Violations of the 1933 Act

• Violation of the Securities Act to intentionally or negligently defraud investors by misrepresenting or omitting material facts in the registration statement and/prospectus.

• Defenses: Statement left out was not material; Plaintiff knew about fraud and purchased stock; Registrant believed statements were true.

• Penalties:

  • Criminal: up to 5 years in prison and $10,000 fine.

  • Civil: damages, refund of investment, injunction.

§3: The Securities Exchange Act of 1934

• Registration of securities exchanges, brokers, dealers, and national securities exchanges and associations.

• Requires continuous disclosure system for corporations with securities sold on national exchanges or assets in excess of $5 million and 500 or more shareholders (Sec. 12 companies or 1934 companies).

Purposes of 1934 Act

• Rule 14(a) proxy regulations.

• Market surveillance by SEC.

• Rule 10(b) prohibits fraud with insider trading and disclosure regulations.

• Rule 16(b) insider reporting and trading.

• Rule 13 tender offer regulations.

Insider Trading: Section 10(b) and Rule 10b-5

• Section 10(b) prohibits the use of any manipulative or deceptive device or contrivance in contravention of rules and regulations of SEC.

• Rule 10b(5) prohibits the commission of fraud in the connection with the purchase or sale of any security.

• Case 41.1: SEC v. Texas Gulf Sulphur (1968).

• Section 10b(5) “Insiders”.

• Rule 10b-5 “Outsiders”.

  • Tipper/Tippee theory--insider’s fiduciary duty must be breached

  • Misappropriation theory -- one wrongfully obtains inside info and trades on it. Courts still require fiduciary duty be breached, e.g., to employer.

  • Case 41.2: U.S. v. O’Hagan (1997).

Violations of the 1934 Act

• Scienter or intent is required to prove civil or criminal penalties under 10(b) and Rule 10b-5.

  • Violator must have had intent to defraud (false statements or wrongfully failed to disclose material facts).

• Criminal Penalties:

  • 10(b) and Rule 10b-5, a person faces $5 million and 20 years in prison, $25 million for partnership or corporation.

  • Sarbanes-Oxley provides for 25 years in prison.

  • Case 41.3: United States v. Stewart (2004).

• Civil Sanctions:

  • Both SEC and Private Parties Can Bring Actions Against Violators under the Insider Trading and Securities Fraud Enforcement Act.

  • Private Actions for violations of 10(b) and Rule 10b-5.

§4: Corporate Governance

• Relationship between a corporation and its shareholders. (See OECD definition.)

• Attempts at Alignment between Officers and Shareholders.

• Corporate Governance and Corporate Law.

• Importance of the Audit Committee.

The Sarbanes-Oxley Act of 2002

• Attempts to increase corporate accountability:

  • Imposes stricter disclosures.

  • Harsher penalties for violations.

  • Requires CEO’s to take responsibility for accuracy of financial statements filed with SEC.

  • Creates new private civil actions.

• Creates Public Company Accounting Oversight Board regulates public accounting firms.

• Key Provisions:

  • Certification Requirements.

  • Loans to Officers and Directors.

  • Protections for Whistleblowers.

  • Enhanced Penalties.

  • Statute of Limitations for Securities Fraud.