Module 24: Federal Securities Acts

Overview

The bulk of the material tested on the exam from this area comes from the Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as amended. Topics included under the scope of the 1933 Act are registration requirements, exempt securities, and exempt transactions. The purposes of the 1933 Act are to provide investors with full and fair disclosure of a security offering and to prevent fraud. The basic prohibition of the 1933 Act is that no sale of a security shall occur in interstate commerce without registration and without furnishing a prospectus to prospective purchasers unless the security or the transaction is exempt from registration.

The purpose of the 1934 Act is the establishment of the Securities Exchange Commission to assure fairness in the trading of securities subsequent to their original issuance. The basic scope of the 1934 Act is to require periodic reports of financial and other information concerning registered securities, and to prohibit manipulative and deceptive devices in both the sale and purchase of securities.

A. Securities Act of 1933

B. Securities Exchange Act of 1934

C. The Sarbanes-Oxley Act of 2002

D. The Wall Street Reform and Consumer Protection (Dodd-Frank) Act of 2010

E. Exemptions for Smaller and Emerging Companies

F. Internet Securities Offering (ISO)

G. Electronic Signatures and Electronic Records

H. State “Blue-Sky” Laws

Key Terms

Multiple-Choice Questions

Multiple-Choice Answers and Explanations

Simulations

Simulation Solutions

The exam often tests on the Federal Securities Acts; however, this is sometimes combined with accountant’s liability or is included within questions concerning corporate or limited partnership law. You should also expect questions on the Sarbanes-Oxley Act of 2002 and the Dodd-Frank Act of 2010. Before beginning the reading you should review the key terms at the end of the module.

