C H A P T E R 2 1
Public and Private Offerings of Securities
TRUE-FALSE QUESTIONS
1. The Securities Act of 1933 is also referred to as the fiblue sky” law.
2. Because of the complexity of federal securities laws, a recognized defense to a charge of violation of
federal securities laws is ignorance of the specific law or laws involved.
3. Under the Securities Act of 1933, an investor may bring a private suit for damages.
4. Investors are prohibited under the Securities Act of 1933 from making highly speculative
investments.
5. The SEC has the statutory authority to approve or disapprove an offering on its merits.
6. The Securities Act of 1934 requires continuous disclosure of certain information regarding publicly
traded securities.
7. A fired herring” is the popular name given to the final prospectus under the 1933 Act.
8. The Sarbanes-Oxley Act created the Public Company Accounting Oversight Board.
9. Investment banking firms are prohibited by federal law from underwriting public offerings of
securities.
10. Shelf registration under the Securities Act of 1933 allows registration of a number of securities at
one time for issuance later.
11. A secondary offering is the subsequent offering of securities by the original issuer.
12. The term fisecurity,” for purposes of the Securities Act of 1933, is narrowly interpreted to include
only such traditional investments as a stock or a bond.
13. The definition of fioffer” under the Securities Act of 1933 is much broader than that in contract
law.
14. Proxies give the proxy holder the right to vote the shares owned by the person who signs the proxy
card.
15. Mere promotion of a security makes a person a seller and, therefore, liable under section 5 of the
1933 Act based upon the sale of a security without an effective registration statement or by means of
a noncomplying prospectus.
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16. Seasoned issuers may make automatic shelf registration offerings which are effective immediately
on filing a registration statement with the SEC.
17. A company that decides to abandon a proposed public offering due, for example, to a lack of
investor interest, must wait at least eighteen months before shifting to a private offering.
18. A prospectus is a selling document as well as a disclosure document.
19. The completion of a public offering terminates the issuer’s relationship with the SEC.
20. According to the SEC, a hyperlink embedded within a prospectus causes the hyperlinked
information to be treated as part of the prospectus.
MULTIPLE-CHOICE QUESTIONS
1. Which of the following is true regarding uniform state regulation of securities?
A. Federal law has entirely preempted the area, and there is no state regulation of securities.
B. Many states have adopted the Uniform Securities Act.
C. Many states have adopted the Proposed Uniform Trading Act.
D. There is no proposed uniform act in regard to securities, and state regulation is inconsistent.
2. Which of the following is false regarding the Sarbanes-Oxley Act?
A. The Act mandates the composition and authority of audit committees at public companies.
B. The Act prohibits personal loans to executives.
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C. The Act requires corporations to disclose whether they have a code of ethics applicable to senior
financial officers and, if not, to disclose why not.
D. The Act gives the SEC the authority to prohibit unfit persons from serving as officers or
directors of a public company for a period of five years.
3. Under the Sarbanes-Oxley Act, discriminating against or discharging an informant
A. is punishable by a fine only.
B. is punishable by a substantial fine or imprisonment for as long as ten years, but not both.
C. is punishable by a substantial fine or imprisonment for as long as ten years, or both.
D. is not addressed.
4. Any transaction that involves an investment of money in a common enterprise with profits to come
solely from the efforts of others is deemed to be a(n) ________ and thus a security.
A. stock issuance
B. investment contract
C. secured sale
D. committed sale
5. A key step in preparing the registration statement is the process of ________, whereby the company,
the underwriters, and their respective counsel assemble and review the information about the
company in the registration statement.
A. due diligence
B. reasonable review
C. strict scrutiny
D. proofing
6. Which of the following is not part of the Howey test?
A. scienter
B. an investment of money
C. common enterprise
D. profits obtained solely through the efforts of others
7. A ________ offering of securities is a subsequent offering by a person other than the issuer.
A. secondary
B. restricted
C. blank check
D. shelf
8. The ________ is the private offering counterpart to the prospectus.
A. private registration prospectus
B. red-herring prospectus
C. private-placement memorandum
D. restricted sale
9. Assuming requirements are met, Rule 144A permits the resale of unregistered securities to qualified
A. issuers.
B. underwriters.
C. institutional buyers.
D. federal banks.
10. Which of the following was the result at the U.S. Supreme Court level in SEC v. Edwards, the case
in the text involving sales of interests in pay telephones and the issue of whether a moneymaking
scheme falls outside the definition of an investment contract because the promised rate of return is
fixed rather than variable?
