Federal Securities Regulations

Question 1

The Securities Act of 1933 (also called the Paper Act, the Truth in Securities Act,
and the _______) regulates the issuing of corporate securities sold to the public
(initial public offerings or IPOs) and through subsequent public offerings (SPOs),
sometimes referred to as “SEOs,” seasoned (i.e., secondary) equity offerings of U.S. equity
securities.

Answer 1

Prospectus Act

Question 2

Issuer information must be disclosed to the Securities and Exchange Commission
(SEC) in a registration statement and published in a

Answer 2

Prospectus

Question 3

The fundamental definition of a security was determined in a case heard before the
U.S. Supreme Court. That case, known as the

Answer 3

Howey Case

Question 4

investment contract is a security if it met four conditions:

Answer 4

■■ the investment of money;
■■ in a common enterprise (pooling);
■■ with an expectation of profits; and
■■ that results solely from the efforts of others.

Question 5

On the basis of Howey, a security is any of the following

Answer 5

Stock
■■ Bond
■■ Debenture
■■ Right or warrant
■■ Note
■■ Put, call, or other option
■■ Limited partnership interests
■■ Certificate of interest in a profit-sharing arrangement

Question 6

Any person who issues or proposes to issue any security is an

Answer 6

issuer

Question 7

Most issuers are

businesses, and the term issuer would also apply to a

Answer 7

government entity

Question 8

Any person who has purchased from an issuer with a view to selling is an

Answer 8

underwriter

**This term does not include a brokerage firm earning a commission on a retail sale to the
public.

Question 9

A _______ is any notice, circular, letter, or communication, written or broadcast
by radio or television, that offers any security for sale or confirms the sale of a security.

Answer 9

Prospectus

***Does not include oral communication

Question 10

A ______ advertisement (one that simply identifies the security, the price, and the underwriters)
is not considered a prospectus nor an offering of the subject security.

Answer 10

tombstone

Question 11

The term ___ or ____ includes a contract for sale or the disposition of a security for
value.

Answer 11

sale, sell

Question 12

The sale of a security does not include:

Answer 12

■■ preliminary negotiations or agreements between the issuer and
underwriter; or
■■ a gift of securities.

Question 13

the SEC merely attempts to make certain that all pertinent information
is fully disclosed in the registration statement and prospectus by requiring that:

Answer 13

the issuer file a registration statement with the SEC before securities are offered or sold
in interstate commerce;
■■ a prospectus that meets the requirements of the act be provided to prospective buyers;
and
■■ penalties (civil, criminal, or administrative) be imposed for violations of this act.

Question 14

The Securities Act of 1933 makes it unlawful to sell or deliver a security
through any
instrument of interstate commerce unless a registration statement is in effect. However,
certain securities are exempted from the registration requirements of the act. The following
issues qualify as exempted securities:

Answer 14

Any security issued or guaranteed by the United States, any state, or any political subdivision
of a state (all federal government issues and municipal securities are exempted
securities)

Any commercial paper that has a maturity at the time of issuance of no more than
nine months (270 days), with the stipulation that the proceeds are to be used by the
issuer to increase working capital and not for the purchase of fixed assets; there is no
minimum denomination or rating requirement similar to that found in the Uniform
Securities Act (exemptions there will be covered in Session 2)

Any security issued by a person organized and operated exclusively for religious, educational,
benevolent, fraternal, or charitable purposes and not for pecuniary profit

Any interest in a railroad equipment trust (for purposes of the law, interest in a railroad
equipment trust means any interest in an equipment trust, lease, or other similar
arrangement entered into, guaranteed by, or for the benefit of a regulated common
carrier to finance the acquisition of rolling stock, including motive power)

Any security issued by a federal or state bank, savings and loan association, building
and loan association, or similar institution

Question 15

The following issue qualifies as an exempt security under federal law but is not exempt
under the Uniform Securities Act and will probably have to register with the state:

Answer 15

Rule 147 issue: any security offered and sold only to persons resident within a single
state or territory, where the issuer of such security is a person resident and doing business
within such state or territory

Question 16

The Rule 147 exemption is available only if the entire issue is offered and sold exclusively
to residents of a

Answer 16

single state

Question 17

If any sales take place to non-residents, the entire issue loses its

Answer 17

exemption

Question 18

The following conditions must be met in order to have a distribution qualify as an intrastate offering
exempt from federal registration.

