Securities Regulation

Professor Gabaldon

Spring 2000

I.Introduction

A.Securities Act of 1933 (Distribution Process)

  1. To require that investors are provided with material info concerning securities offered for public sale; and
  2. To Prevent misrepresentation deceit, and other fraud in the same of securities
  3. Accomplished via disclosure primarily in registration statement
  • Registration  intended to provide adequate and accurate disclosure of material facts concerning the company and the securities it proposes to sell
  1. Securities Exchange Act of 1934 (Order and Disclosure in After-Market)
  1. Effect
  • Extended the disclosure doctrine of investor protection to securities listed and registered for public trading on national securities exchanges
  • Also applies to over the counter market if company has more than $10M in assets and more than 500 investors
  1. Corporate Reporting
  • Must file a registration statement with the exchange and the SEC
  1. Proxy Solicitations
  • Governs soliciting proxies
  • Solicitations whether by management or shareholder groups must disclose all material facts concerning matters on which holders are asked to vote
  • Holders must be given an opportunity to vote “yes” or “no” on each item
  1. Tender Offer Solicitations
  • Reporting and disclosure provisions extended to situations where control of a company is sought through a tender offer or other planned stock acquisition of over 5% of a company’s equity security
  1. Insider Trading
  • Prohibitions are designed to curb misuse of material confidential information not available to the general public
  1. Regulation of brokers and dealers
C.State Blue Sky Laws
  1. Analogous to the ’33 and ’34 Act
  2. Preempted by federal legislation (sometimes)
D.Sources of Federal Securities Law
  1. Statutes at Large (more legit than USC) but most people rely on BNA, CCH etc.
  2. SEC rules and other pronouncements
  3. Policy and interpretative releases
  4. Staff Legal Bulletins
  5. Interpretive and No-Action Letters
E.How Securities Are Marketed and Sold
  1. Private/Small Entities
  1. Form  sole proprietorship, partnerships (general, limited, limited liability), limited liability corporation
  2. Unique contractual relationships
  3. Methods by which securities get to public and trade in aftermarket

(1)Distribution  process in which capital is raised by issuer through placement of security

(2)Aftermarket  secondary market where not capital is raised for the corporation

  1. Public/Large Entities
  1. Form  some are limited partnerships, but most are corporations
  2. Standard contractual relationships
  3. Methods to get securities to public and trade in after-market

(1)Distribution

  • Issuers approached by a “lead” underwriter (like banks) who would act as an agent for an underwriting group, typically a lead underwriter will approach issuer and then assemble the group
  • Lead underwriter interfaces between issuer and underwriting group
  • All members of underwriter group are responsible for contacting dealers
  • Underwriters sell to dealers who in turn sell to the public

(2)After-Market  public trading securities among itself (price does not directly effect company but effects price at which they can later sell to public)

F.Context of 1933 Act Registration
  1. Underwriters
  1. General Definition  function of helping a company or one or more of its major shareholders, sell securities to the public through an offering registered under the Securities Act
  2. Firm Commitment Underwriting  underwriter purchases securities from a company at an agreed price and then attempts to sell to public for a profit (risk on underwriter)
  3. Best Efforts Underwriting  underwriter agrees to use its best efforts to sell an agreed amount of securities to the public, risk remains with issuer, done primarily with small underwriters
  4. Standby Underwriting  used in “rights offerings”, company directly offers its existing security holders the right to purchase additional securities at a given price and the uw agrees to purchase from the company any securities that are offered to the security holders but not purchased by them
  1. Dealers
  • Refers to a firm when it buys and sells securities for its own account (takes and gives title)
  1. Brokers
  • Refers to a firm when it buys or sells as an intermediary for a customer rather than taking or giving title itself
  1. Investment Banking
  • Usually handles the underwriting business
  • Comparison with commercial bankers who make loans and hold depositor’s funds  because Glass-Stegall Act revoked, commercial banks can not have affiliates who underwrite (but are not suppose to use depositors funds)
  • Functions:
  1. assisting companies in the sale of securities, almost always in large amounts to private purchasers such as insurance companies
  2. finding acquisition partners for companies that wish to acquire or be acquired by others
  3. giving financial advice of various sorts
  1. Secondary Market
  1. Process for getting securities on exchanges

