gun jumping iii) Cant take any money or accept any offers iv) Dont have to worry about accreditation or sophistication or number of offerees or purchasers k) Regulation A Cons i) If need 5+ mill then screwed ii) 506 only allows unlimited amount iii) Must do filings and SEC may comment (1) Slow you down (2) Increase costs iv) Not reporting company but all competitors may obtain information v) Not covered securities so full blow state regulation 2) Rule 701 Exemption a) Helps small companies give stock to employees and advisors b) Constitutes restricted securities must look at 4(1) and its safe harbor Rule 144 c) No disclosure but must provide copy of the benefit plan d) e) 7 Things to Keep In Mind i) Availability

(1) not available to reporting companies (2) reporting companies register stock for employees (S-8) ii) Plan (1) Securities must be sold via bona fide compensatory benefit plan iii) Cap (1) Money raised is capped because not designed as capital raising tool (2) Its only a side effect of the plan (a) During any 12 month period it is the greater of (i) 1 mill (ii) 15% of total assets as of the end of the last fiscal year (iii) 15% of class shares still outstanding 1. 2 and 3 allow you to raise 1+ mill; cap is at 5 mill 2. at least 1 mill up to 5 mill iv) Integration (1) Not integrated with any offering (doesnt count against any other transaction exemption v) Disclosure (1) Limited only need to provide employee with copy of the plan (2) Anti-fraud provisions still apply (10(b)(5) (3) Employees present so know whats going on vi) Advisor (1) May in limited circumstances compensate advisors/consultants (a) May be issued to institutions only natural persons and services may not be involved in capital raising activities (lawyer who negotiates new lease) vii) Resale (1) Restricted securities so to re-sell must follow Rule 144 3) Intrastate Offerings (Section 3(a)(11)Exempt from Section 5 registration a) Provide local financing to local businesses i) Local blue sky laws govern b) Just because call on phone, email, and mail things still exempt c) Cant mix and match transaction exemptions if 1 is intrastate i) Everything in-state or not for each d) Not only sold in state but also must come to rest in the state e) Doing business in the state i) choice of incorporation is key ii) corporation may only raise money intrastate in state you are incorporated iii) must have substantial business activities in that state (1) cant create NY subsidiary to raise money and then up flow the cash to DE parent company (2) Rule 147 safe harbor f) Residence within the State i) Formal representations are not enough and if get residency wrong then GAME OVER for exemption (guarantee) (1) Regulation D only need reasonable belief (2) No longer have exemption then hope transaction had qualified under some other offering, if no then must give back money g) All offers must be made intrastate h) Rule 147even if dont comply with Rule then may still come within target

i) Doing business within the state (1) At least 80% of gross revenues and assets must be within state (2) Principal office in state (3) At least 80% of net proceeds must be used within state ii) Resales (1) 147(e)purchasers in offering cant resell to anyone out of state until 9 months after offering is complete (may not be dispositive but will help your case) (2) Preventive measures (147(f)) (a) Legend on stock certificate (securities not registered and set forth 147(e) language (b) Stop transfer notice to transfer agent (c) Obtain written representation from purchaser as to residence (i) Case law says such representation doesnt matter (SEC saw this as draconian) (d) Must communicate resale instructions when you make offering UNDERWRITER LIABILITY 1) Who is an Underwriter a) Who can rely on Section 4(1) transaction exemption and when can they rely i) If issuer, UW, or dealer cant rely on 4(1) ii) Issuer (4(2)) to Purchaser A then to Others (1) If do immediately looks like Purchaser A is UW (2) 4(2) cant be relied on because only available to issuer (a) Purchaser A needs 4(1) iii) Public or Issuer to Control Person then to Others (1) Unlevel playing field in access to information (insider trading) (a) Restrict availability of 4(1) by expanded definition of issuer b) Inadvertent UWSection 12 remedy applies to any person who sells securities that violates Section 5 c) Holder of restricted securities cant sell unless register or another transaction exemption d) UW (2(a)(11) X A B C 1 2 i) Issuerall companies above can be considered issuers if any of the companies own Bs securities and sells them then will be considered an issuer if test is met ii) May apply to anyone who purchases securities with a view to distributing to public (1) Public deserves disclosure protections (2) May offer to sell securities with a view to selling to the public (3) Anyone who participates directly/indirectly in offering of securities to the public 2) SEC v. Chinese Consolidated Benevolent Association a) Section 4(1)only intended to exempt transactions after securities are issued b) Lack of a contractual obligation doesnt matteronly thing that matters is that you are participating in distributing securities to the public c) Chinese guilty of violating the securities laws i) Result if nation does what China didcould restrict Chinas access to US capital markets

3)

4)

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d) Cant gratuitously or unilaterally participate in an offering e) Organization that participates in the distribution may be an UW i) Org wasnt paid, no contract, doing it for benevolent reasonsdoesnt matter SEC v. Guild Films a) Price of pledged stock drops and bank wouldnt call loan if put up more capital so bank attempted to sell stock and transfer agent refused because of the legend on the certificate b) Banks positionwe are pledgee and we never dealt with issuer i) Dont need official relationship/contract to be an UW ii) Good faith argument is irrelevant because of legend on stock certificates (court rejects argument) iii) Pledgee discussed by Congress but rejected by Congressno exemption because would create loophole to get securities in market without registering iv) Didnt purchase securitiesbut selling securities to recoup money lent (sale for value) v) Did banks take securities with view to distributing? Yes because taking collateral to recoup funds vi) UW when sell securities without registering Ira Haupt & Co. (Whiskey Dividend Case) a) IH is an UW because participating in distribution of securities from issuer to the public b) IH not dealing with P&T but dealing with Schulte who controls P&T c) Distribution i) Distribution of large block of stock that makes way to public ii) Schulte intended to sell stock iii) Does preordained number matter, not so long as intent is to distribute large block d) Broker Exemption i) Defense is good but not here because no one believed the argument because only brokerage firm that effectuated the sale of 90,000 shares ii) Lack of knowledge so broker exempt but designed to protect brokers who handle ordinary trades (1) 4(4) meant to monitor distinction between trading and distributing US v. Woflson a) WolfsonControl Person, guiding spirit., large enough stock holder that decisions werent made without his approval b) Defendant argued the sales should fall under 4(1)court rejects the argument and says must find its own exemption i) Because control person cant take advantage of 4(1) c) Brokers werent skewered i) Spread out trades over approximately 15 brokerage houses (1) May argue that didnt know was part of distribution to public (2) Spreading out across brokerage houses goes to show that he knew what he was doing Control Concept (FACT SPECIFIC) a) No mathematical formula b) More stock you own more likely in control c) Wolfson owned 40% and had guiding spirit role d) Stock ownership i) 10% is magic number

ii) 10% publicly traded person, then do analysis to determine if control person iii) 10% reporting person file reports with SEC iv) 16(b)34 Act if 10% and buy and sell within 6 months, then presumes doing so for insider trading purposes and you must divest self of all gains e) Facts to Consider i) If power to force filing RS, then have control (1) Have this via contract (2) Ability to do this without contract ii) If can elect majority of board (goes to % of your stock ownership) iii) New CEO (identity of person), officer director and stock ownership and then determine if control person iv) Doesnt matter if choose to exercise power so long as have power, then control person v) Maybe control groupneed nexus among group (1) 13(d)34 Act if own 5% then must file disclosure statements to state your intentions 7) Rule 144 a) Why important i) Creates safe harbor for Section 4(1) (1) Main purpose to allow holders of unregistered securities to resell to public upon satisfying conditions (a) Before 144bad place because SEC refused to opine whether someone would be deemed an UW (i) Part of taking distribution is to do so with intent to resell (b) Dirt road onto superhighway (i) Few to sell when private placement (ii) Rule 144 is ramp onto superhighway (iii) If dont comply with Rule 144may be able to argue facts and circumstances (iv) Rule 144differentiates between affiliates of Issuer (Rule 144(a)(1)) and non-affiliates (c) 144(a)(3)restricted shares that are acquired in transaction, not involving registration or public offering (d) Restricted securities (securities that are unregistered (i) Acquired from issuer directly/indirectly from affiliate (i.e. private placement (Rule 144(a)(3)(i) b) Control Shares i) Previously registered shares, publicly traded, that are now in hands of an affiliate (control person) when want to resell must comply with Rule 144 (because controlled by control shares) (1) 144(e)(1) limits amount of securities may sell (amount of securities sold for the account of an affiliate (both restricted and unrestricted)) c) Non-affiliates (never been registered) (144(1)) i) Rule 144(d)Holding period (1) Originally2 years then only sold by dribbling them (volume restriction) then 3 years may sell all of them (2) NOW1 year then may dribble into market then after 2 years may sell all

