A rep describes a new fund to a prospect, then hands over a glossy two-page summary before the registration statement is effective. One sentence of "guaranteed growth" and one early mailing can turn a routine solicitation into a Section 5 violation.
When you describe an investment product to a current or prospective customer with intent to win business, you are making a communication the firm must supervise and a statement the antifraud rules reach. Securities Act Section 17 prohibits fraud or material misstatement in the offer or sale of any security. Exchange Act Rule 10b-3 extends the Section 10(b) antifraud prohibition to broker-dealers acting for customers. Describe features and risks accurately, or the description itself becomes the violation.
KEY: A product description meant to solicit business is an "offer" once a security is identified. Antifraud liability attaches the moment you speak, not when money changes hands.
Section 2(b) is the interpretive lens: the SEC must consider efficiency, competition, and capital formation, but that never excuses misleading sales talk.
Common mistakes
- Treating a red herring as an offer to sell. The preliminary prospectus gathers indications of interest only, carries no final price, and binds no one. Accepting orders before effectiveness violates Section 5.
- Confusing the 35 non-accredited cap. Rule 506(b) allows up to 35 non-accredited investors and no advertising; Rule 506(c) allows advertising but requires all buyers to be verified accredited.
- Misreading the intrastate test. Section 3(a)(11) and Rule 147 require every purchaser to be an in-state resident, not just the issuer. One nonresident buyer kills the exemption.
Bottom line
- A preliminary prospectus (red herring) may be used during the cooling-off period to gather indications of interest; it carries no final price and no offer of sale
- The final prospectus must be delivered no later than confirmation of the sale; Rule 15c2-8 governs prospectus delivery by broker-dealers
- New issues move through due diligence, the registration statement, the cooling-off period, and effectiveness; Securities Act Section 5 bars sales before effectiveness
- Rule 134 "tombstone" notices and identifying statements are not prospectuses and not offers; Section 2(b) and Rule 10b-3 anchor the antifraud frame
Exam shortcut
Red herring = interest, final prospectus = sale. If the question shows a binding order before effectiveness, it is a Section 5 violation; if it shows the statutory prospectus arriving by confirmation, Rule 15c2-8 is satisfied. 506(b) vs 506(c) by advertising. See "no advertising, a few non-accredited buyers," pick 506(b) (35 cap). See "general solicitation," pick 506(c) (all buyers verified accredited). Intrastate fails on one outsider.
The full lesson (about 2,409 words, 16 min read) adds 2 worked examples, all 6 common mistakes, a self-check, free in the app.
Learning objectives
- A2
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