Understanding Securities Laws

1. Understanding Securities Laws September 27, 2017

2. Overview • Introduction • Securities Transactions • Corporate Governance • Insider Trading • Conclusion & Trends

3. Introduction

4. Sources of Securities Laws • Securities Act of 1933 • Securities Exchange Act of 1934 • Sarbanes-Oxley Act of 2002 • Dodd-Frank Act of 2010 • JOBS Act of 2012 • Rules & Regulations • Compliance & Disclosure Interpretations • Interpretive Releases • No-Action Letters • SEC Financial Reporting Manual

5. Securities Act of 1933 The Securities Act regulates the offer and sale of securities. • General Rule • Section 5 of the Securities Act requires an issuer must register any offer or sale of its securities unless an exemption applies. • Registration requirement • An issuer must file a registration statement containing SEC disclosure requirements to make an offer, and a registration statement must be effective for a sale to be made. • Section 7 and Section 10 generally specify the information required in a registration statement and a prospectus (used to offer securities to the investing public), respectively. Disclosure usually includes business and financial information about the issuer, its management, the securities being offered and the offering. • Registration exemptions • Section 4(a)(1): Transactions by any person other than an issuer, underwriter, or dealer • Section 4(a)(2): Transactions by an issuer not involving any public offering • Regulation D: Safe Harbor for limited offerings • Regulation S: Offers and sales outside the United States • Rule 144 & Restricted Securities: Resale under specified circumstances • Rule 144A & 4(a)(7) (formerly 4 (1 ½)): Resales of restricted securities to qualified institutional buyers (QIBs) or accredited investors

6. Securities Exchange Act of 1934 The Exchange Act is the principal source of reporting obligations for public companies, and it regulates trading on securities exchanges. • Antifraud provisions • 10(b): Prohibits fraud or manipulation in connection with the purchase of securities • Rule 10b-5: Prohibits making an untrue statement of material fact or omitting a material fact • Both provisions also apply in offerings that are exempt from the registration requirements • Who must register under Section 12 • Section 12(b): Requires registration of securities traded on national securities exchanges • Section 12(g): • May require an issuer to register if a class of its equity securities is held of record by either 2,000 persons or 500 persons who are not accredited investors and the issuer has total assets exceeding $10,000,000 • Allows a bank or bank holding company to have 2,000 shareholders before reporting • Effects of registration under Section 12 • Issuer is subject to the periodic reporting requirements of Section 13(a) or 15(d) • Includes periodic reports on Form 10-K and Form 10-Q and current reports on Form 8-K, among others • Issuer is potentially liable for any material misstatements or omissions • Issuer is subject to the SEC’s Section 14 proxy and tender offer rules • Additional reporting obligations • Reporting of ownership for any holder of more than 5% of any class of an issuer’s equity under Section 13 • Reporting obligations for directors, officers and 10% stockholders as Section 16 insiders • Registration of most brokers and dealers under Section 15

7. Liability and Defenses The Securities Act and the Exchange Act provide investors and sellers of securities with express and implied causes of action, including, but not limited to, the below. • Section 11(a) of the Securities Act • Imposes liability “in case any part of the registration statement, when such part became effective, contained an untrue statement of material fact or omitted to state a material fact required to be stated therein or necessary to make the statements therein not misleading” • Liability may extend to issuer, officers signing a registration statement, directors of issuer, underwriters, auditors and other experts • Section does not apply to offerings exempt from registration. • Section 12(a)(1) of the Securities Act • Strict liability against any person who offers or sells securities in violation of Section 5 • Section 12(a)(2) of the Securities Act • Supplements Section 11 if an offer or sale was made using a prospectus or oral communication containing material misstatements or omissions • Right to rescind • Section 10(b) and Rule 10b-5 of the Exchange Act • Provides an implied right of action that has developed over time in the courts • Applies to all offerings • Civil liability requires a false statement or omission as to a material fact, scienter, reliance on such statement or omission, and damages. • “Due Diligence” Defense • Parties other than the issuer may rely on a due diligence defense if such parties can establish that, based on a reasonable investigation, its belief that the registration statement is accurate and complete was reasonable. • Issuers are still subject to strict liability under Section 11.

