Good Jalil Use

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I. Introduction:

a. Historical Background/Overview:

i. Labor + Capital = Wealth [all societies agree with this capitalist, socialism etc)ii. Formation of capital is the life-blood of business [need capital to form and grow business]

iii. Capital raising system created by wealthy Europeans Merchants- way to spread risk mrchnt bank-corp.

iv. EAST India Tea Company take European goods to America & trade for indigenous goods

1. Risk to take journey: [natives not want it, ship not make it]if ship returns pay captain crew, sell indig

goods & split money left w/ equity owners (ship investors)if ship not make itinvestors lose (pick bad stk

v. First Public Issuance of securities Civil War. Union issue bonds to support war effort paid off w/ 3% int.1. Merchant banks not have enough

2. Sec of Tres. sell war bonds to public to raise capital to finance war [so taxes & bonds finance war]

3. Confederate also sold bonds but b/m worthless so south capital base wiped out

vi. Industrial revolution (Rail, tele etc) Co. need money& not enough from Merchant bankers so turn to publicthere was some fraudulent schemes but only remedy was CL tort fraud not feasible so fraud went unchecked

vii. 1920s states began to enact own securities laws (Blue-sky laws) some success but public soon lost faith so

stock market crash;

1. After Depression - Need capital to jump start the market need investor confidence

viii. FDR campaign new deal b/c knew if capital ceases- a capital system cant function; All banks are

bankrupt no money only source of capital is American public but have no confidence

1. First 100 Days FDR rushed to enact the securities act of 1933 provides full disclosure & remediesix. ALL SECURITIES LAWS about Disclosure if instrument is defined as Security get all sec laws

b. 4 Main Securities Laws (all admin by SEC)

i. Securities Act of 1933 a consumer protection statute, rose from 29 crash main purpose is to mandatedisclosure (thru registration or exemptions) to investors so can make smart informed; full fair; decisions;

1. Deals with Selling & Issuance of securities to the public Which is raising capital;

2. Also have disclosure forced to the SEC; and if insufficient disclosure easier to get damages then CL fraud

3. Regulates primary and secondary offerings----not secondary trading/transactions

ii. Securities Exchange Act of 1934 is a regulatory statute by SEC regulates exchanges, broker/dealers,public Co., insiders, tender offers, and provides anti-fraud provisions

1. Created the SEC incr. investor confidence; regulates how market runs & how broker/Deal run their bus2. Regulates secondary transactions/trading (after market trading)

iii. Investment Company Act of 1940 intended to target pre-crash abuses of investment pools 40 actregulates investment companies; mandates registration & has exemptions; dictates organization and operation

rules; Regulates Mutual funds (pool investing)

iv. Investment Advisors Act of 1940 regulates anyone who for value, gives investment advice as to thepurchase & sale of securities; Act is regulatory & notably prohibits contingent fees based on performance;

v. Blue Sky Laws vary state by state, unlike SEC states only merit review of offering have a fair/just andequitable standard

1. National Securities Market Improvement Act prempt from state review variety of covered securities

including those traded on Nasdaq, NYSE, AMEX

c. Terminology

i. Types of Bank

1. Merchant Bank classical model of getting capital an institution invests its own money inyour firm to develop your product [put your money up]

2. Commercial Bank institution takes deposits & uses it to make investments (ie loans); eg citi

3. Investment Bank institution that goes out & finds the money to invest in firm[puts 2 peopletogether]

ii. Broker/Dealer

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1. Broker (NYSE) exchange market broker puts buyer and seller together and transaction isdone; The buyer is privity to K w/ seller but it is privity w/ an anonymous person; B&S each call their

brokers to make a transaction then brokers met on floor of exchange to complete txn and trades goes on

ticker

a. Broker gets a commission for this need be licensed to get commission

2. Dealer (NASDAQ) OTC market Dealer sells out of its inventory (buyer privity of K w/dealer)

a. If sell MS, Merril dealer would buy it and take it as inventory and puts it on the shelf; if

someone else want to buy MS; ML takes it off shelf & sells it to them;

3. Broker Dealer someone does both exchange and OTC market4. NYSE quotes the last trade price; 50 is last txn btwn buyer and seller that was made thru broker

5. NASDAQ quotes what dealer is willing to pay for the security (bid price) and what dealer is willing to

sell the security for (ask price); Bid ask Spread /markup Dealer ML can make $$-constant Buy/sell

iii. DEBT comes in three forms each is loan to company can be security

1. Notes short term investment (I owe you) promise/obligation to pay (1-4 years)

2. Debentures Intermediate term investments (5-9 years)

3. Bonds long term (10-30 years) generally secured by assets

iv. Equity ownership interest in a company (if stock still need to do economic reality test to see if security)

v. Securitization taking something not a security and turn it into a securityvi. Registration of securities vs. Reg of transactionsyou register an offering not a security and not a Company

vii. Initial capitalputting money up for Co. etc; (trading on exchange not put money into Co just change hands)

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II. What Is a Security

a. Overview:

i. IF something is a security then the Fed. Securities laws apply 33 and 34 act; Investors want the protection

of the securities acts and if security easier for lawsuits and remedies in securities fraud then CL tort fraud;

ii. A security is a security not matter if public stock or closely held Co; not matter to security definition;

iii. IF instrument is a security no offer or sell unless registration or exemption [illegal to opt out sec laws]

sec14 of 33 act any conditions on application of 33 act shall be void [pg 58 policy elective sec laws]

b. Statutory Definition of Security: [first place to start]

i. 33 Act 2(a)(1): The term "security" means any note, stock, treasury stock, security future, bond,debenture, evidence of indebtedness, certificate of interest or participation in any profit-sharing agreement,

collateral-trust certificate, preorganization certificate or subscription, transferable share, investment contract,

voting-trust certificate, certificate of deposit for a security, fractional undivided interest in oil, gas, or other

mineral rights, any put, call, straddle, option, or privilege on any security, certificate of deposit, or group or

index of securities (including any interest therein or based on the value thereof), or any put, call, straddle,

option, or privilege entered into on a national securities exchange relating to foreign currency, or, in general,

any interest or instrument commonly known as a "security", or any certificate of interest or participation in,

temporary or interim certificate for, receipt for, guarantee of, or warrant or right to subscribe to or purchase,

any of the foregoing.

c. Judicial Definition of Security (Investment K)

i. Investment Kshould be default (catch all) definition of securitystarting point of analysis; Best way to see ifinstrmnt is a security is HOWEY Test; - All finan instruments & stocks start w/ Howey but not Notes (Reves)

ii. SEC v. Howey pg 21 US 1946 right after WWII first attempt of court to define security; no investorcomplained about Howeys actions people made money like Howey said, there was no ponzee etc but SEC

sues b/c says cant offer security unless register offering; Howey says its not a security: Howey bought land

and sold strips of land with orange trees on it to the public (fee simple absolute ownership) but then Howey

gave owners the option of entering a service/mngmt K with Howey to plant trees, pesticide, harvest & sell

them as part of pool of oranges to the buyer and Howey Co. takes a certain percentage of sale for its mngmt

and money left over is given to land owners based on how much land owned;

1. Howey states only selling land and offering service K if want; SEC says created investment K2. Buyers of land didnt really want actual oranges they wanted return on their investment make a profit

3. Ct held that this was an investment K and should be registered under the 33 act; Look at theeconomic nature of the enterprise; substance over form; (land ownership combined w/ mngmnt K expect

profit)

4. RULE: investment contract for purposes of securities act means a contract, transaction or scheme

whereby a person invests his money in a common enterprise and is led to expect profits solely from the

efforts of promoters or a third party

a. Solely was a mistake and subsequent cases read it out b/c can just have land owner once a year

pick a orange; so now substantial efforts of others;

iii. Howey Test for investment Ks [risk is irrelevant] A security is any contract transaction or scheme whereby:1. A person invests money (or something of value) [investment of money]2. in a common enterprise, and

3. where expectation of profits and success depends on efforts of others

a. (no more solely others; now predominantly or substantialSEC v. Koscot)

4. [any instrument passing howy is a security; but if not meet howey it still maybe a security justify status as

security in some other definitional matter]

5. [marine bank later added to this better regulatory scheme and uniqueness exception]

6. [howey test -east india tea co. had these factors people invest $$ in common enterprise where profits

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depend on others efforts this is Capitalist system capital/labor dichotomy capital is passive)

iv. HOWEY TEST APPLIED:-Forman extend Howey Test to all securities and maybe Marine bank and Landreth cut back Howey litle

1. Investment of Moneyintention is $$ given over w/ expectation of profit or return on investmentas 1 reason took action; if purchase for use /consumption then not an investment (passivity?) need to

