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Flashcards in Federal Securities Regulation Deck (76):

What is a security?

An investment in some enterprise or business that expects profits and can be traded with others

Includes stocks, bonds, notes, etc.


Do partnership interests count as securities?

Limited partnership interests generally do, but not general partnership interests

Basic rule is that interests which involve management rights are not considered securities


What is a securities dealer?

Someone whose principal occupation involves buying or selling securities

Can be as principal, agent, or broker


What is an underwriter?

A person or company that distributes securities for an issuer


What is a controlling person?

Someone who controls (directly or indirectly) an issuer or is under common control with the issuer

Control is not simply a matter of stock ownership, but any influence (e.g. being an officer)


What is a beneficial owner?

Someone who has the benefits of ownership without the title, being able to influence activity regarding it

E.g. if a spouse has title, or if it is held in trust


Who qualifies as an insider?

Any officer or director and any beneficial owner of more than 10% of any class of equity security


What is a prospectus?

A document which makes an offer for a security sale and provides info about that security


What does not count as a prospectus?

A communication given after the registration statement's effective date, if a written prospectus already has been provided

A communication containing insufficient info about purchasing a security


What is a registration statement?

A statement filed with the SEC providing info about a public offering of securities


What is shelf registration?

A practice where issuers register their securities prior to issuing them, up to three years max -- though the statement still needs to be updated


What is the Securities & Exchange Commission (SEC)?

Independent agency created in 1934 to govern all federal securities laws

Made up of five commissioners appointed by a president, and three max can be of a political party


What power does the SEC have to make and enforce laws?

The SEC is authorized by Congress to make rules to enforce the 1933 and 1934 Acts -- these rules must be proposed and comments requested

SEC can also investigate any violations of these rules and suspend violators' registration, or even have criminal proceedings


What is the ISB?

Independence Standards Board -- governed independence of external auditors

ISB no longer exists, though three pronouncements still remain in effect


What are blue sky laws?

Specific state laws for securities transactions that go beyond federal regulations


What is the main purpose of the Securities Act of 1933?

Transparency in the original issuance of securities


What does the Securities Act of 1933 forbid?

(1) selling a security without an effective registration statement; and offering to sell without a filed (i.e. in-process) registration statement
(2) selling a security without a prospectus
(3) engaging in fraud/material misstatement (even for unregistered securities)


What are the liabilities included in the 1933 Act?

Civil liabilities for violating the registration statement or prospectus rules -- applies to anyone involved in preparing or certifying them (underwriters, directors, accountants, etc.)


What does the 1933 Act include to motivate compliance?

Gives the SEC power to seek writs of mandamus for people to comply with the Act

Mandamus = order from a superior court to do something


What are reasons why some securities are exempt from the registration requirements of the 1933 Act?

(1) unnecessary to protect public
(2) securities already regulated by a gov't agency
(3) nature of the security requires exemption


What are the first three (of ten) classes of securities exempt from registration in the 1933 Act?

(1) securities for gov't purposes (doesn't include securities for public utilities)
(2) nonprofit securities
(3) intrastate securities offerings -- if the issuer gets 80% of gross revenue from same state, and 80% of sales proceeds are used for its operations in that state, and securities are offered only to residents of the same state (and resales within nine months must be to residents as well)


What are the second three (of ten) classes of securities exempt from registration in the 1933 Act?

(4) insurance products (e.g. variable annuities)
(5) non-sale stock transactions -- an issuer exchanges securities with existing holders, but without payment (e.g. stock splits)
(6) short-term paper (e.g. negotiable instruments) whose maturity is less than nine months


What are the last four (of ten) classes of securities exempt from registration in the 1933 Act?

(7) small issues (<$5 million) if not necessary for the public good
(8) court-controlled securities (e.g. in bankruptcy)
(9) securities issued under the Small Business Investment (SBI) Act of 1958 -- if not necessary for the public good
(10) securities sold before sixty days after the 1933 Act was passed (May 27, 1933)


Per the 1933 Act, how are small issues regulated?

In accord with SEC Regulation A, which has more lenient regulations for smaller issues -- thus small issues are called "Reg. A issues"

Reg. A requires not a prospectus, but an offering circular


What is the rule permitting securities sold within 60 days of the 1933 Act's passing (and before) to be unregistered?

Grandfather clause


For the 1933 Act, how do exempt transactions differ from exempt securities?

Exempt securities do not need to be registered for any transactions, but a security in an exempt transaction may be nonexempt in subsequent transactions


What is the broadest class of transactions exempt from registration per the 1933 Act?

Any transactions done by someone besides an issuer, underwriter, or dealer


Per the 1933 Act, what are the three types of exempt transactions under Regulation D?

Those under Rules 504, 505, and 506

For all of these, the SEC still has to be notified of an offering within 15 days of the first sale


Per Regulation D, what transactions are exempt through Rule 504?

