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1
Q

What is the purpose of securities laws?

A

Timing of securities laws is right after the stock market crash of 1929. Statutes in this chapter were designed to give investors better information to assist in making more informed decisions on buying and selling of securities and to prohibit the fraudulent and deceptive practices that precipitated the crash of ’29.

2
Q

When and why was the SEC created?

A

1934 to administer the securities laws and create rules and regulations in the area of securities.

3
Q

What are the basic functions of the SEC?

A
  • Interprets federal securities laws and investigates securities law violations.
  • Issues new rules and amends existing rules.
  • Oversees the inspection of securities firms, brokers, investment advisors and ratings agencies.
  • Oversees private regulatory organizations in the securities, accounting and auditing fields.
  • Coordinates U.S. securities regulation with federal, state, and foreign authorities.
4
Q

The Securities Act of 1933

A
  • governs initial sales of stock by businesses
  • prohibits fraud
  • requires investors (SH) receive financial and other significant info concerning securities
  • many think of this law as a one-time or initial disclosure law
5
Q

When are companies regulated by the SEC?

A

Companies who are going public (IPO) and anyone or any company buying/selling securities are subject to SEC regulations.

6
Q

What is a security?

A
  1. Instruments and interests commonly known as securities, such as preferred and common stocks, treasury stocks, bonds, debentures, and stock warrants.
  2. Any interest commonly known as securities, such as stock options, puts, calls, or other types of privilege on a security or on the right to purchase a security or a group of securities in a national security exchange.
  3. Notes, instruments, or other evidence of indebtedness, including certificates of interest in a profit-sharing agreement and certificates of deposit.
  4. Any fractional undivided interest in oil, gas, or other mineral rights.
  5. Investment contracts, which include interests in limited partnerships and other investments schemes.
7
Q

What is an Investment Contract?

A

An Investment Contract according to the Howey Test is: any transaction (any business venture) 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

8
Q

Examples of Securities

A

Stocks and bonds issued by corporations. Also: interests in whiskey, cosmetics, worms, beavers, boats, vacuum cleaners, muskrats, and cemetery plots, almost any stake in ownership or debt of a company, investment contracts in condominiums, franchises, limited partnerships in real estate, and oil or gas or other mineral rights.

9
Q

What are the basic requirement for companies issuing securities?

A

Unless exempt, securities must be registered with SEC BEFORE offering the security to the public. (registration of securities is VERY expensive and burdensome)

10
Q

Registration of Securities governed by Act of 1933 includes:

A
  1. Prepare a prospectus
  2. Prepare and file a registration statement with the SEC
  3. Registration process
  4. Special treatment for Well-Known Seasoned Issuers
11
Q

Prospectus

A

a disclosure document that describes the security being sold, the financial operations of the issuing corporation, and the investment or risk attaching to the security. It is also a selling tool for the issuing corporation.

12
Q

Registration Statement Contents

A

the registration statement must be written in plain English and fully describe the 5 areas
And it must be filed electronically so it can be posted on the SEC’s online EDGAR database.

13
Q

5 Areas described in the Registration Statement

A
  1. The securities being offered for sale, including their relationship to the registrant’s other securities
  2. The corporation’s properties and business (including a financial statement certified by an independent public accounting firm)
  3. The management of the corporation, including managerial compensation, stock options, pensions, and other benefits. Any interests of directors or officers in any material transactions with the corporation must be disclosed.
  4. How the corporation intends to use the proceeds of the sale.
  5. Any pending lawsuits or special risk factors.
14
Q

What is the purpose of the registration statement and the prospectus?

A

To help unsophisticated investors to evaluate the financial risks.

15
Q

Registration Process - Prefiling

A

The issuer cannot sell/offer securities. as a company you cannot release any information other than generalized statements, you are preparing to file the registration statement

16
Q

Registration Process - Waiting Period

A

Securities can be offered for sale but cannot be sold by the issuing corporation. All issuers can distribute a preliminary prospectus. Most issuers can distribute a free-writing prospectus during this period.

17
Q

Free-writing prospectus

A

Any type of written, electronic, or graphic communication associated with the offer to sell a security and used during the waiting period to supplement other information about the security

18
Q

Registration Process - Posteffective Period

A

Once the registration statement is approved, registration is effective, and the issuer can now offer and sell the securities without restrictions

19
Q

Special treatment for Well-Known Seasoned Issuers (WKSI):

A

a firm that has issued at least $1 billion in securities in the last 3 yrs or has outstanding stock valued at $700 million or more in the hands of the public

They can file their statement and offer securities in the same day, another difference they can use preliminary prospectus in the prefiling period

20
Q

Exempt Securities from Registration:

A
  1. Government issued securities
  2. Bank and financial institution securities
  3. Short-term notes and drafts (negotiable instruments, less than 9-month maturity date)
  4. Securities of nonprofit, educational and charitable organizations
  5. Securities issued by common carriers
  6. Insurance policies, endowment, and annuity contracts
  7. Securities issued in a corporate reorganized – 1 security exchange for another
  8. Securities issued in stock dividends and stock splits
21
Q

Why are the first six exempted?