INVEST;

a. United Housing Foundation v. Forman -pg29 US 1975 in order to buy an apt in Co-OpCity- one needed to buy X shares of stock in the management company and when sold apt you wouldsell your shares back to the management company and get money back; P sued had problems and

instead of state court sues in federal ct bc says mngmt Co sold stock w/o registration so P can get

securities fraud relief

i. HELDThis is not a security even though stock is in the definition of securities look @ whatsreally going on (Economic Reality) & Consumption test & failed 1st prong of Howey(no invst

ii. Economic Reality Test aka basic common sense test no expectation of profit;1. there was no investment of money, person was trying to buy an apt and any

appreciation is in the apt not the stock; invest is give $ for profit;

2. Substance over form governs(like howey) possible challenge - Landreth

3. NOT everything called a stock is stock/Security; - term is not dispositive;

a. Here no rights of stock- non transferable, no pledge or encumber; no

voting rights;

b. reject at outset any suggestion that the present transaction evidence by

the sale of shares called stock, must be considered a security transaction simply b/c

the statutory definition includes the wordsany stock

4. Intl Brotherhood of Teamsters noncontributory compulsory pension plan is noan investment K; economic reality EE sells labor to make living, not an investment,

and ER is the one contributing; also Pension covered by ILISA so marine bank;

iii. USE/Consumption Test Cant double dip invest money and use it as well;;1. If give $ to get goods or services in return that they intend to use it it is not an

investment and therefore not a security [jury question investment or consumption]2. Foreman bought apt to use so no passivity so not investment ;

b. Jaguar example: pg 34 (Use/Consumption Test) Jaguar need capital or car not get produced(take 2yrs), Car will be worth double the price once person gets it; IF this is a security depends:

i. IF Jaguar rep goes to bank/people and says give us money and it will double in 2 years if

want the profit and not the car it is an investment and a security; ie not even see if owners

want the car, have licenses etcjust sell to them get capital & ownr will turn around and sell it

ii. IF Jaguar goes to list of previous customers who own high end and say want this car give us

money now and get car if 2 years worth double the price you paid; IF person wants car not

the profit then this is use/consumption and not an investment/security;

iii. INTENTION of Jaguar [seller] matters & get Rep/Warranty from buyer that for use not profitiv. IF security for one person security for all;

c. SEC v. Edward payphone franchise for prisons structure with a fixed rate of return Thisdoes not violate HOWEY and it can still be a security; whether fixed or variable irrelevant to Howey

test

2. Common Enterprise (Commonality) circuits split as to requisite commonality for Howey(Hor/Ver)

a. HYPO: Ski Resort with 12 lodges; promoter goes to investor if buy this lodge I will maintainit, insure it, rent it etc; (this is a security; say if you use it once a year not consumption?)

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b. (1st determine circuit Broad vertical, Strict vertical than Horizontal-least to most difficult))

c. Horizontal Commonality (howey was this) at least 2 investors who have similar relationshipin the business enterprise they all pool their investments and share the profits

i. Requires an enterprise and class of investors, all of whom share equally or generally in the

success of the venture (Pooling of investors funds);

ii. Investors all rise & fall together; group of investrs all gave $ & promoter takes responsibility

iii. Lodge if your lodge bad spot never rented not matter b/c pool all $ from all investors and

split profits; So pool success and risks; and if one not rented all get little less profit;

iv. Commonality btwn investors rather than investor and promoter(vertical)

v. ONE investor problem: -need 2 for horizontal commonality but POSNER in Lauer if circuithas horizontal com and 1 investor not matter b/c it is character of investment vehicle that

matters, not # of investors, so if theoretically can have multiple investors then requisite

horizontal commonality is met

vi. Wals v. Fox Hills: Ps bought a timeshare for a condo at golf resort & ended up trading theirshare for another work, but left their timeshare time to be rented out by the management co.

Ct. found that although there was an investment of $$, & that Ps were relying on the efforts

of the management co, the scheme failed commonality b/c the other owners were not pooling

their profits into together [fail horizontal commonality no pooling of profits]

d. Vertical Commonality (easier to meet b/c always have promoter & investor link unlike horiz

need many investors or possibility of many) SO if promoter & at least 1 investor share in success orfailure of business venture commonality is met; ---PROMOTER tells investor I will rent your lodge

[individ. Relationship] and take expenses and fees and then you get the profits; so if investor has bad

lodge screwed - no money is pooled;

i. Strict Vertical Commonality - promoter and investor linked both make and lose moneytogether direct and proportionate rise and fall, both share in sucess

1. If not rent lodge still have expenses so here promoter and investor both pay

expenses pro rata so both can lose money

ii. Broad Vertical Commonality some unity of interest but here promoter need not losemoney if investor loses; (NO Lost interest) only some effort on part of promoter for success

1. If not rent lodge promoter not get his % of profits but still gets expenses paid by

investor so promoter does not share in losses ie share of expenses; but only share inupside profits;

iii. Examplerent 1000/month; 100 dollars expenses; promoter gets 10% profit (90); 810 toinvestor STRICT vertical-if not rent lodge 100 expense still paid but promoter pays 10% of

it b/c no rent to take the expense from so share in upside and downside; if BROAD if not

rent Investor pays all 100 expense & promoter pays nothing & gets nothing bc no profit;

3. Efforts of Others:

a. Capitalism is passive investment of money to be used by others and then returned w/ profits;

b. EFFORTS OF OTHERS refer to the party investor is dealing with not some 3rd partyc. Solely by efforts of others has been written out of Howey; (SEC v. Koscot); the investor must

rely predominantly on efforts of others(ie substantial efforts of others) some invest particip not ruin secd. Franchise great investment put $$ have others run but then FOR being examined by SEC forselling security b/c of HOWEY change model now need OWNER-OPERATEDno passive investmen

in franchise b/c FOR (MCD) though provide support not want to be governed by securities laws

i. SO now franchises are generally not securities

e. SEC v. Life Partners pg 43 1996 DC Cir D matched investors with AIDS patients. Thepatients would receive $$ today in exchange for their life insurance policy to be assigned to them; D

would receive commission to match up. CT held these were not investment Ks there was investing of

money and pooling money (common enterprise) for expected profit but no effort of others.

i. Promoters did work before investment but no sufficient efforts of others post investment;

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just wait for people to die and get money capitalist society give money and others do stuff

f. SEC v. EDWARDS fixed income still can be efforts of others;

v. Limitations of Howey:

1. If an instrument no matter what it is called passes howey test it is a security but if not meetHowey it may still be a security, justified thru some other definitional matter;

a. Marine Bank v. Weaver pg 24 - US 1982: - Warren court Sale of CDs insured by FDIC;; It

was a business arrangement btwn parties involving lease of a barn;b. Held CD not security even though met definition of security; b/c FDIC insured & banking laws

c. CASE FUMBLES not matter if it is not something that comes to mind for it to be security

since creative instruments are fine; private vs. public not matter b/c private can be security; not need

publically traded b/c many securities are not; and no prospectus delivered not matter b/c can have

security w/o prospectus;; ALSO risk has nothing to do w/ deciding if it is a security or not;

d. MARINE BANK: - not a security even if pass Howey or 33 definition if

i. Better Regulatory Scheme Exception aka Alternative regulatory protection Test if thereis another regulatory body/law better suited to deal with a given transaction (banking laws)

then trump securities laws [but not fool proof]

1. So can pass howey and still not security- b/c better reg scheme makes registration

an onerous and unnecessary burden; and

2. Marine bankCD issued by MB not security b/c FDIC & banking laws adequate

protct

3. Teamsters v. Daniel & Matassarin v. Lynch - pensions not securities (law)have

ERISA

ii. Uniqueness Exception if offerings has uniqueness such that no other investor could takepart in it; then probably not a security; that would be overreach by 33 act and inefficient

dissemination of information requirements of the acts are justified by economies of scale

that do not exist in unique transaction;

1. Marine bank barn investment very unique to parties no other investor could

share in;

2. Consistent with capitalism need many investors3. Also Unique not mean NOVEL ie no one thought of it before; -- NOT matter if

not come to mind when think of security creative instrument can be security;

e. Reves even though note in security def not all notes securities look at purpose of actf. HOWEY test has nothing about risk as risk is irrelevant and has nothing about the

sophistication of the investor

d. ASSOCIATIONAL FORMALITIES: Interests in Corporations, Partnerships & LLCs as Securities:

i. Stock as Securities - maybe presumption for it to be security but still Howey and Forman

1. Economic reality (common sense test) FORMAN just b/c something is called stock does

not necessarily mean that it is a security/stock notwithstanding the lanaguage of 2(a)(1) that specificallyincludes stock b/c look at Substance over Form;

2. Sale of Business doctrineif there was a sale of 100% of stock of the business then not selling asecurity, b/c selling control, cant be selling efforts of others [howey] so not investment BUT overruled by

Landreth

a. Landreth Timber Co v. Landrethpg 46 US 1985overrule SOBD said selling stock was stockso 2a1 securitybut do not read this as overruling economic reality test of Forman & Howey which

says look at substance over form real intent is purchaser of 100% security is still protected by

Securities laws and Landreth was really stock.

