8. BA Securities Laws

What are the primary sources of law for this module?

1. The restatement of securities

2. Federal statutes, rules, and caselaw

3. Federal and state statutes, rules, and caselaw

2. Federal statutes, rules, and caselaw

Which of the following best describes the relationship between the state corporate law we studied in prior modules and the federal securities law we study in this module?

1. Federal securities law and state corporate law are overlapping regulatory schemes and can both apply to corporate actions.

2. Federal securities law governs publicly traded companies and state corporate law governs privately held companies.

3. Federal securities law governs companies incorporated with the SEC and state corporate law governs companies incorporated in Delaware or other states.

4. Federal securities law mostly preempts state corporate law.

1. Federal securities law and state corporate law are overlapping regulatory schemes and can both apply to corporate actions.

Which topics are covered by federal securities law?

1. All of these are correct

2. Governance requirements

3. Anti-fraud

4. Disclosure requirements

1. All of these are correct

   Right! Securities law is best known for disclosure requirements and anti-fraud provisions. But it also has some governance requirements (rules about board composition and the conduct of shareholder meetings).

If you're interested in securities law, which of the following classes should you take?

1. Securities regulation

2. Secured transactions

3. Antitrust

1. Securities regulation

What is the primary justification for regulating securities transactions more heavily than real estate transactions?

1. Securities transactions are larger dollar value.

2. Purchasers of securities are more vulnerable.

3. Securities transactions have to be evaluated almost entirely based on information produced by the seller.

4. Securities transactions often cross state lines.

3. Securities transactions have to be evaluated almost entirely based on information produced by the seller.

I start a band. I will play bass. My friend Ted will play drums. My brother Sam will play guitar and sing. We each contribute $1,000 to fund our tour expenses, and we agree we will each get 1/3 of band profits. It’s an informal arrangement. It turns out I lied to Ted and Sam about having some gigs lined up for the band, so they invested under false pretenses.

Have I committed securities fraud?

1. Yes because I made a material misstatement of fact.

2. No because even the drummer makes an important effort in a band.

3. No because my misstatements about the gigs are not material

4. Yes because these would be partnership interests under Fenwick and the RUPA definition.

2. No because even the drummer makes an important effort in a band.

   Right! If these are securities it is because they are investment contracts. The key to the investment contract test is that the investors rely primarily on the efforts of others.

I form a corporation named Band Inc. The corporation will operate a band, in which I will play bass. My friend Ted will play drums in exchange for 10 shares of Band Inc. stock. My brother same will play guitar in exchange for 20 shares of Band Inc. stock.

Is the stock a security?

1. Yes because stock is specifically listed in the definition of a security.

2. No because I dealt fair and honestly with Ted and Sam.

3. Yes if I used the word "stock" or "shares" in the purchase agreement.

4. No because Sam and Ted will rely substantially on their own efforts to generate profits.

1. Yes because stock is specifically listed in the definition of a security.

I start a limited partnership named Band LP. The partnership operates a band and owns its recording rights. I need funding to purchase equipment and fund travel expenses. I locate investors and sell them limited partnership interests.

Are the limited partnership interests securities?

1. Yes if I referred to the interests as shares or stock in the purchase agreement.

2. No because partners have equal rights in management.

3. Yes because they qualify as investment contracts.

3. Yes because they qualify as investment contracts.

   Right! Recall that limited partners are required to be passive. And so limited partnership interests are generally investment contracts (limited partners profit primarily from the efforts of others).

I start a corporation named Real Estate Inc. The corporation will own and operate apartment buildings. I need funding to pay for building acquisitions and to cover operating expenses. I sell investors stock of Real Estate, Inc.

Is the stock a security?

1. Yes because stock is specifically listed in the statutory definition of a security.

2. Yes because this stock is an investment contract.

3. No because the corporation holds real estate, the attributes of which can be confirmed through objective third-party reports.

