THE LEGAL ENVIRONMENT OF BUSINESS

CHAPTER 22

Rules Governing the Issuance and Trading of Securities

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Securities Regulation
Definition: Securities are equity or debt instruments: most often stocks and bonds Useful as a means for financing modern corporations Problem: Securities values are easily manipulated and transactions are subject to fraud

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History of Regulation
First efforts at the state level proved insufficient National economic crisis of 1930s Federal laws were needed to Protect integrity of capital markets Protect investors Regulate brokers

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 2009 Pearson Education, Inc. publishing as Prentice Hall

The Securities and Exchange Commission

Goal: To require full disclosure so that investors can make informed decisions Method: Detailed requirements for prospectus; registration; time tables for offering; and certain exemptions from the process Enforcement: Administrative action; injunction; criminal prosecution

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85 year old investment banking firm was heading for insolvency and planned to file bankruptcy Federal regulators urged sale of Bear to J.P. Morgan Agreed to funding Nationwide credit crunch Response differed Investors Employees Government officials Political actors

Bear Stearns Bailout

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Blue Sky Law

1917
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Securities Act of 1933

Purpose: full disclosure on new issue of securities. Definition of security is very broad Howey Test for interpreting security: Common enterprise Reasonable expectation of profit Profits derived solely from the effort of others Regulates initial public offerings Regulates initial public offerings
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Securities Act of 1933

2009 Pearson Education, Inc. publishing as Prentice Hall

Securities Act of 1933

2009 Pearson Education, Inc. publishing as Prentice Hall

Securities Act of 1933

2009 Pearson Education, Inc. publishing as Prentice Hall

Securities Act of 1933

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The Sarbanes-Oxley Act of 2002

Goal: To require CEOs and CFOs to certify financial reports New accounting regulations Criminal penalties 25 years for fraud 20 years for tampering with records Fines up to $5 million

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The Registration process

All nonexempt securities must be registered

Disclosure
SEC does not guarantee the financial outcome Prefiling no offers or sales Waiting period oral offers, but no sales Red Herring Posteffective period 20 days Communications
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Registration: Special situations

Shelf registration registered but held for future

sales Exemptions from registration:

Private placement

Intrastate
Small business

Noninvestment companies
Other exemptions Resale restrictions
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Liability, Remedies and Defenses

Private cause of action for victims of Misrepresentation in registration statement;

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failure to register; fraud in sale Defenses: Due diligence Government remedies: Administrative action; letter of deficiency; injunction; criminal penalties

The Securities Exchance Act of 1934

Goal: Regulate those who run the industry Disclosure: of compensation Approach: Require issuers of securities to register with SEC and the exchange Covers: Brokers and dealers Method: Revocation or suspension of license; private or government suit

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Securities Investor Protection Act (SIPA

Indemnifies customers of insolvent

brokerage firm Collects funds from brokers Limit of protection: $500,000

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The Securities Markets

Exchanges: NYSE and regional exchanges

Over-the-Counter: OTC
Another set of regulations: NASD

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Proxy Solicitations
Fewer than 1 percent of shareholders attend

annual meeting
Proxies used to elect directors and set policy Shareholder proposals: shareholder democracy Proxy contests: insurgents v. management

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Tender Offers and Takeover Bids

Tender offer: offer to buy shares

at premium
Regulated by Exchange Act

Section 13 and 14
Hostile bid: offer is opposed by

management

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Defenses to Hostile Takeovers

Golden Treasury shares to

parachute Poison pill Greenmail Porcupine

friendly parties Shark repellant Scorched earth White knight

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Securities Fraud
Section 10(b): antifraud Insider trading Misstatement of corporation

Mismanagement
Fraud-on-the-market

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Insider Trading and Section 10(b) of the Securities Act

Insiders: Officers, directors; partners in brokerages; attorneys; underwriters and broker-dealers; financial reporters; printers

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Misstatements of Corporations and section 10(b)

Covers: Statements by corporate

executives
In connection with purchase or sale of

security
With scienter
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Corporate Mismanagement and Section10(b)

Covers: Purchase or sale of stock Fraud alleged by

Minority shareholders in class action

or in derivative suits

Plaintiff is purchaser or seller

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Fraud-on-the-Market Theory
Shareholders allege reliance on efficient market Distorted by fraudulent statements or

omissions
Causes market price to be set too high

To detriment of investors and in violation of

10(b)5
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Liability and Remedies

Criminal penalties: SEC and U.S.

Justice Dept.
SEC Action
Private actions under 10-5 and 10(b)

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Short-Swing Profits
Coverage: Director, officer, 10 percent owner Profits made in purchase and sale within 6-month

period Presumed to be based on insider information Remedy: Return profits to corporation Standing: Shareholders, directors, and officers

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State Securities Laws

Blue Sky laws

Regulate securities in intrastate

commerce Similar to federal laws Uniform Securities Act National Securities Market Improvement Act

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E-Commerce and online securities

Internet effectively accelerates trade

EDGAR
Cyber fraud a new problem Example: Pump and Dump

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Global Dimensions
Foreign Corrupt Practices Act of 1977 (FCPA)

Makes bribes to foreign officials in order to obtain

contracts Coverage: All U.S. citizens, agents, and accountants doing business worldwide Penalties: Fines and imprisonment Exempt: Grease payments to low-level functionaries

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OECD Convention on Antibribery

Convention signed by 34 countries in 1997

Criminalizes bribery
Eliminates tax deductions for bribes Requires disclosure Exempt: Grease payments to low level

functionaries

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International Securities Enforcement Cooperation Act of 1990

Goal: Attack money laundering via Swiss banks Create procedures for tracing laundered money International Securities Enforcement Cooperation

Act (ISECA) Methods:

Information exchange;

protects confidentiality; administrative sanctions on violators; SEC investigative powers expanded worldwide

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Foreign Securities Sold in U.S.

Generally, similar SEC registration/exemption

rules apply
Special rules: Public interest exemption; recognition of information filed in issuers

home country;
NASDAQ requirements Regulation S
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