E3- Ch 19- Investor Protection, Insider Trading, and Corporate Governance

Securities Act of 1933

An act that governs initial sales of stock by businesses. Designed to prohibit various forms of fraud and to stabilize the securities industry by requiring that all essential info concerning the issuance of securities be made available to the investing public.

• All securities transactions must be registered with the SEC, unless qualify for exemption.

• Registration- must be filed on SEC’s electronic database EDGAR approved by SEC

Violations:

1. Sec. 11- Registration with material misstatement or omission

2. Sec. 12- No registration filed or false statements in prospectus or sold too early.

3. SEC- Civil Action; DOJ- Criminal Action; Private Parties

Defenses

1. Mistake not Material

2. Investor knew about the misrepresentation at time they bought security OR

3. Due diligence- can be asserted by an defendant. (except issuer of the security)

Punishment

• Triple Punch: DOJ- $10000 to 2M and/or 5 yr prison. SEC- civil sanctions & can request injunction, then you get sued by those who lost $.

Security

An investment of money in a common enterprise with expected profits derived from the efforts of others.

• common stock, treasury stocks, bonds, debentures, and stock warrants, etc

• JOBS ACT allows less expensive, less complicated registration process for small businesses. Still must register with state.

Securities and Exchange Commission (SEC)

Commission whose purpose is to ensure adequate disclosure.

Red Herring

A logical fallacy of presenting a legal or factual issue that is irrelevant and used to divert attention away from the main issues of a case.

• A part of Securities Act of 1933- Limited Advertising Allowed

Tombstone Ad

An advertisement in a newspaper that describes public securities offering and identified the sellers.

• A part of Securities Act of 1933- Limited Advertising Allowed

Securities Exchange Act of 1934

An act that applies to companies with 10M+ in A$ and 500+ Shareholders to prohibit insider trading among other fraudulent practices.

• SEC Rule 10b-5, Rule 16b, and Rule 14a

Violations & Punishments

• Scienter requirement

• criminal penalties: individuals 20 yrs prison &/or 5M fine & partnership/corp. fine up to 25M, under SOX 25 years for willful violation + fine

• civil sanctions: possible penalty of 3x profit or loss avoided.

• Private Party: Can/ will sue

SEC 10b and Rule10b-5

A rule of the SEC that prohibits the commission of fraud in connection with the purchase or sale of any security. Where Insider Breaches Fiduciary Duty in using insider material info (by using for self or tipping off another) with info not yet available to the public.

• prohibits/prevents insider trading and anti-fraud for all levels and all prices.

Insider Trading

When a person buys or sells securities on the basis of information that is not available to the public. Directors, Officers, and majority of shareholders, often have advanced inside info about events that can affect the future market value of the corp. stock. Acting on this info would be giving them a trading advantage over the general public.

Short-Swing Profits

Profits earned by a purchase and sale, or sale and purchase, of the same security withing a six-month period

• SEC 16b

Proxy Statements

Whoever solicists a procy must full and accurately disclose in the ___________ all of the facts that are pertinent to the matter on which the shareholders are to vote.

• Sec. 15a of SEA 1934

Misappropriation Theory

A theory where an individual who wrongfully obtains (misappropriates) insider information and trades on it for personal gain should be held liable because, in essence, that individual stole information rightly belonging to another.

Foreign Corrupt Practices Act

An act that prohibits payments, gifts, or even offers of “anything of value” to a “foreign official” for the purpose of influencing the official or otherwise “securing any improper advantages” in obtaining, retaining, or directing business.

• Amendment to the 1934 Act

• Anti-Bribery Law

Corporate Governance

A set of policies specifying the rights and responsibilities of the various participants in a corporation and spelling out the rules and procedures for making corporate decisions.

Sarbanes-Oxley Act (SOX) 2002

An act to increase corporate accountability by requiring strict disclosure requirements and penalties for violations of securities law. CEOs & CFOs must personally certify that their statements and reports to the SEC are both accurate & complete. Created bc of ENRON.

• Created the PCAOB! oversees and regulates public accounting firms

• Protection given to whistleblowers

• Prohibits specified securities transactions during Blackout Period

• Prohibits auditors from providing both auditing and non-auditing services

• Requires public reporting of corporate ethical codes

• Requires corp. attorneys to report material violations of securities

• Cannot obstruct official proceedings by altering, destroying, or concealing documents

• Increased punishment for violations, under SOX, for WILLFUL violation of ‘34 act- 25 years in prison + fine.

Whistleblower

An employee’s disclosure to gov. authorities, upper-level managers, or the media that the employer is engaged in unsafe or illegal activities.

Blackout Period

A period during which the issuer’s ability to purchase, sell, or otherwise transfer funds in individual account plans (such as pension funds) is suspended.