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Securities Regulation
University of Kansas School of Law
Walter, Roger N.

FALL 2012
I.        Consequence of An Instrument/ Transaction Being a Security
A.     Registration Requirement
1.      Federal Securities Act of 1933 (33’ Act)
–          Securities – Value not inherent – it stems from claims on the assets and earning of the issuer; or voting power that accompanies those claims.
·        Securities are bought and sold in two types of Transactions  in the Securities Market
o   Issuer Transactions – Transactions involving the sale of securities by issuer to investors to raise capital to develop, to grow, or survive.
§  Private Placements – These types of issuer transactions are an exception under the securities laws and escape the rigors of regulation.
§  Public Offerings (Primary Distribution) – Usually done through broker-dealers (underwriters).
o   Trading Transactions – trading transactions are those where the buying and selling of outstanding securities are done amongst investors themselves. (Resales)
·        4 Types of American Securities Markets
o   Bond – Usually large financial institutions, Government securities (US, State, or Municipal bonds)
§  Government Bonds –are exempt from disclosure regulations
o   Equity
o   Derivative/Option Markets
–          1933 Federal Securities Act – Regulates the public offering and sale of securities in interstate commerce.
·        Disclosure – Requires that public offerings of securities occur through the process of “registering” the offer with the SEC.  Requires TWO DOCUMENTS.
o   Registration Statement – Overseen by the SEC’s Corporate Finance Staff and must provide
§  a thorough description of the issuer’s business, property, and management.
§  State any risks
§  Financial information – Certified financial statements from current and previous years, including revenues and earnings for each product line.
§  Management must provide analysis and review of the issuer’s capital needs, solvency, and financial performance – including variances from the preceding year.
§  The rights, privileges and preferences of the offered security must be included.
§  Description of the existing capital structure of the firm.
o   Prospectus – designed to provide all material information necessary for investors to fully assess the merits of the security.
o   Securities can be sold – only after the registration statement becomes effective.
·        Remedies to Protect Investors
o   Section 11 – Right of action for materially false statements in the registration statement.
o   Section 12 – Civil liability upon those who sell securities in violation of Section 5’s registration requirement or for a materially misleading statement.
·        SEC’s Enforcement Powers
o   Power to issue administrative cease-and-desist orders under Section 8A.
o   Power to Prosecute violations civilly in federal courts under Section 20.
2.      State Law
B.     Securities Act of 1934 (34’ Act) — 1934 Securities Exchange Act – Created the Securities & Exchange Commission to deal with the different problems in the securities market.
–          Purpose – The Act is concerned with trading markets and their participants.  The Act instituted a system of continuous disclosure for companies required to register under its provisions.
–          Three Classes of Companies Subject to the Disclosure requirements of this Act – Called a Reporting Company
·        (1) Companies that have a class of securities listed on a national securities exchange (Section 12(b))
·        (2) Companies that have assets in excess of $10 million and that have a class of equity securities held by at least 500 persons (Section 12(g) & Rule 12g-1); AND
·        (3) Companies that have filed a ’33 Act registration statement that has become effective (Section 15(d))
–          Section 13 – Reporting Companies – Required to register with the SEC and thereafter make timely filings of reports under Section 13.
·        These reports do not need to be forwarded to investors but just filed with the SEC, electronically via EDGAR (Electronic Data Gathering, Analysis, and Retrival System).
o   Annual Report (10-K) – Includes an extensive description of the company’s business, audited financial statements for the fiscal year, and management’s discussion and analysis of the position and performance fo the company.
o   Quarterly Reports (10-Q) – include unaudited interim financial statements for the company as well as management’s analysis of financial operations and conditions.
o   Form 8-K – Must be filed within a few days of the occurrence of a material development of the type specified in the form.
§  Change of control
§  Credit downgrade
§  Acquisition or disposition of a significant amount of assets
§  Commencement of insolvency proceedings
§  Change in auditors
§  Resignation of a director in a dispute over policy.
·        Regulation of Exchanges, Broker-Dealers, and Market Abuses
·        Seeks to protect the integrity of capital markets and investors
o   Antifraud & Anti-manipulation provisions.
