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Result of Failure to Comply with Securities Registration

33. What is the effect of failing to register an offering under Section 5 and failing to perfect an exemption to the registration requirement?

Violating Section 5 of the ’33 Act by failing to register an issuance or failing to carry out an issuance in accordance with an applicable exemption can subject the issuer to liability to purchasers of the securities. Specifically, Section 12(a)(1) allows any purchaser to bring a lawsuit to rescind the purchase of the securities (along with interest on the purchase funds) or, if the securities have been sold, to receive the damages suffered from the purchase. Rescinding the purchase transaction is often referred to as “buying a put,” because the purchaser will have the right to force the seller to repurchase the security. The SEC may also have a civil cause of action against the issuer who sells securities in violation of Section 5.

The result of failing to comply with failing to comply with a relevant exemption can be detrimental to an issuer. Rule 508 provides some relief from these effects if an anticipated exemption under Rules 504 – 506 fail because of an insignificant reason. That is, the issuer may be able to defend an action for rescission by demonstrating the following:

•    the issuer’s deviation from the exemption requirement was insignificant with regard to the overall offering;

•    the requirements were not specifically imposed to protect this type of purchaser’s interest; and

•    the issuer honestly (in good faith) attempted to comply with the exemption requirements.

An issuer who successfully demonstrates these elements may be relieved from liability to plaintiff investors or the SEC.

•    Discussion: How do you feel about the repercussions on an issuer for failure to comply with registration requirements or perfect an exemption? Is this provision overly advantageous to the purchaser or securities? Why or why not?

•    Practice Question: ABC Corp sells securities to a small group of investors in several states. ABC did not seek legal counsel and is unaware that its sale of securities is subject to regulation under the securities law?

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