Transcript economics.uta.edu

• Debt
• When bonds are sold, there is often
an issue of a certain amount
• Bonds usually traded on securities
market, so are securities
• Debt financing may also occur by
borrowing money from large
lenders (banks, insurance
companies)
• Instrument usually specifies:
– amount of debt
– length of period
– repayment method
– rate of interest charged
• Handled by professionals who earn
commissions
• Equity
• Equity financing is raising
funds through sale of
company stock
• Sale of company stock to
purchasers (shareholders)
• Shareholders have claim
to future profits of
company
• Company is not obligated
to repay shareholders
• Can usually be traded
Securities Regulation
• States began with blue sky laws to
deter fraudulent securities sales
• Most important Federal laws are:
– Securities Act of 1933
• regulates initial public offerings of securities
– Securities Exchange Act of 1934
• regulates trading in existing securities,
disclosure requirements, securities markets
and professionals
• Securities and Exchange Commission
– agency responsible for enforcement and
administration of federal securities laws
What Is A Security?
• Merely calling it a security
does not make it so
• Have higher legal
protection for securities
• Four basic elements
(Howey test):
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investment of money
in a common enterprise
with an expectation of profits
generated by efforts of
persons other than the
investors
Securities Exempt from
Regulation
• Issued or guaranteed by
government
– Federal, state or local
• Issued by banks
• Issued by religious and
charitable organizations
• Insurance policies
• Annuity contracts
Offering Securities to Investors
• ‘33 Act requires full disclosure of all
material information on security, issuers,
and intended use of money before sale to
public.
• Material information is all relevant
information an investor would want to
know:
– background
– executives
– plan of operation
Registration Statement
• Prospectus (SEC Schedule A)
• Provides material information
about:
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issuer’s finances and business
purpose of the offering
plans for funds collected
risks involved
promoter’s managerial
experience and financial
compensation
– financial statements certified by
independent public accountants
•
Registration
Regulation S-K
– more detailed disclosure Statement
than in prospectus
– used by investment analysts
– available for public
inspection
• Review by SEC
– doesn’t rule on merits
(likelihood of success)
– can require issuers to
indicate high-risk factors to
buyers
– registration effective 20 days
after filing, but SEC can
issue deficiency letter and
issuer will need time to
amend the filing
– can issue stop order to
prevent sale until examiners
are happy
• Costs of
Registration
– Expensive!
– Need securities
attorney, CPA,
printer, underwriter,
etc.
– Need to hire an
underwriter (i.e.
investment banker)
Exemptions From Registration
• Some securities, subject to securities laws, are exempt
from registration requirements:
– New JOBS law.
– Private Placements
• not offered to the public
• usually placed w/institutional investors (pension
plans or insurance companies)
• Regulation D specifies what will qualify as a private
placement exemption
– Made to accredited investors – presumed sophisticated
and wealthy – complex rules
– Common Reg. D offerings are called Small Corporate
Offering Registration (SCOR)
• Rule 144A sale of bonds or stocks to qualified
institutional buyers (QIBs) investors w/portfolio of at
least $100M
Well-Known Seasoned Issuers
(WKSIs)
• Securities issued by WKSIs.
• Issuers that have issued at least $1 billion
in securities previously OR
• Have public-equity market capitalization of
at least $700 million
• Includes most well-known securities firms
• They can file registration statements the
day new offering is announced rather than
submitting for SEC staff review
beforehand
• Can continuously update information –
even on Website
• Securities are under shelf registration –
once announced and registered, they may
be sold at any time over next 3 years.