–          Integrated Disclosure – Adopted by the SEC in the early 1980s whereby certain companies registering securities under the Securities Act could fulfill many of the disclosure requirement demands by incorporating the Securities Act registration statement information from their Exchange Act filings. (10-K)
·        For integrated disclosure, issuers must file a registration statement with the SEC in advance of their offering.
C.     Anti-Fraud Regulation
1.      Federal
2.      State
II.     Definition of Securities – a gateway to federal securities regulations
A.     Statutory Definitions
33’ Act Sec. 2(1): see supplement
34’ Act Sec. 3(10): see supplement
First, laundry list of examples à 2nd, other elusive and susceptible to expansive interpretation (investment contract, certificate of interest in profit sharing agreements) à 3rd, other vast and disordered equivocal instruments to the list
B.     Development of a Framework for Defining an Investment Contract (State blue sky act)
–          Vague but potential expansion of the definition — Sec v. C.M. Joiner Leasing Corp: SEC attempt to stop the offering and sale of assignments of oil leases. The definition includes undivided interest in oil and gas. It doesn’t include divided interest.
·         The court held that “Novel, uncommon, or irregular devices, whatever they appear to be, are also reached if it be proved as a matter of fact that they were widely offered or dealt in under terms or courses of dealing which established their character in commerce as investment contract or as any interest or instrument commonly known as a security”.
–          More precise framework — SEC v. Howey Co.: H tried to use mails to offer and sale of units of a citrus grove development with a contract for cultivation, marketing and remitting the net proceeds to the investor; SEC tried to stop it. Whether the land sales contract, the warranty deed and the service contract together constitute an investment contract within the meaning of Sec. 2(1) of 33’Act.
·         Defined by state blue sky act: An investment contract means a contract or scheme for the placing of capital or laying out of money in a way intended to secure income or profit from its employment. 
·         Defined by this court by following the federal act:  Investor contract means a contract, transaction or scheme whereby
o   A person invest money
§  Cash or noncash
§  Not for the return of a consumable commodity or service, but for financial return
o   In a common enterprise
§  (Majority) Horizontal commonality — Multiple

forts of others
§  “Profit”, the Court has meant either capital appreciation resulting from the development of the initial investment, or a participation in earnings resulting from the use of investors’ fund. When a purchaser is motivated by a desire to use or consume the item purchased, the securities laws do not apply.
§  Managerial and entrepreneur effort doesn’t have to be solely but significant. Expect of profits come from capital appreciation and income or participation in the earnings.
§  The intent of people invest in the house is to rent the house and save money. It doesn’t have to generate money for you.
·         The Attribute test instead of Howey — Howey framework is inappropriate when stock has the normal attributes of stock.(Landreth case) The court stated that it’s not clear that the Howey test is for all kind of security or only for investment contract. Attribute test is more flexible to determine whether it is security.???????
·         Measuring Intent — subjective intent inferred from the fact, “securities is not present if the investor s were attracted primarily by the prospect of acquiring use and not by financial returns on their investment”.
·         Problem 2.1 Customer put down a deposit for new model of Jaguar.
o   It’s not an investment on common enterprise and through the efforts of others. The defense can go that it’s not through the managerial efforts of the company but the market perception. If a promoter promised a fixed return, it doesn’t meet the expectation of profits.
2.      Common Enterprise
–          SEC v. Edwards – whether a moneymaking scheme (selling payphone with 5yr lease-back and guaranteed buyback) is an investment contract simply because the scheme offered a contractual entitlement to a fixed return?
·         11th circuit said it’s not a investment contract. Because investment contract offers either capital appreciation or a participation in the earning, it excludes schemes offering a fixed rate of return. Also the profit is not derived solely from the efforts of others.
·         SCOTUS reversed. The court looked at the intent of the investment, for individual consumption or for profit. Court doesn’t want the promoter to avoid the Act too easy. It embodies a flexible principle, 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.
·         Fixed return rate is consistent with the expectation of profit and thus constitutes security. The promoter is obligated to pay no matter whether the effort of management succeeds. The fact that the investors have bargained for a return on their investment doesn’t mean the return is not also expected to come solely from the efforts of others.
–          The Meaning of Common Enterprise
·         The features of common enterprise:
o   Pooling of funds
o   Sharing of profits or losses
o   Pro rata based on activity of investment
o   Promoter and investor win or lose together
o   Reliance on promoter
o   Economic interdependence