(3) When reporting company, 6 month holding period; volume restriction doesnt apply to non-affiliates ii) Those who resell to another purchaser privately, then may tack holding periods (if 1 held for 3 months, then 2 held 3 months then ok) iii) If give to affiliate, then cant tack holding period because affiliate is deemed an insider (1) If buy from affiliate then have new 6 month holding period iv) What if hedge position during holding period (1) Pre-1990SEC said if invest with intent, then must expose self to losses (a) Hedging would toll your holding period (gone since 1990) (2) NOW no more tolling can hedge immediately (only applies to reporting companies v) What if non-affiliate, non-reporting company (1) 1 year holding period (cant sell to public) (a) No trading market for securities (i) Oddity no current public information (ii) Complete coverage but also disingenuous to require this vi) Non-Affiliate Reporting Company (1) Public informationnon-affiliate of reporting must insure current adequate public information between 6 months and 1 year periods (a) Really should be companys job but also to insure buyers have access to information (b) Can confirm that company has filed reports by looking at Form 10K or 10Q cover which shows information (c) So long as reporting company isnt delinquent in reporting vii) Resales by Affiliates (Restricted and Control Shares) (1) Previously registered securities (2) Holding periodrestricted same as for non-affiliate (6 months) (3) Control Sharesaffiliate no holding period (a) Problem 16(b)short swing profit provision if sell for profit within 6 months and then must comply because presumes inside information (4) Current Public InformationAffiliate current public information whenever resales occur doesnt matter if reporting or non-reporting (restricted and control shares) (a) Level playing field (5) Volume Restriction (a) Affiliaterestricted (dont want high volume that disrupts market (i) During any 3 month windowmay be greater of 1% of shares or average weekly reporting volume in recent past (ii) Apply to restricted and control shares (iii) Must sell pursuant to dribble rule (cant impact market by dumping securities) viii) Manner of Sale (144(f) and (g) (1) Must sell securities to public through ordinary brokers or market maker (2) Doesnt apply to debt securities (3) (g)broker exemption if company with (g) then may avail selves of 4(4) (4) Control and Restricted Shares

(a) If sell material amount in 3 months, then must make Rule 144 filing with SEC (either $50K or 5,000+ shares or units) (5) If sell material amount, then notice filing with SEC (6) Control Sharesno holding period ix) What exemption does non-affiliate rely to sell privately to non-affiliate? (1) Section 4(1) exemption because believing not issuer/UW (2) Section 4(1.5) exemption doesnt reallyexist but 1 non-affiliate selling to another in transaction thats like private placement (a) Not private placement because only for issuers (4(2)) (b) Did non-affiliate take with view for distribution because if so, then lose private placement exemption (i) Evidence of this is to hold onto securities for period of time (ii) Rule 144 only 6 months but still be wary d) 144(1.5) made more sense when holding period was longer i) 144(A)covers resales to certain buyers (1) qualified institutional buyers (QIB)insurance company, pension plans (i) Issuer sells to purchaser under 4(2) or 506 and purchaser flips automatically to ordinary UWs (QIB) under Rule 144(A) and QIBs and markets sell amonth selves 1. PORTALmust qualify to be QIB a. What about issue of holding vs. looking to flip? i. Doesnt matter because QIB isnt the public ii. Rule 144(A) Prelim Tbecause isnt considered selling to public iii. Vast majority of debt securities are 144(A) deals (ii) Sale of common stock isnt eligible because would create private trading market for common stock (iii) Can you issue convertible securities? 1. Yes, but conversion price has to be at least 10% of common stock price (call option has to be out of the money) (iv) Why are most debt securities on NYSE 1. A to B exchange a. I sells debt in 144(A) to QIB 2. I promise to register mirror image debt securities (some interest rate trustee, etc.) 3. once registered QIB will exchange securities for registered debt securities Reguation S 1) Section 5 any offering of securities in interstate commerce which includes foreign countries so Section 5 has global reach 2) Puts parameters on territorial reach of Section 5 3) Also exemption on Section 5 registration if selling to non-US residents but anti-fraud rules still apply 4) Exemption a) If 506 offering and want to offer in England i) Can you offer under Reg S and 506 simultaneously (1) Yes, and purchasers in Reg S dont count in 35 purchasers under 505 and 506 (2) If sale in foreign countries comply with there laws

b) When adoptedpoorly drafted i) Within 1 year rewritten because plagued by loophole (1) US issuernon US resident so could get around registration requirements (2) Rule 905securities sold via Reg S are restricted securities so must comply (i.e. 6 month holding period) Civil Liability and Remedies 1) Section 11false and misleading prospectus and registration statement a) Section 11purchaser sues for difference between amount paid and price sold security or price of security if still holds 2) Section 12 seek rescission (if still hold) or damages if sold 3) Is Malfeasance Redressed a) Section 11 material misstatement or omissions in effective registration statement b) Section 12 material misstatement or omissions in either prospectus (prelim prospectus as well); oral communications relating to prospectus; 12(a)(1)violations of Section 5 (non-registered securities 4) Activities Covered a) Section 11 only sales of securities b) Section 12 offers and sales 5) Defendants Covered a) Section 11laundry list of defendants i) May be used by anyone who acquires a security ii) Never ending liabilityNo, only within 1 year (SOL is 1 year) iii) Section 11(a)if purchased within 1 year, then may sue issuer b) Section 12any person so long as purchased security from that person (need privity) (i.e. 12(a)(1)only person who purchased securities from person who violated Section 5 6) Defenses Allowed a) Section 11 due diligence defense (11(b)(3) i) Escott v. Bar Chris Construction (Bowling Alley Case) (1) Plaintiff alleges that the RS for the issuance of the debentures violated Section 11 of the 1933 Act (2) Plaintiffs also allege entire RS should be expertised because drafted by lawyers (a) Judge says lawyers not exeperts out of professional courtesy (b) Expertsauditors, could be engineers, medicational professionals (anyone with professional malpractice insurance) (c) Only part expertised is audited financial statements (3) Issuer cant plead due diligence defense (4) Burden of proof on defendant because affirmative defense (5) Non-Experts and Due Diligence (a) Nonexpertised part of RS (i) Reasonable investigation of facts (ii) Based on due diligence, must have reasonable grounds to believe and actually believe facts are true (no material misstatement, no omissions) (b) Expertised (i) No reasonable grounds to believe (dont believe) anything materially untrue or no omissions (ii) No independent investigation

1. if no something is red flag, then must do something about it; dont have to fact check everything 2. reasonable re: reasonable investigator11(a) prudent person would do in management of own prospectus (6) Experts and Due Diligence (a) Expertised part of RS (i) Reasonable investigation and reasonable belief nothing misstated 1. investigation-reasonable expert in same position (reasonable accountant) (b) Non-Expertised (i) Must have reasonable belief and believe that it is true and correct (ii) May show this because didnt read other sections (7) Kircher (CFO, DIRECTOR) (a) Did he prove defense to Non-expertised (i) No, reasonable investigation, no discussion because does it everyday (ii) Reasonable belief because he knew the lies and misstatements because of no belief (b) Expertised (i) No, because withheld information and no reasonable belief that information was correct (knew information was incorrect) (8) UWs (a) Did he prove defense to Non-expertised (i) Relied on lawyers (ii) Lawyers attempted an investigation but didnt attempt a reasonable investigation 1. when asked questions given only lip service 2. asked for contracts given 1 insurance contract (iii) must make reasonable attempt to verify information through either attorneys or experts (UWs are gatekeepers of informational veracity) (b) Expertised (i) Must have reason something is wrong 1. because non-expert no investigation needed so nothing in audited financials raised red flags ii) Worldcom Case (1) Reports incorporated into RS for 2 bond offerings, accounting firm unaware of accounting fraud (2) 2000 Bond Offering (a) Relied on comfort letter from auditors (i) Reaffirms audits in 2000 RS (ii) Warned didnt audit anything since 12/31/99 (iii) Did everything supposed to for unaudited financials (iv) Provided negative GAAP assurancesomething came to their attention that caused us to require any changes to unaudited financial statements (NO RED FLAGS) 1. no investigation, but no red flags (3) 2001 Bond Offering (a) Received AA comfort letter but didnt contain negative GAAP assurance

(b) Lawyer point this out to client and UW said dont worry about it because Worldcom is a bear to deal within on this stuff (4) UW ARGUMENTS (a) Comfort letter automatically expertises interim financial statements because lowers burden of review (b) Court disagrees and thus maintains 2 part test and keeps it as unexpertised (i) May rely on comfort letter in investigation (ii) Accounting opinion 3 pre-reqs to make it expertised 1. opinion repeated in RS 2. accountants must be audit opinion 3. accountant must consent (written) to inclusion in RS (so stumble way into being an expert)consent filed with RS (c) may not place blind reliance on audit opinions if red flags so must dig deeper (duty of inquiry) (d) need reasonable belief (e) regarded company as credit risk and JP Morgan was heding its position (f) credit rating lowered (g) worldcom demanded that debt be restructured if want in on UW (i) UWs also reduced own exposure with credit default swaps (5) 2000 RS (a) Earnings to revenue ration lower than competitors (b) Plaintiff argues that this is a red flag that should be investigated because significant analytic to determine financial health (i) Plaintiff shows issue of fact to determine reasonableness (6) 2001 RS (a) Earnings to revenue ration lower than competitors (b) MCI business was deteriorating should caused red flag re: value of assets (c) CEOs personal financial situation gave him motive and opportunity to inflate stock price (i) Similar to CEO dubious health situation is financial standing relevant 1. Summary Judgment graned on this point so not red flag; dont want to mix business and pleasure 2. can make the argument it is relevant (7) cant just place blind reliance on opinion if red flags raised because non-experts need reasonable belief (if red flags, must investigate) b) Section 12(12(a)(1))either show were registered or show exemption existed c) 12(a)(2)may plead reasonable care defense, not liable for misstatements if maintain burden of proof if exercise reasonable care i) This and due diligence considered the same ii) May rebut allegation if can show purchaser knew of material misstatement or omission (1) Also show misstatement not material (2) Also could try and show what sold not a security (3) 11 and 12 must show lost causation (a) Revealed that RS was wrong and 1st trading day stock goes down and same day interest rates go up and OPEC increase prices, may be able to show stock went down for other reasons

