D216 Unit 8 - Consumer Protection, Investor Protection, Corporate Governance

What does the Federal Trade Commission act regulate?

Unfair and deceptive trade practices, including deceptive advertising.

What qualifies as Deceptive Advertising?

Any circumstance where reasonable consumers would be misled by an advertising claim

What are Half Truths in false advertising?

When something appears to be based on factual evidence but then goes off on a tangent. For example, Campbell's Soup’s former advertising campaign - "most" soups are low in fat and cholesterol - heart healthy. While they had lines of heart healthy soup, most were definitely not heart health.

What is a Bait and Switch in false advertising?

To lure in a customer with advertisements for low priced merchandise, and then sell them something else at a higher cost.

What is Puffery in false advertising?

Advertisements containing vague generalities and obvious exaggerations are permissible. For example, “Red Bull gives you wings” is permissible because obviously you are not actually going to grow wings.

What does the Lanham Act do?

Protects businesses from false advertising claims.

Legal assertions made by a competitor about false or misleading representations regarding a product or service, allowing for lawsuits to recover damages.

Bait & Switch Examples (More false advertising)

1. Refuse to show the advertised item

2. Fail to have a reasonable quantity of item in stock

3. Fail to deliver advertised item within reasonable time

4. Discourage employees from selling advertised item.

Telephone Consumer Protection Act

prohibits telephone solicitation using an automatic telephone dialing system or a prerecorded vice. ***REALITY- Facebook v. Duguid, 2021 held To qualify as an "automatic telephone dialing system," a device must have the capacity either to store a telephone number using a random or sequential generator or to produce a telephone number using a random or sequential number generator.

What does the Telemarketing and Consumer Fraud and Abuse Prevention Act do?

It requires telemarketer to identify seller's name, describe product being sold, disclose material fact (total cost). Mandated by the FTC

What are Cooling-Off laws?

FTC (Federal Trade Commission) and various state laws permit the buyer of goods sold door-to-door to cancel the contract within three business days.

What is the Telephone Order Merchandise rule?

The seller must give the buyer an estimated shipping time. If they don’t give an estimate, it must be shipped within 30 days.

What is the Truth-in-Lending Act?

It is a disclosure requirement. It dictates that terms in credit instruments must be clearly disclosed.

APR (annual percentage rate), finance charge, amount financed, and total payments.

Basically it says that when you give me a loan you need to make it clear to me how you’re planning to screw me

What does the Equal Credit opportunity Act do?

It prohibits the denial of credit solely on the basis of race, religion, national origin, color, gender, marital status, or age. Also, you can’t be denied credit based on forms of income, such as if you receive public assistance.

What is the Credit-Card Rule regarding cardholder liability for unauthorized charges?

The cardholder’s maximum liability is set to $50 per card for unauthorized charges

What does the Fair Credit Reporting Act do?

It protects against inaccurate credit reports. If a credit report is inaccurate, this act requires the report to be corrected.

What does the Fair and Accurate Credit Transaction Act do? (HINT: FREE COPY)

This act was made in an effort to combat identity theft. It requires that each major credit reporting agency provides consumers WITH A FREE COPY OF THEIR CREDIT REPORT ONCE A YEAR upon request.

What does the Fair Debt Collection Practice Act do?

It limits collection practices by collection agencies (third parties hired by the creditor to seek collection).

The collection agency must send a validation notice - debtor has 30 days to dispute claim and request written verification of the debt.

The Fair Debt Collection Practice Act says creditors/debt collectors cannot:

• Contact debtor at place of employment

• Call at inconvenient times/ or when represented by attorney

• Contact third parties

• Harass or intimidate - no abusive language

They can’t be doing outrageous activities

What event caused investor protections to be put in place?

The stock market crash of 1929

What caused the Stock Market Crash of 1929?

• The stock market was unregulated.

• People bought on margins (only paying a small percentage of the value and borrowing the rest)

• This caused the great depression!

