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Flashcards in REG 19 - Federal Securities Regulation Deck (44):
1

Which of the following transactions is subject to registration requirements of the Securities Act of 1933?
A. The public sale of stock of a trucking company regulated by the Interstate Commerce Commission.
B. A public sale of municipal bonds issued by a city government.
C. The issuance of stock by a publicly traded corporation to its existing shareholders because of a stock split.
D. The public sale by a corporation of its negotiable ten-year notes.

D. The 1933 Act applies to sales of securities, including stocks, bonds and notes that are issued for periods over nine months.

2

T/F: D induced Ps (and many others) to invest in worm farms. His advertising said that with virtually no work, Ps could buy worms from D, watch them multiply, and then sell them back to D at fabulous prices. Unfortunately, there wasn't much demand for the worms, which multiplied much slower than the promised rate. D could only buy the worms back from purchasers if he could find even more purchasers. In other words, it was a pyramid scheme. Ps sued D, claiming securities fraud. D moved to dismiss, arguing that Ps bought worms, not "securities." D is right on this point.

False.
An investment contract was created.
The investors invested money in a common enterprise, the worm farms. They did so hoping to make a profit when Ps would sell the worms back to D. The investors themselves would not have to do any work as Ps would be the one to do the minimal work required on the worm farms.

3

T/F: ABC owned 100% of the stock of its subsidiary, XYZ Co., which ran an ice cream factory. Paul bought all XYZ's stock from ABC. He later sued ABC for securities fraud. ABC moved to dismiss, arguing that Paul had really bought an ice cream business rather than "securities." This is right.

False.
A share of corporate stock is the prototypical security.

4

Under the Securities Act of 1933, which of the following statements is (are) correct regarding the purpose of registration?

I. The purpose of registration is to allow the detection of management fraud and prevent a public offering of securities when management fraud is suspected.

II. The purpose of registration is to adequately and accurately disclose financial and other information upon which investors may determine the merits of securities.

II only. The primary purpose of registration is to enable investors to make an informed decision as to whether to invest in a public offering.

5

Non-WKSI issuer World Corp. wanted to make a public offering of its common stock. On May 10, World prepares and files a registration statement with the SEC.
On May 20, World places a "tombstone ad," announcing that it was making a public offering. On May 25, World issues a preliminary prospectus and the registration statement became effective on May 30.

On what date may World first sell the shares?

As soon as a registration statement is filed, ORAL offers may be made, as well as limited written advertising. The 20-day waiting period that exists applies to when the securities may actually be SOLD.
Unless the SEC speeds up the approval process, no sale can take place for 20 days after the filing. The AICPA's answer assumes that the waiting period is 20 calendar days, when it is actually 20 business days, but this is still the best answer of the four.

6

A tombstone advertisement
A. May be substituted for the prospectus under certain circumstances.
B. May contain an offer to sell securities.
C. Notifies prospective investors that a previously offered security has been withdrawn from the market and is therefore effectively "dead."
D. Makes known the availability of a prospectus.

D. During the waiting period of 20 days immediately after registering with the SEC, tombstone ads may be placed. Tombstone ads are heavily restricted and may contain only limited information, such as the type of security and where a potential investor would acquire a now-available prospectus.

7

T/F: Albo Corp. filed a registration statement that became effective on January 1, 1998. Ed bought some of the shares, but lost his money when Albo went bankrupt just a few months later. Ed sued the SEC because it had failed to detect that Albo's financial statements contained in its registration statement were fraudulent. Ed has a good claim.

False.
The SEC does not review the merits of the securities being offered nor make any guarantees to investors as to the quality of the securities. Issuers can sell the worst securities imaginable so long as they fully disclose how bad they are. Nor does the SEC guarantee the thoroughness and accuracy of the registration materials. When it allows a registration statement to become effective, the SEC is simply indicating that it has not found anything wrong with the disclosures contained therein.

8

Which of the following securities is exempt from registration under the Securities Act of 1933?
A. Municipal bonds.
B. Securities sold by a discount broker.
C. Pre-incorporation stock subscriptions.
D. One-year notes issued to raise working capital.

A. Governmental securities are exempt from registration under the 1933 Act.

9

Which of the following facts will result in an offering of securities being exempt from registration under the Securities Act of 1933?
A. The securities are non-voting preferred stock.
B. The issuing corporation was closely held prior to the offering.
C. The sale or offer to sell the securities is made by a person other than an issuer, underwriter, or dealer.
D. The securities are AAA-rated debentures that are collateralized by first mortgages on property that has a market value of 200% of the offering price.

