Securities Exchange Act 1934 Essays

Securities Exchange Act 1934 Essays Securities Exchange Act 1934 Essay Securities Exchange Act 1934 Essay The Securities Exchange Act of 1934 JFM GM520 Legal Political Ethical Dimensions of Business April, 12 2010 The Securities Exchange Act of 1934 was passed by congress to strengthen the government’s control of the financial markets. It was preceded by the Securities Exchange Act of 1933 which was enacted during the Great Depression in hopes that the stock market crash of 1929 would not be repeated. The basic difference between the two acts was that the 1933 Act was to govern the original sales of securities by requiring that the issuers, the companies offering the securities, offer up sufficient information about themselves and the securities so that the potential buyers could make informed decisions. The 1934 Act was aimed at the secondary market where buyers don’t buy from the issuer but instead from other investors (Security, 2010). The 1934 Act also required more disclosures from issuers and was enacted to prevent unfair practices at the various exchanges as well as giving the authority of the exchange to the Securities and Exchange Commission which was one of the many administrative agencies set up by the New Deal ideology of Franklin D Roosevelt (Securities, 2003). A major part of 1934 Act is that it required any issuer with over $10 million in assets and 500 or more shareholders to register its stock with the SEC. With this registration came additional required filings such as the 10-Q form, a quarterly financial report, 10-K form, a yearly financial report, as well as an 8-K form used for reporting unusual events, an example of which would be a merger or takeover (Jennings 742). The 1934 Act seems to be an ever changing document as it has been amended by Congress many times through the years. It is due to the need to remedy any new issues that arise whether through technology or new security devices. This paper will focus on two specific sections of the 1934 Act. The first area that I will focus on is Section 10(b) with Rule 10b-5 and the second area that I will focus on is Section 16(b). These sections deal with the antifraud, insider trading and short swing profit issues associated with the trading of securities. Section 10(b) of 1934 Act acts as the insider trader and anti-fraud provision of the act. It was set up to dissuade fraud in the securities market. As example of which would be where sellers might withhold information that should be public and by doing so having an effect on the price. The application of this section is broad as it applies to all the different types of securities for trade. Examples are public, private, over-the-counter and exempt. The only prerequisite for this provision to be in effect is that the transaction must have an interstate commerce connection (Jennings 742). Since in today’s business almost all transactions take place over the internet or via telephone, it would not be very difficult for the Commission to use this provision to bring action against a company or person in violation. One reason for section 10(b) to be included in the 1934 Act was the damage to the market in the late 1920’s and early 1930’s caused by pools. Pools were devices used by certain groups of investors to run up the prices of certain stocks by collectively engaging in well timed transactions. The group would then dump their stocks just before the stock price dropped. Section 10(b) contains provisions to prohibitive this type of deceptive behavior (Securities – Securities.. , 2010). This type of behavior led to the writing of Rule 10b-5: Employment of Manipulative and Deceptive Practices. It basically states that it is against the law to use any scheme to defraud, make any untrue or misleading statements or engage in any course of business that defrauds by the means of interstate commerce (Jones, 2009). Corporations can be in violation of section 10(b) when they fail to disseminate material information about the company, its performance or its future. This applies for both positive and negative information. The SEC promulgated a new rule in 2000 known as Regulation FD that states that this information must be made available at the same time to everyone. Material information has been determined to be any type of information that would affect the buying or selling decision of a security (Jennings 743). A pending takeover or a possible lawsuit is an example of material information. By not abiding to this provision, companies can have charges brought up by the SEC. A person can be in violation of section 10(b) in multiple ways. If one of the sides of a security sale knows non-public information about the security and the sale proceeds then that person has violated section 10(b). If an owner of shares misleads the buyer by giving false statements then that seller is in violation also. Another example of a violation of section 10(b) is when churning occurs. This is when securities are bought and sold repeatedly to give the appearance of activity (Jennings 743). This is similar to what the â€Å"pools† did during the Great Depression. There are often many different types of people who are covered by section 10(b) of the 1934 Act. Two of interest are insiders and tippees. The term Insider refers to corporate executives who often have access to non-public company information. The term Tippee generally refers to the relatives, friends or acquaintances of insiders from whom they receive this insider information. If the insider just passed on the information to a tippee and that person acted on this information and made an unfair transaction then the SEC and courts will find the insider just as culpable as the tippee and will prosecute both parties under