Chapter 43
SECURITIES REGULATION
I. The Securities Act of 1933
A. Definition of a Security
B. Registration of Securities
1. Disclosure Requirements
2. Integrated Disclosure
3. Shelf Registrations
4. Communications
5. Emerging Growth Companies
C. Exempt Securities
1. Short-term Commercial Paper
2. Other Exempt Securities
D. Exempt Transactions for Issuers
1. Limited Offers
a. Private Placements
b. Limited Offers Not Exceeding $5
Million
II. The Securities Exchange Act of 1934
A. Disclosure
1. Registration Requirements for Securities
2. Periodic Reporting Requirements
3. Proxy Solicitations
a. Proxy Statements
b. Shareholder Proposals
4. Tender Offers
a. Disclosure Requirements
b. Required Practices
c. Defensive Tactics
d. State Regulation
5. Foreign Corrupt Practices Act
B. Liability
1. Misleading Statements in Reports
2. Short-Swing Profits
Cases in This Chapter
SEC v. Edwards
Escott v. BarChris Construction Corp.
Matrixx Initiatives, Inc. v. Siracusano
United States v. o’Hagan
Schreiber v. Burlington Northern, Inc.
Chapter Outcomes
After reading and studying this chapter, the student should be able to:
Explain the disclosure requirements of the 1933 Act, including which
securities and transactions are exempt from these disclosure
requirements.
Explain the potential civil liabilities under the 1933 Act.
TEACHING NOTES
The primary purpose of Federal securities regulation is to foster public
confidence in the securities market by preventing fraudulent practices in the sale
of securities. Federal securities law consists principally of two statutes: the
Securities Act of 1933, which focuses on the issuance of securities, and the
Securities Exchange Act of 1934, which deals mainly with trading in issued
securities.
The 1933 Act has two basic objectives:
(1) to provide investors with material information concerning securities offered
for sale to the public and
(3)
The 1934 Act extends protection to investors trading in securities that are
already issued and outstanding. The 1934 Act also imposes disclosure
requirements on publicly held corporations and regulates tender offer and proxy
solicitations.
Both statutes are administered by the Securities and Exchange Commission
(SEC), an independent, quasi-judicial agency consisting of $ve commissioners.
The responsibilities of the SEC include interpreting Federal securities laws;
issuing new rules and amending existing rules; and coordinating U.S. securities
regulation with Federal, State, and foreign authorities.
Congress enacted the Private Securities Litigation Reform Act of 1995
(Reform Act), which amends both the 1933 Act and the 1934 Act. One of its
In response to the business scandals involving companies such as Enron,
WorldCom, Global Crossing, Adelphia, and Arthur Andersen, in 2002 Congress
passed the Sarbanes-Oxley Act, which amends the securities acts in a number
of signiticant respects. The Act allows the SEC to add civil penalties to a
disgorgement fund for the benefit of victims of violations of the 1933 Act or the
1934 Act
In July 2010, President Obama signed into law the Dodd-Frank Wall Street
Reform and Consumer Protection Act (Dodd-Frank Act), including the
To increase U.S. job creation and economic growth by improving access to the
public capital markets for emerging growth companies, Congress enacted the
Jumpstart Our Business Startups Act of 2012 (JOBS Act). As discussed
later in this chapter, the JOBS Act amends both the 1933 Act and the 1934 Act to
provide reduced disclosure requirements for emerging growth companies
(defined as companies with total annual gross revenues of less than $1 billion
during their last completed $scal year) and to expand the availability of
exemptions from registering securities under the 1933 Act.
The SEC has established the EDGAR (Electronic Data Gathering, Analysis,
and Retrieval) computer system, which performs automated collection,
validation, indexing, acceptance, and dissemination of reports required to be
$led with the SEC.
In addition to the Federal laws regulating the sale of securities, each State has
its own laws regulating such sales within its borders. Commonly called blue sky
laws, these statutes all contain provisions prohibiting fraud in the sale of
.
