MGT 641 Chapter 45 "Securities Regulation"

State Statutes Commonly contain:

(1) an antifraud provision prohibiting fraudulent practices and imposing criminal penalties for violations, (2) broker-dealer licensing provisions regulating the persons engaged in the securities business, and (3) provisions for the registration of securities, including disclosure requirements, with a designated government official.

Registration and Reporting Requirements

--Principal Reports - form 10K (fin and non-fin) --Certifications and Disclosure Controls - Sarbanes-Oxley Act of 2002 requires written certification of 10-K and 10-Q's by company CEO and CFO. Knowing misrepresentation, is punishable by a fine up to $1 million and up to 10 years in prison. Companies whose securities are listed on a national securities exchange and unlisted companies with assets in excess of $10 million and a class of equity securities, such as common stock that is held of record by either (1) 2,000 or more persons or (2) 500 or more persons who are not accredited investors, are subject to the reporting requirements of the act.

The Filing Requirements: Registration Statements

--The Registration Process --Regulation A Offerings --Regulation D Exemptions --Intrastate Offerings Exemption --Crowdfunding Exemption --Enforcement of the 1933 Act

Historic Events that Shaped Securities Regulations

1929 Great Depression Mid-1980s - abuse of penny stocks "pump and dump" schemes as well as "churning" of accounts. 2001 SOX 2008 Dodd-Frank

The Registration Process

A REGISTRATION STATEMENT is a document disclosing specific financial information regarding the security, the issuer, and the underwriter. The seller must also provide a PROSPECTUS to each potential purchaser of the securities. The prospectus sets forth the key information contained in the registration statement ***The SEC does not approve or disapprove the securities as being good or bad investments but only reviews the form and content of the registration statement and the prospectus to ensure full disclosure.***

Tender Offers

A corporation or group of investors may seek to acquire control of another corporation by making a general offer to all shareholders of the target corporation to purchase their shares for cash at a specified price. This type of offer is called a cash tender offer. The offer to purchase is usually contingent on the tender of a fixed number of shares sufficient to ensure takeover The bid price is ordinarily higher than the prevailing market price. Should more shares be tendered than the offeror is willing to purchase, the tender offeror must purchase shares from each shareholder on a pro rata basis ***Williams Act: ensures shareholders with a cash tender offer will receive adequate information before voting***

Arbitration of Securities Disputes

Both NASD and securities firms with seats on the New York Stock Exchange have adopted codes of arbitration that allow customers and members to submit disputes to arbitration The arbitration rights are contractual and are set forth in writing when opening an account with the securities firms. Investors who have agreed to arbitrate their securities disputes can be compelled to arbitrate, rather than sue, in courts -NASD is a self-regulatory organization that seeks to detect misconduct and may issue sanctions as a mean of protecting investors. Subject to SEC and thereafter U.S. Court of Appeals review. -Courts are very reluctant to vacate an arbitration award.

Enforcement and Third-Party Market Participants

Broker-dealers are not held to the same rules as investment advisors but most only recommend suitable investments

Regulation D Exemptions

Certain private and limited offerings of securities are exempt from the registration requirements under Regulation D, which includes three different types of exemptions: 1) Rule 506 2) Rule 505 3) Rule 504

Dual Systems

Congress reallocated responsibility between state and federal security regulators in the National Securities Markets Improvement Act (NSMIA)1 recognizing that the dual system of state and federal regulation of securities resulted in duplicative regulation and expenses. The NSMIA allows the STATES to investigate and bring enforcement actions for fraud or deceit or for unlawful conduct by a broker or dealer in connection with securities transactions

Disclosure of Ownership and Short-Swing Profits

Corporate directors and officers owning equity securities in their corporation and any shareholder owning more than 10 percent of any class of the corporation's equity securities are statutorily defined as insiders and must file with the SEC a disclosure statement regarding such ownership and all related transactions. designed to prevent the unfair use of information available to these corporate insiders. This section prevents insiders from participating in short- term trading in their corporation's securities. If such a person sells at a profit any of these securities less than six months after their purchase, the profit is called a SHORT-SWING PROFIT

The Securities Act of 1933

Disclosure Act - designed to secure essential facts for the investor who is buying shares from the company Deals with the original distribution of securities by the issuing corporations, or primary offerings. regulates the sale of securities by a corporation to the first owner, a primary offering MUST HAVE: 1) Exempt Securities OR 2) Exempt Transactions OR 3) Registration

Regulation of Corporate Officers and Auditors

Dodd-Frank also regulates the activities of officers and directors who prepare financial statements include clawback provisions that allow for the recoupment of executive compensation and bonuses based on financial performance when that performance turns out to be falsified.

Enforcement and Whistleblowers

Dodd-Frank authorized the SEC to create a whistleblower program to encourage individuals to provide the SEC with information that would lead to the discovery and prosecution of violations of the federal securities laws. implemented in 2012, allows a monetary award to whistleblowers who provide original information that leads to successful enforcement actions resulting in monetary sanctions over $1 million

The Securities Act of 1934

Focuses on the secondary distribution of securities in the national securities exchanges and in the over-the-counter markets.

