Comprehensive Volume, 18th Edition

Chapter 48: Securities Regulation

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Definitions

The term “securities” is defined as “stocks and bonds issued by a corporation,” and may also include other interests that provide unearned income.The definition is sufficiently broadly to encompass not only stocks and bonds but also any conceivable kind of corporate interest that has investment characteristics.

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Laws Regulating Securities

State blue sky laws, which apply only to intrastate transactions, protect the public from the sale of fraudulent securities. There are two principal laws providing the basic framework for federal regulation of the sale of securities in interstate commerce:

The Securities Act of 1933 The Securities Exchange Act of 1934

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The Securities Act of 1933

The Securities Act of 1933 deals with the issue or original distribution of securities by issuing corporations.

Except for certain private and limited offerings, the 1933 act requires that a registration statement be filed with the SEC and that a prospectus be provided to each potential purchaser.

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The Securities Exchange Act of 1934

The Securities Exchange Act of 1934 regulates the secondary distribution or sale of securities on exchanges.

The 1934 act provides reporting requirements for companies whose securities are listed on a national exchange and unlisted companies that have assets in excess of $3 million and 500 or more shareholders.

Rule 10b-5 is the principal antifraud rule under the 1934 act.

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Securities RegulationI. Blue Sky Laws (State)

Protect public from intrastate sale of worthless securities

II. Securities Act of 1933 (Federal)A. Deals with original issue of securities in interstate commerceB. Administered by the SECC. Requires filing of registration statement with SEC before most offerings or sales of securities to publicD. Requires seller of securities to provide prospectus to potential purchasers

of securities

III. Securities Exchange Act of 1934 (Federal)A. Deals with secondary distribution of securities traded in interstate

commerceB. Administered by the SECC. Requires registration with SEC of exchanges, brokers, and dealersD. Requires reports of financial and nonfinancial information about

registrantsE. Makes trading on “insider information” unlawful

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Registration PeriodsProhibited or Required Activities Permitted Activities

PrefilingPeriod

Issuer must not sell or offer for sale a securitybefore registration statement is filed.

Issuer may plan with underwriters thedistribution of the security.

WaitingPeriod

No final sale of a security permitted during thisperiod.

Preliminary prospectus* containinginformation from the registrationstatement being reviewed by the SECmay be distr ibuted to investors, whomay make offers. Advertisements maybe placed in financial publications,identifying particulars of the security,from whom a prospectus can beobtained, and by whom orders will beexecuted.**

PosteffectivePeriod

Must provide a copy of final prospectus with everywritten offer, confirmation of sale, or delivery ofsecurity. Must update prospectus wheneverimportant new developments occur or after ninemonths.

Sales of the security may becompleted.

* The preliminary prospectus is commonly called the “red herring” prospectus because of the red ink caption required bythe SEC, informing the public that a registration statement has been filed but is not yet effective, and that no final salecan be made until after the effective data.

** These advertisements are sometimes called “tombstone ads’ because they are commonly framed by a black ink border.

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Enforcement

Criminal and civil penalties exist for fraudulent statements made in reporting.

The Securities and Exchange Commission administers both the 1933 and the 1934 Acts.

The SEC under authority of the Williams Act regulates cash tender offers.

The securities industry provides arbitration procedures to resolve disputes between customers and firms.

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Insider Trading

Trading on “inside information” is unlawful and may subject those involved to a civil penalty of three times the profit made on the improperly disclosed information.

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Disclosure of Ownership

A disclosure statement is required by:Corporate directors or officers owning equity securities in their corporation.Shareholders owning more than 10% of any class of the corporation’s equity securities.

Any of the above people selling these securities for a profit less than 6 months after buying them may be guilty of making a short-swing profit.

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Regulation of Accountants

Disclosure rules require accountants to reveal market risk information for derivative investments.

These rules also require a description of the accounting policies used to account for derivatives.

The SEC may disbar or suspend accountants who violate securities laws.

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Industry Self-Regulation

Many securities investment firms have adopted a code of arbitration, giving customers a contractual right to settle disputes through arbitration.

Courts rarely overturn the decisions of an arbitrator in these cases.