Rarely Tested - REGULATION OF ISSUANCES OF SECURITIES

Q: What are the three basic types of securities?

• Equity securities

• Debt securities

• Hybrid securities

Q: What is an equity security?

An equity security represents an ownership interest in a company, generally evidenced by shares of stock. The holder is an owner of the company.

Q: What is a debt security?

A debt security creates a debtor-creditor relationship and does not create an ownership interest in the company.

Q: What is a hybrid security, and how do you determine whether it is more like debt or equity?

A hybrid security has characteristics of both debt and equity. Fleming says to consider these to determine which type the security is:

• Whether there is a maturity date;

• Whether there is a specific obligation to repay a definite amount;

• Whether the holder has voting rights;

• Whether the holder may participate in management; and

• Whether repayment is guaranteed.

Q: What are Blue Sky laws?

Blue Sky laws are state laws regulating the licensing and sale of securities.

Q: What does Section 5 prohibit?

Section 5 prohibits the use of interstate commerce to offer or sell a security unless a registration statement has been filed with the SEC. During the waiting period, written offers must satisfy the statutory prospectus requirements.

Q: When should you discuss Section 5?

Whenever securities are being publicly offered or sold and registration may be required.

Q: What four terms does Fleming identify as important under Section 5?

• Issuer – one who issues or proposes to issue a security.

• Security.

• Sale – an offer, solicitation, or disposition of a security for value designed to generate public interest.

• Registration statement – the detailed disclosure filed with the SEC concerning the proposed issuance.

Q: What securities are exempt from Section 5 registration requirements?

Certain securities, such as those issued by governmental bodies and charities, are exempt because they are regulated by other means, although they remain subject to the anti-fraud provisions.

Q: What transaction is exempt under Section 4?

A sale not involving an issuer, underwriter, or dealer, such as an ordinary transaction between individual investors involving securities that have already been issued.

Q: What is a secondary distribution?

A secondary distribution is a public offering by a person who acquired shares from the issuer in a private placement with the intent to publicly distribute them. Such a person is treated as an underwriter, so the Section 4 exemption does not apply.

Q: Who is a controlled person for purposes of securities regulation?

A controlled person is someone with a controlling relationship to the issuer. Fleming gives a controlling shareholder as an example and treats that person as an issuer for these purposes.

Q: When should you discuss the private placement exemption?

Whenever securities are sold to a small, sophisticated group of investors without a public offering.

Q: What factors indicate a valid private placement (Non public offering)?

Fleming lists these characteristics:

• Non-public offering (no advertising or solicitation)

• Small number of subscribers (usually about 35)

• Investors have sufficient knowledge and experience to evaluate the investment (Ralston Purina)

• Investors have access to the information registration would provide

• Notice is given to the SEC

• Securities are acquired for investment, not immediate redistribution.

Q: When is a dealer exempt from registration requirements?

A dealer is generally exempt unless the dealer is acting as an underwriter during the initial distribution of securities.

Q: When does the pure intrastate offering exemption apply?

When:

• All offerors,

• All offerees, and

• The issuer

are located and doing business within a single state. The rationale is that the offering is limited in scope and state law can regulate it.

Q: When does Section 11 create civil liability?

Section 11 allows a purchaser without knowledge of the misrepresentation to sue persons who signed a registration statement containing a material misstatement or omission.

Q: How are damages measured under Section 11?

The measure of recovery is generally the difference between the amount paid for the security and its market value, limited to the public offering price.

Q: When does Section 12 impose civil liability?

Section 12 imposes civil liability on a person who:

1. Offers a security in violation of Section 5, or

2. Offers or sells a security through interstate commerce using a prospectus or oral communication containing a false statement or material omission.

Q: Does Section 12 apply to exempt securities?

No. Fleming states that Section 12 does not apply to exempt securities.

Q: What important distinction does Fleming make between Section 11 and Section 12(2)?

Section 12(2) requires privity between the seller and purchaser, whereas Section 11 does not.

Q: What defenses and remedies does Fleming identify under Section 12?

• No registration: Absolute liability.

• Section 12(2): A defense exists if the buyer knew of the misrepresentation.

• Remedies: Rescission or actual loss (amount paid minus income received, or actual loss if the security has been sold).

IRAC checklist for Regulation of Issuance of Securities?

• What type of security is involved?

• Does Section 5 require registration?

• Does a Section 4 exemption apply?

• Does an exception eliminate the exemption (secondary distribution, controlled person, etc.)?

• Is there Section 11 liability based on the registration statement?

• Is there Section 12 liability based on the offer or sale?