Securities Regulation - Flashcards

Front 1

Rule 146

Back 1

Provides objective standards for determining when the exemption is available under 4(2)

Front 2

Rule 146 Conditions

Back 2

No general advertising or soliciting in connection with the offering

Offers only to be made to persons the issuer reasonably believes have the requisite knowledge and experience in financial and business matters or who can bear the economic risk

Sales to be made only to persons as described above except that person meeting the economic risk test must also have an offeree representative capable of providing requisite knowledge

Offeree have access to info comparable to that elicited through registration

No more than 35 purchasers

Reasonable care to make sure securities are not resold

Front 3

In what ways does Rule 506 expand Section 4(2)?

Back 3

Focues on purchaser qualification rather than offers and sales

Institutions and purported wealthy individuals irrebuttably are deemed under Reg. D to be sophisticated and to have access to the type of info that a registration statement would have.

Preempts state regulation except for enforcement actions for fraud

Front 4

Rule 507

Back 4

Exemption similar to 506 Large Accredited Investors

unlimited amount of securities and unlimited amount of AI's

no restriction on payment of commissions

not exclusive

limitations on resales

issuer must exercise reasonable care to assure that purchasers are not underwriters

Notice of sales

Bad actor disqualification

limited advertising permitted

no sales to those that are not AI's

Front 5

Rule 508 - Test for Substantial Compliance For offerings pursuant to Rule 504-506

Back 5

(1) the particular requirment is not intended to specifically protect the compliantant.

(2) the compliance defect was not significant to the offering as a whole

(3) There was a good faith effort to comply with all of Regulation D's mandates.

Even if above 3 are met, can not invoke if:
(1) there is general solicitation
(2) the dollar limites of Rule 504-505 are violated
(3) The no. of non-accredited purchasers in Rule 505 and 506 is exceeded.

Front 6

Form D

Back 6

Must be filed with SEC within 15 days after 1st sale of securities

Late filing may be allowed.

No longer a condition to the establishment of any exemption under Reg. D.

Front 7

Two inquiries of the meaning of general solicitation

Back 7

Is the communication in question a general solicitation or advertisment

If it is, is it being used by the issuer or by someone on the issuer's behalf to offer or sell the securities.

Front 8

General solicitation inquiry focus

Back 8

Requires a preexisting relationship between the issuer and the prospective investors which is some substance and duration which is shown by:

The potential investor having previously invested with the broker-dealer which has existed for some duration or

The potential investor has been effectively pre-screened.

Front 9

SEC v. Woodtrails Seattle

Back 9

SEC staff found that mailing of written offers of 330 prospective investors who had previously invested with the issuer over the last 3 yrs did not constitute general solicitation.

Front 10

E.F. Hutton v. SEC

Back 10

Held Questionaires can establish a substantive preexisting relationship if they provide broker-dealer with sufficient info to evaluate the prospective offeree's sophistication and financial circumstantces.

Front 11

IPONET no Action Letter

Back 11

Posted private offerings in a password protected page. In order to receive password and view offerings another company would solicit individuals who met the AI standard as determined by a questionaire to be completed online and once a determination was made they would receive a password.

Front 12

Second Inquiry of general solicitation

Back 12

Two elements:
By the issuer or by someone on the issuer's behalf
To offer or sell securities

If a communication is in an issuer's name or such issuer's management solicits a potential investor, it is clearly by the issuer.

Front 13

Limited offering exemptions

Back 13

These exemptions that reflect Congressional concer that small enterprise should not be unduly burdened in raising capital

3(b), 4(6), 3(a)(11), 3(a)(9), Rule 147 (safe harbor for 3(a)(11), 3(a)(10), Rule 504, 505, 701, Regulation A

Front 14

Section 4(6)

Back 14

Exempts from registration under the '33 Act offers and sales by any issuer soley to one or more AI if the total offering price does not exceed $5 million.

No advertising or soliciation is permitted
Issuer must file notice of sale made pursuant to exemption with SEC

Front 15

Section 3(b)

Back 15

Contains an exemption for small offerings, empowering SEC to exempt from registration any offering of securities where the aggregate amount of such offering doesn't exceed $5 million

Front 16

Section 3(a)(11)

Back 16

Exemption from registration with respect to any security which is a part of an issue offered and sold only to persons within a single state.. where the issuer of such security is a person resident and doing business or if a corpo. incorporated and doing business in a State. Sale to one non-resident destroys the exemption.

Front 17

Rule 147

Back 17

Safe Harbour for Section 3(a)(11) was intended to allow issuers with localized operations to sell securities as part of a plan of local financing. Rule is non-exclusive.

No resales for 9 months from the date of the last sale by issuer

Safe harbour for integration

An offer or sale on the part of the issue to a single non-resident will destroy the exemption.

Front 18

Sec. 3(a)(9)

Back 18

Exchange of security by the issuer with its existing security holders where no commission or other remuneration is paid or given directly or indirectly for soliciting such an exchange.

Front 19

Sec. 3(a)(10)

Back 19

Exempts from registration securities exchanged for a bona fide legal claims settlement in a court or tribunal.

Three Situations involved:
Settlement of private lawsuits
Regorganizations of invosolvent business outside of bankruptcy litigation
Reorganization of solvent business

Court or authorized govt. entity must approve fairness of the terms

Front 20

Rule 504

Back 20

Adopted to facilitate the capital raising needs for small start-up company

Limited offerings and sales of secuirites to not exceed $1,000,000.

Must meet 501 & 502 conditions and state laws.

Front 21

Rule 505

Back 21

exempts sales and offerings not in excess of $5,000,000 (12 month period)

General conditions 501 and 502

Not more than 35 nonaccredited purchasers, but unlimited number of accredited investors

General solicitation or advertising is prohibited and restrictions on resale apply

Must provide written disclosure to all nonaccredited purchasers regarding limitations on resale

Substantial compliance standard applies to all offerings

Unlike Rule 506, the issuer need not make a determination that the purchaser is sophisticated.

Unavailable to issuers that have engaged in certain misconduct

Not frequently used, b/c issuers prefer to seek the 506 exemption where state regulation of the subject offering is preempted.

Front 22

Rule 701

Back 22

Provides an exemption from registration for offers and sales of securities for certain compensation benefit plans adopted for the participation of employees, officers, directors, consultants, and advisers of an eligible company.
Designed to facilitate the issuance of securities for compensation
Does not exempt offers and sales which are intended to raise capital
Permits offerings to be made in public to eligible purchasers
Unless more than $5 mil of securities are to be sold, no specific disclosures
Limitations on resale
Not aggregated with offerings made pursuant to the other Section 3(b) offerings

Front 23

Rule 801 and 802

Back 23

Provide special rules for foreign issuers

Front 24

Regulation A

Back 24

Not really an exemption b/c there is a filing of an offering statement with the SEC

 Purpose Short form of registration
 No concept of effectiveness
 Requires filing of an offering statement – like a registered statement
 However no §11 liability
 Not available for any issuer if it or its affiliated person were subject to discipline
 Issuer may “test the waters. Before filing
 Limited amount
 Was revitalized by simplified forms
 An exemption for registration for non-reporting companies.
 Permits generalized interstate public offerings of up to $5 mill during 12 month period including $1.5 million in non-issuer resales
 No limit on the number of offerees or purchasers
 Authorizes use of broker-dealers to advertise and distribute the securities
 May resell w/o being subject to restrictions on resales imposed by SEC 147, 505-506
 Contains substantial compliance standard
 Frequent use of the Regulation A offering exemption is by privately held non-reporting companies for employee stock option and purchase plans.

Front 25

Rule 1001 - California Exemption

Back 25

o Exempts for registration offers and sales up to $5 million that are exempt from state qualification under para (n) of Section 25102 of the Cali. Corp. Code.
o Promulgated by the SEC under Section 3(b) of the Securities Act to enhance capital raising by small businesses, while seeking to maintain adequate investor protection
o Limited to issuers that are Cali. Corporations or other business entities that are formed under Cali. Law including partnerships and trusts.
o Non-California Corporation may use exemption if more than 50% of its outstanding voting securities are held by Cali. Residents and at least 50% of its property, payroll, and sales can be attributed to Cali.
o Qualified purchasers:
 Any person purchasing more than $150K of securities in the offering or
 A natural person whose net worth exceeds $500, or a natural person whose net worth exceeds $250K if such purchaser’s annual income exceeds $100K in either case the transaction must involve:
• Only one-class voting stock
• An amount limited to no more than 10% of the purchaser’s net worth, and
• A purchaser’s able to protect his or her own interests
o Permitted to test the waters by distributing to qualified and non-qualified purchasers a written general announcement that contains certain specified info.
o Telephone solicitation is specifically prohibited until it can be determined that the prospective purchaser is deemed qualified

Front 26

Preemption of State Regulation (1996 Act)

Back 26

Securities issued by investment companies registered with the Commission
Securities offered or sold to “qualified purchasers”
All securities listed on NYSE, AMEX , NASDA
Other national stock exchanges
Securities issued in connection with exempt transaction under the 1933 Act
 4(2) (Rule 506); 3(a); 4(1)
 Criticism: generally insignificant-doesn’t help small business
 States may still require certain filings

Front 27

NASAA - Model Accredited Investor Exemption

Back 27

o In those states in which the Accredited Investor Exemption is adopted, issuers may avoid state registration requirements if securities are sold only to persons who are or the issuer reasonably believes are accredited investors
o SEC has not promulgated a federal exemption from registration that coordinates with NASAA’s model exemption
o Incorporates the SEC definition of accredited purchasers set forth in Rule 501 of Regulation D

Front 28

Integration of Offerings

Back 28

If a purported exempt offering is integrated with a registered offering, the exemption will be destroyed resulting in liability.

