SECURITIES REGULATION
PAINTER
SPRING 2012
I. Intro/Overview
a. Securities laws are all about DISCLOSURE!
i. Looking at the different types of business assoc and seeing what the managers are doing to the passive investors!
1. Manager managed LLC’s are subject to securities law
b. 1933 Act governs the OFFER & SALES of securities
i. When you have to register or not, etc
ii. Disclosures required in the offers/sales
c. 1934 Act is a fix to more issues—mostly about CONTINUED DISCLOSURES!
i. Focuses more on the trading markets and its participants
ii. 10K, 10Q, 8K, etc for reporting companies
1. Those trading on nat’l exchange
2. Those with assets in excess of 10mil and have a class of equity securities held by at least 500 people
3. Those that have filed 1933 Act registration statement that has become effective
iii. Reporting companies have to register with SEC and file reports via EDGAR
iv. Sets up the SEC to govern all this
v. SH voting (proxy) rules too
d. SOX adds more procedural and substantive safeguards too!
e. Blue Sky Laws
i. Always remember that each STATE has securities laws to follow too!
1. Often require seller to convince state officials of the merit of the offering
ii. 1933 Act precludes states from requiring registration for “covered” securities
1. Ones that trade on nat’l markets
f. THE SEC
i. Makes public releases about the rules/regulations & how to abide by them
ii. Chooses cases to pursue criminally
iii. Writes no-action letters, assuring corp that it will not be investigated for violation of rules if it takes a proposed course of conduct
g. Securities are bought/sold in two settings
i. Issuer transactions: corp sells securities to investors
1. Private placements
2. Or primary distributions
ii. Trading transactions—sales of outstanding shares b/w investors
1. Negotiated privately OR done over an exchange
II. Definition of a Security
a. 33 &34 act both contain specific lists of what a security is—but some of the terms within that are vague and case law has developed to sort it out
i. Stocks, bonds, note, investment K’s
ii. “unless context otherwise requires”—courts can make determination of when the listed things do NOT qualify as securities
b. INVESTMENT CONTRACTS
i. If something is not specifically named in the definition of a security, the only way it can be considered one if it fits Investment contract definition (this is catchall provision!)
ii. RULE: a K, scheme, or transaction whereby a person invests him money in a COMMON ENTERPRISE and is led to expect PROFITS SOLELY FROM THE EFFORTS OF OTHERS
1. SEC v Howey: orange groves case. Buy plot of land and then enter into a service K with management company to grow/cultivate it for you. Fruit on all the tracts are pooled & sold and you get your proportion of that
iii. If you don’t expect a PROFIT, it probably is not an investment K. When person is motivated by desire to USE/CONSUME the item purchased, it’s not a security
1. United Housing Foundation: bought shares of stock in a co-op. Needed X amount to get an apartment in it. This was not for desire of profit but to have a place to live—not an investment K
iv. Profits expected can be Variable (proportion of total, whatever that is) or Fixed
1. Just the fact that investors are seeking out a profit—doesn’t have to be part of the total scheme they invest in. A fixed profit (and even a contractual right to that fixed profit) still qualifies.
2. Return is still expected to come solely from the efforts of others, regardless what the risk/rate of return is
a. SEC v Edwards: pay phones. Buy a phone and they manage/run it. Get $82 per month fixed return. Qualifies as security.
v. Common Enterprise—courts have differing standards on what is required….
1. Vertical commonality: activities of the promoter are the controlling factor in success of investment (don’t necessarily need pooling of funds/interests)
2. Horizontal Commonality: requires pooling of investor funds
a. But can be either variable or fixed return
b. Can even qualify if there is only 1 investor, so long as others were sought
3. Most courts use horizontal enterprise requirement
a. Promoter is selling to multiple people and these people are all at the same level in the enterprise
b. Pooling of funds here is again an issue of contention
i. Most courts say you need the pooling, but some do not require it!
vi. Profits from Efforts of Another
1. Minimal participation from investor will not get you out of this
2. Court will look at the reality of the situation
a. At actual efforts made and work done
i. Giving people the option to do work on their own won’t count if nobody actually takes up that option
b. Timing also has little effect—doesn’t matter whether the effort is made before, during, or after the profit
3. Whether the essential efforts/factors to the success are efforts from another
a. What the significant factor in the profit is
b. AIDS case: selling life insurance policy of dying people to investors—though promoter had to find the AIDS patients the significant factor in the profit was how long they live—not a security!
vii. Interests in Partnerships and LLC’s
1. Have to fit these under investment K to show they are a security, as they are not specifically listed in the acts
2. Typically centers on if the investors are dependent for the profits on the efforts of others
a. Like LP (the LP’s depend on the GP’s to do the work)
i. So GP’s usually are not securities but interests in LP’s are!
ii. GP would only be if you are investing and literally are not doing any work and just depending on the rest of GP’s, but this is rare and hard to meet.
iii. LP usually always will b/c LP’s CANNOT manage or they lose their shield
b. Or manager managed LLC (investors rely on man
3. But they are NOT exempted from 1934 act, so while they don’t have to register, they can still be held liable for fraud in the use of them!
a. Also still included under 1933 sec 17?? For fraud.
xii. TAKEAWAY: to defeat Investment K standard, either be investing NOT FOR EXPECTING PROFITS or profits that do arise are NOT FROM EFFORTS OF OTHERS!
c. STOCK
i. Stock in a FOR PROFIT company is a security, ALWAYS!
1. Non-profits (like co-ops, country club, etc) is NOT security
a. Forman case above is about stock in a co-op, to which the Court used the Howey test. This is a mixup and court later fixes it by creating this separate test for stock under Landreth Timber
b. People tried to use this case/Howey test for corporations—to say that selling 100% of the stock of a corp is not a security sale, b/c you are not buying it for the expectation of profits, but are buying it to own the company
i. Again, this is fixed in Landreth
2. Landreth Timber: any stock in a for profit company is a security
a. Selling 1 share of stock or 100% of the stock will both trigger securities laws!
i. This case was sale of all stock in closely-held corp
b. This is only for stock as commonly defined (so only stock in a corp!)
i. LLC’s LLP’s etc are still under the Howey test!
3. Giving something label of stock is not necessarily enough. Stock has these common characteristics:
a. Right to receive dividends based on proportion of profits
b. Negotiability
c. Ability to be pledged or hypothecated
d. Voting rights
e. Capacity to appreciate in value
d. NOTES
i. Listed specifically in both acts, but certain exemptions apply
1. In 33 Act, notes arising from a current transaction and maturity of less than 9 months are exempted from registration
2. In 34 act, anything with maturity of less than 9 months is exempted totally
3. BOTTOM LINE: short term notes are completely exempt from 34 act, and exempt from registration in 33 act, but still all other provisions of 33 act apply (fraud provisions under 33 act—sec 12 & 17)
a. This makes commercial paper totally exempt from 10b suits!
ii. RULE (Reves v Ernst & Young): just b/c it is called a note does not make the note a security
1. Presume that a note is a security
2. But there is a list of exempted notes that are NOT securities
3. Use the following 4 factors to determine whether a new/different creation should be added to the exempted list (or not), by trying to show it is like those exempted notes…..