(1)List  will contact desired exchanges and sell them on the exchange

  • Need to satisfy certain requirements – disclosure
  • Very stringent/rigorous requirements, the more prestigious the exchange is

(2)Once list privileges are granted, can contact members of the exchange

(3)Function  if willing buyer and seller, can contact members of the exchange

  1. Exchange Vocabulary
  1. Specialist Post – if want to sale a security that is specialists; subject to certain exchanges’ regulations, subject to SEC approval, need to maintain an orderly market
  • Function  matching unless an unorderly market – then specialist may be required to purchase/sell
  1. Over the Counter Vocabulary
  1. Market Maker  dealer than functions in the trading market by maintaining an inventory of a particular company’s securities and holding itself open, on a continuing basis, as willing to buy and sell those securities
  2. Broker  agent who acts on their client’s account
  3. Self Regulated Organization
  • Both market makers and brokers are regulated under the 1934 Act and are required to be members of an SRO
  • Has rules and regulations regarding conduct of brokers and deals that are subject to SEC approval
  • Self-funded
  • NASD is an SRO
  1. Exchange
  1. Form  physical location
  2. Regulation  subject to rigorous regulation by SEC pursuant to 1934 Act
  3. Process
  • Buyer goes to brokerage – brokerage will communicate that desire to a floor trader – member or floor trader will go to a specialist post
  • Seller will contact her broker about purchasing – seller’s broker will communicate to a floor trader – they will go to specialist post and hopefully transaction takes place
  • Specialists perform matching function
  1. Over-The-Counter
  1. Form  everything except selling/buying of securities not listed on an exchange
  • Pink Sheets  advertisements; now we have electronic bulletin boards
  • Market Maker  regularly advertised self as willing to buy or sell x security and usually lots of mm’s per security
  1. Process
  • Buyer goes to broker and broker goes to mm
  • Seller goes to broker and broker goes to mm
  • Mm lacks the matching function, do the transaction with them??????
  1. State Blue Sky Regulation
  1. Types of Regulations

(1)Merit-Based  requires state officials to read info and determine its suitability of securities

  • Not used much anymore except for in “problem markets”

(2)Disclosure-Based  will require filing of basic business information (federal securities laws)

(3)Notice-Based  just need to send notice that will sell or trade

  1. Preemption Law of 1988  forced state regulation into a notice based system for most areas
  2. Typically done by a specialist in a law firm in a large financial center
  1. Reasons for Going Public
  1. Advantages
  • New capital
  • Obtain negotiability – acquisition of companies, employee incentives, liquidity for present S/H, shares may have greater value
  • Future capital on more favorable terms
  • Prestige
  1. Disadvantages
  • Expense of going public (underwriter’s fees – 7-10% of public offering price, legal fees, accounting fees, printing costs, registration and Blue Sky fees, registrar fees, indemnity insurance)
  • Additional obligations of public companies
  • Market expectations
  • Loss of control
  • Higher estate tax valuation
  1. Timing of Going Public and selection of underwriter
  1. When
  • Company’s earning and financial performance
  • Size of company
  1. Selection factors for agent underwriter
  • Reputation and ability to distribute
  • Ability to advise
  • Ability to provide financial services following the offering
  • After market performance of the security
  • Experience in the company’s industry
  1. Situation 2
  1. Scenario
  • Product  specialized computers with specialized software
  • Corporation has two shareholders
  • Want to raise capital
  1. Interests
  • Size of company - $10 million + ultimate sales price
  • How much do you want to raise - $10M
  • Only want to sell 25% of the company
  • Logical price is 2.5M b/c not is likely to pay $10M for 25% control of something that is worth $10M
  • Decide they are willing to sell $3.3M
  • $10M is value of corp.
  • giving up 33% of company
  1. Size of Deal for Underwriters
  • Big Underwriters-$5M+ deals only
  • Regional underwriters will take smaller dals
  1. 1933 Act Registration
A.General Vocabulary and Applicable Statutes
  1. Pre-Filing Period (Basic Rule  no offers, no sales)
  1. Definition
  • Period before registration statement is filed
  1. Relevant Provisions
  • §§5(a),(c)
  1. Waiting Period
  1. Definition
  • Period after registration statement has been filed but has not become effective
  1. Relevant Provisions
  • §§5(a),(b)(1)
  1. Post Effective Period
  1. Definition
  • Period after registration statement becomes effective
  1. Relevant Provisions
  • §5(b)
B.Pre-Filing Period Prohibitions