i. WORK around if sell 100% securities to buyer then securities transaction if sell all assets

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and liabilities of Co. to buyer than not a security transaction;

ii. Partnership as Securities -2(a)(1) not mention partnership as list of securities definition but structure ofpartnership does have implication of whether or not it is a security-

1. General Partnership are generally not securities b/c fail efforts of others prong. Each GPmanages the business & bind the partnership (or has right to) so GP interests are not considered securities

a. BUT if called a GP but not really true general partnership since few attributes of GP only few doall managinga security can be found (KOCH v. Hankins); Forman Economic reality works both ways

b. Chinchila farm got investors from all over country called GPs but still was security b/c passHowey there is efforts of others b/c investors did nothing not know about farm [sub over form]c. Pg 56 Law firm hires associate from other firm to join as GP but finds out after joins firm isgoing down and now can sue in torts or K but wants to sue in securities fraud if truly GP not satisfy

Howey efforts of others so cant sue in federal; but if GP not do mngmtn and senior partners do it

then maybe can; BUT also investment of $ if 35K buy in is it investment to grow or is it just entry fee

more like forman not investment of money;

2. Limited Partnership generally considered securities b/c passivity requirement have efforts ofothers b/c limited partners have no management control GP does that; so LP interest is security passes

Howey:

a. Steinhardt v. Citicorp pg 50, 1997 3rd cir D wanted securitze non-performing loans to get

off their balance sheet so dumped them in LP and sold LP interest to P; LP agreement gave P vetopower (control etc while still preserving DE Limited liability); P sued D but wanted federal so under

securities fraud; CT said efforts of others test was not met- so this is not security b/c P had veto power

so not a passive investor SO FORM calling it LP not automatically mean securities; (no black letter)

i. Again substance over form like Howey and Forman economic realities name not matter

iii. Limited liability interests (LLCs) as securitiesHowey test if members have significant input then notsecurityfails efforts of others (ie member managed); if members are passive then it is security

iv. Real Estate as Securities normally real estate transactions are not securities but if more than simple txnand pass Howey test than can have security LOOK at expectation of parties intent to invest in business for

profit, is there commonality, and is investor relying on efforts of others?

1. SEC Release 5347: ANY the following will aid in a condo (purchased directly from a developer) being

an investment contract: emphasis on economic benefits derived from managerial efforts; offering of

participation in a rental pool arrangement; unit must be offered for rental at any time in the year, use an

exclusive rental agent, or otherwise restricted in occupancy or rental of the unit.

2. Hocking v. Dubois pg 60 1989 9th cir P buys condo in HI form owner in the secondarymarket NOT from the developer. Broker told P that the condo could be put in pool and rented out. CT

applied Howey said it was security created by broker in the aftermarket, investment of $, and

purchased w/ expectation of profit, had rental pool agreement so passes Horizontal comm.(and vertical

Comm); issue was efforts of others;

a. KEY all things have to be offered in one package the mgntmt agreement (to maintain thrumaintenance fees), rental pool agreement cannot get it separately

b. HERE broker created the security even though developer had nothing to do with broker/agent; &

if owner used it once a year still can be security Forman consumption/use and economic reality

c. Case remanded b/c denied SJ not say sec for sure need more info on level of control by investorv. Notes (IOUs) as Securities -2(a)(1) defines securities to include notes (debntres/bonds) but not mean all notes

1. Notes like stocks very name in statutory definition may mean presumption it is a security but: do not

abandon both the HOWEY test and economic reality test (forman).

2. TWO fundamental types of notes: SO Notes look at intent of parties :

a. Investment Notes these are securities (bonds/debentures) if business borrows money then they are securities ie notes for capital improvements, or expansion, general business interest;

b. Commercial Notes NOT securities used for commercial purpose used to finance short termassets, bank financing, commercial asset financing, inventory financing these notes are not securities

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i. accounts receivable -people buy on credit Business sell A/R at discount to bank to financebusiness (pay EEs bills etc) cant do it w/ A/R so borrow against it this is commercial loan

ii. Inventory short term borrowing- dealer not own every car on lot borrow against inventory1. If only equity capital used to buy inventory then limited but if more inventory

can sell more so borrow against inventory and when sell inventory pay loan and buy

more

iii. Cant require registration of all these notes it would restrict business too much

iv. SHORT term usually 1 year max but expectation is pay back in 30 to 60 days

c. REEVES v. Ernest & Young- pg 67 US 1990 (differentiate investment vs commercial notes)Family Resemblance Test: There is a presumption with respect to notes that they are a security but if

the following four part test is met [all 4 parts] a note will not be deemed a security

i. Motivation of the parties 1. Buyer is motivation of buyer an investment (earn profit) then security or is it

commercial purpose short term financing (not security)

2. Seller is it for commercial or consumer purpose (not security) or for general

business purpose (security)

ii. Plan of Distribution to whom selling the notes/is instrument meant to be traded1. To the general public investment note (a security);

2. If to people in business of financing short term assets commercial note not

security

3. Is note designed to be traded investment often have ability so security and

commercial notes almost never ability to trade not security

iii. What are the Reasonable Expectation of investing public (would finance world consider itinvestment note or commercial note)

iv. Is there Another regulator scheme better suited to deal with the instrument (Teamster)[risk is relevant in Reeves debt but not capital - Howey]

vi. Separate Security Issues (pass through security/trust) make security out of basket of non security stuff creating security separate from mere ownership of something (ie the scotch) that is not security

1. Examples of Securitization (making security out of something that doesnt exist as security byselling interest in it) Scotch, orange groves, credit cards, debt/home mortgage;

a. Pass through simple residential mortgage is not security but pooling mortgages and selling

undivided interests is a security, where value is derived from mngmtn of others

2. Scotch Example 12 year tie up can make a security out of common basket of non-securitystuff (buying stuff thats not a security but set up a trust using others money to buy those things and hold it

-then interests in the trust are a security) created a separate security then if meet Howey have a security

SO put scotch in trust and sell interest in the trust created and sold securities

a. Scotch needs to age in oak barrel distillery cant age it in the bottle like wine so Distiller has to

keep scotch for 12 years and cant sell it so can make security out of it

b. Buying 50 barrels of scotch is not security but: if Setup a trust and sell interest in the trust say

10 investors each 1000; The trust then buys the 50 barrels of scotch from the distiller and then distillertakes money and use it to make more scotch etc

c. Once barrels ready and sold the trust pays off all expenses and returns money to investor at say

double the money invested This is securitization; and if pass Howy is security

3. Accounts Receivable Example common security MC/Visa go to restaurant pay w/ card- therestaurant has no money but has to go buy new food etc and pay expenses, so they sell their A/R to MC

or AMEX etc who buy their credit card receipts owed at a discount say 92cents/dollar and rip a check to

the restaurant the next day so they can run their business and then AMEX/MC holds the receivables; BUT

AMEX/MC need lots of money to do this buy of credit receipts etc so they put all the recievables and

package them and securitize them and sell them to investors who buy into the trusts and if want out can

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sell your interests; SO for MC/AMEX need not wait for us to pay off our bills securitize them to get the

money; MC is selling interest securitizing them but they are not securities for MC (the receipts)

4. Mortgage Example: - have 30 year mortgages cant wait that long for payment want to do moremortgages - so securitize them and setup trusts w/ all these mortgages and then sell interest in trusts to

investors; The trust is divided into tranches, where the mortgages always to be paid on time are section A

and their investors get lower interest rate then say the riskier mortgages of the pool say the bottom have

so their investors get higher interest rate;

a. But 100% of the bottom defaults and investors got nothing and then no one started buying into

the trust so couldnt really trade it and sell out and so cant value the trust either since not sellable sobanks now cant get money to pay for other business b/c tied up in these assets that cant be sold or

valued; so illiquidity and gridlock; SO govt TARP buying some of these assets to banks lend more

b. Past Savings and Loans bank kept the mortgages so slow growth b/c cant lend more unless get

more depositors this would be equity loans only but leverage and securitization allows faster growth

and more loans

vii. REMEMBER:

1. Once a security always a security; and if investment says stock presumption it is security

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III. THE Public Offering

a. Overview Offering securities Issuer can 1. Sell it to the public (Ma and Pa America) or 2. Sell it privately. Acompany that wants to sell stock (a security) to the public goes to an underwriter (Ibank) to buy the stock. The

underwriters are retail distributors of securities and distribute the stock to the public.

b. Terminology:

i. Issuer any person (ie company, enterprise, entity) that issues securities1. Like Co issue common stock, or partnership issue membership, or trust take on investors

ii. Underwritermore laterany entity that buys the securities from the issuer & then sells them to a distributionnetwork (brokers). Underwriters are essentially the wholesalers of the securities industry (middleman)1. Ie when MS wants sell securities to the public, not know who is interested so use underwriters who

contact brokers who know who want to buy stock.

iii. Primary Offering - any offering by issuer itself; when the issuer itself sells securities

1. IPO initial public offering first time issuer offers securities to the public the first primaryoffering

2. Public offering any time issuer offers securities after the IPO to the public

3. Private offering a non-public offering4. (IE Each time MS sells its securities it is a 1 offering, can only have one IPO, any other offer by issuer

are just primary offerings)

5. Secondary offering offering of securities by someone other than the issuer,(which requiresregistration)

a. ie Insiders, control persons, affiliates (CEO, BOD, Majority SH) sell stock may need register

b. If Gates wants to sell MS its secondary offering & may need registration.

c. Generally these are statutory underwriters and affiliates under 2a11 but still must be concernedwith 5 registration or seek exemption under 144, 4 (1/2) or Reg A.

