What is meant by the term securities? What is meant by the term securities? What are the two major...

• What is meant by the term What is meant by the term securities?securities?• What are the two major statutes What are the two major statutes

regulating the securities industry?regulating the securities industry?• What is insider trading? Why is it What is insider trading? Why is it

prohibited?prohibited?• What are some of the features of state What are some of the features of state

securities laws? securities laws?

© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 2

• What certification requirements does What certification requirements does the Sarbanes-Oxley Act impose on the Sarbanes-Oxley Act impose on corporate executives?corporate executives?


• Federal securities laws are designed to Federal securities laws are designed to protect investors from deceptive, unfair protect investors from deceptive, unfair and manipulative practices when and manipulative practices when buying or selling buying or selling securitiessecurities..

• Securities are instruments such as Securities are instruments such as corporate stock or limited partnership corporate stock or limited partnership interests that evidence ownership or interests that evidence ownership or debt.debt.


• Securities Act of 1933 regulates Securities Act of 1933 regulates solicitation, buying and selling of solicitation, buying and selling of securities: stocks and bonds. securities: stocks and bonds. • What is a SecurityWhat is a Security? ? –1. Instruments and interests commonly

known as securities, such as preferred and common stocks, treasury stocks, bonds, debentures, and stock warrants.


• What is a SecurityWhat is a Security? (cont’d).? (cont’d).–2. Any interests in commonly known as

securities, such as stock options, puts, calls, or other types of privilege on a security or on the right to purchase a security or a group of securities in a national security exchange.


• What is a SecurityWhat is a Security? (cont’d). ? (cont’d). –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.


• What is a SecurityWhat is a Security? (cont’d). ? (cont’d). –5. Investment contracts, which include

interests in limited partnerships and other investment schemes.


• What is a SecurityWhat is a Security? (cont’d). ? (cont’d). – In SEC v. Howey (1946), the U.S.

Supreme Court held that a security exists in any transaction in which a person: (1) invests (2) in a common enterprise (3) reasonably expecting profits (4) derived primarily from others’ managerial or entrepreneurial efforts.


• Registration StatementRegistration Statement. . –Unless exempt, an offering must be

registered before offered to the public.–Issuing corporation must file a

registration statement and prospectus with the SEC. Prospectus is later distributed to investors.


• Registration StatementRegistration Statement (cont’d). (cont’d).–Contents:• 1. The securities being offered for sale,

including their relationship to the registrant’s other capital securities. • 2. The corporation’s properties and

business (including a financial statement certified by an independent public accounting firm).


• Registration StatementRegistration Statement (continued). (continued).–Contents:• 3. The management of the corporation,

including all benefits, and any interests of directors or officers in any material transactions with the corporation must be disclosed.• 4. How the corporation intends to use the

proceeds of the sale.• 5. Any pending lawsuits or special risk factors.


• Registration StatementRegistration Statement (continued). (continued).–Registration Process.• Waiting Period: securities can be offered but

not sold. All issuers can distribute a red herring prospectus, advertise with a tombstone ad, and a free-writing prospectus.• Posteffective Period: securities can now be sold.

• Registration Process Review.


• Registration StatementRegistration Statement (cont’d). (cont’d).–Registration Process.• Restrictions Relaxed for Well-Known Seasoned

Issuers (WKSI). In 2005, SEC revised the registration process and created new categories of issuers based on size and market presence. WKSI’s have issued $1 billion in securities during last 3 years, or $700 million outstanding stock in public hands.


• Exempt Securities and Transactions.Exempt Securities and Transactions.–Regulation A Offerings.• Up to $5 million in any twelve-month

period is exempt from registration. • Issuer must file a notice with SEC and

offering circular.• Companies can “test the waters” without

actually selling an securities.• Can sell online.


• Exempt Securities and Transactions.Exempt Securities and Transactions.–Regulation D Offerings.• Rule 504: up to $1M during 12 months to

accredited investors only.• Rule 505: up to $5M during 12 months to

both accredited and unaccredited investors.–Private Placement. Rule 506 unlimited if no

general solicitation and notice to SEC. Max of 35 unaccredited investors.


• Exempt Securities and Transactions.Exempt Securities and Transactions.–Resales.• Generally, most securities can be resold

without registration. • Rule 144: Rule 505 or 506 securities trigger

registration requirements unless the sale complies with all of Rule 144’s conditions.• Rule 144A: allows sale only to a qualified

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• ViolationsViolations of the 1933 Act. of the 1933 Act.–Intentional or negligent defrauding of

investors by misrepresenting or omitting material information in the registration statement or prospectus.• Criminal Penalties.• Civil Sanctions.• Defenses.


