Business Law VIII: Federal Securities Regulation

Question 1

Elements of an investment contract

Answer 1

1. Investment of money
2. In a common enterprise
3. With an expectation of profit
4. To be earned primarily by the actions of others

Question 2

Registration Requirements of 1933 Act

Answer 2

1. Initial public offering - sell to general investing public for first time
2. Seasoned offerings - print/sell new securities to the public
3. Secondary offerings - controlling/closely affiliated persons sell their securities under circumstances where it is appropriate to treat transaction as if being made by company

Question 3

Basic Registration Procedure

Answer 3

1. Issuer files registration statement with SEC
2. Issuer waits 20 days for SEC approval
3. Registration statement deemed “effective” and sales begin

Question 4

Distribution process for Securities vs Products

Answer 4

1. Security = Issuer-Underwriter-Broker-Investor

2. Product = Manufacturer-Wholesaler-Retailer-Customer

Question 5

Registration Process: Three Periods

Answer 5

1. Pre-filing period (before filed with SEC) - company can neither offer to sell nor sell securities
2. Waiting period - company can make offers but not sell
3. Post-effective period - issuer may both offer and sell securities

Question 6

Contents of Registration Statements

Answer 6

1. Financial statements audited by independent CPA
2. Names of issuer, directors, officers, underwriters, etc.
3. Risks
4. Description of issuer’s business
5. Description of Security and Intended use for proceeds

Question 7

Exempt Transactions and Securities

Answer 7

1. Bank/Government Securities
2. Short-term notes (commercial, not for investment, maturity less than 9 mos)
3. Charitable organization securities

Question 8

Three types of offerings exempt from registration

Answer 8

1. Small Offerings (not a big threat)
2. Private placement (specific offerees can protect themselves)
3. Intrastate (regulated by that state only)

Question 9

Regulation D Transaction Exemptions

Answer 9

Rule 504 = small offering - $1M in 12 month period (only useable by small companies)

Rule 505 = small offering - $5M in 12 month period

Rule 506 = private placement - Unlimited amount.

Question 10

Regulation A

Answer 10

1. Can raise $50M in 12-month period, pursuant to Jobs Act of 2012.
2. “testing the waters” allows preliminary offering to see if there is interest in purchasing.
3. Simplified disclosure - 2 yrs unaudited financial statements

Question 11

Rule 147, Intrastate Offering

Answer 11

Issuer must be organized/doing business in state where it plans to do offering:

> 80% assets in-state
80% revenue in-state
80% proceeds of offering used in-state

All oferees must also be in-state

Question 12

Blue Sky Laws

Answer 12

1. National Securities Markets Improvements Act (NSMI) preempts state regulation of “covered securities”:
   - listed in national exchange
   - issued by registered investment companies
   - sold to “qualified purchasers”
   - sold pursuant to federal exemptions
2. NSMI ends state merit regulation
3. NSMI allows states to continue to enforce antifraud statutes and require “notice filing”

Question 13

Jumpstart our Business Startups Act (JOBS Act of 2012)

Answer 13

Securities law that amended federal law with hopes of making it easier for small companies to raise capital with hope this would eventually lead to job creation

Question 14

Emerging Growth Companies (EGCs)

Answer 14

Delay regulatory burdens of going public for 5 years if:

1. Less than $1B annual gross revenue
2. Publicly traded less than 5 yrs
3. Public float of less than $700M
4. Not issued $1B in non-convertible debt in prior 3 years

Question 15

JOBS: Crowdfunding

Answer 15

A process by which entrepreneurs and business owners can use internet to rais capital, typically from large numbers of people who invest small amounts with little federal regulation

JOBS allows up to $1M in 12-month period raised this way

Question 16

JOBS: General Solicitation

Answer 16

JOBS relaxes restrictions on advertising/general solicitations w/ goal of giving more clarity to rules

• eliminates ban as long as purchaser are “accredited investors”
• requires issuer to take “reasonable steps to confirm accredited investor status

Question 17

1933 Act - Liability Provisions

Answer 17

Sec. 11 - remedies misleading statements/omissions contained in registration statement as of effective date

Sec. 12 (a)(1) - remedies violations

• offering security before filing registration statement
• selling security before registration statement effective
• selling security without providing prospectus
• providing prospectus that does not comply

Sec. 12 (a)(2) - remedies misstatements/omissions in initial sale that occur outside registration statement

Question 18

1933 Act - Elements that plaintiffs must prove to win a Sec. 11 claim

Answer 18

1. False statement/omission of fact appeared in registration statement - accounting firm only liable for part that it prepared
2. Misstatement or omission was material
3. Plaintiff bought securities that were issued under the defective registration statement
4. Plaintiff suffered damages

Question 19

1933 Act - Accountant defenses under Sec. 11

Answer 19

1. Due Diligence (reasonable investigation, reasonable basis, good faith belief)
2. Special burden on accountants who are “experts”
3. Issuing company itself has no due diligence defense
4. Lack of reliance by plaintiff
5. Alternative causation
6. Statute of Limitations (1 yr notice deadline, 3 yr offering deadline)

Question 20

1934 Securities Exchange Act Purposes

Answer 20

1. Regular disclosure - by major companies even when not raising capital by filing registration statements
2. Punish fraud
3. Created SEC

Question 21

1934 Securities Exchange Act Requirements: Who must file?

Answer 21

1. All companies with shares traded on national exchange
2. All companies greater than $10M in assets and greater than 2,000 shareholders in single class
3. Company that made registered public offering during the year
4. NASDAQ “Bulletin Board” companies

Question 22

1934 Securities Exchange Act Requirements: What must be filed?

Answer 22

Initial Registration Form (Form 10)

• name of officers/directors
• nature of business
• financial structure of firm
• bonus/profit-sharing provisions for officers/directors

Continuous Disclosure Forms

• Annual 10-Ks
• Quarterly 10-Qs
• Interim 8-Ks with interim important info

Question 23

Other 1934 Act filing requirements

Answer 23

1. Concentration of shares - 13D must be filed by anyone acquiring more than 5%
2. Tender offers - includes mgmt. opinion as to whether s/h should tender shares or resist takeover
3. Proxy solicitations
4. Insider trading (officers, directors, owners 10% and greater)

Question 24

Sec. 10(b) and Rule 10b-5

Answer 24

If false statement in registration statement, plaintiff can sue under ‘34 act 10(b).

Standard of liability is scienter (bad intent)

Burden of proof is on the defendant

Question 25

What must plaintiffs prove to win a 10b-5 claim?

Answer 25

1. False statement/omission of material fact
2. Scienter by defendant
3. Reliance by plaintiff in omission case - no need to prove reliance
4. Reliance by plaintiff in active misrepresentation case - must prove reliance
5. Causation - false statements caused plaintiff to enter transaction and in turn caused loss

Question 26

Section 10(b) Defenses

Answer 26

1. Statute of limitations - w/in 2 yrs of when fraud was discovered, w/in 5 yrs of fraud
2. Fraudulent/reckless conduct by plaintiff
3. Bespeaks Caution Doctrine
4. Secondary liability - doesn’t exist

Question 27

Dodd-Frank Act of 2010

Answer 27

Seeks to strengthen financial market performance by:

1. improving financial institutions’ accountability/transparency
2. protecting taxpayers from being saddled with future bailouts
3. protecting consumers from plethora of abusive practices