Chapter 12-Federal Securities Regulations

Question 1

what is the 1933 federal securities act?

Answer 1

it is also called the “truth in securities act” and is concerned with the original issuance of securities intended for sale to the public. the acts intent is to ensure sufficient information is available to potential investors, NOT to determine desirability of the securities.

Question 2

what is the 1934 securities and exchange act?

Answer 2

this act created the SEC which provides ongoing reporting requirements and focuses on secondary offerings of securities and regulates purchases and sales after initial issuance.

Question 3

what is the SEC responsible for?

Answer 3

• administering federal securities laws
• regulating brokers
• issuing rules on details of retaining workpapers and other relevant records connected with audits or reviews (sarbanes oxley act)
• ability to de-list any issuer not in compliance with sarbanes oxley act.

Question 4

what is a security?

Answer 4

it is defined as an investment in an enterprise where the investor intends to make a profit through the managerial efforts, rather than through his own efforts. ex. common stock, preferred stock, treasury stock, bonds, debentures, options, warrants, some notes, limited but not general partnership interest (since involved in the management of the co.) all investment contracts and collateral-trust certificates (type of bond). DOES NOT INCLUDE CERTIFICATES OF DEPOSITS

Question 5

what is a prospectus (part 1) of the registration statement that a company that wishes to go public must file?

Answer 5

it is a written, tv or radio offer to sell securities and must be available to investors before or with every sell. it summarizes the information required in part two (registration statement) which is the following:

• historical company information
• discusses the risks involved

Question 6

what is a registration (part 2) disclosure document that a company that wishes to go public must file?

Answer 6

• basic information
• *names and addresses and amount of securities held by directors, officers, underwriters and shareholders with at least 10% of the stock
• *intended use of the proceeds
• *company’s debt
• *company’s operating history and pending litigation
• financial information
• *audited balance sheet (not more than 90 days old)
• *audited profit and loss statement (for previous 5 years)

ALL OF THIS NEEDS TO BE DISCLOSED

Question 7

when does the SEC deem registrations statements effective?

Answer 7

once they are complete and usually 20 days after they have been filed. securities may now be sold, providing investors receive a prospectus with the sale.

Question 8

before the registration is effective, what may a company do?

Answer 8

it is called the waiting period and the company may still do the following:

• make oral offers to sell
• issue a preliminary prospectus called a “red herring” which is a prospectus that has been filed but is missing certain unavailable information (like issue price) has not yet become effective.
• after the effective date a tombstone ad can be placed announcing how to acquire a prospectus
• for companies that issue securities to the public on a continuous basis, such as mutual funds, a form of registration known as a shelf registration is available. such a registration requires the company to periodically update the prospectus, but allows sales and resales to be continuous for an indefinite period of time. THIS IS NOT AVAILABLE FOR FIRST TIME ISSUERS.
• most states have adopted their own securities laws called “blue sky laws” which contain antifraud and registration provisions. compliance with the federal laws doesn’t automatically imply compliance with the state laws

Question 9

what is a tombstone ad?

Answer 9

it announces the availability of a prospectus on a potential investment and is not itself considered an offer to sell.

Question 10

A registration statement must be filed and a prospectus made available when applicable offerings are based on what?

Answer 10

S-P-I-N

• offer securities (stocks, bonds, debentures, options, warrants, limited but not general partnerships, all investment contracts)
• public issue (large number of people that are issuers of securities; which are the issuing company, officer, director, majority shareholder which is greater than or equal to 10%; dealer; underwriter
• interstate commerce (between states)
• No other exemption is available and there are two types of exemptions which are exempt securities (like mutual bonds) and exempt transactions.

the exemption may relate to the security being offered (exempt securities) or the way in which the security is being offered (exempt transactions)

Question 11

what are public offers?

Answer 11

refers to attempts to transfer shares from the issuing company or other knowledgeable insiders to outsiders who may have no special understanding about the company. it does NOT refer to general trading among members of the public, since this law was not intended to regulate the securities industry as a whole (the 1934 act regulates the industry)

if an issuer sells a security that fails to meet disclosure requirements of the 1933 act, the purchaser may request rescission of the sale.

Question 12

what is interstate commerce?

Answer 12

it refers to offers that involve people in more than a single state. offers in a single state are generally exempt from this act.