A. Securities Act of 1933 (Generally applies to initial issuances [primary offerings] of securities)
1. The purposes of the 1933 Act are to provide potential investors with full and fair disclosure of all material information relating to issuance of securities (such that a prudent decision to invest or refrain from investing can be made) and to prevent fraud or misrepresentation.
a. This is accomplished by
(1) Requiring a registration statement to be filed with Securities Exchange Commission (SEC) before either a public sale or an offer to sell securities in interstate commerce
(a) This is the fundamental thrust of the 1933 Act.
(b) The SEC is a government agency comprised of commissioners and its staff that was created to administer and enforce the Federal Securities Laws . The Commission interprets the acts, conducts investigations, adjudicates violations, and performs a rule-making function to implement the acts.
(1) Can subpoena witnesses
(2) Can obtain injunction preventing sale of securities
(3) Cannot assess monetary penalties without court proceedings
(4) Cannot prosecute criminal acts
(2) Requiring prospectuses to be provided to investors with, or before, the sale or delivery of the securities to provide public with information given to the SEC in registration statement.
(3) Providing civil and criminal liabilities for failure to comply with these requirements and for misrepresentation or fraud in the sale of securities even if not required to be registered.
b. The SEC does not evaluate the merits or value of securities
(1) The SEC can only compel full and fair disclosure.
(2) In theory, the public can evaluate the merits of the security when provided with full and fair disclosure.
(3) The SEC’s function is not to detect fraud or to stop offerings where fraud or unethical conduct is suspected.
(4) The SEC’s functions are also to
(a) Regulate securities markets
(b) Maintain fair markets
(c) Protect investors
(d) Review corporate financial statements
(e) Enforce securities laws
(f) Provide guidance for accounting rules
c. The major items you need to know include
(1) That a registration statement and prospectus are usually required
(2) Which transactions are exempt from registration
(3) Which securities are exempt from registration
(4) What the liability is for false or misleading registration statements
2. Definitions
a. Security—any note, stock, bond, certificate of interest, debenture, investment contract, etc., or any interest or instrument commonly known as a security.
(1) The general idea is that investor intends to make a profit on the investment through the efforts of others rather than through his/her own efforts.
EXAMPLE
Ward is a general partner of WDC partnership in Washington, D.C. Usually, Ward’s interest would not be considered a security because a general partner’s interest typically involves participation in the business rather than mere investment.
(a) Includes limited partnership interests
(b) Includes rights and warrants to subscribe for the above
(c) Includes treasury stock
(d) Investment contract is a security when money is invested in a common enterprise with profits to be derived from the effort of others
EXAMPLE
Blue Corporation in Florida owns several acres of orange trees. Blue is planning on selling a large portion of the land with the orange trees to several individuals in various states on a row-by-row basis. Each purchaser gets a deed and is required to purchase a management contract whereby Blue Corporation maintains all the land and oranges and then remits the net profits to the various purchasers. Even though it may appear that each individual purchased separately the land with the oranges and a management contract, the law looks at the “big picture” here. Since in reality the individuals are investing their money, and the profits are derived from the efforts of others, the law treats the above fact pattern as involving securities. Therefore, the Securities Acts apply.
b. Person—individual, corporation, partnership, unincorporated association, business trust, government.
c. Controlling person—has power, direct/indirect, to influence the management and/or policies of an issuer, whether by stock ownership, contract, position, or otherwise.
EXAMPLE
A 51% stockholder is a controlling person by virtue of a majority ownership.
EXAMPLE
A director of a corporation also owns 10% of that same corporation. By virtue of the stock ownership and position on the board of directors, he has a strong voice in the management of the corporation. Therefore, he is a controlling person.
d. Insiders—(applies to the Securities Exchange Act of 1934) include officers, directors, and owners of more than 10% of any class of an issuer’s equity securities.
(1) Note that debentures are not included because not equity securities.
(2) For purposes of this law to avoid a “loophole,” insiders include “beneficial owners” of more than 10% of the equity stock of issuer.
(a) To determine the amount of “beneficial ownership,” add to the individual’s equity ownership, equity stock owned by
(1) Owner’s spouse
(2) Owner’s minor children
(3) Owner’s relative in same house
(4) Owner’s equity stock held in trust in which owner is beneficiary
EXAMPLE
Linda owns 6% of the common stock of ABC Company in Philadelphia. Her spouse owns 3% of ABC Company’s common stock. The stock was also placed in the name of their two minor children, each owning 1% of ABC Company’s common stock. Linda has beneficial ownership of 11% of the equity securities of ABC Company so she is an insider for the 1934 Act. Note that her husband also qualifies as an insider.
EXAMPLE
Use the same facts as in the previous example except that all four individuals owned debentures of ABC Company. Since these are not equity securities, none qualifies as an insider.
EXAMPLE
Robert is an officer who owns 4% of the common stock of XYZ Company in Washington, DC. Since Robert is an officer, he is an insider even though the ownership level is below 10%.
e. Underwriter—any person who has purchased from an issuer with a view to the public distribution of any security or participates in such undertaking.
(1) Includes any person who offers or sells for issuer in connection with the distribution of any security.
(2) Does not include person who sells or distributes on commission for underwriter (i.e., dealers).
f. Sales of securities are covered by the Securities Act of 1933
(1) Issuance of securities as part of business reorganization (e.g., merger or consolidation) constitutes a sale and must be registered with SEC unless the issue otherwise qualifies as an exemption from the registration requirements of 1933 Act.
(2) Issuance of stock warrants is considered a sale so that requirements of 1933 Act must be met.
(3) Employee stock purchase plan is a sale and therefore must comply with the provisions of the 1933 Act. The company must supply a prospectus to each employee to whom stock is offered.
(4) Stock dividends or splits are not sales.
g. Registration statement—the statement required to be filed with SEC before initial sale of securities in interstate commerce.
(1) Includes financial statements and all other relevant information about the registrant’s property, business, directors, principal officers, together with prospectus, and any amendment, report, or document filed as part of the statement or incorporated therein by reference.
(2) It is against law to sell, offer to sell, or offer to purchase securities before filing a registration statement.
(3) The registration statement and prospectus becomes public upon filing.
(a) The effective date of registration statement is 20th day after filing.
(b) It is against the law to sell securities until the effective date but issuer may offer securities upon filing registration statement.
(c) Such offers may be made
(1) Orally
(2) By tombstone ads that identify security, its price, and who will take orders
(3) By a “red-herring prospectus”
(a) Legend in red ink (thus, red-herring) is printed on this preliminary prospectus indicating that the prospectus is “preliminary” and that a registration statement has been filed but has not become effective.
h. Prospectus—any notice, circular, advertisement, letter, or communication offering any security for sale (or merger).
(1) May be a written, radio, or television communication.
(a) SEC adopted new “plain English” rule for important sections of companies’ prospectuses, including risk factor sections.
(2) After the effective date of the registration statement, communication (written or oral) will not be considered a prospectus if
(a) Prior to or at same time, a written prospectus was also sent.
(b) If it only states from whom written prospectus is available, identifies security, states price, and who will execute orders for it (i.e., tombstone ad).
3. Registration requirements
a. Registration is required under the Act if the securities are to be offered, sold, or delivered in interstate commerce or through the mail.
(1) Interstate commerce means trade, commerce, transportation, or communication (e.g., telephone call) among more than one state or territory of US. This is interpreted very broadly to include trade, commerce, etc. that is within one state but affects interstate commerce.
EXAMPLE
A corporation issues securities to individuals living only in Philadelphia. It is further shown that this issuance affects trade in Delaware. Interstate commerce is affected because although Philadelphia is of course in one state, the effects on at least one other state allow the Federal Securities Acts to take effect under our Constitution. Therefore, registration of these securities is required under the Federal Law unless exemptions are found as discussed later.
(2) Unless it is an exempted security or exempted transaction as discussed later.
b. The issuer has primary duty of registration
(1) Any person who sells unregistered securities that should have been registered may be liable to a purchaser (unless transaction or security is exempt).
(2) Liability cannot be disclaimed in writing or orally by the issuer.
(3) This liability not dischargeable in bankruptcy.
c. The information required, in general, in registration statements
(1) Financial statements audited by independent CPA
(2) Names of the issuer, directors, officers, general partners, underwriters, large stockholders, counsel, etc.
(3) The risks associated with the securities
(4) A description of property, business, and capitalization of issuer
(5) Information about management of issuer
(6) A description of security to be sold and use to be made by issuer of proceeds
d. The prospectus is also filed as part of registration statement
(1) It generally must contain same information as registration statement, but it may be condensed or summarized.
e. The registration statement and prospectus are reviewed by SEC
(1) Amendments are almost always required by SEC.
(2) The SEC may issue stop-order suspending effectiveness of registration if statement appears incomplete or misleading.
(3) Otherwise the registration becomes effective on 20th day after filing (or on 20th day after filing amendment). The twenty-day period is called the waiting period.
(4) It is unlawful for company to sell the securities prior to approval (effective registration date). However, preliminary prospectuses are permitted once registration statement is filed.
f. Applies to both corporate and noncorporate issuers.
g. The registration covers a single distribution, so second distribution must also be registered.
h. The shelf registration is an exception to requirement that each new distribution of nonexempt securities requires a new filing.
(1) It allows certain qualified issuers to register securities once and then offer and sell them on a delayed or continuous basis “off the shelf.”
(2) Advantage is that issuer can respond better to changing market conditions affecting stock.
i. Different registration forms are available
(1) Form S-1 is basic long-form registration statement.
(2) Additional forms now required based on Sarbanes-Oxley Act that require non-GAAP financial measures to be presented so that they reconcile to the most directly comparable GAAP financial measure. The goal is to reduce concerns regarding improper use of non-GAAP financial measures.
(3) Forms S-2 and S-3
(a) These forms were adopted by SEC to ease much of burden of disclosures required under federal securities regulation.
(b) They require less detailed disclosures than Form S-1.
(c) They integrate information required under 1933 and 1934 Acts. Firms already on file with SEC under 1934 Act may incorporate much information by reference to avoid additional disclosure.
(4) Forms SB-1 and SB-2
(a) These forms permitted for small businesses under Regulation S-B.
(1) They reduce amount of financial and nonfinancial information required when registering under 1933 Act and when reporting quarterly information under 1934 Act.
(2) A small business issuer is generally one that has revenues less than $25 million.
4. Exempt securities (need not be registered but still subject to antifraud provisions under the Act).
a. Commercial paper (e.g., note, draft, check, etc.) with a maturity of nine months or less.
(1) Must be for commercial purpose and not investment.
EXAMPLE
OK Corporation in Washington, DC, wishes to finance a short-term need for more cash for current operations. OK will do this by issuing some short-term notes which all have a maturity of nine months or less. These are exempt from the registration requirements.
b. Intrastate issues—securities offered and sold only within one state.
(1) The issuer must be resident of state and doing 80% of business in the state and must use at least 80% of sale proceeds in connection with business operations in the state.
(2) All offerees and purchasers must be residents of state.
(3) For nine months after last sale by the issuer, resales can only be made to residents of state.
(4) All of a particular issue must qualify under this rule or this exemption cannot be used for any sale of the issue.
EXAMPLE
A regional corporation in need of additional capital makes an offer to the residents of the state in which it is incorporated to purchase a new issue of its stock. The offer expressly restricts sales to only residents of the state and all purchasers are residents of the state.
c. Small issues (Regulation A)—issuances up to $5,000,000 by issuer in 12-month period may be exempt if
(1) There is a notice filed with SEC.
(2) An offering circular (containing financial information about the corporation and descriptive information about offered securities) must be provided to offeree. Financial statements in offering circular need not be audited.
(3) Nonissuers can sell up to $1,500,000 in 12-month period.
NOTE: An offering circular (statement) is required under Regulation A instead of the more costly and time-consuming prospectus.
d. Securities of governments, banks, quasi governmental authorities (e.g., local hospital authorities), savings and loan associations, farmers, co-ops, and common carriers regulated by ICC. Public utilities are not exempt.
e. Security exchanged by the issuer exclusively with its existing shareholders so long as
(1) No commission is paid.
(2) Both sets of securities must have been issued by the same person.
EXAMPLE
A stock split is an exempt transaction under the 1933 Act and thus, the securities need not be registered at time of split.
f. Securities of nonprofit religious, educational, or charitable organizations.
g. Certificates issued by receiver or trustee in bankruptcy.
h. Insurance and annuity contracts.
5. Exempt transactions or offerings (still subject, however, to antifraud provisions of the Act; may also be subject to reporting requirements of the 1934 Act).
a. Sale or offer to sell by any person other than an issuer, underwriter, or dealer
(1) Generally covers sales by individual investors on their own account.
(2) May be a transaction by broker on customer’s order. It does not include solicitation of these orders.
(3) Exemption does not apply to sales by controlling persons because they are considered an underwriter or issuer.
b. Regulation D establishes three important exemptions in Rules 504, 505, and 506 under the 1933 Act.
(1) Rule 504 exempts an issuance of securities up to $1,000,000 sold in 12-month period to any number of investors (this is also known as seed capital exemption).
(a) General offering and solicitations are permitted under Rule 504 as long as they are restricted to “accredited investors,” such as banks, insurance companies, high-worth individuals, etc.
(b) The issuer need not restrict purchasers’ right to resell securities.
(c) No specific disclosure is required.
(d) The issuer must send notice of offering to SEC within 15 days of first sale of securities.
(2) Rule 505 exempts issuance of up to $5,000,000 in 12-month period.
(a) No general offering or solicitation is permitted within 12-month period.
(b) Permits sales to 35 unaccredited (nonaccredited term sometimes used) investors and to unlimited number of accredited investors within 12 months.
1] Accredited investors are, for example, banks, savings and loan associations, credit unions, insurance companies, broker dealers, certain trusts, partnerships, and corporations, also natural persons having joint or individual net worth exceeding $1,000,000 (not including value of primary residence) or having individual net income of $200,000 or joint net income of $300,000 for two most recent years.
(2) SEC must be notified within fifteen days of first sale.
(c) The issuer must restrict the purchasers’ right to resell the securities; in general must be held for two years or else exemption is lost.
(d) These securities typically state that they have not been registered and that they have resale restrictions.
(e) Unlike under Rule 504, if nonaccredited investor purchases these securities, audited balance sheet must be supplied (i.e., disclosure is required) as well as other financial statements or information, if readily available.
(1) If purchased only by accredited investors, no disclosure required.
(3) Rule 506 allows private placement of unlimited amount of securities.
(a) In general, the same rules apply here as outlined under Rule 505. Under the provisions of the Jumpstart Our Business Startups (JOBS) Act general solicitation and advertising for Rule 506 offerings is allowed providing that the issuer takes reasonable steps to determine that all of the purchasers are accredited investors. The issuer must also indicate whether it is relying on the provision that permits general solicitation and advertising.
(b) However, an additional requirement is that the unaccredited investors (up to 35) must be sophisticated investors (individuals with knowledge and experience in financial matters) or be represented by individual with such knowledge and experience.
EXAMPLE
