Ch. 7

Exempt Securities

- Government-issued securities - Bank and financial institution securities, which are regulated by banking authorities. - Short-term notes and drafts (negotiable instruments that have a maturity date that does not exceed nine months). - Securities of nonprofit, educational, and charitable organizations. - Securities issued by common carriers (railroads and trucking companies). - Any insurance, endowment, or annuity contract issued by a state-regulated insurance company. - Securities issued in a corporate reorganization in which one security is exchanged for another or in bankruptcy proceeding. Securities issued in stock dividends are stock splits.

Examples of material facts that must be disclosed under SEC Rule 10b-5

1. Fraudulent trading in the companuy stock by a broker-dealer. 2. A dividend change (whether up or down). 3. A contract for the sale of corporate assets. 4. A new discovery, a new process, or a new product. 5. A significant change in the firm's financial condition. 6. Potential litigation against the company.

What is a security?

1. Instruments and interests such as preferred and common stock, bonds, debentures, and stock warrants. 2. Interests such as stock options, puts, and calls, that involve the right to purchase a security or a group of securities on a national security exchange. 3. Notes, instruments, or other evidence of indebtedness, including certificates of interest in a profit-sharing agreement and certificates of deposit. 4. Any fractional undivided interest in oil, gas, or other mineral rights. 5. Investment contracts, which include interests in limited partnerships and other investment scehemes.

Registration Statement

1. The securities being offered for sale, including their relationship to the registrant's other securities. 2. The corporation's properties and business. 3. The management of the corporation, including managerial compensation, stock options, pensions, and other benefits. 4. How the corporation intends to use the proceeds of the sale. 5. Any pending lawsuits or special risk factors.

The Howey Test

A definition for what an investment contract is. Any transaction in which a person invests in a common enterprise reasonably expecting profits derived primarily or substantially from others' managerial or entrepreneurial efforts.

Prospectus

A disclosure statement that describes the security being sold, the financial operations of the issuing corporation, and the investment or risk attaching to the security. The prospectus also serves as a selling tool for the issuing corporation.

Well-Known Seasoned Investor

A firm that has issued at least $1 billion in securities in the last three years or has outstanding stock valued at $700 million or more in the hands of the public.

Registration Statement

Companies issuing a security must file a registration statement with the SEC and must provide all investors with a prospectus.

Violations of the Securities Act (1933)

It is a violation of the Securities Act to intentionally defraud investors by misrepresenting or omitting facts in a registration statement or prospectus. Liability may also be imposed on those who are negligent with respect to the preparation of these publications. 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.

Insider Trading

One of the main goals of Section 10(b) and SEC Rule 10b-5 is to prevent insider trading, which occurs when persons buy or sell securities on the basis of information that is not available to the public.

Registration Process

Prefiling period (must be approved by the SEC) Waiting Period (can be offered for sale but cannot be sold by the issuing corporation) Posteffective Period (once the SEC has reviewed and approved the registration statement and the waiting period is over, the registration is effective and the posteffective period begins.

Rule 506

Private Placement Exemption - exempts private, noninvestment company offerings in unlimited amounts that are not generally solicited or advertised. This exemption is often referred to as the "private placement exemption" because it exempts "transactions not involving any public offerings.

Securities Fraud

Private parties can sue for securities fraud under Rule 10b-5. The basic elements of a securities fraud action are: 1. A material misrepresentation (or omission) in connection with the purchase and sale of securities. 2. Scienter (a wrongful state of mind). 3. Reliance by the plaintiff on the material misrepresentation. 4. An economic loss. 5. Causation, meaning that there is a casual connection between the misrepresentation and the loss.

SEC Rule 10b-5

Prohibits the commission of fraud in connection with the purchase or sale of any security.

Exempt Transactions

Regulation A - Securities issued by an issuer that has offered less than $50 million in securities during any twelve-month specific requirements. Regulation D - Rule 504: Non investment company offerings up to $1 million in any twelve-month period. Rule 505: Private, noninvestment company offerings up to $5 million in any twelve-month period. Rule 506: Private, noninvestment company offerings in unlimited amounts that are not generally advertised or solicited.

Rule 504

The exemption used by most small businesses. It provides that noninvestment company offerings up to $1 million in any twelve-month period are exempt.

Types of Securities

The most common forms are stocks and bonds issued by corporations. Securities can also be things such as interests in whiskey, cosmetics, boats, and lots of other things.

The Sarbanes-Oxley Act

addresses certain issues relating to corporate governance. The act attempts to increase corporate accountability by imposing strict disclosure requirements and harsh penalties for violations of securities law.

The Compensation Committee

an important committee of the board of directors is the compensation committee, which determine the compensation of the company's officers.

State Securities Law

apply mainly to intrastate transactions. Typically have disclosure requirements and antifraud provisions.

Corporate Governance

can be narrowly defined as the relationship between a corporation and its shareholders. Some argue for a broader definition- that corporate governance specifies the rights and responsibilities among different participants in the corporation, such as the board of directors, managers, shareholders, and other stakeholders, and spells out the rules and procedures for making decisions on corporate affairs.

Noninvestment company

firms that are not engaged primarily in the business of investing or trading in securities.

Rule 505

for private, noninvestment company offerings up to $5 million in any twelve-month period. The offer may be made to an unlimited number of accredited investors and up to thirty-five unaccredited investors.

Securities Act of 1933

governs initial sales of stock by businesses. Designed to prohibit various forms of fraud and to stabilize the securities industry by requiring that investors receive financial and other significant information concerning the securities being offered for public sale.

Accredited investors

includes banks, insurance companies, investment companies, employee benefit plans, the issuer's executive officers and directors, and persons whose income or net worth exceeds a certain threshold.

Section 10(b) (act of 1934)

prohibits the use of any manipulative or deceptive mechanism in violation of SEC rules and regulations.

The Securities Exchange Act of 1934

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.

Blue sky laws

regulate the offer and sale of securities within its borders. The phrase "blue sky laws" comes from a 1917 United States Supreme Court decision. The Court stated that the purpose of such laws was to prevent "speculative schemes which have no more basis than so many feet of 'blue sky.'")

Scienter Requirement

the violater must have had an intent to defraud or knowledge of his or her misconduct.