Question 1(a)
According to section 2 (a) (1) of the Securities Act 1933, a security includes a note, stock, investment contract, certificate of interest or participation in any profit- sharing agreement, collateral trust certificate, any interest or instrument commonly known as "security", or any certificate of interest in participation in, and so on. Section 5 of the Securities Act provides for the mandatory registration of a "security" and a registration statement in effect, failure to which, it would be unlawful for any person or individual to offer the security for sale to the public.
The case of Securities Exchange Commission v W. J. Howey Co. 328 U.S. 293 (1946) sets out the general meaning of the term ‘investment contract' as a contract or scheme for the placing of capital or laying out of money in a way intended to secure income or profit from its employment (SEC v Howey). According to the case, the definition of the term within the Securities Act obligates the issuer of the security to provide full and fair disclosure of the nature of the security to potential investors and to comply with all registration requirements pertaining to the security.
According to the case, an investment contract test was to be applied to determine whether a particular venture is an investment contract and therefore a security under the Securities Act. The investment contract test was applied to prove that a company is offering the public a chance or opportunity to contribute some amount of money towards a certain venture that is owned and managed by the company to which the public would share the profits. The members of the public who opt to venture into the investment are attracted solely by the potential returns on the investment they have made (Cox et al., 2009).
Irving Investors can proceed under section 12 of the Securities Act which allows for a private suit to be instituted against MPL for rescission of the contract due to MPL's failure to register the security with the Securities and Exchange Commission. As earlier mentioned, failure to register the security amounts to an offense under Section 5 of the Securities Act. Therefore, MPL is in violation of Section 5 of the Act and Irving Investors are obliged to institute proceedings against them to rescind the contract and recover the consideration given at the beginning of the contract. The Federal government can also institute proceedings against MPL for failure to comply with Section 5 of the Securities Act. The Federal government can seek an injunction or damages. Also, the federal government has the option to institute criminal proceedings against MPL for failure to comply with section 5 of the Act.
Question 1 (b)
The stock test applies when the investors main motivation for offering the instrument to the public is for consumption purposes and not for profit. This was established in the case of United Housing Foundation v Forman 41 U.S 837 (1975), where the court stated that the fact that an instrument is referred to as “stock”, does not necessarily mean that it is. The economic realities of the transaction are what determine whether an instrument is a security or not. From the facts given, MPL issued the instrument solely for their gain or for profit and not for consumption purposes.
Question 2
According to section 5 of the Securities Act, all "securities" must be registered. The registration process timeline involves the pre- filing period during which the registration statement is prepared and filed. After that is the waiting period during which the statement can be amended according to the SEC's recommendations. After the SEC gives a go- ahead, the registration statement effective date is given which leads to the post- effective period where the company can issue the security for sale to the public. During the registration process, before the effective date is issued, Section 5 of the Securities Act allows and prohibits some activities by the issuer in relation to the security within the registration period. Section 5 (c) provides for the prohibitions which are referred to as ‘gun- jumping'.
On the first instance, John Perpetual, the CEO of the company did an interview before the company had sought out an IPO team to take the company public. However, the interview was available at newsstands during the pre- filing period during which Section 5 (a) and (c) prohibit the sale and offers of any kind by the company that would condition the public with information not yet approved by the SEC. The magazine issue hit the newsstands once an underwriter had been approached by the company and was working on making the security public. The CEO's actions were therefore in violation of section 5 (a) by ‘selling' the bikes to the public during the pre- filing period. This was also brought out in the case of Re Carl M. Loeb, Rhoade & Co. (1959,) where press releases were held to have been given with the aim to arouse investor interest and amounted to offers.
Pam Perpetual, the Marketing VP's actions were done during the waiting period. Section 10 of The Securities Act allows a company to make offers during the waiting period but only through a prospectus. Any other offer made is prohibited under Section 5 (b)(1). Section 5 (a) also prohibits any sales during the waiting period. The advertisements amounted to offers which were made through the radio and not through a prospectus. Therefore, the marketing VP's actions were in contravention of Section 5 (b)(1) of the Securities Act.
The powerpoint presentation slides handed out by John Perpetual, the CEO of the company at a roadshow during the waiting period were also in contravention of Section 5 (b)(1) of the Securities Act. Handing out the slides and forgetting to collect them at the end of the presentation was tantamount to conditioning and arousing the public's interest by distributing information before registration is completed as was brought out in the case of Sheinberg v Fluor Corp., 514 F. Supp. 133 (1981).
Section 5 (b)(1) allows a company to issue a prospectus with information to the public during the waiting period of the registration. In the fourth case, Big Bank sent out a prospectus with a cover letter that claimed that IPO to be the biggest the bank has ever handled. Section 10 (a)(1) allows the issuing of prospectus' which contain only information included in the registration statement. Big Bank's cover letter that claimed the IPO to be the bank's biggest ever amounted to an offer since the statement would not be included in the registration statement. The statement was solely made to condition the public's minds and arouse interest in the company's IPO.
References
Cox, J.D., Hillman, R.W., Langevoort D.C. (2009). Securities Regulation: Cases and Materials 7th edition. Aspen Publishers
The Securities Act 1933
