THE SEC
1) Prior to the creation of the SEC, securities were regulated by the Federal Trade Commission
2) SEC’s purpose is investor protection
3) Scope of the SEC’s authority
a) The SEC is almost entirely limited to disclosure requirements (Business Roundtable v. SEC)
b) There are a couple of exceptions:
i) The SEC requires all public companies to have audit committees entirely comprised of independent directors (Rule 10a-3, §301 SOX)
ii) The SEC can only regulate substantive shareholder rights through the mechanism of disclosure (see section on proxy rules)
(1) i.e., regulation of shareholder proposals
c) The SEC may sue the SROs for failure to enforce their own regulations
4) The Exchange Act:
a) The SEC was created by the Securities Exchange Act of 1934.
i) Call it the “Exchange Act” (Brown)
b) Purpose is to regulate the secondary markets (transaction in which the company is not a party)
c) The Exchange Act empowers the SEC to regulate:
i) The stock exchanges
(1) Why?
(a) Protection of investors
(b) Abuses
(i) “Front running”
1. Specialists were trading in advance of a known transaction that will affect stock prices
2. Was essentially an unfair advantage because it was insider trading
ii) Broker-dealers
iii) Self-regulatory organizations (SRO’s)
(1) A stock exchange (national) or organization designed to regulate broker-dealers
(2) 3 SRO’s that really matter for the class
(a) Must apply to SEC for SRO status
(b) NASD
(i) Only SRO that is entire a broker-deal organization
(c) American Stock Exchange
(d) NYSE
(3) Most regulatory actions will be brought by SRO’s
(a) Overlapping regulation
(4) Problems with SRO’s
(a) Self interest
(i) Strict regulation of companies listed on NYSE may lead to companies listing elsewhereàlower profits
(ii) Underfunding of regulatory department because of bottom line
(iii)NYSE is now a public company which changed its interests
(iv)Historical problem with the SRO’s wanting to enforce regulations against their members
(v) NYSE was historically dominated by specialists
(vi)NASDAQ was historically regulated by market makers
iv) Disclosure requirements of public companies
TRADING MARKETS/SRO’s
SELF REGULATORY ORGANIZATIONS GENERALLY
1) Definition of an SRO
a) §3 of the Exchange Act
b) National Securities Exchanges
i) NYSE
ii) AMEX
c) Registered securities associations
i) NASD
d) Exchanges must register with the SEC unless they are allowed an exemption (§5)
i) The exemption requirement are found in §6
2) What do SROs regulate?
a) Trading rules (term of art= market place rules)
i) Brokers have an obligation to find the best price
b) Investor protection
c) Enforcement
d) Disclosure
e) Licensing and supervisory requirements
f) SEC assures the rules of the SROs are in compliance with the Exchange Act
i) Exchanges are required to file proposed rule changes with the SEC (§19(b))
(1) The SEC must also approve
ii) The SEC may also amend the rules of SROs (§19(c))
(1) Can also require the SROs to adopt a rule
(a) However, under 19(b) and 19(c) the SEC is bound to act in a consistent manner with the Exchange Act (no substantive rule adoptions)
3) Regulatory/Enforcement powers of SROs
a) Fine
b) Delisting
c) Revoke or suspend a broker’s license
d) Mandate disclosure
i) Listing standards
(1) The SEC generally does not enforce listing standards, they are contractual agreements, but the SEC still has been allowed to regulate this area nonetheless
(2) Be aware that state law generally gives management more discretion with respect to the characteristics of stock classes than the SROs do
e) Net Capital Requirements (§15(c)(3), Rule 15c3-1)
i) Broker-dealers have to maintain a certain amount of net working capital
f) All SRO disciplinary actions may be appealed to the SEC
4) Difference between the NYSE and NASD
a) NYSE is an exchange, and NASD is just an organization regulating brokers
b) What would a stock exchange have to do that the NASD doesn’t
i) Regulate the companies on the exchange in addition to the brokers
(1) Listing standards
5) Broker-dealers must belong to an SRO
a) Broker-dealers include:
i) Market makers
ii) Investment bankers
b) Dealer §3(a)(5)
i) Any person engaged in the business of buying and selling securities for his own account, through a broker or otherwise
ii) Does not include a bank or any other person insofar as he buys or sells securities for his own account not as a part of a regular business
c) Broker §3(a)(4)
i) Any person engaged in the business of effecting transactions in securities for the account of others
6) SROs’ status as quasi-governmental
a) SROs are granted governmental immunity when performing purely regulatory functions
i) Standing in the shoes of the government
b) If an SRO engages in activity that is not purely regulatory, or profit seeking in nature, they can be sued (Weissman v. NASD)
i) The line is not clear, but pure regulatory activities are the only clearly safe bet
c) There is no private cause of action for violation of an SRO rule
7) Enforcement of listing standards is weak because of the incentives to keep companies on the exchange
a) Hurts members and investors to have a company delisted
NYSE
NASD
1) Only SRO that is entirely a broker-deal
ve $10m in assets on the last day of its most recent fiscal year, it is exempted from the 12(g) reporting requirements (Rule 12g-1)
b) If a company meets the standards in 12(g), it becomes subject the reporting requirements of 13(a)
c) If a company becomes listed on a national securities exchange, it is automatically subject to the reporting requirements (12(b))
d) One other way to become subject to reporting requirements:
i) If a company registered its securities under the 1933 Securities Act, it is subject to 13(a) reporting requirements (15(d), Regulation 15D)
ii) Basically just leads to earlier compliance with reporting requirements
2) Section 13(a) reporting requirements
a) Reporting companies must make two kinds of filings with the Commission:
i) Filings of such information and documents as the SEC requires to keep current the information provided at the time of registration
(1) 8-K
ii) Filings of such annual and quarterly reports as the SEC requires irrespective of the updating requirement
(1) 10-K, 10-Q
b) Regulation 13A requires the filing of reports like 10-K, 10-Q, 8-K, etc.
c) There is no private right of action for violations of 13(a) unless you can turn that violation into a 10b-5 claim
i) You have to be able to show more than they just didn’t do the reports right
d) No showing of scienter is required to establish a violation of this rule (In re Tyson)
i) SEC brings claims for violations of this rule
3) Certification and SOX
a) Reporting companies are required to have their financials and internal controls certified by both the CEO and CFO (13a-14)
i) They can’t have someone else do it for them
ii) Can’t alter the language (see section on Reg. S-K, Item 601)
iii) While the CEO and CFO don’t have to actually sit and check all the numbers themselves, they do have an obligation to ensure that the internal controls are in place and effective
b) To violate this requirement, the offender must knowingly and willfully misrepresent that they knew the statements were accurate
i) Penalty is 20 years in prison
c) If they just don’t sign it, the filings are considered incomplete