8. SECURITIES TRANSACTIONS

9. Securities Transactions Overview • Issuers must comply with the securities laws in various transactions and corporate activities, including: • Securities offerings (debt or equity) • Mergers and acquisitions • Tender offers and exchange offers • Consent solicitations • Share repurchases

10. Securities Offerings • Also known as a capital markets transaction, a securities offering is when an issuer offers or sells its securities, usually to raise capital. • Securities offerings: • may be registered or unregistered (i.e. public or exempt); • may include debt, equity (including IPOs) or hybrid securities; • are typically underwritten ; and • can take many forms ranging from a WKSI shelf takedown to a “144A-for-life” private offering.

11. Key Parties and Documents in Offerings • Key Parties include: • Issuer • Underwriter(s) or initial purchaser(s) • Guarantors (debt) • Auditors • Trustee (debt) • Transfer agent (equity) • SEC (registered offerings subject to review) • Counsel • Key Documents include: • Preliminary offering document (aka the “red”), which may be a prospectus or an offering memorandum • Underwriting or purchase agreement • Indenture and/or supplemental indenture (debt) • Note (debt) • Auditor “comfort” letter • SEC correspondence (registered offerings) • Legal opinions and negative assurance letters from outside counsel

12. Basic Deal Structure for Equity or Debt Offerings Issuer Investment Bank (Underwriter or Initial Purchaser) Investors Sell securities Securities $ (less fees) $ In Registered Deals: Investment banks are called “underwriters” and the disclosure document is called a “prospectus” In 144A Offerings: Investment banks are called “initial purchasers” and the disclosure document is called an “offering memorandum” or “offering circular”

13. Securities Laws and M&A Transactions Certain merger and acquisition transactions may have securities laws implications. • Public M&A often involves: • Merger proxy statements for shareholder approval • Registration of any equity consideration • Section 16 filings • Analysis as to publicly filing target financial statements • 8-Ks and other disclosure requirements

14. Other Securities-related Transactions • A tender offer is when an issuer or third party offers to purchase outstanding securities from all holders. Tender offers are subject to the tender offer rules set forth in Section 14 and Regulation 14E of the Exchange Act. Equity tender offers by issuers are further subject to additional requirements in Section 13e-4. • An exchange offer is a tender offer in which the consideration is another security. • A consent solicitation is a mechanic used to solicit votes from noteholders to modify or waive provisions in an indenture. Consent solicitations often are done in conjunction with a tender offer. • A share repurchase is when an issuer chooses to buy back shares of its equity and may be done by open market purchases, pursuant to 10b-5(1) trading plans or other private transactions

15. Corporate governance

16. Corporate Governance Defined • Corporate governance refers to a set of processes, customs, policies, and laws by which a corporation is directed, administered or controlled. It is a generic term which describes the ways in which rights and responsibilities are shared between the various corporate participants, especially the management and the shareholders. It is based upon the principles of responsibility, transparency and accountability. An important object of corporate governance is to ensure the accountability of certain individuals in an organization through mechanisms that try to reduce or eliminate the principal-agent problems. It is a tool for socio-economic development. It is also known as corporation governance. Source: USLegal.com

17. Regulations, Policies and Standards • Rules and Regulations • Federal (‘33 Act, ‘34 Act, SOX, Dodd-Frank, etc.) • State (business corporation laws) • Stock Exchanges (NYSE or NASDAQ listing standards) • Proxy Advisory Firms • Institutional Shareholder Services (ISS) • Governance ratings • Proxy voting advice • Glass Lewis

18. Corporate Participants • Board • Oversight of Management • Governed by federal law, state law and organization’s articles and bylaws • Management • Accountable to Board • Authority from Board and organization’s governing documents

19. Corporate Participants (continued) • Shareholders • Institutional Investors • Retail Shareholders • Other Stakeholders • Activists • Communities • Consumers

20. Insider trading

21. Insider Trading Background: Section 10(b) and Rule 10b-5 • Section 10(b) of the Exchange Act provides, in pertinent part: It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce or of the mails, or of any facility of any national securities exchange . . . (b) To use or employ, in connection with the purchase or sale of any security registered on a national securities exchange or any security not so registered, or any securities-based swap agreement, any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors. 15 U.S.C. § 78j(b) (2012)

22. Insider Trading Background: Section 10(b) and Rule 10b-5 • Rule 10b-5 provides, in pertinent part: It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange, • To employ any device, scheme, or artifice to defraud, • To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or • To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security. 17 C.F.R. § 240.10b-5 (2015)

