Securities Laws Made Simple

IPO Securities Laws Made Simple

This is going to be a fast review just for the purposes of getting you through an initial public offering. This is not legal advice and you should consult a qualified attorney. What follows below is a only very simplified introductory summary of what you need to know.

To go public you have to register under the Securities Act of 1933. To do this, you file with the Securities and Exchange Commission. You will select a form that is suitable for your company. If you are a plain vanilla U.S. company, not a mutual fund, REIT, foreign company or something else requiring a special form, you will probably use Form S-1, the general, all-purpose registration form.

Before you go public, you will not “jump the gun” by making any public reference to your future plans to go public. You are allowed for more than 30 days prior to filing the offering with the SEC to disseminate factual business information, but not forward looking information, if you have done so regularly before in the ordinary course of business, but you may not refer to the offering. You are allowed to make limited public notices about the offering after you have filed it.

You must deliver a prospectus, or provide access to it, within two days of sale.

For 40 days following the first day of the IPOs public trading, insiders and underwriters cannot publish research reports or earnings forecasts.

IPO Liabilities

Naturally, you can be held liable for investor losses if you file a false offering document. Please note well that not only misstatements are actionable, omissions to state something that would be needed to make the offering document not misleading are also actionable. Omissions count.
Section 11 of the Securities Act of 1933 provides for liability if the registration statement or the prospectus contains an untrue statement of a material fact, omits to state material information which makes the stated facts misleading, or omits material information required by statute or regulation. The investor has to sue within three years after his purchase or less than one year after he discovered the misstatement or omission.
Information as material if there is a substantial likelihood that a reasonable investor would consider the information important in deciding whether to buy the security.
Under Section 11, the issuer is absolutely liable. The underwriter is not liable if it can show that after a reasonable investigation (due diligence) it reasonably believed there was no material untruth or omission. Personally, as a practical matter, I believe that it will be virtually impossible for the underwriter to show that it made a good due diligence investigation if there was something that should have been found out.
The investor need only show that there was a material untruth or omission. He does not have to show it was an intentional misstatement or omission. He does not have to show that he relied on the misstatement or omission.
Damages for violation of Section 11 are the difference between the investor's purchase price and the subsequent sale proceeds or the security's price at the time of the lawsuit. Damages cannot be based on a purchase price greater than the offering price of the security.
Section 12 of the Securities Act of 1933 imposes a liability for a material untruth or omission in the prospectus or in any oral or written communication made by the seller. For a violation of Section 12, the purchase price is refunded to the investor. This is called rescission. If the investor has sold the security, damages are the purchase price minus the sale price.
The investor relying on Section 12 must prove only the material untruth or omission. does not need to show it was intentional and he doesn not need to show that he relied on it.
Following a recent Supreme Court decision, the courts now construe a seller more narrowly to be someone who solicits the investor, e.g., the broker-dealer who calls the investor.
Section 11 can be used by IPO purchasers and it can also be used by aftermarket purchasers.
Section 12 can be used both by IPO purchasers and by aftermarket purchasers. Their aftermarket purchase price serves as the basis for rescission or damages.
Section 17(a) of the Securities Act provides liability for fraud.
Section 10(b) and Rule 10b-5 of the Securities Exchange Act of 1934 impose liability for a material untruth or omission in the registration statement or prospectus for issuers, underwriters, and sellers.
Under 10b-5, the plaintiff must show (1) a material untruth or omission, (2) the defendant knew the statement was false or made a reckless misrepresentation (this state of knowledge is called “scienter”), (3) the investor relied on the false or misleading information, and (4) the investor was damaged by such reliance.
There is also the general case law (common law) of fraud which requires that the investor reasonably relied on a material (important) statement that was false made by a person who knew or should have known it was false and suffered loss thereby. There may also be liability in some cases for negligent misstatements.

Often ignored is such suits is the common law liability of company directors for negligence.

Rule 144

Rule 144 allows you to leak into the market limited quantities of unregistered securities under certain circumstances. You underwriter will want to “lock up” your stock for a period of three to six months so that you will not be dumping on his precious aftermarket by selling under Rule 144.

Short Sales

As a company insider, you are prohibited from short selling the company's stock.

Insider Trading

You are prohibited from using inside (non-public) information to buy or sell the company's stock. The SEC has been vigorous in enforcing this rule. This can result in criminal charges.

Foreign Corrupt Practices Act

The SEC also enforces the FCPA, which says you cannot bribe people overseas, on public companies. They are also quite serious about this rule which can also result in criminal penalties.

Staying Out of Trouble

Document everything. Never say or write anything unless you can document it is true. Make other people sign off on their representations to you.

Keep duplicate copies of these documents in a safe place where they cannot be destroyed. Store them in such a way that you can easily access them fast.

If you suspect their might be a problem, there is – fix it immediately.

Do not use “sales puff.” An example of sales puff is “this is the best stock you can find for the money.” You cannot prove such a statement. Sales puff also sounds unprofessional in the securities industry.

Confide in your attorney. That is what he is there for and and he is used to handling sticky issues. Protect yourself.

Make full disclosure. Your underwriter is a stock salesman. He can tolerate, fix or patch over many ugly things, but if something comes out he did not know about he will not only lose the sale, he will be very angry.

Make liberal use of risk factors in the offering document. If you warned the investor, he cannot sue you for it. Most investors ignore the risk factors. Most that do not ignore them are using as an excuse to back out anyway.

Danger Spots

You might be a defendant if . . . .

Your earnings come out badly after being hyped in the offering

You are using some bogus accounting tricks

You fail to disclose all the risk factors

You engage in illegal activity

You violate the use of proceeds given in the offering document 
and use the money for something else

You failed to disclose something big


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