(b) 11(e) and 12(b)if show stock went down show because of some other reason than your mistake d) Gustafson Case Civil Liability Private Offering i) Gustafson and 2 others sole stockholders found buyer and entered into stock purchase agreement (1) 2 reps and warranties (a) Financial statements were presented present fairly the state of the financial condition (b) Between latest balance sheet and agreement no material adverse change (MAC Clause) (i) In acquisition difficult to get idea whats going on with company buying on past information and hoping business hasnt deteriorated (2) under contract so if information is false may sue under breach of contract if particularly egregious then may sue under torts for punitive damages (3) Questions of factif only this then could sue for misrep but to win must show scienter (intentional/reckless) statement to avoid this turn of facts in warranties ii) Find out estimated earnings were overstated (1) Dealt with this contractually (a) Adjust in price would occur and loser would get difference iii) Purchasers sue before adjustment is paid (12(a)(2) (1) False and misleading prospectus or misleading oral communication (2) Sued because dont want company iv) Why sue under 12(a)(2) not 12(a)(1) because private placement so securities didnt have to be registered (arguing misrepresentation) v) Supreme Court assumed purchase agreement had material misstatements and defendants wouldnt prevail in reasonable care defense vi) Courts decision (1) Whether stock purchase agreement is a prospectus (a) Plaintiffs arguments (i) Look at definition in Section 2(a)(10)definition and congressional intent is to define term broadly (b) SC looks at Sections, 10, 12(a)(2) and 2(a)(10) (i) Section 10 says what prospectus cant be 1. 10(a) final prospectus, 10(b) prelim prospectus 2. Prospectus must contain same info as RS a. only public offerings require RS so only public offerings have a RS b. Court finds that the prospectus is defective because it doesnt contain everything (ii) Section 12(a)(2)false and misleading prospectuses 1. Court found that prospectus used only in public offerings so it should mean same thing throughout act 2. not available to help purchasers of private securities (iii) Section 2(a)(10) 1. narrowly interpreting definition of prospectus eventhough Congress intended broad interpretation

(2) (3) (4) (5) (6) (7)

a. because list of documents wide dissemination so communication should mean public communication so didnt apply to private offering decision is at odds with all legal thoughts and scholarships re: private placement may still sue under 12(a)(1) if private placement wasnt done properly could sue under state blue sky laws common lawmust show that relied on misstatements and defendant knew what was doing (intent), knowledge of misstatements or reckless may sue under 10(b)(5) no put right under 10(b)(5) so must show damages

1934 ACT 1) designed to police secondary trading market 2) level playing field requires public companies to file with SEC to inform the marketplace so reporting companies live in glass houses 3) Section 13(a)each reporting company must file all documents that SEC proscribes a) 13a-1--Annual reports with certification of public accountant10K i) Prepared by inside counsel then shared with outside counsel ii) Discuss business iii) Discuss properties iv) Discuss legal proceedings brought (both sides of v) v) Set for selected financial data vi) Must give investors (MD&A) (1) S-X and S-K integrated disclosure vii) What goes into this is primarily what goes into RS viii) S-3 filers may incorporate enter forms b) 13a-13--Quarterly reports 10Q for first 3 quarters, 4th rolled into annual report i) No need for an audit ii) Not only about recently completed quarter iii) Also shows previous years financials c) 13a-11current reports 8K i) If enter into or terminate material agreement then must disclose it ii) Acquisition or disposition of an asset iii) Any triggering event that would accelerate debt obligations iv) Must summarize noisy exit d) 13a-16for private issuers file 6K e) Duplicate copies must be filed with exchange that trade securities 4) Section 13(b)keep accurate books and records a) Must devise and maintain internal accounting rules that comply with GAAP Reporting Person 1) Section 16(a)reporting person Section 2) Applies to officers, directors, and anyone who beneficially owns 10+% of companys stock 3) Must file statement of all stock own and must file any changes to ownership 4) Must file within 10 days of acquiring 10+% of stock (initial statement of ownership) 5) Form 4 by end of 2nd business day after change occurred a) Gives insight into what execs think of own company

6) Form 5 annual changes in beneficial ownership (file within 45 calendar days of end of fiscal year a) If forget to file Form 4 may play catch up but in 10K must disclose you as late filer b) Transactions that dont count in 16(b) but must be disclosed in Form 5 REGULATION FD (FAIR DISCLOSURE) 1) Get at selective disclosures a) Earnings projections to analysts (heads up to analysts) b) Analysts would exploit information (buy/sell stock for selves) or tell broker friends i) Provided because (1) Intermediaries of information to public so tough to get information want (2) Technology has eliminated this need (3) Key personnel were allowed to benefit from information advantage 2) Designed to level playing field to shore up confidence in capital markets 3) Public when heard about this were outraged a) Retail investors love this b) Everyone who used to profit hates this 4) 100(a)Rule whenever issuer or acting on behalf of issuer disseminates non-public information to certain people must make simultaneous public disclosure if doing intentionally and if do so accidentally then must disclose promptly a) Who cant give disclosure out only reporting companies senior officers, directors, officers, agents, employees or those who regularly communicate with those who are on the list b) Cant tell low level flunky to tell broker because still would be in trouble c) Someone who tells information that breaches fiduciary duty with disclosure, then issuer not responsible i) To whom cant disclose to: (1) 100(b)(1)B/D and analysts, investment advisors (Mutual Funds), institutional investment managers; mutual funds, hedge funds, any holder of securities who would trade on information d) Exceptions i) Temporary insiderspeople who owe issuer duty of trust (attorney, accountant, investment banker ii) Expressly agree confidenceprivate placement memo for private placements iii) Rating agencies iv) Registered offering under 33 Acts (135 Notice) e) Material Information i) Market moving event ii) Factual inquiry iii) Substantial likelihood reasonable investor think its important to make investment decision iv) Earnings information; M&A, tender offers, joint ventures, new products, changes in control, auditors (1) Most would be filed in 8K v) May disclose non-material information (1) If analyst piecing information together and gets final piece so has full picture vi) Non-publicinformation not disseminated in way to investment community (1) When disclosed intentionally must do it simultaneously

(2) If screw up then must disclose promptly (a) No later than 24 hours after senior official discover it (i) Get it out ASAP f) Public Disclosure i) Press release, conference call, 8K (1) 8K file it within few days (typical) (a) Either file or furnish information on 8K (i) Filing under item 5 on 8Ksubject you to liability under Section 18 under 34 Act 1. This information incorporated by reference in RS to extent 8K is referenced a. opens you up to Section 11 liability (ii) Furnish information open to anti-fraud not incorporated by reference (if truly material information then must disclose in RS 1. When file maybe rework information (nuance form) (2) Release information by press release (3) Conference call analystinvite members of public (4) Not GOOD ENOUGHcant just post on website (passive informational system) g) Biggest Concern with FD i) Concern Reg would create chilling effect that analysts would stop talking to company (1) Applies to securities market professionals or holders of information likely to trade on information (2) Limits to issuers personnel (3) Liability only arises if issuers personnel (a) Knows, reckless is not knowing information was material and disseminated (4) Wont lead to loss of filing S-3 privilege (5) Wont impact sale of restricted securities ii) Private liabilitywont create private right of action (1) Stated explicitly and wont form basis of litigation for shareholders (a) Not private liability rule; SEC may smack you around TENDER OFFERS 1) Bidder for all or most of shares for target company 2) Why be involved a) Playing field benefited bidders so Williams Act passed to level playing field between bidders and target companies 3) Tender offerreverse IPO a) ISSUER (adequate material information to buyPublic CompanyBidder (adequate material information in order to sell 4) Problem with regulationgovernment gone too far and target companies are benefiting 5) State corporate law as well made difficult to acquire hostile company a) Entrenched management; less efficient company 6) Williams Actdisclosure and timing based system a) Coercive bidder tactics drop; auction orderly market created 7) Section 13(d)requires mandatory disclosure if purchase 5%+ of companies securities 8) Section 13(e)issuer tender offer (taking company private)