23. Insider Trading Background: Classical Theory of Insider Trading • The fraud or deception in a classical theory case is the breach by an insider of a fiduciary duty owed to shareholders, namely the duty not to take advantage of “information intended to be available only for a corporate purpose and not for the personal benefit of anyone.” Dirks v. SEC, 463 U.S. 646, 654 (1983). • This duty arises because there is “‘a relationship of trust and confidence’” between an insider and shareholders that “prevent[s] a corporate insider from . . . tak[ing] unfair advantage of . . . uninformed . . . stockholders.’” United States v. O’Hagan, 521 U.S. 642, 652 (1997) (quoting Chiarella v. United States, 445 U.S. 222, 228-29 (1980)). • The Supreme Court has held that, in order for an insider to have improperly disclosed inside information, he must do so in breach of a duty of trust and confidence to shareholders and for personal benefit. See Dirks, 463 U.S. at 662. • What triggers insider trading liability in a classical case involving an insider is self-dealing—a breach of confidentiality motivated by a personal, rather than corporate, purpose. United States v. Whitman, 904 F. Supp. 2d 363, 371 (S.D.N.Y. 2012).

24. Insider Trading Background: Misappropriation Theory of Insider Trading • Under the misappropriation theory, in the requisite fraud or deception is located in the breach of a duty owed to a different principal—a source of confidential information, most frequently an employer, but sometimes other individuals or entities to which a duty of trust and confidence is owed. See O’Hagan, 521 U.S. at 652. • A fiduciary’s undisclosed, self-serving use of a principal’s information to purchase or sell securities, in breach of a duty of loyalty and confidentiality, defrauds the principal of the exclusive use of that information. • In this way, misappropriation is an action “akin to embezzlement.” Id. • A duty centered on agency relationships and property rights in information, not self-dealing (as is true for classical cases). See United States v. Libera, 989 F.2d 596, 600 (2d Cir. 1993). • In lieu of premising liability on a fiduciary relationship between company insider and stockholder, misappropriation liability is based on a fiduciary-turned-trader’s deception of those who entrusted him with access to confidential information.

25. Insider Trading: United States v. Newman • In December 2012, a jury in the SDNY convicted Todd Newman (Diamondback Financial) and Anthony Chiasson (Level Global Investors) of insider trading based on tips they received involving financial information for Dell and NVIDIA. • For Newman, the Dell information flowed as follows: • For Chiasson, the NVIDIA information flowed as follows: Career Advice Danny Kuo (analyst) Sam Adondakis (Level Global) Anthony Chiasson (Level Global) Chris Choi (NVIDIA) Hyung Lim (church friend) Rob Ray (Dell) Sandy Goyal (analyst/former Dell) Jesse Tortora (Diamondback analyst) Todd Newman (Diamondback) Friendship

26. Insider Trading: United States v. Newman • On appeal, the primary question was whether the trial court properly instructed the jury that, in order to be held criminally liable, both defendants had to know that the insider-tippers’ breaches were in exchange for a personal benefit. • In December 2014, the Second Circuit reversed the convictions, holding that in order for a tippee of inside information to be guilty of insider trading, the benefit to an insider-tipper “must be of some consequence,” or more than “mere friendship,” and that a tippee must know about the benefit. 773 F.3d 438 (2d Cir. 2014). • Quid Pro Quo. The insider who breached his duty must have done so in exchange either for pecuniary gain or as part of a “meaningfully close personal relationship that generates an exchange that is objective, consequential, and represents at least a potential gain of a pecuniary or similarly valuable nature.” • Knowledge of the Benefit. The Newman panel then concluded that a tippee must know of the tipper’s personal benefit, and held the Government’s failed to prove that Newman and Chiasson had the requisite knowledge that they were trading on inside information or that it was obtained in exchange for a personal benefit.

27. Insider Trading: United States v. Salman • In October 2013, a jury in the N.D. Cal. convicted Bassam Yacoub Salman of insider trading in a number of companies – including, for instance, buying options in Biosite, which thereafter announced its merger with another company – based on tips he received through a series of family/personal relationships. • The information flowed as follows: • Maher Kara testified that he gave the information to his brother, Michael, who he spoke to nearly every day, to “benefit him” and “fulfill whatever needs he had.” Michael then passed it along to Bassam Salman because Salman was about to become “part of the family.” Maher Kara (Citigroup investment banker) Bassam Yacoub Salman (Salman’s sister was engaged to Maher) Michael Kara (Maher’s brother)