A

They are regulated in some other area of the law

22
Q

Why are the last too exempt?

A

They have already registered - they are just moving around

23
Q

Even if securities are exempt form registration companies still must provide investors with…

A
  1. the prospectus
  2. material information on the firm - including financial statements
24
Q

Regulation A Offerings

A

i. Simplified /less expensive procedures: The issuer simply files a notice of the issue and an offering circular with the SEC and issues same to the investors before the sale.
ii. Allows for testing the Waters - means the company can determine potential interest without actually selling any securities or requiring any commitment on the part of those who express interest. This can be done prior to preparing the Reg A offering circular.
iii. 2 types of public offerings under Reg A

25
Q

Tier 1 of Regulation A

A

securities offerings of up to $20mil in a 12-month period

26
Q

Tier 2 of Regulation A

A

securities offerings of up to $50mil in a 12-month period

27
Q

What if an issuer is $20 million or less?

A

They can elect Tier 1 or Tier 2

28
Q

What are the limitations of Tier 2?

A

Purchasers of Tier 2 who are not accredited investors can’t purchase shares that cost more than 10% of their annual income or net worth.

29
Q

Accredited investors:

A

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

30
Q

Regulation D Offerings

A

Small Offerings
Rule 504 and Rule 506

31
Q

Rule 504

A

private, noninvestment company offerings up to $5 million in any 12-mo. Period more narrowed and controlled

32
Q

Investment Company

A

means a firm that buys a large portfolio of securities and professionally manages it for smaller SH/owners

33
Q

For Rule 504 is SEC notification necessary?

A

Yes because of the precautions on resale of these securities and no general advertisement or solicitation is allowed.

34
Q

Rule 506

A

Private Placement Exemption: Rule 506 exempts any private, noninvestment company offerings in unlimited amounts that are not generally solicited or advertised. (ie nonpublic and not generally advertised)

35
Q

How many offers can be made under Rule 506?

A

Offer may be made to an unlimited number of accredited investors and up to 35 unaccredited investors

36
Q

Rule 506 - issuer must believe the unaccredited investors have…

A

sufficient knowledge or experience in financial matters to qualify – must be able to assess risks and merits

37
Q

What is the most important exemption for firms that want to raise funds through the sale of securities without registration?

A

Rule 506

38
Q

Intrastate Offerings

A

Rule 147 offerings which are purely local – restricted to residents of the state in which the offering company is organized and doing business; and is subject to the state securities laws requires the restriction for 9 months, so you can’t sell to someone outside of the state for 9 months

39
Q

Resales and Safe Harbor Rules

A

most securities can be resold without registration

40
Q

What is the exception to the resale rule?

A

resales of restricted securities acquired under Rule 506 have registration requirements unless the sale strictly complies with the details of the safe harbor Rules 144 or 144A (you are not tested on these safe harbor rules)

41
Q

Violations of the 1933 Act:

A
  1. Intentionally defrauding - intentionally misrepresenting or committing facts in a registration statement/prospectus
  2. Negligence in preparation of registration statement/prospectus
  3. Selling securities prior to effective date
  4. Selling securities under an exemption for which the securities do not qualify
42
Q

Remedies for Violating the 1933 Act

A

Criminal violations: fined up to $10,000, or prison for up to 5 years or both fines go to the government (SEC)
Civil Penalties for willful violations and injunctions available

43
Q

Defenses for Violations of the 1933 Act

A
  1. the statement or omission was not material (best and most often defense!!)
  2. the plaintiff knew about the misrepresentation at the time the stock was purchased or
  3. the defendant exercised due diligence in preparing or reviewing the registration and reasonably believed at the time that the statements were true.
44
Q

Blackstone Group, LP is preparing for an initial IPO. They file a registration statement with the SEC. At the time of the filing the private equity investments of Blackstone included FGIC Corporation which insured investments in subprime mortgages and Freescale Semiconductor, Inc. Before the IPO customers of FGIC began to suffer large losses and Freescale lost an exclusive contract to make 3G chipsets for Motorola, Inc. Motorola was Freescales’ largest customer. These losses would affect Blackstone, but the registration statement was silent on these issues.

Martin Litwin and others (investors in Blackstone’s IPO) sued Blackstone and its officers, alleging material omissions from the statement.

A

Blackstone argues a defense of the omissions were not material. Trial Court agreed and dismissed the case. Litwin and other plaintiffs appealed to the 2nd Circuit which said this omission was reasonably likely to be material and remanded the case to trial.

This means the plaintiffs are entitled to the opportunity to prove this omitted information was material.