Front 29

Five Factors to determine whether offerings/sales should be integrated

Back 29

(1) Whether the offerings are part of a single plan of financing.
(2) Whether the offerings were made at or around the same time.
(3) Whether the offerings involve issuance of the same class of securities
(4) Whether the same type of consideration was received
(5) Whether the offerings are made for the same general purposes.

Front 30

Rule 155

Back 30

Provides under certain circumstances safe harbors from the Securities Act integration for a registered offering following an abandoned private offering or a private offering following an abandoned offering.

Front 31

Aggregation of offering price

Back 31

the principal by which an issuer determines the dollar worth of exempt sales available direction undering 3(b)

Front 32

Regulation S - Rule 901-905

Back 32

Territorial approach to extraterritorial applciation based on the the notion that registration requirements are intented to protect U.S. capital markets and all investors in such markets whether they are U.S. residents or foreign nationals.

Front 33

Rule 901

Back 33

States that only offers and sales of securities inside the U.S. are subject to §5.

Front 34

Rule 903

Back 34

 Issuer safe harbor, applicable not only to actual issuer but also to the issuer’s distributors, affiliates, and persons acting on behalf

Three Categories:
o Category I – securities of foreign issuers for which there is no substantial U.S. market interest, securities offered and sold in overseas directed offerings, securities which are backed by the full faith and credit of foreign govts. And securities sold pursuant to certain employee benefit plans.
o Category II – those not eligible under Category I and that are equity securities of a reporting foreign issuer, or debt securities of a reporting issuer or of a nonreporting foreign issuer. Must comply with selling restrictions
 Transaction restrictions – prohibit offers and sales of securities in the U.S. or to U.S. person during a restricted period lasting 40 days
 Offering restrictions – require that all distributors agree in writing that all offers and sales during the applicable restricted period by made in accordance with a Reg. S safe harbor or pursuant to a registration under the Securities Act or an exemption therefrom.
o Category III - all other securities, same offering restrictions as Category II

Front 35

Rule 904

Back 35

Safe harbor for resales

Front 36

General Conditions of Regulation S

Back 36

The offer or sale is made in an offshore transaction

There are no direct selling efforts in the U.S. in connection with the distribution or resale

Front 37

1934 Act

Back 37

o Invented as a continuing disclosure that you must fill out forms and reports if you are a certain size company more times and year.
o Kind of like an incorporation statute
o Disclosure is still the most important part of the Act and issue of broad manipulation of the investments
o Registration Requirement, Annual and Quarterly Reports and Reports on Material Activity

Front 38

Integrated Disclosure Requirement

Back 38

Adopted to ameliorate the expenses and duplication that were prevalent as a result of two differnt reporting mandates under the '33 and '34 act.

Regulation S-K and S-X act as key sources for ascertaining when disclosures are required to be made.

Front 39

What does the Integrated Disclosure Requirement simplify

Back 39

 Uniform requirements for reports and registration statements
 Exchange Act periodic reporting is used to satisfy much of the disclosure necessary in Securities Act registration statements
 The use of informal shareholder communications is encouraged, but not required, to satisfy formal statutory requirements under both Acts.

Front 40

Basic v. Levinson

Back 40

The Supreme Ct. stated that the presumption of reliance is supported by common sense and probability. Recent empirical studies have tended to confirm Congress’ premise that the market price of shares traded on well-developed markets reflects all publicly available information and hence any material misrepresentations. An investor who buys or sells stock at the price set by the market does so on the integrity of that price. Because most publicly available information is reflected in market price, an investor’s reliance on any public material misrepresentations, therefore, may be presumed for purposes of a Rule 10(b)(5) actions.

Front 41

FORM 10-K

Back 41

o Uniform Minimum Disclosure package
 Financial statements
 Amendments to SX and SK
 Disclosures in Annual Report in connection with 10K
 Same requirements as in Registration statement.

Front 42

Form S-1 Registration Form under 1934 Act

Back 42

 Full disclosure in prospectus- used if registrant is in disclosure system <1 year if has sufficient public float and $ 75 million[actually can be used if no other form available]
 Used by enterprises engaging in an IPO, registrants in the Exchange Act reporting system that are ineligible to use Form S-3, and other registrants who choose to utilize it.
 An eligible Form S-1 issuer may incorporate by reference the Exchange Act reports into Securities Act registration statement when it:
• Has filed at least one annual report
• Is current in its Exchange Act reporting obligations
• Has made its exchange Act reports readily accessible on a website maintained by or for such registrant.
 Amendments in S-1

Front 43

Form S-3 Registration Form under 1934 Act

Back 43

 Allows maximum use of incorporation by reference of Exchange Act reports and requires the least disclosure to be presented in the prospectus
 Used by issuers that has timely filed Exchange Act reports for the prior 12 months, have a class of equity security traded on a national securities exchange (such as NYSE) and are not a shell company.
 Less complicated and for those that are much more established

Front 44

Rationale of the 1934 Integration of 1933 registration statments

Back 44

Information that is regularly furnished to the securities markets through 1934 Act periodic report is digested by the marketplace and reflected in the price of the issuer’s securities, thereby eliminating the need to reiterate such information in the public offering context.

Front 45

Scaled Disclosure

Back 45

o Replaces Regulation S-B, adopting additional amendments to the disclosure and reporting requirements under the ’33 and ’34 Acts to expand the number of issuers that qualify for “scaled” disclosure accommodations for smaller reporting companies
o 2007 Amendments include:
 Established category of smaller reporting companies eligible to use our scaled disclosure requirements. Primary determinant for eligibility will be that the company have less than $75 million in public float
 Move 12 non-financial scaled disclosure items form Regulation S-B into Regulation S-K
 Move scaled financial statements requirements in former Regulation S-B into Regulation S-X
 Permit smaller reporting companies to elect to comply with scaled financial and non-financial disclosure on an item-by-item basis
 Eliminates SB forms for registered offerings that could be used by such smaller companies and
 Permits all foreign companies to qualify as smaller reporting companies if they otherwise qualify and choose to file on domestic company forms and provide financial statements prepared in accordance with U.S. Generally Accepted Accounting Principles (GAAP)

Front 46

Shelf Registration Rule 415

Back 46

 Focuses on the Securities Act registration of securities to be offered or sold on a delayed or continuous basis in the future.
 Allowed qualified issuers to raise capital in an expedited manner to capture favorable market conditions while benefiting from significant cost savings in the form of reduced legal, accounting, and other fees.
 Only issuers qualified to register securities on Form S-3 are eligible to conduct primary at the market offerings of equity securities by means of a shelf registration
 No limit on the amount of securities that can be registered pursuant to a shelf registration statement
 Underwriters not required to be identified in shelf registration statement
 Registration statement can be used for up to 3 yrs
 For WKSI by way of “automatic” shelf registration under which the shelf registration statement becomes effective immediately upon filing with the SEC.

Front 47

Plain English Doctrine - Rule 421

Back 47

Requirements to be Clear Concise and Understandable in reports including:
Short sentences;
 Definite, concrete, everyday language
 Active voice
 Tabular presentation or bullet lists for complex material, whenever possible
 No legal jargon or highly technical business terms;
 No Multiple Negatives
 Present info in clear, concise sections, paragraphs, and sentences
 Use descriptive headings and subheadings;
 Avoid frequent reliance on glossaries or defined terms as the primary means of explaining information in the prospectus; and
 Avoid legal and highly technical business terminology.

Front 48

Mandatory Disclosure Cons

Back 48

“This myth of the layman to whom the prospectus is addressed permeates the SEC’s concept of disclosure. It limits the usefulness of disclosure to those who should be its proper objective, the sophisticated investor and professional through whom information ought to filter down to the layman.” Additionally, the system relies on flawed assumption that investors are purely rational actors who can utilize the disclosure effectively to make optimal investment decisions

Front 49

Mandatory Disclosure Pros

Back 49

Proponents assert that in the absence of such a system: (1) some registrants would engage in fraudulent disclosure practices; (2) insider perquisites and salaries as well as underwriter costs would be excessive; (3) current state laws and self-regulatory oversight by themselves would be inadequate for enforcement purposes; (4) the threat of civil and criminal actions would not induce the appropriate level of disclosure; and (5) investors would lose confidence in the system.

Front 50

MD&A

Back 50

Management Discussion and Analysis of Financial Condition and Result of Operations

Emphasis on discussions of known trends, demands, commitments, events and uncertainties.

Provide readers information “necessary to an understanding of a company’s financial statements that enables investors to see the company through the eyes of management”

Requirements intended to provide a narrative explanation of a financial statements that enables investors to see the co. through the eyes of management

Front 51

Rule 175

Back 51

Disclosure of foward looking information - financial projections

 Safe harbor for projections of reserves, income (loss), earning (loss) per share or other financial items, such as capital expenditures, dividends, or capital structure, management plans and objectives for future company operations, and future economic performance included in management’s statements
 precludes liability for the making of issuer forward-looking statements unless the plaintiff establishes that any such statement was made or reaffirmed without a reasonable basis or was disclosed other than in good faith.

