Describe e-securities transactions and public offerings.
CHAPTER 17 Investor Protection and E-Securities Transactions
New York Stock Exchange
This is the home of the New York Stock Exchange (NYSE) in New York City. The NYSE, nicknamed the Big Board, is the premier stock exchange in the world. It lists the stocks and securities of approximately 3,000 of the world’s largest companies for trading. The origin of the NYSE dates to 1792, when several stockbrokers met under a buttonwood tree on Wall Street. The NYSE is located at 11 Wall Street, which has been designated a National Historic Landmark. The NYSE is now operated by NYSE Euronext, which was formed when the NYSE merged with the fully electronic stock exchange Euronext.
After studying this chapter, you should be able to:
1. Describe the procedure for going public and how securities are registered with the Securities and Exchange Commission (SEC).
2. Describe e-securities transactions and public offerings.
3. Describe the requirements for qualifying for private placement, intrastate, and small offering exemptions from registration.
4. Describe insider trading that violates Section 10(b) of the Securities Exchange Act of 1934.
5. Describe the changes made to securities law by the Jumpstart Our Business Startups (JOBS) Act and its effect on raising capital by small businesses.
1. Introduction to Investor Protection and E-Securities Transactions
2. Securities Law
1. LANDMARK LAW • Federal Securities Laws
3. Definition of Security
4. Initial Public Offering: Securities Act of 1933
1. BUSINESS ENVIRONMENT • Facebook’s Initial Public Offering
2. CONTEMPORARY ENVIRONMENT • Jumpstart Our Business Startups (JOBS) Act: Emerging Growth Company
5. E-Securities Transactions
1. DIGITAL LAW • Crowdfunding and Funding Portals
6. Exempt Securities
7. Exempt Transactions
8. Trading in Securities: Securities Exchange Act of 1934
9. Insider Trading
1. Case 17.1 • United States v. Bhagat
2. Case 17.2 • United States v. Kluger
3. ETHICS • Stop Trading on Congressional Knowledge Act
10. Short-Swing Profits
11. State “Blue-Sky” Laws
“The insiders here were not trading on an equal footing with the outside investors.”
—Judge Waterman Securities and Exchange Commission v. Texas Gulf Sulphur Company 401 F.2d 833, 1968 U.S. App. Lexis 5796 (1968)
Introduction to Investor Protection and E-Securities Transactions
Prior to the 1920s and 1930s, the securities markets in this country were not regulated by the federal government. Securities were issued and sold to investors with little, if any, disclosure. Fraud in these transactions was common. To respond to this lack of regulation, in the early 1930s Congress enacted federal securities statutes to regulate the securities markets, including the Securities Act of 1933 and the Securities Exchange Act of 1934. The federal securities statutes were designed to require disclosure of information to investors, provide for the regulation of securities issues and trading, and prevent fraud. Today, many securities are issued over the Internet. These e-securities transactions are subject to federal regulation.
Visit the website of the New York Stock Exchange at www.nyse.com .Click on “About Us” and click on “Overview.” Read the description of NYS Euronext.
In 2012, Congress enacted the Jumpstart Our Business Startups (JOBS) Act, to make it easier for smaller businesses to raise capital, and the Stop Trading on Congressional Knowledge (STOCK) Act, to prohibit insider trading by government employees.
This chapter discusses federal securities laws, e-securities transactions, investor protection, ethics, and securities reform.
The federal and state governments have enacted statutes that regulate the issuance and trading of securities. These are referred to collectively as securities law . The primary purpose of these acts is to promote full disclosure to investors and to prevent fraud in the issuance and trading of securities. These federal and state statutes are enforced by federal and state regulatory authorities, respectively. The following feature discusses major federal securities statutes.
Landmark Law Federal Securities Laws
Following the stock market crash of 1929, Congress enacted a series of statutes designed to regulate securities markets. These federal securities statutes are designed to require disclosure to investors and prevent securities fraud. The two primary securities statutes enacted by the federal government, both of which were enacted during the Great Depression years, are:
· Securities act of 1933. The Securities Act of 1933 is a federal statute that regulates primarily the issuance of securities by companies and other businesses. 1 This act applies to original issue of securities, both initial public offerings (IPOs) by new public companies and sales of new securities by existing companies. The primary purpose of this act is to require full and honest disclosure of information to investors at the time of the issuance of the securities. The act also prohibits fraud during the sale of issued securities. Securities are now issued online, and the 1933 act regulates the issue of securities online.
