1. Securities Law

Securities Law

Playlist: 58 videos; 127 Minutes


Topics: Learning Material

Introduction to Securities Law
Securities is a broad term that basically refers to any form of ownership or beneficial interest in a business entity. Securities law concerns the sale or transfer of these business interests. This chapter introduces the security and the catch-all provision for “investment contracts” as securities. It explains the primary statutory and regulatory framework making up the securities law. It introduces the Securities Exchange Commission and its objectives and functions in enforcing the securities laws. It explains the process of selling or transferring securities to the public, known as issuing securities, before moving on to the subsequent sale or exchange of securities in the public market, such as trading securities on public exchanges. Lastly, it reviews the the major laws and forms of civil and criminal liability associated with violation of the securities laws. For further written and video explanation, discussion and practice questions, see Securities Law (Intro)

What are Securities Laws?
Securities laws are the federal and state statutes and regulations that control the sale or transfer of rights or ownership interests in a business entity (securities). Specifically, securities laws purport to protect the general public from deceptive practices in the sale or trade of securities. The major securities laws include the Securities Act of 1933 and the Securities Exchange Act of 1934. The primary method of protecting investors prescribed under these acts is thorough disclosure of relevant or material information. As we discuss in this chapter, the requirements for the disclosure of information vary based upon the nature of the sale or transfer of securities. For further written and video explanation, discussion and practice questions, see What are "securities laws"?

What is a “Security”?
Most people think of a security as simply stock or other ownership units of a business entity; however, the statutory definition of a security is far more extensive. The term “security” means any, “note, stock, treasury stock, bond, debenture, certificate of interest or participation in any profit-sharing agreement or in any oil, gas, or other mineral royalty or lease, any collateral trust certificate, pre-organizational certificate or subscription, transferable share, investment contract, voting trust certificate, certificate of deposit for a security, any put, call, straddle, option, or privilege on any security, certificate or deposit, or group or index securities (including any interest therein or based on the value thereof) or any put, call, straddle, option, or privilege entered into on a national securities exchange relating to foreign currency, or in general, any interest commonly known as a security.” The definition of a security is broad, but it leaves open the inclusion of any interest not identified within the definition, but that the court deems to constitute a security. There is a great deal of common law surrounding the judicial interpretation of what constitutes a security. Most notably, the term “investment contract” from the definition of a security is construed very broadly and is somewhat of catch-all for business interests that may constitute a security. For further written and video explanation, discussion and practice questions, see What is a "security"?

What is an “Investment Contract”?
The broadest category of a business interest constituting a security is an “investment contract”. Courts have developed a number of tests to determine what constitutes an investment contract. The most influential is the “Howey test”. The elements for determining whether a business interest constitutes an investment contract (and thereby a security) are as follows: an investment of money; in a common enterprise; with the expectation of profits, and derived solely from the efforts of others. Each element of this test requires considerable analysis. Courts have interpreted each element to add a great deal of specificity and complexity to the individual factors. For further written and video explanation, discussion and practice questions, see What qualifies as an "investment contract"?

Major Federal Securities Laws
Securities are subject to federal and state regulation. State securities laws are known as “Blue Sky laws” and are discussed at the end of this chapter. The two primary federal laws governing the trade or sale of securities are the Securities Act of 1933 (’33 Act) and the Securities Exchange Act of 1934 (’34 Act). ’33 Act - The ’33 Act provides the rules for the initial sale of securities to the public. This includes detailed rules for the personal disclosure to prospective purchasers and disclosure of information to the general public through registration with the Federal Government. ’34 Act - The 34’ Act concerns the on-going disclosure requirements once company securities are traded publicly, such as on national exchanges. These laws provide for the substantive content of the disclosure, the procedural disclosure requirements, and the repercussions (such as civil and criminal penalties) for failing to adhere to these laws. Both the ’33 and ’34 Acts are administered by the Securities Exchange Commission. Along with the regulations promulgated by the SEC, they govern the sale or exchange of securities in any context. For further written and video explanation, discussion and practice questions, see What are the primary federal securities laws?

Regulatory Goals of Security Laws
The regulatory goals or purpose of the securities laws include: preventing manipulation of the securities market; full disclosure of “material information” to stakeholders; preventing fraud; and leveling the playing field between insiders of a company and investors. Each of these regulatory goals are not independent. Fairness and the prevention of deceit underline each objective. For further written and video explanation, discussion and practice questions, see What are the regulatory goals of security laws?

What is the “Securities and Exchange Commission” (SEC)?
The Securities and Exchange Commission (SEC) is a semi-independent, administrative agency created in 1934 (as part of the ’34 Act) to regulate the sale or exchange of securities. The commissioners are appointed by the President under the advisement of Congress. The SEC is divided into five main divisions regulating: Corporation Finance, Trading and Markets, Investment Management, Enforcement, and Economic and Risk Analysis. The SEC has quasi-legislative and quasi-executive powers. The SEC develops the regulations to carry out the statutory laws passed by Congress. It has the ability to issue cease and desist orders, issue fines, and bring civil actions against issuers of securities who violate the law. For further written and video explanation, discussion and practice questions, see What is the "Securities and Exchange Commission"?

What is an “Initial Public Offering”?
An initial public offering is the process by which a company first sells an equity interest in the company to the public at large. The primary purpose of the IPO is to generate operating capital for the company. Equity shares in a company constitute securities, so the IPO process is subject to securities law and is closely scrutinized by the SEC. The IPO process is complicated and generally involves a number of professional service providers. The process for an IPO is substantially as follows: Underwriting, Registration, Solicitation of Purchasers. The extensive registration requirements associated with an IPO can be very burdensome and expensive to the company. As such, many companies seeking to raise capital avoid the IPO process and seek equity financing from private investors. This process is known as a “private offering”. For further written and video explanation, discussion and practice questions, see What is an "initial public offering"?

What is a “Direct Public Offering”?
A direct public offering is the process by which a company offers its shares for sale directly to the public without employing the services of an underwriter. The underwriter has the ability to reach out to large institutional investors and guarantee the sale of a certain quantity of securities. In a direct public offering, the company will generally enlist the services of a broker to make certain the offering is carried out in accordance with the securities laws. The requirement to register securities still applies; however, the company may be able to employ an exemption from registration (discussed below). Once registration (or an exemption therefrom) is complete, the company will advertise the offering and begin selling to individuals, investment firms, etc. The direct public offering has become popular for companies seeking to crowdfund its growth. Numerous websites and services now exist to meet this demand. For further written and video explanation, discussion and practice questions, see What is a "direct public offering"?

Securities Act of 1933 (33 Act)
The ’33 Act is a federal disclosure law covering the initial sale of securities to the public. Specifically, the ’33 Act makes it illegal to use the mail or any other means of interstate communication or transportation to sell securities without disclosing certain financial information to potential investors. Most notably, the issuer must register the issuance of securities with the SEC, unless the issuer is able to conduct the issuance pursuant to a registration exemption. Regardless, the ’33 Act covers all initial offers to sell securities and places detailed disclosure requirements on those issuing securities (issuees). These disclosures allow potential investors to make informed decisions about purchasing the issued securities. For further written and video explanation, discussion and practice questions, see Securities Act of 1933

What is an “Offer to Sell” Securities
The ’33 Act specifically regulates any offer to sell securities. The term “offer” is defined very broadly under the ’33 Act as any attempt to solicit interest in buying shares. The definition of an offer to sell securities goes far beyond actually attempting to sell securities. As such, securities law regulates a much wider range of conduct than many people anticipate. For further written and video explanation, discussion and practice questions, see What is an "offer to sell" securities?

Who is Regulated in an Offer to Sell Securities?
The ’33 Act regulates offers to sell securities by a number of individuals, including the issuer, underwriter, controlling party, or sales representative. The “issuer” is the individual or business organization offering a security for sale to the public. “Underwriters” are individuals participating in the original distribution of securities by selling such securities for the issue or by guaranteeing their sale. A “controlling party” is one who controls or is controlled by the issuer, such as a major stockholder of a corporation. A “sales representative” is anyone who contracts with a purchaser or who is a motivating influence that causes the purchase transaction to occur. For further written and video explanation, discussion and practice questions, see Who are the parties regulated in an offer to sell securities?

