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39 Cards in this Set

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Typical Securities

(Securities Act of 1933)
Contracts bearing the names of typical securities and possessing the typical characteristics of those securities are securities
Examples of Securities
1) Common stock that has the potential to pay dividends, for which there is a potential market in which the shareholder may realize capital gains/losses, and which grant shareholders the right to vote for directors and other important matters.

2) Debentures that bear interest, for which there is a potential market in which the debentures may appreciate or depreciate, and a date at which the issuer must pay the debt evidenced by the debenture.
Notes
Notes are presumtively securities, because the Sec. Act of 1933 lists notes as securities. However, notes will not be securities if they bear a strong family resemblance to tests that are not securities.
Family Resembalnce Tests
Notes that meet this test are NOT securities:
1) there is no recognized market for the notes
2) the note is not part of a series of notes
3) the buyer of the note does not need the protection of the securities laws
4) the buyer of the note has no investment objective
5) the buyer has no expectation that the securities laws apply to the sale of the note
Investment Contracts
Many security-like contracts will not have traditional security names, but nonetheless have characterististics of securities. The term "investment contract" is designed to capture under the definition of security those types of securities. The Howey test defines an investment contract.
Howey Test
1) Investment of Money
2) Common Enterprise
3) Profits derived solely from the efforts of the promoter
Howey Test

1) Investment of Money
The buyer of the contract has an investment motive, that is, he is expecting a financial return on his purchase, such as a share of profits and capital appreciation, as opposed to a comsumption, employment, or commercial lending objective.
Howey Test

2) Common Enterprise
a) Horizontal commonality: usually proved by the investors' contributions going into a central pool and the investors' sharing the profits from a central pool.
b) Vertical commonality: all the investors are similarity affected by the efforts of the promoter who is selling the contracts (NOT REALLY USED SO PROBABLY NOT ON EXAM)
Howey Test

3) Profits derived solely from the efforts of the promoter
Usually permits some effort by the investors, provided that the undeniably significant efforts determining the success of the venture are those of the promoter
1933 Act
- concerned about buyers
- Transactions by which securities first/primarily go public
- ISSUANCE
1934 Act
- deals with the secondary market
- once we've gone public
- concerned about BOTH the buyers and sellers
Suitability to Investment Letter
- Written by issuer
- signed by buyer (investor) and sent back to issue
- issuer must check, read, and approve them before issuance
Rule 504
- Issuer: Nonpublic issuer
- Amount Limit: $1,000,000 in 12 month
- Purchasers: No limit
- Qualifications: None
- Disclosure Requirements: None
- General Solicitations: Permitted, if the issuer registered the securities under state law or sold the securities only to accredited investors pursuant to a state securities exemption
- Resale Requirements: No resale restrictions, if the issuer registered the securities under state law or sold the securities only to accredited investors pursuant to a state securities exemption
Rule 505
- Issuer: Any issuer
- Amount Limit: $5,000,000 in 12 month
- Purchasers: (SEE 505 & 506 purchaser flashcard)
- Qualifications: None
- Disclosure Requirements: (see flashcard)
- General Solicitations: Not permitted
- Resale Requirements: (see flashcard)
Rule 505 & 506
Number of Purchaser
- 35 unaccredited purchaser, and
- Unlimited accredited purchasers
- Highlevel insiders
- income > $200,000
- NW (excluding principal residence) > $1,000,000
- Institutional investors
Rule 505
Disclosure Requirements
A) If issuer sells only to accredited purchasers: the issuer must give investors only the information requested by investors
B) If issuer sells to any accredited purchasers, the issuer must give investors:
- the same nonfinancial information as required for a registered offering
- audited financial statements
- Public issuer: 2 BS, 3 IS, 3 states of financial change
- Nonpublic issuer: if amount of securities sold is
a) <= $2 million - 1 BS
b) > $2 million but <= $5 million: 1 BS, 1 IS, 1 statement of change
- Nonpublic issuer: if auding involves unreasonable effort or expense: 1 BS

Any information given to one investor must be given to all investors
Rule 505
Resale Restriction
- Investors may not sell securities of a public issuer for at least 6 months
- Investors may not sell securities of a nonpulic issuer for at least 1 year
- After the passage of the time periods above, a non-affiliated investor may sell the securities w/o volume restrictions
-After the passage of the time periods above, an affiliated investor may sell in any three month period the greater of
- 1% of the issuer's outstanding shares or
- the average weekly volume of the issuer's shares
Rule 506
- Issuer: Any issuer
- Amount Limit: Unlimited
- Purchasers: (see flashcard)
- Qualifications: (see flashcard)
- Disclosure Requirements: (see flashcard)
- General Solicitations: None permitted
- Resale Requirements: Same as 505
Rule 506
Purchaser Qualifications
Issuer must REASONABLY BELIEVE that each purchaser is either
- accredited or
- alone or with his purchaser representative has such knowledge and expereince in financial and business matters to be capable of evaluating the merits and risks of the investment

