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Securities Regulations

16. Securities Regulations. U.S. Financial Markets. Source: Securities And Exchange Commission: GPRA Report , Industry Statistics. Introduction. Securities Regulation Began Due To Great Depression Of 1930’s Designed To Give Potential Investors Factual Information To Make Informed Decision

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Securities Regulations

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  1. 16 Securities Regulations

  2. U.S. Financial Markets Source: Securities And Exchange Commission: GPRA Report, Industry Statistics

  3. Introduction • Securities Regulation Began Due To Great Depression Of 1930’s • Designed To Give Potential Investors Factual Information To Make Informed Decision • Federal & State Laws

  4. Security Investment • Exists When • Person Invests • Others Manage It For Profit • Questions: • Common Business Activity? • Reasonable Expectation Of Profit? • Profits Earned Through Efforts Of Someone Else?

  5. What is a Security? • Per the acts includes: • Note, Stock, Bond, Debenture • Evidence of Indebtedness • Certificate of Interest, Certificate of Subscription • Investment Contract, Voting Trust Certificate • Interest in Oil, Gas or Mineral Rights • Other interests “commonly known as securities”

  6. What is a Security? • Bankers Trust Company served as an agent for corporate customers by placing their commercial paper for sale. This function of a commercial bank acting as a dealer of commercial paper was challenged by the Securities Industry Association. Issue: Were these sales subject to federal securities laws? Held: Yes. The sale of commercial paper is a security and the Glass-Steagall Act prohibits commercial banks from acting as a dealer of such securities. Securities Industry Association v. Board of Governors of the Federal Reserve System, 104 S.Ct. 2979 (1984).

  7. What is a Security? • W.J. Howey Company and Howey-in-the-Hills Service, Inc., are Florida corporations under common control and management. Howey Company offered to sell to the public its orange grove, tree by tree. Howey-in-the-Hills Service, Inc., offered these buyers a contract wherein the appropriate care, harvesting, and marketing of the oranges would be provided. Most of the buyers who signed the service contracts were nonresidents of Florida who had very little knowledge or skill needed to care for and harvest the oranges. These buyers were attracted by the expectation of profits. When the profits were not forthcoming, the buyers sued based on the 1933 Securities Act registration requirements not being satisfied. Issue: Did the Howey Company sell securities? Held: Yes. Sales of orange trees and services contracts were sales of securities. Under the Federal Securities Act of 1933 a security exists whenever one person invests money in a common enterprise with the exception of profits resulting from the efforts of another person. Upon examination of these orange grove transactions, these essential requirements of a security were found to be present. Since the registration requirements were not satisfied, the controllers of these "Howey" companies have violated the Federal Securities Act of 1933. SEC v. W.J. Howey Co., 328 U.S. 293 (1946).

  8. Securities & Exchange Commission (SEC) • Created In 1934-35 Commissioners • Quasi-Legislative & Quasi-Judicial • Regulates • Stock Exchanges • Utility Holding Companies • Investment Trusts • Investment Advisors

  9. SEC Filings http://www.sec.gov/pdf/annrep01/ar01fulldisc.pdf

  10. Documents For Securities Sale • Registration Statement • Disclosure Of Financial Info. • Periods • Pre-filing Period • Waiting Period- 20 Days, Tombstone Ad • Post-effective Period • Prospectus- Final Financials

  11. Exchange Act:Initial Registrations http://www.sec.gov/pdf/annrep01/ar01fulldisc.pdf

  12. Registration Statement Liability • Untrue Statements Of Material Fact • Omits Material Facts • Omits Information Resulting In Misleading Potential Investor

  13. Fraudulent Transactions • Attempt To Defraud • Attempt To Obtain Money/Property By Untrue/Misleading Statements • Attempt To Engage In Transaction/Practice To Defraud/Deceive Purchaser

  14. Security Transaction Defenses • Materiality- Prudent Investor Would Use • Statute Of Limitations- 1 Year After Discovery, No More Than 3 Years • Due Diligence- Reasonable Review Of Financials

  15. SEC Enforcement & Litigation • Section 10(b) & Rule 10b.5- Materiality • Persons Liable • Insiders • Broker-Dealers • Corporations Who’s Stock Purchased/Sold • Those Who Aid/Abet/Conspire To Defraud

