1. CHAPTER 36 SECURITIES REGULATION DAVIDSON, KNOWLES & FORSYTHE Business Law: Cases and Principles in the Legal Environment (8 th Ed.)

2. © 2004 West Legal Studies in Business A Division of Thomson Learning BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. 2 FEDERAL LAWS Securities regulation has come to be known as “federal corporate law.” Securities regulation has come to be known as “federal corporate law.” Stems from extensive federal laws and rules set forth by Securities and Exchange Commission (SEC). Stems from extensive federal laws and rules set forth by Securities and Exchange Commission (SEC). SEC is federal agency charged with enforcement and administration of laws covering securities, public utility holding companies, trust indentures, investment companies and advisers. SEC is federal agency charged with enforcement and administration of laws covering securities, public utility holding companies, trust indentures, investment companies and advisers.

3. © 2004 West Legal Studies in Business A Division of Thomson Learning BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. 3 SECURITIES ACT OF 1933 Defines security as any note, stock, treasury stock, bond, debenture, participation in profit-sharing agreement, or investment contract. Defines security as any note, stock, treasury stock, bond, debenture, participation in profit-sharing agreement, or investment contract. Courts interpret investment contract in a security involves: Courts interpret investment contract in a security involves: – Investment involves money. – In a common enterprise. – Whereby investor has no managerial functions, but expects profit solely from efforts of others.

4. © 2004 West Legal Studies in Business A Division of Thomson Learning BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. 4 Court determines what constitutes a security based on the “economic reality” test. Court determines what constitutes a security based on the “economic reality” test. Disclosure statute meant to protect the unsophisticated investing public. Disclosure statute meant to protect the unsophisticated investing public. Requires registration of most securities when initially offered and enforces various antifraud provisions. Requires registration of most securities when initially offered and enforces various antifraud provisions. SECURITIES ACT OF 1933

5. © 2004 West Legal Studies in Business A Division of Thomson Learning BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. 5 Procedures: unless exemption applies, corporation issuing a security must: Procedures: unless exemption applies, corporation issuing a security must: – File a registration statement with SEC. – Provide prospectus to all prospective investors. Purpose of registration statement and prospectus is protection of unsophisticated investor. Purpose of registration statement and prospectus is protection of unsophisticated investor. SECURITIES ACT OF 1933

6. © 2004 West Legal Studies in Business A Division of Thomson Learning BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. 6 Exemptions: classes of securities exempt from registration: Exemptions: classes of securities exempt from registration: – Securities issued by federal/state governments. – Short-term commercial paper. – Issues by nonprofit organizations. – Issues by savings and loan associations. – Issues by common carriers. – Certain qualifying employee pension plans. – Insurance policies and certain annuities. – Intrastate issues of securities. SECURITIES ACT OF 1933

7. © 2004 West Legal Studies in Business A Division of Thomson Learning BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. 7 Exemptions: the following transactions are exempt from registration and prospectus requirements. Exemptions: the following transactions are exempt from registration and prospectus requirements. – Private offerings. – Transactions by persons other than issuers. – Certain broker and dealer transactions. – Small public issues ($5 million cap to accredited investors). SECURITIES ACT OF 1933

8. © 2004 West Legal Studies in Business A Division of Thomson Learning BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. 8 Antifraud Provisions. Antifraud Provisions. – Section 12 prohibits: Oral or written misstatements of material fact. Oral or written misstatements of material fact. Omissions of material facts that are necessary to keep statements from being misleading. Omissions of material facts that are necessary to keep statements from being misleading. – Section 17 prohibits use of mails or interstate commerce to further any form of fraud. – Section 27A redefines when liability exists for certain misleading “forward-looking” statements. SECURITIES ACT OF 1933

9. © 2004 West Legal Studies in Business A Division of Thomson Learning BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. 9 Section 11 imposes civil liability for: Section 11 imposes civil liability for: – Any registration statement containing untrue statements of material fact. – Omissions of material facts necessary to keep statements from being misleading. – Due diligence is only defense to Section 11liability. – Defense available to any person who had reasonable grounds to believe that registration statement was accurate and did not omit material facts. SECURITIES ACT OF 1933

