(17) RARELY TESTED - Regulation of Issuances of Securities

What is the purpose of securities regulation?

To regulate the issuance and sale of securities and require disclosure to protect investors.

What are the three types of securities?

Equity securities, debt securities, and hybrid securities.

What is an equity security?

A security representing an ownership interest in a company.

What does ownership of an equity security make the holder?

An owner of the company.

What is a debt security?

A security representing a debtor-creditor relationship that does not create an ownership interest.

Does a debt security create ownership in the company?

No.

What is a hybrid security?

A security that resembles both debt and equity securities.

How do you determine whether a hybrid security is debt or equity?

Look to the maturity date, repayment obligation, voting rights, management rights, and guarantee of repayment.

What feature of a hybrid security suggests it is debt?

A specific maturity date and a specific obligation to repay an ascertainable amount.

What features of a hybrid security suggest it is equity?

Voting rights, participation in management, and lack of a guaranteed repayment.

What regulates securities at the state level?

Blue Sky laws.

What is the primary purpose of Blue Sky laws?

State licensing and regulation of securities.

What does Section 5 of the Securities Act prohibit?

Using interstate commerce to offer securities for sale unless a registration statement has been filed with the SEC.

What must be filed before securities may be offered under Section 5?

A registration statement.

May written offers be made during the waiting period?

Only if they satisfy the statutory prospectus requirements.

What is a statutory prospectus?

A document filed with the registration statement containing the key information from the registration statement.

Who is an issuer?

Anyone who issues or proposes to issue a security.

What is a sale under Section 5?

An attempt to offer, dispose of, or solicit an offer to buy a security for value.

What activity is considered a sale even if no securities are transferred?

Conduct designed to stir public interest in a security.

What is a registration statement?

A detailed disclosure statement regarding the proposed issuance and the corporation's financial condition.

What is the purpose of a registration statement?

To force disclosure of information affecting the fairness of the offering and the corporation's financial status.

What are exempt securities?

Securities exempt from registration because they are otherwise regulated, such as governmental or charitable securities.

Are exempt securities still subject to anti-fraud provisions?

Yes.

What transactions are exempt under Section 4?

Sales not involving an issuer, underwriter, or dealer.

What type of transaction is generally covered by the Section 4 exemption?

Ordinary transactions between individual investors involving previously issued securities.

What is a secondary distribution?

A public offering by a person who acquired shares from the issuer in a private placement with the intent to publicly distribute them.

How is a person making a secondary distribution treated?

As an underwriter.

Who are controlled persons for purposes of Section 4 exceptions?

Persons having a controlling relationship with the issuer.

How are controlled persons treated?

They may be treated as issuers.

What is a private placement?

A non-public offering exempt from registration.

What advertising is permitted in a private placement?

None.

How many subscribers are typically involved in a private placement?

Usually about 35.

What level of sophistication must private placement investors possess?

Knowledge and experience sufficient to evaluate the investment.

What case established the sophistication requirement for private placements?

Ralston Purina.

What information must private placement investors receive?

Access to the same information registration would provide.

What notice requirement applies to private placements?

Notice must be given to the SEC.

For what purpose must private placement purchasers acquire the securities?

As investments rather than for immediate distribution.

When is a dealer exempt from registration requirements?

When not acting as an underwriter during the initial distribution.

When is a dealer treated as an underwriter?

When acquiring securities with the intent to resell them.

What is a pure intrastate offering?

An offering in which all issuers, offerors, and offerees reside and do business in the same state.

Why are pure intrastate offerings exempt?

Because of their limited scope and state regulation.

What does Section 11 regulate?

Civil liability for material misstatements or omissions in a registration statement.

Who may sue under Section 11?

A person who acquires a security issued under a materially false or misleading registration statement without knowledge of the defect.

Who may be sued under Section 11?

Every person who signed the registration statement.

How are damages measured under Section 11?

The difference between the amount paid and the market value, limited to the public offering price.

What does Section 12 regulate?

Civil liability for selling securities in violation of Section 5 or by means of false or misleading prospectuses or oral communications.

Does Section 12 apply to exempt securities?

No.

Can liability still exist for misleading prospectuses even when registration is exempt?

Yes.

Does Section 12(2) require privity?

Yes.

Between whom must privity exist under Section 12(2)?

The seller and purchaser.

Who may be liable under Section 12?

Sellers of securities and their controlling persons.

What is the liability standard for an unregistered sale under Section 12?

Absolute liability.

What defense exists under Section 12(2)?

The buyer knew of the misrepresentation.

What remedies are available under Section 12?

Rescission, recovery of the purchase price less income received, or actual losses if the securities have been sold.

Do the anti-fraud provisions of Section 12(2) apply to exempt transactions?

Yes.

How does Section 12(2) differ from Section 11?

It applies to exempt transactions and requires privity.

What did Gustafson v. Alloyd Co. hold regarding Section 12(2)?

Section 12(2) applies only to initial public offerings, not private or secondary sales.

Testable Issue:What are the three types of securities?

Equity securities, debt securities, and hybrid securities.

Testable Issue:What does Section 5 require before securities may be offered?

A registration statement must be filed with the SEC.

Testable Issue:What are the requirements for a valid private placement?

No public offering, approximately 35 sophisticated investors, equal access to information, SEC notice, and investment intent.

Testable Issue:Who may sue under Section 11?

A purchaser without knowledge who acquires securities issued under a materially false registration statement.

Testable Issue:What is required under Section 12(2) that is not required under Section 11?

Privity between the seller and purchaser.

Testable Issue:What remedies are available under Section 12?

Rescission or recovery of actual losses.

Essay Rule:How do you analyze securities issuance regulation?

Identify the type of security, determine whether registration under Section 5 is required or an exemption applies, analyze any Section 11 registration statement liability, analyze Section 12 liability for unlawful sales or misleading prospectuses, determine applicable defenses and remedies, and distinguish exempt transactions from registered offerings.

Master Synthesis:What is the framework for analyzing securities issuance regulation?

Identify the security involved, determine whether federal registration is required or exempt, evaluate compliance with Section 5, analyze civil liability under Sections 11 and 12, apply any exemptions and defenses, and determine the appropriate remedies.