Regulation of
Securities Trading
• If registered under ‘33
Act, must register
under ‘34 Act; if
exempt under ‘33 Act,
must register if traded
on an exchange or
over the counter
(OTC) and has >$5M
assets and 500+
shareholders
• Publicly held company
– publicly traded stock
– most traded OTC
– must file 10-K annual
report
• Privately held
– less than 500
shareholders
– not openly traded
Proxies and Tender Offers
• Regulation FD (Fair Disclosure) in 2002 tried to create
a “level playing field,” requiring public companies to
release information to the public rather than selective
revealing of information
• Proxies
– Permission by shareholders given to someone else
to vote their shares in the manner they instruct
• Tender Offers
– When one company attempts to take over another
– Target company’s stock owners are offered stock
in the acquiring company or cash in exchange for
their stock
Securities Fraud
• Rule 10b-5
• Investors often have • Basis for Securities
trouble proving
Fraud; used more than
other Act sections
common-law fraud
• Unlawful to:
• Usually rely on
– employ device, scheme to
antifraud provisions
defraud
of ‘33 and ‘34 Act for
– make untrue statement of
statutory fraud
material fact
• ‘33 Act: misleading
– engage in act or practice
statements or
which operates a fraud in
material omissions
connection with
purchase/sale of security
Liability For Securities Law
Violations
• Can sue parties who prepared
disclosure docs or other impt. info
about securities
• Can also sue:
– directors of company, CEO, CFO and
accounting officers, accountants,
lawyers
• SEC may also act against them
with civil penalties and criminal
charges
• Have liability for misstatements or
omissions about financial status of
business with publicly traded
securities
Safe Harbor and
Federal Exclusivity
• Safe Harbor
– Securities Litigation Reform Act
of 1995
– Allows companies to predict
profits and their likely success
as long as forecasts are
accompanied by “meaningful
cautionary statements” that ID
“important factors that could
cause actual results to differ
materially from those in the
forward-looking statement.”
– Gives immunity from liability
• Federal Exclusivity
– Securities Litigation
Uniform Standards
Act of 1998
– Requires securities
suits that involve
nationally traded
securities to be
brought “exclusively”
in federal court under
federal law.
Slayton v. American
Express Company
• A group of investors bought American Express (AE) stock
between 1999 and 2001 .
• Sued the company & executives for securities fraud for
misleading investors.
• Contended that AE over-invested in high-yield debt (junk bonds)
– Resulting in loss of hundreds of millions of dollars in 2000 and 2001.
• Investors’ claim was largely based on 10Q report AE filed with
SEC in May 2001 .
– Report stated that while it lost $182 million from its high-yield debt
investment in the 1st Quarter of 2001, future losses expected lower.
• Company later realized that losses were larger than report said
• In July AE announced a further $826 million loss due to writedowns of the junk bonds.
– Caused AE stock to fall.
(Continued)
Slayton v. American Express
Company, cont.
• Plaintiffs claimed May filing was misleading and AE knew or should
have known that losses were worse than reported.
• District court dismissed complaint; investors appealed.
• HELD: Affirmed. American Express wins.
• Not liable under Private Securities Litigation Reform Act IF
– False or misleading statement is “identified as a forward-looking
statement” and has precautionary statement re: important factors that
could cause result to be different.
• Form 10-Q warned that forward-looking statement were “subject to
risks and uncertainties”.
• AE used words like “believe”, “expect”, “anticipate”, “aim”, etc.
• Plaintiffs claim that “forward-Looking Statement” should be
specifically marked that labeled as “forward-looking”.
• SEC disagreed. Statements such as “we expect” and we believe”
designate statement as forward-looking. Don’t need separate
section. Nor does statute say must be a separate section labeled
“forward-looking”.
Sarbanes-Oxley Act
(SOX) Requirements
– CEO and CFO of companies with publicly
traded stock must personally certify that
financial reports comply with SEC rules.
– Knowing misstatements have criminal fines
and imprisonment.
– Protection also for corporate whistleblowers.
– Established Public Company Accounting
Oversight Board to discipline CPAs for
misconduct & also sets accounting standards.
– Sarbanes-Oxley has forced firms to
standardize procedures and accounting.
Insider Trading
• Most controversial application of 10b-5 is
prohibiting insider trading
• Insiders have access to info not available
to public
• May be liable to SEC for profits from such
transactions
• See “London, New York and Sarbanes
Oxley Act. Compares U.S. & European
nations re: impact of Sarbanes-Oxley Act.
U.S. competitive position impacted more
negatively than London. Firms often
choose London’s stock exchange and
junior market over New York.
Insider Trading
Sanctions Act of 1984
• Gives SEC a statutory basis for prosecuting
insider trading.
• The law was strengthened by the Insider
Trading and Securities Fraud Enforcement
Act.
– Increased the maximum fine to $1 million per
action and set maximum prison term to 10 years
per violation. Corporate fines were raised to $2.5
million /violation.
• See Issue Spotter: “Can You Exploit the Gossip?”