Disclosure Documents in an Offer to Sell Securities
The ’33 Act requires that an issuer of securities register with the SEC by filing a registration statement prior to any offer or sale of securities. Further, the issuer (or individual offering to sell securities) must provide a detailed disclosure document, known as a “prospectus”, to any potential investor prior to consummating a sale. Registration Statement - Generally, it is illegal to sell securities to the public unless those securities are registered or there is an exemption from registration. The registration statement is the primary document that the entrepreneur must file with the SEC before undertaking a securities offering. The registration statement provides extremely detailed information about the business and the intended equity offering. The SEC reviews this information and makes it available to the public. Potential investors considering investing in the venture will use this information to make an informed decision. The investor can feel confident in the veracity of the information. Prospectus - Due to the volume of the disclosure included in the statement, it is somewhat difficult for a perspective investor to use the registration statement effectively to glean information about a particular investment opportunity. As such, the SEC requires that an issuer also prepare a “prospectus”, which is summary document containing fundamental information about the issuer, the security issuance, and the terms that apply. It provides the investor with sufficient facts (including financial information) to allow her to make an informed investment decision. At a bare minimum, it includes balance sheets and statements of operation by the investor. The issuer must provide this document to prospective investors prior to selling a security or accepting any investor funds. Like the registration statement, the information contained in the prospectus is subject to review and approval by the SEC. For further written and video explanation, discussion and practice questions, see What are the primary disclosure documents required in an offer to sell securities?

Issuer Ability throughout Registration Process
A company offering its shares for sales to public for the first time (an initial public offerings) must register with the SEC or perfect an exemption from registration. If the company must register, the ability to advertise or offer to sell securities to the public follows a process that is linked to the filing of the registration statement. Generally, companies must follow the following framework and timeline: Pre-filing period, Waiting period, Post-effective period. As stated above, the ability of an issuer to undertake activity in promoting, offering, or selling securities varies somewhat based upon the status of the issuer. For further written and video explanation, discussion and practice questions, see What is an issuer allowed to do at each stage of the registration process?

Classifying Issuers during Registration and Offering Process
The rules applicable to an issuing company during the above time periods depend upon the issuer’s classification. The classifications are as follows: Non-reporting Issuer - This refers to a company that is not subject to any SEC reporting requirements at the time of the issuance. This includes non-public companies below a certain capitalization ($75 million). Unseasoned Issuer - This is a company subject to SEC public reporting requirements, but it has either not been subject to the reporting requirements for 12 consecutive months or does not meet the $75 million public float requirement. Seasoned Issuer - A seasoned issuer is a reporting company that has greater than $75 million in public float, but less than $700 million and at least one year of timely reporting. Well-Known Seasoned Issuer (WKSI) – This is an issuer with worldwide stock float of $700M or outstanding debt of $1billion that has been issued within the past 3 years. Each classification relates to the capitalization of the company or status as a company compelled to report to the SEC. The purpose behind classifying companies in this manner regards the ability of the company to offer for sale or solicit offers to purchase securities during the pre-filing and waiting periods. For further written and video explanation, discussion and practice questions, see How are issuers classified for purposes of the registration and offering process?

Issuer Ability during Pre-Filing Period
During the pre-filing period, no offers to sell or offers to buy securities are permitted. There is a limited exception to this rule under SEC Rule 135, which allows for the announcement of an upcoming offer. The issuer can have discussions with underwriters or with an underwriting syndicate. This allows the company to undertake the procedural arrangements and financing of the offering. In any event, the communications or announcement of the upcoming offer cannot have the purpose or effect of “conditioning of the market”. That is, it cannot cause a market reaction for the pending IPO that is commensurate with the effect of an actual offering. This is a poorly defined standard, which does not provide a great deal of guidance to issuers. There are some other notable exceptions to the general prohibition against offers to sell during the pre-filing period that are worthy of note, including: Emerging Market Company Exception, Section 5(b) Exception, Public Company Exception, Free-Writing Prospectus Exception There are other limited exceptions to the ability to make offers of securities at the pre-filing stage; however, these are the most commonly recognized. . For further written and video explanation, discussion and practice questions, see What is an issuer allowed to do during the "Pre-filing Period"?

Limitation during the Post-Filing, Waiting Period
During the post-registration, waiting period, special rules apply to the general dissemination of information about the issuance. Generally, oral discussions or offers to buy the securities are unregulated. This allows investment banks to carry on a “road show”, which is a concerted effort by the bank to build a book of subscribers for the security issuance. Written offers to sell (or other solicitations) must be accompanied by a prospectus that meets statutory standards for disclosure. Anyone submitting a written request to purchase must receive a prospectus that has been reviewed and approved by the SEC. No actual sales can occur until the registration statement “goes effective” for any issuer. For further written and video explanation, discussion and practice questions, see What are the limitations on the issuer during the "Post-filing, Waiting Period"?

Issuer Ability during Post-Effective Period
During the Post-Effective Period, the issuer can begin selling securities. The issuer must still deliver a statutorily prescribed prospectus to offerees. Additional rules benefiting WKSIs exist during this stage that allow for an automatic “shelf registration”. Shelf registration is the pre-registration of securities that will not be issued until a later date. This can be useful when the business plans for multiple stages of funding over a period of time. For further written and video explanation, discussion and practice questions, see What is an issuer allowed to do during the "Post-Effective Period"?

What is an “Emerging Growth Company”?
An emerging growth company (EGC) is any company that meets the following requirements: the company has less that $1billion or more of total gross revenue in a consecutive 12-month period; is within 5 years of its original IPO; the company cannot have issued more than $1 billion in non-convertible bonds within the last 3 years, and the company does not qualify as a “large accelerated filer”, meaning a public float of over $700 million. Status as an emerging growth company provides a number of benefits to the company with regard to security laws and regulation. Confidentiality - An EGC may make confidential submission to SEC of a preliminary prospectus prior to the public filing with SEC. This gives the SEC an opportunity to review the prospectus and maintains confidentiality about the securities issuance. Unregulated Communications - An EGC may have unregulated oral or written communications with qualified institutional buyers and accredited investors. This effectively allows the EGC to “test the waters” before the preliminary prospectus is filed with SEC. Audited Financial Statements - The EGC must produce 2 years of audited financial statements with the registration statement. Security Analyst Reports - Securities analysts will be permitted to freely publish research reports about companies about to issue securities. Accounting Standards - Exemption from new or revised accounting standards. Auditor Exemptions - The EGC is exempt from compliance with PCAOB rules requiring mandatory rotation of external firms auditing the company. Further, the company executives are not required to produce an auditor attestation of internal controls under section 404(b) of SOX of 2002. Executive Compensation Rights - EGC companies are exempt from many requirements to disclose executive compensation. Also, EGC companies are exempt from “say-on-pay” vote requirements placed on non-EGC companies by securities laws. Say-on-pay rights allow shareholders to vote to approve the compensation of executives of the business. Given the benefits associated with EGC status, companies are apt to monitor their growth and plan for the effects of losing EGC status. For further written and video explanation, discussion and practice questions, see What is an "Emerging-Growth Company"?

Disclosure of Information in an Issuance
Securities laws intend to protect individuals from financial loss due to a lack of understanding of the risk associated with an investment or intentional fraudulent activity by an issuer. As such, the SEC requires that anyone offering to sell securities disclose certain “material” information about the venture to prospective purchasers. The disclosure requirements vary with the type of investor and the amount and context of the security offering. Courts have held that “there must be a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the ‘total mix’ of information made available.” For further written and video explanation, discussion and practice questions, see What type of information must an issuer disclose?