A growing corporation is in need of additional capital and decides to make a new issuance of its stock. The stock is only offered to 10 of the president’s friends who regularly make financial investments of this sort. They are interested in purchasing the stock for an investment and each of them is provided with the type of information that is regularly included in a registration statement.
(4) Disclosures for offerings under $2,000,000 have been simplified to be similar to disclosures under Regulation A.
(5) A controlling person who sells restricted securities may be held to be an underwriter (and thus subject to the registration provisions) unless requirements of Rule 144 are met when controlling person is selling through a broker.
(a) If the following are met, the security can be sold without registration:
(1) The broker performs no services beyond those of typical broker who executes orders and receives customary fee.
(2) Ownership (including beneficial ownership) for at least two years.
(3) Only limited amounts of stock may be sold—based on a specified formula.
(4) Public must have available adequate disclosure of the issuer corporation.
(5) Notice of sale must be filed with SEC.
(6) Small issuers sometimes use offerings over Internet to investors and often use regulation to avoid registration. (Note the JOBS Act of 2012 has provisions that make it easier for firms to make Internet offerings. However, the provision will not be effective or testable on the CPA exam until after the SEC develops the related rules.)
c. Postregistration transactions by dealer (i.e., dealer is not required to deliver prospectus) if the transaction is made at least 40 days after first date security was offered to public, or after 90 days if it is issuer’s first public issue. This exemption does not apply to sales of securities that are leftover part of an allotment from the public issue.
6. Antifraud provisions
a. Apply even if securities are exempt or the transactions are exempt as long as interstate commerce is used (use of mail or telephone qualifies) to sell or offer to sell securities.
b. Included are schemes to defraud purchaser or making sale by use of untrue statement of material fact or by omission of material fact.
(1) Proof of negligence is sometimes sufficient rather than proof of scienter.
(2) Protects purchaser, not seller.
7. Civil liability (i.e., private actions brought by purchasers of securities).
a. The purchaser may recover if he or she can establish that
(1) It was a purchase of a security issued under a registration statement containing a misleading statement or omission of a material fact, and purchaser may also recover if issuer or any person sold unregistered securities for which there is no exemption.
(2) Suffered economic loss.
(3) Privity of contract is not necessary.
EXAMPLE
Third parties who have never dealt with issuer but bought securities from another party have a right to recover when the above is established despite lack of privity.
(4) Need not prove that the defendant intended to deceive.
(5) The purchaser need not rely on registration statement to recover.
b. The purchaser of securities may recover from (1) the issuer, (2) any directors, partners or underwriters of the issuer, (3) anyone who signed the registration statement, and (4) experts of authorized statements (e.g., attorneys, accountants, engineers, appraisers). Liability is not discharged in bankruptcy.
c. The burden of proof is shifted to defendant in most cases; however, except for the issuer, defendant may use “due diligence” defense.
(1) The due diligence defense can be used successfully by defendant by proving that
(a) As an expert, s/he had reasonable grounds after reasonable investigation to believe that his/her own statements were true and/or did not contain any omissions of material facts by the time the registration statement became effective.
EXAMPLE
Whitewood, a CPA, performs a reasonable audit and discovers no irregularities.
(b) S/he relied on an expert for the part of the registration statement in question and did believe (and had reasonable grounds for such belief) that there were no misstatements or material omissions of fact.
EXAMPLE
Greenwood, a CPA, relies on an attorney’s work as a foundation for his own work on contingent liabilities.
(c) S/he did reasonably believe that after a reasonable investigation, statements not in the province of an expert were true or that material omissions did not exist.
EXAMPLE
Lucky, an underwriter, made a reasonable investigation on the registration statement and did reasonably believe no impropriety existed even though misstatements and omissions of material facts existed. Note that the issuer is liable even if s/he exercised the same care and held the same reasonable belief because the issuer is liable without fault and cannot use the due diligence defense.
NOTE: The issuer is liable even if s/he exercised the same care and held the same reasonable belief because the issuer is liable without fault and cannot use the due diligence defense.
d. The seller of the security is liable to purchaser if interstate commerce or mail is used, and if the registration is not in effect and should be, or if the registration statement contains misstatements or omissions of material facts. The purchaser may recover the amount paid plus interest less any income received by the purchaser. The buyer may ask for rescission of sale instead of damages.
e. The statute of limitations is the earlier of these dates:
(1) Two years after discovery is made of fraud, deceit, or manipulation involving contravention of securities laws; or
(2) Five years after such violation of securities laws involving fraud, deceit, or manipulation
8. Criminal liability
a. If person intentionally (willfully) makes an untrue statement or intentionally omits a material fact, or willfully violates SEC Act or regulation.
(1) Reckless disregard of the truth may also qualify.
(2) Tampering with documents to be used in official proceedings do qualify.
b. If person uses interstate commerce or mail to fraudulently sell any security.
c. Person is subject to fine or imprisonment up to twenty years or both.
(1) Injunctions are also available.
d. Criminal liability results even if securities are exempt or transactions are exempt.
9. Increased protection for whistle-blowers of public companies
NOW REVIEW MULTIPLE-CHOICE QUESTIONS 1 THROUGH 26
B. Securities Exchange Act of 1934 (Generally applies to subsequent trading of securities—must comply separately with 1933 Act if applicable, that is, initial issuances rather than subsequent trading).
1. Purposes of the Act
a. To federally regulate securities exchanges and securities traded thereon
b. To require periodic disclosure by issuers of equity securities
c. To require adequate information be provided in various transactions
d. To prevent unfair use of information by insiders
e. To prevent fraud and deceptive practices
2. Following securities must be registered with SEC
a. Over-the-counter and other equity securities traded in interstate commerce where corporation has assets of more than $10 million and 500 or more shareholders. Equity securities include stock, rights to subscribe to stock, or securities convertible into stock. (Note that a provision of the Jumpstart Our Business Startups [JOBS] Act increases this threshold to 500 unaccredited shareholders or 2,000 total shareholders. It also provides that the threshold will not consider shares obtained by a shareholder as a part of a qualified employee compensation plan. This Act will be eligible for testing beginning in January 2013.)
b. Securities that are traded on any national securities exchange must be registered. Securities exempted under 1933 Act may still be regulated under 1934 Act.
c. Securities offered by issuer who was required to register under 1933 Act.
3. Required disclosures in registration include
a. Names of officers and directors
b. Nature of business
c. Financial structure of firm
d. Any bonus and profit-sharing provisions
4. Sanctions available to SEC under the 1934 Act
a. Revocation or suspension of registration
b. Denial of registration
c. Permanent or temporary suspension of trading of securities (injunction)
d. May order accounting and disgorgement of gains made illegally
e. May sanction individuals violating foreign laws
f. May require large traders to identify selves
5. Exempt securities
a. Obligations of US government, guaranteed by, or in which US government has interest.
b. Obligations of state or political subdivision, or guaranteed thereby.
c. Securities of federally chartered bank or savings and loan institution.
d. Securities of common carrier regulated by ICC.
e. Industrial development bonds.
6. Issuers of securities registered under the 1934 Act must file the following reports with SEC.
a. Annual reports (Form 10-K) must be certified by independent public accountant.
b. Quarterly reports (Form 10-Q) must be filed for each of first three fiscal quarters of each fiscal year of issuer.
(1) Must be reviewed by CPA.
(2) Not required to be reported on by CPA.
c. Event reports (Form 8-K) when material events occur such as change in corporate control, significant change or revaluation of assets, or change in amount of issued securities. In most cases the form must be filed within four days after the material event occurs.
d. Similar reports must be provided to shareholders. However, annual report need not be given if issuer had to disclose under 1934 Act only because it made a registered offering under 1933 Act.
7. Whether registered under 1934 Act or not, the securities registered during the previous year under 1933 Act must have periodic reports filed with SEC by issuers.
8. Proxy solicitations
a. Proxy—grant of authority by shareholder to someone else to vote his/her shares at a meeting.
b. A proxy solicitation provisions apply to solicitation (by any means of interstate commerce or the mails) of holders of securities required to be registered under the 1934 Act—must be reported to SEC.
c. A proxy statement must be sent with proxy solicitation.
(1) It must contain disclosure of all material facts concerning matters to be voted upon.
(a) Either misstatements or omissions of material facts are violations of proxy rules.
(b) Material means that it would likely affect vote of average shareholder on proposed action.
(2) The purpose is for fairness in corporate action and election of directors.
d. The requirements of the proxy itself
(1) Indicate on whose behalf solicitation is made
(2) Identify clearly and impartially each matter to be acted on
e. Some of inclusions in the proxy material
(1) Proposals by shareholders that are a proper subject for shareholders to vote on
(2) Financial statements for last two years, certified by independent accountant, if
(a) Solicitation is on behalf of management.
(b) It is for annual meeting at which directors are to be elected.
f. Any person who owns at least 5% or has held stock for six months or more has right of access to lists of shareholders for lawful purpose.
g. The proxy statement, proxy itself, and any other soliciting material must be filed with SEC.
h. Brokers are required to forward proxies for customers’ shares held by broker.
i. Incumbent management is required to mail proxy materials of insurgents to shareholders if requested and expenses are paid by the insurgents.
j. Remedies for violation of proxy solicitation rules
(1) Civil action by aggrieved shareholder for damages caused by material misinformation or omissions of material facts
(2) Or injunctions are possible
(3) Or the court may set aside vote taken and require a new proxy solicitation with full and fair disclosure
9. Tender offers
a. A tender offer is invitation by buyer (bidder) to shareholders of targeted company to tender shares they own for sale for price specified over a period of time.
b. Reporting and disclosure requirements apply to tender offers to provide shareholders full disclosure by both the bidder and targeted company.
10. Short-swing profits
a. A corporation is entitled to recover profits from any insider who sells stock of company within six months of its purchase.
b. Profits that can be recovered are calculated by matching highest sale price with lowest purchase price found within six months.
c. Losses cannot be used to offset these profits.
11. Antifraud provisions—very broad scope
a. It is unlawful to manipulate process and create appearance of active trading (not good-faith transactions by brokers).
b. It is unlawful to use any manipulative or deceptive devices in purchase or sale of securities.
(1) Applies to all securities, whether registered or not (as long as either mail, interstate commerce, or a national stock exchange is used)—this is important.
(2) Includes any act, practice, or scheme which is deceptive or manipulative (against SEC rules and/or regulations)—most importantly, it is unlawful to make any false statement of a material fact or any omission of a material fact that is necessary to make statement(s) not misleading (in connection with purchase or sale of security, whether registered or not).
(a) This is Rule 10b-5 promulgated by the SEC under Section 10(b) of the Act.
NOTE: There are no exemptions under Rule 10b-5.
(3) The plaintiff must prove
(a) The defendant made material false statement or omission of material fact in connection with purchase or sale of securities.
(1) The basic test of materiality is whether a reasonable person would attach importance to the fact in determining his/her choice of action in the transaction.
EXAMPLE
A broker offers to sell a stock and omits to tell the purchaser that the corporation is about to make an unfavorable merger.
(b) The defendant acted with scienter which is either knowledge of falsity, or reckless disregard for the truth.
(1) Negligence is not sufficient.
(2) Note that with antifraud provisions under the 1933 Act scienter need not necessarily be proven.
(c) The defendant must have relied upon false statements or omissions.
(d) The defendant who suffers damages may sue for monetary damages, or rescind the transaction.
(4) Applies to brokers who intend to never deliver securities or who intend to misappropriate proceeds of sales. The SEC by US Supreme Court ruling has power to sue brokers for fraud.
(5) Applies to any seller, buyer, or person who lends his/her name to statements used in the buying and selling of securities. Cross reference this to the 1933 Act that only applies to sellers or offerors of securities.
(6) Applies to insider who buys or sells on inside information until it is disseminated to public.
(a) Includes a broad scope of insiders such as officers, directors, accountants, lawyers, employees at the various levels of firm, consultants, agents, representatives of firm, and any other persons owing a fiduciary duty to company.
(7) Even if exempt from registration under 1934 Act, still subject to antifraud provisions.
(8) Extensive potential liability for insiders
(a) Must forego trading if one has such knowledge until public has information
(1) Includes insiders and anyone with knowledge (e.g., accountant, attorney, engineer)
(2) Illegal for person (tipper) to give inside information to another person (called tippee)
(3) Tippee is liable if acts on inside information until information is known by public
(a) Tipper is liable for illegal profits of tippee.
12. Civil liability
a. Any person (including an accountant) who intentionally (willfully) manipulates a security may be liable to the buyer or seller of that security if the buyer or seller is damaged.
NOTE: Both buyers and sellers may recover under the 1934 Act.
b. Any person who makes a misleading (or of course false) statement about any material fact in any application, report, or document is liable to an injured purchaser or seller if s/he relied on the statement, and did not know it was false or misleading.
(1) Privity of contract is not necessary.
(2) However, the party sued can avoid liability if s/he can prove s/he acted in good faith, and had no knowledge that the statements were materially misleading or false. The SEC may collect liability funds for victims of securities fraud.
13. Criminal liability
a. Has been increased due to Sarbanes-Oxley Act
(1) Individuals in violation of Rule 10b-5 may be put in prison for up to 20 years and/or may be fined for up to five million dollars.
(a) May be put in prison for up to 25 years and/or fined for willful violation of 1934 Act.
(2) Corporations or partnerships are subject to fines of up to 25 million dollars.
b. Criminal liability can also be used for intentional false or misleading statements on material facts provided in applications, reports, or other documents under this Act.
14. The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 prohibits discharge of any debts incurred in violation of securities laws.
15. Both private parties and SEC now have civil remedies against violators of 1934 Act.
a. Private parties may recover from those who violate rule 10b-5 as well as from others sharing responsibility such as attorneys, accountants, corporations.
(1) Private parties may also rescind contracts to purchase contacts when violations hurt them.
b. SEC authorized to give awards to individuals that provide information leading to prosecution of insider-trading violators.
16. Statute of limitations extended for securities fraud
17. Reporting requirements of insiders under 1934 Act
a. Must file statement with SEC
(1) Discloses amount of equity securities
(2) Time of statement disclosure
(a) When securities registered
(b) When registration statement becomes effective
(c) Within ten days of person attaining insider status
(3) Insider must report any changes in ownership within 10 days.
18. Foreign Corrupt Practices Act
a. Unlawful for any domestic company or its officers or employees or agents to offer or give to foreign officials or to political party or political officials something of value to influence decisions.
(1) Excluded are routine governmental actions that do not involve official’s discretion such as processing applications or permits.
(2) Amendment includes attempt by supplier to obtain any improper advantage is unlawful.
b. Requires companies having registered securities to maintain system of internal control and to maintain accurate accounting and to protect integrity of independent audits.
c. Actions of foreign citizens or organizations committed within US also covered.
19. Regulation Fair Disclosure (Reg FD) from SEC requires corporation to disseminate its data equally among investors and analysts to help avoid conflicts of interest by analysts.
a. If one mistakenly gives out inside information s/he must disclose it publicly as soon as is practicable and always within 24 hours or less.
b. Applies also to giving nonpublic information to shareholders who are likely to trade based upon it.
NOW REVIEW MULTIPLE-CHOICE QUESTIONS 27 THROUGH 42

