Securities Regulation

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Securities and Exchange Commission v. Edwards

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Facts of the Case: 
Charles Edwards founded a company that sold pay telephones and then leased them back from the purchasers for a fixed monthly fee. After Edwards filed for bankruptcy, the Securities and Exchange Commission (SEC) sued him for selling securities (considering the telephones to be investments on the part of the purchasers and therefore securities) in violation of the registration and anti-fraud provisions of the federal securities laws.

A federal district court froze Edwards' assets in a preliminary injunction. The 11th Circuit Court of Appeals overruled the district court's injunction for lack of jurisdiction. The SEC, the court reasoned, failed to show that Edwards' selling pay telephones was an "investment contract" under federal securities laws. In defining "investment contract," the court used the Supreme Court's ruling in SEC v. W.J. Howey Co. (1946), that a financial interest is an "investment contract" if it involves (1) an investment of money, (2) in a common enterprise, (3) with the expectation of profits to be derived solely from the efforts of others. The 11th Circuit ruled that the SEC could not meet the test's third part because the purchasers received a fixed fee that was guaranteed by contract and therefore not dependant on Edwards' success.

Question: 
Does the Securities Exchange Act's (1934) term "investment contract" include an investment scheme in which the promoter promises a fixed return or the investor is entitled to a particular rate of return?

Conclusion: 
Yes. In a unanimous opinion delivered by Justice Sandra Day O'Connor, the Court held that an investment scheme promising a fixed rate of return can be an "investment contract" and thus a "security" subject to federal securities laws. The test the Court uses for determining whether a scheme is an "investment contract" is "whether the scheme involves an investment of money in a common enterprise with profits to come solely from the efforts of others." Because the test does not distinguish between promises of fixed returns and promises of variable returns, the scheme at issue here can be defined as an "investment contract."

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Landreth Timber Co. v. Landreth

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§ In Landreth, purchaser was buying all the stock in lumber
□ Court said that even though buyer was buying entire business(business of security doctrine), it still has all characteristics of a security.
□ If it has characteristics of a security, court is not going to look at anything else(Howey Test). Everyone should be protected despite their level of knowledge.
□ If it doesn't look like a stock, then we'll look at the Howey Test(Investment Analysis)
□ Associational Formalities - when you structure it as stock, it will be treated as stock.
□ If it’s a sale of stock between 1 - 100%, then it will be governed by securities regulation.
□ If it's a sale of assets, it won't be treated as securities but consumption.

- sale-of-business doctrine was inapplicable.

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United States v. Leonard

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Partnership and Limited Liability Company Interests. An interest in a limited liability company (LLC) is a security where, notwithstanding that the LLC's governing documents indicate active member participation, member-investors, in reality are limited to having an extremely passive role in the management and operation of the LLC.

○ Here investments were set up as LLC's.
○ The court said these were investment K's b/c
§ Investors had for profit, common enterprise, efforts of others(passive investors).
§ To determine effort of others, court looks at:
□ degree of sophistication, experience, reliance, and level of power(Williamson v. Tucker test)

○ Court here looks back on post-investment analysis

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Hocking v. Dubois

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Real Estate. A real estate purchase constitutes purchase of a security for purposes of antifraud provisions where the investor has no power of control over the management of a common enterprise.

○ The offering of condo units in conjunction with any of the following will cause the offering to be viewed as an offering of securities in the form of investment K's:
1) The condos, with any rental arrangement or other similar service, are offered and sold with emphasis on the economic benefits to the purchaser to be derived from the managerial efforts of the promoter, or a third party designated or arranged for by the promoter, from rental of the units;
2) The offering of participation in a rental pool arrangement; and
3) The offering of a rental or similar arrangement whereby the purchaser must hold his unit available for rental for any part of the year, must use an exclusive rental agent or is otherwise materially restricted in his occupancy or rental of his unit.

○ This fits under the Howey test even though this is a secondary purchaser.

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Reves v. Ernst & Young

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Promissory Notes. Promissory notes with immediate maturity qualify as securities when they are offered and sold to members of the public who seek to invest for profit.

HOLDING AND DECISION: (Marshall, J.) Yes. Promissory notes with immediate maturity qualify as securities when they are offered and sold to the members of the public who seek to invest for profit. The Securities Exchange Act of 1934 sought to broadly define securities to encompass virtually any instrument that is sold as an investment. The intent of Congress was to regulate security investment regardless of its form. The family resemblance test provides the best framework for determining whether an instrument is a security investment. Under the family resemblance test (a note with a term of more than 9 months is a security except if the note in question bears a strong family resemblance to an item on the judicially crafted list of exceptions … or convinces the court to add a new instrument to the list), every note is initially presumed to be a security. However, this presumption may be rebutted by showing four factors. a) Assess the motivations. If the seller's purpose is to raise money for the general use of a business enterprise or to finance substantial investments and the buyer is interested primarily in the profit the note is expected to generate, the instrument is likely to be a 'security.' If the note is exchanged to facilitate the purchase and sale of a minor asset or consumer good, to correct for the seller's cash-flow difficulties, or to advance some other commercial or consumer purpose, then the note is not a security.
b) "Plan of Distribution" of the instrument. Whether it is an instrument in which there is a common trading for speculation or investment. Marketed broadly to the market(i.e. 1600 people) or limited(3 people)?
c) Examine the reasonable expectations of the investing public.
d) Whether some factor such as another regulatory scheme significantly reduces the risk of the instrument: sophistication, collateralization, insured.
Here, the Cooperative sold the demand notes to raise money for its business, and the purchasers expected to earn a profit in the form of interest. The demand notes were advertised publicly and were characterized as investments. Therefore, the public could reasonably expect them to be treated as securities. Finally, the demand notes offered by the Cooperative were uninsured and not covered by any other regulatory scheme. Thus, applying the family resemblance test, the demand notes sold by the Cooperative are similar to security investments and thus are covered by federal securities law. Moreover, the fact that the demand notes had an immediate maturity does not qualify them for the exemption for short-term notes provided by §3(a)(10) because Congress intended that investments of all descriptions be regulated to prevent fraud and abuse. Reversed and remanded.

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Basic Inc. v. Levinson

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Speculative Information and Materiality. The materiality of preliminary merger discussions for purposes of Rule 10b-5 violations depends on the anticipated magnitude of the merger and its probability.

NATURE OF CASE: Appeal from reversal of summary judgment in a class action for violation of Rule 10b-5.
FACT SUMMARY: Basic (D) made misleading statements about merger negotiations which former shareholders (P) contended violated Rule 10b-5.
RULE OF LAW:
The materiality of preliminary merger discussions for purposes of Rule 10b-5 violations depends on the anticipated magnitude of the merger and its probability.
FACTS: In 1976, Combustion Engineering began to take steps to acquire Basic (D), a company that manufactured chemical refractories. Combustion officers met with Basic (D) officers and directors concerning the possibility of a merger. However, Basic (D) proceeded to make three public statements, including a reply to an inquiry by the New York Stock Exchange, denying that it was involved in merger negotiations. On December 18, 1978, Basic (D) finally released a statement that it had been "approached" about a merger. The next day, the Basic (D) board endorsed Combustion's offer of $46 per share. Former shareholders (P) of Basic (D) who had sold their stock after Basic's (D) first statement denying merger negotiations filed a class action for violations of §10(b) of the 1934 Securities Exchange Act and Rule 10b-5. Rule 10b-5 bars false or misleading material statements in regard to securities trading. Basic (D) responded that the statements were not material because it was possible that the merger would not take place. The trial court granted summary judgment to Basic (D), but the court of appeals reversed. Basic (D) appealed.
ISSUE: May statements regarding preliminary merger discussions be material for purposes of Rule 10b-5?
HOLDING AND DECISION: (Blackmun, J.) Yes. The materiality of preliminary merger discussions for purposes of Rule 10b-5 violations depends on the anticipated magnitude of the merger and its probability. In order to prevail on a Rule 10b-5 claim, a plaintiff must show that the statements were misleading as to a "material" fact. A fact is material under Rule 10b-5 if there is a substantial likelihood that a reasonable shareholder would consider the disclosure or omission of the fact to have significantly altered the total mix of information available. Since preliminary merger negotiations often fail, it is difficult to determine whether a reasonable investor would consider the information significant at the time. Therefore, the determination must be made in light of the particular facts of each case. The size of the corporations involved and the potential premiums over market value are proper considerations in deciding whether the magnitude of a merger is significant. This fact-specific inquiry is adopted over a bright-line rule where merger discussions do not become material until an agreement-in-principle is reached. Such a rule does not reflect the purpose of federal securities laws, i.e., to encourage disclosure of relevant information. The case is remanded to determine the anticipated magnitude of the merger and the probability of its occurrence at the time of Basic's (D) misleading statements.

○ Court will look at other things besides P & M in deciding whether something is material:
§ Revenue streams
§ Sources of revenue
§ 5% rule will not be used because something less than 5% on your balance sheet might have a material effect.
§ If it mask a market trend, earnings trend, etc… that would otherwise be quantifiable then it would be considered material
§ If it's easily quantifiable then it might be material
§ Whether a company doesn't meet analyst expectation.
§ If a company is pushing off revenue until future quarters.
§ Whether something that your doing will have an impact on your loan/debt obligations and other valuation of assets.
§ Does it increase management's compensation if they would massage the numbers.
§ If the number conceal an unlawful transaction. Hidden facts that would reveal you stealing money from the company.
§ It's the numbers that would affect the big picture.

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Rule 10b-5

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Employment of Manipulative and Deceptive Devices

It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange,

To employ any device, scheme, or artifice to defraud,

To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or

To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person,

in connection with the purchase or sale of any security.

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Wielgos v. Commonwealth Edison Co.

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Truth on the Market. Cost projections in SEC filings are forward-looking statements that may not form the basis for a fraud claim unless they are made without a reasonable basis.

FACT SUMMARY: Wielgos (P) filed a class action on behalf of investors who bought Commonwealth Edison (Edison) (D) shares in a shelf offering because Edison (D) had underestimated the costs of completing a nuclear reactor.
RULE OF LAW:
Cost projections in SEC filings are forward-looking statements that may not form the basis for a fraud claim unless they are made without a reasonable basis.
FACTS: In September 1983, Commonwealth Edison (Edison) (D) put three million shares of common stock "on the shelf" according to Rule 415 in order to hold the stock for deferred sale. Edison's (D) registration statement incorporated many other SEC filings and a prospectus including cost projections for the nuclear reactors Edison (D) had under construction. In December 1983, Wielgos (P) bought 500 shares of Edison at market price. In January 1983, the Atomic Safety and Licensing Board (ASLB) rejected Edison's (D) request for a license for the Byron I reactor. Edison's (D) stock prices dropped dramatically, and Wielgos (P) filed a class-action suit for the amount that the equity securities declined in price after purchase. Wielgos (P) asserted that Edison (D) had misrepresented the cost of completing the Byron I reactor and had omitted the fact that the ASLB was in the process of considering the application at the time of the shelf offering. The trial court ruled that Edison's (D) cost projections could not be the basis of a fraud claim and that the omission of the license application status was not material. Wielgos (P) appealed.
ISSUE: May cost projections in SEC filings form the basis for a fraud claim?
HOLDING AND DECISION: (Easterbrook, J.) No. Cost projections in SEC filings are forward-looking statements that may not form the basis for a fraud claim unless they are made without a reasonable basis. Material errors in a prospectus that is filed with the Securities and Exchange Commission (SEC) are generally sufficient to prove liability. However, SEC Rule 175 provides that forward-looking statements containing projections of revenues or costs made by the issuers of securities may not be deemed fraudulent. This rule provides a safe harbor for incorrect statements unless they are made without a reasonable basis or are disclosed without good faith. Rule 175 assumes that investors are sophisticated and can understand the limits of predictions. The rule does not require the issuer to reveal the assumptions that are the basis of the projections. Although Edison's (D) statements regarding the costs of Byron I proved to be inaccurate, they had a reasonable basis because they were estimated according to an assumption that everything would proceed without complications. Item 103 of Regulation S-K requires issuers to disclose pending legal proceedings except for ordinary routine litigation incidental to business. Edison (D) disclosed that the Byron I reactor was not licensed. Edison (D) was not required to print statements as to the pending ASLB application because information already in the public domain advised investors that costs would rise if a license was denied. Therefore, Edison's (D) omission of the ASLB pending application was not material. Affirmed.

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Eisenstadt v. Centel Corp.

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"Puffery." Mere sales puffery is not actionable under Rule 10b-5.

NATURE OF CASE: Rule 10b-5 stockholder class action.
FACT SUMMARY: Centel Corp. (D) publicly announced competitive auction process was going smoothly despite receiving only disappointingly low bids.
RULE OF LAW:
Mere sales puffery is not actionable under Rule 10b-5.
FACTS: Centel Corporation (D) announced plans to orchestrate its sale through a competitive auction. Following this announcement, Centel stock rose to $48 per share from $37 per share. Throughout the auction process, Centel (D) was repeatedly disappointed as one prospective bidder after another informed the corporation that they were not interested in purchasing Centel. Centel (D), however, maintained an optimistic public outlook, issuing several press releases assuring that the auction process was going smoothly. Ultimately, Centel (D) received only seven disappointingly low bids. Centel (D) rejected all seven bids and negotiated its sale at $33.50 per share to a nonbidder. The stockholders (P) who purchased Centel (D) stock based upon Centel's optimistic press releases filed this class action.
ISSUE: Does a corporation commit a material misrepresentation under Rule 10b-5 when it engages in puffery?
HOLDING AND DECISION: [Judge not stated in casebook excerpt.] No. Nonspecific representations that an auction process is going smoothly would not influence a reasonable investor to pay more for a stock than he otherwise would. It is well known that the seller of a product will generate positive hype. Further, Centel (D) was not covering up a disaster with its positive hype, as the auction process had not been halted for any reason. Suit dismissed.

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Kaufman v. Trump's Castle Funding

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○ Bespeaks Caution doctrine
§ forward-looking statements are not actionable, even if misleading, if they are accompanied by cautionary language that is substantive and tailored to the specific future projections, estimates or opinions in the prospectus which the plaintiff challenges.

HOLDING AND DECISION: (Becker, C.J.) Yes. Cautionary language in a prospectus, if sufficient, renders alleged omissions or misrepresentations immaterial as a matter of law. Because of the abundant and meaningful cautionary language contained in the prospectus, Kaufman (P) and the other investors have failed to state an actionable claim regarding the statement that the Partnership (D) believed it could repay the bonds. The cautionary statements were tailored precisely to address the uncertainty concerning the Partnership's (D) prospective ability to repay the bondholders. A reasonable investor, having read these cautionary explanations, would understand that the Taj Mahal carried substantial risks. Given this context, no reasonable jury could conclude that the projection materially influenced a reasonable investor. Dismissal affirmed.

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Asher v. Baxter International, Inc

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Statutory Safe Harbor for Forward-Looking Statements. A plaintiff in a fraud-on-the-market securities action states a claim that is not barred at the pleading stage by the safe harbor provisions of §27A of the Securities Act where the plaintiff asserts that a public corporation's cautionary statements that accompanied forward-looking projections omitted "important" risk factors and contingencies.

FACT SUMMARY: Investors (P) claimed that Baxter International, Inc. (D) made future-looking projections that were materially false and not protected by the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 (PSLRA).
RULE OF LAW:
A plaintiff in a fraud-on-the-market securities action states a claim that is not barred at the pleading stage by the safe harbor provisions of Section 27A of the Securities Act where the plaintiff asserts that a public corporation's cautionary statements that accompanied forward-looking projections omitted "important" risk factors and contingencies.
HOLDING AND DECISION: (Easterbrook, J.) Yes. A plaintiff in a fraud-on-the-market securities action states a claim that is not barred at the pleading stage by the safe harbor provisions of Section 27A of the Securities Act where the plaintiff asserts that a public corporation's cautionary statements that accompanied forward-looking projections omitted "important" risk factors and contingencies. First, because the market for Baxter's (D) stock was efficient, Baxter's cautionary language had to be treated as if attached to every one of its oral and written statements. Although Baxter's (D) press releases and oral statements did not repeat cautionary statements made in its public filings, and although Section 27A has special rules requiring cautionary statements in press releases and oral statements, those special rules apply in traditional securities cases, but not in a fraud-on-the-market case, such as the one here. An investor who invokes the fraud-on-the-market theory must acknowledge that all public information is reflected in the price. Here, because the market is assumed to be efficient, it may be assumed that a cautionary statement made in a filing has been widely disseminated and affects the price. Thus, "if the executives oral statements came to plaintiffs through professional traders (or analysts) and hence the price, then the cautions reached plaintiffs via the same route; market professionals are savvy enough to discount projections appropriately. . . . That leaves the question whether these statements satisfy the statutory requirement that they adequately 'identify[] important factors that could cause actual results to differ materially from those in the forward-looking statement'." Here, Baxter's (D) cautions were not boilerplate, because they included Baxter-specific information and mentioned some parts of the business that could cause problems. However, merely mentioning such business segments is by itself insufficient. Otherwise, "any issuer could list its lines of business, say 'we could have problems in any of these,' and avoid liability for statements implying that no such problems were on the horizon even if a precipice was in sight." Nonetheless, the cautions do not need to identify all assumptions and calculations behind the projections, nor do they need to include confidence intervals that include probabilities of deviation. While these would certainly be of help to analysts and investors, they are not required. The PSLRA does not require the most helpful caution; it is enough to "identify[] important factors that could cause actual results to differ materially from those in the forward-looking statement." This means that it is enough to point to the principal contingencies—to "important factors" —that could cause actual results to depart from the projection. Here, the language Baxter (D) chose may have fallen short, because, based on the pleadings, and without the benefit of discovery, there is no reason for a court to believe that Baxter (D) mentioned those sources of variance that (at the time of the projection) were the principal or important risks. For all a court could tell, the major risks Baxter (D) objectively faced when it made its forecasts were exactly those that, according to the complaint, came to pass, yet the cautionary statement mentioned none of them. In addition, the cautionary language remained fixed even as the risks changed. Therefore, based on the pleadings, the investors' (P) claims cannot be dismissed under the PSLRA safe harbor because there is a possibility that Baxter (D) knew of important variables that would affect its forecasts but omitted them from the cautionary language. If, after discovery, Baxter (D) establishes that the cautions did reveal what were, ex ante, the major risks, the safe harbor may still apply. On the other hand, Baxter (D) contends that the full truth had reached the market despite any shortcomings in its cautionary statements. If this is so, however, it is hard to understand the sharp drop in the price of its stock. While a "truth-on-the-market" defense is available in principle, it is not available at the pleading stage. It is also too early to tell whether Baxter (D) is correct in its assertion that its projections panned out, so that there was no material error. Reversed and remanded.

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Section 27A

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Application of Safe Harbor for Forward-Looking Statements

This section shall apply only to a forward-looking statement made by-- Reporting Issuer, Affiliate, or UW

In general

a person referred to in subsection (a) shall not be liable with respect to any forward-looking statement, whether written or oral, if:
the forward-looking statement is:

provided by meaningful cautionary language.

Defenses

Forward looking statement is immaterial; or

the plaintiff fails to prove that the forward-looking statement-- was made with actual knowledge by that person that the statement was false or misleading; or


Oral forward-looking statements

oral forward-looking statement must be accompanied by a cautionary statement and where to find material containing factors that could cause actual results to differ materially from those in the forward-looking statement.