C. So that investors may sell their shares on the secondary market without having to register (unless the shares are restricted-resale shares or the investors are affiliated shareholders), Section 4(1) of the 1933 Act exempts from registration all "transactions by any person other than an issuer, underwriter, or dealer."

10

Under the Securities Act of 1933, the registration of an interstate securities offering is
A. Required only in transactions involving more than $500,000.
B. Mandatory, unless the cost to the issuer is prohibitive.
C. Required, unless there is an applicable exemption.
D. Intended to prevent the marketing of securities that pose serious financial risks.

C. All interstate securities must be registered under the Act, unless they meet one of the many exemptions. For example, securities issued by a bank, or as part of a very limited issue, need not register.

11

Taso Limited Partnership intends to offer $400,000 of its limited partnership interests under Rule 504 of Regulation D of the Securities Act of 1933.

Which of the following statements is correct?
A. The exemption under Rule 504 is not available to an issuer of limited-partnership interests.
B. The limited-partnership interest may be sold only to accredited investors.
C. The total number of non-accredited investors who purchase the limited-partnership interests may not exceed 35.
D. The resale of the limited partnership interests by a purchaser will generally be restricted.

D. The relevant rules have changed back and forth over the years, but currently resale is restricted in Rule 504 offerings, unless either (a) the securities are registered under a state law requiring public filing and delivery of a substantive disclosure document to investors, or (b) the securities are issued under a state-law exemption that permits general solicitation, so long as sales are made only to accredited investors.

12

Under the Securities Act of 1933, which of the following statements concerning an offering of securities sold under a transaction exemption is correct?
A. The offering is exempt from the anti-fraud provisions of the 1933 Act.
B. The offering is subject to the registration requirements of the 1933 Act.
C. Resales of the offering are exempt from the provisions of the 1933 Act.
D. Resales of the offering must be made under a registration or a different exemption provision of the 1933 Act.

D. Just because an initial sale is exempt from registration requirements, it does not necessarily mean resales will be exempt as well. The exemptions are usually granted by the type of issuer, not the type of security. If the person making a resale does not also qualify for an exemption, a registration must be made before the resale. If the resale qualifies on its own for an exemption, then registration is not necessary.

13

Hamilton Corp. is making a $4.5mn securities offering under Rule 505 of Regulation D of the Securities Act of 1933.

Under this regulation, Hamilton is
A. Required to provide full financial information to accredited investors only.
B. Allowed to make the offering through a general solicitation.
C. Limited to selling to no more than 35 non-accredited investors.
D. Allowed to sell to an unlimited number of investors, both accredited and non-accredited.

C. To qualify for this exemption, no more than 35 non-accredited investors may be involved.
There is no limit on the number of accredited investors who may be involved.

14

Imperial Corp. is offering $450,000 of its securities under Rule 504 of Regulation D of the Securities Act of 1933.

Under Rule 504, Imperial is required to
A. Provide full financial information to all non-accredited purchasers.
B. Make the offering through general solicitation.
C. Register the offering under the provisions of the Securities Exchange Act of 1934.
D. Notify the SEC within 15 days after the first sale of the securities.

D. Rule 504 is a very broad exemption.
There is no limit placed on the total number of any class of investors, and there is no requirement that anyone receive financial information.

The restrictions are that the offering cannot be made through general advertising and must not put the issuer over $1mn in offerings in the past year. Also, the SEC must be notified within 15 days of the first sale to qualify for this exemption.

15

Which of the following statements concerning an initial intrastate securities offering made by an issuer residing in and doing business in that state is correct?
A. The offering would be exempt from the registration requirements of the Securities Act of 1933.
B. The offering would be subject to the registration requirements of the Securities Exchange Act of 1934.
C. The offering would be regulated by the SEC.
D. The shares of the offering could not be resold to investors outside the state for at least one year.

A. The 1933 Act gives many exemptions to registration. One of them (in Rule 147) involves intrastate issues. If an offering is made by an issuer who resides in the state, and the offering is made entirely to residents of that state, then registration is unnecessary. There are important requirements contained in Rule 147 that must be met, including that 80% of the funds raised must be used in the state.

16

Which of the following transactions is subject to registration requirements of the Securities Act of 1933?
A. The public sale by a corporation of its negotiable ten-year notes.
B. The public sale by a charitable organization of 10-year bearer bonds.
C. The sale across state lines of municipal bonds issued by a city.
D. Issuance of stock by a publicly traded corporation to its shareholders, because of a stock split.

A. Ten-year notes are securities and their public sale requires registration, absent the existence of an applicable exemption (such as under Regulation D).

