Ch. 22-1 © 2006 Prentice Hall THE LEGAL ENVIRONMENT OF BUSINESS A Critical Thinking Approach Fourth Edition Nancy K. Kubasek Bartley A. Brennan M. Neil

Ch. 22-Ch. 22-11 © 2006 Prentice Hall© 2006 Prentice Hall

THETHE LEGALLEGAL ENVIRONMENTENVIRONMENT OFOF BUSINESSBUSINESS

A Critical Thinking ApproachA Critical Thinking ApproachA Critical Thinking ApproachA Critical Thinking ApproachFourth EditionFourth Edition

Nancy K. KubasekNancy K. Kubasek

Bartley A. BrennanBartley A. Brennan

M. Neil BrowneM. Neil Browne

Nancy K. KubasekNancy K. Kubasek

Bartley A. BrennanBartley A. Brennan

M. Neil BrowneM. Neil Browne

© 2006 Prentice Hall© 2006 Prentice Hall Ch. 22-Ch. 22-22

THE LEGAL ENVIRONMENT OF BUSINESS

CHAPTER 22CHAPTER 22

Rules Governing the Issuance Rules Governing the Issuance and Trading of Securitiesand Trading of Securities



Securities RegulationSecurities RegulationDefinition: Securities are equity or debt Definition: Securities are equity or debt instruments: most often, stocks and bondsinstruments: most often, stocks and bonds

Useful as a means for financing modern Useful as a means for financing modern corporationscorporations

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



History of RegulationHistory of RegulationFirst 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 CommissionThe Securities and Exchange Commission

Goal: To require full disclosure so that Goal: To require full disclosure so that investors can make informed decisionsinvestors can make informed decisions

Method: Detailed requirements for Method: 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: Administrative action; Enforcement: Administrative action; injunction; criminal prosecutioninjunction; criminal prosecution



The Sarbanes-Oxley Act of 2002The Sarbanes-Oxley Act of 2002Goal: To require CEOs and CFOs to certify Goal: 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



The Securities Act of 1933The Securities Act of 1933Definition of “security” – very broadDefinition of “security” – very broad

The ‘Howey Test’The ‘Howey Test’ Common enterprise Common enterprise Reasonable expectation of profitsReasonable expectation of profits Derived solely from the efforts of othersDerived solely from the efforts of others

Regulates initial public offeringsRegulates initial public offerings



The Registration ProcessThe Registration ProcessAll nonexempt securities must be registeredAll nonexempt securities must be registered

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



Registration – Special SituationsRegistration – Special SituationsShelf 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



Liability, Remedies, and DefensesLiability, Remedies, and DefensesPrivatePrivate cause of action for victims of cause of action for victims of

Misrepresentation in registration Misrepresentation in registration statement; failure to register; fraud in statement; failure to register; fraud in salesale

Defenses: ‘Due diligence’ Defenses: ‘Due diligence’

Government Government remedies: Administrative remedies: Administrative action; letter of deficiency; injunction; action; letter of deficiency; injunction; criminal penaltiescriminal penalties



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

Goal: Regulate those who run the Goal: Regulate those who run the industryindustry

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

Covers: Brokers and dealersCovers: Brokers and dealers

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



Securities Investor Protection Act (SIPA)Securities Investor Protection Act (SIPA)

Indemnifies customers of insolvent brokerage Indemnifies customers of insolvent brokerage firmfirm

Collects funds from brokersCollects funds from brokers

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



The Securities MarketsThe Securities MarketsExchanges: Exchanges: NYSENYSE

Over-the-Counter: Over-the-Counter: OTCOTC

Another set of regulations: Another set of regulations: NASDNASD



Proxy SolicitationsProxy SolicitationsFewer than 1 percent of shareholders Fewer than 1 percent of shareholders attend annual meetingattend annual 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: offer to Tender offer: offer to buy shares at premiumbuy shares at premium

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

Hostile bid: offer is Hostile bid: offer is opposed by opposed by managementmanagement



Defenses to Hostile TakeoversDefenses to Hostile Takeovers

Golden Golden parachuteparachute

Poison pillPoison pill

GreenmailGreenmail

PorcupinePorcupine

Treasury Treasury shares to shares to friendly partiesfriendly 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 TradingInsider Trading

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

Insider Trader Sanctions ActInsider Trader Sanctions Act (ITSA) provide treble damages, (ITSA) provide treble damages, other remediesother remedies



Misstatements of CorporationsMisstatements of Corporations

Covers: Statements by corporate Covers: Statements by corporate executivesexecutives

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

With With ““scienterscienter””



MismanagementMismanagement

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

Fraud alleged by Fraud alleged by

Minority shareholders or in derivative Minority shareholders or in derivative suitssuits

Plaintiff is purchaser or sellerPlaintiff is purchaser or seller



Fraud-on-the-Market TheoryFraud-on-the-Market TheoryShareholders allege reliance on efficient marketShareholders allege reliance on efficient market

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 violation of To detriment of investors and in violation of 10(b)510(b)5

Upheld in Upheld in U.S. v. O’HaganU.S. v. O’Hagan



Liability and RemediesLiability and Remedies

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

SEC ActionSEC Action

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



Short-Swing ProfitsShort-Swing ProfitsCoverage: Director, officer, 10 percent ownerCoverage: 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: Return profits to corporationRemedy: Return profits to corporation

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



Regulation of Investment CompaniesRegulation of Investment CompaniesAll investment companies must register All investment companies must register under Investment Company Act of 1940under Investment Company Act of 1940

National Securities Market Improvement Act National Securities Market Improvement Act preempted most state lawpreempted most state law

Required: Annual reports; holdings in bank Required: Annual reports; holdings in bank or exchange member, follow SEC rulesor exchange member, follow SEC rules

State securities laws still cover local issues State securities laws still cover local issues



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 Improvement National Securities Market Improvement ActAct



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

““Pump and dump” example of new types Pump and dump” example of new types of deceptionof deception



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

Penalties: Fines and imprisonmentPenalties: Fines and imprisonment

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



OECD Convention on AntibriberyOECD Convention on Antibribery

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

Criminalizes briberyCriminalizes bribery

Eliminates tax deductions for bribesEliminates tax deductions for bribes

Requires disclosureRequires disclosure

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



International Securities Enforcement International Securities Enforcement Cooperation Act of 1990Cooperation Act of 1990

Goal: Attack money laundering via Swiss banksGoal: Attack money laundering via Swiss banks

Method: Create procedures for tracing laundered Method: Create procedures for tracing laundered moneymoney

International Securities Enforcement Cooperation International Securities Enforcement Cooperation Act (ISECA)Act (ISECA)

Methods: Information exchange; protects Methods: Information exchange; protects confidentiality; administrative sanctions on confidentiality; administrative sanctions on violators; SEC investigative powers expanded violators; 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: ‘Public interest’ exemption; Special rules: ‘Public interest’ exemption; recognition of information filed in issuer’s recognition of information filed in issuer’s home country; NASDAQ requirementshome country; NASDAQ requirements

Documents

Ch. 22-1 © 2006 Prentice Hall THE LEGAL ENVIRONMENT OF BUSINESS A Critical Thinking Approach Fourth Edition Nancy K. Kubasek Bartley A. Brennan M. Neil