Note: If a company does have a name that suggests that it focuses on a particular investment or industry, it must invest at least 80% of its assets in that suggested area!

• A company name suggesting that it focuses its investments in a certain country or geographic region.

Note: If a company does have a name that suggests that it focuses its investments in a particular country or geographic region, it must invest at least 80% of its assets in investments that are economically tied to that suggested area! The company must also disclose in the prospectus the criteria that it uses to select those investments.

• A company name suggesting that distributions are exempt from state or federal income taxes.

Note: If a company does have a name that suggests this, it must invest at least 80% of its assets in investments that are exempt from that suggested income tax! Alternatively, the company could also invest its assets in such a way that at least 80% of the income that it distributes will be exempt from income tax.

THE PROSPECTUS

A prospectus is a formal legal document required by and filed with the SEC. It provides details about an investment offering that is for sale to the public. A legitimate prospectus issued by a company has the SEC's "no approval" clause on its front page. This clause just states that the SEC neither approves nor disproves the information that is in the prospectus (i.e. the merit of the security, the adequacy of the information, etc). It only ensures that the prospectus contains no misleading information and that the registration of the new issue is complete.

REGISTRATION OF A NEW ISSUE

A new issue is a security that has been registered and issued, and is now being sold on the market to the public for the first time. An issuer is a legal entity that develops, registers, and sells securities to finance its operations. When a new issue is registered, the issuer submits its registration statement signed by the issuer’s executive officers, financial and accounting officers, and board of directors. It is submitted three times to the SEC along with the required following fee. The information and documentation that must be in the registration statement is listed under Schedule A of the Securities Act. Some of these items are as follows:

• a "statement of purpose" of the issuer's business
• the public offering price (POP)
• biographical descriptions of the officers and directors
• the specific number of shares held by the senior officers, directors, and underwriters

• identification of individuals who hold at least 10% of the company's securities
• how the proceeds of the issue sale will be used
• the commissions of the underwriter(s)
• a copy of the underwriting agreement
• financial statements (specifically, earning statements from the past three years and the balance sheet)
• copies of the issuing company's "articles of incorporation"

THE REGISTRATION PROCESS

The date on which the SEC receives the registration statement is the official filing date. Once the statement is received, a 20-day cooling-off period begins, during which the SEC reviews the registration statement. The cooling-off period is the timeframe during which both parties to the contract may release themselves from any contractual obligations without penalty.

During this cooling-off period, the issuer may give potential purchasers a preliminary prospectus (also known as a red herring), which is also submitted to the SEC with the registration statement. The red herring is similar to the first prospectus because it contains much of the same information. So, for investors, the red herring is used as a source of information regarding the security being (potentially) offered. It's bold disclaimer on its front page states that the registration statement for the security being offered has been filed with the SEC but has not yet become effective. Therefore, the information in the prospectus is incomplete and may be changed. Offers on the security are not permitted until the registration statement becomes effective. This bold disclaimer is also written in red ink, which is how "red herring" became the nickname.

The red herring document is also used to solicit "expressions of interest" in the respective security (later, those "interests" become orders/transactions). This document never contains the public offering price (POP) or the security's effective date (the day the security will become available for sale to the public). This is because the information is not yet known, as the security is still "in registration" during this cooling off period and not guaranteed for SEC approval. Remember, prospective buyers of the security issue were given the preliminary prospectus (red herring) to determine how much interest might be expressed in the security, but official offers on the security issue are not allowed during this time!

Also during the cooling-off period, the new issue is registered in the states where the underwriter is planning to sell shares. The Blue Sky Laws are the state regulations that require new issues to be registered, and financial details to be provided. This allows an investor to make his decision based on trustworthy data and also protects him from securities fraud.

Before issuing a final prospectus, the underwriter, issuer, accountants, attorneys, and syndicate members will hold a meeting to discuss whether the underwriter and issuer have exercised due diligence toward state and federal securities laws. A due diligence meeting is a careful investigation to ensure that all material information about a security issue has been disclosed to prospective investors. This is all done during the cooling off period.

ISSUING AND UNDERWRITING

During the period between the filing date and the effective date, the issuer and underwriting syndicate may not sell securities, solicit requests for orders, or send out any reports which discuss the company's future sales and earnings. They are permitted to publish a tombstone advertisement.

