Securities Regulation

Outline

Spring 2001

John Owen

  1. Overview of the financial markets
  1. Is it a security?

III.Pre-filing liability

Roadmap summary:

___General Rule:No offer to sell or offer to buy a security is permitted during the pre-filling period

___Ask: Has there been an offer to sell a security (including efforts to condition the market)

___Ask: Has there been an offer to buy a security

___If there has been an attempt to offer to buy or sell a security, do one of the exceptions apply?

___Assemble UW syndicate

___Research report

A.Pre-filling offers to buy or sell a security are prohibited

  1. 5(c) prohibits any person (by the jurisdictional means) from offering to buy or sell a security before the filing of the registration statement

B.Ask: Has there been an offer to buy a security?

  1. Prohibition only applies to issuers, dealers or underwriters
  2. An ordinary investor is not prohibited from making an offer to buy a security from the issuer or an underwriter or dealer before the filing date, although no person in these categories my solicit or accept that offer or make any attempt to sell to him or her
  3. If the communication to buy is between UWs – look to see if the assembling an UW syndicate exception applies.

C.Ask: Has there been an offer to sell (including conditioning) a security

1.Ask:Is this an offer to sell?

  1. Defined in 2(3) as "every attempt or offer to dispose of, or solicitation of an offer to buy, a security or an interest in a security, for value"

2.Ask:Is there an attempt to condition the market?

a.Ask:Does this release arouse public interest [2(a)(3) & Loeb,

Rhodes]

  1. Factors to consider:

1)What is the nature of the statement

Bangor-Punta - An optimistic prediction or a prediction of value may be viewed as conditioning.

However, MD&A now requires some forward-looking statements

2)Who arranged the statement?

If the issuer sent out the press release (as in Loeb, Rhodes) then the communication is more likely to be seen as conditioning

If the media solicited the statement, then 3rd party solicitations from media are considered more news of interest to the public then an attempt to condition.

Release #5180-#5&6 encourage issuers to respond to unsolicited inquiries about factual information and have an open door policy for such

3)Nature of the issuer:

Ask - is the issuer already a public company

If yes, then a press release may be the only way to meet 34 act disclosure act requirements - for this reason, public companies usually get more leeway then IPOs because of the neef to keep SHs informed.

4) Nature of the publication

The broader the circulation, the more likely that it will be viewed as conditioning

Ask - does this release reach the broader investing public

c)Also, consider the release

1) Continue to advertise products and services

2) Continue to send out customary quarterly, annual and other periodic reports to SHs

3) Continue to send out proxy statements and send out dividend notes

4) Continue to make announcements to the press with respect to factual business and financial developments; i.e., receipt of a K, the settlement of a strike, the opening of a plant, or similar events of interest to the community in which the business operates

5) Answer unsolicited phone inquiries from SH, analysts, the press and others involving factual information

6) Observe an open door policy in responding to unsolicited inquires concerning factual matters from securities analysts, financial analysts, security holders, and participants in the communications field who have a legitimate interest in the corporation's affairs

7) Continue to hold SH meetings as scheduled and to answer SHs inquires at SH meetings relating to factual matters

Issuers should avoid:

1) Issuance of forecasts, projections or predictions relating but not limited to revenues, income, or earnings per share

2) Publishing opinions concerning values

D.Ask: Do one of the safe harbors or exceptions to the pre-filing rule apply?

1)Assembling the UW syndicate

a)2(a)(3) excludes from the definition of the terms sell and offer to sell as well as buy or offer to buy:

"preliminary negotiations or agreements between an issuer (or any person directly or indirectly controlling or controled by an issuer or under direct or indirect common control with an issuer)

and any UW or among UWs who are or are to be in privity of contract with an issuer (or any person indirectly or directly controlling or controlled by an issuer or under direct or indirect common control with an issuer)

b)Issue: What does "preliminary negotiations" mean?

1)This has NOT been interpreted to mean the UW agreements CAN NOT be entered into prior to filing or effectiveness.