Answer 18

The securities must be offered or sold exclusively to persons
resident in one state;
persons purchasing the securities
must have their principal residence within the state.
■■ For nine months from the date of the last sale by the issuer of any part of the issue,
resales of any part of the issue by any person will be made only to persons resident
within the same state or territory. This will satisfy requirements that the issue come to
rest in the state in order to claim the exemption.
■■ At least 80% of the issuer’s gross revenue must be derived from operations within the
state.
■■ At least 80% of the proceeds of the offering must be used for business purposes within
the state.
■■ At least 80% of the issuer’s assets must be located within the state.

Question 19

In addition to exempting certain securities, the act also exempts:

Answer 19

■■ transactions by any person other than an issuer, underwriter, or dealer; and
■■ transactions by an issuer that do not involve a public offering (private placement
under Regulation D).

Question 20

The Securities Act of 1933 protects investors who buy new issues by:

Answer 20

requiring registration of new issues that are to be distributed interstate;
■■ requiring an issuer to provide full and fair disclosure about itself and the offering;
■■ requiring an issuer to make available all material information necessary for an investor
to judge the issue’s merit;
■■ regulating the underwriting and distribution of primary and secondary issues; and
■■ providing criminal penalties for fraud in the issuance of new securities.

Question 21

An issuer must file a _________ with the SEC disclosing material information about the issue.

Answer 21

registration statement

Question 22

The information required in the registration statement

may be summarized as follows:

Answer 22

Purpose of issue
■■ Public offering price (anticipated range)
■■ Underwriter’s commissions or discounts
■■ Promotion expenses
■■ Expected use of the net proceeds of the issue to the company
■■ Balance sheet
■■ Earnings statements for the last three years
■■ Names, addresses, and bios of officers, directors, stockholders owning more than 10%
of the outstanding stock (i.e., control persons), and underwriters of the issue
■■ Copy of underwriting agreements
■■ Copies of articles of incorporation

Question 23

After the issuer files a registration statement with the SEC, a 20-day ______ begins

Answer 23

cooling-off period

Question 24

If the SEC finds something is not stated properly, is missing, or needs further explanation, a __________ will be sent describing what needs to
be done in order for the registration to proceed.

Answer 24

deficiency letter

Question 25

The SEC sometimes issues a _______

which demands that all underwriting activities cease.

Answer 25

stop order

Question 26

A _______ is used to acquaint investors with essential facts concerning the new issue. It is also used to solicit indications of buyer interest.

Answer 26

red herring

Question 27

However a red herring cannot be used:

Answer 27

as a confirmation of sale;
■■ in place of a registration statement; or
■■ to declare the final public offering price.

Question 28

A registration statement is normally a very long and complex document for an investor
to read. The act requires the preparation of a shorter document called a

Answer 28

Prospectus

Question 29

There is a specific SEC rule permitting investment companies to use what is known
as an omitting prospectus. The rule is

Answer 29

SEC Rule 482

Question 30

In a major effort aimed at facilitating the capital formation needs of small businesses,
the SEC adopted _______, the private placement exempt transaction

Answer 30

Regulation D

Question 31

Securities offered and sold in compliance with Regulation D are exempt from registration with the
SEC and, as we will learn in the next session, are considered federal covered securities
exempt from registration on the state level as well. Our primary concern is with SEC Rule
506, a private placement where there is

Answer 31

no dollar limit on the amount sold

Question 32

Rule 506 now consists of two sections, 506(b) and 506(c). A company seeking to raise capital through a private placement under Rule 506(b) can sell the offering to an unlimited number of accredited investors (defined below) and up to

Answer 32

35 non-accredited investors

Question 33

On the other hand, Section 506(c) permits the offering to be advertised. There are two primary (and interrelated) requirements in order to do this

Answer 33

All purchasers are accredited investors, or the issuer reasonably believes that they are
accredited investors.

The issuer takes reasonable steps to verify that all purchasers are accredited investors,
which could include reviewing documentation, such as W-2s, tax returns, bank and
brokerage statements, credit reports and the like.

