Legal Issues in Legal Issues in FinanceFinance

Securities Act of 1933Securities Act of 1933

Securities Exchange Act of 1934Securities Exchange Act of 1934

TheftTheftTheft by deceptionTheft by deception

Theft by misappropriationTheft by misappropriation

FraudFraud

Racketeer Influenced and Corrupt Organizations Racketeer Influenced and Corrupt Organizations Act. (1970)Act. (1970)

Regulation FDRegulation FD

Sarbanes-Oxley Act of 2002Sarbanes-Oxley Act of 2002

Corporate Directors and Officers Corporate Directors and Officers DutiesDuties

(Business Judgment Rule)(Business Judgment Rule)

Securities Act of 1933Securities Act of 1933

Objective: To provide prospective Objective: To provide prospective investors with accurate, complete, and investors with accurate, complete, and detailed information about new offerings of detailed information about new offerings of securities.securities.

Securities Act of 1933Securities Act of 1933

Requires that all new issues of securities Requires that all new issues of securities sold in interstate commerce must be sold in interstate commerce must be registered with the SEC before sale, registered with the SEC before sale, unless exempted. Registration includes unless exempted. Registration includes certified financial statements and certified financial statements and prospectus. Prospectus must also be prospectus. Prospectus must also be given to each new purchaser.given to each new purchaser.

Civil and Criminal Penalties for Civil and Criminal Penalties for ViolationViolation

a.a.              Criminal – fine and/or imprisonment. Fines Criminal – fine and/or imprisonment. Fines up to $10,000 and/or imprisonment up to five up to $10,000 and/or imprisonment up to five years.years.

b.b.              Civil – Monetary damages to investors if Civil – Monetary damages to investors if there is a failure to register, registration there is a failure to register, registration statement or prospectus contained materially statement or prospectus contained materially false, misleading factual information, or omitted false, misleading factual information, or omitted material factual information.material factual information.

Civil and Criminal Penalties for Civil and Criminal Penalties for ViolationViolation

Liability extends to Issuer, under writer, Liability extends to Issuer, under writer, directors/partners, all signers, and experts directors/partners, all signers, and experts (accountants and attorneys) who prepared (accountants and attorneys) who prepared or certified part of registration statement.or certified part of registration statement.

  

Plaintiff need not prove reliance.Plaintiff need not prove reliance.

Securities Exchange Act of 1934Securities Exchange Act of 1934

Regulates ongoing trading of securities after Regulates ongoing trading of securities after issuance.issuance.

1. Prohibits Fraud1. Prohibits Fraud

2. Requires Corporate Reports to 2. Requires Corporate Reports to SECSEC

3. Prohibits short-swing profits3. Prohibits short-swing profits

ReportsReports

a.a. Reporting companies must file:Reporting companies must file:

1.1. Annual report, Form 10-KAnnual report, Form 10-K

2.2. Quarterly report, Form 10-QQuarterly report, Form 10-Q

3.3. Early warning report, 8-KEarly warning report, 8-K

Also Reports to SEC concerningAlso Reports to SEC concerning

1.1. Tender offersTender offers

2.2. Proxy SolicitationProxy Solicitation

Securities Exchange Act of 1934 Securities Exchange Act of 1934 Anti-Fraud (Section 10b and Rule 10b-5)Anti-Fraud (Section 10b and Rule 10b-5)

Condemns any device, scheme, or artifice to Condemns any device, scheme, or artifice to defraud.defraud.

1.1. Trading on inside informationTrading on inside information

2.2. Giving or receiving tips based on inside Giving or receiving tips based on inside information information

3.3. Spreading false rumorsSpreading false rumors

4.falsely creating the appearance of 4.falsely creating the appearance of increased trading volume.increased trading volume.

Insider TradingInsider TradingRule 10b-5Rule 10b-5

person with nonpublic confidential, person with nonpublic confidential, inside information, may not use that inside information, may not use that information when trading with a person information when trading with a person who does not possess that information.who does not possess that information.

InsiderInsider: Officers, directors and anyone : Officers, directors and anyone who is entrusted with corporate who is entrusted with corporate information for a corporate purpose.information for a corporate purpose.