What is a security?

Any device or instrument used to show evidence that you have interest in corporate ownership (stock) or debt (bonds)

What are Equity Securities?

An ownership position in a publicly-traded corporation (common stock, preferred stock)

Stocks are equity

What are Debt Securities?

They represent borrowed money that must be repaid (government bonds, corporate bonds, certificates of deposits). Basically you’ve loaned money to a corporation.

Bonds are debts

What is the Securities and Exchange Commission (SEC)?

An independent federal government regulatory agency responsible for protecting investors.

Created in response to the stock market crash and Great Depression.

The SEC was established by the passage of the U.S. Securities Act of 1933 and the Securities and Exchange Act of 1934, largely in response to what event?

The stock market crash of 1929 that led to the Great Depression.

The SEC was established by what two acts?

The SEC was established by the passage of the U.S. Securities Act of 1933 and the Securities and Exchange Act of 1934

The U.S. Securities Act of 1933 Governs what?

It governs the initial sales of stock by businesses.

What is the goal of the U.S. Securities Act of 1933?

The goal is to limit fraud and stabilize securities industries.

What is the purpose of the U.S. Securities Act of 1933?

The purpose is to inform investors about the securities offered for public sales.

The government said “consumers should know what they’re buying, and we should know who’s selling it”

What does the U.S. Securities Act of 1933 actually do?

Requires businesses to register with the SEC before they can actually sell their stock

What is the one time disclosure law?

It mandates that all companies that offer securities must register it ONCE with the SEC. Generally they do not need to be re-registered.

What are the instruments and interests commonly known as securities?

Stocks and bonds basically.

Stocks = Buying interests in the company

Bonds = Buying debts in the company

Examples: Preferred and common stocks, bonds, debentures, and stock warrants.

Interests commonly known as securities (specific examples)

stock options, puts, and calls, that involve the right to purchase a security or a group of securities on a national security exchange.

What are fractional undivided interest Securities?

Oil, gas, or other mineral rights.

Almost any stake in the ownership or debt of a company (having stocks or bonds in a company) can be:

considered a security!

What is the Howey Test?

It determines if a transaction is a security.

It tests if a transaction is an investment contract. If a person invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or a third party, it is a security.

Came from a supreme court case in 1946

US Supreme Court (SEC v. W.J. Howey Co., 1946) said it is an investment contract in any transaction a person:

1) invest

2) common enterprise

3) Reasonably expecting a profit

4) Derived primarily or substantially from others' managerial or entrepreneurial efforts.

What is a Registration Statement?

a statement filed with the SEC that discloses all material information concerning the corporation making a public offering

Issuing corporations must provide all investors with:

a prospectus

What is a Prospectus?

A disclosure document describing the security being sold and the risk involved in the investment to the consumer

What is the Content of a Registration Statement?

1.The securities being offered for sale, including their relationship to the registrant's other securities.

2. The corporation's properties and business

3. The management of the corporation, including managerial compensation, stock options, pensions, and other benefits. Any interests of directors or officers in any material transactions with the corporation must also be disclosed.

4.How the corporation intends to use the proceeds of the sale.

5.Any pending lawsuits or special risk factors.

What is EDGAR?

SEC's on-line database

•Electronic Data Gathering, Analysis, and Retrieval

All foreign and domestic companies must do what with SEC’s Edgar?

must file their registration electronically using EDGAR

•Investors can access database

•initial public offerings (IPOs), proxy statements, annual reports, registration statements

Registration statements are not effective until they have been:

reviewed and approved by SEC.

Prefiling Period

(before filing with the SEC) during this period, the business cannot sell or offer to sell the securities.

Waiting Period

(after filing with the SEC, before approval) the business can offer for sale but can't sell, can start to give preliminary prospectus. ***Minimum waiting period of 20 days

Posteffective Period

(After SEC has approved the registration statement) business may offer and sell securities without restriction. Must offer final prospectus available to all investors.