C. The Sarbanes-Oxley Act of 2002

1. The act covers all public companies.
2. Section 906 certification provision of Act requires that each periodic report that contains financial reports of the issuer must be accompanied with written statement of CEO or CFO that certifies that reports comply fully with relevant securities laws and also fairly present the financial condition of company in all material aspects.
a. Any officer who makes certification while knowing it does not comply with SEC requirements can be fined up to $1,000,000 or imprisoned for up to 10 years, or both.
(1) Officers can be fined for up to $5,000,000 or imprisoned for up to 20 years, or both, for willful violation of this certification requirement.
(2) SEC now permitted to freeze payments to officers and directors during investigation of wrongdoings.
(3) SEC may now prevent unfit individuals from serving as officers or directors of public companies.
b. CEO and CFO must give up any bonuses, incentive-based pay and profits on sales of stock that they received during 12-month time before financial statements are required to be restated because of omissions or misstatements of material facts.
3. Section 302 certification makes officers responsible for maintaining effective internal controls and requires principal executive and financial officers to disclose all significant internal control deficiencies to issuer’s auditors and audit committee.
a. Management must now evaluate any changes in internal control methods.
b. Officers and directors of an issuer or their agents are prohibited from fraudulently influencing or coercing auditors to render financial statements materially misleading.
4. Act amends Securities Exchange Act of 1934 to make it illegal for issuer to give various types of personal loans to or for any executive officer or director.
5. CEO and CFO must give up any bonus, any compensation that is equity based or incentive based, or any profit from sale of corporation’s securities during period when corporation was required to restate financial statements due to wrongdoings.
a. CEO and CFO must give up these bonuses and profits even if wrongdoings were not by them but also if they were by any other officer or employee.
b. Act requires that any wrongdoing officer give up profits from stock sales or bonuses received due to stock being overpriced because of false information.
(1) Act allows not only that improper gains be recovered but also any remedy needed to protect investors.
6. Attorneys are required to report to chief legal counsel or CEO such things as material violations of securities laws or breach of fiduciary duties. Attorneys must report this to audit committee (or another committee) or board of directors if counsel or CEO does not take action.
7. Companies must disclose material off-balance sheet liabilities and transactions.
a. Amendments require management disclosure of information needed by users of financial statements to better understand off-balance sheet arrangements involving such things as their business purpose, market risk, credit risk, liquidity, or other material effects.
8. Pro forma information disclosed to public in financial reports, press releases, etc., must not contain any untrue statement of a material fact or omit any material fact.
a. Pro forma information must also be reconciled with financial statements prepared in accordance with GAAP.
9. SEC now requires that reports by insiders that disclose their securities holdings must be filed electronically with SEC to result in earlier public notification and wider public availability of this information.
a. Issuers having corporate Web sites must also post such information quickly.
10. New rules require disclosures, both financial and nonfinancial, to aid public in assessing risk better pertaining to companies (e.g., disclosing off-balance sheet financing).
a. Also, aid in purpose of Act to produce reports under Securities Acts that are timely and reliable.

D. The Wall Street Reform and Consumer Protection (Dodd-Frank) Act of 2010

The Dodd-Frank Act was passed as a reaction to the recent financial crisis. The Act was designed “to promote the financial stability of the United States by improving accountability and transparency in the financial system, to end “too big to fail,” to protect the American taxpayer by ending bailouts, to protect consumers from abusive financial services practices, and for other purposes.”
1. The Act created the Financial Stability Oversight Council that is charged with identifying threats to the financial stability of the US, promoting market discipline, and responding to emerging risks. The Council will identify significant nonbank financial firms and regulate these institutions, and prescribe risk management standards for payment, clearing, and settlement activities by financial market institutions.
2. The Act increased the types of financial companies that could be seized and liquidated by the FDIC to include insurance companies and nonbank financial companies.
3. The Act requires previously exempt US and non-US advisors of hedge funds, private equity funds, and other private investment vehicles to register with the SEC under the Advisors Act. It also provides for additional reporting requirements for registered and nonregistered advisors.
4. The Act eliminated the Office of Thrift Supervision, distributing its responsibilities to other agencies.
5. The Act created the Federal Insurance Office to regulate insurance companies.
6. The Act created the Bureau of Consumer Financial Protection to regulate the offering of consumer products and services (e.g., credit counseling, check-cashing, etc.) under the federal consumer financial laws.
7. The Act prohibits any “banking entity” from engaging in proprietary trading, or sponsoring or investing in a hedge fund or private equity fund (the Volcher rule).
8. The Act gives authority to the Commodity Futures Trading Commission and the SEC to regulate the derivatives (swaps) markets, including the regulation of swap dealers and major swap participants.
9. The Act has provisions to help prevent conflicts of interests and increase transparency by credit rating agencies.
10. The Act includes broad changes in executive compensation policies for public companies, including
a. Requiring the national exchanges to issue new listing rules requiring companies to develop and implement compensation-recovery arrangements (clawback policies). The Act states that when noncompliance with a financial-reporting requirement leads to an accounting restatement, the company is required to recover from any current or former executive officer all excessive incentive-based compensation paid over the preceding three-year period.
b. Requiring that all members of the compensation committee of the board of directors be independent.
c. Requiring a shareholder nonbinding vote on the prior year’s executive compensation at least every three years, and a vote at least every six years as to whether the vote on compensation should be held more often.
d. Requiring a nonbinding vote by shareholders on “golden parachutes” to be provided to executives as a result of major transactions.
11. The Act provides that the SEC will increase its compliance activities regarding securities trading, and will pay awards to whistle-blowers for providing information about violations of securities laws that result in aggregate monetary sanctions in excess of $1 million.
a. A whistle-blower is eligible to receive 10 to 30% of the monetary penalty if the information is derived from independent knowledge or analysis of the whistle-blower and not known to the government from any other source.
b. Tips can be made anonymously (through an attorney) with the whistle-blower only being identified to the SEC after determination that an award will be given.
c. A broad group of individuals are eligible including employees, customers, and suppliers. Individuals that are generally excluded from eligibility include
(1) Officers, directors, trustees, or partners of an entity, when those individuals learned of information about the misconduct in question from another person or in connection with the company’s processes for identifying potential illegal conduct.
(2) Employees whose main job functions involve compliance or internal audit, or persons who are employed by a firm hired to perform audit or compliance functions or to investigate possible violations of the law.
(3) Employees of public accounting firms performing an engagement required by the securities laws.
However, the above individuals may be still eligible if it appears that the company is attempting to behave in a way that would harm investors or inhibit an investigation, or 120 days have passed since they notified the company of the violation.
d. Whistle-blowers are encouraged to report the information through the normal internal corporate governance system by an indication that doing so will be considered when determining the amount of the award.
12. The act requires mortgage securitizers or originators to retain an economic interest (at least 5%) in a portion of the credit risk of any securitized asset that they create and sell.

E. Exemptions for Smaller and Emerging Companies

1. Smaller reporting companies have reduced requirements for disclosure of financial and nonfinancial information for initial filings (1933 Act) and periodic reporting (1934 Act). Smaller reporting companies are those that
a. Have a common equity public float (market capitalization) of less than $75 million, or
b. Are unable to calculate their public float and have annual revenues of $50 million or less.
2. The Dodd-Frank Act permanently exempted these smaller reporting companies (nonaccelerated filers) from the requirement to have integrated audits of their internal controls.
3. The JOBS Act of 2012 significantly reduced the registration and reporting requirements of “emerging growth companies.” Notably, these companies are exempt for at least 5 years from the requirement to have integrated audits of their internal controls, and the Dodd-Frank provisions regarding executive compensation. A company qualifies as an emerging growth company if its initial public offering (IPO) was after December 8, 2011, and it had less than $1 billion of total annual gross revenues during its last completed fiscal year. A company no longer qualifies as an emerging growth company after the earliest of (1) the completion of a fiscal year in which the company has gross revenues of $1 billion or more, (2) the completion of the fiscal year of the 5th anniversary of the company’s IPO, (3) the issuance of $1 billion in nonconvertible debt in the prior 3-year period, or (4) the company becoming a larger accelerated filer under SEC guidelines.
F. Internet Securities Offering (ISO) (Direct Public Offerings [DPO])
1. ISO used primarily by small businesses to accumulate capital.
2. SEC created electronic database of corporate information.
a. Allows access to much data formerly available only to big institutions.
(1) Thus tends to level playing field between small investors and large investors.
(2) Also, tends to level playing field between small and large businesses.
b. Allows electronic filing.
c. Companies may market securities faster and more cheaply by circumventing paperwork of investment bankers.
d. These securities are typically riskier because often avoid screening processes of various professionals.
3. In general, securities laws and regulations apply to ISO.
4. Prospectuses may be placed online.
5. Secondary market for securities may also be accomplished on websites.

G. Electronic Signatures and Electronic Records

1. Federal law specifies that no agreement, record, or signature required by federal securities laws or state laws can be denied legal effect because it is electronic record or contains electronic signature.
a. Also applies to electronic signatures between investment advisors, brokers, dealers, and customers.
b. SEC may specify manner of file retention but may not discriminate against any specific technology in effort to promote advances in technology.

H. State “Blue-Sky” Laws

1. These are state statutes regulating the issuance and sale of securities.
a. They contain antifraud and registration provisions.
2. Must be complied with in addition to federal laws.
3. Exemptions from federal laws are not exemptions from state laws.
NOW REVIEW MULTIPLE-CHOICE QUESTIONS 43 THROUGH 45

KEY TERMS

Insiders. Includes officers, directors, and owners of more than 10% of any class of an issuer’s equity securities.