Question 34

Under Rule 503 of Regulation D,
an issuer that is issuing securities in reliance on Regulation D must file Form D with
the SEC no later than _____ after the first sale (defined as the time when an investor
has delivered an irrevocable commitment to invest) of securities in the offering

Answer 34

15 days

Question 35

One other point worth mentioning is that there is a proposal that the Form D be filed 15 days _______ to the first sale for those offerings made under 506(c)
rather than the 15 days after as is the case with 506(b) offerings.

Answer 35

prior

Question 36

__________ are unregistered securities purchased by an investor in a private placement and are generally restricted from resale for a stated period of time. They are also called letter securities (or legend securities), which refers to the fact that purchasers must
sign an investment letter attesting to their understanding of the restriction upon resale
and to the legend placed on the certificates indicating restriction upon resale.

Answer 36

Restricted securities

Question 37

A corporate director, officer, greater than 10% voting stockholder, or the spouse of any
of the preceding is a

Answer 37

control person

Question 38

Control person are loosely referred to as _____ or ____ because of their unique status within the issuer.

Answer 38

insiders or affiliates

Question 39

_______ is stock held by a control person

Answer 39

Control stock

Question 40

An investor who is not a control person and has no other affiliation with the issuer other than as an owner of securities is a

Answer 40

nonaffiliate

Question 41

______ was created so that certain resales of already existing securities could be
made without having to file a complete
registration statement with the SEC. The time and
money involved in having to file such a registration are usually so prohibitive as to make it
uneconomical for the individual seller. In almost all cases, those who wish to sell control
stock or restricted stock must do so by filing a ____

Answer 41

SEC Rule 144

Question 42

A is any person engaged in the business of effecting transactions in securities for the account of others

Answer 42

broker

Question 43

A ______ is any person regularly engaged in the business of buying and selling securities
for his own account. Banks, insurance companies, investment companies, and any
persons engaged in investing, reinvesting, or trading in securities for their own account,
either individually or in some fiduciary capacity, but not as part of a regular business, are
not included in this definition

Answer 43

dealer

Question 44

A __________________ is any partner, officer, or director of the broker-
dealer (or any person performing similar functions) or any person directly or indirectly
controlling or controlled by the broker-dealer, including any employees of the brokerdealer,
except that any person associated with a broker or dealer whose functions are solely
clerical or ministerial, shall not be included in the meaning of the term.

Answer 44

person associated with a broker-dealer

Question 45

A ________ is a dealer who holds himself out as being willing to buy and sell a
particular security for his own account and on a regular or continuous basis. This holding
out may be by entering quotations in an interdealer communications system or otherwise

Answer 45

market maker

Question 46

A _______________ is any person engaged in the business of:
■■ collecting, processing, or preparing for distribution or publication information with
respect to transactions in, or quotations for, any nonexempt security; or
■■ distributing or publishing (whether by means of a ticker tape, a communications network,
a terminal display device, or otherwise), on a current and continuing basis,
information with respect to such transactions or quotations.

Answer 46

securities information processor (SIP)

Question 47

A transfer agent is any person who engages on behalf of an issuer of securities in:

Answer 47

countersigning the certificates;

registering the transfer of the issuer’s securities;

exchanging or converting the issuer’s securities;

transferring record ownership of securities by bookkeeping entry without physical issuance
of securities certificates.

Question 48

________ is defined as a stock or similar security. Stock means common or preferred
stock. Similar security would include:
■■ a security convertible into stock (e.g., convertible bond);
■■ any security with a warrant or right attached to subscribe to or buy stock (e.g., a bond
with warrants attached); and
■■ any warrant or right to purchase stock.

Answer 48

Equity Security

Question 49

A _________ is an account set up with preapproved authority for a securities
professional to make transactions without having to ask for specific approval.

Answer 49

discretionary account

Question 50

Discretion is defined as the authority to decide:

Answer 50

which security;
■■ the number of shares or units; or
■■ whether to buy or sell.

Question 51

To identify a discretionary order, try this method: an order is discretionary if
any one of the three A’s is missing. The three A’s are:

Answer 51

■■ Activity;
■■ Amount; and
■■ Asset.