Chapter 37: Securities Regulation

Rule 504, Option 3 (Regulation D)

$5 million max. value of securities sold in 12-month period, provided offering is exempt under state law; unlimited number of accredited investors; no specific disclosure requirement; public advertising permitted; securities not restricted

Rule 504, Option 2 (Regulation D)

$5 million max. value of securities sold in 12-month period; unlimited number of investors; disclosure under state law; public advertising permitted; securities not restricted

Rule 504, Option 1 (Regulation D)

$5 million max. value of securities sold in 12-month period; unlimited number of investors; no specific disclosure requirement; no public advertising permitted; securities restricted

Section 13 of the 1934 Act - disclosure requirements

1. an initial detailed information statement when company first registers 2. annual reports on Form 10-K 3. quarterly reports on Form 10-Q 4. reports of any significant development on Form 8-K (bankruptcy, sale of significant assets, change in auditor, etc.)

Advantage of a DPO

1. cheaper and faster than using an underwriter 2. effective marketing tool; shareholders become even more loyal customers

Disadvantages of a DPO

1. limit to how much a company can raise 2. company officers typically do not have as much expertise in selling stock as securities lawyers, investment bankers, etc. 3. each investor must receive written information about the company; prohibitive cost disclosure when dealing with small investors 4. tricky and time consuming to set up system to permit trades of DPO shares

Issuer's Process for IPO or Secondary Offerings

1. underwriting (firm commitment or best efforts) 2. registration statement 3. prospectus 4. sales effort 5. going effective

Section 24 of the 1933 Act - criminal liability

Justice Department can criminally prosecute anyone who willfully violates the Act

go effective

SEC authorizes a company to begin the public sale of its stock; issuer and underwriter agree on stock price and date

aiding and abetting

a company may go bankrupt in the case of large frauds so plaintiffs seek other to recover losses from; instead of going after those who committed the fraud, may sue those who aided and abetted, using Section 10(b)

Section 10(b) of the 1934 Act - classic insider trading

a corporate insider is guilty if he: 1. has material, nonpublic information 2. breaches a fiduciary duty to his company 3. by trading on the informaiotn 4. whether or not he makes a profit

comment letter

a letter from the SEC to an issuer with a list of changes that must be made to the registration statement

Direct Public Offering (DPO)

a method by which a company sells stock to the public itself, without an investment bank; commonly uses Rule 147A, Reg D, or Reg A and primarily sells shares to stakeholders

private offering

a sale of securities in which the issuer provides less disclosure in return for selling less stock to fewer investors than in a public offering; may not have to provide audited financial statements; amount at stake is too small to justify the heavy expense of a public offering; investors have enough experience to make good decisions/wealthy enough to afford a loss

Exempt Securities

always exempt, throughout their lives, no matter how many times they are sold; 1. government securities 2. bank securities 3. short-term notes (due within 9 months of issuance, not sold to general public) 4. nonprofit issues 5. insurance policies and annuity contracts

Rule 10b5-1 - advanced planning

an insider can avoid insider trading charges if she commits in advance to a plan to sell securities; easy to abuse by executives who do not have to disclose plans or file them with SEC

Tier 1 (Regulation A)

an issuer may sell publicly up to $20M of securities in any 12-month period, with no limit on the maximum amount an investor may buy

Tier 2 (Regulation A)

an issuer may sell publicly up to $50M of securities in any 12-month period; unaccredited investors may not buy stock that costs more than the greater of 10% of their annual income or net worth; complex disclosure requirements

Secondary Offering

any public sale of securities by an issuer after the initial public offering

security

any transaction in which the buyer invests money in a common enterprise and expect to earn a profit predominantly from the efforts of others; statutory definition includes stock, bonds, treasury stock, notes, debentures, evidence of indebtedness, certificates of interest, participation in profit-sharing agreement, etc.

