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Chapter 28 Investor Protection and Corporate Governance. § 1: The Securities and Exchange Commission. SEC is an independent federal agency created by the 1934 Act. Responsibilities: administer the 1933 and 1934 Acts: Make rules to implement the 1933-34 Acts.

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Chapter 28

Investor Protection and Corporate Governance


1 the securities and exchange commission
§ 1: The Securities and Exchange Commission

  • SEC is an independent federal agency created by the 1934 Act.

  • Responsibilities: administer the 1933 and 1934 Acts:

    • Make rules to implement the 1933-34 Acts.

    • Investigate and enforce SEC laws against those who violate rules.

    • Adjudicates offenses with appeal into the court system.


Expanding regulatory powers of the sec
Expanding RegulatoryPowers of the SEC

  • Securities Enforcement Remedies and Penny Stock Reform Act of 1990.

  • Securities Acts Amendments of 1990.

  • Market Reform Act of 1990.

    • National Securities Markets Improvement Act of 1996 exempts certain persons, securities and transactions from securities laws.


2 the securities act of 1933
§ 2: The Securities Act of 1933

  • SEA of 1933 designed to prohibit fraud and require certain essential information so that investors can make informed business decisions.

  • In SEC v. Howey (1946), the U.S. Supreme Court held that a “security” exists in any transaction in which a person: (1) invests (2) in a common enterprise (3) reasonably expecting profits (4) derived primarily from others’ managerial or entrepreneurial efforts.


Registration statement
Registration Statement

  • If a security does not qualify for an exemption under §5 of the Securities Act of 1933, the security must be registered with the SEC and state (seeTexas) securities agencies before offered to the public.

  • Corporation must file a registration statement and prospectus with the SEC. Prospectus is later distributed to investors.


Contents of registration statement
Contents of Registration Statement

  • Description of the significant provisions of the registrant’s “offering” and how the registrant intends to use the proceeds from the sale.

  • Description of the registrant’s properties and business.


Contents of registration statement 2
Contents of Registration Statement [2]

  • Description of the management of the registrant, remuneration, pension, stock offerings, executive interests and compensation.

  • Financial statement certified by and independent accounting firm.

  • Description of pending lawsuits.


Exempt securities
Exempt Securities

  • Bank securities sold before 1933.

  • Commercial paper if maturity date does not exceed 9 months

  • Charitable organization securities.

  • Securities issued to existing securities holders resulting from reorganization, bankruptcy.

  • Securities issued to finance railroad equipment.


Exempt securities1
Exempt Securities

  • Any insurance, endowment, annuity contract or government-issued securities.

  • Securities issued by banks, savings and loan association, farmers' cooperatives.

  • Regulation A, small offering up to $5 million in a 12 month period to “test the waters”; but requires a circular.

  • Securities issued to existing securities holders, stock split, dividend (really a transaction exemption).


Exempt transactions
Exempt Transactions

  • Small “Reg D” Offerings:

    • Rule 504: up to $1M during 12 months to accredited investors only.

    • Rule 504a.

    • Rule 505: up to $5M during 12 months to both accredited and unaccredited investors.

    • Section 4(6): up to $5M solely to accredited investors.

    • Intrastate Offerings (Rule 147).


Exempt transactions 2
Exempt Transactions[2]

  • Rule 147 Intrastate Sales

  • Broker/Dealer Transactions.

  • Casual Sales.

  • Resales of Restricted Securities by “Control Persons” under Rule 144 and 144(a).


Violations of the 1933 act
Violations of the 1933 Act

  • Violation of the Securities Act means to intentionally or negligently defraud investors by misrepresenting or omitting material facts in the registration statement and/prospectus.


Defenses penalties
Defenses & Penalties

  • Defenses: Statement left out was not material; Plaintiff knew about fraud and purchased stock; Registrant believed statements were true.

  • Penalties:

    • Criminal: up to 5 years in prison and $10,000 fine.

    • Civil: damages, refund of investment, injunction.


3 the securities exchange act of 1934
§3: The Securities Exchange Act of 1934

  • Registration of securities exchanges, brokers, dealers, and national securities exchanges and associations.

  • Requires continuous disclosure system for corporations with securities sold on national exchanges or assets in excess of $5 million and 500 or more shareholders (Sec. 12 companies or 1934 companies).


Purposes of 1934 act 2
Purposes of 1934 Act[2]

  • Rule 14(a) proxy regulations.

