34 Act Outline
I. Introduction
a. 34 Act governs secondary distributions – trading transactions
b. Purposes of Federal Securities Regulations
i. Investor Protection – through disclosure
c. SEC – hybrid legislative/executive agency with some judicial function
i. Creates law through rules – gives notice, period of comment, promulgates rules, punishes violators
II. Financial Reporting and Ongoing Disclosure Obligations
a. Periodic Reporting Requirements – ongoing but NOT continuous
i. Reports
1. 8K – certain triggering events mean you must file within 4 days
a. Ex. Entry into or termination of material definitive agreement, Bankruptcy, disposing of assets
2. 10Ks – annual reporting
a. Now includes disclosure of risks – requires updating
b. Disclosure of any written staff comment the issuer believes is material issued more than 180 days before the end of the year that remains unresolved
3. 10Qs – quarterly reporting
ii. Quality of Reports
1. Financial statements – prepared according to GAAP, must be accurate and honest
a. Financial Accounting Standards Board – authority over accounting standards in private sector
b. American Institute of Certified Public Accountants – trade group commonly followed by companies
c. Financial statements are a reflection of the company and managers – presents a conflict of interest – this is why objective standards are important
d. Outside auditors – must be independent
i. Independence is difficult to achieve because of existing relationships
ii. Don’t require rotation of firms – does require rotation of lead audit partner (SOX)
iii. SOX has list of things auditors cannot do
1. Perform management functions
2. Audit his own work
3. Act as advocate for client
iv. Signs off that in accordance with GAAO and accurate
2. Internal Controls
a. Companies must maintain reliable and trustworthy accounting records – also must report on the controls in place
i. CEO certification to auditors who can then report and give an opinion on controls – very broad what they can give the opnion on
b. Have a system of internal accounting controls sufficient to provide reasonable assurances that transactions are only done with management authorization, transactions are properly accounted and recorded, at reasonable intervals assets are compared and corrective action is taken if necessary
c. Examples
i. Responsibility for money
ii. Inventory controls
iii. Anonymous reporting
d. Case: Worldwide – Court found that there were not reasonable controls because anyone could access the inventory.
e. Enforcement
i. Lots of prosecutorial discretion – only looking for
1. Unreasonable deviations from ideal of accurate books, records or internal controls
2. Situations where top management is involved due to misfeasance, lack of adequate supervision or failure to take corrective action
3. Failures that are something more than occasional inadvertent errors
3. Report must “fairly present” the company’s financial position and operations
a. Case: Simon – there was one mistake in the accounting used even though they used GAAP. Court found the financial statements didn’t fairly present the company’s position because a debt was put as a current asset even though the money had been loaned to someone else so the current liabilities exceeded current assets making the company insolvent.
i. Using GAAP isn’t enough – two separate standards
4. MD&A – calls for narrative explanations of financial statements
a. Recognize trends and risks
b. Case: Caterpillar – Brazil company was doing well but knew there was going to be a problem with hyperinflation. They didn’t know how big or what the problem would be so they didn’t disclose. Court found that they should have disclosed.
c. Private litigants – section 303 doesn’t provide for private recovery under 10b5
5. Audit Committees
a. Independent directors
b. No compensation other than director’s fees
c. Auditor reports to committee on all critical accounting
in some circumstances
iii. Bar on material misstatements and half-truths
b. Materiality has an important role in defining content of disclosures to the SEC
i. Line Item Disclosures
ii. Rule 408 – requires registration statements to include any material information necessary to make the required disclosure not misleading
c. Mixed question of fact and law – must be assessed in context
i. Mills v. Electric Auto-Lite – court said materiality entails a finding that information might have been considered important by a reasonable investor, and requires a significant propensity to affect investors.
ii. TSC Industries – Definition of Materiality – information is material if there is a substantial likelihood that a reasonable investor would consider the information important in deciding how to act
1. Other phrasing – information is material if there is a substantial likelihood that the information would have been viewed by a reasonable investors to have significantly altered the “total mix” of information already made available
2. Reasonable Investor
a. SEC v. Texas Gulf – speculators and chartists are reasonable investors entitled to same protection as conservative investors
3. Market Test? Courts are split as to whether there should be some kind of market test for this
4. Should there be a subjective test for one on one dealings?
5. Integrity of management – a lie about qualifications in a registration statement isn’t enough to make the statement material
6. Buried Facts – renders a document misleading if substantive information is set forth in such a manner that the information cannot easily be put together