10. © 2004 West Legal Studies in Business A Division of Thomson Learning BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. 10 Section 12 exacts civil liability from: Section 12 exacts civil liability from: – Person who sells securities through mail/interstate commerce. – By means of prospectus or oral communication. – Includes misrepresentations or omissions of necessary material facts. – Persons can avoid liability if can show they did not know, and could not have known, about the untruths or omissions. SECURITIES ACT OF 1933

11. © 2004 West Legal Studies in Business A Division of Thomson Learning BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. 11 SECURITIES EXCHANGE ACT OF 1934 Regulates secondary distribution of securities. Regulates secondary distribution of securities. Jurisdiction extends to registration and distribution of securities through national stock exchanges, national securities associations, brokers, and dealers. Jurisdiction extends to registration and distribution of securities through national stock exchanges, national securities associations, brokers, and dealers. Reach of 1934 Act is broader than ’33 Act ‘33. Reach of 1934 Act is broader than ’33 Act ‘33.

12. © 2004 West Legal Studies in Business A Division of Thomson Learning BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. 12 The Registration and Reporting provisions: The Registration and Reporting provisions: – Requires any issuer who trades securities on a national stock exchange to register with SEC. – Tries to ensure that investing public has sufficient information about publicly traded securities. – Mandates certain disclosures: Detailed registration statements. Detailed registration statements. Annual and quarterly reports. Annual and quarterly reports. SECURITIES EXCHANGE ACT OF 1934

13. © 2004 West Legal Studies in Business A Division of Thomson Learning BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. 13 Proxy Solicitations: Proxy Solicitations: – An assignment by shareholder of right to vote the shares held by the shareholder. – Management must provide shareholders with proxy statement and form. – Proxy statement must disclose all pertinent information regarding matters under consideration. – Section 14 of Act ‘34 makes it illegal for company registered under Section 12 to solicit proxies in a manner that violates SEC rules and regulations. SECURITIES EXCHANGE ACT OF 1934

14. © 2004 West Legal Studies in Business A Division of Thomson Learning BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. 14 Proxy Solicitations (cont’d): Proxy Solicitations (cont’d): – Disclosure required of proxy solicitations include: the Proxy statement and Proxy form – SEC must approve the statement and form before sent to the shareholders. SECURITIES EXCHANGE ACT OF 1934

15. © 2004 West Legal Studies in Business A Division of Thomson Learning BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. 15 Tender Offers: Tender Offers: – Williams Act, codified in Sections 13 and 14, has regulated tender offers or takeover bids, whether hostile or friendly. – One publicly held corporation attempts to acquire control of another publicly held company. – Provisions force offeror to provide: Target company’s shareholders with names of offerors and interests. Target company’s shareholders with names of offerors and interests. Purpose of takeover. Purpose of takeover. Method of disposing of target firm’s stock and assets. Method of disposing of target firm’s stock and assets. SECURITIES EXCHANGE ACT OF 1934

16. © 2004 West Legal Studies in Business A Division of Thomson Learning BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. 16 Insider Trading: Insider Trading: – 1934 Act regulates insider trading. – Transactions involving material nonpublic information insider must publicly disclose information or abstain from trading in security. – Parties subject to this regulation are: Corporate insiders (directors, officers, etc...). Corporate insiders (directors, officers, etc...). Tippee. Tippee. Anyone else who has access to material inside information. Anyone else who has access to material inside information. SECURITIES EXCHANGE ACT OF 1934

17. © 2004 West Legal Studies in Business A Division of Thomson Learning BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. 17 Insider Trading (cont’d): Insider Trading (cont’d): – Imposes liability for manipulative or deceptive device used in purchase or sale of security. – Proving violation require: Untrue statement of material fact. Untrue statement of material fact. Failure to state material fact needed to make a statement not misleading. Failure to state material fact needed to make a statement not misleading. Reliance upon statement and Reliance upon statement and Injury resulting from such reliance. Injury resulting from such reliance. SECURITIES EXCHANGE ACT OF 1934

18. © 2004 West Legal Studies in Business A Division of Thomson Learning BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. 18 Short-Swing Profits: Short-Swing Profits: – Aimed at gains by corporate insiders. – Insiders and persons owning more than 10 percent of a corporation’s stock. – Must file statements with SEC disclosing extent of ownership and changes taken place. – Pay to corporation any short-swing profits, defined as profit made by buying & selling securities that take place in time period of less than 6 months. 1934 SECURITIES EXCHANGE ACT