A tombstone is basically an announcement that a security is for sale. Anyone (unsolicited) who requests more information will be sent a preliminary prospectus. Direct solicitations are given a final prospectus. Additionally, no subscription payments may be requested, even if they are held in escrow until the effective date.

PROSPECTUS DELIVERY

The underwriter provides both the preliminary and final prospectus to all participating broker-dealers. During the 25-day period following the effective date, the broker-dealers provide prospectuses to clients if the securities are listed on a national exchange or the NASDAQ. There is no aftermarket prospectus requirement if the security is already listed on these markets. The prospectus delivery requirement for non-NASDAQ OTC securities is 90 days if the company has never issued an IPO. If the security has been previously listed, the prospectus delivery requirement is 40 days.

EXEMPT SECURITIES

Some securities are not required to follow the procedures of registration and the prospectus requirements. The Securities Act of 1933 lists the following securities as exempt:

• U.S. government and federal agency issues
• municipal and state issues
• intrastate offerings
• small public offerings

• private placements
• insurance policies (including fixed annuity contracts)
• commercial paper and bankers acceptances with maturities of nine months or less

Regulation D (Reg D) is one of the SEC rules that exempts securities. When a company wants to save time and money, it can sell securities in a non-public offering called a private placement. By selling securities through this private placement, it is exempt from the registration and prospectus processes. However, it must meet the following conditions to qualify for the exemption:

•the buyer must be a sophisticated investor/experienced enough to evaluate the risks involved
•the buyer must have access to the financial information that is included in the prospectus
•the buyer must not have the intention of making a quick sale
•the issue must not be sold to more than 35 non-accredited investors

The Reg D exception does not apply to accredited investors. An accredited investor is defined as the following:

•financial institutions
•private business development companies
•large, tax-exempt plans
•a director, officer, or partner of the issuing company
•anyone with a net worth of $1 million
•an individual whose gross income for each of the past two years was $200,000+ ($300,000 if filing jointly with a spouse); he must have reasonable expectations of meeting that income level the following year too

PROSPECTING AND MARKETING RULES

The Securities Act of 1933 contains four sections pertaining to prospecting and marketing.

Section 5 requires all offers and sales of securities in interstate commerce to be registered (unless an exemption applies). In other words, the sale of unregistered securities is prohibited. It also states that the mail and other interstate means may not be used to sell (or offer to sell) a security unless a registration statement is in effect and has been filed with the SEC, or unless the security is accompanied or preceded by its prospectus.

Section 12 discusses the liability a person will have if he offers or sells a security through a prospectus or via oral communication containing a material misstatement or omission. The person who committed this injustice will be liable to the purchaser of the security, as long as the purchaser did not know about the misstatements or omissions when he bought the security. The purchaser may sue the seller for his money back or any damages if he no longer owns the security. If he wants his money back, he can only sue for the amount for which he originally purchased the security, plus interest. Loss causation just means that a loss was a direct result of someone's wrongful actions. The purchaser who is claiming injustice will plead "loss causation" in court. He must also be able to prove that the misstatements or omissions actually did cause him economic harm.

Section 17 is similar to Section 12 in that it also prohibits types of fraudulent activity in the offer and sale of securities. However, Section 17 does differ from Section 12. Section 17 claims can be based on negligent conduct, but Section 12 claims require proof of loss.

Section 17 also officially states that it is unlawful for a person selling or offering a security (via communication/transportation in interstate commerce or mail) to do any of the following:

•employ any device, scheme, or artifice to defraud
•obtain money or property by means of untrue statements of material facts (or by omitting to state such things)
•engage in a transaction, practice, or course of business involved in fraud or deceit

Lastly, section 17 states that a person is prohibited from using any means of communication or transportation in interstate commerce to publish or circulate any advertisements or notices about a security that is being considered without fully disclosing the past or prospective receipt (which states the security's consideration and amount thereof).

Section 23 basically describes unlawful representations. It states that the registration statement should but might not be true and accurate, and should not but might contain an untrue statement. These securities and their transactions have not been given merit or approval by Congress or other powerful entities. Sellers may not tell buyers that the securities have been approved as such.

FINRA RULE 2210 - COMMUNICATIONS

This rule discusses and governs three categories of "communication" by FINRA member firms. These categories are retail communication, institutional communication, and correspondence. The rule sets forth requirements regarding the approval, content standards, recording, filing, and review procedures for these different forms of communication. It also ensures that all communications are fair, balanced, and not misleading.