Front 52

Hard Information

Back 52

Historical Data

Front 53

Soft Information

Back 53

Forecasts, projections and predicitions

Front 54

Private Securities Litigation Reform Act of 1995

Back 54

Amends both the Securities Act and Exchange Act to provide an expansive safe harbor from liability in private actions for certain forward looking statements made by reporting issuers.

oApplicable to both forward looking written and oral statements so long as:
 The statement identified as a forward-looking statement and is accompanied by meaningful cautionary statements, thus codifying the “bespeaks caution doctrine,”
 The statement lacks materiality
 The plaintiff fails to prove that the statement was made with actual knowledge of its falsity.

Front 55

Probability/Magnitude Test

Back 55

states that materiality will depend at any given time upon a balancing of both the indicated probability that the event will occur and the anticipated magnitude of the even in light of the totality of the company activity.

Front 56

Gaines v. Haughton

Back 56

Ct. held mismanagement need not be disclosed if state law determination. Cts are reluctant to require an issuer to disclose qualitative info that is not economically material.

Front 57

Ganino v. Citizens Utilities Company

Back 57

Ct. applied qualitative economic materiality principles to both narrative and financial statements disclosure, rejecting rigid numerical formula (i.e. less than 5%) According to this view, any approach that designates a single fact or occurrence as always determinative of an inherently fact-specific finding, such as materiality must necessarily be over inclusive or under inclusive.

Front 58

What is the Yeehaw Culture

Back 58

Yeehaw Culture is a culture that puts an organization at risk of ethical collapse.

Front 59

What caused collapse of Yeehaw Culture?

Back 59

 Pressure to maintain those numbers and that performance;
 Fear and silence;
 The Young ‘uns and /bigger –than Life CE0
 Weak Board
 Culture of Conflicts
 Culture of Innovation Like No Other
 Culture of Social Responsibility

Front 60

What were the causes of the Enron Failure?

Back 60

o Fiduciary Failure
o High Risk Accounting
o Inappropriate Conflicts of Interest
o Extensive Undisclosed Off-the books Activity
o Excessive Compensation
o Lack of independence of Directors and Auditors

Front 61

Aims of the Sarbane-Oxley Act - Public Accounting Reform and Investor Protection Act

Back 61

Focues on public companies but may apply to private companies.

o Higher standards for corporate governance, which was typically governed by state law.
 Ignores conflict between states and federal government with respect to corporate governance.
o Increase independence of securities analysts
o New remedies and penalties for violations of the securities laws.
o Hopefully, the enactment of SOX as well as vigorous implementation of the provisions will help restore investor confidence in the integrity of the financial market.

Front 62

Santa Fe v. Green

Back 62

Ct. held that based on the state securities law, the company didn't do anything wrong and federal ct. doesn't deal with fiduciary breaches or internal workings of state business. Case dealt with majority stockholders offering minority stockholders $25 more than what they paid for it.

Front 63

Requirements for Audit Committee

Back 63

o Independence – precludes a member from being affiliated with the company or its subsidiaries other than his/her members on the board of directors.
o Fees – can only charge fees for the auditing by independent auditor and outside advisors
o Consulting – can’t do auditing for same company consulting with
o Funding for independent counsel and staff – the company must provide appropriate funding for the audit committee to pay the fees of an independent auditor, any outside advisers engaged by the audit committee, and the committee’s admin expenses.
oCEO/CFO certification for periodic reports
 Provides for significant criminal penalties for knowingly false certification
o Appointment, Compensation, Retention and Oversight – of the company’s independent auditor and the auditor must report directly to the committee
o Complaints – must establish procedures for handling complaints regarding company’s accounting practices
oPenalties
Knowing violation--$1million, up to 10 years
 Willful violation --$5 million, up to 20 years
 Not applicable to officers who act of ignorance, mistake, accident or sloppiness

Front 64

Audit Committee

Back 64

Established by the board of directors for the purpose of overseeing the accounting and financial reporting processes of the company and the audits of such company’s financial records.

Front 65

Can companies make loans to directors and officers

Back 65

Generally no, however some exemptions if extended in the ordinary course of business by the company and are granted to the fiduciary ont he same basis as loans provided to the general public, no relocation loans or loans to enable purchase of company stock.

Front 66

Insider Trading

Back 66

o Prohibited from trading any equity security, acquired through scope of employment during certain blackout periods – when at least half of the issuer’s individual account plan participants are not permitted to trade in the equity security for more than 3 consecutive business days.
o Applies to directors and executive officers
o SOX also requires that the issuer must deliver notice of blackout periods at least 30 days prior to a blackout period, giving proper notice to employees, executives, and the SEC.

Front 67

Code of Ethics

Back 67

Required for Senior Financial Officers
Attorneys

Front 68

Attorney standard for professional conduct in security violation

Back 68

 Must report evidence of a material violation of the securities laws or breach of fiduciary duty to the company’s CEO or CLC.
 If the CEO or CLC doesn’t respond appropriately, adopting appropriate remedial measures, the attorney is required to report evidence of the violation to the audit committee, another committee comprised entirely of outside directors, or the board of directors.

Front 69

Real Time Disclosures

Back 69

Requires publicly-held companies, as set forth by SEC rules, to make rapid and current disclosure of material changes in their financial operations.

o Emphasized in SOX – required that each issuer reporting under Section 13(a) and 15(d) shall disclose to the public on a rapid and current basis such additional info concerning material changes in the financial condition or operations of the issuer, in plain English

o In ’04, the SEC promulgated amendments to the Form 8-K. By reorganizing and expanding reportable event requirements within the Form 8-K, registrants have a greater responsibility with respect to disclosing particular material events in a timely manner.

Front 70

Disclosure Requirements

Back 70

o Each financial statement must reflect “correcting adjustments”
o Off balance sheet transactions must be disclosed
o Pro forma figures must be reconciled to GAAP and must be presented so as to be understandable to investors.
o Reporting of Insider Transactions - Section 16 forms must be filed within 2 days of transaction (electronically) – expedites disclosures of sales or purchases of equity securities by directors, officers, and 10% shareholders of publicly held registrants. A change in beneficial owners must be reported.
o “Internal Control Report” Must file with annual report on 10K—must include statements by management and accountants—part of the audit engagement – reports on the effectiveness of the internal controls
o Audit Committee Financial Expert - §407 – One member of Audit Committee must be a Financial Expert (must have an understanding of GAAP, experience with respect to the auditing or preparation of financial statements, and understanding of audit committee functions, and experience with internal accounting controls)
o Enhanced SEC Review of Periodic Reports every 3 years—not funded

Front 71

SEC Review Considerations:

Back 71

 Material restatement of financial reports
 Volatility in stock price
 Issuer in the largest capital market
 Energy company with disparate p/e ratio
 Issuer which affects material section of economy

Front 72

New Federal Crimes for Corporate Fraud

Back 72

o Destruction of records in federal investigation
 Concealing or false entries
 Fine up to 20 years
o Destruction of Corporate Audit records
5 years retention
Fine and up to 10 years
o Securities Fraud involving a public company
o New crime; any person who knowingly executes or attempts to execute a scheme or artifice to defraud any person in connection with any security (also applies to broker dealers who are required to register and file reports)
o Tampering with a document to be used in an official proceeding—20 years
o Longer statute of limitations for securities fraud – increased to 2 yrs after discovery of the relevant facts constituting the violation and in no event more than 5 yrs after the violation occurs.
o Criminal penalties increased for mail fraud and ERISA violation
o Review of Federal Sentencing Guidelines (should reflect serious nature of securities, pension and accounting fraud
o Corporate Tax returns to be signed by CEO

Front 73

Whistle Blower Protection

Back 73

file complaint with Dept. of Labor, creates private cause of action for an employee of a publicly-held company who has been discharged or incurred retaliatory treatment b/c he/she has been a whistleblower by providing information re conduct reasonably believed to violate a rule or regulation of the SEC

Front 74

Public Accounting Oversight Board Purpose

Back 74

o Purpose is to oversee the auditing of public companies in order to help ensure accurate and independent financial reporting by public companies subject to the federal securities laws

SEC has oversight of the Board
o Board Membership Appointed by SEC
 3 Non accountants
 2 Accountants
 Full time job
oRegistration with the Board
 Mandatory for all public accounting firms to participate with respect to any issuer

Front 75

Public Accounting Oversight Board Powers

Back 75

 Register firms
 Establish accounting standards
 Conduct inspections
 Conduct investigations and disciplinary proceedings

Front 76

Audit, Quality Control, Ethics and Independence Standards

Back 76

Board’s auditing and control rules must address a number of specific areas
 1) Retention of records
 2) Second partner review
 3) Disclosures of extent of testing internal control structure

Front 77

Sanctions for Accounting Firm Violations

Back 77

o Suspension or revocation of registration
o Censure
o Money penalties
o Injunction
o Required professional education or training
o Whatever is appropriate

Foreign firms can be exempt

Front 78

Qualifications of Public Accounting Oversight Board

Back 78

 Private entity serving public interest
 Trustee majority not associated with registered firm
 Funded by issuers as provided in Act
 Procedures to promptly consider changes to rules
 Must consider international convergence of accounting standards

Front 79

Prohibited Non-Audit Services to Issuer

Back 79

o Bookkeeping and other services related to accounting records or financial statements
o Financial information systems design
o Appraisals or valuations, fairness opinions
o Actuarial services
o Internal audit outsourcing services
o Management functions or human resources
o Broker, dealer, investment adviser or investment banking services
o Legal services
o Anything else the Board determines to be impermissible

Front 80

What is auditors Cooling Off Period?