19. © 2004 West Legal Studies in Business A Division of Thomson Learning BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. 19 Liabilities and Remedies Liabilities and Remedies – Act ‘34 creates private right of action for those who have dealt in securities on the basis of misleading registration statements, tender offers, and proxy solicitations. – Under Section 16, corporations/shareholders suing in a derivative action for the benefit of the corporation may recover short-swing profits. – Catch-all antifraud provision, may be brought by purchaser/seller of any security against person who has engaged in fraudulent conduct. SECURITIES EXCHANGE ACT OF 1934

20. © 2004 West Legal Studies in Business A Division of Thomson Learning BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. 20 Empowers SEC to conduct investigations. Empowers SEC to conduct investigations. SEC can revoke registration or suspend of distribution of the security. SEC can revoke registration or suspend of distribution of the security. Empowers SEC to impose administrative hearing. Empowers SEC to impose administrative hearing. Appropriate cases referred for criminal prosecution. Appropriate cases referred for criminal prosecution. SECURITIES EXCHANGE ACT OF 1934

21. © 2004 West Legal Studies in Business A Division of Thomson Learning BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. 21 SARBANES-OXLEY ACT OF 2002 Resulted from Worldcom/Enron scandals. Resulted from Worldcom/Enron scandals. CEO/CFO Certification of financials. CEO/CFO Certification of financials. Establishment of Audit Committees/ Corporate Governance. Establishment of Audit Committees/ Corporate Governance. Prohibitions on Loans to Directors /Officers. Prohibitions on Loans to Directors /Officers. Restrictions of Executive Compensation. Restrictions of Executive Compensation. Additional Criminal Penalties. Additional Criminal Penalties. Whistleblower Protection. Whistleblower Protection. Creation of Auditor Oversight Board. Creation of Auditor Oversight Board.

22. © 2004 West Legal Studies in Business A Division of Thomson Learning BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. 22 STATE REGULATIONS Transactions involving securities may be subject to state and federal law. Transactions involving securities may be subject to state and federal law. Often called “blue sky laws,” types of provisions are: Often called “blue sky laws,” types of provisions are: – Antifraud stipulations. – Registration requirements for brokers and dealers. – Registration prerequisites for sale and purchase of securities.

23. © 2004 West Legal Studies in Business A Division of Thomson Learning BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. 23 STATE REGULATIONS Methods of securities registration ordinarily exist: Methods of securities registration ordinarily exist: – Notification. – Qualification. – Coordination. State exemptions are similar to federal. State exemptions are similar to federal.

24. © 2004 West Legal Studies in Business A Division of Thomson Learning BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. 24 THE FOREIGN CORRUPT PRACTICES ACT Stops bribery of foreign officials. Stops bribery of foreign officials. Contains anti-bribery provisions and accounting standards. Contains anti-bribery provisions and accounting standards. Criminal penalties may be imposed if officer, director, employee, agent or stockholder corruptly use mail or any instrument of interstate commerce either to offer or pay money to foreign officials to influence assistance to firm. Criminal penalties may be imposed if officer, director, employee, agent or stockholder corruptly use mail or any instrument of interstate commerce either to offer or pay money to foreign officials to influence assistance to firm.

25. © 2004 West Legal Studies in Business A Division of Thomson Learning BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. 25 THE FOREIGN CORRUPT PRACTICES ACT Payments or gifts to facilitate routine governmental action are permitted. Payments or gifts to facilitate routine governmental action are permitted. Record-keeping standards require issuers to: Record-keeping standards require issuers to: – Make and keep records, reasonable in detail, accurately and fairly reflect the transactions and dispositions of the assets. – Devise and maintain a system of internal accounting controls sufficient to provide reasonable assurances.

26. © 2004 West Legal Studies in Business A Division of Thomson Learning BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. 26 THE FOREIGN CORRUPT PRACTICES ACT Criminal penalties: Criminal penalties: – Corporate fines of a maximum of $2 million for violations. – Maximum of five years’ imprisonment. – $100,000 in fines for willful violations by corporate individuals. – Individual civil penalties not to exceed $10,000.