Chapter 19: Investor Protection, Insider Trading, and Corporate Governance

Question 1

Securities

Answer 1

Any instrument representing corporate ownership (stocks) or debt (bonds).

Question 2

Securities and Exchange Commission (SEC)

Answer 2

administers security regulations.

updates its rules/regulations in accordance with legislation (changing requirements of securities).

Question 3

Securities Act of 1933

Answer 3

Governs the initial sale of stock by business.

Question 4

Responsibility of Securities Act of 1933?

Answer 4

Requires Disclosure.

Securities business must disclose information about the issuance of securities to the investing public.

Question 5

Howey Test

Answer 5

Determines which contracts can be considered securities.

Question 6

Investment Contract (4-Part Definiton)

Answer 6

An Investment contract is a transaction in which a person…
1) Invest
2) in a common enterprise
3) reasonably expecting profits in return
4) derived, primarily or substantially, from other’s managerial or entrepreneurial efforts.

Question 7

Ponzi Scheme

Answer 7

fraudulent investment operation, where one pays an investor with funds from later investors (investors who join later), instead of paying w/ money earned by a legitimate means.

Question 8

Section 5 of the Securities Act of 1933 states that a security must be _________________ before being offered to the ______________, unless it qualifies for an exemption.

Answer 8

registered; public

Question 9

General responsibility of the Registration statement filed by a business (under Securities and Exchange Commission), and a prospectus given to public investors.

Answer 9

Provide unsophisticated public investors with information about financial risk involved (w/ investing)

Question 10

Prospectus

Answer 10

It’s a disclosure document outlining

• The securities being sold
• Financial operations of the corporation issuing the securities.
• risk involved w/ investing in securities

Question 11

The Prospectus may also serve as a ___________ tool for the corporation issuing it.

Answer 11

selling

Question 12

Registration Statement

Answer 12

Describes the securities being sold, and their relationship to the issuing corporation’s other securities.

Question 13

Exemption (Exempt Securities)

Answer 13

• Securities maintain exempt status forever.
• (Because) they are low risk investments or regulated by statutes.
• Securities can be resold w/o being registered.

Question 14

Violations of Securities Act of 1933:

• ___________ securities __________ the effective date mentioned on registration statement.
• ______________ (illegally obtaining money from someone by deception) investors by _____________information in registration statement or prospectus.
• ______________ regarding _____________ of registration statement and prospectus.

Answer 14

Selling; before; Defrauding; omitting; Negligence; preparation

Question 15

Remedies for Violation of Securities Act (1933):

• Violators of the Securities Act may be fined up to _____ million dollars and _________________.
• The ________ has the right to seek civil ____________ against those who _______________ violate the Securities Act.
• The ______ may request _________________ against the violator to prevent further _____________ of securities.
• The _________ may also request the court grant ___________, wherein the violator must ____________ profits.
• Parties who suffer ______________ as a result of ________ or ______________ information from registration statements may also sue in ______________ court to recover damages.

Answer 15

$2; imprisoned; SEC; sanctions; willfully; SEC; injunction; sale; SEC; relief; refund; injury; false; omitted; federal

Question 16

Defenses for Violation of Securities Act (1933):

A defendant (issuing corporation) may not be held liable for violation of the Securities Act if they can prove any of the following:

1) Defendant’s ______________ in a registration statement was not an _____________ of a ___________ ____________.

2) The plaintiff ___________ about the misrepresentation at the time of ______________ the stock.

3) Defendant exercised _____ ____________ in preparing registration statement and believe at the time he was making the statement, that the facts were _________ and there were no ____________ of ___________ ___________s.

Answer 16

omission; omission; material fact; knew; purchasing; due diligence; true; omissions; material fact

Question 17

Securities Exchange Act of 1934

Answer 17

Requires the regulation and registration of security exchanges, brokers, dealers, and national securities associations.

Question 18

SEC Rule 10b-5

Answer 18

Securities and Exchange Commission prohibits authorization of fraud in connection w/ purchase or sale of securities.

Question 19

SEC Rule 10b-5 applies to _______ securities being sold by (issuing) corporations, even those that are _______ registered under the ______________ Act of 1933.

Answer 19

all; NOT; Securities

Question 20

Elements necessary to succeed in claim of Securities Fraud Action:

1. ____________ _____________ or omission in connection with the purchase or sale of securities.
2. _____________
3. Plaintiff’s _______________ on material misrepresentation.
4. _____________ loss
5. ____________, meaning there’s a causal connection between the material misrepresentation and economic loss.

Answer 20

Material Misrepresentation; Scienter; Reliance; Economic; Causation

Question 21

Insider Trading

Answer 21

the purchase or sale of securities based on information that hasn’t been released to the public yet.

Question 22

Material Facts that require disclosure under SEC Rule 10b-5:

1) _______________ trading in the company’s stock by a __________-____________ ( firms that sell securities on their own account before selling securities to consumers).

2) A ____________ [amount of money corporation pays shareholders from its profits] change (whether up or down).

3) A contract for the sale of ______________ assets.

4) A new ____________, new _____________, or new ___________.

5) A significant change in the firms _______________ condition.

6) Potential _______________ against the company.