Some communication is public and available to anyone, such as an advertisement. An advertisement can be any printed or electronic form of public media (a newspapers, magazines, signs/billboards, radio/phone/tv/movie ads, etc). Some communication is sent to a target audience. It can also be in printed or electronic form (research reports, performance reports, market letters, sales literature, published articles, press releases about a product or service, excerpts from other ads, etc).

Retail communication is any written or electronic form of communication that is distributed to more than 25 retail investors within a 30-day period. A retail investor is any person other than an institutional investor. Retail communication must be approved by a registered principal before it is used for the first time.

Institutional communication is any written or electronic form of communication that is only distributed to institutional investors. An institutional investor is any bank, insurance company, registered investment company, investment adviser, FINRA member, government entity, or "anyone" with total assets of at least $50 million. The term "anyone" refers to a person, a corporation, a partnership, or a trust. Institutional communication does not have to be approved by a principal as long as policies and procedures have been established regarding proper use (employees must also complete training in this).

The term "correspondence" refers to any written or electronic form of communication that is distributed to 25 or less retail investors within a 30-day period.

Record-keeping -- Per Rule 2210, all institutional communications must be kept for a period of three years from the date of last use. The name of the person who created the item must also be included in this file. Additionally, a file must be maintained containing the source of any statistical tables, charts, or graphs used by a member during his communications with the public.

"Spot-check" Procedures -- Rule 2210 also states that all forms of communication are subject to a spot-check procedure. The Advertising Regulation Department will put this spot-check request in writing, and each member must submit the requested material within a specified timeframe.

Content Standards -- Rule 2210 requires all correspondence to do the following:

•clearly show or state the name (and nickname, if applicable) of the member who involved with the   correspondence
•state the relationship between a member and any other individual(s) involved with the correspondence
•if the latter applies, list the products and services that are being offered

This rule also states that members may not use investment company rankings in any correspondence except for the rankings based on a category created and published by a ranking entity, an investment company, or an investment company affiliate (whose performance is measured by a ranking entity).

FINRA CONDUCT RULE 2212 - GENERAL TELEMARKETING

Wireless Communication -- The sole purpose of this rule is to state that all the same telemarketing rules also apply to wireless telephone numbers!

Outsourcing Telemarketing -- If a member uses another entity (i.e. besides himself or another member) to do telemarketing for him, all the same telemarketing rules also apply to the entity! It is the member's responsibility to ensure that the entity is complying with the rules.

Time of Day Restriction -- A member may not participate in telephone solicitation before 8AM or after 9PM (local time of the person being called) unless the following is true:

•the member has an established business relationship with the person being called
•the person being called has given prior permission to the member
•the person being called is a broker or dealer

Firm-Specific Do-Not-Call List -- A member may not call anyone who has previously has stated that he does not wish to receive any outbound telephone calls from that member or anyone else affiliated with the firm.

National Do-Not-Call List -- A member may not call anyone who has registered his telephone number with the Federal Trade Commission's national "do-not-call" registry.

The following are exceptions to the national registry's "do not call" rule:

•Established Business Relationship Exception: This means that the member has an established business relationship with the recipient of the telephone call. However, if that person ever requests to be placed on the "firm-specific do not call" list, this exception no longer applies (even if the person continues to do business with the member)!
•Prior Express Written Consent Exception: This refers to when the person being called gives prior permission to the caller. The agreement must be written and signed. It must also include the telephone number that the caller should use.
•Personal Relationship Exception: This just means that the caller has a personal relationship with the recipient of the call.

Safe Harbor Provision -- The term "safe harbor" refers to a legal provision that reduces or eliminates liability in certain situations, as long as certain conditions are met. A member will not be liable for a violation if he can prove that it was a mistake, and if the following standards regarding his routine business practice are true:

•Written Procedures: The member establishes and implements written procedures in order to comply with the national do-not-call rules.
•Training of Personnel: After the member writes the procedures, he trains all personnel in them.
•Recording: The member records and maintains a list of "do not call" phone numbers.
•Accessing the National Do-Not-Call Database: The member uses a process to prevent do-not-call solicitations. The "do not call" list he uses is no more than 31 days old. He maintains records to document this process.

