BUSINESS LAW
Twomey • Jennings 1stEd.
Twomey & Jennings
BUSINESS LAW
Chapter 45
Securities Regulation
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BUSINESS LAW
Twomey • Jennings 1stEd.
State Laws Regulating
Securities
• State blue sky laws, which apply only to
intrastate transactions, protect the public
from the sale of fraudulent securities.
• National Securities Markets Improvement
Act of 1996 allocated responsibilities
between federal and state authorities.
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BUSINESS LAW
Twomey • Jennings 1stEd.
Federal Laws Regulating
Securities
• There are two principal laws providing the
basic framework for federal regulation of
the sale of securities in interstate commerce:
– The Securities Act of 1933.
– The Securities Exchange Act of 1934.
• Now, the Sarbanes-Oxley Act of 2002.
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BUSINESS LAW
Twomey • Jennings 1stEd.
Definitions
• The term “securities” is defined as “stocks
and bonds issued by a corporation,” and
may also include other interests that provide
unearned income.
Reves v Ernst & Young (1990) Was
the note issued by the cooperative a
‘security’?
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BUSINESS LAW
Twomey • Jennings 1stEd.
The Securities Act of 1933
• The Securities Act of 1933 deals with the
issue or original distribution of securities by
issuing corporations.
• Except for certain private and limited
offerings, the 1933 act requires that a
registration statement be filed with the SEC
and that a prospectus be provided to each
potential purchaser.
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BUSINESS LAW
Twomey • Jennings 1stEd.
1933 Securities Act
Registration Periods
Prohibite d or Required Activities
Prefiling
Pe riod
Waiting
Pe riod
Permitted Activities
Issuer must not sell or offer for sale a security
before registration statement is filed.
Issuer may plan with underwriters the
distribution of the security.
No final sale of a security permitted during this
period.
Preliminary prospectus* containing
information from the registration
statement being reviewed by the SEC
may be distr ibuted to investors, who
may make offers. Advertisements may
be placed in financial publications,
identifying particulars of the security,
from whom a prospectus can be
obtained, and by whom orders will be
executed.**
M ust provide a copy of final prospectus with every
Sales of the security may be
wr itten offer, confirmation of sale, or delivery of
completed.
Posteffective
security. Must update prospectus whenever
Pe riod
important new developments occur or after nine
months.
* The preliminary prospectus is commonly called the “red herring” prospectus because of the red ink caption required by
the SEC, informing the public that a registration statement has been filed but is not yet effective, and that no final sale
can be made until after the effective data.
** These advertisements are sometimes called “tombstone ads’ because they are commonly framed by a black ink border.
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BUSINESS LAW
Twomey • Jennings 1stEd.
The Securities Act of 1933
• Exemptions from Registration:
– Rule 504 (up to $1M during 12 months).
– Rule 505 (up to $5M to less than 35 unaccredited
investors during a 12 month period).
– Rule 506 (no limitation on money).
• Restrictions on 505, 506 securities.
• Liability.
– False or misleading statements.
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BUSINESS LAW
Twomey • Jennings 1stEd.
Securities Exchange
Act of 1934
• The Securities Exchange Act of 1934 regulates the
secondary distribution or sale of securities on
exchanges.
• The 1934 act provides reporting requirements for
companies whose securities are listed on a national
exchange and unlisted companies that have assets
in excess of $3 million and 500 or more
shareholders.
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BUSINESS LAW
Twomey • Jennings 1stEd.
1934 Act: Rule 10b-5
• Rule 10b-5 is the principal antifraud rule
under the 1934 act.
– Applies to all private securities actions.
– Liability for material misrepresentations or
omissions in fact.
Basic, Inc. v Levinson (1988) Is
Silence Always Golden?
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BUSINESS LAW
Twomey • Jennings 1stEd.
Enforcement
• Criminal and civil penalties exist for fraudulent
statements made in reporting.
• The Securities and Exchange Commission
administers both the 1933 and the 1934 Acts.
• The SEC under authority of the Williams Act
regulates cash tender offers.
• The securities industry provides arbitration
procedures to resolve disputes between customers
and firms.
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BUSINESS LAW
Twomey • Jennings 1stEd.
Section 10(b) and
Rule 10b-5: Insider Trading
• Trading on “inside information” is unlawful
and may subject those involved to a civil
penalty of three times the profit made on the
improperly disclosed information.
SEC v Donna Yun (2001) Is three
times profits a reasonable penalty?
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BUSINESS LAW
Twomey • Jennings 1stEd.
Insider Trading
• Director or corporate employees are liable.
– Temporary insider is a consultant (attorney,
CPA, etc).
– ‘Tippee’ receives information from an insider.
Tippee not liable if the insider does not breach a
fiduciary duty.
Dirks v SEC (1983) When should a
Tippee be liable for insider trading?
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BUSINESS LAW
Twomey • Jennings 1stEd.
Misappropriation
• Occurs when persons with fiduciary duty
steal information and use that information
to trade in securities.
• Liable under Section 10(b) and Rule 10b-5.
U.S. v O’Hagan (1997) Did O’Hagan
misappropriate information?
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BUSINESS LAW
Twomey • Jennings 1stEd.
Disclosure of Ownership
• A disclosure statement is required by:
– Corporate directors or officers owning equity
securities in their corporation.
– Shareholders owning more than 10% of any
class of the corporation’s equity securities.
• Any of the above people selling these
securities for a profit less than 6 months
after buying them may be guilty of making
a short-swing profit.
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BUSINESS LAW
Twomey • Jennings 1stEd.
Regulation of Accountants
• Disclosure rules require accountants to
reveal market risk information for
derivative investments.
• These rules also require a description of the
accounting policies used to account for
derivatives.
• The SEC may disbar or suspend
accountants who violate securities laws.
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BUSINESS LAW
Twomey • Jennings 1stEd.
Industry Self-Regulation
• Many securities investment firms have
adopted a code of arbitration, giving
customers a contractual right to settle
disputes through arbitration.
• Courts rarely overturn the decisions of an
arbitrator in these cases.
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