Answer 22

Fraudulent; broker-dealer; dividend; corporate; discovery; process; product; financial; litigation

Question 23

Insider trading usually involves ____________: _____________ officers, _______________, and majority _____________________. As of late, SEC Rule 10b-5 has extended liability for insider trading to specific “______________” – people who trade based on ___________ information, but acquired the information _______________.

Answer 23

insiders; corporate; directors; shareholders; “outsiders”; inside; indirectly.

Question 24

2 Theories for which Outsiders may be held liable for Insider Trading.

Answer 24

1) Tipper/Tippee Theory
2) Misappropriation Theory

Question 25

Tippee

Answer 25

A person who receives “tips” (inside information) from insiders (tipper)

Question 26

Remote Tippee

Answer 26

Tippee of a Tippee

(receive insider information from the tippee that indirectly received insider information).

Question 27

Tipper/Tippee Theory

Answer 27

1) There was a duty not to disclose (required of tipper).

2) disclosure is made in exchange for personal benefit.

3) tippee knows of breach and benefits from it.

Question 28

Misappropriation Theory

Answer 28

one wrongfully obtains (misappropriates) inside information, and passes it on for personal gain.

(this is a form of stealing property/information that rightfully belongs to another).

Question 29

Proxy

Answer 29

authority to represent someone else

Question 30

Securities Exchange Act of 1934 Regulation of Proxy Statements:

Answer 30

Whoever solicits (requests) a proxy must disclose, in the proxy statement, all relevant information on which shareholders are going to vote.

Question 31

Online Securities Fraud: Investment News Letters

There is a law requiring investment news letters, where corporations tout their _______________, to publicize the name of the ____________ who wrote the newsletter. Many online newsletters don’t do that: this is a sign of ____________. So a __________ investor reading one of these investment newsletters by an anonymous author may beleive the information they’re reading is _____________, but it’s not. The ______________ will profit from convincing investors like this to purchase the ____________ (_____________) they sell.

Answer 31

securities; author; fraud; public; unbiased; fraudsters; stocks; (securities)

Question 32

Online Securities Fraud: Social Media

It’s a bit more difficult for the SEC to spot __________ on social media, where _______________ accounts try to convince users to invest in and trade certain _____________. The government would have to ____________ the social media website to investigate and identify the user spreading false information, but even then social media sites are always being _________________, which makes the job harder.

Answer 32

fraud; anonymous; stocks; subpoena; updated

Question 33

Corporate Governance

Answer 33

• specifies rights and responsibilities of members of a corporation
• spells out rules / procedures for making corporate decisions

Question 34

Corporate Governance: Governance and Corporate Law–

Having a strong and _____________ corporate governance is important, considering corporate ______________ (by _______________) is not the same as corporate ______________ (corporate _______________, ______________ etc…). Those who have corporate ______________ may act in their own best ___________ at the expense of those with corporate ______________.

Answer 34

effective; ownership; shareholders; control; officers; managers; control; interest; ownership.

Question 35

Corporate Governance: Board of Directors–

The Board of Directors must be elected by the ________________, and must direct corporate _____________ (& managers) to act in the best __________ of ___________________. In reality, _______________ don’t really hold ________________ personally liable for corporate ________________

Answer 35

shareholders; officers; interest; shareholders; shareholders; directors; failings

Question 36

The Sarbanes-Oxley Act (2002)

Answer 36

Requires corporate executives to take responsibility for the accuracy of financial statements filed w/ the SEC.

Question 37

Sarbanes-Oxley Act: More internal controls and accountability–

The Sarbanes Oxley Act introduced federal ____________ corporate governance requirements for ____________ companies. The law created new requirements to make the ___________ of ____________ _____________ work more effectively. These requirements included independent _________________ of company _________ by the board of _________ and______________.

Answer 37

DIRECT; public; system; internal controls; monitoring; officers; directors; auditors

Question 38

Sections _____ and ______ of the _______________-___________ Act require high-level managers to create an effective _______________ of ________________ controls. This system must include “______________ _______________ and ________________” and must ensure the ______________ and _____________ of _____________ reports, and results are to be documented ____________ to reporting. This system’s effectivity is reassessed _____________.

Answer 38

302; 404; Sarbanes-Oxley; system; internal; “internal controls and procedures; accuracy; timeliness; financial; prior; annually

Question 39

Sarbanes-Oxley Act: Exemptions for Smaller Companies–

The Sarbanes-Oxley Act initially stated that all public companies must have __________ file ____________ with the ______ regarding the assessment of __________ controls. Congress, though, made an exemption for “____________” companies–companies whose market capitalization is less than $_______ million–saying these companies’ ____________ don’t have to file _________ on the assessment of ___________ controls.

Answer 39

auditors; reports; SEC; internal; smaller; $75; auditors; reports; internal

Question 40

Section _______ of the _______________ - ____________ Act require ______________-_______________ ____________ (___ ___ ___’s) and _______________-______________ ______________ (___ ___ ___’s) to certify the information in corporate _____________ statements are _______________, and “fairly represents the _______________ conditions and results of ____________ of the _________.” This makes __ __ __’s and __ __ __’s directly ____________ for the ___________ of their _____________ reporting.

Answer 40

906; Sarbanes Oxley; Chief-Executive Officers; (CEO’s); Chief-Financial Officers; (CFO’s); financial; accurate; financial; operation; issuer; CEO’s; CFO’s; accountable; accuracy; financial