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Securities Regulation
Temple University School of Law
Lin, Tom C.W.

Securities Regulations Outline
Spring 2014
Professor Lin
I.                   Introduction to the Securities Markets and Securities Regulation
A.    Why do we have securities regulations?
                                                              i.      Congress enacted regulations in the 1930s after the depression to help protect investors from abuses.
                                                            ii.      The principal governing securities prior to the SEC was a buyer-beware system.
1.      Now it is a full disclosure system
2.      Mandatory attempts to get everyone on the same page.
a.       In an attempt to get efficient capital markets
B.     Types of Stock
                                                              i.      Common Stock: the most ordinary type of security offered by corporations.
1.      Lowest liquidation rights
2.      Has voting rights; but is the last to get paid.
3.      Residual; meaning that they receive a share of corporate profits only after the claims of all other ownership interests.
                                                            ii.      Preferred Stock:
1.      More rights and pays dividends
2.      Usually negotiable and has higher liquidation priority compared to Common Stock.
3.      Voting rights contingent on dividends not being paid for a certain amount of quarters.
                                                          iii.      Debt or Bonds: Basically a loan; no voting rights
1.      Has coupons that use yields or interest payments.
2.      They are tradable
3.      Highest liquidation priority
4.      Graded by credit rating agencies
a.       Higher the rating, the lower the interest rate.
5.      There is a benefit of corporations raising capital through debt or bonds.
a.       The interest on these securities is deductible for federal income tax purposes the corporation receives for any interest paid to bondholders.
C.     Types of Securities Transactions
                                                              i.      Primary Transactions
1.      Between the issuer and the investor
2.      Usually in the form of an IPO
3.      Can be stocks and bonds; not limited to just stock.
4.      Involves sophisticated investors.
                                                            ii.      Secondary Transactions
1.      Interactions between investors
2.      Purchase and sale of public stock; but could also be private stock.
D.    Traditional Securities Exchanges: NYSE & AMEX
                                                              i.      Dow Jones Industrial Average
1.      30 large companies that representative of the U.S. market are averaged
                                                            ii.      S&P 500
1.      500 of the largest companies in the United States
2.      This is the best representation of the U.S. economy.
                                                          iii.      NASDAQ Composite
1.      Composite index of all of the companies that are trading on the NASDAQ exchange
2.      Indicator of technology and high growth companies list on the NASDAQ exchange
E.     Bodies of Securities Regulations and Who Enforces Them
                                                              i.      Federal Law
1.      The Securities Act of 1933 governs mostly primary transactions
2.      The Securities Act of 1934 governs secondary transactions
a.       Created the SEC
3.      The Investment Act of 1940 and the Advisor Act of 1940
a.       Regulation of mutual fund investors and advisors
4.      Trust Indenture Act of 1939
a.       Regulates public debts
b.      Bond transactions.
                                                            ii.      State Law a.k.a. Blue Sky Law
1.      The blue sky part comes from times prior to regulation when people would offer people investments in the sky.
2.      PA Blue Sky Law was administered by the banking and securities department.
3.      Martin Act of the State of New York
a.       Contains a broad anti-fraud provision that Elliot Spitzer used to prosecute executives of high profile cases.
4.      The Supremacy Clause
a.       If there is a conflict between state and federal law, federal law wins out.
                                                          iii.      Private Law
1.      Self-Regulating Organizations
a.       SRO
b.      Stock exchanges, credit rating agencies, FINRA
                                                          iv.      Enforcement of the Regulations
1.      FINRA
a.       Allows you to check your broker
2.      SROs
3.      SEC
a.       Initiates civil and enforcement actions
b.      Provides information to the public regarding investigations
4.      Department of Justice
5.      State Regulators and State Attorney Generals
6.      Private Litigants
                                                            v.      Price v. Value
1.      Price refers to what the security is traded at, the value is what the security is actually worth.
a.       Overtime, they should get closer to each other.
2.      The key to long term investing is to make sure that investors in the market have a way of figuring out the price, not necessarily the value
II.                Definition of Securities: Look at the context of what is being “offered” or “sold”
                                                              i.      What is not a security?
