Ch © 2006 Prentice Hall THE LEGAL ENVIRONMENT OF BUSINESS A Critical Thinking Approach Fourth Edition Nancy K. Kubasek Bartley A. Brennan M. Neil Browne Nancy K. Kubasek Bartley A. Brennan M. Neil Browne

© 2006 Prentice Hall Ch THE LEGAL ENVIRONMENT OF BUSINESS CHAPTER 22 Rules Governing the Issuance and Trading of Securities

© 2006 Prentice Hall Ch THE LEGAL ENVIRONMENT OF BUSINESS Securities Regulation Definition: Securities are equity or debt instruments: most often, stocks and bonds Useful as a means for financing modern corporations Problem: Securities values are easily manipulated and transactions are subject to fraud

© 2006 Prentice Hall Ch THE LEGAL ENVIRONMENT OF BUSINESS History of Regulation First efforts at the state level proved insufficient National economic crisis of 1930s Federal laws were needed to Protect integrity of capital markets Protect investors Regulate brokers

© 2006 Prentice Hall Ch THE LEGAL ENVIRONMENT OF BUSINESS The Securities and Exchange Commission Goal: To require full disclosure so that investors can make informed decisions Method: Detailed requirements for prospectus; registration; time tables for offering; and certain exemptions from the process Enforcement: Administrative action; injunction; criminal prosecution

© 2006 Prentice Hall Ch THE LEGAL ENVIRONMENT OF BUSINESS The Sarbanes-Oxley Act of 2002 Goal: To require CEOs and CFOs to certify financial reports New accounting regulations Criminal penalties 25 years for fraud 20 years for tampering with records Fines up to $5 million

© 2006 Prentice Hall Ch THE LEGAL ENVIRONMENT OF BUSINESS The Securities Act of 1933 Definition of “security” – very broad The ‘Howey Test’ Common enterprise Common enterprise Reasonable expectation of profits Reasonable expectation of profits Derived solely from the efforts of others Derived solely from the efforts of others Regulates initial public offerings

© 2006 Prentice Hall Ch THE LEGAL ENVIRONMENT OF BUSINESS The Registration Process All nonexempt securities must be registered SEC does not guarantee the financial outcome Prefiling – no offers or sales Waiting period – oral offers, but no sales ‘Red Herring’ Posteffective period – 20 days

© 2006 Prentice Hall Ch THE LEGAL ENVIRONMENT OF BUSINESS Registration – Special Situations Shelf registration – registered but held for future sales Exemptions from registration: Private placement Intrastate Small business Noninvestment companies Other exemptions

© 2006 Prentice Hall Ch THE LEGAL ENVIRONMENT OF BUSINESS Liability, Remedies, and Defenses Private cause of action for victims of Misrepresentation in registration statement; failure to register; fraud in sale Defenses: ‘Due diligence’ Government remedies: Administrative action; letter of deficiency; injunction; criminal penalties

© 2006 Prentice Hall Ch THE LEGAL ENVIRONMENT OF BUSINESS The Securities Exchance Act of 1934 Goal: Regulate those who run the industry Approach: Require issuers of securities to register with SEC and the exchange Covers: Brokers and dealers Method: Revocation or suspension of license; private or government suit

© 2006 Prentice Hall Ch THE LEGAL ENVIRONMENT OF BUSINESS Securities Investor Protection Act (SIPA) Indemnifies customers of insolvent brokerage firm Collects funds from brokers Limit of protection: $500,000

© 2006 Prentice Hall Ch THE LEGAL ENVIRONMENT OF BUSINESS The Securities Markets Exchanges: NYSE Over-the-Counter: OTC Another set of regulations: NASD

© 2006 Prentice Hall Ch THE LEGAL ENVIRONMENT OF BUSINESS Proxy Solicitations Fewer than 1 percent of shareholders attend annual meeting Proxies used to elect directors and set policy Shareholder proposals: shareholder democracy Proxy contests: insurgents v. management

© 2006 Prentice Hall Ch THE LEGAL ENVIRONMENT OF BUSINESS Tender Offers and Takeover Bids Tender offer: offer to buy shares at premium Regulated by Exchange Act Section 13 and 14 Hostile bid: offer is opposed by management

