2. P A R T P A R T Corporations History & Nature of Corporations Organizational and Financial Structure of Corporations Management of Corporations 10 McGraw-Hill/Irwin Business Law, 13/e © 2007 The McGraw-Hill Companies, Inc. All rights reserved.

3. P A R T P A R T Corporations Shareholders’ Rights & Liabilities Securities Regulation Legal & Professional Responsibilities of Auditors, Consultants, and Securities Professionals 10 McGraw-Hill/Irwin Business Law, 13/e © 2007 The McGraw-Hill Companies, Inc. All rights reserved.

4. Securities Regulation – Part 1 PA E TR HC 45 “Quality, at its broadest and most basic level, is the protection of the investor interest. This principle reaffirms a simple and salient truth – markets exist by the grace of investors.” Arthur Levitt, Jr., former SEC chairman (Sept. 23, 1999)

5. Learning Objectives  Purposes of securities regulation  The Securities and Exchange Commission  The Securities Act of 1933  The Securities Exchange Act of 1934  Tender offer regulation  State securities law 45 - 5

6.  Security : investment of money in common enterprise with expectation of profits solely from efforts of others such as stocks, bonds  Three purposes of Securities Act of 1933 and Securities Exchange Act of 1934 : require disclosure of information material to investors, impose liability on those making inadequate or false disclosures, regulate the security industry and markets What is a Security? 45 - 6

7.  The Securities and Exchange Commission (SEC) investigates violations of securities laws and holds administrative hearings to determine whether laws have been violated  Legislative, executive, and judicial functions  Administrative decisions may be appealed to SEC commissioners and Court of Appeals  Electronic filings made with SEC’s EDGAR:  Electronic Data Gathering, Analysis, and Retrieval system www.sec.gov/edgar.shtml www.sec.gov/edgar.shtml The SEC 45 - 7

8.  Most SEC actions resolved through consent orders rather than litigation  SEC may impose civil penalties (fines) up to $500,000 and issue cease and desist orders  SEC may ask courts to grant injunction  Person may contact SEC in advance of a transaction or course of action, and ask SEC to issue a no-action letter SEC Enforcement 45 - 8

9.  1933 Act regulates the sale of securities as they pass from issuer to public investors in with regard to registration and liability  A corporate issuer may not offer to sell or sell securities unless securities are registered with SEC or exempt from registration  Registration requires filing a registration statement with the SEC Securities Act of 1933 45 - 9

10.  Sale of securities requires underwriting by securities market professionals  Prospectus: sales document of an offering registered under the 1933 Act  Information in registration statement must be in the prospectus  Allows potential investor to base decision on all relevant data about issuing company Underwriting & Prospectus 45 - 10

11. 1. Prefiling period : securities may not be offered or sold, must avoid publicity 2. Waiting period: securities may be offered, but not sold; tombstone ad and road show for analysts and institutional investors allowed; preliminary prospectus 3. Posteffective period: after effective date set by SEC and using final prospectus, securities may be offered and sold Securities Offering Timeline 45 - 11

12. 1. Securities exemptions  Exempt securities never need registration: short term note or draft, insurance policy or annuity contract, and securities issued by a nonprofit, banking institution, regulated common carriers, or the government 2. Transaction exemptions  Registration requirement depends upon type of transaction Exemptions to Registration 45 - 12

13.  Intrastate (Rule 147)  Offering securities solely to investors in one state by an issuer resident and doing 80% of firm’s business in that state  Private Offering (Rule 506 of Regulation D)  Offering to less than 35 unaccredited purchasers with sufficient investment knowledge and an unlimited accredited investor-purchasers Transaction Exemptions: Intrastate & Private Offerings 45 - 13

14.  Rule 504, Regulation D : Nonpublic issuer may sell up to $1 million of securities in a 12-month period to any purchaser  General selling efforts permitted  Rule 505, Regulation D : Any issuer may sell up to $5 million of securities in a 12-month period to less than 35 unaccredited investors (unlimited accredited investors)  General selling efforts prohibited Transaction Exemptions: Small Offerings 45 - 14

15.  Regulation A : Nonpublic issuer may sell up to $5 million of securities in one year  No limit on number of purchasers, no purchaser sophistication requirement, and no purchaser resale restriction  Disclosure document is the offering circular, which must be filed with SEC 45 - 15 Transaction Exemptions: Small Offerings

16.  Section 11: civil liabilities for damages when a registration statement misstates or omits a material fact on its effective date  Purchaser may file suit for damages caused by misstatement or omission  Defenses: (a) purchaser knew of omission or misstatement when security was purchased, (b) due diligence defense 1933 Act Liability Provisions 45 - 16

17. Other 1933 Act Provisions  Section 12(a)(2) prohibits misstatements or omissions of material fact in any written or oral communication regarding a security  Section 17(a) prohibits use of any device to defraud, or a false or misleading statement, in connection with offer or sale of securities  Section 24 imposes criminal liability for willful violation of Act, rules, regulations 45 - 17

18. Test Your Knowledge  True=A, False = B  The SEC only has executive power to enforce congressional statutes.  Most SEC actions are resolved through consent orders rather than litigation.  The 1933 Act regulates the sale of securities as they pass from the issuer to public investor.  Registration requires underwriting by corporate insiders and financial controllers. 45 - 18