(Consultant, lawyer, auditor) (Consultant, lawyer, auditor)

Insider TradingInsider Trading

Tippees: Recipients of inside Tippees: Recipients of inside information from insiders.information from insiders.

Requires:Requires: Breach of fiduciary dutyBreach of fiduciary duty

Benefit to tipperBenefit to tipper Tippee aware of breachTippee aware of breach

PENALTIESPENALTIES

Criminal Penalties for violation. Fines Criminal Penalties for violation. Fines up to 1$ million and /or up to 1$ million and /or imprisonment up to 10 yearsimprisonment up to 10 years

  Civil. Monetary damages. SEC can sue Civil. Monetary damages. SEC can sue for violation of insider trading regulations for violation of insider trading regulations and seek triple the amount of profits and seek triple the amount of profits gained or loss avoided by the guilty partygained or loss avoided by the guilty party

  

Short Swing ProfitsShort Swing Profits

Directors, officers and persons owning 10% Directors, officers and persons owning 10% or more of stock may not make or more of stock may not make profits or avoid losses by trading within profits or avoid losses by trading within six-month period of time.six-month period of time.

Racketeer Influenced and Racketeer Influenced and Corrupt Organizations Act Corrupt Organizations Act

(1970(1970 Federal Crime to engage in racketeering Federal Crime to engage in racketeering

activity in the acquisition, maintenance activity in the acquisition, maintenance or conduct of the affairs of a business or conduct of the affairs of a business enterprise or to conspire to do any enterprise or to conspire to do any racketeering activities.racketeering activities.

Incorporates by reference 26 federal Incorporates by reference 26 federal crimes and 9 state felonies, including: crimes and 9 state felonies, including: securities fraud, mail fraud and wire securities fraud, mail fraud and wire fraud.fraud.

Requires two or more offenses.Requires two or more offenses.

Racketeer Influenced and Racketeer Influenced and Corrupt Organizations Act Corrupt Organizations Act

(1970(1970 PenaltiesPenalties Criminal - $25,000 per violationCriminal - $25,000 per violation

Up to twenty years Up to twenty years imprisonmentimprisonment

Civil – Government : Divestiture or Civil – Government : Divestiture or dissolution dissolution of businessof business

Private:Private: Treble damages Treble damages Attorneys feesAttorneys fees

Regulation FD (Fair Regulation FD (Fair Disclosure)Disclosure)

Prohibits senior company officials and others who Prohibits senior company officials and others who regularly communicate with investors or analysts regularly communicate with investors or analysts from privately disclosing to a few outsiders material from privately disclosing to a few outsiders material nonpublic information. nonpublic information.

OutsidersOutsiders: In general, securities market : In general, securities market professionals or holders of securities who may trade professionals or holders of securities who may trade on the basis of the informationon the basis of the information

Material InformationMaterial Information: Information is material if : Information is material if there is a substantial likelihood that a reasonable there is a substantial likelihood that a reasonable shareholder would consider it important in making an shareholder would consider it important in making an investment decision.investment decision.

  

Regulation FD (Fair Regulation FD (Fair Disclosure)Disclosure)

Disclosures to news organization, Disclosures to news organization, suppliers, strategic partners and suppliers, strategic partners and customers would not be covered. customers would not be covered.

Private investor cannot sue under Private investor cannot sue under the Regulation. Only SEC can bring the Regulation. Only SEC can bring an action for noncompliance.an action for noncompliance.

Regulation FD (Fair Regulation FD (Fair Disclosure)Disclosure)

If disclosure takes place issuer must make If disclosure takes place issuer must make public disclosure of same information:public disclosure of same information: (a) simultaneously (for intentional disclosures),(a) simultaneously (for intentional disclosures),

(b) promptly (for non-intentional disclosures)(b) promptly (for non-intentional disclosures)

Methods of disclosure:Methods of disclosure: 8-k8-k Any method reasonably designed to provide broad Any method reasonably designed to provide broad

nonexclusionary distribution to the publicnonexclusionary distribution to the public

Sarbanes-Oxley Act of Sarbanes-Oxley Act of 20022002

The Board will have five financially-literate The Board will have five financially-literate members, appointed for five-year terms. members, appointed for five-year terms. Two of the members must be or have been Two of the members must be or have been certified public accountants, and the certified public accountants, and the remaining three must not be and cannot remaining three must not be and cannot have been CPAs. have been CPAs.

