CHAPTER 36 SECURITIES REGULATION DAVIDSON, KNOWLES & FORSYTHE Business Law: Cases and Principles in the Legal Environment (8 th Ed.)

CHAPTER 36CHAPTER 36SECURITIES REGULATIONSECURITIES REGULATION

CHAPTER 36CHAPTER 36SECURITIES REGULATIONSECURITIES REGULATION

DAVIDSON, KNOWLES & FORSYTHE DAVIDSON, KNOWLES & FORSYTHE Business Law: Cases and Principles Business Law: Cases and Principles

in the Legal Environmentin the Legal Environment (8 (8thth Ed.) Ed.)

2© 2004 West Legal Studies in Business© 2004 West Legal Studies in BusinessA Division of Thomson LearningA Division of Thomson Learning

BUSINESS LAW: BUSINESS LAW: Cases & PrinciplesCases & PrinciplesDavidson Davidson • Knowles • Forsythe 8• Knowles • Forsythe 8 thth Ed. Ed.

FEDERAL LAWSFEDERAL LAWSFEDERAL LAWSFEDERAL LAWSSecurities regulation has come to be known Securities regulation has come to be known

as “federal corporate law.”as “federal corporate law.”Stems from extensive federal laws and rules Stems from extensive federal laws and rules

set forth by Securities and Exchange set forth by Securities and Exchange Commission (SEC).Commission (SEC).

SEC is federal agency charged with SEC is federal agency charged with enforcement and administration of laws enforcement and administration of laws covering securities, public utility holding covering securities, public utility holding companies, trust indentures, investment companies, trust indentures, investment companies and advisers.companies and advisers.



SECURITIES ACT OF 1933SECURITIES ACT OF 1933SECURITIES ACT OF 1933SECURITIES ACT OF 1933 Defines security as any note, stock, treasury stock, Defines security as any note, stock, treasury stock,

bond, debenture, participation in profit-sharing bond, debenture, participation in profit-sharing agreement, or investment contract.agreement, or investment contract.

Courts interpret investment contract in a security Courts interpret investment contract in a security involves: involves: – Investment involves money. Investment involves money. – In a common enterprise. In a common enterprise. – Whereby investor has no managerial functions, but Whereby investor has no managerial functions, but

expects profit solely from efforts of others.expects profit solely from efforts of others.



Court determines what constitutes a security Court determines what constitutes a security based on the “economic reality” test.based on the “economic reality” test.

Disclosure statute meant to protect the Disclosure statute meant to protect the unsophisticated investing public.unsophisticated investing public.

Requires registration of most securities Requires registration of most securities when initially offered and enforces various when initially offered and enforces various antifraud provisions.antifraud provisions.

SECURITIES ACT OF 1933SECURITIES ACT OF 1933SECURITIES ACT OF 1933SECURITIES ACT OF 1933



Procedures: unless exemption applies, Procedures: unless exemption applies, corporation issuing a security must:corporation issuing a security must:– File a registration statement with SEC.File a registration statement with SEC.– Provide prospectus to all prospective investors.Provide prospectus to all prospective investors.

Purpose of registration statement and Purpose of registration statement and prospectus is protection of unsophisticated prospectus is protection of unsophisticated investor.investor.




Exemptions: classes of securities exempt from Exemptions: classes of securities exempt from registration:registration:– Securities issued by federal/state governments.Securities issued by federal/state governments.– Short-term commercial paper. Short-term commercial paper. – Issues by nonprofit organizations.Issues by nonprofit organizations.– Issues by savings and loan associations.Issues by savings and loan associations.– Issues by common carriers.Issues by common carriers.– Certain qualifying employee pension plans.Certain qualifying employee pension plans.– Insurance policies and certain annuities.Insurance policies and certain annuities.– Intrastate issues of securities.Intrastate issues of securities.




Exemptions: the following transactions are Exemptions: the following transactions are exempt from registration and prospectus exempt from registration and prospectus requirements.requirements.– Private offerings.Private offerings.– Transactions by persons other than issuers.Transactions by persons other than issuers.– Certain broker and dealer transactions.Certain broker and dealer transactions.– Small public issues ($5 million cap to Small public issues ($5 million cap to

accredited investors).accredited investors).




Antifraud Provisions.Antifraud Provisions.– Section 12 prohibits:Section 12 prohibits:

Oral or written misstatements of material fact.Oral or written misstatements of material fact. Omissions of material facts that are necessary to Omissions of material facts that are necessary to

keep statements from being misleading.keep statements from being misleading.

– Section 17 prohibits use of mails or interstate Section 17 prohibits use of mails or interstate commerce to further any form of fraud.commerce to further any form of fraud.

– Section 27A redefines when liability exists for Section 27A redefines when liability exists for certain misleading “forward-looking” certain misleading “forward-looking” statements.statements.




