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Securities Regulation
Professor Bradford
April 27, 2013
8:30 a.m.
3 Hours and 25 Minutes
GENERAL INSTRUCTIONS
1. This is a partially open book exam. You may use the Cox, Hillman, Langevoort casebook; the 2012 supplement to the casebook; the required statutory supplement; any handouts provided by the professor; and any materials, such as notes or outlines, written and prepared exclusively by you. During the exam, you may not use or possess any other materials, written, digital, or recorded. You may not use or possess a cell phone or any other electronic device other than the computer on which you are taking the exam. You may not consult with or communicate with any other person during the exam. If you have any other books, notes, briefcases, book bags, cell phones, electronic devices, or other items, you must bring them to the front of the room now. You may not take any of these items to another designated exam room.
2. This exam has ten (10) pages, including the instructions. The page numbers appear on the top right-hand corner of each page. Please check to be sure that this copy has all the pages.
3. You have three hours and twenty-five minutes (3:25) to complete the exam. You must turn in your answers in this room, even if you are taking the exam somewhere else in the building. If you finish more than five minutes early, you may turn in your answers in the Dean’s Office.
4. The exam consists of six (6) questions. The recommended time for each question is as follows:
Question 1……………………..…….. 45 Minutes
Question 2………………..………….. 25 Minutes
Question 3…………………..……….. 30 Minutes
Question 4..………………………….. 40 Minutes
Question 5…………………………… 35 Minutes
Question 6…………………..……….. 30 Minutes
Each question will be weighted in accordance with its recommended time.
5. Do not spend all of your time writing. Think about the issues and organize your answers before writing. Be concise. Be organized. Long, disorganized, rambling answers will be penalized, as will merely “dumping” portions of your notes or outline into your answers rather than answering the question posed.
6. This exam will require you to interpret and apply many of the statutory provisions and regulations we have examined. You should not just state general principles, but should cite the relevant sections and subsections of the statutes and regulations and explain how the language of those rules applies to the facts of the question. An answer that doesn’t cite and analyze relevant statutes or regulations is incomplete and will not receive full credit.
7. If you believe that additional facts are needed to answer a question, state exactly what those facts are and how they would affect your answer. If you believe that a question is ambiguous or unclear, note the ambiguity or lack of clarity and indicate how it affects your answer.
8. The Honor Code is in effect.
EXAM 4 INSTRUCTIONS
9. You must take the exam on a computer that has the latest version of the Exam 4 software installed. Use the OPEN mode. If you have not previously installed the Exam 4 software, please notify the exam administrator immediately.
10. Be sure to enter your exam number in the Exam ID field. (Do not use your NU Card ID number or your social security number.) You will be required to enter your exam number twice. Select the course name from the drop-down box. Be sure you find the folder for this course, because that is where your exam will be stored. Verify that the information is correct just before you select “Begin Exam.”
11. Do not worry about headers, footers, page numbers, or double-spacing your exam; the software does all that for you when the exam is printed.
12. When you are finished, please submit your exam electronically. A pop-up box will show the status of your exam. It should show a black bar with 100% in it and a message that says, “Your file has been successfully stored.” If you do not get this message, please see Vicki Lill in the Dean’s office immediately. After successfully submitting your exam, exit Exam 4 before leaving the classroom.
13. If you have any technical problems during the exam, please report them immediately to the Dean’s Office; we will assume you had no technical problems until you reported them. Be prepared to finish your exam by writing it. (Regular notebook paper is O.K.)
Question One
(45 Minutes)
Acme Corporation is a Delaware corporation. Its business is designing and selling precision milling machinery. Acme is not a reporting company under the Exchange Act.
On January 15, 2013, Acme raised $3 million cash selling Class A voting stock to fifty members of the general public in an offering pursuant to Regulation A. Those offers and sales complied with all of the conditions of the regulation.
Acme needed the money to design a new milling machine and to produce a prototype of that machine. At the time, Acme thought $3 million would be enough to design the machine and develop a final version ready for marketing. However, Acme ran into engineering problems in testing and must completely redesign and reengineer the machine. That will cost Acme another $2-3 million. Acme needs that money by no later than May 15, 2013.
To raise the additional $2-3 million, Acme plans to sell Class B stock. Class B stock has the same voting and other rights as Acme’s Class A stock, except it has a $1 per share dividend preference.
Acme is working with Broker, Inc., a registered brokerage company, on this latest financing. Broker has a list of 2,500 clients who at some time in the past filled out a questionnaire indicating they have a net worth in excess of $1 million, excluding the value of their principal residence. Broker plans to send an e-mail to all 2,500 clients asking if they are interested in Acme’s offering. The stock will be sold only to people on the list who respond affirmatively. To raise the required $2-3 million, Broker believes Acme will have to sell to roughly 50 to 60 of these clients.
Acme wants to sell these securities pursuant to Regulation D. Discuss whether the Rule 504, 505, or 506 exemptions are available for this proposed offering. (Do not discuss any other exemption.)
Question Two
(25 Minutes)
Gamma, Inc. is a Delaware corporation. It is not an Exchange Act reporting company. Gamma is in the process of preparing for an initial public offering of its common stock. It expects to file a registration statement with the SEC on May 10.
Gamma has been in business for five years. Every year, a couple of weeks before its annual meeting, Gamma releases a letter from Fred Founder, Gamma’s founder and CEO, commenting on Gamma’s performance and its future prospects. Gamma has done well over its five-year history, so Founder’s comments are generally very positive.
On April 20, 2013, Gamma released this year’s letter from Founder. The letter explained that Gamma had done well over the past year, then added: “Gamma’s prospects over the next two years are extremely good. We anticipate significant increases in both revenues and net income.” The letter said nothing about the upcoming public offering.