• ViolationsViolations of the 1933 Act (cont’d). of the 1933 Act (cont’d).–Defenses: Statement left out was not

material; Plaintiff knew about fraud and purchased stock; Registrant believed statements were true.


• Provides for registration of securities Provides for registration of securities exchanges, brokers, dealers, and exchanges, brokers, dealers, and national securities exchanges and national securities exchanges and associations. associations. –Applies to companies with $10 million

in assets and 500 or more shareholders. .


• Section 10(b), SEC Rule 10b-5, and Insider Section 10(b), SEC Rule 10b-5, and Insider Trading.Trading.–Section 10(b) prohibits use of any

manipulative or deceptive device or contrivance in violation of SEC rules and regulations.–SEC Rule 10b(5) prohibits fraud in connection

with the purchase or sale of any security.


• Section 10(b), SEC Rule 10b-5, and Section 10(b), SEC Rule 10b-5, and Insider TradingInsider Trading (cont’d). (cont’d).–Applicability of SEC Rule 10b(5).• Virtually all cases concerning the

trading of securities, whether on exchanges, OTC, or private.


• Section 10(b), SEC Rule 10b-5, and Insider Section 10(b), SEC Rule 10b-5, and Insider TradingTrading (cont’d). (cont’d).– Insider Trading.• Goal of 10(b) and 10b-5 is to prevent purchase or sale

of securities on basis of information that is not available to the public.• Applies to corporate directors, officers, and others

with “inside” information.• Applies to anyone who has access to or receives

nonpublic information.


• Section 10(b), SEC Rule 10b-5, and Insider Section 10(b), SEC Rule 10b-5, and Insider TradingTrading (cont’d). (cont’d).–Disclosure Under SEC Rule 10b-5:• Any material omission or misrepresentation in

connection with the sale or purchase of security may violate Section 10(b) or SEC Rule 10b-5. • Examples of materials facts in disclosure:• Fraudulent trading by broker.


• Section 10(b), SEC Rule 10b-5, and Insider Section 10(b), SEC Rule 10b-5, and Insider TradingTrading (cont’d). (cont’d).–Disclosure Under SEC Rule 10b-5:• Dividend Change.• Contract for sale of corporate assets.• New discovery, process, or product.• Significant change in firms financial condition.• Potential litigation against the company.


• Section 10(b), SEC Rule 10b-5, and Section 10(b), SEC Rule 10b-5, and Insider TradingInsider Trading (cont’d). (cont’d).–Disclosure Under SEC Rule 10b-5:• CASE 37.1 SEC v. Texas Gulf Sulphur Co.SEC v. Texas Gulf Sulphur Co.

(1968). Who were the insiders in this case and what should they have done differently?


• Section 10(b), SEC Rule 10b-5, and Section 10(b), SEC Rule 10b-5, and Insider TradingInsider Trading (cont’d). (cont’d).–Private Securities Litigation Reform Act:

provides a “safe harbor” for publicly-held companies making forward-looking statements.


• Section 10(b), SEC Rule 10b-5, and Section 10(b), SEC Rule 10b-5, and Insider TradingInsider Trading (cont’d). (cont’d).–Outsiders and SEC Rule 10b-5.• CASE 37.2 Stonebridge Investment Partners,

LLC v. Scientific Atlanta, Inc. (2008). What element of the plaintiffs case was lacking?• Tipper/Tippee Theory--insider’s fiduciary duty

must be breached.


• Section 10(b), SEC Rule 10b-5, and Section 10(b), SEC Rule 10b-5, and Insider TradingInsider Trading (cont’d). (cont’d).–Outsiders and SEC Rule 10b-5.•Misappropriation Theory -- one

wrongfully obtains inside info and trades on it. Courts still require fiduciary duty be breached, e.g., to employer.


• Section 10(b), SEC Rule 10b-5, and Insider Section 10(b), SEC Rule 10b-5, and Insider TradingTrading (cont’d). (cont’d).–Insider Reporting and Trading – Section

16(b).• Requires recapture of all short-swing profits by

insiders (those owning 10% of equities) to corporation.• Applies to stocks, warrants, options, and

securities.