No Duty to update Forward Looking Statements.

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In the Matter of Franchard Corp.

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Management Integrity. An issuer must disclose all information that reveals the quality of management since that factor is an essential ingredient in an informed investment decision and hence, a material fact.

Management Integrity. An issuer must disclose all information that reveals the quality of management since that factor is an essential ingredient in an informed investment decision and hence, a material fact. FACT SUMMARY: Glickman transferred money from Franchard Corp. to one wholly owned corp. and pledged his controlling stock without informing the directors or disclosing the information in the registration statements.
RULE OF LAW:
An issuer must disclose all information that reveals the quality of management since that factor is an essential ingredient in an informed investment decision and hence, a material fact.
ISSUE: Is the quality of management a material fact that must be disclosed in the registration statements filed by an issuer?
HOLDING AND DECISION: (Cary, Chairman) Yes. The quality of management is a material fact that must be disclosed in the registration statement to comply with the securities acts. This essential ingredient of informed investment decision is aided by the requirement that the issuer disclose management's past business experiences, the company's past financial status, any conflict of interest on the part of insiders that may conflict with their duty of loyalty to the corporation, the remuneration paid or proposed to be paid to management, and material transactions between the corporation, its officers, directors and holders of more than 10% stock and their associates. Glickman's transactions were material not only because of the substantial sums involved but also because they displayed Glickman's managerial ability and personal integrity. Since the offering was based on Glickman's reputation, information on his activities is material for many reasons: (1) it would reveal his strained financial position, (2) it is germane to an evaluation of his integrity, which is always material but even more so in view of Glickman's dominance and the relationship to his wholly owned corporation, (3) because Franchard (D) was operated on a cash flow basis and because of Glickman's need for cash, he had a powerful motive to maintain high distribution rates and high prices for the A shares; (4) the possible loss of control due to the pledges holds material significance since it was Glickman's reputation and control of Franchard (D) which induced investment. Disclosure remains a requirement even though the directors do not know of the transgressions. Congressional determination was that an issuer should not pass the loss to investors regardless of the diligence used to prepare a statement. Ordinarily a stop order would issue in such a case, but distributing copies of this opinion to past and present stockholders will be enough since Glickman has departed, transferring his controlling B shares to management, and registrants disclosures prior to these proceedings and the filing of amendments to the 1960 statements were a bona fide attempt to comply, and the publication containing the true facts was sent to Franchard stockholders.

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In the Matter of W.R. Grace & Co

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The Interface of Materiality and Corporate Governance. Officers and directors violate federal securities laws by failing to provide accurate and complete disclosure of information set forth in proxy statements and periodic reporting provisions of the securities laws.

FACT SUMMARY: Certain officers and directors of W.R. Grace & Co. (WRG) failed to make certain disclosures on Forms 10-K and proxy statements. The Securities and Exchange Commission (SEC) issued a report concluding that they failed to fulfill their obligations under the federal securities laws.
RULE OF LAW:
Officers and directors violate federal securities laws by failing to provide accurate and complete disclosure of information set forth in proxy statements and periodic reporting provisions of the securities laws.
ISSUE: Do officers and directors violate federal securities laws by failing to provide accurate and complete disclosure of information set forth in proxy statements and periodic reporting provisions of the securities laws?
HOLDING AND DECISION: Yes. Officers and directors violate federal securities laws by failing to provide accurate and complete disclosure of information set forth in proxy statements and periodic reporting provisions of the securities laws. With regard to Grace, Jr.'s retirement benefits, even if Bolduc and Pyne assumed that WRG's disclosure counsel (which had participated in drafting the retirement agreement for those benefits) had considered the adequacy of the disclosure concerning those benefits, they should not have relied upon that assumption. They should have raised the issue by, for example, discussing the absence of disclosure with disclosure counsel. Likewise, with regard to the related-party GHSC transaction, even if Bolduc and Erhart assumed that counsel had considered whether the proposed transaction had to be disclosed, they should not have relied on that assumption, and should have raised the issue. Accordingly, none of these officers and directors fulfilled their obligations under the federal securities laws. WRG's violations resulted from these failures, and reflected Grace, Jr.'s substantial influence over the company. Because the WRG board has changed significantly since Grace, Jr.'s death, the Commission will not issue cease-and-desist orders or take other action against these individuals.

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Section 5

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prohibits “any person, directly or indirectly” from:
i. (a) selling a sec. using interstate omm.. until RS becomes effective
ii. §5(c) offering a sec. using interstate omm.. prior to filing of RS
ii. (b)(1) using interstate commerce to transmit any prospectus after a RS has been filed unless it meets §10
-------------a. §10 requires a final §10(a) prospectus now that RS effective
ii. (b)(2) – using interstate omm.. to delivery a security or confirm a sale w/out prospectus that meets §10(a) req. (must be final SP w/ price)

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Rule 163A

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Exemption from Section 5(c) of the Act for Certain Communications Made by or on Behalf of Issuers More than 30 days Before a Registration Statement is Filed.

1) Must be made before 30 days that the registration is filed.
2) Can't reference the securities offering.
3) Communication must reasonably be prevented from being disseminated into public past 30 days from registration period.
4) protects everyone including WKSI's.
5) Not available to certain communications
6) Needs to be by or on behalf of an issuer.
7) Applies to issuers, not underwriters.

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Rule 168

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For 34 Act reporting issuers.

For 34 Act reporting issuers
i. (a) Factual biz. info and forward looking statements excluded from def. of offer
a. Periodic filings are included

ii. (d) Must be similar “timing, manner, form” as released previously in “regular course of business.”


Exclusion. A communication containing information about the registered offering or released or disseminated as part of the offering activities in the registered offering is excluded from the exemption of this section.

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Rule 169

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For non 34 Act reporting issuers.


i. (a) Factual biz. info excluded from def. of offer
a. Does not exclude forward looking info

ii. (d) Must be similar “timing, manner, form” as released previously in “regular course of business”
iii. (d)(3) Disseminated to those acting in capacity other than investors (e.g., customers/suppliers)

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Rule 163

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Exemption from Section 5(c) of the Act for Certain Communications By or On Behalf of Well-Known Seasoned Issuers.

a. (a)Exempts all oral/written offers
i. exempts for pre-filing period only
b. (a)(1)Must treat the offer as a free writing prospectus (FWP)
i. File it w/ SEC promptly after filing RS
ii. Written communications must include legend informing investor of statutory prospectus and how to get it
c. Reg. FD prohibition on selective disclosure applies

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Rule 135

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Safe Harbor from §5 for notice of offering
a. Exempts short, factual statement of proposed registered offering
i. (a)(2)Only identify: issuer, amount, basic terms, and timing of offering, purpose of offering (w/out stating UW name)
b. (a)(1) Must include Legend that the notice doesn’t constitute an offer
c. Note – for small business, this is the only way to get the word out

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Rule 137

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ii. NON PARTICIPATING broker-dealers
a. R. 137 Research report not included under §2(a)(11) def. of “offer” thereby excluding broker from def. of UW and allowing him to take advantage of §4(3) and R. 174 safe harbors if:
i. (b) broker dealer has not received compensation from a participant
ii. (c) broker dealer publishes the research report in the regular course of business

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Rule 138

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iii. Safe Harbors for PARTICIPATING broker-dealers
a. The Issuer must be a 34Act reporting co. up to date on filings AND
b. R. 138 – limited safe harbor for §2(a)(10) and §5(c)
i. Issuer’s offering falls into one of two classes of securities
a. common stock or security convertible into common stock
b. debt or securities not convertible into common stock
ii. Broker-dealer may report on the class of securities that issuer IS NOT offering (the class already in secondary mkt) AND
iii. Broker dealer regularly publishes report on this class of sec.

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Rule 139

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iii. Safe Harbors for PARTICIPATING broker-dealers
a. The Issuer must be a 34Act reporting co. up to date on filings AND

c. R. 139 – broader safe harbor
i. Report can be specific to the issuer if:
a. Issuer is eligible to register under S-3 AND
b. B/D has regularly published reports on this issuer

ii. Report can comment on the issuer if:
a. Report devotes no more space to the issuer than it does to other issuers in the same industry
b. B/D regularly publishes these type of reports

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How to meet §10 requirements for a prospectus?

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Preliminary SP : Prospectus can omit some info for purposes of satisfying §5(b)(1) - Waiting Period
a. R. 430 – can omit price of offering and price dependant info, provided that it contains substantially that information to satisfy 10(a).

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Sec 2(a)(10)

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i. §2(a)(10): broad def of prospectus – “any…communication, written or [broadcast] which offers…or confirms the sale of any security”


ii. offer is not written or broadcast → face to face is okay

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Rule 134

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Communications Not Deemed a Prospectus.

Tombstone adds exempt from def. of prospectus.
Safe Harbor for 5(b)(1) - Waiting Period.
Complies with 2(a)(10).
Eligibility- issuers & participants.

a. Similar to R. 135 short and factual statement but a bit broader
i. (a) Can include same info as 135 plus business of issuer, price of the security, and name of all UW.
b. But list of inclusive items is VERY specific, if include something not on list, exemption doesn’t apply
i. ex. can’t include forward looking statements
c. (d) Can solicit offers if:
i. Send a SP (FWP doesn’t count) w/ the solicitation or before the solicitation
a. (f) If solicitation is electronic, a like to the SP is fine
ii. Include a legend stating security can’t be sold prior to RS becoming effective and offer can be withdrawn.

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Rule 164.

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Applicable in the Waiting Period & Post-Effective Period.
Free Writing Prospectus (FWP)
a. A FWP that meets the definition of R. 433 will be considered same as §10(b) prelim SP
b. What is a FWP?
-----------i. R. 455: Gen’l Def. FWP – Written communication that offers to sell or solicits an offer to buy a security that has RS filed
-----------------a. Written = print, broadcast, graphic (electronic media)
--------------------------i. But not real time electronic commucation
-----------ii. Basically any offer or solicitation that isn’t face to face
d. Point – Any issuer/UW can make offers or solicit offers so long as they include a SP and file it w/ SEC.
e. If violate 433 – no §11 liability but §12(a)(2) antifraud liability

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Rule 433

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Conditions to Permissible Post-Filing Free Writing Prospectuses:

i. R. 164(e)(f): Investment co., shell co, and penny stock offerings are excluded and same ineligibility under R.405 as applies to WKSI (basically if done anything bad)

ii. (c)(1) FWP can’t contain info contrary to SP

iii. (c)(2)Include legend saying RS has been filed w/ SEC and where investor can get SP
---------a. Non-Reporting and Non-Seasoned issuers must also include the SP w/ the FWP unless:
----------------i. (b)(2)(i)FWP made by non-paid, unaffiliated source.
---------------ii. Already sent SP to the investors and there have been no material changes
--------------iii. FWP is electronic and included a hyperlink to SP

iv. (g)Must retain a copy of the FWP for 3 yrs. after date of offering

v. (d)(1)Issuer must file the FWP made by issuer or participants based on issuer info w/ the SEC on or bf/ date of first use unless:
---------a. (d)(1)(i)(B)&(h)(2)FWP made based on information which the issuer didn’t provide
---------b. (d)(5)The terms of the offering contained in the FWP are not the final terms, in which case must file final terms w/in 2 days of being determined.
---------c. (d)(3) FWP doesn’t contain substantive changes/additions from previously filed FWPs
---------d. (d)(8)(i) It is a pre-recorded roadshow
---------------i. (ii) Except that non-reporting issuers doing common equity offering must file pre-recorded roadshows unless they make it available to the public
---------e. (f)(1)If made by an uncompensated media source on info provided by issuer/participant then only have to file /w 4 days of becoming aware.

vi. Other participants, besides issuer, must file FWP w/ SEC if:
---------a. (d)(1)(ii)They used it to achieve “broad unrestricted dissemination”
-----------------i. SEC says large mailing to customer list is not broad unrestricted dissemination
---------b. (f)(1)If made by an uncompensated media source on info provided by issuer/participant then only have to file /w 4 days of becoming aware.

vii. R. 164(b)(c)Can cure a missed filing/omitted legend if made unintentionally/good faith and fix as soon a possible

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i. All written/broadcast offers (§5(b)(1)) and confirmation of sales (§5(b)(2)) must:

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a. Meet the requirements of a §10(a) prospectus OR
b. Be preceded or accompanied by a §10(a) prospectus
i. Then the communication is called a “free writing” under §2(a)(10)(a)
a. This replaces the R. 164 FWP safe harbor

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R. 174

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a. R. 174 - §5(b) delivery requirements don’t apply after:
i. 0 days if issuer was 34 Act reporting issuer prior to the offering
ii. 25 days if issuers securities will be listed on a nat’l exchange

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iv. R. 172

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Exempts Sending Confirmations and Notices
Access = delivery in all transactions
a. (a)(c) – If effective RS and final §10(a)SP on file w/ SEC then delivery not required under §5(b)(1)
b. Rule doesn’t apply:
i. When sending a “free writing”

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Rule 173

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-issuer and UW sales must either be accompanied by a SP or must provide one within two business days after the completion of such sale.

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a. §10(a)(3)

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2. Updating the SP:

If SP has to be delivered more than 9 months after RS effective date → must update info that is more than 16 mos. old.

notwithstanding the provisions of paragraphs (1) and (2) of this subsection (a) when a prospectus is used more than nine months after the effective date of the registration statement, the information contained therein shall be as of a date not more than sixteen months prior to such use, so far as such information is known to the user of such prospectus or can be furnished by such user without unreasonable effort or expense;

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Shelf Registrations

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§ Allows you to file a registration without having to do a public offering for a while.

Avoids the gun jumping rules

(offerings done on continuous or delayed basis) can be done if:
i. R. 415 Conditions must be met
a. (a)(1)Types of offerings that qualify
i. Securities being offered/sold by somebody other than the registrant or a parent/subsidiary of registrant
ii. Securities being converted
iii. Securities being offered continuously from the effective date through longer than 30 days
iv. Securities registered under S-3
b. Time limits on Shelf Registration
i. (a)(2)2 yrs. for securities being not registered under S-3 and being sold on continuous basis above
ii. (a)(3)3 yrs. for all other qualified offerings

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Updating Shelf Registration

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i. (a)(3)Must do a S-K 512: Item 512(a) undertaking which requires filing a post-effective amendment to RS for:
a. §10(a)(3) changes to SP
b. “fundamental changes” to info in RS
c. material changes in plan of distribution
ii. Exception – S-3 registrants do not have to file the this info as a post effective amendment if info contained in periodic filings
iii. But ALL issuers reset the effective date of the RS for liability purposes when they update the undertakings info

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a. 415(a)(6)

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Automatic Shelf Registrations
i. Just file an ASR every 3 yrs. and it becomes effective immediately
ii. Qualifications
a. Must be a WKSI
b. Must be a RS on file
c. Must be for the kind of offering filed on S-3
d. Indicate name or class of security
i. but don’t have to specify quantity
ii. can add more classes at a later time by filing post effective amendment
iii. Benefits
a. WKSI can continuously sell indeterminate amounts of almost any class of securities w/out delays.

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R.415 Base Prospectus

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i. Issuers may omit info such as price, and UW from SP when file w/ shelf reg.
a. Satisfies §5(b)(1) def. of prospectus during waiting period BUT NOT §5(b)(2) during post effective period until the omitted information has been added.
b. R. 424(b)(2) must add the omitted info w/in 2 days of determining price
i. Can file through a incorporation by reference, prospectus supplement, or post effective amend.
c. Item 512(A) & R.430(B) filing the omitted info resets the effective date of the RS for liability purposes

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a. R. 424(b)

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Updating in the Post-Effective Period

1. Updating the RS Generally
a. R. 424(b) – Substantive changes to SP must be filed as a post effective amendment to the RS (b/c SP is part of RS)
i. “substantive” = material
ii. amendment to RS resets the effective date for liability purposes

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○ Who can sue under Section 11?

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§ Anyone who buys stock issued pursuant to a defective registration statement.
§ Requirements:
1) P must not have been aware of the truth at the time he bought the securities.
2) No action may be maintained unless brought within one year after discovery of the falsity or omission was or should have been made, and in any event no more than 3 years after the security was offered to the public.
3) P has to show that the securities purchased were issued pursuant to the registration statement in question.

a. Strict Tracing – P must show w/ “reasonable certainty” that specific shares she purchased were part of the public offering under the fraudulent RS
i. Mere possibility that P’s shares came from the offering or that shares where commingled in a fungible mass w/ shares from the offering is not enough (Abbey v. Computer Memory)

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Who can be sued under Sec 11?

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a. (a)(1) – Those who signed the RS (pursuant to §6(a) includes issuer, CEO, CFO)
b. (a)(2), (3) – Directors, or named as soon to be directors, or performs similar functions
c. (a)(4) – Experts who prepared or certified a part of RS
d. (a)(5) – UW
e. §15 – Control Persons of any of the above
§ 15(a) - issuers, controlling shareholder, underwriters(11a - they can be sued as of the time they became involved in the offering), director, anyone about to become a director, expert who contributed to drafting of reg. stmt, certain officers.


If such person acquired the security after the issuer has made generally available to its security holders an earning statement covering a period of at least twelve months beginning after the effective date of the registration statement, then the right of recovery under this subsection shall be conditioned on proof that such person acquired the security relying upon such untrue statement in the registration statement or relying upon the registration statement and not knowing of such omission, but such reliance may be established without proof of the reading of the registration statement by such person.

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Elements of a Sec. 11 claim:

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a. Material misstatement/omission in the RS
b. Reliance on the misstatement required only if:
i. D released an earnings statement covering at least a 12 mo. period after the effective date
a. filing of post effective amendment re-sets the effective date
ii. But P does not have to prove that she read the RS
c. No requirements of scienter – but see defenses below

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Defenses to Sec. 11 claim:

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§ Doesn't apply to issuers
a. One of the above two elements weren’t proven
b. §11(a) – P had actual knowledge of the fraud (also goes to no materiality)
i. D could announcement misstatement to entire mkt
ii. Once correct misstatement in “total mix” in mkt, no longer material
c. §11(b)(1) – D blew whistle (must quit and tell SEC)
d. §11(e) loss causation defense – P’s loss from depreciation in stock price was due to factors other than the misstatement in the RS
i. if price actually went up, could also argue not material (Ackerman)
e. that if such part of the registration statement became effective without his knowledge, upon becoming aware of such fact he forthwith acted and advised the Commission, in accordance with paragraph (1) of this subsection, and, in addition, gave reasonable public notice that such part of the registration statement had become effective without his knowledge;
f. §13 – SOL
g. §11(b)(3) Due Diligence – for everybody but issuers
ii. Experts DD requirements
a. Expertised portion - Reasonable investigation AND reasonable grounds to believe AND did believe the truth
i. Can’t just rely on mngt integrity (Worldcom)
b. Non- expertised portion – no liability (§11(a)(4)
iii. Non-Experts
a. Expertised portion - Reasonable grounds to believe AND did believe the truth
i. But does not have to make separate investigation
b. Non-expertised portion - Reasonable investigation AND reasonable grounds to believe AND did believe the truth
iv. §11(c) Reasonable Investigation Standard - that required by a prudent man in management of his own property (Escott v. BarChris)
i. How high up in the org. D was
ii. How much D participated in preparing the RS
iii. D’s background education/knowledge
b. SEC Rule 176 Factors
i. Type of Issuer, Type of security, Type of person, Office held
ii. Reasonable reliance on employees whose documents should have given the D knowledge of the particular facts
ii. Can’t rely on expertised portion if “red flags” raised

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Measure of Damages - 11(e)

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§ Sec 11 creates a presumption in favor of a recessionary measure of damages, based upon the difference between the amount paid for the security(so long as that does not exceed the offering price) and
a) Its value at the time of the suit,
b) The consideration received on resale if the security was sold before the suit, or
c) The consideration received if the security was sold after the suit, but before judgment, if that would produce a lesser measure than that stated in (a).