Question 13

when the securities act of 1933 law applies, what is required for those offerings the securities?

Answer 13

each prospective investor with a document known as a prospectus, containing substantial historical information about the company and discussion of the risks involved in the securities

Question 14

what are the exemptions under the 1933 Securities Act

Answer 14

A-C-I-D_B-R-A-I-N-S

• -*Regulation A (small offerings of less than or equal to 5 million within 12 months/ must notify the SEC within 15 days with whats called an offering circular (is a summary of the registration statements and it is just not audited and is not in alot of detail). they can advertise and resell it immediately
• -*Commercial paper (notes, bonds) with maturities less than or equal to 9 months and used for commercial purposes (not investing) so they are short-term bonds issued by the organization; casual sales and sale by OTHER THAN issuer, underwriter, dealer, officers or someone that has greater than or equal to 10%
• -*INTRAstate offerings; at least 80% of co sales are exclusive to state of incorporation (means in a single/ONE state) and principal place of business, buy buyers cannot resell outside the state (non-residents) for 9 months. Securities are offered exclusively to residents of that state
• -*Regulation D; private placement offerings (504,505,506)
• -*Brokerage transactions means i am not a controlling person like an officer, director or own more than 10%
• -*Regulated industries (savings and loans ex: cd’s)
• -*Agencies of government (railroads, municipal bonds)
• -*Insurance contracts/Policies but STOCK ISSUED BY INSURANCE COMPANIES IS NOT EXEMPT
• -*Not for profit (charity/church)
• -*Stock dividends and splits (exchanges with existing holders) as long as no commission is paid

Question 15

what is the regulation A (small offering) exemption?

Answer 15

it applies to offerings by issuers that raise up to 5 million over a time period not exceeding 12 months (the same limits as rule 505 of Regulation D). such an offering can be freely advertised and there are no restrictions on resale or the types of investors. the only requirements are;

• the SEC must be notified within 15 days of the first sale (the same requirement that applies to all Regulation D offerings)
• an offering circular (mini-registration statement) containing key information about the company must be prepared and provided to all prospective investors (an offering circular is far less extensive than a prospectus and none of the information in the circular needs to be audited
• nonissuers are allowed to sell up to 1,500,000 of securities within 12 months.

Question 16

Commercial paper sales (like bonds, notes that mature in less than or equal to 9 months) which are sold in “casual sales” are also exempt under the 1933 securities act. what are they?

Answer 16

these refer to sales by persons not connected with the issuing company and are available to all sellers EXCEPT:

• -*Issuers
• -*underwrites
• -*dealers
• -*directors
• -*officers
• -*owners of at least 10% of any class of sharesHOLDERS

Question 17

what are a few other minor exemptions?

Answer 17

• -*sales of government securities
• -*issuances by companies that are already being regulated by a federal agency such as banks regulated by the federal reserve system and railroads regulated by the interSTATE commerce commission
• -*insurance policies
• -*fund raising by non-profit organizations
• -*short-term loans to be repaid within 9 months (also known as commercial paper)
• -*exchanges of securities with existing shareholders at no charge such as stock splits and dividends.

Question 18

what is regulation d rule 504?

Answer 18

rule 504 applies to offerings up to 1 million to be completed within 12 months (seed capital exemption)

• -*sec must be notified within 15 days of first sale and the following apply:
• **no advertising to non accredited investors
• **resale to nonaccreditied investors is permitted
• **no special info given to investors
• **unlimited number of investors
• **cannot use if required to report under 1934 act

Question 19

what is regulation D rule 505?

Answer 19

relates to offerings up to 5 million to be completed within 12 months:

• *the SEC must be notified within 15 days of first sale
• *all general solicitation (advertising) of the offer prohibited
• *no resale for 2 years (investment purpose only - restricted security); the issuer needs to take reasonable steps to assure that the purchaser is buying for investment purposes and not for underwriting purposes
• *unlimited number of accredited investors
• *limited to 35 or fewer non accredited investors
• *audited balance sheet must be provided to non accredited investors
• *can use if required to report under 1934 act

Question 20

what is an “accredited investor”

Answer 20

includes banks, savings and loans, credit unions, insurance companies, broker dealers, certain trusts, partnerships and corporations, wealthy individuals which includes people with a net worth exceeding 1,000,000 (excluding primary residence meaning your house) or net income of 200,000 (300,000 mfj) for the two most recent years

Question 21

what is regulation D rule 506?

