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Securities Regulation
University of North Carolina School of Law
Hazen, Thomas Lee

Sec Reg

I. Introduction
** The key in all of this is disclosure and not the inherent fairness in a transaction. Sarbanes-Oxley has, however, increased the regulation of transactions in terms of their fairness and represents a shift in the original approach. These federal securities laws were enacted following the market crash of ’29 as it became apparent that the state regulatory (“blue sky”) schemes were not sufficient. Remedies are CUMULATIVE.**

a. Overview of SEC – established by §4 of the 1934 Act as the regulation of securities had become too great a burden of the FTC.
1. Has most of the powers given to administrative agencies except those to resolve disputes between private parties.
a. Competition with the CFTC for the financial derivative jurisdiction
b. law enforcement and investigative powers
c. Has administrative adjudicatory powers – most of the securities laws are made here.
d. Can suspend broker dealers as well as remove listings of certain companies
2. Rulemaking powers
a. Delegated by statute (e.g. §10/10b-5)
b. Interpretive Powers – has the power to pass rules interpreting a statute. While this doesn’t have the force of law, courts generally give strong deference to the Commission.
c. Administrative Procedure Act applies – notice and comment period for proposed rules.
3. Sources of SEC interpretation
a. SEC Releases
i. Adopting Release (after a rule has been adopted)
ii. Interpretive Releases – these do not go through the notice/comment process but is a good statement of the Commission’s interpretation of the rule of statute.
b. No Action Letters (like IRS Private Letter Rulings)
i. These are not an interpretation by the Commission, rather it is a statement written by staff in either the Enforcement or Corporate Finance Division.
ii. While these also do not carry the force of law, it is rare that the SEC will retract from its position in the letter (as applied to the individual company) unless the corp doesn’t do what their letter says they are going to do.
b. 1933 Truth in Securities Act (’33 Act)
1. Purpose: Covers the registration of securities in a public offering – adopts the policy of full disclosure. The Registration applies to the offering and not the security.
a. Secondary individual offering MAY trigger registration requirements if enough stocks are being sold.
2. Sections
a. §2: Definitions: Includes a list of things that are considered securities. There are specifically enumerated items that are considered securities, followed with the more “generic” term of investment contract (detailed later as most litigation as to §2 deals with this as they are more non-conventional investment schemes – issue is framed as to whether you have an investment contract within the meaning of the act.) The definition of securities is the same as the 1934 Act, with the exception of short term notes.
b. §3: Exempted Securities (first must determine whether something is a security and then see if it is exempt from the act.) – Distinguish excluded securities.
1. Exemption only as to registration requirements, other provisions – particularly those regarding fraud are still applicable. An excluded security is excluded from the Act entirely.
2. Exempted securities:
i. government securities
ii. not-for-profit
iii. small offerings
iv. employee stock offering
v. intrastate offering
c. §4: Exempted Transactions – this applies to the actual transaction, not the security.
a. Exempted transactions:
i. by person other than the issuer, underwriter, or dealer
ii. by certain broker/dealers
iii. accredited investor transactions
iv. private placement (§4(2) exemptions – detailed later in outline)
d. §5 – Hazen calls this the “heart of the act” ~ requires that any sale of securities must comply with the registration requirements of the act. This section does not address fraud, only compliance with registration. It is unlawful to sell OR offer to sell an unregistered security. Establishes presumption that sales in an unregistered offering are unlawful.
e. §6/8: Procedure for registration with the SEC, including acceleration of registration statements, delaying amendments, and stop orders.
f. §7: details the information that must be contained in the registration statement
g. §10: details the information that is required in a prospectus
h. §11: civil liabilities for false statement in registration statement
i. §12: civil liability for false statement in prospectus and other communications regarding the security. Also provides that anyone who purchase a security that was sold in violation of §5 has a one year right of rescission.
j. §17 – prohibits fraud or deceit in securities sold in interstate commerce. The fraud provisions apply to all securities, even those exempted by §3.
3. Other
c. 1934 Act
1. Purpose: Deals more with regulation in the market rather than the IPO
2. Sections
a. §4: establishes SEC
b. §9: prohibits manipulation of securities prices
c. §10: anti-fraud provisions (10b-5)
d. §11: broker/dealer transactions
e. §12: Registration requirements: applies to public companies (unless otherwise exempt) and 12(g) companies (those with at least 500 s/h of one class and §10 mil. total assets. The companies covered under this section are subject to the periodic reporting requirements as well as §14 proxy regulation.
f. §13: periodic reporting
g. §14: proxies
d. Market Regulation – this falls under the 1934 Act
1. SEC – umbrella org that oversees the SROs of the market orgs (NYSE, NASD etc)
2. NASD (National Association of Securities Dealers): regulates members of the OTC market
3. AMEX and NYSE are self-regulatory (SRO) – but still subject to SEC oversight
a. These exchanges have listing standards for companies (e.g. 20% voting share requirements)
4. Broker/dealer regulation – every broker dealer doing business in interstate commerce must be a NASD member.
e. Other Federal Financial Regulatory Schemes
1. Public Utility Holding Company Act (1935) – Hazen says this should have been repealed but after ENRON, the repeal of registration and regulation of energy compa

allowed to pursue the exploration of the land themselves or through another drilling company. Although the land purchase alone not does NOT constitute an investment contract, the marketing + the required service package with the purchase led the Court to find that this was in fact a security.
i. Results: (1) violation of §5 of ’33 Act (no scienter showing required); (2) §12(a)(1) provides a private right of action against persons who violate §5.

b. SEC v. Howey (1946): This case establishes the economic realities test. The Court finds that the divided land interests in fee simple in part of an orange grove is a security. Although it is only an interest in the land, the distinction is made in that the value of the land itself is fairly negligible and any profit that will be derived will be through the efforts of the promoter. Court also notes that the profits were pooled on a pro rata basis as well as the nature of the investors – most lived up north and would rarely, if ever, actually be in the orange groves. Thus, the investors must rely solely on the efforts of others. Court also notes, from a more policy-oriented perspective, that this is the type of investment that Congress was considering when it created the disclosure requirements of the 1933 Act. Looks at the economic realities of the investment.
4. Specific applications of the Howey Test
a. Investment of Money: “investor chooses to give up a specific consideration in return for a separable financial interest with the characteristic of a security. (see Daniel below)
i. Per Daniel, a contributory retirement plan will be considered a security while that seem to indicate that a compulsory, non-contributory plan would not be considered a security. (some voluntary action on the part of the investor appears to be required)
b. Requirement of a common enterprise
i. Horizontal Commonality: pooling of interests of investors that is generally combined with a pro rata share of the profits. This is considered a security. Thus, a commodities pool would be considered a security.
ii. Vertical Commonality: Promoter shares the risk with the investors but there is no other investor(s) involved. While there is a split as to whether this will be considered a security, but the majority rule is that this fails to meet the Howey common enterprise test. The narrower approach taken that does permit vertical commonality to create a common enterprise if the “investors fortunes are tied to the fortunes of the promoter.”