  16. Insider Transactions • Insider • Owns More Than 10% • Director/Officer • Insiders Must File Within 10 Days • Short-Swing Profits • Non-Public Information • Civil & Criminal Liability

  17. State Blue Sky Laws • Registration By • Notification • Qualification • Coordination • Exemptions • Isolated Transaction • Limited Offer Within Stated Time • Private Offering • Number Of Holder Not Greater Than Specified

  18. Overview of Legislation • Regulation of Publicly Traded Securities • Securities Act of 1933- Disclosure on IPO’s (one-time) • Securities Exchange Act of 1934- Periodic Disclosures • Monthly, Quarterly, Annual • Securities & Exchange Commission (SEC)

  19. Securities Act (1933) • Disclosure Law- Going Public • Sanctions Of Violations- Intentional • Criminal Punishment • Civil Liability For Injured Parties • Injunction- Equitable Remedy • Parties That Must Comply • Issuers • Underwriters • Controlling Persons • Sellers

  20. Securities Act of 1933 • Registration Requirements • the purpose of requiring registered securities offerings is to ensure that investors have the information they need to make intelligent investment decisions. • Registration Statement - Document describing company and its securities • Reviewed by SEC to make sure not per se fraudulent • Prospectus - Document used to promote a security • the purpose of Section 5’s restrictions on when and how a seller of securities may communicate with prospective buyers: to ensure that an investor has the time to make an intelligent investment decision based on either the prospectus or face-to-face communications in which the investor has an opportunity to ask questions.

  21. Securities Act of 1933 • Electronic Filing- EDGAR • Exemptions • Securities • Government issued or guaranteed • Short-term notes and drafts

  22. Securities Act of 1933 • That Section 3 of the 1933 Act exempts the following securities from the registration and prospectus requirements: • a. Commercial paper arising out of current transactions with a maturity not exceeding nine months. • b. Securities issued by not-for-profit corporations. • c. Government securities. • d. Securities of national banks, state banks, or the Federal Reserve Board. • e. Securities of savings and loan institutions and farmers' cooperatives. • f. Securities issued by carriers subject to the Interstate Commerce Commission. • g. Insurance contracts. • h. Exchanges with existing security holders. • i. Intrastate offerings. • j. Securities declared exempt by the SEC's rules and regulations.

  23. Antifraud Provisions of 1933- Liability • Improper Offers/Sales • Improper: • Timing • Manner • Content

  24. Antifraud Provisions of 1933- Liability Defective Registration Statements • Section 11 liability: • a. Privity is not required. • b. Reliance is not ordinarily required. • c. The purchaser need not prove that the defendants were negligent. Instead, the defendants must disprove their negligence by establishing DUE DILIGENCE.

  25. Antifraud Provisions • Defective Registration Statements • see Gustafson v. Alloy Company below • Under Section 12(1) of the 1933 Act the remedy is rescission or damages. • Nonprofit securities • Financial institution securities • ICC-regulated • Insurance and annuity contracts

  26. Antifraud Provisions • The shareholders of Alloyd, Inc. sold their stock in a private sale agreement. The contract specified a price for the estimated increased value in the company's worth between the time of sale and the end-of-the-year audited financial statements. The contract further provided that any party disappointed with estimated value could seek an adjustment after the financial records were audited. The buyers were disappointed with the estimated increased value. Rather than seeking an adjustment in the purchase price, they sought to rescind their purchase under § 12(2) claiming that the information provided (as a prospectus) at the time of the sale was false or misleading. Issue: Does § 12(2) apply to private sale contracts? Held: No. When the 1933 Act was enacted, the term prospectus was well understood to refer to documents soliciting the public to acquire securities from the issuer. Section 12(2) does not extend to a private sale contract since that contract is not held out to the public as a "prospectus" in the meaning of the 1933 Act. Gustafson v. Alloyd Co., Inc., 115 S.Ct. 1061 (1995).