Answer 21

• *unlimited as to dollar value and time
• *all requirements of rule 505 apply
• *non accredited investors must be sophisticated investors or be represented in their purchase by a sophisticated investor
• *can use if required to report under 1934 act
• *under the JOBS act title II now allowed for general solicitation provided all purchasers are accredited investors

Question 22

summarize regulation D (private placement) rule 504

Answer 22

-no advertising to nonaccredited investors

• -*MUST NOTIFY THE SEC WITHIN 15 DAYS OF THE FIRST SALE
• -*resale to nonaccredited investor is permitted
• -*offerings of less than or equal to 1,000,000 is the threshold
• -*offerings must occur within the first 12 month period
• -*you don’t have to provide any financial information.

Question 23

summarize regulation D (private placement) rule 505

Answer 23

-MUST NOTIFY THE SEC WITHIN 15 DAYS OF THE FIRST SALE
-NO ADVERTISING
-INVESTMENT PURPOSES ONLY AND CANNOT RESELL FOR 2 YEARS
-offerings up to 5 million
-OFFERINGS MUST OCCUR WITHIN A 12 MONTH PERIOD
-unlimited ACCREDITED investors
-NON ACCREDITED INVESTORS CANNOT BE MORE THAN 35 SO LESS THAN OR EQUAL TO 35
-ACCREDITED INVESTORS NO financial information has to be provided
NON-ACCREDITED INVESTORS MUST BE PROVIDED WITH AN AUDITED BALANCE SHEET

Question 24

summarize regulation D (private placement) rule 506

Answer 24

• -*MUST NOTIFY THE SEC WITHIN 15 DAYS OF THE FIRST SALE
• -*NO ADVERTISING
• -*INVESTMENT PURPOSES ONLY AND CANNOT RESELL FOR 2 YEARS
• -*UNLIMITED DOLLAR AMOUNT over 5 million
• -*UNLIMITED AMOUNT OF TIME FOR ISSUANCE
• -*UNLIMITED ACCREDITED INVESTORS
• -*NON ACCREDITED INVESTORS MUST BE LESS THAN OR EQUAL TO 35
• -*ACCREDITED INVESTORS DO NOT HAVE TO BE GIVEN FINANCIAL INFORMATION
• -*NON ACCREDITED INVESTORS MUST BE GIVEN AN AUDITED balance sheet and be represented by an ACCREDITED investor means you must go through a broker.

note: under JOBs act, general solicitation allowed if all are accredited investors

Question 25

what is the exemption rule under 144 that relates to section 505 & 506?

Answer 25

a purchaser of restricted securities in a private offering (regulation D) who purchased them for investment purposes rather than resale, may resell the securities subject to certain restrictions w/o being subject to registration provisions. the securities must have been held for at LEAST 2 years, only limited amounts of stock may be sold (ex. they may not all be dumped on the market but can be trickled in and no more than 1% of all outstanding shares can be sold every 3 months) and the SEC must be notified of the intention to sell the restricted securities.

Question 26

what happens if a company violates the securities act of 1934?

Answer 26

the company maybe sanctioned by the SEC by having trading of its securities suspended, or having registration of its securities for sale to the public denied, suspended, or revoked. the SEC also have the power to regulate and sanction brokerage firms and investment advisers.

Question 27

what does the 1934 act deal with?

Answer 27

deals with the subsequent purchase and sales of securities. says that certain size companies have registration and reporting requirements and all purchasers and sellers of securities must adhere to the anti-fraud provisions.

**under the liability provisions of section 10, rule 10b-5, it is unlawful to make any untrue statement of a material fact or omit to state a material fact (ex writing off a material bribe as a consulting fee in a 10Q)

**under section 18, it is unlawful to make false or misleading statements with respect to a material statement unless done in “good faith” ex. intentionally filling an incorrect quarterly report with the SEC)

Question 28

when do the registration or reporting requirements (S-1)under the 1934 act apply?

Answer 28

it applies if either:

• *listed or traded on a national exchange OR
• *at least 10 million in assets AND 500 shareholders

the required disclosures are:

• *Name of officers and directors
• *nature of business
• *financial structure of firm
• *any bonus and profit-sharing provisions.