Laws Controlling Disclosure Process During Issuance
Regulation S-K is an SEC promulgated regulation that applies to new issuances under the ’33 Act and subsequent sale or transfer of securities under the ’34 Act. This regulates the specific types of information that an issuer must disclose to the public. The primary disclosure statement in an IPO is the registration statement (Forms S-1 and S-3 for Securities Act (33 Act)). Publicly-traded companies are subject to Schedule 14A (requiring disclosure of proxy statements). Public companies are also subject to continued reporting by filing form 10-K, 10-Q, 8-K for ’34 Act. For further written and video explanation, discussion and practice questions, see What laws govern the mechanics of disclosure in a securities offering?

Exemptions from Registration Requirements
The registration and public offering process is extremely burdensome for startup companies. Numerous statutory and rule-based exemptions to the securities registration process exist. The statutory exemptions fall under Sections 3 and 4 of the ’33 Act. The rule-based exemptions are based upon statutory exemptions and are found primarily in “Regulation A” and “Regulation D” of the ’33 Act. These statutory and rule-based exemptions either exempt this type of security from registration or exempt a particular type of transaction from registration. For further written and video explanation, discussion and practice questions, see Exemptions from 1933 Act Registration

”Exempt Securities” vs “Exempt Transactions”
Certain types of securities and certain transactions are deemed by the SEC to be exempt from registration requirements. Exempt Security - Common types of exempt securities are government securities, bank securities, high-quality debt instruments, non-profit securities, and insurance contracts. Most important for private, for-profit companies is the broad exemption under Section 4 of the ’33 Act of “transactions by an issuer not involving any public offering.” This is known as a “private offering”. A private offering is generally for a lesser amount of money that is invested by a small number or closely-related investors. Exempt Transaction - An exempt transaction is a transaction that does not warrant full-blown registration. Exempt transactions generally involve either a limited amount of capital or sophisticated or accredited investors. For further written and video explanation, discussion and practice questions, see What are "exempt securities" and "exempt transactions"?

What are “Restricted Securities”?
Restricted securities, as the name implies, are subject to restrictions on when they can be sold or transferred following their issuance. Rule 144 of the ’33 Act lays out the rules for restricted securities. Holder Restrictions - Restricted securities in public companies are those held by officers, directors, or major shareholders (10% of total shares). These individuals cannot sell a number of shares greater than 1) the average weekly trading volume for the shares during the prior 4 weeks of trading, or 2) a quantity equal to 1% of total shares outstanding. Transactional Restrictions - Securities issued pursuant to a transactional exemption are also restricted from immediate resale. Regulation D exemptions prohibit resale for 12 months following the date of the issuance. This is to make certain that an exemption is not used as a straw transaction to transfer shares to individuals who could not otherwise be investors under the applicable exemption. For further written and video explanation, discussion and practice questions, see What are "restricted securities"?

Section 3(a) Exemption
Section 3(a) Exemption - Section 3(a)(11) is an “intrastate offering exemption” designed to allow businesses to seek local funding. The issuer may offer securities for sale to residents of the state in which the business primarily does business without registering the issuance or securities with the SEC. Exempt Security - Section 3(a)(11) offers an exemption for a class of securities, rather than an exemption for the particular issuance or transaction. The securities can be freely resold without worrying about registration. Benefits of Section 3 Exemptions - The exemption is attractive to issuers because it allows for: an unlimited number of investors, an unlimited amount of raised capital, and general solicitation of investors may be allowed under the applicable state law. Coming to Rest - Purchasers cannot immediately resell the security, as that resale may involve out-of-state purchasers. If the securities have not “come to rest” then resale out of state destroys the exemption for the entire offering. Integration Doctrine - The “integration doctrine” applies to Section 3 issuances. This doctrine states that any offering of securities by the issuer within the last 12 months may be integrated into the current offering. Even if the other offerings were under another exemption, they may be “integrated” into a single transaction. If the issuances are integrated, it is possible that the prior offering will cause the loss of the registration exemption for the present and former transactions. For further written and video explanation, discussion and practice questions, see Section 3(a)?

Section 3(b) Exemption
Section 3(b)(1) Exemption - Section 3(b)(1) of the ’33 Act is an exemption from registration of securities. It gives the SEC authority to define the types of exempt transactions where the value of securities issued does not exceed $5 million (“small issues” exemption). Section 3(b)(2) Exemption - Section 3(b)(2) allows the SEC to define a new “small issuance” class with a limit on the amount of funds raised of $50 million. These are unrestricted securities, which can be traded freely. For further written and video explanation, discussion and practice questions, see Section 3(b)?

Rule 147 Exemption
Rule 147 of the ’33 Act is a safe harbor for section 3(a)(11). It lays out the strict requirements that the issuer must meet to remain within the confines of the statutory exemption. To qualify for the intrastate offering exemption under SEC Rule 147:the issuer (company) must be incorporated in the state where the offering is made;
• at least 80% of the issuer’s revenues must come from business within that state; at least 80% of the issuer’s assets must be located in that state; and at least 80% of the proceeds of the offering must be used in that state. As the name of the exemption implies, the issuer and all purchasers of the security must be primary residents of the state in which the securities are sold. As previously stated, a single offer or sale to an out-of-state individual destroys the exemption. Under the broad definition of an offer under the ’33 Act, any inadvertent contact with an out-of-state investor regarding the intended offering could be considered an offer to sell the securities. Lastly, a purchaser cannot resell the security to an out-of-state purchaser within 9 months of the issuance. For further written and video explanation, discussion and practice questions, see What is a "Rule 147 Exemption"?

Section 4(a) Exemption
Section 4 provides for two statutory exemptions from registration of securities by an issuer. The exemptions available under Section 4 of the ’33 Act provide for transactional exemptions for the securities, rather than a blanket exemption for the security itself. Private Offering Exemption - Section 4(a)(2) - Section 4(a)(2) provides that, “the provisions of section 5 shall not apply to transactions by an issuer not involving any public offering.” The SEC has deemed certain transactions to constitute “private offerings” and fall outside of the scope of a public offering. That is, the securities are not being sold in a public offering and, therefore, are exempt from the registration and reporting requirements of Section 5.The characteristics of a section 4(a)(2) offering are as follows: Exempt Transactions - Section 4 provides for a long list of exempt transactions that include: transactions falling under Section 4(2) and Reg. D and Rule 144A; securities issued as compensation – Rule 701; cross-border rights and exchanges for business combinations: Rule 800-802; and foreign issuances: Reg. S (Rules 901-905). Benefits of Section 4(a)(2) - Section 4(a)(2) allows for the following benefits: there is no geographical limitations on the issuance within the United States; an unlimited number of offerees and investors; and there is no limit upon the amount of money raised in the issuance. Limitations of Section 4(a)(2) - The following limitations apply to a section 4(a)(2) exemption: Disclosure - Prospective purchasers must receive the pre-sale, statutory disclosures in the form of a private placement memorandum. Sophistication Requirement - The issuer may offer or sell securities only to investors who are sophisticated and are not in need of the public protections afforded under the SEC’s regulations. Courts have interpreted this standard to mean that an investor must have the financial ability to bear the risk of loss in the investment or extensive business experience and open access to necessary information. Integration - This offering may be integrated with prior offerings within the past 12 months. General Solicitation - The offering cannot involve the general solicitation of purchasers. This concept is discussed further below. Restricted Securities - These are “restricted securities”. They cannot be resold unless: they are held for 6 months (reporting company) or 12 months (not a reporting company); or they are registered prior to resale; or the seller perfects another transactional exemption. For further written and video explanation, discussion and practice questions, see What is a "Section 4(a) Exemption"?

Section 4(a)(5) Exemption
Statutory Exemption for Accredited Investors - Section 4(a)(5) -Section 4(a)(5) of the ’33 Act provides a statutory exemption for securities sold in accordance with its provisions. The following limitations apply to a Section 4(a)(5) issuance: Disclosure - The issuer must provide a prospectus to purchases that complies with ’33 Act disclosure provisions; Accredited Investors - The issuer can only offer and sell securities to accredited investors; General Solicitation - The issuer cannot undertake any advertising or other forms of general solicitation of purchasers; Dollar Value - The maximum offering amount cannot exceed $5,000,000; Notice - The issuer must provide notice of sale to the SEC; Restricted Securities - Securities sold under section 4(a)(5) constitute "restricted securities" under Rule 144(a)(3) and cannot be resold in the future without registration or perfection of a separate exemption; and State Registration - Securities exempted under section 4(a)(5), like some other statutory exemptions, do not fall within the meaning of a federally covered security. The result is that federal law does not preempt state laws regulating the securities. For further written and video explanation, discussion and practice questions, see Section 4(a)(5)?