6. Secondary Trading after market trading- trading of securities in the open market by theaverage person. It has nothing to do w/ secondary offerings and the securities have already come to rest in

the public. It is exempted from registration

a. ie buy/sell securities by persons other than issuer or person who must concern himslf w/ registrant

7. THE 33 act only concerns itself with primary and secondary offerings and Nothing to do with secondary

trading/transactions. The 34 act is primarily concerned w/ secondary (after market) trading.

c. SECTION 5 of the 33 Act - this is what the 33 act is all about. Everything else is commentary

i. Intro: Absent some exception/exemption, it is unlawful to offer a security unless registration is filed w/ theSEC & unlawful to sell/buy security unless registration statement is in effect. Registration is of the offering.

1. Theory behind 33 act is consumer protection and disclosure by the issuer every time sellssecurities so the investor can make an informed decision; Risk is irrelevant can sell risky securities just

need to disclose

2. Registration statement: 2 parts: 1. Prospectus is a disclosure document/sales brochure and 2.SEC forms (housekeeping); This registration statement is what every issuer must draft up and file with

SEC.

3. 33 and 34 act are criminal statutes says it is unlawful.4. Section 4(1) - Section 5 not apply to any person other than ISSUER, UNDERWRITER andDEALER

a. 4(1) exempts secondary trading (we buy/sell stock) from 33 actonly concern is 1 /2 offerings

ii. 5(a): Unless a registration statement is in effect as to a security, it shall be unlawful for any person, directlyor indirectly-- 1. to make use of any means or instruments of transportation or communication in interstate

commerce or of the mails to sell such security through the use or medium of any prospectus or otherwise; or 2

to carry or cause to be carried through the mails or in interstate commerce, by any means or instruments of

transportation, any such security for the purpose of sale or for delivery after sale

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1. unless registration stmt is declared effective by SEC its unlawful (criminal ramifications) for any person

(not mean human being) to sell a security; Reg stmt expires after 9mos so need new reg to reissue after 9m

iii. 5(c): It shall be unlawful for any person, directly or indirectly, to make use of any means or instruments oftransportation or communication in interstate commerce or of the mails to offer to sell or offer to buy through

the use or medium of any prospectus or otherwise any security, unless a registration statement has been filed

as to such security, or while the registration statement is the subject of a refusal order or stop order or (prior to

the effective date of the registration statement) any public proceeding or examination under section 8

1. Once registration stmt is filed but even before it is effective can make offers to buy or sell. BUT Before

registration is filed cant offer to buy or offer to sell any security,

iv. 5a/5c interpretations:

1. Unlawful so criminal statutory ramifications jail, fine etc

2. Any person - 2(a)(2) person means an individual, a corporation, a partnership, an association..trust

3. Commerce clause language if Constitutional challenge as to whether Congress has power to pass sec reg

4. 4(1)sec 5 only applies to issuer, underwriter, and dealers; so any offering by them (ie sell stock) must be

registered (have effective registration stmnt) and so secondary trading is exempt (not issuer/under/deal);

v. Registration Statement: bulk is prospectus other part is housekeeping stuff;1. SEC thru regs tells what to include in registration stmnt; once effective can sell securities;

a. Sue if registration statement is misleading/material omission; cant sue on preliminary prospectus

2. Prospectus a. a disclosure document/ sales brochure, whenever issuer/underwriter sells a security it must send

prospectus to the potential buyer to inform them about the security; Finances etc;

b. Prospectus must comply with 10.

3. Purposeis disclosure a. good,bad,ugly to investor to make informed investment decision; risk irrelevant

b. Buried disclosure is no disclosure at all

4. Reading Level: -

a. written in plain English at a NY Times reading Level (no legalizes/jargon)

5. Standard for Drafting: [TRUTH is not the standard] ----see Materiality SECTION pg 15a. Statements cant be materially misleading

i. So if truth Chinese market for telephones is 1BN, cant put that in prospectus for smallcompany seeking to raise capital to make phones b/c misleading gives the impression he can

play in that market but really cant [can say idiot if buy stock no one sues but it is sales doc]

b. Anything material must be included

c. [tension if disclose everything and too much bad stuff no one buys stock, if but if not disclose

then sue later on if material] also drafter of reg statement needs to know all cant rely on managers.

6. 33 act sec 5 - Registration statement is registration of the offering not the stock/security a. No such thing as registered security. Securities sold correspond to registration stmnt; SO if MS

issues stock to public (stock cert 123) under a registration stmnt & MS wants to buy it back (treasury

stock) & then resell to public some time later MS cant unless a registration stmnt is in effect to sell the

security since old one is outdated, stock is not registered

7. Shelf Life is 9mos from date of latest financial information in the registration statement-info get old

a. SO use latest financials in reg statement b/c if 6mos old only have 3 mos left on it

b. Not mean it is better to buy stk from issuer not 2 trading b/c want all info &prospectus only fromissuer offerings b/c 34 act requires prospectus type info be available to the public; so 2 trading is ok.

8. Fraud for prospectus is longer SOL than the 9mos (3-5Years?)

9. FORMS for Registration Statement:

a. Make disclosure easierintegrated disclosure formsREG S-K (Co. info) & Reg S-X (accting inf

b. S-1 = list of questions to be answered in prose, used by anyone who not qualify for short form,

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which established Companies use. Every IPO uses S-1, this is default form;

c. S-2 = shorter form for more seasons companies

d. S-3 = even shorter form for even more seasons companies lots of info out there

e. S-4 = for mergers

f. S-K =complete package of questions -forms above reference S-K by stating which Qs to answer10. Disclosure required by Forms/registration statement:

a. Info wrt to the registrant

i. S-K - Descrip of business, director security ownership, comp, hi/low prices, legalproceedings; S-X need financial stmts and income stmts, audited

b. Distribution of proceeds: underwriter describe agreement w/ issuer and use of proceeds

c. Securities of registrantrights/privileges/ preference of securities offered; price disparity to dirctrs

d. Exhibits: not part of prospectus, ie lawyers opinions, articles of incorp

e. Everything else material to an investor and anything issuer believes investor should know

vi. REGISTRATION PROCESS:

1. Once Registration stmt drafted (by Sec Lawyers) submit it electronically via EDGAR (electronic data

gathering and retrieval system), SEC then reviews and comments on it (but not verification of mertis)

thru a comment letter. Issuer responds by filing amendments go back and forth for a while;

2. After all comments are incorporated and amendments filed registration statement is declared effective

3. Once registration statement is effective securities subject to that registration can be lawfully sold to the

public under 5(a); (before could just offer 5(c));

4. SEC cant refuse to declare registration effective under statute and prevent sale- if make all proper

disclosure/amendments but can keep commenting;

5. NO Merit Review: - SEC doesnt verify if all correct, just b/c declare registration effective notmean SEC signed off and verified all statements are true; So disclaimer says on prospectus SEC review

not means sign off on everthing;

6. Timing 8(a) SEC has 20 days to declare registration statement effective

a. But every issuer that files registration statement makes a voluntary amendment waiving the 20days for SEC benefit. Quid pro quo in Return -SEC will allow the issuer to go effective on the

date/time of his choosing, once everything is ready to go effective near completion of review. (also get

good faith working relationship w/ SEC); [timing offer is critical]7. Can take weeks to months to prepare registration statement & is very expensive (ie 90K for

10MN offer)

vii. GUN JUMPING

1. Overview: gun jumping is any efforts/touting made to promote the sale of stock, even indirectefforts to pre-condition the market, prior to registration these are deemed to be tantamount to making

offers in violation of 5(c) [illegal offers]. Guidelines change w/ each phase of the registration process.

