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Securities Regulation I. The Framework of Securities Regulation A. Securities Transactions i. Issuer Transactions: Transactions involving the sales of securities by the issuer to investors a) Private Placement of Securities
? This is where the issuer sells securities to a select number of investors
? This is the most expedient form of issuer transactions
?????Special exemptions exist under the securities laws to enable private placements to escape the rigors of regulation b) A Public Offering
? This is a "Primary Distribution"
? The selling effort usually occurs through a syndicate of broker-dealers, known as underwriters
?????An offering on behalf of an issuer going public for the first time is called an Initial Public Offering ii. Trading Transactions: The purchasing and selling of outstanding securities among investors. a) Resale may occur either through private negotiation or through public markets b) "Secondary Distribution": This is where the amount of securities to be sold is so great as to support a public offering iii. Securities Markets: The facilities through which the outstanding securities are publicly traded a) The Securities Markets can roughly be divided into:
? (1) Bond Market
? (2) Equity Market
? (3) Derivative/Options Market b) Government Securities are exempt from the disclosure regulations
? Regulation of government securities focuses on those who sell the government securities B. Legal Framework of Securities Regulation (Federal Securities Laws) i. The Securities Act of 1933 (Securities Act/'33 Act) a) Regulates the public offering and sale of securities in interstate commerce b) The Securities Act is all about DISCLOSURE
? "Sunlight is said to be the best of disinfectants: electric light is the most efficient policeman." J. Brandeis
?????The Securities Act's disclosure demands apply to public offerings of securities that occur through the process of "registering" such an offering with the SEC. c) Registration Statements
? Through the preparation of registration statements, the Securities Act seeks to ensure full and fair disclosure in connection with the public distribution of securities.
? The required disclosures are set forth in the SEC regulations and covers all significant aspects of the issuer's business. 1
In General, the registration statement requires:
? A thorough description of the issuers business, property, and management
? Extensive financial information, including certified financial statements for the current and several previous years as well as revenues and earnings for each significant product line
? Management must provide its analysis and review of the issuer's capital needs, solvency, and financial performance, including any analysis of any variances in revenues or profits from the proceeding years (MD & A)
? A detailed description of the rights, privileges, and preferences of the offered security, as well as the existing capital structure of the firm
? "Risk Factors" that make the offering speculative must also be disclosed in the first section of the Registration Statement d) Prospectus
? Most of the registration statement's substantive information is also required to be disclosed in the prospectus.
? The objective of the registration process is the production of a prospectus that includes most of the information disclosed in the Registration Statement.
? The prospectus is designed to provide all material information necessary for investors to fully assess the merits of their purchase of the security. e) The underwriters' selling efforts cannot commence until the registration statement has been filed with the SEC, and no sales or deliveries of securities may occur until the registration statement is effective. f) Once the registration statement becomes effective, actual sales can be made, and the purchased securities can be delivered. g) SS 3 exempts numerous categories of securities from the Securities Act's registration requirements h) SS 4 exempts securities sold in certain types of transactions i) SS 11 provides a private right of action for materially false statements in the registration statement j) SS 12 imposes civil liability upon those who sell securities in violation of SS 5's registration requirements as well as upon anyone who sells any security in a public offering by means of a materially misleading statement k) The SEC's enforcement powers include the power to issue cease-and-desist orders under SS 8A and to prosecute violations civilly in the federal court under SS 20. ii. The Securities Exchange Act of 1934 (Exchange Act/'34 Act) a) SS 4 created the SEC. b) The Exchange Act's concern is trading markets and their participants. c) The Act contains a system of continuous disclosure for companies required to register under its provisions
? Three categories of companies are subject to continuous disclosure requirements. ANY COMPANY THAT MEETS (1), (2), or (3) = "Reporting Company":
? (1) Companies that have a class of securities listed on a national securities exchange. SS 12(b).
? (2) Companies that have assets in excess of $10 million and that have a class of equity securities held by at least 2,000 persons. SS 12(g) and Rule 12g-1. 2
The JOBS Act amended the Exchange Act here such that the requirement here was changed from 500 to 2,000 record shareholders.