· Securities exchange act of 1934. The Securities Exchange Act of 1934 is a federal statute designed primarily to prevent fraud in the subsequent trading of securities. 2 This act has been applied to prohibit insider trading and other frauds in the purchase and sale of securities in the after markets, such as trading on securities exchanges and other purchases and sales of securities. The act also requires continuous reporting—annual reports, quarterly reports, and other reports—to investors and the Securities and Exchange Commission (SEC). Securities are now sold online and on electronic stock exchanges. The 1934 act regulates the purchase and sale of securities online.
These acts have been amended over the years. Additional federal statutes that promote investor protection and regulate securities issuance and trading are the Jumpstart Our Business Startups (JOBS) Act and the Stop Trading on Congressional Knowledge (STOCK) Act.
Securities and Exchange Commission
The Securities Exchange Act of 1934 created the Securities and Exchange Commission (SEC) , a federal administrative agency that is empowered to administer federal securities law. The SEC is an agency composed of five members who are appointed by the president. The major responsibilities of the SEC are:
Securities and Exchange Commission (SEC)
The 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.
Go to the website of the Securities and Exchange Commission, at www.sec.gov . Click on “What We Do” and read the introduction.
· Adopting rules (also called regulations) that further the purpose of the federal securities statutes. These rules have the force of law.
· Investigating alleged securities violations and bringing enforcement actions against suspected violators. These enforcement actions may include recommendations of criminal prosecution. Criminal prosecutions of violations of federal securities laws are brought by the U.S. Department of Justice.
· Bringing a civil action to recover monetary damages from violators of securities laws. A whistleblower bounty program allows a person who provides information that leads to a successful SEC action in which more than $1 million is recovered to receive 10 percent to 30 percent of the money collected.
· Regulating the activities of securities brokers and advisors. This includes registering brokers and advisors and taking enforcement action against those who violate securities laws.
Definition of Security
Congress has enacted the Securities Act of 1933, the Securities Exchange Act of 1934, and several other securities statutes to regulate the issuance and sale of securities. For these federal statutes to apply, however, a securitymust first be found. Federal securities laws define securities as:
(1) An interest or instrument that is common stock, preferred stock, a bond, a debenture, or a warrant; (2) an interest or instrument that is expressly mentioned in securities acts; or (3) an investment contract.
· Common securities. Interests or instruments that are commonly known as securities are common securities .
Common stock, preferred stock, bonds, debentures, and warrants are common securities.
· Statutorily defined securities. Interests or instruments that are expressly mentioned in securities acts are statutorily defined securities .
The securities acts specifically define preorganization subscription agreements; interests in oil, gas, and mineral rights; and deposit receipts for foreign securities as securities.
· Investment contracts. A statutory term that permits courts to define investment contracts as securities. The courts apply the Howey test 3 to determine whether an arrangement is an investment contract and therefore a security. Under this test, an arrangement is considered an investment contract if there is an investment of money by an investor in a common enterprise and the investor expects to make profits based on the sole or substantial efforts of the promoter or others.
A limited partnership interest is an investment contract because the limited partner expects to make money based on the effort of the general partners. Pyramid schemes where persons give money to a promoter who promises them a high rate of return on their investment is an investment contract because the investors expect to make money from the efforts of the promoter.
A flexible standard for defining a security.
A test stating that an arrangement is an investment contract if there is an investment of money by an investor in a common enterprise and the investor expects to make profits based on the sole or substantial efforts of the promoter or others.
Mutual funds sell shares to the public, make investments in stocks and bonds for the long term, and are restricted from investing in risky investments. Because mutual funds are sold to the public, they must be registered with the SEC.
