Module 15 - Federal & State Regulations Flashcards
Two major congressional acts were passed after the 1929 STOCK MARKET CRASH:
- The Securities Act of 1933
* The Securities Exchange Act of 1934
INVESTMENT COMPANY ACT
- In 1940
- Passed to require the registration and regulation of investment companies.
SECURITIES ACT OF 1933
- Exclusively for the regulation of newly issued securities, both stocks and bonds.
- The first major congressional act passed after the stock market crash of 1929. The two major purposes of the 1933 Act were:
• To ensure that all corporate securities sold interstate were registered
• To give the public the opportunity to make a well-founded judgment before purchasing a security issued by a corporation
Every corporate issue that is sold to the public on an interstate basis must be registered.
• The 1933 Act provides for “full and fair” disclosure in the issuance of any new security.
• The issuer must provide either a PROSPECTUS or an OFFERING CIRCULAR with every new issue of a corporate security.
SECURITIES EXCHANGE ACT of 1934
Passed regarding a multitude of securities regulations. Among the many regulations, the 1934 Act:
• Required the registration of the national securities exchanges and broker/dealers
• Required publicly held companies to report to the SEC
• Emphasized the requirements to abide by the antifraud provisions of the Securities Act of 1933
The Securities Act of 1933 requires the issuer to register the security with the SEC. Information regarding the issue and its issuer must be spelled out in the REGISTRATION STATEMENT and filed with the SEC.
Remember for Test
A REGISTRATION STATEMENT
Must be filed with the SEC for review. A 20-day minimum waiting period, referred to as the COOLING-OFF PERIOD, is required from the time the registration statement is filed until the date the registration becomes effective (the EFFECTIVE DATE).
The SEC has the authority to issue a STOP ORDER
Suspend the sale of the securities if the registration statement contains untruths, misleading statements, or omissions of material facts.
The SEC declares the registration statement effective on the EFFECTIVE DATE meaning:
- The issue can be sold to the public.
- Sales of the issue can be solicited using sales materials and information about the issuer.
Prior to the effective date, the only thing that can be sent to the public is the PRELIMINARY PROSPECTUS.
• No research reports, writing or notes on prospectuses, summaries of prospectuses, or other forms of information can be given.
• Nothing can be sent to customers with the preliminary prospectus.
Remember for Test
PRELIMINARY PROSPECTUS
A means of creating interest in an issue during the registration of the issue. The preliminary prospectus is similar to the regular prospectus, except it does not include the offering price, or other information regarding the underwriting syndicate. The preliminary prospectus is also known as a RED HERRING.
The objective of the red herring is to provoke INDICATIONS OF INTEREST from customers
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INDICATION OF INTEREST
Not binding on the investor to buy the securities, and it is not binding on the broker/dealer to deliver the securities. That is the difference between an order and an indication of interest
During the registration period, broker/dealers cannot accept orders for the new issue nor can they accept money for when the issue becomes effective.
Remember for Test
The following quote must appear on the front cover of every prospectus so that investors know the limitations of the SEC’s capacity in reviewing new securities:
“These securities have not been approved or disapproved by the Securities and Exchange Commission nor has the Commission passed upon the accuracy or adequacy of this prospectus. Any representation to the contrary is a criminal offense.”
FINAL PROSPECTUS
Buyers of the issue must receive a FINAL PROSPECTUS prior to purchasing the new issue. The PUBLIC OFFERING PRICE and the UNDERWRITING SPREAD are included in the final prospectus.
The securities are released for sale when the registration statement becomes effective.
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The Securities Act of 1933 exempts the following issues from the registration requirements:
- Securities issued or guaranteed by the U.S. government or its agencies
- Securities issued by states, municipalities, or public authorities
- Securities that mature in less than 270 days (e.g., commercial paper, banker’s acceptance)
- Issues of $5 million or less (Regulation A offerings)
- Private placements (Regulation D offerings)
- Securities sold intrastate (Rule 147 offerings)
- Sales of RESTRICTED AND CONTROL SECURITIES (Rule 144 offerings)
- Other miscellaneous offerings, including securities of religious, charitable, and educational institutions
- Certain Eurodollar bonds.
All U.S. government securities are EXEMPT from registration because they are considered extremely safe. Government issues are debt issues from the Federal Reserve Board. If the securities are governmental agency issues, they are issued by the governmental agency issuing the debt
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All MUNICIPAL SECURITIES are exempt from registration under the Securities Act of 1933. However, municipal securities and other exempt securities are not exempt from the antifraud provisions of the act.
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All COMMERCIAL PAPER with a duration of more than 270 days must be registered with the SEC
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If an issue will mature in less than 270 days, the Securities Act of 1933 deems that it does not have to be registered with the SEC.
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COMMERCIAL PAPER
- COMMERCIAL PAPER, which is the most common short-term corporate debt issue, usually has maturities of 30 days, 60 days, 90 days, 120 days, or 270 days.
