Chapter 37
Corporate Securities

WHAT THIS CHAPTER IS ABOUT

The general purpose of securities laws is to provide sufficient, accurate
information to investors to enable them to make informed buying and selling
decisions about securities. This chapter provides an outline of federal
securities laws.

CHAPTER OUTLINE

I. THE SECURITIES AND EXCHANGE COMMISSION (SEC)
Administers the federal securities laws and regulates the sale and purchase
of securities.

A. THE SEC'S BASIC FUNCTIONS

1. Require disclosure of facts concerning offerings of certain securities.

2. Regulate national securities trading.

3. Investigate securities fraud.

4. Regulate securities brokers, dealers, and investment advisers.

5. Supervise mutual funds.

6. Recommend sanctions in cases involving violations of securities laws.
(The U.S. Department of Justice prosecutes violations.)

B. THE SEC'S REGULATORY POWERS
Congress has expanded the SEC's powers to include the power to seek sanctions
against those who violate foreign securities laws; to suspend trading if
prices rise and fall in short periods of time; and to exempt persons,
securities, and transactions from securities law requirements.

II. SECURITIES ACT OF 1933
Requires that all essential information concerning the issuance (sales) of
new securities be disclosed to investors.

A. WHAT IS A SECURITY?

1. Courts' Interpretation of the Securities Act
A security exists in any transaction in which a person (1) invests (2) in a
common enterprise (3) reasonably expecting profits (4) derived primarily or
substantially from others' managerial or entrepreneurial efforts.

2. A Security Is an Investment
Examples: stocks, bonds, investment contracts in condominiums, franchises,
limited partnerships, and oil or gas or other mineral rights.

B. REGISTRATION STATEMENT
Before offering securities for sale, issuing corporations must (1) file a
registration statement with the Securities and Exchange Commission (SEC) and
(2) provide investors with a prospectus that describes the security being
sold, the issuing corporation, and the investment or risk.

1. Contents of a Registration Statement

a. Description of the significant provisions of the security and how the
registrant intends to use the proceeds of the sale.

b. Description of the registrant's properties and business.

c. Description of the management of the registrant; its security holdings;
its remuneration and other benefits, including pensions and stock options;
and any interests of directors or officers in any material transactions with
the corporation.

d. Financial statement certified by an independent public accountant.

e. Description of pending lawsuits.

2. Twenty-Day Waiting Period after Registration
Securities cannot be sold for twenty days (oral offers can be made).

3. Advertising
During the waiting period, very limited written advertising is allowed.
After the period, no written advertising is allowed, except a tombstone ad,
which simply tells how to obtain a prospectus.

C. EXEMPT SECURITIES
Securities that can be sold (and resold) without being registered include-

1. Small Offerings under Regulation A
An issuer's offer of up to $5 million in securities in any twelve-month
period (including up to $1.5 million in nonissuer resales). The issuer must
file with the - SEC a notice of the issue and an offering circular (also
provided to investors before the sale). A company can test the waters
(determine potential interest) before preparing the circular.

2. Other Exempt Securities
a. All bank securities sold prior to July 27, 1933.

b. Commercial paper if maturity does not exceed nine months.

c. Securities of charitable organizations.

d. Securities resulting from a reorganization issued in exchange for the
issuer's existing securities and certificates issued by trustees, receivers,
or debtors in possession in bankruptcy (see Chapter 30).

e. Securities issued exclusively in exchange for the issuer's existing
securities, provided no commission is paid (such as stock splits).

f. Securities issued to finance the acquisition of railroad equipment Any
insurance, endowment, or annuity contract issued by a stateregulated
insurance company.
g. Any insured, endowment, or annuity contract issued by a state-regulated
insurance company.

h. Government-issued securities.

i. Securities issued by banks, savings and loan associations, farmers'
cooperatives, and similar institutions.

