1. McGraw-Hill/Irwin Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 16 Regulation of Securities, Corporate Governance, and Financial Markets

2. 16-2 The Securities Act of 1933 KEY POINT: The Securities Act of 1933 covers the process of issuing or reissuing securities to the public. The law requires registration and certain disclosures and authorizes the SEC to oversee the transactions.

3. 16-3 Howey Test Investment Commonality Profit Expectations Efforts of Others

4. 16-4 Securities that are Exempt Commercial paper (such as promissory notes that are purchased by investment banks) with a maturity date of less than nine months. Securities of charitable organizations. Annuities and other issues of insurance companies. Government-issued securities; municipal bonds. Securities issued by banks and other institutions subject to government supervision.

5. 16-5 Liability for Violations The ’33 Act imposes both civil and criminal penalties on those offerors and sellers of securities who violate the act’s provisions.  (1) rescission of the investment,  (2) civil penalties and fines, and  (3) incarceration for egregious cases.

6. 16-6 The Securities Act of 1934 Regulates the sale of securities between investors after an investor purchased it from a business entity issuer. Regulates brokers, dealers, securities associations, brokerage firms, and other business entities that are engaged in the sale of securities between investors.

7. 16-7 Section 10(b) Section 10(b) of the ’34 Act is the primary antifraud provision covering the trading of securities. Makes it a criminal offense to engage in any fraud, directly or indirectly, in connection with the purchase and sale of any security. Very broad, and the SEC enforces this section (often referred to as rule 10(b)(5) ) strictly.

8. 16-8 Insider Trading When a corporate insider has access to information not available to the general public, the insider may not trade in their company’s stock on the basis of the inside information. Insiders include executives, managers, corporate counsel, consultants, employees, brokers, accountants, vendors, partners, and even majority shareholders.

9. 16-9 Private Securities Litigation Reform Act of 1995 The PSLRA made it more difficult to pursue litigation under the securities laws based solely on commentary by the company’s executives. The PSLRA provides safe harbors from lawsuits that shield the company and its officers and directors so long as the principals acted in good faith and disclosed all relevant facts.

10. 16-10 The Sarbanes-Oxley Act of 2002 (SOX) Passed in response to revelations of corporate fraud and malfeasance in publicly held companies. The law aims to solve specific mechanism failures in accounting methods and requires higher levels of fiduciary responsibilities for those involved in corporate governance.

11. 16-11 Substantial Penalties Officers who certify required financial report filing knowing that the report is inaccurate are subject to criminal penalties of:  up to $1million in fines and 10 years incarceration.  for cases in which the certification was used as part of a larger fraudulent scheme, the penalties increase to $5 million in fines and 20 years incarceration.

12. 16-12 learning outcomes checklist 16 - 1 Articulate factors that differentiate, and the laws that regulate, the primary and secondary securities markets. 16 - 2 Apply the legal test for what constitutes a security. 16 - 3 Distinguish between classifications of equity and debt instruments and give an example of each.

13. 16-13 learning outcomes checklist 16 - 4 Recognize the fundamental reason behind securities regulation and have a working knowledge of the legal process leading to issuance of original securities. 16 - 5 Describe the role of the Securities and Exchange Commission (SEC) in securities law compliance and enforcement. 16 - 6 List the major categories of securities and transactions that are exempt from registration requirements

14. 16-14 learning outcomes checklist 16 - 7 Understand the ethical and legal duties of corporate insiders. 16 - 8 Identify the legal standard necessary to bring a securities fraud suit against directors and officers in light of the Private Securities Litigation Reform Act. 16 - 9 Explain the role of state blue-sky laws in securities regulation

15. 16-15 learning outcomes checklist 16- 10 Show an awareness of the impact of the Sarbanes-Oxley Act on a corporation’s officers and directors and its corporate governance. 16 - 11 Articulate key protections afforded by regulation of the financial markets.