.

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Hertzberg v. Dignity Partners, Inc.

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Persons Bringing Suit. Standing under §11 of the Securities Act of 1933 is not conditioned upon privity.


Procedural Posture
○ Appeal from a dismissal of a 11 action.

Facts
○ Dignity Partners issued a registration statement for an IPO of Dignity Common stock.
○ Dignity was in the business of buying the rights to life insurance proceeds from people with AIDS, paying a lump sum up-front and taking over the responsibility for paying the premiums.
○ Shortly after the offering, it became known that AIDS patients were living longer than expected due to new AIDS treatments.
○ As a result, Dignity (D) posted huge losses and the stock plummeted.
○ Hertzberg (P),who purchased D stock on the open market more than 25 days after the IPO but before news of the longer life expectancy of AIDS patients or large losses to Dignity became public, filed a class action alleging violation of 11.

Issue
○ What constitutes standing to file a Sec 11 claim?

Holding:
○ "Any person acquiring security" under a registration statement with misstated or omitted information may bring an action for losses caused by the misstatement or omission. It is irrelevant that the investors here did not purchase D stock in the initial IPO or within 25 days.
○ Reversed.

10/11/2011, 11:15 AM

Plaintiffs who purchase in the aftermarket may bring Sec 11 claims if they are able to trace their shares to the PO to which the registration statement pertains

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Escott v. BarChris Construction Co.

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The Defendants and Their Defenses. Directors and officers must pursue a reasonably diligent investigation in order to avoid liability for false registration statements under §11.


NATURE OF CASE: Action for violation of §11 of the Securities Act of 1933.
FACT SUMMARY: The purchasers (P) of debentures issued by BarChris (D) alleged that the directors and officers of BarChris (D) were responsible for false statements and material omissions in the registration statement.
RULE OF LAW:
Directors and officers must pursue a reasonably diligent investigation in order to avoid liability for false registration statements under §11.
ISSUE: Are directors and officers required to pursue a reasonably diligent investigation in order to avoid liability for false registration statements under §11?
HOLDING AND DECISION: (McLean, J.) Yes. Directors and officers must pursue a reasonably diligent investigation in order to avoid liability for false registration statements under §11. Section 11 of the Securities Act subjects the issuer to strict liability for damages caused by material misrepresentations or omissions in a registration statement. Other persons associated with the distribution, such as the signers of the statement, the directors of the issuer, accountants who prepared materials serving as the basis for the statement, and the underwriters, are also subject to liability but may assert a due diligence defense. Experts, such as accountants and lawyers, are responsible for conducting a reasonable investigation with respect to the expertise portion of the registration statement. Directors and underwriters may rely on the expert's opinion for the expertise portion but must reasonably investigate other facts asserted in the statement. BarChris' (D) accountants, Peat, Marwick (D), did not conduct a complete audit of BarChris (D) and failed to note danger signals in the materials that were examined before providing financial figures which formed the basis of the 1961 registration statement. Therefore, Peat, Marwick (D) failed to undertake a reasonable investigation as required to assert the due diligence defense. The directors such as Birnbaum (D), Auslander (D), and Grant (D) were entitled to rely on the information audited by Peat, Marwick (D) for the expertise portion of the statement. However, they did not take any steps to investigate the truth of other statements in the registration document. Thus, these directors (D) also do not qualify for the due diligence defense. Therefore, since the misrepresentations in the registration statement for the debentures were material, BarChris (D) and the other persons associated with the registration are jointly and severally liable under §11 to the purchasers (P). Motion denied.

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Akerman v. Oryx Communications Inc.

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Damages. Liability under §11 for material misrepresentations in registration statements may be avoided or reduced by proving that the depreciation in the value of the stock resulted from other factors.

NATURE OF CASE: Appeal from summary judgment in an action for damages for violation of the Securities Act.
FACT SUMMARY: Akerman (P), a purchaser of Oryx Communications, Inc.(D) stock, claimed that an inadvertent error on a registration statement caused the stock price to drop.
RULE OF LAW:
Liability under §11 for material misrepresentations in registration statements may be avoided or reduced by proving that the depreciation in the value of the stock resulted from other factors.
HOLDING AND DECISION: (Meskill, J.) Yes. Liability under §11 for material misrepresentations in registration statements may be avoided or reduced by proving that the depreciation in the value of the stock resulted from other factors. Section 11(a) of the Securities Act imposes civil liability for damages caused to purchasers of the securities on the issuer and signatories of a registration statement that contains material misrepresentations or omissions. However, under §11(e), defendants may reduce their liability by proving that the depreciation in the value of the stock was not caused by the material misstatements. Under §11(e), the defendants carry a heavy burden of proving that other factors caused the depreciation in value because Congress desired to allocate the risk of uncertainty to the issuers rather than the purchasers. Oryx (D) presented evidence that the misstatement made in the registration statement was barely material because the prospectus contained a pessimistic forecast of the performance of its subsidiary. Thus, the accounting error was unlikely to have altered perceptions about performance. Furthermore, the price of Oryx's (D) stock actually rose after the error was disclosed to the public. Akerman's (P) evidence that other stocks did not do as poorly as Oryx (D) in the same period is not entitled to weight because it does not reflect any of the countless variables that might affect stock performance. Therefore, Oryx (D) met the burden of proving that factors other than registration statement error caused the depreciation in the stock. Affirmed.


○ How do you prove negative causation?
§ Look at comparable companies possibly, or
§ Look at across-the-board performance.
§ Market trends
§ Various metrics.
§ Comparable control group(i.e. sector based, type of company)

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Hyer v. Malouf

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By Means of a "Prospectus or Oral Communication." An action brought under §12(a)(2) of the Securities Act of 1933 for alleged misrepresentations and omissions made by the issuer of securities by means of a prospectus will not be dismissed where issues of fact have been raised as to whether the securities were offered in a "public offering."

NATURE OF CASE: Motion to dismiss claim under §12(a)(2) of the Securities Act of 1933.
FACT SUMMARY: Investors (P) contended that their action against Malouf (D), brought under §12(a)(2) of the Securities Act of 1933 for alleged misrepresentations and omissions made by Malouf (D) in his offering documents, should not be dismissed because they raised issues of fact as to whether the securities had been offered in a "public offering."
RULE OF LAW:
An action brought under §12(a)(2) of the Securities Act of 1933 for alleged misrepresentations and omissions made by the issuer of securities by means of a prospectus will not be dismissed where issues of fact have been raised as to whether the securities were offered in a "public offering."
ISSUE: Will an action brought under §12(a)(2) of the Securities Act of 1933 for alleged misrepresentations and omissions made by the issuer of securities by means of a prospectus be dismissed where issues of fact have been raised as to whether the securities were offered in a "public offering" ?
HOLDING AND DECISION: (Campbell, C.J.) No. An action brought under §12(a)(2) of the Securities Act of 1933 for alleged misrepresentations and omissions made by the issuer of securities by means of a prospectus will not be dismissed where issues of fact have been raised as to whether the securities were offered in a "public offering." Section 12(a)(2) provides a cause of action to a purchaser of a security against one who offers or sells a security "by means of a prospectus or oral communication" that includes an untrue statement or omission of material fact. The phrase "by means of a prospectus" has been interpreted to limit its reach to public offerings, and a prospectus has been defined as a document that must include the information contained in the registration statement, unless there is an applicable exemption. Whether an offering is public or private depends on whether the particular class of persons affected needs the protection of the 1933 Act. An offering made to all potential investors who are shown not to need such protection is not considered a "public offering." There are several factors in making this determination: (1) the number of offerees; (2) the sophistication of the offerees; (3) the size and manner of the offering; and (4) the relationship of the offerees to the issuer. A court may determine that the investors do not need the protection of the 1933 Act if all the offerees have relationships with the issuer affording them access to or disclosure of the sort of information about the issuer that registration reveals. Here, the investors (P) have alleged that Malouf (D) offered the securities through the Project Offerings, which they assert constitute prospectuses. They also allege that the offerings were made to the general public in connection with a public offering, and list 21 investors. Because the determination as to whether there was a public offering is fact intensive, discovery is needed to determine whether each of those investors needed the protection of the 1933 Act, what their relationship with Malouf (D) was like, and whether they had access to the type of information in a registration statement. Therefore, dismissal at this stage is inappropriate. Motion to dismiss is denied.

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§12(a)(1) Liability

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Private cause of action for violating §5.

a. Standing - Any person who purchases a security that violates § 5 can sue…


□ Not required to show state of mind(this is strict liability)
□ No requirement of injury to P
4) The action has been brought within the time stated in the SOL found in Sec 13.

b. Potential Ds - Any person who offered or sold the security in violation of § 5 to the P.
i. Seller = issuer
ii. Offerer = UW, broker, promoter if motivated by his own financial interests (can’t be offering to gratuitously benefit issuer).
a. Ex. (from Pinter case)
i. Direct financial interest in the sale
ii. Serving financial interests of the issuer (e.g. employment)
a. Ct’s split over whether ministerial financial interest counts
c. The offer or sale must violated §5

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§12(a)(2) Liability

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Extends the rescissionary remedy of 12(a)(1)to situations where a person offers or sells a security by the use of an instrumentality of interstate commerce by means of a false or misleading prospectus or oral communication.

§ Applies only to public offerings by issuers.


1. Elements
a. Standing – Any P who purchases a security from
b. Potential Ds – Any person who offered or sold the security through
i. Same analysis as §12(a)(1) applies for offerers
c. Interstate Commerce “by means of”
d. A Prospectus
i. Must be a §10 prospectus (only for registered offerings) or the more broad §2(a)(10) prospectus?
a. Gustafson answers (investment K called “prospectus” covered?)
i. Majority – §10 and §2(a)(2) prospectuses are the same and they both are: A document available to the public that describes a public offering of securities by issuer/controlling shareholder
ii. Dissent - §10 meaning of prospectus is entirely diff. than §2(a)(10) gen’l def., which should apply in §12(a)(2) actions
iii. Point – even through majority was formalistic, it actually came to a meaning that was somewhere between the two definitions
b. Point/Subsequent Interp. – It must be a public offering AND there must be a §5 delivery obligation
i. Secondary and Private placement transactions not covered
e. That contained a material misstatement/omission
f. Note: “By means of” – implied as a limited causal inquiry that the misstatement played a part in P’s decision to purchase
i. Sanders case – P doesn’t actually have to read prospectus, can prove through efficient mkt hypothesis



offers or sells a security (whether or not exempted by the provisions of section 3, other than paragraphs (2) and (14) of subsection (a) of said section), by the use of any means or instruments of transportation or communication in interstate commerce or of the mails, by means of a prospectus or oral communication, which includes an untrue statement of a material fact or omits to state a material fact necessary in order to make the statements, in the light of the circumstances under which they were made, not misleading (the purchaser not knowing of such untruth or omission), and who shall not sustain the burden of proof that he did not know, and in the exercise of reasonable care could not have known, of such untruth or omission

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Defense to Sec 12(a)(2)

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a. P knew about the misstatement
b. §12(b) Loss causation - P’s loss from depreciation in stock price was due to factors other than the misstatement in the RS
c. Reasonable care defense – D didn’t not know and could not have known the truth through the exercise of reasonable care
i. Similar to DD defense but no affirmative duty to make an investigation in non-expertised portions like w/ §11.

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Pinter v. Dahl

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Section 12(a)(1). Liability under §12(1) of the Securities Acts extends only to persons who successfully solicit the purchase of securities for their own personal gain or that of the securities owner.

NATURE OF CASE: Appeal from a judgment denying damages in action for violations of §12 of the Securities Act.

FACT SUMMARY: Pinter (D), the seller of interests in an oil drilling venture, asserted a counterclaim for contribution against Dahl (P) for soliciting other investors to buy into the venture.

RULE OF LAW:
Liability under §12(1) of the Securities Acts extends only to persons who successfully solicit the purchase of securities for their own personal gain or that of the securities owner.

ISSUE: Does liability under §12(1) extend to a person who urges the purchase of security but whose motivation is solely to benefit the buyer?

HOLDING AND DECISION: (Blackmun, J.) No. Liability under §12(1) of the Securities Act extends only to persons who successfully solicit the purchase of securities for their own personal gain or that of the securities owner. Section 12(1) provides that any person who offers or sells a security in violation of the registration requirement shall be liable to the purchaser. This language contemplates a buyer-seller relationship similar to traditional contractual privity. Persons who do not pass title or the interest in a security may be included within the class of defendants only in certain circumstances. Since the language of §12 includes persons who make offers to sell, an individual engaged in solicitation is within the scope of the Act. This interpretation is consistent with the purpose of the Act to promote full and fair disclosure of information to the public in the sales of securities. However, persons who offer gratuitous advice or urge another person to make a particular investment are not sellers or offerers within the meaning of §12. Liability only extends to solicitors who are motivated by financial gain. Although Dahl (P) did not receive a commission for soliciting the sales of the securities sold by Pinter (D), the evidence does not clearly indicate whether Dahl (P) sought to receive financial benefit from the investments for himself or for Pinter (D). Therefore, the judgment is vacated, and the case is remanded to determine Dahl's (P) motivation for the solicitations.

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Gustafson v. Alloyd Co.

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By Means of a "Prospectus or Oral Communication." For the purposes of determining a right of rescission under §12(2), the term "prospectus," as used in the Securities 1933, refers to documents related to public offerings, not to private secondary sales.

NATURE OF CASE: Appeal from grant of right of rescission in private securities sale.

FACT SUMMARY: Alloyd Co. (P) sought to rescind its purchase of Alloyd, Inc. from Gustafson (D) under §12(2) of the Securities Act of 1933 due to misstatements in the contract of sales.

RULE OF LAW:
For the purposes of determining a right of rescission under §12(2), the term "prospectus," as used in the Securities Act of 1933, refers to documents related to public offerings, not to private secondary sales.

HOLDING AND DECISION: (Kennedy, J.) Yes. For the purposes of determining a right of rescission under §12(2), the term "prospectus" as used in the Securities Act of 1933 refers only to documents related to public offerings. Three sections of the 1933 Act are relevant to a determination of the meaning of the word "prospectus" : §2(10), the definition; §10, the information required in one; and §12, which impose liability for misstatements in one. The meaning should be consistent throughout. Section 10 confines the term to documents that must include the information from the registration statement. A registration statement is required, for the most part, only in public offerings. Read consistently §12(2) liability, attaches only when there is a §10 requirement to issue the prospectus, as in a public offering. The argument that any offer is a prospectus under §12 would require a holding that the term is broader in §12 than in §10. This argument arises from the definition of the term in §2(10), which provides that "[t]he term 'prospectus' means any prospectus, notice, circular, advertisement, letter, or communication, written or by radio or television, which offers any security for sale or confirms the sale of any security." Alloyd Co. (P) and the dissent rely on the word "communication" to give prospectus a broad definition, yet they fail to consider the public nature of the §2(10) list. In context, the list refers to documents of wide dissemination, but leaves out face-to-face and phone conversations. Congress provided the right to rescind in §12(2) for documents prepared under investigation with established procedures in the context of a public offering. It is not plausible to believe that Congress intended every casual communication in the secondary market to grant a right of rescission absent evidence of fraud or reliance. Legislative history supports this interpretation. Reversed and remanded.


○ The issue is over a Stock Purchase Agreement
§ Under 2(a)(10) it would be a prospectus however under 12(a)(2) the court says it's not
§ They says 12(a)(2) applies only to public offerings where there needs to be a statutory prospectus.

○ If you're a P you're going to have argue that this was a public offering and it was a statutory prospectus.

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Aaron v. Securities and Exchange Commission

Back 53

NATURE OF CASE: Appeal from a judgment for violating federal securities law.

FACT SUMMARY: The Securities and Exchange Commission (SEC) (P) contended that Aaron (D), a supervisor in an investment firm, sold stock based upon unfounded recommendations and failed to stop after the issuer informed him of the improprieties.

RULE OF LAW:
Proof of scienter is required under §17(a)(1) of the Securities Act but not under §§17(a)(2) and 17(a)(3).

ISSUE: Is proof of scienter required under §17(a) of the Securities Act?

HOLDING AND DECISION: (Stewart, J.) Yes. Proof of scienter is required under §17(a)(1) of the Securities Act but not under §§17(a)(2) and 17(a)(3). Congress intended securities legislation to be construed flexibly in order to effectuate its remedial purposes. However, where the language of a provision is sufficiently clear in its context, it is unnecessary to examine policy considerations in order to determine the meaning of the provision. The language of §17(a) strongly suggests that Congress intended a scienter requirement under §17(a)(1) because it states that it is unlawful to "employ any device, scheme, or artifice to defraud." These terms plainly connote knowing or intentional practices. By contrast, the language of §17(a)(2) prohibits the obtaining of money by any untrue statements. Nothing in this language evinces an intent requirement. Finally, the language of §17(a)(3), prohibiting any person from engaging in a practice that "operates or would operate as a fraud," plainly focuses on the effect of conduct rather than on the culpability of the person responsible. Thus, there is no scienter requirement in this subparagraph. This result is not inconsistent with §17(a) because each subparagraph was meant to proscribe distinct categories of misconduct. The decision by the court of appeals is reversed, and the case is remanded for a determination in light of this decision.

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Sec 17(a)

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§ Limited to fraud by sellers.
§ Statute requires fraud "in the offer or sale" of a security.
§ It's not limited to fraud in the process of a distribution of securities.
§ Liability may exist under 17(a)(2) even if D's have not themselves made any false statements.

Fraudulent Interstate Transactions

Use of interstate commerce for purpose of fraud or deceit

It shall be unlawful for any person in the offer or sale of any securities or any security-based swap agreement (as defined in section 206B of the Gramm-Leach-Bliley Act [15 USCS § 78c note]) by the use of any means or instruments of transportation or communication in interstate commerce or by use of the mails, directly or indirectly--

to employ any device, scheme, or artifice to defraud, or

to obtain money or property by means of any untrue statement of a material fact or any omission to state a material fact necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading; or

to engage in any transaction, practice, or course of business which operates or would operate as a fraud or deceit upon the purchaser.

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2. “With a view to”

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– inquiry into purchasers mental state or purpose for the purchase at the time of the purchase.
a. If it was an investment purpose – then the view was not to distribution and not an UW.
b. Inquiry is whether there was a change in purchasers circumstances to change his mind from view to investment when purchased to view to distribution when sold or whether the view to distribution was there all along.
i. Passage of time (Ackerberg)
a. If purchase held for 2 yrs. then presumption they have “come to rest” and initial purchase was made w/ investment intent
b. If purchase held for 3 yrs. then “conclusive presumption” they have come to rest.
ii. Unexpected change in purchasers circumstances (Gilligan, Will)
a. Must be an expected change in investor’s circumstances (not a downturn in issuer) that forces investor to sell.

