1. Prentice Hall © 20071 PowerPoint Slides to accompany The Legal Environment of Business and Online Commerce 5E, by Henry R. Cheeseman Chapter 27 Investor Protection and Online Securities Transactions

2. Prentice Hall © 20072 The Securities and Exchange Commission (SEC) Created by the Securities Exchange Act of 1934 and empowered to administer federal securities laws. Major responsibilities Adopt rules Investigate alleged securities violations and bring enforcement actions Regulate activities of securities brokers and advisors

3. Prentice Hall © 20073 Definition of a Security A security must exist before securities laws apply. A security is: An interest or instrument that is common stock, preferred stock, a bond, a debenture, or a warrant An interest or instrument that is expressly mentioned in securities acts An investment contract

4. Prentice Hall © 20074 Investment Contracts An investment contract is a security if: An investor invests money In a common enterprise With the expectation of profit from the significant efforts of others

5. Prentice Hall © 20075 Going Public: The Securities Act of 1933 A federal statute that primarily regulates the issuance of securities by corporations, partnerships, associations, and individuals

6. Prentice Hall © 20076 Registration Statement Document that an issuer of securities files with the SEC that contains required information about the issuer, the securities to be issued, and other relevant information

7. Prentice Hall © 20077 Prospectus Written disclosure document that must be submitted with registration statement. It is provided to prospective investors to enable them to evaluate the financial risk of an investment.

8. Prentice Hall © 20078 Limitations on Activities During the Registration Process Prefiling period Issuer cannot sell or offer to sell the securities. Issuer cannot condition the market for the offering. Waiting period Begins when the registration statement is filed. Issuer can condition the market during this period.

9. Prentice Hall © 20079 Limitations on Activities During the Registration Process Posteffective period Begins when registration statement is effective and ends when the issuer sells all the securities or withdraws them from sale.

10. Prentice Hall © 200710 Regulation A Offerings Simplified registration process Issuers may sell up to $5 million of securities to the public during a 12-month period. An offering statement must be filed for any offering over $100,000. There are no restrictions on resale.

11. Prentice Hall © 200711 Violations of the Securities Act of 1933 Private actions Section 12 imposes civil liability for violations, including making misrepresentations concerning the offer or sale of securities. Section 11 provides for civil liability when a registration statement misstates or omits a material fact. Due diligence defense may be used by all defendants except the issuer.

12. Prentice Hall © 200712 Violations of the Securities Act of 1933 SEC Actions Consent order – defendant agrees not to violate securities laws in the future but does not admit past violations. Injunction Disgorgement of profits

13. Prentice Hall © 200713 Violations of the Securities Act of 1933 Criminal liability for willful violation of the act or rules and regulations Violator may be fined up to $10,000 or imprisoned for up to 5 years, or both.

14. Prentice Hall © 200714 Transactions Exempt from Registration Nonissuer exemption Intrastate offerings Private placements Small offerings

15. Prentice Hall © 200715 Intrastate Offerings Three requirements to qualify for intrastate exemption: Issuer must be a resident of the state for which the exemption is claimed. Issuer must be doing business in that state. 80% of assets are located in the state 80% of gross revenues are derived from the state 80% of proceeds must be used in the state All purchasers of securities must be residents of the state.

16. Prentice Hall © 200716 Private Placements Issuer may sell securities to an unlimited number of accredited investors: Natural person with a net worth of at least $1 million Natural person with an annual income of at least $200,000 for the previous two years and who reasonably expects $200,000 in the current year. Corporation, partnership, or business trust with more than $5 million assets

17. Prentice Hall © 200717 Private Placements Accredited investors, continued: Insiders of issuers Certain institutional investors, such as registered investment companies and pension plans Issuer may also sell to no more than 35 nonaccredited investors; these persons must be sophisticated investors.

18. Prentice Hall © 200718 Small Offerings Offerings are exempt from registration if the sale of securities does not exceed $1 million during a 12- month period.

19. Prentice Hall © 200719 Resale Restrictions Securities sold as intrastate offerings, private placements, or small offerings have restrictions on resale. Intrastate offerings – cannot be resold to a nonresident for 9 months. Private placements or small offerings must be held for 1 year. After that date, there are further restrictions.

20. Prentice Hall © 200720 Preventing Resale of Restricted Securities To protect the nontransferability of restricted securities, the issuer must: Require the investors to sign an affidavit stating that they are buying the securities for investment, acknowledging that they are purchasing restricted securities, and promising not to transfer the shares in violation of the restriction. Place a legend on the stock certificate describing the restriction. Notify the transfer agent not to record a transfer of the securities that would violate the restriction.

21. Prentice Hall © 200721 Rule 144A “Qualified institutional investors” may buy unregistered securities without being subject to holding period restrictions. This makes it possible for foreign issuers to raise capital in the U.S. from sophisticated investors without going through registration process disclosures.

22. Prentice Hall © 200722 Securities Exempt From Registration Some securities are exempt from registration. These include: Securities issued by any government in the U.S. Short-term notes and drafts that have a maturity date not exceeding 9 months Securities issued by nonprofit issuers Securities of financial institutions Securities issued by common carriers

23. Prentice Hall © 200723 Trading in Securities: The Securities Exchange Act of 1934 A federal statute that primarily regulates the trading of securities

24. Prentice Hall © 200724 Section 10(b) and Rule 10b-5 Section 10(b) prohibits the use of manipulative and deceptive devices in the purchase or sale of securities. Prohibits insider trading Rule 10b-5 clarifies the scope of Section 10(b) Applies to all transfers of securities Only conduct involving scienter is a violation.

25. Prentice Hall © 200725 Insider Trading It is illegal for a company insider to use material nonpublic information to make a profit by trading in company securities.

26. Prentice Hall © 200726 Insider Trading Insiders include: Officers, directors, and employees at all levels of the company Lawyers, accountants, consultants, and other agents and representatives hired by a company on a temporary basis Others who owe a fiduciary duty to the company

27. Prentice Hall © 200727 Tipper-Tippee Liability Tipper A person who discloses material, nonpublic information to another person Tippee The person who receives material, nonpublic information from a tipper

28. Prentice Hall © 200728 Violations of the Securities Exchange Act of 1934 Private actions SEC actions Consent order Injunction Disgorgement of profits Criminal liability Sarbanes-Oxley Act – SEC may prevent a person who has committed securities fraud from acting as an officer or director in a public company.

29. Prentice Hall © 200729 Short-Swing Profits Section 16(a) Statutory insider – executive officer, director, or 10% shareholder Short-swing profits from trades of company equity securities by a statutory insider within 6 months of each other belong to the company. Involuntary transfers are not included. There are generally no defenses; no intent needs to be proven.

30. Prentice Hall © 200730 Sarbanes-Oxley Act Securities firms must establish “walls” between investment banking and securities analysis areas. Securities analysts must disclose in a research report or public appearance any conflicts of interest that are known or should have been known to exist at the time.

31. Prentice Hall © 200731 State Securities Laws Many states have adopted the Uniform Securities Act, called “blue sky laws.” Blue sky laws require registration of certain securities and provide exemptions from registration.