I. THE SECURITIES ACT OF 1933
This act, also known as the “Truth in Securities Act,” requires that a
registration statement be $led with the SEC and that it become effective
before any securities may be o*ered for sale to the public, unless the
transaction in which the securities are o*ered is exempt or the securities
themselves are exempt from registration.
• The purpose of registration is to disclose financial and other information
A. DEFINITION OF A SECURITY
The 1933 Act de$nes a security as any note, stock, bond, debenture, evidence of
indebtedness, pre-organization certi$cate of subscription, investment contract,
voting-trust certi$cate, fractional undivided interest in oil, gas, or other mineral
rights, or any interest or instrument commonly known as a security.
Courts have interpreted the term “investment contract” to require an investment
of money or other consideration and an expectation of pro$t derived from the
effort of others. Thus, limited partnership interests are usually considered
securities because limited partners may not participate in management or
control of the partnership. On the other hand, general partnership interests are
usually held not to be securities because general partners have the right to
participate in management of the general partnership.
CASE 43-1
SEC v. EDWARDS
Supreme Court of the United States, 2004
540 U.S. 389, 124 S.Ct. 892, 157 L.Ed.2d 813
http://scholar.google.com/scholar_case?q=540+U.S.+389&hl=en&as_sdt=2,34&case=14322712118728699297&scilh=0
O’Connor, J.
“Opportunity doesn’t always knock * * * sometimes it rings.” [Citation.] And sometimes it hangs
up. So it did for the 10,000 people who invested a total of $300 million in the payphone
sale-and-leaseback arrangements touted by respondent under that slogan. The Securities and
Exchange Commission (SEC) argues that the arrangements were investment contracts, and thus
I
Respondent Charles Edwards was the chairman, chief executive officer, and sole shareholder of
ETS Payphones, Inc. (ETS). ETS, acting partly through a subsidiary also controlled by
respondent, sold payphones to the public via independent distributors. The payphones were
offered packaged with a site lease, a 5-year leaseback and management agreement, and a
buyback agreement. All but a tiny fraction of purchasers chose this package, although other
management options were offered. The purchase price for the payphone packages was
approximately $7,000. Under the leaseback and management agreement, purchasers received
$82 per month, a 14% annual return. Purchasers were not involved in the day- to-day operation
of the payphones they owned. ETS selected the site for the phone, installed the equipment,
In its marketing materials and on its website, ETS trumpeted the “incomparable pay phone”
as “an exciting business opportunity,” in which recent deregulation had “open[ed] the door for
profits for individual pay phone owners and operators.” According to ETS, “[v]ery few business
opportunities can offer the potential for ongoing revenue generation that is available in today’s
pay telephone industry.” [Citation.]
The payphones did not generate enough revenue for ETS to make the payments required by
the leaseback agreements, so the company depended on funds from new investors to meet its
obligations. In September 2000, ETS filed for bankruptcy protection. The SEC brought this civil
enforcement action the same month. It alleged that respondent and ETS had violated the
registration requirements of §§5(a) and (c) of the Securities Act of 1933, [citation], the antifraud
provisions of both §17(a) of the Securities Act of 1933, [citation], and §10(b) of the Securities
Exchange Act of 1934, [citation], and Rule 10b-5 thereunder, [citation]. The District Court
concluded that the payphone sale-and-leaseback arrangement was an investment contract within
II
“Congress’ purpose in enacting the securities laws was to regulate investments, in whatever form
they are made and by whatever name they are called.” [Citation.] To that end, it enacted a broad
definition of “security,” sufficient “to encompass virtually any instrument that might be sold as
an investment.” [Citation.] * * * [The 1993 Act and the 1934 Act] define “security” to include
“any note, stock, treasury stock, security future, bond, debenture, * * * investment contract, * * *
others.” [Citation.] This definition “embodies a flexible rather than a static principle, one that is
capable of adaptation to meet the countless and variable schemes devised by those who seek the
use of the money of others on the promise of profits.” [Citation.]