Unregistered nonpublic companies (often these are closely held) can have private offerings exempt under certain conditions


What are the rules governing exempt transactions for Rule 504 of Reg. D?

(1) max of $1 million of securities in a twelve-month period
(2) ads/solicitation are allowed in limited circumstances
(3) resale within two years is allowed under certain circumstances


What is a main difference between Rule 504 and Rules 505 and 506 in Regulation D?

504 only deals with private offerings for nonpublic companies, while 505 and 506 deal with private offerings for both public and nonpublic companies


What are the rules governing exempt transactions for Rule 505 of Reg. D?

(1) max of $5 million of securities in a twelve-month period
(2) sales are allowed only to 35 nonaccredited investors (not limited on accredited ones)
(3) audited financial statements must be disclosed, if sold to any nonaccredited investors
(4) no ads/solicitation allowed
(5) issuers should reasonably ensure buyers aren't underwriters
(6) resale is not permitted within two years


Who count as accredited investors?

(1) institutional investors
(2) executives of the issuer itself
(3) any investors with a sufficient net worth or income


How does Rule 506 compare with Rule 505 of Reg. D?

(1) no limit on the total amount of securities sold
(2) also limited to 35 nonaccredited investors
(3) also forbids any ads/solicitation
(4) also requires audited financials to be disclosed to nonaccredited investors
(5) also forbids resale within two years


Per the 1933 Act, under what circumstances are private offerings under Section 4(2) exempted?

If the issuer can show that the potential buyers are "sophisticated" enough that they do not need the extra protection of registration -- and also that the info available to the investors is sufficient for them


What are various factors on which Section 4(2) makes judgments?

(1) characteristics of the potential buyers
(2) size and marketability of the offerings (since that might betray an intent to resell, which would make it public rather than private)
(3) purpose of the investors' purchase (i.e. resale or not)
(4) what advertising is used


Per the 1933 Act, when are dealers' transactions exempt from registration requirements?

If the dealer is not participating in the original distribution and the issuer is filing reports with the SEC, then the dealer does not need a prospectus


Per the 1933 Act, how long is the original distribution period?

If the company has already issued securities before, then 40 days from either (a) the effective date of the registration statement or (b) the beginning of the offering, whichever is later

If the company has not already issued securities, then 90 days from (a) or (b), whichever is later


What is Rule 144 of Regulation D?

Lays down the "safe harbor" rules by which restricted securities can be resold without registration

Restricted securities = securities from a private offering (i.e. a Reg. D offering)


What are the five safe harbor rules of Rule 144?

(1) info about the issuer must be publicly accessible
(2) seller must have held securities for two years
(3) within three months, cannot sell more than 1% of outstanding shares in that class, or more than avg. weekly volume of last four weeks
(4) notice must be filed with SEC
(5) sales must be done through brokers, with various limits


Per Rule 144, what are the limits placed upon brokerage sales of restricted securities?

-broker must receive ordinary commission
-no soliciting allowed
-broker must inquire if the seller qualifies for Rule 144 exemption


What all must be included in a registration statement submitted to the SEC?

Everything required by Schedule A of the 1933 Act:
(1) basic info -- issuer, controlling persons (including % under control), and/or underwriters
(2) financial info -- financial statements for issuer, description of issuer's contracts, info on previously-issued securities
(3) any other material info


What else must be written related to registration statements?

Any experts who assisted in preparing or certifying registration statements must consent to the info in writing


What must be included in a prospectus?

Most of the basic info, and all of the financial info, from the registration statement

Info can be excluded if SEC does not deem it necessary for the public interest


What is a red herring prospectus?

A preliminary prospectus -- an earlier draft of a prospectus which can be used to garner interest in the securities before they can be sold, though it is not required

States in red ink that the final prospectus could be different, hence "red herring"


What is the period called during which a red herring prospectus is soliciting interest?

Waiting period -- period between filing and the effective date of the registration statement


When does a registration statement become effective?

Barring any problems, 20 days after filing -- though this can be accelerated


What are different responses the SEC can have to a filed registration statement?

(1) letter of deficiency = gives the issuer a chance to fix problems in the registration statement
(2) refusal order = delays the effective date for further review; this must be given within 10 days of filing
(3) stop order = also delays the effective date; but the grounds for this is a material problem in the statement, and only concluded after a hearing


What are the maximum criminal penalties for violations of the 1933 Act?

For any willful violations of the Act or fraudulent activity, max $10,000 fine and 5 years imprisonment


For a civil suit regarding the 1933 Act, what does the plaintiff need to prove?

Merely that the registration statement for securities purchased was materially false or misleading -- not that the purchaser relied on the statement, nor that the problem was caused by negligence or fraud

This makes all the implicated parties both jointly and severally liable


Regarding the 1933 Act, what is the best defense for a civil suit?

The experts behind the statement must prove that they exercised due diligence -- this, at most, would leave the issuer responsible for the defective registration statement

The issuer must prove that the injured party was already aware of the defect in the registration statement


For the 1933 Act, what are the maximum damages to be sought for a civil suit?