A. That entitlement to a fixed rate of return did not prevent the arrangement from being an
investment contract.
B. That entitlement to a fixed rate of return prevented the arrangement from being an investment
contract.
C. That entitlement to a fixed rate of return did not prevent the arrangement from being an
investment contract, but only because the underlying company went into bankruptcy.
D. That entitlement to a fixed rate of return prevented the arrangement from being an investment
contract, but only because the underlying company went into bankruptcy.
11. Which of the following is true regarding whether the ficommon enterprise” element of the SEC v.
W.J. Howey Co. case requires horizontal or vertical commonality?
A. The federal circuits are in agreement that there must be horizontal commonality even if vertical
commonality can be shown.
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B. The federal circuits are in agreement that there must be vertical commonality even if horizontal
commonality can be shown.
C. There is a split in the federal circuits as to whether the common enterprise element of the test can
be met by showing horizontal commonality or whether there must be vertical commonality.
D. There is a split in the federal circuits as to whether the common enterprise element of the test can
be met by showing vertical commonality or whether there must be horizontal commonality.
12. Which of the following is true regarding whether the interest of a limited partner in a limited
partnership is considered a security?
A. Such an interest is considered a security only if the limited partnership involves an investment in
real estate.
B. Such an interest is not considered a security because a partnership, not an investment scheme, is
involved.
C. Such an interest is rarely considered a security because limited partners, to protect their limited
liability, are prohibited by law from taking part in the control of the partnership business.
D. Such an interest is almost always considered a security because limited partners, to protect their
limited liability, are prohibited by law from taking part in the control of the partnership business.
13. The ________ is the disclosure document that an issuer of securities provides to each prospective
purchaser under the 1933 Act.
A. registration statement
B. prospectus
C. investment contract
D. placement memorandum
14. Assuming Rule 504 of Regulation D otherwise applies, it exempts offerings of up to _______ within
a _______ period, and there may be _______ purchasers.
A. $2 million, six-month, up to 100
B. $500,000, two-year, up to 500
C. $1 million, twelve-month, an unlimited number of
D. $100,000, three-month, up to 50
15. Which of the following is not considered a traditional shelf offering?
A. securities offered pursuant to employee benefit plans
B. securities offered pursuant to dividend reinvestment plans
C. securities issued to alter voting rights for shareholders
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D. securities issued in connection with business combination transactions
16. Under Section 13, any person acquiring beneficial ownership of more than _______ of the equity
shares of a reporting company must file a Schedule 13D providing information regarding the
acquisition within ten days after crossing the designated ownership mark.
A. 3%
B. 5%
C. 25%
D. 51%
17. Which of the following is not an accredited investor under Rule 501?
A. any national bank
B. any director of the issuer
C. any corporation with total assets in excess of $1 million
D. any natural person with a net worth in excess of $1 million
18. If an issuer makes successive sales within a limited period of time, the SEC may ________ the
successive sales, resulting in the loss of a private-offering exemption.
A. restrict
B. register
C. integrate
D. qualify
19. Assuming no exemption applies, what is the penalty for a violation of section 5 of the 1933 Act
through offering a security for sale without an effective registration statement or by means of a
noncomplying prospectus?
A. The purchaser may keep the shares if the investment proves successful; or if within one year
from the date of purchase the investment proves unprofitable, the investor can get his or her money
back.
B. The purchaser must keep the shares if the investment proves successful; or if within one year
from the date of purchase the investment proves unprofitable, the investor will be refunded his or her
money.
C. The investor has no option to keep the shares but will be refunded his or her money.
D. The investor must hold the shares for at least two years but will be refunded his or her money if
the investment has failed to show a profit within that amount of time.
20. Securities issued in a private placement are called ________ securities.
A. qualified
B. private
C. restricted
D. shelf
21. A(n) ________ is defined under the 1933 Act as any person who has purchased from an issuer with a
view to, or offers or sells for an issuer in connection with, the distribution of any security.
A. investment banker
B. underwriter
C. dealer
D. secondary seller
22. Which of the following was the result on appeal in In re Lehman Bros. Mortgage-Backed Securities
Litigation, the case in the text involving whether rating agencies that helped select a pool of
mortgages for a mortgage-backed security were underwriters under the 1933 Act or controlling
persons under section 15 of the 1933 Act?