Section 18 of the 1934 Act - liability for filings

anyone who makes a false or misleading statement in any filing under the 1934 Act is liable to buyers or seller who acted in reliance on the statement and can prove that the price at which they bought or sold was affected by the false filing

road show

as part of the sales process, company executives and investment bankers make presentations to potential investors; can't make sales, but can solicit offers; closely regulated by the SEC

registration statement

document that an issuer files with the SEC to initiate a public offering of securities; purposes to notify the SEC that a sale of securities is pending and to disclose information to prospective purchases; include description of issuer, business, stock, proposed use of proceeds from offering, and 3 year of audited financial statements

SEC

federal agency that enforces securities laws; can bring ceases and desist orders, levy fines, confiscate profits from illegal transaction; does not have authority to bring criminal action, refers those cases to Justice Department

purchaser representatives

have enough knowledge and experience to evaluate stock purchases; must be consulted by unsophisticated, unaccredited investors

Section 11 of the 1933 Act - errors in registration statement

if a final registration statement contains a material misstatement or omission, the purchaser of a security can recover from everyone who signed the registration statement; all signers are jointly and severally liable, except experts who are only liable for misstatements for which they were responsible

insider trading

illegal because: 1. undermines integrity of stock markets 2. offends our fundamental sense of fairness 3. everyone who buys and sells stock pays a slightly higher price if insider traders skim off some of the profits for market makers

Section 10(b) of the 1934 Act - misappropriation

illegal for anyone: 1. with material, nonpublic information 2. to breach a fiduciary duty to the source of the information (different than insider trading) 3. by revealing or trading on the information existence of personal fiduciary relationship: 1. recipient has promised to keep the information secret 2. communicator has a reasonable expectation that the recipient will not tell because of their relationship of trust 3. recipient has obtained the information from her spouse, parent, child, or sibling

Section 12(a)(1) of the 1933 Act - selling unregistered securities

imposes liability on anyone who sells a security that is neither registered nor exempt; purchaser can demand rescission (return of money+interest) or ask for damages

tippers

insiders are liable if: 1. reveal material, nonpublic information about their company in violation of their fiduciary duty 2. know the information is confidential, and 3. benefit (or expect to benefit) directly or indirectly

accredited investors

institutions (such as banks and insurance companies) or financially qualified individuals; net worth (not counting home) of $1M+ or annual income of $200K+

SEC Rule 147A

issuer is not required to register securities that are sold only to residents of one state if that state is the issuer's principal place of business; can't be sold (primarily or secondarily) out of state for 6 months

Rule 144

limits the resale of control and restricted securities (issued by public companies)

Regulation D

most popular route for private offerings; regulates 1. how much stock can be sold 2. how many and what type of purchaser can buy stock 3. how issuer can advertise 4. what issuer must disclose 5. when securities can be resold Rule 504 (Options 1,2,3) and Rule 506

Rule 506 (Regulation D)

no limit on value of securities sold in a 12-month period; no limit on accredited investors, no more than 35 unaccredited investors who must either be sophisticated or have a purchaser representative; disclosure required only for unaccredited investors; no public advertising permitted if sold to unaccredited investors, permitted if sales are limited to accredited investors; securities restricted

Quality of Offering

not evaluated or investigate by the SEC, but does ascertain that the company disclosed all required information about itself and the security selling; a buyer can make a reasoned decision on whether to buy or sell securities if they have full and accurate information about a company and the security it is selling

sophisticated investors

people who can assess the risks of an offering

Section 11 Damages

plaintiff need only prove that there was a material misstatement or omission and that she lost money; does not have to prove reliance, that she bought the stock from issuer, or defendant was negligent; can recover difference between what she paid and value of stock on date of lawsuit

Rule 10b-5 - fraud

prohibits any person, in connection with a purchase or sale of any security, from employing any device, scheme, or artifice to defraud; interpreted by courts: 1. misstatement or omission of a material fact 2. scienter - intent 3. purchase or sale (buyers and seller, not someone who failed to purchase stock because of material misstatement) 4. reliance (difficult to prove in open-market trades, so often assumed by courts) 5. economic loss 6. loss causation