Members of the Board are appointed by the Members of the Board are appointed by the Securities and Exchange Commission, Securities and Exchange Commission, "after consultation with" the Chairman of "after consultation with" the Chairman of the Federal Reserve Board and the the Federal Reserve Board and the Secretary of the Treasury.Secretary of the Treasury.

Section 103: Auditing, Quality Section 103: Auditing, Quality Control, And Independence Control, And Independence

Standards And RulesStandards And Rules.. The Board shall: The Board shall:

(1) register public accounting firms; (1) register public accounting firms;

(2) establish, or adopt, by rule, "auditing, quality (2) establish, or adopt, by rule, "auditing, quality control, ethics, independence, and other control, ethics, independence, and other standards relating to the preparation of audit standards relating to the preparation of audit reports for issuers;" reports for issuers;"

(3) conduct inspections of accounting firms; (3) conduct inspections of accounting firms;

(4) conduct investigations and disciplinary (4) conduct investigations and disciplinary proceedings, and impose appropriate sanctionsproceedings, and impose appropriate sanctions

(etc) (etc)

Standard SettingStandard Setting

The Board would be required to The Board would be required to "cooperate on an on-going basis" "cooperate on an on-going basis" with designated professional groups with designated professional groups of accountants and any advisory of accountants and any advisory groups convened in connection with groups convened in connection with standard-setting, standard-setting,

Section 104: Inspections of Registered Section 104: Inspections of Registered Public Accounting FirmsPublic Accounting Firms

Annual quality reviews (inspections) Annual quality reviews (inspections) must be conducted for firms that must be conducted for firms that audit more than 100 issues, all audit more than 100 issues, all others must be conducted every 3 others must be conducted every 3 years. The SEC and/or the Board years. The SEC and/or the Board may ordermay order

a special inspection of any firm at a special inspection of any firm at any time.any time.

Section 201: Services Outside The Section 201: Services Outside The Scope Of Practice Of Auditors; Scope Of Practice Of Auditors;

Prohibited Activities.Prohibited Activities.

It shall be "unlawful" for a registered public It shall be "unlawful" for a registered public accounting firm to provide any non-auditaccounting firm to provide any non-audit

service to an issuer contemporaneously service to an issuer contemporaneously with the audit, including: with the audit, including:

(1)bookkeeping or other services related to (1)bookkeeping or other services related to the accounting records or financial the accounting records or financial statements of the audit client; statements of the audit client;

(2)financial information systems design and (2)financial information systems design and implementation; implementation;

(3) appraisal or valuation services, fairness (3) appraisal or valuation services, fairness opinions, or contribution-in-kind reports; opinions, or contribution-in-kind reports;

Section 201: Services Outside The Section 201: Services Outside The Scope Of Practice Of Auditors; Scope Of Practice Of Auditors;

Prohibited Activities.Prohibited Activities.

(4) actuarial services; (4) actuarial services;

(5) internal audit outsourcing services; (5) internal audit outsourcing services;

(6) management functions or human (6) management functions or human resources; resources;

(7) broker or dealer, investment adviser, (7) broker or dealer, investment adviser, or investment banking services; or investment banking services;

Section 201: Services Outside The Section 201: Services Outside The Scope Of Practice Of Auditors; Scope Of Practice Of Auditors;

Prohibited Activities.Prohibited Activities.

8) legal services and expert services 8) legal services and expert services unrelated to the audit; unrelated to the audit;

(9) any other service that the Board (9) any other service that the Board determines, by regulation, is determines, by regulation, is impermissible.impermissible.

The Board may, on a case-by-case basis, The Board may, on a case-by-case basis, exempt from these prohibitions any exempt from these prohibitions any person, issuer, public accounting firm, person, issuer, public accounting firm, or transaction, subject t review by the or transaction, subject t review by the Commission. Commission.

Section 203: Audit Partner Section 203: Audit Partner Rotation.Rotation.

The lead audit or coordinating partner The lead audit or coordinating partner and theand the

reviewing partner must rotate off of reviewing partner must rotate off of the auditthe audit

every 5 years.every 5 years.