D. EXEMPT TRANSACTIONS
Securities that can be sold without being registered include those sold in
transactions that consist of-

1. Small Offerings under Regulation D
Offers that involve a small amount of money or are not made publicly.

a . Offerings Up to $1 Million
Non-investment company offerings up to $1 million in a twelvemonth period
[Rule 5041].

b. Blank-Check Company Offerings Up to $500,000
Offerings up to $500,000 in any one year by companies with m specific plans
are exempt ff (1) m general solicitation or advertising is used, (2) the SEC
is notified of the sales, and (3) precaution is taken against nonexempt,
unregistered resales [Rule 504a].

c. Offerings Up to $5 Million
Private, non-investment company offerings up to $5 million in a twelve-month
period ff (1) m general solicitation or advertising is used; (2) the SEC is
notified of the sales; (3) precaution is taken against nonexempt,
unregistered resales; and (4) there are m nine than thirty-five unaccredited
investors. If the sale involves any unaccredited investors, all investors
must be given material information about the company, its business, the
securities [Rule 505).

d. Private Offerings in Unlimited Amounts
Essentially the same requirements as Rule 505, except (1) there is no limit
on the amount of the offering and (2) the issuer must believe that each
unaccredited investor has sufficient knowledge or experience to evaluate the
investment Rule 5061.

e. Offerings to Qualified Purchasers
Offerings up to $5 million per transaction to qualified purchasers (wealthy,
sophisticated investors) only [Rule 10011.

2. Small Offerings to Accredited Investors Only
An offer up to $5 million is exempt if (1) m general solicitation or
advertising is used; (2) the SEC is notified of the sales; (3) precaution is
taken against nonexempt, unregistered resales; and (4) there are m
unaccredited investors [Section 4(6)].

3. Intrastate Issues
Offerings in the state in which the issuer is organized and doing business
are exempt [Rule 147] ff, for nine months after the sale, m resale is made to
a nonresident.

4. Resales ('Safe Harbors')
Most securities can be resold without registration. Resales of blank-check
company offerings [Rule 504a], small offerings [Rule 505], private offerings
[Rule 506], and offers to accredited investors only [Section 4(6)] are exempt
from registration if-

a . The Securities Have Been Owned for Two Years or More
If seller is not an affiliate (in control with the issuer) [Rule 144].

b. The Securities Have Been Owned for at Least One 'Year
There must be adequate public information about the issuer, the securities
must be sold in limited amounts in unsolicited brokers' transactions, and the
SEC must be notified of the resale [Rule 144].

c. The Securities Are Sold Only to an Institutional Investor
The securities, m issue, must not have been of the same class as securities
listed on a national securities exchange or a U.S. automated interdealer
quotation system, and the seller an resale must take steps to tell the buyer
they are exempt [Rule 144A].

E. VIOLATIONS OF THE 1933 ACT
If registration statement or prospectus contains material false statements or
omissions, liable parties include anyone who signed the statement.

1. Defenses
Statement or omission was not material; plaintiff knew of misrepresentation
and bought stock anyway; due diligence (Chapter 51).

2. Penalties
Fines up to $10,000; imprisonment up to five years; injunction against
selling securities; order to refund profits; damages in civil suits.

III. SECURITIES EXCHANGE ACT OF 1934
Regulates the markets in which securities are traded by requiring disclosure
by Section 12 companies (corporations with securities on the exchanges and
firms with assets in excess of $10 million and five hundred or more
shareholders).

A. INSIDER TRADING-SECTION 10(b) AND SEC RULE lOb-5
Section 10(b) proscribes the use of "any manipulative or deceptive device or
contrivance m contravention of such rules and regulations as the [SEC] may
prescribe.' Rule lOb-5 prohibits the commission of fraud in connection with
the purchase or sale of any security (registered or unregistered).

1. What Triggers Liability
Any material omission or misrepresentation of material facts in connection
with the purchase or sale of any security.