Back 80

o Former employees of auditing firm – can’t perform audit of a company if the registrant’s CEO, CFO, Controller, or chief accounting officer was employed by the subject auditor during the 1-yr period prior to the initiation of the audit and participated in any capacity in an audit of an issuer

Front 81

Analyst Conflicts of Interest

Back 81

o Requires SEC, NYSE and NASD to adopt rules reasonably designed to address:
 Conflicts of interest between research analysts, investment banking divisions and issuers
 Disclosures made to analysts

Front 82

How to separate Investment Banking from Research Analyst?

Back 82

o Build “Chinese Wall”
o Research reports may not be reviewed by investment bankers prior to public

Front 83

Quiet Periods during Public Offerings or "Booster Shots" Prohibitions

Back 83

Due to prospectus delivery requirements in The Securities Act of 1933, investment banks that manage an initial public offering (IPO) cannot issue opinions on the firms during the first few weeks of the IPO aftermarket. (1) Analysts unaffiliated with the managing underwriters are not bound by this regulation, but they rarely initiate coverage before the underwriters.

The goal of the "quiet period" is to delay potentially highly volatile events, such as analyst recommendations, and allow the market to establish the intrinsic value of newly public firms based on information contained in the prospectus.

Front 84

Regulation AC - Disclosure by Analysts

Back 84

Requires disclosure of certain conflicts of interest such as:

o Ownership of investments in issuer
o Broker-dealer compensation received from issuer
o Issuer a client of firm and service provided
o Compensation based on overall investment banking revenues
o Must certify truthfulness of views expressed in research reports and public appearances.

Front 85

Research Report

Back 85

o Written or electronic communication that includes an analysis of equity securities of individual companies or industries which provides information reasonably sufficient on which to base an investment decision.

Front 86

General Rule for Issuer Disclosure Obligations

Back 86

No affirmative disclosure for an issuer to disclose material non-public information

Front 87

Issuer Affirmative Disclosure Requirements

Back 87

o When SEC rules and regulations require disclosure of specified info
o When mandatory disclosure of forward-looking information is called for by Item 303 or Regulation S-K which pertains to MD&A
o When selective dissemination of material information has been inadvertently made to investors or analysts, disclosure to the investing public must promptly be made
o When the issuer is purchasing or selling securities in the markets;
o When the information revealed by the issuer contains a material disclosure deficiency at the time that the statement is made
o When the issuer previously has made a public statement that although accurate when made, continues to be alive, in the marketplace and has become material false or misleading as a result of subsequent events
o When material nonpublic information has been leaked by, or rumors in the marketplace are attributable to the issuer

Front 88

Chiarella v. United States

Back 88

The ct held that absent a duty to disclose, silence by a party will not incur Section 10(b) liability
o The 1st circuit opined – although in the context of a public offering there is a strong affirmative duty of disclosure it is clear that an issuer of securities owes no absolute duty to disclose all material information
o Chiarella was a printer that printed prospectus and registration statements. He figured out which companies were thinking about merging and bought stock in the company and made money on it. He didn’t work for either company. U.S. brought suit against him.
o Supreme Ct. says that what he did may have been shady, but there is no law against what he did. Dissent said that if you knew info that was material you had a duty to disclose.

Front 89

REPO

Back 89

Situation where you have a borrow who has an asset and they borrow from the bank on the basis of that asset and then they have to pay back with interest. Short term borrowing, very liquid

Front 90

Test for Determining when Disclosure is Required

Back 90

 Is the known trend, demand, commitment, event or uncertainty likely to come to fruition? If management determines that it is not reasonably likely to occur, no disclosure is required.
 If management cannot make that determination, it must evaluate objectively the consequences of the known trend, demand, commitment, event, or uncertainty, on the assumption that it will come to fruition. Disclosure is then required unless management determines that a material effect on the registrant’s financial condition or results of operations is not reasonably likely to occur.

Front 91

Contents of MD&A (See Reg. S-K)

Back 91

• Most important information should be the most prominent
• Avoid unnecessary duplication
• Executive-level overview that provides context for the rest of the discussion
• Focus on material information
• Key performance indicators
• Known trends, events, demands, and uncertainties that are likely to have a material effect on financial condition or operating performance
o Analysis
 Should explain management’s view of the implications and significance of the information
o New Information
 What must be disclosed
 In doing analysis –avoid immaterial information
o Liquidity and Capital Resources
 Should and should nots – what can you keep secret patents that are going to be issue, new products
 Debt Instruments, Guarantees and Related Covenants
 Cash Management
o Critical Accounting Estimates
 Is the nature of the estimates for assumption material due to the levels of subjectivity and judgment necessary to account for highly uncertain matters or the susceptibility of such matters to change
 Is the impact of the estimates and assumptions on financial condition or operating performance material
 How do your prophesize what is going to happen next year – data you can’t always be sure of

Front 92

Companies Obligations on Rumors and Third Party Statements

Back 92

o A company has no duty to correct or verify unless rumors can be attributed to the company.
 However, if the company adopts or becomes entangled with rumors or 3rd party statements (such as analyst forecasts) so as to render such statements attributable to the company, Section 10(b) liability.

Front 93

Does Company Have to Disclose Mergers and Acquistions?

Back 93

Basic, Inc. v. Levinson- Governs Disclosure of merger negotiations. There the issuer on 3 separate occasions falsely denied that it was engaged in merger negotiations. The materiality of the merger negotiations depends at any given time upon a balancing of both the indicated probability that the event will occur and the anticipated magnitude of the event in light of the totality of the company activity. Didn’t involve timing of disclosure nor obligation to speak. Absent the existence of some triggering events like presence of a competing tender offer, present law may not require the issuer affirmatively to disclose the existence of such negotiations even if they are material.

Front 94

Bespeaks Caution Doctrine

Back 94

o Where an offering statement, or other disclosure documents of future forecast, projections and expectations are not actionable as securities fraud if there is cautionary warnings, qualifications, and disclaimers in regard to projections and other forward looking info

In re Donald Trump Casinos Securities Litigation - The 3rd Cir. Held that the prospectus including “warnings, and cautionary language tailored to the specific future projections, estimates or opinions in the prospectus and that these disclosures defeated the materiality of the forward-looking statements.

A blanket warning that the investment is risky is likely to be insufficient

Front 95

What forward looking statements does the Private Securities Litigation Reform Act not protect?

Back 95

 Included in financial statements prepared in accordance with GAAP
 Contained in an initial public offering registration statement
 Made in connection with a tender offer
 Made in connection with a partnership, llc or direct participation program offering
 Made in beneficial ownership disclosure statements filed with SEC under 13(d)

Front 96

When is there a duty to update?

Back 96

o A duty to update may be present when the issuer previously has made a statement that, although accurate when made, continues to be alive in the marketplace and has become materially false or misleading as a result of subsequent events
o SEC 14e-2 calls for the subject company to disclose in a tender offer to its security holders of any material change relating to the position previously taken.

Front 97

What is Regulation FD?

Back 97

The regulations basic premise provides that when an issuer or person acting on its behalf discloses material nonpublic information to selective persons it must make public disclosures of that information. The timing of when the issuer must make such a public disclosure depends on whether the selective disclosure was intentional or non-intentional.

Applies to an an issuer of a company that has a class of securities registered under Section 12 or is required to file reports under Section 15.

Front 98

What is the purpose of Regulation FD?

Back 98

To put the investing public on equal playing field with market insiders; Prevent “tipping’ of inside info; Preserve integrity of the securities market threatened by issuers selectively disclosing info as a means to secure favorable reviews by analysts

Front 99

When does Regulation FD apply?

Back 99

When material non-public information is disclosed to:
 A broker or dealer, or a person associated with a broker or dealer
 An investment advisor, and institutional manager or a person associated with either
 An investment company or affiliated person thereof
 A holder of the issuer’s securities, where it is reasonably foreseeable that the holder will purchase or sell the issuer’s securities based on the info.

Front 100

What is considered material information?

Back 100

Info is material if there is a substantial likelihood that a reaosnable shareholder would consider it important in making an investment decision and that would have been viewed by the reasonable investor as having significantly altered the total mix of info made available.

Front 101

What are examples of material information?

Back 101

Earnings information; mergers, acquisitions, tender offers, joint ventures or changes in assets; New Products or discoveries or developments regarding customers or suppliers; changes in control in management; change in auditors; events regarding issuer’s securities; and bankruptcies or receiverships.

Front 102

What is Regulation FD?

Back 102

The regulations basic premise provides that when an issuer or person acting on its behalf discloses material nonpublic information to selective persons it must make public disclosures of that information. The timing of when the issuer must make such a public disclosure depends on whether the selective disclosure was intentional or non-intentional.

Applies to an an issuer of a company that has a class of securities registered under Section 12 or is required to file reports under Section 15. There is no private remedy for FD violation.

Front 103

What is the purpose of Regulation FD?

Back 103

To put the investing public on equal playing field with market insiders; Prevent “tipping’ of inside info; Preserve integrity of the securities market threatened by issuers selectively disclosing info as a means to secure favorable reviews by analysts

Front 104

When does Regulation FD apply?

Back 104

When material non-public information is disclosed to:
 A broker or dealer, or a person associated with a broker or dealer
 An investment advisor, and institutional manager or a person associated with either
 An investment company or affiliated person thereof
 A holder of the issuer’s securities, where it is reasonably foreseeable that the holder will purchase or sell the issuer’s securities based on the info.

Front 105

What is considered material information?

Back 105

Info is material if there is a substantial likelihood that a reaosnable shareholder would consider it important in making an investment decision and that would have been viewed by the reasonable investor as having significantly altered the total mix of info made available.

Front 106

What are examples of material information?