Section 11 imposes civil liability for: Section 11 imposes civil liability for: – Any registration statement containing untrue statements Any registration statement containing untrue statements

of material fact. of material fact. – Omissions of material facts necessary to keep Omissions of material facts necessary to keep

statements from being misleading.statements from being misleading.– Due diligence is only defense to Section 11liability.Due diligence is only defense to Section 11liability.– Defense available to any person who had reasonable Defense available to any person who had reasonable

grounds to believe that registration statement was grounds to believe that registration statement was accurate and did not omit material facts.accurate and did not omit material facts.




Section 12 exacts civil liability from:Section 12 exacts civil liability from:– Person who sells securities through mail/interstate Person who sells securities through mail/interstate

commerce.commerce.– By means of prospectus or oral communication.By means of prospectus or oral communication.– Includes misrepresentations or omissions of necessary Includes misrepresentations or omissions of necessary

material facts.material facts.– Persons can avoid liability if can show they did not Persons can avoid liability if can show they did not

know, and could not have known, about the untruths or know, and could not have known, about the untruths or omissions.omissions.




SECURITIES EXCHANGE ACT OF SECURITIES EXCHANGE ACT OF 19341934


Regulates secondary distribution of Regulates secondary distribution of securities. securities.

Jurisdiction extends to registration and Jurisdiction extends to registration and distribution of securities through national distribution of securities through national stock exchanges, national securities stock exchanges, national securities associations, brokers, and dealers.associations, brokers, and dealers.

Reach of 1934 Act is broader than ’33 Act Reach of 1934 Act is broader than ’33 Act ‘33.‘33.



The Registration and Reporting provisions:The Registration and Reporting provisions:– Requires any issuer who trades securities on a Requires any issuer who trades securities on a

national stock exchange to register with SEC.national stock exchange to register with SEC.– Tries to ensure that investing public has Tries to ensure that investing public has

sufficient information about publicly traded sufficient information about publicly traded securities.securities.

– Mandates certain disclosures:Mandates certain disclosures: Detailed registration statements.Detailed registration statements. Annual and quarterly reports.Annual and quarterly reports.





Proxy Solicitations: Proxy Solicitations: – An assignment by shareholder of right to vote the An assignment by shareholder of right to vote the

shares held by the shareholder.shares held by the shareholder.– Management must provide shareholders with proxy Management must provide shareholders with proxy

statement and form.statement and form.– Proxy statement must disclose all pertinent information Proxy statement must disclose all pertinent information

regarding matters under consideration.regarding matters under consideration.– Section 14 of Act ‘34 makes it illegal for company Section 14 of Act ‘34 makes it illegal for company

registered under Section 12 to solicit proxies in a registered under Section 12 to solicit proxies in a manner that violates SEC rules and regulations.manner that violates SEC rules and regulations.





Proxy Solicitations (cont’d): Proxy Solicitations (cont’d): – Disclosure required of proxy solicitations Disclosure required of proxy solicitations

include: the Proxy statement and Proxy forminclude: the Proxy statement and Proxy form– SEC must approve the statement and form SEC must approve the statement and form

before sent to the shareholders.before sent to the shareholders.





Tender Offers: Tender Offers: – Williams Act, codified in Sections 13 and 14, has Williams Act, codified in Sections 13 and 14, has

regulated tender offers or takeover bids, whether hostile regulated tender offers or takeover bids, whether hostile or friendly.or friendly.

– One publicly held corporation attempts to acquire control One publicly held corporation attempts to acquire control of another publicly held company.of another publicly held company.

– Provisions force offeror to provide:Provisions force offeror to provide: Target company’s shareholders with names of offerors and Target company’s shareholders with names of offerors and

interests.interests. Purpose of takeover.Purpose of takeover. Method of disposing of target firm’s stock and assets.Method of disposing of target firm’s stock and assets.





Insider Trading: Insider Trading: – 1934 Act regulates insider trading.1934 Act regulates insider trading.– Transactions involving material nonpublic Transactions involving material nonpublic

information insider must publicly disclose information insider must publicly disclose information or abstain from trading in security.information or abstain from trading in security.

– Parties subject to this regulation are:Parties subject to this regulation are: Corporate insiders (directors, officers, etc...).Corporate insiders (directors, officers, etc...). Tippee.Tippee. Anyone else who has access to material inside Anyone else who has access to material inside

information.information.





Insider Trading (cont’d):Insider Trading (cont’d):– Imposes liability for manipulative or deceptive Imposes liability for manipulative or deceptive

device used in purchase or sale of security. device used in purchase or sale of security. – Proving violation require:Proving violation require:

Untrue statement of material fact. Untrue statement of material fact. Failure to state material fact needed to make a Failure to state material fact needed to make a

statement not misleading.statement not misleading. Reliance upon statement andReliance upon statement and Injury resulting from such reliance.Injury resulting from such reliance.





Short-Swing Profits:Short-Swing Profits:– Aimed at gains by corporate insiders.Aimed at gains by corporate insiders.– Insiders and persons owning more than 10 Insiders and persons owning more than 10

percent of a corporation’s stock. percent of a corporation’s stock. – Must file statements with SEC disclosing extent Must file statements with SEC disclosing extent

of ownership and changes taken place.of ownership and changes taken place.– Pay to corporation any short-swing profits, Pay to corporation any short-swing profits,

defined as profit made by buying & selling defined as profit made by buying & selling securities that take place in time period of less securities that take place in time period of less than 6 months.than 6 months.