Question 29

under the jobs act what are the stipulations for shareholder limits?

Answer 29

**title V adjust the 500 shareholders to 500 NONACCREDITED shareholders or 2,000 total shareholders. it allows a private company to remain private longer

**title VI of the Jobs act also exempt shares held by employees from the 500 who received their shares under an employee stock compensation plan.

Question 30

what are the period reports that must be filed by the company with the SEC?

Answer 30

• form 10K which is the annual comparative audited financial statements certified by a CPA within 60 DAYS AFTER YEAR END of the fiscal year covered by the report for LARGE ACCELERATED FILERS (companies w/a market value of at least 700 MILLION in equity held by non affiliates); 75 DAYS AFTER YEAR END COVERED BY THE REPORT FOR ACCELERATED FILERS WITH AT LEAST 75 MILLION IN EQUITY; 90 DAYS AFTER THE END OF THE FISCAL YEAR COVERED BY THE REPORT FOR ALL OTHER REGISTRANTS OF LESS THAN 75 MILLION IN EQUITY AND THEY ARE CALLED NON ACCELERATED FILER
• Form 10Q quarterly UNAUDITED but REVIEWED financial information for each first 3 fiscal quarters due with in 45 DAYS of the END OF THE QTR (40 DAYS AFTER THE END OF THE FISCAL QUARTER FOR ACCELERATED AND LARGE ACCELERATED FILERS)
• Form 8K are current reports due shortly after certain key events (CHANGE IN OFFICERS, DIRECTORS, RESIGNATION OF DIRECTORS, CHANGE IN CONTROL) MUST BE FILED WITHIN 4 DAYS OF A MAJOR CHANGE IN THE COMPANY
• Proxy statement is the identification and objective discussion of matters to be voted on at the upcoming shareholder meeting.

Question 31

companies with market value of outstanding securities of greater than 700 million which are called large accelerated filer have what filing requirements under the 1934 act?

Answer 31

must file the following:
10K in 60 Days AFTER YEAR END
10Q in 40 (days after the end of a qtr)

Question 32

companies with market value of outstanding securities of greater than 75 million but less than 700 million which are called ACCELERATED FILERS have what filing requirements under the 1934 act?

Answer 32

must file the following:
10K in 75 Days AFTER YEAR END
10Q in 40 days (after the end of a qtr)

Question 33

companies with market value of outstanding securities of less than 75 million which are called NON-ACCELERATED FILERS have what filing requirements under the 1934 act?

Answer 33

must file the following:
10K in 90 Days after year end
10Q in 45 days

Question 34

what is a tender offer?

Answer 34

attempts to buy 5% or more of a class of stock and is considered a takeover bid by a prospective acquirer to all stockholders to tender their stock at a specified price. the person wishing to acquire the stock (the bidder) must file with the SEC. but the target company doesn’t need to file with the SEC.

Question 35

what do owners of 5% or more have to file?

Answer 35

Schedule 13D showing the following:

• source of the funds used for purchase
• amount of stock owned
• price offered for the shares
• future plans for the company and disclose to the SEC; the company; and the stock exchange.in which it is traded

Question 36

what are the rules for insider trading?

Answer 36

directors, officers, and 10% or greater shareholders must report every purchase and sale. profits resulting from a purchase and sale within six months (short swing profits) must be returned to the corporation.

Question 37

what is a proxy solicitation?

Answer 37

-the right to vote someones shares at a shareholder meeting. must be sent to each shareholder and must notify the SEC 10 days PRIOR to MAILING

Question 38

what is regulation fair disclosure (FD)?

Answer 38

it states that if a issuer unintentionally discloses material information to select persons including holders of securities and stock professionals, the SEC requires that the info be disclosed as soon as possible to the general public through either a press release or form 8K and if an issuer INTENTIONALLY discloses material information to select persons they must disclose that information SIMULTANEOUSLY TO THE GENERAL PUBLIC

Question 39

what is the liability for not meeting the reporting requirements or violating provisions of the 1933 or 1934 act?

Answer 39

a company not meeting the reporting requirements or violating provisions of the 1933 or 1934 act could have the registration of its securities suspended or revoked and be civilly liable. the cpa may be criminally liable if they violate any provision of the acts or willfully omits a material fact required to be stated in a registration statement.