1. Yes because stock is specifically listed in the statutory definition of a security.

I start an LLC named Real Estate LLC. It will acquire and hold real estate. I will get the necessary funding by selling LLC interests to dentists and retirees. I will be the sole manager of the company and the dentists and retirees will not have a role in management.

Are the LLC interests securities?

1. Yes because the dentists and retirees are not sophisticated and need protection.

2. Yes because LLC interests are investment contracts.

3. No because the LLC just holds real estate, and real estate is not a security.

4. No because LLC interests are not securities under the Robinson case.

2. Yes because LLC interests are investment contracts.

   Right! LLC interests are not specifically listed as securities, but these particular LLC interests likely meet the criteria for investment contracts because they are passive in nature.

I’m launching a food cart. I post a 10-page business plan on Facebook. I offer my 200 “friends” on Facebook the opportunity to buy LLC ownership units at $500 per unit. Three of my Facebook friends, each of whom is accredited, invest.

Is the transaction likely to be exempt under Section 4(a)(2) case law?

1. No because the number of offerees and their relationship to me is problematic.

2. Yes because only three Facebook friends invested.

3. Yes because I posted a business plan.

1. No because the number of offerees and their relationship to me is problematic.

   Good answer. There's no clear numerical threshold for number of offerees, but 200 feels a bit high. And the fact that someone is a Facebook friend, doesn't seem meaningful enough for evaluating the propriety of a financial relationship. It neither suggests they know you well enough to ensure a good flow of information nor suggests you know them well enough to evaluate whether this investment is suitable for them.

Same facts, but this time I only offer the units to 50 of my business school classmates.

Is the transaction likely to be exempt under Section 4(a)(2) case law?

1. Yes because there are fewer offerees and they are sophisticated.

2. I think this is right, though there are no rock solid answers under this murky caselaw.

3. Yes because LLC interests are not securities.

2. I think this is right, though there are no rock solid answers under this murky caselaw.

   No because the number of offerees is still problematic, and the business plan is not the same level of disclosure investors would receive in a registered public offering.

I launch a startup company. I include a feature on the startup's website -- "click here to invest." I sell stock to five people who click that button. I make sure they are accredited by having them check a box on a page of the stock purchase agreement that says: "I hereby certify that I meet the standard for an accredited investor under Rule 506."

Is the transaction exempt under the Rule 506 safe harbor?

1. Yes because the purchasers are accredited.

2. Yes because I took extra steps to confirm accredited investor status.

3. No because this is a general solicitation.

4. No because general solicitations are never allowed under Rule 506.

3. No because this is a general solicitation.

   Good answer! This is just investor self-certification. The kind of extra steps that would allow for general solicitation are more extensive, such as checking account statements to verify assets or tax returns to verify income.

I launch a startup company. I offer stock to the law firm that is representing the company, my college roommate who has an MBA from Haas business school, and a former entrepreneur who is mentoring me at a startup incubator. I sell a total of $300K in stock to the three of them. I never check if they're accredited. I provide them a slide show presentation describing the product and the projected market and I answer all of their questions.

Is the transaction exempt under the Rule 506 safe harbor?

1. No because I never checked if they are accredited.

2. No because this is a general solicitation and I did not adequately confirm accredited investor status.

3. Yes because non-accredited investors are technically allowed in Rule 506 offerings.

4. Yes because the investors sound like they're most likely accredited.

1. No because I never checked if they are accredited.

   Good answer. For all practical purposes, you have to only sell to accredited investors under Rule 506. Otherwise, you need to provide audited financial statements and other disclosure that is usually not practical.

Same facts as above. Is the transaction exempt under Section 4(a)(2) caselaw?

1. No because $300K is a lot of money (size of offering factor).

2. Yes because this is a small offering to relatively sophisticated investors I know pretty well.

3. No because I haven't taken appropriate steps to verify accredited investor status.

4. Yes because I provided disclosure equivalent to what they would get in a registered offering.

2. Yes because this is a small offering to relatively sophisticated investors I know pretty well.

   Right! Several factors look good here.