section 10(b) (Securities – Securities†¦, 2010). I find this to be quite an interesting fact. The insiders need to be very careful what they discuss outside of the office. Violations of section 10(b) can happen due to timing. The textbook discusses how some insiders and tippees involved with a company named Texas Gulf Sulphur, back in 1968, were in violation because they bought stocks too quickly after a press conference announcing the discovery of minerals. They made purchases by telephone faster than the information was disseminated to the public. The SEC found them in violation due to timing only, but that was enough to be considered guilty (Jennings 746). It’s important to keep in mind that this violation would be much less likely to happen today because of the technology surrounding the security exchange. Funny enough, the telephone would probably be considered slower than the internet based transactions that are very common today. A trend that has recently emerged as a violation of section 10(b) is the use of the internet to engage in pumping and dumping. Although not a new concept, the internet has been used to increase the effect because of its ability to disperse particular company information very quickly in order to affect stock prices. Persons initiating this deceptive behavior can sell their stocks for profit once they see that the changes to price have occurred. This type of behavior is considered fraud since it is a manipulation of company information for profit. An example of this would be if a group of people collaborated to spread false information on a financial blog or website in the hopes that the price would fluctuate enough to make large profits in a short amount of time. They use the anonymity of the web to attempt this. (Security, 2010) Convictions of violations of section 10(b) can not be based on negligence. It must be based on a person’s intent to defraud. This intent to defraud is known in investment circles as scienter. Penalties for 10(b) violations have been getting stiffer in recent times in attempts to curb the behavior. Violations can carry up to 25 years in prison in addition to monetary penalties depending on the severity and extent of the crime. Corporate financial officers can have additional penalties due to the ease of access to company insider information. If they are found to be in violation and bonuses were found to be paid out as a result of false information, then the bonus money must be returned to the company. If this person attempts to file bankruptcy to avoid paying the money back they will discover that it’s a lifetime obligation in the eyes of the government (Jennings 749). So anxious is the Securities Exchange Commission to prosecute these violations, that it has amended the 1934 Act through passage of additional laws such as the Sarbanes Oxley Act and the 1988 Act as well as working with the American Bar Association in order the strengthen their control. Whistleblowers who report violations can be rewarded with up to 10 percent of the recovered monies in a violation. These whistleblowers are now protected from retaliation and /or termination when they are aiding in a prosecution case as well. Lawyers are now not bound by attorney-client privilege when securities fraud is involved because the ABA amended their code of ethics in 2003 (Jennings 749). Section 16 of the 1934 Act is the liability section that deals with the stock trading by corporate insiders. An insider in this case is defined as an officer, director or a ten percent or more shareholder. Section 16(b) requires these insiders to report any sales and purchases of company stock. These transactions are tracked and during a six month period of time the SEC determines the profits taken. These profits are known as short-swing profits. The amount of the profit is calculated by matching the highest sale with the lowest purchase and the amount profited must be returned to the company. The rationale behind this is that the SEC has to assume that the person used a certain amount of insider information when making the decision to buy or sell stock (Jennings 750). This is in essence just keeping a tab on their actions. This also applies to stock options used as compensation to many executives at large corporations. These options have been troublesome to manage over the last few years and have caused the demise of some companies so many have changed to offering special classes of stock instead (Jennings 750). The Securities Exchange Act of 1934 is a very broad law that I would imagine is very difficult to learn completely. I have learned a lot from writing this paper and I can truly appreciate the reason for its enactment. There so many ways for manipulations of the market in today’s world. The technology in place to keep track of the massive amount of transactions must be incredibly complex. I am sure that there will be future amendments created to enforce new more creative ways to manipulate the system for illegal profits. Jennings, Marianne Moody. The Legal, Ethical and Global Environment of Business. Ohio: South-Western, 2009. Jones, Ronald. â€Å"Securities Exchange Act of 1934. † Securities Lawyer’s Deskbook. 1998-2009. The University of Cincinnati College of Law. April 4, 2010. law. uc. edu/CCL/34Act/index. tml Securities and Exchange Commission. The American Economy: A Historical Encyclopedia. Santa Barbara: ABC-CLIO, 2003. Credo Reference. Web. April 5 2010. Securities – Securities Exchange Act of 1934. Web. April 5,  2010   http://law. jrank. org/pages/10097/Securities-Securities-Exchange-Act-1934. html. Security. Encyclopedia Britannica. Encyclopedia Britannica Online. Encyclopedia Britannica, 2010. Web. April 4,  2010   http ://search. eb. com/eb/article-27311. [ 1 ]. (footnote continued)