Securities Regulation

“Definition of insider trading: Stealing too fast.”

Calvin TrillinEssayist

Created in 1934 to regulate the securities industry

Creates laws in three different ways:◦ Rules: Through which the SEC fills in the crucial

details◦ Releases: Informal pronouncements from the

SEC on current issues◦ No-action letters: States that the SEC will take

no action if the transaction is done in a specified manner

Requires that before offering or selling securities, the issuer must register the securities with the SEC unless the securities qualify for an exemption◦ Issuer: A company that sells its own stock

When an issuer registers securities, the SEC does not investigate the quality of the offering

General exemption – Issuer must determine whether they are exempt from the registration under the 1933 Act◦ Based on two factors:

Type of security Type of transaction

Inherently low-risk Regulated by other statutes Not really investments Following securities are exempt from

registration:◦ Government securities◦ Bank securities◦ Short-term notes◦ Non-profit issues◦ Insurance policies and annuity contracts

Section 4(2) of the 1933 Act exempts from registration “transactions by an issuer not involving any public offerings”

Interstate offering exemption:◦ Under SEC Rule 147, an issuer is not required to

register securities that are offered and sold only to residents of the state in which the issuer is incorporated and does business Rule 147 is a safe harbor

Safe harbor: A set of requirements that, if met, indicate automatic compliance with a law

Regulation D◦ Accredited investors: Institutions (such as

banks and insurance companies) or wealthy individuals To qualify, individuals must have a net worth (not

counting their home) of more than $1 million or an annual income of more than $200,000

◦ Sophisticated investor: Someone who is able to assess the risk of an offering

◦ Restricted stock: Securities purchased strictly for investment purchase

Regulation A◦ Permits an issuer to sell up to $50 million of

securities publicly in any 12-month period Crowdfunding

◦ JOBS Act – Permits privately held companies to sell up to $1 million in securities in any 12-month period

The issuer typically sells shares to its stakeholders:◦ Customers◦ Employees◦ Suppliers◦ Community

Advantages:◦ Cheaper and faster ◦ Effective marketing tool◦ Easy mechanism for reaching potential investors

Downsides:◦ Limit to how much a company can raise◦ Company officers typically lack the expertise◦ Each investor must receive written information

about the company◦ Tricky and time-consuming

Initial public offering (IPO): A company’s first public sale of securities

Secondary offering: Any public sale of securities by a company after the initial public offering◦ Followed by an issuer for either type of sale:

Underwriting Firm commitment underwriting: The underwriter

buys stock from the issuer and sells it to the public Best efforts underwriting: The underwriter does not

buy the stock from the issuer but instead acts as the issuer’s agent in selling the securities

Registration statement: Two purposes Notify the SEC that a sale of securities is pending Disclose information to prospective purchasers

Prospectus Sales effort Going effective

Rule 144 limits the resale of two types of securities issued by public companies: ◦ Restricted security: Any stock purchased from

the issuer in a private offering◦ Control security: Stock held by any shareholder

who owns more than 10 percent of a class of stock or by any officer or director of the company

Liability for selling unregistered securities◦ Imposed on anyone selling unregistered and non-

exempt securities Fraud

◦ The seller of a security is liable for making any material misstatement or omission, either oral or written, in connection with the offer or sale of a security

Criminal liability◦ Imposed on anyone who willfully violates the Act

Liability for the registration statement◦ If a final registration statement contains a material

misstatement or omission, the purchaser of the security can recover from everyone who signed the registration statement Damages – Only to prove that there was a material

misstatement or omission and that plaintiff lost money Material: important enough to affect an investor’s

decision Due diligence: An investigation of the registration

statement by someone who signs it

General provisions for the 1934 Act◦ Registration requirements – An issuer must

register with the SEC if: It completes a public offering under the 1933 Act Its securities are traded on a national exchange It has at least 2000 shareholders and total assets

that exceed $10 million

Disclosure requirements—Section 13 - Requires companies to file the following documents:◦ An initial, detailed information statement when

the company first registers◦ Annual reports on Form 10-K◦ Quarterly reports on Form 10-Q, which are less

detailed than 10-Ks◦ Form 8-K to report any significant developments

Proxy requirements—Section 14 – Allows shareholders to vote without attending the meeting