9) Section 14(d)Tender Offer by 3rd parties (hostile tender offers included) a) Schedule Tender Offer sent to shareholders (Schedule 14D-9response to offer) 10) Section 14(e)anti fraud provisions 11) Section 14(f)most Tender Offers 2-step takeover (acquire most shares if get 50%+ of shares then second step (before doing so may replace board of directors with own nominees a) Requires acquirer to send target company FYI your directors are fired 12) REG MAsubset of SKREG MAM&As special disclosure WILLIAMS ACT 1) Section 14(d)(1)3rd party bidders a) Requires bidders to file Schedule TO before acquiring 5% of equity securities of reporting company i) If debt securitiesno filing required ii) Schedule TOrequires terms of offer and must tell target shareholders purpose offer; plans for target post acquisition; detail financing behind offer b) Bidder may choose how to disseminate information i) Long form vs. summary publication (1) Long form publicationbidder publishes lengthy summary of TO in paper form (2) Summary publicationpublication in paper form and pursuant to 14d-6 and invite target shareholders to ask for offering materials (also sending information to shareholders) (code names used occasionally c) If all cash tender offer or merger then must put near front of summary term sheet (plain English and bullet points that lay out principle terms d) Targets management must respond to Tender Offer i) File 14D-9; 14E-2must file within to business days (1) Most importantinformation in item 4managements recommendation with reasons for position (i.e. offering price is inadequate (a) Target brings in attorneys and investment bank with defensive tactics (b) Looking for value enhancing alternative strategy (internal strategy or white knight (friendly takeover) (c) Framework tender offers are madebalance of power too far to target company TENDER OFFERS BEGIN 1) 14d-2bidder published, sent or given means to tender (means to tenderreceive materials to transmit shares to bidder (letter of transmittal to tender shares (accept offers) 2) Need to know because rest of temporal framework builds off this date (SCM 25) a) Temporal framework i) 14e-1antifraud if launch Tender Offer must remain 20 business days after offer given ii) If bidder increases price, drops amount of shares seeking then give additional 10 days iii) Additional days added if any material changes 3) May cancel @ any time during offer period and bidder must return shares promptly a) 1 provision may be anti-trust approval 4) Section 14d-7withdrawal rights provision even if tender shares; until shares accepted for payment may withdraw shares a) Tender not permanent until shares accepted for payment

5) 6) 7) 8)

9)

b) Requires bidder to pay best price offered to any security holder c) All holders rulemust be open to all holders of target class of securities cant offer to some and not allrenders illegal defensive tactic in UNOCAL caseoffer to buy all shares for junk bonds but not bidder shares i) DE may do under state law ii) Exclusionary tender offer illegal under federal law Section 14d-8proration rulewhenever seeking less than 100% of stock must buy stock on pro-rated basis so there wont be rush to get in early Section 14e-5private purchaser placementanti-discrimination rule cant privately negotiate for stock while tender offer is pending Section 14e-8illegal to announce Tender Offer Plan if dont have reasonable intent to do socant do if full of shit Schedule a) Must identify group members, who you are b) Source of funding; how many shares do you own c) Item 4 purpose for investment; prelude to takeover for investment purposes (any plans or proposals, plans for TO; make up of board) i) Extraordinary corporate activities, merger, changing makeup of board d) 13d-2must amend schedule promptly if material change (within 2 business days) if change purpose e) Difference between Schedule 13d and Schedule 13gstarter form for institutional investor i) That acquirer 5+% in ordinary course of business ii) Normal form must file only have to file 45 days after end of calendar year (notice filing) iii) File 13d within 14 days of act that puts you over 5+% threshold (1) Early warning system (alert marketplace) (2) Prevents creeping act of purchasers EPSTEIN v. MCA, Inc. a) Chairman of MCA made separate agreement where would obtain preferred stock in subsidiary bidder would put in amount equal to 106% of his shares were worth i) 6% premium on his shares b) This agreement made right before TO launched; his agreement consummated after TO closed c) Violation of 14d-10? i) Problem concerned with agreements made during TO ii) Violated because doesnt matter when signed up (1) Functionality testbig issue was agreement integral part of overall TO (a) Entire deal conditioned on consummation of TO (b) Performance tied to TO (price paid to him was tied to TO) (timing also key) (c) Him receiving premium price is violation of 14d-10 d) Section 13(d)Purpose is to warn of sudden takeover; any person or group holds 5+% of any class of equity security must file within 10 days of acquiring 5+% of stock i) Filing early warning to shareholders and target to implement defensive strategies ii) Prevent creeping acquisitions where lose opportunity for premium iii) Covet shareholder who wants to sell may want to hold to get premium e) 14e-5cant purchase shares outside purview of TO period f) 13dany person or group becomes beneficial owner of 5% of equity

BENEFICIAL OWNERSHIP 1) When do you become beneficially ownership a) Record owner listed on companys books b) Rule 13d-3(a)any person who directly/indirectly by contract owns shares i) Voting power and/or investment power ii) Direct disposition of shares (i.e. sell) 2) Groups a) 13d-5when 2 or more people agree to act together for purpose of acquiring , holding, voting, or disposing of equity securities b) Criticism of 13d-3 and 13d-4never mentions word voting so SEC has overstepped authority i) Effect of dissuading institutional investors from getting together and exercise shareholder activism 3) How do we penalize people for violating 13d a) SEC v. First City Financial Corp. i) Parkingown stock without having any record of you owning the stock (3rd party enter into put and call agreement; could call shares away at exact price and commission; holder could put shares to 3rd party at any time (1) Problem counterparty credit risk (2) If First City beneficial ownerhad to file sooner (3) What was FCs ultimate goalsave some money (a) District Courtpurposefully violated reporting (b) Equivalent of information (i) Those sold without complete information harmed (ii) Disgorged profits (how do you determine profit) (iii) SEC only reasonably proximateburden of proof (iv) Dont have to prove damages to the penny 4) Tender Offer not defined in 34 Act 5) Distinguish between issuers buying own stock 6) 13a-5disclosure obligations a) 13e-4issuer buys own shares through Tender Offer b) Buy some shares or buy all shares 7) 13e-1applies to buyback stock while TO 3rd party is ongoing (defensive re-purchases) a) Normal stock buyback programs have nothing to do with 13e-1 and 13e-4 b) Not all issuer repurchases are TO 8) SEC v. CHH a) Repurchase of own shares during 3rd party TO b) If price doesnt climb to TO price then market doesnt believe deal will happen i) Price could go even higher if so could signal another bidder ii) Also market may believe offer is too low c) CHH defensive strategies i) Deal with General Cinemaswhite squire defensebecause lesser defense than white knight (1) Put chunk of voting power in ally (a) Convertible voting power could be 22% and agreed to vote share only as CHH management directed (b) Also got option for crown jewel lock up agreement for Waldenbooks Co.

(2) CHH purchase up to 15 million shares for up to no more than $500 mill and if this happens then voting power would become 33% (a) This was successful and increase amount to buyback to 18.5 mill shares and wound up buying 17.5 mill shares which was 50% of common shares outstanding d) SEC alleges i) CHH engaged in illegal TO violated 13(e), especially 13e-4 (1) Both 13e-1 and 13e-4 involve repurchasing of shares (a) Prevents buyback during 3d party TO (i) Only can do if discloses minimal information 1. statement of amount of shares purchased; purpose of purchase and source and amount of funds (need enough shares just in case convertibles are converted (ii) why require disclosure 1. need level playing field (without disclosure of whos buying then people may think rival bidder or price too low a. sanctioned market manipulation (2) 13e-4subject to some safeguards as 3rd party TO (self TO) 9) Wellman Factors (determine the existence of a Tender Offer) (not all have to be present) a) A solicitation may constitute a tender offer even though some of the 8 factors are absent or , when many factors are present, the solicitation may nevertheless not amount to a tender offer because the missing factors outweigh those present b) Active and widespread solicitation of public shareholders i) Done on open market; no direct solicitation ii) Filing made but mandated by 13e-1 c) Solicitation made for a substantial percentage of stock i) Unless 1 is present then 2 cant be here d) Offering price made at premium over market price i) Done higher than market price but no premium because done at price it was trading at e) Terms of offer firm or negotiable i) Purchases made at different market prices so offer wasnt firm f) Offer contingent on fixed number of shares or fixed maximum number of shares i) Wasnt fixed on minimum number of shares to be purchased ii) If 50+% then may engage in 2nd step merger iii) All Tender Offers condition at least a majority of shares g) Offer only open for limited period of time i) Only purchasing based on ordinary market forces ii) No timetable h) Offeree subjected to pressure to sell stock i) No because no premium, no limited time offer ii) Pressure of marketplace i) Public announcements accompanying large accumulation of shares i) Wouldnt make announcement but for SEC rules ii) Made market purchases, no fixed terms; not dependent on purchase of certain number of shares iii) No premiums iv) Not limited time offer

j) No traditional hallmarks of Tender Offer k) 9th Circuit refuses to adopt S-G Securities Test l) Publicly announcement of intent to acquire block of stock of target company to acquire control m) Subsequent rapid acquisition by purchaser of large blocks of stock through open market, privately negotiated purchases i) No guidance, vague, difficult to apply n) Not only process is important but also result if get 50+% of stock then one may presume engaged in a TO 10) Hanson Trust v. SCM Corp. a) SCM defensive tactics i) Agreed to merge with Merrill (white knight defense) ii) Also crown jewel arrangement to buy 2 most profitable companies if hostile third party acquires 33% of stock b) Hanson Terminates Tender Offer c) Same day Hanson purchases SCM stock from private transaction and bought shares on open market i) Hanson why would they do this? (1) They had retreated to fight another day (2) NY law required 2/3 supermajority vote for merger but if acquired just less than 2/3 then could scuttle merger and then go back to Hanson d) At issue whether 6 purchases of stock were de facto continuation of Tender Offer i) Hanson didnt go out looking for shares, other holders went to Hanson and offered shares ii) 1 open market purchasenothing special with purchase iii) District court rules de facto continuation of TO e) Congressional definition of Tender Offer i) General publicized bid by an individual or group to buy shares of a publicly-traded company, the shares of which traded on a national securities exchange, at a price substantially above the current market price ii) Offer was usually accompanied by newspaper and other publicity, a time limit for tender of shares in response to it and a provision fixing a quantity limit on the total number of shares of the target company that would be purchased f) 2nd circuit doesnt adopt Wellman Factors (unwise and unnecessary) i) Look at Ralston Purina (offering to those who may fend for themselves (1) Want to protect people and point of 14(d) is to protect people (a) TOs reverse IPOs (2) If solicitees need protection then bidders must make filings (a) Unless file then solicitees substantial risk that will lack information to make considered appraisal g) Hanson acts not a TO i) Similar to Private Placement (1) Small group of people involved (6) (2) Qualified buyers that could fend for themselves (at least 5 of the sellers) (3) Presumably if have that number of shares will be ok ii) Not pressured to sell, Hanson was contacted to purchase iii) Motivated to sell by market iv) Didnt engage in solcitation

