Legal Issues in Finance

1
Legal Issues in Finance
2

• Securities Act of 1933
• Securities Exchange Act of 1934
• Theft Theft by deception
• Theft by misappropriation
• Fraud
• Racketeer Influenced and Corrupt Organizations
  Act. (1970)

3

• Regulation FD
• Sarbanes-Oxley Act of 2002
• Corporate Directors and Officers Duties
• (Business Judgment Rule)

4
Securities Act of 1933

• Objective To provide prospective investors with
  accurate, complete, and detailed information
  about new offerings of securities.

5
Securities Act of 1933

• Requires that all new issues of securities sold
  in interstate commerce must be registered with
  the SEC before sale, unless exempted.
  Registration includes certified financial
  statements and prospectus. Prospectus must also
  be given to each new purchaser.

6
Civil and Criminal Penalties for Violation

• a.       Criminal fine and/or imprisonment.
  Fines up to 10,000 and/or imprisonment up to
  five years.
• b.       Civil Monetary damages to investors
  if there is a failure to register, registration
  statement or prospectus contained materially
  false, misleading factual information, or omitted
  material factual information.

7
Civil and Criminal Penalties for Violation

• Liability extends to Issuer, under writer,
  directors/partners, all signers, and experts
  (accountants and attorneys) who prepared or
  certified part of registration statement.
•  
• Plaintiff need not prove reliance.

8
Securities Exchange Act of 1934

• Regulates ongoing trading of securities after
  issuance.
• 1. Prohibits Fraud
• 2. Requires Corporate Reports to SEC
• 3. Prohibits short-swing profits

9
Reports

• Reporting companies must file
• 1. Annual report, Form 10-K
• 2. Quarterly report, Form 10-Q
• 3. Early warning report, 8-K
• Also Reports to SEC concerning
• 1. Tender offers
• 2. Proxy Solicitation

10
Securities Exchange Act of 1934 Anti-Fraud
(Section 10b and Rule 10b-5)

• Condemns any device, scheme, or artifice to
  defraud.
• 1. Trading on inside information
• 2. Giving or receiving tips based on inside
  information
• 3. Spreading false rumors
• 4.falsely creating the appearance of increased
  trading volume.

11
Insider TradingRule 10b-5

• person with nonpublic confidential, inside
  information, may not use that information when
  trading with a person who does not possess that
  information.
• Insider Officers, directors and anyone who is
  entrusted with corporate information for a
  corporate purpose.
• (Consultant, lawyer, auditor)

12
Insider Trading

• Tippees Recipients of inside information from
  insiders.
• Requires
• Breach of fiduciary duty
• Benefit to tipper
• Tippee aware of breach

13
PENALTIES

• Criminal Penalties for violation. Fines up to 1
  million and /or imprisonment up to 10 years
•  
• Civil. Monetary damages. SEC can sue for
  violation of insider trading regulations and seek
  triple the amount of profits gained or loss
  avoided by the guilty party
•  

14
Short Swing Profits

• Directors, officers and persons owning 10 or
  more of stock may not make profits or
  avoid losses by trading within six-month period
  of time.

15
Racketeer Influenced and Corrupt Organizations
Act (1970

• Federal Crime to engage in racketeering activity
  in the acquisition, maintenance or conduct of the
  affairs of a business enterprise or to conspire
  to do any racketeering activities.
• Incorporates by reference 26 federal crimes and 9
  state felonies, including securities fraud, mail
  fraud and wire fraud.
• Requires two or more offenses.

16
Racketeer Influenced and Corrupt Organizations
Act (1970

• Penalties
• Criminal - 25,000 per violation
• Up to twenty years imprisonment
• Civil Government Divestiture or dissolution
  of business
• Private Treble damages Attorneys fees

17
Regulation FD (Fair Disclosure)

• Prohibits senior company officials and others who
  regularly communicate with investors or analysts
  from privately disclosing to a few outsiders
  material nonpublic information.
• Outsiders In general, securities market
  professionals or holders of securities who may
  trade on the basis of the information
• Material Information Information is material if
  there is a substantial likelihood that a
  reasonable shareholder would consider it
  important in making an investment decision.
•  

18
Regulation FD (Fair Disclosure)

• Disclosures to news organization, suppliers,
  strategic partners and customers would not be
  covered.
• Private investor cannot sue under the
  Regulation. Only SEC can bring an action for
  noncompliance.

19
Regulation FD (Fair Disclosure)

• If disclosure takes place issuer must make public
  disclosure of same information
• (a) simultaneously (for intentional disclosures),
• (b) promptly (for non-intentional disclosures)
• Methods of disclosure
• 8-k
• Any method reasonably designed to provide broad
  nonexclusionary distribution to the public

20
Sarbanes-Oxley Act of 2002

• The Board will have five financially-literate
  members, appointed for five-year terms. Two of
  the members must be or have been certified public
  accountants, and the remaining three must not be
  and cannot have been CPAs.
• Members of the Board are appointed by the
  Securities and Exchange Commission, "after
  consultation with" the Chairman of the Federal
  Reserve Board and the Secretary of the Treasury.