2. Conditioning the market - when issuer, underwriter or dealer attempt to condition the publicand arouse public interest in the issuer as a prelude to undertaking a public offering.

a. Prefiling Hype = disguised offer of security; - SEC not like

3. Statutory and theoretical basis for prohibiting pre-conditioning of the market is found in thebroad definition of offer of a security set out in 2(a)(3) of 33act.

a. SEC position: Pre-Conditioning of the market is in reality a disguised offer to sell securities,which are subject to the upcoming offer. And under 5(c) an offer to sell securities absent some

exemption may be made only thru a prospectus (part of the filed registration statement).

b. SEC v. Loeb, Rhoades Co. 1959- LR was going to underwrite an IPO and started advertisinghow great the security was BEFORE a registration statement was filed so getting the market excited

about the offering. SEC took position that pre-conditioning the market prior to the offering was a

disguised offer b/c LR was garnering interest in the Co., even though the security was never mentioned

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by LRs press releases etc SO this was a violation of 5(c) and gave rise to concept of gun jumping.

i. Though can do normal self promotion but not was LR was doing as underwriter

4. IN REGISTRATION: TIME FRAME:

a. One has to worry about gun jumping when one is IN REGISTRATION

i. Prior to in registration can do whatever you want; (subject to fraud limitations)

ii. Once in registration rules as to what can be said and done; like no offer until filing

b. Conservative analysis -issuer is in registration once senior management has made a good faithfirm decision to proceed with a registration (Jalil like this)

c. Liberal analysis an issuer is not in registration until a letter of intent has been signed w/ anunderwriter. So in registration at a later point.

d. In Registration begins in either case before registration statement has even been drafted or filed

i. Issuer is also called registrant;

5. REGISTRATION PROCESS 3 PERIODS:

a. Pre-Filing Period aka Quiet / consistent period the period between when the issuer is inregistration & the filing of the registration statement

i. Cant make direct or indirect offers; no conditioning market, no appearance of offers

ii. ONLY allowed consistent remarks (oral/written), underwriter negotiations(2a3) or rule 135.1. Not really quiet period b/c law only requires be consistent;

iii. Consistency allowed: During Pre-filing pd an issuer should carry on as normal but shouldclear all public communications through securities counsel and refrain from giving forward

looking stments or going just beyond the facts & normal advertising & running of the Co.

1. General remarks should be consistent w/ the past.

a. if not ordinary can be seen as disguised offer

2. Example issuer cannot launch a new marketing campaign;

3. SEC 5180- there is no basis in secrities acts or in any policy of the SEC whichwould justify the practice of non-disclosure of FACTUAL information by a publicy

held company on the grounds that it is in registration.

a. public companies have a legitimate reason to disseminate info and make

announcements; as they always disseminate information,b. privately held (non-public) Co. in registration have far less justification

to make announcements/facts unless in news for some other reason.

iv. RULE 135 Safe Harbor describes when a notice is not a disguised offer. An issuer inregistration may make a rule 135 Com/PR about upcoming offer which contains following

1. Mandatory: legend -Communications must state that an offer may be made onlyby a prospectus and that this information given is not an offer. [if no offer no 5c]

2. Permissible items: can include no more than name of issuer, title, amount andbasic terms of securities to be offered, anticipated timing of offer, amount of offering,

whether offer is directed to a particular class of purchases (public/private) brief

purpose of offering;

3. Prohibited items: name of underwriters, offering price; (generally no obligationuntil day b/f offer)

v. THUS once in Registration can do 135 PR, conduct business and communicate in normal

manner and behind scenes negotiate w/ underwriter; and once find UW start Reg stmnt work.

b. Waiting Period (waiting for effectiveness From SEC) the period after first draft of registrationis filed and until Registration statement is effective; [have SEC review & back/forth w/ SEC]

i. Gun jumping analysis changes-Generally NO written material allowed except PP; Oral is Ok.

1. b/c all now know who underwriter is and that there is offering to be made

ii. Still cant sell security - 5(a) until registration statement is effective

iii. Oral offers / Oral statements allowed [no radio/tv they are seen as prospectus?]

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1. BUT: Offers subject to qualification are to solicit indication of interest on

part of the buyer and No binding offer or acceptance may be made (and no sales

consummated, $$ accepted) until registration statement is declared effective.

2. No limitations on what can be said can make offers just cant be accepted

3. Underwriter doing lot of oral sales efforts during waiting period and using

PrePros

4. (once effective either at or prior to confirmation of the sale customer must

receive final prospectus)

iv. Writing3 things allowed Preliminary Prospectus, Underwriter negotiations, rule 1341. Preliminary Prospectus aka Red Herring: Written offers maybe only madethru preliminary prospectus no statutory requirement that preliminary prospectus be

distributed, SEC position - it will not grant effectiveness to registration statement until

it gets assurance from underwriters that PrePros in form closest to final prospectus was

circulated to all investors who demonstrated indication of interests. [reduce surprise

when final prospectus comes with or prior to confirmation of order]

a. RED Herring red legend says Preliminary prospectus / incompleteprospectus and gives indications of possible changes

b. Amendments need to keep sending prospectuses out SEC not granteffectivenes unless most recently circulated PrePros is substantially same as final

c. Final preliminary need circulate at least 48 hours b/f effectivenessand if final prospectus will materially differ from final PrePros then have to

Re-Circulate FINAL PROSPECTUS since not substantially same as PrePros

and should wait 48 hours. Usually if material diff. just Re-circulate PrePros and

then wait another 48 hours before effective. [only pricing information should

differ]

d. Underwriter circulates this broadly to get interest

2. RULE 134 tombstone ad safe harbor of what can be included in anannouncement regarding the offering to be made once a registration statement has

been filed:

a. The term prospectus shall not include a notice, circular, ad, letter or other

communication published or transmitted to any person after a registrationstatement has been filed if it contains only the statements required or permitted:

i. Communication May include: name of issuer of security, full title of

security and amount being offered

ii. Communication Must include: following (if reg stmnt not effective): A

registration statement relating to these securities has been filed with the SEC

but has not yet become effective. These securities may not be sold nor may

offers to buy be accepted prior to the time the registration statement becomes

effective. This communication shall not constitute an offer to sell or the

solicitation of an offer to buy nor shall there be any sale of these securities in

any state in which such offer, solicitation or sale would be unlawful prior to

registration or qualification under the securities laws of such state.

c. Post Effective Period after registration statement becomes effective i. Formal offers can be made and accepted and sales may be consummated

1. Any sale consummated it must be accompanied or preceded by a final prospectus

unless shown that investor already has a copy of final prspctlike multiple sales to

him

ii. Issuer/underwriter can choose effective date

iii. Investment decisions usually based on preliminary prospectus b/c trades get done instantly

once registration is effective

iv. 5(b)(1) requires that after registration statement is filed and effective, all written offers to

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Rule 134

Communications not

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15/82

sell must be in connection with a prospectus that complies with 10 of 33 act

v. 5(b)(2) - requires final prospectus is required to be delivered w/ security when delivered

1. Rule 434 do not need to send complete prospectus can send multiple docswhich collectively contain all the necessary information.

vi. DOCTRINE of FREE WRITING once registration statement is declared effective canwrite/say whatever you feel so long as communications is accompanied by final prospectus

1. Waitng period no written comm. Except PP or rule 134 but once effective -all

free writings are no longer prospectuses (as were in past) so not need safe harbor2. Need good faith that mailed prospectus

vii. PROSPECTUS DELIVERY

1. ISSUER must continue to deliver prospectus under 5(b) so long as they are

offering security to the public

2. Underwriters and dealers need to distribute prospectus so long as there are

shares remaining in their allotment

3. Nonparticipating dealers must deliver prospectus for 40 days after effectiveness

6. NEGOTIATIONS with Underwriters:

a. 2(a)(3) excludes any preliminary negotiations between the underwriters and the issuer oramong underwriters who are or are to be in privity of K w/ issuer from the broad definition of offer;

i. w/o this issuer would not be able to discuss offering w/ prospective underwriter b/c it would

be considered an offer, and then could not do any offerings; [so even pre-filing can do this]

7. SHELF REGISTRATION: - SEC will not accept registration statements and review themunless the issuer has good faith intent to make the offerings and go effective ASAP.

a. Exception Rule 415 Shelf Registration Act certain large issuers that meet certain tests canfile shelf registration statements in advance and keep their information current with the SEC and go

effective whenever they want to issue the securities;

8. BLANK Check Companies - RULE 419 some companies raise money w/ no particularpurpose for that money in mind. RULE 419 must keep that money in escrow until the purpose is

disclosed to the investors and they approve of it:

9. GUN JUMPING EXAMPLES: pg 172/179/186

a. Pre-filing period i. Co. puts add in business week touting company but previous ads were in BYTE not allowed

1. Need to remain consistent once in registration (good faith to do offering)

ii. Co. VP starts talking to Ibank about an offering or solicits more Ibanks Fine - 2a3;

iii. Co. tells Ibank will get commission if move their stock illegal offer?

iv. Co. VP sends written agreement w/ underwriters to Cos other office fine w/in Co

communications not commerce clause power even if interstate.

v. Jane hears of offer and writes in offering to purchase illegal offer and cant be accepted

vi. Ibank issue statement disclosing Co will do offer and what its for and how big OK rule 135but cant identify underwriter in pre-filing period

vii. Co sends out annual reports fine if consistent but now say its glossier problematic

viii. Co. VP to give speech arranged prior to being in-registration fine as long as consistent

b. Waiting Period:

i. Co issues PR announcing filing of reg stmnt and offering no good b/c offers must be thru

preliminary prospectus or orally but rule 134 safe harbor can name underwriter

ii. Broker at underwriter calls jane and tells her to buy some stk and sends preliminary pros

