© 2013 The McGraw-Hill Companies, Inc. All rights reserved. Chapter 23 Securities Regulation 1 Copyright © 2016 McGraw-Hill Education. All rights reserved.

© 2013 The McGraw-Hill Companies, Inc. All rights reserved. Chapter 23 Ethical Dilemma Although the Securities and Exchange Commission has existed as a federal administrative agency for over seventy years (the Commission was created in 1934,) some critics question the need for its continued existence, or alternatively argue for significant deregulation of stock trades. According to critics, there is arguably no need for significant federal regulation of publicly- traded securities, since market conditions dictate legitimacy and honesty in securities transactions; after all, for how long could a corporation exist if it does not strive to ensure the integrity of its stock? How do you respond to this line of reasoning, that the “free market” will dictate fair and honest stock trades? In your answer, consider the history and mission of the Securities and Exchange Commission. (Reference: 2

© 2013 The McGraw-Hill Companies, Inc. All rights reserved. Chapter 23 Case Hypothetical Thomas Abramson is a quality control manager for Capitol-IZE Pharmaceutical Company, Inc. The company is headquartered and has its principle production facility in Indianapolis, Indiana. For several years, Capitol-IZE Pharmaceutical has been engaged in the research and development of a new cancer drug, Izerion. As part of the federal regulatory procedure for mass-marketing a new drug, Capitol-IZE Pharmaceutical applied to the Food and Drug Administration (FDA) for final approval of Izerion. Yesterday, Thomas’s supervisor informed him in somber fashion that the FDA had rejected the company’s application for final approval of Izerion. Apparently, the FDA was concerned about serious side effects that manifested during the drug’s clinical trials. Thomas’ supervisor further advised him that next Monday, Capitol-IZE Pharmaceutical is scheduled to “go public” with a press release concerning the FDA’s rejection of Izerion. Thomas is frantic. He owns approximately 6,000 shares of Capitol-IZE Pharmaceutical stock, and he knows that news of the FDA’s rejection of Izerion will be disastrous to the company, its employees and its shareholders. Capitol-IZE Pharmaceutical stock is currently valued at $47.50 per share, and news of the FDA’s disapproval of Izerion will likely drive the stock down to one-half of its current value. Thomas quickly ran the numbers on his calculator. A reduction of 50% in the stock’s value would represent a personal loss of $142,500. Thomas’ Capitol-IZE Pharmaceutical stock is his only retirement plan, aside from a modest pension he will receive from the company (assuming the company survives Monday’s announcement.) Thomas has a plan. Today, he will instruct his financial planner to immediately sell all 6,000 shares of his Capitol- IZE Pharmaceutical Company, Inc. stock. Thomas rationalizes his decision by assuring himself that anyone else in his position would do the same thing. Is Thomas Abramson’s plan legal? Is it ethical? 3

© 2013 The McGraw-Hill Companies, Inc. All rights reserved. Security Definition: Investment in a common enterprise with the reasonable expectation of profit gained predominantly from others’ efforts 4

© 2013 The McGraw-Hill Companies, Inc. All rights reserved. Securities and Exchange Commission (SEC) Created in 1934 to: Enforce securities laws Interpret provisions of securities acts Regulate the activities of securities brokers, dealers, and advisers Regulate the trade of securities on securities exchanges 5

© 2013 The McGraw-Hill Companies, Inc. All rights reserved. Expansion of SEC Powers in the 1990s Securities Enforcement Remedies and Penny Stock Reform Act of 1990 Market Reform Act of 1990 Securities Acts Amendments of 1990 National Securities Markets Improvement Act of 1996 Sarbanes-Oxley Act of

© 2013 The McGraw-Hill Companies, Inc. All rights reserved. The Securities Act of 1933: Terminology, Rules, and Procedures Registration Statement: Document containing Description of securities offered for sale Explanation of how proceeds from sale of securities will be used Description of registrant’s business and properties Information about management of company Description of pending lawsuits in which registrant involved Certified financial statements 7

© 2013 The McGraw-Hill Companies, Inc. All rights reserved. The Securities Act of 1933: Terminology, Rules, and Procedures (Continued) Prospectus: Written document similar to registration statement, used as an advertising tool to attract potential investors 8

© 2013 The McGraw-Hill Companies, Inc. All rights reserved. The Securities Act of 1933: Terminology, Rules, and Procedures (Continued) Periods of the registration statement and prospectus filing process: Pre-Filing Period Waiting Period Post-Effective Period 9

© 2013 The McGraw-Hill Companies, Inc. All rights reserved. The Securities Act of 1933: Terminology, Rules, and Procedures (Continued) Exempt Transactions-Securities exempt from standard SEC registration requirements Limited Offers: Involve small amounts of money, or are offered only to sophisticated investors -Private Placement Exemption: Exempts private offerings of securities -Rule 505: States that private offerings may not exceed $5 million in a twelve-month period, and firms do not have to believe that investors have a reasonable ability to evaluate risk -Rule 504: Exempts non-investment firms that offer no more that $1 million in securities in a twelve-month period -Section 4(6): Exempts securities offered only to accredited investors for amount less than $5 million Intrastate Issues: Exempt local investors in local businesses Re-sales of Securities: Exempt transactions by any person other than an issuer, underwriter, or dealer 10

© 2013 The McGraw-Hill Companies, Inc. All rights reserved. The Securities Act of 1933: Terminology, Rules, and Procedures (Continued) Restricted Securities: Securities acquired under Rule 505, 506, or Section 4(6) that must be registered for resale, unless investor follows Rule 144 or 144(a) Violations may result in: Administrative Action Injunctive Action Criminal Prosecution 11

© 2013 The McGraw-Hill Companies, Inc. All rights reserved. The Securities Exchange Act of 1934: Terminology, Rules, and Procedures Section 10(b): Prohibits use of “manipulative and deceptive devices” to bypass SEC rules Insider Trading: Trading in which company employee or executive uses material inside information to make profit Misappropriation Theory: Individual who wrongly acquires and uses inside information for profit is liable for insider trading 12

© 2013 The McGraw-Hill Companies, Inc. All rights reserved. The Securities Exchange Act of 1934: Terminology, Rules, and Procedures (Continued) Tipper/Tippee Theory: Individual who receives material inside information as a result of insider’s breach of duty is guilty of insider trading Statutory Insiders: Certain stockholders, executive officers, and directors who must file reports detailing their ownership and trading of the corporation’s securities Short-Swing Profits: Profits made from sale of company stock within any 6-month period by statutory insider; per Section 16(b), these profits must be returned to company 13

© 2013 The McGraw-Hill Companies, Inc. All rights reserved. The Securities Exchange Act of 1934: Terminology, Rules, and Procedures (Continued) Proxy: Document that authorizes an individual to vote shareholder’s share of stocks at a shareholder’s meeting Proxy Solicitation: Process of obtaining authority to vote on behalf of shareholder Violations of Securities Exchange Act of 1934 may result in: -Criminal penalties -Civil penalties -Suits against those involved in insider trading under Insider Trading and Securities Fraud Enforcement Act of

© 2013 The McGraw-Hill Companies, Inc. All rights reserved. State Securities Laws “Blue Sky” Laws: Regulate the offering and sale of purely intrastate securities 15