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Control Person Distributions

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○ 2(a)(11) - One who purchases from a control person, or sells for a control person, or otherwise participates, directly or indirectly, in a distribution of the control person's securities is an underwriter.
○ The control person is not an issuer and therefore cannot use the issuer-based exemptions established in 4(2) or 4(6), Regulation D,o Rule 147.
○ If the issuer's offering has come to rest, the control person is not protected by her investment intent.

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C. §4(1) exemption for Control Persons Re-sales

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2(a)(11) Def. of control persons for determining whether UW present in transaction.
a. Control Persons = Persons directly or indirectly under the control of the issuer or controlling the issuer, shall be considered the issuer as well.
2. Two step analysis:
a. Is control person offering directly to investors w/out the use of a 3d pty?
i. If yes, then use same analysis to determine if acting as an UW as would use fore everybody else (above).
b. If control person offering to investors w/ help of a 3d pty then:
i. §2(a)(11) – control person is considered same as the issuer.
ii. Must determine if 3d pty acting as an UW:
a. Test: Are the securities being “distributed”? This is Ralston Purina inquiry – Can the investors fend for themselves?
b. If securities are not being “distributed” then § 4(1) exempts entire transaction → this is referred to as exemption 4(1 ½).
i. Note: 3d pty participation as the broker does not count as a “dealer” under §4(1) (Ackerman)
a. If it did, then nearly all secondary mkt transactions would get swallowed up by §5 requirements.
b. “Dealer” under §4(1) is more like an UW w/ stake in the offering, not a neutral broker.
c. If securities are being distributed (b/c doesn’t pass Ralston Purina test) → 3d pty falls under §2(a)(11) def. of “UW” and destroy the §4(1) exemption to the transaction. All ptys on the hook for §5 violation if security not registered.
i. But 3d pty broker can be exempt under §4(4) if the transaction was unsolicited.
a. §4(4) is a personal exemption only for the broker (Wolfson).
3. Policy – Why make it harder for control persons?
a. Control persons have an information advantage that the investor doesn’t share.
b. Control persons have the ability to force the issuer to register the security

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Safe Harbor from Def. of UW

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1. R.144 – If meet the conditions of the rule, then won’t be considered an UW for purposes of §4(1) exemption regardless of investment intent (distribution). Regulates the resale of restricted & controlled securities.
a. Conditions:
i. Must be adequate information on the mkt about the issuer
a. All 34 Act reporting co.s meet this requirement
ii. If the security is “restricted” the seller must have held for 6 months if Reporting Issuer and 1 year if Non-Reporting Issuer
a. restricted security = gained directly or indirectly (through broker) from the issuer or affiliate (control person) through a 505, 506 offering or transaction not involving a “public offering.”
iii. Restriction on amount of security sold in a 3 mo. Period, cannot exceed the greatest of
a. 1% of outstanding securities, or
b. The average weekly trading volume for such securities on all nat’l exchanges for a 4 week period, or
c. The average weekly trading volume for such securities pursuant to an effective reporting plan during a 4 week period.
iv. Sale must take place through an unsolicited transaction such as by broker or market maker.
v. Must file From 144 notice of sale w/ SEC no later than placing first order for sale w/ the broker
a. Doesn’t apply to sales less than 5,000 shares or less than $50,000 w/in a 3 mo. period
b. R. 144(b)(1) – Safe Harbor to the Conditions
i. Non affiliates (non control persons) can sell the securities w/out restrictions if hold on to for 1 yr. from purchase.

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The term person when used with reference to a person for whose account securities are to be sold in reliance upon Rule 144

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Any relative or spouse of such person, or any relative of such spouse, any one of whom has the same home as such person;

Any trust or estate in which such person or any of the persons specified in paragraph (a)(2)(i) of this section collectively own ten percent or more of the total beneficial interest or of which any of such persons serve as trustee, executor or in any similar capacity; and

Any corporation or other organization (other than the issuer) in which such person or any of the persons specified in paragraph (a)(2)(i) of this section are the beneficial owners collectively of ten percent or more of any class of equity securities or ten percent or more of the equity interest.

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SEC v. Chinese Consolidated Benevolent Association

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NATURE OF CASE: Action to restrain sale of bonds which have not been registered with the Securities and Exchange Commission (SEC).

FACT SUMMARY: A committee was formed to solicit funds from the Chinese community to purchase bonds from the Chinese government.

RULE OF LAW:
Foreign bonds must be registered. A party is an underwriter even if he is not authorized by the issuer and even if he does not receive compensation.

ISSUE: Is an association an underwriter where it solicits funds for the purchase of unregistered securities if it is not authorized to do so by the issuer and no compensation is received for its activities?

HOLDING AND DECISION: (Hand, J.) Yes. Foreign bonds must be registered with the SEC (P). This is required under the Securities Act of 1933 to protect the ultimate purchasers. The Committee (D) solicited funds to purchase these bonds for value. It is immaterial whether or not they were authorized to act for the Chinese government or whether it merely accepted the benefits of their unauthorized activities. In any event, the Committee (D) was participating in the sale of an unregistered security between the issuer and a purchaser. This brings the Committee (D) within the definition of an underwriter under §5 of the Securities Act of 1933. This section applies to the entire transaction in the sale of the security. It cannot, as urged by the Committee (D), be broken up into its component parts. The Committee's (D) activities were a necessary part of the sale and it acted as an underwriter. The order of the district court is reversed and the Committee's (D) activities are enjoined until such time as the bonds have been registered. Reversed with directions.

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United States v. Wolfson

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NATURE OF CASE: Appeal of conviction for violation of federal securities laws.
FACT SUMMARY: Wolfson (D) and his associates, controlling shareholders in a corporation, utilized brokers to effect the sale of unregistered shares.
RULE OF LAW:
Controlling shareholders who utilize brokers to effect the sale of unregistered shares are in violation of the Securities Act.
FACTS: Wolfson (D) and several associates owned a de facto controlling block of shares of Continental Enterprises, Inc. Over a period of time, Wolfson (D) and his associates, through several brokers, sold large blocks of unregistered Continental stock. The Justice Department instituted a criminal action against Wolfson (D) and his associates for violating registration provisions of the Securities Act. They were convicted and appealed.
ISSUE: Are controlling shareholders who utilize brokers to effect the sale of unregistered shares in violation of the Securities Act?
HOLDINGA ND DECISION: (Woodbury, J.) Yes. Controlling shareholders who utilize brokers to effect the sale of unregistered shares are in violation of the Securities Act. Section 5(a) of the Act makes it unlawful for any person to effect the sale of an unregistered security in a transaction involving an issuer, underwriter, or dealer. Wolfson (D) argued that the brokers were in fact not issuers, underwriters, or dealers. However, "underwriter" is statutorily defined as anyone who purchases from an issuer with a view to distribution. "Issuer" is defined at §2(11) to include individuals controlling an issuer. Here, since Wolfson (D) controlled Continental, the brokers who bought from him were underwriters, and the transaction fell within the ambit of the Act. Affirmed.

10/18/2011 11:01 AM
• D owned 40%of the company.
• Court says the transaction is exempt, not the players.
• D was a control person, therefore an issuer.
• This was a distribution(public offering) and therefore needs to be registered.

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502(d)

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Limitations on resale. Except as provided in Rule 504(b)(1), securities acquired in a transaction under Regulation D shall have the status of securities acquired in a transaction under section 4(2) of the Act and cannot be resold without registration under the Act or an exemption therefrom. The issuer shall exercise reasonable care to assure that the purchasers of the securities are not underwriters within the meaning of section 2(a)(11) of the Act, which reasonable care may be demonstrated by the following:

Reasonable inquiry to determine if the purchaser is acquiring the securities for himself or for other persons;

Written disclosure to each purchaser prior to sale that the securities have not been registered under the Act and, therefore, cannot be resold unless they are registered under the Act or unless an exemption from registration is available; and

Placement of a legend on the certificate or other document that evidences the securities stating that the securities have not been registered under the Act and setting forth or referring to the restrictions on transferability and sale of the securities.

While taking these actions will establish the requisite reasonable care, it is not the exclusive method to demonstrate such care. Other actions by the issuer may satisfy this provision. In addition, Rule 502(b)2(vii) requires the delivery of written disclosure of the limitations on resale to investors in certain instances.

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Intrastate Offering Exemption

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3(a)(11) ○ Exempts securities offered and sold to only residents within a State, as long as issuer is doing at least 80 percent of its business within that State.
○ The entire issue of securities must be offered and sold exclusively to residents of the state.
○ If any part of the issue is offered and sold to a nonresident, the exemption is unavailable not only for the securities so sold, but for all securities forming a part of the issue, including those sold to residents.

Any security which is a part of an issue offered and sold only to persons resident within a single State or Territory, where the issuer of such security is a person resident and doing business within or, if a corporation, incorporated by and doing business within, such State or Territory.

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• Doing Business Within the State Requirement

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○ Performing substantial operational activities in the State of incorporation.
○ Not satisfied by functions in the State such as bookkeeping, stock record and similar activities or by offering securities in such State.
○ Cannot be used if proceeds are to be used primarily for out of state business.
1) Not only should the business be located within the State,
2) but the principal or predominant business must be carried on there and
3) Substantially all of the proceeds of the offering must be put to use within the local area.

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Resales for 3(a)(11)

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○ Cannot be made to nonresidents, but
○ Can be resold to nonresidents after enough time has passed.
○ If resales are done prior to the completion of the offering, the transfer of securities to a nonresident will undermine the validity of the original placement.
§ Rule 147 provides a safe harbor in the form of a 9 month holding period after last sale of security during the issue before securities may be sold to nonresidents.

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• 147 Safe Harbor

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Used to clarify 3(a)(11) - Part of an Issue

○ Going to look at these factors and determine if the securities warrant the exception. One or more factor may be determinative.
1) Are the offerings part of a single plan of financing;
2) Do the offerings involve issuance of the same class of security;
3) Are the offerings made at or about the same time;
4) Is the same type of consideration to be received; and
5) Are the offerings made for the same general purpose.

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§3(b)

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no issue of securities shall be exempted under this subsection where the aggregate amount at which such issue is offered to the public exceeds $5,000,000.

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Regulation D

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Rules Governing the Limited Offer and Sale of Securities Without Registration Under the Securities Act of 1933

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Accredited investor.

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Accredited investor. Accredited investor shall mean any person who comes within any of the following categories, or who the issuer reasonably believes comes within any of the following categories, at the time of the sale of the securities to that person:

501(a)(1)-(3) - bank, employee benefit plan with over $5,000,000 in assets; private business development company under 202(a)(22) of the 40’ Act; Charitable (501(c)(3)) organization with assets exceeding $5,000,000

501(a)(4) – director, executive officer or general partner of issuer (or an office or stakeholder of this level of a general partner of the issuer)

501(a)(5)(6) – natural persons with a net worth (or joint net worth with spouse) of more than $1,000,000 exclusive of value of primary residence (Dodd Frank 413(a)); any natural person with income of more than $200,000 in each of the 2 most recent years or ($300,000 together with spouse) and a reasonable expectation of the same income.

501(a)(7) – Trust with total assets of $5,000,000

501(8) – An entity in which all investors are themselves accredited investors

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504 Offering (3(b))

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Exemption for Limited Offers and Sales of Securities Not Exceeding $1,000,000.

The aggregate offering price for an offering of securities under this Rule 504, as defined in Rule 501(c), shall not exceed $1,000,000, less the aggregate offering price for all securities sold within the twelve months before the start of and during the offering of securities under this Rule 504, in reliance on any exemption under section 3(b), or in violation of section 5(a) of the Securities Act.

4. Rule 504 Qualifications
a. May not be a 34 Act reporting co, investment or blank check co.
i. Basically only small companies
b. Up to $1mil. in aggregate offering
i. But must reduce offering by amount of other offerings done under §3(b) or in violation of §5 w/in past 12 month
c. Unlimited number of purchasers
d. No disclosure requirements – R. 502(b)
e. Other benefits unique to 504 – if the security complies w/ state law registration requirements then:
i. Purchasers don’t have to register the security to resell it
ii. Issuers may engage in gen’l solicitations


Aggregate Offering Price 501(c) $1,000,000
Number of Purchasers No limit
Information Requirement None
Manner of Offering 504(b)(1)
(certain offerings exempt from 502(c) requirements, otherwise required)

Limitation on Resale - 504(b)(1)
(certain offerings exempt from 502(d) requirements, otherwise required)
Integration: Subject to integration factors
(6 mo. per.) 502(a)
File Notice of Sale Must File Form D

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505 Offering (3(b))

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Exemption for Limited Offers and Sales of Securities Not Exceeding $5,000,000.

5. Rule 505 Qualifications
a. May not be a an investment co.
i. All 34 Act reporting co. are eligible
b. Up to $5mil. in aggregate offering
i. But must reduce offering by amount of other offerings done under §3(b) or in violation of §5 w/in past 12 month
c. Only have 35 non-accredited purchasers
i. Accredited purchasers and live in relatives don’t count as purchasers
d. Some limited disclosure – R. 502(b)
e. Disqualification if the issuer, affiliate, UW, officer/director, or 10% owner has been involved in specified conduct which violates securities laws

Information Requirement: For Non-Accredited investors (certain fin. information required for offerings up to $2,000,000 and for offerings up to $7,500,000 (which would include the 2-5 million offering)) 502(b)

Manner of Offering: No general solicitation
- No general advertising
- No general invitations to seminars
- 502(c)


Limitation on Resale:In order to resell – must have another exemption absent registration and issuer must take “reasonable care” to comply 502(d)

Integration: Subject to integration factors
(6 mo. per.) 502(a)

File of Notice of Sale: Must File Form D

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506 Offering (4(2))

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Exemption for Limited Offers and Sales Without Regard to Dollar Amount of Offering.

a. All issuers eligible
b. No limit on offering amounts
c. No more than 35 non-accredited investors (Note non-accredited investors must be sophisticated or have a purchaser- representative 506(b)(2)(i) (ii) (See 501(h) for definition of purchaser rep.))
d. Information Requirement: For Non-Accredited investors (certain fin. information required for offerings up to $2,000,000 and for offerings up to $7,500,000, and for offerings exceeding $7,500,000
502(b)
e. Manner of Offering: No general solicitation
- No general advertising
- No general invitations to seminars
- 502(c)
f. Limitations on Resale: In order to resell – must have another exemption absent registration and issuer must take “reasonable care” to comply 502(d)
g. Integration: Subject to integration factors
(6 mo. per.) 502(a)

f. Must File Form D (Rule 503)

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502(c) prohibition on gen’l solicitations

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prohibition on making gen’l solicitations on any of the Reg. D offerings (this is the biggie)
a. This only applies if solicitation is arguably gen’l – offer to a handful of ppl is fine even if you don’t know them.
b. If solicitation is arguably gen’l then:
i. Kenman Corp. - Must be a pre-existing relationship the type which issuer can determine if offeree is sophisticated
ii. Note - meeting where attendees have been invited by a gen’l solicitation also counts – R. 502(c)(2).
c. Can get around this by creating a stable of clients prior to offering

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b. Rule 503

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Must file a Form D w/ SEC w/in 15 day of first sale
i. If ct. has ordered an injunction from violation → can’t use Reg. D

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SEC v. Ralston Purina Co.

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NATURE OF CASE: Action to enjoin the unregistered offerings of stock under the Securities Act of 1933.
FACT SUMMARY: Ralston Purina (D) offered treasury stock to their key employees which the Securities and Exchange Commission (SEC) (P) attempted to enjoin.
RULE OF LAW:
The exemption in §4(1) of the Securities Act of 1933, which exempts transactions by an issuer not involving any public offering from the registration requirement, applies only when all the offerees have access to the same kind of information that the Act would make available if registration were required.

ISSUE: Does an offer of stock by a company to a limited number of its employees automatically qualify for the exemption for transactions not involving any public offering?
HOLDING AND DECISION: (Clark, J.) No. The Securities Act does not define a private offering or what is a public offering. It is clear that an offer need not be open to the whole world to qualify as a public offering. If Ralston Purina (D) had made the stock offer to all of its employees, it would have been a public offering. The court looked at the intent of the Securities Act, which is to protect investors by promoting full disclosure of information thought to be necessary for informed investment decisions. When the Act grants an exemption, the class of people involved, were not considered as needing the disclosure that the Act normally requires. Therefore, when an offering is made to people who can fend for themselves, the transaction is considered to be one not involving a public offering. Most of the employees purchasing the stock from Ralston Purina (D) were not in a position to know or have access to the kind of information which registration under the Act would disclose, and, therefore, were in need of the protection of the Act. Stock offers made to employees may qualify for the exemption if the employees are executive personnel who, because of their position, have access to the same kind of information that the Act would make available in the form of a registration statement. Absent such a showing of special circumstances, employees are just as much members of the investing public as any of their neighbors in the community. The burden of proof is on the issuer of the stock, who is claiming an exemption to show that he qualifies for the exemption. Also, since the right to an exemption depends on the knowledge of the offerees, the issuer's motives are irrelevant. It didn't matter that Ralston Purina's (D) motives may have been good because they didn't show that their employees had the requisite information. Therefore, judgment reversed.

10/24/2011 11:46 AM
• Offering a lot of shares. Seems like a lot.
• The randomness also doesn't seem like a private offering.
• Court uses the "fend for themselves" test.
○ Employees did not understand the risks and the importance of diversification.

• Court rejects the numerical test and focus on the "fend for themselves" test.

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• Determining the Aggregate Offering Price in Offerings Under Rules 504, 505

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○ 504 & 505 limit the aggregate offering price on offerings within any 12-month period.
○ The Maximum aggregate offering price is lowered by the amount of any other securities sold within specified time periods in reliance upon any of the Sec 3(b) exemptions.
○ Aggregation occurs with respect to offerings pursuant to any of the sec 3(b) exemptions that take place within the 12-month period preceding the start of the offering under Rule 504 or 505.

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• Integration

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○ Means that two ostensibly distinct offerings will be treated as one for purposes of determining the availability of an exemption from registration requirements.
○ 502(a) - Securities offered less than 6 months before the start or six months after the completion of a Reg-D offering may be integrated with the offering (with the likely result that the conditions of the Regulation will not be satisfied) if it is part of the same issue.

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Even if questionnaires say that investors are all accredited, you have to

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wait 45 days.

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Mark v. FSC Securities Corp.