Prospectus. Any notice, circular, advertisement, letter, or communication offering any security for sale (or merger).

Proxy. Grant of authority by a shareholder to someone else to vote the shareholder’s shares at a meeting.

Registration statement. The statement required to be filed with the SEC before the initial sale of securities can occur.

Security. Any debt or equity interest in a company including a note, stock, bond, certificate of interest, debenture, investment contract, etc.

Underwriter. Any person who has purchased from an issuer with a view to the public distribution of any security, or a party who participates in such an undertaking.

Multiple-Choice Questions (1–45)

A. Securities Act of 1933

1. A preliminary prospectus, permitted under SEC Regulations, is known as the

a. Unaudited prospectus.

b. Qualified prospectus.

c. “Blue-sky” prospectus.

d. “Red-herring” prospectus.

2. Under the Securities Exchange Act of 1934, which of the following types of instruments is excluded from the definition of “securities”?

a. Investment contracts.

b. Convertible debentures.

c. Nonconvertible debentures.

d. Certificates of deposit.

3. A tombstone advertisement

a. May be substituted for the prospectus under certain circumstances.

b. May contain an offer to sell securities.

c. Notifies prospective investors that a previously-offered security has been withdrawn from the market and is therefore effectively “dead.”

d. Makes known the availability of a prospectus.

4. Under the Securities Act of 1933, which of the following statements most accurately reflects how securities registration affects an investor?

a. The investor is provided with information on the stockholders of the offering corporation.

b. The investor is provided with information on the principal purposes for which the offering’s proceeds will be used.

c. The investor is guaranteed by the SEC that the facts contained in the registration statement are accurate.

d. The investor is assured by the SEC against loss resulting from purchasing the security.

5. Which of the following statements concerning the prospectus required by the Securities Act of 1933 is correct?

a. The prospectus is a part of the registration statement.

b. The prospectus should enable the SEC to pass on the merits of the securities.

c. The prospectus must be filed after an offer to sell.

d. The prospectus is prohibited from being distributed to the public until the SEC approves the accuracy of the facts embodied therein.

Items 6 and 7 are based on the following facts:

Sandy Corporation is considering the following issuances:

I. Notes with maturities of three months to be used for commercial purposes and having a total aggregate value of $500,000.

II. Notes with maturities of two years to be used for investment purposes and having a total aggregate value of $300,000.

III. Notes with maturities of two years to be used for commercial purposes and having a total aggregate value of $200,000.

6. Which of the above notes is (are) exempt securities and need not be registered under the Securities Act of 1933?

a. I only.

b. II only.

c. I and III only.

d. I, II, and III.

7. Which of the above notes is (are) subject to the antifraud provisions of the Securities Act of 1933?

a. I only.

b. II only.

c. I and III only.

d. I, II, and III.

8. Which of the following is not a security under the definition for the Securities Act of 1933?

a. Any note.

b. Bond certificate of interest.

c. Debenture.

d. All of the above are securities under the Act.

9. Which of the following requirements must be met by an issuer of securities who wants to make an offering by using shelf registration?

Original registration statement must be kept updated The offer must be a first-time issuer of securities
a. Yes Yes
b. Yes No
c. No Yes
d. No No

10. Which of the following securities would be regulated by the provisions of the Securities Act of 1933?

a. Securities issued by not-for-profit, charitable organizations.

b. Securities guaranteed by domestic governmental organizations.

c. Securities issued by savings and loan associations.

d. Securities issued by insurance companies.

11. Which of the following securities is exempt from registration under the Securities Act of 1933?

a. Shares of nonvoting common stock, provided their par value is less than $1.00.

b. A class of stock given in exchange for another class by the issuer to its existing stockholders without the issuer paying a commission.

c. Limited partnership interests sold for the purpose of acquiring funds to invest in bonds issued by the United States.

d. Corporate debentures that were previously subject to an effective registration statement, provided they are convertible into shares of common stock.

12. Universal Corp. intends to sell its common stock to the public in an interstate offering that will be registered under the Securities Act of 1933. Under the Act,

a. Universal can make offers to sell its stock before filing a registration statement, provided that it does not actually issue stock certificates until after the registration is effective.

b. Universal’s registration statement becomes effective at the time it is filed, assuming the SEC does not object within twenty days thereafter.

c. A prospectus must be delivered to each purchaser of Universal’s common stock unless the purchaser qualifies as an accredited investor.

d. Universal’s filing of a registration statement with the SEC does not automatically result in compliance with the “blue-sky” laws of the states in which the offering will be made.

13. If securities are exempt from the registration provisions of the Securities Act of 1933, any fraud committed in the course of selling such securities can be challenged by

SEC Person defrauded
a. Yes Yes
b. Yes No
c. No Yes
d. No No

14. Issuers of securities are normally required under the Securities Act of 1933 to file a registration statement with the Securities Exchange Commission before these securities are either offered or sold to the general public. Which of the following is a reason why the SEC adopted the registration statement forms called Form S-2 and Form S-3?

a. To require more extensive reporting.

b. To be filed along with Form S-1.

c. To reduce the burden that issuers have under the securities laws.

d. To reduce the burden of disclosure that issuers have for intrastate issues of securities.

A.5. Exempt Transactions or Offerings

15. Regulation D provides for important exemptions to registration of securities under the Securities Act of 1933. Which of the following would be exempt?

I. Issuance of $500,000 of securities sold in a 12-month period to forty investors.

II. Issuance of $2,000,000 of securities sold in a 12-month period to 10 investors. The issuer restricts the right of the purchasers to resell for two years.

a. I only.

b. II only.

c. Both I and II.

d. Neither I nor II.

16. Pix Corp. is making a $6,000,000 stock offering. Pix wants the offering exempt from registration under the Securities Act of 1933. Which of the following provisions of the Act would Pix have to comply with for the offering to be exempt?

a. Regulation A.

b. Regulation D, Rule 504.

c. Regulation D, Rule 505.

d. Regulation D, Rule 506.

17. Eldridge Corporation is seeking to offer $7,000,000 of securities under Regulation D of the Securities Act of 1933. Which of the following is (are) true if Eldridge wants an exemption from registration under the Securities Act of 1933?

I. Eldridge must comply with Rule 506 of Regulation D.

II. These securities could be debentures.

III. These securities could be investment contracts.

a. I only.

b. I and II only.

c. II and III only.

d. I, II, and III.

18. An offering made under the provisions of Regulation A of the Securities Act of 1933 requires that the issuer

a. File an offering circular with the SEC.

b. Sell only to accredited investors.

c. Provide investors with the prior four years’ audited financial statements.

d. Provide investors with a proxy registration statement.

19. Which of the following facts will result in an offering of securities being exempt from registration under the Securities Act of 1933?

a. The securities are nonvoting preferred stock.

b. The issuing corporation was closely held prior to the offering.

c. The sale or offer to sell the securities is made by a person other than an issuer, underwriter, or dealer.

d. The securities are AAA-rated debentures that are collateralized by first mortgages on property that has a market value of 200% of the offering price.

20. Regulation D of the Securities Act of 1933

a. Restricts the number of purchasers of an offering to 35.

b. Permits an exempt offering to be sold to both accredited and nonaccredited investors.

c. Is limited to offers and sales of common stock that do not exceed $1.5 million.

d. Is exclusively available to small business corporations as defined by Regulation D.

21. Frey, Inc. intends to make a $2,000,000 common stock offering under Rule 505 of Regulation D of the Securities Act of 1933. Frey

a. May sell the stock to an unlimited number of investors.

b. May make the offering through a general advertising.

c. Must notify the SEC within 15 days after the first sale of the offering.

d. Must provide all investors with a prospectus.

22. Under Regulation D of the Securities Act of 1933, which of the following conditions apply to private placement offerings? The securities

a. Cannot be sold for longer than a six-month period.

b. Cannot be the subject of an immediate unregistered reoffering to the public.

c. Must be sold to accredited institutional investors.

d. Must be sold to fewer than twenty nonaccredited investors.

23. Which of the following statements concerning an initial intrastate securities offering made by an issuer residing in and doing business in that state is correct?

a. The offering would be exempt from the registration requirements of the Securities Act of 1933.

b. The offering would be subject to the registration requirements of the Securities Exchange Act of 1934.

c. The offering would be regulated by the SEC.

d. The shares of the offering could not be resold to investors outside the state for at least one year.

24. Pix Corp. is making a $6,000,000 stock offering. Pix wants the offering exempt from registration under the Securities Act of 1933. Which of the following requirements would Pix have to comply with when selling the securities?

a. No more than 35 investors.

b. No more than 35 nonaccredited investors.

c. Accredited investors only.

d. Nonaccredited investors only.

25. Which of the following transactions will be exempt from the full registration requirements of the Securities Act of 1933?

a. All intrastate offerings.

b. All offerings made under Regulation A.

c. Any resale of a security purchased under a Regulation D offering.

d. Any stockbroker transaction.

26. Under Rule 504 of Regulation D of the Securities Act of 1933, which of the following is (are) required?

I. No general offering or solicitation is permitted.

II. The issuer must restrict the purchasers’ right to resell the securities.

a. I only.

b. II only.

c. Both I and II.

d. Neither I nor II.

B. Securities Exchange Act of 1934

27. Dean, Inc., a publicly traded corporation, paid a $10,000 bribe to a local zoning official. The bribe was recorded in Dean’s financial statements as a consulting fee. Dean’s unaudited financial statements were submitted to the SEC as part of a quarterly filing. Which of the following federal statutes did Dean violate?

a. Federal Trade Commission Act.

b. Securities Act of 1933.

c. Securities Exchange Act of 1934.

d. North American Free Trade Act.

28. The Securities Exchange Commission promulgated Rule 10b-5 under Section 10(b) of the Securities Exchange Act of 1934. Which of the following is (are) purpose(s) of the Act?

image

29. Integral Corp. has assets in excess of $4 million, has 350 stockholders, and has issued common and preferred stock. Integral is subject to the reporting provisions of the Securities Exchange Act of 1934. For its 2008 fiscal year, Integral filed the following with the SEC: quarterly reports, an annual report, and a periodic report listing newly appointed officers of the corporation. Integral did not notify the SEC of stockholder “short swing” profits; did not report that a competitor made a tender offer to Integral’s stockholders; and did not report changes in the price of its stock as sold on the New York Stock Exchange. Under SEC reporting requirements, which of the following was Integral required to do?

a. Report the tender offer to the SEC.

b. Notify the SEC of stockholder “short swing” profits.

c. File the periodic report listing newly appointed officers.

d. Report the changes in the market price of its stock.

