Ch. 42 Securities Law and Corporate Governance Flashcards Preview

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Flashcards in Ch. 42 Securities Law and Corporate Governance Deck (79):

Securities generally include what?

Any instruments evidencing corporate ownership (stock) or debts (bonds)


What major act did Congress pass after the latest economic recession?

Dodd-Frank Act


What act created the SEC?

Securities Exchange Act of 1934


What are the 5 basic functions of the SEC?

1) Interpret fed securities laws and investigate securities law violations
2) Issue new rules and amend existing rules
3) Oversee inspection of securities firms, brokers, investment advisers, and rating agencies
4) Oversee private regulatory organizations in the securities, accounting, and auditing fields
5) Coordinate US securities regulation with fed, state, and foreign authorities


What does the Securities Act of 1933 govern?

Initial sales of stock by businesses


What is the basic purpose of SA'33?

To require disclosure


What test does the US Supreme Court use to interpret SA'33?

Howey Test


What test guides the determination of what types of contracts can be considered securities?

Howey Test


Explain the Howey Test.

US Supreme Court holds that an investment contract is any transaction in which a person
(1) invests
(2) in a common enterprise
(3) reasonably expecting profits
(4) derived primarily or substantially from others' managerial or entrepreneurial efforts


Can an investment contract in a franchise qualify as a security?



What does Section 5 of SA'33 broadly state?

That if a security does not qualify for an exemption, that security must be registered before it is offered to the public


A corporation issuing a security must first do what?

File a registration statement with the SEC and provide all investors w/ a prospectus


What is a prospectus?

Disclosure doc that describes
1) the security being sold,
2) the financial operations of the issuing corp &
3) the investment or risk attaching to the security


The SEC's EDGAR database includes material on what?

- IPOs
- Proxy statements
- Corporation annual reports
- Registration statements
- Other docs filed with SEC


What five things must the registration statement fully describe in plain English?

1) Securities being offered for sale (including relationships to registrant's other securities)
2) Corporation's properties and business (including audited F/S)
3) Management of corporation (including managerial compensation, stock options)
4) How corp intends to use sale proceeds
5) Any pending lawsuits or special risk factors


May the issuer sell or offer to sell securities during the prefiling period of the registration process?



May the issuer offer to sell securities during the waiting period?

Yes (but can be offered for sale but cannot be sold yet)


What does the preliminary prospectus often lack that the final prospectus has?



What is a free-writing prospectus?

Any type of written, electronic, or graphic offer that describes the issuer or its securities and includes a legend indicating that the investor may obtain the prospectus at the SEC's website


What period in the registration process begins once the SEC has reviewed and approved the registration statement and the waiting period is over?

Posteffective period


What can the issuer do in the posteffective period of the registration process?

Can now offer and sell the securities w/o restrictions


Define well-known seasoned issuer (WKSI).

A firm that has issued at least $1b in securities over the last 3 years OR has at least $700m of value of o/s stock in the hands of the public


What can WKSIs do on the day they announce a new offering?

-Can file registration statements on the day they announce a new offering and are not required to wait for SEC review and approval
-Can use a free-writing prospectus at any time, even during prefiling period


Under Regulation A, an exemption from registration is available for an issuer's offerings that do not exceed what amount in securities during any 12-month period?

$5 million in securities


Issuers with Regulation A Offerings must file what with the SEC in lieu of a registration statement?

Notice of the issue and an offering circular, which must also be provided to investors before the sale


Companies are allowed to test the waters for potential interest before preparing the offering circular. To test the waters means to do what?

- To determine potential interest w/o actually selling any securities OR requiring any commitment from those who express interest


Can companies sell their securities via the internet using Regulation A?



What size offerings does Regulation D deal with?

Small offerings


Which exemption under Regulation D is used by most small businesses?

Rule 504


What does Rule 504 of Regulation D state?

Provides that noninvestment company offerings up to $1m in any 12-month period are exempt


Define noninvestment company.

Firms that are not engaged primarily in the business of investing or trading securities


Define investment company.

Firm that buys a large portfolio of securities and professionally manages it on behalf of many smaller shareholders/owners


Give an example of a well-known type of investment company.

Mutual fund


Explain Rule 505 under Reg. D.

Private, noninvestment company offerings up to $5m in any 12-month period are exempt


Explain Rule 506 under Reg. D.

Private, noninvestment company offerings in unlimited amounts that are not generally advertised or solicited are exempt


Rule 505 under Reg. D

Under this exemption, the offer may be made to what type of investors?

- Unlimited # of accredited investors
- Up to 35 unaccredited investors


Define accredited investor.

Includes banks, insurance companies, investment companies, employee benefit plans, the issuer's executive officers and directors, and persons whose income or net worth exceeds a certain threshold


What is Rule 506 under Reg. D often referred to as?

Private Placement Exemption


Most securities can be resold without what?

W/o registration


Resales of restricted securities acquired under Rule 505 or Rule 506 trigger the registration requirements unless the party selling them complies with what?

Rule 144 or Rule 144A


What are Rule 144 and Rule 144A sometimes referred to as?

Safe harbors


Rule 144 exempts restricted securities from registration on resale if what four conditions are met?