Back 106

Earnings information; mergers, acquisitions, tender offers, joint ventures or changes in assets; New Products or discoveries or developments regarding customers or suppliers; changes in control in management; change in auditors; events regarding issuer’s securities; and bankruptcies or receiverships.

Front 107

Timing of when issuer must make public disclosure of material information.

Back 107

o If the issuer intentionally and selectively discloses material nonpublic info, then it must disclose the same info simultaneously to the public, but if the selective disclosure is non-intentional the issuer must disclose the info promptly or as soon as is reasonably practical.

Can make by filing a form 8-K or with press releases or press conferences.

Front 108

Responding to Auditors Requests

Back 108

A customary practice of auditors is to transmit audit inquiry letters to client corporations, which thereupon forward such requests to their counsel for assessment and response. The info provided is employed by the auditor in opining on the corporation’s annual financial reports.

 Lawyer can furnish information concerning the following matters:
 Overly threatened or pending litigation, whether or not specified by the client
 A contractually assumed obligation which the client has specifically identified and upon which the client has specifically requested, in the inquiry letter for comment to auditor
 An unasserted possible claim or assessment which the client has specifically identified and upon which the client has specifically requested in the inquiry letter for comment to the auditor

Front 109

Section 4(1) of 1933 Act

Back 109

 Generally permits individual investors to resell their securities without registration, provided such resales are viewed as transactions. Can't be an issuer, underwriter or dealer.

 B/C §4(3) and 4(4) exempt most transactions by broker-dealers, the problems that arise under §4(1) generally involve underwriters.

Front 110

Is State Regulation Preempted by 4(1) and 4(3)?

Back 110

Yes, if the issuer is a 1934 reporting company, if not state laws may still apply.

Front 111

Section 2(a)(11) - What is the definition of an underwriter

Back 111

Any person who purchases a security from an issuer with a view to, or offers or sells for an issuer, in connection with the distribution of any security or has a direct or indirect participation in any such undertaking.

Front 112

What is a distribution?

Back 112

Is the entire process by which in the course of a public offering the block of securities ultimately comes to rest in the hands of the investing public.
 Rules 141 and 142 exemptions.

Front 113

In what ways can a person become an underwriter?

Back 113

 By purchasing from an issuer with a view to distribution
 By offering or selling for an issuer in connection with a distribution.
 By participating, directly or indirectly, in the distribution or underwriting effort.
 By selling securities of the issuer on behalf of a control person in connection with the distribution of any security.
 By purchasing securities of the issuer from a control person with a view to distribution

Front 114

What is a Control Person?

Back 114

Someone who has the possession (direct or indirect of the power to direct or cause the direction of the management and policies of a person whether by ownership of voting or otherwise. Issuer is defined to include the person who controls the issuer.

Front 115

What is the presumptive underwriter doctrine?

Back 115

One who purchases more than 10% of an offering, may be deemed to be an underwriter unless such person establishes sufficient investment intent. (Abandoned by the SEC)

Front 116

Contractural Agreements to Sell

Back 116

o Because of the ambiguities associated with the concept of control, a person who may be viewed as an affiliate may contract with the issuer when he/she acquires stock for the right of demand registration thereby granting the control person the contractual right to demand that the issuer filed a 1933 Act registration statement when the person wishes to dispose of his/her stock
o Such control person should insist that the issuer covenant to provide Rule 15c2-11 information. If the control person induces the issuer to disseminate this info, the current info requirement of Rule 144, which provides safe harbor in the resale context will be satisfied.

Front 117

What are PIPES?

Back 117

Private investment in Public Equity – involve the purchase of securities in an issuer private placement, the issuer’s subsequent registration of the restricted stock with the SEC, and, upon effectiveness of the registration statement, the ability of the PIPE investors to resell immediately their stock into the public markets.

Front 118

What persons risk becoming an underwriter?

Back 118

 Person who has acquired “restricted securities” from an issuer, relying on the 4(2) exemption or Reg. D
 An affiliate of the issuer selling either restricted or unrestricted securities of the issuer.

Front 119

What is a Holding Period?

Back 119

In determining whether a person has purchased from the issuer with a view to distribution, the amount of time that the person held the security prior to resale is deemed a relevant factor.
 A rule of thumb for ascertaining investment intent under Section 4(1) exemption provides that the SEC normally should not initiate an enforcement action against a party who is not a control person and who held the securities for at least 2 years prior to resale.

Front 120

What are Restrictive Legends?

Back 120

 Normally are placed on securities acquired in an unregistered offering of restricted securities, subject parties may claim this establishes their investment intent at the time of purchase
 Rejected by most courts holding that the purchase of stock from an issuer under an investment restriction is by no means a conclusive defense to underwriter status.

Front 121

What is the Change in Circumstances Doctrine?

Back 121

May serve as a valid defense to underwriter status. Hard to establish. The subject party asserts that it bought the stock with investment intent but that subsequent unforeseen changes compelled the earlier than planned sale of stock – SEC says this no longer applies

Front 122

How can sales by pledgees become underwriters?

Back 122

Arises in connection with sales by pledgees (banks) of securities pleged by control persons or non-affiliates

SEC v. Guild Films – the pledgor, a controlling shareholder, pledged as collateral for a bank loan a substantial block of securities which bore a restrictive legend on the face of the securities. After the shareholder defaulted on the loan, the bank, knowing of the restrictive legend, sold some of the securities w/o a registration statement being filed. The 2nd Circuit held that the bank was an underwriter.

May be mitigated by:
o A Covenant by the pledgor to effect registration of the securities in the event of the pledgor’s default
o The invocation of an exemption from registration, such as Section “4 ½” exemption
o A more circumspect approach to accepting pledgor securities as collateral.

Front 123

Rule 144 - Persons Deemed Not to be engaged in a Distribution and therefore not “Underwriters”

Back 123

The SEC adopted Rule 144 to establish specific criteria for determining whether a person is not engaged in a distribution. Rule 144 creates a safe harbor from the Section 2 (a)(11) definition of underwriter.
 A person satisfying the applicable conditions of the rule is deemed not to be an underwriter for 2(a)(11); therefore, is able to meet the Section 4(1) exemption from registration and the purchaser will receive nonrestricted securities

Front 124

Effect of Rule 144

Back 124

If a sale of securities complies with all of the applicable conditions of Rule 144:
 Any affiliate or other person who sells restricted securities will be deemed not to be engaged in a distribution and therefore not an underwriter for that transaction.
 Any person who sells restricted or other securities on behalf of an affiliate of the issuer will be deemed not to be engaged in a distribution and therefore not an underwriter for that transaction; and
 The purchaser in such transaction will receive securities that are not restricted securities.

Front 125

Affiliate

Back 125

A person that directly or indirectly through one or more inermediaries, controls, or is controlled by or is under common control with such an issuer.

Front 126

Restricted Security

Back 126

Securities as those securities that are acquired directly or indirectly from the issuer, or from an affiliate of the issuer, in a transaction or chain of transaction not involving any public offering, or securities acquired from the issuer that are subject to resale limitations of Regulation D under the Act, or securities that are subject to the resale limitations of Regulation D and are acquired in a transaction or chain of transactions not involving any public offering.

Front 127

Debt Securities

Back 127

Bonds, Notes, Debentures and other evidences of indebtedness in which investors furnish capital to a corporation in return from a promise by the corporation to repay the principal in full at a future specified date and to pay the investor affixed rate of interest thereon for the term of the loan.

Front 128

Non-Affiliates

Back 128

Person who have acquired securities from either the issuer or an affiliate of the issuer in a transaction not involving a public offering

Front 129

Affiliates Ability to Sell Unrestricted Shares – Five General Requirements to Utilize 144

Back 129

• There is specified information currently available to the public about the issuer
• The person seeking to sell the restricted securities must meet the holding period established by the rule. This holding period is 6 months for restricted securities reporting issuers and 1 yr for restricted securities of non-reporting issuers.
• The sale occurs subject to restrictions on volume
• The sale occurs subject on the manner of sale
• Appropriate notice of reliance on the rule is given

Front 130

Affiliates and Restricted Shares

Back 130

 Restricted shares held by an affiliate are subject to mandatory holding period the same as in the case of a non-affiliate.

Front 131

Private Resales of Control and restricted securities

Back 131

 Section 2(a)(11) - Is there a distribution involved; if not NO Underwriter
 Distribution is the same as a Public Offering

Front 132

Rule 144 Requirements

Back 132

 Current Public Information on Issuer must be available
 Holding Period for Restricted Securities [generally 1 year; none for nonaffiliates if such for 3 months and securities acquired from issuer 2 years ago.
 Promissory Notes, Other Obligations or Installment Contracts
 Limitation on Amount of Securities Sold, 500 shares or total price < $10,000.
 Manner of Sale must be made by Brokers’ transactions without solicitation
 Notice of Proposed Sale

Front 133

Ways to get around Resale prohibitions.

Back 133

o Covenant to register in event of default
o Exemption from registration
o Be careful in accepting securities as collateral
o Key issue, not the pledgee’s culpability : Should such sales be permitted where the effect is to place into the hands of uninformed investors securities which have never been part of a registered offering
o Can’t register because the issuer can only register the stock

Front 134

SEC v. Chinese Consolidated Benevolent Association

Back 134

o SEC trying to prevent the sale of Chinese Securities though the mails without registration
o Exemption in 4(1) does not protect those who are engaged in steps necessary to the distribution of security issues. The court concludes” The aim of the issuer is to promote the distribution of the securities and of the Securities Act is to protect the public by requiring that investors be furnished with adequate information; therefore “sell” for an issuer ought to be read as covering continuing solicitations.