17

T/F: Sally was excited when she got in on the ground floor and was able to buy shares from Dingle Corporation's IPO on the same day the registration statement became effective. The stock price quickly rose above the offering price and Sally wished to sell her Dingle shares and grab a quick profit. To do so, she will have to sell pursuant to a Regulation D exemption.

False.
Only if the shares are exempt under Rule 504, 505, 506 or Rule 147 Interstate Offering are there resale restrictions placed on the shares.
If they are under Registration A, there are no restrictions on the resale of shares.

18

A qualifying firm that declares itself to be an EGC enjoys all the following benefits for up to five years after its IPO, except:
A. Need not comply with SOX 404(b) requirement of audit for internal controls.
B. Need not comply with new PCAOB rules.
C. Reduced disclosure regarding executive compensation.
D. Immunity from fraud liability.

D. Obviously even EGCs are not going to be allowed to commit fraud with impunity.

19

Sam is a multimillionaire. He invested $100,000 in Company A's crowdfunded venture. Later that year, he wanted to invest in Company B's crowdfunded venture. What is the largest amount Sam can invest in B's offering?
A. $0
B. $10,000
C. $100,000
D. $1,000

A. $100,000 is the most someone can invest in crowdfunded ventures during the course of a single year.

20

A qualifying firm that declares itself to be an EGC enjoys the following benefits during its IPO:
A. Confidential review of its registration statement by the SEC.
B. Reduced requirement for audited financial statements.
C. A and B.
D. None of the above.

C. Both A and B are true. While most benefits accruing to EGCs have to do with reduced regulatory burdens in the five years after going public, these two benefits accrue during the IPO process. Another benefit is more publicity, such as analyst research published by an investment bank that is part of the underwriting syndicate.

21

The JOBS Act allows general solicitation in a Reg D Rule 506 offering if the issuer takes "reasonable steps" to insure what?
A. That it files a registration statement with the SEC within 15 days of its first sale.
B. That it raises no more than $50 million in a single year.
C. That it sells only to accredited investors.
D. All of the above.

C. General solicitation will be allowed under Rule 506 (and 505) Reg D offerings only if the issuer takes reasonable steps to insure that it sells only to accredited investors. If it does not engage in general solicitation, the issuer can sell to up to 35 unaccredited investors under Reg. D.

22

Under the JOBS Act, a foreign company cannot
A. Be an EGC.
B. Use the crowdfunding exemption.
C. A and B.
D. None of the above.

B. Foreign firms cannot use the crowdfunding exemption.

23

T/F: The JOBS Act's Emerging Growth Company (EGC) provision allows a company to hold an IPO, yet avoid most of the regulatory burdens of a public company for up to five years.

True

24

T/F: The JOBS Act reinvigorated the Regulation A exemption by raising the ceiling on funds that can be raised through the exemption to $50 million in a given year.

True

25

Ivor and Associates, CPAs, audit the financial statements of Jaymo Corporation.
As a result of Ivor's negligence in conducting the audit, the financial statements include material misstatements.
Ivor was unaware of this fact. The financial statements and Ivor's unqualified opinion are included in a registration statement and prospectus for an original public offering of stock by Jaymo.
Thorp purchases shares in the offering. Thorp receives a copy of the prospectus prior to the purchase, but does not read it. The shares decline in value as a result of the misstatements in Jaymo's financial statements becoming known.

Under which of the following Acts is Thorp most likely to prevail in a lawsuit against Ivor?
I. Securities Act of 1933, Section 11
II. Securities Exchange Act of 1934, Section 10(b), Rule 10b-5

Yes, No
The key fact here is that Ivor did not know of the error. It acted negligently, but not with bad intent (scienter). Absent bad intent, there can be no fraud and therefore no liability under Section 10(b) of the 1934 Act, which is an anti-fraud statute. However, defendants who are merely negligent are liable for materially false statements in a defective registration statement pursuant to Section 11 of the 1933 Act.

26

In which of the following types of action, brought against a CPA who issues an audit report containing an unqualified opinion on materially misstated financial statements, may a plaintiff prevail without proving reliance on the audit report?
A. An action for common-law fraud.
B. An action for common-law breach of contract.
C. An action brought under Section 11 of the Securities Act of 1933.
D. An action brought under Rule 10b-5 of the Securities Exchange Act of 1934.