It has evolved to mean that "an offer or sale to an UW" is exempted from § 5

2)Research reports

a)Rules 137 & 139 carve out exceptions here

b)Rule 137

1)Only applies if the dealer is not participating in the distribution

2)The research report will be ok if:

1) 34 act company

2) this kind of report is given out over the ordinary course of business

3) Dealer receives no compensation from the registrant outside of the regular subscription or purchase price of the document

4) Dealer must not be a participant in the distribution of the security

b)Rule 139

1)A dealer can participate in the distribution and still make a recommendation if:

1) The issuer is S-3 eligible

2) AND the company meets minimum float/investment grade requirements of these forms

3) AND the opinion or recommendation is contained in a publication which is distributed with reasonable regularity in the normal course of business

or

1)The recommendation is of a kind distributed with reasonable regularity in an industry-wide report

or

1) is a comprehensive list of recommended

securities

and

2) The issuer is given no greater

prominence then anyone else

and

3) The opiinion is no more favorable then in the last publication

  1. Waiting period liability

Roadmap overview:

___Oral offers are now permitted

___Written offers via a preliminary prospectus or a summary

prospectus are permitted

___These prospectuses will not be enough to consummate a

sale, however.

___Tombstone ads and identification statements, if they follow the

rules, will be ok

  1. § 5(b)(1) requires that any writings (i.e. – any prospectus) used in conjunction with an offer meet the requirements of § 10

(1)§ 5(b)(1) speaks in terms of a prospectus and “prospectus” is defined in § 2(a)(10) as an offer made in writing (or by radio or television)

(2)As a result, it is perfectly ok to make an oral offer any time after the filing date even though they are not accompanied or preceded by a § 10 prospectus

(a)The ability to make oral offers does not mean that you can say anything that you want

(1)Shouldn’t admit the press to a road show

(2)The information discussed should be consistent with the information in the prospectus

(3)A tombstone ad will also be permitted

(a)2(a)(10)(b) provides that the tombstone will not be considered a prospectus even if it doesn’t meet the requirements of § 10 if:

(1)It states from whom a § 10 prospectus may be obtained

(2)Does no more then:

(a)Identify the security

(b)State the prcie

(c)State who will execute orders

(d)Contain other information permitted by the SEC in rules and regulations

(b)These restrictions are enforced for several reasons:

(1)Was not designed as selling literature

(2)2(a)(10)(b) is designed to simply afford a device for screening out those prospective customers who might be sufficiently interested in the particular security to ask for a prospectus

(c)The 2(a)(10)(b) exception was expanded upon by Rule 134 and Rule 134a (what Hu calls an identifying statement)

(1)The rule permits a document to include up to 14 categories of information without constituting a prospectus

(2)The Rule DOES NOT permit the sender of the communication to solicit an indication of interest unless:

(a)The communication is accompanied or preceded by a § 10 prospectus and

(b)It contains a statement to the effect that until the effective date, no offer can be accepted, no part of the purchase price received, any offer to buy may be withdrawn or revoked, and any indication of interest will involve no obligation or commitment of any kind.

(c)It can only further the purpose of the statute and the rule to include a detachable form on which the recipient may request a copy of the prospectus.

(4)A preliminary prospectus or a summary prospectus may also be used to meet the § 10 requirements

(a)The preliminary prospectus [§ 10(a), Rule 430]

(1)Outside of the tombstone, the only offer in writing permitted by 5(b)(1) is a § 10 prospectus

(2)The SEC adopted Rule 430(a) without adverting to the 10(b) power

(3)Rule 430(a) allows a preliminary prospectus to meet the 5(b)(1) / § 10 requirements:

(a)A form of prospectus

(b)Filed with the registration statement

(c)Shall be deemed to meet the § 10 for the purposes of 5(b)(1)

(d)Prior to the effective date

(e)If it contains substantially the same information required to be included in the § 10(a) prospectus

(f)Except “for the omission of information with respect to the offering price, underwriting discounts or commissions, discounts or commissions to dealers, amount of proceeds, conversion rates, call prices, or other matters dependent upon the offering price:

(g)And the caption “subject to completion” and the legend (see the rule) appear in red ink on the outside of the front cover (rather then being imprinted on every page) [THIS comes from S-K It. 501 (10) “magic language”]

(4)Rule 430A permits a registrations statement to be declared effective without pricing data; pricing information must be disclosed to the SEC 15 days after the effective date or by making a formal post-effective amendment