28. Insider Trading: United States v. Salman • On appeal, Salman argued that his conviction should be overturned because the Government failed to introduce evidence that (a) Maher received a tangible benefit in exchange for the inside information or (b) Salman knew of any such benefit. • In July 2015, the Ninth Circuit affirmed the conviction. Judge Jed Rakoff (SDNY), sitting by designation in the appeals court in San Francisco, wrote the opinion. Unbound by Second Circuit precedent, Rakoff wrote that “[t]o the extent Newman can be read to go so far, we decline to follow it….” 792 F. 3d 1087 (9th Cir. 2015). • “If Salman’s theory were accepted and this evidence found to be insufficient, then a corporate insider or other person in possession of confidential and proprietary information would be free to disclose that information to her relatives, and they would be free to trade on it, provided only that she asked for no tangible compensation in return.” • “Proof that the insider disclosed material nonpublic information with the intent to benefit a trading relative or friend is sufficient to establish the breach of fiduciary duty element of insider trading.”

29. Insider Trading: Newman and Salman in the Supreme Court • In October 2015, the Supreme Court denied certiorari (No. 15-137) in Newman based on, among other things, no circuit split. • In January 2016, the Supreme Court granted certiorari in Salman v. United States, 15-628, in which they addressed the following question: Does the personal benefit to the insider that is necessary to establish insider trading under Dirks require proof of “an exchange that is objective, consequential, and represents at least a potential gain of a pecuniary or similarly valuable nature,” as the Second Circuit held in Newman, or is it enough that the insider and the tippee shared a close family relationship, as the Ninth Circuit held in this case? • On December 6, 2016, the Supreme Court “easily” affirmed Salman’s conviction, rejecting Newman’s heightened personal benefit standard when the tipper is a “relative or friend.”

30. Insider Trading: The Supreme Court’s Holding in Salman • The Court rejected Salman’s argument that an insider must receive a pecuniary quid pro quo from a tippee for there to be a sufficient personal benefit. The Court held that Dirks made clear that a tipper breaches a fiduciary duty—and receives a personal benefit—by making a gift of MNPI to a “trading relative or friend.” • Notably, the Court declined to adopt the government’s broader argument that “a tipper personally benefits whenever the tipper discloses confidential trading information for a noncorporate purpose.” • Rather, the Court found that Dirks “easily resolves the narrow issue presented here.” • In applying Dirks, the Court found that “Maher, a tipper, provided inside information to a close relative, his brother Michael. Dirks makes clear that a tipper breaches a fiduciary duty by making a gift of confidential information to ‘a trading relative,’ and that rule is sufficient to resolve the case at hand.”

31. Insider Trading: The Supreme Court’s Holding in Salman • The Salman Court remained silent on how the Dirks standard would apply in situations when there is not “proof of a meaningfully close personal relationship,” such as Newman, where there was only a casual social/business relationship between tipper and tippee. • The Court found “no need for us to address those difficult cases today, because this case involves precisely the gift of confidential information to a trading relative that Dirks envisioned.” • The Court also failed to disturb Newman’s holding — with which the government seemed to agree — that the government must prove that the tippee knew that the tipper disclosed the inside information for a personal benefit.

32. Insider Trading: Open Questions Post-Salman • What is the scope of the personal benefit requirement beyond friends and relatives? Was the Salman court’s silence on tips to market professionals intentional, such that a heightened requirement is necessary in that circumstance? • Similarly, what exactly is a friend? Under Dirks, it need be a “meaningfully close personal relationship.” Where will that line be drawn now? • Can the government avoid proving a concrete personal benefit by simply arguing that the tipper meant to give a gift to the tippee? • Does the other half of Newman remain intact? Must the government demonstrate that a downstream tippee “had knowledge that the information originated from an insider in breach of a fiduciary duty and for personal benefit.” • In the civil context, is “should have known” enough?

33. Insider Trading Cases Post-Salman: • Convictions Upheld on Appeal • United States v. Rajaratnam, 09 Cr. 1184 (SDNY, March 3, 2017). Founder of Galleon Group hedge fund was convicted in May 2011, and sentenced to 11 years in prison, for profiting up to $63.8 million for insider trades in eBay, Goldman Sachs, and Google Inc. between 2003 and 2009. • United States v. Bray, No. 16-1579 (1st Cir. Feb. 24, 2017). The defendant convicted for trading after receiving a tip about a bank acquisition on a cocktail napkin from a country club buddy who worked at the bank. • Insider Trading Cases Post-Salman: • United States v. Walters (Mickelson) • Appeal of United States v. Gupta • United States v. Durant and Payton • United States v. Blasczcak, et al.

34. Conclusion & trends