An introduction to the fundamentals of dynamic business law and business ethics chap023

Chapter 23 Ethical DilemmaAlthough the Securities and Exchange Commission has existed as a federal administrative agency for over seventy years the Commission was created in 1934, some

Chapter 23

Securities Regulation

Chapter 23 Case Hypothetical

Thomas Abramson is a quality control manager for Capitol-IZE Pharmaceutical Company, Inc The company is

headquartered and has its principle production facility in Indianapolis, Indiana For several years, Capitol-IZE

Pharmaceutical has been engaged in the research and development of a new cancer drug, Izerion As part of the

federal regulatory procedure for mass-marketing a new drug, Capitol-IZE Pharmaceutical applied to the Food and Drug Administration (FDA) for final approval of Izerion

Yesterday, Thomas’s supervisor informed him in somber fashion that the FDA had rejected the company’s application

for final approval of Izerion Apparently, the FDA was concerned about serious side effects that manifested during the drug’s clinical trials Thomas’ supervisor further advised him that next Monday, Capitol-IZE Pharmaceutical is

scheduled to “go public” with a press release concerning the FDA’s rejection of Izerion

Thomas is frantic He owns approximately 6,000 shares of Capitol-IZE Pharmaceutical stock, and he knows that news

of the FDA’s rejection of Izerion will be disastrous to the company, its employees and its shareholders Capitol-IZE

Pharmaceutical stock is currently valued at $47.50 per share, and news of the FDA’s disapproval of Izerion will likely

drive the stock down to one-half of its current value Thomas quickly ran the numbers on his calculator A reduction of 50% in the stock’s value would represent a personal loss of $142,500 Thomas’ Capitol-IZE Pharmaceutical stock is

his only retirement plan, aside from a modest pension he will receive from the company (assuming the company

survives Monday’s announcement.)

Thomas has a plan Today, he will instruct his financial planner to immediately sell all 6,000 shares of his Capitol-IZE

Pharmaceutical Company, Inc stock Thomas rationalizes his decision by assuring himself that anyone else in his

position would do the same thing

Chapter 23 Ethical Dilemma

Although the Securities and Exchange Commission has existed as a federal

administrative agency for over seventy years (the Commission was created in

1934,) some critics question the need for its continued existence, or

alternatively argue for significant deregulation of stock trades According to

critics, there is arguably no need for significant federal regulation of

publicly-traded securities, since market conditions dictate legitimacy and honesty in

securities transactions; after all, for how long could a corporation exist if it does not strive to ensure the integrity of its stock?

How do you respond to this line of reasoning, that the “free market” will dictate

fair and honest stock trades? In your answer, consider the history and mission

of the Securities and Exchange Commission.

(Reference: http://www.sec.gov/about/whatwedo.shtml )

Definition: Investment in a common

enterprise with the reasonable

expectation of profit gained predominantly

from others’ efforts

Securities and Exchange Commission

(SEC)

Created in 1934 to:

• Enforce securities laws

• Interpret provisions of securities acts

• Regulate the activities of securities brokers,

dealers, and advisers

• Regulate the trade of securities on securities

exchanges

Expansion of SEC Powers in the 1990s

• Securities Enforcement Remedies and Penny

Stock Reform Act of 1990

• Market Reform Act of 1990

• Securities Acts Amendments of 1990

• National Securities Markets Improvement Act of

1996

• Sarbanes-Oxley Act of 2002

The Securities Act of 1933: Terminology, Rules,

and Procedures

Registration Statement: Document containing

• Description of securities offered for sale

• Explanation of how proceeds from sale of securities will

be used

• Description of registrant’s business and properties

• Information about management of company

• Description of pending lawsuits in which registrant

involved

The Securities Act of 1933:

Terminology, Rules, and Procedures

(Continued)

Prospectus: Written document similar to

registration statement, used as an

advertising tool to attract potential

investors

The Securities Act of 1933:

Terminology, Rules, and Procedures

(Continued)

Periods of the registration statement and

prospectus filing process:

• Pre-Filing Period

• Waiting Period

• Post-Effective Period

The Securities Act of 1933: Terminology, Rules, and

Procedures (Continued)

• Exempt Transactions-Securities exempt from standard SEC

registration requirements

• Limited Offers: Involve small amounts of money, or are offered

only to sophisticated investors

-Private Placement Exemption: Exempts private offerings of

securities

-Rule 505: States that private offerings may not exceed $5

million in a twelve-month period, and firms do not have to

believe that investors have a reasonable ability to evaluate risk

-Rule 504: Exempts non-investment firms that offer no more

that $1 million in securities in a twelve-month period

-Section 4(6): Exempts securities offered only to accredited

investors for amount less than $5 million

• Intrastate Issues: Exempt local investors in local businesses

The Securities Act of 1933: Terminology, Rules,

and Procedures (Continued)

Restricted Securities: Securities acquired under Rule

505, 506, or Section 4(6) that must be registered for

resale, unless investor follows Rule 144 or 144(a)

Violations may result in:

• Administrative Action

• Injunctive Action

• Criminal Prosecution

The Securities Exchange Act of 1934:

Terminology, Rules, and Procedures

• Section 10(b): Prohibits use of “manipulative and

deceptive devices” to bypass SEC rules

• Insider Trading: Trading in which company

employee or executive uses material inside

information to make profit

• Misappropriation Theory: Individual who wrongly

acquires and uses inside information for profit is

liable for insider trading

The Securities Exchange Act of 1934:

Terminology, Rules, and Procedures

(Continued)

• Tipper/Tippee Theory: Individual who receives

material inside information as a result of insider’s

breach of duty is guilty of insider trading

• Statutory Insiders: Certain stockholders, executive

officers, and directors who must file reports detailing

their ownership and trading of the corporation’s

securities

• Short-Swing Profits: Profits made from sale of

company stock within any 6-month period by

statutory insider; per Section 16(b), these profits

must be returned to company

The Securities Exchange Act of 1934:

Terminology, Rules, and Procedures

(Continued)

• Proxy: Document that authorizes an individual to vote

shareholder’s share of stocks at a shareholder’s meeting

• Proxy Solicitation: Process of obtaining authority to vote on

behalf of shareholder

• Violations of Securities Exchange Act of 1934 may result in:

-Criminal penalties

-Civil penalties

-Suits against those involved in insider trading under Insider

Trading and Securities Fraud Enforcement Act of 1988

State Securities Laws

“Blue Sky” Laws: Regulate the offering

and sale of purely intrastate securities