v) Didnt offer premium and not contingent on acquiring fixed minimum number of shares and no fixed time period vi) Announced publicly terminating TO but reserved right to purchase shares on market or in private negotiations (1) Because TO termination was made publicly then just coincidence transaction was made same day WHO IS A BIDDER? 1) MAI Basic 4 v. Prime Computer Inc. a) Whether Drexel, investment advisor, is also a bidder i) Drexel was financial advisor on how to structure hostile TO ii) Drexel direct equity stake iii) Drexel indirect equity stake iv) Acts as junk bond underwriter for deal (1) Trying to raise $875 mill in junk bond financing b) Court looks to Coppers v. AMEX (Who is a bidder?) i) Central to the offer ii) Motivating force iii) Principal planner/player (1) Financial advisor who had multiple roles could become bidder c) Courts decision i) Drexel was a bidder (1) Close association with companies, board representations, indispensable to this bid (could you always say this about financing) (2) Remedycould do curative disclosure, not all information of TO, whether Drexel was weak or strong is important (3) Big problem is probably direct/indirect ownership stakes, groups typically look up to see who really runs the show (4) Must disclose current financials of Drexel; affiliated officers directors mixed up with the companies (5) How can court require disclosures of Drexel if considered a bidder? (a) Court acting with equitable powers (b) Company that brought case is Prime Computer and is really just stalling the takeover so they may make Basic Group go away so court realizes this tactic was designed to do Civil Liabilities under the 34 Act 1) Section 18false and misleading periodic reports 2) Section 14(a)false and misleading proxy disclosures 3) 14(a)(9)false and misleading provides for private cause of action 4) 14(e)Williams Act anti-fraud provisions Section 10(b)catch all provision 1) Cant devise anything to scam people a) For fed government to be involved need some connection to interstate commerce b) Cant have fraudulent schemes and up to SEC to prevent such schemes c) Applies to registered and unregistered securities 2) Rule 10(b)(5)directly and indirectly and interstate commerce

a) Employ any device, scheme or artifice to defraud b) Any untrue statement material fact or omission any material fact (12(a)(2) c) Any act, practice, course of business that would act as fraud or in purchase of sale or purchase of securities 3) 3 scenarios applied to a) Material misrepresentations in corporate statements b) Insider trading (until recently 10(b)(5) was only insider trading rule) i) No SEC rule saying no to insider trading c) Manipulate market (artificially inflate stock price) 4) Private cause of action10(b)(5) 5) 1 constraintmust be in connection with purchase or sale of any security Standing to Sue 1) Blue Chips Stamps Case 2) How plaintiff was allegedly harmed a) Prospectus pessimistic appraisal of companys future kept them from buying stock i) Saying was overly pessimistic so missed out on profits 3) Plaintiff didnt buy or sell securitiesdoes he have a case under 10(b)(5) 4) Court looks at the Birnbaum ruling a) Plaintiff class was limited to actual purchasers and sellers of securities i) If embrace B then would exclude 3 classes of purchasers (1) Potential purchaser of shares (a) Why wouldnt purchaseoverly pessimistic representations or omissions of favorable materialplaintiff in this case would lose (2) Actual shareholder who decides not to sell because of overly optimistic representations (3) Shareholders/creditors anyone related to issuer whose securities lose value because people doing insider tradingf closely held securities lose value be b) Congressional intent supports B i) Congress had 2 opportunities to overrule B (1) 16(b)reporting person buys/sells within 6 months must give profit back to company c) Good reason to exclude these plaintiff i) Because difficulty in ascertaining damages; plaintiff seeking conjectional and speculative damages (1) Trying to determine what would I have done (2) Dependent upon oral testimony and such testimony has the highest chance for abuse 5) This plaintiff needs a B exception a) Plaintiff argues that because of consent (antitrust decree has the legal right to buy) i) Court rejects this argument (1) Court says this was in actuality an option to buy and not contractual obligation to buy (2) If contractual obligation to buy then better case but would probably have to deal with contract law (lower courts much more likely to side with plaintiffs) 6) If cant seek damages; can you pursue injunctive relief a) Cowin v. Bresler i) Information was put out to depress price

ii) iii) iv) v)

(1) Plaintiffs belief did so because controlling shareholders wanted to purchase rest of the company Purchaser didnt purchase securities Wants injunctive relief to stop misrepresentations because artificially depressed price and would naturally rise with correct information Court felt this case wasnt distinguishable from Blue Chip so injunctive relief denied Plaintiff also sued under 14(a) and 14(a)(9) for false/misleading proxy materials (1) Plaintiffs believed executives perpetrated fraud and that proxy materials didnt state would perpetuate a fraud (a) may be actionable under state law

Fraud 1) Expansion of 10(b)(5) a) Santa Fe Industries v. Green i) Attempt to engage in freeze out merger of minority shareholders (1) Freeze out mergerSection 253 DGCL if own 10% of stock then may force company to merge into you without consent or notice to minority shareholders only need pass Board of Directors resolution/ no shareholder meeting necessary (a) DE legislature provided remedyability to pursue appraisal rights (court will determine fair value of shares and force company to pay them in cash ii) Did they pursue appraisalno, instead sued to stop merger under 10(b)(5) (1) Plaintiffs claimno prior notice, fraudulent appraisal and Morgan Stanley participated in fraud (lacked justifiable business purpose) (a) Morgan Stanley said assets worth at least $600 but only offered $150 (i) Howd they get document (Form 14(f)information was in filing iii) District Court ruled against plaintiff; DE says dont need business purpose or approval and prove appraisal remedy (1) If full disclosure made 10 (b)(5) can never be violated iv) Ct Appeals reversed dont need to point to non-disclosure or misrepresentations to succed v) What is fraudulent conduct? (1) Breach of fiduciary duty by affecting merger because no prior notice and engaging in merger without justifiable business purpose (a) If no valid business purpose for merger, then disclosure of this fact wont mitigate vi) Realization that if tell about fraud doesnt matter because still liable for fraud vii) Supreme Court reverses and looks at statutes language (1) Conduct that violates 10(b)(5)? (a) Only conduct that is manipulative or deceptive, doesnt cover all breaches of fiduciary duty so merger neither deceptive/manipulative (i) Deceptiveno deception in disclosure so because of disclosure either go along with merger or seek appraisal rights (ii) Lack of advanced warningeven if received couldnt enjoin in DE (iii) Manipulativemost manipulations done through non-disclosure didnt do this so dont need to sue in federal court 1. fed focus on disclosure and plaintiffs action only tangential to this focus 2. fed shouldnt apply if adequate remedy under state law

Duty to Update and Correct 1) Time Warner Case a) Combined entity 10 bill after merger b) Plan to reduce debt by establishing strategic partnerships with companies thatll infuse capital into Time Warner c) Plaintiffs claim suffered damages when TW announced plan was still on track when in reality it wasnt successful d) New offerrights offering, offering only made to existing shareholders and those who chose not to get diluted e) Plan viewed as negative and dire strategy and price of stock plummeted f) Should TW be liable for these statements? i) Anonymous Statements (1) No, because will police this because people will dismiss anonymous sources (a) Civil procedure rule 9(b)plaintiff must allege fraud with particularity and if dont then game over so cant rely solely on anonymous sources ii) Attributable Statements (1) Said talks were ongoing and hoped theyd be successful (2) Talks with strategic partnerships were ongoing (a) Not actionable (b) If hold liable then must prove that talks on on-going (look at materiality and damages statement used (3) Company said hopes talks would be successful (a) Not actionable (b) Unless can show that execs didnt have belief then cant find company liable for misrepresentation for opinions on hopes or desires iii) Non-Disclosure of Problems with Strategic Alliances (1) What must issuer due (when must an issuer correct previous statements (a) Reliance is key (b) Statements impactful today may be irrelevant in future and impact of statement lessens over time (c) May have duty to correct or update if original projections were misleading because of intervening events (d) Did TW have duty to update? (i) No because nothing said was wrong (ii) No definite (concrete) positive projections that may need to be corrected 1. only said hope of talks coming to fruition no deals said to be struck by certain date or struck at all so not erroneous iv) Non-Disclosure of Alternative Methods (1) No duty to disclose everything (2) Concrete results are disclosable (8K) (3) Discussions dont have to disclose everything (4) If not material concrete event then whether you disclose is volitional (a) A corporation is not required to disclose a fact merely because a reasonable investor would very much like to know that fact. Rather, an omission is actionable under the securities laws only when the corporation is subject to a duty to disclose the omitted facts (i) Only obligation to disclose unless legal duty to disclose

