CHAPTER 38

1. Click your mouse anywhere on the screen to advance the text in each slide. After the starburst appears, click a blue triangle to move to the next slide or previous slide. CHAPTER 38 Securities Regulation

2. Quote of the Day “Definition of insider trading: Stealing too fast.” Calvin Trillin essayist

3. Securities and Exchange Commission (SEC) • Created in 1934 to regulate the securities industry: • Rules – to fill in gaps left by state securities statutes. • Releases – informal pronouncements on current issues, particularly proposed changes in the rules. • No-Action Letters – the answer to a question; states that the SEC will take no action (meaning that they approve of the transaction in question.)

4. What is a Security? • A security is any transaction in which the buyer: • (1) invests money in a common enterprise and, • (2) expects to earn a profit predominately from the efforts of others.

5. Securities Act of 1933 • The 1933 Act requires that, before offering or selling securities, the issuer must register the securities with the SEC, unless the securities qualify for an exemption. • When an issuer registers securities, the SEC does not investigate the quality of the offering. • The 1933 Act prohibits fraud in any securities transaction.

6. 1933 Act -- Exemptions • General Exemption – those made by the SEC “for the public interest.” • Exempt Securities • Government securities, Blank securities, Short-term notes, Non-profit issues, Insurance policies and annuity contracts • Regulation D covers private offerings; Regulation A covers “small” public offerings.

7. 1933 Act -- Exemptions • Exempt Transactions • Section 4(2) of the 1933 Act exempts from registration “transactions by an issuer not involving any public offerings.” • Under SEC Rule 147, an issuer is not required to register securities that are offered and sold only to residents of the state in which the issuer is incorporated and does business.

8. Public Offerings • Direct Public Offerings – stock sold directly by the company, without going through a broker. • A company’s first public sale of securities is called its initial public offering (IPO).

9. Public Offerings (cont’d) • A company selling stock may hire an investment bank to serve as the underwriter. • In a firm commitment underwriting, the bank buys the stock, then resells it. Risk of loss is borne by the bank. • In a best efforts underwriting, the bank acts as the agent, selling the stock for the company, which bears the risk of loss.

10. Public Offerings (cont’d) • A registration statement is required for a company preparing to sell stock. Its purpose is: • To notify the SEC that a sale of securities is pending, and • To disclose information to purchasers. • A prospectus is a portion of the registration statement which must be given to prospective purchasers. • The company’s sales effort is restricted during the pre-filing and waiting periods.

11. Sales Restricted Securities • Rule 144 limits the resale of two types of securities: control securities and restricted securities. • A control security is one held by any shareholder who owns more than 10 percent of a class of stock or by any officer or director. • A restricted security is any stock purchased in a private offering.

12. Liability • Liability is imposed on anyone selling unregistered and non-exempt securities. • Fraud imposes liability on the seller if any interstate commerce is used (such as U.S. mail, telephone, banks – which includes practically every transaction!)

13. Liability (cont’d) • Criminal liability is imposed on anyone who willfully violates the Act of 1933. • Liability for the registration statement may be imposed on all its signers. • If a final registration statement contains a material misstatement or omission, the purchaser of the security can recover from everyone who signed the registration statement.

14. Securities Exchange Act of 1934 • Registration – an issuer must register with the SEC if: • It completes a public offering under the 1933 Act, • Its securities are traded on a national exchange, or • It has at least 500 shareholders and its assets exceed $10 million.

15. Securities Exchange Act of 1934 (cont’d) • Section 13 requires companies to file the following documents: • An initial, detailed information statement when the company first registers. • Annual reports on Form 10-K, containing a detailed analysis of the company’s performance, and information about officers and directors. • Quarterly reports on Form 10-Q, which are less detailed than 10-Ks. • Form 8-Ks to report any significant developments or changes.

16. Securities Exchange Act of 1934 (cont’d) • Proxy Requirements - Section 14 – allows shareholders to vote without attending the meeting. • Short-Swing Trading - Section 16 – prevents insiders from manipulating the market, using inside information; this section limits how much stock can be sold and purchased within a 6 month period.

17. Liability • Section 18 – holds liable anyone who makes a false or misleading statement in a filing. • Section 10(b) prohibits fraud in connection with the purchase and sale of any security whether or not the security is registered under the 1934 Act. This applies to: • Misstatement or omission of material fact • Scienter (willful misstatement) • Either purchasers or sellers

18. The Private Securities Litigation Reform Act of 1995 • Insider Trading • Someone who trades on inside information is liable only if he has a fiduciary duty to the company whose stock he has traded. • Fiduciaries • A fiduciary violates Rule 10b-5 if she trades stock of her company while in possession of nonpublic material information.

19. Reform Act of 1995 (cont’d) • Tippers -- Insiders who pass on non-public, material information are liable under Rule 10b-5, even if they do not trade themselves, as long as: • (1) they know the information is confidential and, • (2) they expect some personal gain.

20. Reform Act of 1995 (cont’d) • Tippees --Those who receive tips are liable for trading on inside information, even if they do not have a fiduciary relationship to the company, as long as: • (1) they know the information is confidential, • (2) they know it came from an insider who was violating his fiduciary duty, and • (3) the insider expected some personal gain.

21. Reform Act of 1995 (cont’d) • Takeovers • This rule prohibits trading on inside information during a tender offer if the trader knows the information was obtained from either the bidder or the target company. • Misappropriation • A person is liable if he trades in securities (1) for personal profit, (2) using confidential information, and (3) in breach of a fiduciary duty to the source of the information.

22. Foreign Corrupt Practices Act • Under the Foreign Corrupt Practices Act, it is a crime for any American company (whether reporting under the 1934 Act or not) to make or promise to make payments or gifts to foreign officials, political candidates, or parties in order to influence a governmental decision, even if the payment is legal under local law.

23. Blue Sky Laws • State statutes regulating securities are called blue sky laws (because crooks were willing to sell investors “a piece of the great blue sky”). • There is little uniformity among state securities regulations; even the Uniform Securities Act has been customized in most states.

24. “Congress passed the Securities Act of 1933 and the Securities Exchange Act of 1934 to ensure that the country never suffers through another economic crisis as catastrophic as the Great Depression. It is in no small part owing to these laws that the United States has enjoyed so many years of economic stability.”

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