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NATURE OF CASE: Action seeking to rescind stock purchases.
FACT SUMMARY:FSC Securities (D), in a stock offering, relied on investors' own conclusions regarding their status as sophisticated investors.
RULE OF LAW:
For an issuer to rely on the safe harbor provisions of Rule 506, Regulation D, it must reasonably believe that nonaccredited investors meet sophistication standards.
FACTS: FSC Securities Corp. (FSC) (D) acted as broker-dealer on an issuance of an investment dealing with Spanish Arabian horses. In contacting potential investors, the paperwork contained language to the effect that only sophisticated investors should invest, and the subscription agreements contained a prequalifying questionnaire and required investors to warrant that they had sufficient knowledge to evaluate the investments. These affirmations were accepted by FSC (D) without anyone actually reviewing them. When the investment proved unprofitable, numerous investors (P) sued for rescission due to lack of registration. FSC (D) raised the private placement safe harbor exception of Regulation D, Rule 506, contending that the purchases (P) were sophisticated.
ISSUE: For an issuer to rely on the safe harbor provisions of Rule 506, Regulation D, must it reasonably believe that nonaccredited investors meet sophistication standards?
HOLDING AND DECISION: (Simpson, J.) Yes. For an issuer to rely on the safe harbor provisions of Rule 506, Regulation D, it must reasonably believe that nonaccredited investors meet sophistication standards. This requires that the issuer have undertaken some effort to discover the investors' levels of sophistication. To merely rely on the investors' own assertions in this regard may be sufficient. However, in this case, FSC (D) presented no testimony or evidence other than blank subscription documents that anyone at FSC (D) or the general partnership had actually seen or reviewed the documents executed by the investors (P). Therefore, FSC (D) has not satisfied the burden of proof imposed by Rule 506, that is, the issuer's reasonable belief as to the sophisticated nature of each purchaser (P).

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In the Matter of Kenman Corp.

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NATURE OF CASE: Administrative proceedings for violations of solicitation rules.
FACT SUMMARY: Kenman Securities (D) advertised an offering to individuals with no prior relationship with Kenman (D).
RULE OF LAW:
When a broker-dealer advertises an offering, the targets of any solicitation or advertisement must have a pre-existing relationship with the offeror.

ISSUE: If a broker-dealer advertises an offering, must the targets of any solicitation or advertisement have a pre-existing relationship with the offeror?
HOLDING AND DECISION: Yes. When a broker-dealer advertises an offering, the targets of any solicitation or advertisement must have a preexisting relationship with the offeror. An offering pursuant to Rule 506 must comply with the rules under Regulation D. Rule 502(c) of Reg. D precludes the offer and sale of securities "by any form of general solicitation or general advertisement." Here, Kenman (D) and Kenman Securities (D) engaged in general solicitations, so exemptions from registration and the safe harbor of Rule 506 were not available for the offerings.

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How to plead scienter

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○ You have to plead with particularity and strong inference

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E. Who Can Sue under 10b-5:

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Two limiting rules
1. “In connection with” requirement
a. P must be a purchaser or seller of a sec. (Blue Chip Stamps: P discouraged from the purchase through overly pessimistic statement had no standing)
i. 3 classes of P’s who have no standing
a. Potential purchaser who didn’t buy
b. Potential seller who didn’t sell
c. Shareholder/creditors who suffered harm b/c of fraudulent purchase/sales of insiders (insider trading)
i. But shareholders of the issuer can bring a derivative suit if the issuer was a purchaser or seller.

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F. Defendants under 10b-5

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1. Lang. of rule: “any person” who violates “directly or indirectly” is liable
2. Who is a secondary violator?
a. No aiding and abetting liability in private cause of action (Central Bank)
i. Aiding and abetting not covered by plain lang. (congressional intent)
a. None of the other private actions cover aiding and abetting
ii. Worry about providing too much deterrence
a. aiding and abetting is broader than indirect violations
b. discourage 3d ptys from providing advice
b. Central Bank essentially eliminates secondary violators
3. Who is primary violator – “ANY person” who:
a. Employs an agent to commit the fraud/misrep. (e.g., business entities)
b. Otherwise, two different tests used by court
i. Bright Line (2d Cir Ernst & Young)
a. Statement must be directly attributable to D to be primary violator
i. D friendly test – no matter how strong D’s scienter is, if didn’t directly make the statement then no liability
ii. Substantial Participant (9th Cir.)
a. 3d pty may be primarily liable for statements made by others if “significant participation” in making the statement
i. similar to a “but for” inquiry
ii. ex. accountant who helped draft a ltr. sent to SEC
iii. Third test created by Enron judge
a. If 3d pty was involved in created the fraudulent transaction AND has scienter → primary violator
iv. This entire inquiry is trying to find a balance b/t compensation goal (deep pocket D’s help P), deterrence goal (want to deter but don’t want to discourage some socially desirable activity), and limiting friv. suits

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G. Elements of 10b-5 cause of action

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1. Conduct by D – two choices
---------------a. manipulative or deceptive (lang. for §10(b)) AND
-------------------------i. scheme or device to defraud (language of (a)) OR
------------------------ii. act, practice, or course of biz which operates to defraud (lang. of (d)).
------------------------iii. Sante Fe Industries – breach of fid. duty not enough w/out it being manipulative or deceptive b/c plain breach of fid. duty is state law claim – don’t want to expand into state law (primary concern).
---------------b. materially false statement, misstatement, or omissions (lang of (b) and (c))
------------------------i. Must be material
------------------------ii. Duty to correct?
--------------------------------a. Yes, if statement incorrect when made
------------------------------------------i. no scienter inquiry into why original statement incorrect
--------------------------------b. Split if correct when made then later becomes incorrect (updating)
------------------------------------------i. 7th Cir – no duty to update at least until next periodic disclsoure
------------------------------------------------------a. not update isn’t manipulation, it’s neg’l
------------------------------------------------------b. requiring continuous discl. infringes on periodic discl. rules
------------------------------------------------------c. can’t correct a statement that wasn’t incorrect when made
-----------------------------------------ii. 2nd Cir – maybe if prior statement “alive”/forward looking
-------------------------------c. No, if statement made by a 3d pty unless D becomes “entagled”
------------------------iii. PSLRA Safe Harbor for forward looking statements - §21E
-------------------------------a. Forward looking statement is not material if include cautionary warning not to rely (codification of Bespeaks doctrine)

2. Scienter

3. Reliance (only private P’s have to prove, not the SEC)
----------------------a. Omissions - where there is a duty to disclose, and D makes an omission, P’s reliance is PRESUMED (don’t have to prove)
----------------------b. Misrepresentations – P does not have to have been a recipient of the misrepresentation to rely on it (can also prove face to face reliance). Must be material.

4. Loss Causation
----------------------a. §21D(b)(4) – in any 34 Act violation P had burden of proving D’s act/omission caused the loss
--------------------------------i. This is proximate cause inquiry – P must show price inflated b/c misrepresentation AND price dropped b/c truth leaked to mkt
-------------------------------ii. Proving price was artificially inflated alone is not enough b/c:
--------------------------------------a. If P sells b/f price drops (truth disseminated) then no loss
--------------------------------------b. Price may drop, not b/c truth of misstatement leaked, but b/c of other economic or mkt factors

5) Loss Incurred

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5. Damages

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a. Factually similar to loss causation, but quantitative focus
b. Two diff. goals being accomplished
i. Deterrence – make sanction just greater than D’s benefit/social harm
a. sanction must be greater than benefit b/c prob. of getting caught is less than 100% (Sanct’n X Prob. must be > Expected benefit/harm)
ii. Compensation – pay P back for out of pocket expenses
c. Remedies/damage calculation possibilities
i. Out of pocket expenses: Price sold at – actual value at time of sale
a. When applicable
i. FOM – some misstatement which causes stock price to artificially rise then drop when truth is disseminated
ii. Face to face transactions
iii. This is the typical rule

ii. Disgorgement – D gives D’s profits to P
a. When applicable
i. When D’s profits are greater than P’s losses
ii. Face to face and Open mkt
b. Problems
i. Serves deterrence by way overcompensates P

iii. Rescission – put P back in position would have been if no fraud
a. Can be return of security, return of purchase price, or purchase price – sale price (until P found out about the fraud)
b. When applicable
i. Fraud in the inducement (including lie about risks involved)
ii. Face to face transactions only

iv. Benefit of the bargain: Value promised – value received
a. When applicable
i. Must show “value promised” with certainty (rare)
a. unusually only to prevent unjust enrichment
ii. Face to face transactions only

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Tellabs, Inc. v. Makor Issues & Rights, Ltd.

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• Pleading Scienter. Under the Private Securities Litigation Reform Act of 1995 (PSLRA), to qualify as "strong" within the intendment of §21D(b)(2), an inference of scienter must be found by a reasonable person to be cogent and at least as compelling as any opposing inference of nonfraudulent intent.

NATURE OF CASE: Appeal from reversal of dismissal of action brought under the Private Securities Litigation Reform Act of 1995 for securities fraud.
FACT SUMMARY: Shareholders (P) of Tellabs, Inc. (Tellabs) (D), who brought suit under the Private Securities Litigation Reform Act of 1995 (PSLRA) claiming that Tellabs (D) and its officers (D) had intentionally deceived investors about the true value of the company's stock, contended that they had pled with particularity facts giving rise to a "strong inference" that Tellabs (D) and the officers (D) had acted with the required scienter.
RULE OF LAW:
Under the Private Securities Litigation Reform Act of 1995 (PSLRA), to qualify as "strong" within the intendment of §21D(b)(2), an inference of scienter must be found by a reasonable person to be cogent and at least as compelling as any opposing inference of nonfraudulent intent.

ISSUE: Under the Private Securities Litigation Reform Act of 1995 (PSLRA), to qualify as "strong" within the intendment of §21D(b)(2), must an inference of scienter be found by a reasonable person to be cogent and at least as compelling as any opposing inference of nonfraudulent intent?
HOLDING AND DECISION: (Ginsburg, J.) Yes. Under the Private Securities Litigation Reform Act of 1995 (PSLRA), to qualify as "strong" within the intendment of §21D(b)(2), an inference of scienter must be found by a reasonable person to be cogent and at least as compelling as any opposing inference of nonfraudulent intent. As a check against abusive litigation in private securities fraud actions, PSLRA includes exacting pleading requirements that require plaintiffs to state with particularity both the facts constituting the alleged violation, and the facts evidencing scienter, i.e., the defendant's intention "to deceive, manipulate, or defraud." As set out in §21D(b)(2), plaintiffs must "state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind." However, Congress left the key term "strong inference" undefined. The key issue in this case is whether the Court of Appeals' formulation of that term is adequate; it is not, because it does not capture the stricter demand Congress sought to convey by its use of that term. Congress did not shed much light on what facts would create a strong inference or how courts could determine the existence of the requisite inference. With no clear guide from Congress other than its intention to strengthen existing pleading requirements, Courts of Appeals have diverged in construing the term "strong inference." Among the uncertainties are whether courts should consider competing inferences in determining whether an inference of scienter is "strong." Thus, the Court's task is to prescribe a workable construction of the "strong inference" standard that promotes the PSLRA's twin goals of curbing frivolous, lawyer-driven litigation, while preserving investors' ability to recover on meritorious claims. The Court establishes the following prescriptions: First, faced with a motion to dismiss a §10(b) action, courts must, as with any motion to dismiss for failure to plead a claim on which relief can be granted, accept all factual allegations in the complaint as true. Second, courts must consider the complaint in its entirety, as well as other sources courts ordinarily examine when ruling on motions to dismiss. The inquiry is whether all of the facts alleged, taken collectively, give rise to a strong inference of scienter, not whether any individual allegation, scrutinized in isolation, meets that standard. Third, in determining whether the pleaded facts give rise to a "strong" inference of scienter, the court must take into account plausible opposing inferences. The Court of Appeals expressly declined to engage in such a comparative inquiry, but Congress did not merely require plaintiffs to allege facts from which an inference of scienter rationally could be drawn. Instead, Congress required plaintiffs to plead with particularity facts that give rise to a "strong" —i.e., a powerful or cogent—inference. To determine whether the plaintiff has alleged facts giving rise to the requisite "strong inference," a court must consider plausible, nonculpable explanations for the defendant's conduct, as well as inferences favoring the plaintiff. The inference that the defendant acted with scienter need not be irrefutable, but it must be more than merely "reasonable" or "permissible" —it must be cogent and compelling. In this way, the inference is "strong" in light of other explanations. Tellabs (D) contends that when competing inferences are considered, as per this formulation, Notebaert's (D) evident lack of pecuniary motive will be dispositive. While motive can be a relevant consideration, and personal financial gain may weigh heavily in favor of a scienter inference, the absence of such a motive is not fatal. Because allegations must be considered collectively, the significance that can be ascribed to an allegation of motive, or lack thereof, depends on the entirety of all the facts alleged. Finally, The court of appeals was unduly concerned that a court's comparative assessment of plausible inferences would impinge upon the Seventh Amendment right to jury trial. Congress, as creator of federal statutory claims, has power to prescribe what must be pleaded to state the claim, just as it has power to determine what must be proved to prevail on the merits. It is Congress's prerogative, therefore, to allow, disallow, or shape the contours of §10(b) private actions, including the pleading and proof requirements thereof. Vacated and remanded.

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Possible Exceptions to the Privilege Not to Disclose:

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○ Half-truths (avoid half-truths)
○ Duty to Update (when an issuer makes a statement that is true when released, it assumes a duty to revise or update that statement to reflect subsequent events so long as the original statement remains "alive" - that is still being relied on in the marketplace.)
○ Duty to Correct
○ Fiduciary Duty
○ Listing Standards of Various Stock Exchanges may require a duty to disclose.

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In re Time-Warner Securities Litigation

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NATURE OF CASE: Appeal from the dismissal of a securities fraud complaint.
FACT SUMMARY: After Time-Warner (D) made public statements in connection with various methods it put forward as a means of reducing its debt, shareholders (P) filed an action for securities fraud, alleging that Time-Warner (D) had made material misrepresentations and omissions in its public statements.
RULE OF LAW:
A duty to disclose arises whenever secret information renders prior public statements materially misleading, not merely when that information completely negates the public statements.

ISSUE: Does a duty to disclose arise whenever secret information renders prior public statements materially misleading, not merely when that information completely negates the public statements?
HOLDING AND DECISION: (Newman, J.) Yes. A duty to disclose arises whenever secret information renders prior public statements materially misleading, not merely when that information completely negates the public statements. None of the statements made by Time-Warner (D) constitutes an affirmative misrepresentation. However, the allegations of nondisclosure are more serious. Whether consideration of the alternative approach constitutes material information and whether its nondisclosure renders the original disclosure misleading remain questions for the trier of fact. An omission is actionable under the securities laws only when the corporation is subject to a duty to disclose the omitted facts. When, as here, a corporation pursuing a specific business goal announces an intended approach for reaching it, the corporation may be obligated to disclose other approaches which are under active and serious consideration. The allegations of nondisclosure and of a motive theory indicating scienter are sufficient to withstand a motion to dismiss. Reversed in part, affirmed in part, and remanded.

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Gallagher v. Abbott Laboratories, Inc.

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NATURE OF CASE: Appeal in class action for fraud under §10(b) of the Securities Exchange Act of 1934 and Rule 10b-5.
FACT SUMMARY:A class of shareholders (P) of Abbott Laboratories, Inc. (Abbott) (D) claimed that Abbott (D) committed fraud under §10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 by deferring public revelation of actions taken against it by the Food and Drug Administration (FDA), instead of revealing such actions immediately.
RULE OF LAW:
Firms do not have a duty of continuous disclosure under the federal securities laws.

ISSUE: Do firms have a duty of continuous disclosure under the federal securities laws?
HOLDING AND DECISION: (Easterbrook, J.) No. Firms do not have a duty of continuous disclosure under the federal securities laws. The securities laws do not impose a system of continuous disclosure. Instead, firms are entitled to keep silent about both good and bad news unless positive law creates a duty to disclose. The 1933 Act requires firms to reveal information only when they issue securities directly or through an underwriter. That was not the case here, as no class members purchased stock in any manner that would have triggered this disclosure duty during the period at issue. Section 13 of the Securities Exchange Act of 1934 permits the Securities and Exchange Commission (SEC) to require issuers to file annual (10-K) and other periodic (10-Q) reports. As "periodic" suggests, this does not mean "continuous." Section 13 contemplates that such reports will be snapshots of a corporation's status on or near the filing date, with updates due not when something "material" happens, but on the next prescribed filing date. Nothing in the regulations requires immediate disclosure of a firm's regulatory problems. Under current regulations, Abbott (D) did not have a duty to correct its 10-K report, because the statements made in that report, which issued before the FDA issued its letter, were accurate when made; an amendment is necessary only if the statements were incorrect when made. The duty to update, therefore, required only that Abbott (D) issue accurate disclosure statements in its next periodic report. The class (P) also failed to show that statements by White were fraudulent. These statements, at best, were puffery. They were accurate as to Abbott's (D) past performance and there was nothing to indicate that White did not honestly believe that the company's growth would continue. Thus, the class (P) has not met the requirements for pleading fraud with respect to White's statements, even if it were possible to treat as "fraud" the "predictive components in White's boosterism." [Affirmed.]

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Affiliate Ute Citizens v. United States

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NATURE OF CASE: Appeal from judgment for defendants in fraud action under Rule 10b-5.
FACT SUMMARY: Gale (D) and Haslem (D) were agents for members of a tribe of Native Americans (P) in selling shares of a tribal corporation. The tribal members (P) charged violations of Rule 10b-5 for Gale (D) and Haslem's (D) failure to disclose material information that could have influenced their decisions to sell.
RULE OF LAW:
Under Rule 10b-5, an obligation to disclose material fact and the withholding of such fact establishes the requisite element of causation in fact necessary to make out a case of fraud.

ISSUE: Under Rule 10b-5, does an obligation to disclose material fact and the withholding of such fact establish the requisite element of causation in fact necessary to make out a case of fraud?
HOLDING AND DECISION: (Blackmun, J.) Yes. Under Rule 10b-5, an obligation to disclose material fact and the withholding of such fact establishes the requisite element of causation in fact necessary to make out a case of fraud. The court of appeals' reading of Rule 10b-5 is too narrow. The first and third subparagraphs of that rule are not restricted to affirmative misrepresentations. Gale (D) and Haslem's (D) activities implicate those other subparagraphs, because they engaged in "a course of business" or a "device, scheme, or artifice that operated as a fraud upon the Indian sellers." Accordingly, they had a duty under the Rule to disclose the fact that they were market makers. It is unavailing to assert that they did not make positive representations or recommendations: the sellers had a right to know that Gale (D) and Haslem (D) were in a position to gain financially from the tribal members' (P) sales to those seeking to profit in the non-Indian market Gale (D) and Haslem (D) had developed and encouraged. Positive proof of reliance, under the circumstances of this case, was not necessary to show causation. All that is necessary is that the facts withheld are material in the sense that a reasonable investor might have considered them important in making an investment decision. The obligation to disclose, combined with the withholding of material fact, establish the requisite causation element. [Reversed on this issue.]

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AUSA Life Insurance Co. v. Ernst & Young

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NATURE OF CASE: Appeal from dismissal of a securities fraud claim.
FACT SUMMARY: In reviewing causation, the district court dismissed the case for failure to prove "loss causation."
RULE OF LAW:
Loss causation under Rule 10b-5 turns on foreseeability.

ISSUE: Was it foreseeable that E&Y's (D) lax accounting standards on JWP's behalf would cause losses to AUSA (P)?
HOLDING AND DECISION: (Oakes, J.) Yes. The loss causation inquiry in this case turns on whether JWP would have been able to make the fatal acquisition absent E&Y's (D) misstatements. The underlying policy of the securities laws to encourage corporate disclosure weighs in favor of finding loss causation here. Remand for further factual findings by the district court on the matter of foreseeability, with the instruction that foreseeability findings turn on fairness, policy and a "rough sense of justice."