1. duty to disclose not disclosed material in relation to prior statements if subsequent event occurs and if not disclosed then would render prior statement misleading a. Material if impacts market, if substantial likelihood that disclosure of omitted fact would be viewed by reasonable investor as altered total mix of information available (5) Non-disclosure is possible to survive motion to dismiss (a) If 1 avenue is shut off and pursue new avenue must announce new avenue 2) Burlington Coat Factory Case a) CAO comfortable with earnings per share for 1994 b) CEO refused to comment on projections for fiscal year earnings only 1.2 down from projection of 1.3-1.2; price of shares dropped c) Duty to correct projections once was clear wouldnt hit projections d) Plaintiff confused duty to correct and duty to update e) Duty to Correct i) Historical statement that believe is true but because of subsequent events statement wasnt true then must correct within reasonable time of discovery (1) If erroneous statement must correct (2) If historical statement has continued vitality must be corrected (a) If statements impact on the market no long then no duty (i) Particular duty to correct a specific prior statement exists as long as traders in the market could reasonably rely on the statement ii) Projections (1) Forecast isnt factual but what goes into forecast is factual so that is something that may be corrected (a) If projection determined to be wrong either correct whole projection or just information that went into projection (2) Duty to Correct Projections (a) No because plaintiff couldnt point to any facts that made projections erroneous (i) Didnt discover times errors made (b) Projections guesstimates and not typically required to be corrected (3) Duty to Update Projections (a) In contrast to the duty to correct, concerns statements that, although reasonable at the time made, become misleading when viewed in the context of subsequent events (updating might be required if a prior disclosure had become materially misleading in light of subsequent events (i) Plaintiffs argue that Company shouldve updated statement as soon as realized wouldnt hit projection 1. slippery slopeif liable for projections then people will stop giving them 2. projections may have to be updated daily, weekly, hourly (Google didnt give any (b) Plaintiffs argument has to be that the projection contained an implicit factual representation that remained alive in the minds of investors as a continuing representation (i) To determine if implicit in an ordinary forecast is a function of what a reasonable investor expects as a result of the background regulatory

structure. In particular, we note three features of the existing federal securities disclosure apparatus 1. except for specific periodic reporting requirements, there is no general duty on the part of a company to provide the public with all material information. Thus possession of material nonpublic information alone doesnt create a duty to disclose it. 2. An accurate report of past successes doesnt contain an implicit representation that the trend is going to continue and hence doesnt in and of itself obligate the company to update the public as to the state of the quarter in progress 3. regulatory framework aimed at encouraging companies to make and disclose internal forecasts by protecting them from liability for disclosing internal forecasts that although reasonable when made turn out to be wrong in hindsight (c) Forecasts are not actionable so long as done in reasonable manner and in good faith dont have to update based on every twist and turn of the market (d) Voluntary disclosure of ordinary earnings forecast doesnt trigger a duty to update (e) If have pattern of earnings guidance and then choose not to then may have to alert market re: change iii) RumorsPublicly Circulated Inaccuracies (1) No duty to correct or respond unless start them yourself (a) You may respond Insider Trading 1) In re: Cady Roberts & Co. a) Disclose or abstain ruleeither disclose or refrain from trading on information b) Insider Information i) Corporate information thats not publicly disclosed ii) Material inside information is to company itself (property) iii) Insider information buy/sell securities based on this material undisclosed information c) Fraudulent part of insider trading i) Law concerned with owner of the information, the company itself ii) Not all insider trading is illegal (1) Insiders and reporting persons (officers, directors, or holders of 10+% of stock) (a) Unfair if trade on own companys non-public information (b) Insiders viewed as defrauding company and shareholders (i) Cady Roberts (c) 16(b)presumes insiders that make purchases and sales of stock at profit, then presumes insider trading and if do so within 6 months then must give back gain to company (2) Fiduciaries and temporary insiders (a) Lawyers, investment bankers, accountants come across information during course of job (i) OHagan (3) Intentional tippee, individuals given insider information by insider on purpose (a) Dirks

(4) Accidental Tippee (a) Individuals who receive information from corporate insider intentionally and act on it (i) SEC v. Barry Switzer (ii) Dirks case 2) Chiarella v. US a) Worked for printing company b) Name of target not included in Schedule TO c) Deduced who bidder was d) Traded on information i) Company had prohibitions on trading e) Indicted on 17 counts10(b) and 10(b)(5) f) Issue: Whether shouldve informed targets shareholders about takeover i) District court and Ct of Appealsanyone who receives information must inform market before trading (1) Aiming towards protecting public ii) No relationship to sellers of securities and did so on open market (faceless transaction) g) Supreme Courtdo you have duty to trading partner? i) No so long as no relationship of trust (confidential or fiduciary) ii) No parity of information rule; need not disclosed why selling or buying iii) Use information advantage to your benefit h) Supreme Courtdid he have duty to employer and to companies employing employer i) Court doesnt address this because issue never submitted to jury ii) Dissentmisappropriation theory (misappropriated information from employer and is actionable under 10(b)(5) 3) Dirks v. SEC (Tippee liability) a) Officer of broker/dealer; analyst covers insurance b) Secrist tells former officer of Equity Funding and tells him about earnings overstatement and fraud i) Urges Dirks to investigates; and he does c) Discusses findings with clients and investors d) After investigation WSJ refused to publish and after telling clients WSJ publishes story e) Dirks doesnt personally trade f) Dirks labeled as a tippee (intentional) g) SECs position on intentional tippees (cant trade on information receive) i) Regardless of motive or occupation (1) Know information confidential (2) Know come from corporate insider (3) Either disclose then trade; or (4) Refrain from trading h) Accidental tippee i) Do you know info confidential ii) Should you know came from corporate insider then may be i) Supreme Court reaffirms Chiarelladuty to disclose only arise when special relationship exists i) Tippee/tipper may have relationship; may not have ii) If no connection then look at where information comes from

(1) Whoever possesses information is imbued with duty (a) Supreme Courts responsemere possession of information doesnt created duty; special relationship between tippee and tipper does this (b) Footnote 16language believed information gets to market place by getting inside information to analysts then disseminates (i) Reg FDflies in face of footnote cant tell select few people 4) Tippee/Tipper Rules a) When are tippees prohibited form trading: i) Cant trade on material non-public information when improperly given to you (when insider breached fiduciary duty to shareholder) and when tippee knew or shoulve known has been breached (1) When do we know tipper breached duty (a) When tipper personally benefited directly/indirectly from disclosure (b) Only breach when insider selling (c) Cant be derivative liability for tippee unless fiduciary duty breach b) Benefit from informationpecuniary gain (pay tippee) reputational gain (makes you feel good? c) If doing it to fee good then still on hook and same as if you yourself took money and gave money to tipper d) Whether insider benefited question of fact for jury and not easy to decide e) Didnt breach but receive information (accidental tippee i) Barry Switzer Case (1) No because insiders didnt benefit had no idea disclosed information f) Footnote 21morally wrong for tippee to trade on information that doesnt breach duty then no securities law violation g) Insider didnt benefit only wanted to disclose fraud, no expectation of srouces(s) to keep information confidential h) Dirks and tippers wee trying to stop corporate fraud i) Cant have tippers refrain from reporting fraud 5) US v. OHagan a) Is there 10(b)(5) liability when use information that is misappropriated b) Partner unrelated to Pillsbury merger purchases call and put options and made 4.5 mill c) Partner convicted but reversed by court of appeals because says 10(b)(5) cant be grounded on misappropriation i) Required neither non-disclosure fraud or deception ii) Misappropriation not really part of 10(b)(5) d) With respect to deceptionfailure to disclose to Grand Met was trading on information (deception) so traditional fraud inherent in misappropriation information for own gain e) 14(e), 143-39a)doesnt hold responsible because SEC exceeded authority when adopted rule i) Must be breach of duty and mere possession of information not enough f) Misappropriation Theory i) Use for own purposes confidential information in violation of duty owed to source of information (1) How would Chiarella come outbreach of duty because owes duty to employee and though employer to client ii) Santa Fe Industries cant violate 10(b) without deception or manipulation