Front 135

What are the Factors to Determine controlling person?

Back 135

 Ability to obtain Registration or direct management
Officer or Director
Relationships
Contractual relationship

Front 136

Typical problems with controlling persons.

Back 136

 Secondary distribution of stock by a controlling person through various underwriters—none of the transactions registered
 Shares did not come from issuing company
 Shares did come from controlling person
 Practical test for control-is the person able to require a registration
 Burden of Proof
o Secondary Offerings
 Only the issuer can register a secondary public offering
 Contractual rights
 Piggy Back registration
 Pitfalls: Disclosure; manipulative activity

Front 137

What Public Resales are available outside Rule 144?

Back 137

o No exemption available to underwriters in any circumstance.
o Exemptions for dealers 4(3)
o Exemption for brokers 4(4)
o Investor may be covered by 4(1) and dealer by 4(3) or 4(4)

Front 138

Broker Dealer Reasonable Inquiry Test

Back 138

o Rule 144-part test
 Broker must be carrying on only normal brokerage functions
 Broker must have no reason to believe that the controlling person’s total sales exceeded a specified amount [Note 2007 changes.]
o Broker cannot solicit a sale, it is acting as someone else’s agent
o Dealer can sell stock itself

Front 139

The Control Group Theory - Rule 405

Back 139

 Under the theory , a person is in control if he or she is a member of a group that controls.
 The theory applies to shareholders, families, and officers or directors who may be considered part of a control group.

Front 140

The 4(1 &1/2 )Exemption

Back 140

o Based on SEC No Action Letters; example Transaction #1 private sale under 4(2) : transaction #2 private sale
o Seeks to fill a gap in the statutory exemptive scheme
o Permits affiliates to make private sale of securities held by them so long as some of the established criteria for sale under 4(1) and 4(2) are satisfied
o Ackerberg v. Johnson; 892 F2d1328 ( 8th Cir, 1989): Sale by Chairman of the Board etc. of 16,500 shares for $10,000,000—no need for information provided by registration had access to information and was sophisticated

Front 141

4(1/2) Exemption Criteria

Back 141

 While source is 4(1) exemption the determination of standards to govern the exemption is primarily derived from Section 4(2) authority combined
 Advertising and general solicitation are not permitted
 Limited number of purchasers
 Holding period for certain length of time
 Access to registration type information

Front 142

144A

Back 142

o Safe Harbor for private re-sales of restricted securities to “qualified” institutional buyer (QIBs)
o Directed at providing resale markets in three different settings:
 Sale of debt securities from underwriters to (QIB’s)
 Re-sales of restricted securities originally sold pursuant to private or limited offerings, such as pursuant to Rule 505 or 506.
 Resales of securities of foreign enterprises offered outside of the US (Reg. S)

Front 143

Requirements for 144A

Back 143

 Restricted to QIBs - QIB’s must have eligible$100 million invested in securities (if a bank or S&L has net worth of $25million) Broker Dealer must have $10 million invested of securities of issuers that are not affiliated with such dealer.

 Qualifying the Prospective Purchaser – it is the sellers’ responsibility to qualify the prospective purchaser. In other words, the seller or its agent must reasonably believe that such purchaser is a QIB

 Exclusive of Fungible Securities - Does not apply if ‘fungible or of the same class) like as securities trading on a U.S. Exchange

 Provision of information on request - Upon request to the issuer, such issuer must provide to the holder and to the prospective purchaser certain basic information concerning the issuer’s business and financial statements

 Notice - Must notify QIB that seller is relying on Rule 144A as an exemption
o PORTAL is an electronic market on which pre-approved Investors may trade securities qualifying under 144A.

Front 144

What is the criticism of 144A?

Back 144

May adversely impact individual investors, may be invalid as exceeding scope of SEC’s authority in this area, possible development of two-tiered market system one for private and one for public and the diminished availability of many quality investments to smaller investors.

Front 145

Rule 145 - Corporate Reorganizations

Back 145

Makes clear that when plans of reorganization where an exchange of shares is going to occur or issuance of new stock are submitted to shareholders for approval, the corporation makes an offer to sell within the meaning of Section 2(a)(3) of the Act.

o Absent an exemption from registration, the sale of securities pursuant to Rule 145 triggers the registration requirements of Sec. 5 as well as the diligence obligations
o Rule 145 transactions may be registered pursuant to Form S-4
o 145(b) provides certain exceptions to authorize the corp. to communicate basic info including issuers name, brief description of the business of the parties and a brief description of the transaction.

Front 146

Persons who are affiliates of the acquired entity that receive securities in registered business combinations and who subsequently transfer such securities will not be deemed underwriters if:

Back 146

 The securities are sold in compliance with the provisions of paragraphs c, e, f, and g or Rule 144 and at least 90 days have elapsed since the time that such securities were acquired in connection with the transaction

 The person is a non-affiliate of the issuer, has been a non-affiliate of the issuer for at least 3 months, has held the securities for at least a 6 month period and the issuer has complied with the current public reporting requirements of Rule 144

 The party is a non-affiliate of the issuer, has been a non-affiliate of the issuer for at least 3 months, and has held the securities for at least 1 yr.

Front 147

Spin Off

Back 147

o Classic spin-off occurs when a parent corporation distributes shares of a privately held subsidiary as a stock dividend to its current shareholders.

You start with an old corp that splits in half.
Next, a new corporation is formed –
 Old Corp gets 100% shares of New Corp.
 Old Corp transfers assets of Business 1 to New Corp.
 Old Corp. gives shares of New Corp. to Old Corp. shareholders dividend.
 Shareholders now have 100% in old corp. and 100% shares in new corp.

Front 148

When do Spin Off's not require registration?

Back 148

• Shareholders of the parent corp. do not provide any consideration for the spun-off shares
• The shares spun-off are distributed pro rata to the parent corp’s shareholders
• Adequate info about the subsidiary and the spin-off must be provided by the parent corp. to both the stockholders and the securities trading markets
• The parent corp. has a valid business purpose justifying the spin-off, and
• If the parent corp. elects to spin-off restricted securities, it must have held such securities for a requisite period of time.

Front 149

Split off

Back 149

Split-offs are a type of reorganization where the stock of a subsidiary is offered in exchange for shares in the parent company. A split-off differs from a spinoff in that the shareholders in a split-off must exchange their shares of stock in the parent company in order to receive shares of the subsidiary, whereas the shareholders in a spin-off do not need to trade in their shares in order to receive shares in the subsidiary. The key difference here is that you have to take action to opt into a split-off and you have to give up your shares in the parent company to receive shares in the subsidiary.
 Old Corp. Forms New Corp.
 Old Corp. Gets all New Corp. shares
 Old Corp. redeems 50% of Old Corp. for New Corp.

Front 150

Split Up

Back 150

Start with old corp. that splits in half for business 1 and business 2
 Two new corporations are formed, New Corp. A and New Corp. B
 Transfer all assets of Business 1, which gives its shares to old corp.
 Transfer all shares to new corp. B
 End up with liquidation of old corp. and now shareholders owns shares in two new corporations.

Front 151

What does the 1933 Act Imposes Civil Liability for?

Back 151

 The offer or sale of a security in violation OF Section 5 of the Act
 Material omissions or false statements in the registration statement and
 Material misstatements or omissions in a prospectus or oral communications used to offer or sell a security

Section 11 and 12

Front 152

Section 11 of 1933 Act

Back 152

Imposes Liability if the Registration Statement, including the prospectus, is materially misleading (Due Diligence Defense)

Front 153

Who is Subject to § 11 Liability?

Back 153

o Signers of the registration statement: Issuer—strict liability (no due diligence defense); CEO-due diligence defense; CFO=due diligence defense; Chief Accounting officer-due diligence defense

Majority of Board of Directors-due diligence defense; Directors (whether or not signers)-due diligence defense

o Person’s named with his/her consent in the registration statement

o Experts- due diligence defense - Experts are only liable for expertise Sections which they prepared. To assert due diligence defense, experts must show that, after reasonable investigation, they had reasonable grounds to believe and did believe that the statements were true

o Non-experts - non-experts must show that, after reasonable investigation, they had reasonable grounds to believe and did believe that the statements were true.

Expert Sections-non-experts must show that they had no reason to believe and did not believe that the expertise sections were misleading.

o Underwriters of the offering-due diligence defense

o Control person under §15 of a party liable under §11

Front 154

In re Equity Funding Corp. of America Securities Litigation

Back 154

Under Section 11 Liability - Where the statute specifically limits those who may be held liable for the conduct described by the statute, the courts cannot extend liability, under a theory of aiding and abetting to those who do not fall within the categories of potential def’s in the statute.

Front 155

Registration Statement is Divided into two parts:

Back 155

o Registration statement is divided into two parts
 The part prepared by experts
 Everything else

Front 156

Escott v. BarChris

Back 156

Section 11 Bible

BarChris was engaged in construction of bowling alleys. Sold debentures to investors with material misstatements in registration statements. CEO, President, VP, Accountants, Directors were held liable for the misrepresentation.

Front 157

Who may bring an action under Section 11?

Back 157

o Must have purchased the security where a means or instrument of interstate commerce was used in connection with the offer or sale
o At the time of the purchase, must not have known of the misrepresentation or nondisclosures
o Must show that the misrepresentation or nondisclosure was material
o Available in initial offering
o Need not establish privity
o Can recover for aftermarket purchases but subject to the often difficult tracing requirement
 Must show they in fact purchased shares pursuant to initial public offering and registration statement
o Normally need not to show reliance upon the disclosure deficiency
 Where the plaintiff acquired securities more than 12 months after effective registration statement date and if issuer has made earnings available covering the 12-month period, plaintiff must show reliance on the misstatement or omission
o Need not prove that the misrepresentation or nondisclosure ‘caused’ the loss
o Must bring action within the time period set forth by the statute of limitations
 §13 provides that an action pursuant to §11 must be brought within 1 yr after the discovery should have been made by the exercise of reasonable diligence but in no event shall any such action be brought more than 3 yrs after the security was offered to the public.

