Securities Regulation Ch 37 Flashcards
CH 37 Securities Regulation
Federal Securities Laws
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- The Securities Act of 1933 (the 1933 Act) to regulate the issuance of new securities.
- The Securities Exchange Act of 1934 (the 1934 Act) to regulate companies with publicly traded securities.
- The Securities and Exchange Commission (SEC) to enforces securities laws.
Security: Any transaction in which the buyer invests money in a common enterprise and expects to earn a profit predominantly from the efforts of others
-invests money in a common enterprise and
-expects to earn a profit predominantly from the efforts of others.
Securities Act of 1933
- The 1933 Act requires that before offering or selling securities, the
issuer must register them with the SEC unless they qualify for an exemption
issuer: A company that sells its own stock - The SEC does not, itself, evaluate or investigate the quality of any offering; it simply ascertains that, on the surface, the company has disclosed all required information about itself and the security it is selling.
- exempt securities are always exempt, throughout their lives, no matter how many times they are sold. Stock sold in an exempt transaction is exempt only that one time, not necessarily in any subsequent sale.
Exempt Securities
The 1933 Act exempts the following securities from registration:
Government securities
Bank securities
Stock in nonprofit organizations
Insurance policies and annuity contracts
These securities are
1.inherently low risk,
2.regulated by other statutes, or
3.not really investments.
Exempt Transactions
(Intrastate Offering Exemption, Regulation D, and Crowdfunding)
private offerings: A sale of securities in which the issuer provides less disclosure in return for selling less stock to fewer investors than in a public offering.
* Intrastate Offering Exemption.\
Under SEC Rule 147A, an issuer is not required to register securities that are sold only to residents of the state that is the issuer’s principal place of business.
* Regulation D.
-Accredited investors: Institutions (such as banks and insurance companies) or financially qualified individuals
-Sophisticated investors: People who can assess the risks of an offering
-Purchaser representatives: People with enough knowledge and experience to evaluate stock purchases.
-Restricted stock: Securities purchased in a private offering
* Crowdfunding
Regulation crowdfunding permits privately held companies to sell up to $1.07 million in securities in any 12-month period
Public Offerings
(Classic Pulbic Offering, Regulation A, Do-It-Yourself Public Offerings)
[ Classic Public Offering ]
secondary offering: Any public sale of securities by an issuer after the initial public offering
This is the process an issuer follows for either an IPO or a secondary offering:
* Underwriting. Companies hire an investment bank to serve as underwriter.
-firm commitment underwriting: The underwriter buys stock from the issuer and resells it to the public
-best efforts underwriting: The underwriter does not buy the stock from the issuer but instead acts as the issuer’s agent in selling the securities
* prospectus: A document that provides potential investors with information about a security
* registration statement: The document that an issuer files with the SEC to initiate a public offering of securities
* Sales effort. Even before the final registration statement and prospectus are completed, the investment bank begins its sales effort
-road show: As part of the sales process, company executives and investment bankers make presentations to potential investors
* Going effective. Once the SEC has finished its review of the preliminary registration statement, the agency sends the issuer a comment letter,
-comment letter: A letter from the SEC to an issuer with a list of changes that must be made to the registration statement
-go effective: The SEC authorizes a company to begin the public sale of its stock
the rules governing all of the following offering methods require issuers to make certain disclosures, allow them to advertise, and permit the ensuing stock to be resold.
[Regulation A]
An offering under Regulation A (Reg A) is a small public offering, with a maximum value of $50 million in any 12-month period. There are some limits on how much particular investors may buy (depending on their wealth). Disclosure is less onerous than for a standard public offering.
[Do-It-Yourself Public Offerings]
A CPO relies heavily on investment banks to sell the securities. Some companies, both large and small, have decided to eliminate the middleman and sell their securities themselves.
* Direct Public Offerings.
-direct public offering (DPO): A method by which a company sells stock to the public itself, without an investment bank
* Direct Listings
A DL is different from a CPO in the following ways:
-Cheaper
-Equal treatment for all buyers.
-Uncertain price
-Reduced sales effort
Rule 144: Restrictions on the Resale of Securities
After a company has gone public, Rule 144 regulates the sale of control securities and restricted securities:
- control security: Stock held by any shareholder who owns more than 10 percent of a class of stock or by any officer or director of the company
- As we have seen, a restricted security is stock purchased from the issuer in a private offering (such as Reg D). These shares generally cannot be sold, even privately, for a year.
Liabilitiy under the 1933 Act
Issuers can violate the 1933 Act in three ways:
- Selling securities that are neither registered nor exempt.
- Fraud: lying about the securities.
