1. Chapter 41 Investor Protection, E-Securities, and Wall Street Reform

2. Securities and Exchange Commission (SEC)  Federal administrative agency empowered to administer federal securities laws  Adopts rules and regulations to interpret and implement federal securities laws  Investigates alleged securities violations and brings enforcement actions  Regulates activities of securities brokers and advisors Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall. 41-2

3. Definition of a Security  Common security: Interests or instruments that is common stock, bond, debenture or warrant  Statutorily defined security: Interest or instrument mentioned in securities acts  Investment contract: Flexible standard for defining a security  Howey Test is applied to determine investment contract Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall. 41-3

4. Initial Public Offering: Securities Act of 1933  Primarily regulates the issuance of securities by a corporations, limited partnerships, and associations  Initial public offering: sale of securities by an issuer to the public  Securities are registered with SEC by means of:  Registration statement  Prospectus Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall. 41-4

5. Initial Public Offering: Securities Act of 1933  Regulation A: Permits issuer to sell securities pursuant to a simplified registration process  Civil liability under Section 11: Imposed on persons who intentionally defraud investors by omitting facts in registration statement  Civil liability under Section 12: Imposed on persons who violate provisions of Section 5  Criminal liability: Imposed on persons who willfully violate the act Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall. 41-5

6. Securities Exempt from Registration  Securities issued by any government in the U.S.  Short-term notes with maturity date not exceeding nine months  Securities issued by nonprofit issuers  Securities of financial institutions  Insurance and annuity contracts  Stock dividends and stock splits  Securities issued in corporate reorganization Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall. 41-6

7. Transactions Exempt from Registration Nonissuer Exemption Intrastate Offering Exemption Private Placement Exemption Small Offering Exemption Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall. 41-7

8. Transactions Exempt from Registration  Nonissuer exemption: Security transactions not made by issuer, do not have to be registered with SEC  Intrastate offering exemption: Permits local businesses to raise capital from local investors without registering with SEC Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall. 41-8

9. Transactions Exempt from Registration  Private placement exemption: Permits issuers to raise capital from unlimited number of accredited investors without registering with SEC  Law permits no more than thirty-five nonaccredited investors to purchase securities  Small offering exemption: Permits sale of securities not exceeding $1 million during twelve-month period Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall. 41-9

10. Sarbanes-Oxley Act  Establish rules for separation of investment banking and securities advice functions of securities firms to eliminate conflicts of interest  Fear that analysts would be pressured to give high marks to companies being assisted by firm’s investment bankers  Protects analysts from review, pressure, and oversight by investment bankers 41-10

11. Securities Exchange Act of 1934  Primarily regulates trading in securities  Provides for registration of companies with SEC  Filing of periodic reports by companies  Regulation of security exchanges, brokers, and dealers Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall. 41-11

12. Section 10(b) and Rule 10b-5  Section 10(b): Prohibits use of manipulative and deceptive devices in the purchase or sale of securities in contravention of the rules and regulations of SEC  Rule 10b-5: Clarify reach of Section 10(b) against deceptive and fraudulent activities in purchase and sale of securities  Only conduct involving scienter (intentional conduct) violates Section 10(b) and Rule 10b-5 Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall. 41-12

13. Violations of 1934 Act  Civil liability: Plaintiff may bring civil action and seek rescission of securities contract  SEC actions:  Enter into consent decrees with defendants  Seek injunctions in court  Seek court orders requiring defendants to disgorge illegally gained profits  Criminal liability: Criminal offence to willfully violate provisions of the act Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall. 41-13

14. Violations of 1934 Act  Insider trading: Insider uses material nonpublic information to make a profit by trading in the securities of the company  Tipper-tippee liability  Tippee is liable for acting on material information  Tipper is liable for profits made by tippee  Tipper: person who discloses material information  Tippee: person who receives material information Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall. 41-14

15. Case 41.1: Insider Trading  Case  United States v. Bhagat  436 F.3d 1140, Web 2006 U.S. App. Lexis 3008 (2006)  United States Court of Appeals for the Ninth Circuit  Issue  Is Bhagat criminally guilty of insider trading and tipping? Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall. 41-15

16. Violations of 1934 Act  Misappropriation theory: Imposed on outsider who misappropriates information about a company, and then trades in securities of the company  Aiders and Abettors:  Those who knowingly assist in fraud  They are criminally liable, but no private cause of action exists against them Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall. 41-16

17. Short-Swing Profits  Profits made by statutory insiders on trades involving equity securities that occur within a time period of six months  Statutory insider: A person who is an executive officer, a director, or a 10-percent shareholder of an equity security of the company Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall. 41-17

18. Section 16(b)  Profits made by statutory insider on transactions involving short-swing profits belong to the corporation  SEC Section 16 rules  Defines officers to include only executive officers who perform policy-making functions  Relieves insiders of liability for transactions that occur within six months before becoming a insider Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall. 41-18

19. Consumer Protection Act and State Securities Laws  Dodd-Frank Wall Street Reform and Consumer Protection Act: Regulates hedge funds and derivatives and provides protection to consumers regarding financial products and services  State “blue-sky” laws: State securities laws that regulate issuance and trading of securities Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall. 41-19

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