- Companies in need of large sums of money ($2 million or more) issue commercial paper issues, which are considered relatively safe, for a short period of time.
BANKER’S ACCEPTANCE
These are issues brought to market by banks to help fund American companies that sell foreign goods.
• They are usually for 14 to 30 days.
• They are for the amount of money a U.S. retailer owes a bank that has paid a foreign company for goods received.
• The retailer will pay off the bank after the sales of the goods are completed.
• They are considered relatively safe.
REG A OFFERINGS
- Offerings of $5 million or less in a 12-month period.
- These securities are not fully exempt from registration. This is because the SEC requires that issuers of these securities file a letter of registration instead of a registration statement. This short form advises the SEC of the issuance. However, the rules do not require the issuing company to fully register its issue.
- Under this registration, the COOLING-OFF PERIOD is only 10 days, instead of the usual 20 days.
- Prospective purchasers receive an OFFERING CIRCULAR instead of a prospectus
REG D OFFERINGS are also known as PRIVATE PLACEMENTS.
Remember for Test
Rule 506
- An unlimited amount of a Reg D offering can be offered to investors under Rule 506. (Under Rule 504, the limit is $1 million; the Rule 505 limit is $5 million.)
- However, in a Reg D offering under Rule 506, the offering can only be sold to a maximum of 35 unaccredited investors plus an unlimited number of accredited investors.
Here are some additional facts about Rule 506:
- Commissions are permitted.
- No general solicitations are permitted — no advertising.
- Resales are done under Rule 144, which is discussed in Section 2.5.
To be qualified as ACCREDITED INVESTORS, they must meet at least one of the following:
- Have a net worth of at least $1 million
- Have income in excess of $200,000 in each of the last two years and have an expected income of $200,000 in the upcoming year
- Purchaser of $150,000
- Be a private business development corporation
- Be a bank, insurance company, investment company, or other financial institution with $5 million or more in assets
- Be a college/university endowment fund or nonprofit organization with $5 million or more in assets
- Be a director, officer, or general partner of the issuer
- Be a joint venture or partnership where all the owners are accredited investors
RULE 147 OFFERINGS
Made by issuers in a particular state to investors in that same state. These offerings are also known as INTRASTATE OFFERINGS.
To qualify as an intrastate offering, certain provisions of the issuer and the purchasers are required
100% of the purchasers of the issue must be residents of the same state as the issuer.
• To prove residency, purchasers must show their voter’s registration card or voter’s certificate.
The issuer must meet these requirements:
• At least 80% of the issuer’s gross revenues must be from operations of the business within that state.
• At least 80% of the proceeds of the issue must be utilized for operation of the issuer’s business within the state.
• At least 80% of the assets of the issuing company must be within the state.
All securities sold under Rule 147 must be sold to residents of the state.
• Investors are not permitted to resell their securities to an out-of-state resident for nine months after the last date of sale by the issuer.
• Rule 147 securities are registered only with the state within which it is issued; not with the SEC.
RESTRICTED SECURITIES, LEGEND STOCK, or LETTERED STOCK.
Previously unregistered securities are securities that had been purchased through a private placement directly from the company
RESTRICTED AND CONTROL STOCK
Affiliates of an issuer include officers, directors or major stockholders of a company who directly or indirectly control, are controlled by, or are under common control, of the issuer. Stock owned by these people is called RESTRICTED AND CONTROL STOCK.
Two types of stock are sold under Rule 144, and each has its own HOLDING PERIOD requirement.
- RESTRICTED SECURITIES are shares of stock that have not been previously registered and must be held for at least six months, with no liens against them, and by one investor.
- During the time the securities are held, the investor may purchase, or sell short other shares of the same issuer in the secondary market, but there may be no liens against the restricted stock.
- CONTROL SECURITIES are shares of stock that an affiliate has purchased in the open market, but there is no six-month holding rule with these securities.
In a 90-day period, the amount of stock that can be sold under Rule 144 is limited to the greater of 1% of the outstanding shares or the average weekly trading volume of the four calendar weeks preceding the filing of the notice of sale.
Remember for Test
FORM 144
- Must be filed with the SEC in order to sell the shares, unless the amount of securities sold within any 90-day period does not exceed 5,000 shares and the aggregate proceeds do not exceed $50,000.
- (Know that a filed Form 144 is good for 90 days. To remember this, think in terms of Rule 144 = 1 + 4 + 4 = 9 for 90 days.)
Sale Under Rule 144A
Under Rule 144A, Form 144 does not need to be completed for any sale of the restricted securities if the buyer is a Qualified Institutional Buyer (QIB). A QIB is any institutional buyer and can include buyers from: • Mutual funds • Banks • Insurance companies • Trust companies
INDIVIDUALS CANNOT purchase the shares under 144A. If individuals are purchasing the shares, the offering must be executed as a regular 144 offering with the appropriate form filed.