(5)Distribution of preliminary prospectus

(a)The SEC has no authority to order the distribution of the preliminary prospectus, so they use accelerated effectiveness as a carrot

(1)15c2-8 (c) requires a dealer to make his or her best efforts to distribute a prospectus upon request (this is under the 34 act and doesn’t effect an acceleration request)

(2)15c2-8 assumes that fraud is present if there is an offer to sell by a broker-dealer and no prospectus is delivered (this is a 34 act rule)

(3)15c2-8(g) requires the managing UW to furnish copies of preliminary prospectus to all participating brokers or dealers

(4)15c2-8(b) Requires delivery of preliminary prospectus to any person requesting it at least 48 hours before the effective date if he issue is an IPO

(5)Release 4968 and R. 460 – must make a good faith effort to distribute a reasonable number of copies of the registration statement (preliminary prospectus) to dealers in order for the SEC to accelerate the effective date

(6)Rule 460 permits the SEC in evaluating a request for acceleration to take into account if the issuer has taken reasonable steps to make adequate information (and copies of the registration statement) available

(7)Rule 461 uses acceleration as a carrot to insure prompt distribution of amendments – see Rule 461(b)(2)

(6)Amending the preliminary prospectus

(a)See 5(a)(6) above

(b)The summary prospectus [10(b), Rule 431]

(1)Allows the use of a prospectus for purposes of 5(b)(1) which omits in part or summarizes information in the prospectus specified in 10(a)

(2)Must be filled with the registration statement

(3)Is not deemed to be part of the registration statement for § 11

(a)This is repetitive because §11(a) extends liability only to any part of the registration statement that was deficient “when such part became effective”

(b)It also seems strange that we remove 11 liability from the underwriter or issuer but still allow the broker-dealer to be stuck with liability under § 12 and 17

(4)Requirements to be able to use Rule 431:

(a)Applies only if the particular registration statement form so provides

(b)Requires the summary prospectus must be filed as part of the registration statement

(c)The registrant must have been a 34 Act reporting company for the past three years

(d)The registrant has had a default free record since the end of the last fiscal year

(e)The summary prospectus must contain:

(1)Whatever information is specified in the instructions to the particular form

(2)May contain other information contained in the registration statement or specified in Rule 134(a) [the tombstone ad rule]

(3)May employ “such condensed or summarized form as may be appropriate in the light of the circumstances under which the [summary] prospectus is to be used

(4)Must be captioned a “preliminary summary prospectus” when used before the effective date

(5)Must be filed 5 days prior to use, subject to acceleration

(f)Meets the requirements of § 10 only for the purpose of §5(b)(1) – a summary prospectus meeting the requirements of the Rule may be sent through the mails or interstate before with a preliminary or a final prospectus, but the rule does not affect the requirement of §5(b)(2) that the complete, final 10(a) prospecuts precede or accompany any deliver of the security that is effected by use of mails or interstate means.

V.Going effective

  1. § 5(a) indicates that you can’t sell until a registration statement is effective
  2. § 8(a) indicates that a statement goes effective 20 days after filing if there is no SEC action
  3. § 8(a) permits a request for acceleration
  4. SEC review and stop orders
  1. During the waiting period, SEC conducts customary or full review where SEC accountant and lawyer scrutinize every word and then they send comments to the SEC branch chief who compiles them and sends a comment letter to the issuer (which then gets forwarded to UW) soliciting changes (i.e. more disclosure) or more information
  2. The comment letter process is a negotiation between the SEC and the issuer (but this negotiation process means more time)
  3. Issues during the comment letter/review process:
  1. Plain English

Levitt started the plaing English movement – under Rule 421

  1. Changing the registration statement

Changes that are adopted from the comment letter are submitted in a new version of the RS with a cover letter to the SEC that points out where changes were integrated into the new version. Note – this is not an amendment, but a whole new version

