Intro to Securities Law A.

Intro to Securities Regulation

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Private Placements (exempt transax) Being classified as a private company allows you to avoid the requirements of SEC compliance, which is mundane filings at the SEC. A private company allows more freedom of operation. Private placements are the exact opposite of IPOs. a. Factors of its a private placement or IPO: i. Issue type: 1. # of offerees Helps determine magnitude of the total offer and determine sophistication level of offerees. Focus is on offerees, not ultimate buyers. Higher the offerees, more likely its IPO. 100 people makes it seem more like public. 2. Size of Offering Is the amount being offered. It is the financial amount at stake. Low number of shares issued looks private. 3. Manner of Offer The process by which the company solicits investors. Does the company reach out to selected individuals or does it make public advertisements? a. Phone call private b. Newspaper - public ii. Investor Type 1. Sophisticated vs. Unsophisticated Actual investor education is not determinative, it is whether the investor has access to information needed to make an informed decision about the risk in investment. What is important is actual knowledge, relationship to people in the business, access to people with information about the investment. If they are not sophisticated, you are in trouble bc you have to do registration statements. Why? In order to protect public. So this uniform disclosure requirement helps protect public. If sophisticated investor, they don't need this info @ all. SEC kind of decides what sophisticated investors are: banks, financial institutions, insiders @ your company, a. Doran v Petro Management Corp. i. dude had more than 1 mil bucks, had multiple holdings, he is sophisticated. Trying to argue was public offer and therefore subject to SEC laws. Question was of access information. You can raise money for private stuff with unsophisticated ppl; if you have pretty solid relationship with them or they have relationship with other sophisticated members (ex family members) Basic Securities Fraud

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Scientor There must be an intent to defraud; or firms must have undertaken task recklessly negligent; mere negligence is not enough. i. Not difficult to prove bc firms usually intend the acts that create the basis for the fraud in the first place 1. i.e. the firm surely intends to issue a press release Proximate Cause The misrepresentation must be the proximate cause of the loss. Loss is calculate when you sell, not when the misrep is made. Loss must be actual. Dura Pharmaceuticals v Broudo. i. Assuming the P did ultimately sell @ a loss, the loss on the transax might be explained by other factors unrelated to the misstatementslike economic circumstances, changed investor experiances, new industry-specific facts, conditions or other events 1. thus the opinion in Dura suggests that the P have to wait until they have suffered actual economic loss as a consequence of revelation before they might seek redress for securities fraud a. not good bc it promotes firms to conceal the misstatements longer so that the revelation of loss might be attributed to something else Material Misrepresentation: first and foremost basic security fraud cases require some form of deception/misepresentation 1. ex would be issuing false press release or manipulating financial statements proof of an unfair/unscrupulous ax, even if true, would not be enough for securities fraud. Sante Fe Industries v Green. i. goal of security law is to promote full disclosure and stamp out deception 2. must be misrep of material fact a. misrep of trivial fact not enough b. may keep firms from over-supplying info so as to hide imp info within the weeds of trivial info ii. Preliminary Agreements vs. Reasonable Investor Standard

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The standard of materiality is whether a reasonable investor would want to know about the transaction. Firm merger is always a critical event. You only must disclose preliminary agreements if a reasonable investor would want to know about it . Probability/Magnitude Approach Materiality depends on the likelihood of the outcome

and the relative magnitude of the transaction. a. Genlly in order to assess the probability that the event will occur, factfinder will need to look @ indicia of interest in the transaction @ the highest corporate levels i. ex. board resolutions, instructions to investment bankers, and actual negotiations btw principles or their intermediaries b. to assess the magnitude of the transaction to the issuer of the securities allegedly manipuated, a factfinder will need to consider such facts as the size of the two corp entities and of their potential premiums over market value

i. Basic v Levinson: Because a merger is a critical firm event, surely a

rsnble investor would want the truth with respect to almost all potential merger negotiations, even where no agreement had been reached, if an agreement was rnsbly likely to occur from them.

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Reliance: the misrep must have led the complaining party to have changed their position in some way; a death knell to most P bc many P will have no direct notice of the misrep a. why is there usually no direct notice? Bc most shareholders are passive and don't actively day trade and watch info i. ergo, shareholders usually rely on indirect/remote reliance ii. Actual Reliance Not needed in securities fraud cases. If actual reliance was all that mattered, securities fraud cases wouldnt proceed because theres usually never actual reliance. iii. Presumptive Reliance 1. Capital Working Markets these markets incorporate all public info to value shares. A false public statement is incorporated in the price of the share. a. P need only show that (1) public mistatements were made and (2) that they traded in (relied on) an efficient market, regardless of whether the traders had actually learned of the misstatements themselves 2. Public Information The misrepresentations must be public. 3. Presumptive Reliance is rebuttable Its a high burden, but corporation can show that plaintiffs did not rely on the misrepresentations or that they wouldve sold their stock anyway. a. Show by direct evidence either that the market price was not affected by the misleading disclosure OR that the P were not fooled by the deception i. i.e. suppose P sold stock bc of reasons unrelated to misstatement or perhaps the P have credible counter-intel that the misstatements were actually false ii. D could show that the misstatements did not artificially swing trading prices, bc the market didnt move on the basis of the public statements 4. Presumptive reliance also allows plaintiffs to band together for a class action, because they dont have to each show their individual actual reliance. Standing: one only has standing to sue in connection with the purchase or sale of a security i. P cannot bring a securities fraud case based on an expectation that they would have traded in the securities firm, if not for the fraud.