• Judges are looking at three different questions:
1) Would the truth in financial have made it less likely that the business could have gone forward?
2) Was it foreseeable that the business statements would have caused the loss? This answer is too remote, and it doesn't shed light on proximate cause.
3) Would the disclosure have put P on notice of other possible risk taking? This would cast a wide note, imposing liability to disclose on any risk taking.

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Dura Pharmaceuticals Inc. v. Broudo

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NATURE OF CASE: Appeal from order reversing dismissal—for failure to state loss causation—of a complaint in a securities fraud class action.
FACT SUMMARY: Dura Pharmaceuticals, Inc. (Dura) (D) asserted that investors (P) who had filed a securities fraud class action had not alleged or proved "loss causation" in their complaint, which only claimed that the price of Dura (D) stock on the date of purchase was inflated because of misrepresentations.
RULE OF LAW:
An inflated purchase price will not by itself constitute or proximately cause the relevant economic loss needed to allege and prove "loss causation."

ISSUE: Will an inflated purchase price by itself constitute or proximately cause the relevant economic loss needed to allege and prove "loss causation" ?
HOLDING AND DECISION: (Breyer, J.) No. An inflated purchase price will not by itself constitute or proximately cause the relevant economic loss needed to allege and prove "loss causation." Normally, in fraud-on-the-market cases such as this one, an inflated purchase price will not itself constitute or proximately cause the relevant economic loss. First, as a matter of pure logic, the moment the transaction takes place, the plaintiff has suffered no loss because the inflated purchase price is offset by ownership of a share that possesses equivalent value at that instant. Additionally, the logical link between the inflated purchase price and any later economic loss is not invariably strong since other factors may affect the price. Thus, the most logic alone permits one to conclude is that the inflated purchase price suggests that misrepresentation "touches upon" a later economic loss, as the court of appeals found. However, to touch upon a loss is not to cause a loss, and it is the latter that is required bylaw. The court of appeals' holding also is not supported by precedent. The common-law deceit and misrepresentation actions that private securities fraud actions resemble require a plaintiff to show not only that had he known the truth he would not have acted, but also that he suffered actual economic loss. Nor can the holding below be reconciled with the views of other courts of appeals, which have rejected the inflated purchase price approach to showing loss causation. Finally, the court of appeals' approach is inconsistent with an important securities law objective: to promote public confidence in the marketplace. They do so by deterring fraud, in part, through the availability of private securities fraud actions. The securities laws make clear Congress's intent to permit private securities fraud actions only where plaintiffs adequately allege and prove the traditional elements of cause and loss, but the court of appeals' approach would allow recovery where a misrepresentation leads to an inflated purchase price but does not proximately cause any economic loss. Here, given a plaintiff's need to prove proximate causation and economic loss, the investors' (P) complaint failed adequately to allege these requirements. The complaint here contains only the allegation that their loss consisted of artificially inflated purchase prices. However, as concluded here, such a price is not itself a relevant economic loss. And the complaint nowhere else provides Dura (D) with notice of what the relevant loss might be or of what the causal connection might be between that loss and the misrepresentation. Thus, it does not even satisfy the Federal Rules of Civil Procedure's requirement of "a short and plain statement of the claim showing that the pleader is entitled to relief." Ordinary pleading rules are not meant to impose a great burden on a plaintiff, but it should not prove burdensome for a plaintiff suffering economic loss to provide a defendant with some indication of the loss and the causal connection that the plaintiff has in mind. Allowing a plaintiff to forgo giving any indication of the economic loss and proximate cause would bring about the very sort of harm the securities statutes seek to avoid, namely the abusive practice of filing lawsuits with only a faint hope that discovery might lead to some plausible cause of action. Reversed and remanded.

• Durra
○ How do you show materiality if there's no price drop? Have to show the loss causation has to relate to conduct alleged.
○ In fraud-on-the market, there's bad news revealed and price drops.
○ How do you separate the causal connection where bad news is revealed in a bundle?
§ Look at how analysts(3rd party objective parties) are reacting to the news and how are they going to separate it out.
§ Do a comparative analyses and see how other companies reacted to similar news.

○ What do you have to show for loss causation:
§ Actual loss
§ Information in the market caused price fluctuation

○ How are you going to make the connection for proximate causation:
§ Look at needs of investors(i.e. cash flow).
§ What were the damages suffered?
§ Then make the connection.

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Stoneridge Investment Partners, LLC. v. Scientific-Atlanta, Inc.,

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"Scheme Liability."
For purposes of a private cause of action under §10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5, a third-party customer/supplier of a company is not a primary participant, even though its deceptive acts are part of a scheme to defraud investors, where the investors have not relied on the third-party customer/supplier's acts. (Stoneridge Investment Partners, LLC v. Scientific-Atlanta, Inc.)

NATURE OF CASE: Appeal from affirmance of dismissal of private cause of action for violation of §10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5.
FACT SUMMARY: Investor (P) in Charter contended that Charter's customers/suppliers (D) violated §10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5 by agreeing to arrangements that allowed Charter to mislead its auditor and issue a misleading financial statement affecting its stock price.
RULE OF LAW:
For purposes of a private cause of action under §10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5, a third-party customer/supplier of a company is not a primary participant, even though its deceptive acts are part of a scheme to defraud investors, where the investors have not relied on the third-party customer/supplier's acts.

ISSUE: For purposes of a private cause of action under §10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5, is a third-party customer/supplier of a company a primary participant, even though its deceptive acts are part of a scheme to defraud investors, where the investors have not relied on the third-party customer/supplier's acts?
HOLDING AND DECISION: (Kennedy, J.) No. For purposes of a private cause of action under §10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5, a third-party customer/supplier of a company is not a primary participant, even though its deceptive acts are part of a scheme to defraud investors, where the investors have not relied on the third-party customer/supplier's acts. First, precedent in Central Bank of Denver, N. A. v. First Interstate Bank of Denver, N. A., 511 U.S. 164, (1994), established that §10(b) liability does not extend to aiders and abettors. Therefore, the investors (P) must prove reliance on the customer/suppliers' (D) deceptive acts, since reliance is an element of a §10(b) cause of action. A rebuttable presumption of reliance has been found in two circumstances. First, if there is an omission of a material fact by one with a duty to disclose, the investor to whom the duty was owed need not provide specific proof of reliance. Second, under the fraud-on-the-market doctrine, reliance is presumed when the statements at issue become public. Neither presumption applies here, since the customer/suppliers (D) had no duty to disclose and their deceptive acts were not communicated to the investing public during the relevant times. The investors (P), as a result, cannot show reliance upon any of the customer/suppliers' (D) actions except in an indirect chain that is too remote for liability.
The investors' (P) reference to so-called "scheme liability" does not, absent a public statement, answer the objection that they did not in fact rely upon the customer/suppliers' (D) deceptive conduct. Were this concept of reliance to be adopted—i.e., that in an efficient market investors rely not only upon the public statements relating to a security but also upon the transactions those statements reflect—the implied cause of action would reach the whole marketplace in which the issuing company does business. There is no authority for this rule. The customer/suppliers' (D) deceptive acts, which were not disclosed to the investing public, are too remote to satisfy the reliance requirement. It was Charter, not the customer/suppliers (D), which misled its auditor and filed fraudulent financial statements; nothing the customer/suppliers (D) did made it necessary or inevitable for Charter to record the transactions as it did. The Court's precedents counsel against investor's attempt to extend the §10(b) private cause of action beyond the securities markets into the realm of ordinary business operations, which are governed, for the most part, by state law. See, e.g., Marine Bank v. Weaver, 455 U.S. 551, 556 (1982). The investors' (P) theory, moreover, would put an unsupportable interpretation on Congress's specific response to Central Bank in PSLRA §104 by, in substance, reviving the implied cause of action against most aiders and abettors and thereby undermining Congress's determination that this class of defendants should be pursued only by the SEC. The practical consequences of such an expansion provide a further reason to reject investor's approach. The extensive discovery and the potential for uncertainty and disruption in a lawsuit could allow plaintiffs with weak claims to extort settlements from innocent companies. It would also expose to such risks a new class of defendants—overseas firms with no other exposure to U.S. securities laws—thereby deterring them from doing business here, raising the cost of being a publicly traded company under U.S. law, and shifting securities offerings away from domestic capital markets. Moreover, the history of the §10(b) private right of action and the careful approach the Court has taken before proceeding without congressional direction provide further reasons to find no liability here. The §10(b) private cause of action is a judicial construct that Congress did not direct in the text of the relevant statutes; thus, caution must be used against expanding it judicially. If it is to be extended, it must be extended by Congress. Finally, secondary actors, such as the customer/suppliers (D) here, are subject to criminal penalties and civil enforcement by the SEC. Affirmed and remanded.


○ The material misstatement here was the accounting fraud.
○ Who seems more responsible for the actual fraud: the stoneridge suppliers.
○ Court said suppliers didn't owe a duty to charter shareholders; they didn't disseminate fraudulent accounting statements.
○ What acts are too remote to constitute detrimental reliance:
§ Unless there's a statement out there attributable to this 3rd party, then it's just aiding & abetting.

○ There must be reliance & duty to disclose.
○ You need causation in order to prevent erroneous law suits & to prevent companies from constantly worrying about liability.

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Wright v. Ernst & Young LLP

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Primary Participants.
Aiding and abetting by a secondary actor in the making of a false or misleading statement is not sufficient to trigger Section 10b liability where the statement is not attributed to the secondary actor at the time of its dissemination. (Wright v. Ernst & Young LLP)


NATURE OF CASE: Appeal from dismissal of a class action alleging violations of §10b and Rule 10b-5.
FACT SUMMARY: Finding no actionable federal securities claim, the district court dismissed the class action.
RULE OF LAW:
Aiding and abetting by a secondary actor in the making of a false or misleading statement is not sufficient to trigger Section 10b liability where the statement is not attributed to the secondary actor at the time of its dissemination.

ISSUE: Is aiding and abetting by a secondary actor in the making of a false or misleading statement sufficient to trigger Section 10b liability where the statement is not attributed to the secondary actor at the time of its dissemination?
HOLDING AND DECISION: (Meskill, J.) No. Aiding and abetting by a secondary actor in the making of a false or misleading statement is not sufficient to trigger Section 10b liability where the statement is not attributed to the secondary actor at the time of its dissemination. In order to be held liable under Section 10b, one must actually make a false or misleading statement. No false or misleading statement was attributed to Ernst & Young (D) in BT's press release. Thus, Ernst & Young (D) neither directly nor indirectly communicated misrepresentations to investors. Affirmed.

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• Sec 15 of Securities Act and 20(a) of Exchange Act

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○ Hold control persons liable to the same extent as the person they control.

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• Affirmative Defense for control person

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○ Under Sec 15 the control person avoids liability if it is established that "the controlling person had no knowledge of or reasonable grounds to believe in the existence of the facts" upon which the liability of the control person is alleged to exist.
○ Under Exchange Act 20(a): liability arises "unless the controlling person acted in good faith and did not directly or indirectly induce the act or acts constituting the violation or cause of action."

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• SOL for any claim of fraud, deceit, manipulation, or contrivance

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○ Must be brought not later than the earlier of "2 years after discovery of the facts constituting the violation" or "5 years after such violation."

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Culki

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○ You can rescind when the contract violates the terms of the Act
○ If the K could be performed consistent with '34 Act, then it can't rescinded pursuant to 29(b).
○ This whole transaction could have complied the Exchange Act that's why it did not satisfy 29(b) rescission.

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Donahoe v. Consolidated Operating & Production Corp.

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Control Person and Respondeat Superior Liability. On a theory of "control person" liability, the good faith defense exculpates defendants whose behavior is merely negligent.

NATURE OF CASE: Appeal of summary judgment in favor of defendants in action alleging securities violations.
FACT SUMMARY: Fifty-four investors, including Donohoe (P), were lured into investing in an ill-fated oil drilling project by an individual they claimed was controlled by shareholders Nortman (D) and Berrettini (D).
RULE OF LAW:
On a theory of "control person" liability, the good faith defense exculpates defendants whose behavior is merely negligent.

ISSUE: On a theory of "control person" liability, does the good faith defense exculpate defendants whose behavior is merely negligent?
HOLDING AND DECISION: (Cudahy, J.) Yes. On a theory of "control person" liability, the good faith defense exculpates defendants whose behavior is merely negligent. Control person liability is most generally used in a respondeat superior context to hold a brokerage house liable for the securities violations committed by its employees. Outside of that setting, a more flexible approach is used; the question to be answered is whether the control person took reasonable measures, in the particular situation, to prevent the securities violation. In this case, Nortman (D) and Berrettini (D) took steps to prevent fraud. Whether their steps were perfect is not at issue; they did enough to merit a good faith defense to control person liability. Affirmed.

• Donahue
○ For control person , court is looking at:
§ Control over day-to-day operations, and
§ How much control over this specific operation

○ Bridges had the experience and had the control over day-to-day operations. The other people weren't capable of preventing the fraud.

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Berckeley Inv. Group, Ltd. v. Colkitt

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Rescission and Restitution.
(1) For purposes of a rescission claim under §29(b) of the Securities Exchange Act of 1934, an agreement does not violate §5 of the Securities Act of 1933 where downstream sales related to the agreement are tangential to the parties' basic obligations under the agreement. (2) A party is not entitled to summary judgment against a rescission claim under §29(b) of the Securities Exchange Act of 1934, which is premised on a violation of §10(b) of that Act, where there are material issues of fact as to the moving party's intent to violate the securities laws and whether that party was reckless in its belief that it was entitled to an exemption from those laws.

NATURE OF CASE: Appeal from summary judgment granted to plaintiff on defendant's claim for rescission of a contract under Section 29(b) of the Securities Exchange Act of 1934.
FACT SUMMARY: Colkitt (D) contended that an agreement he had entered into with Berckeley Investment Group, Ltd. (Berckeley) (P), a Bahamian corporation, whereby Berckeley (P) would pay him $2 million for the right to convert discounted unregistered shares of National Medical Financial Services Corporation (NMFS), had to be rescinded under §29(b) of the Securities Exchange Act of 1934 (Exchange Act) because the agreement was made in violation of §10(b) and Rule 10b-5 of the Exchange Act and because performance of the contract violated those statutory provisions, as well as §5 of the Securities Act of 1933 (Securities Act).
RULE OF LAW:
(1) For purposes of a rescission claim under §29(b) of the Securities Exchange Act of 1934, an agreement does not violate §5 of the Securities Act of 1933 where downstream sales related to the agreement are tangential to the parties' basic obligations under the agreement.
(2) A party is not entitled to summary judgment against a rescission claim under §29(b) of the Securities Exchange Act of 1934, which is premised on a violation of §10(b) of that Act, where there are material issues of fact as to the moving party's intent to violate the securities laws and whether that party was reckless in its belief that it was entitled to an exemption from those laws.

ISSUE
(1) For purposes of a rescission claim under § 29(b) of the Securities Exchange Act of 1934, does an agreement violate §5 of the Securities Act of 1933 where downstream sales related to the agreement are tangential to the parties' basic obligations under the agreement?
(2) Is a party entitled to summary judgment against a rescission claim under § 29(b) of the Securities Exchange Act of 1934, which is premised on a violation of §10(b) of that Act, where there are material issues of fact as to the moving party's intent to violate the securities laws and whether that party was reckless in its belief that it was entitled to an exemption from those laws?
(Fisher, J.)
(1) No. For purposes of a rescission claim under §29(b) of the Securities Exchange Act of 1934, an agreement does not violate §5 of the Securities Act of 1933 where downstream sales related to the agreement are tangential to the parties' basic obligations under the agreement. To void the Agreement under §29(b), regardless of which violation he claims, Colkitt (D) must establish that: (1) the contract involved a prohibited transaction; (2) he is in contractual privity with the other party; and (3) he is in the class of persons that the securities acts were designed to protect. He must also demonstrate a direct relationship between the violation at issue and the performance of the contract; i.e., the violation must be inseparable from the performance of the contract rather than collateral or tangential to the contract. In a case involving a financing transaction virtually identical to the one here (also, incidentally, where Colkitt (D) was a party), it was held that short sales following the agreement were completely independent of the parties' respective obligations under the terms of the agreement. Other cases have supported such an interpretation where an agreement could not be performed without violating the securities laws. Here, although the Agreement contained references to §5 that allegedly induced Colkitt (D) to enter into the Agreement, Berckeley's (P) downstream sales were tangential to the parties' basic obligations under the Agreement: Berckeley's (P) obligation to loan Colkitt (D) $2 million and his obligation to provide Berckeley (P) with convertible debentures. At the time the parties entered into the Agreement, the Agreement could be performed without violating provisions of the securities laws. Therefore, even if Berckeley's (P) downstream sales of unregistered NMFS shares violated §5, those sales were too attenuated to establish a §29(b) claim. Affirmed as to this issue.
(2) No. A party is not entitled to summary judgment against a rescission claim under §29(b) of the Securities Exchange Act of 1934, which is premised on a violation of §10(b) of that Act, where there are material issues of fact as to the moving party's intent to violate the securities laws and whether that party was reckless in its belief that it was entitled to an exemption from those laws. To prove that Berckeley (P) violated §10(b) and Rule 10b-5, Colkitt (D) must prove that (1) Berckeley (P) made a misstatement of material fact, (2) with scienter, (3) in connection with the purchase or sale of a security, (4) upon which Colkitt (D) reasonably relied, and (5) that Colkitt's (D) reliance was the proximate cause of his injury. To prevail on his §29(b) claim, however, Colkitt (D) does not have to establish the reliance or causation elements of a §10(b) claim. Colkitt (D) claims that Berckeley (P) represented in the Agreement that all subsequent sales of converted NMFS shares would be made in accordance with the Securities Act's registration requirements; that Berckeley's (P) subsequent sales violated §5 of the Securities Act, and that since Berckeley (P) was an "underwriter," it was not entitled to an exemption from the registration requirements; that he relied on Berckeley's (P) representations to enter into the Agreement; and that he suffered damages as a result. As to Berckeley's (P) intent at the time it entered the Agreement, Colkitt (D) has presented evidence that it was always Berckeley's (P) intent to sell the stock in the U.S. market as soon as reasonably possible after the restricted period in the Agreement (100 to 120 days) to maximize its return. The structure of the deal, as well as a lack of evidence of a viable foreign market for the shares gives rise to an inference that Berckeley (P) intended to resell the converted shares back into the U.S. Because under the terms of the Agreement Berckeley (P) in all likelihood knew that it would be holding a large number of unregistered shares within one year from the Agreement unless it sold them as quickly as possible, and because of a lack of a foreign market, Colkitt (D) has created a material issue of fact that at the time of the Agreement, Berckeley (P) intended to resell the converted shares back into the U.S. In addition, Colkitt (D) has also adduced evidence that Berckeley (P) violated §5 of the Securities Act. The question then becomes whether he has created a material issue of fact as to whether Berckeley (P) was aware that it was not entitled to an exemption under §4(l) from the registration requirements. Section 4(1) exempts from the registration requirements "transactions by any person other than issuer, underwriter, or dealer." The issue then becomes whether Berckeley (P) was an "underwriter." Berckeley (P) can establish that it was entitled to the §4(l) exemption by proving that the acquisition of the shares was not made with a view to distribution, or that the sale of the shares was not made in connection with a "distribution" —which has been interpreted to mean a public offering. Berckeley's (P) quick turnaround sale of the converted shares at least creates an issue of fact as to whether it acquired the shares with a "view to distribution." Berckeley (P), however, can still demonstrate that it did not act as an "underwriter" if the sale of the shares was not made in connection with a "public offering," which in turn depends on whether the stock issuance was made to investors that needed the protection of the securities laws. Berckeley (P), however, has not adduced any evidence to meet its burden that it is entitled to an exemption under §4(1) because it has not shown that in the U.S.—the only market for the shares—the shares would be sold exclusively to sophisticated investors. To the contrary, by placing the shares with a broker, Berckeley (P) was selling to the highest bidder without regard to the bidder's level of investing acumen. For these reasons, the record indicates that Berckeley (P) made a misrepresentation of material fact regarding its intent to resell and its status as an underwriter. Because Colkitt (D) has raised a dispute of material fact as to whether Berckeley (P) intended to illegally resell the shares in the U.S., the next issue that must be resolved is whether Berckeley (P) had the requisite scienter to violate the §5 registration requirement at the time it entered the Agreement by being reckless in its belief that it would be entitled to a §4(l) exemption. The resolution of this issue requires understanding the interrelationship of Rule 144, Regulation S, and an SEC interpretive release relating to Regulation S. Regulation S has two safe harbor provisions, Rule 903 and Rule 904, which prohibit the resale of unregistered securities within 40 days. The SEC interpretive release clarified that Regulation S did not alter the availability of the §4(l) exemption for the resale of securities, but also explained that Regulation S was inapplicable to schemes to evade registration, even though in technical compliance with the regulation. Thus, the Regulation S safe harbors would not be available for transactions that were part of a scheme to evade registration, and a 40-day holding period could not be used to circumvent Rule 144's 2-year holding period requirement. The net effect of these interrelated rules, regulations, and interpretive releases is to create an issue of fact as to whether it would have been reckless for Berckeley (P) to rely solely on the 40-day restricted period to foreclose any possibility that it was an "underwriter" at the time it entered into the Agreement. This issue must, therefore, go to a trier of fact, which may or may not believe Berckeley's (P) explanation that the law was so unclear at the time that it did not act with scienter. Reversed and remanded as to this issue.

