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Securities Regulation
Rutgers University, Newark School of Law
Guseva, Yuliya

 
Securities & Market Regulation
Spring 2015
Guseva
 
Intro:
·         Importance of the capital market and investments for the economy
·         Importance of investments to people relative to other decisions people make
·         Something about investments makes people act irrationally
·         Investments are intangible
·         Collective action problems among investors
·         Efficient Capital Market Hypothesis (ECMH)
o   In an efficient market, current prices always and fully reflect all relevant information about commodities being traded.
o   Not just capital markets, but also commodities like wheat and other goods.
·         Common Law Fraud Elements:
o   Material Misrep or omission
o   Scienter
o   Reliance
o   Causation
o   Damages
o   10b-5 adds jurisdiction & transactional nexus
·         Availability of information affects willingness to participate in market
·         Investors discount amount they are willing to pay if information is unavailable
·         Asymmetric information affects willingness to
·         participate
·         Don’t bet against the smart money!
·         Information can be gleaned from trading
·         Fraud affects willingness to participate
·         Purpose of Federal Securities Law
o   Prevent stock market crashes
o   Protect investors from fraudsters
o   HOW?
§  FULL DISCLOSURE
·         Make sure that investors have all the information they need to make informed decisions
§  Prevention of Fraud
§  NOTE: Agency cost problem re: disclosure – how to make disclosure credible?
 
 
 
 
 
 
 
 
 
Present Discount Valuation:
$1.00 today = $1.02 one year from now
·         Interest = compensation for….
o   Deferring consumption
o   Risk of inflation
o   Uncertainty
·         Equation 
o   Best guess of the value of the future return on investment
o   Discount for the:
§  Time value of money
§  Inherent risk of investment
Capital Asset Pricing Model
·         Equation 
o    = Risk-Free Rate
o    = Entire Stock Market Rate
Summary
Investors must be compensated for the time value of money and for bearing risk
Discount rate reflects the level of risk from an investment
Diversification can eliminate firm-specific risks, but not market-wide risks
Disclosure helps investors in:
·         Making an estimate of future cash flows
·         Assessing the risk of the firm relative to the market as a whole (beta)
 
Mandatory Disclosure Arguments:
·         Coordination Problems
·         Agency Cost
·         Positive Externalities
·         Duplicative Research
 
Disclosure matters because:
·         Efficient Capital Market Hypothesis – In an efficient market, current prices always and fully reflect all relevant information about commodities being traded.
·         Not just capital markets, but also commodities like wheat and other goods.
 
Efficient Capital Market Hypothesis
Weak
Semi-Strong
Strong
All info concerning historical prices is fully reflected in the current price.
Current prices incorporate all historical info and all current public info
Prices incorporate all info, whether publically available or not.
Implication: prices change only in response to new info.
Implication: investors can not expect to profit from studying available info because market has already incorporated info accurately into the price.
Implication: if true, no identifiable group can earn systematic positive positive abnormal returns from securities trading. ie: you can’t beat the market.
 
TYPES OF MARKETS & INFORMATION
Weak
Semi-Strong
Strong
TYPES OF EFFICIENCY
Informational
Fundamental (Allocational)
 
Anomalies that make sense:
·         P/E effect
o   Price to earnings ratio
o   Low p/e stocks show positive cumulative abnormal returns
·         Small capitalization stocks
o   Showed positive cumulative abnormal returns (CARs)
·         Both dissipated
Anomalies that don’t make sense:
·         Seasonal effects
o   Stocks show significant positive CARs in January and on Fridays
o   Positive CARs for sunny days in NY
·         Super Bowl effect
o   Years in which a NFC (or pre-merger NFL) team wins the Super Bowl, stocks show positive CARs
Summary:
Efficient market hypothesis is a theory about how information is reflected in securities prices
At least for large exchanges, best evidence thus far supports semi-strong form:
Security price reflects all publicly available information
Price changes occur fairly rapidly (minutes or hours, not days) once information is released to public
Informational efficiency is not the same thing as fundamental efficiency
 
Securities & Exchange Commission
Divisions
Offices
Corporation Finance
General Counsel
Trading & Markets
Chief Accountant
Investment Management
International Affairs
Enforcement
Credit Ratings
Risk Fin
Investor Advocacy & Education
 
 
 
 
 
Materiality
What matters to investors:
·         SA Rule 408 and SEA Rule 12b-20
·

currently proposed transaction, in which the registrant was or is to be a participant and the amount involved exceeds $120,000, and in which any related person had or will have a direct or indirect material interest
Reg S-K 406
Disclose whether the registrant has adopted a code of ethics that applies to the registrant's principal executive officer, principal financial officer, principal accounting officer or controller, or persons performing similar functions. If not, explain why.
The Event Study
An information event date is identified when new information revealing past fraud is made public.
An event window, typically of 1 to 3 days, is constructed around the event date. The expected return that the company in question should receive given overall market movement during the event window is calculated.
The expected return is subtracted from actual return for the company to generate an “abnormal return”.
Given the past variance of returns for the particular company, it is possible to calculate the probability that the abnormal return is in fact statistically different from zero.
 
Efficient Markey Capital Hypothesis:
·         3 levels
·         Things to consider:
o   Abnormal return, or was entire market moving?
o   Confounding disclosures?
o   Litigation costs?
o   Efficient market?
o   Information leakage?
 
Statistics and Materiality
Simple Example:
Establish a “Null” Hypothesis and assume true for now
It is winter today
Look at observable data and compare with what we should expect to see if null hypothesis is true
·         The temperature outside is 100 degrees
·         Suppose in NYC during the winter 95% of the days range in temperature from 10 degrees to 55 degrees
3.      If the observed data is outside the 95% range then we can say that we reject the “Null” hypothesis at the 5% confidence level.
·         NOTE: Does failure to reject the “Null” hypothesis mean that we can accept the “Null” hypothesis? If we observe that the temperature is 50 degrees does this mean that it is definitely winter?