Chapter 16

Question 1

Securities transactions have what type of settings?

Answer 1

1) original and re-issuance by a business to raise capital (primary market)
2) the purchase and sale of securities between investors (secondary market)

Question 2

What governs the securities market?

Answer 2

federal and state securities laws

Question 3

Issuing a security to the public market for the first time is known as…

Answer 3

Initial Public Offering

Question 4

Why do investors sell securities in the secondary market?

Answer 4

investors sell securities to other investors in the hopes of making a profit or preventing a loss. business do not use the secondary market to raise capital
*it is a way to provide cash flow so investors can continue their investments in the primary market

Question 5

What type of investments are regulated by securities laws?

Answer 5

• stocks and bonds *agreements to invest
• partnership interests *participation in a pool of assets
• stock options *certain types of promissory notes
• warrants

Question 6

What are the two ways a federal securities statute defines a security?

Answer 6

1) by recognizing specific forms of securities such as notes, stocks, treasury stocks, transferable shares, bonds, and debentures
2) by a generic, catchall definition including profit sharing agreements, collateral trust certificates, preorganization certificates or subscriptions, investment contracts, and a fractional undivided interest in gas, oil, or other mineral rights.

Question 7

What is the general definition of a security?

Answer 7

any investment where a person gives something with an expectation of profit through the efforts of a third party

Question 8

What constitutes a security offering (Howey Test)?

Answer 8

1) cash or non-cash investment in exchange for the hope of a return
2) investments that have a horizontal commonality (multiple investors with a common expectation of profit) or a vertical commonality (single investor with the hope of a profit from the promoter of the investment)
3) expectation of a return on the investment
4) the efforts of the promoter must be the primary source of revenue that results in a profit. investor is not really involved

Question 9

What constitutes a security offering (Howey Test)?

Answer 9

1) cash or non-cash investment in exchange for the hope of a return
2) investments that have a horizontal commonality (multiple investors with a common expectation of profit) or a vertical commonality (single investor with the hope of a profit from the promoter of the investment)
3) expectation of a return on the investment
4) the efforts of the promoter must be the primary source of revenue that results in a profit. investor is not really involved

Question 10

What are the two general types of securities?

Answer 10

equity and debt

*some securities have restriction on the right to sell the security

Question 11

What is an equity instrument?

Answer 11

an investor’s ownership interests where the return is based on the ventures performance without the promise of a return

Question 12

What are the two prevalent forms of securities?

Answer 12

common stock and preferred stock

Question 13

What is common stock (most common) ?

Answer 13

the investor is entitled to payments (dividends) based on the company’s profitability
*the BOD decides whether or not to pay dividends and the amount of payment

Question 14

Under what circumstance is a common stockholder given the right to payment?

Answer 14

if the company is sold for a profit or dissolved

Question 15

Do common stockholders have the right to vote?

Answer 15

depends on if they have voting or nonvoting stock

Question 16

Why do common stockholders have the greatest amount of risk?

Answer 16

they are subordinate to creditors and preferred stockholders.

Question 17

What type of equity is less risky than common stock?

Answer 17

preferred stock because they have preference rights over common stockholders when 1) the company pays dividends and 2) the company fails or files for bankruptcy
*preferred stock may be voting or non-voting

Question 18

What are examples of debt instruments?

Answer 18

promissory notes (most common), bond, debentures

• debt instruments are senior in priority to common and preferred stock
• investors are primarily interested in a fixed rate of return regardless of profitability and expect repayment of debt

Question 19

What is a promissory note?

Answer 19

a promise to pay back a certain sum of money plus accrued interest over a period of time. the lender is paid monthly with principal and interest payments

Question 20

What are bonds?

Answer 20

• debt instruments that secured with collateral
• used to raise capital by splitting up long-term debt
• investors expect fixed interest payments at regular intervals
• the face amount of the bond is not due until maturity

Question 21

What is a debenture?

Answer 21

unsecured debt backed by the corporations general credit history

Question 22

What is the rationale behind secuities regulations?

Answer 22

to protect investors and assure public confidence in the integrity of the market

Question 23

What is the underlying premise of all securities regulations?

Answer 23

disclosure

Question 24

Are securities law primarily a federal or state matter?

Answer 24

federal

Question 25

What is the Securities and Exchange Commission?

Answer 25

the federal administrative agency charged with rulemaking, enforcement, and adjudication of federal securities laws?