2. Who Can Be Liable
Those who take advantage of inside information when they know that it is
unavailable to the person with whom they are dealing.

a. Insiders
Officers, directors, majority shareholders, and persons having access to or
receiving information of a nonpublic nature on which trading is based
(accountants, attorneys).

b. Outsiders

1) Tipper/Tippee Theory
One who acquires inside information as a result of an insider's breach of
fiduciary duty to the firm whose shares are traded can be liable, if he or
she knows or should know of the breach

2) Misappropriation Theory
One who wrongfully obtains inside information and trades m i t to his or her
gain can be liable, ff a duty to the lawful possessor of information was
violated and harm to another results.

B. INSIDER REPORTING AND TRADING-SECTION 16(b)
Officers, directors, and shareholders owning 10 percent of the securities
registered under Section 12 are required to file reports with the SEC
concerning their ownership and trading of the securities.

1. Corporation Is Entitled to All Profits
A firm can recapture a II profits realized by an insider m any purchase and
sale or sale and purchase of its stock in any six-month period.

2. Applicability of Section 16(b)
Applies to stock, warrants, options, securities convertible into stock.

C. PROXY STATEMENTS-SECTION 14(A)
Regulates the solicitation of proxies from shareholders of Section 12
companies. Whoever solicits a proxy must disclose, in the proxy statement,
all of the pertinent facts.

D. VIOLATIONS OF THE 1934 ACT

1. Criminal Penalties
Maximum jail term is ten years; fines up to $1 million for individuals and to
$2.5 million for partnerships and corporations.

2. Civil Sanctions

a. Insider Trading Sanctions Act of 1984
SEC can bring suit in federal court against anyone violating or aiding in a
violation of the 1934 act or SEC rules. Penalties include triple the profits
gained or the loss avoided by the guilty party.

b. Insider Trading and Securities Fraud Enforcement Ad of 1988 Enlarged the
class of persons to civil liability for insider-trading violations, increased
criminal penalties, and gave the SEC authority' to (1) reward persons
providing information and (2) make rules to prevent insider trading.

IV. REGULATION OF INVESTMENT COMPANIES
Investment companies and mutual funds are regulated by the SEC under the
Investment Company Act of 1940, the Investment Company Acts of 1970, the
Securities Act Amendments of 1975, and later amendments.

A. WHAT AN INVESTMENT COMPANY IS
Any entity that (1) is engaged primarily "in the business of investing
reinvesting or trading in securities' or (2) is engaged in such and has more
than 40 percent of the company's assets in investment securities.(Does not
include banks, finance companies, and others).

B. WHAT AN INVESTMENT COMPANY MUST DO
Register with the SEC by filing a notification of registration and, each
year, file reports with the SEC. All securities must be in the custody of a
bank or stock-exchange member.

C. WHAT AN INVESTMENT COMPANY CANNOT DO
No dividends may be paid from any source other than accumulated,
undistributed net income. There are restrictions on investment activities.

V. STATE SECURITIES LAWS
All states regulate the offer and sale of securities within individual state
borders. Exemptions from federal law are not exemptions from state laws,
which have their own exemptions. Under the National Market Securities
Improvement Act of 1996, the SEC regulates most national securities
activities.

TRUE-FALSE QUESTIONS

(Answers at the Back of the Book)

1. Generally, if a security does not qualify for an exemption, it must be
registered before it is offered to the public.

2. A nonexempt security must be accompanied by a prospectus to investors.

3 . Securities issued by banks are normally exempt from the SEC registration
requirements.

4. Securities resulting from a corporate reorganization issued for exchange
with the issuer's existing security holders are exempt @ the SEC registration
requirements.

5. The Securities Act of 1933 is concerned primarily with the resale of
securities, and the Securities Exchange Act of 1934 is primarily with
disclosure on the issuance of securities.

6. Rules requiring full and accurate disclosure of all pertinent facts apply
to proxy statements under the Securities Exchange Act of 1934.

7. All states regulate the offer and sale of securities within their
borders.

8. Penalties for, insider trading may include triple the profits gained
or the loss avoided by the guilty party.

9. SEC Rule lOb-5 prohibits the commission of fraud in connection with
the purchase or sale of registered securities only.

10. No security can be resold without registration.