Insider Trading Laws Go Back To 1934
Now we’re going to talk about trading or selling stocks. State statutes that restrict the selling of stocks are called Blue Sky laws. They usually require stock brokers to be licensed, prohibit fraudulent practices and require a registration of certain securities (I will use the words stocks, shares, and securities interchangeably, unless otherwise indicated). In addition to state regulations, there are federal laws as well. The federal security laws cover the trading of stocks, bonds and even investment contracts. Some key points:
The Securities Act of 1933 was passed to regulate the initial offering of stock by a company. Before a security can be sold publicly in interstate commerce, a registration statement must be filed with the Securities Exchange Commission (SEC). This statement discloses certain financial information about the securities. The seller must also provide a prospectus to each potential investor. This is to ensure that there is full disclosure of information about the company to the buyer so they can make an informed decision to invest.
Small businesses may avoid some of the requirements by filing under a Regulation A offering. This allows a business to raise up to $5 million in a year by using a simplified process. There are other exemptions from registration. A Rule 505 exemption allows offerings of less than $5 million to less than 35 non-accredited purchasers; however, these must be non-solicited and non-advertised sales. A Rule 506 exemption allows companies to raise an unlimited amount of money by private placement of shares. This exemption generally involves investment houses that advise their private investors where to invest their funds. A Rule 504 exemption allows companies to raise $1 million without any registration or regulation. Aside from the allowed exemptions, serious penalties lie for those who violate the SEC rules. Violators may be charged both civilly and criminally.
The Securities and Exchange Act of 1934 is like the follow-up to the Securities Act of 1933. While the first Act covered the initial offering of stock, the 1934 Act covers the resale of stocks (thus the word “Exchange”). The Securities Exchange Act of 1934 includes the rules that govern the major trading houses, such as NASDAQ and the New York Stock Exchange. It requires companies that are listed on the major exchanges with over $3 million in assets to file numerous financial statements.
Recently, this issue has been in the news as many companies have used creative accounting to make these financial statements appear to increase the company’s income or assets, while decreasing the debt or liabilities. Companies who use non-standard accounting practices may be held liable, both civilly and criminally, as can their officers who participated in the fraudulent activity.
The Securities Exchange Act of 1934 also restricts certain trading practices. The most well-known, and most highly publicized of these rules is the rule against insider trading. Companies must take steps to ensure that information that may affect the value of their stock is kept confidential until it is released to the public as a whole. Those who obtain the information in advance cannot use their knowledge for personal gain. Violators may be forced to pay up to three times the profits gained or lost in an insider trade. An insider is not just an employee or officer of the corporation. It includes anyone involved with the company and anyone who learns confidential information from someone who is involved with the company, who makes security transaction on that information.
A few years ago, the secretary of a company leaked information to her husband, who in turn gave half a dozen people the stock tip. All were arrested on insider trading and had to return their income plus pay heavy fines. To diminish insider trading, owners of companies making an initial public offering are restricted from selling shares for a period of time. In addition, shareholders with at least 10% share of the company must register their shares with the SEC, as must corporate officers and directors.
Al Kelley is a Florida business law attorney located in Key West and previously taught business law, personnel law and labor law at St. Leo University. He is also the author of “Basics of . . . Business Law”. This article is being offered as a public service and is not intended to provide specific legal advice. If you have any questions about legal issues, you should confer with a licensed Florida attorney.
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