Question 26

How is the SEC different from other administrative agencies?

Answer 26

* its an independent agency that does not have a seat in the President's cabinet * the agency is not subject to direct control by the President

Question 27

Who composes the SEC?

Answer 27

five commissions appointed by the President and subject to the advice and consent approval by the Senate.

Question 28

What may cause the removal of a commissioner?

Answer 28

misconduct | *the SEC has wide-ranging executive, legislative, and judicial powers

Question 29

The SEC has what type of executive powers?

Answer 29

* the power to investigate potential violations of securities laws and regulations * the power to issue a cease and desist order * the power to initiate criminal charges against and individual or company

Question 30

What type of legislative powers is given to the SEC?

Answer 30

* Congress grants the SEC power to draft and publish securities regulations and interpretations of statutes, rules, and court decisions. * ability to issue interpretive letters and no-action letters to advise the community on how to proceed (not binding, but carry significant weight with courts)

Question 31

The SEC's judicial powers include...

Answer 31

* its role as a hearing tribunal for enforcing certain securities violations including alleged indiscretions of brokers in their business dealings * it has the power to suspend or revoke professional licenses of brokers

Question 32

What is the highest profile division of the SEC?

Answer 32

The Enforcement and Corporation Finance because of its responsibility to investigate and enforce action against violators

Question 33

What is EDGAR?

Answer 33

a public database that acts as a clearinghouse for corporations to submit filing requirements and disclosures

Question 34

What are the mandates of the Securities Act of 1933?

Answer 34

1) a registration filing for any venture selling securities to the public 2) certain disclosures concerning the issuer's governance and financial condition 3) SEC oversight over the registration and issuance of securities

Question 35

What are the preregistration documents required for a company to sell securities?

Answer 35

1) letter of intent-indicates management and board of approval to issue shares 2) comfort letters-corporate counsel verifying adherence to corporate formalities, compliance, and opinion on the financial records 3) underwriting agreement-amt of securities offered, compensation for underwriters, representations and warranties of the issue and underwriters

Question 36

What are the four phases of registration?

Answer 36

1) preregistration documents 2) issuer beings prefiling period while the registration statement is being prepared 3) SEC review of the statement 4) after the registration statement expires

Question 37

What are the two parts of the registration statement?

Answer 37

1) prospectus-gives realist view of the issuer's business, risk factors, financial position, financial statements, and disclosures 2) supplemental information supporting the prospectus

Question 38

Can securities be marketed or sold during the SEC's review of the registration documents?

Answer 38

nope

Question 39

How many days does the SEC have to review the registration document?

Answer 39

10

Question 40

During the 10 day registration review period, what can the SEC do to prevent the registration from taking effect?

Answer 40

the SEC can issue a refusal order within the 10 day review period

Question 41

Can the SEC stop the registration from taking effect after the 10 registration review period?

Answer 41

yes, by issuing a stop order

Question 42

At what point is it too late for the SEC to stop the registration?

Answer 42

if the SEC does not respond 20 days after the filing date, then the registration becomes effective

Question 43

Can the security be marketed or sold during the SEC review phase?

Answer 43

the security can be marketed under strict guidelines, but it cannot be sold

Question 44

When can securities be sold to the public?

Answer 44

once the registration becomes effective

Question 45

What happens during the post-registration time?

Answer 45

securities may be sold and marketed to investors, but investors must receive a prospectus *marketing materials are still subject to SEC oversight

Question 46

What is the purpose of allowing companies to file for exemption from the securities registration process?

Answer 46

to assist business ventures seeking smaller amounts of capital from the public investment community *most businesses offer their securities on an exempt basis

Question 47

What is the most common type of exemption?

Answer 47

nonpublic offerings to a limited number of sophisticated investors who know the issuer or who privately negotiate their securities purchases

Question 48

What is a safe harbor exemption?

Answer 48

offerings with specified dollar limitations and/or limitations on the number of investors

Question 49

What is a condition of estabilishing an exemption?

Answer 49

the seller must make available or provide an investor with a company prospectus and disclosures

Question 50

What are some examples of securities that are exempt from the registration requirements?

Answer 50

1) commerical paper with a maturity date of less than 9 months 2) securities of charitable organizations 3) annuities and other issues of insurance companies 4) government-issued securities (municipal bonds) 5) securities issued by banks and other institutions supervised by the government 6) under Regulation D, securities up to $5 million in any 12 month period

Question 51

Are both transactions and securities eligible for exemption?