1. §5(a)  no sales

  1. Statutory Language
  • Unless a registration statement is in effect as to a security, it shall be unlawful for any person, directly or indirectly –
  • To sell such security through the use or medium of any prospectus or otherwise; or
  • To carry any such security for the purpose of sale or for delivery after sale
  1. Basic Meaning
  • Prohibits the sale of securities unless a registration statement has become effective (at the end of the waiting period) and no sale or delivery for purposes of sale before the effective date
  1. Related Issues
  • What is a sale  §2(a)(3)

2. §5(c)  no offers

a. Statutory Language

  • It shall be unlawful for any person . . . to offer to sell or offer to buy through the use or medium of any prospectus or otherwise any security, unless a registration statement has been filed as to such security . . .
  1. Basic Meaning
  • Cannot offer before filing a registration statement
  1. Related Issues
  • What is an offer  §2(a)(3)
  • Rule 135  safe harbor from definition of “offer
  • SEC releases 3844 and 5180
  1. What is an Offer?
  1. Section 2(a)(3)

(1) Statutory Language

  • The term “offer to sell”, “offer for sale”, or “offer” shall include every attempt or offer to dispose of, or solicitation of an offer to buy, a security or interest in security, for value
  • Not a complete definition b/c says “shall include”
  1. Offer to buy
  • The solicitation of an offer to buy is considered an offer to sell. As a result, it is not possible to avoid the “no offer to sell” prohibition of §5© by phrasing an offer in terms of a solicitation of an offer to buy
  1. General Interpretation
  • Definition read broadly and includes things that may not have been considered an offer at common law including conditioning the market for the securities to be sold
  1. Conditioning the Market

(1)Generally

  • In the pre-filing period, it is not legally possible to begin a public offering or initiate a public sales campaign

(2)Securities Act Release No. 3844

  • A public sales campaign is only unlawful when it involves an offer as defined in the Act
  • General attempts to stir up market interest can be an offer even if do not mention actual offer before filing
  • “priming the pump”
  • “gun jumping”
  • Example 1  underwriter sent brochure describing in glowing possibilities of market; no reference to issuer, security or particular financing; contained name of underwriter
  • Intent was to stimulate interest, clearly was the first step in a sales campaign to effect a public sale of a security  violation
  • Example 4  underwriter distributed to NASD members company info, issuer and prospects, but info was misleading  violation
  • Example 6  President at co. was asked a year in advance to give a speech about company and industry; decided to give into to interested customers etc; then the company began filing out a registration statement
  • Scheduling of speech had not been arranged in contemplation of a public offering
  • No violation but printed copies should not be received by a wider audience or given out at speech

(3)In Re Carl M Loeb, Rhoades & Co. (1959)

(a)Background

  • Underwriters put out press release before reg. stmt. filed
  • Described the property involved, related the company’s development plans in general, outlined the proposed securities offering, and mentioned the names of the two managing underwriters
  • Did not directly offer to sell any securities

(b)Holding

  • Publicity of this type and in this situation must be presumed to set in motion or to be a part of the distribution process and therefore involved an offer to sell or a solicitation of a n offer to buy
  • Such release and publicity was of a character calculated, by arousing and stimulating investor and dealer interest in the securities . . ., to set in motion the process of distribution

(4)Securities Act Release No. 5180 (1971)

(a)Publicity

  • While a publicly held company may not legally initiate publicity that is for the purpose of facilitating the sale of securities a business as usual general publicity effort probably does not run afoul of §5(c)

(b)When information is requested by shareholders

  • Factual information should be provided
  • Responses involving predictions, forecasts, projections, and opinions, concerning value are not acceptable

(c)Generally

  • New advertising campaign might raise questions especially when it is presented in media that seem calculated to reach investors rather than merely customers
  • Lawyer needs to focus on the real reason for a particular action

(5)Interpretive Letter Request and Response

(a)Companies Activities

  • Initiate and maintain periodic meetings with securities analysts, brokers, etc.
  • Want to know if should stop this when start registration stmt.

