the legal environment of business © 2009 pearson education, inc. publishing as prentice hall ch....

THE LEGAL ENVIRONMENT OF BUSINESS

© 2009 Pearson Education, Inc. publishing as Prentice Hall© 2009 Pearson Education, Inc. publishing as Prentice Hall Ch. 22-Ch. 22-11

The Legal Environment of BusinessThe Legal Environment of Business

A Critical Thinking ApproachA Critical Thinking Approach

55thth Edition Edition

Nancy K. KubasekNancy K. Kubasek

Bartley A. BrennanBartley A. Brennan

M. Neil BrowneM. Neil Browne




CHAPTER 22CHAPTER 22

Rules Governing the Rules Governing the Issuance and Trading of Issuance and Trading of

SecuritiesSecurities



Securities RegulationSecurities Regulation

Definition:Definition: Securities are equity or Securities are equity or debt instruments and are most debt instruments and are most often stocks and bondsoften stocks and bonds

Useful as a means for financing Useful as a means for financing modern corporationsmodern corporations

Problem:Problem: Securities values are easily Securities values are easily manipulated and transactions are manipulated and transactions are subject to fraudsubject to fraud



History of RegulationHistory of Regulation First efforts at the state level proved First efforts at the state level proved

insufficientinsufficient

National economic crisis of 1930sNational economic crisis of 1930s

FederalFederal laws were needed to laws were needed to

Protect integrity of capital marketsProtect integrity of capital markets

Protect investorsProtect investors

Regulate brokers Regulate brokers



The Securities and Exchange The Securities and Exchange CommissionCommissionGoal:Goal: To require full disclosure so that To require full disclosure so that

investors can make informed decisionsinvestors can make informed decisions

Method:Method: Detailed requirements for Detailed requirements for prospectus, registration, time tables for prospectus, registration, time tables for offering, and certain exemptions from the offering, and certain exemptions from the processprocess

Enforcement:Enforcement: Administrative action, Administrative action, injunction, criminal prosecutioninjunction, criminal prosecution



Bear Stearns BailoutBear Stearns Bailout 85 year old investment banking firm was heading 85 year old investment banking firm was heading

for insolvency and planned to file bankruptcyfor insolvency and planned to file bankruptcy Federal regulators Federal regulators

Urged sale of Bear to J.P. MorganUrged sale of Bear to J.P. Morgan Agreed to fundingAgreed to funding

Nationwide credit crunchNationwide credit crunch Response differedResponse differed

InvestorsInvestors EmployeesEmployees Government officialsGovernment officials Political actorsPolitical actors



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

Goal:Goal: To require CEOs and CFOs to certify To require CEOs and CFOs to certify financial reportsfinancial reports

New accounting regulationsNew accounting regulations

Criminal penaltiesCriminal penalties

25 years for fraud25 years for fraud

20 years for tampering with records20 years for tampering with records

Fines up to $5 millionFines up to $5 million



Securities Act of 1933Securities Act of 1933

Purpose:Purpose: full disclosure on new issue of full disclosure on new issue of securities.securities.

Definition of security is very broadDefinition of security is very broad Howey Test for interpreting “security”:Howey Test for interpreting “security”:

Common enterpriseCommon enterprise Reasonable expectation of profitReasonable expectation of profit Profits derived solely from the effort of Profits derived solely from the effort of

othersothers Regulates initial public offeringsRegulates initial public offerings

Regulates initial public offeringsRegulates initial public offerings



All nonexempt securities must be registeredAll nonexempt securities must be registered DisclosureDisclosure SEC does not guarantee the financial SEC does not guarantee the financial

outcomeoutcome Prefiling – no offers or salesPrefiling – no offers or sales Waiting period – oral offers, but no salesWaiting period – oral offers, but no sales

‘‘Red Herring’ Red Herring’ Posteffective period – 20 daysPosteffective period – 20 days CommunicationsCommunications