1.      Home purchases are not securities cases; however sometimes they can be. See case
2.      Savings account at a bank is not a security.
                                                            ii.      Even if something is not called a security, does not mean that it is not a security. We have to look at the context in which it is being offered or sold under.
                                                          iii.      If it fits under the Howey test, then there is a strong chance that it is a security.
B.     SEC v. Howey: The test to see if what is being offered is a security. P. 106
                                                              i.      Test for Howey: Look to see if it is a contract, transaction or scheme.
1.      A person invests his money
2.      In a common enterprise
3.      Is led to expect profits
4.      Solely from the efforts of the promoter or third party.
a.       The “others” does not have to be to the same “other”; just not the original investor.
                                                            ii.      In this case, it could be argued that the contract is not an investment contract if they are split up; one would be investing in just the land.
                                                          iii.      Definition of investment contract: for the purposes of the Securities Act means a contract, transaction, or scheme whereby a person invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or third party, it being immaterial whether the shares in the enterprise are evidence by formal certificates or by nominal interests in the physical assets employed in the enterprise.
C.     Application of Howey
                                                              i.      SEC v. SG Ltd.
1.      SG was selling virtual shares of make believe companies to “investors”.
2.      SEC is claiming that it is substance over form of the item being offered; just because you do not call it a security does not alleviate it from securities law. i.e. game v. serious commercial venture.
3.      There are two classes of stock.
a.       Privileged shares with 10% interest
b.      Non-privileged shares.
4.      Even though virtual shares exclusively mentioned in the ’33 or ’34 Acts, the court still applied the Howey test.
a.       The first factor deals with investment of money for specific consideration in return for a separable financial interest with the characteristics of a security.
                                                                                                                                      i.      Court rules that there is the existence of this factor.
b.      The commercial enterprise status is examined next using commonality and pooling.
                                                                                                                                      i.      Court finds that there is pooling.
c.       Finally, they look at the profits expected and the court states that there is clear evidenc

nagement stayed on as part of the exchange of cash for the stock; but the company goes under after the sale because there was considerable damage to the mill that was not fixed.
3.      The attorney, Dennis, is arguing that there was a false start so the sale of stock should not have taken place.
a.       There is a Sale of Business doctrine that is no longer good law.
                                                                                                                                      i.      It stated that when you sell 100% of stock, it is exempt and not covered by securities law.
b.      Basically done to make it easier for small businesses to change hands.
4.      There is an argument that the Howey test should be applied; but he court says that is does not need to be applied in this case.
a.       Instead, the court looks at the economic reality of the stock.
b.      Justice Powell says that if, on its face, it is stock then there is no need to go further into tests to determine if it is stock. Pretty straight forward.
5.      Securities regulation exists to protect ALL investors, not just passive or active ones.
6.      You could look at a Fraud Claim; and you could also look at Corporate Law.
a.       However, the court is worried that states like Delaware would make laws favorable to Companies and allow for transactions likes this to go on without repercussion.
7.      By creating a strict securities rule, people will want to get around it. So having this test helps us determine if something should be governed by securities law.
                                                          vi.      Reves v. E&Y: NOTES are securities under Section 3(a)(10) Securities Exchange Act of 1934
1.      The issue is whether the note issued by the Co-Op are securities and therefore covered by the SEC
a.       Farmer’s Co-Op is selling these notes to raise capital for their business.
b.      They have a variable interest rate as well to keep it higher than local financial institutions.
2.      E&Y was alleged to have done a poor job with their financials and auditing.
a.       They are being sued for a failure to audit and 1,600 members losing 10 million in investments.
b.      They claim that it wasn’t registered, so they were treated differently. If it had been registered properly, E&Y would have treated the notes differently.
3.      The court then addresses the notes with the Howey test:
a.       However, the court doesn’t want to  use this because it is a “note” and not a pure stock or investment contract.
4.      Court looks at two tests: Investment v. Commercial Test; and Family Resemblance test (from the 2nd Circuit)
a.       Investment v. Commercial Test
                                                                                                                                      i.      Investment is more likely to be a security
                                                                                                                                    ii.      Commercial is less likely to be a security.
1.      Expecting to be repaid is not an investment necessarily.
b.      Family Resemblance Test
                                                                                                                                      i.      Since the note is not on a list of things that are not securities; the court presumes that it is a security.