Discuss whether Founder’s letter violates section 5 of the Securities Act.
Question Three
(30 Minutes)
Videogame Studios, Inc. (“VSI”) recently posted an ad on Barowners.com, a web site for people who own bars or similar establishments. The ad offers to sell bar owners a touchscreen video game called Drunken Amazement that has tested well with bar patrons in several major cities.
The base cost to purchase a game is $5,000. For an additional $1,200, VSI offers a leaseback/servicing arrangement that, the ad says, will “eliminate most of the risk.” If a Drunken Amazement purchaser elects to take the leaseback/servicing arrangement, VSI will find a location to install the game, install and service the game, and collect revenues. VSI agrees to give the game purchaser an “absolute veto” over where the game is installed.
VSI agrees to pay people electing the leaseback/servicing option $125 a month, no matter how much revenue the game generates. If the game earns less than $125 a month, VSI will bear the loss; if it earns more than $125 a month, VSI gets to keep the additional revenue.
The leaseback/servicing arrangement lasts for five years, at the end of which VSI will, at the purchaser’s option, either return the game to the purchaser or buy the game from the purchaser for $500.
Discuss whether this scheme involves an investment contract. (Do not discuss the consequences if it is an investment contract—just whether it is one or not.)
Question Four
(40 Minutes)
Zappa Corporation is an Exchange Act reporting company. Its common stock is traded on the New York Stock Exchange.
The closing price of Zappa’s common stock at the end of trading on January 7, 2013 was $40 a share. Shortly after market trading closed on January 7, Zappa issued the following press release:
After a couple of weeks of secret negotiations, Zappa has agreed to sell the company to Buyer, Inc., a privately held German company. The price will be $50 cash per share. This transaction requires the approval of a majority of Zappa’s shareholders. The shareholder meeting will be held on March 29, 2013.
This release contains forward-looking statements. The merger is subject to contingencies, including shareholder approval. Because of those contingencies, we cannot guarantee that the transaction will occur as specified.
Although the press release did not mention it, the agreement with Buyer contained a price adjustment clause. That clause provided for a 10% reduction of the sales price if the value of the Euro declined more than five percent relative to the U.S. dollar. Zappa’s CEO, who approved the press release, knew of the price reduction clause but deliberately omitted any mention of it from the release. She thought disclosing it might negatively affect the price of Zappa’s shares. In addition, at the time she (and many economic analysts) believed it was highly unlikely the Euro would decline at all relative to the U.S. dollar, much less by 5 percent.
After the press release, Zappa’s stock price rose to $48 a share. On January 10, Plaintiff purchased 4,000 shares of Zappa’s stock for $48 a share. Plaintiff was not aware of the press release or the pending sale to Buyer.
When Buyer’s CEO read the Zappa press release, he insisted that Zappa publicly disclose the price adjustment clause. Zappa did so, on January 15, 2013. The market price of Zappa’s common stock immediately fell from $48 to $46.50 per share.
Between January 10 and March 29, the Euro declined about 4.5% relative to the dollar (not really, but assume so for purposes of this question). However, it never reached the 5% level, so the price adjustment clause was not triggered.
On March 29, the Zappa shareholders approved the sale to Buyer. Seventy-seven percent of the Zappa shares voted in favor of the deal; only 10% of the shares voted against. On April 15, Plaintiff received $50 a share for his shares.
Shortly after that, Plaintiff sued Zappa for a violation of Rule 10b-5, arguing that Zappa’s failure to disclose the price adjustment clause in the press release was fraudulent. Zappa has made four arguments why it should not be liable:
1. The omission was not material.
2. Zappa is protected by the safe harbor for forward-looking statements.
3. Plaintiff did not rely on the misstatement.
4. The omission did not cause a loss to Plaintiff.
Discuss how the court should resolve each of these four issues. (Do not discuss any other issues.)
Question Five
(35 Minutes)
Smith is an unsophisticated accredited investor who owns 25,000 of the 100,000 outstanding shares of Omega Corporation. Smith acquired her shares six months ago in a series of purchases from a number of smaller shareholders. Those shareholders acquired them from Omega in a Rule 505 offering a year prior to that.
Smith is not an officer or director of Omega, but three of Omega’s seven directors were nominated by Smith at Omega’s most recent annual meeting.
Omega is not an Exchange Act reporting company, and its shares are not actively traded. In the last month, only 100 Omega shares have changed hands. No one other than Smith owns more than 5,000 shares.
Two months ago, Smith sold 100 Omega shares to a close friend, Jones, for $5,000. Smith would now like to sell as many additional shares as possible. She has hired a broker, Bob Broker, to help her sell the shares.
Smith and Broker plan to send an e-mail to all of Broker’s customers notifying them that Smith’s shares are available. Omega has a public web site on which it posts detailed information about the company and its operations, including audited financial statements. The notice would direct people to that web site for information about the company.
To be safe, Smith wants to sell her shares using the Rule 144 safe harbor. Discuss whether she may do so and, if so, any restrictions on her sales.
Question Six
(30 Minutes)
Delta Corporation is an Exchange Act reporting company. The market value of its public equity held by non-affiliates is approximately $100 million and it is eligible to use Form S-3. Delta is not a well-known seasoned issuer.
On April 5, 2013, Delta filed a registration statement to sell an additional $25 million worth of common stock. That registration statement has not yet become effective.
Capital Analysts Corporation, an independent securities analyst, recently published a very favorable report on Delta. The report mentioned Delta’s upcoming offering and indicated that Delta was a “great buy.”
Delta would like to put a hyperlink to the analyst’s report on Delta’s web site. Discuss whether it may do so today without violating the Securities Act, and, if it may, any conditions to doing so. (Don’t discuss whether the analyst has violated the Act, just whether Delta would violate the Act if it put up the hyperlink.)