Answer 51

yes, transaction exemptions fall under Regulation D

Question 52

What are Regulation D transactions?

Answer 52

limited offers of a relatively small amount of money or offers made in a limited manner

Question 53

What are some of the Regulation D exemptions (by rule number)?

Answer 53

1) Rule 504-exempts a noninvestment company offering up to $1 million in any 12 month period 2) Rule 504a-exempts offerings up to $500k in any 12 month period by certain companies 3) Rule 505-exempts a private investment company offering up to $5 million in any 12 month period 4) Rule 506-exempts a private noninvestment company offerings in unlimited amounts that are not generally advertised to the public

Question 54

Which Regulation D rule apply to private noninvestment companies?

Answer 54

rule 505 and 506

Question 55

What is the dollar limit amount for rule 504?

Answer 55

$1 million within 12 months

Question 56

Is there a dollar limit amount for rule 506?

Answer 56

nope

Question 57

What is the dollar limit amount for rule 504a?

Answer 57

$500k within 12 months

Question 58

What is a private placement?

Answer 58

the issuer only accepts investments from those who meet the standards for accredited investors (sufficient experience to understand the investment risk, ability to protect their own interests) * investors must meet personal net worth or income requirements in order to qualify * company disclosures are made through a private placement memorandum

Question 59

What are the most common private placement transactions?

Answer 59

1) offerings made up to $5 million to accredited investors within a 12 month period 2) purely local offerings, both issuer and investor must be within the same state, cannot sell to nonresident for 9 months

Question 60

How does the 33' act penalizes violators?

Answer 60

1) recission of the investment by the investor 2) civil penalties and fines 3) incarceration for egregious cases

Question 61

If a company fails to comply with the 33' act, what are its possible defenses?

Answer 61

1) ommission or misrepresentation was not material | 2) the investor knew about the risk and proceeded anyway

Question 62

What is the purpose of the Securities Act of 1934?

Answer 62

it regulates the sale of securities between investors after an investor purchased it from a business entitly issuer.

Question 63

The 34' act has authority over who?

Answer 63

brokers, dealers, securities associations, brokerage firms

Question 64

What is required by the 34' act if an issuer wants to sell a security on a national exchange

Answer 64

registration with the SEC and disclosure of all pertinent details to the potential investor

Question 65

The 34; act requires disclosure of what type of information?

Answer 65

1) the financial performance 2) corporate governance procedures 3) any changes in risk since the last report

Question 66

What is covered in Section (10)b of the 34' act?

Answer 66

* the primary antifraud provision covering the trading of securities * against the law to engage in fraud, directly or indirectly, in connection with the purchase and sale of any security * known as insider trading

Question 67

Who is considered an "insider"?

Answer 67

executives, managers, corporate counsel, consultants, employees, brokers, accountants, vendors, partners, and majority shareholders

Question 68

What is the Insider Trading and Securities Fraud Enforcement Act?

Answer 68

* it raised the criminal penalties for insider trading * increased the liability of brokerage firms for wrongful acts of their employees * gave the SEC more power to pursue violators

Question 69

What is the tipper-tippee liability?

Answer 69

an extension of rule 10(b)(5) that includes outside parties who leak and who learn of the insider information and trade stock based on that information

Question 70

Rule 10(b)(5) is violated if...

Answer 70

1) the information released by the tipper constitutes a breach of fiduciary duty to the company 2) the tipper receives a personal benefit for giving up the tip 3) the tippee knew that the information was wrongfully disclosed 4) the tippee benefited from the information

Question 71

What is Section 16 of the 34' act?

Answer 71

it imposes restrictions and reporting requirements on ownership positions and stock trades made by certain corporate insiders *provides transparency of all stock trades by insiders and prohibits insiders from earning short-wing profits

Question 72

According to Section 16, who is an insider?

Answer 72

an executive officer, a director, or a shareholder with ten percent or more ownership *insiders are required to file reports with the SEC disclosing stock ownership and trading of their company stock

Question 73

Why would the SEC want a report disclosing ownership and trading activity?

Answer 73

to monitor unusual activity that could be a sign of trouble or stock manipulation

Question 74

What is the clawback provision of Section 16(b)?

