Ch 2 S3 Federal Regulations

Question 1

INSIDER TRADING REGULATIONS UNDER THE
SECURITIES AND EXCHANGE ACT OF 1934

Answer 1

TECHNICAL INSIDER DEFINITION UNDER 1934 ACT

COURT’S DEFINITION OF INSIDER

CHINESE WALLS

VIOLATION FOR INSIDER

INFORMER BOUNTY

RULE 10B-5-1- PRE-ARRANGED TRADING PLAN

Question 2

INSIDER TRADING REGULATIONS UNDER THE
SECURITIES AND EXCHANGE ACT OF 1934

Answer 2

insiders are prohibited from trading based on nonpublished
info.

Question 3

INSIDER TRADING REGULATIONS UNDER THE
SECURITIES AND EXCHANGE ACT OF 1934

TECHNICAL INSIDER DEFINITION UNDER 1934 ACT

Answer 3

officer, director, or 10% shareholder

Question 4

INSIDER TRADING REGULATIONS UNDER THE
SECURITIES AND EXCHANGE ACT OF 1934

COURT’S DEFINITION OF INSIDER

Answer 4

person receiving nonpublic info. that can
influence price of stock and trades on info.

• liability for tipper (person who gave information
that resulted in a trade) AND tippee (person
who traded)

once information is public, person can trade;
information is considered public once it has been
released by the news media

Question 5

INSIDER TRADING REGULATIONS UNDER THE
SECURITIES AND EXCHANGE ACT OF 1934

CHINESE WALLS

Answer 5

brokers/dealers must have procedures to prevent
misuse of material nonpublic info.

• designed to fully segregate info. flow from
firm’s research and investment banking units
from firm’s trading unit

• Required Chinese Wall Between:

Research-Investment Banking, Retail Sales, Trading

Investment Banking-Research, Retail Sales,
Trading

Question 6

VIOLATION FOR INSIDER

Answer 6

defined as person who misuses material inside
information to trade

minimum penalty is the greater of 3 times profit
achieved or loss avoided (treble damages)

criminal penalties include $5MM fine and
up to 20 years in jail!

note that if a “controlling person” knew of
insider trading activity and recklessly
disregarded the fact that a violation occurred,
then that person could also be subject to a
$25MM fine
• fines are payable to the Department of
Treasury

Question 7

INFORMER BOUNTY insider trading

Answer 7

to be paid up to 10%-30% to informants of
infractions

• insiders can be sued by any person who traded
that security during time period inside trades
occurred

• statute of limitations is 5 yea

Question 8

RULE 10B-5-1- PRE-ARRANGED TRADING PLAN

Answer 8

a statutory insider is given a safe-harbor from
being accused of insider trading if the insider
establishes a pre-arranged trading plan
§ this allows trading of the company’s
securities based on an algorithm … or based
on a written plan which sets forth when and
how much in securities are to be bought or
sold

Question 9

REGULATION FD (FAIR DISCLOSURE)
the SEC passed this to address issues related to
insider trading; the 3 issues addressed:

Answer 9

l) the selective disclosure by issuers of material
non-public information • 2) when a trader is deemed to be an “insider” • 3) the breach of family or other non-business
relationships giving rise to liability due to their
trading

Question 10

REGULATION FD (FAIR DISCLOSURE card 2

Answer 10

the rules are designed to promote the full and fair
disclosure of infonnation by issuers

public disclosure must be made when an issuer ( or
person on behalf of an issuer) discloses material
non-public information to securities market
professionals and/or holders of the issuer’s securities
who may trade based on the information they just
received

any nev,,s must be broadly disseminated to the public
(i.e. there are no longer selective quarterly
conference calls with securities industry research
analysts or big institutional money managers
“clueing these people in’’ on the outlook ofa
company)
t

o avoid liability for:
• intentional disclosures, the issuer must
simultaneous disclose the information by broad
distribution to the public: or • unintentional disclosures, the issuer must
promptly (within 24 hours) disclose the info
either by filing an SK with the SEC or by broad
distribution of the info to the public

Question 11

TRADE BASED ON INSIDE INFORMATION • defined:

Answer 11

a trade made on the basis of material
non-public information, if the trader was aware
of the material, non-public information when
the person made the purchase or sale

Question 12

SPECIFIC DEFENSE AGAINST ALLEGED INSIDER
TRADING

Answer 12

the person can prove that a trade was not based
on such “inside information” if:

the person (before becoming aware of the
information) had entered into a binding
contract to buy or sell the security;

the person demonstrates that the contract to
buy or sell specified the amount, date, and
price of the trade and that the person had no
further influence over the trade; and

the trade happened because of the prior
contract instructions

Question 13

FAMILY MEMBER INSIDER TRADING

Answer 13

a duty of trust or confidence exists when:

a person agrees to maintain information in
confidence;

two people have a history or practice of
sharing confidences such that the recipient
should know that the material is “nonpublic”
and should remain confidential; or
a person receives or obtains material nonpublic
information from close family
members (spouses, parents, children, and
siblings)

