1. Copyright © 2004 by Prentice-Hall. All rights reserved. PowerPoint Slides to Accompany BUSINESS LAW E-Commerce and Digital Law International Law and Ethics 5 th Edition by Henry R. Cheeseman Slides developed by Les Wiletzky Wiletzky and Associates, Puyallup, WA Chapter 38 Investor Protection and Online Securities Transactions Chapter 38 Investor Protection and Online Securities Transactions

2. 38 - 2Copyright © 2004 by Prentice-Hall. All rights reserved. Federal law did not regulate the securities markets until after the stock market crash of 1929. Securities laws are designed to help prevent a similar crash today.

3. 38 - 3Copyright © 2004 by Prentice-Hall. All rights reserved. The Securities and Exchange Commission (SEC)  Federal administrative agency that is empowered to administer federal securities laws.  The SEC can adopt rules and regulations to interpret and implement federal securities laws.

4. 38 - 4Copyright © 2004 by Prentice-Hall. All rights reserved. Definition of a Security  A security must exist before securities laws apply.  Securities are defined as: An interest or instrument that is common stock, preferred stock, a bond, a debenture, or a warrant 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 interest or instrument that is expressly mentioned in securities acts An investment contract An investment contract

5. 38 - 5Copyright © 2004 by Prentice-Hall. All rights reserved. Landmark Law: The Securities Act of 1933  Primarily regulates the issuance of securities by a corporation, a general or limited partnership, an unincorporated association, or an individual.  Section 5 of the Act requires securities offered to the public through the use of the mails or any facility of interstate commerce to be registered with the SEC.

6. 38 - 6Copyright © 2004 by Prentice-Hall. All rights reserved. Registration Statement  A covered issuer of securities must file a written registration statement with the SEC.  It contains required information about the issuer and the securities to be issued.  The SEC does not pass upon the merits of the registered securities.  It decides only whether the issuer has met the disclosure requirements.

7. 38 - 7Copyright © 2004 by Prentice-Hall. All rights reserved. Prospectus  A written disclosure document that must be submitted to the SEC along with the registration statement.  It is provided to prospective investors to enable them to evaluate the financial risk of the investment.

8. 38 - 8Copyright © 2004 by Prentice-Hall. All rights reserved. Limitations on Activities During the Registration Process The Prefiling Period The Waiting Period The Posteffective Period

9. 38 - 9Copyright © 2004 by Prentice-Hall. All rights reserved. Regulation A Offerings  A regulation that permits the issuer to sell securities pursuant to a simplified registration process.  Such offerings may have an unlimited number of purchasers. They do not have to be sophisticated investors. They do not have to be sophisticated investors.  There are no resale restrictions on the securities.

10. 38 - 10Copyright © 2004 by Prentice-Hall. All rights reserved. Securities Exempt From Registration With the SEC (1 of 2) 1.Securities issued by any government in the U.S. 2.Short-term notes and drafts that have a maturity date that does not exceed nine months 3.Securities issued by nonprofit issuers 4.Securities of financial institutions that are regulated by the appropriate banking authorities 5.Securities issued by common carriers that are regulated by the Interstate Commerce Commission 1.Securities issued by any government in the U.S. 2.Short-term notes and drafts that have a maturity date that does not exceed nine months 3.Securities issued by nonprofit issuers 4.Securities of financial institutions that are regulated by the appropriate banking authorities 5.Securities issued by common carriers that are regulated by the Interstate Commerce Commission

11. 38 - 11Copyright © 2004 by Prentice-Hall. All rights reserved. Securities Exempt From Registration With the SEC (2 of 2) 6.Insurance and annuity contracts issued by insurance companies 7.Stock dividends and stock splits 8.Securities issued in a corporate reorganization where one security is exchanged for another security. 6.Insurance and annuity contracts issued by insurance companies 7.Stock dividends and stock splits 8.Securities issued in a corporate reorganization where one security is exchanged for another security.