A. The court ruled that the proof established that the rating agencies were both underwriters and
controlling persons under the 1933 Act.
B. The court ruled that the proof failed to establish that the rating agencies were either underwriters
or controlling persons under the 1933 Act.
C. The court ruled that the proof established that the rating agencies were underwriters under the
1933 Act but that the proof failed to establish that the rating agencies were controlling persons under
the 1933 Act.
D. The court ruled that the proof established that the rating agencies were controlling persons under
the 1933 Act but that the proof failed to establish that the rating agencies were underwriters under
the 1933 Act.
23. Which of the following activities are not regulated by the 1934 Act?
A. primary securities sales
B. proxy solicitations
C. insider trading
D. tender offers
24. To which of the following is an entrepreneur likely referring when using the term fiangel” in
reference to an investment plan?
A. An investment banker
B. A venture capitalist
C. Lenders of last resort who provide needed funds once it appears that an entrepreneur who has
started a company is in financial trouble.
D. Family, friends, and wealthy individual investors to whom the entrepreneur first turns to seek
funds
25. Which of the following may be sued under Section 11 of the Securities Act of 1933, which provides
a remedy for a person who purchases a security pursuant to a misleading registration statement?
A. The underwriters.
B. Persons who gave their consent to be named in the registration statement as future directors.
C. Both underwriters and persons who gave their consent to be named in the registration statement
as future directors.
D. Any officer as well as underwriters and persons who gave their consent to be named in the
registration statement as future directors..
26. Which of the following was passed in 2010 and represents the most sweeping reform of U.S.
financial markets since the Great Depression?
A. The Laughlin – Glover Investor and Financial Reconciliation Act
B. The Mallicoat – Whaley Consumer and Investor Securities Protection Act
C. The Dodd – Frank Wall Street Reform and Consumer Protection Act
D. The Barnhill – Obama Wall Street Investors Reconciliation Act
27. According to the ________ doctrine, a court may determine that the inclusion of sufficient
cautionary statements in a prospectus renders immaterial any misrepresentations and omissions
contained therein.
A. actual cause
B. bespeaks caution
C. common sense
D. trap door
28. A _______ company is a development-stage company that has no specific business plan or has a
business plan to acquire a currently unknown business.
A. illegal
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B. bespeaks caution
C. blank check
D. best-efforts
29. Tina, in-house counsel for a start-up company, is asked what the company must do if it plans to offer
securities for sale only outside the U.S. What advice should she give in relation to the application of
section 5 registration requirements?
A. That so long as the company is incorporated in the U.S., all aspects of section 5 apply, and that
any offer or sale outside the U.S. is subject to the federal registration requirements.
B. That offers or sales outside the U.S. are not subject to federal registration requirements so long as
only accredited investors are involved but that, otherwise, any offer or sale is subject to the federal
registration requirements.
C. That offers or sales outside the U.S. are not subject to federal registration requirements so long as
only accredited investors are involved and no more than $5 million in sales are made but that,
otherwise, any offer or sale is subject to the federal registration requirements.
D. That offers and sales outside the U.S. are not subject to section 5 registration requirements.
Fact Pattern 21-1 (Questions 30-31 apply)
Joan enjoys cross stitching, and her husband, John, makes items using a woodworking process.
They would like to make more items and open a small shop selling their handiwork, but they need
additional capital with which to purchase raw materials, rent space, and advertise. Joan and John
discuss the idea with their neighbors during the annual neighborhood picnic. A number of the
neighbors say that they would like to invest in the project. This was entirely the initial idea of the
neighbors, and Joan and John did not coerce them in any way. Joan and John, however, quickly
draw up contracts that the neighbors signed providing that each investor would receive a certain
interest in the shop. An attorney who lived in the neighborhood and specialized in family law asked
if there were some laws that John and Joan needed to satisfy in order to seek investors. The
neighborhood consensus, however, was that, so long as no one was misled and acted voluntarily, no
problem existed. John and Joan proceeded with the shop and made a significant amount of profit.
Disagreements arose among the neighbors, however, regarding exactly who was entitled to what.
30. Refer to Fact Pattern 21-1. Which of the following is true regarding the application of federal
securities laws to John and Joan’s situation?
A. The arrangement with the neighbors was at the suggestion of the neighbors; and federal security
law would, therefore, not apply.
B. Contracts such as those involved with the neighbors would not be considered securities and,
therefore, federal securities law would not apply.
