Securities Regulation, Quiz 1

When does a company have to disclose a reason for a resignation?

(8k) when a direct resigns because of a disagreement with registrant on a matter relating to registrant's operations, policies or practices

WHat does the 1933 act focus on?

primary transactions

SA Rule 408 and SEA Rule 12b-20

requires mandatory disclosures to be supplemented with "further material information, if any, as may be necessary to make the required statements in light of the circumstances under which they were made not misleading."

What does the 1934 act focus on?

secondary transactions, market intermediaries, including broker-dealers and securities exchanges; this established the SEC

What must be disclosed if an executive resigns, is terminated, retires, etc?

the fact that the event has occurred and the date of the event

What does 13b5 require?

a. No person shall knowingly circumvent or knowingly fail to implement a system of internal accounting controls or knowingly falsify and book, record, or account described in 13(b)(2); only way that 13b2 can lead to criminal sanctions.

When is something intentional?

the senior official knows or is reckless in not knowing that it is both material and nonpublic.

When must an 8k event be disclosed?

within 4 business days

Cash flow rights, liquidation rights, and voting rights for common stock, preferred stock, and bonds

Common stock: residual and discretionary right to cash; it can liquidate the residual interests; it can vote Preferred Stock: It has a fixed and discretionary dividend; it has medium liquidation rights; its voting rights are contingent Bonds: fixed, nondiscretionary interest payments; it has the highest liquidation rights; it has no voting rights

When is preferred stock used?

1. raise capital for new startup companies 2. older companies that need an infusion of cash

Two anomalies that don't make sense

1. seasonal effects: significant positive CARs in January and on fridays 2. Super Bowl effect: Years in which a NFC (or pre-merger NFL) team wins the Super Bowl, stocks show positive CARs

Materiality will depend on balancing

1. the indicated probability that the event will occur and 2. the anticipated magnitude of  the event in light of the totality  of the company activity."

How do you delist after registered public offering?

<300 shareholders and suspended 1 year after offering OR <500 shareholders and <10mil in assets for 3 years

How do you delist after listing with 10mil in assets and more than 2000 shareholders?

<300 shareholders or <500 shareholders and <10mil in assets for 3 years

Howey test for investment K

A contract, transaction, or scheme where 1. A person invests his money 2. In a common enterprise and 3. Is led to expect profits 4. Solely from the efforts of the promoter or a third party

Investment company act of 1940

The Investment Company Act of 1940 and the Investment Advisers Act of 1940 regulate, among other things, mutual funds and their directors, managers, and advisors. The Investment Company Act requires that certain defined investment companies register with the SEC. Among other things, the Investment Company Act provides specific requirements governing the responsibilities of the fund's board of directors, the capital structure of the fund, and transactions between a fund and its insiders. In addition, the Investment Company Act regulates disclosures to fund investors (including mandatory disclosures on fund objectives, risks, and performance).

Jobs act of 2012

The JOBS Act is intended to make capital formation easier for small businesses by reducing the burdens of becoming a public company. We touch on the Dodd-Frank Act in Chapter 4, 7, 9, and 10.

What two components are needed to calculate PDV?

a. Best guess at value of investment return in future b. Discount the general time value of money and the risk inherent in the investment

WHat is the absolute priority rule for liquidation?

a. Debt holders paid first b. Preferred shareholders paid second c. Common is last to be paid d. Some exceptions apply

Efficient Capital Market Hypothesis

ECMH posits that the securities market price of an actively traded security will incorporate info related to the security.

Dodd Frank Act of 2010

The Dodd-Frank Act of 2010 represents Congress's most recent major legislation affecting the securities markets. Although it primarily affects the regulation of financial institutions, it also includes a hodgepodge of amendments to the securities laws, most notably relating to securitization, say on pay, proxy access, and whistleblowers. We touch on the Dodd-Frank Act in Chapter 3, 7, 11, and 12.

implication of strong ECMH

Implication: If true, no identifiable group can earn systematic positive abnormal returns from securities trading.

What is PDV?

To make an investment decision, investors may compare PDV with the required upfront investment.

Goals of security regulation

deter fraud and provide information

What is required to disclose about management?

1. 401: provides for bio information on directors and officers, including business experience for past 5 years 2. 402: requires disclosure of executive compensation, including stock options 3. 404: details disclosures for transactions between the issuer and certain related parties, including family members of any director or officer. a. Related party: child, stepchild, parent, in-law, etc.

What do investment banks do in primary market transactions?

1. Assist issuers offering and selling securities in most public offerings in the U.S. 2. Provide advice and financial expertise 3. May be underwriter, taking on financial risk that offering will not sell to investors. 4. Compensated by the spread, the difference between the discounted price they pay issuer and price paid by public.

Two anomalies that made sense

1. Companies with low price/earnings ratio had higher returns. If the return is higher than the risk (meaning the price is low), then it is abnormal 2. Showed positive Cumulative Abnormal Returns (CARs) These anomalies have largely disappeared.

How do you delist after listing on a national exchange?