19. Test Your Knowledge  True=A, False = B  An investment contract in a corporation is a security.  Registration statements are sales documents of an offering registered under the 1933 Act.  All securities are exempt from registration unless specifically required to be registered by statute. 45 - 19

20. Test Your Knowledge  True=A, False = B  Rule 506, Regulation D exempts a private offering to less than 35 unaccredited purchasers from registration requirements.  Rules 504 and 505 provide an exemption from registration for offering securities priced at less than $10.  Section 11 establishes civil liability for damages when a registration statement misstates or omits a material fact. 45 - 20

21. Test Your Knowledge  Multiple Choice  The important time periods in a securities offering are:  (a) Prefiling period  (b) Waiting period  (c) Posteffective period  (d) All of the above  (e) All of the above plus due diligence period 45 - 21

22. Thought Questions 45 - 22  Do the registration requirements of the 1933 Act make sense? Are the provisions too harsh or to lax with regard to potential liability and penalties?

23. Securities Exchange Act of 1934  1934 Act requires periodic disclosure of material information by issuers of publicly held equity securities  Must file a 1934 Act Registration Statement  1934 Act also regulates insiders’ transactions in securities, proxy solicitations, tender offers, brokers and dealers, and securities exchanges 45 - 23

24. Periodic Reporting  Issuers that register securities under 1934 Act must file several periodic reports:  Annual report (Form 10-K), quarterly report (Form 10-Q), monthly report (Form 8-K) when material events occur; comparable reports to shareholders  Issuers who disclose under 1934 Act for registered offering under 1933 Act must file same reports 45 - 24

25. Insider Holdings & Tradings  Section 16(a) requires statutory insiders to disclose ownership of their firm’s securities within 10 days of becoming owners and report subsequent transactions within two business days after a trade of the securities  Statutory insider: officer holding registered equity securities, director, owner of >10% of a class of registered equity securities 45 - 25

26. 1934 Act Liability Provisions  Section 18 imposes liability on any person responsible for false or misleading statement of material fact in any filing under 1934 Act  Person who relies on a false or misleading statement in a filing may sue for damages  Defendant may raise defense of good faith  No knowledge (scienter) statement was false or misleading 45 - 26

27. Section 10(b) & Rule 10b-5  Section 10(b) prohibits use of any deceptive device in contravention of any SEC rules  Defendant must have had intent to deceive  Rule 10b–5 prohibits misstatements or omissions of material information  Private plaintiff must proof reliance  Any information a reasonable investor would consider important to a decision and for which disclosure would have altered decision 45 - 27

28. Insider Trading  Rule 10b–5 prohibits a person with inside information (nonpublic, confidential) from using the information when trading securities with a person without the information  Insider : anyone with confidential corporate information for a corporate purpose  Disclose-or-refrain rule : insider must disclose information before trading or refrain from trading  Tippees receive inside information 45 - 28

29.  Rule 10b–5 prohibits a person trading in securities for personal profit from using confidential information misappropriated by a breach of fiduciary duty owed to source of the information ( misappropriation theory )  Thus, person violates Rule 10b–5 if s/he steals confidential information about firm’s intent to make a tender offer for another firm and buys securities of the second firm Misappropriation Theory 45 - 29

30.  Reg. FD (fair disclosure): when issuer or person acting for issuer discloses material nonpublic information to securities market professionals and holders of issuer’s securities, it must make public disclosure of that information  File or furnish Form 8-K or use other method designed to effect broad, nonselective disclosure to the public Regulation FD 45 - 30

31.  Section 32: Individuals may be fined up to $5 million and imprisoned up to 20 years for willful violations; businesses may be fined up to $25 million  Foreign Corrupt Practices Act: no American firm may to offer, promise, or make gifts or payments of anything of value to foreign officials to influence governmental decision 1934 Act Criminal Liability 45 - 31

32. Test Your Knowledge  True=A, False = B  The 1934 Act requires periodic disclosure of material information by issuers with publicly held equity securities.  Periodic reports include the Form 10-K, the Form 10-Q, and Form 8-K.  If corporate management solicits proxies for a particular vote, it must issue an information statement. 45 - 32

33. Test Your Knowledge  True=A, False = B  Rule 10b-5 defines an insider as anyone with confidential corporate information for a corporate purpose.  Section 18 imposes liability on any person responsible for false or misleading statement of material fact in any filing under 1934 Act 45 - 33

34. Test Your Knowledge  Multiple Choice  Which of the following is false regarding Regulation FD?  (a) A company should establish clear rules for content of information that may be disclosed  (b) If an issuer makes a disclosure of material nonpublic information to a stock broker, it should immediately publicize a denial of that information  (c) “FD” stands for “fair disclosure” 45 - 34

35. Test Your Knowledge  Multiple Choice  A lawyer knows that a client corporation is about to file for bankruptcy. To whom among the following may the lawyer relay this information?  (a) No person  (b) To a relative who might hold securities in the company  (c) To the SEC to begin an investigation 45 - 35

36. Thought Question 45 - 36  Alan Greenspan stated: “Private capital markets are the fundamental building block of the capitalist system…Such markets can function properly only if investors bear the costs of their bad decisions and bad luck and reap the benefits of their good decisions and good luck.”  Speech to the Financial Crisis Conference on July 12, 2000  Do you agree with his statement?