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INTRODUCTION TO SECURITIES REGULATIONProfessor HazenR EGULATORY SYSTEM Securities transactions are subject to both federal and state law o Federal securities laws apply to transactions that use mails or facilities of interstate commerce—broadly defined, interstate phone call suffices.  National Se...

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INTRODUCTION TO SECURITIES REGULATION Professor Hazen REGULATORY SYSTEM  

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Securities transactions are subject to both federal and state law o Federal securities laws apply to transactions that use mails or facilities of interstate commerce—broadly defined, interstate phone call suffices. National Securities Markets Improvement Act of 1996: o Federal securities laws were amended to preempt state regulation of certain classes of securities and transactions o Old regime – concurrent state and federal regulation, o New regime - narrowed state law via preemptions in many areas of securities regulation, including:  Registration and reporting requirements  State regulation of broker-dealers and investment advisers Blue Sky laws – state laws regulating transactions in securities. o Most contain one or more of three provisions:  Prohibitions against fraud in the sale of securities;  Requirements for registration of brokers and dealers; and  Requirements for registration of securities to be sold in the state. Uniform Securities Act o 4 major parts:  Antifraud provisions;  Broker-dealer registration provisions;  Security registration provisions; and  Definitions, exemptions, and administrative and liability provisions. o Most states have adopted most or some of the provisions. 6 Major Statutes of Federal Securities Law: o Securities Act of 1933 o Securities Exchange Act of 1934 o Trust Indenture Act of 1939 o Investment Company Act of 1940 o Investment Advisers Act of 1940 o Securities Investor Protection Act of 1970 All securities rules are codified in 17 CFR Securities Act of 1933 o First act following the great depression o People blamed the great depression on crash of stock market  Information wasn’t getting out there properly o Regulates public offerings of securities  Requires registration of a transaction, but once they are public 1933 no longer applies  Form S1-general registration form  Name of company  Name of officers  SK-key to answering the items o Disclosure approach to regulation (Brandeis: “Sunlight is the best disinfectant”) o § 2: defines terms in the act

2 § 3&4: exempt various kinds of securities (3) and transactions (4) from its registration requirements § 5: prohibits offers and sales of securities, which are not registered with the SEC.  Security and not be offered or sold unless it is registered or exempt o § 6 & 8: specify the procedure for registration o § 7, 10 & Schedule A: prescribe the contents of the registration statement and prospectus o § 11 & 12: specify civil liabilities for false or misleading statements o § 17 prohibits fraudulent or deceptive practices in the sale of securities o § 27 & 27A: restrictions on class action litigation under the Act, created a safe harbor for projections and other forward-looking statements. Securities Exchange Act of 1934 o Extended federal regulation to trading in securities which are already issued and outstanding o § 4: established the SEC, transferred responsibility for administering the 1933 Act by Title II. o § 12, 13, 14 & 16: impose disclosure and other requirements on publicly traded companies.  Disclosure every quarter (10Q) and year (10k) o § 12: issuers of class of stock trading on a national securities exchange must register w/ SEC.  §12(a) traded on a national exchange = must register & follow reporting requirements  §12(g) companies with total assets >$10M and a class of equity securities ≥ 500 shareholders must register w/ SEC o § 13: periodic filing w/ SEC for companies registered under §12 o § 14: regulates the solicitation of proxies from holders of such securities o § 16: officers, directors and 10% owners must report purchases & sales, must disgorge short swing profits. o § 9 & 10 prohibit various kinds of manipulative or deceptive devices or contrivances. o Also regulates broker-dealer industries, broker-dealers must register, transfer agents, rating agencies, etc. Trust Indenture Act of 1939 o Applies generally to public issues of debt securities in excess of $1M. o Such issues are registered under the 1933 Act, but must also qualify under this Act, which imposes standards of independence and responsibility on the indenture trustee and requires other provisions for the protection of the security holders. o Statute not limited to disclosure, regulates the merits as well Investment Company Act of 1940 o Gives the SEC regulatory authority over publicly-owned companies which are engaged primarily in the business of investing and trading in securities. o Regulates the composition of the management of investment companies, their capital structure, approval of their advisory contracts and changes in investment policy, and requires SEC approval for any transactions by such companies. o 1970 amendments impose additional controls on management compensation and sales charges. Investment Advisers Act of 1940 o Amended in 1960 o Established a scheme of registration and regulation of investment advisers comparable to §15 of the 1934 Act with respect to brokers o 1996 Amendments preempt state regulation of investment advisers with > $25M of assets under management, exempts from the Act advisers $10M in assets and either o ≥500 unaccredited investors; or o ≥2,000 investors, accredited or not.  Ineligible issuers o Ineligible for any of the special exemptions or lower standards o Issuers who have been in trouble with the SEC  Emerging Growth Company o Introduced by the 2012 JOBS ACT, which lessened disclosure requirements for small businesses o Smaller companies subject to relaxed disclosure requirements

