Securities Regulation
Introduction
Info  Price
(last updated 18 Jan 12)
Information  Price
• Auction 1: no information
– Information is critical to pricing
– Discount for lack of info
• Auction 2: inside information
– Information through signaling
– Efficient Capital Market Hypothesis
• Auction 3: widespread information
– Can you feel the fraud?
– Consider effect on subsequent auctions
Securities industry demographics
(Feb 2009)
Public companies:
• 12,000 (securities
registered with SEC)
• 7,500 operating
companies
Investment advisers:
• 11,300 (includes hedge
fund managers)
• up from 7,546 in 2002
Broker-dealers:
• 5,500 firms
• 173,000 branch offices
(up from 75,000 in 2001)
• 665,000 registered reps
Mutual funds:
• 950 complexes (such as
Vanguard)
• 4,600 registered funds
(Vanguard 2050 Target Fund)
Nationally recognized statistical
rating organizations
• Ten (S&P, etc)
Stock exchanges
• Eleven exchanges (NYSE)
Clearing agencies
• Five
What are incentives to disclose?
Nature of US securities regulation
Securities regulation
Mandatory disclosure
• Sales of securities to public
• Public companies – periodic disclosure
Antifraud liability
• Private actions
• SEC enforcement
Regulate intermediaries (gatekeepers)
• Self-regulation
• SEC disciplinary oversight
***
Legislation
• Securities Act of 1933
• Securities Exchange Act of 1934
• 5 Commissioners
• 4 Divisions
• various offices (inc OGC)
Securities fraud
Elements
•
•
•
•
•
•
Material
Misrepresentation or omission
Scienter
Reliance
Causation
Damages
Rule 10b-5 adds:
• Jurisdictional nexus (federal court)
• Transactional nexus (“in connection
with purchase or sale of securities”)
How value an investment?
What is a security?
Types of Securities
Type
Cash Flow
Rights
Liquidation
Rights
Voting
Rights
Common
stock
Residual +
discretionary
Last in line
(junior)
Elect board +
fundamental
transactions
Preferred
stock
Residual +
fixed
Next in line
Contingent
(sometimes)
P&I: fixed +
contractual
First in line
(senior)
None
Debt
Valuation
Which investment would you
choose? (assuming 5% interest
rate)
1.Put $10 million under mattress
for two years
2.Annuity that pays $2.5 million
every year for next four years
3.Preferred stock that pays
$400,000 per year (in perpetuity)
Investment #3
#1
#2
n
FV
=
PV
*
(1
+
i)
^
(assume 4% interest rate)
1 = $ 2,380,952
PV1
PV
$10,000,000
+.05) 2
PV ===$2,500,000/(1.05)
FVpymt / i /2 (1
PV2 = $2,500,000/(1.05) = $ 2,267,574
2
PV == $10,000,000
/
(1.05)
PV
FV
/
i
3
*
*
*
pymt
PV3 = $2,500,000/(1.05)
= $ 2,159,594
PV
$10,000,000
/4 (1.1025)
PV4
= $ 2,056,756
PV ===$2,500,000/(1.05)
$400,000 / .05
PV = $$400,000
9,070,295/ .04
PV
=
$8,000,000
PVPV
= $ 8,864,876
= FV / (1 + i) ^ n
PV = $10,000,000
End
#2 - $10 million in 2-year 10% bond
FV = PV * (1 + i) ^ n
PV = FV / (1 + i) ^ n
Year FV
1 $1,000,000
Present Value
$1,000,000 / (1.05) 1 = $ 952,381
2
$1,000,000
$1,000,000 / (1.05) 2 = $ 907,029
2
$10,000,000
$10,000,000 / (1.05) 2 = $ 9,070,295
Total
$10,929,705
#5 - zero-coupon bond ($15 million – 3 years)
FV = PV * (1 + i) ^ n
PV = FV / (1 + i) ^ n
Year FV
$0
1
Present Value (discount 15%)
$0
2
$0
$0
3
$15,000,000
$15,000,000 / (1.15) 3 = $ 9,860,000
Total
$9,860,000
#5 - zero-coupon bond ($15 million – 3 years)
FV = PV * (1 + i) ^ n
PV = FV / (1 + i) ^ n
Year FV
$0
1
Present Value (assuming 5%)
$0
2
$0
$0
3
$15,000,000
$15,000,000 / (1.05) 3 = $ 12,957,562
Total
$12,957,562