(b)SEC Response

  • During the period that an issuer is in registration, issuer need not stop activities
  • Activities desirable b/c have eventual effect of conveying useful information to investing public
  • Type of information should still conform with No. 5180
  • Activities may give rise to “priming the market” argument especially when issuer starts them right before registration process begins (these issuers should stop), but issuers who have a history of doing this would generally seem to have a sound basis for refuting a “gun-jumping” inference
  1. Exceptions to Definition of “Offer”

(1)§2(a)(3)

(a)Statutory Language

  • Offer shall not include preliminary negotiations or agreements between and issuer (or agent) and any underwriter or among underwriters who are or are to be in privity of contract with an issuer

(b)Effect

  • Exception is limited to underwriters – does not cover dealers
  • Company can find an underwriter in pre-filing period
  • Managing underwriter can talk to other securities firms to gauge their interest in joining underwriting syndicate
  • Managing underwriter cannot begin to assemble the dealer group at all

(2)Rule 135  Notice of Certain Proposed Offerings

(a)Statutory Language

  • For purposes of §5, a notice given by an issuer that is proposes to make a public offering of securities to be registered under the Act shall not be deemed to offer any securities for sale if:

(1)notice says that offering will be made only by means of a prospectus; and

(2)Contains no more than the following additional language:

  • Name of issuer
  • Title, amount, and basic terms of the securities, amount of offering, anticipated time of offering, brief statement of the manner and purpose of the offering without naming the underwriters
  1. Special Situations

(1)§2(a)(3)

  • Any security given or delivered with, or as a bonus on account of, any purchase of securities or any other thing, shall be conclusively presumed to constitute a part of the subject of such purchase and to have been offered and sold for value

(2)Options

  • Options/convertible securities/warrants shall not be deemed to be an offer or sale; but the issue or transfer upon the exercise of such right shall be deemed a sale of the security
  • The underlying security does not have to be registered originally when the conversion or exercise cannot occur immediately, but rather can only tae place at some point in the future
  • At the time the conversion or exercise can occur, an offer exists, and the filing of a registration statement or the availability of a registration exemption is required
  1. Jurisdictional Means
  • Language in §5(a) and §5(c)
  • “means or instruments of transportation or communication in interstate commerce or of the mails”
  • Interpretation
  • Very broad
  • Any use of the telephone satisfies the requirement
  • If offer at the country club, probably not satisfied, but if friend then telephones for more info probably have the jurisdictional means b/c offeror reasonably could have foreseen the use of the telephone by the offeree
C.Waiting Period
  1. §5(a)  no sales or deliveries
  1. Prohibits  no sales and no deliveries
  2. Defining a Sale

(1)Statutory Definition (§2(a)(3)) (not complete definition)

  • “the term ‘sale’ or ‘sell’ shall include every contract of sale or disposition of a security or interest in a security for value”
  • read liberally

(2)Significance of Including “contract of sale”

  • In the waiting period, certain offers may be made. When an offer is accepted a contracts is created and §5(b)(1) is violated b/c a sale has occurred
  • Cure  offerors should condition their offers in such a way that they cannot be accepted until the registration statement is effective

(3)In Re Franklin, Meyer & Barnett

(a)Background

  • Salesmen accepted checks sent by customers in payment for offered shares
  • Sales sold other securities for customers and held the proceeds for application against the purchase price of the offered shares

(b)Holding

  • Salesmen accepted orders for stock during the waiting period
  • Although they initially invited indications of interest in the form of checks and the proceeds of the sale of other securities, they went beyond the permissible scope of the Act.
  • If take money in anticipation for subsequent sale, this is a sale within definition and will be a violation should return money promptly or say do not intend to apply to sale of stock until some even and they don’t get any priority then possibly okay
  1. §5(b)(1)  no prospectus unless a §10 prospectus
  1. statutory language
  • Unlawful for any person . . . to carry or transmit any prospectus relating to any security with respect to which a registration statement has been filed under this title, unless such prospectus meets the requirements of section 10.
  1. Prospectus Definition (§2(a)(10))

(1)Statutory Language