Regulation A Exemption
Regulation A is a “conditional small issues” exemption from registration available for issuances that meet certain characteristics. Like Section 3(11), Regulation A provides for an exemption of the actual securities issued under the exemption. As such, the securities are not restricted from later sale. General Limitations - The following general limitations apply to all Regulation A exemptions: Private, Non-Reporting Company - The issuer cannot have stock registered with the SEC under Section 12 (i.e., cannot have stock that is traded on a public exchange) or be a reporting company under Section 15(d) of Securities Exchange Act of 1934 (’34 Act). US Company - The company must be a US or Canadian-based company. Operating Company - It cannot be an investment company, shell company, or involve fractional interests in oil or gas rights. Types of Regulation A Exemption - Regulation A is actually divided into two classes of issuances, as follows: Tier 1 Issuance: The maximum amount of the issuance is $5 million in a 12-month period. There is no limit on the number of amount of securities purchased by any investors. Tier 2 Issuance: The maximum amount of the issuance is $50 million in a 12-month period. An investor may only purchase a number of securities valued at 10% of her annual income or 10% of her net worth, whichever is less. Regulation A Disclosures - Regulation A is a middle ground between complying with the full registration and disclosure requirements of Section 5. The issuance requires review by the SEC prior to sale of the securities. The issuer must file an offering statement containing both non-financial and financial disclosures about the company and the issuance. This document has several components, including offering circular and financial statements. The issuer’s CEO, CFO, and majority board members, and any selling shareholder must sign the offering statement certifying the information contained therein. This certification subjects these individuals to liability for any material omissions or misstatements. While this exemption does entail a filing requirement, the filing is far less demanding than those completing the entire registration process. Regulation A and General Solicitation - Regulation A allows the issuer of securities to “test the waters” for interested investors. That is, the issuer can use a written document or a radio or television broadcast to seek feedback from interested investors. The purpose of this provision is to allow the issuer to determine, prior to preparing the detailed offering disclosure documents, whether or not there is sufficient interest from investors to proceed with the issuance. The key limitations are that the test-the-waters communication must be filed with the SEC on the date of use. Regulation A and State Regulations - Regulation A securities are not exempt from state regulation. This means that, even though the federal exemption applies, states may require that the issued securities be registered in the state and, in some states, undergo a merit review. Perhaps most importantly, many states do not allow general solicitation of investors unless the securities being sold are registered. This would strictly limit the open solicitation of purchasers in person or through television, radio, or Internet. So, even though Regulation A allows for testing the waters, the state may require state registration prior to doing so. For further written and video explanation, discussion and practice questions, see What is a "Regulation A Exemption"?

Regulation D Exemption
Regulation D is the most commonly used set of exemptions for private placement. It consists of Rules 501-508 of the ’33 Act. In addition to several statutory exemptions from registration, the SEC adopted Regulation D to provide "safe harbors" for issuers of securities. These exemptions are referred to as safe harbors because compliance with these rules will provide for an exemption from the standard disclosure requirements. Unlike the statutory exemptions, such as Section 4(a)(2) or Section 4(a)(5), failure to achieve or perfect an exemption is not completely detrimental to the validity of the securities offering. Rather, if the validity of the issuance under a Regulation D rule is challenged, the issuer can then attempt to assert a statutory exemption for the issuance. As such, Regulation D provides a safe harbor for pursing an exemption and leaves open other possibilities for seeking exemption if somehow the offering runs afoul of the Regulation D exemptions. Regulation D, Rule-Based Exemptions - Regulation D, rules 501, 502 and 503 provide definitions and conditions for the applicable exemptions. Rules 504, 505 and 506, are the substantive exemptions. Rules 507 and 508 lay out the consequences for failing to comply with the requirements of an individual exemption. Taken together, these rules provide for the most commonly employed exemptions to securities registration requirements. Limitations of Regulation D include: Issuer Protections - A notable limitation of Regulation D safe harbor provisions is that they only provide exemptions for the issuers of the securities during the original issuance of the security. The rules do not exempt individuals who later sell those same securities to third parties. General Solicitation - Another important limitation is the restriction on the ability to make offers to sell securities to individuals. Many Regulation D exemptions prohibit issuers from soliciting investors to purchase the securities. Accredited & Sophisticated Investors - Some exemptions limit the ability to sell securities to a certain number of “accredited investors” or “sophisticated investors”. Accredited investors are individuals with a net worth (not counting their primary residence) of more than $1 million or an annual income of more than $200,000 or institutions (such as banks and insurance companies). A sophisticated investor is an individual who has sufficient knowledge or experience to assess the risks of an offering themselves. For further written and video explanation, discussion and practice questions, see What are "Regulation D Exemptions"?

Rule 504 Exemption
Rule 504 is a transactional exemption from registration under Regulation D for small securities offerings. The statutory authority for the rule is pursuant to Section 3(b) of the ’33 Act. The general requirements and limitations on the exemption are as follows: Issuer Protections - The exemption is available to the original issuer. The exemption is available to any company that is not a “reporting company”, “investment company”, or a “blank check company” under the Securities Exchange Act. Dollar Limits - Rule 504 allows an issuer an exemption for small offerings of shares with an aggregate annual value of up to $1 million. The issuer may not split a single offering between Rule 504 and some other exemption. Any other offerings during the previous twelve-month period, even if under another exemption, will be integrated into the Rule 504 offering. Number of Purchasers - The issuer can make sales to an unlimited number of persons. It does not matter whether the purchasers are sophisticated or accredited investors. Restricted Securities - Securities are restricted. Affiliates and non-affiliates of an issuer who wish to resell securities must look elsewhere for a transactional exemption. General Solicitation - Rule 504 prohibits the issuer or anyone on the issuer’s behalf to "offer or sell the securities by any form of general solicitation or general advertising”. Rule 504 does allow for general solicitation in the following circumstances: the offering is registered in the state where securities are sold; or the state permits general solicitation and sales are only made to accredited investors in that state; or the state of issuance does not require registration, but the securities are registered in another state. Private Placement Memorandum - To qualify for this exception, the state law must require "the public filing and delivery to investors of a substantive disclosure document before sale." The disclosure document must disclose all material information to investors. State Regulation - A Rule 504 exemption does not preempt state regulations of securities under such an issuance. States may still regulate the issuance. For further written and video explanation, discussion and practice questions, see What is a Rule 504 Exemption?

Rule 505 Exemption
Rule 505 of Regulation D provides a transactional exemption from registration of a securities issuance. Issuer Protections - The exemption is generally available to all types of issuers (individuals, non-corporate businesses, corporations, as well as those reporting under the ’34 Act) but it is not available for investment companies or for issuers that are subject to any statutory disqualification provisions, such as companies formally sanctioned by the SEC for untrue statements or omissions in securities offerings. Dollar Limits - This exemption allows an issuer to raise up to $5 million within a 12-month period. Purchaser Requirements - The exemption allows for sale to an unlimited number of accredited investors and up to 35 non-accredited investors. Restricted Securities - The securities exempted in the issuance are restricted from resale. General Solicitation - General solicitation of purchasers is prohibited in the same manner as under a Rule 504 exemption. Private Placement Memorandum - The issuer does not have to make specified disclosures to accredited investors, but it must make extensive disclosures to non-accredited investors. This is normally done through the private placement memorandum, a disclosure document similar in nature to the prospectus. Notably, the disclosures must include certified financial statements. State Regulation - Rule 505 does not provide an exemption from registration of securities under state law. This is similar to a Rule 504 offering. For further written and video explanation, discussion and practice questions, see What is a Rule 505 Exemption?