Basic v Levinson: P engaged in business of manufacturing chem refractories and Combustin Engineering is a company producing mostly alumina-based refractories; combustin decided it wanted to merge with P and buy it; P company made 3 public statements denying it was engaged in merger negotiations; class ax suit where dudes claimed they were injured by selling P company stock @ artificially depressed prices in a market affected by petitioners misleading statements and in reliance thereon; company couldnt say no comment when asked bc it make people believe actually going to merge Ct looked @ whether they could properly apply presumption of reliance in certifying the class, rather than requiring each class member to show direct reliance on Basic's statements an omitted fact is material if there is a substantial likelihood that a rsnble shareholder would consider it important in deciding how to vote made sure not to set too low a minimum so ppl could over-abundance info to fulfill materiality requirment there must be a substantial likelihood that the disclosure of the omitted fact would have been viewed by the rsnble investor as having significantly altered the total mix of info made available. Where the event is contingent or speculative in nature its difficult to ascertain whether the rsnble investor would have considered the omitted info significant @ the X merger negotiations fall into this category role of materiality rqmnt is to filter out essentially useless info that a rsnble investor would not consider significant, even as part of a larger mix of factos to consider in making his investment decision secrecy rationale (to avoid bidding war) is not enough to argue why not material; info concerning the existence and status of preliminary merger discussions is significant to the

rsnble investor's trading decision Ct FOUND no valid justification for artifically excluding from the def of materiality info concerning merger discussions, which would otherwise be considered significant to the trading decision of rsnble investor, merely bc agreement-in-principle as to price and structure has not yet been reached by the parties speculate info or events looks @ materality @ any given time upon a balancing of both the indicated probability that the event will occur and the anticipated magnitude of the event in light of the totality of the company activity whether merger discussions are material depends on the facts; if a small company probably want to know earlier than normal bc ends the life of that company to determine probability look @ indicia of interests to determine magnitude look @ size of the 2 corporate entities and of the potential premiums over market value no particular fact/event short of closing the transax need be either necessary or sufficient by itself to render merger discussions material materiality depends on the significance the rsble investor would place on the withheld/misrepresented info ? of reliance fraud on the market theory: in an open and developed securities market, the price of a company's stock is determined y the available material info regarding the comp and its business. Misleading statements therefore will defraud purchasers of stock even if the purchasers do not directly rely on the misstatements requiring proof of individualized reliance from each member of the proposed P class effectively would have prevented respondents from proceeding with a class ax since individual issues then would have overwhelemed the common ones market acts as unpaid agen of the investor informing him that given all the info available to it, the value of the stock is worth the market price presumption P relied bc requiring a P to show a speculative state of facts (i.e. how e would have acted if omitted material info had been disclosed or misrep not been made) would place an unnecessarily unrealistic evidentiary burden on the rule 10b-5 P who has traded on an impersonal market where materially misleading statements have been made into an impersonal, welldeveloped market for securities, the reliance of ind P on the integrity of the market price may be presumed bc most public available info is reflected in market price, investors reliance on any public misreps therefore may be presumed can rebut by any showing that severs the link btw the alleged misre and either the price received or paid by the P, or his decision to trade @ a fair market price will be sufficient to rebut presumption of reliance show market makers were privy to truth about merger and market price thus not affected by misrep show news of merger discussions credibly entered into the market and dissipated the effects of misreps show P divested shares without relying on integrity of market i.e. P believed company statements were false and company indeed engaged in merger discussions and who believed stock underpriced but sold nonetheless cause of unrelated concerns (potential antitrust problems or political pressue to divest shares of certain business) could not have relied on integrity of price he knew had been manipulated Dissent problem with theory is that judges arent economists Ct assumes people rely on integrity of market; said sometimes ppl buy stock bc they think price reflected is inaccurate no evidence misrep made for purpose of manipulating stock price or with any intent to engage in underhanded trading of company stock doesnt like speculative nature of it bc possible some bought stock after misreps made knowing they were lies only to then be able to make huge profit

West v Prudential Securities: dude told 11 clients that Jefferson Savings Bancorp was certain to be aquired soon @ big premium; ax alleged on behalf of EVERYONE who bought jefferson stock during x period and not just the eleven dude told fraud-on-the-market approach must be public here the value of info was in fact that info wasnt public; dude letting them in on a secret misrep P allege that unimportant whether info publically made (info disseminated through press release); Ct rejects bc broadens Basic to include oral frauds as ax by a class causation is a shortcoming in this class certification (change in jefferson stock price not attributable to dudes lies to eleven clients) markets are efficient in the sense that they rapidly adjust to all public info no similar mechanism explains how prices would respond to non-public info; these do not come to the attention of professional investors or money managers so the price-adjustment mechanism just described doesnt operate