C. Contracts such as those involved with the neighbors appear to be securities; but state law, not
federal law, would apply.
D. Contracts such as those involved with the neighbors would be considered securities; and,
therefore, federal securities law would apply.
31. Refer to Fact Pattern 21-1. Which of the following is true regarding the application of state
securities laws to John and Joan’s situation?
A. There are no state securities laws because these have been entirely preempted by federal law.
B. Although state securities laws, called blue sky laws, have been preempted in some respects, they
remain viable in other respects; and state law should be consulted to ensure compliance.
C. State securities laws have not been preempted in any respect; and state securities laws, called
yellow dog laws, should be consulted to ensure compliance.
D. John and Joan may elect whether they want state securities laws rather than federal securities
laws to apply.
Fact Pattern 21-2 (Questions 32-33 apply)
Alice and her general partner, Greg, own several businesses. Alice is very interested in salt water
aquariums and decides that a good venture for the partnership would be the development of a
business to raise tropical fish. She plans to issue stock to start the fish business with the idea that she
and Greg will purchase a majority of the stock. She has a friend, Tony, a plastic surgeon with a
good practice, who has expressed interest in the venture because he believes that the presence of fish
in waiting rooms reduces anxiety and encourages patients to spend more money. Alice does not
want to go to the expense and trouble of a formal registration under the 1933 Act and seeks advice
on how to avoid that process should the partnership issue securities.
32. Refer to fact pattern 21-2. As far as Greg is concerned, which of the following is true?
A. Selling to Greg would not trigger registration requirements because his status as a general partner
results in him being considered an accredited investor.
B. Selling to Greg would not trigger registration requirements so long as he purchases at least 10%
of outstanding stock.
C. Selling stock to Greg would not trigger registration requirements because he is a tombstone
investor.
D. Selling stock to Greg would trigger registration requirements.
33. Refer to fact pattern 21-2. As far as Tony is concerned, which of the following is true?
A. Selling to Tony would not trigger registration requirements because of the professional
exemption.
B. Selling to Tony would not trigger registration requirements if it can be established that his
income or net worth meets amounts required to qualify him as an accredited investor.
C. Selling to Tony would not trigger registration requirements so long as he purchases under 5% of
the stock.
D. Selling to Tony would trigger registration requirements.
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Fact Pattern 21–3 (Questions 34-35 apply)
Yolanda has filed the registration statement, in connection with a public offering of stock in ABC
Corgi, a company dedicated to the production of clothing and toys highlighting the highly prized
Welsh Corgi breed of dog. The registration statement is not yet effective. Yolanda would like to
move forward with promoting the company as much as possible. She asks for advice regarding
activities in which she could legally participate. She is particularly interested in making
presentations to large institutional investors.
34. Refer to fact pattern 21-3. Which of the following is true regarding Yolanda’s situation?
A. Because she is in the active period, no sales of securities are allowed.
B. During this quiet period, offers to buy may be accepted.
C. During this waiting period, so long as requirements are met, she may solicit offers to buy
securities but may not accept them yet.
D. During this quiet period, no sales of securities are allowed; and the red herring may not be
distributed
35. Refer to fact pattern 21-3. Which of the following are true regarding selling efforts to institutional
investors during this period.
A. Such efforts are called roadshows and are legal so long as SEC requirements are followed.
B. Such efforts are an illegal type of promotion referenced as selling promotions.
C. Such efforts are called concerted sales and are legal so long as the SEC gives prior approval.
D. Such efforts are simply called felonies and can result in fines as well as jail time.
ESSAY QUESTIONS
1. Discuss when a promissory note will be considered a security including a detailed discussion of the
family resemblance test.
2. Set forth the three tests under which a general partnership may be found to be a security?
3. Explain the scope and purpose of Section 11 of the Securities Act of 1933 regarding misleading
registration statements. What is the state of mind required in order to establish a violation of Section
11?
4. Set forth the difference between firm commitment underwriting and best-efforts underwriting.
5. Set forth the two principal federal acts that regulate securities transactions and issuers. Additionally,
list the three beliefs federal securities laws embody as set forth in the text. Do you believe that the
securities rules that are in place are sufficient to protect investors? Why or why not? Discuss fully.
ISSUES: The two principal federal acts that regulate securities transactions and issuers are the
Securities Act of 1933 and the Securities Exchange Act of 1934. The federal securities laws embody
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