1934 SECURITIES EXCHANGE 1934 SECURITIES EXCHANGE ACT ACT

1934 SECURITIES EXCHANGE 1934 SECURITIES EXCHANGE ACT ACT



Liabilities and RemediesLiabilities and Remedies– Act ‘34 creates private right of action for those who Act ‘34 creates private right of action for those who

have dealt in securities on the basis of misleading have dealt in securities on the basis of misleading registration statements, tender offers, and proxy registration statements, tender offers, and proxy solicitations. solicitations.

– Under Section 16, corporations/shareholders suing in a Under Section 16, corporations/shareholders suing in a derivative action for the benefit of the corporation may derivative action for the benefit of the corporation may recover short-swing profits.recover short-swing profits.

– Catch-all antifraud provision, may be brought by Catch-all antifraud provision, may be brought by purchaser/seller of any security against person who has purchaser/seller of any security against person who has engaged in fraudulent conduct.engaged in fraudulent conduct.





Empowers SEC to conduct investigations.Empowers SEC to conduct investigations.SEC can revoke registration or suspend of SEC can revoke registration or suspend of

distribution of the security. distribution of the security. Empowers SEC to impose administrative Empowers SEC to impose administrative

hearing.hearing.Appropriate cases referred for criminal Appropriate cases referred for criminal

prosecution.prosecution.





SARBANES-OXLEY ACT OF 2002SARBANES-OXLEY ACT OF 2002 Resulted from Worldcom/Enron scandals.Resulted from Worldcom/Enron scandals. CEO/CFO Certification of financials.CEO/CFO Certification of financials. Establishment of Audit Committees/ Corporate Establishment of Audit Committees/ Corporate

Governance.Governance. Prohibitions on Loans to Directors /Officers.Prohibitions on Loans to Directors /Officers. Restrictions of Executive Compensation.Restrictions of Executive Compensation. Additional Criminal Penalties.Additional Criminal Penalties. Whistleblower Protection.Whistleblower Protection. Creation of Auditor Oversight Board.Creation of Auditor Oversight Board.



STATE REGULATIONSSTATE REGULATIONSSTATE REGULATIONSSTATE REGULATIONSTransactions involving securities may be Transactions involving securities may be

subject to state and federal law.subject to state and federal law.Often called “blue sky laws,” types of Often called “blue sky laws,” types of

provisions are:provisions are:– Antifraud stipulations.Antifraud stipulations.– Registration requirements for brokers and Registration requirements for brokers and

dealers.dealers.– Registration prerequisites for sale and purchase Registration prerequisites for sale and purchase

of securities.of securities.



STATE REGULATIONSSTATE REGULATIONS

Methods of securities registration ordinarily Methods of securities registration ordinarily exist:exist:– Notification.Notification.– Qualification.Qualification.– Coordination.Coordination.

State exemptions are similar to federal.State exemptions are similar to federal.



THE FOREIGN CORRUPT THE FOREIGN CORRUPT PRACTICES ACTPRACTICES ACT


Stops bribery of foreign officials.Stops bribery of foreign officials.Contains anti-bribery provisions and Contains anti-bribery provisions and

accounting standards.accounting standards.Criminal penalties may be imposed if Criminal penalties may be imposed if

officer, director, employee, agent or officer, director, employee, agent or stockholder corruptly use mail or any stockholder corruptly use mail or any instrument of interstate commerce either to instrument of interstate commerce either to offer or pay money to foreign officials to offer or pay money to foreign officials to influence assistance to firm.influence assistance to firm.




Payments or gifts to facilitate routine Payments or gifts to facilitate routine governmental action are permitted.governmental action are permitted.

Record-keeping standards require issuers to: Record-keeping standards require issuers to: – Make and keep records, reasonable in detail, accurately Make and keep records, reasonable in detail, accurately

and fairly reflect the transactions and dispositions of and fairly reflect the transactions and dispositions of the assets.the assets.

– Devise and maintain a system of internal accounting Devise and maintain a system of internal accounting controls sufficient to provide reasonable assurances.controls sufficient to provide reasonable assurances.




Criminal penalties:Criminal penalties:– Corporate fines of a maximum of $2 million for Corporate fines of a maximum of $2 million for

violations.violations.– Maximum of five years’ imprisonment.Maximum of five years’ imprisonment.– $100,000 in fines for willful violations by $100,000 in fines for willful violations by

corporate individuals.corporate individuals.– Individual civil penalties not to exceed Individual civil penalties not to exceed

$10,000.$10,000.

Documents

CHAPTER 36 SECURITIES REGULATION DAVIDSON, KNOWLES & FORSYTHE Business Law: Cases and Principles in the Legal Environment (8 th Ed.)