CHAPTER 21 Financing, Investor Protecting, Online Securities Offerings

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CHAPTER 21Financing, Investor Protecting,
Online Securities Offerings
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Learning Objectives

• What is meant by the term securities?
• What are the two major statutes regulating the
  securities industry? When was the SEC created,
  and what are its major purposes and functions?
• What is insider trading? Why is it prohibited?
• What are some of the features of state securities
  laws?
• How are securities laws being applied in the
  online environment?

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Introduction

• The stock market crash of 1929 showed the need
  for
• More disclosure from issuers.
• Prohibition of deceptive, unfair and manipulative
  practices in the purchase and sale of securities.

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Introduction

• The Securities Act of 1933 and Securities
  Exchange Act of 1934 are designed to protect
  investors from deceptive, unfair and manipulative
  practices when buying or selling securities.
• Securities are instruments such as corporate
  stock or limited partnership interests that
  evidence ownership or debt.

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Corporate Financing
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Bonds
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Stocks

• Common Stock represents true ownership of a
  corporation. Provides pro-rata (proportional)
  ownership interest reflected in control, earnings
  and assets.
• Preferred Stock has preferences over common
  stock.
• Cumulative Preferred.
• Participating Preferred.
• Convertible Preferred.
• Redeemable or Callable Preferred.

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Sarbanes-Oxley Act of 2002

• Attempts to increase corporate responsibility by
• Stricter disclosure requirements.
• Harsher penalties for legal violations.
• Corporate officers take responsibility for
  financial statements and SEC reports.
• CEOs and CFOs must personally certify reports.
• Oversight by Public Company Accounting Oversight
  Board.
• Protections for Whistleblowers.
• Enhanced Penalties.

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Securities Act of 1933

• Securities Act of 1933 regulates solicitation,
  buying and selling of securities.
• In SEC v. Howey (1946), the U.S. Supreme Court
  held that a security exists in any transaction in
  which a person (1) invests (2) in a common
  enterprise (3) reasonably expecting profits (4)
  derived primarily from others managerial or
  entrepreneurial efforts.
• SEC v. Alpha Telcom, Inc. (2002).

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Registration Statement

• If a security does not qualify for an exemption
  under 5 of the Securities Act of 1933, the
  security must be registered with the Securities
  Exchange Commission (http//www.sec.gov) and
  state securities agencies before offered to the
  public.
• Corporation must file a registration statement
  and prospectus with the SEC. Prospectus is later
  distributed to investors.

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Registration Statement

• Description of the significant provisions of the
  registrants offering and how the registrant
  intends to use the proceeds from the sale.
• Description of the registrants properties and
  business.

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Registration Statement

• Description of the management of the registrant,
  remuneration, pension, stock offerings, executive
  interests and compensation.
• Financial statement certified by and independent
  accounting firm.
• Description of pending lawsuits.

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Exempt Securities

• Bank securities sold before 1933.
• Commercial paper if maturity date does not exceed
  9 months.
• Charitable organization securities.
• Securities issued to existing securities holders
  resulting from reorganization, bankruptcy.
• Securities issued to finance railroad equipment.

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Exempt Securities

• Any insurance, endowment, annuity contract or
  government-issued securities.
• Securities issued by banks, savings and loan
  association, farmers' cooperatives.
• Regulation A, small offering up to 5 million in
  a 12 month period to test the waters but
  requires a circular.
• Securities issued to existing securities holders,
  stock split, dividend (really a transaction
  exemption).

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Exempt Transactions

• Small Reg D Offerings
• Rule 504 up to 1M in 12 months to accredited
  investors only.
• Rule 504a up to 500K but no ads.
• Rule 505 up to 5M during 12 months to both
  accredited and unaccredited investors.
• Section 4(6) up to 5M solely to accredited
  investors.

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Violations of the 1933 Act

• Intentional or negligent fraud of investors by
  misrepresenting or omitting material facts in the
  registration statement and/prospectus.
• Defenses Statement left out was not material
  Plaintiff knew about fraud and purchased stock
  Registrant believed statements were true.
• Penalties
• Criminal up to 5 years in prison and 10,000
  fine.
• Civil damages, refund of investment, injunction.

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Securities Exchange Act of 1934

• Registration of securities exchanges, brokers,
  dealers, and national securities exchanges and
  associations.
• Requires continuous disclosure system for
  corporations with securities sold on national
  exchanges or assets in excess of 5 million and
  500 or more shareholders (Sec. 12 companies or
  1934 companies).

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Section 10(b) and Rule 10b(5) Insider Trading

• Section 10(b) prohibits the use of any
  manipulative or deceptive device or contrivance
  in contravention of rules and regulations of SEC.
• Rule 10b(5) prohibits the commission of fraud in
  the connection with the purchase or sale of any
  security.
• SEC v. Texas Gulf Sulphur Co. (1968).

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Section 10(b) and Rule 10b(5) Insider Trading

• Insider Trading
• Advance information available to corporate
  officers and directors that can affect future
  value of stock.
• Insider trading prohibited
• 10b(5) Insiders (Officers, Executives and
  Directors).
• 10b(5) Outsiders.
• Tipper/tippee theory--insiders fiduciary duty
  must be breached.
• Misappropriation theory -- one wrongfully obtains
  inside info and trades on it -- Courts still
  require fiduciary duty be breached, to employer,
  for instance.

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Insider Reporting and Trading

• Section 16(b).
• Recapture by corporation of profits during
  previous six months gained by insider trading.
• Applies to stocks, warrants, options and
  convertible securities.

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Penalties for Violationsof the 1934 Act

• 10b violationscienter or intent is required to
  prove criminal penalties.
• Imprisonment up to 10 years, fines up to 1
  million, 2.5 for partnership or corporation.
• 16(b) -- strict liability -- no fault or scienter
  required -- civil penalties.
• United States v. Stewart (2004).

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Regulation of Investment Companies

• Act on behalf of many smaller shareholders by
  buying stock and professionally managing the
  portfolio. (MUTUAL FUNDS.)
• To safeguard company assets, all securities must
  be held by a bank or stock exchange member.
• No dividends paid except from undistributed net
  income.

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State Securities Laws

• State securities laws are called blue sky laws.
• Issuers must comply with federal and state
  securities laws and states do not allow the same
  exemptions as federal government.
• States could require registration or
  qualification.
• Uniform Securities Act has been adopted in part
  by many states.

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Online Securities Offerings

• Landmark Online IPO (1996) Spring Street Brewing
  Company.
• Regulations for online offerings.
• SEC October 1995 use of electronic media should
  be at least an equal alternative to paper-based
  media. Downloadable prospectus is permissible.

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Online Securities Offerings

• Online IPOs may deliver a prospectus by
• Giving timely and adequate notice (e-mails).
• Making the online communication system readily
  accessible.
• Requiring evidence of delivery (email return
  receipt).

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Online Securities Offerings

• Online offers should not link to other sites in
  prospectus.
• Problems with status of investors on a general
  website. For example, Reg D offerings can only be
  made to accredited investors.
• Perhaps use password protected website.

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Online Securities Fraud

• SEC tries to enforce anti-fraud provisions of
  Securities Laws.
• Use and abuse of internet chat rooms.
• Where is the line between free speech and fraud?
• Pumping and Dumping buyer pumps the stock and
  after it rises, he dumps it, selling at a higher
  price.
• Selling unregistered securities by unregistered
  stock brokers is a problem.