Chapter 3 study notes

Question 1

SEC emergency suspension

Answer 1

emergency means a major market disturbance characterized by (a)
sudden and excessive fluctuations of securities’ prices generally, or a substantial threat of such
fluctuations, that threaten fair and orderly markets, or (b) a substantial disruption of the safe or
efficient operation of the national system for clearance and settlement of securities, or threat to
such operation.
May not last more then 10 days
presidential approval not needed.

Question 2

Schedules 13D

Answer 2

Section 13(D) of the Exchange Act requires anyone who acquires more than
5% of an issuer’s equity securities to notify the issuer, the exchange where the securities are traded,
and the SEC within 10 days after the acquisition.

Question 3

Schedule 13 G

Answer 3

Schedule 13G is an alternative to Schedule 13D and is usually filed by institutional investors (e.g.,
mutual fund companies) that have no intention of influencing or controlling the issuer (passive
investors).

Question 4

Schedule 13-F

Answer 4

SEC Rule 13f-1 of the Securities Exchange Act of 1934 requires quarterly filings
when institutional investment managers (e.g., investment companies, holding companies, and
hedge funds) exercise investment discretion over at least $100,000,000 in equity securities. The
schedule includes information concerning the securities that are owned by the filer. This form must
be filed regardless of whether the filer is registered with the SEC.

Question 5

Official List of Section 13(f) securities

Answer 5

The SEC publishes a list of equity securities that would require the institutional investment manager
to file Form 13F.

Question 6

Form 3

Answer 6

an insider is a director,
officer, or owner of more than 10% of the stock of a corporation. These individuals are considered to
have the ability to control or influence the actions of the corporation. Individuals are required to
report to the SEC within 10 daysThe initial filing when an individual becomes
an insider is accomplished on Form 3, while changes in beneficial ownership are filed on Form 4

Question 7

Short-Swing Profits

Answer 7

Insider sells stock received within six months or holds it for six months sells it and then buys it back within six months.

Question 8

Rule 10b5-1 Plans

Answer 8

For insiders to preestablish trading plans.
 The following must be executed prior to the person becoming aware of the insider information:
 A written plan that is binding entered into to purchase or sell the security
 The plan instructs another person to purchase or sell the security for this person
 The details of the plan must describe:
 The specified amount of securities to be purchased or sold, and the price at which and date
on which the securities were to be sold or,
 Include a written formula or algorithm for determining the amount of securities to be
purchased or sold, and the price at which and the date on which the securities were to be
purchased or sold
 The person who created the plan is not permitted to exercise any subsequent influence over how,
when, or whether to effect purchases or sales, and the individual who makes the purchase and sale
decisions must not be aware of the material, non-public information.

Question 9

(Form 14A).

Answer 9

Proxy Statement
The SEC requires a company to provide shareholders with a proxy
statement prior to its annual meeting. The proxy statement contains information that will be voted
on during the annual shareholder meeting. Detailed information concerning proposed executive
compensation and ownership percentages is required in this document.

Question 10

Proxy Statement Types

Answer 10

Preliminary proxy - filed with the SEC ten days prior to the definitive proxy being sent to clients.
Definitive proxy - filed with the sec no later then when it’s sent to clients.

Question 11

Schedule TO

Answer 11

any person who makes a tender offer
and becomes the owner of more than 5% of a company is required to file Schedule TO (tender offer)
as soon as feasible on the commencement date.

Question 12

SEC Rule 14e-5 Tender offer BD exceptions

Answer 12

The SEC has created a number of exemptions to permit firms to transact their
regular business during the tender offer period. Some of the exempt activities include:
 Purchases by the dealer-manager or its affiliates on an agency basis
 Purchases on a principal basis, provided the dealer-manager and its affiliates are not market makers
 Purchases by an affiliate of the dealer-manager, if the affiliate maintains and enforces written policies
and procedures that are designed to prevent the flow of information (i.e., information barriers), and
the purchases are not made to facilitate the tender offer

Question 13

SEC Rule 13e-3,

Answer 13

Going Private Transactions
The issuer is required to file a Schedule 13E-3 with the SEC and make certain disclosures
to shareholders. In addition, the issuer is required to file certain information with the SEC, such as
reports and opinions by a financial adviser. The issuer will usually attach a summary term sheet
along with other required disclosures to the proxy statement that is given to shareholders.