No more than the price of the security when offered to the public


For the 1933 Act, what is the statute of limitations for civil suits?

Generally, one year from the moment of discovering the material error in the statement (or from when it should have been discovered by due diligence) -- and three years from the issuance date is the strict maximum

Malice or fraud does not have such a restriction


How does the Securities Exchange Act of 1934 differ from the 1933 Act?

The 1933 Act focuses on original offerings, while the 1934 Act focuses on the secondary market


Who is required to register under the 1934 Act?

(1) national security exchanges
(2) brokers and dealers involved in interstate securities commerce
(3) corporations with (a) either securities traded nationally or >$10 million in assets and (b) a class of stock held by more than 500 people


What is included on the registration statement under the 1934 Act?

(1) nature of business
(2) financial structure of business
(3) bonus or profit-sharing arrangements of business
(4) officers and directors


What other practices are regulated by the 1934 Act?

(1) tender offers for more than 5% of a company's stock
(2) solicitations for stockholders' proxy votes
(3) margin requirements (i.e. how much must be in an account for further credit to be given to buy more stocks)


What is a corporation's public float?

The total shares issued by the corporation available to be traded publicly -- total outstanding stock minus restricted stock


What are the different kinds of filers under the 1934 Act?

(1) non-accelerated filer = public float < $75 million
(2) accelerated filer = public float between $75 and $700 million
(3) large accelerated filer = public float of $700 million or more


What are the different forms to be filed with the SEC?

(1) Form 10-K = annual report, contains audited financials
(2) Form 10-Q = quarterly report, contains unaudited financials
(3) Form 8-K = for specific events, such as a change in director or bankruptcy


What is the filing deadline for the Form 10-K?

(1) for non-accelerated filers, within 90 days of year-end
(2) for accelerated filers, within 75 days
(3) for large accelerated filers, within 60 days


What is the filing deadline for the Form 10-Q?

(1) for non-accelerated filers, within 45 days of quarter-end
(2) for accelerated filers, within 40 days
(3) for large accelerated filers, within 40 days


What is the filing deadline for the Form 8-K?

Within four business days of the event


What are the disclosure requirements for insiders?

They must disclose all significant info or else refrain from trading their company's stock

Insiders include 10% stockholders and anyone else privy to secret info about the company that would influence investors


What does Section 10(b) of the 1934 Act cover?

It forbids any fraudulent trades done on any securities in the United States (whether registered with the SEC or not)


What are the maximum penalties enforceable under Section 10(b) of the 1934 Act?

Max fine of $100,000 and/or max imprisonment of 5 years


According to Section 10(b), how do suits by private parties differ from prosecutions by the SEC?

The SEC can charge someone for negligence or fraud, while private parties can only claim action in case of fraud

This is not the same for all SEC rules


What are some rules governing proxy solicitations?

(1) written proxy statement must be given, which includes info about the proxy (including whether it is revocable or not)
(2) proxy statement must include an annual report, if the proxy relates to the annual meeting
(3) proxy statement must be filed with the SEC (with annual report)


What is a tender offer?

An offer to an entire class of stockholders to purchase their shares at a given price, usually higher than the market price


What occurs if a tender offeror is offered more stock than he actually desired to fulfill his purpose (e.g. to take control of the company)?

He does not need to purchase all the offered stock, only the desired amount -- but he must purchase from each person who offers stock pro rata


What are some rules governing tender offers?

-any tender offer which would make someone into the beneficial owner of 5% or more of a company's stock requires filing with the SEC, the exchange, the issuer, and to other stockholders of the same class
-form filed with SEC must state purpose of purchase and other info about the purchaser


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

Requires independent auditors to disclose potential problems in the company under audit, especially fraud

Potential problems include (a) illegal acts, (b) related party transactions, and (c) an inability to be a going concern


What is the Securities Litigation Uniform Standards Act of 1998 (SLUSA)?

The PSLRA prohibited frivolous lawsuits (often class-action suits) regarding securities transactions, but since this applied only to federal courts, it shifted many such lawsuits to state courts

The SLUSA corrects this, forbidding such lawsuits at the state level too


What is Regulation Fair Disclosure (FD)?

Reg. FD requires issuers to disclose relevant info to all investors simultaneously -- i.e. it forbids selective disclosure of info

If unintentional, the company should quickly make efforts to spread the info more widely


What is the Dodd-Frank Wall Street Reform & Consumer Protection Act of 2010?

Responding to the late-2000s recession, this comprehensively changed financial regulations in the U.S.

Called the "Dodd-Frank Act" for short


What are some of the main features of the Dodd-Frank Act?

-required financial advisors to municipalities (i.e. municipal advisors) to register with the SEC
-required financial advisors for private funds (e.g. hedge funds) to register with the SEC
-made the SEC study how to lower the costs of complying with SOX -- and then added Section 404(c) to SOX
-gave incentives to whistleblowers