?????(3) Companies that have filed a '33 Act registration statement that has become effective. SS 15(d). Reporting Companies are required to register with the SEC and thereafter make timely filings of reports required by SS 13 of the '34 Act
? Unlike with respect to the '33 Act disclosures, there is no requirement here that disclosures be forwarded to investors or market professionals
? All registrants are required to file their '33 Act registration statements and their periodic reports in electronic format
?????The present system is EDGAR (Electronic Data Gathering, Analysis, and Retrieval System Reports required by the '34 Act for Reporting Companies (SS 13)
? Form 10-K (Annual Report)
? An extensive description of the company's business, audited financial statements for the fiscal year, and MD & A
? Form 10-Q (Quarterly Report)
? Unaudited interim financial statements for the company as well as Management's analysis of financial operations and conditions
? Form 8-K
? Must be filed within a few days of the occurrence of a material development of the type specified in the form
? Change in control
? Credit downgrade
? Acquisition or disposition of a significant amount of assets
? Commencement of insolvency proceedings
? Change in auditors
?????Resignation of a director in a dispute over policy Integrated Disclosure
? Certain companies registering securities under the '33 Act can fulfill many of the '33 Act's disclosure demands by incorporating into the '33 Act registration statement information from their '34 Act filings.
? Under integrated disclosure, issuers are required to file a registration statement with the SEC in advance of their offering and for most issuers there is a period of delay before issuers can sell the registered securities. The '34 Act also requires companies that are subject to the continuous disclosure requirements under SS 12(b) or SS 12(g) [(1) of (2) above] to make full and fair disclosure of whenever soliciting their stockholders' proxies and to otherwise comply with the numerous proxy rules the commission has promulgated under SS
14(a). Through the Williams Act, the '34 Act was amended such that disclosure by an outsider is required where more than 5% of a class of registered equity securities is or will be owned as a result of a tender offer or purchase. 3
iii. The Sarbanes-Oxley Act of 2002 (SOX) a) The Act sets forth broad prescriptions for corporate governance, authorizes the SEC to develop rules for professional conduct for lawyers, and regulates areas that have always been the province of the states, such as loans to officers and directors. b) SOX does not alter the core functioning of the securities laws, but the Act introduces important procedural and substantive requirements for public companies as additional safeguards to protect investors. c) SOX made various amendments to the '33 Act and the '34 Act iv. Dodd-Frank Act a) Dodd-Frank made various amendments to the '33 Act and the '34 Act v. JOBS Act a) The JOBS Act made various amendments to the '33 Act and the '34 Act vi. Regulation of Investment Advisors and Investment Companies a) The Investment Company Act of 1940
? Regulates investment companies (e.g. money market funds, mutual funds)
? "Investment Companies" are companies formed for the purpose of buying, selling, and holding a portfolio of securities for investment rather than for control. b) The Investment Advisers Act of 1940
? Regulates Investment Advisors
? An "Investment Advisor" is one engaged in the business of rendering investment advice to others for compensation. vii. The SEC a) Organizational Structure
? Five Commissioners appointed by the President for five-year terms
? One Commissioner is designated by the President to be the Chairman
? Four Principle Divisions:
? (1) Division of Corporate Finance
? (2) Division of Trading and Markets
? (3) Division of Investment Management
? (4) Enforcement Division viii. Sources of Securities Law a) (1) Statutes b) (2) SEC Regulations
? E.g. Rule 144 under the '33 Act, Rule 10b-5 under the '34 Act c) (3) Forms d) (4) SEC Releases
? Proposing Release
? Proposes a new rule
? Adopting Release
? Issuing final rule and discusses changes made from proposed rule
? Helps practitioners to know what the SEC is trying to do e) (5) SEC No-Action Letters
? A company says to the SEC, we propose to do X, and we believe it to be in 4
compliance with the law
? If the SEC staff agrees that it would be in compliance with the law, the staff will issue a "no-action letter" stating that the staff "will recommend to no action to the Commission."
? BUT no-action letter are not binding on the SEC
? No-Action Letters DO NOT represent the official view of the Commission. 17 C.F.R. SS 201(d).