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• Insider Trading

Back 101

○ Refers to any unlawful trading by person possessing material nonpublic information, whether or not the trader is truly a corporate "insider"

Front 102

Chiarella v. United States

Back 102

Duty to Abstain or Disclose.
Under §10(b) of the Securities Exchange Act, a duty to disclose does not arise from the mere possession of nonpublic information.

NATURE OF CASE: Appeal from a conviction for securities fraud.

FACT SUMMARY: Chiarella (D), an employee at a financial printing business, deduced the names of target companies prior to the public announcements of takeover bids and used the information to make profits in the stock market.

RULE OF LAW:
Under §10(b) of the Securities Exchange Act, a duty to disclose does not arise from the mere possession of nonpublic information.

ISSUE: Does a duty to disclose arise from the mere possession of nonpublic information under §10(b) of the Securities Exchange Act?

HOLDING AND DECISION: (Powell, J.) No. Under §10(b) of the Securities Exchange Act, a duty to disclose does not arise from the mere possession of nonpublic information. Silence in connection with the purchase or sale of securities may operate as actionable fraud under §10(b) under certain circumstances. This liability is premised upon a duty to disclose arising from a relationship of trust between the parties to the transaction. This duty to disclose guarantees that corporate insiders will not benefit through fraudulent use of nonpublic information. However, the language of §10(b) does not support a general duty between all participants in the market to disclose all material, nonpublic information. Chiarella (D) had no relationship with the sellers of the target company's securities that he purchased. Chiarella (D) was not an agent or a fiduciary; he was a complete stranger who dealt with the sellers only through the market. Thus, Chiarella (D) had no duty under §10(b) to disclose the information he had. Therefore, Chiarella's conviction must be overturned.

○ The key to establishing a violation of the "abstain or disclose" rule is to find a fiduciary nexus between the trader and the marketplace.
○ There can be no duty to disclose where the person who has traded on inside information was not the corporation's agent, fiduciary, or was not a person in whom the sellers of the securities had placed their trust and confidence.

Front 103

US v. O'Hagan

Back 103

The Misappropriation Theory.
(1) Criminal liability under SEC Rule 10b-5 may be predicated on a theory of misappropriation. (2) Under §14e of the Securities Exchange Act of 1934, the SEC may prohibit acts, not themselves fraudulent under the common law or §10(b), if the prohibition is reasonably designed to prevent acts and practices that are fraudulent.

NATURE OF CASE: Appeal following reversal of convictions for violations of Rules 10b-5 and 14e-3(a).
FACT SUMMARY: O'Hagan (D), a partner at a Minnesota law firm that represented a company planning a tender offer of the Pillsbury Company, used information of the upcoming tender offer to make a personal profit of over four million dollars.
RULE OF LAW:
(1) Criminal liability under Securities and Exchange Commission (SEC) Rule 10b-5 may be predicated on a theory of misappropriation.(2) Under §14e of the Securities Exchange Act of 1934, the SEC may prohibit acts, not themselves fraudulent under the common law or §10(b), if the prohibition is reasonably designed to prevent acts and practices that are fraudulent.

ISSUE:
(1) May criminal liability under SEC Rule 10b-5, be predicated on a theory of misappropriation?
(2) Under §14e, may the SEC prohibit acts, not themselves fraudulent under the common law or §10b, if the prohibition is reasonably designed to prevent acts and practices that are fraudulent?
HOLDING AND DECISION: (Ginsburg, J.)
(1) Yes. Criminal liability under SEC Rule 10b-5 may be predicated on a theory of misappropriation. Under the traditional theory of insider trading liability, Rule 10b-5 is violated when a corporate insider trades in securities of his corporation on the basis of material, nonpublic information. Under the misappropriation theory, a person commits fraud in connection with a securities transaction under Rule 10b-5 when he misappropriates confidential information for securities trading purposes in breach of a duty owed to the source of the information. In lieu of premising liability on a fiduciary relationship between a company insider and purchaser or seller of the company's stock, the misappropriation theory premises liability on a fiduciary-turned-trader's deception of those who entrusted him with access to confidential information. Several courts of appeal have held that criminal liability may be predicated on a misappropriation theory, and this Court agrees. Both theories of liability under Rule 10b-5 involve the same essential elements: the deceptive use of information in connection with the purchase or sale of securities. O'Hagan (D) used private information he learned from his firm's association with Grand Met to personally profit from the Pillsbury tender offer.
(2) Yes. Under §14e of the Securities Exchange Act of 1934, the SEC may prohibit acts, not themselves fraudulent under the common law or §10b, if the prohibition is reasonably designed to prevent acts and practices that are fraudulent. The SEC did not exceed its rulemaking authority under §14(e) when it adopted Rule 14e-3(a) without requiring a showing that the trading at issue entailed a breach of fiduciary duty. Rule 14e-3(a) is a disclose-or-abstain from trading requirement as characterized by the SEC. This insider trading rule creates a duty to abstain or disclose without regard to whether the trader owes a fiduciary duty to the source of the information. O'Hagan (D) was clearly under a duty to refrain from trading because he had gained his information through the confidential relationship between his firm and Grand Net. The court of appeal's assertion that the Rule violates the SEC's rulemaking authority because of the lack of a fiduciary requirement is a misinterpretation of previous Supreme Court decisions. Furthermore, because Congress has authorized the SEC to prescribe legislative rules, their judgments should be accorded more than mere deference or weight. Reversed and remanded.

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Regulation FD

Back 104

○ Applies to communications to securities market professionals and to any holder of the issuer's securities under circumstances in which it is reasonably foreseeable that the security holder will trade on the basis of the information.
○ Issuer personnel has to know or is reckless in not knowing that information selectively disclosed is both material and nonpublic.

Reg FD prohibitions against selective disclosure
a. R. 100 – Whenever an issuer discloses material non-public info to a covered group, the issuer must make that info public
i. Applies only ’34 Act reporting companies (registered companies)
ii. “Covered” groups include:
a. broker dealers
b. investment advisors/investment companies
c. any investor in the issuer that is reasonably expected to trade on the info
iii. Not covered groups include:
a. rating agencies
b. doesn’t apply during public offering process
b. If discl. intentional → must make simultaneous discl. to public
c. If discl. unintentional → must discl. to public w/in 24 hrs. or by time trading commences on NYSE, whichever is sooner
d. R. 102 – No private cause of action

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Rule 14e-3

Back 105

○ Once a substantial step toward the commencement of a tender offer has been taken, it bars any person(other than bidder) from acquiring any securities while in possession of material information that he knows or has reason to know:
1) Is nonpublic; and
2) Was acquired from the bidder, the target, or any person associated with either one of these.
§ Breach of fiduciary duty is not a required element.
§ Anti-tipping provision. Barring the communication of material nonpublic information concerning a tender offer to persons where it is reasonably foreseeable that such communication is likely to result in unlawful trading.

unless within a reasonable time prior to any purchase or sale such information and its source are publicly disclosed by press release or otherwise.

Front 106

Dirks v. SEC

Back 106

Tippers and Tippees.
A "tippee" does not violate securities laws by trading on inside information if his sources did not reveal the information for personal gain.

NATURE OF CASE: Review of administrative censure.
FACT SUMMARY: Dirks (D), a "tippee," gave investment advice based on inside information which had been obtained from tippers not acting for personal gain.
RULE OF LAW:
A "tippee" does not violate securities laws by trading on inside information if his sources did not reveal the information for personal gain.
FACTS: Dirks (D), a stock market analyst, became aware of allegations that Equity Funding of America was in precarious financial condition due to massive fraud. He undertook an investigation. Based on information obtained from certain insiders, Dirks (D) concluded that Equity Funding was in weak financial shape and that its value would greatly diminish when the facts became known. He advised several clients to sell. Subsequently, Equity Funding's situation became known to the public and its value plummeted. The Securities and Exchange Commission (SEC) (P) undertook an investigation resulting in Dirks (D) being held by the SEC (P) to have violated Rule 10b-5 by trading on inside information. As punishment, he was censured. The Court of Appeals for the District of Columbia affirmed, and the U.S. Supreme Court granted review.
ISSUE: Does a "tippee" violate securities laws by trading on inside information if his sources did not reveal the information for personal gain?
HOLDING AND DECISION: (Powell, J.) No. A "tippee" does not violate securities laws by trading on inside information if his sources did not reveal the information for personal gain. Securities laws do not exist to guarantee equal access to information for all investors. They exist to prevent those having access to inside information from using their privileged positions for personal gain. Consequently, one who is not an insider cannot, as a usual matter, violate Rule 10b-5 for using inside information, as there is no violation of a position of trust in doing so. The exception to this rule is when the tipper/insider uses the tippee as a conduit for trading on the tipper/insider's behalf. This will occur when the tipper realizes some personal benefit by providing the information in question. Here, Dirks (D) was not an insider. There was no evidence that his sources received any benefit by providing him with information regarding Equity Funding. This being so, Dirks (D) did not violate Rule 10b-5. Reversed.

11/15/2011 10:17 AM
• Secrest still owes a duty to his former employee because it was obtained in the course of his employment.
• Not violation because Secrest wasn't benefitting from it.
• Dirks owed no duty and he wasn't providing it for a benefit, he was providing it to bring it to light.

Front 107

Sec 16

Back 107

○ Reporting obligation, imposed on officers, directors, and very person who is directly or indirectly the beneficial owner of more than 10 percent, to file with the SEC forms that indicate holdings in the issuer's stock upon achieving insider status.
○ Thereafter, most purchases or sales by the insider have to be reported by the end of the second business day following the transaction on Form 4.


○ If purchase brings you over 10%, that won't first trigger Sec 16. But subsequent purchases will.

§ Transaction that brings you below is a sale - 9.9% shareholder - you're home free.

○ Policy
§ Discloses to public of possible problems or material information concerning the company.

○ Sec 16(b) - What's the remedy?
§ Any profit

○ Sec 16 Damages
§ Even if person loses money, they will still be liable for that loss.

○ Executive Compensation
§ Is generally excluded from Sec 16

Front 108

Feder v. Frost

Back 108

The Scope of Section 16(b).

For the purposes of insider trading under Section 16(b), a beneficial owner includes statutory insiders who have an indirect pecuniary interest in the subject securities.

NATURE OF CASE: Appeal from dismissal of a Section 16(b) complaint.
FACT SUMMARY: In ruling on §16(b) complaint, the district court found that defendant did not realize any profits from the transactions at issue.
RULE OF LAW:
For the purposes of insider trading under §16(b), a beneficial owner includes statutory insiders who have an indirect pecuniary interest in the subject securities.
FACTS: Feder (P) is a shareholder of IVAX Corporation. Frost (D) is a statutory insider of IVAX. Frost (D) also controls the firm Frost-Nevada Limited Partnership (FNLP). Frost (D), along with FNLP, is a controlling shareholder of North American Vaccine, Inc. (NAVI). Various times throughout late 1995 and early 1996, Frost (D) and FNLP purchased IVAX shares and NAVI sold IVAX shares. All purchases and sales by Frost (D), FNLP, and IVAX can be matched to determine profits and, when matched, disclose substantial short-swing profits. Although the profits accrued to NAVI, Feder (P) filed a legal action against Frost (D), contending that the profits were attributed to Frost/FNLP on a pro rata basis as a result of the increase in value of their NAVI holdings. Frost/FNLP filed a 12(b)(6) motion to dismiss, which was granted below.
ISSUE: Does an indirect pecuniary interest in securities qualify an insider for liability as a beneficial owner under §16(b)?
HOLDING AND DECISION: (Winter, C.J.) Yes. An indirect pecuniary interest in securities qualifies an insider for liability as a beneficial owner under §16(b). The SEC promulgated Rule 16a-1 pursuant to its congressionally conferred power to define technical terms and issue rules appropriate to implement the Exchange Act. Rule 16a-1(a)(2) defines beneficial owner as "any person who, directly or indirectly, through any contract, arrangement, understanding, relationship or otherwise, has or shares a direct or indirect pecuniary interest in the equity securities." Frost/FNLP had an indirect pecuniary interest in NAVI's IVAX stock because they shared indirectly in NAVI's profit through an increase in the value of their NAVI holdings. Reversed.

Front 109

Texas International Airlines v. National Airlines Inc.

Back 109

The Takeover Problem.

Traditional cash-for-stock sales within the context of a takeover may form the basis for §16(b) liability.

NATURE OF CASE: Appeal from summary judgment in an action for declaratory relief and counterclaim for recovery of short-swing profits.
FACT SUMMARY: Texas International (TI) (P) sold its National (D) stock to Pan Am as part of a merger within the period of short-swing transactions covered by §16(b).
RULE OF LAW:
Traditional cash-for-stock sales within the context of a takeover may form the basis for §16(b) liability.
FACTS: In March 1979, TI (P) purchased 121,000 shares of National (D) common stock as part of an attempt to gain control of National (D). On the date of the purchase, TI (P) owned more than 10% of National (D). Approximately four months later, TI (P) and Pan American Airways entered into a stock purchase agreement whereby TI (P) agreed to sell 790,700 shares of National (D) stock to Pan Am at $50 a share. In 1978, National (D) and Pan Am had entered into a merger agreement that provided for an exchange of $50 for each share of National (D) stock. The merger agreement was to take effect in September 1979. Thus, TI (P), as a National (D) stockholder, would have received the same price for its stock under the merger agreement if it hadn't sold the National (D) stock in July 1979. Shortly after the sale, TI (P) sought declaratory relief that it was not liable to give the profits on 120,000 shares it purchased in March back to National (D). The trial court ruled for National (D), and TI (P) appealed.
ISSUE: May traditional cash-for-stock sales within the context of a takeover form the basis for §16(b) liability?
HOLDING AND DECISION: (Johnson, J.) Yes. Traditional cash-for-stock sales within the context of a takeover may form the basis for §16(b) liability. Section 16(b) imposes strict liability against insider traders who purchase and sell securities within a six-month period. Persons or companies that own more than 10% of a company's stock are considered insiders for purposes of §16(b). Congress intended that insiders should disgorge profits based upon access to confidential information. In Kern CountyLand Co. v. Occidental Petroleum Corp., 411 U.S. 582 (1973), the Supreme Court approved a narrow exception to §16(b) for unorthodox transactions such as hostile takeovers. In these transactions, the Court held that liability should only be imposed where there was access to confidential information. However, unorthodox transactions under Kern County do not include traditional cash-for-stock sales because these transactions are purely voluntary. Here, TI (P) voluntarily entered into the transaction with Pan Am before the merger was complete. The volitional character of the deal means that it does not fit the exception of Kern County and is sufficient reason to trigger the applicability of §16(b). Since TI (P) sold National (D) stock within six months of its purchase and owned more than 10% of the company, it may not keep the profits from the purchase under §16(b). Affirmed.

Front 110

Sec 17

Back 110

Section 17 -- Fraudulent Interstate Transactions

Use of interstate commerce for Fraud in offer or sale.

Standing: SEC Only.
Defendants: Any offeror or seller.
Elements: Neg'l is enough.
Defenses: none.
Remedy: Administrative, judicial.

Front 111

7. Defenses – counter arg. to whether something effects the “total mix”

Back 111

a. Truth on the mkt – the mkt already knew about the undisclosed info and incorporated it into security price
b. Bespeaks caution doctrine – forward looking statements immaterial if accompanied by discl. that projection may not come to fruition
i. not a hard and fast rule – securities is not a “buyer be ware” mkt
c. Statement was puffery – everybody knows the kind of info given isn’t the kind that reasonable ppl. should rely on.
i. if everybody knows its puffery then wouldn’t effect reasonable investor’s decision
ii. not a factual or meaningful statement (too vague)
iii. terms we routinely throw around w/out meaning
iv. ex. – “everybody loves us,” “you’ll get 100% return” –too unbelievable

Front 112

Rule 141

Back 112

(exception under 2(a)(11) for those who would otherwise be considered as underwriters where “interest is limited to a commission from an underwriter or dealer not in excess of the usual and customary distributors' or sellers' commission.”)

Front 113

Rule 142

Back 113

exception for institutional investors who buy and hold will not be considered UW's for purposes of 2(a)(11)

Front 114

102(e)

Back 114

SEC Rule of Practice 102(e) (censure or bar of Professionals).

SEC may deny, temporarily or permanently, the privilege of appearing or practicing before it in any way to any person who is found by the Commission after notice and hearing:
1) not to posses the requisite qualifications to represent others, or
2) To be lacking in character, integrity, or to have engaged in unethical or improper professional conduct; or
3) To have willfully violated, or willfully aided and abetted the violation of the federal securities laws or rules and regs. hereunder

Front 115

102(f)

Back 115

meaning for "practice before the Commission":
○ "transacting any business with the Commission"
○ "the preparation of any statement, opinion, or other paper by any attorney, accountant, engineer or other professional or expert filed with the Commission in any registration statement, notification, application, report or other document…"

Front 116

102(e)(1)...(iv)

Back 116

• Accountants - Violation of Pro Standards
○ Intentional, knowing or reckless conduct resulting in violation of applicable professional standards; or
1) "a single instance or highly unreasonable conduct" that results in a violation of pro standards in a situation in which the accountant should know that heightened scrutiny is warranted, or
2) "repeated instances of unreasonable conduct, each resulting in a violation of pro standards, that indicate a lack of competence to practice before the Commission"

Front 117

to safeguard against Pro Conduct violations

Back 117

Need to institute training & checklist systems

Front 118

SEC v. National Student Marketing Corp.