Stop orders and the like

  1. The SEC can use a 8(d) stop-order , assuming that they meet the notice requirements
  1. The SEC can also make 5(c) apply if they decide to conduct an 8(e) examination as to whether or not to issue a stop order. In this case, the SEC would use 8(d) and 8 (e) to stop all marketing efforts by invoking 5(c), even though it is in the waiting period
  1. § 8 (b) would allow the SEC to issue a refusal order if the registrations statement is facially insufficient – but this is rarely used b/c its not enough time for the SEC to look at the registration statement
  1. Going effective
  1. Technical rule: § 8 indicates that a registration statement becomes effective on the 20th day after filing if the SEC takes no action
  1. This is not used – everything would be stale
  1. As a general rule, issuers want to ACCELERATE effectiveness
  1. Governed by rules 460-461
  1. 461(b) bases acceleration requests on the “adequacy of information .. available to the public” [§ 8 and Rule 461(b) and Rule 460 (a)]
  2. This is evidenced in large part by 460(b)(1)’s requirement for the “adequate distribution of the preliminary prospectus”
  3. Thus – the SEC uses acceleration as a carrot to force early distribution of the prospectus
  1. With the request for acceleration, the issuer will also file a pricing amendment indicating the price

(1)The sec will not review the price because this speaks to merit

(2)NOTE – Rule 430A allows for effectiveness

(under certain circumstances) even though the prospectus may not have pricing information

Rule 434 indicates that under these same conditions a Rule 430A partial (a la, no pricing) accompanied by a term sheet con = a § 10(a) prospectus for the purposes of 5(b)(2) (post-effective) requirements

  1. Blue sky concerns
  1. During the waiting period, the state may also conduct a review of the registration statement
  2. Fed law has preempted most of this bull-shit
  3. Three levels of possible review
  1. Merit
  2. Disclosure
  3. Collecting a fee

4.NASD also approves a registration statement – but they just check UW compensation

VI.Post-effective period

  1. Overivew

1.Begins the morning of the day on which request for acceleration and pricing amendment is filed

2.Issues surrounding effectiveness and the selling of shares

a.Hot offering and preferential placements

  1. Entire allotment sold a couple of hours after the registration statement goes effective
  2. Usually in a situation like this, retail investors never got an opportunity to buy the shares
  3. Preferential placements go to institutional investors, suppliers, family and friends – they get to buy at a deep discount
  4. Brokers/dealers can come under scrutiny for not disclosing the fact that a large portion of the increased return the investor enjoys is a result of the fact that the investor was able to buy at an artificially lower price because of the preferential placement
  5. A PP with a supplier amounts to noting more then a kick-back
  6. PPs with an II is nothing more then an attempt to please the II so that you can get a better rating - this is why most retail investors never have a chance to get their hands on a hot IPO

b.Sticky offering

1.The entire offering is not sold a couple of hours after effectiveness

2.This is often the result of poor pricing

c.Selling shareholders

1.Corporate insiders who have previous issues of stock through private placement (like a VC firm etc..) have piggy back rights to toss their shares into the public offering

2.The advantage to the shareholder is that he doesn’t have to file a registration statement in order to sell his shares

  1. Note: If the selling shareholders look too excited to sell off their shares, outside investors may be worried about why they are selling their shares – if enough investors ask, it may cause the price of the stock to go down
  2. Conversely, shareholders have are at an advantage to sell their shares in an IPO because generally, IPO prices are always over-valued -- because a company will generally only go public when it know that the market will overprice its shares
  1. Permissible methods of offering a security are still much the same as in the waiting period
  1. Preliminary prospectus and a summary prospectus are no longer enough
  1. Effectiveness terminates §5(a) prohibition against using the mails on interstate facilities to sell or deliver the security
  1. Post-effective prospectus deliver requirements
  1. § 5(b)(2) requires that, unless the buyer has already received a complete §10(a) prospectus, then the security may not be delivered (through the mails or interstate commerce) without sending a complete §10(a) prospectus along with it
  2. Oral offers and oral acceptance and oral confirmation
  1. Scenario: The whole transaction resulting in the sale was oral
  2. Does not constitute a 2(a)(10) prospectus, because it has all been oral,
  3. Catch – if the dealer eventually delivers the security after the sale, then 5(b)(2) requires delivery of a § 10 (a) prospectus before or along with the delivery of the security
  4. Other catch – 10b-10 [34 act] requires that brokers confirm transaction in writing, so in order to send the customer that writing, which would be a free writing, the broker will have to conform with 5(b)(1) and send a 10(a) transaction
  5. Thus, even entirely oral transactions will eventually have a prospectus sent

2A.Special issue when dealing with an IPO