Question 14

Regulation M-A

Answer 14

During Tender Offers
In general, Regulation M-A updates disclosure rules for the contemporary market while preserving
investor protections. This is accomplished by:
1. Reducing certain restrictions that conflict with the investor’s need for information
2. Setting rules to balance the treatment of cash tender offers versus stock tender offers
3. Simplifying disclosure requirements to facilitate compliance while still increasing investor
understanding

Question 15

Summary Term Sheet

Answer 15

Regulation M-A requires that a summary term sheet be provided to investors
as part of the disclosures made in a tender offer or merger. This information must be provided in a
plain English format to owners of the security so that they may understand the significance of, and
essential features of, the proposed transaction. The summary term sheet should serve as an overview of
material information and must provide a cross-reference to the more detailed disclosures found
later in the document.

Question 16

Fairness Opinion

Required Content

Answer 16

1. Whether a financial adviser to a party in the transaction will receive compensation contingent on
   the completion of the merger or takeover
2. Whether the broker-dealer will receive any other significant payment contingent on the completion of
   the transaction
3. Whether a material relationship existed within the past two years between the broker-dealer and
   any party subject to the fairness opinion
4. Whether information obtained from the party that has requested the fairness opinion has
   been independently verified by the member firm
5. Whether the fairness opinion was approved by a fairness committee
6. Whether the fairness opinion addresses the fairness of the compensation paid to corporate
   insiders, relative to the compensation received by public shareholders

Question 17

Broker-Dealer Fairness Committee

Answer 17

Broker-dealers often create an internal committee to render
fairness opinions. Broker-dealers are required to have written procedures addressing the following:
1. Identification of the types of transactions on which it will issue a fairness opinion
2. Identification of the circumstances in which it will use a fairness committee
3. A process used to select members of the fairness committee and the standards necessary to
become a committee member
4. A process that promotes a balanced view by the fairness committee. This is accomplished by
selecting some members from outside the deal team.
5. A process to determine whether the valuation analysis used by the committee and reflected in
the fairness opinion is appropriate

Question 18

Hart-Scott-Rodino Act

Answer 18

The Hart-Scott-Rodino (HSR) Act is a federal antitrust law that requires certain companies or
financial investors, such as hedge funds planning a merger or acquisition, to file notice with the
Federal Trade Commission (FTC) and the Antitrust Division of the Justice Department, before the
deal is completed. The merger may not be completed until 30 days after the notice is filed. In certain
cases, the regulators may request more information, which will delay the completion of the merger
for an additional 30 days.

Question 19

HSR waiting period

Answer 19

HSR also requires financial investors to file and comply with the 30-day waiting period for stock
transactions and a 15-day period for cash transactions, unless the purchase was for investment
purposes only and without the intent to control the company. Broker-dealers may control or be
affiliated with investment entities such as hedge funds, private equity, and venture capital
partnerships. These types of investors may be subject to the filing and waiting periods of HSR.

Question 20

Restricted and Watch Lists

Answer 20

Only firms that engage in investment banking, research, or arbitrage
activities are required to maintain restricted and watch lists.
The restricted list must be distributed to employees, while the contents of the watch list are
generally known only to selected members of the legal and compliance departments.

Question 21

Bounties

Answer 21

The Act allows the granting of bounties for information leading to the payment of
penalties in connection with insider trading violations. The SEC has the power to determine the
amount of the bounty, which may not exceed 10% of the penalty.

Question 22

Manipulative Activity

Damages

Answer 22

An individual who suffers damages because of the manipulation of the price of a security may sue
the manipulator for recovery of the damages. Action must be brought within three years of the
manipulative activity and within one year of discovery.