21
Section 103 Auditing, Quality Control, And
Independence Standards And Rules.

• The Board shall
• (1) register public accounting firms
• (2) establish, or adopt, by rule, "auditing,
  quality control, ethics, independence, and other
  standards relating to the preparation of audit
  reports for issuers"
• (3) conduct inspections of accounting firms
• (4) conduct investigations and disciplinary
  proceedings, and impose appropriate sanctions
• (etc)

22
Standard Setting

• The Board would be required to "cooperate on an
  on-going basis" with designated professional
  groups of accountants and any advisory groups
  convened in connection with standard-setting,

23
Section 104 Inspections of Registered Public
Accounting Firms

• Annual quality reviews (inspections) must be
  conducted for firms that audit more than 100
  issues, all others must be conducted every 3
  years. The SEC and/or the Board may order
• a special inspection of any firm at any time.

24
Section 201 Services Outside The Scope Of
Practice Of Auditors Prohibited Activities.

• It shall be "unlawful" for a registered public
  accounting firm to provide any non-audit
• service to an issuer contemporaneously with the
  audit, including
• (1)bookkeeping or other services related to the
  accounting records or financial statements of the
  audit client
• (2)financial information systems design and
  implementation
• (3) appraisal or valuation services, fairness
  opinions, or contribution-in-kind reports

25
Section 201 Services Outside The Scope Of
Practice Of Auditors Prohibited Activities.

• (4) actuarial services
• (5) internal audit outsourcing services
• (6) management functions or human resources
• (7) broker or dealer, investment adviser, or
  investment banking services

26
Section 201 Services Outside The Scope Of
Practice Of Auditors Prohibited Activities.

• 8) legal services and expert services unrelated
  to the audit
• (9) any other service that the Board determines,
  by regulation, is impermissible.
• The Board may, on a case-by-case basis, exempt
  from these prohibitions any person, issuer,
  public accounting firm, or transaction, subject t
  review by the Commission.

27
Section 203 Audit Partner Rotation.

• The lead audit or coordinating partner and the
• reviewing partner must rotate off of the audit
• every 5 years.

28
Section 302 Corporate Responsibility For
Financial Reports.

• The CEO and CFO of each issuer shall prepare
• statement to accompany the audit report to
  certify the
• appropriateness of the financial statements and
  disclosures contained in the periodic report, and
  
• that those financial statements and disclosures
  fairly
• present, in all material respects, the
  operations and financial condition of the
  issuer."

29
Section 401(a) Disclosures In Periodic Reports
Disclosures Required.

• Each financial report that is required to be
  prepared in accordance with GAAP shall
• reflect all material correcting adjustments . . .
  that have been identified by a registered
  accounting firm . . . ."
• "Each annual and quarterly financial report . . .
  shall disclose all material off-balance sheet
  transactions" and "other relationships" with
  "unconsolidated entities" that may have a
  material current or future effect on the
  financial condition of the issuer.

30
Section 401(a) Disclosures In Periodic Reports
Disclosures Required.

• The SEC shall issue rules providing that pro
  forma financial information must be presented so
  as not to "contain an untrue statement" or omit
  to state a material fact necessary in order to
  make the pro forma financial information not
  misleading.

31
Title VIII Corporate and Criminal Fraud
Accountability Act of 2002.

• Felony to "knowingly" destroy or create
• documents to "impede, obstruct or influence"
• any existing or contemplated federal
  investigation.
• Auditors are required to maintain "all audit
• or review work papers" for five years.

32

• statute of limitations on securities fraud claims
  is extended to the earlier of five years
• A new crime for securities fraud that has
  penalties of fines and up to 10 year imprisonment.

33
Title IX White Collar Crime Penalty Enhancements

• Maximum penalty for mail and wire fraud increased
  from 5 to 10 years.
• SEC may prohibit anyone convicted of securities
  fraud from being an officer or director of
• any publicly traded company.
• Maximum penalties for willful and knowing
  violations of this section are a fine of not more
  than 5,000,000 and/or imprisonment of up to 20
  years.

34
Directors Duties

• Directors and Officers are considered to be in a
  fiduciary relationship with the Corporation which
  relationship imposes certain duties.
• 1. Obedience
• 2. Due care
• 3. Loyalty

35
BUSINESS JUDGMENT RULE

• Directors and Officers are not liable for
  decisions which adversely affect the Corporation
  so long as they
• 1. Engaged in a reasonable investigation prior
  to making the decision
• 2.  Had no conflicts of interest
• 3.  Had a rational basis for believing the
  decision was in the best interests of the
  company.