OK as long as solicitation for indication of interest

1. orally can say anything no matter how strong armed but only written is PrePros

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iii. Broker sends note to Jane says this is a good buy NO good only writing is PrePros or 134

iv. Check sent to broker for shares NO good can only solicit offers not sell

v. Third party not involved in offering places info on website about offering OK can say

whatever want if not involved

vi. Co puts hyperlink on website linking to third party report NO good

vii. Underwriter sends letter to Jane describing other stock in Co and how good it is should be

fine unless seen as rousing interest.

viii. Broker send PrePros to all known and follow up phone call both fine

c. Effective period og195i. Sally mailed a prospectus she never sees it and puts in for 100 shares THIS is ok just need

good faith that mailed prospectus

ii. Can send anything post effective as long as accompanied by prospectus

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viii. MATERIALITY OF INFORMATION standard prospectus are held to

1. A prospectus will be actionable if a statement or omission is Materially Misleading.a. So if say 10K sq ft warehouse and actually 9998sqft cant sue not material

2. Truth is not the standard a true statement can be misleadinga. And if lie still cant sue unless material so say director is 58 but he is actually 60

3. Even if the registration form not specifically ask for it if it is material it must be included;4. There is no liability if the misstatement/omission is immaterial.

5. IF something happens after the prospectus-need to amend prospectusPost Effective Amendments

6. What Rises to the Level of Materiality (ie must be in prospectus)

a. Reasonable Investor Standard a fact is material if there is a substantial likelihood that areasonable investor would consider it important in deciding whether to invest (TSC v. Northway)

i. This is an objective standard reasonable investor not based on individual preference

b. 5% Rule of Thumb - something is generally material if it reflects 5% of earnings or income ornet assets; [not bright line test should not survive SJ]

c. Market Test effect on price should be measure of damages not measure of materiality If weassume market is efficient and all reasonable investors then maybe if info comes out and stock goes

down then info is material but Market is not reasonable investor?

d. Buried Disclosure doctrine even if disclosed all material information, that information mustbe CLEAR, READABLE, and must be SUFFICIENTLY PROMINENT for its relative importance.

i. Buried disclosure is no disclosure at all, cant hide

e. IRRELEVANT to materiality if issuer to be harmed by disclosure and thus must include ifit is material information see below

f. EXEMPTION of material disclosure can go to SEC to exempt disclosing material info

i. Ie if legitimate competitive reason not to disclose and if not affect totality of info;g. Examples:

i. Pg 583 disease resistant rose in prospectus small part of business but C bought stock b/c

very impt to him, it was terminated and not told to C; C sues not win b/c must be material

to a reasonable investor- cant be catering to each wacko

ii. OR above lie about age not material if 59 instead of 57

7. FUTURE EVENTS and Materiality - if future event is uncertain or speculative what to includein Pro?

a. Basic v. Levinson-pg 584 US 1988 Co was in merger discussions and did not mention it andargued that uncertain if it will occur so not discuss it. CTpaternalistic approach to materiality is no

defense. It is material if substantial likelihood reasonable invesor would consider it important and

significantly alters total mix of info available adopts TSC position;

b. Probability magnitude test to determine wrt contingent or speculative information or events,whether it is material and should be included depends at any given moment upon balancing of both the

indicated probability that the event will occur and the anticipated magnitude of the event in light of the

totality of the company activityi. PJ assign number to both probability and magnitude if sum exceeds X then disclose it;

ii. Issue is if include something that not pass the test it can be misleading like say we are

thinking about merging -there is high magnitude but very low probability it will occur;

iii. SO Gates says in golfing takeover Co, or acquisition dept calls farily low probabitly but if

MSs inv bank calls now have high probability

iv. FLIPhigh probability buy truck next yr-already have 200 trucks low magnitude no disclosre

c. ON GOING DUTY TO DISCLOSE once issuer has disclosed something must continue todisclose and reveal it;

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i. past could remain silent on material info btwn filings 10Ks 34 act and disclose when file but

SOX duty to keep disclosing material info in real time

ii. SOX 409 each issuer under 13a and 15d (every public co) shall disclose to public on arapid and current basis such additional info concerning material changes since the financial

condition or operation of the issuer in plain English, which may include trend, qualitative

determinative which would be necessary or useful to investors.

d. OBVIOUS FACTS: - some facts are so obvious that even if they are material, the issuer doesnthave to disclose them (if obvious or common knowledge)

i. stock bought at 10 now 8material & prospectus not say stk can go down not need disclose

ii. Wieglos v. Commonwealth Edison Co constructing powerplant obvious it could havecost overruns; it happened so many times so not need put in the prospectus

iii. SEC not want huge overloaded prospectus

iv. TRUTH on MARKET misstatment not material b/c savvy investor knew prospectus wrong

and stock price moved accordingly efficient market accounted for inaccurate info

e. DISCLOSURE OF SOCIAL CONCERNS/Non quantifiable facts: - to what extent mustissuer disclose social concerns and social action and info not in best interest of company

i. Social issues gray area

1. Bribery - SCHLITZ beer marker needs to pay of distributor or Co loses sodoing something to help company but still reasonable investor would want to know

2. Also illegal activity, health issues all need be disclosed

3. Deals with integrity of mngmt if material to that want to know it

4. Even if non financials not come to % mark disclose if material if reasonable

investor would care;

5. Foreign Corrupt Practices Act any international payoffs must be disclosedii. Need to disclose even if bad for SHs

1. Ex. Pg 592-11-2; A finds out her factory encroaches on neighbor & if find out

will have factory torn down so if disclose bad for SHs today but not matter b/c

material info so must disclose in prospectus

iii. Dont have to disclose trade secrets

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IV. TRANSACTIONS EXEMPT FROM REGISTRATION

Things an issuer can use Things a control person can use Things a reporting

company can use

Things a private

company can use

Things investment

companies can use

3(a)(11) [Rule 147] Rule 144 (only if public co.) Rule 505 4(2) [Rule 506] 4(2) [Rule 506]

4(2) [Rule 506] 4 (1 ) 4(2) [Rule 506] Rule 504

Rule 504 Reg A (only if non-public co.) 3(a)(11) Rule 505

Rule 505 Reg A

Reg A (only if non-public co.) 3(a)(11)3(a)(9)

a. Overview:

i. Offering/sale exempt from registration process of 5 of 33 act.ii. There are Exempt transactions exempt b/c manner in which security is being offerediii. There are Exempt securities exempt b/c type of security being offered; (ie US treasury bond)iv. TYPES of exemptions: 5 cant offer security w/o registration

1. 2(a)(3) underwriter negotiations and agreements permitted b/f registration not an offer

2. 4(1) registration requirements of 5 only apply to issuer, underwriter and dealer wrt thatoffering so not apply to secondary trading (but does to secondary offering ie someone other than issuer

offers)

3. 4(2) registration reqs of 5 not apply to transactions by issuer not involving public offering4. (both 4s are exempted transactions)

5. 3 exempted securities but drafting error has both exempt securities and certain exempttransactions.

a. Ie 3a11 intrastate exemption is an exempt transaction; 3b plenary power up to 5MN

b. 3(a)(11) Intrastate Exemption any security which is part of an issue offered and sold only to personsresident w/in a single state or territory, where the issuer of such security is person resident and doing business w/in

or if a corporation, incorporated by and doing business w/in such state or territory

i. This is an exempt transaction not exempt security; and therefore not need any disclosure or file registrationstmnt but still cannot make affirmative misrepresentations (also state laws may require some disclosure)

ii. Rationale: political compromise states rights advocates in congress when 33 act passed and act passed oncommerce clause power;

iii. SEC HATES 3a11 and will enforce it strictly SO one offer or sale out of state and blown;1. Rule 147 is not the only way to satisfy 3a11 but since SEC strict stupid not to follow 147

iv. RULE 147 safe harbor for intrastate offering; if follow Rule SEC not come after you only for issuer.1. The rule shall not raise any presumption that the exemption provided by 3(a)(11) of the act is not

available for transactions by the issuer which do not satisfy al of the provisions of the rule

2. TEST:

a. ISSUER needs to be a resident of and doing business w/in the state or territory in which all offers

and sales are made (at time of offering) and

b. No part of the issue be offered or sold to non-residents w/in period of time specified by rule

3. RESIDENCY REQUIREMENTS:

a. Corporation & Limited partnership are residents in state in which they are incorporated/organized

b. General partnership is resident of the state where its principal office is located

c. Individuals is resident of the sate where he has his principal residence is located.

