Secondary Distributions

In General
1. § 5 literally requires that every sale of a security either be registered or exempt.
2. Crucial Inquiry: Whether the securities have come to rest.
  1. The law seems to be that it takes 2-3 years for securities to come to rest.
    - "Many courts have accepted a two year rule of thumb to determine whether the securities have come to rest." Ackerman v. Johnson (pg. 383)
    - "[A] three-year holding period is 'well nigh conclusive' that securities were acquired without a view to distribution." Ackerman v. Johnson (pg. 383)
  2. BUT as a practical matter, Rule 144 is used 99% of the time.
3. Where the distribution of securities is pursuant to a transaction exemption (unregistered) and the securities have NOT come to rest, the resale is part of the same distribution.
  1. Therefore, the resale is part of the same transaction and the resale is still exempt insofar as the resale does not spoil the exemption (e.g. a resale of securities to out of state purchasers would spoil the intrastate exemption).
4. Where the distribution of securities is pursuant to a transaction exemption (unregistered) and the securities have come to rest, the resale is a separate transaction in and of itself and must find its own exemption.
  1. The question then becomes whether there is an applicable exemption to show that there is no violation of § 5.
5. IN MOST CASES, the resale of a security will fall under §4(1) as it will not be a transaction by an issuer, underwriter, or a dealer.
6. Therefore, the big issue here is whether the person reselling the security is an "underwriter."
The "Underwriter" Concept
1. § 4(1) exempts transaction by everyone except transactions by an "an issuer, underwriter, or dealer."
  1. Definition of an underwriter:
    - § 2(a)(11) provides that "underwriter" means "any person who has purchased from an issuer with a view to, or offers to sell for an issuer in connection with, the distribution of any security, or participates or has a direct or indirect participation in any such undertaking, or participates or has a participation in the direct or indirect underwriting of any such undertaking; but such term shall not include a person whose interest is limited to a commission from an underwriter or dealer not in excess of the usual and customary distributors’ or sellers’ commission. As used in this paragraph the term 'issuer' shall include, in addition to an issuer, any person directly or indirectly controlling or controlled by the issuer, or any person under direct or indirect common control with the issuer."
    - Four broadly defined roles that qualify someone as an underwriter:
      - (1) Any person who purchases from an issuer with a view to the distribution of a security; OR
        
        TWO ISSUES:
        
        (1) Investment Intent? - IF investment intent, not an underwriter
        
        The length of time the purchaser held the shares before reselling them plays a pivotal role in determining whether the purchaser acquired the shares with a view to their distribution.
        
        At one time, most practitioners believed that investment intent is established if the shares have been held for three years. See, e.g., Sommer, Considerations Leading to the Adoption of Rule 144 (pg. 346)
        
        For holding periods less than three years, consideration must be given to the circumstances surrounding the shares' purchase as well as any change to the circumstances after their purchase.
        
        There is something of a bendpoint at two years.
        
        If the shares have been held for more than two years, there is a presumption of investment intent.
        
        If the shares are held for less than two years, there is a presumption that the shares were purchased with a view to distribute the shares.
        
        If the holding period period is less than two years, the factors of (1) the purchaser's circumstances when he purchased the shares and (2) a change in circumstances must rebut the presumption.
        
        If the shares have been held for more than two years, but less than three years, these factors should not support an inference of intent to distribute.
        
        Cases re investment intent:
        
        In G. Eugene England Foundation v. First Federal Corp. (pg. 347), the Tenth Circuit held that the defendant's holding period of 16 months was not sufficient to establish investment intent where there was no change of circumstances; therefore, the defendant was deemed to be an underwriter.
        
        In Neuwirth Investment Fund v. Swanton (pg. 347), the court found a sufficient change in circumstances to rebut the presumption of the purchase with a view to distribute where the purchaser became insolvent and were resold by the liquidator. The court noted that it was the change in circumstances that caused the security to be sold not a lack of investment intent.
        
        (2) Distribution?
        