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PRE-FILING PERIOD Process:  Form a Team: o Investment bankers/potential lead underwriters  If interest is there, then lead underwriter drafts a non-binding letter of intent to the company (don’t have to worry about §5(a)) o Auditor certified to do SEC audits o Outside counsel  Draft Registration Statement o Registration statement includes prospectus and supplemental part  S-1 – long form, one size fits all  S-3 – form available to large, existing public companies o Prospectus – the only part that normally goes to the public offerees of the securities  The legal offering document  Describes the company’s business and responds to all the disclosures required in a narrative  Company’s business, risk factors, management’s discussion and analysis of financial condition and results of operations, material transactions with insider  s, use of proceeds, competition, key customers, government regulation, employees, etc.  Detailed disclosure of compensation, rights, awards, benefits, etc.  Cannot contain half-truths: statements that are literally true but misleading in context o Supplemental information available for public inspection at the SEC office  Prepared in an item-and-answer form  Disclose recent sales of unregistered securities & statement of exemptions relied upon.  Past violations may be remedied by a rescission offer  Normally not seen by investors  Should put gag on corporate executives concerning the IPO to avoid §5(c) problems  Then do a complete legal and accounting checkup o Make sure books are auditable – many small companies have problematic books o What legal health is the company in? any lawsuits; compliance with state and federal labor/environment laws; title to the property; superfund exposure; antitrust concerns; etc. o Lawyers determine whether the articles of incorporation and bylaws are suitable for a public company  Larger boards  Non-cumulative voting  Exculpatory provisions  Enough shares authorized, including enough shares authorized for foreseen future offerings  Do it now so you’re not subject to proxy rules of 1934 Act  Change purpose/state of incorporation o Need to know going in what the prospectus is going to look like when you file it  The Gun Jumping Rule: No illegal offers o “Gun Jumping” is a term of art used for illegal offers in connection with registered public offerings.  Matter of Carl M. Loeb, Rhoades & Co.: Press release by company mentioned the offering, expected proceeds, expected asset size, and development plans for the land. Newspapers that received the press release were told about potential offering price range for the IPO. Final statutory prospectus had different, more negative information o Held: that the final press release was in violation of § 5 and therefore a prohibited gun jumping  Definition of an offer is very broad  Purpose is to control abuses in steps toward the formal offer, and give investors time to think about the information they’re communicating  We worry about communication that “condition the public mind or arouse interest in particular securities” (don’t want speculative frenzy even if only meant to be news, not offer)  Look at both intent of speaker, and impact on public  Issuer and lead underwriter here had no prior record of communication with the public