Question 40

what does the sarbanes oxley act require?

Answer 40

each periodic report that contains financial reports of the issuer must be accompanied with written statement of the CEO or CFO that certifies that reports comply fully with relevant securities laws and also fairly present the financial condition of company in all material respects:

• *any officer who makes certification while knowing it does not comply with SEC requirements can be fined up to 1 million or imprisoned up to 10 years or both. officers can be fined up to 5 million or imprisoned for up to 20 years or both for willful violation of this certification requirement.
• *amends 1934 act to make it all illegal for issuer to give various types of personal loans to or for any executive officer or director
• *requires executives of an issuer to forfeit any bonus or incentive based pay or profits from the sale of stock, received within 12 months prior to an earnings restatement when misconduct was present
• *requires the auditor to promptly inform the board of directors (audit committee) of all significant problems identified during the engagement.
• *violations of rules of the public company accounting oversight board (pcaob) of the sarbanes oxley act are treated as a violation of the securities act of 1934 with its penalties

Question 41

what are the 5 types of opinions for an audit report?

Answer 41

• *unqualified/unmodified opinion which is the standard “clean” opinion
• *unqualified/unmodified opinion with an emphasis of a matter or other matter
• *qualified opinion - except for; disagreement with management of non-gaap, inadequate disclosure, inconsistency, scope limitation
• *adverse opinion - “does not present fairly”
• *disclaimer of opinion - “we do not express an opinion”

Question 42

what is the 1934 securities and exchange act?

Answer 42

is the law that created it is deals with subsequent trading; the SEC and gave it broad powers to regulate the securities industry. it is unrelated to the securities act of 1933 and a company that is exempt under one act does not mean it is exempt under both acts. they are unrelated!

Question 43

what is the jobs act?

Answer 43

established in 2012 the jobs act (jump start our small business startups) was enacted as a means of stimulating the economy by making it less difficult for business, and particularly emerging growth companies (ECG’s) to access the public capital markets. an emerging growth company is a business that had revenues of less than 1 billion as of the end of its most recent fiscal year.

Question 44

when is an entity no longer an EGC?

Answer 44

at the earliest of the following:

• *the last day of the year in which the 5th anniversary of the IPO falls
• *the last day of the year in which annual revenues are 1 billion or more
• *the date on which an entity has issued more than 1 billion in non-convertible debt in the previous 3 year period
• *the date on which the entity is considered to be a large accelerated filer which is greater than 700 million market value of securities outstanding

Question 45

what does title I of the jobs act do?

Answer 45

it is geared toward reopening american capital markets to emerging growth companies (the IPO “on ramp”). this section benefits entities considered ECGs by reducing some reporting and disclosure requirements. this was passed to encourage companies to issue ipo’s as they had been declining in previous years. it allows the company to be partially exempt from certain disclosures that were deterring companies from choosing to go public.

Question 46

what are the reduced disclosures under title I in the jobs act of 2012

Answer 46

• eliminates requirement for executive compensation discussion and analysis in relation to the performance of the entity
• makes EGC exempt from provisions of dodd frank requiring entities to allow stockholders a “say on pay” vote related to executive compensation
• exempts EGC from dodd frank requirement to disclose comparing compensation of the CEO to the average compensation of all other employees
• amends the securities act of 1933 to require ONLY 2 years rather than 5 years of financial information in the registration statement filed in connection with its IPO; allows underwriters of IPO’s to prepare research papers before and after the offering; allows solicitation to qualified institutional buyers and accredited investors before or after the filing of a registration statement prior to it being made public for SEC staff to review; an EGC is also permitted to file a confidential IPO registration statement with the SEC that must be made public at least 21 days before it begins actively promoting the sale of its offering
• amends the 1934 act to allow ECGs to use the effective date applicable to nonpublic entities for new standards, which is generally later than that for public entities.
• amends sarbanes oxley reducing requirements for EGCs; exempts EGCs from the requirement for the auditor to attest to managements assessment of internal control over financial reporting; exempts auditors of EGC’s from partner rotation and from providing additional information about the audit and the financial statements
• eliminates requirement to provide selected financial information for periods prior to the first audited financial statements included in the entity’s first registration statement
• reduced disclosures related to executive compensation and eliminates the requirement for executive compensation discussion and analysis.