© 2006 Prentice Hall Ch THE LEGAL ENVIRONMENT OF BUSINESS Defenses to Hostile Takeovers Golden parachute Poison pill GreenmailPorcupine Treasury shares to friendly parties Shark repellant Scorched earth White knight

© 2006 Prentice Hall Ch THE LEGAL ENVIRONMENT OF BUSINESS Securities Fraud Section 10(b): antifraud Insider trading Misstatement of corporation MismanagementFraud-on-the-market

© 2006 Prentice Hall Ch THE LEGAL ENVIRONMENT OF BUSINESS Insider Trading INSIDERS: Officers, directors; partners in brokerages; attorneys; underwriters and broker- dealers; financial reporters; printers Insider Trader Sanctions Act (ITSA) provide treble damages, other remedies

© 2006 Prentice Hall Ch THE LEGAL ENVIRONMENT OF BUSINESS Misstatements of Corporations Covers: Statements by corporate executives “In connection with purchase or sale of security” With “scienter”

© 2006 Prentice Hall Ch THE LEGAL ENVIRONMENT OF BUSINESS Mismanagement Covers: Purchase or sale of stock Fraud alleged by Minority shareholders or in derivative suits Plaintiff is purchaser or seller

© 2006 Prentice Hall Ch THE LEGAL ENVIRONMENT OF BUSINESS Fraud-on-the-Market Theory Shareholders allege reliance on efficient market Distorted by fraudulent statements or omissions Causes market price to be set too high To detriment of investors and in violation of 10(b)5 Upheld in U.S. v. O’Hagan

© 2006 Prentice Hall Ch THE LEGAL ENVIRONMENT OF BUSINESS Liability and Remedies Criminal penalties: SEC and U.S. Justice Dept. SEC Action Private actions under 10-5 and 10(b)

© 2006 Prentice Hall Ch THE LEGAL ENVIRONMENT OF BUSINESS Short-Swing Profits Coverage: Director, officer, 10 percent owner Profits made in purchase and sale within 6- month period Presumed to be based on insider information Remedy: Return profits to corporation Standing: Shareholders, directors, and officers

© 2006 Prentice Hall Ch THE LEGAL ENVIRONMENT OF BUSINESS Regulation of Investment Companies All investment companies must register under Investment Company Act of 1940 National Securities Market Improvement Act preempted most state law Required: Annual reports; holdings in bank or exchange member, follow SEC rules State securities laws still cover local issues

© 2006 Prentice Hall Ch THE LEGAL ENVIRONMENT OF BUSINESS State Securities Laws “Blue Sky” laws Regulate securities in intrastate commerce Similar to federal laws Uniform Securities Act National Securities Market Improvement Act

© 2006 Prentice Hall Ch THE LEGAL ENVIRONMENT OF BUSINESS E-Commerce and Online Securities Internet effectively accelerates trade EDGAR Cyber fraud a new problem “Pump and dump” example of new types of deception

© 2006 Prentice Hall Ch THE LEGAL ENVIRONMENT OF BUSINESS Global Dimensions Foreign Corrupt Practices Act of 1977 (FCPA) Makes bribes to foreign officials in order to obtain contracts Coverage: All U.S. citizens, agents, and accountants doing business worldwide Penalties: Fines and imprisonment Exempt: ‘Grease payments’ to low-level functionaries

© 2006 Prentice Hall Ch THE LEGAL ENVIRONMENT OF BUSINESS OECD Convention on Antibribery Convention signed by 34 countries in 1997 Criminalizes bribery Eliminates tax deductions for bribes Requires disclosure Exempt: ‘Grease payments’ to low level functionaries

© 2006 Prentice Hall Ch THE LEGAL ENVIRONMENT OF BUSINESS International Securities Enforcement Cooperation Act of 1990 Goal: Attack money laundering via Swiss banks Method: Create procedures for tracing laundered money International Securities Enforcement Cooperation Act (ISECA) Methods: Information exchange; protects confidentiality; administrative sanctions on violators; SEC investigative powers expanded worldwide

© 2006 Prentice Hall Ch THE LEGAL ENVIRONMENT OF BUSINESS Foreign Securities Sold in U.S. Generally, similar SEC registration/exemption rules apply Special rules: ‘Public interest’ exemption; recognition of information filed in issuer’s home country; NASDAQ requirements