• if a family member trades, and these situations
exist, then liability exists

Question 14

PROHIBITIONS AND RULES UNDER THE
SECURITIES AND EXCHANGE ACT OF 1934

SECTION 9

SECTION 10

SECTION 15

Answer 14

got nothing here

Question 15

PROHIBITIONS AND RULES UNDER THE
SECURITIES AND EXCHANGE ACT OF 1934
SECTION 9

Answer 15

unlawful practices (common sense things, like):

inducing the sale of a security by using false
statements

pegging (stabilizing) the price of a security
in the market other than under the prescribed
rules set by the SEC

• suits must be brought within 2 years of
discovery but no later than 5 years after the
violation occuned

Question 16

PROHIBITIONS AND RULES UNDER THE
SECURITIES AND EXCHANGE ACT OF 1934

SECTION 10

Answer 16

SECTION 10 • it is unlawful to use any deceptive or
manipulative device in violation of the Act

• Rule 10-b-J
manipulation applies to both exempt and
non-exempt securities

• Rule 10-b-3
it is unlawful for broker-dealers. including
municipal broker-dealers. to use employ any
deceptive or manipulative device

• Rule 10-b-5
“catch-all” fraud rule
it is illegal for any person to commit
undefined actions that would operate as
fraud

Question 17

PROHIBITIONS AND RULES UNDER THE
SECURITIES AND EXCHANGE ACT OF 1934

SECTION 15

Answer 17

broker-dealers that effect transactions in nonexempt
securities must be registered

• allows the SEC to censure, suspend, or revoke
the registration of a broker-dealer or associated
person

Question 18

INVESTMENT ADVISERS ACT OF 1940
established to

Answer 18

require registration of investment
advisers with the SEC and to regulate their actions
on a Federal level

this regulation is split between the Federal and the
State Governments

• bigger investment advisers

registered at the Federal level
do NOT have to be registered in each state
in which they do business

• smaller investment advisers
regulated at the State level

must register in each State in which they
wish to conduct business
do NOT have to register with the SEC

Question 19

INVESTMENT ADnSERS ACT OF 1940

INVESTMENT ADVISER DEFINITION

Answer 19

any person who receives compensation for
advising others about:

securities;

OR
the advisability of investing in securities

Question 20

INVESTMENT ADVISERS ACT OF 1940

EXCLUDED From the Definition

Answer 20

banks or bank holding companies

lawyers, accountants, teachers, or engineers

broker-dealers and their registered reps. who
do not separately charge for advice

publishers of newspapers, magazines, or
financial publications of a general and
regular circulation

any person who advises SOLELY about
U.S. Government securities

Question 21

INVESTMENT ADVISERS ACT OF 1940

EXEMPT from Registration under Federal
Law

Answer 21

Intrastate Exemption
• an investment adviser with its
principal office in 1 State who only
renders advice to residents of that
State
• here, only State law applies

Adviser to Insurance Companies

Question 22

INVESTMENT ADVISERS ACT OF 1940

FEDERAL REGISTRATION AS AN INVESTMENT
ADVISER

Answer 22

if the Investment Adviser has assets of
$100MM or more under management and/or
renders advice to investment companies, it must
register with the SEC

• a.k.a. Federal Covered Adviser

• Investment Advisers with less than $ lOOMM
under management are not required to register
with the SEC - they are registered only at the
State Level

Question 23

INVESTMENT ADVISERS ACT OF 1940

INVESTMENT ADVISORY CONTRACTS

Answer 23

must be in writing

• cannot provide for compensation based upon
capital gains in the account

• cannot provide for a “reduction” in the advisory
fee if the account does not reach a specified
performance (i.e. contingency fee)

• cannot allow for assignment of the contract to
another adviser unless the customer consents

• must provide notification of any changes in
composition of the partnership (if the adviser is
a partnership)

Question 24

INVESTMENT ADVISERS ACT OF 1940

TRANSACTIONS

Answer 24

anti-fraud provisions apply to all circumstances,
regardless of an investment adviser being
exempt or excluded from registration

• IAs act as fiduciaries always acting in their
clients’ best interests and cannot charge their
clients more than other IAs offering comparable
services

• BDs are held to a lower “suitability” standard -
recommendations must be “suitable” and the
lowest cost isn’t necessarily a factor when
making a recommendation

Question 25

INVESTMENT ADVISERS ACT OF 1940

TRANSACTIONS

Answer 25

lnvestment Adviser Principal Transactions

Agency Cross Transaction

Question 26

INVESTMENT ADVISERS ACT OF 1940

TRANSACTIONS

lnvestment Adviser Principal Transactions

Answer 26

buying a security from a customer into the
adviser’s account; OR
selling a security to a customer from the
adviser’s account:
is prohibited UNLESS the adviser:
discloses prior to completion of the
transaction that the adviser is acting as
principal;
obtains customer consent

Question 27

INVESTMENT ADVISERS ACT OF 1940

TRANSACTIONS

Agency Cross Transaction

Answer 27

telling one client to sell a security and telling
another client to buy the identical security:

is prohibited UNLESS the adviser:
recommends the transaction to only 1side of
the cross (if both transactions are solicited,
the cross is not allowed);
acts in the best interests of both customers to
obtain the best price;
obtains a written consent from the customer
to effect the transaction and which discloses
that the adviser is acting as a broker for both
buyer and seller. receiving a commission
from both sides or the trade, and that a
potential conflict of interest exists;
sends to each client (at least annually) a
written disclosure regarding the number of
these transactions and total commissions
received from such transactions during the
past year