        Distribution = Public Offering
        
        The meaning of "distribution" is governed by the standard set out in Ralston Purina for whether there is public offering. Gilligan, Will & Co. v. SEC (pg. 348)
        
        "An offering to those who are shown to be able to fend for themselves is a transaction 'not involving a public offering.'" Ralston Purina (pg. 269)
        
        The critical inquiry is whether or not the offerees "have access to the kind of information which registration would disclose." Ralston Purina (pg. 269)
      - (2) Any person who offers or sells for an issuer in connection with a distribution; OR
        
        This can be the case even where there is no contract, no understanding between the issuer and the seller, and the seller does not receive any compensation from the issuer. See SEC v. Chinese Consolidated Benevolent Association (pg. 340)
      - (3) Any person who participates or has a direct or indirect participation in the activities of (1) or (2) above; OR
      - (4) Any person who participates or has a participation in the direct or indirect underwriting of any such undertaking.
    - Members of a public offering's selling group are expressly excluded from the underwriter classification, provided that the commission received from an underwriter or dealer is "not in excess of the usual and customary distributors' or sellers' commission."
      - Rule 141 refines the meaning of "usual and customary" to include not only a direct payment by an underwriter, but also the "spread" permitted the dealer who as principal purchases from the underwriter and resells at a higher price, so long as the payment or spread is not in excess of what is usual and customary
        
        BUT Rule 141 does not protect a dealer who manages the offering or performs functions normally performed by an underwriter.
Control Person Distributions
1. The definition of "underwriter" in § 2(a)(11) provides that "[a]s used in this paragraph the term 'issuer' shall include, in addition to an issuer, any person directly or indirectly controlling or controlled by the issuer, or any person under the direct or indirect common control with the issuer."
  1. Thus, anyone who purchases from a control person, or sells for a control person, or otherwise participates, directly or indirectly, in a distribution of the control person's securities is an underwriter.
2. Where the distribution of securities is pursuant to a transaction exemption (unregistered) and the securities have NOT come to rest, the resale is part of the same distribution.
  1. This is exactly the same whether the person reselling the securities is a control person or not.
  2. Here, you must evaluate whether the transaction exemption is spoiled by the resale.
3. BUT where the the distribution of securities is pursuant to a transaction exemption (unregistered) and the securities have come to rest, the issue becomes whether the person purchasing from the control person or selling on behalf of the control person is an underwriter. If so, then the transaction is not exempt and there is a § 5 violation.
4. If a person is a control person, it doesn't matter if the securities were previously registered. If it is a secondary distribution rather than merely a trading transaction, the distribution will either need to be registered or be exempt.
5. Meaning of Control
  1. Unites States v. Wolfson (pg. 356)
    - In that case, Wolfson was a control person where he and members of his family, his right hand man, and his first lieutenant (people closely associated with him) owned a total of 40% of the outstanding stock of the company.
      - The court stated that "[a]s the largest individual shareholder [Wolfson] was [the company's] guiding spirit in that the officers of the corporation were subject to his direction and control and that no corporate policy decisions were made without his knowledge and consent." (pg. 356)
  2. Rule 405 defines control functionally in terms of a person or group's influence over management and business policies
6. Broker's Exemption - § 4(4)
  1. §4(4) exempts "brokers' transactions, executed upon customers' orders on any exchange or in the over-the-counter market but not the solicitation of such orders."
  2. Where a broker is selling on behalf of a control person and falls within the definition of an underwriter, the § 4(4) brokers' exemption only applies to the broker's part in the transaction; the control person has to find his own exemption. Since these are transaction exemptions and not exemptions for particular classes of persons, the transaction can violate § 5 even where the brokers' exemption applies. See Wolfson
  3. In In re Haupt & Co. (pg. 361), the Commission held that the brokers' exemption is not available for sales made on behalf of a control person in a distribution. The brokers' exemption only applies to trading transactions, and the Commission viewed the situation as a distribution on behalf of...

Secondary Distributions - Securities Regulation

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