Chapter 46 SECURITIES REGULATION

State Regulations State blue sky laws, which apply only to intrastate transactions, protect the public from the sale of fraudulent securities. National Securities Markets Improvement Act of 1996 allocated responsibilities between federal and state authorities.

Federal Regulation There are two principal laws providing the basic framework for federal regulation of the sale of securities in interstate commerce: The Securities Act of 1933. The Securities Exchange Act of 1934. Now, the Sarbanes-Oxley Act of 2002.

Definition The term “securities” is defined as “stocks and bonds issued by a corporation,” and may also include other interests that provide unearned income.

The Securities Act of 1933 The Securities Act of 1933 deals with the issue or original distribution of securities by issuing corporations. Except for certain private and limited offerings, the 1933 act requires that a registration statement be filed with the SEC and that a prospectus be provided to each potential purchaser.

Registration Process

The Securities Act of 1933 Exemptions from Registration: Rule 504 (up to $1M during 12 months). Rule 505 (up to $5M to less than 35 unaccredited investors during a 12 month period). Rule 506 (no limitation on money). Restrictions on 505, 506 securities. Liability. False or misleading statements.

Securities Exchange Act of 1934 The Securities Exchange Act of 1934 regulates the secondary distribution or sale of securities on exchanges. The 1934 act provides reporting requirements for companies whose securities are listed on a national exchange and unlisted companies that have assets in excess of $3 million and 500 or more shareholders.

1934 Act: Rule 10b-5 Rule 10b-5 is the principal antifraud rule under the 1934 act. Applies to all private securities actions. Liability for material misrepresentations or omissions in fact.

Enforcement Criminal and civil penalties exist for fraudulent statements made in reporting. The Securities and Exchange Commission administers both the 1933 and the 1934 Acts. The SEC under authority of the Williams Act regulates cash tender offers. The securities industry provides arbitration procedures to resolve disputes between customers and firms.

Section 10(b) and Rule 10b-5: Insider Trading Trading on “inside information” is unlawful and may subject those involved to a civil penalty of three times the profit made on the improperly disclosed information.

Insider Trading Director or corporate employees are liable. Temporary insider is a consultant (attorney, CPA, etc). ‘Tippee’ receives information from an insider. Tippee not liable if the insider does not breach a fiduciary duty.

Misappropriation Occurs when persons with fiduciary duty steal information and use that information to trade in securities. Liable under Section 10(b) and Rule 10b-5.

Disclosure of Ownership A disclosure statement is required by: Corporate directors or officers owning equity securities in their corporation. Shareholders owning more than 10% of any class of the corporation’s equity securities. Any of the above people selling these securities for a profit less than 6 months after buying them may be guilty of making a short-swing profit.

Regulation of Accountants Disclosure rules require accountants to reveal market risk information for derivative investments. These rules also require a description of the accounting policies used to account for derivatives. The SEC may disbar or suspend accountants who violate securities laws. Section 307 Sarbanes-Oxley.

Industry Self-Regulation Many securities investment firms have adopted a code of arbitration, giving customers a contractual right to settle disputes through arbitration. Courts rarely overturn the decisions of an arbitrator in these cases.