The Registration ProcessThe Registration Process



Registration: Special situationsRegistration: Special situations Shelf registration – registered but held for Shelf registration – registered but held for

future salesfuture sales

Exemptions from registration:Exemptions from registration: Private placementPrivate placement IntrastateIntrastate Small businessSmall business Noninvestment companiesNoninvestment companies Other exemptionsOther exemptions

Resale restrictionsResale restrictions



Liability, Remedies and DefensesLiability, Remedies and Defenses Private cause of action for victims ofPrivate cause of action for victims of

misrepresentation in registration misrepresentation in registration statement;statement;

failure to register;failure to register; fraud in salefraud in sale

Defenses:Defenses: ‘Due diligence’ ‘Due diligence’ Government remedies:Government remedies:

administrative action; administrative action; letter of deficiency; letter of deficiency; injunction; injunction; criminal penaltiescriminal penalties



The Securities Exchance Act of 1934The Securities Exchance Act of 1934

Goal:Goal: Regulate those who run the industry Regulate those who run the industry

Disclosure: Disclosure: of compensationof compensation

Approach:Approach: Require issuers of securities to Require issuers of securities to register with SEC and the exchangeregister with SEC and the exchange

Covers:Covers: Brokers and dealers Brokers and dealers

Method:Method: Revocation or suspension of Revocation or suspension of license; private or government suitlicense; private or government suit



Securities Investor Protection Act Securities Investor Protection Act (SIPA)(SIPA) Indemnifies customers of insolvent Indemnifies customers of insolvent

brokerage firmbrokerage firm

Collects funds from brokersCollects funds from brokers

Limit of protection: $500,000Limit of protection: $500,000



The Securities MarketsThe Securities Markets Exchanges:Exchanges: NYSE and regional exchanges NYSE and regional exchanges

Over-the-Counter:Over-the-Counter: OTC OTC

Another set of regulations:Another set of regulations: NASD NASD



Proxy SolicitationsProxy Solicitations Fewer than 1 percent of shareholders attend Fewer than 1 percent of shareholders attend

annual meetingannual meeting

Proxies used to elect directors and set Proxies used to elect directors and set policypolicy

Shareholder proposals: shareholder Shareholder proposals: shareholder democracydemocracy

Proxy contests: insurgents v. managementProxy contests: insurgents v. management



Tender Offers and Takeover BidsTender Offers and Takeover Bids Tender offer:Tender offer: offer to buy offer to buy

shares at premiumshares at premium

Regulated by Exchange Act Regulated by Exchange Act Section 13 and 14Section 13 and 14

Hostile bid:Hostile bid: offer is offer is opposed by managementopposed by management



Defenses to Hostile TakeoversDefenses to Hostile Takeovers

Golden Golden parachuteparachute

Poison pillPoison pill

GreenmailGreenmail

PorcupinePorcupine

Treasury shares Treasury shares to friendly partiesto friendly parties

Shark repellantShark repellant

Scorched EarthScorched Earth

White knightWhite knight



Securities FraudSecurities Fraud

Section 10(b): antifraudSection 10(b): antifraud

Insider tradingInsider trading

Misstatement of corporationMisstatement of corporation

MismanagementMismanagement

Fraud-on-the-marketFraud-on-the-market



Insider Trading and Section 10(b) Insider Trading and Section 10(b) of the Securities Actof the Securities Act

Insiders:Insiders: Officers; Officers; directors; partners in directors; partners in brokerages; attorneys; brokerages; attorneys; underwriters and broker-underwriters and broker-dealers; financial reporters; dealers; financial reporters; printersprinters



Misstatements of Corporations and Misstatements of Corporations and Section 10(b)Section 10(b)

Covers:Covers: Statements by corporate Statements by corporate executivesexecutives

““In connection with purchase or In connection with purchase or sale of security”sale of security”

With “With “scienterscienter””



Corporate Mismanagement and Corporate Mismanagement and Section10(b)Section10(b)

Covers:Covers: Purchase or sale of stock Purchase or sale of stock

Fraud alleged byFraud alleged by

Minority shareholders in class action Minority shareholders in class action

or in derivative suitsor in derivative suits

Plaintiff is purchaser or sellerPlaintiff is purchaser or seller



Fraud-on-the-Market TheoryFraud-on-the-Market Theory

Shareholders allege reliance on efficient Shareholders allege reliance on efficient marketmarket

Distorted by fraudulent statements or Distorted by fraudulent statements or omissionsomissions

Causes market price to be set too highCauses market price to be set too high

To detriment of investors and in To detriment of investors and in violation of 10(b)5violation of 10(b)5



Liability and RemediesLiability and Remedies

Criminal penalties:Criminal penalties: SEC and SEC and U.S. Justice Dept. U.S. Justice Dept.