45
Q

The Securities Exchange Act of 1934

A
  • provides for the regulation and registration of securities exchanges, brokers, dealers, and national securities associations, such as the National Association of Securities Dealers (NASD).
  • requires continuous periodic disclosures by publicly held corporations, so SEC can regulate subsequent trading.
  • applies to Section 12 Companies
  • Act authorizes the SEC surveillance of the market looking for fraud, market manipulation and misrepresentations
46
Q

Section 12 Companies

A

section 12 of the Act requires companies with assets exceeding $10 million and which have 500 or more shareholders to file annual, quarterly and sometimes even monthly reports with the SEC

47
Q

Section 10(b)

A

prohibits the use of any manipulative or deceptive mechanism in violation of SEC rules and regs.

48
Q

SEC Rule 10b-5

A

prohibits the commission of fraud in connection with the purchase or sale of any security (whether registered or not).

49
Q

5 Basic Elements of a Securities Fraud Claim

A
  1. A material misrepresentation (or omission) in connection with the purchase and sale of securities
  2. Scienter (a wrongful state of mind)
  3. Reliance by the plaintiff on the material misrepresentation
  4. An economic loss
  5. Causation, meaning that there is a causal connection between the misrepresentation and the loss
50
Q

Disclosure under SEC Rule 10b-5

A

any material omission or misrepresentation (failure to disclose) of material facts in connection with the purchase or sale of a security may be a violation.

51
Q

6 common examples of material facts requiring disclosure to prevent fraud claims:

A
  1. Fraudulent trading in the company stock by a broker-dealer
  2. A dividend change (up or down)
  3. A contract for the sale of corporate assets
  4. A new discovery, process, or product
  5. A significant change in the firms’ financial conditions
  6. Potential litigation against the company
52
Q

Insider Trading

A

any time a person buys or sells securities on the basis of information that is not available to the public.
a. gives the “insider” a trading advantage over the general public, if acted on.
b. liability is present when the “insider” takes advantage of such info in their personal transactions when they know that the info is unavailable to those with whom they are dealing.
c. Liability and penalties under the statute extend to anyone (not just insiders) who has access to or receives info of a nonpublic nature on which trading is based.

53
Q

Potential double exposure for corporate insiders:

A

two ways to be sued
The insider doesn’t have to gain financially to have the SEC come after them

54
Q

Outsiders and SEC Rule 10b-5

A

people who are not corporate insiders but who trade on inside information acquired indirectly. Just as liable as insiders

55
Q

Tipper/Tipee Theory

A

corporate insider (tipper) breaches fiduciary duty to not disclose (to tippee)

56
Q

Eric McPhail was a member of the same country club as an executive at American Superconductor. While they were golfing, the executive shared information with McPhail about the company’s expected earnings, contracts, and other major developments, trusting that McPhail would keep the information confidential. Instead, McPhail tipped off 6 of his other golfing buddies at the country club, and they all used the nonpublic information to their advantage in trading. Who is liable under SEC Rule 10b-5 for insider trading?

A

Players here are:
American Superconductor Executive - tipper
McPhail = tippee
6 golfing buddies = tippers of a tipple

Who is liable under SEC Rule 10b-5 for insider trading?
Everyone
Executive has breach fiduciary duty to his employer, American Superconductor

57
Q

Misappropriation Theory

A

outsiders wrongfully obtains (steals) inside info and then trades on it for personal gain. Don’t have permission to have this information

58
Q

Insider Reporting and Trading - §16(b)

A

(often called the recapture provision) – any “insider” who buys and sells or sells and buys for profit within 6 mo. (short-swing profits), must return profits to the corporation.Therefore, the corporation has the power/right to recapture these profits. This is a strict liability section of the Act. In other words, the issuer (the corporation) does NOT have to allege misuse or even the existence of insider information to win.

59
Q

Who is an “insider?”

A

officers, directors and large shareholders (owning 10% or more of a class of equity stock)

60
Q

What is an “insider” required to do?

A

File reports with the SEC on their ownership and trading in their corporation’s securities

61
Q

The Private Securities Litigation Reform Act

A

Companies like to make financial forecasts. If the predictions don’t play out it can lead to them being sued. Cautionary statements prevent liability.

62
Q

Violations of the 1934 Act

A
  1. §10(b) and Rule 10b-5 violations are based on “scienter” which means intent to defraud or knowledge of misconduct.
  2. §16 violations are based on strict liability. Neither “scienter” nor negligence is necessary.
63
Q

Corporate Governance and Sarbanes-Oxley Act (SOX)

A
  1. SOX attempts to increase corporate accountability by imposing strict disclosure requirements and harsh penalties for violations of securities laws
  2. SOX requires chief corporate executives to take personal responsibility for the accuracy of financial statements and reports that are filed with the SEC; if knowingly make false statements they can be fined up to $1 million and 10 years in prison or both