RULE 135A OF THE SECURITIES ACT OF 1933: GENERIC ADVERTISING

This rule pertains to generic advertisements that are put out about an investment company selling a security. If the company does not mention its name, the sale of the security is not permitted. These advertisements must contain the name and address of the registered broker-dealer who is associated with the sale. If prospectuses are being sent to an interested party, the advertisement must state that the sponsor of this ad is the principal underwriter or investment adviser. The ad must also list the number of investment companies that will be providing the prospectuses/information about the security.

RULE 156 OF THE SECURITIES ACT OF 1933: MISLEADING SALES LITERATURE

This rule pertains to the sales literature of an investment company. It prohibits the use of any material that is misleading in regards to the offer or sale of a security. Sales literature is considered misleading if it contains an untrue statement of a material fact or if it fails to include an important fact. Providing information about the past (or future) performance of a security is also considered to be misleading. If performance data is used, the ad must clearly state that the data does not guarantee any results. Rule 482 is next in this section and will explain exactly what the ad must say about the performance data.

Statements or exaggerations regarding the character, management skills, and techniques of an investment company might also mislead a client into buying or selling a security. Sales literature includes communication in the form of writing, radio, or television that is used to induce the sale of a security of an investment company. Sales literature also includes any oral or written communication that occurs between issuers, underwriters, dealers, and any other parties involved in the offer or sale of a security.

RULE 482 OF THE SECURITIES ACT OF 1933: ADVERTISING AND INFORMATION IN THE PROSPECTUS

Recall that Rule 135a applies to generic advertising in the selling of a security of an investment company. While Rule 482 also refers to advertising, it requires specific, additional information to be disclosed in the advertisement. The key is to let the investor know that additional information is available to him. It also states that if an advertisement does list the required additional information, then it is considered to be part of the prospectus (especially if the actual prospectus has not included the additional information).

The following specific, additional information must be disclosed in the advertisement:

• A statement advising an investor to consider investment objectives and risks, as well as the investment company's charges and expenses before he decides to invest
• A statement explaining that the prospectus contains pertinent information
• A statement advising an investor to carefully read the prospectus prior to investing
• Where (or from whom) an investor can obtain a prospectus
• Procedures for investing in the investment company

Rule 482 also outlines specific information that must be disclosed when an advertisement contains performance data. The information is as follows:

• That the data is old and does not guarantee future results
• That the return and value might fluctuate, making the investment worth more or less than the original cost
• A phone number or website from which an investor can obtain the most current performance data

RULE 10B-3 OF THE SECURITIES EXCHANGE ACT OF 1934: MANIPULATIVE AND DECEPTIVE DEVICES BY BROKERS OR DEALERS

This rule prohibits a broker or dealer from manipulative, deceptive, or fraudulent behavior in the purchase or sale of a security.

RULE 34B-1 OF THE INVESTMENT COMPANY ACT OF 1940: MISLEADING SALES LITERATURE

Recall that Rule 156 has prohibited any sales literature (advertisements) from being misleading and from omitting any facts that should be known by an investor in the sale or purchase or a security. Rule 34b-1 merely defines that if necessary material is omitted, then the sales literature is officially deemed as misleading.

RULE 35D-1 OF THE INVESTMENT COMPANY ACT OF 1940: INVESTMENT COMPANY NAMES

The SEC adopted this rule because it thought that certain investment company names were possibly misleading to investors. In other words, investors were focusing on an investment company's name to determine the company's investments and risks. Investors were using this information to decide with whom they should invest their money. The SEC has determined that the following investment company names are misleading to investors:

• A company name suggesting that the securities it sells are guaranteed or approved by the U.S. government.

• A company name suggesting that it focuses its investments on a specific type of securities.

Note: If a company does have a name that suggests that it focuses on a particular investment or industry, it must invest at least 80% of its assets in that suggested area!

• A company name suggesting that it focuses its investments in a certain country or geographic region.

Note: If a company does have a name that suggests that it focuses its investments in a particular country or geographic region, it must invest at least 80% of its assets in investments that are economically tied to that suggested area! The company must also disclose in the prospectus the criteria that it uses to select those investments.

• A company name suggesting that distributions are exempt from state or federal income taxes.

Note: If a company does have a name that suggests this, it must invest at least 80% of its assets in investments that are exempt from that suggested income tax! Alternatively, the company could also invest its assets in such a way that at least 80% of the income that it distributes will be exempt from income tax.