*****Exception to the Waiting Period (waiting for SEC to approve your registration)

Well Known Seasoned Issuers (WKSI) firm that has issued at least $1 billion in securities in the last three years/or outstanding stock valued at $700 million. The can file on date they make a public offering. No waiting period, can offer prospectus anytime.

Low-risk investments or securities regulated by other statutes are

exempt from registration with the SEC.

For how long do exempt securities maintain their exempt status?

forever and they can also be resold without being registered.

Exempt Transactions (exempt from registering with the SEC)

1. Nonpublic offerings involving a small number of investors

2. Securities sold only to residents of a state

3. Crowdfunding

Most securities can be resold

without registration. SEC is generally only concerned with initial offerings

Crowdfunding Platform

an Internet site which collects money given by people who are willing to finance a project

Ex. Kickstarter

Violations of the 1933 Act (the one that created SEC)

It is a violation to intentionally defraud investors by misrepresenting or omitting facts in a registration statement or prospectus.

Criminal violations of the 1933 act are prosecuted by the US Dept. of Justice. What is the penalty for criminal violations?

Penalty fine up to $10,000 and imprisoned for up to five years

Civil Sanctions for violating the 1933 act

1. Injunction to stop further sales of securities

2. Court order refund of profits

3. Private parties can bring suit in federal court to recover their losses

Defense to 1933 Act

Requirements for defendants to prove non-materiality, plaintiff's knowledge, and due diligence in preparing statements.

The Securities Exchange Act of 1934

Requires continuous periodic disclosures by publicly held corporations to enabled the SEC to regulate subsequent trading.

Basically, publicly held corporations need to report to the government.

The Securities Exchange Act of 1934 applies to

Companies that have assets in excess of $10 millions and five hundred or more shareholders. Known as SECTION 12 COMPANIES (section 12 of act)

How often must Companies file reports with SEC?

annually, quarterly (monthly during a merger)

Section 10b-5

Prohibits commission of fraud in connection with the purchase or sale of securities.

Section 10b-5 covers

almost all types of securities ***Do not have to be registered under 1933 act to apply

Private Parties can sue for securities fraud if:

•1. A material misrepresentation in connection with the purchase and sale of securities.

•2. Scienter (the defendant had the intent to commit fraud. It means a wrongful state of mind)

•3. Reliance by the plaintiff on the material misrepresentation.

•4. An economic loss

•5. Causation, meaning that there is a causal connection between the misrepresentation and the loss.

What is the major goal of 10(b) and SEC Rule 10b-5?

to prevent insider trading

Insider Trading occurs when

a person buys or sells securities on the basis of information that is not available to the public.

Insider Trading applies to

anyone who has access to the information of a nonpublic nature on which trading is based - not just for corporate insiders

What is the Tipper/Tippee Theory?

Anyone who acquires insider information as a result of a corporate insider's breach of their fiduciary duty

Wha is the Misappropriate theory?

Gained insider information and act upon it. (arguing you stole the information)

Section 16(b) allows for

the recapture by the corporation of all profits realized by an insider on the purchase or sale of stock within 6 months of the inside information.

The Private Securities Litigation Reform Act (PSLRA) (1995)

Provides a safe harbor for publicly held companies to make forward-looking statements. Protected against securities fraud if they include meaningful cautionary statements identifying important factors that could cause actual result to differ materially from those in the forward-looking statements.

** Meaningful Cautionary Statements**

Basically: if you make a prediction about what will happen, you are allowed to announce it to the public as long as people know it’s just a prediction, not a guaranteed future vision.

10b-5 says you must have what to be convicted?

Must have Scienter to be convicted. That is intent to defraud and knowledge of your misconduct. Insider trading

Criminal penalties for fraud of Individuals (in respect to 10b)

fined up to $5 million and imprisoned up to twenty years

Criminal penalties for fraud by corporation or partnership (in respect to 10b)

The corporation can be fined up to $25 million

Under Sarbanes-Oxley, what penalty is there for violators of act 10b?

willful violation of act 10b violators (corporate officers) can be imprisoned for up to 25 years.

