Source: https://2012books.lardbucket.org/books/the-law-corporate-finance-and-management/s20-securities-regulation.html
Timestamp: 2019-04-25 12:57:46+00:00

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This is “Securities Regulation”, chapter 17 from the book The Law, Corporate Finance, and Management (v. 1.0). For details on it (including licensing), click here.
In Chapter 15 "Legal Aspects of Corporate Finance", we examined state law governing a corporation’s issuance and transfer of stock. In Chapter 16 "Corporate Powers and Management", we covered the liability of directors and officers. This chapter extends and ties together the themes raised in Chapter 15 "Legal Aspects of Corporate Finance" and Chapter 16 "Corporate Powers and Management" by examining government regulation of securities and insider trading. Both the registration and the trading of securities are highly regulated by the Securities and Exchange Commission (SEC). A violation of a securities law can lead to severe criminal and civil penalties. But first we examine the question, Why is there a need for securities regulation?
The Securities Act of 1933 and the Securities Exchange Act of 1934 are two federal statutes that are vitally important, having virtually refashioned the law governing corporations during the past half century. In fact, it is not too much to say that although they deal with securities, they have become the general federal law of corporations. This body of federal law has assumed special importance in recent years as the states have engaged in a race to the bottom in attempting to compete with Delaware’s permissive corporation law (see Chapter 14 "Corporation: General Characteristics and Formation").
The Supreme Court ruled that notes that are not “investment contracts” under the Howey test can still be considered securities if certain factors are present, as discussed in Reves v. Ernst & Young, (see Section 17.3.1 "What Is a Security?"). These factors include (1) the motivations prompting a reasonable seller and buyer to enter into the transaction, (2) the plan of distribution and whether the instruments are commonly traded for speculation or investment, (3) the reasonable expectations of the investing public, and (4) the presence of other factors that significantly reduce risk so as to render the application of the Securities Act unnecessary.
The logic of the Borak case (discussed in Section 17.1.3 "Securities Act of 1933") also applies to this act, so that private investors may bring suit in federal court for violations of the statute that led to financial injury. Violations of any provision and the making of false statements in any of the required disclosures subject the defendant to a maximum fine of $5 million and a maximum twenty-year prison sentence, but a defendant who can show that he had no knowledge of the particular rule he was convicted of violating may not be imprisoned. The maximum fine for a violation of the act by a person other than a natural person is $25 million. Any issuer omitting to file requisite documents and reports is liable to pay a fine of $100 for each day the failure continues.
Long before congressional enactment of the securities laws in the 1930s, the states had legislated securities regulations. Today, every state has enacted a blue sky lawA state law that regulates the offering and sale of securities to protect the public from fraud., so called because its purpose is to prevent “speculative schemes which have no more basis than so many feet of ‘blue sky.’”Hall v. Geiger-Jones Co., 242 U.S. 539 (1917). The federal Securities Act of 1933, discussed in Section 17.1.3 "Securities Act of 1933", specifically preserves the jurisdiction of states over securities.
The Supreme Court has placed limitations on the liability of tippees under Rule 10b-5. In 1980, the Court reversed the conviction of an employee of a company that printed tender offer and merger prospectuses. Using information obtained at work, the employee had purchased stock in target companies and later sold it for a profit when takeover attempts were publicly announced. In Chiarella v. United States, the Court held that the employee was not an insider or a fiduciary and that “a duty to disclose under Section 10(b) does not arise from the mere possession of nonpublic market information.”Chiarella v. United States, 445 U.S. 222 (1980). Following Chiarella, the Court ruled in Dirks v. Securities and Exchange Commission (see Section 17.3.2 "Tippee Liability"), that tippees are liable if they had reason to believe that the tipper breached a fiduciary duty in disclosing confidential information and the tipper received a personal benefit from the disclosure.
The Supreme Court has also refined Rule 10b-5 as it relates to the duty of a company to disclose material informationInformation that would be likely to affect a stock’s price once it became known to the public., as discussed in Basic, Inc. v. Levinson (see Section 17.3.3 "Duty to Disclose Material Information"). This case is also important in its discussion of the degree of reliance investors must prove to support a Rule 10b-5 action.

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