Rule 506(b) Exemption
Rule 506 of Regulation D allows for two exemptions of securities issuances. The statutory authority for a Rule 506 is pursuant to Section 4(a)(2) of the ’33 Act. Rule 506 exemptions are the most commonly employed exemptions to securities registration.Rule 506(b) Safe Harbor Exemption - Has the following characteristics: Issuer Protection - Rule 506 protections available for issuers are similar those of Rule 505. The notable exception is that the limitations for reporting companies under the ’34 Act, or the so-called “bad boy” disqualifications do not apply to this exemption. Dollar Limits - This exemption allows for an unlimited dollar value for issuances. Purchaser Requirements - An issuer may sell its securities to an unlimited number of accredited investors and up to 35 non-accredited investors. Restricted Securities - This is a transactional exemption. As such, this exemption applies only to issuers and does not cover later sales by investors. General Solicitation - Rule 506(b) does not allow for general solicitation, which means that the issuer cannot use general advertising methods to reach potential customers. Of note, this general rule applies only to actual sales of securities, rather than to both offers and actual sales. Private Placement Memorandum - Rule 506(b) information disclosures are divided between accredited and non-accredited investors. There is no information disclosure requirement for the accredited investors, but the non-accredited investors must receive extensive disclosures. These disclosures are similar to those required under other Regulation D exemptions. The issuer must provide a private placement memorandum containing the necessary disclosures. Also, all non-accredited investors must meet a sophistication requirement. More specifically, they must have the knowledge or resources necessary to evaluate the merits of the investment. State Regulation - Section 18 of the ’33 Act exempts Rule 506 securities from registration requirements or a merits review under state law. As such, states cannot place additional registration requirements on the security issuance. For further written and video explanation, discussion and practice questions, see What is a Rule 506(b) Exemption?

Rule 506(c) Exemption
Rule 506(c) - Exemption Pursuant to JOBs Act of 2013 - The JumpStart our Businesses Act of 2013 (JOBs Act) made extensive changes to the securities registration exemption regime. As a result, it allowed the SEC to develop Rule 506(c) exemption with the following characteristics: Issuer Protections - Rule 506(c) applies to issuers to the same extent as Rule 506(b). Dollar Limits - The exemption allows an issuer to raise an unlimited amount of funds. Purchaser Requirements - The most daunting requirement of Rule 506(c) offerings is the requirement that the issuer verify that each purchaser of securities is accredited. An issuer who fails to exercise reasonable care in making this determination risks losing the exemption. The standard for judging an issuer’s reasonable efforts to make this determination is uncertain. The SEC identified four primary methods of verifying that an individual is an accredited investor, including: Annual Income - The issuer may examine proof of the purchaser’s income, such as IRS filings from the last two tax years. Net Worth - The issuer may examine bank statements, brokerage statements and other statements of securities holdings, certificates of deposit, tax assessment, or appraisal reports, and consumer reports from a national agency, or obtain a written representation that purchaser has disclosed all liabilities. Professional Certification - The issuer may receive a written representation from a registered broker-dealer or investment advisor, licensed attorney, or CPA that such person has taken reasonable steps to verify that the purchaser is an accredited investor as of the last three months. Written Verification - If the prospective purchaser is a previously verified accredited purchaser, a written verification that such person is still accredited. Restricted Securities - The shares received by the investor under the exemption are “restricted”. General Solicitation - The rule allows for general solicitation in an issuance where all purchasers are accredited investors and the issuer takes reasonable care to determine that each investor is accredited. Private Placement Memorandum - Before consummating a sale, the issuer must provide the purchaser with adequate disclosures under Regulation D. State Regulation - Rule 506(c) are covered securities that are exempt from state regulation. For further written and video explanation, discussion and practice questions, see What is a Rule 506(c) Exemption?

Rule 502(d) and Rule 144 Safe Harbor
Rule 502(d) requires that issuers of securities pursuant to an exemption under Regulation D take the following three steps to make certain the shares are not resold during the restricted period: reasonable inquiry to determine if each purchaser is buying the security for himself or for someone else; written disclosure to each purchaser that the securities are restricted; and a legend on the securities noting the resale restriction. The SEC promulgated Rule 144, which allows a “safe harbor” for purchasers to resell their shares after one or two years, depending on how much public information about the issuer is available. In any case, the issuer must make certain that the shares are not being purchased with the intent of immediate resale. This safe harbor rule provides additional comfort to a purchaser of the security. As such, it adds liquidity to the security by making it easier to later sell and trade in the market. For further written and video explanation, discussion and practice questions, see What is Rule 502(d) and the "Rule 144" Safe Harbor?

Disclosures of Information for Exempted Issuances
The perfection of an exemption does not completely relieve an issuer’s disclosure requirements. The disclosure document that is generally used by businesses perfecting a registration exemption is the “private placement memorandum” (PPM). The issuer must disclose to potential investors at the time of the offer or prior to the business accepting any offer of investment funds. The PPM is very similar to the prospectus and is similarly demanding in its disclosure requirement. The PPM requirement requires extensive work and effort to prepare, but it is far less burdensome to the business than registering the issuance. Types of Disclosure - Securities law breaks down the disclosure requirements for issuers of securities based upon the type of investor or purchaser of the securities. The relevant disclosure provision governing issuances is Rule 502(b)(2). It requires that issuers provide both financial and non-financial information. The company is required to provide the equivalent information as is required under SEC Form 1-A. It is important to note that the information disclosure or delivery requirements set forth in Rule 502(b) are only applicable to offerings under certain exemptions. Offerings to accredited investors do not require furnishing information. Non-Financial Information - Non-financial information required by Rule 502(b) includes: the management team; the industry; the type and characteristics of the securities offered; any third-party facilitators in the offering process; and the risks involved in the type of security being offered. More precisely, the required information is listed in Part 1 of the registration statement that the business would be required to use, absent the applicable exemption. This information is deemed necessary to allow the investor to make an informed decision about whether to undertake the investment. Financial Information - Financial information about the business must be disclosed via the financial statements of the business. The extent of disclosure, which can be extremely detailed, depends on the size of the offering. The greater the dollar value the more extensive the disclosure requirements. The amount of required financial information varies between issuances below $2 million, between $2 million and $7.5 million, and above $7.5 million. Generally, the variation is the amount of financial data of the company and whether that information must be audited and certified by the company executives. The information requirement serves to provide the investor with information that may not be available because the business is not required to register the information with the SEC. For further written and video explanation, discussion and practice questions, see What are the disclosure requirements for companies employing an exemption?

Filing “Form D”
To claim an exemption from registering a securities issuance, the issuer must provide notice to the SEC of the issuance and claimed exemption. The entrepreneur provides notice by filing Form D with the SEC. Form D is currently filed in electronic format and must be filed within 15 days of the first sale of securities in the offering. The Form D is generally available through the SEC website (EDGAR). Form D makes basic disclosure about the issuance. This information includes the amount or value of the issuance and the names of company officers and directors. For further written and video explanation, discussion and practice questions, see What is the requirement to file "Form D"?

Effect of Failing to Register an Offering
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. For further written and video explanation, discussion and practice questions, see What is the effect of failing to register an offering under Section 5?