30. Which of the following factors, by itself, requires a corporation to comply with the reporting requirements of the Securities Exchange Act of 1934?

a. Six hundred employees.

b. Shares listed on a national securities exchange.

c. Total assets of $2 million.

d. Four hundred holders of equity securities.

31. The registration provisions of the Securities Exchange Act of 1934 require disclosure of all of the following information except the

a. Names of owners of at least 5% of any class of nonexempt equity security.

b. Bonus and profit-sharing arrangements.

c. Financial structure and nature of the business.

d. Names of officers and directors.

32. Under the Securities Act of 1933, which of the following statements is correct concerning a public issuer of securities who has made a registered offering?

a. The issuer is required to distribute an annual report to its stockholders.

b. The issuer is subject to the proxy rules of the SEC.

c. The issuer must file an annual report (Form 10-K) with the SEC.

d. The issuer is not required to file a quarterly report (Form 10-Q) with the SEC, unless a material event occurs.

33. Which of the following persons is not an insider of a corporation subject to the Securities Exchange Act of 1934 registration and reporting requirements?

a. An attorney for the corporation.

b. An owner of 5% of the corporation’s outstanding debentures.

c. A member of the board of directors.

d. A stockholder who owns 10% of the outstanding common stock.

34. The Securities Exchange Commission promulgated Rule 10b-5 from power it was given the Securities Exchange Act of 1934. Under this rule, it is unlawful for any person to use a scheme to defraud another in connection with the

Purchase of any security Sale of any security
a. Yes Yes
b. Yes No
c. No Yes
d. No No

35. The antifraud provisions of Rule 10b-5 of the Securities Exchange Act of 1934

a. Apply only if the securities involved were registered under either the Securities Act of 1933 or the Securities Exchange Act of 1934.

b. Require that the plaintiff show negligence on the part of the defendant in misstating facts.

c. Require that the wrongful act must be accomplished through the mail, any other use of interstate commerce, or through a national securities exchange.

d. Apply only if the defendant acted with intent to defraud.

Items 36 through 38 are based on the following:

Link Corp. is subject to the reporting provisions of the Securities Exchange Act of 1934.

36. Which of the following situations would require Link to be subject to the reporting provisions of the 1934 Act?

Shares listed on a national securities exchange More than one class of stock
a. Yes Yes
b. Yes No
c. No Yes
d. No No

37. Which of the following documents must Link file with the SEC?

Quarterly reports (Form 10-Q) Proxy Statements
a. Yes Yes
b. Yes No
c. No Yes
d. No No

38. Which of the following reports must also be submitted to the SEC?

Report by any party making a tender offer to purchase Link’s stock Report of proxy solicitations by Link stockholders
a. Yes Yes
b. Yes No
c. No Yes
d. No No

39. Which of the following events must be reported to the SEC under the reporting provisions of the Securities Exchange Act of 1934?

image

40. Adler, Inc. is a reporting company under the Securities Exchange Act of 1934. The only security it has issued is voting common stock. Which of the following statements is correct?

a. Because Adler is a reporting company, it is not required to file a registration statement under the Securities Act of 1933 for any future offerings of its common stock.

b. Adler need not file its proxy statements with the SEC because it has only one class of stock outstanding.

c. Any person who owns more than 10% of Adler’s common stock must file a report with the SEC.

d. It is unnecessary for the required annual report (Form 10-K) to include audited financial statements.

41. Which of the following is correct concerning financial statements in annual reports (Form 10-K) and quarterly reports (Form 10-Q)?

a. Both Form 10-K and Form 10-Q must be audited by independent public accountants and both must be filed with the SEC.

b. Both Form 10-K and Form 10-Q must be audited by independent public accountants but neither need be filed with the SEC.

c. Although both Form 10-K and Form 10-Q must be filed with the SEC, only Form 10-K need be audited by independent public accountants.

d. Form 10-K must be audited by independent public accountants and must also be filed with the SEC; however, Form 10-Q need not be audited by independent public accountants nor filed with the SEC.

42. Burk Corporation has issued securities that must be registered with the Securities Exchange Commission under the Securities Exchange Act of 1934. A material event took place yesterday, that is, there was a change in the control of Burk Corporation. Which of the following statements is correct?

a. Because of this material event, Burk Corporation is required to file with the SEC, Forms 10-K and 10-Q.

b. Because of this material event, Burk Corporation is required to file Form 8-K.

c. Burk Corporation need not file any forms with the SEC concerning this material event if the relevant facts are fully disclosed in the audited financial statements.

d. Burk Corporation need not file any form concerning the material event if Burk Corporation has an exemption under Rules 504, 505, or 506 of Regulation D.

C. The Sarbanes-Oxley Act of 2002

43. Under the Sarbanes-Oxley Act which of the following officers must periodically certify that reports comply fully with relevant securities laws and also fairly present the financial condition of company in all material aspects?

a. The chairman of the board and the chief executive officer.

b. The secretary and the chief executive officer.

c. The chief financial officer and the chief executive officer.

d. The chief risk officer and the chief executive officer.

D. The Wall Street Reform and Consumer Protection (Dodd-Frank) Act of 2010

44. Which of the following is not an aspect of the Wall Street Reform and Consumer Protection (Dodd-Frank) Act of 2010?

a. The act increased the regulation of insurance companies.

b. The act prohibits banks from engaging in proprietary trading.

c. The act puts limits on the compensation of corporate chief executive officers.

d. The act requires mortgage originators to retain an economic interest in a portion of the credit risk of any securitized asset that they create and sell.

45. The Wall Street Reform and Consumer Protection (Dodd-Frank) Act of 2010 requires

a. All members of the compensation committee of the board of directors to be independent.

b. All members of the corporate governance committee of the board of directors to be independent.

c. All voting members of the board of directors to be independent.

d. All members of the risk management committee of the board of directors to be independent.

Multiple-Choice Answers and Explanations

Answers

image

Explanations

1. (d) A preliminary prospectus is usually called a “red-herring” prospectus. The preliminary prospectus indicates that a registration statement has been filed but has not become effective.

2. (d) Securities include debentures, stocks, bonds, some notes, and investment contracts. The main idea is that the investor intends to make a profit on the investment through the efforts of others. A certificate of deposit is a type of commercial paper, not a security.

3. (d) A tombstone advertisement is allowed to inform potential investors that a prospectus for the given company is available. It is not an offer to sell or the solicitation of an offer to buy the securities. Answer (a) is incorrect because the tombstone ad informs potential purchasers of the prospectus and cannot be used as a substitute for the prospectus. Answer (b) is incorrect because it informs of the availability of the prospectus and cannot be construed as an offer to sell securities. Answer (c) is incorrect because the tombstone ad notifies potential purchasers of the prospectus. It does not notify that the securities have been withdrawn from the market.

4. (b) The registration of securities under the Securities Act of 1933 has as its purpose to provide potential investors with full and fair disclosure of all material information relating to the issuance of securities, including such information as the principal purposes for which the offering’s proceeds will be used. Answer (a) is incorrect because information on the stockholders of the offering corporation is not required to be reported. Answer (c) is incorrect because the SEC does not guarantee the accuracy of the registration statements. Answer (d) is incorrect because although the SEC does seek to compel full and fair disclosure, it does not evaluate the securities on merit or value, or give any assurances against loss.

5. (a) If no exemption is applicable under the Securities Act of 1933, public offerings must be registered with the SEC accompanied by a prospectus. Answer (b) is incorrect because the SEC does not pass on nor rate the securities. Answer (c) is incorrect because the prospectus is given to prospective purchasers of the securities. Answer (d) is incorrect because the SEC does not pass on the merits or accuracy of the prospectus.

6. (a) Notes are exempt securities under the Securities Act of 1933 if they have a maturity of nine months or less and if they are also used for commercial purposes rather than investments. The actual dollar amounts in the question are not a factor. The notes described in II are not exempt for two reasons; they have a maturity of two years and are used for investment purposes. The notes in III are not exempt because the maturity is two years even though they are for commercial purposes.

7. (d) Whether the securities are exempt from registration or not, they are still subject to the antifraud provisions of the Securities Act of 1933.

8. (d) The definition of a security is very broad under the Securities Act of 1933. The basic idea is that the investor intends to make a profit through the efforts of others rather than through his/her own efforts. Notes, bond certificates of interest, and debentures are all considered securities.

9. (b) If an issuer of securities wants to make an offering by using shelf registration, the actual issuance takes place over potentially a long period of time. Therefore, s/he must keep the original registration statement updated. There is no requirement that the offeror must be a first-time issuer of securities.

10. (d) Under the 1933 Act, certain securities are exempt. Although insurance and annuity contracts are exempt, securities issued by the insurance companies are not. Answer (a) is incorrect because securities of nonprofit organizations are exempt. Answer (b) is incorrect because securities issued by or guaranteed by domestic government organizations are exempt. Answer (c) is incorrect because securities issued by savings and loan associations are exempt.

11. (b) Securities exchanged for other securities by the issuer exclusively with its existing shareholders are exempt from registration under the 1933 Act as long as no commission is paid and both sets of securities are issued by the same issuer. Answer (a) is incorrect because nonvoting common stock is not exempted under the Act. The amount of the par value is irrelevant. Answer (c) is incorrect because although the securities of governments are themselves exempt, the limited partnership interests are not. Answer (d) is incorrect because no such exemption is allowed.

12. (d) Even though the issuer may comply with the Federal Securities Act of 1933, it must also comply with any applicable state “blue-sky” laws that regulate the securities at the state level. Answer (a) is incorrect because it is unlawful for the company to offer or sell the securities prior to the effective registration date. Answer (b) is incorrect because registration becomes effective on the twentieth day after filing unless the SEC issues a stop order. Answer (c) is incorrect because a prospectus is any notice, circular, advertisement, letter, or communication offering the security for sale. No general offering or solicitation is allowed under Rules 505 or 506 of Regulation D whether the purchaser is accredited or not.

13. (a) Even if the securities are exempt under the Securities Act of 1933, they are still subject to the antifraud provisions. Both the person defrauded and the SEC can challenge the fraud committed in the course of selling the securities.