4. DOING BUSINESS issuer is doing business w/in a state if: (meet all?)a. 80% of its gross revenue are derived from that state

b. 80% of its assets are in that state

c. 80% of the proceeds of the offerings are to be used in that state

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d. principal office or place of business is in that state;

5. OFFEREES and PURCHASERS: - offers to sell and sales may be made only to personsresident of state or territory which issuer is resident.

a. Same resident rules above for the purchasers but Corporations organized for specific purpose of

acquiring part of the issue will not be deemed to be residents of a state unless all the beneficial owners

of the corp are residents of the state.

6. ADVERTISING UNDER 147 can use TV, Radio, Newspaper so can advertise to out of state but need to use legend that states offer limited to people in certain state.

7. UNDERWRITERS - on a 3(a)(11) need not be a resident of state of offering (ie same stateas issuer)

8. RESALE LIMITS: [restricted securities]a. Security must be hold by residents of the state for 9mos (starting date of last sale or last pmt is

received); and even if one person sells out of state exemption is blown (so no straw men)

i. Tacking: 9mos period tacks back to date of issuance so purchaser can sell to other residentsduring 9mos period and no new 9mos period

ii. Best way to control hold all shares in escrow for 9mos then allow investors to get them

iii. Or have K that says cant resale for 9mos to nonresidents or consequences?

iv. IF purchaser moves out of state depends on intentions to see if destroy exemption

9. TIMING / INTEGRATION: - any offering 6 months apart (before or after) will not beintegrated

a. Cant do intrastate exemption offering in NY as bulk and then same time do registered offering in

other states; (Residency req prevents doing intrastate exemptions in many states but so does integration)

v. IMPLICATIONS OF 3(a)(11)

1. There is no requirement to give any disclosure under 3a11 b/c not w/in 5; [maybe state laws]2. Advertising must be reasonably calculated to address the state in question and can advertise to antoher

state as long as have legend noting offer is limited to this state residents

a. But cant say advertise to all NY MDs b/c know not all live in NY

3. Rule 147 is just a safe harbor if follow it valid 3a11 exemption but it is not the only way to satisfy

3a11 but sec is strict on 3a11 enforcement;

4. There is no numerical limitation as to how many people can offer to and can do general solicitation;

c. DOCTRINE OF INTEGRATION: - SEC will integrate 2 or more separate offerings and treat them as onesingle offering, if certain factors are present.

i. Integration prevents and issuer from improperly avoiding registration by artificially dividing a single offering

so that exemptions appear to apply to the individual parts where none would be available to the whole.

ii. Integration depends on analysis of specific facts and circumstances; but Follow Safe Harbors to avoid integ.iii. Five Factors of Integration:(none dispositive) (prelim notes Rule147 & Rel 33-4434) use if no safe harbor-

1. Are the offerings part of a single plan of financing? (what is money raised for)2. Do they involve the same class of securities? (ie common stock/debentures)

3. Are the offerings made at or about the same time?a. RULE of thumb if offerings are a year or more apart SEC will generally not integrate, if

offerings 6mos or less apart SEC will probably integrate; 6mos-1yr apart look at factors

4. IS the same type of consideration received? (ie one for cash other is securities exchanged for merger)

5. Are the offerings made for the same general purpose?

iv. EXAMPLES:

1. Do a 3a11 and w/in 6mos do public registered offering if SEC integrates them then in trouble b/c 3a11

exemption is blown b/c had interstate offering; and 5 registered offering blown b/c had solicitation thru

3a11 offering prior to registration statement filed

2. Suppose you offer common stock in NY in Sept. under 3(a)(11). Then you also do a registered offering of

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notes the same day in all 50 states. The common stock is used to purchase equipment, and the note

offering is to hire more salesman. To argue that the two offerings should not be integrated (thus denying

the benefit of 3a11 as to the common stock offering). They dont involve the same security or class

thereof, but they are offered at the same time. They receive the same type of consideration, but arguably

some are making equity investments while others debt. They are not used for the same purpose

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d. 4 EXEMPTED TRANSACTIONS

i. 4(1) section 5 does not apply to transactions by any person other than issuer, underwriter, dealer

1. underwriter is defined different see below

2. this exemption allows secondary trading w/o registration

ii. 4(2) Private placement (non-public offering) issuer only ---RULE 506 is safe harbor for 4(2)

1. Overview:

a. Opposite of public offering is not private offering (its non-public); lots use this exemption2. 4(2) Exempted transactions transactions by an issuer not involving any public offering

3. Old Test: SEC -4 factor test to see if exemption applies: 1. Number of offerees (35) & their relationship

to each other and the issuer; 2. Number of units offered; 3. Size of the offering; 4. Manner of the offering

4. SEC v. Ralston Purina -pg 276 US 1953D pet food store -offered securities to its EEs under the belief

that it was not a public offering, nor did D solicit the EEs to purchase shares (253 buy). SEC sued said

offering was made to too many people (>35) to be considered non-public. COURT rejected both

arguments & found that :

a. the public (noun) is anyone who needs protection of the 33 act

i. public is Financial unsophisticated person

b. A person does not need protection if they have

i. 1. Sophistication (wrt financial matters) 2. Access to information abou the issuerc. Size of offering and number of people being offered to does not matter. NO QTY limit

i. If sell to one financially unsophisticated person it is public offering and need to register

ii. If sell to 10000 business school professors offering is non-public - 4(2) exemption

5. RALSTON PURINA TEST FOR 4(2) Non-Public Offering: 3 requirements:

a. Sophistication of investor stnd relevant inquiry should be whether the investor can

understand and evaluate the nature of the risk beyond the information supplied to him. The relevant

inquiry should not be whether the investor is knowledgeable on all latest nuances & techniques of

corporate finance. (ABA)

i. It is a question of fact based on business acumen, business experience

ii. Just because wealthy does not mean youre a sophisticated investor for 4(2)iii. Issuer can send questionnaire for investor to fill out; (Sec v.Kenton take SSN chk bank no gd)

b. Access to information: (if sophisticated w/o info no good) can be satisfied in one of 2 ways:

i. Position with Issuer have disclosure b/c of access to info thru ones position w/ issuer.

1. Ie directors or officers cant apply to any EE.

ii. Disclosure investor receives same disclosure had issuer prepared a registration statement

1. Ie private placement memo

c. No General Solicitation an issuer cant generally solicit for non-public offering:

i. This is b/c cant even make offer to a non-sophisticated person w/o blowing exemption so no

general ads that say this is just for sophisticated persons (need register to even offer)

ii. SO Issuer can go to Ibank and they can find investors that they know from previous

experience are sophisticated this way no general solicitationiii. MUST Reasonbly believe in good faith thru prior info or relation that they are sophisticated

SEC prefers had relationship w/ them prior so know sophisticated

d. [RISK has nothing to do with it]

e. Courts approach to who is sophisticated (above saw ABA) pg 284

i. 9th cir sophistication is one of 4 factors size etc so not good test can have huge prvte P

ii. 10th cir persons of exceptional business experience

iii. 5th cir greater emphasis on disclosures than sophistication

iv. 8th cir not require sophistication and emphasizes offerees access to information

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v. Others sophistication alone is not dispositive need access to info

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e. REGULATION D (Rules 501 508)

i. Introduction:

1. Regulation is just a collection of related rules

2. REG D does double duty exemptions- 1. Two methods to adhere to 3(b) [Rule 504 & 505] which

allows exemption of any kind of offering so long as its under 5MN; 2. Provides a safe harbor for 4(2)

private placement (rule 506 for non-public offering following reasoning of Ralston Purina)

3. REG D developed by Congress as part of the Small Business Initiative to provide inexpensive efficient

ways to raise capital & still respect the securities laws. Balance protect investors w/ promote Small busin

ii. 3(b) The Commission may from time to time by its rules andregulations, and subject to such terms andconditions as may beprescribed therein, add any class of securities to the securities exempted as provided inthis section, if it finds that the enforcement of this title with respect to such securities is not necessaryin thepublic interest and for the protection of investors by reasonof the small amount involved or the limitedcharacter of the publicoffering; but no issue of securities shall be exempted under thissubsection where theaggregate amount at which such issue is offered to the public exceeds $5,000,000.