(get from Suitability Investor Letter)
Regulation A
- Issuer: Nonpublic issuer
- Amount Limit: $5,000,000 in 1 year period
- Purchasers: No limit
- Qualifications: None
- Disclosure Requirements: the issuer must use an Offering Circular
Financial statements in the Offering Circular
- Need not be audited unless otherwise required
- 1 BS, 2 IS, 2 CF, 2 statements on financial change
- General Solicitations: Permitted
- Resale Requirements: No restrictions
Rule 147
- Issuer:
a) Issuer organized and doing business in teh offerrees and purchasers state
b) Issuer has 80% of its assets in the state
c) issuer generates 80% of its gross revenues from the state
d) Issuer uses 80% of the offering's proceeds in the state
- Amount Limit: Unlimited
- Purchasers: no limit
- Qualifications: all offerees and purchasers must reside in the issuer's state
- Disclosure Requirements: none
- General Solicitations: Permitted
- Resale Requirements: Investors may not sell the securities outside the issuers state for 9 months
Rule 506
Disclosure Requirements
A) If issuer sells only to accredited purchasers: the issuer must give investors only the information requested by investors
B) If issuer sells to any accredited purchasers, the issuer must give investors:
- the same nonfinancial information as required for a registered offering
- audited financial statements
- Public issuer: 2 BS, 3 IS, 3 states of financial change
- Nonpublic issuer: if amount of securities sold is
a) <= $2 million - 1 BS
b) > $2 million but <= $7.5 million: 1 BS, 1 IS, 1 statement of change \
c) >$7.5 million: 2 BS, 3 IS, 3 statement of change
- Nonpublic issuer: if auding involves unreasonable effort or expense: 1 BS

Any information given to one investor must be given to all investors
Securities Exchange Act Section 10 (b) and Rule 10b-5
1) Misstatement or omission of material fact
2) in ANY communication in connection with the purchase or sale of any security
3) Plaintiff
- SEC
- Any purchaser or seller
a) who relied on the misstatment or omission
b) whose damages were caused by the misstatmetn or omission
4) Defendant
- must be primarily responsible for the misstatment or omission AND
- must have acted with SCENTER
a) knew of the misstatment/omission
b) gross recklessness in ascertaining the trust
5) Important features
- Scienter standard
- No privity required b/w plaintiff & defendant
- Plaintiff must prove defendan'ts fault = scienter
Securities Exchange Act Section 12 (a)(2)
1) Misstatement or omission of material fact
2) in ANY communication in connection with the ISSUANCE of securities by the issuer
3) Plaintiff
a) any purchaser of the securities
b) whose damages were caused by the misstatement/omission
4) Defendant
a) must have sold the security or have actively solicited the sale
b) must have a financial interest in the sale
c) Defense: did not know & could not reasoanbly known of the misstatement/omission of materal fact
5) Important features
a) Negligence standard
b) Modified privity requirement
c) Reliance by plaintiff not required
d) Defendant msut prove lack of fault = not negligent
Securities Act Section 11
1) Misstatement or omission of material fact
2) in ANY communication in connection with the purchase or sale of any security
3) Plaintiff
a) Any purchaser of securities issued pursuant to the registration statement
b) Whose damages were caused by the misstatement/omission
4) Defendants
a) Issuer
b) directors of issuer
c) signer of registration statement (CEO, CFO, etc)
d) underwriters of the issuance
e) Experts who issued an opinion contained in the registration statement
1) Auditors who issued audit opinions
2) Tax lawyers who issuer tax opinions
f) Defense for any defendant except the issuer (see flashcard)
5) Important Features
a) Negligence standard
b) No reliance by plaintiff required
c) No privity required b/w plaintiff & defendant
d) Defendant must prove lack of fault = not negligent
Securities Act Section 11

Defense for any defendant except the issuer
1) For nonexpert in regard to nonexpertised porrtion of the registraton statement: After a reasonable investigation, the defendant had reason to believe and did believe that there were no misstament/omission of materal fact in the nonexpertised portion of the registration statement
2) for expertised portion of the registration statement:
a) for Nonexpert: the nonexpert defendant had no reason to believe and did not believe that there were any misstatment/omission of material fact in the expertised portion of the registration statment
b) For expert, After a reasonable investigation, the expert had reason to believe and did believe that there were no misstatment/omission of material fact in the expertised portion of the registration statmetn contributed by the expert
Business Judgment Rule