• Section 10(b), SEC Rule 10b-5, and Section 10(b), SEC Rule 10b-5, and Insider TradingInsider Trading (cont’d). (cont’d).–Regulation of Proxy Statements.• Section 14(1) of the 1934 Act regulates

the sale of proxies from shareholders of Section 12 companies.• Remedies for violations include

injunctions to damages.


• Section 10(b), SEC Rule 10b-5, and Section 10(b), SEC Rule 10b-5, and Insider TradingInsider Trading (cont’d). (cont’d).–Violations of the 1934 Act.• Scienter or intent is required to prove civil or

criminal penalties under 10(b) and Rule 10b-5.• Violator must have had intent to defraud (false

statements or wrongfully failed to disclose material facts).


• Section 10(b), SEC Rule 10b-5, and Section 10(b), SEC Rule 10b-5, and Insider TradingInsider Trading (cont’d). (cont’d).–Violations of the 1934 Act (cont’d).• CASE 37.3 Gebhart v. SEC Gebhart v. SEC (2010). What

factors did the court analyze to determine if scienter was present?• Criminal Penalties.


• Section 10(b), SEC Rule 10b-5, and Section 10(b), SEC Rule 10b-5, and Insider TradingInsider Trading (cont’d). (cont’d).–Violations of the 1934 Act (cont’d).• Criminal Penalties. –10(b) and Rule 10b-5, a person faces $5 million

and 20 years in prison, $25 million for partnership or corporation. –Sarbanes-Oxley provides for 25 years in prison if

willful.


• Section 10(b), SEC Rule 10b-5, and Section 10(b), SEC Rule 10b-5, and Insider TradingInsider Trading (cont’d). (cont’d).–Violations of the 1934 Act (cont’d).• Civil Sanctions. Both SEC and Private Parties

Can Bring Actions Against Violators under the Insider Trading and Securities Fraud Enforcement Act. Private parties may bring action for violations of 10(b) and Rule 10b-5.


• State securities laws are called “blue sky” State securities laws are called “blue sky” laws.laws.

• RequirementsRequirements: Issuers must comply with : Issuers must comply with federal and state securities laws and federal and state securities laws and states do not allow the same exemptions states do not allow the same exemptions as federal government.as federal government.

• Concurrent RegulationConcurrent Regulation: : Uniform Securities Uniform Securities Act has been adopted in part by many states.Act has been adopted in part by many states.


• Relationship between a corporation Relationship between a corporation and its shareholders. and its shareholders. • Attempts at Alignment Attempts at Alignment between between

Officers and Shareholders.Officers and Shareholders.–Stock Options?


• Corporate Governance and Corporate Corporate Governance and Corporate LawLaw..–Board of Directors: responsible to ensure

all corporate officers are operating in best interests of shareholders.–Compensation Committee: assess

performance and design fair compensation systems.


• Corporate Governance and Corporate Corporate Governance and Corporate LawLaw..–Sarbanes-Oxley Act of 2002. Attempts to

increase corporate accountability by imposing strict disclosure requirements and harsh penalties for securities violations.


• Corporate Governance and Corporate Corporate Governance and Corporate LawLaw (cont’d). (cont’d).–Sarbanes-Oxley Act of 2002. •More Internal Controls and Accountability:

Direct federal corporate governance requirements. High-level managers must maintain internal controls and disclosures.


• Corporate Governance and Corporate Corporate Governance and Corporate LawLaw (cont’d). (cont’d).–Sarbanes-Oxley Act of 2002 (cont’d).• Certification and Monitoring Requirements.

Section 906 of Sarb-Ox requires chief executive officers and chief financial officers certify that information in the corporate financial statements complies with Sarb-Ox.


• Corporate Governance and Corporate Corporate Governance and Corporate LawLaw (cont’d). (cont’d).–Sarbanes-Oxley Act of 2002 (cont’d).• Certification and Monitoring

Requirements. Requires independent auditor report except for smaller companies of less than $75 million market capitalization (2010 exemption).


• The SEC is aggressively prosecuting The SEC is aggressively prosecuting internet fraud using traditional laws.internet fraud using traditional laws.• Investment ScamsInvestment Scams..• Online Investment Newsletters and Online Investment Newsletters and

Forums.Forums.


• Ponzi Schemes. Ponzi Schemes. (e.g., Bernard Madoff).(e.g., Bernard Madoff).–Offshore Fraud.–“Risk-Free” Fraud.

• Hacking into Online Stock AccountsHacking into Online Stock Accounts..–Hackers leave software at public

terminals that records keystrokes.


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