1. DELIST 2. <300 shareholders or <10mil in assets for 3 years

Why regulate securities different than consumer goods?

1. Importance of the capital market and investmentsfor the economy 2. Importance of investments to people relative to other decisions people make  Something about investments makes people act irrationally 4. Investments are intangible 5. Collective action problems among investors

Three ways to become a public company

1. Listing on national exchange 2. Over the counter stocks: 10 mil in asssets, securities held by at least 2000 people (or 500 non-accredited investors 3. File a registration statement under securities act.

Two types of orders in a secondary market

1. Market order: indicates the investor would like to purchase a specified number of shares in a company at best available market price 2. Limit Order: specifies the number of shares and the limit price. Transaction doesn't occur until conditions are met

What do institutional investors do in primary market transactions?

1. Mutual funds aggregate the investment money of many smaller investors and reinvest the funds in securities.

What is present value?

1. Present value = the amount of money the market would pay today to receive the future money a. i.e. the value of $1.00 today is $1.02 in a bank account with a 2% interest rate.

What do accounting firms do in primary market transactions?

1. Provide auditing services so investors are confident about the veracity of financial statements.

Why does money have time value?

1. The reason that money has time value is that you can use money to make more money 2. The bank is essentially renting your money when it pays interest so it can charge a higher interest rate to another party and make a profit.

What do attorneys do in primary market transactions?

1. Typically take the lead role in drafting disclosures to be filed with the SEC

What is weak, semi-strong, and strong ECMH?

1. Weak: current price reflects the info found in all past prices for that security 2. Semi-strong: stock market price will reflect all relevant publicly available info 3. Strong: stock market price of a company incorporates all info, whether it is public or not.

3 categories of securities

1. instruments commonly known as such 2. instruments specified by act 3. investment contracts

Exclusions to FD

1. journalist questions 2. persons owing a duty of trust or confidence to issuer 3. persons who agree to keep info in confidence

If an issuer is required to prepare an accounting restatement due to the material noncompliance of the issuer, as a result of misconduct, with any financial reporting requirement under the securities laws, the chief executive officer and chief financial officer of the issuer shall reimburse the issuer for -

Any bonus or other incentive-based or equity-based compensation received by that person from the issuer during the 12-month period following the [release] of the financial document embodying such financial reporting requirement; and any profits realized from the sale of securities of the issuer during that 12-month period

What is the PDV formula?

Cash flow/(1+Discount rate (probably a percentage)) to the (# of years) power.

SOA of 2002

Congress enacted the Sarbanes-Oxley Act in response to corporate scandals at Enron, WorldCom, Adelphia, Global Crossing, and Tyco, among other major publicly-held corporations, providing new regulation for almost all significant players in the capital markets. The law is a mélange of legislative reactions to the scandal du jour. Among other things, the Act establishes a new quasi-governmental Public Company Accounting Oversight Board to regulate accountants along the lines of the SROs. It also prohibits auditors from performing certain non-audit consulting services for reporting issuers and requires companies to have audit committees made up exclusively of independent directors to oversee the company's relationship with its outside accountants. The Act directs the SEC to promulgate new rules to encourage more objective securities market analysts (which the SEC has now done with Regulation AC). Attorneys for issuers are obligated under the Act to reveal evidence of securities law violations to the corporate board of directors. Corporate CEOs and CFOs face new certification requirements for the information contained in their Form 10-K and 10-Q filings, as well as on the internal control structure of their companies. Finally, the Act increases the fines and criminal penalties for white-collar crime. We cover the more notable features of the Sarbanes-Oxley Act in greater detail in Chapters 4 & 12.

Arguments favoring disclosure

Facilitates comparable disclosures by different companies Reduces agency costs within firm Overcomes an externality problem for firms disclosing information Reduces duplicative research by professional investors and analysts

Difference between fundamental and information efficiency

Fundamental: Price reflects actual present discounted value Informational (this is what happens): the market incorporates info into stock market despite irrational trading.

What are some other important offices in SEC?

General Counsel's Office-advice to Commission, appeals, opinions Chief Accountant-SEC has authority, but works with Financial Accounting Standards Board regarding GAAP Regional offices around the country, e.g., New York

To compensate for the PDV, what do banks do?

Give interest: This is compensation for 1. deferring consumption 2. risk of inflation 3. uncertainty

What is main difference between Howey and family resemblance test?

Howey requires the profit arise from the efforts of others.

Implication of semi-strong ECMH

Implication: Investors can not expect to profit from studying available information because market has already incorporated information accurately into the price.

Implication of weak ECMH

Implication: Prices change only in response to new information.

What is SEC?

Independent agency: five commissioners, one chairman, no more than three from any one party

What is material?

Information is material if there is a "substantial likelihood that the disclosure ... would have been viewed by the reasonable investor as having significantly altered the 'total mix' of information made available."

When must an intentional/ non-intentional disclosure be given to the public?

Intentional: simultaneously Non: promptly within 24 hours or by time trading resumes of NYSE, whichever is later

CAPM formula

Return = Risk-free rate + beta (Risk of entire stock market - Risk-free rate)

How does the family resemblance test, the test used to determine whether a note is a security, work?

