Business
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.
i.
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,
ii.
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.
So
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). Under
10(b)(5), it is only if the customer proves that the
recommendation was made with scienter. That’s hardcore. In the case, a
The
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.
Lastly,
Shipman argues that securities laws are one of
Attorney
General Spitzer in
Some examples of exemptions
Around
93% of all transactions are exempt. Let’s
go over some of the important ones.
4(1)
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.
This
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.
The
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.
What
about 3(a)(11)?
Generally don’t use the 85% rules in Rule 147. 85% of the assets must be in