Chapter 19- Investor Protection and Corporate Governance

Corporate Governance

-A set of policies specifying the rights and responsibilities of the various participants in a corporation and spelling out the rules and procedures for making corporate decisions -The goal is to make sure that the interests internal personel of the corporation do not infringe on the interest of shareholders

Concurrent Regulations

-Since the adoption of the 1933 and 1934 federal securities acts, the state and federal governments have regulated securities concurrently. Issuers must comply with both federal and state securities laws, and exemptions from federal law are not exemptions from state laws. -Uniform Securities Act in 2002 to coordinate state and federal securities regulation and enforcement efforts

Exempt Transactions

-crowdfunding

Online Securities Fraud

Can be found in: -investment newsletters -social media -Ponzi Scheme- a form of fraud that lures investors and pays profits to earlier investors with funds from more recent investors.[2] The scheme leads victims to believe that profits are coming from product sales or other means, and they remain unaware that other investors are the source of funds.

The Sarbanes-Oxley Act

Generally, the act attempts to increase corporate accountability by imposing strict disclosure requirements and harsh penalties for violations of securities laws. Among other things, the act requires chief corporate executives (CEOS) to take responsibility for the accuracy of financial statements and reports that are filed with the SEC.

Promoting Accountability

- Audited reporting of the corporation's financial progress so that managers can be evaluated. -Must have independent outside auditors and the company covers the cost of the independent auditors -Legal protections for shareholders so that violators of the law who attempt to take advantage of shareholders can be punished for misbehavior and victims can recover damages for any associated losses.

Regulation of Proxy Statements

- Whoever solicits a proxy must fully and accurately disclose in the proxy statement all of the facts that are pertinent to the matter on which the shareholders are to vote -Remedies for violations are extensive, ranging from injunctions to prevent a vote from being taken to monetary damages.

State Security Laws

- also called the Blue Sky Laws -every state has their own set of corporate security laws - BSL allows states to regulate the offer and sale of securities within its borders .

Security Basics

- any instrument representing corporate ownership (stocks and bonds) -sale and transfer of securities are heavily regulated by state and federal statutes and the government (SEC) -Securities Act of 1933 - governs the initial sale of stock by business - all essential information concerning the issue of securities be made to the investing public

What is a Security

-A security is an investment that represents either an ownership stake or a debt stake in a company -instruments and interest such as common stock, preferred stock, treasury stocks, bonds, debentures, stock warrants -right to purchase a security or group of securities on national security exchange -any fractional or undivided interest in oil, gas, or other minerals -investment contracts in limited partnerships or other investment schemes

Violations of the 1934 Act

-For either criminal or civil sanctions to be imposed, scienter is not required -Scienter-defendant intentionally made false statements or wrongfully failed to disclose material facts. -May also impose civil sanctions

Violations of the 1933 Act

-Intentionally defraud investors by misrepresenting or omitting facts in a registration statement or prospectus -Liability is also imposed on those who are negligent for not discovering the fraud. Selling securities before the effective date of the registration statement or under an exemption for which the securities do not qualify also results in liability. -There are three basic defenses to charges of violations under the 1933 act. A defendant can avoid liability by proving any of the following: -The statement or omission was not material. -The plaintiff knew about the misrepresentation at the time of purchasing the stock. -The defendant exercised due diligence in preparing the registration and reasonably believed at the time that the statements were true.

Attempts of Aligning the Interest of Officers with Those of Its Sharehodlers

-Officers get Stock options- A right to buy a given number of shares of stock at a set price, usually within a specified time period -When the market price rises above that level, the holders can sell their shares for a profit. Because a stock's market price generally increases as the corporation prospers, stock options give the officers a financial stake in the corporation's well-being and supposedly encourage them to work hard for the benefit of the shareholders. -Stock options have turned out to be an imperfect device for encouraging effective governance. Executives in some companies have been tempted to "cook" the company's books in order to keep share prices higher so that they could sell their stock for a profit

SEC 10 and SEC10b-5

-SEC 10 SEC10b-5 -A rule of the Securities and Exchange Commission that prohibits the commission of fraud in connection with the purchase or sale of any security. -Fraud actions include: - A material misrepresentation (or omission) in connection with the purchase and sale of securities. -Scienter (a wrongful state of mind). -Reliance by the plaintiff on the material misrepresentation. -An economic loss. -Causation, meaning that there is a causal connection between the misrepresentation and the loss

Exempt Securities

-Securities that are exempt from registration with the SEC and do not require a registration statement -government issued securities -bank and financial institution securities -securities of nonprofit or charitable organizations -insurance politics or endowments -securities issued in stock dividends or stock splits

The Securities Exchange Act of 1934

-The 1934 Securities Exchange Act provides for the regulation and registration of securities exchanges, brokers, dealers, and national securities associations, such as the National Association of Securities Dealers (NASD). -Unlike the 1933 act, which is a one-time disclosure law, the 1934 act provides for continuous periodic disclosures by publicly held corporations to enable the SEC to regulate subsequent trading. -Other provisions in the 1934 act require all securities brokers and dealers to be registered, to keep detailed records of their activities, and to file annual reports with the SEC. -The act also authorizes the SEC to engage in market surveillance to deter undesirable market practices such as fraud, market manipulation (attempts at illegally influencing stock prices), and misrepresentation. In addition, the act provides for the SEC's regulation of proxy solicitations for voting.

Insider Trading

-The purchase or sale of securities on the basis of information that has not been made available to the public -MNPI material fact distinguishes insider trading-the purchase or sale of a security must substantially affect the stock price for it to be considered insider trading -The 1934 act defines inside information and extends liability to those who take advantage of such information in their personal transactions when they know that the information is unavailable to those with whom they are dealing. Section 10(b) of the act and SEC Rule 10b-5 apply to anyone who has access to or receives information of a nonpublic nature on which trading is based—not just to corporate "insiders." -The person who receives the insider trading information can be held liable under the tipper/tippie theory and the misappropriation theory -PSLRA- safe harbor for publicly held companies to make financial forecast and those statements are protected against liability for security fraud

Requirements under state security laws

-Typically, these laws have disclosure requirements and antifraud provisions, many of which are patterned after Section 10(b) of the Securities Exchange Act and SEC Rule 10b-5. -State laws also provide for the registration of securities offered or issued for sale within the state and impose disclosure requirements

Content of Registration Statement

-securities being offered for sale and relationship to issuers other capital securities -corporations property and business (includes a financial statement certified by an independent accounting firm) -details about the management of the corporation -how the corporation intends to use the proceeds of the sale -any pending lawsuits or special risk factors

Registering a security

-security must be registered before being offered to the public -corporation must file a registration statement with the SEC and be reviewed and approved by them to be effective -Prospectus- a written disclosure document with all information about the security such as its form, financial operations of the company, and investment risk of attached must be disclosed to investor

Howey Test

-used to interpret whether or not there is an investment contract -an investment contract is any transaction where a person -invest - in a common enterprise - reasonably expecting profits - derived primarily or substantially from other managerial or entrepreneurial efforts -SEC v. Howey- defines whether or not something is a security