What is “Crowdfunding”?
The edition of Section 4(a)(6) to the ’33 Act introduced equity crowdfunding as a viable option for seeking investors in a new business. Crowdfunding is a sort of mini-public offering that allows the general public to purchase securities directly from an issuer through authorized, private exchanges. Section 4(a)(6) provides for a Section 5 registration exemption for issuances conducted in accordance with specific crowdfunding methods. To qualify for the exemption under Section 4(a)(6), crowdfunding transactions by an issuer (including all entities controlled by or under common control with the issuer) must meet specified requirements, including the following: the amount raised must not exceed $1 million in a 12-month period (this amount is to be adjusted for inflation at least every five years); individual investments in a 12-month period are limited to: the greater of $2,000 or 5 percent of annual income or net worth of an individual, if the annual income or net worth of the investor is less than $100,000; 10 percent of annual income or net worth (not to exceed an amount sold of $100,000), if annual income or net worth of the investor is $100,000 or more (these amounts are to be adjusted for inflation at least every five years); and transactions must be conducted through an intermediary that either is registered as a broker or is registered as a new type of entity called a “funding portal.” Many entrepreneurs see the availability of crowdfunding as an important financing option for smaller companies that otherwise lack the resources to seek a public offering or to comply with statutory or rule-based exemptions. Section 4(a)(6) places the burden of compliance on the crowdfunding broker or portal. To become registered as a crowdfunding broker or funding portal, the entity must comply with the following: implement procedures to protect purchasers of securities against fraud; refrain from providing investment advice or soliciting purchasers; provide disclosures substantially similar to those required in a registration or disclosure document; allow for questions and feedback on securities being issued; file an offering statement with the SEC disclosing the terms and details of all issuances (which is also available to investors); and make annual filings with the SEC and make those fillings available to the public on the crowdfunding site or portal. The qualified broker or portal must also make certain that all investors meet the accreditation standards laid out by Section 4(a)(6). It cannot employ intermediaries to sell securities on behalf of the broker or portal. It must make certain the securities are understood to be restricted and, with limited exception, cannot be sold within a 12-month period of purchase. For further written and video explanation, discussion and practice questions, see What is "crowdfunding"?

Liability Under the the Securities Exchange Act of 1933
The 1933 Act provides for both criminal and civil liability for individuals who violate its provisions in the issuance of securities. Civil liability generally arises when a purchaser of securities sues the issuer (or its agent) for failure to comply with the registration or applicable exemption requirements under the 33 Act. This often includes (unintentionally) failing to make or making incomplete or erroneous disclosures of material information to purchasers of securities. Criminal liability generally arises when an issuer (or its agent) willfully violates the securities laws in a manner that defrauds or deceives a purchaser of securities. Remedies for civil and criminal violation range from the ability to recuperate the amount paid for the securities to fines and imprisonment. For further written and video explanation, discussion and practice questions, see Liability Under the Securities and Exchange Act of 1933

Civil Liability under Section 11 of the 33 Act
Liability Under Securities Exchange Act of 1933 - Sections 11(a) and (b) of the 33 Act provide for strict liability (tort liability) for issuers who make material misstatements or omissions in the issuance of securities. This provision primarily applies to omissions and errors in disclosure pursuant to a public offerings. For example, an error in a private placement memorandum or registration statement could give rise to Section 11 liability. Requirements for Liability - To be liable for a Section 11 violation, the issuer must make a material misstatement or omission of information in the transaction. An individual may be liable if the final registration statement contains any: untrue statement of material fact; omits material facts required by a statute or government regulation; or omits information that makes the stated information materially misleading. The plaintiff does not have to demonstrate or prove any reliance on the statement. It is sufficient to demonstrate that the information was erroneous or misleading. The limitation is that the purchaser must not know that the information is erroneous or misleading at the time of purchase. Lastly, the securities the plaintiff purchased must be traceable to the registration statement or disclosure document at issue. This requirement is easy to meet in an IPO, but it may be difficult in subsequent purchases of shares issued in private offerings. Who is Potentially Liable - The issuer is potentially liable under Section 11. Further, Section 15 makes any person or entity that controls an issuer potentially liable. This provision provides for joint and several liability for the controlling person or entity under agency principles. Liability extends to those who endorse or sign their names (“signer”) to assert the veracity of the information. This generally leads to potential liability for corporate directors, underwriters, and others who take part in the preparation of the registration statement or prospectus. Any “signer” has a due diligence defense, though an insider CEO and CFO will have hard time asserting this defense. The due diligence defense regards the amount of effort and care the signer exercised in verifying the erroneous or omitted information. Section 11(e) provides for rescission of the transaction (along with interest) or damages suffered (losses sustained) from the later sale of the securities. For further written and video explanation, discussion and practice questions, see What is civil liability under "Section 11" of the 33 Act?

Civil Liability Under Section 12 of the 33 Act
Section 12 of the ’33 Act provides for civil liability for issuers of securities in two situations. Section 12(a)(1) - This provision provides a civil cause of action for purchasers of securities against issuers who sell securities without registering the securities or perfecting an exemption. Within the applicable statute of limitations, the purchaser must show that she purchased the shares from the issuer. Section 12(a)(2) - This provision provides a cause of action for purchasers against issuers who makes a material misstatement or omission in a prospectus or other communication made as part of the sale of securities to the purchaser. The purchaser must not know that the information is incorrect at the time of purchase. As a remedy for violation under either subsection, the purchaser may rescind the purchase and receive interest on the money invested and any damages incurred by the investment. Generally, these causes of action are only available to purchasers in the original issuance of the securities. Individuals who purchase the securities in a subsequent sale cannot bring these actions. The issuer is potentially liable under Section 12, which makes anyone controlling the issuer potentially liable. The SEC may also bring a civil action against the issuer. For further written and video explanation, discussion and practice questions, see What is civil liability under "Section 12" of the 33 Act?

Defenses to Section 11 and Section 12 Actions
An issuer subject to claims by purchasers of securities under Sections 11 and 12 of the 33’ Act has several available defenses that may relieve her of civil liability. These defenses are as follows: Materiality Defense - The defendant may argue that the false or misleading information is not material and thus should not have had an impact on the purchaser’s decision-making process. Materiality is the kind of information that an average prudent investor would want to have so that she can make an intelligent, informed decision whether or not to buy the security. Statute of Limitations - The statute of limitation to bring an action against an issuer is one year. The statutory period does not start to run until the time of discovery of the actionable conduct or the conduct would have been made with reasonable diligence. In no case can a plaintiff bring an action more than 3 years after the security is properly sold to the public. Due Diligence - An issuer may defend against liability under Sections 11 or 12 if she conducted adequate due diligence and such effort failed to uncover the misleading or omitted material information. With information included in a registration statement, the due diligence defense applies differently to portions of the registration statement that includes “expertised” information versus “non-expertised” information. Basically, the issuer is personally responsible for conducting a reasonable investigation of any information that is not reviewed or certified by a qualified expert. The issuer has a due diligence defense when relying on experts to identify and provide information in the disclosure statement. Courts have interpreted this defense to offer a sliding scale for determining the requirement of personal due diligence versus the ability to rely upon experts. In summary, a successful defense must show that a reasonable investigation of the financial statement of the issuer and controlling persons was conducted. Further, the expert must prove that there was no reason to believe any of the information in the registration statement or prospectus was false or misleading. In effect, this defense requires proof that a party was not guilty of fraud or negligence. Negative Causation Defense - Negative causation is a defense claiming that something other than the material misstatement or omission in a disclosure statement caused the damages (i.e., the value of the equity to fall). For further written and video explanation, discussion and practice questions, see What are defenses available to charges under Sections 11 and 12?

Civil Liability Under Section 17 of the 33 Act
Section 17 of the ’33 Act is an anti-fraud provision applicable to the initial sale or issuance of securities. It makes it illegal to “employ any device, scheme, or artifice to defraud … obtain money or property … engage in any transaction, practice, or course of business which operates or would operated as a fraud or deceit upon the purchaser.” It is primarily a government enforcement provision and courts generally do not allow a private cause of action by purchasers against the issuer under this provision. For further written and video explanation, discussion and practice questions, see What is civil liability under "Section 17" of the 33 Act?

Criminal Liability Under 33 Act
Section 24 of the ’33 Act allows the Department of Justice (DOJ) to bring a criminal action against anyone who knowingly and willfully violates the ’33 Act. This normally only arises in situations where an issuer commits fraud in the sale of securities. The SEC cannot bring a criminal action itself, but it regularly works in hand with the DOJ to substantiate claims of securities fraud. For further written and video explanation, discussion and practice questions, see What is potential criminal liability under the 33 Act?

