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Chapter 23
Rules Governing the Issuance and Trading of
Securities
Introduction
Chapter Twenty-Three addresses these questions:
• What role do federal and state governments play in regulating securities?
• What is the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010?
• What is the Sarbanes-Oxley Act of 2002?
• How are the Securities Act of 1933 and Securities Exchange Act of 1934 related?
• What rules apply to the various actors in the state securities laws?
• How are e-commerce, online securities disclosure, and fraud regulation related?
• What are the global dimensions of rules governing the issuance and trading of securities?
Achieving Teaching Excellence
Exciting Audiovisuals—Using Slides and Music to Enhance Classroom Experiences
An article by Peter Frederick presented good ideas about how to promote active learning in
class. Frederick, a history professor presented several ideas for promoting active learning in
history classes. One works particularly well in legal environment of business classes. Frederick
presented a section on using slides and music in class to evoke students’ emotional learning.
tone for a topic, raise questions, and encourage rethinking. He writes that “emotional experience
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leads to cognitive insights.” Then, he gives several examples of how to use audio-visual media in
class. Some of his examples are as follows:
1. Establish a mood for a particular class period by showing slides. Or, as students walk into
Frederick explains how music and slides are intensely active experiences for students. He
advises instructors to be careful as they evoke emotional as well as intellectual responses from
the students. He advises instructors to respect the students’ need for privacy. Frederick suggests
How can instructors use Frederick’s ideas in their classes? Is it even possible to take some of
his ideas and use them with a topic as securities regulation? First, it is important to recognize that
some areas of law evoke more emotional responses than others. Labor law and constitutional law
probably trigger more emotions than contract and antitrust law. Thus, this idea for improving
what happens in class will work better in some chapters of the legal environment of business
Another idea would be to put several short, powerful statements from court cases about
securities fraud on a transparency. Instructors could put several strong statements that show the
damage fraud can inflict on investors and the market in general. Once instructors start looking,
they might be surprised at how many sources of great audio-visual material are available. The
Internet certainly makes it easier to find good sources.
The instructors could start by doing an audio-visual activity for one or two chapters during
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References
• Peter Frederick, “Active Learning in History Classes,” 16 TEACHING HISTORY 67
(1991).
Chapter Overview, Topic Outline, and Discussion Questions
Chapter Overview
Both because of their importance to the operation of the United States’ free enterprise
society and because of the ease with which they can be manipulated, securities have been
regulated by governments for nearly a century. This chapter chiefly examines the role of the
federal government in regulating securities. It introduces the subject with a brief history of
Both the Securities Act of 1933, which governs the issuance of securities and outlines the
registration requirements for both securities and transactions (and the allowable exemptions from
those requirements), and the Securities Exchange Act of 1934, which governs trading in
securities, are discussed. Next, the chapter examines the state securities laws and online
Topic Outline
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I. Introduction to the Regulation of Securities
A. Summary of Federal Securities Legislation
B. The Securities and Exchange Commission
2. Structure
4. Division of Trading and Markets
6. Division of Economic and Risk Analysis
7. Division of Investment Management
II. Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010
A. Oversight of Financial Problems by Regulatory Agencies
B. Risk Taking by Large Banks and Nonbanks
C. Executive Compensation
D. Too Big to Fail
III. The Sarbanes-Oxley Act of 2002
A. Corporate Accountability
B. New Accounting Regulations
C. Criminal Penalties
IV. The Securities Act of 1933
A. Definition of a Security
2. Reasonable Expectations of Profit
3. Profits Derived Solely from the Efforts of Others
a. Securities and Exchange Commission v. Edwards
B. Registration of Securities under the 1933 Act
2. Registration Statement and Process
4. Prefiling Period
6. Posteffective Period
8. Shelf Registration
C. Securities and Transactions Exempt from Registration under the 1933 Act
The Legal Environment Of Business: A Critical Thinking Approach
3. Small Business Exemptions
5. Exempt Securities
D. Resale Restrictions
E. Liability, Remedies, and Defenses under the 1933 Securities Act
1. Private Remedies
3. Failure to File a Registration Statement
5. Governmental Remedies
7. Injunctive Action
8. Criminal Penalties
V. The Securities Exchange Act of 1934
A. Registration of Securities Issuers, Brokers, and Dealers
2. Registration of Brokers and Dealers
B. Disclosure: Compensation
C. Securities Markets
D. Proxy Solicitations
1. Procedural and Substantive Rules
3. Proxy Contests
E. Tender Offers and Takeover Bids
1. Rules Governing Tender Offers
F. Remedies and Defensive Strategies
1. Remedies
2. Defensive Strategies
G. Securities Fraud
1. Section 10(b) of the Securities Exchange Act
a. Siracusano v. Matrixx Initiatives, Inc.
