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The reporting lines of the auditor to the audit committee to maintain independence from
the chief financial officer and the corporate accounting staff.
That public companies must have audit, compensation, and nominating committees that
include only independent directors.
Additional Matter for Discussion:
The requirement that the audit partner of the external auditing firm must rotate off the
audit engagement at least every five years.
D. Financial Statements and Controls
Emphasize:
Sections 302 and 404 of the Sarbanes-Oxley.
Evidence that Sarbanes-Oxley is having a positive impact.
On additional provisions of the Sarbanes-Oxley Act.
Additional Matter for Discussion:
How Sarbanes-Oxley simultaneously adds to and helps control the financial difficulties
Sidebar 17.5—“Extending Whistleblower Protection”
VI. Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (LO 17-7)
Emphasize:
That this is a massive bill that addresses a large number of reform issues.
That numerous new administrative organizations were created to oversee the reforms.
That it will take several years to realize the many results of the reforms addressed.
Table 17.4—“Major Provisions of Dodd-Frank Wall Street Reform and Consumer
Protection Act”
List some of the new agencies brought in to bring in financial reform.
VII. Jumpstart Our Business Startups (JOBS) Act 2012
Emphasize:
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That this is a provision meant to help smaller businesses find the necessary capital to grow.
That the goals of the JOBS Act are to ease burdensome federal regulations and allow
individuals to invest in start-ups through relaxed rules for some initial public offerings.
Answers to Review Questions and Problems
Introduction
1. What Is a Security?
1933 Act. Since these registration requirements were not satisfied, the controllers of these
Howey companies have violated the Federal Securities Act of 1933. Securities and
Exchange Commission v. W.J. Howey Co., 328 U.S. 293 (1946).
2. Securities and Exchange Commission
The Securities Act of 1933: Going Public
3. Parties Regulated
4. Documents Involved
a. The registration statement and the prospectus are the two documents required by the
1933 Act.
b. The three time periods are known as the (1) pre-filing period, (2) waiting period, and
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5. Liability
No. “Sale” or “sell” includes every contract of sale or disposition of a security for value.
6. Defenses
Possible defenses include (1) arguing the information relied on was not important enough to
Securities Exchange Act of 1934: Being Public
7. Section 10(b) and Rule 10b-5
a. Section 10(b) and Rule 10b-5 declare that it is unlawful to use the mails or any other
instrumentality of interstate commerce or any national securities exchange to defraud
any person in connection with the purchase or sale of any security.
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demonstrated Wharf never intended to allow United to purchase 10% of the company’s
stock. This oral promise is the basis of the fraud in connection with the purchase of a
security and thus the violation of § 10(b) and Rule 10b-5. Wharf (Holdings) Limited v.
United International Holdings, Inc., 121 S.Ct. 1776 (2001).
8. Insider Transactions
vice versa as in this case. Donna is liable for the civil penalty of three times her illegal
profits. She also is subject to the criminal sanctions of ten years in jail plus a fine of up to
$1,000,000.
9. Nonpublic Information
Information is “material” if there is a substantial likelihood that a reasonable investor would
10. Additional Civil Liability
11. Criminal Liability
The Sarbanes-Oxley Act of 2002 increases criminal penalties for fraudulent securities
Other Considerations
12. Private Securities Litigation Reform Act of 1995
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specific allegations of wrongdoing, (2) limiting plaintiffs’ damages, (3) restricting the
amount of attorney fees that can be recovered, and (4) requiring the appointment of a
lead plaintiff in class-action suits.
13. State Blue Sky Laws
Businesspeople must understand that in addition to federal securities laws and SEC
regulations, compliance with state securities laws is necessary to avoid potential civil and
criminal liability.
Sarbanes-Oxley Act of 2002
14. Revitalization of SEC
The primary method of revitalizing the SEC was a large budget increase. This financial
15. Accounting Reforms
The PCAOB requires accounting firms to separate their auditing functions from their
16. Corporate Governance
Due to the requirements of the Sarbanes-Oxley Act, independence is now part of several
aspects of how a public company operates. First, all members of the company’s audit
17. Financial Statements and Controls
Section 302 requires the CEO and CFO to certify the accuracy of quarterly and annual
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manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
financial statements filed with the SEC. More significantly, section 404 requires these
officers to certify the existence of internal financial controls. Both the financial statements
and internal controls are subject to audits. The section 404 certification costs have been
higher than Congress likely envisioned. Although most businesspeople seem to applaud the
requirements of section 404, there is some anticipation that Congress may reduce, or even
eliminate, the certification of internal financial controls.
18. Whistleblower Protections
Beyond reinvigorating the SEC, the Sarbanes-Oxley increased the criminal penalty for
securities fraud, lengthened the statute of limitations in civil cases, and created the crime of
conspiracy to commit securities fraud.
Business Discussion #1
1. Can the three of you just begin advertising for investors?
2. What steps must be followed to comply with the law?
3. How much time is needed before investors can be approached legally?
Business Discussion #2
1. What concerns should you have regarding these conversations?
Conversations with friends, customers, and clients about investing in a company’s stock
2. Is there anything about your expectations of the company’s future performance you must or
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must not share?
Full and accurate disclosure to potential investors of the required financial aspects and the
leadership of your organization are required to avoid the liability for failing to comply with
securities laws and regulations.
Business Discussion #3
1. What requirements of Sarbanes-Oxley will you have to meet?
As a publicly-held corporation, the provisions of Sarbanes-Oxley impacts corporate
2. What is involved in offering a new company’s stock for sale to the public?
3. Are there aspects of doing business as a publicly traded company that are different from
operating as a partnership?
degree of federal regulation of the organization is greater with a corporation, through the
securities laws covered in this chapter.