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PowerPoint Slides to Accompany
ESSENTIALS OF BUSINESS AND
ONLINE COMMERCE LAW
1st Edition
by Henry R. Cheeseman
Chapter 18
Investor Protection and Online
Securities Transactions
Slides developed by
Les Wiletzky
Copyright © 2006 by Pearson Prentice-Hall. All rights reserved
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.
Copyright © 2006 by Pearson Prentice-Hall. All rights reserved.
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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
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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
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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
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Registration Statement

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

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
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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
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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
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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
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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
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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
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Private and Other Transactions Exempt
from Registration (2 of 2)
Exempt transactions:
1. Intrastate offering exemption
2. Private placement exemption
3. Small offering exemption
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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
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Securities Exempt From Registration
With the SEC (1 of 2)

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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
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Securities Exempt From Registration
With the SEC (2 of 2)


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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
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Violations of the Securities Act of 1933
(1 of 2)

SEC Actions

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
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
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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
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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
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The Securities Exchange Act of 1934:
Trading in Securities


Federal statute that primarily regulates the
trading in securities
It provides for the regulation of
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Securities exchanges
Brokers
Dealers
Contains provisions that assess civil and
criminal liability on violators of the act
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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)
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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
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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
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Insider Trading

One of the most important purposes of
Section 10(b) and Rule 10b-5 is to prevent
insider trading:
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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
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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
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Tipper – Tippee Liability
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Tipper
A person who discloses nonpublic information to another
person
Liable for the profits made
by the tippee


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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
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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
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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
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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
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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
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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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