Secondary Distributions Outline

Secondary Distributions

1. 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."

2. 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...

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