STart with a presumption that a note is a security, then consider four factors to determine if the note has a family resemblance to non-securities 1. motivation of seller and buyer 2. plan of distribution 3. reasonable expectations of investing public 4. presence of alternative regulatory regime

What is puffery?

Something an investor is not reasonable in relying on. Something that is not capable of being proven false?

Investment advisers act of 1940

The Investment Advisers Act imposes a number of requirements on certain investment advisers. Among other things, investment advisers must register with the SEC, avoid certain types of fee arrangements, and maintain specified books and records. The Investment Advisers Act also limits the types of allowable advertising on the part of investment advisors. For example, investment advisers may not use testimonials in their advertisements. We leave topics arising under these laws to more advanced courses in securities regulation.

Self regulatory organizations

The SEC is not the only source of regulation for the securities markets. Several quasi-regulatory private entities operate as an additional layer of investor protection. Among these entities are FINRA (Financial Industry Regulatory Authority) and the national securities exchanges (including the NYSE and Nasdaq). The SEC has the power to approve, disapprove or modify SRO rules as it "deems necessary or appropriate to insure the fair administration of the self-regulatory organization" under § 19 of the Exchange Act.

Trust indenture act of 1939

The Trust Indenture Act of 1939 regulates contractual terms relating to publicly issued debt securities, including bonds, notes, and debentures above a specified dollar amount (presently $10 million). The formal agreement between the issuer and the holders of public debt securities is known as a "trust indenture." The Act specifies that the trust indenture must, among other things, provide for the appointment of a trustee to represent the public bondholders as a group. The Act also provides for both the independence of the trustee as well as standards governing the conduct of the trustee. This law is generally covered in courses on corporate finance.

When do you apply the Howey economic realities test?

a. First determine if it is labeled as something within the definition and if it has those characteristics. 1. The right to receive dividends contingent upon an apportionment of profits 2. Negotiability 3. The ability to be pledged or hypothecated 4. The conferring of voting rights in proportion to the number of shares owned 5. The capacity to appreciate in value. b. If it does not, ask if the instrument could fall within the investment contract definition c. If it could fall within that definition, then you apply the economic realities test

10b-5

Unlawful 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 . . .in connection with the purchase or sale of any security.

When is a note, draft, bill of exchange, or banker's acceptance exempted as a security?

When it arises out of a current transaction and matures within 9 months. If there is a possibility that the note could be collected after 9 months, then it does not fit the exemption.

What is high/low beta?

b. Low beta i. Indicates that the stock does not move greatly with market fluctuation ii. Low amount of systematic risk and low discount rate c. High beta i. Indicates large movement of stock's returns with market returns ii. High amount of systematic risk and high discount rate

What is the truth on the market defense?

failure to disclose or inaccurate disclosure of material information may be excused where that information has been made credibly available to the market by other sources

Regulation FD: If a company discloses material, nonpublic info to certain groups such as brokers, advisors, or investment companies, THEN

he must also disclose that info to the public

Three public company disclosure requirements

i. Form 8-k filed on occurrence of specific events ii. Form 10-k filed annually iii. Form 10-Q filed quarterly

WHat does 404 of SOA require?

i. Managers to include a statement in the company's annual report on the manager's responsibility for the company's internal controls for financial reporting and provide an assessment of those controls. ii. Each registered public accounting firm that prepares or issues the audit report for the issuer shall attest to and report on the management's assessment of the firm's system of internal controls for financial reporting.

Evidences of materiality

i. Presence or absence of the info already in the investing public's hands ii. Dollar magnitude of the misstatement or omissions as a percentage of earnings, revenues, or assets. iii. Stock price change around the date of disclosure or the truth

303, MD & A REQUIRES

i. Requires narrative discussion of issuer's financial condition ii. Changes in financial condition iii. Results of operations iv. Describe any known trends or uncertainties that have had or that the registrant reasonably expects will have a material favorable or unfavorable impact on net sales or revenues or income from continuing operations. If the registrant knows of events that will cause a material change in the relationship between costs and revenues the change in the relationship shall be disclosed

What does 13b2a require?

ii. 13(b)(2)(a): Exchange Act requires that the company make and keep books, records, and accounts, which, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the issuer.

What does 13b2b require?

iii. 13(b)(2)(b): Every public company shall devise and maintain a system of internal accounting controls sufficient to provide reasonable assurances that 1. AUTHORIZATION: Transactions are executed with management's general or specific authorization. 2. RECORDED: Transactions are recorded as necessary to permit preparation of financial statements in conformity with generally accepted accounting principles or any other criteria applicable to such statements, and to maintain accountability for assets. 3. ACCESS: Access to assets is permitted only in accordance with management's general or specific authorization 4. DIFFERENCES: The recorded accountability for assets is compared with the existing assets at reasonable intervals and appropriate action is taken with respect to any differences.

Two types of risk

iii. Unsystematic Risk: risks that can be reduced through diversification iv. Systematic Risk: Affects all companies similarly and cannot be reduced by diversification