Answer 74

it allows a corporation to recapture any profits earned by an insider on the purchase and sale of the company's stock that occurred within a six month period (short-wing profits)

Question 75

What is the purpose of the clawback provision?

Answer 75

to deter insiders from profiting by manipulating the stock's short-term performance * a strict liability statue because the insider's intent does not matter

Question 76

What is the Private Securities Litigation Reform Act of 1995 (PSLRA) ?

Answer 76

* made it difficult to pursue litigation based solely on management's comments about company performance * provide safe harbor from lawsuits as long as the principals acted in good faith and disclosed all relevant facts * must prove scienter

Question 77

What is scienter?

Answer 77

evidence of specific intent to deceive, manipulate, or defraud

Question 78

What is scienter?

Answer 78

evidence of specific intent to deceive, manipulate, or defraud

Question 79

What is the Securities Litigation Uniform Standards Act of 1998?

Answer 79

to prevent certain State private securities class action lawsuits alleging fraud from being used to frustrate the objectives of "the Reform Act" (PSLRA)

Question 80

What is the purpose of blue-sky laws?

Answer 80

to protect investors from unsavory issuers selling nothing more than blue sky * intended to cover intrastate securities * additional safeguard for investors when the federal government declines jurisdiction

Question 81

Are blue-sky laws state or federal?

Answer 81

state

Question 82

What are some provisions of blue-sky laws?

Answer 82

* fraud in the sale of securities * registration requirements for brokers and dealers * exemptions * civil liability for issuers failing to comply * remedies for defrauded investors

Question 83

What is corporate governance?

Answer 83

* the procedure and system used by the officers and directors to establish lines of responsibility, approval, and oversight among the key stakeholders * set out rules for making corporate decisions

Question 84

What is the purpose of direct government regulation of corporate decision making?

Answer 84

* to ensure public confidence in publicly traded markets | * to protect investors

Question 85

What is the Sarbanes-Oxley Act of 2002?

Answer 85

* to impose stricter regulation and controls on how corporations do business through regulation of three broad areas: auditing, financial reporting, and internal corporate governance * provides for additional enforcement and increased penalties for violation of existing securities laws

Question 86

What is the Sarbanes-Oxley Act of 2002?

Answer 86

* to impose stricter regulation and controls on how corporations do business through regulation of three broad areas: auditing, financial reporting, and internal corporate governance * provides for additional enforcement and increased penalties for violation of existing securities laws

Question 87

What is the Public Company Accounting Oversight Board (PCAOB) ?

Answer 87

a federal agency that replaced the accounting industry's self-regulation

Question 88

What does the PCAOB do?

Answer 88

* it implements, administers, and enforces the SOX act | * establishes regulations that standardize certain auditing procedures and ethical parameters

Question 89

Who is required to register with the PCAOB?

Answer 89

accounting firms that audit public companies must register with the PCAOB and they are subject to its oversight and enforcement authority

Question 90

How does the SOX act increase auditors independence?

Answer 90

1) setting mandatory rotation of auditing partners 2) banning accounting firms from providing its customers with non-auditing consulting services 3) restrict accounting employees from leaving the firm to work for the client

Question 91

How does SOX make corporate officers more accountable?

Answer 91

* CEO and CFO must personally certify the accuracy of all SEC filings * they must ensure that the certification is based on reliable and accurate information through internal financial fraud-detection controls subject to review by outside auditors

Question 92

The SOX Act regulations set standardized_________ ________ ________ and restricts certain types of _________ ________ that are not ____________to auditors

Answer 92

financial reporting formats, accounting methods, transparent

Question 93

The SOX Act requires that public companies maintain audit committees compose of...

Answer 93

independent directors with at least one director with sufficient financial acumen to probe audit in depth

Question 94

What is the audit committee's obligations?

Answer 94

1) authority to monitor, engage, and terminate the company's outside auditing firm 2) implement a system of controls that involves a comprehensive examination of the audit reports and methods used by the company and outside auditors 3) establish a structure that facilitates communication directly between the audit committee and the auditors

Question 95

Does the SOX Act require companies to establish a code of ethics and conduct for its top financial officers?

Answer 95

Duh! | *officers and directors are also obligated to disclose their own buying and selling of stock within a certain time frame

Question 96

Under what conditions are executive performance bonuses required to be retroactively forfeited back to the company?

Answer 96

If the bonuses are tied back to false reports or issued without appropriate controls (clawback provision)