Civil Sanctions for 10b-5 Fraud

Penalty of up to triple the profits from gain or loss avoided by guilty party

Investment newsletter

Simple: must disclose when advertisements are paid for

companies can pay newsletter to tout their securities. REQUIRED to disclose paid advertising, many newsletter don't follow this rule. Fraudster will directly profit by convincing investor to buy or sell particular stocks.

What is a Ponzi scheme?

It’s a fraudulent investing scam promising high rate of return with little risk to investors.

It uses investments from later investors to pay early investors. Eventually there is not enough money coming in to pay investors.

A Ponzi scheme is a fraudulent investing scam which

generates returns for earlier investors with money taken from later investors.

What is Corporate Governance rooted in?

The relationship between a corporation and its shareholders.

Corporate Governance is the system by which

companies are directed and controlled. Boards of directors are responsible for the governance of their companies.

The shareholders' role in corporate governance is to

appoint the directors and the auditors and to satisfy themselves that an appropriate governance structure is in place.

The responsibilities of the board include

setting the company's strategic aims, providing the leadership to put them into effect, supervising the management of the business and reporting to shareholders on their stewardship.

Corporate governance is therefore about what the board of a company does and how it sets the values of the company, and it is to be distinguished from

the day-to-day operational management of the company by full-time executives

What is the Goal of Stock Options for corporate governance?

The goal is to align corporate officers' interest with company shareholders. Enable holder to purchase shares at a set price, if price rises can sell at profit. Thought- give officer financial stake in corporation and encourage them to make it a success.

Problem with Stock Options for corporate governance?

They tempt officers to cook company books to keep share prices high. Or shared get repriced, so if drop in value, officer does not lose income.

State corporation statues set up legal framework for corporate governance in order to do what?

promote accountability

Who elects the Board of Directors and what does the board of directors do?

elected by shareholders. Supposed to oversee that officers are operating business wisely. Can be sued if they fail to be effective board members.

What does the Audit Committee do and who does it consist of?

It oversees the corporation’s accounting and financial reporting process. It consists of both internal and outside auditors.

What does the Compensation Committee do?

It determines the compensation of the company's officers

What is the purpose of the SOX Act or Corporate Responsibility Act of 2002?

To increase corporate accountability by imposing strict disclosure requirements and harsh penalties for violation of securities law.

It came about because big corporate accounting firms were lying through their teeth

SOX Act created the Public Company Accounting Oversight Board in order to:

regulate and oversee public accounting firms.

Sox Act REQUIRES what of CEOs and CFOs?

CHIEF CORPORATE EXECTUTIVES (CEO's and CFO's) TO TAKE PERSONAL RESPONSIBILITY for the accuracy of financial statements and reports filed with the SEC.

In regards to the SOX act, CEO and CFO must

certify that accounting reporte “fully comply" with SEC requirements and "fairly represent in all material respects," the financial condition of the corporation.

Sox Act protects what group?

Whistleblowers - cannot fire or discriminate again employee

How does Sox Act increase Internal Control?

High-level managers must establish and maintain an effective system of internal control. SENIOR MANAGEMENT MUST REASSESS THE SYSTEMS EFFECTIVENESS ANNUALLY.

Exception for Internal Control in respect to the SOX Act

Smaller Companies (under $75 million) are excluded

Financial Control under the SOX Act

Requires independent auditors to review management’s assessment of internal control

SOX Act says NO LOANS TO DIRECTORS AND OFFICERS during what period:

initial public offering.

According to the SOX Act, members of a publicly traded corporation's audit committee, must be

OUTSIDE DIRECTORS.

Under the SOX Act, an audit committee must have what?

A written charter, and the committee must have at least one financial expert on the audit committee. Committee must hold executive meetings without company officers present.