C. With minor exceptions, a plaintiff in a Section 11 suit need not provide reliance in order to prevail.

27

Petty Corp. makes a public offering subject to the Securities Act of 1933.
In connection with the offering, Ward & Co., CPAs renders an unqualified opinion on Petty's financial statements included in the SEC registration statement. Huff purchases 500 of the offered shares.
Huff brings an action against Ward under Section 11 of the Securities Act of 1933 for losses resulting from misstatements of facts in the financial statements included in the registration statement.
Ward's weakest defense would be that

A. Huff knew of the misstatements when he purchased the stock.
B. Huff's losses were not caused by the misstatements.
C. Ward was not in privity of contract with Huff.
D. Ward conducted the audit in accordance with GAAS.

C. This is no defense at all. Privity of contract is absolutely not required in a Section 11 action.

28

Holly Corp. engage Yost & Co., CPAs, to audit the financial statements to be included in a registration statement Holly is required to file under the provisions of the Securities Act of 1933. Yost failed to exercise due diligence and did not discover the omission of a fact material to the statements.
A purchaser of Holly's securities may recover from Yost under Section 11 of the Securities Act of 1933 only if the purchaser

A. Brings a civil action within one year of the discovery of the omission and within three years of the offering date.
B. Proves that the registration statement was relied on to make the purchase.
C. Proves that Yost was negligent.
D. Establishes privity of contract with Yost.

A. These are the relevant time limits. A plaintiff may not bring a claim forever, but must act within these time restraints.

29

Under the liability provisions of Section 11 of the Securities Act of 1933, a CPA may be liable to any purchaser of a security for certifying materially misstated financial statements that are included in the security's registration statement.
Under Section 11, which of the following must be proven by a purchaser of the security?
I. Reliance on the financial statements
II. Fraud by the CPA

No, no
Under Section 11 of the 1933 Act, a plaintiff need not show either reliance or fraud (or even negligence) by the defendants. However, defendants can win the day if they can disprove reliance. And the defendants other than the issuer can win if they can establish that they acted with due diligence. The primary things that plaintiffs must show to win their Section 11 claim are that there was a material misstatement in the registration statement on the effective date; that they can trace their shares to that registration statement; and that they suffered damages.

30

To be successful in a civil action under Section 11 of the Securities Act of 1933, concerning liability for a misleading registration statement, the plaintiff must prove the
I. Defendant's intent to deceive.
II. Plaintiff's reliance on the registration statement.

No, no
Section 11 states that if "any part of the registration statement...contained an untrue statement of material fact...any person acquiring such security...(may bring a civil lawsuit)." Showing an intent to deceive is unnecessary to win a civil lawsuit, as is a plaintiff's reliance on the false statement.

31

T/F: Salto Corp. sold shares pursuant to a Regulation D exemption. Salto's offering circular contained several fraudulent statements that fooled investor Chauncey, who lost all his money. Chauncey probably has a good Sec. 11 claim against Salto.

False.
Chauncey would have a claim under Sec. 12(a)(2) as the remedy violation would be of selling a security before the registration statement becomes effective; providing a prospectus that does not comply with Sec. 10 requirements.

32

What is the standard that must be established to prove a violation of the anti-fraud provisions of Rule 10b-5 of the Securities Exchange Act of 1934?
A. Negligence.
B. Intentional misconduct.
C. Criminal intent.
D. Strict liability

B. To be liable under Rule 10b-5 of the 1934 Act, a defendant must act intentionally. Courts hold that a defendant must act with scienter (intent) or "extreme recklessness" (which is similar to scienter) to be liable under 10b-5.

33

Jay and Co., CPAs, audit the financial statements of Maco Corp. Jay intentionally gives an unqualified opinion regarding the financial statements, even though material misstatements were discovered. The financial statements and Jay's unqualified opinion are included in a registration statement and prospectus for an original public offering of Maco stock.

Which of the following statements is correct regarding Jay's liability to a purchaser of the offering under Section 10(b) and Rule 10b-5 of the Securities Exchange Act of 1934?
A. Jay will be liable if the purchaser relied on Jay's unqualified opinion on the financial statements.
B. Jay will be liable if it was negligent in conducting the audit.
C. Jay will not be liable if the purchaser's loss was under $500.
D. Jay will not be liable if the misstatement resulted from an omission of a material fact by Jay.

A. The 1934 Act sanctions intentional acts that manipulate or deceive. If a purchaser wishes to recover, (s)he must also prove reliance on the false statements; (s)he must have suffered a loss BECAU.S.E OF THE FALSE STATEMENT.

34

Which of the following might prevent a plaintiff investor from recovering from a defendant accountant in a Section 18(a) lawsuit?
A. The document containing the false statement was not filed with the SEC.
B. The plaintiff did not read the false document.
C. The defendant established that it acted in good faith and did not know of the error in the document.
D. All of the above.

