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Securities Regulation Law
SEC laws and securities litigation

Additional Law Flashcards





Overview of six Federal Security Regulation statutes




‘33 Act - Securities Exchange Act of 1933

  • Pertains to transactions between stock issuers and public (primary distributions)
  • Crux of Act - Section 5 of ‘33 Act - every "offer" or sale of security must be registered for exempt from registration
  • Civil remedies for violations

‘34 Act – Securities Exchange Act of 1934

  • Pertains to secondary exchanges/trading (trading between investors)
  • Crux of Act – regulates in two ways: 1) req’s public companies to make continuous disclosures to the public (10K, 10Qs, proxy statements); 2) Regulates conduct of market participants - rules & conduct req's for partic’s
  • Established enforcement mechanisms and created the SEC
  • However, SEC was a nod to "no regulation" crowd in Congress - more biz sympathetic than FTC

‘35 Act - Public Utility Holding Act of 1935 (repealed in 2005)

‘39 Act - Trust Indenture Act of 1939

  • Very limited application - applies to large debt offerings ($100+ mill)
  • Requires a trust indenture to be entered into so that a trustee steps in on behalf of debt holders and enforce payments if a company defaults

‘40 Act - Investment Advisor Act of 1940 AND Investment Company Act of 1940

  • Regulates investment advisors – those in biz of providing others w/ advice re securities
  • Regulates businesses that buy and sell securities like mutual funds, hedge funds, etc.
  • 40 Act on regulates activity related to securities - investment advisors and companies do a lot of other things beside buy and sell securities
1932 Senate Banking Committee "Pecora" Hearing Findings:

Four key findings:


Fraud/manipulation – Joe Kennedy was worst offender – buying up stock w/ friends, touting value and selling at high price – “pump and dump”


Lack of issuer disclosures (no mandated disclosure – had to ask company directly for information, favored big institutions or little guys)


High leverage - could buy a lot of stock w/ a little money (low margin)


No federal regulator – state control only, no federal oversight


How do 6 FSR statutes reflect Congressional response to Pecora findings?


  • ’33 Act – promotes disclosure re primary distribution
  • ’34 Act – promotes disclosure and prevents fraud/manip re post IPO actions by participants, PLUS sets up federal regulatory agency and gives it enforcement powers
  • ’35 Act – N/A (repealed)
  • ’39 Act – prevents fraud and manipulation w/ regards to debt instruments
  • ‘40 Act – prevents fraud and manipulation by advisors and investment firms


Sarbanes Oxley Act of 2002 - what is it about?

Biggest change in securities laws since 1930's and 1940's

Amends previous securities laws rather than creating new laws

Req’s add’l disclosures, faster disclosures, & more penalties making fraudulent disclosures


SEC Mission Statement

1) protect investors


2) promote fair and orderly markets (such as secondary trading)


3) facilitate capital formation (allowing companies to get $$)

SEC organizational structure

One Chairman


Five Commissioner (usually politically divided)


4,000 Staff members


Four Divisions


Eleven Regional Offices



Functions of four operating divisions



Corp Fin - oversees disclosure process for companie raising $$ thru securities

  • Covers both ‘33 Act and ‘34 Act companies (IPO & post-IPO)
  • Per SOX, SEC has to review a public filing of each of the 12,000 publicly traded companies once each year
  • Big part of job is monitoring acct’g profession – each of the 12,000 publicly traded companies has to provide audited financial statements and follow GAAP conventions

Trading and Markets - oversees major participants in trading markets


Investment Management - oversees $30 trillion industry of investment advisors; enforces and interprets 2 1940's acts


Enforcement – in charge of enforcing SEC acts - brought 650 cases worldwide in 2008


Parts of the regulatory scheme of securities industry


  • SEC: only one part of the total regulatory scheme
  • Trading markets; facilities thru which securities are bought and sold
    • Exchange - physical locations - NYSE, AMEX & regional
    • OTC - no physical location, just network of dealers connected by phone & computers. (NASDAQ well known, but NASDAQ no longer OTC-only, also licensed exchange)
    • ECN (electronic communication networks) - large investors connect directly w/o going through public network
  • SRO - defined: internal regulators for exchanges and OTC organizations

    • FINRA – internal regulator for NYSE and NASDAQ
  • MSRB - Municipal Securities Rulemaking Board - set standards for issuance of municipal securities.  Town issue bonds to fund municipal projects, the MSRBs oversee these
  • PCAOB - Public Company Accounting Oversight Board - created by SOX - oversees accounting firms who audit companies that over public stock
  • Blue sky laws – state-level regulations




Major sources for the federal securities laws



  • Constitution - Interstate Commerce Clause is hook for the federal securities laws - need jurisdictional nexus
  • Congressional statutes – 15 USCA_ is code pleading
    • SEC referrers to statutes as “Section 5”
  • SEC rules/regulations – 17 CFR_ is code pleading
    • Regulations defined: group of rules that relate to same subject
  • SEC staff and informal guidance
    • Interpretive guidance, e.g. speeches or pamphlets on new laws
    • “No Action Letters”
  • Litigated decisions



Basic v. Levinson - why did case get heard in light of TSC case decision?


TSC a proxy battle materiality case, Basic about director’s misleading statement about merger agreement



Basic v. Levinson - why didn't TSC adopt low materiality standard?


If materiality standard too low, investors woudl be buried in disclosure docs.  Issuers would have to disclose everything, would be too taxing to sift through it all

Basic v. Levinson - why didn't Basic court adopt 3rd Cir. "agreement in principal" test?

Agreement in principal test: material re a merger agreement does not become material until there is an "agreement-in-principle" as to the price and structure of the transaction has been reached btwn merger partners

Ct. rejects b/c: 1) test underestimates investor's ability to sift through info; 2) SEC rules meant to protect investors not corps; 3) rule is a convenience for corp rather than a usuable bright line rule



Basic v. Levinson - court adopts "reasonable investor test", why?

RULE: reasonable investor test - protects investors interest, but is also flexible depending on the event and its likely damage to investor

Step 1: Would info be significant to a reasonable investor?

Step 2: If yes, balance probability & magnitude: materiality depends on balancing indicated probability that event will occur & anticipated magnitude of event in light of totality of corporate activity


Section 2(1) of '33 Act - definition of “security"


Definition: any note, stock, bonds, debenture, investment contracts, voting trust certificate, etc.  An exhaustive list but no definitions for each of the items.


- Some identified items relatively straightforward - e.g. stock, bond, debenture

- Some identified items need more interpretation - e.g. "investment contract", "note"

"Investment contracts" is a catch-all category for investment device through which companies can raise money that may or may not be a security



SEC v. Howey test for 'investment contract"


(Howey-in-the Hills orange grove contracts)


RULE: four part test adopted by court – “investment contract” defined:

 - Entail an investment of money

 - For a common enterprise

 - Involves an expectation of profits

 - Profits coming solely from efforts of others (not investor)


Offer and sale are separate acts, although 15% of people in Howey-in-the-Hills scheme didn't purchase the service contract, they were still offered a "security"


Investment K exists even when enterprise is not speculative or promotional in character and where the tangible interest which is sold has intrinsic value indep of success of the enterprise


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