1. Copyright © 2008 by West Legal Studies in Business A Division of Thomson Learning Chapter 46 Securities Regulation Twomey Jennings Anderson’s Business Law and the Legal Environment, Comprehensive 20e Anderson’s Business Law and the Legal Environment, Standard 20e Business Law: Principles for Today’s Commercial Environment 2e

2. Copyright © 2008 by West Legal Studies in Business A Division of Thomson Learning 2 State Regulation 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.

3. Copyright © 2008 by West Legal Studies in Business A Division of Thomson Learning 3 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.

4. Copyright © 2008 by West Legal Studies in Business A Division of Thomson Learning 4 The term “security” is defined as “stocks and bonds issued by a corporation,” and may also include other interests that provide unearned income. Definition of Security

5. Copyright © 2008 by West Legal Studies in Business A Division of Thomson Learning 5 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.

6. Copyright © 2008 by West Legal Studies in Business A Division of Thomson Learning 6 Registration Process

7. Copyright © 2008 by West Legal Studies in Business A Division of Thomson Learning 7 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. Exemptions from Registration

8. Copyright © 2008 by West Legal Studies in Business A Division of Thomson Learning 8 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.

9. Copyright © 2008 by West Legal Studies in Business A Division of Thomson Learning 9 Sarbanes Oxley Act Requires written certification of the 10-K and 10-Q reports by each company’s CEO and CFO. –“Knowing” misrepresentation can lead to $1million fines and 10 years in prison. –“Willful” misrepresentation can lead to $5million fines and 20 years in prison.

10. Copyright © 2008 by West Legal Studies in Business A Division of Thomson Learning 10 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. Litigation Reform Act. –Safe Harbor Rules. –Lawyer Reporting of Wrongdoing. 1934 Act: Rule 10b-5

11. Copyright © 2008 by West Legal Studies in Business A Division of Thomson Learning 11 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.

12. Copyright © 2008 by West Legal Studies in Business A Division of Thomson Learning 12 Enforcement 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.

13. Copyright © 2008 by West Legal Studies in Business A Division of Thomson Learning 13 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.

14. Copyright © 2008 by West Legal Studies in Business A Division of Thomson Learning 14 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.

15. Copyright © 2008 by West Legal Studies in Business A Division of Thomson Learning 15 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. Regulation FD (SEC rule).

16. Copyright © 2008 by West Legal Studies in Business A Division of Thomson Learning 16 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.

17. Copyright © 2008 by West Legal Studies in Business A Division of Thomson Learning 17 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.

18. Copyright © 2008 by West Legal Studies in Business A Division of Thomson Learning 18 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.