  27. Securities Exchange Act (1934) • Being Public- File Forms With: • Stock Exchange • SEC- Periodic Reports • Affects • Businessperson • Accountant • Lawyer • Investor

  28. Securities Exchange Act of 1934 • Registration of Securities-Disclosure Required when • 500 or more shareholders and issuer’s assets > $3 million • Interstate trading • On a national stock exchange

  29. Securities Exchange Act of 1934 • Periodic Reports • Gallagher v. Abbott Laboratories • The court ruled that Abbott did not violate the disclosure provisions of the 1934 Act because it did not have duty to disclose all information material to its stock prices as soon as it was discovered by the company. The court stressed that, rather than continuous disclosure, the 1934 Act insists only upon periodic disclosure.

  30. Securities Exchange Act of 1934 • Short-Swing Trading by Insiders • Individual filing by Insiders • Insider = • Officer with registered equity securities • Director • Owner of 10% or more of a class of equity securities • Issuer can recover insider trade gains within 6 month period • Purpose: To prevent speculation based on inside information

  31. Securities Exchange Act of 1934 • Regulation of Proxy Solicitations • to allow shareholders to exercise their voting rights intelligently and to permit insurgent shareholders to have a fair opportunity to oust incumbent management. • the information required by the SEC to be included in proxy statements where directors are to be elected. (This is in addition to the requirements for annual financial reports that must be sent with or prior to a proxy statement for an annual meeting.)

  32. Securities Exchange Act of 1934 • Regulation of Proxy Solicitations • a. The person making the solicitation of proxies and the methods to be employed. • b. Interests of directors, officers, and certain others in matters to be acted upon. • c. Certain information about nominees and those continuing in office, including occupation for the last five years, relationships to executive officers, and interests in firms that deal with the corporation. • d. Whether the corporation has audit, nominating, and compensation committees, and if so, their membership and how often they met in the past year.

  33. Securities Exchange Act of 1934 • Regulation of Proxy Solicitations • e. Names of directors who have attended less than 75 percent of directors and board committee meetings. • f. Certain information if a director has resigned or declined to stand for reelection because of a disagreement with the corporation. • g. Compensation of directors, including fringe benefits—specific directions are given as to how this information must be shown. • h. Name of and information about the independent public accountants and their relationship with the corporation.

  34. Provisions of 1934 Act- Liability • Prohibit Manipulation of Security Price • e.g. “Wash Sale” - simultaneous sale/buy • Impose Liability for False Statements in Filed Documents

  35. Section 10(b) & Rule 10(b-5) • Section 10(b) and Rule 10b-5 is the most important liability section in the securities laws! • Misstatements/Omissions • Elements of a Rule 10b-5 violation (Designed to stop fraud) • (1). In an omission case, the fraud requirement dictates that there be a duty to disclose, usually because of a fiduciary duty owed the plaintiff.

  36. Section 10(b) & Rule 10(b-5) • Misstatements/Omissions • Elements of a Rule 10b-5 violation • (2). If there is no fraud—that is, no misstatement or omission— there is no Section 10(b) liability. Thus, mere corporate mismanagement or other breach of a fiduciary duty that corporate managers owe to shareholders does not create liability under this provision. There must be a misstatement or omission. • Rule 10b-5 requires a showing of scienter—intent to deceive. Note, however, that recklessness may establish scienter

  37. Section 10(b) & Rule 10(b-5) • Plaintiff must be Purchase or Seller • Must show Reliance, unless omission • Statute of Limitations May Apply

  38. Section 10(b) & Rule 10(b-5) • San Leandro Emergency Medical Group v. Philip Morris • Philip Morris was held to have not omitted a material fact and, therefore, not did not violate Rule 10b-5. The court held that Philip Morris did not have a duty to give advance notice of its deviation from the company’s historical pricing strategy. First, when it made its initial optimistic assessments, the company had no idea they were unreasonable. Second, the court was reluctant to require companies to give advance notice of sensitive pricing information out of fear it would become available to competitors.

  39. Section 10(b) & Rule 10(b-5) • Conduct- Rule 10(b-5) • Continuous Immediate Disclosure of Material Information

  40. Section 10(b) & Rule 10(b-5) • Conduct- Rule 10(b-5) • Inside Information • Anyone, not just an officer or director, who has information that is material (likely to affect investors’ desire to buy, sell, or hold the corporation’s securities) about the corporation and that is not generally available to the investing public violates Rule 10b-5 of the SEC if he or she trades in the security. There have been a number of recent actions by the SEC against people such as printers and secretaries who had gained inside information and acted upon it.