1) Adequate current public info about issuer
2) Person selling securities has owned them for at least 6 months if issuer is subject to reporting requirements of '34 act (if not, seller must have owned the securities for at least 1 year)
3) Securities are sold in certain limited amounts in unsolicited brokers' transactions
4) SEC is notified of the resale


Is it a violation of SA'33 to intentionally defraud investors by misrepresenting or omitting facts in a registration statement or prospectus?



Who prosecutes criminal violations?

Dept. of Justice


What are two punishments for SA'33 criminal violations?

Violators may be fined up to $10,000, imprisoned for up to 5 years, OR BOTH


What are three basic defenses to charges of violations under SA'33?

A defendant can avoid liability by proving ANY of the following:
1) Statement or omission not material
2) Plaintiff knew about the misrepresentation at the time the stock was purchased
3) Defendant exercised due diligence in preparing the registration and reasonably believed at the time that the statements were true


The Securities Exchange Act of 1934 provides for what?

Provides for the regulation and registration of securities exchanges, brokers, dealers, and national securities associations


Unlike the 1933 act, which is a one-time disclosure law, the 1934 provides for what?

Continuous periodic disclosures by publicly held corporations to enable the SEC to regulate subsequent trading


SEA'34 applies to what type of companies?

Companies that have assets in excess of $10m and 500 or more S/Hs (section 12 companies)


How often are Section 12 companies required to file reports with the SEC?

Annually and quarterly (sometimes even monthly if specified events occur such as a merger)


What does Section 10(b) under SEA'34 prohibit?

Prohibits the use of any manipulative or deceptive mechanism in violation of SEC rules and regulations


What does SEC Rule 10b-5 prohibit?

Prohibits the commission of fraud in connection with the purchase or sale of any security


Does a security need to be registered under the 1933 act for the 1934 act to apply?



What are the basic elements of a securities fraud action?

1) Material misrepresentation (or omission) in connection w/ purchase and sale of securities
2) Scienter (a wrongful state of mind)
3) Reliance by plaintiff on the material misrep
4) An economic loss
5) Causation, meaning that there is a causal connection b/w the misrep and the loss


Define scienter

A wrongful state of mind


One of the major goals of Section 10(b) and SEC Rule 10b-5 is to prevent what?

Insider trading


Is a dividend change an example of a material fact calling for disclosure under SEC Rule 10b-5?

YES (if it is significant enough that it would likely affect an investor's decision as to whether to purchase or sell the company's securities)


What two theories have been developed under which outsiders may be held liable for insider tradiing?

1) The tipper/tippee theory
2) The misappropriation theory


A tippee is liable only if what requirements are met?

1) There is a breach of a duty not to disclose inside info
2) The disclosure is made in exchange for personal benefit
3) The tippee knows (or should know) of this breach and benefits from it


Liability for insider trading may be established under the misappropriation theory. Define the misappropriation theory.

Holds liable an individual who wrongfully obtains (misappropriates) inside info and trades on it for his personal gain b/c the individual basically stole info rightfully belonging to another


What does Section 16(b) of the 1934 act provide for?

The recapture by the corporation of all profits realized by certain insiders on any purchase and sale or sale and purchase of the corporation's stock w/i any 6-month period


What act provides a safe harbor for publicly held companies that make forward-looking statements such as financial forecasts?

Private Securities Litigation Reform Act of 1995 (PRLRA)


Section 14(a) of SEA'34 regulates what?

Solicitation of proxies from S/Hs of Section 12 companies


Violations of the 1934 Act may lead to what types of liability?

Criminal and civil liability


For either criminal or civil sanctions to be imposed under the 1934 Act, what must exist?

Scienter (had intent to defraud or knowledge of his misconduct)


Is scienter or negligence required for Section 16(b) violations?



Violations of Section 16(b) include what?

Sale by insiders of stock acquired less than 6 months before the time of sale (or less than 6 months after the sale, if selling short--that is, selling securities that one does not yet own)


What are the criminal penalties for violations of Section 10(b) and Rule 10b-5 for individuals?

An individual may be fined up to $5m, imprisoned for up to 20 years, OR BOTH


What are the criminal penalties for violations of Section 10(b) and Rule 10b-5 for a partnership or corporation?

May be fined up to $25m


Which article of the UCC imposes various requirements relating to the purchase and sale of securities?

Article 8


What are states' corporate securities laws often referred to as?

Blue sky laws


Unless an exemption from registration is applicable, issuers must register or qualify their stock with the appropriate state official, often called a what?

Corporations commissioner


Define corporate governance.

Relationship b/w a corporation and its S/Hs


How have some corporations sought to align the financial interests of their officers with those of the company's S/Hs?

by providing the officers with stock options (which enable them to purchase shares of the corporation's stock at a set price)


Generally, what does the Sarbanes-Oxley Act of 2002 seek to do?

Seeks to increase corporate accountability by imposing strict disclosure requirements and harsh penalties for violations of securities law


What new entity did SOX create?



What does the PCAOB do?

Regulates and overseas public accounting firms


Which 2 sections of SOX require high-level managers to establish and maintain an effective system of internal controls?

Section 302 and 404


Section 906 of SOX requires what?

CEO and CFOs need to certify the accuracy of the info in the corporate F/S