(1) Deception because fiduciary pretending to be loyal to source of information when really isnt (2) Whats the harmif think games rigged then will stop playing (public policy) (3) Is it bad timing? (4) Grand Met hurt could become expensive deal (5) What about confidential information company can use and not to be used by others (6) Defrauding company of exclusive use of information iii) Cady Roberts (1) Misappropriationtargets corporate outsiders (a) OHagan not insider of Grand Met so dont go after him for traditional insider trading (2) Could OHagan insulate self from liability (a) Grand Met couldve given him permission (i) Theoreticallycouldve covered his ass if told Grand Met about disloyalty because any company would seek injunction (b) Couldve announced will begin trading on information (c) Haasstealing is stealing iv) 10(b)5-2provide guidance as to trust and confidence that triggers misappropriation theory v) Rule 14e-3(a)8th Circuit said SEC exceeded authority noting must be some breach of duty (1) Supreme Courtdoesnt agree and says statute designed to prevent fraudulent conduct so SEC more latitude in adopting rules than prohibiting activity (a) SEC may prohibit acts not fraud under statute and common law g) 10(b)5-1 i) Just because possess inside information does it mean youre trading on this information ii) Awareness standardif aware of inside information then presumed trading on inside information (1) Policydark view of humanity and that if possess information then you will act on it iii) Affirmative Defense10(b)5-1(c)(1)(i) (1) Tailored for senior execs, private contract to sell securities not being influenced by information (2) If show e things may show didnt insider trade (a) Before becoming aware of information entered into binding contract to purchase or sell security, provided instructions to another person to execute trade for its account or adopted written plan for trading securities (i) Automatic/done in advance (b) Contract instruction or plan expressly specified amount, price, and date or provided written formula or algorithm and dates or didnt permit person to exercise any subsequent influence (i) Cant influence sale 1. no power to effectuate how, when or whether trade will be done (c) Purchase or sale is pursuant to plan, instruction or contract; no alteration, deviation from prior contract, etc.occurred after became aware of information

iv) Affirmative Defense for Entities (10(b)5-1(c)(2) (1) Entity wont be guilty if can demonstrate who effectuated trade didnt know of information and instituted policies and procedures to insulate selves from inside information (Chinese wall) v) 10(b)5-2Misappropriation theory must be duty of trust/confidence (1) Non-business relationships (a) 3 non-exclusive situations have duty and cant trade (i) Whenever person agrees to maintain information in trust or confidence 1. may be consequences to tippee (ii) when 2 people have history, pattern/practice of sharing confidences such that recipient of information knows or reasonably should know that person telling information expects will keep quiet 1. implicit maintenance of confidence (understood will be kept confidential) (iii) Bright line testwhen person receives or obtains information from spouse, parents, kids, siblings,--affirmative defense is available if defendant can show no duty of trust or confidence existed in relationship 1. may present evidence to the contrary that no relationship existed Scienter and Reliance (Culpability) 1) Ernst and Ernst v. Hochfelder a) Nayprime fraudster induces plaintiff to invest (put money into escrow) (Ponzi Scheme) i) Created mail ruleno one could open mail sent to company addressed to him or sent c/o him ii) Fraud came to light when killed self and indicated company was bankrupt iii) Plaintiffs went after deep pocket accounting firm (1) Accounting services and prepped annual reports and performed audits (2) Theory negligently conducted audits (a) Negative non-feasance if not negative wouldve discovered mail rule and thus saved plaintiffs some money (b) Didnt allege that defendant was in on fraud that they were just negligent (3) Independent action when doesnt include manipulation or intent to deceive on part of defendant (a) District court rejects Ernsts defense that aiding and abetting could be found from negligence and then concluded that no issue of material whether Ernst was negligent (so summary judgment motion granted) (i) But if were negligent then cause of action could go on (b) Court of Appeals embraces negligence and that had common law and statutory duty (i) Genuine issues of fact existed and issues of fact existed based on negligence (c) Supreme Court reverses and says must have intent to deceive, negligence not enough (i) Must allege scienter on part of defendant, injunctionstill need scienter (ii) So long as making 10(b)(5) action then need scienter 1. Scientermental state and embraces intent to deceive, defraud, or manipulate

(d) Reckless? Supreme Court refuses to address topic but 11 of 12 circuit courts have embraced recklessness as enough (i) Reckless conduct may be defined as a highly unreasonable conduct, involving not merely simple, or even inexcusable negligence, but an extreme departure from the standards of ordinary care, and which presents a danger of misleading buyers or sellers that is either known to defendant or is so obvious that the actor must have been aware of it 1. may be phrased as either lesser form of intent, an extreme departure form the standards of ordinary care or severe reckelessness (e) look at section 10(b) and cant be broader than original 10(b) and it uses manipulative or deceptive (i) intent is needed (ii) knowing or intentional conduct (iii) catch all provision (legislative history) thou shall not devise cunning devices (f) other provisionsSection 11negligence covered but also contains procedural protections (due diligence defense and limits who you may go after)Congress knew what was doing so cant rely on 10(b) (i) 1 problem3 parts (2)(3)imply negligence may be enough and SEC cant go beyond 10(b)(5) and if negligence not covered so tough 1. could argue negligence covered in (2)(3) but doesnt jive with legislative history or language in statute Private Securities Litigation Reform Act 1) Historical v. forward looking a) Historicalmay be sued for recklessly made historical statement with regard to ordinary standards of reasonableness and due diligence b) Forward lookingprojections, etc.PSLRA if couched in meaningful cautionary language around statements cant be sued successfully i) Even if reckless in creating statements (plaintiff must show company made them with actual knowledge (intent) that were untrue or could never come true 2) Reliance (based on common law fraud) a) Basic v. Levinson i) B publicly traded and combustion engineering prevented from buying B in mid-60s but in mid-70s still wanted to buy B so combustion had meetings re: merger (1) 77-78-B made pronouncements that wasnt engaged in merger discussions (2) B asks NYSE to halt trading because were approached re: merger and next day B board approves merger and next day announced merger approved ii) Plaintiffs argue market price is depressed (1) Each time put out price release not in discussions it depressed price (a) Plaintiffs sold shares after first announcement and made small profit at artificially depressed prices (b) Plaintiffs allege defendants perpetuating fraud on market iii) B knew was in discussions said wasnt material misrepresentations because market may move on M&A information (1) Reliance must be shown because its the nexus between conduct of fraudster and plaintiff in question (a) Did each plaintiff have to prove read press release--No

(i) If required that then couldnt have true class action because issues between individual plaintiffs would consume litigation (b) Court allowed fraud on market theory (i) Creates rebuttable presumption that plaintiffs when selling securities (or purchases) did rely on press release 1. economic underpinnings a. market digests information and isnt able to operate efficiently i. market price distiller of information and those who rely on stock prices are relying on press releases ii. market interposed between buyer and seller and transposes information to buyer in market price iii. market performing valuation function for buyer iv. unpaid agent of buyer v. lying to market is same thing as lying indirectly to investors and purchasers 2. To rebut a. Family member hurt and must make payment to hospital and so must sellnot relying on integrity of market i. Will sell regardless of what market price is ii. May show market not efficientCompany thinking traded only a few 1,000 traded daily, no analysts following stock iii. Slow market know along about lies and reflects price based on anticipated merger (c) Justice White (i) Everyone assuming stock price reflects true intrinsic value of stock (i.e. market perfectly effective in establishing companys value) (ii) May purchase stocks because people believe price isnt what stock is really worth (iii) Can you rebut presumptionimpossible and only in most extreme cases (iv) Reflects information but doesnt discern truthful information from rumor and innuendo 3) Causation a) Transactional causationreliance (presumed because of fraud on the market theory) b) Loss causation (approximate causation c) Dura Pharmaceuticals v. Broudo i) Alledged fraudfalse statements re: Dura future drug profits; said future FDA approval for asthma spray device (1) Said profits lower and FDA wont approve spray ii) Plaintiffs claim harmed by misrepresentations re: FDA and profits (1) Paid artificial, inflated prices for stock (a) Only statement in complaint re: economic loss re: FDA disapproval (b) Reliance on market paid inflated price and suffered damages iii) District court said re: drug profitabilityfailed to allege satisfactory state of mind (intent or reckless) (not on appeal) iv) Spray device claim failed to allege loss causation (1) Injury causes at time of transaction (2) Did allege adequate claim

(a) Plaintiffs show price on date of transaction is inflated because of misrepresentation (9th Circuit out of whack with other circuits v) Supreme Court (1) 6 elements of cause of action for 10(b)(5) (a) Material misrep or omission (b) Scienter (wrongful state of mind) intent/recklessness (c) Misrep must be made in connection with buy or sale of security (d) Reliance (transactional causation; presumed if relied on market (e) Damageseconomic loss (f) Loss causation, proximate causationcausal connection between material misrep and actual loss vi) How do you show this statement inflated price (thousands of things impact price (i.e. stocks across board dropped 10% vii) Supreme Court doesnt embrace inflated purchase price approach (1) Wont in and of itself constitute economic harm (a) Higher purchase price will sometimes cause economic loss so misstatement has little or no effect on purchase price (b) Many cases no loss occurs at all because you typically buy and sell before fraud discovered (c) If purchaser sells later after fraud discovered inflated price may be affected by (i) Changed economic conditions; market conditions or company or industry changes, change in transactional conditions may cause drop in price 1. longer time between purchase and sale more factors effect price (d) goes beyond 34 Acts goals (i) could provide investors with broad insurance from market losses

PSLRA 1) class action based on fraud and 10(b)(5) 2) Congress thought suits were frivolous and promoted by lawyers 3) Clinton vetoed legislation but veto overridden in 1995 4) Perceived explosion of class actions and costs associated 5) People believed 10+% drop in price meant management engaged in fraud 6) Firms had pre-drafted complaints with ready-made plaintiffs a) Some firms funding plaintiffs investment in company 7) Perceptions of suits not in time with realities a) Issuers whose stock dropped 10+% sued at modest rate of 4.9% b) Most companies sued were tech companies because so volatile c) Perceptionmoney going to lawyers and not plaintiffs i) Plaintiffs only received 5% of losses but fraud only need to be substantial factor in loss ii) 21.1% suits recovered 50% of damages iii) 19.3% recovered iv) 32% less than 10% recovered 8) Act designed to lower attorneys fees and increase riskiness of suit 9) Made more difficult to bring case; think long and hard about filing claims