? ALSO no-action letters are not binding on private parties who can challenge the transaction. f) (6) Interps
? Telephone request for guidance from SEC
? Written up in Interpretation manual
? Manual is available on the SEC's website g) Amicus Briefs
? Positions taken in such briefs are typically approved by the Commission before the position is taken. h) SEC Staff/Member Speeches
??? ?Followed closely by the Securities Bar II. Securities Markets A. Markets and Investors i. The Structure of the Trading Markets a) Securities not listed on an exchange are a part of the over-the-counter market b) Exchanges
? Can be either National or Regional
? National: NYSE is the largest U.S. equity market followed by the Nasdaq
? BUT approximately 60% of the orders for NYSE stocks are executed on regional exchanges or Electronic Communications Networks (ECNs) of which are outside of the exchange
? Regional: There are six regional exchanges
?????Exchanges are Self-Regulated c) Over-the-Counter Market
? Securities not listed on an exchange are referred to as over-the-counter securities
? The core of the over-the-counter market is the "market-maker"
? A broker who does not own the security the investor requests can purchase the security from a market-maker
? The market-maker is an individual who maintains an inventory in the traded security
? FINRA operates an electronic filing bulletin board (the OTCBB) for non-Nasdaq over-the-counter stocks
? Price quotes are available
?????Where a stock is not listed on the OTCBB, the stock is traded in a paper-base market called the "Pink Sheet Market" d) How Exchanges Function (The Order Process)
?????Market Order: Where the customer instructs his broker to purchase or sell a 5
security at the best available market price OR
? Limit Order: Where the customer instructs his broker to purchase the security at a particular price.
? The broker will first try to match the order with that of another customer in the firm
? If not, the order will be routed to a Floor Broker who represents buyers and sellers in the crowd.
? If the Floor Broker cannot fulfill the order, he will invoke the services of a Specialist, who can trade for his own account
? The Specialist intervenes in order to smooth imbalances between the supply and demand for a particular security.
? The NYSE rules require specialists to address short-term imbalances between buy and sell orders by using their own capital or inventory to fill gaps that might arise.
? An alternative function of the Specialist is to maintain a limit order book in which unfulfilled orders are recorded and later filled by the specialist as market conditions permit.
? Specialists make their money because of the spread between the buy price and the selling price
?????BUT Today, much of the matching of buyers and sellers is done by computers e) Block Trading: Trades of 10,000 or more shares customarily occurring directly between institutional investors without the use of brokers f) Bond Markets
? Bond markets are almost totally dealer markets.
? Bond dealers are linked by computers, and most of the liquidity of the bond markets is provided by a few of the trading desks of large investment banking firms.
? Bond markets are almost exclusively an institutional investor medium. ii. Globalization a) There is a major trend towards the globalization of securities markets iii. Institutionalization a) Fifty years ago, individuals held 90% of U.S. equities. b) As of 2005, institutional investors held 61.2% of total U.S. equities iv. Derivative Markets a) Derivative: A financial instrument whose value depends on the price of some underlying instrument b) Types of Derivatives:
?????Stock Options: Rights to buy or sell securities from or to another at some predetermined price and date
?????Call Options: The right to buy
?????Put Options: The right to sell
? Futures: Contracts that call for future delivery of some commodity at a fixed price and date
? BUT Financial Futures 6
Created to protect against and bet on market price movement of currency and "baskets" of securities
? Settlements of financial futures are in cash, rather than actual delivery of the underlying commodity
? E.g. Index Futures: One can buy or sell an index (e.g. S & P 500) for "delivery" at some future date.
?????Exclusive jurisdiction over futures is given to the Commodities Futures Trading Commission (CFTC)
? Credit-Default Swaps
? Most derivatives are over-the-counter derivates and thus not subject to government regulation B. The Efficient Market Hypothesis i. Three different forms of the Efficient Market Hypothesis: a) (1) Strong Form
?????The strong form of market efficiency occurs when security prices reflect all information, whether that information is publicly available or not. b) (2) Semi-String Form
? The semi-strong form of market efficiency exists if security prices reflect all publicly available information.
?????The true fight today is whether securities markets are efficient in the semi-strong form. c) (3) Weak Form
? The weak form exists when security prices reflect all the information embodied in the past prices of the security.
? If securities markets are efficient in the weak form, then investors cannot extrapolate a security's future price from a series of past prices.
?????A stock's future price cannot be extrapolated from only its past price changes ii. Fundamental Efficiency a) Efficiency in the sense that not only do investors process information quickly but also that their trading prices reflect accurate estimates of a security's intrinsic value iii. Informational Efficiency vs. Allocational Efficiency a) There are really two distinct aspect of market efficiency
?????Informational Efficiency: The speed with which market prices adjust to new information
? Allocational Efficiency: Concerns the allocation of resources to their best or highest use iv. Whether the market for a particular security is deemed to be an efficient one a) FACTORS (Cammer v. Bloom):
? (1) Percentage of shares traded weekly
? (2) Analysts following
? (3) Presence of market makers and arbitrageurs
? (4) Eligibility to take advantage of the SEC's integrated disclosure procedures pursuant to Form S-3 for engaging in public offerings AND
??? ?(5) Responsiveness of security's price to new information 7
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