Securities Exchange Act of 1934
Securities Exchange Act of 1934 (’34 Act) regulates transfers of securities after the initial sale. Basically, it picks up where the ’33 Act leaves off. More specifically, it deals with regulation of securities exchanges, brokers, and dealers in securities. It also created the Securities and Exchange Commission. The ’34 Act makes it illegal to sell a security on a national exchange unless a registration is effective for the security. Registration under the ’34 Act requires filing prescribed forms in a timely manner with the applicable stock exchange and the SEC. The registered issuer must then file periodic reports as well as report significant developments that would affect the value of the security. The ’34 Act contains several provisions allowing for civil liability of individuals trading securities. For further written and video explanation, discussion and practice questions, see The Security Exchange Act of 1934

Registering Under the 1934 Act (34 Act)
A company issuing securities must either register or perfect and exemption from registration. There are, however, other situations that subject a company to SEC public reporting requirements. The company becomes known as a “reporting company”. A company is generally required to register with the SEC if it meets any of the following characteristics: it completes a public offering pursuant to the ’33 Act; securities of the company are traded on a national exchange (such as the NYSE or CME); or it has 2,000 or more total shareholders (or 500 or more unaccredited shareholders) of unrestricted securities and a total asset value of more than $10 million. The 2,000 (or 500 unaccredited) shareholder rule does not apply to shareholders who acquired shares through sanctioned crowdfunding or pursuant to employee compensation plans. Notably, if an issuer later drops below the shareholder limitation numbers, it may apply to the SEC to be exempted from the ’34 Act reporting requirements. For further written and video explanation, discussion and practice questions, see When must an issuer register pursuant to the 34 Act?

Disclosures from “Reporting Companies”
A reporting company must make routine disclosures to the public by filing reports with the SEC. The information required to be disclosed is substantially as follows: Reporting Company Initial Statement - Similar to the registration statement required under the ’33 Act, a company initially registering as a reporting company under the ’34 Act must make an initial disclosure of information. This information primarily concerns the operations, equity structure, and securities issued by the company. Annual Reporting - Reporting companies are required to make detailed annual reports to the SEC, which are also provided to security holders. The disclosure takes place on Form 10-K and it contains all relevant operational data, an explanation of company performance, audited financial statement, and detailed information about corporate officers and directors. Quarterly Reports - The reporting company must file and disclose to shareholders a quarterly report on Form 10-Q. The quarterly report contains similar information to that contained in the annual report, but it only covers the most recent quarter of the fiscal year. Also, the financial statement included in the quarterly report is not audited. Special Reports - The reporting company must disclose to the SEC and shareholders via Form 8-K any major operational, structural, financial, or ownership changes in the company within a reasonable time of the occurrence. Major occurrences include: new security issuances, changes in corporate control (officer and directors), mergers, acquisitions, changes in auditor, etc. The information disclosed in each of the above reports must be certified as accurate by corporate executives (including the company’s CEO and CFO). These individuals must also attest to the operable status of controls over internal affairs and finances. This includes attesting that the company has in place an audit committee to examine the efficiency of internal controls. For further written and video explanation, discussion and practice questions, see What disclosures are required of reporting companies under the 34 Act?

Liability under Section 10(b) and Rule 10(b)(5)
Section 10(b) prohibits fraud in connection with the purchase and sale of any security. This provision applies whether or not the security is registered under the ’34 Act. The SEC adopted Rule 10(b)(5) to implement section 10(b). Together, these anti-fraud provisions are the basis for most litigation under the ’34 Act. These provisions make it unlawful to use most communication methods (such as the mail, internet, or wire) or any national securities exchange to defraud any person in connection with the purchase or sale of any security. Any party directly connected to the sale of securities is potentially liable; though there may be limits on the liability of certain professionals, such as auditors, bankers, accountants, etc. Rule 10(b)(5) allows for a cause of action by the SEC as well as private actions. Generally, Rule 10(b)(5) prohibits the following conduct in connection with the sale of a security: using any device, scheme, or other artifice to defraud purchasers; making any untrue statement or failing to disclose any material fact that make the statement misleading; or employing any practice that would deceive or defraud. These prohibitions give rise to a potential cause of action for plaintiffs under Rule 10(b)(5), the elements of which are as follows: Deceit - A plaintiff must demonstrate deceit through the misrepresentation or omission of information. This must be done either intentionally or recklessly. Simple negligence is not enough to establish liability. Material Information - The information must be material to the purchaser of the security. That is, the information must be important to a potential investor in making the decision of whether or not to purchase the security. What is material information is interpreted very broadly and based on the individual situation of the company. Purchase of Sale of a Security - The information must directly related to the purchase or sale of a security. An individual who does not purchase or sell a security based upon the deceitful information cannot bring an action under this provision. Reliance on the Information - The actual purchaser must rely on the misrepresented information. Reliance is assumed if material information is omitted or broadly stated to the whole market. Cause Damages - The plaintiff must suffer some actual damages resulting from or caused by the omission or misrepresentation. This normally comes in the form of a diminution in the value of the shares purchased. In summary, to recover under Rule 10(b)(5), a plaintiff, whether the SEC or a private plaintiff, must show that an individual trading in securities had an intent to deceive the purchaser. Intent to deceive may be inferred from a partial or untimely disclosure of important information. For further written and video explanation, discussion and practice questions, see What is liability under "Section 10(b)" and "Rule 10(b)(5)"?

Insider Trading under Rule 10(b)(5)
Insider trading is the sale or purchase of securities by individuals privy to non-public, material information of a firm based upon her special relationship with the firm. Generally, anyone who has material, non-public information must either disclose that information prior to trading the securities or abstain from trading in the effected or related security. Normally, insiders include officers, directors, and professionals in fiduciary relationships with the firm. The negative aspect of insider trading is that it provides individuals an advantage over others in the sale or purchase of securities and undermines the integrity of the market and the confidence of those investing in securities. Section 10 of the ’34 Act has been broadly interpreted to prohibit the practice of trading securities based on material, non-public information received as an insider or from an insider of a company. Elements of a 10(b)(5) Action - The insider or an individual receiving information from an insider is liable for trading securities based on the information. A “tippee” is a person who learns of nonpublic information from an insider. Upon receipt, this person is considered to be a legal, temporary insider. As a temporary insider, the tipee is subject to the prohibitions of Section 10(b) prohibiting the insider from trading securities based upon the inside information. The elements of a 10(b)(5) action are the same for criminal and civil actions and are as follows: Information - The insider must have material, non-public information. Fiduciary Duty - A core element of a 10(b)(5) action is the breach of a fiduciary duty. Insiders and third parties may have a fiduciary with regard to the material, non-public information. Insiders - Corporate insiders have a fiduciary duty to the company. Third Parties - A fiduciary duty exists for third parties in a personal relationship with an insider if: the third party receives information and promises to keep the information secret; the insider has a reasonable expectation that the recipient will not tell; or the recipient has obtained the information from her spouse, parent, child or sibling. Trading and/or Misappropriation - Either the insider or third party may breach a fiduciary duty by trading on (i.e., using the information to make stock trades) or misappropriating the information. Insiders (Tippers) - The insider breaches a fiduciary duty by trading on the information. Further, an insider misappropriates and breaches his fiduciary duty by transmitting information if: he knows the information was confidential, and he expected some personal gain. Third Parties (Tippees) - Third parties misappropriate information obtained through a professional or personal relationship from an insider. Therefore, a third party violates a fiduciary duty to the rightful owner of the information by trading on the information if she knows: the information is confidential, that it was transmitted in breach of a fiduciary duty, and the insider expected a personal gain from transmitting the information. The idea of holding a third-party, recipient of material, non-public information liable for trading on that information is based on theory that the information is misappropriated from the rightful owners (shareholders). The third party has no duty to reveal the nonpublic information to the public, since she was not in a fiduciary position with respect to company. Trading on that information, however, is effectively breaching a duty owed to those shareholders to either disclose that information or refrain from trading. In summary, anyone who has material, non-public information must either disclose the information prior to trading the securities or abstain from trading in the effected or related security. For further written and video explanation, discussion and practice questions, see What is "insider trading" under Rule 10(b)(5)?