  • Market surveillance by SEC.

  • Rule 10(b) prohibits fraud with insider trading and disclosure regulations.

  • Rule 16(b) insider reporting and trading.

  • Rule 13 tender offer regulations.


Insider trading section 10 b and rule 10b 5
Insider Trading: Section 10(b) and Rule 10b-5

  • Section 10(b) prohibits the use of any manipulative or deceptive device or contrivance in contravention of rules and regulations of SEC.

  • Rule 10b(5) prohibits the commission of fraud in the connection with the purchase or sale of any security.

  • Case 28.2:SEC v. Texas Gulf Sulphur (1968).


Insider trading section 10 b and rule 10b 51
Insider Trading: Section 10(b) and Rule 10b-5

  • Section 10b(5) “Insiders”.

  • Rule 10b-5 “Outsiders”.

    • Tipper/Tippee theory--insider’s fiduciary duty must be breached

    • Misappropriation theory -- one wrongfully obtains inside info and trades on it. Courts still require fiduciary duty be breached, e.g., to employer.

    • Case 28.2:U.S. v. O’Hagan (1997).


Violations of the 1934 act
Violations of the 1934 Act

  • Scienter or intent is required to prove civil or criminal penalties under 10(b) and Rule 10b-5.

    • Violator must have had intent to defraud (false statements or wrongfully failed to disclose material facts).

    • Case 28.4:United States v. Stewart (2004).


Violations of the 1934 act1
Violations of the 1934 Act

  • Criminal Penalties:

    • 10(b) and Rule 10b-5, a person faces $5 million and 20 years in prison, $25 million for partnership or corporation.

    • Sarbanes-Oxley provides for 25 years in prison.


Violations of the 1934 act2
Violations of the 1934 Act

  • Civil Sanctions:

    • Both SEC and Private Parties Can Bring Actions Against Violators under the Insider Trading and Securities Fraud Enforcement Act.

    • Private Actions for violations of 10(b) and Rule 10b-5.


4 corporate governance
§4: Corporate Governance

  • Relationship between a corporation and its shareholders.

  • Attempts at Aligning the Interests of Shareholders with those of Officers.

  • Corporate Governance and Corporate Law.


The sarbanes oxley act of 2002
The Sarbanes-Oxley Act of 2002

  • Attempts to increase corporate accountability:

    • Imposes stricter disclosures.

    • Harsher penalties for violations.

    • Requires CEO’s to take responsibility for accuracy of financial statements filed with SEC.

    • Creates new private civil actions.

  • Creates Public Company Accounting Oversight Board regulates public accounting firms.


The sarbanes oxley act of 20021
The Sarbanes-Oxley Act of 2002

  • Key Provisions:

    • Certification Requirements.

    • Loans to Officers and Directors.

    • Protections for Whistleblowers.

    • Enhanced Penalties.

    • Statute of Limitations for Securities Fraud.


5 regulation of investment companies
§5: Regulation of Investment Companies

  • Act on behalf of many smaller shareholders by buying stock and professionally managing the “portfolio.” (MUTUAL FUNDS.)

  • To safeguard company assets, all securities must be held by a bank or stock exchange member.

  • No dividends paid except from undistributed net income.


6 state securities laws
§ 6: State Securities Laws

  • State securities laws are called “blue sky” laws.

  • Issuers must comply with federal and state securities laws and states do not allow the same exemptions as federal government.

  • States could require registration or qualification.

  • Uniform Securities Act has been adopted in part by many states.


7 online securities offerings and disclosures
§ 7: Online Securities Offerings and Disclosures

  • Springstreet Brewing Co. was the first online IPO (1996).

  • Regulations Governing Online Securities Offerings:

    • Timely and Adequate Notice of Delivery of Information.

    • The online communication system must be easily accessible.

    • Some evidence of delivery is required.


Potential liability created by online offering materials
Potential Liability Created by Online Offering Materials

  • Online offerings should exercise caution in hyperlinking to external documents.

  • There is also a concern if the offering is placed on a website that can be viewed by anyone.

    • Many offerings are restricted to a limited number of “unaccredited” investors.


Online securities fraud
Online Securities Fraud

  • The SEC is aggressively prosecuting internet fraud using traditional laws.

  • Investment Scams.

  • Using Chat Rooms to Manipulate Stock Prices.

    • Pumping and Dumping.

    • Jonathan Lebed charged with securities fraud.


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