DEFINED
1) BOD maks an informed decision
a) Requires board to make a reasonable investigation
b) Board may rely on others, such as consultants & employees
2) BOD has no conflicts of interests
3) BOD has a rational basis to believe that the decision is in the best interets of the corporation--the board's decision may not be grossly negligent
Business Judgment Rule

CONSULTANT's/INVESTMENT BANKER's ROLE
1) Conduct a reasonable investigation of the facts
2) Determine the vision/strategy of the corporation
3) Investigate whether board members have a personal interest in the matter under consideration
4) Inform the BOD of the facts revealed by the reasonable investigation
a) written report to board prior to meeting
b) Oral report to board, with Q&A period
c) Recommend that board take sufficient time to discuss & deliberate
5) check the fit b/w the decision & the corporate vision/strategy
- * Decision must fit logically or rationally with the corporation's strategy
6) Check the fit b/w the decision & the facts revealed by the reasonable investigation
- * Decision must fit logically or rationally with the facts revealed by the reasonable investigation
Instrinsic Fairness Standard

DEFINED
1) Applies when one or more members of the BOD is interested in the decision
2) Requires the decison of the board be fair to the corporation--a reasonable person acting at arm's length would bind the corporation to the transaction
Instrinsic Fairness Standard

CONSULTANT's/INVESTMENT BANKER's ROLE
1) Conduct a reasonable investigation of the facts
2) Determine the vision/strategy of the corporation
3) Investigate the extent to which board members have a personal interest in the matter under consideration
4) Inform the BOD of the extent to which board members have a personal interest in the matter under consideration
5) Inform the BOD of the facts revealed by the reasonable investigation
a) written report to board prior to meeting
b) Oral report to board, with Q&A period
c) Recommend that only the disinterested directors vote on the matter under consideation
d) Inform the BOD of the facts revealed by the reasonable investigation
a) written report to board prior to meeting
b) Oral report to board, with Q&A period
c) Recommend that board take sufficient time to discuss & deliberate
6) check the fit b/w the decision & the corporate vision/strategy - is the transaction fair in relation to the corporation's strategy (reasonable decision)
7) Check the fit b/w the decision & the facts revealed by the reasonable investigation - is the transaction fair to the corporation (reasonable decision)
Usurpation of a Corporate Opportunity

ELEMENTS
1) the officer or director receives the opportunity in her corporate capacity
2) the opportunity has a relation to an existing or prospective corporate activity
3) the corporation is financially able to take advantage of the opportunity
Usurpation of a Corporate Opportunity

CONSEQUENCE
1) the director or officer must sell the opportunity to the corporation at the price she paid
2) the director or officer must give to the corporation all profits and other benefits she has received by exploiting the opportunity
Due Diligence Defenses under Section 11 of 1933 Act

EXPERT
Liable only for the expertised portion of the registration statement contributed by the export.

Example:
- Auditor issues an audit opinion regarding financial statements
- Geologist that issues a report regarding mineral reserves
- Lawyers that issues a tax opinion regarding the tax deductibility of losses
Due Diligence Defenses under Section 11 of 1933 Act

NONEXPERT
Liable for the entrie registration statement

Examples:
- Directors of the issuer
- CEO, CFO, CAO of issuer
- underwriters who assist in the sale of the securities and help prepare the registration statement
EXPERT

For EXPERTISED Portion of the Registration Statement
After a reasonable investigation, the expert had reason to believe and did believe that there were no misstatment/omission of material fact in the expertised portion of the registration statmetn contributed by the expert
NONEXPERT

For EXPERTISED Portion of the Registration Statement
the nonexpert defendant had no reason to believe and did not believe that there were any misstatment/omission of material fact in the expertised portion of the registration statment
EXPERT

For NONEXPERTISED Portion of the Registration Statement
Not liable for this portion of the registration statement
NONEXPERT

For NONEXPERTISED Portion of the Registration Statement
After a reasonable investigation, the defendant had reason to believe and did believe that there were no misstament/omission of materal fact in the nonexpertised portion of the registration statement
Section 11 Due Diligence Checklist
1) Know the issuer's business & industry
2) Read the prospectus/registraiton statement
3) read important meeting minutes (BOD, executive committee, audit committee, S/H meetings)
4) Read important correspondence
5) Read materal contracts
6) Ask Q's of management & others who have information
7) Make inquiries that relate to information in the registration statement
8) Follow up red flags
9) don't rely on glib statements of management
10) Get confirmations of information from outside sources
11) comply wth GAAP & GAAS (auditors only)
12) Follow the frim's written review program (auditors & underwriters)
13) spend adequate time on S-1 review
14) Review relevant financial records during S-1 review
15) leave a paper trail of the investigation, keeping work papers and written records of conversatoins
14) Attend the due diligence meeting