3. Misstatements of Corporations and Section 10(b)
a. Securities and Exchange Commission v. Texas Gulf Sulphur Co.
5. Fraud-on-the-Market Theory and Section 10(b)
H. Liability and Remedies under the 1934 Exchange Act
2. SEC Action
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3. Private Actions
a. The Wharf (Holdings) Limited v. United International Holdings, Inc.
I. Short-Swing Profits
A. Purpose and Coverage
B. Liability
VI. State Securities Laws
VII. E-Commerce, Online Securities Disclosure, and Fraud Regulation
A. Marketplace of Securities
B. E-Commerce and Fraud in the Marketplace
VIII. Global Dimensions of Rules Governing the Issuance and Trading of Securities
A. Legislation Prohibiting Bribery and Money Laundering Overseas
1. The Foreign Corrupt Practices Act of 1977, as Amended in 1988 and 1998
3. The International Securities Enforcement Cooperation Act of 1990
B. Legislation Governing Foreign Securities Sold in the United States
C. Regulations and Offshore Transactions
IX. Summary
Discussion Questions for Chapter Twenty-Three
1. Explain relationships between the Securities Act of 1933 and the Securities and Exchange
Act of 1934.
2. Explain relationships between the Foreign Corrupt Practices Act of 1977 (FCPA) and the
International Securities Enforcement Cooperation Act of 1990 (ISECA).
The FCPA prohibits the direct or indirect giving of “anything of value” to a foreign official
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3. Evaluate this statement: The Securities and Exchange Commission (SEC) evaluates the
worth of a public offering of securities by a corporation.
4. Evaluate this statement: It is easy to tell whether something is a “security”. One would just
have to look at it carefully.
This statement is inadequate because sometimes it is very difficult to tell whether something
5. Explain relationships between the prospectus and Part II information statement.
Both the prospectus and the Part II information statement are parts of the registration
6. Explain relationships between the Securities Act of 1933 and shelf registration.
The Securities Act of 1933 regulates the initial issuance of securities. Shelf registration is
7. What basic rationales underlie the exemptions to the 1933 Securities Act?
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8. Explain relationships between the due diligence defense and the business judgment rule.
The business judgment rule protects directors and managers from poor decisions, as long as
they make decisions that reflect good faith. The due diligence defense is much less forgiving
9. Explain relationships between proxy solicitations and takeover bids.
One relationship between proxy solicitations and takeover bids is that both are regulated by
10. Explain relationships between insider trading and misstatements of corporations.
Both insider trading and misstatements of corporations are specific kinds of securities fraud
under Section 10(5) of the exchange act. Insider trading is the use of nonpublic information
11. Explain relationships between insider trading and fraud-on-the-market theory.
Both insider trading and fraud-on-the-market theory are specific kinds of securities fraud
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12. Evaluate this statement: Congress has defined “insider trading” clearly.
13. Evaluate this statement: States are not allowed to regulate in the area of securities law.
14. Why are global dimensions of securities law especially important?
Answers to Critical Thinking about the Law Questions, Case Summaries,
Answers to Review Questions, Review Problems, and Case Problems
Suggested Answers to Critical Thinking about the Law Questions
1. The ethical norm emphasized here is security, defined as to achieve the psychological
2. First, it is important to know whether Buy-It-Here really misrepresented itself. It is possible
3. Here, the cases are similar because both women lost money in the stock market when a
company they invested in went bankrupt. However, the two cases are different in such a
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1. The government prefers the norm of security. Government actors wanted to bailout Bear
2. This is a judgment call. Preferably, markets would weed out weak companies such as Bear
Stearns. The complexity here, though, is that, if Bear had gone bust, the ripple effects might
have been unbearable.
Case Summary—Securities and Exchange Commission v. Edwards
This case is in the book to illustrate how cases can be interpreted to define security. In this
Case Summary—Litwin v. Blackstone Group, LP
Blackstone Group, LO, manages investments. In corporate preparations for an initial public
offering (IPO), Blackstone filed a registration statement with the Securities and Exchange
Commission (SEC). At the time, corporate private equity investments included FGIC
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decisions.
Case Summary—Barbara Schreiber v. Burlington Northern, Inc.