14. (c) The SEC adopted the Forms S-2 and S-3 to decrease the work that issuers have in preparing registration statements by permitting them to give less detailed disclosure under certain conditions than Form S-1 which is the basic long form. Answer (a) is incorrect because these forms decrease, not increase, reporting required. Answer (b) is incorrect because when permitted, these forms are used instead of Form S-1 which is the standard long-form registration statement. Answer (d) is incorrect because the purpose of the forms was not directed at intrastate issues.

15. (c) The issuance described in I is exempt because Rule 504 exempts an issuance of securities up to $1,000,000 sold in a 12-month period to any number of investors. The issuer is not required to restrict the purchasers’ resale. The issuance described in II is also exempt because Rule 505 exempts an issuance up to $5,000,000 sold in a 12-month period. It permits sales to 35 unaccredited investors and to any number of accredited investors. Since there were only 10 investors, this is met. The issuer also restricted the purchasers’ right to resell for two years as required.

16. (d) Under Regulation D, Rule 504 exempts an issuance of securities up to $1,000,000 sold in a 12-month period. Rule 505 exempts an issuance of up to $5,000,000 in a 12-month period. So Rule 506 has to be resorted to for amounts over $5,000,000. Regulation A can be used only for issuances up to $1,500,000.

17. (d) When more than $5,000,000 in securities are being offered, an exemption from the registration requirements of the Securities Act of 1933 is available under Rule 506 of Regulation D. Securities under the Act include debentures and investment contracts.

18. (a) Under Regulation A of the 1933 Act, the issuer must file an offering circular with the SEC. Answer (b) is incorrect because the rules involving sales to unaccredited and accredited investors are in Regulation D, not Regulation A. Answer (c) is incorrect because although financial information about the corporation must be provided to offerees, the financial statements in the offering circular need not be audited. Answer (d) is incorrect because the issuer is not required to provide investors with a proxy registration statement under Regulation A.

19. (c) Sales or offers to sell by any person other than an issuer, underwriter, or dealer are exempt under the 1933 Act. Answer (a) is incorrect because the Act covers all types of securities including preferred stock. Answer (b) is incorrect because closely held corporations are not automatically exempt. Answer (d) is incorrect because debentures, as debt securities, are covered under the Act even if they are highly rated or backed by collateral.

20. (b) Regulation D of the Securities Act of 1933 establishes three important exemptions in Rules 504, 505, and 506. Although Rules 505 and 506 have some restrictions on sales to nonaccredited investors, all three rules under Regulation D allow sales to both nonaccredited and accredited investors with varying restrictions. Answer (a) is incorrect because although Rules 505 and 506 allow sales to up to 35 nonaccredited investors, all three rules allow sales to an unlimited number of accredited investors. Answer (c) is incorrect because Rule 506 has no dollar limitation. Rule 505 has a $5,000,000 limitation in a 12-month period and Rule 504 has a $1,000,000 limitation in a 12-month period. Answer (d) is incorrect because Regulation D is not restricted to only small corporations.

21. (c) Under Rule 505 of Regulation D, the issuer must notify the SEC of the offering within 15 days after the first sale of the securities. Answer (a) is incorrect because under Rule 505, the issuer may sell to an unlimited number of accredited investors and to 35 unaccredited investors. Answer (b) is incorrect because no general offering or solicitation is permitted. Answer (d) is incorrect because the accredited investors need not receive any formal information. The unaccredited investors, however, must receive a formal registration statement that gives a description of the offering.

22. (b) The private placement exemption permits sales of an unlimited number of securities for any dollar amount when sold to accredited investors. This exemption also allows sales to up to 35 nonaccredited investors if they are also sophisticated investors under the Act. Resales of these securities are restricted for two years after the date that the issuer sells the last of the securities. Answer (a) is incorrect because there is no such restriction of sale. Answer (c) is incorrect because sales may be made to an unlimited number of accredited investors and up to 35 nonaccredited investors. Answer (d) is incorrect because sales can be made to up to 35 nonaccredited investors.

23. (a) When the issuer is a resident of that state, doing 80% of its business in that state, and only sells or offers the securities to residents of the same state, the offering qualifies for an exemption under the 1933 Act as an intrastate issue. Answer (b) is incorrect as the offering also qualifies for an exemption under the 1934 Act. Therefore, as the offering is exempted from both the 1933 and 1934 Acts, it would not be regulated by the SEC. Answer (d) is incorrect because resales can only be made to residents of that state nine months after the issuer’s last sale.

24. (b) Rule 506 permits sales to 35 unaccredited investors and to an unlimited number of accredited investors. The unaccredited investors must also be sophisticated investors (i.e., individuals with knowledge and experience in financial matters).

25. (b) Under Regulation A, an offering statement is required instead of the more costly disclosure requirements of full registration under the Securities Act of 1933. Answer (a) is incorrect because not all intrastate offerings are exempt. They must meet specified requirements to be exempt. Answer (c) is incorrect because many securities sold under Regulation D cannot be resold for two years. Answer (d) is incorrect because there is no such exemption for stockbroker transactions.

26. (d) Under Rule 504 of Regulation D, general offerings and solicitations are permitted. Also, the issuer need not restrict the purchasers’ right to resell. Note that both I and II are requirements of Rules 505 and 506 of Regulation D.

27. (c) Under the Securities Exchange Act of 1934, issuers of securities registered under this Act must file quarterly reports (Form 10-Q) for the first three quarters of each fiscal year. The financial data in these may be unaudited; however, material misinformation is a violation of the 1934 Act. Answer (a) is incorrect—the Federal Trade Commission Act does not apply to this action. Answer (b) is incorrect because the Securities Act of 1933 applies to the initial issuance of securities and not to the secondary market of publicly traded securities. Answer (d) is incorrect because NAFTA is an agreement designed to promote free trade between the US, Mexico, and Canada.

28. (b) Purposes of Section 10(b) of the Securities Exchange Act of 1934 include deterring fraud in the securities industry and encouraging disclosure of relevant information so investors can make better decisions. The SEC does not rate the securities.

29. (c) Under the Securities Exchange Act of 1934, issuers of securities registered under this Act must file annual and quarterly reports with the SEC. The company must also file current reports covering certain material events such as a change in the amount of issued securities, a change in corporate control, or a change in newly appointed officers. Answer (a) is incorrect because a competitor’s making a tender offer need not be reported to the SEC. Answer (b) is incorrect because Integral Corp. need not notify the SEC of stockholder “short swing profits.” Answer (d) is incorrect because the company need not report information on the market price of its stock to the SEC. This market price information is already public information because the stock is traded on the New York Stock Exchange.

30. (b) Securities must be registered with the SEC if they are traded on any national securities exchange. Securities must also be registered if they are traded in interstate commerce where the corporation has more than $10 million in assets and 500 or more shareholders.

31. (a) The Securities Exchange Act of 1934 has registration provisions that require specified disclosures including bonus and profit-sharing arrangements, the financial structure and nature of this business, and names of officers and directors.

32. (c) Under the Federal Securities Act of 1933, which incorporates the filing requirements of the Federal Securities Exchange Act of 1934, the issuer must file with the SEC an annual report on Form 10-K. Answer (a) is incorrect because the issuer must file the annual report with the SEC but is not required to distribute it to its stockholders. Answer (b) is incorrect because the solicitation of proxies triggers certain proxy solicitation rules. Answer (d) is incorrect because it is the current report on Form 8-K that is filed when material events occur. The Form 10-Q is filed each of the first three quarters of each year and is known as the quarterly report.

33. (b) Under the 1934 Act, insiders include officers and directors of the corporation as well as owners of 10% or more of the stock of the corporation. Accountants, attorneys, and consultants can also be insiders subject to further regulation under the 1934 Act. Creditors, that is, owners of debentures are not considered to be insiders.

34. (a) Under Rule 10b-5, it is unlawful to use schemes to defraud in connection with the purchase or sale of any security. Note that this rule was made from powers given the SEC under the Securities Exchange Act of 1934, which applies to purchases in addition to sales of securities.

35. (c) For the Securities Exchange Act of 1934 to apply, including the antifraud provisions of Rule 10b-5, there must be shown a federal constitutional basis such as use of the mail, interstate commerce, or a national securities exchange. Answer (a) is incorrect because the antifraud provisions apply whether or not the securities had to be registered under either the 1933 Act or the 1934 Act. Answer (b) is incorrect because under Rule 10b-5, the plaintiff must prove more than negligence (i.e., either knowledge of falsity or reckless disregard for the truth in misstating facts). Answer (d) is incorrect because the plaintiff could recover if the defendant acted with reckless disregard for the truth.

36. (b) If the shares are listed on a national securities exchange, they are subject to the reporting provisions of the 1934 Act. There is no provision concerning a corporation owning more than one class of stock that by itself requires that it be subject to the reporting provisions of the 1934 Act.

37. (a) Under the 1934 Act, Link must file with the SEC annual reports (Form 10-K), quarterly reports (Form 10-Q), current reports (Form 8-K) of certain material events, and proxy statements when proxy solicitations exist.

38. (a) When there is a proxy solicitation, Link must make a report of this to the SEC. Also, reports of tender offers to purchase securities need to be submitted to the SEC.

39. (a) A tender offer is a request to the shareholders of a given company to tender their shares for a stated price. If the tender offer was unsolicited, the corporation must report this to the SEC under the reporting provisions of the Securities Exchange Act of 1934. Also, trading by insiders such as officers, directors, or shareholders owning at least 10% of the stock of a corporation registered with the SEC must also be reported to the SEC under the 1934 Act. Likewise, solicitation of proxies must be reported to the SEC.

40. (c) Under the Securities Exchange Act of 1934 which applies if interstate commerce or the mail is used, any purchaser of more than 5% of a class of equity securities must file a report with the SEC. Answer (d) is incorrect because the required annual report (Form 10-K) must be certified by independent public accountants. Answer (a) is incorrect because each company must also comply with the filing requirements under the Securities Act of 1933. Answer (b) is incorrect because there is no exemption from filing proxy statements simply because the company has only one class of stock.

41. (c) Forms 10-K (annual reports) and 10-Q (quarterly reports) must be filed with the SEC. Forms 10-K containing financial statements must be audited by independent public accountants. However, this is not true of Forms 10-Q which cover the first three fiscal quarters of each fiscal year of the issuer. The financial statements in 10-Qs must be reviewed by public accountants.