12. 38 - 12Copyright © 2004 by Prentice-Hall. All rights reserved. Transactions Exempt from Registration  Certain transactions are exempt from registration.  Exempt transactions are subject to the antifraud provisions of the federal securities laws.  The issuer must provide investors with adequate information.

13. 38 - 13Copyright © 2004 by Prentice-Hall. All rights reserved. Transactions Exempt from Registration (continued) Nonissuer Exemption Intrastate Offering Exemption Private Placement Exemption Small Offering Exemption

14. 38 - 14Copyright © 2004 by Prentice-Hall. All rights reserved. Resale Restrictions  Certain resale restrictions are placed on securities issued pursuant to exemptions from registration. Rule 147 Rule 147 Rule 144 Rule 144

15. 38 - 15Copyright © 2004 by Prentice-Hall. All rights reserved. Rule 144A (1990)  Rule adopted by the SEC to increase the liquidity of the registered securities.  The rule permits “qualified institutional investors” to buy unregistered securities without being subject to the holding periods of Rule 144.

16. 38 - 16Copyright © 2004 by Prentice-Hall. All rights reserved. Integration of Exempt Offerings  Separate offerings that qualify for individual exemptions from registration will be integrated if they are really part of one large offering.  This larger offering must then be examined to see if it qualifies for an exemption from registration.

17. 38 - 17Copyright © 2004 by Prentice-Hall. All rights reserved. Integration of Exempt Offerings (continued)  If offerings are integrated and the combined offering does not qualify for an exemption, the issuer has illegally sold unregistered securities.  This subjects the issuer to certain civil fines and criminal penalties.  Purchasers may rescind their purchases and recover the price they paid.

18. 38 - 18Copyright © 2004 by Prentice-Hall. All rights reserved. Liability Provisions of the Securities Act of 1933  Criminal Liability – Section 24 imposes criminal liability on any person who willfully violates the act or the rules or regulations adopted thereunder.  SEC Actions – Consent order Consent order Injunction Injunction Request ancillary relief from the court Request ancillary relief from the court

19. 38 - 19Copyright © 2004 by Prentice-Hall. All rights reserved. Liability Provisions of the Securities Act of 1933 (continued)  Private Actions – Private parties who have been injured by violations of the act have the following recourse against the violator: Section 12 – civil liability Section 12 – civil liability Section 11 – civil liability Section 11 – civil liability

20. 38 - 20Copyright © 2004 by Prentice-Hall. All rights reserved. Landmark Law: The Securities Exchange Act of 1934  Federal statute that primarily regulates the trading in securities.  It provides for the regulation of Securities exchanges Securities exchanges Brokers Brokers Dealers Dealers  Contains provisions that assess civil and criminal liability on violators of the act.

21. 38 - 21Copyright © 2004 by Prentice-Hall. All rights reserved. Section 10(b)  A provision of the Securities Exchange Act of 1934.  Prohibits the use of manipulative and deceptive devices in the purchase or sale of securities in contravention of the rules and regulations prescribed by the SEC.

22. 38 - 22Copyright © 2004 by Prentice-Hall. All rights reserved. Rule 10b-5  A rule adopted by the SEC to clarify the reach of Section 10(b) against deceptive and fraudulent activities in the purchase and sale of securities.  All transfers of securities are subject to this rule. i.e., stock exchange, over-the-counter, private sale, merger i.e., stock exchange, over-the-counter, private sale, merger

23. 38 - 23Copyright © 2004 by Prentice-Hall. All rights reserved. Insider Trading  One of the most important purposes of Section 10(b) and Rule 10b-5 is to prevent insider trading. When an insider makes a profit by personally purchasing shares of the corporation prior to public release of favorable information, or When an insider makes a profit by personally purchasing shares of the corporation prior to public release of favorable information, or By selling shares of the corporation prior to the disclosure of unfavorable information By selling shares of the corporation prior to the disclosure of unfavorable information

