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Chapter 16

Regulation of
and Financial

McGraw-Hill/Irwin Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.
The Securities Act of 1933


 The Securities Act of 1933 covers the

process of issuing or reissuing securities to
the public. The law requires registration and
certain disclosures and authorizes the SEC to
oversee the transactions.

Howey Test

 Investment

 Commonality

 Profit Expectations

 Efforts of Others

Securities that are Exempt

 Commercial paper (such as promissory notes that

are purchased by investment banks) with a maturity
date of less than nine months.
 Securities of charitable organizations.
 Annuities and other issues of insurance companies.
 Government-issued securities; municipal bonds.
 Securities issued by banks and other institutions
subject to government supervision.

Liability for Violations

 The ’33 Act imposes both civil and criminal

penalties on those offerors and sellers of
securities who violate the act’s provisions.

 (1) rescission of the investment,

 (2) civil penalties and fines, and
 (3) incarceration for egregious cases.

The Securities Act of 1934

 Regulates the sale of securities between

investors after an investor purchased it from
a business entity issuer.

 Regulates brokers, dealers, securities

associations, brokerage firms, and other
business entities that are engaged in the sale
of securities between investors.

Section 10(b)

 Section 10(b) of the ’34 Act is the primary antifraud

provision covering the trading of securities.

 Makes it a criminal offense to engage in any fraud,

directly or indirectly, in connection with the purchase
and sale of any security.

 Very broad, and the SEC enforces this section

(often referred to as rule 10(b)(5) ) strictly.

Insider Trading

 When a corporate insider has access to information

not available to the general public, the insider may
not trade in their company’s stock on the basis of
the inside information.

 Insiders include executives, managers, corporate

counsel, consultants, employees, brokers,
accountants, vendors, partners, and even majority

Private Securities Litigation Reform Act
of 1995
 The PSLRA made it more difficult to pursue litigation
under the securities laws based solely on
commentary by the company’s executives.

 The PSLRA provides safe harbors from lawsuits that

shield the company and its officers and directors so
long as the principals acted in good faith and
disclosed all relevant facts.

The Sarbanes-Oxley Act of 2002
 Passed in response to revelations of
corporate fraud and malfeasance in publicly
held companies.

 The law aims to solve specific mechanism

failures in accounting methods and requires
higher levels of fiduciary responsibilities for
those involved in corporate governance.

Substantial Penalties

 Officers who certify required financial report

filing knowing that the report is inaccurate are
subject to criminal penalties of:
 up to $1million in fines and 10 years incarceration.
 for cases in which the certification was used as
part of a larger fraudulent scheme, the penalties
increase to $5 million in fines and 20 years

learning outcomes checklist

 16 - 1 Articulate factors that differentiate, and the

laws that regulate, the primary and secondary
securities markets.

 16 - 2 Apply the legal test for what constitutes a


 16 - 3 Distinguish between classifications of equity

and debt instruments and give an example of each.

learning outcomes checklist

 16 - 4 Recognize the fundamental reason behind securities

regulation and have a working knowledge of the legal process
leading to issuance of original securities.

 16 - 5 Describe the role of the Securities and Exchange

Commission (SEC) in securities law compliance and

 16 - 6 List the major categories of securities and transactions that

are exempt from registration requirements

learning outcomes checklist

 16 - 7 Understand the ethical and legal duties of

corporate insiders.

 16 - 8 Identify the legal standard necessary to bring

a securities fraud suit against directors and officers
in light of the Private Securities Litigation Reform

 16 - 9 Explain the role of state blue-sky laws in

securities regulation

learning outcomes checklist

 16- 10 Show an awareness of the impact of

the Sarbanes-Oxley Act on a corporation’s
officers and directors and its corporate

 16 - 11 Articulate key protections afforded by

regulation of the financial markets.