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Securities Regulation
St. Thomas University, Minneapolis School of Law
Kaal, Wulf A.

Securities Regulation

Professor Kaal

Fall 2011

CHAPTER 1. Introduction to the Securities Markets and Securities Regulation

I. The Basics

A. The Marginal Utility of Capital Doctrine

1. There are diminishing returns in consumption

2. The first unit of consumption of a good, service (or capital) yields more utility than the second and subsequent units

II. Perfect World

A. Contracting creates no costs

B. Perfect Information

C. Perfect Foresight

D. Perfectly Rational Individuals

E. Every contract will be complete

F. Everybody is homo oeconomicus (utility maximizing individual)

G. There is no opportunistic behavior

H. Pareto efficiency (nothing you do makes anyone worse off)

I. Markets function perfectly and never fail – contracts cover all eventualities and never fail – firms never collapse

III. Real World

A. Transaction costs

1. Information costs

2. Search costs

3. Bargaining and decision costs

4. Policing and enforcement costs

B. Information asymmetry

C. Opportunism of contracting parties

D. Bounded Rationality

1. Individuals have limited ability to store, retrieve, and utilize information

2. Systematic distortions in human perception or thinking

3. In practice, all decision makers act subject to imperfect information and limited cognition

E. Contracts are incomplete as limitedly rational individuals are subject to information asymmetries and cannot account for all eventualities

IV. Because of real life factors

A. Failure of Contracts

B. Firms collapse

C. Market Failure


V. Origins

A. Historical Background

1. Stock Market Crash (1929)

2. Great Depression (1930s)

B. Purposes

1. Information Asymmetry

i. Parties involved know different things at different levels – securities regulation tries to put things at a more even playing level

2. Purposes

i. Protect investors

ii. Prevent stock market crashes

C. Solution – Federal Securities Laws

1. Full Disclosure

i. Make sure that investors have all the information they need to make informed decisions

VI. Salt-Walter Confections

A. Should we provide “merit” regulation?

1. No – but the benefit would be you would have the right to return these “cookies” if they don’t taste they way you expected them to taste

2. But we cannot set a standard across the board of what something should taste like, because no one has the same ideas about what tastes good

B. Should we force disclosure?

C. Should we impose “gun-jumping” rules (i.e. rules concerning the public offering process)?

D. Should attempt to educate the public as to the varying quality of cupcakes sold in the U.S?

1. No – they will be educated through their own consumption. This would be costly and the knowledge will get out anyway

VII. Summary

A. There is a difference in what we need to do between a tangible product and an intangible product

1. People can figure out tangible products out by themselves

2. The intangible products, like securities, cannot be evaluated like a tangible product

i. Policy evaluation changes – government has to step in to protect us

ii. Give the public information because there is a potential for fraud

iii. Therefore, we require mandatory disclosure

B. SWC, Inc.

1. If you are going to regulate to protect the public investors – what do you do?

i. Mandatory disclosure? – Yes

ii. Gun-Jumping Rules? – Yes

iii. Antifraud Liability? – Yes

iv. Merit Regulation? – Yes

v. Investor Education? – Yes (in theory)

2. Collective Action Problem

i. Difficult for a group to coordinate their decisions

C. Summary of Background information

1. Importance of the capital market and investments for the economy

2. Importance of investments to people relative to other decisions people make

i. Given that people do this, our rules really have to address that problem

3. Something about investments makes people act irrationally

4. Investments are intangible

5. Collective action problems among investors

II. Types of Securities


The Capital Market

Primary Market Transactions

Issuer to Investor

Securities Exchange

a. You use to be able to do this, as long as people like you believed in growth stocks, but as soon as analysts started covering this more because of the inefficiencies, they reached an equilibrium

iii. Anomalies that doesn’t makes sense

a. Seasonal effects

i. Stocks show significant positive CARs in January and on Fridays

ii. Positive CARs for sunny days in New York

b. Super Bowl effect

i. Years in which a NFC team wings, positive CARs

D. Summary

1. Efficient market hypothesis is a theory about how information is reflected in securities prices

2. At least for large exchanges, best evidence thus far support semi-strong form:

i. Security price reflects all publicly

V. Regulatory Apparatus

A. Securities Exchange Act of 1934

1. This comes first because the secondary market is MUCH larger and therefore, way more important and at the core of federal securities law

B. Securities Act of 1933

C. Investment Company Act of 1940

1. Registration of investment companies with the SEC

D. Investment Advisors Act of 1940

1. Investment advisors (broker -dealer)

E. Trust Indenture Act of 1939

1. Regulates contractual terms relating to publicly issued debt securities, including bonds, notes, and debentures above a specified dollar amount (currently 10 million)

F. Sarbanes-Oxley Act of 2002

VI. Securities and Exchange Commissions

A. Divisions

1. Corporate Finance

2. Trading and Markets

3. Investment Management

4. Enforcement

B. Ways by which the SEC influence the capital markets

1. The SEC may engage in formal rulemaking

2. The SEC brings enforcement actions

3. The SEC’s staff often will grant individuals and companies a “no action letter”