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Basic Concepts of Securities Regulations PART 1

  • Whether you are looking to invest, or are already investing in securities in the public market or stock exchange you may wonder if your investment (and thus the issuer of the securities) is subject to the Security Exchange and Commission’s regulations?
    • If you are in fact dealing with securities, the short answer is most likely yes. The United States Security Exchange and Commission, or SEC, was created under federal law to enforce regulation on public offerings through a full and fair disclosure policy.

  • Not sure if you are dealing with securities in the first place?
    • First off, you need to make sure you are dealing with securities within the meaning of the Security Act of 1933 and the Security Exchange Act of 1934 that is therefore subject to SEC regulations. The definition of securities provided by both federal laws is lengthy, broad, and often confusing to investors. The courts[1] have acknowledged this ‘problem’ and provided us with a test that states that whenever you have an investment of money, through a common enterprise, with expectation of profits, to be attained solely from the efforts of others, you are then dealing with a security.

  • Who is the SEC and what does the enforcement of federal regulation of securities through full and fair disclosure entitles?
    • The SEC was created by the Security Exchange Act of 1934, (during the peak of the Great Depression) with the worthy mission of restoring investors’ confidence in the capital markets by way of providing reliable information and clear rules for honest dealing. The idea here is that by mandating public corporations to disclose material information of their operations and financial performance, the market will then attain a healthy dose of transparency and thus levels the playing field to enable investors to make informed decisions when trading securities offerings.
    • Once the corporation goes public to access the public markets, it must disclose a considerate amount of information to the investors and the public on a regular basis. Generally, there are two types of reporting:
      • Periodic reporting, examples are: Registration statement and De-registration; Quarterly and Annual reports.
      • Reportable events, or real time reporting: There are at least 31 reportable events that generally must be reported within four business day. This reporting compliance are triggered by a number of matters that could potentially have an immediate market impact. In other words, events that are material to the investors that would allow them to make informed decisions.

  • What is then the potential liability for SEC violations?
    • Full and fair disclosure sounds great, but: What if the corporation is not playing fair by withholding important information from the investors (either intentionally or unknowingly)? Is the disclosed information material? Is the company really complying with all the required reporting?
    • Federal law set out civil and criminal actions for violations of securities regulations. Common violations normally involve: fraud; insider trading; and false filing (reporting).  The SEC may take direct civil action against the corporation in the federal courts that could range from substantial monetary penalties, up to disbarment or de-registration of the corporation or its officers. The SEC may also refer criminal actions to the United States Department of Justice for prosecution against corporate officers who must likely will end up spending some jail time. If that was not enough, in many instances the regulations also recognize private actions.

To recap, in exchange for access to the public market, a corporation must comply with strict federal securities laws and regulations. In our next Blog we will talk about the importance of disclosure, its general requirements and examples of bad behavior (ponder about Tesla’s tweeter and the ensuing federal suit by the SEC).


[1] SEC v. W.J. Howey Co., 328 U.S. 293 (1946)


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