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When, as, and if issued securities, commonly known as “WHEN ISSUED” securities,
Securities that have been authorized, sold by an underwriter to prospective investors, and have not yet had the certificates issued.
• These transactions are made conditionally because the certificates are not available and the issuer may withdraw the issue.
• The time before distribution of the certificates could be indefinite.
• Often these are debt securities, but could also be equity securities.
• Another name is “when, as, and if distributed,” but are best known as WI securities.
Securities that are traded “when issued” are usually stock trading after a stock split or stock dividend, or bonds issued by the U.S. government and municipalities.
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SHELF OFFERINGS
- Simplified method of registering issues that allows the securities to be offered on a continuous or delayed basis. They are designed to register the securities in such a way that an issuer can sell securities in one or more separate offerings. Often, the issuer wants to sell securities, but wants to wait until a more favorable time
- The maximum time that a shelf offering can be offered is three-years.
- When an issuer and/or underwriter decides to sell the new issue as a shelf-offering, they have three years to bring the shares to market without having to re-register them.
• After three-years, the unsold shares must be re-registered, or they will incur penalties, even if only a small portion is left.
• During the three-year period, the underwriter can bring all of the shares to market at one time, or offer a small quantity of shares on a continuous basis.
If an issue is going to be offered as a shelf offering, the SEC must be informed. If the shares are an IPO (Initial Public Offering), then the SEC has to be petitioned, on Form S-3, to allow the shares to be issued on a continuous basis or brought to market at a time that is more favorable to the issuer.
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WELL KNOWN SEASONED ISSUERS
Many corporations have issued stocks previously and now want to issue more shares. If corporations have issued stock more than one or two times, they become known as “WELL KNOWN SEASONED ISSUERS,” commonly called a WKSI corporation.
The specific rules that make a WKSI offering possible are:
- The corporation must be an issuer that is widely followed in the market.
- The company must file an S-3 form, a type of shelf-offering registration statement.
- The company must have at least a common equity float of $700 million, or
- In the previous three years have issued at least $1 billion of nonconvertible debt or preferred stock.
An offering as a WKSI cannot be any of the following:
- A shell company (see Section 11.0 in this module)
- An issuer in penny stock
- Presently in bankruptcy or insolvency
- A company that is not current with its SEC reports
The following are benefits of having a WKSI offering:
- The SEC does not review the registration statement.
- The registration statement is effective upon filing, so if it is filed by the opening of business, it can be sold that day.
- The issuer does not need to pay in advance for the securities that will be issued; rather, they only pay as the shares are sold.
- Securities and issuers that are subsidiaries of the company with a WKSI offering can be added to the WKSI offering in a post- amendment and be effective immediately.
- Companies can have an unspecified amount of securities, and do not have to specifically state what securities will be issued; however, any securities that will be issued must be described in the base prospectus.
- If companies exclude some information about the offering, it can be added in a post-amendment.
- No fees are due upon filing, but will be paid later.
- A new shelf-offering for the WKSI issuer must be filed every three years.
- There is no requirement to give a final prospectus to every purchaser of a WKSI offering. However, it must be provided to any person requesting it.
Remember for Test
A CHINESE WALL
A procedure that is established by a broker/dealer firm to restrict and prohibit nonpublic, material information from being disclosed to other employees of the firm.
• Broker/dealers establish this doctrine to restrict insider information obtained by the investment banking department from being used by the retail and institutional trading departments.
• Nonpublic information obtained by the underwriters of the firm cannot be leaked to the sales departments for enticing sales of an issuer.
• In addition, any nonpublic information that is obtained by a sales person may not be shared with other sales people in the same department, with the institutional sales department, or the investment banking department.
Exchange of securities under Rule 145,
In an exchange of securities under Rule 145, the investors who turn in their shares of existing stock receive new shares from that same corporation or a new corporation. These new shares are immediately transferable.
• Investors can sell the stock in the open market upon receiving the shares or keep them until a later time.
Broker/dealers handling the old shares and distributing the new shares cannot charge commissions.
SECURITIES EXCHANGE ACT OF 1934
The second major congressional act passed to regulate the securities industry after the stock market crash of 1929. The main purpose of the 1934 Act was to establish and maintain fair and honest markets for securities. The 1934 Act deals with the secondary transactions of securities, whereas the Securities Act of 1933 only deals with new issues
Keep this in mind when asked a question regarding either act: 1933 is only for NEW ISSUES; 1934 is only for SECONDARY ISSUES.
Remember for Test
SECURITIES REGISTRATION WITH THE SEC
The Securities Exchange Act of 1934 requires that all corporations issuing equity securities (stock) or debt securities (bonds) register these securities with the SEC.
• In addition to registering securities before selling them, all corporations that have issued securities are required to submit accurate facts and financial reports every year to the SEC. These include QUARTERLY REPORTS, as well as AUDITED FINANCIAL ANNUAL REPORTS. Other reports have to be made if changes to the company occur. However, you do not need to know the names of these reports or their numbers for the Series 7 exam.