-Material: Important enough to affect a decision - Errors in the registration statement
- “prudent person in the management of his own property.” This investigation is called due diligence.
Securities Exchange Act of 1934
The purpose of the 1934 Act is to maintain the integrity of this secondary market.
Example: Suppose that an automobile company registered and sold securities for the first time in 1946. Purchasers of those securities knew a lot about the firm—in 1946
Registration Requirments
An issuer must register with the SEC under the 1934 Act if:
- It completes a public offering under the 1933 Act or
- Its securities are traded on a national exchange (such as the NYSE) or
- It has at least 2,000 shareholders (or 500 who are unaccredited investors) and total assets that exceed $10 million
going dark: When a company deregisters under the 1934 Act
Disclosure Requirements
These reporting companies must file the following documents:
A company’s CEO and CFO must certify that:
reporting companies: Companies registered under the 1934 Act
* An initial, detailed information statement when the company first registers (similar to the filing required under the 1933 Act);
* Annual reports on Form 10-K, containing audited financial statements, a detailed analysis of the company’s performance, and information about officers and directors;
* Quarterly reports on Form 10-Q, which are less detailed than 10-Ks and contain unaudited financials; and
* Form 8-K to report any significant developments, such as bankruptcy, a change in control, a purchase or sale of significant assets, the resignation of a director as a result of a policy dispute, a change in fiscal year, or a change in auditing firms.
A company’s CEO and CFO must certify that:
* The information in the quarterly and annual reports is true,
* The company has effective internal controls, and
* The officers have informed the company’s audit committee and its auditors of any concerns that they have about the internal control system.
Liability under the 1934 Act
(False Filings, Fraud,
False Filigns
Anyone who makes a false or misleading statement in any filing under the 1934 Act is liable to buyers or sellers who
1. acted in reliance on the statement and
2. can prove that the price at which they bought or sold was affected by the false filing.
Fraud: is prohibited.
Section 10(b) and the SEC’s Rule 10b-5 prohibit fraud in connection with the purchase and sale of any security
-A violation of Rule 10b-5 requires the following elements:
* Misstatement or omission of a material fact.
* Scienter. Scienter is a legal term meaning that someone has acted with the intent to deceive or with deliberate recklessness as to the possibility of misleading investors. Negligence is not enough to create liability.
* Purchase or sale. Rule 10b-5 applies to both buyers and sellers
* Reliance. A plaintiff must show that she relied on the misstatement or omission
* Loss. The plaintiffs must suffer a loss in the value of their investment.
* Causation. The loss must have been caused by the misstatement of a material fact.
Scienter
Reliance
[Insider Trading: §§16 and 10(b)]
(Section 16: Short-Swing Trading, )(Section 16: Short-Swing Trading, Misappropriation, Takeovers, and Advacned Planning)
Insider trading is illegal because:
- It undermines the integrity of stock markets. Investors will not be willing to buy in the market unless they believe in its fundamental honesty.
- It offends our fundamental sense of fairness. No one wants to play in a rigged game.
- Investment banks typically “make a market” in stocks, meaning that they hold extra shares so that orders can be filled smoothly.
- Section 16: Short-Swing Trading
Section 16 applies to officers, directors, and controlling shareholders who own more than 10 percent of the company. The statute imposes two requirements on insiders:
1. Report
2. Disgorge - Section 10(b): Classic Insider Trading
-Insiders. A corporate insider is guilty of insider trading under §10(b), if he:
–Has material, nonpublic information and
–Breaches a fiduciary duty to his company
–By trading on the information
–Whether or not he makes a profit. - Tippers. Insiders are liable as tippers if:
-They reveal material, nonpublic information about their company in violation of their fiduciary duty;
-They know the information is confidential; and
-They benefit (or expect to benefit) directly or indirectly. - Tippees. Those who receive inside information, or tips, may also be liable, even if they do not have a fiduciary relationship to the company or the tipper. Tippees are liable when:
-They trade on the information,
-They know it is confidential,
-They know that it came from an insider who was violating his fiduciary duty, and
-The insider benefited (or expected to benefit) directly or indirectly.
Misappropriation
Misappropriation is a violation of §10(b). It is illegal for anyone:
* With material, nonpublic information
* To breach a fiduciary duty to the source of the information
* By revealing or trading on the information or
* To be a tippee who trades after obtaining information from the person who carried out the misappropriation.
The courts have determined that a personal fiduciary relationship exists if:
-The courts have determined that a personal fiduciary relationship exists if:
-The recipient has promised to keep the information secret;
-The communicator has a reasonable expectation that the recipient will not tell because of their relationship of trust; or
-The recipient has obtained the information from her spouse, parent, child, or sibling.