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What are Section 11 Defenses available to the Issuer?

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Only defenses available to the issuer, who is strictly liable are the purchaser’s knowledge of the misstatement or omission, lack of materiality, lack of causation, equitable defenses or SOL.

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When can a non-issuer Defendant avoid liability under Sec. 11?

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 Before the effective date of registration he or she resigns from or ceases or refuses to act in his/her capacity ascribed to him or her in the registration statement
 Advises the SEC and the issuer in writing of the action taken and disavowing responsibility for such part of the registration statement
 After such part of registration statement has become effective (1) if he or she was unaware that it had become effective, and (2) upon becoming aware of such facts, acts forthwith, and (3) advises the SEC in writing as set forth above, and (4) gives reasonable public notice that such part of the registration statement had become effective w/o his or her knowledge.

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Due Diligence Test for Reasonable Investigation and Reasonable Belief

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The level of care that a prudent person would exercise if his or her own money were at stake.

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What factors are taken into account when determining whether or not the conduct of a person constitutes a reasonable investigation or a reasonable ground for belief of due diligence?

Back 161

o Type of issuer
o Type of Security
o Type of person
o Office held (if any) when the person is an officer
o Another relationship to issuer (if director)
o Reasonable reliance on officers, etc who’s duties should have given knowledge of particular facts
o When the person is an underwriter, the type of underwriting arrangement, role as an underwriter, and the availability of info with respect to the registrant
o Responsibility for integrated disclosure of fact or document at the time of filing from when it was incorporated.

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What liability are joint violaters subject to under sec. 11?

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Joint and several liability, accordingly a plaintiff is entitled to recover the entire judgment from any violater.

Two common techniques- contributory and indemnification

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Directors Due Diligence

Back 163

Indicates that while less may be required of certain outside directors in order to meet their due diligence obligations, reasonable investigation still requires some affirmative action and therefore outside directors must make some effort of independent verification of the info in the registration statement

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Attorney Due Diligence

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With respect to assuming “expert” status, it is clear that an attorney whose role is to render legal advice or assist in preparation of the registration statement does not thereby become an expert within the meaning of §11, however counsel who renders a formal legal opinion which is included in the registration statement with his/her consent is considered an expert within §11.
o Lawyers can be held liable as primary violators under 10(b) as sellers or under §12(b) as “control persons”

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Underwriters Due Diligence

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o Underwriters to a public offering are uniquely situated to verify the accuracy of the statement.
o Not expected to have intimate knowledge of corporate affairs

Problem is that the are usually not participants in the drafting of disclosures and registration statement

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Accountants Due Diligence

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o Usually has to do with failure to provide accurate certified financial statements as part of registration statement or audit procedures
o Written work program utilized for review conformed to GAAS (generally accepted auditing standards usually provide accountants with due diligence defense.

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What are Benefits of Shelf Registration?

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 Cost savings
 Flexibility (can time offering to advantageous market conditions
 Variations on terms of securities on short notice

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What are concerns of shelf registration?

Back 168

 Adequate disclosure – reduces the quality and timeliness of disclosure available
• Builds on existence of timely and accurate corporate disclosure
 Jeopardizes the liquidity and stability of our primary and secondary markets by encouraging less individual investor participation in capital markets
 Due Diligence-what if new underwriter
• Procedures have changed-opportunities for continuous due diligence
• Automatic shelf registration statements become effective immediately upon filing with the SEC

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What are damages for violations of Sec. 11?

Back 169

The difference between the original price of the security and its present price

Front 170

What does Incorporation by reference to periodic reports may make it more difficult to do?

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 Satisfy Section 11’s “due diligence” obligation
 Satisfy Section 12’s “reasonable care” standard
 Make sure that what is being referenced is actually incorporated in the statements

Front 171

Gustafson v. Alloyd Co. Inc.

Back 171

Ct stated that Section 12(a)(2) remedy is limited to purchasers of securities in a public offering by an issuer or its controlling shareholders. Suggests that Section 12(a)(2) may apply in offerings that take on a public nature but are exempt from Securities Act registration pursuant to Section 3 of the Act.

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Difference between Sections 11 and 12

Back 172

 Section 11 provides a civil antifraud provision for misstatements in the Registration Statement.

 Section 12 imposes civil liability on sellers of securities when:
• Where a security is sold in violation of Section 5, and
• Where a security is sold by means of a prospectus or oral communication which contains a material misstatement or omission

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Section 12(a)(1)

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o Provides that anyone who offers or sells a security in violation of Section 5’s registration and prospectus requirements is liable to the purchaser. (private right of action)
o Privity is required, must have relationship - Defendant must have a direct relationship with the plaintiff and have been directly involved in the sale.
o Statute of limitations is 1 yr
o Damages are limited to the return of the purchase price of the security with interest. If securities are no longer owned by the purchaser, the defendant is liable for damages
o No casual connection is required. Change in circumstances or market factors not a defense.

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Section 12(a)(2)

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o Provides an express private remedy for material misstatements or omissions by Sellers of Securities in connection with the sale or offer for sale of a security by means of a prospectus or oral communication
o Limited to purchasers of securities in a public offering by an issuer or controlling shareholder
o Privity requirement – relationship
o Subjects only “sellers” to potential liability
o Broker is seller if deals directly with the plaintiff.

No aiding and abetting under Sec. 12

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Defense to Section 12(a)(2) violation

Back 175

Defendant did not know and in the exercise of reasonable care could not have known of the untruth or omission. (§11 Defense requires reasonable investigation- more diligent)

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Who is a seller?

Back 176

• One who owned the security sold to the purchaser
• An agent for a vendor who successfully solicited the purchase
• One who solicited the purchase with the intent to personally benefit thereby, and
• One who, w/o financial benefit to oneself, solicited the purchase with the motivation to serve the owner’s financial interests

Front 177

Pinter v. Dahl

Back 177

The Supreme Court construed the term “sell” to encompass those persons who engage in “solicitation” of the buyer. Upon examining the language and purpose of Section 12(a)(1), the Court thereupon defined “seller” under that provision as extending to one “who successfully solicits the purchase, motivated at least in part by a desire to serve his own financial interests or those of the securities owner.

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Section 15

Back 178

o Anyone who controls a person liable under section 11 or 12 may be jointly and severally liable to the same extent as the controlled person.
o Exception to the Rule is if the controlling person had no knowledge of or reasonable grounds to believe in the existence of the facts by reason of which the liability of with the liability of the controlled person is alleged to exist.

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Cort v. Ash – Implied Rights of Action Factors for 1934 violations

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 Is the plaintiff one of the class for who especial benefit the statute was enacted
 Is there any indication of legislative intent, explicit, or implicit, either to create such a remedy or to deny one
 Is it consistent with the underlying purpose of the legislative scheme to imply such a remedy for the plaintiff
 Is the cause of action on traditionally relegated to state law, in an area basically the concern of States, so that it would be inappropriate to infer a cause of action based solely on federal law.

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Post Court - Standards for Implied rights of action

Back 180

o Does statute create a federal right in favor of plaintiff?
o Invention of Legislature: intent to create a remedy or to deny one
o Is it consistent with the legislative scheme to imply a remedy for plaintiff?
o Is the cause of action one traditionally relegated to state law:
 Inappropriate to imply a federal cause of action not specifically authorized by congress.

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Which sections have federal courts declined to find an implied right of action?

Back 181

 Section 6
• Against a national securities exchange based on the exchange’s failure to enforce its own rules
• Against a broker-dealer, listed corp., or other subject party based on a violation of the exchange rules
 Section 7
• No private damages action on behalf of investors against financial institutions and brokers for violations of the margin requirements.
• No congressional intent

o Tender Offers – implied private right of action for damages under §14(c) on behalf of target corporation but not a damages remedy on behalf of the offeror.

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Section 17 of the 1933 Act

Back 182

o It shall be unlawful for any person in the offer or sale of any securities by the use of any means or instruments of transportation or communication in interstate commerce or by the use of the mails directly or indirectly -
 Unlawful to employ any device scheme or artifice to defraud.
 Unlawful to obtain money or property by means of
• False or misleading statement of material fact
• Omissions of material fact necessary to make statement untrue in light of circumstance
 Unlawful to Engage in manipulative activity

Front 183

Principals re: Section 17(a)

Back 183

o Protection afforded by 17(a)(1) goes beyond investors to encompass financial intermediaries such as broker-dealers
o Fraud “In” offer or sale of securities as contrasted with “in connection”
o 17(a) extends to secondary trading market – have to prove who you brought it from and who they brought it from
o 17(a)(1) requirement of Scienter – Needed in many cases where availability of injunctions (mostly brought by the SEC)
o 17(a)(2) and (3) need to show any negligence

Front 184

What are some obstacles to viiolaitons of State Court regulations claims?

Back 184

• Cause of Action – some don’t recognize private right of action
• Plaintiffs - sometimes purchasers only
• Shorter Statute of Limitations
• Limit on secondary market frauds
• Limit on class action litigation
o Unlike federal law which recognizes the fraud on the market theory to create a presumption of reliance, thereby facilitating use of the class action mechanism, a number of state courts have declined to adopt and individualized proof of reliance impedes class certification

Front 185

What are some advantages to violations of State Court regulation claims?