Aiders and Abettors.

For many years the courts and the SEC held aiders and abettors, such as banks, accountants, trustees, and attorneys, liable in private actions In a 1994 decision, the Supreme Court limited the liability of such aiders and abettors. Court made a distinction between primary violators who directly misstate or omit material facts that investors rely on and secondary violators or aiders and abettors **Aiders and abettors are liable in private actions, the Court held, only if investors can show reliance on their material misstatements or omissions. **

Applicability and Definition of Security

For the securities acts to apply, the transaction must involve a "security" within the meaning of the acts Congress adopted a definition of security sufficiently broad to encompass virtually any instrument that might be sold as an investment The 1933 act applies to the sale of securities, including (1) stocks, (2) corporate bonds, and (3) any conceivable type of corporate interest or instrument that has the characteristics of an investment security, including convertible securities and variable annuities ***Includes INVESTMENT CONTRACTS***

Trading on Insider Information

Illegal insider trading occurs when a person who owes a fiduciary duty to a company buys or sells a security while in possession of material nonpublic information Those accused of insider trading may face both criminal and civil actions Individuals convicted of CRIMINAL insider trading may be sentenced up to 20 years in prison per violation and can face fines of up to $5 million or twice the gain from the offense. In a CIVIL action by the SEC, an individual may have to disgorge any profits from the offense and may have to pay fines not to exceed the greater of $1 million or three times the amount of the profit gained or loss avoided

Misappropriation Theory of Insider Trading

Individuals who steal nonpublic information in breach of a fiduciary duty and trade securities are guilty of insider trading as "misappropriators."

Remedy for Investors

Investors who lack information possessed by insiders and sell during the relevant time period may recover from any insider who used information

Enforcement of the 1933 Act

Issuers, sellers, and "aiders and abettors" may be subject to civil and criminal liability under the 1933 act --Issuer's Civil Liability for False or Misleading Statements --Civil Liability of Sellers of Securities. --Criminal Liability.

Class-Action Reforms

Lead plaintiff status is given to person with the largest financial interest who then selects lead council Reforms were necessary to protect against "lawyer-driven lawsuits" in which a class-action counsel would direct a "professional" plaintiff to buy a security to have standing to bring a class-action lawsuit

Exempt Securities Considered

RESTRICTED Securities acquired under Rules 506, 505, and 504 exemptions from registration are considered restricted securities Their resale may require registration Rules requiring registration of these Regulation D securities prior to resale ensure that investors purchase these securities as an investment rather than for public distribution Generally, all restrictions expire after two years.

Private Actions: RULE 10B-5

Rule 10b-5 applies to all securities if use is made of mail, interstate commerce, or a national stock exchange a civil action for damages may be brought by any private investor who purchased or sold a security and was injured because of false, misleading, or undisclosed information

Litigation Reform.

The Litigation Reform Act places a heightened pleading requirement on plaintiffs attempting to plead fraud in securities cases and requires not only that the plaintiffs specify each statement alleged to have been false or misleading and the reason for the belief but also that the plaintiffs plead "scienter"—the mental state embracing intent to deceive, manipulate, or defraud. also provides for PROPORTIONATE LIABILITY, as opposed to joint and several liability, for defendants who are found not to have knowingly committed a violation of the security laws

Litigation Reform Act

The Private Securities Litigation Reform Act (PSLRA, or the Litigation Reform Act) of 1995 was passed because of: (1) congressional concern over an excess of frivolous private securities lawsuits, (2) the financial burdens placed on accountants and other professional advisors by such litigation, (3) concern that the investors in a class-action lawsuit have their interests fairly represented Important Features = Safe Harbor Rules Litigation Reform Class-Action Reforms Aiders and Abettors Misappropriation Theory of Insider Trading Regulation FD

Regulation FD

The SEC adopted Regulation FD (FAIR DISCLOSURE) in 2000 to end the practice of selective disclosure by issuers of securities to security analysts and selected institutional investors of important nonpublic information such as advance warnings of negative or positive earnings results, before disclosing the information to the general public Shareholders and the general public were at a disadvantage regarding such information.

State Regulations

To protect the public from the sale of fraudulent securities, many states have adopted statutes regulating the intrastate sale of securities State laws regulating securities are called BLUE SKY LAWS. The term blue sky is derived from the purpose of such laws, which is to prevent the sale of speculative schemes that have no more value than the blue sky statutes designed to protect the public from the same of worthless stocks and bonds

Short-Swing Profit

Under section 16(b), the corporation may sue a director, an officer, or a major stockholder for a short-swing profit. The corporation may recover that profit even if the corporate insider had no fraudulent intent in acquiring and selling the securities. The corporation must bring the lawsuit within two years after the date the profit was realized.