Section 302: Corporate Section 302: Corporate Responsibility For Financial Responsibility For Financial

Reports.Reports.The CEO and CFO of each issuer shall prepare The CEO and CFO of each issuer shall prepare statement to accompany the audit report to certify statement to accompany the audit report to certify

the the

appropriateness of the financial statements and appropriateness of the financial statements and disclosures contained in the periodic report, and disclosures contained in the periodic report, and

that those financial statements and disclosures that those financial statements and disclosures fairlyfairly

present, in all material respects, the operations present, in all material respects, the operations and financial condition of the issuer." and financial condition of the issuer."

Section 401(a): Disclosures In Periodic Section 401(a): Disclosures In Periodic Reports; Disclosures Required.Reports; Disclosures Required.

Each financial report that is required to be prepared Each financial report that is required to be prepared in accordance with GAAP shall in accordance with GAAP shall

reflect all material correcting adjustments . . . that reflect all material correcting adjustments . . . that have been identified by a registered accounting have been identified by a registered accounting firm . . . ."firm . . . ."

"Each annual and quarterly financial report . . . shall "Each annual and quarterly financial report . . . shall disclose all material off-balance sheet transactions" disclose all material off-balance sheet transactions" and "other relationships" with "unconsolidated and "other relationships" with "unconsolidated entities" that may have a material current or future entities" that may have a material current or future effect on the financial condition of the issuer.effect on the financial condition of the issuer.

Section 401(a): Disclosures In Section 401(a): Disclosures In Periodic Reports; Disclosures Periodic Reports; Disclosures

Required.Required.The SEC shall issue rules providing The SEC shall issue rules providing that pro forma financial information that pro forma financial information must be presented so as not to must be presented so as not to "contain an untrue statement" or "contain an untrue statement" or omit to state a material fact omit to state a material fact necessary in order to make the pro necessary in order to make the pro forma financial information not forma financial information not misleading.misleading.

Title VIII: Corporate and Title VIII: Corporate and Criminal Fraud Criminal Fraud

Accountability Act of 2002.Accountability Act of 2002. Felony to "knowingly" destroy or createFelony to "knowingly" destroy or create

documents to "impede, obstruct or documents to "impede, obstruct or influence"influence"

any existing or contemplated federal any existing or contemplated federal investigation.investigation.

Auditors are required to maintain "all Auditors are required to maintain "all auditaudit

or review work papers" for five years.or review work papers" for five years.

statute of limitations on securities statute of limitations on securities fraud claims is extended to the fraud claims is extended to the earlier of five yearsearlier of five years

A new crime for securities fraud that A new crime for securities fraud that has penalties of fines and up to 10 has penalties of fines and up to 10 year imprisonment.year imprisonment.

Title IX: White Collar Crime Title IX: White Collar Crime Penalty EnhancementsPenalty Enhancements

Maximum penalty for mail and wire Maximum penalty for mail and wire fraud increased from 5 to 10 years.fraud increased from 5 to 10 years.

SEC may prohibit anyone convicted of SEC may prohibit anyone convicted of securities fraud from being an officer securities fraud from being an officer or director ofor director of

any publicly traded company.any publicly traded company. Maximum penalties for willful and Maximum penalties for willful and

knowing violations of this section are a knowing violations of this section are a fine of not more than $5,000,000 fine of not more than $5,000,000 and/or imprisonment of up to 20 years.and/or imprisonment of up to 20 years.

Director’s DutiesDirector’s Duties

Directors and Officers are considered to be Directors and Officers are considered to be in a fiduciary relationship with the in a fiduciary relationship with the Corporation which relationship imposes Corporation which relationship imposes certain duties.certain duties.

1.1. ObedienceObedience

2.2. Due careDue care

3.3. LoyaltyLoyalty

BUSINESS JUDGMENT BUSINESS JUDGMENT RULERULE

Directors and Officers are not liable for Directors and Officers are not liable for decisions which adversely affect the decisions which adversely affect the Corporation so long as they:Corporation so long as they:

1.1. Engaged in a reasonable investigation prior Engaged in a reasonable investigation prior to making the decisionto making the decision

2.2.    Had no conflicts of interestHad no conflicts of interest

3.3.    Had a rational basis for believing the Had a rational basis for believing the decision was in the best interests of the decision was in the best interests of the company.company.