CONCEPT SUMMARY Definition of Security
|Type of Security||Definition|
|Common securities||Interests or instruments that are commonly known as securities, such as common stock, preferred stock, debentures, and warrants.|
|Statutorily defined securities||Interests and instruments that are expressly mentioned in securities acts as being securities, such as interests in oil, gas, and mineral rights.|
|Investment contracts||A flexible standard for defining a security. Under the Howey test, a security exists if an investor invests money in a common enterprise and expects to make a profit from the significant efforts of others.|
Initial Public Offering: Securities Act of 1933
The Securities Act of 1933 regulates primarily the issuance of securities by corporations, limited partnerships, and companies. Section 5 of the Securities Act of 1933 requires securities offered to the public through the use of the mails or any facility of interstate commerce to be registered with the SEC by means of a registration statement and an accompanying prospectus.
Securities Act of 1933
A federal statute that regulates primarily the issuance of securities by corporations, limited partnerships, and associations.
Section 5 of the Securities Act of 1933
A section that requires an issuer to register its securities with the SEC prior to selling them to the public.
A business or party selling securities to the public is called an issuer . An issuer may be a new company (e.g., Facebook) that is selling securities to the public for the first time. This is referred to as going public . Or the issuer may be an established company (e.g., General Motors Corporation) that sells a new security to the public. The issuance of securities by an issuer is called an initial public offering (IPO) .
initial public offering (IPO)
The sale of securities by an issuer to the public.
Many issuers of securities employ investment bankers , which are independent securities companies, to sell their securities to the public. Issuers pay a fee to investment bankers for this service.
A company that is issuing securities to the public must file a written registration statement with the SEC. The general form for registering with the SEC is called Form S-1 . The issuer’s lawyer normally prepares the S-1 filing registration statement with the help of the issuer’s managers, accountants, underwriters, and other professionals. The registration statement is filed electronically with the SEC.
A document that an issuer of securities files with the SEC and that contains required information about the issuer, the securities to be issued, and other relevant information.
A registration statement must contain descriptions of (1) the securities being offered for sale; (2) the registrant’s business; (3) the management of the registrant, including compensation, stock options and benefits, and material transactions with the registrant; (4) pending litigation; (5) how the proceeds from the offering will be used; (6) government regulation; (7) the degree of competition in the industry; and (8) any special risk factors. In addition, a registration statement must be accompanied by financial statements certified by certified public accountants.
Registration statements usually become effective 20 business days after they are filed unless the SEC requires additional information to be disclosed. A new 20-day period begins each time a registration statement is amended. At the registrant’s request, the SEC may accelerate the effective date (i.e., not require the registrant to wait 20 days after the last amendment is filed). The date that the registration becomes effective is called the effective date .
The SEC does not pass judgment on the merits of the securities offered. It decides only whether the issuer has met the disclosure requirements.
A preliminary prospectus is a written disclosure document that must be submitted to the SEC along with the registration statement. A prospectus contains much of the information included in the registration statement. This preliminary prospectus is used as a selling tool by the issuer. It is provided to prospective investors to enable them to evaluate the financial risk of an investment. The issuer must make a final prospectus (which includes the final price of the securities and any amendments required by the SEC) available to purchasers before or at the time of purchase. The issuer can make the final prospectus available on a website.
A written disclosure document that must be submitted to the SEC along with the registration statement and given to prospective purchasers of the securities.
Go to the New York Stock Exchange website, at www.nyse.com/about/listed/IPO_Index.html ,to view the “IPO Showcase” list of the most recent IPOs. What is the most recent listing? Click on the company’s name and read the brief history of the company.
A prospectus must contain the following language in capital letters and bold (usually red) type:
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
The following feature discusses the initial public offering of Facebook, Inc.
Business Environment Facebook’s Initial Public Offering
Facebook is a social networking service that was launched in 2004. Facebook has more than 1 billion users worldwide who post billions of comments and hundreds of millions of photographs daily using the Facebook network.
Facebook originally sold stock to several personal and institutional investors, but the company remained a privately held company for eight years. In 2012, Facebook, Inc., went public by issuing shares in an initial public offering (IPO). In the IPO, 421,233,615 shares of Facebook, Inc., were sold to th
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