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

Federal Trade Commission regulate

unfair and deceptive trade practices, including deceptive advertising.

Deceptive Advertising

when reasonable consumers would be misled by an advertising claim

Half Truths

appears to be based on factual evidence Ex. Campbell's Soup - "most" soups are low in fat and cholesterol - heart healthy.

Bait and Switch

lure in consumer with ad for low price merchandise, then sell them something else

Puffery

vague generalities and obvious exaggerations are permissible.

False Advertising Claims under Lanham Act

protects trademarks and false advertising claim.

Bait & Switch Examples

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.

Telemarketing and Consumer Fraud and Abuse Prevention Act

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

Cooling-Off laws

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

Telephone Order Merchandise rule

must give seller estimated shipping time. No estimate must ship within 30 days.

Truth-in-Lending Act

disclosure requirement. Terms in credit instrument must be clearly disclosed. APR (annual percentage rate), finance charge, amount financed, and total payments.

Equal Credit opportunity Act

prohibits the denial of credit solely on the basis of race, religion, national origin, color, gender, marital status, or age. Also, on forms of income, such as public assistance.

Credit-Card Rules

limits cardholder liability to $50 per card for unauthorized charges

Fair Credit Reporting Act

Protects against inaccurate credit reports. Requires correction of report.

Fair and Accurate Credit Transaction Act (FREE COPY)

Effort to combat identity theft. Requires each major credit reporting agency to provide consumer WITH A FREE COPY OF THEIR CREDIT REPORT ONCE A YEAR

Fair Debt Collection Practice Act

Limits collection practices by collection agencies. Must send validation notice - debtor has 30 days to dispute claim and request written verification of the debt.

Fair Debt Collection Practice Act says you cannot

•Contact debtor at place of employment

•Can't call at inconvenient times/ or when represented by attorney

•Can't contact third parties

•Can't harass or intimidate - no abusive language

Stock Market Crash of 1929

•Stock market unregulated.

•People buying on margins (only paying small percentage of value and borrowed rest)

•Caused great depression!

What is a security?

Any instrument evidencing corporate ownership (stock) or debt(bonds)

Equity Securities

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

Debt Securities

represent borrowed money that must be repaid (government bonds, corporate bonds, certificates of deposits

Securities and Exchange Commission - SEC

Independent federal government regulatory agency responsible for protecting investors.

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 the

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

U.S. Securities Act of 1933 Governs

initial sales of stock by businesses.

U.S. Securities Act of 1933 Goal

to limit fraud and stabilize securities industries

U.S. Securities Act of 1933 Purpose

was to inform investor about the securities offered for public sale.

One time disclosure law

All companies that offer securities must register with the SEC

Instruments and interests commonly known as securities

preferred and common stocks, bonds, debentures, and stock warrants.

Interests commonly known as securities

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

fractional undivided interest Securities

oil, gas, or other mineral rights.

Almost any stake in the ownership or debt of a company can be

considered a security!

Howey Test

determines that 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.

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.

Registration Statement

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

Issuing corporation must provide all investors with

a prospectus

Prospectus

disclosure document describe security being sold and the risk involved in the investment

Content of 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.

EDGAR

SEC's on-line database

•Electronic Data Gathering, Analysis, and Retrieval

All foreign and domestic companies

must file their registration electronically using EDGAR

•Investors can access database

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

Registration statement not effective until

reviewed and approved by SEC.

Prefilling Period

(before filing) cannot sell or offer to sell the securities.

Waiting Period

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

Posteffective Period

(approved) offer and sell securities without restriction. Must offer final prospectus available to all investors.

*****Exception of Waiting Period

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.

Exempt securities maintain their exempt status

forever and can also be resold without being registered.

Exempt Transactions

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.

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

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

Criminal violations are prosecuted by the US Dept. of Justice

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

Civil Sanctions

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

Continuous periodic disclosures required by publicly held corporations to enabled the SEC to regulate subsequent trading.

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)

Companies must 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 (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.

10(b) and SEC Rule 10b-5 major goal

to prevent insider trading

Insider Trading occurs when

a person buy or sell 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

Tipper/Tippee Theory

anyone who acquires insider information as a result of a corporate insider's breach of her fiduciary duty

Misappropriate theory

gain 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**

10b-5

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

Criminal penalties for fraud of Individuals

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

Criminal penalties for fraud by corporation or partnership

fined up to $25 million

Under Sarbanes-Oxley

willful violation of act violators (corporate officers) imprisoned up to 25 years.

Civil Sanctions for 10b-5 Fraud

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

Investment newsletter

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.

A Ponzi scheme

is a fraudulent investing scam promising high rate of return with little risk to investors.

A Ponzi scheme is a fraudulent investing scam which

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

Corporate Governance

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 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

Goal of Stock Options

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

makes officer tempted to cook company books to keep shar prices high. Or shared get repriced, so if drop in value, officer does not loose income.

State corporation statues set up legal framework for corporate governance to

promote accountability

Board of Directors

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

Audit Committee

oversee the corporations accounting and financial reporting process, includes both internal and outside auditors.

Compensation Committee

determine compensation of the company's officers

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.

SOX Act created the Public Company Accounting Oversight Board to

regulate and oversee public accounting firms.

Sox Act REQUIRES

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

CEO and CFO must

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

Sox Act protect

Whistleblowers - cannot fire or discriminate again employee

Sox Act increases Internal Control

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

Exception for Internal Control

Smaller Companies (under $75 million ) excluded

Financial Control

require independent auditors to review managements assessment of internal control

NO LOANS TO DIRECTORS AND OFFICERS during

initial public offering.

All members of a publicly traded corporation's audit committee, must be

OUTSIDE DIRECTORS.

Audit committee must have a written charter, at least one financial expert must be on

the audit committee. Must hold executive meeting without company officers present.

Penalties if CEO or CFO lies on financial statement

punishment up to 1 million in fines and/or 10 years in prison