  41. Section 10(b) & Rule 10(b-5) • Conduct- Rule 10(b-5) • United States v. O’Hagan • An attorney in a law firm that represented a corporation began purchasing call options for the corporation’s stock after learning of the company’s confidential tender offer plans. The court found the attorney criminally liable for securities fraud in violation of Section 10(b) and Rule 10b-5 under the misappropriation theory.

  42. Section 10(b) & Rule 10(b-5) • SEC v. ZANDFORD, 122 S.Ct. 1899 (2002) • FACTS: William Wood opened an investment account for the stated purpose of preserving the principal and producing income. This investment account authorized Charles Zandford to exercise his discretion in determining which investments to make on behalf of Mr. Wood and his daughter. Through the purchase of securities, Mr. Zandford fraudulently transferred funds from the Wood investment account. The SEC sought to have Mr. Zandford repay funds taken from the Wood account. Mr. Zandford argued the SEC lacks jurisdiction over these wrongful acts since the transactions were not in connection with the sale of a security. The District Court ruled in favor of the SEC, but the Fourth Circuit reversed. • ISSUE: Were the transactions conducted by Mr. Zandford “in connection with the purchase or sale of any security?”

  43. Section 10(b) & Rule 10(b-5) • SEC v. ZANDFORD, 122 S.Ct. 1899 (2002) • DECISION: Yes. • REASONS: 1. The SEC has consistently held that a broker violates Section 10b and Rule 10b-5 when he accepts payment for securities that not delivered or sells securities while misappropriating the funds. • 2. Courts should defer to this reasonable interpretation of securities laws by the SEC. • 3. Mr. Zandford’s fraud coincided with the sales of securities; thereby subjecting himself to the jurisdiction of the SEC.

  44. tender Offer Regulation • History • Tender Offer - Public Offer to purchase shares at a specified price. May be in connection with hostile takeover attempt. • Williams Act (1968) • To give both sides opportunity to present their case

  45. Tender Offer Regulation • State’s Typically Regulate Tender Offers • Shareholders are protected by federal tender offer rules: • a. Minimum offering period. Shareholders have at least 20 business days to consider their decision to sell. • b. Withdrawal period. Shareholders may withdraw their tendered shares if a higher bid is made. This allows an investor to reconsider an imprudent decision and promotes an auction market for the shares. • c. Proration of purchases. Shareholders need not fear tendering too late if the offer is oversubscribed, since the purchaser must prorate its purchases among all tenderers.

  46. State Securities Legislation • State Securities Regulations/ Blue-Sky Laws • Broker-Dealer Registration Typically Required • Uniform Securities Act (1985)

  47. Sarbanes-Oxley Act (2002) • Increase In SEC Budget • Created Public Company Accounting Oversight Board • Members Of Corporate Audit Committee Must Be Independent • CEOs Certify Financial Statements • Increases Criminal Penalties

  48. Overview of Presentation I. Disclosure • Earnings Releases • Non-GAAP Financial Measures • MD&A • Certification/Disclosure Controls & Procedures/Item 307 Disclosure II. Relationship with Outside Auditor • Retaining, Supervising and Managing Relationship with Outside Auditor • Non-audit Services — Procedures For Pre-approval and Disclosure III. Boards and Committees IV. Other Governance Issues • Codes of Ethics • Lawyer Professional Responsibility

  49. Earnings Release • New Earnings Release Filing Requirement. • Earnings releases regarding a completed fiscal quarter or a completed fiscal year must be furnished on Form 8-K. • Timing: must be furnished to the SEC within five business days after release is disseminated. • Requirement is set forth in new Item 12 on Form 8-K. • Requirement effective beginning March 23, 2003.

  50. Filing Information vs. Furnishing Information: Liability and Incorporation by Reference • Information provided under Item 12 of Form 8-K will be treated as “furnished” rather than “filed” for Exchange Act and Securities Act purposes. • This means that the company will not have liability for the information under Section 18 of the Exchange Act. • But the company will still have liability under Rule 10b-5. • The fact that the information is “furnished” rather than “filed” also means that the earnings release will not be automatically incorporated by reference in a registration statement, proxy statement or other report, unless the company expressly so states. This means you don't have automatic Securities Act liability.

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