Chapter 28 Investor Protection and Online Securities Offerings

© 2004 West Legal Studies in BusinessA Division of Thomson Learning 1

Chapter 28Chapter 28Investor Protection and Investor Protection and

Online Securities OfferingsOnline Securities Offerings


§§ 1: The Securities and 1: The Securities and Exchange CommissionExchange Commission

SEC is an independent federal agency created by SEC is an independent federal agency created by the 1934 Act.the 1934 Act.

Responsibilities: administer the 1933 and 1934 Responsibilities: administer the 1933 and 1934 Acts:Acts: Make rules to implement the 1933-34 Acts.Make rules to implement the 1933-34 Acts. Investigate and enforce SEC laws against those who Investigate and enforce SEC laws against those who

violate rules.violate rules. Adjudicates offenses with appeal into the court Adjudicates offenses with appeal into the court

system.system.


Expanding RegulatoryExpanding RegulatoryPowers of the SECPowers of the SEC

Securities Enforcement Remedies and Penny Securities Enforcement Remedies and Penny Stock Reform Act of 1990.Stock Reform Act of 1990.

Securities Acts Amendments of 1990.Securities Acts Amendments of 1990.Market Reform Act of 1990.Market Reform Act of 1990.

National Securities Markets Improvement Act of National Securities Markets Improvement Act of 1996 exempts certain persons, securities and 1996 exempts certain persons, securities and transactions from securities laws.transactions from securities laws.


§ 2: The Sarbanes-Oxley § 2: The Sarbanes-Oxley Act of 2002Act of 2002

Attempts to increase corporate accountability:Attempts to increase corporate accountability: Imposes stricter disclosures.Imposes stricter disclosures. Harsher penalties for violations.Harsher penalties for violations. Requires CEO’s to take responsibility for accuracy Requires CEO’s to take responsibility for accuracy

of financial statements filed with SEC.of financial statements filed with SEC. Creates new private civil actions.Creates new private civil actions.

Creates Public Company Accounting Oversight Creates Public Company Accounting Oversight Board regulates public accounting firms.Board regulates public accounting firms.


The Sarbanes-Oxley The Sarbanes-Oxley Act of 2002Act of 2002

Key Provisions:Key Provisions: Certification Requirements.Certification Requirements. Loans to Officers and Directors.Loans to Officers and Directors. Protections for Whistleblowers.Protections for Whistleblowers. Enhanced Penalties.Enhanced Penalties. Statute of Limitations for Securities Fraud.Statute of Limitations for Securities Fraud.


§§ 3: The Securities Act of 1933 3: The Securities Act of 1933 SEA of 1933 designed to prohibit fraud and require SEA of 1933 designed to prohibit fraud and require

certain essential information so that investors can certain essential information so that investors can make informed business decisions.make informed business decisions.

In In SEC v. Howey SEC v. Howey (1946)(1946), the U.S. Supreme Court held , the U.S. Supreme Court held that a “security” exists in that a “security” exists in anyany transaction in which a transaction in which a person: (1) invests (2) in a common enterprise (3) person: (1) invests (2) in a common enterprise (3) reasonably expecting profits (4) derived primarily reasonably expecting profits (4) derived primarily from others’ managerial or entrepreneurial efforts.from others’ managerial or entrepreneurial efforts.

Case 28.1:Case 28.1: SEC v. Alpha Telcom, Inc.SEC v. Alpha Telcom, Inc. (2002). (2002).

http://caselaw.findlaw.com/scripts/getcase.pl?court=US&vol=328&invol=293


Registration StatementRegistration Statement

If a security does not qualify for an exemption If a security does not qualify for an exemption under §5 of the Securities Act of 1933, the under §5 of the Securities Act of 1933, the security must be registered with the SEC and security must be registered with the SEC and state (state (seesee TexasTexas) securities agencies before ) securities agencies before offered to the public.offered to the public.

Corporation must file a registration statement Corporation must file a registration statement and prospectus with the SEC. Prospectus is and prospectus with the SEC. Prospectus is later distributed to investors.later distributed to investors.

http://www.ssb.state.tx.us/


Contents of Contents of Registration StatementRegistration Statement

Description of the significant provisions of the Description of the significant provisions of the registrant’s “offering” and how the registrant registrant’s “offering” and how the registrant intends to use the proceeds from the sale.intends to use the proceeds from the sale.

Description of the registrant’s properties and Description of the registrant’s properties and business.business.


Contents of Contents of Registration Statement Registration Statement [2][2]

Description of the management of the Description of the management of the registrant, remuneration, pension, stock registrant, remuneration, pension, stock offerings, executive interests and offerings, executive interests and compensation.compensation.

Financial statement certified by and Financial statement certified by and independent accounting firm.independent accounting firm.

Description of pending lawsuits.Description of pending lawsuits.