* * * Thus, when we held that “profits” must “come solely from the efforts of others,” we
were speaking of the profits that investors seek on their investment, not the profits of the scheme
in which they invest. We used “profits” in the sense of income or return, to include, for example,
dividends, other periodic payments, or the increased value of the investment.
* * *
We hold that an investment scheme promising a fixed rate of return can be an “investment
contract” and thus a “security” subject to the federal securities laws. The judgment of the United
States Court of Appeals for the Eleventh Circuit is reversed, and the case is remanded for further
proceedings consistent with this opinion.
It is so ordered.
B. REGISTRATION OF SECURITIES
The purpose of registration is to disclose financial and other information
adequate and accurate enough to enable investors to judge the merits of
securities. Registration does not insure against loss — the SEC does not judge
the merits of any security or guarantee accuracy of information in a registration
statement.
Disclosure Requirements
Registration calls for
(1) a description of the registrant’s properties and business,
(2) a description of the signiticant provisions of the security to be o*ered for
sale and its relationship to the registrant’s other capital securities,
(3) information about the management of the registrant, and
(4) financial statements certi$ed by independent public accountants.
page, summary, and risk factors section of their prospectuses in plain English.
After the effective date, the issuer may make sales, provided the purchaser has
received a final prospectus.
Integrated Disclosure
Integrated disclosure is permitted for issuers subject to both the 1933 and 1934
Acts in an e*ort to reduce or eliminate unnecessary duplication of reporting. This
integrated system provides for different levels of disclosure, depending on the
issuer’s reporting history and market following. All issuers may use the detailed
form (S–1) described previously.
effective December 1, 2005 the SEC amended these rules to recognize four
categories of issuers: non-reporting issuers, unseasoned issuers, seasoned
issuers, and well-known seasoned issuers.
1. A non-reporting issuer is an issuer that is not required to $les reports
under the 1934 Act. Such an issuer must use Form S-1.
2. An unseasoned issuer is an issuer that has reported continuously under
the 1934 Act for at least three years. Such an issuer must use Form S-1
but is permitted to disclose less detailed information and to incorporate
some information by reference to reports $led under the 1934 Act.
3. A seasoned issuer is an issuer that has $led continuously under the 1934
Act for at least one year and has a minimum market value of publicly held
Shelf Registrations
Shelf registrations permit certain qualified issuers to register securities that are
to be o*ered and sold “o* the shelf” on a delayed or continuous basis within two
years. The information in the original registration must be kept accurate and
current. As amended in 2005, shelf registrations permit seasoned and
well-known seasoned issuers to register unlimited amounts of securities that are
to be o*ered and sold “o* the shelf” on a delayed or continuous basis in the
future.
Communications
The SEC’s 2005 revisions greatly liberalize the rules regarding written
communications before and during registered securities offerings. These rules
create a new type of written communication, called a “free-writing prospectus,”
which is any written o*er, including electronic communications, other than a
statutory prospectus. The Jexibility provided under the new rules depends upon
the characteristics of the issuer, including the type of issuer, the issuer’s history
of reporting, and the issuer’s market capitalization.
1. Well-known seasoned issuers may engage at any time in oral and written
communications, including a free writing prospectus, subject to certain
conditions.
Emerging Growth Companies
The JOBS Act de$nes an emerging growth company (EGC) as a domestic or
foreign issuer with total annual gross revenues of less than $1 billion
(periodically adjusted for inJation) during its most recently completed $scal year
if that issuer did not first sell common equity securities in an initial public
offering (IPO) on or before December 8, 2011. An issuer continues to be deemed
to be an EGC until the earliest of the following: (1) it has annual gross revenues
C. EXEMPT SECURITIES
The 1933 Act exempts a number of specific securities from its registration
requirements; these are known as exempt securities. The securities may also be
resold without registration, because the exemption applies to the securities
themselves.