Investment Company Act
• Primarily in the business of investing or trading securities
• Three types of Investment Companies
– face-amount certificate companies – issue debt securities paying
fixed rate of return
– unit investment trusts – offer fixed portfolio of securities
– management companies – most important type
• open-end company known as a mutual fund
– no specific number of shares, expand as long as new
investments
– invested in portfolio of securities
• two kinds of mutual funds: load and no-load
– load: sold through securities dealer; have commissions
(load) of some % of price
– no-load: Sold directly to public through mail or Internet; no
sales commissions
Investment Advisers Act
(IAA) Regulates Securities
Professionals
• Must be registered
with
SEC
– effecting transactions
• Can’t churn
for the account of
• Brokers
others
• Dealers
– buying and selling
securities for own
account
• Advisers
– charging fees for
investment advice
– excessive buying and
selling of client’s
account to get
commissions
• Can’t scalp
– buy stocks for
personal benefit then
urge clients to buy so
price goes up
Stock Market Regulation
• New York Stock Exchange and other exchanges
governed by the Financial Industry Regulatory
Authority (FINRA)
– An independent regulatory authority that sets
rules of behavior for its traders
– Handles most disputes
– Helps oversee brokerage firms and employees
• Self-Regulation of Securities Markets
– SEC has power to monitor
– Includes stock exchanges such as NYSE, AMEX,
NASDAQ
• Regulation of Securities Transactions
– Regulates actions of securities
professionals who do actual trading
– Professionals can’t trade for their own benefit
ahead of customers
Penalties Include Suspension or Expulsion
Arbitration of Disputes
• Usually investors with
investment firms sign a
standard form indicating
disputes must be
arbitrated, not litigated.
• SEC rules govern the
arbitration process.
• The Supreme Court
upholds the binding
nature of arbitration
agreements.
The Consumer Financial
Protection Bureau
• 2010 Dodd-Frank Act
• Established new agency: Consumer Financial Protection Bureau
(CFPB) within the Federal Reserve
• Still “getting up to speed”
• Attorneys-general have authority to enforce Bureau rules
• Instructions from Congress to the CFPB
– Crack down on financial scams/gimmicks aimed at ordinary consumers
and debtors
– Ensure terms of financial documents are transparent & can be
understood by a reasonable consumer
– Focus on practice of non-bank institutes, i.e. payday lenders, that seem
unfair
– Look at existing rules i.e. those of the Equal Credit Opportunity Act, and
make sure rules are not in conflict with each other
Dodd-Frank Wall Street Reform
and Consumer Protection Act
• Dodd-Frank Wall Street Reform Act (2010).
• Established new regulatory authority in consumer credit area.
• Focuses on financial markets and oversight in large-scale
financial problems.
• Regulators oversee general market conditions – prepared to act
in case of crisis.
• Oversight of “systemic risk” – market-wide problem.
• Example: Financial meltdown in 2007-08 by the Financial
Stability Oversight Council.
• Regulators can intervene in financial institution in case of
trouble.
• Trading of derivatives also open to greater regulatory
oversight.
• Greater desire for transparency.
Latta v. Rainey
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From 2001 through 2004, Mobile Billboards of America (MBA) sold mobile
billboard “investments” in U.S.
Investors given “offering circular” claimed to comply with federal and state
regulations.
Each billboard unit was $20,000.
Owner leased the unit for 7 years to Outdoor Media Industries (OMI), a shell
company owned/operated by MBA’s principals.
Investors would receive average return of 13.49%/year.
After 7 years, MBA would buy back the billboards & return investment.
MBA claimed it had a Reserve Guaranty Trust (RGT) – $5,000 of each $20,000
would be placed in RGT.
Investors received a certificate to receive share of money earned by funds
invested in RGT, plus the right to the $20,000 investment.
Latta, terminally ill, wanted a secure investment.
Rainey, “Certified Senior Advisor” with MBA (of North Caroline) said
Billboards was a “safe company – “absolutely no risk”.
Latta invested $100,000.
(Continued)
Latta v. Rainey, cont.
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Rainey received a commission of 16-20%. Lattas received “lease payments”
from OMI the first year. This was classic Ponzi scheme.
Secretary of State of North Carolina, investigated.
MBA ordered to cease and desist from sales.
Rainey collected Latta’s final investment.
Latta and others sued.
Rainey filed for bankruptcy; Mr. Latta died.
Trail court Held MBA billboard sales were unregistered securities – violation
of federal and state law.
Also breach of fiduciary duty by Rainey to Latta, fraudulent concealment,
securities fraud and conversion.
Jury awarded Mrs. Latta $95,503.40, plus $750,000 punitive damages. Court
reduced punitive damages to $286,510. Rainey appealed.
HELD: Affirmed.
Elements of fraud:
– 1) False Representation or Omission of Material Fact
– 2) Intent to Deceive
– 3) Reasonable Reliance (by Lattas)
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All elements were present here