Introduction. Learning Objectives. Slide 1 F I F T E E N T H E D I T I O N. Slide 2. Slide 3

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1 Slide 1 F I F T E E N T H E D I T I O N TheLegal & Regulatory Environment of Business Chapter 15 Sarbanes-Oxley and Securities Regulations REED SHEDD PAGNATTARO MOREHEAD McGraw-Hill/Irwin Copyright 2010 by The McGraw-Hill Companies, Inc. All rights reserved. Slide 2 Introduction Securities regulation began due to Great Depression of 1930 s Designed to give potential investors factual information to make informed decision Federal & state laws Substantially modified by Sarbanes-Oxley (2002) 15-2 Slide 3 Learning Objectives To understand the meaning of the term securities. To appreciate the broad scope of the securities laws and regulations. To learn about how the Sarbanes-Oxley Act impacts businesses. To comprehend the difference between a public offering and subsequent securities transactions and how the law cover all these dealings. To grasp how private individuals and organizations make claims to enforce securities laws. 15-3

2 Slide 4 Securities Act Securities Exchange Act Securities Laws Insider Trading & Sec. Fraud Securities Enforcement Remedies Act Sarbanes- Oxley Slide 5 What is a Security? Exists When Person invests Others manage it for profit Questions: Common business activity? Reasonable expectation of profit? Profits earned through efforts of someone else? 15-5 Slide 6 Securities & Exchange Commission Created in commissioners Quasi-Legislative & Quasi-Judicial Regulates Stock exchanges Utility holding companies Investment trusts Investment advisors 15-6

3 Slide 7 Sarbanes-Oxley Act Congress increased SEC authority Increased budget More investigative & enforcement staff Increased authority over governance issues 15-7 Slide 8 Sarbanes-Oxley Accounting Reforms Creates public company accounting oversight board Separation of auditing and consulting in accounting firms Auditing firms must refrain from certain nonauditing functions 15-8 Slide 9 Sarbanes-Oxley and Corporate Governance Increase independence of auditors Maintain trust of Public & Corp. SH At least one member of audit committee to be financial expert Auditor reports to audit committee Preserve audit records 7 years. 15-9

4 Slide 10 Financial Statements & Controls Under Sarbanes-Oxley Most controversial CEO & CFO to certify accuracy of quarterly & annual financials Subject to independent auditor review Execs must return bonuses paid as result of incorrect financials Slide 11 Sarbanes-Oxley & Securities Fraud Strengthened securities fraud punishment Created crime of conspiring to commit securities fraud Whistleblower protection Slide 12 Securities Act of 1933 Disclosure law- going public Sanctions of violations - intentional Criminal punishment Civil liability for injured parties Injunction - equitable remedy Parties regulated Issuers Underwriters Controlling persons Sellers 15-12

5 Slide 13 Documents Required For Securities Sale Registration statement Disclosure of financial info. Prefiling period Waiting period- 20 days, tombstone ad Posteffective period Prospectus- final financials Provided to interested investor Detailed facts about issues Financial information Slide 14 Registration Statement Liability Criminal penalty for willful violation or fraud (civil also possible) Fraud Untrue statements of material fact Omits material facts Omits information resulting in misleading potential investor Slide 15 Fraudulent Transactions Attempt to defraud Attempt to obtain money/property by untrue/misleading statements Attempt to engage in transaction/practice to defraud/deceive purchaser 15-15

6 Slide 16 Security Transaction Defenses Materiality - prudent investor would use Statute of limitations - 1 year after discovery, no more than 3 years Due diligence - reasonable review of financials Slide 17 Securities Exchange Act of 1934 Regulated transfers of securities after initial sale Being public- file forms with: Stock exchange SEC- periodic reports Affects Businessperson Accountant Lawyer Investor Slide 18 Antifraud Provisions Section 10(b) & Rule 10b.5- Unlawful to use mails or interstate commerce on national securities exchange to defraud in security transaction Persons liable Insiders Broker-Dealers Corporations who s stock purchased/sold Those who aid/abet/conspire to defraud 15-18

7 Slide 19 Securities Settlements $335 Mil. Ernst & Young 2000 $300 Mil. Ernst & Young 2008 $225 Mil. PWC Slide 20 Rule 10b-5 Damages Plaintiff must prove Out-of-pocket losses Excess of paid and received Measured at time of purchase Slide 21 Materiality under Section 10(b) Plaintiff must establish existence of a material misrepresentation or omission in connection with purchase or sale of a security

8 Slide 22 Insider Transactions Short-swing profits Insider Non-public information Civil & criminal liability Owns more than 10% Director/Officer Insiders must file within 10 days Slide 23 Securities Class Action $7.2 Bil. $6.2 Bil. $3.2 Bil. Enron 2006 WorldCom 2005 Tyco Slide 24 Private Securities Litigation Reform Act (1995) Only SEC can sue 3d parties not directly responsible for securities violations. Private plaintiff must allege sclenter (knowledge) of company or executives Private damages limited 15-24

9 Slide 25 State Blue Sky Laws Registration by Notification Qualification Coordination Exemptions Isolated transaction Limited offer within stated time Private offering Number of holders not greater than specified 15-25