Back 118

Disclosure of Inaccuracies by the Securities Lawyer. Attorneys who become aware of material inaccuracies in securities documentation presented to their clients abet violations of securities laws if they do not disclose such inaccuracies.

NATURE OF CASE: Appeal from injunctions issued in securities fraud action.
FACT SUMMARY: While representing a merger target, Lord, Bissell and Brook (D) declined to disclose potentially unfavorable information about the suitor corporation to the target's shareholders.
ISSUE: Do attorneys who become aware of material inaccuracies in securities documentation presented to their clients abet violations of securities laws if they do not disclose such inaccuracies?
HOLDING AND DECISION: (Parker, J.) Yes. Attorneys who become aware of material inaccuracies in securities documentation presented to their clients abet securities laws violations if they do not disclose such inaccuracies. A party abets a securities law violation if three elements are satisfied: (1) a violation by a principal; (2) knowledge of the violation; and (3) assistance in the violation. The first two elements are usually clear-cut; the problem is deciding what exactly constitutes "assistance." Here, it is undisputed that a securities law violation occurred, as the comfort letter relied upon by Interstate's board was materially inaccurate. Lord, Bissel & Brook (D) became aware of the inaccuracies when it received the corrected letter. The issue thus becomes whether Lord, Bissel & Brook (D) assisted the securities law violation. This requires a resolution of the issue as to whether inaction can constitute assistance. This court is of the opinion that inaction in conjunction with a duty to disclose constitutes assistance. Here, Interstate's attorneys, Lord, Bissel & Brook (D), had a fiduciary duty, which includes disclosure of information relevant to its finances. Thus, having failed to disclose, Lord, Bissel & Brook (D) abetted the law violation. The court went on to hold, however, that there was insufficient evidence of potential future violations by Lord, Bissel & Brook (D), so injunctive relief was unwarranted. Reversed and complaint dismissed.

Front 119

Part 205.3(b) of Commission Rules of Practice

Back 119

"Standards of Pro Conduct for Attorneys Appearing and Practicing Before Commission"

(b) Duty to report evidence of a material violation. (1) If an attorney, appearing and practicing before the Commission in the representation of an issuer, becomes aware of evidence of a material violation by the issuer or by any officer, director, employee, or agent of the issuer, the attorney shall report such evidence to the issuer's chief legal officer (or the equivalent thereof) or to both the issuer's chief legal officer and its chief executive officer (or the equivalents thereof) forthwith. By communicating such information to the issuer's officers or directors, an attorney does not reveal client confidences or secrets or privileged or otherwise protected information related to the attorney's representation of an issuer.

Front 120

Further Violations under 102(e)

Back 120

In imposing the disciplinary sanction under 102(e) the Commission is not required to prove a reasonable likelihood of any further violations as is required in judicial injunctive actions.

The length of the bar is guided roughly by how egregious the professional's offense was, so that willful participation in client's fraud has resulted in lifetime bars.

Front 121

Material Violation under SEC Rules of Practice

Back 121

205.2(i)

(i) Material violation means a material violation of an applicable United States federal or state securities law, a material breach of fiduciary duty arising under United States federal or state law, or a similar material violation of any United States federal or state law.

Front 122

Where to Report Material Violations

Back 122

(3) Unless an attorney who has made a report under paragraph (b)(1) of this section reasonably believes that the chief legal officer or the chief executive officer of the issuer (or the equivalent thereof) has provided an appropriate response within a reasonable time, the attorney shall report the evidence of a material violation to:

(i) The audit committee of the issuer's board of directors;

(ii) Another committee of the issuer's board of directors consisting solely of directors who are not employed, directly or indirectly, by the issuer and are not, in the case of a registered investment company, “interested persons” as defined in section 2(a)(19) of the Investment Company Act of 1940 (15 U.S.C. 80a–2(a)(19)) (if the issuer's board of directors has no audit committee); or

(iii) The issuer's board of directors (if the issuer's board of directors has no committee consisting solely of directors who are not employed, directly or indirectly, by the issuer and are not, in the case of a registered investment company, “interested persons” as defined in section 2(a)(19) of the Investment Company Act of 1940 (15 U.S.C. 80a–2(a)(19))).

Front 123

'34 Act 21(a)

Back 123

Authority and discretion of Commission to investigate violations
1. The Commission may, in its discretion, make such investigations as it deems necessary to determine whether any person has violated, is violating, or is about to violate any provision of this title, the rules or regulations thereunder

2. Authority to Publish a Report of Investigation

iii. SEC criteria for giving leniency to company
a. Accidental or willful violation
b. Circumstances leading up to violation
i. where there compliance procedures in place?
c. How pervasive was the misconduct (how high up chain did it go?)
d. How long did the misconduct last
e. What was the harm
f. How was the harm detected/who uncovered
g. Response time of company
h. How did the company respond
i. internally and w/ regard to regulators and investors
i. What process did company use to resolve problem
i. Were the audit committee and/or directors informed?
j. Commitment to learning the truth
k. Did the company turn investigation over to outside firm?
l. Company and employee cooperation in the investigation?
m. Measure company is taking to prevent future violations
n. Has the company changed hands since misconduct occurred?

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ii. §21(b)

Back 124

gives SEC power to issue subpoenas
a. also very broad – just has to be new info (not reported in filings)
i. can investigate an entire industry if they want
ii. don’t want to make SEC run to ct. every time wants subpoena

Front 125

i. §21(c)

Back 125

if subpoena not complied w/ need to go to fed. ct. to get order to comply. If still not comply → contempt of ct.

a. Ct. will enforce if SEC says investigation in progress (no proof of violation need) Why?
i. Can’t submit proof if investigation just beginning
ii. Ct. doesn’t have time to do fact finding on every subpoena
iii. Reduced expectation of privacy w/ public co.’s
b. Can only overcome if issued in bad faith (no legit. purpose) or unduly burdensome (SEC already has the info or can easily get)

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Administrative Proceedings

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a. §21C '34 Act
(§8A in 33 Act - C & D Order Proceedings

iii. Potential Defendants
a. Any broker, dealer, investment advisor, or accountant who violates any securities law
b. Any of the same who “is, was, or could be” the cause of a violation due to an act or omission person should’ve known would contribute to violation
i. Especially useful for sanctioning accountants as an alternative to Rule of Practice 102(e) b/c that requires showing willful ethical violation whereas this only requires neg’l

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iv. Sanctions for Violation of 8a or 21C

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a. SEC administrative judge cease and desist order to stop current violation or prohibit future violations of same kind
i. If violate the order – seek civil penalties and/or injunction in fed. ct.
b. Temporary cease and desist order – must stop the violation and prevent dissipation of assets pending the outcome of the proceeding
i. SEC must show violation likely to result in significant dissipation of assets, harm to investors, or pub. interest
ii. Requires notice to issuer and a hearing unless notice hearing prior to issuing order would harm pub. interest
c. Disgorgement of funds resulting from violation
d. Auditor can get civil penalties for violating whistle blowing duty of §10(A)(b) (see §21B for range of civil penalties)
e. Officer/Director bar from serving public companies
i. must violate §10(b) and be “unfit” under §12(C)(f)

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'34 Act 21(a)

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Authority and discretion of Commission to investigate violations
1. The Commission may, in its discretion, make such investigations as it deems necessary to determine whether any person has violated, is violating, or is about to violate any provision of this title, the rules or regulations thereunder

2. Authority to Publish a Report of Investigation

iii. SEC criteria for giving leniency to company
a. Accidental or willful violation
b. Circumstances leading up to violation
i. where there compliance procedures in place?
c. How pervasive was the misconduct (how high up chain did it go?)
d. How long did the misconduct last
e. What was the harm
f. How was the harm detected/who uncovered
g. Response time of company
h. How did the company respond
i. internally and w/ regard to regulators and investors
i. What process did company use to resolve problem
i. Were the audit committee and/or directors informed?
j. Commitment to learning the truth
k. Did the company turn investigation over to outside firm?
l. Company and employee cooperation in the investigation?
m. Measure company is taking to prevent future violations
n. Has the company changed hands since misconduct occurred?

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ii. §21B

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Exchange Act - money penalties against B/D, registered dealers, registered representative; gives SEC power itself to impose money penalties in any proceeding instituted pursuant to sections 15(b)(4), 15(b)(6), 15D, 15B, 15C, 15E, 21C, or 17A against any person

May order an accounting & disgorgement.

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i. §21(c)

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if subpoena not complied w/ need to go to fed. ct. to get order to comply. If still not comply → contempt of ct.

a. Ct. will enforce if SEC says investigation in progress (no proof of violation need) Why?
i. Can’t submit proof if investigation just beginning
ii. Ct. doesn’t have time to do fact finding on every subpoena
iii. Reduced expectation of privacy w/ public co.’s
b. Can only overcome if issued in bad faith (no legit. purpose) or unduly burdensome (SEC already has the info or can easily get)

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§21C '34 Act
(§8A in 33 Act

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- C & D Order Proceedings

ii. Cause for the proceeding
a. Violation of any securities laws

iii. Potential Defendants
a. Any broker, dealer, investment advisor, or accountant who violates any securities law
b. Any of the same who “is, was, or could be” the cause of a violation due to an act or omission person should’ve known would contribute to violation
i. Especially useful for sanctioning accountants as an alternative to Rule of Practice 102(e) b/c that requires showing willful ethical violation whereas this only requires neg’l

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iv. Sanctions for Violation of 8a, 21C

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a. SEC administrative judge cease and desist order to stop current violation or prohibit future violations of same kind
i. If violate the order – seek civil penalties and/or injunction in fed. ct.
b. Temporary cease and desist order – must stop the violation and prevent dissipation of assets pending the outcome of the proceeding
i. SEC must show violation likely to result in significant dissipation of assets, harm to investors, or pub. interest
ii. Requires notice to issuer and a hearing unless notice hearing prior to issuing order would harm pub. interest
c. Disgorgement of funds resulting from violation
d. Auditor can get civil penalties for violating whistle blowing duty of §10(A)(b) (see §21B for range of civil penalties)
e. Officer/Director bar from serving public companies
i. must violate §10(b) and be “unfit” under §12(C)(f)

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b. §15(c)(4) Disclosure Violation Proceedings

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i. Cause for the proceeding
a. Violations of 34 Act §§ 12, 13, 14, 15(d) covering periodic disclosure requirement and proxy solicitations
ii. Potential Defendants
a. Any person subject to the above disclosure requirements who violated them and
b. and any person who was a cause of the failure to comply who knew or should have known would contribute to the failure to comply( includes accountants and lawyers)

iii. Sanctions
a. Admin. judge order to stop disclosure violations
i. If don’t comply, get order compelling obedience from fed. ct.
ii. If break that order, sanction is contempt of ct.

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Prior Notice of C & D order contrary to public interest when

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reasonably likely to result in a respondent's flight from prosecution, destruction of or tampering with evidence, transfer of assets or records, improper conversion of assets, impeding the SEC, or further harm to investors.

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21A

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Civil Penalties for Insider Trading

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'33 Act - 20(d)

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20 - Injunctions and Prosecution of Offenses

20(d) - Money penalties in civil actions

punitive in nature; tiers of violations; 1st Tier violation by natural person is $5,000, violation by entity - $50,000; these may not be registered persons; you have to prove substantial negligence to get higher penalty

Allows for disgorgement orders against those violate Act.

Same as 21(d)(3) of '34 Act.

Both '33 - 20(e) and '34 - 21(d)(2) bar or suspend officer, directors if they violate Act and are unfit to serve.

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KPMG, LLP v. SEC

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SEC Enforcement Sanctions. (1) A cease-and-desist order is not vague where it merely enjoins a firm from engaging in future violations of certain securities laws and from causing such violations. (2) Negligence is an appropriate basis for violations underlying a §21C cease-and-desist order.

ISSUE:
(1) Is a cease-and-desist order vague where it merely enjoins a firm from engaging in future violations of certain securities laws and from causing such violations?
(2) Is negligence an appropriate basis for violations underlying a §21C cease-and-desist order?
HOLDING AND DECISION: [Judge not stated in casebook excerpt.](1) No. A cease-and-desist order is not vague where it merely enjoins a firm from engaging in future violations of certain securities laws and from causing such violations. The cease-and-desist order tracks the language of §21C and inserts the relevant provisions where §21C uses "provision, rule, or regulation." And although, as KPMG (D) contends, GAAS is a complex scheme and subject to divergent professional interpretations, it is not a set of indefinite and open-ended standards subject to the whims of the SEC (P). KPMG (D) fails to show that it will have difficulty in applying the SEC's (P) order to the vast majority of its contemplated future actions. And, if KPMG (D) does find itself in the situation where it sincerely is unable to determine whether its proposed action violates the order, it may always seek the SEC's (P) definitive advice on the issue.(2) Yes. Negligence is an appropriate basis for violations underlying a §21C cease-and-desist order. Contrary to KPMG's (D) assertion that the SEC (P) created an improper presumption that a past violation is sufficient evidence of some risk of a future violation, the SEC (P) found that "some risk" of a future violation need not be very great, and that absent evidence to the contrary, a finding of past violation raises a risk of future violation. Here, that risk was based on KPMG's (D) "manifestly inadequate level of scrutiny" and "consistent failure to recognize the seriousness of this misconduct," i.e., the violations flowed from negligence. In addition, the SEC (P) found some other, independent "blatant out-and-out violation[s]" of GAAS. Accordingly, the SEC's (P) determination that negligence is an appropriate basis for violations underlying a §21C cease-and-desist order is affirmed. Petition for review is denied.

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'34 Act - 12(j) & 12(k)

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Trading Suspension.

Usually pertain to delinquent filings of '34 Act periodic filings.

b. (j) – indefinitely suspension
i. must provide notice and hearing to issuer first

a. (k) - suspend for up to 10 days & no more than 90 days on Nat'l Exchange
i. S. Ct. held can’t do repeated 10 day suspension w/o notice & hearing
ii. But R. 15c2-11 – broker dealers can’t resume trading until info on company is current (requires current periodic filings)

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When is it appropriate to fine the entity?

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Need to ask few questions:

1) the presence or absence of direct benefit to the corp as a result of the violation; and
2) the degree to which the penalty will recompense or further harm the injured shareholders
3) the need to deter?
4) extent of injury?
5) level of complicity?
6) presence of prevention?
7) extent of cooperation?

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Burden of Proof for Issuing Injunction

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SEC must demonstrate realistic likelihood of recurrence of future violations.

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'34 Act - 12(j) & 12(k)

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Trading Suspension.

Usually pertain to delinquent filings of '34 Act periodic filings.

b. (j) – indefinitely suspension
i. must provide notice and hearing to issuer first

a. (k) - suspend for up to 10 days & no more than 90 days on Nat'l Exchange
i. S. Ct. held can’t do repeated 10 day suspension w/o notice & hearing
ii. But R. 15c2-11 – broker dealers can’t resume trading until info on company is current (requires current periodic filings)

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When is it appropriate to fine the entity?

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Need to ask few questions:

1) the presence or absence of direct benefit to the corp as a result of the violation; and
2) the degree to which the penalty will recompense or further harm the injured shareholders
3) the need to deter?
4) extent of injury?
5) level of complicity?
6) presence of prevention?
7) extent of cooperation?

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Burden of Proof for Issuing Injunction

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SEC must demonstrate realistic likelihood of recurrence of future violations.

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15(b)(4)

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SEC may sanction any broker/dealer that has been temporarily or permanently enjoined for violating the securities law.

The sanction can include suspension for up to 12 months.

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Knowledge

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• Requires proof of more consciousness of guilt on the defendant's part, although this can include the defendant deliberately closing his eyes to what he had every reason to believe were the facts.

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Sec 24 of '33 Act

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○ Provides crim penalties for willfully violating
○ Misrep/ommission material fact in reg stmt
○ Not more than 10K fine or 5 year jail time
○ Ignorance is not a defense

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• Sec 32 of '34 Act

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○ Provides penalty for anyone who willfully violates '34 act, other than 30(a)
○ And anyone who willfully or knowingly makes material misrep/ommission in a filing and up to 5 million
○ Willfully means a realization that D was doing a wrongful act.
○ No knowledge of rule/regulation can be a defense but typically when rule is highly complex, otherwise knowledge of facts is enough to constitute violation.
○ Ignorance can also be a defense

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• Mail & Wire Fraud Statutes

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1) Scheme to defraud(includes to deprive another of the intangible right to honest services), and
2) The use of mail or interstate wire communication for purpose of executing the fraud.
○ Sufficient that D knew or could reasonably foresee use of mail or wire in the ordinary course of business. Don't have to actually prove fraudulent statement was transmitted by mail or wire.
○ D must have knowledge of a scheme
○ Negligence not enough to prosecute, but recklessness is enough.

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• Criminal RICO Statutes

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○ Means of curbing organized crime's infiltration and corruption of legitimate business as well as the use of certain so-called racketeering activities in the conduct of business.
○ Racketeering activity includes securities fraud & mail & wire fraud
1) Prohibits using or investing income obtained from "A pattern of racketeering activity" to acquire an interest in an enterprise," engaged in or affecting commerce;
2) Acquiring or maintaining an interest in such an enterprise through a pattern of racketeering activity;
3) Conducting the affairs of an enterprise through a pattern of racketeering activity; or
4) Conspiring to commit any of the first three prohibitions.
○ Sanctions include: fines, imprisonment, and mandatory forfeiture of property.

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• "Conduct or Participate" Element of Rico

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○ D's must have been conducting or managing the enterprise's affairs and not just their own affairs.
○ Reves - Accounting firm did not involve itself in client's affairs.

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US v. Dixon

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Criminal Provisions of the Federal Securities Laws. The willfulness requirement of §32(a) is satisfied where the defendant is aware that he is doing a wrongful act.

NATURE OF CASE: Appeal from conviction for the failure to disclose loans under §32(a) of the Exchange Act.
FACT SUMMARY: Dixon (D), president of AVM, attempted to evade Securities and Exchange Commission (SEC) (P) disclosure requirements involving a loan from the company.

ISSUE: Is the willfulness requirement of §32(a) of the Exchange Act satisfied where the defendant is aware that he is committing a wrongful act?
HOLDING AND DECISION: (Friendly, J.) Yes. The willfulness requirement of §32(a) of the Exchange Act is satisfied where the defendant is aware that he is doing a wrongful act. A conviction for failure to make proper reports under §32(a) includes the requirement that the violation be willfully and knowingly committed. A person can willfully violate an SEC (P) rule without knowing of its existence. Thus, this state-of-mind requirement may be established by proof that a defendant realized he was doing a wrongful act. Dixon (D) had loans totaling more than $20,000 during 1970. Therefore, the lack of disclosure was a clear violation. Dixon (D) caused the corporate books of AVM to show debts of the secretary which were in fact his own debts. These acts are wrongful when they lead to the very violations that would have been prevented if the defendant had acted with the aim of scrupulously obeying the rules. Thus, Dixon (D) both violated the rules and had an intent to deceive, which is enough to meet the modest state-of-mind requirement of §32(a). Dixon's (D) conviction is affirmed.