1. SEC has Plenary (absolute) power to exempt from 5 registration any offering so long as not >5MN

2. SEC can proscribe rules etc regarding this exempt offering of 50% equity interest

iv. Any Accredited Investor

b. A Corporation, partnership, or other entity shall be counted as one purchaser unless:

i. Corporation/partnsp.. was formed for the purposes of purchasing securities in the offering and

is not an accredited investor. [formed for purpose of doctrine] --To determine: Q of fact1. look@ nature&duration of prior activities, structure of entty, proposed activites

of enty size of capitalizn related to offering (505/506), whether equity owners can opt

out; &

2. 40/60 Test -No more than 40% of the assets of the newly formed corp are

invested in the 505/506Txn and 60% of the assets are invested in real, good faith

investments

3. [so if formed 10 yrs ago no prob, if formed recently then see % assets invested in

offering and % invested elsewhere, but if formed just for offering then no good]

ii. then each beneficial owner of equity securities or equity interests in the entity shall count as a

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separate purchaser for all provisions of Regulation D except as to (a) above. [look thru]

c. A non-contributory benefit plan w/in title 1 of ERISA shall count as 1 purchaser where trustee

makes all investment decisions for that plan

4. 501f- Executive Officer: President, VP, senior mngmt who performs similar policy making functions

iv. RULE 502 General Conditions To Be Met [that are applicable to Reg D each rule picks from this]

1. 502a -Integration Offerings made more than 6 mos before start of Reg D and more than 6 mos after the

completion of REG D offering will not be integrated (safe harbor)

a. If the issuer does not avail itself to the safe harbor, offerings may or may not be integrated

i. Look at the facts of each case and weigh Five Factors discussed above (pg 18)

b. B/c there are size limits in 504 or 505 offerings if integrate separate offerings can blow exemption

c. If integrate 3(a)(11) w/ REG D corrupt exemption b/c Rul 147 can generally solicit 4(2) cannot

2. 502b - Information Requirements / Disclosure

a. There are no disclosure requirements for certain 504 offerings & offerings to accredited investors

b. Rule 505 and 506 offerings may require disclosure to the investor (if non-accredited)

c. If disclosure is required the following rules must be followed:

i. If the issuer is Not a reporting company (non-public) the issuer must give the investor the

same information it would have given if it had filed a registration statement;

1. Need progressive more detailed financial info as offering size increases: under

2MN; up to 7.5MN and over 7.5MN;

ii. If issuer is a reporting co. it must give the investors copies of reports it has given the SECiii. Issuer must also give investors in Rule 505 and Rule 506 offerings the opportunity to ask

questions and receive answers [not need in rule 504 b/c no disclosure requirement)

3. 502c -Limitations on the Manner of Offerings / No General Solicitation

a. There can be NO general solicitation or Ads in certain 504? & ALL rule 505 & 506 offerings

b. So cant send out info to anyone you dont have a preexisting relationship with. [no strangers]

4. 502d -Limitations on Resale / Restricted Securities (502d)

a. REG D offerings are exempt transactions from registration so securities purchased in REG D

offering cannot be resold w/o registration or exemption from registration.

v. RULE 503 Filing of Notice of Sales FORM D

1. When REG D offering or sale is made the issuer shall file a notice on FORM D w/ the SEC no later than

15 days after the first sale of securities in the offering [Simple form gives notice to SEC did exempt offrng

vi. RULE 504 Exemption from Registration for Offerings under $1MN

1. Overview-statutory authority is 3(b) which gives SEC plenary authority to exempt offering up to $5MN

If requirmnts are met phrase is Doing a 504; Rule 504 is to encourage Small business to be created/grow

2. Implications:

a. NO disclosure required

b. Exempt from 5 registration b/c of 3(b)

c. UP to $1MN in securities offerings ; and no limits on number/character or purchasers

3. Eligible Issuers: (Only a private company)

a. Issuer that are NOT a reporting company, subject to 13&15d of 34 act (no public co like MS)

b. Issuers that are NOT an investment company (ie mutual funds)

c. No blank check companies Co w/ no business plan how to use the proceeds of the offering

d. IF NOT above can offer up to $1MN in securities w/o registering

4. Limitations/conditions: [Follow 501 and 502a,c,dno disclosure(b)]

a. Qualification of Investors Can offer to anyone; and no limit on number of people

i. Investors do not need to be sophisticated, it is irrelevant b/c 3(b) not 4(2)

b. Integration-502a safe harbor cant integrate offerings made > 6mos b/f or 6mos after this offer

c. Solicitation -502c no general solicitation (no ads in paper or TV like rule 147 in state offering)

i. Cant even offer to strangers just sell to people known or introduced to

d. Restricted Securities 502d so cannot be freely resold (follow certain rules ie rule 144)

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Websites are

tricky not

allowed unless

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i. Note: If state law of at least one state where securities sold requires filing w/ state & delivery

of disclosure document to all purchasers even those in states w/o reqmnt or if state law allow

general solicitation so long as sales are made to only accredited investors; then 502c,d not

apply So there can be general solicitation and securities received will not be restricted

e. Aggregation: aggregate offering price cannot exceed $1MN; [avoid abuses]

i. Count against the $1MN offering limit all 3b offerings (504/505/A) w/in the previous 12 mo

1. ie did 250K 504 offer 1/3/08; now its 7/1/08 max 504 offering can be done is

750K

vii. RULE 505 Exemption from Registration Offerings Not Exceeding $5MN

1. Overviewstatutory authority is 3(b) which gives SEC plenary authority to exempt offering up to $5MN

2. Implications:

a. Exempt from 5 registration b/c of 3(b)

b. UP to $5MN in securities offerings

3. Eligible Issuers:

a. Issuers that are NOT an investment company (ie mutual funds)

b. Can offer up to $5MN in securities w/o registering

i. A reporting company (public Co like MS / GE) may use Rule 505.

4. Limitations/conditions: [Follow 501 and 502a,b,c,d]

a. Number of Purchasers -35- (not offerees); character not matter

i. NO more than 35 Purchasers in Rule 505 Offering [rule 501eaccredited investors not count]1. 505 offering may have unlimited accredited invstrs/relatives & 35 non-accredited

invst

2. Rules pg20relative spouse trust/estate >50% BO, accred inv all dont count;

corp is 1

b. Integration-502a safe harbor cant integrate offerings made > 6mos b/f or 6mos after this offer

c. Disclosure-502b - follow rules laid on in rule 502b

i. if selling to accredited investor no disclosure [so if keep offering all accredited no disclsure]

ii. If selling to non-accredited investor disclose per 502b- like reg stmnt private co; pub SEC rpt

d. Solicitation -502c no general solicitation or advertisement

e. Restricted Securities 502d so cannot be freely resold (follow certain rules ie rule 144)

f. Aggregation: [to avoid abuses]i. Aggregate offering price in Rule 505 cant exceed $5MN w/o registration

ii. Count against the $5MN offering limit all 3b offerings (504/505/A) w/in the previous 12 mo

1. Did 504 offer for 1MN 12/1/08; now its 9/1/09 and want to do 505 offer max is

4MN

iii. NOTE: also for 504 and 505 previous 3b offering date is the date of completion of the

offering not start of offering; so need count in previous 12 mos any completions

iv. NOTEonly count 3b offerings in 504/505 so 4(2) offerings & 3(a)(11)R 147 not count

viii. RULE 506 Exemption from Registered Offerings w/o Regard to the Dollar Amount of the Offering

1. OverviewRule 506 is the 4(2) safe harbor; statutory authority is 4(2) [non-public offerings] (not 3b)

a. 506 states how to do a valid private placement (non-public offer) under Ralston Purina [sophistic]b. Can still do 4(2) w/o Rule 506 but take a risk w/ SEC

2. Implications:

a. Exempt from 5 registration b/c of 4(2) non-public offering

b. NO limit on the amount of offeringso aggregation is not an issue here &not aggregte w/ 504/505

3. Eligible Issuers:

a. All Issuers may do a Rule 506 offering and utilize this safe harbor;

4. Limitations/conditions: [Follow 501 and 502a,b,c,d]

a. Number of Purchasers -35- (not offerees)

i. NO more than 35 Purchasers in Rule 506 Offering [rule 501eaccredited investors not count]

26

# of purchasers

Look at 501epg 20

# of purchasers

Look at 501e

pg 20


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1. 505 offering may have unlimited accredited invstrs/relatives & 35 non-accredited

invst

2. Rules pg20relative spouse trust/estate >50% BO, accred inv all dont count;

corp is 1

b. Nature of Investor: - Need sophistication b/c cant ignore Ralston Purina

i. Law makes assumption that all accredited investors are sophisticated

ii. 506(b)(2)(ii) - If non accredited investor either alone (or if unsophisticated) through purchase

representative must have such knowledge and experience in financial and business matters to

be capable of evaluating the risks and merits of the investment1. Thus every non-accredited investor needs sophistication using tests above 4(2)

c. Integration-502a safe harbor cant integrate offerings made > 6mos b/f or 6mos after this offer

d. Disclosure-502b - follow rules laid on in rule 502b

i. if selling to accredited investor no disclosure [so if keep offering all accredited no disclsure]

ii. If selling to non-accredited investor disclose per 502b- like reg stmnt private co; pub SEC rpt

e. Solicitation -502c no general solicitation or advertisement

f. Restricted Securities 502d so cannot be freely resold (follow certain rules ie rule 144)

5. Examples/ Notes on 506:

a. If had 50 sophisticated investors but not accredited then cant do 506 offrng b/c 35 purchaser max

i. Can still do 4(2) non public offering just cant utilize the safe harbor

b. Cant Mix and Match Rule 506 w/ 4(2)i. For Rule 506 all accredited investors are assumed sophisticated

ii. But if doing a 4(2) offering not rule 506 then every investor needs to prove his or h

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