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Chapter 15—Sarbanes-Oxley and
Securities Regulations
REED SHEDD PAGNATTARO MOREHEAD
F I F T E E N T H E D I T I O N
TheLegal & RegulatoryEnvironment of Business
McGraw-Hill/Irwin Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved.
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Slide 2
15-2
IntroductionSecurities 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)
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Slide 3
15-3
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.
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Slide 4
15-4
Securities Laws
Securities
Act
Insider
Trading
& Sec. Fraud
Sarbanes-
Oxley
Securities
Exchange
Act
Securities
Enforcement
Remedies Act
1933
1934
1988
1990
2002
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Slide 5
15-5
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?
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Slide 6
15-6
Securities & Exchange Commission
Regulates Stock exchanges
Utility holding companies
Investment trusts
Investment advisors
Created in 1934-5
5 commissioners
Quasi-Legislative & Quasi-Judicial
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Slide 7
15-7
Sarbanes-Oxley Act
Congress increased SEC authority
Increased budget
More investigative & enforcement
staff
Increased authority over
governance issues
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Slide 8
15-8
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
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Slide 9
15-9
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.
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Slide 10
15-10
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
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Slide 11
15-11
Sarbanes-Oxley & Securities
Fraud
Strengthened securities
fraud punishment
Created crime of
conspiring to commit
securities fraud
Whistleblower
protection
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Slide 12
15-12
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
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Slide 13
15-13
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
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Slide 14
15-14
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
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Slide 15
15-15
Fraudulent Transactions
Attempt to defraud
Attempt to obtain money/property by untrue/misleading statements
Attempt to engage in transaction/practice to defraud/deceive purchaser
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Slide 16
15-16
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
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Slide 17
15-17
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
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Slide 18
15-18
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
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Slide 19
15-19
$335Mil.
$300
Mil.
Ernst & Young
2000
Ernst & Young
2008
Securities Settlements
$225
Mil.
PWC
2007
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Slide 20
15-20
Rule 10b-5 Damages
Plaintiff must prove
Out-of-pocket losses
Excess of paid and received
Measured at time of purchase
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Slide 21
15-21
Materiality under Section 10(b)
Plaintiff must establish
existence of a
material misrepresentation
or omission in connection with
purchase or sale of a security.
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Slide 22
15-22
Insider Transactions
Insider
Owns more than 10%
Director/Officer
Insiders must file within 10 days
Short-swing profits
Non-public information
Civil & criminal liability
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Slide 23
15-23
Securities Class Action
$7.2Bil. $6.2
Bil. $3.2Bil.
Enron
2006
WorldCom
2005
Tyco
2007
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Slide 24
15-24
Only SEC can sue 3d
parties not directly
responsible for
securities violations.
Private Securities Litigation
Private plaintiff must
allege “sclenter”
(knowledge) of company
or executives
Reform Act (1995)
Private damages
limited
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Slide 25
15-25
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
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