Question 23

SEC has created Rule 10b-18

Safe Harbor

Answer 23

If the following conditions are met by an issuer, the SEC will assume that the
issuer is not trying to manipulate its own stock price:
 Use one broker-dealer to place bids and make purchases in any trading session. The rule does
permit an issuer to use one broker-dealer during normal business hours and a different broker-dealer
during after-hours trading.
 Avoid making purchases at certain times of the day. Issuers may not make purchases that are the
first transaction reported that day, nor may purchases be made during the last half-hour of the
normal trading day. If the securities are actively traded, the prohibition is within the last 10 minutes of
the trading day.
 Limit the bid or purchase price of securities at certain prices. The price may not be higher than the
highest independent bid or the last independent transaction price, whichever is higher, for securities
quoted or reported in the consolidated system or interdealer quotation system that displays at least
two quotations. For example, if the last transaction was $23.53 and the current bid/ask spread is
$23.50 - $23.60, the highest price at which they could buy the stock would be $23.53. For all other
securities, purchases must be effected at a price no higher than the highest independent bid obtained
from three independent dealers.
 Limit the amount of stock purchased on any single day. The total volume on any single day may not
exceed 25% of the ADTV for that security. However, once each week in lieu of purchasing less than
the 25%, the issuer may effect one block purchase if no other 10b-18 purchases are made that day.
Note that the block purchase is not included when calculating a security’s four-week ADTV under
this rule.

Question 24

SEC has created Rule 10b-18
Safe Harbor
Block Purchase

Answer 24

A block purchase under this rule is defined as a quantity of stock that either (i) has a purchase price
of $200,000 or more, or (ii) is at least 5,000 shares with a purchase price of at least $50,000, or (iii) is
at least 20 round lots that total 150% or more of the trading volume for that security (or, if trading
volume data is not available, is at least 20 round lots that total 1/10th of 1% of the outstanding
shares of the security, less the shares beneficially owned by affiliates.

Question 25

SEC has created Rule 10b-18
Safe Harbor
Trading Halt Alternatives

Answer 25

Since issuer purchases can provide liquidity in periods of market turbulence, the timing and volume
rule is relaxed following a market-wide trading suspension. The Rule 10b-18 safe harbor is available
to an issuer that bids for or purchases its common stock either:
 From the reopening of trading to the close of trading on the same day as the imposition of the
market-wide trading suspension, or
 At the next day’s opening, if the market-wide trading suspension was in effect at the scheduled close
of trading
In the event that either of the aforementioned exceptions is used, the volume of purchases must not
exceed 100% of the ADTV for that security.

Question 26

Sarbanes-Oxley Act (SARBOX or SOX)

Annual Report

Answer 26

A company’s management must institute a system of internal controls so that its
financial reports will be as accurate and reliable as possible. An assessment of the effectiveness of
these controls and an attestation by the company’s public accounting firm must be contained in the
company’s annual report.

Question 27

Sarbanes-Oxley Act (SARBOX or SOX)

Financials

Answer 27

Annual and quarterly reports filed with the SEC must disclose all material offbalance
sheet transactions. Companies using non-GAAP (pro forma) financial data must also
include the comparable GAAP calculations and a reconciliation of the two sets of figures.

Question 28

Sarbanes-Oxley Act (SARBOX or SOX)

CEO and CFO Certifications of Annual Report

Answer 28

The Sarbanes-Oxley Act requires the
principal executive officer and the principal financial officer (also referred to as the chief executive
officer and chief financial officer) of public companies to personally certify that the company’s
quarterly and annual reports are accurate and complete, and that effective controls and procedures
have been established relating to the disclosure of all material information.

Question 29

Audit committee

Answer 29

 According to Sarbox, in general, each member of the audit committee must be a member of the
board of directors of the issuer and be independent.
 According to Regulation S-K, the issuer must disclose either:
 That it has at least one audit committee financial expert serving on its audit committee, or
 That it does not have an audit committee financial expert serving on its audit committee.
 If it has a financial expert(s) on its audit committee, it must disclose the name(s).
 A financial expert is generally defined as someone who understands GAAP and financial
statements, has audit experience, can evaluate financial statements, can understand
internal controls over reporting systems, and understands the audit committee
functions.
 According to the listing requirements of the NYSE and Nasdaq, an issuer must have at least one
person on the audit committee who meets the definition of a financial expert.