Dura Pharmaceuticals v Broudo: company alleged that asthma medicine was going to be approved by FDA; people bought shares based on this @ inflated price; FDA did not approve and now people pissed bc shares arent worth what they thought theyd be. (39 a share falling to 21) did recover within a week though. Ct held that an investor may not est loss causation by alleging that security price was inflated bc of misrep cannot simply allege in the complain, and subsequently est, that the price of the security on the date of purchase was inflated bc of misrep to prove fraud cause economic loss @ the moment the transax takes place, the P has suffered no loss; the inflated purchase price is offset by ownership of a share that @ that instant posseses equivalent value logical link btw inflated purchase price and later sell @ loss not strong anything could cause loss especially where more x in btw buying and selling @ a loss admitted that this high price may show stronger indica of lower sell price but this just shows touch of loss not cause of loss statute makes clear Congress' intent to permit private securities fraud ax for recovery where, but only where, P adequately allege and prove the traditional elements of causation and loss Imp to note: Ct said complaint failed bc it stated that loss consisted of artifically inflated purchase prices failure to claim share prices fell significantly after the truth became known suggests plaintiffs considered the allegation of purchase price inflation alone sufficient; which it IS NOT should have provided what econ loss might be or of casual connection might be btw that loss and the misrep concerning spray device This is our basic causation case 2 ways to talk about loss and thats inflated price loss or actual decline as loss prior to the truth coming out = inflated price loss post truth coming out = actual decline as loss Ct here didnt like using inflated price as loss; need to look at truth effects on price Santa Fe Industries v Green: P sought to by Kirby timberwhich was a subsidiary company which P owned 95% ofP gave notice to D and minority shareholders and offered them shares @ 25 dollars over market price; D alleged that actually shares worth 772, not 150. D alleged this constituted a violation of rule 10b-5 bc P employed a device/scheme/or artifice to defraud and engaged in an act/practice/or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase/sale of any security rejected that 10b-5 states that a breach of fiduciary care by majority stockholders, without any deception/misrep/nondisclosure, violates the statute and the rule manipulation refers to practices intended to mislead investors by artificially affecting market activity didnt think Congress meant to bring within the scope of 10b instances of corporate mismanagement such as this, in which the essence of the complaint is that shareholders were txted unfairly by a fiduciary statute not meant for private cause of ax where remedy available through state law theres no federal cause of ax we are reluctant to federalize the substantial portion of the law of corporations that deals with transactions in securities, particularly where established state policies of corporate regulation would be overridden Congress by 10b did not seek to reg transax which constitute no more than internal corporate mismanagement From Class reliance has been extended to unwealthy unaware investors even if you do actually rely your losses are going to small if you are unsophisticated investor; then you wouldnt hire lawyer bc even your remedy wouldnt cover the costs needed for attnys; thus Cts started this presumptive reliance

Doran v Petro Mgmt Corporation: PMC hires P as partner, he puts in cash. He oversees oil process in wyoming. PMC drills to much and produces too much in violation of state regulations. Pipes sealed for a yr. Prior to this, P offered chance to be special participant to which he agreed. Pipes reopened. Company isnt doing hot, company goes into default, and judgment entered agnst P/D/and two others telling them to pay. P sues saying k with PMC violated securities acts and hes not liable CT disagreed the offer and sale of the special participant interest was a private offering bc P was a sophisticated investor who didnt need the protection of the Securities Acts P offered that D offered/sold securities to him and that the d used interstate transportation or comm in connection with the sale or offer of a saleboth prima facie for violation of securities acts however D argued exception to rule saying offer was private 4 factors whether an offering qualifies for exemption number of offerees and their rlthsp to each other and the issuer # of units offered want small number to be private size of the offering want it to be modest financial stakes to be private manner of the offering look to see if intermediaries used like securities exchance, and if theres

ads exemption question turns on knowledge of offerees # of offerees and rlthp to each other and issuer reflected in this helps indicate magnitude of offer and to determine the char and knowledge of the persons thus identified number of offerees not purchasers not decisive but very imp; more offerees the more liklihood that the offering is public here only 8 ppl offered limited partnership; pts to private rlthp to issuer evidence of a high degree of business or legal sophistication not enough favorable to D though more imp is rlthp btw promoters and purchasers and access to the kind of info which registration would disclose all offerees must have had available info a registration statement would have afforded a prospective investor in a public offering not ind sufficient for exemption however need either disclosure or effective access to info access to files and relevant info afforded merely by the position of the offeree or by the issuers promise to open appropriate files and records to the offeree as well as to answer inquiries regarding material info