1
Chapter 28
Investor Protection and
Corporate Governance
N.B.: TYPE indicates that a question is new, modified, or unchanged, as follows.
N A question new to this edition of the Test Bank.
+ A question modified from the previous edition of the Test Bank.
= A question included in the previous edition of the Test Bank.
TRUE/FALSE QUESTIONS
1. Securities generally do not include any documents evidencing corporate
ownership or debt.
2. The Securities and Exchange Commission (SEC) requires companies to file
certain information electronically so that it can be posted on the SEC’s EDGAR
database.
3. All securities transactions must be registered with the Securities and Exchange
Commission—there are no exemptions.
4. Once a registration statement has been filed, a waiting period begins while the
Securities and Exchange Commission reviews the statement.
2 TEST BANK—UNIT SIX: THE REGULATORY ENVIRONMENT
5. A well-known seasoned issuer cannot file a registration statement until after it
announces a new offering.
6. Securities offerings in unlimited amounts can be exempt from the registration
requirements in certain circumstances.
7. Most securities can be resold without registration.
8. Liability can be imposed on those who are negligent in not discovering fraud in
connection with a registration statement or prospectus.
9. The Securities Exchange Act of 1934 applies to companies that have assets in
excess of $5 million and five hundred or more employees.
10. Section 10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5
apply just to corporate “insiders.”
11. The key to liability under Section 10(b) of the Securities Exchange Act of 1934
and SEC Rule 10b-5 is whether information omitted or misrepresented in
connection with the purchase or sale of a security is material.
12. Corporate “outsiders” may not be held liable for insider trading under Section
10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5.
13. In the context of Section 16(b) of the Securities Exchange Act of 1934, insiders
include officers, directors, and large stockholders of Section 12 corporations.
14. For civil sanctions to be imposed under Section 10(b) of the Securities
Exchange Act of 1934 and SEC Rule 10b–5, the violator must not have had an
intent to defraud or knowledge of his or her misconduct.
15. The Securities and Exchange Commission does not regulate the content of
proxy statements.
16. Private parties can sue violators of Section 10(b) of the Securities Exchange
Act of 1934 and SEC Rule 10b-5 for rescission of a contract to buy securities.
17. Every state has it own corporate securities laws that regulate the offer and sale
of securities within tis borders.
18. Corporate accountability can be increased by imposing strict disclosure
requirements and harsh penalties for securities laws.
19. Under the Sarbanes-Oxley Act of 2002, chief financial officers must certify the
accuracy of information in corporate financial statements and reports that are
filed with the Securities and Exchange Commission.
20. The Securities and Exchange Commission does not enforce the antifraud
provisions of the securities laws in the online environment.
MULTIPLE CHOICE QUESTIONS
1. Cotton Products Corporation is a public company whose shares are traded in
the public securities markets. With respect to financial and other significant
information concerning its securities, the Securities Act of 1933
a. imposes increased responsibility on chief corporate executives.
b. prevents insiders from trading among themselves.
c. requires disclosure.
d. creates a “safe harbor” for companies to make forward-looking
statements.
2. Guitar Factory Corporation files a registration statement and delivers a
prospectus to the appropriate parties. These items are intended to enable the
evaluation of certain financial risks by
CHAPTER 28: INVESTOR PROTECTION AND CORPORATE GOVERNANCE 5
a. market professionals to explain to all investors.
b. government regulators to disclose to the general public.
c. sophisticated investors only.
d. unsophisticated investors.
3. Global Trade Corporation is a public company that is poised to issue securities
that do not qualify for an exemption from registration. This means that Global
Trade must
a. file a registration statement with the SEC.
b. issue the securities through an online registration site.
c. refrain from issuing the securities to unregistered investors.
d. register the securities with a national stock exchange.
4. Household Products Corporation wants to make an offering of securities to the
public. This offering is not exempt from registration under the Securities Act of
1933. Before Household Products sells its securities, it must provide investors
with
a. a forward-looking financial forecast.
b. an investment contract.
c. a prospectus.
d. samples of its products.
5. Riverwalk Restaurants Corporation is a noninvestment company that wants to
issue stock of $3 million in a twelve-month period. Riverwalk, with less than
$20 million in annual sales, qualifies as a small business issuer. Before
Riverwalk sells the stock, it must provide investors with
a. an offering circular.
b. a notice of the issue.
c. a red herring prospectus.
d. a tombstone ad.
6. Fleet Delivery Corporation is a public company with a market capitalization of
less than $75 million. Fleet is poised to issue securities in a transaction that,
under the Securities Act of 1933, is “exempt.” This enables Fleet to
a. reduce the compliance costs by not requiring an auditor report.
b. buy and sell the securities without liability for “recaptures.”
c. make forward-looking financial forecasts without liability.
d. withhold inside information from accredited investors.
7. As part of a stock offering for Designer Studio Corporation, the firm’s
accountant Evelyn intentionally misrepresents material facts in the prospectus.
Flores buys the stock unaware of the misrepresentation and suffers a loss.
Evelyn may be subject to
a. a fine and damages only.
b. a fine and imprisonment only.
c. a fine, imprisonment, and damages.
d. damages only.
8. Space Trips Inc. files a registration statement with the SEC before making an
offering to the general public. The registration contains false, immaterial
statements of which the investors are unaware. Space Trips is charged with
violating the Securities Act of 1933. Space Trips’s best defense is
a. the investors were not aware of the misrepresentations.
b. the issuer reasonably believed the misstatements were true.
c. the offering was made available to the general public.
d. the untrue statements were not material.