Question 47

what does title II of the jobs act of 2012 state?

Answer 47

it relates to access to capital for job creators:
eliminates prohibition against general solicitation and general advertising provided all purchasers are accredited investors for regulation D, 506. allows offer of sale of securities including use of general solicitation and general advertising, to persons other than qualified institutional buyers provided that all sales are to those believed to be qualified institutional buyers. also eliminates firewalls established to prevent research analysts from communicating with their firms IPO bankers and their banks IPO clients

Question 48

title III under the jobs act relates to crowd funding, what does it state?

Answer 48

allows entities to issue securities through crowd funding which is the obtaining of small investments from a large number of investor. this would be an additional exemption that would make it possible for privately owned companies to sell securities to investors over the internet through registered crowdfund portals.

• *maximum of 1 million may be raised in a 12 month period
• *crowfunding must be done through an intermediary registered with the SEC
• *limits are set on amounts individual investors may invest like the greater of 2,000 or 5% of annual income or net worth if annual income or net worth is less than 100,000; up to 10% of annual income or net worth, up to a maximum of 100,000 if income or net worth exceeds 100,000
• *eliminates limit of 2,000 total investors and 500 nonaccredited investors in crowd funding.

Question 49

what does title IV (small company capital formation) of the jobs act of 2012 state?

Answer 49

expands on regulation A exempting offerings to the public of up to 50 million and provides an exemption for a new class of securities

• *aggregate offering up to 50 million within 12 month period
• *securities may be offered and sold publicly
• *securities must be unrestricted equity securities, debt securities, and debt securities that are convertible into equity securities
• *must provide annual audited financial statements

Question 50

what does title V (private company flexibility and growth) of the jobs act of 2012 state?

Answer 50

amends the securities exchange act of 1934 to make the threshold for registration of total assets exceeding 10 million and at least 2,000 investors or at least 500 non accredited investors. this allows private companies to remain private longer

Question 51

what does title VI (capital expansion) of the jobs act of 2012 state?

Answer 51

addresses when a shareholder would be required to file a registration statement. title VI also says that a shareholder who received their shares as part of an employee compensation plan will NOT be counted as part of the 500 shareholders.

Question 52

what does title VII (outreach on changes to the law) of the jobs act of 2012 state?

Answer 52

requires the SEC to provide information about the changes online

Question 53

why was the dodd frank act passed (it is also known as the wall street reform and consumer protection act of 2010)?

Answer 53

it was passed to promote the financial stability of the U.S., improve the accountability and transparency of the financial system, END “too big to fail”; END bailouts (like gm, chrysler, citigroup and bank of america) and to protect consumers from abusive financial services practices. it affects many aspects of the financial system and many financial regulatory agencies (i.e. regulators) sets up new regulatory agencies, and calls for regulators to adopt over 240 new rules and regulations.

Question 54

what does title I of the dodd frank act state?

Answer 54

it relates to financial stability and it creates the “financial stability oversight council (FSOC). this council is tasked with identifying risks to U.S. financial stability, promoting market discipline by eliminating the expectation of a government bailout, and responding to emerging threats to financial stability. it is responsible for monitoring the financial system, collecting information, and making recommendations to other agencies and is subject to audit by the US comptroller general.

the council is authorized to require registration with and oversight by the federal reserve of nonbank financial entities if their financial distress or other factors could make them a threat to U S financial stability (systematically important financial institutions, SIFIs). the council may also require bank holding companies with total assets of at least 50 BILLION and non bank financial entities required to register to SUBMIT CERTIFIED REPORTS indicating their financial condition, systems for managing risks, transactions with subsidiary depository institutions, the extent to which adverse conditions may affect US financial stability (stress tests) and companies plans for orderly shutdown should they become insolvent (living wills)
-this title also creates the office of financial research (OFR) to support the council fulfilling its purpose. it consists of a data center, responsible for data collection, and a research center and analysis center. the OFR can also issue a subpoena when necessary

Question 55

What does title II of the dodd frank act state?

Answer 55

Gives the secretary of treasury the authority to liquidate financial companies that pose as a significant threat to US financial stability. It will identify financial companies as candidates for receivership, appointing the federal deposit insurance corporation as receiver. Companies can voluntarily go into receivership or the FDIC will evaluate & decide