Short-swing trading—Section 16 – Prevents corporate insiders from taking unfair advantage of privileged information to manipulate the market:◦ Insiders must report their trade within two

business days◦ Insiders must turn over to the corporation

Section 18 ◦ Anyone who makes a false or misleading

statement in a filing under the 1934 Act is liable to buyers and sellers who: Acted in reliance on the statement Can prove that the price at which they bought or sold

was affected buy the false filing Section 10(b)

◦ Prohibits fraud in connection with the purchase and sale of any security whether or not it is registered under the 1934 Act

Insider trading◦ A crime punishable by fines and imprisonment

Fiduciary duty◦ Any corporate insider who trades while in

possession of nonpublic material information in violation of his fiduciary duty to his company is liable under Rule 10b-5

Misappropriation◦ Anyone of the following is liable for insider

trading: Anyone with material, non-public information Anyone who breaches a fiduciary duty to the source

of the information Anyone who reveals or trades in the information

Tippers – Anyone who reveals material nonpublic information in violation of his fiduciary duty is liable if he:◦ Knows the information is confidential◦ Expected some personal gain

Tippees - Those who receive tips are liable for trading on inside information, even if they do not have a fiduciary relationship to the company, as long as: ◦ They know the information is confidential◦ They know it came from an insider who was

violating his fiduciary duty◦ The insider expected some personal gain

Takeovers◦ Rule 14e-3 prohibits trading on inside information

during a tender offer if the trader knows the information was obtained from either the bidder or the target company

Advanced planning◦ Under Rule 10b5-1, an insider can avoid insider

trading charges if she commits in advance to a plan to sell securities

An amendment to the 1934 Act The Act:

◦ Requires companies to disclose if they have an ethics code and, if they do not, why not

◦ Imposes fines and imprisonments on anyone who interferes with federal investigation into fraud

◦ Permits a whistleblower on a securities law violation to sue the company if it retaliates Makes it a crime to retaliate against a whistleblower

◦ Establishes a new Public Accounting Oversight Board to oversee the auditing of reporting companies

Amends the 1934 Act to provide a reward system for whistle-blowers

Establishes a requirement that reporting companies tell the SEC and post on their websites information about their use of “conflict materials”

Statutes that regulated the sale of securities Exemption from state regulation

◦ National Securities Market Improvement Act of 1996, under which states may no longer regulate offerings of securities that are: Traded on a national exchange Exempt under Rule 506, or Sold to a qualified purchaser

State regulation◦ States take one of the following approaches to

securities offerings: Registration by notification Registration by coordination Registration by qualification

Facilitating state regulation - Options that ease the process of complying with state requirements:◦ Coordinated equity review: Issuer deals with

only one state, which coordinates comments from all other states

◦ Small company offering registration: For use in offerings of up to $1 million over any 12 month period

◦ Uniform limited offering exemption: Most states largely exempt from registration any offerings under Rule 505

““The 1929 stock market crash and the The 1929 stock market crash and the Great Depression that followed were an Great Depression that followed were an

economic catastrophe for the United economic catastrophe for the United States. The Securities Act of 1933 and States. The Securities Act of 1933 and the Securities Exchange Act of 1934 the Securities Exchange Act of 1934

were designed to prevent such were designed to prevent such disasters from ever occurring again. disasters from ever occurring again.

Whether or not they achieve that goal, Whether or not they achieve that goal, they undoubtedly enhance the they undoubtedly enhance the

reliability and stability of the securities reliability and stability of the securities market.”market.”