Associations Class Notes
There is a hypothetical here for tomorrow that I’m missing because I was several minutes late. At least I managed to write down tomorrow’s assignment.
More on exemptions
Ralton Purina established, among other things, that with all exemptions the burden
of pleading and proof in every detailed respect falls upon the claimant of the
exemption. R.C. 1707.38-.45 establishes
the same thing in
1. Both federally and in
2. State law is often more demanding than federal law. For example, R.C. 1707.29 and .44-.45, in a criminal case, make a defendant far more vulnerable than in a federal criminal prosecution. The major case on the subject is State v. Warner out of the Ohio Supreme Court from the 1980’s. The court held that R.C. 1707.29 means what it says: the mens rea element in a criminal prosecution under R.C. 1707.29 is simply ordinary negligence. Federally, the mens rea element is willfulness, which has been construed as a very high burden on the federal government.
3. How much does federal law preempt state law? The short answer is some but not much. In the 1990’s, there were three big federal statutes.
a. First, in 1996, there was NSMIA, or the National Securities Markets Improvements Act. This Act has several preemptive provisions.
As to investment advisors, the federal government takes over primary regulation
of the big ones and the states take over primary regulation of the little ones. As a result, in the 1990’s,
NSMIA also says that if a company is listed on a major exchange or on
the national market system of the NASD, no state can require registration of
the issuance of securities by that company.
It reads just like R.C. 1707.02(E) in Ohio. Before this federal Act, several states like
iii. Only the state of incorporation can deal with alleged securities and fiduciary duty violations.
iv. As to mutual funds, certain things were reserved to the SEC, while the states can do certain other things.
v. We’ll later discuss the provision dealing with Rule 506.
b. In 1998, an act was passed that says with respect to certain fraud and other suits they will become subject to the 1995 federal act (which was very pro-defendant). If they are in state court, they are to be removed to federal court where the defendant advantages of the 1995 Act apply. There is a big exception, though. In an action for breach of fiduciary duty under the law of the state of incorporation, the 1998 Act doesn’t apply, and if the plaintiff’s lawyer is careful in drafting, you can avoid the 1995 Act.
c. In CTS from the U.S. Supreme Court in the 1980’s, the Court said that regulation of tender offers by the states must be reasonable and limited and if they are not reasonable and limited then they will be preempted.
there is some federal preemption but not a heck of a lot. Common law remedies are not displaced by federal
or state securities laws. When would common
law remedies be the best? It’s more
often than you think! In a recent big Ohio
case out of Cleveland, a discount broker then known as Olde
& Co. This firm was a member of the
NYSE. The issue involved suitability. Under the federal securities laws, a
securities broker must avoid recommending unsuitable securities to
purchasers. There is a remedy under Rule
10(b)(5), it is only if the customer proves that the
recommendation was made with scienter. That’s hardcore. In the case, a
plaintiff argued that Olde & Co. is a member of
the NYSE and that one of the rules of the NYSE says that every member must “know
thy customer”. The primary purpose of
the rule is to protect the member firm.
If a customer doesn’t buy up after he buys, the member firm is
responsible to the party on the other side of the transaction. The court held that under
We don’t know why this case didn’t go to arbitration. Usually, broker-dealers will force customers to sign arbitration clauses up front, and usually the broker-dealer insists on arbitration. We don’t know why they didn’t do so here! In arbitration, suitability claims under 10(b)(5) require scienter, at least in theory. But in practice, arbitrators will often give recovery for mere negligence on the part of the broker-dealer firm regarding suitability. On the other hand, studies of all massive arbitration system, like the securities system, indicate that arbitrators tend not to give lavish or large awards. They cut down on the amount. They’re more liberal in giving the plaintiff something, but the dollar amounts are smaller.
Shipman argues that securities laws are one of
General Spitzer in
Some examples of exemptions
Around 93% of all transactions are exempt. Let’s go over some of the important ones.
says that if you’re not an issuer or an underwriter or an affiliate of the
company, stock which you purchase through the organized trading markets will be
exempt. For example, I’m contacted by
Johnson in Dayton who is a physician.
Three months ago, he bought GM stock, registered in his own name,
through the NYSE. He is not a director
or officer of GM. Neither is his wife or
any other relative. He doesn’t meet the
10% rule, which is the third way you can be an affiliate. If you add up the GM stock all of his family
owns, it’s still well under 10% of the shares outstanding. Insofar as the Securities Act of 1933 is concerned,
he has a 4(1) exemption. Insofar as
To sell the stock, he will have to sell it through a broker, but he had to have a brokerage account in order to buy the stock in the first place. If you are an affiliate as defined in Rule 405, you must construe 4(1) with 2(11), which gets tricky. 2(11) defines “underwriter” in terms of a person taking with a view to distribution. In United States v. Wolfson out of the Second Circuit, the court held that in a criminal case the last sentence of 2(11) applies not only to the first sentence of 2(11) but also to 4(1), meaning that an affiliate owning stock can sell only in one of only three ways:
1. The company files a registration statement for him. This happens only once in 10,000 times because it’s very expensive.
2. As to public companies, Rule 144 provides a limited, specified exemption that is widely used.
3. He can make a non-distribution. Look at 2(11)’s first sentence, and you’ll find the word “distribution”. The SEC concedes that if an affiliate makes a non-distribution, 4(1) applies to him.
Let’s say an affiliate bought the stock on the NYSE and he now wants to sell. He can sell under Rule 144 on the stock exchange (but there’s a lot of paperwork). He will get market price for his stock on the exchange. Can he legally make a non-distribution? Yes, in theory. The SEC says that the term “distribution” in 2(11) equals “non-public offering” in 4(2) as defined by Ralston Purina. He could sell the stock to a big mutual fund with a legend saying that the taker is buying for investment and not distribution. The taker cannot sell for one year. If there is full and fair disclosure to the mutual fund up-front, that would be perfectly legal. However, he won’t do that because he’ll have to sell at a 15-40% discount. So he’ll go to the internal general counsel to get the paperwork going to sell and he’ll sell under Rule 144 at the full market price. So to construe 4(1) you must construe it with 2(11), United States v. Wolfson, and Rule 144.
accounts for the fact that in the
Another person that cannot use 4(1) is someone who has purchased stock in an exemption and sells before it has come to rest. That is why under Regulation D securities sold under that exemption must be legended. In the public trading markets, delivery to your broker of a legended security is per se bad delivery! Therefore, if you buy in a 506 offering and get legended securities, then even if the company is a public company you’ll be unable to sell the securities until you get the company to issue you a “squeaky-clean” certificate.
Can a person be both an affiliate and also not meet the “come to rest” period? Yes. What’s the “come to rest” period? At common law, it is two years. Under United States v. Sherwood out of the Southern District of New York in the 1950’s, under Rule 144 for a public company the period is cut to one year. Public companies are treated better under the securities laws in about eight ways.
SEC introduction to Regulation D talks about “come to rest” and
integration. Rule 504 is the “mom and
pop” exemption. This exemption cannot be
used by a public company or investment company.
There is a dollar limit of $1,000,000.
Under all of Regulation D, there can be no general advertising. The
same is true under 4(2). If you’re an
Is Rule 504 a 4(2) rule? That is, is it adopted under 4(2)? No, it’s adopted under 3(b) of the Securities Act of 1933 which gives the commission power to adopt exemptions for (1) private offerings and (2) limited public offerings below a certain number of dollars (currently $5-$7.5 million). Rule 504 is broader in the sense that it can cover limited public offerings just as R.C. 1707.03(O) can.
Generally don’t use the 85% rules in Rule 147. 85% of the assets must be in