Tipee

a person who learns of nonpublic information from an insider A tippee is subject to the insider's fiduciary duty to shareholders when the insider has breached the fiduciary duty to shareholders by improperly disclosing the information to the tippee and when the tippee knows or should know that there has been a breach. Such a breach occurs when an insider benefits personally from her disclosure. When the insider does not breach a fiduciary duty, a tippee does not violate the securities laws. breach must involve a personal benefit

Rule 506

a rule that provides general permission to offer and sell to a potentially indefinite number of individuals who meet the definition of ACCREDITED investor Accredited = Individual = $200,000 with Spouse = $300,000 OR $1 million in Net Worth (excludes residence) **Must be in each of Prior 2 years AND expects the same in current year** specific information must be provided to all buyers if any buyers are nonaccredited investors; the number of nonaccredited investors is limited to no more than 35 investors.

Investment Contracts

a statutory term that allows courts to define investment contracts as securities Developed by the Supreme Court, is sufficiently broad to allow the securities acts to apply to a wide range of investment transactions or schemes, including the sale of bottled whiskey, cattle-breeding programs, and a limited liability partnership to operate local telephone companies. Under the Supreme Court's definition, an investment contract exists if the following elements are present: (1) an investment of money, (2) a common enterprise, (3) an expectation of future profits from the efforts of others.

Rule 504

an issuer can offer and sell securities up to $1 million within a 12-month period without registration and without most of the restrictions contained in Rules 505 and 506.

Crowdfunding Exemption

attracting small individual contributions from a large number of people The JOBS Act requires the SEC to create a crowdfunding exemption that would allow companies to raise $1 million in any 12-month period.

Dodd-Frank Enforcement Powers

creates reforms to help restore market trust in Wall Street and protect the economy, American consumers, investors, and businesses act created the Financial Stability Oversight Council to oversee the various government agencies responsible for regulating financial institutions Dodd-Frank further increased the SEC's power

Rule 505

exempts from registration offerings of less than $5 million to no more than 35 NONACCREDITED purchasers over a 12-month period. No limit exists on the number of accredited investors who may participate. No general solicitation or general advertising is permitted under Rule 505. If any prospective investors are nonaccredited, the issuer must furnish all investors specific information on the issuer, its business, and the securities offered for sale.

Role of SEC

is to protect investors even as it oversees efficient operation of the markets through monitoring compliance with the law and enforcing its rules and regulations. Its role and regulations expand as market events and activities change.

Intrastate Offerings Exemption

may be used to finance local business operations through local investment The company must be organized in the state where it is offering securities and it must meet the so-called Triple 80 requirement All of the offerees and purchasers must be residents of the same state where the offering is made. The exemption may be lost if a sale is made to even one out-of-state person The exemption does not limit the number of persons who may purchase the securities and there is no limit on the size of the offering.

Liability for "Material Misstatements or Omissions of Fact": RULE 10B-5

prohibits the making of any untrue statement of a "material" fact or the omission of a material fact necessary to render statements made not misleading

The Securities Exchange Act of 1934

regulates the sale of securities from one owner to another, the secondary markets. These laws cover holding companies in utility businesses, trustees for debt securities, mutual funds, and investment advisors

Safe Harbor Rules

shelter for issuers from liability for forward-looking statements that were not known to be false when made and were accompanied by cautionary statements

Regulation A Offerings

simplified registration process for small business security issues Regulation A originally allowed registration exemptions for offerings of securities up to $5 million in a 12-month period The new regulation, sometimes referred to as Regulation A+, increases the amount of capital a business can raise in a Regulation A offering from $5 million to $50 million One of the primary benefits of the new regulation is that it allows companies to register only with the SEC and exempts them from registering with state financial regulators One of the significant advantages of Regulation A is that it allows companies to "test the waters" through general solicitation and advertising before filing an offering statement Only companies that are organized in and have their principal place of business in the United States or Canada are eligible for Regulation A exemptions

Antifraud Provisions

the 1934 act makes it unlawful for any person to use any manipulative or deceptive device in contravention of SEC rules. --Private Actions --Liability for "Material Misstatements or Omissions of Fact" --Reliance and the Fraud-on-the Market Theory

Reliance and the Fraud-on-the Market Theory & RULE 10B-5

the plaintiff MUST show "reliance" on the misrepresentation and resulting injury. For Reliance a plaintiff must prove: (1) a material misrepresentation or omission by the defendant; (2) scienter; (intent or knowledge of wrongdoing) (3) a connection between the misrepresentation or omission and the purchase or sale of a security; (4) reliance upon the misrepresentation or omission; (5) economic loss; (6) loss causation. The FRAUD-ON-THE-MARKET-THEORY creates a presumption that securities fraud plaintiffs relied on the misrepresentation The theory assumes that the market price of shares reflect publicly available information, including material misrepresentations.

Registration Process

three time periods: (1) the pre-filing period, (2) the waiting period or quiet period, from the date of filing with the SEC to the date the registration statement becomes effective (a minimum of 20 days but commonly extended for additional 20-day periods after each amendment by the issuer in compliance with SEC requirements for additional information), (3) the post-effective period. **see notes for details**

Regulation of Attorneys and Accountants by the SEC

•Accountants who prepare statements filed with the SEC with preparer's consent are deemed to be practicing before the SEC. •The SEC may disbar or suspend those who are unqualified or unethical