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Investor Protection Laws: Safeguarding Securities Investments

Explore the history and regulations of securities laws, roles of the SEC, registration processes, exemptions, and consequences of violations in online securities transactions.

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Investor Protection Laws: Safeguarding Securities Investments

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  1. PowerPoint Slides to AccompanyESSENTIALS OF BUSINESS ANDONLINE COMMERCE LAW1st Editionby Henry R. Cheeseman Chapter 18 Investor Protection and Online Securities Transactions Slides developed by Les Wiletzky

  2. Federal law did not regulate the securities markets until after the stock market crash of 1929. Securities laws are designed to help prevent a similar crash today.

  3. The Securities and Exchange Commission (SEC) • Federal administrative agency that is empowered to administer federal securities laws • The SEC can adopt rules and regulations to interpret and implement federal securities laws

  4. Definition of a Security • A security must exist before securities laws apply • Securities are defined as: • An interest or instrument that is common stock, preferred stock, a bond, a debenture, or a warrant • An interest or instrument that is expressly mentioned in securities acts • An investment contract

  5. The Securities Act of 1933 • Primarily regulates the issuance of securities by corporations, partnerships, associations, and individuals • Section 5 of the Act requires securities offered to the public through the use of the mails or any facility of interstate commerce to be registered with the SEC

  6. Registration Statement • A covered issuer of securities must file a written registration statement with the SEC • It contains required information about the issuer and the securities to be issued • The SEC does not pass upon the merits of the registered securities • It decides only whether the issuer has met the disclosure requirements

  7. Prospectus • A written disclosure document that must be submitted to the SEC along with the registration statement • It is provided to prospective investors to enable them to evaluate the financial risk of the investment

  8. Limitations on Activities During the Registration Process • Section 5 of the Securities Act of 1933 limits the types of activities that an issuer, an underwriter, and a dealer may engage in during the registration process • These limitations are divided into three time periods: • The Prefiling Period • The Waiting Period • The Posteffective Period

  9. Sale of Unregistered Securities • Sale of securities that should have been registered with the SEC but are not violates the Securities Act of 1933 • Investors can rescind their purchases and recover damages • Civil and criminal penalties can be imposed by the U.S. government

  10. Regulation A Offerings • A regulation that permits the issuer to sell securities pursuant to a simplified registration process • Such offerings may have an unlimited number of purchasers • They do not have to be sophisticated investors • There are no resale restrictions on the securities

  11. Private and Other Transactions Exempt from Registration (1 of 2) • Certain transactions in securities are exempt from registration • Exempt transactions are subject to the antifraud provisions of the federal securities laws • The issuer must provide investors with adequate information

  12. Private and Other Transactions Exempt from Registration (2 of 2) Exempt transactions: 1. Intrastate offering exemption 2. Private placement exemption 3. Small offering exemption

  13. Resale Restrictions • Certain resale restrictions are placed on securities issued pursuant to exemptions from registration • Restricted Securities – securities that were issued for investment purposes pursuant to the intrastate, private placement, or small offering exemptions • Rule 147 • Rule 144

  14. Securities Exempt From Registration With the SEC (1 of 2) • Securities issued by any government in the U.S. • Short-term notes and drafts that have a maturity date that does not exceed nine months • Securities issued by nonprofit issuers • Securities of financial institutions that are regulated by the appropriate banking authorities • Securities issued by common carriers that are regulated by the Interstate Commerce Commission

  15. Securities Exempt From Registration With the SEC (2 of 2) • Insurance and annuity contracts issued by insurance companies • Stock dividends and stock splits • Securities issued in a corporate reorganization where one security is exchanged for another security

  16. Violations of the Securities Act of 1933(1 of 2) • SEC Actions • Consent order • Injunction • Request ancillary relief from the court • Criminal Liability – Section 24 imposes criminal liability on any person who willfully violates the act or the rules or regulations adopted thereunder

  17. Violations of the Securities Act of 1933(2 of 2) • Private Actions – Private parties who have been injured by violations of the act have the following recourse against the violator: • Section 12 – civil liability • Section 11 – civil liability

  18. Sarbanes-Oxley Act of 2002 • Section 501 of the Act established rules for separating investment banking and securities advice functions of securities firms, thus eliminating many conflicts of interests

  19. The Securities Exchange Act of 1934: Trading in Securities • Federal statute that primarily regulates the trading in securities • It provides for the regulation of • Securities exchanges • Brokers • Dealers • Contains provisions that assess civil and criminal liability on violators of the act

  20. Continuous Reporting Requirements • The Securities Exchange Act of 1934 requires issuers to file periodic reports with the SEC: • Annual report (Form 10-K) • Quarterly reports (Form 10-Q) • Monthly reports (Form 8-K)

  21. Section 10(b) • A provision of the Securities Exchange Act of 1934 • Prohibits the use of manipulative and deceptive devices in the purchase or sale of securities in contravention of the rules and regulations prescribed by the SEC

  22. Rule 10b-5 • A rule adopted by the SEC to clarify the reach of Section 10(b) against deceptive and fraudulent activities in the purchase and sale of securities • All transfers of securities are subject to this rule • i.e., stock exchange, over-the-counter, private sale, merger

  23. Insider Trading • One of the most important purposes of Section 10(b) and Rule 10b-5 is to prevent insider trading: • When an insider makes a profit by personally purchasing shares of the corporation prior to public release of favorable information, or • By selling shares of the corporation prior to the disclosure of unfavorable information

  24. Insiders are defined under Section 10(b) and Rule 10b-5 as: • Officers, directors, and employees at all levels of the company • Lawyers, accountants, consultants, and other agents and representatives who are hired by the company on a temporary and non-employee status to provide services or work to the company • Others who owe a fiduciary duty to the company

  25. Tipper A person who discloses non-public information to another person Liable for the profits made by the tippee Tippee The person who receives material non-public information from a tipper Liable for acting on material information that he or she knew (or should have known) was not public Tipper – Tippee Liability

  26. Violations of the Securities Exchange Act of 1934 (1 of 2) • Criminal Liability – Section 32 imposes criminal liability on any person who willfully violates the act or regulations adopted thereunder • SEC Actions – • Consent order • Injunction • Seek court orders • Insider trading sanctions

  27. Violations of the Securities Exchange Act of 1934 (2 of 2) • Private Actions – The courts have implied private right of action under Section 10(b) and Rule 10b-5 • Generally, a plaintiff may seek rescission of the securities contract or recover damages from a defendant who has engaged in manipulation and deceptive practices that have caused the plaintiff injury

  28. Short-Swing Profits: Statutory Insiders • Section 16(a) of the 1934 act – defines any person who is an executive officer, a director, or a 10 percent shareholder of an equity security of a reporting company as a statutory insider for Section 16 purposes

  29. Short-Swing Profits: Section 16(b) • Short-Swing Profits – Profits made by statutory insiders on trades involving equity securities that occur within six months of each other • Section 16(b) – A provision of the 1934 act that requires that any profits made by a statutory insider on transactions involving short-swing profits belong to the corporation

  30. State Securities Laws • Most states have enacted securities laws that regulate the issuance and trading of securities • These acts are often patterned after, and are designed to coordinate with, federal securities laws • The Uniform Securities Act (a model state statute) has been adopted by many states

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