Back 185

 Many state securities acts provide successful plaintiffs may recover reasonable attorneys fees and punitive damages
 Statute of limitations – longer statute of limitations like §12(a)(2)
 Monetary damages based on negligent material misrepresentations or omissions made in the initial offering context as well as in the secondary trading markets
 Extends liability exposure to those who materially aid in consummating transaction

Front 186

SLUSA - Securities Litigation Uniform Standards Act of 1998

Back 186

o With certain exceptions preempts state law with respect to securities class actions involving nationally traded securities (Securities claims about nationally traded securities)
o The authority of state securities commissioners preserved.
o State actions also may be brought in individual actions, derivative suits and in going private action, tender offers, and mergers.

Front 187

Definition of Willful

Back 187

“It is well settled” that a finding of willfulness does not require a finding of intention to violate the law . It is sufficient that registrants be shown to have known what they were doing.

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SEC enforcement mechanisms

Back 188

Investigations - formal and informal
Injunctions
Reports of Investigations
Refusals and Stop Orders
Suspension Proceedings
Broker-Dealer disciplinary sanctions
Displinary proceeding
Suspended trading
Revoking or suspending registration in a security
Review of SRO sanctions
Disciplinary actions agianst investment advisors and investment companies
Officer and director bar
Financial penalties

Front 189

SEC investigations may be triggered by:

Back 189

 Members of the public
 Communications from other state and federal agencies
 Examination of filings with the Commission
 Inspections conducted by SEC, staff of self regulatory organizations
 Congressional inquiries
 Other parties being investigated
 Newspapers, competitors, shareholders, directors of a company
 Former employees
 Friends
 Due Process does not apply to a preliminary investigation

Front 190

What are SEC preliminary inquiries?

Back 190

 When the SEC learns of possible violations of the federal securities law, it generally conducts a preliminary investigation—facts, documents, etc.
 No process is issued or testimony compelled—may be simply a telephone conversation between staff and subject party’s counsel.
 Staff may make informal requests for documents, testimony and communications

Front 191

What should counsel do when there are examinations of witnesses during preliminary investigations?

Back 191

 Request no court reporter
 Warn the witness that (although voluntary) false testimony may be subject of punishment under federal and state perjury laws.

Front 192

What are early issues in preliminary investigations by the SEC?

Back 192

 Will a formal investigation result from the informal inquiry
 Are there alternatives
 Should counsel assert all applicable privileges
 Is there a treat of a criminal referral
 Will other government agencies become involved
 What documents should be produced
 Disclosure problems
 Is a quick settlement possible

Front 193

Formal Investigations by SEC

Back 193

o SEC may initiate a formal investigation if it appears that the Act has been or is about to be violated.
o Usually may not be initiated until after the completion of a preliminary investigation.
o SEC may also investigate “facts, conditions, practices or matters” which may be “necessary or proper for the purposes of prescribing rules and regulation or for recommending legislation”

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What is a formal order of investigation by SEC?

Back 194

o A formal investigation is a fact finding (not adjudicative proceeding; it is initiated by the entry of an order outlining:
o Scope of investigation authorized by the Commissions
o Appointing members of the staff with the power to issue supoenae ad testificandum and duces tecum and to administer oaths.
o Specific language dealing with the suspicions that prompted the inquiry;
o No notice to the investigates and no opportunity to be heard.

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Grounds for Defense against enforcement of SEC subpoena

Back 195

 Inquiry too indefinite
 Inquiry is not reasonably related to an investigation which the SEC has authority to conduct
 The information is already in the agency’s possession
 Bad Faith or abusing process

Front 196

What are counsel's limitations during witness examinations of SEC investigation?

Back 196

 Advise the witness before, during and after the conclusions of the examination
 Briefly question witness at the conclusion of the examination to clarify answers
 Make summary notes
 May make relevancy objections relating to the scope of the examination of demand for documents

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Privileges and SEC investigation issues

Back 197

o Counsel is responsible to insure that the witness is aware of and exercises constitutional and legal rights not to give protected testimony
o Timely objection is necessary
o Fifth Amendment
 May be invoked as a response to specific questions, not as an excuse for non-appearance
 May not be asserted by a Corporation
 Adverse inference in subsequent proceeding

Front 198

Settlement of SEC Investigations

Back 198

o Enforcement actions may be settled with the respondent neither admitting nor denying the allegations contained in the SEC’s Complaint

Front 199

What are the benefits of settling a SEC investigation?

Back 199

 Less costly than trial to conclusion
 Adverse publicity
 Avoid adverse findings of fact that may be used offensively against the client in another action
 May affect pending or potential business transactions

Front 200

What are the Supreme Court's Standards for enforcing Subpoena requests by the SEC?

Back 200

Agency must show:
• That the investigation will be conducted pursuant to a legitimate purpose
• That the inquiry may be relevant to the purpose
• That the information is not already with the agency’s possession, and
• That the administrative agency steps required by the federal statutes have been followed
 If the stated elements are established, the burden shifts to the opposing part to challenge the issuance of the subpoena

Front 201

Parallel Proceedings

Back 201

o Concurrent or successive civil proceedings by the SEC and criminal investigation by U.S. Attorney
o Have been held to be constitutional, only restricted in limited circumstances
o Adverse consequences that may flow from providing information to SEC can be massive – may undermine party’s 5th amendment privilege against self-incrimination

Front 202

What is the standard for imposing an injunction in an SEC action?

Back 202

Is there a reasonable likelihood that the defendant, if not enjoined, will again engage in the volatile conduct

Front 203

What factors are relevant to demonstrate likelihood of repetition of future violations?

Back 203

Scienter
 reliance on advice of counsel
 gravity of offence
 sincerity of assurance against future violations
 past violations.

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Section 21(a) (1934 Act) Reports of Investigation

Back 204

o Allows the Commission to make such investigations as it deems necessary to determine whether any person has violated or is violating or is about the violate the Exchange Act.
o Can avoid the usual requirement of having to find an actual violation while persuading parties to modify conduct or take corrective steps
o Because of these allowances, SEC may report all information concerning a violation

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What are some collateral consequence of SEC actions?

Back 205

o Primary purpose of injunctive relief under Federal Securities Laws: To deter future volatile conduct not to punish the violator
o Injunction disqualifies party from serving as a director, officer or employee of a company.
o Injunction may be basis for barring an attorney, accountant or other professional from practicing before the SEC
o Other equitable relief

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What are categories of SEC adjudicatory functions?

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 Licensing functions
 Declaration of status orders-granting or deny of exceptive orders
 Disciplinary enforcement function–stop orders and cease and desist orders.

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What is a cease and desist order?

Back 207

 Imposed against any person who is deemed to have a cause of the subject violation
 May require not only that the party cease and desist from the proscribed acts but that he/she effect compliance within prescribed time periods and pursuant to specified conditions.
 SEC must prove a violation of securities laws and provide a justifiable explanation why such sanction is appropriate.

Front 208

What is a refusal and stop order?

Back 208

Authorize the SEC to issue refusal orders and stop orders in connection with materially incomplete, inaccurate, or false and misleading registration statements.

Front 209

What are Broker-Dealer disciplinary Sanctions imposed by SEC?

Back 209

 Outright revocation of registration
 Suspension of registration
 Censure, or barring an associated person from associating with a broker-dealer
 Can be barred from becoming a member of a registered securities association

Front 210

What is suspended trading by the SEC?

Back 210

Suspends over the counter or exchange trading of a security, not to exceed 10 days, unless based on new circumstances

Front 211

What can the SEC bar the officer and director from if a violation is found?

Back 211

Prohibits a person from serving as either of a publicly-held enterprise if a violation is found

Front 212

What are some financial penalties for SEC violations?

Back 212

May levy money penalties against “regulated” persons, provided that the Commission concludes that the penalty imposed is the “public interest” and that def engaged in prohibited conduct.

5 yr SOL

Front 213

What is other Ancillary or Other Equitable Relief for SEC violations?

Back 213

o Disgorgement, appointment of receiver, appointment of independent members to the board of directors, and appointment of special counsel.

Front 214

What considerations are looked at to acess money penalties?

Back 214

 The presence or absence of a direct benefit to the corporation as a result of the violation. [unjust enrichment]
 The degree to which the penalty will recompense or further harm the injure shareholders.
 The need to deter the particular type of offense.
 The extent of the injury to innocent parties
 Whether complicity in the violation is widespread throughout the corporation
 The level of intent on the part of the perpetrators
 The degree of difficulty in detecting the particular type of offense
 Presence of lack of remedial steps by the corporation
 Extent of cooperation with Commission and other law enforcement efforts

Front 215

What factors does SEC look at to modify or dissolve injunctions?

Back 215

o Subsequent change of factor or law
o The extent of adverse, unforeseen collateral consequences
o Whether the injunction has fulfilled its objectives
o Whether the individual deterrent effect of the injunction has ceased
o The decree’s effect on societal deterrence
o Whether a govt. entity is a party to a litigation and the adverse effect that granting motion would have on entity’s resources
o The extent and nature of the public or other countervailing interest involved

Front 216

Can you have criminal prosecutions for SEC violations?

Back 216

o Willful violations of the Securities Laws Rules and Regulations are punishable by fine or imprisonment. [1933 Act Section 24 and 1934 Act Section 32]
o The SEC transmits the evidence to the Department of Justice which decides whether or not to prosecute and handles the prosecution.