Exempt SecuritiesExempt Securities

Bank securities sold before 1933.Bank securities sold before 1933. Commercial paper if maturity date does not exceed Commercial paper if maturity date does not exceed

9 months9 months Charitable organization securities.Charitable organization securities. Securities issued to existing securities holders Securities issued to existing securities holders

resulting from reorganization, bankruptcy. resulting from reorganization, bankruptcy. Securities issued to finance railroad equipment.Securities issued to finance railroad equipment.


Exempt SecuritiesExempt Securities Any insurance, endowment, annuity contract or Any insurance, endowment, annuity contract or

government-issued securities.government-issued securities. Securities issued by banks, savings and loan Securities issued by banks, savings and loan

association, farmers' cooperatives.association, farmers' cooperatives. Regulation A, small offering up to $5 million in a 12 Regulation A, small offering up to $5 million in a 12

month period to “test the waters”; but requires a month period to “test the waters”; but requires a circular.circular.

Securities issued to existing securities holders, stock Securities issued to existing securities holders, stock split, dividend (really a transaction exemption).split, dividend (really a transaction exemption).


Exempt Exempt TransactionsTransactions

Small “Reg D” Offerings:Small “Reg D” Offerings: Rule 504: up to $1M during 12 months to Rule 504: up to $1M during 12 months to

accredited investors accredited investors onlyonly.. Rule 504a.Rule 504a. Rule 505: up to $5M during 12 months to both Rule 505: up to $5M during 12 months to both

accredited and unaccredited investors.accredited and unaccredited investors. Section 4(6): up to $5M solely to accredited Section 4(6): up to $5M solely to accredited

investors.investors. Intrastate Offerings (Rule 147).Intrastate Offerings (Rule 147).


Exempt Exempt TransactionsTransactions [2][2]

Rule 147 Intrastate SalesRule 147 Intrastate SalesBroker/Dealer Transactions. Broker/Dealer Transactions. Casual Sales. Casual Sales. Resales of Restricted Securities by “Control Resales of Restricted Securities by “Control

Persons” under Rule 144 and 144(a).Persons” under Rule 144 and 144(a).


Violations of the 1933 Act Violations of the 1933 Act Violation of the Securities Act means Violation of the Securities Act means

to intentionally or negligently defraud to intentionally or negligently defraud investors by misrepresenting or investors by misrepresenting or omitting material facts in the omitting material facts in the registration statement and/prospectus. registration statement and/prospectus.


Defenses & PenaltiesDefenses & Penalties

DefensesDefenses: Statement left out was not material; : Statement left out was not material; Plaintiff knew about fraud and purchased stock; Plaintiff knew about fraud and purchased stock; Registrant believed statements were true.Registrant believed statements were true.

PenaltiesPenalties: : Criminal: up to 5 years in prison and $10,000 fine.Criminal: up to 5 years in prison and $10,000 fine. Civil: damages, refund of investment, injunction.Civil: damages, refund of investment, injunction.


§4: The §4: The Securities Securities Exchange Act of 1934Exchange Act of 1934

Registration of securities exchanges, brokers, Registration of securities exchanges, brokers, dealers, and national securities exchanges and dealers, and national securities exchanges and associations. associations.

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


Purposes of 1934 ActPurposes of 1934 Act [2][2]

Rule 14(a) proxy regulations.Rule 14(a) proxy regulations.Market surveillance by SEC.Market surveillance by SEC.Rule 10(b) prohibits fraud with insider trading Rule 10(b) prohibits fraud with insider trading

and disclosure regulations.and disclosure regulations.Rule 16(b) insider reporting and trading.Rule 16(b) insider reporting and trading.Rule 13 tender offer regulations.Rule 13 tender offer regulations.


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

Section 10(b) prohibits the use of any Section 10(b) prohibits the use of any manipulative or deceptive device or contrivance manipulative or deceptive device or contrivance in contravention of rules and regulations of in contravention of rules and regulations of SEC.SEC.

Rule 10b(5) prohibits the commission of fraud Rule 10b(5) prohibits the commission of fraud in the connection with the purchase or sale of in the connection with the purchase or sale of any security.any security.

Case 28.2:Case 28.2: SEC v. Texas Gulf Sulphur SEC v. Texas Gulf Sulphur (1968).(1968).


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

Section 10b(5) “Insiders”.Section 10b(5) “Insiders”.Rule 10b-5 “Outsiders”.Rule 10b-5 “Outsiders”.

Tipper/Tippee theory--insider’s fiduciary duty must Tipper/Tippee theory--insider’s fiduciary duty must be breachedbe breached

Misappropriation theory -- one wrongfully obtains Misappropriation theory -- one wrongfully obtains inside info and trades on it. Courts still require inside info and trades on it. Courts still require fiduciary duty be breached, fiduciary duty be breached, e.g.,e.g., to employer. to employer.