Damages under Section 10 and Rule 10(b)(5)
While both the SEC and a private plaintiff may enforce the antifraud provisions of Section 10 and Rule 10(b)(5), only purchasers or sellers of securities may bring a private action for damages under Rule 10(b)(5). A private plaintiff in a suit under 10(b)(5) may recover for the actual damages suffered as a result of purchasing the security. As part of the action, a buyer must allege specific damages due to the seller’s fraud. The measure of damages is generally the difference between what is paid over the value of the security received. The measure of a defrauded seller’s damages is the difference between the fair value of all that the seller received and the fair value of what he or she would have received had there been no fraud. In an SEC action under 10(b)(5), the civil penalty for gaining illegal profits with nonpublic information is three times the profits gained. The statute of limitation is 5 years from the wrongful transaction. For further written and video explanation, discussion and practice questions, see What damages are available under Section 10 and Rule 10(b)(5)?

Insider Trading under Section 14 of the 34 Act
Rule 10(b)(5) is not the only securities law to target trading of securities by individuals with inside information. Rule 14(e)(3) is an insider tradition provision that applies specifically to corporate buyouts or takeovers. This provision prohibits anyone from trading on insider information if the trader knows that the information was obtained from either party to the proposed buyout. The information is effectively misappropriated from the companies. No fiduciary duty is required as in 10(b)(5) actions. For further written and video explanation, discussion and practice questions, see What is "insider trading" under Section 14 of the 34 Act?

Liability Under Section 16 of the 34 Act
Section 16 of the ’34 Act governs the sale or transfer of securities by “insiders” of the corporation. An insider is an officer, director, or large shareholder (holding 10% or more of outstanding securities). Insiders must generally register with the SEC an indicate their ownership interest at the time of filing the registration statement or within 2 days of becoming an insider (i.e., acquiring a large ownership of shares). Section 16 prohibits insiders from making “short-swing” profits by trading their shares within 6 months of the registration or acquiring the shares. There is an assumption that insiders have material, non-public information during this period. As such, any trades during this period are per se illegal. Any profits derived from the sale are forfeited to the corporation. For further written and video explanation, discussion and practice questions, see What is liability under Section 16 of the 34 Act?

Liability Under Section 18 of the 34 Act
Section 18 of the ’34 imposes liability on any person “who shall make or cause to be made any false and misleading statement of material fact in any application, report, or document filed under the act”. Section 18 is based upon a theory of fraud. Unlike under rule 10(b)(5), however, Section 18 applies only to the documents required to be filed under the ’34 Act. This includes annual, quarterly, and special reports. A plaintiff must prove that: the defendant knowingly made a false statement; the plaintiff relied on the false or misleading statement; and the plaintiff suffered damages as a result of that reliance. Unlike the sections 11 and 12 of the 1933 Act, the defendant’s good faith in making the written statement is a defense. Further, unlike sections 11 and 12, the Section 18 plaintiff must prove reliance by the plaintiff shareholder on that information. For further written and video explanation, discussion and practice questions, see What is liability under Section 18 of the 34 Act?

Liability Under Securities Enforcement Remedies Act
The Securities Enforcement Remedies Act provides for additional civil liability for defendants found to have violated the securities laws. A judge may impose fines of up to $500,000 per institution and $100,000 per individual. This can also lead to a court prohibiting an individual from serving as an officer or director of a corporation. For further written and video explanation, discussion and practice questions, see What is liability under the "Securities Enforcement Remedies Act"?

Criminal Liability Under the 34 Act
The ’34 Act provides for criminal sanctions for willful violations of its statutes or corresponding regulations. More specifically, it imposes liability for false, material misstatement in applications, reports, documents, and registration statements. Individuals face up to a 25-year sentence and business entities face fines of up to $25 million. Many professionals (accountants) have been found guilty for failure to disclose information. The common defense for this criminal charge is a lack of intent to deceive or defraud. For further written and video explanation, discussion and practice questions, see What is criminal liability under the 34 Act?

What are “Blue Sky” Laws?
“Blue-sky laws” are state laws regulating the sale of securities within that state. These laws are so named from early laws passed in Kansas and in the Midwest to protect investors from undertaking investments that had no more substance than the blue sky. Issuers of securities must comply with these state laws as well as the previously discussed federal regulations. Blue-sky laws may allow for both civil and criminal penalties against violators. The requirements of state blue-sky laws will differ among the states, but they are all based closely on the Uniform Securities Act, promulgated in 1956. For further written and video explanation, discussion and practice questions, see What are blue sky law?

Complying with State Securities Law
Generally, no. In 1996, Congress passed the National Securities Markets Improvement Act (NSMIA) with the purpose of simplifying the registration process for issuers of securities. The NSMIA preempted any state regulation of certain “covered securities”. Covered securities include: those traded on a national exchange (such as the NYSE or CME); securities of registered investment companies, and offers of securities exempt from Federal registration under Regulation D, Rule 506. NSMIA effectively limited the ability of states to regulate many security offerings. In addition to these preempted offerings, states also recognize any number of exemptions for certain issuances of securities: isolated transactions involving the issuance of securities; offers or sales to a limited number of offerees or purchasers within a stated time period; issuances qualifying as private offerings under Rule 504; and issuances to a predefined, but limited, number of purchasers. Another optional model law is known as the Uniform Limited Offering Exemption. This provision excuses certain securities offerings, such as offerings issued pursuant to Regulation D, Rule 505. For further written and video explanation, discussion and practice questions, see When is an issuer required to comply with state securities laws?

Registration Requirements under State Law
Registration pursuant to federal law focuses on disclosure of information to offerees and purchasers. States adopt this approach, but also may impose a test to make certain the security being issued meets certain quality standards. This is known as a “merit review”. The merit review examines certain qualities, such as the financial stability of the company making the issuance. Other examinations may focus on the terms or rights associated with the issued security. With this in mind, states generally employ one of three registration methods for issuers of securities: Registration by Qualification - Some states require issuers to undergo a full-blown registration, complete with a merit review. Issuers registering with the SEC must file duplicate documents with the state’s administrative agency regulating securities. Unless a state official objects, the state registration becomes effective automatically when the federal registration statement is deemed effective. Registration by Notification - Some states permit issuers with an established track record to simply file a notice before offering their securities. This allows issuers to offer securities for sale automatically after a stated time period expires unless the state administrative agency takes action to prevent the offering. Registration by Coordination - Some states permit issuers that have registered with the SEC to file copies of the federal registration statement (and perhaps some additional documents) with the state. This process requires a more detailed disclosure by the issuer. A security cannot be offered for sale until the administrative agency grants the issuer a license or certificate to sell securities. For further written and video explanation, discussion and practice questions, see What are the registration requirements under state law?

“Coordinated Registration” under State Securities Law
There are two primary options for registration by coordination that ease the process of complying with state securities requirements. Coordinated Review-Equity - This type of review is designed for use during an IPO that is seeking registration (not seeking a statutory or rule-based exemption from registration). It is generally not allowed for limited registrations under Regulation A. Under this program, the issuer files to register its securities in Pennsylvania. Pennsylvania Securities Commission (PSC) acts as an administrator and collects the required disclosure documents. The PSC will also choose another state that requires a merits review and solicit this state to review the offering. The issuer may then register this disclosure and merit review in any other state in which it seeks to sell securities. One state takes the lead on all disclosure concerns, while another assumes responsibility for any merit issues. Coordinated Review-Small Company Offering Registration - Most states permit the use of CR-SCOR for offerings under Rule 504 or Reg A, Tier 1. Under this program, registration only requires a simplified disclosure form. The issuer would be able to submit this form in lieu of going through the standard state disclosure or merit review requirements. Also, the SCOR system separates the US into five filing regions. Rather than filing a SCOR disclosure in each state where securities will be sold, the issuer can file in a region to cover all the states in that region. For further written and video explanation, discussion and practice questions, see What is "coordinated registration" under state law?


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