D. A, B, and C are all accurate.

35

Which defense must an accountant establish to be absolved from civil liability under Section 18 of the Securities Exchange Act of 1934 for false or misleading statements made in reports or documents filed under the Act?
A. Lack of gross negligence.
B. Exercise of due care.
C. Good faith and lack of knowledge of the statement's falsity.
D. Lack of privity with an injured party.

C. this is the most precise answer.
Section 18(a) establishes a presumption of liability for false statements in filed documents, but allows defendants to escape liability if they prove that they "acted in good faith and had no knowledge that such statement was false or misleading."

36

Dart Corp. engages Jay Associates, CPAs, to assist in a public stock offering. Jay audits Dart's financial statements and gives an unqualified opinion, despite knowing that the financial statements contain misstatements.
Jay's opinion is included in Dart's registration statement. Larson purchases shares in the offering and suffers a loss when the stock declines in value after the misstatements became known.

In a suit against Jay, under the anti-fraud provisions of Section 10(b) and Rule 10b-5 of the Securities Exchange Act of 1934, Larson must prove all of the following, except
A. Larson was an intended user of the false registration statement.
B. Larson relied on the false registration statement.
C. The transaction involved some form of interstate commerce.
D. Jay acted with intentional disregard of the truth.

A. A private action under the 1934 Act is similar to a common-law fraud action in that the plaintiff must show that he relied on the misstatement and that the defendant intended to deceive in making the misstatement.
But, unlike a common-law fraud action, there is no requirement of privity, or even that the plaintiff was an intended user of the false statement.

37

Ted buys Synchotic Corporation shares based on Synchotic's announcement of record earnings. But just a few days later, on July 1, 2010, Synchotic admits that its earnings had been artificially inflated via fraudulent earnings management. Its stock price drops dramatically that day, and Ted makes a significant loss. Ted wishes to bring a 1934 Act securities-fraud lawsuit against Synchotic. In terms of the statute of limitations, when must Ted bring his lawsuit?
A. Within one year of when he should have discovered the fraud or within three years of the fraud.
B. Within one year of when he should have discovered the fraud and within three years of the fraud.
C. Within two years of when he should have discovered the fraud or within five years of the fraud.
D. Within two years of when he should have discovered the fraud and within five years of the fraud.

D. This answer is correct because it uses the correct statute of limitations (2yr/5yr, rather than 1yr/3yr), and notes properly that the plaintiff must meet both deadlines.

38

T/F: Section 18(a) imposes scienter-based liability.

False.
Section 18(a) assumes liability if filed documents contain materially false statements and it shifts the burden of proof to defendants, such as accountants, to establish that they "acted in good faith and had no knowledge that such statement was false or misleading."

39

T/F: Section 18(a) places the burden of proof regarding the issue of the defendant's good faith upon the plaintiff.

False.
The defendant must provide the proof regarding the fact that they acted in good faith.

40

Seimone, an auditor for the ABC accounting firm, learns that her audit client, Bupkis Co., is about to announce a record profit. She buys Bupkis shares in a fake name and profits upon the public announcement. Which of the following is true?
A. The SEC may bring civil charges against Seimone.
B. The SEC may bring criminal charges against Seimone.
C. A and B.
D. None of the above.

A. The SEC may bring civil charges against Seimone.

Only the Department of Justice may bring federal criminal charges. However, both civil charges (by the SEC) and criminal charges (by DOJ) are commonly brought in insider-trading cases.

41

Among the ways that the Dodd-Frank Act impacts accountants are:
A. It created the Consumer Financial Protection Bureau (CFPB) to minimize accountants' abuses of their clients.
B. It authorizes the PCAOB to regulate accountants who audit non-public broker-dealers.
C. It designates the "Big Four" accounting firms as "too big to fail."
D. All of the above.

B. The Bernie Madoff ponzi scheme prompted Congress to extend the PCAOB's authority to cover non-public broker-dealers.

42

Which of the following is accurate regarding the Dodd-Frank whistleblower provisions?
A. They exclude accountants from recovering whistleblower rewards, because they are supposed to be looking out for fraud anyway.
B. They require whistleblowers to report suspected violations internally to their employers as an initial measure.
C. They require whistleblowers to report to the SEC before reporting to their employers.
D. None of the above.

D. All three of the answers are inaccurate.

(A) An accountant received the first payout under the Dodd-Frank program.
(B & C) Dodd-Frank encourages, but does not require, whistleblowers to report internally before going to the SEC.

43

T/F: The Dodd-Frank Act fundamentally changes the way most accountants practice their profession.

False.

44

T/F: Dodd-Frank largely exempts accountants from regulation by the Consumer Financial Protection Bureau (CFPB).

True

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