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Underwriting Techniques o Strict Underwriting (no longer used)  A designated issuing house advertised the issue and received applications and subscriptions from the public on the issuer’s behalf after an announced date.  When sufficient applications were received, the lists were closed and the issuer allotted the securities directly to the applicants or subscribers.  For a fee or a premium, the underwriter agreed to take up whatever portion of the issue was not purchased by the public within a specified time.  Underwriter protected himself by agreements with sub-underwriters o Firm-Commitment Underwriting  Contractual obligation that if underwriter cannot sell all securities, it will buy the rest for its own investment account  Assures the issuer of a specified amount of money at a certain time, subject frequently to specified conditions precedent, and shifts the risk of the market to the investment bankers  Issuer typically sells the entire issue outright to a group of securities firms, who in turn sell at a price differential to a selling group of dealers or to the public.  Under the 1933 Act, only negotiations between the issuer and underwriters are permitted before the filing of the registration statement. o Best-Efforts Underwriting  Issuer distributes securities through firms that merely undertake to use their best efforts  If no one buys, then risk falls on issuer o Shelf Registration  WKSIs can use shelf registration whereby the registration is more flexible and the statement becomes effective upon filing.  Can engage in oral and written communications at any time, subject to a few conditions:  Must be current in its reporting obligations  Must be eligible to register a primary offering of its securities on Form S-3 or Form F-3.  Issue has requirements ($700M of common equity market capitalization) and a majorityowned subsidiary of a well-known seasoned issuer can also be considered the same  Quiet period begins 30 days before registration statement is filed  Safe harbor for ordinary course disclosures during the pre-filing and waiting periods, so long as there is no specific reference to the upcoming offering.

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No sales or deliveries o § 5(a)(1): no sales o § 5(a)(2): no deliveries o § 2(a)(3) defines sale No Offers to Sell or Buy o § 5(c): makes it unlawful for any person directly or indirectly to make use of any means or instruments of interstate commerce or of the mails to offer or to sell or offer to buy a security unless a registration statement has been filed  Stems from the express language that a parties may not legally begin a public offering or initiate a public sales campaign prior to the filing of a registration statement  Publication of certain information, though not an express offer, may in fact attribute to an effort to sell securities o § 2(a)(3) defines offers to sell o § 2(a)(3) exempts preliminary negotiations or agreements between issuer and underwriter(s)  Dealers may not seek inclusion in the selling group o Loeb, Rhoades Case:  “Offer to sell” includes every attempt or offer to dispose of, or solicitation of an offer to buy, a security or interest in a security for value  Includes any communication reasonably calculated to generate a buying interest

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Contained descriptive material concerning assets of the company Named underwriter, which generates buying interest (know who to contact to buy securities) Prefiling Gun-Jumping Exemptions Prefiling Period

Rule 135: Offering Announcements  Allows notice of public offering (exemption from definition of “offer”)  Applicable only to issuer or selling security holder; cannot name underwriter  Requirements:  Legend: statement that the notice does not constitute an offer  Limited information: (i) name of issuer, (ii) title, amount, terms of security, (iii) amount of the offering, (iv) timing of the offering, (v) brief statement of the manner and purpose, (vi) who is offering directed to, (viii) (special requirements for rights offerings, offerings to employees, exchange offers, mergers)  Can issue corrections of misstatements about the offering  Also applies to waiting period Rule 163: WKSI “Free Writing Prospectus”  An offer by or on the behalf of a WKSI is exempt from § 5(c) provided that:  Permits written communications, if they contain legend (where to get copy of prospectus once available and instructions to read it) and are filed with SEC after filing registration statement  These written communications are considered “free writing prospectus” [Rule 405] and a 2(a) prospectus  Available only to WKSIs in prefiling period; not available to underwriters or other participants Rule 163A: Preregistration Communication  Permits communications 30+ days before filing registration statement that does not reference a securities offering that is or will be the subject of a registration statement  Creates safe harbor for issuers, but not underwriters or other participants Rule 168: Regular Communication (by reporting issuers)  Permits factual info and SEC-filed forward-looking information, provided timing, manner, and form are similar to past releases (excluded from definition of offer); may not reference offering  Applies to domestic reporting issuers (and seasoned reporting foreign issuers), but not underwriters or other participants  Also applies to waiting and posteffective periods Rule 169: Regular Communications (by new issuers & existing public companies)  Permits regularly released factual information, but not forward-looking information (excluded from definition of offer); provided timing, manner, and form are similar to past releases  May not reference offering; must be intended only for non-investors  Applies to non-reporting issuers and reporting issuers, but not underwriters or other participants  Also applies to waiting and posteffective periods