Section 10(b) of the 1934 Act - fraud

prohibits fraud in connection with the purchase and sale of any security, whether or not the security is registered under the 1934 Act

Rule 14e-3 - takeovers

prohibits trading on inside information during a tender offer if the trader know the information was obtained if either the bidder or the target company

Securities Exchange act of 1934 - registration requirements

requires issuers with publicly traded stock to continue to make information available to the public so that current and potential investors can evaluate the company; 1. completes a public offering under the 1933 Act 2. securities are traded on a national exchange 3. has at least 2,000 shareholders (or 500 who are unaccredited investors) and total assets that exceed $10M (does not include shareholders who acquire stock through employee compensation plans or crowdfunding)

Regulation Crowdfunding

risky to invest, less oversight by SEC; permits privately held companies to sell up to $1M in securities in any 12-month period provided that they: 1. sell the securities through only one online platform operated by a broker-dealer or funding portal (registered with SEC, takes steps to prevent fraud, does not offer investment advice or solicit purchases, provides disclosure, offers a channel for discussions of offerings) 2. files an offering statement with SEC available to investors 3. file annual reports with SEC and post on website 4. limits investments by individual to to 5 or 10% of income or net worth 5. limit any outside advertising to a simple notice of offering information 6. do not pay anyone to sell securities 7. prohibit resale of stock for one year

restricted stock

securities purchased fro investment purposes; buyer cannot resell, publicly or privately, for one year

Regulation A

small public offering (technically private offering) 1. issuers may advertise 2. stock is unrestrestricted security 3. issuers must make certaiin disclosures to investors

Blue Sky Laws

state securities statutes

National Securities Markets Improve Act

states may no longer regulate offering of securities that are: 1. traded on a national exchange 2. exempt under Regulation D Rule 506 3. sold only to qualified purchasers (usually accredited investors) 4. issued as a Tier 2 offering under Regulation A

Securities Exchange Act of 1934

statute regulates companies with publicly traded securities

control security

stock held by any shareholder who owns more than 10% of a class of stock or by any officer or director of the company; protects other investors from precipitous declines in stock price if all sold at once

restricted security

stock purchased in a private offering; cannot be sold for one year, but if company goes public, can sell after six months

Exempt Transaction

stock sold is only exempt that time, not necessarily in any subsequent sale; private offerings

Section 16 of the 1934 Act - short-swing trading

strict liability, applies even if the insider did not actually take advantage of secret information; applies to officer, directors, and controlling shareholders who own more than 10% of the company; required to: 1. report their insider status to the SEC; any trades of company stock within 2 business days 2. disgorge - turn over to the corporation any profits they make from purchase and sale of company securities in a six-month period

Section 11 Due Diligence

the company is always liable and has no defense for a material misstatement; but signers can avoid liability by showing that he investigated the registration statement as thoroughly as a "prudent person in the management of his own property"

prospectus

the document that provides potential investors with information about a security

Section 12(a)(2) of the 1933 Act - fraud

the seller of a security is liable for making any material misstatement or omission, either oral or written, in connection with the offer or sale of a security; applies to public, private, registered, or unregistered offerings that involves interstate commerce (almost all)

Securities Act of 1933

the statute that regulates the issuance of new securities; before offering or selling securities, the issuer must register them with the SEC unless they qualify for an exemption

tippees

those who receive inside information may also be liable even if they do not have a fiduciary relationship to the company or the tipper; liable when: 1. trade on the information 2. know it is ocnfidential 3. know that it came from an insider who was violating his fiduciary duty, and 4. insider benefited (or expected to benefit) directly or indirectly **can also be guilty of misappropriation

firm commitment underwriting

underwriter buys stock from the issuer and resells it to the public; underwriter bears risk that stock may sell at a lower-than-expected price

best efforts underwriting

underwrites does not buy the stock from the issuer but instead acts as the issuer's agent in selling the securities; company bears risk that stock may sell at a lower-than-expected price

merit reveiw

unlike federal statutes, some state statutes focus on the quality of the investment