24. 38 - 24Copyright © 2004 by Prentice-Hall. All rights reserved. Insiders are defined under Section 10(b) and Rule 10b-5 as:  Officers, directors, and employees at all levels of the company  Lawyers, accountants, consultants, and other agents and representatives who are hired by the company on a temporary and non-employee status to provide services or work to the company  Others who owe a fiduciary duty to the company  Officers, directors, and employees at all levels of the company  Lawyers, accountants, consultants, and other agents and representatives who are hired by the company on a temporary and non-employee status to provide services or work to the company  Others who owe a fiduciary duty to the company

25. 38 - 25Copyright © 2004 by Prentice-Hall. All rights reserved. Tipper – Tippee Liability Tipper  A person who discloses non- public information to another person.  Liable for the profits made by the tippee. Tipper  A person who discloses non- public information to another person.  Liable for the profits made by the tippee. Tippee  The person who receives material non-public information from a tipper.  Liable for acting on material information that he or she knew (or should have known) was not public. Tippee  The person who receives material non-public information from a tipper.  Liable for acting on material information that he or she knew (or should have known) was not public.

26. 38 - 26Copyright © 2004 by Prentice-Hall. All rights reserved. Liability Provisions of the Securities Exchange Act of 1934  Criminal Liability – Section 32 imposes criminal liability on any person who willfully violates the act or regulations adopted thereunder.  SEC Actions – Consent order Consent order Injunction Injunction Seek court orders Seek court orders Insider trading sanctions Insider trading sanctions

27. 38 - 27Copyright © 2004 by Prentice-Hall. All rights reserved. Liability Provisions of the Securities Exchange Act of 1934 (continued)  Private Actions – The courts have implied private right of action under Section 10(b) and Rule 10b-5. Generally, a plaintiff may seek rescission of the securities contract or recover damages from a defendant who has engaged in manipulation and deceptive practices that have caused the plaintiff injury. Generally, a plaintiff may seek rescission of the securities contract or recover damages from a defendant who has engaged in manipulation and deceptive practices that have caused the plaintiff injury.

28. 38 - 28Copyright © 2004 by Prentice-Hall. All rights reserved. Short-Swing Profits: Statutory Insiders  Section 16(a) of the 1934 act – defines any person who is an executive officer, a director, or a 10 percent shareholder of an equity security of a reporting company as a statutory insider for Section 16 purposes.

29. 38 - 29Copyright © 2004 by Prentice-Hall. All rights reserved. Short-Swing Profits: Section 16(b)  Short-Swing Profits – Profits made by statutory insiders on trades involving equity securities that occur within six months of each other.  Section 16(b) – A provision of the 1934 act that requires that any profits made by a statutory insider on transactions involving short-swing profits belong to the corporation.

30. 38 - 30Copyright © 2004 by Prentice-Hall. All rights reserved. Other Federal Securities Laws Racketeer Influenced and Corrupt Practices Act (RICO)  Federal statute that provides for both criminal and civil penalties for engaging in a pattern or practice of racketeering activities. Racketeer Influenced and Corrupt Practices Act (RICO)  Federal statute that provides for both criminal and civil penalties for engaging in a pattern or practice of racketeering activities. Private Securities Litigation Reform Act of 1995  Federal statute that provides a safe harbor from liability for companies that make forward-looking statements that are accompanied by meaningful cautionary statements of risk factors. Private Securities Litigation Reform Act of 1995  Federal statute that provides a safe harbor from liability for companies that make forward-looking statements that are accompanied by meaningful cautionary statements of risk factors.

31. 38 - 31Copyright © 2004 by Prentice-Hall. All rights reserved. State Securities Laws  Most states have enacted securities laws that regulate the issuance and trading of securities.  These acts are often patterned after, and are designed to coordinate with, federal securities laws.  The Uniform Securities Act (a model state statute) has been adopted by many states.

32. 38 - 32Copyright © 2004 by Prentice-Hall. All rights reserved. Commodities Regulation  Section 4b of the Commodity Exchange Act – prohibits fraudulent conduct in connection with any order or contract of sale of any commodity for future delivery.