10) Section 21D a) (a)(1)only applies to private class action arising under 34 Act i) Plaintiffs firms redirected class action suits to state court (1) 1998Congress pass SLUSApre-empted any purported state class action with respect to publicly traded securities redirected suit to federal court b) (a)(2)sworn certification i) Must be signed by lead plaintiff ii) Targets professional plaintiff iii) Must state reviewed complaint and authorized its filing iv) Must certify didnt buy security @ direction of lawyer v) Must disclose any other suit similar they were part of in previous 3 years vi) Must state wont accept any additional payment other than pro rata share of any settlement unless ok-ed by court c) (a)(3)lead plaintiff i) Once filed complaint ii) After complaint filed must publish that you filed complaint iii) Within 60 days after publication anyone may challenge plaintiff as lead plaintiff and court may appoint lead plaintiff (1) KEYsomeone who most adequately represent loss and presumption that plaintiff who lost most money (a) Most likely lead plaintiff is an institutional investor (b) Eliminates race to the courthouse, i.e. take charge of litigation iv) Could be advantage as lead plaintiff (court could award you more money v) May overcome presumption by showing person who lost most, could be plaintiff subjected to unique defenses, or doesnt adequately represent class vi) Lead plaintiff picks law firm thatll represent class d) (a)(6)attorneys fees cant exceed reasonable % of amount of any damages; prejudgment interest paid to class e) (a)(7)Settlement Statementmust be sent to all class members i) Disclosure statement (1) Amount of settlementaggregate and per share basis (2) Damages that may have been awarded (3) Attorneys fees (4) Reasons for settlement f) Enhanced pleading requirements go too far; too pro-publicly traded company i) (b)(1)if plaintiff alleges defendant made material omission or misstatementmust list each statement; reasons why misleading ii) (b)(2)recovery dependent on particular mens rea (i.e. 10(b)(5)) must state with particularity with strong inference that defendant had mens rea (1) Complaint must state with particularity facts giving rise to strong inference that defendant acted intentionally/recklessly (all without discovery) iii) (b)(3)if not met then must dismiss complaint (1) All discovery must be stayed during process of motion to dismiss (a) May stay action in parallel state court (i) Heavily dependent upon public information (press releases, etc.) iv) (b)(4)plaintiff burden of proving that defendants act or omission caused loss (i.e. proximate cause) g) Frivolous lawsuits

i) Congressional intent court must make written record of how each attorney complied with rules (if frivolous then mandatory that court must impose sanctions ii) Defendant only jointly and severally liable if defendant knowingly violated securities law and then if didnt then only particular percentage of damage (i.e. not knowingly may only sue for 10%) h) Silicon Graphics, Inc. i) Plaintiffs must meet what standard? (1) Significantly higher standard why Clinton vetoed (2) Strong inference must be shown by deliberate recklessness, or conscious misconduct in great detail (facts constitute strong inference of intent to commit fraud (3) Pleading motive and opportunity to commit fraud is not the question (all facts in great detail that support claim (4) Haas thinks this goes too far ii) 2nd Circuit pre-PSLRA (1) Plaintiffs must merely required to show facts that demonstrate simple recklessness, motive to commit fraud and opportunity to commit fraud (strong influence of fraud or intent) (a) Filter that catches frivolous suits and some legit suits Section 16(b) 1) Clearly designed to prevent insider trading of Cady type 2) Only profits disgorged if sell at loss then not disgorged 3) Also covers short salessell securities today you dont own and then buy when goes down 4) Applies regardless of intent (strict liability offense) 5) Only applies to equity securities a) Doesnt apply to debt securities but may subject to insider trading liability 6) Convertible securities3(a)(11)means any security thats convertible into stock so it is considered an equity security 7) Profits go back to issuer (in line with Chiarella dont owe duty to trading partner) 8) Suit may be brought by issuer a) Issuers obligation to bring suit if fails to do so holder of any security may bring suit on behalf of issuer 9) 16(b)flip side of 16(a) mandates filing by reporting persons so whenever engage in trading activity must file with SEC 10) Sale 1 day after period closeseven if didnt violate 16(b) then still may bring 10(b) or 10(b)(5) suit 11) 16(b)policy most egregious types of insider tradingpresumption its on inside information PROFIT 1) How do you calculate profit if multiple purchases and sales of securities a) Match highest sale price with lowest purchase price i) List all purchases ii) List all sales iii) Match purchases at lowest price iv) Repeat process until down to zero (1) Amount disgorged is sum of profits realized

2) Is it really strict liability offense a) Kern County v. Occidental Petroleum Corp. i) KC signed up to merge with Tenneco (White Knight) ii) Dont get cash, get convertible preferred stock iii) Occ throws in towel but decides to purchase iv) Shares tendered to it which is greater than 10% granted to T a call option to re: purchase shares of preferred stock Occ will receive v) Why would Occ an T agree to do this (1) T wants to get ride of minority shareholder and Occ doesnt want to be stuck with stock (mutually beneficial) b) Call option granted within 6 months of closing of TO but call option couldnt be exercised until 6 months and 1 day i) Occ realized $20 mill profit c) New company sued Occ for disgorgement d) Supreme Court address 2 questions i) Did Occ affectively sell common stock when irrevocably bound to sell pursuant to merger agreement (1) Occ gave up something of value for convertible preferred stock (2) Hostile parties also know what may happened if lose out (a) Compelling argument (i) How M&A deals wind up eventhough lose still get to sell stock at higher price (ii) Is information may engage in abusive trading 1. this information isnt what insider trading is about because information wasnt being used to exploit 2. highly unlikely Occ although transactional insider would be provided to any inside information because adversary of KC a. look at inside information people had and motivations of parties (3) why might exchange as part of merger not constitute sale (a) involuntary exchange (transaction)exchange (i) required by law to exchange because of California law (ii) Occ didnt vote for merger and under California lawnon-votes are no votes and regardless had votes to close deal (4) Is the exchange a saleNoin this case, different facts may lead to different result (5) Some slight wiggle room away from strict liability ii) Did Occ grant of call option constitute a sale of Occs position in KC stock at time of grant (1) Grant of an option isnt a sale (2) Grant of an option; giving opportunity to exploit inside information because not speculative abuse of inside informationlook at the circumstances (3) Mutual advantages to both sides (a) Motivations of parties so any leverage Occ had wasnt based on inside information but rather its stock ownership (b) Optiongives rights to buy stock from Occ (i) Any subsequent increase in valuation would go to holder of call option; if fell out of the money then wouldnt exercise option

1. economics of options unlikely and could use to advantage so no sale so no profit to disgorge (4) dissent says this is crap and we should just keep with strict liability (conclusive presumption that used inside information) cant carve out transaction Put and Call Options 1) writing of call option doesnt constitute a sale of a security 2) does writing of option constitute sale or purchase or does exercise of option constitute sale or purchase a) call optionright to call away asset on given date at given price b) put optionholder has right to sell to counterparty or asset on given date at given price 3) 16(b)(6)put equivalent position and call equivalent positionmay enter into transaction without calling it such so SEC doesnt care what you call it 4) Sale occurs when reporting person enters into PEP and purchase occurs when enter into CEP a) Where Occ entered into call option, it was for benefit of T if Occ had right then will be considered a purchase i) 16(b)(6)when exercise option no sale or purchase occurs (1) If have option (when enter into is a sale) and exercise option then no sale (2) If enter into call option is purchase and when exercise option then no purchase (a) Without this then reporting person may stock and enter into put option within 6 months even though put option is exercised after 6 months Profits realized 1) CBI v. Hortonprofits must be of direct pecuniary benefit to insider himself a) Dont have to match sale and purchase because profit realized to insider i) Trust bought at low price (sons only beneficiaries ii) If H was beneficiary then result different but only disgorge her portion of profit Feder v. Martin Marietta 1) Is it possible corporation/partnership may be deemed an insider if 1 of directors/officers sits on board of another 2) Martin Marietta owns 10% of stockNo a) Not reporting person 3) Sperrys theoryBunker (officer of Martin and Sperry board member a) Can Martin be deemed an insideryes based on deputization i) Fact based test ii) Deputization if company A deputizes director to be on board of company B and may be deemed to be insider if person deputized by company A (1) Must affirmatively deputize personNo look at facts not title 4) Martin owns stock of Sperry and Bunker has inside information that may allow Martin to manage investment based on inside information (potential for speculation 5) Investment powerdoes person exercise power of approval over investment in Sperryif so then obligation to exploit inside information then may hold Martin liable for short swing profits 6) Court holds Bunker was deputy and so Martin was reporting person a) Key Facts i) Bunker personally responsible for investment in Sperry

ii) Looked at Bunkers resignation letter and indicated that Martin shall be repped on Sperrys board because of investment iii) Martin approved Bunkers membership on Board iv) Martin had investments elsewhere and had director of those companies v) Martin defends against lawsuit because Bunker resigned (1) Court said doesnt matter (2) Inside information impact diminishes over time but only gradually 10+% Holders 1) Must be 10+% holder both at time of purchase and sale within 6 month window a) Purchase that puts you over 10% DOES NOT count for 16(b) purposes i) Odd because of analysis in KC case b) Any sale made while holder of 10% that drops you below 10% does count for 16(b) Officers 1) Merrill Lynchlook at function and not title a) Look at substance of job even if no title may be given access to information; does person perform policymaking function i) Environmental impact policymaybe considered an officer