42. (b) When certain material events take place, such as a change in corporate control, the corporation covered under the 1934 Act must file Form 8-K, a current report, with the SEC within four days after the material event occurs. Answer (a) is incorrect because Burk Corporation must file Forms 10-K, annual reports, and Forms 10-Q, quarterly reports, whether or not a material event has taken place. Answer (c) is incorrect because there is no such exception provided. Answer (d) is incorrect because Rules 504, 505, and 506 under Regulation D apply to the initial issuance of securities under the Securities Act of 1933 and do not relieve Burk Corporation from the filing requirements with the SEC under the 1934 Act.

43. (c) The requirement is to identify the officers that must certify to financial reports under the Sarbanes-Oxley Act. Answer (c) is correct because the chief financial officer and the chief executive officer must certify.

44. (c) The requirement is to identify the item that is not an aspect of the Wall Street Reform and Consumer Protection Act of 2010. Answer (c) is correct because the act does not put limits on CEO compensation. Answers (a), (b), and (d) are incorrect because they are all aspects of the Dodd-Frank Act.

45. (a) The requirement is to identify the requirement of the Dodd-Frank Act of 2010. Answer (a) is correct because the Dodd-Frank Act requires all members of the compensation committee to be independent. Answers (b), (c), and (d) are incorrect because they are not requirements of the Act.

Simulations

Task-Based Simulation 1

image

Situation

You will have 15 questions based on the following information:

Butler Manufacturing Corp. planned to raise capital for a plant expansion by borrowing from banks and making several stock offerings. Butler engaged Weaver, CPA, to audit its December 31, 2009 financial statements. Butler told Weaver that the financial statements would be given to certain named banks and included in the prospectuses for the stock offerings.

In performing the audit, Weaver did not confirm accounts receivable and, as a result, failed to discover a material overstatement of accounts receivable. Also, Weaver was aware of a pending class action product liability lawsuit that was not disclosed in Butler’s financial statements. Despite being advised by Butler’s legal counsel that Butler’s potential liability under the lawsuit would result in material losses, Weaver issued an unqualified opinion on Butler’s financial statements.

In May 2010, Union Bank, one of the named banks, relied on the financial statements and Weaver’s opinion in giving Butler a $500,000 loan.

Butler raised an additional $16,450,000 through the following stock offerings, which were sold completely:

  • June 2010—Butler made a $450,000 unregistered offering of Class B nonvoting common stock under Rule 504 of Regulation D of the Securities Act of 1933. This offering was sold over one year to 20 accredited investors by general solicitation. The SEC was notified eight days after the first sale of this offering.
  • September 2010—Butler made a $10,000,000 unregistered offering of Class A voting common stock under Rule 506 of Regulation D of the Securities Act of 1933. This offering was sold over one year to 200 accredited investors and 30 nonaccredited investors through a private placement. The SEC was notified 14 days after the first sale of this offering.
  • November 2010—Butler made a $6,000,000 unregistered offering of preferred stock under Rule 505 of Regulation D of the Securities Act of 1933. This offering was sold during a one-year period to forty nonaccredited investors by private placement. The SEC was notified 18 days after the first sale of this offering.

Shortly after obtaining the Union loan, Butler began experiencing financial problems but was able to stay in business because of the money raised by the offerings. Butler was found liable in the product liability suit. This resulted in a judgment Butler could not pay. Butler also defaulted on the Union loan and was involuntarily petitioned into bankruptcy. This caused Union to sustain a loss and Butler’s stockholders to lose their investments. As a result

  • The SEC claimed that all three of Butler’s offerings were made improperly and were not exempt from registration.
  • Union sued Weaver for
    • Negligence
    • Common Law Fraud
  • The stockholders who purchased Butler’s stock through the offerings sued Weaver, alleging fraud under Section 10(b) and Rule 10b-5 of the Securities Exchange Act of 1934.

These transactions took place in a jurisdiction providing for accountant’s liability for negligence to known and intended users of financial statements.

Items 1 through 5 are questions related to the June 2010 offering made under Rule 504 of Regulation D of the Securities Act of 1933. For each item, indicate your answer by choosing either Yes or No.

Yes No
1. Did the offering comply with the dollar limitation of Rule 504? image image
2. Did the offering comply with the method of sale restrictions? image image
3. Was the offering sold during the applicable time limit? image image
4. Was the SEC notified timely of the first sale of the securities? image image
5. Was the SEC correct in claiming that this offering was not exempt from registration? image image

Items 6 through 10 are questions related to the September 2010 offering made under Rule 506 of Regulation D of the Securities Act of 1933. For each item, indicate your answer by choosing either Yes or No.

Yes No
6. Did the offering comply with the dollar limitation of Rule 506? image image
7. Did the offering comply with the method of sale restrictions? image image
8. Was the offering sold to the correct number of investors? image image
9. Was the SEC notified timely of the first sale of the securities? image image
10. Was the SEC correct in claiming that this offering was not exempt from registration? image image
10. Was the SEC correct in claiming that this offering was not exempt from registration? image image

Items 11 through 15 are questions related to the November 2010 offering made under Rule 505 of Regulation D of the Securities Act of 1933. For each item, indicate your answer by choosing either Yes or No.

Yes No
11. Did the offering comply with the dollar limitation of Rule 505? image image
12. Was the offering sold during the applicable time limit? image image
13. Was the offering sold to the correct number of investors? image image
14. Was the SEC notified timely of the first sale of the securities? image image
15. Was the SEC correct in claiming that this offering was not exempt from registration? image image

Task-Based Simulation 2

image

Situation

Coffee Corp., a publicly held corporation, wants to make an $8,000,000 exempt offering of its shares as a private placement offering under Regulation D, Rule 506, of the Securities Act of 1933. Coffee has more than 500 shareholders and assets in excess of $1 billion, and has its shares listed on a national securities exchange.

Items 1 through 5 relate to the application of the provisions of the Securities Act of 1933 and the Securities Exchange Act of 1934 to Coffee Corp. and the offering. For each item, select from List II whether only statement I is correct, whether only statement II is correct, whether both statements I and II are correct, or whether neither statement I nor II is correct.

List II

A. I only
B. II only
C. Both I and II
D. Neither I nor II
image
image

Simulation Solutions

Task-Based Simulation 1

image
Yes No
1. Did the offering comply with the dollar limitation of Rule 504? image image
2. Did the offering comply with the method of sale restrictions? image image
3. Was the offering sold during the applicable time limit? image image
4. Was the SEC notified timely of the first sale of the securities? image image
5. Was the SEC correct in claiming that this offering was not exempt from registration? image image

Explanations

1. (Y) Rule 504 exempts an issuance of securities up to $1,000,000 sold in a 12-month period to any number of investors. Butler made the offering for $450,000.

2. (Y) This offering involved a general solicitation which is now allowed under Rule 504 providing the solicitation is to only accredited investors.

3. (Y) This offering was sold over the applicable 12-month period in Rule 504.

4. (Y) The SEC was sent notice of this offering eight days after the first sale. Under Rule 504, the SEC must be notified within 15 days of the first sale of the securities.

5. (N) Even though this stock was sold by general solicitation, this is allowed under Rule 504.

Yes No
6. Did the offering comply with the dollar limitation of Rule 506? image image
7. Did the offering comply with the method of sale restrictions? image image
8. Was the offering sold to the correct number of investors? image image
9. Was the SEC notified timely of the first sale of the securities? image image
10. Was the SEC correct in claiming that this offering was not exempt from registration? image image

Explanations

6. (Y) Rule 506 allows private placement of an unlimited dollar amount of securities.

7. (Y) These securities were sold through private placement which is appropriate under Rule 506.

8. (Y) Rule 506 allows sales to up to 35 nonaccredited investors who are sophisticated investors with knowledge and experience in financial matters. It allows sales to an unlimited number of accredited investors.

9. (Y) The SEC was notified 14 days after the first sale of the offering which is within the 15-day rule.

10. (N) Since this offering met the requirements discussed in 6. through 9. above, the SEC was incorrect.

Yes No
11. Did the offering comply with the dollar limitation of Rule 505? image image
12. Was the offering sold during the applicable time limit? image image
13. Was the offering sold to the correct number of investors? image image
14. Was the SEC notified timely of the first sale of the securities? image image
15. Was the SEC correct in claiming that this offering was not exempt from registration? image image

Explanations

11. (N) Rule 505 exempts an issuance of securities up to $5,000,000. Butler made a $6,000,000 unregistered offering of preferred stock.

12. (Y) The offering was sold during the applicable 12-month period.

13. (N) Rule 505 permits sales to 35 nonaccredited investors. Butler went over this limit by selling to 40 nonaccredited investors.

14. (N) The SEC was notified 18 days after the first sale of this offering which is over the 15-day requirement.

15. (Y) This offering was not exempt from registration because it went over the $5,000,000 limit and the stock was sold to more than 35 nonaccredited investors.

Task-Based Simulation 2

image
image

Explanations

1. (A) Statement I is correct because under Regulation D, Rule 506, the corporation may make a private placement of an unlimited amount of securities if it meets certain requirements. Statement II is incorrect. Coffee Corp. may still make an exempt offering under the Securities Act of 1933 even if it will be subject to the requirements of the Securities Exchange Act of 1934.

2. (B) Statement I is incorrect because up to 35 nonaccredited investors may purchase shares under Regulation D, Rule 506, if they are sophisticated investors. Statement II is correct because Rule 506 does allow sales to up to 35 nonaccredited investors assuming they are also sophisticated investors, that is, individuals with knowledge and experience in financial matters, or individuals represented by people with such knowledge and experience.

3. (B) Statement I is incorrect and Statement II is correct for the same reason. Regulation D, Rule 506, has no dollar limit on the placement of securities as long as other requirements are met.

4. (B) Statement I is incorrect because Regulation D has no requirements putting restrictions on resales to nonresidents. Statement II is correct because Regulation D requires that the issuer take reasonable steps to see that purchasers of the exempt offering are not underwriters and are buying for investment.

5. (D) Statement I is incorrect. Under Regulation D, the SEC must be notified within fifteen days of the first sale of the securities. Statement II is incorrect because the Quarterly Reports do not require SEC notification of the first sale of exempt securities.

..................Content has been hidden....................

You can't read the all page of ebook, please click here login for view all page.
Reset
3.147.47.166