SEC ActionSEC Action

Private actions under 10-5 and Private actions under 10-5 and 10(b)10(b)



Short-Swing ProfitsShort-Swing Profits Coverage:Coverage: Director, officer, 10 percent owner Director, officer, 10 percent owner

Profits made in purchase and sale within 6-Profits made in purchase and sale within 6-month periodmonth period

Presumed to be based on insider informationPresumed to be based on insider information

Remedy:Remedy: Return profits to corporation Return profits to corporation

Standing:Standing: Shareholders, directors, and officers Shareholders, directors, and officers



State Securities LawsState Securities Laws ““Blue Sky” lawsBlue Sky” laws

Regulate securities in Regulate securities in intrastateintrastate commercecommerce

Similar to federal lawsSimilar to federal laws

Uniform Securities ActUniform Securities Act

National Securities Market National Securities Market Improvement ActImprovement Act



E-Commerce and online securitiesE-Commerce and online securities

Internet effectively accelerates tradeInternet effectively accelerates trade

EDGAREDGAR

Cyber fraud a new problemCyber fraud a new problem

Example:Example: “Pump and Dump” “Pump and Dump”



Global DimensionsGlobal Dimensions Foreign Corrupt Practices Act of 1977 (FCPA)Foreign Corrupt Practices Act of 1977 (FCPA)

Makes bribes to foreign officials in order to Makes bribes to foreign officials in order to obtain contractsobtain contracts

Coverage:Coverage: All U.S. citizens, agents, and All U.S. citizens, agents, and accountants doing business worldwideaccountants doing business worldwide

Penalties:Penalties: Fines and imprisonment Fines and imprisonment

Exempt:Exempt: ‘Grease payments’ to low-level ‘Grease payments’ to low-level functionariesfunctionaries



OECD Convention on AntibriberyOECD Convention on Antibribery

Convention signed by 34 countries Convention signed by 34 countries in 1997in 1997

Criminalizes briberyCriminalizes bribery

Eliminates tax deductions for bribesEliminates tax deductions for bribes

Requires disclosureRequires disclosure

Exempt:Exempt: ‘Grease payments’ to low ‘Grease payments’ to low level functionarieslevel functionaries



International Securities Enforcement International Securities Enforcement Cooperation Act of 1990Cooperation Act of 1990 Goal:Goal: Attack money laundering via Swiss banks Attack money laundering via Swiss banks Create procedures for tracing laundered moneyCreate procedures for tracing laundered money International Securities Enforcement International Securities Enforcement

Cooperation Act (ISECA)Cooperation Act (ISECA) Methods:Methods:

Information exchange;Information exchange; protects confidentiality; protects confidentiality; administrative sanctions on violators; administrative sanctions on violators; SEC investigative powers expanded SEC investigative powers expanded

worldwideworldwide



Foreign Securities Sold in U.S.Foreign Securities Sold in U.S. Generally, similar SEC Generally, similar SEC

registration/exemption rules applyregistration/exemption rules apply Special rules:Special rules:

‘‘Public interest’ exemption; Public interest’ exemption; Recognition of information filed in Recognition of information filed in

issuer’s home country; issuer’s home country; NASDAQ requirementsNASDAQ requirements

Regulation SRegulation S



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Copyright © 2009 Pearson Education, Inc. Copyright © 2009 Pearson Education, Inc. Publishing as Prentice HallPublishing as Prentice Hall

the legal environment of business © 2009 pearson education, inc. publishing as prentice hall ch....

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