Short-Term Commercial Paper
The act exempts any note, draft, or bankers’ acceptance (a draft accepted by a
Other Exempt Securities
These include, under the 1933 Act:
(1) securities issued or guaranteed by domestic governments, such as
municipal bonds;
(2) securities of domestic banks and savings and loan associations;
(3) securities of nonpro$t charitable organizations;
D. EXEMPT TRANSACTIONS FOR ISSUERS
Limited Offers
In addition to exempting specific types of securities, the 1933 Act also exempts
issuers from the registration requirements for certain kinds of transactions.
These exempt transactions include
(1) private placements (Rule 506),
(2) limited o;ers not exceeding $5 million (Rule 505),
(3) limited o;ers not exceeding $1 million (Rule 504) and
(4) limited o;ers solely to accredited investors (Section 4(6)).
If the issuance meets certain conditions, Rule 504 permits general solicitations,
and acquired shares are freely transferable. The conditions are that the issuance
is either (1) registered under State law requiring public $ling and delivery of a
disclosure document to investors before sale or (2) exempted under State law
permitting general solicitation and advertising so long as sales are made only to
accredited investors.
or other governmental approval. These exemptions apply only to the original
issuance; resales may be made only by registration, unless the resale quali$es
as an exempt transaction.
Crowdfunding Exemption
Crowdfunding is the use of the Internet to raise small amounts of money from
a large number of contributors. The JOBS Act requires the SEC to adopt rules to
Regulation A
Regulation A, another transaction exemption, permits an issuer to sell $5 million
in securities in an unregistered public offering if certain conditions are met.
Regulation A places no restrictions upon the resale of securities issued pursuant
to it.
To expand the availability of Regulation A for issuers, the JOBS Act directs the
SEC to amend Regulation A or adopt a similar exemption (commonly referred to
as “Regulation A+”) with the following terms:
Intrastate Issues
This exemption covers a security that is o*ered and sold only to residents of one
state. The issuer must be incorporated or organized in the state of issuance and
must conduct 80 percent of its business in the state. No resale of these
securities is permitted for nine months.
NOTE: See Figure 43-2: Exempt Transactions for Issuers under the 1933 Act.
E. EXEMPT TRANSACTIONS FOR NONISSUERS
Rule 144
Rule 144 exempts certain resales of restricted securities. If there is adequate
current information about the issuer, the seller has held the security for two
years, the securities are sold in limited amounts and in unsolicited brokers‘
transactions, and the SEC is noti$ed of the sale, then the resale is exempt. A
Act than on resales of securities of nonreporting issuers.
Nonreporting Issuers Amended Rule 144 — requires for an aGliate selling
restricted securities that there be adequate current public information about the
issuer, that the aGliate selling under the rule have owned the restricted
securities for at least one year, that she sell them only in limited amounts in
unsolicited brokers’ transactions, and that notice of the sale be provided to the
Reporting Issuers Amended Rule 144 — requires for an aGliate selling
restricted securities that there be adequate current public information about the
issuer, that the aGliate selling under the rule have owned the restricted
securities for at least six months, that she sell them only in limited amounts in
unsolicited brokers’ transactions, and that notice of the sale be provided to the
Rule 144A
To improve the liquidity of restricted securities, in 1990 the SEC adopted Rule
144A, which provides an additional, nonexclusive safe harbor from registration
for resales of restricted securities. Only securities that at the time of issue are
not of the same class as securities listed on a national securities exchange or
quoted in a U.S. automated interdealer quotation system (“nonfungible
securities”) may be sold under Rule 144A. Such nonfungible securities may be
Regulation A
Also provides a registration exemption for resales of a limited amount of
securities by non-issuers.
F. LIABILITY
The 1933 Act imposes sanctions for noncompliance with its requirements,
including administrative remedies by the SEC, civil liability to injured investors,
and criminal penalties.