9. Fresh Fruit Company has assets of less than $10 million and fewer than fifty
shareholders. Gourmand Pastries, Inc., has assets of more than $50 million
and more than five hundred shareholders. The Securities Exchange Act of
1934 applies to
a. Fresh Fruit and Gourmand Pastries.
b. Fresh Fruit only.
c. Gourmand Pastries only.
d. neither Fresh Fruit nor Gourmand Pastries.
10. Bonds & Stocks Corporation, and its officers, directors, and shareholders, buy
and sell securities. SEC Rule 10b-5 applies to the purchase or sale of
a. a security by a financial corporation only.
b. a security involving a corporate insider only.
c. a security involving short-swing profits only.
d. any security.
11. To raise capital to form Business Apps Corporation with Cris, Dona sells bonds
and stock in other companies, and plans to register an initial public offering
under the Securities Act of 1933. SEC Rule l0b-5 covers
a. just about any form of securities.
b. only bonds.
c. only securities registered under the Securities Act of 1933.
d. only stock.
Fact Pattern 28-1 (Questions 12–13 apply)
Dhani, an accountant for Eureka! Inc. learns of undisclosed company plans to market
a new laptop. Dhani buys 1,000 shares of Eureka stock. He reveals the company
plans to Fay, who tells Geoff. Both Fay and Geoff buy 100 shares. Geoff knows that
Fay got her information from Dhani. When Eureka! publicly announces its new laptop,
Dhani, Fay, and Geoff sell their stock for a profit.
12. Refer to Fact Pattern 28-1. Under the Securities Exchange Act of 1934, Fay is
most likely
a. liable for insider trading.
b. not liable because Fay did not prevent others from profiting.
c. not liable because Fay did not misappropriate any information.
d. not liable because Fay does not work for Eureka!
13. Refer to Fact Pattern 28-1. Under the Securities Exchange Act of 1934, Geoff
is most likely
a. liable for insider trading.
b. not liable because Geoff is only a tippee, not a tipper.
c. not liable because Geoff is too far down the chain of disclosure.
d. not liable because Geoff traded on the basis of a material fact.
14. Rico does not work for Street Bikes Company, but wrongfully obtains inside
information concerning the firm. Based on the information, Rico buys and sells
Street Bikes stock for personal gain. The Securities and Exchange Commission
CHAPTER 28: INVESTOR PROTECTION AND CORPORATE GOVERNANCE 9
prosecutes Rico, arguing that he is liable because he stole information rightfully
belonging to another. This argument is
a. the blue-sky theory.
b. the misappropriation theory.
c. the free-writing prospectus theory.
d. the tipper/tippee theory.
15. OnSpec, Inc., and its officers, directors, and shareholders, buy and sell
securities. Section 16(b) of the Securities Exchange Act of 1934 covers
purchases and sales of securities involving
a. corporate insiders.
b. misappropriation.
c. short-swing profits.
d. tippers and tippees.
16. Grain Mills Corporation is required to register its securities under Section 12 of
the Securities Exchange Act of 1934. Section 14(a) of the act regulates
a. the declaration of dividends by Grain Mills’s board of directors.
b. the later re-registration of Grain Mills’s securities.
c. the short-swing activities of Grain Mills’s insiders.
d. the solicitation of proxies from Grain Mills’s shareholders.
17. Cattle Ranch Company offers its stock for sale only in a single state. The law in
Cattle Ranch’s state is like the law in most states. Cattle Ranch’s offer is sub-
ject to state securities statutes that include
a. antifraud and disclosure provisions.
b. antifraud provisions only.
c. disclosure provisions only.
d. neither antifraud nor disclosure provisions.
18. Boats & Yachts Corporation is a public company, which California regulates
and in which Dorian invests. The Sarbanes-Oxley Act of 2002 introduced direct
federal corporate governance requirements to
a. public companies.
b. private investors.
c. state regulators.
d. the Securities and Exchange Commission.
19. HVAC Heating & Air Conditioning, Inc., is a public company whose shares are
traded in the public securities markets. Under the Sarbanes-Oxley Act of 2002,
to ensure that HVAC’s financial results are accurate and timely, the firm’s
senior officers must set up and maintain
a. internal “disclosure controls and procedures.”
b. external “release and reveal timetables.”
c. personal “peruse and review liability policies.”
d. public “information and discussion forums.”
20. Rollo is the chief executive officer of Specialty Magazines, Inc., which is
required to file certain financial reports with the Securities and Exchange
Commission (SEC). Under the Sarbanes-Oxley Act of 2002, Rollo must
a. certify that the reports are complete and accurate.
b. designate a corporate official to assume liability for inaccuracies.
c. do nothing.
d. read the reports and be prepared to answer questions about them.
ESSAY QUESTIONS
1. Ridley is an officer of Sun Watts, Inc. Ridley knows that a Sun Watts engineer
recently developed a new, inexpensive method for collecting, storing, and
converting solar power into fuel. Ridley takes advantage of this information to
buy Sun Watts stock from Taylor and, after the discovery is announced, to sell
the stock to Ulrich at a profit. Taylor claims that this is a violation of federal law.
Is Taylor correct? If so, what federal law has Ridley violated, and what are its
possible penalties?
2. When OmniOil Corporation wishes to issue certain securities, it must provide
sufficient information for Petra, and other unsophisticated investors, to evaluate
12 TEST BANK—UNIT SIX: THE REGULATORY ENVIRONMENT
the financial risk involved. Specifically, the law imposes liability for making a
false statement or omission that is “material.” What sort of information would
Petra consider material?