In this landmark case, the U.S. Supreme Court interpreted the meaning of the Williams Act.
The Court was concerned with the correct interpretation of the word “manipulative”, which is the
Suggested Answers to Critical Thinking about the Law Questions
1. The court tries to figure out what the word “manipulative” means.
Case Summary—Siracusano v. Matrixx Initiatives, Inc.
In this case, Matrixx Initiatives, Inc. sold Zicam Cold Remedy, a homeopathic product
marketed as stopping or minimizing cold symptoms. In December 1999 Matrixx began to receive
questions from physicians whose patients used Zicam and developed anosmia (loss of the sense
of smell). Researchers at medical facilities contacted Matrixx in 2002 to offer access to studies
showing that zinc sulfate (present in Zicam) was linked to anosmia. During this time Matrixx’s
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Suggested Answers to Critical Thinking about the Law Questions
1. This is a difficult question to address, since no one knows how he or she might react unless
actually faced with the situation. In this case, two time periods and events could have
triggered a duty to disclose before the FDA became involved in 2004: a) 1999, when Matrix
2. If consumers were aware of such studies, it could cause them to cease the use and purchase
3. Such a decision can be devastating to a company. Upon the FDA issuing such a recall, the
Case Summary—Securities and Exchange Commission v. Texas Gulf Sulphur Co.
This case has been included in the text as it deals with insider trading. The SEC filed a suit
against the Texas Sulphur Company (TGS) along with 13 of its officers, directors, and
employees for violating the Section 10(b) of the Exchange Act and SEC Rule 10(b)-5. TGS had
acquired an option to acquire land 160 acres of land in Timmons, Ontario, where there were
Case Summary—The Wharf (Holdings) Limited v. United International Holdings, Inc.
In this case, the Supreme Court ruled in favor of United, when it alleged securities fraud
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Answers to Review Questions
23-1. The Stop Trading on Congressional Knowledge Act of 2012, or STOCK Act, was
enacted in 2012 with the goal of clarifying the ambiguity of the legality of trading on the
23-2. The shareholder proposal may be excluded if under the particular state law, it would be
unlawful if agreed to by the directors; it involves a personal grievance; it relates to
23-3. The courts use the following criteria to determine whether an instrument or transaction
will be called a security:
• Whether there existed a contract or scheme whereby an individual invested money
23-4. All securities that meet the Howey test and do not fall under an exemption to the 1933
Act must be registered under the 1933 Act.
23-5. A material misstatement is a significant misrepresentation of fact, while an omission is
the significant failure to disclose that which the law requires. Materiality is an inherently fact-
Answers to Review Problems
23-6. Livingston will win. He does not perform policy functions. Instead, he handles day to day
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23-7. Estrada is correct; the offering need not be registered with the SEC. Section 3 of the
Securities Act of 1933 provides an exemption for any “security which is part of an issue
23-8. The shareholders of Dumont can likely recover in a suit against the company under the
Securities Exchange Act of 1934. One of the purposes of the 1934 Act was to ensure the
full disclosure of all material information to potential investors. Section 10(b) of the 1934
23-9. The statements are material if the information would affect the judgment of the average
prudent investor. It is a question of whether the facts listed here would affect the probable
23-10. In S.E.C. v. Intern. Min. Exchange, Inc., 515 F. Supp. 1062 (1981), the court cited the
Howey test established by the United States Supreme Court for determining what a
23-11. Continental will lose. The private placement exemption applies when the number of
purchasers is 35 or less (here there are 38). Also, it is unclear whether the sellers have any
Answers to Case Problems
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23-12. The court noted that five elements are required in order to prove a primary violation of
Rule 10b-5. In particular, a plaintiff must demonstrate: 1) a material misrepresentation or
23-13. The appellate court noted that although the lower court had previously dismissed the
complaint without prejudice while giving the shareholders specific instructions about
ways to remedy the complaint’s deficiencies, the shareholders were unable to follow
those instructions and failed to adequately allege any actionable securities law violations.
23-14. The appeals court reversed and remanded this case. In addition to that the court dismissed
Thinking Critically about Relevant Legal Issues
1. The author wants strict punishments because not only do those who commit fraud
2. The author provides no data, just broad concepts about why, in theory, white collar crime is
very dangerous to the economy.
3. Some data about how often these crimes occur and how the economy has suffered because
The Legal Environment Of Business: A Critical Thinking Approach
4. The section about the way the general economy is harmed is a little ambiguous. The author
5. One could argue that many times, the investors are not completely sure of the extent of the