Permitted Activities in Prefiling Period: Exemptions from § 5(c) Pre-Filing Restrictions Preliminary Negotiations  (§ 2(a)(3)) exemption – Preliminary negotiations and agreements between an issuer and any underwriter or among underwriters who are or are to be in privity of contract with an issuer are exempt from § 5(c) o Allows for the creation of an underwriting syndicate; does not include members of the selling group (dealers helping to distribute the security) o SEC still concerned with the creation of a very broad distribution system too early in the process, particularly during the quiet period. Be careful of widely-distributed emails/letters Non-issuer/underwriter/dealer Transactions  (§4(a)(1)) – Transactions made by any person other than issuers, underwriters, and broker/dealers o Implicates a person other than an issuer, underwriter and broker/dealer if that person transacts with a non-exempt issuer, underwriter, and broker/dealer in a manner that goes against section 5(c)

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Does not apply to news media to seek out and publish financial news, and absent any collusion with sellers, § 5(c) has no application to them – Loeb Rhoades § 2(a)(4) defines issuer § 2(a)(11) defines underwriter o Ordinarily a broker-dealer becomes subject to restrictions at any time when he commences to participate in the preparation of a registration statement or otherwise reaches an understanding with the person on whose behalf a distribution is to be made that the firm will become a managing underwriter, whether or not the terms and conditions of the underwriting have been agreed upon § 2(a)(12) defines dealer

Company Announcements  Rule 135: Limited information made available to the public o Statements to the effect that the published information does not constitute an offer of securities for sale AND the notice includes no more than:  The name of the issuer  The title, amount, and basic terms of the securities offered  Probably not allowed to include price  Amount of the offering, if any, to be made by selling security holders  The anticipated timing of the offer  A brief statement of the manner and the purpose of the offering without naming the underwriters  Shouldn’t include very many details o Four exceptions where additional information can be filed:  Rights offering to existing security holders  Class of security holders eligible to subscribe  Subscription ratio and expected subscription price  Proposed record date  Anticipated issuance date of the rights; and  The subscription period or expiration date of the rights offering  Offering to employees of the issuer or an affiliated company  The name of the employer  Class of employees being offered the security  Offering price and  Duration of the offering period  Exchange offering  Basic terms of the exchange offer  Name of the subject company  Subject class of securities sought in the exchange offer  Rule 145(a) offering o Second Circuit says this rule is exclusive. That is, if you don’t comply, you’re in trouble. However, other circuits have held this to be an interpretative rule, where if you don’t comply, you’re not safe, but you’re not necessarily in trouble WKSI Communication  Rule 163: Provided the offer is filed with the SEC and contains a legend that offering will be by prospectus, WKSIs may use a free writing prospectus during the pre-filing period o Communication will be deemed a free-writing prospectus o Conditions:  Legend  Notice to investors: o That the company may file a registration statement o Encouraging them to read the related prospectus before buying  An immaterial or unintentional failure to include the specified legend will not result in a violation of section 5(c) of the Act or the loss of the ability to rely on this section so long as:

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A good faith and reasonable effort was made to comply with the specified legend condition; The free writing prospectus is amended to include the specified legend as soon as practicable after discovery of the omitted or incorrect legend; and If the free writing prospectus has been transmitted without the specified legend, the free writing prospectus is retransmitted with the legend by substantially the same means as, and directed to substantially the same prospective purchasers to whom, the free writing prospectus was originally transmitted.

Filing  If the company later files a registration statement, the 163 communication must be filed with the SEC  Failure to do so will be excused if the failure was immaterial or unintentional and if a good faith and reasonable effort was made to comply, and filed as soon as practicable

Preregistration Communication  Rule 163A: Communications by or on behalf of an issuer that are more than 30 days before the filing of the registration statement and that do not refer to a securities offering will not be considered an offering o Company relying on Rule 163A must take reasonable steps within its control to prevent further distribution or publication of the communication within 30 days Regularly Released Factual Information and Forward-looking Statements  Rule 168: The dissemination of factual b...