Case 28.3:Case 28.3: U.S. v. O’Hagan U.S. v. O’Hagan (1997).(1997).


ScienterScienter or intent is required to prove civil or or intent is required to prove civil or criminal penalties under 10(b) and Rule 10b-5.criminal penalties under 10(b) and Rule 10b-5. Violator must have had intent to defraud (false Violator must have had intent to defraud (false

statements or wrongfully failed to disclose material statements or wrongfully failed to disclose material facts).facts).

Case 28.4:Case 28.4: In re MCI WorldCom, Inc. In re MCI WorldCom, Inc. Securities LitigationsSecurities Litigations (2000). (2000).

Violations of the 1934 ActViolations of the 1934 Act



Criminal Penalties: Criminal Penalties: 10(b) and Rule 10b-5, a person faces $5 10(b) and Rule 10b-5, a person faces $5

million and 20 years in prison, $25 million million and 20 years in prison, $25 million for partnership or corporation.for partnership or corporation.

Sarbanes-Oxley provides for 25 years in Sarbanes-Oxley provides for 25 years in prison.prison.



Civil Sanctions:Civil Sanctions: Both SEC and Private Parties Can Bring Both SEC and Private Parties Can Bring

Actions Against Violators under the Insider Actions Against Violators under the Insider Trading and Securities Fraud Enforcement Trading and Securities Fraud Enforcement Act.Act.

Private Actions for violations of 10(b) and Private Actions for violations of 10(b) and Rule 10b-5.Rule 10b-5.


§5: Regulation of §5: Regulation of Investment CompaniesInvestment Companies

Act on behalf of many smaller shareholders Act on behalf of many smaller shareholders by buying stock and professionally managing by buying stock and professionally managing the “portfolio.” (MUTUAL FUNDS.)the “portfolio.” (MUTUAL FUNDS.)

To safeguard company assets, all securities To safeguard company assets, all securities must be held by a bank or stock exchange must be held by a bank or stock exchange member.member.

No dividends paid except from undistributed No dividends paid except from undistributed net income.net income.


§ 6: State Securities Laws § 6: State Securities Laws State securities laws are called “blue sky” State securities laws are called “blue sky”

laws.laws.Issuers must comply with federal and state Issuers must comply with federal and state

securities laws and states do not allow the securities laws and states do not allow the same exemptions as federal government.same exemptions as federal government.

States could require registration or States could require registration or qualification.qualification.

Uniform Securities Act has been adopted in Uniform Securities Act has been adopted in part by many states.part by many states.


§ 7: Online Securities § 7: Online Securities Offerings and DisclosuresOfferings and Disclosures

Springstreet Brewing Co. was the first online Springstreet Brewing Co. was the first online IPO (1996).IPO (1996).

Regulations Governing Online Securities Regulations Governing Online Securities Offerings:Offerings: Timely and Adequate Notice of Delivery of Timely and Adequate Notice of Delivery of

Information.Information. The online communication system must be easily The online communication system must be easily

accessible.accessible. Some evidence of delivery is required.Some evidence of delivery is required.


Potential Liability Created by Potential Liability Created by Online Offering MaterialsOnline Offering Materials

Online offerings should exercise caution in Online offerings should exercise caution in hyperlinking to external documents.hyperlinking to external documents.

There is also a concern if the offering is placed There is also a concern if the offering is placed on a website that can be viewed by anyone.on a website that can be viewed by anyone. Many offerings are restricted to a limited number of Many offerings are restricted to a limited number of

“unaccredited” investors.“unaccredited” investors.


§ 8: Online Securities Fraud§ 8: Online Securities Fraud

The SEC is aggressively prosecuting internet The SEC is aggressively prosecuting internet fraud using traditional laws.fraud using traditional laws.

Investment Scams.Investment Scams.Using Chat Rooms to Manipulate Stock Prices.Using Chat Rooms to Manipulate Stock Prices.

Pumping and Dumping.Pumping and Dumping. Jonathan Lebed charged with securities fraud.Jonathan Lebed charged with securities fraud.


Law on the WebLaw on the Web

SEC’s Edgar databaseSEC’s Edgar database..Free Edgar.Free Edgar.Center for Corporate Law at University of CincCenter for Corporate Law at University of Cinc

innati School of innati School of LawLaw..

Securities Act of 1933Securities Act of 1933. . Securities Act of 1934Securities Act of 1934..Information on Investor ProtectionInformation on Investor Protection..

Legal Research Exercises on the Web.Legal Research Exercises on the Web.

http://www.sec.gov/edgarhp.htm

http://www.freeedgar.com/

http://www.law.uc.edu/CCL



http://www.law.uc.edu/CCL/33Act/index.html

http://www.law.uc.edu/CCL/34Act/index.html

http://www.securitieslaw.com/

http://wleb.westbuslaw.com/

Chapter 28 Investor Protection and Online Securities Offerings

Documents